Financial accountability in Nepal : a country assessment

A W OR L D B AN K C O U N T R 'A I Financial Accountability in Nepal 25833 A Country Assessment March 2003 ~~ THE WORLD BANK   A W O R L D B A N K C O U N T R Y S T U D Y Financial Accountability in Nepal A Country Assessment U~~~~~~~~~~ THE WORLD BANK His Majesty's Government of Nepal Washington, D.C.  Copynght t 2003 The International Bank for Reconstruction and Development / The World Bank 1818 H Street, N W. Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in the United States of Amcnca First printing: March 2003 1 2 34050403 World Bank Country Studies are among the many reports originally prepared for internal use as part of the continuing analysis by the Bank of the economic and related conditions of its develop- ing member countries and to faclitate its dialogues with the governments. Some of the reports are published in this series wvith the least possible delay for the use of governments, and the academic, business, financial, and development communities. 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Finance, Public-Nepal. 2. Finance, Public-Accounting-Nepal. I. World Bank II. Series. HJ1320.9.F55 2003 657' .095496-dc2l 2003042271  TABLE OF CONTENTS Abstract ........................................................... vii Preface ................................. ix Abbreviations and Acronyms .......... ....................... xi Executive Summary ..................................1 Development Action Plan ............. .................................. 9 Part A: Introduction Chapter I Introduction ............................................... 29 Economic and Historical Background ..................................... 29 Government Interest and Programs to Improve Financial Accountability .... ........ 30 Country Assistance Strategy Provisions Relating to Financial Accountability .... ...... 31 Objectives of the Country Financial Accountability Assessment ..... .............. 31 Related Recent and Ongoing Studies ...................................... 32 Part B: Public Sector Chapter II Central Government Budgeting, Financial Planning, and Cash Flow Management .................................. 37 Statutory and Legal Framework ............ ............................. 37 Consolidated Fund ............................. 38 Budget Preparation and Implementation . ............................. 38 Debt Management ... ........ ...................................... 41 Financial Management of Externally-Funded Projects ........ .................. 42 Recommendations ....................... ........................... 42 Chapter m Central Government Accounting and Financial Reporting .... ...... 45 Statutory and Legislative Framework ...................................... 45 Bookkeeping and Accounting . ........................................ 46 Accounts Staff ...................................................... 47 Financial Reporting . ................................................. 47 Procurement and Assets Management ..... ............................... 47 Internal Audit ........................... 48 Problems and Issues ..... ............................................ 48 Recommendations .............. 50 Chapter IV Local Government Accounting and Financial Reporting .... ........ 53 Statutory and Legal Framework .......................................... 53 Financial Accountability Provisions of the Local Self-Governance Act, 1999 .... ...... 54 Implementation Status of the Legal Provisions ............................... 55 Recommendations . ............ ..................................... 59 Chapter V Cross-Cutting Issues in Public Sector's Financial Accountability ...... 61 Internal Control Procedures ............................................ 61 Procurement Policies and Practices ....................................... 63 Staffing ........... ............................................... 64 Records Management .............. 65 Output Monitoring With Respect to Budget Allocation and Expenditure: Issues and Challenges .................................. 65 iii  iv Use of Information Technology . ......................................... 67 Financial Accountability in State-owned Enterprises ........................... 67 Chapter VI Independent Auditing ...................................... 69 Legal Framework .................................................... 69 Independence ....................................................... 70 Budget ......................................................... 70 Staff Recruitment and Conditions of Service ................................ 71 Equipment, Vehicles, and Information Technology ............................ 71 Auditing Standards and Guidelines ......... .............................. 72 Audit Backlog ........... .......................................... 72 Quality of Work and Audit Reporting ........ ............................. 73 Recent Reliability and Timeliness .......... ............................... 73 Reporting Destination and Follow-up ........ ............................. 74 Implementation of OAG Recommendations .. ..................... ........ 75 Performance Auditing-Linking Expenditure to Outputs and Outcomes .... ......... 76 Recommendations . .................................................. 77 Chapter VII Oversight Arrangements ................................... 79 Role of Civil Society . .................................................. 79 Role of the Press . .................................................... 80 Official Oversight Arrangements .......... ............................... 80 Role of the Office of the Auditor General .................................. 80 Role of the Public Accounts Committee ................................... 81 Role of the Commission for the Investigation of Abuse of Authority .... ........... 83 Oversight by the Judicial Council ......... ............................... 84 Oversight by Transparency International of Nepal ............................ 85 Part C: Fiduciary lRisk Assessment Chapter VMII Fiduciary Risk .......................................... 89 Nature of Fiduciary Risk . .............................................. 89 Experience with the World Bank Portfolio .................................. 91 Implications for Programmatic Lending and Budgetary Support .... .............. 94 Part 1): Private Sector (Chapter IX Private Sector Accounting and Auditing ........................ 99 Legal Framework ..................................................... 99 Accounting Standards and Practices ......... .............................. 99 Auditing Standards and Practices ......... ............................... 100 Recent Developments Regarding Accounting and Auditing Standards .... ......... 100 The Accounting and Auditing Profession .................................. 100 Institute of Chartered Accountants of Nepal ............................... 101 Supply and Demand for Accountants and Auditors ........................... 103 Training of Accountants and Auditors .................................... 104 Recommendations . .................................................. 104 Chapter X Accountability in The Financial Sector ......................... 107 Banks and Finance Companies ...... .................................. 