MEMORANDUM OF UNDERSTANDING (MoU) Between the Royal Government of Cambodia. And. The Asian Development Bank (ADB)

Transcription

1 MEMORANDUM OF UNDERSTANDING (MoU) Between the Royal Government of Cambodia And The Asian Development Bank (ADB) on The Fact-Finding Mission to process the Public Financial Management Program Cluster for Rural Development Subprogram 1 (P41373 CAM) 23 June 2008, Phnom Penh, Cambodia I. INTRODUCTION 1. A Fact Finding Mission (the mission) 1 from the Asian Development Bank (ADB) visited Phnom Penh from 9 23 June The purpose of the Mission was to: (i) prepare the Public Financial Management Program Cluster for Rural Development (PFMPCRD) and to design the supporting policy matrix for the program grant; (ii) to agree on the expected impact, outcomes, medium-term policy framework, and implementation arrangements; (iii) to identify measures to strengthen National Audit Authority (NAA); and (iv) discuss the expected objectives, activities, and outputs of the proposed TA projects grant component. 2. This MoU records discussions with officials of the Ministry of Economy and Finance (MEF) and the NAA, the Executing Agencies (EAs) and Ministry of Agriculture, Forestry and Fisheries (MAFF), Ministry of Rural Development (MRD) and Ministry of Water Resources and Meteorology (MOWRAM), the implementing agencies (IAs). A wrap-up meeting chaired by H.E. Vongsey Vissoth, Deputy Secretary General of the MEF, was held on 20 June 2008 to discuss the draft MoU and its Appendices. The list of officials met is provided in Appendix 1. The Policy Framework for the Program is attached in Appendix 2. The Design and Monitoring Framework for the Program is attached in Appendix 3. Details of Progress on Implementation of Subprogram 1, is attached in Appendix 4. Finally, summary of proposed TA projects and implementation arrangements is attached in Appendices 5 and This MoU is subject to the approval of higher authorities of the Royal Government of Cambodia (the Government), and the Management of ADB. II. BACKGROUND 1 The Mission comprised Prasanna Jena, Governance Specialist and Mission Leader and assisted by Rita O Sullivan, Senior Legal Counsel; Samiuela Tukuafu, Senior. Financial Sector Specialist; Liv Bjornestad Economist,; Chamroen Ouch, Program Officer (Governance), CARM, Ros Kheng, national PFM expert and Many Cheng, national capacity development expert. The team was assisted by the team of TA consultants, Les Henning, team leader; and Nihal Fernandopulle, audit specialist. The Mission benefited from the guidance and assistance of the ADB Country Director for Cambodia, the Director, SEGF Headquarters, ADB and from Kelly Bird, Economist, ADB.

2 2 4. The RGC is according primacy to governance reforms, PFM and rural development. The RGC is committed to maintaining high growth rates and poverty reduction objectives and to reduce income inequality levels which exist between rural and urban areas in Cambodia. As Cambodia s poverty reduction strategy, the National Strategic Development Plan (NSDP) replaces previous medium-term strategies (the second Socio- Economic Development Plan (SEDP-II) , the Rectangular Strategy for Growth (RSG), Employment, Equity and Efficiency in Cambodia ( ) and the National Poverty Reduction Strategy (NPRS) and harmonizes long-term targets already established in the Cambodian Millennium Development Goals (CMDGs), first formulated in 2003 and updated in The key strategic areas are divided according to thematic areas: (i) establishing a core of good governance; (ii) maintaining the broad environment for strategy implementation (domestic stability, international integration, development partnerships, and favourable macroeconomic and financial circumstances; (iii) enhancing the agricultural sector; (iv) improving physical infrastructure; (v) promoting private sector-led growth and job creation; and (vi) building capacity and human capital. The NSDP , outlines a clear set of measurable and prioritized goals for achievements in the areas of governance, financial management and rural development although some sectors have stronger prioritization and monitoring indicators than others. Figure 1 below provides a framework for linking the key reform issues identified in the key policy instruments developed by RGC and the ADB to support the objective of strengthening Public Financial Management (PFM) for rural development (the NSDP, the Public Financial Management Reform Program (PFMRP), the Rural Development Priorities, and ADB s Country Strategic Program (CSP) The Governance Agenda. In addition to commitments identified and committed to in the NSDP, Cambodia s participation in ADB-OECD anticorruption initiative and Action Plan for Asia and the Pacific in 2003 is evidence of its commitment to fostering policy dialogue, providing policy analysis, and building capacity around the governance agenda. Following ADB s adoption of the Second Governance and Anticorruption Action Plan, (GACAP II) in 2006, Cambodia participated in regional technical assistance (RETA) 6385 on Governance and Capacity Development Initiatives to implement GACAP II in April 2007 and facilitated risk assessments in MRD and MOWRAM as further evidence of its commitment to governance reforms. 6. The PFMRP was launched in December 2004 to address weaknesses in Cambodia s PFM system. PFMRP is a comprehensive reform program which aims to establish a strong PFM system which would facilitate the implementation of the NSDP. Drawing on Public Expenditure and Financial Accountability (PEFA) best-practice, the PFM reform program has been designed as a long-term rolling program, building on a series of platforms. There are four platforms specifying a package of reform activities, including complementary institutional, capacity and incentive reforms, that, when completed, would deliver tangible improvements in PFM and serve as a basis for later platforms. When completed, the four platforms would provide a comprehensive PFM system for Cambodia. To date platform one has been implemented. Platform one aimed to achieve a position in which the budget becomes more credible as an instrument of strategic and day-to-day management of public resources because it delivers a reliable and predictable resource to individual budget managers. Platform one also aimed to ensure that the budget reflects all significant public resources and their deployment, thereby enabling steps in subsequent platforms to hold budget managers more accountable for the efficient and effective use of resources. Platform two is expected to be implemented between 2009 and As of late 2007, all ADB financed projects for Cambodia have adopted Good Governance Frameworks (GGFs) which have been agreed by the Government. Such GGFs include various fiduciary risk mitigation measures that the Government needs to implement related to (i) procurement, (ii) fiduciary management, (iii) complaints and remedies mechanisms, (iv) code of ethical conduct, (v) sanctions, and (vi) certain project specific elements.

