Report No. 26839-RU Report No. 26839-RU Russian Federation Country Financial Accountability Assessment
Public Disclosure Authorized Authorized Disclosure Disclosure Public Public September 16, 2003
Operations Policy and Services Unit Europe and Central Asia Region
usa eeainCountry Financial Accountablility Assessment Russian Federation Public Disclosure Authorized Authorized Disclosure Disclosure Public Public Public Disclosure Authorized Authorized Disclosure Disclosure Public Public
Document of the World Bank Public Disclosure Authorized Authorized Disclosure Disclosure Public Public CTJFtFtENCY EOUIVALENTS Unit of currency = Ruble
EXCHANGE RATE US$ 1 = 3 1.825 Rubles (December 30,2002)
ACRONYMNS AND ABBREVIATIONS
AC Accounts Chamber PAC Public Accounts Committee ASOSAI Asian Organization of Supreme Audit PEIR Public Expenditure and Institutional Institutions Review CAS Country Assistance Strategy PIU Project Implementation Unit CBR Central Bank of Russia PSC Public Sector Committee COA Chart of Accounts RF Russian Federation CID Control and Inspections Division RFTA Regional Fiscal Technical Assistance CIFA Core Integrative Fiduciary Assessment ROSC Report on Observance of Standards and Code CPI Corruption Perceptions Index SAI Supreme Audit Institution CPPR Country Portfolio Performance Reviews SAL Sectoral Adjustment Loan DFID Department for International Development SNAO Swedish national Accounting Office (UK) ESW Economic and Sector Work SOE State-Owned Enterprise EUROSAI European Organization of Supreme Audit su Spending Units Institutions FMI Financial Management Initiative TGL Treasury General Ledger FMIS Financial Management Information System TI Transparency International FSAP Financial Sector Assessment Program TSA Treasury Single Account FT Federal Treasury USSR Union of the Soviet Socialist Republics GAO General Accounting Office (USA) VPN Virtual Private Network GDP Gross Domestic Product WBI World Bank Institute GFS Government Financial Statistics IAS International Accounting Standards IASC International Accounting Standards Committee IBRD International Bank for Reconstruction and Development IMF International Monetary Fund IFAC International Federation of Accountants IF1 International Financing Institutions INTOSAI International Organization of Supreme Audit Institutions ISA International Standards on Auditing KRU Financial Control Department MOD Ministry of Defense LAN Local Area Network MOF Ministry of Finance MOEDT Ministry of Economic Development and Trade MPS Material Product System NAO National Accounting Office (UK) NGO Non-Governmental Organization OECD Organization for Economic Cooperation and Development
Regional Vice-president: Shigeo Katsu, ECAVP Country Director: Julian Schweitzer, ECCUl Sector Director: Alain Colliou, ECSPS Sector Manager: John Hegarty, ECSPS Task Team Leader: Roberto Tarallo, LCOAA Russian Federation: Countw Financial Accountabilitv Assessment I
TABLEOF CONTENTS
TABLE OF CONTENTS ...... i PREFACE ...... i EXECUTIVE SUMMARY ...... IV I. COUNTRY CONTEXT ...... 1 Governing Structures ...... 1 Strengthening Central Control., ...... 2 Economic Prospects and Public Sector Reform ...... 2 I1. PUBLIC SECTOR BUDGET MANAGEMENT ...... 5 Soviet Legacy and Progress to Date ...... 5 Budget Planning and Preparation ...... 6 Budget Execution ...... 7 Revenue Management ...... 9 Monitoring and Evaluation...... 10 Recommendations ...... 10 I11. TREASURY SYSTEM ...... 13 Soviet Legacy ...... 13 Treasury Operations in 2001-2002 ...... 14 Treasury Single Account and Treasury Development Project ...... 15 Short-term Enhancements ...... 16 Inclusion of Ministry of Defense ...... 17 Inclusion of Customs Revenues ...... 17 Inclusion of Extra-budgetary Funds ...... 17 Closing of Off-budget Accounts ...... 18 Recommendations ...... 18 IV. PUBLIC SECTOR ACCOUNTING AND FINANCIAL REPORTING ...... 20 The Soviet Legacy ...... 20 Accounting System., ...... 21 Reporting., ...... 21 Budget Code ...... 22 Treasury Reporting ...... 22 Sub-national Governments ...... 23 Recent Developments ...... 23 Recommendations ...... 24 V . INTERNAL CONTROLS AND INTERNAL AUDITING ...... 25 Government Ministries...... 25 Federal Treasury ...... 26 MOF's Control and Revision Department ...... 27 Developing Intemal Audit Function...... 29 Recommendations ...... 30 Russian Federation: Counfw Financial Accounfabiiifv Assessment ii
VI. EXTERNAL AUDIT ...... 33 Legal and Institutional Framework ...... 33 Scope of Responsibilities ...... 35 Activities and Procedures ...... 36 Dissemination of Audit Findings...... 38 Staffing ...... 39 Audit Standards ...... 39 Recommendations ...... 40 Scope of Work ...... 40 Work Program...... 42 Enforcement Role ...... 42 Conformity with International Standards ...... 44 Complementarity of Internal and External Audit ...... 44 Relationship with Local Governments ...... 45 Capacity Development ...... 46 Quality Assurance ...... 46 VI1. PORTFOLIO FIDUCIARY CONSIDERATIONS ...... 48 Recommendations ...... 48 Conditions for Moving towards Ministry-based Implementation ...... 49 Audit of Bank Projects ...... 50 ANNEX I:CORRUPTION AND GOVERNANCE IN THE RUSSIAN FEDERATION ...... 52 ANNEX 11: LIST OF COUNTERPARTS MET ...... 53 ANNEX 111: BIBLIOGRAPHY AND REFERENCES ...... 55 ANNEX IV: MAP OF THE RUSSIAN FEDERATION ...... 56 Russian Federation: Counfw Financial Accountabilifv Assessment i
PREFACE
This report was prepared on the basis of the findings of a World Bank mission to the Russian Federation from January 22 to February 6, 2001 by a Task Team comprised of Roberto Tarallo, Team Leader, Sr. Financial Management Specialist, and Clifford Isaak, Sr. Financial Management Specialist.
The report is based on the results of interviews with public institutions, at the federal level, as well as on detailed analysis of the laws, documents and other information collected. On the part of the Government, the counterparts to the assessment lent their full and proactive support to the CFAA mission and engaged with the Bank's team in a comprehensive dialogue about the issues identified by the assessment. The Bank is grateful to the Government of the Russian Federation for this cooperation. The list of counterparts met is provided in Annex 1. Documents reviewed are listed in Annex 2.
Scope of the Report
This CFAA concentrates, by design, on federal-level public sector financial management. As part of the core diagnostic reports carried out by the Bank in all client countries, its results feed into the fiduciary discussion presented in the new Russian Federation Country Assistance Strategy (CAS), covering FY03-05; and into the Core Integrative Fiduciary Assessment (CIFA) which, upon the request formulated by the Country Director for the Russian Federation (RF), integrates the analyses of the Country Procurement Assessment Report (CPAR) and various sectoral Public Expenditure Reviews (PER) that have been completed recently. In consideration of the systemic importance of the Russian Federation in the world's economy, the task of assessing private sector accounting and auditing has been placed within the scope of work undertaken, in 2002, to prepare a Report on Observance of Standards and Codes (ROSC) for the Russian Federation under the joint IMFIWorld Bank Financial Sector Assessment Program (FSAP)'.
The summary action plan stemming from the Russian Federation CFAA recommendations is presented in the Core Integrative Fiduciary Assessment (CIFA); therefore, the two reports were presented to the authorities, and are to be examined, jointly. The draft CFMCIFA reports were discussed at a workshop, held in Moscow in July 2002, seeing the participation of the Bank teams, as well as representatives from the Ministry of Finance, the Federal Treasury, and the Accounts Chamber. The final
The RF Accounting and Auditing ROSC will summarize the extent to which internationally recognized accounting and auditing standards, and other associated standards recognized as useful for the operational work ofthe IMF and the World Bank, are followed by private sector entities and the government agencies that deal with their activities. These include standards regarding data dissemination, monetary and financial policy transparency, fiscal transparency, banking supervision, securities, insurance, payments systems, corporate governance, accounting and auditing, and insolvency and creditor rights. Reports summarizing countries' observance ofthese standards are prepared and published on a voluntary basis. They are used to help sharpen policy discussions with national authorities, by rating government agency performance and by assessing the level ofrisk in private sector activities. CFMCIFA reports incorporate the views of the counterparts to the two assessments, and the suggestions received, at the July 2002 workshop.
Purpose of the Report
A CFAA considers the strength of the public financial accountability framework of a country. The aim is to assess whether the existing framework, as designed and as practiced, is sufficient to ensure proper use of funds, both the country’s own resources as well as those provided by the Bank and other institutions.
One of its main purposes is to assist the Bank in assessing the risks which the financial accountability fiamework poses for the implementation ofBank programs and the use of Bank funds, and proposing suitable measures to manage these risks. It also supports dialogue with the borrower country and development partners on financial accountability matters, and assists in the design ofprograms to build financial management capacity.
The CFAA involves a diagnostic exercise covering the financial management systems of a country. It is not an audit, and it does not provide assurance that all funds are being used for intended purposes. However, it provides a well-informed and objective assessment of the strengths and weaknesses of financial management systems, a diagnosis of problems and advice on their resolution, and an indication of the level of financial accountability risk in the country concerned.
Each CFAA is expected to cover a minimum core content-areas that must be covered in all CFAAs. Although financial accountability encompasses a wide range of activities in the private and public sectors of an economy, for the purpose ofthe CFAA, the following are considered to be core:
a Budgeting a Public Sector Accounting and Financial Reporting a Public Sector Internal Control System a Public Sector Auditing a Legislative Scrutiny ofthe Public Sector Financial Management
In the context of a country’s overall governance environment, the executive arm of the government has an obligation to the public for safekeeping and proper use of public resources entrusted by its constituents, and to provide a credible legalhegulatory framework to promote good financial governance in both private and public sectors ofthe economy. The institutional and legalhegulatory regime that seeks to provide this assurance constitutes the public financial accountability framework in a count$.
The Bank’s interest in the CFAA primarily lies in providing inputs for managing fiduciary risks. The Bank’s fiduciary responsibilities to its shareholders and the
In the context of the private sector, high quality financial reporting and robust audit infrastructure should provide reasonable assurance to interested parties that financial operations are conducted properly and that investments are managed with due care and are protected from the risk of fraud and misuse; and to determine the developmental actions to support an enabling environment for private sector development. Russian Federation: Countrv Financial Accountabilitv Assessment iii borrowing government’s fiduciary responsibilities to its citizens are closely related. If the borrowing government meets its fiduciary responsibilities to the citizens, the Bank’s fiduciary responsibilities are automatically met. It is therefore necessary for a country to develop a proper financial accountability framework, in design as well as in practice. The CFAA, therefore, needs not only to focus on the existing systemic weaknesses giving rise to fiduciary risks, but also to present advice on developmental needs.
Acknowledgements
The mission members wish to acknowledge the extensive cooperation and assistance received from officials and staff of the public organizations, state agencies and other institutions interviewed. Mmes Lydia Petrashova and Anna Jouravleva, Financial Management Officers, and Ms. Julia Checkaljuk, Team Assistants in the Bank’s Moscow Office, provided support with fact-finding and documentation gathering activities, as well as logistic arrangements for the mission and, together with Ms. hila Kuka, Team Assistant, ECSCS, with report preparation. Messrs. John Hegarty, Regional Financial Management Adviser, Core Services Europe and Central Asia (ECA) and David Shand, Financial Management Adviser, OPCFM and Peer Reviewer, offered invaluable comments and provided other important inputs to the task. Ms. Suzanne Snell, Consultant, assisted with the editing and formatting of the report. Russian Federation CFAA: Executive Summarv iv
EXECUTIVESUMMARY
Country Context
State Structure. The Russian Federation is a federative democracy, adhering to the principles of separation ofpowers under a presidential system. The Constitution provides for a bicameral legislature (Federal Assembly, composed of the Lower House, the State Duma; and the Upper House, the Federation Council) and for a strong executive. The 1992 Law on Judges established the independence ofthe judiciary. The Constitution also provides for a multi-party system and fiee elections.
Administrative Structure. The Russian Federation (RF) comprises three tiers of government: (i)the central (federal level) government; (ii)the second tier, consisting of 89 Subjects (regional level)- oblasts, autonomous oblasts, republics, autonomous republics, ethnic republics, krais (regions) and okrugs (districts)- which, for the most part, have a unified budgetary relationship with the federal government; and (iii)a third tier (district level), containing rayons (municipalities and townships) that are subordinated to the second tier of government. The great variation in the administrative regions’ climate, endowment, and economic base, make effective fiscal and economic management at the national level quite complex. The recently launched strengthening of institutional development at the second and third tiers of government, accompanied by reinforcement ofthe governance process fiom the top down, should also be accompanied by reforms in the regions that take into account the need for a balance ofpower between the center and the periphery and for harmonization of regional and federal laws, along with reform at the local government level, especially in the area of public financial management.
In 2000, the country was reorganized into seven super-administrative districts by presidential ruling. These districts - created as an additional tier of the federal government, with very limited rights and responsibilities - are regarded as part of a strategy to reassert federal government control over the regional governments. The restoration of a strong Russian state, including diminished influence of the business oligarchy, emerged in the early phase of economic transition, has the support of the majority ofpublic opinion and is regarded by various observers as the only way out ofthe difficulties ofthe post-Soviet era.
Economic Prospects. Due to rapid economic growth, progress on tax collection, extremely high world oil prices, and relatively effective exchange rate policies, Russia’s macroeconomic picture looks positive. Strengthening policy-making and budget management, including public sector financial management-accounting, financial reporting, internal and external audit-is an important element in keeping public finances and debt on a stable, long-run course so that genuine, long-lasting stabilization can be achieved.
Public Sector Reform. This CFAA took stock ofwork in 2001-2002 at the federal level in public sector budget management and the treasury system . It focuses on public sector accounting and financial reporting, internal controls, and internal and external audit. Recommendations proposed in these areas, and in regard to portfolio fiduciary Russian Federation CFAA: Executive Summarv v considerations, are meant to be considered within the broader scope of the implementation of the Expenditure Efficiency program developed by the Russian Ministry ofFinance, and other concomitant public sector reform efforts.
Institutional reforms and capacity building in the public sector, and associated improvements in the governance structure, are at the core of the Russian Federation’s program of economic transformation and development, launched in 2001. New policy approach, systems and procedures under discussion by the World Bank and the authorities would improve the MOF’s ability to plan and control federal budget execution. The renewed emphasis and dialogue between the Russian authorities and the International Financing Institutions (IFIs) in these areas is demonstrated by the unprecedented volume of economic and sector work being undertaken by the World Bank, covering public investment, federal budget management reform, and anti- corruption efforts, as well as the number of large projects under preparation-treasury development, regional fiscal reform, tax administration modernization, and customs reform.
Budget Management
The decision to make the transition from a centrally planned to a democratic, market- oriented economy also involved a decision to radically transform the public sector, in particular the Ministry of Finance, which has a central role in public finance management. In public sector budgeting, as in other areas, the Russian Federation has taken a gradual approach to reform.
Progress was made during 2001-2002. First, the federal government has sharply curtailed the use of offsets and, with the growth of the revenue stream, the budget has lately been better managed and, owing to the positive macroeconomic situation of the country, presently remains in surplus. Secondly, expenditure control has been strengthened. Thirdly, the tracking of, and accounting for, funds from the Federal Treasury have greatly improved. Lastly, the government has made progress in distinguishing general government operations from those ofother functional uses.
Planning and Preparation. Multi-year forecasting has been carried out within the Ministry of Economic Development and Trade (MOEDT) and the MOF’s Budget Policy Department for many years. As a result, a framework for medium-term aggregated forecasts and targets is in place, together with the capacity to carry out short and medium- term forecast and macroeconomic analyses underlying the budget and to publish them in the annual budget document. However, there were no mechanisms to ensure consistency with macroeconomic constraints through the budget preparation process. There were also some problems with budget classifications: Government Finance Statistics (GFS) economic classifications were yet to be fully implemented; and in the way the work of the Accounting Methodology department within the MOF is organized, in particular, how it interacts with the Federal Treasury.
The budget preparation process in RF followed a top-down approach that was not completely grounded on detailed analyses of programs or spending needs. Some of the sectoral departments within the MOF (e.g. department for sectoral financing) were pretty active during budget formulation stage, collecting and processing information from line Russian Federation CFAA: Executive Summaw vi ministries. However, some of them (e.g. department for social policy) did not actively participate in annual budget formulation or execution oversight, but function only as the contact points between the MOF and the relevant line ministries. Funding allocations did not reflect sectoral policies and objectives, leading to a strong need to amend the budget at the execution stage. The resulting deficiencies in execution and wide gaps between plans and actual outcomes undermined the capacity to implement public policy. In particular, policy over-commitments and use of the budget as a ‘control’ device (forcing management within actual resources, rather than setting out hard budget constraints for all users) were the main determinants ofthe extensive generation ofarrears that occurred until 2002.
Budget Execution in 2002. Steps were taken to increase expenditure accountability, including adoption of a system of contract registration and authorization, and a system of commitment recording for tracking utility-related expenditures. Coverage ofthe Treasury system was extended, including recording proceeds from off-budget accounts. Government has adopted the principle of establishing a Treasury Single Account (TSA) for federal budget revenues and expenditures, and the new Budget Code requires all budgetary entities to open an account with the Treasury.
Major remaining weaknesses in controlling expenditure commitments, reducing arrears and improving cash management should be resolved with the introduction of the TSA, but this process will take time and interim improvements are required. While total arrears have dropped significantly in 2000 and 2001, there is no complete tracking of current or past arrears, symptomatic of the focus on the current budget cycle alone. Accounting principles and reports for extra-budgetary funds are not yet compatible with those for regular budget funds (as defined in the Chart of Accounts), and differences in the timeframe and approval process still leave extra-budgetary funds beyond the reach of budget execution discipline.
Revenue Management. Most taxes, bases, and rates were set by central government, and central government also prescribes revenue-sharing formulae. Taxpayers paid taxes where they had been registered (either as individuals or business entities), through the local level offices of federal Ministry of Finance and Treasury. The 1999 tax code provides a legal basis for all taxes and protection of taxpayers’ rights. There has been significant progress in improving tax collections in recent years, due to better enforcement oftax laws. Strong disincentives for the regions to engage in non-cash offset settlements schemes oftax bills, that have historically lowered cash receipts to be shared with central government, are embedded in the tax legislation as well as the Treasury’s tax-sharing procedures. However, application ofthe legislation at the regional level lacks consistency and, in spite ofthe significant progress in improving tax collections in recent years, taxation remains a problem area.
Monitoring and Evaluation. Historically, there has been a lack of reporting on budget outputs. The objective of the MOF’s planned Expenditure Efficiency program was to improve budget efficiency by introducing performance budgeting through a quasi- contractual agreement between central and line agencies regarding performance, as well as better monitoring and evaluation. Spending units would be held accountable for their Russian Federation CFAA: Executive Summarv vii results, introducing greater focus on budget outputs, and creating mechanisms for competition for budget financing through program proposals.
Recommendations. The first step is to achieve a stable policy consensus on budget formulation and the improvement of routine budget execution capacity; only then can the focus shift to performance. The CFAA recommends
strengthening the strategy phase of budget preparation in order to link within a single framework, macroeconomic resource constraints and sectoral and program targets, over a horizon extending beyond the immediate budget cycle;
adoption of a uniform, simplified budget coding structure hlly incorporating GFS hnctional and economic classifications;
adoption of a more participatory approach to budget planning and formulation, involving the MOF, central ministries and agencies, and second-line spending units, which should provide detailed spending plans as inputs to the budget process;
introduction of accounting principles by entities with extra-budgetary funds and preparation of reports that are compatible, and can be consolidated, with Treasury accounts and fiscal reporting;
preparation of a program of institutional development for the MOF, including analysis of procedures now in use to plan and active application of modem information technology;
amendment of the chart of accounts (COA) to filly reflect the budget classification, with the objective of integrating the Register (records of transactions) into the Treasury accounting ledger;
progressive extension of the current partial system for commitment control to cover other type ofexpenditures; and
introduction of complementary reforms evaluation and oversight of budget performance outside the executive, specifically legislative scrutiny, external audit and the broader role of civil society, including publication of budget reports and analysis.
Treasury System
Under the Soviet system, the central bank, and more generally the whole banking sector, operated as the de facto treasury for the govemment. Since its creation in 1992 as a department ofthe MOF, the Federal Treasury (FT) has implemented a system to manage the budget execution process. Some essential elements of a modem treasury system have already been implemented with respect to the payment system, flow of funds, and cash management. The Central Bank of Russia (CBR) operates a clearing system consisting of regional clearing centers in each region and a national clearing center in Moscow. Manual clearing procedures are still used quite extensively, originating delays in Russian federation CFAA: Executive Summary viii payments. The CBR is planning to move towards a modern, real-time, gross settlement system, but there is no specific timetable for this.
In 2001-2002, there was significant progress towards establishing a modem and efficient federal treasury system in RF. The systems were able to provide the minimum information support required for basic treasury functions, and short-term enhancements of this system were underway. The next phase was the introduction of full treasury functions, with an initial step taken with the January 2000 approval of the concept of a Treasury Single Account (TSA) for federal budget revenues and expenditures. The adoption of the TSA was an integral part of the overall strategy for the further development of the Treasury, setting new procedures for flows of federal budget funds and accounting rules.
