Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 89023 v2 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix May 24, 2020 Page 1 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix CONTENTS Section 1. Theme One: Strengthening PFM Legal And Institutional Framework ................................ 8 1.1 Legal and Institutional Framework ..............................................................................................................8 1.2 Fiscal Responsibility Legislation In Karnataka .......................................................................................... 12 1.3 Updating PFM Manuals and Codes ........................................................................................................... 15 1.4 Strengthening Internal Financial Advisors ................................................................................................. 16 Section 2. Theme Two: Enhancing Credibility and Comprehensiveness of the Budget ...................... 18 2.1 Budget Process ........................................................................................................................................... 18 2.2 Passing Full Budget before start of the Year .............................................................................................. 19 2.3 Comprehensiveness of Budget Documentation.......................................................................................... 20 2.4 Credibility of Budget – Expenditure Outturn and Composition ................................................................. 22 2.5 Credibility of the Budget- Revenue Forecasting and Outturn .................................................................... 25 2.6 Supplementary budgets .............................................................................................................................. 29 2.7 In-year Adjustments to Budget Allocation – Rules of Re-Appropriation .................................................. 33 2.8 Predictability of Availability of Funds ....................................................................................................... 34 2.9 Estimation of Salaries ................................................................................................................................ 39 2.10 Managing Public Investment Funding ....................................................................................................... 40 2.11 Rationalization of Schemes ........................................................................................................................ 44 2.12 Departmental Medium Term Fiscal Plans .................................................................................................. 45 2.13 Strengthening Legislative Scrutiny of Budget ........................................................................................... 46 Section 3. Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency .......... 50 3.1 Accounting and Reporting ......................................................................................................................... 50 3.2 Treasury Management ................................................................................................................................ 66 3.3 Cash Management ...................................................................................................................................... 73 3.4 Subsidies- Targeting, Accountability and Transparency ............................................................................ 75 3.5 Payroll Controls - HRMS ........................................................................................................................... 78 3.6 Procurement (KTTP and E-Procurement) .................................................................................................. 81 3.7 Public access to Key fiscal information ..................................................................................................... 85 Section 4. Theme Four: Improving Fiscal Assets and Liability Management System ......................... 90 4.1 Government Guarantees ............................................................................................................................. 90 4.2 Off Budget Borrowings .............................................................................................................................. 93 4.3 Investments in Government Companies ..................................................................................................... 96 4.4 Debt Management Recording and Reporting ........................................................................................... 100 4.5 Loans and Advances ................................................................................................................................ 105 4.6 Monitoring Arrears of Payments .............................................................................................................. 108 Page 2 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 4.7 Unencashed Cheques ............................................................................................................................... 111 Section 5. Theme Five: Strengthening Audit and Legislative Oversight ............................................ 114 5.1 Effectiveness of Internal Audit ................................................................................................................ 114 5.2 External Auditing - Responsiveness ........................................................................................................ 118 5.3 Strengthening Karnataka State Accounts & Audit Department (KSAD) ................................................. 122 5.4 Legislative Review – External Audit ....................................................................................................... 129 Section 6. Theme Six: Improving PFM in Local Self Governments ................................................... 134 6.1 Local Self Governments - Overview ........................................................................................................ 134 6.2 Urban Local Bodies and PRIs – Common Issues and Recommendations ............................................... 138 6.3 Urban Local Bodies –Recommendations ................................................................................................. 139 6.4 Panchayat Raj Institutions –Recommendations ....................................................................................... 139 6.5 Accounting Reforms - Urban Local Bodies ............................................................................................. 140 6.6 Accounting Reforms – Gram Panchayats ................................................................................................ 141 Section 7. Theme Six: Improving PFM in State Owned Enterprises (SOE) ..................................... 143 Section 8. 2014 Reform Action Plan – Suggested Next Steps.............................................................. 150 Section 9. Annexures ............................................................................................................................ 162 9.1 Assessment of internal audit function in Karnataka – C&AG ................................................................. 162 9.2 Note On Internal Audit Practices in GOI and other States ....................................................................... 165 9.3 Note on Legislative committees ............................................................................................................... 167 9.4 Note on IFMIS ......................................................................................................................................... 169 Page 3 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix LIST OF TABLES Table 1: Legal Framework of Public Financial Management in Karnataka ..............................................................10 Table 2: Numerical Rules in Karnataka Fiscal Responsibility Act and status of compliance .....................................13 Table 3: Budget Documentation 2013-14 in GoK .......................................................................................................21 Table 4: Comprehensiveness of information included in Budget Documentation in GoK ..........................................21 Table 5: Budgeted vs. Actual expenditure of GoK, net of debt service ........................................................................23 Table 6: Primary and Compositional Expenditure Variance ......................................................................................23 Table 7: Compositional Expenditure Variance of > 5% in GoK Departments ...........................................................24 Table 8: Transactions in the Contingency Fund ..........................................................................................................25 Table 9: Budgeted and Actual Revenue of GoK ..........................................................................................................26 Table 10: Comparison of RE and Actuals with Original Budget .................................................................................27 Table 11: Revenue out turn of Own Resources compared to Original Budget ............................................................27 Table 12: Revenue Outturn for Commercial Tax Department.....................................................................................28 Table 13: Revenue Outturn for Excise Department .....................................................................................................28 Table 14: Supplementary Estimates as a percentage to Original Estimates in GoK...................................................30 Table 15: Karnataka - Original and Supplementary Estimates and Savings ..............................................................30 Table 16: Financing the Supplementary Estimates .....................................................................................................32 Table 17: Powers of Re-appropriation in GoK ..........................................................................................................33 Table 18: Trend of issue and quality of Re-appropriation Orders in GoK..................................................................33 Table 19: Delegation of Financial Powers presuming concurrence of Finance Department ....................................36 Table 20: Actual Expenditure as % of total for the quarter and cumulative ..............................................................37 Table 21: Decrease in Rush of Expenditure ...............................................................................................................38 Table 22: Pace of Expenditure in Government of India ..............................................................................................38 Table 23: Public Investment or Plan Expenditure in GoK ..........................................................................................41 Table 24: Status of IGAS and IGFRS ..........................................................................................................................51 Table 25: Progress of Reconciliation of Revenue and Expenditure ............................................................................53 Table 26: Personal Deposit Accounts not closed at end of financial year ..................................................................54 Table 27: Outstanding Utilization Certificates ............................................................................................................55 Table 28: Outstanding Utilization Certificates in Sample States ................................................................................56 Table 29: Percentage of Receipts and Expenditure accounted for under Account Head 800 in Govt. of Karnataka .56 Table 30: Percentage of Receipts and Expenditure accounted for under Account Head 800 in Sample States ..........56 Table 31: Key Recommendations made by XIII CFC for Disclosure in Budget/Finance Accounts ............................65 Table 32: Modules of KII.............................................................................................................................................70 Table 33: Cash balances of GOK ................................................................................................................................73 Table 34: Major Explicit Subsidies in Karnataka .......................................................................................................76 Table 35: Comparison of KTTP with Rajasthan Procurement Act ..............................................................................82 Table 36: Details of progress in e-procurement ..........................................................................................................84 Table 37: Public availability of year-end financial statements ...................................................................................87 Table 38: Public availability of State External Audit Reports in Karnataka ...............................................................87 Table 39: Aggregate Guarantees Issued and Outstanding ..........................................................................................90 Table 40: Off Budget Borrowings in SOE/SPVs of Government of Karnataka ...........................................................94 Table 41: Provision of Debt Servicing in State Budget for Urban Local Bodies ........................................................95 Table 42: Book Value of Investments of Government of Karnataka ............................................................................96 Table 43: Reconciliation issues in Investments ...........................................................................................................97 Table 44: Borrowings or Public Debt of Government of Karnataka .........................................................................100 Page 4 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Table 45: Public Debt level (Total Liabilities) prescribed by KFRA compared to actual (percent of GSDP) ..........100 Table 46: Debt Sustainability Analysis conducted by the C & AG for GoK ..............................................................102 Table 47: Institution-wise outstanding of Loans and Advances in GoK ....................................................................105 Table 48: Arrear of Expenditure Bills in Public Works Department, Karnataka ......................................................109 Table 49: Unencashed cheques under major head 8670 ...........................................................................................112 Table 50: Effectiveness of Internal Audit ..................................................................................................................116 Table 51: Status of Compliance of Inspection Reports – Revenue Sector .................................................................119 Table 52: Status of reply to Draft Audit Paras ..........................................................................................................119 Table 53: Status of pending Action Taken Reports ....................................................................................................119 Table 54: Status of Meetings of Audit Ad Hoc Committees .......................................................................................120 Table 55: Pendency of Revenue leakage reported by C&AG in Commercial Tax Department ................................120 Table 56: KSAD strengths and weakness ..................................................................................................................123 Table 57: Status of outstanding audits as on 31.03.2014 ..........................................................................................126 Table 58: Mandate of Legislative Committees for review of external audit reports .................................................130 Table 59: Financial assistance to ULBs & PRIs (Rs. in crores) ...............................................................................135 Table 60: Accounts and audit report – Current Status ..............................................................................................140 Table 61: GPs Accounts Current Status in Panchatantra .........................................................................................141 Table 62: Profile of SOEs in Government of Karnataka ...........................................................................................143 Table 63: PFM Issues in Karnataka PFM – Status of 2004 PFMA Recommendations ............................................145 Table 64: Action and suggested next steps for implementation .................................................................................150 Table 65: Year wise Number Reports issued by CoPA ..............................................................................................167 Table 66: Year wise Number of Hearings held by CoPA ..........................................................................................167 Table 67: Year wise Number of Hearings held by CoPU ..........................................................................................168 Page 5 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix ACRONYMS AFS Annual Financial Statements IFA Internal Financial Advisors AG Karnataka Accountant General (Accounts (A&E) and Entitlement) IFAC The International Federation of Accountants AG Integrated Financial Management (Audit) Karnataka Accountant General (Audit) IFMIS Information System ALMC Asset Liability Monitoring Cell IGAS Indian Government Accounting Standards Indian Government Financial Reporting AMS Audit Monitoring System IGFRS Standards International Public Sector Accounting ATR Action Taken Report IPSAS Standards BE Budget Estimates KBM Karnataka Budget Manual Comptroller and Auditor General (India's C&AG KFC Supreme Audit Institution) Karnataka Financial Code 1958 CCO Chief Controlling Officer KFRA Karnataka Fiscal Responsibility Act, 2002 CGA Comptroller General of Accounts KII Khajane II Committee on Local Bodies and Panchayati CoLB Raj Institutions KPR Act Karnataka Panchayat Raj Act, 1993 CoPA Committee on Public Accounts KSAD Karnataka State Accounts Department CoPU Committee on Public Undertakings KTC Karnataka Treasury Code 1963 KTTP Karnataka Transparency in Public CSS Centrally Sponsored Schemes Act Procurement Act, 1999 CTD Commercial Taxes Department LOC Letter of Credit DCB Demand Collection Balance MCE Manual of Contingent Expenditure 1958 DDO Drawing and Disbursing Office MIS Management Information Systems Double entry accrual based accounting DEAS system MTFP Medium Term Fiscal Plan DMA Directorate of Municipal Administration NLTA Non-Lending Technical Assistance DMTFP Departmental Medium Term Fiscal Plan OBB Off Budget Borrowings DoFP Delegation of Financial Powers PAC Public Accounts Committee PD DOT Directorate of Treasuries Account Personal Deposit Account Department of Personnel & Administrative Public Expenditure and Financial DPAR Reforms PEFA Accountability Public Financial Management and DPE Department of Public Enterprises PFMA Accountability Departmentally Related Standing DRSC Committees PMS Project Management Software DSS Directorate of Small Savings PPP Public Private Partnership Panchayat Raj Institutions (Rural Local EIU Economic Intelligence Unit PRI Governments) ERC Expenditure Reforms Commission PSE Public Sector Enterprises FC Central Finance Commission SOE Public Sector Undertakings FD Finance Department of GoK PWD Public Works Department FMRC Fiscal Management Review Committee RBI Reserve Bank of India Fiscal Responsibility and Budget Department of Rural Development and FRBM Management Act, 2003 RDPR Panchayati Raj FRL Fiscal Responsibility Legislation RE Revised Estimates FY Financial Year RTI Act Right to Information Act, 2005 Government Accounting Standards Advisory GASAB Board SE Supplementary Estimates GDP Gross Domestic Product PFMA State Finance Accountability Assessment GFS Government Finance Statistics SFC State Finance Commission GIA Grants in Aid SPV Special Purpose Vehicles GoI Government of India TP Taluk Panchayats (Block level Rural Local Page 6 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Government) GoK Government of Karnataka UC Utilization Certificates Gram Panchayats (Village level Rural Local GP Government) UDD Urban Development Department GSDP Gross State Domestic Product UID Unique Identification Urban Local Bodies (Urban Local HoD Head of Department ULB Governments) HRMS Human Resource Management System VOA Vote on Account IAW Internal Audit Wing WRD Water Resources Department Zilla Panchayats (District level Rural Local IDF Institutional Development Fund ZP Government) Page 7 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Section 1. THEME ONE: STRENGTHENING PFM LEGAL AND INSTITUTIONAL FRAMEWORK 1.1 LEGAL AND INSTITUTIONAL FRAMEWORK Framework of key PFM Institutions in Karnataka 1. Karnataka follows a parliamentary system of governance, modeled on the Westminster system, with three distinct branches of government namely the Legislature, the Judiciary and the Executive. Karnataka has a bi-cameral Legislature consisting of two Houses: the Legislative Assembly comprising of members directly elected through adult 1 franchise, and the Legislative Council with members elected or appointed by various groups through an electoral college . The Governor, who is the constitutional Head of State, is appointed by the President of India. The Council of Ministers, headed by the Chief Minister, exercises all executive powers of the state. The Chief Secretary is the head of the administrative service. 2. The State Government is organized by departments primarily on functional lines. There are 37 departments under 28 Administrative (or Secretariat) Departments dealing with subjects such as finance, planning, public works, health, education, social welfare, and energy. These Administrative departments are responsible for policy formulation and also oversee the “field� departments attached to them. Each Administrative department is headed by a Principal Secretary or Secretary (an officer of the Indian Administrative Services – IAS), who reports to one or more ministers. Administratively, Karnataka is divided into four revenue divisions (Bangalore, Mysore, Belgaum and Gulbarga), 49 sub-divisions, 30 districts (headed by a Deputy Commissioner of a District Magistrate from the IAS), 176 Taluks (or blocks) and 5630 Gram Panchayats. Other institutional agencies include the urban and rural local bodies, government companies, statutory corporations, boards and authorities and societies. 3. The key departments, positions and other internal and external institutions that influence PFM in the state are: a. The Finance Department has a Principal Secretary as head of the department. The Finance Department has overall responsibility for fiscal and financial management, including fiscal policy, aggregate fiscal management, budget formulation and administration, cash management, debt management (asset liability monitoring), and financial reporting. The Finance Department also manages the Treasury (which is a big contributor to PFM) which handles receipts and payments for the State Government. The Finance Department has several major departments under its fold such as commercial taxes, excise, insurance, pension, and small savings. b. The Planning Department2 has a Principal Secretary as the head of the department that is divided into several divisions (such as plan finance and resources, human development, plan monitoring and information and project formulation) is involved in allocating and approving Plan expenditure, which represent about 40% of total expenditure of the state. The Planning department produces the five-year and annual plans of the state and also spearheads the preparation of the annual Economic Survey of the State. c. The Heads of the Departments - HoD (usually Principal Secretaries or Secretaries) are principal officers responsible for their departments’ activities, for the proper use of funds, and for internal controls within their departments. Departments are responsible for monitoring adherence to budgets, for performance, and for 1 25 elected by the Legislative Assembly members; 25 by the local authorities; 7 each by graduates and teachers; and 11 nominated by the Governor of Karnataka 2 Full name of the department is Planning, Program Monitoring and Statistics Department | Theme One: Strengthening PFM Legal And Institutional Framework 8 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix authorizing payment of expenditures. PFMA functions in the departments are looked after by an Internal Financial Advisor (in some of the major departments) or financial advisors deputed from the Finance Department/Karnataka State Accounts Department. The day to day PFM responsibilities are primarily with Drawing and Disbursing Officers (DDO) at all levels of each department who is responsible for all expenditure in the designated office and the main link between the department and the Treasury. d. The State Finance Commission (SFC) constituted under the Constitution of India (Article 243) every five years recommends the principles for the distribution of the net proceeds of the taxes, duties and fees, and grants to be provided by the State to the urban and rural local bodies. In Karnataka, three SFCs have submitted their reports, and the recommendations influence PFM in urban and rural local bodies. e. The Comptroller and Auditor General of India (C&AG) through the offices of the Principal Accountant General – Accounts and Entitlement (PAG – A&E) and Audit (PAG – Audit) play a major role in the PFM environment in the state. The PAG (A&E) is vested with the accounting function of the state it compiles the accounts of Karnataka, and prepares the monthly accounts, and annual accounts of the State Government – the Finance Accounts and Appropriation Accounts – that are tabled in the State Legislature post audit. The AG (Audit) is the external auditor of the government and audits all government departments and entities except the ULBs and Gram Panchayats. The reports of the AG (Audit) provide an account of the working of PFM, and the main reports (six such reports are issued every year) are tabled in the State Legislature. The external independent audit of the local bodies (such as ULBs, Gram Panchayats, universities and funds) is vested in the Controller, Karnataka State Accounts Department (KSAD). f. KSAD is one of the key departments of GoK which supports both accounting and auditing functions 3 for GoK. KSAD functions under the direct control of the Finance Department and is headed by a Controller who is a senior KSAS staff. It provides accounting support function to all departments across the State and auditing services to those organizations which are not audited by C&AG. g. The audit reports of the C&AG and KSAD are subject to Legislative scrutiny by three committees of the Legislature namely the Committee on Public Accounts (CoPA or the Public Accounts Committee – PAC), Committee on Public Enterprises (CoPU) and Committee on Local Bodies (CoLB) and all these oversight bodies have significant influence on PFM as they enforce follow-up of and compliance with audit reports. Legal Framework for PFM 4. The Constitution of India provides the guidance on several aspects of PFM in state governments in India supplemented by the Government of India and the C&AG. The Constitution inter alia: (i) establishes a central role for the State Legislature in authorizing and overseeing the use of public funds; (ii) requires annual budgets to be presented to the State Legislature, and mandates reporting against these budgets; (iii) appoints the C&AG as the auditor for all states as well as the central government; and (iv) regulates domestic borrowings by state governments (and bars external borrowing). 5. The PFM structures in Karnataka are embodied in its Budget Manual, Financial Rules and Treasury Code and in the Karnataka Fiscal Responsibility Act, 2002, the Ceiling on Guarantees Act, 1999 and Karnataka Transparency in Public Procurement Act, 1999 that cumulatively contain principles covering budgeting, revenue and expenditure, delegation of authority, accounting, procurement, pay, allowances & pensions, stores, works etc. and are supplemented through circulars issued from time to time. These primary documents are supplemented by Government Orders, the Public Works Department 3 KSAD also functions as the treasurer for 309 charitable endowments. KSAD is the authorized agency for calculating and approving the pensionary benefits to the municipal employees. | Theme One: Strengthening PFM Legal And Institutional Framework 9 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Code, the departmental office procedures and other notifications/circulars issued. Table 1 tabulates the legislation, rules, manuals and other key directions that influence PFM in the state. Table 1: Legal Framework of Public Financial Management in Karnataka PFM Legislation and Documents Issued under PFM Area Authority A. Legislation  The Karnataka Fiscal State Legislature To provide inter alia for the responsibility of the State Responsibility Act, 2002 as Government to ensure fiscal stability and sustainability by amended up to 2011 achieving sufficient revenue surplus, reducing fiscal deficit and removing impediments to the effective conduct of fiscal policy and prudent debt management through limits on State Government borrowings, debt and deficits, greater transparency in fiscal operations of the State Government and use of a medium-term fiscal framework.  The Karnataka Ceiling on State Legislature To provide for limits on Government Guarantees issued on Government Guarantees Act, behalf of the government departments, public sector 1999 undertakings, local authorities, statutory boards and corporations and co-operative institutions etc., for promoting fiscal discipline in the State.  The Karnataka Local Fund State Legislature To provide inter alia for the responsibility of Local Fund Authorities Fiscal Responsibilities Authorities to ensure best practice of PFM of local funds by Act, 2003 achieving sufficient revenue surplus, ensuring prudent management of public fiscal operations of the Local Funds and use of a medium term fiscal frame work. Provides a framework for budgeting, accounting and auditing for the Local Fund Authorities, mandates a Medium Term Fiscal Plan for the Local Fund Authorities, lays down principles for financial management, ensures transparency in Fiscal Management at the local level, ensures proper procedure for preparation, submission and audit of accounts and ensures proper scrutiny and adherence to the audit reports.  The Karnataka Transparency in State Legislature To provide for ensuring transparency in public procurement Public Procurement, 1999 of goods and services by streamlining the procedure in inviting, processing and acceptance of tenders by the Procurement Entities.  The Karnataka Municipal State Legislature Comprehensive legislation governing the working of Corporations Act, 1964 municipal corporations in Karnataka.  The Karnataka Municipalities State Legislature Comprehensive legislation governing the working of Act, 1976 municipalities in Karnataka  The Karnataka Panchayat Act, State Legislature Comprehensive enactment governing the working of the 1993 three-tier Panchayati Raj system (rural local bodies).  The Karnataka State Civil State Legislature Act to provide for the recruitment and conditions of service Services Act 1978 of civil servants and the secretarial staff of the Karnataka State Legislature  The Karnataka Conduct of State Legislature To provide for a certain minimum number of days of conduct Government Business in the State of Government business in the State Legislature Legislature Act, 2005 B. Rules and Manuals  The Karnataka Budget Manual Provides for all matters relating to the form and content of the budget including preparation, amendments, approval etc.  The Karnataka Financial Code Article 283 of the Provides for all matters relating to accounts and controls (1958) Constitution | Theme One: Strengthening PFM Legal And Institutional Framework 10 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix PFM Legislation and Documents Issued under PFM Area Authority  The Karnataka Treasury Code Article 283 of the Deals primarily with the procedure to be followed and the (1963) Constitution initial accounts to be kept at the State Treasuries, and with the accounts returns to be rendered by the Treasuries to the Accountant General. These rules are supplementary to the Financial Code.  The Karnataka Public Works Provides for all matters relating to generation of bills, Accounts Rules payments and maintenance of accounts for PWD.  The Karnataka State Accounts Sections 3 and 8 of Provides the method of recruitment and minimum Services (Recruitment) Rules the Karnataka State qualifications for each category of posts of the State Accounts (2011) Civil Services Act, Services along with scheme of examination and syllabus 1978  Karnataka Civil Services Sections 3 and 8 of Provides for compulsory computer literacy test for specified (Computer Literacy Test) Rules the Karnataka State officers of the State Civil Services (2012) Civil Services Act, 1978  Manual of Contingent Article 283 of the Rules for regulating Contingent Expenditure 4 in the state Expenditure (1958) Constitution departments  The Government of Karnataka Defines the role and responsibilities of the Internal Financial (Consultation with Financial Advisor (IFA) and when the departments need to take Adviser) Rules 1982 concurrence from IFA for carrying out financial transactions.  Rules of Procedure and Conduct Article 208 of the Defines the constitution, tenure, quorum and functions of the of Business in Karnataka Constitution Legislative Committees for examination of accounts and Legislative Assembly (2011) audit reports of the state departments, public undertakings and local bodies and PRIs supplemented by the internal rules of the committees C. Other Documents  Reports of the Expenditure Constituted under the To draw up recommendations aimed at improving the quality Reforms Commissions Fiscal Responsibility of expenditure in order to obtain better outputs and outcomes Act keeping with the Legislative mandate given under various provisions of the KFRA  Reports of the State Finance Article 243 of the To review the financial positions of the urban and rural local Commission Constitution bodies and determine the principles for distribution of state taxes to them, determination of taxes by these institutions; recommend measures for improving their financial position, best utilization of resources etc. D. GOI Documents  The C&AG (Duties, Powers Parliament of India Establishes the duties and powers of the C&AG in respect of and Condition of Services) Act, auditing and accounting functions in the states. It provides for 1971 the C&AG to compile the accounts of the states and be its auditor by a combination of law and executive action. This Act provides the duties, responsibilities and powers of the C&AG.  Government Accounting Rules, A set of rules providing uniform form of financial reporting 1990 and accounting standards. 6. Besides the above, GoI also provides significant funds to the state on account of Centrally Sponsored Schemes (CSS) and most of these schemes have prescribed their own set of rules and procedures including PFM which are followed by the state and its agencies. The Central Finance Commissions (CFC) constituted under Article 280 of the Constitution of 4 All incidental and other expenses which are incurred for the management of an office as an office or for the technical working of a department other than items such as works, tools and plant and stock | Theme One: Strengthening PFM Legal And Institutional Framework 11 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix India also make recommendations on strengthening of PFM in the states – thirteen such commissions have been formed so far and their reports are available – the 14th CFC has been formed and is presently functioning. 1.2 FISCAL RESPONSIBILITY LEGISLATION IN KARNATAKA 7. A Fiscal Responsibility Legislation (FRL) requires governments to commit to fiscal policy objectives and strategies that can be monitored. The objective is to improve fiscal outcomes and/or reverse fiscal imbalances and to induce less biased and Fiscal Responsibility Legislation more sustainable and transparent fiscal policy and improve fiscal A legal framework that embeds in law an outcomes. This is one of the instruments of a robust fiscal policy agreed-on set of policies, processes and framework for aggregate fiscal management. arrangements, encompassing the whole PFM process, intended to improve fiscal 8. Karnataka was the first state in India to enact a FRL – the outcomes, discipline, transparency and Karnataka Fiscal Responsibility Act 2002 (the KFRA). The KFRA is a accountability. law separate from the general budget or financial management law and is a rule-based legislation i.e. it not only defines the fiscal responsibility principles but also places limitations on key fiscal policy aggregates in the form of “numerical rules�. KFRA sets the targets for revenue deficit, fiscal deficit, guarantees 5, and total liabilities and, in 2011 introduced a numerical limit for outstanding debt. Definitions for revenue deficit, fiscal deficit and total liabilities have also been included in the Act. These numerical rules have to be applied ex ante i.e. at the time of preparation of the original budget. Notably, off-budget borrowings, by public sector undertakings and special purpose vehicles where liability for repayment is on the GoK is considered for computing fiscal deficit and liabilities and the interest on such borrowings is considered as revenue expenditure. 9. Overall, the KFRA broadly meets the requirements of model fiscal responsibility legislation. The KFRA provides the statutory back up for preparation of Medium Term Fiscal Plan (MTFP ). It prescribes that the budget must be consistent with the objectives and targets of the MTFP, that the fiscal impact of either shortfall in revenue or excess of expenditure over pre-specified limits arising from any new policy should be fully offset, and that supplementary estimates must be accompanied by corresponding curtailment of expenditure and/or augmentation of revenue. The legislation also articulates an “Escape Clause� i.e. the circumstances under which the KFRA limits could be exceeded 6 and the authority to approve such excesses. Disclosure requirements to be made in the state budget documents have been provided. There is also a requirement of submitting a mid-term review report to the state Legislature by the Finance Minister and this has been done up to September 2013 (published in November 2013). 10. In 2011, the KFRA was amended to pave the way for setting up a Fiscal Management Review Committee headed by the Chief Secretary of the State7. FMRC reviews the fiscal and debt position of the State and its progress on fiscal correction path as required under the KFRA. The Committee deliberates in detail a mid-year fiscal and debt parameters and thereafter advises the Finance Minister on the remedial measures to be adopted to ensure adherence to the parameters stipulated in KFRA. The FMRC during the mid-term review of the fiscal 2013/14 focused broadly on the fiscal challenges in the year, resource and expenditure, prudent fiscal management, deficit management and adherence to KFRA amongst others. The committee provided recommendations for enhancing robustness of fiscal position, mobilizing more resources for capital 5 This is covered under the Karnataka Ceiling to Government Guarantees Act, 1999. The Act came into effect from April 1999 with the objective to fix a limit on government guarantees, issued on behalf of the Government Departments, Public Sector undertakings, Local Authorities, Statutory Boards and Corporations and Co-operative Institutions, for promoting fiscal discipline in the state. 6 An Escape Clause provides the numerical rules with the flexibility to deal with exceptional circumstances. In the KFRA, the escape clause is on grounds of unforeseen demands on the state finances due to national security or natural calamity. Such excess need to be approved by the State Legislature and the accompanying report should state the likely extent of the excess and the reasons. 7 Other members of the committee are: PS-Finance, PS-Planning, Economic advisor to the CM, NIPFP representative and Secretary (B&R) who is the member secretary of the committee. | Theme One: Strengthening PFM Legal And Institutional Framework 12 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix formation and improving expenditure effectiveness during the MTFP period. The recommendations of FMRC are essentially aimed at increasing the capital expenditure, minimizing lower priority revenue expenditure, increasing non-tax revenue, ensuring fiscal sustainability and pursuing prudent planning and appraisal mechanisms to improve outcomes. Some of the key recommendations of the FMRC which has bearing on the PFM for the state are: a. Relook into the issue of subsidies. b. Follow-up with departments for improving their non-tax revenues. c. Avoid and moderate inclusion of large expenditure commitments in supplementary estimates. d. Focus on consolidating existing institutions and improving their effectiveness. e. Approve new initiatives and works requiring implementation over multiple years only after reviewing the fiscal sustainability of the total expenditure rather than expenditure during the year of approval only and thereby avoid buildup of fiscal stress due to unfunded expenditure commitments. f. Move over to medium term (3 to 5 years) appraisal and approval cycle for the schemes from the currently practiced annual cycle. g. Revisit and control the preference for implementation of schemes and programmes through society and SPV mode and managing funds through bank and personal deposit accounts outside the Consolidated Fund. 11. GoK has achieved the limits set out in the Numerical Rules, but has to fully meet certain other provisions of the KFRA. Table 2 summarizes the explicit numerical rules embedded in KFRA and the present status of compliance. Table 2: Numerical Rules in Karnataka Fiscal Responsibility Act and status of compliance Numerical Target/Limit Remarks Rule Deficit Reduce Revenue Deficit 8 as a percent of GSDP Revenue surplus achieved since 2004/05 Rules between 2002 to 2006 and bring to nil by 2006 Reduce Fiscal Deficit9 as a percent of GSDP between Fiscal Deficit maintained below 3% except during 2002 to 2006 and bring it to no more than 3% of 2009/10 (with Legislative approval), but reverted GSDP by 2006 back in 2010/1110 Debt Rules Not to give guarantees exceeding the limits stipulated Limit achieved since enactment of the Guarantee Act in the Karnataka Ceiling to Government Guarantees Act, 1999 i. e. not to exceed 80% of Revenue Receipts of second previous year Reduce Total Liabilities 11 as a percentage of GSDP Achieved since 2010/11 between 2002 to 2015 and bring it to no more than 25% of GSDP by 2015 12. Overall, while GoK is in compliance with most of the statutory provisions of the KFRA there are some areas where GoK has to be strictly in line with the KFRA provisions, for instance: (a) current liabilities are not being paid in timely 12 manner; (b) supplementary estimates are not fully “fiscally neutral� ; and (c) exceeding the numerical rule of deficit by amending the Act for economic recession, which escape clause is presently not available in the Act. 8 Defined as difference between revenue expenditure and revenue receipts 9 Defined as total disbursements from the Consolidated Fund (excluding debt repayment) over total receipts into the Consolidated Fund (excluding debt receipts) 10 The Legislature permitted the numerical rule in respect of fiscal deficit to be exceeded during three consecutive years 2008/09 to 2010/11 following amendments made to the KFRA. However, GoK actually exceeded the statutory rule only in one year 2009/10 11 Defined as the sum of liabilities under the Consolidated Fund and the Public Account of the state 12 The KFRA requires that “Whenever one or more supplementary estimates are presented to the Houses of Legislature, the State Government shall also present an accompanying statement indicating the corresponding curtailment of expenditure and/or augmentation of revenue to fully offset the fiscal impact of the supplementary estimates in relation to the budget targets of the current year and the Medium Term Fiscal Plan objectives and targets for the future year�. | Theme One: Strengthening PFM Legal And Institutional Framework 13 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 13. GoK’s performance in terms of the statutory provisions and actual implementation is superior to the FRL at GoI level in some instances. Primarily, the KFRA considers off-budget borrowings for computation of fiscal deficit and total liabilities while the GoI FRL does not require this. While KFRA has an “Escape Clause�, all deviations at GoI require the approval of the Parliament. Although GoK sought approval of the State Legislature to breach the limit on three occasions, yet GoK actually exceeded the limit only once and reverted back within the limit the next year. At the central level, due to the 2007 international financial crisis, the deadlines for the implementation of the targets in the Act was initially postponed and subsequently suspended in 2009. From 2009 to 2012, GoI was in continual non-compliance with FRBM targets and was unable to eliminate revenue deficit or reduce fiscal deficit to 3 per cent of GDP. In 20 11, Prime Minister’s Economic Advisory Council publicly advised the Government of India to reconsider reinstating the provisions of the FRBMA starting 2011/12. In May 2013, the Act was amended to dilute and defer the deficit targets. 14. GoK has yet to operationalize the Karnataka Local Fund Authorities Fiscal Responsibility Act 2003. GoK also enacted the Karnataka Local Fund Authorities Fiscal Responsibility Act, 2003, which was the first act of such nature for local fund authorities. Local fund Authorities mean bodies under the control of the state government and would include the urban and rural local bodies (municipalities and panchayats) and the development authorities. The Act mandated preparation of a MTFP13 and laid down the principles of prudent financial management, fiscal management, preparation of accounts and auditing procedures, and emphasized on a process of public engagement through social audit. This Act also provides that the State Government may withhold release of funds to any local fund authority, which fails to furnish accounts to the concerned authority within 6 months from the end of the financial year. The Act though enacted in 2003 has not been operationalized, which is an area of concern. The 2004 PFMA had also recommended that the Act be implemented. This Act if operationalized and implemented at the local bodies would help in improving the fiscal and financial management framework of these bodies. 15. Summary of Issues a. It is perceived that the onus of compliance with KFRA is only with the Finance Department. It needs to be appreciated that KFRA as a legislation should be followed by all departments. In actual practice however, the onus is on Finance Department to adhere to the statutory provisions of the KFRA. b. The Act could be reviewed from view point of actual experience gained over the last decade of implementation.  The KFRA allows limits for revenue deficit and fiscal deficit to exceed on grounds of national security or natural calamity. In actual practice, GoK had exceeded the limits of fiscal deficit in times of extending an “economic stimulus package� or “to counter recessionary conditions� for which it had to go for amendment in the act for three consecutive years. Therefore, these situations could be considered for inclusion in the escape clause.  The escape clause as presently enacted does not provide the modality for re-establishing compliance i.e. a specific path back to the rule and treatment of accumulated deviations. c. GoK needs to strengthen its systems to meet the requirements of the KFRA or provide clarity and strengthen the provisions. These are:  current liabilities are not being paid in timely manner (refer section on Monitoring Arrears of Payments);  supplementary estimates not being fully fiscally neutral (refer section on Supplementary budgets );  it is not clear whether Performance Guarantees fall within the purview of the ceiling on outstanding guarantees (refer section on Government Guarantees );  the Act does not prescribe sanctions for non-compliance; and 13 The Act had envisaged that “in furtherance to Medium Term Fiscal Plan, the State Government decided to disintegrate the MTFP on departmental lines and prepare Departmental Medium Term Fiscal Plan for each department along with the MTFP for the entire St ate�. | Theme One: Strengthening PFM Legal And Institutional Framework 14 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix  does not provide time limit for submission of the mid-year report and presently is submitted half-yearly. d. The Local Fund Authorities Fiscal Responsibility Act passed in 2003 has not yet been operationalized. This means that local self-governments (ULBs and PRIs) and other GoK agencies that handle state funds (such as development authorities) are presently not covered under the FRL. 16. The priorities identified for the 2014 PFM Reform Action Plan are: a. The provisions and requirements of the KFRA need to be disseminated so as to inculcate a sense of ownership amongst all departments and agencies. This could be supported through capacity building measures, workshops, and notes reiterating role of the departments in compliance to the KFRA. b. The Local Fund Authorities Fiscal Responsibility Act needs to be operationalized so that the urban and rural local bodies in particular are also covered within the ambit of a FRL. This would also pave the way for preparation of sectoral MTFP, as envisaged in the Act. c. Produce review report on a quarterly basis compared to the present half-yearly periodicity. This would be in line with the central legislation. d. GoK may consider the need for broadening the scope of the escape clause so as to avoid frequent amendments to the legislation as well as define the modality of reverting to status quo over a defined period of time. (for action plan on fiscally neutral supplementary budgets, payment arrears and performance guarantees, please refer to respective section) 1.3 UPDATING PFM MANUALS AND CODES 17. Section 2 outlines the important manuals and rules which impact the PFM environment of the State. GoK has been from time to time updating the manuals through circulars and amendments. However, most of these manuals were written at a time when only government departments were spending all the amounts and creation of SPVs or other parastatals were not envisaged. With the advent of several reforms in the IT especially Treasury computerization and changes in the business process, GoK needs to review and update these manuals. The key manuals of (a) Karnataka Financial Code 1958 (KFC), (b) Karnataka Treasury Code 1963 (KTC), (c) Manual of Contingent Expenditure 1958 (MCE), and (d) Karnataka Budget Manual (KBM) needs to be updated to reflect changes due to KTTP Act and IT computerization in departments. While KFC and MCE has not been revised, in case of KTC14 a revised Treasury Code was prepared along with the implementation of Khajane I (computerized treasury system). However the same was not formally adopted and notified by the GoK. The KBM was revised substantially in 2000 but would also require a detailed review on certain aspects as highlighted in the report. This was a suggestion in the 2004 report and is relevant even as of today. With the imminent introduction of new IFMIS (Khajane II) by GoK, all the manuals and codes, including certain Acts needs to be aligned with the revised business process as planned in Khajane II. GoK has already constituted a panel of experts to review and update these manuals and codes. 