Report No. 36496-NG Nigeria A Fiscal Agenda for Change Public Expenditure Management and Financial Accountability Review (PEMFAR) (In Two Volumes) Volume I: Main Report May 25, 2007 Poverty Reduction and Economic Management 3 Country Department 12 Africa Region Document of the World Bank FMF Federal Ministryo f Finance FPO Federal Payment Offices FRB Fiscal Responsibility Bill FRC Fiscal Responsibility Council GDP Gross Domestic Product GFS GovernmentFinancial Statistics GIFMIS GovernmentIntegratedFinancial Management InformationSystem HIPC HighlyIndebtedPoor Countries HIV/AIDS HumanImmuneVirudAcquired ImmuneDeficiencySyndrome HR HumanResources IBRD International Bank for ReconstructionandDevelopment ICPC Independent Corrupt Practices andRelated Offences Commission ICT Information& Communication Technology IDA International Development Association ID IdentityCard IDF Institutional Development Fund IFAC International Federation o f Accountants IFIs International Finance Institutions IFMIS IntegratedFinancialManagement Information System IGR Independent GovernmentRevenues IMF International Monetary Fund IPP Independent Power Producers IPSASs International Public Sector Accounting Standards ISPOS Irrevocable Standing Payment Orders Jv Joint Venture LGAs Local Government Authorities LNG LiquefiedNaturalGas M&E Monitoring andEvaluation MDAs Ministries, Department andAgencies MDG MillenniumDevelopment Goals MTEF Medium Term Expenditure Framework MTFF MediumTermFiscal Framework MTSS MediumTermSector Strategies MYT Multi-YearTariffs NAPIMS NationalPetroleumInvestments andManagement Services NASS NationalAssembly NBUs New Business Units NEEDS NationalEconomic Empowerment Development Strategy NEPA NationalElectricity Power Authority NERC NationalElectricity Regulatory Commission NGO Non-Governmental Organisation NPA NigerianPort Authority NIP NationalProgramfor Immunization NIPP NationalIntegrated Power Project NRC NigerianRailway Authority NLNG Nigeria LiquefiedNaturalGas NNPC NigerianNational PetroleumCorporation NPC NationalPlanningCommission OAGF Office o f Accountant General o f Federation OECD Organizationfor Economic Cooperation andDevelopment OHSF Office o f Heado f Service o f Federation OPEN Oversight o f Public Expenditure under NEEDS OSAP-MDG Office o f the Special Adviser to the President on the Millennium Goals PAC Public Accounts Committee ii PB Procurement Bill PEFA Public Expenditure andFinancial Accountability PEMFAR Public Expenditure Management and Financial Accountability PER Public Expenditure Review PFM Public FinancialManagement PHCN Power Holding Company o fNigeria PIP Public Investment Program PPA Power PurchaseAgreement PPR Public Procurement Regulator PPT PetroleumProfit Tax PRSP Poverty Reduction Strategy Paper PSI Policy Support Instrument REA RuralElectrification Agency RMAFC Revenue Mobilization, Allocation andFiscal Commission ROT Rehabilitate, Operate, Transfer S A I Supreme Auditing Institution SPEB State Primary Education Board SSAP-MDGs Senior Special Assistant to the President for the MDGs SWGs Sector Working Groups TB Tuberculosis TIAD Treasury InternalAudit Department UBE Universal Basic Education UBEC Universal Basic Education Commission UNCITRAL UnitedNations Commission on InternationalTrade Law USAID UnitedStates Agency for InternationalDevelopment USD United States Dollar VAT Value Added Tax VPF Virtual Poverty Fund Vice President = Gobind T. Nankani Country Director = HafezGhanem Sector Director = SudhirShetty Sector Managers = Yvonne M.Tsikata V. S. Krishnakumar EdwardOlowo-Okere Task Team Leader = Lev M.Freinkman ... 111 Table of Content LIST OF TABLES ................................................................................................................................ V LIST OF BOXES ................................................................................................................................. VI LIST OF FIGURES ............................................................................................................................ VI ACKNOWLEDGMENTS ................................................................................................................. VI1 INTRODUCTION .................................................................................................................................. 1 1. MAIN TRENDS INNIGERIA PUBLIC FINANCE ................................................................ .3 A. RECENTMACROECONOMICDEVELOPMENTS........................................................ B. FISCALPERFORMANCE OFTHE CONSOLIDATED GOVERNMENT ............................. c. FISCALOPERATIONS OF THE FEDERAL GOVERNMENT ............................................................... 16 D. FEDERALEXPENDITURESTRUCTUREAND QUALITY OFEXPENDITURE....................................... 28 E. NON-BUDGET COMPONENTSOF THE FISCALSYSTEM ................................................................ 39 F. CONCLUSIONSANDRECOMMENDATIONS.................................................................................. 44 2. FISCALMANAGEMENT: ASSESSMENT OF THE CURRENT SITUATIONAND STRATEGIC DIRECTIONS FOR REFORM ......................................................................... 46 A. PERFORMANCEINLIGHTOFTHERECOMMENDATIONSOFPREVIOUSWORLD BANKREPORTS.46 B. MAN PFMTRENDS: SUMMARY OFPEFAASSESSMENT .......................................................... c. 50 ...................................................................................... 51 Modernization of Financial Management................................................................................ STRATEGIC DIRECTIONS FOR REF0RM 69 Improving Quality of Budget Spending........... ............................................................... 78 Strengthening the Capacity of the Budget Oftice ...................... 84 D. RECOMMENDATIONSFORPRIORITYREFORMMEASURES .. 88 3. AN ASSESSMENT OFTHE PUBLIC FINANCIAL MANAGEMENT PERFORMANCE OF NIGERIANSTATES ........................................................................................................... 93 B. CONTEXTOFPFMREFORMS......................... .............. C. DETAILED PEFAPFMASSESSMENT REPORT............................... D. CONCLUSIONSANDRECOMMENDATIONS ...................................... 4. REFORM PROGRESSINTHE AREA OF PUBLIC PROCUREMENT .......................... 133 A. RECOMMENDATIONSOFTHENIGERIA CPAR(2000).... ............ B. SUMMARY OFPROGRESS........................... ......................................................... C. RECOMMENDATIONS ........................................................................................ 5. PUBLIC FINANCINGOF A POWERSECTOR INTRANSFORMATION ..................... 143 A. THE CHALLENGE ..,. , ................ ...................... 143 Sector Performance Government Spending i Main Factors that Pose System-wide P F M Issues Sectoral Issues ............. .................................... B. CONCLUSIONSAND RECOMMENDATIONS ............................................................................... 153 ANNEX 1: PEFA PERFORMANCE FRAMEWORK-ANALYSIS OF INDIVIDUAL INDICATORS ........................................................................................................................... 155 ANNEX 2: LEGISLATIVE FRAMEWORKFOR PUBLIC FINANCIAL MANAGEMENT 244 REFERENCES ................................................................................................................................... 255 iv Listof Tables Table 1.2: Main fiscal trends for the consolidatedgovernment. 1999.2005. Nbillion..................48 Table 1.1: Key Macro Economic Indicators.2001-08..................................................................... Table 1.3:Changes inthe actual distribution of FederationAccount revenues across three Table 1.4: Real growth inFederationAccount allocationsto various Governmenttiers (%) ....... 11 Governmentlevels (%)..................................................................................................... 10 Table 1.5: Growth inreal budget expenditures. 1999.2005. in 1999 constant prices .................... 13 Table 1.6: Budgetperformancemeasuredas % of the non-oil GDP. 1999-2005.......................... 14 Table 1.7:Mainoperations with the excess crude account. 2004.06. US$billion ....................... 16 Table 1.8:Budgetedandnon-budgetedFederalGovernmentrevenues. 1999-2008. actualand projections.Nbillion........................................................................................................ 19 Table 1.9:Budgetedandnon-budgetedFederalgovernmentexpenditures. 1999-2008. actual andprojections.Nbillion ................................................................................................. 19 Table 1.10:Dynamicsof Federalgovernment non-interestexpenditure aggregates. 2001-05 (% ofGDP)....................................................................................................................... 22 Table 1.11: Comparativedynamics ofmaincomponents within the overall budget frnancing of MDAs. 2001=1002'....................................................................................................... 23 Table 1.12: Deviations inFederalbudgetexecution. measuredas the differencebetweenthe approvedand executedbudgets. in% 'I.3f........................................................................ 24 Table 1.13: DeviationsbetweenFederalbudgetsproposedby executive and approved by legislature.......................................................................................................................... 25 Table 1.14: Analysis of deviations inbudget expenditurecomposition. 2001-04 ......................... 26 Table 1.15: Federalbudget spending bymainMDAs. actual. 2001-04 ........................................ 29 Table 1.16: Expenditurestructure ofthe 2004-06 Federalbudgets. % of the total MDA spendingby main functional groups................................................................................. 30 Table 1.17: Federalgovernmentexplicit budgetsupport to key commercialparastatals - subsidies and investment grants. 2001. Naira million ...................................................... 36 Table 1.18:Federalgovernmentbudgetsupport for selectedparastatals. Nmillion..................... 38 Table 1.20: Governmentfinancing of investment inthe oil sector ("Cash calls..). 2002-05 .........40 Table 1.19: Operationsof the Federalextra-budgetaryfunds. 2001-05. Nbillion ........................ 42 Table 2.1: Progress inReformingFederalPFM SystemReviewed against Some Core 47 Table 2.2: Evolutionof federalgovernmentexpenditureplans. 2004-06 .................................... RecommendationsDevelopedinthe PER(2001) and CFAA (2000) .............................. 59 Table 3.1: AggregateExpenditureOutturns. Average for 3 States. ........................................... 102 Table 3.2: Composition of ConsolidateExpenditureOutturnsComparedto Consolidate 104 Table 3.3 : ConsolidatedAggregateRevenueOutturnfor Sample States................................... OriginalBudget for Bauchi and EnuguStates. 2002-04. Nbillion................................ 106 Table 3.4: ConsolidatedInternal Revenue Outturnfor Sample States. ....................................... 106 Table 3.5: Federation(Statutory) RevenueOutturnfor Kaduna State. ...................................... 107 Table 3.6: Comprehensivenessand Transparency: Summaryof Assessment............................. 110 Table 5.1 GenerationCapacity. Populationand GDP (2003) ..................................................... Table 3.7: State ofAudited FinalAccounts. 2001-05 ................................................................ 126 144 Table 5.2: A snapshot ofrecent developments inthe power sector............................................ 145 Table 5.3: Power sector performance.2001-05.......................................................................... 148 Table 5.5: NEPA's Borrowing. 2000-04. year end stocks. Nmillion......................................... Table 5.4: FederalGovernmentExpenditureon the Power Sector. 1999-04. Nmillion.............146 149 Table 5.6: NEPA Balance Sheet. 2000-04. end year stock. Nmillion ........................................ 153 V ListofBoxes Box 1.1: Significant budgetexpendituresinthe past did not always bring improvementin servicedelivery................................................................................................................. 32 Box 1.2: Efficiencyand accountabilityproblemswith inNigeria's National Immunization 33 Box 1.3: Lengthy completion times inroadconstruction.............................................................. Program............................................................................................................................ 35 Box 1.4: EITIinNigeria................................................................................................................ 41 Box 2.1: Summaryof Conclusions from the Preparationof the EconomicReform and 50 Box 2.2: Public FinancialManagementReformsinSouthAfrica andUganda............................ GovernanceProject........................................................................................................... Box 3.1: Credibility of the Budget: Summary of Assessment.................................................... 62 102 Box 3.2: Policy BasedBudgeting: SummaryofAssessment...................................................... 113 Box 3.3: Predictability and Control inBudget Execution: SummaryofAssessment.................. 116 Box 3.4: Accounting, Recordingand Reporting: Summary ofAssessment............................... 124 Box 3.5: External Scrutiny and Audit: Summary of Assessment............................................... 125 Box 3.6: InternationalDevelopmentPartners: SelectedPrograms to Build PFM Capacityat 132 Box 5.1: NEEDSTargets for 2007 ............................................................................................. the State Level ................................................................................................................ 146 ListofFigures Figure 1.1: Trends inmain FiscalAggregates. ConsolidatedGovernment. RealGrowth 7 Figure 1.2: Taxationburdeninoil andnon-oil sectors, 1999-2005................................................ relative to 1999................................................................................................................... 9 Figure 1.3: Relative shares ofmaintypes oftaxationinthe consolidated government Figure 1.4: Governmentexpenditureand oilprice, 1999=100...................................................... revenues, 1999-2005........................................................................................................... 9 Figure 1.5: Consolidatedstate andlocal governmentexpenditures, 1999-2005,% of GDP ......... 13 15 Figure 1.6: Federalbudgetsurplus/deficit accordingto governmentand consolidated definition, % of GDP........................................................................................................ 20 Figure 1.7: Annual disbursements of loans by the IFIsto the Federalgovernment, 2001-05, USDmillion...................................................................................................................... 21 Figure 1.8: Realgrowth inFederalexpenditureaggregates, 2001-05 (2001=100) ....................... Figure 3.1:Annualbudgetexecutionat the state level, 2001-04, % ........................................... 22 104 Figure4.1: The E-GovernmentProcurementFramework.......................................................... 138 v i ACKNOWLEDGMENTS The study was prepared by the World Bank team led by Lev Freinkman. The primary authors o f the study are Lev Freinkman (Chapter l), Lev Freinkman, Michael Stevens, Allan Gustafsson and Gert van der Linde (Chapter 2), Chinedum Nwoko (Chapter 3), Bay0 Awosemusi, Mette Lassens, and Soren Staugaard Nielsen (Chapter 4), and Mohua Mukherjee (Chapter 5). The PEFA Assessment report reflected in Annex 1was prepared by Mike Stevens, Allan Gustafsson, Lev Freinkman, Gert van der Linde, Bay0 Awosemusi and Ilaria Chessa. Adebola Babalola provided research assistance. The team gratefully acknowledges the contributions o f the Government Interagency Working Group on PEMFAR set up by the Federal Minister o f Finance for its guidance, cooperation, and support in all stages o f preparing the report. This high level group was ledby Alhaji IbrahimH.Dankwambo, the Accountant General o fthe Federation. H e was assisted by Prof. Sylvester Monye, Director o f the Economic Relations Department inthe Federal Ministry o f Finance. Steve Aborishade and Gbenga Fetuga anchored the group and greatly facilitated data gathering efforts both from federal agencies and state governments. The intensive efforts o f the Ministry o f Finance, Budget Monitoring and Price Intelligent Unit, and other agencies in helping to prepare this report are gratefully acknowledged. The team i s also grateful to Dr. Bright Okogu, Adviser to the Minister o f Finance, Ms. M. 0. Olowu, Director Budget Monitoring and Evaluation (FMF), Ms. Abimbola Ogunsetan, Senior Special Assistance to President on Budget Matters, and Mr. Tajudeen Oyawoye, Special Assistant to President (BMPIU). The participation o f four state governments from Bauchi, Cross River, Enugu, and Kaduna states has been greatly appreciated. In addition, the team benefited greatly from discussions with the representatives o f the donor community, local think tanks, and independent experts. The background papers on particular aspects o f federal government's public financial management (PFM) performance and on fiscal developments in a sample of Nigerian states were produced by a team o fNigerian consultants that included: Bauchi - Prof. Israel 0.Taiwo, Prof Halidu Abubakar, Dr.Patricia A h , and Mr.Bashiru Jumaire Cross River - Prof. Festus Egwaikhide, Dr.Ayo Odushola, Dr. Godwin Akpan, and Mr. Moses Odu Enugu - Prof. Ukwu I.Ukwu, Mr. Patrick Okonji, Mr. Chinedu Eze, and Mr.Andrew Oliko Kaduna - Dr. Hyacinth E. Ichoku, Dr. Adamu Mohammed, Ms. Caroline Nege, and Mr. Adamu Bello Analysis o f fiscal developments at the federal level was facilitated by the background papers prepared by Prof. Israel 0. Taiwo, Prof. Festus Egwaikhide, Prof. Ginigeme F. Mbanefo, and Prof. Akpan Ekpo. Additional background papers were prepared by AFTFM Unit o f the World Bank (preliminary update o f CFAA ZOOO), Louis Edozien and Wuraola Abiola (power sector), Ramboll Management, and Subramaniam Janakiram (procurement). vii The team led by Soji Apampa helped to prepare and analyze the budget monitoring survey which is reflected Annex 3. The survey was undertakmg in cooperation with the Budget Monitoring Department (FMF), Stolen Wealth Coalition, and Center for Democracy andDevelopment. Important contributions to the report was also provided by Victoria Kwakwa (World Bank). The team is also grateful for the valuable comments and suggestions received from Martin Alsop (DMO), Ulrich Bartsch (IMF), Graham Daniel (Consultant), William Monks (Consultant), Matthew Morris (DFID), Adenike Sherifat Oyeyiola (World Bank), PeterA. Osei (World Bank),andMauricio Villafuerte (IMF). Emily Evershed assisted with editing the report, while Maude Jean-Baptiste, Gloria Kwembe, and Helen Okeke provided excellent administrative and production support duringthe entire preparationprocess for the study. Robert Taliercio, David Shand, Abebe Adugna, Rogati Kayani, Irina Luca, and Jean- JacquesVerdeaux were the peer reviewersfor the study. Yvonne M. Tsikata, Krishnakumar V.S, and Edward Olowo-Okere were the Sector Managers supervising the preparation of the study. Sudhir Shettywas the Sector Director, andHafez M.H.Ghanemwas the CountryDirector for Nigeria. The preparation of the study benefited from generous co-funding provided by the governments o f UK and Switzerland. The Boell Foundation Nigeria co-financed the undertakingofthe budget monitoringsurvey. The mainPEMFARmission worked inNigeriainJanuary2006. viii INTRODUCTION Weakness o f the public finance management (PFM) system inNigeria has been one o f the fundamental factors responsible for the country's poor growth performance o f the last decades. These weaknesses have been well documented in a number o f reports, including those produced by the World Bank. Some o f the most important problematic areas include: Lack o f a sustainable fiscal framework to manage the volatility o f oil revenues. T h i s encouraged a "boom and bust" fiscal policy, which became a source of fundamental macroeconomic problems. Inadequate budget formulation, expenditure prioritization, and expenditure control that resulted in inadequate financing o f core public services 0 Absence o f accountability mechanisms, which fueled large scale corruption and misuse o f public funds within the budget execution process Insum, the poor management ofpublic resources preventedNigeria from usingits natural resource wealth as basis for sustainable economic growth. Over the last three years, the Federal Government o f Nigeria (FGN) has begun to undertake significant economic and financial management reforms geared to reducing poverty as outlined inthe country's National Economic, Empowerment and Development Strategy (NEEDS). Among its core implementation strategies, the NEEDS emphasizes changing the way the Government works through improved efficiency, transparency and strengthened anti-corruption activities. The key elements o f the strategy include improving the budgetary planning process, maintaining an oil-price based fiscal rule, adopting a Medium Term Expenditure Framework (MTEF), making public procurement transparent, efficient, open and competitive, strengthening the budget office, and ensuring better collaboration between the executive and the legislature on the budget. The government efforts to ensure a radical departure from its traditional fiscal policies and practices yielded some initial results: 0 Nigeria achieved important successes in managmg the latest oil price windfall, by introducing an oil price-based fiscal rule, restraining its public spending, and accumulating fiscal reserves. This result i s especially significant, given the considerable autonomy o f states and local governments over their fiscal decisions. Growth performance o f the economy has improved. Growth o f the non-oil sector in2004-05 was above 7%. Private sector confidence inthe economyappears to be strengthening, evidenced amongst others by continued FDIflows. The FGN has made major strides towards improved fiscal transparency and in its fight against corruption. The EITIinitiative helps to bringmore transparency into management o f oil resources. Major savings were obtained from reforms in the federal procurement system. Some important practical steps were made to improve budget accounting, monitoring and reporting. 0 The Government i s also paying increasing attention to restructuring its expenditure policies toward better financing o fMDG-related activities. 1 The PEMFAR i s a consolidated diagnostic tool designed to enhance Bank, development partners' and member countries' knowledge o f PFM arrangements and reform challenges. The PEMFAR intends to cover the tasks that have been traditionally undertaken by separate Bank reports such as the public expenditure review (PER), country financial accountability assessment (CFAA), and country procurement assessment Review (CPAR). The core objective o f the Nigeria PEMFAR i s to advise the Government (federal and participating states) on how (i)to better focus and sequence its PFM, including the procurement reform agenda within a broader economic reform framework, and (ii) identify directions and instruments o f restructuringits expenditure patterns on both macro and sectoral levels. The PEMFAR also aims to inform international development partners on how they could provide more efficient support for the PFM reforms in Nigeria by identifying the main bottlenecks within the existing reformprocess. The PEMFAR's other objective was to review the post-2001 expenditure patterns and recent trends in PFM practices and assess the accumulated effects o f the ongoing government reform efforts. The assessment in the report i s done against two types o f benchmarks. First, the current fiscal performance is measured against recommendations made by the earlier World Bank PER (2001), CPAR (2001) and CFAA (2000). Second, assessment i s undertaken against the benchmarks o f best international practice suggested within the PEFA performance management framework (PEFA, 2005). This provides an important comparative cross-country perspective on Nigerian assessment; it also helps identify some binding constraints within the existing PFM system and thus better prioritize the recommendations. The study was prepared by the World Bank team in close cooperation with the specially established Government Working Group chaired by Alhaji Ibrahim H. Dankwambo, Accountant General o f the Federation, and in consultation with development partners and Nigeria's civil society organizations. The analysis was based on an in-depth review o f (i) Nigerian legislation, regulations, government programs, and business processes in the PFMarea; (ii) data on approved and executed federal and state government budgets; (iii) FGNreports and statistics, including those produced with the help o f the Working Group's members; (iv) fiscal data collected from specially commissioned surveys; (v) detailed studies o f fiscal performance and P F M arrangements in four states; and (vi) findings and data gathered under the ongoing Bank and DFIDprojects. The main P F M mission took place in January 2006. Most data collection was undertaken between January and April 2006. It is hopedthat the Government will findthe work o f the PEMFARuseful inits efforts to define a second round o f reforms in this area that will deepen the ongoing initiatives and deliver improvements inpublic service delivery. 2 1. MAINTRENDSINNIGERIA PUBLIC FINANCE 1.1 T h i s chapter reviews the broad public expenditure trends inNigeria for the period since 1999, i.e. since the begmningo f the current oil price cycle, with a primary focus on the developments over the period o f 2001-05. Starting with a briefreview o f the general macroeconomic developments inNigeria, the chapter discusses issues o f revenue allocation, the dynamics o f main revenue and expenditure aggregates, fiscal balances, and the allocation o fFederal budget expenditures. A. RECENT MACROECONOMIC DEVELOPMENTS' 1.2 Over the last several years Nigeria has made important progress in macroeconomic stabilization, structural reforms, and the strengthening o f mechanisms and institutions for accountability. Nigeria's PRSP, the National Economic Empowerment and Development Strategy (NEEDS), focuses on three main pillars: (i) strengthening governance and fighting corruption; (ii) growing the private sector; and (iii) empowering Nigerians through improved service delivery. Given the history o f economic mismanagement and deep rooted corruption, the Government has prioritized major economic and financial management reforms. Among its core implementation strategies, the NEEDS emphasizes changing the way the Government works through improved efficiency, transparency and strengthened anti-corruption activities. 1.3 NEEDS aims at achieving a medium-term annual growth o f 7 percent to 9 percent inthe non-oil economy, equivalent to realper capita income growth o f at least 4 percent. At the same time, it aims to maintain single digit inflation, raise gross international reserves to 7-8 months o f imports (goods), and reduce the public debt burden to sustainable levels. Such sustained high growth rates are necessary to reduce by half the current levels o f poverty by 2015 in order to meet the benchmarks o f the Millennium Development Goals (MDGs). 1.4 Implementation o f the reforms under the NEEDS combined with favorable international oil prices i s yielding some positive results, including: (i)improved macroeconomic stability; (ii) renewed private sector confidence in the economy; and (iii) stronger growth performance. The non-oil sector grew by more than 7 percent each year in2004-06. Table 1.1presents keymacroeconomic indicators for 2001-08. 'The CountryEconomicMemorandum(CEM) for Nigeria, whichwas preparedsimultaneouslywith the PEMFAR,providesextensiveanalysis ofthe socio-andmacroeconomiccontextof ongoingreforms. The PEMFARdoes not undertakeanin-depthreviewoftheseissues. 3 Table 1.1: Key MacroEconomicIndicators, 2001-08 Table 1.1: Key Macroeconomic Indicators, 2001-08 Actual Est. Projections 2001 2002 2003 2004 2005 2006 2007 2008 Growth. Investment. and Savlnm Real GDP growth(%, af I990factor costs) 3.3 1 4 109 6.1 6 9 6 1 5 2 5 4 Non-oil (%, af I990factor costs) 4.3 8 0 4.4 7 4 8 2 7.0 5.3 5 4 Gross investment (%of GDP) 24.1 26 2 23.9 22.4 20 9 21 1 22.3 21 7 Publicfixed investment (%of GDP) d 13.8 100 9 7 9 1 9 1 9.0 9.5 8.8 Grossnationalsavings (% of GDP) 28.6 14 5 21.1 27.0 33 4 35 2 37.6 37 3 m v and Prlceg Broadmoney( O hchange) 27.2 21 6 24.1 14.0 I 6 5 17.0 Consumer inflation,(%, annual average) 18.0 I 3 7 14 0 15.0 17 9 9.4 6.5 5 5 Treasury bill rate (%, endofperiod) 20.0 I 4 9 14.9 14.3 12 0 DAS ofiicial exchange rate (nairaper US$:average) 112.0 1222 130.9 134.3 131 0 Terms of trade (%change) -104 -0 5 2.5 20 5 37 8 8.9 3.5 -1 1 PubllcFlnnnce (Consolidated Government) Governmentrevenueandgrants (%of GDP) 42 1 36 4 37.I 43 1 43 3 48.5 49.5 47.9 Governmentexpenditure,total (%of GDP) 47.0 40 7 38.4 35.4 33 4 31 1 32.0 31 5 Non-oil primarybalance(% of non-oil GDP,commitment -43.2 -29 9 -34.4 -35.2 -39 8 -39.6 -37.8 -35 9 basis) Overall balance(%of GDP, commitment basis) 4 . 9 -4 2 -1.3 7.7 9 9 17.5 17.5 I6 4 Balance of Pavmenti Expom of goods and services (% ofGDP) 43.3 40 9 49.7 54.6 55 2 53.6 53 4 52.2 Iqomofgoodsandservices(%of GDP) 32 5 41 8 41.5 37.4 33 9 33.1 33.0 32.5 Current accountbalancePA of COP) 4.5 -11 7 -2 7 4 6 12 6 I 4 2 15.3 15.7 Gross Internationalreserves(US$billion) 104 7 7 7 5 17.0 28 3 45.8 71 4 98 5 Gross Internationalreserves(months of impom ofgoods 6.5 3 9 3.4 6.1 8 8 13.1 19.6 25 5 and services) External debt Externaldebt outstanding (US$billion) ai, bi 29.7 31 0 32.9 35 9 20 5 4.8 4.8 4.7 Externaldebt outstanding (%of GDP) ai, bl 62.3 67 2 57 2 50.4 20 7 4.2 3 7 3 5 Debt servicedue (%of exports of goods and services) 12.1 I 5 6 10.3 7 8 6 4 1.2 I O 1.1 GDP (US$billion) 47.7 46 1 57.6 71.3 99 1 1162 122.7 129.1 I I a/ Nominal public sector short- and long-term debt, end of period. b/ In2005-06 reflectsthe results ofthe debt relief under the Paris Club. c/ Excludinggovernment investmentsinthe oil sector. Source:IMF 1.5 The key factors that together underpinned a fundamental change in the macroeconomic framework for public expenditure management in Nigeria in the recent past are highlighted below. 1.6 In 2004 the government introduced oil price rule based budgeting, which limits the annual utilization o f oil revenues to the level associated with a pre-determined oil price. All extra revenues that derive from the difference between actual and predetermined prices are saved in a special excess crude account. This innovation resulted insizeable budget surpluses and arapidaccumulation offoreign currency reserves. At the end o f 2006, the gross international reserves amounted to US$46 billion, about 6 times the level o f reserves at the end o f 2003. 1.7 The government used part o f its oil savings to finalize the debt relief ameement with the Paris Club through a combination o f arrears clearance, debt write-off and purchasing back the rest of debt at discount. The total cost to the government o f removing over US$30 billion o f debt was about US$12 billion. The final payment was made in April 2006, after which Nigeria's debt profile has improved drastically. Its external public debt declined to below 5 percent o f GDP compared to 57 percent in2003. 4 1.8 In January 2006, Nigeria received the first sovereim credit ratings BB- in its history from both Fitch and Standard & Poor's. This was a strong sign o f recognition by the capital markets of government reforms undertaken since 2003. This positive market perception was further facilitated by the Paris Club agreement. Portfolio investment increased sharply in the weeks immediately following the announcements on credit ratings. 1.9 Improved fiscal performance provided the government with the opportunity to reduce its reliance on the Central Bank of Nigeria (CBN) for deficit financing. A sizeable decline in CBN lending to the government occurred between 2003 and 2004, and has been an important factor in keeping inflation broadly under control, despite a massive inflow o f foreign exchange. Average real annual growth in private sector credit exceeded 10percent in2004-05. 1.10 Notwithstanding the significant improvements in macroeconomic management, the exchange rate and inflationarv Dressures remain substantial, while real appreciation of Naira has accelerated. The annual average CPI inflation peaked at 28 percent in August 2005. An aggressiveresponse from the CBN helpedto reduce inflation to 11.6 percent by the end of 2005 on a year-to-year basis. It i s estimated that dollar equivalent of Nigeria's GDP in2006 was twice as highas its 2003 level due to the combined effect o f growth and an appreciation o fthe currency. 1.11 Progress towards unification of the exchange rate market was substantial. The Government and CBN took steps to increase both exchange rate and interest rate flexibility that included the successful implementation of a wholesale market for foreign exchange in February 2006, as well as further liberalization of the exchange rate market inMarch2006. 1.12 The Government and CBN were also successful in completing a major consolidation of the banlung sector in late 2005, which was triggered by raising the minimum capital requirements for commercial banks from about US$15 million to US$190 million. As a result, through mergers and acquisitions, 25 much larger banks have emerged out of 89 original banks. This consolidation i s expected to facilitate deepening of the domestic market for government debt, in addition to other benefits. 1-13 The Government has made significant progress with privatization including concessions) of several major companies in steel, petrochemicals, mining, ports, and so on. The proceeds from privatizationin 2005 amounted to N43 billion (US$ 130 million). Privatization will further strengthen the fundamentals necessary for growth, and remove at the same time, a substantial subsidy burden from the budget. 1.14 Nigeria has moved closer towards normalizing its relations with the international financial community. The International Monetary Fund (IMF) authorized its Policy Support Instrument (PSI) for Nigeria in October 2005. Two program reviews by the IMF were successfully completed in the course o f 2006. Nigeria is fully servicing its external debt and is about to agree on a debt buy-back with commercialcreditors. 1.15 The medium-term macroeconomic outlook for Nigeria is positive against a backdrop of high international oil prices, increased external reserves, a reduced public debt burden, and improved growth performance. The government is working with the major international oil companies to ensure a substantial increase in both oil reserves as well as in the capacity to produce oil. This will enhance further growth in oil revenues and provide the government with additional fiscal space. The installed production 5 capacity is expected to increase to 4.5 millionbarrels of oil in2010 from the current level of 3.5 million barrels per day (Fitch Ratings, 2006). The government's investments inthe oil sector have been on the rise: from US$2.0 billion in 1999, to US$2.6 billion in 2000, and to US$4.0 billionin2005. Additionally, the government i s also pursuingan ambitious development strategy for the gas sector that aims to more than double the production of liquefiednatural gas (LNG) between2006 and2009. B. FISCAL PERFORMANCEOF THE CONSOLIDATED GOVERNMENT Revenuepet$ormance 1.16 The primarydeterminants of the government's expenditure inNigeria arejust two -performanceofthe country's oil sector, andrules ofrevenue sharing amongdifferent tiers of government. On the revenue side, Nigeria's performance depends excessively upon revenues from oil and gas. In2004-05, oil and gas revenues exceeded 80 percent o f the total revenues raised by all tiers of government. Relatively stable oil production levels2, coupled with reasonable stability inthe oil taxation regime, have together resulted in total government revenues being strongly correlated with trends in the international price of oil. While the average annual oil price increased by more than 4 times between 1998 and 2005 (from US$13.1 to US$55.2 per barrel in current U S dollars), all levels of government in Nigeria experienced a colossal increase in their revenues. Using 2006 budget assumptions, an oil price increase of US$l.O per barrelleads to about N l O O billion (US$750 million or 0.65 percent o f 2006 GDP) in additional government revenues, of which about N48 billion corresponds to the Federal government's share. 1.17 Figure 1.1 presents the main trends in real revenues and expenditures3 of the consolidated government since 1999. It shows that total government revenues4 in 2005 were indeed2.5 times higher (inconstantNaira) than in 1999, while oil revenues were 2.9 times higher. Accounting for the considerable appreciation of Naira, the U S dollar equivalent of total government revenues grew even faster, from US$11 billion in 1999 to more thanUS$42 billion in2005 (Table 1.2). 1.18 The annual changes in real revenues mirror the dynamic of oil prices. The deviations betweenrevenue and oil price trends can be explained largely by two factors: (i)an increase in the efficiency of tax administration; and (ii)changes inthe real exchange rate o f Naira. In particular, the following deviations between revenue and oil price growth are worth noting: 0 Duringthe early part ofthe periodin2000-0 1, the revenue growth (by more than 100 percent between 1999 and 2001) was much stronger than the recovery in oil price (about 55 percent). This increase reflects significant improvements in tax administration during the early years of the civilian administration. The administration of the petroleum profit tax (PPT) was the most remarkable - proceeds from this tax increased by more than 350 percent in real terms within these two years. The 2005 dailylevelofoil extractionof 2.39 millionbarrelswas only marginallyhigherthan the 1997 levelof 2.35 millionbarrelper day (mbd).However, it is worthnotingthat deteriorationof security situationinNiger delta in2005-06 preventedNigeriafrom attainingits original, muchhigheroilproductiontargets (2.7 mbdin2005). All deflationinthis chapteris CPIbased. Total consolidatedrevenuesincludegross revenuesof the FA, VAT account, andindependentrevenuesof all governmentlevels. Thus, this aggregateincludes all deductions fromthe FA (suchas for externaldebt payments andNNPC investments)madebeforethe distributionof funds across the three tiers of government. 6 0 In2005, however, annual growth in government revenues was much weaker than the corresponding increase in the price o f oil. Revenues increased by only 16 percent, while the oil prices were 44 percent higher than the previous year. Three factors were responsible for this deterioration in the relative performance o f revenue against oil prices: (i) weak collection o f non-oil taxes -- the collection o f non-oil taxes in real terms declined by 3 percent, while collection in oil taxes increased by 20.5 percent; (ii)a drastic increase in the implicit subsidization o f domestic oil products which reached N219 billion' in 2005 amounting to 1.7 percent o f GDP and close to 4 percent o f consolidated government revenues; these subsidies were paid by the Nigerian National Petroleum Corporation (NNPC) at the expense o fNNPC's payments to the Federation Account (FA); and (iii)significantrealappreciationoftheNairaby18percentrelativetotheUS a dollar during 2005, which effectively reduced the domestic value o f the dollar- denominated oil revenues. Figure 1.1: Trends in main FiscalAggregates, ConsolidatedGovernment, Real Growth relative to 1999 1 Real growth in fiscal aggregates, 1999=1 - 3.50 --eConsolidatedgov revenues,gross 3.00 I 2.50 o/w: Total Oil 2.00 taxes, gross 1.50 +Consolidatedgov expenditures Price of Nigerian oil (U.S. dollars Der barrel) 1.19 Growth inthe oil price and the respective increase inthe share o f oil sector GDP also resulted in significant growth in collected government revenues measured as percentage o f GDP, from 29.4 percent in 1999 to 43.4 percent in 2005. This trend, however, reflects quite a different dynamic o f the real tax burden in the oil and non-oil sectors (Figure 1.2). The effective tax rate in the oil sector increased from about 65 percent o f oil GDP in 1999 to about 70 percent in 2004-05. While there i s certainly room for further improvement in the tax administration6 o f oil revenues, by international standards, the Nigerian oil industry has been reasonably well taxed. At present, the potential gains from better utilization o f oil taxes already collected, through improvements in expenditure management, significantly outweigh the potential benefits from further improvementson the revenue side. As estimatedby Nigeria National PetroleumCorporation(NNPC). The recent EITIaudit pointed to important weaknesses inthe way how the liabilities for petroleumprofit tax are assessed and enforced, and more generally to a needto strengthen internal governmentprocedures for control and managingfunds received from the oil and gas sector. It also suggested improvementsinprocedures for assessment o f oil royalty and establishing the legal basis of gas royalty (Hart Group, 2006). 7 Table 1.2: Main fiscaltrends for the consolidatedgovernment,1999-2005, Nbillion 1999 2000 2001 2002 2003 2004 2005 Consolidatedgovt revenues,gross 1,011 1,985 2,247 2,064 2,795 4,126 5,642 as % GDP 29.4% 42.4% 42.1% 36.6% 37.1% 43.1% 43.4% -Total FederallyCollected Revenue,gross 972 1,940 2,178 1,964 2,656 3,973 5,452 -Subnational IGR, state+localgovts 39 45 69 100 139 153 190 as % of total revenues 3.9% 2.3% 3.1% 4.8% 5.0% 3.7% 3.4% memo: Total oil taxes, gross 745 1,646 1,733 1,476 2,107 3,350 4,759 Consolidatedgovt revenues, US$ bn 11.0 19.4 20.1 16.9 21.4 30.9 42.4 Consolidatedgovt expenditures 990 1,642 2,386 2,337 2,776 3,230 4,274 as % GDP 28.8% 35.1% 44.7% 41.5% 36.8% 33.7% 32.9% -Expenditurescontrolled by the federal authorities,w/o debt amortization 762 1,136 1,618 1,442 1,585 1,707 2,312 as % GDP 22.1% 24.3% 30.3% 25.6% 21.0% 17.8% 17.8% -Subnational(state+local)expenditures 228 505 768 895 1,190 1,523 1,962 as % GDP 6.6% 10.8% 14.4% 15.9% 15.8% 15.9% 15.1% memo: o/w state govt expenditures 168 360 591 725 921 1,100 1,360 local govt expenditures 60 145 171 170 269 423 602 Overall Governmentbalance 21 343 -138 -273 19 895 1,368 as % GDP 0.6% 7.3% -2.6% -4.9% 0.3% 9.4% 10.5% Source: OAGF, FMF,IMF, staff estimates. 1.20 Meanwhile, the taxation o f the non-oil sector remains at a low level. The effective rate o f non-oil taxation has been on the decline, from 17.5 percent o f non-oil GDP in 2002 to 14.5 percent in 2005. International experience highlights that achieving a collection target o f 20 percent o f non-oil GDP can be considered reasonable as a longer term performance benchmark for non-oil tax administration. The obvious areas for improvement include taxation o f imports by customs, and the administration o f sub- national taxes such as property taxes.' For instance, collection o f import and export duties declines by more than 20 percent in real terms in 2001-05 notwithstanding the fact that the dollar value o f imported goods more than doubled during the period. The effective average import tariff, estimated as the ratio o f total collected customs duties and value o f all imported goods, declined from 13.5 percent in 2001 to 7.2 percent in 2005. The latter indicates major problems within the customs administration and underlines a need to accelerate customs reforms. 1.21 While the reform challenges on the expenditure side by far exceed those related to additional revenue mobilization, the FGN has to continue its recent efforts to raise efficiency o f tax administration. Measures to change the structure o f government revenues towards a higher share o f domestic taxation are o f particular importance to help reduce economic volatility. There is also a critical link between quality o f tax administrationand improvements inthe environment for private sector growth. 1.22 The government has launched a comprehensive reform program in the tax and customs administrations, which include: (i) a simplification o ftax rules; (ii) simplification o f the import tariff and a noticeable reduction in the average tariff level; (iii) increase in the Value Added Tax (VAT) rate from 5 to 10 percent; (iv) lower effective tax rate for personal income tax; and (v) substantial investments in building the capacity o f the Federal InlandRevenue Service (FIRS) to support more effective tax enforcement. 1.23 Because government revenues are so highly dependent on oil taxes that are collected by the Federal authorities and distributed through the FA, it i s not surprising 'Story, Crandall and Daniel (2005) provide a detailed set of recommendations for strengtheningtax administration inNigeria. 8 that the Federal government dominates revenue collection. Historically, total independent than 5 percent o f the total government revenues - in2005 these were just 3.4 percent o f government revenues (IGR) o f State and Local governments have amounted to not more the total government revenues. Revenues o f the FA inthe past have amounted to not less than 85 percent o f the total (in 2005 these were 91.3 percent o f the total), while other revenues collected by the Federal government, including VAT, have accounted for the remaining 5-10 percent o fthe total (Figure 1.3). Figure 1.2: Taxation burden in oil and non-oil sectors, 1999-2005 I 70% 60% oil rewnues, asoh 50% of oil GDP 40% 30% Inon-oilrevenues, as O hof non-oil 20% GDP 10% 0% Figure 1.3: Relative shares of main types of taxation in the consolidated governmentrevenues, 1999-2005 100% 90% rn Subnational IGR, 80% state+local 70% 60% Other federally 50% collected revenues, 40% inc VAT 30% 20% Federation account 10% 0% 1999 2000 2001 2002 2003 2004 2005 I I Distribution of the Federation Account Revenues 1.24 Duringthe years o f military rule, allocation o f fiscal resources inNigeria became highly centralized. The sub-national governments were left with rather limited revenue raising powers, while the Federal government had the central role in the fiscal system o f collection o f most revenues and their sharing, both vertically and horizontally, based on generic formulas. At the same time, under the military, the Federal government commonly used its powers in a discretionary way to make up-front deductions from the FA for various projects and thus reduce the common pool o f funds available for sharing with other government levels. 1.25 The current formula for sharing revenues across three government levels was basically inherited from the military government in 1999. But the principles that determine the amount o f funds available for formula-based distribution were significantly 9 modified. Two major adjustments were introduced to comply with: (i)the derivation principle re-introduced in the 1999 Constitution, which granted 13 percent o f mineral revenues to those states where resource extraction takes place; and (ii) the 2002 Supreme Court decision, which basically eliminated the discretionary practice o f deductions from the FA bythe Federal government. 1.26 Although there i s a recommendation for a new revenue sharing formula pending before the National Assembly, this i s yet to be passed into law. The current vertical sharing o f the net FA proceeds i s based on the formula that emerged in 2002: 54.68 percent o f total revenues is allocated to the Federal government, 24.72 percent to State governments (SGs), and 20.6 percent to Local government authorities (LGAs). These shares reflect some adjustment in favor o f subnational governments - before 2002 the shares o f different government levels were 56:24:20 respectively. 1.27 Table 1.3 presents changes in the structure o f actual FA allocations, which derive from the above mentioned legal adjustments since 1999. It shows a substantial change in the revenue structure within the Nigerian federation since the return o f elected combined share o f revenues increased by 80 percent - from less than 20 percent o f the government in 1999. SGs became the major beneficiaries o f this change, and their total revenues in 1999 to 35.8 percent in2005. LG shares demonstrate a large increase as well, from 11.7 percent to 18.3 percent. This is a manifestation o f major decentralization inthe fiscal system. The total share o f the revenues o f SGs and LGs combined, in 2005 exceeded one half o f the FA allocations, while in 1999 this had amounted to only one third. 1.28 It is worth notingthat the change inFA distribution was very rapid, andmost o f it took place between 1999 and 2001. Duringthis period, real revenues o f SGs increased three fold. Changes after 2001 have been much more modest and were driven primarily by further growth inthe price o f oil, which has particularly benefitedoil producing states through oil derivation payments. Inreal terms, the consolidated SG revenues from the FA in2005 exceeded their 1999 level by 4.7 times, while for LGAs this growth was 4.0 and for the Federal government, 2.6 times (Table 1.4). Table 1.3: Changes in the actual distribution of Federation Account revenues across three Government levels (YO) - Federal 1999 2000 2001 2002 2003 2004 2005 68.7 68.4 49.2 47.6 49.4 46.3 45.9 -State, inclFCT - Local 19.7 19.8 31.6 31.9 31.6 35.3 35.8 11.7 11.8 19.2 20.5 19.0 18.4 18.3 Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Source: Staff estimates based on the OAGF and IMFdata. 10 Table 1.4: Real growth inFederation Account allocations to various Government tiers (YO) 1999-2005 2001-2005 2.59 1.46 2.58 1.34 1.73 1.25 4.71 1.52 4.04 1.27 memo: states w/o derivation oil 4.48 1.35 1.29 What was the primary driver for such rapid restructuringin revenue allocation in the first years of the returnto democracy? Apparently,the change was driven by a stricter adherenceto the basic provisions o f the Constitution, i.e. by improved fiscal discipline. In the 1990s the military governments regularly withheld substantial amounts of oil revenues and did not transfer them to the FA for sharing with the other tiers of government. It was estimated that actual transfers to the FA amounted only to about a half of what was due between 1991 and 1996, while the rest was spent by the Federal government directly (Nwoko, 1999). 1.30 It is worth noting, however, that the distribution of the above benefits of fiscal decentralization was highly uneven across sub-national governments. This i s because about a third (3 1.8 percent in 2005) of all FA allocations to states reflects derivation oil payments and, as such, they are concentrated inoil producing states. While there are 9 oil producing states in Nigeria, most production i s concentrated injust 4 states in the Niger delta (Akwa Ibom, Bayelsa, Delta, and Rivers). These 4 states jointly received about 90 percent of all derivation oil payments, or about USS2.0 billion in 2005. It means that these 4 states, in addition to the regular FA allocation, have been receiving through the derivation oil channel, about 40 percent o f the total funding available for FA distribution to all 36 Nigerian states. In 2004-05, such states as Rivers and Bayelsa received as derivation oil income three times more money than through their regular FA allocation. 1.31 The derivation principle, which i s constitutionally mandated, i s a source of major fiscal advantage for oil-producing states. The fact that despite all these additional revenues, the oil producing states of Nigeria did not perform much better than the rest of the country in terms of service delivery or human development indicators, indicates that major problems exist inthe expenditure management and accountability systems of these states. The recent UNDP (2006) report presents a picture of pervasive poverty, environmental degradation, and longstanding exclusion of local communities in Niger Delta. It claims that the preeminent underlying cause o f this situation is failure of governance at all levels.' 1.32 Insummary,the gains fromthetransitionto civilian rulewere quiteconsiderable in terms of both transparency in the allocation of major revenues as well as for fiscal decentralization. These changes have beendrivenby several factors: 0 Substantial improvements in the administration of oil taxes over 2000 to 2001, which at least partially i s likely to reflect a reduced diversion of revenues from the FA. * Therecent reportby HumanRightsWatch(2007) presents further evidence ofgovernanceproblemsinNiger Delta. 11 Stricter enforcement o f Constitutional requirements with respect to the allocation o f funds accumulated inthe FA. 0 Restoration o f the derivation principle in the 1999 Constitution, which awarded the oil producing States with a much larger share o f oil revenues. Supreme Court Decisions o f 2002 that further reduced the size o f the first line deductions from the FA. 1.33 However, a serious limitation o f the current fiscal decentralization arrangements in Nigeria relates to an excessive dependence o f sub-national governments on statutory allocations from the FA and federally collected VAT. Internal government revenues (IGR) of most SGs do not exceed 10 percent o ftheir total budget revenues. This share for LGAs is even lower. International experience highlights that such a high degree o f disparity between spending levels and own tax collection efforts creates significant incentive distortions for the affected governments. It largely undermines government incentives for expanding a local tax base and thus for facilitating growth, while at the same time, reducing demand from local taxpayers for government accountability and budget transparency. One of the possible directions for addressing this incentive problem in Nigeria relates to the introduction of a presumptive tax on Small and Medium Enterprises (SMEs) andmaking it an entirely sub-national tax to be shared between states and LGAs on the basis o f derivation. Expenditure Trends 1.34 This section examines the broad trends in government expenditure to estimate the actual degree o f fiscal expansion within the current oil price cycle. The "boom and bust" fiscal policy o f the previous decades under which government expenditures closely mirrored oil price fluctuations, has been a primary cause o f Nigeria's macroeconomic problems, such as excessive currency appreciation and debt ~verhang.~Thus, it is important to understand how significant the recent adjustments to the fiscal policy in Nigeria are, when compared to the broader historical trends. 1.35 Table 1.5 and Figure 1.4 present core information on trends in real consolidated government spending since 1999. They cover all main types o f expenditures, i.e. those reflected in the official budgets o f all tiers o f the government, as well as those that have been spent outside o f the regular Federal budget. Below in the section 1.3 we provide a more detailed explanation o f how the Federal expenditure aggregate was estimated to ensure its comparability throughout the period. 1.36 Our analysis suggests that the government fiscal policy became more prudent during the period, particularly since 2004. While in 2005 the consolidated government expenditures were about twice as highinreal terms than in 1999, almost the entire growth occurred early in the period o f 2000-01'0. Between 2001 and 2005 the real level o f consolidated government spending remained practically unchanged. Between 2003 and 2005 the consolidated expenditures increased by only 13 percent despite the fact that the oil price practically doubled. While rapid expenditure growth in 1999-2001 looked similar to what happened to government spending in Nigeria during the earlier episodes Nigeria. Policy Options for Growth and Stability. World Bank, 2003, June. loExpenditure growth in2000-01 may also reflect better budget coverage, i.e. more adequate incorporation of both revenues and expenditures inthe operations of the FA and inrespective government budget reports after the end of military rule. 12 o f growing oil price, the more recent experience suggests a radical shift towards a much more responsible fiscal policy. Figure 1.4: Government expenditure and oil price, 1999=100 450% 400% --tConsolidatedgovt expenditures 350% 300% +Federalgovt expenditures 250% 200% -A- Subnational 150% (state+local) expenditures 100% Amrage price per 50yo barrel (in US$) 0Yo 1999 2000 2001 2002 2003 2004 2005 1.37 While the volume o f consolidated government spending in real terms has remained basically unchanged since 2001, the relative size o f government expenditures measured as a share o f GDP have declined considerably, from about 45 percent of GDP in 2001 to below 33 percent o f GDP in 2005, to become more in line with other developing countries. The decline in relative size o f government interventions is an important positive development, as it signifies reduced levels o f government intervention inthe economy. Inthe pastNigeria has suffered from excessivepublic sector control over economic activity, which has been a primary source of rent seelung behavior and political patronage. Table 1.5: Growth in real budgetexpenditures,1999-2005, in 1999 constant prices Realtom(1999Prleer) 1999 zoo0 2001 2002 2003 2004 2005 consolidatedsavt expMdbJres 990 1,535 1,890 1,629 1,696 1,717 1,926 -Expendtmmnbulledbythefederal authonbes,w/o debtamft 762 1,063 1,282 1,005 969 907 1,042 -subnaDoMI(StatetlOCd) expenditures 226 472 808 624 727 809 884 mna &state govtexpenddlwes 166 336 473 505 583 585 613 localQ7.4 expendibrres 60 136 136 119 164 225 271 shareof f-1 s w n g inmewd.% 769% 892% 678% 81 7% 571% 529% 541% Iconsunwp ~ cie~ e (ani-udaverwe).% x 86 6 9 180 137 140 150 179 Source: Staff estimates based on the OAGF and IMFdata. Note: CPI deflated. 1.38 The 2006 Federal budget as approved has been rather expansionary. It suggests a real growth in the total federally controlled budget expenditure of 16.6 percent. This was justified by a need to address several structural issues simultaneously, including: (i) acceleration o f civil service reform; (ii) repayments o f some budget arrears to pensioners and domestic contractors; (iii)monetization o f previously implicit petroleum price subsidies; and (iv) covering incremental costs o f the 2007 national elections. Given the recent history o f significant fiscal restraint, such an expansion does not represent a major risk on its own. Still, inthe medium term, the government should commit to a lower rate o f expenditure expansion than was budgeted in2006. 13 Table 1.6: Budget performancemeasured as % ofthe non-oilGDP, 1999-2005 1999 2000 2001 2002 2003 2004 2005 ConsolidatedGovt Total non-oilrevenues 11.6% 14.4% 17.4% 17.5% 16.9% 16.0% 14.5% Total non-oilminterestexpenditures 28.1% 49.5% 54.0% 52.6% 51.6% 52.0% 54.5% N m i l primarybalance -16.5% -35.1% -36.6% -35.1% -34.7% -36.0% 40.0% FederalGovt Federal N m i l primarybalance -12.1% -20.0% -20.2% -18.5% -15.9% -14.6% -17.5% Source: IMF, FMF, staff estimates. 1.39 Inan oil-dependent economy, an important alternative measure of sustainability o f fiscal policy i s commonly based on the use o f non-oil sector GDP (instead o f the conventional GDP that i s heavily affected by oil price fluctuations). Table 1.6 shows the performance o f the Nigerian government from this perspective. The data confirm the serious fiscal restraint instituted since 2001: consolidated non-oil non-interest government expenditures have been growing over 2001-05 broadly in line with the growth in non-oil GDP. Still, this was accompanied by a noticeable growth in the consolidated non-oil budget deficit, o f almost 5 percentage points o f non-oil GDP, since 2002. The latter was a direct result o f serious deterioration in the collection o f non-oil taxes. It is worth noting, however, that the non-oil deficit o f the Federal government declined from 20 percent to 17 percent o f non-oil GDP, and that all the growth in consolidated non-oil deficit since 2000 was due to the operations o f sub-national governments. The share o f federal government in the consolidated non-oil deficit declined from 55 percent in 2001 to 43 percent in2005. 1.40 The above aggregate expenditure trend masks serious differences between the dynamics o f federal and sub-national spending. In fact, the entire fiscal expansion o f the 1999-2005 has been driven by the growth in sub-national spending, which within six years has increased almost four times in real terms. Federal government expenditure, on the other hand, increasedby only 35 percent inreal terms since 1999. In2005, moreover, Federal government expenditures were much below their 2001 level (see Table 1.5 above). 1.41 Such a significant difference in trends between Federal and sub-national expenditures means that expenditure decentralization o f the Nigerian fiscal system has been proceeding at a rate even higher than the pace o f revenue decentralization discussed above. The share o f sub-national budget spending in the consolidated budget doubled from 23 percent in 1999 to 46 percent in 2005. This decentralization was driven primarily by changes in the revenue sharing arrangements from the FA allocation, including the decline inthe share o f first line charges. 1.42 Expenditure decentralization has created both new opportunities and challenges for public service delivery inNigeria. Given that Nigerian sub-national governments are mainly responsible for financing such basic public services as primary health and education, decentralization creates the potential for further improvements inthe financing o f these priority sectors. At the same time, due to well-known capacity constraints at the sub-national level, this expansion in financing creates a substantial risk o f a decline in spending efficiency. It also risks misuse o f funds due to weak transparency and reporting arrangements. As shown in Chapter 3, analysis o f the expenditure patterns for a limited group o f states identified serious weakness in the composition o f budget expenditure at the state level, and highlighted a gap between announced state government objectives o f social development and poverty reduction, and the priorities that emerge from the analysis o f actual expenditures. Overall, the key problem with fiscal decentralization in Nigeria i s that its pace exceeded by far the speed in improvements in accountability o f 14 subnational governments for efficient use o f their budgets and improvements in service delivery. 1.43 Rapid expenditure decentralization, largely determined by the 1999 Constitution, took place in the environment where, due to the existing political economy o f revenue sharing, there i s insufficient demand for developing stronger mechanisms to support horizontal fiscal equalization. This poses a risk o f inequality growing across states, especially with respect to the quality and availability o f social services. This inequality i s likely to widen in the medium to longer term as a result o f several simultaneous effects: (i) built-ininequality in horizontal allocation formulas that are, at the moment, biased in per capita terms in favor o f less populous states; (ii) different opportunities for raising sub-national revenues related to cross-state development differences; and (iii) differences in sub-national expenditure policies. To be able to achieve its national development targets, in particular with respect to MDGs, the federal government will need to develop its capacity for monitoring cross-state differences in access to core social services. It will also at some point need to expand federal equalization programs to provide additional opportunities to citizens in less developed states. The FGNhas recently made an effort to enhance its capacity to monitor state expenditure patterns, although progress i s constrained by lack o f constitutional authority to request proper budget reporting and disclosure by states. 1.44 Moreover, LGA spending has been growing even faster than state government spending, which means that sub-national budget systems in turn become increasingly decentralized (Figure 1.5). This aggravates further the policy risks mentioned earlier. According to the C B N data, the total LGA expenditure increased from 1.8 percent o f GDP in 1999 to 4.6 percent in 2005. Over this same period, LGAs' consolidated size increasedrelative to the total sub-national government expenditure from 36 percent to 44 percent. 1.45 Itis worth noting, however, that LGAshave, inreality, rather limited autonomy in making expenditure decisions. A large share o f local expenditures i s driven by decisions o f state governments. Moreover, the state governments pursue policies o f the withholding and centralization o f FA transfers to LGAs to finance specific programs and projects. This is often done in a rather non-transparent way, when such centralized funds remain outside o f both state and local budgets. Overall, transparency in the inter-governmental fiscal arrangements within the states needs to be significantly improved. Figure 1.5: Consolidatedstate and localgovernmentexpenditures, 1999-2005, % of GDP I 14.0% I 1 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% I 1999 2000 2001 2002 2003 2004 2005 15 Budget Surpluses,Excess Oil Revenue Savings, and Debt Deal 1.46 Consolidated expenditure growth has recently been much more modest than the growth in revenues leading to the accumulation o f sizeable budget surpluses. As shown above in Table 1.2, as recently as in 2002 the consolidated government had run a deficit in excess o f 5 percent o f GDP. With the adoption o f oil price based rule in 2004, the government has managed to drastically improve consolidated fiscal balance and has accumulated surpluses that have on average exceeded 10 percent o f GDP in both years 2004 and 2005. 1.47 In2004, the budget was prepared onthe basis of an oilprice ofUS$25 a barrel, while the actual average price was US$38.3. In 2005 the budget reference price for oil was US$30, while the actual price was US$55.20. This innovation has also resulted in rapid accumulation o f foreign currency balances with the excess crude account (Table 1.7). 1.48 Paris Club Ameement. The Government has used its excess oil savings to resolve one o f its major macroeconomic andpolitical problems related to excessive external debt. Inearly 2005 Nigeria's external debt amounted to about US$36 billion, out of which debts to Paris Club exceeded US$30 billion. These debts were largely the result of accumulated unpaid interest and penalties on loans that were disbursed duringthe military era and were mostly mismanaged. A historic agreement was reached in October 2005 under which Nigeria paid o f f its arrears and then bought back the remainder of its debt at 75 percent discount, using excess oil revenue savings. Total costs o f the deal to Nigeria were US$12.4 billion. Final payment o f US$4.8 billion was made by the FGN in April 2006. 1.49 The deal with the Paris Club has been a major achievement o f the government's economic team. Immediate impacts o f this deal include: (i) a greatly improved image o f Nigeria in the international arena; (ii) receiving a decent investment rating from leading internationalrating agencies that will enable better terms o f international financing for the Nigerian private sector; and (iii) the saving o f about US$1 billion ininterest payments for the consolidated budget. Table 1.7: Main operationswith the excess crude account, 2004-06, US$billion 2004 2005 2006f Annual Inflow 5.9 13.0 19.0 Annual Distribution 0.0 3.0 0.0 Paris Club debt 7.8 4.8 Power sector project 0.4 1.5 Balance at the year end 5.9 7.8 20.5 Source: IMF, FMF. Note: Data for 2006 are the mid-year projections. c. FISCAL OPERATIONS OF THE FEDERAL GOVERNMENT Fiscal Segmentation 1.50 T h i s section reconstructs the full picture o f Federal government's fiscal operations that includes the expenditure and transfers that remain outside the official Federal budget. The segmentation o f the Nigerian budget system has its legal origins in the 1999 16 Constitution, but it i s also influenced by some traditional budgetary practices, inherited from the military era. At the time o f military rule, various legal and illegal instruments were used to keep a substantial portion o f the government's spending o f f the regular budget and thus away from public scrutiny. Since 1999 important improvements have been made. The 2002 Supreme Court decisions were o f particular importance in this regard, because they led to a more accurate reflection o f operations with foreign debt in the Federal budget. 1.51 Currently, three sizable parts o f the Federal government's fiscal operations remain outside o f the regular federal budget. They include: 0 Government revenues from the oil sector that are reinvested into the development o f oil fields as a government contribution to joint ventures with the major oil companies (so called "cash calls"). These investments are made as a first charge on the FA, and are therefore deducted before FA proceeds are distributed among the three tiers o f government. Federal extra-budgetary funds (EBFs), including the off-budget funding for the Federal Capital Territory (FCT). These funds" form a fixed percentage o f total distributed FA proceeds within the constitutionally determined share o f the Federal government. The combined share o f EBFs amounts to 6.2 percent o f the total Federal government's share o f FA that i s 54.68 percent, while the remaining 48.5 percent i s channeled through the regular Federal budget. Revenues accumulated with the excess crude account and the expenditures incurred directly from this account are not reflected in the Federal government's budget either (see Table 1.7 above). However, in2006 the FGN introduced a major step to consolidate a federal portion o f spending, funded from the excess crude account, with its regular budget. It was done through a submission o f supplementary annual budget that covered both operations with foreign debt and financing o f major infrastructure projects (in power and gas sectors). 1.52 While the current practice o f managing "cash calls" and extra-budgetary funds is fully in line with the existing legal framework o f Nigeria, international experience suggests that such fiscal segmentation is often detrimental to progress with public finance management. In general, segmentation complicates fiscal prioritization. It also poses a risk that some parts o f the fiscal system may become less transparent, which would undermine overall efficiency o f public spending. It i s worth noting, however, that, when compared to the recent past, government accountability in Nigeria for use o f off-budget funds has actually increased over the last three years. The National Assembly has been exercising much more efficient scrutiny o f such spending during both budgeting and reporting on actual fund utilization. Still such spending remains less transparent than that in the regular budget. The reporting on off-budget spending is less regular, such expenditures are not subject to standard requirements o f budget audit, and major investment projects funded from the excess crude account are not covered by standard procurement rules. 1.53 Inaddition to the main off-budget items mentionedabove, there are some smaller off-budget channels such as the following: (i)education tax fund to finance programs in Inaddition to the FCTtransfer, there are 3 federal EBFs: Stabilization, Development of Mineral Resources, and Deviation and Ecology. A briefanalysis o ftheir operations is provided later inthis chapter. 17 the education sector; (ii) special customs levies for financing custom development, and (iii) revenues,includinguserfees, oflineministriesandagencies. Thegovernment own also keeps o f f budget all donor funded projects, including those under the World Bank credits. 1.54 Tables 1.8 and 1.9 present relative dynamics for the budgeted and non-budgeted parts o f Federal fiscal operations for revenues and expenditures. On the revenue side, at the end o f military era, more than half o f the revenues were kept outside o f the budget. This share declined considerably to about 37 percent by 2003. However, with the introduction in 2004 o f the excess crude account (which on its own i s a significant positive innovation), this share has inoreased again, and exceeded 55 percent o f revenues in2005. 1.55 On the expenditure side, the share o f off-budget spending has been lower historically, at about one third o f the total.'* This share increased only modestly between 2002 and 2005. This i s because the growth in off-budgeted revenues was not accompanied by an equivalent growth in government expenditures. Instead, funds were saved with the excess crude account. When the analytic framework i s expanded to cover debt amortization payments, which were brought back to the budget after 2002 and constituted more than 10 percent o f total Federal government outflows in 2003-04, it can be argued that the budget's coverage o f federal outflows increased relative to 2001. Still, up to 2005 progress was not very significant. Too much o f government spending, including critical public investments in the oil sector, basically remained outside o f the regular budget process. Submission o f the 2006 supplementary budget that covers considerable part o fpreviously off-budget spending indicates a substantial improvement. 1.56 The government should introduce legislation that delineates clear responsibility for the approval, execution, audit and disclosure o f expenditures under those components o f the public finance system that are currently outside o f the regular Federal and State budgets. To the extent that this i s consistent with the Constitutional requirements, the link between these expenditures and the regular Federal budget may be further formalized. A possible solution could be based on the introduction o f a special section in the federal budget (Appropriation Bill) to cover all the expenditures, administered by the FGN on behalf o f the entire federation, at least as memo items that do not require parliamentary approval. As an intermediary step, the FGN may also consider steps to disclose more information on these expenditure flows in both the Fiscal Strategy Paper and the Budget ImplementationReport. 1.57 Both because o f the limited budget coverage, and because o f the deficiencies in the current budget classification, the official presentation o f the Federal budget by the government i s neither sufficiently informative nor does it reflect well the actual trends in Federal revenue and spending. This presentational problem i s the most significant in the official reports on Federal government deficit, as presented, for example, recently in the government's Fiscal Strategy Paper and Call Circular. Figure 1.6 illustrates the differences between official estimates o f Federal deficit and those estimated inthis report. The latter are based on the consolidation o f the Federal government's fiscal operations and are much closer to an internationally accepted definition o fthe budget deficit. T h i s is somewhat a statistical effect relatedto the fact thatwe do not consider inour expenditureframeworkhere the government's debt amortizationpayments,whichbefore2003 were largelyoff budget. 18 Table 1.8: Budgetedand non-budgetedFederal Government revenues, 1999-2008, actual and projections, Nbillion I999 2000 2001 2002 2003 2004 2005 2OO6f 2007f 2008f Total revenues byfederal govl 764 1,463 1,419 1,164 1,514 2,093 3,161 3,854 3,652 3,787 as% GDP 22.22 31.29 26.57 20.66 20.10 21.86 24.35 26.33 23.31 22.18 A. IncludedInthe federal budget 370 927 655 678 961 1,178 1,405 1,549 1,651 1,840 as% GDP 10.76 19,83 12.27 12.03 12.75 12.30 10.62 10.58 10.54 10.78 FederationAccount, gross, incl excess oil 348 681 597 593 866 1,095 1,323 1,442 1,487 1,849 VAT 7 9 14 16 20 24 27 32 76 92 Fed God Independent Revenue 15 38 44 68 54 59 55 75 86 99 B. Not reflected Inthe federal budget 394 536 763 486 554 016 1,756 2,305 2,002 1,946 as 36 GDP 11.45 11.46 14.30 6.63 7.35 9.57 13.53 15.74 12.77 11.40 Fundingfor JV Cash Calls, Bn NGN 163 266 392 346 421 455 532 542 581 581 Fundingfor National/NNPCPnorityProject! 24 22 38 8 Fundingfor repaymentexternaldebts 158 175 232 40 FederalGov excess oil savings, net 324 1,039 1,562 1,236 1,164 Allocationfor Fed EBFsand FCT 16 42 49 41 e4 78 97 124 102 109 NationalJudicial Council, before 2003 10 13 2 EducationFundTax 4 7 16 10 10 17 33 39 40 45 CustomsSpecial Levies 9 12 24 30 39 40 32 37 43 46 Others (Refundto Importerr & Incentives) 10 1 2 22 C. Off budget revenues,as %of total 51.6% 36.6% 53.8% 41.8% 36.6% 43.7% 55.6% 59.8% 54.8% 51.4% Note: 2006 data do not reflect the 2006 supplementarybudget, which i s expectedto reduce the share of off-budgetrevenuesbelow its 2005 level. Source: IMF, FMF, staff estimates. Table 1.9: Budgetedand non-budgeted Federal government expenditures,1999-2008, actual and projections,Nbillion 1809 .... 2000 2001 2002 2003 2004 2005 2006es 20071 ZOO8f ob1expendlturescontrolledbythe federal uthorltles 762 I,I36 1,618 1,442 1,585 1,701 2,312 2,784 2,440 2,59 as % GDP 22.14 24.30 30.30 25.61 21.05 17.83 17.80 19.02 15.57 151E ,.Off-budaettransferslwlo debtamortlutlon) 29 71 101 93 133 137 185 200 185 20 edera EBks and FCT ' 16 42 49 41 84 78 97 124 102 10 lationalJudicial Council, before2003 10 13 2 ducation Fund 4 7 16 10 10 17 33 39 40 4 .ustomsSpecial Levies 9 12 24 30 39 40 32 37 43 4, lthers (Refundto Importers& Incentives) 0 0 0 10 1 2 22 0 0 I I.Offludget Investments 211 294 435 360 434 481 618 783 636 65 undlngfor JV Cash Calls 183 268 392 346 421 455 532 542 581 58 lational/NNPCPriorityProjects 24 22 38 8 lationalPower Project 50 196 0 I ionorfunded projects 4 4 5 6 14 26 35 45 55 70 :. Budgetedexpendltures(wlo debt amort) 521 771 1,081 989 1,018 1,090 1,509 1,801 1,619 1,739 as % GDP 15.2 16.5 20.3 17.6 13.5 11.4 11.6 12.3 10.3 102 BudgetedTransfers: 8 25 36 42 79 92 85 90 Niger Delta DevelopmentCommission 7.5 14 10 14 22 26 20 21 NatioMl Judicial Council 11 26 28 33 35 37 39 UBE 24 30 26 30 Debtservlce, Interestonly 140 188 359 213 242 246 386 246 242 232 -external, cash 48 83 204 42 72 42 186 26 22 22 -domestic 91 104 155 171 170 204 200 220 220 210 MDA Expenditure 382 584 715 737 740 803 1,044 1,463 1,292 1,417 as % GDP 11.1 12.5 13.4 13.1 9.8 8.4 8.0 10.0 8.2 8 3 SurpluslDeflclt 3 327 -199 -279 -71 386 849 1002 1,213 1,19! as % GDP 0.1 7.0 -3.7 -4.9 -0.9 4.0 6.5 6.8 7.7 7 ( I.Offbudgetexpenditures,as *hoftotal 31.5% 32.1% 33.2% 31.4% 35.8% 36.2% 34.7% 35.3% 33.6% 32.9Y !em: amrtization of foreign debt, 1/ 110 92 34 101 163 185 952 660 60 71 !em: deficit per governmentpresentation -200 -.. -155 -161 -352 as % GDP -2.7 -1.6 -1.2 -2.4 '/ mostlyoff-budgetbefore 2003 Note: 2006 data do not reflect the 2006 supplementary budget, which i s expectedto reducethe share of off-budgetexpenditures below its 2003-05 level; (ii)Allocationsto the FederalCapitalTerritory (FCT) are covered by a separate budget, voted by the NASS independentlyfrom the federal budget. FCT allocationsamount to less than 0.2%of GDP a year. Source:IMF, FMF, staffestimates. 19 1.58 According to the government definition o f deficit, the Federal government remained in deficit in excess o f 1 percent o f GDP throughout the period under review in this report. This is rather a biased summary estimate for government fiscal operations at a time when the Federal government has been runningimpressive budget surpluses o f more than 5 percent o f GDP on average in2004-05. The difference between the two estimates i s largely due to the fact that the government's definition does not reflect revenues saved with the excess crude account. But the following factors also play a substantial role in shiftingthe government's definition further away from internationalconventions: 0 Government budget presentation considers external debt amortization as expenditure but not a financing item, and this tends to increase government deficit estimates. Externally funded expenditures are still not budgeted in Nigeria, and this tends to underestimate the government deficit, in other words, it influences the deficit estimates in the opposite direction than the two previous factors. Because o f the growing volume o f activities that are funded from credits by international financial institutions (primarily IBRD and AfDB), the role o f this factor has become more important inrecent years (Figure 1.7). The manner in which capital spending i s reflected in the government budget further complicates the picture. For several years now, the FGN has been extending the end o f fiscal year to give the MDAs more time to complete their projects funded from the current year's budget. As a result, a significant amount o f spending made early in the year i s reported by the BOF as having been made duringthe precedingyear. This practice contradicts the cash-based budget accounting used for presenting the rest o f the government budget. In our analysis in this chapter we tried (to the extent possible), to restore the consolidated Federal government fiscal picture as it corresponds to the cash accounting principle. Figure 1.6: Federal budget surplus/deficitaccordingto government and consolidated definition, YOof GDP 1 8.0 6.0 4.0 2.0 0.0 -2.0 1.59 When compared to other Sub-Saharan countries, the level o f donor support to Nigeria remains low. Currently Nigeria receives less than US$3 per capita in development assistance compared to the regional average o f US$28. However, as could be seen from Figure 1.7, the volume o f donor support has been growing rapidly, although from a low base. Total disbursements from loans from International Financial Institutions 20 (IFIs), including IDA, increased almost 5 times between 2001 and 2005 reachingUS$250 million (which i s still less than 0.3 percent o f GDP)13. In addition, as estimated by the NPC, Nigeria received between US$50 and US$60 million annually in grant disbursements. l4 Given the rapidly growing volumes o f donor support, it seems quite important that the FederalMinistryo f Finance (FMF) adopts a decision to integrate major donor inflows into the regular budget, as well strengthen institutional arrangements for donor coordination. Figure 1.7: Annual disbursements of loans by the IFIsto the Federalgovernment, 2001-05, USD million Annual Disbursements of loans by IFls, US$ mn 300 250 200 150 100 50 0 2001 2002 2003 2004 2005 1.60 Table 1.10 and Figure 1.8 present a dynamic o f total non-interest federal spending and its individual components in 2001-05. This information is complementary to the data inTable 1.5 and is important for assessing the direct impact o fgovernment fiscal policies on the non-governmental sector. Table 1.10 shows a drastic decline in the non-interest federal spending as a percentage o f GDP, from 23.6 percent in 2001 to 14.6 percent in 2005. Inreal terms, total non-interest expenditures in 2005 amounted to only 86 percent o f the 2001 level, while budgeted expenditures by MDAs, i.e. expenditures on core service provision, declined by 19 percent over the same period (Figure 1.8). At their lowest point in 2004, real budget expenditures on MDAs amounted to less than three fourths o f the 2001 level. The only expenditure component which did not decline in real terms was other federal expenditures, which benefited from significantly increased fundingfrom the extra-budgetary funds, includingthe Education Tax Fund. 1.61 The decline in real total federal spending continued until 2004. In2005 real non- interest federal spending increased for the first time since 2001 by more than 11percent and recovered to their 2002 level. Expenditure o f MDAs also increased in 2005 and reached its 2003 level. It i s estimated that in 2006 the consolidated federal expenditure grew even faster, inexcess o f 15 percent inrealterms. 1.62 The above data indicate a relative decline inthe net volume o f resources available for federal financing o f public services in recent years. While this conservative expenditure policy brought the important benefit o f macroeconomic stability, in the situation o f slow improvements in spending efficiency, it has restricted the scope o f short term benefits from the recent hike in oil prices for the Nigerian population and the private sector in general. This has unavoidably led to populist pressure to relax the current fiscal stance. To mitigate against these pressures, the government has to launch a major effort to raise the efficiency o f public spending within a prudent budget envelope. l3Estimatesbythe FMFandDMO. l4This likely underestimatesthe actualamount of grant support becausemechanismsof donor coordinationin Nigeriaremainunder-developedandinformationsharingis limited. 21 1.63 Table 1.11 compares the trends in main expenditure aggregates within the MDA budget envelope over 2001-05. Capital spending was most affected by the expenditure restraint, its real volume (on a cash basis) halving. Payroll expenditures were the most protected, showing a real decline o f only 6 percent during the period. As a result, the share o f capital spending in the overall MDA envelope declined from 44 percent to 28 percent, while the share o f payroll increased from 38 percent to 44 percent o f the total. 1.64 The PEMFARteam was unable to obtain reliable data on the trend ina number o f employees on the Federal government's payroll. In the absence o f any noticeable employment cuts inthe public sector before 2006, it i s safe to assume a rather stable level o f Federalbudget employment o f about 1 million for the period o f 2001-05. Inthis case, the data in Table 1.11 would suggest only modest erosion in the average public sector salary after 2001. The 2006 budget was prepared based on the nominal roll o f 996.7 thousand federal employees. It i s expected that this level will decline by about 10 percent in2007 due to bothverification exercise inthe course o f 2007 budget preparation as well as the ongoing restructuringo fthe public sector. Table 1.10: Dynamicsof Federal government non-interest expenditureaggregates, 2001-05 (Yo of GDP) 2001 2002 2003 2004 2005 Total non-interest expenditures undertaken by the federal authorities 23.60 21.93 17.85 15.28 14.83 Federal budget non-interest expenditures 13.53 13.79 10.30 8.83 8.65 olw: MDA Expenditure 13.39 13.09 9.82 8.39 8.04 Off-budget Investments 8.17 6.35 5.77 5.02 4.76 Expenditure by other federal level entities 1.90 1.78 1.78 1.43 1.42 Figure 1.8: Real growth in Federal expenditureaggregates, 2001-05 (2001=100) +Totalnon-interest 110 I I expenditures 105 100 ---IC-Federal budget 95 90 85 -A- o h : MDA 80 Expenditure 75 Off-budget 70 lnvestments 60655 +I+Expenditureby 2001 2002 2003 2004 2005 other federal entities 22 2001 2002 2003 2004 2005 MDA Expenditure: Payroll 100 105 87 92 94 Overheads 100 64 85 65 87 Capital Spending, cash basis, I/ 100 76 56 50 57 1.65 Given the historical capital bias in Nigeria's budgets, the recent compression in capital spending in favor o f recurrent costs (including financing o f nominal salary increases) should not, in principle, be seen as a negative change. In fact, past budgets often failed to provide adequate financing for operation and maintenance o f government facilities. However, little evidence exists that this recent change in the aggregate expenditure structure has brought about much expenditure rationalization at the micro level. The primary concern here i s about adequacy o f funding for overheads and accountability for rational use o f these funds. Before 2006 financing o f the overheads showed a lot o f instability (Table 1.11). Moreover, incentives o f civil servants are still overwhelmingly biased towards initiating new investment projects and not towards service delivery and better utilization o f the existing capacity. The FGN launched several important initiatives, such as sector expenditure strategies discussed in Chapter 2 that aimed to address these problems. Budget Predictability 1.66 This section examines the degree o f predictability o f the budget and the issue o f fiscal discipline in the budget system. It is broadly accepted that budget predictability i s an important factor for improving service delivery as it helps executing agencies to plan and deliver activities in an orderly way. 1.67 Table 1.12 presents our estimates for the deviations between the approved and actually executed Federal budgets across the main expenditure aggregates. The table i s based on the budget structure used in Nigeria's budget process, i.e. expenditure aggregates reflected here are not fully comparable with those used in the earlier tables because o f the manner in which annual capital spending i s reflected inthe government's budget execution reports as explained earlier (see para. 1.59). 1.68 Table 1.12 shows a dramatic improvement in the quality o f budget execution since 2004, but from a low level. In sum, the average deviation for aggregated non- interest federal budget expenditures for the last two years, 2004 and 2005, excluding debt service payments, has declined to a level that is close to the Public Expenditure and Financial Accountability (PEFA) benchmark o f 5 percent (indicator PI-1)15 for good international practice in aggregate expenditure management. In contrast, the average deviation was about 27 percent in 2001-03. Moreover, if instead o f the origmal 2005 budget, one looks at its revised version, agreed upon in June 2005 by two branches o f power, thenthe level o f budget execution inthat year was even higher. 1.69 In the past, adopting unrealistic annual budgets was rather common in Nigeria. The capital investment bias in the budget process created strong incentives within the l5Annex 1presentsa full PEFA assessment(28 performance indicators) for Nigeria. 23 system to put into the Appropriation Bill inflated and unaffordable capital estimates, which allowed MDAs to initiate additional new investment projects, but complete relatively few of them. The average level of implementation for the capital budget in 2001-03 was only about 50 percent. It is estimated that more than half of all budget projects remainnever completed. 1.70 2003 marked a transition towards a new and more disciplined budget process. First, the government was reluctant to fully implement the highly inflated budget approved by the National Assembly (NASS). Second, to improve quality and transparency of execution, the Federal government introduced a new system to provide centralizedoversightofprocurement within the capitalbudget. The new systemthat aims to enable greater competition and transparency in the procurement system, became a challenge for most MDAs. This coupled with the government's reluctance to implement the inflatedbudget, slowedthe implementationofthe capitalbudget. As a result, the 2003 capitalbudget was executedat the levelof only one third of what was adopted, while the total actual non-debt spendingamountedto about two thirds ofthe budgetedamount. 1.71 The real improvements in budgetingoccurred during the preparation, approval, and implementationof the 2004 budget, which demonstratedreal significant progress in terms of extent of its execution. The capitalportionofthis budget was fully implemented, with rather modest over-spendingon the recurrent budget side. In2005 two branchesof the government agreed on the revised annual budget in June 2005, which also showed a highlevelofbudget implementation, 103percenton average. Table 1.12: DeviationsinFederal budget execution, measured as the differencebetweenthe approved and executed budgets, in % Average deviation, 2001 2002 2003 2004 2005,2/ 2004-05 Total Expenditures, wlo debt service -16.7% -28.4% -36.5% 3.0% -8.4% 5.7% MDA Spending -16.7% -29.4% -38.3% 3.3% -7.4% 5.3% olw: Current Expenditure 13.3% -9.8% -11.8% 5.8% -0.3% 3.0% Payroll 1.4% -8.4% -5.9% 5.7% -4.2% 5.0% Pensionsand Gratuities 4.3% -16.0% 3.9% 0.7% 2.3% OverheadCosts 48.8% -19.2% -20.4% 6.9% 8.9% 7.9% Capital Expenditure,Releases -33.~1% -49.6% -71.4% -0.4% -15.8% 8.1% Debt Service 32.6% 27.3% -1.9% 8.9% 14.0% 11.4% Transfers -2.8% 1.9% -4.2% -11.9% 8.1% Total revenues 29.6% -9.1% 7.8% 10.2% 9.0% -12.1% -22.1% -31.7% 4.0% -4.7% 4.3% "indicates under-spendingrelativeto the budget Source: IMF, BOF, OAGF, staff estimates. Note: Capital expenditures are reflected as they are shown in government budget execution reports, i.e. they are not cash based as the case of the earlier tables. 1.72 Two major factors, however, are still imbedded inthe budget processes that pose a significant risk to budget predictabilityin the future. In other words, further efforts are neededto ensurethat recent improvements inbudget disciplineare sustained. 24 First, further work is needed to build consensus between the legislative and executive branches o f government, both on their respective roles in budgeting as well as on the desirable extent o f fiscal policy restraint. This was the primary factor that led to a number o f complications inthe course o f the 2005 budget cycle relative to 2004. We discuss this issue indetail inChapter 2. Second, the relative success in the implementation o f the capital budget in 2004-05 has been achieved only through the Federal government's decision to extend the end o f the fiscal year much beyond December 31. While this helped to show an improved implementation ratio in the budget execution reports, in substance, this practice does not improve actual budget predictability for MDAs significantly because the agencies cannot know in advance either whether a decision on an extension would be made, or how long the next extension would be. Importantly, this i s a distortionary budgetingpractice, which should be discontinued. 1.73 It is worth noting that the low level o f annual budget execution inNigeria is not related to poor budget revenue performance, which i s the common source o f budget shortfall in other countries. The second but last line in Table 1.12 presents the deviation index for budget revenues, which corresponds to the PEFA revenue indicator PI-3. It indicates that in 3 o f the last 4 years, actual budget revenues were considerably above the budgeted level due primarily to unexpectedly high oil prices16. This suggests a core disconnect in budgeting between revenue and expenditure estimates, a result o f the legislature having a tendency to increase budget expenditures without paying much attention to the government revenue estimates. According to the current legislation, the National Assembly does not vote the revenue side o f the budget. 2002 2003 2004 2005 Total MDA Expenditures 42.7% 52.8% 20.2% 14.2% Current Expenditure 15.0% 18.4% 23.0% 12.4% PersonnelCosts 12.1% 10.0% 10.7% n.a. Overhead Costs 24.6% 36.9% 82.5% n.a. Capital Expenditure 84.7% 123.6% 16.5% 16.4% 1.74 Table 1.13 further illustrates the differences in perceptions o f responsibility for budgeting between the Federal government and the National Assembly. The data in the table show the extent to which the recently approved annual budgets have exceeded the government's original proposals. The data do show a clear sign o f improvement in 2004- 05 relative to the earlier period. In both 2002 and 2003 the legislature passed a capital budget that was about twice higher than the original government proposal. While the NASS continued to revise the executive budget proposal upwards in more recent years, this gap, while still high, declined to about 16.5 percent in2004-05. Moreover, the agreed revised budget for 2005 was even closer to the original budget proposal o f the executive. 16Itdoes notmeanyet that revenueplanningis good. Deviationsinnon-oiltax collections, especially in collections of independent government revenues(IGR) remainsvery high. Inboth2003 and 2004 the actual IGR collectionamountedto only about one third ofthe budgetedlevel. 25 The relative size o f expenditure added by the legislature to the annual budget in the course o f budget hearings has declined further in2006 and 2007. Table 1.14: Analysis of deviationsin budget expenditurecomposition, 2001-04 Deviation in the Deviation in the overaII expenditure expenditure level cornposition Difference A B B-A 2001 16.7% 24.9% 8.2% 2002 29.4% 32.8% 3.4% 2003 39.9% 39.9% 0.0% 2004 3.3% 8.0% 4.7% Source: OAGF, staff estimates. Note: Composition index in column B is estimated on the basis o f the 22 largest MDAs by expenditure. 