Treasury Development Project. The long-term process of implementing a full range of treasury functions, including commitment recording, General Ledger, and comprehensive financial reporting, received support under a Treasury Development Project now being prepared by the MOF and the World Bank. The government is very committed to the project, as it realizes the vital importance of a functioning Treasury to meet the needs of public financial administration in the context of a market economy. The first phase of upgrading and increasing the coverage of the basic systems was completed by the year 2002, by bringing into the system the Ministry of Defense (MOD), customs revenues, a number of extra-budgetary funds and most of off-budget accounts. The agencies and personnel had become thoroughly familiar with the workings of the interim systems and associated changes in business processes, Treasury moved to a full-function system based on more advanced technology and procedures.
Recommendations. The development and implementation of a full-function Treasury system will take several years and is not expected to become fully operational before 2004/05. In the interim, the CFAA recommends
0 immediate implementation of an improved system of expenditure monitoring, including commitment control, replacement of cash rationing with more orderly and effective cash-management systems; and introduction of a sound accounting system for government operations;
0 extension of Treasury control of expenditure commitments to all items of the economic expenditure classification, including contract monitoring; and
0 replacement of weekly cash finding limits by monthly funding of established expenditure commitments, in order to reduce the incidence ofad hoc discretionary budgetary adjustments conducted in a non-transparent manner during budget execution.
Accounting and Financial Reporting
The progressive setup of the treasury system is already allowing for greater timeliness and effectiveness of accounting and reporting, and for fill ownership of the MOF over these fundamental management tools. The MOF is proceeding with improvements within the existing system, including preparation of the federal budget execution balance sheet Russian Federation CFAA: Executive Summarv ix starting in 2000. There are plans to prepare quarterly and annual financial statements on federal budget execution. Ultimately, the MOF’s Treasury Development Project would include development and deployment of a Financial Management Information System (FMIS) that would provide the type of information required for decision making, management control, and budget formulation in subsequent years. The new Budget Code, which requires recording ofall stages ofthe payment process, provides a strong basis for comprehensive release of information to the public (now a legal requirement). The Code became effective in January 2000 but was not hlly implemented by December 2002.
Accounting. Some practices represented in 200 1-2002 holdovers from the Soviet system, and government accounting relied heavily on reporting from the banking system. The Budget Department Accounting Unit summarized approved expenditure authorization reports that were presented to the MOF by the spending units and keeps reconciled financial records with the banking system. Reporting from the banking system is carried out in cash terms, and reflects the distribution of budgetary funds rather than actual spending. Detailed accounting of actual expenditures is made available to the MOF from ministries’ reports on a monthly and quarterly basis, with a time lag of several weeks. Accounting was oriented mostly to the recording of transactions and not to providing information for fiscal management, the emphasis being mainly on cash flows. While accounting for the government as a whole was recorded in 2001-2002 and reported on a cash basis, some institutional budget records were maintained in an accrual-related form that is, however, not integrated with the Federal Treasury accounts.
Reporting. In 2001-2002 the MOF publishes aggregated budget information on the federal budget, showing monthly and year-to-date revenues, expenditure, and financing data in comparison with the same period in the preceding year. The MOF also published data on domestic and external debt, but not on guaranteed debt, fiscal contingent liabilities, or quasi-fiscal activities. Data were published on the MOF website, and government finance statistics largely complied with international best practice (though the methodology is not available for public scrutiny).
Coverage. The Federal Treasury coverage of expenditures has expanded, enabling improved compilation of government finance statistics. The Treasury is delivering its analytical statements and summary reports on budget execution in a more timely manner, and a considerable improvement in the quality of data is also observable. As a result, monthly data on revenues, expenditures and financing of the federal and local governments are provided on a regular basis. For the first time, in 2000, the MOF prepared a quarterly report by agency and economic structure based on reports from the Federal Treasury.
Treasury coverage continues to expand, but this reform will fully realize its positive effects only if accompanied by improvements in budget reporting. Starting with the 2001 budget the three state extra-budgetary funds (Pension Fund, Social Insurance Fund and Medical Insurance Fund) have been incorporated into the Treasury Chart of Accounts, but no instructions for implementing their inclusion have been issued. It is expected that the integral use, by the EBFs, of budget classifications as the budgetary organizations - enabling to achieve proper consolidation of general government accounts in financial reporting - will take a few more years to be implemented. The bulk of off-budget Russian Federation CFAA: Executive Summarv X revenues was included but some accounts, especially at the regional level, remained outside of the Treasury system. Coverage of Ministry of Interior expenditure was incomplete, and little information was available on presidential activities financed outside the budget, which were also not subject to adequate financial control mechanisms. State secrecy laws also introduce some elements of non-transparency and uncertainty into the fiscal account (for instance, changes in stock of non-monetary precious metals). There were also coverage problems due to the delay in obtaining measure of revenue and expenditure arrears in a cash basis system, and insufficient data on extra-budgetary and off-budget revenues at the local government level.
Classification Systems. Also, two incompatible classification systems were used in 200 1- 2002 : fiscal data follow one Chart of Accounts reflecting functional distinctions, while budget follows the Government Finance Statistics (GFS) economic classification system.
Recommendations. The CFAA’s main recommendation is to proceed with all due speed to implement government’s plans to use a Treasury General Ledger (TGL), to compile summary reports of records for control and analysis and produce fiscal reporting, and to complete the ongoing transfer of spending units’ off-budget funds to Treasury accounts .
Pending completion ofthese plans, the CFAA recommends
0 review ofexisting budget classifications and coding structures and design ofa revised structure and COA that conform with the IMF GFS classification methodology (both functional and economic) and that are suitable for both project preparation and execution;
0 integration ofthe two existing coding systems (budget classifications and Chart of Accounts) and creation ofa single classification system and a single COA for use by all spending units.
Internal Controls and Internal Auditing
Modem intemal audit functions exist only at the inception stage in the R??.The exercise of internal and financial controls within the MOF was carried out in 2001-2002 by two bodies: (1) the Federal Treasury’s Control and Inspections Division(CID), which performs ex-ante, transactional controls over expenditure authorizations, current controls over bookkeeping functions, and, to some extent, cash management (mostly in the form of cash rationing), and (2) the MOF’s Financial Control Department (KRU), which performs ex-post verifications and inspections over budget execution. The CID covers central and sub-national treasury offices and is an integral part of the treasury system, ensuring the integrity and consistency of operations transiting through the Treasury. The KRU successfully overcame the main problem of its predecessor institution, which was the lack of independence from the accounting and reporting functions of its parent ministry. However, much is to be done in order to move away from the review of individual transactions to an approach based on analyzing the quality of the organization’s management controls and procedures, so to act as a true internal audit body. Russian Federation CFAA: Executive Summarv xi
Resource Limitations. Both CID and KRU also suffered from resource limitations. The Treasury is limited in the scope, number and effectiveness of its control activities by insufficient human resources, office space, and information system infrastructure. While software is used for data compilation, the actual control activity is reportedly done semi- manually using labor-intensive procedures and extensive paperwork. As Treasury coverage extends to MOD, off-budget, and extra-budgetary operations, the workload is increasing. KRU’s charter requires its controllers to review no less than 50 percent of budget allocations for the previous year, through meticulous procedures tracing transactions back to primary documents. Since all records are paper-based, the process involves an enormous amount of voucher checking. Also, the bulk of KRU’s resources are absorbed by ad hoc inspections based on requests from state enforcement bodies such as the financial police.
Developing Internal Audit Function. Although the work ofthe two agencies complement each other, these checks and balances did not ensure a sufficiently controlled environment for public financial management. Despite KRU’s recent progress in adopting a risk- and quality-based approached to its functions, the setup was not conducive to the exercise, by the MOF, of proper internal audit functions, that was, objective and independent processes of evaluating whether or not present control functions were carried out in accordance with sound financial management criteria. To that extent, the internal auditor needed to be completely independent from the people being audited. The internal audit function needs to be’ separate and distinct from the CID’s ex-ante and current controls that are a normal part of Treasury’s general accounting functions, and from KRU’s internal control procedures used to ensure oversight by the executive branch and assess the legality and propriety of public expenditures.
The further development of Treasury functions, both in terms of coverage and increased operational effectiveness, served to institutionalize these control functions and make them more automatic and systematic @.e. embedded in the system). In particular, the establishment of the Treasury Single Account (TSA) will entail significant investment in information technology and training, supported in part by the forthcoming Treasury Development Project.
Recommendations. The CFAA recommends the modernization of government’s internal and financial controls and the introduction of sound internal audit functions, by putting in place both a new institutional framework and a capacity development program that covers staff training and upgrading ofmethodology and information systems. In that respect, a new, organic regulation of public sector internal controls and internal audit functions was under preparation that will, hopefully, lead to a more appropriate setup. The World Bank is available to review and comment on the proposed reform, and the Bank and other donors could also make resources available for internal audit capacity development, under a comprehensive civil service reform program - the desired outcome being the emergence of a civil service and organizational culture of closely following rules and procedures embedded in the government culture, especially spending units. Russian Federafion CFAA: Execufive Summarv xi i
The institutional choice at the federal level is between a centralized or a decentralized intemal audit model. Each model has its advantages and risks. Whatever the new structure adopted, the CFAA recommends that
internal audit be regarded primarily as an important management tool, and its recommendations be concretely implemented, to promote stricter enforcement of policies and procedures;
the intemal audit model shift away from the old inquisitorial mentality and inspection-based approach to a new audit model, based on service orientation and performancehisk assessment;
intemal audit hnctions be independent from other organizational and functional departments;
intemal audit staff report directly to the head ofthe organization;
the intemal audit body’s prerogatives, functions, and reporting lines be regulated by an audit charter and its activities laid down in an annual work plan;
audit tasks be carried out by multi-disciplinary teams with skills in handling accounting and financial data, information technology, and the legal and procedural aspects ofgovernment’s operations and;
intemal audit units have appropriate links with the Accounts Chamber, allowing extemal auditors to rely on the work ofinternal auditors regarding the adequacy and correct functioning ofinternal controls.
External Audit
The establishment of the Accounts Chamber (AC) as the country’s Supreme Audit Institution (SAI) in 1995 represented a significant step in institutionalizing the accountability ofthe executive to the legislature. In that sense, the AC filled an important gap in the country’s financial accountability fi-amework. Prior to its transition to the principle of separation ofpowers and adoption of a new constitutional setup, the Russian Federation had no tradition of an independent, ex-post, extemal audit function for public financial management. The Constitution lays the foundation for the independence and neutrality of the Accounts Chamber, containing explicit stipulations regarding the institution’s powers and scope of activities, and ensuring that these cannot be changed unscrupulously.
Scope. The Accounts Chamber is a member of INTOSAI and of European and Asian regional SA1 organizations. Its decision-making body is the Collegium, composed ofthe chairman, the deputy chairman and the twelve auditors of the Chamber. The Accounts Chamber’s primary role is to undertake extemal audit of revenues, expenditures, and borrowings of all central government agencies and government-invested organizations, including extra-budgetary funds, the use of state property (including post-privatization development of enterprises), and report on its findings to the legislature. It is also required to provide an independent expert opinion on the draft federal budget law and Russian Federation CFAA: Executive Summarv xiii may conduct ad hoc audits - upon request from the executive and the legislature - with the Collegium deciding which requests go into the annual work plan. Its access to offices, documents and information is extensive.
The broad scope of the AC's activities carries the risk that the Chamber becomes involved in matters of policy and administration that are rightly the prerogative of the executive branch of government. The AC's broad prerogatives can be justified during transition period (when Treasury functions are being developed, and financial controls and internal audit functions are being strengthened), and the AC feels that it does not unduly interfere in matters of governance. Nonetheless, the AC's exercise ofpreliminary budgetary controls - such as proving expert opinion on the draft federal budget law - may compromise its work as SAI. In due course, as proper internal audit functions and financial reporting capabilities are put in place, certain ofthe AC's prerogatives should be revisited and its attributions refocused on financial and performance auditing, in line with INTOSAI standards.
Funding. The Accounts Chamber depends on annual budget allocations, which are determined by the executive and it has no revenue sources of its own. In order to fully implement the constitutional requirement ofindependence and neutrality ofthe Chamber, and protect the AC from expenditure cuts, alternative funding arrangements are to be sought, de-linked from executive powers control (for instance vesting the parliamentary Committees of the two assemblies with the prerogative to determine funding for the AC activities).
Technical Capacity. The Chamber conducts on average more than 400 audits every year, mostly by teams of three or four inspectors. About ten percent of its resources are absorbed by ad hoc requests, not included in the annual work plan. The Chamber uses a risk-adjusted sampling methodology to select spending units; audit activities are supported by computerized information systems, including a database designed to support auditing techniques. However, this system is still unfolding its potential to allow for off-site, desk review of data. As a result, inspectors still mostly carry out on-site inspections. Regarding internal policies and procedures considerable progress has been made; the organizational structure of the AC is being revised and improved, and the chairman intends to increase the efficiency of Chamber's operations by codifying audit methodology and associated processes. In 2000, internal regulations were modified to require greater interagency coordination and to adopt a risk-based approach to conduct more extensive audits ofthe most significant entities.
Coverage. The Accounts Chamber employs some 1, 150 Moscow-based staff, of whom the majority are professional staff involved in audit work, which enables it to give full examination to line ministries once a year. Authorities below this level (e.g. second-level spending units) are likely to receive attention less frequently. The Accounts Chamber has no authority to audit the execution of regional or local entities' budgets. Regional and local governments are covered by local bodies of external audit, similar to the Accounts Chamber, set up by the regional and local legislatures. In 2000, the Accounts Chamber did assist with the creation of an Association of Control and Audit Bodies and a Union of Municipal Audit Bodies, important steps in the institutionalization ofthe relation between the Chamber and its regional and local counterparts. Russian Federation CFAA: Executive Summaw xiv
Standards. In 2001 the Chamber is elaborated its own auditing standards intended to conform with those presented in the Lima Declaration of Guidelines on Auditing Precepts. Although the Chamber is gradually moving towards the implementation of a fbll range of INTOSAI’s Standards, its audit objectives remain legalistic in nature, reflecting the country’s traditions and cultural attitudes towards state control functions as well as the Chamber’s priorities in carrying out extemal audit. The Chamber carries out documentary reviews of the executed budget that are, essentially, compliance-oriented and address a variety of topics, including legal, organizational, administrative, and other non-financial aspects of public financial management. Since in 2000 the Russian Federation began preparing an annual federal government balance sheet, it has become topical to perform financial audits, in the sense of attestation of public accounts. In this respect, the opinion issued by the Chamber on the government’s budget execution report makes explicit reference to government financial statements.
Follow-up and Dissemination of Results. The Accounts Chamber reports to the State Duma and the Federation Council. The Federal Assembly may pass a resolution on the findings presented in the reports, but legislative audit resolutions do not necessarily lead to a response from the executive. The Chamber’s final annual audit report must be approved by the Council, submitted to the State Duma, and then published. Individual reports to the legislature may be provided to the press on an informal basis, and those not covered by state secrecy or confidentiality clauses are summarized in the Accounts Chamber’s periodic bulletin. The Chamber routinely issues press releases, gives conferences and maintain its website, where a number ofreports are published.
Recommendations. The CFAA strongly supports the Chambers’ program of institutional and methodological improvements, in particular its preparation of a long- term plan to assess public institutions’ performance (value for money) in the use ofpublic funds. The CFAA further recommends that
0 the Chamber enhance its financial audit capabilities and expand its financial audit activities to cover the annual financial statements of individual government entities;
0 the Chamber’s role be mainly focused on ex-post auditing, in order to avoid compromising the effectiveness and credibility ofits work. Responsibility for providing advice to the legislature on budget formulation, revenue and expenditure forecasts, and policy analysis remain with the Committees on Budget and Taxes, with the Chamber acting in a limited advisory capacity upon request;
0 the Chamber be freed from its involvement in budget matters, its obligation to carry out work for the executive, and its obligation to accept ad hoc requests. Responsibility for reporting on the progress ofbudget execution remain solely with the executive branch, including the Treasury and the MOF. The Chamber be given a free hand, under all circumstances, to rule on the merit ofad hoc requests coming from the legislature;
0 mechanisms be established for the executive to provide an official response to the Chamber’s findings and recommendations and respond to parliamentary Russian Federafion CFAA: Execufive Summaw xv
recommendations for action, including formal processes to determine the extent ofadministrative and judicial action to be triggered by the Chamber's findings. In particular, in the absence ofa dedicated parliamentary audit committee, that the Council ofFederation Committee for Coordination with the Accounts Chamber and the Budget and Tax Committee ofthe State Duma devote greater attention to scrutinizing and publicizing the Chamber's activities and following them up;
0 the Chamber work on the implementation ofINTOSAI Standards on Auditing, with the objectives ofgradually aligning financial audits to international best practice, particularly in the areas of evaluation ofinternal controls and analysis of financial statements; enhancing the internal quality assurance functions over its audit activities, particularly in the areas ofplanning, execution and reporting; and establishing external quality assurance mechanisms through /external review by another SAI;
0 the work ofthe Accounts Chamber be reviewed, on a regular basis, by another SAI, including staff exchanges that provide exposure to international experience;
0 legislation on regional and local audit bodies be considered, providing for specialization and adequate division oflabor between the federal and sub-national audit bodies and a coordinating role by the federal Chamber;
0 a capacity development program be prepared for the Accounts Chamber to support the previous recommendations.
Portfolio Fiduciary Considerations
The CFAA finds that the World Bank is adequately discharging its financial management fiduciary responsibilities with respect to its lending operations. The CFAA risk assessment concludes that the current ring-fencing approach to project implementation arrangements should be maintained, recognizing that - based on the effective operationalization of the reforms being introduced in public financial accountability - the present arrangements could in due course be subject to revision.
In 1999, the Bank introduced front-end accountability requirements that continue to be justified in light ofthe weak overall control environment in the Russian Federation. Bank staff have been consistently implementing the project financial management arrangements mandated by the Financial Management Initiative (FMI) since 1998. The Bank's Moscow-based financial management team also took innovative steps, now regarded as best practice Bank-wide, to improve the audit quality of Bank-financed projects by introducing a system ofpre-qualification ofprivate sector audit firms.
The arrangements did pose some limitations on developmental impact, since they potentially detract from line ministries' ownership of projects and might limit in-house capacity building at the line ministry level, as compared to establishing stand-along PIUS. However, these drawbacks were positively offset by cost-effectiveness and efficiency considerations. Russian Federation CFAA: Executive Summarv xvi
Recommeizdations. Based on the CFAA’s findings regarding existing weaknesses in the public sector financial accountability framework, the CFAA recommends that
the current ring-fencing approach to institutional and implementation arrangements be maintained for Bank-assisted projects in the Russian Federation;
the framework currently in place for govemment oversight ofthe Foundations be maintained;
current arrangements for the annual audit ofBank-assisted projects-audit by private sector audit firms competitively appointed among those pre-selected-be maintained;
the work performed by the Accounts Chamber, including its reports on Bank- financed projects, be reviewed by the Bank on a regular basis and taken into consideration in project preparation and supervision;
fiduciary functions (disbursement, procurement, accounting and reporting, and operational reviews) continue to be outsourced to specialized agencies, even in cases where partial project management may be vested in sectoral ministries or agencies;
the eventual establishment of Special Accounts in commercial banks be conditional on a positive reassessment ofthe institutions’ soundness, along with fit and proper ownership;
the channeling ofloan funds through Treasury be regarded as a medium- to long- term objective dependent on the full adoption and smooth operation ofthe Treasury Single Account, universal Treasury coverage, preparation ofa statement of accounting policies, ability to deal with special purpose financial statements like those required by the Bank; and introduction of sound internal auditing functions;
a shift of loan funds to Treasury be a prerequisite to allowing the transfer ofa full range ofproject implementation activities (including financial management) to ministries and government agencies; and
technical assistance continue to be provided by the World Bank and other donors to develop capacity within key state institutions (Ministry ofFinance, Federal Treasury, and Chamber ofAccounts) and to strengthen public financial accountability and financial management systems. Russian Federafion CFAA: Counfw Confexf 1
I.COUNTRY CONTEXT
1. The Russian Federation (RF) is the largest country in the world, with a multiethnic population of over 145 million. It is composed of more than seven dozen administrative regions, which vary greatly in their climate, endowment, and economic base, making effective fiscal and economic management at the national level quite complex. Without some degree of re-centralization, the Russian Federation was facing the danger of progressive fragmentation. The launched strengthening of institutional development at the second and third tiers of government, accompanied by reinforcement of the governance process from the top down, should also be accompanied by reforms in the regions that take into account the need for a balance ofpower between the center and the periphery and for harmonization of regional and federal laws, along with reform at the local government level, especially in the area of public financial management.
Governing Structures
2. The Russian Federation is a democratic, federative, rule-of-law state with a republican form ofgovernment(Artic1e 1 ofthe Constitution (approved by referendum on December 12, 1993), , adhering to the principles of separation of powers under a presidential system. .” Article 3 ofthe Constitution provides for free elections and Article 13 guarantees a multi-party system3. The 1992 Law on Judges established the independence of the judiciary. The Constitution provides for a bicameral legislature (Federal Assembly, composed of the Lower House, the State Duma; and the Upper House, the Federation Council) and for a strong executive. The President is given strong powers, including the right to issue legally binding decrees and directives, to appoint senior members of the judicial and executive branches and, in certain circumstances, to dissolve the Duma. Presidential decrees and directives, like other laws, may be appealed to the Constitutional Court. The political situation has solidified; a more cooperative relationship between the Duma and the President has developed since Mr. Putin was sworn in as President in May 2000.