18. GoK should formalize and reactivate this committee constituted for revision of the manuals and code. It is imperative that KII team is also represented on this committee to provide inputs on the changes in the treasury system. GoK should provide all resources including technical and manpower, including external expertise to this committee. A time bound action plan to be agreed with the committee. After the finalization and adoption of these manuals it is important that changes 14 Any payment above Rs. 10 crores are referred to the FD, however no such provision exist in the KTC and AG (A&E) has pointed this out in the treasury inspection report. | Theme One: Strengthening PFM Legal And Institutional Framework 15 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix are disseminated to all stakeholders through training and workshops. This is the priority action for the 2014 PFM Reform Plan. 1.4 STRENGTHENING INTERNAL FINANCIAL ADVISORS 19. The institution of Internal Financial Advisors (IFA) was envisaged ad a key person in the overall PFM framework of GoK to play an important role in supporting the departments on financial matters. The IFA system in GoK came into force in 198215. IFA is expected to work as the representative of the FD and is deputed to the departments to render advice as well as ensure that all decisions are taken with financial prudence within the overall fiscal framework of the state. 20. The original rules read with the amendments and circulars, prescribe the duties and functions of IFA comprehensively. The key PFM areas for which IFA is responsible are: a. Ensure that budget estimates are properly framed and time schedule as per budget calendar is followed; b. Scrutinize budget proposals and assist Secretary in the formulation of budget proposals, advice on budgeting for new schemes; c. Maintain proper accounts as per rules; d. Review from time to time progress of expenditure, follow up on supporting supplementary estimates savings and surrenders, and monitor budget and treasury controls related to the department; e. Review audit objections, Inspection reports, and support in settlement of the audit paras; f. Ensure adherence to KFRA; g. Advise in implementation of KTTP and carry out internal audit of procurements; h. Prepare, update and implement Departmental Medium Term Fiscal Plan (DMTFP); and i. Monitor Personal Deposits, PD accounts and releases to Boards and Corporations and GIAs. 21. The rules provide sufficient scope and powers to the IFA to discharge the roles and responsibilities, yet institutional mechanism has met with partial success. The rules provide that the IFA role would be advisory in nature; but if his/her recommendations are not accepted, then the department needs to clearly articulate the reasons for not accepting IFA’s views. The roles and responsibilities framed also demanded a high level of interaction by the IFA with the departments. The partial success of this institutional mechanism is due to the following inter-related reasons: one, skill gaps and low capacity in the IFAs16, which restricts their effectiveness in discharging their responsibilities; secondly the due to the above reason there is differing level of IFA engagement in departments; and lastly due to multiple departments being handled by IFAs they are not able to devote adequate time for supporting the departments. 22. IFA skills differ depending on the department from where they are taken on deputation. IFAs are currently recruited from three sources; namely from KSAD, Secretarial Services and deputation from C&AG. IFAs from KSAD17, are able to comprehend the entire role and are also consulted by the Department to provide inputs. However, in case of IFAs deputed from secretary services, their role is restricted to opinion on service matters, administrative and staffing issues and very less on the PFM areas. This is an area of weakness which GoK needs to review and address. GoK should change the rules to make it mandatory that staff from KSAD is posted as IFA in the departments. 15 GO NO. FD 24 BUD 31 dated 15th July 1982-Consultation with Financial Advisors Rules and updated by circular No. FD 16 BUD 2003 dated 9th July 2003. 16 Report on Strengthening Financial Management Systems (April 2009) points out that officers with sufficient training and experience in modern financial management systems should be posted as financial advisors in the ministries / departments. 17 Only 3 IFAs currently are from KSAD. | Theme One: Strengthening PFM Legal And Institutional Framework 16 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 23. IFAs work in a matrix structure where they have dual reporting lines - to the Administrative Department and the Finance Department. Administrative Department need to ensure that due consultations are held with IFA on matters of fiscal and financial importance as outlined in the Rules18. According to the rules, a proposal not reviewed by the IFA should not be considered by the FD. Moreover, the FD is required to conduct regular monthly meetings of IFAs, monitor their performance and provide them regular training programs to keep them up to date on the PFM reforms and changes taking place at the state level. However, in reality this practice is not being followed. This practice needs to be followed and strengthened so that IFAs can benefit from FD guidance on a time to time basis and deliver better advice for the departments. 24. GoK should carry out review of the IFA post as well as supporting structure in each of the departments based on the work profile and work load. Currently most of the IFAs are not supported with adequate IT infrastructure and qualified personnel to assist them. With the manifold increase in budgets, transactions and works, adequate number of IFA posts needs to be created for the larger departments. Also, based on the analysis, FD and KSAD need to identify staff and provide them training for this role. GoK MTFP for 2011-15 also states that “Institution of IFAs has to be strengthened by identifying sufficient number of officers with requisite background and seniority and who have at least 5 years’ service left for superannuation. They should be supported with required infrastructure, exposed to extensive training including computer skills, to match the job chart of IFAs.� 25. Recognizing the above recommendations following are the priority actions identified in this area : a. IFA roles and responsibilities should be included in the KFC and KBM so that all Departments recognize the role of IFA as part of the top management and decision making process. b. IFAs should be provided extensive training including computer skills, to match the job chart of IFAs. c. IFA should be recruited from KSAD, and suitable officers need to be identified, trained and groomed. The IFA recruitment rules for this purpose should be amended. d. FD should review the work profile of the IFA in departments so that in departments with larger workload, dedicated (full-time) IFA can be posted. The institutional structure, support staff requirements for IFA function as well as the IT infrastructure, needs to be deliberated and developed. FD should take more proactive role in assessing the performance of the IFAs. 18 The Expenditure Reforms Commission report has recommended that internal controls through the IFAs in the Departments need to be strengthened and their participation in the day to day financial management ensured. | Theme One: Strengthening PFM Legal And Institutional Framework 17 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Section 2. THEME TWO: ENHANCING CREDIBILITY AND COMPREHENSIVENESS OF THE BUDGET 2.1 BUDGET PROCESS 26. The Karnataka Budget Manual and the KFRA19 provide the legal framework for budget literature and Legislative scrutiny and scope in Karnataka. These include requirements of presenting the budget to Legislature, process of scrutiny of the budget and its discussion and voting by the Legislature. The Karnataka Budget Manual prescribes a five-stage process for presentation of the budget and its approval by the Legislature (Figure 1). This is based on the provisions of the Constitution of India (Articles 203 and 204). Figure 1: Five Stage Process for passing of Budget in Karnataka Legislative Assembly Presentation of the Budget Presented (Feb/Mar) by the Finance Minister making a speech explaining the Salient features of the budget and Government policies General Discussion (max 10 days) Budget discussed either as a whole or on any question of principle or policy involved therein; no motion passed nor budget details discussed; Finance Minister may makesa reply at the penultimate day Discussion and Voting on Demand for Grants (min 15 days/max 20 days) Demand moved by Minister in charge (or deputy); Motions can be moved to reduce any demand; If voting not completed by last day or appointed hour, demand/s is "Guillitoned" i. e. voted without discussion Appropriation Bill After Voting, Appropriation Bill introduced to provide for the appropriation out of the Consolidated Fund of the State of all moneys required to meet (a) the grants made by the Assembly and (b) the expenditure charged on tre Consolidated Fund Governor's Assent After Governor's assent to the Bill, the amounts shown in the Act and the Schedule thereto become the sanctioned grants for expenditure under various demands 27. The Karnataka Budget Manual provides the framework of Rules which guides the Budget preparation in the state. The Budget Manual along with budget instructions provides detailed guidance on how the budgetary should be prepared and presented to the Legislature. Every year the budget process starts in the month of October when a detailed budget circular is issued by the FD to all departments. The budget circular issues instructions to the estimating officers to provide the budget request duly scrutinized by the IFA of the department. The budget circular is divided into four circulars covering specific areas: (i) General instructions; (ii) Appendix B- Estimates of salaries; (iii) Revenue and Capital Receipts Estimates; and (iv) Non plan other than salaries. The budget manual and the budget circular also prescribes preparation of a list of civil works to be executed in the FY, which should be estimated and submitted along with the budget in the form of Appendix E. 19 read with Karnataka Conduct of Government Business in the State Legislature Act, 2005 and Chapter XX of the Rules of Procedure and Conduct of Business in Karnataka Legislative Assembly (2011) | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 18 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 28. As a precursor to the budgeting exercise, GoK carries out resource estimation in the month of August-September to determine the plan outlay. The annual plan is finalized based on the resources available after meeting the requirements of non-plan expenditure and subsidies. This amount is intimated to the Planning Commission and the final plan size is agreed with the commission by January. Once the final plan size is determined the planning department does the resource allocation among departments and ensures that the overall ceiling is not breached. FD also has discussions with the departments to finalize the budget requirement department wise. FD then compiles20 both the plan and non-plan expenditure and finalizes the budgetary numbers keeping in mind the fiscal indicators as outlined in the KFRA. Along with the budget, MTFP (Medium Term Fiscal Plan) is prepared which provides rolling forecast for four financial years including the budget year. This document provides Macro-economic assumptions in respect of revenue receipts and expenditure, capital receipts and borrowing, inflation, compliance to fiscal indicators, GSDP growth rate, other assumptions and statements as required by KFRA and XIII FC. This document is presented to the Legislature in compliance with Section 3 of the KFRA. 29. The Karnataka Conduct of Government Business Act recommends a Budget Session ordinarily in the first week of March and to be held for a minimum period of 20 days (Section 4) while the rules prescribe the maximum number of days for general discussion and for voting. Besides, the Budget Manual also provides for constitution of a Committee on Estimates “for the examination of such of the Estimates as it may deem fit to refer to the Committee or as are specifically referred to it by the Assembly or the Speaker� (article 337). The Estimates Committee can examine the Estimates throughout the year and may submit a report. However, the demand for grants can be voted irrespective of whether the Estimates Committee has 21 made any report or not (Rules 267 – 269) . 2.2 PASSING FULL BUDGET BEFORE START OF THE Y EAR 30. Every year GoK obtains a Vote on Account from the state Legislature in February or March. In actual practice, while the entire budget is prepared and laid in the house, a Vote on Account is obtained for meeting the expenditure for the first four months of the FY, and the full budget is passed only during June or July when the Legislature meets again. The discussion and voting on the full budget takes place during the second phase when the session is held in June/July. The situation is the same today as it was at the time of the 2004 PFMA report. 31. Karnataka, like a few other states, prefers to use the mechanism of Vote on Account and postpones the passing of the full demands. The Constitution of India permits Vote on Account (Article 20622) for making a grant in advance pending completion of detailed procedure. This is reiterated in Article 81 of the Karnataka Budget Manual that allows a Vote on Account when detailed procedure cannot be completed “relating to the Voting of grants and passing of the Appropriation Bill before the commencement of the Budget year�. It is, therefore, envisaged that full budget is passed before the commencement of the year, but an escape clause is available in situations such as elections are due shortly or when a new 23 government has been formed and time is needed to prepare the full budget. 32. GoKs Budget Manual describes the procedure for preparation of the budget and its presentation, discussion and voting in the Legislature, but does not mandate passing of the budget within the fiscal year . The annual budget 20 Currently most of the budget data is sent over manually or in excel sheets which is then compiled and consolidated by computer cell in FD. Budget Management Information software has been developed and implemented in the computer cell, which consolidates all the budget data and prepares the budget documents in the prescribed formats. 21 There is a separate document called the Rules of Procedure (Internal Working) of the Committee on Estimates (June 2013) that is supplemental to the main rules 22 Article 206(1)(a) of the Constitution - to make any grant in advance in respect of the estimated expenditure for a part of any financial year pending the completion of the procedure prescribed in article 203 for the voting of such grant and the passing of the law in accordance with the provisions of article 204 in relation to that expenditure 23 States that adopts Vote on Accounts are Tamil Nadu, West Bengal, Karnataka, Andhra Pradesh, Kerala, Manipur, Nagaland and Sikkim | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 19 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix circular (issued in October) contains a Calendar for regulating the budget work and this envisages finalizing the budget estimates by December 20 – the calendar however does not provide a time plan for Legislative approval of the budget. 33. Many states pass the entire budget before the start of the financial year like Gujarat and MP and this is also one of the PEFA good practices. This was also the recommendation made in the 2004 PFMA report. Karnataka needs to meet this good practice of passing the Full budget passed before FY annual budget before the start of the fiscal year. The last three budgets for 2011/12, GOI and 21 states like Gujarat, MP, 2012/13 and 2013/14 were passed on June 24, 2011, July 30, 2012 and July 30, AP, UP, Bihar, Uttarakhand, HP, 2013, respectively which is 3-4 months from the start of the fiscal year. Punjab, and Maharashtra pass full budget every year. Dimension/Good Practice Current Status Timely budget approval by the Legislature Karnataka Legislature passes a Vote on Account by the close The Legislature has, during the last three years, approved of the financial year authorizing expenditure for April to the budget before the start of the fiscal year July. Full budget is discussed and full demands are voted during the second phase of the budget session in June/July i. e. well into the fiscal year. 34. The 2004 PFMA recommended GoK to present budget in early February so that it can be passed by end- March and this recommendation is relevant today and should be pursued by GoK. This mandate should be provided through an amendment to the Budget Manual and also provide for exceptional use of Vote on Account under specified circumstances. The budget legal document should mandate passing the annual budget before the start of the fiscal year. The budget manual should have provisions, and the annual circular should contain the procedure that not only provides for sufficient time for the departments to meaningfully prepare their detailed budget proposals as per guidance but also facilitate passing of the budget before start of the fiscal year. The Annual Budget Calendar should also state the intent of passing the budget before commencement of the fiscal year (the planned date of tabling of the budget in the Legislature and dates of discussions and voting may be stated in the budget calendar or communicated separately, in consultation with the Karnataka Legislative Secretariat). The priority identified for the 2014 PFM Reform Action Plan is to present and pass the full budget before beginning of the financial year. 2.3 COMPREHENSIVENESS OF BUDGET DOCUMENTATION 35. Annual budget documentation submitted to the Legislature for scrutiny and approval should allow a complete picture of government fiscal forecasts, budget proposals and out-turn of previous years. The legal basis of budget documentation (literature) to be presented before the Karnataka Legislature is embodied in the Karnataka Budget Manual 24 supplemented by the Karnataka Fiscal Responsibility Act, 2002 (KFRA). The Budget Manual requires the government to present the following to the Legislature: Finance Minister’s Speech, Annual Financial Statement, Detailed Estimates, Detailed Estimates of Irrigation, Electricity and Public Works, Plan Budget and Budget Memorandum. The KFRA requires the government to ensure greater fiscal transparency in public interest and, as far as practicable, minimize the secrecy in preparation of the annual budget. The KFRA requires the government to place before the Legislature along with the budget, a Medium Term Fiscal Plan (MTFP) and statements disclosing specified items 25. 24 Chapter IX – Presentation of the Budget and its disposal by the Legislature that prescribes the Budget to be presented in six volumes 25 Significant changes to accounting standards, policies and practices; contingent liabilities by way of guarantees; actual liabilities arising out of borrowings by PSUs and SPVs and other equivalent instruments where liability for repayment is on GoK; all claims and commitments made by the GoK having potential budgetary implications, including revenue demands raised but not realized; tax expenditure; losses incurred in providing public goods and services through public utilities and undertakings; liability in respect of major works and contracts; and subsidy payments and the impact of the same on the fiscal position of the State including in relation to the targets set. | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 20 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 36. The 2004 PFM Reform Action Plan recognized that the annual budget document contained substantial information and was a useful document. The document contained the budget for that year, revised estimates for the previous year, and actuals for the preceding year. The budget covered most major transactions of the State Government, except off-budget borrowing from Special Purpose Vehicles and expenditures met from these borrowings. External agency funds (including project-related funds) were integrated into the budget. 37. The budget literature continues to contain and disclose significant information. The Budget for 2013/14 contained the documents listed in Table 3 below. GoK also prepares an annual Economic Survey Report that provides a commentary on the economy as a whole and of the major sectors. This is presented to the Legislature prior to the submission of the budget. Table 3: Budget Documentation 2013-14 in GoK  Budget Speech separately for Agriculture  Expenditure Volumes  Budget Highlights  Public Works  Annual Financial Statement  Irrigation  Budget at a Glance  Zilla Parishad Plans (region wise)  Overview of the Budget  Plan documents  Medium Term Fiscal Plan  Budget Allocation for Urban Local Bodies  Demand for Grants  Budget Memorandum  Agriculture Budget  Action Taken Report  Gender Budget  Motion for Demands  Vote on Account  Appropriation Bill  Receipts Volume  Supplementary Provisions 38. GoK’s Budget Documentation is comprehensive. The comprehensiveness of information contained in the annual budget of GoK was benchmarked with the 9 elements based on PEFA good practices (Table 4). The documentation for 2013/14 budget as presented to the State Legislature in February was considered for this purpose. The benchmarking indicates that the budget documentation meets the 9 elements considered by PEFA. Table 4: Comprehensiveness of information included in Budget Documentation in GoK Framework Requirements Element Information Source included in Budget Documentation 1. Macro-economic assumptions, Yes Macro-economic assumptions in respect of revenue receipts including at least estimates of aggregate and expenditure, capital receipts and borrowing, inflation growth, inflation and exchange rate. and GSDP growth rate are provided in the MTFP which is placed before the Legislature along with the budget. 2. Fiscal deficit, defined according to GFS Yes Budget Speech, Budget Highlights and Overview of the or other internationally recognized Budget with a discussion in the MTFP26. standard. 3. Deficit financing, describing Yes The Overview of the Budget that includes a statement titled anticipated composition. “Financing Deficit� 4. Debt stock, including details at least for Yes  Summary position is provided in Annual Financial the beginning of the current year. Statement and Overview of the Budget;  Detailed disclosure in Receipts Volume and Expenditure Volume 2 (detailed break up) giving actual for the previous year and revised estimates of the 26 In India, the budget classification system is uniform for all stages of administration and is based on GFS/COFOG standards. | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 21 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Framework Requirements Element Information Source included in Budget Documentation current year;  Full details in Budget Memorandum.  Additionally, detailed breakup of debt is provided in Statement No. 6 of the Finance Accounts which for the previous year is available to the Legislature before the budget is presented27.  A discussion on debt is provided in the MTFP. 5. Financial Assets, including details at Yes  Details of shares and securities held by the government least for the beginning of the current year. are provided in the Budget Memorandum.  Details of other financial assets including cash balances are not disclosed in the budget  Detailed break up of financial assets is provided in the Finance Accounts which for the previous year is available to the Legislature before the budget is presented. 6. Prior year’s budget outturn, presented Yes Detailed Estimates in the same format as the budget proposal. 7. Current year’s budget (either the Yes Detailed Estimates revised budget or the estimated outturn), presented in the same format as the budget proposal. 8. Summarized budget data for both Yes Budget at a Glance, Overview of the Budget revenue and expenditure according to the main heads of the classifications used, including data for the current and previous year. 9. Explanation of budget implications of Yes Budget Speech, Budget Highlights new policy initiatives, with estimates of the budgetary impact of all major revenue policy changes and/or some major changes to expenditure programs. 39. The current disclosure of key fiscal information to public as described above matches all the 9 elements prescribed by PEFA. Dimension/Good Practice Current Status Share of the 9 elements listed information in the budget The most recent budget documentation (2013/14) fulfills all documentation most recently issued by the state the 9 listed information and hence the budget literature is government comprehensive. Recent budget documentation fulfils 7-9 of the 9 information benchmarks 2.4 CREDIBILITY OF BUDGET – EXPENDITURE OUTTURN AND COMPOSITION 40. The government should have the ability to deliver public services as expressed in policy statements, output commitments and work plans. The composition of expenditure in a budget reflects the policy intent of the government. 27 Finance Accounts for 2010-11 were presented before the legislature on Dec 8, 2011 and for 2011-12 on Dec 10, 2012 | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 22 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix External factors or poor revenue outturn may be behind the deviations, which needs to be recognized. There are two essential aspects that impact budget credibility in execution:  ability to maintain actual expenditures at the level approved in the original budget; and  extent of variation of the composition of actual expenditure from the composition in the original budget arising on account of reallocations between budget heads during execution. To measure expenditure outturn and composition of expenditure outturn, the methodology provided in PEFA guidelines has been followed. Aggregate expenditure out-turn compared to original approved budget 41. Actual expenditure is compared to original budget excluding debt service payments which to a large degree is 28 outside the control of the government . The data for budgeted and actual expenditure of GoK on administrative classification is readily available in government documents – in the budget documents and the annual Appropriation Account audited by the Supreme Audit Institution. The data for three years 2010/11, 2011/12 and 2012/13 are summarized in Table 5. Table 5: Budgeted vs. Actual expenditure of GoK, net of debt service (Rs. in crore) Particulars/Year 2012-13 2011-12 2010-11 Budget Estimates 94,266 76,325 61,930 Actual Expenditure 88,345 77,448 64,467 Actual Expenditure Deviation (absolute) (-) 5,921 1,123 2,537 Actual Expenditure Deviation (percent of budget estimates) (-) 6.3% 1.5% 4.1% Source: Budget estimates from the Annual Financial Statements; Actual expenditure from the Appropriation Accounts 42. GoK’s record of implementing the budget has shown significant progress since the 2004 PFMA - the deviation of actual expenditure and original budget was not being more than 5% in two of the last three years . The buoyant revenue achievement was been a major contributory factor leading to this favorable position. At the time of the 2004 PFMA, Karnataka’s record in terms of implementing the budget as passed was not impressive as both revenues and expenditures showed wide deviations from budget estimates. Composition of expenditure out-turn compared to original approved budget 43. The PEFA methodology for calculating composition of expenditure outturn requires adjusting the allocations from the original budget for each of the twenty largest ministries by the aggregate variance and then calculating by how much the actual out-turn for each ministry differed from the adjusted allocations and is calculated for the most recent three years. The computation does not take into account the supplementary estimates (also approved by the Legislature) but takes the original budget as the base. Table 6 shows variation on expenditure composition for the three years 2010/11, 2011/12, and 2012/13. The high level of compositional variance tapered during 2011/12 (down from 12% to 10.4%) but significantly increased in 2012/13 to 19.3% and is quite large compared to the primary variance. Table 6: Primary and Compositional Expenditure Variance Particulars 2012/13 2011/12 2010/11 Total Primary Variance 6.3% 1.5% 4.1% Average compositional 19.3% 10.4% 12.0% Variance 44. During the last three years, some departments with compositional variance exceeding 5% are listed in Table 7. 28 PEFA Guidelines also require that donor funded expenditure be excluded if beyond the control of the government. Such expenditure in GoK is about 2% of total expenditure (excluding debt servicing) and not being material, has not been excluded from the calculations. | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 23 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 29 Table 7: Compositional Expenditure Variance of > 5% in GoK Departments Department 2012/13 2011/12 2010/11 Finance -29.3% 11.7% -17.72% Urban Development -19.5% -5.9% -4.12% Water Resources -14.7% -14.3% -8.63% Rural Development and Panchayati Raj -15.3% 18.2% Energy 29.8% 16.0% 60.12% Public Works 33.4% 18.1% 14.20% Health & Family Welfare -6.5% Agriculture and Horticulture -30.1% -26.1% -33.81% Social Welfare 5.9% Home & Transport 14.2% -6.5% -5.85% Revenue 51.0% 14.8% 5.00% Women and Child Development 8.7% -7.92% Commerce and Industries 11.9% 19.43% Housing 9.8% -10.1% -20.73% Animal Husbandry and Fish -9.0% -9.46% Forest, Ecology and Environment 55.7% -20.8% 67.87% Food & Civil Supplies. 15.0% -9.0% Co-operation 160.0% Infrastructure Development -26.9% -33.6% -18.10% Source: Budget estimates from the Annual Financial Statements; Actual expenditure from the Appropriation Accounts 45. An analysis in three departments exhibiting material deviations reveals the following -  The Cooperation Department sought Rs. 1,815 crore on account of Crop Loan Waiver Scheme 2012 through 2 nd installment of supplementary estimates which was not envisaged at the time of presentation of 2012-13 budget in March 2012 as the scheme was declared by GoK in August 2012 (This was to be funded entirely through cash outflow, actual expenditure however was Rs. 930 crore only).  For the Energy Department, additional grants were sought through supplementary estimates for paying arrears in subsidy for IP sets and making investments in power utilities (total Rs. 1,500 crore). Such expenses should have been envisaged and provided in the original budget.  The budget composition also gets affected in view of natural calamities as for instance in the Revenue Department which required additional grants for disaster relief (Rs. 2,359 crore). Part of these additional demands was to be met from a specific fund (the National Disaster Relief Fund) 46. This indicates that requirements do come up in-year necessitating inclusion in supplementary estimates resulting in composition deviation, as evident from the above instances. While appreciating the genuine in-year requirements, an increasing expenditure composition deviation indicates a weak coupling between budget formulation and budget implementation. High level of supplementary estimates contributes to significant adjustments in the original budget estimates in GoK. This clearly indicates that the need for more budgetary discipline and effective expenditure management systems and anticipation of expenditure at the time of original budget formulation. This is an area of improvement in budgeting which GoK needs to address in the coming years. 47. An ancillary measure of budget credibility is the amount of expenditure charged to Contingency Vote. In Karnataka, as in other Indian states, the Legislature by law30 has established a Contingency Fund placed at the disposal of the 29 (+) denotes actual expenditure more than original budget and (-) denotes actual expenditure less than original budget | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 24 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Governor to enable advances to be made for meeting unforeseen expenditure pending authorization of such expenditure by the State Legislature. The appropriation for the Contingency Fund is made from the Consolidated Fund of the State and the fund is recouped by debiting the expenditure to the concerned functional major head in the Consolidated Fund of the State. The maximum balance in the Contingency Fund can be Rs. 80 Crore. Of this, the amount of expenditure initially met from Contingency Fund could be much less. Table 8 provides a summary of the transactions in the Contingency Fund of GoK. The conclusion is that the Contingency Fund is used to meet only a miniscule amount of expenditure that is finally recouped from the Consolidated Fund and put to vote. Table 8: Transactions in the Contingency Fund (Rs. in crore) Transaction 2012/13 2011/12 2010/11 2009/10 Opening 79.49 67.47 80.00 77.90 Receipts 0.51 12.53 2.10 Disbursements 0 0.51 12.53 Closing 80.00 79.49 67.47 80.00 Expenditure from Contingency Fund 0.46 35.77 44.75 38.17 Expenditure un-recouped at the close of the year -- 0.51 12.53 Source: Finance Accounts Statement No. 18 48. The expenditure budget outturn and compositional variation when compared to the dimensions under PEFA benchmarked to good practices indicates that expenditure composition variance needs to be addressed by GoK. Dimension/Good Practice Current Status The difference between actual primary expenditure and the In the last three years, actual expenditure has originally budgeted primary expenditure deviated from original budget expenditure by more In no more than one of last three years has actual expenditure than 5% in one year only. deviated from budgeted expenditure by amount equivalent to more than 5% of budgeted expenditure Extent of the variance in expenditure composition during the last Variance in expenditure composition has exceeded three years 10% in all the three most recent years. This is an Variance in expenditure composition exceeded 5% in no more than area for intervention. one of the last three years The average amount of expenditure actually charged to the The actual expenditure actually charged was on an contingency vote over the last three years average less than 3% of the original budget Actual expenditure charged to the contingency vote was on average less than 3% of the original budget 49. There is a need for GoK to reduce the expenditure composition variance, from the present high level, in phases say over a two-year period and this is the priority action for the 2014 PFM Reform Action Plan. Budget estimation is needed to be strengthened and reduction in in-year adjustments via supplementary needs to be achieved (also refer discussions in the following sections). 2.5 CREDIBILITY OF THE BUDGET- REVENUE FORECASTING AND OUTTURN 50. The major sources of income of the GoK are from own tax and non-tax revenue, devolution of central taxes and Grants in Aid from GoI. 30 The Karnataka Contingency Fund Act, 1957 last amended in 1985 as provided in Article 267(2) of the Indian Constitution. The amount for the fund has been steadily increased from Rs. 10 crore in 1976 to Rs. 80 crore at present. | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 25 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix  The major own tax revenue (about 2/3rd of total state revenue) are from Commercial Taxes (comprising Value Added Tax, Entertainment Tax, Luxury Tax, Professional Tax), State Excise, Stamps and Registration and Vehicle Tax.  The major own non-tax revenue (about 6% of total state revenue) are Royalty and Interest Receipts and other departmental revenue.  Central devolution of taxes and grants-in-aid as mandated in the Constitution of India (Articles 268 to 270,, 272 and 275). Besides, the state also receives grants for Plan Schemes (Central/State Plan Schemes, Centrally Sponsored Plan Schemes and Special Plan Schemes). The share of central taxes in the state revenue is about 16% and grants-in- aid is about 12%. 51. The 2004 PFMA identified that Karnataka suffered from excessive revenue forecasts that were largely generated bottom-up by the various tax departments. There was no central, specialized capacity in the Finance Department to assess their reasonableness nor was there a model or a common format to facilitate analysis or to disaggregate between revenue increases due to economic growth and those due to policy changes. As was evident from the data at that time, there was a bias towards optimism in these forecasts which led to increasing the total expenditure outlay of the budget. 52. An accurate revenue forecast is a key input to the preparation of a credible budget. Optimistic revenue forecasts can lead to unjustifiably large expenditure allocations and to larger fiscal deficits, should spending not be reduced in response to an under-realization of revenue. On the other hand, pessimism in the forecast can result in the proceeds of an over-realization being used for spending that has not been subjected to the scrutiny of the budget process. Accurate forecasting of domestic revenue is a critical factor in determining budget performance, since budgeted expenditure 31 allocations are based upon that forecast . 53. In GoK, data on budgeted and actual tax and non-tax revenue are readily available in government documents and disaggregated by major revenue heads. Revenue is normally deposited with the government Treasury and hence the data is available electronically in the Treasury’s Khajane application and is also available in the accounting a pplication of the AG (A&E). The latter publishes monthly revenue data along with Civil Accounts. 54. In all the last three years, the budget estimates for own tax revenue had been revised upwards vis-à-vis the original estimates during in-year budget adjustments indicating buoyancy in tax collections. The budgeted and actual revenue over the last three years of the GoK are summarized in Table 9 below. Table 9: Budgeted and Actual Revenue of GoK (Rs. in crore) Year Tax Revenue Non Tax Revenue State Share in Central Central Grant In Aid Total Taxes BE RE Actual BE RE Actual BE RE Actual BE RE Actual BE RE Actual 2012/13 51821 53493 53754 3193 3796 3966 13094 12500 12647 13354 15095 7809 81461 84884 78176 2011/12 43817 45775 46476 3675 3189 4087 10419 11075 11075 8402 8359 8168 66313 68398 69806 2010/11 36228 38049 38473 2820 3519 3358 9060 9310 9506 5530 6906 6869 53639 57785 58206 2009/10 32721 29339 30579 2130 2495 3334 7645 7000 7360 5893 7573 7883 48389 46406 49156 Source: (a) BE and RE: GoK Annual Financial Statement (Budget), Statement 1, Consolidated Fund of India - Revenue Account – Receipts; (b) Actuals GoK Finance Accounts, Volume 1, Statement No. 2 Table 10Error! Reference source not found. provides the revised revenue estimate and actual as percentage of the original estimates. The data indicates the unpredictability of central grant in aid and also indicates a need of better estimation of non- tax revenue. 31 PEFA Jan 2011 | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 26 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Table 10: Comparison of RE and Actuals with Original Budget Year Tax Revenue Non Tax Revenue State Share in Central Grant In Total Central Taxes Aid RE Actual RE Actual RE Actual RE Actual RE Actual 2012/13 3% 4% 19% 24% -5% -6% 13% -42% 4% -4% 2011/12 4% 6% -13% 11% 6% 6% -1% -3% 3% 5% 2010/11 5% 6% 25% 19% 3% 5% 25% 24% 8% 9% 2009/10 -10% -7% 17% 57% -8% -4% 29% 34% -4% 2% 55. A comparison of budgeted and actual revenue (the Revenue Outturn) provides an overall indication of the quality of revenue forecasting. For computing the aggregate outturn, the methodology suggested in the PEFA guidelines has been followed. For computation, only own tax and non-tax revenue has been taken. GoK has little control over share of 32 central taxes and grants-in-aid and hence, as recommended in the PEFA Guidelines , these two revenue sources have not been considered while computing revenue outturn. In all the last three years, actual revenue has exceeded the budgeted. This is an improvement since the 2004 PFMA – at that time on average, only 90% of budgeted revenues were raised during the year and no sustained improvement in this ratio was evident. Table 11: Revenue out turn of Own Resources compared to Original Budget (Rs. in crore) Particulars/ Year 2012/13 2011/12 2010/11 Original Budget Estimates (own tax and non-tax revenue) 55,014 47,492 39,048 Actual 57,720 50,563 41,831 Actual Revenue as a percent of budget estimates 105% 106% 107% Source: Table10 above 56. The Revenue Outturn compares favorably with the good practices when benchmarked to PEFA. Dimension/Good Practice Current Status Actual domestic revenue compared to domestic revenue in the Actual domestic revenue was between 96% and 106% in originally approved budget. two of the last three years. Actual domestic revenue was between 96% and 106% of budgeted revenue in at least 2 of the last three years 57. Commercial Taxes Department (CTD) and Excise Department (ED) are the major contributors to the state’s revenue and nearly 80% of the state revenue is budgeted and collected by these departments. Major administration reforms and rationalization efforts (besides tax reforms) were undertaken by CTD and ED, and these have contributed to the robust revenue outturn. 58. Commercial Tax Department has developed and implemented e-initiatives for all its core functionalities. Commercial Taxes constitute more than 60% of the States own tax revenue and is an important department both from fiscal and financial management point of view of the state. CTD has a very important role in providing revenue forecasts for the MTFP. Table 12 provides the revenue outturn (actual compared to the original budget) – and this is positive in the last three years. Currently the forecasts are based on external economic data including inflation, GDP Growth and buoyancy of taxes; however commodity wise tax forecast is not made presently. The CTD has restructured the tax administration regime and has introduced e-governance as a key tool to improve efficiency in the department that has resulted in improved tax collection and its buoyancy. The following prominent initiatives have been carried out by CTD to promote electronic administration of the various Acts: 32 Share of the state in central taxes is dependent upon the sophistication of the revenue forecasting capabilities of the central government and the actual budget performance based on realization of the projected revenue. Grants in Aid from central government are also dependent upon many factors. | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 27 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix a. Online Registration for dealers b. Online tax payments and mandatory e-payments for assesse with tax dues of more than Rs. 10,000, through 20 banks c. Online filing of tax returns (achievement is nearly 100%) d. Online generation of statutory forms such as delivery notes (e-Sugam), transit passes (e-Suvega) e. IT and risk based audit systems, the e-Comprehensive Audit System. Table 12: Revenue Outturn for Commercial Tax Department (Rs. in crore) Particulars/ Year 2012/13 2011/12 2010/11 Original Budget Estimates 31,100 26,700 22,500 RE 32,250 27,930 22,500 Actual 31,875 27,611 22,803 Actual Revenue as a percent of original budget estimates 102% 103% 101% Source: Commercial Tax Department 59. Excise Department has planned for total computerization of its activities including e-payment mechanism covering 90% of the total revenue. ED contributes nearly 20% to the state’s tax revenue. The e -payment system, for payment of excise duty by 36 distilleries, is being linked to Treasury Network Management Center and later on planned for integration with Khajane II. Implementation of e-payment system and the application Online Allotment of Spirit and Molasses (both developed by the National Informatics Center - NIC) will be a significant step in e-governance and contribute to improving revenue collections. This initiative has also come at the right time in view of the significant rise in revenue from excise over the years – almost doubling from Rs. 5,792 crore in 2008-09 to Rs. 11,070 crore in 2012-13. Revenue outturn of the Excise Department over the last three years is briefed Table 13. Like commercial taxes, excise duty revenue outturn has also been positive. Table 13: Revenue Outturn for Excise Department (Rs. in crore) Particulars/ Year 2012/13 2011/12 2010/11 2009/10 Original Budget Estimates 10,775 9,115 7,500 6,565 RE 11,300 9,500 8,200 6,800 Actual 11,070 9,828 8,345 7,001 Actual Revenue as a percent of budget estimates 103% 108% 111% 107% 60. The quality of revenue forecasting, particularly from own taxes, done by GoK has been realistic. In case of both CTD and Excise Department, the revenue collections have exceeded the original budget estimates which augur well for the state. This was helped by the IT and governance initiatives taken by these departments to improve collections. This can be reinforced through adoption of the following which are suggested to be included in the 2014 Reform Action Plan. | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 28 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 61. CTD is in the process of setting up an Economic Benefits of Economic Intelligence Unit Intelligence Unit. In line with the 2004 PFMA recommendations,  Maharashtra was the first state to implement the EIU a consultancy tender has been floated for creating an Economic (2009) to minimize physical monitoring of dealers, Intelligence Unit within CTD for forecasting and economic enhanced use of data analytics and identification of intelligence. The purpose is to improve the dealer transaction fraud and tax evasion cases and creation of e-evidence. analytical capabilities of the CTD including benchmarking the tax In 2012, the EIU unearthed VAT evasion of Rs. 1000 performance with relevant economic and tax data available on the crore in hawala dealing  Kerala has also established an EIU in 2013 for public domain and with other tax authorities to help detect tax collecting effective market intelligence to study, identify evasion, increase tax compliance in the State, resulting in State and detect tax evasion practiced in the state. Special revenue enhancement. posts were created for the EIU. 62. GoK could implement a Revenue Forecasting Tool. The budget circular on preparation of capital and revenue receipts estimates (issued in October-November) provides some 33 guidance on tax and non-tax revenue estimation . A formal revenue forecasting model has presently not been implemented in GoK, but is under consideration. A modern revenue forecasting model is based on statistical analysis of relevant data. CTD is already working on developing such model which is a part of the TOR for EIU. The Income Tax Department of the GoI has also recognized such need and is working on developing a model. 2.6 SUPPLEMENTARY BUDGETS 63. The legal basis for supplementary budget emanates from Article 205 of the Constitution of India and these are replicated in the Karnataka Budget Manual (clauses 282 to 292). Supplementary demands (also called Supplementary Budget or Estimates – SE) can be made in the following circumstances,: a. where the amount authorized to be expended for the current FY is Supplementary Budget or found to be insufficient for the purposes of that year; Estimate b. when a need has arisen during the current FY for supplementary or A grant, approved by the additional expenditure upon some new service not contemplated in Legislature, being an estimated the original budget for that year amount of further expenditure that c. advances obtained from the Contingency Fund can be recouped by may be necessary in a FY over and presentation in the SEs and obtaining Legislative approval above the expenditure authorized by the Legislature in the original d. Expenditure allowed by Finance Department by way of budget and which cannot be met “additionalities� during the year which needs ratification by the through Re-appropriation Legislature 64. GoK presents three Supplementary Budgets to the State Legislature No. of SEs passed by other states every year: This is normally done during June/July, December/January and  Madhya Pradesh, Chhattisgarh, February/March. The first SE (called the 1st Installment) is presented along with Assam, Jharkhand – 3  Bihar and Kerala – 2 the original budget itself, as initially a Vote on Account is obtained from the  Gujarat, Odisha, Uttar Pradesh, State Legislature in February/March. While part of the supplementary Uttarakhand, Himachal Pradesh expenditures are met from anticipated savings of various departments, there are and most North Eastern States- 1 substantial amount of net cash outgo in these supplementary proposals. This (between Dec and March) 33 Relevant factors such as the target fixed, the progress of actuals and the anticipated additional yield from the measurers of enhancement of existing taxes, the estimated loss of revenue on account of abolition or reduction of taxes consequent to the implementation of such taxation laws passed by the State Legislature after the Budget Estimates were finalized and presented, tax arrears to be collected, the demand for the coming year and assumption of a reasonable higher growth rate in respect of tax revenue and also the performance in the previous years, the progress / trend of actuals of the current year and the impact of the new measures of taxation | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 29 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix practice has raised questions relating to the sanctity of annual budget as a policy instrument and the concept of hard budget constraint in observing fiscal discipline. The 2004 PFMA recommended reducing the number of SEs to 1 – a decision in this regard is yet to be taken by GoK34. At the central government level, three supplementary demands are introduced, first in July, second November and the third in March – before the budget for ensuing year is presented. 65. The percentage of aggregate SE to original estimates is high in GoK when compared to other states. As shown in Table 14, in GoK, aggregate SEs reduced from 18% in 2010/11 to 14% in 2011/12, but increased to 17% in the last FY 2012/13 and this is still high as compared to other states. The SEs passed by most other Indian states is 10% or less than the original budget (exceptions include Madhya Pradesh 29%, Bihar 18%, Tamil Nadu 14% and West Bengal 13% and some North Eastern states)35. Within the departments, the SEs are significantly higher (and showing an increasing trend) such as in the case of Cooperation Department (284%, 66% and 52%) and Public Works Department (46%, 44% and 40%), respectively for the last three years (2012/13. 2011/12 and 2010/11), as percent of original budget. Generally, 5-6 departments account for about 60% of the total SE that include Public Works, Rural Development and Panchayati Raj and Energy Table 14: Supplementary Estimates as a percentage to Original Estimates in GoK 2012-13 2011-12 2010-11 Supplementary 1 3.42% 2.24% 1.31% Supplementary 2 8.54% 4.40% 7.02% Supplementary 3 5.41% 7.04% 9.90% Total 17.35% 13.68% 18.23% Source: Compiled from Appropriation Accounts 66. Frequent in-year budget adjustments through reliance on supplementary budgets undermine the sanctity and discipline of the budget preparation process. The departments get the “flexibility� to make significant in-year adjustments. This also affects the composition of the budget vis-à-vis that approved by the Legislature (refer section on expenditure outturns). 