1.75 Table 1.14 extends the analysis o f budget predictability to the level o f individual MDAs in line with the format suggested in the PEFA framework (indicator PI-2). It compares the deviation relative to the approved budget in the aggregate non-debt expenditure level (column A) with the weighted deviations in allocations for individual MDAs (column B). This indicator reflects the structure o f the overall expenditure shortfall - whether in the case o f expenditure squeeze all MDAs are affected more or less similarly, or whether large budgets cuts for some agencies are accompanied by extra funding provided to the others? The analysis was based on the 22 largest MDAs ranked by their overall expenditure envelopes. These have a combined share in aggregate expenditures o f about 85 percent. Data in column A in principle correspond to those in Table 1.12, line "MDA spending". l7 1.76 The results in Table 1.14 suggest that the composition o f the actual budget spending varies insignificantly from the original budget, i.e. generally most MDAs face rather similar expenditure deviations in the course o f budget execution. For each o f the last 3 years (2002-04)'' for which data are available, variance in expenditure composition exceeded overall deviation in the aggregate non-interest expenditures by less than 5 percentage points, which is a PEFA benchmark for good international practice. It has been rather uncommon for Nigeria to over-spend relative to the budget on some MDAs, while at the same time introducing deeper cuts for others. 1.77 Broadly speaking, before 2004, the MDAs which were the most affected by expenditure shortfall have been those with the largest investment programs, like the Ministries o f Water, Works, Power and Steel, FCT. This i s because most o f budget deviation was concentrated inthe capital budget. Allocations for social ministries, such as Health and Education, were better protected because their budgets are more wage intensive. BudgetArrears 1.78 Significant deviations between the approved and executed budgets in an environment o f weak commitment control have with time led to the accumulation o f "SmalldifferencesbetweenthosetwodatasetsderivefromthefacttheestimatesinTable1.14 exclude budget spending on pensions as well as on repayment of wage arrears, for which the OAGF execution reports do not provide a breakdownby MDA. '*No detailedexecutiondata for 2005 havebeenavailableyet. 26 significant budget arrears. The two main types o f federal government arrears are debts to contractors andto pensioners. 1.79 The total contractors' arrears of the federal government were originally (in late 2005) estimated to amount to N275-300 bn (about 2.2 percent o f 2005 GDP). Intensive audit of contractor claims prior securitization of this category o f debt has reduced their magnitude to about N135 bn, i.e. to the levelthat i s less than halfthe original estimates. It i s believed that a large part of contractor arrears i s the legacy o f military rule, and also that a significant portion o f the original current contractors' claims were inflated. The problem i s that the Federal government does not have any regular reporting mechanism on budget commitments and arrears which could help to consolidate and monitor outstanding contractor claims. 1.80 Since 2005 the FMFundertooka special effort to buildan adequateunderstanding of scale o f the budget arrears problem. This was done through a special data request sent to the MDAs to report on the stock o f budget arrears as of the end of 2004, building a database within the BOF, and setting up a mechanism for verification, auditing and deflating the reported claims. The process is still unfinished, but in 2006, as part of its annual budget, the FGNcleared contractor arrears inthe amount o f about N96 bnthrough a combination o f cash payments (to small local contractors) and issuing federal bonds. The FGNplans to fully clear the stock of remaining contractor arrears in 2007 through additional issuingo f 2-5 years bonds. This is an extremely encouraging development. 1.81 It should be noted, however, that as of now the process of arrears repayment has been handled as a special one-time-only exercise. It i s important for the government to establish an adequate monitoring system to prevent the accumulation of new budget arrears after they are removed by the ongoing clearing exercise. In particular, the government will needto strengthen commitment control and reporting to reduce the risk of arrears accumulationinthe future. 1.82 There are also additional types of budget arrears, including arrears on: 0 utility payments the incidence o f which remains unknown, although the arrears to the government telecom provider have been settled in 2005 (in the amount ofN5.6 bn); and 0 payments to international organizations such as debts on membership dues, which were estimated to amount to N53.6 bn based on the 2005 unaudited survey. 1.83 Pensions arrears. Under the Pension Act adopted in 2004 the National Pension Commission i s required to estimate the debts accumulated in the old pay-as-you-go pension system and to manage their clearance. The Pension Commission completed the first round of pension verification exercise by the middle o f 2006, which covered about 70 percent o f the federal pension schemes (excluding parastatals). The exercise helped to reduce the earlier uncertainty about the size of the federal pension arrears. Based on the latest information, the stock of such arrears is likely to be about N l O O billion or 0.6 percent of GDP.19 Some of the outstanding pension arrears are old, but there is also a portion o f relatively recent pension debts. Over the last few years, the FMFhas continued to under-fundpensions in the annual budgets on the ground that the MDAs were unable to justify their pension funding claims in budget proposals. The Pension Commission This includespensionarrears of federalparastatals,whichare estimated at the levelof N20 billion. 27 estimates that in 2005 alone, under-funding o f pensions was inthe range o f N6 billion to N12 billion. 1.84 In2006, the FGNraisedN75 billionthroughissuinggovernment bonds to finance repayment o f pension arrears and deposited these proceeds with the special account inthe Central Bank. A framework for clearing the pension arrears was finalized inthe course o f 2006, and the Pension Commission started actual arrears repayment in the middle o f 2006. About N45 billion in pension and gratuity arrears were cleared by early 2007. This covered about a half o f 280,000 federal pensioners, whose pensions were inarrears. 1.85 Overall, by conservative estimates, at the end o f 2005 Federal budget and pension arrears stood at a level not less than N300 billion (US$2.3 billion), which i s about 20 percent o f the total 2005 federal budget expenditures. This means that as o f the end o f 2005 Nigeria was not able to meet the minimum performance requirement under the PEFA (indicator PI-4), which considers stock o f arrears at 10 percent o f total budget spending to be a maximum threshold for satisfactory performance in the area o f expenditure payment management. However, given government's current commitment to clear the main types o f federal arrears, it i s likely that the stock o f arrears would be reduced substantially (as much as three times relative to its 2005 level) by the end o f 2007. D. FEDERAL EXPENDITURESTRUCTUREAND QUALITY OF EXPENDITURE 1.86 This section looks at the evolution o f the expenditure structure across main sectordministries. Given the absence o f functional budget classification, we used administrative classification, i.e. we analyzed the changes in expenditure shares allocated to individual large ministries and groups o f MDAs. Thus, we consider the MDA shares as a proxy for sectoral shares inthe overall expenditure composition. 1.87 The Government's NEEDS identified core government policy priorities and made a commitment to expand funding within these policy areas. Those priorities include public health (particularly, immunization and HIV/AIDS treatment and prevention), teacher supply, rural electrification, youth programs, gender mainstreaming, rural water supply, road infrastructure, slum upgrading, environmental issues, and agriculture. The priorities were operationalized recently inthe course o f discussions over utilization o f the gains Nigeria obtained from the debt relief. 28 Table 1.15: Federalbudget spending by mainMDAs, actual, 2001-04 Percent of total MDA spending 2001 2002 2003 2004 Social I8.2% 20.3% 26.2% 20.0% Education 9.3% 8.9% 10.6% 10.6% Health 5.5% 5.2% 6.3% 7.1Yo Environment 0.2% 0.2% 0.3% 0.4% Sports & Social Development 1.8% 2.9% 7.1% 0.5% Women Affairs 1.5% 3.1yo 1.9% 1.5% Infrastructure 21.O% I8.7% 13.3% 20.4% Works & Housing 7.2% 8.2% 7.2% 8.8% Water Resurces 4.4% 3.0% 3.8% 4.6% Power & Steel 9.3% 7.5% 2.3% 6.9% Administration 18.2% 27.2% 26.4% 20.5% Security 25.5% 22.2% 22.8% 22.1Yo Industry and Commerce 6.7% 5.0% 6.1Yo 6.1Yo Other 10.5% 6.6% 5.2% 10.9% Source: Staff estimates based on the OAC data. Note: Based on the data on the 31 largest MDAs. 1.88 Table 1.15 tracks the evolution o f the actual expenditure structure in the federal budget by six main groups o f MDAs. The 31 largest MDAs were clustered in these six groups that broadly reflect different core government functions. All but one2' MDG Ministryfell into the two groups within this classification - Social (that covers Health, Education, Women's Affairs, etc.) and Infrastructure (that covers MDAs responsible for roads, power, water, etc). Table 1.15 suggests rather high stability in the composition o f federal expenditure. The changes that occurred between 2001 and 2004 were quite modest and to some extent just a reflection o f the budget shift from capital to recurrent spending discussed earlier. As a result, the share o f MDAs responsible for financing o f Social and Administration functions somewhat increased, while the share o f MDAs in Infrastructure declined. It i s worth noting the relative decline in spending on the security group that covers defense, police, etc. By the same reason, the budget outcomes in 2003, when the capital budget releases declined twofold in real terms compared to the previous year, show an unusually high share o f social and administrative expenditures relative to the trend. In short, the data do not indicate any significant policy shift in expenditure allocations before 2005. Exceptfor the MinistryofAgricultureandRuralDevelopmentthatis includedinIndustryandCommercegroup. 29 Table 1.16: Expenditure structure of the 2004-06 Federal budgets, YOof the total MDA spendingby main functional groups 2006 FGNbudgetproposal 2004 2005 wlo MDG adjustedfor cost actual estimated allocation Total o f reforms 1 2 3 4 5 Social 19.4 16.0 14.4 16.7 19.4 Infrastructure 18.9 18.3 15.3 17.9 20.8 Administration 19.9 20.0 20.8 19.3 22.4 Security 21.3 18.7 17.1 15.8 18.4 Industryand Commerce 6.1 5.5 4.6 4.7 5.4 IOtherservice 14.4 21.6 27.7 25.7 13.6 o/w wide votes I 8.3 16.1 22.8 21.I 8.3 Source: BOF, 2006 Call Circular. Note: Based on the data on 31 largest MDAs. BOF data on 2004 budget outcome are somewhat different from OAGF numbersinTable 1.15. 1.89 Table 1.16 reviews the expenditure composition proposed by the Federal government for 2006 federal budget as reflected in the 2006 Call Circular2*, and compares it with the expenditure structures for 2004-05. Inthe course o f the preparation o f 2006 budget, debt relief savings inthe amount o f N l O O billion or 8 percent o f the total original MDA envelope was allocated to the ten Ministries known as the "MDG Ministries" as increment to their regular annual budget envelopes. These are the ministries o f Health, Education, Water, Power and Steel, Works, Housing, Agriculture, Environment, Youth, and Women Affairs. According to the 2006 Call Circular, this increased the total allocation for MDG Ministries in the final budget proposal submitted bythe Government to the NASSby about 25 percent. 1.90 Column 3 in Table 1.16 reflects the proposed 2006 budget allocations before the distribution o f debt relief gains among the 10 MDG Ministries. Column 4 shows the total allocations inclusive o f these gains. The data suggests that despite these additional N l O O billion, the proposed 2006 shares o f social and infrastructure sectors, while higher than in 2005, were still lower than the ones in2004.22 1.91 Does this result indicate that there i s disconnect between the announced government policy objectives and the realities o f annual budget practice? Probably not. To explain we have to check the changes in MDAs' shares happened in 2005-06 across all six MDA groups. The analysis shows that the only portion o f MDA envelope that benefited from considerably larger budget allocations inthat period was the one, which i s reflected in Table 1.16 as "Other MDAs". The expansion in this latter budget category was driven primarilyby a large increase in spending on various service-wide votes that do not have a breakdown by individual MDA in the existing administrative classification. Most o f such service-wide spending reflects new commitments o fthe Federal government to finance implementation o f several key structural reforms and address other structural issues that are a legacy o f the past. Inthe 2006 budget proposal, the largest service-wide spending relates to the costs of: (i)pension reform which was 4.5 percent o f the total MDA spending; (ii) explicit budget financing o f petroleum subsidies; (iii) recapitalization 21While theNationalAssembly introducedsome changesto the FGN's budgetproposalduringitsbudget discussions,the ultimate2006AppropriationBillwas muchcloser to the executiveproposalthan it was the case in therecentpast. So the mainproportionsreflectedinTable 1.16weremostlypreserved. 22This excludes largeoff-budgetinvestments inpower, which in2006 are expectedto exceed20 percent of the totalMDA budget spending. 30 o f development banks; and (iv) partial repayment o f arrears to local contractors and pensioners. Strong expansion in this type o f spending i s just another reflection o f the difficult reform environment in Nigeria, where the government has been trying to expand its pro-poor spending against other competing priorities, such as an urgent needto address major structural problems that hamper the country's longer-term development prospects. 1.92 Column 5 in Table 1.16 re-estimates the main expenditure shares o f individual MDA groups by adjusting for increased budget costs o f structural reforms. It presents a hypothetical budget structure under the assumption that the share o f Other MDA expenditure in2006 budget were held at its 2004 level o f 8.3 percent, while the rest o f the budget structure remains as presented in 2006 budget. The result indicates that if other conditions remain comparable, then the 2006 share o f social sectors would not decline relative to 2004, while the share o f infrastructure and administrationwould increase. 1.93 Overall, we do not see much reason for concern about the aggregate sector/MDA structure o f the Federal budget expenditure. It seems unlikely that the Federal government i s missing some major opportunities to improve financing o f core MDG services just because the aggregate expenditure allocations among key ministries may be inadequate. Within the current set o f institutional and policy constraints the Federal government has made a commendable effort so far to increase the real level o f MDG financingz3.Three points are worth noting inthis context. First, the 2006 budget provides for a substantial increase in the total MDA budget envelope, about 16 percent in real terms relative to 2004 based on data from the Budget Office o f the Federation (BOF). Thus, even constant budget shares would bringmore funding for core services: proposed 2006 social spending are 21 percent higher in real terms than those in 2005, while real expenditure on infrastructure increased by 13 percent. Second, given the history o f large deviations between the agreed and executed budgets, one should be more concerned about actual than plannedbudget spending. The real developmental value o f 2006 budget can be assessedonly after the end o f fiscal year. 1.94 Third, and by far the most important, the broadconclusion ofthis report is that the core problem within Nigeria's budget system i s low efficiency o f budget spending, not inadequate amount o f finding (Box 1.1). The major improvements in service delivery in the core sectors in the short to medium term should come as much from further expenditure growth as from much better utilization o f the existing allocations. The evidence from sectoral and state level studies undertaken in the course o f PEMFAR preparation, as well as from other analysis, points to major opportunities to improve cost efficiency in the system through stronger transparency and accountability arrangements for the utilization o f public funds at the project/activity level (Box 1.2). These in turn are closely connected to conditions in the civil service and the wider public service, chiefly loss o f skills and general capacity, eroded accountability, and an incentives structure that does not encourage good performance by staff. The situation in the health sector i s probably the most striking example o f the existing problems with spending efficiency. As the Government's recent MDGs Report summarizes it, `Nigeria is failing to provide adequate healthcare to its people" (Nigeria.. ., 2006). The country could achieve better health outcomes and many lives could be saved at the current health expenditure levels if these resources were allocated more efficiently to provide the majority o f the population with better accessto healthservices andboost preventive measures. 23At the sametime, the government couldbuildbetterunderstandingof actualpublicexpenditure onmainsectors by introducinga proper functionalclassificationinline with the internationalstandards.Also, it wouldbedesirable to adjust the currentbudgetpresentationinorder to reducethe shareof service wide votes andcharge insteada largerportionof expenses directlyagainst specific MDAs that incurredthose costs. Inparticular, annualpension spendingandcostsof salary adjustmentsshouldbeincorporatedinto the regular MDA envelopes. 31 Box 1.1: Significantbudget expendituresin the past did not always bring improvementinservice delivery Health: It i s estimated that total spending in the sector (public and private) exceeds 6 percent of GDP, which is rather high by international standards. However, the health outcomes remain extremely low and have not improved over the years. Infant and maternal mortality rates remain highat 110 and 8 per 1,000 births in2005, respectively. Moreover, infant mortalityincreasedby20 percent between 1990 and 2005 (Nigeria 2006 MDGs Report). Communicable diseases (particularly malaria and diarrhea) are the main causes o f mortality, which can be easily prevented or treated at relatively low cost. Education: This sector has been attracting a significant amount of funding over the last 4-5 years from all tiers o f the government without much change in social indicators. This helped to improve significantly net primary enrollment. Also, the share o f the primary school students that reach grade 5 increased from 71 percent in 2000 to 78 percent in 2005 (Nigeria 2006 MDGs Report). But the quality o f nation's teaching and schooling remains o f concern, and this is reflected in poor literacy outcomes. Adult literacy rate was only 64 percent in 2004. Roads: Inadequate funding for maintenance, rehabilitation and asset renewal during the previous decades is the major reason for high transportation costs and poor safety conditions. It i s estimated that between 50 and 70 percent of road network i s inpoor condition (Willoughby, 2007). The FGN recently has increased funding for the sector to address the problem. Power: In 2001-05, the Federal government spent, through investment grants, subsidies, and loans in the sector, about N270 billion or more than US$2 billion, while the massive power shortages remain the major development constraint for the private sector and a critical social problem. A partial explanation for this low impact of budget spending relates to the low completion rate of initiated investment projects in the sector. The value of unfinished construction has increased by N82 billion since 2000 (see also Chapter 5). 32 Box 1.2: Efficiency and accountability problemswith in Nigeria's NationalImmunizationProgram Routine immunization against DPT, measles, polio and TB i s proven to be one o f the most cost- effective interventions for reducing childhood illness and mortality. Yet, national coverage for full immunization in Nigeria i s less than 13 percent, one o f the lowest rates in the world, even lower than inmany countries in conflict, such as the Democratic Republic o f Congo. Nigeria's immunization program i s by far the most expensive among developing countries. The 2005 budget for National Program for Immunization (NPI) was based on unit costs over US$28per child under 1. However, ifthe budget numbers are adjusted in line with the internationally accepted denominator o f children fully immunized before their first birthday the actual unit cost amounts to US226 per fully immunized child. Because NPI's financial management procedures lack transparency, precise estimates of unit costs in the program are difficult to assess. However, even if the lowest available figure for 2005 is used, this still comes to US$56per fully immunized child, more than double the norm for developing countries. This represents a waste o f scarce national resources. Furthermore, recent fieldwork has revealed excessively high rates of vaccine wastage. For instance, the relatively expensive Yellow Fever and Hepatitis B vaccines account for half of total Nigeria's vaccine expenditure, but the evidence from several northern states shows that 80 percent o f Hepatitis B vaccine is wasted or unused. This is a vaccine that is globally in short supply. The level o f accountability and disclosure within the NPI remains extremely low. There is evidence o f systematic falsification o f data at the local level in order to meet centrally set targets. Different official documents provide conflicting figures, and some documents having arithmetical errors adding up to billions o f Naira. There remain unanswered questions about program financing raised by international audit teams, includingthose from the EC and IBRD. Source: FBA Consultants (2005). 1.95 Major past inefficiencies in Nigeria's public investment spending can be also statistically illustrated on the basis o f the Incremental Capital Output Ratio (ICOR), which i s estimated as a ratio between annual national investments and annual increase in GDP. Nigeria's historical ICOR o f 12.724was very high, more than double that o f a better managed oil economy such as Indonesia. Hence, real GDP growth generated over the long run from incremental unit o f investment was twice lower in Nigeria than in Indonesia. Inthe past, public investments (including those in the oil sector) made about two thirds o f the total (public plus private) country's investments in fixed capital. Thus, the low historical ICOR for Nigeria indicates low average efficiency o f government spending (both budgeted and off-budget) and is primarily reflection o f fiscal mismanagement under the military rule. If Nigeria's ICOR were brought down to the level o f Indonesia, the same amount o f public investment would translate into a considerably higher rate o f GDP growth, adding 1.4 percentage points per annum. Given that the average rate o f economic growth in Nigeria over the past 25 years was only 3 percent, this would indicate a significant improvement inperformance. 1.96 The recent government fiscal and governance reforms clearly helped to improve efficiency o f public investments, as reflected ina positive dynamics o f ICOR. Average 10 year ICOR (1994-2004) declined considerably to the level (10.4) that i s much closer to the performance o f other oil producing economies (Indonesia - 9.2, Mexico - 7.9, Gabon 11.8, and Ecuador - 10.5). Moreover, the most recent data for 2003-05 show further improvement in ICOR to about 8. This progress could be attributed to government 24This is the long-term ICOR average calculated over the period 1975-2004. A similar ICOR estimate for Cameroon is 5.0, while for Gabon- 18.8. 33 initiatives in the areas o f public procurement, budgeting, and corruption control. Substantial further improvements, however, remain essential. 1.97 The above conclusion regarding major gains that could be realized from improvements in the quality o f budget spending is even more relevant for state and local budgets. As discussed earlier in the chapter, the states were the main beneficiaries o f the post 1999 budget expansion and have major responsibilities for core public services. Thus, the slow pace o f improvement in primary services should be seen as an indirect indication that state budgets in general, and in particular those in oil producing states, are affected by major problems inexpenditure efficiency. 1.98 At the most general level, the government should continue to place greater emphasis on improving spending efficiency, concentrating on areas such as following: 0 Improvements in efficiency o f sectoral expenditure by strengthening linkages between individual projects and MTSS objectives, increasing financing o f maintenance and operational costs, while rationalizing both payroll costs and other recurrent inputs; Restructuring o f public service delivery - for example, in health the governments at all levels should pay more attention to financing o f primary health andprevention compared with tertiary services (hospitals); 0 Improvements in the quality o f the government's capital project portfolio by focusing on fewer projects, which are adequately funded and executed, to ensure a decline in completion times, as well as in numbers o f unfinished projects (Box 1.3); and 0 Strengthening in the quality o f project planning and implementation, including improvements in economic and financial analysis o f project proposals, project costing, and monitoring o f physical construction. 1.99 The PEMFAR-sponsored budget monitoring25o f projects financed with money repatriated from Switzerland ("Abacha Loot") pointed to some weaknesses in internal budget accounting and reporting processes at the MDA level. Overall, the total repatriated sum o f about N65 billion was fully utilized for various pro-poor government projects implemented in budget 2004 and 2005. Spending was allocated for priority projects in 5 sectors (roads, power, health, education and water) which were distributed across all six geo-political zones o f the country. However, repatriation o f the recovered Abacha loot was delayed, and spending commenced as part o f the general budget in 2004 prior to the decision to monitor utilization o f the funds. This made the process o f traclung the utilization o f the funds difficult, particularly given weak budget reporting systems in the participating MDAs. More recently, however, the Government has instituted a Virtual Poverty Fund mechanism, with appropriate budget coding, for tracking pro-poor expenditures that are financed using Nigeria's savings from its recent Paris Club debt deal. This new mechanism will make it easier for Nigerians to assess the utilization o f the debt relief savings. 25World Bank.2006. Utilization of RepatriatedAbacha Loot. Results ofthe field monitoring exercise. December. 34 Box 1.3: Lengthy completiontimes in road construction In October 2005 the team from the BOF Monitoring Department undertook a monitoring of 50 large budget projectsinfour federal MDAs (Ministries of Health, Works, andWater and Population Commission).This Box presents the findings of monitoring efforts for one of these four MDAs, the Ministry of Works, which i s responsibleinter alia for the constructionof Federalroadsand bridges. While the general findings of this effort have been rather similar across the four MDAs, the Ministry of Works has been selected here because of high homogeneity in its project portfolio, which makesit easier to presentthe brief summary that follows. The monitoring exercise covered 20 road and bridge projects with the total project costs of NlOO billion, which was an equivalentto about US$1billion at atime when most projectswere approved. Out of these 20 projects, 12 were approved and work commenced before 2002, while another 6 projects were approved in 2002-03. According to the original contracts, 14 projects in the sample were supposedto be completed in3 years or less, including 6 projectswhich hada completiontime of not morethan 2 years, while the rest hadoriginal completiontime of slightly morethan 3 years. The monitoring exercise revealed a highly unsatisfactory picture of both project financing and completionrate.By the time of monitoring (October 2005), accordingto the original schedules, 18 projectswere supposed to havebeen completed. However, it was found that only 55 percent of the total original contract amount was releasedto the contractors from the moment of project initiation, and no project in the sample was completed. Moreover, for 15 out of 20 projects the current completionrate remains below 70 percent, including 4 projects with the completion rate below 30 percent.This suggeststhat inmost cases muchmoretime and budget funding will be neededbefore projectsare completedand public investmentswould resultin improvementsinservice delivery. Source: BOF (2006). Reporton 2005 CapitalProjectsMonitoring Exercise. Budget Subsidies 1.100 The issue o f quality o f budget spending i s also related to the incidence o f subsidies in the budget system, in particular producer subsidies. In most cases, government subsidies to state enterprises are driven by a necessity to cover their losses that reflect both operational inefficiency and defects in the business environment. As such, they are largely a direct waste o f public funds. 1,101 Historically inNigeria, the sector o f state enterprises has been over-developed and highlyinefficient. The state-owned companies have dominated such key sectors as power, telecom, ports, railways, steel, petrochemicals, mining, etc. Table 1.17 presents official government data on budget support to key commercial parastatals in 2001, which is the last year this kind o f data i s available. The data in the table reflect only a portion o f government subsidization burden because those cover only direct budget support and do not cover other channels o f subsidization such as tax exemptions and tax arrears, off- budget support (such as e.g. port surcharge), and costs of investments projects in specific sectors directly fbnded by the government. Still the costs o f explicit federal budget subsidies and grants were significant and amounted to about 0.7 percent of GDP. 35 Table 1.17: Federalgovernment explicitbudget support to key commercial parastatals - subsidies and investmentgrants, 2001, Naira million Investment Operational grants subsidy Total Steel mills 1,711.4 1,040.0 2,751.4 Coal company 283.6 20.0 303.3 Oil refineries 6,998.0 599.6 7,597.6 Mines (solid minerals) 4,919.8 46.7 4,966.5 NEPA, power sector 3,858.4 431.I 4,289.5 ChemicaIs 504.0 5.0 509.3 Railways 283.6 595.1 878.7 Ports 500.0 218.9 718.3 Airports 1,625.6 629.9 2,255.5 Telecom 8,300.0 3,100.9 11,400.9 Sugar 506.0 6.0 512.3 asTotal GDP 29,490.4 6,693.2 36,183.6 % of 0.55 0.13 0.613 Imemo: 2001 GDP, bn 5,339.11 I Source: OAGF Note: Does not include indirect support (such as tax exemptions and tax arrears), off-budget support (such as e.g. port surcharge), and costs of investments projects in specific sectors directly funded by the government. 1.102 The recent privatization drive has already resulted in several major transactions, but much more effort is needed to complete the process. The purpose of the following paragraphs i s to show, using several specific examples, the costs associated with poor performance o f SOEs and demonstrate, by implication, potential fiscal gains from privatization in Nigeria. Privatization has been bringing major budget savings that could become a source for essential increase in funding in the MDG sectors over the medium term. 1.103 So far in Nigeria, weakness in parastatals' operational performance has taken place in an environment o f weak government monitoring and accountability mechanisms for utilization o f budget funds. Parastatals do not generate any regular reporting on their use o f budget subsidies and grants. They are supposed to submit annual audits to the Office o f Auditor General, but many parastatals are considerably late with their submissions. There i s no central government office, that i s responsible for monitoring financial performance o f the largest federal parastatals to keep track o ftheir losses, debts, and contingent liabilities, or to monitor risks that arise from this part of the public sector for sustainability of the fiscal system o f Nigeria in general. Moreover, the existing economic classification o f the budget remains underdeveloped - its does not contain a subsidy item. Thus, government spending on subsidies could not be separated in the budget reports from the overall spending on overheads. Budget investment grants to commercial parastatals also cannot be easily separated from the rest o f capital budget. The scope o f government monitoring o f budget support to commercial parastatals has further reduced since 2001 on the grounds the government aimed at privatization o f most o f these companies that would eliminate a need for budget support. 1.104 As a result, neither the Federal Government nor its key ministries have a clear picture of total annual budget funding that i s allocated to main commercial parastatals. It essentially hides the scale o f the burden that parastatals generate for Nigeria's budget 36 system26. The analysis below i s based partially on work done by Adam Smith International (2006) as part o f the DFID program o f privatization support. It also benefited from the analysis o f the power sector prepared as a contribution to this report (Edozien and Abiola, 2006). 1.105 Table 1.18 presents the estimates for total government support to 3 major parastatals in the ports, railways, and power sectors respectively, i.e. the Nigeria Ports Authority (NPA), the Nigeria Railways Corporation (NRC), and the Nigeria Electric Power Authority (NEPA). The estimates cover several major channels o f budget support - - explicit budget transfers including subsidies and investment grants, as well as some o f the important implicit subsidies like tax arrears andbudget loans. 1.106 Table 1.18 provides just conservative low-end estimates o f budget support because some important data e.g. those on tax arrears are missing or are incomplete. In addition, the data do not reflect potential budget costs o f current contingent liabilities in the parastaral sector, such as costs o f their pension liabilities. 1.107 Despite these data limitations, the total amount o f identified budget support to the three parastatals i s quite high.In2001, total subsidies o f all sorts amounted to 1.7 percent o f GDP, which i s almost twice higher than the budget allocation made available to the Federal Ministryo f Health in that year. By 2004 the level o f subsidization seems to have declined considerably. Still, based on partial information, total 2004 budget support received by these three state-owned companies was in the range o f 0.9 percent o f GDP. This i s comparable to the actual 2004 budget spending on the Federal Ministry o f Education, and was higher than the spending on the Ministryo f Health. The power sector parastatalNEPA absorbed more than two thirds o f total subsidies for the group. 1.108 Another major part o f existing subsidies in the fiscal system i s set o f price and tariff subsidies on specific goods and services, primarily petroleum products and electricity. In both cases the government has been facing fierce political opposition to necessary price adjustments and subsidy elimination. There i s also a substantial tariff subsidyprovidedto power generation through under pricednatural gas. 1.109 In the downstream petroleum sector, the Government has embarked on the process o f deregulation, which has helped to reduce subsidies. Prices for petroleum products were adjusted upwards twice in 2005. Prices are currently set by the regulatory agency on the basis o f import cost structure, including margins for transporters, dealers and marketers. However, the government has indicatedthat there will be no further price increases in 2006 from the current level o f about US50 c per liter. 26A separateproblemrelates to the verybroadconcept ofparastatalsusedinNigeriathat mixestogether traditionalgovernmentdepartments(whichare supposedto bebudget funded) and statecommercialcompanies (whichare supposedto beable to cover their financing needsindependentlyfrom the budget). 37 Table 1.18: Federalgovernmentbudget support for selectedparastatals,N million 1. Grants and Quasi-Grants 6,471 5,712 4,166 10,490 Federal GovernmentGrant 500 500 500 500 Portdevelopmentsurcharge 5,971 5,212 3,666 9,390 Governmentpayment for WB Loan 0 0 0 600 2. Tax exemptions Income tax exemption estimate 1,594 36 0 0 Total 8,065 5,747 4,166 10,490 as % of GDP 0.17 0.11 0.07 0.14 NRC (NIG RailwaysCorporation) 1. Grantsand Quasi-Grants 12,780 932 11,583 10,205 Federal GovernmentGrant 2,617 932 3,899 1,637 Federal GovernmentFinanced Projects 10,163 0 7,684 8,567 Total 12,780 932 11,583 10,205 as %of GDP 0.24 0.02 0.15 0.11 NEPA (NIG Electric Power Authority) 1. Grants and QuasCGrants 24,464 65,801 38,207 8,1129 57,849 Federal GovernmentCapita Grant 23,464 47,905 27,040 5,207 46,476 Rural Electrification 1,000 13,500 5,500 0 7,948 Operating subsidy 0 4,396 5,667 3,622 3,425 2. Loans, net inflow n.a. 5,600 7,692 5,498 1,625 Federal Governmentloans, 1/ n.a. 600 788 676 567 Foreign loans obtained through the FGN, 1/ n.a. 5,000 6,904 4,822 1,058 3. Tax arrears (flow) VAT and other taxes, 2/ 1,000 1,273 1,891 2,207 -7 Total 25,464 72,674 47,790 16,534 59,467 as % of GDP 0.54 1.36 0.85 0.22 0.62 loverall total for 3 parastatals,as % of GDP 0.72 I.71 0.94 0.51 0.73 Source: Adam Smith International(2006). Edozien and Abiola (2006). staff estimates. Notes: 1/rough estimate for 2001, 2l rough estimate for 2000.~I 1.110 Until 2006, the petroleum product subsidies remained implicit and were funded directly by the NNPC through a deduction from its payments to the Federation Account. As from 2006, that subsidy mechanism became explicit. The cost o f this subsidy - originally estimated at $4150 bn for 2006 -were shared equally by the federal government and subnational governments and were supposed to be treated as regular budget expenditure rather than as a pre-FA deduction. However, the amounts allocated in 2006 budgets proved to be insufficient, given that world oil prices remained very high, while according to the NNPC its costs o f subsidization in 2005 amounted to W219 bn. The government budget for 2007 provides for clearance o f subsidy payment arrears accumulated in2006. 1.111 Inthe power sector, the tariff rates have remained unchanged for some time. In 2005 the weighted average tariff inthe PHCN (former NEPA) system was only 345.52 per kwh, while a reasonable estimate o f the tariff required for full cost-recovery with an adequate profit margin i s about W7.09 per kwh. It suggests the annual 2005 subsidy to electricity consumers was about 8517.4 bn (0.17 percent o f GDP). As shown further in Chapter 5, a large share o f current government budget support to the power sector could be explained by the losses the sector accumulates due to inadequate tariff levels and sizeable non-payments for electricity by consumers in the public sector. In other words, budget subsidies to the PHCN are largely compensation for distortive government tariff policy andpoor payment discipline o f government entities. 38 1.112 These consumer subsidies are highly distortive and tend to be regressive (i.e. benefit disproportionally those groups that are better off). The government should try to phase them out as soon as there i s more supportive political environment for this measure. E. NON-BUDGET COMPONENTS OF THE FISCAL SYSTEM Federal Extra-Budgetary Funds 1.113 As mentioned above, in line with the constitutional requirements, three extra- budgetary funds (EBFs) are created within the overall share o f Federal government inthe total FA revenues allocated among the three tiers o f the government. These are: (i) Derivation and Ecology Account with revenues o f 1.46 percent o f total net FA revenues; (ii)DevelopmentofNaturalResourcesAccountwithrevenues of3percentoftotalnet FA revenues; and (iii)StabilizationAccount with 0.72 percent o f total net FA revenues. An additional 1 percent o f net FA funds within the Federal government's quota is allocated to the development o fthe FederalCapital Territory (FCT). 1.114 Overall, 8 percent o f the original Federal government share inthe FA is set aside for these purposes and utilized outside o f the regular budget process. This significant amount o f money, estimated to be about N94 billion in 2005, i s close to the value o f the annual savings the Federal government has accrued as a result o f the Paris Club agreement. These three accounts are fully under the control o f the Federal government, and it i s difficult to see institutional or legal constraints that could prevent the full integration o f these funds with the regular federal budget. This should be done without delay to ensure a more strategic use o f the money in line with the overall government fiscal strategy and better public oversight over their spending. Transfer to the FCT should be converted into the regular budgeted transfer, similar to the one that currently exists for the National Judicial Council. 1.115 There are two important management problems that need to be addressed in order to strengthen fiscal management o f these funds. First, most o f the money allocated to these EBFs remain unspent. While utilization had increased in 2004-05 (Table 1.19), by the end of 2005 the accumulated and mostly dormant combined balance o fthe three funds amounted to N62 billion, or more than US$465 million. This money would be better used ifintegratedwiththeoverallcashmanagementsystemofthe government. 1.116 Second, the ultimate objective o f these funds is not well defined. The review of actual disbursements from these EBFs does not suggest that disbursements have been made according to either a specific government strategy or the original fund charters. For instance, disbursements from the Development o f Natural Resources Fund, the largest o f the three, recently included: (i)a loan to the Ministryo f Water to finance construction o f Gurara Dam; (ii) a loan to the Ministry of Power and Steel to pay disengagement benefits to steel workers; (iii)loan to the Ministryo f Foreign Affairs to buy a chancery in Tokyo; (iv) a loan to the Ministry o f Interior to finance the national ID card project, and so on. These are probably important and fully justifiable uses o f government money. However, it remains unclear why such financing should come from the Natural Resource Development Fundandtherefore remain o f fbudget. 1.117 Similarly, a considerable share o f recent withdrawals from the Derivation and Ecology Account was channeled to finance traditional infrastructure projects, such as roads, bridges, and railways upgrading. Such spending should be moved into the regular budget envelopes o fthe respective MDAs. 39 1.118 Insummary, the current management o fthe EBFs creates an impression that they have been used as a special reserve fund for the government to finance regular government projects that by any reason did not get adequate allocation in the regular federal budget. This suggests a major segmentation o f the budget process and should be reformed. Table 1.19: Operationsof the Federal extra-budgetary funds, 2001-05, Nbillion 2001 2002 2003 2004 2005 Total Revenuesof EBFs and transfer to FCT II 47.0 42.7 83.4 78.0 94.0 olw transfer to FCT 8.5 7.5 13.5 18.5 20.0 Total Expendituresby EBFs n.a. 8.6 36.4 105.1 84.2 Total balance,year end n.a. 35.7 80.6 53.7 62.1 Cash Calls: Public Investments in the Oil Sector 1.119 The Nigerian government remains a major shareholder in a number o f joint ventures in the oil sector and provides large annual investment contribution to the operations o f the various oil companies. Government investments in the sector are managed by the NNPC that prepares annual requests for funding on the basis o f consultations with the oil companies. The funding itself called "cash calls" is made on behalf o f three levels o f the government and it takes the form o f deductions from the FA that remain as such outside o f the regular Federal budget. The annual level o f funding reachedUS$4 billion in2005. 1.120 The existing institutionalarrangements for public investments inthe oil sector are the direct legacy o f the military era, and may need to be reformed. Such major items o f public expenditure normally should be subject to the normal approval, reporting and auditing procedures as well as legislative oversight. Recently there has been a clear trend both towards more transparency with respect to NNPC operations as well as towards better management o f oil revenues in general (Box 1.4). The National Assembly has become more proactive in scrutinizing both the cash call request and their utilization. However, firther integration o f cash calls into the regular budget process would provide a stronger legal framework to secure these encouraging new improvements. 40 Box 1.4: EITIin Nigeria The Extractive IndustriesTransparency Initiative (EITI) promotes transparency and accountability with respect to extractive industry payments made by companies and revenues received by governments in oil and minerals-rich developing countries. Implementing EITI in Nigeria will help ensure that oil, gas and mining revenues contribute to sustainable development and poverty reduction. Nigeria is the largest oil and gas producer in Africa, and has taken a leading regional role in makingits petroleumrevenues and contracts transparent.InMarch 2005, the National Stakeholders Working Group hired the London-based Hart Group to audit Nigeria's oil revenues. The audit process is planned to proceed in three stages: (i)a reconciliation of financial information on payments and receipts; (ii)an audit on amounts of oil and gas produced, lifted, lost, refined and exported; and (iii)a review of the industry processes, aimed at making recommendations for improving transparency and efficiency. An Interim Financial Audit Report covering data from 2003 and 2004 was published in January 2006. In addition, the House of Representatives of the National Assembly approved on 19 January 2006 a Transparency Law that includes mandatory annual revenuehax audits of the extractiveindustriessector. Oil companies will be legally required to disclose payments, and the recently established Oil Revenue Monitoring Unit will be made independent of the FMF. Finally, under the EITI umbrella considerable efforts have been made to build the capacity of civil society and community groups to deepen their awareness of the implementationoftheprogram. I 1.121 The existingarrangements for financing cash calls were seenbythe EITIAuditors as being o f an "opaque nature" (Hart Group, 2006). Inpractice, the funds designated for joint venture investments never reach the Federation Account, they are put aside by the NNPC itself before it makes any payments to the FA and excess crude account. Indue course, the NNPC informs both the Central Bank and Federation Account Allocation Committee on the amounts it retained for cash calls funding. As a result, neither the Accountant General nor any other government institution has sufficient capacity to monitor and verify the amounts actuallyretained by the NNPC.27 1.122 A fuller integration o f the oil investments into the budget will also bring the government some immediate savings associated with better cash management. As follows from the NNPC reports, the actual amounts invested by the corporation into the joint ventures recently have been much lower than the funding retained by the NNPC from transferring to the FA (Table 1.20). The balance has been gradually accumulated in the special NNPC account with the CBN, and by the end o f 2005 it exceeded US$1 billion. This large pool o f public money remains underutilized, while the government continues to borrow from the local capitalmarket at the positive real interest rate. ''Thisis actuallyapart of abigger issue highlightedby the EITI auditors- inadequatecontrolby the OAGF over flows (both inflows andoutflows) throughthe FederationAccount. 41 Table 1.20: Government financingof investmentinthe oil sector ("Cash calls"), 2002-05 2002 2003 2004 2005 ~~~~~ A. FedAccount releasesto the NNPC, N bn 74 421 455 532 B. NNPC use of publicfunds, US$ mn 3,634 3,005 3,670 o/w: Cash call 3,089 2,741 3,176 NAPIMS 57 60 60 repaymentof debts to JV partners 488 204 434 C. NNPC use of publicfunds, N bn 458 406 487 Difference,A - C, N bn -37 49 45 Balanceof the NNPCaccountwith the CBN, year end, US$ mn 340 205 598 1,091 Memo: Average exchange rate, N/US$ 17.5.00 176.00 135 71 137.(j Source: OAGF,NNPC, staff estimates. Education Trust Fund (ETF)28 1.123 The Education Trust Fund (ETF; also known as the Education Tax Fund) was established under the Education Trust Fund Act o f 1993 (amended in 1998) with the objective o f improving the quality o f education in Nigeria by mobilizing additional funding for educational facilities, promoting innovative approaches in education, and championing new literacy-enhancing programs. The ETF receives funding from a 2 percent profit tax surcharge on all businesses registered in Nigeria, including oil companies. Operations o f the Fund are managed by its Secretariat, which i s administered primarily with income from the Fund's investments, and supervised by the Board of Trustees. 1.124 Between 2001 and 2004, the ETF received about N53 bn to finance its core activities. Recently its fundinghas been growing quite rapidly due to the strong growth in profits inthe oil sector. The fund revenues in 2005 were estimated to reach N33 bn (0.25 percent o f GDP) compared to N16 bn in 2001 and N10 bn in 2002. In other words, the rate o f expansion in ETF funding by far exceeds the recent growth in the budget o f the Federal Ministry o f Education (FME). In 2003 the ETF budget amounted to only 16 percent o fthe FMEbudget, while in2005 its share was 33 percent, i.e. twice higher. 1.125 The ETF disburses funds directly to educational institutions managed by all three tiers o f the government. According to the Act, these allocations should be broadly percent - secondary, and 30 percent - primary. In addition, the ETF i s empowered to consistent with the following statutory requirements: 50 percent for tertiary education, 20 spend about 20 percent o f the total funds for specific educational programs selected by its Board. Recently, the ETF was active in funding programs to facilitate ICT access in Nigerian education as well as library development. 1.126 The ETF management sets individual funding quotas for educational institutions, which have to submit specific projects requests, to utilize their quotas. Thus the process o f selecting beneficiaries i s non-competitive, practically every one gets some funding, but the average size o f the funded project tends to be small. The ETF has issued a set o f ** This sectioni s basedon Omoregie et al. (2006). 42 guidelines to potential beneficiaries to help them with the preparation o f their requests and with more efficient utilization o f funds. The Fund's Technical Department conducts regular monitoring o f the project sites to assess ifthe allocations are used in line with the agreed project objectives. 1.127 Reportedly, the interventions o f the ETF have been quite successful in terms o f satisfactory completion o f rather important and highly visible projects. Systematic monitoring has been undertaken by the ETF to ensure the appropriate use o f funds. Still, ETFoperations remains completely disconnected from both the normal budgeting process o f its beneficiaries and budget programs undertaken by the Ministry o f Education. ETF support cannot be relied upon as a source o f funding for longer term institutional development o f recipients. Some integration o f ETF grants with the core budgeting arrangements in the sector i s needed. In addition, high dependence o f ETF on petroleum profit tax makes its fundingbase rather volatile. Pension System 1.128 The government recent pension reform, which has been operational since July 1, 2005, brought in a new fully funded pension system based on the system o f individual pension accounts that replaced the system that has been highly segmented, poorly managed andbroadly unaffordable. Inthe long run, this would help to put the pensions on a sustainable footing and avoid the pension arrears problem. The base contribution rates are set at 15 percent o f payroll, split equally between the employer and employee. The National Pension Commission, an independent body set up under the comprehensive Pension Act o f 2004, is responsible for managing the contributions. As o f April 2006, the funds under its management have been accumulating at the rate o f about N35 billion a year.29However, this amount i s expected to increase dramatically inthe short term, given the budgeted size o f federal payroll and assuming a high level o f compliance. The total amount o f annual contributions could be as large as N80 billion, or 0.6 percent o f GDP. 1,129 So far these funds were accumulated with the special account o f the Central Bank and the C B N invested them in treasury bills. InFebruary 2006, the Commission granted licenses to the first five private pension fund administrators, and it i s in the process o f transferring pensionfunds to them for management. 1.130 The primary concern o f the commission relates to the insufficient depth o f the Nigerian capital markets to accommodate the expected inflow o f pension savings. The government has been working on legislationto facilitate growth inmarket capitalization. 1.131 The pension funds, in line with the requirements o f the Pension Act and international best practice, should continue to be kept and managed completely independently from the government budget. However, the government and National Assembly should have the capacity to enforce the requirementso f the Pension Act, which i s basically sound in terms o f the transparency and accountability o f pension fund operations. 1.132 The Pension Commission also made progress with both accounting and securitization o f accumulated pension benefits under the old system for all current federal government employees. All eligible employees (800,000, including those in military and police) will start receiving their retirement benefit bonds within the next 15 months. The 29 This amount seems to be rather low. Based on the size o fthe federal budget payroll and 15% tax rate, the expected collections should be closer to N80 billion a year. The reasons for this discrepancy are unclear. 43 Government i s committed to monetize these bonds at the moment o f actual retirement o f their holders. A retirement fund has been set up in the CBN since 2005 (through annual contributions o f 5 percent o f federal payroll), which i s supposed to finance these bond payments. 1.133 The Pension Commission has established its website (www.pencom.gov.ng) that contains a lot o f legal and regulatory information on the pension reform, pension fund administrators and other reform stakeholders, as well as on major ongoing reform initiatives such a pension verification exercise. However, the website does not provide any systematic statistical or financial data regarding the performance o f the pension system. Broad dissemination o f such financial information along with results o f future audits o f pension funds would be an important step towards high transparency standards o fthe pension system. 1.134 However, the government i s not fully prepared yet to address the full costs o f transition to the new system. Of particular concern i s the lack o f adequate cash flow projections for possible demand for funding associated with the redemption o f retirement bonds. Under the ongoing civil service reforms, it i s expected that quite a number o f federal employees may be retiring soon when the balances o f the government retirement fund in the C B N remain low. The government should be better prepared to handle this potential financial gap, which may be considerable given that the benefits under the old system were rather generous, and because they were entrenched3' the government could not adjust the pre-reform level o f benefits as a part o f its reform package. The Pension Commission should accelerate the development o f proper fiscal projections and modeling instruments and set up realistic plans to finance the gaps insystem duringthe earlier years o f pension reform implementation. In turn, these should be integrated with the broader fiscal scenarios being developed as the Federal Government moves towards planning its budgets within a Medium Term Expenditure Framework (MTEF). F. CONCLUSIONSAND RECOMMENDATIONS 1.135 The main conclusions and recommendations from this chapter could be summarized as following: 0 Since 2001 the Federal government expenditure policy has been much more prudent than it used to be during the earlier episodes o f high oil prices. Fiscal restraint has become a major component o f improved macroeconomic management. 0 Other indications o f the strengthened fiscal discipline include improved budget predictability, although from a low level, and much better transparency in the utilization o fthe FA. 0 The FGN made a strong commitment to resolve the problem o f budget arrears, including pension arrears. This important initiative should be accompanied by steps to strengthen the system o f commitment control and undertake other necessary steps to ensure that budget arrears, once cleared, would not re-emerge inthe future. 30The government has thepower to retrench a redundantpublic officer,butmustprovidecompensationequivalent to a month'spay for every year of service. Inaddition, longservingofficers begindrawingtheir pensions immediatelyon separation. Thus civil servicereforms, whichaimto downsizeoverstaffeddepartments, mayraise the Government'stotalwage andpensionsbillinthe short andmediumterm. 44 0 Nigeria's fiscal system has undergone rapid decentralization. Sub-national budgets, especially o f the main oil producing states, have benefited from a significant growth in available resources. This has created new opportunities as well as risks for improving the delivery o f core services. The government has made impressive progress in establishing and maintaining aggregate fiscal discipline, and there are also signs that the quality o f budget expenditure has started to improve. However, the pace o f quality improvements associated with budget management reforms at the sector level (planning and implementation o f specific projects and programs) has been generally slower than progress inmacroeconomic management. Similarly, progress in addressingpublic service capacity and incentive problems has been slower than expected. This means that visible public benefits from recent oil price increases interms o fbetter services so far have been limited. This creates additional pressures for fiscal expansion. Improvement in expenditure efficiency should be seen as a key priority for the next stage o f fiscal reforms and has to be considered as a central element in the reform agenda o f the next federal administration. It will require a radical change in incentives that government officials face, based on much stronger accountability for rational utilization o f public funds.31 This challenge is even more acute at the state and local government levels. 0 Progress to reduce inherited budget segmentation has been made recently, but it should be further advanced. Too much o f the government's spending, including critical public investments inthe oil and power sectors, still remains outside o f the regular budget process. This segmentation to a large extent reflects the existing constitutional limitations and traditional PFM arrangements. The government should move more aggressively towards budget consolidation. This includes, inter alia, a need for proper incorporation o f external borrowing and other donor fundinginthe federal budget. Changes in the format o f budget presentation would be important to further support government's policy o f fiscal transparency. This change should include a shift to the international standardso fbudget classification. 0 Subsidization o f major parastatals declined but remains significant. As the FGN continues its privatization program, it i s important that an integrated monitoring system to track the financial performance o f parastatals, including non- commercial parastatals inhealth and education, i s put inplace. 31The next Chapter discusses indetail the issues ofbudget accountability within the broader context of PFM reform. 45 2. FISCALMANAGEMENT: ASSESSMENT OF THE CURRENT SITUATIONAND STRATEGICDIRECTIONS FORREFORM 2.1 The government reform team that came to the office in 2003 inherited a substantially weakened budget management system. The legacy o f military regime included poor compliance with existing fiscal regulations, informality and a lack o f transparency in budget practices, outdated concepts o f budgeting, weak capacity and distorted incentives for civil servants. 2.2 Since 2003 the Federal Government o f Nigeria (FGN) has made a significant effort to advance the reform o f the PFM system. Among the major achievements to date has been the adoption o f an oil-based fiscal rule that has greatly improved the quality o f macroeconomic management. Simultaneously, the FGNhas taken important steps toward increasing the transparency o f the budget process, ensuring more efficient cash management, reforming the procurement process, updating the legal framework for PFM, reallocating budget resources in support o f the MDG-related government functions, strengthening monitoring and evaluation (M&E), and introducing a more strategc longer- term focus in budget management. This has helped to reduce waste in public resources, particularly on the capital budget and payroll sides. The impact o f these early measures i s also evident in significantly improved fiscal and broader macroeconomic outcomes. Recent surveys, including those done by the World Bank Institute, suggest that, while corruption remains a serious problem, since 2002 there has been a considerable reduction in bribery, particularly in the area o f public procurement, and tax and permit administration (Kaufmann, 2006). There i s no longer the systemic looting o f public resources that characterized the military rule. Nevertheless, current reforms will need to be sustained and accelerated in order to ensure that the Nigerian public receives good value for publicly spent money. 2.3 This chapter assesses the current P F M practices against two types o f benchmarks. First, the current fiscal management performance is reviewed against recommendations made by earlier World Bank reports such as the Public Expenditure Review (PER, 2001) and Country Financial Accountability and Procurement Assessments (CPAR, 2001 and CFAA, 2000). Second, an assessment is undertaken against the benchmarks o f best international practices suggested within the PEFA performance management framework (PEFA, 2005). The mainpart o fthe chapter focuses on a detailed descriptiono fpriorities for further government PFMreformefforts. A. PERFORMANCEINLIGHT OFTHE RECOMMENDATIONS OF PREVIOUS WORLD BANKREPORTS 2.4 Table 2.1 summaries progress made within the public finance area against the recommendations o f the World Bank Public Expenditure Review PER (2001) and Country Financial Accountability Assessment CFAA (2000). As can be noted from the table, overall progress o f reforms has been uneven. The government made important advances in several areas, including macro and debt management, budget formulation, and procurement reform. Less progress, however, was made with respect to capacity building, including in the Budget Office, and in such key areas as budget execution systems and financial accountabilitythrough reporting, monitoring, and disclosure. 46 Table 2.1: Progressin ReformingFederalPFM System ReviewedagainstSome Core RecommendationsDevelopedinthe PER ( 101) and C F f i (2000) Risks/ Issues CFAA (2000) & PER (2001) Progress to Date Recommendations Oil windfall revenuesare PER: Create technical The government introducedan oil price poorly managed committee to examine feasible based FiscalRuleand accumulated savings options sizeable savings from oil windfall. Sub-national governments PER: Sendclear messageto CBNmodified provisioningrules for face ariskof accumulating domestic financial institutions commercialbanksto reducetheir debts that are beyondtheir andto subnational incentivesto lendto states. capacityto repay governmentsthat they are fully Practice of deductingdomestic debt responsiblefor their lending service obligationsof states from their andborrowing decisions statutoryallocationswas not fully PER: Endcurrent practiceof discontinued. deductingdomestic debt The new Debt ManagementOffice service obligationsof states (DMO) was established,which greatly from their statutory allocations increasedgovernment capacityto PER: Strengthendomestic and manage public debt. However, so far the external debt reportingsystems DMO's priority focus has beenon strengtheningexternaldebt management. New externalborrowing guidelines were approved, but their enforcement remains to be enhanced. Budgetprocessdoes not PER & CFAA: Seek better A consensus onthe respectiveroles of achieve the goals of fiscal understandingbetween the executive and legislatureinthe discipline, allocative and executive andlegislatureon budget process is still evolving, which operationalefficiency role ofthe latter inthe budget limitsprogresstowards stricterbudget process discipline. PER & CFAA: Movetowards Noticeableprogresstowards fiscal an integrated, policy strategy, budget integration, responsive, reliableandtimely establishmentof arealisticMTEF and budgetwithin amediumterm timely passingofthe AppropriationBill expenditure framework was made. (MTEF) Establishment of BPMIUresultedin PER: Strictly enforcenew major improvements inthe enforcement procurementregulations of federal procurementrules. PER & CFAA: Strengthen As apart ofthe Debt ReliefGain classification,monitoring and program, in2005 the FGN launcheda evaluationofbudget major effort to upgradeits M&E system, implementation which is currentlyinthe design and PER: Clean up capital launchphase. programs New budget classificationintroducedfor CFAA: Improveinter- 2005 budget, including improved governmental fiscal relations, disaggregationof capitalexpenditure. fiscal policy coordination, and Furtherimprovements neededto fully reportingto Federallevel by meet internationallyrecognized states information requirementsand standards. The public investment program remains segmented. Some improvementinaggregate fiscal reporting. FiscalResponsibilityBill aims at improving intergovernmental coordinationand monitoring. Budget institutionsare PER: Consolidatebudget Consolidationofbudget functionsinthe fragmented and weak functionsinthe Budget Office BOF was mostly completed, but its PER: Create abudgetofficers' capacityremainsweak. cadre No budget officers' cadre was PER:Comtwterizebudget established, BOF i s mainly staffedwith 47 RisksI Issues CFAA (2000) & PER (2001) Progressto Date Recommendations activities generalistsfrom the commonpool of PER:ReconfigureNPC into a civil servants. Ministry of Economywith Insufficientprogresswith responsibilityfor development computerization. strategy andpolicy The NPCmandatestill needs clarification, inparticular with respectto its role in the budget process. Accountability inpublic PER: Makebudget documents Some progresswas made inimproving spendingis weak readily availableto public general accessibilityof budget PER: Subject first charges to information. normalbudgetary screening Significantparts of federation account process allocationsremainoutside ofthe regular PER & CFAA: Make final budgetprocess(althoughthere are accountsregularlyavailableto constitutionallimitations for achieving PAC full budgetconsolidation). CFAA: Improveperformance Efforts are under way to reducethe orientationandintroduce backlog, but the 2001accountsare still performance measurementin the latestthat were submittedto PAC. budgetingand implementation Accounts for 2002,2003 and 2004 have reportingsystems beensubmittedto the Auditor-General. PAC meets on aregularbasis andthere i s improvedcooperation with Auditor General. Since 2005 executingagencies are requiredto develop strategic goals, objectives, performancemeasures, and improvedcostingoftheir budgets. Sector performance indicatorswere integratedin2007-09 MTSS. Ineffective PFM Regulatory CFAA: Updatethe Regulatory A new Finance(Control and frameworksand lack of a Framework- reissue the Management) Bill was prepared, PFM improvementplan FinanceAct 1958; Audit Act reviewedby stake holders and submitted 1958; RevisedFinancial to the AGF inAugust 2006. Regulations 1999. FiscalResponsibilityBill i s in CFAA: EnforceLegislation legislativeprocess. andRegulatoryRequirements Improvedenforcement of legislative CFAA: Developand requirementsthroughimprovedsystems, implementaPFMreform training and implementationofAuditor program General/PACrecommendations. SpecificAgencies (EFCC & IGPC) establishedand activeininvestigation andpromotionof disciplinary action. Weak budgetexecution CFAA: Improvemanagement Cash ManagementCommittee(BOF, systems and controlsystems for OAGF and CBN) establishedto improve revenue, cash, commitments coordination, basedon improvedcash and expenditure forecasting systems. Commitments are CFAA: Establisheffective now cashbackedandtimely cash internalaudit system releasesmore consistentwith the CFAA: Improveaccounting, Budget. Further strengthening is needed reportingandmonitoring onthe technical aspects of cash systems. Clear backlogof management. FinancialStatements ERGP also supportseffortsto computerizeand cleanthe payroll, with BPSR providing further restructuring andpayreview exercises. eThe GIFMIS project will implement improvedfinancial control, accounting 48 Risks/ Issues I CFAA (2000) & PER(2001) Progressto Date Recommendations andreporting systems andcapacity for managementofrevenue, expenditure, assets and liabilities. Recruitmentof qualified accountants has improved,the Treasury School has beenaccredited to the Abuja University and acurriculum developed, but much remainsto be done to implement effectivetraining systems. Weak external auditing CFAA: Improveeffectiveness Positiveenvironmentfor use ofAudGen systems of Auditor-General's Office work through EFCC/ICPCregulatory though an improvedlegal framework, resourcesand staffing.A framework, capacity and audit number ofhighprofile cases relatingto operations ministers/top civil servants incourt or CFAA: Improve subject to executivediscipline. responsivenessto Audit New Audit Billis in legislativeprocess. queries andreports Muchremainsto be done to strengthen staffing, other resources, and work methodsinthe Auditor-General's Office. Responsiveness to Audit queries and reports needs further improvements. 2.5 Inearly 2005 the World Bank (2005c), as part of the preparation of the Country Partnership Strategy (CPS), also made a "light" assessment o f Nigeria's progress in areas of fiscal accountability arrangements relative to the recommendations o f the CFAA (2000). The keyfindings ofthis assessment could be summarized as follows: 0 Political commitment to the reform process has been strong within the top level of the government, although in some areas this has yet to translate itself into a hlly articulated development plan. 0 The reform program is still in its initial stages, but its impact has already been significant on particular aspects o fthe PFM operations. 0 While most areas of PFM continue to show weaknesses, these weaknesses in most cases are recognized by the government, and appropriate reform efforts are either ongoing or are planned. 0 Overall, despite recent progress, the fiduciary assurance environment in the FGNremains weak. 2.6 We believe, and as we show later in this chapter, that the above assessment, although almost two years old, remains fairly accurate with respect to the current status of the PFMreforminNigeria. 2.7 The above mentioned report highlighted several areas in which noticeable progress was made after 2000, includingthe rationalization of government accounts, the restructuringof the OAGF, the setting up of the DMO, the partial automatization of the CRF operations, and progress in upgrading budget classifications. At the same time, the report identified particular areas in which the reform progress requires further strengthening: slow computerization of the accounting processes, weak commitment 49 control, weak internal control systems, lack o f effectiveness in external audit, ant the inadequate response o fthe executive to audit findings. 2.8 The above findings are also consistent with the assessment made during the preparation o f the World Bank financed Nigeria Economic Reform and Governance Project (ERGP, World Bank, 2004b). The project design provides more than US$50 million to address the main weaknesses in the financial management systems (see Box 2.1), with special emphasis on strengthening the external audit function and computerization o f the budget process on the basis o f GIFMIS. On the latter, the project document suggested a detailed incremental strategy for GIFMIS implementation. However, to date progress with the implementation o f this ERGP component has been modest. Additional implementation skills are needed to main counterpart government agencies, as are strong project champions at the technical level to drive the change on a daily basis. Both these drawbacks limit the utilization o f opportunities provided by the ERGP. Box 2.1: Summary of Conclusionsfrom the Preparationof the EconomicReformand Governance Project The Federal Government's financial management and accountability systems require further strengthening in several respects: The expenditure control and accounting systems are essentially manual The delays inthe preparation and submission of budget reports undermine the efficiency of budgetary control and management Annual financial reports do not comply with internationalstandards The treasury systems are weak, which contributes to unpredictability inbudget funding Departmental supervision and internal control are weak, and there is substantial wastage of funds There is weak demand for control and accounting from the accounting officers Budget holders are not heldaccountable for their use of funds Source: World Bank (2004b), p. 25. B. MAINPFMTRENDS: SUMMARY OF PEFAASSESSMENT 2.9 The trends inthe Nigerian P F M system were reviewed against the earlier findings reported above and 28 performance indicators developed within the PEFA (2005) framework32.Summary Table inAnnex 1provides an overview o f the main findings. The following section o f this Chapter presents a more detailed description, informed by the PEFA analysis, o f the current situation in particular PFM areas, including ongoing changes, as well as additional recommendations for accelerating the reform process. Annex 1contains an indicator-by-indicator presentation o f PEFA diagnostic results. 2.10 The main emphasis in the PEFA analysis was on an evaluation o f current trends and identification o f the immediate priorities to move forward, not to produce the set o f explicit scores. Still, it i s worth mentioningthat, from a PEFA perspective, the single best functioning component in the Nigerian PFM system i s the mechanism o f fiscal transfers to states from the federation account (Performance Indicator 8, [PI-8]). The allocation formula for federation transfers i s clear and stable, while disbursements are made regularly, based on the agreed schedule. 32Issues coveredby indicators 1-4were discussed inChapter 1. 50 2.11 Ingeneral, the diagnostic confirmed a broadtrend toward a system-wide upgrade, reflecting strong commitment o f the government to policy reforms. In more than half o f 28 PEFA individual areas there has been noticeable improvement over the last few years inbothperformance as well as underlyingsystems. 2.12 At the same time, the analysis suggests that in most cases the above improvements have been rather modest. Moreover, because the initial pre-reform level was extremely low, even after several years o f reforms the PFM system remains in need o f substantial strengthening. Overall, if a strict PEFA scoring system were to be applied, it would likely highlightthat Nigeria is unable to meet the minimumPEFA performance requirements (Grade C) for a large part o fthe indicators. 2.13 Areas o f recent improvement include: budget classification (PI-5), the comprehensiveness o f budget documentation (PI-6), public access to budget information (PI-10), the transparency o f taxpayer obligations (PI-13), the effectiveness o f taxpayer registration (PI-14), the management o f cash balances and debts (PI-17), and the quality o f in-year budget reporting (PI-24). 2.14 At the same time, indicators or their components where performance remains weak, and where little material progress has been made recently include: the incidence o f government spending that remain o f f budget (PI-7), the consolidation o f fiscal data for enlarged government (part o f PI-8), the oversight o f fiscal riskrelated to the operations o f state enterprises (part o f PI-9), the control and collection o f tax arrears (part o f PI-15), the availability o f information on funds received by service providers (PI-23), the timeliness and quality o f annual accounts (PI-25), and quality/depth o f legislative scrutiny o f the budget (PI-27). 2.15 Overall, despite various ongoing reform initiatives, the government remains at the early stages o fupgrading its PFMsystems. Furthermore, it i s worth noting that the reform progress summarized above has been largely concentrated at the federal level. While some states have embarked on similar reforms (e.g., due process in procurement, budget transparency, and the MTEF approach in budgeting), this effort by states i s neither widespread nor comprehensive at the state level. Chapter 3 gives a broad overview o f the trends inPFMat the state level. c. STRATEGIC DIRECTIONSFORREFORM Acceleratingthe Transitionto a New BudgetModel 2.16 The direction o f PFM reform in Nigeria could be described as a combination o f two thrusts. The first i s the restoration o f basic capacities and accountabilities allied with the progressive replacement o f manual with modem IT based financial management systems. The second is a transition from the traditional paradigm, centered on the concept o f the Rolling Public Investment Plan (PIP) and dual budgets, to a new paradigm, which entails loolung at both parts o f the budget together, within a Medium Term Expenditure Framework (MTEF). Eventually, this could lead to the Federal Government's preparing its budgets on a program basis to strengthen the focus on service delivery. The old paradigm no longer functions as it once did, and with it the country's PFMsystem has lost important elements o f budget discipline associated with the formal time, the FGN has not moved to a programmatic budget structure -- before such a project cycle and its built-inappraisal, monitoring and evaluation processes. At the same transition to the new paradigm can be safely contemplated, several weaknesses need to be 51 addressed in critical areas, including expenditure control, fiscal reporting, internal auditing and accounting. 2.17 As a result o f this, the spending units o f the FGN still operate some important elements o f the traditional dual budget system, but without the benefits o f a disciplined project cycle, including critical appraisal o f projects before including them in annual budgets and effective monitoring and evaluation o f their implementation. In its place has come a system, in which incentives o f civil servants were seriously distorted. The justification for capital spending i s often weak, while the monitoring o f both spending and actual progress with the implementation (especially for multi-year projects) i s even weaker. This has resulted in a build up o f partially completed low value development projects at all levels o f government. 2.18 Moreover, the new model o f service delivery rather than capital investment led budgetingi s still being defined, and the transition has not been a smooth progression from one functioning budget system to a better one. Rather, the starting point for reform has been a weak system o f budgeting, inherited from the military era, so that the reform o f the budget systems has had to proceed in parallel with the re-establishment o f the basis o f good financial management. The reform process has been further complicated by two additional constraints. The first i s the depleted capacity o f staff inthe central management agencies, compounded by inadequate pay and poor working conditions. The second has been the tremendous daily pressures o f budget management in an environment when the reform team has had to deal with the inherited burden o f major fiscal and institutional problems, such as large one-time payments associated with structural reforms, pension and contract arrears, uncompetitive procurement, payroll leakages, external debt relief, etc. Not surprisingly, all this has greatly complicated the transition to the new budget model. 2.19 T h i s section describes the changes that are taking place to form a new model o f budgeting, and the further steps that need to be taken. Since both across and outside o f the government the understanding o f the direction o f the budget reforms i s quite low, the section begins by describing the traditional budget model. This remains the reference point for many officers, and it i s necessary to explain the pathology o f its breakdown and why something other than restoration is required. The TraditionalModel: National Planning and Dual Budgets 2.20 For at least four decades the Federal Government presented to the National Assembly a budget that had a dual structure, with separate sets o f estimates for the current and capital budgets. The year 2006 i s the first year since independence in which current and capital spending estimates have been presented in a single volume, showing both types o f spending under a single vote for each ministry, extra-ministerial department and agency.33 2.21 In its heyday, the dual budget model, as followed in Nigeria and many other developing countries in the 1960s and 1970s, was part o f a broader system o f national development planning. Such plans reflected the development consensus o f the times, namely, that the public sector should play the leading role in the economy, and that special emphasis should be placed on public investment as the catalyst for growth, economic development and social transformation, including the provision o f basic social 33Evenin2006, the AppropriationBill showedthe two separately: Part C-Recurrent (Non-debt) Expenditure, andPartD-CapitalExpenditure. 52 needs (the forerunner o f present day MDGs). National planning agencies (like the NPC) took a lead in preparing five year development plans, typically comprising: (i)a macroeconomic framework, commonly driven by an investment-led growth model; (ii) a set of sectoral policy chapters describing the policies and intended programs o f the main government agencies; (iii)a fiscal plan showing the evolution o f the budget and its financing over the plan period; and (iv) a public investment program (PIP), listing all development projects, both ongoing and new, with their planned spending phased over the plan period. 2.22 Politicians liked five year development plans because they could talk to their constituents about the projects that would be implemented. Government officials liked the plans because they were expansionary and underscored the importance of government. Budget-makers liked them because the fiscal chapter provided an aggregative framework for annual budgets and the public investment program simplified the preparation o f the capital budget. Donors, such as the World Bank, liked the plans because they displayed a pipeline o f projects which could be selected for external financing. Even when donors came to be critical o f national planning, the PIP was still thought o f as a useful instrument, and the Bank continued to review countries' PIPSuntil quite recently.34 And for the first decade or so aRer independence, the model seemed to work in many African countries, delivering respectable economic growth and successfully laying down the physical and social infrastructure for what became termed the "development state." 2.23 Organizationally, the dual budget model in many cases, including that o f Nigeria, was associated with a split inresponsibilities for annual budget preparation. The FMFhad the responsibility for the current budget and the NF'C put together the capital budget, including issuingthe guidelines for the preparation o f investment projects and appraising them before their inclusion inthe Rolling Plan. It i s worth noting, however, that this split persisted longer in Nigeria than in most other countries in the region, where the finance ministries took over both functions, either as a result of planning merging with finance or through the demise o f planning and growth inthe power o f the finance ministry.35 2.24 Underpinning the national planning/dual budget model were certain preparation disciplines. First and foremost was the macroeconomic framework and its associated fiscal plan for the government's budget. If the plan was realistic and adhered to, ministries could see the resources that would be available to them in future years, both current and capital, and in this sense the model had some attributes of an MTEF. Underpinning the PIP was the discipline o fthe project cycle, usually articulated ina set o f guidelines issued by the planning agency on project identification, preparation, cost benefit calculation and appraisal, and implementation monitoring and evaluation. And projects were linked to the fiscal plan (i.e., departments had to demonstrate that the incremental recurrent costs o f projects could be fitted within their projected recurrent budget envelopes). Most o f Nigeria's planning and budgeting staff were reared in this system. The Unravelingof Dual Budgets 2.25 T h i s model o f planning and budgeting, however, began to unravel in many countries from the 1970s onwards. It had several fundamental flaws. First, it was 34One ofthe last of its kind, the CapitalProjectsReview, was camed out by the Bank for Nigeria in2001. 35Insome countries inEast Africa, suchas Tanzania andUganda, the governments went through cycles of merging Finance and Planningand separatingthem. 53 relentlessly expansionary for government spending. This was because o f the underlyng macroeconomic model that over-emphasized the role o f public investments, coupled with the tendency o f politicians and planners to be over- optimistic about growth targets and budget financing. This led to the inflating o f the PIP, thus delayng the completion o f projects and the enjoyment o f their benefits. Second, the system encouraged departments to underestimate the incremental recurrent costs o f projects, which resulted in the subsequent underfunding o f operations and maintenance expenditures, further diminishingproject benefits. Third, few countries sustained the discipline o f a strong project cycle with careful scrutiny o f project costs and benefits before they were begun. This caused ex post project returns to be much lower than expected, and "white elephants" began to appear inthe PIP. Fourth, it discouraged departments from thinking o f the recurrent and capital portions o f their budgets in an integrated way. Instead, it engendered capital budget bias - the beliefthat capital budget spendingin some way was inherently more "developmental" than current budget spending.36 Fifth, with their public sector bias, national plans tended to be associated with policies that reduced the space for private sector growth by absorbing too much bank credit and also through either excessive regulation or outright nationalization. This further limited economic growth and thus deprived governments o fthe revenuesneededto finance their ambitious plans. 2.26 There then followed, in many countries, a spiraling down o f the national planning/dual budget model. The tightness o f revenues caused recurrent spending, other than that on the wage bill, to be curtailed. Maintenance and routine equipment renewal were neglected, which resulted in deterioration inpublic assets. Inturn, this led to a new sort o f project appearing in the capital budget - renewal and rehabilitation schemes. Service delivery suffered, as underpaid staff began to regard what remained o f operating budgets as an opportunity for pay enhancement. Project preparation and monitoring standards slipped, and the development value o f the capital budget declined further. The orderly release o f funds to all budgeted projects gave way to cash rationing, which prioritized debt servicing and salaries, as well as releases to selected (but not necessarily the most important) projects, leading to a buildup o f incomplete projects and arrears to suppliers and contractors. Without the routine o f periodic policy evaluation and plan updates, sector policies lost definition, while policymaking became opportunistic and de- linked from costs, with departments petitioning for additional funds to meet needs rather than managing priorities within the existing resources. The expansion o f spending commitments caused countries to enter into a cycle o f unsustainable debt buildup. 2.27 The trajectory o fthe budget system decline inthe past inNigeria demonstrates all o f these pathologies and more. Inparticular, the most serious capital budget bias, with its disconnect between recurrent and investment spending, found its way into the culture o f budgeting in Nigeria. The present focus o f budgeting, reinforced by the incentives o f civil servants, is rooted in the project paradigm, which stimulates the expansion o f new construction without paying sufficient attention to the proper financing o f the operations and maintenance costs o f the existing facilities. In the late 90s the volume o f capital spending inthe federal budget exceeded the volume o f recurrent expenditures. Since then a significant adjustment has been made, and budget resources have shifted from capital to non-wage O&M spending. Still, the ratio between capital and recurrent non-debt federal spending as proposed inthe 2006 Appropriation Bill i s as highas 56 per~ent.~' 36This beliefinthe developmentalsuperiority of capital spendingpersistsinNigeriatill today, for example, inthe FRBwhichgives priority to capitalspendinginthe useof excess oilproceeds. "Infact,thisratiounderestimatestheactualgovernmentcommitmenttocapitalspendingbecauseitdoesnot includelarge off-budgetinvestmentspendinginthe oil andpower sectors. 54 2.28 Moreover, the concept o f the capital budget in Nigeria eroded with time. The capital budget became an amalgam38 o f (i)new equipment shopping lists, (ii)the rehabilitation, renovation and repair o f existing public assets, (iii) new construction, and (iv) some purely recurrent activities, which have found their way into the capital budget. These latter activities were driven in part by a desire to obtain additional expenditure flexibility, but in part also by a genuine misunderstanding o f the concept o f capital spending.At all levels o f government, the paradigm o fbudgeting for service delivery that seeks the efficient combination o f current and capital resources has yet to be fully developed. Towards a New Planning and BudgetingModelfor Nigeria 2.29 Restoring the traditional national planninddual budget model to its former working order would have been an improvement on the situation that the economic team found in 2003. But it would have been unsustainable because o f its internal dynamics, and inappropriate because o f the global shift away from a public sector led model o f development. Thus, the ongoing transition to the alternative model, based on the principles outlined inthe government reform program and listed below appears to be the most sustainable strategy for Nigeria: A fiscal strategy aimed at ensuring that, ina mineral-based economy, the budget i s not entirely pre-determined by the highly unstable level o f current revenue, thereby controlling aggregate spending, the budget deficit, and the share o f national resources absorbed by the public sector. This is to be achieved by anchoring the fiscal strategy in a fiscal rule, which binds the executive and the legislature to prepare budgets on the basis o f the long run price of oil, while sterilizing temporary additional oil revenue in an excess crude account. A medium term expenditure framework (MTEF) that strengthens a strategic dimension o f the budget process and at the same time disciplines policymalung with costs and availability o f funds. The MTEF is an efficient instrument for facilitating explicit discussions on budget priorities, ensuring that resources are allocated to the agreed priorities within the annual budgets, and providing for the predictable fundingo f approved programs and projects on a multi-year basis. Greater integrationof the current and capital components o f MDA budgets, to ensure that decisions on current and capital resource allocations are made from the perspective o f improving service delivery. The introduction o f medium term sector strategies (MTSS) to encourage MDAs to better define their goals and objectives, identify priority programs, focus available resources on them, and set targets and measure performance. A new budget preparation timetable to allow for the in-depth discussion o f government fiscal strategy and program priorities in advance o f the preparation o f the detailed estimates. The aim would be to strengthen the strategic focus o f 38Itis worthnotingthat the integrityofthe capitalpartofthe 2006 AppropriationBill improveddramaticallyas a resultofrecentchanges inbudget classificationas well as ofmuchstricter supervisionofsectoral submissionsby the BOF. Still, the 2006 capitalbudgetcontains a number ofpurelyrecurrentitemssuchas the fundingof various studies andstrategies, audits, conferences, monitoringexercises,promotionalcampaigns, etc. However,the most obvious examplesof classificationdistortionstypicalof the previouscapitalbudgets (e.g.,financingof various subsidies) havebeenremoved. 55 public spending, and at the same time to build consensus among stakeholders, so as to enable a quicker and less conflict-ridden approval o fthe Appropriation Bill. Strengthening cooperation between the legislature and the executive in the budget process. 0 Support for budget execution through the modernization of financial management systems, and the improvement o f budget classification, cash management, fiscal reporting, monitoring, procurement, and internal audit and accounting. Greater accountability and transparency inthe budget process to ensure better public access to budget information, the expansion o f public consultations, and broader civil society participation inbudget monitoring and evaluation. The remainder o fthis section discusses some o f these developments in greater detail. 2.30 Fiscal Strategy Based on a Fiscal Rule. Against the background o f sharply rising international oil prices, the Federal Government has, since 2004, sought to base annual budgets not on forecast revenues but on what revenues might be under assumptions reflecting the average long run price o f oil, while it proposed to sterilize additional oil revenues in an excess crude account at the Central Bank. Thus, in 2004, the budget was put together on the basis o fan assumed oil price o fUS$25 a barrel. In2005 the reference price was US$27, and it subsequently increased to US$30. For 2006 the budget reference price was originally US$33, which subsequently increased to US$35. 