Cambodia: Preparing the Strengthening of Public Financial Management for Rural Development Projects

Technical Assistance Consultant s Report Project Number: TA 4988 CAM September 2008 Cambodia: Preparing the Strengthening of Public Financial Management for Rural Development Projects Draft Final Report: September 2008 Prepared by Les Henning, Nihal Fernandopulle and Russell Leith Cambodia This consultant s report does not necessarily reflect the views of ADB or the Government concerned, and ADB and the Government cannot be held liable for its contents. (For project preparatory technical assistance: All the views expressed herein may not be incorporated into the proposed project s design.)

CONTENTS I. BACKGROUND AND INTRODUCTION 1 A. Objectives of the Technical Assistance 1 B. Implementation of the Technical Assistance 1 C. Rural Sector Description and Objectives 2 D. ADB Involvement in the Rural Sector 3 II. PUBLIC FINANCIAL MANAGEMENT REFORM 4 A. The Public Financial Management Reform Program (PFMRP) 4 B. PFMPR in Rural Development Ministries 6 C. ADB s Contribution to PFMRP 9 D. External Audit Function 9 E. Internal Audit Function 10 F. Inter-governmental Financial Relations 13 III. OTHER ACTIVITIES AND OUTPUTS 15 A. PFMRP Annual Retreat 15 B. Equipment Procurement 15 APPENDICES APPENDIX 1 LIST OF PERSONS MET 16 APPENDIX 2 22 Appendix 2A Summary of PFM Reform Program 23 Appendix 2B ADB Submission on Cambodia PFMRP, Stage 2 Framework 28 APPENDIX 3 Reviews of the Financial Management and Planning Functions of 32 MAFF, MRD and MOWRAM, Final Report APPENDIX 4 MAFF PFM Capacity Development Plan 92 APPENDIX 5 MOWRAM PFM Capacity Development Plan 133 APPENDIX 6 MRD PFM Capacity Development Plan 173 APPENDIX 7 NAA Draft Capacity Building and Training Plan for Loan Projects 213 APPENDIX 8 Assessment of International Audit Function in MOWRAM 224 APPENDIX 9 Assessment of International Audit Function in MAFF 264 APPENDIX 10 Assessment of International Audit Sub-Decree 290 APPENDIX 11 322 Appendix 11A - Report on workshops held for the NAA on auditing loan projects 322 September 2008 Page i

Appendix 11B Report on workshops held for Internal Audit in MAFF and MOWARM 325 Appendix 11C Timetable to develop internal audit manuals for MAFF and MOWARM 328 Appendix 11D Elements of internal audit work plans for MAFF and MOWARM 333 Appendix 11E MAFF and MOWRAM organizational structures 338 Appendix 11F Networking Arrangements between NAA and Internal Audit: TOR and 352 cost estimates APPENDIX 12 Cambodia Draft Law on Administration Management of Capital, 356 Provinces, Municipalities, Districts and Khans September 2008 Page ii

ABBREVIATIONS ADB AusAID CAP CARM D and D DPC EAP FMIS IFAPER IMF MAFF MOEYS MOI MEF MOWRAM MRD NAA NSDP PFM PFMPCRD PFMRP PPTA RGC RRP TA TORs WB Asian Development Bank Australian Agency for International Development Consolidated Action Plan Cambodia Regional Mission (ADB country office) Devolution and deconcentration Development Partners Committee External Advisory Panel Financial Management Information System Integrated Fiduciary Assessment and Public Expenditure Review International Monetary Fund Ministry of Agriculture Forestry and Fisheries Ministry of Education Youth and Sport Ministry of Interior Ministry of Economy and Finance Ministry of Water Resources and Meteorology Ministry of Rural Development National Audit Authority National Strategic Development Plan Public financial management Public Financial Management Program Cluster for Rural Development Public Financial Management Reform Program Project preparatory technical assistance Royal Government of Cambodia Report and Recommendation of the President (of the ADB) Technical assistance Terms of reference World Bank September 2008 Page iii