67. The “savings� are more than the aggregate SEs undermining the “realism� of budgeting in GoK. Apparently, actual expenditure falls short of even the original estimates, and the “savings� (budgeted less actual expenditure) is more than the aggregate of the SEs, and an upward trend is seen over the last three years, as reflected in Table 15. For instance, in 2012/13, actual expenditure was less than the sum of original and SEs in all departments except one and the aggregate savings are more than the SEs. Similarly, in 2011-12, actual expenditure in over two-thirds of the departments was less than the original estimates and the aggregate savings almost equaled the SEs. Savings are more than SEs is a phenomenon in most states of India. But West Bengal, Himachal Pradesh and J & K are amongst the few states who exhibit marginal savings of 1- 2%. Table 15: Karnataka - Original and Supplementary Estimates and Savings (Rs. in crore) Particulars 2012/13 2011/12 2010/11 Revenue Capital Total Revenue Capital Total Revenue Capital Total Original Budget 83183 24522 107705 66181 21557 87738 54160 17900 72060 Supplementary Estimates 14203 4487 18690 6867 5140 12007 8028 5106 13134 Revised (Original + 97386 29009 126395 73048 26697 99745 62188 23006 85194 Supplementary) Actual Expenditure 78614 21341 99955 65510 21320 86830 54372 18543 72915 Savings (net) 18772 7668 26440 7539 5376 12915 7901 4463 12364 34 For FY 2013/14, due to change in government, full budget was re-presented in July 2013 and hence for this year only two supplementary budgets were presented in November 2013 and February 2014 35 Source: CAG Report on State Finances 2012/13 or 2011/12 of respective states | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 30 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Particulars 2012/13 2011/12 2010/11 Revenue Capital Total Revenue Capital Total Revenue Capital Total Net Savings as percent of Total 132% 171% 141% 110% 105% 108% 98% 87% 94% Supplementary Estimates Actual Expenditure/ Original 95% 87% 93% 99% 99% 99% 100% 103% 101% Budget Source: Supplementary Estimates and Appropriation Accounts 68. A brief analysis of some large ticket items in the SEs for 2012/13, as below, included in the SEs calls for a need of making the budget process more efficient so that the expenditure can be anticipated and planned and included in the original budget.  Education Dept. – demand for PRIs including revised pay scale (SE 2)  RDPR – provision for state share of central scheme; demand for PRIs; provision for road works; repairs and maintenance (SE 2)  Energy Dept. – provision for subsidy (SE 2 and 3); equity contribution to power utilities (SE 3)  Public Works Dept. – provision for payment of pending bills 69. The C&AG has pointed to cases of unnecessary SEs. For instance, in 2011/12, out of Rs. 4,766.66 crore of SEs, the C&AG assessed that Rs. 1,615.27 remained unutilized (34%). While it is positive to note that in Karnataka the actual expenditure is within the original budget, however the composition of the budget in terms of sectoral allocation significantly changes due to the frequent in year budget adjustments. From the analysis that the original budget numbers is more aligned to the actual expenditure, the need for 3 supplementary budgets could be reviewed and rationalized. 70. Presentation in Supplementary Budgets does not provide the clear picture. Data on savings and surrenders are not disclosed in the SE and hence a complete picture is not available in a single report. Again, this practice in Karnataka follows other states who also do not disclose savings, surrenders and re-appropriations in their supplementary budgets. Odisha discloses surrenders made in individual demands, but not in the aggregate. 71. Supplementary Estimates are not Fiscally Neutral as required by KFRA. The KFRA requires that the fiscal impact of the SE should be fully offset 36. The 2004 PFMA recommended presenting a “fiscal neutrality� table to be shown per grant and that supplementary budgets should be allowed only if there are offsetting fiscal savings. Presently, the SE documents provide a brief write up on the sources to meet the supplementary estimates (these are summarized in Error! Reference source not found.), but do not provide the fiscal neutrality details or table. The earlier SEs for instance, 2011/12 and 2012/13 SE1) did not provide any strategy for meeting the cash outgo part of the SE. Thereafter, the SEs stated that cash outgo was to be funded from “from general buoyancy in tax and non �tax revenue and savings in provision for other schemes� or through “suitable expenditure prioritization� without providing any details. In SE2 of 2013- 14, GoK stated that “actual releases of the amounts included in the Supplementary Estimates….would be made based on the fiscal position and in compliance with provisions of the Karnataka Fiscal Responsibility Act�. This implies that at the point in time, GoK passed the SE, it had not assessed the sources of funding the additional demands. As discussed above, the data on savings, surrenders and re-appropriation are not disclosed in the supplementary budgets and also the impact on the fiscal deficit is not stated in the SE. This practice is not strictly in line with the disclosure requirements of the KFRA Act. Table 16 indicates net cash outgo (additional commitments) equaled 52%, 67% and 77%, respectively for the three years (2012/13, 2011/12 and 2010/11), of the total SE and this remained “unfunded�. Moreover, actual expenditure and savings/surrenders are not disclosed in the SE even in the 2nd and 3rd installments. 36 The KFRA requires that “Whenever one or more supplementary estimates are presented to the Houses of Legislature, the State Government shall also present an accompanying statement indicating the corresponding curtailment of expenditure and/or augmentation of revenue to fully offset the fiscal impact of the supplementary estimates in relation to the budget targets of the current year and the Medium Term Fiscal Plan objectives and targets for the future year�. | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 31 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Table 16: Financing the Supplementary Estimates (Rs. in crore) Year Central Adjustments Other Receipts Recoveries Cash Outgo Total Assistance 2013-14 1,225 2,918 -- 2,882 5,173 12,198 2012-13 2,608 149 20 6,250 9,663 18,690 2011-12 798 32 998 2,095 8,084 12,007 2010-11 532 392 126 2,018 10,067 13,135 Source: Government of Karnataka, Supplementary Estimates 72. Summary of Issues  GoK presents three Supplementary Budgets to the State Legislature every year. Therefore, frequent in-year budget adjustments through reliance on supplementary budgets undermine the sanctity and discipline of the budget preparation process  The percentage of aggregate SE to original estimates is high in GoK when compared to other states  The “savings� are more than the aggregate SEs undermining the “realism� of budgeting in GoK and the budget process can be made more efficient so that the expenditure can be anticipated and planned and included in the original budget  The C&AG has pointed to cases of unnecessary SEs  Presentation in Supplementary Budgets does not provide the clear picture – data on surrenders and actual expenditure is not included in the SE document  Supplementary Estimates are not Fiscally Neutral as required by KFRA – a significant part of the additional expenditure remains “unfunded� 73. The issues identified in this area can be addressed by including the following priorities in the 2014 PFM Reform Action Plan. Recommendations on SEs made in the 2004 PFMA report are still relevant. a. Reduce the number of SEs presented to GoK every year from 3 to 2 (and to 1 in the long term). The primary recommendation of this study is that GoK passes the full budget before the start of the FY (refer section 2.2). While this transition takes place GoK also needs to strengthen its budgetary estimation process, so that the need for in-year amendments as early as in June-July should be avoided. The first SE would therefore ideally be presented and passed in November/December coinciding with the tabling of the Mid-Year Report in the Legislature. b. Supplementary Budgets should be Fiscally Neutral in accordance with the KFRA. The KFRA mandates that the fiscal impact of the SEs should be fully offset by curtailment of expenditure and/or augmentation of revenue (i.e. should be fiscally neutral) and this should be presented in an accompanying statement (i.e. a Fiscal Neutrality table). This presently has not been fully achieved as SEs remains “unfunded� by significant amounts and this need to be brought in line with the KFRA. The FMRC has recommended avoiding and moderating inclusion of large expenditure commitments in supplementary budgets. Full scrutiny of proposals/expenditure proposed in SE should be carried out before including them in the SE. In respect of additional plan commitments for which approval is obtained through SEs, MTFP of GoK recognizes the need for mobilizing additional resources along with identifying savings in other plan schemes to meet the enhanced requirement. GoK needs to implement these recommendations. c. Actual expenditure and surrenders should be disclosed in the SE so that it provides clear picture to the readers on the fiscal impact of the additional demand. Presently, actual expenditure for the first half year is being presented in the Mid-Year Review Report under KFRA. Therefore it is desirable that actual expenditure should also be included in SE2 and SE3. | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 32 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 2.7 IN-YEAR ADJUSTMENTS TO BUDGET ALLOCATION – RULES OF RE-APPROPRIATION 74. One important element of budget execution is a set of clear and transparent rules for in-year amendments to the budget without ex-ante approval of the Legislature. One of the instruments available is through the mechanism of Re- appropriation. The Karnataka Budget Manual and the Karnataka Financial Code (Articles 308 to 314) contain the rules of re-appropriation. These Re-appropriation powers are exercised at the levels of the Finance Department, The transfer, by a competent authority, of Administrative Department and the Head of Department. Re-appropriation savings from one unit of appropriation to mechanism cannot be used to meet expenditure that increases the outlay, meet excess expenditure under another unit or from a grant for non-recurring expenditure to provide for additional within the same grant or charged recurring expenditure, or from one grant to another, or from a revenue appropriation … Karnataka Budget Manual head to a capital head, or from charged to voted expenditure and vice versa, or re-appropriation to a new service. Subject to these restrictions, or heads under which no provision exists at all, the powers of re-appropriation in GoK are briefed in Table 17. Table 17: Powers of Re-appropriation in GoK Level Power of Re-appropriation Finance Department Power to sanction any re-appropriation within a grant from one Major, Minor, or Subordinate head to another Departments other than Power to sanction re-appropriation within a grant between heads subordinate to Major head Finance Department not exceeding Rs. 5,00,000 (provided it does not incur in a recurring liability) Power to sanction re-appropriation within a Major head provided each re-appropriation does not exceed Rs. 20,000 Head of Departments Power to sanction re-appropriation from one unit of appropriation (detailed head) to (HoD) another within the same Major head not exceeding Rs. 1,00,000 per annum per detailed head provided funds for plan items are not transferred to non-plan and a recurring liability is not created. This power has been enhanced by GoK in April 201037 – now HoDs can re-appropriate up to Rs. 5,00,000 between two units of appropriation under same major head and within same demand subject to specified restrictions. Source: Karnataka Financial Code and GoK orders 75. There is an overall rising trend in the amount of Re-appropriations including injudicious or defective orders in GoK. Significant re-appropriations undermine the sanctity of the original budget. Re-appropriations are made through Re- 38 Appropriation Orders issued by the concerned delegated authority . The amount of re-appropriation doubled during 2011/12 as compared to the previous year and has further increased during 2012/13. The amount of injudicious orders (i.e. even after issue of Re-appropriation Orders, either the full unutilized budget provision was not re-appropriated or there was excess over budget provision even after re-appropriation) have increased. There are also defective orders (i.e. re-appropriation orders issued beyond the sanction powers or not self-balanced or not signed by the competent authority) and there is a two-fold increase in the last two-years. The trend of Re-appropriation Orders is detailed in Table 18, the reasons for this trend need to be ascertained. Table 18: Trend of issue and quality of Re-appropriation Orders in GoK (Amount in Rs. crore) 2012/13 2011/12 2010/11 2009/10 No. Amt. No. Amt. No. Amt. No. Amt. Re-appropriation Orders 461 5,631 476 5,277 366 2,635 350 2,305 37 GO No. FD 2 TFP 2010 dated April 30, 2010 38 All Re-appropriation Orders have to be sent to the AG latest by April 30 from the close of the FY and coordinated in the Finance Department by a Deputy Secretary level officer. These orders are required by the AG for the purpose of preparing the State’ s Appropriation Accounts. | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 33 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Of which Injudicious Orders 57 1,145 60 1,970 60 647 62 786 Defective Orders 37 612 35 205 30 343 31 45 Source: C &AG, Report on State Finances 76. GoK matches well with good practice under PEFA in respect of existence of a set of clear and transparent rules for in-year budget amendments through re-appropriation. Dimension/Good Practice Current Status Rules for in-year amendments to the budget without ex- Clear rules for in-year budget amendments at the level of the ante approval by the Legislature Finance Department, Administrative Departments and Head Clear rules exist for in-year budget amendments by the of Department exist in the Karnataka Financial Code. There executive, set strict limits on extent and nature of is a need for minimizing injudicious or defective re- amendments and are consistently respected appropriation orders. 77. The mechanism of Re-appropriation needs to be strengthened. This is a better option vis-a-vis seeking additional funds through Supplementary Budget from the Legislature as it provides flexibility to the departments to transfer savings in one scheme to another that need additional funds, and is a much faster process. Re-appropriations are carried out with the belief that the re-appropriated amount would be fully utilized, but due to various reasons such as slow pace of implementation of schemes and treasury processes, the sums re-appropriated lapse without being utilized. Though this situation is inevitable, large-scale “injudicious orders� need to be corrected through better assessment techniques. On the other hand, defective re-appropriations can be effectively checked through systems control and firming up controls at the Treasury level. Large surrenders should be dis-incentivized and Departments should ensure prudence in effecting re- appropriations. Under Khajane-II, Re-appropriation Orders are proposed to be automated i.e. system generated and the number of defective orders is expected to reduce drastically. 78. The following priority action points are recommended for inclusion in the 2014 PFM Reform Action Plan. a. Revise the financial limit of delegation for re-appropriation: The delegation of re-appropriation at the level of the Head of Department contained in the Karnataka Financial Code was last revised in April 2010. GoK may consider reviewing and revising these limits to a more contemporary level. b. Identify the reasons for high level of Re-appropriation Orders and develop strategy to control the rising trend: Reasons for the current increasing trend of issue of Re-appropriation Orders including injudicious and defective orders need to be ascertained so as to develop and implement a strategy for arresting this trend and controlling the issue of Re-appropriation Orders. Interpretation and lack of awareness could be a reason for incorrect application of the re-appropriation procedures in the departments. c. Following the above study workshops to be held to disseminate the rules and procedures around Re- appropriations. This would help in a better understanding of the rules of re-appropriation with the objective of reducing the quantum of re-appropriation including injudicious and defective orders. 2.8 PREDICTABILITY OF AVAILABILITY OF FUNDS 79. Effective execution of the budget, in accordance with the work plans, requires that the spending departments receive reliable information on availability of funds within which they can commit expenditure. The Finance Department is required to provide reliable information on the availability of funds for a reasonable time horizon to entities that manage administrative (or program) budget heads in the government budget. To be reliable, the amount of funds made | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 34 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix available to an entity for a specific period should not be reduced during that period. This also ensures that spending during the year will be a uniform pace avoiding rush of expenditure at the year end 80. Technically, with the passing of the budget, full authority to spend is available to the departments, subject to some restrictions. In Karnataka, the State Legislature initially passes a Vote on Account (VOA), an interim budget for the first four months of the financial year i. e. April-July in the month of March of the previous year. This is followed by passing of the full budget generally in June/July. Once the VOA or budget is passed, an Appropriation Act is passed and the Finance Department then issues an authorization to the departments to incur expenditure. In practice, the Finance Department issues instructions on measures to enforce economy in expenditure and Delegation of Financial Powers that restricts departments to incur new commitments and making related payments or that which affects the timing of payment. These delegations relates to - (a) financial powers to sanction expenditure (called the general delegation of common financial powers); and (b) powers to release funds for making payments. 81. The 2004 PFMA estimated that, excluding for salaries, pensions and interest which typically cannot be cut in the course of the year, there was about a 20% chance that any budgeted expenditure will not be expensed . “Rationing of expenditure� at that time included budget cuts, economy drives, payments delay by the Treasury and ban on re - appropriation. The 2004 PFMA Report assessed the reasons for this situation - unrealistic budgets especially revenue estimates; unfunded supplementary expenditure estimates; inadequate control over departmental commitments, especially on the capital side; the process for making adjustments to unforeseen events during the year was insufficiently institutionalized and untimely; lack of timely and reliable information on within-year budget performance; lumpy fund flows especially from GoI; limited cash-flow smoothing options. Consequently, unpredictable funding resulted in delays, lobbying, and poor expenditure effectiveness; suppliers, wary of late payment, increased their prices to compensate; cash rationing led to arrears. GoK has taken measures as suggested in the 2004 PFMA to further enhance individual clearance limits for release of funds without recourse to the Finance Department and delegation to HoDs . Delegation for sanction of expenditure 82. Resources available to the departments for capital works are known through the sectoral allocations made at the time of preparation of the budget and conveyed by the Planning Department in the Plan document. This allows the departments to prepare their annual plans based on the expected sectoral allocation. Provision for a work can be made in the budget only if the administrative approval and technical sanction has been obtained. The delegation of common financial powers was enhanced in 2001 and most recently in 2010 and provides delegation at the level of heads of departments and officers at the division, district, sub-division and Taluk levels, with special powers provided to some departments. These delegations cover approvals for all kinds of transactions - from administrative approval to advances, re-appropriation and recruitment. For instance, the power to accord administrative approval up to the level of the head of departments was enhanced to Rs. 100 lacs for one work and further enhanced to Rs. 500 lacs presuming concurrence of the Finance Department. These powers are further sub-delegated to the subordinate offices with defined limits. 83. The effect of liberalization of financial powers should reflect in faster approvals of schemes and works, including timely preparation of Appendix E (list of approved works) in Public Works and Irrigation Departments for submission to Legislature along with the budget documentation – the situation however has yet to exhibit significant improvement and there are delays obtaining/providing administrative approvals and preparation of Appendix E. Delegation for Release of Funds 84. Once the expenditure is incurred, actual drawl of funds from the government Treasury is subject to certain restrictions defined in the Delegation of Financial Powers (DoFP) that are vested in the Principal Secretaries/ Secretaries of the Administrative Departments. The extent to which the DoFP are increased and streamlined at the level of the departments, with less recourse to the Finance Department, provides the level of flexibility available to the departments for planning and executing various works and also determines the timing of the expenditure. | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 35 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 85. At the time of the 2004 PFMA Report, the delegated authority was Rs. 0.5 million in each case with a cap of Rs. 30 million in a month. By 2006, DoFP limit to the administrative departments was enhanced to Rs. 10 million subject to overall 39 Rs. 50 million in a month . These restrictions were essential due to the fiscal position of GoK at that time and to ensure that sufficient cash was available to back budget releases. As GoKs fiscal position improved, and recognizing the need for “ timely availability of funds at various levels of government for implementation of government programs� and also “ensuring that the expenditure is not crowded or bunched towards the end of the financial year � with an aim to “improve the quality of 40 expenditure�, GoK significantly revised its DoFP in 2008 and – a. segregation was made between “release of funds� for revenue expenditure and capital expenditure b. concept of items for which funds could be released “assuming concurrence of the Finance Department� and items for which “prior concurrence of Finance Department� was required was introduced c. thresholds were prescribed for release of funds during the first three quarters of the financial year d. items were specified for which prior concurrence of Finance Department was required and items that were exempted from such requirement. 86. DoFP for release funds introduced in 2008 were periodically revised and the applicable DoFP were documented in 42 an omnibus circular of May 201341 and of April 2014 . The DoFP scheme now defines the quantum of funds that could be released each quarter/month for different categories of expenditure and distinction between revenue and capital expenditure made in 2008 was discontinued. The release of funds without concurrence of the Finance Department since financial year 2012/13 is summarized in Table 19. Funds for the first two quarters (Q1 and Q2) can be released as specified presuming concurrence of the Finance Department and during the last two financial years, this was extended to the third quarter (Q3) as well. For the ongoing financial year, the latter relaxation was made in November 2013 that could be made earlier (preferably at the start of the quarter). Table 19: Delegation of Financial Powers presuming concurrence of Finance Department Item Release of Funds presuming concurrence of Finance Department Since FY 2012/13 Q1 & Q2 Q3 Annexure II items43 Full release can be made up to budget provision State Schemes with budget provision more than Rs. 1/12th of budget provision each 500 lacs for specified subsidy, share capital, plan/non- month plan schemes of Public Works Department and major, medium and minor Irrigation State schemes with budget provision more than Rs. 500 Up to 50% of budget provision in up to 75% of budget lacs other than above two installments of 25% each provision provided 75% utilization of previous tranche/s or approval of Finance Department State schemes with budget provision less than Rs. 500 In two tranches – 50% and then balance after utilization of 75% of lacs first tranche Debt Servicing As per terms and conditions of the debt subject to availability of budget provision Rural local bodies - central plan schemes and CSS On receipt of central share except lump sum provisions under object head 300 Urban local bodies - non-Plan Grants Up to 50% of budget provision in two installments of 25% each 39 Other than employee payments and higher limit for drought relief 40 Government Order No. FD 1 TFP 2008 dated May 16, 2008 41 Government Order No. FD 12 TAR 2013 dated May 20, 2013 42 Government Order No. FD 03 TFP 2014 dated April 4, 2014 43 Includes salary and wages and other employee payments, scholarship, pension and medicines | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 36 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Item Release of Funds presuming concurrence of Finance Department Externally Aided Schemes For Q1, Q2 and Q3: 25% each provided 75% utilization of previous tranche/s CSS routed through the state budget (from FY 2014/15) Can be released on receipt of central share conveyed through the credit confirmation slip from Finance Department obtained from the Reserve Bank of India Source: Compiled from Circulars of the GoK Enhancement of Delegation of Financial Powers and its impact: 87. It is expected that the simplification and enhancement of the DoFP should get reflected in an increase in the pace of expenditure during the year and decrease in “rush of expenditure� during the last quarter/month of the financial year. Such a 44 phenomenon was prevalent at the time of the 2004 PFMA . The effect of enhancement and simplification of DoFP was broadly assessed based on the monthly/quarterly expenditure for FY 2007/08 (pre enhancement year), FY 2009/10 (post enhancement year) and the last three financial years up to FY 2013/14, summarized in Table 20. Data indicates improvement in the pace of expenditure during Q2 and Q3, but expenditure during the last month in still high at more than 1/3rd of total annual. Table 20: Actual Expenditure as % of total for the quarter and cumulative Year Q1 Q2/ (cumulative) Q3/ (cumulative) Q4 2007/08 17% 22% (39%) 21% (60%) 39% 2009/10 17% 19% (36%) 23% (59%) 39% 2011/12 15% 19% (34%) 18% (52%) 36% 2012/13 13% 26% (39%) 23% (62%) 39% 2013/14 17% 25% (42%) 23% (65%) 36% Source: Monthly Civil Accounts and Finance Department Figure 2: Trend of expenditure in each quarter 100% 80% Q4 60% Q3 40% Q2 20% Q1 0% 2007/08 2009/10 2012/13 2013/14 88. There has been a significant decline in rush of expenditure during the last month of the financial year from 26% to 19%, and in case of Plan expenditure from 42% to 30% between 2002 and 2013, though as stated above, expenditure during the last quarter remains high ( Table 21) that provides a comparison of the extent of “rush of expenditure� over the years. 44 In 2000/01, 29% of total expenditures and 37% of capital expenditures were incurred in the final month of the fiscal year; similarly in 2001-02, 26% of total expenditures and 42% of capital expenditures were incurred in the final month. Accounting problems were identified as responsible for this concentration. There was also a “carryover period� in which spending in the first days, or even weeks , of the new fiscal year, was counted against the budget of the previous year. With the implementation of Khajane, this practice has been discontinued. | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 37 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Table 21: Decrease in Rush of Expenditure Month of March Month Total Expenditure as % of Total Year Plan Expenditure as % of Total Year Expenditure Expenditure 2002 26% 42% 2008 23% NA 2010 24% NA 2012 21% 31% 2013 23% 30% 2014 19% Source: 2004 PFMA Report, Monthly Civil Accounts and Finance Department 89. Under the Cash Management system of the Government of India, the expenditure during the last quarter is restricted at 33% and 15% during the month of March (both in terms of scheme and demand) – GoK needs to take measures to moderate its spending during the month of March according to the benchmark of 15% in GoI. Table 22 summarizes the pace of expenditure in GoI over 2011/12 and 2012/13 – it indicates uniform pace of expenditure and curtailment of example in fourth quarter to the benchmark of 33%. This could be attributed to the cash management system at GoI based on the modified exchequer control expenditure management system and the economy measures which the GoI Finance Department takes. Another example is Odisha that fixes the last date up to which certain types of Treasury bills can be submitted for payment such as for instance bills for purchase of machinery, equipment or vehicle, share capital investment can be presented only up to March 11th and there is a ban on budgetary funds being transferred to civil deposit accounts 45. Table 22: Pace of Expenditure in Government of India Quarter Quarterly expenditure as % Quarterly expenditure as % of Total Expenditure of Plan Expenditure Q1 22% 20% 21% 20% Q2 27% 26% 28% 23% Q3 21% 23% 22% 24% Q4 30% 31% 29% 33% Source: cga.nic.in 90. Overall, liberalizing the DoFP in Karnataka has facilitated some improvement in the pace of expenditure and a decline in rush of expenditure at end of the year. This is a positive trend and would need to be continued and sustained in the coming years. This could be further improved if the impediments caused by some factors are mitigated such as time taken to obtain administrative approvals, delay in grounding of works on time, and higher spending during the first 2-3 quarters (front-loading) so that corrective measures can be taken timely. Maintaining uniform pace of expenditure (alternately avoiding rush at the year-end) is a sound principle of PFM. It helps to avoid fiscal imbalance or temporary cash mismatches and quality of expenditure incurred in a rush could be compromised. 91. The following priority action points for the 2014 Reform Action Plan are suggested: a. It is suggested that the circular authorizing release of funds for any quarter should be issued before the start of the quarter so that the departments can plan in advance.46 45 Despite these measures, the C&AG continue to cite instances of breach of this PFM principle. Governments should therefore seek to minimize this phenomenon of rush of expenditure and avoid recurrence on a case to case basis 46 The circular for authorization of release of funds in respect of schemes with budget provision of Rs. 50 million and above for the third quarter has been issued after the commencement of the quarter e. g. for 2011/12, the circular was issued on October 13, 2011 and for 2013/14 on November 16, 2013. | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 38 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix b. In 2001, the Finance Department published a Compendium of Delegation of Financial Powers including delegation of various departments. The Finance Department could consider collating all the circulars on this topic and publishing an updated Compendium. c. In some states (e. g. Punjab, Assam, Odisha) and the Government of India, Delegation of Financial Powers Rules has been made and any change is issued as an Amendment to these financial rules. GoK may adopt this mechanism. d. Finance Department can organize workshops to disseminate the DoFP for better understanding and explaining the rationale for enhancement and simplification including the linkage with the pace of expenditure. e. The Government Financial Rules, 2005 of the GoI considers rush of expenditure in the closing months of the financial year as a breach of financial propriety and recommends that it should be avoided. A similar provision is made in the Budget Manual of Government of Odisha (for instance). The KFC makes a reference to rush of expenditure in respect of grant in aid and suggests that there should be no occasion for a rush of expenditure for payment of these grants in the month of March. It is suggested that GoK may consider rush of expenditure as a breach of financial propriety or regularity and accordingly include a provision similar to GoI it in the KFC. 2.9 ESTIMATION OF SALARIES 92. Appendix- B is the appendix used by GoK to estimate the budget requirement of salaries for the entire state. The budget circular clearly articulates the methodology for estimation of salaries and this is carried out on bottom up approach i.e. the actual data starts from the field, consolidated at the head of department, which is then verified by IFA/estimating officer and submitted to the FD for compilation. Based on the data, the FD computer cell inputs all the data in the software and estimation of salaries is done for the state. While this process is robust the following issues need to be addressed as a part of the action plan. 93. Appendix B is presently prepared independent of Human Resource Management System (HRMS) by the FD and the process takes about 2 ½ to 3 months. If HRMS captures sanctioned and vacant posts, then Appendix B can be generated through HRMS and the full HR data would reside in one application. Significant human resource and time will be freed if this is done (20% expenditure but 80% effort). There is a plan to dovetail Appendix B software with HRMS and discussions are going on this regard. This will also validate the data residing in HRMS as only those staff entered in HRMS would be taken for estimation of salaries in future. The FD needs to work with HRMS team to ensure that suitable formats are designed for generating Appendix B from HRMS and in future it should be a part of the overall design of HRMS II. 94. Budgets for salaries, include substantial provision for vacant posts which is provided under the head 2070 under Demand 3 – Finance Department. At the time of budget preparation not all of these posts would have been planned for being recruited during the year. Such provision can be used only when the amount is transferred to other heads during supplementary budgets. The same issue was also highlighted in the 2004 report. During FY 12-13 the amount provided for vacant posts was Rs.999 crores 47 which was not utilized. During the last eight years the C&AG in its Report on State Finances has raised the issue of excess provision for vacant posts resulting in subsequent savings on account of the following : a. Estimates for salaries was not made with reference to the staff to be likely on duty, but was based on full sanctioned strength which is not in accordance with the Budget manual; b. Lump sum Provision was made under one demand which was inappropriate. 47 There was additional Rs.2500 crores provided for payment of 6 th Pay commission recommendations which was never used . | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 39 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 95. The need for such provisioning is not clear especially when most of the amount is not utilized. In case of Tamil Nadu budget provision is made only for posts which are actually filled up. GoK with the implementation of HRMS has the capability to estimate the actual salary expenditure in a scientific manner and should provide budget only for actual filled posts and an estimate for the posts planned to be filled during the FY. Similar issue was identified in the provisioning of salaries for ULB, which GoK has withdrawn from this FY. Figure 3: Trend of budget provision for vacant posts Vacant post - Provision 1200 1000 Amount in Rs. Crores 800 600 400 200 0 2008-09 2009-10 2010-11 2011-12 2012-13 Amount in Crores 450 400 850 849.97 999.98 96. In view of the above and the recurring objection made by the auditor, it is suggested that policy of providing for vacant posts should not be pursued as it distorts the revenue expenditure and fiscal indicators. 97. The following priorities have been identified for 2014 PFM Reform Action Plan. a. Going forward, GoK needs to integrate Appendix B with HRMS/HRMS II and ensure uniform database for salary estimation as well as payments. b. GoK should not pursue the policy of provision for full sanctioned posts as a part of the budget preparation process and can adopt the Tamil Nadu model of providing budget for only filled up posts. 2.10 MANAGING PUBLIC INVESTMENT FUNDING 98. An essential function of any government is strategic management and funding of public investments. These are public goods generally in the form of civil works and in the Indian context called Plan expenditure. Such a strategy would provide a framework to fund a new project or continue funding of on-going projects (including decision on abandonment or suspension) and providing for maintenance costs post-completion48. Governments have to create fiscal space for public investment spending through the budgetary processes but within certain constraints : These primarily include - (a) budget envelope available for public investment is residual after budgetary provision has been made for committed liabilities (i. e. non-discretionary often recurrent spending on salaries, devolution, debt servicing collectively called as Non-plan expenditure); (b) limits to fiscal deficits mandated by the fiscal responsibility legislation; and (c) restrictions on gross public 48 This section does not discusses the management of investment projects from inception to post-evaluation – it rather covers how the government plans for and takes a decision on funding public works. | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 40 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix debt which more often is the main source of funding public projects. GoK too faces these constraints and has to budget taking these into consideration. 99. In Karnataka, capital spending has been about 40% of total government spending, and as compared to other states is relatively higher (Table 23). Table 23: Public Investment or Plan Expenditure in GoK (Rs. in crore) Year Plan (Capital) Non-Plan (Revenue) Spending Total Proportion of Plan to Spending (incl. debt servicing) Spending Non-Plan Spending 2013/14 (up to Feb 2014) 33,010 51,050 84,060 39% 2012/13 36,691 58,809 95,500 38% 2011/12 34,073 49,868 83,941 41% 100. In Karnataka, the fiscal management principles on investment spending are provided in the KFRA and the framework is described in the Budget Manual supplemented with Budget Circulars. The major public works are carried out by two departments – Public Works (PWD) and Irrigation Departments, and in case of the latter mainly by the public sector undertakings (SOE) within its administrative control. The process of budgeting major works is as follows:  Funds for works can be proposed for inclusion in the budget only after administrative approval and technical sanction had been accorded by the competent authority and the works have been prioritized “in order of urgency� and stating the “grounds on which a particular work is considered necessary�. A list of new major works (including Deposit Works or works to be executed through contributions from other departments/agencies) is required to be prepared and forwarded by each HoD to the Chief Engineer who consolidated these around major heads and forwards to the Finance Department. (Rules 132 to 134 of Karnataka Budget Manual).  A list of ongoing works as well as fresh works proposed showing detailed estimates of expenditure in respect of works costing over Rupees one lakh each is required to be prepared and submitted to the Legislature along with the budget for discussion – this is commonly known as Appendix E and is considered part of the budget literature ( Rule 195 of the Budget Manual). Appendix E, after sanction of budget, is required to be circulated amongst the implementing officers not later than April of the relevant financial year. 101. The guiding principle is to ensure that sufficient amounts are set apart for ongoing works in order to complete them early, and thereafter propose provisions for new works. The annual budget circulars provide further guidance on provision of funds for works. The minimum quantum of provision is based on the following criteria –  for on-going works and new works with estimates of less than Rs. 5.00 crore, a minimum allocation of 40% and 60% is to be provided for the budget year and the next year, respectively;  for works with estimates of more than Rs. 5.00 crore, a minimum 30% should be made during the first year and the balance cost of 70% provided in the next two years as per the implementation schedule;  for maintenance and repairs of roads, bulk grants are allotted by GoK for further distribution to executing divisions based on length and category of road under its jurisdiction. The works are taken up after obtaining approval from SE, who is the competent authority for approval of program of works of a division under his control. 102. GoK has attempted to integrate investment spending with the rest of the budget and put in place an investment spending strategic framework - yet in practice it suffers from inadequate compliance including sequencing and prioritization of projects as the following discussion indicates. | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 41 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 103. The objective of preparing Appendix E and having it approved by the Legislature was to instill fiscal discipline so that only those works which are listed in the Appendix are taken up and completed, instead of new works being added during the course of the year, at the cost ongoing works and funds diverted to them. In practice, Appendix E is not prepared and submitted along with the budget and Legislative approval not obtained. In the last 3-4 years, appendix E has not been prepared and submitted on a timely basis (particularly PWD) and it has mostly been submitted at the end of the financial year, which undermines the usefulness of this document, the relevance of the data is diminished and moreover this is not presented to the Legislature. Moreover, Appendix E that is prepared is incomplete as not all major heads are included. There is also a mismatch between budget provision and the grant provided in the Appendix .  For instance, due to delayed preparation of Appendix E for 2011/12, the Finance Department was able to approve it on March 26th, 2012 after a lapse of about one year of passing the budget and that too for only three major heads 4059, 4216 and 5054. Moreover, printing further delayed it by more than 5 months and the Appendix E was available to the departments in September, 2012.  For Demand for Grants of the Public Works Department, during the year 2011-12 as against the total expenditure of Rs. 3,596 crore under capital major heads - 4059, 4216 and 5054, the estimated value of the list of works provided in Appendix E was only for Rs. 1,767 crore - therefore expenditure of Rs. 1,828 crore was without Legislative approval (Source: C&AG Audit Report on Economic Sector 2011/12). 104. The Public Accounts Committee (PAC) of Karnataka Legislature has expressed serious concerns over the abnormal delay in preparing Appendix E despite it being an integral part of the budget and therefore should be submitted to the Legislature along with the budget. The Legislative committee also recommended prioritizing budget provision for completing ongoing works before considering provision for new works. The PAC also opined that any expenditure on works not included in the approved Appendix E is devoid of Legislative sanction and hence unauthorized (see Box). 105. A serious concern which emerges from non-preparation of Appendix E is over commitment and backlog of unpaid bills, especially in case of PWD. During the past two years, PWD has reported more than Rs.,1000 crore49 (~$200 million) of pending bills and it is expected to rise as per projections particularly under roads as according to the department the budget provision is insufficient to allow for completion of ongoing works. As of Unauthorized Expenditure if not included now a lump sum provision is made for these heads in the state budget in Appendix E based on which the Appendix E is drawn up. (also refer Monitoring Works included in Appendix-E should be Arrears of Payments). The C&AG also reported that lack of budgetary regarded as list of works approved by the State Legislature and expenditure on works control (non-preparation of Appendix E) resulted in creation of clear not included in Appendix-E should be liability of Rs. 1,509 crore on Government towards pending work bills as treated as unauthorized. of March 2012. There are also instances of short release of grants Public Accounts Committee, 6th Report though provided in the Appendix E. This adversely affects timely (2009/10) Jan 2011 completion of works besides leading to accumulation of pending bills. PWD has identified procedural bottlenecks for preparation of appendix E, like plan size not known in advance and all schemes proposed in Appendix E requiring prior administrative and other approval and this process is time-consuming 106. The Irrigation Department50 has three major SOEs under its administrative control that executes several large projects, but these are not included in Appendix E. These SOEs are Karnataka Bhagya Jal Nigam Limited (KBJNL), Karnataka Neeravari Nigam Limited (KNNL), and Cauvery Niraavari Nigama Limited (CNNL) to whom GoK 49 As of March 2012 Rs.1,486 crore, March 2013, Rs. 1,044 crore and October 2013, Rs. 1,221 crore. 50 In case of PWD, KRDCL is a PSU which carries out roads and bridges works. Apart from them there are EAP projects which are handled by PIUs in the department which are not reflected as part of appendix E. | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 42 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix provides significant budgetary support and guarantee support for capital works. 51 The Budget Manual requires preparation of Appendix of works by the Irrigation and PWD departments. However, the manual is not explicit whether works to be executed out of budgetary funds transferred to SOEs is to be included in Appendix E. Perhaps the situation where such companies would be created by the departments and most of the work would be carried out by these companies was not envisaged in the budget manual. This needs to be factored by GoK through clarification/amendment to the budget manual so as to include works executed by these SOEs in Appendix E. 107. There is need to assess the utility of Appendix E in terms of presentation, as it exhibits only schemes which are being proposed to be paid under the current budget , leaving scope for committed liabilities and ongoing schemes not being included in the Appendix. Accumulation of such committed liabilities could be an area of concern that could put pressure on budget funds directed for payments of old liabilities and in effect could prevent new works to be taken. 108. The 2004 PFMA report made two recommendations – (a) give priority in budgeting to payment of arrears, then for completion of ongoing works and lastly for adding new works (Tamil Nadu follows similar system for budgeting civil works) -The situation as of now is by and large the same as prevailing at the time of the 2004 assessment and the recommendations remain relevant even today and (b) computerization of such works and tracking committed liabilities. 109. Computerization of PWD Civil works: PWD has developed contract management software in Oracle platform which is known as Project Monitoring System (PMS). This software has been developed and implemented in 2013 and most of the works data has been populated in the system. PWD uses this software which provides a good MIS on the commitments, the outstanding bills and list of all works. With this software PWD can track commitments, work progress, and balance of works to be carried out in the contracts. This software has capability to provide reports at different levels namely State level, District level, Division level and work wise details as well as generate financial projections based on milestones for the contracts already issued by PWD. This feature can be used for resource scheduling for the next 2-3 years which can give information for the GoK on the committed capital expenditure for PWD and the resources required for the new works. 110. To sum up, PAC and the C&AG have expressed serious concern over undue delay in preparation and finalization of Appendix E and the uncontrolled growth of pending bills. The PAC recommended that it is necessary for Finance Department to take strict measures to release grants so that works are completed as per time schedule shown in Appendix E, besides discouraging the tendency of taking up works not provided in the Appendix. GoK is yet to fully implement these recommendations. The C&AG has reported that funds aggregating Rs. 773 crore were locked up in incomplete projects as at the end of 2012-13 (Rs. 1,047 crore as of the close of 2011/12). 111. The Fiscal Management Review Committee suggested that all approvals for new initiatives and works requiring implementation over multiple years should be based on fiscal sustainability of the total expenditure and that GOK should ideally move to medium-term (3 to 5 years) appraisal and approval cycle for the schemes. The GOK needs to prioritize the capital expenditure requirements of the state and ensure that the capital expenditure proposals are reviewed and approved with a view on their overall impact on the fiscal position of the state. 112. The following priorities have been identified for 2014 PFM Reform Action Plan. a. PWD and Irrigation Departments to work with the Finance Department to analyze the bottlenecks in the timely and adequate preparation of Appendix E as per the budget calendar. This is to ensure that Appendix E is submitted to the Legislature along with the budget for discussion and Legislative approval. It should be re-emphasized that no payment for works should be allowed unless the work is included in Appendix E. 51 Nearly Rs.8000 crores were provided as equity and grant support in the last two financial years | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 43 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix b. PMS software can generate financial reports based on milestones for the contracts already issued by PWD and this feature can be used for resource scheduling for the next 2-3 years. GoK can consider preparing Appendix E on rolling forecast model for 3 years and introducing MTEF in PWD. c. The PMS software could be further developed to prepare Appendix E. d. GoK needs to review if the works carried out by the SOEs and Externally Aided Projects should be included in the Appendix E. If such a decision is taken, then GoK would need to include this requirement specifically in the budget manual. e. The PMS software in PWD should be mainstreamed and interlinked with Khajane II having the functionality of entering all bills in PMS and linked to Khajane II for payment. This will also facilitate PWD (and Irrigation Department who may also adopt this application) and Finance Department monitor open commitments on a concurrent basis. f. Last but not the least, GoK could consider adopting the Tamil Nadu model for estimating civil works. 