107 Insurance Companies ........................ 110 Cooperative Societies and Unions ........................ 111  V Chapter XI Corporate Governance ............................. 113 Legal Framework ........... ........... 113 Registrar of Companies ................ ....................... ...... 115 Securities Exchange Board .............................. ......... .116 Stock Exchange .................. .............. 118 Recommendations .............................. .......... ........ 118 Part E: Non-Governmental Organizations Chapter XT Accountability in The Non-Governmental Organizations .......... 121 Legal Framework ....................................... ........... 121 Non-Governmental Organization Numbers and Activities ...................... 122 Financial Reporting and Auditing Requirements ......... .................... 122 Transparency of Fund Flow from Donors to Non-Governmental Organizations ...... 122 Effectiveness of Monitoring Mechanism .............. ..... .............. 123 Current Initiatives for Development ............................. ... 123 Legal Reform Initiative .. ......................... ............ ..... 124 Recommendations ......... ............................. ........... 125 Part F: Development Action Plan and Implementation Strategy Chapter XIII Development Action Plan and Implementation Strategy .... ...... 129 Realism and Prionties . ................................................ 129 Implementation Strategy .............................................. 130 Possible Risks and Plans to Overcome Them ......................... ..... 130 Suggested Next Steps ....................................... ....... 130 Annexes Annex A: Concept Note ........................... 133 Annex B: List of Persons Interviewed ...... ......... ......... .......... 141 Annex C: Selected References .......................... ......... ..... 147   ABSTRACT This document assesses the quality of finiancial accountability and transparency in Nepal and Tmakes recommendations for improvement. The financial accountability assessment is a joint exercise of His Majesty's Government of Nepal (HMGN) and the World Bank, with strong partic- ipation by donor partners as well as private agencies. The findings and recommendations were widely discussed with various government agencies, non-government agencies, private sector, oversight agencies, and donor partners, and were thoroughly reviewed by external peer reviewers representing UNDP, Asian Development Bank, SNV-Dutch Aid Agency, and Department for International Development (DFID-UK), as well as by the Bank's internal and external peer reviewers representing the Financial Management Anchor, and Bank staff working on Procure- ment, and Poverty Reduction and Economic Management (PREM). The review concluded that the lack of compliance and poor implementation of the regulations is the single most important problem that affects public sector financial accountability of Nepal. With respect to publtc funds, the report reviews the Government's budgeting, financial planning, cash flow management, accounting and financial reporting, at the central and local government level. It also reviews the standards and practices of the external "oversight' agencies-the Office of the Auditor General, the Public Accounts Committee, the Commission for the Investigation of Abuse of Authority, the Judicial Council, and the Transparency International of Nepal It assesses what it would take to qualhy the country for programmatic lending or budgetary support in replacement of individual project lending. With respect to the private sector, the report examines accountLng and auditing standards and practices, the development of the Institute of the Chartered Accountants of Nepal, the demand for, and the supply and traimng of accountants and auditors. It also examines the accountability in the financial sector that includes banks, finance companies, insurance companies, and cooperative societies and unions. The report also assesses the framework for corporate gov- ernance and reviews the activities of the Registrar of Companies, the Securities Exchange Board, and the Stock Exchange. With respect to non-governmental sector, it exammes the financial accountability aspect of non-governme'ntal organizations. vii   PREFACE The Nepal Country Financial Accountability Assessment (CFAA) analyzes the budgeting, Taccounting, financial reporting and auditing systems, standards and practiccs in both the pub- lic and private sectors of Nepal's economy. The objectives are to. (a) assess the strengths and weaknesses of the system, as well as the fiduciary risk suLbject to investments in both the public and private sectors, and (b) identify needs for capacity buLilding in these areas. The study was conducted throughout as a joint excrcise of His Majesty's Government of Nepal (HMGN) and the World Bank (WB), with strong participation by donors as well as privatc agencies. In December 2001, HMGN formed a high-level National Steerng Committee (NSC) to work with the Bank's CFAA team. The NSC has becn playing a pivotal and strong leadcrship role which provided not only a high level of government ownership, but also extremely useful quality assurance, particularly witlh rcgard to ensuring the factual accuracy of the CFAA. The Concept Note for the CFAA (see Annex A) was prepared with significant ilput of the NSC and, as part of the initial phase of the CFAA, the NSC prepared a Position Paper focusing on most of thc topics to be covered by the CFAA, explaining the current position and initiatives of HMGN. Thc NSC has been meeting regularly with the WB Team to discuss progress, facilitated and participated in the fact-finding visits by the WB Team in February 2002, and called a donors meeting the same month to brief them about the CFAA. The NSC reviewed evcry draft of the CFAA report, coor- dinating and transmitting all government comments thereon; and orgamzed the CFAA stakehold- ers' workshop (see bclow). Very early in the exercise, the CFAA team reviewed previous analytical work by the WB, the Asian Developmcnit Bank (ADB), the United KYigdom Department for International Develop- ment (DFID), and others. In addition, national consultanits with expertise in relevant sectors cov- ered in the CFAA conducted in-depth research anld intcrviews with a large number of stakeholders representing both the policy and implementation levels, and submitted written findings. Their findings were incorporated in the first draft of the CFAA report which was circulated to a 1lnted group of people on March 28, 2002. This draft was tested and supplemented with additional information collected during fieldwork in Nepal in February 2002 This draft was revised incor- porating the comments from the WB's peer reviewers and the NSC members. A revised draft was produced on April 30, 2002. The revised draft was again circulated to a liiuted group of people but included the external peer reviewers representing the donor group, the NSC members, vanous government agencies, oversight agencies and private sector agcncies. Comments were received from donor peer reviewers (ADB, DFID, SNV and UNDP), various agencies in the government and the private sector, the Social Welfare Council, the Public Accowuts Committee, the Office of the Auditor General and from