3 3 7. Rural Development. Economic growth has contributed to significant poverty reduction in Cambodia, but the impacts have not been equally spread across the population. Between the first household survey in 1993/4 and the most recent in 2004, poverty fell by around a quarter (from 47 percent in 1993/4 to 34.7 percent in 2004). However, in rural areas this figure was higher at 39.2 percent of the population in According to a World Bank Study on inequality (2007) Cambodia s average living standards as measured by consumption of goods and services per capita per day, increased by 32 percent in real terms between 1993/4 and However, rural living standards rose much more slowly than in Phnom Penh. Income inequality levels have stabilized between rural and urban areas. In fact the majority of the increase in income inequality took place during the 1990 s and was due to rising income inequality within the rural sector, a phenomenon that was not pronounced in urban areas. Nevertheless, income inequality between urban and rural populations both in terms of income levels and social indicators remains a problem in Cambodia. Rural poverty requires continuing urgent policy attention. Overcoming weaknesses in PFM in rural development sectors, will increase service delivery levels to the most vulnerable and promote a more equal economic growth trajectory, leading to increased per capita income of rural dwellers and reduced levels of rural poverty. 8. PFM Reforms and Rural Development. The soundness of Cambodia s PFM system will strongly impact rural development outcomes Pro-rural development policies will only be as effective as the PFM system which manages this policy objective. The current weaknesses in Cambodia s PFM system are a real threat to the effective implementation of the NSDP and its rural poverty reduction agenda. Increasing the quality of PFM systems in rural development is a key policy priority for Government and the ADB because improving policy implementation in these productive sectors directly contributes to economic growth prospects. Service delivery extension in these sectors is key for the rehabilitation of the countries rural road network, for the provision of safe water and for the extension of agriculture services. 9. The Government recognized the challenge of rolling out PFM reforms to the rural development ministries (and to all other line ministries). Involvement of rural development ministries and a sense of ownership of the PFMRP by these ministries will be a pre-requisite to PFMRP success. Building capacity of the MRD, MOWRAM, and MAFF for timely budget preparation; efficiency of budget execution; accounting accuracy; comprehensive and timely financial reporting; and internal audit is a priority. The underlying emphasis for PFM reforms in these Ministries is continued development of capacity through acquisition of knowledge, skills, and leadership qualities (capacity development activities and change management measures). Human resources are the key to make reform successful in MRD, MOWRAM, and MAFF. This requires that there be sufficient incentives and motivational development to support the reform and capacity development program.

4 4 Figure 1: Reform Linkages Links between the National Strategic Development Program, Public Financial Management Reform Program (PFRMP 2), Rural Development Priorities, and ADB Country Strategy Program Pillars NSDP Priorities Establishing a core of good governance 2. Maintaining the broad environment for strategy implementation 3. Enhancing the agricultural sector 4. Improving physical infrastructure 5. Promoting private sector-led growth and job creation 6. Building capacity and human capital The Rectangular Strategy Growth (RSG), for Employment, Equity and Efficiency in Cambodia Good governance 2. Good environment for policy implementation 3. Four strategic growth rectangles (1) agricultural sector; (2) private sector growth and employment; (3) continued rehabilitation and construction of physical infrastructure; and (4) capacity building and human resource development. PFMRP Priorities by Platform Platform 1. Increase budget credibility, strengthen macro fiscal and revenue forecasting and streamline spending Platform 2. Implement effective financial accountability Platform 3. Achieve a fully affordable policy agenda through policy budget linkage Platform 4. Achieve effective program Platform 2/CAP2 Core Areas Continuing P1 activities including rollout to line Ministries at central and provincial levels 2. Implementation of P2 activities: Strengthen horizontal and vertical lines of accountability Improve instruments for responsible financial management Implementation of the new budget classification and chart of accounts Improved budget and financial management systems Improved accounting, financial reporting and transparency Improved auditing and inspection Further developing the fiscal decentralization and strategy Implementation of stage 2 capacity development plan Strategy Agriculture & Water , Agriculture Sector Strategy Plan and MRD Key Priorities a 1. Institutional capacity building and management support program (institutional capacity within MAFF, MOWRAM, MRD and in sub-national entities) 2. Agricultural and agri-business support program 3. Water resources, irrigation and land management program 4. Other rural infrastructure (transport, electricity) 5. Increasing access to rural finance 6. Extension of service delivery to sub national institutions including provincial line ministries CSP (2005-9) Pillars 1. Broad-based economic growth including investments in agriculture and irrigation 2. Inclusive social development including through provision of rural water supply and sanitation facilities 3. Good governance, through improvements in public financial CAP = Consolidated Action Plan, CSP = Country Strategy Program, MAFF = Ministry of Agriculture Forestry and Fisheries, MOWRAM = Ministry of Water Resources, MRD = Ministry of Rural Development, NSDP = National Strategic Development Plan, PFMRP = Public Financial Management Reform Program, RSG = Rectangular Strategy for Growth, SAW = Strategy for Agriculture and Water a The Ministry of Rural Development does not have a sector strategy developed at present. However, priorities have been identified in the Strategic Budget Framework Budget III. MACROECONOMIC DEVELOPMENT 10. Cambodia s overall macroeconomic performance has been positive over the last five years, high growth rates have been sustained, and poverty has been