2.11 RATIONALIZATION OF SCHEMES 113. Government of Karnataka follows a six-tier classification structure. (see section 3.1 for further details). In the 6-tier classification system, a Scheme is the fourth tier called the Sub-Head and is considered as a unit of appropriation. Since each activity is denoted by a Scheme, this led to multitude of schemes and many budget line items. GoK made several attempts at reducing the number of schemes was. For instance, in the year 2002/03 departments such as Health, Commerce and Industry, Agriculture and Animal Husbandry reduced the number of schemes they operated. This continued for the next years and schemes were further reduced or clubbed on the lines of programs with the number declining from 3000 to 2500 – still a very large number. With the introduction of performance budgeting, the need for a multitude of schemes was re-visited. It was acknowledged that several schemes had common objectives and often the same target beneficiaries and moreover, a large number of schemes complicate monitoring and implementation and also compromises focused approach. Program budgeting was expected to consolidate the schemes into programs. The 2004 PFMA suggested further reduction in the number of line items or schemes in the budget. 114. In Karnataka, the total number of active schemes presently is 1874 schemes besides having nearly 15000 schemes which are not used on a regular basis (Source Planning and Finance Department). 274 schemes were added in last financial year 2013/14. GoK itself assessed that there were 351 plan and 311 non-plan schemes with provision of less than Rs. 10 million each 52. GoK therefore formulated the following rules with the objective of reducing the number of schemes or budget line items to avoid re-appropriations and supplementary: (a) Budget estimating officers will undertake a review of all the schemes coming under their control and merge non-plan and State Plan schemes with similar objectives into one scheme; (b) no line item with a provision of less than Rs. 10 million will normally be allowed in the budget estimates 53. A large number of schemes creates difficulty in budget process and thinly spreads the available budget across into various heads. Therefore, GoK needs to review the procedure for creating new schemes as well as the scheme hierarchy followed in the state. It would be advisable to put in place a mechanism for a periodic (say once in 3 years) comprehensive review of the schemes by the departments to weed out the schemes no longer required and to rationalize existing schemes. GoK should review these schemes and should identify opportunity for rationalizing and merging schemes with similar nature of objective and expenditure. This is suggested as a priority action for the 2014 PFM Reform Action Plan. 52 Government of Karnataka, Budget Estimates 2014/15, Office Memorandum No FD 09 BPE 2013 dated October 8, 2013 53 Except Centrally Sponsored Schemes and Central Plan Schemes may be shown separately even if the total scheme provision is less than Rs. 10 million based on the scheme guidelines issued by Government of India. | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 44 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 115. The Sundaramurthi Committee appointed by the GoI has suggested radical changes for classification of government transactions and the manner in which the information would be available for decision-making54. The Committee has suggested rationalization and reorganization of the information content of the existing six-tier hierarchical structure into separate logical dimensions. The system proposed comprises of seven mutually exclusive segments with their own individual hierarchical structure. One of the segments of classification pertains to programs and schemes. This requires development of a standard list of programs along with suitable schemes and sub-schemes mapped to them (program classification system). GoI, with the support of the World Bank, is piloting this classification system in select central government departments. Since GoK had in the early 2000s piloted performance based system55, it can benefit by adopting the classification system suggested by the Sundaramurthi Committee (post piloting and mandated for implementation by GoI). Implementation of Khajane II would facilitate the adoption of the new system. 2.12 DEPARTMENTAL MEDIUM TERM FISCAL PLANS 116. Budgeting in state governments in India involves preparing a single year annual plan for revenue and expenditure based on “line budgeting� emphasizing on inputs rather than outputs, objectives and results . This broadly follows the time horizon for appropriation of expenditure by the Legislature on an annual basis. To understand fiscal developments and understand the implications of policies beyond one year, a medium term perspective is required. Therefore, instead of preparing budget for a single year, a rolling (typically) 3-year budget is prepared taking into account the policy priorities and resource envelope – this is the Medium Term Budget Framework or Fiscal Plan (MTFP). MTFP at the state level was introduced in GoK in 2000-01. 117. Karnataka was the first state to introduce MTFP at the departmental level in 2002/03 . GoK introduced multi- year budgets and performance targets at the departmental level, called the Departmental Medium Term Fiscal Plans (DMTFP). The objective was to promote departmental planning and accountability by disaggregating the state MTFP into DMTFPs and replacing the input based budgets. The DMTFP included performance targets, strategies, resources and major programs to be undertaken over the period of the MTFP. Emphasis was on programs and sub-programs indicating the forward estimates at the program level providing the predictability of fund flow to enable better expenditure management. Preparation of DMTFP was piloted across five departments and later on introduced in another 15 in 2003/04 with all DMTFPs tabled in the State Legislature. The 2004 PFMA assessed that “the DMTFPs have helped in establishing a better link between departmental performance targets and costs�. It suggested th at departmental budgets should be based on the DMTFP, should be the focus of Legislative discussions and the targets should be cascaded downwards to the filed units within a department. In the MTFP of 2005/06 to 2009/10, GoK also introduced DMTFP Allocation Tables. 118. The initiative of multi-year budgeting at departmental level could not be sustained and it was discontinued by 2007/08. The following could be attributed to this situation: a. DMTFPs were not dovetailed with the demand-wise annual budget (Source: MTFP 2005/06 to 2008/09); b. lack of staff capacity to prepare MTFP; c. departments not having own revenue resources could not get the full allocations as projected in the MTFPs; d. A realistic resource envelope was not provided to the departments so as to help them to plan their departmental MTFP; e. Any planning by the department is made in the form of a scheme. The scheme continues as long as it has funds and the role of the department is only to administer these schemes subject to fund availability. Most of the times these schemes where an outfall of the government policy which the department ends up in implementing. f. The MTFPs prepared were rather a long wish list of the departments without priority which could not be funded by the GoK. 54 Controller General of Accounts, Ministry of Finance, Govt. of India – Report of the Committee to Review the List of Major and Minor Heads of Accounts of Union and States 55 Under the USAID supported India Fiscal Management Reform Project (REFORM) | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 45 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 119. The Finance Department prepares a MTFP for the entire state which is presented along with the budget every year. However, this MTFP is not supported by the DMTFPs as envisaged earlier. The Urban Development Department is the sole department in GoK that continues to develop a MTFP. Greater Bangalore City Corporation (BBMP) introduced MTFP from 2009/10 providing anticipated scenario over the next 5 years . This was part of the mandatory reform under JNNURM. However, it appears that this was discontinued in later years. 120. A pre-requisite for development of DMTFP is communication of indicative ceilings to each department and the departments respecting these ceilings to develop their budget proposals. The expectation is that each department would take the resource ceiling as given and allocate spending among its activities to achieve its objectives. At this stage, departments are expected to think strategically and evaluate their existing programs (effectiveness, usefulness etc.) and determine inputs or policy that will best help them attain the objective by maximizing the effectiveness and efficiency of spending. When the over-all funding is known in advance, framing policy discussion, objectives, programs or means of delivery may be explored. An important issue here is for the line departments to develop capacity for policy and program evaluation skills, assess effectiveness and cost and develop options - these skills can be developed through training. The budget requests from the departments to the Finance Department must, apart from numbers, contain text explaining the policy, changes in policy from the past, reallocation decisions, new objectives, output and outcome targets associated with the resource levels and allocations. A formal process to critically review ongoing programs as part of the budget process will also help ensure efficiency of ongoing policies and programs. The GOK has introduced RFD for the departments and going forward should dovetail the DMTFP based on the results and outcomes agreed in the RFD. 121. The recommendations of the 2004 PFMA are still relevant. The 2004 PFMA suggested providing departments with more flexible budgets would enable them to perform better. This would require: (a) a fundamental shift away from the current system of overly detailed line-item budgeting; and (b) greater re-appropriation powers for departments. Implementing such changes would involve some important conceptual changes: budget line-items would be prepared at an aggregate level instead of the detailed level used for accounting. A common code structure would apply to budgeting and accounting, but the more detailed codes would be used for accounting, and only the aggregate codes would be used for budgeting. GoK could consider this shift along with the implementation of KII across the state. The accounting code can be detailed in the KII while the budget head can be prepared and maintained at a higher level which can be approved in the Legislature. Re- appropriation rules would need to be amended to allow Medium Term Expenditure Framework (MTEF) in Government of Chhattisgarh unlimited departmental re-appropriation between schemes  MTEF (similar to MTFP) has been implemented in two within programs and between object heads. most important departments – Health and Education – supported by the State Partnership Program funded by 122. The priority action plan for GoK would be to the European Union. For implementation, external develop a framework including design of the DMTFP consultants were engaged to develop the framework, and a roadmap for implementation, particularly in the prepare a manual and spearhead the actual development larger departments. UDD and also BBMP should in the two departments. continue to prepare the MTFP. Being the largest ULB in the state, BBMP can provide a demonstration of the usefulness of the MTFP to other ULBs who can also over the medium term, adopt this multi-year budgeting tool. This would also meet one of the requirements of the Local Bodies FRL – preparing a sectoral MTFP and ultimately extending it to the rural local bodies (the Panchayats). Full DMTFP should be made available in public domain. 2.13 STRENGTHENING LEGISLATIVE SCRUTINY OF BUDGET 123. The annual budget, as passed by the Legislature, provides the power to spend to the government authorities. This requires the Legislature to rigorously examine and debate the budget, and if this power is not effectively exercised it | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 46 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix undermines the accountability of the government to the electorate. The factors to be assessed include the scope of the Legislative scrutiny, whether internal procedures for scrutiny are well-established and followed, and that adequate debate and time is allowed for that process. 56 124. The Karnataka Budget Manual and the KFRA provide the legal framework for budget literature and Legislative scrutiny and scope in Karnataka. These include requirements of presenting the budget to Legislature, process of scrutiny of the budget and its discussion and voting by the Legislature. The process of preparation of the budget is described in section 4.1 ibid. The minimum budget Working of GoK Committee on Estimates (2013/14) documentation that is required to be presented to  Constituted on Aug 1, 2013 with 18 members 57 Legislature is provided in the Budget Manual – in actual  Has held 29 meetings till date practice, the executive produces documents beyond the  Subjects selected: (a) Estimates and projects undertaken by Public Works, Energy, Water Resources, Minor minimum contained in the law (as discussed in section Irrigation Departments and (b) Budget estimates, 4.3). administration expenditure and buildings works at Karnataka Bhawan 125. The Karnataka Budget Manual prescribes a five-  No bills referred to the Committee stage process for presentation of the budget and its  I report on PWD submitted in Nov 2013 approval by the Legislature. This is based on the provisions of the Constitution of India (Articles 203 and 204). The Karnataka Conduct of Government Business Act recommends a Budget Session ordinarily in the first week of March and to be held for a minimum period of 20 days (section 4) while the rules prescribe the maximum number of days for general discussion and for voting. Besides, the Budget Manual also provides for constitution of a Committee on Estimates “for the examination of such of the Estimates as it may deem fit to refer to the Committee or as are specifically referred to it by the Assembly or the Speaker� (article 337). The Estimates Committee can have maximum of 18 members selected on proportional representation basis but no Minister can become a member. The Committee can examine the Estimates throughout the year and may submit a report. However, the demand for grants can be voted irrespective of whether the 58 Estimates Committee has made any report or not (Rules 267 – 269) . 126. In actual practice, the Karnataka Legislature passes a Vote on Account each year in Feb/Mar followed by passing of the full budget in Jun/Jul. After the budget is presented in the Legislature and the Finance Minister’s speech is over, the Legislature passes the Vote on Account authorizing expenditure for the first four months of the financial year. No discussion or voting takes place at this stage. The discussion and voting on the full budget takes place during the session held in July. For 2012/13 budget, 6 days were allotted for this purpose and, for 2013/14, 11 days were available to the Legislature for in-house deliberations – this is not strictly in line with the Budget Manual that prescribes a minimum of 15 days for discussions and voting.. Moreover, between the session in February and the one in July (recess for three months), the procedure for review of budget, if any, is not documented. The sole Committee on Estimates too does not examine any demand for grants for the purpose of informing the Legislature. The Karnataka Legislature spends much less time in the review of the budget proposals. 127. In respect of Legislative scrutiny of budget, the 2004 PFMA recorded situation similar to the one prevalent today i. e. not much progress has been made. At that time, the Legislature’s Rules provided for a Committee on Estimates to examine any estimates, but this was not a requirement for consideration or approval of the Demands for Grants by the Legislature. In practice, this Committee system had not been functioning. This gap continues even to this day. Subject 56 read with Karnataka Conduct of Government Business in the State Legislature Act, 2005 and Chapter XX of the Rules of Procedure and Conduct of Business in Karnataka Legislative Assembly (2011) 57 These include the Finance Minister’s Speech, The Annual Financial Statement, Detailed Estimates and separately for public wor ks and irrigation, Plan Budget, Budget Memorandum. 58 There is a separate document called the Rules of Procedure (Internal Working) of the Committee on Estimates (June 2013) that is supplemental to the main rules | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 47 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Committees of the Legislature constituted at that time to examine budget demands of individual departments after the Vote- on-account had been passed, is no longer in existence now. GoI - Departmentally Related Standing Committees  Constituted in 1993, presently there are 24 DRSCs each with 21 members from Lok Sabha and 10 from Rajya Sabha (but no Minister)  DRSCs consider demand for grants, annual reports and long term policy documents, and examine bills (subject to some restrictions)  Examination of demands is done by DRSCs during the recess after general discussion is completed in Feb/Mar and the next session (Jun/Jul)  During 2011/12, DRSCs submitted 4 reports on demand for grants and GoI accepted 68% of the recommendations made by the DRSCs Andhra Pradesh  The provision of the DRSCs are embedded in the Budget Manual and during 2013, 12 DRSCs presented 33 reports on the demand for grants for 2013/14 to the Legislature on June 11, 2013 (second phase of budget session started on Jun 10, 2013) West Bengal  There are 22 DRSCs covering all government departments, to carry out what is known as a “Pre -Budget Voting Scrutiny� and present their report to the state legislature Himachal Pradesh  Himachal Pradesh DRSC’s considered the demand for grants for 2013/14 for 5 days and submitted its report on March 28, 2013 in time for voting on the demands in the State Legislature Kerala  Kerala has 14 Subject Committees who submit their reports on the scrutiny of the demand for grants, follows up issue of Action Taken Reports. A Handbook on Subject Committees (May 2011) guides the functioning of these committees. 128. Departmentally Related Standing Committees (DRSC) have been constituted with the primary function of examination of the demand for grants at the GoI (see box) and some states such as Andhra Pradesh, West Bengal and Himachal Pradesh, while Kerala has constituted Subject Committees. The process of Legislative scrutiny in Karnataka when benchmarked to good practices in PEFA framework indicates that this important function can further be strengthened by (a) establishing DRSCs covering at least the major departments; (b) providing more time for Legislative debate on the budget. Dimension/Good Practice Current Status Scope of the Legislature’s scrutiny The Karnataka Legislature’s review covers fiscal policies The Legislature’s review covers fiscal policies, medium term and aggregates, medium term fiscal plan (under KFRA) and fiscal framework and medium term priorities as well as details of expenditure and revenue. details of expenditure and revenue Extent to which the Legislature’s procedures are well- The Legislature’s procedures for budget review are firmly established and respected established in the Karnataka Budget Manual and the Rules of The Legislature’s procedures for budget review are firmly Procedure and Conduct of Business in Karnataka Legislative established and respected. They include internal Assembly and include internal organizations arrangements organizational arrangements, such as specialized review include review committees and negotiation procedures. committees, and negotiation procedures Adequacy of time for the Legislature to provide a The budget is presented in Legislature in February and the response to budget proposals (time allowed in practice Finance Minister makes his/her speech and the Appropriation for all stages combined) Bill for the Vote on Account is passed without any | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 48 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix The Legislature has at least two months to review the budget discussion on the budget. The full budget is discussed in proposals Legislature during July. The procedure of review of budget during the intervening three months is not documented. Summary of Issues 129. The Karnataka Legislative Assembly presently devotes relatively less time on discussions and voting the demand for grants. The time available between the presentation of the budget and its subsequent discussion is not effectively used. 130. There is only one Legislative committee for examination of the demands and this too is not effectively active in supporting the Legislature. The Karnataka Legislative Assembly rules and the Budget Manual prescribe only one committee for examination of the demands (the Committee on Estimates) and this committee itself is not very active and is unable to complete its examination and make a report prior to the second phase of the budget session. Some other states have constituted DRSCs to support the Legislature to scrutinize the demands prior to discussion and voting. 131. The following reforms would enhance the contribution of the Legislature to PFM and improve its oversight. a) The Karnataka Legislature could devote more time on discussions and voting the demand for grants. The time available between the presentation of the budget and its subsequent discussion could be more effectively used to examine the demand for grants. b) The Karnataka Legislative Committee could consider the DRSC mechanism implemented at the central level and by some states. This would deepen the scrutiny of the demands and provide inputs to the Legislature for a well- informed discussion on the budget. DRSCs could be made the sub-committees of the main Committee on Estimates. This may need amendment to the Budget Manual and the Rules of Procedure and Conduct of Business in Karnataka Legislative Assembly. c) The Legislative committee/s should be provided with adequate technical support and capacity building programs held so that the Legislative skills to examine the budget are enhanced. Some headway has been made in this area as for instance newly elected members underwent a 2-day training in budget by a professor from the Indian Institute of Management. More such skill-building measures need to be taken. | Theme Two: Enhancing Credibility and Comprehensiveness of the Budget 49 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Section 3. THEME THREE: STRENGTHENING ACCOUNTING, REPORTING , CONTROLS, AND TRANSPARENCY 3.1 ACCOUNTING AND REPORTING 132. The primary unit for state accounting is the Treasuries and the compilation of accounts and preparation of the annual statements is done by the State Accountant General (Accounts & Establishment) . The Treasuries maintain the initial and subsidiary accounts as all payment bills are presented by the DDOs to their designated Treasury and on the other hand, all receipts are deposited in the government account. The Treasuries render monthly accounts to the AG (A&E) for compilation and preparation of the Basis of Accounting Annual Financial Statements (AFS) of the state. Information for the purposes of Governments in India follow the cash the AFS is also obtained from the Reserve Bank of India and other state basis of accounting (other than some government agencies. periodical book adjustments) on historical cost basis 133. The AFS comprise of the Finance Accounts and the Appropriation Accounts and are prepared in accordance with Article 149 to 151 of the Constitution of India and the format is decided by the Comptroller General of India (CGA) in consultation with the C&AG. In Karnataka, the Finance Accounts is prepared in two volumes – volume I contains the consolidated position of the state finances are the accounts and volume II contain detailed accounts and supporting schedules. The disclosures have improved over the years primarily guided by the recommendations of the Central Finance Commissions. Most of the 2004 report recommendations on disclosures have been addressed in the current Finance Accounts. Appropriation Accounts are in a single volume and presents the expenditure in the year compared with the budget allotment adjusted for re-appropriations, surrenders and supplementary and information is provided for each demand for grants. Accounts maintained in the state 134. Accounts are maintained in three parts: a. Consolidated Fund. Receipts of the State Government from taxes and duties, non-tax revenues, grants and loans received, and repayments of loans/advances due to the State Government are deposited into the Consolidated Fund. State Government expenditures, debt repayments, and loans given are paid from the Consolidated Fund. Fiscal indicators e.g., fiscal and revenue deficits and debt stock are determined with reference to transactions in the Consolidated Fund. Receipts are accounted for under four main categories: (a) Revenue Receipts; (b) Capital Receipts (usually negligible); (iii) Borrowings; and (iv) Recovery of loans and advances. Similarly, payments are accounted under four main categories: (a) Revenue Expenditure; (ii) Capital Expenditures; (iii) Repayment of borrowings; and (iv) Loans and Advances. b. Public Account. The Public Account was established to account for all other public monies received by the State Government i.e., those that are received by the Government as a banker or trustee, and are not credited to the Consolidated Fund e.g., employees’ Provident and Insurance Funds; repayable deposits received from the public, contractors, etc. c. Contingency Fund. This is a relatively small “imprest� ( maximum Rs. 80 crore) periodically drawn from the Consolidated Fund to meet unforeseen expenditure which arise during the course of a year pending authorization of the expenditure by the State Legislature. Expenditures incurred from the Contingency Fund are finally accounted for in the Consolidated Fund. Classification of accounts 135. A six-tier classification structure is used for accounting purpose: | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 50 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix a. Tier 1: Major heads (four digits): The first digit classifies items into revenue receipts, capital receipts, revenue expenditures, revenue expenditures or capital expenditures, borrowings, and loans given. The next three digits classify items into sectors/functions. b. Tier 2: Sub-major heads (two digits): These further break down the sectors/functions into sub-functions. c. Tiers 3- 5: Minor heads (three digits), Sub-heads (one digit) and Detailed heads (two digits): These are used for programs/program groups sub-divided into schemes or sub-schemes. d. Tier 6: Object heads (three digits): These indicate the type of expenditure e.g., salaries, rent, etc. 136. Expenditure data can be generated by sectors, programs/schemes, and type. The combination of this six-tier structure or a 15-digit code is an account head. The first three tiers (up to the minor head level) use a standard list of codes that is common to GoI and all state governments. The state has flexibility to adopt its own coding scheme for the last three tiers (including the object heads). Accounting and Reporting Standards 137. The C&AG constituted the Government Accounting Standards Advisory Board (GASAB) 59 with the broad mandate to develop standards for government accounting and reporting against “the backdrop of the new priorities emerging in the Public Finance Management and to keep pace with International trends...the new priorities focus on good governance, fiscal prudence, efficiency & transparency in public spending �. The accounting and reporting standards developed by GASAB are called the “Indian Government Accounting Standards� (IGAS) which is based on cash based accounting and the “Indian Government Financial Reporting Standards� (IGFRS) based on the accrual concept. While IGAS are mandatory, IGFRS are recommendatory till piloting the standards are successfully completed. The standards developed by GASAB and notified by the GoI are mandatorily applicable to the Union and State Governments from the date of notification in the Gazette. Table 24 briefs the standards notified by GoI, approved by GASAB pending notification and exposure drafts. GoK meets all the disclosure requirements as outlined in IGAS 1 to 3. Table 24: Status of IGAS and IGFRS Standard Notified by GoI Approved by GASAB, pending Exposure drafts notification IGAS  Guarantees given by  Foreign Currency transactions  Accrual Exposure Draft (AED) 6 (cash based Governments: Disclosure and loss or gain by Exchange (Accounting Policies, Changes accounting Requirements (IGAS1) -2010 Rate variations (IGAS 7) in Accounting Estimates and standards)  Accounting and Classification of  Public Debt and Other Liabilities Errors) Grants-in-aid (IGAS2) -2010 of Governments: Disclosure  Exposure Draft (ED) 4 (General  Loans and Advances made by Requirements (IGAS 10) Purpose Financial Statements of Governments (IGAS 3)-2012 Government) IGFRS  IGFRS 1 : Presentation of  (accrual Financial Statements based  IGFRS 2: Property, Plant & accounting Equipment standards)  IGFRS 3: Revenue from Government Exchange Transactions  IGFRS 4: Inventories  IGFRS 5: Contingent Liabilities (other than guarantees) and Contingent Assets: Disclosure Requirements 59 www.gasab.org | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 51 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 138. The accounts are compiled by the AG (A&E) and then presented for audit to the AG (Audit). Based on the audit by AG, the C&AG issue a certificate on the “true and fair view� of the financial position and the receipts and disbursements. The Finance Accounts and Appropriation Accounts are tabled in the state Legislature and then made available in the public domain. Full accounts are available on the website of the C&AG and also the state AG. Once tabled, the accounts are referred to the Legislative oversight committees for examination. The dates of submission of the accounts for audit, issue of audit report and tabling in the state Legislature are summarized in Table 38: Public availability of State External Audit Reports in Karnataka. 139. Ownership over State Accounts: One point of interest is that the GoK, like other states in India, does not sign the annual accounts compiled by the AG. This implies that the state governments do not take direct ownership over the annual accounts. GoK with the implementation of GoI accounts are signed by the KII would be in a position to generate and prepare the accounts and financial Controller General of Accounts who certifies that the statements from KII. So GoK can work with AG (A&E) gradually to establish accounts are the correct ownership as a gradual process. This suggestion was made in 2004 report and is statements of the receipts and relevant in current context also. In case of GoI, the accounts are signed by the CGA on disbursements of the GoI. behalf of the GOI. 140. The 2004 PFMA brought out several areas of shortcomings and made recommendations in accounting and financial reporting that were prevalent at that time. For one, the report identified several issues relating to the Public Account . For instance, book/accounting adjustments between the Consolidated Fund and the Public Account causing distortions in the GoK’s financial performance and position; Revenue and Expenditure being accounted for in the Public Account rather than in the Consolidated Fund; less rigorous internal controls in transactions through the Public Account; no Legislative control over expenditure made from the Public Account. Recommendations included discontinuing (or at least minimizing) book transfers particularly for overcoming any legal compliance 60 or for carry-forward of balances (such as Personal Deposit Accounts) and introducing automatic rules for end-of year lapsing and writing back balances in the accounts. Other steps suggested were one-time clean-up of long-outstanding balances, considering some items as cash balance of the state and improving transparency in presentation of the Public Account. Some of these recommendations are still relevant, not because GoK did not take steps to implement them but because these items build up over time. 141. Arrears in reconciliation, non-adherence to accounting controls, weaknesses in systems for recording, reporting and monitoring of fiscal and assets and liabilities, and reporting if transfers to other public sector entities were areas that were identified for strengthening. Un-reconciled items included bank balances, intra public sector transfers, sub-accounts, employee fund accounts. Inadequate systems included those around off-budget borrowings, guarantees, payables, debt, investments and loans and advances. Many of these issues have been addressed, including recommendations made by the Finance Commissions. Implementation of the Treasury computerization has been completed, better controls over guarantees have been achieved, debt database has been created, cleaning up of suspense accounts have been carried out, disclosures in financial statements have improved and off-budget borrowings have been reduced. Yet, many of the areas continue to exhibit weaknesses dealt with in the 2004 PFMA including weak controls over investments and loans and advances; un-reconciled or long-outstanding balances such as unencashed cheques or personal deposit accounts. These issues are covered in Section 6. 142. This report takes stock of the steps taken by GoK to address the key findings from the 2004 PFMA, including in light of recent developments such as introduction of mandatory government accounting standards or developments at the central level affecting the state governments. In some areas, performance of GoK has been compared with other states. Reconciliation of Revenue and Expenditure 60 Such as where earmarked revenues are not used for any specified purpose | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 52 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 143. The Karnataka Financial Code (KFC) prescribes monthly reconciliation between the AG (A&E) and the departments for both receipts and expenditure. Overall, the Chief Controlling Officer is responsible for final reconciliation and forwarding certificates of reconciliation to the AG (A&E) “in order to ensure credibility of accounts a nd avoid probable 61 fraud and embezzlement of money� . a. In case of receipts, Controlling Officers reconcile departmental figures of revenue with those of actual credits into the Treasuries and accounted in the books of Accountant General (rule 34 of KFC). b. On the expenditure side – (a) all DDOs reconcile figures of expenditure with those booked in their designated Treasury and forward reconciled figure to their Controlling Officers (CO); (b) the COs forward these to the Chief Controlling Officer (CCO); (b) AG (A&E) forwards the monthly statement of receipt and expenditure to the CCO once monthly Civil Accounts are rendered to GoK; (c) the CCO reconciles the receipts and expenditure figures as furnished by AG (A&E) with those compiled by him/her on the basis of the figures furnished by DDOs and Controlling Officers (rule 187-A and 199 of KFC) and submits an annual certificate of reconciliation to the AG. 144. While GoK has achieved more than 90% in terms of reconciliation of revenue figures, achievement in terms of reconciliation of expenditure is only 58% and there is slippage over the last few years (see Table 25). States such as Gujarat and Uttar Pradesh have achieved nearly 100% reconciliation on both revenue and expenditure. The matter of concern appears to be continuous slippage over the last four years - marked decline on the expenditure side - and this need to be addressed. Significant non-reconciliation of revenue and expenditure could adversely impact the assurance on completeness and correctness of the accounts. Table 25: Progress of Reconciliation of Revenue and Expenditure Financial Year Receipts Expenditure 2012-13 94.26% 58.11% 2011-12 98.00% 66.44% 2010-11 98.20% 67.08% 2009-10 99.00% 71.33% Source: Government of Karnataka, Finance Accounts and C&AG Report of State Finances 145. Reconciliation is normally done post year-end and GoK gives time up to May 31st to the HoDs to finalize. As at close of March 2014, tentative data indicates that - (a) revenue reconciliation had been fully done by 4 CCOs, partially by 51 and 24 had yet to carry out the exercise; and (b) expenditure reconciliation had been fully done by 6 CCOs, partially by 98 62 and 90 had yet to do so . This problem is expected to be resolved once Khajane II is operational, as there would be one database and DDO would be actually entering the details in KII– but till that time, past reconciliation has to be completed. Personal Deposit Accounts 146. Personal Deposit (or PD) Accounts are deposit accounts maintained in the Treasury in the nature of a banking deposit account. PD Accounts can be opened only with the specific permission of the Government after consultation with the AG. PD Accounts are allo wed to be opened “in cases where the ordinary system of accounting is found not suitable for the transaction� (clause 286 of the KFC). PD accounts are often created by “transferring funds from the Consolidated Fund for 61 GoK Circular No. FD 49 TAR 2012 dated November 27, 2012 62 PAG (A&E) | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 53 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 63 discharging liabilities of the GoK arising out of special enactments� (clause 286-A of KFC) . Each PD has an Administrator who maintains detailed accounting of the transactions. The KFC has detailed provisions for the operation of the PD Accounts. The balance in the PD account is shown in the Public Account in state’s financial statements. 147. In case of PD accounts created out of funds transferred from the Consolidated Fund, unspent balances as at the close of each financial year need to be transferred back to the Consolidated Fund (as minus debit to the original head of account but if the reversal is done in subsequent year, by credit to revenue head). In other words, the PD accounts will lapse and can be re-opened next year 64 . This rule is not strictly being followed in Karnataka and significant balances are carried forward to the subsequent year/s. Nearly, half of the PD accounts are inoperative, some have adverse balances and none of the Administrators have reconciled the balances with the Treasury and the AG (A&E). Majority of the funds are released to the Deputy Commissioners from the State Disaster Response Fund and keeping such funds in the Personal Deposit Accounts is not in accordance with the rules. The Public Accounts Committee had also expressed concern over the outstanding in the PD accounts (Jan 2012). Table 26: Personal Deposit Accounts not closed at end of financial year (Rs. in crore) Financial Year Amount transferred to PD Account during Closing Balance at end of FY not the year transferred to Consolidated Fund 2012-13 3,582 2,086 2011-12 2,737 1,478 2010-11 2,201 1473 2009-10 3,491 1,214 Source: Government of Karnataka, Finance Accounts and C&AG Report of State Finances Abstract Contingent Bills 148. Abstract Contingent (AC) Bills are bills without details of the contingent or travelling expenditure and allowed to be drawn from the Treasury without scrutiny – therefore the payment is of the nature of an advance. Once the expenditure has been incurred, the AC Bill has to be settled through submission of a corresponding Detailed Contingent (DC) Bill submitted to the AG. The provisions for AC Bills are contained in the Karnataka Manual of Contingent Expenditure, 1958 (clause 36) 65 including time limit for submission of the DC Bills . 149. AC Bills needs to be followed scrupulously, so they don’t accumulate for non-settlement. When the amount is drawn it is accounted as expenditure AC Bills - Practices in other states which is a key accounting policy issue in all states. Treasuries keep a watch  Madhya Pradesh has banned drawl of over outstanding AC Bills and drawers of AC Bills are required to submit a funds against AC Bills (in 1999) certificate with their salary bills to the effect that DC Bills have been except in one case  In Uttar Pradesh, details of individual forwarded to the AG for all outstanding AC Bills. The Public Accounts AC Bills (Treasury and DDO wise) Committee had expressed concern over the high level of AC Bills and has are in public domain on the website of recommended action against the DDOs for not rendering accounts (Jan 2012). the State AG In Karnataka, the quantum of outstanding AC Bills are contained at a reasonable level and showing a decreasing trend over the years in both outstanding as well as fresh drawls during the year - as at March 2013, the outstanding AC Bills were Rs. 122 crore of which Rs. 45 crore were drawn in March 2013 63 PD accounts can also be created with funds other than from the Consolidated Fund of the state such as earnest money deposits or money belonging to prisoners in jails. 64 This rule is similar to other states with the exception of some states such as Odisha (PD account to be closed if remaining inoperative for three FY after the last transaction) and Bihar (PD account to be closed if balance lying unspent for two consecutive FY). 65 The Manual of Contingent Expenditure requires submission of DC Bills to the countersigning officers before close of first week on the month succeeding the month in which the AC Bill was drawn and forwarded to the AG before 15th of the succeeding month | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 54 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix itself66. AC Bills aggregating Rs. 67 crore are outstanding prior to FY 2012-13 (i. e. more than 1 year) for want of submission of DC Bills. Normally, the previous AC Bill should be settled prior to drawl of another AC Bill and Treasury system ensures that this control is exercised. Reserve Funds 150. Reserve Funds are created by the state government to meet specific liabilities or for specific and well-defined purposes, including those that may arise in the future. The source of funding could be the Consolidated Fund of the state or from other agencies or governments or public subscriptions. The balances in some of these reserve funds are invested in longer term securities called “Investments from Earmarked Funds� and the balances in reserve funds and earmarked investments are shown respectively in statements 18 and 19 of the state Finance Accounts. In case of funds created out of the Consolidated Fund contribution, initially expenses are made from the Consolidated Fund and then transferred to the respective fund. Similarly, receipts from other than the Consolidated Fund are taken as revenue of the state and then transferred to the fund account after charging of to the functional head of account. This procedure has been prescribed so that there is Legislative control over the expenditure. 151. As of the close of March 2013, GoK had 44 reserve funds with a balance of Rs. 15,760 crore of which only 9 are active and the remaining 33 are lying dormant for over 30 years with balances aggregating Rs. 49 crore . There are instances of two other issues in accounting of Reserve Funds - (a) partial/full expenditure not transferred to the Fund despite having credit balance (e. g. Port Development Fund; Failed Well Compensation Fund); and (b) amount not transferred to the Fund due to absence of budget provision (Depreciation Reserve – Commercial; Consumer Welfare Fund; Karnataka Silk Worm.... Stabilization Fund). GoK needs to review these funds and take a policy decision on closing these unused funds. Utilization Certificates Utilization Certificates - Practices in other 152. GoK provides grants to various state agencies. At the time of states  In Uttar Pradesh, details of individual release of these grants, the expenditure is charged off to the functional outstanding UCs (Treasury and DDO wise) head of account. The terms of the grant require the recipient agencies to are in public domain on the website of the submit Utilization Certificates (UC) as a confirmation of utilization of State AG the funds provided. The UCs are submitted to the parent department and also forwarded to the AG (A&E) within the time stipulated in the grant letter. UCs outstanding beyond a specified period indicates absence of assurance on utilization of grants for intended purposes. 153. GoK has over the years significantly reduced the backlog and delay in submission of UCs by the grantee institutions (Table 27). About 86% of the outstanding UCs as of March 2013 pertains to one department – Health & Family Welfare (Rs. 521 crore) out of which 80% is for the FY 2012-13 due only in the next FY 2013-14. Table 27: Outstanding Utilization Certificates (Rs. in crore) Financial Year UCs outstanding pertaining to UCs outstanding pertaining to Total UCs outstanding prior FY reported FY 2012-13 164 451 615 2011-12 566 738 1,304 2010-11 1,149 497 1,646 66 Government of Karnataka, Finance Accounts 2012-03. The average amount per AC Bill in Karnataka is Rs. 125,000 as compared to Rs. 277,000 in Gujarat and Rs. 40.82 lacs in Bihar. | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 55 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 2009-10 1,061 130 1,191 Source: Government of Karnataka, Finance Accounts and C&AG Report of State Finances 154. In terms of submission of UCs, Karnataka fares well over other states where the level of outstanding UCs is extremely high including huge backlogs (Table 28). Table 28: Outstanding Utilization Certificates in Sample States (Rs. in crore) State Financial Year UCs outstanding UCs outstanding Total UCs pertaining to prior FY pertaining to reported outstanding FY Karnataka 2012-13 164 451 615 Gujarat 2011-12 7,964 1102 9,066 Madhya Pradesh 2012-13 46,546 28,241 74,787 Uttar Pradesh 2012-13 59,087 7,538 66,625 Odisha 2012-13 18,719 3,502 22,221 Kerala 2012-13 146 342 488 Bihar 2012-13 17,233 17,454 34,687 Maharashtra 2011-12 62,565 25,677 88,242 Source: Finance Accounts of respective state Accounting of Revenue and Expenditure under Minor Head 800 – Other Revenue/Expenditure 155. Revenue and expenditure are accounted for under specified head of account and corresponds to that approved by the state Legislature. In the eventuality of either non-availability of the specific head of account or due to incorrect identification of expenditure under the available heads of account at the budget stage or appropriate minor head has not been provided in the accounts, the Minor Head 800-Other Expenditure / Other Receipts are to be operated. Routine operation of minor head 800 is to be discouraged, since it renders the accounts opaque. 156. Table 29 briefs the percentage of total receipts and total expenditure that was accounted for under the account head 800. There is a sudden spurt in booking transactions under the miscellaneous head of account in the last FY 2012-13 vis-à-vis earlier years. This is also significantly higher when compared with a sample of seven states ( Table 30). Table 29: Percentage of Receipts and Expenditure accounted for under Account Head 800 in Govt. of Karnataka Financial Year Percentage of Receipts under Head 800 to Percentage of Expenditure under Head 800 Total Receipts to Total Receipts 2012-13 28% 31% 2011-12 2% 11% 2010-11 6% 14% 2009-10 6% 13% Source: Government of Karnataka, Finance Accounts and C&AG Report of State Finances Table 30: Percentage of Receipts and Expenditure accounted for under Account Head 800 in Sample States State Financial Year Percentage of Receipts under Percentage of Expenditure under Head 800 to Head 800 to Total Receipts Total Expenditure Karnataka 2012-13 28% 31% Gujarat 2011-12 6% 16% | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 56 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Madhya Pradesh 2012-13 21% 14% Uttar Pradesh 2012-13 12% 13% Odisha 2012-13 2% 10% Kerala 2012-13 2% 7% Bihar 2012-13 9% 2% Maharashtra 2011-12 1% 10% Source: Finance Accounts of respective state 157. The Public Accounts Committee during examination of the C&AG Report for 2010 had commented on the significant amount accounted for under miscellaneous head. A Committee comprising representatives of the State Government, Office of the Principal Accountant General (G&SSA and Principal Accountant General (A&E) has been constituted to scrutinize the existing classification in accordance with the List of Major and Minor Heads. Every year, this committee identifies the correct head of account and shifts the amounts from Minor Head 800 to appropriate Minor Heads. 158. Several departmental entities are in arrears in submission of Accounts: Many of the departments dealing in stores and stocks and departmental commercial/quasi commercial undertakings default in preparation of accounts. In case of autonomous units (comprising mainly of boards, commissions and authorities) accounts are in arrears by one year and audit reports of earlier years have yet to be placed before the state Legislature. 