3. The Russian Federation comprises three tiers of government: (i)the central (federal level) government; (ii)the second tier, consisting of 89 Subjects (regional level)- oblasts, autonomous oblasts, republics, autonomous republics, ethnic republics, krais (regions) and okrugs (districts)- which, for the most part, have a unified budgetary relationship with the federal government; and (iii)a third tier (district level), containing rayons (municipalities and townships) that are subordinated to the second tier of government. Each Subject has its own legislature: republic presidents and krai and oblast governors are popularly elected, with electoral laws varying from region to region.
4. Although the system inherited after the disintegration of the Union of the Soviet Socialist Republics (USSR) is formally federative, in practice, formal relations between
In the Russian system, voters cast two votes in their federal Duma election: one for a candidate in the local electoral district and one for a political party or alliance. Half ofthe 450 seats are filled through direct voting and the other half by parties and alliances that meet a 5-percent threshold in proportional voting. While voter participation in both the 2000 presidential and the 1999 parliamentary elections topped 60 percent, actual membership in political parties is very low. Personalities play a major role in the political arena, and many parties are formed around a single individual or group ofindividuals. Russian Federation CFAA: Country Contexi 2 the three levels of government have continued to be more like those based on a highly centralized, unitary government. According to Article 5 of the Constitution, all 89 Subjects are equal in status; however, a series of bilateral power-sharing treaties signed by the Federation with many of its 89 Subjects introduced significant practical distinctions in institutional and administrative terms.
Strengthening Central Control
5. In 2000, the country was reorganized into seven super-administrative districts by Presidential ruling. The reform involved the creation of a new State Council, whose decisional body is a presidium whose seven members represent the new federal districts and are personally appointed by the President. This reorganization process (the new districts were created as an additional tier of the federal government, but with very limited rights and responsibilities) is regarded as part ofMr. Putin’s strategy to strengthen the state as a way for the federal govemment to reassert its control over the regional governments. Historically, weak central control has tended to perpetuate the dominance of the governors’ and local elites’ power structures.
6. The restoration of a strong Russian state has the support of the majority ofpublic opinion and is regarded by various observers as the only way out of the difficulties ofthe post-Soviet era4. In particular, the reassertion of central control is viewed as necessary to continued success in the Kremlin’s power struggle with the oligarchs, powerfill businessmen who exercise great direct economic power and great indirect political influence, who emerged from earlier phases of the transition, and who are perceived as one ofthe main obstacles to further democratization in Russia.
Economic Prospects and Public Sector Reform
7. Due to rapid Gross Domestic Product (GDP) growth, progress on tax collection, extremely high world oil prices, and relatively effective exchange rate policies, Russia’s macroeconomic picture looks positive. Under the current situation, the govemment should ensure that public finances and debt are placed on a stable, long-run course so that genuine, long-lasting stabilization can be achieved. This will require, among other steps, strengthening policy-making and budget management, including public sector financial management-accounting, financial reporting, and internal and extemal audit.
8. This CFAA, whose scope is limited to the federal level, takes stock ofwork in in public sector budget management, accounting and financial reporting, the treasury system, internal controls, internal and extemal audit. Recommendations proposed in these areas and in regard to portfolio fiduciary considerations are meant to be considered within the broader scope of the implementation of the Expenditure Efficiency program
This era has been characterized by varying degrees ofpolitical commitment to reform, including often contradictory economic policies and measures; inadequately developed legal and public finance management systems; large non-payment system across the public/private sector, with high incidence of non-transparent operations (offsets and barter transactions); decline in foreign investments; prevalence of wage and pension arrears; a large informal economy; an unstable and inefficient banking system; and widespread corruption throughout virtually all sectors ofthe economy (see also Box on Govemance and Corruption). Russian Federafion CFAA: Country Confexf 3 developed by the Russian Ministry of Finance, and other concomitant public sector reform efforts.
9. The Country Assistance Strategy (CAS), presented in 1999, and the 2001 CAS progress report, gave considerable emphasis to public sector management, govemance and accountability, recognizing that institutional barriers and capacity limitations in key public sector institutions represented factors that inhibit growth and economic transformation. In particular, the CAS progress report stressed the importance attached by the World Bank to the government’s 10-year economic development program, “Basic Trends in Social and Economic Development of the Russian Federation Over the Long Term”, generally called the Gref Report after the name of the Minister of Economic Development and Trade.
10. Reforms to promote greater transparency and accountability in fiscal management require, in fact, progress in the achievement of fbll budget coverage and control, accompanied by robust accounting and auditing systems. The government is committed to improving fiscal management by strengthening the Federal Treasury’s role. Further investment and efforts will be needed to complete the process of bringing public expenditures within the accounting and reporting framework of the treasury system, in order to facilitate consistent accounting and fiscal reporting within the government sector as a whole. The Russian Federation has in place a strong budget execution process, which needs to be complemented by enhanced policy and budget formulation, monitoring and evaluation procedures, and effective external audit and legislative oversight.
11. At the same time, broad civil service reform is needed to overcome problems of overlap and duplication of fbnctions within Russia’s public administration, to bring order to the chaotic policy environment confronted by many investors, and to bring coherence to Russia’s underlying legal and regulatory structures. The Bank’s April 2000 qualitative assessment ofRussian public administration found that the public sector was overstaffed, illogically organized, and lacking in quality staff, service orientation and policy analysis. In 1991, the Government created the Main Administration for Civil Service Cadres Training (Roskadry), a special organization for the selection and grooming of fast-track civil servants. Yet there remained an acute shortage of efficient civil servants at all levels ofgovernment.
12. Government’s May 2000 Program for State Reform recognizes the need to foster a service-delivery mentality and to enhance the personal accountability and productivity of civil servants through performance-based, meritocratic human resource management. The law now bars civil servants from holding office in federal or local governments, and prospective civil servants must report income and property holdings. But a 1991 law prohibiting civil servants from engaging in private business is largely ignored. Low pay is one reason that competent individuals avoid public administration jobs.
13. Institutional reforms and capacity building in the public sector, and associated improvements in the governance structure, are at the core of the Russian Federation’s program of economic transformation and development, presented in the Gref Report and launched in 2001. In 2002 the government has expressed interest in receiving assistance from the World Bank in the areas of budget formulation and budget execution. New Russian Federation CFAA: Countrv Context 4 systems and procedures under discussion by the World Bank and the authorities improved in the beginning of 2001the MOF’s ability to plan and control federal budget execution. The renewed emphasis and dialogue between the Russian authorities and the International Financing Institutions (IFIs) in these areas was demonstrated by the unprecedented volume of economic and sector work being undertaken by the World Bank, covering public investment, federal budget management reform, and anti- corruption efforts, and the number of large projects under preparation-treasury development, regional fiscal reform, tax administration modernization, and customs reform. Russian Federation CFAA: Public Sector Budaet Manaaemenf 5
11. PUBLIC SECTOR BUDGETMANAGEMENT
14. In public sector budgeting, accounting and reporting, as in other areas, the Russian Federation has taken a gradual approach to reform. The decision to make the transition from a centrally planned to a democratic, market-oriented economy also involved a decision to radically transform the public sector, in particular the Ministry of Finance, which has a central role in public finance management. A public sector modeled on the needs of central planning, it was recognized, was ill-suited to the demands of a market economy, and important institutional reforms were required. In the process of economic and political transformation, public finance management systems shed some of their previous functions and took on new tasks in order to become an efficient instrument ofeconomic management.
Soviet Legacy and Progress to Date
15. Under the Soviet Union, the budget was a subset of national planning, and allocations were made largely in physical terms, rather than on a monetary basis5. Normative standards were developed for the conduct of government programs, and these formed the basis on which the budget was constructed. The economic system’s transition forced the government to develop new procedures and tools for preparing, executing and evaluating the budget. This long process of economic transformation and institutional adaptation involved the gradual elimination of many practices and mechanisms characteristic of an economic system based essentially on barter. The widespread non- collection of taxes and use of offset mechanisms-forgiveness of taxation in exchange for goods and services-contributed to an environment of unrealistic budgeting and an inadequate framework for accountability in the operations of the enlarged public sector (including state-owned enterprises).
16. In 2000-2002 progress was made. . First, the federal government has sharply curtailed the use of offsets and, with the growth of the revenue stream, the budget has lately been better managed and, owing to the positive macroeconomic situation of the country, presently remains in surplus. Secondly, expenditure control has been strengthened. Thirdly, the tracking of, and accounting for, funds from the Federal Treasury have greatly improved. Lastly, the government has made progress in distinguishing general government operations from those of other economic sectors6. Despite the government’s continuing improvement of fiscal management systems and processes, many relationships need further clarification and more complete information is required on fiscal activity. The available information still does not provide a sufficient base to support transparent, accountable and efficient government operations, particularly with regard to defense spending and full inclusion of off-budget revenues, especially at the sub-national level.
17. Key issues remaining in public sector budget management are:
Physical planning was done using a Material Product System (MPS) that utilized full-count surveys and cumulative data reporting procedures to monitor performance under annual plan targets. In August 2001, the MOF completed a register ofentities that receive budgetary funds. The next step would be removing from the register, firms and other entities that are not hlfilling an appropriate function. inadequate framework for budget preparation, approval, implementation and monitoring;
weaknesses in the macroeconomic framework needed for planning and elaboration ofrevenue and expenditure projections;
inappropriate budget classifications, which do not allow meaningful budget execution monitoring and reporting;
lack ofadministrative capacity to adjust the budget in response to changing circumstances;
lack ofreliable, comprehensive and timely accounting information;
underdeveloped debt and cash management operations that are not linked to overall budget management; and
dispersion ofbudget resources in many spending unit accounts, leading to unnecessarily high cash balances within the public sector and undermining the government’s ability to efficiently manage aggregate cash flows and minimize public sector borrowing.
Budget Planning and Preparation
18. With regard to financial planning, multi-year forecasting has been carried out within the Ministry of Economic Development and Trade (MOEDT) and the MOF’s Budget Policy Department for many years. As a result, a framework for medium-term aggregated forecasts and targets is in place, together with the capacity to carry out short and medium-term forecast and macroeconomic analyses underlying the budget and to publish them in the annual budget document. However, there are no mechanisms to ensure consistency with macroeconomic constraints through the budget preparation process. There are also some problems with budget classifications and in the way the work of the department is organized, in particular, how it interacts with the Federal Treasury.
19. Conceming budget classifications, the budget is prepared, discussed and approved following functional formats and classifications rather than the Government Finance Statistics (GFS) full economic classifications7. The Duma approves the budget at the level of categories (razdel) and sub-categories (podrazdel) ofbudget expenditures on the basis of functional classifications. The Government then approves quarterly breakdown ofbudget expenditures.
20. The budget preparation process in RF follows a top-down approach that is not grounded on detailed analyses of programs or spending needs. Based on a set of parameters, such as macroeconomic forecasts and projected changes in payroll, the MOF Budget Department sets expenditure financing limits (the resource envelope) for the
Within the Budget Department there is a division of methodology of budget classifications, created in 1998. Russian Federation CFAA: Public Sector Buduet Manauement 7 spending units. The units in tum formulate their expenditure breakdowns based on these assigned ceilings. This process applies to all civilian ministries but not to the Ministry of Defense (MOD), which is presently not covered by the Federal Treasury and remains under the direct supervision of the President. Some of the sectoral departments within the MOF (e.g. department for sectoral financing) are pretty active during budget formulation stage, collecting and processing information from line ministries. However, some ofthem (e.g. department for social policy) do not actively participate in annual budget formulation or execution oversight, but function only as the contact points between the MOF and the relevant line ministries. Thus, the consultative process required to set funding allocations that reflect sectoral policies and objectives is poorly developed.
21, Following the same approach, line ministries and other state agencies prepared an aggregate budget plan within the established overall ceiling for the spending units under their authority. Such indirect or second-line spending units might number in the thousands and may operate with little coordination from the parent ministry, as in the case of schools and other educational institutions that form spending units within the Ministry ofEducation. Financing needs not covered by the established limit are listed in a special form that is then attached to the aggregate budget plan. As a result of these practices, a strong need emerged to amend the budget at the execution stage. Spending units prepared their budget plans at the implementation stage. Each quarter, spending ministries file detailed spending plans with the Treasury, which used these as a basis for controlling commitments and payments. Thus deficiencies in budget planning led to deficiencies in execution and wide gaps between plans and actual outcomes, undermining capacity to implement public policy. In particular, policy over-commitments and use of the budget as a ‘control’ device (forcing management within actual resources, rather than setting out hard budget constraints for all users) were the main determinants of the extensive generation ofarrears that occurred until recently.
22. The role ofthe legislature in annual budget formulation is assigned to the Finance and Taxes Committee of the State Duma. The committee is charged with: (i)providing advice on budget formulation to the government; (ii)reviewing the draft budget proposal and estimating the budget impacts of amendments and new legislation; (iii)monitoring the budget outtum during the year, advising the legislature on revisions, blockage and sequesters; and (iv) reviewing the budget execution reports. The committee’s core budget staff provide budget data and analysis, review the macroeconomic assumptions underlying the budget, and selectively evaluate programs and report to the legislature on how their performance might be improved. However, there is a lack of clarity in the respective roles ofthe executive and the legislature in budget formulation.
Budget Execution
23. In budget execution, major weaknesses include the lack of means to control expenditure commitments and, until recently, the consequent frequent generation of arrears; the lack of effective and efficient cash management arising from the incomplete coverage of the treasury system; and the absence of comprehensive reporting on budget outputs. The introduction of the Treasury Single Account (TSA) with the Central Bank of Russia should solve most of these problems but this process is still underway, and in the interim, hrther clarification ofbudget execution procedures is required. Russian Federation CFAA: Public Sector Budaet Manaqement 8
24. At the beginning of the year, following the annual budget law approval, the ministries are informed oftheir annual allocations, broken down in quarterly and monthly payments (in purely mathematical terms). As a result of the ongoing inventory and categorization of budget recipients conducted by the MOF, the distinction between regular budget organizations and entities that receive government grants has been clarified and, for the 2001 budget, only budget organizations received line items appropriations, whereas other budget recipients will receive transfers in the form of grants.
25. There is no tracking of current or past arrears, symptomatic of the focus on the current budget cycle alone. If an item is overspent (cash request in excess ofthe relevant appropriation), the Treasury implements a cash-rationing system and exercises its prerogative to stop all payments. The unpaid requests are carried over to the next period, creating arrears that are, however, not recorded as such. While a precise quantification of the arrears generated by this practice is not available, total arrears have dropped significantly in 2000 and 20018.
26. The Federal Treasury adopted in February 2001 a system of contract registration for budgetary institutions as a significant step forward in the area ofcommitment control. Starting with the 2000 budget, a system of “commitment re~ording”~was introduced for tracking utility-related expenditures (heating, natural gas, fuel, electric power and water supply). Spending units contracting with suppliers for an amount above 20,000 rubles are required to submit a copy of the contract to the Federal Treasury for registration. The Treasury checks for consistency with the relevant budgetary allocation and confirms that the unit has not exceeded the authorized level of their commitment limit. Without the Treasury’s registration stamp, spending units are forbidden to use budget funds to pay for their contracts.
27. Starting with the 2001 budget, proceeds from off-budget accounts have been recorded in the Treasury system (they are retained as separate nominal accounts with the treasury system). However, spending units are continuing to use off-budgetary funds to cover current expenditures, although the MOF recommended that off-budget revenues be used to cover capital expenditure”. Accounting principles and reports for extra-budgetary hdsare not yet compatible with those for regular budget funds, and differences in the timeframe and approval process still leave extra-budgetary funds beyond the reach of budget execution discipline.
28. Government directive No. 107 of January 23, 2000, approved the concept of the Treasury Single Account (TSA) for federal budget revenues and expenditures. The adoption ofthe TSA is an integral part ofthe overall strategy for the further development of the Treasury, setting new procedures for flows of federal budget funds and accounting
* Wage and pensions arrears at the federal level are negligible in amount and mostly due to technical reasons, such as submission ofinaccurate information to the Treasury and transactions delays in processing funds transfers to recipients’ accounts. Instituted by Order N-806 dated July 15, 1999. loThe analyses relating to capital and investment budgeting are presented in the study prepared by the Poverty Reduction and Economic Management Unit ofthe Europe and Central Asia Region (ECSPE) of the World Bank “Russia: Towards Improving the Efficiency ofPublic Investment Expenditures”, September 18,200 1. Russian Federation CFAA: Public Sector Buduet Manauemenf 9 rules. Under the new Budget Code, all budgetary entities are required to open an account with the Treasury. But the greatest challenge is in the implementation ofthe Budget Code provisions, which will require better definition ofbudget execution procedures.
Revenue Management
29. With the passing of the new Tax Code Part I, which came into effect on January 1, 1999, a legal basis now exist for all taxes, and taxpayers are provided legal assurance of administrative and judicial protection of their rights. This information is opportunely conveyed to the public, and the Tax Code Part I and I1documents are both available on a government website. However, application and enforcement of the legislation is another matter. In spite of the significant progress in improving tax collections in recent years, taxation remains a problem area.
30. In 2001 the Russian government derived only about 15 percent of its annual revenues from income taxes, a far smaller proportion than in most OECD countries. Payment of taxes was made through commercial banks (using payment orders and a specific coding system), with the Central Bank of Russia functioned as clearing-house. Cash and related payment orders were received by the Treasury, which tracked payment and performs the associated accounting and reporting functions. Treasury revenue data covered (i)taxes, (ii)non-tax revenue, and (iii)revenues ofbudgetary funds.
31. A tax-sharing arrangement between the center and the regions is in place. Tax payers pay taxes where they are registered (either as individuals or business entities), through the local level offices of federal Ministry of Finance and Treasury. The RF’s 89 Subjects of the Federation (or Regions) have only limited rights to set tax bases and tax rates, determined mostly by central government. The central government also prescribes the split ofrevenue from the value-added tax (VAT) and the corporate tax. The problem is concrete interpretation of rules and regulations and differences in practices among the regional Tax Inspectorates (for instance, in the registration oftaxpayers for tax purposes). These interpretations sometimes constitute flagrant violations of the legislation. Differences in interpretation also undoubtedly affect the accuracy and completeness of tax base assessment and may represent a window of opportunity for corruption of state officials’ ’.
32. Before year 2000 there was a strong incentive for the regions to collect taxes in non-cash (offset) form, since this would mean fewer cash receipts to share with central government. Since 2001 the federal share has been calculated as a percentage oftotal tax revenue including offsets, and this procedure should provide a strong disincentive for the regions to engage in non-cash settlements resulting in non-payments. As a result of the new provisions, the regions will retain the share of cash to which they are entitled, but only after the value ofnon-cash offsets has been deducted. And according to the Budget Code, the mutual write-down of liabilities that creates offsets is not applicable to transactions involving tax payments.
l1For instance in the form of discretionary arrangements (less frequent off-site checks and inspections from the tax authority) andor mutually beneficial negotiations oftax liabilities - the fmal result being to reduce financial resources available for public use. Russian federation CFAA: Public Sector Budset Management 10
33. Roles, responsibilities and powers in the area of enforcement are divided among the Ministry ofTaxes and Duties (MTD), the Tax Inspectorate, the Federal Treasury, and the Financial Police. The MTD primarily sets bases and rates. The Tax Inspectorate and its organization varies somewhat from the state administrative classification. It receives tax documentary receipts and conducts taxpayer audits covering up to three prior years, aimed at verifying the reasonableness and fairness of tax returns and tax payments. The Federal Treasury’s role is limited to determining whether there are tax arrears during its revenue tracking. The Financial Police mainly conducts investigations on criminal actions before the government’s prosecutor.
Monitoring and Evaluation
34. As ofDecember 2002 in terms ofbudget monitoring and evaluation, historically there was a lack of reporting on budget outputs. The MOF’s Expenditure Efficiency program placed strong emphasis on assessing budget performance, holding spending units accountable for their results, introducing greater focus on budget outputs, and creating mechanisms for competition for budget financing on the basis of programs. The Expenditure Efficiency concept included ambitious and wide-ranging proposals on budget management reform. International experience indicates that the effective implementation of this kind of performance budgeting is achieved through long-term programs of institutional strengthening, initiated by a significant preliminary phase of strategy formulation and design.
35. The objective of the Expenditure Efficiency program is to improve budget efficiency by introducing performance budgeting through a quasi-contractual agreement between central and line agencies regarding performance. Performance budgeting is not purely a budget execution issue but also involves setting objectives, priorities, and targets during the financial planning phases. Therefore, budget formulation and implementation will also need to be improved by developing more effective budget control over execution and upgrading MOF’s information collection capacity. The introduction ofthe necessary balance between control and performance will be crucial to the achievement of performance budgeting. At the same time, spending units must be involved in the design process and accept the performance approach as a better way for managing their resources, rather than an MOF-imposed system. The involvement of other key stakeholders, including the Duma Budget Committee and civil society, should also be considered.
Recommendations
36. The first step is to achieve a stable policy consensus on budget formulation and the improvement of routine budget execution capacity; only then can the focus shift to performance. In budget formulation, core problems include the absence of mechanisms to ensure consistency with macroeconomic constraints throughout the budget preparation process; poorly developed consultative and collaborative processes for defining funds allocations; fragmentation arising from the prevalence of extra-budgetary fimds and use ofoff-budget resources; and lack of clarity in the respective roles ofthe executive and the legislature in budget formulation. It will therefore be crucial to strengthen the strategy phase of budget preparation, linking within a single framework, (I)the overall resource constraint deriving from the macroeconomic scenario; (ii)sectoral policies, objectives and performance targets; (iii)and proposed budget allocations on broad sectoral/program level, over a horizon extending beyond the immediate budget cycle.