2.3 1 These have been administrative decisions which have prevented the budget repeating the boom and bust cycle o f the previous decade, while at the same time enabling foreign exchange reserves to be rebuilt and external debt reduced. To make the process statutory, a Fiscal Responsibility Bill (FRB) has been drafted and i s now before the National Assembly. When passed, it will bind both the executive and the legislature as well as subordinate tiers o f government to preparing their budgets within a Federation- wide MTEF, based on the fiscal The FRB also introduces a debt management framework, limiting borrowing to capital expenditures and human development, and requires a stock o f government debt to stay within a sustainable share o f national income determined by the Minister o f Finance, overseen by a Fiscal Responsibility Council, with sanctions for offending governments. 2.32 T h i s i s an extremely important piece o f legislation which should contribute greatly to orderly and predictable budgeting at all levels of government, and its implementation i s Nigeria's best insurance against a future run-up o f unsustainable debt. Assuming that it is passed by the National Assembly, FMF will need to make a substantial effort to explain how budget preparation will work for state and local governments and also to develop, consult and disseminate the required MTEF, which will become the foundation for budget-making by all governments in Nigeria. State governments, on their part, will have an important role to play in assisting local governments to comply with the new requirements. 39The FRB proposesthat the expenditure frameworkbebasedon a pre-determinedCommodityReferencePrice for oil. All tiers of governmentmustplantheir budgetswithin the framework. Excessoil proceedsare to be saved by eachgovernmentbybeingdepositedinseparate accountsinthe CentralBank, andmaybedrawnupononly if the oil pricefalls belowitspre-determinedlevel; however, a portionmaybeusedinthe followingyear for capital projects. 56 2.33 Critical to the smooth workings o f the fiscal responsibility legislation will be the way in which the FMF carries out the developments o f the MTEF and builds consensus around its fiscal strategy. This needs to be done in a way that yields a level o f total revenues that grows steadily over time, delivers sustainable and predictable budgets, commands the confidence o f budget stakeholders at all levels, and results in a level o f consolidated government spending that i s consistent with a stable fiscal and monetary policy. Fortunately, within limits, the Minister o f Finance has some flexibility in setting MTEF parameters and, if necessary, would be able to fine tune the provisions o f the FRB.40The appointment o freputable and experienced people to the Fiscal Responsibility Council, which will monitor the implementation o fthe law, will be key. 2.34 Medium Term Expenditure Framework. The FMF has made a serious commitment to prepare and maintain a medium term perspective for annual budgets. The year 2007 i s the fourth year in a row that the BOF has announced the preparation o f budgets on this basis. Since 2004, the FMF prepared the government's Fiscal Strategy Paper annually, shared it with the Federal Executive Council and the National Assembly, and used it for annual budget preparation. Most recently, the call circular for 2006, for the first time, gave spending ministries and departments a single ceiling for their combined recurrent and capital spending in an effort to encourage them to see the two parts o ftheir budgets as a single whole and thus optimize their expenditure structure. As mentioned earlier, the Fiscal Responsibility Bill contains a requirement for the preparation and regular update o f the MTEF for the entire Federation to consist o f the following elements: (i)a Macroeconomic Framework projecting the main macroeconomic aggregates o fthe economy over the next three years, (ii) a Fiscal Strategy Paper describing the fiscal policies and developmental priorities o f the FGN, and (iii) and Expenditure and Revenue Framework. Such an aggregate fiscal framework for all tiers o f government has yet to be developed, and inturnwill require a substantial improvement in in- and end-year reporting on budget execution by states and local governments to the FGN. 2.35 Duringthe 2007 budget process, the BOF, based on several accomplishments of the previous years, has further developed the MTEFbuildingblocks, including (i)fiscal a framework, which is focused on the main fiscal aggregates and the financial and economic assumptions that underlie these aggregates; (ii)and expenditure framework comprising a set o f expenditure envelopes for the main spending departments, disciplined by the aggregate spending constraints; and (iii)clear links between medium term framework and annual expenditure ceilings. The major innovation o f the 2007 budget cycle was the introduction o f 3 year indicative expenditure envelopes (2007-09) for all MDAs, as reflected in their sector expenditure strategies. In addition, separate budget envelopes were introducedto ensure financing o f major reform initiatives such as a public service reform. 2.36 Future strengthening o f the MTEF will need to address the following challenges that exist: Inthe environment o f highoil prices and significant pressing expenditure needs, the FGN so far has found it difficult to stay within the expenditure limits, introduced by its own Fiscal Strategy documents. Table 2.2 shows that between the preparation o f its Fiscal Strategy papers in 2004 and 2005, the FGN 40While the Commodity Reference Price i s basedon a moving average of several years of oil prices, the Minister can vary the resulting amount +/- 5 percent. Furthermore, the Minister should have some flexibility inmaking forecastsof future oil production. 57 substantially relaxed its expenditure policy. Total MDA expenditure targets for 2006 increased fiom 8.2% o f GDP (as was envisioned in the 2004 Fiscal 2006 federal budget was further expanded - the overall MDA envelope reached Strategy) to 9.7% (per the 2005 Fiscal Strategy). Moreover, actually approved 10.5% o f GDP. This suggests that, inaddition to the oil price fiscal rule, the FMF should also contemplate targeting the share o f government spending in GDP, since too rapid growth in spending could strain absorptive capacity, raise construction prices, and, ultimately, affect the structure o fthe economy. Additional effort will be needed for strengthening the process o f justification o f MDA expenditure envelopes, which should be based on the accurate costing o f existingpolicies, as well as linked to the efficiency o f budget spending withinthe existing programs. This will require improvements in both the quality o f cost data used for budgeting and monitoring and evaluation (M&E) o f budget spending. Currently, the cost data appear quite weak and they are not collectedshared in a systematic way. This creates uncertainties about what the delivery o f any policy or program should cost to the budget. Additionally, there i s a need to improve integration o f the results o f M&E in budget planning and resource allocation decisions. As was successfully tested during the preparation o f 2007 budget, a fully articulated MTEFprovides a strategic vehicle for consultations with the National Assembly and other stakeholders on spending priorities, ahead o f the submission o f detailed estimates. This practice o f strategic consultations on expenditure priorities early in the budget cycle needs to be institutionalized. In the course o f such consultations, the FMF should be firm on the aggregate expenditure constraints but flexible on sector shares and how MDAs allocate the resources within their envelopes, provided that these allocations are broadly reflective o f government priorities and are in compliance with the agreed costs o f implementing priority programs. Respectively, decisions on medium term expenditure priorities (in the form o f 3 year envelopes) should be explicitly communicated to all stakeholders through both the Fiscal Strategy Paper and the call circular. To build credibility, the 3 year envelopes need to be hard constraints, alterable only in the context o f a politically approved trade-off with another use o f funds. A fiesh look should be taken at the provisions o f FRB Section 39(7), which permit unlimited use o f excess crude revenues accumulated in one year for spending on capital programs the following year. This undermines the purpose o f the FRB and the MTEF through a return to the boom and bust spending cycles o f former times, triggered by oil revenue spikes. 58 Table 2.2: Evolution of federal government expenditure plans, 2004-06 11,800 14,575 14,575 14,575 13,600 15,528 Source: Staff estimates based onthe data from the BOF and IMF. 2.37 Greater Integration of the Current and Capital Parts of the Budget. Giving MDAs a single call circular resource envelope is the first step in integratingthe two parts of the budget. Many MDAs may not take advantage initially of the opportunityto shift funds between current and capital and vice versa because of inertia and because of complicated motivations within the existing transitional budget arrangements. At the moment,becausethe tighter procurement regime under "due process" applies only to the capitalside ofthe budget, it creates a perverseincentive for departments to shift spending backto the relativelymore laxlypolicedcurrent part oftheir budgets. It will be necessary to control for this bias and to ultimately ensure that the same procurement discipline applies to all parts of the budget. Meanwhile, much progress remains to be made for addressing the bias for capital spendingthat persists from the old dual budget paradigm, despiterecent effectiveeffortsbythe BOFto containthis bias. 2.38 Induecourse(andthis step shouldnotberushed, since it entails amajorculture change and must proceed in parallel with further financial management reforms), the budget should be restructured along program lines, completingthe integrationof current and capital spending and more closely linking policies and spending. All OECD countries and many middle income countries, including South Africa, organize their budgets along programlines, and eventuallyNigeriawill needto make the transition. It involves a major shift inbudgetingfrom spendingto create assets to spendingto improve service delivery. The new objectiveof the Ministry's capitalbudget will needto become to finance the incremental capital costs of existing and new service delivery policy. It will mark a paradigm change in the way government i s managed, and require new staff skills and incentives, and a change in how politicians view budgets. The preparation process of 2007-09 MTSS filly recognized a need for this transition to a programmatic budgeting and for several sectors (e.g. in aviation) the efforts were made to examine sector expenditure within a programmatic structure, making an important positive development. Efforts are also underway to integrate performance indicators into the sector strategiesofvarious ministries. This needsto be accompaniedby a cultureshift, in which MDAs move from looking at their spending in terms of implemented projects to viewing budgeting as a tool for effective service delivery through a combination of current wage andnon-wage,transfers, andcapitalspending. 2.39 Medium Term Sector Strategies (MTSS). With the encouragement ofthe BOF, 8 pilot ministries undertook the preparation of MTSS as part of the budget process for 59 2006. This effort was expanded for the 2007 budget preparation, with the number o f participating ministries increasedto 19, representing 77% o f total MDA expenditure. 2.40 The first set o f strategic plans was put together by private sector consultants. These plans follow a pattern o f strategic planningcommonplace inthe private sector: the identification o f missions, goals, key initiatives and performance indicators with which to monitor key programs. 2.41 For the 2007 budget cycle, the expanded and much more substantive set o f MTSS was the result o f work by sector planning teams, comprising staff from each line ministry, outside sector experts, andprivate consultants versed instrategic planning. The entire MTSS preparatory process was seriously strengthened. This time, sector planning teams had an explicit mandate to review all programs o f the MDA to align them with NEEDS, MDG goals and other clearly adopted government policies, along with the review o f staffing levels. 2.42 Strategic sector plans are critical building blocks to an MTEF-based budget reform program in that they encourage MDAs to think about goals and objectives and activities to achieve them, thereby filling a vacuum left by the demise o f national planning's sector plans. Additionally requiring MDAs to develop key performance indicators for their monitoringthem would help change the culture withinthe government towards a greater emphasis on results. The strategic sector plans with a set o f ministry- specific goals and initiatives to achieve the intended results can then be used by the BOF inone-on-one discussions with ministries on their detailed budget submissions. This will help to shift the argument away from the negotiation o f inputs to the discussion o f what could be actually delivered by usingsectoral resources. 2.43 Strategic plans are, therefore, both about the improvement o f the allocative function o f the budget (Level 2 efficiency) as well as the efficiency and effectiveness with which budgeted resources are used (Level 3).41 The latter i s o f increasing importance to budgeting in Nigeria, as the BOF tries to shift the debate from the quantity o f resources absorbed by a particular MDA to what i s actually achieved in terms o f outputs and outcomes, marking a substantial change to the traditional Nigeria's budget culture. Changing the budget model alone, however, will be insufficient to bring about the necessary change in the absence o f complementary changes in how the public sector i s managed. 2.44 To derive the maximum yield from the MTSS exercise, the BOF will need to ensure that the following issues are addressed in the future rounds o f work on strategic planning: Strategic plans should embrace all the activities and projects o f ministries, including donor-funded initiatives, and should not be a sub-set o f the most important activities. Inthe absence o f this, essential trade-offs between activities will not be made, and there will be a risk o f strategic plans becoming bids for additional budget resources.42 4'The Bank's Public Expenditure Management Handbook (World Bank, 1998) suggeststhat a goodbudget system performsefficiently at three levels: (i) Level 1 is setting and achieving aggregate fiscal goals; (ii) 2 is the Level budget's ability to allocateresources inline with governmentpolicy andprogrampriorities; (iii) 3 is about Level spendingbudgetresources efficiently and effectively. 4219 MTSS that were preparedin2006 did cover all domesticallyfinanced activities,but so far achievedonly limitedcoverage of donor fundedprojects. 60 The BOF should aim at broad stability o f MDAs' envelopes, while at the same time making annual adjustments when justified to the previously established sector ceilings early in the budget cycle, i.e. in advance o f the MTSS preparatiodupdate. This would help to make the MTSS much more practical, making a shift in the analysis by sectoral teams from perceived needs in to the potential availability o fresources. The strategic plans should become a vehicle for encouraging MDAs to analyze recurrent and capital spending ina more integrated way. Ministries' strategic plans should be integrated with the functional reviews that some ministries are carrying out as part o f the Public Service Reform Program, since they are complementary. In turn, this requires coordination between the BOF and the Office o f Head of Civil Service and the National Planning Commission. The strategc plans should address not only the financial resources allocated for each program, but also how the MDAs' staff resources will be deployed. Progressively, strategic plans should draw on information on the efficiency and effectiveness o f service delivery, such as that collected through regular budget monitoring as well as through specially commissioned service delivery surveys or expenditure tracking exercises. MTSS should be built on a detailed analysis o f how efficiently the sector has used its resources in the past and how this efficiency o futilization could be improved. The BOF should develop appropriate reporting formats and procedures for MDAs to provide regular reports on the implementation o f their MTSS. These reports should cover information on both actual budget allocations across various programs/objectives and changes inthe ministries' performance indicators. 2.45 Finally, the BOF should review the process and experience with budget management reforms in South Africa and Uganda (Box 2.2), including their use o f Sector Working Groups (SWGs) as a means o f strengthening the sector planning teams by making the process more participatory. SWGs in these countries comprise not only ministry staff but also stakeholders from outside the government that are knowledgeable about sector issues. SWGs have been shown not only to improve the quality and relevance o f budget plans, but also to build wider ownership and understanding o f sectoral policy priorities. InNigeria, a move towards a SWG model was initiated as a part o f the 2007-09 MTSS process with the involvement o f representatives o f civil society, organized private sector, and independent experts. Government agencies with cross- cutting mandates (e.g. on issues such as gender and AIDS/HIV) were also represented in sectoral planningteams. 61 Box 2.2: PublicFinancialManagementReformsin SouthAfrica and Uganda When examples o f successful PFM reform in Sub-Saharan Africa are sought, the spotlight usually turns to South Africa and Uganda. These are well known for their best practice budget reforms, anchored in a MTEF. The budget processes of the two countries are, nonetheless, distinctive, each one reflecting individual country circumstances. Uganda, heavily aid dependent, retained the dual budget and used the MTEF to improve aggregate performance, allocate resources in line with government priorities, and managethe aid process effectively, including donor demands for poverty spending to be protected in the budget. A noteworthy feature o f Uganda's MTEF i s the use o f Sector Working Groups (SWGs) to bring stakeholders into the budget preparation process. South Africa, which never had a dual budget system, has been particularly effective in usingthe MTEFto discipline the policy making process and force ministers to examine the long run costs o f new programs and confront trade-offs between and within departments. Moreover, PFM reforms in both countries extend much further than developing effective MTEFs and should be seen as rather comprehensive packages. Although it took several attempts, Uganda has successfully modernized its government financial management through the implementation o f a package based IFMIS solution that operates on a state of the art ICT platform South Africa likewise has state o f the art financial management, though the transformation was less difficult, since over the years the government had a better record o f keeping its FM systems upto date. Both countries upgraded their external audit functions, by enacting greater independence for the Auditor-General and his staff, and building capacity for a higher standard of auditing and the introduction o f modern International Standards and ICT Auditing. South Africa, not without controversy, has had an effective Public Accounts Committee. Uganda brought up to date its Finance Act, sharpening roles and responsibilities, particularly with regard to the finance ministry and vote holders in MDAs, and introducing international standards (IPSAS and GFS). South Africa's Public Finance Management Act (2000) is a comprehensive overhaul of accountabilities, introducing many best practice features o f fiscal reporting, transparency and accounting for results. Both countries have strengthened the legal framework for public sector procurement - South Africa even mandates open competitiveprocurement by public bodies inits constitution. Uganda and South Africa have also used tracking surveys to monitor whether budgeted funds reach service delivery agencies and are translated into outputs. Both countries have also engaged in the development o f the Public Sector Accounting profession through extensive training and development o f independent Public Sector Accounting Bodies. Most important o f all, South Africa and Uganda built strong finance ministries. South Africa did this by bringing the department of State Expenditure into the National Treasury and heading the latter by a powerful and able minister. Uganda amalgamated the Finance and Economic Planning Ministries, and built a strong technical team to lead it. Uganda has also provided for strong leadership and restructuring o f the Treasury operation to facilitate IFMS implementation. Inbothcountries, these were critical steps that lendauthority to the reforms andhelpedto institutionalize them. -46 Budget Preparation Timetable. For several years the BOF has wanted to start the budget preparation process earlier and to bringit to the National Assembly intime for the passage o f the Appropriation Bill before the new financial year begins, but the circumstances were not been conducive. The 2004 budget preparation started very late and was presentedto the National Assemblyjust as the new financial year was beginning, and it was several months into the year that the Appropriation Bill was passed. The 2005 budget was brought to the National Assembly on 12 October 2004, but came under so 62 much criticism that it had to be withdrawn and resubmitted. Again, the government had to begin the financial year without a budget passed, by using provisional warrants. The 2006 budget preparation was intended to start earlier, but the BOF was preoccupied with getting the 2005 budget going (after the National Assembly had greatly changed the executive's proposed budget, passing the Appropriation Bill only in the second quarter) and thus the call circular went out only on 7 October, 2005. Consequently, the budget speech was delivered only on 6 December, 2005. 2.47 Inpart this was aresult oftensions between the executive andthe legislature over the composition and size o f annual budgets, and the passage each year before 2006 o f an Appropriation Bill, which the executive regarded as unimplementable. Thus, once the Appropriation Billhas been signed into to law, the budget had to be remade again, before implementation can begin. In part, however, the problem was also created by the extremely limited capacity within the BOF, which has to rely in its budget preparation on a small group o f very hard working officials and advisers. Untilthe BOF's capacity can be adequately enhanced, the risk o f late budget submissions i s likely to persist. 2.48 However, there i s growing consensus on the type o f budget preparation timetable the FGNshould adopt. It should start much earlier than has been the case, allowing time for (i)preparation and discussions o f the overall fiscal strategy ahead o f detailed budget estimates, and (ii)the tabling of the budget inthe National Assembly sufficiently before the beginning o f the new financial year to give both houses adequate time to scrutinize the proposals, reach agreement on the Appropriation Bill, and vote its approval by 31 December. This points to a Budget Speech in October, and presentation on the fiscal strategy, accompanied by an MTEF document, by April or M a y each year. In turn, the budget calendar should be reflected in legislation, as i s planned in the updated finance law. 2.49 The passage o f the 2006 Appropriation Bill in mid-February 2006, without material changes to the aggregate level o f expenditures, allowed a timely start o f the 2007 budget process. Moreover, the preparation process for 2007 budget was hrther improved, and the FMF made a commitment to keep it under a more disciplined timetable. It established a clear timetable, and shared it with key stakeholders. The MTEF was developed in March and April, with the MTSS process following in M a y and June. The Fiscal Strategy Paper was presented in late June, followed by the 2007 budget call circular in July. The Budget proposal was sent to the National Assembly in mid-October. The timetable also included discussions with the National Assembly over the fiscal strategy, MTSS documents and detailed budgets, all prior to the formal presentation o f the annual budget in October. This timetable and extensive consultation process helped ensure a timely passage o f the 2007 Appropriation Act before the end o f 2006, a significant achievement. 2.50 What remains to be institutionalized i s the form o f the debate on fiscal strategy, and the extent to which its conclusions would be binding on the executive in the subsequent stages o f budget preparation. This report argues, however, that under the first best scenario the legislature's resolution on the MTEF framework should not have as much power, at least not until a strongly worded fiscal rule becomes legally binding. In an economy that i s heavily dependent on oil revenues, the legislature i s prone to demand higher revenue projections from the executive, and with these expenditures as well, 63 because with oil as the chief source o f revenues, it i s not electorally constrained by tax burden consideration^.^^ Strengthening Cooperationbetween the Legislature and the Executive in the Budget Process 2.51 The present potential for tensions between the executive and the legislature over the budget preparation represents a serious impediment to achieving development goals through effective government spending. The situation is characterized by the misunderstanding o f motives on both sides, and, ina more fundamental sense, by a desire, found in many democracies but exacerbated in mineral revenue dependent economies, to maximize both public spending for constituency voters and the benefits derived there become polarized, and -- in the sense that conflict in one year sets up conditions for a from. Unfortunately in such circumstances arguments over the budget process can repeat in the following year - they have the potential to become perpetual. However, there has been a clear positive trend recently: since negotiating a mutually acceptable compromise over 2005 Appropriation Bill, there was much better cooperation between two branches o f power inthe course o f preparation o f both 2006 and2007 budgets. 2.52 Like other countries in Africa that gained independence from Britishcolonialism, Nigeria's first Constitution restricted the legislature's power to change "money bills," thereby curtailing the parliamentarians' ability to add, subtract or alter programs and projects in the budget estimates submitted by the executive. This effectively left the legislature only the option (unlikely to be exercised) o f voting against the budget as a whole. While this was consistent with the traditions o f the "Westminster" model, it was felt by the framers o f Nigeria's present Constitution (and that o f 1989)to be incompatible with a true presidential system in which the President is elected independently o f the legslature for a fixed term, and the Constitution i s based on a strict separation o f powers. Thus, the 1999Constitutionexpressly authorizesthe legslature to change budgets. 2.53 The National Assembly has done this in each o f the past five years, altering the President's budget by introducing significant additional spending (much less, though, in 2006-07), chiefly through new or expanded projects, but also by adding to the legislature's own vote (although 2006 and 2007 have seen agreements reached to limit this trend). On the revenue side, the National Assembly has argued that the revenue estimates have been too conservative, suggesting that the executive should both set more stretching targets for domestic revenues and rely on more generous projections o f future oil prices and production. However, recent production shortfalls due to the situation inthe Niger Delta have been recognized by the legislature as requiring more conservative budget assumptions. 2.54 In the early years after the return to democracy, the President challenged the legislature's right to change the budget, and threatened to veto the amended budget on the grounds (i) such a large budget could not be implemented, and (ii) if the money that that were spent, it would be macroeconomically destabilizing. Moreover, it was the role o f the executive, not the legislature, to propose the country's budget; the latter's responsibility was to review and approve. The National Assembly, on its part, threatened 43 There i s a case for requiringthe legislatureto vote revenuesas well as expenditures. AlthoughNigeriahas modeledthe bulk of its constitutionalarrangementsona USstyle full presidentialmodel, with complete separation of powers,its legalframework for budgetmakingis still influencedby inheritedUKtraditions, where the parliamentvotes only changes to tax rates,not overallrevenues. Onthe other hand, explicitlyrequiringthe legislatureto approverevenuescouldresult ininflatedvalues onbothsides of the budget equation, makingmore difficult the executive'stask ofsettingandimplementinga sensiblefiscal strategy. 64 to override the veto. Faced with this threat (and threats o f impeachment), the President would sign the greatly increased Appropriation Bill. The Minister o f Finance, on behalf o f the President, then would use the executive's control over cash releases to rein in spending.44 2.55 T h i s annual confrontation between the executive and the legislature (which was most pronounced in 2002-03, when the National Assembly adopted the annual budget with the MDA envelope that exceeded the government proposalbymore than 40 percent) undermined good budgeting and fiscal discipline inNigeria in several ways: It delayed the passage o f the Appropriation Bill, typically until well into the second quarter. While current spending continued at the previous year's levels through provisional warrants, capital budget warrants have been held up. The late issue o f capital warrants undermined orderly procurement planning and reduced the time available for MDAs to implement investment projects, which resulted in project delays, capital budget underspending, and discretional extension o f the end o f the fiscal year for capital spending to the end o f March o f the following year andeven later. The remaking o f the capital budget by the cash release system in turn adversely affected budget predictability, making it more difficult for MDAs to use resources efficiently, while increasingthe chances for payment arrears. The delay in passing the Appropriation Bill and the consequent executive remaking o f it also prevented the BOF from starting the next year's budget preparation cycle in a timely way. This resulted in inadequate consultation, insufficient space for departments to prepare their submissions, and, ultimately, tabling o f the new budget with not enough time for review and approval before the financial year begins. The preoccupation o f the legislature with adding spending to the budget each year deflected it from scrutinizing the content o f the executive's budget and the quality o f its execution, and from determining whether programs and projects are effective. Many o f these negative impacts highlighted above are likely to be mitigated by the improved timetable of the 2007 budget cycle. 2.56 In the earlier days, the government's lawyers argued that the legislature was exceeding its powers in changing the executive's budget. At present, the executive concedes that the legislature has a right under the Constitution to change the budget, and it has shifted to a more pragmatic approach. This approach entails, first, briefing the National Assembly early in the budget preparation cycle on the macroeconomic parameters underlying the federal budget and on why the budget should be the size proposed by the executive. Second, the executive has gone some o f the way towards meeting the legislature's wishes by including "constituency projects" in the executive's budget. Most recently, as mentioned above, the government has proposed a Fiscal 44Technically,the Ministerhasthe mandatedo this since the AppropriationBill simply authorizes the maximum amount of spendingthat canbeincurredagainstheads(and sub-heads). Furthermore,the Ministerof Finance, under the Finance(ControlandManagement)Act, 1958, has fiscal stewardshipresponsibilities,whichcanbe invokedto curb spendingifeconomic circumstancesrequirethis. 65 Responsibility Bill (FRB), the core o f which i s a fiscal rule. The FRB intends to defuse the conflict by taking the size o f the budget outside o f the legislature's or the executive's power to determine it (although the FRB allows the Minister of Finance the necessary flexibility in determining the reference commodity price). Finally, the government has made strenuous efforts in the past two years to better link FGN spending to poverty reduction goals through the adoption o f the NEEDS and the strengthening o f MDG- and poverty-related programs in annual budgets. The 2007-09 MTSS preparation included a consultative process to involve the legislature in reviewing the linkages between the proposed budgets and objectives o f NEEDS and MDGs. Moreover, key members o f the legislature were invited to contribute to a preliminary stage o f budget preparation. This helpedto increase the acceptability o fthe budget proposal for the legislature. 2.57 The extended, sometimes difficult, but ultimately successful negotiations over the 2005 Appropriation Bill have been seen by many as a beginning o f the new, much more collaborative approach to budget making by bothbranches o f power. In2005 the National Assembly originally voted the Appropriation Bill, which the government saw as inconsistent with prudent macroeconomic policy. The negotiations to amend the Bill were ongoing till late M a y 2005 and resulted in a compromise with a considerably lower overall expenditure envelope -- capital vote was reduced by 22% and overheads by 26% versus the original voted budget. Much earlier approval o f both 2006 and 2007 budgets, driven by more intensive consultations in the course o f their preparation, suggests progress towards a better organization o f the budget process. It establishes a good foundation for strengthening collaborationbetween executive and legislature. 2.58 A separate but closely related issue to the above issue o f control over the spending level i s the extent of the legislature's control over budget expenditure. Currently in Nigeria, the legislature executes its right, backed by the constitutional provisions, to control the budget at the level o f detailed estimates.45 For example, the 2006 Appropriation Bill states that "In the event that a need arises to vire amounts within the heads of expenditure to which sums have been appropriated under this Act, such virement shall only be effected with theprior approval of the National Assembly." This severely restricts the ability o f the executive to manage the budget. Effectively, it takes away the Finance Minister'svirement powers and diminishes hisher control over budget implementation. 2.59 Internationally, countries span a spectrum as regards the level o f detail at which their legislature controls the budget. In some countries, such as the United States, the legislature seeks to control spending to a greater detail, and there i s very little discretion for the executive to move money around, even between items within the same program. With its constitution influenced by US principles, Nigeria seems to be moving in this direction. This means that, in its move away from the Westminster-type budget model, Nigeria has been moving to a model that lies at the opposite end o f the above spectrum and characterized by strong powers o f the legislature (with respect to both the level o f spending and level o f detail o f budget control) that could make the budget rigid and difficult to implement. 2.60 By comparison, most OECD legislatures seek to control the budget at a much higher level o f aggregati~n.~~There the approach i s often that the legislature controls the l3The core legislation (such as such as 1958 F(C&M) Act) is not entirely clear on this matter. However, specific legislation (such as annual Appropriation Bills) gives these powers to NASS. 46South Africa also approves its budgets at a more aggregate level than inNigeria. 66 budget down to the program level:' and within programs the executive, through the Ministry o f Finance, has the authority to change allocations. This is consistent with the view that the legislature should be concerned with programs overall, not with how they are financed in detail, and that the executive should have the flexibility to move funds around within a program so as to achieve the most efficient implementation. There are two reasons that support this view. First, if spending i s to achieve its objectives, some degree o f flexibility i s necessary without returning to the legislature for re-voting. Second, there is the widely held view that the more the legislature seeks to control the fine detail o f the budget, the less attention it will pay to scrutinizing the larger and more important allocations. Inshort, the legislature elsewhere, including inNigeria, should not micro-manage the budget and should not try to restrict the executive's powers to make reasonable budget reallocations. 2.61 What are the main strategic options before the executive for further strengthening cooperation between the two branches o f government on the powers, based on positive tendencies o f the last two years, to make and remake budgets? 1. Seek a constitutional amendment to circumscribe the legislature's powers to amend money bills. This would be a highly desirable outcome from the executive's point of view (Nigeria could adopt the rule found in some other presidential system countries that allows the legislature to cut or eliminate any project or program and to propose an expenditure increase, but only ifreductions are identified elsewhere in the budget4*). However, this would require a constitutional amendment supported by a two-thirds majority and agreement by the legislature to a reduction in its fiscal powers in order to facilitate transition to a less confrontation budget making process. Under the circumstances, this seems to be a highlyunlikely scenario. 2. Further increase in consultation between the executive and the legislature upstream in the budgetpreparation cycle. Such an approach has been pursued in the last two budget cycles by the executive, which has made efforts to consult with National Assembly members early in the budget process on both level and composition o f expenditures. This strategy i s worth sustaining, but it will be insufficient in itself without additional key factors like more effective implementation o f existing budget projects and programs, as well as better reporting to the NASS on actual budget outcomes. The success o f this strategy, to an even greater extent than with the others, would depend upon capacity building within the NASS through the establishment of a professional Budget Office, as proposed by the independently promoted Budget Procedure Bill. It would be also important to make the legislature more aware o f the macroeconomic consequences o ftoo large a government budget. 3. Adoption of a two-stage process for budget approval, in which,prior to the issue of the budget call circular, the executive wouldpropose and the legislature would vote on a binding aggregateframework for the budget. This option has merit and would be an adaptation o f the "Swedish model" o f budget approval. The voting on the aggregate size o f the budget would be in the context o f a medium term fiscal framework, which would be accompanied by a statement on the 47Nigeria does not have a program structure, and usually this rule is interpreted in Nigeria's context as the executive power to shift money within both sub-heads and projects, but not between them without returning to the legislature for approval. 48Chile, for example, is one country whose constitutionincorporatessucha rule. 67 government's medium term fiscal strategy. It could also entail a presentation on the proposed division o f spending between the main sectoral portfolios, which would then guide the preparation o f a call circular. The drawback here, from the executive's perspective, would be that should the legislature adopt a fiscal framework that differed considerably from that proposed by the executive, the latter would be obliged to make a budget consistent with that new (and possibly expanded) framework - a worse situation than exists currently.49 In Nigeria's circumstances, it would appear that the introduction o f the Swedish model would be fiscally safe only ifcombined with a good Fiscal Responsibility Law. 4. Bind both the executive and the legislature to a more disciplined budget process by enacting of a fiscal responsibility law, incorporating afiscal rule. InNigeria's case a fiscal responsibility law is an essential foundation for a sustainable solution, though the actual bill may need further fine tuning once it i s passed. Other fiscal rules are possible, but that currently proposedby the FRB would have the effect o f making statutory the present arrangements for "excess oil proceeds'' sterilization and smoothing oil revenues that the FGN has imposed on itself in recent years. 2.62 In practical terms, a realistic strategy to move forward would be some combination o f options 2,3, and 4, above. Such a strategy should also be supported bythe more efficient and effective implementation o f existing budgets, which would raise the overall trust o f and responsibility for budget decisions. By this means, Nigeria has the prospect o f turningthe existing cycle o f budget-making into a better informed and more developmental one. 2.63 At the same time, the important priority for the government is to clarify (as part of the overall ongoing effort to modernize the P F M legal framework) the extent of control over public spending by the National Assembly. A preferable longer-term solution would be to define, in line with both the OECD experience as well as Nigeria's own past practice, legislative control in terms o f heads and sub-heads, leaving the flexibility to determine the distribution o f spending between items for the executive through FMF contr01.~' Inturn, the government needs to enforce more strictly its own virement rules, which are reasonably well defined in the existing financial regulations, but require improved compliance. Such a solution would then need to be reflected in other pieces of the existing legislation, including, possibly, through the clarification o f the ICPC Law (the Corrupt Practices and Other Related Offences Act, 2000), which currently could be interpreted as making all forms o f virement illegal.51 2.64 However, the practical strategy o f moving ahead with fiscal management reforms should explicitly recognize a certain challenge for developing a modem PFM system in Nigeria, which i s associated with the existing constitutional limitations that provide the legislature with strong budget powers. In particular, if the above mentioned preferable solution for clarification o f budget powers proves to be politically unacceptable, both branches will need to work hard together to develop mutually acceptable procedures for budget approval and budget virement, based on broad consultation and information sharing. With respect to virement, the executive then will have to plan its requests for 49Such a risk is apparent inthe proposedBudgetProcessBill, whichprescribes a multistageapprovalprocess,but whichwouldsignificantlyshift the controlof budgetmakingto the legislature. 50Inturn, the FMF, throughFinancialRegulations,coulddelegatehe-confirmthelimitedvirementauthority (within sub-heads)to the MDAs. 51Section22(5) of the Law. 68 budget changes in advance to give the legislature adequate time for scrutiny, while the legislature would be expected to review virement requests on a priority basis. Modernization of Financial Management 2.65 Legal Framework. The government has moved ahead with an ambitious legslative agenda, which promises to deliver fundamental improvements to the PFM legal framework. The early adoption o f the Fiscal Responsibility Bill, the Audit Bill, the EITIBill, and the Procurement Bill, and amendments to the Finance Act, are critical for sustaining the reform momentum as well as for securing recent gains in fiscal discipline. None o f these laws has as yet been enacted, though several are well advanced within the regular hearingprocess inthe Senate and the House. At the same time, a detailed review5* o f the drafts suggests the potential for further strengthening. In some areas more work is needed to address inconsistencies, overlaps, and, at times, lack o f clear separation between individual drafts. Inthe case of the Fiscal Responsibility Bill, the application o f statute law in an area where the constitution gives state and local governments independent budget making powers needs further reflection. 2.66 The most critical issue to resolve in the P F M legal framework at the federal level i s the extent o f control over public spending by the National Assembly (as discussed above). Simultaneously the Minister o f Finance has to retain the legal powers for sufficient discretion in budget execution. Ifthe rules for budget implementation give the Minister no flexibility in releasing funds to approved budget lines, then this severely curtails the Minister's ability (and duty under the law) to safeguard public monies and manage fiscal risks. This i s critical to the stewardship role o f the Minister, rightly highlighted in the proposed amendments to the Finance (C&M) Act. At the same time, the Budget Procedure Bill (BPB), independently introduced by the National Assembly, suggests a major shift o f the responsibility for fiscal and macroeconomic management to the legislature. Such a shift conflicts with the conceptual framework outlined in both the Finance Act andthe FRB. Nigeria -- being the equivalent o f an Organic Budget Law in other systems. Its current 2.67 The Finance Act represents the centerpiece o f the PFM legal framework in revision was triggered by the understanding that, while the original Law was still broadly sound, it needed updatingto strengthen the roles and responsibilities o f the main actors in PFMand also to reflect Nigeria's move from a primeministerial to a presidential form o f government. 2.68 The new Finance (C&M) Act rightly focuses on the regulation o f PFM (revenues, expenditures, assets and liabilities), as did the earlier law. It articulates well the stewardship function o f the Minister o f Finance, together with the Minister's powers o f inspection and oversight, as well as the responsibility for fiscal policy and coordination o f different players in PFM. Critically, the Minister has the power to limit spending in the public interest, and likewise the OAGF has the power to withhold funds from a poorly performing MDA. 52 Detailedcommentson the draft bills are providedinAnnex 2. See also Chapter 4 for comments on the Procurement Bill. 69 2.69 The critical directions for strengthening the Finance (C&M) Bill are the following: 0 MDAs should be obliged to submit annual reports on budget execution, combining both narrative on activities and outputs, and expenditure information. 0 As the FGN moves to integrate the capital and current budgets over the medium term, the existence o f a separate Development Fund (whose rules are set forth inthe Second Schedule) will require review. 0 Introduction o f a section in the draft (which its predecessor had) on the creation and operation o f funds - though it contains details o f existing funds inthe FirstSchedule. 0 Clarification o f the language o f section 34. Currently, it could be interpreted as a requirement for a separate Appropriation Act for each MDA, which would be detrimentalto budget comprehensiveness. 0 The draft should be brought in line with the FRB to use common language andupdatedparadigms o f fiscal management. 2.70 At the same time, it is worth noting that substantial gains from the ongoing legislative refinements could be achieved only if the capacity exists to significantly improve the enforcement o f both laws and financial regulations. The current weaknesses in the Nigerian PFM system derive less from deficiencies in the legal framework and more from a failure to operate the accountability and control mechanisms that have been in place for many decades. The 1958 Finance (C&M) Act and the various financial regulations issued since then, while requiring modernization, are fundamentally sound. They provide for accounting officers (i.e., vote holders) to take responsibility for complying with well-defined expenditure control and reporting requirements. They also provide the Minister o f Finance with considerable powers to hold these officers to account, including through withholding budget releases to MDAs, disallowing expenditures and imposing disciplinary actions on individual officers. However, these powers have seldom been exercised in the past.53 Updating the legal framework for public financial management therefore needs to be accompanied by a greater determination to ensure that the rules are applied. The potential for doing this has been admirably demonstrated in the area o f procurement, where huge savings accrued from re- negotiatingover-priced contracts and making the biddingprocess more open, predictable, and competitive. 2.71 A specific risk that the FGN presently faces relates to the possibility that the National Assembly could approve all three pieces o f major legislation (the FRB, the BPB, and the Finance (C&M) Act) with few amendments. While this might seem a positive development inthe short term because it provides for the enactment o f a fiscal rule, inthe longer term such an outcome could be unsustainable owing to the inherent conflicts between the various laws. It also would create the risk that each branch o f power would behave as if"its" respective piece o f legislationwas the authoritative one. 53Inthe course of 2006, therehasbeenanincrease inapplication ofthesepowers. 70 2.72 It may, therefore, be worth considering the following alternative configuration of laws, which could be negotiated between the two branches ifnecessary: 0 A law on fiscal discipline that imposes discipline on the fiscal framework for all three tiers o f g ~ v e r n m e n t .The core o f that law would be the description ~ ~ o f the different components o f a common fiscal rule - revenue determination rules (complemented by a specific reference to the allocation mechanism), deficit rules, and aggregate expenditure ceilings derived from these rules. And to reinforce this, the law would introduce limits on the stock o f debt, as well as transparency andreporting standards. 0 A law on budget procedure that defines the components and procedures for the preparation, deliberation, voting and follow-up o f the budget for the Federal Government - a harmonized amalgam o f the budget process sections o f both the FRB and the BPB with some additions, which would respect the role o f the executive to set policy and that o f the legislature to review and approve it, while giving the Minister o f Finance the power to control budget execution. 0 A law on budget implementation that sets out the roles, powers and responsibilities o f the main government actors in executing the budget and managing the finances o f the FGN- essentially the present Amended Finance (C&M) Act adjusted to take account o f what i s provided for in the prior two acts. The Minister o f Finance would be empowered through this law to issue regulations which would be tabled inthe legislature. 2.73 Budget Pre~entution.'~International best practice regarding budget presentation entails an annual budget document that provides the general reader with a clear picture o f how the government intends to collect and spend public monies in the coming year, and also allows for meaningful comparisons with recent trends in actual revenues and expenditures. Over the last two years, the quality o f federal budget presentation has improved considerably and it has moved much closer to the recognized international standards in this area. Starting from the 2006 budget cycle, the annual budget package submitted by the FGN to parliament includes, in addition to the standard Appropriation Billwith the detailed expenditure estimates, a copy o f Fiscal Strategy Paper (FSP) and a set o f MTSS. The presentation o f FSP, which contains a set o f key fiscal aggregates (both revenues and expenditures), made the entire package much more informative because it gives a broader picture o f the budget, interms o f broader availability o f funding and how it is allocated, and in terms o f the overall size and balance between revenues, expenditures and financing. The FSP also presents key historical trends. 2.74 The main directions for further strengthening the informational content o f the annual budget package include the following: 54There is a serious concernthat the currentconstitutionallimitationsmaynot allow for introductionof a single law that imposes fiscal discipline on all tiersofthe government. Thus, the FGNmayneedto preparean alternative strategy that wouldinclude:(i) adoptionof a law that covers only federalgovernment finance, (ii) draft of a separatemodellaw for states, and(iii) of anincentivestructureto encouragestates to adopt sucha model design law. The modellaw for states may also give states greater supervisorypowers over localgovernmentbudget making-to the extentthis is not grantedinthe existinglocal governmentlawsofstates. "ThisandseveralfollowingsectionsreflectamoredetailedPEFAassessmentthatispresentedinAnnex1. 71 Presentation o f consolidated revenue estimates, showing all the expected sources o f government revenue, including revenues accumulated with the excess crude oil account; Provision o f consolidated deficit/surplus estimates; at the moment, the FSP presents only "notional" deficit estimates that do not reflect government revenues accumulated with the excess crude account; The inclusion o f information on "cash calls" into the government fiscal framework, since this i s a major part o f public investment; at the moment, the revenue section in the FSP shows government revenues from crude oil sales on a net basis; The incorporation o f external borrowinglgrants into the fiscal framework, as well as in the detail estimates, and identification o f sub-headditems that are financed from this source; Presentation o f more detailed information on excess crude oil revenue inflows, accumulated balances, andtheir use; A breakdown o f debt servicing to separate amortization from interest payments; Expansion in cost information for major capital projects: for projects that are implementedover more than a year, the budget package may provide the total estimated project cost (in addition, to the current year appropriation), the balance to completion, and ifnecessary reasons for cost adjustment. 2.75 Budget Execution. The FMF has established a high level Cash Management Committee with representatives from all agencies involved in revenue mobilization, expenditure management and financing, together with a supporting Cash Management Unit based in the OAGF. It has tightened fiscal discipline and improved the overall credibility o f the budget. Cash releases have been based on the projections o f the Committee. However, as the quantitative analysis in Annex 1 (Indicator PI-16) shows, this is yet to help reducethe variability inmonthly releases withinthe year, despite much less variation inrevenue inflows. 2.76 Thus, further work is required to strengthen technical capacity o f the cash management committee to ensure a more predictable pattern o f resource availability at the MDA level, particularly on the capital side o f the budget. The causes are variations in oil output and fluctuations in oil prices (the latter having a perverse immediate effect, gven the current subsidization o f domestic petroleum products and the limit on spending mandated by the fiscal rule), as well as the late approval o f the budget. This is a case where improvements in several areas (fine tuning the fiscal rule, achieving earlier budget approval, reducing subsidization, strengthening short-term borrowing instruments) would make cash releases more predictable and thus would improve budget execution. 2.77 An additional source o f budget uncertainty relates to the recent government practice o f extending the end o f the budget year for the purposes o f capital budget implementation. This i s justified on the grounds that, because annual budgets are approved late, there i s not enough time to implement the investment program before the end o fthe calendar year. This practice undermines the entire concept of annual budgeting. 72 For the last two years it created a situation in which a disproportionate part o f annual investment spending was concentrated in the early part o f the following year.56This goes against the government objectives o f quality improvement and transparency in spending. Inparticular, it generates additional problems for reliable accounting and effective audit. The FGNshould discontinue this practice o f budget carry-over and fiscal year extension. This should not be problematic if accompanied by ongoing efforts to comply with the budget calendar and to have annual budgets adopted on time, but the challenges o f reversing the entrenched practice should not be ~nderestimated.~~ Ifthere is still a need for rollover o f unfinished projects, a better way to handle this would be, in line with international practice, re-appropriation o f unspent funds for the next year, e.g. in the form o f supplementary budget. 2.78 Cash management efficiency has also improved recently through the creation in 2004 o f a central capital account, which has helped to reduce short-term government borrowing, and the introduction o f small-scale computerized systems to record disbursements and cash releases. But further consolidation o f government accounts is needed. For example, in the last few years the NNPC investment account and the accounts o f the federal extrabudgetary funds together have had a more or less permanent positive balance in excess o fUS$1 billion. 2.79 The FGN has also made efforts to strengthen key aspects o f resource management. Rationalizing procurement practices within "the due process" has been the most significant success so far.58 In addition, important progress has been made in privatization, and both payroll and pension reforms have been initiated. The debt management function has been transferred to a specialist unit (DMO) that has been successful in improving the quality o f external debt management. The FMF also made significant progress inverification o f the outstanding stock o f domestic government debts and their clearance (see Chapter 1). Additional effort i s needed, however, to strengthen the system o f commitment control. 2.80 A civil service reform program has been extended from the pilot ministries and agencies to the entire civil service, several ministries have undertaken radical restructuring, and work i s under way to computerize the civil service roster and the payroll. Some efforts have also been made to clean up the payroll through verification exercises. In addition, a number o f policies have been adopted to improve the efficiency o f resource management at the sectoral level (e.g., in tertiary education institutions). As the MTEF i s developed, the BOF will need to agree with the Office o f the Head o f Service appropriate changes to the system o f establishment contr01.~' 2.81 However, a significant impediment to improving fiscal management through better linking budgeting with policy objectives remains, as the recurrent and capital budgets continue to be fundamentally separated. N o material progress has been reported 56 By the endof 2005, the utilizationofthe annualcapitalbudgetamountedto onlyN196 billion, less than 40 percent of the approvedbudgetof N505 billion. The FGNcontinuedto implementthe 2005 budget for most ofthe first halfof 2006. Bymid-Mayadditional N216billion inbudget investmentswas spent (i.e., more than for the entire2005) to reach anoverall 81 percentutilizationratio. 57 It is also likely to beillegal,since underthe existinglegal frameworkfor PFM, unlessexpresslyprovidedfor in the Appropriationor SupplementaryAppropriationlaw, moneysvotedbut not spent automaticallylapseat the end o f the financial year. 58 See the Chapter4 on ProcurementAssessment. 59 Underthe traditionalmodel, MDAs are constrainedby an approvedorganizationalstructure, completewith authorizedpositions(establishment),determinedby the OHSF. This is animportantcontrolsystemfor checking positioncreep,ifoperatedproperly. It needsto bebroughtup to date, integratedbetterwith the budget cycle, and take intoaccount the outcome of the MDAs' strategic planningexercise. 73 in commitment control and vote book maintenance. To date, the FGNdoes not have the capacity to efficiently monitor its outstanding commitments and, related to this, there is a major informational weakness with respect to the consolidated estimates o f the existing government arrears and contract liabilities. The existing decentralized payroll management system has a limited capacity to control fraud and requires a radical change. As a part o f 2007 budget preparation, a new information system was introduced, based on biometric verification o f the nominal rolls, which has the potential to address this concern and lay the foundations for a modern centralized payment system. 2.82 Budget Accounting and Reporting. The accounting and reporting system is among the areas o f public financial management in Nigeria that requires the greatest additional strengthening and has, in many ways, worsened in relation to the system in place several decades ago. It allows neither effective control nor useful analysis o f the composition o f government expenditure. There are no standard reporting formats (neither horizontal - across states, nor vertical - across different government tiers), which is a real barrier to producing an accurate set o f consolidated accounts for enlarged government. The budget monitoring system has been fragmented, under-funded, and under-utilized6'. Regular feedback on the results of public spending has been largely missing, and this i s one o f the core factors that have been driving deterioration in the quality o f budget projects and programs inNigeria over the years. 2.83 Public access to information on government finances i s generally inadequate to support strong accountability arrangements. This i s a result o f three different problems, all of which will have to be addressed simultaneously ifthe government wants to continue its progress toward fiscal transparency and accountability. These problems, which are well recognized by the BOF, include: (i) the absence o f a practice o f producing some important fiscal reports; (ii) the poor quality o f particular reports that are produced; and (iii)inadequatepublic accesstothe fiscal reports that are regularlygenerated. Initial efforts to address these through the publication o f the annual budget documentation, FAAC allocations and the Budget Implementation Report have been made. However, these efforts will need to be substantially enhanced in the future for the government to meet its own targets o f accountability and transparency. Opportunities offered by the Internet for efficient dissemination o f budget outcomes should be better utilized in the future. 2.84 Overall, inadequate budget reporting i s a source o f a major knowledge gap regarding Nigeria. There are no reliable data on consolidated expenditures for the main sectors and on core public sector programs/projects. This creates a major disadvantage for the country's policymaking and undermines opportunities for the analysis o f Nigerian fiscal developments in a comparative context. The information is especially scarce with respect to subnational budget spending, mostly because the mechanisms for inter- governmental information sharing remain weak within the Nigerian Federation, making the coordination o f fiscal and sectoral policies difficult. In addition, the lack o f reliable comparative data on state performance, including in the fiscal area, weakens the mechanisms o f competition across the states further undermining accountability of state governments. 2.85 Recognizing these weaknesses, the Federal Government has taken initial steps to address them. The 2004 Budget Implementation Report, first o f this kind, was published 6oRecentdiagnostic reportclaims that within the governmentM&Ehas notbeenregardedas animportant function. Limitednumber of monitoringreports is producedandthey do nothavemuchimpactonbudget allocationandprogramprioritizationprocesses.Almost no evaluationis takingplace(Hadenet al. 2007). 74 by the FMF in late 200561 and the 2005 report was prepared. The 2005 report reflects inter alia the findings from a special monitoring survey o f large public investment projects. The Accountant General's Office i s now able to generate monthly reports on budget execution by MDAs, which is a significant improvement relative to the recent past. The Government has been strengthening its budget monitoring arrangements through the establishment o f OPEN (see below) and other initiatives, including strengthening the Department for Budget Monitoring and Evaluation in the BOF. This positive trend should be reinforced as the Government continues with its modernization o fpublic financial management. 2.86 In 2004 the government introduced a system o f regularly disclosing information on revenue allocations to all levels o f the government, making a significant stride towards fiscal transparency in Nigeria, where federal allocation i s by and large the dominant source o f government revenues. This initiative could be further enhanced by the publication o f the entire cash flow statement o f the Federation account, including information on both gross revenues and all up front withholdings made from the account revenues before their distribution to individual governments. The latter could include, for example, information on the financing o f the NNPC and other public investments (such as the new power project), as well as on external debt payments. This would be a welcome addition to the current publications on gross and net allocations for each government entity. 2.87 The most urgent problem is the weakness o f in-year and year-end reporting on spending by the MDAs. A system o f monthly budget execution reports by the MDAs has existed on paper but disciplined enforcement i s lacking. A large number o f MDAs have been in substantial arrears and some did not report at all during the year. In the second part o f 2006, the FMF has started to exercise its powers o f withholding funds to non- reporting MDAs to encourage the timely returns o f transcripts.62 This practice, which is consistent with the existing financial regulations in Nigeria and in line with the international practice, deserves institutionalization, in keeping with the government's commitment to full enforcement o freportingrequirements. 2.88 Improvements have been made recently in the accounting area through the introduction o f the Accounting Transaction Recording and Reporting System (ATRRS), the recruitment o f additional staff, and in-service training. Assisted by the IMF and USAID, ATRRS was developed and implemented with ERGP support. As o f M a y 2006, all 78 federal MDAs had their ATRRS fully installed and more than half were current on their monthly budget reporting. Implementation at Federal Pay Offices has not yet succeeded. Much o f the accounting processes, however, continue to remain manual. 2.89 The present budget/accounting classification system does not offer adequate possibilities for analyzing the budget in a comprehensive way. The mixing o f standardized economic classifications for recurrent expenditure with individual project names or specific, nonstandard, descriptions o f capital expenditures makes it difficult to analyze the economic composition o f total expenditures. The government recognizes this handicap and has initiated improvements inthe chart o f accounts by developing a 15-digit code that has been used for the preparation o f 2006 and 2007 budgets. The new code, 61In additionto the analysis of variousaspects ofbudget execution, thereportemphasizes the problemswith the data onactualbudgetimplementationavailableat the MDA level. Furthermore,thepowerof withholdinghas beenincreasinglyappliedat the projectlevel: funds havebeen withheldfromcapitalprojectspendingtheir full compliancewith projectinformationrequirements, including informationoncosting. 75 however, does not yet fully conform to International Public Sector Accounting Standards (PSAS) as defined by the International Federation o f Accountants (IFAC) and adopted bythe UN. 2.90 Inthe mediumterm - four to seven years -the Federal Government will need to put in place a full-fledged, modern budgeting, accounting, management and reporting system. The work o f preparing the ground for the implementation o f the new system has begun and should include the preparation o f a complete modem, multi-dimensional chart o f accounts, which meets all reasonable informationalhalytical, control and management needs. 2.91 Audit, Oversight and Anti-corruption Efforts. Little substantive evidence exists o f significant change inthe effectiveness o f the external audit inuncovering or addressing leakages within the public sector, while the overall response to audit queries remains inadequate. Audit reports are not yet freely available for public scrutiny. The capacity o f the Audit Office requires significant enhancement, while the conditions o f service are insufficient for recruiting or retaining qualified personnel. An effective audit system depends critically on timely year-end accounts from the Accountant-General, but there have been significant challenges for timely production o f such accounts. 2.92 The Government has been making a concerted effort to eliminate the backlog o f consolidated annual accounts. The OAGF has re-submitted the 2002 accounts (after revisions) to the Auditor-General in September 2005, and it planned to finalize the 2003 accounts in early 2006. The 2004 accounts were subsequently submitted to the Auditor- general in June 2006. However, at the moment the National Assembly claims that it has not received audited government financial statements since at least the 2001 budget. 2.93 The Public Accounts Committees (PACs) o f the National Assembly have been reactivated with good cooperatiodrelationships with the Office o f the Auditor-General. The PACs, however, are poorly resourced in terms o f technical support staff and ICT. PAC members have expressed dissatisfaction with both the quality o f audit reporting and the inadequate response from the executive to concerns raised bythe PACs. 2.94 The OAGF was recently restructured and new Treasury and Internal Audit Departments were established. Parallel efforts are being made within the government to strengthen the internal audit. Currently internal audit units are understaffed with limited skills and resources for delivering adequately on their mandate. Moreover, internal audit methods and focuses require significant improvements in line with modem practices. It should be stressed, however, that raising the effectiveness o f the internal audit system i s as much a demand side as a supply side issue. Until accounting officers are held more accountable for the way their votes are used, internal audit units will not be afforded sufficient importance, and a sustained capacity buildingo f their staff will not take place. 2.95 The preparation o f the new Audit Bill was the key recent development in the area o f audit. Broadly, the PEMFAR team feels that the current draft introduces a sound framework for going forward to provide Nigeria's Supreme Audit Institution (SAI) with greater independence, particularly with regard to staff recruitment and pay, and to provide the mechanisms for setting the budget o f the Office o f the Auditor-General o f the Federation. Currently, the SA1 is underfunded, and while the Auditor-General i s a statutory officer with protection against dismissal, his staff remain regular civil servants, which raises questions about their ability to conduct truly independent audits, and, indeed, 76 about the Auditor-General's ability to recruit, retain and motivate professionals of the quality needed for this critical watchdog function. 2.96 Potential key areas for further strengthening o f the Bill are the following: 0 Additional clarification o f the Auditor-General's role and powers in respect o f statutory corporations 0 A requirement for the executive to produce regular reports on actions taken consequent on the Auditor-General's findings and the PAC's reports 0 An independent panel o f eminent practitioners who will review the quality o f the SAI's work and also, possibly, guide its pay setting for SA1staff The introduction o f an explicit requirement to cover public procurement in audits63 2.97 Here it should be stressed again that the medium term prospects for strengthening the budget audit process will depend not so much on the ultimate quality o fthe Law, but more on how the Law i s implemented. The critical implementation requirements o f an effective audit process could be summarized as follows: A newly empowered SA1 should be prepared to address its work energetically, "shake the trees" and perform a true watchdog function. Inturn this will require considerable investment in staff development. 0 `The executive should have the capacity to meet the statutory deadline for the completion o f accounts and financial statements, which has not been the case in Nigeria for many years. 0 The executive will need to seriously consider audit findings and to follow up on them in a timely and systematic manner, for the audit process to function productively. This i s a matter o f how effectively the Ministry o f Finance in its stewardship role holds accounting officers responsible, and whether the FMF's actions are backed up sufficiently by the Head o f Service and the President's Office. Failure to respond to audit queries should have disciplinary consequences, officers should be sanctioned for loss o f funds, criminal penalties should be applied to fraud, officers in charge o f budgets should be evaluated for the discharge o f their fiduciary responsibilities, and accounting officers removedhetiredfor lax oversight. 2.98 The FGN has successfully supported strengthening the anti-corruption agencies such as the Independent Corrupt Practices and Related Offences Commission (ICPC) and the Economic and Financial Crimes Commission (EFCC). It has raised the profile o f its anticorruption drive through the arrest and trial o f high-level officials. As discussed in Chapter 1, Nigeria has made significant progress in advancing its commitment to the Extractive Industries Transparency Initiative (EITI). An international firm has audited the oil and gas accounts o f both government and oil companies for 1999-2004, and the government has made its findings available through the Internet. Other critical actions 63This is because theproposedBureauofPublicProcurement i s an internalgovernmentregulator, albeit with considerableoperationalindependence,ofpublicprocurement, andnot an externalwatchdoglikethe Auditor- General's Office. 77 include the publication of audited NJWC accounts and the transparent licensing o f new oil exploration and production rights. It i s important that, in line with the EITI, the above transparency and good governance initiatives are extended to cover major parastatals in other sectors as well. 2.99 Automatization/GIFMIS. The FGN i s in the early stages of financial management systems modernization. An automated system for recording CRF transactions and reconciling with CBN bank statements was introduced recently. This has made possible improved reporting on budget releases. But much o f the PFM system continues to remain manual, relyingon transcript data, and i s inefficient. The Ministryof Finance still lacks reliable access to the Internet, which i s a pre-condition for setting up a modem integrated system. 2.100 An important first step has been the development of an Accounting Transactions Recording and Reporting System (ATRRS), and it was originally planned that the system would become fully operational by the end of 2005. It records the transactions of the manual accounting system in an Access data base, which then facilitates timely monthly balancing and rendering o f account returns by MDAs and federal pay offices (FPOs) to the OAGF. The ATRRS is a pragmatic stop-gap measure to address some immediate problems. A deliberate choice was made to keep the system simple in order to allow for its quick deployment. It does not require any re-engineering of the accounting and reporting processes. The ATRRS has the potential for considerably expediting both reporting and reconciliation - it allows for the generation of budget execution reports within three weeks after the end o f a period. As of May 2006, all 78 federal MDAs had their ATRRS fully installed, and more than half were current on their monthly budget reporting.64The rollout o f the system to the Federal Payment Offices (FPOs) outside of Abuja was also completed in2005, and results are awaited. 2.101 However, the ATRRS provides only a partial solution. In line with the best internationalpractice, the government has to accelerate the implementation of a full-scale GIFMIS that offers multiple opportunities for improved budget implementation through better information and control systems, and also for the compilation of the annual budget estimates. At the moment the GIFMISproject i s still inthe very early stages: initial effort has beenfocused on establishing the project office; improving the project team's capacity through training, mobilizing international advisers; undertaking study tours; initiating stake holder consultation; initiation of the conceptual design of the GIFMIS; effecting interim improvements to accounting processes; and the development of a new Finance (Control and Management) Bill. A full-scale GIFMIS will take several years to implement.65Lessons from similar undertakings in other countries highlight that (i) it always takes longer than first envisaged, (ii) comprehensive IT solutions often fail, and (iii) GIFMIS implementation should be accompanied by broad improvements in financial accountability, in particular the personal responsibility of accounting officers for compliance with financial regulations. ImprovingQualityof Budget Spending 2.102 The paradox of Nigeria's current situation i s that the country with enormous development needs and large recent incremental earnings fkom the oil boom, facing 64Still, 24 MDAs havetheir reportsinarrears (up to three months), while 10 MDAshavenot yet launchedtheir reporting. 65The World Bank (2004b), throughthe EconomicReformandGovernanceProject(ERGP), is supportingthe first stages of GIFMISimplementation,as well as the automationofpayrollmanagement.The ERGPreportsuggested a detailedphased-inapproachfor GIFMISimplementation. 78 significant risks for effective utilization o f its earnings immediately to expand its development programs. One constraint i s o f a macroeconomic nature. The absorptive capacity o f the economy i s low, while at the same time it i s prudent to save a portion o f the current windfall in anticipation o f a future oil price decline. A second, equally important, constraint relates to the challenges o f achieving consistently high value for money inbudget spending. It i s clear that substantial scaling-up o f expenditures must be undertaken in parallel with the efforts to accelerate improvements in the quality o f government spending. It will require further strengthening in budgeting and budget controls to provide assurance that money reach their indicated beneficiaries, who spend them efficiently either to deliver public services or to implement specific projects. 2.103 Achieving MDGs in Nigeria would ultimately require an expansion in budget financing incore social and infrastructure secto@. However, based on the experience of the earlier oil booms, there exists considerable inherent risk in a rapid scaling up in Nigeria. Due to the oil wealth, there i s currently a fiscal space for such a large increase in public expenditures that it may exceed government capacity to manage this incremental spending in a way that delivers good value for money. Overly rapid relaxation o f fiscal policy has to be avoided. As recognized by the government reform program, saving a portion o f the windfall gains and their utilization over the longer time period (i.e. spreading their use over the oil price cycle) would help to get more gains from the same amount o f resources. There are two key reasons for this: First, as experience o f the previous oil booms suggests, oil price increases are temporary, and therefore spending the entire amount o f windfall leads to the expenditure level that cannot be sustained in the mediumterm. At the same time, high volatility o f public spending (fast budget expansion in times o f high oil prices, followed by expenditure compression when prices go down) proved to be quite detrimental to macroeconomic stability and private sector investments (World Bank, 2003b). Thus, some stability and predictability in the level o f government expenditures i s critical for establishing a conducive macroeconomic environment for growth (Baunsgaard, 2003). This stability could be ensured only if budget planning is based on much lower oil revenues that are currently projected, given the recent oil price development^.^' Second, fast growth in public expenditure at times o f high oil prices poses a risk o f poor project selection and deterioration in overall quality o f budget spending. For Nigeria, such a risk should be o f particular concern, given the well recognized need to strengthen the quality o f the existing project portfolio. Because o f the existing capacity constraints in the PFM system, the FGN should avoid drastic increases in spending levels and favor a gradual budget expansion inline with the MTEF, backed up by measures to improve expenditure prioritization, costing, project preparation, selection and execution, as well as links to M&E reports. Expenditure expansion may be particularly successful in areas where it explicitly linked to a well-designed and costed MTSS. Thus, there is a need to synchronize government scaling up efforts with those to advance PFMreforms. World Bank (2005a) report provided some preliminary aggregated estimates for incremental public spending needed for Nigeria to achieve MDGs in2015. ''The related reasonis that rapid expansion ofpublic spending inthe economy that is too largely dependent on the public sector poses a risk of generating price and long term structural distortions (such as e.g. over-investments in the real estate). 79 2.104 There i s plenty o f anecdotal evidence that the efficiency o f public spending in Nigeria has been historically low.68Thus there are countless stories o f projects that were never completed, or infrastructure never maintained, and o f critical supplies that were held up or diverted away from the front line o f service delivery. However, there i s insufficient analytical information on this problem that would help to identify the main sources o f the inefficiencies and would suggest specific steps to address them. This information scarcity i s a reflection o f weaknesses inbudget reporting and evaluation. 2.105 The FGN has launched several major reform initiatives that aim at reducing inefficiency and waste in budget spending and ensuring a steady improvement in the quality o f public expenditures. Some o f these reforms are discussed elsewhere in this report. The most noticeable changes include: (i) procurement reformthat helpedto reduce costs o f government contracts and improve accountability o f contractors; (ii)MTSS preparation that links specific project spending with ultimate development objectives; (iii) efforts by the MDG office to channel a considerable portion o f new investments, including in water and rural electrification, to completion o f the existing projects; (iv) payroll verification undertaken by the BOF that helped to remove from the public payroll about 65,000 ghost workers; etc. These efforts will need to be continued and scaled up. 2.106 At the most general level, higher spending efficiency inNigeria should bethought o f at all o f the followingthree levels (World Bank, 1998) simultaneously: 0 Rationalizing budget allocation by shifting more resources towards MDG- related areas in line with the NEEDS priorities. The government i s currently doing this by committing all debt relief gains for incremental MDG spending. Improvingthe structure o f expenditure at the level o f sectors and programs by aiming at more rational proportions (e.g., between recurrent and capital spending, between payroll and other operational costs, between the financing o f different types o f institutions such as hospitals versus primary health facilities, etc.). Improving expenditure efficiency at the project/facility level through better project justification, more efficient public procurement, shorter implementationtime, better facility utilization, etc. 2.107 It is not possible for this report to provide additional specific recommendations that could improve the quality o f public expenditures. The primary objective o f the entire PFM reform agenda is explicitly about improvement in public expenditure efficiency. Thus, most o f the recommendations inthe report are in some ways related to the issue o f spending efficiency. What follows is merely a quick reminder on several dimensions o f this issue, some of which are already recognized and being pursued by the government, which are discussed inmore detail elsewhere inthis report: 0 Improving sectoral budgeting through MTSS i s a major government initiative aimed at strengthening the link between sectoral spending programs and longer term development objectives. 0 Alongside the ongoing MTSS effort, there i s an urgent need to undertake a review o f the existing investment portfolio in order to reduce the number o f 68Chapter 1 provides several examples of such evidence. 80 projects in the pipeline and stop the funding o f projects that have a rate o f return below the threshold, or cannot demonstrate otherwise a robust economic rationale. 0 A Virtual Poverty Fund (VPF) was set up to improve both the budgeting and monitoring o f poverty-reducing spending under the debt relief gain program. T h i s i s a critically important pilot program with a strong potential for scaling UP* Major efforts have to be channeled to further improve the quality o f budget reporting and monitoring, and the disclosure o f budget outcomes and their evaluation. The objective should be the creation o f a data-rich environment with respect to budget spending, which would support the spotting o f inefficiencies on the basis o f better analysis and broader access to the data o f various stakeholders. 0 The increasedpersonal accountability o f accountingofficers for the utilization o f funds inline with the approved budget i s critical. The predictability of funding i s another key pre-condition for efficient service delivery and project implementation. There i s a potential for significant gains through both (i) further strengthening o f cash management and more regular releases to MDAs, and (ii) stricter supervision over MDA use o f funds. Given the important role o f the states in both the financing and the delivery o f core public services, the FGN should explore ways o f encouraging the states to upgrade their expenditure portfolio, including through the financing o f mutual projects with the states and matching grant schemes. 0 Civil service reform needs to be accelerated to rebuild capacity and address distorted staff incentive structures. Expanding government co-jhancing of donor projects 2.108 Expansion o f cooperation with the IDA, AfDB, EU, and other development partners inthe form o fjoint investment projects (co-financing) could be seen a quick way to raise efficiency o f specific components within the government investment portfolio, as well as a tool for accelerated capacity building in the area o f public investment management, including project selection, preparation, implementation, monitoring, and evaluation. Shifting a portion o f its incremental investment resources to co-financing o f joint projects, implemented under the IDA supervision, will give the government access to IDA'Ssupervision capacity for project implementation, while at the same time provide an opportunity for training the participating government staff, as well as for improving the government's own procedures for project management. 2.109 In other words, during times o f high oil prices, when Nigeria does not face a serious financing constraint, cooperation with the donors could be focused more on addressing another Nigeria's development constraint that relates to weak institutional capacity within the public sector for quality budget/project management. The World Bank and other international partners could offer their project management experience to alleviate this constraint. Joint investment projects with donors could be designed in such a way that the IDA and other partners would provide only the start-up project funding and would help to set up appropriate project implementation mechanisms. Scaling-up the 81 projects would become entirely the government's responsibility. For this purpose, the government could use the same project preparation and implementation facilities that would be jointly established under the initial IDA projects. Alternatively, the Government could cooperate with donors in developing sector strateges with Government and external agencies funding separate projects within a common sector- wide approach. 2.110 In the medium to long term, the government could keep the amount o f tied borrowing from IDA stable, but at the same time could vary its own contribution to joint investment projects by reducing project co-financing during the times o f low oil prices. This would help at times o f budget shortfalls when it could be necessary for the government to free resources for maintainingthe stability o f vital current expenditures. 2.111 The above approach could be practically tested within the framework o f debt relief gain program (called OPEN- see below), managed by the MDG office. The OPEN program benefits from special financing and monitoring arrangements within the overall government public investment program. It may be possible to arrange for (i) expansion in financing available for this highprofile MDG-focused program within the existing budget envelope, and (ii) directing some o f these additional resources for co-financing o f donor projects under the broad supervision o fthe MDG office. 2.112 The recent track record o f government co-financing o f IDA projects in Nigeria has not been successful. Serious delays in co-financing led to major delays in project implementation and caused a general deterioration in the quality of IDA'Sportfolio. The Bank management response to this problem was drastic reduction and at times full elimination o f mandatory co-financing requirements for IDA projects in Nigeria. While this greatly helpedto accelerate project implementation, it should be considered as just a short term emergency measure. Over the last couple o f years the Government undertook several steps to strengthen its budget execution, which in principle provides a more supportive environment for a reliable project co-financing. Moreover, in the long term full isolation o f Bank and other donor projects from the Nigerian budget process is undesirable, because it reduces the impact such projects have on capacity buildingwithin the government, especially on the project management side. Overview of Public Expenditure under NEEDS (OPEN) 2.113 Nigeria's success in negotiating debt relief from the Paris Club in 2005 has greatly eased the country's foreign debt service burden and brought in additional resources to increase the development impact o f government spending. Consistent with the government's own policy intentions and with understandings reached with creditors, N l O O billion has been set aside for spending in the 2006 federal budget on specially designated Millennium Development Goals (MDG) projects. Some of these are ongoing projects, others are new. They are being implementedby ten ministries whose mandates are most relevant to the achievement o f the MDGs. Inturn, the MDGprojects are seen as a key component in the implementation o f the Nigeria Economic Empowerment and Development Strategy (NEEDS), 2.114 The mechanism through which these projects are being selected and funded i s called Overview o f Public Expenditure under NEEDS (OPEN). It i s established in the format o f a Virtual Poverty Fund (VPF) - virtual because it enables the government to assure the reliable funding o f MDG projects without creating a parallel budgeting 82 mechanism. Here, Nigeria i s drawing on the experience o f other countries, which have undergone debt reliefand have set up similar mechanisms. 2.115 By agreement with the Minister of Finance and the Director-General o f the Budget Office, the oversight o f both the selection and the implementation o f the MDG debt relief funded projects was assigned to the Office o f the Senior Special Assistant to the President responsible for the MDGs (SSAP-MDGs), workmg with the budget staff o f the ten ministries. These projects have been given a special coding, which will enable spending on the MDG projects to be tracked through the year. The emphasis will be on ensuring that the funding o f these projects is undertaken on time, and that it reaches the front line service delivery units, i s spent on the purposes intended, and leads to the outcomes envisaged in the projects. More broadly, the aim i s to demonstrate the transparent use o f debt relief gains and to provide information on what works and what does not in achievingthe MDGs. 2.1 16 Projects were selected for their contribution to the eight MDGs,~'but particularly for their potential for scaling up and their ease o f monitoring. The program has a high profile inthe government. Most o f the resources, inthe first instance, will be spent bythe Federal Government either directly or operating through its decentralized units across the 36 states. Over time, a systemo f conditional grants to states i s expected to be developed. 2.117 There are several ways in which the OPEN initiative has the potential to accelerate a broader change in expenditure management. First, the way in which the expenditure tracking system under OPEN i s designed can strengthen the overall monitoring capacity as well as pioneer new ways o f involving non-government stakeholders in monitoring public service delivery. Presently, the monitoring o f projects i s weak, and i s conducted infrequently by civil servants. The MDG program would help enhance budget monitoring across the government by (i) initiating a baseline assessment o f various existing M&E systems, and (ii)introducing a system o f regular program execution reports to be made publicly available. Moreover, the lessons learned in engaging the civil society and beneficiaries in monitoring government MDG spending could be applied to other parts o f the budget. 2.118 Second, withinthe existing institutional setting, the office o fthe SSAP-MDGs has become a facilitator o f inter-agency coordination aimed at addressing various cross- cutting PFM issues, such as budget classification, reporting formats, the automation o f reporting, etc. O f particular importance, has been the office's work on costing o f the MDG programs, which included a systematic effort to collect, verify, and disseminate a broad set o f unit cost data and other costing information that could be broadly used across the government. 2.1 19 Third, the results from OPENmonitoring could be used to improve sector policies and medium term sector strategies. Eventually, it may become necessary to supplement the monitoring o f MDGs with in-depth assessments o f the mandates, staffing, and organizational and governance issues o f some o f the agencies responsible for implementing the MDG programs if deficiencies o f a more systemic nature are revealed bythe tracking o f spending. 69 Debtreliefresourceshasbeentargeted, via the VPF, to: immunization,HIV/AIDStreatment and prevention,teacher supply,ruralelectrification, youthprograms,gendermainstreaming,ruralwater supply, roadinfrastructure,slum upgrading,environmentalissues,andagriculture. 