159. In respect of accounting and reporting benchmarks set under PEFA, GoK fares well though there are some areas that could be strengthened. Dimension/Good Practice Current Status Regularity of Bank Reconciliation All bank accounts of the GoK linked to the Treasuries are Bank reconciliation for all government bank accounts reconciled monthly at all levels. take place at least monthly at aggregate & detailed levels, usually within 4 weeks of end of period. Regularity of reconciliation and clearance of Reconciliation and clearance of suspense accounts and advances suspense accounts and advances taken place annually and outstanding balances are carried Reconciliation and clearance of suspense accounts and forward. Details of Suspense accounts are provided in Statement advances take place at least quarterly, within a month No. 18 of the State’s Finance Accounts and form part of the from end of period and with few balances brought Public Account. Outstanding in Suspense Accounts (excluding forward. items like unencashed cheques or Cash Balance Investment Account) as at the close of FY 2013 was only Rs. 8 crore (previously Rs. 55 crore). Completeness of Financial Statements The Finance Accounts and Appropriation Accounts are the A consolidated government statement is prepared government consolidated accounts and are prepared annually on annually and includes full information on revenue, cash basis of accounting. They include full information on expenditure and financial assets/liabilities. revenue, expenditure and financial assets/liabilities but do not include the local government expenditure. Timeliness in submission of Financial Statements The AFS, compiled by the AG (A&E), have been submitted for The statement is submitted for external audit within 6 audit within 6 months of the close of the FY, in the last three months of the end of the fiscal year years. Accounting Standards used All statements are prepared under the Indian Government IPSAS or corresponding national standards are applied Accounting Standards, IGAS. However, these are not fully for all statements aligned with Cash IPSAS developed by IFAC. 160. The rules governing the areas discussed in this section in respect of accounting and reporting are adequately mandated in the PFM documents; the issue lies in their application and compliance that needs to be enforced . An across the board action plan for these areas would not address the problem as the issues are of disparate nature and needs to different ways of resolving them. Not only this, GoK would need to ensure that the achievement made in the past is sustained, for instance in submission of DC Bills, reconciliation of expenditure. It is also important to recognize that most | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 57 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix of these issues are being addressed in Khajane II – but the pre-requisites for successful migration are availability of legacy data and up to date reconciliation. The following broad strategy is suggested and a particular area could be addressed by applying one or more of these action points. a. The provisions of the KFC in respect of the areas discussed above need to be reiterated through workshops, GOs, and capacity building measure. b. FD should designate a nodal office with adequate staff to collect and collate the information on these key areas and monitor their resolution with the concerned IFAs/CCOs/DDOs. Presently, this information is not available centrally and is provided by the AG in the Finance Accounts. c. A one-time exercise to clear and clean up the backlog such as in the case of reconciliation of expenditure, and UCs needs to be undertaken. Clearance of UCs can be attempted faster as the bulk of the outstanding pertains to only one department. d. The periodicity of certain actions could be reduced as for instance submission of UCs (presently 1 year) or unencashed cheques. This would require the concerned CCOs or DDOs to initiate action much earlier than mandated presently and hence backlog would be prevented to a large extent. e. Accounting issues such classification under miscellaneous heads, operation of reserve funds and issue of Alteration Memos for lapsed cheques should be resolved in consultation with the AG. (Accounting and reporting issues in cases of investments, guarantees, unencashed cheques, SOEs and local self-governments are covered under the respective sections). Disclosure of CSS funds and expenditure 161. A recent development that could affect GoK as well is that all funds under Centrally Sponsored Schemes will be released through state budgets, as compared to direct transfers to implementing agencies hitherto. Funds under many Centrally Sponsored Schemes (CSS) traditionally flowed to implementation agencies (mainly societies) outside of the state budget under PFM structures mandated by the GoI with little accountability by the state governments. The Chaturvedi Committee recommended that “procedure for transfer of funds to the states should be reformed to ensure full accountability and efforts must be made to gradually move over transfers through the state budgets and it is not possible to in the current system to monitor the actual flow of funds.� 67 Based on these recommendations, the Planning Commission decided (December 2013), that with effect from 2014/15, all funds under CSS will be released as central assistance to the state plan through the state budgets only. This has the implication that state governments would need to make provisions for receipts under CSS in their budget and for the releases and that the size of the state plan would increase considerably. According to this changed fund flow mechanism, GoK has budgeted for CSS funds under Major Head 1601 for 2014/15. Therefore, the state plan has increased to Rs. 15,745 crore in 2014/15 as compared to Rs. 3,958 crore during the year 2013/14. Break-up of receipts under the various CSS are also available in the budget (in the budget document Detailed Estimates of Revenue and other Receipts). The provision however has been made under the Minor Head 800. 162. The CSS funds from the state budget would be released to the implementing agencies and at this point, the release would be accounted for as expenditure in the state accounts. Utilization of these funds would be monitored through prescribed scheme specific fiduciary guidelines including submission of utilization certifications. In the traditional mechanism, details of funds released directly to the implementing agencies were disclosed in the Finance Accounts (Appendix 7) – however, the corresponding expenditure was not disclosed and the information was obtained from the Comptroller General of Accounts. With the funds being routed through the state budget, this appendix is no longer needed. 67 Planning Commission, Report on the Committee on Restructuring of Centrally Sponsored Schemes, B. K. Chaturvedi (September 2011) | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 58 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 163. The transfer of funds mechanism through state budget is evolving and on certain aspects presently there is less clarity such as the reporting mechanism between GoK and GOI, and between implementing agency and GoK, submission of UCs and audit reports. As and when this clarity emerges GoK needs to issue a circular in this regard. The role of Central Plan Scheme Monitoring System (CPSMS) in tracking these transfers and expenditure also need to be explored by the GoK. Going forward, actual expenditure incurred by the implementing agencies through CSS funding should be disclosed in the Finance Accounts so as to provide a complete picture of funds released by GoK and the related expenditure. Transfers to be shown as per IGAS 2 164. All transfers from the state to implementing agencies under CSS, ULBs, PRIs for devolution and other schemes are treated as expenditure in the state accounts at the time of release. This is as per the current accounting policy followed in the states. IGAS-2 recommends that any transfer made to ULBs/PRIs and any other public sector enterprise irrespective of the nature of expenditure should be treated as revenue expenditure in the State accounts. FD is already following this requirement in the previous budgets and should continue to follow this accounting standard as it has become effective from 2010. 165. In terms of disclosure of state accounts towards transfers to ULBs and PRIs, currently the state accounts exhibit only the transfers made to the ULBs and PRIs. The state account s don’t exhibit the actual expenditure incurred by the ULBs and PRIs. Going forward the DMA and RDPR needs to collect details on the actual transfers, actual expenditure and balances which should be exhibited as a separate schedule in the Finance Accounts. This was a recommendation in 2004 report also. An MIS cell needs to be established in DMA and RDPR which would exclusively work on monitoring and collecting these financial data from the field. Issue of fund II in Zilla Panchayat (ZP)/Taluk Panchayat (TP) 68 166. ZP and TP have three types of fund accounts maintained in the public account : Fund 1: Grants from GOI and State share of such schemes; Fund 2: State plan schemes and Fund 3: Own resources. While Funds 1 and 3 don’t lapse at the financial year end, fund 2 lapses at the year end and any balance on the last date of the FY is nullified by the Treasury. As per GO69, unutilized amount70 in this fund account is to be reversed to the Consolidated Fund in the next financial year. However in practice this is not done, thus inflating the expenditure for the year of transfer. This is an issue which has not been resolved for the past three to four years and the balances in this account have been increasing. The accounting treatment also gets vitiated as the earlier year expenditure is offset by showing this reversal in the next financial year which affects the fiscal indicators in which the reversal is carried out. This is an issue which has both policy and procedural gaps and needs to be addressed by the GoK with AG. While ULBs, ZPs and TPs are all third tier of governments differential treatment of fund accounts needs to be reviewed . ZP/TP reversal of fund II balance should be seen in light of the treatment provided to ULB PD accounts which don’t lapse at the year end. GoK should review this policy and the GO issued in this regard. If the reversal has to be done: a. It needs to be done within the FY, as on 31 st all the balances except for cheques issued needs to be reversed in the Treasury and the same should be reflected as a reduction in the expenditure head. This could be achieved by having a cutoff date for issue of cheques from the PD account. (or) 68 G.O. No. FD 07 ZPA dated 8th September 2004 69 G.O. No. FD 07 ZPA dated 8th September 2004 read with circular dated 14 July 2005 70 Unspent balances of Rs. 1,657.72 crore under ZP and TP fund account II were not withdrawn. Source CAG report on Local Bodies – 2012. | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 59 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix b. It could be done as a part of the periodical adjustments carried out by the AG (A&E). GoK should intimate to the AG (A&E) how much is the lapsable amount in the PD account and the amount to be written back for the year. This option would provide time for the Treasuries to prepare the statements as well as reflect correct expenditure amounts in the finance accounts. 167. The other option is to follow the ULB model where the amounts don’t lapse at the end of the FY and it is adjusted while budgeting for the next year requirements. GoK should consult with AG on the appropriate accounting treatment for this issue and take a onetime clean up action in this regard. 168. For ZP and TP nearly 90% of the payments are made through Treasury and accounts are available through Treasury itself. In case of schemes which are funded directly by GOI to ZPs and TPs, project specific bank accounts are maintained and control over such accounts are very minimal. GoK needs to exercise control on the way bank accounts are opened and operated at the ZP/TP level71. The AG in its report has highlighted the issues of bank accounts not updated, not reconciled, and also has listed some the bank accounts which have become in-operative due to closure of the schemes. KII is also is trying to address this issue as a part of the PRI module. The advent of bank accounts and combining them into the monthly accounts would require changes to the PRI accounting rules. 169. From FY 14-15 funds for CSS handled by ZP and TP would pass through the state budget. GoK should consider, transferring, and making payments through the Fund 1 in the public account instead of using Bank accounts for ZP and TP. This will improve the expenditure controls and also the entire accounts of ZP and TP would be available in the treasury system. One time review of bank accounts and closure of inactive accounts needs to be carried out. A comprehensive review of the bank accounts needs to be conducted, and then GO needs to be issued for closure of inactive accounts, and balances should be transferred to the Treasury. Only those bank accounts which are required by the CSS schemes should be maintained. ZP/TP link document 170. At the state level the transfers to the ZP/TP are shown as single line item under the respective minor head. However for each ZP and TP a detailed link document is prepared which bifurcates the budget into different object heads of expenditure. From FY 13-14, both ZP and TP link documents are prepared using software and this file is shared with the TNMC and Treasury uploads these link documents and provide budget for the ZP/TP. This is a considerable improvement to the situation in 2004 when only ZP link documents where prepared and that to it took lot of efforts to be updated in the Treasury. One of the key issues in the link document is that the object codes used in the link document cannot be easily matched with the object code used in the State budget. Hence it becomes difficult for the state to consolidate the expenditure and provide an overall view of expenditure for the state including the PRIs into various object heads. Object codes in the link documents should be aligned with the state object heads so that it could be used for reporting consolidation and analysis. Proposed change to classification of accounts 171. Government of India constituted a committee under the chairmanship of Sh. C.R. Sundramurti, Controller General of Accounts to review the present classification system and to develop a system better suited to display the nature and objective of Government expenditure. On review of the existing classification system it was felt that there are some inadequacies in the system which poses limitation on its effectiveness in capturing relevant budgeting and accounting data. A new chart of accounts with seven dimensional mutually exclusive classifications (Administrative, Functional, Program, Recipient, Target, Economic and Geographic) has been proposed to the GOI. However the acceptance and the 71 Detailed circulars in this regard has been issued by FD, however the implementation in this regard is not effective. | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 60 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix implementation of this new chart of accounts is yet to take place. If this classification system is approved and mandated by GoI then it would apply to the state and also would affect the accounting classification being designed in KII. Comprehensiveness of Accounting and Reporting - Transition from Cash to Accrual basis of Accounting 172. The XII CFC recommended, and this was reiterated by the XIII CFC, transition from cash accounting to accrual based accounting. Governments in India follow the cash system of accounting which records the physical movement of cash to and from the government treasury. However, not Drawbacks of Cash based system of accounting all government transactions involve an immediate inflow or  Lacks adequate framework for accounting of assets and liabilities, depicting consumption of resources outflow of cash such as for instance goods or services and presenting the full picture of the government's received but not paid for. Cash accounting can be used by financial position at any point of time governments to “manage� their deficits by deferring outflow  No effective way of tracking assets created out of of cash. On the other hand, accrual basis of accounting public money diluting accountability of departments entails recording of government transactions when the for management of government assets economic event happens and not when there is an actual cash  Lacks transparency, and impaired ability to transaction. For instance, the transaction would be recorded accurately predict the future cost of a current financial commitment. when the goods have been consumed or services rendered or, in case of revenue, such as when the tax assessment is finalized, or pension liabilities on the public exchequer will be reflected with the help of actuarial valuation. Moreover, accrual basis of accounting requires accounting for all assets and liabilities captures the full cost of services provided by the government. Governments across the world have recognized the value of reporting on accrual basis with the financial statements prepared on accrual basis72. 173. Government of India is pursuing the transition from cash basis of accounting to accrual. An Apex Committee for implementation and transition to accrual based accounting in governments was constituted in September 2011. Operational guidelines for accrual based financial reporting were issued in June 2011. And, 21 state governments have agreed in principle to implement accrual accounting. Some of the reporting formats suggested by the Central Finance Commissions are prerequisites for accrual based accounting. 174. The Government Accounting Standards Advisory Board (GASAB) has now issued accrual based accounting standards – Indian Government Financial Reporting Standards (IGFRS) – and five such standards have been developed so far73. These are presently recommendatory for pilot studies. In line with this, a study on piloting accrual accounting was conducted in two departments of Andhra Pradesh74 (other such studies have also been done). The study developed model accrual financial statements and documented the key learnings from the pilot. 72 Such as New Zealand, Australia, United Kingdom, USA, Canada, France, Indonesia, Turkey, Philipines, Chile and Singapore 73 The equivalent international standards are the International Public Sector Accounting Standards (IPSAS) developed by IPSAS Board of the International Federation of Accountants 74 Government Accounting Standards Advisory Board (GASAB) Secretariat Comptroller and Auditor General of India, India-Journey to Government Accrual Accounting, Research Study on Piloting Accrual Accounting in the State of Andhra Pradesh (March 2010) with technical assistance from Deloitte | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 61 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 175. While GoK follows cash basis of accounting at the state level, it has mandated accrual based accounting for Accrual Accounting in ULBs in Karnataka – urban local bodies and for Gram Panchayats75 while the Implementation Strategy Companies Act mandate accrual accounting for  Through support of ADB and World Bank companies. These bodies produce a full balance sheet, an  Amendments made in Karnataka Municipal income statement and a cash flow statement. It is to be Accounting and Budgeting Rules 2006 and Karnataka Municipal Accounting Manual noted that these bodies presently do not form part of the  Phased implementation in 51 ULBs from April state accounts. For ULBs, transition from single entry cash 2006, 4+69 ULBs from Apr 2007, 4 ULBs from based accounting to fund based double entry accrual system Apr 2008 and 85 from Apr 2009 was done under the ADB assisted Nirmal Nagar Program  Recruitment of 92 Commerce Graduates and and World Bank assisted Karnataka Municipal Reforms Accountants through the Karnataka Public Service Project (see box for implementation strategy) and Commission facilitated under the JNNURM. Transition for Gram  Support provided through a State level Consultant Panchayats was facilitated under the Gram Panchayat and Chartered Accountant firms for each ULB for field support Budgeting and Accounting Rules since 2007 through online  Training modules developed for opening balance software called Panchatantra. This also meets one of the sheet and valuation of assets, and about 5000 staff financial management principles of the Local Bodies trained Fiscal Responsibilities Act – adoption accrual system of  Deployment of software called e-Gov Financials accounting for payables and receivables. 176. GoK has achieved a robust cash accounting Madhya Pradesh system and the next step would be to set a The IFMIS has the facility for accrual based roadmap for transition from cash to accrual accounting as and when the decision of transition from basis for state accounting. The 2004 SFAA also cash to accrual is taken by the Government suggested that since “basic systems are functioning satisfactorily and in accordance with satisfactory cash-basis standards, a structured move towards accrual accounting, based on appropriate accounting standards, could be considered�. Other states are also moving towards accrual accounting albeit at a slow pace (see box). GoK is in a relatively advantageous position as it has already implemented an IFMIS in the form of Khajane which is presently being upgraded to the next version, and this would help in adoption and application of accrual basis. The next version Khajane II would have an accounting and reconciliation module. GoK has also implemented most of the Maharashtra supplementary information disclosure suggested by the CFCs Under the stewardship of the state Accountant and that will facilitate transition to accrual basis. General, a Pilot Study for Migration to Accrual based accounting system has been initiated for two departments – Public Works and School Education. A 177. There are few caveats in the transition from cash to tender for engaging external consultants for this accrual . The first one being that such transition would arise purpose has been floated in May 2014 only when GOI adopts and implement accrual accounting. Sequencing of some activities prior to adoption of accrual accounting would be important such as for instance information on financial liabilities and valuation of land and buildings. Transition to accrual accounting is a costly proposition as it involves adoption of a government wide integrated financial information system (IFMIS), extensive training and change management. Political leadership and buy-in and change agents at all levels of the government would be crucial for the success of this initiative. There is often a long time lag between the resolution to adopt accrual accounting and its full implementation. Also with the transition GoK would need to take a decision whether to go for an accrual based budget 75 This was part of the “bubble-up approach� to transition mentioned in the XIIIth CFC report | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 62 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix execution report 76 . Lastly, a structured strategy of implementation, such as that adopted in implementing accrual accounting in ULBs, would be crucial to ensure success. Enhancing Coverage of Reporting – Including all Public Entities in Fiscal Reports 178. Financial reports of GoK, including its annual financial statements, show only the revenue and expenditure of its departments and its own debt. Transfers made to local bodies and other parastatals are reported as transfers, but the actual revenue and spending and debt of these public entities are kept outside budget reports. In present times, several entities are created by governments to perform public functions, occasionally with the objective of reducing their deficit or debt by transferring responsibilities to these public bodies. 179. The principle gaining ground is that accounts of those entities which the government is responsible and can be held accountable should be consolidated with the general government accounts. Government reports can either include (a) the general government sector i. e. that part which is included in the budget; or (b) the general government and its sub-sectors such as for instance the local governments; or (c) the entire public sector that includes the general government sector, its sub-sectors and other government owned entities (for instance at least the non-commercial government companies and corporations). This practice follows the reporting standard in the private sector that requires companies to consolidate all entities that they control, even if the latter are legally distinct. 180. The 2004 SFAA reported that “consolidated all-of-government budgets are not prepared or presented.... there is also need to rationalize the reporting of transfers to various public sector entities in the State Government’s budget and accounts�. The SFAA further elaborated that preparation of “all -of-government� accounts including the state government and public entities are important since: in many cases, these other entities are separate from the State Government in form, but not in substance; and the financial performance of these entities substantially affects the Government’s fiscal position 181. Therefore, the decision on which components of the government should be included in fiscal reports is of importance, in case of GoK on two counts – a) The total devolution to urban and rural local bodies in Karnataka is to the tune of 40% of net owned revenue or Rs. 22,542 crore (2011/12 19,460 crore) which is about 25% of total expenditure (Source: Statement no. 8, Finance Accounts); and b) From the current year 2014/15 onwards, all central funds would be routed through the state budget (unlike direct transfers to implementing agencies). Funds transferred outside the state budget (which eventually would now be through the budget) during 2012/13 were of the order of Rs. 6,649 crore (2011/12 Rs. 5,469 crore) which is about 7% of state’s expenditure (Source: Appendix 7, Finance Accounts). In both the cases, per extant practice, funds from the Consolidated Fund of the State will be transferred to local bodies or agencies implementing the central schemes and the transfer of funds is charged off to the final head of account (as grants in aid) and actual utilization is followed through utilization certificates. It is also to be noted that the fiscal data of public entities (local governments, PSUs) are also not consolidated as a sector and reported (except partially in the report of the C&AG) – therefore, information on consolidated revenue, expenditure, assets, liabilities including borrowing is not readily available and is not part of periodic reporting. 76 Ideally, budgeting and reporting should be on the same basis. However, many governments (such as USA) have chosen to continue with cash based budget reports even when they have switched over to accrual reporting system. | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 63 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 182. Presenting consolidated financial data on public entities would enhance coverage of reporting and also provide insights into the fiscal risks that these public entities pose for GoK and also on their performance. Presently, there is no Indian Reporting standard (cash or accrual) on consolidation 77. In the interim, GoK could consider the following suggestions for enhancing coverage of its reporting. a) CSS Implementing agencies: Amounts of direct transfer of central funds (without routing through the state budget) under each scheme are disclosed in the state’s Finance Accounts – the actual expenditure, however, is not compiled and disclosed. As stated above, central funds will now be routed through the state budget. GoK could therefore implement a mechanism for reporting not only the transfers to the implementing agencies (these are mainly incorporated as societies), but also provide a consolidated scheme-wise report of the expenditure incurred under main heads. b) Local government: In case of rural local governments, financial statements of each tier could Consolidation of Annual Reports of Panchayats be consolidated to get the consolidated financials for prescribed under Kerala Panchayat Raj a district and further consolidated for the state. (Accounts) Rules, 2011  Each Panchayat prepares an annual report including Similarly, financial statements of urban local bodies annual financial statements, budget variance report, can be consolidated (including separately for each key ratios etc. type, if required) for the state. Again, this is possible  The annual reports are sent to the district officer for as financial statements are in uniform format and preparing a consolidated district annual report for available in digital form (e-Gov Financials). These further consolidation to prepare the state will be a full consolidation of the revenue/ consolidated report. expenditure and assets/liabilities. Such a system is The consolidated database is available up to 2011/12 followed in Kerala (see box). c) Government Companies and Corporations: Two types of annual data on government companies and corporations are presently available. One, the Department of Public Enterprises has started publishing an annual book on these entities providing inter alia a brief of their financials. Second, financial data is also provided in the Report on Public Sector Enterprises of the C&AG. But both these have partial and dispersed data that is available much later after the close of the financial year. GoK could institute a mechanism for building a central repository of financial database of government companies and corporations which can be used to present a consolidated financial report of these entities. 183. One mechanism for reporting would be to present data on the entire public sector in the form of sub-sectors i.e. separately for government, local government, companies and corporations and other entities. This would be more useful once accrual basis of accounting is implemented and when government assets and liabilities are also accounted for – this system will then be at par with the public entities. Till this is achieved, separate statements of consolidated financial data for local governments, companies and corporations and other state implementing agencies can be produced, included in Finance Accounts and available to the public. This would need consultation with the state Accountant General. Enhancing Transparency in Budget and Finance Accounts 184. Finance Commissions at the central levels are constituted by the President of India under Article 280 of the Constitution of India. The terms of reference of these commissions include making recommendations to improve the transparency in budget and annual accounts. Thirteen commissions have been constituted so far and submitted their reports78. The latest report available is that of the XIII Central Finance Commission (December 2009) applicable for the 77 An international standard based on accrual accounting is available IPSAS 6 – Consolidated and Separate Financial Statements 78 The XIVth Finance Commission has been constituted in January 2013 and expected to submit its report by October 2014 | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 64 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix period 2010-2015. The XIII CFC has recommended specific and additional disclosures in the budget documents and/or finance accounts of the states for greater transparency some of which have been brought forward from the report of the XII CFC. Some key disclosures recommended and their status in GoK is summarized in Table 31. Table 31: Key Recommendations made by XIII CFC for Disclosure in Budget/Finance Accounts Recommendation of the XIII CFC Disclosure Status in GoK Suggestion for 2014 PFM Reform Plan Providing a statement on Budget and Appendix 13 of the Finance Accounts Provide object heads for maintenance expenditure Finance provides segregation of maintenance segregation of bifurcating between work charged Accounts expenditure in Minor Head 200 only into maintenance expenditure expenditure and other expenditure salary and non-salary portions. into salary and non-salary across six major heads viz. public There is no disclosure in the budget. components. works, housing, major irrigation, medium irrigation, minor irrigation and roads and bridges.  This statement is intended to provide insight on the quality of maintenance expenditure. Provide list of all public sector Budget and Presently such a disclosure has not been Constitute an expert enterprises that yield a rate of Finance made. committee to determine return lower than benchmark rate Accounts the benchmark rate of decided by an expert committee. return. Provide a list of This would improve the SOEs providing rate of quality and transparency of return lower than the investment in government benchmark rate. companies List of Inventory of vacant land Budget A partial inventory of government land Issue instructions to all with departmental and non- (acreage) is presently provided in MTFP departmental and non- departmental undertakings. This is (for 20 districts). departmental expected to contribute to better undertakings to provide protection of public assets against an annual return of vacant the threat of encroachment. And it land with area and will also enable effective utilization estimated market value. of land for projects thereby ALMC could be minimizing the need for fresh land entrusted with collation acquisition. and consolidation of this information. Disclose details relating to Budget and The transfers to ULBs and PRIs are GoK has broadly adopted expenditure incurred by the PRIs Finance budgeted under major head 3604 the disclosures suggested by detailed heads and object codes Accounts. (Compensation and Assignments to Local by the XIII CFC in under the minor heads 191, 192 and Bodies and PR Institutions). The following respect of ULBs and PRIs 193 for ULBs and 197, 197 and details are available in budget in respect of making 198 for PRIs. Prepare a supplement supplementary documents- distinct provisions for to the budget showing plan and (a) ULB category wise allocation under local bodies in the non-plan wise classification of plan and non-plan under the relevant minor budget. transfers to different categories of heads with details heads of account Going forward, GoK urban ULBs PRIs. including object code. could disclose object- (b) Budget allotment to PRIs giving code wise allocations to category-wise plan and non-plan PRIs (presently not expenditure district-wise scheme-wise. done). (c) Budget allocation to ULBs – scheme- wise for plan and non-plan with detailed head up to object code. Appendix 4 to the Finance Accounts also discloses classification of grant in | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 65 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Recommendation of the XIII CFC Disclosure Status in GoK Suggestion for 2014 PFM Reform Plan aid/assistance to various categories of ULBs and PRIs under plan and non-plan schemes Details of contra-entries as well as Finance Details of book adjustments that do not GoK has broadly met the the summary of transactions Accounts represent actual cash transaction are disclosures suggested by between the public account and the disclosed in the Finance Accounts the XIII CFC. consolidated fund should be (Annexure A) and details of transfers provided as a separate annex to the between Consolidated Fund and finance accounts of the states. Contingency Fund are also available in the Finance Accounts (Statement no. 18). Details transactions in the Public Account are available in the said Statement No. 18 and transactions with the Consolidated Fund are provided by way of notes. Provide statement on Finance Appendix 3 of the Finance Accounts Additionally disclose comprehensive data on all subsidies Accounts provides details of explicit subsidy i. e. implicit subsidies in the subsidy that has been as paid by the finance accounts government. The C&AG have reported implicit subsidies of Rs. 1,893 crore for FY 2012/13 that are not disclosed in the Finance Accounts. Implicit subsidies are outlined in the MTFP. Provide statement on consolidated Finance Appendix 2 provides details of salary GoK may consider information on the number of Accounts department-wise by Major Head disclosing information on employees at each level along with segregating between plan and non-plan. number of employees in the commitment on salary. Number of employees presently is not the Finance Accounts disclosed. based on the information collected for Appendix B of the Budget. Include a separate statement Finance Link budget document is prepared but the GoK should prepare link indicating head-wise details of Accounts object codes used for PRIs and ULBs are documents using uniform actual expenditures under the same not the same as used for the State object codes and should heads as used in the budget for both disclose the head wise PRIs and ULBs. details in the budget and Finance accounts. Seven additional Appendices were Finance  Annexure B to the Finance Accounts GoK has broadly met the recommended by the XII CFC. The Accounts provides Particulars of disclosures suggested by XIII CFC recommended specific details/information awaited from the XIII CFC. compliance with the following - Departmental/Treasury Officers in  instances where verification connection with reconciliation of and acceptance of balances balances involving large amounts has  Appendix 10 provides details of been delayed incomplete public works contracts  information on details relating individually for works costing Rs. 1 to reconciliation of balances crore and above  statement of incomplete capital works costing Rs 1 crore and above 3.2 TREASURY MANAGEMENT | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 66 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 185. The Directorate of Treasuries (DOT) is one of the key players in supporting and maintaining overall PFM framework in the state. DOT works under the State’s Finance Department (FD), and is the backbone for the financial transactions related to expenditure and revenue of the government. Treasury offices are the basic unit for recording the financial transactions of the government and are the starting point of public accounts. All state funds and to a large extent central funds are handled by these treasuries. In GoK, the DOT is headed by the Director of Treasuries who is supported by Joint Director and Treasury officers. In 2012, out of the 2936 sanctioned strength 2218 posts were filled up in the treasuries. GoK has 2 Special Treasuries (State Huzur Treasury and Pension Treasury), 31 District Treasuries (2 in Bangalore and one each in 29 Districts), 182 sub- treasuries and one Stamps Depot in the state. GoK has set up a Treasury Network Management Centre (TNMC) in Bangalore which works as the IT network Centre to support the working of treasuries across the state. DOT implemented a core treasury system “Khajane� across the state in 2004. All the treasuries were computerized and networked to the central database in TNMC using a client server model. Khajane was a core treasury software and covered the following modules related to treasury functions: (a) Receipts; (b) Payments ; (c) Deposits; (d) Pensions; (e) Social security pensions; (f) Budget allocation and monitoring; (g) Stamps and strong room; (h) Accounts and (i) MIS. Implementation of Khajane lead to significant improvements in the treasury management, cash management and controls available in the PFM system. 186. DOT’s role begins once the budget is passed and allocations are made. The budgetary allocation is made by the FD and is intimated to the administrative department secretary and TNMC, which uploads the allocation in the software. The department secretary then bifurcates the budget allocation to offices under his control and the allocation is entered by TNMC. The budget authorization process is depicted below: Figure 4: Budget authorization process FD HOD (200) CCO (1000) DDO (22000) | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 67 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 187. Once the allocations are uploaded the concerned CCOs/DDOs can start submitting the bills to the Treasury. Each DDO is provided with the allocation and the budget code, based on which the DDO can use the budget. The DDO prepares and passes the bills manually and submits all the required documents manually to the Treasury for payment. The Treasury carries out all validation checks as mandated, checks the budget availability, process payments and issues cheque in favor of the party. Once the Treasury passes the bill in the system the budget balance is automatically reduced and simultaneously accounts are updated for the particular head. So for all departments, where payments are made through treasury online accounting is being done at Treasury and budget is monitored on a real time basis. 188. Khajane ensured the following controls were implemented in the field: a. Online budget monitoring through the system, monitoring of revenue and expenditure for better management of budget and utilization; b. System based clearance after checking for budget availability, i.e. if there is no budget available then payments would not be processed; c. Monthly generation of accounts from the system which is passed on to AG (A&E) for accounts compilation; d. All internal controls are built in the system and 17 validations are carried out automatically by the system; e. Better cash management due to availability of budget and cash position online; f. Elimination of systemic manipulation possible in manual system like overdrawal of funds, fraudulent withdrawals, delay in settling claims etc.; g. Generated Comprehensive Financial management information system; and h. Followed FIFO basis for payments which meant that there can be no out of turn payments 189. Currently treasury management has significantly improved to the baseline set out in the 2004 report . At that time Khajane was being rolled out, and normally the accounts were delayed by two – three months. LOC system was still in vogue which affected the budget monitoring and cash position of the state. Now Khajane has been implemented across the state and it has improved the overall PFM control as outlined above. In terms of submitting reports to the AG there has been overall improvement in the situations as now the monthly and yearly accounts are submitted within the due date. MIS Reports like Monthly Revenue Receipts (Tax & Non-Taxes) and monthly major head-wise and scheme-wise expenditures are available to the Finance Department. Daily RBD Position, a Weekly and Monthly expenditure statements are available to the Finance Department for better financial management. Details of expenditure demand-wise and scheme-wise are available to the concerned Secretaries to the Government. 190. Until 2008 GoK used to follow “Letter of Credit (LOC)�system in four departments (PWD, Water Resources, Minor LOC System Irrigation, and Forestry) which were the major spending departments. Treasury used to give periodic authorizations These departments would make their own payments and then used to (letters of credit) to the agency banks to honor checks drawn by these Departments up to send payment vouchers to the AG’s Office, along with a summary or specified limits and departments use to issue abstract of receipts and payments classified by account head. This checks drawn on the agency banks. system had its own pitfalls as there was always time lag between actual payments and accounting. As the payments used to happen at | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 68 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix the field there was less control on the accounts submission, sometimes these DDOs would not render accounts to the AG on a timely basis. This system also affected the monitoring of budget and cash balance on a real time basis because while payments would have been made from the banks, the treasury systems would be updated only when the accounts are entered at the AG level. The issue of making more payments than the budget provision or non-reconciliation of banks with the accounts also took place. GoK has withdrawn this method of payments and now all departments are using the Treasury to make the payments. This is a good practice which other states also need to follow to improve their budgetary and cash management control. While this reform has really strengthened the treasury and budget control for paid bills, some departments have resorted to unhealthy practice of carrying out more work than the budgeted amount and piling up unpaid bills which is not reported to Treasury. To this extent the gains of this reform is negated. 191. While Khajane generates 62-B the treasury schedule for DDO’s and 62 E for CCO’s on a monthly b asis, most of these officers do not reconcile their books of accounts with the treasury statement and the AG accounts on a timely basis (refer para 144). Also Khajane has the functionality for making e-payments but however this functionality was not used for making payments to the vendors. Even today vendor payments are made through cheques printed by Treasury. These are areas which can be addressed by the DOT within a short time frame. Khajane also has issues in terms of monitoring ZP/TP object head wise expenditure as the current functionality only addresses overall budget control on the fund balances maintained by the ZP/TP in the public accounts. The other priority areas of computerization as highlighted in the 2004 report like DDO computerization and computerization of capital works are being developed as part of KII. 192. GoK carried out a functional and technical review of Khajane in 2008, where certain issues in terms of functionalities and hardware were identified by the consultants. In terms of functionalities the following issues were identified: a. Khajane was a core treasury system and did not change the way how the stakeholders like CCO/DDO were working. The DDOs used to pass the bills manually and send them for treasury, where treasury used to enter them again leading to possible errors in misclassification of accounts. b. Data redundancy and duplication is prevalent in the current system as the existing manual processes and framework has been computerized without business process re-engineering. For e.g. even today DDO maintains manual books of accounts, Treasury maintains another set of books in computerized database and AG(A&E) maintains the third set of books leading to data duplication and reconciliation issues. If there is one integrated database and DDO are provided access to the treasury portal to enter the bills, then the need for maintaining manual books as well as carrying out reconciliation would be eliminated. Similarly if AG adopts the treasury figures and provides the details of loan payments to be entered in the same database, then parallel records at AG level can be avoided. So for each DDO two sets of books had to be reconciled every month which was not followed by the DDOs and CCOs were required to reconcile the total expenditure with AG which was not followed in most of the cases; c. Budget preparation and finalization was done manually and then entered into the system. Khajane I did not have any budget preparation module; and d. Key areas like Investments, Loans, Guarantees, Audit compliance where maintained outside the system in other databases and software’s which was not linked with Khajane (refer Theme Four: Improving Fiscal Assets and Liability Management System). 193. Due to the above issues and also security issues highlighted by the consultants GoK embarked on developing and implementing a web based IFMIS79 which is known as Khajane II (KII). The above challenges are being addressed as a part 79 Refer annexure 9.4 on IFMIS | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 69 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix of the IFMIS development. The work done by GoK in terms of preparing the vision for the IFMIS, strategy for planning and developing the IFMIS is commendable. The KII covers all the key areas covered by an IFMIS system and has followed all the good practices for implementing the system such as: a. This initiative is spearheaded by a Principal Secretary level officer from the GoK supported by officers from FD, Treasury, Departments and all other stakeholders. b. As a part of the reform, GoK constituted a dedicated team to work on developing this product along with consultants and involved all the process holders to prepare the Functional Requirements of the System (FRS). c. As part of development of the FRS, GoK ensured to review the business process underlying the transaction and have modified the processes as required to avoid duplication and enhance efficiency of the system. d. A consultancy firm has been hired for system development and integration while another firm has been hired to carry out third party audit of the development process of the software. Adequate resources both in terms of budget as well as technical manpower have been provided by the GoK for the team. e. Powers to take decision like reviewing the outputs and providing sign off has been provided to the KII team which goes a long way on timely review of outputs and implementation. 194. These good practices can be internalized by other states while planning for implementing an IFMIS in their state. 195. KII is planned to be implemented in two phases – phase I will cover 12 core treasury modules for which Software Requirement Study (SRS) has been completed; and phase II that will cover functionalities of other departments (such as asset liability management, budget preparation , cash management) for which SRS is being developed and expected to be completed shortly. Overall 24 separate modules have been envisaged under KII (refer Table 32) Table 32: Modules of KII Bill Preparation & Submission Non Treasury Transactions Bill Processing Budget Preparation Payment Authorization Cash Management Budget Control Fiscal Management Receipts Asset & Liability Management Deposit Management Expenditure Tracking PRI Financial Management Audit Compliance Management Pension Management Document Management System Beneficiary Management/Social Security Pension House Building Advance New Pension Scheme Treasury Inspection Account And Reconciliation Inventory & Strong Room General Administration Works Module 196. As a part of the KII implementation the business process review has been carried out and the processes have been redesigned in certain cases. Such changes in the process could necessitate the need to change the underlying rules and manuals to align these legacy documents to the new process which the GoK intends to undertake once the overall SRS is completed. The Treasury Code would need to be revised at the time of implementation of KII. Similarly, the Manual of Contingent Expenditure, Karnataka Financial Code, and other relevant manuals would need revisions (also refer section on Updating PFM Manuals and Codes). 197. GoK has made month wise implementation plan for piloting and roll out of the software. Piloting of the core treasury modules is expected to be done in 2 Treasuries by September 2014 (Bangalore and Dharwad) to test and stabilize the system and then the system would be rolled out to other districts. All modules are expected to go live from FY15. Legacy data will be transferred through e-migration for which a team is proposed to be constituted. | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 70 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 198. Some of the key areas which KII addresses over the previous treasury system and which would strengthen the PFM are: a. DDO computerization: Under KII all DDOs office would be computerized and all primary level data entry would be done in the DDO office. b. Budget preparation: Earlier in Khajane, budget preparation used to be manual exercise and all data used to be sent by the Departments to FD where the data would be entered in the computer cell and the budget prepared. In KII it is proposed that the DDO would enter the budget requirements which would be scrutinized by the CCO and send then submitted to the FD for budget finalization. With introduction of this module the entire budget preparation would be online. c. Bill preparation and submission would be through the system: The DDO would prepare the primary bills for payment in the system which would be approved by the competent authority in the system. The approved bills are forwarded to Treasury and based on validation, and budget availability e- payments would be made. Due to change in the process there would only on point of data entry in this model. d. One set of accounting books: As the DDO would enter all the data from his office, the primary book of accounts would be maintained in the KII system itself. DDO can shift over to the computerized books of account and 80 generate their books of account from the system. This would also in future make the practice of reconciliation between DDO books and treasury books redundant as there would be only one database in which all accounts would be maintained. An important development which is going on in parallel is that the AG (A&E) would have data input rights and can view the full accounts. When this module is operationalized there would be one database for the state accounts and all reconciliation issues would be sorted out as all adjustments and generation of reports would be carried out in KII database. e. Payments can be made only against those works which have been entered in the system and a unique work ID has been generated. This would ensure budget control at work level which is not currently being followed. Also it would address the issue of providing for one work and paying for another work which is very rampant in the manual system. f. Key features planned under of Khajane II  electronic payments would be default mode of payment and GoK aims to move more than 90% of government payments to e-payment platform 80 GoK is engaging with AG to gradually discard the manual books and move to the computerized books and records. This would be achieved once the rollout of the software is successful. | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 71 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix  includes accounting for PRIs (ZP/TP), Guarantees, Investments, Loans and Advances, Debt etc., which would be an enhancement over the previous treasury system.  