Select Committee on European Scrutiny Seventh Report


BUDGET AID TO ACP COUNTRIES

(22721)
11670/01
Special Report No. 5/2001 of the Court of Auditors on counterpart funds from structural adjustment support earmarked for budget aid (seventh and eighth EDFs).


Legal base:
Deposited in Parliament: 2 October 2001
Department: International Development
Basis of consideration: EM of 10 October 2001
Previous Committee Report: None
To be discussed in Council: No date set
Committee's assessment: Politically important
Committee's decision: Not cleared; referred to the International Development Committee for its Opinion

Introduction

10.1  The Court of Auditors' Special Report examines the European Commission's monitoring of the use of the counterpart funds from the European Development Fund (EDF) support for structural adjustment programmes in countries of the ACP (African, Caribbean and Pacific).

10.2  The EDF support in question finances development co-operation under the Fourth Lomé Convention. This is an agreement between the European Community and its Member States and the ACP countries, which has now been superseded by the Cotonou Agreement.

10.3  At the beginning of the 1980s many ACP countries had substantial balance of payments and budget deficits, which they financed by recourse to external debts on a scale that was often excessive, compared with their growth and revenue prospects. Structural adjustment support under Lomé was provided by the Community as a contribution to macro-economic programmes led by the International Monetary Fund (IMF) and the World Bank to help these ACP countries out of their difficulties. The structural adjustment programmes aim to restore economic equilibrium and reduce their domestic (budget) and external (balance of payments) deficits.

10.4  The EDF contributions are paid, in euros, into an account opened by the beneficiary government, usually with its central bank. The counterpart from the beneficiary country of these contributions is made in the form of a deposit of the equivalent amount in national currency in a bank account, with two signatories,[46] with the same bank. They take the form of:

    —balance-of-payments support which contributes to the economic and financial equilibrium of each country, within a framework co-ordinated by the IMF; and

    —support for the budgets of the beneficiary countries, with priority given to the social sector.

10.5  Each programme is subject to a financing agreement between the Commission and the beneficiary government and, in most cases, includes conditions and procedures for using the counterpart funds, mostly to support public expenditure within the country's budget.

The audit

10.6  Summarising its findings, the ECA says that it found some weaknesses in the Commission's management of budget expenditure targeting, the provision of funds, the use of technical assistance, auditing and the administrative organisation of the Commission departments. These confirmed the importance for the Commission of:

    "monitoring more closely the quality of public finance management in beneficiary countries, the volume and regularity of the social sector expenditure and the refocussing of programmes, in co-ordination with all the parties concerned, in order to achieve effective poverty reduction in the beneficiary countries."

10.7  The Commission's controls of expenditure were not always effective because the data on the implementation of budgets were, in some cases, non-existent or inaccurate. Technical assistance was under-used. A positive finding was that from 1998 onwards the Commission's organisation of its audit of programmes improved.

10.8  The ECA cautions that:

    "Given the weaknesses in the national implementation and control procedures for public expenditure, it is unrealistic to think that in the priority sectors, the beneficiary States' expenditure will always be effected regularly and will have a real impact on the level and quality of social services. The reforms that have been undertaken by these countries in the area of public finance management are recent and will only be fully effective in the longer term. The reality of this was confirmed by the audits that have been undertaken by the Commission from 1998 onwards. The budgetary authority must be aware of the inherent risks of the approach that has been adopted, must insist that the risks be evaluated through audits of public expenditure and should endeavour to reduce the extent of them gradually by encouraging effective implementation of reforms in the ACP countries and, in particular, by means of a concerted action by all the donors together."

10.9  In order to improve control over implementation of support and ensure that it develops in line with the new guidelines of the budgetary authority, the ECA recommends that the Commission should:

    "a)base its programmes on a strategy and a plan for the reform of public finance management and on intensive co-ordination between all the parties concerned;

    b)draw up clear guidelines so that its departments are better able to assess progress in the management of public finance in each of the countries concerned and to carry out a qualitative appraisal of the expenditure, otherwise there is a risk that programme objectives might not be achieved;

    c)lay down procedures for monitoring and control of each programme, before the financing agreements are concluded;

    d)effect a better distribution between its own departments of responsibility for monitoring general macroeconomic and institutional support, on the one hand, and, on the other, responsibility for appraising the operation of the social sectors;

    e)in co-ordination with the IMF, improve the predictability of annual budget support, irrespective of the source of the funding; and

    f)within the framework of multilateral approaches, integrate its sectoral support into the budgets of the beneficiary countries wherever possible."

