Report No. 27425-MD Moldova Country Financial Accountability Assessment September 12, 2003 Operations Policy and Services Unit Europe and Central Asia Region Document of the World Bank CURRENCYEOUIVALENTS (Exchange Rate Effective October 8,2002) Currency Unit = Moldova Lei US$ 1 = 13.5020Moldova Lei FISCAL YEAR January 1to December 31 ABBREVIATIONSAND ACRONYMS AAFM The Association of Audit Firms in Moldova ACAP The Association of Professional Accountants and Auditors of Moldova ACCA The Association of Chartered Certified Accountants ATU Administrative Territorial Units (Local Government authorities) CAS Country Assistance Strategy CD Customs Department CFAA Country Financial Accountability Assessment CoA Court of Accounts CPAR Country Procurement Assessment Report EBF Extra Budgetary Funds EBRD European Bank of Reconstruction and Development ECA Europe and Central Asia EU European Union FCR Department of Financial Control and Revision FY Fiscal Year EUROSAI European Organization of Supreme Audit Institutions IAS International Accounting Standards (encompassing IFRS) IASB International Accounting Standards Board IFAC International Federation of Accountants IFRS International Financial Reporting Standards INTOSAI International Organization of Supreme Audit Institutions IPSAS International Public Sector Accounting Standards ISA International Standards on Auditing LGI Local Government Institutions MoF Ministry of Finance MoLSP Ministry of Labor and Social Protection MTEF Medium Term Expenditure Framework NAS National Accounting Standards NBM National Bank of Moldova NGO Non-Governmental Organization NPA National Procurement Agency NSA National Standards of Auditing NSIH National Social Insurance House PEMR Public Economic Management Review PRSP Poverty Reduction Strategy SAI SupremeAudit Institution SAC-I11 Third Structural Adjustment Credit SOE State Owned Enterprise SSIB State Social Insurance Budget STS StateTax Service USAID US Agency for International Development RegionalVice-president: ShigeoKatsu, ECAW CountryDirector: Luca Barbone, ECCU2 SectorDirector: Alain Colliou, ECSPS SectorManager: John Hegarty, ECSPS Task Team Leader: Ranjan Ganguli, ECSPS Moldova: Country Financial Accountability Assessment i TABLEOFCONTENTS TABLE OF CONTENTS ........................................................................................................................... i PREFACE ................................................................................................................................................. 11 EXECUTIVE SUMMARY ..................................................................................................................... IV DEVELOPMENT ACTION PLAN .................................................................................................... VI11 1. COUNTRYBACKGROUND ......................................................................................................... 1 2. PUBLIC SECTORFINANCIAL MANAGEMENT .................................................................... 3 Budget formulation ................................................................................................................................. 3 7 Revenue systems ................................................................................................................................... BudgetExecution.................................................................................................................................... 10 Accounting and Financial Reporting..................................................................................................... 12 Internal Control andAuditing ............................................................................................................... 14 3. EXTERNAL OVERSIGHTOF PUBLIC FINANCIAL MANAGEMENT ............................. 16 External Auditing .................................................................................................................................. 16 Parliament................... ................................................................................................................... 19 4. LOCAL GOVERNMENTINSTITUTIONS ............................................................................... 21 Accounting and Treasury Systems.................................................. Local Government Budgets................................................................................................................... 22 Reporting........................... .............................................................. Internal Control and Inte ........................................................................... External Oversight............ ....................................................... Capacity of Local GovernmentInstitutions ............................................ 5. PRIVATE SECTORACCOUNTINGAND AUDITING ........................................................... 27 Enterprise Sector ................................................................................................................................... 27 Banking Sector .................... ............................................................................................................ 32 6. FIDUCIARY CONSIDERATIONSINRESPECT OFBANK-FINANCEDPROJECTS ......35 RelianceonPublic Sector FinancialManagementFramework............................................................. 35 ProjectFinancial Management........................................... ............................................................. 35 National Bank of Moldova................................................. ....................................... 37 ANNEX 1: CFAA NATIONAL STEERINGCOMMITTEE .............................................................39 ANNEX 2: ARCHITECTUREOF PUBLIC FINANCIALACCOUNTABILITY .......................... 40 ANNEX 3: MAPOF MOLDOVA ......................................................................................................... 41 PREFACE This report was prepared after missions to Moldova in 2002 and 2003 by a Task Team comprising Ranjan Ganguli (Task Team Leader, ECSPS), M.Mozammal Hoque (Senior Financial Management Specialist, OPCFM), Elena Nikulina (Economist, ECSPE), Andrew Mackie (Financial Management Consultant, ECSPS) and Andrei Busuioc (Research Analyst, ECCMD). A counterpart team in the form of a National Steering Committee (NSC), comprising members o f Government, the Court o f Accounts, the National Bank of Moldova and the Parliamentary Committee for Economy, Industry, Budget and Finance, was specifically formed for the purpose o f the CFAA (the full composition o f the NSC i s shown in Annex 1). This CFAA was discussed fully with the NSC prior to finalization and the Development Action Plan (DAP) included within the report, listing and prioritizing the report's main recommendations, was endorsed by the NSC. The report i s based on the results o f interviews and discussions with various public and private institutions as well as an analysis o f various data gathered during the missions including copies o f various legislation, instructions and reports. Government and private sector counterparts lent their full and proactive support to the CFAA missions and engaged with the Bank's team ina comprehensive dialogue. The Bank is grateful for this cooperation. Objectiveof CountryFinancialAccountabilityAssessment There i s considerable empirical evidence o f a strong causal relationship from better governance to better development outcomes'. A country's financial accountability framework i s a significant element o f that aspect o f governance relating to the capacity o f govemment to manage resources and implement sound policy. A CFAA is a diagnostic instrumentsdesigned to facilitate a common understanding by the borrower, Bank and their development partners o f the borrower's public and private sector financial accountability framework. Inturn this enables the development o f plans to address any issues identifiedas well as o f appropriate capacity-building programs. CFAAs also support the Bank in the exercise o f its fiduciary responsibilities by identifying the strengths and weaknesses o f a country's financial accountability arrangements and the risks that these may pose to the use of Bank funds. CFAAs are not audits; they are not intended to and do not provide assurance on the specific uses to which Bank funds have been or may be applied. Relationship of the CFAA to the CAS, lending program and policy dialogue with the Government The Board endorsed the CAS Progress Report in June 2002, which provided emphasis in public sector reforms and improving governance. The Government confirmed its commitment for strengtheninggovernance by adopting a comprehensive public sector reform strategy. The strategy comprises three elements: (i) public administration reform; (ii) public expenditure management; and (iii)public/private interface. The CAS Progress Report recognized that Government has made significant progress in streamlining and improving public expenditure management, especially in the areas o f budget execution, cash management, and debt management. ' Kaufmann,Kraayand Zoido-Lobath (1999)."Govemance Matters". World Bank InstitutePolicyResearch Working Paper2196 Moldova: Country Financial Accountabilitv Assessment iii In addition, the Government is currently in the process of preparing a Poverty Reduction Strategy Paper (PRSP). The Government and all major stakeholders consider poverty reduction to be the major development challenge for Moldova. Meeting this challenge requires analysis and better coordination among agencies to design and monitor appropriate anti-poverty policies andprograms. The Government has welcomed the PRSP process as the primary mechanism for orienting and coordinating govemment and partner activities. The Government's PRSP preparation status report and action plan have been favorably assessed by Fund-Bank staff as reflecting Government commitment to poverty reduction and to the PRSP process. It is the intention that this CFAA will provide input to PRSP by contributing to the design o f the program of reform for the country's financial accountability framework. Finally, the reform program supported by the Bank-financed Third Structural Adjustment Credit (SAC-111) includes measures to improve fiduciary management. The agreement by Government to implement the agreed stages o f this CFAA's Development Action Plan i s a conditionfor disbursement of the thirdtranche. Scope and terms of reference of CFAA The scope and terms of reference o f the CFAA were articulated and agreed both internally within the Bank and externally with the MoldovanNational Steering Committee inthe CFAA InitiatingConcept Memorandum o f July 19,2002. Acknowledgements The CFAA team wishes to acknowledge the extensive and grateful cooperation and assistance received from the staff o f the various institutions who contributed to the CFAA, including officials and staff of the Government, state agencies and enterprises, private sector institutions, and bi-lateral and multilateral organizations. Grateful thanks go also to the Bank's Public ExpenditureManagement Review and SAC-I11task team as well as the staff o f the USAID-funded Fiscal Reform Project and Financial Management Training and Advisory Activity Project for their considerable research on which a significant proportion o f this CFAA i s based. In addition: Carlos Elbirt (Moldova Country Manager) provided invaluable in-country assistance and information; John Hegarty (Manager, Financial Management, ECA) and peer reviewers, Kapil Kapoor (SASPR) and Marius Koen (AFTQK), offered much appreciated comments and inputs; and Ana Cristina Hirata and Roula Balkash assisted with the editing and formatting o f the report. Moldova CFAA: Executive Summarv iv EXECUTIVE SUMMARY 1. The overall conclusion o f this report i s that despite some progress inimprovingpublic financial management, the financial accountability framework in Moldova i s weak and requires substantial strengthening. This has important implications for both the Govemment and the Bank: the Government will need to make a significant effort over a long period o f time to attend to the issues identified within this report; and the Bank cannot rely on the Moldovan financial accountability ffamework to ensure that funds are spent for intended purposes, but rather the Bank will need to review and assess each operation's financial management risks and arrangements on its own merit. Public Sector 2. Budget formulation: The budget formulation process is fragmented and consequently the Government presents the budget to Parliament in a fragmented, rather than in a consolidated and comprehensive manner. The Law on Budget System and Budget Process (1996), requires Parliamentary approval o f the state budget only, rather than the overall national budget framework. The State Social Insurance Budget i s formulated by the National Social Insurance House and approved by the Parliament separately. Donor financed investments and extra-budgetary resources o f institutions financed by state budget are not integrated into the state budget but approved as separate annexes to the annual state budget law. Domestically financed capital investments are incorporated in the state budget as a single line, without a breakdown by functional classification. No explicit allocation i s made inthe annual budget for repayment of arrears accumulated during the previous years. Based on the foregoing, the budget does not provide a comprehensive or complete view o f public revenues and expenditures, which diminishes its effectiveness as a tool o f public policy. The ongoing efforts to introduce medium-term expenditure framework (MTEF) are aimed at eliminating many o f the above shortcomings. Due to capacity constraints budget formulation tends to follow an incremental and input oriented approach. Program budgeting pilots are being introduced gradually to take account o f these structural weaknesses. The CFAA additionally recommends that each ministry's Collegium Board formally and regularly consider its ministry'sbudget and budget execution reports. 3. Budget execution and cash management: The CFAA identifies several weaknesses inthe cash management process which, if addressed, would ensure greater predictability of cash release and reduce penalty payments on overdue liabilities. The establishment o f a Cash ManagementUnit inthe Ministry o f Finance in2001 is a positive development but much still needs to be done in order to improve its methodological skills. In addition, greater coordination i s needed between related departments e.g. Budget Synthesis Department and Debt Department o f Ministry o f Finance and the Tax and Revenue authorities. More needs to be done in order to communicate cash forecasts and budget execution reports to the line ministries. 4. Public sector accounting: The Government enacted detailed instructions for accounting o f public institutions in 1995, based on a double entry modified cash basis. N o consolidated financial statements are prepared that reflect the financial position o f the entire public sector. The present accounting and treasury laws and regulations should be more concise and simplified. Moldova CFAA: Executive Summarv v 5. Internal control and auditing: The role o f public sector internal audit is relatively under-developed in Moldova. Existing internal audit organizations need to move from ex- post control and inspection activities to an audit model which i s supportive o f improving the overall control environment. The Ministry o f Finance, after appropriate consultation with line ministries and the rest o f the public sector, needs to establish a framework for internal audit within the public sector. 6. External audit: The Court o f Accounts (CoA) i s responsible for the independent audit o f the financial statements o f the public sector. The Law o f CoA should be revisited; the Court's excessive powers should be reduced; and its activities should focus exclusively on the audits o f public sector organizations. The CoA needs additionally to gear its audit activities towards advising on systems improvements and risk mitigation measures rather than fault-finding. Although extensive legal powers and responsibilities are extended to the CoA, the office faces significant capacity constraints to carry out its mandate and requires substantial strengthening. Several proposals are suggested, including: (i) the twinningo f the CoA with a more developed Supreme Audit Institution; (ii) development and provision o f the learning events for the staff o f the CoA, and (iii) the development o f a revised audit methodology inaccordance with internationalnorms. 7. Parliamentary oversight: Parliament is active inimproving financial accountability in the country. However, further development o f Parliamentary oversight o f public expenditures i s still possible. As the executive arm o f Government develops a more strategic approach to budgeting, Parliament, and particularly the Parliamentary Committee on Economy, Industry, Budget and Finance, should regularly review the financial performance and position o f individual ministries. The CFAA also recommends that Parliament pay greater attentionto the reports o f boththe Court of Accounts and the Ombudsman. 