5 5 reduced. However surging price inflation is now a growing concern for the economy. Growth averaged 11.1% between 2003 and Albeit, that growth has been primarily concentrated in garments, tourism, and construction, suggesting a need for economic diversification to protect the economy from a global downturn. In line with a rapidly growing economy, Cambodia s money supply has been increasing rapidly, partly as a response to a growing demand for credit from the private sector, and partly due to increasing capital inflows from foreign direct investors (FDI). Notwithstanding, economic growth has supported national poverty reduction levels, but income inequality is on the rise. 11. Cambodia s fiscal performance has been positive, but revenue mobilization remains relatively weak. The Budget deficit has declined from 5.4 % to 2.0 % between 2003 and Total expenditure has fallen over the period as has the domestic funded share of the State budget. Government measures to strengthen tax collection have resulted in an increase in the revenue effort, but, at 11.3% of gross domestic product (GDP) in 2007, budget revenue as a percentage of GDP remained low relative to other countries at comparable stages of development. Oil and gas discoveries could provide a significant source of future revenue, underlying the establishment of an adequate legal and policy framework to maximize the potential benefits. 12. Rural poverty and social and income inequality rates remain a concern for Cambodia s most vulnerable. In Cambodia 80 % of the population and 90% of the country s poor live in rural areas. Current poverty rates in rural and inaccessible areas are nearly double the poverty rate in urban areas Cambodia s poorest areas need greater access to basic goods and services such as clean water, education, and health services. Therefore, the efficiency of public resources targeted for rural development and increasing private sector led economic opportunities in rural areas could support a more equitable and sustainable growth trajectory. Given this priority, the roadmap for improving Cambodia s development prospects would include the following - increasing revenue and decentralization of resource management, improving the capacity of rural ministries to deliver services, investment in rural infrastructure, and reducing the cost of doing business. 13. Inflation is a major concern for Cambodia s development prospects in the near-term and the monetary and fiscal authorities are taking action. After remaining in the single digits in recent years, inflation has accelerated sharply since September 2007 when it registered at 6.4% annual consumer price inflation. It is likely that inflation has risen further in recent months, fuelled by rapid credit expansion, capital inflows, and rising food and energy prices. To counteract inflationary pressures, the Government has been building up its deposits in the banking sector to offset liquidity growth, and the National Bank of Cambodia (NBC) has doubled the minimum reserve requirement to 16 % (effective July), and allowed, upon proper verification, domestic banks to invest a higher proportion of their surplus funds abroad. The Ministry of Finance (MOF) has also announced a series of structural measures to help curb food inflation over the longer-term. IV. PFM SECTOR CHALLENGES AND OPPORTUNITIES 14. PFM in Cambodia. A strong PFM system supports aggregate control of budget resources, prioritization, accountability, and efficiency in the management of public resources and delivery of services, which are critical to the achievement of public policy objectives, including the Millennium Development Goals (MDGs). Effective PFM systems are also critical for ensuring effectiveness of donor financial assistance since aid is