Programme design: scope of expenditure targeting

10.10  In giving discharge to the Commission in respect of the sixth, seventh and eighth EDFs for the 1998 financial year, the European Parliament (EP) said that the use of counterpart funds suffered at times from inadequate management, poor supervision and insufficient evaluation.[47] The audit is a follow-up to this Resolution. It assessed the Commission's supervision of the use of the counterpart funds, not the structural adjustment programmes themselves.

10.11  In all the countries where the EDF provides structural adjustment support, the IMF exercises surveillance over public finance in general. In 1996 the World Bank observed that, given the fungibility[48] of all government funds, it was more important for the Bank, in the context of structural adjustment loans, to look at the foreign exchange reserves and budget management as a whole, rather than concerning itself with the detailed application of its aid. At the time of the seventh EDF, the Report says that fund-providers in general were still only moderately interested in the qualitative aspects of public expenditure, which was why, starting with the audits of counterpart funds undertaken from 1995 onwards, the Commission gradually began to seek assurance as to the regularity and relevance of public expenditure by beneficiary countries in the sectors targeted by counterpart funds. However, it often confined itself to identifying expenditure to the amount of the Community finance, despite the fungibility of the budget support provided. In 2000, the Commission recognised the limited effectiveness of targeting, as well as its perverse effects, in certain cases, on the procedures and deadlines for budget implementation, but the Report says it has still to define its approach to controlling expenditure, by seeking joint action with other donors.

Programme design: choice of target expenditure

10.12  The report comments:

    "In many countries the IMF considers that the question of domestic arrears is crucial, because of its repercussions on the country's financial situation, as well as that of the private sector, and the banking sector in particular. Assuming responsibility for the arrears helps to redress the financial situation. It also makes it possible to free up resources quickly and can be equated with general budget support. There is, however, a risk that by taking over the residual results of past bad management or unauthorised expenditure, donors will take the responsibility away from the authorities and endorse the practices that gave rise to the arrears. Moreover, providing the finance to clear arrears constitutes action to correct public finance only if it is part of effective reforms that will prevent their resurgence."

10.13  The report comments that the Commission Communication of February 2000 on Community support for economic reform programmes and structural adjustment[49] gave very few figures concerning the nature of the target expenditure. In particular, there was no mention of the fact that, according to the Commission's estimates, taking over the arrears absorbed about 7% of the support from the seventh EDF.

Controlling programme execution

10.14  The report says:

    "The Commission divided the structural adjustment support among the eligible countries for two-year periods. As the Commission did not think it possible to obtain reliable budget deficit statistics for the various countries, the link between these allocations and real financial needs is tenuous and is only one of the criteria for allocating resources. In the case of Senegal in 1998, whereas the Commission had provided the EDF Committee with justification for the Community support on the grounds of immediate financial need, at the end of 2000, ... (10.7 million euros) remained unutilised in the counterpart funds account and the authorities appeared to be in no hurry to use it."

10.15  Attention is also drawn in the report to the calendar used by the Commission in making support available. Under the prevailing system, beneficiary countries cannot be certain of financial support until just before it is actually disbursed by the Commission staff, often at the end of the financial year and after the countries in question have drawn up the budget for the financial year for which the support was programmed. Delays also occurred in the creation of the counterpart funds by the central bank and in the transfer of funds to the general treasury accounts. The ECA comments:

    "This situation does not make it any easier for beneficiary countries to meet their foreign and domestic payment deadlines, nor does it help them avoid a build-up of payment arrears."

10.16  It illustrates the point with an example:

    "In Malawi, a payment of 16 million euro scheduled for July 2000 was disbursed by the Commission at the end of December 2000, after several reminders from the Delegation to Commission headquarters. For its part, the central bank was late in paying funds into the counterpart funds account, for the previous payment. The World Bank has estimated that the financial cost to Malawi of payment delays by all fund-providers is around 11 million US dollars per year."

10.17  There is, the report says, no generally agreed practice among the IMF and the beneficiary countries as regards the procedures and timetable for incorporating Community financial support into the national accounts.

10.18  In several of the Commission Delegations, checks on bank statements and the conversion rates applied were insufficient. In Mozambique, the exchange rate applied by the central bank in order to constitute the counterpart funds was 3% below the most favourable rate. Furthermore an additional 1% was levied by way of handling charges. According to the Court's estimates, the margin thus obtained by the central bank was _4 million. In Mozambique and Senegal, the Delegations did not have any bank statements that could be used to check that the counterpart funds had been set up correctly.