83 2.120 Care must be taken, however, to ensure that the MDGprogram remains contained by the overall parameters o f the budget. More broadly, the government is engaged in an effort to keep aggregate spending consistent with the long run price o f oil and the absorptive capacity o f the economy, in terms o f both the ability o f departments to spend well and the requirements o f fiscal and monetary stability. If the MDG projects are to be scaled up, this must come from reallocations within the currently agreed envelopes, and must be based upon confirmation from monitoring and evaluation to the effect that spending i s efficient and effective." 2.121 Technically, all 2006 OPEN federal spending i s classified as capital budget expenditure, which makes it easier to set arrangements for its monitoring and reporting within the constraints o f the current accounting system. However, substantively not all o f the proposed expenditures (including those allocated to cover program monitoring costs) are o f a capital nature. The current approach distorts the budget classification but, more important, it may have a distortive effect on MDG programs - creating incentives for an additional increase in capital spending even in cases where, at the moment, binding financial constraints relate to inadequate recurrent spending. The latter, as analysis o f sectoral expenditure patterns suggests, may be rather a common problem - in health, for example, historically, there has been a clear imbalance between spending on structures (construction o f hospital buildings) and on their runningcosts (including medicines). It is worth noting that there has been a concerted effort on the part o f the MDG Office to address this potential bias, including through its contribution to MTSS development to ensure that incremental recurrent spending is factored in MTSS in line with currently undertaken capital projects. In particular, in the health sector since 2004 the government provided for a steady increase in financing o f personnel costs relative to capital budget. Still, it may be desirable to move a relevant portion o f the OPEN program into the recurrent part o f the federal budget, while maintaining the existing arrangements for procurement and monitoring that proved their effectiveness. Strengtheningthe Capacity of the Budget Office 2.122 As one o f the early steps to reform budget management processes, in 2003 the government and its economic team decided to bringthe responsibility for preparing both parts o fthe budget together, through the formation o fthe Budget Office o f the Federation (BOF). A Director-General (of permanent secretary rank) was appointed from outside the government to head it. Organizationally, the BOF was located withinthe Ministryo f Finance, though with the Director-General retaining some direct reportingresponsibilities to the President. 2.123 Since then, several actions have been taken to strengthen the BOF's capacity. First, "relationship teams'' were created to deal with both the capital and current budget requirements o f the respective ministries. Second, staff who had been engaged in preparing and supervisinglmonitoring the implementation o f the capital budget in the NPC were transferred to the BOF. Third, the BOF was reorganized into four main departments: (i) Expenditure, (ii) Revenue, (iii)Monitoring and Evaluation, and (iv) Fiscal Affairs. Fourth, under a USAID contract, a consulting team was contracted to provide technical expertise and help buildcapacity. ' OIn the 2006 budget call circular, the eight ministries designated for MDGprojects received an average increase intheir envelopes of26.4percent, compared with 17.0percent for MDAs as a whole. Buttheir baseline, non-MDG envelopes were increasedby much less (were even reduced inreal terms). Inthis sense, the MDG allocation was not significantly additional, but instead resulted in reallocation within the MDAs' envelopes in favor o f the sub- heads that are more closely related to poverty reduction (and that are expected to be more intensively monitored). Given the absorptive capacity constraints, this should be seen as an appropriate outcome. 84 2.124 At the same time, a number o f changes were made to the budget process itself. These are discussed elsewhere inthis report, but may be summarized as follows: The BOF has initiated upstream consultations and briefings with the Federal Executive Council and the National Assembly on the overall strategy for the budget and its macroeconomic underpinnings. The BOF made substantial progress in developing a Medium Term Expenditure Framework for annual budgeting, starting with an MTFF and based on a fiscal rule linked to the long run price o f oil, and then complementing it by developing sectoral strategies and introduction o f 3 year sectoral envelopes. 0 The BOF has initiated a series o f Medium Term Sector Strategies (MTSS), aimed at improvements in the prioritization o f the MDAs' expenditure programs and the expansion o f MDG-related spending. 0 The BOF has contributedto the drafting o f a Fiscal Responsibility Bill, which will make the oil-price based rule statutory while at the same time imposing additional fiscal management responsibilities on the FMF. 0 The call circular sent by the BOF to MDAs has been unified, eliminating separate ceilings for the current and capital parts o f the budget, while the ceilings themselves have been made firmer. 2.125 Insum, the economic team made significantprogress inconsolidatingthe old dual structure o f the federal budget process and managed to centralize the preparation o f major government budget decisions, including those on expenditure allocations, within the Ministry o f Finance.'l The traditional budget model has been substituted by a more disciplined and fiscally sustainable approach to budget formulation. This new model has a stronger potential for focusing government spending on efficient and effective service delivery, with allocations determined by the government's development priorities rather than on an incrementalist continuationo fpast spending trends. 2.126 This formidable agenda o f change, which i s still unfinished, is made more complex by the need to tackle, in parallel with the reform o f the budget process, the pressing legacy problems o f past economic mismanagement, as well as the need to develop new modes o f cooperation with the legislature inthe budget making process. 2.127 Inherited Capacity Constraints. Unfortunately, the bulk o f BOF staff has been left behind by these changes, notwithstanding efforts to build their capacity. As with so many other departments o f the Federal Government, the BOF's staff historically has the wrong skills profile - an excess o f poorly qualified staff in lower and middle grades, and too few staff with the relevant professional qualifications in the senior technical and management positions. Traditionally, the Public Expenditure Department o f the FMF, the predecessor o f the BOF, was staffed with generalists, civil servants from the common The peculiarlegacyof the dualbudgeting,whichstill needsto be addressed, relates to a split responsibility for the coordinationof donor-fundedprograms.While the FMFis responsible for donor programsthat are credit based, those supportedwith grantsremainunder the authorityof the NPC. As a result, the modernframework for coordinationandmonitoringdonorprogramshas notemergedinNigeriaas yet, while all types ofdonor funding remainoutsideofthe government budget. 85 administrative pool, whose career expectation was to be rotated through central government administrative posts and who had few incentives to acquire the in-depth knowledge specific to budget management. To address the problem, in 2006 the BOF staffing levels were reduced drastically - from more than 500 in total in early 2006 to about 225 one year later. The reduction affected largely staff at the lower grade levels and those without appropriate qualifications. The BOF management believes that the office could be quite effective with only 100 staff, if these were well trained, computer literate professionals, familiar with modem budgeting techniques and well motivated. 2.128 For the last few years, the main policymaking work (such as setting the overall fiscal framework, determining MDA envelopes, pullingthe Appropriation Bill and budget estimates together, andre-setting the budget implementation strategy after approval o f the Bill in a heavily modified form) has essentially been carried out by a small team o f consultants and advisers, operating from the office o f the Director-General. Few regular BOF staff were co-opted in the process. This demonstrates that the challenge o f institutionalizing the budget management reforms in the BOF, largely unaddressed, remains formidable. 2.129 Inmicrocosm, the BOF reflects the broader problems o f the Federal Civil Service -lowpayandpoormotivation, aninabilityto attract andretainasufficientnumberof high caliber professionals, overstaffing, lack o f computer skills, poorly functioning performance management systems, and excessive rotation o f staff members. In this sense, the challenges the BOF faces are not different from those o f other departments o f the Federal Government. However, the problem i s that the BOF i s supposed to be an agent promoting change in the rest o f the public sector. To date, it has succeeded in doing this largely by the efforts o f a small and dedicated team around the Director- General. But the budget reform agenda i s only partly complete, and there i s a concern that the BOF's capacity has not been built sufficiently to ensure sustainability. Indeed, the broader institutional culture withinthe BOF seems to have changed little. 2.130 Thus, it i s important to emphasize a critical need for the stronger coordination o f PFM reforms with parallel reforms in the civil service. There are several reasons why this is necessary: 0 Public service reform, with its potentially heavy severance pay costs, must continue to be fitted into the aggregate fiscal envelope for spending over the medium term. 0 The reviews o f ministerial mandates, organizational structures and staffing levels need to be made consistent with the MTSS, beyond the initial work done inthis area inthe 2007 budget. The incentive structure facing ordinary civil servants - pay, workmg conditions, discipline, and accountability mechanisms - needs to be transformed in order to turn the tide on informal PFM practices and ensure compliance with the new formal rules o f PFM. 2.13 1 Capacity Building Strategies. There are essentially two strategies that the Director-General (Budget) can adopt. The first i s an incrementalist one, the second is more radical. 86 2.132 An incrementalist amroach would mean continuing the past efforts to build capacity through training and computerization by relying heavily on donor support and external consultants. This would also require an engagement with the Head o f Service to transfer out non-performing staff, and seek additional technical and professional posts in the middle and upper grades. Existing proposals to create a specialist cadre o f budget officers, with its own scheme o f service and rather tightly drawn entry qualifications, could be enacted. Specialist staff, once trained, would therefore not be at risk o f transfer to unrelated jobs elsewhere in the FGN, though they might be posted to satellite budget unitsinMDAs. 2.133 As the Public Service Reform Program proceeds, and a more nuanced policy on civil service pay i s developed, remuneration for the BOF staff would become more realistic, and the Office would be better able to recruit and retain qualified and experienced professionals from outside the Civil Service. At the same time, as has happened in some pilot civil service reform ministries, consultants could be engaged to review the present organizational structure and staffing levels, prepare job descriptions relevant to the emerging new budget paradigm, and propose new gradings where necessary. T h i s would complement the work that has been already done within the Budget Office, including reorganization, defining o f work schedules, and mapping o f policy and procedures. Consultants could also be requested to draw up a more intensified training program for the BOF. The BOF could also employ several residential international advisers who would help accelerate the change by bringing international experience, including one from another developing country that had been addressing similar challenges o f budget management and civil service reform in the past. The advisers could be made responsible for coordinating and prioritizing all existing and planned capacity buildingactivities. 2.134 An incrementalist approach would have the advantage o f being supported by the ongoing Civil Service reform efforts, led by the Head o f Service. The risks are that the pace o f that reform would not be rapid enough, and that pay structures would remain insufficiently motivating, so that even if new technical and professional positions were created in the BOF, pay levels would not be adjusted rapidly enough to attract the caliber o f staff needed. Furthermore, the BOF's ability to recruit mid-career professionals from outside the Civil Service into line positions might be blocked by the Federal Civil Service Commission's appointment rules. These rules might also frustrate efforts to make annual performance reviews more meaningful. Overall, the success o f the BOF's capacity building strategy o f working within the Civil Service system would be crucially dependent on the speed and vigor o f broader Civil Service reforms, which would determine a timeline for how quickly the changes needed to support growth in professionalism could be made. 2.135 The radical alternative to working within the Civil Service system would be to enclave the BOF and to give it special agency status outside the normal Civil Service rules. This would be consistent with the argument that special arrangements are necessary for agents o f system-wide change like the central management agencies, and that the first task o f institutionalizing reform in a setting such as present-day Nigeria would be to secure the capacity o f the key reform bodies. The special status could either be given temporary (until the rest o f the Civil Service catches up) or could be viewed as permanent. Implementing such an option would require substantial political support from the top o fthe administration. 87 2.136 Much like the first approach, this would entail engaging management consultants to review the mandate, define the tasks o f the BOF and make recommendations for a new organizational structure and the staffing needed to make it work. The actual structure might not be very different from the present one, but both the staffing profile and the staffing level would be, with increased numbers o f staff in the technical and professional grades. Job descriptions would need to be developed, with clear qualifications criteria. Since the BOF would be a "stand apart" agency, separate Human Resources management systems, including performance review processes and non-civil service pay scales, would have to be developed. The existing staff would then be screened (a task contracted out to specialist Human Resources consultants), and those deemed insufficiently qualified or poorly performing would be retrenched with an equitable severance package or returned to the Head o f Service for redeployment. Those deemed qualified would be selected for jobs inthe new structure, along with external candidates, including those from outside o f the public service. Accompanying the changes would be an increased investment inboth staff training and office equipment. 2.137 It is beyond the remit o f the PEMFAR report to recommend which o f these two alternatives should be chosen. Its role i s simply to outline the alternatives and suggest that there be a serious discussion o f each course's pros and cons, including the political economy considerations. The choice i s not unrelated to the course that civil service reform itself will take in the coming years. In theory, a model o f civil service reform could be adopted whereby a uniform structure o f public service pay i s discarded, and improved pay and work conditions are introduced in steps as part o f the reform implementation: only MDAs which are prepared to undergo comprehensive restructuring and reform would be eligible for the enhanced pay scales. D. RECOMMENDATIONSFORPRIORITYREFORMMEASURES 2.138 Maintaining momentum with budget reforms i s critical to whether the FGN can establish a better budgeting system, one that provides for sound fiscal policy over the oil price cycle, allocates resources according to government priorities, and improves the efficiency and effectiveness o f departmental spending. The immediate challenge is to pass legislation that supports stable budgeting and adequate consultation during preparation, strikes a workable balance between the roles o f the executive and the legislature, and provides for an engaged debate on priorities and needs ahead o f detailed budget estimates preparation. 2.139 As the government defines priorities for the next round o f PFM reform, the followingtwo key issues require immediate attention: Sustainability of reforms. The immediate risk for government reform strategy relates to slow progress in capacity buildingwithin both the Ministry o f Finance and the relevant departments in the ministries. Critical capacity building needs should be identified and a plan to address these needs outlined and implemented to ensure that budget, financial management and procurement staff, including in the BOF, the accountant general's office and in line ministries, are fully engaged and can carry forward the PFMreform effort. 0 Sequencing of further reform steps. It is important to separate the immediate reform agenda from medium-to-longer-term issues. The practical reform strategy should reflect on the paramount capacity constraints within the government which 88 hold back the inevitable transition to a new budget model built around a programmatic budget structure within the MTEF. 2.140 This report argues that in terms o f immediate reform priorities the major effort should be channeled to facilitate (i) raising the efficiency o f budget spending and (ii) improving transparency. To date, there exists the gap between substantively improved fiscal discipline at the macro level and a less rapid impact o f reforms at the sectoral level on both budget allocation and project execution. While the scope o f the government reform program would remain unavoidably broad, some re-balancing o f priorities seems justifiable. While untilrecently the reform team has invested most o f its effort and made the greatest progress in such areas as macroeconomic and debt management, budget formulation, the upgrading o f the PFM legal framework, and the launching o f the high profile anti-corruption drive, the most pressing priorities for the immediate future relate to (i)improvements in reporting, monitoring and audit, and (ii) capacity buildingwithin the budget system, in particular in the BOF. Accelerating the GIFMIS implementation could be seen a platform for many other required improvements on the budget execution and reporting side. Reforms should also place greater emphasis on strengthening the control and oversight o f budget execution, with budget holders being held accountable for the way in which resources have been used. Anti-corruption programs have to be built into the existing institutions, rather than remaining an area for "special operations", such as the Economic and Financial Crimes Commission (EFCC). 2.141 Inpracticalterms, this would requirea stronger emphasis on enforcement relative to new policymaking. The immediate priority i s to improve the quality and availability o f the general information on how the government actually spends its money. The government expenditure reports need more details, greater accuracy, be more timely, and be produced at greater frequency. The ultimate goal is to ensure (i) that every recipient o f public funds produces a regular report on how much money i s received, for what purpose, and how the money i s spent, (ii) that these reports are publicly available, and (iii) the reports are regularly analyzed and intensively used for preparation o f policy and budgetingdecisions. Particular steps inthis direction could include the following: 0 Introduction o f monthly reporting on budget releases, commitments, actual expenditure, arrears and revenues. 0 Introduction o f regular reporting on government operations which currently remain outside o f the budget process (excess crude account, cash call spending, federal extrabudgetary funds, external grants and loans). Development o f options (consistent with the existing constitutional constraints) for their gradual integration with the regular budget process and making them subject to the regular requirements on approval, reporting and auditing. 0 Strengthening o f the responsibility o f MDAs and parastatals for regular budget reporting to the OAGF. Continue to use the power o f withholding budget allocations to MDAs and parastatals that either report late or do not comply with the established reporting standards. Request MDAs to produce their annual accounts that would reflect utilization o f both budget allocations andown revenues. 0 Establishment and enforcement o f firm deadlines for the submission o f financial statements to the Auditor-General, the submission o f Audit Reports 89 to the PAC, the PAC discussion and National Assembly approval, and the FMFresponseto audit findings. Ensuringthat the reports ofthe Auditor-General are publiclyavailable. Introduction of changes to the reporting regime for parastatals aimed at establishing arrangements that support the regular submission of their accounts to the dedicated government unit, which could monitor their financial performance and generate a consolidated performance and risk report. Further advancement of recent efforts to improve budget presentation. Transparency and quality ofthe annual budget documents may be additionally improved by providing better structured information on the macroeconomic framework, important fiscal aggregates, fiscal risks, and the overall composition of expenditure in institutional and functional terms, as well as in terms of financing. Review o f the format of annual statements and agree on amendments to bring these closer to the cash-based International Public Sector Accounting Standards. Accord of the highest possible priority to the full implementation and proper maintenance o f the ATRRS as an interim means of ensuring prompt and complete in-year financial reporting from the MDAs. Strengthened coordination and information sharing between the main government agencies involved in budget execution, in particular between the OAGF andthe CBN for timely reconciliation of accounts. Expansion in the strategic use o f external advisors -- spend more money to buy expertise that is not currently available within the government, e.g. on independent project evaluation, project audit, and so on. 2.142 With respect to other components o f the budget process, priority directions for further advancing the currently ongoing reforms would include: Securing macroeconomic discipline by embedding a fiscal rule in the legal framework for budget-making, as intended bythe Fiscal Responsibility Bill. Establishinga consistent legal framework for the PFM inplace: (i) the update Finance (Control and Management) Act 1958 to emphasize the roles of accounting officers, timely fiscal reporting and annual accounts, the mandating o f a follow-up on audit findings, the denial of cash releases to MDAs that do not comply with budget reporting requirements, and generally the strengthening of the stewardship role of the FMF; (ii)enactment of the FRB, EITIBill, and new Audit Bill; and (iii) the Procurement Law and pass establish the Bureau of Public Procurement. Adoption of a more realistic and respectedbudget timetable, either by law or by administrative commitment, for preparing and approvingthe budget before the beginningo f the fiscal year. The Foundation for this change has been laid 90 inthe 2007 budget cycle. This should includereachingan understanding with the National Assembly on how it could become a party to a more orderly process (e.g., through a multi-stage budget approval process or other procedural adjustments). Discontinuation o f the practice o f extending the end o f the budget year. Strengthening the multi-year perspective in the budget. The immediate emphasis should be on further strengthening the MTSS. MTSS have the potential to become the principal tool for sector ministry planning that helps to clarify functions, reduce organizational duplication, and facilitate the transition to a new vision o f sector ministry operations -- MDAs would become less project-driven, but more service-oriented and more accountable for achieving an agreed set o f performance targets. Final redefinition o f the new role o f NF'C inthe budget process and policy coordination generally. Building capacity in the Budget Office, including by institutionalizing a special budget cadre o f civil servants. An important priority area would be developing a set o f databases to help the BOF monitor the quality o f budget submissions and strengthen the demands for the quality o f proposed budget expenditures. Such databases should include information on the unit costs o f construction and service delivery, staffing and payroll levels, a roster o f ongoing investment projects, etc. Strengthening the budget monitoring and evaluation system through (i) better funding o f the M&E function, (ii) improved disclosure o f monitoring results, (iii)better coordination among different agencies involved inM&E, (iv) expanded participation o f civil society, and (v) the incorporation o f M&E outcomes inthe MTSS development process. The proposed MDG expenditure monitoring system could serve as a model for upgrading M&E standards across the board. Ensuringthat the Ministryo f Finance has an adequate room for efficient day- to-day budget implementation. Given the existing legal limitations, this may require either (i) a joint search with the legislature for a new definition o f powers for virement within the budget heads that i s acceptable to both branches, or (ii) development o f a new procedure for legislative scrutiny o f virement requests that would provide for a speedy review and approval o f such requests. Ensuring a steadier revenue inflow by reviewing the mechanisms for transferring oil revenue to the Federation Account. If and when necessary, complementing such efforts to stabilize the revenue flow with an improved capacity to meet short-term liquidity requirements through capital market operations rather than the C B N overdraft facility. 0 Development o f options for increased co-financing o f IDA and other donor projects as a quick way to raise efficiency o f investment spending and accelerate capacity buildinginproject preparation and implementation. 2.143 Inthe medium term perspective (three to five years), the above reforms needto be complemented by additional measures that are much more demanding in terms o f institutional capacity. These measures should include the following: 91 Completely overhauling cash management, including establishing o f a Government Group Account (also known as a Single Treasury Account) to replace all individual MDA accounts in commercial banks Deepening sector policies by remaking the content of sectoral envelopes through the improved orientation of sectoral spending on service delivery, the better costing of policies and other tools available within the MTEFparadigm 0 Launchingthe restructuring o fthe budget along programmatic lines 0 Complete implementation o f a modern budgeting, financial control, accounting, financial reporting, and management information system (GIFMIS), incorporating a modern chart of accounts based on international best practice 92 3. AN ASSESSMENT OF THE PUBLIC FINANCIAL MANAGEMENT PERFORMANCE OF NIGERIAN STATES 3.1. This chapter uses the PEFA P F M Performance Measurement Framework to assess the public financial management performance o f Nigerian states. Its overarching objective i s to contribute to state governments' reform processes by determining the extent to which reforms are yielding improved performance. The subsidiary objectives are: to (i)to increase state governments' ability to identify and learn from reform successes and failures; (ii) to provide elements that would assist in developing a reform road map for states; and (iii) to reduce transaction costs for partners by harmonizing dialogue between state governments and donors. 3.2. The core finding i s that the public financial management performance o fNigerian states i s very weak and inneed o f urgent reform. There are scattered cases o f individual success stories; however, taken together they amount to little and do not have a meaningful effect on the national economic development and poverty reduction agenda. The fiscal reform challenge is a huge one; left alone, the states are not in a position to confront it. Therefore, the Federal Government needs to play a key and substantive role in charting the course o f reform in the states and in implementing this reform. It is important, as well, for donors to weigh in meaningfully by leveraging resources and technical assistance to this key area o fneed. 3.3. Indeed, the Federal Government and donors need to pay closer attention to fiscal management reforms at the sub-national government (SNG)72 level for several other reasons. First, as shown in Chapter 1, Nigerian SNGs control more than 50 percent o f public funds. Second, they enjoy a significant degree o f autonomy in expenditure decisions. Third, by constitutional provisions, they are primarily responsible for the delivery o f core public services. Fourth, they are quite independent in determining both the pace o f and the priorities for their reforms. Therefore, Federal Government reforms alone cannot achieve the goals o f efficient service delivery, poverty reduction, and economic development. Given the weak capacity in SNGs, Federal Government and donor interventioni s imperative, beginning with the states. 3.4. The organization o f this chapter i s as follows. In addition to this introduction, Section 1 includes an overview, a short explanation o f the PEFA Measurement Framework, and methodology, and the scope, limitations and constraints that might affect the usefulness o f findings. Section 2 provides some background on the reform context in the states, in its economic, fiscal, and legal dimensions. Section 3 presents a detailed assessment, grouped into six major or core themes. Finally, Section 4 concludes by drawing lessons and discussing possible next steps. ''InNigeria, SNGs consist of states and local governments. However, local governments are under the control and supervision o f their parent state governments. Inpractice, states directly control the fiscal affairs o f their local governments, 93 A. OVERVIEW 3.5. At independence in 1960, Nigeria's sub-national constituents o f three region^'^ had considerable autonomy over their fiscal and financial management systems. colonial rulers -- they had independent PFM systems, and had the freedom to develop Although all the regions had similar systems, courtesy o f a common heritage from the their PFM systems at their own individual pace. For example, between 1957 and 1958, each region enacted its distinct, if similar, organic Finance Act, and it was within the powers o fthe legislature to amend or change the law as it deemed fit. Similarly, different wage policies and salary regimes applied in each region. However, the incursion o f the military in 1966 and their complete control o f the political landscape until 199974 seriously eroded the autonomy o f sub-national governments (SNGs). The military administration later truncated the regions into smaller states75and ran the entire country as a de facto unitary system. 3.6. The unitary approach o f the military meant that the central Federal Government seized the initiative for making fiscal management policies for both the center and the states. Finance circulars issued from the center were copied to the states for implementation. Since the states were under the control o f military governors/administrators (with no previous civil administrative experience), whose postings were purely military duties, they had no option but to see such circulars and other policy instruments as directives. Thus, the SNGs lost the power to control the development o f their financial management systems. They merely copied what the center did. Since no substantial reform o f the PFM system took place at the center under the military,nothingtook place at the SNG level. 3.7. With the returnto civil rule, and with elected executive heads and legislators in 1999, state governments regained the liberty to reassert their fiscal autonomy. Indeed, the 1999 Constitution granted essential powers to state governments inPFMissues and by so doing seriously circumscribed the authority o f the Federal Government and its ability to directly require or influence fiscal reforms in the SNGs. State governments were thus free to reform, each at its pace, without necessarily waiting for the FederalGovernment to initiate the process. This chapter examines the extent to which state governments have usedthis autonomy to reformtheir systems since 1999. It uses the PEFA76Framework as a diagnostic tool. The framework provides a common approach across countries for measuring and monitoring PFM performance progress, and a common platform for dialogue. ThePFMPe$ormance Measurement Framework 3.8. The design o f PEFA framework i s to measure the PFMperformance o f countries across a wide range o f development over time.77 It includes a set o f high-level indicators that measures and monitors the performance o f P F M systems, processes and institutions against established benchmarks o f best practices. It assesses the extent to which the PFM system sustains the implementation of policies and the achievement o f developmental 73The three regionswere Northern,Western andEastern. In 1963,on attainingrepublicanstatus, a fourthregion, Midwest, was createdout of the Westernregion. 74Exceptfor briefinterregnumsfrom October 1979to December 1983, whenthere was a civil administration,and 1991to 1993,whenthere was a diarchic arrangement, with the militaryincontrolat the center. 75Currently,there are 36 states, excludingthe FederalCapital Territory (FCT). There are plansto createan additionalstateinthe SouthEastto bringthe totalto 37, excludingthe FCT. 76PublicExpenditureandFinancialAccountability;see Public Financial Management Performance Management Framework, June 2005, PEFA Secretariat; the documenti s also availableat www.pefa.org. 77Annex 1presentsthe full list ofindicatorsalongwith the full PEFA assessment for the federal government. 94 objectives through supporting aggregate fiscal discipline, strategic allocation o f resources and efficient service delivery. 3.9. The framework identifies six critical dimensions o f performance o f an open and orderly PFM system. (i)Credibility of the budget measures budget realismand its implementation as intended. (ii)Comprehensivenessand transparency assesses the comprehensiveness o f the oversight o f the budget and fiscal risk, and the accessibility o f fiscal and budget information to the public. (iii) Policy-based budgeting examines the extent to which the budget i s prepared with due regard to government policy. (iv) Predictability and control in budget execution appraises the extent to which the budget is implemented inan orderly and predictable manner; it also examines arrangements for the exercise o f control and stewardship inthe use o f public funds. (v) Accounting, recording and reporting considers the adequacy o f records and information produced and disseminated. Finally, (vi) external audit and scrutiny assesses the extent to which arrangements for the external scrutiny o f public finances and follow-up by the executive are effective and efficient. 3.10. This set o f high-level indicators focuses on the operational performance o f key elements o f the PFM system rather than on the inputs that enable the PFM system to reach a certain level o f performance. For example, the framework does not measure the factors affecting performance, such as the legal framework o f the existing capacity levels ingovernment. Inaddition, it does not involvethe analysis o f fiscal policy, which would determine the extent to which fiscal policy i s sustainable, whether budget expenditures are achieving their desired effect o f poverty reduction and whether there i s value for money for service deli~ered.'~The framework focuses on assessing the extent to which the P F M system i s an enabling factor for achieving such outcomes. Scopeof Analysis and Method of Data Collection 3.11. The study team collected data for this assessment from several key sources, the most important o f which relates to two sets o f immediate research inputs. The first one consists o f the reports o f four consultants appointed by the World Bank to carry out detailed PEFA-type assessment in four states, deliberately selected to reflect the NortWSouth balance: Bauchi, Cross River, Enugu and Kaduna". The four states were selected from the 10 to 12 states that ranked highest among the 37 states and the Federal Capital Territory, inthe SEEDS benchmarking exercise jointly carried out by the Federal Government and some donors.80 Ifthe actual average performances o f states differ from the findings herein, this i s likely to be in a negative direction, since these four states under detailed review are among the best performers in the country. Data analysis for this chapter was based on reports o f these states from 2002 to 2004. It was not possible to include later years in the analysis because o f delays inthe production o f financial reports. At the time, the consultants were in the field in the first quarter o f 2006, several of the states had not finalized their 2005 accounts. ''In this chapter, these gaps havebeenfilled, where necessaryto providea more completepicture, with informationfrom other sources. ''These consultants are UkwuI. (Enugu State), Israel0.Taiwo(Bauchi State), FestusEgwaikhide(Cross Ukwu RiverState), andHyacinthE. Ichoku(Kaduna State). ` OThe SEEDS (StatesEconomicEmpowermentandDevelopmentStrategy) benchmarkingexercisedrew varying levelsoffundingandparticipationfromthe federalgovernment, DfID, EU, UNDP, CIDA andthe WorldBank. The assessmentcovered four broadareas of economic managementnamely, policy, budget and fiscal management, communicationandtransparency,andservicedelivery. The FCT and 35 of the 36 states participatedvoluntarilyin the assessment. OnlyBayelsaStatedidnotparticipate. 95 3.12. The second research input consists o f a less intense review of recent public financial management (PFM) developments in about a dozen or so states. This review carried out by World Bank staff from the second half o f 2006 involved a review o f recent financial developments in states such as Imo, Delta, Lagos, Ondo, Akwa Ibom, Oyo, and Abia, among others. Fundingand time constraints limited a wider selection o f states. It i s therefore should be highlighted to state that the assessment o f state PFM systems inthis chapter reflects the situation as o f about the middle o f 2006. 3.13. Besides, the findings largely confirm the conclusions o f several other earlier studies that PFM-related arrangements differ little across the states because o f their common history and experience as explained inthe preceding sub-section. A number o f these studies carried out by the World Bank deserve mention. The State and Local Governance in Nigeria (2002jK1,covered six states (one from each o f the six geopolitical zones): Bauchi, Nassarawa, Rivers, Anambra, Ogun, and Sokoto. The Nigeria State Finances Study (2003jK2spanned 15 states carefully selected to represent a complex interaction o f state experiences and circumstances. Specifically, the selection criteria ensuredrepresentation o f the six geopolitical zones. It included rich, moderatelyrich, and poor states, covered some highlyurbanized states and some more rural ones, and selected states with large populations, and relatively small and sparsely populated statesg3. In addition, the Bank also carried out a number o f studies and reviews inLagos State. These include a State Public Expenditure Review (2006), a State Procurement Assessment and Review (SPAR), and Lagos State FinancialAssessment and Review (SFAR) in2002/3. 3.14. A one-day (three days for local consultants) workshop was organized in mid- January 2006 for officials o f the Federal Government, the participating four states and the four consultants to familiarize them with the PEFA PFM framework. The assessments were carried out in a participatory manner, with the involvement o f state officials, throughout. The consultants initially spent two weeks in the states, working with designated officials, on information gathering, after which they produced a draft report. Thereafter, the drafts were given to the respective state governments for comments after which the consultants finalized their reports. 3.15. In addition to these PEFA PFM assessment reports on states, this chapter draws on the reports o f several recent reviews of public expenditures for individual states. Within the past six to seven months, the World Bankhas commissioned PERs on Bauchi, Cross River and Kaduna States.g4 The DFID also commissioned a study on Enugu State's public expenditure system. Earlier in 2002-03, the Bank had carried out a wider PER review, covering the period 1997- 2000, o f 15 states, spread across all o f the geopolitical zones o f the country and covering both the oil-rich states and the poorer, non-oil rich states. These earlier reports, though dated in parts, provide useful background material for this chapter, especially in the presentation o f baseline information for assessing how far states have progressed with their reform efforts. 3.16. Finally, the results o f the SEEDS benchmarking exercise referred to above also provided useful input into this chapter. Despite weaknesses o f this exercise, which are related to the fact that it was the first such exercise in Nigeria, the results showed that all the states performed poorly in budget and fiscal management, which on average was the weakest dimension o f state performance. The conclusions inthis chapter largely confirm "ReportNo.24477-UNI 82 ReportNo. 25710-UNI 83 The states coveredinthe study are Kebbi, Kano, Sokoto, Niger (pulled out later),Kwara, Bauchi, Borno, Imo,Ebonyi, Enugu(puledout later), Ondo, Lagos, Oyo, A h a Ibom, Rivers, Cross River, andDelta. 84 Conductedbythe teams ledby HaliduAbubakar, Ayo Olusolaand CarolineNege, respectively. 96 that not even the best-performing states in Nigeria have gone far with their financial management reforms. Limitations and Constraints 3.17. The collection o f accurate fiscal information for analysis in Nigeria i s challenging. This challenge exists in all tiers o f go~ernmentbut it becomes ~ ~ progressively more acute in the lower tiers. The problem i s both qualitative and quantitative. At times, the reports may not be available at all, or they may not be reliable, or they are not kept at a sufficient level o f detail to permit useful analysis. At other times, the data may exist, but administrative practices and bureaucratic bottlenecks do not permit their release. This i s an important constraint for this chapter. The level o f this difficulty varies from state to state. Some states keep better records than others; some keep more records, and still others make them more readily available. Wherever possible, we have tried to reconstruct the available data to provide a clear and more accurate pictureaX6 3.18. As indicated above, the full-scale PEFA PFM assessment was conducted in only four states. The legitimate question that obviously arises i s to what extent these four states can be considered a statistical representation o f all Nigerian states, and therefore whether generalized conclusions can be drawn based on such data. N o claims are made here o f the proper statistical representation o f Nigerian states. However, the findings show that the fiscal problems o f Nigerian states remain similar. It i s not necessary to carry out a large-scale study o f Nigerian states before drawing valid general inferences and conclusions about their fiscal performance. The conclusions reached here are a fair representation of the general ~ituation.'~N o doubt, a number o f states have gone further with their reforms than others. This chapter will reflect the performance o f such outlying states to the extent possible. B. CONTEXT PFMREFORMS OF 3.19. This section briefly discusses the context o f economic and social reforms in the country in general, examiningthe incentives for states to embark on PFMreforms. It also appraises the legal and institutional framework designed to support fiscal reforms, in states inparticular, and, by extension, inNigeria ingeneral. The Context of Economic and Fiscal Reforms in States 3.20. The National Economic Empowerment and Development Strategy (NEEDS), launched by the Federal Government in March 2004, arguably provides strategy for the ongoing P F M reform in Nigeria. This i s correct only in so far as NEEDS i s the first successful attempt to articulate the government's vision for national development and poverty reduction in a coherent manner, to give it focus and to outline the role o f the key institutions o f state inthe process. Since the launching o f NEEDS, the pace o f reforms at the federal level has accelerated significantly. 85Inall fairness, the situation is gradually changing at the federal levelwhere boththe quantity andquality o fdata have improved considerably over the years butstill fall far short o f international standards. 86For example, reclassifymg capital expenditures to remove non-capital spendingor to reflect GFS standards "Asalreadyindicated, sincethestatesinthisstudyrepresentthebetterperformingstates,anybiasinthe conclusions hereini s likely to show that the average fiscal performance o f Nigerian states is below what i s reported here. 97 3.21. Although Nigeria i s a federation with sub-national governments imbued with fiscal autonomy, so that states could proceed with their reform programs independent o f the Federal Government, not many states have taken the initiative to reform their PFM systems. Several related reasons accounts for this. The first i s the considerably weaker capacity at the state level, which makes it difficult for states to initiate meaningful reforms on their own. Further, the low pay structure in state public services does not attract qualified professionals from the private sector and academia. Inaddition, after the return to civil administration, donors concentrated their technical aid and assistance at the Federal Government level, perhaps understandably, because it was considered fitting for the central government to show the way for SNGs.@ 3.22. Following the preparation o f NEEDS and the commencement o f its implementation in 2004, the Federal Government requested state governments to prepare their own development strategies, SEEDS, anchored in the same policies and similar reform principles enunciated in the NEEDS. Incentives for state governments to comply came from two related initiatives. The first was the Federal Government/donors partnership to provide technical support to states willing to prepare their SEEDS. The second was the extension o fthis partnership to assessing the states' reformprogress. Legal and Institutional Frameworkfor PFM in the States 3.23. There i s no common legal and institutional platform for state PFM reforms in Nigeria because the Constitution grants the Federal Government only the most limited and indirect influence over the fiscal and financial affairs o f SNGs. The plans, budgets, accounts, procurements, etc. o f SNGs are not subject to federal control and scrutiny. The most clearly recognized implication o f this arrangement i s the difficulty it creates for the coordination and management o f macroeconomic and fiscal policies. The less acknowledged, but equally important, other implication i s the lack o f authority for the Federal Government to set and enforce minimum standards o f fiscal conduct for constituent governments. On the positive side, however, the arrangement affords reform- minded SNGs the space required to proceed independently with PFM reforms without waiting for the center. Inother words, the Constitution provides the necessary space for individual governments, federal and state, to proceed, if they wish, alone with their reform efforts.89 3.24. Notwithstanding this lack o f common statutory impetus for PFM reforms, the legal and institutional arrangements for reform in states are similar to each other and to the federal arrangements, although they remain independent. In any case, state governments so far have shown a tendency to model changes intheir P F M systems on the Federal Government's. It i s inthis context that the general discussion below o f the legal framework and institutional arrangements makes sense. Legal Framework 3.25. Each government, federal and state, has a complete, if outdated, set o f finance regulatory instruments. At the federal level, there are an organic Finance (Management ** Many donors, including the World Bank, only recently began to move to states to do serious diagnostic and analytical work that will help to accelerate their governance and fiscal reforms. *'Indeed, some state governments, such as Lagos and Delta, have independently undertaken huge and ambitious reform o f the budget and accounting systems by introducing integrated personnel and financial management information systems. 98 and Control) Act," enacted in 1958 and a set o f detailed operational rules and guidelines for the day-to-day management o f financial activities, called Financial Regulations," derived from them. The regulations cover accounting, internal auditing and stores procedures and routines. Some state governments extract and issue parts o f these regulations as separate regulations. Thus, in some states there i s the Stores Instructions, inaddition to the Financial Instructions. In2000-01the Federal Government and various state governments revised their financial regulations after the inception o f civil administration.'* Still all these legal instruments require further modernization to bring them in line with current political developments and evolutionary trends in public financial management as discussed in the previous chapter. There i s also a need for the Finance Act to reflect more adequately the fact that the Nigeria has moved from the Westminster Parliamentary mode o f government to the presidential republic. 3.26. Further, the existing legal framework does not allow for multi-year budgeting and clearly refers to budgeting one year at a time. For instance, section 81 o f the 1999 Constitution enjoins the President to present one year budget estimates at a time before the National Assembly. (Section 121 contains similar provisions on state governments.) Relying on this provision, the Legislature has not accepted the need to consider medium term revenue and expenditure estimates. Consequently, the SNGs have been unable to align properly with global trends and international best practice by effectively adopting the Medium Term ExpenditureFramework (MTEF) approach to b~dgeting.'~ 3.27. Although there are several other shortcomings inthe legal framework, the Federal Government i s taking steps to correct many o f the problems as part o f its reform process. Several new draft laws are at various stages o f preparation or are before the National Assembly awaitingpassage into law (see Chapter 2 for details). Institutional Framework 3.28. The institutions for public financial management in the federal and state governments are also largely similar but are independent o f each other. Federal institutions do not control sub-national government institutions. At the federal level, a Ministry o f Finance has the responsibility for budget and treasury functions. However, this is a recent development, as the planning (including capital budgeting) function was the responsibility of the National Planning Commission (NPC) until 2004 when the planning and budgeting functions were consolidated in the Budget Office o f the Federation (BOF) inthe Federal Ministryo f Finance (FMoF). This was aimed not only at achieving improved coordination o f the budget process but also at eventually moving towards consolidating the capital and recurrent budgets into a unified, single budget. However, most state governments still runparallel Ministries o f Finance and Ministries of Economic Planning andBudget.94 3.29. Offices o f the Accountant-General (OAG), at both the federal and state levels, perform the actual treasury functions o f government, including accounting and internal audit. The OAGs are creations o f the Finance Acts and are powerful, semi-autonomous institutions under the general supervision o f respective ministries o f finance. In many State versions, which are different only inthe slightest, most inconsequential, details, are mostly called Finance (Miscellaneous) Acts or Laws. Financial Instructions at the state level and Financial Memoranda at the local level. 92The uniform Financial Memoranda (for local governments) were last revised in 1992by the military government. 93There are serious efforts and a steady move towards MTEF at the federal level. 94Some states have State Planning Commissions inplace o f a Ministry o fEconomic Planning and Budget. 99 states, the old Ministries o f Finance have been truncated with and the budgeting and planning functions carved out to form either a State Planning Commission or a full- fledged Ministry o f Economic Planning and Budget. Examples o f states where this has happened include Lagos, Imo, Kaduna, Bauchi, Cross River, Akwa Ibom, Sokoto, Ondo, Delta, Enugu, Abia, Rivers, and Anambra. In these states, the Ministries o f Finance would appear to exist as a mere relic o f their old selves, and it i s difficult to understand what their actual functions currently consist o f under an arrangement where both treasury and planninghudgetary functions are outside o f their direct purview and control. Inat least one o f the states under review, the Ministry o f Finance consists o f only one Directorate, that o f Administration, and there i s currently no single professional in the Ministry. 3.30. The OAGs post accounts officers to all Ministries, Departments and Agencies (MDAs) with self-accounting status to carry out government treasury and accounting functions. Inaddition, they have sub-treasuries outside o f the capital (federal or state, as applicable) to facilitate government transactions. The Federal Government has one sub- treasury in each o f the 36 states and the FCT, and in each o f the police formations, malung a total o f 78 sub-treasuries. Accountants at the MDAs and sub-treasuries are expected to make monthly, quarterly, half-yearly and annual returns to the respective accountants-general. The OAGs also post internal auditors from their Treasury Internal Audit Department (TIAD) to each MDA with a self-accounting status and to all sub- treasuries. Treasurers o f local governments perform similar functions at the local level. 3.31. At the federal level, a Budget Monitoring and Price Intelligence Unit (BMPIU) was set up in 2001 under the Presidency to oversee the procurement o f major public contracts. Most state governments thus far have not managed to set up equivalent institutions. Cross River State recently set up a Due Process Office to carry out functions similar to those o f the federal BMPIU, but the office i s still in its infancy.95 Several other states, including Enugu and Bauchi and at least 10 others, are also working to set up Due Process units; however, they are all still grappling with teething capacity problems. As follows from observations made during preparation o f this study and the results o f the SEEDS benchmarking exercise, it i s still quite common for most states that contractors for major public contracts are chosen through selective bidding or other similar non- transparent processes. 3.32. The Office o f the Auditor-General completes the list o f institutions with formal responsibility for PFMat both the federal and state levels. The Office96i s a constitutional creation (by implication) with responsibility for auditing all the accounts and offices o f government. The federal and individual state governments maintain separate and distinct Offices o f the Auditor-General, and the scope o f their authorities i s limited to the government that set them up. The functions o f auditors-general do not overlap across federal and state governments. The Constitution does not make provision for the auditors- general for local governments. Thus, local governments do not set up such offices; instead, each parenthost state government has established an Office o f the Auditor- General for Local governments, appointing one Auditor-General to jointly audit all local government accounts and offices inthe state. 95Boththe USAID andEUare currently involvedinaneffortto helpbuildinstitutionalcapacityof this unit. 96At the federalandstatelevels,that is. 100 Summary 3.33. In summary, there is no national framework, legal or institutional, for PFM reform. However, the Federal Government i s attempting to enact a Fiscal Responsibility Law that will suggest minimum acceptable fiscal performance standards for all governments, federal, state and local, and will introduce a national supervisory framework for fiscal reforms, a Fiscal Responsibility Council. The law also aims to institutionalize the reform process by introducing a national supervisory council to oversee the process o f fiscal reforms. It will not be possible for state governments to attain these standards without substantially reformingtheir P F M systems. However, there are still major unresolved issues, centering on the constitutional powers o f the Federal Government to set enforceable minimum PFM standards for other governments o f the Federation. 3.34. There i s therefore no nationwide agenda for PFMreform inNigeria. The Federal Government does not dictate to state governments what actions to take in this direction. Reform o f the state PFM systems, as things currently stand, i s state-specific, with each government free to pursue reforms as it deems fit and at its own pace. However, the capacity o f and incentives for state governments to design and implement PFM reform programs without some form o f federal assistance and/or stimulation i s a serious issue that needs attention. Should the Fiscal Responsibility Bill currently before the National Assembly i s passed in the form proposed by Executive (that is, made the Bill applicable to all tiers o f the government), it would create the substantial additional agenda for fiscal reforms and the incentive for them. Even if the version o f the Bill passed restricts its application to the federal government, it i s still possible for the Federal Government to use it creativelyto advance an agenda for state PFMreforms. Subsequent sections o f this chapter discuss one way to achieve this. C. DETAILED PEFAPFMASSESSMENT REPORT 3.35. This section presents a consolidated (as opposed to individual) assessment9' o fthe PFMperformance o f the four Nigerian states against PEFA performance benchmarks. It uses the six core dimensions9' o f the PEFA PFM Performance Measurement Framework noted in Section 3.1 as thematic headings for the discussion. A small box within the discussion space o f each core dimension provides a summary o f the assessment for that dimension. Credibility of the Budget 3.36. This measure assesses the extent to which the budget i s realistic and i s implemented as intended. Similar to Chapter 1, it does this by comparing aggregate expenditure outturns to the original approved budget, the composition o f expenditure outturns to the original approved budget, and the aggregate revenue outturn to the original approved budget. It also examines the size o f expenditure payment arrears and how this i s monitored. Box 3.1 presents a summary o f the states' performance under this core dimension. 3.37. How does the aggregate expenditure outturn compare with the original budget? Table 3.1 shows a declining trend in deviations (but from the high level), from more than 97 However,performances that are markedlyoutsidethe average onbothsides, whether from within or outsideof the sample, will behighlighted. 98 That is, excludingdonorpractices. 101 40 percent in2002 to less than 20 percent in2004. Overall, aggregate expenditure outturn for three o f the four states in the study for the period 2002 to 2004'' were significantly lower than the budget, with the percentage deviation averaging 30.9. Ineffect, for two o f the three years, actual spending was less than 70 percent o f budgeted amounts. These large differences obviously reflect adversely on the ability o f state governments to deliver public services as expressed intheir policy statements, including inthe budget. This level o f outturnundermines the credibility o fthe budget. Box 3.1: Credibility of the Budget:Summary of Assessment Consolidated aggregate actual expenditure compared with the consolidated original budget posted a very high average outturn o f 31 percent during the period 2002 to 2004. Even though for individual years the average outturn was in consistent decline from 41 percent in 2002 to 19 percent in 2004, there is no evidence that this positive development is a result o f a conscious effort on the part of state governments to improve planning. Consolidated aggregate revenue performance and consolidated internal revenue performance within the period averaged a low 85 percent and 72 percent, respectively, underliningthe low planning capacity o f state governments. Historically, states did not maintain records o f the stock o f such expenditure payment arrears as salary, pension and gratuities, suppliers and contractors, rents and interest payments. Recently, however, and as part o f the reform efforts, individual states are beginning to maintain records of some payment arrears they consider important. Thus, in individual states, there are now traces of records o f contractor debts, pensions and gratuities, and interest payments on foreign debts. The data are not comprehensive, but even then, the debt profile is not good for some states. Table 3.1: Aggregate ExpenditureOutturns,Average for 3 States, nominalNbillion 3.38. There are several explanations for this development. First, there i s the systemic poor projection o f the revenues that drive the budget, arising from the states' inability to forecast revenue flows from the center. Much o f the states' revenues derive from unconditional formulaic transfers from the federation account, which i s largely composed o f oil revenues. Granted that world oil prices are volatile and not easy to predict, however, states have not taken advantage o f recent efforts by the Federal Government to reduce the negative impact o f this situation by introducing an oil-based fiscal rule that pegs the oil price for budget purposes. Traditionally, at the state level there i s the tendency to exaggerate these revenues at the time o f budgeting, leading to larger but unrealistic budgets. 3.39. Second, state governments also overestimate borrowing, which in their budget presentation, they wrongly treat as part o f revenue. The tradition inmany states i s to beef up budgeted resources with loan proceeds even while negotiations are not completed and/or they have not yet fulfilled conditions for the drawdown o f the proceeds o f 99Datafor the fourth state havenotbeenincludedbecausethey requiremajorrework; however, they also show a highdegreeof variability. 102 negotiated loans. As often happens, delays may affect the completion o f negotiations, or states may not be able to fulfill all conditions precedent to drawdown, such as counterpart funding. These affect the ability o f states to draw on the loanproceeds and, consequently, their ability to implement the budget as planned. 3.40. Third, the political class does not provide MDAs with the necessary guidance on fiscal policy and the consequent sectoral budget ceilings. Without clarity on budget policy and sectoral ceilings, there i s usually an annual "fight" among MDAs to receive a large share o f the budget. This provides the incentive for MDAs to exaggerate their annual budget requests inhopes o f getting more. 3.41. Fourth, the fact that the majority o f these variances i s attributable to capital spending'" reflects the lack o f due diligence in the financial management o f capital projects. States routinely and repeatedly admit some projects into the budget yearly without executing them. They also do not subject new projects to a proper appraisal and feasibility study before admitting them into the budget. Aligned with this i s the continued use o f the imprest accounting system in place o f the treasury system envisioned in the Financial Regulations/Instructions. 3.42. Under the treasury accounting system,'" the Ministry o f Finance and the responsible MDAs control the capital budget. However, states have wrested decisions on capital budgets from the Ministry and the MDAs and vested this in the Office o f the Governor. Even with budget provision, MDAs must submit requests for capital spending to a central authority, with the result that the projects, in which the administration has political interest, receive funding on a priority basis. In Enugu State, for example, the available data show that out o f the 24 heads o f capital expenditure in the period 2002 to 2004, 10 heads attracted no funding at all in any o f the three years, although the budget allocated funds to them regularly. Of the 24 heads, only four recorded an actual expenditure o f one-third and above o ftheir budget allocation. 3.43. Fifth, in-year budget adjustments, including extraordinary spending, contribute to the deviations. Ill-defined emergency needs and ad hoc political commitments often lead to additional spending, which the legislature later ratifies through a supplementary budget process. In Bauchi State, for example, originally unbudgeted spending on rural electrification amounted to about N21 million in2005. 3.44. Finally, states do not take budget formulation seriously enough. Officials show a noticeably higher level o f interest in executing the budget than in articulating the principles and policies that underpin the budget preparation. This frequently results in budgets that do reflect neither real existing policy priorities o f senior state government officials nor actual resource constraints. Such budgets are just impossible to get fully implemented, which leads to highdeviations. 3.45. However, it i s significant that budget deviations showed a consistent decline in all those years. This i s largely due to the increased revenue flows from the center to the states because o f improved oil revenue performance and greater transparency in the handling o f the Federation Account revenue distribution. At this point, however, available evidence does not support the argument that this positive development i s a result o f improvements in states' revenue prediction and planning. Still, it may be See Table 3.2 below. lo'For anexplanationofthe treasury accountingsystem, see below, underPredictability and Control in Budget Execution. 103 possible that following the introduction o f the oil price based rule at the federal level in 2004, the states' revenue expectations became more realistic. 3.46. The low level o f budget execution has not been limited to the four states in our sample. The Figure 3.1 presents actual similar data on annual budget execution, 2001-04, for five other states and the Federal Capital Territory selected here for no reason other than availability. It shows that although the level o f actual budget execution was increasing during the period, it still remained rather low. On average, budget execution for these five states andFCT amounted only to 64 percent between 2001 and 2004. At the same time, individual states' performance varies considerably. At the upper performance level, Lagos and Osun States averaged over 80 percent inbudget execution. At the other end, the budget spending inJigawa State and the FCT amountedto less than 50 percent o f the approved budget. Figure3.1: Annualbudget executionat the statelevel, 2001-04, % Eudget Rrforn'ence 01 SamMerianStates, 2001 2CC4 - ~ 1oc 00% 80 00% 6C 00% 40 004. 20 004. 0 oc% 3.47. How does the composition of expenditure outturn compare to the original approved budget? Table 3.2 shows the composition o f consolidated expenditure outturn for Bauchi and Enugu States, for 2002 - 2004. While consolidated capital budget allocation averaged N24 billion during the period, consolidated capital budget outturn averaged less than N10 billion, leaving a budget deviation o f about 60 percent. Thus, capital budget implementation averaged just about 40 percent duringthe period. On the other hand, consolidated recurrent budget showed a relatively small deviation o f less than 7 percent during the period. It is therefore obvious that the capital part o f the budget is largely responsible for most deviations within the budgets o fthese particular states. Table3.2: Compositionof ConsolidateExpenditure OutturnsCompared to Consolidate OriginalBudgetfor Bauchiand EnuguStates, 2002-04, Nbillion Table 3J: Cmodionof ConsoiidatedExpenhr 0- Comaredto Consoiidated hindBulnttforBaulhiandEwStater.Noo1.!OM INunBbnsl I1 Capital Total Clpaal Retwuent Total Capital TotalI Capital Retment Total ConsohdattdM e t 216 I Rennreut I1 148 364 11 206 II 191 II 397 1I 295 I Rtment I1 242 537 239 1I 194 II 433 ConsohLd Outapn 1 7 1 II 148 1 219 I 6 2 1 172 1 234 I 160 11 221 I 381 I1 98 I 180 I 278 1 ConsohLdBudgetDewon .145 0 0 .I45 .I44 .19 -163 .I35 -21 -156 -141 .I? -155 'itof Delition 67.1 0.0 398 699 99 11.1 4 5 1 8.: t91 $91 69 358 3.48. What explanations are there for the wide gap between policy intent and policy implementation in the capital budget? Why for instance, do state governments continue 104 to make large annual budgetary allocations to the capital budget notwithstanding the fact, as Table 3.2 shows, that they are able to implement less than 40 percent o f it? Why is deviation inrecurrent expenditure much lower? There are several reasons for this. 3.49. First, state governments seem to have an ideological bias towards the capital budget believing that the larger capital budget reflects their greater commitment to social and economic development. It has been common for states to approve budgets with the exceptionallyhighshares o f capital spending, inexcess o f 60 percent, while actual budget execution usually shows capital spending below 40 percent o f the total. The latter ratio is a better reflection o f states' fiscal capacity and, at the same time, it i s much closer to budget proportions that are common internationally. It appears that elements o f this tendency to adopt unrealistically large capital budgets persist. This conclusion reflects a situation, where some states (for example, Enugu) carry particular capital items in the budgets from year to year without even beginning to fund them at all. Moreover, available data for approved 2006 state budgets from 10 states show the average share o f capital spending exceeded 55 percent o fthe totallo2,somewhat lower than in the earlier years, but still too high. 3.50. Second, in the absence o f clearly defined budget priorities and sectoral budget ceilings, MDAs scramble to have a sizeable representation in the capital budget as an illustration o f their power and significance. At the same time, within the existing budget process, personal accountability o f government officials for large deviations inthe capital budget has been rather weak. L o w levels o f capital budget execution have been quite common, and respective deviations are not seen any longer as managerial deficiencies. Finally, there is little deviation in the recurrent budget because it consists mainly o f committed personnel costs, which do not vary much. In contrast to the capital budget, there have been much stronger incentives at the state government level to provide adequate financing o f budgeted payroll and avoid accumulation o f wage arrears. Overheads have since ceased to be an important component o f recurrent budgets in many states. 3.5 1. How does aggregate revenue deviation compare to the original approved budget? Consolidated aggregate revenue deviations for the sample states averaged 15 percent for the period 2002-04 (Table 3.3).'03 This means the average actual revenue performance o f 85 percent o f the budget. Best practice as indicated in the PEFA PFM Framework i s 97 percent. The Nigerian states' performance is therefore very low and reflects the inability o f the states to make effective revenue projections. As already indicated, this i s also a major factor contributing to the high expenditure deviations o f state budgets. What are the factors that are responsible for this highrevenue deviation? 3.52. State officials are quick to blame this on the volatile nature o f the international oil prices on which much o f states' revenues depend. (On the average, oil denominated Federation revenues account for between 85 and 90 percent o f the total revenues o f states.) States argue that this dependence directly translates any fluctuation in oil prices to states' revenues through the statutory Federation sources. As plausible as this argument appears on the surface, it i s faulty on several grounds. For example, the lo*This sample includeAnambra, Bauchi, Bayelsa, Gombe, Imo, Jigawa, Kaduna, Lagos, Plato, andRivers states (Ndujihe, Clifford. Politics of States' Budgets.Guardian.6 January 2006). '03The low aggregaterevenueoutturn in2003 was a fortuitous occurrenceresultingfrom increasedtransfers to states inthat year following the 2002 Supreme Courtrulingrequiring the immediate sharingof all revenues accruing to the Federationamong the three tiers of government. The ruling specifically forbade the saving of any portions of oil revenues without the consensusof all states. 105 internally generated revenue (IGR) o f states posts relatively higher deviations than their aggregate revenue. Table 3.3: ConsolidatedAggregate RevenueOutturn for Sample States, 2002-04, NominalNbillion 2002 2003 2004 Average Consolidated Budget Revenue 51.34 68.54 81.92 67.27 ConsolidatedActual Revenue 61.07 64.40 97.89 74.45 Revenue Deviation 9.73 -4.14 15.97 7.19 O/, nf nnviatinn 18 Q5 1QAQ Id83 ]Source:World Bank Staff estimates using official data from Bauchi, Cross River, Enugu, and Kaduna States 3.53. If external factors were responsible for the high revenue deviation, the IGR of states would show smaller deviations than the deviation o f the consolidated aggregate revenue. But, as Table 3.4 shows, the consolidated actual IGR o f the sample states for the period fell short o f the consolidated budget by an average o f over 28 percent. It i s noteworthy that for each o fthe years 2002,2003 and 2004, IGRvariance was consistently higher than aggregate revenue variance. In other words, states are less able to predict their internal revenues than they are able to predict statutory revenues. While the FGN recently managed to improve predictability o f both its revenues and transfers from the Federation Account, states' progress inthis area has been lagging. Table 3.4: Consolidated Internal RevenueOutturn for Sample States, 2002-04, NominalNbillion 3.54. Another fact that shows that high revenue variance in states is symptomatic o f states' weak capacity to plan is that the Federal Government introduced an oil price based fiscal rule from 2004 which benchmarks the budget at a predetermined reference price o f oil. Excess earnings from oil above this reference price are not immediately distributed but saved. The introduction o f this fiscal rule was with the full agreement o f state governments.lo4 Although state governments are regularly advised early on the reference price for the year, they still generally do not reflect it properly intheir budgetslo5because o f a routine and mechanical approach to planning, capacity problems, and a general failure to accord the planningfunction the attention it deserves.lo6 3.55. An entrenched mechanical, but ineffective, planningroutine'" and weak capacity are the root causes o f the high revenue variances in states. Nothing reflects this more IO4 Indeed, giventhe SupremeCourt rulings of April 2002, it is not possibleto introducesucha fiscal rule policy without the full agreementofall stategovernments. IO5 With the exceptionof Kaduna State, amongthe samplestates,andImo State, outsidethe sample states. IO6 For example, evidencegatheredfromKaduna State duringthe fieldwork shows thatMDAs generallyhaveonly tendays after therelease ofthe call circularto articulateandsubmittheirbudgetproposalsto the Ministry of EconomicPlanning. As explainedbelow, this is notthe exception,but the practiceinmost states (seepara. 3.72- 3.74). lo' Evidenceentrenchedplanningroutinesis nothardto findinstates. They range fromtheweak linkbetween policy andplanshudgets,lack ofsectoralstrategiesto underlinethebudget, improperdefinitionof the capital budgetto includeitems that haveno investmentor developmentalvalues, poor recordofimplementationofthe budget, to ineffectivemonitoring, evaluationandreportingmechanismsto guidebudgetimplementation. 106 than the fact that even when federal authorities release indicative figures o f expected revenue availability for the next fiscal year, states generally fail to reflect them in their fiscal projections. Kaduna State i s one notable exception to this among the sample states. Data from the state confirm official claims that Kaduna state receives and reflects federal fiscal rule data inits revenue forecast. Table 3.5 shows the outturn o f federation revenue receipts against the budget for Kaduna State for the period. Deviations average only 4 percent in the period 2002 to 2004, showing that the state took seriously the information provided by the Federal Government.'08 Table 3.5: Federation(Statutory) RevenueOutturn for Kaduna State, 2000-04, NominalNbillion u.44 I -u.CJ.Y YOof Deviation I 0.00 I 10.55 I 1.45 I 4.00 Source: World Bank Staff estimates uslng official data from Bauchl, Cross River, Enugu, and Kaduna States 3.56. There is a history behind the mutually reinforcing mechanical, routine attitude to budget planningand weak technical and human planningcapacity in states. The attitude to planning, like most problems with PFM in Nigeria, crept in during the military era, when state military governments routinely ignored plans and budgets and did not use them to justify government policy actions. There was usually no relationship between actual government expenditures and the budget. There were also no budget execution reports, in-year or end-year. As the planning function eroded, the mechanical attitude to planningdeveloped. The brightest amongthe planningstaff left the service and were not replaced. Although Nigeria returned to civil administration seven years ago, the situation persists. 3.57. How large is the stock of expenditure payment arrears and to what extent is it monitored? This assessment and the statements in the following paragraphs draws from various sources. First, it draws for purposes o f comparison with baseline datdinformation, from the earlier World Bank studies mentioned earlier in this chapter. Second, it obtains its main evidence from data collected from the four sample states where the PEFA team carried out in-depth analysis. Finally, it also took data from information obtained by World Bank staff who in the course o f 2006 conducted a less intensive review o f fiscal and financial developments inabout 10 or so states, as indicated above. These observations hold correct up to the middle o f 2006. 3.58. While state governments make efforts to keep some records (even if they are not comprehensive) o f their formal debts, untilrecently they did not do the same for the more informal debts. Thus, for example, state governments did not make efforts to keep reliable records o f arrears o f salaries, pensions and gratuities, services, rents, interest on domestic and external debts, etc. The cash basis used for government accounting meant that the records for these expenditures are available only after making payments. The government kept no formal records o f commitments or overdue payments. However, in recent times, and as part o f their reform efforts, some state governments are takmg steps to redress the issue by ensuring that a modicum o f records i s available on some o f the more intractable o fthese informal debt obligations. All the same, it is still not possible to lo*Duringthe field work, KadunaStateofficials adduced two reasons for whichthey usefederalfiscal projections intheir budget. First, it would formthebasisonwhichthey wouldreceivefederationfunds; therefore,it madeno sense to themto ignore them. Second, they lackedthe technical personnel,knowledgeandequipment to make meaningfulprojectionson their own. 107 obtain comprehensive, reliable and systematically kept information on the stock of expenditure payment arrears to informthe assessment o fthis measure. 3.59. What types o f expenditure payment arrears do state governments accumulate? To begin with, there are no records o f salary arrears in states. Most state governments claim not to have outstanding salaries that are overdue. In many states, this i s largely correct insofar as the direct salary o f civil servants i s concerned. However, in addition to owing one or two months o f salary arrears, some states owe various forms o f allowances, such as leave and monetization benefits, directly or through their parastatals. There are no formal records o fthese. 3.60. Nevertheless, some states have started to keep records o f pensions and gratuities, and contract and supplies arrears. Inaddition, Bauchi State also keeps records o f interest on foreign (not domestic) loans and from 2005, o f outstanding statutory transfers to local governments. Even then, it i s not clear to what extent states' records are comprehensive and complete because, for example, o f uncertainty about how the initial data (the opening balance) and cut o f f dates were determined. 3.61. Despite lack o f comprehensive data, the observable debt trends in some o f the states present a worrying picture. Cross River State i s an example. The stock o f pension and gratuities arrears in Cross h v e r State rose steadily from N633 million in 2002 to N688 million in 2003, and N1,076 million in 2004. This stock alone represented 5 percent and 3.7 percent, respectively, o f total Cross River State expenditure in 2002 and 2004. When added to the stock o f contract expenditure arrears, the picture changes dramatically. Contractor arrears amounted to N5,768 million in 2003 and N15,092 million in 2004.'09 Taken together, the stock o f pensions and gratuities and contractor arrears translates to 55.6 percent o f total Cross River State expenditures in 2004. This i s extraordinarilyhigh. The PEFA P F M benchmark for best practice is 2 percent. Comprehensivenessand Transparency 3.62. The indicators covered under this group are: (i) classification o f the budget; the (ii) comprehensiveness oftheinformationincludedinthebudgetdocumentation; (iii) the the extent o f unreported government operations; (iv) the transparency of inter-government fiscal relations; the (v) oversight o f aggregate fiscal risk from other public sector entities; and (vi) public access to key fiscal information. 3.63. m a t form does budget classiJication take in Nigerian states? Does it meet international bestpractice? Is there aproper classijkation systemfor states' budget? In most states in Nigeria, the budget follows a dual format, recurrent and capital, with a different classification format for each. The recurrent budget i s organized using both administrative and economic classifications, which makes possible the tracing o f recurrent expenditures to administrative units (MDAs), and to some economic categories (e.g., personnel costs, overhead costs, pensions and gratuities, etc.). The capital budget, on the other hand, i s classified along functional and sub-functional categories."' There are four common functional categories, namely, economic services, social services, regional development, and general administration. The sub-functional heads differ from state to state but generally range between 20 and 25. Even then, some states do not produce a breakdown o f capital spending by MDAs. IO9By end-2005, the stock ofcontract debt arrears was N18,956 million. 'loSectors andsub-sectors 108 3.64. Budget classification in Nigerian states differs from international best practice"' in several important respects. The budget is not presented in a format that reflects the most important classifications. The presentation allows for administrative and functional analysis o f spending inonly a limited way. Although all the states have poverty reduction strategies as evidenced in their SEEDS, there i s no definition o f poverty reducing expenditure, and such spending i s not linked directly to the classification o f the budget. The functional classification i s not detailed enough, consisting o f only four main functions and 20 to 25 sub-functions. This i s against the 10 main functional and the 69 sub-functional categories in the UN-sponsoredCOFOG. The budget i s also not arranged programmatically to reflect the poverty reduction strategy and as such there i s no effort to reflect this in the classification (see Box 3.2). Two o f the states in the sample, Cross River and Enugu, are in the process o f following the Federal initiative to institute reform o ftheir budget classificationsystems. 3.65. How comprehensive is the information included in budget documentation? The purpose o f providing comprehensive information to the legislature i s to present a complete picture o f government fiscal forecasts, budget proposals, and outturns o f previous years. The current practice i s similar in most states inNigeria. The information included in the budget documentation is not comprehensive enough to enable the legislature to effectively scrutinize budget proposals. Much necessary information i s not provided due to the lack o f or the inadequacy o fthe data. 3.66. Generally, budget documentation to the State House o f Assembly (SHA) covers two main categories: (i) spending estimates for the current and the preceding year broken down into heads and subheads, and (ii)in some states, actual revenues for two to three quarters o f the current year. Necessary information that i s usually not provided includes information on previous years' budget outturn,'12 debt stock and financial assets. The budget speech discusses the macroeconomic setting only in very broad terms, focusing essentially on how developments in the international oil market are expected to affect oil earnings and the revenue o f the state. However, the budget papers do not sufficiently document this. 3.67. To what extent are government operations unreported? The experience o f the states inthe study is similar, with little significant variation. Budget estimates and budget reports (where produced) include data on all actual expenditures,' l3 including deviations from origmal budget provisions and spending on items not originally included in the budget. The latter was reported only in Bauchi State; even then, this was included in the budget and accounting reports. However, states do not properly report on at least three forms o f extra-budgetary transactions. ' ' I As representedby the UN-supportedClassificationofFunctionsofGovernment (COFOG). 'I2 Where this is presentedat all, it is presentedin a fragmentary and selectivemanner inthebudget speech. In Lagos State, publishedbudgetsroutinelyincludedetails of theprecedingyear's outturns. However,this is includedby the BudgetOfficeat the time ofpublication,whichis usuallysometime after approvalby the legislature. This informationis notpartofthe documentationpresentedto the SHA at the timeof consideringthe budget for approval. Except, as reportedinone state, for securityvotes, which, inany case is not an explicitline iteminthe budget. 109 Table3.6: Comprehensiveness and Transparency: Summary of Assessment Budget classiJication neither meets international standards nor lends itself for use in monitoring budget spending on poverty alleviation, programs, or detailed government functions and activities. Budget documentation varies widely among states but i s generally inadequate, although there are efforts at improvement. Since the return to civil administration, states are making increasing efforts to report on all actual spending with the observable exception, in some states, o f "security votes." In addition, it would appear that states generally underreport revenue flows from the center as well as debt service obligations because they account for only net receipts from the Federation Account (after the deduction of debt service charges) instead of the gross revenues. Fiscal relations between states and their component local governments are not as open and transparent as they could be. To varying degrees, state governments withhold part o f transfers due to local governments from both the center and the states. State governments' oversight of fiscal risks from other public sector entities is weak and needs improvement in all the states. The existing rules of fiscal reporting by parastatals and local governments could be more strictly enforced to enable state governments to produce one consolidated annual fiscal report for parasatals in the state. Public access to keyfiscal information is improving in some states but not in others. Public demand for fiscal information is weak because o f the technical way o f publishing such information. These reports are also not publishedin a timely manner. 3.68. First, Federal Government deductions for external debt service and ISPOs (irrevocable standing payment orders)' l4 issued by states on their Federation Account receipts are not included in the budgets or any o f the reports. In other words, state governments' receipts from the Federation Account (FA) are shown on a net, rather than gross, basis, thereby understating both revenues and debt service expenditures. Second, information on the flow o f donor funds i s sketchy in most states, ifavailable at all. Third, states do not publish withholdings of local governments' Federation revenue receipts, held for various purposes. 3.69. How transparent are thejscal relations between states and their component local governments? The fiscal relationship between states and local governments inNigeria is not transparent, despite claims to the contrary by the states ~urveyed"~.For instance, the Constitution requires that transfers o f funds to local governments from the Federal Government be channeled through their parent state governments. State Houses o f Assembly have enacted laws that enable them to withhold part o f these funds for various purposes, such as payment o f local government teachers' salaries and other staff salaries and pensions. In at least one state in the sample, an additional deduction made includes funds for the construction and maintenance o f rural roads, the provision o f primary healthcare, the funding o f primary education, etc. In 2005 the total amount o f local government funds withheld monthly by that state averaged 87.5 percent o f LGAs' receipts from the Federation. There i s weak accountability for money so deducted because states do not report the deductions in their budgets. In addition, whereas states are constitutionally required to transfer 10 percent o f their total revenues to the local `I4These are written legal instrumentsexecutedon the Minister of Financeby state governmentsthat have borrowedfrom banks and the security markets, authorizingthe federal governmentto deduct specifiedamounts at specifiedintervalsfrom transfers due to the affected states indirect settlementof their maturingdebt obligations. ISPOsprovideanirrevocableguarantee without which banks andthe security markets are not willing to lendto state governments. `15 To check this trend, the Federal Government, in2004, enactedalaw makingit ajailable offencefor any state accountantgeneralto tamper with federation allocations to local governments. Despitethis law, the Revenue Mobilization, AllocationandFiscal Commission(RMAFC), aconstitutionalbody chargedwith monitoring fiscal efficiency of all governments,complains that the practicepersists. 110 governments under their jurisdiction, when they do this at all, they transfer only 10 percent o ftheir internally generated (butnot total) revenues. 3.70. How effective is the oversight of aggregate fiscal risk from other public sector entities? Oversight rules over public sector entities are similar in all the states. While Departments o f Local governments in each state monitor local governments' activities, parent MDAs supervise autonomous government agencies (AGAs) and parastatals. Local governments and AGAs cannot borrow without the authority o f the state government, which guarantees the debt. Each state government requires monthly reports, including on debts, from both Local governments and AGAs. In addition, each state government appoints an Auditor-General for local governments to audit the accounts o f local governments. 3.71. These clear arrangements notwithstanding, state government oversight o f fiscal risks from local governments and AGAs i s poor. The study could find no evidence that parastatals and AGAs actually submit fiscal reports to their supervising MDAs on a regular basis. N o evidence was also found inmost cases to show that the annual accounts o f these entities are audited in a timely manner. There was also no evidence o f the consolidationo f the annual reports o f parastatals. Except for Bauchi State, which showed a high level o f compliance o f local governments with monthly and annual fiscal returns, the evidence from the states showed that local governments were rather casual and irregular about their fiscal reports and accounts. In all four states in our core group, including Bauchi, there was no evidence that state finance authorities consolidate local government fiscal reports. 3.72. How accessible to the public is key fiscal information? The experience varies among states. Cross River State publishes the details o f its budget in its local newspaper. EnuguState uses its two websites to publicize some o fits reports andactivities. With the assistance o f DFID, it is also publishingseveral newsletters that disseminate information to the public. N o other state in the sample has a functional and active website.'16 In general, states do not routinely circulate their fiscal reports (budget documentation, budget execution reports, year-end financial statements, audited financial statements, etc.) to the public. They are available only on demand and for sale at a price which does not usually exceed their cost o f production. Public demand for these documents i s weak and usually comes from donors, researchers and students. The reports are usually published late. Nevertheless, two important extreme cases are noteworthy. 3.73. The first case i s the peculiar case o f Bauchi State. InBauchi State there i s very tight and restricted control over all fiscal documents, including the budget, in-year and year-end budget reports, audit reports, etc. Necessary approvals and authorizations must be obtained before access i s granted. The public can obtain the annual budget documents only with the prior authorization o f the Commissioner for Economic Planning and Budget. The circulation o f year-end financial statements is restricted and must first be approved by the Commissioner for Finance and the Accountant-General. External audit reports are prepared and printed but their circulation i s restricted to the State Executive Council and the State House o f Assembly. 3.74. At the opposite end o f the spectrum is Kaduna State, leading a number o f other states, including Nassarawa and Delta, which are beginning to publish their audited 'I6Cross River Staterecentlyestablished a website, but at the timeof the fieldwork hadnotpostedany fiscal informationonit. However,a numberof states outside the samplemaintainactivewebsites andthey occasionally uploadthemwith vital fiscal informationsuch as thebudget and auditor's report. Examplesare Lagos,Delta and ImoStates. 