6 6 increasingly provided through modalities that make use of national PFM systems. They are also required to ensure the sustainability of rural development and economic growth in the long term. Effective PFM systems moderate fiduciary risks since they increase transparency, thereby reducing the scope for irregularities. However, budget control effectiveness could be limited by other factors such as a weak legal and regulatory framework and human resource capacity constraints. 15. The budget process in Cambodia requires to be strengthened in a number of areas. Cambodia suffers from scarcity of budget resources; domestic revenues are inadequate (about 11% of GDP), which is well below the average of low income Asian countries (16%) and donor resources substantially account for capital investments each year although investment funding is still inadequate in most areas. As a result, budget planning exercises produce budget unrealistic estimations, and ultimately lead to under-funded service delivery outcomes. Furthermore governance weaknesses result in resources not reaching their targeted beneficiaries. In order to overcome these deficiencies a number of areas need strengthening. Firstly, there is need to institute effective control mechanisms in the procurement processes. Some progress in legislation has been made in this regard which will hopefully produce a positive impact on the ground. Secondly, the regulatory framework at the central level in the sector ministries to monitor procurement practices needs to be revamped. In recent years, deficiencies in procurement have highlighted risks to donor assisted programs and projects. 3 Thirdly, there is need to strengthen the accountability chains, without which the effectiveness of the budget as an instrument to affect poverty outcomes would be undermined. Fourthly, there is an urgent need to address the need for capacity building within the Government. In the area of PFM, there is a scarcity of qualified and competent finance specialists and line managers. There are visible asymmetries in roles, resources allocated and responsibilities assigned. 16. Positively, progress in PFM reforms has contributed to more effective and efficient directing of public spending towards poverty reduction. To date priorities include preparation for using revenues that are expected to flow from oil and gas within a few years; reallocating spending towards priority goals; raising capital spending; and emphasizing economic sectors (roads, irrigation, energy) that shape distribution of opportunities and the pattern of growth). 17. The PFRMP. The PFMRP is a multi-stage program to reform Cambodia s PFM system implemented from 2005, with a ten year planning and implementation horizon. It was designed in response to the systemic weaknesses identified above in all aspects of PFM. The first stage of the PFMRP, Platform 1, was completed in Platform 1 was rolled out as a preparatory phase to improve budget credibility and the day to day management of public resources by delivering a reliable and predictable resource envelope to individual managers. Activities undertaken in stage 1 included improving the comprehensiveness of budget formulation and execution, improved realism and sustainability of the budget (developing a revenue and borrowing strategy, improving the macro-fiscal framework and revenue capacity and developing a debt management function) and streamlining the ability of budget holders to spend in line with their budget approvals (streamlining the commitments and payments process including outsourcing of MEF financial controllers to selected line ministries, reform and deconcentration of the procurement process from MEF to line ministries, increasing use of the banking system rather than cash for government transactions, commencing the consolidation of government bank accounts into a Treasury Single Account and arrears were totally eliminated. 3 An ADB funded independent Institutional Corruption Risk of Assessment of Cambodia s MRD conducted in May/June 2007 found that MRD s financial and accountability systems are in need of reform and significant reform measures are necessary to reach good PFM standards.

7 7 18. In addition, a number of activities were undertaken in Stage 1 in preparation for later platforms. Internal audit capacity was developed in MEF and internal audit units were established in 23 of 35 spending agencies. Preparatory work was commenced to establish a government-wide Financial Management Information System (FMIS). A program budgeting structure was piloted in seven selected ministries and work commenced on a framework for fiscal decentralisation to lower level administrations in later platforms. 19. An independent review of the program in mid 2007 (the External Advisory Panel) found that much progress had been made in meeting the program s objectives for Platform 1 and that the program had reached out significantly to spending agencies (procurement, payments, cash management and arrears reforms, introduction of internal auditing, piloting of program budgeting and PFM training). However, the review also found that the reforms had acquired only limited take up in the spending agencies and that further consolidation would be necessary in later platforms. 20. For the second stage of the program, the Government with assistance from development partners has prepared a Platform 2 framework and has approved its implementation between late 2008 and The theme of Platform 2 will be to improve accountability for achieving effective financial management so that civil servants at all levels feel responsible for how they manage and control public finances. 21. The overall goal of Platform 2 of the PFMRP is to improve accountability for achieving effective financial management. Therefore the main theme of Platform 2 is increased accountability of those who are responsible for the safe, efficient and effective management of public resources. Building capacity in internal auditing has been identified as a key objective in the PFMRP towards achieving this goal. An effective internal auditing function will ensure that adequate control systems are established so that assets are safeguarded; financial reports are reliable; laws and policies and procedures are complied with; resources are used economically, efficiently and effectively; and the overall objectives of the entity are achieved. The challenges facing internal audit units are to ensure that capacity is built so that they can deliver a professional service and that the top management supports the effective functioning of an independent internal audit activity. 22. To broaden the program, its oversight and direction will be carried out by a reconstituted PFM Reform Steering Committee whose membership has been widened to include all budget institutions. In addition, the Government has required by sub-decree that all ministries establish PFM Working Groups to plan and implement PFM reforms in individual spending agencies. 23. The NAA. In 2000 the RGC enacted the Law on Audit with the assistance of ADB TA No In 2002 the ADB provided another TA No to support the development of the NAA, the supreme audit institution in Cambodia that has responsibility for executing the external auditing function of the government. The NAA is an independent audit organization reporting directly to the National Assembly and the Auditor-General is appointed by the National Assembly. The NAA is provided with a financial budget from the MEF and approximately 225 staffs are employed. The NAA is headed by the Auditor General with two Deputy Auditor Generals. The NAA undertakes audits of ministries and public enterprises and audit reports are submitted to the National Assembly. The lack of experienced audit staff is a serious constraint and strengthening professional competence will require considerable investment in capacity building in various fields of auditing. 24. The Rural Sector. Economic growth has contributed to significant poverty reduction in Cambodia, but the impacts have not been equally spread across the population. Between the first household survey in 1993/4 and the most recent in 2004, poverty fell by around a quarter (from 47 percent in 1993/4 to 34.7 percent in 2004). However, in rural areas this