the NSC. A final draft CFAA report incorporating all these com- ments was then used to make a presentation to a stakeholders' workshop held in Kathmandu on June 11, 2002. The workshop was attcnded by about 200 participants representing government agencies, private entities, donor partners, NGOs/INGOs, academicians, representatives of various political parties, media and others The recommendations of the workshop were, thereafter, incorporated in the final CFAA report, before formal discussions and adoption of the Developmcnt Action Plan by HMGN in June 2002. The NSC members wcre: Bansidhar Ghimirc, Financial Comptrollcr General, FCGO, ulltil April 2002 and following his retirement the new Financial Comptroller General Madhab Prasad Ghiriure effecuve May 9, 2002 (Convener); Rameshorc Prasad Khanal, Joint Financial Controller General, FCGO (Member Secretary); Ram Kumar Shrestha, Joint Secretary, National Planning Commission (Member), Ramesh Raj Satyal, Assistant Auditor General, Office of the Auditor Gen- eral (Member); Madhav Prasad Ghimire, Joint Secrctary, Budget Division, Ministry of Finance (Member); Ram Krishna Kharel, Under Secretary, Ministry of General Administration (Member); Pramod Koushik, General Secretary, Association of Chartered Accountants of Nepal (Member); ix  x and Purushottam Lal Shrestha, Secretary, Institute of Chartered Accountants of Nepal (Member). Durgesh Kumar Pradhan, Accounts Officer, FCGO, provided administrative support to the NSC. The WB's CFAA Preparation Team was led by Bigyan Pradhan, Senior Financial Management Specialist (CFAA Task Team Leader) at the WB's Nepal Country Office, and supported by Uche Mbanefo (Chairman of PROFIMA Limited and a former WB Regional Financial Management Advisor for the Africa Region), as Lead Consultant, Narayan D. Sharma (Procurement Liaison), Ahmed Ahsan and Roshan Bajracharya (Public Expenditure Review Liaison), as well as the follow- ing national consultants: Upendra Pradhanang; Nagendra Rajbansh; Chandra Bahadur Nemkul, Harihar Regmi; and Pradeep Shrestha. Nagendra Nakarmi provided administrative support to the CFAA Team. Peer reviewer from the South Asia Region (SAR) who provided comments was: Vinod Sahgal, Public Financial Accountability Specialist. External peer reviewers who provided comments were: Ivonna Kratynski, Loan Department (WB); Pierre Messali and David Shand (WB FM Anchor); Paul Edwin Sisk (LCOAA-WB); AUlister Moon, (PREM ECA-WB); John Fitzsimon (former Acting Regional Financial Management Advisor, South Asia Region); Richard Vokes and Krishna Ram Panday (Asian Development Bank); Stephen Sharples (DFID); Biswas Gauchan (UNDP); and Addie van Dallen (SNV-Dutch Aid Agency). Messrs. Kenichi Ohashi (Country Director, Nepal) and Robert Saum (Acting Regional Financial Management Adviser) provided guidance and support to the CFAA team. Numerous other persons in both the public and pnvate sectors, including training institutions, the Office of the Auditor General and the Public Accounts Com- muttee provided much information, which made this CFAA possible. The NSC and the CFAA team sincerely thank all the persons and institutions listed above and all persons whom the team met (listed in Annex 2), as well as many others not specifically men- tioned, for their contributions and support to the work of preparing this assessment.  ABBREVIATIONs AND ACRONYMS ADB ............. ........ Asian Development Bank ADBN .. .............Agricultural Development Bank of Nepal ADDCN ... .....Association of District Development Committees of Nepal AG .. .....................Auiditor General AGM ........... .......... Annual General Meeting ASB.....S B.... ...... ..Auditin g Standards Board ASOSAI .... . Asian Organization of Supreme Audit Institutions BAS .. . . . . . . . . . . . . . . . . . Board of Auditing Stanidards BPI................ .. ......Bribe Payers Index CA................ ..... Chartered Accountant CAPA ............Confederation of South Asian and Pacific Accountants CAS ... .. ...............Country Assistance Strategy CCSC...... I Corruption Control Suggestion Committee (1999) CF............. ...........Consolidated Fund CFAA ....... .......Country Financial Accouintability Assessment CIAA ...... . ..Commission for the Investigation of Abuse of Authonty CONSTITUTION......... . Constitution of the Kingdom of Nepal, 1990 CMED...............Central Monitoring and Evaluation Division CPAP .... . ..........Country Procurement Assessment Report CPIL.............. . ....Corruption Perception Index CPPR............... . Country Portfolio Performance Review DAP........ .............Development Action Plan DAO ....................District Administration Office DC ..........................District Council DDA . .. ...... ..........District Development Area DDC ............ ......District Development Committee DFID.............Department for International Development (U.K.) DTCO ................District Treasury and Controller Office ECA............... ..Europe &Central Asia Regional Office ESW ..... ... ... ..... Economiuc &r Sector Work FASB ......... ..... . Financial Accounting Standards Board FAR............... . Finan-cial Adminisfration Regulations, 1999 FCGO................ . Financial Comptroller General Office FM ........................Financial Management FMIS . .............Financial Management Information System FMR .. .. ..............Financial Monitoring Report FMS .......... .........Fina-ncial Maniagement Specialist FNCCI ........Federation of Nepalese Chambers of Commerce & Industry FSTAP .... . ..... . Financial Sector Technical Assistance Project FY .....~...... ..................Fiscal Year GFS ........ ..... .... Government Fina-ncial Statistics HM............. . ...... .His Majesty The King HMGN ......... ..... . His Majesty's Government of Nepal HRD.................... Human Resource Development LAD......................Internal Aucit Department IAS.............. .....International Accounting Standards IASB ... . .........International Accounting Standards Board IC.. ...... ....... ........Internal Control ICAI...... ..........Institute of Chartered Accountants of India ICAN................Institute of Chartered Accountants of Nepal ICB...................International Competitive Bidding IDA .......... ......International Development Association IDF ...................Institutional Development Fund xi  xii IFAC ..... International Federation of Accountants IMF ..... International Monetary Fund INGO ..... International Non-governmental Organization INTOSAI ..... International Organization of Supreme Audit Institutions ISA ..... International Standards on Auditng IT ..... Information Technology JBIC ..... Japan Bank for International Cooperation JC ......Judicial Council LSGA ..... Local Self-Governance Act, 1999 MA ..... Municipal Area MC ..... Municipal Council MDAC ..... Ministerial Development Action Committee MOF ......Ministry of Finance MOLD ......Ministry of Local Development MTEF ..... Medium-Term Expenditure Framework MWCSW ..... Ministry of Women, Children, and Social Welfare NASC ..... Nepal Administrative Staff College NAS ..... Nepal Accounting Standards NBL ..... Nepal Bank Limited NCB ..... National Competitive Bidding NDAC ..... National Development Action Committee NDF ..... Nepal Development Forum NEPSE ..... Nepal Stock