I. BACKGROUND AND INTRODUCTION A. Objectives of the Technical Assistance 1. The overall objective of the PPTA has been twofold: to assist RGC rural development minsitries in planning to improve their public financial management (PFM) capacity particularly under PFMRP and, secondly, to assist ADB to design a program to aid those agencies in improving their PFM capacity. The activities of the PPTA have been directed at producing six main outputs: (i) an update on progress of the Public Financial Management Reform Program (PFMRP) during its Platform 1 implementation and during planning for Platform 2, (ii) review of progress in implementing PFM reforms in MAFF, MOWRAM and MRD, (iii) review of the implementation of the internal audit function in the three line ministries, (iv) review of the capacity of the NAA to carry out an effective external audit function, (v) training needs analyses of MAFF, MOWRAM, MRD and NAA to assess their need for PFM-related training and other skills development and (vi) preparation of capacity development plans for MAFF, MOWRAM, MRD to provide for PFM-related and other types of capacity development in those ministries. B. Implementation of the Technical Assistance 2. The PPTA (4988CAM: Preparing the Strengthening of Public Financial Management for Rural Development Project) was intended to be implemented between December 2007 and August 2008. However, because of delays in recruitment of consultants, the implementation period has been from March to September 2008. 3. The executing agency for the project has been the MEF and the implementing agencies have been MAFF, MOWRAM, MRD and NAA. 4. The project commenced on 3 March 2008. Mr Les Henning, Public Financial Management Specialist/Team Leader, provided in-country inputs to the project from 3 March to 10 May and from 2 June to 30 August 2008. Mr Russell Leith, Institutional Development Specialist, provided inputs between 3 and 22 April, 14 May and 6 June, 17 June and 11 July and 24 July and 20 August 2008. Mr Nihal Fernandopulle, Audit Specialist, provided inputs between 6 and 20 April, 1 and 12 May, 11 June and 17 July and 28 July and 27 August 2008. National consultants Mr Ros Kheng, Budget Consultant, Mr Many Cheng, Capacity Development Consultant and Mr Nop Saravoan, Audit Consultant, have been employed continuously with the project since 10 February, 27 March and 5 May respectively. 5. A project inception report including work plan was submitted to the authorities and the ADB in early April 2008 and a mid-term report on progress to 30 June 2008 was submitted in early July. The PPTA team made a presentation of PPTA findings and recommendations to representatives of MEF, MAFF, MOWRAM, MRD and ADB in Phnom Penh on 26 August. 6. While accompanying ADB missions and during project interviews the project has met with a large number of officials from MEF, MAFF, MOWRAM, MRD and NAA and with other donor agencies. Team members have established good working relations with all of these officials and the project team is very grateful for the cooperation and assistance it has received. A list of persons met during the PPTA is included in Appendix 1 below. September 2008 Page 1

C. Rural Sector Description and Objectives 7. High economic growth rates since the mid-1990s have contributed to significant poverty reduction in Cambodia (from 47 per cent of the population in 1993-94 to 34.7 per cent in 2004 (latest figures available)). However, the impacts of growth have not been evenly spread and rural poverty at 39.2 per cent remained significantly higher than the national average in 2004. 8. The RGC is committed to sustaining high rates of economic growth and in meeting its Millennium Development Goal (MDG) targets. As Cambodia s poverty reduction strategy, the National Strategic Development Plan (NSDP) 2006-2010 builds on the MDG targets and outlines a strategy for reducing poverty through rural development. Of the NSDP s Rectangular Strategy s four key components there are two which directly affect rural development: (A) Enhancement of the Agricultural Sector by (i) improving productivity and diversifying the agricultural sector, (ii) land reform and mine clearance, (iii) fisheries reform and (iv) forestry reform and (B) Further Rehabilitation and Construction of Physical Infrastructure through (i) further construction of transport infrastructure and (ii) management of water resources and irrigation. Of the 43 high level development targets set in the NSDP 2006-2010, eight are directly in the rural development sector and are shown in the following table. Table 1: NSDP 2006-2010 Targets Target ENHANCE AGRICULTURAL PRODUCTION AND PRODUCTIVITY Actual 2005 Target 2010 Paddy yield per hectare (tons) 1.97 2.4 Irrigated land including supplemental irrigation (% of rice area) Land reform: land titles to farmers (% of total agricultural land) 20 25 12 24 RURAL DEVELOPMENT Rural roads rehabilitated (kms-out of 28,000) 22,700 25,000 Safe drinking water access (% of rural population) 41.6 45 Sanitation access (% of rural population) 16.4 25 ENVIRONMENTAL SUSTAINABILITY Forest cover (% of total area) 60 58 Fuel wood dependency 83.9 61 September 2008 Page 2

9. The most challenging strategic goal for the rural sector, however, will be to reach the target of reducing poverty to below 25 percent of the total population by 2010, from 34.7 percent in 2004. Because, as indicated above, a higher proportion of the poor live in rural areas, meeting the NSDP poverty reduction goal by 2010 will require welltargeted and increasingly efficient public sector programs, as well as significant private investment. 10. A serious deficiency in Cambodia s public financial management system has been the low budget execution rate by ministries, i.e. rural ministries actual expenditures have frequently fallen significantly short of their approved budgets. For example, Ministry of Agriculture, Forestry and Fisheries spent only 90 percent of its current budget in 2003, although it increased its disbursement rate to 96.9 percent by 2007. Ministry of Rural Development increased its rate of current spending from 80.5 percent to 93.3 percent of approved budget over the same period and Ministry of Water Resources spending rate declined from 95.9 percent to 93.5 percent of budget over the same period. Poor PFM systems in line ministries have serious impacts on the efficiency and effectiveness of service delivery of line ministries programs and thus the attainment of poverty reduction goals. D. ADB Involvement in the Rural Sector. 11. From the resumption of ADB operations in1993 to the end of 2007, ADB had supported the agriculture and natural resources sectors with a total approved amount of $125.5 million (five loans, one grant project and 25 technical assistances (TAs)). This comprises approximately one quarter of the total assistance approved by ADB for Cambodia. At the end of 2007, continuing loans and grants (three project loans, one program loan and one project grant) for agriculture and natural resources totaled $83.59 million or 15.9 per cent of ADB s active portfolio in Cambodia. Also, in late 2007, the active TA portfolio in the agriculture and natural resources sector totaled nine projects for a total value of $7.05 million. September 2008 Page 3