8. Local governments*:Moldova's local governments share many o f the same financial management capacity constraints as central government. They are additionally weakened by frequent changes in administrative-territorial organization o f the country and the lack o f clarity on the future direction o f fiscal decentralizationreforms. Local budgets are an integral part o f the national consolidated budget and about 30 percent o f public funds are used for local budgets. The CFAA proposes a range o f reforms to improve local government financial management, including: (i)simplifying public sector accounting laws and regulations to make them more comprehensible; (ii) preparing annual performance reports and making them publicly available; and (iii) developing an institutionalized financial management training program for local government staff. Private Sector 9. Accounting and auditing: The refonn effort for private sector accounting and auditing from 1995 onwards was led by the Ministryo f Finance, with the support o f technical assistance from the World Bank, USAID and the Soros Foundation. The CFAA recognizes the work that hasbeendone inthis area but argues that further resources are requiredinorder to maintainand deepen the reforms achieved thus far. 'The English-languageversion of this CFAA uses the term "Local Government" whereas, for linguistic purposes,the Romanian-languageversion uses a term that maybe more directly translatedas "Local Public Authorities". Moldova CFAA: Executive Summarv vi 10. Financial reporting: the Law of Accounting was adopted in 1995. It needs to be completely revised to be consistent with EU Directives and other intemational norms. The Government has also introduced 23 National Accounting Standards (NAS), and another ten are under development. The Govemment needs to establish an institutional framework to maintain and update the NASs (see discussion below regarding the role o f professional accounting institutions). The CFAA also recommends that: (i) financial institutions, listed companies and entities of public interest should be required to prepare consolidated financial statements in accordance with International Accounting Standards and applicable EU legislation; and (ii) financial reporting for SMEs be simplifiedand brought into line with the EUDirectives andRegulations. 11. Auditing: a number of significant challenges have an adverse effect on the quality of enterprise auditing in Moldova. The present Law on Auditing i s out o f date and needs to be aligned with EU Directives and Regulations and best international practice. The rules that stipulate which companies require an audit, under the Law o f Joint Stock Companies, should also be revised and simplified in accordance with EU Directives. The quality o f the auditing education i s poor and the process by which auditors are certified i s not transparent. In addition, the mechanisms to monitor and license auditors need to be revised in line with international norms. The present laws confuse the role o f statutory auditors with that o f state- controlled activities. The statutory audit requirement should be extended to apply to non- banking financial institutions, listed companies and entities o f public interest, including state owned enterprises and NGOs. 12. Accounting and auditinginstitutions: There is an urgent need for sustainable and adequately resourced accounting and auditing standard-setting institutions in Moldova. The Audit Law makes provision for an Association of Audit Firms in Moldova (AAFM) to coordinate the operations o f audit firms, develop auditing standards and develop examination programs, however, this organization has not been established. Other institutions, such as the Association o f Professional Accountants and Auditors (ACAP), an organization founded in 1996 with the support of USAID, are also fairly weak. 13. Accounting Education:There have been a number of initiatives aimed at improving the education of accountants and undergraduates. More needs to be done, in particular to improve the training, education and certification process for auditors. ACAP and other institutions have developed programs with could be developed as a pre-requisite for candidates seeking certification as auditors inMoldova. 14. Banking:Inaccordance with the Law o f Financial Institutions (1995) andthe Law on National Bank o f Moldova, banks are licensed, regulated and supervised by the National Bank of Moldova (NBM). Some elements o f IAS affecting banks have not been incorporated into NAS and as a result, there are some differences between NAS and IAS. Thus, and for reasons o f compliance with local legislation and international comparability, banks with foreign stakeholders have to maintain accounting records and prepares financial statements under both NAS and IAS. As already noted, the CFAA recommends that the Law should require IAS for financial reporting inthe banking sector. Auditors o f banks are required to be acceptable to the NBM. The CFAA recommends that the NBM and MoF should work together to develop a common institutional framework for the education, training and certification of auditors, regardless o f the sector inwhich they operate. Moldova CFAA: Executive Summarv vii Fiduciary aspectsin respect of Bank financedprojects 15. The CFAA concludes that there i s a need for substantial strengthening o f the overall public financial management framework. It would therefore be inappropriate for the Bank to place a blanket reliance on that framework for the purposes o f satisfying the Bank's fiduciary financial management requirements. Reliance on any particular aspect o f the country's financial management framework would need to be established on a case-by-case basis with reference to the specific financial management arrangements of the institutions involved. DevelopmentAction Plan 16. It would be unrealistic and impractical for the authorities to try to simultaneously address the many recommendations in this report. Immediately following this executive summary is a Development Action Plan (DAP) that lists and prioritizes the main recommendations o f this CFAA. The overall responsibility for the implementation o f the DAP rests with the Ministry o f Finance however the Ministry o f Economy, the Ministry o f Labor, the Court of Accounts and the National Bank of Moldova also play significant roles. The DAP was endorsed by the National Steering Committee that was formed specifically for the purpose of this CFAA. X x L . 5: 3.. P cd a0 cd - < x X I - 3 .Z 4 z 0 8 c) E+ E 5 M +- 5 * f838 0 w a, cm 4- cd -1 8 z \d. 2 n % 1. COUNTRYBACKGROUND 1. Moldova i s a small republic lying between Ukraine and Romania. It i s one o f the poorest countries o f Europe with a per capita GNP o f approximately US$400. The total population o f Moldova i s 4.3 million (including Transnistria) and an estimated 55 percent of the population lives inpoverty. Moldova i s predominantly an agricultural country, with few natural resources. Poor economic performance over the past decade has been attributed to political instability and unresolved separatist conflict. Moldova is one o f the Region's most heavily indebted countries and it has been facing a liquidity crisis in servicing its debts, Moldova's external debt service managed by the Ministry o f Finance accounted for about 30 percent o f state budget revenues in2002 and i s expected to exceed 35 percent in2003. Institutional constraints 2. The country has undergone a number o f fundamental reforms to its institutions and legislation since gaining independence in 1991 from the former Soviet Union. The dissolution o f the Soviet Union required the newly independent states to build from scratch the set of institutions which are part and parcel of modem statehood and democracy. Like other CIS countries, Moldova started the transition period with a low level o f institutional capacity in its public sector. The situation in Moldova has, however, been exacerbated over the last decade by chronic political instability and volatility, with ten governments over this period. Moreover, increasing politicization has led to high levels o f turnover in the civil service at each change o f government.(up to 20 percent turnover at each change o f govemment, with turnover down to deputy head o f department). This has resulted in chronic policy discontinuity, weakening o f institutional capacity, erosion o f institutional memory, and extremely low staff morale. 3. Institutional capacity has, in some limited areas, improved since independence. For example, Moldova has one of the strongest central banks in the FSU. The Ministry of Finance's technical capacity has also been considerably developed. Both these agencies were the beneficiaries of substantial externally funded technical assistance. However, even inthese cases, the sustainability o f the improvements will depend on implementingdeep public sector reforms to depoliticize the public administrationand provide appropriate incentives to be able to retain good quality professionals. Quality of Governance 4. Overall, Moldova's quality o f governance has remained poor, and i s among the weakest inthe region. Moldova hadthe worst performance among twenty transition countries when compared on a governance index by the EBRD (1999). Moldova also rated the lowest among seven transition countries with respect to perceptions o f quality and efficiency of central government services in the World Bank/EBRD Business Environment and Enterprise Performance Survey (BEEPS-1999). 5. Persistently extremely low compensation levels in the civil service combined with exposure to opportunities for rent-seeking as elements o f a market economy developed (the new private sector, emergence o f some SMEs, restructuring o f existing enterprises, privatization) has led to Moldova experiencing high levels o f both state capture and administrative corruption. At the same time there have been few external pressures on the system for appropriate behavior on the part o fpublic officials. Politicians have beenunable to secure discipline within the system. The private sector has not been able to form business associations capable o f lobbying effectively for business-oriented policies. Civil society i s weak. Citizens have extremely low expectations o f the public sector and extremely limited opportunities to participate meaningfully indecision-making processes. Structure of Government 6. The transition period has been characterized by a large degree o f political instability, with ten governments since independence. The absence o f political consensus behind economic reforms over this period, frequent changes o f government, and weak institutional capacity all combined to produce a stop-and-go pattern in the implementation o f economic reforms. 7. The new Constitution was approved in 1994 and established a parliamentary form o f government with the Prime Minister as the chief executive and the President as the head o f state. A single chamber Parliament o f 101 members i s elected by the people for a term o f four years3. The authority o f Parliament was expanded in 2000 through amendments to the Constitution, following which the President i s now elected for a four year term by Parliament rather than by direct popular vote. The Government consists o f a Prime Minister, First Vice- Prime Ministers, Vice-Prime Ministers and ministers as determined by the organic law. 8. Moldova i s a unitary republic comprising the central government and two tiers o f local government. The structure of local government has been undergoing continuous changes duringthe last years. The most recent reform introduced through approval o f the new Law on Administrative-Territorial Division took place in spring 2003 and basically reversed the earlier reform of 1999. The present administrative territorial division comprises 32 regions (rayons), autonomous territorial unit o f Gagauzia with special legal status, Municipalities o f Chisinau and Balti, 52 towns (municipalities) and 847 communes (villages). For the purpose o f this CFAA the administrative territorial division introduced in 1999 was taken as a basis, as the assessment was done before the March 2003 Law was enacted. Also, so far, the most recent reform did not have significant implications for financial management framework at the local government level. In the former administrative territorial division, one tier o f local public administrations was represented by ten Judets (counties), Chisinau municipality and the autonomous territorial unit o f Gagauzia. Another tier o f local government was represented by communes, villages and municipalities. As part o f the 1999 reforms, the central government introduced the office o f Prefect to represent central government inJudets, Chisinau municipality and the autonomous territorial unit o f Gagauzia, and report to the State Chancellery. These offices were closed down though the March 2003 legislation and replaced with the 8 zonal offices o f the State Chancellery. Each administrative territorial unit continues to elects its local council through popular vote. The heads o f localpublic administrations (primardmayors) are also directly elected by the people. Many o f the unitswithin local public administrations have dual subordination reporting to the respective central ministries as well as to the local public administration. 9. A schematic diagram depicting the interrelationships of the various organs of Parliament, central government and local government as relates to the country's public sector financial accountability framework may be found in Annex 2. These organizations are considered further inthe public sector sections o f this CFAA. The electoral system is based on the party list and not on direct vote for the people's representatives. Moldova CFAA: Public Sector Financial Manaqement 3 2. PUBLIC SECTOR FINANCIALMANAGEMENT 10. Effective public financial management is important in the promotion o f economic growth. A well designed financial management system helps to allocate public resources efficiently, controls both the availability and use o f funds, signals the future impact o f current management actions and provides information for sound decision making. Basic financial and budgetary control i s o f extra significance in view of Moldova's present financial hardship and cash flow constraints. 11. This section ofthe CFAA highlightsissues relatingto Moldova's public sector budget formulation, budget execution, revenue systems, accounting and financial reporting, and intemal audit. This includes a discussion o f cash and debt management as well as o f Treasury. Budgetformulation4 12. The national public budget o f Moldova includes the State Budget, the Budget o f the Administrative Territorial Units (ATUs or Local Budgets), Extra-Budgetary Funds (EBFs) and the Budget o f the State Social Insurance Budget(SSIB). Each i s described briefly below. The State Budget covers the operations o f central govemment ministries and departments including their decentralized structures in the territories and transfers to SSIB and ATU (local) budgets. Budgets of AdministrativeTerritorial Unitsare preparedby the respective localpublic administration authorities but adjusted based on the resources provided by the central government within 15 days o f approving the State Budget Law. Budgets o f ATUs account, on average, for 30 percent o f the total national budget. EBFs include those funds earmarkedby specific fees and charges corresponding to their end uses including, for example, the fund for social aid, the ecology fund, and the text book fund. EBFs are included into the State Budget Law in separate annexes. Budget institutions may also have extra-budgetary resources from charges and fees obtained through rendering services, authorized by legislation. In the 2003 State Budget, these extra-budgetary resources were also included inthe annual State Budget Law as an annex. Extra-budgetary funds and resources account for about 6 percent o f the national budget expenditures. The SSIB budget includes expenditures for pensions, non-pension social insurance programs (unemployment, sickness and matemity benefits), and most social assistance benefits, with pensions accounting for the largest share o f expenditures. SSIB budgeted revenue comprises revenues from social insurance contributions o f organizations and individuals and also includes transfers from the state budget to cover non-insurance program spending. The SSIB budget i s approved by an annual social insurance budget The Bank's Public Economic Management Review gives a very detailed analysis of the process o f budget formulation. This CFAA gives an overview of the process and highlights the salient financial management issues. law and i s administered by a semi-autonomous agency, the National Social Insurance House (NSIH), which falls under the auspices o f the Ministryo f Labor (MOL). 13. The state budget cycle for any given fiscal year starts, in accordance with the Law on Budget System and Budget Process, in April of the preceding fiscal year. However, for the FY2003 and FY2004 budget cycles, the process began at the start o f the preceding fiscal year with the approval by Government o f an "Action plan for the formulation of a MediumTerm Expenditure Framework and draft o f the budget for respective year". Based on this plan, the Ministry of Finance prepares a methodological note providing detailed guidelines and timetables to line ministries and departments about the budget formulation process. Inearly June, line ministries and departments submit their budget requests to the MoF, who reviews them and, after a process of bilateral negotiations, prepares a state budget incorporating the individual budgets o f the line ministries and departments. State budget transfers to the SSIB are separately negotiated by the MoF and MoLSP, based on the legislative commitment to state-funded benefit payments. 