Exchange NGO ..... Non-Governmental Organization NGSDO ..... Non-Governmental Social Development Organization NIDC ..... Nepal Industrial Development Corporation NPC ..... National Planning Commission NPR ..... Nepalese Rupees NRB ..... Nepal Rastra Bank NSC ..... National Steering Committee OAG ..... Office of The Auditor General OIC ..... Office-m-Charge PAC ..... Public Accounts Committee PAAN ..... Public Administration Association of Nepal PER ..... Public Expenditure Review PERC ..... Public Expenditure Review Commission PMR ..... Project Management Report PREM ..... Poverty Reduction and Economic Management PRSP ..... Poverty Reduction Strategy Program PSC ..... Public Service Commission PWD ..... Public Works Directives RATC ..... Revenue Administration Training Center RBB ..... Rastriya Banijya Bank RID ..... Revenue Investigation Department ROC ..... Registrar of Companies RMC ..... Reform Monitoring Committee SAI ..... Supreme Audit Institution SAR ..... South Asia Region SAFA ..... South Asian Federation of Accountants SBD ..... Standard Bidding Documents SDC ..... Swiss Agency for Development and Cooperation SEBO ..... Securities Board SOE ..... State-owned Enterprise SPD ..... Special Police Department SWC ..... Social Welfare Council TIN ..... Transparency International of Nepal  xiii UNDP ... United Nations Development Program VAT ..................... Value Added Tax VC ........ Village Council VDA . Village Development Area VDC ... ............................. Village Development Committee WE .. World Bank WVPFR ... World Press Freedom Review   EXECUTIVE SUMMARY Tj1he six specific objectives of this CFAA set out in paragraph 5 of the Concept Note (see Annex A) have been accomplished, and the 13 areas identified for review in paragraph 8 of l the same Note have been covered. The Government is serious and committed to improv- ing public and private sector financial management. Reforms in financial management are now critical and should be approached in an integrated way covering planning, budgeting, accounting, intcrnal control, internal audit, external audit and oversight. Reform in only one area of financial management will not result in the same degree of expected benefits. The failure to comply with the impressive legal and regulatory fiduciary framework that exists makes fiduciary risk in Nepal "High" by the standards of that same framework, whose faithful implementation would have brought risks closer to "best practice" standards found in developed countries. Rather, fiduciary risk in Nepal is at a lcvel similar to that found in many developing countries. Various actions, including capacity buwlding, aimed at systemic improvements in both public and private sector financial accountability still leave a large gap between precept and practice. Further capacity build- ing recommended in the Development Action Plan is designed to close this gap, and introduce international accounting and auditing standards in both the public and the private sectors. The Public Sector Nepal's legal and regulatory framework for ensurng public sector financial accountability is very impressive for a country at its level of economic development. The Constitution of the Kingdom of Nepal, 1990 requires the National Budget to be presented with an account of the goals achieved from prcvious spending. It accords the Auditor General (AG) complete legal and professional inde- pendcnce, cxcmpting his emoluments and the budget of his office, Office of the Auditor General (OAG), from parliamentary vote. The Constitution also created a Commission for the Investigation of Abuse of Authority (CLAA) to investigate and recommend action against errant and corrupt officials, and prosecute them, if necessary.  2 WORLD BANK COUNTRY STUDY The Public Accounts Committee (PAC), headed by a member of the main Opposition Party in the Parliament, is very proactive. It meets all the year round, discussing, not only the public accounts and the AG's annual report and recommendations thereof, but also practically every aspect of public sector financial management. Its meetings are open to, and receive full coverage in, the press. It intervenes in the procurement process, even while it is stll going on, if it suspects any impropriety. Its collaboration with the AG is exemplary. It sends the AG's recommendations to Government with a directive for the implementation of such recommendations. The Financial Procedures Act, 1999 and the Financial Administration Regulations (FAR), 1999, contain very detailed and comprehensive provisions for: budget preparation and approval; and accounting and reporting on budget implementation, every four months; a detailed report (Schedule 2 of the FAR) requiring a statement, not only of the expenditure, but also of the physical results and goals achieved; elaborate procurement and internal controlprocedures; annualfinancial statements at all levels, with a consolidatedfinancial statement for the whole government at the end of each fiscal year; lnternal and external audits, Ministerial review of project implementation at regular intervals throughout the year, with rewards for good performers, and explanations for poor performance. As required by the Constitution 1990, the Minstry of Finance (MOF) every year submits a detailed report to the Parliament just before the presentation of the budget, comparing the achievement with the set target for each line miniistry. Since the progress report is reqtuired to be submitted dur- ing the budget session around May/June, it is able to report the actual progress only for nine months of the current fiscal year and provide estimated figures for remaining three months. An actual figure for the full year can only be realistically provided if this requirement of submitting the physical progress report is shifted to the winter session of the Parliament. This is an area whlch His Majesty's Government of Nepal (HMGN) might wish to review to make the report more meaningful with actual figures of achievements achieved in the past, followed by some analysis of major achievements and failures, and the suggestions for improved performance in subsequent years. For the local level, the Local Self-Governance Act (LSGA), 1999 explamns the local govern- ment structure so well as to make it crystal-clear even to someone who has never known Nepal. The roles, responsibilities, and relationships of District Development Committees (DDCs), Mumcipalities, and Village Development Committees (VDCs), and the Councils which govern them are very clcarly explained in the Act. The regulations for financial accountability at the local level are, if anything, even more impressive than those at the center. They contain sensible provi- sions and instructions for: budget preparation; proper accounting and reporting; creation of an Accounts Committee in every local body to oversee financial management; internal and external audit, project monitoring; and a most elaborate and impressive system for "ex-post" evaluation of projects, which assesses, not only the direct costs and benefits of each project, but also its employ- ment creation effects, and cven its impact on the ecology. In practice, however, most of the impressive laws and regulauons described above are more honored in the breach than in the observance. The Schedule 