8 8 figure was higher at 39.2 percent of the population in According to a World Bank Study on inequality (2007) Cambodia s average living standards as measured by consumption of goods and services per capita per day, increased by 32 percent in real terms between 1993/4 and However, rural living standards rose much more slowly than in Phnom Penh. Income inequality levels have stabilized between rural and urban areas since the late 1990 s. However, progress in reducing income inequality between rural and urban areas is still a priority for Government and Development Partners. 25. A key thrust of the NSDP is to encourage growth in rural areas, and in particular in the agricultural sector. Agriculture which employs 70 percent of the rural population (who are 90 percent of total population) and accounts for about one third of GDP remains vulnerable to external shocks and to unfavorable weather conditions. Productivity in the agriculture sector is also low. The NSDP aims to reduce vulnerability of the sector and identifies increasing agricultural productivity through land reforms, expanding rural credit and other measures as key areas for progress. Infrastructure in rural areas is also a critical area for development, to ensure rural poverty reduction and to reduce income inequality between rural and urban areas since this will increase access of rural dwellers to services and to markets for distribution of goods and services. The NSDP identifies the following objectives for rural development which are to be implemented by MRD: (i) restored and repaired rural roads of 25,000 km s length, (ii) increase the ratio of rural people who have access to sanitary water to 45%, and (iii) increase the ratio of rural people who have access to hygiene services to 25%. 26. The Ministry of Agriculture (MOA) has a Sector Strategic Plan which outlines the policy objectives of the MOA such as increasing agricultural productivity and reducing the sectors exposure to external shocks. The Water and Agriculture sectors have a joint strategic plan for , developed by the Technical Working Group on Agriculture and Water (TWGAW), focused on development of agriculture and agri-business, land and water resources management, and irrigation development. This framework is developed with the aim of assisting farmer and rural communities to increase food security and income generation, reduce vulnerability, increase the surplus of agricultural products for processing and exports, sustainable management and development of land, irrigation and water resources. Increasing institutional capacity for the management of the agriculture and water resources program including in the areas of PFM is one of the key focuses of their strategy. 27. In sum, the rural development Ministries are supported by a broad policy framework at the national level and rural Ministries are trying to coordinate their sector policies by for instance creating the joint strategic plan for water and agriculture. A strategy for rural development, which is fully integrated in an operational sense, should be a priority to coordinate different initiatives. The significant role and contribution of the productive versus the social sectors in the process of rural development should also be strengthened. Policies should also be harmonized and prioritized across and within sectors in the rural development Ministries to avoid policy overlap and improve coordination between the three rural focused Ministries. 28. Public Financial Management and Rural Development. Pro-rural development policies will only be as effective as the PFM system which finances this policy objective. The current areas which need to be strengthened in Cambodia s PFM system as described above continue to pose some challenges to the effective implementation of the NSDP and its rural poverty reduction agenda. Moreover, as Cambodia moves forward with its reform agenda the financial management system will also have to evolve to cope with the increased pressure of a more technically challenging policy and planning environment, such as will be required for the movement away from the current system of line budgeting to programmatic budgeting. Implementation and impact of the rural development objectives identified in the NSDP is also limited by scarcity of budget resources to finance policy implementation.

9 9 29. Although the NSDP has resulted in some degree of operationalization of sector policy, the plan does not adequately address prioritization of budget expenditure between sectors. The combined executed share of the recurrent budget for the Water, Agriculture and Rural Development Ministries was equivalent to 0.35% of GDP in 2006 or 4.4 % of total recurrent expenditure. Although rural development comprises more than the shares allocated to these three sectors, that is resources are also allocated for health, education, which are roughly 20 percent of the recurrent budget, and other infrastructure, current expenditure allocated to the three priority ministries for rural development is still comparatively low in relation to development needs. In addition, resources available for activities in these sectors do not have identified sources of financing and/or their total cost is beyond the amounts available from current government or donor resources. In order to meet the objectives for rural development outlined in NSDP these sectors will require sustained funding from external sources, an increase in the domestic resource mobilization efforts, as well as a consideration by the Government of a reallocation of expenditure into the social and productive sectors in order to reduce income inequality between rural and urban areas, and to meet the poverty reduction objective of reducing poverty to 31 % by 2010 in line with the NSDP target. 30. In conjunction to the efforts made on the part of the Government to improve its PFM system and to meet the objectives for rural development established in the NSDP, so to should development partners in Cambodia ensure that they are working in line with international best practices for aid provision and that development partners interventions are directly aligned with those of the Government. Donor interventions in the rural sector in Cambodia have to date tended to be piecemeal in nature and as a result the rural sector is highly projectized, which creates problems for creating an integrated approach to planning and to budgeting. Development partners should ensure that their projects and programs in the rural sector are coordinated and streamlined with the Government sector policies. In addition, development partners should prioritize the utilization of government systems for the delivery of their projects and move towards more efficient modalities for the delivery of aid such as programmatic support to the national budget or to individual sectors. Finally, development partners should ensure that the distribution of donor resources between the social and productive sources, be aligned to Government priorities, rather than supply driven by donor priorities established at the headquarter level. 31. The three Ministries supporting Rural Development are restricted by the existing system in the area of PFM, which require urgent addressing if they are to efficiently implement their sector policies and increase service delivery in rural areas. Some of these issues are outlined below: Line agencies such as Agriculture, Water, and Rural Development currently rely on an incremental approach to planning and budgeting. There is a limited link between annual expenditure planning and medium term planning and financing in MAFF, MRD, and MOWRAM. Whereas the health and education sectors have relatively strong sector budget planning, the rural development ministries are still at an early stage of developing the linkages between their policies, programs, and the budget process. Finance departments in line ministries have limited control over allocating and disbursing funds to provincial departments. Also, reporting of expenditure and revenue execution from provincial departments to central ministries is limited. Implementation of the planned fiscal decentralization should therefore have an impact on increasing the