II. PUBLIC FINANCIAL MANAGEMENT REFORM A. The Public Financial Management Reform Program (PFMRP) 12. PFMRP was adopted in December 2004 in response to observed weaknesses 1 (low budget execution rates, excessive payment arrears, fiduciary risks associated with cash-based transactions systems, low resource mobilization rates and poor control systems) in public financial management (PFM) 2. PFMRP was established as a 10-year reform program, based on a sequenced platform approach: Platform 1: Making the budget more credible in terms of timely and predictable delivery of funds (including improving the comprehensiveness of the budget; strengthening macro-fiscal and revenue forecasting and streamlining spending processes); Platform 2: Implementing effective financial accountability; Platform 3: Achieving a fully affordable policy agenda through policy-budget linkage; and Platform 4: Achieving effective program performance accountability. 13. Stage 1 of the program covered the period 2005 to 2007, with 2007 also being designated as a transition year for planning the changes needed to move to Stage 2 of the program. The methodology in Stage 1 of the PFMRP was to design and implement a series of activities (and related actions) that would contribute directly to meeting the objectives of Platform 1 as well as a set of activities which were deemed to be prerequisites for commencement of Platforms 2, 3 and 4 in later years. 14. Major outputs of Platform 1 of the program included (i) establishment of a revenue mobilization strategy, together with improved macro-fiscal planning, (ii) improved resource flows from improved revenue collection techniques in National Treasury (also assisted by strong economic growth), improved cash management (including consolidating several hundred government bank accounts into the Treasury Single Account) and increased use of the banking system (rather than cash) for government transactions, (iii) incorporation of off-budget revenues into the budget, (iv) implementation of a debt management function in MEF, (v) streamlining the expenditure commitments and payments system to improve budget holders ability to spend in line with budget provision, (vi) reduction in the stock of payment arrears and measures to avoid re-accumulation of arrears and (vii) implementation of revised procurement procedures. 15. Activities undertaken in Stage 1 as prerequisites for later platforms included (i) redesign of the chart of accounts and budget classification and (ii) initial design of a government-wide Financial Management Information System, (iii) introduction of an internal audit function, (iv) redesign of the budget cycle, introduction of program budgeting on a pilot basis in selected ministries, (v) investigating options for fiscal decentralization and (vi) completion of a PFM capacity development plan. 16. The PFMRP was reviewed by an independent External Advisory Panel in early 2007. As a result of the review, it was recognized at the annual PFMRP retreat in Siem 1 World Bank/ADB, Integrated Fiduciary Assessment and Public Expenditure Review, 2004 2 MEF, Public Financial Management Reform Program: Strengthening Governance in Cambodia through Enhanced Public Financial Management, 2004 September 2008 Page 4

Reap in April 2007 that, while not all activities proposed under Platform 1 had been fully completed, sufficient progress had been made for the overall objectives of Platform 1 to have been substantially achieved and for planning for Platform 2 to commence. 17. MEF prepared, in consultation with development partners, a framework for implementing Stage 2 of the PFMRP from 2008 to 2010 in the document Building on Improved Budget Credibility toward Achieving Better Financial Accountability (also known as the PFMRP Consolidated Action Plan Stage 2 (CAP2)), which outlines the proposed second stage and the second platform of the PFMRP. 18. The activities in Stage 2 are grouped in three main types; (i) continuing Platform 1 activities that need to be strengthened in Stage 2, (ii) Platform 2 activities that are to be implemented in Stage 2 and (iii) activities for later platforms (3 and 4) which need to be commenced in 2008. 19. The continuing Platform 1 activities are (i) to further improve revenue policy and administration, (ii) debt management and (iii) cash and bank account management. The activities planned for Platform 2 are: (i) improving lines of accountability by clarifying roles, functions and responsibilities between levels of government and within spending agencies, (ii) improved instruments for encouraging responsible financial management including an incentives and sanctions regime, (iii) further completing implementation of the chart of accounts and the budget classification, (iv) improved budget implementation and financial management by further streamlining of the commitments and payments system and commencing implementation of the FMIS, (v) improved accounting, financial reporting and transparency by adoption of international accounting standards, quarterly and annual budget execution reporting and an improved budget document, (vi) completing the coverage and strengthening internal audit in line ministries, (vii) developing fiscal decentralization policy and strategy and (viii) building institutional capacity and motivational measures. Activities planned for Stage 2 as prerequisites for later platforms include (i) further integration of the recurrent and capital budgets, (ii) further inclusion of off-budget revenues and expenditures in the budget and (iii) further implementation of program budgeting. 20. The PPTA prepared a summary and comments on the PFMRP Stage 1 outcomes and activities proposed for Stage 2, a summary table of which can be found in Appendix 2A (full details can be found in Appendix 1 of the Mid Term Review). Also, the PPTA prepared the ADB s submission to the RGC on the CAP2 which is included as Appendix 2B. In the submission the ADB indicated that it strongly supported the proposed framework as a suitable basis for Stage 2 of the program, but suggested some options for strengthening the framework. These were (i) inclusion of specific internal audit training activities for line ministries, (ii) further clarification of line ministries intended involvement in internal audit, program budgeting and further reform of the commitments and payments system. Also, clarification was required on whether further action would be required in Stage 2 on certain Platform 1 activities which remained incomplete (further out-posting of financial controllers to line ministries, preparation of an IT strategy, additional public expenditure tracking surveys (PETS) and completion of government asset registers. 21. CAP2 was adopted as the framework for PFMRP Stage 2 at the annual program retreat in June 2008, with implementation to commence in late 2008. September 2008 Page 5