111 financial statements in national newspapers. For example, on M a y 31, 2006, Kaduna State published an advertorial on its 2005 audited financial statements in a leading national daily newspaper.' '' The publication consists o f four statements, namely: (i) a cash flow statement, (ii)a statement o f assets and liabilities, (iii)a statement o f the consolidated revenue fund, and (iv) a statement o f the capital development fund. It also includes a statement o f the accounting basis, the signed Auditor-General's certificate, and a signed statement o f financial responsibility by the Accountant-General. Nassarawa and Delta States have published similar statements although their accounts are not as up to date as Kaduna's. Policy Based Budgeting 3.75. T h i s core dimension measures performance in two areas: orderliness and participation inthe annual budget process, and a multi-year perspective in fiscal planning, expenditure policy and budgeting. While participation o f MDAs and political stakeholders in the annual budget process may be improving, performance in this area i s still far from meeting international standards (see Box 3.3). Although each state has a budget calendar, it i s not strictly adhered to, which results in late approval o f the budget each year.' l8There i s no multi-year perspective in fiscal planning, expenditure policy and budgeting despite the existence o f development strategies and three-year rolling plans in each state. 3.76. How orderly and participatory is the annual budget process? Although the financial regulations o f each state contain a clear and fixed budget calendar, there i s wide- spread failure to adhere to this calendar in the preparation o f the annual budget, except in Cross River State. The calendar typically provides for the budget process to begin in April and for the executive proposals to be submitted to the legslature by September or October. However, as the field work has shown, the budget process generally commences between August and September when the call circular to MDAs to submit their budget proposals goes out."g This does not allow MDAs sufficient time to articulate their budget proposals. In Kaduna State, for example, MDAs are allowed about 10 days to do this. The result i s an incremental budget approach where MDAs generously mark up the preceding year's submissions. The notable exception is Cross River State, which for each o f the three years o f this review commenced the budget process early, allowed MDAs six weeks to submit their proposals, and sent the executive budget to the legislature by September 1. 3.77. The budget process does not involve all parties - the political class and MDAs - in a properly integrated, top-down and bottom-up budgeting approach, and in an orderly and timely manner. The State Executive Council (SEC) does not provide a fiscal framework or policy thrust to guide and focus the budget process; neither does the call circular contain sectoral budget ceilings. Although there exists a development strategy in each state (SEEDS), the MDAs have not articulated and costed sector strategies to inform their contributions and budget submissions. The current approach i s that MDAs make their proposals while the SEC (political class) approves the budget based on ill-defined state priorities and unstable situation analysis. This a recent habitformedby the stateandothers. Kadunaevenpublishedall its financial statementsfrom fiscal 2002. "* With the exceptionof Cross River State, where thebudget calendaris respectedandwhere the budget is a proved, eachyear, well beforethe commencementofthe next fiscal year. Withthe exceptionof Cross RiverStatewhere thebudget circulargoes out inApril. 112 Box 3.2: Policy Based Budgeting: Summary ofAssessment Participation of MDAs and political stakeholders in the annual budget process may be improving; however, performance in this area is still far from meeting international standards. Although each state has a budget calendar, this is not strictly adhered to, which results in late approval of the budget each year. There is no multi-year perspective for fiscal planning, expenditure policy and budgeting despite the existence o f development strategies and three-year rolling plans ineach state. 3.78. The result o f all o f these factors i s that state legislatures have not approved the budget before the commencement o f the new fiscal year in any o f the three years, 2002 to 2004. The budget i s typically approved about the end o f the first quarter or the beginning o f the second quarter o f the year. There are two notable exceptions. The first i s Cross k v e r State, where for each o f the years the budget was approved well ahead o f the commencement o f the fiscal year. The second i s Bauchi State, which for each o f the years submitted its budget to the State House about the third week o f December, but still had it approved before the commencement o f the year. The explanation provided for this i s that the entire budget process in the state i s a joint and collaborative venture between the executive and the legislature. However, there was no evidence o f meaningful legislative contribution to the budget preparation. 3.79. Is there a multi-year perspective in Jiscal planning, expenditure policy and budgeting? State governments have not begun to prepare multi-year fiscal forecasts to form the basis for the functional allocation o f budget resources. They only prepare three- year rolling plans that have limited practical usefulness as a planning tool. First, there i s no proper fiscal and macroeconomic context or framework for the plans. Second, they cover only capital items, completely excluding the recurrent implications o f the planned spending. Third, they are not informed by sector development strategies and are often a mere listing o f desired projects based on some informal appraisal. Fourth, although costs are tagged on each item, the projects are not properly costed and budget estimates are not useful guides to spending commitments. Finally, they serve limited purposes in guiding real budget spending, because items included in the plans are often rolled from year to year without beingfunded while items not originally inthe plan are funded. 3.80. Inreality, the technical requirements for preparinga sound multi-year fiscal plan do not yet exist and need to be established. These requirements include the technical expertise and equipment for data collection, collation and analysis, as well as for forecasting, scenario building and sensitivity analysis. As yet there i s even no proper connection between medium-term fiscal policies as elaborated in the various states' SEEDS documents and their yearly budgets. In other words, state governments generally lack the ability to build a proper link between policy and budget, which i s an important step in the MTEF process. Moreover, discipline in budget execution should be much stronger before the development o f the MTEFwould bejustified. 3.81. For instance, in Enugu state the analysis revealed considerable disconnect between the policies outlined in the SEEDS and the composition o f budget allocations o f the recent years. For instance, the Government stated inthe SEEDS its intensionto reduce the maternal mortalityto 100per 1,000 and infant mortality to 30 per 1,000 live birthsby 2009. But in both 2004 and 2005 annual budget estimates contain no initiatives or programs aimed at addressing maternal and child health. The government investments in the health (as well as in education) sector have been directed mostly to the tertiary level, which i s not an efficient way to address the problem o f high infant and maternal mortality. The operating expenses (overhead) in health were rather low, about ten million 113 naira a year in 2004-05. In 2005 most o f actual investments in primary and secondary health in Enugu state were funded by the donor projects, primarily by the World Bank and DFID. 3.82. State governments do not carry out debt sustainability analysis. Most states have a good idea o f their formal debts (debts preceded by formal negotiations and evidenced by written agreements such as external loans, domestic bank loans, securitized debts, etc.)12' However, states generally do not keep records o fthe more informaltypes o f debts such as pension and salary arrears, contractor debts and commitments, and contingent liabilities, including bank guarantees for state parastatals and local governments. The lack o f proper debt analysis i s already telling in states like Bauchi, which i s carrying a huge contractor debt burden. Although states are generally confident that they can cope with the current stocks o f debt, there is need for an in-depth analysis, and better monitoring, o f the situation. However, the ability o f state governments to conduct such an analysis on their own i s severely constrained by the same capacity issues highlighted inthe precedingparagraph. 3.83. The SEEDS document o f each state government contains sections on medium- term development objectives and broad strategies for attaining them. However, the strategies are too broad to provide useful guides for sectoral budget allocations. They do not show an analysis o f the current situation; neither do they make a choice o f strategies based on the consideration o f different options and alternative scenarios. In addition, although SEEDS provides indicative costs for proposed policies, these are often "guesstimates" rather than costs rigorously built up from reliable data and information. Often, the costs in SEEDS do not cover both investment and recurrent expenditure. They are not intended to provide, and are not used as, a practical guide to annual budgeting. 3.84. Linkages between investment budgets and forward expenditure estimates are hard to find in many cases. Many investments decisions have weak links to sector strategies. They are poorly appraised prior to investment. Their recurrent cost implications are included inforward budget estimates only invery rare cases. Predictability and Control in Budget Execution 3.85. This core dimension seeks to assess performance in nine key areas. These areas are: (i) the transparency o f taxpayer obligations and liabilities, (ii) effectiveness o f the measures for taxpayer registrationand tax assessment, (iii) the effectiveness in collection o f payments, (iv) the predictability o f the availability o f funds for commitment expenditures, (v) the recording and management o f cash balances, debt and guarantees, (vi) the effectiveness o f payroll controls, (vii) the competition, value for money and controls in procurement, (vii) the effectiveness o f the internal controls for non-salary expenditure, and (ix) the effectiveness o f the internal audit. Box 3.4 summarizes the current situation inthese areas. 3.86. H o w transparent are taxpayer obligations and liabilities? SNGs have limited control over taxes, legislation and administration. The Federal Government legislates on the bulk o f taxes. It is therefore not appropriate to assess states on the clarity and comprehensiveness o f these taxes. They can be heldresponsible only for the clarity and comprehensiveness o f the relatively minor taxes on which they legislate. These taxes Eachstategovernmenthas a Public DebtOfficeinthe Ministryof Financeor Officeofthe Accountant-General where it keepsa (formal) debt register. At leastfour stategovernments, Ekiti, Lagos, Enugu, and Cross River, haverecentlyconvertedtheseofficesintofull-fledgedDebtManagementOffices. 114 include property taxes, development levies, etc. The evidence suggests considerable overlapping o f these taxes. For example, the new land registration and sales taxes in Lagos are still the subjects o f litigation because they overlap, with other taxes. There i s also a question about their legality. Similarly, several state and local taxes overlap causing multiple taxation. 3.87. Notwithstanding the issue o f multiple taxation, most states are good at providing taxpayers with information on their tax liabilities and the administrative processes regarding where and how to pay their taxes. This information i s usually disseminated through the print and electronic media, billboards, posters and handbills. Access to information on taxpayer liabilities i s therefore good, although sometimes the information sounds more like threats on the dire consequences o f evading a particular tax than like constructive explanations o f issues on which the taxpayer requires knowledge. However, one aspect o f the access to information on administrative procedures that i s not that effective that concerningthe procedures for addressing grievances. 3.88. Most state tax laws contain provisions relating to the settlement o f the grievances o f taxpayers. There are elaborate provisions for appealing perceived wrongful assessments, beginning with administrative panels and, if the party appealing i s not satisfied, going all the way to highest courts in the land. However, the tax appeal system inmany states inNigeria is not effective. There are several reasons for this. First, and perhaps most important, the appeal process in many states i s not well established and remains insufficiently clear to taxpayers. Second, the process i s cumbersome, time- consuming, and expensive, even for small appeals. Finally, most taxpayers are not even aware o f the existence o f this process; consequently, they cannot avail themselves o f the opportunity. The two important exceptions are Cross River and Kaduna States, where recent efforts have revived the tax appeal system. These states have also set up Revenue Courts and are making efforts to ensure that they are efficient and effective. In Kaduna State, for example, the Revenue Court sits twice a week and disposes o f about 20 cases per sitting. 3.89. How effective are measures for taxpayer registration and tax assessment? A taxpayer database does not exist in any o f the states in the sample; however, it exists in Lagos State. Lagos State has developed a taxpayer database with a unique taxpayer identification number for each taxpayer. This database i s linked with other government registration systems that involve elements o f taxable turnover and assets, including the issue o f business and motor vehicle licenses, the payment o f water rates, landregistration, etc. Even then, Lagos State does not yet carry out occasional surveys o f potential taxpayers, such as selective physical inspections o f business premises and residences, to ensure compliancewith the registration requirements. 3.90. The practices among the four states inthe sample differ from the good example o f Lagos and among themselves. None o f the four states has an integrated database; separate tax registers exist for each tax'21 and often they are not comprehensive. For example, the PIT database often captures only taxpayers engaged in formal employment that are subject to the PAYE system because the law compels employers to provide tax administration authorities with such information. Where registers for employees in the informal sector exist at all, they are often not updated and are unreliable.'22 Within the sample group there are important differences regardingresponsibility for the tax registers. "' InCrossRiver State, registeredtaxpayers in2005 breakdownas 38,164 for PAYE,68,874 for direct assessment, and22,702 for the urbandevelopmenttax. "'With the possibleexceptionofCrossRiver State, whichclaims to revise the registerannually,but this claim couldnotbe verified. 115 InBauchi State, for example, areatax officescompileandkeepthetax regrsters, whereas in Kaduna and Cross River States this task in centrally done. Enugu State, with the assistance o f DFID, i s just conducting a household survey to construct a database o f taxpayers. 3.9 1. Are penalties for non-compliance with registration and declaration obligations effective? To begin with, there cannot be a penalty for non-compliance with tax registration when there i s no law requiring such registration (with the exception o f Lagos State). The tax laws are replete with penalties for tax offenses but these are not effective for a number o f reasons, including: (i) poor commitment to internal revenue generation resulting from dependence on oil revenue flows from the center; (ii) political pressure; (iii)lackofinformation;and(iv)inadequatecapacityintaxoffices.'23 Inaddition,some o f the penalties are too light to have the desired impact and there i s no consistency and fairness intheir administration. Box 3.3: Predictabilityand Controlin BudgetExecution:Summary ofAssessment States are good at providing information to taxpayers on their obligations. However, it is possible to make the process more helpful and constructive. Measures for taxpayer registration and assessment are weak, fragmentary and ineffective among the sample states, although Enugu State is currently carrying out a household survey to register taxpayers. Lagos State, which is outside of the sample states, provides the best example o f taxpayer registration in Nigeria. Generally, tax collection systems are weak due to a discernible lack o f political will to improve the process. However, more states are beginning to make greater use o f banks to improve collections. States' MDAs cannot predict the availability o f funds for commitment because the Ministries of Finance do not inform them. Most states have abandoned the treasury accounting system that uses warrants to release budget allocations to MDAs. Personnel and capital budget execution are centralized and MDAs receive irregular monthly imprests to meet overheads, in most states. States attempt monitor cash balances closely, but the capacity to do so effectively i s lacking. Some states are introducing a single treasury accounting system; others try to consolidate all cash accounts regularly. Generally, states do not use computers to facilitate cash management. States are converting their public finance/debt offices to Debt Management Units. However, all they do currently is maintain a register on formal debts. They do not have the capacity to track the more informal debtdarrears or carry out debt sustainability analyses. States are introducing the use of computers to facilitate payroll controls and some have integrated the payroll with the nominal roll for more effective management. However, the system is not yet functioning optimally in any state. Most public procurement is carried out through the selective bidding process, even though the rules provide for open competitive bidding as the default procurement method. Controls for non-salary expenditure management are weak but improving. Similarly, internal audit is receiving greater recognition than in the past and internal audit queries receive better respect. However, the function still suffers from a lack o f real independenceand a low level of skills and professionalism. 3.92. Although tax audit units exist in the Revenue Offices, none o f the sample states showed evidence o f programs for planning and monitoring tax audit and fraud investigations. The result i s that tax audit i s not systematically carried out. This means that the system for discovering and investigatingtax frauds i s weak. Tax frauds are only investigated when they are reported or are somehow discovered. lZ3Cross River State is beginningto enforce compliance. At the time of the field study, 70 tax defaultcases were pendingbeforethe Revenue Court. 116 3.93. Is the collection of tax payments effective? H o w high i s the collection ratio for gross tax arrears? It i s difficult to answer this question owing to lack o f proper statistics on the total tax debt collected. The only tax effectively collected, to some extent, inmost states i s the PAYE. The reason is that employers must deduct this tax from salaries and remitthe proceeds directly to the tax authorities. Eventhen there are sometimes delays in remitting the proceeds to the revenue administration. Most states do not have the information to assess the performance o f direct assessment and other taxes. The only possible exception among the sample states i s Cross River State, which indicated that tax arrears (excluding the new urban development tax arrears, for which the amount was 88.7 percent o f estimated tax liabilities) amounted to a negligible 2 percent o f collections in 2005. This statistic could not be verified, however. 3.94. Was the transfer o f tax collections to the Treasury by the revenue administration effective? Generally, states are discouraging physical cash transactions between the taxpayer and revenue officials, and are designing alternative systems that increasingly rely on the use o f banks. The system works as follows (with minor variations from state to state): in urban areas, taxpayers pay directly to the Revenue or Treasury Account in designated banks. In rural areas, where banks are not numerous, revenue officials continue to collect tax proceeds in cash, but must deposit them in a bank within 24 or 48 hours, depending on how far away the area i s from the nearest designated bank. Revenue-collecting MDAs follow the same routine in banlung their proceeds. The systemmay not be working perfectly yet, but it is a considerable improvement on the old process. 3.95. H o w often i s the reconciliation o f tax returns carried out? Most states reported monthly reconciliation o f some sort, but this i s not comprehensive. The reconciliation involves only a checking o f collections by banks or the revenue authorities, on one hand, against receipts by/remittances to the Treasury, on the other. Collections by the revenue/banks are not reconciled against the original assessments; and since states do not keep records o f arrears, these cannot be reconciled with receipts by the Treasury. The reconciliation effort i s therefore incomplete. 3.96. How predictable is the availability of funds for commitment of expenditures? H o w reliable are cash flow projections? Three out o f the four states in the study showed evidence o f preparing monthly cash flow statements in one form or another. However, the statements are, in most cases, a listing o f actual cash receipts on a monthly basis to enable the state governor or a cash committee to decide on allocations. They are not forward projections o f cash; neither do they involve a systematic monitoring o f trends. They also do not involve any sensitivity analysis under different scenarios. The reason often adduced for this failure to plan i s that the oil revenues on which state governments largely depend are unpredictable. What emerges from this lack o f planning i s a sort o f "management by emergency/exigency" in which the pressures o f the moment determine priorities and guide government decisions on cash allocations. 3.97. H o w often do the Ministries o f Finance inform the MDAs o f ceilings for expenditure commitment? H o w reliable i s the information? The Ministries o f Finance do not inform the MDAs o f ceilings for expenditure commitment in a way that guides their budget commitments. The reason i s that states' MDAs do not have the power to implement their budgets. Usually, states centralize the implementation o f the capital budget in the Office o f the Governor or around select committees. Personnel costs are also centralized inthe Office o f the Accountant-General or, as inthe case o f Bauchi State, in the Directorate of Computer Services. MDAs only receive monthly imprests for settlingpetty administrative overheads. The size and frequency o f these imprests depends 117 on the availability o f cash, its size and whether a particular MDA has accounted for its previous receipts.'24 3.98. H o w frequent and how transparent are adjustments to budget allocations decided above the level o f management o f MDAs? The situation varies from state to state. Kaduna State uses the legislature to vire and readjusts budget allocations in the third or fourth quarter o f the year, when the extent o f actual implementation i s somewhat clear. To achieve the same purpose, Cross River State uses a select Funds AllocatiodDisbursement Committee o f about four persons headed by the Governor. In both Enugu and Bauchi States, the Governors make decisions on the allocation and reallocationo f funds, and it i s not clear to what extent the SHAs approve them. InBauchi State, the Accountant-General prepares a statement o f actual cash flows for the benefit o f the Governor only. The Governor uses this to decide on disbursement. All the states in the study, apart from Kaduna, use supplementary budgets to reallocate resources, usually after incurring the expenditure. Briefly, decisions on budget adjustments are generally not transparent. 3.99. How are cash balances, debts and guarantees recorded and managed? What is the quality o f the recording and reporting o f debt data? As indicated earlier, every Nigerian state has a department charged with the responsibility for public debts either in the main Ministry o f Finance (for example, Cross River State) or in its Office o f the Accountant-General (Bauchi State). Some state governments are converting these offices into independent Debt Management Units, modeled after the federal Debt Management Office (DMO), for example, Cross River, Enugu, Lagos, Ekiti and Bauchi States. However, these offices, whether independent or not, do not yet comprehensively record and report on state debts. The offices maintain a register o f formal domestic debts (i.e., formally negotiated borrowings from debt institutions and the capital market). Often, however, there i s no information on the more intractable informal types o f debt, such as salary, pension and contractor arrears. Usually, also, information on external debt i s scanty, dated, and unreliable and depends mostly on information provided by the federal DMO for the records and management o f these debts.'25 For example, Cross River State could only provide external debt records as o f December 2001 as obtained from the federal DMO. 3.100. Inaddition, states do not deliberately plan or schedule debt repayments or weigh the overall impact o f their debt burdens. Because o f this, they are not able to manage their debt obligations effectively. Cross River State provides an example o f a state that urgently needs, but does not carry out, a debt sustainability analysis (with its huge borrowings from banks and the security market to finance its ambitious tourism development projects), even though it budgets for its debt obligations. As o f December 2003, Bank loans and contractual liabilities in Cross River State stood at about U S $8 million and US $78 million, respectively. This i s in addition to U S $31 million raised from the capital market in 2004, multilateral debt obligations o f U S $50 million as o f 2001 (obviously not yet liquidated, and likely expanding with several new signings since then), and a Paris Club debt o f U S $21 million (recently redeemed, courtesy of the debt deal by the Federal Government). There are also pensionarrears o f sizable magnitude. InEnuguState, beginningwith 2005, theMinistryofFinancebecameregularwith the monthlyreleaseof impreststo MDAs. Priorto this time there was noregularityinthese releases. 125A noteworthyexceptionamongthe samplestates is Kaduna, whichkeeps a meticulousrecordof externaldebts showingdatesigned, loadcreditamount, amount drawndown, total repayment,andamount outstanding. Total amountoutstandingonexternaldebts inKadunastoodat US$67,814,757 inDecember2005. However,the debt records do not show a repaymentschedule. 118 3.101. To what extent do state governments consolidate cash balances? Among the sample states, the experience differs with the maintenance o f bank accounts. While Enugu State maintains a single centralized Treasury Account, Bauchi and Cross hver States have multiple accounts in various banks. In Bauchi State, the Central Accounts Unit reconciles and consolidates all the accounts monthly. In Cross River State, consolidation i s a weekly exercise while reconciliation i s monthly. There i s no evidence in any o f the sample states o f the inclusion o f project accounts in the consolidation process. There i s also no electronic clearing and payment arrangement in place in any o f the states. 3.102. What i s the system for contracting loans and issuing guarantees? The Federal Government guarantees the states' external borrowings. However, the respective state Ministries o f Finance guarantee all domestic loans, where permitted. In addition to these state guarantees, domestic lending institutions and the securities markets require federal guarantees in the form o f irrevocable standing payment orders (ISPOs) for maturing obligations issued against the borrowing state's share o f federation allocations and directly paid over by the Federal Government. Although states keep some records o f such ISPO-guaranteed debts, there was no evidence to assess the quality and usefulness o f such records. State governments approve and guarantee loans to parastatals and local governments, where they have borrowing powers. 3.103. How effective are payroll controls? What i s the degree o f integration and reconciliation between personnel records and payroll data? Cross River State has the most advanced payroll controls system among the sample states. This system has several features o f a modern payroll system. First, it i s a fully automated system, using the MACEPAY 6.0 software package with a FOXPRO 6.0 database. Second, it integrates the payroll, managed by the Accountant-General, with the nominal roll, managed by the Head o f Service. Third, the payroll system makes direct salary payments into the bank accounts o f individual staff. Fourth, it automatically transfers retiring public servants from the payroll to the pensions roll as their retirements fall due. The process inthe other sample states i s not as advanced. Enugu and Bauchi States have some form o f automation o f the payroll controls process, but Kaduna State does not have such an arrangement. InBauchi, the payroll function is inthe Computer Services Unit and not in the Office o fthe Accountant-General or Head o f Service. 3.104. H o w timely are changes to personnel records and the payroll? Inthis area, Cross h v e r State also displays the best example among the sample states. In Cross River changes to the payroll originate from the Head o f Service who must specifically advice the Accountant-General on additions, name changes, pay point changes, and other amendments. The Accountant General must effect authorized changes in no more than two weeks. Bauchi State decentralized the process by allowing MDAs to directly make observations and issue variation orders on payroll such as promotions and retirements. Variations for promotions must, however, pass through the Establishment Committee, which oversees promotions. Variations are generated monthly and they are put into effect within one month. InKaduna State, where the system is not computerized, the Ministry o f Finance controls the payroll system and effects variations arising from promotions and retirement as promptly as possible. Although staff responsible for effecting such variations are penalized for any undue delays, recent audit reports indicate cases o f overpayment within the period 2002 to 2004. 3.105. What internal controls are there for changes in the personnel records and the payroll? Inaddition to what i s described above, inCross h v e r State the Auditor-General i s informed o f any payroll changes to facilitate verification. Further, the Computer 119 Payroll Unit in the Office o f the Accountant-General effects authorized changes and prints an update trail, which a designated accounting officer checks. The Unit also prepares monthly salary variance reports and provides an explanation. In addition, periodic audits establish cases o f unclaimed salaries from banks. Cases where salaries remain unclaimed for three months are investigated to determine the status o f such staff and to ascertain whether changes to the payroll are necessary. In Bauchi State, three independent agencies provide internal control oversight over the payroll process, including variations. These agencies are staff officers o f MDAs designated for that purpose, MDA accountants, who are also staff o f the Office o f the Accountant-General, and internal auditors. 3.106. Are there personnel audits to identify control weaknesses and/or ghost workers? After the return to civil administration, all state governments carried out staff audits to identify ghost workers and other internal control weaknesses, and to provide the initial data for the computerization o f the payroll process in those states that adopted this process. Events since then do not suggest that the audits effectively checked the incidence o f ghost workers. For example, in Cross River State the Office o f the Accountant General carries out periodic audits to ascertain unclaimed salaries from banks, which the banks would then refund to the government. Between December 2004 and December 2005, the amount o f such unclaimed salaries amounted to about US$213,000 (i.e., on average, the monthly pay o f more than 1,000 workers). In Kaduna State, payroll control checks for fiscal 2003 and 2004 showed an overpayment by the Pensions Board o f about US$116,000 in unearned salaries. These cases do not inspire confidence inthe effectiveness o f the payroll audits. 3.107. Do theprocurement controls achieve competition and valuefor money? To what extent do Nigerian states award contracts that exceed the established threshold for small purchases through an open competitive process? The evidence suggests that most states do not use the competitive procurement process even though their Financial Instructions provide for it as the preferred method o f procurement, and the less competitive selective tendering should be used only in special circumstances. There are exceptions, however, inCross River andKaduna States. Cross River State uses open competition whenthe size o f the contract exceeds a clear threshold and it considers that the task i s within the capability o f many contractors. With the exception o f its two star projects, Tinapa and Cable Car, which the state considered not to be within the capability o f local contractors because o f their highly technical and specialized nature, the state used the competitive process to award all other contracts above the threshold o fN 5 million (about US$40,000). Kaduna State fixedreviews the threshold annually. Inthe period under review it used the open competitive bidding process to award contracts exceeding N500,OOO (about US$4,000). 3.108. What is the justification for the use o f less competitive methods o f procurement? The Financial Instructions provide two justifications for the use o f less competitive methods o f procurement: namely, when the value o f the procurement i s below the established threshold, and cases o f emergency. Under these circumstances, the rules allow the use o f selective tendering. Inpractice, however, Nigerian states do not follow this strictly. For example, Bauchi State uses selective tendering to award most contracts inthe state, justifyingthis use under the "emergency" clause. Cross River State does not use emergency as justification but uses technical complexity to explain the use o f selective tendering for the complex Tinapa and Cable Car projects. The two contracts 120 awarded usingthis means are huge.'26 This should have been sufficient reason to throw the competition open to the "whole world." 3.109. Do Nigerian states have operational procurement complaints mechanisms? Although the regulations containprovision for addressing complaints arising inthe course o f procurement, the system i s not effective. For example, inthe few cases where Bauchi State used the open tendering process, aggrieved contractors provided detailed and accurate information in their complaints, which they filed. Although these details helped in identifying false claims by winners, there was no case o f a contract award being reversed on that account. InEnugu State it was not possible to obtain full and verifiable information about the procurement appeals process. Although Cross River State claimed to deal promptly with procurement appeals, it was not possible to ascertain the process or to obtain statistics o f complaints handled annually. 3.110. How effective are internal controls for non-salary expenditure? H o w effective are expenditure commitment controls? Controls over expenditure commitment were not effective before 1999. Two factors were responsible for this. First, there was a failure to revise the financial regulations inherited from the colonial era to make them more relevant to the needs o f the time. Second and more important was the deliberate influence o f the military culture o f discipline, which promoted unquestioned obedience for superior orders over established rules and procedures. Thus, it became normal practice to circumvent established processes for expenditure commitment, including the procurement process. 3.111. The practice did not disappear automatically after the return to civil government in 1999, as elected officials continued to "enjoy the privilege" of ad hoc procedures over established and tested controls. With the advent of governance and PFM reforms by the Federal Government, citizens are beginning to question the culture o f impunity at the state level and demand greater adherence to established rules and norms. Although Federal Budget Monitoring and Price Intelligence (BMPIU) types o f offices have emerged in most states, they are not as effective and have not been able yet to change much the earlier practices. States continue use the old way o f approving tenders and bids. Field evidence suggests however, that Cross River State i s ahead o f the other sample states inadvancing the due process approach. 3.112. H o w comprehensive, relevant and understandable are other internal control rules and procedures? Vestiges o f the military relic remain, for example, in the continued use o f the imprest instead o f the regulatory treasury system o f expenditure control. The introduction and use o f the imprest system undermined the comprehensiveness and relevance o f other control systems, especially the vote head usually classified as "Other Charges." The budget does not specify what constitutes "Other Charges." Each MDA receives an imprest for "Other Charges" which it uses at its discretion. This does not make for effective internal controls and rational management, as there i s no guarantee that MDAs will be mindful o f providing the materials needed for critical operations and essential supplies and services. Itwas not possible to ascertaintheir exact values from state officials at the time of the fieldwork for this report. However, the Cross River State GovernmentissuedNGN4 billion(US32 million) in2004, specifically earmarkedfor financing of to these projects. Inaddition, since 2004, there havebeenregular budget allocations to the projects. However, the GuardianNewspaperof February9,2007 reportedthe CEO of Tinapa as sayingthat the State hadthus far spent aboutN50billiononthe project - N45 billiononthe mainproject, while N5 billion-- onthe constructionof the film centre. 121 3.113. Prior to military rule, both the national and sub-national governments operated the "treasury accounting system". **'The system worked through periodic warrant (usually quarterly) releases, which made available budget amounts - capital and current - to MDAs. Under the military, the treasury system was first, gradually violated in all states (and to some extent, at the Federal level as well), and eventually, abandoned for the "imprest" system. With the imprest system, the incurrence o f most expenditures was centralized. For instance, award o f all capital expenditure contracts was centralized inthe Office o f the Governor. Similarly, payment o f personnel emoluments, salaries, allowances, and pension, was centralized in the Office o f the Accountant-General. Warrants thus fell into disuse. To run their agencies, MDAs chief executives received small monthly "imprests". These imprests were not tied to any specific budget item, current or capital. As a result, imprests were accounted for by simply "retiring" their expenditures with appropriate documentary receipts. They were not, and could not be, matched against budget expenditure items. Under the imprest system, capital expenditures did not always match budgetary provisions. It was not uncommon to find contracts awarded for items not previously included inthe budget. 3.114. As part o f the ongoing reforms, the Federal Government has moved back fully to the treasury accounting system, and the use o f quarterly warrants to release full budget amounts to MDAs. State Governments are a step behind inthis development. Not many o f them have fully restored the treasury system, even though several have put in place measures that seek to reduce extra-budgetary spending. However, a number o f states, includingEnugu, are malung concerted efforts inthis direction. 3.115. What i s the degree o f compliance with the rules for processing and recording transactions? Except for the deviations above, most states are moving gradually to strengthen enforcement o f compliance with the rules for processing and recording transactions. Kaduna State, in particular, takes cases o f non-compliance with established rules seriously. For example, in 2004, 132 audit queries were issued to different accounting officers for infringements such as unvouched payments, loss o f funds and stores, misclassification, and over payment. The cases were also referred to the Public Accounts Committee o f the state legislature. In addition, state bureaucrats are also learning once again to treat the pre-audit function o f internal audit with seriousness. However, state internal auditors generally lack the skills, training, and motivation necessary to effectively discharge their functions. 3.116. How effective is the internal audit in states? What are the quality and coverage o f the internal audit function like? Intheory, the internal audit function in Nigerian states has good coverage. The design o f the function i s to provide complete and continuous (monthly and quarterly) audit reports o f the accounts and records o f revenues, expenditures, plants, and allocated stores. The function is also responsible for the management audit covering other areas o f the functions o f MDAs. In addition, the internal audit function includes a half yearly report which comments on: (i) the degree to which safeguards against fraud are working effectively; (ii)the accuracy o f the accounting records; (iii) controls for receipts and payments; (iv) the controls for the receipt and issue o f stores; and (v) the verification o f cash and stores held. Inspectors from the Office o f the Accountant-General sometimes perform this last function. 12* 12'The Financial Regulations provide for this. 12'Offices of Accountants-General also have Directorates of Inspection whose main hnctions include mid-term and annual reviews o f the internal controls system. 122 3.117. However, do internal auditors effectively discharge these functions? The reports o f auditors-general (external auditors) in most o f the sample states generally complain o f the failure o f internal auditors to prevent malfunctions and mismanagement. There are a number o f reasons for this. First, internal auditors are relativelyjunior staff o f the Office o f the Accountant-General (the Auditor-General in the case o f Cross River State) assigned to MDAs to interact with and report on the activities o f very superior functionaries such as commissioners and permanent secretaries. Second, internal auditors do not have administrative independence because, at some point, these superior officers may preside over decisions affecting their career prospects. Third, internal auditors generally have a low level o f skills and professional training. Fourth, state officials generally have low respect for internal auditors and disregard audit queries. However, they are beginning to come to terms, albeit slowly, with the reforms that are introducing due process. 3.118. H o w frequent are internal audit reports and how widely are they distributed? The prescribed frequency o f internal audit reports in the Financial Instructions i s monthly, quarterly, half-yearly and annually. Generally, the reports go to the management o f the MDA. Copies also go to the Accountant-general, the Auditor-general and the Commissioner for Finance. However, there are questions about the timeliness o f the reports. For example, duringthe period under review, 2002-04, the external audit reports o f Kaduna State clearly indicate late receipt o f the internal audit reports. The same issues exist in other states. The most common explanation for this, in addition to the factors mentioned above, i s late receipt o freturns from MDAs. 3.119. What i s the extent o f the management response to the internal audit findings? As should already be clear, the management response to the internal audit findings is generally poor, but it i s slowly improving. There is a general tendency to ignore audit queries and to disregard internal audit reports. However, the citizens' demand for greater accountability and transparency in government i s gradually bringing about a change in attitude. Clearly, in several states (for example, in Kaduna and Cross River States), increasing legislative interest in audit reports i s also helping to bring about greater management attention to audit queries, both internal and external. Accounting, RecordingandReporting 3.120. This core dimension focuses on four areas: (i) the timeliness and regularity o f accounts reconciliation; (ii) the availability o f the information on resources received by service delivery units; (iii) quality and timeliness o f in-year budget reports; and (iv) the the quality and timeliness o f annual financial statements. This subsection presents the details o f the findings, with a summary inBox 3.5. 3.121, How timely and regular are accounts reconciliations? The available evidence shows that the states in the study place due emphasis on regular (monthly and quarterly) reconciliation o f accounts and bank statements. However, timeliness might be an issue. Lapses were observed in one or two states where either no evidence was provided to support the timeliness o f bank reconciliation or where the Auditor-General's report clearly indicateda lack o f timeliness inthe exercise. 123 Box 3.4: Accounting, Recordingand Reporting: Summary of Assessment Reconciliation o f the annual accounts and bank statements is carried out monthly. However, sometimes there are delays, which attract the attention o f auditors. Most states do not operate suspense accounts as all accounts are classified. Those states that keepthem clear them monthly. There is no evidence to show that state governments have information on resources received by service delivery units. There are no formal public expenditure tracking and monitoring surveys, and the existing accounting systems are not designed to gather such information on a routine basis. Most state governments produce both in-year and end-year budget execution reports, which reflect the structure of budget approval. However, those reports do not include government commitments and they are not produced on time. The reports are also generally uncritical. The final annual accounts o f state governments cover only mainline MDAs. Accounts of AGAs and most parastatals are not consolidated. In terms o f the timeliness o f the accounts, the result i s mixed; some states are timely, but others are not. The accounts do not conform to International Public Sector Accounting Standards (IPSAS). 3.122. There was no evidence o f the use o f suspense accounts in most o f the states; all accounts are classified and transactions posted directly. Only Bauchi State indicated the use o f suspense accounts for advances, which are classified by the Accountant-General as subsidiary accounts. The Directorate o f Inspection in the Office o f the Accountant- General keeps and reconciles all subsidiary accounts. The internal controls loop is provided by the Directorate o f Operations, which verifies them to ensure that they are cleared monthly. There was no evidence o f uncleared balances on these accounts. 3.123. How available is information on the resources received by service delivery units? The need to ensure that service delivery units receive the resources budgeted for them i s not being met currently in any o f the states studied, for three reasons. First, the physical monitoring and reporting culture in the government does not function effectively. Second, the routine accounting system i s not designed or equipped to capture such information. Third, there i s no public expenditure tracking and monitoring system in place. In appreciation o f this problem, Kaduna State devised an ingenious mitigation measure. Some frontline service delivery units are allowed to retain the revenues they generate. However, such revenue estimates and actual revenue receipts by those agencies are fully accounted for in the budget and the accounts. While this i s an important improvisation, it does not fully resolve the problem o f ensuring that service delivery units receive the amounts budgeted for them andthat information on this i s routinely available. 3.124. Do in-year budget reports meet acceptable standards of quality and timeliness? Three out o f the four states inthe sample prepare in-year and end-year budget execution reports, the only exception being Enugu State. The practice i s uneven. Bauchi and Kaduna States produce monthly, quarterly and annual reports; Cross River does not produce monthly reports. The coverage o f the reports i s similar. They include statements o f budgeted amounts, actual expenditure and amount due, categorized by major expenditure heads. They also include information on actual payments/disbursements but do not report on commitments. There i s also no attempt to critically analyze or interpret the data, or draw lessons that could guide the future. Generally, the reports are not produced on time, except for Cross h v e r State where quarterly reports are produced six to eight weeks after the end o fthe quarter. Insummary, both the quality and timeliness o f budget reports need improvement. 3.125. Do annual jnancial statements meet acceptable standards of quality and timeliness? The Accountant-General, on the basis o f returns received from MDAs, produces the annual accounts o f states. Inall the states, the accounts cover the activities 124 o f MDAs but exclude the accounts o f AGAs and independent parastatals. Inthis regard, they are not comprehensive; otherwise, the accounts cover all other budget expenditures. The accounts are prepared on a cash basis; consequently, they do not include detailed information on government assets and liabilities. In addition, they are not prepared in accordance with any known public sector accounting standards, since there are no such standards in Nigeria and the country has not adopted the IPSAS. Rather, governments base their final accounts on several regulatory documents, some o f which are dated. These are the Finance (Control and Management) Act, 1958, the State Financial Regulations and the recently issued Standard Chart o f Accounts. None o f these is a good substitute for accounting standards. Budget Cycle: External Audit and Scrutiny 3.126. This core dimension assesses the extent to which the arrangements for the scrutiny o f public finances and the follow-up by the executive are working. To do this it covers three critical areas: namely, the scope, nature and follow-up o f external audit; the legislative scrutiny o f the annual budget law; and the legislative scrutiny o f the external audits. The details o f the findings are in the following paragraphs, while the summary i s inBox 3.6. 3.127. m a t is the scope of the external audit function and how are audit jindings followed up? The arrangement o f the external audit function i s similar in all states for two reasons. First, it i s a constitutional function, and second, it evolved through a common heritage and the experience o f colonial and military governance. The Auditor- General i s responsible for the audit o f all government accounts and offices excluding autonomous agencies. The duties o f the Auditor-General in relation to these agencies i s limited to compiling a list o f qualified external auditors from which the agencies may choose, advising on the scale o f fees to be paid to the auditors, and receiving and reviewing the audit reports. Auditors-general also have powers to carry out periodic spot checks on the accounts o fthese agencies as they deem fit. Box 3.5: ExternalScrutiny and Audit: Summary of Assessment States do not accord the external audit function its rightful place in the public financial management process. Although years o f arrears o f the external audit o f the final accounts are clearing, there is little evidence o f an effective follow-up o f audit findings in most states, whether by the executive or the legislature. There is evidence that in some states the Public Accounts Committees (PACs) of the legislature are placing more interest on external audit findings. Similarly, legislativescrutiny ofthe annual budget law is weak andineffective. 3.128. By constitutional provision, audited accounts o f the states should be submitted to the legslature within 90 days o f the Auditor-General's receiving them from the Accountant General. According to the financial regulations in operation in all states, the Accountant-General has up to six months from the end o f the fiscal year to prepare the final accounts for the year. Ineffect, audit o f the accounts for the fiscal year ending in December should be completed and submitted to the legislature by September 30 o f the following year. 3.129. At the return o f civil administration in 1999, the accounts o f most state governments were several years in arrears o f preparation and audit. Evidence from the four states surveyed shows that the situation i s beginning to change gradually, with three o f the four states having audited annual accounts for at least up to 2003 (see Table 3.6). O f the four states, Bauchi State i s the only one with significant arrears o f more than three 125 years. In Bauchi State, the last set of audited financial accounts submitted to the legislature i s 2001. The situation in Bauchi reflects the complete lack o f capacity in the Office o f the Auditor-General, which does not have more than three university degree holders in its service. For instance, Imo State has audited its accounts up to fiscal 2005. Moreover, audited final accounts for 2002, 2003, and 2004 are available on its Ministry o f Finance ~ e b s i t e ' ~ ~ . Table3.7: State of Audited FinalAccounts, 2001-05 State Last Year of CompleteAudited Account No of Years of Arrears Bauchi 2001 3 years, 2002,2003, 2004 Cross River 2005 none Enugu 2003 1year, 2004 Kaduna 2005 none 3.130. The quality o f the audit work i s generally low but even then it differs from state to state and reflects the level o f the local capacity. Audit techniques and procedures are archaic and are generally lacking in depth. Generally, inadequate attention i s paid to the audit function in the states, and auditor independence i s an issue. Although the Constitution guarantees the tenure and salary o f Auditors-General, it has not sufficiently insulated their appointment from political interference. Further, it does not guarantee them the necessary tools for their work. The budget for their work, including provisions for staff salary and training costs, i s subject to executive and legislative approval, thus affording a veritable tool for subtle but effective political interference, if not control. Audit staff are civil servants and are recruited, remunerated, promoted, and disciplined by the same civil service organs, the Civil Service Commission and the Head o f Service, that are subject to their audit. 3.131. The external audit function is not yet seen as a necessary part o f the PFM system. There i s evidence that audit reports are forwarded to the legislature as required by law. However, it i s not clear that the findings are followed up. Innone o f the states was there clear evidence o f the follow-up on audit findings by the legislature and/or the Ministryo f Finance. This is reflective o f state legislatures, which have yet to acquire the necessary capacity, depth, and robustness to discharge their oversight functions. 3.132. Does the legislature scrutinize the annual budget law? This lack o f depth described in relation to audit reports i s also evident in the exercise o f legislative scrutiny o f the annual budget law. Generally, the trend across Nigerian governments (federal and state) used to be late submission o f the budget each fiscal year to the legislature, thereby affording it little time for thorough debate. With the exception o f Cross River State, no other state legislature has successfully passed a budget process law that commits the executive to present its budget proposals on time to enable the legislature to discuss it exhaustively before approval and to set a time limit for the legislature to approve the budget.13' This notwithstanding, there have been significant improvements in submission o f the budget to the legislature since the start o f fiscal reforms in 2004. For instance, the Federal Government presented budgets for fiscal 2006 and 2007 to the legislatures in October o f the preceding year. A number o f additional states have been doing the same. Examples include Ondo, Rivers, Kaduna, Imo, Enugu, andAkwa Ibom States. ' 2 9www.imostateministryoffinance.org I3O Sucha lawis currentlybeforethe Cross River State Assembly. It suggests that thebudget mustbe approved wellbeforethe commencementof the new fiscal year. This lawwill merelybecodifjmg what is already the practiceinthe state. A similar law, the Budget ProcessBill, is pendingbeforethe National Assembly. 126 3.133. Legislative scrutiny o f the budget i s further hampered by the poor quality and quantity o f the information provided as part o f the budget documentation. As already indicated, the budget information provided to the legislature consists mainly o f spending estimates, comparative budget figures for the previous year (some states), and actual spending figures for part o f the outgoing year (some states). State budget presentations do not include a macroeconomic framework - assumptions/estimates o f aggregate growth, inflation, etc. Most state government budgets do not include statements on deficit financing, debt and stock, financial assets as well as a proper explanation o f the budget implications o f new policy initiatives. Many state governments do not have the capacity to analyze and provide such a level o f documentation as part o f the routine process o f budgeting. 3.134. The level o f expertise and technical knowledge o f the members o f the legislature also affects the quality o f the debate on fiscal issues. The current reality i s that this is very low, partly because o f lack o f experience with legislative oversight functions occasioned by the many years o f military dictatorship when there were no legislatures. In this sense, it is understandable that legislators are still learning the "tricks o f their trade". This perhaps explains their failure to insist on receiving, and thoroughly examining, the minimumdocumentation onbudget proposals necessary for their work. 3.135. Another, not totally unrelated, factor that has been contributing to weakness o f legislative oversight on budget issues relates to what i s called "constituency projects". In the early years o f return to civil rule, there was much friction between the respective Federal and State executives, on the one hand, and their corresponding legislative counterparts on the other, regarding the inclusion o f such projects into the budget. Constituency projects are often populist, poorly conceptualized, and ill-appraised project ideas promotedhponsored for their political constituencies by respective legislators for mostly reasons o f political expediency. Often in the past, haggling over the inclusion o f these projects contributed to delays in passing the budget. In some cases, legislators, on their own, have included such projects in the budget proposals submitted by the executives before passing them. In at least one o f the states in the sample, inclusion o f constituency projects was seen by the government as a condition for easy passage o f the budget. Inthis state, the budgets do not show any other discernable legislative imprints. 3.136. Does the legislature scrutinize external audit reports? The experience varies considerably among the states. In Cross River State, the PAC o f the SHA takes four to six months to complete its scrutiny o f the audit report submitted by the Auditor-General. Persons and MDAs indicted by the report are required to first state their cases in writing before appearing before the Committee. For proper follow-up o f the decisions o f the Committee, an Audit Enforcement Unit was established in the Office o f the Auditor- General in 2004. For the 2002 and 2003 accounts, 44 and 69 cases respectively were handled, covering theft, embezzlement, unaccounted-for revenue, failure to retire imprests, and non-execution o f contracts. Notwithstandingthis impressive profile, it was not possible to obtain a record o f the final resolutionloutcome o f the cases. Further, the Audit Enforcement Unit is not backed by law and appears to be located in the wrong agency. It would seem that, by the nature o f its functions, the Ministryo f Finance i s best positionedto host the Unit. 3.137. Kaduna State's audits are also up to date. The legislature i s therefore in a position to follow up on the reports. Although there i s evidence that the PAC debates the audit findings, it is not clear what the local arrangements are for follow-up. Officials claim that these decisions are followed up rigorously; however, the same adverse comments and complaints are found inthe audit reports from year to year. The implication is either that 127 the legislature does not effectively scrutinize audit reports, or that, if it does, there i s no effective follow-up to and enforcement o f its decisions. 3.138. EnuguState has just begun to clear its backlog o f audited accounts, courtesy o f a DFID-backed reform program. Therefore, there i s a heavy workload ahead for the PAC inthis regard. The legislators have already complainedthat the administrationtakes little notice o f audit queries and does not take the trouble to apply sanctions. The most recent audited account for Bauchi State i s for 2001. N o evidence was provided to show that audited reports are considered by the SHA. Legislators claimed to have their own internal mechanism for monitoring PFMperformance in Bauchi. Evidence was produced to show that physical inspection o f some projects takes place in the state; however, there was no evidence o f public hearings o f any sort. The predominant sanction was a verbal warning. N o record o f recommended corrective actions bythe legislature was available. D. CONCLUSIONSANDRECOMMENDATIONS 3.139. It i s necessary to reiterate the point made earlier in this Chapter. While data analysis for this report relates to the period 2002 to 2004, the assessment o f PFMsystems i s more recent relating to the situation in place by the middle o f 2006. Inability to extend data analysis to later dates was not a matter o f choice. Rather, it was a matter o f expediency and realismreflectingthe actuality o f budget reporting that by the time o f the fieldwork in the first quarter o f 2006, data for 2005 was not available in a number o f the states in the study. However, a number o f specially designed subsequent trips undertaken to the four sample states and several other non-sample states including Lagos, Imo, Delta, provided opportunity to gain further insight into later developments o f the PFM systems o f those states. It i s therefore correct to claim that this assessment reflects the state of public financial management as at the middle halfo f 2006. 3.140. From the presentation above, two quick conclusions are inevitable. First, while assessment o f the PFMperformance o f states (taken together) showed some improvement as o f the first half o f 2O06l3l relative to the pre-reform before 2004, progress was relatively slow and insufficient comparative to the need. It is clear that states' performance do not meet the minimumPEFA performance requirements (grade C) for a number o f indicators. This means that the PFM systems o f Nigerian states, in reality, are far behind modern requirements. Second, the analysis suggests that states are lagging behind the Federal Government in almost every area o f P F M reform. In other words, state governments are not properly complementing the efforts o f the Federal Government to build modem PFM structures that would ensure effective service delivery to the people. There are however, notable exceptions exemplified by Kaduna and Cross E v e r States (from the sample states) and Delta State (from outside the sample states), which have recorded relative successes in some areas. The following sections draw lessons from them. 3.141. What other general conclusions about Nigerian states can we draw from the small, non-representative sample selected for this study? H o w relevant will such a conclusion be to the states? The suggestion here i s that for a number o f reasons mentioned in the introduction, the conclusions should apply, to various extents, to most Nigerian states. Although recently, some states have begun to pull away from the pack and make individual progress towards PFM reforms, we were not able yet to identify a state that moved too far ahead to find these conclusions irrelevant. 13' This i s the periodfor the analysis. For obvious reasonstherefore, any developments inthe PFMreformprocess thathavehappenedsince this periodwas notincludedinthis report. 128 Lessons Learned: Observations and Findings 3.142. What are the lessons learned from this analysis? First, there are a few recent across-the-board improvements in PFM in states, even if they are not deep. Second, states share common problematic areas and challenges. Third, there are a few examples o f good state initiatives, some o f them coming from outside the sample. Fourth, there i s variability among states inboth the substance andthe pace o freforms. 3.143. Some recent across-the-board improvements in PFM are evident. Although budget deviations are still high, indications are that the trend i s on a downward slope. There have been recent efforts to produce and publish audited final accounts, even if the accounts do not contain sufficient information. States are clearing the final accounts backlog and some states are up-to-date with their final accounts. Public access to fiscal information has improved, with some states beginning to publish their reports, including audited accounts in newspapers. Participation in the budget process i s opening up; MDAs, civil society groups andmembers o fthe public have opportunities to make inputs, though limited, into the process. Payroll controls have improved across the board, with states using one or another form o f computerization to improve payroll management and minimize the incidence o f ghost workers. Increasingly, states are usingbanks to improve the efficiency o f tax and other revenue collections. These are encouraging developments. 3.144. However, these changes do not go far enough to make a significant impact on overall fiscal management and service delivery. Moreover, common PFM weaknesses remain serious in a number o f key areas. Perhaps the most important common constraint i s the lack o f political commitment to carry out a comprehensive reform o f the PFM system. For diverse reasons, different vested interest groups resist attempts to introduce reforms that threaten their interests. For example, state governments are reluctant to implement tax reforms, for fear o f moving against the interests o f small but very rich and powerful local elite. Similarly, some corrupt government officials, together with their allies from outside the public service, who benefit from the system, do not want to see procurement reforms succeed. In the same vein, organized labor fights any attempt to modernize the civil service that might entail loss o f employment. Several state governments that sought to implement necessary reforms have had to roll them back or even abandon some o f them along the line. For example, political interference has stymied the tax reform processes in Kaduna and Bauchi States, forcing a scaling back. EnuguState abandoned its civil service reforms and recalled sacked workers, while Cross River State has hadto redefine and scale back its own civil service reformprogram. 3.145. In addition, states face an acute shortage o f technical and human capacity to design and implement reforms. This capacity gap i s reflected everywhere, from the lack o f real progress in moving towards a multi-year budget framework and developing modern budget classification codes, and the low quality level o f annual accounts, reporting and auditing, to the inability o f the legislature to scrutinize the budget and audit reports and enforce their recommendations. Aggravating this capacity problem i s the inability o f the public service in all states to compete for qualified and experienced professionals owing to the low wage system in the public services o f states. The average monthly take home wage o f a director (the highest rankingcareer civil service position) in state service i s below US$300. Common difficulties are evident also in the areas o f tax administration and procurement reforms. Finally, states are experiencing difficulties in enacting the laws that would facilitate PFMreforms. 3.146. Notwithstanding these difficulties, there are instances o f real progress in PFM reform, including among states outside o f the study sample. For example, Lagos and 129 Delta states have moved ahead o f even the Federal Government towards modem integration o f their budget, accounts and payroll information management systems. The projects are going on in phases and the states are encountering various problems; however, they are making steady progress. Lagos State also has the best example, among all Nigerian governments including the Federal Government, o f a modem tax registration and accounting system. 3.147. Among states in the sample, Cross River and Kaduna States are blazing the trail with good practices inaccounts production. For the past three years Cross River State has presented its budget to the legislature by September 1and had it approved well before the commencement o f the new fiscal year. Enugu State i s conducting a household taxpayer registration survey. The state has also provided a good example o f starting to use its website to disseminate budget information. 3.148. Finally, the study reveals that there is a highdegree o f variability among states in their reformefforts. This level o fprogress reflects the highpriority andthe commitment accorded to P F Mreform on the part o f the political leadership. There i s also variability in the state reform agendas. For example, Cross River State started with accounts reform and has recently moved to budget and tax reforms, whereas Enugu State i s just commencing serious PFM reforms. Enugu had previously concentrated its efforts on the provision o f physical structures, roads, schools, hospitals, etc. 3.149. The emerging picture i s that o f a lack o f compulsion for states to reform. They choose to reform, decide what to emphasize, and reform at their own pace. However, that pace i s generally slow, perhaps even sluggish. There i s need to imbue the reform process with a sense o f urgency both to hasten the process and to widen its scope. Nevertheless, the real question i s whether the states can "go it alone," without deliberate Federal Government's involvement in setting the reform agenda, establishing benchmarks, and providing incentives for states to participate inthe process. Moving Ahead 3.150. What then are the priority reform areas? H o w should the immediate reform agenda look like? It i s necessary first to enhance public awareness and create a greater demand for reforms. Initial reforms should aim at strengthening governance through increased transparency and accountability. Accounting and reporting reforms should therefore receive top priority at the beginning and the governments need to focus on making more budget information available to the public, in quantity, quality, and timeliness. Integrating the accounting, budget, and payroll systems will facilitate the productiono f budget reports. 3.15 1. Budget reforms then will both complement and deepen accounts reforms. Budget reforms should begin with improving budget execution, including budget monitoring and reporting. Eventually, states will need to move towards a multi-year budget framework, basing this on medium term fiscal forecasts and sector strategies, and integrating the capital and recurrent budgets. Budget reform should also include a new budget classification system that will facilitate accounting and expenditure tracking and analysis. To encourage value for money inpublic spending, procurement reforms are essential and should be part o f the budget reform package. At some point, it will be necessary to reform the civil service, including professionalizing it and introducing a competitive pay structures. Without this, the other reforms will not be sustained. 130 3.152. Since states do not have sufficient incentive to carry out these reforms on their own, how can the Federal Government facilitate the process? Given the autonomy o f state governments in fiscal and financial management matters, the Federal Government can do little by way o f direct intervention. Inthis regard, the Fiscal Responsibility Bill (FRB), when adopted, would expand incentives for states to improve their PFMsystems and comply with the future national standards o f good budgeting. However, to become effective, the FRB will require a development o f considerable amount o f supporting regulations and monitoring mechanisms. To complement potential positive effects o f the FRB, the Federal Government may consider several additional policies that would bear indirect influence o f state fiscal performance. 3.153. First, it could continue to provide good examples for the states to follow. Second, it should develop model financial regulations and laws for states and encourage states to adopt them. Third, it should offer technical assistance (TA), including training, to states willingto follow its examples. Fourth, the Federal Government could support the offer o f TA with the creation o f a States PFM Reform Assistance Fund, to provide matching grants to assist states with implementation o f PFM reforms. In the medium term, the FGN could start sponsoring joint projects with states under the conditions o f the acceptance o f the prescribed minimumPFMreforms. Such a minimumamount o f P F M reforms might include state equivalents o f key federal laws, including the Fiscal Responsibility Law. Finally, the Federal Government should create a well-staffed unit in the Federal Ministry o f Finance to monitor and coordinate the reform efforts o f states, disseminate best P F M practice, and administer the Fund suggested here. This persuasive approach should be more effective than trying to coerce states to reform. 3.154. More strategically, the FGN should encourage a further discussion on directions for reforming fiscal federalism arrangements inNigeria. The existing model o f federalism remains a source o f fundamental constraints for both PFM reforms in states and improvements in service delivery. A solution for its gradual transformation could be found on the basis o f the best international practice and lessons from Nigeria's own experience. The World Bank plans to contribute to this debate by preparing in cooperation with Nigerian partners in the course o f 2007 a policy note focused on core reform issues inthe area o f inter-governmental fiscal arrangements. 3.155. What would the role o f international development partners be in this arrangement? Donors could actively support federal initiatives as outlined above by collaborating with the Federal Government in four ways. First, international partners should continue to provide assistance in benchmarking the states' reform efforts. Their continued involvement inthe exercise would enhance its credibility and would challenge the states. Second, donors should be ready to help the FGNprovide the necessary TA for reforming states in coordination with broader PFM priorities o f the federal government (Box 3.7 reflects on some ongoing P F M programs in states). It is likely that more states would show interest in the reform effort than the Federal Government would cope with once it puts the necessary machinery inplace. Third, donors need to leverage resources in support o f the reforming states, since the cost o f reforms i s likely to be much higher than could be financed by the federal and state governments in the medium term. Finally, international partners should direct their support to the above-mentioned unit in the Federal Ministry o f Finance that would monitor and coordinate state level PFMreforms. Such a unit would require TA to build its own capacity, as well as develop and apply reformbenchmarks and model regulations for states. 131 Box 3.6: International DevelopmentPartners: Selected Programsto Build PFM Capacity at the State Level Untilquite recently, donor support to states was concentrated on improvements in core service delivery, in particular in human development, roads, and agriculture. Relatively less support was provided to governance reforms, including those aimed to improve public accountability and transparency o f government budgets. Lately, however, there has been a significant shift in the structure of donor programs. This was informed by realization that governance reforms, including fundamental changes in public financial management systems, are critical for securing sustainable improvements in public service delivery. In 2001, the UK Department for International Development introducedthe State and Local Government Programme (SLGP) in a number o f states and the Federal Capital Territory. The SLGP design aims to combine selected reforms in state governance with budget support for service delivery in specific sectors. The project helped to upgrade individual state-level systems in budget formulation, accounting, tax administration, payroll management, etc., reflecting specific needs and priorities o f participating states. For instance, in Enugu, the project helped the state government clear a backlog o f annual accounts, and also assisted with undertaking a household survey for preparing a comprehensive taxpayer database. SLGP I1 is now in preparation, and it i s likely to have a stronger focus on governance accountability, based onthe lessons learned inthe ongoing project. The State Governance and Capacity BuildingProject (SGCBP) by the World Bank i s currently perhaps the most ambitious state-level donor project in the PFM area. The six year project launched in October 2005 is operational in three states (Bauchi, Cross River, and Kaduna) and has overall level o f support o f U S 1 8 million. The project structure has two components: a core reform component that is common to all the states and a state specific component. The common component includes activities to facilitate: (i) adoption o f organic public finance legislation, (ii)introduction o f multi-year budgeting, (iii)accounting and treasury reforms, (iv) public auditing reforms, (v) introduction o f budget and treasury management information systems (BATMIS), and (vi) human resources reforms. This component recognizes the similarity inPFM challenges state governments are facing. The Bank plans to roll out a similar SGCBP I1 project in additional three or four states. However, so far implementationo f the current SGCBP has been slow. The European Commission is rolling out a major governance program in two states (Cross River and Osun). The project includes a budget and governance component. The specific activities o f the project are still under design. The Canadian International Development Agency (CIDA) recently rolled out a C$l million Governance Reform Facility (GRF) to target small, time bound, and focused initiatives aimed at improving public sector accountability in the federal government, as well as in the two focus states (Bauchi and Cross River). The Facility will finance activities (based on requests from potential beneficiaries in both government and civil society) that promote government transparency and accountability, including those that deal with the demand side o f governance reforms. Each activity budget must be within C$lOO,OOO limit. 132 4. REFORMPROGRESSINTHE AREA OF PUBLIC PROCUREMENT 4.1 This update o f the Country Procurement Assessment review (CPAR) was carried out as a follow-up on the CPAR (2000), which made major recommendations on the need to reform public procurement inNigeria. The objectives o f this update are to establish the need for and to guide the development of, an action plan to improve Nigeria's procurement process. The update i s expected to be presented in the form o f a concise report and be integrated into the Nigeria PEMFAR. With this in mind, the focus o f the assessment was on the following four pillars o fthe public procurement system: 0 The Legislative and Regulatory Framework (Pillar 1): The availability o f implementingregulations, documentation and tools to support the implementation o f the new Procurement Act (with a focus on the complaint mechanisms and the existence o f contract administrationand dispute resolution provisions). 0 The Institutional Framework and Management Capacity (Pillar 2): The degree o f procurement mainstreaming and its integration into the Public Financial Management (PFM) system, the establishment and existence o f a functional managementhegulatory body, and the existence o f an institutional development capacity through a national capacity buildingstrategy. 0 The Procurement Operations and Market Practices (Pillar 3): The efficiency o f procurement operations and practices linked to the development o f an institutional capacity, and the functionality o f the public procurement market. 0 The Inteaitv o f the Public Procurement Svstem (Pillar 4): The existence o f effective control and audit systems in public procurement, the existence and efficiency o f the appeals mechanism, the degree o f access to information and the existence o f ethics and anti-corruption measures. 4.2 Since FY2001, Nigeria has been implementing slowly a procurement reform program based on the recommendations o f the FY2000 CPAR. This has brought about improvements in obtaining value for money in public sector expenditures and in introducing some level o f transparency into the procurement process. However, the contract administration still suffers from inefficiency and delays in contract payments, while delays in the Nigerian Customs further exacerbate the problem. The Federal Government o f Nigeria adopted the comprehensive and ambitious Procurement Action Plan'32in2000. Details o f the 2000 CPAR recommendations and what has been achieved are enumerated below. "* The Action Plan reflected many o f the recommendations of the first CPAR for Nigeria, produced in June 2000. The implementation of the Action Plan was supported by EMCAP, an IDF grant and the ongoing Economic Reforms and Governance Project. 133 A. RECOMMENDATIONS OF THE NIGEFUA CPAR(2000) 4.3 The CPAR recommendations o f 2000 could be summarized as follows. > Legislative and Regulatory Framework: . Establish a procurement regulatory body for policymaking and quality control . o f the procurement function, to prepare standard documents and serve as an appeals mechanism for complaints. Prepare a procurement law based on UNCITRAL inthe medium term. P Procedures and Practices: . Discontinue registration lists as an eligibility criterion for open competitive tendering. . Employ open tendering accompanied by advertising. Define tender evaluation criteria in tender documents, improve evaluation . procedures, assure transparency and confidentiality, use appropriate tender andperformance securities and publishcontract awards. Use reputable procurement agents where local capacity i s lacking. 9 Organization andResources . Abolish departmental tender boards with political influence as well as the . Federal Tender Board and create ministerial tender boards consisting o f civil service professionals. D o not involve the Federal Executive Council inthe procurement process. 9 ProfessionalProcurement Cadre . . Carry out a procurement capacity needs assessment; increase training resources. Create a procurement cadre and provide incentives for assuring integrity and efficiency. Launching Public Procurement Reform 4.4 Since the CPAR, Nigeria's public procurement management has substantially improved. Many CPAR recommendations have been implemented or are being carried out. In this regard, the CPAR o f 2000 has been a positive catalyst, because it supported the agenda o f financial sanitation o f the regime o f President Obasanjo which came to power in 1999. Before 2000, public procurement was in fact unregulated and non- transparent, and represented a huge cost to the Treasury because o f widespread fraud and corruptive practices. The FGN took the following several key actions to advance the procurement reform. 4.5 The Federal Ministry o f Finance (FMF) circulated Guidelines for Due Process Certification o f Contracts, contained in Circular No. F15775 o f June 27,2001, on "New Policy Guidelines for Procurement andAward o f Contracts inGovernment Ministries and Parastatals." The guidelines included a number o f critical measures such as: (i)the abolition o f Federal and Departmental Tender Boards and their replacement with Ministerial Tender Boards; (ii)the requirement for the preparation o f quarterly 134 procurement plans; (iii) application o f open competitive tendering procedures and the the making o f contract splitting to circumvent this principle a serious offence; (iv) the nationwide advertising o f public contracts above 10 million Naira; (v) the creation o f clearly defined and transparent tender and proposal evaluation criteria; and (vi) the requirement to submit tender and performance securities, public tender openings, and award contracts to the lowest evaluated bidder, the publication o f tender awards in the national press, and the carrying out o f procurement audits and inspections. 4.6 The Government created the Budget Monitoring and Price Intelligence Unit (BMPIU) inthe same year as a Due Process Unit located within the Presidency, to ensure that this Circular was carried out. The BMPIU provides "due process certificates for award o f contract" after review o f the procurement documents prepared by the MDAs. The BMPIU also carries out due process reviews for the certification o f contract payments. Market prices are reviewed for adequate guidance ("the right cost o f the contract"); if proposed contracts are too costly compared with this price analysis, the BMPIUmaynot certify the proposed awardo fthe contract andmay request that the price be adjusted to the market level. Contract prices were reduced substantially and, in 2004, reportedly saved the Treasury about US$750 million equivalent. 4.7 Six years after the 2000 CPAR, collaboration between procurement and financial management has been strengthened considerably. A Cash Management Team chaired by the Minister o f Finance, o f which the BMPIU i s a member, ensures that payments are made only when certified by the BMPIU. B. SUMMARY OFPROGRESS 4.8 In the framework o f the four pillars o f a sound public procurement system developed in OECD-DAC since 2003, progress with procurement reform can be summarized as follows. Pillar I:Legislativeand RegulatoryFramework 4.9 As recommended by the CPAR, a Procurement Bill has been prepared under the auspices o f the BMPIU. The Bill was submitted to the National Assembly for enactment in January 2004, and then re-submitted in 2005. Several public hearings have already been held. It is currently being debated in Parliament. The Bill adheres to the principles o f the UNCITRAL model law, and outlines the principles o f open competition, transparent procurement procedures, clear evaluation criteria, award o f contract to the lowest evaluated tenderer, and contract signature. The legislative framework i s applicable to all procurement categories (suppliers, contractors, consultants) and must be applied for all public hnds regardless o f value. The Bill has provisions for exceptions to competitive tendering, which are the exception rather than the rule. 4.10 However, the Bill also contains a number o f elements that are peculiar to the circumstances o f Nigeria. This should be seen against the backdrop o f the fraud and corruption prevailing before 2000. The drafters o f the Bill therefore felt that public procurement required a strong overview and strong control from the top. 4.11 Inanticipationofthe enactment ofthe Billin2006, the BMPIUis also preparing Regulations, Standard Bidding Documents and Manuals for the Procurement o f Goods, Works and Consulting Services, which are in line with internationally acceptable procurement standards. The Procurement Bill prescribes the minimum contents o f the 135 tender and proposal documents as well as the essential elements o f a complaints and appeals mechanism. Pillar11: CentralInstitutionalFrameworkand Capacityfor Public Procurement Training 4.12 The Procurement Bill provides for procurement planning and its integration into the budget formulation process in order to assure timely payments o f contractual obligations, and also prescribes that there should be no procurement without a corresponding budget provision. On the other hand, the Bill presupposes that the budgetary system provides for the timely release o f funds to make contractual payments. The Bill also provides for the creation o f the Bureau o f Public Procurement (BPP) as the policymaking and controlling oversight institution. However, when the World Bank was given the opportunity to comment on the draft Bill, it expressed some misgivings with respect to the overbearing oversight by the National Council on Public Procurement, which i s presided over by the President. 4.13 Inaddition, the BPPwill includethe prior review function ofthe current BMPIU, whose staff will be moved to the BPP. There i s concern in line with the Bank's comments on the Bill that the prior review thresholds are currently too low to give adequate responsibility to the ministries-departments-agencies-parastatals (MDAs), and that the BMPIU/BPP staff will be overloaded with excessive document review and will become a bottleneck in the procurement process (a complaint which i s frequently heard in the halls o f the National Assembly). The current prior review structure, if adopted by the BPP without change, would also blur the lines between the BPP's oversight o f the procurement function and the procurement implementation function, which i s the responsibility o f the MDAs. The prior review function will therefore have to be relaxed. More authority should be given to the MDA Tender Boards for contract awards. However, this should be counterbalanced by a stringent post-review process instituted by the BPP. The Bill further provides that the BPP shall issue a no objection certificate for payment for all procurement within the purview o fthe Act. 4.14 There are still several deficiencies in these provisions. F A , as indicated above, they would drag the BPP into being involved in the implementation function rather than dealing with the oversight function, its primaryresponsibility. Second, to effectively and efficiently perform this function, the Bureau would require a large staff given the large size o f the public service (about 30 ministries and 500 parastatals) and in view o f the large number o f requests for certification that could therefore be expected. This might invariably cause delays and provide avenues for seeking rents (corruption) by the BPP staff, especially if there i s a change from the current transparency policy. Third, these provisions would be difficult to implement and would also dilute government accountability for contract management, as the MDAs might not assume full responsibility for the contracts, while, on the other hand, the BPP will not be a signatory to the contract and therefore cannot enforce compliance with contract conditions. 4.15 The Bill also gives the BPP the power to review, investigate and prosecute non- compliance officers or agencies. This might lead to duplication o f functions o f other investigating agencies if the government and might be counterproductive as the BPP would not have the skills and experience required to carry out such functions. Cases o f non-compliance, when identified by the BPP, should be reported to other already established government agencies such as the ICPC and the EFCCto handle. 136 4.16 The functions o f the BPP are otherwise in line with the recommendations o f the CPAR and the prevailing international concepts o f procurement oversight bodies. The BPP would also have the role o f coordinating relevant procurement training programs to buildand maintainprocurement capacity. Pillar111: ProcurementOperationsand Public ProcurementMarket Performance 4.17 The FGNissued circulars regarding the creation o f a Procurement Cadre (January 2005) and the establishment o f Procurement Units in the MDAs (February 2005). At present, Resident Due Process Teams (RDPTs) at the MDAs prepare the due process documentation for MDA procurement. The procurement function has been delegated to the MDAs, and the BMPIU staff attends the procurement meetings o f the RDPTs. However, an analysis has not been carried out yet on how these RDPTs actually work and how efficient they are, as well as how they coordinate within the MDAs and with the BMPIU. 4.18 To strengthen the procurement function, the BMPIU, with support from the Economic Reform and Governance Project (ERGP), i s launching a two-phased procurement capacity and training needs assessment o f the MDAs. The first phase o f this study will analyze the procurement activities and functionalities of the MDAs, and the second phase will develop a comprehensive training program. After that, the training program will have to be carried out over the next few years. The recommendations o f the needs assessment will be critical for the reinforcement o f the institutional procurement framework andthe creation o f a professional procurement cadre. 4.19 It appears that the benefits o fthe improvements inprocurement made since 2000 are mainly accruing to the government because o f the more stringent controls on procurement practices. Open competition has certainly increased, but for the private sector the public procurement process remains largely unclear. Contract administration i s weak, while the lack o f standard documents and procedures represents an essential drawback. Dispute resolution i s not regulated, the complaints mechanism i s flawed, and appeal i s non-existent. Communication between the public and the private sectors, especially the small entrepreneurs and suppliers, i s limited'33.Although the government has a website, it i s only a static information portal without any interaction with the users, and the government has yet to relate its use to public procurement. The BMPIUdoes not have its own website, and procurement information i s not widely available. 4.20 Improved communication with and engagement o f the private sector in the domain o f public procurement i s an area in which considerable improvement could be made in a relatively short term, ifthe political will can be mobilized. As part o fthe CPAR update, a study to determine the private sector's perception o f the public procurement system has been launched. The special questionnaires were designed together with the government team prior to undertake a survey o f the private sector's views. Such a mini market research effort will help to identify the priority actions to improve private sector perceptions. Preliminary feedback from the private sector with respect to access to public procurement, tender evaluation and contract award, and contract administration is still rather mixed. The study results will be discussed in a workshop to be attended by the private sector and the government representatives in August 2006. A detailed report on '33As suggestedby the focus group discussionsandinterviews conductedby the PEMFAR teamandthe preliminaryreportonthe surveyofprivatesectorperceptionsonpublicprocurement, undertakeninthe secondpart of 2006. 