Country Financial Accountability Assessment Nicaragua...NICARAGUA COUNTRY FINANCIAL ACCOUNTABILITY...

January 13, 2003

Document of the World Bank

Report N

o. 27922-NI

Nicaragua

Country Financial A

ccountability Assessm

ent

Report No. 27922-NI

NicaraguaCountry Financial Accountability Assessment

Financial Management, Operations Support UnitLatin America and Caribbean Region

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Nicaragua Country Financial Accountability Assessment i

B C N CAW CFAA

CGR

CONPES

CPA CPAR

C T I

CUC CUT DAF

DGA DGCG

DGCP DGI DGP DGTEC DIGEFUP DMFAS

EC EFA-FTI

EMTAC

GTZ

HIPC IDA

IDB

IMF INTOSAI

IT MECD

MHCP

MAIN ABBREVIATIONS AND ACRONYMS

Central Bank o f Nicaragua Country Analytic Work Country Financial Accountability Assessment Controller General o f the Republic National Council for Economic and Social Planning ' Authorized Public Accountant Country Procurement Assessment Report Investments Technical Committee Single Accounting Entry Treasury Single Account Financial Administration Department Directorate o f Customs Directorate o f Government Accounting Directorate o f Public Credit Directorate o f Revenues Directorate o f Budget Directorate o f Technology Directorate o f Public Function Debt Management and Financial Analysis System European Commission Education for All - Fast Track Initiative Economic Management Technical Assistance Credit German Agency for Technical Cooperation Highly Indebted Poor Country International Development Association Inter-American Development Bank International Monetary Fund International Organization o f Supreme Audit Institutions Information Technology Ministry o f Education, Culture and Sports Ministry o f Finance and Public Credit

MINSA MOU

MTEF

NGO

OAF%

PBL PER PFM PRGF

PRSC

PRSP

PSAC

ROSC

SECEP

SGPRS

Ministry o f Health Memorandum O f Understanding Medium Term Expenditure Framework Non Governmental Organization Office of Fiscal and Economic Affairs Policy Based Loan Public Expenditure Review Public Financial Management Poverty Reduction and Growth Facility Poverty Reduction Support Credit Poverty Reduction Strategy Paper Programmatic Structural Adjustment Credit Report on Observance o f Standards and Codes Secretariat o f Strategy and Coordination of the Presidency Strengthened Growth and Poverty Reduction Strategy

SIDUNEA Customs system SIGADE

SIGFA

SILAIS SIT SNIP

SREC

SWAP TGR

UA

Debt Management and Financial Analysis System Integrated Financial Management System Local Health Care Service Units Tax Information System National Public Investment System Secretariat for Economic Relations and Cooperation Sector Wide Approach Treasurer General o f the Republic Customs Union

UCRESEP Coordination Unit for the Public Sector Reform and Modernization Program

WB World Bank

Nicaragua Country Financial Accountability Assessment 11

TABLE OF CONTENTS

MAIN ABBREVIATIONS AND ACRONYMS ........................................................................... i EXECUTIVE SUMMARY ..................................................................................................... i v CHAPTER 1 . BACKGROUND AND CONTEXT ..................................................................... 1

Country Background .............................................................................................. 1 Issues o f Economic Development ........................................................................ 2 IDA Assistance to Nicaragua ................................................................................. 3 IDB Assistance to Nicaragua ................................................................................ 4 Objectives and Scope ............................................................................................ 4 Methodology ......................................................................................................... 6

CHAPTER 2 . THE BUDGET SYSTEM ................................................................................. 8 Legal and Institutional Framework ........................................................................ 8

Formulation .......................................................................................................... 13 Execution ............................................................................................................ 14

Coverage and Information Provision .................................................................. 10

Reporting and Control ........................................................................................ 19

CHAPTER 3 . ANALYSIS. FINDINGS AND RECOMMENDATIONS ...................................... 22 Legal and Institutional Framework ...................................................................... 22 Budget Development .......................................................................................... 23 Integrated Financial Management System ........................................................... 25

Specific Aspects of Budget Execution ................................................................ 32 Monitoring and Evaluation ................................................................................. 33 Accounting and Financial Reporting .................................................................. 34

Public Participation .............................................................................................. 38

Treasury .............................................................................................................. 28 Internal Control and Internal Audit .................................................................... 30

External Auditing ................................................................................................ 36

Donor Coordination and Harmonization ............................................................ 39 Human Resources for PFM ................................................................................ 43 Debt Management and Contingent Liabilities ..................................................... 43 Revenue Issues ..................................................................................................... 45

. .

CHAPTER 4 . CONCLUSIONS AND ACTION PLAN ............................................................ 51 Conclusions .......................................................................................................... 51 General Principles o f Reform .............................................................................. 52 Action Plan for Improving PFM .......................................................................... 57

ANNEX 1 List of Persons Interviewed ................................................................... -63

... Nicaragua Country Financial Accountabilitv Assessment 111

ANNEX 2 Nicaragua: Capacity for External Aid Coordination ................................. .66 ANNEX 3 Financial Management and Audit Arrangements for SWAps.. ................... .74 ANNEX 4 Channelling IDA Disbursements through the Treasury Single Account ...... .79 ANNEX 5 Terms of Reference for Mainstreaming CFAA Action Plan ....................... 80

REFERENCES ....................................................................................................... 83

STATISTICAL ANNEX ............................................................................................ 87

The Country Financial Accountability Assessment (CFAA) i s a diagnostic tool that provides information to country governments and donors on the state of public financial management systems and identifies priorities for action.

This CFAA report was prepared by a team led by Manuel Vargas (Financial Management Specialist, WB) and comprising Stephen Doherty (Sr. Social Development Specialist, DB), Eduardo Zapico-Goni (Sr. Financial Management Specialist, WB), HernBn Pfluecker, Enrique Cosio, Jes6s Castejdn and Victor Caso (Consultants). Ki t ty Monterrey (Director of Technology and Integrated Financial Management System, MHCP) coordinated the CFAA on behalf of the Government of Nicaragua. Yolaina Montoya (WB) and Sobeyda Castillo (IDB) provided field support. Alicia Orellana and Gilma Unda (WB) provided administrative assistance. Suzanne Snell (WB) edited the document. Peer Reviewers are Suzana Abbott (Lead Operations Officer, WB), Sanjay Vani (Sr. Financial Management Specialist, WB), and IDB’s Management Review Committee.

The CFAA Team thanks the Minister of Finance and Public Credit, Mr. Eduardo Montealegre, for his collaboration and support. The Team also appreciates the extensive collaboration provided by Jamil Sopher (CAW Adviser, WB), Ulrich Lachler (Lead Economist, WB), Amparo BalliviBn (Country Manager, WB), Sandra Henderson, Susana Sitja (Modernization o f the State Specialists, IDB) and Eduardo Balckcel (Resident Repre sent at ive , IDB ) .

NICARAGUA COUNTRY FINANCIAL ACCOUNTABILITY ASSESSMENT

Executive Summary

1. The overarching goal of this Country Financial Accountability Assessment (CFAA) i s to assist the Government in achieving effective implementation of i t s strategy for strengthened growth and poverty reduction through good public financial management. The CFAA i s a joint document of the participating Banks, the World Bank and the Inter-American Development Bank.

Summary of Findings

2. The principal conclusions of this Country Financial Accountability Assessment are listed below, in order of presentation in the report.

Legal framework. The laws and regulations governing public financial management are generally sound, but there i s a growing need for consolidation and modernization.

0 Budget development. The Government has gradually improved budget classification, realism and participation of executing entities in i t s preparation. Still, there i s budget incrementalism and an effective separation of recurrent and investment budgeting. Moreover, the budget document does not fully encompass al l state funds and the traditional single-year budget planning system inhibits adequate public expenditure planning.

0 Financial management system. The Government’s integrated financial management system has considerably improved public financial management, establishing the concept of increased efficiency through integration of budgeting, accounting, treasury, public debt and procurement. The continued implementation, improvement and expansion of the system are critical to the overall financial management reform.

0 Treasury. Operation o f the treasury single account system has contributed significantly to effective cash position controls, but absence o f detailed cash flow programs and presence o f global budget transfers prevents adequate cash management.

0 Internal control and internal audit. While the integrated financial management system has allowed for effective central controls on overall spending, the internal control and internal audit capacity in spending entities needs improvements to provide effective assurances o f legality and efficiency of expenditures.

