Auditing And Poverty Reduction

1. Auditing And Poverty Reduction WBI Regional Workshop on TOWARDS AUDIT EFFECTIVENESS Addis Ababa, Ethiopia 12 May, 2003 David Shand Financial Management Advisor World Bank Washington DC

2. Sound Public Financial Management (PFM) and Poverty Reduction • PFM issues are at heart of Bank’s dialogue with most African countries • Substantial growth in Bank’s PFM work in recent years reflects perceived relevance of good PFM to poverty reduction • PFM objectives - aggregate fiscal control - good resource allocation, to meet poverty objectives - operational efficiency in delivering services • Good service delivery is reflected in the second and third objectives • Similar developments in other IDIs and in major bilateral donors

3. Sound PFM and Poverty Reduction • But overall disappointing progress in PFM improvement – clearly a long-term process • Growth of budget support lending - by Bank and others • Increased PFM diagnostics - World Bank Country Financial Accountability Assessments (CFAAs), Public Expenditure Reviews (PERs ), HIPC expenditure tracking assessments, IMF Fiscal Transparency Reviews (ROSCs) etc • Reviewing how the PFM system is working – to meet developmental needs of countries and fiduciary objectives of donors (reasonable assurance on quality of PFM) • PFM capacity development interventions – from small institutional development grants through major lending operations

4. Sound PFM and Poverty Reduction (cont’d.. • PFM conditionality in budget support lending (many conditions on internal and external audit and parliamentary scrutiny) • PFM reforms often part of overall public sector reform programs or lending operations • Efficient execution of a poverty focused budget is crucial • Including non wastage and diversion of funds through corruption • Non-execution of the budget is a major failing in many developing countries • May reflect unrealistic budgets, cumbersome centralized processes, lack of reliable or all three

5. Sound PFM and Poverty Reduction (cont’d.. • As is fiscal transparency • Accountability for the use of public resources • Do we have reliable information on the public finances? • Follow up of Bank expenditure tracking surveys shows the impact of transparency in improving budget execution • How can we establish linkages between PFM and poverty impacts • But while we agree auditing is not an end in itself, let's not pretend too much about demonstrating a direct link with poverty reduction

6. PFM and Auditing • Audit is a major component of the PFM system along with • budget development • budget execution and monitoring • external reporting • legislative review and follow up • These components should be mutually reinforcing or inter-dependent • For example to carry out a financial audit, timely financial reporting is necessary • For audit to have impact, strong legislative follow up is generally necessary • Audit can itself be regarded as an integrated system, viz - External audit (partly) relies on internal audit - Legislative follow up of external audit completes the audit chain Audit can itself be regarded as an integrated system, viz External audit (partly) relies on internal audit Legislative follow up of external audit completes the audit chain

7. Audit Adding Value to PFM Where can audit add value to the PFM system ? Firstly some caveats • If systems are broken, priority must be to fix them • Audit may identify systems problems - and should propose remedies • But strengthening audit should not divert scarce technical resources (e.g. accounting and information technology skills) from fixing the problem • Audit generally adds more value where there is something to audit viz - a functioning PFM system, - including auditable financial statements • Reporting each year a litany of problems, which are already known, and which are not being addressed does not necessarily add value

8. Audit Adding Value to PFM (cont’d) • Audit must support reforms, can be a catalyst for PFM reforms (and public sector reforms generally) • Audit pro-active review of the budget execution and financial reporting systems, identifying problems and suggesting solutions, may be particularly useful • Consider now the value audit may add through - compliance auditing - anti-corruption focus - financial auditing - performance auditing

9. COMPLIANCE AUDITING • A key aspect of improving PFM • Reviewing adherence to the financial control framework and the robustness of the framework • A priority focus in countries with poor governance • Internal audit has a key role here • The control framework aims to assist in budget execution, facilitate the correct flow of funds • And avoid divergence of funds through corruption or other factors • Many financial controls are established to guard against corruption or improper practices e.g procurement rules, payroll controls

10. Auditing and Corruption • Corruption is a major impediment to good governance and poverty reduction • Audit does not exist specifically to prevent or uncover corruption - an expectation gap here ? • But good auditing will prevent and uncover corruption • Public sector auditing has a more pro-active focus on detecting and deterring corruption, than private sector • But is this more the role of specialized investigative or anti-corruption bodies ?

11. Financial Audits • Often no adequate published financial statements – and they may be years late • The main financial statements are often the budget documents - or budget execution reports - which are not audited • Financial auditing should add credibility to financial statements • World Bank sees improved financial auditing as playing a major role in fiscal transparency

12. Performance Audits • Many variations on scope and methodology of performance auditing • Is there value in performance auditing in the absence of performance measurement, let alone a performance management regime • Perhaps the skills needed in performance auditing be better used in performance management - for example in developing and monitoring sectoral strategies, feeding policy issues into the budget, program evaluation within ministries etc ? • General World Bank view is skepticalof priority of performance auditing in developing countries

13. Key Issues in Audit Performance • Need to move from independence and beyond capacity to impact • ability to review and report in a timely manner • reports which are acted on by the government and which improve PFM - and public sector performance • but audit independence is important , as is authority, right to report and coverage of all public sector organizations • capacity is also important - quality of the diagnosis and recommendations and significance of cases and issues raised • and timeliness and quality of the audit reports, using professional auditing methodology and standards • Resolving expectation gaps - audit does not provide absolute assurances about correctness, probity or legality

14. Key Issues in Audit Performance (cont’d..) • and quality of advice to management (management letters) • and follow up by audit committees, legislatures etc. • Audit institutions also need to be accountable - self assessment, independent review and peer review • collaboration, not competition between internal and external auditing • but how do we create a demand for good auditing ? • from the executive as well as the legislature and the public in the case of external auditing • from management in the case of internal auditing, seeing it as value adding

15. What good auditing looks like • Constructive engagement with the client, not "gotcha" approach • Correct diagnosis of problems and clear, timely reporting on them • Identifying significant systemic issues - focus on "road conditions, not traffic accidents“ • Materiality and risk, not just formality and legality • Audit institutions as a major source of information on the functioning of the PFM system • feeding into PFM diagnostic studies (World Bank CFAAs and PERs, IMF Fiscal Transparency Reviews)

16. What good auditing looks like (cont’d) • External audit respected as a guardian of the public interest • Internal audit regarded as eyes, ears and advisor of senior management • Audit as a supporter of reform and a catalyst for change

17. The World Bank and public sector auditing • The Bank perceives significant problems in the quality and impact of public sector auditing in developing countries • World Bank strategy to work on this - diagnosis of audit quality and impact as part of PFM diagnostics (CFAA etc) - review acceptability of audit institutions as auditors of Bank financed projects • work collaboratively with other donors on audit capacity building, promoting twinning and peer review • While at the same time improving our understanding of different audit models - and avoiding a one size fits all approach

18. Conclusions • Sound PFM is crucial in achieving poverty reduction • Auditing is a key aspect of PFM - improving the internal control framework and adherence to it - thereby improving budget execution - and reducing corruptions risks - contributing to improved fiscal transparency - a catalyst for PFM reforms in particular, and public sector reforms generally