137 138 carries out a due process review o f the procurement undertaken by the MDAs before awarding the contract. For contracts above N50 million (about $US400,000), the BMPIU prepares the due process documentation itself for review and decision by the Federal Executive Council - a body composed o f ministers and chaired by the President. The Accountant-General does not allow payments unless the BMPIU has certified due process. The Auditor-General carries out expenditure review and audits and for procurement expenditures verifies whether due process was carried out. Cases requiring disciplinary action are supposed to be highlighted in its annual report that i s submitted to the National Assembly for further action. However, the annual audit reports have not been completedyet for the past three years. 4.24 According to the Procurement Bill, the BPP i s explicitly mandated to perform procurement audits (i.e. to examine how a procurement process was undertaken and whether it complied with the relevant regulations and procedures). Typically, a procurement audit will note areas o f non-compliance, indicating, if appropriate, why the non-compliance occurred, the impact it had on the outcome o f the procurement, and any recommendations deriving from the non-compliance. The recommendations might range from proposing disciplinary action against the individual or organization committing the act o f non-compliance to proposing changes to the procedures. The due process review presently carried out by the BMPIU already encompasses some o f the elements mentioned. Thus, the expertise and experience o f the BMPIUshould be transferred to the new BPP. 4.25 Since more than one entity i s involved in conducting the procurement audit, it is apparent that there i s considerable scope for cooperation between the Office o f Auditor- General and the BPP. This i s particularly the case given that the BPP will be a new entity with a new mandate. The OAGF and the BPP should establish open lines o f communication and a collaborative, strategic approach for the monitoring, audit and oversight actions associated with the procurement and disposal function. They will coordinate undertaking o f financial, value for money, and procurement audits that would cover all the relevant procurement entities. 4.26 In their partnership in area o f public procurement and disposal functions, the OAGF and the BPP would need to establish targets for the number, value and sectors o f procurement/disposal entities that they audit annually. They would also together identify specific activities that warranted value for money audits, and would ensure that, for example, 20 percent by value o f all procurement activities o f this type completed during the year receive a procurement audit. The Government should ensure that their allocated budgets are sufficient to meet these targets. 4.27 The FNG established in 2003 the Economic and Financial Crimes Commission (EFCC); which has made considerable progress in bringing fraud to justice. It collaborates with the Auditor-General and the National Assembly in pursuing cases o f financial crimes. The Independent Corrupt Practices and Related Offenses Commission (ICPC) was created in 2000 and became effective in 2003 after a long battle in the National Assembly. It has created and staffed about 138 Anti-Corruption Units inMDAs. The ICPC now counts about 36 offices nationwide with about 230 staff, including investigators and prosecutors/lawyers. It oversees the quality o f the Anti-Corruption Units in the MDAs and has prepared guidelines for their operations. It has handled over 40 cases involving some 100 alleged offenders and obtained at least 5 convictions. However, the judicial system is slow and inadequate for arriving at quick sentences. The ICPC coordinates its activities with the anti-corruption community, including the EFCC. 139 However, a well-defined and operational appeals mechanism for complaints in public procurement has yet to be created but i s provided for inthe Procurement Bill. Assessment of Progress in Procurement Reform 4.28 Progress made in with procurement reformhas been considerable -- mainly inthe area o f subjecting the MDAs to greater rigor inthe procurement process, leading to open competition for most contracts. However, the reform process still faces several critical challenges. First,the BMPIUi s not well equipped to deal with procurement reforms since it is primarily occupied with due process tasks. Its limited staff is not very familiar with the requirements o f procurement reform and i s very slow in pursuing the action plan established under the ERGP. Second, if the Procurement Bill does not pass, there will be no legal basis for extendingthe reforms to an independent policy body such as the BPP. The establishment o f the BPP, based on the procurement law, should lead to a better defined framework for greater accountability in procurement. Inshort, without the Bill it would be difficult to achieve a more credible budget process for public capital investment expenditure. To make the government's reforms sustainable, the BPP needs to be established, fully staffed, and made operational. 4.29 The BMPIUshould be transformed into the BPP and could become the executive arm for prior review and control, as well as a facilitator for further procurement reform. The Procurement Law and a well staffed BPP would assure the use o f modern procurement procedures and regulations, standard bidding documents and manuals, and would establish a functional complaints mechanism. It would give credence to the circulars regardingthe creation o f a procurement cadre and would coordinate the delivery o f the extensive training needed for the staff assigned to the procurement units.All o f this i s presently non-existent, which leaves a major risk o f possible slippage in standards in the case o f a regime change or other critical events. C. RECOMMENDATIONS 4.30 The following recommendations are intended to help guide the development o f an action plan for the improvement o f the procurement process inNigeria. Pillar 1: 0 The National Assembly should pass and enforce the implementation o f the Procurement Bill. The BPP should issue Procurement Regulations and Guidelines. The BPP should issue Standard Procurement Documents. 0 Political influence on the BPP should be removedreduced through the removal/compositiono f the National Council. 0 The prior review role o f the BPP should be removedreduced. As a minimum, a highprior review threshold should be set for the BPP. Pillar 2: 0 Ensurethat the expertise and know-how o fthe RDPTsis passed onto the new procurement set-up, i.e., to the Procurement Planning Committees, Tender Boards andprocurement functions o f the MDAs. 140 0 Ensure proper working relations between the BPP investigative unit and other law enforcement agencies, for example by establishing Memoranda o f Understanding(MOU) on operational activities between the relevant parties. 0 Through a functional review, carefully assess the BPP's role and functions against its required staffing needs. Ensure that the BPP's has the staff competencies and staffing level, that will enable it to carry outs its mandate. 0 Ensure that procurement units are established in all MDAs. The procurement unit should be staffed with qualified procurement staff and headed by a certified procurement expert. 0 Step up efforts to ensure proper alignment between the procurement system and the broader financial management system, including mandatory requirements for proper procurement planning as part o f the multi-annual budgetingprocess, andproper feedback mechanisms. Pillar 3: The BMPIU should be encouraged to pursue and accelerate the capacity building in public procurement by, inparticular, advancing the following steps: 0 Further strengthening of the Procurement Reform Stakeholders Committee to obtain feedback from the public on the procurement reforms and convey to the public what the contents o f the reforms include. The composition o f the existing Stakeholders Committee will need to be broadened and a proper TOR developed after the Procurement Bill is passed to Law. 0 The organization o f a workshop on E-GP to share good practices from other countries with successful E-GP applications, such as from Australia, Brazil, Korea, India, etc. 0 The carrying out o f a comprehensive E-GP assessment in Nigeria covering both the private and public sectors. Develop a E-GP strategy and action plan with clearly defined milestones for implementingE-GP inNigeria. 0 Piloting E-GP applications in one or two sectors where the quick demonstrative effects are possible. 0 Contract consultants to undertake (i) the Procurement Capacity and Training Needs Assessment, and (ii) the Procurement Baseline Indicator Survey. Pillar 4: 0 The Office o f Auditor-General and the BPP should establish open lines o f communication and a collaborative, strategic approach for the monitoring, audit and oversight actions associated with the procurement and disposal function. This includes the establishment o f targets for the number, value and sectors o f 8ocurement and disposal entities and activities they audit annually, andthe government should ensure that their allocated budgets are sufficient to meet these targets. 0 With respect to the strategic framework, the distinction between the procurement strategy and the action planning should be made clearer. The latter should include a costing o f the proposed actions and should identify which entities are responsible for ensuring that action i s taken. The roles and 141 mandates of the BPP, the EFCC, the ICPC and the Prosecutor General with respect to responsibilities for receiving and investigating procurement complaints, carrying out investigations,prosecutingcases of the infringement of the public procurement rules need to be clarified. Also, measurable indicatorsshouldbe developed andbaselines established. Consideration should be givento establishinga high levelinter-agency forum for coordinating anti-corruption efforts across government. The BPP should be representedinthe forum. Priority should be given to ensuring that the corruption cases pending in the High Court are moved forward, either by offering support to the High Court or by setting up a special task force within the High Court to deal with these cases The ICPC should increase its capacity for prevention, in particular system reviews focusing on identifying the underlying mechanisms and institutional weaknesses that make room for corruption. Procurement should be a priority area for a thorough system review, starting with the main procuring entities andhighriskunits. Periodic surveys should be undertaken on corruption in public procurement. The initial focus should be on establishing baseline indicators on which future improvements canbe measured. 142 5. PUBLICFINANCING OFA POWERSECTOR IN TRANSFORMATION'34 5.1. The need for large investments to modernize power delivery inNigeria cannot be in dispute. Along with the investments, there has been tremendous momentum in implementation o f sectoral reforms since 2004. The passage o f the Electricity Act in March 2005 marked a major milestone, as did the unbundling o f the Power Holding Company o f Nigeria into a transmission company and autonomous successor entities for generation and distribution o f power. In addition there was the introduction o f a new regulatory authority for the electricity sector, the establishment o f a rural electrification agency, and o f course the launch o f the National Integrated Power Project (NIPP) which saw the injection o f a massive volume o f investment resources into the sector (USS9 billion) to boost power generation capacity, as well as to upgrade transmission and distribution networks. Looking ahead, the critical issues deserving the attention o f policymakers are the quality o f the processes used to undertake such volumes o f spending, a proper mix of public and private expenditures, and the extent o f accountability inthe system for results and impact from the costs incurred. Additionally, there i s the need to link the pace o f spending to the continued implementation o f sectoral reforms in order to keep the sector's demands on the public budget under control, i.e. to avoid unforeseen situations that result either in large ongoing subsidy requirements or in accumulation o f implicit government liabilities, which both have adverse macroeconomic implications. 5.2. This chapter reviews power sector performance and recent policy initiatives as well as trends in government spending inthe sector. The current level o f policy attention and financial resources dedicated to the power sector i s most welcome and much appreciated by the large numbers o f businesses and households without access to reliable public sector power. To reduce the risks o f repeating any errors o f the past, this chapter aims to identify factors which led to the low efficiency o f previous public sector investments, to provide potential cautionary notes for the current government investment strategy, and to provide recommendations that could increase the effectiveness o f future government expenditure in this very critical sector. Another reason for looking back to the period 1999-2004 is so that future improvements can be benchmarked against this baseline. It i s hoped that the present review may also help FGNto address the existing gaps in the sector management framework and ensure a higher return on its future investments. A. THECHALLENGE 5.3. Ina country with over 130 million people, Nigeria's electric utility company has only 4.6 million customers and delivers inadequate and poor quality power supply. Given the tremendous backlog o f unmet demand for electricity, and the well established correlation between modern energy use and increased income, it is clear that secure and reliable power supply i s critical for economic growth and poverty reduction. Nigeria needs a well-implemented strategy for the rehabilitation and expansion o f its electricity sector. 134This chapter draws on a backgroundpaper preparedby 0.N.Edozienand Z. Abiola for the World Bank inMay2006. 143 5.4. What would have to be some o f the features o f a balanced and well-implemented, coherent strategy? The sector investment program must be balanced to satisfy the following technical, institutional, and economic requirements: (i) the generated power must be affordable to the sector as a whole, i.e. revenues from sales o f electricity to customers should be adequate to pay for the generated power; (ii)transmission and distribution networks must be in place and functioning with minimal technical losses to deliver the power to paying customers; (iii) demand patterns and the location o f load centers must be well understood; and (iv) commercial and administrative systems must be in place to efficiently bill and collect payments from customers. In other words, any spending strategy that aims at an increase in generation capacity alone will not be sustainable inthe medium term. This has been recognizedby the Nigerian policymakers, and about US$1 billion o f resources each have been allocated to the transmission and distribution sectors respectively. 5.5. Nigeria has spent significant resources on the power sector at various times in the past, but improvements have been elusive. Today, electricity generation per capita in Nigeria i s less than 30% o f that in peer group countries (Table 5.1). It i s therefore more critical than ever to ensure that all safeguards are in place to avoid any repetition o f past mistakes. Most importantly, there i s now a sectoral reform program underway, which was not the case inthe past, which provides grounds for optimism. 5.6. Still, what are some o f the factors behind the lagging performance that i s evident from Table 5.1? No new generation capacity was added between 1990 and 1999, and much o f the existing generation plant was poorly maintained. Consequently, peak generation capacity declined between 1991 and 1999. Only 19 out o f 79 generating units were in operation in mid 2000, and some estimates placed peak generation capacity, which was operational, as low as 1,500 MW from an installed nominal capacity o f 5,850 Mw. 5.7. There i s also inefficient use o f available capacity. Available data indicates that the installed capacity in Nigeria generated less than half the possible output in 2005. Another problem plaguing the sector was that technical losses in the transmission and distribution system were as high as 40%. The transmission system had also suffered from extensive vandalism and inadequate maintenance, and there were several system collapses affecting large parts o fthe electricity network. Table 5.1 GenerationCapacity, Populationand GDP (2003) Country Population GDP GDP Generation Generation (million) ($billion) per Capita ('MW) per Capita Ghana 20.2 5.3 262.4 1,200 59.41 Nigeria 137.0 57.4 419.0 4,000 29.20 Egypt 77.5 76.6 988.4 17,600 227.10 Algeria 32.1 82.0 2,554.5 5,900 183.80 Malaysia 23.5 115.0 4,893.6 14,000 595.74 Venezuela 25.4 145.0 5,708.7 81,300 3,200.79 SouthAfrica 42.7 196.0 4,590.2 40,500 948.48 India 1,100.0 808.0 734.5 126,300 114.82 Indonesia 242.0 827.4 3,419.0 101,000 417.36 Brazil 186.1 1,492.0 8,017.2 82,500 443.31 Source: Staff and consultant estimates. 144 5.8. Generation is the most visible weakness o f the Nigerian power sector because of the gap between actual output and total demand. Because o fthis, load shedding has been endemic. Currently available generation capacity i s about 3,3OOMW, which i s less than 30% o f estimated demand. Thus, the primary challenge facing the sector i s how to rapidly increase the amount of electricity generated, together with the balancing elements that have been mentionedpreviously. NIPP proposes to directly address that requirement. Sector Performance and Recent Policy Initiatives 5.9. There has been a sharp increase in reform momentum in the Nigerian electricity sector starting in 2000, first in terms o f planning the reforms, and particularly since 2004 also interms of the implementation (Table 5.2). Table 5.2: A snapshot of recent developmentsin the power sector Decline Stabilization Reform 1990-99 2000-04 2005 4 No new generation capacity Power sectorbecame one of Legislationenactedto remove added, poor maintenanceof the highest priorities of public sectormonopoly old assets, actual generation civilian administration of about 1,500MW against Unbundlingof NEPA into 18 installedcapacity of Limited progress in new businessunits (NBUs) 5,800MW improving sector performance completed; conversion of NEPA into the holding Transmissionnetwork ElectricPower Sector Reform company (PHCN) vandalized, limitingability to ImplementationCommittee transport the smallamount of establishedto recommenda Introductionof financial availablepowerthroughout program for reform and performancetargets for NBUs the network private sector-ledgrowth Increaseinthe share of Distribution network Planswere drawnup to meteredcustomersfrom 40 degenerated, very few unbundlethe power sector percentin2002 to 67 percent meteredcustomers,high utility NEPA andprivatize ofthe total number of incidenceof power theft and most of new companies customersin2006 technicalinability to deliver World Bankassisted with a IndependentRegulator high quality power to end- transmission development established users project($loom) and Government decisionto Several system collapses knowledgeproducts (CREST) to expedite crucial invest$4.2 billion of oil Low staff and customer investments and emphasize windfall inmassivepublic morale anddeep-rooted attention to the commercial sector generation, corruptionperceptions focus ofthe utility transmission and distribution regardingutility staff projects World Bank support to reform program($172m) 5.10. The policy objectives o f the power sector are starting to be aligned with those in the National Economic Empowerment and Development Strategy (NEEDS), as well as with the MDGs. NEEDS has established a number o f targets to be met for the power sector by 2007 (Box 5.1). The NEEDS targets are incorporated into a medium term strategic plan prepared by the Ministry o f Power and Steel as part of a three year budgeting exercise, with additional commitments on expanding access and strengthening o f the Ministry's capacity to supervise the sector. The 2005-08 sector plan identified a need for government fundingo fUS$3.18 billion. 5.11. This considerable reform momentum was accompanied by tangible improvements in the sector's operational performance (Table 5.3). Between 2001 and 2004, total electricity generated grew by 30 percent and transmission losses reduced from 18 percent 145 to less than 10 percent. Electricity delivered to the distribution zones increased by 43 percent while distribution losses went down from 27 percent to 20 percent. PHCN collections more than doubled between 2001 and 2004, and improved further in 2005. The increase beyond the growth in electricity delivered and sold was due to the tariff adjustment undertaken inFebruary 2002. - Box 5.1: NEEDS Targets for 2007 0 Increasein generation capacity by 138 percent from 4,200 MW to 10,000 MW; 0 Increase in transmission capacity by 60 percent from 5,838 megavolt amperes (MVA) to 9,340 MVA; 0 Increaseindistribution capacity by 80 percent from 8,425 MVA to 15,165 MVA; 0 Increaseintariff collections from 70 percent to 95 percent; 0 Reduction o f transmission and distribution losses from 45 percent to 15 percent; 0 Reduction of controllable costs by at least 30 percent; and 0 Right sizing of staff strength by about 15 percent. Table 5.3: Power sector performance, 2001-05 Elect. Generated (GWh) 17,563.9 21,544.0 22,029.8 22,916.8 19,664.0 Trans. Loss (YO) 18.1% 11.3% 14.8% 10.0% 13.6% Elect. Delivered (GWh) 14,392.7 19,112.7 18,771.5 20,631.2 16,982.1 Distribution Loss ("/a) 27.0% 36.5% 29.6% 20.2% n.a Electricity Sold (unit) 9,648.6 11,242.0 12,247.0 15,994.0 n.a Cash Collected (Nm) 31,176.7 48,307.7 57,010.0 71,056.9 57,099.3 Per kW Generated 1.8 2.2 2.6 3.1 2.9 Per kWh Sold 3.2 4.3 4.7 4.4 n.a Source: PHCN Market Operations and Accounts. Note: `/ 2005 data are for the first 10months. 5.12. It is encouraging that a major effort has been undertaken to reform the power sector. However, recent improvements in generation lagged behind growth in power demand, i.e. power shortages in Nigeria have continued to worsen, while public dissatisfaction with the sector performance has become a major political issue. Moreover, all recent developments must be viewed in the context that FGN spent more than N200 billion (about US$2 billion) inthe sector from 1999 to 2005, and 0 electricity i s still delivered to less than halfthe population, while 0 electricity supply meets less than a third o f the existingdemand. 5.13. Several surveys suggest that electricity supplied from the grid accounts for only about 60 percent o ftotal consumptioninthe country. The rest i s provided for by a variety o f off-grid, self generation and backup generation capacity at costs that are on average as highas US$O.2O/kWh. Non-reliable and expensive power supply has been seen as a key factor that undermines competitiveness o fNigerian manufacturing. 5.14. Interms of new generation capacity, back in 1999 the then-new administration recognized the scale o f the challenge in the sector relative to the resources that were available at the time, and prepared to embark on a power sector reform program to attract private sector investment in generation and eventually in distribution. Consequently, government policy sought to disengage from the generation sub-sector through 146 Rehabilitate, Operate, Transfer (ROT) arrangements involving private investors to strengthen and operate the existing plants for improved efficiency prior to privatization. Reform policy also aimed to promote private generation through Emergency Power Projects (EPPs) and Independent Power Projects (IPPs). 5.15. However, before 2004 actual private sector investment in power was minimal due to uncertainties o f the expected power sector reforms and the absence o f a clear regulatory structure. 5.16. Since 2004 higher crude oil prices have facilitated a major re-orientation o f the FGN strategy towards expansion in public investments in the power sector. The core o f modified strategy is to rely mostly on public financing to accelerate growth in generation capacity, and then work on expanding private participation in the sector through privatization and public-private partnership. Accordingly, the FGN's investment program in power generation was expanded drastically and at the moment has three main components: 0 plants to be set up by oil companies, with significant public sector involvement through NNPC, in the southeastern part o f the country (with the total new capacity o f about 1,400MW) plants in the Niger Delta under the National IntegratedPower Project (NIPP) (about 2,62OMW), which are funded from the excess crude account; 0 plants that are identified in the strategc plan o f the Ministry o f Power and Steel and are currently at various stages o f conceptualization and implementation in the public sector (previously under the PHCN) (about 4,OOOMW) 5.17. The plants under the first bullet point above are referred to as the Joint Venture IPPs (JV IPPs), and they potentiallypose some riskto the FGNbudget since they involve Power Purchase Agreements backed by sovereign guarantees to the private sector. Such arrangements are financially sustainable only if backed by improvements in payment discipline in the sector together with commensurate tariff adjustments to achieve cost recovery through tariffs. Without this, the consequence would be a higher subsidy burden for the government budget. However, there are encouraging signs that payment discipline inthe sector has been improving as a result of the reforms already introducedto improve commercial performance o f the sector. For example, monthly revenues collected by the distribution companies have doubled inthe past two years. This i s a most positive trend, and as more and more customers are metered, and losses are reduced, it i s expected that revenues will continue their sharp upward trend. 5.18. Whether this expected trend in growing liquidity o f the sector will be adequate in the long run depends on the sector's ability to sustain and absorb the relatively higher purchase prices o f power from the JV IPPs. As long as these power purchases can be paid for with rising customer revenues, there i s no risk to the Federal budget. The question o f how much maximum burdenthe securitization agreements could theoretically pose on the budget depends on the rather low probability that all contingencies will materialize at the same time, resulting in a need for simultaneous payouts to all guarantee holders (clearly unlikely). It is highlighted here only to underline the important link between strengthening commercial performance in the distribution sub-sector and being able to respect the contractual agreements made with IPPs inthe generation sub-sector, as a way o f avoiding budget burdenon FGN. 147 5.19. In addition to the JV PPs, in August 2006 the power regulatory agency has granted licenses for four indigenous PPs with a total generation capacity o f 1,700MW. All of the above, if realized, will create new generation capacity o f almost four times more than currently available. 5.20. Will there be enough customer revenues to pay for all this P P power without recourse to government subsidies or calling in guarantees? It is too early to tell, but the answer is clearly related to quality and reliability o f service delivered to customers. The following innovations for improvement in service delivery by PHCN are a most encouraging development, boding well for the sector's ability to continue with increased revenue collection: The establishment o f Customer Care Centers in all the Business Unitsnationwide (these are the NEPA successor companies for power distribution), to handle customer complaints; 0 The establishment o f anti-corruption and transparency units, at Corporate Headquarters and sub-unitsinthe Zones, andbusiness units; The publication o f telephone help lines o f the eleven distribution company Chief Operating Officers, Business Unit Managers GovernmentSpendingin the Sector 1999-2004 5.21. From 1999 to 2004 the federal government spent W152.3 billion on generation, transmission, distribution and related infrastructure o f National Electricity Power Authority (NEPA), another 4417.1 billion on NEPA operating subsidies, and another W34.3 billion on directly executed rural electrification projects (Table 5.4). The annual documented subsidy i s about W.3billion (US$33 million). Table 5.4: FederalGovernmentExpenditureon the Power Sector, 1999-04, N million Total Allocation 2,206 26,881 75,151 36,036 31,000 46,476 Amount Released Generation 0 7,500 9,860 6,287 880 32,786 Transmission 611 13,128 28,045 16,885 2,478 10,820 Distribution 1,230 2,836 10,000 1,944 560 2,429 Other capital 365 0 0 1,924 1,290 442 Total Cap. Expenditi 2,206 23,464 47,905 27,040 5,207 46,476 Shortfall 0 3,417 27,246 8,996 25,793 0 loperating subsidy 0 0 4,396 5,667 3,622 3,425 IRural ElectrificationII 1,000 13,500 5,500 0 7,948 6,400 Total Expenditure 8,606 24,464 65,801 38,207 8,830 57,849 ASYo of GDP 0.30% 0.50% 1.20% 0.70% 0.10% 0.60% I ASYo of FGNAlloc. 5.60% 4.60% 9.10% 5.20% 0.90% 4.70% As Yo of FGN Capex I n.a. n.a. 15.90% 15.20% 6.60% 16.50% Source: PHCN ManagementReport, Interviews. 5.22. NEPA has also benefited from considerable indirect subsidization through two main channels: (i)government lending, and (ii) accumulation o f tax arrears. Borrowings from the Federal government, including foreign loans obtained through the federal 148 government, have been a major source o f financing NEPA operations, including recent investments. At the end o f 2004, the stock of outstanding debt to the government exceeded N50 billion (US$385 million), which represents about 30 percent o f the direct government support to NEPA in 1999-2004. More than two thirds o f the total NEPA's debt was to the Federal government (Table 5.5). Table 5.5: NEPA's Borrowing,2000-04, year end stocks, N million Owed to FGN n.a. 11,423 12,211 12,887 13,454 Owed to Foreign Lenders through FGN n.a. 28,174 35,078 35,900 36,958 Owed to Foreign Lenders n.a. 21,662 12,486 14,666 16,088 Owed to State Governments 8 8 8 8 8 Owed to Local Banks 1,997 23,367 16,184 12,612 8,494 Owed on Overdrafts 552 4,333 4,572 2,425 2,063 Total n.a. 88,967 80,539 78,498 77,066 Source:NEPA Audited Accounts, 2000-2004. 5.23. The guarantee o f NEPA's foreign debt by the federal government is a reflection of the low creditworthiness of the sector, as still perceived by private investors and lenders. Local financial institutions provided less than 14 percent of NEPA's borrowing. O f their contribution, 20 percent was in the form of expensive short term credits and overdrafts. 5.24. NEPA's tax arrears were growing steadily since 2000. The overall increase intax debts bythe end of 2004 amounted to N5.4 billion (US$41 million). Tax arrears comprise more than 20 percent ofNEPA's total payables that are overdue. 5.25. Between 1999 and 2004, the Ministry of Power and Steel spent 3434.3 billion (US$264 million) on rural electrification projects. Investments in rural electrification continue to be greatly influenced by political pressure. Evenwhen most rural distribution projects are completed, the qualityheliability o f electricity delivered i s poor. This i s in large part due to nationwide power shortages, and the low priority accorded by distribution companies to those at the end of the (poorly configured) line which additionally incurs hightechnical losses. Moreover, a large number o f rural electrification projects remain incomplete. Prior to 1999, there were 340 incomplete rural electrification projects under the Ministry o f Power and Steel. This number had grown to 1,141 projects by February 2003 and to 1,500 projects by the end of 2005. Officials at the Ministry's Rural Electrification Department estimate that no less than WO billion (US$ 300 million) i s needed to complete all these projects, i.e. more than the actual total amount spent in 1999-2004. Some of these projects are over fifteen years old, so the portion of the earlier investments may need to be written off and redone in order for projects to be finished. Corrective measures are now being taken: under the Debt Relief Gain program, the government allocated about N18 billion in 2006-07 for completion of the ongoing rural electrification projects. Results reported on 2006 budget performance for Debt Relief Gain-funded projects are encouraging: 258 projects have achieved 85% completion and some have even been commissioned. About 560 Constituency Electrification Projects have achieved 45% completion on average. An additional 85 Constituency projects are awaiting Federal Executive Council approval and are slated for completion by December 2007 if approved. Moreover, the Power Sector 2007-2009 MTSS states that N20 billion will bemade available for project completion ineach of 2007 and 2008. This injection of funds should undoubtedly be accompanied by the introduction of new processesthat will avoid a repetition of the old scenario in future, that had left over a one thousand five hundredprojects incomplete. 149 Main Factorsthat Pose PotentialRisks of UnderminingEffectiveness of FGNExpendituresinthe Sector 5.26. Four inter-related primary factors explain the very low level o f effectiveness o f the earlier large government expenditures inthe power sector, o f which two are related to budgetary oversight and two are directly inthe power sector. The proposedsolutions that have been recently introduced for budgetary oversight are also described below. They are important and require adequate institutional support going forward, in order to prevent a return to some o f the earlier lapses: System-widePFMIssues o Weakness in the FGN budget planning, leading to a segmented investment portfolio with many unfinished projects. While the total fixed assets o f NEPA grew by almost 200 percent (about N77 billion) between 2000 and 2004, more than half o f this growth (N40 billion) was due to an increase in the costs o f unfinished projects (work-in-progress) reflecting the long implementation delays. At the same time, assets in generation increased by only N21 billion. In other words, for every Naira spent on completed projects in generation, two Nairas were frozen inuncompletedconstruction. o Recent measures to address this situation include strengthening o f sector expenditure prioritization on the basis o f MTSS. Inparticular, the FGNdecided to earmark N9.1 billion in the 2007 budget for the completion o f 32 major transmission projects, with a total value o f N60 billion. Once these funds are spent and the projects successfully completed, every Naira spent in 2007 will result in unfreezing o f five Naira from earlier investments. A supplementary budget was proposed for 2006 in connection with NIPP, which i s expected to generate inthe mediumterm the following outputs over and above planned in the regular FGNbudget: o Generation: a) NIPP (2743 MW);b) conversion o f existing plants (1882 MW);c) Mambilla Hydro Plant (2600 MW); o Transmission: a) 11,898 km o f transmission wires; b) 48% increase in total transmission network; o Distribution: a) 79,005 km o f distribution wires; b) 22% increase intotal distribution network. o Additional developments in the budget process that FGN has introduced in order to respond to the pre-2004 issues highlighted earlier include: o The provision o f three year expenditure envelopes for the sector, which will add significantly to the predictability o f funding, and hence forward- planning. o In the course o f both the 2007-2009 MTSS preparation and the 2007 budget process, substantial data has been captured on past expenditures and ongoing projects, which will provide a platform for more effective planning infuture, as well as M&Eand value-for-money analysis. 150 o Weakness in reporting, monitoring and oversight: The Ministry o f Finance presides over a system for monitoring and evaluation o f budget execution which has not been fully effective in the past, despite several agencies with a mandate for supervision and monitoring. In practice, the intended checks and balances have not worked as a comprehensive system. For example, there has been no robust mechanism to generate a consistent set o f records to track individual disbursements from the Budget Office (BOF) to Accountant General Office (OAGF), to line Ministries and their parastatals, and to their ultimate beneficiaries. Financial records appear to be maintained independently and separately at each stage o f the disbursement process. While the staff in the BOF know the authorized investment amounts against individual projects in the portfolio, the OAGF until recently could only confirm their overall cash releases to the Ministryo f Power and Steel. o Recent Measures to address this situation: The newly introduced Automated Treasury Transaction Reporting System (ATTRS) i s expected to provide an important immediate response to this problem, in the interim period until a full GIFMIS has been rolled out. The reforms in public procurement headed by the Budget Monitoring and Price Intelligence Unit (BMF'IU) helped to raise in cost efficiency o f government spending and improve accountability o f contractors. Sectoral Issues o Inadequate tariff policy: The PHCN's average weighted tariff is below the tariff required for full cost recovery with an adequate profit margin. It i s estimated, based on the analysis undertaken for this report, that a reasonable level o f the tariffrequired for full cost-recovery inthe sector with an adequate profit margin is W7.09 (US$ 0.055) per kWh. This estimate reflects on generation prices in the existing power purchase agreements between independent private generators and the former PHCN that provide an appropriate costing benchmark. The implied average weighted tariff currently inthe systemi s only $45.519. Thus a "reasonable average tariff' should be about 30 percent higher than the one today. It i s still below the current maximum commercial and industrial tariff o f $48.50 per kWh, but it is considerably higher than the current residential tariff. Raisingthe average tariffto N7.09 would bringit muchcloser to the international average. o Two proposedregulatory actions byNERC may help to close the gap. The first is a proposed rule on multi-year tariffs (MYT) which, if adopted, could lead to a "glide path" for closing the gap over a 4-5 year period by raising average tariffs. The second i s NERC's proposed power purchase agreement (PPA) benchmarking rule which was issued for public comments to be received by the end o f February 2007. While the benchmarking rule would not affect any existing PPAs, it may lead to lower priced PPAs in the future. Hence, the combination o f the two regulatory actions could gradually close the gap -- the first, by increasing future revenues and the second, by reducing future power purchase costs. o The difference between the existing and cost-recovery tariffs, multiplied by the quantity o f electricity delivered can be considered to be an implicit tariff subsidy underwritten by the federal government. It is estimated that in 2005 total implicit tariff subsidy received by paying customers was S17.4 billion or 0.17 percent o f GDP. However, there are two additional and even larger implicit subsidies to electricity consumers within the system: (i)inefficiency and non-technical losses 151 in the distribution system, and (ii) non-payment for the electricity supplied. the Our estimates suggest that total electricity consumer subsidies inthe system at the moment amount to 8577 billion (almost US$600 million) a year, which i s close to 0.8 percent o f GDP. They are a result o f the two factors combined - depressed tariffs as well as weaknesses in corporate governance. o Weak Corporate Governance and Poor Performance of NEPA: Legacy issues in the sector include the fact that there have been several indications o f weaknesses in corporate governance at NEPA, which were reflected in poor operational performance, overstaffing, and inadequate attention to maintenance. o Accumulated losses o f NEPA for the period 2000 to 2004 were w42 billion, which exceeded the overall amount o f government operational subsidies. It i s worth noting, however, that losses declined from a higho f 2415.82 billion in2001 to a modest profit o f 850.74 billion in 2004, which represents a substantial and significant improvement, reflecting some o f the commercial strengthening measures that were introduced. Money owed to NEPA by customers more than tripled over the period, as debts from private consumers grew from N34.5 billion in 2001 to N88 billion in 2004. The collection rate was only about 70 percent in 2003-04. It increased by about 5 percentage points in 2005, and has been improving in 2006, which continues to be encouraging and may reflect some o f the fruits o f the unbundling. The collection rate i s a crucial variable that must continue to be monitored, particularly as much more expensive power from IPPs starts to be pumped into the system. The sector cannot afford to absorb high losses on delivered power, i.e. the sector has to pay for it and yet revenues remain uncollected from customers. That i s why the commercial strengthening measures andtariff readjustments are crucial, to restore the sector's financial viability with minimal and decliningrecourse to budget subsidies, as early as possible. o NEPA's uncollected receivables from federal, state and local government agencies grew from N14.2 billion in 2001 to N43.9 billion in 2004. Government agencies consistently accounted for about 30 percent o f receivables throughout this period. Analysis o f the receivables as o f December 2001 indicates that the army and air force alone accounted for almost half o f the 30 percent that was the government's share o f debts to NEPA. A sensitization effort o f the implications o f non-payment (particularly as the costs rise due to power purchases from IPPs) and the shifting o f greater burden to those who cannot avoid payment, typically household customers with prepaid meters, may be useful in this respect. Collection difficulties could potentially also be a disincentive to private investors, or could at the least induce them to seek FGN guarantees or other risk mitigation instruments. IDA has supported the Nigerian power sector to develop a distribution product called Commercial Reorientation o f the Electricity Sector- Toolkit (CREST), which aims at loss reduction and improved financial performance. This i s a promising initiative that should be scaled up. 5.27. All o f the measures described above that have been introduced to address the previous weaknesses, should ensure that the proposed additional large investments inthe sector this time would make a real difference in sector performance. 152 Table 5.6: NEPA Balance Sheet, 2000-04, end year stock, N million F i x e d asset S 39,423 74,324 96,581 104,849 115,791 ICash 15,456 14,773 8,017 4,949 7,167 Stocks 13,711 20,057 27,906 25,786 24,151 Consumer debtors 4,565 4,504 9,740 11,709 13,861 0ther receivables 20,208 39,062 24,881 24,334 47,388 Current liabilities -37,816 -64,243 -66,924 -97,129 -103,663 L o n g term debt -37,939 -41,034 -50,461 -22,9 15 -16,115 N e t Assets 17,606 47,444 49,742 51,581 88,580 E q u i t y 3,858 3,858 3,858 3,858 3,858 Capital grants 32,234 73,229 82,886 91,792 126,445 Reserves 1 17,445 17,746 18,092 18,525 Losses I -18,486 -47,089 -54,749 -62,162 -60,249 17,606 47,444 49,742 51,581 88,580 Source: Consultants'Estimatesand NEPA Audited Accounts. B. CONCLUSIONS AND RECOMMENDATIONS 5.28. The power sector's performance has improved recently, but it i s still short o f existing customers' expectations. Weaknesses inthe budgeting arrangements, governance problems in the sector, and an inadequate tariff policy have been major factors that significantly limited the benefits fiom previous public investments in the sector. These weaknesses are now being addressed in a variety o f ways, and it i s important to provide all required support to these new initiatives. 5.29. Government's direct investments in the sector are likely to remain significant in the medium term. The latest emphasis in the government's power reform program has been on rapid increase in generation capacity based on major additional public investments in the sector. Recent initiatives to improve budget planning, monitoring, reporting, and procurement should be further advanced. 5.30. The government should establish a set o f performance benchmarks to monitor improvements in commercial performance o f the unbundled power companies until they are privatized. 5.31. A special effort is needed to maintain the strengthened supervision o f the rural electrification program. A new control mechanism should be designed to slow the current pace o f project proliferation, at least until installed and functioning power generation capacity catches up with the number o f rural connections, making it feasible to supply highquality and reliablepower to these outlying locations. The respective roles o fRural Electrification Agency (REA) and the Ministry's rural electrification function should be clarified and funded appropriately with accountability linked to funding. 5.32. The government should build a consensus with respect to a desirable future sector configuration. This i s best done based on informed discussion and consultation with core stakeholders, and the decisions clearly communicated to the private sector. There i s need for careful consideration o f how to allocate access to the most profitable commercial and industrial customers who are today generating their own power at high cost. Such customers are likely to remain outside the public sector fiamework for some time to come, but they may be willing to participate in purely market-based solutions that would 153 accelerate improvements in their power supply, while also increasing their efficiency and productivity, with positive impacts on economic growth. 5.33. A considerable residential tariff adjustment is likely to be needed, without which the tariff may not sustain the ongoing and future capital investments in the sector. Various consultancies have called for incremental increases inthe average tariff o f 42-50 percent over two to five years, with most o f adjustment to affect the residential tariff. The regulator has been working on the preparation o f the multi-year tariff rule to address these problems, including the issue o f potential transitional subsidy support. A targeted awareness-building initiative concerning the reforms underway i s needed urgently to prepare the ground for future tariff changes. 154 ANNEX 1: PerformanceFramework-Analysis of IndividualIndicators The List of the Indicator Set I C(ii)Predictabilityand ControlinBudget Execution I PI-13 Transparency o f taxpayer obligations and liabilities PI-14 Effectiveness o f measures for taxpayer registration and tax assessment PI-15 Effectiveness in collection of tax payments PI-16 Predictability inthe availability o f funds for commitment o f expenditures PI-17 Recordingand management o f cash balances, debt and guarantees PI-18 Effectiveness o f payroll controls PI-19 Competition, value for money and controls in procurement PI-20 Effectiveness o f internal controls for non-salary expenditure PI-21 Effectiveness o f internal audit I PI-23 IAvailability o f information on resources received by service delivery units I PI-24 Quality andtimeliness o f in-year budget reports PI-25 Quality and timeliness o f annual financial statements PI-26 Scope, nature and follow-up o f external audit PI-27 Legislative scrutiny o fthe annual budget law PI-28 Legislative scrutiny o f external audit reports 155 3 0 3 U 3 3 rg b 5 b 3E e 2 Y 3 e, m a e, 3 U 3 > * 0 bs 0 "2 .p E -pe @ .E rc 0 3. 5 3 3 3. D D 5 c0 e, e, f, rc 0 141 3 3 3 U D U U U 3 '1 3 '1 N If! N U U 3 5 3 z s ri N ru 0 W 0 PI-1: Aggregateexpenditureout-turn comparedto original approvedbudget Best Practice Best practicefor thepurpose of the PEFA assessment is deJined as: I n no more than one out of the last three years has the actual expenditure deviatedfrom budgeted expenditure by an amount equivalent to more than 5% of budgeted expenditure. The comparison is based on the primary expenditure aggregate, i.e. it excludes debt service charges, and also excludes externally funded project expenditures. Present situation Table 1-1presents the estimates for deviations between approved and actually executed federal budgets across main expenditure aggregates. It shows a dramatic improvement in the quality o f budget execution since 2004, and thus inbudget predictability, but from the low level. In sum, the average deviation for aggregate non-interest federal budget expenditures (excluding debt service payment) for the last two years (2004-05) has declined to the level that i s close to the PEFA benchmark o f 5% for a good international practice inthe aggregate expenditure management. Incontrast, the average deviation was about 27% in 2001-03. Still in two out o f the 3 last years (2003 and 2005), actual expenditure deviated from the originally budgeted level by more than 5%, out o f which in one year (2003) by large margin. However, it i s worth noting that the above conclusion i s based on the originally adopted 2005 Appropriation Bill. InJune 2005, as a result o f negotiations between the legislature and executive, a revised budget was approved, which provided for a reduced by 11% level o f total expenditures. This revised budget was fully executed (actual 2005 spending amounted to 103.2% o fthe level envisioned by the revisedbudget). The main remaining weakness relates to the execution o f the capital budget and insufficient cooperation between executive and legislature in budgeting, which i s discussed indetail inthe mainreport. Insummary, before 2004 Nigeria was affected by a tendency to adopt highly inflated and broadly unimplementable budgets. This has been improving recently, but further consolidation o f the emerging more cooperative arrangements between legislature and executive are required. Reforms under way The proposed Fiscal Responsibility Bill will introduce a legal framework for predictable and sustainable budgeting, and thus would reduce a risk o f passing an inflated Appropriation Bill that could difficult to implement. On the execution side, the government i s making steady progress in the broad set o f areas (including budget formulation, cash management, procurement, etc.), which hold a promise o f bringmg a more orderly budget execution process. Assessment Sustainability o f recent improvements in budget predictability remains o f concern. The relative success in the implementation o f capital budget in 2004-05 has been achieved only through the FGN's decisions to extend the end o f fiscal year much beyond December 31. While this helped to show an improved implementationratio in the budget execution reports, in substance this practice does not improve much actual budget 164 predictability for MDAs because they cannot know in advance if a decision on such an extension would be made and, if yes, how lengthy the next extension could be. More generally, this is a highly distortivebudgetingpractice, which shouldbe stopped. Another concern relates to the remaining disagreements on a desirable extent of fiscal policy restraint.This poses arisk ofre-emergenceofinflatedbudgetsinthe future. Table 1-1: Deviationsinfederal budgetexecution, measuredas the differencebetweenthe approved and executed budgets, in YO1/,3/ Average deviation, 2001 2002 2003 2004 2005,21 2004-05 Total Expenditures,wlo debt service -16.7% -28.4% -36.5% 3.0% -12.9% 7.9% MDASpending -16.7% -29.4% -38.3% 3.3% -13.2% 8.3% 3iw: Current Expenditure 13.3% -9.8% -11.8% 5.8% -1.0% 3.4% Payroll 1.4% -8.4% -5.9% 5.7% -4.2% 5.0% Pensionsand Gratuities 4.3% -16.0% 3.9% 0.7% 2.3% OverheadCosts 48.8% -19.2% -20.4% 6.9% 6.3% 6.6% Capital Expenditure, Releases -33.8% -49.6% -71.4% -0.4% -27.9% 14.1% DebtService 32.6% 27.3% -1.9% 8.9% 14.0% 11.4% Transfers -2.8% 1.9% -4.2% -7.4% 5.8% Total revenues 29.6% -9.1% 7.8% 9.8% 8.8% Mem:Total Expenditures -12.1% -22.1% -31.7% 4.0% -4.7% 4.3% 1/ Including supplementary budgets, 21 Results for 2005 are based on the originally voted Appropriation Bill, 31"-"indicatesunder-spendingrelativeto the budget Source: IMF, BOF, OAGF, staffestimates. 165 PI-2: Compositionof expenditureout-turncomparedto originalapprovedbudget Best Practice This indicator measures the extent to which actual expenditure composition varies from the composition of the original budget, i.e. extent of expenditure reallocation in the course of budget execution. The analysis is based on the empirical assessment of variance in the expenditure composition and its difference from variance in the overall expenditure level as measured in the indicator PI-I. The best practice is defined as the case when variance in expenditure composition exceeded overall deviation in primary expenditure by no more than 5 percentage points in any of the last three years. It means, e.g. in a particular case of budget shortfall, that allocations to all or almost budget holders are reduced in contrast to the situation when budgets cuts for some are accomanied bv additional Present situation Table 2-1: Analysis of deviations inbudget expenditure composition, 2001-04 Deviation in the Deviation in the overall expenditure expenditure level composition Difference A B B-A 2001 16.7% 24.9% 8.2% 2002 29.4% 32.8% 3.4% 2003 39.9% 39.9% 0.0% 2004 3.3% 8.0% 4.7% I Source: OAGF, staff estimates. Note: Composition index in column B i s estimated on the basis o f the 22 largest MDAs by expenditure. Table 2-1 presents a comparison between the deviation (relative to the approved budget) in the aggregate non-debt expenditure level (column A) with the weighted average deviation in allocations for individual MDAs (column B). It helps to understand the structure o f the overall expenditure shortfall - whether inthe case o f expenditure squeeze all MDAs are affected in more or less similar way? The analysis was based on the 22 largest MDAs ranked by their overall expenditure envelopes with the combined share in the aggregate expenditures o f about 85%. Data in column A in principle correspond to those inTable 1-1, line "MDA pend ding".'^^ The results in Table 2-1 suggest that the composition o fthe actual budget spending varies insignificantly from the original budget, when the budget faces a shortfall, usually no MDA is protected fi-om it. For each o fthe last 3 years (2002-04)'36 for which the data are available, variance in expenditure composition exceeded overall deviation in the aggregate non-interest expenditures by less than 5 percentage points, which i s a PEFA benchmark for good international practice. Small differences betweenthose two data sets derive from the fact the estimates inTable 1-1 exclude budget spending on pensions as well as on repayment o f wage arrears, for which the OAGF execution reports do not provide a breakdown by MDA. 136No detailed execution data for 2005 havebeenavailable yet. 166 Assessment Disorderly reallocation o f funds during the budget execution seems is not a problem for Nigeria. The budget holders used to be seriously affected by the deviation in the aggregate level o f expenditure, but not much by changes inthe expenditure composition. Before 2004 the MDAs, which were the most affected by expenditure shortfall, have been those with the largest investment programs (such as Ministries o f Water, Works, Power and Steel, FCT). This is because most ofbudget deviation was concentrated inthe capital budget. Allocations for social ministries, such as Health and Education, were better protected because their budgets are more wage intensive. The structure o f budget execution improved considerably in 2004 and, if measured against the revised budget, in 2005. Inbothyears the level o f capitalbudget execution was above 90%. 167 PI-3: Aggregate revenue out-turn compared to original approved budget Best Practice This indicator measures realism of government revenue projections. The performance is considered to meet the standards of the best internatioinal practice if aactual domestic revenue collection was below 97% of budgeted domestic revenue estimates in no more than one of the last threeyears. Present situation Table 3-1 presents the deviation index for federal budget revenues for 2001-2004. It indicates that in 3 out o f 4 last years actual budget revenues were considerably above the budgeted level due primarily to unexpectedly highoil prices. Formally speaking it would suggest that Nigeria deserves high marks for its performance in this indicator. However, this would be too an early conclusion. The FGNstrong overall revenue performance was to a larger extent result o f its luck with strong growth in oil prices than it was due to good budget planning. This claim i s supported by rather high deviations in non-oil tax collections, especially in collections o f independent revenues o f the federal government (IGR).Inboth 2003 and 2004 the actual IGRcollection amounted to only about one third o f the budgeted level. The small weight o f such revenues in the overall budget framework reduces the negative impact o f this trend on overall budget execution. The IGRperformance improved drasticallyin2005, but this improvement was filly due to the oil sector as well - more than half o f 2005 IGR derived from the signature bonus paid by the oil companies that won tenders for new oil blocks. Table 3-1: Deviations infederal budget revenue performance, measured as the difference betweenthe approved and executed budgets, inO/o 1/, 2/ 2 0 0 2 2 0 0 3 2 0 0 4 2 0 0 5 Total revenues 29.6 -9.1 7 . 8 % 9 . 8 % olw I G R 36.3 - 6 7 . 2 % - 6 6 . 2 % 2 2 8 . 8 % Reforms under way The Government has made commitments to significant improvements in tax administrationaimed at better collection performance, inparticular non-oil taxes, and less costly administrative arrangements for taxpayers. See the indicators PI-11, 12 and 13 for more information. Assessment The overall revenue performance has been rather strong recently. This suggests a major disconnect inbudgetingbetween revenue and expenditure estimates -the legislature has a tendency to increase budget expenditures without payng much attention to the government revenue estimates. According to the current legislation, the National Assembly does not vote the revenue side o fthe budget. At the same time, revenue performance o fnon-taxes remains weak, while their budgeting i s quite unrealistic. 168 PI-4: Stock and monitoringof expenditurepayment arrears ~ Best Practice PEFA bestpractice benchmarks in this area are summarized asfollows: (i) Thestock of arrears is low (Le. is below 2% of total expenditure) (ii) Reliable and complete data on the stock of arrears is generated through routine procedures at least at the end of eachjscal year (and includes an ageprofile). Present situation Significant deviations between approved and executed budgets in the environment of weak commitment control prior to 2004 led with time to the accumulation of significant budget arrears. Two main types of budget arrears are debts to contractors and to the pensioners. There are also additional types o f budget arrears, such arrears on payments to international organizations andutilitypayments. It is believedthat the large part of contractor arrears is the legacy of the militaryrule, as well as that a significant portion of the current contractors' claims is inflated. The total contractors' arrears of the federal government were originally (in late 2005) estimated to amount to N275-300 bn (about 2.2% of 2005 GDP). Intensive audit of contractor claims prior securitization of this category of debt has reduced their magnitude to about N135 bn, i.e. to the levelthat is more than twice below the original estimates. There is a considerable uncertainty about the stock of federal pension arrears, which by current estimates would amount to not less than N l O O bn (0.6% of GDP). Over the last few years, the FMF continued to under-fund pensions in the annual budgets on the grounds that the MDAs were unable to justify their pension funding claims in budget proposals. The Pension Commission estimates that in 2005 alone underfinancing of pensions was inthe range ofN6-12 bn. The incidence of utility arrears remains unknown, although the arrears to the government telecom provider have been settled in 2005 (in the amount of N5.6 bn). Arrears to international organizations are estimated to amount to N53.6 bn based on the 2005 unaudited survey. Reforms under way Since 2005 the FMF undertook a special effort to build an adequate understanding of scale of the budget arrears problem. This was done through a special data request sent to the MDAs to report on the stock of budget arrears as o f the end of 2004, building a database within the BOF, and setting up a mechanism for verification, auditing and deflating the reported claims. The process i s still unfinished, but in 2006, as part of its annual budget, the FGNcleared contractor arrears inthe amount of about N96 bnthrough a combination o f cash payments (to small local contractors) and issuing federal bonds. The FGN plans to fully clear the stock o f remaining contractor arrears in 2007 through additional issuingof 2-5 years bonds. Under the Pension Act adopted in2004 the National Pension Commissionis requestedto estimate the debts accumulated in the old pay-as-you-go pension system and to manage their clearance. The Commission started the verification exercise in April 2006. A framework for clearingthe pension arrears was finalized inthe course of 2006, and about N45bninpension and gratuity arrears were cleared by early 2007. 169 Assessment Overall, by conservative estimates that reflect the results o f recent verification, at the end o f 2005 federal budget arrears stood at the level about N300 bn (US$2.3 bn), which i s about 20% o f the total 2005 federal budget expenditures. The FGN does not have any regular reporting mechanism on budget commitments and arrears, which could help to collect, verify and consolidate outstanding contractor claims and arrears. While the government commitment to clear its stock o f arrears i s an encouraging development, so far the process o f arrears repayment has been handled as a special one-time-only exercise. It i s important for the government to establish an adequate monitoring system to prevent the accumulation o f new budget arrears after they are removed by the ongoing clearing exercise. In particular, the government will need to strengthen commitment control and reportingto reduce the risk o f arrears accumulation in the future. 170 PI-5: Classificationof the budget Best Practice Bestpracticefor thepurpose of the PEFA assessment is defined as: The budget formulation and execution is based on administrative, economic and sub- functional classijication, using GFYCOFOG standards or a standard that can produce consistent documentation according to those standards. (Program classijication may substitute for sub-jimctional classipcation, if it is applied with a level of detail at least corresponding to subjiunctional.) Forfurther discussion of principlesfor budget classijication seeAppendix PEFA-1. Present situation Budget classification systems have received increasing attention in recent years. This i s partly because international standards have been developed and gained increasing acceptance, but also because with the greater use o f information technology, PFM information can be made available to budget users in a much more meaningful andtimely way. In a deeper sense, the budget classification system used by governments is a signpost o f the state o f financial management development. Nigeria still has to make significant progress to achieve these standards. Until2006, when some modifications were introduced, the budget and the accounts o f the FGN were identified using a twelve-digit code string. The administrative classification is central for the way the budget i s currently presented. The code string specifies 1) the institution responsible for the appropriation and, in the case o f recurrent expenditure, 2a) the economic nature o f the appropriation (usingsome standardized aggregate categories such as e.g. payroll) or, in case o f "capital investment", 2b) the name o f the project or 2c) the non-standardized specified economic nature o f the capital expense. The distinction between recurrent and capital i s done only through the numbering in line-item part o f the code string. These seven last digits o f the code are also referred to as "sub-heads". The institutions are grouped into "Heads", normally corresponding to ministries. Thus, each institution's budget contains a more or less detailed breakdown o f traditional recurrent costs for runningthe institution and then a more or less long list o f investment projects implementedby that institution. The Head aggregate defines the responsibility o f the vote-holder, or accounting officer, and with sub-heads constitute the framework within which virements take place. The economic classification remains highly under-developed. For instance, it does not contain a "subsidy" category, and a debt service entry combines both interest payment and amortization. Furthermore, the current definition o f budget deficit differs -considerably from international usage. The definition o f capital spending i s rather liberal - a large portion o f what i s classified in Nigeria as investment spending would be by any normal standards considered as recurrent spending. Until recently this used to include budget spending on e.g. various training programs, including study tours, subsidies on fertilizers, and other operating costs. But the government tightened the definition o f investments somewhat and cleaned up the investment program during the preparation o f the 2006 budget. 171 Prior to 2006, there was no functional budget classification that identified the purpose o f spending. As a result, there was no reliable way to track total government spending on particular core public services, including those in such important MDG areas like education and health. Nigeria has yet to adopt the international standard o f COFOG (UN Classification o f Functions o f Government). However, the new 15-digit COA, although not meeting the COGOF standard, does contain a section that would make such tracking possible. Indeed the OAGF and the MDG Office are jointly pioneering such tracking with the 2006 budget. Reforms underway The present budget/accounting classification system offers very limited possibilities for analyzing the budget in anything but very rudimentary ways. The mixing o f standardized categories o f economic classifications for recurrent expenditure with individual project names or specific, non-standard descriptions o f capital expenditure makes it impossible to analyze the economic composition o ftotal expenditure. As a stop gap measure, awaiting a more thorough overhaul o f the budget and accounting system, a slightlymodified "chart-of-accounts" was introduced for the 2006 budget (after some testing in 2005). The code string has been extended to fifteen digits in order to allow the introductiono f a uniform, standardized economic classificationto potentially be applied to capital as well as the recurrent part o f the budget. The role o f the present sub- head classification will be taken over by a new classification category within the code string termed "budget control". The administrative classification + the budget control code together define budget appropriations. The classification o f the 2006 Appropriation Billimproved considerably, inparticular inits recurrent part. The government i s committed to broad improvements inbudget reporting on the basis o f the Transaction Recording and Reporting System (ATRRS). A deliberate choice has been made to keep the ATRRS simple in order to allow its quick deployment. It does not require any re-engineering of the accounting and reporting processes. And as only limited changes have been made to the chart o f accounts, they can be handled by those MDAs that (for some time until ATRRS i s hlly rolled out) will continue to do their accounts manually. Back in2002 a standardized reporting format for subnational governments was developed and appr~ved'~'.However, its implementationremains voluntary for states and it appears that rather limited use o fthis format has been made so far. This i s in part because the new reporting system i s expected to be computerized, but the required software is still at the testing stage. Furthermore, the 2002 proposal was not sufficiently ambitious in terms o f closing the gap between the current budget practices in Nigeria and international standards in classification and reporting. Moreover, there i s a clear lack o f nationwide standards for budget presentation and disclosure. A few states are reforming budget accounting andreporting systems on their own. The Fiscal Responsibility Bill contains several important clauses, which potentially could lead to improvements, including through across the board standardization, in both budget classification and reporting. ~~ 13'Report on Standartization of Federal, States, and Local Government Accounts inNigeria (2002). 172 Assessment The budgeting, accounting and reporting system - including the classification system- is one o f the weakest links in public financial management in Nigeria and has, in many ways, degenerated in relation to the system in place at Independence. It allows neither effective control nor any useful analysis of the composition of government expenditure. The budget estimates are mostly too detailed for legislative oversight, while the accounts are too coarse-grained for management purposes. The reason for this i s that the accounting system i s designed primarily as a system for recording budget expenditures, andits classification system permitsonly limited analysis. It is impossible to get a view o f the functional composition o f public spending because there i s simply no functional classification o f expenditure and none can be derived using any o f the other dimensions o f the present classification system13*. It is not possible to analyze the economic composition o f public spending mostly because there i s no way to separate the recurrent and capital components o f projects, save by painstakingly going through the Budget Estimates page by page, item by item, and making a judgment based on the descriptiono f each one. And inmany cases, the project i s a large single entry.. The most urgent problem, however, i s not deficiency o f classification, but the lack of timely in-year and year-end reporting on spending by the MDAs. See further PI-24 and PI-25. The ATRRS initiative i s a sensible stop-gap measure to address this problem. Inthe medium-term- four to seven years - the Federal Government will need to put in place a full-fledged, modem budgeting, accounting, management and reporting system (and has begun planning for this). One part o f the work should be to prepare a complete modem, multidimensional chart o f accounts, which meets all reasonable informational/analytical, control and management needs. It should make possible to present the budget and accounts in a number o f dimensions: programmatic, functional, institutional, economic, and possibly others. Reform of the budget classification system, however, needs to be sequenced carefully. No attempt should be made to immediately introduce any functional or programmatic classification into the ATRRS. What could possibly be done at this stage i s to centrally attach a functional code to the responsibility part o f the new CoA (Head + organization), which would make possible to derive an approximate functional breakdown o f FGN expenditure. 13*Expenditureby Ministrycouldbeusedas a roughproxyfor spendingby function.This approachhas serious limitations,however, becauseministries as a rule tendto undertakenon-profilefunctions andincurnon-profile expenditures. Thus, manyMDAsprovidelimitedhealthservices to their staff. Inthe absenceoffunctional classification,the latter makesimpossibleto estimatetotalhealth spendingof the federalgovernment. 173 PI-6: Comprehensivenessof informationincludedinbudget information Best Practice A bestpractice budget would contain information on all elements list in Table 6.1. Present situation Over the last two years, the quality o f federal budget presentation has improved considerably and it moved much closer to the recognized international standards in this area. Starting from the 2006 budget cycle, the annual budget package submitted by the FGNto parliament includes, in addition to the standard Appropriation Bill with detailed expenditure estimates, a copy o f the Fiscal Strategy Paper (FSP) and a set o f Medium Tern Sector Strategies (MTSS). The table below summarizes (in column 2) the information provided in the 2007 Budget Bill against the PEFA benchmarks. To the list o f PEFA benchmarks we have added a number o f other pieces o f fiscal information that a modem budget document could usefully contain. The third column reflects information that would be required either inan MTEF document or in the annual budget bill, if, for example, the present version o f the Fiscal Responsibility Bill were passed. The fourth column reflects information requirements explicitly referred to in the Budget Procedure Bill presently before the National Assembly. A parenthesis around a tick indicates that, in the case o f the 2007 budget document, the presented information i s not complete or, inthe case o f the bills, that the interpretation i s unclear. Before the 2006 budget, the documentation included in the budget package was made up o f three key components: a short budget speech, an Appropriation Bill which authorizes the spending against heads, and a volume of detailed Budget Estimates, which was quite fine grained generally, but also included some very large sub-heads without further item level information. The budget package generally lacked summary analyticaltables. Beginning with the 2006 budget, the government initiated the preparation o f Medium Term Sectoral Strategies (MTSS) for select MDAs. The 2006 MTSS contained some narrative on the link between NEEDS and the budget, and they were given to the legislature as part o f the annual budget process. For 2007 the Government decided to expand the list o f ministries covered by MTSS to cover at least 75% o f total budget spending and considerably strengthen their analytical and informational content. The 2007 MTSS documents were developed around the need to build a stronger bridge between NEEDS, MDGs, three year expenditure proposals, and annual budget plans. They also provided significant amounts o f detail on a programmatic breakdown o f sectoral envelopes, as well as details on MDAs' investment programs, including on implementation o f select largest projects. The 2007 MTSS started to integrate performance information and targets. Moreover, since the 2006 budget cycle, the budget package has included the FSP, which contains a set o f key fiscal aggregates (both revenues and expenditures) and analytical tables. It has made the entire package much more informative because it gives a broader 174 picture o f the budget, in terms o f availability o f funding and how it i s allocated, and in terms o f the overall size and balance between revenues, expenditures and financing. The FSP also discusses the execution o f the previous year's budget and results achieved, and it presents key historical trends. The 2007 FSP also includes section on fiscal risks and provides more detailed information on government debts. Inthis way, the inclusion o f the FSP inthe package o f budget documents i s a major step forward inbudget transparency. Table 6.1: Informationin the budget documents PEFA Budget FR BP Benchmarks 2007 Bill Bill 1 2 3 4 Macro-economic assumptions, including at least estimates o f aggregate growth, inflation and exchange rate. Fiscal deficit, defined according to GFS or other internationally recognized standard. Deficit financing, describing anticipated composition. Debt stock, including details at least for the beginning o f the current year. Financial Assets, including details at least for the beginning o f the current year. Prior year's budget outturn, presentedinthe same format as the budget proposal. Current year's budget (either the revised budget or the estimated outturn), presentedinthe same format as the budget proposal. Summarized budget data for bothrevenue and expenditure according to the main heads o f the classifications used (ref. PI-5), including data for the current and previous year. Explanation o f budget implications o f new policy initiatives, with estimates o f the budgetary impact o f all major revenue policy changes and/or some major changes to expenditure programs. Other information Medium-term fiscal framework Tax expenditure Description and assessment o f fiscal risk Strategic, economic, social and developmental priorities Summary o finstitutional, economic and functional composition o f expenditure Development objectives, performance indicators and targets Performance o f on-going budget programdactivities (4 The main remaining weaknesses in the informational content o f the annual budget package include the following: 0 Presentation o f revenues does not have consolidated estimates showing all the expected sources o f government revenue, including revenues accumulated with the excess crude account; 0 No consolidated deficit/surplus estimates: at the moment, the FSP presents only "notional" deficit estimates that do not reflect government revenues accumulated with the excess crude account; 0 Insufficient incorporation o f information on "cash calls'' into the government fiscal framework; at the moment, the revenue section in the FSP shows government revenues from crude oil sales on a net basis; 0 No reflection o f external borrowing/grants into the fiscal framework, as well as inthe detail estimates; 0 Presentation o f more information on the excess crude account needs more details, showing revenue inflows, accumulated balances, and their use; 0 A breakdown o f debt servicing has to separate amortization from interest payments; 175 Information on major capital projects: such as total cost for projects whose implementation extends for more than a single budget year. Though the 2007 MTSS provide the total estimated project cost (inaddition, to the current year appropriation) and the balance to completion) for the set of key projects, this i s not systematic; moreover, normally this information i s provided in the detailed budget estimate^'^'. Developing consolidated estimates on government fiscal assets and tax expenditures andincorporating them inthe budgetpackage; 0 Detailed appropriations may need to provide more comparative information with the with previous years' budget performance; at the moment, the FSP does gwe comparisons with preceding years, but only at the level of budget heads. Reforms underway As mentioned above, since the 2006 budget cycle, the BOF has achieved major improvements in the informational content o f its annual budget submission. Moreover, the established process of the annual update of both FSP and MTSS is expected to provide further steady progress in this area. This i s likely to be driven by improved coverage and costing in the MTSS, and by the future informational demands from the NASSthat would emerge as part ofbudget consultations with the legislature. As discussedinthe main text of this report, there are two partly overlapping and insome areas contradictory bills at various stages inthe parliamentary review process: the Fiscal Responsibility Bill (FRB) and the Budget Procedure Bill (BPB). Both bills contain clauses that specify what information should be presented to the National Assembly, either in a Fiscal Strategy Paper (the term used in the FRB), a Three Year Macroeconomic Plan (the term used in the BPB) or in the annual budget. An eventual implementation o f the relevant clauses'40would further increase the information content of the budget documents. See columns 3 and 4 inthe table above. Assessment Over the last two years the BOF managed to make important progress inthe direction of international standards of budget presentation. There i s still room for further improvements though that could be undertaken inseveral complementary directions: 0 Bringing into the budget package additional information as suggested in the comments above; 0 Modifying the formats of both the Budget Speech and the Budget Estimates, which were set decades ago. Inparticular, the Budget Speech could give more emphasis to government policy choices and linkages between policy priorities (such as those inNEEDS)andproposed expenditure allocations; and 0 Reforming the budget classification system to make Nigeria's fiscal aggregates consistent with internationaldefinitions. 139Currently,it is difficult to tell from thebudget estimateswhether a project incapitalbudgetisjust beginning, hasbeenrunningfor manyyears with no imminent completion,or is infinal year of spending. Fromthis perspective,the currentpresentationof thebudgetdoesnotprovide anopportunityto determinewhether the Government'spolicyobjectiveofgivingpriority to completingexistingprojectsis well reflectedinthe budget. I4OSomeadditionalre-draftingmayberequiredinorder to makethe two bills compatible. 176 PI-7: Extentof unreported governmentoperations Best Practice A Government Financial Statistics (GFS) Manual defines the general government sector and its sub-sectors as all government units and all non-market Not-for-Profit- Institutions that are controlled and mainly financed by government units. This coverage principle implies among other things that the budget and the accounts should include any revenue accruing directly to general government institutional units, for example servicefees and external grants. The GFSManual can be downloadedfrom http://www.imf.orgtexternallpubs/ft/gfs/manual/pdf/all.pdf For thepurpose of the PEFA assessment, best practice is defined as: i. The level of unreported extra-budgetary expenditure (other than donor funded projects) is insignipcant (below I% of total expenditure) ii. Complete income/expenditure information for 90% (value) of donor-funded projects is included in government fiscal reports, except for assistance provided in-kind or when donorfunded project expenditure is insignijkant (below I% of total expenditure) Present situation Currently, a significant portion o f public spendingremains outside o f the federal budget. The three main parts o f either unreported or under-reported government operations include: a) first line charges o f the Federation Account, b) donor funds (both grants and loans), and c) own (non-budget) revenues o f MDAs. In addition, the government has not introduced as yet a clear reporting framework on performance o f the newly established pensionsystem (fully funded scheme). As shown in Chapter 1 o f the report, the extent o f off-budget government operations remains highly significant. As o f 2005, about a third o f the total expenditures o f the federal government remained off-budget. The main types of off-budget spending include141: (i)financing o f oil sector investments (cash call); (ii) some costs o f external debt service, including the most recently those related to Paris Club deal; (iii)other priority development projects funded from excess oil revenues, such as recent major investment in power generation, and (iv) statutory extra-budgetary funds (Stabilization, Development o f Natural Resources, and Ecology), which receive 3.18% o f total funds distributed through the Federation Account. Some o f these budget coverage problems arise from lack o f constitutional clarity on how to treat common federation expenditures, i.e. spending undertaken on behalf o f all 3 levels o f the government. The recent payments to clear the Paris club debts, investments inpower generation and distribution (NIE'P), and more traditional government investment in the oil sector (cash calls) fall into the same category o f common expenditures. Stemming from the Supreme Court judgment o f 2002, the Federal Government has ceased to have jurisdiction over these expenditures. Thus, the federal budget can include only direct federal government expenditures, but not common expenditure o f the federation. The procedure for oversight over these prior expenditures is as follows. The Federation Account Allocation Committee (FAAC) first agrees on malung these expenditures. Then the Federal Executive Council approves them, after which the National Assembly discusses and votes on them, but completely separately from the federal government The incidenceofoff-budgetspendingwas reducedin2006 throughthe supplementary budget (see below). 177 budget. By constitutional requirement, the Auditor General ofthe Federationis supposed to audit the Federation Account and submit the findingsto the legislature and the FAAC. Although the rational behindthese arrangements i s clear, they are far from ideal from the accountability/transparency perspective. The authorities may want to consider an introduction of alternative arrangements, e.g. to treat common federation expenditures as part of the central government expenditures, for informational purposes, and budget and account for them as a separate section o f the federal budget. It could be made clear that this special category of expenditure is being included not for appropriation, but to assist legislators comprehend the full range o f federal government spending. According to the current regulations, if and when revenue accrues directly to an MDA, it should be transferred to the CRF.'42Whether or to what extent this i s actually done i s very difficult to a~certain.'~~ do so would require in-depth audits o f a representative To sample o f government institutions and the collaboration o f the commercial banks to get access to MDA accounts held in these banks. However, the recent deployment o f the TRRS simplifies the reporting process because the monthly transcript shows revenue collected by eachMDA on a bankby bankbasis. Although Nigeria i s not a major aid recipient in per capita terms, total aid flows are substantial. In2004, for example, according to the OECD data, Nigeriareceived a total o f USD 574 million ingrants and multilateral development loans. Table 7.1 Bilateral(from the DAC countries) and multilateral developmentassistanceto Nigeria, USDmillion 2004 3 14 260 573 2003 200 118 318 2002 215 101 3 16 Source: OECD-DAC. None o f this assistance i s shown in the budget estimates, neither on the revenue nor on the expenditure side of the budget. N o government consolidated accounts have been produced since 2002, but it i s not to be expected that, when the latter eventually are produced, audited, and presented to the National Assembly, they will contain information on aid flows and their application. It has not been possible to ascertain whether any MDAs have routines for capturing external assistance intheir individual accounts, which in part reflects a broader problem - there is no requirement for MDAs to prepare and disclose their annual accounts. Many Nigerian parastatals would by international (GFS) standards be considered to be normal general government units. While subventions to parastatals are reflected in the budget, even to the extent o f reporting separate personnel and overhead costs in some detail, spending financed from own non-budget revenues i s missing. This constitutes another type o f "underreporting" inthe sense that it contributes to an underestimate o f the size of general government. Furthermore, the reporting bythe parastatals i s often lagging 14*Some non-profitparastatals/institutions are empoweredby their establishing laws to keep back some of the revenues they generate. Examples are schools and universities that retainschool fees and other user charges. 143There is no requirement for MDA to produce and submit their annual accounts t o the OAGF. Currently, MDAs have to submit to the OAGF only their monthly expenditure transcripts. See also PI- 24. 178 - despite recent improvements, about 50 out of 400 parastatals had not provided the Auditor General with their 2004 annual reports by late 2005. Reforms underway The major FGN initiative in this area relates to the introduction o f a supplementary budget in 2006 to cover the federal portion o f total costs (funded from the excess crude account) o f repaying London Club debts and financing major infrastructure projects (in power and gas sectors). This does not fully address a problem o f budget coverage associated with the existence of excess crude account, but it does bringback to the federal budget a large chunk o f government investments. In addition, since 2005 the BOF have presented some information on the first line charges, for information, not appropriation, inthe FiscalStrategy Paper (FSP). There have also been various efforts in the related areas, such as those aimed at better donor coordination and strengthening debt and arrears management, which ultimately could leadto better budget coverage, based on better information o f actual financial flows inthe public sector. Assessment The budget coverage remains limited, but important progress was made recently to integrate a large piece o f off-budget investments into the annual budget through the 2006 supplementary budget. This reduces the disconnect between the annual budget process and operation o f the excess crude account. Such a disconnect has been o f special concern because it undermines transparency in managing windfall oil revenues. Further steps in this direction are desirable: while maintaining the structure o f the saving account, the FGN may need to introduce more systematic reporting on the account's operation and balances and link such reports more closely to the regular budget execution reports. The same relates to the spending covered under the first line charges: more regular reporting on such spending, as well as public disclosure o f audit results for these spending lines (in cases when such audit i s undertaken) would be a significant improvement relative to the current situation. A further step towards budget consolidation would be information on subvented parastatals' own revenues and their total spending: such aggregates should be also shown in the budget documents, even if the National Assembly is called upon to vote only the central government subvention. Ultimately, both the annual budget package and budget execution report should cover all the main pieces o f public finance. This process o f expanding coverage could be gradual, and would be fully in line with the recent government steps: a partial integration o f oil savings, cash call spending, and federal extra-budgetary funds with the regular budget to be pursued by presenting them jointly within the same fiscal framework at various stages o f the budget process (preparation, approval, reporting on actual execution, and audit results). The present budgeting and accounting system i s designed only for allocating and recording the use o f central revenue funds (CRF). For the current system to control the flow o f other government money, the latter have to be channeled through the CRF and/or CCA. But then they would be fully pooled and thus made indistinguishable from tax and non-tax domestic financing. Given the current problems with reliability and timeliness o f 179 the government accounts, such a solution would be problematic for donors, who as arule want to be able to track the use o ftheir contributions. The government could consider undertaking an audit of government institutions (including accounts held in commercial banks) to assess the degree of compliance with the requirementsto report andtransfer revenues to the CRF. The FMFshould introducea requirement for MDAs to produce their annual accounts, which should cover inter alia their non-budget revenues and account balances with commercial banks. Such information should be consolidated and reflected in annual government reports on budget execution. Some o f the reforms in this area may require amending the constitution in a way that would requirethe Federal Government to budget for, and the National Assembly to vote on, common Federation expenditures as separate part o f the a single Federal Government budget. 180 PI-8: Transparency of intergovernmentalfiscal relations Best Practice The systemfor allocation of funds between diferent tiers of the government - unconditional as well as conditional transfers - should be rule-based, transparent and predictable. Sub- national governments shall be able to make realistic projections with respect to the amount of transfers to be made available to them in the course of the fiscal year. Actual releases of transfers during theyear should be made in a regular predictable way. To ensure transparency of earmarked transfers, it should be possible to assess to what extent they have been used for the intended purposes by their ultimate beneficiaries. Such an assessment can be based on analysis of either published accounts of subnational governments ~ and respective individual institutions or regular statistical surveys. I Present situation Responsibilities The division o f responsibilities among government tiers inNigeria is laid out inthe 1999 Constitution. Part Io f the Second Schedule describes the exclusive legislative rights o f the federal government over functions o f national concern, such as defense and foreign affairs. Part I1 describes the concurrent areas in which both the federal and the state governments can act. These areas include e.g. education, both secondary and tertiary. The Fourth Schedule provides a list of functions, such as water and sanitation, that are the responsibility o f local government authorities (LGAs), as well as the list o f functions for which state governments are responsible, but in which local governments can participate at the discretion o f the states. The latter also include the provision and maintenance o f primary,adult andvocationaleducation. Financing The bulk o f revenue for all three levels o f government comes from oil. All oil revenue, which takes many different goes into the Federation Account (FA) together with the proceeds from some federation level non-oil taxes'45. VAT i s collected by the federal Government and distributedon the basis o f 15:50:35 shares to the federal Government, states and local governments, respectively. Before proceeds o f the Federation Account are distributed to the three government levels, a number o f deductions are made. The most important ones are the government contribution to joint oil exploration ventures. Currently, several deductions are administratively made, based on politically expedient agreements reached between the federal Government and state governors. The most important i s the deduction for the Excess Crude Oil account, part o f which (a portion o f the 2004 savings) was released in 2005 to states as additional FA transfers. Currently Federation Account distributions are calculated on the basis o f a long run oil price o f $35 per barrel, the figure gwen to states The bulk of oil revenuesderivefromcrude oil exports, domestic sales ofcrude, royalties,andpetroleumprofit tax. 14'Exciseand fees, importduty, companyprofit tax andother taxes on companies. 