14. Collection o f state budget revenues i s the responsibility o f the Customs Department (CD) and State Tax Service (STS). The CD i s responsible for the collection o f taxes on imported goods, including VAT on imports, as well as customs duties; the C D contributes more than two thirds o f state budget revenues (or about 40 percent o f the national public budget revenues). The STS collects taxes on domestically-produced goods and all other domestic taxes including social insurance contributions. The Ministry o f Finance i s responsiblefor forecasting state budget revenues. 15. After the draft budget is reviewed and approved by the Government, the Minister of Finance, on behalf o f the Government, presents it to Parliament in October for approval. Parliament reviews the budget both at the general session, and in sessions of the Parliamentary Commission for Economy, Industry, Budget and Finance and other parliamentary committees. Parliament approves the budget after three readings; the Ministry of Finance may make adjustments to the budget after the first and second readings based on the deliberations o f Parliament. The state budget should be approved by Parliament before the date o f December 5, however the FY2003 budget was approved by Parliament in mid- November 2002. 16. Local governments' are responsible for formulating their own budgets, and line ministries are responsible for submitting budget proposals for their sectors as well as for formulating the budgets o f their extra-budgetary resources. The analytical capacity of local government and line ministries i s weak and reduces their ability to produce and defend their budget proposals. In most cases, budget formulation is incremental in nature and input- oriented rather than output- or outcome- oriented. Ministries, departments and local government institutions regard the budget formulation process simply as a means o f extracting more resources from the public purse. As such, budget estimates are sometimes very high, often 50-200% in excess o f the implicit ceilings provided to them by the MoF as part of the MTEF process (see discussion o f MTEF further below). In addition, they bear little relationship with strategic priorities and often represent an opening gambit in budget negotiations with the MoF. This causes the MoF to play the role o f "gate keeper" in preparing the national budget. Budgetnegotiations are often dominated by the MoF and the focus o f the budget negotiations becomes one simply o f controlling the budget numbers The English-languageversion of this CFAA uses the term "Local Government" whereas, for linguistic purposes, the Romanian-languageversionuses a term that maybe more directly translatedas "Local Public Authorities". rather allocating resources efficiently and strategically. The process o f prioritizing expenditures i s weak and budgetedexpenditures are seldom requiredto satisfy any particular rates o f return other poverty reducing criteria. 17. The state budget is presented by the Government to Parliament in a fragmented rather than in a consolidated and comprehensive manner. The Law on Budget System and Budget Process (1996) only requires that Parliament approves the state budget. The NSIH together with the MoLSP are responsible for the preparation o f the budget o f the State Social Insurance Budget which, once approved by Government, i s approved by Parliament separately from the state budget. Financing o f capital investments is reflected in the state budget as a single item, without a breakdown by functional classification. Donor financed investments, as well as extra-budgetary resources o f state budget financed institutions are not integrated into the state budget, but are approved as separate annexes to the annual State Budget Law. No explicit allocations are made in the annual state budget for repayment o f arrears accumulated during previous years. These matters compromise the comprehensiveness and transparency o f the budgets as a whole. Recognizing the shortcomings o f this approach, the Ministry of Finance has initiated consolidated analysis o f the national budget framework as part o f the efforts to introduce medium-term budget planning. The first attempt to analyze the overall national budget framework, including the state budget, local budgets, state social insurance budget, extra-budgetary funds and resources, and donor financing o f investments was undertakeninspringo f 2003. Moldova CFAA: Public Sector Financial Manaqement 6 18. As implied above, strategic planning is weak across the Government both in line ministries and at the center. In recognition o f this, the Government is moving towards a strategic approach o f budget formulation through the development o f a Medium-Term Expenditure Framework (MTEF) and the Ministry of Economy has prepared a medium-term macroeconomic forecast for the 2001,2002 and 2003 budgets. Inaddition, a strategic budget planning phase was added to the budget calendar which was approved for the first time in a new format in February 2002. The Government also approved a paper, Main Directions o f Budgetary-fiscal Policy, to underpin a medium-termbudgeting strategy for the period 2003- 2005. InDecember 2002, the Government approved the schedule for the preparation o f 2004- 2006 MTEF as part o f the 2004 budget formulation process. The strategic planning being introduced by these initiatives should considerably improve the comprehensiveness and allocative efficiency o fbudget formulation. 19. The Government is still adapting to the MTEFprocess andneeds further experience in order to benefit from this approach. However, the MTEF i s a step in the right direction towards strategic planning and increasing the transparency o f the budget process. The Government initially piloted a strategic planning o f expenditures under MTEF in the ministries o f Health and Education and the Ministry o f Social Protection was included in the pilot for the 2004-2006 MTEF. Indeveloping expenditureplans, sector expenditurestrategies are beingconsidered and, when fully developed, will be usedto determine: resource allocation between sectors, identifying sectors that require a greater share o f public expenditure resources; budget priorities within sectors, identifying programs that require a greater share o f a sector's resources; and key measures required to improve operational performance, identifying priority items within sector andprogrambudgets. 20. In 2001, and with the support of the USAID-financed Fiscal Reform Project, the Government tested program budgeting on a pilot basis for the FY2002 budget in the ministries o f Health, Education and Finance. However, success was limited by capacity constraints - the depth o f capacity had been overestimated and thus insufficient assistance was provided to augment this capacity. The initial plan envisaged moving to full implementation o f program budgetingfor the preparation o f the 2003 budget, with the aim o f having it operational throughout Government in 2003. The plan has now been scaled downwards in view o f the poor results o f the pilots. In order to move forward with further implementation of program budgeting, it will be necessary to build capacity inthe MoF, and also inthe line ministries. 21. A key element of budgetary reform is to increase the transparency o f budget formulation through a consultative process drawing in all stakeholders. Some limited consultation takes place regarding budget formulation, and indeed ministries do have so- called Collegium Boards comprising a fairly wide range o f stakeholders which could provide a forum for such a consultative process. However, budget formulation remains quite a closed technical exercise. Recently, as part o f the development o f the MTEF, both trade unions and employer unions were included in the MTEF taskforce, the composition o f which was approved by a government decision. This CFAA recommends that each ministry's Collegium Board formally and regularly consider its ministry's budget and budget execution reports. This will facilitate more creative ideas for budget preparation and also will increase the transparency o f the budget process. BudgetExecution 22. After the budget i s approved, the MoF establishes monthly allocation limits to the line ministries based on forecast revenues and sources o f financing. Line ministries use these limitsto develop a financial plan showing the monthly distribution o f budgetary expenditures for the fiscal year, by institution and also by expenditure category. These financial plans are then registered on the treasury ledger system to provide inputs on monthly expenditure and cash requirements for spending agencies. All adjustments to the financial plan are cleared through the MoF. Flow of funds 23. The State Treasury i s subordinate to the MoF and was created in 1993 through a Presidential decree to manage state funds, carry out budget operations and enforce budget discipline. Its responsibilities include: financial analysis, budget execution, cash management, accounting, the provision o f financial information, and the maintenance of appropriate treasury systems. The primary objective o f the Treasury i s to ensure that sufficient cash i s available from the various revenue agencies and other organizations to fulfill the day-to-day execution of the budget. The implementation of a central treasury system in 1997 contributed to improved control over cash and over unauthorized expenditures. The Treasury now validates all expenditures requested by line ministries against budget appropriations and the availability o f funding prior to payment authorization. It also facilitates monitoring of budget execution and timely reporting of the state budget, thus contributing to improved fiscal transparency and accountability. The central treasury system is now able to provide information on the execution o f the state budget at the end o f each day. The state budget operations have been serviced by the Treasury since 1997, and budget o f ATU (local budget) operations have been serviced since 2001. 24. Treasury operates four types o f bank accounts, which are normally referred to as "treasury accounts". These comprise: state budget accounts, accounts o f administrative territorial budgets (Le. local budget accounts), accounts o f the extra-budgetary resources o f institutions financed by the state budget, and foreign currency accounts. Central Treasury operates eleven accounts, all o f which are held with the National Bank o f Moldova, including: the single account for state budget revenues and expenditures, the special state budget account for the preparation o f the winter season, the special state budget account for revenues from sales o f land, and eight foreign currency accounts for various donor funding and assistance. 25. Territorial treasuries operate all four types o f treasury accounts although not all maintain foreign currency accounts if local circumstances do not warrant them. Each territorial treasury operates a single account for all revenues and expenditures o f all administrative territorial units served by the territorial treasury. The state budget accounts o f territorial treasuries are used to accumulate funds from the central Treasury's state budget account at the NBM and subsequently to finance expenditures o f state budget institutions located in the territory served by the territorial treasury. The state budget accounts throughout the treasury system are not operated as a "single treasury account" inthat there i s no requirement for territorial treasuries to transfer unutilized funds to the bank account o f the central treasury at the end o f each day or any other period, save for the end o f the fiscal year, December 31, when unutilized balances must be returned to central Treasury. As a result, central Treasury cash management and particularly debt financing i s made more difficult. N o revenues pass through the state budget accounts o f territorial treasuries. The territorial treasury bank accounts themselves are heldat three commercial banks, Banca Sociala, Banca de Economii and Moldinconbank, which were selected after a tender process inFY2000. 26. The funds o f EBFs such as the ecology fund, flow through the state budget accounts o f the treasury system, either through the NBMaccount or through the state budget accounts o f territorial treasuries. By contrast, extra-budgetary resources o f state budget institutions are accumulated in separate bank accounts opened by territorial treasuries. Extra-budgetary resources of state budget institutions are deemed to have been "earned" by the state budget institution and are not included in the state budget. These include, for example, revenues from fees charged by universities and health institutions. However, these earnings are monitored by the MoF through the treasury system. 27. The revenuebank account o f the National Social Insurance House is heldat the NBM with the central Treasury as its holder. The expenditure bank accounts of the SSIB are maintained at the commercial bank, Banca de Economii, and are administered by the NSIH. The expenditures o f the SSIB fall outside the authority o f the Treasury. CashManagement 28. Cash management has three primary objectives: (a) to ensure that expenditures are smoothly financed duringthe year, so as to minimize borrowing costs; (b) to enable the initial budget policy targets, especially the surplus or deficit, to be met and (c) to contribute to the smooth implementation o f both fiscal and monetary policy6. Effective cash management should: 0 recognize the time value and opportunity cost o f cash; 0 enable line ministries to plan expenditure effectively; 0 be forward-looking, anticipating macroeconomic developments while accommodating significant economic changes and minimizingthe adverse effects on budget execution; be responsive to the cashneeds of lineministries; 0 be comprehensive, covering all inflows of cash resources; and plan for the liquidation o f both short and long term cash liabilities. 29. In Moldova, peaks and troughs in cash availability create considerable uncertainty amongst budget executors. As a result, spending organizations are unable to implementtheir budgets and are forced to accumulate arrears even when operating within agreed budget parameters. The PEMR indicates that the deviations between planned and actual expenditures inthe years 1999, 2000 and 2001 have been 6.1%, 2% and 10.7% respectively. Guidelinesfor PublicExpenditureManagement, B.H.Potterand Jack Diamond, IMF, 1999. Moldova CFAA: Public Sector Financial Manasement 9 Inadequate analysis o f cash flow requirementsmakes it difficult to prepare and implement a cohesive borrowingplanto meet the demand for cash. 30. With unreliable cash forecasting and poor linkages to debt management, Treasury officials regularly plan and allocate cash for budget execution on a daily rather than on any longer period, based on the actual funds available on the day. Thus budget executors are not informed in advance about cash shortages and continue to enter into contracts and other obligations for which, although budgeted, no funds may be available. Formal adjustments to financial plans may take place only if amendments to the budget law are passed in Parliament, but this i s a time-consuming process which can result in considerable delays in the execution o f the budget. All o f this undermines the Government's role in setting expenditure priorities through the Budget Law. To improve the cash managementprocess, the Government established a Cash Management Unit in 2001 in the Ministry o f Finance; however, this unit still not effective inits intendedrole o f managing cash inthe public sector. The MoF should develop and make public a regulation on state budget cash allocations in order to increase transparency o f public cash management.. 31. A number o f other issues have been identified that are symptomatic of broader weaknesses incash flow management and internal control procedures: payments to contractors are frequently made in advance o f the goods or services being delivered, which i s inappropriate; the Government incurs significant penalty charges because o f delays in paying suppliers as a result o f the cash shortages; Until recently, the SSIB bank balance was held in a non-interest bearing commercial bank account. On December 31,2002, the Government approved legislative acts allowing the NSIH to place and invest these funds in commercial bank deposit accounts and government securities. However, the procedures and regulations for the selection o f the commercial banks and the investment in government securities have yet to be finalized. The latest Memorandum o f Understanding concluded with the IMF requires the adoption o f investment guidelines, including maturity and risk profiles, based on the best-interests o f the Social Fund's stakeholders. 32. Despite the above-described rather gloomy picture o f cash management, some progress has been made in settling accumulated arrears although the situation in this respect remains unstable. As mentioned in the PEMR, in 2001, for example, the Government was unable to prevent accumulation o f new arrears. While the most recent developments indicate a gradual reduction inthe stock o f accumulated areas for the past years, commitment control systems are not yet robust enough to ensure the sustainability o f the trend. 