0 Decentralized budget execution. Despite an adequate legal framework and growing initiatives for de-concentration and decentralization o f budget execution, the

Nicaragua Countrv Financial Accountability Assessment V

underlying financial management systems s t i l l do not contribute to increased efficiency o f service delivery.

Monitoring and evaluation. Public investment planning capacity has increased, but deficient monitoring and evaluation systems help perpetuate the existence of obsolete and ineffective programs.

Accounting and financial reporting. Although budget execution reports are prepared on time, the lack of adequate government financial statements and institutionalized public sector accounting affects the review and analysis o f public finances.

0 External audit. A program for strengthening and modernization of the Controller General i s underway. In the meantime, the lack o f external audit reports on government financial statements i s a serious obstacle to transparency in public finances.

0 Public participation. The institutional foundations to allow for public participation in the scrutiny of public expenditure are already in place. But effective implementation w i l l require dealing with significant challenges posed by the lack of traditions o f consultation with the public and of meaningful public access to information, the abstract and complicated nature of available information on public finances, and the physical difficulty o f accessing the information.

0 Aid coordination. The Government i s proactively engaging the donor community in the development of a coordination and harmonization agenda. Still, the Government’s own internal coordination capacity must be strengthened if it wants to effectively reform external aid channeling practices that encourage over-investment, create costly parallel structures, and diffuse development effort.

0 Human resources. Although highly qualified managers can be found at certain institutions, the lack o f a proper civil service framework has inhibited the development of professional, adequately paid financial management and audit officers.

0 Debt management. Considerable capacity to manage and provide detailed information on foreign public debt has been developed, but there i s s t i l l a need for specific capacity upgrading o f internal debt management and for compilation of data on contingent liabilities. Overall, efforts underway to enhance coordination among the different bodies involved in public debt management need to continue.

0 Revenue systems. Although a program to modernize tax and customs administration i s underway, the revenue system’s administrative capacity remains generally weak and the coordination mechanisms for funding and reporting to the treasury need enhancements.

General Principles of Reform

3. Government of Nicaragua making a strong commitment to:

Substantial improvement in public sector financial management depends on the

Implement inter-institutional arrangements to monitor public financial management improvements. The Government would prepare an inter-institutional accord to implement the CFAA Action Plan. The principal objective o f the accord would be the establishment of a mechanism to monitor and document, on a quarterly basis, progress on the benchmarks included in the Action Plan. Key actions of the Plan would be incorporated in the reform program supported by the Poverty Reduction Support Credits (PRSC) and Policy-Based Loans (PBL).

0 Create a consolidated and modern Public Financial Management Law. The plethora of norms and regulations should be inventoried and analyzed to clearly determine all duplications, inconsistencies, and gaps relative to actual practice and technological advances. This inventory would serve as the basis for drafting a consolidated Public Financial Management Law and regulations to be presented to the National Assembly.

0 Implement comprehensive, well-planned and accountable budgeting. As a benchmark of the Phase I Action Plan, the Government would calculate the recurrent cost implications o f the Public Investment Program and increase disclosure of public funds in the budget document. The latter should also adequately classify capital and recurrent expenditures and be complemented with the macroeconomic framework and methodology used in i t s preparation. For Phase 11, the Government would prepare the budget under a medium-term expenditure framework, present complete accounts of Central Government revenues and expenditures in the budget document, break down the transfers and institutional and functional classifications, and relate specific outputs to budgeted costs to serve as a basis for ex-ante feasibility and ex-post evaluation.

Increase institutional and technical coverage of the integrated financial management system (SIGFA). The gradual implementation of the treasury, procurement, human resources and physical assets modules of SIGFA would run parallel, to enhancements in the system’s security and to extension o f coverage, at the individual transaction level, to key noncommercial entities o f the Executive and large implementation units such as hospitals (Phase 11).

Develop cash flow programming and extend coverage of the Treasury Single Account. The impact of the Treasury Single Account w i l l be limited if i t i s not extended, at individual transaction level, to key noncommercial Executive Branch spending entities. The extension of the Treasury Single Account would be a benchmark for Phase LI; actions in the shorter term should include the development of cash flow programs that would contribute to the substantial elimination o f decision- making in scheduling individual expenses and payments at the central level.

Nicaragua Country Financial Accountability Assessment v i i

Prepare and implement a plan to strengthen the internal control and internal audit system. Strengthening internal controls in Nicaragua’s environment w i l l necessarily imply the development of efficient ex-ante controls and correlated training and technological upgrading. In addition, the functions o f internal auditors must be clarified and they should also be given the independence they need vis-&vis the Controller General o f the Republic and the entities to which they report. The magnitude of this task requires a gradual process for which results in Phase I would be limited to the preparation of a realistic, sustainable, and comprehensive plan effectively owned by the Government, complemented with pilot expenditure tracking surveys.

0 Ensure sound financial management systems for efficient de-concentrated decentralized public service delivery. As the Government advances in the extension of autonomous schools and results-based health care units, the evaluation of the underlying financial management systems and the consequent determination of actions to help guarantee efficient and legal use of funds are crucial to the programs’ effectiveness, sustainability and credibility. The program of actions should be in place by the end of Phase I.

Establish a monitoring and evaluation system. To effectively evaluate performance in implementation of the development strategy and to identify ineffective programs, the Government would complement the financial information provided by the integrated financial management system with a Monitoring and Evaluation System, to be functional by Phase I.

Produce meaningful government financial statements. The budget execution report does not provide sufficient information to hold the Government accountable for i t s financial management. At a minimum, this report should be complemented with a cash balance reconciliation, historical expenditure data, level of payment arrears (Phase I), and execution presented to the same detail and coverage as the budget document, all under a plan to implement international standards and ensure full disclosure o f public sector financial statements (Phase 11). For this critical process to take place, restructuring of the government accounting function w i l l be required.

0 Produce independent and professional external audits o f government accounts. Under i t s modernization program, the Controller General would devote specific resources to prepare (Phase I) and execute (Phase 11) a realistic plan to produce a compliance/financial audit report o f public sector accounts in line with international standards. This process w i l l require not only upgrading o f sk i l ls and technology, but restructuring o f the Controller’s functions and governance arrangements.

0 Accelerate arrangements for public participation in the scrutiny of public finances. In an environment where formal control entities present weaknesses, fostering of social control mechanisms becomes even more important. As a f i rs t step, the Government should promptly present the draft Law on Public Access to Information to the National Assembly. Concrete arrangements for operationalizing the public’s rights of access to information on public finances would be established in

NicaraPua Country Financial Accountability Assessment v i i i

Phase I. B y Phase 11, the access, quality, and media used for dissemination would be substantially enhanced.

Institute effective coordination of external aid. In Phase I, a single and systematically reconciliated registry of public investments, including external aid, would be in place. Other key benchmarks would be: (i) agreement on financial management arrangements for sector-wide approaches; (ii) development of internal control and accountability procedures for use of funds by regional offices, non- governmental organizations and communities; and (iii) substantial quality improvements in the private audit function that certifies use o f external aid. Throughout the process, the use of the Treasury Single Account system for the channeling of external funds would be progressively increased.

0 Establish an adequate base of proficient public financial management and audit officers. The National Assembly should approve the Civ i l Service Law soon (HIPC Completion Point condition). The new merit-based pay scale and competencies policy should be promptly put into effect, along with specific training programs for financial managers and internal auditors on methodology to ensure legality and efficiency o f expenditures.

0 Maintain accurate data for debt management. Phase I actions would lead to effective coordination of the entities in charge o f public debt, with data clean-up and complete uploading o f debt information into a single database. In a longer term timeframe, calculation and proper disclosure of contingent liabilities would be achieved.

0 Enhance tax and customs administration. Under the program for strengthening o f tax and customs administration, adequate integrated recording procedures would be functioning, as agreed with the Treasurer General o f the Republic (Phase I). At the same time, the effects of forthcoming regional customs integration would be analysed and acted on, In Phase 11, arrangements for monitoring the tax gap, effective data- crossing mechanisms to support the inspection processes, and transferring the tax collection function to the banking system, would be put in place.


1. BACKGROUND AND CONTEXT

Country Background

1.1 Nicaragua i s the largest country in Central America in terms of land mass, and the least densely populated. Although more than half of the population now lives in urban areas, Nicaragua remains a predominantly agricultural country. The country’s principal exports are coffee, sugar-both o f which render the country very vulnerable to terms o f trade shocks- beef and seafood (shrimp and lobster). Non-traditional, maquila exports, mainly in the textile/garment sector, are growing rapidly. Nicaragua’s most important trading partner i s the United States, followed by i t s Central American neighbors. At the time of preparation o f this Country Financial Accountability Assessment (CFAA), creation o f the Central American Free Trade Area (CAFTA) was under negotiation.