181 and local governments for the purpose of making their budgets for 2006.'46 Part of these proceeds is beingused to retire external debt, as Nigeria's contribution to the Paris Club debt deal. Another part is beingusedfor the national power project. Another implicit deduction that increased strongly up through 2004-05 was compensation to the NNPC for domestic sales of petroleum products at regulated below world-market prices. As from 2006, that subsidy mechanism became explicit - sales are subsidized at a fixed per liter rate regardless of who produces or imports the petrol. The cost of this subsidy - estimated at W150 bn in 2006 - will be shared equally by the federal government and subnational governments and will be treated as regular budget expenditure rather than as apre-FAdeduction. Earlier on, external debt servicingwas also a first line charge (deduction), but each tier of government has now - as a result of the 2002 SupremeCourt decision -taken over its share of the aggregatepublic debt14'. Since the late 9Os, transparency of the FA allocations has improved, largely due to a relative decline in total FA prior deductions and a respective increase in the amount of funds available for a formula-based distribution. The net Federation Account receipts are shared between the Federal Government, the states and LGAs according to a fiercely watched over formula. The first take on FA net receipts is a "13% derivation". This means that 13 percent of total net receipts from mineral resources are shared by the oil-producing states within the federation in proportion to their share of total produ~tion'~~. remainder14' is shared between the The three tiers of government inthe proportions of 52.58%, 26.72% and 20.60%. These shares have been stable since 2002. Inaddition, states are supposed to share with LGAs 10% o f their total revenues from all sources (section 162(7) of the 1999 constitution), but many states apparently do not implementthis requirement. The allocation of Federation Accounts is overseen by a Revenue Mobilization, Allocation and Fiscal Commission (RMAFC). The horizontal allocation from the FA to the states is based on the formula described in Table 8.1: 40 percent o f the total allocation i s shared equally between the states, 30 percent i s allocated usingthe state population as weights, and a further 30% is allocated by reference to other state characteristics. 14`Since2004, the transfers to the three tiers of governmenthavebeenbasedon aprudentoil benchmarkprice set to beclose to the historical averageworld marketprice for oil. 14'The external debt of all three tiers of government is, however, still managedby the federal Debt Management Office and some of these debt operationsremainoff-budget,especially at the state level. See also PI-7. 14'Inthe Supreme Court's rulingof2002, it was decidedthat the littoral stateshadno claim to the 13% derivation on oil produced offshore, revenues o f which belongto the entire federation. This was in line with the military era law that dichotomized odoff shore oil. However, a political settlement on this sensitive issue was reached in 2003, and the National Assembly enacted a law abrogating the dichotomy and thus over-riding the Court ruling.The situation since 2003 has been the 13% derivation principle applies equally to both onshore and offshore oil. 149Ofthe FederationAccount revenues, i.e., receipts from oil less 13% derivationplus company income tax (CIT), excise duties, customtariff, stamp duties, etc. 182 'I'ablc 8.1: ~ ~ ~ o ccriteriaaof~~ ~ ~ cAccount ttrarisfers ~ a t ~ ~ a ~ a across the states Proportion YO One task of the ~~~~~~~ 1s to review the rwenuc a~locationformu~as- vertical and l i ~ ~ r i ~-o at ileast,~once etcry five years, ~ ~ a Ho~twer,any recon~x~~endarior~the by ~ o ~ ~ i sbecomesneffective only af'tcr the Nalmal ~~ssembly passed it into law. s i ~ has As the al~oca~ioii031 resenue i s an extremely ~on~ent~ous in Nigeria, none of the of issue two proposa~s~iit~ierto madeby the C o ~ i i ~ ~ shas~beeniable to pass boththe Houseand s o ~ the Senate. The oil ~roduc~ng states in the south have xiiounted po~iticalpressure to increase the share of net oil rc~enucgoing back to the oil p ~ o d u ~ ~ ~ ~ gthe states 'hderi~~ari~~n"-cons~derabl~. Currently, they advocate an increase froni present 13% to 25% after ivhich it would be increased by five p e r ~ ~ n pointsea year for five years to ~ a ~ reach 50%. The noohern states OR the other hand haire arg~cdfor rilcrcased a ~ l o ~ a t ~ o n ~ on account of their lower levels of d e ~ y e l ~ ~harsher~natura1condit~onsand greater ~ ~ e i ~ , incidence of poverty. As there has been nu ~ ~ i e c l i a ~to~breakithis pofitical dead~ock. ~ s ~ i the allocat~onforniuias de~e~i~ncdan Executive Order by til 1999 have remattied ~iichanged. According to the ~ u n s ~ i ~ ~rcs~o~~s~bil1ty ~ r i o n ~ for basic ation ion in pr~n~iple tvith the lies state ~o~e~~ments, in which LGA could p a r t ~ ~ t p1aIowever, during the niilitary era, ~ ~ . I,Grts were sadd~~d wieh ~espons~b~li~yp r i m ~ red~~cation,~ for ~ ~ t i tcachers' ~ ~ ~ ~ ~ ~ n salaries. This r~sponsibt~i~y proved lo be non-affordableand led to mmsive a c c ~ i n ~ ~ l ~ ~ i o ~ i of arrears of teachers' salmes. The Federal ~ o ~ e ~ n nstepped tit and set up thc State ~ c n r Primary ~ d ~ ~Boardst (SPED)~in~all states. Then it dedu~~ed ~ t o primary school teacher salaries dircctly from LGAs' share of the ~ederationAccount aiid t~~nsferr~dover to this the SPER to payreachers. On return to civil adniin~str~rion, Supreme Court decided that these deduc~~oiis the were unco~~s~~tut~o~a~ and that primaryeducat~onwas not the resp~~is~bi LGAs but states. ltry of This stopped the d~ductio~is the Federal ~ o ~ e ~ ndectdedtto coiivert the SPEBs and ~ e n into Universal Basic ~duca~iun (WE) ~ ~ ~ ~ mfor the spurposc ~of~cha~in~~ing ~ s ~ o s its owti funds to p ~ ~ i stares~as ~o~~di~ionalc ~ igasants,~ In the 2006 federal ~ p a ~ ~ a~~ m t~~ i budget proposal the allocat~onto the liRE scheme was $430 bti. Total estimated annual transfer to local g * v e ~ m e ~is~ ~ s 'X'he flow of funds from the Fedcration ~ ~ c c tu thenstates aid to LGAs i s rel~ti~ely o ~ ~ tra~sparentas niost of it IS based on a simple md carefully guarded formula. Actual 183 disbursements are made once a month based on a stable timetable well known to all stakeholders. Information on how much i s being allocated to the Federal Government, different states and to LGAs is available on the web site o f the Federal Ministry o f Finance.150 What obscures the picture are two aspects o f the Federation Account's operations. The first relates to deductions from the Account, both interms o f statutory deductions such as joint venture cash and administratively determined deductions such as the excess crude and the petroleum subsidy. Under current arrangements, the Federation Accounts Allocation Committee (FAAC), the Federal Executive Council (FEC) and the National Assembly (NA), inthat order must approve requests raisedby the NNPC for joint venture cash calls. Similarly, the NA must approve transfers to the excess crude account, over which it maintains vigilant oversight. However, due to gaps in the 1999 Constitution, these arrangements are not part o f the annual budget process o f the Federal Government. There has also been lack o f transparency over the generation o f oil revenues, though with Nigeria's participation inthe Extractive Industries' Transparency Initiative (EITI), this i s improving. The second aspect i s the withholding by state governments o f the allocations to local governments and the execution o f the associated programs by the states. Generally, there i s a lack o f transparency about mechanisms o f these withholdings, while in some cases withholdings are excessive and undermine the entire idea o f local self-governance. It also raises serious concerns about budget equity. H o w much this affects the actual allocation to the local communities i s difficult to assess because o f non-availability o f comprehensive reporting on sub national budget execution. This points to a need to review the effects o f the current federalism arrangements on intra-state equity as well as on service delivery. Predictability o f transfer flows to states could be further increased ifthe states made more active use o f the annual revenue projections prepared by the Federal Ministryo f Finance. At present, they are under-utilizing this information intheir budget process, which affects realism o f their budget plans. If the Fiscal Responsibility Bill i s passed, the explicit sharing o f this information would become a statutory responsibility o fthe FMF. 150 http://www.fmf,gov.ng/detail.php?link=faac 15'These are Nigerian Government's contribution to the cost of oil extraction. 184 PI-9: Oversight of aggregate fiscal risk Best Practice For thepurpose of the PEFA assessment best practice as relates to the centralized oversight of fiscal riskfrom other public sector entities is defined as: (i) All major autonomous government agencies and public enterprises submitfiscal reports to the central government at least six-monthly, as well as annual audited accounts, and central government consolidatesfiscal risk issues into a report at least annually; (ii) Sub-national (SN) governments should not generate fiscal liabilities for the central government; (iii) The netfiscal position should be monitored regularly and consolidated at least annually for all levels of SN government, and the central government consolidates overallfiscal risk associated with SNgovernment operations into annual (or morefrequent) reports. Forfurther discussion of principlesfor fiscal risk management see Appendix PEFA-2. Present situation The Nigerian public sector includes a large number o f autonomous agencies and parastatals. Most o f them would in other countries be considered normal government agencies as they are 100 percent financed by regular budget funds. They have often sought and been given the semi-independent status in order to enjoy greater flexibility in terms o f personnel management and salary scales. This type o f parastatals does not constitute any fiscal risk different from any other government agency. The other type o f parastatals i s commercial operations which, for various reasons, receive subsidies from the budget but that are also expected to return any surplus to the Consolidated Revenue Fund. All federal level parastatals inNigeria normally present audited statements to the Office o f Auditor General, but some are late with such submissions. They do not submit any in- year financial reports. Overall the financial performance o f parastatals has been weak, and the budget subsidies and other government support (capital grants, tax benefits, etc) to ailing parastatals, including recapitalization o f state-controlled financial institutions, has been rather common (see Chapter 1 o f the main report). State owned companies in the utility sector (such as power, railways, and ports) have been among major beneficiaries o f government budget support. Recent privatizations revealed considerable accumulation o f debts and other liabilities by parastatals, which i s another indication o f problems in their performance. These points to the existence o f serious fiscal risks associated with operations o f parastatals, and the need for a thorough review o f the reporting and oversight arrangements for the sector. Another source o f fiscal risk to the Federal Government i s the lack o f hard budget constraints on the states and there are no mechanisms in place for monitoring their fiscal positions. Many states built up significant amounts o f domestic debt, some o f it dangerously short term and with high interest costs, in the years following the return to democracy, when oil prices were not as high as they are today, and invested the proceeds incapital projects ofdoubtful provenance. Although higher FederationAccount transfers have eased the budgetary situation o f states inrecent years, the need to meet debt service costs burdens state budgets. More recently, the Central Bank o f Nigeria has made clear that banks lend at their own risk to state governments. The DMO Act o f 2003 introduced 185 a requirement for states (and parastatals) to obtain an approval o f the Federal Ministryo f Finance for new external borrowing.152 Under the Fiscal Responsibility Bill, clear borrowing rules for state and local governments are prescribed. The major fiscal risk inNigeria has inrecent years been fluctuations in the oil price. It is, however, a risk that could have been better managed had the federal, state and local governments and respective Assemblies pursued a more prudent fiscal policy. Historically, increased public spending fuelled by high oil prices has been difficult to scale back when prices were low, resulting in a build o f public debt. But since 2003 the Federal Government has shown much greater restraint in terms o f spending expansion relative to what happened in the earlier episodes o f high oil prices. To create an equally disciplinedbudget process has proven more difficult, however. Because the Executive has not been always capable o f containing pressure to increase the expenditure envelope beyond what i s compatible with fiscal di~cipline'~~, it has had to resort to cash rationing duringbudget execution. This resulted in additional uncertainty o f expenditure dynamics and thereby in more inefficiency o f public spending. The earlier approval o f the 2006 budget with only minor amendments by the National Assembly has been an important positive development. Reforms underway Inregard to consequences o f oil price fluctuations on public finances, the introduction o f an oil-priced fiscal rule, from 2004 on an administrative basis should, inprinciple, reduce fiscal risk considerably. This will be further strengthened once the Fiscal Responsibility Bill is passed, which would anchor the budgets of all tiers of government to the long run price o f oil, as determined by the law's benchmarkingmechanism. Inregard to the monitoring of fiscal risk stemming from the operations o fparastatals and publicly owned companies there are no special reform efforts underway. However, the government made considerable progress in its ambitious privatization program, which aimed at privatization (including concessions to private operators) o f major parastatals in transport (railways, ports), telecoms, power, and manufacturing (oil processing, steel, etc.). The Central Bank has also brought about a dramatic and necessary consolidation o f the banking sector by significantly raising reserve requirements. It i s expected that new system o f fewer much larger commercial banks that emerged in early 2006 would be less vulnerable to shocks and more prudent in their lending to public bodies. As such this represents a lower riskto government finances. The government has been successful in strengthening capacity o f the Debt Management Office (DMO), which among other things helped to raise the quality o f monitoring o f external debts, accumulated by individual states. The D M O i s planning to establish a similar monitoring o f states' domestic debts. The DMO i s also inthe process o f amending the DMO Act to close some potential regulatory loopholes. Assessment The Government i s right in focusing its efforts on managing the fiscal risk that derives from the combined effect o f oil price fluctuations and weaknesses in the budget process. The introduction o f the oil priced fiscal rule was a giant step forward. However, the rule However, state could float their bonds at the internationalmarket without such approval. 153At leastbefore 2006. 186 has not fully delivered yet the stability in expenditure patterns that was hoped for and it i s possible that the rule can be improved on technically. A fiscal rule, however well designed, can bring only a limited set o f benefits unless there i s a budget process - backed up by legislation-that ensures responsible fiscal behavior on the part o f National parastatals. The three pieces o f the legislation -- the Fiscal Responsibility Bill, the Budget Assembly as well as on the part o f other players such as state and local governments and Procedure Bill and the amendments to the Finance (Control and Management) Bill -- are crucial for defining the characteristics for the future budget process. It i s important that the decision-making processes inboth the Executive and the Legislative are structured in a way that fosters fiscal discipline and accountability. Beyond this critical priority, the government has to introduce steps to strengthen its centralized oversight o f other key risks in the fiscal system, especially those related to operations of both parastatals and subnational governments. A major missing element in the country's arrangements for fiscal risk management i s lack o f proper reporting and consolidationo f information on debts, deficits, and contingent liabilities incurred by these public entities. 187 PI-10: Publicaccess to key fiscalinformation Best Practice For thepurpose of the PEFA assessment, bestpractice in availability offiscal information is defined as: (i) Annual budget documentation: A complete budget package can be obtained by thepublic through appropriate means after it is submitted to the legislature. (ii) In-year budget execution reports: The reports are routinely made available to thepublic through appropriate means within one month of their completion. (iii) Year-endfinancial statements: The statements are made available to the public through appropriate means within six months of completed audit. (iv) External audit reports: All reports on central government consolidated operations are made available to the public through appropriate means within six months of completed audit. (v) Contract awards: Award of all contracts with value above approximately USD 100,000 equivalent arepublished at least quarterly through appropriate means. Present situation Table 10.1 below summarizes the current availability of information on the finances o f the Federal Government. Generally speaking, at the moment little information on Nigeria's government finances is publicly available on a regular basis. In some cases the information does not exist or i s not complete and therefore not published. This is, for example, the case of in-year financial reports from the MDAs. In some cases a deliberate choice has been made not to publish the information such as the reports by the Auditor General, because of its "sensitive nature". For the most part, however, the non-availability of fiscal information is simply the result of a lack o f habit and well-established procedures. The Annual Report of the Central Bank contains an important set o f estimates for annual budget aggregates, including consolidated budget expenditures of state and local governments, total debt estimates, and CBN profit. In a sense, this report represents a unique source of publishedinformation on budget statistics. The report is available in a limited number of free copies, and it i s on sale to the public at a nominal price to help offset the cost of its production. The Federal Ministry of Finance has a website as does the Budget Office. The FMF website often contains only limited volumes of substantive economic and financial information, and much o f it i s dated'54. The one important exception is detailed information on the FA allocations to various governments. The latter i s an important recent innovation (see PI-8)lS5. Forexample, while the FMFwebsiteimmediatelycarriedthe Minister'saddress to the Conferenceon Financingfor Developmenton21 May2006, its summary ofthe Government's economicreformprogramreports the status ofcomponentsonly up to September 2004, andthe issueof budgetwarrants only up to 2004 Q2. I" Thereis a roomfor additionalimprovementsinqualityofpublisheddata on FA allocations. The FGNshould start publishingthe entirebalancesheet of the FA, includinginformationonbotha) gross revenues, andb) all up front withholdings madefromthe accountrevenuesbeforetheir distributionto the governments. The lattershould includeinparticular informationonfinancingofNNPC andother public investments(suchas a new power project), as well as externaldebtpaymentsby states. 188 The Ministry also produces popular, simplifiedversions o f the adopted budgets, which it distributes widely to the public. The Ministry holds interactive public sessions on the budget to present the key facts to the public and media. The BOF site i s technically simple but does contain a considerable collection of annual call circulars, fiscal frameworks for the budget, budget speeches, and appropriationbills. Since 2004, it also started to post quarterly warrants. This i s an important advance on previous standards. However, the site does not contain yet any information on actual budget execution and as such does not inform public on actual level and structure of government budget spending. This is due largely to limited amount o f data available on actual budget execution, as discussedinthe main report. The website of Debt Management Office (DMO, www.dmo.gov.ng) contains detailed information on the stock of federal public debt (both domestic and external) and debt service, which i s updated on the annual basis. The website of National Pension Commission (www.pencom.gov.ng) contains legal and regulatory info on pension reform, on pension fund administrators and other reform stakeholders, and on major ongoing reform initiatives, such a pension verification exercise. However, it does not provide any systematic statistical or financial data on the performance o f pension system. This stems from the fact that the Commission i s a new entity that in many cases has to develop from scratch the body o f information it needs to function efficiently. 189 Table 10.1: Summary of public availabilityof informationon FederalGovernment finances Type On Printed? Latest Comments Web? Produced BudRetproposal Yes Yes 2006 Approvedbudget Yes Yes 2005 Not easilv available. Onlv three copies- for the 1999 and-2000- were foundinthe library. Supplementary estimates No No 2005 Not availableoutside the BOF In-yearexecutionreports No Yes 2004 Narrativeexecutionreportfor 2004 budgetwas producedinlate 2005 for the first time. In-yearfinancial statements No No 2005 MDAs are supposedto producein- year summaries of cashbooks, but not their annual accounts. Externalauditreportsof No No 2002 The accounts for 2003 havebeen federalconsolidated submittedto the National Assembly accounts buthavenotbeenpublished. Externalauditreportsof No Some N/A Someaudit reportsfor individual individualMDAs States andfor MDAs are available online but most are difficult to come by. Externalauditreportsof No Some NI Someaudit reportsfor individual parastatals/SOEs parastatalsare availableonlinebut most are difficult to comeby. Externalauditreports of No No NI No specific info. It is believedthat government extra-budgetary extra-budgetaryfunds are not funds coveredby any regular audit arrangements. The Auditor General for the Federationis supposedto audit the FederationAccount and submitthe reportto theNA. Publictenders No N/A Difficult to access Contractawards No NIA Difficult to access * NI- NoInformation Reforms underway While there i s a general willingness and ambition to expand availability of financial information, there are limited concerted efforts being made to improve on the present situation, at least as far as the PEMFAR team was able to ascertain. The core ongoing reform initiative in this area i s drafting the Fiscal Responsibility Bill, which i s currently under consideration in the National Assembly. The Bill, once adopted, would expand informational content of the budget documentation (see PI-6), as well as impose much stricter budget disclosure requirements on all government tiers. In addition, the Procurement Bill, which is also with the National Assembly at the moment, will strengthen legal framework for mandatory publication o f public procurement information. To a large extent, the Bill will formalize and consolidate the current procurement practices of the federal government, which over the last few years 190 made a major effort'56 to make public procurement more transparent and competitive, including through better accessibility o ftender information. Assessment The availability o f information on the public finances o f the Nigerian Federation i s generally poor. Overall, this i s a result o f three different problems, all o f which have to be addressed simultaneously if the Government wants to continue its progress toward fiscal transparency and accountability. Those problems are: (i) no practice o f producing some important fiscal reports; (ii) poor quality o f particular reports that are produced, and (iii) inadequate public access to fiscal reports that are regularly generated. However, the basic infrastructure for publishing information using the Internet exists. Most o f the relevant institutions have websites. All it takes is appropriate encouragement to stimulate the institutions concerned to develop routines for regularly publishing relevant legal documents, fiscal reports, and other core statistics on the web. As regards to the deliberate choice on the part o fthe Government and the Auditor General o f not disclosing "sensitive" documents, the Government should weigh the long-term benefits o f transparency against the possible short-term political inconveniences. In that vein, the Government should give more emphasis to the passage o f the Freedom o f Information Bill, which has been before the National Assembly for over five years. The Bill, if passed would ensure, in line with the best internationalpractice, a request-based public access to most information on government operations (not just budget-related), thereby givingthe general public statutory right o f access to public information except for certain closely defined categories, together with a monitoring and appeals mechanism. Ledby the Budget Management and Price Intelligence Unit (BPMIU), establishedwithinthe President's Office. 191 PI-11: Orderlinessand Participationinthe Annual Budget Best Practice (5, A clear annual budget calendar exists, is generally adhered to and allows MDAs enough time (at least six weeksfrom receipt of the budget circular) to meaningfully complete their detailed estimates on time. (ii) A comprehensive and clear budget circular is issued to MDAs, which reflects ceilings approved by Cabinet (or equivalent) prior to the circular's distribution to MDAs. (ii5, The legislature has, during the last three years, approved the budget before the start of the$scal year I Present situation The annual budget calendar i s customary and not laid down by law. Nonetheless, the Budget Office o f the Federation (BOF) aims to complete budget preparation each year in time for the President to make his Budget Speech by mid October. This would leave approximately 7-8 weeks before the National Assembly breaks for Christmas and the new financial year begins. In practice, this intention i s seldom reali~ed'~',and even when it has been, the budget has not been passed until well into the new financial year, necessitating the issue o f provisional warrants to supply temporary funding at the previous year's level. The difficulties the executive has had each year in getting the Appropriation Bill passed by the legislature have had knock-on effects the following year. Often it has been April or M a y before the time the President has assented to the Appropriations Bill. By then, there have been so many changes to the executive's original budget, that it takes many weeks for the BOF to revise the Estimates, and for the FMF to decide what o f the legislature's approved budget can be implemented and affordably funded, and for the Minister to authorize the Accountant-General to release funds158. Furthermore, although the Budget Speech 2005 was delivered inOctober 2004, tabling o f the final version o f the executive's Estimates was delayed, because o f the need for further rounds o f adjustment, untilJanuary 2005. In recent years, the BOF has seldom been in a position to begin the budget preparation cycle until after the mid-point o f the current financial year has been passed. This has made it difficult for the BOF to fit in upstream legislature briefings on the overall macroeconomic context for the budget, and issue the call circular in sufficient time for adequate departmental estimates preparation, and at the same time achieve the target date for the Budget Speech. In this way, the confrontational relationship between the executive and the legislature, exacerbated by the capacity constraints o f the BOF, has become circular. The difficulties experienced in one year ensure they will be repeated in '" For fiscal2006 and 2007, the Presidenthas beenable to makehis budgetspeechto theNational Assembly on October 12intheprecedingyear. Is* The changes madeby the legislatureto the executive's2005 budgetproposalswere substantial, andincluded notonlynew spending(N350 billion was addedto the capitalpartof the budget),whichgreatlyraised the budget aggregates,but alsomovingmoneybetweenandwithin heads. BoFstaffthenhadto spend a great deal oftime listingandenteringinthe changes to the Estimates,assessingthe implicationsto the coherenceof the executive's originalbudget, what couldbeimplemented, andwhat couldbe afforded. The AppropriationsBillwas dulysigned by the President, but this was only thebeginningofworkingout a viablebudget executionplan. 192 the next. In an effort to reduce misunderstanding about the country's fiscal realities, the BOF recently has made efforts to brief both legislators and stakeholders more broadly on fiscal policy and the government's development priorities. Relatively early legislative approval o f the 2006 budget was an indication that these efforts may be bearing hit. Following this early approval, a budget timetable for 2007 budget preparation was laid down, providing significant additional time for consultations with the National Assembly, both on revenue forecasts, fiscal strategy and key ideas o f the MTSS documents for key sectors. This was a very positive development, and every effort should be made to comply withthe newtimetable for future budgets. The budget circular, which i s issued to ministries, i s comprehensive and clear, giving spending ministries and departments absolute ceilings within which they must prepare their submissions. It also contains formats for the submission o f estimates proposals, and accompanying instructions. Prior to issuing the Call Circular, the BOF briefs both the Federal Executive Council (FEC) and the National Assembly on the macroeconomic context for the budget. In doing so it provides ministers and legislators three year macroeconomic projections and what, in effect, i s a Medium Term Fiscal Framework. There i s no prior formal submission o f MDA ceilings to FEC.15' As a result, ministerial ownership o f the budget strategy i s weak, reflected in the fact that most ministries regard the ceilings as the initial position o f the FMF in a process whereby allocations may be bargained upwards. Inrecent years, the BOF has been able to hold the line, but the habit o f ministries to view the ceilings as soft limits, which can be bargained, has taken a long time to die. This has diminished their willingness to prioritize, and some ministers improperly have lobbied the legislature to increase their budget shares once the budget reaches the National Assembly. Building on its earlier progress with MTEF development, the BOF has managed to achieve a significant reform consolidation during the 2007 budget cycle. Through the MTSS preparation, the MDAs were reconciled with their proposed expenditure ceilings for 2007-09 relatively early in the budget cycle. This allowed for more efficiency in budget preparation than in the previous years, with MDAs' greater acceptance o f the realities o f resource availability. In turn, this strengthened their incentive to prioritize withinthe envelopes rather than bargainfor increases inallocations. Consequently, it was easier to for the Federal Executive Council to approve the final 2007 sectoral envelopes that for major sectors varied little from the initial envelopes usedfor MTSS development. This consistency practically stopped any further bargaining for resources duringthe later stages o f 2007 budget approval. Reforms Underway An innovation duringthe preparation of the 2006 budget was the introduction, on a pilot basis, o f Medium Term Sector Strategies (MTSS), prepared with the help o f consultants for eight pilot ministries. It was expanded to cover a further eleven MDAs, to bring the total to 19 for fiscal 2007. At the same time the Fiscal Responsibility Bill now before the legislature will require all tiers o f government (and thus the FGN) to prepare their budgets on the basis o f stable assumptions on the long term price o f oil, in effect mandating a MTFF. Furthermore, the Budget Process Bill, initiatedinthe National Assembly, aims to make the budget preparation calendar statutory. Confusingly, the BoF (and some of the recent draft legislation) refers to the aggregate fiscal framework as a MTEF. 193 The 2007 budget process was much more disciplined, based on stronger collaboration among all primarystakeholders and provides a strong foundation for future progress. The BOF adopted a schedule for the preparation of the 2007 budget, beginning with the preparation of Medium Term Sector Strategies, followed by a two stage budget submission processto the legislature, with briefings and discussion on the MTFF ahead of the issue ofthe call circular. The aim was to complete the preparation of detailedbudget Estimates in time for a Budget Speech in October and budget approval before the end of 2007. This was achieved. Assessment Three developments are critical to better outcomes in budget preparation. The first i s speedy and coherent passage of the Fiscal Responsibility law and associated legislation through the National Assembly. As discussed elsewhere in this report, inconsistencies betweenthe government's own draft laws (the Fiscal Responsibility Bill and the Finance (Control and Management) Act Amendment Bill) need to be ironed out. Inaddition, if the legislature's own Budget Process Bill is to be passed, it, too, needs to be made consistent with the FGN's two laws ina way that respects the roles and responsibilitiesof the MinistryofFinance inbudgetpreparation andexecution. The second is buildingthe capacity of key government agencies (particularly the NPC and the BOF) to play the larger role demandedof them once the Fiscal Responsibilitylaw i s passed. Presently the two agencies do not work synergistically, and the BOF continues to rely heavily on a small group of consultants and advisers in the Director-General's fi-ont office with the rest of the staff performing routine functions and, for the most part, not engagedinthe budget reform process. The third necessary development for better budget making is a more constructive relationship between the legislature and the executive. Hopefully, this will be the outcome of present initiatives to strengthen the legal framework for public financial management, and increased dialogue betweenthe two branches on the means and goals of government budgets. Briefings of the National Assembly on the macroeconomic situation and the government's fiscal strategy are an important step forward improving understanding of the environment for budgeting, and for building consensus on what it contains. The launching of a process o f sector strategic planninghas highpotential to sharpenpriorities. However, there needs to be coordination between the MTSS plans that the BOF i s sponsoring and the MDA functional reviews that the Headof Service is leading, as part o f the Public Service Reform Program. These needto go hand inhand. 194 PI-12: Multi-Year Perspectivein FiscalPlanning,ExpenditurePolicy and Budgeting Best Practice (5, Forecasts offiscal aggregates (on the basis of main categories of economic and functionalhector classification) arepreparedfor at least three years on a rolling annual basis. Links between multi-year estimates and subsequent setting of annual budget ceilings are clear and differences explained. (ii) Debt sustainability analysis (DSA)for external and domestic debt is undertaken annually. (iii) Strategiesfor sectors representing at least 75% ofprimary expenditure exist with full costing of recurrent and investment expenditure, broadly consistent with fiscalforecasts. (iv) Investments are consistently selected on the basis of relevant sector strategies and recurrent cost implications in accordance with sector allocations and included inforward budget estimatesfor the sector. Present situation Forecasts o f fiscal aggregates, covering the next and further two years, have been prepared by the BOF in the past three budget preparation cycles, and have formed the basis for the setting o f annual budget ceilings for the spending departments. A critical issue has been estimating the future price o f oil, and also production, assumptions that determine the amount o f oil revenues flowing to the Federation Account, and, in turn, the FGN's share. Typically, the BOF has cautiously assessedrevenues and tried to limit the growth o f the overall budget, but both sides o f the budget have been increased following FEC deliberation in the face o f buoyant international oil prices. This has led to considerable variability inthe MTFF as it i s rolledforward from one year to the next. Following the creation some five years ago o f the Debt Management Office (DMO) as a semi-independent agency o fthe FMF,regular and highquality debt sustainability analysis has been undertaken in recent years with the help o f international partners. Initially, the DMO was preoccupied with external debt, but with the successful attainment o f debt relief from the Paris Club, the DMO i s now broadening its coverage to include domestic debt as well, and the results tied in with the formulation o f the government's medium term fiscal strategy. Thus the D M O plans to undertake debt sustainability analysis for domestic debt as well. The FGNi s only at the beginning o f the process o f developing sector strategies to support budgeting. Some 8 out o f 44 MDAs were covered in 2006 budget, which has been widened by the inclusion of a further 11for 2007 budget. The focus has been on shifting MDApriorities towards priorityprojects andprograms, as articulated inthe NEEDS. The process o f 2007 budget preparation included better costing for these priority programs, while the NEEDS only provided general indicative costs. Furthermore, the guidelines for the MTSS, which the BOF produced, contained a procedure for reassessing the totality o f existing programs, inaddition to NEEDS related activities. Although NEEDS priorities are beginning to influence budget making, the bulk o f existing investment projects have not been selected on the basis o f clear sector strategies, nor are their incremental recurrent costs well articulated and factored in to future MDA resource availability estimates. Indeed, in many cases the total costs o f projects i s not 195 known, and thus the amount o f resources required for their completion. However, begnningwith the 2007 exercise, Government i s working to change the situation. Reforms Underway Although the FGN has still a long way to go in the development o f a well functioning MTEF,this is the goal ofthe FMF, and will be a requirement, anyway, once the new legal framework for public financial management i s in place. Indeed, a MTEF based on realistic forecasts o f the long runprice o f oil, likely production levels, the performance o f the economy and an assessment o f the absorptive capacity o f the government for public revenues i s a sine qua non for managing a mineral-driven economy. A significant step taken during the 2006 budget preparation cycle was the abolition o f separate capital and recurrent budget ceilings for MDAs, and their fusion into a single envelope, to encourage departments to consider the trade-offs between the running costs o f existing policies and programs and the investment costs o f new projects. Another important step supporting a multi-year approach to budgeting has been the introduction o f Medium Term Sector Strategies, now being expanded from a pilot basis in2006 to a wider coverage in2007. Assessment As far as budgeting is concerned, the Federal Government is in transition. Formerly, it operated a classic investment-led dual budget system based on a Rolling Plan, which in turn was buttressed by a project planningdiscipline coordinated by the NPC. This fell into decay during the years o f military rule, and the incoming democratic government inherited, in effect, a system which retained the form of the traditional model, but without the substance o f a macroeconomic framework, clear sector plans and accurately costed andproperly appraisedprojects. With the paradigm o f government changing, it no longer made sense for the government to returnto the traditional planningand budgeting model. The ultimate goal i s a more program oriented, single structure budget cast within a MTEF, which reflects a sustainable use o f oil revenues and a balanced share of public spending in GDP. The new legal framework, including the Fiscal Responsibility law, a longer and more consultative time frame for budget preparation, the MTEF itself, and parallelreforms in fiscal reportingand accounting, are the means of getting there. Much o f the energy o f the BOF management team has been devoted to getting the overall size o f the budget right, improving the quality o f its contents, and making space for new program priorities. The BOF has also had to accommodate some large one-off items, partly arising from legacy problems, partly from new policy commitments inadequately costed. At the same time, the tension with the legislature has been draining for BOF personnel, requiring them to extensively rework the Budget Estimates and determine how the budget can be implemented consistent with macro-economic goals once the Appropriation Bill has been passed by the National Assembly. Pre-occupied with managing the present, the BOF has each year delayed the launch o f the next year's preparation cycle, sowing the seeds for another cycle o f hasty budget preparation and confrontation with the legislature. However, with the relatively early approval o f the 2006 budget, the BOF was able to use the opportunity to escape from this vicious cycle and launch the fiscal 2007 budget process inMarch 2006. At the same time, the BOF will need to pay increasing attention to the quality o f spending, whether inputs are translated into outputs and whether the intended outcomes are achieved. Far too much o f the energy o f stakeholders in budgeting in Nigeria is expended on competition for inputs,almost for their own sake, with insufficient attention 196 paid to whether the results and services are delivered in the public interest. NEEDS,the MTSS andthe MDGsprovide an opportunity to shift the balance. To achieve this, future MTSSshould be further focused on strengthening the linkbetween budgeting and service delivery, real integration o f investment projects into the sectoral strategy, and accounting o f implication o fthe investment program on future recurrent spending. 197 PI-13: Transparency of Taxpayer Obligations and Liabilities Bestpractice is defines as: (i) tax liabilities of taxpayers as spelt out by laws and regulations are clear and comprehensive; (ii) taxpayer education with respect to tax liabilities andprocedures is effective; (iii) a tax appeals mechanism isproperly functioning. Present Situation Clarity o f legislation on tax obligations is important to enhance compliance. When current tax legislation was approved in 1999, the Federal Inland Revenue Service (FIRS) issued guidelines for taxpayers that since then have neither been refreshed nor re-issued. The authorities mentioned that the FIRS Department for Tax Policy makes annual publications in newspapers on tax rates due by different categories o f taxpayers. A FIRS website http://www.firs-nigeria.org/ was set up on lO* M a y 2005 but contains only an outline o f the tax policy without further information and updates on tax changes nor tax assessment forms or guidance on self-assessment. The recent enterprise surveys160 conducted in Abia and Anambra states clearly indicate the perception by businesses that tax regulations are still a barrier to growth and business development; among the problems highlighted in the surveys are double taxation161, the frequent changes in tax rates and the significant administrative burden associated with tax demands, including overlapping claims from different tiers o f government. According to the survey administered by the Nigerian Economic Summit Group, 27 percent o f SMEs pay five more different types o ftaxes (MultipleTaxation inNigeria, 2006). There i s also little clarity about the criteria applied by the FIRS (together with NIPC, the Nigeria Investment Promotion Council) in selecting companies that benefit from income tax waivers provided for inthe Industrial Development Decree No. 22 o f 1971 and NIPC Act 16 o f 1995. The estimated total costs o f these exemptions to Government are not available. Further, the cost o f exemptions to Government should be estimated by the Revenue Authority in advance o f issuing the waivers (e.g., the cost o f waivers issued to 24 companies in the first quarter o f 2006) and this would need to be reflected in the budgetas a tax expenditure itembut currently it is not. A dedicated taxpayer service and education function was set up in the headquarters, but no strategic plan for service and education focused on improving taxpayer compliance has been drawn to date. Further, the skill mix o f the staff working in the unit i s not in line with good practice, lacking higher level staff able to handle taxpayer enquiries effectively. No single tax appeal mechanism exists in Nigeria; different bodies and rules apply for different types o f taxes without streamlining and harmonization. N o Tribunal cases outcomes are publishedfor the purpose o f guidance and taxpayer education. Inthe current system, taxpayers have 30 days to object to their tax assessment; the objection i s initially reviewed by a Tax Inspector who either revises the tax assessment or rejects the objection providing reasons. Incase o f rejection, the taxpayer has the right to appeal to the Board o f Appeal Commission that meets quarterly. If rejected again, the next stage i s to appeal to 160 ClusterDevelopmentPrograminEasternNigeria:Administrative andInfrastructureCost Survey of the ManufacturingSector (Abia andAnambra States). A reportby F Cand Skoup Consultants, February2003. E.g., VAT paidbothonraw materialsandagainonfinishedgoods. 198 the Supreme Court. It i s not possible to establish the effectiveness o f the current appeal mechanism as no information was provided on the number o f appeal cases filed and resolvedinthe past three years, the length o f the process and value o f settled disputes. Reforms Underway The FIRS has initiated a package o f legislative amendments to the tax laws, submittingin the past year to the National Assembly eight bills related to tax policy and tax administration. The proposed amendments aim at redressing some o fthe existing faults in the design o f VAT regime, such as the absence o f regstration threshold. The amendments also include provisions for the improvement o f tax appeals mechanism, e.g. the inclusion o f right o f objection, the consolidation o f VAT Tribunals, and a clearer definition o f the timetable for dispute resolution. The bills are at the 2"d reading and public hearing stage and the authorities believe they may pass into law within the first halfo f 2006. Assessment and Recommendations The Revenue Administration (RA) needs to focus and i s already doing so on getting the legislative amendments approved. 162 Once passed, the focus should then shift to enforcement through the work o f the various decentralized units.The FIRS website needs to be upgraded and include FAQs,taxpayer forms and guidance notes for self assessment. The skills mix o f staff working in the dedicated taxpayer service should be reviewed and include higher level staff able to handle taxpayer enquiries effectively. Taxpayer service units should be extended from headquarter-level to regionaltax departments with the aim to cover taxpayers contributing to the largest portion o f revenues. Appeals mechanisms for different taxes (VAT, PIT, CIT, etc.) should be streamlined and harmonized, ideally merged into a single appeal mechanism with well defined rules and timing for resolution o f cases. The criteria for issuingtax exemptions need to be clarified and the total cost o f exemptions to the Government should be estimated in advance and factored into the budget as a tax expenditure item. 162The FIRS is already planning a retreat with the Joint Committee for Finance and Budget with the aim to clarify aspectsofthe amendments and speedup approval. 199 PI-14: Effectiveness of measuresfor taxpayer registration and tax assessment Bestpractice is defined as: (Q Theexistence and accuracy of controls in the taxpayer registration system; (ii) Theeffectiveness of penaltiesfor non-compliancewith registration and declaration obligations; (iiQTheplanning and monitoringof tax audits andfraud investigation. Present situation Each state tax office currently holds a register o f taxpayer^'^^. A soft copy o f each taxpayer register i s sent to the FIRS HQonce a year. The Corporate Affairs Commission (CAC) also sends copy o f company registration certificates to the FIRS headquarters for tax assessment purposes. But the coordination between FIRS headquarters, its decentralized offices and the CAC i s not systematic, leading to inaccuracies in the taxpayer information and consequently inthe tax assessments. Penalties against non-compliance are currently either too low to constitute a deterrent for tax evasion (e.g., failure to file VAT returns attracts a flat penalty o f N 5,000) or too complex to be enforced due to the limited legal powers o f the FIRS. The Audit Department established a year ago in the HQoffice with the aim to monitor compliance performance in key sectors and focus on high risk customers i s responsible for all taxpayers including large taxpayers. The central Audit Department i s small and the capacity o f staff weak, translating into a low number o f cases processed per year and work being focused more on data reconciliation than on assessment and litigation. Little work has been done inrelation to defining and then identifying risks. There i s no method for the central Audit Department to receive intelligence from the field in order to commence identifyng risks to then develop a strategic plan. What happens i s that the decentralized offices identify problematic taxpayers (not on the basis o f pre-determined criteria) and Audit HQ approves those audits to be undertaken. There i s also no collection o f tax data, let alone collection o f industry data to begin the process o f risk identification. Reforms Underway While the FIRS reorganized itself based on a functional structure with the aim to improve its effectiveness, some process functions (e.g., taxpayer registration) are still managed by taxpayer database - that will be then computerized and form the basis to move to a single decentralized offices inthe states. Hence, in the ongoing process o f constructinga single Tax Identification Number (TIN)'64- there is a clear risk o f transferring the current data integrity deficiencies from individual taxpayer registers to the single central database. This process would therefore require data validation (or re-registration). It was not possible to determine whether such data validation or re-registration process is being pursued. The process is further complicated bythe adoption o f a complex file numbering in the compilation of the single database which does not appear to adhere to good international practice. 163Company registration fee with the CAC has increased fiom NSOO to N20,000 hence reducing the incentive to register and therefore skewing tax assessment and revenue collection. '64A single TIN system forms a key component o fthe Integrated Tax Administration System (ITAS). 200 The current legislative amendments address both the level o f penalties and increase the administrative powers o f the FIRS to effectively enforce these penalties. Assessment and Recommendations Inthe process o f compiling the taxpayer database, a taxpayer data validation (or taxpayer re-registration) process should be undertaken to reduce risk o f data errors being transferred and to improve hture tax assessments. Simplification o f the file numbering system should also be considered. The incentives for company registration could be reviewed to encourage registration, and hence contribute to revenue collection and accuracy o ftax assessment. Staff audit capacity both at central level and inthe operational departments (startingfrom the regional units) need to be boosted both through training and on-the-job periodic rotation. A national audit plan for all domestic taxes would need to be developed, defining parameters and risk-based triggers for audit assessment including respective responsibilities o f central and operational units and reporting mechanisms. Such an audit plan- to be implementedby decentralized offices - should be periodically monitored by the central Audit Department. 201 PI-15: Effectivenessin Collection of Tax Payments Bestpractice is defined as: (a) Collection ratio of tax arrears collected during the fmal year to their stock at the beginning of fiscal year is high; (b) Regularity and effectiveness of tax transfersfrom revenue authority to the treasury; (c) Frequency of complete accounts reconciliation between tax assessments, collections, arrears records and receipts by the treasury. Present situation No database on tax arrears appears to exist, categorizing the debts by age, just amounts and tax type. It was therefore not possible to obtain year-by-year data on arrears and collection rates'65to enable an assessment o f effectiveness o f collection. This is the result o f how accounts are kept inthe offices under different file numbers and manually and o f how information i s transferred. The administrative arrangements for tax collection are also not conducive to maximizing tax compliance and collection. For example, state tax offices'66 collect Personal Income Tax (PIT), while good practice suggests it i s more efficient for a single central entity to be incharge o fPIT collection, as both companies and unincorporated businesses already pay VAT to this central entity. Further, current VAT and Company Income Tax (CIT) payment arrangements and PIT tax withholding exclude some government parastatals that are major FIRS debtors (e.g., the NNPC). Taxes collected are transferred by banks to the C B N on a weekly basis, while reconciliation o f data on tax collected by the FIRS and cash transferred to the CBN takes place on a monthly basis. Reforms Underway Accuracy o f tax arrears calculations - hence arrears collection ratio and its evolution over time - depends on the accuracy o f self assessments and on the timely transfer o f information about collection from the banking system and from the FIRS state offices to the headquarters. A review o f arrears has commenced with the aim to remove irrecoverable debts and a Task Force was established in 2005 for the reconciliation and recovery o f the current stock o f arrears, beginning with a study o f existing arrears and their classification by size and age. But the management and monitoring o f tax arrears needs considerable improvement, including the development o f enforcement collection plans and providing for the use o f a broader range o f actions and exchanges o f information between FIRS, the Accountant General's Office and other agencies. A pilot project has begun in 2005 to facilitate real-time information transfer on tax collection from the banks to the FIRS. This project should enable the FIRS establish exactly what had been paid by individual taxpayers and circumvent the problem so far encountered o f banks failing to remit amounts collected. This pilot i s still at an initial Except from some estimates for too long a period to be meaningfully interpreted Except the Federal Capital Territory 202 phase and i s yet to be comprehensive enough to be able to capture all tax payments made to the banks16' and to comprehensively update the record on collection. Assessment and Recommendations The immediate priorities could be summarized as follows: Improve the management and monitoring o f tax arrears, for example by developing enforcement collection plans and inter-agency coordination on enforcement across the FIRS, Accountant General's Office and other agencies. Improve quality o f data on arrears and records on collection. Improve data on tax debt disputes and strengthen resolutionlappeal mechanisms. Roll out the FIRSpilot project with the banking sector to ensure timely record on collection as well as timely transfer o f all tax payments to CBN. Speed up regional connection between state-level C B N and FIRS offices to enhance communication and information sharing, including data sharing on collections and timeliness o ftransfers to the CBN. 16'The FIRS aims to establish an ICT connection between local CBN offices and the state FIRS offices to ensure more regular and comprehensive updates ofcollection and arrears information 203 I PI-16: Predictabilityinthe Availability of Fundsfor Commitment of Expenditures Best Practice (i) A realistic andprudent budget, i.e. the one with enough margin to accommodate a reasonable level of crystallisedjiscal risk; (ii) A budget approved on time, i.e. before the beginning of thejiscalyear; (iii) Respectfor the approved budget, i.e. that the Executive does not effectively alter the budget in the course of its execution,for example through a conscious use of the cash release system to this effect; (iv) Eficient cash management that ensures that the government is never illiquid. Present situation Figures 16-1 to 16-4 depict the monthly flows of cash in and out of the Consolidated Revenue Fundin2002-05. Most striking is the erratic nature of the flows. While revenue flows appear to have stabilized somewhat over the years, outflows (i.e. releases) in each year display a very irregular pattern. This irregular release pattern makes it difficult for federal institutionsto planspendingand executebudget ina predictableway. The levelof expenditure variability was made even greater in 2004-05, despite some stabilizationof revenue inflows after introductionofthe oil pricerule. Fig. 16-1: Cash flow for the CRF of the FederalGovernment in 2002 190.00 , I 100.00 - -\ - A Y A I \ I Month. Source: OAGF 204 Fig. 16-2: Cash flow for the CRF of the Federal Government in2003 1 150.00 (50.00) - / (r00.00) - Months Source:OAGF Fig. 16-3: Cash flow for the CRF of the Federal Government in 2004 150.00 50.00 -f .~ I Months Source: OAGF 205 Fig. 16-4: Cash flow for the CRF of the Federal Government in2005 400,0000 300.0000 200.0000 100.0000 6 (200.0000 (300,0000 (400.0000 (500.0000 (600.0000 Month. Source: OAGF As one may expect, the graphs above indicate that within-the-year variation in revenue flows have steadied in the recent years. This conclusion i s also supported by comparison o fvariations in monthly in- and outflows (Table 16-1). Table 16-1: Monthly in-year coefficients of variation for in- and outflows, CRF of the Federal Government (Standard deviation/ Average monthly flow), in percent 2002 2003 2004 2005 Inflow 47 32 15 37 outflow 42 28 48 75 Source: Own estimates based on the OAGF data. The increase in the revenue fluctuation measure in 2005 was entirely due to the large spike in revenues in December because o f a high year-end adjustment payment,, i.e. the payment to make up for the difference between actual oil price and the benchmark price used for the calculation o f the preliminary monthly payments to the Federation Account. Because o f the steep rise inthe world market price for oil, the 2005 adjustment payment was unusually high. In fact, the 2005 December inflow to the Federal Government was almost three times the average o f the rest o f the months, which had important macroeconomic repercussions. Thus there has -save for the end o f2005 -been a decrease inthe fluctuations inthe flow o f funds to the Federal Government. The predictability o f the total inflow has, however, not increased to the extent perhaps hoped for, when the oil price based budgeting was introduced. There have been two main reasons for this. Firstly, the fiscal rule only fixes the price to be used for the distribution o f funds from the Federation Account. Changes in output - as those experienced as a result o f the insurgency in the Niger Delta and delays with oil production from new deep water fields - cannot be mitigatedthis way, andthose have directly impacted on the flow to the Federal Government. Secondly, the increase in the world price o f oil has had the partial perverse effect o f reducing the revenue transferred to the consolidated revenue fund. This i s because the NNPC has been allowed to deduct from its payments to the federation account the cost o f subsidizing domestic sales o f petroleum products. As the price o f oil in the world market increased, the size o f this deduction increasedas well. 206 However, as can be seen from the table above, the steadyng o f the inflow to the Federal Government has not ledto a steadying o f fund releases to the MDAs.On the contrary, the fluctuations inoutflows have increased over this period. A number o f factors, some o f which are listed below, have conspired to produce this increasinglyerratic release pattern. The uneven inflow o f revenue particularly during the first years o f the period and undeveloped mechanisms for short-term borrowing to meet liquidity shortages left the government with no option but to resort to cash rationing. Inits decisions on the release o f funds, the government's Cash Management Committee has given priority to the payment o f salaries. Some o f the tap-on-tap-off decisions have affected the release o f funds for overheads, but it is mostly the capital investment projects that have had to bear the brunt o f the rationing. The execution was particularly stop-and-go in 2004 as seen from Figure 16-3. The 2005 Appropriation Act, as voted by the National Assembly, was considered fiscally irresponsible by the Executive and there was an informal agreement with the president that the capital budget would be executed only at 75-80 percent o f the sums appropriated by the National Assembly. Uncertainty around this process probably contributed to the variability o f releases in2005. The 2005 budget was approved late - in April - and thus its execution began late. However, there was a hangover in the form o f payments made in respect o f the 2004 fiscal year duringthe first three months o f 2005. Similarly, in 2005 the execution o f the capital budget was rather poor up until December and there was pressure from the National Assembly to show better spending performance. As a result, the 2005 fiscal year for implementation o f capital projects was extended once again and was ongoing as late as the middle o f M a y 2006. Another factor that has contributed to the erratic release o f funds for capital projects has been the introduction o f the centralized due process in public procurement. Teething problems inthis process - in and by itself very salutary reform- slowed down the overall process o f budget clearances and contributed to the jerkiness in the release o f funds for investment. Reforms underway The Government established a Cash Management Committee in 2004 with the aim to strengthen control over cash releases. The Committee is supposed to meet monthly and prioritize the releases within the real cash constraints. The Committee's creation did help to strengthen budget discipline in terms o f both more transparent spending prioritization and control over releases (to make them closer to agreed priorities). Within this framework, the predictability and stability o f budget funding most likely improved for a limited set o f top priority projects and activities. However, as the above data suggest, it didnot helpto improve budget predictability as a whole. As from 2006, the domestic petroleum product subsidy has been made explicit. It has been moved from the revenue to the expenditure side o f the federal budget and a provision has been made for an annual subsidy to the tune o f W150 bn to be shared fifty- fifty by the federal government and the states. This will increase the predictability o f the budget, but it will not totally eliminate the fiscal risk associated with unexpected moves in the oil price. In the course o f 2006 the world market price went beyond the price 207 underlying the W5 bn subsidy set aside in the budget, and the government was forced, given its continued control for the price o f petrol and commitment for stayng within its budget parameters, to accumulate arrears to the industry. The explicit provision was made in 2007 budget to clear these arrears arising from higher than expected world priceshubsidies in 2006. To reduce the distorting effect o f the catch-up payment o f Petroleum Profit Tax at the year-end, the Government intends to renegotiate the MoUs with the oil companies so as to have the tax adjustments for the differences between benchmark and actual oil price be made monthly with one month delay. Assessment The high level o f expenditure variability suggests a low level o f budget predictability, especially for capital spending. There are at least four factors responsible for such variability: (i) fluctuations in revenues, (ii)problems with cash management, (iii) delays with the budget approval, and (iv) delays with obtaining procurement (BPMIU) certification. The government has making an effort to address all these problems, but so far progress has been limited. The reforms listed above should reduce the fluctuations o f the revenues accruing to the three tiers o f government but it will not eliminate them. One way to further reduce the fiscal risk associated with fluctuating oil price could be through a redefinition o f the fiscal rule so that annual budget revenue from oil becomes de-linked from both the price o f oil and the volume o f production and instead link it to GDP. Such an approach, which could be considered at a future point, would o f course require a good deal o f government restraint o f the type exercised by the more disciplined oil producing nations. There would need to be a clear policy o f building up a substantial buffer fund that can be used for meeting short- and medium term fluctuations in both price and production volume, as well as for providing for future generations o f Nigerians. With such a buffer fund in place, Nigeria would be able achieve a revenue flow, that i s close to 100 percent predictable. Within the existing arrangements, unexpected changes in oil production will still have a strong impact on revenue as will potential increases inthe world price o f oil beyond what i s assumed for the purpose o f calculatingthe cost o f the petroleum subsidy. The only way to eliminate the latter risk would be to eliminate entirely the petroleum subsidy. Any remaining short-term fluctuations should be evened out through a deepened market in government securities that would allow the Government to meet short-term fluctuations in the demand for cash. The introduction o f a single treasury account replacing all the individual accounts in commercial banks held by Treasury and the MDAswould also go a longway to smoothen liquidity. However, much o f the jerkiness in the release o f funds to the MDAs has nothing to do with fluctuations in the revenue, but rather with an undisciplined budget process and because o f weaknesses in cash management. A sine qua non o f efficient budget execution is a budget that is approved well before the beginning o f the fiscal year. A core objective o f the legislation that is now being processed in the National Assembly must be to provide the framework for a budget process that delivers an approved budget on time and o f a size that i s fiscally sustainable and macroeconomically sound. Cash rationing i s the bane o f effective financial 208 management. But as long as treasury management remains relatively undeveloped, it is important that at least cash rationing i s routinized, meaning that releases are based on rules - and thus predictable to the MDAs, and the cash management system does not become a second and overriding budget process. With time MDAs will become more accustomed to the procurement review process and the public procurement process itself should operate more smoothly, which would reduce delays currently associated with the due process and help smooth releases o f investment appropriations. The release o f large amounts o f funds late in the fiscal year and the extension of the time for making capital commitments and payments under existing spending authorizations until March 31 o f the succeeding year is bad budget practice, and should be avoided wherever possible. It i s constitutionally questionable since it destroys the annuality o f the budget, in which spending authorization lapses and must be re-voted. At best it can be seen as a response to the late passage o f the Appropriation Bill and the restriction of provisionalwarrants to current spending only, a defacto slippage of the fiscal year for the capital budget by a quarter. Fortunately, the earlier and less contentious approval o f the 2006 budget grves the Government an opportunity to put this practice behindit. 209 PI-17: Recordingand Managementof Cash Balances,Debt and Guarantees Best Practice For thepurpose of the PEFA assessment best practice in debt and cash management is defined as: (i) Domestic andforeign debt records are complete, updated and reconciled on a monthly basis with data considered of high integrity. Comprehensive management and statistical reports (to cover debt service, stocks and operations) areproduced at least quarterly. (ii) All cash balances are calculated daily and consolidated. (iii) Centralgovernment's contracting of loans and issuance of guarantees are made against transparent criteria andfiscal targets, and all have to be approved by a single responsible government entity. Afuller discussion of best practice as relates to cash and debt management and the management of guarantees can befound in Appendix PEFA-3. Present situation The Office o f the Accountant General o f the Federation operates a number o f accounts in the CBN some o f them for the Federation, others for the Federal Government. The central account for the Federation i s the FederationAccount. It is the account, which receives the revenues that are subsequently distributed to all three tiers o f government: the Federal Government, the States and the Local Government authorities. There i s a separate account for the Excess Crude Oil funds, which holds saved oil revenues - generated by world market prices above the agreed benchmark oil price for budgeting purposes - which are not transferred to the Federation Account. The Government's co- financing o f investment in the oil industry (so called cash calls that are funded as a deduction from the FA) i s channeled through a suspense account in the CBN, the NAPIMS/JV Cash Call Account.'68 The central accounts for the Federal Government held in CBN are the accounts for the Consolidated Revenue Fund (CRF) and for the Central Capital Account (CCA). In addition, there are three accounts for federal extra-budgetary funds - Stabilization, Natural Resource Development, and Ecology. There are also separate accounts for holding proceeds under external development credits and grants, such as those from the World Bank. Funds collected under the newly introduced accumulative pension scheme have been channeled to one more account and consequently invested by the CBN in Treasury Bills and other securities. All accounts are treated as separate accounts by the CBN. For the execution o f the budget, funds are released to MDAs, which keep their own accounts with commercial banks. There i s no central management or even oversight o f the cash balances o f such accounts. Thus no one knows how large government cash balances with commercial banks are. 16*NNPC, the state-ownedoil company, furthermore operatestwo off-shoreaccountswith the United Bank ofNigeria in London.These accounts are used as transit accounts for oil export proceedsandfor direct paymentfor inputsto the oil industry. 210 The MDAs receive no interest on deposits with commercial banks, but neither do they pay any fees on banking transactions. N o estimate o f the cost o f this arrangement has been made, but one can suspect that revenue earned by the banks on interest free government deposits and on floats on transactions involving public funds by far exceed the revenue forgone because o f fee-free transactions. The opportunity cost o f the idle balances sittingin the MDAs' commercial bank accounts i s the cost o f borrowing an amount equal to those idle balances to meet the government's cash flow needs - or, if the government resorts to rationing rather than short-term borrowing, the efficiency losses associated with delayed and/or erratic budget execution. These costs could be potentially high at the prevailing domestic interest rates, but quantitative estimates are not possible without data on consolidated MDA balances. The same holds true for the government accounts with the CBN. The FGN accumulates interest only on its balances with the Excess Crude Account, while all other government accounts with the CBN are interest free. They are all treated as separate accounts and the Government pays interest on any overdraft on the CRF account even if and when there are positive balances in the other government accounts with the CBN. At the year-end in 2005, for example, the combinedbalance o fthree federal extra-budgetary hnds amounted to more than N62 bn16' (i.e. almost half a billion U S dollars), while the execution o f the budget was heldback duringthe year. Moreover, at the end o f 2005, there were more than a billion USD sitting in the NAPIMS/JV Cash Call Account. In both cases, such significant positive balances with the off-budget government accounts became rather a permanent feature. The government does issue Treasury bonds but there i s no deep secondary TB market, which would allow mitigating day-to-day fluctuations in cash flow demands. Using the overdraft facility o f the CBN i s expensive and has undesirable monetary effects"' even though the monetary effects o f an overdraft are mitigated by positive balances with the Central Capital Account. The cost o f borrowing is, however, not as the CBN so far has refused to consider the CRF and the C C A as one account for the purpose o f interest calculations. The C B N charges interest on overdrafts, but it does not pay interest on CCA positive balances. With respect to debt management, much effort has been invested inestablishing the Debt Management Office (DMO) under the FMF and building its capacity. So far, the DMO has focused on managing all external debts (for both federal and state governments) and FederalGovernment's contractual debts (Treasury Bills, other securitized debts, and debts to the Central Bank). Thus far, the D M O does not have capacity to monitor non- contractual federal debts (budget arrears) and state domestic debts. The DMO, with the assistance o f the IMF, has been undertaking a regular debt sustainability analysis, and it has been strengthening its own capacity inthis area. With regard to external borrowing, in line with the DMO Act (2003) and more recent guidelines for government external borrowing, neither Federal MDAs nor Parastatals, nor any State government can contract new external borrowing without the approval o f the Federal Ministry o f Finance, which acts on behalf o f the FGN. This approval is usually given after the DMO made financial analysis o f the loan proposal and the loan proposal 169 Two thirds o f this total represent the balance o f the Fundfor Natural Resource Development. This overdraft facility may ina not too distant future be eliminated precisely because of its unwanted monetary effects. 211 has been approved by both the Federal Executive Council and the National Assembly. The DMO checks the overall debt burden o f states that apply for new borrowing authorization. It i s expected that the total costs o f debt service should not exceed 40% o f the transfer that the state receives fkom the Federation Account."* With respect to external borrowing by parastatals, the current established practice is that such borrowing is done on the basis of on-lending through the FMF. The Ministry o f Finance contracts the loans on behalf o f parastatals, and this debts i s explicitly reflected in the country's sovereign debt profile. The parastatals then have to sign an agreement with the FMFthat sets upthe conditions o fdebt repayment. With respect to domestic commercial borrowing by states, the key existing requirement for borrowers relates to compliance with the rules o f the Securities and Exchange Commission, primarily the issuance o f an ISPO (Irrevocable Standing Payment Order), which in case o f default empowers the federal government to deduct debt payments at source from the state's monthly statutory allocation. Reforms underway The recent debt deal with the Paris Club (completed in spring o f 2006) was a major government policy achievement. As a result o f this deal, the entire stock o f debt to Paris Club (which exceeded U S 3 0 bn in the middle o f 2005) was eliminated through a combination o f cancellation and repayment. This fundamentally improved Nigeria's debt profile and opened an opportunity for gettingan investment rating.'" The successful deal i s also an indirect reflection o fthe DMO's greatly increased capacity to manage country's external debts. The DMO now plans to focus on normalization o f debts to the London Club o f commercial creditors. The D M O is inthe process o f amending the DMO Act in order to close some potential loopholes. The DMO also aims to deepen the market in treasury bonds in order to better manage short-term fluctuations in the Federal Government's liquidityneeds. It also plans to build capacity and set up a regulatory framework, which would allow an efficient monitoring o f domestic debt accumulated by state governments. Draft government strategy on domestic debt management aims to set up a system that covers, in addition to conventional debts, debts to contractors, pension andprivatization liabilities. As far as the PEMFARteam has been able to ascertain, there are no concrete plans to replace the plethora o f accounts in commercial banks with a Federal Government group account, also known as a Single Treasury Account. Assessment Cash management i s one o f the weakest areas o f Nigeria's PFM. A concerted effort in this domain - improving the budget process to ensure timely issue of warrants, introducing a government group account / single treasury account, replacing the C B N overdraft facility with open market operations to meet short term fluctuations in liquidity needs, and strengthening capacity o f Cash Management Committee to reduce excessive variability o f cash releases - should be high on the (including on the borrowing side) in the federal budget. Moreover, the overall debt management capacity o f the government remains weak due to the large stock o f unregulated budget arrears, for which there are no "'However,states(2006). are allowedto float internationalbondswithoutFMF's approval. FitchRatings 212 final estimates as yet, and weaknesses in commitment control that create risk for re- emergence o fbudget arrear inthe future (see PI-4). 213 PI-18: Effectiveness of Payroll Controls Best Practice (i) Personnel and database and payroll are directly linked to ensure data consistency and monthly reconciliation. (ii) Required changes to the personnel records and payroll are updated monthly, generally in timefor thefollowing month's payments. Retroactive adjustments are rare (freliable data exist, they show corrections in not more than 3% of salary payments). (iii) Authority to change records andpayroll is restricted and results in an audit trail. (iv) A strong system of annualpayroll audit exists to identia control weaknessesand/or ghost workers. Present situation The Federal Government operates a decentralized payroll system, whereby MDAs are responsible for managing their own payrolls, consisted with government-wide procedures set by the Accountant-General, and for reconciling these payrolls with personnel data systems, and agreed organizational structures and establishment lists. Where staff belong to a cadre that i s posted out to departments, such as accountants, the cadre parent department operates the payroll. Treasury Pay Offices, staffed by such seconded accountants, are responsible for drawing up the line ministry's payroll, based upon inputs from the ministry's Personnel and Administration Department. Intheory the payroll is linked to the personnel records system, and formal controls are sound. Inpractice, the Federal Government has not fully recovered from the period under military rule when abuse o f personnel policies was widespread, controls were manipulatedand there was widespread pay and allowance fraud. Many o f these practices continued after the change to democratic governance, though much effort has been expended in curbing abuses, and restoring the traditional system. H o w quickly the required changes to payroll are effected in response to new appointments, postings, promotions and suspensions etc varies greatly across government. In some departments changes are made withinthe month, others take longer. Authority to change records i s restricted, and signatures o f the directors o f finance and accounts, and o f administration are normally required. At the end o f each year, every staff i s required to fill in a personnel emoluments card, and the information is checked by the department's internal audit unit. Notwithstanding the carrying out o f several federal Government wide staff censuses since 1999, payroll fraud has not yet been eliminated, but much greater confidence can be given to nominal rolls than previously, and if fraud remains, it requires the collusion o fmany. The weakest part o f the payroll and personnel management system is the establishment list - the list o f authorized positions for each MDA. This no longer has much credence, and the focus o f control in practice has been the payroll. Here, the underfunding o f the payroll, which occurred in 2005, indicates weakness in payroll and personnel management. Line ministries, on their part, seldom look at personnel and other parts o f 214 their budgets in an integrated way. Each, as it were, presents an opportunity to contest for more resources. Reforms underway Payroll and personnel management systems in the FGN remain largely manual, and a major effort is currently underway (financed by the IDA credit) to modernize manual systems by introducing an integrated payroll and personnel management system. Specifications for the new system have been drawn up, the contracts were granted and the installation i s planned for 2007 on a turnkey basis. Special efforts will be made to verify the accuracy o f personnel data entered into the new system, if necessary through further staff audits. Inthe course o f the 2007 budget preparation process, for the first time, payroll budget estimates were based on actual nominal rolls submitted by MDAs. The payroll verification undertaken as a part o f 2007 budget helped to identify about 65 thousand ghost workers and believed to improve substantially reliability o f nominal rolls. These nominal rolls provide the platform for roll-out o f the biometrically verified integrated payroll management system, which inturnwill form the basis o f centralized direct payroll payment arrangements. The completion o f these reforms would provide for a major reduction inthe level o fpayroll fraud. Assessment The coverage o fthe new management system i s the civil service, which comprises around 165,000 staff, for whom several rounds of audits and censuses have eliminated much o f the pre-existing fraud, so the authorities believe. Success o f the new payroll and personnel information system (PPIs) will depend partly on the manner, in which its installation and roll out i s management, but most o f all on whether MDA managers value the better controls and information flows that such a system makes possible, and use them as designed. Much less attention has been paid recentlyto the broader public service (intotal about 1.1 million), where the condition o f payroll and personnel management systems has been less well diagnosed, and this lies outside the ambit o f this PEFA assessment. This needs to be addressed as part o f the government's broader plans for public sector reform. The Bureau o f Public Service Reform recently produced guidelines for parastatal reform173,and as this part o f the reform program unfolds, attention will need to be paid to the payroll management reform dimension. Nigeria Public Service reform: Generic Guidelinesfor the Reform of Parastatals, Bureau of Public Service Reforms, March 2006 215 PI-19: Competition,Value for Money and ControlsinProcurement Best Practice (i) Use of open competition: Accurate data on the method used to award public contracts exists and shows that more than 75% of contracts above the threshold are awarded on the basis of open competition (ii) Justijkation for use of less competitive procurement methods: Other less competitive methods when used are justified in accordance with clear regulatory requirements (iii) Complaints mechanism: A process (deJined by legislation for submission and timely resolution of procurement process complaints is operative and subject to oversight of an external body with data on resolution of complaints accessible to public scrutiny Present situation Use o f Open Competition. Public procurement, a long recognizedarea o f highcorruption risk in Nigeria, is one where reforms have gone a long way fostering transparent and accountable processes. For many years Nigeria operated a tender board system governed by rules issued by the Ministry o f Finance under the Finance (Control and Management) Act 1958. While these rules in themselves were basically sound, they were observed more in the breach. Rigged, non-competitive and costly procurement o f works, goods and services proliferated, with huge costs to public funds and large private gains to those who participated inthe process on both sides. Inaddition, goods were often not delivered and works not completed. Contractors made o f f with large advance payments, the proceeds o f which were shared with complicit officials, including those who should have been inan oversight role. The initial efforts o f the democratic government were to eliminate the most egregiously false contractors' claims, and a large number o f these were cancelled as a result o f the Kolade Commission's work in 2000. However, starting in 2001, the FGN began putting inplace a new regulatoryprocess for capital budget procurement by issuingProcurement and Award o f Contracts Circular. It covered a number o f critical measures such as (a) abolition o f Federal and Departmental Tender Boards, and replacing them with Ministerial Tender Boards, (b) requirement for the preparation o f quarterly procurement plans, (c) application o f open competitive tendering procedures and making contract splitting to circumvent this principle a serious offence, (d) requirement for nationwide advertising o f public contracts above N10 million, (e) clearly defined and transparent bid and proposal evaluation criteria, (f) requirement for submitting tender and performance, etc. To implement the Circular, the Budget Monitoring and Price Intelligence Unit (BMPIU) was established at the Presidency in 2001. BMPIU regulates and sets standards for all Federal Government contracting, which must be consistent with a July 2002 Treasury Circular on Due Process Guidelines for Award o f Capital Projects. These guidelines embody best practice principles o f open competitive procurement with award to the lowest evaluated tender. They also introduce the concept o f "due process certification" before final contract award approval, to signifythat the correct process has been followed, the right winner has emerged, and at an acceptable cost. Three thresholds are operated. Contracts below Naira 1 million can be approved departmentally, provided Due Process 216 guidelines are followed. Contracts between Naira 1million and Naira 50 million must be reviewed and signed off by a Resident Due Process Team in the ministry, parastatal or agency, chaired by the permanent secretary, but with a representative o f BMPIU participating as observer in all meetings to provide independent endorsement. For contracts over Naira 50 million the due process certification i s handled by BMPIU directly, after careful examination o f all the relevant documentation submitted by the department. All contracts above Naira 50 million must be submitted to the Federal Executive Council for final approval, and this cannot be done without BMPIU certification. Furthermore, without BMPIUcertification, the Accountant-General will not release funds. BMPIU also reviews large contract implementation, and issues a due process certificate for payment o f the advance sum (which must not exceed 25% o f the contract price), and visits the project site once aggregate payments reach 50% o f the contract sum, to ensure that commensurate work i s being done. BMPIU hears appeals from aggrieved bidders. B P M I U also performs a function o f price monitoring. Where the correct bidding process has been followed, but the price o f the low bid i s still excessive relative to unit price benchmarks, BMPIUwill withhold certification, but give the lowest bidder (failing that, the second lowest) the opportunity to lower prices. In the first few years o f BMPIU's operation, an astonishing $750 million was saved inthis manner, as contractors adjusted their pricing to the changed contracting environment. Justification for the use o f less competitive procurement methods. In accordance with the due process policy, direct contracting i s allowed only in exceptional circumstances, such as natural disasters, emergency situations, and for small contracts below N1million. Existence and Operation o f a Procurement Complaints Mechanism. There i s no independent mechanism to handle complaints from bidders or contractors and consultants. The MDAs concerned are responsible to handle the complaints, but because there i s no underlying legal and regulatory framework, potential complainants refrain from filling their concerns for fear o f blacklisting or repercussions during the bidding process. Reforms Underway BMPIUis viewed by both the government and the donor community as an outstanding success, and the thrust o f present reforms i s to institutionalize the process through the enactment o f a public procurement law. This has been drafted and i s currently considered by the National Assembly. BMPIUwould thus become a statutory public procurement regulator (Bureau for Public Procurement, BPP), still within the Office o f the President, and would be formally empowered to issue procurement regulations. The Procurement Bill itself has clauses, which embed best practice principles of open, competitive procurement by all public bodies, specify an appeals mechanism, limit exceptions to the rule o f competitive bidding, and prescribe sanctions and penalties in cases where due process i s not followed. In anticipation of the enactment of the Bill in 2006, BMPIU is preparing procurement Regulations, Standard Bidding Documents and Manuals. To strengthen the procurement function, it i s launching a procurement capacity and training needs assessment o f the MDAs that aims at the development of a comprehensive training program to be carried out over the next few years. Simultaneously, BPMIU i s preparing the measurement o f public procurement performance in selected MDAs based on the Baseline Indicator 217 System developed in OECD-DAC. It has also begun to undertake a private sector public procurement perceptionanalysis, to get private sector's perspective on ongoing reforms. Several states have shown interest inreplicating the BMPIUdue process reforms, though none has passed a state procurement law, and it remains to be seen how many governors are prepared to relinquish personal control over tender processes. Assessment It would be wrong to conclude that public procurement is now corruption free inNigeria. The focus o f BMPIU has been on capital projects, routine procurement o f goods and services under recurrent overheads continue to be costly and uncompetitive, and highly vulnerable to collusion between buyer and seller. The area o f BMPIU's greatest success has been in large works and supply contracts, those over Naira 50 million, where direct certification by BMPIUi s required. However, to reduce the risk o f possible deterioration, it is importantthat the Procurement Billis passed without mucho fadditional delay. Moreover, the current system remains excessively centralized, with the BPMIUat the top, which poses a risk of overstretching the limited BPMIU capacity and slowing down the procurement process. Because BPMIU staff has been largely focused on exercising its prior review and other control functions, they have fewer opportunities to work on policy reforms to facilitate building a sustainable national procurement system, which i s sustainable inthe longer term. There are several challenges that must be met once the new law i s passed and the work o f BMPIUis institutionalized: 0 BMPIU's undoubted success now needs to be institutionalized. Transferring staff from BMPIU to the BPP in a way that ensures its unique esprit and dedication to the public interest i s maintained requires addressing pay, incentive and workplace issues. A cadre o f procurement specialists will need to be created, and considerable investment made in training and capacity building for public procurement broadly. 0 While the successor to BMPIU can continue its direct scrutiny o f large contracts, 70% o f contracts by value are between Naira 1million and Naira 50 million, whose oversight i s delegated presently to Resident Due Process Teams in the ministries, extra ministerial departments and agencies. Controlling the risk o f slippage in standards requires strengthening o f the accountability framework for public financial management as a whole, holding accounting officers accountable for their management o f public funds. This requires the continued strengthening ofthe Ministryo fFinance in its stewardship role, working alongside the BPP. Ensure that not just medium and large scale capital contracts are subject to open and competitive procurement, but also contracts within the recurrent part o fthe budget. Improve the transparency o f the procurement process by advertising all tenders publishing contract awards, and producing a regular annual report 218 which provides quantitative data on federal Government contract tendering andawards. 