B. PFMRP in Rural Development Ministries 22. While much of the focus of Stage 1 was on activities in MEF, line ministries also had a major role in its implementation. The involvement of line ministries including MAFF, MOWRAM and MRD in Stage 1 has included (i) streamlining the commitments and payments system (by removing commitments requirements for salaries and nonprocurement purchasing and out-posting financial controllers to selected ministries), (ii) consolidation of ministries bank accounts to the Treasury Single Account in National Treasury to improve cash management and reduce fiduciary risks, (iii) reducing ministries payment arrears (which were paid out by MEF) to improve their ability to meet current year expenditures, (iv) deconcentration of procurement by introducing new purchasing procedures including raising the thresholds for line ministries to do their own procurement without prior MEF approval, (v) introduction of internal audit units in line ministries (units were set up in MAFF and MOWRAM but not MRD), (vi) introduction of program budgeting on a pilot basis in seven ministries (including MAFF and MRD, but not MOWRAM) and (vii) introduction of strategic budget plans in the budget preparation process as a first step to linking budget planning and policy priorities. 23. While there has been significant progress with the Platform 1 objective (improved budget credibility) (revenue out-turns are now within five per cent of budget estimates, MAFF s expenditure execution rate has increased from 94 to 97 per cent between 2005 and 2007, MRD s increased from 90 to 93 per cent and MOWRAM s from 89 to 93 per cent), many of the reforms particularly at line ministry level have had limited impact and may not be sustainable in the longer term without further reinforcement. 3 For example, while 23 of 35 budget-funded agencies have established internal audit units, it is unclear which, if any, are producing good quality audit reports, Further, despite efforts to rationalize the number of government bank accounts, ministries still hold a large number of accounts (about 1,800). (However, the rural development ministries hold only small numbers of accounts.) 24. In planning for PFMRP Stage 2, MEF has recognized the need for greater involvement of line ministries in the program in order to (i) meet the Platform 2 objective of increased financial accountability and (ii) strengthen the reforms, which were introduced in Platform 1. There will also be a need to commence or strengthen activities, which are prerequisites for Platform 3 and 4. The assistance to be provided under the proposed ADB program cluster will be directed at meeting these objectives. 25. MAFF, MOWRAM and MRD will be brought into PFMRP implementation more closely in Platform 2 by including them (along with representatives of all other line ministries) on the PFM Reform Committee, the high level group that sets the policy direction and oversights implementation of the program. Also, all line ministries will be required to prepare their own PFM Ministry Action Plan and a PFM Capacity Building Plan. 26. Further enhancements of Platform 1 activities which will be implemented between 2008 and 2010 will include (i) further improvement of revenue policy and collection including implementation of an oil and gas revenue policy (It is expected that ministries such as MAFF which have significant non-tax revenues should review and periodically adjust the rates of their fees and charges) and (ii) further improvements in public procurement including implementation of procurement rules and regulations and 3 External Advisory Panel report, 2007 September 2008 Page 6

standard bidding documents, MEF ex-post monitoring of ministries procurements and greater transparency of bidding opportunities. (All ministries will be required to participate in the further procurement reforms.) 27. Other Stage 2 activities in which MAFF, MOWRAM and MRD will participate are (i) improving accountability by defining appropriate financial responsibilities between management levels in ministries (and between levels of government), (ii) implementing the new economic and administrative classifications in the chart of accounts and budget classification by 2009 and the new functional classification by 2010, (iii) improved and more frequent budget reporting, (iv) further deepening of internal auditing procedures introduced in Platform 1 including MEF quality control of internal audit reports and (v) implementation of new financial arrangements at sub-national level pursuant to the deconcentration and devolution organic law passed in 2008. 28. Further work will be undertaken in preparation for activities, which are to be fully implemented in Platforms 3 and 4 from 2011 to 2015. MRD and MAFF as pilot ministries for program budgeting will be required to review and amend their program structures and budgeting procedures in the light of lessons learned in Platform 1. All ministries will be required to bring donor-funded programs and projects into their budget preparation cycle to the greatest extent possible. 29. A major focus of Platform 2 will be capacity building in line ministries under the PFM capacity development plan prepared by the Economics and Finance Institute (EFI) of MEF in 2007 and approved by the Government as the blueprint for PFM capacity building until 2010. The plan provides for extensive (up to 8,000 participants across the public sector) training in 33 different PFM technical skills, (ii) broader skills development training (leadership, management), (iii) new human resources policies (accelerated advancement, job rotation, overseas scholarships and study tours). It is also proposed that the Merit Based Pay Initiative will become available to all line ministries to extend incentives to staff to improve their performance and to participate in the PFMRP. The proposed TAs to MAFF, MOWRAM, MRD and NAA under the proposed ADB program cluster should be designed to fit seamlessly with the PFM capacity development plan. 30. To assist the line ministries to prepare for PFMRP Stage 2 and for the ADB to design activities for its proposed rural development program cluster, the PPTA has carried out functional reviews of the finance and planning departments of MAFF, MOWRAM and MRD with the cooperation of the staffs of those ministries. The reviews, which are reported at Appendix 3, confirmed earlier findings such as those of the 2007 EAP that the take-up of PFM reforms in line ministries between 2005 and 2007 had been slight. 31. The main findings of the reviews were that (i) estimated receipts and expenditures of donor projects (which can comprise a large proportion of the resources available to the three ministries) were not being included in preparation of the ministries budgets, (ii) there was poor or non-existent coordination in including provincial departments budget estimates in the ministries budgets preparation, (iii) there was poor coordination between preparing the program and non-program budgets (MAFF and MRD), (iv) there was inadequate reporting of budget execution by provincial departments during the fiscal year, (v) accounting systems in the three ministries are rudimentary (although MAFF is introducing a commercial accounting package prior to its inclusion in the FMIS pilot in 2010), (vi) the internal audit function was not yet well developed in the two ministries (MAFF and MOWRAM) in which it had been introduced, (vii) although new procurement procedures had been introduced, fiduciary risks associated with public procurement by the ministries appeared to be still high and (viii) September 2008 Page 7