37. The CFAA recommends that the present budget classification, based mainly on the Government Financial Statistics (GFS) system, be improved with respect to the separation of functional and economic classifications, the effective use of the latter in budget formulation, and adoption of a uniform, simplified coding structure to be used for all budget items. This would improve the quality of financial information and all aspects of public sector management, especially at the sub-national level'*.
38. The CFAA recommends that budget planning and formulation evolve towards a more participatory, collaborative approach involving the MOF and central ministries and agencies. Second-line, or indirect, spending units, should also be integrated into the decisional approach, which would make results more predictable and avoid the need for extensive modifications during budget execution. Spending units should provide detailed spending plans as inputs to the budget process, rather than preparing them at the implementation stage as is now the practice.
3 9. Entities with extra-budgetary funds should be required to introduce accounting principles and prepare reports that are compatible, and can be consolidated with, Treasury accounts and fiscal reporting. The budget for extra-budgetary funds should follow the same timeframe as the state budget, and the approval process should be coordinated with the approval of the state budget to the fullest extent possible, to ensure that the government's budget execution discipline can be consistently applied.
40. In budget execution, the biggest challenge ahead is the improvement of management tools and techniques, including meaningful reporting for decision-making purposes, and strengthening of the control environment. The CFAA recommends preparation of a program of institutional development for the MOF, including analysis of procedures now in use to plan and control federal budget execution and implementation of measures for enhanced efficiency of the budget process, including changes in the organizational structure and administrativehnternal procedures and active application of modem information te~hnology'~.
41. The CFAA recommends that the chart of accounts (COA) be amended to fully reflect the budget classification and to provide a consistent basis for recording and reporting financial transactions, with flows separated from stocks into different sections. Nominal accounts should be eliminated, additional control features adopted and tracking of all bank accounts strengthened, by incorporating these accounts into the ledger. The final objective would be the integration of the Register (which records the full
l2Through the World Bank Regional Fiscal Technical Assistance (RFTA) project. One of the components ofthe project relates to assistance to sub-national governments for budgeting and accounting, including the development of a Code ofGood Practice for regional financial management. l3Recently the World Bank initiated the State Statistical System Project that aims to improve the quality of the government's financial statistics and compilation of General Government Accounts in the National Accounts system. Russian federation CFAA: Public Sector Budget Manaqement 12 classification of transactions) into the Treasury accounting ledger, so that the integrity and accuracy of fiscal reports are ensured.
42. The CFAA recommends that the current partial system for commitment control be progressively extended to cover all types of expenditures. Ideally, all contracts, regardless of their amount, should be registered with the Treasury, since the relevance and effectiveness ofcommitment control could be circumvented by subdividing contracts to fall below the control threshold^'^. Improved commitment recording would promote improved cash management and related controls, and enhance the coverage and reliability offinancial accounting and reporting functions.
43. Once a stable policy consensus on budget formulation and the improvement of routine budget execution capacity has been achieved, it would be possible to consider measures to improve performance- holding spending units accountable for their results, introducing greater focus on budget outputs, and creating mechanisms for competition for budget financing. Strengthening the link between budgets and performance will be highly dependent on prior action to strengthen the connection between budgets and actual expenditure.
44. In view of strengthening the overall budgetary system, the CFAA recommends that the reforms to be carried out by the MOF and central agencies in the area ofbudget formulation and execution be accompanied by reforms in the areas of evaluation and oversight ofbudget performance outside the executive, specifically legislative scrutiny, external audit and the broader role of civil society. Bringing more actors into the oversight process would involve (i)the establishment of effective independent financial audits by the Chamber of Accounts (discussed in Section V of the CFAA), (ii)the establishment of consultative mechanisms with key stakeholders (inter alia, representatives of industrial, banking and labor associations, the media, NGOs, FIs and the donor community), and (iii)publication of regular budget reports and analysis in an easily understandable format made available to the general public.
45. Extending the budget horizon would involve implementation ofthe Expenditure Efficiency program, which includes further development of basic budget management processes and implementation of the treasury system within the framework ofthe Budget Code. The Bank was asked to provide assistance and advice on issues in budget management, and they are covered in the World Bank document, “Issues in Budget Management Reform.” The document outlines the major steps and actions required: (i) integration of expenditure review functions into the process ofbudget preparation in the next budget cycle; (ii)addressing existing over-commitments in the budget and establishing a baseline for expenditure policy commitments within the budget process; (iii)classification ofbudget institutions in the ongoing review of spending ministries; and (iv) sequencing of budget management reform within the broader plan for the implementation of the Expenditure Efficiency concept.
l4Extending commitment control to all contracts is the long-term vision for the Treasury system; however this is beyond current capabilities and, even conceived as a medium-term achlevement, this would take resources away from the systemic improvements being sought through the expansion of the Treasury system. Furthermore it may require changes in the budgeticivil legislation which may be problematic. Russian federaation CFAA: Treasurv Svstem 13
111. TREASURYSYSTEM
46. In 2001-2002 there was significant progress towards establishing a modern and efficient federal treasury system in RF. Systems are able to provide the minimum information support required for basic treasury functions, and short-term enhancements of this system are underway now. The next phase is introduction of full treasury functions, with an initial step taken with the January 2000 approval of the concept of a Treasury Single Account (TSA) for federal budget revenues and expenditures.
47. The importance of development ofthe Treasury was emphasized in earlier Bank Economic and Sectoral Work (ESW), especially the 1996 report, “Fiscal Management in Russia,” which provided a broad review ofpriorities in public financial management and the key role ofa modem treasury system within the required overall reform program. The International Monetary Fund (IMF) Fiscal Affairs Department completed a review of financial management (Government Financial Management: Key Issues and Options for Improvement, Feb. 1998) that included detailed recommendations on treasury systems, and these recommendations have been drawn on substantially in the Federal Treasury development to date. The IMF also has had a resident Treasury Advisor in place. The Bank’s 1998 fiscal policy note on budget management recommended that priority be given to the development of the Treasury, noting the need for enhancement of information systems and a broad program oftraining and staff development.
48. Implementing a full range of treasury functions, such as commitment recording, General Ledger, and comprehensive reporting, is a long-term process that will receive support under a Treasury Development Project prepared by the MOF and the World Bank. The Treasury Development Project supports key institutional and operational reforms that will bring about the desired improvements in public financial management, primarily structural administrative transparency. The government is very committed to the project, as it realizes the vital importance of a functioning Treasury to meet the needs of public financial administration in the context of a market economy. The government also intends for development of the treasury system to be completed in close consultation with the Chamber of Accounts, the Supreme Audit Institution, in order to ensure compatible development of the Chamber’s own information systems and staff expertise.
Soviet Legacy
49. Under the Soviet system, the central bank (Gosbank), and more generally the whole banking sector, operated as the de facto treasury for the government. The distribution of expenditure authorizations followed a detailed spending plan called the smeta, which typically authorized departments to spend a certain amount within a given time period for specified goods and services. To finance the expenditures, quarterly allocations of funds were placed in a bank account at the disposal of the budgetary spending unit (one of the state banks specialized in carrying out these payments). The payment process was initiated by a payment order from the budgetary unit, which had to identify in detail the purpose and nature of expenditure by the appropriate codes of the budgetary classifications. Whether this passed through the specialized banks or the central bank, the payment order’s conformity with the smeta was checked and the payment was made either in cash or by transfer to another bank account. This link, which Russian Federation CFAA: Treasurv Svstem 14 was instrumental under a centrally planned economy by reason of its peculiar system of allocation and use of economic and financial resources, ceased to exist in 1992, when the cash execution of the budget, for the first time, linked expenditure payments to actual cash collections.
Treasury Operations in 2001-2002
50. Since its creation in 1992 as a department ofthe MOF, the Federal Treasury (FT) has implemented a system to manage the budget execution process. The treasury system is organized according to a vertical structure with the Treasury Headquarters in Moscow; 89 branches at the regional level (oblasts), and about 2,150 offices at the local government level (rayons). The Federal Treasury (FT) provides key intermediate services to public sector agencies, while also carrying out key control functions. In respect to the payment system, flow of funds, and cash management, some ofthe essential elements of a modern treasury system have already been implemented. In particular:
0 Budget appropriations for ministries and other spending units are recorded in the treasury system;
0 Spending limits are sanctioned, by the MOF for ministries, and by the parent ministry for indirect spending units (SUs);
0 Expenditure transactions for a significant portion ofspending units funded from the federal budget are routed through the appropriate branch ofthe Treasury, which then forwards them to a branch ofthe Central Bank ofRussia (CBR) if these transactions take place at the oblast level, or to a local branch of Sberbank, the largest state-owned bank with a dense network oflocal coverage, if transactions occur at a level where there are no branches ofthe CBR;
0 The CBR and Sberbank have opened treasury “personal accounts” at their various branches for the SUs;
0 Prior to forwarding the expenditure transactions for payment to the relevant CBWSberbank branches, the FT ensures that the expenditure is in accordance with the budget appropriations and sanctioned limits for the SUs;
0 Revenue transactions from taxpayers are deposited in the appropriate account at the CBR, which informs the Treasury ofthe receipts. The Treasury advises the State Tax Administration (STA) on the amounts ofrevenue received from various types oftaxpayers (sources).
51. The Treasury is currently using a number of custom-developed application software packages to assist it in performing its functions. In the middle of2002, all oblast and more than 90 percent of rayon Treasury offices have implemented a basic set of computerized information systems. These packages are used to (a) record data on cost estimates received from ministriedother spending units; (b) record and process knd allocation transactions from the MOF to the ministries and from ministries to their subordinated units; and (c) process payment requests received from spending units at the local Treasury offices. The essential control in the system, however, is on the amount of Russian Federation CFAA: Treasurv Svstem 15 finds allocated by the MOF to the spending units for a given economic category: the system checks for the availability offinds and then processes a payment order against the Treasury accounts held at the local branch ofthe CBWSberbank. All Treasury offices use the same codification and classifications and report back to the Federal Treasury level.
52. The system has the capacity to receive payment requests and cost estimates from spending units in electronic form, but this is in general not implemented, since spending units do not have the necessary facilities to produce these documents in electronic formats that can be read by the system. The links between the Treasury units to the cash settlement center within the CBR, used for transmittal of payment instructions to the CBR, are mostly computerized. In such cases the CBR regards the Treasury as just another client bank in its payment system, and the corresponding Treasury office uses a special workstation and software provided by the CBR to allow electronic signature and secure data transmission. In areas where these facilities are not available, transactions are carried to the bank in hardcopy format. On the revenue side, a computerized system is also in use to process receipt transactions from the CBR oblast branches and maintain the necessary data.
53. The CBR operates a clearing system consisting of regional clearing centers in each region and a national clearing center in Moscow. Manual clearing procedures are still used quite extensively, originating delays in payments. The CBR is planning to move towards a modern, real-time, gross settlement system, but there is no specific timetable for this. The Central Bank is also working on improving the capacity of the banking system to handle electronic payments, including recognition of electronic signatures, which are not acceptable under current legislation.
Treasury Single Account and Treasury Development Project
54. In its 1998 review, the IMF recommended the implementation of a centralized treasury system, in which all government funds are placed in a Treasury Single Account (TSA) at the CBR, with sub-accounts maintained at the sub-national branches of the CBR. Spending units’ bank accounts would be closed and all receipts and payments would be processed by the Treasury, which would control the TSA and would ensure that expenditures are in accordance with budget appropriations. The adoption ofthe TSA is an integral part of the overall strategy for the further development of the Treasury, setting new procedures for flows of federal budget funds and accounting rules. On January 23, 2000, the concept of TSA was approved for federal budget revenues and expenditures (Government Directive No. 107), and its full implementation would receive support under the MOF’s Treasury Development Project, receiving World Bank financing.
55. The centralized model was designed to address the main problems of a system under which the MOF would periodically distribute funds to spending units’ bank accounts and these units would directly process payment transactions against their accounts. This arrangement resulted in a situation where, on the one hand, sizable idle balances could build up in spending units’ bank accounts and, on the other, the government could be in deficit in overall terms, causing additional borrowing and/or causing arrears in payments. In addition, the MOF could not exercise any control to ensure that public expenditures incurred by spending units were in accordance with Russian Federation CFAA: Treasuw System 16
budget appropriations and did not receive timely information on receipts and expenditures to allow it to perform its fiscal management functions properly.
56. The Treasury Development Project would support the development of suitable institutional and organizational arrangements for Treasury operations and provide technical assistance, computer equipment, software and training to enable the government to design, develop, test and implement systems, procedures and processes, related regulations and training programs for budget execution, Treasury operations and cash management. From a system architecture stand-point, the project envisages the installation of distributed applications so that processing capacity would be available at all major nodes of the network: i.e. the oblast and rayon Treasury offices. These offices would process receipt and expenditure transactions and pass on information to the next higher level. As the telecommunication infrastructure improves, the treasury system could move to a more centralized approach in which processing capacity is located at fewer nodes that are accessible via dedicated telecommunication lines or via Virtual Private Network (VPN).
57. It was decided to adopt a phased approach, starting by upgrading and increasing the coverage of the basic systems 2001-2002 in use within the Treasury (which encompass only part of the functionalities required for a full treasury system); and then move on to a full-function system based on more advanced technology and procedures, after the agencies and personnel involved in budget execution have become thoroughly familiar with the workings of the interim systems and associated changes in business processes. The main steps would be (a) to improve coverage and capacity with present application software and additional hardware; (b) to conduct an institutional review ofthe Federal Treasury; (c) to design full-function treasury systems and associated procedures; (d) to procure/develop new application software; (e) to implement system at pilot sites; and (f) replicate systems countrywide. Systems could become fully operational by 2004/05 at the earliest.
58. The key remaining issues in the development of the treasury system can, therefore, be divided in two groups: (i)extension of Treasury coverage, and (ii) improvements in Treasury systems, functions and procedures. However, the program entails a significant broadening of the scope of Treasury operations, to which there are considerable capacity constraints, in terms ofthe size and complexity of the investments required, technological and procedural changes, associated accounting and reporting matters, development of technical skills, and high standards of service delivery. These capacity constraints would be addressed under the Treasury project.
Short-term Enhancements
59. Current systems are able to provide the minimum information support required for basic treasury functions. However, establishing the full range oftreasury functions, all addressed under the MOF’s Treasury Development Project, will take some time. In order to provide reasonable support to the Federal Treasury, even in a short-term perspective, current systems need enhancements in functionality, such as improved fiscal reporting and consolidation, enforcement of spending limits, and basic ledger functions, Russian Federation CFAA: Treasurv Svstem 17 accompanied by an improvement ofoperational procedures relating to the systems in use, until a full-function treasury system can be designed, developed and implemented.
60. The main objectives of short-term enhancements in functionality were to bring into the system (i)the Ministry of Defense (MOD), (ii)Customs revenues, (iii)extra- budgetary funds, and (v) off-budget accounts. These developments are discussed below. State-owned enterprises (SOE) activities would remain outside the treasury system.
Inclusion of Ministry of Defense
61. The MOD and the FT have concluded pilot projects for processing MOD payment orders through the treasury system, under special requirements for confidentiality, dedicated LANs, secure telecommunication channels, and special banking arrangements. The MOD has been transferred to the system in two phases. The first involved the setup ofan account in the central FT for release ofbudget appropriations to lower level units. It also included extending the treasury system to centralized procurement and other centrally made expenditures ofthe MOD (first level operations) from an account opened in the FT department of Moscow City, and a gradual extension oftreasury coverage to all payments at the next tier ofunits (second level operations). The second phase, involving extending treasury operations to a substantial number of units operating at third and lower levels nationwide (this could involve an additional 5,000 SUs with about 15,000 accounts) was completed in 2001. Starting with the 2002 budget cycle, all MOD spending units are under the Treasury, which has taken over MOD budget execution. Information system support would need to be enhanced to ensure security of information transfer between SUs and the FT, and between the FT and CBR branches. The additional transaction load may require upgrading the hardware installed at the Treasury offices responsible for processing these transactions.
Inclusion of Customs Revenues
62. On the revenue side of the budget, the accounts of the Customs Committee (including those in which advance duty deposits are made by traders) have been moved, since end-2000, under the Treasury. Accredited commercial banks are involved only to the extent they provide payment guarantees or letters ofcredit to foreign trade companies for customs duty payment. The payroll taxes are now collected by the tax service, although there are some coordination problems in the implementation of this reform between the tax authorities and the social insurance policy agencies.
Inclusion of Extra-budgetary Funds
63. The Russian government has taken steps to bring the majority of extra-budgetary fimds into the budget and to halt the earmarking of revenues to others15. The budget coverage ofextra-budgetary funds has been progressively expanded and most EBFs have been eliminated or incorporated into the budget, such as Employment Fund and state Road Fund (although at the regional level it would still remain an extra-budgetary fund).
l5The 2001 budget envisaged the elimination of earmarking for the Ecological Fund, Fund for the Federal Tax Police, State Anti-Crime fund, Prospecting Fund, Fund for Support of Military Reform, Biological Resources Fund, Aqueous Resources Fund, and the Fund for MOF Audit Divisions. Russian Federation CFAA: Treasurv Svstem 18
Their funding is now shown as regular line items under the relevant budget classification, Only three EBFs exist at present - the Pension Fund, the Social Insurance Fund and the Medical Insurance Fund - and, given their specialized nature and role, there is no plan to integrate the three remaining state EBFs in the budget and put them under the Treasury control. However, as part ofthe Chart of Accounts reform, state EBFs will use the same budget classifications as the budgetary organizations, thus enabling to achieve a proper consolidation of general government accounts in financial reporting - which is likely to be achieved around 2005.
Closing of Off-budget Accounts
64. Many budget organizations supplement their financial resources through commercial and other revenue-generating practices, which originate off-budget revenues. Whereas formal extra-budgetary hnds are set up under specific legislation, off-budget revenues are set up under broad Civil Code provisions. Budget organizations are required to report commercial incomes on a quarterly basis, and all off-budget accounts of federal budgetary organizations have been progressively moved under the Treasury where, however, they remain separated from budget accounts. Reportedly, there are some off- budget accounts still remaining outside the Treasury system, but this represents a violation ofthe law and sooner or later they will be closed.
65. The closing of off-budget accounts has several legal and institutional implications. Some agencies have statutory rights to conduct off-budget activities, and the MOF is preparing a proposal for amendments in the relevant legislation. Since the Treasury experienced problems, for the accounts which are not yet under its purview, in obtaining reports of off-budget accounts from banks (because they feel they could be breaching bank confidentiality regulations), amendments to the banking law were prepared to facilitate such reporting at the end of 2001. One possible solution that was explored involved organizing off-budget activities as a separate business entity or some type of commercial operation. Developments in this area are also relevant for the off- budget activities of sub-national governments16. Treasury information systems is being upgraded to accommodate the additional transactions resulting from the inclusion of off- budget accounts.
Recommendations
66. The development and implementation of a full-function Treasury system will take several years and is not expected to become fully operational before 2004/05. Pending the achievement of the broader scope of initiatives and reforms, both institutional and technical, entailed by the World Bank-assisted Treasury project, the CFAA recommends that government take immediate steps to implement an improved system of expenditure monitoring comprising the following elements: (i)control over commitments; (ii) replacement of cash rationing with more orderly and effective cash-management systems;
l6Resolution no. 1001 recommended that member regions ofthe Russian Federation apply similar measures to the ones required for federal agencies, and the 2001 budget law contains the corresponding recommendations. The city government ofSt. Petersburg has already integrated its off-budget accounts into its regular treasury procedures. Russian Federation CFAA: Treasurv Svstem 19 and (iii)introduction of a sound accounting system for govemment operations. At the same time, the Treasury should expand its coverage and comprehensiveness.
67. The CFAA recommends that Treasury control of expenditure commitments be extended to all items of the economic expenditure classification and should entail monitoring items and contracts above the established thresholds. Current weekly cash funding limits should be replaced by funding of the established monthly limits of expenditure commitments, based on projected money resources. The combined impact of these measures would be to substantially improve cash management and reduce the incidence of ad hoc discretionary budgetary adjustments conducted in a non-transparent manner during budget execution.
68. An important achievement will be the improvement ofthe control framework that enables the treasury system to properly manage public money and property. Required controls include (i)financial controls over revenue management (e.g. collection and custody, including the banking arrangements), and (ii)expenditure execution procedures in the form of (a) budgetary ex-ante controls (e.g. warrant control and linkages of claims with budget appropriations for both capital and recurrent expenditures), and (b) ex-post control processes (e.g. verification of goodshervices receipts). Some of these checks and balances will eventually be embedded in the treasury system (e.g. reliance on electronic transfers rather than movements of cash and registration of contracts and indication of payment title/stage). However, some of the required new management controls- especially those relating to the independent verification of adequacy of procedures, reliability of information technology, soundness and propriety of overall administrative arrangements, and safeguards of financial and physical assets within spending units-will require the development of modem, risk-based intemal audit hnctions within the MOF and other central govemment agencies, especially the Ministry of Taxes and Revenues and Customs Commission (see section V ofthe CFAA). Russian Federation CFAA: Public Sector Accounting and Financial Repoi?inq 20
IV. PUBLIC SECTOR ACCOUNTING AND FINANCIAL REPORTING
69. The provision ofaccurate fiscal reporting on current and previous years’ actuals is regarded as a necessary tool to provide MOF management with the type of information required for decision making and management control and for budget formulation in subsequent years. The MOF’s Treasury Development Project would include development and deployment of a Financial Management Information System (FMIS) that would provide such information. The progressive setup of the treasury system is already allowing for greater timeliness and effectiveness of accounting and reporting, and for full ownership of the MOF over these fundamental management tools. The MOF is proceeding with improvements within the existing system, including preparation of the first federal budget execution balance sheet in 2000, and plans to prepare quarterly and annual financial statements on federal budget execution.