33. The introduction o f the treasury system led to improvements in controls over expenditure commitments incentral government but control i s still weak inlocal government. A computerized system has recently been developed to manage commitments but it i s not fully operational inall territorial treasuries. Treasury currently records all purchases of goods and services over 5,000 Lei and therefore significant expenditures are tracked. However, the commitments system at the local government level needs to be fully implemented as a mater o f priority, as it will play a significant role inimproving cash management and allocation. Debt Management 34. Moldova received its first credits in 1992 with an initial borrowing o f US$ 13 million. By 1997, the total external debt administered by the Ministry of Finance had risen to US$ 797 million and by the end o f 2001, total external public debt (including debt administrated by NBM) and publicly guaranteed debt stood at US$ 960 million7representing about 65 percent o f GDP8. The challenges facing the Government in debt management are greatest in the areas of energy arrears, repayments to multilateral and commercial creditors, and contractual contingent liabilities such as guarantees. Following the establishment o f the legal arrangements for the issuance o f guarantees, the Government has abstained from providing guarantees on loans contracted by state enterprises. However, it still honors debt service obligations resulting from old loan guarantees. Although contractual contingent liabilities have benefited from the existence o f a clear rule-based approach, the materialization o f various implicit liabilities in an ad hoc manner, particularly energy arrears of budget institutions and enterprises, has resulted ina rapid accumulation o f public debt. 35. Strengthening debt management has been high on the agenda o f institutional reforms promoted by the Ministryo f Finance for several years, in order to obtain least-cost financing of the fiscal deficit in the short-term and fiscal sustainability o f debt service over the medium- and long-term. The Government has given priority to the formulation of a debt strategy that incorporates all forms o f government liabilities including external and domestic debt as well as direct and contingent liabilities. 36. Recently, the Government approved a decree establishing a new Department o f Public Debt, distinct and separate from the Treasury Department, to be responsible for all public debt issues. The department's responsibilities include the management o f public debt, assets and liabilities, debt sustainability analysis, formulation o f a comprehensive debt strategy, and the negotiation and contracting o f loans. Revenue systems 37. The main types of budgettax revenues are value added tax, excises, corporate income tax, personal income tax and customs duties. Corporate income tax, VAT and road tax are shared between state budget and budgets o f ATU. Corporate income tax and VAT, usually i s transferred wholly to ATU budgets with the exception o f the Chisinau municipality, which retains only fifty percent o f corporate income taxes and ten percent o f VAT. Fifty percent of road tax i s shared with budgets o f ATU. Revenues collected by the State Tax Service (STS) and Customs Department (CD) are transferred to the Central Treasury on the date o f receipt. '*Thisfigure excludesexternal energy arrears. In 2001, total debt service for public and publicly guaranteeddebt amounted to 42% of central government revenues (SourcePEMR, table 1.7). The Central Treasury inturn transfers shared revenues to the appropriate regional treasuries' local bank accounts. 38. In2001, collected state budget revenues were about 14percent less than forecast and in 2002, revenues were at a level equal to 96% of those originally forecasted. General government revenues fell from almost 40 percent of GDP in 1997 to about 31 percent in 2001, Additionally, there are significant tax arrears. These matters raise concerns about the quality o f revenue projections, revenue collections and revenue leakages. The Ministry o f Finance i s responsible for forecasting state budget revenue, the National Social Insurance House is responsible for revenue forecasts o f SSIB, and local government i s responsible for revenue forecasts o f ATU budgets. The quality o f revenue projections across the Government seems to be undermined by weaknesses in the analytical foundation and by the use o f simplistic forecasting techniques. No computerized models are used and forecasts appear to be determined with limited inputsfrom the tax enforcement and collection agencies (the STS and CD). Inaddition, there i s muchthat can be done to improve governance and enforcement capacity in order to improve the present situation. Finally, it was noted that the current subordination o f the CD and STS to, respectively, the Prime Minister and Minister o f Finance, makes it difficult to coordinate an effective strategy to collect all tax revenues due and tackle evasion. 39. The C D collects over two-thirds o f total state budget revenues (or about 40 percent o f the national public budget revenues), essentially through VAT on imports and excise, and revenue collection has increased in the past year by 34 percent. The Govemment sets monthly revenue targets to the Customs administration, which are essentially based on the previous year's performance. The system o f revenue targets is inspiredby the old centralized planning, but does not have the expected impact. All Customs control mechanisms are designed to increase collections on existing transactions, with the strong suspicion that all importers are likely to defraud. Forgone revenues on fraudulent, or non-declared, transactions, i s ignored. There i s only a very limited concept of risk management, and no attention to facilitation. The marginal cost o f compliance therefore becomes high, and it i s borne bothby the business community and the administration. A major problem facing C D i s valuation fraud. As in many other transition counties, the C D had no culture o f checking declared values in an environment o f state-run foreign trade. The rapid emergence of small importers, combined with cross-border "suitcase trade" generated an enormous workload for Customs and created immediate opportunities for fraud and rent-seeking. The administration was incapable o f controlling the large-scale revenue erosion and this situation led to the introduction o f a Pre-Shipment Inspection system (PSI) in 2001, supported by the IMF9. Despite declared measures to improve control and reduce leakages o f revenues, including the creation o f specialized subdivisions for the prevention o f customs fraud and the deployment o f internal auditors to conduct regular inspections o f economic entities, significant informal trade persists, especially through the Transnistria region. While the issue o f Transnistria goes much beyond the role o f the CD, it i s essential that a real preventative and enforcement strategy be put inplace. Recentlythe C D has embarked on a modernization strategy aimed at achieving EU best-practice standards, including integrated border management and consistency with numerous international conventions, such as the WTO, and, as far as border management i s concerned, the Geneva Convention on simplification o f border controls. The overall objective i s to combat smuggling and reduce corruption. The main elements o f the strategy include: reviewing procedures and operations, coordinating legislation, developing a new approach to organization and staffing, strengthening enforcement activities and computerizing operations. The CD i s being assisted in the implementation o f this strategy At the time ofthe CFAA fieldwork, PSI was not operatingpendinglegislation to be approvedby Parliament, MoldovaCFAA: PublicSector FinancialManaqement 12 through the Bank-financed project, Trade and Transport Facilitation in South Eastern Europe (TTFSE).The project will be implemented between2003-2006 and is co-financed by the U S Government. 40. STS has developed and has started to implement a rudimentary risk-based approach for the verification and control o f taxes payable by economic entities in accordance with which the STS targets entities in sectors thought to have a high probability o f tax evasion. The STS includes a security department which i s an internal control function after a fashion inthat itaims to control andmonitorthe activities andbehaviors ofthe workforce ofthe STS. STS has expended considerable effort in improving national tax administration and these efforts were supported during the last few years by a large-scale technical assistance project, the USAID Fiscal Reform project. In addition, the new Tax Code enacted in 2001 with the assistance o f the project included a specific chapter on tax administration. The efforts aimed at upgrading the capacity o f the State Tax Service include a wide range o f activities: the development o f new procedures compatible with provision o f the tax administration chapter o f the tax code; the upgrade o f the STS information systems; the establishment o f the Large Taxpayers Unit; strengthening o f internal audit; and training. Accounting and Financial Reporting 41. The former Soviet Union had a highly regulated and prescriptive accounting framework. Moldova abandoned this framework, and Parliament enacted a new Accounting Law in 1995 which provides the basic rules for accounting. This Law i s discussed in more detail inthis CFAA inthe section on private sector enterprise accounting. Based on the Law, the MoF issued detailed instructions for accounting inpublic institutions financed by the state budget, as well as for extra-budgetary resources. Ministries, departments and LGIs may additionally establish accounting procedures for subordinated public institutions. 42. The laws, rules and regulations relating to accounting and treasury operations are quite cumbersome. They are weakly drafted and structured, with no table o f contents or grouping o f clauses in a logical order. The regulations are overly detailed and prescriptive. Clear and concise drafting will support a greater understanding and reduce the cost o f compliance. A recent trend in contemporary legislation has been to move away from prescriptive and detailed legislation to laws based on broad principles. This reflects the view that prescriptive legislation i s unable to deal with a rapidly changing contemporary environment whereas principle-based legislation will generally continue to be appropriate despite environmental and other changes inthe future. 43. The accounts o f ministries and departments are maintained on modified cash basis". However, line ministries and departments maintain lists o f commitments and liabilities in their subsidiary systems. Spending units record liabilities as incurred, but revenues are recorded only when received. The spending units maintain their own accounting records in prescribed formats using a double entry system of accounting. Only the National Social loUnder the modifiedcashbasis of accounting, records are commonly heldopen for around a monthafter the end ofthe accountingperiod. Receiptsand paymentswhich occur duringthe specifiedperiodbut originatein the previousaccountingperiodare recognizedas receiptsandpaymentsofthe previousreportingperiod(IFAC -GovernmentalFinancialReporting-AccountingIssuesandPractices-2000). Moldova CFAA: Public Sector Financial Manaaement 13 Insurance House now maintains its accounts on an accrual basis and will produce financial statements inaccordance with International Accounting Standards' '(IAS)as o f 2002. 44. Treasury maintains records o f all revenues and payments purely from a budget accounting perspective and follows a cash basis o f accounting and budget appropriations whilst tracking expenditure commitments in central govemment. Since 1997, the Government has used both economic and functional classifications that are generally in line with the IMF-advocated Government Finance Statistics (GFS). Inaddition, the Government i s currently developing program classifications that are being tested in the pilot sectors o f health, education and social protection. The Treasury system i s currently being set up in 37 local treasuries to serve 634 separate local governments where it will also track expenditure commitments in local government. With the expansion of the Treasury system, there i s an associated increase inrisk for public sector financial management. Treasury needs to assess these risks particularly in terms o f procedures and controls, systems continuity, cash management and forecasting. For example, the disaster recovery plan for the Treasury's computer systems appears inadequate. 45. The accounting functions in ministries are performed by dedicated units headed by ManagersKhief Accountants responsible for accounting for, reporting on and controlling budgeted expenditures, according to the Accounting Law and relevant instructions and guidelines. The integrity o f primary documents, accounting registers, financial reports, their formulation and their archiving are the responsibility o f the ManagerKhiefAccountant. 46. It is not clear that appropriate use i s made of financial informationfor the purposes of management. Treasury and line ministries prepare a variety o f financial reports but many of these reports do not appear to be used. Inaddition, whilst each line ministryprepares its own financial statements, including balance sheets showing the individual ministry's assets and liabilities, no consolidated financial statements are prepared that reflect the financial position of the entire public sector. Were such consolidated financial statements to be prepared, they would provide valuable information on the financial position o f the public sector, provide key inputsto cash management systems, and also serve to increase transparency. 47. The Ministry of Finance prepares a report on the implementation o f the state budget and its relationship with ATU budgets in respect o f the period to December 31 o f each year and presents this report to the Government and Parliament by May 1 o f the following year. The approved state budget data i s then made available to the public; the annual state budget and the local governments' budgets are published inthe Official Gazette'* and are also posted on the Government's website. The Statistics Department disseminates budget execution data for all levels o f government operations through its official publications, on a monthly and quarterly basis. The state budget's monthly, quarterly, and annual data are generated by the Treasury and the MoF disseminates these data directly through the media, providing monthly fiscal data on tax collection, budget execution, and financing o f the state and ATU budgets. For the purposes of this report, the term "IAS" encompassesthe standards endorsedby the International AccountingStandards Board(IASB), includingthose designated"International FinancialReportingStandards" fIFRSl `*Inaddition, the four-volumeAnnual Report on budget executionfor these levels of government is only for internalGovernmentuse. Internal Control andAuditing 48. Public sector internal auditing i s relatively under-developed, fragmented and suffers from a weak capacity. It is limited to ex-post verifications and inspections over the execution o f the budget and aims to detect cases o f inappropriate use o f funds. There are no ex-ante assessmentso f the control framework o f ministries and other government agencies, which are essential objectives o f modern internal audit functions. 49. The Financial Control and Revision Unit (FCR) i s a unit accountable to the Minister o f Finance. The FCRperforms financial audit activities and inspections o f state budget, ATU budgets and EBFs. The audit of central government ministries and agencies i s however outside the FCR's mandate. The FCR also conducts audit activities regarding the use o f budget allocations to state-owned enterprises. 50. The present organization o f the FCR was approved by Resolution o f the Government dated May 27, 2002 upon the creation o f the Center o f Struggle against Economic Crime and C~rmption'~. The traditions o f the function date back much further to the Control and Revision Departments which operated under the former Soviet Union. In terms of its institutional arrangements, the FCR is physically and functionally separate from the accounting and reporting functions o f the MoF. In operational terms, ad-hoc inspections based on requests from various enforcement and control bodies, such as the Court o f Accounts, the President's Office and Parliament, still absorb a lot o f FCR's resources and undermine the full development o f a proper internal audit function. 51. Currently the FCR employs 155 staff headed by a director general who i s appointed and can be dismissed by the Minister o f Finance. The FCR has seven central units: General, Education, Healthcare, Public Institutions (two divisions), Audit Methodology/Legal and Economic/Financial.Inaddition it has ten territorial structures. 52. The value of the reports produced by FCR are limited because they focus on lapses and irregularities in individual transactions, but neither regularly nor in a systematic manner assesses issues o f economy and efficiency, weaknesses in financial management, management performance, or procedures and internal controls. As the reports are inthe main limitedto compliance issues, the utility of the FCR as a means to improvingpublic financial management i s limited. 53. The MoF established a small internal audit department in the state Treasury in 1997. The department currently has five staff and in May 2002 became subordinated directly to the Minister of Finance. The role of the Treasury Internal Audit function .is to audit the central and territorial treasuries. The department also conducts ad-hoc assignments at the request o f l3The Center was createdwith staff from the Financial Guard, Economic Police and apart of the former DFCR. the MoF. In 1998, the department prepared an Internal Audit Manual with the technical assistance o f an IMF adviser to the MoF. 54. The State Tax Service, Customs Department and National Social Insurance House have also recently established their own internal audit departments, all o f which are in the early stages o f development. 