1.2 The country i s one of the poorest and least developed in Latin America, with an income per capita officially valued at US$420 in 2001. I t s social indicators generally improved during the second half of the 1990s, with some exceptions, notably child malnutrition, access to water and sanitation, and literacy rates.

1.3 Nicaragua i s one of the most indebted countries in the world, and at the same time one of the most aid dependent. I t s external indebtedness i s scheduled to be significantly reduced through the multilateral debt relief initiative to Highly Indebted Poor Countries (HIPC), under which Nicaragua reached the Decision Point in 2000. Nicaragua’s economy also i s characterized by extremely high fiscal deficit (14 percent o f GDP, after grants, in 2001) and trade deficit (38 percent of GDP in 2001), which have been largely sustained in the past through equally high levels of foreign aid. The biggest macroeconomic challenge currently facing Nicaragua i s how to reduce i ts fiscal and external deficits to sustainable levels.

1.4 In recent years, efforts to strengthen the public sector witnessed important successes, such as the introduction of an integrated financial management system at the central government level, but also suffered a major setback at a global level in the wake o f constitutional reforms of 2000. Political accommodations during the reforms resulted in the division of key state institutions along party lines, including the Supreme Court o f Justice, the Controller General of the Republic (CGR), and the Supreme Electoral Council, which undermined their legitimacy.

1.5 During 2002, i t s f irst year in power, the new administration’s agenda has been dominated by a firm commitment to root out large scale-corruption and to increase transparency in the use of public funds. This effort has been widely recognized as an extremely positive initiative for the country’s development, but has occasioned some frictions with members of the previous administration that have led to impasses in the National Assembly.

IMF Staff Report for 2002 Article I V Consultation.

1.6 The first Poverty Reduction Strategy Paper (PRSP) Progress Report and Joint Staff Assessment were reviewed by the IDA and IMF Boards in December 2002. A new three- year Poverty Reduction and Growth Facility (PRGF), designed to put Nicaragua’s fiscal balances on a sustainable path, was approved by the IMF Board in December 2002.2

Issues of Economic Development

1.7 The Government’s Strengthened Growth and Poverty Reduction Strategy (SGPRS), as outlined in i t s PRSP and PRSP Progress Report, was prepared over a period of two years, involving broad-based participation from many sectors of society and support from virtually the entire international community. I t contains short-, medium- and long-term indicators for poverty reduction and Millennium Development Goals, with the overarching objective o f reducing the number of people living in extreme poverty from 19.4 percent of the population in 1993 to 9.3 percent in 2015.

1.8 The strategy rests on four pillars: (i) broad-based economic growth with an emphasis on productive employment generation and rural development; (ii) greater and better investment in the human capital of the poor; (iii) better protection for vulnerable populations; and (iv) the strengthening of institutions and good governance. These four pillars are intertwined with three cross-cutting themes: a reduction in environmental degradation and ecological vulnerability, an increase in social equity and further decentralization. The new administration has expressed i t s support for the strategy, with particular emphasis on the first and fourth pillars.

1.9 The leading developmental question for the CFAA i s then: How do current public financial management (PFM) practices and accountability arrangements in Nicaragua affect the SGPRS? In working through the implementation of the strategy, i t i s necessary to take account of five factors that are key to i t s effectiveness.

(a) Improving the climate for private sector investment (first pillar) w i l l depend in large part on the Government’s progress towards improving governance (fourth pillar). Clearly, transparent and accountable public financial management and independent and professional external controls are critical elements o f good governance - and are also means through which Government and the public can help establish that public resources are spent in accordance with agreed priorities.

(b) Effective institutional strengthening (fourth pillar) must be based on strong financial management systems and human resources that ensure legality and efficiently increase the impact of public expenditures.

(c) The ability of this aid-dependent Government to increase the impact of public expenditures w i l l necessarily be correlated to i t s capacity to coordinate and harmonize channeling of donor funds.

This section was based on the World Bank’s 2002 Nicaragua Country Assistance Strategy (CAS).


(d) Investments in human capital and protection for vulnerable groups (second and third pillars) wil l be effective only to the extent that government agencies develop the financial management capacity to allocate and use public funds in a manner that increases quality, relevance and timeliness of public service delivery.

(e) Implementation of the overall strategy w i l l be severely hampered if the Government i s unable to contain the fiscal deficit, manage public debt, meet the conditions for structural loans, and reach the HIPC Completion Point, all of which depend on effective underlying financial management systems.

1.10 The overarching goal of th is CFAA i s to assist the Government in addressing these challenges and achieving effective implementation of i t s development strategy, through good public financial management. This, in turn, wi l l provide the CFAA participating Banks (WBIIDB) with the best fiduciary assurance to their assistance to the country, which i s focused on the SGPRS.

IDA assistance to Nicaragua

1.1 1 The PRSP i s at the center o f the World Bank Group’s assistance framework for Nicaragua over the next three years, as presented in the 2002 Country Assistance Strategy. Planned IDA assistance involves an increased reliance on program lending, beginning with a Programmatic Structural Adjustment Credit (PSAC). Poverty Reduction Support Credits (PRSCs) w i l l follow, once it i s clear that the required environment for this type of assistance i s in place, i.e. that the public expenditure program adequately supports PRSP implementation, and that the Government shows strong commitment and progress in improving public financial management and procurement systems. Complementing the PRGF arrangement with the IMF, the PSAC and PRSCs wi l l provide assistance that i s conditioned on progress made in implementing specific measures contemplated in the PRSP, which coincide with key actions broadly identified in the HIPC Completion Point matrix.

1.12 Under this framework, the bulk o f IDA financial assistance eventually would be provided under the PRSCs. Remaining IDA operations would consist mainly o f technical assistance operations to help implement specific measures contemplated in the PRSP and highlighted in the PSACPRSC policy matrix. The move towards programmatic lending would undoubtedly improve the impact o f public programs through better donor coordination and stronger country ownership, and goes hand in hand with the transition toward sector-wide approaches (SWAPS), which i s being advocated b y the Nicaraguan Government and many donors.

1.13 Preliminary findings and recommendations from the preparatory work for this CFAA were incorporated to the Nicaragua Country Assistance Strategy and PSAC documents. Chapter 4 o f this CFAA establishes the probable linkages between the CFAA Action Plan and the PRSC Policy Matrix. Chapter 3 and Annex 3 address the main financial management implications o f SWAP support.


1.14 Implementation of the CFAA Action Plan w i l l be partially financed by IDA credits for Economic Management Technical Assistance (EMTAC I, ongoing; EMTAC 11, under preparation).

IDB assistance to Nicaragua

1.15 The objective of the Inter-American Development Bank’s 2003 Nicaragua Country Strategy, which w i l l guide IDB actions for approximately four years, i s to support the Nicaraguan Government’s efforts to attain the goals o f the SGPRS, which forms an integral part of the HIPC process. The actions included in the lending program are chiefly investments and short- and medium-term technical cooperation to tackle the three main challenges: economic growth, governance, and the productivity of the very poor. The strategy takes account of the confluence o f support from a number of bilateral and multilateral institutions, and w i l l generate synergies, avoid unnecessary duplications in programs, and favor coordinated execution of donor-supported programs.

1.16 In the specific area of supporting economic growth through strengthened fiscal policy, the IDB wi l l fund a number of operations, including a Modernization of the State and Fiscal Reform Policy Based Loan (PBL) aiming to reduce spending and increase tax collection, followed by a second PBL in the area of fiscal modernization. The preparation o f the above-mentioned PBLs w i l l produce specific linkages with the CFAA, which IDB Country Strategy regards as one of the elements to define actions required to strengthen fiscal policy.

1.17 Implementation of the CFAA Action Plan wi l l be partially financed by IDB’s ongoing loans for Strengthening of Tax and Customs Administration, and Strengthening o f the CGR, along with i ts technical cooperation programs o f Support for the National Council for Economic and Social Planning (CONPES), Strengthening of Private External Auditing Services, and the planned Strengthening of the Executive Branch’s Internal Audit System and Action Plan for Public Sector Modernization.