10 10 role of the rural line departments in the management of their own sectoral budget resources. The Public Investment Program (PIP) for the investment budget has not had the desired effect on the expenditure management process and in guiding expenditure outcomes in the area of rural development. The budget execution process is currently delinked from the actual budget proposal prepared by rural Ministries for the capital budget. However, this should be partially overcome in future through the implementation of the budget strategic plan (IBSP). Capacity limitations in MRD, MAFF, and MOWRAM are a going concern. In addition there is weak coordination between the three ministries in the area of rural development policy which has led to examples of program duplication in the past. There is limited line agency discretion; in particular most rural ministries are unable to reallocate spending across line items in response to emerging needs. The reporting, accounting and internal control systems require improvements in rural development ministries, since they currently result in a weak control environment. 32. Support to improve operational efficiency and effectiveness of ministries dealing with rural development is urgently required. Reforms leading to timely and predictable release of funds to targeted rural beneficiaries can significantly increase budget execution rates for pro-poor sectors, and increase value for money of spending of scarce resources. At the same time, a strengthened PFM system will ensure accountability of service providers to targeted beneficiaries by rationalizing expenditure policy and enhancing financial accountability by reducing fiduciary risks to public funds. As such, reform of PFM and in particular support to key ministries which support rural development are key to ensure a further reduction in rural poverty levels and for the promotion of more equitable urban rural growth trajectories in the country. 33. Platform 1, of necessity, placed heavy emphasis on building capacity first in MEF by internal restructuring of the ministry and introduction of a Merit Based Pay Initiative to provide incentives to civil servants to facilitate the reform process. However, in order to address current weaknesses in PFM in the three priority spending agencies, it will be important to build commensurate capacity by rolling out the training program and other measures designed under Consolidated Action Plan 2 (CAP2) to these rural focused Ministries. To deliver the same level of training and capacity building to the three priority rural line ministries, the Government has agreed to additional technical assistance support from the ADB for training and capacity building in the area of PFM for MAFF, MOWRAM, and MRD to be delivered in conjunction and without overlap to the MEF s Capacity Development Plan under CAP2. In addition, the establishment of a longer term view on civil service salary reform can help to address the current incentive weaknesses in the three line ministries. A. Objective and Scope V. PROPOSED PROGRAM 34. ADB is processing a grant to the Government to strengthen PFM. The grant is currently estimated at $12.1 million, comprising a grant program component of $ 8 million and a grant project component of $ 4.1 million. Recognizing that the Government may need a longer time to achieve progress in PFM, ADB is committed to long-term support through a cluster program with the first subprogram being a sector development program. The second

