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Source: World Bank
30 June 2004


Report No. 28990-GZ


West Bank and Gaza
Country Financial Accountability Assessment

June 2004

West Bank and Gaza (MNCA4)
Operational Core Services Unit (MNACS)
Middle East and North Africa Region

CONTENTS
INTRODUCTION - 1
EXECUTIVE SUMMARY - 1
1. BACKGROUND - 7
2. SUMMARY OF RECENT PFM REFORMS - 7
3. DONORS AND THE PA - 8
4. AID MANAGEMENT - 9
5. THE WORLD BANK AND THE PA - 10
6. ISSUES CONCERNING TRACKING OF FUNDS - 11
7. THE LEGAL FUMEWORK FOR PFM - 13
8. BUDGET CONSTRUCTION - 16
9. CENTRAL TREASURY ACCOUNT - CASH MANAGEMENT AND BUDGET EXECUTION - 23
10. EXPENDITURE ARREARS - 26
11. DEBT MANAGEMENT - 26
12. GOVERNMENT ACCOUNTING SYSTEM - 27
13. PUBLIC SECTOR PAYROLL - 31
14. PA COMMERCIAL INVESTMENTS - 33
15. STATE OWNED ENTERPRISES - 35
16. OTHER COMMERCIAL ACTIVITIES - 37
17. PUBLIC INSTITUTIONS - 37
18. EXTERNAL AUDIT - 37
19. FINANCIAL CONTROL AND INTERNAL AUDIT - 40
20. THE ROLE OF PLC IN PFM - 45
21. PROCUREMENT - 46
22. FISCAL REPORTING - 47
23. LOCAL GOVERNMENT - 50
24. PFM CAPACITY AND POSSIBLE TECHNICAL ASSISTANCE NEEDS - 51
ANNEX 1: LIST OF DESIRABLE FURTHER ACTIONS - 53
ANNEX 2: LIST OF I(EY OFFICIALS AND OTHERS MET - 57

INTRODUCTION

Work on this CFAA commenced with a mission to West Bank and Gaza (WB&G) from 25 September to 2 October 2003. During this mission extensive discussions were held with the Minister of Finance, with key PA officials, with the IMF and with other donors, particularly DFID and the EU. A draft report was delivered to the Minister of Finance in early December, as the basis for further discussions. A second mission was undertaken from 7 to 13 February, 2004 for these further discussions, to finalize the report.

In both missions full cooperation was received from the Minister of Finance Dr. Salam Fayyad and senior PA officials. All information requested was readily provided. Comments by the Minister and his senior officials have been taken into account in preparing this report.

A Bank internal review meeting was held on March 30, 2004. The comments and advice of the peer reviewers, Jean Van Houtte (World Bank, AFTP4), David Sewell (World Bank, MNATC) and Karim Nashashibi (IMF) are gratefully acknowledged. The assistance of the UK Department for International Development (DFID) in providing filnding for a consultant as part of the CFAA team is also acknowledged.

EXECUTIVE SUMMARY

This CFAA is able to report major improvements in the public financial management (PFM) system of the West Bank and Gaza (WB&G) in the period since mid-2002. On the basis of these improvements, and of Palestinian Authority (PA) commitment to further reforms, the World Bank is able to support a program of general donor budget support to the PA.

However, the CFAA also identifies a significant number of actions which still need to be implemented. Most of the essential steps are either under implementation by the PA, or are planned.

RECENT AREAS OF IMPROVEMENT

As set out below, major improvements in budgeting (both development and execution) and in fiscal transparency have been introduced during the tenure of the present Minister of Finance. These are highly creditable developments, and mark a major departure from the PFM regime in force prior to his incumbency. Such improvements have clearly positioned the WB&G PFM system on an upward path, and there is reason for confidence that this progress will continue. For this to occur, however, the issues of capacity development discussed in Section 24 of the Main Report will need to be addressed.

Notable improvements in PFM include the following:

1. All Palestinian Authority (PA) revenues are now paid into the Central Treasury Account (the CTA), a single treasury account which brings together all government revenues and provides a single pool of funds out of which all expenditures are paid. This has eliminated previous non-transparent and discretionary spending from various off-budget petroleum, tobacco and alcohol excise revenue accounts.

2. The 2003 Budget process represented the first serious attempt in WB&G to develop a budget that accounts for all revenues and sets meaningful (and manageable) limits on expenditure. The process was reinforced during 2004 Budget preparation. An orderly system of budgetary appropriation is now in force.