Objectives and Scope

The main objectives of the exercise are to:

Identify the main strengths and weaknesses of public sector financial accountability arrangements, and their implications for the effective implementation of Nicaragua’s growth and poverty reduction strategy and the application of PRSC, PBL, and HIPC resources.

Recommend a time-bound action program to improve Nicaragua’s public financial management systems. The action program includes reforms that could be supported by conditionality under the upcoming PRSCs and PBLs, and specific actions that could be incorporated to components o f technical assistance financed by the participating Banks and other Donors.

Nicaragua Country Financial Accountabilitv Assessment 5

1.19 As indicated in the WB 2003 CFAA Guidelines, CFAAs are not audits and do not seek to provide assurance on individual items of expenditure. Nor do they provide a “pass” or “fail” assessment of a country’s PFM system in terms of i t s adequacy for managing external funds.

1.20 This CFAA assesses PFM arrangements in the Executive Branch and the external audit function o f the CGR. The CFAA addresses the following themes, with exceptions as noted:

General legal and institutional framework. Since the framework i s well documented, the CFAA focus was on updating available information and evaluating mechanisms for enforcement.

Budget development. Budget planning and formulation issues are well documented, particularly in the WB’s Public Expenditure Review (PER).3 The CFAA work was thus limited to updating information from the PER and presenting the main issues from the PER in summarized form.

Budget execution. The CFAA analyzes the effectiveness of PFM arrangements related to the integrated financial management system, treasury operations, internal control and internal audit, performance monitoring and relevant aspects of de- concentrateddecentralized budget execution.

Fiscal reporting and transparency. The CFAA evaluates the strengths and weaknesses of the institutions and processes for accounting and financial reporting, external auditing, and public participation in scrutiny o f public finances.

Debt management and contingent liabilities. The CFAA looks into the adequacy o f institutional arrangements for debt management and the extent to which contingent liabilities are monitored. The CFAA does not address issues of debt policy or sustainability.

Revenue issues. The CFAA covers adequacy o f tax and customs practices vis-&-vis the overall PFM system, but not issues o f tax policy or administration.

Donor coordination and harmonization. The Government’s capacity to coordinate external aid and implement SWAP operations i s analyzed from a financial management perspective.

Human resources for PFM. The CFAA concentrates on the availability of qualified financial management professionals and major barriers to meeting this need.

1.21 Areas not covered by this CFAA are: legislative review of budget execution, local governments, public enterprises, investment projects, private sector, and the accounting profession.

World Bank, 2001. Nicaragua Public Expenditure Review.

Methodology

1.22 Internal coordination. The two participating Banks (WB and IDB) agreed to collaborate in the overall coordination of diagnostic work in financial accountability, as per their April 2001 Memorandum of Understanding, reaffirmed in March 2002.4 In carrying out the CFAA, the participating Banks organized joint missions, shared costs, and used a single methodology and the same procedures for quality assurance review and disclosure. A single joint CFAA document wi l l be issued. This approach i s fully compliant with the accords o f the 2003 Rome High Level Forum on Harmonization.

1.23 In parallel with the CFAA, the WB has prepared a Country Procurement Assessment Report (CPAR). The CFAA Team has closely coordinated i t s activities with the CPAR Team to ensure that the financial aspects related to procurement, such as internal controls, external audits, donor coordination and harmonization, were reviewed in a coordinated manner.

1.24 Coordination with the Government. The main government counterpart for the CFAA i s the Ministry o f Finance and Public Credit (MHCP). The CFAA work was coordinated by the Director o f Technology and Integrated Financial Management System, with whom the findings and recommendations were discussed.

1.25 Coordination with other Donors. The CFAA field missions included extensive consultations with the donor community. The European Commission (EC) wi l l undertake a “conformity and reality test,” a separate but complementary exercise to the CFAA. Coordination and information-sharing channels for the EC exercise have been agreed with the CFAA Team.

1.26 Data collection. The CFAA’s main sources o f information include: (i) reports available at various central, spending and control entities; (ii) outputs o f the accounting and reporting systems; (iii) interviews; and (iv) reports produced by international agencies. A detailed l i s t o f references i s provided at the end o f this report. In particular, the CFAA builds upon the following documents:

World Bank - Country Assistance Strategy IDB - Country Strategy World Bank - Public Expenditure Review (PER) IMF -Report on Observance of Standards and Codes (Fiscal Transparency) World Bank/IMF - Assessment and Action Plan for Tracking HIPC Resources IDB - Study on the Challenges for Modernizing the Tax System Nordic Consulting Group - Review o f the Operational Status o f SIGFA World Bank/IDB - Various project reports

1.27 Questionnaires. In advance of the main field mission, MHCP asked a sample of government agencies participating in the assessment to complete a questionnaire designed

WB/IDB Memorandum o f Understanding, April 9,200 1 ; agreement on Financial Management Diagnostic Work: Collaboration between Participating Multilateral Development Banks, March 19,2002.

Nicaragua Countrv Financial Accountability Assessment 7

by the CFAA Team, soliciting their views of the current financial management environment, their own practices and capacity, and their suggestions for improvements.

1.28 Interviews were conducted with key officials of the government agencies participating in the assessment. In addition, the CFAA team interviewed leaders of private business, professional associations, civil society, and representatives o f the donor community. Annex 1 presents a l i s t of those interviewed.

Interviews.

1.29 Analysis. The analysis of the information collected in preparation for and during the main field mission that took place in November 2002, and the respective findings and recommendations, are presented in Chapter 3 of this report. The two main criteria used for evaluating the systems and processes were (1) their contribution to the implementation of the Government’s growth and poverty reduction strategy, and (2) the degree of risk that they presented to PRSC and PBL funds flowing into the country. Chapter 4 summarizes the main conclusions and presents in a matrix form the CFAA Action Plan, which was prepared in consultation with staff preparing the PRSC. The content of the CFAA Action Plan i s a selection o f the most important recommendations in this report and i s consistent with all other activities of the participating Banks currently in progress in Nicaragua.

1.30 Dissemination of the findings and recommendations. A draft of this report was discussed with the Government and key donors, and their reactions were taken into consideration in the final version. The participating Banks encourage the Government to circulate the report appropriately.

2. THE BUDGET SYSTEM

2.1 This chapter i s based on excerpts from Chapter V o f the WB Public Expenditure Review (PER, December 2001), modified as needed to reflect recent changes. The information herein provided serves as the framework for the CFAA analysis and recommendations in the following chapter.

Legal and Institutional Framework

2.2 Legislative instruments for public expenditure management. These are contained in various laws and regulations listed in Box 2.1. The basic legislation governing the cycle o f budget and expenditure i s shared between a Budget Regime Law (last revised in 1991) and the annual Budget Law.

Box 2.1: Laws and Rules Governing Public Expenditure Management in Nicaragua:

The major formal rules that guide public expenditure management are as follows:

Articles 112-115 o f the 1987 Constitution (as modified in 1995) f ix the broad responsibilities o f the Executive and the Assembly in the budget process. The Budget Regime Law (Law 51 o f 1988, as modified by Law 136 o f 1991) establishes procedures for the formulation, approval, and execution o f the budget. The Annual Law of the General Budget of the Republic: specifies the Revenue and Expenditure Budgets (including the precise modifications that the Assembly has made to the draft budget submitted by the Executive) and how the deficit is to be financed; and expands on the general rules laid down in the Budget Regime Law. These general rules have been similar in the Annual Law from year to year. Since 1997, the National Assembly has passed, at the Government’s request, a Law to ModijjJ the Annual Law of the General Budget of the Republic. This law incorporates the Government’s requests for changes in the budget, as well as the modifications that have occurred under the President’s authority (such as additional donor funding). The Ministry o f Finance and Public Credit (MHCP) issues annual Norms and Procedures for Budget Execution and Control which provide detailed instructions to Budget spending entities. Presidential Decree No. 44 o f June 1998 establishes the legal and organizational basis for the integrated financial management and audit system (SIGFA). A number o f manuals and rules (on budget formulation, modification, programming, monitoring & evaluation, and internal audit) have been developed under the SIGFA program, though i t i s not clear to what extent they are in use. The Law for State Purchasing (Law 323 o f 1999, modified by Law 349 o f 2000 and regulated by Decree 21 o f 2000) establishes the regime for public procurement. The regime for external audit is established by the Organic Law for the CGR and the System o f Government Audit (1980, modified by Law 361 o f 2000). The constitutional amendment o f 2000 (Law 330) changed the Controller’s Office from a single head to a five-person board. The CGR issued Technical Regulations o f Internal Control and Internal Audit for the Public Sector in 1995. The Law for Organization, Competencies and Procedures o f the Executive Branch (Law 290 o f 1998) dictates the organizational framework o f the Executive Branch.