219 PI-20: Effectiveness of Internal Controls for Non-Salary Expenditure Best Practice (i) Comprehensive expenditure commitment controls are in place and effectively limit commitments to actual cash availability and approved budget allocations (as revised). (ii) Other internal control rules and procedures are relevant, incorporate a comprehensive and generally cost effective set of controls, which are widely understood. (iii)Compliance with rules is very high and any misuse of simplijied and emergency procedures is insignijicant. PresentSituation The Federal Government on paper has a comprehensive set o f controls for expenditures, but they rely upon manualprocedures, accounting and reporting systems, and compliance i s very uneven. Although abuse i s less than it was under military governments (when there was widespread disregard o f all types o f controls), a highdegree o f misuse o f finds continues, particularly with regard to spending on overheads. Controls exist for assets and liabilities, but again are very unevenly implemented. Aware o f the weakness o f control systems in line ministries, extra-ministerial departments and agencies, the FMF seeks to control spending through cash rationing. This i s now more tightly appliedthan it was a few years back, when MDAshad substantial balances intheir bank accounts. The current control framework i s set forth in Financial Regulations, issued by the FMF under the Finance (Control and Management) Act, 1958, together with Accounting Instructions and other FMF circulars. It i s a decentralized system, in which Accounting Officers (typically the permanent secretary o f a ministry) are responsible for the proper spending o f their votes, in accordance with rules and regulations. In practice, this responsibility i s delegated to the Finance andAccounts departments in each MDA. There are also Federal Pay Offices (effectively treasuries) in major ministries and in the states, which are staffed by accountants seconded by the Office o f Accountant-General o f the Federation, who, on receipt o f payment orders, issue checks on behalf o f the ministry from one o f several accounts the ministryhas with commercial banks. The Finance and Accounts Departments have delegated responsibility for ensuring that the vote i s controlled within the ministry through a system o f commitment controls, ensuring that purchase o f goods and services i s consistent with cash availability. Funds are released into these accounts by the OAGF issuing "mandates" to the central Bank o f Nigeria. Inturn, quarterly warrants are prepared by the BOF and signed by the Minister o f Finance, authorizing the Accountant-General to effect payments. Payroll warrants are issued monthly, overhead warrants are issued quarterly, with specified monthly installments. Capital projects are warranted individually, from finds held in the Central Capital Account (a form o f Development Fund) at the Central Bank. Funds are not released by the OAGF until MDAs provide evidence that procurement and contracting procedures have been followed. This i s done through the BMPIU (and its resident teams in ministries) certifying that tendering has been properly conducted or that project implementation has been proceeding in the correct manner. For urgent payments on all categories o f expenditures, a selective system o f advance payments against a warrant, an "Authority to Incur Expenditure" - AIE -may be issuedby the FMF. 220 By the second week o f the following month, ministries and departments are supposed to report expenditures and revenues to the OAGF's Consolidated Accounts Division. This i s done manually (there i s no electronic link) through the sending o f a transcript o f transactions. Intheory, furnishingo f the monthly report should be a condition o f the next tranche o f funds released, but a quarter o f ministries and departments run late, and generally this does not result inrestriction o freleases. A cash management committee, chairedbythe Minister o fFinance, draws up a cash flow planwhich is rolled over monthly, and forms the basis for the monthly release of funds to ministries and departments. Priority i s given to salaries, overheads and debt servicing. What i s left over i s rationed among projects (this was acutely felt in 2005 due to oil production shortfalls, the Government's commitment to sterilize proceeds from higher than expected oil prices, and the concomitant requirement to make up the difference to oil companies for domestic sales at low regulated prices. Typically, half o f the capital budget i s distributed inMay/June, following the signature o f the Appropriations Bill and the subsequent adjustments to the Estimates, on a fairly uniform basis, with the rest, subject to available funds, towards the end o f the year. This late release results in low actual capital budget spending (typically little more than half o f the spending approved), but ensures that aggregate fiscal targets are achieved. Unfortunately, this has two side effects. The first i s a large carry-over. Normally, the carry-over o f spending commitments becomes a charge against next year's budget, since provision lapses and must be re-voted. However, in the past two years, the FMF has allowed funding to carry-over as well, effectively extending the financial year for capital projects up to 31 March (and possibly 30 June in 2006). This dubious practice undermines the annuality o f the budget. The second i s the deepening mistrust o f the legislature, which believes the executive i s deliberately sabotaging the capital program it approved in the budget making process. Indeed, the political pressure to spend i s one o f the reasons why the financial year for capital projects, defacto, has been extended. At the ministry level, records o f commitments/arrears are maintainedmanually, andmay be incomplete, with poor control over local purchasing, misclassification o f expenditures and misuse o f virements to regularize improper spending ex post. The FMF has little knowledge o fthe magnitude o f commitments duringthe year. Reforms underway The government has carried out a number o f reforms in recent years to strengthen controls. First, the cash release system has been tightened, so that balances in MDA commercial bank accounts are now much less than they were. Second, BMPIU's due process certification has cut back sharply on capital project abuse, both duringtendering and in making payments to contractors and suppliers - particularly by excessive advance payments. Third, the introduction by the OAGF o f the Accounting Transactions Reporting and Recording System (ATRSS), coupled with a new coding structure, now gives the FMF more timely and detailed information on ministerial spending. Furthermore, the OAGF has begun initial design work on an Integrated Financial Management Information System (GIFMIS), which holds the possibility o f more timely and tighter control inthe future, though considerable investments will have to be made in the telecommunications systems linking ministries and departments for this to yield its potential benefits o f more automated fund control. Revision o f the Finance (Control and 221 Management) Act, 1958 should spell out more clearly the roles and responsibilities of accounting officers, and sharpen sanctions for misuse o f funds and overspending of votes. Assessment Although the existing expenditure control and asset management systems in ministries and departments are traditional and manual, and could benefit greatly from modernization, the critical issue at the line level i s the climate for financial management in government. Tighter management of releases, the due process certification of capital projects and the operation of the ATRRS are instruments o f central control, by the FMF, and have contributedto a changed climate. What is needednow are actions to transfer the demand for greater accountability in public financial management to line ministries and departments, so that accounting officers demand well functioning financial control systems because they are vital for the performance o f their ministries, rather than an imposition by the FMF. Initial steps inthis direction would be to "up the ante" on timely reporting (including reconciliation of bank accounts) by ministries and departments prior to the release o f funds (including those for PESand overheads), tougher sanctioning of accounting officers who do not perform, and greater emphasis on responsible financial management as a requisite for career advancement by senior officers. Also critical i s a less confrontational budget approval process between the executive and the legislature. The remaking of the annual budget two thirds through the year and the late and partial release of funds makes for unpredictability and uncertainty, further strainingcontrol systems. 222 PI-21: EffectiveAudit Control Best Practice (4 Internal audit is operational for all central government entities, and generally meets professional standards. It isfocused on systemic issues (at least 50% of stafftime). (ii) Reports adhere to a fixed schedule and are distributed to the audited entity, ministry of finance and the SAI. (iii) Action by management on internal audit findings is prompt and comprehensive across central government entities. Internal Audit services are provided by a Department in the Office o f the Accountant- General o f the Federation, which is headed by a Director who reports to the Accountant- General. Internal auditors are drawn from the general pool o f government accountants - there i s no separate career stream for internal auditors - and are posted by an OAGF committee to ministries, extra-ministerial departments and agencies across government. Some 60 internal auditors work in the central department, with about 900 spread across the ministries, whose accounting officers are required to establish internal audit units in each major organizational structure. 169 staff are professionallyqualified. Present situation The Department o f Internal Audit is one o f eight departments o f the Office o f the Accountant General o f the Federation. It had 60 staff in headquarters, and a further 900 posted out to ministries, extra-ministerial departments and agencies. Financial Regulations require that all accounting officers must establish internal audit units intheir organizational structures. Internal auditors are drawn from the wider pool o f government accountants, under the control o f the Accountant-General. There i s no separate career stream for auditors. As o f early 2006, 169 of the staff o f the Department are professionally qualified (holding either professional qualifications in accounting or graduate degrees in accounting or related fields like economics). Parastatals have their own internal audit structures, and are not under the control o f the Accountant-General. These arrangements have been inplace inNigeria for many years. The staffs main focus o f work i s compliance auditing, though it i s asserted that some systems auditing takes place. A constraining factor to do more o f the latter i s the skills and experience o f staff. Monthly reports are prepared and sent to both the accounting officer o f the department where they are posted and to the Director o f the Internal Audit Department in the OAGF. Demand for regular feedback to management on the performance o f internal control systems i s variable. Some accounting officers value the work o f their internal audit unit, others ignore internal auditors or frustrate their work. The Director o f Internal Audit makes periodic visits to ministries and departments, to discuss internal audit performance with chief accountants and accounting officers, and reports to the Accountant-General, but sanctions against accounting officers are seldom leveled, resulting ina systemthat can "bark but not bite". Reforms Underway The weaknesses o f the present system are well recognized by senior OAGF managers, who are anxious to modernize the internal audit function, raise professional standards and make advancement for internal auditors conditional on their performance as well as seniority and the passing o f exams. Current efforts within the OAGF are focused on 223 improving staff capacity through training in modern internal auditing techniques and encouraging unitsto undertake more system based audits. Assessment While the leadership o f the Internal Audit Department in the OAGF i s committed to modernizationand reform, most o f the constraints faced by the present system are beyond their control, since they are arise from cross cutting issues, which must be addressed across a broader front o f financial management and civil service reform. Staff skills need to be upgraded, but with government pay scales for accountants approximately one fifth that o f accounting professionals in the private sector, the Department has difficulty attracting, retaining and motivating qualified staff. The number o f internal auditors i s not the issue -the function could be carried out effectively with fewer but better qualified and motivated staff, particularly if the largely manual accounting systems operated by ministries are modernized and greater use made o f IT. But the most critical changes are required on the demand side. Presently, the climate o f financial management in the Federal Government i s "soft". Accounting officers are seldom if ever sanctioned for irregularities or loss o f funds, and the stewardship o f their votes i s not a factor in the appointment, transfer and promotion o f senior managers in government. Financial Regulations and instructions from the Accountant-General provide a sound framework for the conduct o f public finances, but until releases are withheld from late or inaccurately reporting entities and their managers called to account, the demand side o f the internal audit equation will remain weak. Consequently, while coverage o f internal audit inthe FGNi s good, and reports are timely and well distributed, management response to internal audit findings remains disappointing, and this feeds back to the quality o f auditing. 224 PI-22: Timeliness and Regularity of Accounts Reconciliation Best Practice I n modernfinancial management systems, bank accounts reconciliation isjidly automated through the linking of the Cash Book module of the FM system with the banking institutions. It is done at least on a daily basis. For thepurpose of the PEFA assessment best practice is defined as: (4 Bank reconciliationfor all central government bank accounts takeplace at least monthly at aggregate and detailed levels, usually within 4 weeks of end ofperiod. (ig Reconciliation and clearance of suspense accounts and advances take place at least quarterly, within a monthfrom end ofperiod and withfew balances broughtforward. Present situation The OAGF has earlier on reported problems with the reconciliation o f the accounts held inthe CBN, however, beginning from 2005 they were reconciledmonthly. Segmentation o f the government fiscal system (with a considerable chunk o f public finance remaining off-budget), multiplicity o f government bank accounts, and low level o f computerization o f the PFM processes, taken together, create considerable challenges for full and accurate account reconciliation. There i s an indirect indication that the current process i s still far from being perfect: the IMF regularly reports considerable statistical discrepancies in the annual fiscal accounts. That is, the reconciliation between OAGF fiscal accounts and C B N monetary accounts, undertaken by the IMF staff, suggests non- trivial discrepancies, e.g. up to N l O O bn at the end o f 2005 (i.e. increase in government deposits with the C B N in 2005, as reported in monetary accounts, was much larger than the one, which would be consistent with the budget deficit reported by the OAGF). Reconciliation against the accounts held in the commercial banks i s the responsibility o f each MDA. Inprinciple, this reconciliation should be done monthly as part o f the process o f preparing the monthly cash book reports to the OAGF. Prior to the roll out o f the ATRRS, these monthly reporting requirements were not been properly respected, leading to a significant build up o f a backlog o f reports. However, with the recent, roll out o f the system, which has a bank reconciliation module, the situation has improved. A recent review by the World Bank showed that 60 o f the 78 MDAs that report to the OAGF were up to date in sending their accounts transcripts, including bank reconciliation statements, to the OAGF. Most o f the remaining MDAs were only a few months in arrears. Per diem and other benefits in connection with business travel and workshops constitute an important and extensively used supplement to low public sector pay. The volume o f advances to public sector employees i s therefore large. There are also important advances paid to contractors. Responsibility for reconciling and clearing suspense accounts and advances rests with the individual MDAs. The ATRRS i s helping to facilitate the clearing, reconciliation and reporting on advances. Reforms underway With the deployment o f the Accounting Transaction Recording and Reporting System (ATRRS), the routine work o f reconciling the bank accounts with the General Ledger i s 225 becoming easier. However, the version software has a problem with proper accounting o f advances that requires urgent correction. Assessment Reconciliation that has hitherto been a problem i s beginning to improve with the implementation o fthe ATRRS across the board. The recent directive by the President to the OAGF and Budget Office to withhold releases o f further funds (recurrent and capital) to MDAs that default in the preparation and transmission o f their monthly reports to the OAGF is helping to instill the much needed discipline into the reporting process. Although the OAGF i s implementing the directive only partially to give MDAs time to get used to the new arrangements, it has already sanctioned two o f the most chronically defaulting MDAs. For the same reason o f discipline, however, inparallel with tightening the reporting requirements, the OAGF needs to make its cash releases more predictable, so MDAs see a clear advantage inkeeping current with bank reconciliation. More broadly, the issue o f MDAs failing to reconcile their bank accounts on a regular basis, and requiring external impetus to do so, suggests they themselves see little value in accurate financial information. This i s evidence o f a soft financial management culture that still pervades the public sector. Although the President in his letter referredto above sought to henceforth make vote holders explicitly accountable for the proper management o f their budgets, it will require a sustain effort by the authorities to make reporting (and accountability) part o fpublic work ethic. 226 PI-23: Availability of Information on ResourcesReceivedby Service DeliveryUnits Best Practice Best practicefor thepurpose of the PEFA assessment is defined as: Routine data collection or accounting systems provide reliable information on all types of resources received in cash and in kind by both primary schools and primary health clinics across the country. The information is compiled into reports at least annually. I I Present situation The Federal Budget contains over 750 institutional entities, in addition to which federal Government programs like UBEdisburse to almost an equal number o f lower tier entities, particularly at the local government level. Similarly state and local government budgets, usingtheir own revenues and statutory allocations, fund a further range o f institutional entities, the total number o f which has not been accurately counted. This reflects the federal structure o f Nigeria. Many services are delivered not by the federal Government, but by separately funded and independent state and local governments At the same time, there i s considerable overlap, and the Federal Government maintains a broad range o f federal schools and universities, clinics and hospitals, research and training institutes, standard setting authorities and regulatory bodies, agricultural extension entities and river basin authorities, and so forth. Itis on the other handrather coarse-grained when it comes to the economic breakdowno f the budget and thus also inthe accounts - since the latter interms o f structure are only the mirror image o f the budget. Adding to the problem i s the general lack o f discipline when it comes to reporting bythe MDAs and parastatals. Most basic social services, like primary health service and basic education, are provided by the state and local governments. There is thus no direct accounting information available at the federal level in regard to the full amount o f resources used within these sectors. At the same time, there i s no system in operation for consolidating accounting information from the states andthe local governments. Neither i s there information on the use o f external grants and loans in these sectors. Thus, at this point in time, there i s no comprehensive information readily available on total public spending on basic social services in Nigeria. N o tracking survey has yet been carried out, but one has been initiated as part o fthe overall PEMFARexercise. This survey should hopefully also be able to ascertain whether particular front-line service units and the population using these units generally receive adequate information on resources budgeted for them and on those actually received. Consultations with Nigerian NGOs inthe course o fthe PEMFARpreparation suggest that overall availability o f budget information at the subnational level is extremely poor. In most cases, information on local budget spending in general and on budgets o f individual front-line service providers inparticular remains unobtainable to local community groups. Anecdotal evidence suggests that much o f this money i s spent on salaries and allowances or transferred to other uses. 227 Reforms underway The deployment o f the ATRRS will improve to a degree the information on resources used at the Federal Government level and will allow analyzing expenditure in greater economic detail. It will not increase the level o f institutional detail, however. The implementation o f a standardized reporting format from the states and local governments would sharpen the overall picture o f the finances o f the lower tiers o f government but it will not, as presently designed, provide any information at the level o f individual front-line service providers. This i s inherently difficult in a federal structure, and particularly so in Nigeria, where the constitution emphasizes the independence o f each tier and standards o f financial management at the local government level are very low. At the same time, under the new federal Debt Relief Gain (DRG) program, the government has committed to channel its savings from the Paris Club Deal (about $750 mna year) into priority projects inMDG sectors, including inhealth andeducation. As a part o f the program, managed by the Office o f Senior Special Advisor to the President, the government decided to set up a comprehensive monitoring mechanism to ensure that funds are utilized for their intended purposes. This monitoring will be usinga system o f budget reports generated by recipients o f program funding, including by service providers. This creates an opportunity to start closing the above mentioned information gap at the federal level. To do this, the program beneficiaries should be requested to report on all their public funding, i.e. received under the DRG and from other budget sources. Assessment Because Nigeria is a federal state, accounting information on resource use for social service delivery will always be spread over a large number o f governments. In the short term, it i s not realistic to expect a complete compilation o f the accounting record o f front- line service delivery units.Priority must be givento getting a reasonably complete picture o f state and local level finances at an aggregate level. Inthe longerterm, it shouldbepossibleto develop amore advancedreportingsystemthat would allow collecting detailed accounting information from the second and third tiers o f government. The federal government should start using more intensively various co- financing arrangements in education and other MDG sectors, such as matching and conditional grants, to encourage recipients to produce and disclose their financial accounts in line with the federal standards. Such "light reporting conditionality" could be piloted within the existing UBEscheme, as well as under the debt reliefinitiative. Inthe short term, tracking surveys carried out on a stratified sample o f states and LGAs would allow getting a snapshot o f actual financing public service delivery at the front line. The government should, furthermore, encourage public sector service providers to disclose their budgets to local communities and other stakeholders, especially in the MDG sectors. Ultimately, timely and accurate information on how monies are used by front line service providers will become available only when the current capacity and governance problems o f local governments are tackled across Nigeria. 228 PI-24: Quality and Timeliness of In-Year BudgetReports Best Practice For thepurpose of the PEFA assessment bestpractice in in-year reporting is defined as: (i) Presentation of data allows direct comparison of budget execution with the original budget. Reported information covers all items of budget estimates. Expenditure is covered at both commitment and disbursement stages. (ii) Reports areprepared quarterly or morefrequently, and issued within 4 weeks of end of period. (iii) There are no material concerns regarding data accuracy. (iv) There are reliable instrumentsfor data verification in place, based on combination of field monitoring, audit, and statistical analysis. Present situation Monthly information on cash releases to MDAs and other entities exists. Prior to the roll out o f the ATRRS, MDAs' reporting on the actual use o f funds released to them was much less reliable, however. With this roll out, the system o f monthly budget execution reports (expenditure transcripts) by the MDAs, which existed only on paper for a long time, seems to have become significantlymore effective. The number o fMDAs seriously defaulting intheir reporting, has reduced drastically and all o f them now do some in-year reporting. One o f the reasons for the lax attitude on the part o f MDAs i s that the Federal Ministryo f Finance has been reluctant to put any serious pressure on the delinquent MDAs. Recently, however, the President, by a letter o f M a y 10,2006, informed MDA accounting officers that they would be personally responsible for any default in producing their monthly reports. The President further directed the OAGF and the Budget Office to withhold further release of all funds for current and capital spending to any MDA that fails to transmit its report to the OAGF 21 days after the end o f any month. Inthe second part o f 2006 this directive was enforced in over a dozen o f cases, which led to a significant improvement inreporting compliance. The ATRRS i s also making it possible for MDAs to report monthly on their individual accounts held in commercial banks. The ATRRS transcripts show transactions on each bank account separately and reconcile them automatically after each entry, debit or credit, thereby providing some monthly information on budget execution, which was hitherto lacking. The complements information on a cash position o f the Consolidated Revenue Fund,the CCA, and o fthe other government accounts heldwiththe CBN. There are no in-year reports produced by parastatals, federal extra-budgetary funds and autonomous agencies. PhysicaWoutputmonitoring Physical monitoring and control o f budget implementation has been consistently weak. There is, however, a great deal of awareness o f the problem and several institutions are trying to do something about it. Although each MDA is supposed to have an in-house monitoring unit, they have produced little and are held in low esteem by those in the 229 executive concerned about whether public funds are used effectively, and by the National Assembly. To address the problem, several external monitoring units have been set up. There i s a new Budget Monitoring and Evaluation Department inthe Budget Office. The National Planning Commission also aspires to monitor the execution o f the budget in general and individual projects in particular. The mandate o f the Budget Monitoring and Price Intelligence Unit (BMPIU) at the Presidency includes the monitoring o f multi-year investment projects. The Office o f the Senior Special Adviser to the President on the Millennium Development Goals (OSSAP-MDG) i s in the process o f creating an infrastructure -which would partly rely on participation o f civil society organizations and private sector institutions - to monitor MDG projects funded with savings from the debt relief. The National Assembly also carries out evaluations/project visits. The work o f these external monitoring units appears to be largely uncoordinated and face capacity problems. Reforms underway In terms o f in-year financial reporting, the full roll-out o f the Accounting Transaction Recording and Reporting System should dramatically improve the flow o f cash book information to the OAGF. It records the transactions o f the manual accounting system in an Access data base, which then facilitates timely monthly balancing and rendering o f account returns by MDAs and federal pay offices (FPOs) to the OAGF. As o f M a y 2006, all 78 federal MDAs had their ATRRS fully installed and more than half were current on their monthly budget reporting. The reports are summary reports broken down by institution and project andwithin those by personnel costs, overhead, and capital. As discussed above, there is a considerable effort to strengthen budget monitoring, but it would benefit from better coordination, improved funding, and more systematic disclosure/sharing o f monitoring results. Ongoing work by the MDG Office to strengthen coordination, including preparation o f a baseline study o f M&E systems, promises to provide a sound basis for further positive changes inthis area. Assessment Financial and substantive reporting and monitoring i s a very weak area in the management o f the Nigeria public finances. These weaknesses leave the Federal Government open to diversion o f funds and outright corruption. Poor information about the rate o f execution o f the budget - in particular, with regard to investment projects - furthermore increases liquidity costs as it makes very difficult to tailor the pace o f fund release to the actual rate o f execution. But in a larger sense, these deficiencies are not technical so much as environmental, insofar as for many years "soft" financial management has been part o f how the Federal Government has wanted to run its affairs. MDAs did not submit monthly budget execution reports partlybecause failure to report incurs no penalty, but most importantly because stakeholders within the public sector have been comfortable with the status quo and stakeholders outside the Government either don't care or feel powerless to demand better accountability. The key to better reporting, and, indeed, better financial management overall, lies in changing that environment. The recent effort by Government to sanction defaulting MDAs is a step in the right direction. However, Government needs to do more to really change the reporting culture inthe public sector. 230 PI-25: Quality and Timeliness ofAnnual FinancialStatements Best Practice For thepurpose of the PEFA assessment best practice in generation of annualfinancial statements is defined as: (9 A consolidated government statement is prepared annually and includes full information on revenue, expenditure andfinancial assetskabilities. (ii) The statement is submittedfor external audit within 6 months of the end of thefiscal year. (iii) IPSAS or corresponding national standards are applied for all government financial statements. Present situation No full set o f audited government financial statements have been presented to the National Assembly since 2001'74, but an effort i s underway to reduce a backlog of late accounts. The 2002 accounts were submitted to the Auditor General's Office in April 2004 and resubmitted in September 2005 after errors pointed out by the Auditor-General were corrected. The 2003 and 2004 accounts could not be submitted untilissues inregard to the 2002 accounts are sorted out, but it was subsequently reported that the 2004 accounts were submitted inJune 2006. The submission o f the 2004 final accounts means that in the past 15 months, the OAGF has successfully prepared the accounts for both 2003 and 2004, an achievement made possible by the ATRRS deployment. The OAGF expects that the 2005 accounts could be readyby December 2006, andthe 2006 accounts -- by April 2007. Parastatals and independent agencies submit audited financial statements directly to the National Assembly but the Auditor-General's Office gets copies of audited statements. The latter are used for two purposes: a) to monitor the use o f budget subventions, and b) to determine how much of revenue parastatals have to turn over to the Exchequer. Most of these financial statements are submitted within seven to eight months after the closing of the year.'75 It i s difficult to assess the quality o fthe consolidated statements. An indication of existing weaknesses may be the fact that Auditor-General had to send back the 2002 accounts to the OAGF because they still contained liabilities of parastatals that had been privatized and where the liabilities were handled over as a part o fthe privatization deal. It is worth noting that the audits carried out by the Auditor-General are focused on compliance. No performance or value for money audits are carried out. An indication that the value for money of public spending leaves something to be desired is the fact that the BMPIUinits first year of operations was able to save USD 674 million byrenegotiating contracts already negotiated and agreed bythe MDAs. The membersof NationalAssembly claimthat they didnot receivethe 2001 accounts either, butthe meetings inthe OfficeofAuditor Generalsuggeststhatitis likelythatitwas finalizedandsubmittedto theNational Assembly. However,becausethe documentis highly confidentialandproducedina limitednumber ofcopies, it just mayhavegone missing. Whatpercentageofparastatalsandindependentagencieshavesubmittedtheir 2004 accounts? Who are the major sinners? 231 The team has not been inthe position to evaluatethe quality ofthe audited accounts from the parastatals. Reforms underway As indicated above, the government is now making a concerted effort to eliminate the backlog of consolidated accounts. The deployment of the ATRRS i s accelerating their production and by 2007 the Government ought to be able to respect the deadlines for its submission as set inthe Constitution. Assessment The members of National Assembly have vociferously complained about the non- submission of audited consolidated accounts. Despite this pro-active attitude of the legislature, it has taken considerable time after the return to democracy for the Government to get up to speedtackling the backlog. At the same time, the FMF demonstrates somewhat lax attitude towards the laggard MDAs.Fundshave been releasedwithout any reports having beenproduced. The moral hazard o f this practice i s obvious. In addition, failure to produce timely accounts and financial statements weakens the accountability nexus that i s at the heart o f PFM. However, as noted in PI-22 and 24, acting under a May 2006 Presidential directive, the OAGF and Budget Office have started instilling reporting discipline by sanctioning defaulting MDAsthrough withholding further release of funds to them. 232 PI-26: Scope, Nature and Follow-Up of External Audit Best Practice (i, All entities of central government are audited annually covering revenue, expenditure and assetsAiabilities. A full range offinancial audits and some aspects of performance audit are performed and generally adhere to auditing standards, focusing on signijkant and systemic issues. (ii, Audit reports are submitted to the legislature within 4 months of the end of the period covered and in the case offinancial statementsfrom their receipt by the audit ofice. (iii) There is clear evidence of effective and timelyfollow-up. Present situation The Auditor-General o f the Federation and his staff constitute Nigeria's Supreme Audit Institution (SAI). It i s a long established office, dating back to well before independence, responsible for auditing central government entities. There are similarly constitutionally mandated auditors-general in the states. At the local government level auditors are statutory rather than constitutional, deriving their powers from states' local government laws. In former times, the Auditor-General o f the Federation's specific powers and responsibilities were spelled out in an audit law. However, this law was excluded from the 1991 consolidation o f the Laws o f Nigeria, and starting from 1979 its provisions have been incorporated in all Nigeria's Constitutions, including the 1999 Constitution. While this is a less than satisfactory situation, for the most part, it does not appear to have affected the operations o f the SAI. The post o f the Auditor-General i s a Presidential life-tenure appointment (subject to legislative approval) with protection from arbitrary dismissal, but staff are regular civil servants, appointed through the Federal Civil Service Commission, posted by the Head o f Service, and employed under regular civil service pay and conditions. The Auditor- General submits his budget through the Ministry o f Finance, and argues, with some justification, that the office has not been resourced inline with its responsibilities. The constitution sets a time limit (90 days) for the Auditor-General to complete his audit and submit the findings to the National Assembly. On the other hand, the Accountant- General, by provisions o f the Financial Regulations (a subsidiary legislation deriving fromthe Finance (Control and Management) Act, 1958), has six months from the end o f the financial year to submit the year's accounts to the auditor general for audit. Ineffect, by statutory requirements, the audited final accounts should be ready within nine months o f the year end. In contrast to the Director of Internal Audit, the Auditor-General maintains that he has been able to recruit qualified staff on civil service terms, though whether these allow him to attract the best available i s open to question, given the gap with private sector salaries. Audit coverage extends to all ministries, extra-ministerial departments and agencies, and i s chiefly compliance based. N o special effort is made to audit high risk areas, and the office does not undertake performance auditing (though the lack so far o f a performance framework inbudgetingwould make this difficult). But the main constraint to effective external auditing is the late submission o f accounts for auditing. In earlier years, the Auditor-General produced a single report, combining the annual accounts o f ministries with the financial statements o f the government. 233 Nowadays, the report i s intwo parts: Part Icomprises the accounts o f the ministries, and Part I1 the government financial statements. Unfortunately, both reports are seriously delayed, chiefly because o f late submission o f accounts to audit. Thus the Auditor- General was only able to audit the 2002 annual accounts and financial statements, as recently as March 2006, and even more recently completed the 2003 audits. He is currently auditing the 2004 accounts. Furthermore, although the 2002 audited accounts have been sent to the National Assembly, only Part Io fthis report has been published. Follow-up o f audit findings i s weak. There i s no formal mechanismfor reportingback to the Public Accounts Committee on action taken to address audit findings. Accounting officers are supposed to take action on PAC recommendations for surcharge, recovery and correction o f errors, but compliance is haphazard. While the Inspectorate Department o f the OAGF regularly visits ministries and reports to the Accountant-General, this i s chiefly to ensure compliance with the OAGF accounting instructions and not to check whether audit findings are being addressed. Reforms underway The main reform underway i s the passage o f a new Audit Law. This is an important step which will enhance the independence o f the Auditor-General, by allowing himto submit his budget directly to the National Assembly, to recruit staff independently, and to propose terms and conditions for their employment no longer tied to civil service pay and conditions. At the same time, resources are being invested in capacity building, re- equipment, and, for the future, a new building. Assessment The new audit law will enhance the independence o f the Auditor-General and his staff, bringingthe legal framework for external auditing more into line with international best practice. But this will not in itself ensure an effective external audit system. Three vital changes are needed, two o f which lie outside the power o f the Auditor-General to directly influence. The first i s the timely submission o f accounts to audit, which i s dependent on the Accountant-General and the accounting staff in the MDAs rendering accounts within the statutory time period, which they do not currently do (but hope to begin to achieve by 2007 due to the positive impact o f the ATRRS). Partly, this i s a question o f catching up on a backlog inherited from earlier years, but as the years o f military rule recede, this becomes a less convincing excuse, and rectifying incomplete submissions by MDAs. Late submission also stems from the failure to modernize manual accounting systems - a requirement Nigeria i s only now starting to address. But in a more fundamental sense, it i s about the importance senior management across government attaches to timely accountinginformation. The second i s the vigor with which the Auditor-General and his staff tackle their mandate. A visit to his offices leaves the impression that he and his staff have been the poor relations in the public financial management family, lacking sufficient qualified staff, office equipment and vehicles and a conducive work environment to surmount the challenges o f the job. Assuming the new audit law i s passed, greater independence in budgeting and human resource management will alleviate these constraints. This needs to be accompanied by a more aggressive spirit, focusing audit resources on highrisk areas, and more frankly evaluating the efficacy o f financial control systems. 234 The third change that is needed i s more aggressive follow-up to audit findings - whether these are individual audit queries raised during the year, or in the Auditor-General's annual report. Currently, little priority i s gwen to audit findings, and there i s no formal mechanism o f reporting on actions taken. Within ministries, extra-ministerial departments and agencies, senior management must set the tone by leading through example, which does not happen yet. Across Government, a stronger role needs to be playedbythe FMF, usingpowers o f surcharge and recovery, sanctioning (even removing) accounting officers who fail to correct errors and address system weaknesses, and even withholding budget allocations from ministries whose financial management systems are shown to be defective. Finally, to support these changes, the modernization o f the Chart o f Accounts would enable the Auditor-General over time to broaden the scope o f his audit, particularly if it takes place in the context o f the development and implementation o f an integrated financial management system. 235 PI-27: Legislative Scrutiny of the Annual Budget Law Best Practice (4 The legislature's review coversfiscal policies, medium termfiscal framework and medium term priorities as well as details of expenditure and revenue. (ig The legislature's procedures for budget review are firmly established and respected. They include internal organizational arrangements, such as specialized review committees, and negotiation procedures. (iii) The legislature has at least two months to review the budget proposals. (iv) Clear rules exist for in-year budget amendments by the executive that set strict limits on extent and nature of amendments and are consistently respected. Present situation Since the return to democracy in 1999, the executive's budget proposals have undergone critical review in the National Assembly, where committees o f both houses examine the budget proposals in a fairly structured way, and seek to harmonize their findings. Traditionally, the focus was primarily on the details o f spending, less attention was given to revenues or to the overall fiscal stance o f the b~dget''~.Although in recent years the executive has accompanied the budget estimates with the set o f medium term fiscal aggregates presented in the Fiscal Strategy Paper, the Budget Estimates document itself gwes no spending information beyond a single year, and thus the focus o f scrutiny i s on the year ahead. Since the constitution requires the President to present only one year's budget at a time, the NA does not formally vote/approve a medium term framework. However, it does a review o f the medium term framework informally. Although it has been the intention is recent years to present the budget sufficiently in advance o f the new financial year to allow enough time for legislative review, until recently the budget speech has been delayed, and in 2004 the executive had to revise the Estimates after the budget speech had been given. As a result, the Appropriation Bill has often not been approved untilseveral months into the new financial year, necessitating the executive invoking provisional warrant procedures to provide temporary spending authority, at the previous year's level. However, the situation improved inthe fiscal 2006 when the President presentedthe budget on October 12,2005, and the national Assembly approved the budget in February 2006. A major successful effort has been made to get 2007 budget approved beforethe end o f2006. Clear rules exist for in-year budget amendments, but in the absence o f a working MTEF, or the enactment o f the Fiscal Responsibility Bill, there are no legal limits to the scale o f supplementaries. However, the executive did not submit supplementary budgets in 2004- 05. In2006, a supplementary budget was tabled to reflect the federal portion o f costs o f several large infrastructure projects as well as o f partial repayment o f London club debts (both financed from the excess crude account). The 1999constitutiondoes notrequiretheNationalAssembly to scrutinizeandvote onrevenueproposals as partofthe annualbudgetprocess. Itmerelyrequiresthe Presidentto laybeforethe NA detailsofproposed appropriation. However,the executivepresentstherevenueframeworkto theNA as a separate volume. Usually, theNA debatesit andadjustsit, butdoes not formallyvote it into law to avoidcontraveningthe constitution. The revenueprofile adoptedby theNA, rather than the onesubmittedby the executive, forms the basisofitsdiscussion ofthe appropriationbill. Inpreviousyears, the tendencyof the legislatureto inflatethe revenueestimateshas resultedinunrealisticallylargeappropriationsvoted. 236 A distinctive feature o fthe budget process inNigeria is the absence o fconstraints, such as found inmost other countries, on the legslature's ability to change the executive's budget proposals. Before 2006, Nigerians have each year seen the executive present its fiscal program and detailed spending proposals, only to see them substantially amended by the legislature during the budget estimates scrutiny process. Typically, this has taken the form o f significant increases in spending, usually o f capital programs and o f the National Assembly's own vote, and only nominal reductions. To balance the increases, revenues estimates have been increased, usually by changing assumptions on both oil price and oil production, and by adjusting upwards internal revenue projections on the grounds that the executive's estimates were too conservative. Threats o f presidential veto have been countered by mustering votes to overthrow any veto. Each year, the President has signed an Appropriation Bill larger than the executive's initial budget proposal. The net effect has been to make the real budget less predictable, and to deepen the mutual suspicion between the executive and the legislature. Over the last two budget cycles, considerable progress was made towards a more collaborative budgeting, based on much broader consultations with legslature starting from rather early stages o f the budget process. Institutionalizinga Fiscal Strategy Paper as a part o f the annual budget package has helped to achieve a better balance in legislative scrutiny between broader fiscal policy review and detailed scrutiny o f budget appropriations. Reforms Underway There are a number o f reforms underway which should improve the budget making and approval process (as discussed elsewhere in the PEMFAR). Hopefully, reforms will also rebuild trust between the two branches o f the government. The executive has proposed a Fiscal Responsibility Bill, which would mandate budgetingwithin a MTFFdetermined on the basis o f the long run price o f oil. At the same time, the Budget Office o f the Federation has been making changes to the executive's budget process, which should improve the quality o f spending and lead to budgets being made within a MTEF, with priorities established and trade-offs made through a preparation o f Medium Term Sector Strategies (MTSS)'". These reforms have already led to a more transparent and informative budget documentation. In 2007 the annual budget package included the FSP and MTSS documents, Appropriation Bill and detailed expenditure estimates. Better structured interaction with the National Assembly resulted in a more collaborative process and helped to expand the scope o f discussions over the budget policy. Recent improvements provide a basis for further advances inthe quality o f legislative review. The legislature, on its part, has tabled a Budget Process Bill which would mandate an earlier start to the budget preparation and approval process, inwhich a two stage approach to budget approval would be adopted. First, the legislature would approve the aggregate framework for the budget, and, once the call circular had been issued consistent with this framework, the legislature would approve the detailed spending proposals. The Budget Process Bill also suggests the creation o f a National Assembly Budget Office, which would greatly increase the legislature's ability to scrutinize the budget and analyze aggregate fiscal strategies. 177InFiscal2006, theBudgetOfficepilotedthe MTSSinfiveMDAs. Thepilotwas expandedto 19MDAs for fiscal 2007. 237 Assessment Elsewhere inthe PEMFAR Report, the specific provisions o f these two bills are analyzed and discussed. Enactment o f the Fiscal Responsibility Bill i s a vital step towards more sustainable budgeting. The Budget Process Bill, which has positive features on the budget preparation timetable, needs, however, to be reconciled with the Fiscal Responsibility Bill and the proposed updating o f the Finance (Control and Management) Act, since in its present form, it would have the effect o f shifting fiscal policy responsibilityto the legislature, and seriously undermine the authority o f Federal Ministry o f Finance. The critical direction is to build onrecent progress o fbuildinga more consultative budget process and reducing the tensions between the two branches o f the government that are inherent in the Nigeria's constitutional arrangements guiding the budget process. If reforms can be sustained, there are good prospects to rebuild trust. The more wasteful spending can be eliminated from departmental budgets, the greater the resources that can be allocated to priority programs. Coupled with approval o f the budget before the start o f the financial year, and the passage o f the Fiscal Responsibility Bill, this should lead to more predictable funding and timely completion o f projects. Establishment o f a National Assembly Budget Office could support a more constructive and professional legislative scrutiny process. 238 PI-28: LegislativeScrutiny of ExternalAudit Reports Best Practice (4 Scrutiny of audit reports is usually completed by the legislature within 3 monthsfrom receipt of reports. (ii) In-depth hearings on keyjndings takeplace consistently with responsible officers from all or most audited entities, which receive a qual@ed or adverse audit opinion. (iii)The legislature usually issues recommendations on action to be implemented by the executive, and evidence exists that they are generally implemented. Present situation The critical issue in Nigeria i s not whether the Public Accounts Committees o f both houses to complete their scrutiny o f audit reports within 3 months (though, since they meet only when the legislature i s in session, and have separate hearings, the time taken can be greater than three months), but the long delay before audit reports reach them. The constitution requires the Auditor-General to complete his audit within 90 days o f the receipt o f accounts, and broadly this i s complied with. The fundamental problem is late and incomplete submission o f accounts by the Accountant-General, which largely vitiates the purpose o f external auditing and legislative review. The PEMFAR team was unable to get a consistent picture o f how late reports are received, but it seems clear that: (i) the appropriation accounts o f the MDAs are incomplete and reach the Accountant-General late. (The latest published Auditor-General's report the team could obtain was for 2002, and this covers the various MDAs and agencies under his audit mandate (Part I).178 (ii) In turnthis has delayedthe submission and auditingo f the consolidated financial statements o fthe Federal Government (Part 11). Thus, the complaint o fthe legislature's two PACs i s that they have seen no consolidated financial statements from the Federal Government later than 1999. Nonetheless, the two PACs have held hearings on the ministerial accounts that have been submitted and audited by the Auditor-General, and accounting officers and directors o f finance have been called in to give explanations for irregularities detected by the audit. These hearings are open to the public. Conclusions are drawn and recommendations made to recover lost funds, address irregularities and sanction those responsible. The PACs believe that their scrutiny o f the accounts has had some salutary effects, but there does not seem to be a consistent system o f government reportingback on action taken. Reforms Underway PACs complain that they do not have expertise in depth to probe alleged irregularities, and that ministries dispute their conclusions. In a well functioning system, staff o f the Auditor-General's Office should be on hand to support the committees. Passage o f the new Audit Bill, by increasing the SAI's independence, will pave the way for its capacity building, which in turn should benefit the committees. Updating the Finance (Control and Management) Act provides an opportunity for emphasizing the statutory responsibility o f accounting officers to render accounts and for the Accountant-General to consolidate them and pass on to the Auditor-General. And if a National Assembly ~ The 2003 Part IIreport is understoodto havebeensubmitted to the Auditor-General,butthenhadto bereferred back for adjustments. 239 Budget Office i s created, directly or indirectly its staff could support the work o f the committees. Assessment At the tail end o fthe budget cycle, legislative scrutiny o f audit reports is at the mercy o f timely and relevant actions by agents upstream. At the moment, the work o f the PACs i s largely form without substance. Noise i s created about financial irregularities, but when these are alleged to have happened many years previously, and the once responsible officials have moved on, the committees' traction on present day public financial management i s minimal. In turn, this feeds the legislature's distrust o f the executive, which may be reciprocated when the fi-ustration o f committee members turns to media posturing. The important fact is that, after years o f military dictatorship, public accounts committees are now functioning again inNigeria. The PEMFARteam, moreover, was unable to get a copy o f the PACs' own reports, and so judge the relevance o f their recent comments. Making the PACs effective watchdogs o f the Federal Government's public financial management will depend on how successfully other reforms are pursued. The important priority for PACs i s to push for regular production o f both in year and end o f year budget execution reports and their public review. 240 Appendix PEFA-1. Budget andAccounting Classification A best practice budget i s classified in a number of complementary dimensions. The core dimensions are: organizational, economic, programmatic, and functional but other dimensions may be useful as well. It may, for example, be useful to classify public spendinginterms of source o f funds if and when earmarked external project financing is an important source of revenue. The economic classification used in the budget would be an appropriate aggregate mapping o f the detailed chart-of-accounts used for the accounting. 1.e. rather than presenting the budget at the detailed level of the accounts, it would be presented at in terms of larger economic aggregates. A functional classification based on the standardized Classification of the Functions of Government (COFOG) used for SNA and GFS statistics allows presenting the expenditurekost side o f the budget in ways that allow international comparisons and an analysis of the actual spending priorities of the Government. A functional classification may not necessarily be an independent dimension but could be implemented as an attribute of a programmatic classification. Inthis case, every program and project may be givena functional attribute, which is then usedto summarize spendingby function. The programmatic classification provides a framework for political and management decision making and accountability. It must thus be tailored to the needs o f government political priorities, as well as linkedto the administrative structure of the government. Some of the classification dimensions are used only for providing information on the composition of the budget, while others would form the basis for the appropriations. When it comes to the appropriations, these may be defined using any combination of dimensions. Funds may, for example, be appropriated for institutions within programs or for programs within institutions. They may be appropriated as block grants to recipients or be linked to specific categories of expenditure such as cost of personnel, other recurrent cost, etc. Ifearmarked external fundingi s important, funds may be appropriated separately according to the sources o f funds. 241 Appendix PEFA-2. Bestpractice inRelationto Fiscal Riskin General A statement o f fiscal risk should be provided within the annual budget to give an overview o f all material fiscal risks and to be quantified to the extent possible. Where allowance for a risk has been made in a budget contingency reserve, this should be noted. The statement should contain information on risks broken down into the following categories: 1. Sensitivity to variations in key forecasting assumptions - fiscal effects o f variations in key assumptions underpinning the macroeconomic forecasts (e.g., the effect on the fiscal deficit o f a 1percentage point increase or decrease in GDP growth, inflation, interest rates, oil price, or the exchange rate from the base line assumed in the budget forecast); and the fiscal effects o f variations in key assumptions underpinningthe budget forecasts o f revenue and expenditure (e.g., a variation in the effective tax rates, public sector wage increases, or the average number o f claimants for social assistance). 2. Contingent liabilities - these may include guarantees, indemnities, and warranties; uncalled capital (e.g., in international financial institutions), litigation against the government, and the risk o f having to bail out insolvent sub-national governments and parastatals andfully or partly government owned corporations. 3. Uncertainty about the size o f specific expenditure commitments - where provision has been made in the budget for expenditure on an itemor activity, but there i s a greater-than-usual degree o f uncertainty about the likely cost, the risk should be disclosed. For example, the government may have given a blanket undertaking to depositors o f a specified distressed financial institution that their deposits would be honored. However, at the time o f finalizing the budget, the cost o f this commitment may still be highlyuncertain. 4. Other items that have not been included in the budget because o f the extent o f uncertainty about their timing, magnitude, or eventuality - for example, the government may have announced a general intention to introduce a tax or change inexpenditure policy, the details ofwhich havenot been finalized sufficiently for inclusion inthe budget. [Adaptedfrom Manualon FiscalTransparency, FiscalAffairsDepartment,IMF] 242 Appendix PEFA-3.Modernmanagementof cash,debt and guarantees Ina modem public administration all cash is managed within one or several government group accounts also known as single treasury accounts. A group account consists o f one virtual top account and a number o f sub-accounts. The top account holds the calculated balance o f all the sub-accounts within the account structure. Sub-accounts can be made interest bearing in order to stimulate a rational timing o f payments on the part o f the agencies. The sub-accounts can also have over-draft facilities attached to them to enable agencies to meet short-term cash needs that go beyond what i s immediately available. Group accounts can be operated by the central bank or by one or several commercial banks under a contract with the government. The top account(s) is /are cleared at least once daily. 1.e. any surplus or deficit i s eliminated through the buyingor selling o f short- term market instruments. Medium and long-term financing needs are met through a basket o f borrowing instruments o f different maturity. Debt management and cash management are thus completely integrated and managed by one institution, be it a separate agency or by a department o f the Treasury. Depending on the constitutional set- up o f the country and on the institutional capacity, such an office or department could also manage the debt and cash management o f lower level governments and o f other government entities such as parastatals. Alternatively, the institution managing debt and cash for the central government can be given the simpler task o f collecting and collating information on the debt o f public entities that potentially can impact on the central government and the general economy. Guarantees can and should preferably be issued at or close to its actuarial cost, i.e. companies benefitingfrom a government guarantee pay for this service. The government can decide to subsidize the guarantee, but the smaller the subsidy, the larger the volume o f guarantees that can be issued, given a chosen level o ftotal riskto the government. 243 ANNEX 2: LEGISLATIVE FRAMEWORK FOR PUBLIC FINANCIAL MANAGEMENT Introduction 1. This Note summarizes what the PEMFAR team sees as the main issues to be addressed in the coming months, as several important pieces o f new legislation go forward, each dealing with aspects o f the legal framework for public financial management (PFM). 2. The various pieces o f draft legislationcomprise the following: 0 Fiscal Responsibility Bill (FRB) 0 Amendment o f the Finance (Control and Management)Act o f 1958 (FC&MA) 0 Budget Procedure Bill (BPB) 0 Auditor-General's Bill (AGB) 0 Procurement Bill (PB) 3. All but the BPB have originated inthe executive. The FC&MA and the AGB, as far as the Bank i s concerned, can be traced back to the first IDA credit operation after the returnto civil rule, the Economic Management Technical Assistance project (EMCAP), approved in 2000, and the Country Financial Accountability Assessment (CFAA) which was undertaken in 2000. Similarly, the PB can be traced to the Country Procurement Assessment Review (CPAR) undertaken also in 2000, which recommended the strengthening o f the legal framework for public procurement, through the enactment o f a separate procurement law, based upon the UNCITRAL model law. The FRB i s a later development, aimed at correcting the boom and bust tendencies o f historic oil revenue driven budgeting across all tiers o f government, through the formalization o f a fiscal rule, and also seeking to regulate the budget making responsibilities o f the executive and the legislature at the national government level. The BPB, however, i s a draft law independently introduced into the National Assembly. None o f these laws has yet been enacted, though several o f them are well advanced, having been tabled in the Senate and the House, and public hearings have either been conducted or are scheduled to take place shortly. 4. Apart from the overriding requirement that such laws must be consistent with the Constitution, there i s no particular reason why there should not be several laws, each dealing with a particular dimension o f PFM, as opposed to a single omnibus law covering budget process, financial management, procurement and audit together. The 1958 Finance (Control and Management) Act was in several respects an omnibus law. Nowadays, the trend i s to have separate legislation covering budgeting, financial management, procurement and auditing. There i s also the issue o fhow much to put inthe legislation and what should be left to regulations issued under the law, which will vary according to country legal and administrative traditions. But form i s much less important than substance, and what is important in the legal framework for PFM is that the principles guiding it should be clearly stated, the key institutions and their powers, roles and responsibilities should be clear, and the main processes to be followed specified. However, if the legal framework covering PFM is contained in several different laws, they should be consistent. As this Note explains, the current draft laws are in conflict at present, and this needs urgently to be addressed. 244 5. Detailed comments on emerging laws have been provided by the Bank to FGN counterparts, as drafts have emerged, in recent years, and the purpose o f this Note i s not to repeat these comments, so much as to give an overview o f where matters stand presently, to highlightthe areas o f conflict and paradigm inconsistency, and to advise the FMoF on critical issues to address as the process goes forward. Auditor-Genera1's Bill 6. Detailed comments on this draft law have recently been provided to the FGNin a separate Note. Broadly, we feel the draft i s an important step forward giving Nigeria's supreme audit institution (SAI) greater independence, particularly with regard to staff recruitment and pay, and the mechanisms for setting the budget o f the Office o f the Auditor-General o f the Federation. Currently, the SA1 i s under funded, and while the Auditor-General himself i s a statutory officer with protection against dismissal, his staff remain regular civil servants, which raises questions about their ability to conduct truly independent audits, and, indeed, for the Auditor-General to recruit, retain and motivate professionals o f the quality neededfor this critical watchdog function. 7. The new law fills a gap in the existing legal frame~ork"~.It also provides a sound legal basis for going forward. In our comments we suggested some additions - such as the following: FCSC's shortlist for the position o f Auditor General to expressly include professionally qualified candidates from outside the public sector, as well as from inside. Types o f audit the S A I i s empowered to undertake, including submitting separate reports to the legislature. Greater clarity in the Auditor-General's role and powers in respect o f statutory corporations. Copying o f SAI's budget proposals to the Minister o f Finance for observations (but without power to change). Panel o f eminent practitioners to review quality o f SAI's work, possibly also to guide pay setting. Explicit requirement to cover public procurement inaudits"'. Mandatory executive reporting on actions taken consequent on Auditor- General's findings and PAC reports. Should recommendations along these lines be proposed during the passage o f the Bill through the National Assembly, the FGN should accept them. If not, the Bill i s strong enough as it stands to provide a good legal foundation for an effective external audit process. "'Whilethere hadbeena separate Audit Lawonthe statute books for some decades, duringthe consolidationof the LawsofNigeriawhichwas completedin 1991,the Audit Lawwas, for reasonsnot understoodby the Bank, dropped, leavingonly the provisionsinthe Constitutionon the Auditor-General. While this providesfor the Office,it does not for his staffanddeals withSA1functions ina peremptoryway. This is becausethe BureauofPublic Procurement,reporting as it does to a Councilheadedby the President, i s an agent ofthe executivebranch-aninternalregulator, albeitwith considerable operationalindependence, of publicprocurement,not an externalwatchdoglikethe Auditor-general. 245 8. Here it should be stressed that the three most critical requirements o f an effective audit process have to do with how the law i s implemented. The first i s the extent to which a newly empowered SA1 i s prepared to address its work energetically, "shake the trees" and perform a true watchdog function. The second i s whether the executive can meet the statutory deadline for the completion o f accounts and financial statements, which has not been the case in Nigeria for many years. The third is how seriously audit findings are treated by the executive, inturn a matter o f how effectively the Ministryo f Finance inits stewardship o f public funds role, holds accounting officers responsible, and whether FMoF actions are backed up by the Head o f Service and the President's Office. Public Procurement Bill 9. The World Bank has commented extensively on the draft procurement law prior to its tabling (and re-tabling) in the legislature, and it i s not proposed to repeat these comments inthis Note'*l. 10. In our view, the following are the key issues determining whether procurement reform will achieve its objective o f a permanent improvement in the transparency and competitiveness o fpublic procurement. Successfultransfer o f the staff o f the highlyeffective BMPIUto form the core staff o f the new Public Procurement Regulator (PPR) - which will entail, inter alia, dealingwith pay, incentive and workplace issues. Substantial training o f specialist staff across government in the new regulations and professional procurement generally. management operates - here close cooperation between the PPR and the Strengthening o f the accountability framework in which MDA senior FMoF will be critical. While the PPR will set the rules on procurement for MDAs to follow, the overall responsibility for proper use o f public monies rests with the Minister o f Finance. Thus the OAGF would be right to withhold a cash release if he had grounds to believe that procurement rules were being disregarded. 11. As the Bill moves through its various stages in the legislature, there may be opportunities to incorporate some o f the changes suggested by the Bank (including those summarized in the footnote). Nevertheless, if it is approved as submitted, the Bill will provide a much stronger basis than existed previously for the changes achieved by the BMPIUto be institutionalized. '*'Comments by the Bank have included the following observations: (1) The Council is a heavy superstructure, and its chairing by the President could make it difficult for the National Assembly to scrutinize its performancein committee. Placing the Council under the Ministero f Finance would be more consistent with the latter's financial stewardship function, and the Billcould provide for the D-G to be summoned. (ii) Creation o f a separate fund not under the control o fthe OAGF fragments budgeting and financial managementresponsibility. (iii) It is unnecessary and may heightenrisks to designateministers andparastatal chairmen as "authorizing authorities" o f contract award. (iv) National preferences are probably unnecessary and inconsistent with tariff liberalization. (v) Regulations under the Act shouldbe tabled inthe NationalAssembly, with a time period for a resolution ifthe legislaturewants to change them. 246 Finance Act Amendment 12. The updating of this pre-Independence law was first suggested by the Bank immediately following the return to democracy, and funding to engage consultants was providedinthe EMCAPcredit. It was felt at the time that, while the originalF(C&M)Act was still broadly sound, it neededupdating, to strengthenthe roles and responsibilitiesof the main actors in PFM, and to reflect the fact that in the interveningyears, Nigeriahas movedfromaprimeministerial to a presidentialformof government. 13. The first draft, producedby consultants Deloittes, was felt by the Government to be too much influencedby the South Afiican Public Finance and Management Act (an excellent law in its context), and insufficiently understanding of Nigerian PFM conditions. It was rejectedand a fresh start made by a working group ledby the OAGF. The working group, after several iterations (shared with the Bank), produced a draft entitled: A Billfor the Amendment of the Finance (Control and Management) Act CAP 144LFN 1990 andfor matters connected therewith, datedMay 2005. This representsthe latest draft, but it has beenovertakenbythe subsequentdraftingof a FiscalResponsibility law, and the former has been referredto a fresh working group, again under the general supervision of the OAGF, to review its provisions, and bring it into line with the FRB. These commentsare offeredinthis light. The maintask of the government review group, as we see it, i s to retain the currently well articulated sections on the powers of the Minister of Finance and the Accountant-General of the Federation, and to bring other sections into line with the FRB and to use common language and updatedparadigms of fiscal management. The new F(C&M)A rightly focuses on the regulation of PFM - revenues, expenditures, assets andliabilities-as didthe earlier law. While much of the wording traces back to the earlier law, the present draft articulates well the stewardship function of the Minister of Finance, together with powers of inspection and oversight, and the issue of financial regulations. Also included is the Minister's responsibility for fiscal policy and for coordinatingthe role-playersinPFM. Critically,the Minister has the power to limit spending inthe public interest, and likewise OAGF, as both agent of the Minister and Chief Accounting Officer of the Government, may withhold funds from a poorly performing MDA. Such powers should be exercised without prior legislature approval (see below). The draft acknowledges the central role of the OAGF in managing the ConsolidatedRevenue Fund(CRF) includingissuingTreasury Circulars, and for MDAs to report budget revenues and expenditures regularly to him. It also describes well the responsibilitiesof an AccountingOfficer. It recognizes the role of the NPC in providingpolicy advice, settingnational priorities and goals, and in preparing plans. But it makes statutory the production of a Rolling Plan (and Development Targets), an old paradigm instrument which has lapsed, instead of more explicitly supportingMedium Term Sector Strategies and a MTEF, which are generally seen as more appropriate instruments of modem public financial management. 247 Accordingly, the requirement for a Medium Term Fiscal StatementIg2should be linked to both a MTEF and whatever the fiscal rule i s adopted through the FRB, and a clearer explanation o fthe latter provided. The BoF i s rightly given the task o f coordinating annual budget preparation, allowing sufficient time for consultation and critical review, and providing for the identification o f fiscal risks. Instead o f requiring statutory corporations and the Central Bank to submit their annual budgets with the Appropriations Bill, and surrender 4/5' o f their operating surpluses, the Government should review the governance structure of parastatals generally, and provide for a new framework either in this or another piece o f legslation. (We understand that the BPSR i s planning to undertake this work). At the same time, clauses inthe draft dealing with the reporting and revenue remittance responsibilities of each government tier, and limitations on the legislature ability to change revenue estimates might be better transferred to the FRB. The OAGF should have a deadline (4-6 months) for the completion o f the Consolidated Financial Accounts and their submission to the Auditor-General. Matters like opening of bank accounts, creation of internal audit units, and many other details should be provided for in Financial Regulations rather than the law itself, which should focus on roles, responsibilities and powers, and the principles to be reflected in statutory instruments. MDAs should be obliged to submit annual reports on budget execution, combining both narrative on activities and outputs, and expenditure information. (Alternatively, this could be made a transparency and accountability requirement for all tiers o f government, under the FRB). require a separate Appropriation Act for each MDA, or group o f MDAs - as is The interpretation o f section 34 should be clarified - it could be interpreted to the case inthe US, which has 13 separate Appropriation laws, to the detriment o f budget comprehensiveness. The draft law lacks a section (which its predecessor had) on the creation and operation o f funds - though it contains details o f existing funds in the first schedule. Generally, the new law should be checked against the 1958 law to ensure that there are no gaps incoverage. As the FGN moves to integrate the capital and current budgets over the medium term, the existence o f a separate Development Fund (whose rules are set forth inthe Second Schedule) will require review. '**The opportunitycanbetakento clarifyterms. Inmost countriesa MTFF-MediumTermFiscal Framework- comprises the fiscal aggregates,revenues,expenditures andbalance,projectedby the Government andwhichis intendedto form the overallframeworkwithin whichsectoralallocations are madefor annualbudgets. The MTFF maybe supportedby a FiscalStrategy,whichis a mostlynarrativeaccountofthe macro-economiccontextinto whichthe fiscal strategy fits, andthe Government'sstrategy for revenues, spendingandthe deficithplus. In Nigeria's context,the FiscalStrategywouldalso givethe rationalefor anoilpricebasedfiscal rule. A MTEF- MediumTermExpenditureFramework- developsthe MTFF into a set of sectoraVportfolioenvelopes, reflecting the cost of existingandnew policiesandprograms (bottom-up),disciplinedby the aggregatespending envelope (top-down) determinedby the MTFF. 248 Fiscal Responsibility Bill 14. The Fiscal Responsibility Bill i s now before the National Assembly, following a vigorous campaign led by the Debt Management Office to promote the FRB and its underlyng rationale. As a result, there has been extensive consultation on the present draft, both with governors, legslators and representatives o f civil society. The objective o f the FRB i s to break the cycle o f boom and bust budgeting, arising from wild fluctuations in the oil price, the major determinant o f public revenues in Nigeria. Its coverage i s intended to be all tiers o f government, but the FRB also tries to regulate the budget process o fthe FGN, and improve fiscal reporting across tiers o f government. 15. It creates an independent statutory body, the Fiscal Responsibility Council, governed by a Board with regional, Federal Government, private sector and civil society representation to monitor and enforce the Act. The Minister o f Finance, on hisher part, i s required to prepare a Medium Term Expenditure Framework for the Federation, comprising (i)a Macroeconomic Framework projecting the main macroeconomic aggregates o f the economy over the next three years, (ii)a Fiscal Strategy Paper describing the fiscal policies and developmental priorities o f the FGN, and, (iii)an Expenditure and Revenue Framework, with revenues based on a pre-determined Commodity Reference Price for oil. All tiers o f government must manage their fiscal affairs and plan their budgets within the MTEF. Excess proceeds are to be saved by each Government by depositing them in separate accounts in the Central Bank, and may be drawn upon only ifthe oil price falls below its pre-determined level, though a proportion may, however, be used the following year for capital projects. 16. The FRB then goes on to lay down a process o f annual budget-making for the FGN, with a call circular issued no later than 1 July, with the resulting budget submitted to the Federal Executive Council early in September, and to the National Assembly by early November, leading to the passing o f the budget not later than the second week in January. 17. Like the Finance Bill, the FRB also provides for the submission o f annual budgets by statutory corporations to the FMoF, and four-fifths o f operating surpluses to the Consolidated Revenue Fund. 18. It also places conditions on increasing government expenditure, including on personnel by all tiers, and on contracting, which must be consistent with procurement regulations. And the FRB also creates a debt management framework, limiting borrowing to capital expenditure and human development, and within a sustainable share o f national income determined by the Minister o f Finance, overseen by the Fiscal Responsibility Council, with sanctions for offending governments. 19. The FRB lays down fiscal transparency and reporting standards, including the requirement for public hearings during the budget process, publication o f audited accounts within six months o f the end o f the financial year, enabling consolidated accounts o f the Federation to be published within nine months. And each government must produce a budget execution report. Finally, the FRB defines the "reference Commodity Price" as a 5 year moving average o f oil prices (initially, 10 years), with a spread o f up to $5, as determined by the Minister. 20. This i s an important piece o f legislation, and it i s hoped that it will pass without substantial change through the National Assembly, and thus be binding on all tiers o f 249 government for the preparation o f the FY07 budget. Should, in the course o f the public hearings, the opportunity arise for some fine tuning o f the FRB, the following changes could be contemplated: 0 The opportunity could be taken to make the terminology o f the FRB more consistent with international practice. What the FRB specifies i s not, strictly speahng, a MTEF but a MTFF - a Medium Term Fiscal Framework. The latter specifies fiscal aggregates - total revenue, spending and the fiscal balance. A MTEF, as usually understood, is a more elaborated expenditure framework, comprising envelopes for the main spending ministries, and thus forms the basis for setting the sectoral ceilings in the Call Circular. Nigeria is, o f course, free to adopt whatever terminology it favors in its legislation. But labeling a MTFF as a MTEF could prove confusing as the next stage in the budget reformjourney is contemplated. 0 The timetable for key steps in the new budget process should be revisited. First, ifthe MTEF(Le. MTFF) is to influence budgeting at all levels of government, it must be available much sooner than four months - ll(1)b - before the commencement o f the next financial year - nine months would be more appropriate. Likewise, the latest date for the issue o f the FGN Call Circular (1 July) could be advanced by either one or two months. Inturn, this would leave sufficient time for the National Assembly to pass the Appropriations Bill by mid December, allowing warrants to be prepared and issued by the start o f the new financial year. Clauses which give priority to capital spending (11(2)c(iv), 46( l)a, 49(2)b) could be either softened or interpreted flexibly - ifthe goal i s sustained service delivery, the aim should be a balance o f current and capital spending, not a capital spending bias. 0 Make clear that the virement powers o f the Minister are not subject to pre- approval by the National Assembly - 3l(2) suggests this mightbe so. 0 Proportional restoration o f spending restrictions (32(2) may not be in the public interest. For example: if revenues recover only partly, it makes more sense to complete one road thanhalf complete two. 0 Generally, the Minister needs selective impoundment powers, otherwise the stewardship role would be impossible. (If economic circumstances change, the government should be able to stop spending on a project or service without the prior permission o f the legislature. Alternatively, the Minister may decide to stop finding a departmental activity ifcontrol systems are shown to be inadequate and public funds would be wasted). 0 To lessen the risk that the Council and the Minister depart in different directions, and given the stewardship role of the latter, a sentence could be added requiring the FRC to consult regularly with the Minister. 21. Assuming the FRB is passed into law inthe next few months, a major effort will be required bythe FMoF, both to explain how it will work to state and local governments, but also to develop, consult anddisseminate the requiredMTEFMTFF,which will be the foundation for budget making by all governments inNigeria. State governments, on their part, have an important role to play assisting local governments comply with the new requirements. 250 Budget Procedure Bill 22. In the course o f the PEMFAR preparation, a copy was acquired o f the Budget Procedure Bill, which i s sponsored by members o f the National Assembly. There are several admirable features in the Bill. But there are also features which would significantly shift responsibility for budget-making from the executive to the legislature, and, indoing so, undermine the position o fthe Ministerand the BoF. 23. Among the positive features o fthe Bill are: Provides for fiscal and monetary programs and economic and social plans in a generic way, which avoids old paradigm instruments, and would allow new developments like NEEDS and the MTEFto be defined as consistent with the BPB. The budgets o f constitutional bodies are protected, which makes it consistent with new legislationlike the Auditor-General's Bill. 0 It requires any bill introduced into the National Assembly to be accompanied by estimates o fits financial implications. It provides a flexible limit on Supplementaries without prior approval, which mightbe construed as supporting the virement powers o fthe Minister. 0 Transparency is mandated for annual debt, new loans and grants, and on guarantees andtax expenditures. 0 It creates a National Assembly Budget Office with a reasonable set of functions. 24. The Bill also provides for a two stage budget process, at first glance similar to the "Swedish Model", in which the fiscal framework for the budget i s debated and approved ahead o f the submission o f the detailed budget estimates. However, the way the Bill specifies the process, it would have the effect o f malung the executive subordinate to the legislature inthe budget process. 25. By 1April the President must introduce an "indicative preliminary revenue and expenditureframework of Governmentfor the nextJinancial year" - not unlike the FRB, though in this case, the framework covers only the Federal Government -the BPB is not concerned about other tiers o f government. Both Houses debate the framework, and collectively approve it, and send it back to the President by 30 June. (It i s not clear whether the NationalAssembly setsjust the aggregate size o fthe budget or also the sector envelopes - probably the latter, though the actual clause specifymg this i s absent.) 26. Although not precisely specified, the next step i s for the President to submit detailed Estimates and the proposed Appropriation Bill. Each minister must in addition submit a "Policy statement on the preliminary estimates" thus providing supporting material for the House and Senate sector appropriations committees to evaluate and approve or change the ministerial detailed budget submissions. This work is to be completed by 30 September, and by mid November the Budget Committees have collated the results for Senate and House debate o f the budget as a whole. 15 December is the deadline for sending the approved Appropriation Bill to the President for assent. 27. On the face o f it, this is a multi-stage process that, as in Sweden, could foster a more harmonious budget-making process. It starts early enough to enable budget 251 preparation and approval to be completed before the start o f the new financial year, and it recognizes that approving the fiscal aggregates need not be done at the same time as the Estimates details. However, there are some very serious drawbacks, from the executive's standpoint. 0 It leaves the National Assembly determining the aggregate fiscal framework for the budget. The executive would propose, but the final arbiter would be the legislature. This conflicts with the executive's responsibility for macro- economic management. 0 The President would also propose an indicative allocation o f spending between the spending ministries. The legislature would collectively review the proposal, using the policy statements o f ministers to determine whether they agreed or neededto change the allocations. 0 It is not clear precisely when the President would submit the detailed estimates to the legislature. This could be at the same time as the sector envelopes, or after the latter have been approved. It i s probably the latter, in that the committees' reports on the detailed estimates are not due until 30 September. Ifthe detailed estimates followed after the aggregate size o f the budget had been approved and, in turn, the portfolio allocations within it, this would mean that the executive could find itself having to make a detailed budget different to what it would have done under the present system'83. This would make the executive, ineffect, the agent o fthe legislature. The role o f the Minister o f Finance (and the BoF) would be diminished. Although the Minister can prescribe the form each ministerial Policy Statement should take, the legislature would, in effect, take-over budget making responsibility. Likewise, line ministries report directly to the legislature half yearly on budget execution. This would encourage sector ministers to see the legslature rather than the FMoF/BoF as the arbiter o f their budgets, and therefore underminebudget unity. 28. Should the National Assembly pass the Fiscal Responsibility Bill, this would narrow the gap between the two branches' views o f the aggregate size o f the budget. But the FRB i s concerned only with the fiscal aggregates. If passed alongside the FRB, the BPB would still leave budget allocational decisions inthe hands o f the legislature. This would not be inconsistent with the Constitution which expressly (Article 59( 1)) permits the National Assembly to change an appropriation bill. But it would limit severely the executive's ability to formulate and implement its own budget policy, and thus radically alter the balance o f powers between the two branches, and change governance inNigeria. It would also make it difficult for the FMoF/BoF to move to the next stage o f budget reform, namely, developing a true MTEF, since, under the BPB, the determination o f sector spending envelopes would be assumed by the legislature. Under the present system, although each year it has led to conflict with the legislature, the executive at least has the responsibility of making a complete budget - even ifit is later changed by the legislature (and changed back again through the cash release system). 252 Conclusions 29. There are three critical issues that these various pieces o f draft legislation raise, which will need to be watched as the bill hearings unfold, and the FMoF i s required both to explain the provisions in the legislationit has put forward, and respond to amendments suggested by the legnlature, and gve a reasoned response to the legislature's own Bill, the BPB. 30. The first i s who makes the budget. Unlike most other c ~ u n t r i e s ' ~the,legislature ~ in Nigeria has substantial budget making powers, by recent constitutional design. Although in each o f the past five years this has given rise to deep conflict between the two branches o f government and in no small way led to budget implementation inefficiency (which fuels the conflict in subsequent years), it seems to be a fact o f public financial management inNigeria that the country must live with. The FRB i s an attempt to defuse the conflict by taking the size o f the budget outside either the legislature's power to determine, or the executive's (though the FRB wisely allows the Minister necessary flexibility in determining the reference Commodity Price). Recent efforts by the BoF and the Minister to brief legislators on the economic background to the budget are another attempt at a more harmonious budget making process. Establishment o f the National Assembly Budget Office, ifit is staffed with good professionals, could also help. 31. The second critical issue i s who controls the budget once it is passed. In most OECD countries (but not the US, which again is an outlier) the legislature is content to control the broad aggregates and main allocations o f the budget, and leave the executive discretion to use voted resources in the most efficient way to achieve approved policy the main divisions o f these heads (typically in the form o f programs - the Nigerian objectives. Thus OECD parliaments mostly seek to control ministerial votes (heads) and equivalent on the capital budget side would be a project, and a sub-head on the current budget side). 32. This leaves the finance ministry free to set internal rules (as can be found currently inthe FinancialRegulations) governing the movement o f approved funds within programs (or projectshb-heads). There are two reasons for this. First, if spending i s to achieve its objectives, some degree o f flexibility i s necessary without returning to the legislature for re-voting. Second, there i s the widely held view that the more the legislature seeks to control the fine detail o f the budget, the less attention it will pay to scrutinizing the larger and more important allocations. In short, the legislature should not micro-manage the budget. 33. Some o f the draft legislation threatens to limit this flexibility. And the present drafting o f the Appropriations Bill contains wording that makes the detailed Estimates part o f the Bill, suggesting that the legislature i s trying to control the budget down to the item These tendencies need to be resisted. The only other major countrywith similar legislaturebudget makingpowers is the UnitedStates, where the President'sbudget is merelythe openingproposalina longprocessofpolitical bargaining. Three criticalfeatures ofthe US systempreventit spiralingout of control. First, the Congressearly inthe scrutinyprocesspasses a budget resolution,whichcaps aggregatespendinganddisciplinesthe subsequentpoliticalbargaining. The second i s the votingrecordso f Senatorsand Congressmen, whichensure that thosewho vote for additional taxes are unlikelyto bere-elected. The thirdis the CongressionalBudgetOfficewhichproduceshighlyregarded,non- partisananalysesofbudgetsustainabilityandrelatedissues. Forexample, the 2006 AppropriationsBill contains wording that: (i) defines the Scheduleto containthe detailedEstimates of expenditure, and(ii) states that "In the event that a need arises to vire amounts within heads of expenditure to which sums have been appropriated under thisAct, such virement shall only be effected with the prior approval ofthe National Assembly". 253 34. The thirdmajor issue i s a related one, and has to do with the need for the Minister o f Finance to retain sufficient discretion in budget execution to safeguard public monies, which i s the stewardship role o fthe Minister. Ifthe rules for budget implementation give the Minister no flexibility in releasing funds to approved budget lines, then this severely curtails the Minister's ability (and duty under the law) to safeguard public monies and manage fiscal risks. 35. There i s a possibility that the National Assembly could approve all three pieces o f major legislation with few amendments. While this might seem a good outcome for the Executive in the short term because it provides for enactment o f a fiscal rule, in practice such an outcome could be a nightmare, with the inherent conflicts between the various laws, and each branch o f power behaving as if "their" respective piece o f legislation was the authoritative one. It would make the disputes o f the past few years appear as prologue to complete breakdown o f the budget process. 36. To avert such a setback, it would be worth considering an alternative configuration o f laws, which could be negotiated between the two branches in the event that the passage o f all existing bills seems the likely outcome. T h i s could take the following form: 0 A Law on fiscal discipline that in general but still explicit terms imposes discipline on fiscal framework for all three tiers o f government. The core o f that law would be the description o f different components o f a common fiscal rule - revenue determination rules (complemented by a specific reference to the allocation mechanism), deficit rules, and aggregate expenditure ceilings derived from those. And to reinforce it, the law would introduce limits on the stock o f debt and transparency and reporting standards. 0 A Law on budget procedure that defines the components and procedures for the preparation, deliberation, voting and follow-up o f the budget for the Federal Government - a harmonized amalgam o f the budget process sections o f the FRE3 and the BPB with some additions which would respect the role o f the executive to set policy, and the legislature to approve it, and give the Minister o f Finance the power to control budget execution. 0 A law on budget implementation that sets out the roles, powers and responsibilities o f the main actors in the Executive in executing the budget and managing the finances of the FGN- essentially the present F(C&M) Amendment draft adjusted to take account o f what i s provided for in the prior two acts. 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