55. This CFAA recommends that a strategy should be prepared for an effective public sector internal audit function. There are various models of internal audit. The following bullet-points outline one possible approach: An InternalAudit Department would be created, headedby a Chief Government Internal Auditor (CGIA), reporting to the Prime Minister or Minister of Finance, and which would have the following responsibilities: (a) standard-setting - to develop public sector internal audit standards and enforce their implementation; (b) recruitment - to develop recruitment policy including entry and promotion criteria and recruit internal audit staff for all internal audit positions across the Government; (c) training - to develop and deliver assurance - to develop quality assurance mechanisms to ensure high quality internal audit structured training programs, including continuous education programs; (d) quality work; and (e) internal audit work - to carry out internal audit work upon the request of a line ministry, for example in circumstances where the line ministry lacks appropriate capacity. Each line ministry would be responsible and held accountable for maintaining an appropriate internal control framework. Each line ministry would establish an internal audit department responsible for conducting internal audit activities within the line ministry and which would submit internal audit reports to the line minister and the ministry's Collegium Board. (Procedures would need to be established to ensure that staff are not transferred from accounts preparation departments to these internal audit departments to mitigate the risk that staff audit financial statements that they have prepared). Each line minister would prepare an annual assurance letter addressed to the Prime Minister or Minister of Finance confirming that an effective internal control framework has beenmaintainedwithin the ministryand describing key issues as well as any remedial action plans to address material weaknesses. This would reinforce the accountability o f the line minister to maintain an effective internal control framework in the ministry and strengthen the decentralized internal audit structure. The Prime Minister or Minister o f Finance would annually prepare a summary table o f all line ministers' assurance letters and present it to the Council o f Ministers for discussion. This would enhance the Government's awareness o f the state of its financial management framework. 56. Finally, the Government also recently established the Center for the Struggle against Economic Crime and Corruption. The Center i s headed up by a director who i s administratively responsibleto the Prime Minister. It i s understood that the Center has inthe region o f 1,000 staff, most o f whom have been recruited from the Economic Police, the Financial Guard as well as from the Ministry o f Finance's Department o f Financial Control and Revision. Recommendations-Public Sector Internal Auditing 7 TheMinistry of Financeshouldprepare a srrateglifor apublic sector internal auditfunction. Moldova CFAA: External Oversiqht of Public Financial Manaqement 16 3. EXTERNAL OVERSIGHT OF PUBLICFINANCIAL MANAGEMENT 57. It is generally recognized that one o f the important ways of increasing government accountability i s to oversee in a regular and effective manner the way the Government and other public institutions raise and spend public funds. This sectionreviews the workings and effectiveness o f the three main oversight institutions o f the Court o f Accounts (CoA), Parliament and its committees, and the Ombudsman. External Auditing 58. The Constitution invests Parliament with the power to establish the Court o f Accounts established in 1994 upon the enactment o f the Law on the Court o f account^'^ and its powers (CoA), the Supreme Audit Institution (SAI) o f the Republic o f Moldova. The CoA was and functions have subsequently beenmodified on occa~ion'~. The legislative framework has significant benefits inboth defining and regulating its activities: the CoA enjoys the freedom to choose what to audit, how to audit and when to audit and report. The CoA also has the independence to develop its own audit methodology, including auditing standards, audit manuals and other necessary guidance. The independence o f the office is thus theoretically guaranteed; there i s no restriction on access to information or records needed to carry out their responsibilities. However, the CoA i s dependent on the Ministry o f Finance (MoF) for its budget allocation and consequently the scope o f its activities i s indirectly determined by the MoF 59. Broadly speaking, and in accordance with its legislative framework, the CoA audits and controls the formation, administration and use o f all public funds and public property. The CoA is also empowered to audit the budget and expenditures o f Parliament, the President, the State Chancellery, the Supreme Justice Court, the Economic Court, the General Prosecutor's Office, specialized public administration authorities, the National Bank o f Moldova and those commercial banks inwhich the state has an equity interest. Finally, and upon the written request o f at least 20 members o f Parliament, the CoA may be required to perform additional audits without further ratification by Parliament. The number o f such ad hoc audit and controls, which cannot be accurately predicted nor planned in advance, accounts for approximately 20-25 percent o f the workload o f the CoA. 60. In addition to its auditing functions, the CoA has been invested with the power to undertake the following control and enforcement activities: demand that disciplinary action be initiated against those responsible for the misuse o f public resources to recover damage caused to the state; suspend the bank accounts of audited organizations and individuals; submitmaterials to investigative agencies inrespect o ffinancial offenses; demand the suspension from office o f those deemed to have grossly violated or failed to enforce the law; and l4Law of Republic of Moldovaon Court ofAccounts - No. 312-XI11of December8, 1994publishedinthe Official Monitor ofthe Republic of MoldovaNo. 7/77of February2, 1995 l5Law on Court of Accounts as amendedbythe Parliament on May 17,2002 (Law 1063XV) Moldova CFAA: External Oversight of Public Financial Manaqement 17 countersign all documents relating to public debt. The countersignature by the Chairperson of the CoA i s required to ensure the legality o f the debt and its registration in the public debt register. 61. The above described control and enforcement activities appear excessive and beyond the scope o f what is generally considered the responsibility o f a Supreme Audit Institution. There i s too great an emphasis on control, prosecution and enforcement rather than audit. This CFAA therefore proposes the following revisions to the Law on the Court o f Accounts: Article 4.1 gives the CoA free and unlimited access to any physical person's or legal entity's acts, documents, and information. In addition, article 26(g) gives the CoA the right to demand that disciplinary action be initiated against those responsible for violations inthe use o f public financial resources and recover damage whilst article 26(i) gives the CoA the right to demand the suspension from office o f individuals who have committed gross violation o f law or failed to enforce it. These investigative and prosecutorial powers o f the CoA extend beyond the normal remit o f a supreme audit institution and should be removed. Voluntary cooperation by individuals and entities should o f course be encouraged, however, where the CoA suspects or discovers irregularities, it should refer the matter to the appropriate law enforcement or regulatory agencies (as i s envisaged in article 8 o f the law) and make reference to the matter intheir audit reports. Article 20(g) permits the CoA to "exercise control over the ... activity o f other control bodies" which thus compromises their independence (e.g. there are instances, where the CoA instructed the Department o f Financial Control and Revision o f the Ministry o f Finance to carry out some o f the control functions on its behalf). Article 23 requires the CoA to countersign "all documents related to public debts, from which liabilities o f the country appear". This compromises the oversight function o f the CoA by actively involving the CoA inthe operations o f Government. Article 31(e) gives the CoA the right to request copies o f documents relating to any financial transaction from the National Bank o f Moldova and commercial banks with state shareholdings. This appears to extend the audit scope o f the CoA beyond the state sector and thus i s unnecessarily intrusive given that the CoA i s in any case invested with the right to audit and control the formation, administration and use o f all public funds and public property. 62. The CoA operates under the leadership o f a Chairperson with the support o f a Deputy Chairperson and five Members. The Chairperson i s appointed by Parliament for a term o f five years. The Deputy Chairperson and five Members are also appointed by Parliament but are nominated by the Chairperson. The Parliament may dismiss the Chairperson, Deputy Chairperson and Members by majority vote in the event o f unsatisfactory performance, violation o f law or abusive o f power. The Chairperson and the Deputy Chairperson are authorized to participate inParliament and Government sessions. 63. The CoA staff numbers 187 o f which 104 are at the central offices, and the remainder are at the territorial courts. Recent amendments to the Law on the Court o f Accounts have eliminated the territorial courts, however the CoA intends to ask Parliament to sanction their reestablishment as well as increase CoA staff to 212. The CoA i s organized in six main divisions: control and analysis; organizational, information and analytical; public funds formation and utilization control; public authorities control; state property management and banking activities; and legal. Moldova CFAA: External Oversightof Public FinancialManaqement 18 64. The CoA appears to lack suitably qualified and trained audit personnel in most areas including basic financial auditing and computer auditing. In addition, the CoA does not maintain an inventory o f the skills and competencies o f its present staff with a view to determining its future staffing needs. There seem to be no entry requirements for staff joining the CoA in terms o f experience and qualifications, although the positions of Chairperson, Deputy Chairperson, Members, and heads o f departments, divisions and sections are required to have a higher education and at least fifteen years o f work experience in finance, economics or law. Consequently the CoA mostly staffed by generalists. Recruitment o f qualified personnel i s difficult, given the small number o f practicing accounting and auditing professionals, particularly those willing to join the relatively poorly paid public sector, yet the professional development opportunities offered to its staff are still rather limited. Some staff have had the benefit o f participating in study tours o f and fellowships in other more established SAIs, and also o f attending EUROSAI and INTOSAI seminars and professional conferences, however, professional development o f CoA staff primarily takes the form o f on-the-job training. 65. The relatively weak capacity o f the staff o f the CoA i s also reflected in its relatively poor audit methodology. Audits tend to be performed ina rather haphazard manner without reference to risk assessments or evaluation o f the auditees' procedures and control environments. In recognition o f this, the CoA i s committed to and i s in the process o f upgrading its audit methodology leveraging on its connections with neighboring SAIs, particularly that o f Ukraine. Although muchremains to be done, the prospects that the CoA's audit methodology canbe significantly improved inthe next few years are good. 66. The reports o f the CoA do not contain audit opinions on financial statements but rather detail lapses and irregularities in individual transactions. They do not provide assessments of issues such as economy, efficiency, performance, and accounting and internal control systems. The reports appear unstructured, rather long and detailed which make them difficult to understand, not only interms o f facts but also, and more importantly, interms o f implications for the state o f the public sector financial accountability framework. Thus, the utility o f the CoA audit as a means to strengthening the public financial accountability framework i s limited. 67. CoA reports are finalized after consultation with the auditee in a public session inthe offices of the CoA, at which all the Members o f the CoA and the auditee are present. Although the full texts o f the reports o f the CoA are not made public, decrees based on their reports are publishedinthe Official Monitor within ten days16. 68. There i s currently no provision or arrangement for an extemal review o f the activities of the CoA either by a private firm o f professional accountants or by another country's SAI. A twinning arrangement such as those arranged with the support o f the EUbetweenthe CoA and a more experienced S A I would be very useful inthis regard, not only to help develop the professional capacity o f the organization but also to provide a degree o f extemal review and assurance about the quality o f the CoA. l6InFY2002, the CoA issued about 200 decrees in the Official Monitor Moldova CFAA: External Oversbht of Public Financial Manasement 19 Parliament 69. It is understood that Parliament is fairly active in improving the country's financial accountability framework. It has enacted various laws and decrees to improve both the internal and external oversight functions in Moldova. It has also instituted various parliamentary committees, o f which the Committee on Economy, Industry, Budget and Finance i s primarily responsible for attending to matters o f financial management. Unfortunately, the CFAA team was not able to gain access to the proceedings or minutes o f Parliament or its committees. Therefore this CFAA's analysis o f Parliament i s necessarily restricted. 70. The state budget i s approved by Parliament after three readings. Parliament also reviews the financial statements presented by Government with appropriate reference to the reports o f the Court o f Accounts and may direct the executive arm o f the Government to attend to the matters raised in the CoA's report. As discussed earlier, Parliament or a parliamentary faction comprising at least 20 members o f Parliament, may require the CoA to perform additional audits and controls. Every May, the Ministry o f Finance presents Parliament with financial statements showing the results o f the previous fiscal year. 71. It is believed that both Parliament and the Parliamentary Committee on Economy, Industry, Budget and Finance do not regularly review the performance o f individual line ministries and government agencies, particularly interms o f revenues generated, expenditures incurred, outputs and outcomes, value-for-money, and the quality of accounting and internal control procedures. Thus Parliament loses a valuable opportunity to shape the activities and strategies o f the individual ministries and also strengthen the overall quality o f public financial management. This CFAA recommends that Parliament should regularly review the financial performance and position o f individualministries. 72. In 1997, the institution of Ombudsman was established as a democratic and independent organ. It comprises three Parliamentary Advocates whose status, duties and terms o f office are established by the Law on Parliamentary Advocates. The activities o f the Parliamentary Advocates are aimed at ensuringthe observance o f constitutional human rights and freedoms by central and local public authorities, institutions, organizations and enterprises. The Ombudsman investigates formal complaints made by citizens or entities on a wide variety o f matters including financial and direct remedial actions. By March 15 o f every year, the Ombudsman i s required to submit an annual report to Parliament, a summary o f which i s to be publishedin the Official Monitor. Unfortunately, it is understood that the Moldova CFAA: External Oversiaht of Public Financial Manaaement 20 CY2001 annual report has still not been discussed by Parliament. The CY2000 annual report that was discussed by Parliament and summarized in the Official Monitor does not make a very favorable impression o f the Ombudsman. The effectiveness o f the Ombudsman i s to a great extent dependent on the actions o f Parliament, based uponthe Ombudsman's reports as well as the appointment o f appropriate Parliamentary Advocates. Parliament should be encouraged to be more proactive in terms o f reviewing the reports o f the Ombudsman and acting upon the Ombudsman's recommendations. Additionally, the full text o f the Ombudsman's reports should be made public. Moldova CFAA: Local Government Institutions 21 4. LOCAL GOVERNMENT1'INSTITUTIONS 73. The Constitution o f Moldova (Article 109-113) establishes the concept o f local autonomy and addresses the organization and function o f local governments. The administrative territorial division o f the country has been undergoing continuous changes during the last years. The most recent change took place inspring 2003, after a new version of the Law on administrative territorial division was approved by Parliament on March 18, which basically reversed the earlier reform o f 1999. InMoldova there are two tiers o f local government. After the enactment o f the March 2003 Law, one tier o f local public administrations i s again represented by rayons (these units already existed during the Soviet times), Chisinau municipality and Gagausi autonomous region. Another tier i s representedby communes (villages) and municipalities. The administrative territorial division introduced in 1999 created ten larger intermediary level self-governing judets and Garauzia Autonomy and Chisinau municipality as Administrative Territorial Units. The 1999 reforms kept the former level o f local governments o f around twelve municipalities, 43 Town Primarias and 593 Communes Primarias. (These figures do not include the Transnistria Region, which i s not under the control o f the Government o f Moldova and is not covered under the CFAA). The Judets Council coordinated the activity o f the village and town councils to achieve public service atjudets level. Thejudets council was elected and worked inaccordance with the law. At village andtown level, the public administrationauthorities through which localautonomy i s executed are represented by the elected local councils and mayors. The new law on local public administration approved in March has not significantly changed the local public financial management framework. Current administrative territorial division comprises 32 rayons, autonomous territorial unit o f Gagausia with special legal status, Municipalities o f Chisinauand Balti, 52 towns (cities) and 847 communes. General finance divisions of administrative territorial units have been re subordinated to the new superior tier local public administration units.The role o f Prefect has beenreplaced with 8 State Chancellery territorial offices. Judet councils have been replacedwith rayon councils. For the purpose o f this CFAA the administrative territorial division introduced in 1999 was taken as a basis, as the assessmentwas done before the March 2003 Law was enacted. 