2 of the FAR reporting on physical and goal achievements is almost never momtored. If this was prepared and monitored, the linkage between financial progress and physical outputs/outcomes could be measured in ways that would filly meet World Bank's financial management requirements for projects it finances. Monitoring of compliance with the provisions of the FAR either does not take place, or is not accorded the prior- ity implied by the Regulations. The penalties and fines prescribed by the FAR for non-compliance with reporting or other requirements are almost never imposed. About 95 percent of the cases brought by the CIAA at the court of law against errant officials failed, although the success rate is said to have improved to as much as 50 percent more recently Good performers are rarely rewarded and poor performers rarely probed or penalized; such rewards as are awarded often baf- fle many officials as to their justification. Monitoring is severely wcak both at the central and local levels. Most local bodies do not monitor projects or evaluate their impact as required by the LSGA 1999. Accounting staff, though they possess minimum technical qualifications required for the job, are generally weak in project accountng and financial management. Technical staff often give low prionty in terms of allocating resources to mstitute a good financial management system  FINANCIAL ACCoUNTABILITY IN NEPAL 3 in their respective entities/projects Compliance with internal controls is weak, and internal audit is ineffective at all levels. In short, a culture of non-compliance makes a mockery of an exemplary legal and regulatory framework. Lack of compliance and poor implementation of the regulations is the single most important problem that affects public sector financial accountabifity in Nepal Further, whether justified or not, there is a widely held belief that proactive intervention of the PAC and the CIAA, has often caused delays in decision making in government offices. If proactive involvement of the PAC during the implementation process has helped in many respects to check any malpractices or misdeeds, it has also caused severe delays in decision-making, with negative effects on development A nght balance is required, and their roles will be more significan-t in cases of serious malpractice operafions where post-mortems are required. Several reasons are advanced for the dichotomy between precept and practice noted above. They include: insufficient political commitment to, or demand for, compliance wvith financial accountability rules and regulations; a reluctance to punish or impose sanctions on anyone, reported corruption in civil service appointments, promotions an-d transfers, politicization of the civil service and its decision-making processes; and some donors and foreign development partners bypassing the governmenit's system in establishing financial systems and requirements for projects they support, thereby contributing to lack of respect for the law and regulations of the country. In seeking to explain the lack of compliance, two factors have had a sigmficant and practical impact. Firstly, the implementation of a good legal and regulatory framework for accountability such as exists in Nepal reqwures a good finanicial management framework, which was never put into operation. For example, tying expenditures to outputs and outcomes requires. a budgetary system which budgets output or results expected from expenditures as well as funds; an accounting sys- tem which records quantitative and qualitative achievements as well as financial data; a reporuing system which includes quantitative and qualitative results as well as financial statements; and an auditing system whiclh enables an independent auditor to trace expenditures and their results through the entre system. Secondly, there were so many sources of distractions and instability, including frequent government changes, that other urgent pre-occupations crowded out financial management from the political radar screen. Flowing from the above analysis, the challenge faced in this CFAA is how to bring about the behavioral and attitudinal change that will shift government and other officials from a culture of non-compliance to one based on implementation of the country's existing impressive legal and regulatory framework The diagnosis of issues in this CFAA does not come as a surprise to many government staff or other professionals working in the development arena. The matters covered are subjects of almost continuous discussion. The key challenge is how to bring about change in the way one thinks and in the way one acts, how to reinforce the country's laws and regulattons, and howv to motivate a large group of de-motzvated ctvil servants 7who are capable of producing better reszults and outcomes. Changes do not happen by preaching-they require "leaders" or "change agents," both at the political and bureaucratic levels, whose demonstration effect can motivate people for better results. Development and implementation of capacity building plans at institutional/organi- zational levels, involving Human Resource Development plans including training, can help to bring about sustainable change in behavior and attitude. Certain principles are helpful m confronting this daunting task. As a proverb says, "an ounce of prevention is worth a poutnd of cure." It is important to accord high priority to preventive meas- ures which will help to promote the accountability culture. Therefore, (a) individuals (or offices) should not be entrusted with funds, unless it has been confirmed beforehand that they can prop- erly account for them; and (b) since managers are either unable or unwilling to impose sanctions, it is best, if possible, to avoid putting them in a position where they have to decide whether or not to impose a sanction. Tranlslating these pnnciples into practice requiLres a strong political will and incentive or disincentive structure. The two principles enunciated in the precedmg paragraph have led to a number of recom- mendations which are elaborated in the Development Action Plan (DAP), attached to this Execu- tive Summary The recommendations are essentially designed to bring about compliance with  4 WORLD BANK COUNTRY STUDY existing public sector financial accountability laws and regulations. Any new legislation or regula- tion the Government finds it necessary to introduce in this connection should have the same objective of strengthening the implementation of what already exists. Budgeting and Accounting The key recommendation is for HMGN to show leadership by requiring that: o Only a competent and qualified individual be appointed to any position involving the han- dling of state funds, and transparent criteria be developed to prove the competency of such an individual. Only a competent individual should be allowed to handle any State funds, whether in the form of revenue, or as a spending budget. A key criterion of such compe- tence is the ability to properly account for the funds as required by existing regulations, including reports on physical results or measurable goals (a) achieved from previous expen- ditures, and (b) to be achieved from the proposed program/development expenditure. o No budget should be accepted or approved from anyone or any office, whether