Use of technical assistance

10.19  There were very marked variations in the use of technical assistance. Technical assistance budgets were under-utilised and often late in terms of the timetable for releasing the counterpart funds, to such an extent that, at the end of 2000, only 31% of the total finance available had been paid out.

10.20  The ECA recommends that:

    "Technical assistance for beneficiary administrations should be clearly distinguished from the technical assistance that helps EDF authorising officers and the Commission Delegations to fulfil their obligations".

Auditing

10.21  The financing agreements provide for financial audits to be carried out at the instigation of the Commission or of the national authorities. In only two countries were the audits carried out annually, covering all the support for one budget year, rather than covering one or several programmes over a number of financial years. The ECA found that annual audits made a more timely contribution to programme monitoring. They intermeshed with the budgetary arrangements and reinforced the national public finance control systems.

10.22  Before 1998, the audits financed under the programmes rarely highlighted the internal control weaknesses that affected the use of the counterpart funds. Irregularities in Côte d'Ivoire of ineligible expenditure amounting to _44 million gave the Commission "a better idea of the risks associated with its approach". The financial audits subsequently ordered by the Commission proved to be much more effective. The report says:

    "These arrangements are a significant advance in the Commission's attention to tangible reform of the mechanisms for sound management of budget execution in beneficiary countries."

10.23  However, it says in its final appraisal that:

    "It is important for these audits to be retained, but there is no guarantee that there will be provision for this under the current reorganisation."

10.24  The report adds that:

    "Any ineligibility discovered did not result in funds being repaid to the EDF, but in several cases new programmes were suspended pending corrective action".

The Commission's administrative organisation

10.25  When the emphasis of the programme switched to budget aid and the quality of public finance management, the two precise sets of instructions on the procedures for monitoring counterpart funds, which dated back to 1991, were not updated. The report says:

    "It would have helped the Delegations to be consistent in their monitoring of different countries and managers had they been able to consult detailed information on the role of technical assistance, conditions for the release of counterpart funds to the general exchequer accounts, the line to be followed as regards arrears and the refinancing of past expenditure, respect for the annuality of the budget, and the nature and scope of the checks to be made by the various parties concerned. In most of the financing agreements this omission was remedied by a reference to subsequent protocols of agreement, which in many cases continued to be terse or irrelevant".

10.26  The Commission services responsible were "afflicted" by the lack of organisation in file management. The report says:

    "Given the heavy workload, the amounts at stake, the small number of staff and the high staff turnover, these departments should be able to rely on an information system that is rigorously maintained, complete and reliable".

and, later:

    "As of end-2000, however, the Commission, in the context of its reform of external aid, had still not defined the human resources and skills required at headquarters and in the Delegations to monitor the use of budget aid, particularly as regards the overall qualitative appraisal of public finance management".

Public finance management

10.27  The report points out that, since EDF budget support is subject to the beneficiary country's public expenditure procedures, it is subject to the same internal controls, and therefore the same risks, as expenditure that is financed from national income. It differs in this respect from project aid, which is implemented according to the procedures imposed by individual providers. Yet, it was not until 1998 that the Commission began to carry out qualitative appraisals of public expenditure management in ACP countries.

10.28  Reforms of public finance in most of the countries examined focussed initially on the framework for drawing up budgets. The place of the public sector in social policies, and the capacity of governments to collect and analyse sectoral statistics, have still not received sufficient attention. The ECA considers these aspects essential to any appraisal of the sectoral effects of budget finance, as NGOs and religious organisations often provide a substantial proportion of the social services available to the population.

10.29  The report details shortcomings in expenditure procedures. These were fairly similar from one country to another and included:

    "Imperfect mastery of procurement procedures [which] led to excessive costs, because contracts were not put out to tender".

10.30  It comments that the recent reforms in a number of the countries under review must be welcomed as a very positive advance. Nevertheless, it says, they are still far from providing assurance that there is a sound institutional framework and it is difficult to judge how long it will be before they begin to take effect.

10.31  In 1999, the World Bank began to evaluate beneficiary countries' ability to account for the implementation of their national budgets. In early 2001, the Commission and the World Bank considered introducing an enhanced form of co-operation, with joint objectives and pooled financial resources.

Volume of expenditure in social sectors

10.32  The ECA found it difficult to establish "a chain of causality between increased expenditure in social sectors and EDF aid". In some countries "it was not possible to discern any relationship between the support provided and the budget input to the social sectors".