74. The local councils and the mayors operate under the law as autonomous administrative authorities and are assigned the task o f solving public affairs in villages and towns. The above schematic diagram explains the organization o f local government in Moldova and their reporting relationship to central government. 75. To monitor the activities o f local government ,the central government introduced the system o f prefect's offices in 1999. These offices represent the central government injudets and report to the State Chancellery. There i s activating a General Financial Division o f ATU, which i s subordinated to the Prefect and to the Ministry o f Finance. The General Financial Division o f ATU plays a key role in the financial management o f the ATU budgets 18. Each o f the administrative territorial unitselects its local council through a popular vote. The heads o f local public administrations (primars/mayors) are directly elected by the people. Many o f the units within local public administrations have dual subordination, reporting to the respective central ministries as well as the localpublic administration heads. The English-language version of this CFAA uses the term "Local Government" whereas, for linguistic purposes, the Romanian-language version uses a term that may be more directly translated as "Local Public Authorities". '*InChisinau, the General FinancialDivisionis part o f mayor's office and reports both to the Minister o f Finance and the mayor (the primary responsibility i s to the Minister o f Finance). Structure of Local Government and Linkages with the Central Government" 76. In 2001, the newly elected Parliament initiated amendments to the legal framework that partially reversed the 1999 reforms. The implementation of these amendments remains unclear as the Constitutional Court subsequently invalidated part o f them. In consequence, there i s currently much confusion regarding the status o f the 1999 reforms including the central issue o f how much has actually been decentralized. This has in tum resulted in an unclear localbudget formulation process with the General Financial Division (see below). Local GovernmentBudgets 77. The law on Budgetary System and Budgetary Process2' formally acknowledges and integrates budgets o f local governments as autonomous entities into the country's budgetary system. For preparing the ATU budgets, the central government establishes ratios between state budget and ATU budgets (normative o f defalcations from general state revenues and quantum of transfers), which are stipulated in the State Budget Law. For this purpose the Ministry of Finance issues unique expenditure norms (taking into consideration some particularities o f ATU) 21. Expenditure norms play a central role in the establishment o f transfers amount from the state budget to ATU budgets. As these expenditure norms cannot 19The chart is based on the territorial-administrative division that was introduced in 1999and prior to the enactment of the revised March 2003 law on territorial administrative division. Budget organizations under upperbig box are part of central governmentandbudgetorganizationsunderthe lower bigbox are local governments. The local governmentshave operationalindependence. But for budget, they dependon the Ministry of Financefor central governmenttransfers andthe General Financial Division of the Ministry of Finance also reviews their revenuegenerations. 2oOrganic law #847/96, Article 2. Expenditure``norms" are used as a planningtool and determinetransfers from the state budget. Moldova CFAA: Local Government Institutions 23 take into account totally the local peculiarities and specificities, they tend to cause misallocation of public resources. 78. Revenues o f the ATU budgets include local taxes and fees, proportion of state taxes and fees, transfers from the state budget, sales of assets o f local bodies and other collections as provided in the legislation. ATU budgets are prepared based on the projected tax revenue and transfers from the state budgets . ATU budgets inMoldova are generally revenue driven, meaning that amount o f spending approved in the budget must be less than or equal to the amount o f expected revenue. The General Financial Division subordinated to the Ministryo f Finance tries to minimize the destabilizing effects o f shortfall by estimating revenues as accurately as possible, however, and as discussed elsewhere in the CFAA, this i s not always successful. 79. Local public bodies prepare their budgets showing the estimated taxes and expenditures and submit them to the Ministryo f Finance through the ATU General Financial Division. After the approval o f the state budget, the local public bodies amend their budgets to make it consistent with the annual state budget law and communicate as much to the Ministry ofFinance. After approval ofthe budget, the localpublic bodies submittheir budget to the Ministry o f Finance with monthly distribution o f revenues and expenditures. 80. The local council formally approves the budget but this approval does not o f itself authorize local government to enter into bindingagreements in respect o f transfers from the state budget. Like many democracies, such authority comes from the annual state budget law approved by Parliament which species the amount o f the transfer from the state budget to the ATU budgets . Parliament neither approves nor vetoes ATU budgets and the State Budget Law itself does not distribute funds, rather it grants authorization to enter into binding agreements. 81. There i s little incentive for the local government to improve its revenue forecasting. The current transfer system creates an incentive for Primarias to underestimate their budgets, as this maximizes transfers from the state budget. As such, local government has a tendency to lower revenue projections in order to obtain larger transfers from central government. However, the General Finance Division o f ATU, which plays an oversight role on behalf o f the Ministry o f Finance, can help to correct the situation by ensuringthat the macroeconomic indicators and methodological notes prepared respectively by the Ministry o f Economy and MinistryofFinanceat the start ofthebudget formulation cycle are appropriately incorporated into ATU budgetrevenue forecasts. 82. Territorial treasury or any designated bank, which acts as the agent o f the Ministry o f Finance, carries out cash execution o f ATU budget. All revenues are collected and all expenditures are made inaccordance with the respective fiscal legislation and Law on Local Public Finances. 83, In order to ensure local autonomy, public administration bodies of administrative territorial units develop and approve income and expenditure budgets and are entitled to establish certain local taxes and duties. This, in theory, provides complete autonomy to local government institutions in the execution o f ATU budgets. However, inpractice, the General Financial Division o f ATU subordinated to the Ministry o f Finance, in the exercise o f its oversight function, occasionally plays a significant role in budget execution and accordingly undermines the autonomy o f local government institutions. Moldova CFAA: Local GovernmentInstitutions 24 84. The budgets o f villages (communes), cities (municipalities) and subsequent major adjustments to these budgets require the approval of the Local Councils. The village or city Council can approve minor changes between institutions while the Primaria can approve movements within an institution. All o f these changes have to be agreed and registered with the ATU General Finance Division, which tends to give them a significant role in the determination o f the changes. Normally, the ATU General Financial Division does not reject changes in the budget, particularly when they relate to the allocation o f increased revenue flows. Inmany cases, expenditures are also tightly controlled through other mechanisms such as wage norms and rates, and limitsplaced on the number o f employees inspecific areas. 85. Changes to the overall budget position, such as an increase intotal revenues, requires Local Council approval. A movement o f funds between institutions requires Local Council approval while the movement of funds within institutions requires Primar approval. In the latter two cases, the changes have to be agreed and registered with the ATU General Financial Division thus underminingthe authority o f the Local Council and Primar. 86. The role and consequent influence o f the ATU General Financial Division undermines the autonomy o f the Primarias and creates delays in the processing o f low-level budget changes. A more effective role for the ATU General Financial Division would be to monitor Primarias on key priority areas such as arrearsand the payment o f salaries, and thus add greater value to the budgetary process. Accounting and Treasury Systems 87. There are detailed laws and rules and regulations for accounting o f local govemment institutions. These laws are very long, very cumbersome and difficult to understand. These rules may be simplified, and manuals and guidelines may replace some provisions o f these very detailed rules and laws. 88. Currently, all treasury accounts are created and controlled by the Central Treasury. The Treasury controls how Primarias can capture and store financial information. For the purpose o f consolidating govemment accounts and consistent accounting treatment this control i s important. The Government introduced execution o f ATU budgets through territorial treasuries in 2002, which improved controls over budget execution. However, the current 15-digit code for expenditures in the treasuries' chart o f accounts limits the budget executors ability to devise their own codes and thus get useful analyses from the treasury system. 89. Transfers from the State Budget to Judets or Primarias, and from Judets to Primarias are classified as revenues o f Judet's budgets and villages or cities budgets as appropriate. The Territorial Treasury ensures transparency o f ATU budgets revenues and expenditures, controls spending of all government entities including state budget units located within the jurisdiction o f each territorial treasury, and improves the availability, reliability, and timeliness o f information on the ATU budgets . The territorial treasury consists o f thirteen regional treasury offices and 26 local territorial branches in towns . All fiscal operations of LGIs are now conductedthrough localtreasury branches. Itis expectedthat this will improve transparency and accountability for the use of public funds by local governments. 90. The State Budget Law codifies the agreed sharing arrangements regarding the three revenues sources that are transferred in full to judets, being Value Added Tax, Income Tax and Road Tax. Current practice i s for these revenues first to be brought into the bank Moldova CFAA: Local Government Institutions 25 accounts o f the state budget before distribution to the Administrative and Territorial Units (ATUs) budgets, which can result in long delays in the receipt of these revenues. Other revenues are retained in full by Primarias. A key issue for the Primaria i s the sharing arrangements to the budgets o fjudets. Reporting 91, Reports on localbudget execution are prepared onmonthly, quarterly, half-yearly, and yearly bases. These reports are disseminated to the public through local newspapers and notice boards both inside and outside local government institutions, which increases the transparency o f the execution o f the ATU budgets. However, there i s no system of publishing annual performance reports reflecting the cost of services provided by the local governments. 92. Currently the treasury provides a limited range o f reports for Primarias. Primarias and the ATU General Financial Division have identified additional information that they would like to receive, as well as different formats for this information. Providing different reporting formats i s a relatively easy programming function. A small team o f Primarias and ATU General Financial Division staff should be consulted on the production o f reports to ensure that they are designed according to needs. Different Primarias may wish to receive different reports. Itmay be possible to create a unique reporting file for each Primaria, which stores the report profile. These reports would be produced as per current practice. Internal Control andInternal Audit 93. There i s still ambiguity about the roles and responsibilities o f the Ministry o f Finance, Prefect Office, ATU General Financial Division and the local governments. Providing clarity about the roles and responsibilities o f each distinct organizational structure and some guidance onhow each organization can best execute its role inthe overall government control environment will facilitate a more coordinated approach to financial management. To assist all parties where conflicting demands or requests have been forthcoming, it would also be useful to prepare a diagram of the key decision flows and accountabilities in local government financial management. 94. Local government institutions issue all payment orders. However, these orders are sometimes issued without adequate verifications. After the introduction o f the territorial treasury system, the local governments becomes more dependent on the territorial treasury to play the role o f the "gate keeper". This approach is increasing the burden o f the Territorial treasury and weakening the intemal control environment o f the local government institutions. The Government should review this situation and try to increase the institutional capacity o f the local govemments, by establishingadequate internal control mechanism. 95. Inlocalgovernments, many transactions are settledusingcash, which carries a greater risk of theft and its use should be minimized. Again, collusion and fraud are not prevented by exclusive use oftransfers, and opportunities for fraud exist with bothmethods o fpayment. As such, there is a needof more control both of cash payment and transfers including proper reconciliation for all transfers on a regular basis. 96. The Chisinau municipality has an internal audit unit and carries out internal audits on a regular basis. Audit i s also carried out by the Department for Financial Control and Revision o f the Ministry o f Finance once in a year for all municipalities and judets. For communes (villages), this audit i s carried out once every other year. External Oversight 97. The ATU General Financial Division subordinated to the Ministry o f Finance and Prefects office carries out external oversight functions. In addition, the CoA also oversees judets' budgets every year. There is little direct community involvement in budget preparation and review o f financial statements o f the local governments. Inorder to increase public participation and transparency, local government may consider forming Budget and Audit Committees that include representatives of civil society and ensuring that its financial statements are publiclyavailable. Capacity of Local GovernmentInstitutions 98. The capacities of local government institutions are very weak. Over-dependence on budget execution controls interritorial treasuries could paradoxically weaken the capabilities and accountabilities o f local governments further. The active central government oversight o f the many financial management activities o f local government ranging from budget preparation through to control over budget execution impairs significantly the autonomy o f local government. The longer this continues, the weaker will become the financial management capacity o f local government institutions. It i s a challenge to distinguishclearly the decentralized functions o f central government from the decentralization or devolvement o f power to local government. 