at vfllage, municipal, district, Department or Ministry level, nor should Parliament approve any National budget, unless the budget contains (a) a retrospective account of physical or other measurable achievements or goals resulting from previous expenditures, and (b) a prospec- tive forecast of the physical results or other measurable goals expected from proposed expenditures. A suitable simplified framework should be developed that can be realistically implemented at the local (village, municipal and district) level. o Every disbursement to any office (whether at local or at central level) should be against a report from that office showing (a) expenditures for the immediately preceding period and their physical or other measurable achievements, and (b) the proposed expenditures and their anticipated physical or other measurable achievements. Implementation of these recommendations will require officials to take a positive act of either dehberate defiance or error not to comply, not just a passive failure to call for reports after the funds have already been disbursed. Compared with the new recommendations, the existing system is like shutting the gate after the goats have escaped. Three recent developments justify a feeling that the time is ripe for meaningful reform: (a) mdige- nous Nepalese clamour for improved financial accountability and control of corruption has risen to a crescendo that can no longer be ignored; (b) shrinking earnings and rising expenditures have created a budgetary squeeze necessitating considerable budgetary support; and (c) Nepal's develop- ment partners have become more insistent than ever on visible improvements in transparency and accountability as a condition for providing budgetary support. The confluence of these three cur- rents have produced a powerful wind of change, forcing good financial accountability to the fore- front as a social, political, and economic desideratum. Given opportunities must be seized in order to bring about reforms in financial management in an integrated approach covering planning, budgeting, accounting, internal control, internal audit, external audit and oversight. Reform in only one area of financial management will not result in the same degree of expected benefits. Independent Auditing and Parliamentary Oversight In addition, the CFAA revealed two Nepalese institutions, the OAG and the PAC, which are iden- tifying weaknesses in the system and pressing government to implement remedies. In fact, it was largely through their reports and activities that the extent of non-compliance with existing laws and regulations became evident. Therefore, to improve the chances that the recommendations in paragraph 11 Wvll be complied with, it is further recommended that: o the Monitoring Section of the National Planning Commission (NPC) be strengthened ensunng full ownership by NPC to institute a realistic system in order to monitor all devel- opment projects, in addition to the core projects, in close collaboration with concerned line ministries, and to report the progress three times a year;  FINANCIAL ACCOUNTABILITY IN NEPAL 5 * the Fmancial Comptroller General Office (FCGO) and the internal audit services at central and local levels be strengthened to enable them to (a) certify offices qualified to receive and properly account for funds, (b) monitor compliance with the new regulations (that is, the above recommendations) all through the year, and (c) take proactive actions to rectify any issues that are against rules and regulations, before they are pointed out by the external auditors; * the OAG be strengthened to improve its capacity to confirm each year whether or not the new rules are being complied with, to provide services in financial auditing and outcome based performance auditing; * the capacity of the line ministries be strengthened to be able to effectively monitor their programs and also prepare a time-bound action plan to rectify issues or implement recom- mendations in the OAG's report-and the MOF to monitor the implementation of such action plans of all ministries; * the Ministry of Finance (MOF) be strengthened by establishing an effective monitorng system to follow up reported irregularities and periodicaLly report on the actions taken. Such a monitoring function should include the status of the following: (a) audit backlogs and action plan to keep all audits up-to-date, (b) revcnue realization, (c) clearing reimbursable grants and loans, (d) tax deduction at source, (e) repayment of principal and interest made by HMGN on guaranteed loans but not recovered from concerned institutions, (t) dividends receivable, and other receivables, from corporate bodies and boards, (g) amounts to be paid by HMGN to various entities, and (h) follow-up on the recommendations of the PAC; and * the PAC be strengthened to improve its capacity to insist on political demand for accounta- bility and transparency, and on compliance with the new regulations. Other capacity building needs, in addition to the six listed above, may very well surface as HMGN contemplates the detalled capacity implications of implementing the DAP. Fiduciary Risk and Programmatic Lending The failure to comply with the impressive legal and regulatory fiduciary framework that exists makes fiduciary risk in Nepal "High" by the standards of that same framework, whose faithful implementation would have brought risks closer to "best practice" standards found in developed countries. Even some developed countries also have similar problems, but the real challenge is the effective use of scarce resources for fighting poverty. Fiduciary risk in Nepal is, however, at a level similar to that found in most developmg countries. The area of attention important for minimizing fiduciary risk on programmatic lending is compliance with the impressive framework that exlsts. If the joint efforts by the OAG and PAC succeed in improving compliance with existing regulations, programmatic lending to Nepal should face fiduciary risks similar to those found in developed countries. It is, therefore, critically impor- tant to begin implementing the DAP designed to enforce compliance with existing laws and regu- lations. For fiduciary risk on programmatic lending to approximate the fiduciary risk now accepted for project lending, accountability and internal control standards in the whole civil service must approximate those currently existing in the WB-financed projects. The existing legal/regulatory framework meets these standards. It remains to get compliance to attain the same level. The objec- tive for HMGN should be to harmonize the reporting system, making it acceptable to all donors, in "one reporting system" coming out of the government's accounting and reporting framework. Some budgetary support or programmatic lending should be possible almost immediately through a combination of: (a) A pragmatic program of targeted assessment and "sanitization" of sectors and institutions scheduled to benefit from such lending; and (b) The implementation of the recommendations made in the DAP for the public sector as a whole, likely to be completed over the medium term.  6 WORLD BANK COUNTRY STUDY For example, to ensure that no urgently-needed budgetary support for poverty reductnon and other worthwhile objectives is held up by the