covers all other entities like SOEs, Societies, GIA institutions which operate government funds outside the treasury system through banking channel.  links RBI, National Securities Depository Limited (NSDL), Banks, CAG and all other external stakeholders to the system so that it can cover all government related transactions in one database. 199. The key challenges and action plan for implementation of KII is summarized below: a. GoK needs to rework the staffing structure both at Treasuries as well as the DDOs office to have adequate skilled manpower to implement the requirements of KII. GoK needs to have HR plan for both Treasuries and DDOs in line with KII requirements including competency mapping, reskilling and capacity building, to operate KII. b. Training has to be provided to all 22000 DDO’s and 1000 CCOs most of them would be new users to such a system. While it is easy to train the treasury staff who are familiar with Khazane, constant support and training would be required for other users. GoK needs to prepare a change management strategy and training plan to address this challenge. This has been recognized by GoK in their overall KII implementation plan. c. As a part of the KII implementation, GoK should review the number of DDOs and rationalize the number of DDOs. d. In case of data migration all the current data needs to be moved to the software as well as in certain cases like loans, debts, and investments where data is to be entered in the system for the first time, reconciliation, verification and validation of the data needs to be completed before it is finally entered and signed off in the system. GoK needs to prepare a data migration strategy for each of these areas and plan to address this challenge. e. GoK needs to decide on the roll out strategy of the systems for all DDOs. Either there could be a complete roll out across all DDOs or done District by District. GoK needs to clearly define a cutoff date by which roll out would be accomplished. After the roll out GoK needs to decide if there is a need for parallel run of both manual and computer books in DDOs. Ideally parallel systems should not be encouraged for more than 6-9 months and the withdrawal of manual books should be timed around the closing period of the FY. GoK needs to issue a GO outlining clear timelines on the implementation and how the manual books81 would be withdrawn from the DDOs. f. KII needs to integrate/develop the following software’s /database currently used by other departments (most of these find mention in the FRS 2010): i. Budget Management Information Software (would be integrated with KII); ii. Supplementary Estimate Information System (would be developed in KII); iii. Debt management-debt data maintained in Excel sheets (would be developed in KII); iv. Guarantees, Investments and Loans & advances- maintained in Excel sheets by DSS (would be developed in KII); v. Audit monitoring system including PAC module (would be developed in KII); vi. Cash management to produce cash forecast and support in decision making for loans and investments (would be developed in KII); 81 Concurrence from AG would be required for this purpose. | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 72 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix vii. Linkage to e-receipts of the revenue departments (would be linked to KII); viii. Linkage with e-procurement software (would be linked with KII); ix. Linkage to HRMS for pay bill (would be integrated with KII); x. Project Management Software of PWD for generating PWD contract wise progress, payments, and bills– needs to be integrated with KII xi. Beneficiary Management Software – used by departments like education and health to track subsidies needs to be integrated with KII. xii. ULB software and GP software to be integrated with KII for reporting purposes xiii. ZP/TP Module and build fund control in KII for PD accounts related to ZP/TP. g. Develop and implement a Contract Management Module: Currently contract management module is not being implemented in any of the departments. E-procurement software stops at the time of issue of work order, while the current Khajane starts at the time of payment of bills against these work orders. KII needs to interlink the entire process and should develop a contract management module as a part of the works module so that the progress of works as well the payments made to contracts can be captured in the system. In future this module can be used for monitoring commitments and preparing budgetary estimates for capital works. 3.3 CASH MANAGEMENT 200. An effective cash management system is another major element of overall fiscal management and is an important requirement for avoiding unnecessary borrowing and interest costs. Therefore, it is essential that all bank accounts are known and consolidated and that there are defined arrangements for timely electronic clearing and payment arrangements with the bankers. 201. In India, the system of cash management is nearly uniform across states. The receipts and withdrawals are recorded at the Treasuries and Sub Treasuries who are attached to branches of designated banks handling the state government business (these are called “Government Business Branches and for Karnataka the designate d bank is the State Bank of Travancore). Effectively, this means maintaining a Treasury Single Account which is a pre-requisite for effectiveness of cash planning. Information then flows from these branches to the Reserve Bank of India (RBI) at Nagpur on a daily basis. RBI then consolidates the cash position of the state and generates a daily cash position that is shared with the Finance Department. This system is well established though states have to rely solely on the information from RBI as their own systems are unable to provide the data. 202. Presently, Karnataka has a comfortable cash position. It has not availed any special or normal Ways and Means Advances from RBI since 2007/08. Cash surpluses above the minimum prescribed limit by RBI (presently Rs. 2.63 crore) are automatically invested in Government of India 14-day/91-day Government of India Treasury Bills. GoK has a system of estimating the timing of its Open Market Borrowing by communicating an advance indicative calendar for borrowings. The State’s policy is to go for need based borrowings and maintain only basic minimum cash surplus as buffer. Table 33 summarizes the cash balances of GoK. Table 33: Cash balances of GOK Particulars/As of March 31 2013 2012 2011 2010 Total cash balance 10,511 9,609 7,667 9,773 Of which Invested in Treasury Bills 6,872 7,641 6,872 8.782 Investment of Earmarked Funds 3,568 1,962 1,444 980 Source: State Finance Accounts | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 73 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 203. In actual practice, the Finance Department forecasts monthly and annual cash requirement based on certain assumptions, but a scientific tool for this function has not been implemented. There are also certain items that have a significant bearing on the cash position of the state and its management. a. GoK does not normally allow its departments to open bank accounts, but there are instances of drawl of money from Treasuries and depositing them in bank accounts and information of unspent balances funds under central schemes kept in bank accounts is not readily available. There are certain implementing agencies at the state level that receive central funds directly (i. e. these funds are not routed through the state accounts) for program implementation 82 . These agencies, however, receive funds (including state share as applicable) in bank accounts that remain outside the state budget. These bank accounts are neither consolidated nor included in the cash balance position of the state. This is prevalent in almost all the states in India. Though there has been an attempt to record the receipts and transfer of funds in the State Finance Accounts from 2012/13, the guidelines do not require collection and consolidation of the balances in bank balances of these agencies. The State Finance Accounts contain an appendix giving details of funds transferred outside the state budget, but these also do not provide details of the bank balances. From 2013/14, central funds will be routed entirely through the state budget – but, the system of keeping funds in bank accounts outside the Treasury is expected to continue. Under the new regime, knowledge of bank accounts and balances on a periodic basis would gain significance and GoK would need to institute a system to obtain the information and consolidate them and consider these in its cash forecasting. This is expected to be addressed by the KII where all banking transactions are expected to be covered. b. Unencashed cheques are not considered under the cash position of the state although cash remains in the Treasury– this therefore has a bearing on the cash position of the state 83. There is a rising trend on account of unencashed cheques. Information on unencashed cheques including age-wise analysis and likelihood of encashment is not known on a consolidated basis. c. The 2004 SFAA identified off-budget borrowings and government guarantees as factors that had a bearing on effective cash management. The main constraint at that time was lack of an organized system to record these liabilities and hence complete and reliable information was not available for determining the cash balance position. This has largely been addressed by GoK and now full data on these two items are available along with the due dates for crystallization of liability which enables GoK to plan for honoring these obligations. 204. On one hand while GOK has cash balances on other hand there are arrears of payments and loans being taken by the government. One plausible explanation is that due to fiscal parameters of the KFRA, arrears are not cleared while cash balance is being maintained. This is an area which needs to be reviewed on a holistic basis. 205. Control over expenditure including its incidence over the year is also a component of cash management. GOK currently manages cash forecast based on excel sheets. GOK could integrate the cash management with the Monthly Programme Implementation Calendar (MPIC) to estimate the expenditure requirements for each month. The system if implemented would be similar to the system being implemented by GOI (refer box). Salient Features of Cash Management System in Government of India - Modified Exchequer Control based Expenditure Management What does this system seeks to achieve  Greater evenness in the budgeted expenditure within the financial year, especially in respect of items entailing large sums of advance releases and transfers to corpus funds. 82 Funds transferred directly to the state implementing agencies during 2011/12 for major schemes aggregated Rs. 7,190 crore (Source: C&AG Report on State Finances 2011-12). 83 For detailed discussion on unencashed cheques, please see section XXX | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 74 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix  Reduce rush of expenditure during the last quarter, especially the last month of the financial year.  Reduce tendency of parking of funds.  Effectively monitor the expenditure pattern.  Better planning of Indicative Market Borrowing Calendar of the Central Government. Who is responsible for implementing the system?  Cash Management Cell, Budget Division, Department of Economic Affairs, Ministry of Finance  The Financial Advisor of the respective departments How does the scheme works  A Monthly Expenditure Plan (MEP) separately for Plan and Non-Plan is prepared, on specified format, and included as an annex for each Demand for Grant. The MEP is drawn so that expenditure in the quarter and month of March dies not exceed 33% and 15%, respectively both at the level of scheme and also overall Demand for Grants  Based on the above, Quarterly Expenditure Allocations (QEA) is fixed and the departments can issue cheques only up to this limit. Beyond this limit and carry forward of savings in the QEA require permission of Ministry of Finance  MEA and QEA for the 4th quarter is subsumed in the revised estimates 206. GoK can consider the following action plan for cash management: a. Carry out a study on cash management practices and the amount of cash deposited with entities outside the treasury and options on how cash management could be made better. This study should be led by FD and can be supported by external consultants b. Carry out a study on cash balance maintained and how the debt scheduling is being pursued by the GOK. This study should be led by FD and can be supported by external consultants. The cash balance and forecasting mechanism should be linked to the debt scheduling c. Review if the cash parked with entities outside treasury could be reverted back to the treasury d. Develop a cash forecasting model for monitoring cash management and integrate with KII e. Link cash management projections with the Monthly Programme Implementation Calendar 3.4 SUBSIDIES- TARGETING, ACCOUNTABILITY AND TRANSPARENCY 207. It is not uncommon for Governments in India to provide Explicit or Implicit subsidies to disadvantaged or specified sections of the societies. GoK provides two kinds of subsidies: a. Explicit Subsidy: where subsidy is explicitly provided by the government as expenditure in its budget for certain schemes. b. Implicit Subsidy: that arise when the government is unable to recover the costs it incurs in the provision of social and economic goods/services, which are mainly private goods/services in nature, even though sometimes these may have extended benefits. It can be indirect, can also be in kind or take the shape of tax concessions. Budgetary support to financial institutions, inadequate returns on investment, and poor recovery of user charges 84 from social and economic services provided by the government fall in the category of implicit subsidies . 208. Explicit subsidies are the second largest component of development revenue expenditure in Karnataka and are about 10% of revenue receipts or expenditure. During 2012/13, GoK provided explicit subsidy of Rs. 10,709 crore (Rs. 7,390 crore during 2011/12) which is expected to be about Rs. 14,200 in 2013/14 (BE). Such subsidies are accounted for under the 84 The principle is that Governments need to take measures such as earning an adequate return on its investments or recover cost of borrowed funds rather than bearing these in the form of implicit subsidy | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 75 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Object Code 106 (Subsidy) and disclosure is made in the State’s Finance Accounts (Appendix 3) and also in the budget document (Overview of the Budget). Public sector undertakings are the largest recipients of the subsidy (Rs. 8,320 crore during 2012/13) and it is largely paid to the companies in the power and infrastructure sectors. Subsidy payments are mainly in the areas shown in Table 34. Table 34: Major Explicit Subsidies in Karnataka Area Amount Purpose (Rs. crore) Power Rs. 7,050 crore Financial assistance to electricity supply companies to cover loss due to rural electrification power subsidy provided for free supply of electricity to farmers for usage of agricultural pump sets), and contribution towards pension Food Rs. 991 crore Differential cost of food grains under Public Distribution System Co-operation Rs.1,323 crore Waiver of overdue loans (principal as well as interest) given to farmers Transport Rs. 385 crore Fare concession extended to students, freedom fighters, physically challenged, etc.85 Housing Rs. 280 crore Urban Development Rs.86 crore 209. GoK also provides Implicit Subsidies. These were in the order of Rs. 2,466 crore during 2012/13 (Rs. 1,897 crore 86 during 2011/12) . These are subsidies that are not accounted for under Object Code 106, but are disclosed in the budget documents (these are also disclosed in the Report of States Finances of the C&AG). For instance, a major scheme that is considered as an implicit subsidy in the budget document and also in the audit report is the Bhagyalakshmi scheme of GoK (2012/13 Rs. 755 crore; 2011/12 Rs. 486 crore) as it is not accounted for under code 106. 210. Way back in 2004, the XII Central Finance Commission had recommended that states should identify expenditure on account of implicit subsidies and make disclosure in the Finance Accounts. GoK has yet to commence this disclosure like most of the states. Odisha is one such state that discloses implicit subsidy in the Finance Accounts, though partially. 211. One of the key areas in the term of reference of the Expenditure Reforms Commission (ERC) is to review the framework of subsidies87. The ERC pointed out that the current system of tracking of subsidy bill in GoK is limited to the budget head (object code) 106 - Subsidy. However, there are a number of other items, especially in the industrial sector, that extend other forms of support for promotion of sales, purchase of raw material etc. The ERC recommended that GoK identifies all such schemes, irrespective of the amount, and report the total subsidy bill. 212. The estimation of explicit subsidy also needs to be strengthened as there is significant difference between the budgeted amount and the actual subsidy bill. For instance, original budget estimates for 2012/13 were Rs. 7,583 crore but the actual subsidy bill went up to 10,709 crore (+41%). Similarly, for 2011/12, the actual subsidy outgo was Rs. 7,390 crore against original budget of Rs. 6,242 crore (+18%). In the most recent year 2013/14, subsidy was budgeted at Rs. 9,314 crore but revised to Rs. 12,391 crore (post change in government) and the actual is estimated to be over Rs. 14,200 crore ( Source: Overview of the Budget). 85 The PAC in its 13th report (December 2011) had recommended that the said subsidy be borne by the corporations within their resources as these were earning profits and were working on commercial lines. 86 Overview of the Budget, 2014/15 87 Review the framework of all subsidies, both explicit and implicit, examine the economic rationale for their continuance and make recommendations for making subsidies transparent and suggest measures for maximizing their impact on target population at the minimum cost. A detailed account of the explicit and implicit subsidies in Karnataka is provided in the 4 th report of the ERC (June 2011). | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 76 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 213. The MTFP 2014/18 recognizes that the challenge lies in ensuring that these subsidies do not become a permanent source of additional support and thereby deter these sectors from undertaking reforms. With the number and scope of subsidy-based beneficiary oriented schemes increasing, there are demands beyond the provisions made in the budget and most often these have to be accommodated through Supplementary Estimates. Therefore, GoK acknowledges that expenditure on subsidies needs to be moderated in the medium to long term to make them fiscally sustainable through improving systemic efficiencies in sectors like energy, rational cross subsidization of costs, providing incentives to sectors to perform rather than increasing their dependence on subsidies and also effective identification and targeting of beneficiaries. 214. Bhagyalasksmi scheme of GoK is a major scheme that administered in accordance with a well-detailed institutional and PFM structures including tracking and reporting mechanisms. The objective of the scheme is to promote the birth of girl children in below poverty line families and to raise the status of the girl child in the family in particular and society in general. Under the Bhagyalaksmi scheme each child is tracked through a unique ID via a Child Tracking System over the life of the girl-child, a 3-stage verification process, online payment of scholarship and payment administration managed by Life Insurance Corporation of India which also provides the utilization Certificate. 215. On the other hand, there are schemes in respect of which there is no database of beneficiaries and the subsidy is computed based on assumptions. Hence, there are issues in targeting, accountability and reporting of these subsidies. a. In case of the Power sector, the subsidy is calculated on an overall basis – there is no tracking based on actual electricity consumption. The reason is that only about 25% of IP sets are metered. b. In case of Transport subsidy, either concession is provided to a class of population or passes are issued free/on concessional terms and the cost is borne by GoK. The claim by the road transport companies are made on the same number of passes equally over four quarters, based on the allocation made in the budget. Full details of the number of beneficiaries are not maintained. There is a move to capture this information through Electronic Ticketing Machines and this should be pursued. c. The Department of Fisheries implements 13 schemes involving disbursement of subsidy to a large number of fishermen for various purposes. The Department does not maintain database of beneficiaries at the level of the implementing officers and controlling officers. There is an absence of verification of manual registers, maintained in the Taluk offices, to acknowledge the receipt of the subsidies at the time of disbursing subsidy to a beneficiary to rule out double payments. The absence of database aggravates the risk that of granting subsidy to the same beneficiary under the same scheme during different periods more than once (C&AG Audit Report 2011/12). d. The Department of Sericulture makes provision for subsidy payments under the object head “059 -Other expenditure� instead of “106-subsidies�. The C&AG Audit Report 2012/13 points to grant of subsidy to ineligible beneficiaries in Sericulture Department, and without full compliance with the guidelines in the Agriculture Department. 216. The priorities for strengthening the targeting, accountability and transparency in subsidies could include the following: a. Each scheme involving subsidies should have a mechanism for specific identification of beneficiaries and a system of tracking and monitoring to provide fiduciary assurance and should not be based only on assumptions (which can be adopted for budgeting purposes). Departments/agencies administering schemes involving subsidies should create web-based information system for tracking and monitoring (on the lines of the Child Tracking System of the Bhagyalakshmi scheme) and for improved transparency. Such beneficiary tracking system should be interlined to KII for making payments and recording the subsidies incurred under these heads. b. Implicit subsidies should be recognized as explicit subsidies with proper provision in the budget and accounting under appropriate budget code. Till implicit subsidies are continued, full disclosure should be made in the Finance | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 77 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Accounts as recommended by the XII CFC. The recommendations of the ERC need to be implemented and all subsidies needs to be worked out and presented in the finance accounts. 3.5 PAYROLL CONTROLS - HRMS 217. In 2004, GoK set a priority to computerize its payroll system and it has successfully implemented a computerized Human Resource Management System (HRMS) as a centralized web based application. The objective was to maintain service records of all employees and make employee payments electronically to improve controls and efficiency over the payroll system prevalent at that time which was decentralized and manual with transaction-level controls at the level of the DDOs and the Treasury office. 218. Development of the HRMS commenced in 2005, was piloted across few DDOs and rolled out in a phase manner covering few districts in each phase. The application successfully went live in Feb 2008 across the state and is presently managed by GoK’s Department of e-Governance. HRMS has seven modules88 and presently covers all employees of the state government, approximately 5.5 lacs, including teachers, employees of Taluk Panchayats and Urban Local Bodies, 70,000 employees of fully aided educational institutions, employees of some public sector undertakings, and about a lac Anganwadi workers. User access to HRMS has also been provided to the State Accountant General and Karnataka Government Insurance Department (KGID). Successful implementation of an IT based payroll system is a major achievement for GoK as expenditure on salaries (excluding salary grant to urban local bodies 89 ) constituted about 26% of revenue expenditure net of interest payments during 2012/1390and HRMS has improved the control environment around this vital function due to its design features. 219. HRMS is designed as an Integrated database for Service Register and Pay bill unlike other states that have a Pay bill system only. This feature implies that HRMS is capable of updating service records and generating payroll as an integrated database. a. Service Registers of all employees are now available in electronic form and all events pertaining to an employee are recorded in the electronic Service Register by the designated Drawing and Disbursing Officer (DDO) and approved by the Head of Department (HOD). Each employee is identified through a unique KGID number. Other modules enable entering information on promotion, suspension and transfers. b. The Pay Bill module generates the Pay Bill Report and Pay Slips based on the leave data entered by the DDO91. Items such as Dearness Allowance applicable globally to all employees are entered in HRMS centrally and changes due to an event such as a promotion are system calculated as business rules are entered centrally. Also time-based increments are automated. The electronic Service Register is directly linked to the Pay Bill module so that for any change in the Service Register affecting pay, the change is automatically made in the Pay Bill module. c. E-payments to staff directly from treasury have been rolled out in 15 districts while in other districts the payment is made by the Treasury to the DDO in form of cheque which is further handed over to the staff. 220. Changes to the personnel database and pay bill are made in time for generating the month’s Pay Slips under defined internal controls. 88 Service Register, Pay Bill, Transfers, Promotion, Suspension, Compliant Monitoring and Reports. A detailed “HRMS User Manual� is available (2009). 89 Salary is presently part of the grants released to the Panchayats. Salary is accounted for at the district Panchayats but not included in state accounts. 90 C&AG, Report on State Finances for the year ended Mar 31, 2013 91 The default attendance is 100%. The DDO enters the leaves taken by the employee and the system calculates the actual days worked by that employee. | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 78 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix a. The changes could be made by a designated Data Entry Operator (DEO) but requires verification by the DDO (and HOD as per delegation). Data entered by the DEO is marked as unapproved till approved by the concerned DDO. Changes to static data are subject to approval from the central level. No retroactive changes are permitted – all changes are made in a current date with “date of effect� being filled up. To view or validate changes, a draft Pay Bill is generated and is finalized once approved by the DDO. Increments are already entered by the DDO for each employee and this can be stopped with approval of the HOD. b. On transfer, the Service Register of the employee is transferred from the source DDO (Transfer OUT) to the destination DDO (Transfer IN) on the system itself. Once Transfer OUT is made, the record appears as Unapproved at the destination and requires approval by the concerned DDO. Changes such as adding new DDO or head of account is done centrally (at Bangalore) based on written signed request sent by the concerned DDO. c. Centrally, HRMS is managed by a team of two officials supported by an outsourced maintenance team including database administrators, testers and developers (together forming the Help Desk). Exception reports are generated and reviewed at the central level. All the above processes are detailed in the HRMS User Manual. 221. GoK is now upgrading HRMS to the next level two to enhance its capabilities and further improve efficiencies. The upgraded application will include features such as direct interface to employees including accessibility to mobile platform, linking to Khajane II to do away with paper bill, and including tax details and computation. HRMS 2 is expected to be ready for rollout in about 1 – 1 ½ years horizon – the Functional Requirement Study has been completed and finalization of the vendor is underway. 222. The C&AG have brought out major concerns on the data validity particularly in respect of legacy data . The C&AG has conducted an audit of the HRMS (in 2013) and has issued its report that was tabled in the State Legislature on February 25, 201492. The key areas of concern are: a. Insufficient data validation procedures to weed out duplicates and errors; and b. Not all government rules incorporated in the software by way of validation checks are automated computation thereby allowing manual interventions – these indicate ineffective application controls 223. There are issues, other than raised by the C&AG, that need to be addressed, preferably during upgrading HRMS to the second level which will contribute in strengthening the PFM systems around this IT application. a) A partial or full payroll audit or staff survey has not yet been undertaken. . A payroll audit essential to establish the integrity of the pay transactions and to assess the effectiveness and continuity of internal controls has not been conducted. The State AG audits the payroll on a test check basis as part of its annual audit of a department or its units and is limited to the units that are taken up for audit in a year. The audit is concentrated on pay fixation aspects. The AG however does a detailed check when the employees’ case is referred to it after retirement for fixation of pension. b) HRMS is presently not integrated with the treasury system Khazane. Presently, the Pay bill is generated (through the Pay bill module) and a hard copy is presented to the designated Treasury for generation of cheque/transfers. Therefore, the functionality of online transfer of Pay bill to the Treasuries is presently not available 93. This leads to duplication of work including the risk of possible data entry errors. c) A Disaster Recovery Plan (DRP) is presently not in place. A DRP is being piloted in Belgaum after which it will be placed before the Change Request Committee and the Steering Committee for approval. 92 C&AG, Report No. 3 of 2014, Report on the General and Social Sector (cag.gov.in) 93 The original design included this functionality but it could not be rolled out due to infrastructural problems at the Treasuries, at that time. | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 79 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix d) Linkage between HRMS and preparation of Appendix B is absent (refer section on appendix B). e) E-Transfer of salaries presently covers only 15 districts headquarters only. For other, the Treasury issues cheques to DDOs for distribution to the employees. This facility needs to be extended to all districts & Taluks. States such as Uttar Pradesh, Uttarakhand and Jharkhand has achieved near 100% in terms of direct transfer of salaries to the bank account of the employee. 224. GoK’s current PFM systems around Payroll function fares well when benchmarked to good practices under PEFA. Dimension/Good Practice Current Status Degree of integration and reconciliation between In HRMS, Personnel database is directly linked to the payroll personnel records and payroll data as for any change in the personnel database affecting the Personnel database and payroll are directly linked to ensure payroll status of an employee, a corresponding change in the data consistency and monthly reconciliation payroll is automatically done. Timeliness of changes to personnel records and the Required changes to the personnel records and payroll are payroll updated monthly, generally in time for the following month’s Required changes to the personnel records and payroll are payments. Retroactive adjustments are not permitted. updated monthly, generally in time for the following month’s payments. Retroactive adjustments are rare Internal controls of changes to personnel records and the Authority and basis for changes to personnel records and the payroll payroll are clear, and an audit trail has been established –all Authority to change records and payroll is restricted and changes can be made through a transaction change process results in an audit trail. through the Service Record Module – Update Basic Details and the change is preserved. Existence of payroll audits to identify control weaknesses A comprehensive Payroll audit has not been undertaken in and/or ghost workers the past, but an IT audit of HRMS has been conducted by the A strong system of annual payroll audits exists to identify AG. control weaknesses and/or ghost workers. A third party evaluation of HRMS is also planned to assess the impact of HRMS - the Karnataka Evaluation Authority is managing the selection of the consultants, presently in the Expression of Interest (EOI) stage. A security and technical audit is also planned and engagement of a consultant is expected by end-April 2014. 225. A reform plan to further strengthen the Payroll systems should include the following actionable points. Some of these could be taken up under development of HRMS 2 or Khajane 2. a) Analyze the audit findings from the C&AG report (and the results of the third party evaluation and security/technical audit now planned) and prepare a mitigation plan. This is to ensure that deficiencies in effectiveness of application controls and automation of government rules through validation checks are incorporated in the development of HRMS version 2. b) Initiate a comprehensive payroll audit for validating the database prior to migration/roll out of HRMS II: This will include (i) a documentation check, to ensure that everyone on the payroll is appropriately documented and authorized to receive a particular amount of pay including entitlements, and (ii) a physical verification that the payees exist and are identified before payment. Payroll audits should be undertaken periodically to identify ghost workers, fill data gaps and identify control weaknesses. The third party evaluation and security/technical audit that is planned could be integrated with Payroll audit. At the time of implementation of HRMS II it would be beneficial to validate the existing database which could be done in a phased manner and carry out migration once the entire database is checked and validated. | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 80 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix c) Include data on sanctioned and filled posts in HRMS to enable preparation of Appendix B from the same data source. This functionality would bring significant savings in human effort and time (Estimation of Salaries). d) Provide web enabled interface to employees to view their master data and propose rectifications. This will help “cleaning� the data and weeding out any inconsistencies in the legacy data. e) Provide interface for transfer of Pay bill electronically to Khajane. This is to do away with physical transfer of the Pay-bill and minimize the associated risks. f) Roll out e-payment of salaries across all districts. Going forward, the default payment mode under Khajane 2 is electronic and this should take care of salary payment electronically. g) Develop and institutionalize a Disaster Recovery Plan (DRP): Efforts are already underway and needs to be expedited. 3.6 PROCUREMENT (KTTP AND E-PROCUREMENT ) 226. GoK enacted the Karnataka Transparency in Public Procurement Act (KTPP Act) in 1999 and framed the rules in 2000. The Act came into implementation from 2000 and has been from time to time modified and enhanced with amendments/circulars. After the enactment of the KTPP, the State Government of Karnataka started implementing the Act meticulously. The Act has been implemented across all departments and government organizations working in GoK. The Act mandates that all goods and services above one lakh have to be procured following a tendering process. Whenever there were 94 issues in implementing the Act/Rules, amendments to a particular clause of the Act or rule were issued . Compared to situation in 2004 when the Act was in its initial stages of implementation, currently the understanding and implementation of the Act by the departments have improved substantially in GoK. All departments follow the KTTP except for certain very specific exceptions provided by the GoK like Externally Aided Projects. 227. Generally the departments have been following the provision of Act except in certain cases where AG (Audit) has highlighted certain unhealthy practices followed by the departments like splitting of works to avoid tender, not providing mandated minimum time to contractors for submission of bids, and not collecting EMDs as per the rules etc. GoK needs to carry out a systemic review of the audit reports relating to procurement and take steps to address these systemic issues. Currently no procurement plans are prepared which can be compared with the budget estimates and the MPIC submitted for review. 228. Due to change in the PFM environment and lot of amendments and clarifications issued in the past 12 years it would be prudent for GoK to review and redraft the Act and Rules taking into account, the good practices from procurement acts of other states and GOI. Penal provisions if any for non-compliance, needs to be included in the Act. The following areas of procurement can be added to the Act/Rules: a. PPP model of procurement is not outlined in the Act which needs to be incorporated in the Act; b. A separate chapter on Code of Integrity for procuring entity or bidders is to be included in Act/Rule. This would set out the penal provision for the bidders in case the bids were won following any fraudulent/corrupt practices. c. Penal provisions for violating the Act/rules should be included d. Include a requirement of procurement plan entity wise for each of the item of goods, works or services to be procured during the year to keep track on the procurement and expenditure with reference to budget estimate. 94 Some of the suppliers/contractors approached the legal forum for clarifications/decision and the same are available in the form of case laws. So for there are 53 cases for which the judgement has been given. | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 81 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix e. Public disclosure of contracts awarded on the website. 229. The following table provides the comparison of certain key rules in the Rajasthan procurement act compared to KTTP which GOK can consider as a part of enhancing KTTP. Table 35: Comparison of KTTP with Rajasthan Procurement Act SL.NO Karnataka Rajasthan 1. No detailed instruction in the Act about the Whereas in Rajasthan Act there is a detailed Procurement Plan to be prepared instructions about the preparation and its contents. 2. As of now there is no provision for taking bid Rajasthan Act envisages the provision for taking in security declaration form State govt., lieu of bid security, a bid securing declaration shall Undertakings, Corporations etc. be taken from Departments' of the State Government and Undertakings, Corporations, Autonomous bodies, Registered Societies, Cooperative Societies which are owned or controlled or managed by the Government and Government Undertakings of the Central Government. 3 Penalty. Whoever contravenes the provisions of this Act or the rules made there under shall be punishable with imprisonment for a term which may extend to three years and with fine which may extend to five thousand rupees. So for no evidence to show that the same has been implemented effectively 4 There is no such provision in the KTPP Act Lack of competition.- (1) A situation may arise where, if after evaluation of bids the bid evaluation committee may end-up with one responsive bid only, in such situation, the bid evaluation committee should check as to whether while floating the Notice Inviting Bids all necessary requirements to encourage competition like standard bid conditions, industry friendly specifications, wide publicity, sufficient time for formulation of bids, etc. were fulfilled. If not, the Notice Inviting Bids should be refloated after rectifying deficiencies. The bid process shall be considered valid even if there is one responsive bid. 5 No such review of performance of contractors Review of performance of Registered contractors exists. They may consider in evolving such every year to ensure the contractor possess the review to ensure the quality, competency of the technical competence, financial resources, necessary contractor. equipment to carry out the work, managerial capability, reliability, experience etc; 6 Consider in introducing such clause and Provision of incentive for completion of work before disclosed in the tender document in selected schedule time of completion in some important work cases where the time is the essence for the (not all work) to get the work done in time and avoid completion of the work.. cost overrun. 230. Apart from changes to the Act, capacity building programs, trainings and workshops should be conducted for staff across departments. A user guidance manual should be prepared and shared with the procuring entities. 231. Prior to the introduction of an e-Procurement platform, procurement in GoK was carried out through a manual tendering process. This process involved obtaining internal approval of the projects, publishing a Notice Inviting Tenders (NIT) in several media outlets, bid submissions (voluminous sheaths of paper) by suppliers, bid evaluations by departments, and finally, the awarding of the Contract, issuing supply order and signing of agreements. The complete process required a | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 82 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix long chain of internal authorizations and scrutiny (at times involving several departments), several visits by suppliers to departments, and the generation of paper-based statements and evaluations. 232. GoK introduced e-procurement through an Ordinance on the 25th of Nov. 2006. The KTPP Act was amended to enable to include e-Procurement system in Public procurement on the 27th of April 2007. E-Procurement is aimed to enhance transparency, accountability, reliability and responsiveness in all government procurement activities. The e-Procurement system is a ‘Unified’ solution, i.e., a common platform used by all Government departments / agencies patronizing it. The implementation of e-Procurement system has enabled bidders to easily navigate through Tenders published by various government departments / agencies and efficiently submit tenders. Also, the system has enabled departments in standardization of procurement methodologies and instant retrieval of MIS. Currently more than 200 departments and organizations use the e-procurement platform. 233. This project is being implemented in PPP mode, wherein private partner has invested to set-up and operationalize the e-procurement system. The e-procurement system is hosted out of the Data Centre facility provided by Government. Training for government officials is provided in a training set-up established by the Government. The cost for up-gradation of IT infrastructure and provision of internet connectivity in department offices is borne by the Government. Private partner earns revenue from this project by charging transaction fees for usage of the system. Usage herein refers to: a. Processing of supplier registration application b. Submission of online bids by a bidder c. Handling of contracts online & d. Online submission of invoices by contractors 234. The transaction fees is paid by suppliers / contractors to GoK, which gets consolidated and after due processing is paid to private partner for the services rendered. Payment to the contractor is done only to the extent the system get used. This project is being implemented in Build Own Operate and Transfer (BOOT) model. 235. Introduction of KTTP and e-procurement has increased the transparency in process of procurement there by enhancing PFM in GoK. The following are the key benefits of the e-procurement system which is currently being followed: a. Improvement in Transparency, accountability, efficiency, economy, fairness b. 10% reduction in tender premium (saving approximately USD 3 billion) c. 2 to 3 fold increase in bidders participation d. 40% reduction in tender cycle time e. The Earnest Money Deposit (EMD) is refunded to the bidder as soon as the contract is awarded without any delay. f. Cartelization and physical prevention has reduced g. Technical sanction/approvals obtained through online work flow. 236. The system has about 15,000 registered contractors and 4500 government users. More than 20,000 tenders valued more than USD 15 Billion cumulatively have been published in this platform by 115 Government departments since inception of this project. Most of the Government departments now use the platform to publish tenders valued at Rs. 5 Lakhs (approx. 10,000 USD) and above. | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 83 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Table 36: Details of progress in e-procurement 2007- 2008- 2009- 2010- 2011- 2012- S. No. PARTICULARS 08 09 10 11 12 13 TOTAL 1 Departments/Boards/Corporations 7 19 31 58 60 32 207 2 PSUS/Central Government Org. 74 972 1072 2455 0 1 4574 3 Number of Government Users 74 972 1072 2455 3138 2127 9838 4 Number of Suppliers Registered 130 1775 4420 7700 12271 9989 36285 5 Number of Tenders Published 15 1262 4883 14166 46759 64034 131119 Value of tenders Published(INR in 6 Crores) 57 10226 25630 33554 27603 56360 153430 No. of Government Officials & Suppliers Trained 7 865 1034 2936 3803 5066 3418 17122 8 No of digital Signature issued 205 1003 1874 3966 1710 3156 11914 237. The system has been subjected to functional and security audit by a reputed third party audit agency. The key finding of the audit are a. Time savings due to automation of key steps from indent management to evaluation of tender b. Improved participation of bidders/contractors c. Centralized registration by the bidders were strongly supported by the suppliers and user departments d. Better governance such as generation of various reports and MIS relevant to the respective department e. Increased accountability on Government officials due to transparent e-procurement system. 238. The main concern with respect to employees of user departments were increase in workload post introduction of e- procurement as many departments retain the practice of evaluation and decision making on the basis of hard copy of tender documents in addition to e-procurement. Over dependency of key staff for approval and forwarding of task was also a key area of concern that challenged the overall efficiency of e-procurement with respect to timelines. In order to overcome the current challenges that prevent e-procurement platform to realize its full benefits, the consultant proposed certain areas of improvement. The significant suggestions are: a. proactive involvement of supplier community in training initiatives, b. encourage delegation to reduce the bottleneck of approvals, and c. Provision of automatic alert to suppliers on status of change of key events during the bid process etc. 239. The e-procurement system in GoK is envisaged as a unified end to end e-Procurement platform. The primary purpose of the e-Procurement system is to facilitate automation of the entire procurement cycle from the stage of estimate / indent creation till the payment to the Contractor/Supplier. All modules of the software have been approved for Go-live. However, the modules being actively used are: Supplier Registration, Indent Management, e-Tendering and e-Auctions. The modules to handle post tendering activities viz. Contract Management and Catalogue Management modules is ready but is yet to be fully operational. 240. While e-procurement is being used by all departments, there are certain issues in the process. | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 84 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix a. The current e-procurement system is only up to bid evaluation stage. Once the bid is uploaded by the vendor, the bids are downloaded and evaluated outside the system manually. After the evaluation is completed then the evaluation is entered in the system. b. Contract management module of e-procurement, has not been implemented. Departments use their own system for monitoring the contract progress. This is an area of concern as the contract management module was a key part of e-procurement software and which was to be and implemented gradually in departments. c. Also while all other software’s have been audited by CAG IT wing, this software has not been audited by the AG. It would be imperative for the GoK to get an IT audit of the e-procurement software through AG office. d. Even though the rules have provision for EOI, e-procurement system does not have a provision for calling for EOI for short listing under selection of Consultancy firm. e. The issue of work order is not included in the e-procurement module. f. In some department/Ministries there is no provision to get the online approval from the competent authority after a particular level. It is being obtained manually. 241. The following key actions can be considered for strengthening e-procurement: a. A CAG audit of the e-procurement software should be conducted so that any gaps in the software could be addressed; b. Contract management module and its implementation should be reviewed by the government so that suitable arrangements can be done in KII to develop this very important aspect c. Online Bid Evaluation Process is required to be developed to reduce the manual and outside system evaluations. d. Include issue of work order in the system or this function needs to be captured in KII. e. Provide adequate delegation of powers as required by the departments in consultation with the DPAR. f. Include provisions for EOI in the e-procurement system. 242. Apart from changes to the system, capacity building programs, trainings and workshops should be conducted for staff across departments. A user guidance manual should be prepared and shared with the procuring entities. 