70. At the same time, the provision of more timely and reliable data on budget outcomes, and the availability of financial data for public scrutiny-including their attestation following appropriate external audit procedures-would increase transparency and accountability, laying a strong foundation for realistic public financial management and stronger incentives for responsiveness to public interests. At present, the only mandatory document presented by the executive to the parliament is the annual report on budget execution. The final account is presented to the legislature within 12 months of the year’s end and is audited by the Chamber of Accounts. Once it is fully implemented, the Budget Code will provide a stronger basis for comprehensive release of information on public financial operations to the public, as it requires that the consolidated budget be presented to the Duma with the federal budget law for the forthcoming year.
The Soviet Legacy
71. Under the Soviet Union, the banking system was very instrumental for maintaining public sector accounts. The system, through its regional network, was in fact relied upon not only for funds disbursement but also for government accounting, with accounting and record-keeping systems parallel to those maintained by the government ministries. An advantage of the old system was that the banks had a vested interest in carefully checking the claims for spending and rapidly reporting to the center (Gosbank), so that they could be compensated for the free financing they were extending to the government. Under this system, the central bank compiled monthly reports on budgetary operations classified by chapters and featuring the most detailed breakdown.
72. Some practices used in 2001-2002 represent holdovers from the old system, and government accounting still relies heavily on reporting from the banking system. The Budget Department Accounting Unit summarizes approved expenditure authorization reports that are presented to the MOF by the spending units and keeps reconciled financial records with the banking system. Reporting from the banking system is carried out in cash terms, and reflects the distribution of budgetary funds rather than actual spending. Detailed accounting of actual expenditures is made available to the MOF from ministries’ reports on a monthly and quarterly basis. However, there is a time lag of several weeks. Russian Federation CFAA: Public Sector Accounfinu and Financial Reportinu 21
Accounting System
73. Accounting is based on the budget classifications and thus is oriented mostly to the recording of data and not to providing information for fiscal management, the emphasis being mainly on cash flows. Accounting methodology for budgetary organizations at the federal and sub-national level is issued by the MOF’s Accounting Methodology department, but there is a lack of consistency in the basis of accounting. While accounting for the government as a whole was recorded and reported in 2001-2002 on a cash basis, some institutional budget records were maintained in an accrual-related form that was, however, not integrated with the Federal Treasury accounts. The annual report on budget execution submitted by the executive to the parliament did not include a statement ofaccounting policies.
74. The MOF has received a proposal of assistance from the UK Department for International Development (DFID) to translate into Russian, accounting standards issued by the Public Sector Committee (PSC) of the Intemational Federation of Accountants (IFAC). The adoption of IFAC-PSC Exposure Draft 9, “Financial Reporting Under the Cash Basis ofAccounting,’’ should be considered directly applicable to current practice.
Reporting
75. The Ministry of Finance (MOF) is responsible for reporting central government operations and central government debt. Data are published on the MOF website. The MOF publishes aggregate budget information on the federal budget, showing monthly and year-to-date revenues, expenditure, and financing data in comparison with the same period in the preceding year. The MOF also publishes data on domestic and external debt. Data on guaranteed debt are not published nor are fiscal contingent liabilities or quasi- fiscal activities disclosed. The Budget Code does, however, require that the annual budget law place an upper limit on the provision of public guarantees and that such guarantees be included as a type of debt obligation in the sovereign internal debt of the Russian Federation.
76. Fiscal data were compiled in accordance with the annual law on the Federal Budget, which makes no provision for the compilation of govemment finance statistics (GFS) or dissemination of the data to the public. However, starting in 1998, for the preparation of the 1999 annual budget17, the budget classifications were changed to incorporate the GFS classification system. As a result, general government operations and central government debt did not fully comply with the GFS Manual concepts, although government finance statistics largely complied with international best practice, even if the methodology was available for public scrutiny.
77. Fiscal data were compiled on a cash basis and, owing to the delay in obtaining measures ofrevenue and expenditure arrears (for civilian but not military sectors), these data did not provide complete coverage of government operations. l8Coverage problems
l7In the 1998 budget execution report a breakdown of expenditures by economic classification is missing. ’*The methodology for the compilation offiscal data is based on the classification system (Chart of Accounts, COA) defined in the federal laws” The Russian Federation Budget Classification” no. 115 of Russian Federation CFAA: Public Sector Accounting and Financial Reoorfina 22 with regard to data on arrears and local government activities precluded accurate estimation of cash revenues collected at the general government level. A complete economic classification of government finance statistics was not published and the consistency in compilation procedures is not known.
78. With regard to local governments, full information on extra-budgetary funds, off- budget revenues, and offsets was not available in 2001-2002. This lack of data precludes accurate estimation of cash revenues collected at the general government level. The World Bank is proposing a Fiscal Federalism and Regional Fiscal Reform Loan (a sectoral adjustment loan, SAL) aimed at assisting the government in strengthening the overall framework of fiscal federalism and in improving fiscal management at the regional level, introducing greater transparency and accountability mechanisms. The loan would support government’s efforts to introduce at the regional level, and have consistently applied, standards for budget management, financial control, information disclosure, and audits.
Budget Code
79. In terms of reporting, the fiscal management system is govemed by the Budget Code, which requires recording of all stages of the payment proces~.’~The Budget Code provides a strong basis for comprehensive release of information to the public (public reporting of public financial operations is a legal requirement), but it is not fully implemented. The Code requires that the consolidated budget of the Russian Federation (including federal and sub-national governments, but excluding extra-budgetary funds) be presented to the State Duma with the federal budget law for the forthcoming year. Budgeting and reporting for the four extra-budgetary funds is carried out independently, with quarterly reports and annual budgets available to the public.
80. In 2001-2002 incomplete coverage was the key weakness of budget reporting. The bulk of off-budget revenues, which involved substantial expenditures, were not included (although this is a larger problem at the regional than the federal level) and coverage of Ministry of Defense and Ministry of Interior expenditures was incomplete. Little information was available on presidential activities financed outside the budget, which are also not subject to adequate financial control mechanisms. State secrecy laws also introduced some elements of non-transparency and uncertainty into the fiscal account (for instance, changes in stock ofnon-monetary gold and other precious metals).
Treasury Reporting
8 1. The Federal Treasury coverage of expenditures has expanded, enabling improved compilation of government finance statistics.20 The Treasury is delivering its analytical
~~ August 15,1996 and on “The Russian Federation 1999 Budget” no. 36 ofFebruary 22, 1999, and Mer revisions. l9In principle, it is also in conformity with the eventual adoption ofaccrual-based accounting and reporting although practical implementation ofthese principles is not currently feasible. *’See section I1above on Budget. For example, starting with the 2001 budget, the Road Fund is included in the Treasury system and the Treasury COA incorporates the three main social extra-budgetary funds (Social Insurance Fund, Medical Insurance Fund, Pension Fund). However, since instructions have not been prepared by the FT, the system is not actually in use. Russian Federation CFAA: Public Secfor Accounfinu and Financial Rewltinu 23 statements and summary reports on budget execution in a more timely manner, and a considerable improvement in the quality of data is also observable. As a result, monthly data on revenues, expenditures and financing of the federal and local governments are provided on a regular basis. For the first time, in 2000, the MOF prepared a quarterly report by agency and economic structure based on reports from the Federal Treasury.
82. Improved and more widespread use of Treasury information would require users of its reports to be involved in the definition of the type of financial information they need, However, the mindset offers considerable resistance to this kind of thinking. Spending units maintain their own financial records and prepare their own financial statements, in accordance with the prescribed classifications and formats issued by the MOF. But the type of information produced by the spending units (based on administrative and functional classifications) is hdamentally different from that required by line ministries and MOF (based on economic classifications, i.e. composition ofexpenditure).
Sub-national Governments
83. In 2000-2001 at the sub-national government level, all 89 regional and the almost 2,300 local Treasury offices followed the same COA, capturing all transactions at the receipt and payment stage by full budget classification. However, this detailed transactional information was recorded in a separate accounting register, and it was aggregated before being posted in the accounting ledger that uses the present COA. Detailed transaction data, including economic classification data, was not available to the regional and central offices ofthe Treasury through the general ledger.
84. Reports are submitted to the Federal Treasury on a monthly basis for consolidation. The monthly fiscal reports now produced are by functions. Reports by composition of expenditure (economic categories) and institutions, which are needed for receipts and expenditure monitoring, are done only at the end of each quarter, after reconciliation with similar reports submitted by the line ministries. The fiscal reports produced with the same periodicity by the spending units are reconciled by the Federal Treasury with its own records. However, this is mostly compilation work, since the ability, and the authority, to analyze the data in a more meaningful fashion are lacking.
85. The preparation ofmonthly budget execution reports by full budget classification is hampered by the limitations ofthe existing application software. At the same time, the need for reconciliation against financing limits is the main reason for the present delay in generating reports by full economic classification. Another complication derives from the fact that sub-national Treasury offices have not yet implemented a database of all spending units. Thus, the extent ofthe coverage ofthe sub-national government revenues and expenditures remains uncertain.
Recent Developments
86. The preparation of interim and annual financial statements, as published by the governments of many OECD countries, is a new accomplishment in the Russian Federation. Government Resolution No. 695 of September 15, 2000, contains provisions on submission, by the MOF to the government, of quarterly and annual statements on Russian federafion CFAA: Public Sector Accounfina and financial Reportins 24 federal budget execution. The following financial statements and documents are to be submitted on a quarterly basis: (i)Report on federal budget execution; (ii)Federal budget execution balance sheet; and (iii)Explanatory notes.
87. For the first time in 2000, a federal budget execution balance sheet for the Russian Federation has been prepared.21 The balance sheet contains data for the reporting period and the previous year based on the balances of accounts following the Single Chart ofAccounts for budget execution22. Also for the first time in 2000, interim reports showing the budget flows and net financial position have been prepared by the MOF and circulated within the government, to supplement the annual report on budget execution.
Recommendations
88. The CFAA recommends that a Treasury General Ledger (TGL), be used to compile summary reports ofrecords for control and analysis and produce fiscal reporting. This will be a major step forward in the establishment of complete, meaningful and timely fiscal reporting. Among the problems that the TGL would solve is that of ineffective and non-timely reconciliation ofaccounts with budget appropriations and with bank accounts (the accounts classifications used by the Central Bank ofRussia not being wholly compatible with those used by the Treasury). The lack of consistency in the basis ofaccounting (cash basis vs. accrual basis) also needs to be addressed.
89. As an intermediate step in developing the fiscal reporting system of Treasury prior to the establishment of the TGL, the CFAA recommends that existing budget classifications and coding structures be reviewed and a revised structure and COA be developed that conforms with the IMF GFS classification methodology (both functional and economic) and that is suitable for both project preparation and execution. The two coding systems (budget classifications and Chart of Accounts) should be integrated, and all spending units should be brought under a single classification system and a single COA.
90. Coordination of operations between the Federal Treasury and the CBR call for the opening of Treasury accounts to register spending units’ off-budget funds. Pending the full merger of off-budget funds into government accounts, the CFAA recommends clear tracking ofoff-budget funds, so that the information (already collected by the MOF) is compiled and consolidated in order to allow more meaningful and complete reporting and better control.
” The preparation offederal budget execution final account is regulated by the provisions ofthe MOF Order no. 15102.17.2000 (Instructions On Accounting of Budget Execution) and MOF Order no. 296/10.30.2000 (On Inventory ofAccounting Objects in the Russian Federation). 22 For capital expenditure, the State Ministry ofProperty establishes the accounting rules for the whole country. Russian Federation CFAA: Internal Controls and lnfernal Auditinu 25
v. INTERNAL CONTROLS AND INTERNAL, AUDITING
91. Under the Soviet Union, budgetary controls were many and varied, including (i) checks and balances within each ministry, (ii)verifications exercised by the Central Bank and the rest of the state banking apparatus, which was in charge of disbursement and transfer of funds23,(iii) inspections exercised by the Directorate ofFinancial Control and Audit within the Ministry of Finance, and (iv) ultimately, ad hoc controls by the Party, The Ministry of Interior also had an autonomous Inspection Board. Control activities monitored conformance with decisions made at higher levels on the allocation of financial resources and the direction of physical operations under the economic plan.
92. As a result, state audit functions inherited from the Soviet era consisted, during the initial phases of transition, of many different (and often uncoordinated) inspections and budget control functions. These quasi-audit functions, mainly concentrated within the Ministry of Finance, covered central and local government^^^, government agencies and state-owned enterprises. During the transitional period, the institutions that had been responsible for control and investigation practices in the USSR were weakened, since the old procedures did not relate to the new political and governance arrangements or to new procedures and practices for public financial management in a market economy. As programs and practices became obsolete, the disappearance of the old, strict control and sanction regime created a sense of breakdown in professional discipline among civil servants. The result was less control over the destination and purpose of disbursements and over the activities ofspending units. What was needed in 2001-2002 was a transition to a new professional orientation focusing on service provision and diagnostics rather than investigations and sanctions. This would, in turn, help to develop a civil service and organizational culture of closely following rules and procedures, embedded in the government culture, especially spending units.
Government Ministries
93. The Budget Code of the Russian Federation (passed by the Duma in July 1998 and promulgated in July 1999 to take effect from January 2000) is vague with respect to internal controls and internal audit functions. The exercise of internal and financial controls within the MOF is carried out by two bodies:
0 the Federal Treasury’s Control and Inspections Division (CID), which performs ex-ante, transactional controls over expenditure authorizations and, to some extent, cash management, along with current controls over bookkeeping functions; and
0 the MOF’s Financial Control Department (KRU), which perfoms ex-post verifications and inspections over the execution ofthe budget.
94. These checks and balances, although complementing each other, still do not ensure a sufficiently controlled environment for public financial management. The CID
23 Until 1992, Central Bank controls consisted in an exact matching ofdisbursements with appropriations in the budget, item by item. 24 Regional Ministry of Finance staff reported both to the regional authorities and to the Federal MOF. Russian Federation CFAA: lnfernal Controls and lnfernal Audifinq 26
operates in coordination with the institutions in charge of ex-post financial controls (JCRU) and external audit functions (Accounts Chamber). The CID oversees the regional and local treasury offices and carries out special tasks. For example, in case of multi- regional, large-scale inspections, MOF intemal by-laws prescribe that joint CIDKRU teams be associated with other sectoral departments’ control bodies. The results ofthese inspections are communicated to the MOF and, depending upon the importance of the findings, to the government.
95. There are admittedly legal and practical difficulties in integrating the work ofthe CID, the KRU and the Accounts Chamber that often result in duplication and/or lack of coverage. These overlapping functions should be rationalized and reallocated among the existing bodies. On the one hand, within the line ministries and state agencies, intemal and financial controls are needed primarily to check the legality of disbursements and correctness of accounting transactions. All ministries and state agencies with a network of subordinate units (Le., indirect spending units) are required to have internal control bodies and each chief of administration is obliged by law to exercise internal control, but compliance with these provisions is problematic and their effectiveness dubious. Even when these bodies are in place, their recommendations often are not concretely implemented, undermining consistent enforcement ofpolicies and procedures.
96. Since it is common knowledge that internal controls are defective in many institutions, it would be a major accomplishment to fully develop modem intemal audit hnctions that, at present, exist only at the inception stage. Only recently did KRU (guided by capacity building initiatives financed by the Swedish government) begin to implement basic intemal audit functions, trying to move away from the review of individual transactions to an approach based on analyzing the quality of the organization’s management controls and procedures. Internal audit finctions should, in fact, be aimed at detecting systematic weaknesses and assessing the adequacy of the control framework of ministries and state agencies.
Federal Treasury
97. The establishment of the Federal Treasury contributed to the development of a more disciplined public financial management system in the Russian Federation, supported by the activities carried out by the Federal Treasury’s Control and Inspections Department (CID), which covers central and sub-national governments’ treasury offices. Its activities are mainly geared to assess compliance with the budget law provisions, and detect cases ofinappropriate use offunds (for instance, funds allocated to salaries that are used for another purpose), including recourse to on-site inspections. In this sense, the CID is an integral part of the treasury system, ensuring the integrity and consistency of operations transiting through the treasury.
98. Amendments to the Budget Code were prepared in 2001 to legitimatize the Federal Treasury’s control fimctions., From 1999 to 2002 in fact, greater consensus was achieved on the need for the development of a law-based environment for public sector management. However, much remains to be done before the Federal Treasury is in a position to assume an enforcement role, including imposition of sanctions based on law. In the interim-pending the required amendments of the Budget Code-the MOF has Russian Federation CFAA: lnfemal Controls and lnfernal Auditing 27 enacted intemal orders regulating relations between the Federal Treasury and the KRU and detailing the different control functions and associated responsibilities relating to the budget execution process.
99. Two types of control procedures are in place within the Treasury, ex-ante controls and current controls. Ex-ante controls are compliance-type verifications aimed at checking that expenditure requests conform to previously approved budget appropriations and that budget execution conforms to the general financial rules. Specifically, the control is geared towards assessing whether budget recipients are spending according to the prescribed budget classifications. Each account is subject to specific control procedures to check that spending does not exceed budget commitment limits approved by a higher authority for each financial year. During the year, the spending units’ administrators approve expenditures, assigning each a budget code, and the Treasury compares these claims with the right to use funds for that particular type of expenditure based on the current year’s budget law appropriations. When expenditures are incurred (for instance, a contract is entered into), the Treasury monitors the consistency between these undertakings and the specified budget limits, assuring that obligations do not exceed approved commitments. The Treasury is also responsible for checking collections of all central and local level revenues, including customs payments.
100. Current controls consist of procedural controls exercised by checking payments documents submitted by the spending units. At this stage, the Treasury checks that documents are correctly filled in (according to the prescribed formalities); that they contain references to the underlying contract (for instance, the payment is an advance or a final one); and that the cash payment is within the approved limits.
101. However, the Treasury is limited in the scope, number and effectiveness of its control activities by insufficient human, office space and information system infrastructure, and this is a major problem. While software developed in-house is used to compile all data for the central, regional and local Treasury offices in order to report to the MOF on the control work done, the actual control activity is reportedly done semi- manually, following excessively labor-intensive procedures and involving extensive paperwork. At the same time, the workload is increasing. For example, the Ministry of Defense and spending units’ off-budget activities, both of which previously operated outside the Treasury, are gradually being brought inside the system.
MOF’s Control and Revision Department
102. The Control and Revision Department (KRU) is an administrative unit within the MOF in charge ofex-post controls and quasi-audit hnction~~~.As its name suggests, the KRU performs financial control and inspection functions. Its scope is the control of federal budget resources, mostly funding-related, and its activities consist of various controls over budgetary entities’ financial activities conducted on a routine basis which, in some cases, extend beyond the line ministries to the public sector’s productive and commercial activities (state-owned enterprises). Federal institutions are under the jurisdiction of the federal KRU in Moscow; at the sub-national level, there is a network
25 KRU’s other important function is licensing auditors (both individuals and firms). Russian Federation CFAA: lnfernal Controls and lnternal Audifins 28 ofregional organizations corresponding to the sub-national Finance departments. In fact, each Subject of the RF has a local KRU office charged with oversight of regional and municipal budgets.
103. Although its establishment was approved by a Government resolution dated August 6, 1998, the traditions of the KRU date back almost 80 years. The KRU can, in fact, be seen as a reorganization ofthe former Directorate ofFinancial Control and Audit of the MOF, since its initial resource endowment consisted of office space, equipment and staff brought in from the legacy institution. In terms of its institutional setup, the KRU has overcome the main problem ofits predecessor institution, which was the lack of independence from the accounting and reporting functions ofits parent ministry, in which it participated as a substantial contributor. However, in operational terms, ad hoc inspections based on requests from various enforcement bodies (for instance, the financial police), still absorb the bulk of KRU resources, undermining the hll development ofproper internal audit functions.
104. The ex-post controls carried out by the KRU are explicitly aimed at increasing the efficiency of budget expenditure. To that extent, the KRU must follow up on violations identified in the work carried out by the Treasury. KRU’s reporting responsibilities are limited to the preparation of a documentary audit once every two years. The control methodology followed encompasses three stages (as described in executive orders):
0 preparation ofthe audit, in which the Treasury provides the KRU with documentation relating to the flow offunds and other selected data;
0 the audit process per se, comprising the analysis ofdocuments and spending units’ financial reports, independently carried out by KRU staff; and
0 follow-up actions on the audit findings, currently still a prerogative ofthe Treasury.
105. Currently, KRU employs almost 7,000 staff over the entire territory of the Russian Federation. Entry requirements for controllers are: (i)higher education in economics (or equivalent education); and (ii)relevant professional experience. Thus, young graduates are rarely hired and, when they are, they are provided with on-the-job induction and internal training programs, mostly with the Academy of Budget and Treasury, a continuing professional education institution that provides training each year to eight to ten groups of 25 people each. These hiring practices provide little scope for the institution to benefit from external expertise and to renew and enrich its capabilities with exposure to innovative methods and different backgrounds. The criteria for the selection and training of new staff have reportedly been changed recently to relate more to skills and less to experience. With the decentralization of administrative functions, regional offices now have their own education facilities outside the MOF system.