implementation of the above recommendations, it Ts recommended that sectors, Mmiistries, and institutions scheduled to benefit from budgetary sup- port be the first to be assessed and certified by a panel of independent experts representing the accountability institutions which include, MOF, FCGO, NPC and OAG (may also include experts designated by donor partners participating in budgetary support), as complying with the account- ability standards recommended above. As of June 15, 2002, the following Ministries had already been identified for possible budgetary support, and therefore for such early review: Health, Edu- cation, Water Resources, Works and Physical Planning, and Agnculture and Cooperatives. Any weak points revealed should be strengthened as an indispensable element and component of the budgetary support package. Implementation of such actions should be closely monitored and reported. Necessary pre-conditions for budgetary support lending are likely to involve the imple- mentation of some other DAP actions or sub-actions, including, for example: report on HMGN actions in response to the PAC directives regarding the implementation of about 82 past OAG recommendations; the establishment in the MOF of a system for the regular monitoring and reporting of actions taken m response to OAG reports; the publication, every four months, of a financial statements by the FCGO comparing budgeted with actual receipts and payments; enhance independence of OAG and enhance audit quality of OAG by making an external peer review arrangements; and discussion with donors on the modalities for the inclusion of all foreign financial assistance in HMGN budgets and accounts. Following the full implementation of the proposed integrated financial management improve- ment program, a quwck review would be desirable to confirm the effectiveness of the compliance system, before a generalized programmatic lending benefiting all sectors, Ministries, and institu- tions is launched. Based on current evidence, this situation may arrive sooner in central govern- ment than in local bodies. All levels of government would need to be reviewed for adequate com- pliance before moving forward. The guiding principle always should be that no office at central or local level should receive any funds without first demonstrating the capacity to the civil society at large, to budget and account for them in a manner which links them to outputs and outcomes and which presents such accounts for OAG audit in a timely manner. A Task Force or a Reform Monitoring Committee should continue to be in action to monitor the implementation of the recommendations of the CFAA (see end of this Executive Summary). The status of implementa- tion should be periodically reported to the Finance Committee of the Parliament, the Finance Secretary, and Nepal's development partners. The Private Sector and Hon-Governmental Organizations Development of pnvate sector accounting and auditing is relatively new. A professional body for accounting and auditing professionals, the Institute of Chartered Accounts of Nepal (ICAN), was established in 1997 through the enactment of the Chartered Accountants Act, 1997. In the pri- vate sector, three key issues are: (a) the lack of accounting and auditing standards, (b) the weakness of the very young ICAN, whlich would ordinarily spearhead (or at least play a key role) in the development of private sector accounting and auditing standards; and (c) the weakness of most of the oversight institutions, such as the Nepal Rastra Bank (NRB), which monitors the banking sector; the Registrar of Companies; and the Social Welfare Council, which monitors non-governmental organizations (NGOs). To improve the financial accountability situation in the private sector, this CFAA recommends (among others): o support for the on-going efforts by the Government and ICAN to create an Accounting Standards Board and an Auditing Standards Board;  FINANCIAL ACCOUNTABILITY IN NEPAL 7 * a realisuc assessment and determination of the appropnate role for ICAN, in view of its sustainable resources; and * agreement on a level of Government grant support to ICAN until it achieves financial self-sufficiency. Considerable capacity building (human resource development including training and consultancy) will also be requwred at ICAN to implement the needed changes. To improve the financial accountability situation m NGOs, this CFAA recommends (among others). * formulation of polhcies for streamlining the administrative and legal framework within which NGOs operate, in order to enhance their functional and financial accountability, transparency and effectiveness; * enactment of comprehensive legislation exclusively for registration and governance of NGOs, including international NGOs (INGOs), and * strengthening the Social Welfare Council (SWC) to enable it to effectively monitor the activities and finances of all NGOs, and to require all NGOs and INGOs to register, and file annual audited accounts with the SWC. Development Action Plan (DAP) and Overall Implementation Strategy There are close to about 100 detailed recommendations m the chapters of this CFAA. They clearly cannot all be implemented at the same time, nor should they be accorded the same priority, even though they are all important. Therefore, eight key recommendations are presented in the Development Action Plan (DAP) as deserving the highest priority attention at the national level. They are: * compliance with the constitutional, statutory and regulatory framework by tying budgets and cash releases to forecasts of, and reports on, results and outputs; * improvement of Nepalese public sector accounting and auditing standards and practices; * strengthening of financial accountability at the local level; * strengthening the independence and capacity of the OAG, * strengthening the PAC and the CIAA; * reducmg fiduciary risks on projects; * strengthening private sector accounting and auditing standards; and * strengthe^ning the regulation and monitoring of NGOs. The implementation of the DAP itself constitutes a ninth action. The other recommendations not included in the DAP should be included in detailed development plans at the sector or institutional level. The selection rationale and DAP Implementation Strategy are presented in Part F-Chapter XIII. The close collaboration between HMGN and the WB, and the lead role taken by the NSC in directing the CFAA, are clear indications that HMGN accords a high priority to improving finan- cial accountabilty and implementing the recommendations in the DAP. A Reform Monitoring Committee (RMC), with members representing appropriate public and private sector agencies, will monitor the implementation of the DAP. The RMC is expected to nominate specific individu- als (or groups of individuals) within the committee as sub-comrnittees to monitor specific actions in the DAP. They are to liaise Arith HMGN or other agencies responsible for taking actions, and report back to the full RMC every quarter The RMC will report implementation progress to the Nepalese public and development partners at pre-determined intervals. HMGN wll formally constitute the RMC (with representation from private sector as well), name its members, and issue it with terms of reference incorporating the work and operating pro- cedures outlined in the attached DAP and Chapter XIII by August 31, 2002 The RMC will hold its first quarterly meeting and nominate its sub-committees by no later than September 30, 2002.  