2.3 Attributes and powers of different branches of government. The Budget Regime Law requires an annual Revenue Budget and Expenditure Budget. The annual Budget Law indicates the sources o f the net financing requirements, i.e. the difference between the totals


of the two Budgets. These sources (which are thus not formally part o f the Revenue Budget) are external grants, net loan disbursements (all external loans are on concessional terms), and net internal financing.

2.4 Nicaragua's Executive has powers of proposing and executing the budget that are s i m i l a r to other Latin American countries, with the same tendency towards a relatively circumscribed role for the legislature (in the name of strengthening the Executive's capacity to control the overall fiscal balance). Nicaragua's Assembly cannot increase expenditures without providing for increased resources, and i t would have to provide for any increased tax revenues through separate legislation. In addition, the Assembly cannot change expenditures on personnel remuneration, pensions, debt servicing, or legal obligations, i.e. the principal fixed-cost elements. Each year, in practice, the Assembly makes only marginal modifications to the Budget. In early 2003, following the Assembly's introduction of modifications to the budget inconsistent with the macroeconomic and fiscal programs, the Executive exercised a partial veto which lead to a compromise that involved a slight (less than 1 percent) increase in expenditures, accompanied b y tax legislation to maintain the budget deficit in line with the macroeconomic program targets.

The authority to modify the budget can be summarized as follows:

According to a constitutional amendment of 1995, the Assembly must approve any proposal to increase or reduce budget allocations, to reduce revenues, or to transfer expenditures between institutions. As a result, a Law to Modify the Annual Budget Law has been passed each year since 1997 - see Box 2.1.

According to the Budget Regime Law, the President can increase or decrease the Budget for reasons of war, natural disaster, or new, unbudgeted donations for specific projects, and has to periodically inform the Assembly of these modifications.

Specifically on unbudgeted external aid, the 2003 Budget Law allows the subsequent incorporation of grants, in money or kind, and disbursements o f concessional loans (which must have already been approved by the Assembly) into the budget. Such modifications need to be reported, after the fact, to the Assembly, and this i s done through the quarterly reports from the Ministry o f Finance and Public Credit (MHCP).

The MHCP can authorize transfers, within a budget entity, between programs, subprograms and groups o f expenditure, and can modify allocations to personnel- related lines o f expenditure. However, the MHCP cannot transfer funds from investment to recurrent expenditure.

The budget entities can make transfers between activities within the same program or subprogram, and between lines of expenditure (excluding personnel) within the same group.

The Constitution and various laws and practices mandate that certain revenues or expenditures are reserved for certain priorities, thereby reducing the flexibility of the budget

(see Box 2.2 for a l i s t of earmarking practices). The Constitution requires that six percent of the budget go to the universities and four percent to the judiciary. The municipalities and the tax and customs agencies enjoy legally earmarked funds. Actual budget allocations are a matter o f interpretation - should the Revenue or the Expenditure Budget be the denominator? - and negotiation. But in total, these reserved uses of funds are significant, accounting for 2 1 percent of the 2003 Revenue Budget and 11 percent o f the Expenditure Budget.

Box 2.2: Funds Earmarked in the Budget

The Constitution (Article 125) requires that universities receive six percent o f the budget (without specifying whether this i s the Revenue or Expenditure Budget). The Constitution (Article 159) requires that the Judiciary receive at least four percent o f the budget (without specifying whether this i s the Revenue or Expenditure Budget). The Constitution requires that municipalities are allocated a “sufficient percentage“ o f the budget. This figure was set by law as one percent. A 2000 law providing autonomy to the Directorates General for Customs and Tax (Law No. 339, Article 19) specified that each would receive a budget allocation o f three percent o f their respective tax collections (reducing to 2.5 percent after 5 years). Government entities are entitled to their own miscellaneous fees and charges (rentas con destino especifico), as long as the Treasury confirms availability o f funds. In addition, the 2003 Budget Law allows the police to retain half the fines they levy.

Mandated Expenditures as Percent of 2003 Budget

Revenue Budget Expenditure Budget Universities 7.7% 5.3% Municipalities 1.6% 1.1% Supreme Court 5.0% 3.5% D G A (Customs) 1.1% 0.8% DGI (Taxes) 1.5% 1 .O% Entities‘ own funds 3.7% 2.6% Total 20.6% 11.3%

Coverage and Information Provision

2.7 Government. In practice coverage i s incomplete, mainly in the following areas:

Coverage. In principle, the budget covers all income and spending o f the Central

(a) Donor approaches to support in Nicaragua continues to be project tied and in the form o f direct disbursement (or in kind contributions) to individual budgetary institutions to a large extent outside the Treasury Single Account (CUT) system. Budget institutions have limited incentive for disclosing these “off budget” resources in the preparation process since it may offset “on budget” resources within a fixed budget ~ei l ing.~

(b) The 2003 Budget Law allows the subsequent incorporation of unbudgeted grant and loan disbursements into the budget. The Norms and Procedures for Budget Execution and Control, in turn, require those funds to flow through the CUT unless

Nordic Consulting Group, 2002. Review o f the Operational Status o f SIGFA.

Nicaragua Countrv Financial Accountabilitv Assessment 11

the donor requests otherwise, and mandates that the budget transactions be recorded in the integrated financial management system. Again, though, there i s little incentive to encourage compliance with these requirements.

(c) The budgets of the decentralized entities are approved by their governing bodies and, pursuant to the constitution, are required to be submitted to the National Assembly along with the national budget (in the “Budget statistical annex”), only for the purpose of providing information. However, compliance with this requirement i s not rigorously observed.6 The 2003 Budget includes “transfers to autonomous entities’’ and “allocations to decentralized entities and other institutions” that amount to C$2,786 million, while the “Budget statistical annex” accounts for C$1,692 in incoming Government transfers. The difference represents 10.3 percent of the expenditure budget (after debt interests), with the universities (6.9 percent) constituting the largest undisclosed budget.

(d) The 2003 Budget Law requires that all Government entities’ retained income from miscellaneous fees and charges (own funds) go into a Treasury account. In practice, entities may s t i l l collect some of these funds in bank accounts that are not reported to the Treasury, and hence are not in the budget - this practice, however, i s decreasing and the amounts involved are not perceived as significant.

2.8 There i s no consolidation o f the general government budget. Municipal government operations are relative1 minor, but limited information i s available on municipal budget execution or borrowing (with the exception o f the Municipality o f Managua). Y 2.9 The information content of the budget. The Budget Regime Law mandates that the budget include objectives, goals, and programs, but leaves the MHCP free to adopt the structure and classification i t wants. Box 2.3 l i s ts the main classifications currently used in the Budget. In addition to information on expenditures by detailed l ine item, by sources of funds, and by project, the document l is ts the agency’s organizational chart, policy objectives, numbers of personnel by level, and programs.’ But there are some shortcomings:

(a) There i s no historical information on budgeted or executed expenditures, hence no frame of reference for new expenditure proposals that the National Assembly (or the public) can use.

IMF, 2002. Report on Observance of Standards and Codes - Fiscal Transparency Module. Idem.

* Budget documents from 2000-2003 appear on the MHCP’s web page (http://www.hacienda.Lrob.ni/).


Functional Structure of Expenditures The expenditures are grouped into eight headings, with a ninth for debt service:

1 Defense and security m Education 1 Health 1

1 Housing and community services 1 Cultural and recreational services 1 Economic services 1

' 1 Government administration

Social services and social assistance

Public debt interests and expenditures

Box 2.3: Budget Classifications

The 2003 Budget document presents expenditures classified in the following dimensions:

Institutions 1 There are 19 budget Entities: 15 from the Executive branch (12 ministries, the Presidency, INIFOM -

Nicaraguan Institute for Municipal Development-, and the Public Prosecutor); and four independent branches (Assembly, Judiciary, Supreme Electoral Council, and CGR). 30 Autonomous and Governmental Entities and four State Enterprises receive capital and current transfers from the central government (as well as, in some cases, donor funds and own funds). The budgets o f these 34 Entities are presented in the Budget Statistical Annex, but are not consolidated with that o f the Central Government. In addition to the municipalities, almost 30 other private and public institutions and funds receive transfers from the central government. These include, in rough order o f importance, the universities, various investment projects, worker indemnity and export funds, UCRESEP, and NGOs. These institutions and funds must report on the use o f these funds, but do not present budgets according to the Budget Regime Law and annual budget laws.

m

m

Programs and Projects 1

1

The total expenditure budget o f the 19 Entities i s divided into 106 Programs, some o f which identify broad physical goals. Each Program i s contained within a single Entity. All capital costs are assigned to Projects or "Other" (smaller capital works). The 19 Entities have 214 Projects (all o f them sitting inside Programs), while another 131 Projects were in Autonomous and Governmental Entities. The Budget Statistical Annex contains a compilation o f recurrent and capital expenditures related to the Poverty Reduction Strategy.