106. KRU activities are based on an annual work plan approved by MOF senior management. Ideally, the plan should be approved prior to the commencement of the financial year. But the required coordination with other institutions involves time- consuming consultations and negotiations that inevitably lead to delays. As a result, the consolidated plan is not normally approved until early March of the current year. KRU Russian Federafion CFAA: lnfernal Controls and lnfernal Audifina 29
activities are regulated by a charter: based on their terms of reference, controllers must review no less than 50 percent of budget allocations for the previous year. Their reviews consist of meticulous inspections tracing transactions back to primary (source) documents. Since records are all paper-based, the substantive testing process involves an enormous amount of voucher checking. Numerous ad-hoc reviews are also conducted upon request ofstate enforcement bodies, such as the financial police.
107. Internal control functions at the sub-national level are conducted by regional and local KRUs, which prepare their inspections plans independently ofthe federal KRU. The regional and local KRUs are branches of the local Finance departments, which are autonomous legal entities, separate from the federal MOF. The activities ofthe regional and local KRUs are regulated by the Budget Code and departmental orders. When violations and/or fraudulent use of funds are identified, the relevant information is submitted to the Treasury and the money returned to the budget. At the same time, sanctions are directly applied: a common sanction is the right to close the spending unit’s account, which has proved effective in stopping unapproved or non-controlled disposition of funds. However, since the treasury system does not cover all transactions, in many cases it is the federal MOF’s Budget Department that reduces the funds allocated to the sub-national govemments. In case of criminal violations, information is submitted to the prosecutor.
Developing Internal Audit Function
108. As of December 2002 the Ministry of Finance does not have in place a proper internal audit department. Internal audit should be an objective and independent process of monitoring and providing technical advice to the administrative units, with the aim of adding value by reviewing the design and operation of internal control systems, procedures and requirements, improving, in this way, the functioning ofthe organization concerned26.MOF procedures were limited in 2001 and in the beginning 2002 to internal control procedures used to ensure oversight by the executive branch over the integrity of fiscal operations. Ex-ante and current controls were part of Treasury’s general accounting functions. The Treasury gave an approval stamp authorizing an expenditure, and performed selective controls over revenues. Ex-post functions carried out by the Control and Revision Department (KRU) represented financial control functions, mainly geared at assessing expenditures’ legality and propriety.
109. Adding internal auditing functions to the MOF’s traditional internal and financial control procedures (alongside the authorizing officer and the financial controller) would make the entire control system more effective, since the focus would be to evaluate whether or not present control functions are carried out in accordance with sound financial management criteria. The internal auditor would then, in fact, be completely independent from the organizational unit being audited. A full range of internal audit functions would, inter alia, include verification that: govemment resources and assets are
26 In June 1999 the Board of Directors of the Institute of Internal Auditors approved the following , definition ofinternal auditing: “Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization’s operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control and governance processes.” Russian Federation CFAA: lnfernai Controls and lnfernai Auditin0 30 safeguarded; duties are appropriately segregated; govemment agencies’ activities are carried out on the basis ofwritten instructions and job descriptions; and disaster recovery and physical securities measures are in place.
110. The further development of Treasury functions, both in terms of coverage and increased operational effectiveness, will serve to institutionalize these control functions and make them more automatic and systematic (i.e. embedded in the system). In particular, the establishment ofthe Treasury Single Account (TSA) will entail significant investment in information technology and training, funded in part by the forthcoming Treasury Development Project.
Recommendations
111. The CFAA recommends the modemization of govemment’s internal and financial controls as well as the introduction of sound intemal audit fictions, in order to strengthen executive oversight of budgetary organizations, enhance the accountability and transparency of public financial management processes, and minimize inherent risk factors, including weak controls over possible waste and misuse of resources. The two main steps required are to put in place:
0 a new institutional framework, accompanied by reform ofthe relevant institutions along the lines discussed above; and
0 a capacity development program, involving human resources (staff training and development), methodology and information systems upgrade.
1 12. Regarding institutional restructuring and reform, organic regulation of public sector internal controls and internal audit functions was under preparation in 2001-2002 that will, hopefully, assists to a more appropriate setup. The World Bank is available to review and comment on the proposed reform, advising the government on the most appropriate organizational and functional design for the new internal audit functions. Regarding capacity development, various resources could be made available (from the World Bank and bilateral donors) under a comprehensive civil service reform program.
113. The institutional choice at the federal level is between a centralized or a decentralized intemal audit model. A centralized model would involve the creation of a specialized intemal audit function within the MOF (serving line ministries and other state agencies) in order to separate ex-post financial control functions (to be retained within the KRU) and internal audit functions, which are more of a preventive nature and risk- based. This reform could be achieved through a spin-off of some KRU staff and resources to create new intemal audit units exclusively devoted to the new tasks. The risk associated with a centralized model is that it could revive, in a different form, the old state controls that existed in the Soviet Union. Prior to the establishment of the KRU, federal inspectors from the Directorate of Financial Control and Audit of the MOF, with branches in all the line ministries and local governments, used in fact to perform controls in all areas, vertically and horizontally.
114. Should a centralized system be adopted, the internal audit department within the MOF would report directly to the Minister ofFinance (and, possibly, the Prime Minister) Russian Federation CFAA: lntemal Controls and Infernal Auditina 31 and would be responsible for verifying compliance with rules and procedures of all the federal ministries and agencies. In the Russian Federation, the MOF would be hierarchically in a position to audit other ministries. It must be noted that the KRU already exercises these functions since, in the absence of internal audit units within line ministries, KRU controllers check the propriety ofinternal controls within these spending units.
115. A decentralized model would imply the delegation of internal audit functions to specialized structures across the various budgetary institutions, involving the creation of small internal audit units within the line ministries and other first-level budgetary institutions. At the federal level, it is recommended that a small internal audit unit be established within each line ministry, with a “dotted-line” (Le. functional link) to the federal-level internal audit department within the MOF. Such internal audit units would be organizationally and administratively part of the individual ministry/agency (i.e. answerable to the Minister, or the head of administration), but functionally would also report to the federal-level internal audit department. Such decentralized internal audit functions should, in fact, be always subject to independent monitoring and quality assurance functions carried out by a central body, to ensure uniformity of approach and consistency ofresults. The internal audit department within the MOF would thus assume a central role, being invested with coordination, quality control and monitoring functions. This model describes the arrangements required for decentralization to work without problems within the federal-level institutions. However, given the increased autonomy of sub-national governments, it would not be automatic for a body of the central executive branch to be involved in the internal audit functions of an autonomous local government. Therefore, the regional and local KRUs should undergo a similar evolution to that described for the federal level.
116. Should a decentralized model be considered for the federal government, internal audit units would be established in all government institutions: ministries (including the MOF for review of its own operations and general oversight), and state agencies. The units would directly report to the head of the entity and be responsible to perform compliance and operational audits over the activity ofthe entity. At the same time, these units would be subject to quality controls initiatives led by the MOF internal audit department. The risk associated with the decentralized model is that the internal audit units could not be ensured to have sufficient autonomy or access to adequate financial and human resources.
117. Regardless ofthe model adopted, the CFAA recommends a change ofmentality and approach toward internal audit, at all levels of government. The MOF should move away from the old inquisitorial control and on-site inspection-based model to a new audit model based on service orientation. Internal auditors would broaden their focus beyond individual transactions to concentrate rather on the efficiency, economy, and effectiveness of operations, and the reliability of the administrative systems and overall control environment within which transactions take place. Internal auditors would continue to carry out compliance tests of procedures as well as substantive tests of Russian Federafion CFAA: lnternal Controls and lnfernai Auditing 32 transactions and submit recommendations for remedial actions, but within a more systematic and structured framework (for instance, adopting the COSO
118. This change in mentality would go hand-in-hand with the shift from a control- based approach to a systemic, risk-based model of management controls . The internal audit function would, in fact, primarily represent an important management tool, to independently oversee financial management practices within an agency, minimizing risks and improving performance. The introduction of a modem model of internal audit would greatly contribute to the government’s efforts to improve budget management and, more broadly, public financial management systems.
119. Whether centralized or decentralized, internal audit functions should be independent from other organizational and functional departments and internal audit staff should report directly to the head of the organization. The internal audit body’s prerogatives, functions and reporting lines should be regulated by an audit charter and its activities laid down in an annual work plan. Audit tasks should be carried out by multi- disciplinary teams with skills in handling accounting and financial data, information technology, and the legal and procedural aspects of government’s operations. The internal audit units would have appropriate links with the Accounts Chamber, allowing external auditors to rely on the spending units’ own control framework, and the work of internal auditors regarding the adequacy and correct functioning ofinternal controls.
’’ The committee ofsponsoring organizations (COSO) issued its publication which discusses the important role the internal control environment plays in corporate governance, and included a framework for documenting and evaluating an entity’s internal control environment (generally referred to as COSO). COSO is a framework used to evaluate an organization’s control policies and standards, and which emphasizes a comprehensive approach to evaluating controls in the “whole” institution, and emphasizes the level ofownership ofcontrols in the units that are responsible for them. Russian Federafion CFAA: Exfemal Audit 33
VI. EXTERNALAUDIT
120. The establishment of the Accounts Chamber (AC) as the country’s Supreme Audit Institution (SAI) in 1995 represented a significant step in institutionalizing the accountability ofthe executive to the legislature. In that sense, the AC filled an important gap in the country’s financial accountability framework. Prior to its transition to the principle of separation ofpowers and adoption of a new constitutional setup, the Russian Federation had no tradition of an independent, ex-post, external audit hnction for public financial management. After the breakup of the Soviet Union and until the dissolution of the Supreme Soviet in 1993, there was an Audit Commission of the Supreme Soviet, which could be regarded as an embryonic external audit authority. However, the Commission’s few staff and inadequate resources meant that it had to rely on the Directorate of Financial Control and Audit for most of its information needs. The new Constitution eventually provided for an independent SAI, responding exclusively to the Federal Assembly.
Legal and Institutional Framework
121. The Accounts Chamber is a constitutional body. The Constitution lays the foundation for the independence and neutrality of the Accounts Chamber, containing explicit stipulations regarding the institution’s powers and scope of activities, and ensuring that these cannot be changed unscrupulousl?’. The Law On the Accounts Chamber ofthe Russian Federation, which came into force in January 1995, reiterates the independence of the Chamber from the executive branch of the government and clearly states the principles of legality, neutrality and objectivity. The Chamber is the “body of state financial control established by the Federal Assembly ofthe Russian Federation and accountable to it;” it “shall exercise control over the execution of the federal budget based on the principal of legality, regularity, objectivity, independence and openness.” However, the broad scope ofits activities - including expressing an expert opinion on the draft budget law for a budget whose execution it then must audit - carries the risk that the Chamber becomes involved in matters ofpolicy that are rightly the prerogative ofthe executive branch ofgovernment.
122. In the current situation with a newly introduced treasury system, where financial controls remain weak and proper internal audit functions within the executive are lacking, the broad range of activities carried out by the Accounts Chamber (in obedience to its legal mandate) are justifiable and probably warranted In particular, the Chamber’s “operational controls” date from the period of the Chamber’s establishment when, in the absence oftreasury functions as currently implemented, “the budget used to be executed through authorized banks with numerous delays, losses as well as abuses as the fimds flowed from the Central Bank accounts to the accounts ofthe budget recipient^"^^. As the
28 “For the purpose of exercising control over fulfillment of the federal budget, the Federation Council and the State Duma establish the Accounts Chamber of the Russian Federation, the composition and the order of the activities of which are determined by the Federal Law.” The Constitution of the Russian Federation (article 10 1, paragraph 5). 29 Source: The Accounts Chamber ofthe Russian Federation - Opinion on the World Bank documents “Russian Federation. Country Financial Accountability Assessment” and “ Russian Federation. Core Integrative Fiduciary Assessment - An Analysis ofPublic Financial Management”. Russian Federation CFAA: External Audif 34
Treasury system ofbudget execution was later put in place, those controls “were replaced with the tasks of controlling the timeliness of disbursement of funds by the Treasury and their legality”30. As stated in the Lima Declaration ofGuidelines on Auditing Precepts, in fact, “the legal situation and the conditions and requirements of each country determine whether a Supreme Audit Institution carries out pre-a~dits”~* .
123. In order to respond to these requirements, the Chamber has elaborated a comprehensive methodology covering all the stages ofthe budget process. The Accounts Chamber, based on its experience, deems the above prerogatives to be necessary and extremely important32.Although the Chamber feels that they do not interfere in political and other governance matters, functions carried out in the context ofpreliminary, ex-ante controls, such as providing an expert opinion on the draft federal budget law, may however compromise the effectiveness and credibility ofthe work ofthe SAI; and current controls may unduly delay government financial operations and/or result in overlapping and duplicative activities. In due course, based on the development of proper internal audit functions and the further development of government financial reporting capabilities, certain prerogatives of the Accounts Chamber could be revisited in order to concentrate on ex-post, extemal audit functions. This recommendation is not intended to limit the authority and/or restrict the scope of Accounts Chamber work, but rather to re- focus its functional and operational attributions, in line with developments taking place elsewhere (e.g. Treasury functions and reform ofthe KRU) and the increasing importance offinancial audits that involve attestation ofgovernment financial statements.
124. The Accounts Chamber is headed by a chairman, who exercises overall control over the activities ofthe Chamber and represents the Chamber within Russia and abroad. The chairman is appointed (and can only be dismissed) by the State Duma on a majority vote; the deputy chairman is appointed by the Federation Council, also on a majority vote. In addition, there are twelve auditors, half of whom are appointed by the State Duma and the other half by the Federation Council. Auditors can only be removed from office by a decision of the assembly that appointed them and under specified circumstance^^^. Candidates are nominated by a member ofthe relevant assembly and are appointed by a majority vote of the deputies. The backgrounds of the auditors vary, although in most cases they have experience of state control, economics or finance; former politicians may be considered. Although there are no explicit provisions in the Law regarding reappointment, it is accepted opinion (within the Chamber and in other circles) that the members of the Chamber may be reappointed after having served an initial term.
125. The term of service of the chairman, the deputy chairman, and the auditors is six years (a period of office longer than that of members of the two federal assemblies that appointed them). The activities of the Chamber may not be suspended because of the
30 Source: see previous reference. 31 Paragraph 4, Section 2. 32 The importance of the described forms ofbudget control are noted in the special resolution “Supreme Audit Institutions and Control over State Budget Execution” adopted by the fifth EUROSAI Congress (Moscow, May, 2002). 33 Such as breach ofRussian Federation law; if they are recognized as incapable by a decision ofa court; or by a decision by a new parliament where at least two-thirds ofthe members ofthe State Duma or Federation Council vote to cancel the powers ofthe members ofthe Chamber. Russian Federation CFAA: External Audif 35
dissolution of the parliament. The immunities and legal protections granted to the members of the Chambers imply that they may not be detained, arrested or made criminally responsible without the consent of the assembly that appointed them; that criminal proceedings may be brought against them only by the prosecutor general; and that they may not be made criminally responsible for their actions without the consent of the Chamber.
126. The Accounts Chamber is a collegial body: the Collegium, composed of the chairman, the deputy chairman and the twelve auditors of the Chamber, is the institution’s decisional body. The Collegium approves the Chamber’s annual audit program, whose operational details are further defined in work plans elaborated by the audit departments. It organizes the audit work, determines the methodology of controls and inspection activities, and approves the audit reports and other information to be delivered to the Federal Assembly. Sessions of the Collegium are normally held on a weekly basis. Decisions adopted by the Collegium require majority support and are taken on a collegiate basis. All members, including the chairman, are equal in terms of voting rights, although the chairman tends to have greater influence. In case of dissent from the majority view, members may express a minority viewpoint in a special opinion.
Scope of Responsibilities
127. Pursuant to the law, the Accounts Chamber’s primary role is to undertake the external audit of federal funds ( termed “total complex documentary examination”) and report on its findings to the legislature. In addition, it is responsible for a range of other tasks, including providing an “independent expert opinion” on the draft federal budget law (“preliminary control^")^^. In particular, based on the provisions ofthe Budget Code, the opinion of the Chamber on the draft federal budget law for the upcoming year, submitted to the State Duma by its Chairman, may serve as a ground for rejection ofsaid draft law. The Chamber also considers requests from the President of the Russian Federation, government committees, and commissions of the Federal Assembly Chambers, individual deputies, and government authorities ofthe Subjects ofthe Russian Federation; however, it is the Collegium that decides on the inclusion of an ad hoc audit in the work plan. Finally, the law also gives the Chamber the right to pre-audit government expenditures (“current contr01s~~)~~.
128. To hlfill these responsibilities, the Accounts Chamber has elaborated an audit methodology establishing a control cycle over the execution of the budget of each financial year, involving ex-ante, concomitant and ex-post audits in the form of:
0 preliminary control ofthe draft budget for the next year;
0 current control, during the period ofexecution ofthe annual budget; and
34 The Law on the Accounts Chamber requires the Chamber to give its opinion on the draft federal budget, problems ofbudgetary and finance policy, drafts laws and other acts onbudgetary and financial matters, drafts ofinternational treaties with legal implications for the federal budget, and projects to be financed from the federal budget. 35 The Law on the Accounts Chamber requires the Chamber to provide, on a quarterly basis, a report on the execution ofthe federal budget that compares income and expenditure data against targeted amounts. Russian Federation CFAA: External Audit 36
0 documentary examination ofthe budget for the previous year.
129. Based on the objectives and timeline set up in the annual audit program, quarterly operational (current) work plans are prepared and adjusted during the year as necessary. There is in fact an obligation for the Chamber to examine requests for changes to the audit plan and for ad hoc audit activities, although, as already mentioned, the Collegium has the final word on the proposed changes and non-planned audit tasks.
130. According to the Law on the Accounts Chamber, the scope of activities of the Chamber encompasses all entities that receive, remit or use resources of the federal budget; use or manage the federal property; enjoy tax, customs or other exemptions and privileges, granted by the federal law or federal bodies of state power. It is the Chamber’s responsibility to examine the final accounts ofrevenues, expenditures and borrowing of central government agencies, other autonomous bodies, and of government-invested organizations. The Chamber is also required to examine the execution of the financial plans of the federal extra-budgetary funds; the use of state property (both in terms of its management and post-privatization development of enterprises); and the use of hnds by all other Subjects receiving financial support from the federal budget36. The Chamber’s powers of access to offices, documents and information is extensive37. While these provisions appear strong, there are some problems in their practical implementation. For instance, although the Council of Federation instructed the Chamber to audit the Central Bank of Russia, and Law on the Central Bank was amended to remove ambiguity about the Chamber’s rights ofaccess, no audit from the Chamber has yet taken place.
131. In line with the financing arrangements observed in countries with longer, established traditions of public extemal audit, the Accounts Chamber is exclusively funded by the federal budget (provided for in a separate line item) and has no revenue sources of its own. Although the budget is agreed by the State Duma and Federation Council, the Ministry of Finance has a strong influence over budget drafting and, therefore, may indirectly affect the Chamber’s autonomy and independence (by cutting back its resources). In practice, however, it should be noted that - since the establishment of the Accounts Chamber- there has been no difference of opinion between the executive and the Chamber regarding the financing ofits costs3*.
Activities and Procedures
132. Intemal policies and procedures regarding the activity of the Accounts Chamber are regulated by regulations approved by the Collegium. Considerable progress has been made since its establishment: the organizational structure is being revised and improved, and the chairman intends to increase the efficiency of Chamber’s operations by codifying methodology and associated processes. The guidelines prepared to date pertain mainly to
36 The audit ofthese Subjects is mandatory when budgetary support (from the federal budget) exceeds 50 percent oftheir consolidated budget. 37 Unjustified refusal to present the required information to the Chamber, or inability to present documents and other materials as well as presentation ofincomplete or false information, entails criminal liability as per the Criminal Code ofthe Russian Federation. 38 In case ofany differences ofopinion with the federal Ministry ofFinance in the preparation ofthe Accounts Chamber’s budget, the records ofsuch differences shall be submitted to the State Duma which, should such situation occur, retains final decision on the Accounts Chamber budget. Russian Federation CFAA: External Audit 37 the scope of Chamber activities, the methodological aspects of which can be considered to be in the inception stage. Since 1995 the institution has accumulated experience in conducting analytical work over the last seven years, following a rather empirical approach: principles and norms are now being generalized on the basis of this practical experience.
133. In 2000, following the appointment of a new chairman, the Chamber’s internal regulations were modified to require greater interagency coordination. The modifications were related to the introduction of a program for enhancing the efficiency of the Chamber’s activities (for instance, the adoption of a new risk-based methodological approach, based on conducting more extensive and detailed audits ofthe most significant entities); and also to the content of important, concomitant legislative reforms, such as the enactment of the Budget Code and amendments to the Tax Code. Based on the new instructions, proposed activities identified at the audit planning stage must be coordinated with the work of other relevant state entities and agencies (including parliamentary ~ommittees)~~.
134. Audit planning and reporting are both regulated under the Accounts Chamber’s internal rules and procedures. However, in 2002 the Chamber worked on defining quality control mechanisms. The plan was to establish a dedicated organizational unit that should be responsible for operations evaluation and other quality assurance mechanisms (e.g. peer reviews). The Chamber appreciates that quality control can be only established by developing general guidelines (principles and policies) and assessing compliance with the procedures and practices contained in the guidelines.
135. The preparation ofthe work plan is a core activity ofthe Accounts Chamber. The steps followed in the preparation ofthe audit plan are as follows:
0 During the last quarter, auditors prepare their proposals for the following year, basically a list ofthe entities subject to audit and a conceptual framework. Some proposals may encompass joint work with different organizational units.
0 The proposals are agreed upon with the chairman who, with the support ofthe deputy, prepares a summary document that is submitted to the Collegium for official approval, normally by the end ofDecember.