only a small, and probably inadequate, amount of PFM training had been provided to line ministries (in MOWRAM only three staff had attended PFM training provided by MEF during Stage 1). 32. The results of the reviews indicated that significant effort would be required in MAFF, MOWRAM and MRD for institutional and staff capacity building during PFMRP Stage 2. The reviews showed that there is a need for significant strengthening of PFM activities which were commenced in Platform 1 such as improving budget comprehensiveness (i.e. inclusion of off-budget revenue and expenditure items in the budget), procurement procedures, internal audit and implementation of the new chart of accounts, as well as the activities scheduled for Platform 2 such as improved accounting and budget execution reporting. The reviews also suggest that further effort will be required to consolidate program budgeting in the two ministries (MAFF and MRD) in which it has been piloted. There is a need for MAFF to engage with MEF in planning for introduction of FMIS. 33. To assist line ministries and ADB further in implementing PFM reforms, the PPTA prepared PFM capacity development plans for MAFF, MOWRAM and MRD, based on training needs assessments carried out in cooperation with the staffs of those respective ministries. 34. The methodology of the training needs assessments comprised three parts: (i) identification of the PFM training and other capacity development needs specified or implied in the PFMRP Stage 2 framework (CAP2) which included the PFM capacity development plan, (ii) by using the PFM Working Group in each ministry as a focus group in which middle to senior managers in the finance, planning and internal audit departments were asked to identify the development needs of their staff and themselves and (iii) a survey of the staff in the finance, planning and internal audit departments of the ministries to ascertain their views on their organization, their prior experience, training and qualifications and their perceived needs for their own development. The focus groups and surveys sought views on general skills development as well as focusing specifically on PFM training needs. Seventy-four respondents in MAFF, 33 in MOWRAM and 50 in MRD completed the survey questionnaire. 35. The responses, which are summarized in attachments to the capacity development plans for MAFF, MOWRAM and MRD, are included in Appendices 4, 5 and 6 respectively. The respondents indicated needs for a wide range of training in PFM topics which are to be provided in the EFI s proposed schedule of training as well as other activities not currently scheduled by EFI such as enhanced procurement and internal audit training. 36. The capacity development plans have matched the demand for training with the scheduled training program which EFI proposes to deliver between 2008 and 2010. The proposed plans allocate a proportion of training places to each ministry for all of the PFM and related courses which EFI proposes to offer. In addition, the plans propose training in other areas not presently covered by the EFI schedule. These additional courses include enhanced internal audit, enhanced procurement, program budgeting, commitments and payments system changes, preparing budget execution reports, monitoring and evaluation techniques and implementing devolution and deconcentration. The training plan for each ministry also includes proposed staff numbers to be trained, training modality and implementation period. Training of rural development ministry staff on these supplementary topics would be suitable for inclusion in the proposed ADB TA project. September 2008 Page 8

37. Other general development topics included in the training plans were business English, report and project proposal writing skills, project management, supervisory skills and basic and advanced IT packages. Consideration should also be given to including these topics in the ADB TA project or funding them from the project s resources. 38. The capacity development plans also identified other personal development measures which would be suitable for finance and planning staff of the three ministries. These include scholarship schemes offered by various development partners, study tours and in-country courses such as the Japan/ADB Public Policy Training Program. The capacity development plans also recommend that the members of the PFM Working Group in each ministry should be admitted to the Merit Based Pay Initiative (MBPI) as a first step in extending that scheme to line ministries. An option which should be considered in relation to MBPI is whether funding of the scheme in the three rural development ministries would be eligible expenditure in the ADB TA project. 39. The PPTA was requested by the PFM Working Group in MRD to assist it in preparing the PFM Ministry Action Plan (MAP), which is the mandatory strategic plan for PFM reform activity in the ministry from 2008 to 2010. Although this task was additional to the existing TORs and work plan of the PPTA, the Director SEGF agreed that the PPTA should remain flexible in meeting ministry requests for ad hoc assistance and, as this appeared to be a significant activity, ADB would be prepared to rearrange other less significant activities from the PPTAs TORs and work plan, if necessary, to accommodate it. In the event, a draft of MRD s MAP was prepared within existing project resources and can be found in Appendix 5 of the Mid Term Review. The draft has been submitted to MEF for comment and has been developed further with MRD staff, including discussion of a work plan to implement its various components. As well as assisting the ministry develop its internal audit function (see section 2.5 below) and its PFM capacity development plan (as detailed above), the project has advised the PFM Working Group in MRD on options for joining the MBPI. C. ADB s Contribution to PFMRP 40. ADB has contributed significantly since 2005 to activities of the Public Financial Management Reform Program (PFMRP) Platform 1. ADB provided assistance to the RGC in TA No. 2566CAM-Developing Capacity in Audit and Inspectorate Functions to establish the National Audit Authority (NAA). In TA No. 3634CAM Strengthening Public Financial Management, ADB assisted the Government in 2004 and 2005 to (i) set up an internal audit function, initially in MEF and (ii) strengthen the institutional structure of the NAA. Also, the project assisted MEF to establish a medium term expenditure framework and a macroeconomic forecasting capability. In TA No. 4441CAM-Support to Public Financial Management Program, ADB assisted MEF to establish a debt management function. This activity involved setting up a debt management office in the ministry, installation of a debt management database, preparation of debt management procedures and a manual and staff capacity building. PFM-related technical assistance (although not formally part of the PFMRP) was provided to MAFF in TA No. 4428CAM- Strengthening National Program Budgeting for the Agriculture Sector which prepared a program-based financial management system including a new chart of accounts, a monitoring and evaluation framework and manual and a financial training manual. D. External Audit Function 41. The National Audit Authority which was established under the Audit Law of 2000 is the supreme audit institution of Cambodia which reports directly to the National September 2008 Page 9