11 11 subprogram of the overall cluster is currently estimated at $15 million. The project component will address institutional capacity development. 35. The subprograms will facilitate successful implementation of Government s PFM reform strategy, through Program policy prior actions. Prior Actions are prior anticipated actions to be accomplished satisfactorily before grant disbursement. The Program includes milestones which are significant policy measures, programs or strategies/plans, or activities that help accomplish the prior actions and achievements towards the Government s medium term goals. 36. To ensure the above outcomes, a policy reform program has been initiated over the period June 2006 to March 2009 to improve governance for macroeconomic growth, to strengthen PFM in rural development ministries, and strengthen external audit. These policy measures are included under Subprogram 1 which will be submitted to the ADB Board for consideration in December It will comprise approximately 30 policy measures as accomplished between June 2006 and the end of September Of these policy measures identified under subprogram 1, 23 have already been accomplished. The Mission proposes seven prior actions to be accomplished by end September Subprogram 2 will be submitted to the ADB Board for consideration in 2010 upon completion of the key triggers. The Program proposes technical assistance with priorities given to public debt management, internal audit, PFM in rural development ministries and strengthening NAA. Appendix 2 presents the proposed Policy Matrix for the Cluster Program which details the policy actions for sub program 1 and policy triggers and milestones for Subprogram 2. The Design and Monitoring Framework that details, impact, outcome, output, input and activities with milestones is in Appendix 3. Progress on Implementation of Subprogram 1 is in Appendix 4. Technical assistance (TA) support (Appendix 5) will be provided and implemented simultaneously with Subprogram 1. Over the next several weeks details of the TA terms of reference for consulting services and costing will be developed and discussed with the Government. B. Program Benefits 37. The program is expected to yield significant benefits as effective PFM systems are crucial for Cambodia to make progress in reducing poverty. Sound financial management in government underlines affordability and optimality in resource allocation and informs good PFM practices. Besides, PFM improves institutional arrangements and management practices to support efficient and effective delivery of public services. The program is geared to increased aggregate fiscal discipline. Lack of budget discipline and budgetary realism can lead to mismatches between policies and resources. By allocating resources in accordance with strategic priorities, the Program will ensure greater linkages between policy making, planning and budgeting for programs which are essential prerequisites for sustainable budgetary outcomes. The budget system should ensure reallocation from lesser to higher priorities and from less to more effective programs, thereby achieving allocative efficiency. By improving comprehensiveness and transparency in budget formulation, and ensuring effective budget execution, including procurement practices, accounting and reporting, the Program will ensure gains in operational efficiency and promote transparent and costeffective public expenditure management. This will ensure value for money and effective controls on expenditure. In addition, by providing greater focus on performance, external accountability, audit and scrutiny, as well as effectiveness of management oversight and internal control, the Program will foster greater accountability and efficiency in the management of public resources and delivery of services, which are critical to the achievement of public policy objectives, including achievement of the NSDP objectives and CMDGs. By strengthening institutions such as the NAA, the Program will strengthen a critical pillar of the national integrity system that will improve fiduciary oversight and will be a

12 12 bulwark against malfeasance in resource use. Overall, strengthened PFM systems will enhance development effectiveness. C. Impact and Outcome 38. The program impact will strengthen PFM as an enabling condition for poverty reduction and good governance in support of rural development. The outcome would be the ministries dealing with rural development will improve PFM capacities for achieving aggregate fiscal discipline, good prioritization of resources and efficient delivery of public services in a transparent and accountable way D. The Program Grant 1. Component 1. Improving Governance for Macroeconomic Growth 39. Debt management capacity was strengthened in MEF in PFMRP Platform 1 to enhance budget resource mobilization and to improve the sustainability of the budget. A debt management database has been installed and standard operating procedures prepared, including a debt management manual. In PFMRP Platform 2 continuing activity is expected including preparation of a debt management sub-decree and strategy, establishment of a middle office function in the Debt Management Office in MEF and enhanced training in use of the debt management database. 40. A major activity in PFMRP Platform 1 has been to streamline the ability of budget agencies to spend in line with their budget provisions. To that end, MEF has decentralized procurement to spending agencies under a new procurement decree and prakas and implemented annual procurement plans. Within certain monetary thresholds ministries are now free to make their own procurement decisions without MEF approval. Procurement reform will be taken further in Platform 2 by the introduction of a Procurement Law and new implementing rules and regulations, by implementing ex-post reviews of ministry procurement activity by MEF and further training of procurement staff in line ministries. More transparent and competitive procurement will be encouraged by requiring line ministries to post all bidding opportunities to a government procurement website. 41. The budget execution rate is being improved and fiduciary risks reduced by increased use of the banking system (rather than cash) for government transactions, improved cash management including further consolidation of government bank accounts and streamlining of government expenditure commitments and payments processes. Fiscal transparency is being increased by the publication of an annual budget summary and further transparency reforms are planned for PFMRP Platform 2 including publication of an annual budget document, in-year budget execution reports and public release of audited public financial accounts after they have been submitted to the National Assembly. Institutional changes completed in PFMRP Platform 1 have included the implementation of a Merit Based Pay Initiative (MBPI) in MEF to provide incentives to civil servants for improved performance and to participate in the PFM reforms. MBPI will be extended to some other line ministries in Platform 2 of the program, possibly as part of a wider civil service reform program. 2. Component 2. Strengthened Financial Management in the Rural Sector 42. Significant progress has been made in PFM reform in the rural ministries (MAFF, MOWRAM, and MRD) during the PFMRP Platform 1 period of 2005 to Budget planning has been improved by the introduction of Budget Strategic Plans which link preparation of the budget to ministries strategic goals at a number of pilot ministries