136. The Chamber conducts on average more than 400 audits every year4’. The work is normally carried out by a team of three or four inspectors, although more complex audits may be carried out by a team consisting of up to a dozen functional sub-teams. Teams are composed of a varying number ofjunior, senior, and lead inspectors, based on the complexity and location of the work, and are led by a chief inspector. In selecting
39 Coordination is required with the audit authorities ofthe President and government (KRU), the federal counter-espionage services, external intelligence services, the federal agencies ofcommunication and information, law enforcement agencies, the control bodies ofthe Subjects ofthe Federation, the central bank, tax administration and tax police, and the MOF. 40 In 2001, for instance, the Accounts Chamber carried out 409 audits covering 1,545 institutions and organizations (source: The Accounts Chamber ofthe Russian Federation - Opinion on the World Bank documents in “Russian Federation: Country Financial Accountability Assessment” and “ Russian Federation. Core Integrative Fiduciary Assessment - An Analysis ofPublic Financial Management”. budget spending units, the Chamber utilizes a risk-adjusted sampling methodology; audits are supported by computerized information systems, including a database designed to support auditing techniques. However, this system is still unfolding its potential to allow for greater use of off-site, desk review of data. As a result, inspectors still mostly carry out on-site inspections.
137. On the basis of their work, auditors prepare their returns (called “acts”), which include all findings and details of legislative, financial and other violations, including their monetary value. Where the inspectors have examined the efficiency of operations, they will include details in their acts. The acts are submitted to the auditor-in-charge, who prepares a report. The report is signed and submitted to the Collegium, where it is either adopted or rejected. If adopted, the full report is sent to the State Duma, with a cover letter. In addition, the auditor-in-charge submits an endorsement to the auditee, which is copied to the relevant minister, sometimes the prime minister and the prosecutor general as deemed appr~priate~~.
Dissemination of Audit Findings
138. The Accounts Chamber reports to the State Duma and the Federation Council. The reports, signed by the inspectors who did the fieldwork, include a summary signed by the chairman highlighting any shortcomings identified as well as legal violations and include recommendations for action, including suggested legal amendments. The Federal Assembly may pass a resolution on the findings presented in the reports, but these resolutions do not necessarily lead to any response fi-om the executive. At the end ofeach quarter, the various departments ofthe Accounts Chamber prepare a cumulative report on the work done during the year. The departmental reports feed into the annual report ofthe Chamber, which also includes information on the Chamber’s own performance. The Chamber’s annual report is reviewed by the Budget and Taxes Committee of the State Duma and the Committee for Coordination with the Accounts Chamber ofthe Federation Council, which make recommendations to the assemblies. On the basis of these recommendations, proposals may be made for further work by the Chamber, to be incorporated into its work program the following year. The final Accounts Chamber annual audit report must be approved by the Council, submitted to the State Duma, and then published.
139. In terms of providing information to the general public, the Chamber follows a policy of transparency. Individual reports to the legislature are not published, but copies may be provided to the press on an informal basis. The results of individual reviews and investigations that are not covered by state secrecy or confidentiality clauses are summarized in the Accounts Chamber’s monthly bulletin. The bulletin has a limited circulation of about 2,000 copies, distributed mostly within state institutions and agencies. For more general dissemination purposes, the Chamber routinely issues press releases and gives conferences; more recently it also launched a website, where many reports are published, contributing to an increase in its openness and greater public availability ofaudit results.
41 There are two types ofendorsements. Some may simply list the violations and make recommendations that certain practices be discontinued because they are damaging the public interest. Others are in the form oforders, which state explicitly when mandatory action must be taken (for instance, returning funds). Russian Federation CFAA: External Audit 39
Staffing
140. The Accounts Chamber professional staff (inspectors) receive no formal certification as public auditors. Recruitment is by personal recommendation and jobs are not advertised; there are different qualification requirements for each level. There is no specific code on the conduct of Chamber employees but there are orders from the chairman on specific topics such as recruitment procedures, confidentiality, and the handling ofsensitive documents. As state officials, staff are bound by the federal Law On Public Service and are required to sign an agreement binding them to confidentiality and barring them from undertaking independent work. Induction of new staff is mostly carried out in-house and/or through external training courses with the various state academies. In carrying out its functions, the Chamber has the right to enlist other state control bodies and, importantly, the prerogative to contract non-state audit services and individual specialists.
Audit Standards
141. The Accounts Chamber is a member of INTOSAI , as well as of regional bodies such as the European Organizations of Supreme Audit Institutions (EUROSAI), and the Asian Organization of Supreme Audit Institutions (ASOSAI).
142. In 2001 the Accounts Chamber was currently elaborating its own auditing standards, intended to conform with those presented in the Lima Declaration of Guidelines on Auditing Precepts. Although the Chamber is gradually moving towards the implementation of the full range of INTOSAI’s Standards, its audit objectives are fundamentally of a legalistic nature (basically determining the level of compliance with the law, rules and regulations). This methodological approach reflects, on the one hand, the country’s traditions and cultural attitudes towards state control functions; on the other hand, it is also the result of the relative priorities ofthe various aspects of extemal audit set out by the Chamber. As a result, the activities of the Accounts Chamber are mainly focused on the “legality” and “regularity” objectives of audit. In this respect, the Chamber carries out documentary reviews of the executed budget that involve substantive testing (analytical procedures), covering examination ofpayment documents and receipts, their verification (“analysis of maximally possible quantity of original payment documents and verification of authenticity of accounting information” 42) and comparisons with MOF’s and Federal Treasury’s own accounts, as well as reconciliation with Central Bank’s and other credit institutions’ financial documentation.
143. The Chamber’s investigations are therefore documentary in nature (assessment of the regularity of administrative functions from a formal and substantial viewpoint) and their scope is compliance-oriented (assessment of adherence to established rules and regulations). Consequently, the reports issued by the Chamber address a variety oftopics, including non-financial ( i.e. legal, organizational, administrative) aspects of public financial management. Since in 2000 the Russian Federation began preparing an annual federal government balance sheet, it has become topical to perform financial audits, in the sense of attestation of public accounts. In that regard, the opinion issued by the Accounts Chamber on the report of the government on the execution of the federal
~~
42 Publicationentitled Accounts Chamber of the Russian Federation 1995-2000, pg. 17. budget43, makes explicit reference to financial statements. The Accounts Chamber’s opinion, based on the provisions ofthe Budget Code, is not legally binding; however, the State Duma, having considered the Accounts Chamber’s opinion, may reject the government’s report on the execution ofthe federal budget.
Recommendations
144. A well-functioning, independent external audit is a key pillar of a country’s financial accountability framework and an important factor contributing to the stabilization ofthe balance ofpower between the executive and the legislative branches. In particular, the issuance by the Accounts Chamber of a general audit assurance on the Russian Federation government’s financial position is important in terms oftransparency and accountability of government operations, as well as public confidence. In that regard, the Chamber should (i)enhance its financial audit capabilities, i.e. attestation of the annual govemment’s report on budget execution and related financial statements, and (ii) expand its financial audit activities to also cover the annual financial statements of the individual government entities under its purview, in order to reinforce and complement its general audit assurance on general government’s consolidated accounts. In order to function fully in accordance with its constitutional mandate and on a par with other longer established Supreme Audit Institutions, the Accounts Chamber has embarked on a program of improvements involving both institutional and organizational reforms, accompanied by a targeted program of capacity building that would allow it to better fulfill its core ex-post, extemal audit responsibilities. In particular, the Accounts Chamber has prepared a long-term plan to assess public institutions’ performance (value-for- money) in the use ofpublic funds. The CFAA strongly supports these efforts.
Scope of Work
145. Regarding institutional reforms, the CFAA believes it is important to the Accounts Chamber’s effectiveness that its role be well defined and that it undertake work appropriate to its independent status, in order to avoid compromising the effectiveness and credibility of its work. The CFAA identified three practices that it considers inappropriate for the preservation ofthe Chamber’s independence and neutrality:
0 its involvement in budget matters, specifically its role in budget preparation when it provides an independent assessment ofthe draft federal budget, including assessing the credibility of forecasts made by the government in preparing the annual federal budget law, and proposing adjustments ofbudget parameters and other indicators in the course ofthe parliamentary budget approval process44 ;
43 For example, the Chamber’s opinion on the execution ofthe 2000 federal budget states that 29 articles of the Budget Code were violated in the course ofbudget execution and that the volume ofexecuted revenues and expenditures were overestimated. The report also contained proposals related to the improvement of the budget legislation. 44 For example, for the 2002 federal budget law, the Accounts Chamber pointed out that budget forecasts were underestimated because they were based on incorrect basic macroeconomic indicators. In response to the observations ofthe Chamber, the government increased the projections ofGDP and ofrevenue receipts by over 3 percent and over 1 percent, respectively. 0 its obligation to carry out work for the executive, such as interim reporting on budget execution; and
0 ad hoc requests from the legislature or other state organs - which are, in any case, rather limited (amounting, in 2001, to less than 10 percent ofthe total number of audits carried out by the Accounts Chamber).
146. Traditionally, providing advice to the government on the budget is seen as a task within the hctions of a parliamentary Public Accounts Committee (PAC)-in the Russian Federation the parliamentary Committees on Budget and Taxes-and of the Ministry of Finance and/or the Treasury. Also, traditionally, auditors are not supposed to participate in any way in activities they will later be auditing. SAIs are properly involved in the budget cycle only ex-post, once the government has reported to the legislature on budget execution. The danger is that involvement prior to agreement on the budget may compromise the Accounts Chamber’s subsequent ability to comment and independently assess the use of budget funds. Involving the Chamber in budget discussions inevitably politicizes its audit work, and may also undermine public confidence in the objectivity and nonpartisan quality ofthe Chamber’s professional work.
147. For these reasons, the CFAA believes that it would be appropriate to limit the Chamber’s role to ex-post auditing. Given the framework for budget management in the Russian Federation, responsibility for providing an independent expert opinion to the Federal Assembly on budget formulation, revenue and expenditure forecasts, and policy analysis for draft laws should remain the prerogative of the parliamentary Committees on Budget and Taxes. In doing so, the legislature should always consult with the Accounts Chamber to allow experience gained from the audit work to be brought to the attention ofthe Committee’s members. The Chamber is reportedly in direct contact with the parliamentary Committees; this collaboration with the legislature is desirable and should be enhanced, with the Chamber carrying out, upon request, advisory hnctions to the Committees on specific matters that may arise during the review of the draft budget law and interim reports on budget execution.
148. The law also requires the Accounts Chamber to provide a quarterly “operational report on the progress ofbudget execution” that compares revenue and expenditure data against targeted amounts45. This ensues from the Accounts Chamber’s task oforganizing and exercising control over the “timely execution of the revenues and expenditures” of the federal budget (and the budgets of the federal extra-budgetary funds) in terms of “amounts, structures, and end-uses.’’ Also in this case, although the executive can clearly benefit from drawing on the knowledge and experience of the Chamber (for instance in terms of feedback into next year’s budget process), the CFAA recommends that responsibility for reporting on the progress ofbudget execution should remain solely with the executive branch, including the Treasury and the MOF. A more appropriate role for the Accounts Chamber would involve, for example: helping to set standards for government accounting and financial reporting; drawing attention to potential or actual conflicts of interest in government stewardship activities; and encouraging management
~
45 Special attention is given to the impact onbudget execution ofthe general economic situation ofthe country and trends in macroeconomic indicators that measure tax receipts, tax-compliance, and financial sector performance, among others. Russian Federation CFAA: External Audit 42
to develop sound financial and oversight practices over its operations, including robust financial reporting, a sound control framework, and modem internal audit functions.
Work Program
149. A key aspect of an Accounts Chamber’s independence is its ability to set its own work program. Audit requests from the legi~lature~~are common practice in many countries and also represent an indirect control mechanism to ensure that the SAI’s work program is aligned with parliamentary needs and concerns. The Lima Declaration of Guidelines on Auditing Precepts itself states that the powers of the national legislature to mandate ad hoc audits may not be challenged. SAIs normally consider these requests on their merits and decide whether to turn them down or postpone action; preserving its discretion to decide is, in fact, a fundamental aspect of a SAI’s independence. Presently, the mandates (resolutions) of either Chamber of the federal Assembly, and requests signed by at least one-fifth of the total number of the State Duma or the Council of Federation, are subject to mandatory inclusion in the work plans and programs of the Accounts Chamber.
150. In order to preserve the Accounts Chamber’s full independence and ensure that its resources are used on the highest priority tasks, the CFAA therefore recommends that:
0 budget policy be formulated exclusively by the executive and the legislature’s PAC;
0 budget execution reporting hnctions be the sole responsibility ofthe MOF; and
0 the Accounts Chamber be given free hand, under all circumstances, to rule on the merit ofad hoc requests coming from the legislature (Le. there should be no obligation for the Chamber to take on work outside its independently planned investigations).
Enforcement Role
151. In terms of enforcement aspects of the Chamber’s audit work, the Law on the Accounts Chamber establishes a clear link between identifying irregularities and correcting them. In fact, the Law gives the Chamber the authority (once it has identified breaches of law and regulations “that cause direct damage to the state” as well as in the event of “intentional or systematic violation of rules”), to issue mandatory orders to the management of the audited body mandating rectification or repayment (accruing to the federal budget). The procedure in place when audit results show embezzlement ofpublic funds or assets implies submission of the audit materials by the Accounts Chamber directly to law-enforcement authorities. In the event ofrepeated non-compliance or undue execution ofremedial actions prescribed by the Chamber, it may seek authorization from the State Duma to suspend all types of financial, payment and settlement operations on the accounts ofthe entities in violation.
46 Or from the government, since INTOSAI guidelines clearly state that the maintenance ofthe SAIs’ independence does not preclude requests from the executive proposing matters for audit. Russian Federation CFAA: External Audit 43
152. The danger of granting the Accounts Chamber such corrective powers is that its independence may be compromised when it becomes embroiled in disputes between the executive and the legislature. There may also be a risk ofundermining its reputation if its orders are ignored or challenged in the courts. The Chamber could then become a direct and active participant in a series ofpotentially time-consuming or difficult lawsuits. The role ofthe Chamber might more properly focus on drawing the results ofits audits to the attention ofthe executive and the parliament, and then overseeing the results ofthe action that parliament or government chooses to take - the ultimate sanctions being ordered and applied by the courts, for instance, in cases of fraudulent behavior uncovered by the Chamber involving criminal violations.
153. It is, in fact, the government’s responsibility to ensure that funds are properly managed and control weaknesses eliminated, and the legislature’s to ensure that the government takes appropriate action, opportunely advised by the Chamber. At the same time, adequate oversight should be exercised on the public audit functions carried out by the Accounts Chamber, in order to close the state accountability loop. At present, these oversight functions are performed by the Council of Federation Committee for Coordination with the Accounts Chamber and, in part, by the Budget and Tax Committee of the State Duma47. The Accounts Chamber reports are, in fact, discussed by these parliamentary Committees, and resolutions on these reports are issued by the two houses of the Federal Assembly. In absence of a dedicated parliamentary Audit Committee, the CFAA specifically recommends that the two Committees devote greater attention to scrutinizing the activities of the Accounts Chamber, publicizing audit conclusions and outcomes, and following them up. In particular, formal processes are to be introduced for government to respond to parliamentary recommendations for action following scrutiny ofthe results ofthe Chamber’s audit activities, processes that would determine the extent of administrative and, possibly, criminal judicial action, to be triggered by the findings presented in the Chamber’s reports.
154. The Council of Federation Committee for Coordination with the Accounts Chamber and the Budget and Tax Committee of the State Duma should also be vested with responsibility to determine the Accounts Chamber financing needs, in order to address issues relating to the funding ofthe Chamber’s operations. Recent developments in intemational best practice4*, in fact, suggest that in order to protect the funding of the SAI, its budget should be determined exclusively by the parliament, based on the financing needs arising from the audit plan for the next year, including all necessary operating expenses as well as investments. Pursuant to the current budget legislation of the Russian Federation, budget drafting is an exclusive power of the executive branch; however, opportune changes may be considered to ensure that the Accounts Chamber financing is protected, and therefore not subject to reduction when public expenditures are being cut.
4’ The Council ofFederation Committee for Coordination with the Accounts Chamber, with a view to refine the functional attributions of the Accounts Chamber, has prepared a draft law on amending the federal law On the Accounts Chamber, which has been submitted for consideration to the State Duma. 48 For instance, New Zealand’s Public Audit Act, 2001. Russian Federation CFAA: External Audit 44
Conformity with International Standards
155. An important aspect pertaining to the core functions of a Supreme Audit Institution is the definition and consistent implementation of audit standards. The CFAA recommends that the Accounts Chamber work on the implementation of INTOSAI Standards on Auditing, with the objectives of:
0 gradually aligning financial audits to international best practice, such as that observed in OECD countries, particularly in the areas ofevaluation ofinternal controls and analysis offinancial statements;
0 enhancing the internal quality assurance functions over its audit activities ( particularly in the areas ofplanning, execution and reporting; and
0 establishing external quality assurance mechanisms through external review by another SAI.
Complementarity of Internal and External Audit
156. The reliance of the external auditors-the Chamber- on the work performed by the government’s internal auditors is particularly important. The goal should be to avoid duplication and to reinforce the process through which policies, procedures and practices governing public financial management are verified as being adequate and sound. Internal and external audit should be compatible and complementary, and both should follow a risk-based approach. The primary role of an organization’s internal audit functions is, in fact, to exercise preventive control, and ex-ante and current controls over the operations of an organization should therefore be the prerogative of internal auditing. The ultimate goals ofexternal audit are:
0 to provide, ex-post, an assurance that accounts fairly present the financial position and the results ofoperations ofan organi~ation~~;and
0 to detect systematic control weaknesses and associated risks in a professional, judgmental manner, and provide practical recommendations for their removal.
157. The differing roles of internal and external audit also imply differences in the extent and frequency of required access to government records. In particular, in 2001 access to Treasury information systems by the Accounts Chamber was under debate by the government, the Federal Assembly, and the Chamber itself. Obtaining direct, on-line
49 In fact, unless there is total coverage (100 percent oftransactions), there is always the possibility that errors, misstatements, corruption and fraud may remain undetected. At the same time, verifying only recorded transactions will necessarily fail to detect successfully hidden income and expenditure (as in the case ofdouble-bookkeeping or black revenues) that can only be tracked by analyzing the auditee’s sources ofrevenues and typology ofexpenditures. A more suitable approach would be to assess the risk (statistical probability) that assets and revenues are not entered in the books (or are recorded for incorrect amounts), and the risk ofcorrupt behaviors that could undermine existing internal controls, such as collusion. The assessment ofrisk could be derived from sectoral norms and patterns, data time series, and related past experience. Hypotheses should be corroborated by tests conducted on the basis ofan appropriate level of materiality. real-time access to the Treasury General Ledger was regarded by the Accounts Chamber as a valuable means of maintaining oversight over government spending and receipts. However, this day-to-day type ofmonitoring and compliance checks is part ofthe ex-ante and current control responsibilities of the Federal Treasury Controls and Inspections Department (CID). Likewise, the risk analysis of government’s financial and payment systems is better placed within the framework of developing modem internal audit functions within the Ministry ofFinance. Although the Chamber should clearly have full and unrestricted access to all sources ofdata and documentation - including the full range of Treasury accounts and records - to carry out its ex-post external audit work, the real- time examination of transactions by the Accounts Chamber is a costly and duplicative activity. Day-to-day oversight of Treasury operations could be effectively achieved through enhanced communication, including data exchange, between the Accounts Chamber and government’s control and audit bodies within the Treasury and MOF, with the aim of building mutual reliance and recognizing the different specialization and prerogatives ofinternal and extemal auditing.
Relationship with Local Governments
158. The Chamber is a federal authority and currently has no regional branches within the territory of the Russian Federation. The Accounts Chamber employs some 1,150 regular staff, of whom the majority are professional staff involved in audit work. This staff complement enables the Chamber to give full examination to line ministries once a year. Authorities below this level (e.g. second-level spending units) are likely to receive attention less frequently.
159. The Accounts Chamber has no authority to audit the execution of the budgets of regional administrations or local state bodies. Pursuant to the provisions of the Budget Code, control over the execution of the respective budgets ofthe Subjects ofthe Russian Federation and the local self-government bodies is the responsibility of the respective financial control bodies of the Subjects of the RF and the municipal financial control bodies. As a result, regional and local authorities have set up their own control and audit bodies (also called Accounts Chambers) in 74 of the Subjects of the Russian Federation, which are established by the Subjects’ legislative bodies and the representative bodies of the local self-governments.
160. Traditionally, the regional and local Accounts Chambers have worked quite separately from the federal-level Accounts Chamber. The CFAA finds that there is a need to redefine and institutionalize the relation between the federal Accounts Chamber and the regional/local governments’ Accounts Chambers. Significant accomplishments in that direction are (i)the establishment, at the end of 2000, of the Association of Control and Audit Bodies of the Russian Federation, created under the aegis of the Accounts Chamber”; and (ii)the establishment, in 2002, of the Union of Municipal Audit Bodies, which was also created with the participation of the Accounts Chamber. In order to fully exploit the potential of these initiatives, the CFAA recommends that the enactment of legislation on regional audit bodies be considered, providing for specialization and adequate division of labor between the federal and the sub-national Chambers, and for a
50 The chairman of the Accounts Chamber is also the chairman ofthe Association of Control and Audit Bodies of the Russian Federation. Russian Federation CFAA: Extemal Audit 46
coordinating role by the federal-level Accounts Chamber. The system would work as a network, with the Accounts Chamber in the lead by defining methodological approach and exercising quality control over the work of regional and local control and audit bodies.