Assembly and Senate. In recognition of its independent status, the external audit function has not been formally included in the PFMRP. However, it has been acknowledged that external audit of the public accounts and performance and compliance auditing are essential to ensuring accountability over public resources (including donor-funded projects) and therefore effective service delivery to the rural development sector. 42. As indicated above, ADB has provided significant assistance for establishing and strengthening the external audit function in two TAs between 1999 and 2003. In recognition of its lack of experienced audit staff and its lack of capacity to undertake certain activities such as performance auditing, the NAA has requested the ADB to provide further assistance to strengthen its capacity. Accordingly, the outputs of this PPTA will be used in the preparation of the proposed TA to strengthen capacity in the NAA under the ADB program cluster. 43. A major output of this PPTA has been the preparation of an assessment of the capacity of the NAA (Appendix 2 in the Mid Term Review). The main findings of the assessment were review of (i) the audit law and sub-decree, (ii) NAA s relationship with the legislature and legislative committees, (iii) NAA s structure, staffing, processes and procedures and (iv) NAA s relationship with the internal audit and inspectorate functions. The report also includes terms of reference for a proposed peer review of NAA by another national audit institution. RGC agreement in 2008 to such a peer review proceeding has been included as a policy action trigger for sub-program 1 of the proposed ADB program cluster. The report includes conclusions and recommendations for reform of the NAA and for improving its institutional and staff capacity. 44. Another significant output has been the completion of a capacity building plan for NAA which is included at Appendix 7. The plan is intended to fit under the NAA s Strategic Development Plan 2007-2011 and focuses particularly on training and capacity building for loan project audits. It proposes training for NAA staff in (i) RGC and donor procurement procedures and auditing of procurements, (ii) donor project financial management requirements, (iii) donor standard operating procedures, (iv) audit planning, (v) review and evaluation of internal controls including IT controls, (vi) loan arrangements and English language training to allow auditors to understand manuals etc. 45. Initial training was provided to NAA staff (including the Deputy Secretaries General) by the PPTA in July 2008. The workshops delivered 14 hours of contact time to 28 staff of the authority on the procedures for auditing loan projects. Further detail on the content of the training and the outcomes are shown in Appendix 11A. 46. The PPTA is assisting the NAA to undertake a pilot performance audit of an ADB development project for school construction in MOEYS (Second Education Sector Development Project: ADB Loan No. 2122CAM). As part of the pilot audit the consultants have been training the staff of the audit department responsible for loan projects in audit planning, determining audit objectives, developing the audit program, preparing internal control checklists and carrying out the audit. Training was also provided on the key features of the procurement, financial management and project management regulations. E. Internal Audit Function 47. An internal audit function was established in PFMRP Platform 1 as a prerequisite for achieving effective financial accountability which is the main thrust of September 2008 Page 10