99. The benefits o f decentralization can only be realized when local authorities and managers are given sufficient autonomy and are made more accountable for their decisions. The Government may consider restoring the exercise o f financial accountability both horizontally and vertically in local governments. The Government should also take major steps to develop the capacity o f local government institutions i.e. both the elected council membersas well as the executivesworking inlocalgovernment institutions. . Recommendations LocaI GovernmentInstitutions - Institutionalarrangementsfor the training of theJinanciaImanagement staflof the local governments should be developed. 5. PFUVATE SECTORACCOUNTING AND AUDITING 100. The role o f an accounting system during the time o f Soviet central planning was to provide economic and statistical data and information relevant to the needs o f the fiscal and other state authorities. These systems did not however satisfy the needs of a market economy. Inrecognition o f this, the Government has made a considerable effort to develop and implement a private sector financial accounting and auditing framework inline with best international practice. 101, The reform effort was led by the Ministry o f Finance with the support o f technical assistance from the World Bank, USAID and the Soros Foundation. The key outputs o f these reforms include the development o f National Accounting Standards (NAS) and National Standards o f Auditing (NSA) based respectively on International Accounting Standards22 (IAS) and International Standards on Auditing (ISA). The Association of Professional Accountants and Auditors of the Republic o f Moldova (ACAP) was founded in 1996 with technical and financial assistance from USAID and became the first associate member o f the International Federation o f Accountants (IFAC). 102. The CFAA recognizes the work that has been undertaken in the area of accounting and audit reform but highlights a number o f key areas in which reforms are still required. The CFAA recognizes the valuable recommendations o f the 2002 Comparative Study on Accounting and Auditing, a report that was prepared with the support o f an EU TACIS Projece3'and endorses many o f those recommendations. Enterprise Sector Accounting 103. The plan for the implementation o f the accounting system reforms included a comprehensive set o f NAS and revised chart o f accounts within a revised legislative and regulatory framework. The reform put particular emphasis into the development of training materials and many o f the NASs were issued with detailed comments on their application. The standards were approved by the Ministry o f Finance having been prepared by the Working Group financed by the World Bank, the Government o f Moldova and the USAID- financed Moldova Accounting ReformProject (MAW) . 104. The basic concepts and approach to accounting are laid out inthe Law on Accounting (1995). In addition to the Law the following normative documents serve as the legislative basis for accounting inMoldova: Concept o f Accounting Reform inthe Republic of Moldova; National Accounting Standards; Chart o f Accounts; and Comments on National Accounting Standards. ** For the purposes ofthis report,the term "IAS" encompasses the standardsendorsedbythe International AccountingStandardsBoard(IASB), includingthose designated"International FinancialReportingStandards" (IFRS). 23Assistance for Implementationofthe Partnership and CooperationAgreement betweenthe Republic of Moldovaandthe EuropeanUnion Moldova CFAA: Private Sector Accountina and Auditina 28 105. The Law o f Accounting was adopted by Parliament on April 4, 1995, before the development o f the concept note and the other elements o f the new framework. It therefore needs to be revised to conform with European Union (EU) Directives and Regulations, as well as IAS. The following five areas inparticular have been identified as requiringrevision: The Law (Art. 3) assumes that fiscal reporting i s the objective o f accounting, which i s out o f step with subsequent normative acts as well as international best practice. As discussed earlier, the needs of other stakeholders should also be considered. There are contradictions between the Law and NAS. For example, the Law requires only a balance sheet and income statement, while NAS 5, which i s itself based on IAS, additionally requires a cash flow statement, a statement o f changes in owners' equity and explanatory notes to describe, amongst other things, the entity's accounting policies. The Law has no provision for consolidated financial reporting as required by the EU 7th Directive and IAS. NAS 25 and 27 on the other hand, allow for consolidation and outline the basis o f accounting for investments inassociate companies. The present bookkeeping and accounting regulations in the Law and inN A S 4 could be simplifiedinline with EUDirectives. The Law i s overly prescriptive in terms o f the rules and requirements regarding bookkeeping, the organization o f an accounting department and internal control issues. All o fthese matters would bebetter addressedinguidance notes or other literature. 106. National Accounting Standards (NAS) were developed by a Working Group composed o f experts from the Ministry o f Finance, the tax authorities, practicing accountants and auditors, and academics. At the time o f the CFAA fieldwork, there were 29 NAS in force with another 16 under development. Generally, the numbering and much o f the narrative o f the NAS corresponds to IAS; however the standards have been adapted with the apparent intention to accommodate the country's specific requirements and legislation. As a result, whilst NAS can be said to be based on IAS, a number o f important issues remain, including: NAS lag behind IAS and are therefore incomplete. Individual NAS are still being developed which correspond with existing IAS, e.g. IAS 8 (Net profit for the period) and IAS 10 (Events After the Balance Sheet Date). Additionally, there are some IAS for which no equivalent NAS exists and must still be drafted, e.g. IAS 36 (Impairment of Assets) and IAS 37 (Provisions, Contingent Liabilities and Contingent Assets). The period since the adoption of the initial NAS has been one o f considerable activity by the InternationalAccounting Standards Board (IASB), the IAS standard-setter. As a result many o f the IAS on which the NAS have been based were amended. These amendments need to be reflected in the relevant NAS. The main example i s relates to IAS 1 (Presentation of Financial Statements), which was amended to address issues formerly addressed by IAS 5 and IAS 13, both o f which were subsequently withdrawn. However, NAS 1hasnotbeenamendedto reflect changes made inIAS 1. There i s no formal note o f or other guidance on the differences between NAS and IAS, which would be helpful to stakeholders, practitioners, standard-setters as well as actual and would-be foreign investors. 107. The effort to develop and implement NAS under the leadership o f the Ministry of Finance i s commendable. Despite the loss o f momentum in the reform process since cessation of donor-financed technical assistance, the Government nevertheless needs to keep Moldova CFAA: Private Sector Accountins and Auditins 29 abreast o f developments in international accounting standards, particularly in view of significant harmonization efforts. For example, as o f 2005, the EU will require listed companies, banks and insurance companies in its member countries to prepare consolidated financial statements in accordance with IAS24. This approach should also be adopted in Moldova. Further, and consistent with EU regulations, entities that fall outside the above definition, being mainly small and medium sized enterprises, should be given the option o f applying IAS or NAS, rather than beingrequired to comply with the very prescriptive NAS4 (Accounting for Smaller Companies). The CFAA therefore also recommends that the Law o f Accounting for SMEs be amended inconformity with the relevant EUDirectives and IAS25. Auditing 108. The basic concepts and approach to auditing are laid out in the Law on Auditing26. However, the Law on Auditing does not conform to international best-practice and the provisions o f EUDirectives. More specifically, the Law is deficient inthe following areas: The current objective o f the audit (Art. 3)27 as described in the Law blurs the distinction between a financial audit and the activities o f state financial control. Consistent with the EU's 4th and 7th Directives and also ISA200, the objective of an audit o f financial statements should be redefined unambiguously as enabling a qualified auditor to express an opinion whether the financial statements have been prepared, in all material respects, inaccordance with anidentifiedfinancial reporting framework. The Law (Art 5.) differentiates between four types of audits: enterprises, banks, other financial institutions and listed companies. Such differentiation i s unnecessary as the conceptual framework for the conduct of audits i s the same for each economic sector. The Law does not identify standards for the education, training and qualification o f auditors as i s set out in the EU's 8th Directive. Although the Ministry o f Finance has established minimum qualification requirements as well as a certification program for auditors, these need to be enhanced. The Law (Art. 8) provides for a qualifications committee within the Ministry o f Finance to certify auditors. The qualifications and examination structure should be enhanced inline with international best practice. The Law (Art. 3) provides illustrations o f the type o f additional work that may be undertaken by statutory auditors. This i s too general to be enforced and the issue i s any event covered in detail in the recently issued Code of Professional Conduct for Auditors and Accountants (see below). 109. In 2000, with the assistance of the international donor community, the Ministry of Finance drafted a revised Law on Auditing. However, the process o f enacting the law was halted after various negative comments including those which expressed concern regarding pervasive ambiguity inthe formulation o f the draft that would have allowed for a wide range 24EUmemberstates also havethe optionof extendingthe requirementto producefinancial statementsin accordancewith IASto unlistedcompanies, companieswhere there is a significantpublic interest (e.g.state ownedenterprises)andto legalentities. 25The InternationalAccounting StandardsBoard(IASB) is currentlyworkingon a projectto develop standards for Small and MediumSizedEntities. 26Law onAuditing-Republic of MoldovaNo 729-XI11of February 15, 1996. "InaccordancewithArticle3oftheLawonAuditing,"thepurposeofauditisreviewingandanalysisofthe financial reports, fiscal declarations,payments and settlements documents and other financial liabilities of business entities, in order to access their reliability,completenessand complianceofsuch documentswiththe current legislationandrequirementsfor accountingandauditing". Moldova CFAA: Private Sector Accountinq and Auditina 30 o f interpretations and thus inconsistent implementation and audit quality. Thus the present Law on Auditing remains inurgentneed o f revision. 110. The Government should also review the certification and continuing education requirements o f statutory auditors benchmarked against the EU 8th Directive and the IFAC International Education Guidelines 2 and 928. It i s appropriate that certain aspects o f the certification and licensing o f auditors could be delegated to the auditing profession (e.g. education and training) inorder to ease the burden on the Ministry o f Finance. 111. The requirements for an audit o f corporate bodies is dealt with in the Law on Joint Stock Companies which was adopted in 1997, and revised in 2002. According to the 1997 Law, joint stock companies with more than 50 shareholders are obliged to have an annual requested by 10 percent o f the shareholder^^^, the State Security Commission or court audit by an independent audit company. Inthe 2002 revision an audit i s not obligatory unless decision. Separate laws make various statutory provisions for the audits o f banks, insurance companies and listed companies. 112. The statutory audit requirement should apply only to publicly traded companies, financial institutions and public interest companies. The CFAA recommends that the Government o f Moldova apply the auditing exemptions in the EU 4th Directive for SMEs3' when there is no public interest requirement for the audit o f financial statements. From a cost- benefit perspective this not only reduces the strain on professional accounting resources but also reduces the burden on smaller companies where auditing services do not proportionately serve the public interest. 113. At the time of the CFAA fieldwork, the Government had issued 37 National Standards o f Auditing, which were developed by the Ministry o f Finance Work Group that was established in 2000 with the support o f USAID. The application o f these standards became compulsory beginningwith the audits o f the year ending December 31, 2001, They closely follow the IFAC International Standards on Auditing and provide comprehensive rules regarding the conduct o f the financial audit. The Government has also issued the Code o f Professional Conduct for Auditors and Accountants, based on the Code o f Ethics for Professional Accountants approvedby IFAC. 114. The ISA and the Code of Professional Conduct represent intemational best-practice and provide a reliable benchmark on which to frame the institutional arrangements o f the country's audit profession. Accounting and Auditing Institutions 115. There i s an urgent need for sustainable and adequately resourced accounting and auditing standard-setting institutions in Moldova. The Audit Law makes provision for an Association o f Audit Firms inMoldova (AAFM) to coordinate the operations o f audit firms, develop auditing standards and develop examination programs, however, this organization has not been established. *'The basic education,training and qualificationrequirementsare set out inArt. 4-8 ofthe EU 8" Directive. 29The Law requiresthe audit fees to bepaidby the shareholders ifthe general assemblyofthe companydoes not concur with this requirement. 30The EU4" Directiveprovides exemptionsfor small companies basedon the amount ofturnover, new assets andnumber of employees. Auditorilor Profesionisti - ACAP) was founded in 1996 with the support o f USAID technical 116. The Association o f Professional Accountants and Auditors (Asociatia Contabililor si assistance. It i s a voluntary public organization o f individuals, formed based on their common interests inthe development o f accounting and auditing. ACAP currently has 1,900 members divided into a number o f sub-categories ranging from full to student member. ACAP has no specific membership requirements and subscriptions are 45 MDL (US$3) per annum. 117. Members o f ACAP participated inthe Working Groups for the development o f NAS and NSA and disseminated supporting training materials inaccounting and audit. Inaddition ACAP i s developing a certification program for accountants (see below for a discussion under accounting education). The CFAA recognizes the early work of ACAP to develop its constitution and certification program, however, ACAP has unfortunately suffered from constitutional difficulties over the last twelve months. 118. The Government should review the institutional arrangements o f the private sector accounting and auditing profession. In the medium term, and once sufficient capacity has been established, appropriate institutional arrangements should be put in place for the development, maintenance and updating o f standards, and also the training, education, regulation and oversight o f professional accountants and auditors. Accounting Education 119. ACAP developed a certification program for accountants that requires candidates to pass three tests within a two year period. Those qualified to take the exams and who have successfully passed all the stages are conferred the title of Certified Professional Accountant. The qualification does not meet all the requirements of the IFAC Education Standard No.9 but the syllabus is a highlyrelevanttechnicianlevel qualification for Moldova at this time. 120. The first examinations took place in 1997. The examination procedures appear robust and there are international experts on the Examination Committee. The pass rate for the exam i s low. Inrelation to the need for trained accountants, the number o f applicants taking the examinations has also been The program does not confer any special membership rights in ACAP and is not currently recognized by Government, for example as a pre- requisite for entry into the auditing profession. 121. The Chartered Association of Certified Accountants (ACCA) are also active in Moldova and it i s estimated that approximately 35 applicants are currently undertaking these examinations in Chisinau. The majority o f applicants are from the international audit firms andjoint ventures, as classes and examinations are conducted inEnglish. Inorder to prepare for the exam, applicants either enroll in correspondence courses or take classes inRomania. As with the ACAP certification the Government should consider this qualification as a pre- requisite for entry into the audit profession. 