3. Reflecting these new and improved processes, the budget speeches and extensive background budget data are posted on a regular basis on the Ministry o f Finance’s (MOF) external website, itself a symbol of a new approach to transparency and improved budget management. The full Budget documents for 2003 and 2004, which were published, include information on economic parameters, balance of payments, monetary aggregates, external public debt and public sector employment.

4. MOF is exercising firm control over budget expenditures - with the obvious caveat that the chronic post-September 2000 shortage of Budget funds has led to strict limits on non-wage expenditures and to continuous ad hoc adjustments, with funds often being released by MOF on a daily basis. While far from ideal, MOF has had little other choice. One consequence of chronic revenue shortage and the erratic nature of donor budget support has been a periodic accumulation of expenditure arrears to the PA’s pension funds, to commercial suppliers. These arrears and the short-term commercial bank debt that MOF has also contracted are, however, being transparently handled. The IMF is also regularly monitoring budget execution and the arrears and debt situation.

5. Following the integration of the separate West Bank and Gaza accounting systems, monthly budget execution reports are now being prepared and posted on MOF’s external website within a few days of the end of each month. These reports appear to provide reliable information, although delays in closing some ministries’ accounts each month mean that some of the information is only preliminary.

6. A program of placing in each ministry financial controllers who report to MOF has been initiated. This program is designed to ensure appropriate ex ante controls over expenditures.. A Director-General of Financial Control position in MOF to overview and manage this important function has been created and recently filled.

7. In response to the weakness in the external auditing function (paragraph 13 below), MOF has launched a program to develop an ex post internal audit department in MOF. This program should be accelerated and given strong extemal technical support. The need for a clear separation of the ex ante financial control function from expost internal auditing is now well accepted, and has led to recent clarifications. A Director-General of Internal Audit position is created in MOF to manage and develop this function is currently being filled.

8. Control over the civil service payroll has improved significantly. MOF has taken charge of the central payroll system from the General Personnel Council (GPC, the PA’s central personnel agency), and is now in a position to monitor new recruitment and pay all public sector salaries, and thereby to contain civil service hiring. The salaries of the PA’s 73,000 civil servants have all paid through direct deposit into personal employee bank accounts for some time. From end March 2004 this system of direct salary deposit has been extended to the entire 56,000 security establishment staff.

9. In the 2004 Budget, the previous large discretionary transfer appropriation for the President’s Office has been virtually eliminated (from US$49.75 million in the 2003 Budget to US$0.62 million in the 2004 Budget), with these funds instead transferred to relevant service ministries (Health, Education and Social Affairs).

10. The establishment of the Palestine Investment Fund (PIF) has brought all PA equity holdings, including virtually all state-owned enterprises (SOEs), under MOF oversight and within a centralized and commercially-oriented management framework. An audit and valuation of all these assets has been completed, with outcomes published on the PIF’s external website. PIF has now published its first annual report and audited financial statements (for the 2003 year), and these are available on its website.

11. Measures have been taken to reduce PA monopolistic activities in the importation of cement, while the management o f the Petroleum Commisssion (PC, the PA’s petroleum monopoly) has been taken over directly by MOF. The PC is currently under audit and valuation. These actions have led to the capture of lost revenues and have diminished opportunities for non-transparent funds allocation or their diversion.

AREAS REQUIRING IMPROVEMENT

There are residual weaknesses in financial accountability which relate to the lack of adequate public aggregate financial statements, inadequate auditing and the undeveloped oversight role of the Palestinian Legislative Council (PLC). The shortcomings in the PA’s audit systems mean it is not yet possible to confirm the reliability of financial statements and the adequacy of the operation of internal control systems.

12. In January 2004 the PA produced a first-ever set of consolidated financial statements; these are for the year 2002 and were published more than 12 months after fiscal year’s end. The previous lack of such statements and this particular delay reflect a lack of qualified accounting personnel and the absence of documented procedures for the closing of accounts. While these statements are a promising first attempt, they have a number of limitations which are discussed in Section 22 of the Main Report. The financial statements for the year 2003 offer an opportunity for improvements. Disclosures should go beyond budget execution to cover PA debt, PA arrears and contingent liabilities, and the PA’s financial assets (including the investments of the PIF).