PFMRP Platform 2. With ADB technical assistance, the Internal Audit Department in MEF was formed in 2005 by transfer of 20 staff from the General Inspections Department. Internal audit standards and a code of conduct were prepared by MEF and disseminated to line ministries. Some training in audit procedures was provided to line ministries by MEF. 48. The Audit Law of 2000 requires each ministry to establish an internal audit function in accordance with the sub-decree on internal audit (No. 40/ANK/BK of 2005). Internal audit units have been established in MAFF and MOWRAM and a draft subdecree to establish an internal audit function in MRD was approved by the Prime Minister in August 2008. The independent review by the External Advisory Panel (EAP) in early 2007 found that 19 ministries (subsequently increased to 24 of 35 budgetfunded agencies) had established internal audit units but that only seven were found to be operational. The EAP found that the capacity of these units to carry out internal audits effectively was low. The report cited the findings of a WB appraisal which identified (i) internal audit skills development, (ii) guidance on internal audit methodologies and (ii) acquisition of sufficient resources as major requirements of line ministry internal audit departments. 49. An effective internal audit function is essential in line ministries to strengthen internal controls processes to reduce fiduciary risks and to provide assurances to development partners and other stakeholders. In PFMRP Platform 2 it is intended to complete the coverage of internal audit to all line ministries and to strengthen capacity in all ministries in support of the Platform s main objective of increasing financial accountability. In continuation of its earlier assistance, the ADB program cluster will support a TA project to strengthen internal audit in MEF, MAFF, MRD and MOWRAM. 50. To support the preparation of that TA, the present PPTA has completed a number of outputs. Reviews of the internal audit capacity of MOWRAM and MAFF (shown at Appendices 8 and 9 respectively) have confirmed the view that capacity within the internal audit units is weak. 51. In the MOWRAM review it was found that, although the internal audit unit has a three year work plan and has produced five audit reports, its capacity to undertake audits at a professional standard remains low, due mainly to inexperience of the staff and lack of appropriate educational qualifications. Also there is no generally accepted auditing methodology in place and there are no internal audit procedures manuals. The report includes conclusions and recommendations for improving staff capacity and internal audit procedures, including a three year internal audit training plan which is at Annex E of the report. 52. The review of internal audit in MAFF reaches similar conclusions to the MOWRAM review. Generally, the capacity to undertake adequate internal audits is low and various measures to improve staff capacity and audit procedures will be required. The three year internal audit training plan outlined above is a generic plan and will be appropriate for MAFF and for MRD when its internal audit unit is established. 53. The PPTA assisted MAFF in undertaking a pilot audit of the payments cycle. The Agricultural Office of Steung Treng province was selected for the pilot audit. The internal audit department had scheduled to undertake this audit as part of its annual work plan for 2008 and the PPTA consultants assisted the audit team in executing this audit. The audit focused on evaluating the internal control systems relating to the payments system covering (i) repairs and maintenance of buildings and temples; (ii) accommodation expenses; and (iii) payments of subsidies to enterprises. These three September 2008 Page 11

items of expenditure represent over 50% of the total expenditure of the 2007 budget allocation for this province. 54. Audit objectives, audit programs and Internal Control Questionnaires were developed together with a detailed planning document. Several training sessions were conducted with the audit teams before the commencement of each phase of the field audit. 55. The PPTA prepared an assessment of the existing internal audit sub-decree which is included as Appendix 10. The assessment concluded that the internal audit sub-decree is adequate to enable the functioning of an effective and professional internal auditing activity in the public sector, as it has been based on the practices recommended by international internal auditing standards. The sub-decree can be strengthened further by introducing provisions to require the establishment of audit committees, permitting external appointments to the more senior positions in the ministry audit departments, permitting the use of short-term experts and contractors for specialized areas of internal audit, requiring an external assessment of the internal audit function once every five years and by requiring that the ministries develop and maintain proper auditing procedures manuals. 56. A two-day workshop on internal audit concepts and procedures was delivered to 33 audit staff of MAFF and MOWRAM in July 2008. Details of the training topics and the outcomes are also shown in Appendix 11B. 57. The PPTA prepared a report advising on the content which should be included in proposed internal audit procedures manuals for MAFF and MOWRAM. The report is included as Appendix 11C. Similarly, an outline of the elements which MAFF and MOWRAM will have to consider in preparing their annual internal audit work plans is included as Appendix 11D. The factors to be considered include: (i) the annual revenue and expenditure cycles, (ii) auditing of procurement, inventories and fixed assets, (iii) auditing of trading and semi-commercial operations (MAFF), (iv) efficiency and effectiveness of projects, (v) resettlement schemes (MOWRAM) and adequacy of disaster and emergency relief programs (MOWRAM). 58. The shortcomings in the current organizational structures of MAFF and MOWRAM s internal audit departments which were identified in the above reviews have been addressed in proposed new structures for the departments which are included in Appendix 11E. This appendix also includes proposed job descriptions for the various levels of audit staff in the two departments. Because of similarities in the functions of NAA and internal audit departments in line ministries there are risks of overlap and duplication occurring. For this reason, good coordination between these functions is essential and accordingly proposed arrangements for networking between the internal and external audit functions are outlined in Appendix 11F. 59. As indicated above, MRD proposes to establish a functional internal audit unit by the end of 2008. Sub-decree No 113 for establishing the internal audit department in MRD was approved by the Prime Minister on the 13 August 2008. A director and two deputy directors have since been appointed to IAD, although no other staff have yet been appointed. The department is not yet operational and the director has requested the assistance of the TA audit consultants to assist him during this initial stage of start up. 60. The project agreed with MRD s PFM Working Group that the domestic audit consultant will work with the Director of IAD during September 2008 to assist him to: September 2008 Page 12