122. USAID, through its FinancialManagement Training andAdvisory Activity (FMTAA) Project and the Soros Foundation have been conducting a range o f other training and educationactivities: Education of accountants at its computer training center inChisinau; 3 1From 1999-2001 126 have participatedinthe certification examination and 22 have passed MoldovaCFAA: Private Sector Accounting and Auditing 32 Development o f accounting curriculum at the Accounting faculty at the Academy o f Economic Studies; Training o f instructors inaccounting, audit and financial management; Exchange program for accounting students and academic staff with the University of Nebraska; and Publication of textbooks and manuals inRomanian. 123. Overall, the CFAA notes the progress that has been made in the area o f financial management training in the last five years. Moldova is making progress inthe development o f training courses that meet the needs o f a market economy. This is important, since the demand for accounting professionals, particularly at an undergraduate level, i s high. The CFAA recommends that further work be done to increase the supply o f high quality professional level qualifications inMoldova. State Owned Enterprises (SOEs) 124. SOEs are regulated by the 1994 Law on State Owned Enterprises, as well as other applicable laws relating to the activity o f enterprises e.g. the Law on Joint Stock Companies, The legislationprovides various regulations relating to the governance of SOEs but there are no specific requirements relating to accounting, financial reporting or auditing. The CFAA argues that there i s a "significant public interest" in SOE activities and that they should be required to prepare their consolidated financial reports under IAS and be subject to an independent audit. This requirement should be included in a revision to the Law on State Owned Enterprises. Non Governmental Organizations (NGOs) 125. NGOs are governed by the Law on Public Associations (1997) and the Law on Philanthropy and Sponsorship (1995). There are no specific regulations on accounting or financial reporting for NGOs and thus they adhere to the requirements relating to commercial enterprises. This creates a number o f problems including: ($the reports submitted to the Government Statistical Department do not disclose sufficient information about the NGO's activities because there are no specific financial reporting standards applicable to NGOs; and (ii) areinconsistenciesbetweentheaccountingrulesandNGOsstatuteswithregardto there the treatment of net income obtained from various types o f statutory and non-statutory activities. A draft accounting standard for NGO accounting and financial reporting has been prepared and could be further developed to address financial accountability and transparency issues. Because o f the public interest in transparent and accountable activities o f NGOs it i s appropriate that NGOs be obliged to have a statutory audit, although very small NGOs may alternatively bepermitted to have independent examination by a citizen o f good standing. Banking Sector Accounting 126. Inaccordance with the Law of Financial Institutions (1995) and the Law onNational Bank of Moldova (1995), banks are licensed, regulated and supervised by the National Bank of Moldova (NBM). 127. The National Bank o f Moldova participated inthe Working Group for the preparation o f NAS and developed NAS 30, Disclosures in the Financial Statements o f Banks and Similar Financial Institutions, a standard that closely resembles the similarly named IAS 30 but also contains specific cash flow disclosure requirements based on IAS 7, Cash Flow Statements, as well as some provisions o f IAS 39, Financial Instruments: Recognition and Mea~urement~~. In addition, some other elements of IAS affecting banks have not been incorporated into NAS. As a result, there are some differences betweenNAS and IAS. Thus, and for reasons of compliance with local legislation and international comparability, banks with foreign stakeholders often have to maintain accounting records and prepare financial statements under bothNAS and IAS. 128. The C F M recommends that banks be obliged to prepare consolidated financial statements inaccordance with IAS. Auditing 129. The Law on Financial Institutions was adopted in 1995. Article 34 o f the Law requires every bank to appoint an independent external auditor acceptable to the NBM. Article 34 also provides that the auditor can assist in the maintenance of proper accounts and records in the manner established by the NBM. Whilst an auditor i s clearly in a position to and indeed should advise a client's management o f accounting policies and procedures that do not conform with local legislation or international best-practice, the notion o f an auditor assisting inthe maintenance o f a bank's financial records runs contrary to international best- practice including IFAC's Code o f Ethics for Professional Accountants and ISAs, which deem such non-assurance services provided by the auditor to be a threat to the auditor's independence. Accordingly, this C F M recommends that clarification i s issued inrespect o f this particular provision of Article 34 to distinguish clearly the circumstances where an auditor i s involved inthe maintenance o f a bank's accounting records from those inwhich an auditor i s merely making management aware o f material weaknesses in the design or operation o f the bank's accounting and internal control systems which came to the auditor's attention duringthe course o f the audit. 130. All banks are requiredto have an annual audit by external auditors deemed acceptable to the NBM as determined by a special committee o f the NBM. As with auditors o f enterprises, the acceptability o f and continuing education requirements for auditors o f banks would benefit from benchmarking against the EU 8th Directive and the IFAC International Education Guidelines 2 and 9. Also, the processes o f MoF-certification and NBM-evaluation o f auditors would be less onerous and more efficient and transparent if the criteria for these processes for non-bank and bank auditors were unified to the maximum extent possible and any remaining differences explicitly explained and reconciled. 32IAS 39 is effective for financial statements covering financial years beginning on or after January 12001 Moldova CFAA: Private Sector Accountinq and Auditins 34 0 TheLaw of Auditing and Law of Joint Stock Conipaniesshould be revised und enacted: 0 Statutoly audit requirement to be extended to apply to non-banking financial institutions, listed companies and entities of public interest; Hamionize the institutional framework for the education, training and certification of auditors. Moldova CFAA: Fiduciarv Considerations in resDectof Bank-Financed Proiects 35 6. FIDUCIARY CONSIDERATIONSINRESPECTOF BANK-FINANCED PROJECTS Reliance on Public Sector Financial Management Framework 131. In view of the foregoing analysis it is clear that there is a need for substantial strengthening in the areas o f budgeting, treasury management, financial reporting, internal auditing and external auditing in Moldova. It would be inappropriate to place a blanket reliance on the existing public sector financial management framework for the purposes of satisfying the Bank's fiduciary financial management requirements if there are significant concerns about its operation and integrity. Reliance on any particular aspect o f the country's financial management framework for the purposes o f satisfying the Bank's financial management requirements would need to be established on a case-by-case basis with reference to the specific financial management arrangements o f the institutions involved. Project Financial Management 132. This section o f the CFAA does not constitute a detailed assessment o f the financial management arrangements affecting the projects financed by the Bank. The CFAA did not seek to and does not confirm the appropriateness o f the projects' financial management arrangements and i s not a substitute for normal supervision o f the portfolio's financial management arrangements. Rather, this section o f the CFAA identifies and addresses certain generic project financial management issues across the portfolio o f Bank-financed projects in Moldova. Issues raised by the Countly Portfolio PerjGormance Review 133. A Country Portfolio Performance Review (CPPR) held in Chisinau in October 2002 with representatives o f the Bank, government and project implementing agencies raised the following issues which have a bearing on the financial management arrangements of Bank- financed projects: Standalone project implementing agencies. The CPPR concluded that, in general, beneficiary entities and government institutions lacked appropriate capacity to implement even relatively simple Bank-financed projects. Thus a specialized project implementation agency such as a Project Implementation Unit (PIU) would almost always be required to implement such projects. Over the course o f time, a few specialized project implementation agencies have evolved to implement projects in an entire sector (e.g. agriculture, energy, banking and private sector, education and health) and their continued use i s to be encouraged until sufficient capacity has been created within the appropriate ministry or beneficiary entity. Government counterpart funding. Due to the cash flow problems referred to elsewhere in this CFAA, the Government is not always able to collect sufficient funds on a timely basis for its contributions towards Bank-financed projects. In 1999, the Government o f the Republic of Moldova received a grant from the Government o f the Netherlands and thus was able to cover its counterpart commitments during 1999-2002. The draft CY2003 State Budget provides some preliminary allocations to cover the Government's contribution to projects financed by the Bank and other development organizations, however these appear insufficient to meet the Government's needs. It i s understood that Moldova CFAA: Fiduciarv Considerations in respect of Bank-Financed Proiects 36 the Ministry of Finance has drafted a regulation, currently under discussion, governing the disbursement o f grant funds to address this issue. Taxes. Bank funds have been inappropriately used to finance ineligible taxes, primarily the income taxes o f consultants employed by the various project implementing agencies. Inone particular project, the Bankhad financed atotal of US$136kof ineligible income taxes, which the Government became obliged to refundto the Bank. Salary scales. There continues to be significant differences between salary scales o f the financial management consultants employed by project implementing agencies and their peers inthe civil service. ProjectJinancial management staff 134. Project financial management staff comprises individual local staff and consultants employed on inconsistent TORs, duration o f contract, and remuneration. It i s moderately difficult to recruit qualified financial management staffs although it is by no means clear that all financial management consultants recruited are o f the highest available caliber. The financial managementpersonnel are remuneratedprimarily from Bank funds as well as grants administered by the Bank, which are co-financed by the Government. Project implementing agencies employ, on average, one or two financial management personnel. 135. The CFAA recommends the development o f standard qualifications, TORs, contracts and remuneration for all projects' financial management personnel in order to reduce the wide variations amongst them and increase the overall quality o f such personnel. The CFAA also recommends that the "skills gap" between financial management civil servants and the project implementing agencies' financial management personnel be evaluated with a view to assessing the feasibility o f civil servants fulfilling the financial management needs of Bank- financed projects and replacingthe more costly financial management consultants. ProjectJinancial management systems 136. Project implementing agencies are free to develop their own financial management arrangements with no central guidance or oversight nor with any incentive or encouragement to share lessons learned and best-practice. Consequently, financial management systems range from those based on simple spreadsheets and standard accounting packages, to fully customized project accounting software. The most widely used project accounting software package i s 1C Bookkeeping System, a simple Russian accounting software package. Other projects use various accounting software packages: some designed specifically to meet the requirements o f Bank-financed projects; some which also satisfy local Moldovan accounting and reporting requirements. The prices for a fully implemented accounting software, tailored to particular project's circumstances, able to produce appropriate financial monitoring reports, and including delivery o f a full training course, relevant manuals and support, range from about US$ 2,000 to around US$ 30,000. This diversity o f approaches have resulted ina significant amount o f total financial management-related project expenditures, most notably software costs and consultancy fees. It was also noted that there i s little, if any, integration with responsible line ministries andtheir financial management systems. 137. This CFAA recommends that inorder to minimize the risks and costs associated with the development and management o f multiple financial management systems at the many project implementingunits implementing Bank-supported project, a forum to oversee such matters should be established, perhaps led and coordinated by the MoF's Foreign Debt Department. This group couldhold regular workshops to share lessons learned and examples o f best practice in the design and implementation o f project financial management arrangements, including example procedures and accounting manuals. This group should also be charged with the responsibility to form a strategy better to integrate project financial management arrangements with those o f responsible line ministries. Audit arrangements 138. At the time of the CFAA, the borrower was substantially incompliance with all audit covenants o f Bank-financed projects. 139. This CFAA recommends that audit firms currently performing the audits of Bank- financed projects as well as any others expressing an interest in performing such audits, should be reviewed by a team of Bank financial management specialists. This review would be conducted on the basis o f both informationprovided by the auditors and on-site visits with the objective ofconfirmingtheir acceptability to the Bank. 140. Additionally, the Court o f Accounts (CoA) performs various ad hoc audits o f Bank- financed projects. Unfortunately, there have been a few misunderstandings between the CoA and the various project implementing agencies about both the objectives o f these audits and also the manner inwhich Bank-financed projects are implemented. This CFAA suggests that the CoA could benefit from some explanation and training in the specific areas of disbursements, financial management and procurement in Bank-financed projects as well as the Bank's project cycle more generally. National Bank of Moldova 141. Given the key role o f the National Bank o f Moldova (NBM) in Bank-financed projects, particularly with respect to adjustment operations, this section o f the CFAA evaluates the fiduciary risks to the Bank associated with the use o fthe NBM. 142. The basic legislation governing the NBMcomprises the Law on the National Bank o f Moldova (1995) and the Statute o f the NationalBank o f Moldova. The NBMi s managed by the Council of Administration comprising five members: the Governor o f the NBMwho acts as the Chairman o f the Council, a First Vice-Governor and three Vice-Governors, all o f whom are appointed by Parliament. 143. The NBMi s required to maintain at all times accounts and records adequate to reflect its operations and financial condition in accordance with sound internationally acceptable accounting principles. The NBM i s required to prepare annual financial statements, and although the NBM's rules are less than unequivocal in its audit requirements, the NBMhas since 1998 prepared financial statements in accordance with International Accounting Moldova CFAA: Fiduciary Considerations in resDectof Bank-Financed Proiects 3% Standards (IAS) and has had them audited in accordance with Intemational Standards on Auditing(ISA). The audits for the years endedDecember 31,2000 and 2001were performed by the Paris office of PricewaterhouseCoopers; the audit opinions were unqualified, however the audit reports did contain an emphasis of matter in respect of the "present uncertainty in the Republic of Moldova surrounding the likely future direction o f domestic economic policy, regulatory policy and political developments". 144. A high-level assessmentofthe NBMinmid-2002 concludedthat althoughthe NBM's general quality o f financial reporting appeared satisfactory, the Nl3M's procedures and controls to manage resources could be strengthened. Key recommendations and concems expressed by the assessment have either already been or are currently actively being implemented and addressed. Moldova CFAA: Annex 1 CFAA National Steerina Committee 39 ~ ANNEX1: CFAA NATIONAL STEERING COMMITTEE The National Steering Committee for the CFAA comprisedthe following: Chair Mrs.GrecianiiZinaida Minister o f Finance Members Mrs.DurlestanuMariana FirstDeputy Minister ofFinance Mr.IvanovAlexei Deputy Head, Committee for Economy, Industry, Budget and Finance inParliament Mr.LupuMarian DeputyMinister ofEconomy Mr.PenteleiVasile Chairperson, Court of Accounts Mr.ProdanIon DeputyGovernor, NationalBank ofMoldova Mr.RevencoValerian Ministerof Labor and Social Protection MoldovaCFAA: Annex 2: Architectureof Public FinancialAccountabilitv 40 ANNEX2: ARCHITECTUREOFPUBLICFINANCIAL ACCOUNTABILITY Moldova CFAA: Annex 3: MaD of Moldova 41 ANNEX3: MAP MOLDOVA OF