1

Sources of funds m

1

Treasury resources and Entities' own funds come from the Revenue Budget. External grants, net (concessional) loan disbursements and net internal financing are part of the net financing requirement.

Classification by Purpose of Expenditure (economic classif cation of expenditures) The detailed budget line items (renglones) are classified under these groups: 1. 2. 3. 4. 5. 6. 7. 8. 9.

Personnel services (servicios personales) (recurrendcapital) Non-personnel services (servicios no personales) (recurrendcapital) Consumables (materiales y suministros) (recurrendcapital) Equipment (bienes de USO) (capital) Current transfers (transferencias corrientes) (recurrent) Capital transfers (transferencias de capital) (capital) Financial investments (Activos financieros) (capital) Debt service (servicio de la deuda) (recurrent) Other expenditures (otros gastos) (recurrent)


Function-based classification of spending information in the Budget i s of a very general nature, broken down into eight groups that are only disaggregated by administrative units. The institutional or organization classification i s at the ministerial level and does not identify the different administrative units, within the ministries, responsible for implementing the different spending programs. This hinders the process of assigning responsibility for the use of public funds.’

The work o f the 19 Budget Entities i s divided into 106 programs. For instance, the Ministry o f Education has 11 programs, of which six are for final outputs -Primary, Secondary, Pre-school, etc. - and five are for administrative, coordinating and support tasks. While the program basis provides useful information on how the Government plans to spend i t s money, no subsequent use (i.e. in reporting on execution) i s made of the program categorization and there i s no reporting on physical execution of targets (indicated in some o f the programs).

While much of the planned expenditure i s clearly laid out, some information i s s t i l l opaque. For instance, 0.4% of the 2003 expenditure budget (after debt interests) consists of unspecified items such as “other transfers” (recurrent and capital), “transfers to private sector” and “global allocations”. A single budget line in the Ministry of Transport and Infrastructure, “goods in the public domain”, accounted for 6.4% of the expenditure budget after interests. Moreover, in the case of transfers to autonomous entities, i t i s not always clear which organizations are the recipients.

A large, but unknown, amount of donor disbursement i s miss-classified as capital expenditure, when it i s actually recurrent.

There i s no information in the Budget document about macroeconomic prospects and their link to revenues.

Formulation

2.10 The sequence of events for budget formulation i s summarized as follows:

(a) In July, MHCP and Central Bank establish the budget policy framework within the framework o f the Poverty Reduction and Growth Facility (PRGF); thus, the IMF has a key influence at this stage. The budget policy framework comprises projections o f revenues and internal and external financing, macroeconomic targets, and employment and salary targets. I t dictates the overall limits on current and investment expenditure, and detailed budget preparation i s then accordingly bifurcated.

(b) In a May-July cycle, the Secretariat of Strategy and Coordination of the Presidency (SECEP) prepares the Public Investment Plan (PIP), on the basis o f information from the sectoral entities. The inter-ministerial Investments Technical Committee

IMF, 2002. Report on Observance of Standards and Codes - Fiscal Transparency Module.


(CTI) coordinates the process and endorses the PIP which i s sent on to the Economic Cabinet and the MHCP.

Based on the broad directives from the MHCP, each Budget entity prepares sectoral budgets by the beginning of September.

MHCP considers these sectoral proposals in the light o f ceilings i t draws up for each entity based on last year’s budget, the prior record o f execution, and the Government’s new policy orientations. MHCP then discusses the proposals with the Entities. There i s more room for discussion of options for projects than for recurrent spending, but in practice the sectoral Entities (and the Council o f Ministers) have limited influence in the decision-making process.

MHCP revises, and ensures consistency between, i t s pre-draft Revenue and Expenditure Budgets and debt-servicing estimates. MHCP then presents consolidated pre-draft Revenue and Expenditure Budgets to the President and Economic Cabinet, who make a decision by the end o f September.

The President sends the draft Budget to the plenary o f the National Assembly by October 15. The draft then goes to the Budget Committee, which confers with MHCP, then sends an Opinion to the plenary. The Assembly, meeting on ordinary session until December 15, considers, amends, and passes the Budget. If the Assembly i s not able to pass the Budget law by the end of the year, the Executive’s proposal i s put into effect.

2.1 1 From this description, i t i s clear that the current budget formulation process, as in many Latin American countries, i s dominated b y concerns o f aggregate fiscal discipline. In the process, funds are allocated on a largely incremental basis, with little room for considerations about prioritization of expenditures. Preparation o f the PIP (i.e. the investment budget) i s a partial exception. SECEP has the capacity, tools, and procedures for prioritization (unlike most o f the ministries), but i t s role in prioritization i s vitiated by the de facto preponderance of donors in investment decisions. The PIP i s well integrated into the budget cycle from the viewpoint of aggregate fiscal discipline, but from the viewpoint of prioritization i t constitutes, as in many aid-dependent countries, an unintegrated enclave, in two senses. First, i t substitutes in part for the failure o f planning-and-coordination units at the ministerial level. Second, there i s virtually no effort to calculate, let alone act on, the implications of today’s investments for tomorrow’s recurrent expenditure.

Execution

2.12 The Legislative, Judicial, and Electoral Powers and the universities are responsible for executing their budgets. These entities receive from MHCP 1/12th of their annual recurrent expenditure budget each month, and they receive budgeted investment funds according to a timetable to be presented to MHCP. The Executive Power i s responsible for executing i t s own budget (including that o f autonomous bodies and governmental entities). MHCP controls the execution process, the Directorate of Budget (DGP) ensuring that execution concords with the budget, the Directorate o f Government Accounting (DGCG)


that transactions are registered, and the Treasury that payments are made. SECEP i s accorded some co-responsibility for monitoring execution o f the PIP.

2.13 Controlling aggregate expenditure. Budget execution i s reported on the basis o f payment orders (“6rdenes de pago”). MHCP programs all budgeted expenditures (i.e. does not hold back any reserve).

2.14 Some of donor funding gets included in the modified Budget (see para. 2.7b), but normally only when it i s spent, and may well s i t around, unannounced in ministry bank accounts, until execution happens. And some i s never reported. Part o f the problem i s that the reporting formats of the MHCP and the Secretariat for Economic Relations and Cooperation (SREC, o f the Ministry o f External Relations) are too different to be used for the purposes o f reconciliation. MHCP receives data from the Entities that largely pertain to cash, while SREC reports on cash, in kind contributions, and flows to non-government organizations in a way that i s difficult to sort out.

2.15 The Treasury has, since 2000, operated a Single Treasury Account (CUT) system that captures almost all budgeted revenues. The most important resource flows that escape the CUT are donor disbursements made into separate bank accounts. Also, but to a gradually lesser degree, entities may s t i l l maintain some of the own-revenues they collect from fees and charges in unauthorized and unmonitored commercial bank accounts, even though this i s expressly prohibited.

2.16 The CUT was established as part of the evolution o f an Integrated Financial Management and Audit System (SIGFA - see Box 2.4). SIGFA integrates budget, accounting, treasury, and payroll systems through a common set of rules and procedures, and a single database (despite i t s name, i t has no audit features). Development of the system began in 1995, in 1998 the integrated database became operational in MHCP (“SIGFA- Central”), and 31 Budget entities were operating the system in real time by the end of 2002. SIGFA registers the cash transactions o f the CUT, but can additionally account for donor resources that flow into separate bank accounts i f reported to MHCP. The CUT and SIGFA represent substantial, but not yet complete coverage o f revenues and expenditures o f the Central Government.