8 WORLD BANK COUNTRY STUDY It will issue its first DAP Implementation Progress Report by December 31, 2002 and issue its first report to the next NDF. The DAP, and progress in its implementation, will also feature prominently in the Governance and Accountability section of the WB's next Country Assistance Strategy (CAS). This CFAA should also serve as a useful working document for policy makers, as well as set the stage for all development partners interested in assisting HMGN to promote financial accountability and good governance.  DEVELOPMENT ACTION PLAN 9  TIMING (FISCAL YEAR)a PRIORITY MEDIUM-TERM LONG-TERM 0 KjEY ACTION SUB-ACTIONS RESPONSIBILITY 2002/03 2002/04-2006/07 2006/07+ EXPECTED BENEFITS > A. HMGN com- I Reinforcement of Rules: Lead: et v R o Confirms that O ply with the Demand retrospective report and MOF funds are being I Constitution prospective forecasts as part of all bud- spent on the of the King- gets (i) initially under five sectoral min- Others: intended purpose. dom of istries (Agriculture, Education, Health, NPC, Nepal, 1990, Water Resources and Works & Physical MOLD, and the Planning) where MTEF is being piloted; Line Ministries Financial (ii) during the medium term, work out a Administra- plan for implementation in other min- tion Regula- istries; and (iii) as the third phase, tions (FAR), extend to local bodies. all budgets 2. Linking Fund Release to Lead: V V anbdgash Progress Report: FCGO releases to Reject every cash disbursement request forecasts of from any office, central or local, failing to Others: submit retrospective report and MOF, and reports on, the phytsi prospective forecast of measurable NPC cal achieve- phoutputs and goals, as well as financial mentl , goal- report and forecast ments, goals or outcomes 3. Amendment of FAR and LSGA: Lead: V V resulting Review existing Schedules, particularly FCGO, from such Schedules 2, 3 and 5 of FAR and the MOLD public LSGA for their adequacy in implement- expenditure. ing sub-actions I and 2 above, and sup- Others: plement them as needed. MOF, OAG, NPC  4. Budget Monitoring: Lead: v * Timely alert Strengthen the Monitoring Section of NPC, regarding prob- the NPC ensuring full ownership by FCGO lems and issues in NPC to institute a realistic system to development monitor all development projects on a Others: projects regular basis requiring mandatory MOF reporting on a four monthly basis. Fur- ther, FCGO prepare budget implementa- tion reports and make such reports available in the same frequency. 5. Effective Internal Audit: Lead: v V * Confirms that Verify all offices, central and local, at FCGO, funds are least once dunng the year and report to being spent on the OAG on their compliance with Sub- Others: the intended Actions I and 2 above, and certify their DTCOs purpose. capacity to comply. 6. Effective External Audit: Lead: V V Confirm in OAG Annual Report OAG whether every office, central and local, complied during the year with Sub-Actions I and 2 above, name non-compliers, and -n recommend actions for them. z z 7. Output Monitoring Report: Lead: > > Accounting and reporting systems be FCGO expanded by creating codes to permit O 0 the recording of quantitative and other Others: 0 z output data to compare with bench- NPC, marks established in budgets; and MOF, upgrade the current software used by Line Ministries FCGO to accommodate output moni- z toring codes. Support: Zm Donors ! (continues)  TIMING (FISCAL YEAR) O PRIORITY MEDIUM-TERM LONG-TERM D z KEY ACTION SUB-ACTIONS RESPONSIBILITY 2002/03 2002/04-2006107 2006107+ EXPECTED BENEFITS Z n 0 8. Reinforcement of Rules on Lead: v c z Sanctions or Penalties: PAC Direct HMGN to take legal actions in consideration of recommendations of OAG. 9. Amendment of Laws: Lead: V M Review and amend existing Acts and MOF other related Rules and By-laws for compadibihty with all actions and sub- Others: actions above, particularly to ensure that FCGO, laws permit appropriate sanctions and NPC, penalties. OAG, Line Ministries 10. Capacity Building: Lead: V V Prepare capacity building plan covering a FCGO comprehensive human resources devel- opment plan to bring about sustainable Others: change in attitude and behavior to NPC, implement suggested reforms.The plan MOF, should include amongst others training OAG, of all budget, accounting, auditing, PAC MOLD, and legal staff, central and local, in imple- Line Ministries menting the above sub-actions. Support: Donors  B. Improve 1. Creation ofASB and BAS: Lead: V * Country will, for Nepalese Create and support the Financial the first time, Accounting Accounting Standards Board (ASB) and MOF have recognized and Auditing the Board of Auditing Standards (BAS) national account- Standards to formulate appropriate accounting Others: ing and auditing and Prac- standards for the use of public sector, FCGO,OAG, standards, in tices. private sector, local bodies, and NGOs. ICAN, public and private FNCCI sectors, based on IASB and IFAC accounting and auditing standards. 2. Dissemination of Standards: Lead: v V Issue accounting and auditing standards ICAN applicable to Government, banks, insur- ance companies, state-owned enterprises, Others: corporations, non-governmental organi- FCGO, zations and other entities. OAG, Universities 3. Formulation and Enforcement of Lead: v v * Enable the moni- Accrual Accounting System in FCGO toring of debtors, Government: creditors, accrued Develop a roadmap and a realistic time- Others: expenses and z z bound action plan for the medium to OAG, other assets and Z long-term introduction of accrual ICAN liabilities including accounting in government based on a other financial carefully-phased plan Support: transactions 0 Donors z 4. Policy Decision for Inclusiveness of Lead: * Promote trans- all Resource Inflow: MOF parency and good < (a) Discuss with donors the inclusion of governance to be z all loans, grants, direct donor pay- Others: able to keep track Z ments, and beneficiary contributions NPC, (continues)  TIMING (FISCAL YEAR) PRIORITY MEDIUM-TERM LONG-TERM i KEY ACTION SUB-ACTIONS RESPONSIBILITY 2002/03 2002/04-2006/07 2006/07+ EXPECTED BENEFITS > n for all projects in Nepal within the OAG, of all incoming 0 C National Budget, accounting and Line Ministries resources on z -I audit; accrual accounting (b) Implement the plan agreed with Support: basis -i C: donors. Donors i S. New Chart of Accounts: Lead: 0 Facilitate (i) com- Introduce new accounting codes and FCGO parison of finan- classifications by activity, which corre- cial statements spond to (i) budget codes and classifica- Others: with the budget, tions, and (ii) codes and classifications MOF, and (ii) harmo- used in project budgets and accounts, NPC, nization of including for donor-funded projects. OAG reporting system 6. Capacity Building in Internal Audit Lead: 6/ 0 Improved internal Service: FCGO control and assur- Strengthen the internal audit service at ance of compli- all levels of government-central and Others: MOF, ance with the localthrough Human Resource MOLD legal provisions Development (HRD) including training. Support: Donors 7. Integrated Treasury System: Lead: o