3.7 PUBLIC ACCESS TO KEY FISCAL INFORMATION 243. Public Access to Key Fiscal Information is mainly through the website of the Finance Department and the AG: Transparency will depend on whether information on fiscal plans, positions and performance of the government is easily accessible to the general public or at least the relevant interest groups. GoK provides fiscal information to the public through the website of the Finance Department (finance.kar.nic.in) including the budgets (and supplementary budgets), the MTFP, quarterly receipts/expenditure and taxes collected. Audit reports and annual financial statements are available on the website of the Accountant General Karnataka (agkar.cag.nic.in). The major enabling legislations for public disclosures are briefly discussed in the box below. | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 85 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Legislation for Fiscal Transparency in GoK The Right to Information Act (RTI Act) - GoK has implemented the RTI Act, in order to promote transparency and accountability in the working of every public authority. Primarily, the Act empowers all citizens to have the right to information, and all public authorities to sou moto publish minimum prescribed information and to appoint Information Officers. The Karnataka State Information Commission has been constituted under the RTI Act headed by a State Chief Information Commissioner supported by a maximum of Ten State Information Commissioners who exercises powers as prescribed in the RTI Act 2005 mainly to receive and enquire into complaints, guide public authorities about the implementation of the Act. 33 departments of GoK have appointed Public Information Officers and published the minimum information on their websites. A time period of thirty days has been prescribed for providing information requested under the Act. The Karnataka Fiscal Responsibility Act - Public disclosure requirements have been significantly enhanced through the KFRA which requires the State Government to ensure greater fiscal transparency and minimize secrecy in the preparation of the annual budget. The key disclosure requirements mandated are –  GoK to publish a half-yearly report which shows whether it is on track in achieving its targets and, if not, what remedies it will take;  Key fiscal information, e.g., contingent liabilities from guarantees, off-budget borrowings through Special Purpose Vehicles, tax arrears, tax expenditures, losses through public sector entities, expenditure arrears of major works and contracts, and subsidy payments; and Significant changes in the accounting standards, policies or practices that affect the computation of fiscal indicators. Karnataka Ceiling on Government Guarantees Act - requires GoK to place before the Legislature a comprehensive report on the liabilities that the State may incur in future, if the State fails to meet the contractual obligation stated in the performance guarantee. Guarantees, other than Performance Guarantees, are disclosed in the annual budget documentation and the Finance Accounts. Karnataka Transparency in Public Procurement Act, 1999 – All goods and services of Rs. 5 lacs and above are to be procured by inviting Tenders through the electronic platform 244. The PEFA framework lists six elements of information to which public access is essential and GoK disclosure of key fiscal information has been benchmarked against these elements and also against the position assessed in the 2004 PFMA. GoK makes available four out of the six essential elements for public disclosure – details of contracts awarded and budgetary allocation to primary resource/delivery units are not appropriately publicized and the public can get this information only under the RTI Act.  Annual budget documentation: (Benchmark: A complete set of documents can be obtained by the public through appropriate means when it is submitted to the Legislature): The Karnataka Budget Manual prescribes the “budget literature� required to be presented befo re the state Legislature. Additionally, the KFRA requires GoK to lay the Medium Term Fiscal Plan before the Legislature along with the annual budget. Traditionally, documents are deemed to be publicly disclosed when they are laid before the Legislature. Full budget documents when presented to the Legislature are also available to the public in electronic form on the website of the Finance Department. This is an improvement since 2004 – as at that time only the Overview of the Budget and Budget Speech were accessible on the website and not the full budget. Printed copies continue to be available with some difficulty. Supplementary Budgets are also available to the public once it is passed by the state Legislature. The set of disclosures compares well with the PEFA framework.  In-year budget execution reports: (Benchmark: The reports are routinely made available to the public through appropriate means within one month of their completion): | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 86 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix While detailed in-year budget execution reports are prepared, these are made available to the public with a time lag of one to two months which is slightly delayed in comparison to the benchmark. Details are provided below: i. Reports in respect of tax and non-tax revenue collected and receipts and expenditure (at a glance) along with deficits as percentage of GSDP compared to the budget estimates are published on a quarterly basis on the website of the Finance Department. The information is usually available within 2- 3 months of the close of the quarter. However the last quarter report is not normally published. 95 ii. Monthly Accounts at a Glance compared to budget estimates along with fiscal indicators and Monthly Civil Accounts which discloses detailed head wise figures are published on the website of the PAG (A&E) Karnataka. The latter report details the budget allocated, actual receipts and expenditure both for the current month and progressive expenditure. Normally these reports are finalized and publicly available with one to two months’ time lag. iii. Mid-year review of state finances (half-yearly) as mandated by the Section 6(2) of the KFRA is prepared by the FD and reviewed by the FMRC and then placed before the Legislature within 2 months from close of the half-year and hosted on the website of the Finance Department.  Year-end financial statements: (Benchmark: The statements are made available to the public through appropriate means within six months of completed audit). Year-end financial statements comprise of the State Finance Account and Appropriation Account and are made available to the public after they have been audited by the C &AG and placed before the Legislature. Full copy of the audited financial statements is available, in electronic form, on the website of the C&AG/AG Karnataka. In recent years, the audited financial statements are available to GoK within six months from close of fiscal year and made public within 3 months of completed audit in the next session of the Legislature (refer Table 37 ) and so meets the benchmark. This is commendable and is an improvement since 2004 both in terms of easy access to the public and completion of audit/ placing before the state Legislature. In 2004, the audited accounts were placed before the Legislature usually after one year from close of financial year but not in the session immediately after receipt of audit accounts. Table 37: Public availability of year-end financial statements Financial Year Date of signing by the C&AG Date of placing before Months taken to place report before Legislature Legislature after completed audit 2012-13 2011-12 Sep 14, 2012 Dec 10, 2012 3 2010-11 Sep 26, 2011 Dec 12, 2011 2½ 2009-10 Nov 30, 2010 Feb 25, 2011 3 Source: Karnataka Legislative Assembly Secretariat  External audit reports: (Benchmark: All reports on government consolidated operations are made available to public through appropriate means within 6 months of completed audit). Full text of all audit reports issued by the C&AG are available on the website of the C&AG (www.cag.gov.in) and the AG Karnataka (www.agkar.cag.gov.in) after the reports have been placed before the state Legislature, and are also available as a priced publication. Usually six types of audit reports are issued by the C&AG covering the government’s operations (refer Table 38 ). Reports are therefore available to the public within six months of completed audit i.e. actually available within 1-2 months of completed audit; and hence meets the benchmark. Table 38: Public availability of State External Audit Reports in Karnataka Audit Report 2012-13 2011-12 2010-11 2009-10 Date of Date of Date of Date of Date of Date of Date of Date of 95 The Accounts include revenue expenditure and deficits; capital expenditure, deficit financing, monthly trend of revenue and expenditure | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 87 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix signing placing signing by placing signing by placing signing by placing by before C&AG before C&AG before C&AG before C&AG Legislature Legislature Legislature Legislature 1. State Feb 5, Feb 19, Jan 22, Feb 14, Feb 27, Mar 30, Feb 1, Mar 14, Finances 2014 2014 2013 2013 2012 2012 2011 2011 2. Civil NA NA NA NA Feb 27, Mar 30, Feb 25, Mar 14, 2012 2012 2011 2011 3. General Feb 5, Feb 25, Jan 22, Feb 14, NA NA NA NA and Social 2014 2014 2013 2013 Sector (GSS)96 4. Economic Feb 5, Feb 19, Feb 11, Feb 14, NA NA NA NA and 2014 2014 2013 2013 Revenue Services Sector (ERSS) 5. Public Feb 24, Feb 26, Feb 11, Feb 14, Feb 27, Mar 30, Feb 11, Mar 14, Sector 2014 2014 2013 2013 2012 2012 2011 2011 Undertakin gs 6. Revenue Jan 27, Feb 19, Jan 30, Feb 14, Mar 14, Mar 30, Mar 1, Mar 14, Receipts 2014 2014 2013 2013 2012 2012 2011 2011 7. Local Not Not issued Not issued Not Issued Jul 13, Jul 27, Jun 23, Dec 7, Bodies issued 2012 2012 2011 2011 Source: Karnataka Legislative Assembly Secretariat and respective report  Contract awards: (Benchmark: Award of all contracts with value above approx. USD 100,000 equiv. are published at least quarterly through appropriate means). GoK has adopted e-Procurement system as mandated in the KTPP Act and has made it mandatory for all its departments and organizations to procure goods and services or award construction works exceeding Rs 5 lacs each 97 on the e-Procurement portal . Accordingly, all tenders and e-Auctions are published on the e-Procurement portal. Details of contracts awarded, however, are not made public in any medium and this information can be accessed by the public through RTI.  Resources available to primary service units: (Benchmark: Information is publicized through appropriate means at least annually, or available upon request, for primary service units with coverage in at least two sectors, such as elementary schools or primary health clinics. Information on resources available to the primary service units particularly the schools and hospitals is not disseminated to the public at large. Such information may be disclosed by some schools or hospitals on an individual basis locally and such information can only be accessed under the RTI Act. 245. GoK discloses four of the six essential elements to the public as benchmarked under PEFA. Dimension/Good Practice Current Status Public Access to key fiscal information GoK makes available to the public four out of the six The government makes available to the public 5-6 of the 6 elements of information listed in the PEFA framework. listed types of information 96 The GSS and ERSS reports were earlier issued as one report – The Civil Report. From 2011-12, the Civil Report was segregated into GSS and ERSS Reports 97 www.eproc.karnataka.gov.in. Please see section for detailed discussion on procurement | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 88 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 246. Summary of issues a. Contracts awarded are not available in the public domain b. Information on resources available to the primary service units is not disseminated to the public at large 247. The priorities for the 2014 PFM Reform Action Plan could include - a. GoK to publicly disclose information on contracts awarded on the e-Procurement website. Initially this can be done for contracts over $ 100,000 and later on mandated in the KTPP Act for full disclosure. b. Budgetary allocation to primary service units particularly the primary schools and primary health centers should be publicized on the website of the Education and Health Departments. | Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency 89 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Section 4. THEME FOUR: IMPROVING FISCAL ASSETS AND LIABILITY MANAGEMENT SYSTEM 4.1 GOVERNMENT GUARANTEES 248. GoK provides substantial Guarantees for borrowings of various public sector entities . Guarantees are in the nature of contingent liabilities and the issuing government is called upon to pay when a guarantee is invoked. Aggregate level of guarantees issued and outstanding in GoK is summarized in Table 39. In terms of value, the maximum guarantees have been provided in respect loans of the cooperative institutions and the state financial corporations. There has been no invocation of guarantees during the past few years. Table 39: Aggregate Guarantees Issued and Outstanding (Rs. in crore) 2012/13 2011/12 2010/11 Aggregate Guarantees issued 14,306 13,262 19,150 Guarantees Outstanding (including interest) 6,688 6,515 6,618 Source: State Finance Accounts 249. The legal basis for issuing Guarantees emanates from the Constitution of India. Article 293 of the Constitution of India permits the states to give guarantees within fixed limits. In 1999, GoK enacted the Karnataka Ceiling on Government Guarantees Act (effective from April 29, 1999). The Act provides that the total outstanding government guarantees as on the first day of April of every year shall not exceed 80% of the state’s revenue receipts of the second preceding year as in the books of the AG. The KFRA draws upon the provisions of the Guarantee Act and mandates its compliance. This has been adhered to by GoK since 1999 and presently (April 2013) the outstanding is about 11% of the prescribed base down from 14% a year hence (MTFP 2014-2018). In Karnataka, all guarantees require the concurrence of the Finance Department which issues the GO for giving the guarantee and also authorizing the official who will sign the guarantee deed. Guidelines in respect of “aspects to be reviewed while recommending cases� has been prescribed by GoK through circular of 2003 that requires the concerned Administrative Department to review each case in terms of public interest, credit worthiness of the borrower, financial viability of the project and the terms of the guarantee. 250. There is a system of reporting and disclosures in respect of guarantees . A summary position of guarantees given by GoK is given in “Overview of Budget�, details are provided in the Finance Accounts as Statement No. 9 in accordance with the disclosure requirements prescribed by the Ministry of Finance, GoI (2010) and discussion on guarantees is also included in the MTFP. Disclosure requirements relating to guarantees in the accounts of the governments (Union and States) have now been specified in the Indian Government Accounting Standards - 1 (IGAS) notified by the Central Government in December 2010. GoK is in compliance with the disclosure requirements. 251. The 2004 PFMA identified a number of shortcomings in the PFM framework governing Guarantees. a. The system for recording and reporting of guarantees was weak. There were no systems for this purpose. b. Guarantees were approved by the Finance Department; however, the Finance Department did not sign the guarantee itself. c. The concerned departments signed the guarantees, maintained data on them and monitored the performance of the entities to which guarantees have been issued. The Finance Department received information on the guarantees only when there was a possibility of default and payments needed to be made. d. Reporting of guarantees was based on ad hoc information collected by the Finance Department from the various departments. Although this ad hoc system produced information for annual reporting, given the extensive volume of guarantees, the system needed to be strengthened. | Theme Four: Improving Fiscal Assets and Liability Management System 90 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 252. The 2004 PFMA recommended several measures to strengthen the system. The Finance Department needed to countersign all guarantees, and maintain a central system to record the various guarantees made and discharged. A system for regular monitoring of the financial performance of the entities to which the guarantees were provided was needed to enable early follow-up action. A systematic methodology for evaluating the risks of these guarantees, both for monitoring and reporting purposes was recommended to be done as per the Reserve Bank of India’s Report of the Group to Assess the Fiscal Risk of State Government Guarantees, July 2002. 253. GoK has carried out reforms particularly in establishing a credible guarantee database. It has institutionalized the recording and reporting of guarantees in the Asset Liability Monitoring Cell 98 (ALMC) under the Finance Department’s Directorate of Pensions, Small Savings, and Asset Liability Monitoring. ALMC collects data from the departments on a yearly basis and updates the guarantee database (or at lesser interval as and when information is provided). As of now, the guarantee database matches with the State Finance Accounts compiled by the AG (A&E). The ALMC also carries out balance confirmation with some of the lender institutions who are responsive, but not with the department or entity which takes the guarantee. While details are available with the ALMC in respect of Guarantees issued after 2004, some details of guarantees issued before this period are not readily available. The guarantee database is currently being maintained in excel spreadsheets and the system is working sufficiently well to meet the current requirements. Cleaning up of the database was done in 2012 by deleting guarantees for which the loans were repaid which resulted in reducing the maximum amount guaranteed from Rs. 19000 crore to Rs. 13000 crore. 254. The current study identifies structural and other issues to strengthen the PFM arrangements in respect of Guarantees. a. GoK recognizes the need to evolve a comprehensive State Guarantee Policy (MTFP 2013-17) similar to the policy of the GoI. At the Central level, guidelines are imbibed in a Guarantee Policy supplementing the Government Financial Rules, 2005 (chapter 11). The Government of Gujarat’s Guarantee Order of 1988 is another instance of a comprehensive document. b. GoK needs to operationalize its Guarantee Reserve Fund. This was set up in 1999-2000 with a corpus of Rs. 1 crore pursuant to the recommendations of the XI Finance Commission. The objective of the Fund is “to provide for a sudden discharge of State’s obligations on guarantees�. Besides the original contribution, there has been no further transfer to the Fund which is lying dormant. The C&AG reports that Guarantee Fee of Rs. 714 crore have not been transferred to the Reserve Fund and a part of it was utilized for payment of financial relief, on building expenses and investments99. c. Guarantee Commission is not recovered but adjusted through book entries. The Guarantee Act mandates a charge of guarantee commission (minimum 1%) and prohibits waiver of the guarantee. As of March 2013, guarantee commission receivable was Rs. 360.35 crore. Each year, GoK indirectly adjusts the guarantee receivable either as subsidy or equity to the same entity that was to pay the guarantee commission – such amounts were of the order of Rs. 127 crore and Rs. 69 crore during 2012-13 and 2011-12, respectively disclosed in the State Finance Accounts. This has been reported by C&AG as non-compliance with the Guarantee Act. d. The current database could be further strengthened. It does not capture information such as date of expiry of guarantees which facilitates tracking the due date for obtaining no dues from the concerned lending institutions for deleting the guarantee from the outstanding; a process that presently takes considerable time. The database maintained on spreadsheet does not provide advance automatic “flags� on expiry date of the guarantee, arrears of guarantee commission etc. and for which an application would be needed. GOs of FD conveying its concurrence to 98 Vide GO No. FD 25 Savula 201, dated 21.04.2010 99 C&AG, Report on State Finances, March 31, 2013 | Theme Four: Improving Fiscal Assets and Liability Management System 91 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Guarantees is not copied to ALMC directly leading to delays in recording of guarantees. The CAG in its report on State Finances (2011-12 and 2012-13) has observed that the amount of guarantees does not include the guarantees given by GoK to some power utilities ((Bangalore Electricity Supply Company Limited (BESCOM) 100, Gulbarga Electricity Supply Company Limited (GESCOM) and Chamundeshwari Electricity Supply Corporation Limited (CESC)) for loans taken by the latter (“and hence the statement on guarantees is not complete and reliable�). The ALMC, however, does not concur with this observation and hence there is a need to reconcile this with the AG. The above steps are expected to strengthen the database and migration to the proposed Asset Liability Management Module in the 2nd phase of Khajane II would be easier. e. A system of tracking, recording and reporting of Performance Guarantees has presently not been established. The Karnataka Guarantee Act allows GoK to issue Performance Guarantees (PG) “in the interest of development o f infrastructure�. The PGs issued by GoK is presently not captured in the database maintained by ALMC. The statute requires that GoK will place before the state Legislature a comprehensive report on the liabilities that the State may incur if the obligations in the PG are not met. This is an area which needs to be reviewed and if any PGs are given it needs to be updated in the database. f. Staffing at ALMC is an issue, as there are no core finance professionals or staff from Finance Department in this cell. While the ALMC is recording and reporting on guarantees, investments and loans & advances), a more strong linkage with and frequent reporting to FD would improve interactions so that issues are discussed and resolved more frequently. The available staff from DSS requires training including a better understanding of corporate financial statements. 255. GoK’s PFM systems around issuance of guarantees match well when benchmarked to good practices under PEFA. Dimension/Good Practice Current Status Systems for issuance of guarantees GoK’s criteria for issuance of guarantees are documented in Issuance of guarantees are made against transparent criteria a 2003 circular and needs to be updated and issuance of a and fiscal targets, and always approved by a single State Guarantee Policy is desirable. Fiscal targets are responsible government entity. prescribed through legislation and adhered. The delegated authority for issuance of guarantee is vested solely in the Finance Department. 256. The following priorities have been identified for 2014 PFM Reform Action Plan. a. Develop a Government Guarantee Policy. The MTFP 2013-2017 already recognizes the need to develop such a policy, on lines of the policy issued by Government of India. This is an initiative which is in the right direction and must be done expeditiously. A guarantee policy provides direction relating to consideration in reviewing the guarantee proposals, channels of submission of proposals and the decision levels, execution of guarantee agreements and their monitoring, recording and reporting and rules in respect of guarantee fees and maintaining a Guarantee Redemption Reserve. The new policy should also include norms for risk profiling of the guarantees at the time of appraisal of the proposal and periodically post-issue of the guarantee. b. Operationalize the Guarantee Redemption Fund. This is a requirement of the XIII Finance Committee and has been echoed by the C&AG. The State Public Accounts Committee has also recommended that GoK operationalize the Guarantee Redemption Fund and transfer the guarantee fee received to the fund. 100 The audited financial statements of BESCOM disclose payment of Guarantee Fee to GoK in 2011-12 and 2010-11. However, the financial statements do not disclose which loans are covered by government guarantee | Theme Four: Improving Fiscal Assets and Liability Management System 92 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix c. As a corollary to the above, GoK should revisit its policy of book adjusting guarantee commission so as to be in compliance with the Guarantee Act. d. Further strengthen the database and widen reconciliation efforts: Reconciliation efforts are underway and should be continued - system of obtaining no dues/clearance certificate from the concerned lending institutions for deleting the expired guarantees from the outstanding list and clearing old items should be strengthened. The database should include fields for capturing information such as due date of guarantees (other than for continuing guarantees). Confirmation of balances with the beneficiary and lending entities needs to be carried out every year. All GOs by FD authorizing the issue of guarantees must be directly copied to the ALMC. IGAS 1 ( ibid) requires disclosure of PGs given by state government for fulfillment of contracts and if this is to be complied with, a database would be required to be maintained. e. GoK has entrusted ALMC the work of tracking government investment under loans and shares, and but not guarantees. The GoK needs to amend the GO to include maintenance of guarantees by the ALMC. f. Resource constraints in ALMC should be addressed through training, and appointing finance professional The ALMC staffing should be reviewed by the FD, which needs augmentation with finance professionals for short tenures and staff from FD. The ALM cell should be led by the staff from FD and the current officers can be trained for carrying out their activities with more focus on fiscal and financial management of corporate form of business and also IGAS disclosure requirements. g. Develop and incorporate the guarantee database in KII. The Functional Requirement Specification of Khajane II recommends building capability in the application to capture all details of guarantees. This is a step in the right direction and should be pursued. All legacy data needs to be incorporated in KII. In case implementation of the Asset Liability Module in Khajane II is in the distant future (more than 2 years), then an suitable application compatible to KII for recording and reporting of guarantees (along with loans and advances and investments) could be developed for use by the DSS (in contrast to the present system of maintaining database on spreadsheets). 4.2 OFF BUDGET B ORROWINGS 257. State governments in India often float companies/corporations (Public Sector Undertakings – SOEs) or Special Purpose Vehicles – SPVs) to implement programs outside the state budget. Ideally, funding for these programs should be arranged outside the state Off-Budget Borrowings budget i. e. the funds should not have a “contingent effect� on the state Liabilities via state agencies that have a budget. However, due to the social and development nature of the program potential risk on state finances, including being implemented by these state owned agencies and more often an debt sustainability and is a component of absence of revenue streams or long gestation periods, funds raising outside contingent liabilities of the state the state budget is difficult. To support such SOE/SPVs some form of “credit enhancement� is needed – one such instrument is to provide a sovereign guarantee to the lenders. This implies that although the funds are available to the SOE/SPV, the state government has often to provide budgetary support to pay the interest or repay the loan when such companies are unable to repay such loans from their own funds. Expenditure met out of these borrowings or corresponding assets created are not part of state budget or accounts. 258. Significant off-budget borrowings mean that the budget is not comprehensive . Recognizing this, the 2004 PFMA documented the steps being taken or planned by GoK to control OBB: a. the KFRA required off-budget and on-budget borrowing to be consolidated in determining the achievement of fiscal targets i. e. OBB are considered part of the state’s own borrowings; | Theme Four: Improving Fiscal Assets and Liability Management System 93 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix b. the annual quantum of OBB had started to drop; and c. GoK planned to phase out its OBB by 2006-07 259. Over the years, GoK has curtailed its OBB and has reduced the outstanding and its interest costs – in fact there were no fresh OBB during 2008-09 to 2010-11 (see Table 40). Overall, the ratio of fiscal liabilities including OBB is within the limit prescribed by the XIII Finance Commission. Table 40: Off Budget Borrowings in SOE/SPVs of Government of Karnataka (Rs. in crore) 2012-13 2011-12 2010-11 2009-10 2008-09 1. Outstanding as the beginning of the year 1917 2056 2749 3747 6222 2. Raised during the year 18 512 -- -- -- 3. Repayment during the year 480 665 689 984 640 4. Outstanding as at the close of the year 1455 1903 2060 2763 5582 5. Interest Paid during the year 101 166 184 202 569 595 Source: C&AG, Report on State Finances for items 1-3 and 5; item 4 is derived 260. Off Budget Borrowings are adequately disclosed. Details of OBB are disclosed in the Budget documents (planned for the budget year), the MTFP and the Mid-Year Review Report under KFRA and a discussion is included in the C&AG’s annual Report on State Finances. 261. GoK is the leading state in India to include OBB for the purpose of calculating fiscal deficit. The KFRA mandates that OBB would be treated as the state’s own borrowings for arriving at the fiscal deficit and that interest on such OBB met by the government would be considered as revenue expenditure. However, the definition of “total liabilities� in KFRA presently does not include OBB – this need to be done through an amendment of the Act (see Chapter 3 on Fiscal Responsibility Legislation) – in actual practice, GoK considers OBB towards computation of Total Liabilities. An amendment to KFRA to include OBB in total liabilities is already underway. 262. Although GoK has not fully eliminated OBB, yet it has taken several steps to curtail the outstanding, follow prudent accounting norms and improve transparency all in compliance with the KFRA. Key measures taken by GoK are - a. Fiscal policy in respect of OBB is provided in the MTFP. In MTFP 2009-13, GoK committed to eliminate OBB from 2008-09 “to ensure transparency in fiscal performance�. For three successive years 2008 -09 to 2010-11, no fresh OBB were raised. In MTFP 2011-15, GoK decided to allow OBB in a limited manner, but maintaining at the same level as at the close of 2009-10 “as the State Government was well advanced on the fiscal consolidation road map set in the FRA� and based on the recommendations of the XIII Finance Commission. In MTFP 2012-16, the limit was fixed at Rs. 3,249 crore. In 2011-12 the amount raised through OBB was lower than the repayments and in 2012-13, the OBB was restricted to a small amount of Rs. 18 crore (see Error! eference source not found. above). Due to availability of fiscal space, GoK allowed fresh OBB of Rs. 1,250 crore during 2013-14 to the three water resource management companies. For 2014-15, GoK has planned to raise Rs. 2,335 crore as OBB and Rs. 183 crore are due for repayment. b. Earlier interest on OBB was included in capital expenditure even though there was no corresponding build-up of assets in the state accounts that resulted in understatement of interest expenditure and overstatement of 101 Excluding releases made to urban local bodies for servicing of debt | Theme Four: Improving Fiscal Assets and Liability Management System 94 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 102 capital expenditure / revenue surplus and this was not in compliance with the KFRA . From 2011-12 onwards, interest on OBB is now appropriately included in revenue expenditure. 263. While GoK follows good practice in respect of disclosure of OBB the following issues needs to be addressed. a. The C&AG has reported release of budgetary funds despite the SOE/SPV having surplus liquid funds available: Krishna Bhagya Jala Nigam Ltd. and Karnataka Road Development Corporation had cash balances of Rs. 1,246 crore and Rs. 791 crore, respectively as at March 31, 2013 mainly on account of funds released during 2008-09 and 103 2011-12 for servicing of debt, but not utilized . This is an issue from the cash management perspective of the state. b. Debt servicing met by GoK for city corporations are not considered as OBB. GoK makes provision in its budget for debt servicing on account of borrowings of the City Corporations - this has been included for the first time since 2011-12. Apparently these are not considered as OBB, even though the obligations are met by GoK, as except for provision in the state budget, the amount of loans is not disclosed. These OBB of the ULBs are also not considered in the computation of Total Liabilities. The amount towards debt servicing of ULBs provided in the state budget is briefed in Table 41. Table 41: Provision of Debt Servicing in State Budget for Urban Local Bodies (Rs.in crore) 2014-15 2013-14 2012-13 2011-12 Debt Servicing costs of ULBs provided in state budget 408 517 375 279 (actual) (actual) Source: Government of Karnataka, Detailed Estimates of Expenditure Vol 2 264. The following priorities have been identified for 2014 PFM Reform Action Plan. a. Going forward, GoK needs to ensure that budgetary funds directed towards debt servicing should be utilized for the intended purposes by the SOE/SPV. And, GoK to assess the uncommitted financial resources available with the SOE/SPV prior to release of funds for debt servicing. b. GoK to make adequate disclosure of OBB on account of ULBs in the budget document including MTFP and include the amount outstanding for the computation of Total liabilities (in the same manner as done for SOE/SPVs). 102 The KFRA stipulates that interest payment by Government towards borrowings by PSUs and Special Purpose Vehicles (SPVs) and other equivalent instruments where liability for repayment is on Government, shall be treated as revenue expenditure 103 C&AG Report on State Finances, 2012-13 | Theme Four: Improving Fiscal Assets and Liability Management System 95 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 4.3 INVESTMENTS IN GOVERNMENT COMPANIES 265. There is a ten-fold increase in total investments between March 2002 (2004 PFMA) and March 2013. GoK makes investments in government companies and corporations, other companies and in entities such as regional rural banks and cooperative institutions/local bodies. Investments may emanate out of conversion of loans to equity or providing funds to state companies to honor their commitments to financial institutions. This forms 35% of GoK’s total asset base (Statement No. 1, State Finance Accounts 2012-13). The book value of investments over the years is summarized in Table 42. Table 42: Book Value of Investments of Government of Karnataka (Rs. in crore) Type of Investee 2012/13 2011/12 2010/11 Stock Flow Stock Flow Stock Flow Statutory Corporation 2,154 121 2,032 255 1,777 104 Regional Rural Banks 21 22 2 19 Government Companies 45,369 5,056 40,313 5,594 34,716 5,369 Joint Stock Companies 1,562 1,562 5 1,557 450 Cooperative Institutions and 358 366 12 352 1 Local Bodies Total 49,464 5,177 44,295 5,868 38,421 5,924 Source: State Finance Accounts Statement No. 14 266. Information on Investments is provided in the budget and the financial statements . Summary information on investments is provided in the “Overview of Budget� and a detailed statement of investments of the GoK is included as Statement No. 14 of the Finance Account of the state. All proposals of investments require the prior concurrence of the Finance Department. 267. The 2004 PFMA identified the following areas of concern in respect of PFM environment governing Investments, particularly in recording and reporting. a. Data on investments was maintained in individual departments and there was no central source that had the responsibility for recording and monitoring these investments or a system to record them. b. Information required about these investments for year-end reporting in the Finance Accounts was obtained in an ad hoc manner from various departments. c. Systems for recording of investments were weak apparent in the differences that exist between data in the State Government’s accounts and those in the corresponding entities’ accounts. d. Investments in public sector entities were classified as capital expenditure rather than capital transfers. e. Furthermore, they were reported at their invested values instead of their true value. In many cases, public sector entities had significantly eroded net worth, and in some cases, exhibited negative net worth. 268. GoK has strengthened and institutionalized the system of recording and reporting of its Investment portfolio. Maintenance of database in respect of Investments has been centralized with the ALMC of DSS since 2005. The ALMC collects annual information on investments from the respective investees in predefined form and updates its database, presently maintained on spreadsheets. 269. Accounting and controls in this area has not kept pace with the growth in the investment portfolio . Reconciliation of investment data between Finance Accounts and that provided by the investee-institution remains a concern. Material differences are pending due to both due to identification and reconciliation issues: As of March 2013, investment had been reconciled between the investee-institutions and the Finance Accounts for an amount of Rs. 2013 crore (Rs. 1774 crore as of March 2012) being just 4% of the total portfolio. There is a net difference is Rs. 13,590 crore as of March 2013 that has increased over the difference of Rs. 12057.20 crore as of March 2012 which needs to be reconciled - this difference | Theme Four: Improving Fiscal Assets and Liability Management System 96 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix is over 27% of the total investment – the figure in Finance Accounts exceeds that reported by the investee-institutions (details in Table 43). There are cases where the amount reported in the Finance Accounts exceeds that reported by the institution (Rs. 15,657 crore) and vice versa (Rs. 2,067 crore) and some of these differences are material and pertain to the past several years104. The resultant effect of these differences is two-fold – one, the Finance Accounts may not exhibit the correct investments of GoK and two, this could impact the dividend to which GoK is entitled to. Table 43: Reconciliation issues in Investments (Rs. in crore) Entity As per DSS Finance Net Difference Excess of Excess of Accounts between Finance Finance DSS over 2012-13 Accounts and Accounts Finance DSS over DSS Accounts Working Statutory Corporations 1,594 2,152 560 733 173 Regional Rural Banks 22 21 (-) 1 - 1 105 Working Government Companies 32,449 45,307 12,857 14,582 1,724 Non-Working Government Companies 84 63 (-) 21 16 5 Joint Stock Companies 1,726 1,562 (-) 164 - 164 Cooperatives 0 358 358 358 - Total 35875 49,464 13,589 15,657 2,067 Source: Directorate of Small Savings, Finance Department GoK 270. The reasons for the differences identified point to the need for a complete revamping of identification, accounting and reporting of investments by all stakeholders – GoK, AG and the investee-institution. The major difference pertains to GoK’s own working companies.  Often, government orders on investments are issued near to the close of the financial year. So while the transaction is accounted by the AG in the Finance Accounts, action may be wanting from the investee-company.  Government order is issued under minor head 190 or 211 – Investments (under major head pertaining to Capital Outlay) which reflects the intent of GoK to invest in the capital of the investee. This, however, may not be considered as investment by the investee-company but rather as capital grant in their books. For instance, in Karnataka Housing Board and Rajeev Gandhi Rural Housing Corporation for amounts released by GoK under minor head 190 for repayment of HUDCO loans or Karnataka Police Housing Corporation for funds released by GoK for construction of residential quarters under AHS III scheme under Major Head 2055 and Minor Head 211 – in these cases the investee-companies contend that these amounts are construction grants or capital expenditure and not share capital.. These transaction are recorded in the state accounts by the AG based on the government order issued without ascertaining whether the investment has been allotted by the investee-company or not.  Investments made by GoK is parked as Advance against Equity pending allotment as the authorized capital of the investee-company is not sufficient to issue the additional share capital (for instance Karnataka Road Development Corporation Ltd., Rs. 1786 crore shown as advance against equity but authorized share capital available is for Rs. 200 crore only). 104 The quantum of differences reported by the C&AG in its Report on Public Sector Undertakings differ from the difference identified by the ALMC- this needs to be reviewed. 105 Major differences pertain to Rail Infrastructure Development Corporation (Rs. 1900 crore); Karnataka Housing Board (Rs. 1137 crore); Karnataka Power Corporation Ltd. (Rs. 680 crore); Karnataka Power Transmission Corporation Ltd. (Rs. 425 crore); Karnataka Niravari Nigama ltd. (Rs. 1087 crore); Krishna Bhagya Jala Nigam (Rs. 1053 crore); Karnataka Road Development Corporation (Rs. 2261 crore); Karnataka State Industrial Infrastructure Development Corporation (Rs. 1196 crore) | Theme Four: Improving Fiscal Assets and Liability Management System 97 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix  In some cases loans have been converted into equity but has not been considered by AG for want of GO. Eg (BMRCL)  Other reasons include non-accounting of assets due to want of budget provision and hence the contra accounting in investments yet to be done; non-accounting by AG including want of the government orders; merger of companies but GoK’s investment not reflected in the continuing entity; and investee-company under liquidation or ceased to exist 271. Identification of the reasons for the differences and the process of reconciliation is under way, yet formal adjustment or resolution is yet to be achieved – as and when the difference is identified, the DSS recommends to the Finance Department to issue a government order for corrective action which are pending issuance. In 2012, ALMC had engaged the services of consultants for reconciliation and some success was achieved. ALMC has already commenced reviewing the share capital position in the Annual Reports of the investee-institutions. 272. There are other operational issues discussed under Guarantees that are applicable to the investment portfolio - present database is maintained on spreadsheets and an application for recording and tracking investments and dividend has not been developed; ALMC or AG not in possession of some GOs authorizing the investment and ALMC is collecting these GOs from the respective investee-institution; and staffing at ALMC is an issue including their limited understanding of corporate matters and financial statements. 273. The following priorities have been identified for the 2014 PFM Reform Action Plan. a. Develop Operational Guidelines, in consultation with the AG, providing clear norms for determination, timing of accounting and reporting of investments. These guidelines, to be followed by the Administrative Departments while recommending investment proposals, should elaborate circumstances when the transaction is to be considered as investment (alternately capital grant), the prior conditions necessary for making investments (for instance, ensuring availability of sufficient authorized capital with the investee-company), issuing appropriate government orders, confirmation by the investee-institutions and reporting the transaction to the AG and ALMC. b. Identification and reconciliation of differences between state accounts and investee-company accounts should be widened and issue of necessary government orders for corrective action expedited. This exercise needs to be carried out on top priority basis. ALMC has already examined most of the cases. Reconciliation efforts, in the first instance, focus on “big ticket� items, those pertaining to recent years and those companies that declare dividends (so that there is no loss of revenue). Corrective action recommended by DSS should be expeditiously implemented. External support to supplement staff constraints within ALMC could be obtained for a short tenure for one time reconciliation. Going forward, reconciliation should be done on a concurrent basis, at least quarterly, reported to FD and action taken at the earliest possible and efforts should be made that no difference is carried forward to the next financial year/s. c. The government order authorizing the investment must be explicit as to the intent of the government – whether to invest in the entity or provide it as a grant and the correct head of account should be stated. Till such time as the share is not allotted by the investee-institution, the amount not be charged to minor head 190 as this gets reflected as investments in the state accounts. All GOs must be copied to the ALMC so as to eliminate their dependence on the investee-institution. d. Resource constraints in ALMC should be addressed through training, and appointing finance professionals: The ALMC staffing should be reviewed by the FD, which needs augmentation with finance professionals and staff from FD. The ALM cell should be led by the staff from FD and the current officers can be trained for | Theme Four: Improving Fiscal Assets and Liability Management System 98 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix carrying out their activities with more focus on fiscal and financial management of corporate form of business and also IGAS disclosure requirements. e. Develop and incorporate the investments database in KII. The Functional Requirement Specification of Khajane II recommends building capability in the application to capture all details of investments. This is a step in the right direction and should be pursued. All legacy data needs to be reconciled and incorporated in KII. In case implementation of the Asset Liability Module in Khajane II is in the distant future (more than 2 years), then an suitable application compatible to KII for recording and reporting of investments could be developed for use by the DSS (in contrast to the present system of maintaining database on spreadsheets). | Theme Four: Improving Fiscal Assets and Liability Management System 99 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 4.4 DEBT MANAGEMENT RECORDING AND REPORTING 274. Public Debt of the Government of Karnataka comprises of market borrowings, loans from financial institutions including National Bank for Agriculture and Rural Development (NABARD) and National Cooperative Development Corporation (NCDC), securities issued to the National Small Savings Fund (NSSF) collectively called Internal Debt (about 84% of total public debt), and loans from Government of India. There is no external debt. The total borrowings or public debt of GoK over the years are summarized in Table 44. Table 44: Borrowings or Public Debt of Government of Karnataka (Rs. in crore) Particulars 2012/13 2011/12 2010/11 2009/10 2008/09 Market Borrowings 63,418 54,333 48,762 45,468 39,996 Loans from GoI 11,634 10,982 10,515 9,902 9,692 Total 75052106 65315107 59277 55370 49688 Source: Statement No. 1, Finance Accounts GoK 275. Debt Strategy - the KFRA requires the state to maintain Government debt at prudent levels as recommended by the XIII CFC. GoK, therefore, manages its debt so that the outstanding liabilities (including off-budget borrowings) as the end of FY 2010/11 to 2014/15 does not exceed the specified percentage of estimated GSDP that are based on the targets fixed by the XIII CFC. GoK has maintained these levels much before the timeline fixed, as summarized in Table 47. These fiscal rules ensures ex ante fiscal discipline. Interest payment as a percentage to total revenue receipts were 8.68% in 2011/12 that is below the 15% threshold prescribed by the XIII CFC and down from 9.69% in 2010/11. GoK has not availed any Ways and Means Advances since the last few years. Table 45: Public Debt level (Total Liabilities) prescribed by KFRA compared to actual (percent of GSDP) Particulars 2014/15 2013/14 2012/13 2011/12 2010/11 Prudent Public Debt level per KFRA 25% 25.4% 25.7% 26.0% 26.2% Actual levels maintained by GoK 22.7% (RE) 22.7% 22.9% 23.6% Source: C&AG, Report on State Finances, 2012/13 and GoK, Medium Term Fiscal Plan (2014-2018) 276. Debt Contracting - raising of debt by GoK is subject to consent of the Government of India under article 293 of the Constitution. Market borrowings are raised in tranches as per requirement determined by the GoK based on cash position and funds requirements. This is done in auctions managed by the Reserve Bank of India (RBI) in accordance with a borrowing calendar. Debt contracting is centralized with the RBI or falls under pre-defined norms such as the Rural Infrastructure Development Fund Loans from NABARD. All debt is raised centrally by the Finance Department, GoK unlike the situation in 2004 – at that time “Departments may be engaged in negotiations with GoI for loans, without the knowledge of the Finance Department and loans may suddenly appear.� 106 The corresponding amounts shown in the MTFP 2014/18 are Rs. 68,698, Rs. 13131 and Rs. 82,099 crores that do not match with the figures in the Finance Accounts 107 The corresponding amounts shown in the MTFP 2013/17 are Rs. 56,853, Rs. 11,782 and Rs. 68,635 crores that do not match with the figures in the Finance Accounts | Theme Four: Improving Fiscal Assets and Liability Management System 100 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 277. Debt Management Institution - there is no formal Debt Management Office (DMO) in GoK – the maintenance of debt profile of Debt Office in GoI all loans borrowed by GoK and repayments of principal and payment of GoI has set up (Sep 2008) a Middle Office interest are done by the Computer Cell under a Special Officer (Budget) for Debt Management in Ministry of assisted by an Under Secretary and Senior Assistant. In actual practice, Finance with major focus on skill building market borrowings and NSSF loans are handled by the Fiscal Reforms and developing expertise required for a fully functional DMO and the major Cell; determination of debt timing and quantum is looked after by an function include work related to legislation Assistant Controller; while the debt data is looked after by a retired Joint of the “Public Debt Management Agency of Secretary level officer from GoK, all in the Finance Department. India� Therefore, the various debt functions are dispersed. At GoI, the debt management functions are presently performed by various agencies including the RBI and Ministry of Finance. These will be undertaken by a “Middle Office� in a phased manner to ensure a smooth transition from the existing arrangements 108. Functions of Middle Office for Debt Management, Government of India  Pilot the evolution of the legal and governance framework appropriate to an independent debt office  Formulation of a long term debt management strategy consistent with sustainability requirements  Formulation of annual debt issuance strategy and periodic calendars of borrowing  Forecasting cash and borrowing requirements  Formulation of a comprehensive risk management framework  Ensuring compliance to debt/cash management policy strategy and risk guidelines  Developing and maintaining a centralized database on Government liabilities  Dissemination of debt related information to the public – the quarterly Report on Public Debt Management 278. GoK maintains a comprehensive and complete Debt Data: Debt data is recorded on spreadsheets since 2004/05. This data covers all loans availed by GoK and provides detailed information on all aspects of the debt and is recorded based on letters and clearance memo issued by the RBI. Debt data is also maintained by the AG and reconciliation between GoK and AG is done at least bi-annually. Earlier, GoK tried to implement the Commonwealth Debt Recording System, but could not succeed to technical issues. Overall, the present debt data recording system is a significant improvement over the quality of debt data in 2004. At that time, an organized system to record these liabilities was not prevalent (e.g., the amounts borrowed, source, terms, debt-servicing dates, payments made, outstanding balances, etc.) and information on these borrowings and outstanding amounts were obtained in an ad hoc manner from the respective departments and the public sector entities. Such a system was especially necessary for cash management because the debt service payments, at that time, were large. Going forward, a debt data recording functionality as part of the Asset Liability Management Module is planned in the second phase of Khajane II. 279. Reconciliation prior to 2004/05 is under process and there are some reconciliation issues in respect of loans from NCDC, NSSF and financial institutions and loans for central plan and sponsored schemes Public Transparency – Debt Data written off on the recommendations of the 13th CFC. The differences Disclosure have increased during the period 2009/10 to 2011/12, particularly on The Government of Gujarat discloses the account of NABARD and NCDC, and are about 1% of the outstanding debt stock on the website of the Finance market borrowing. Department along with the average cost of the funds under each category (http://financedepartment.gujarat.gov.in/debt/deb t_stru.php ) 108 A Bill is proposed to be introduced to set up the Public Debt Management Agency that intends to separate the work of the RBI from the determiner of interest rate and acting as banker to GoI | Theme Four: Improving Fiscal Assets and Liability Management System 101 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 280. Public Transparency - there is a system of Debt Data reporting and Disclosure . A summary of the debt position of the state (stock and flows) is provided in the annual State Finance Accounts (Statement No. 6) including borrowing from internal debt, GoI, other obligations and debt servicing. Another statement No. 15 provides a detailed account on borrowings and other liabilities showing public debt and other interest bearing obligation during and up to the end of the reporting period, maturity profile, repayment schedule and interest rate profile. The MTFP and the Mid-Term Review Report under KFRA also provide detailed discussion on the composition of state debt. Debt data is not specifically available on the website of the Finance Department though the data can be assessed in the documents mentioned above. 