2.17 A Program Supervision Committee, composed o f the various units of MHCP involved in budget execution, meets every week to oversee the cash position and i t s conformity with quarterly revenue and expenditure targets agreed with the IMF. I f a shortfall in revenues emerges, MHCP’s short-tenn options to control the cash position are to increase the floating debt (typically by delaying payment on 15/30-day debts) or to delay commitments on expenditure on investment projects. There i s little short-term latitude in improving tax revenues or cutting recurrent costs, and no legal instruments for short-term borrowing - the Central Bank i s only allowed to lend short term to pay external debt.

Box 2.4: SIGFA (Integrated Financial Management and Audit System)

SIGFA i s the public financial management leg o f a donor-supported program of institutional development - or public sector reform - underway since the mid-1990s. The other two legs o f this program are civil service reform - where progress has been slow - and organizational and functional restructuring of the government.

SIGFA arose from initial diagnostic studies undertaken between 1993 and 1994 with the support of the World Bank, USAID and IDB. These diagnostic studies established that public sector financial management in Nicaragua was poor, and constrained the government's ability to execute i ts policies and programs in a cost effective, efficient, and transparent manner. There was no government-wide accounting system; expenditure controls and cash flow management practices were weak; management and control o f public credit were poor; public procurement was cumbersome; l inks between the rudimentary public employment system and the budget and expenditure control process were weak; and ex post audit capacity was weak and limited.

SIGFA's implementation began during the second half of 1995. Since then, SIGFA has registered the following progress:

= I t became operational in 1998 for MHCPs core financial management operations: budgeting, accounting and treasury. The systems of budget formulation (SIGFAFOR) and budget execution (SICOIN) were fully implemented and operating at 31 Budget entities by 2002. These entities can monitor their budget implementation in real time. Two subsystems have been introduced: a cash management subsystem for the Treasury Single Account (CUT) and a government payroll subsystem (SNF). A subsystem to monitor the physical execution o f the budget has also been developed and tested, but has not been put in operation yet. A basic legal framework for SIGFA has been established. I t legitimates and helps provide sustainability to implementation, though i t falls short of being an organic law for public sector financial management. Financial management standards and procedures, for both central and local levels, have been issued (see http:f/www.hacienda.gob.niJsigfa). Extensive training, covering approximately 4,000 financial managers and administrators, has been provided Extemal and intemal audit standards were developed in close coordination with the CGR, and training thereon was provided.

Expansion plans include increased institutional coverage o f noncommercial government entities, including municipalities, and implementation of systems for procurement, human resources, and physical assets.

2.18 Controlling individual transactions. Entities cannot incur debt without MHCP authorization or spend in excess o f their budget. For most expenditures (personnel costs, services, and transfers), commitments and payments are made at the request o f the spending entities, but these have little room to exercise direct control. Only in the areas of petty cash (small amounts disbursed from revolving funds in the entities' own bank accounts) and direct capital expenditures (24 percent of total expenditures less debt interests), are commitments significantly under the control of Budget entities.

2.19 At the beginning of the year and each quarter, budget entities must submit to the DGP requests for quarterly programming, which should contain physical, financial and cash programs. DGP authorizes the quarterly commitment and the monthly accrual ceilings. Transactions for budget execution are registered as follows:

(a) Commitment ("compromiso"). This i s a necessary prior step for subsequent accrual and payment of budgeted funds. I t enables to check that there i s sufficient availability under the corresponding budget lines against which to charge the commitment, as the law requires. In practice, commitments and accruals are recorded simultaneously.


(b) Accrued liability ("devengado"). In theory, this stage happens when a service becomes liable for payment, for instance because i t has been delivered. In practice i t i s recorded against the payment order ("orden de pago"), which i s a request for the MHCP to make a direct payment for a service or a transfer to a public -or private- sector organization. DGCG validates the request.

(c) Payments. The Treasury then issues a check or transfers the funds, automatically recording the payment (that i s not recorded when the checks are actually delivered to the provider). Transfers to autonomous and decentralized entities and state enterprises are registered as expenditures when the transfers are made; however, the 2003 Budget Law required these entities to prepare monthly reports on use of funds as a pre-requisite for subsequent transfers.

2.20 Throughout the three stages, a single electronic document (single accounting entry, CUC) i s used. At the year end, any uncommitted budget amounts lapse. Accrued liabilities that have not been paid (Le., floating debt) are recorded as part o f that year's Budget execution, but paid next year before February 15.

2.21 The only significant case where commitment occurs in excess of the amount budgeted i s in capital spending. This reportedly happens sometimes with Ministry o f Transport projects and other externally-funded projects. Even though the Budget Regime Law does not permit it, there i s l i t t le that MHCP feels i t can do about i t and the extra expenditure i s absorbed through lengthening the floating debt (local funds) or delaying recording in the system (external funds).

2.22 MHCP i s responsible for oversight of the government's fixed assets, and the Budget entities are responsible for regular reporting to MHCP of changes. In practice, there i s incomplete knowledge and little effective control of these assets. This function has not been incorporated to SIGFA.

2.23 Budget realism. The credibility o f the budget can be roughly indicated by the extent to which Budget entities receive the resources initially indicated. Budget statistics indicate a marked improvement in the credibility o f the budget in recent years, as illustrated with two aggregate measures, the ratio of the total executed budget to the initial budget and the standard deviation of the ratio of executed budget to initial budget for each Budget entity. These measures are reported in Tables 2.1 to 2.3.

2.24 Budgets have been formally amended, following the 1995 constitutional reform, in each year since 1997 (we have data on the 1997-1998, and 2000-2002 revisions). Interestingly, though, since 2000 spending execution has been closer to the initial than the amended budgets. On the other hand, during that same period budget modifications have reduced the volatility of execution, as measured by the standard deviations.

2.25 Since 1997, actual revenues, particularly from taxes, have been generally close to the initial budget (Table 2.1). A notable exception was the low level o f execution in 2001, when real GDP growth dropped to 3.3 percent, against projections o f 5.5 percent (GDP growth in 2002 was of 5.9 percent).


Table 2.1: Aggregate Revenue Budget Execution, 1993-2002 (in percent)

I1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Modified Budget as percent of Initial Budget Tax revenue 101 100 99 Non-tax revenue 100 100 99 Total revenue 101 100 99 Executed Budget as percent of Modified Budget Tax revenue 96 89 101 Non-tax revenue 116 102 116 Total revenue 98 90 102 Executed Budget as percent of Initial Budget Tax revenue 98 89 100 Non-tax revenue 116 102 114 Total revenue 90 100 117 111 99 103 104 99 90 102 Source: World Bank PER (December, 2001) and MHCP budget and execution documents

2.26 In the aggregate, from 1996 onwards budgets came to be more accurate predictors of actual total public expenditures (Table 2.2) - again, 2001 being the exception as lower revenues constrained the levels of spending (though not to a rate sufficient to prevent widening o f the public sector fiscal deficit, which increased from 8.1 to 14.3 percent of GDP in 2001). A high rate o f execution of the capital budget in 1999 reflected the effects of higher-than-planned foreign aid after Hurricane Mitch.

Table 2.2: Aggregate Expenditure Budget Execution, 1993-2002 (in percent)

I 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 /Modified Budget as percent of Initial Budget Current expenditure Capital expenditure

110 103 111 102 99 105 104 127 101 119

Total expenditure 108 103 118 102 106 Executed Budget as percent of Modified Budget Current expenditure 105 101 96 86 92

Total expenditure 102 99 89 78 87 Executed Budget as percent of Initial Budget Current expenditure 11 1 118 118 109 103 103 95 106 88 92 Capitalexpenditure 157 190 217 95 103 100 126 103 67 91 Totalexpenditure 120 133 142 104 103 102 108 105 79 92

Capital expenditure 98 96 81 67 77

Source: World Bank PER (December, 2001) and MHCP budget .and execution documents

2.27 L ike the rate o f execution, the inter-institutional volatility of execution has fallen since the second half of the 1990s (Table 2.3). In 2000, however, the standard deviation was high, partly due to modifications to the initial Budget resulting from the 2000 Constitutional amendments and reforms to the Electoral Law. The volatility of execution of the capital budget, though i t has improved, remains markedly greater than that o f the current budget.