General appraisal

10.33  In its general appraisal, the ECA comments that, because counterpart funds are made available as part of the national public expenditure procedures in beneficiary countries, and because of the inherent risk of those procedures, it is unrealistic to think that the quantitative objectives being pursued in the priority sectors can be achieved without any hitches, that expenditure will always be executed regularly, and that it will always have a positive impact on the situation in the social sectors.

10.34  The desire to provide balance of payments support and support for social sector budgets simultaneously sometimes affected decision-making. Controls on counterpart funds, in some cases were reduced to:

    "formal administrative justification and ex post facto checks on expenditure with no direct relation to properly functioning, government-run, social services for the benefit of vulnerable and disadvantaged people."

10.35  The Commission's headquarters departments did not pay sufficient attention to certain aspects of overall supervision nor to the technical aspects of the use of programme funds. The ECA says, however, that the new guidelines, and especially the increased importance attached to strengthening the management and control of public finance, should improve the effectiveness of the mechanism, provided that the framework for monitoring reforms has been improved, by means of institutional support if necessary, and that the Commission deploys appropriate resources to ensure that implementation is consistent and co-ordinated with the main providers of funds.

The Commission's response

10.36  The Commission's response, headed by a summary, is attached to the document.

10.37  Amongst points made, the Commission notes that macroeconomic programmes in which the Bretton Woods Institutions[50] play a major role are complex and that it has sought to make sure that its concerns are taken into account, such as shielding priority sectors. While other donors have confined themselves to providing aid for cash-flow, the Commission has sought to make sure that its aid promoted spending in these sectors. But it is vital, it says, that developing countries improve their management of public finances. This will obviously take time and will have to be done in stages. Its approach has been consistent with the principles laid down in the Lomé Convention: respect for countries' priorities, a realistic pace of reforms, adaptation to needs and flexible implementation.

10.38  However, the Commission says that it endorses the recommendations of the ECA, which reflect the guidelines followed in the programmes implemented over the past two years: increased co-ordination under the Poverty Reduction Strategy Papers, pursuit with the Bretton Woods Institutions of common instruments for assessing the quality of the management of public finances, increased importance of issues related to public finances, development of budget performance indicators and performance indicators in the social sectors. New instructions based on developments in its practices and those laid down in the Cotonou Agreement are now being finalised.

10.39  In response to the ECA's proposal that the overall quality of public finances should be assessed with other donors, using specified indicators, the Commission undertakes to specify the monitoring arrangements in the financing agreements, rather than in protocols for the use of counterpart funds. In addition, it will check that a sum equivalent to its aid has enabled basic expenditure in the priority sectors to be properly financed. It selects as these sectors: audited arrears, wages of primary schoolteachers, nurses and doctors and other expenditure vital to reducing poverty.

Conclusion

10.40  The European Court of Auditors has produced a penetrating analysis of a complex situation, accompanied by some highly educational examples of how budget aid can fail to fulfil the good intentions of the donors. The Court includes some criticisms of the Commission, but balances these with an acknowledgement of the weaknesses in the national implementation and control procedures for public expenditure of the beneficiary countries. In its defence, the Commission says that it is vital that developing countries improve their management of public finances.

10.41  The Court includes words of caution to the budgetary authority to be aware of the inherent risks of the approach adopted by the Community in providing this type of support to African, Caribbean and Pacific countries and goes on to make a number of sound, practical recommendations. Some appear to be no more than common sense, raising the question of why these measures were not put in place before. Perhaps there was some reluctance on the part of the Commission to take what might have been seen by the beneficiaries as intrusive steps. Recent reforms, such as the obligation for beneficiary countries to draw up Poverty Reduction Strategy Papers, against which the allocation of funds can be checked, are a welcome move in the direction of jointly agreed objectives. The Commission accepts the recommendations and adds further undertakings of its own to meet additional points made in the report.

10.42  In 1998, after irregularities in Côte d'Ivoire amounting to _44 million, the Commission ordered financial audits which proved to be much more effective. The European Court of Auditors says that these were significant reforms, but that there is no guarantee that they will be retained under the current reorganisation of the Commission.

10.43  We consider it appropriate to refer this report to the International Development Committee for its Opinion, in the context of its inquiry into The effectiveness of the reforms of European Development Assistance.

10.44   Meanwhile we do not clear the document.


46  Joint signatures of the Commission Delegate and the national authorising officer. Back

47  OJ No. L 234, 16.9.2000, p.1. Back

48  That is, which are perfectly substitutable. Back

49  (21000) 6191/00; see HC 23-xiv (1999-2000), paragraph 11 (12 April 2000). Back

50  The International Monetary Fund and the World Bank. Back


 
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