13. There is no adequately functioning system of audit, either external or internal. The external audit institution, the General Control Institute (GCI) reports formally to the President, but neither reports to nor is responsive to the PLC. While the GCI’s mandate contains some desirable features of an external audit organization - such as adequate budgetary independence and the power to obtain information - its capacity is weak and the quality of its work low, and it has had no discernible effect on public accountability. New definitional legislation and a major capacity building program are urgently needed. Draft legislation currently being considered by the PLC would establish a new Council of Administrative and Financial Control to replace the GCI. The draft provides for an independent appointment and reporting process for the Head o f the Council, for formal reporting to the PLC as well as the President and for coverage of all PA entities, and is a satisfactory basis for reforming the extemal audit function. Desirable improvements that should be made to the draft in the course of the second and third reading by the PLC include explicit provision for auditing the PA’s annual financial statements, clear reference to the international auditing standards that will be applied, and a clarification that compliance, financial and performance audits will all be carried out.

14. The PLC still lacks the information, resources and experience to play a full role in financial accountability. The weakness of the GCI and the absence of external audit reports has been a severe handicap in developing this role.

15. MOF still has insufficient ability to control security service recruitment and staffing numbers. Strict procedures over civil service hirings are in place in MOF; there is a need to apply the same controls to security service hirings.

16. Donor project financing is not well-integrated into the Budget (although some donors have created sub-accounts in the CTA), and this limits the PA’s ability to set clear spending priorities and to properly budget for the recurrent cost implications of capital expenditures. The PA has begun to address this issue through the 2004 Budget, which at a conceptual level linked recurrent budget expenditures with an emergency, humanitarian and developmental program for which donor financial support is crucial (these latter needs are detailed in the Socio-Economic Stabilization Plan 2004-5, prepared by the Ministry of Planning with the active cooperation of MOF). Improving the operational linkages between the recurrent and capital components of the annual spending plan, however, is being hindered by donors’ adherence to their own preferred financing procedures. Unless there are good reasons to the contrary, all donor funding should be provided through the CTA.

17. Aggregate cash flow forecasting and management by MOF’s Treasury Department requires further development, as discussed in Section 9 of the Main Report. Desirable steps would include a daily rather than weekly “sweeping” of revenue and expenditure accounts, a further consolidation of public bank accounts, stricter control over commercial bank borrowing and the establishment of systematic cash planning under a committee with representatives from the Budget, Treasury and Revenue departments of MOF.

A PROGRAMA ND TIMETABLEFO R IMPROVING PALESTINIAN PUBLIC FINANCIAL MANAGEMENT

Some of the issues detailed above can be addressed relatively quickly. The following should be implemented by June 30,2004:

Other reforms currently underway will take longer to implement in full They should be reflected in the proposed Multi Donor Budget Trust Fund benchmarks that will be developed between the PA and the donor community for fulfillment by December 31, 2004 and by June 30,2005.

It should be noted that these measures have all been identified by the PA itself as PFM reform objectives.

This CFAA contains many other recommendations, of varying degrees of importance, to improve PFM in the PA. They are listed at the end of each section of the Main Report, and are summarized in a table at the end. There is a need to develop a timebound action plan to ensure that these other agenda items are also addressed in the appropriate sequence. This Action Plan should be developed by the Ministry of Finance through appropriate consultations and in various fora by the end of June 2004.

OVERALL RISK ASSESSMENT

The Palestinian PFM system is judged to be adequate insofar as the World Bank’s criteria and standards for approval of a general budget support operation (or adjustment lending) are concemed.

The World Bank has a four-point scale for assessing the financial management risks inherent in government financial management systems: low, moderate, significant and high.

This CFAA has concluded that the risk level in the Palestinian PFM system are still significant, but that it should be possible to achieve a rating of moderate by the time of the next CFAA if the proposed program of PFM reforms is well-implemented. A key factor in the current rating is the lack of a properly functioning external audit institution.

It should be understood that that the World Bank provides budget support to many countries in which the level of fiduciary risk is assessed as significant, or even high - presuming that there is a strong government commitment to needed reform. Compared with many of these countries, the Palestinian PFM system shows significant strengths. Of 26 CFAAs completed in 2003, the risk level was assessed as high in 14 countries, significant in 8 countries, moderate in 3 and low in only 1 country.

An important factor which qualifies the PA’s PFM system as adequate under the World Bank fiduciary requirements for budget support is a track record of significant improvements in the last two years. The PA’s agreement to a continuing reform program, incorporating the PFM benchmarks set out above, reinforces this judgment.

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