Capacity Development
161. To support the substantive recommendations of this report, the CFAA recommends preparation of a capacity development program for the Accounts Chamber, built around the objective of building financial audit (attestation) capabilities. The steps involved in this program would be:
0 in terms ofresources, developing an adequate skills mix, including training to equip the Accounts Chamber’s professional staff with strong financial auditing and financial controls diagnostic skills; and
0 in terms ofapproach, moving beyond cataloguing errors in order to target systemic control weaknesses.
162. The World Bank is keen to provide assistance and guidance where possible, especially with respect to the transition to INTOSAI Standards on Auditing. In the process of building internal capacity, a possible pragmatic solution in the short term could be for the Accounts Chamber to contract out the assurance part of its audit activities to private sector audit firms. Financial audits would be conducted under the umbrella ofthe Chamber’s legal authority, but would be carried out by mixed audit teams (private sector auditors and Chamber inspectors). Chamber auditors would certainly benefit from the exposure to audit methodology and practices, in effect a form ofon-the- job training. Although the feasibility of this approach is nominally guaranteed under the Accounts Chamber Law, it may have a negative impact on the Chamber’s reputation and could potentially generate legal and regulatory conflicts (for instance, relating to access to information by non-state auditors). These risks should be carefully evaluated by the authorities and ways found to mitigate them, if this approach is to be followed. This recommendation is of particular relevance with respect to the annual audit of the Central Bank of Russia, which could be carried out by a mixed audit team, including Chamber inspectors.
Quality Assurance
163. In terms of overall quality assurance, besides establishing a dedicated organizational unit in charge ofinternal quality control, the CFAA recommends that the work ofthe Accounts Chamber be reviewed, on a regular basis, by another SAI. Initiating external quality control and operational reviews of the Chamber by another SA1 would represent a natural evolution in the working relations-including staff exchanges, that provide exposure to international experience- that have recently been established with SAIs in other countries from which the Accounts Chamber has received technical assistance in the form of bilateral cooperation, including the US General Accounting Office (GAO). Twinning arrangements have reportedly been established between the Accounts Chamber and the UK National Accounting Office (NAO) and the Swedish National Accounting Office (SNAO); the involved institutions, in broadening and Russian Federation CFAA: External Audit 47 deepening their operational involvement with the Accounts Chamber, could consider the opportunity ofintroducing inter-institutional peer-review programs. Russian Federation CFAA: Portfolio Fiduciarv Considerations 48
VII. PORTFOLIO FIDUCIARYCONSIDERATIONS
164. The CFAA found that, with respect to its lending operations, the World Bank is adequately discharging its financial management fiduciary responsibilities. The CFAA risk assessment concluded that the current ring-fencing approach to project implementation arrangements should be maintained, recognizing that - based on the effective operationalization of the reforms introduced in public financial accountability - the present arrangements could in due course be subject to revision. The overall control environment in the Russian Federation is in fact evolving but, at present, is still weak (see box on Corruption and Governance).
165. In 1999, within the existing fiduciary framework for adjustment lending, the Bank introduced front-end accountability requirements consisting of a real-time tracking system, complemented by an external, independent audit of the Deposit Account held at the Central Bank. These requirements were designed to ensure that disbursements of its remaining adjustment loan balances reach the Ministry of Finance’s budget accounts or are utilized directly by the Central Bank of Russia only for sovereign, external debt payments.
166. As for the Bank’s investment lending, since 1998 Bank staff have been consistently implementing the project financial management arrangements mandated by the Financial Management Initiative (FMI). The Bank’s Moscow-based financial management team also took innovative steps, now regarded as best practice Bank-wide, to improve the audit quality of Bank-financed projects. In coordination with the MOF, the team introduced a system of pre-qualification of private sector audit firms (either domestic or part of an international network), aimed at retaining only those firms that demonstrate adequate technical capabilities and internal quality control mechanisms.
Recommendations
167. Based on the CFAA’s findings regarding existing weaknesses in the public sector financial accountability framework and the scope for hrther developments, and in line with the agreements reflected in the Country Portfolio Performance Reviews (CPPR), the CFAA recommends that, from a fiduciary perspective, the current ring-fencing approach to institutional and implementation arrangements be maintained for Bank-assisted projects in the Russian Federation. For investment-type operations, these arrangements are based on (i)assignment ofproject management and implementation responsibilities to multi-project Foundations, which are autonomous, non-commercial legal entities; and (ii) maintenance of loan funds (Special Accounts) within major state banks of the Russian Federation, owing to the (still) ongoing stabilization of commercial banks following the August 1998 financial crisis.
168. In terms of governance, the CFAA considers that the framework currently in place for government oversight of the Foundations is satisfactory. This framework involves Russian Federation CFAA: Porffolio Fiduciary Considerations 49
0 agency agreements between MOF and the Foundations that define rights and responsibilities for implementation ofeach specific project;
0 supervisory boards (composed ofrepresentatives ofMOF, Ministry ofEconomic Development and Trade and relevant sectoral ministries) that approve the yearly budget, broken down by projects, and perform other oversight functions;
0 interministerial committees that oversee, for instance, procurement (review of every contract above specified thresholds); and
0 management oversight, through regular reporting by the Foundations to the MOF and relevant ministries, annual external audits and regular controls performed by the Accounts Chamber, MOF’s Control and Revision Department (KRU) and other government controllers.
169. Taken together, this combination of budgetary controls and day-to-day implementation monitoring represent a powerfbl deterrent to collusion and can ensure the transparency and accountability ofthe Foundations’ activities.
Conditions for Moving towards Ministry-based Implementation
170. The present arrangements do pose some limitations on developmental impact, since they potentially detract from line ministries’ ownership ofprojects and may limit in- house capacity building at the line ministry level. However, these drawbacks are positively offset by cost-effectiveness and efficiency considerations. In the case ofmulti- project Foundations, in fact, the incremental start-up costs for additional projects are minimal. For instance, in the area of financial management, the only additional cost is to customize existing accounting software to take into account the new project. A stand- alone PIU would need to purchase and install its own accounting software, train new staff, and prepare an operational manual. Likewise, individual project auditing costs are lower when grouped under the umbrella of the Foundations’ audit arrangements. Finally, multi-project Foundations tend to remain lean, employing highly skilled staff to provide specialized, professional services across a range of projects under implementation, thereby also ensuring consistency ofresults.
171. Owing to the World Bank’s Europe and Central Asia Regional guidelines on Project Implementation Units (PIU), and renewed interest from the government to reconsider the benefits of ministry-based implementation arrangements, the CFAA believes that the present arrangements could, in due course, be subject to revision, with three ultimate objectives:
0 the progressive transfer of management responsibilities to sectoral ministries and relevant state agencies;
0 the placement of Special Accounts in commercial banks, in consideration ofthe benefits accruing to project execution from a more expedited, efficient service and better operational conditions; and
eventually, the channeling ofloan funds through the Treasury. Russian Federation CFAA: Poltiolio Fiduciarv Considerations 50
172. The first objective, which could be considered for new projects on a case-by-case basis, would be achieved by empowering the relevant line ministries and state agencies (the beneficiaries) with the project’s strategic governance along with monitoring and evaluation functions. However, pending the graduation of the government’s financial management and procurement capacity and infrastructure to a level of performance that would allow the World Bank to rely on those systems, the CFAA recommends that fiduciary functions (disbursement, procurement, accounting and reporting, and operational reviews) continue to be outsourced to specialized agencies. Such agencies (possibly the successors oftoday’s Foundations) present the advantage ofutilizing skilled consultants and reliable, suitable, and stand-alone computerized information systems.
173. Achievement of the second objective (Special Accounts in commercial banks) would require the positive reassessment of credit institutions’ soundness, along with fit and proper ownership.
174. The third objective (channeling loan funds through Treasury) would need to be regarded as a medium- to long-term objective, as the treasury system is not equipped, at present, to operate in harmony with World Bank disbursement procedures or accounting and reporting requirements. Shifting loan funds to Treasury would depend on achieving positive results in the following activities (some already underway), among others:
0 fill adoption and smooth operation ofthe Treasury Single Account and universal coverage ofthe Treasury;
0 refinement ofpublic sector accounting and reporting (including preparation of a statement ofaccounting policies), and its capability to deal with special purpose financial statements; and
0 strengthening government internal controls over accounting and reporting as well as internal auditing functions, which need to be reoriented to a system- management and risk-based approach.
175. The CFAA believes that such a shift to Treasury should, in fact, be a prerequisite to allowing the transfer of a full range of project implementation activities (including financial management) to ministries and govemment agencies (the first objective).
Audit of Bank Projects
176. Based on the Bank’s current audit policy, the CFAA recommends maintaining current arrangements for the annual audit of Bank-assisted projects, which involve audit by private sector audit firms competitively appointed among those pre-selected by the Bank, in consultation with the MOF (11 firms at present). In addition, the work performed by the Accounts Chamber should also be reviewed by the Bank on a regular basis and taken into consideration in project preparation and supervision. The Accounts Chamber routinely performs documentary reviews ofBank projects because they involve international borrowing and the use ofbudget funds in the form ofcounterpart financing. These reviews are geared mostly towards assessing the efficiency and cost-effectiveness ofproject expenditure and the prevention andor detection of possible waste ofresources and abuses. Russian Federation CFAA: Portfolio Fiduciarv Considerations 51
177. All Chamber reports received by the Bank are reviewed by the Bank’s Moscow- based financial management team and any issues related to non-compliance with loan stipulations, as well as cases of ineligible expenditure, are being followed up at the country level. While it is, in fact, recognized that the Accounts Chamber reports are important for portfolio monitoring and evaluation as well as for follow-up purposes, the CFAA found that there have nonetheless been several instances in the Chamber’s reports of misunderstandings as to the legal and operational aspects of loan funds disbursement and tracking mechanisms (especially in the case of adjustment operations). More importantly, the Chamber’s reports do not provide the type of audit assurance on project financial statements and accessory financial information and summary schedules (Special Account Statement and Statement of Expenditures) that are needed, under the current audit policy, to discharge the Bank’s fiduciary obligations. While Accounts Chamber reports need to be taken into account, the CFAA believes that they cannot, nor should they, replace the audit reports carried out by private sector auditors. Accordingly, the World Bank
0 has advised all audit firms engaged in Bank-assisted projects to review the Accounts Chamber reports as part of their normal audit procedures (relating to the examination ofall external correspondence); and
0 has undertaken an open dialogue with the Accounts Chamber regarding Bank- assisted projects.
178. At a more general level, the CFAA recommends that Russian Federation authorities ensure that the World Bank receives the Accounts Chamber’s annual report on federal budget execution, as per the MOF’s request. Bank review of and familiarity with this information would help to build the bridge between the front-end accountability arrangements now governing the Bank’s budgetary support to the Russian Federation and the execution of the budget. In the medium term, should the Bank and the Russian Federation agree to arrange for investment projects to be implemented by ministries and state agencies, for loan funds to be channeled through and operated by the Treasury, and/or for a move towards programmatic lending, the CFAA recommends that the Bank review these annual budget execution reports in order to enhance the overall level of assurance that public fimds are being used for the intended purposes. The CFAA believes that reaching this level of assurance will require continued technical assistance, from the World Bank and other donors, to develop capacity within key state institutions (Ministry of Finance, Federal Treasury, and Chamber of Accounts) and to strengthen public financial accountability and financial management systems. ANNEX1: CORRUPTION AND GOVERNANCEIN THE RUSSIANFEDERATION
The 1999 CAS for the Russian Federation highlighted the fact that corruption is perceived to be widespread and deep-rooted, undermining efforts in economic management and public sector administration reform. The evidence of the pervasive incidence of corruption, and associated waste and misuse of resources, is alarming. According to Nations in Transit 2001, “organized crime and corruption cost Russia about USD 15 billion a year, according to figures provided by the State Duma Security Committee. According to the Ministry of Interior, crime cartels controlled in 2000 about 40 percent of Russia’s private enterprises, around two-thrds of state enterprises, and 50 to 85 percent ofbanks. The black market economy, which was largely criminally run, amounted in 2000 to about 40 percent ofRussian GDP.” According to a Gallup International poll reported in April 2000 (conducted through interviews with senior bankers, business leaders and government officials), Russia placed in the top 20 of the most corrupt countries in the world. Russia was ranked 82 out ofthe 90 countries surveyed in the Transparency International’s 2000 Corruption Perceptions Index (CPI) and received a score of2.1 on a scale of 0 (highly corrupt) to 10 (highly clean). According to the World Bank Institute (WBI) indicators of governance, which aggregate data from a wide range of extemal surveys and assign higher ranks to better performers, the Russian Federation falled in the lowest quartile: m112” of 155 countries in terms of graft/corruption (measuring perceptions of corruption, where corruption is defined as the exercise ofpublic power for private gains) and 01 16” of 156 countries in terms of government effectiveness (combining perceptions of the quality ofpublic administration provision, the quality ofthe bureaucracy, the competence ofthe civil servants, the independence ofthe civil service from political pressures, and the credibility ofthe government’s commitment to policies).
During the economic transition, owing to the persistence of Soviet era power structures, corruption mainly took the form of: (i)grand corruption, which involved high state officials and state enterprises run by oligarchs, often in association with various criminal organizations; and (ii)adrmnistrative and petty corruption, which involved graft and bribery ofcivil servants. As to the former, scandals have come to light in recent years over the non-transparent way in which privatization was carried out during the Yeltsin era (second half of 199Os), when insider deals allowed members of the elite to move between government and business, using their connections and positions to accumulate private fortunes. As to the latter, administrative corruption in 2000 had a major impact on business activities - particularly affecting small-medium enterprises (SME) - increased the cost of doing business as well as discouraged foreign investments. It also had repercussions on households, given the hidden (or extra-cost) ofaccess to basic services, such as health, education, etc, which, in turn, diminished the trust in public institutions.
A transparent framework for privatization was introduced under the 1997 Privatization Law. However, the concept ofconflict of interest (and of setting clear boundaries between public and private sector activity) was not widely assimilated in the Russian Federation. Politicians have often combined executive power with a direct or indirect interest in businesses that are affected by that power.
Corruption and money laundering have received considerable press attention, specifically the transfer of allegedly illegally earned money through the commercial banking system. Such fiduciary risks and related allegations of lack oftransparency in government raise the stakes vis-a-vis the reputation and development risks for both the Bank and the development community at large, Effective enforcement of the newly adopted money-laundering legislation would be a crucial step in producing concrete results in the fight against criminal organizations and in improving the country’s intemational standing.
Strong and determined political leadership is needed to overcome the institutional causes and systemic impact of corruption. Recognizing the importance of curbing corruption to foster economic development, including higher quality of public abstration’s service delivery, and the creation of an enabling environment for further development of the private sector, the present government is committed to fight corruption and extortion and to institute a climate of openness and trust in relations between citizens and the public administration, on the one hand, and of transparency in the conduct of business, on the other. A parliamentary commission on corruption was established in 2000. The commission, composed of 19 Duma deputies, is conducting studies to analyze evidence ofcorruption and it is expected to come up with recommendations for improving legislation in this area. While the govemment has taken some very positive steps in a number ofreform areas, however, the commitment ofthe authorities to create a high-level inter- ministerial anti-corruption commission, at present, has not been fulfilled Russian Federation CFAA: Annex I/: List of Counfemads Mef 53
ANNEX11: LISTOF COUNTERPARTS MET
Meeting Contact person
~ Mr. Vladimir Sergeevich Belov, Secretariat Head ofDepartment offinancing tel. 298 9196 ofvarious sectors ofeconomy, fax 913 4459, ! MOF Department ofInternational cooperation fax ~ 913 43 11 I Mr. Vladimir Anatolievich Secretariat Shalaev, Deputy Head ofBudget tel. 298 9795 Policy Department, MOF direct 298 9764
Mr. Richard Clifford, Head ofthe Resident Mission
Mr. Mstislav Platonovich Ms. Lena Dobrolyubova Afanasief, Deputy Head of Secretariat Department, Accounts Chamber
Mr. Paul Smith, USAID, Banking Sector Reform Project
Ms. Tatiana Gennadievna Secretariat tel. 298 9640, fax 9280059 Nesterenko, Deputy Minister of Address: Ilyinka, 9 - 5 pod’ezd Finance, Head ofTreasury Internal phone 9640 ~~~ Ms. Valentina Grigorievna Zueva, Secretariat: t. 298 9640, f. 9280059 Deputy head ofthe main Address: Ilyinka, 9 - 5 pod’ezd department ofFederal Treasury nternal phone 9640
Mr. Andrei Yurievich Petrov, Mr. Alexei Mitin, Head ofthe division of Deputy Minister ofFinance control for the auditing practice Mr. Andrei V. Krikunov, Head of Tel. 298 05 34, the State Financial Regulation and Mr. Krikunov Andrei Vasilievich, secretariat Audit Department (KRU) 298 05 17 Address: Ilyinka, 9 - 5 pod’ezd
Mr. Mikhail Mikhailovich State Duma, entrance 10 from Georgievsky per.1 Zadomov, Deputy Chairman ofthe ’ State Duma Committee on Budget 1 andTaxes Russian Federation CFAA: Annex // List of Counterpark Met 54
Meeting Contact person ~___~__ -~~ ___ Mr. Alexei Yurievich Simanovsky, Mr. Alexander Mitkov, Assistant to Head Director ofPrudential Banking Division for cooperation with international Supervision Department, Central financial organizations t. 929 455 1 Bank ofRussia (CBR)
Ms. Larissa Valerievna Gorbatova, Secretariat-tel. 220 04 64 f.22005 11 Deputy Head ofAuditing and Direct 220 9203 Methodology Department, MOF Address: Slavyanskaya ploschad’, dom 4, str. 3 room 533 (premises ofthe Ministry ofLabor) I /Is. Ludmila Ivanovna Gudenko, Mr. Alexander Mitkov, assistant to Head Iirector ofAccounting and I Division for cooperation with international Leporting Department, CBR financial organizations t. 929 455 1 1 1 Ms. Semenovna Sitnikova, Mr. Alexander Mitkov, assistant to Head Director ofDepartment for Division for cooperation with international j Licensing, Banking and Auditing financial organizations t. 929 455 1 activities, CBR Mr. Evgeniy Arkadievich Dzhima, Director ofIntemal Audit and Inspections Department, CBR I Ms. Samokhina Galina All calls to the Federal Commission for Evgenievna, Head ofDepartment Securities Market should be made through the for Regulation ofSecurities Market reception - t. 935 87 90. For further assistance Mr. Solodyankin Dmitriy please ask Mr. Alexander Viktorovich Germanovich, Head ofDepartment Zagorskiy, Assistant to Igor Vladimirovich for Securities Market’s Kostikov, Chairman-f. 959 9308 Supervision Russian Federation CFAA: Annex 111: Bibliosraphv and References 55
ANNEX 111: BIBLIOGRAPHYAND REFERENCES
e Accounts Chamber ofthe Russian Federation 1995-2000 (booklet published by the AC) e The Accounts Chamber of the Russian Federation - Opinion on the World Bank documents in “Russian Federation: Country Financial Accountability Assessment” and “ Russian Federation. Core Integrative Fiduciary Assessment - An Analysis of Public Financial Management” e Accounts Chamber ofthe Russian Federation: Act On Auditing Efficiency and Expediency Disbursement ofthe IBRD Loan RU-4234 for the Social Protection Implementation Project by the Russian Foundation for Social Reforms in 2000 and 1” Quarter 2001, June 6,2001 e Accounts Chamber ofthe Russian Federation: Report on Findings ofthe Thematic Review of Legality, Efficiency and Eligibility ofExpenditures under the Bureau of Economic Analysis Loan of the International Bank for Reconstruction and Development (IBRS) #21 (213), June 9,2000 e British Broadcasting Corporation: Text ofRussian’s President Annual Address to the Federal Assembly, April 3,2001 e Freedom House: Nations in Transit 2001 - Russia e Government of the Russian Federation: Basic Trends in Social and Economic Policy ofthe Government of the Russian Federation, 2000 e International Monetary Fund: Russian Federation - Report on Observance of Standards and Codes, September 14,2000 e Russian Federation MOF: RF Federal Budget Execution Report for January- September 2000 - Explanatory Note e Swedish Ministry ofFinance (Swedish-Russian Cooperation Programme): A note on Budget and Accounts Classifications, February 2002 e The World Bank Poverty Reduction and Economic Management Unit (ECSPE): Russia - Towards Improving the Efficiency ofPublic Investment Expenditures, September 18,2001 e The World Bank, Operation Evaluation Department (OED): The Bank’s Efforts to Build Capacity for Public Financial Accountability in Russia, September 2001 e The World Bank, Operation Evaluation Department (OED): World Bank’s Assistance for Public Sector Management and Governance in Russia, September 200 1 e The World Bank: Budget Management in the Russian Federation - Fiscal Policy Note, June 1998 e The World Bank: Fiscal Management in Russia, 1996 e The World Bank: Russian Federation - Issues in Budget Management Reform (draft), October 17,2001 e The World Bank: Russian Federation - Treasury Development Project; Aide Memoire and Implementation Plan: Pre-appraisal mission September 15-October 3, 2000; Project Appraisal Document (Decision Meeting Review Package); Quality Enhancement Review (February 2001) e The World Bank Europe and Central Asia Region - Anticorruption in Transition: Confronting the Challenge of State Capture. Russian Federaiion CFAA: Annex IV: Map 56
ANNEX IV: MAP OF THE RUSSIANFEDERATION