Draft a Prakas for the IAD based on the requirements of the internal audit subdecree; Identify the key activities undertaken in the ministry; Draft a suitable organizational structure for the IA; Prepare an outline of the internal audit work plan; and Prepare position descriptions for each audit staff member 61. Advice was provided to the Director of IAD to increase awareness of the approach and purpose of internal audit and the techniques and methodologies that are used in modern internal auditing. The need to have a clear demarcation of responsibilities between the newly established internal audit function and the existing inspection function in MRD was also emphasized. F. Inter-governmental Financial Relations (Devolution and Deconcentration-D and D) 62. As the majority of Cambodia s poor live in rural areas, improving service delivery to rural communities is seen as an essential step for poverty alleviation. The 2003 IFAPER report noted that decentralization of service delivery responsibility is an essential part of public sector reform. Also, as noted by this project in the functional reviews of the three rural development ministries there is a lack of coordination between the central offices of the ministries and their provincial departments for budget planning and execution, thus detracting from the efficiency of service delivery in rural areas. 63. In PFMRP Platform 1 preparatory work on inter-governmental financial relations was commenced as a pre-requisite for reforms which were to be carried out in later platforms. In the 2007 EAP report progress was noted as (i) enactment in 2001 of a commune and sangkat organic law, (ii) setting up a Commune and Sangkat Fund (to receive central government funding equivalent to about 2.5 percent of recurrent expenditure each year) and (iii) establishment of a system of fiscal grants to communes and sangkats based on a simple fiscal equalisation formula. 64. However, the other levels of sub-national government (provinces, municipalities, districts, and khans) have lacked adequate legal mandates as to their institutional structures, roles and responsibilities (expenditure mandates) and revenue powers and sources. To this end, a devolution and deconcentration organic law was prepared and presented at a major conference in Sihanoukville. The PPTA consulted with the Development Partners D and D Working Group and the DPC on the draft law in March 2008 and prepared a summary and comments on the draft organic law (included at Appendix 12). As the law was introduced for passage to the National Assembly on 27 March 2008, there was no opportunity to engage the relevant ministries on the issues raised in the comments paper. 65. The organic law provides a clearly defined institutional basis for sub-national administrations. It legislates for expenditure responsibilities of the various levels of government to be determined and for a system of assigned revenue types (mostly nontax revenues), shared taxes (with the central government) and conditional and unconditional transfers from the central government to sub-national administrations, which are to be included in a law on the financial regime and asset management of subnational administrations. MEF has prepared drafts of the financial law, an early version of which was translated to English by the project team. September 2008 Page 13

66. However, the implementation provisions of the organic law have been deferred for inclusion in 32 further laws, decrees and sub-decrees. The National Committee on Deconcentration and Devolution (within MOI) with the assistance of high level officials from other ministries is currently working on developing these implementation arrangements, although it is unclear when these tasks will be completed. 67. The PFMRP Stage 2 framework provides for a detailed plan to be prepared to support initial implementation of the fiscal and financial provisions of the D and D organic law (Objective 27). Also, Objective 21 of the framework proposes that the budget holders and lines of accountability at the various levels of government be clearly defined as a basis for improving accountability. 68. Because further policy development has been delegated to the National Committee (and which went into abeyance during the period of the 2008 national elections), the PPTA has been unable to engage further with the authorities on D and D issues. However, after the National Committee has completed the assignment of expenditure roles and of revenue types to sub-national levels, line ministries will require considerable assistance to implement the new arrangements. Therefore, it is recommended that the TA on strengthening PFM reforms in the three rural development ministries remain flexible in responding to assistance needs for the new arrangements. September 2008 Page 14

III. OTHER ACTIVITIES AND OUTPUTS A. PFMRP Annual Retreat 69. MEF conducted its annual review meeting for the PFMRP on 28 and 29 May 2008, at which the Prime Minister launched Platform 2 of the program. The ADB Country Director was requested to deliver a closing address on behalf of the development partner community. Mr Russell Leith attended the retreat as an observer. B. Equipment Procurement 70. The project has completed procurement by competitive quotes of computers and other office equipment for the NAA, MAFF and MRD. This equipment is intended to contribute to increased productivity in these agencies. September 2008 Page 15

APPENDIX 1 LIST OF PERSONS MET September 2008 Page 16

MINISTRY OF ECONOMY AND FINANCE ( MEF) H.E. Aun Porn Moniroth H.E. Hang Chuon Naron Mr. Tep Vannda H.E. Vongsey Vissoth Mr. Sunly Thearith Mr You Channan Mr. Khuth Sakhan Secretary of State Secretary General, National Economic Council Assistant to H.E Hang Chuon Naron Deputy Secretary General Assistant to Deputy Secretary General Deputy Chief Director of Administration and Financial Management Department of Investment and Cooperation H.E. Chan Sothy Mr Pen Thirong Director of Department of Investment and Cooperation First Deputy Director of Department of Investment and Cooperation Mr. Chhuon Samrith Mr. Hak Ponnarin Ms Sun Naly Reform Committee Secretariat (RCS) Dr. Sok Saravuth Mr. Youk Bunna Mr. Bou Vong Sokha Mr. Bun Roith Mr. Nuon Vithya Chief, ADB Division Deputy Chief, ADB Division Deputy Director of Debt Management Unit Director of Department of Budget Management, PFM Reform Secretariat Deputy Head of Secretariat and Program Coordinator Liaison Officer for PFM Reform Committee at RCS Liaison Officer (CRS), Chief of Administrative Office (BD) Liaison Officer ( PFMRC) Mr. Ieng Auntouch Liaison Officer ( Revenue Group ) Internal Audit Department ( IAD ) Dr. Chea Vuthna Mr. Var Neov Non-Tax Revenue Department Mr. Aun Bunhak Mr. Thao Sokmuny Director of Internal Audit Department Director of Non-Tax Revenue Department Deputy Director of Non-Tax Revenue Department September 2008 Page 17