Table 2.3: Standard Deviation of Expenditure Budget Execution in 20 Entities, 1993-2002 (in percent)

I 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 \Modified Budget as percent of Initial Budget Current expenditure Capital expenditure

7 37

Total expenditure 21 24 91 9 11

Current expenditure 1

Total expenditure 15 30 10 13 9

Current expenditure 325 272 16 31 27 7 13 76 11 7 Capitalexpenditure 756 156 249 130 141 134 75 26 69 33

Executed Budget as percent of Modified Budget

Capital expenditure 17

Executed Budget as percent of Initial Budget

Total expenditure 289 183 66 28 31 19 31 94 16 15 Source: World Bank PER (December, 2001) and MHCP budget and execution documents Coverage: The 20 entities consist o f the 19 Budget entities (see Box 2.3) and the line covering transfers to autonomous and government entities and state enterprises. Note: The standard deviation measures, for any given year, the extent to which the percentage change in allocations for each o f the 20 Budget entities i s dispersed around the average. Thus, for instance, while the total execution for 2002 was eight percent lower than the Initial Budget (Table 2.2), the average deviation o f the 20 Entities from the Initial Budget was 15 percent (Table 2.3). The entities that had no budget allocation for capital expenditures were excluded from the 2000-2002 calculations.

Reporting and control

2.28 Reporting. SIGFA allows for real time data on budget execution and monthly reports are prepared for MHCP’s internal use. Additionally, the following reports are submitted to the National Assembly and posted on MHCP’s website (httP:Nwww.hacienda. gob.ni/) in a timely fashion:

(a) MHCP sends a quarterly budget execution report to the Assembly within 30 days o f the end of the period. These reports compare accrued execution to the modified budget.

(b) MHCP i s required to prepare an annual year-end report (“Informe de L iqu idac ih del Presupuesto”). This i s sent to the President and the CGR. The President then sends i t to Assembly b y the end of March o f the following year.

2.29 The emphasis o f both quarterly and annual reports i s on fiscal balance, the broad financial transactions underlying it, and the rate of accrued execution against the modified Budget. There i s no reporting on government financial statements (including monetary accounts), the floating debt, the physical execution of programs, or operational efficiency o f execution. Although the amount of data provided has increased recently, the reports are not prepared in the same detail as the Budget, and do not provide any historical information or references to the initial Budget. Finally, the reports do not cover al l autonomous and decentralized entities - other than the transfers made by the Central Government - and the accounts are not consolidated.


2.30 Internal audit. Internal audit units report to their respective Ministers. However, the CGR Organic Law provides the CGR with the authority to approve creation of new internal audit units, issue the applicable audit norms, evaluate the internal auditors, and review the internal audit annual plans. These plans (and the internal audit norms) are rarely implemented, as the internal audits primarily deal with special requests from the Ministries or the CGR.

2.31 External audit. The CGR i s the independent external auditor, subject only to compliance with the Constitution and laws. I t i s headed by a five member Superior Council elected by the National Assembly for a five year term. The CGR has the constitutional authority to norm the public administration control system, and responsibility to perform inspections o f all Government institutions, including state enterprises. I t s law provides the CGR with 33 general functions, such as to perform financial, compliance, operational, integral and special audits, to evaluate performance and advise on strengthening capacities and procedures for public sector budget execution, and to establish individual administrative responsibilities for instances of noncompliance with laws and regulations. In practice, CGR i s not able to cover adequately these broad tasks; for instance, the Government budget execution reports have never been audited. I t also suffers from a lack of resources, more so in the quality of i t s employees (and i t s capacity to apply modem auditing techniques) than in their numbers. CGR's budget for 2003 represented 0.8 percent o f the total expenditure budget (after interests); about 20% of i t s budget corresponded to the Modernization Program - see Box 2.5.

Box 2.5: Modernization Program of the CGR

In mid-2002, IDB approved a US$5.4 million loan for a US$6 mil l ion Program for Modernization and Strengthening o f the Controller General o f the Republic (CGR). The program objective i s to improve the efficiency and effectiveness o f oversight in public administration by modernizing and strengthening the CGR as the supreme audit institution responsible for overseeing the administration o f State resources. The program i s centered around four components:

Strengthening of the CGR organizational and management structure. The objective i s to strengthen the CGR's institutional response capacity to efficiently carry out the duties under the current legal framework and help ensure effective human resource management in order to improve staffing, and staff performance and motivation based on skills.

Strengthening of CGR control mechanisms. The objective i s to modernize and strengthen control mechanisms as expedient, effective tools for ensuring transparency in public administration.

Design and implementation of a training structure. The objective i s to design and set up a comprehensive continuing training structure to enable employees o f the CGR and internal auditing units o f other government agencies to upgrade their technical and human sk i l l s and capabilities.

Development of technology infrastructure. The objective to develop a technology platform as basis for the integrated implementation o f various information systems.

Implementation o f the Program began at the end o f 2002.


2.32 Civil society. To date, the principal mechanism for wider participation in policy review and evaluation, both ex-ante and ex-post has continued to be the National Council for Economic and Social Planning (CONPES). Members of CONPES include representatives o f private enterprises, banks, chambers of commerce, agricultural producers, ranchers and fisheries, trade unions, universities, political parties, and NGOs. The principal strengths o f CONPES are the wide range o f social participation that i t engenders and the fact that i t has political support and political independence, which gives i t the opportunity to validate, analyze in greater detail, and evaluate the plans o f the Government in terms o f their expected results.

2.33 However, CONPES does not have a particularly accessible method o f disseminating the results of i t s work. I t has a website containing i t s publications but as yet does not produce the kind of information which could be used by civil society and members o f the public to determine if the Government i s complying with i t s policies.

3. CFAA ANALYSIS, FINDINGS AND RECOMMENDATIONS

3.1 management (PFM) arrangements in place in Nicaragua, and i s structured as follows:

This chapter analyses and proposes recommendations on the public financial

General legal and institutional framework. Budget development. Budget execution: integrated financial management system, treasury, internal control and internal audit, specific aspects of budget execution (de- concentratioddecentralization), monitoring and evaluation. Fiscal reporting and transparency: accounting, external audit, public participation. Donor coordination and harmonization. Human resources for PFM. Debt management and contingent liabilities. Revenue issues: tax and customs.

Legal and Institutional Framework

3.2 Since the legal and institutional framework i s functional and the prospects are dim for effective legal reform due to the National Assembly’s strong polarization, efforts in the short term should concentrate on enforcement o f current laws and regulations. However, the Government should begin to analyze and consolidate them with the aim of developing a modern far-reaching PFM Law.

3.3 The rest of this chapter addresses specific legal, institutional and enforcement issues in the discussion of each PFM topic. Overall, there are four main contradictions and ambiguities that exist in the legal and institutional framework.

(a) Although the separation between the fiscal functions of the executive and legislative branches i s generally well defined, certain contradictions exist between the regulation governing the two branches’ authority to modify the budget during the current budget year.

(b) Within the executive, there i s a need for clearer rules on the respective functions in budget preparation of the MHCP’s Budget Directorate (DGP), which prepares the budget, and the Secretariat of Coordination and Strategy o f the Presidency (SECEP), which prepares the public investment program.

(c) Clarification of responsibility i s also needed regarding internal controls, now shared by the MHCP, the spending entities and the Controller General of the Republic (CGR), and regarding CGR’s role vis a vis the accounting and internal audit framework.


(d) Important mechanisms such as the integrated financial management system (SIGFA) and multi-year budgeting framework do not have status o f Law.

3.4 cover each relevant area of PFM. The main findings and recommendations are:

The main strength i s the comprehensive set o f laws and regulations that essentially

(a) The lack of consolidation of laws and regulations may affect transparency and stability, and generate duplication of effort and friction among institutions.

Prepare a complete inventory and analysis of PFM laws, regulations, and procedures, identifying duplications, inconsistencies, and gaps. Finalize a draft of a consolidated PFM Law and present it to the National Assembly. Fi l l gaps through Executive Decrees to the extent possible.

Budget Development

3.5 Planning. Although recent developments in the integrated financial management system (SIGFA) w i l l help in preparation o f a multi-year budget, the budget document does not yet present a Medium Term Expenditure Framework (MTEF) or any long term spending scenario. The budget document does not provide historical information on previous budgets/executions and the macroeconomic underpinnings of i t s preparation.

3.6 Realism. From 1996 onwards, execution has been generally close to the initial annual budget, with decreasing volatility in revenues and current expenditure budgets. As for capital investments, volatility and in-year budget adjustments are mainly due to lack of timely information on projected donor support during the budget preparation cycle.

3.7 Comprehensiveness. In the budget document for 2003, most extra-budgetary funds were incorporated in a “statis

Country Financial Accountability Assessment Nicaragua...NICARAGUA COUNTRY FINANCIAL ACCOUNTABILITY...

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