13 13 including MAFF and MRD. Further improvements in budget planning will be introduced during Platform 2 by extending the use of the Medium Term Expenditure Framework to most budget agencies and by including all donor-funded program and project funding in the state budget from Budget preparation and execution have been improved by the introduction in line ministries of new economic and administrative classifications in the chart of accounts and budget classification, which are being extended further to include standardized functional and program classifications from Planning for a government-wide FMIS has progressed in Platform 1 and MAFF will be included in the system on a pilot basis with several other ministries and provincial treasuries from The new system is expected to significantly improve the efficiency of budget execution and budget reporting. A monitoring and evaluation framework for service delivery has been prepared under an ADB TA project and introduced in MAFF. The framework will be introduced in MOWRAM and MRD as their new mechanism for monitoring service delivery. 45. Harmonized project management procedures have been developed jointly by the World Bank and ADB. MAFF, MOWRAM, and MRD are adopting the Standard Operating Procedures, the Procurement Manual and the Financial Management Manual from the new procedures and will be applying them to the execution of all bank-funded projects and programs. 46. Strengthening capacity in procurement will contribute to efficient budget execution and minimize fiduciary risks. As of 2007 all ADB financed projects for Cambodia have adopted GGFs which have been signed by the Government. Such GGFs include various fiduciary risk mitigation measures that the Government needs to implement related to (i) procurement, (ii) fiduciary management, (iii) complaints and remedies mechanisms, (iv) code of ethical conduct, (v) sanction, and (vi) certain project specific elements. 47. Internal audit is in the early stages of introduction in Cambodia. The Law on Audit of 2000 requires each ministry and state enterprise to establish an internal audit department. An internal audit sub-decree was passed in 2005 and 23 budget-funded agencies have established an internal audit department. Internal audit departments in MOWRAM and MAFF were established in 2007 and staff appointed. MRD is in the process of preparing a subdecree to establish its internal audit unit. 48 The capacity for effective internal audit in line ministries remains low, however, and extensive training will be provided to MAFF, MOWRAM, and MRD under the program to improve their capacity to undertake effective internal audit evaluations. Also, it is expected that procedures will be established for ministries senior managements to take effective action to implement internal audit recommendations. 49 The Economics and Finance Institute (EFI) of MEF has prepared a PFM capacity development plan covering a wide range of training and personnel development activities to be undertaken during PFMRP Platform 2. MAFF, MOWRAM, and MRD staff will participate fully in these activities with training to be provided by the EFI or by ADB-funded advisers to the rural development ministries. 50. An organic law on administrative arrangements for sub-national levels of government was passed in March 2008 and a sub-national financial law has been drafted by MEF. MAFF, MOWRAM, and MRD will discuss with the Ministry of Interior and MEF in planning the assignment or delegation of appropriate roles and responsibilities for service delivery to provinces and districts. MAFF, MOWRAM, and MRD will also be involved in implementing

14 14 new financial arrangements, including assigned and shared revenues and fiscal grants, for sub-national administrations. 3. Component 3. Strengthened External Audit 51. Two vital functions for establishing accountability over public resources are internal and external audit. The PFMRP has recognized the importance of the NAA as the key institution that will independently report to the parliament and the public on whether public resources have been accounted for and managed efficiently and effectively. To enable NAA to discharge its obligations properly it is essential that the NAA has the skills and competence to undertake audits in a professional manner. Following international good practices, this ADB TA will support a cluster approach over the medium term in supporting NAA. The ADB will support an audit peer review for making recommendations for NAA strengthening, assist in preparing implementation subdecrees for the Audit Law, support capacity building in undertaking financial, compliance and performance audits of projects funded by overseas development assistance. VI. IMPLEMENTATION ARRANGEMENTS A. EA and IA, Funds Flow arrangements, Reporting, Procurement, Auditing 52. Implementation arrangements for PFMPCRD. Given the thrust of the proposed PFMCPRD for strengthening public financial management in rural development ministries, it is proposed that the MEF be the EA through its PFMRP Steering Committee (PFMRPSC) Secretariat. As such, MEF would proactively monitor and facilitate the implementation of the agreed reform actions to ensure that they are met in a timely manner. MAFF, MRD, MOWRAM would act as the IAs. Other key IAs (of focused TA projects) would be the Economics and Financial Institute, MEF, Department of Internal Audit, MEF, and Department of Investment and Cooperation (DIC), National Treasury and MAFF, MRD, and MOWRAM (Appendix 6). Besides, NAA would be the EA for the audit component of PFMPCRD and also function as the IA for the TA project for strengthening the effectiveness of NAA. 53. Program management. MEF as the EA will be responsible for the overall implementation of subprogram 1, including complying with all policy actions, program administration, disbursements, and maintenance of all program records. The program will utilize coordination and program management structures established by the government and development partners of the PFMRP. The institutional arrangement for Stage 2 of PFMRP is built around (i) Economic and Financial Policy Committee which is the government level body chaired by the Senior Minister, MEF with other key ministers of the government; (ii) PFMRPSC chaired by Secretary of State of the MEF and other senior Government officials from all ministries; (iii) Technical Working Group level which is comprised of PFMRPSC and development partners to monitor the PFM Program; and (iv) a PFM technical working group at each spending ministry and budget entity chaired by the member of PFMRPSC. The Public Financial Reform Program Steering Committee will be the steering committee for this program. 54. Subprogram I as a single tranche grant will be from June 2006 to 31 March There are seven prior policy actions under subprogram 1 to be completed prior to the end of September 2008, which are set out in the policy matrix at Appendix 2. An additional 23 policy accomplishments are acknowledged under Subprogram 1 and provide the foundations for further reforms and capacity building under subsequent Subprogram 2. The Government and ADB will prepare a completion report for subprogram 1 by June 2009, which, subject to subprogram 2 being approved, will be used as part of the overall program completion report. The proposed single-tranche grant for Subprogram 1 of $8 million would help the Government meet its medium-term financing needs.