281. GoK’s Debt Sustainability Analysis is based on the indicators suggested by the XIII CFC - Interest Payments to Revenue Receipts (IP/RR) and Total Liabilities to GSDP. Besides, the C&AG also conduct an annual Debt Sustainability Analysis (DSA) for the state on five indicators on a 5-year rolling period and the results are provided in the Report on State Finances. This framework is followed for each state by the C&AG. The results of the DSA for 2012/13 are given in Table 46. Both the GoK and C&AG analyses however refer to the short term debt sustainability analysis on a static basis i.e. the DSA is carried out in respect of borrowings outstanding as on a particular date. Table 46: Debt Sustainability Analysis conducted by the C & AG for GoK Parameter Results (C&AG Report on State Finances 2013) Debt Stabilization  During 2008-13 the primary revenue balance was positive and sufficient to meet interest expenditure  In 2012-13, interest and quantum spread109 were positive. Sufficiency of incremental non-debt  The resource gap was negative during 2008-10, turned positive in 2010/11 and receipts (resource gap110) once again was negative in 2011/12 as well as in 2012/13 indicating that the State had to depend on borrowed funds for meeting current revenue and capital expenditure Net availability of borrowed funds  Debt redemption ratio continued to be less than one since 2010/11 and was 0.8 (debt redemption ratio111) in 2012/13 (0.9) as debt redemption was lower than debt receipts  16% of debt receipts were available in 2012/13 for productive/capital expenditure as compared to 13% in the previous year Burden of interest payments  The ratio of interest payments to revenue was 9.5% in 2012/13, same as in (Interest Payments/Revenue Receipts) 2011/12112, that was below the limit of 15% prescribed by the 13 th CFC. Maturity profile  Around 33% of the outstanding stock of market borrowings at the end of 2012/13 belonged to a maturity bracket of 5-7 years and 46% in the maturity bracket of 7 years and above, indicating no short term redemption pressure Source: C &AG Report on State Finances 2012/13 Fiscal Sustainability Analysis by RBI (2013) 282. The RBI has conducted a study on sub-national debt  Rate of nominal growth of GDP should be more than rate sustainability 113 including an indicator led analysis of fiscal of growth of debt sustainability comprising of six parameters (see box). Based on this  Real output growth should be higher than real interest rate assessment (up to 2012/13), on two main parameters (Interest  Primary Balance should be in surplus  Primary Revenue Balance should be in surplus and Payments to revenue Receipts and Debt to GSDP ratio), RBI has adequate to meet interest payments categorized Karnataka under medium risk category. GoK should  Interest Burden defined by Interest Payments to GDP ratio examine alternate DSA models such as that of the International should decline over time Monetary Fund, which looks at both short and long term  Interest Payments as a proportion of Revenue Expenditure should decline over time  Interest Payment as a proportion of Revenue Receipts 109 Interest spread is the difference between average lending rate and average should borrowing fall over time rate. Quantum spread is the product of debt stock and interest spread 110 Resource gap is the adequacy of incremental non-debt receipts of the State to cover the incremental interest liabilities and incremental primary expenditure. Negative resource gap indicates non-sustainability of debt. 111 Debt Redemption Ratio is Principal + interest payments to total debt receipts and application of available borrowed funds 112 GoK estimates IP/RR to be 8.68% and 8,74% respectively during 2011/12 and 2012/13 (different from C&AG’s assessment), and is expected to reduce to 8.27%, as per MTFP2014/18 113 Reserve Bank of India, Sub-National Debt Sustainability: An Assessment of the State Governments, Jan 10, 2013 (www.rbi.org.in) | Theme Four: Improving Fiscal Assets and Liability Management System 102 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix impact of debt on the state finances and adopt the model with parameters that are broader than the parameters on which the current DSA is based. 283. Debt Repayment Management – GoK has commenced contribution to RBI Consolidated Fund Scheme: The X and XI Sinking Fund – Practices in other states Central Finance Commissions recommended creation of a Sinking  The state of Maharashtra created a Sinking Fund fund for amortizing open market loans. GoK created such a sinking in 1999 through a contribution of 3% of its annual fund in 1999/2000, but there had been no accretion to the fund since market borrowings. then. The C&AG, RBI and the PAC have emphasized setting up  Gujarat contributes to the CSF of the RBI for redemption of debt raised from Open Market such a fund through suitable contribution from revenues for taking Borrowings and the corpus as on March 2013 was care of the loan discharges. In FY 2014, GoK contributed Rs. 1000 Rs. 6,917 crore. crore 114 to RBI’s Consolidated Fund Scheme (CSF) being 1% of total outstanding liabilities which was transferred from the existing Fiscal Management Fund. During FY 14-15, a sum of Rs. 500 crore has been earmarked for transfer to the fund. GoK will need to make adequate contribution to build up the corpus up to 3-5% of the state liabilities. 284. The current debt management, recording and reporting practices in GoK matches well when benchmarked to good practices under PEFA. Dimension/Good Practice Current Status Scope and Frequency of Debt Data Analysis GoK monitors its debt sustainability through the two DSA for internal and external debt is undertaken annually parameters: interest payments to revenue receipts and total liabilities to GSDP which is provided in the MTFP. Debt Sustainability Analysis is undertaken annually by C&AG on five indicators over a 5-year rolling period. Quality of Debt Data Recording and Reporting Debt records are complete, updated and reconciled at least Debt records are complete, updated and reconciled on a bi-annually. Data quality is of fairly high quality though monthly basis with data considered of high integrity. some gaps and reconciliation problems are recognized. Comprehensive management and statistical reports (cover Comprehensive data on debt stocks and service are produced debt service, stock and operations) are produced at least annually and some data is also available half–yearly in mid- quarterly year review report under KFRA, and also in monthly accounts on the website of the AG Karnataka. 285. Summary of Issues - a. A dedicated Debt Management Office has presently not been formed in GoK and a second line of management is missing. A more permanent and robust debt office is needed. b. Debt data is presently maintained on spreadsheets and the risk of data completeness and integrity is higher. c. While reconciliation of debt data with AG takes place periodically, reconciliation of data prior to 2004/05 and the issues with loans from NCDC and NABARD need to be resolved. d. GoK to provide adequate budget provisions to build up a corpus fund equivalent to 3-5% of the state’s liabilities. e. Debt Sustainability Analysis methodology adopted by GoK refers only to the short term debt sustainability aspects on historical data. 286. The following priorities actions are identified for 2014 PFM Reform Action Plan in the area of debt management, recording and reporting. 114 Head of Account 2048 by plus under Plan and minus under Non Plan and has been met from the Fiscal Management Fund | Theme Four: Improving Fiscal Assets and Liability Management System 103 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix a. Set up a combined Debt and Cash Management Office within the Finance Department and depute experienced officers for dealing exclusively with debt and cash management, recording and reporting. b. A sub-module for Debt Management within the Asset Liability Module is planned under Khajane II. In case this is developed and implemented with some time lag (say more than two years), software in Oracle or similar application could be developed and debt data maintained on spread sheets can be migrated to new software (and finally e-migrated to Khajane II). c. Reconciliation issues in debt data should be resolved with the AG on priority (being 1% of the total open market debt) and debt data integrity be established in full. d. Continue budgetary contribution to the Consolidated Sinking Fund maintained by RBI to build a corpus of 3 to 5% of the state’s liabilities. e. Examine alternate DSA models such as that of the International Monetary Fund, which looks at both short and long term impact of debt on the state finances and adopt the model with parameters that are broader than the parameters on which the current DSA is based. f. Disclose debt data and DSA on the website of the Finance Department. | Theme Four: Improving Fiscal Assets and Liability Management System 104 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 4.5 LOANS AND ADVANCES 287. Significant amounts of loans and advances are extended by the GoK to state agencies including statutory corporations, government companies, cooperative institutions, urban development authorities, urban local bodies, and to government staff. The rules and regulations governing the grant of loans and advances in GoK are contained in the Karnataka Financial Code (articles 185-198 of the KFC). The salient provisions in the KFC governing Loans and Advances are briefed in the following box. Loans and Advances - Salient provisions in Karnataka Financial Code  All loans require special sanction of GoK unless covered under a general order  Loans expected to be provided during the next year including recoveries should be provided in the budget  Special rules on loans and advances (e. g. made to local bodies and cooperatives) can be made by the concerned department in their departmental manuals or standing orders  Order sanctioning a loan or advance should be in a prescribed format and each such order will specify the terms and conditions of the loan or advance  The sanctioning authority is responsible for fiduciary assurance over the end use of the loan and advance; utilization certificate (in prescribed format) to be provided by the concerned CCO/sanctioning authority to the auditors  General rules for repayment, charging of interest, default etc. have been included; GoK has the power to remit the interest due or postpone the repayment 288. Table 47 provides an institution group-wise break-up of the loans and advances made by GoK. The loans and advances portfolio of GoK shows an increasing trend over the years from Rs. 9,623 crore in 2011 to Rs. 11,198 crore in 2012 and Rs. 12,143 crore in 2013. Hence, it is imperative that this area in governed by a set of adequate, effective and continuing system of internal controls. Table 47: Institution-wise outstanding of Loans and Advances in GoK (Rs. in crore) Institution Group As on March 31, 2013 As on March 31, 2012 Statutory Corporations 4,762 3,950 Government Companies 2,877 2,803 Urban Development Authorities and Housing Boards 2,876 2,884 Cooperatives including Banks 805 715 Others 823 846 Total 12,143 11,198 289. The loan and advances portfolio in GoK is characterized by significant control weakness including record keeping and arrears in reconciliation. a. Loans and advances have not been reconciled by any of the Chief Controlling Officer (CCO). This despite specific instructions of the Finance Department to the Treasuries that non-salary bill should not be passed unless it is ensured that the process of reconciliation of loans and advances is full and complete 115. b. Loans and advances have adverse balance of Rs. 1,186 crore (as of March 2013) due to mis-classification of recoveries and poor reconciliation by the concerned CCOs 116 . The reasons for adverse balances are - non 115 Government of Karnataka, Finance Accounts 2012-13 116 ibid | Theme Four: Improving Fiscal Assets and Liability Management System 105 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix reconciliation by the departmental authorities and credits appearing in accounts without corresponding debits under the same heads. Reconciliation efforts are underway between Departmental Officers, Treasuries and ALMC c. Loans and advances are made without finalizing the terms and conditions . Out of the 58 loans for Rs. 1,270 crore sanctioned by GoK in 2012-13, loans valued at Rs.551 crore (43%) were sanctioned without specifying any terms and conditions117. This is not in conformity with the requirements of the KFC. d. Departments do not share the detailed accounts on Loans and advances with AG. The responsibility of maintaining detailed accounts of loans and advances vests with the concerned department granting the loan or advance. For loans and advances that are sanctioned by GoK, the detailed accounts are maintained by the Accountant General. Information on loans and advances in respect of which detailed accounts are maintained by the department is not furnished to the AG – such information was provided for only 22 out of 842 cases for 2012-13118. e. Further, loans and advances are made when earlier loans were in arrears 290. The ALMC is entrusted with collation of details and reconciliation of loans to 173 institutions. The methodology adopted by ALMC is to obtain details of the loans from the institution and reconcile with the Finance Accounts. As of March 2013, ALMC has achieved reconciliation only in 98 institutions with outstanding loans of Rs. 3,595 crore (30% of total portfolio outstanding). In some of these cases, though the cause of the difference has been identified, yet the rectification is yet to be finalized. Reconciliation of remaining 75 institutions is underway – aggregate outstanding involved Rs. 7,687 crore as per Finance Accounts (63% of total outstanding) – the net difference between Finance Accounts and the books of the institutions is Rs. 3,761 crore! The biggest difference is on account of Karnataka Water Supply and Drainage Board – Rs. 2,383 crore – and the power utilities, and these differences are yet to be analyzed. The concern is that there are differences in current year transactions as well. 291. A limitation that ALMC is likely to face is the lack of information on individual outstanding in the Finance Accounts from FY 2012-13 due to the revised classification and disclosure norms of IGAS 3 (see below). This would put further limitations on reconciliation and ALMC has yet to consult with the AG for providing this information outside of the Finance Accounts. For the remaining balance of Loans and Advances no specific agency has been designated for reconciliation. 292. Loans and Advances are disclosed in the Finance Accounts and an annual report of loans (and reconciliation position) is submitted to the Finance Department by ALMC. Disclosure requirements under IGAS 3 – Loans Disclosure requirements now follow the Indian Government and Advances Accounting Standard 3 (IGAS 3) effective from FY 2012-13 and  Summary by loanee group-wise and sector-wise GoK’s Finance Accounts are largely in compliance except for  Summary and detailed statements (with loanee unavailability of some information such as loans in perpetuity. names) of repayments in arrears  Major and Minor head wise details The disclosure requirements under IGAS are onerous (see  Details of loans and advances made during the year box) and GoK would need to strengthen its systems around (with name of loanee) Loans and Advances to provide full and validated  Amount of interest in arrears information for disclosure.  Loans made in perpetuity  Loanee-wise details where terms and conditions not settled  Fresh loans and advances made where there are arrears 117 ibid 118 ibid | Theme Four: Improving Fiscal Assets and Liability Management System 106 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 293. There are significant arrears in repayment of the loans and advances including some in arrears since the past several years. The annual gross repayments are equivalent of 1-2% of the outstanding. In respect of loans to institutions, Rs. 3,790 crore119 (March 2013) are in arrears and hence are stressed assets. Many of these are to institutions that are not capable of repaying these amounts on their own due to their precarious financial conditions. Such loans are carried at their historical cost and writing off has not yet been considered by GoK. A strategy to address these is yet to be formulated by GoK. 294. Summary of Issues a. Policy Issues i. There are significant arrears in repayment of the loans and advances including some in arrears since the past several years. A strategy to address these is yet to be formulated by GoK. b. Reconciliation and Reporting Issues ii. has not been done by any of the Chief Controlling Officer iii. there are adverse balances iv. Reconciliation of 75 institutions is underway - – aggregate outstanding involved Rs. 7,687 crore as per Finance Accounts and difference to be reconciled is Rs. 3,761 crore v. ALMC entrusted with reconciliation of institutions is faced with resource constrains vi. agency to reconcile advances other than to institutions has not been designated vii. adequate information on loans in respect of which detailed accounts are maintained by departments are not provided to the AG viii. need to strengthen systems to provide full and validated information to meet the disclosure requirements of IGAS 3 c. Compliance Issues i. Loans and advances are made without finalizing the terms and conditions ii. Further loans and advances are made when earlier loans were in arrears 295. Most of the above shortcomings were also highlighted in the 2004 PFMA. To strengthen the systems around its Loans and Advances portfolio, the following priority actions are suggested for the 2014 PFM Reform Action Plan. a) Strengthen and widen reconciliation of the portfolio. Constitute a dedicated team for working on the reconciliation exercise. Initially focus on the “big ticket� items starting from the later years and working backwards. To facilitate this, GoK issue GO to all CCOs maintaining detailed accounts to ensure that all information is available to the team. This is to be accorded high priority. b) Institute formal Reporting System for updating database and to meet IGAS 3 requirements to provide full and validated information for reconciliation. A standard reporting format should be developed meeting IGAS 3 requirements, and status to be submitted to ALMC say on a bi-annual basis for updating the database and reconciliation with the Finance Accounts. c) Initiate a special audit of the detailed records of Loans and Advances maintained departmentally. The objective of the audit would be to review - (a) the maintenance, completeness and adequacy of the records maintained and underlying controls; and (b) the compliance with the KFC in respect of sanction of loans and advances; and make recommendations for strengthening this area. d) Issue GO reiterating rules governing sanction and monitoring of loans and advances and ensure strict compliance particularly grant of further loans when previous are in arrears. Loans should be made only after 119 For instance, BWSSB has arrears of Rs.2710 crore including interest. | Theme Four: Improving Fiscal Assets and Liability Management System 107 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix the terms and conditions have been agreed and finalized and included in the sanction letter/GO. Cases where this is not compiled are now required to be disclosed in the Finance Accounts. e) GoK to develop a strategy to address the significant arrears in loans. This could include the methodology for conversion of loans to grant or equity. f) Resource constraints in ALMC should be addressed through training, and appointing finance professionals: The ALMC staffing should be reviewed by the FD, which needs augmentation with finance professionals and staff from FD. The ALM cell should be led by the staff from FD and the current officers can be trained for carrying out their activities with more focus on fiscal and financial management of corporate form of business and also IGAS disclosure requirements. g) Develop and incorporate the loans and advances database in KII . The Functional Requirement Specification of Khajane II recommends building capability in the application to capture all details of loans and advances. This is a step in the right direction and should be pursued. All legacy data needs to be reconciled and incorporated in KII. 4.6 MONITORING ARREARS OF PAYMENTS 296. One of the fiscal management principle envisaged in the KFRA is to “ensure discharge of current liabilities in a timely manner�. Current liabilities/ arrears are expenditure obligations under a specific legal obligation/contractual commitment that has been incurred by the government, for which services have been obtained but payment has not been made. A high level of arrears can indicate a number of different problems, such as inadequate commitment controls, cash rationing, inadequate budgeting for contracts, under-budgeting of specific items and lack of information. Internationally, arrears are defined as default in payments for goods and services beyond 30 days of passing of bills or rising of invoice by the supplier or service provider. 297. The 2004 PFMA Report assessed that unpredictability of funding and cash rationing at that time, resulted in inordinate delays, lobbying, and ineffective poor expenditures as well as a buildup in arrears. The fiscal policy framework made no mention of arrears (i.e., pending bills), apart from reporting requirements. Although departments, particularly those with high capital spending, recorded and maintained data on arrears (i.e., bills not paid), the system of recoding was weak and there was no mechanism to compile this information to report (end-year or within-year) or to monitor the total amount of arrears. 298. The 2004 Action Plan recommended to accord first claim on resources to payments of arrears under a defined hierarchy of priorities. This implied increasing control over entry of capital projects into the budget under which first priority is given to payment of arrears, maintenance second, ongoing projects third, and new initiatives fourth. In short, this meant that the first priority in determining annual expenditure allocations should be full payment of all expenditures already incurred, so that arrears do not accumulate. Reduction in the size of arrears is important for better fiscal and cash- flow management. 299. Guidelines issued by GoK for including works in the budget are not strictly followed by the departments. Instructions are provided in the budget circulars and budget manual to the effect that no works should be included in the budget unless (a) plan and estimates have been approved administratively and sanctioned technically; (b) the works are included in Appendix E; and (c) a minimum provision is proposed in the budget 120. A system of pre-scrutiny of new plan schemes is also prescribed – the heads of departments are required to send the proposals to the Secretary of the Administrative Department who will forward the proposal to the Planning and Finance Departments for approval and 120 For works estimating less than Rs. 5 crore, minimum 40% provision is mandated in year 1 and the balance in year 2. For works of higher estimates, provision of minimum 30% in year 1 and the balance in years 2 and 3 in required. | Theme Four: Improving Fiscal Assets and Liability Management System 108 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix clearance. This includes scrutiny by the Internal Financial Advisors 121 in case of departments having this position. The objective is to avoid detailed examination of the proposals / Schemes at a later date and the schemes could be implemented in the beginning of the financial year itself. Over commitment without adequate budget leads to payments arrears, which is not in line with KFRA 2002.This also exhibits internal control weakness in the system which could lead to excess payments and frauds122 300. GoK like other state governments follow the cash basis of accounting and hence outstanding payments are not disclosed in the annual accounts (i.e. Finance Accounts) and hence these are required to be compiled and consolidated separately outside of the accounting system. A consolidated statement of payment arrears, therefore, is not available in GoK. There are no payment arrears of “committed liabilities� on salaries, pension and debt servicing in Karnataka. Therefore, this section deals with arrears of payments (bills passed but not paid by the due date) arising from rendering of services or provision of goods or execution of works to the government, and in particular those pertains to the Public Works Department of GoK (PWD) besides discussing arrears on account of electricity bills payment. According to international norms, the stock of arrears should be less than 2% of the total expenditure. Payments Arrears in GoK are at a high level thus undermining the prudent financial management principles and have a contingent effect on the fiscal parameters of the state. a) Arrears data is available for PWD but it did not distinguish between current outstanding and arrears. During the past two years, PWD has reported more than Rs.1000 crore (~$200 million) of pending bills and it is expected to rise as per projections particularly under roads as according to the department the budget provision is insufficient to allow for payment for ongoing works (Table 48). The total budget under the major heads of PWD for 2013/14 is Rs. 8,174 crore (Annual Financial Statements 2013/14 ) and the arrears as a percentage of total budget is about 15% down from 24% in 2011/12 but slightly higher than 2012/13. Over commitment without adequate budget leads to arrears which is in contravention of the KFRA 2002. It is also understood that there are arrears in expenditure bill payments in the several public sector enterprises (Nigams) under the Irrigation departments, for ~Rs.650 crore. A strategy for clearance of arrears is presently not visible. b) PWD is also one of the departments that requires significant supplementary provisions, about 40% of original budget estimates during 2010/11 and 2011/12 and 80% during 2012/13 although actual expenditure falls short of the aggregate of original and supplementary estimates. It is noted that many supplementary provisions are made for “payment of pending bills� that shows the ad hoc nature of the estimation process. For instance, a provision of Rs. 700 crore was proposed in the Third Supplementary Estimates for 2012/13. As on March 2014, the total awarded cost of contracts in PWD is Rs.14,283 crore, out of which value of work done is Rs. 5,453 crore, and payment which is in arrears is Rs.1208 crore. An amount of Rs. 8,830 crore of works is expected to be completed and paid in the next two years. It would be prudent that MTEF is introduced in PWD and a proper scheduling of works is carried out to work out the budget requirements. Table 48: Arrear of Expenditure Bills in Public Works Department, Karnataka (Rs. in crore) As at the close Amount of Arrears Outstanding of Plan Non Plan Total Total Total As percent of As percent of Arrears Budget Expenditure Outlay Actual Outlay Expenditure 31-Mar-12 1486.4 6151 5116 24% 29% 31-Mar-13 852.54 191.89 1044.4 7677 6562 14% 16% 121 In some departments IFA role is limited to administrative work, which affects their effectiveness of acting as advisors and providing the right financial perspective to the departments. 122 Refer Report No. - 2 of 2014 Government of Karnataka - Report of the Comptroller and Auditor General of India on Economic Sector- Issues in civil works carried out in Magadi Taluk | Theme Four: Improving Fiscal Assets and Liability Management System 109 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 31-Oct-13 1033.99 186.92 1220.9 8174 15% Source: Public Works Department, Government of Karnataka and Karnataka Appropriation Accounts c) Besides the arrears in PWD, there are also arrears on account of electricity dues of the urban and rural local bodies for which funds have to be provided in the budget of GoK. For urban local bodies, the estimated amount of electricity dues is Rs. 500 crore while for the rural local bodies’ electricity dues is Rs.3300 crore. Provision is made each year in the state budget for clearance of these dues. In 2013/14, a provision of Rs. 135 crore was made, but Rs. 100 crore was reverted at the time of full budget presentation in July 2013. GoK has constituted a committee to study the issues of electricity dues by Panchayats and also determine the exact dues. In 2012/13, non-plan untied grant under State Finance Commission recommendation for the fourth quarter was not released. 301. Disclosure of arrears is neither made in any government document nor available in public domain 123 . Maharashtra has a system of disclosing outstanding liabilities in its statement under FRBM (see Box). 302. Due to the system of accounting followed, payment arrears are not captured in expenditure and remains outside the system The Maharashtra Fiscal Responsibility and unless paid. As at the close of October 2013, the estimated Revenue Budgetary Management Act 2005 124 Surplus of GoK was Rs. 1,692 crore and arrears of PWD itself An Annual Statement of Miscellaneous Liabilities Outstanding is disclosed in the budget documents (Rs. 1221 crore) are 72% of the surplus. Full provision for in respect of major works, contracts and supplies payment arrears if made could adversely affect the fiscal (presently for each contract of over Rs. 1 crore) indicators of GoK. One of the reasons for this situation is and arrears of grants payable to various institutions commencement of new capital works (including those cleared by etc. This is being done on an annual basis in March the state Cabinet) without ensuring adequate funding provisions or providing details as of the close of the previous completion of works already underway. year. 303. The current system of control over payment arrears in GoK and the estimated stock of arrears when benchmarked to good practices under PEFA indicate that substantial efforts are needed to remedy the situation. Dimension/Good Practice Current Status Stock of expenditure payment arrears (as a percentage of The stock of payment arrears in PWD is about 15% of the actual total expenditure for the corresponding fiscal year) budgeted expenditure of PWD (FY 2013/14) but has shown a and any recent change in the stock. decline over the previous years. There are other payment The stock of arrears is low (i.e. is below 2% of total arrears but quantification is not available. expenditure Availability of data for monitoring the stock of Reliable and complete data, generated through routine expenditure payment arrears. procedures, may be available on an individual and standalone Reliable and complete data on the stock of arrears is basis for some departments. The data available does not generated through routine procedures at least at the end of distinguish between current outstanding and arrears and does each fiscal year (and includes an age profile) not provide an age profile. 304. Summary of Issues a. Guidelines issued by GoK for including works in the budget are not strictly followed by the departments. b. Data on arrears is presently available on standalone basis and is neither compiled nor consolidated. c. Currently there is no visible strategy for clearance of payment arrears – significant supplementary estimates are made for “payment of bills� 123 Appendix 10 of the Finance Accounts provides a Statement of Commitments on Incomplete Public Works Contracts including “Pendi ng Payments�. It is, however, not clear if the “Pending Payments� are current or arrears and besides this appendix does not provide “Pending Payments� for other than incomplete works. 124 Accountant General Karnataka, Monthly Fiscal Indicators, Monthly Accounts at a Glance, October 2013 (http://agkar.cag.gov.in) | Theme Four: Improving Fiscal Assets and Liability Management System 110 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix d. Payment arrear data is not in public domain e. Piling of such liabilities by PWD is an issue which leads to draining of the budget provision for payments of old liabilities and in effect could prevent new works to be taken. This needs to be brought in line with requirements of KFRA 2002. 305. The following priority actions are identified for the PFM Reform Action Plan that could address the issue of payment arrears over the medium term. However, the most crucial aspect is that the guidelines in the budget circular for estimating the works and paying arrears need to be strictly followed. a. Recognize the existence of these financial liabilities. A formal and clear definition of payment arrears is required (this was also a recommendation in the 2004 PFMA). b. Institute a periodic reporting system. Institute a system of recording and consolidation of expenditure payments outstanding across all departments and para-statals, distinguishing between current outstanding and arrears. This is fundamental as existence and completeness of data on arrears, is essential not only to recognize the arrears but also to develop a strategy so that new arrears do not accumulate. c. Develop a strategy for clearance of arrears as on a cut-off date. While liquidation of historical arrears may not be immediate, GoK has to (a) determine strategy to clear payment arrears by setting a time table, and (b) make adequate budgetary provision. d. Improve transparency. Disclose expenditure payments outstanding in the mid-year report and budget documents. 4.7 UNENCASHED CHEQUES 306. Cheques issued by the Treasury but remaining unpaid are “Unencashed Cheques� and specific treatment is prescribed for their cancellation in case the cheques remain unpaid for over 1 year from issue. Cheques are issued by the Treasuries based on the bills rendered by the Drawing and Disbursing Officers. The relevant expenditure/advance head is debited and Public Account Head 8670 is credited 125 reflecting the liability of the state, and the balance under 8670 is shown separately in the State’s Finance Accounts (Statement No. 18). The Karnataka Financial Code (KFC) prescribes (Rule 75) that cheques that remain unpaid (or unencashed) for a period of 12 months or more from the date of issue should be destroyed or cancelled by the DDO and the Treasury should be informed to stop payment (such cheques are termed time-barred). The Treasury is required to prepare an annual list of all such cheques (by May 15th of next year) and submit an Alteration Memoranda to the AG for adjustments (by June 1st of the next year) and to the concerned DDO. After making the entries, the AG is required to inform the Treasury along with transfer entry numbers date. 307. The 2004 PFMA reported that reliable information on the amount of unencashed cheques was not available (at that time) as the bank accounts were not reconciled regularly. There were major unreconciled amounts in GoK’s bank balances specifically relating to unencashed cheques - both in the Treasuries and the departments under Letter of Credit mechanism. The accounting system did not provide basic information required for cash management viz., the government’s bank balance and amount of unencashed cheques and the cash position of the state were incomplete from the state’s perspective, since it excluded unencashed cheques. The report recommended including unencashed cheques as part of cash balances, and not in the Public Account.. 125 The standard accounting process is as follows: The amount of cheques issued against bills are shown under the head 8670 – Cheques and Bills and included in the List of Payments. Subsequently, the Treasury Officer obtains the Schedule of Paid Cheques from the bank and sends it to the AG and the amount of paid cheques is shown under head 8675 – Reserve Bank Deposits by contra credit to head 8670 and the balance in head 8670 represents unpaid or unencashed cheques. | Theme Four: Improving Fiscal Assets and Liability Management System 111 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 308. The specified procedure appears not to be working effectively as the quantum of unencashed cheques is showing an increasing trend over the years. The outstanding as at March 2013 is at a level of Rs. 6,820 crore compared to Rs. 1,120 crore in 2001/02, (see Table 49Error! Reference source not found.). The level of unencashed cheques is showing a continuous increase over the years. While some increase could be attributed to increase in overall quantum of transactions handled by the Treasuries, but a 6-fold increase needs to be viewed seriously. The AG (A&E) has estimated that the State Huzur Treasury itself accounts for unencashed cheques of Rs. 1759 crore from 2003-04126. Table 49: Unencashed cheques under major head 8670 (Rs. in crore) As of March 31 2013 2012 2011 2010 2009 Amount of Unencashed Cheques 6820 6785 4195 4520 3972 Source: C&AG Finance Accounts 309. Time barred cheques include items such as recoveries from contractors, subsidy payments including cases where names do not match and judiciary cheques that are valid only for three weeks. The accumulation of such cheques adversely impacts the adequacy of internal controls and could be an indicator of frauds. Beneficiaries may be deprived of subsidies or cheques could be issued deliberately to show better budgetary performance, Moreover, the balance of unencashed cheques is shown in the Public Account and hence not considered in the cash position of the state. 310. The following issues emerge that needs to be addressed to strengthen the PFM in this area. - a. Treasuries are not strictly following the prescribed procedure The KFC details the procedure for identification, reporting and adjustment of cheques issued but remaining unpaid for over 12 months - Alteration Memos are either not prepared or the process is delayed and regular follow up is not done. Year-wise break up is also not available. There are also instances where Alteration Memos were prepared and submitted to the AG, the clearance by the AG took an inordinately long time (5-6 years). Moreover, the current timeline of annual reporting of unencashed cheques over 1 year appears too long. b. Unencashed cheques also pose issues in respect of accounting. When these cheques over 1 year are cancelled in later years, expenditure of previous year/s need to be reversed in the year when the cheque is cancelled that may distort the expenditure/receipt of the current year if the quantum is high. There is some ambiguity as to which head of account should be affected. 311. The head 8670 – Cheques and Bills is an intermediary accounting device for initial record of transactions which eventually has to be cleared/withdrawn and accumulation of balance is not to be allowed. The priorities identified for 2014 PFM Reform Action Plan are two-fold – (a) to identify the time-barred cheques under 8670 and reduce the present accumulated balance by making necessary accounting reversal; and (b) to strengthen the process of identification, reporting and cancellation of unencashed cheques to avoid the past situation. The AG has already taken up this matter on its priority agenda and following up on a monthly basis127. With introduction of KII and payment through e-transfers, these issues are expected to be addressed automatically. In the interim the following actions are suggested. a. Clear the backlog of unpaid cheques. In respect of the outstanding in head 8670 on a cut-off date, carry out a one-time special exercise so that cheques remaining unpaid for over a year from the date of their issue are identified by the Treasuries, their non-payment is confirmed by the respective DDOs and lists of such cheques are sent to the AG for issue of Alteration Memos. 126 AG (A &E), Report on the Annual Inspection of Treasuries, 2011/12 127 The Central Treasury section in the office of the AG is calling for monthly lists of cheques issued and cheques encashed in for further analysis to identify unencashed cheques. | Theme Four: Improving Fiscal Assets and Liability Management System 112 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix b. Initiate a special study to identify the underpinning causes for accumulation of unencashed cheques. This will help in formulating a strategy for both clearing of backlog and to avoid its recurrence. For this study, retired officers from AG or Karnataka Institute of Public Auditors (KIPA) or FD could be availed. c. Reiterate instructions to all Treasuries and DDOs forthwith to follow the procedure prescribed in the KFC . This is important so that reporting of unencashed cheques is current and efforts should be made to reverse such cheques within the FY. Develop a process for compilation and collation of unencashed cheques (cheque-wise and year-wise), reporting to the Treasury and then liaisoning with AG for issue of Alteration Memos on a priority basis. The AG is strengthening its internal procedures and is gearing up to receive list of unencashed cheques over 1 year and issue of Alteration Memos at any time and not wait after the close of the FY – the AG has also instituted a system of reporting on Alteration Memos received and disposed of. On the other hand, the Treasuries should report such cheques to the AG for cancellation say at least once every quarter and not wait till the close of the FY. d. Reduce the periodicity of cancellation of unencashed cheques from the present 12 months to 3 months – this would require amendment to the KFC. The GoI and some state governments such as West Bengal and New Delhi already follow the procedure of cancellation of cheques six months after the month of its issue. In fact, the Treasury Rules, 2005 of West Bengal requires writing back of all cheques remaining unpaid as on June 30 th of the next year and the corresponding date in UP is April 30. Since treasury cheques are valid for three months succeeding the months of issue, GoK can adopt this period for identifying unencashed cheques and reversing them in the accounts. In case the beneficiary approaches GoK, a new cheque can be issued under the same budget head. e. Monthly reporting of lapsed cheque to AG: Currently the treasuries report to the AG once in a year after the FY closure which does not help in passing the reversal entries within the FY. All treasuries should report to AG every month the list of lapsed cheques so that AG can advise on the accounting treatment to be followed in such cases. f. Finalize the accounting treatment post reversal of the unpaid cheques in consultation with the AG particularly for those items reversed in subsequent FY. The options available are either to reflect the amount under a specific income head (such as 2075) or to reduce it from the current year expenditure. | Theme Four: Improving Fiscal Assets and Liability Management System 113 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Section 5. THEME FIVE: STRENGTHENING AUDIT AND LEGISLATIVE OVERSIGHT 5.1 EFFECTIVENESS OF INTERNAL AUDIT 312. Internal audit is intended to examine and evaluate the level of compliance with the rules and procedures so as to provide a reasonable assurance on the adequacy of the internal control (C&AG). An effective internal audit system, both in the manual as well as computerized environment, is a pre-requisite for the efficient functioning of any Department The objective of an internal audit function is to have a deterrent and reforming effect in the direction of prevention of mistakes and to play a corrective role by pointing out mistakes and ensuring remedies without loss of time. 313. The 2004 PFMA concluded that practically there was no internal audit system in GoK barring internal audit wings (IAW) in some revenue earning departments. The function existing at that point in time was limited in terms of coverage and follow up of audit findings and absence in the major spending departments. The situation is summarized below. a. Major revenue-earning departments had IAWs, though Stamps and Registration was an important exception. There is no formal system of internal audit in all the other departments including major spending ones. b. Internal audit focused on transactions and compliance, but a systematic review of the adequacy of control systems, nor identifying systemic improvements was absent. c. Follow-up of internal audit findings was inadequate. d. The external auditor covered some aspects that would normally have been part of an internal audit, e.g., detailed transaction audits, and reporting of compliance with the various rules. 314. The 2004 Action Plan recommended introducing a small, focused internal audit function to improve the effectiveness of the system focusing on identifying systemic improvements, and reporting on implementation of these systemic improvements. It recommended that internal audit function should contract with and draw extensively on expertise from professional accounting and management firms (e.g., chartered accountants, cost accountants, management consultants). 315. GoK has not travelled far in strengthening the internal audit arrangements in government and no significant reform interventions have been made in this vital function . Internal audit guidelines were last issued in 1992 prescribing an annual audit, units to be audited at least once in two years and the report to be submitted within two months of completed audit. The C&AG has reported non-existence of IAWs in departments and identified serious shortcomings in the function in departments having established an IAW, (as briefed in Annex 9.1). C&AG has observed non-functional IAWs, shortage of audit staff strength, inadequate coverage of auditee-units, absence of internal audit manual and lack of follow up of audit reports. In conclusion, internal audit function is not effective in GoK. 316. The Commercial Tax Department (CTD) of GoK has established audit and review mechanisms as proxy to internal audit. These include risk based e-Comprehensive Audit System, analytics based system of comparative analysis of dealers, and a Peer review system besides having an Internal Audit cell. These are briefed in the box below. The department proposes to further strengthen the systems through IT including random selection of 10% cases for audit and concentrating more on the quality and correctness of orders. While it may be argued that these are not internal audit systems under the traditional definition, yet for a revenue department, such audit and review systems (in particular IT based taking advantage of the repository of digital data available) are more efficient and effective than the archaic transactional audit procedures. The lesson learned is that within the overall audit methodology, internal audit procedures should be attuned to the nature of business of each department to achieve optimum benefit. | Theme Five: Strengthening Audit and Legislative Oversight 114 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Audit and Review Mechanisms in Commercial Tax Department, GoK  E-Comprehensive Audit System: a pre-defined risk assessment criteria1 is applied electronically to the entire population of assesses out of which cases meeting the risk criteria are thrown up by the system. These cases are reviewed by the officers and a sub-set is identified for audit, approved by the Commissioner through “Assignment Notes�. For instance, in 2012/13 from a total of 5 lakh assesses, the system highlighted ~80,000 cases that met a t least one of the risk parameters, and post review about 36,900 cases were assigned by the Commissioner for detailed scrutiny.  Comparative Analysis of Dealers: The CTD systems have a separate module that does an analytical analysis (data mining) based on 4 parameters on a two year comparison – output tax payable, input tax earned, tax payable and tax actually paid and other parameters such as non-filers, return filed but tax not paid, carried forward of tax etc.  Peer Review: Order of an officer is directed to another officer of same cadre (this is system generated). The peer reviewer looks for apparent errors in the assessment and reports to the Joint Commissioner in case errors are identified; else the file is returned to the originating officer. The entire system is digital  Sou Moto Reassessments: done at the level of Asst. Commissioner and Jt. Commissioner which are referred to the Commissioner for final approval.  Compulsory Audit: Each assesse with an annual turnover of Rs. 10 crore and above are required to get the books of account audited by Chartered Accountants. The report is submitted in prescribed format and is uploaded online.  Internal Audit Cell: CTD established an internal audit cell in 2010/11 under a Deputy Commissioner (Internal Audit) supported by 2 Commercial Tax Officers and about 55 officers. The emphasis of internal audit is to review the correctness of orders issued in respect of mistakes apparent on record or sou moto revisions.  Others: Other mechanisms include a Vigilance Cell under a Joint Commissioner, Mobile Squads and Enforcement Wing under an Additional Commissioner 1 This is a set of 9 criteria taking into account items various parameters and the criteria is decided by the Assistant Commissioner (Inspection and Control) on a year to year basis. | Theme Five: Strengthening Audit and Legislative Oversight 115 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 317. At the central level, the Internal Audit function is decentralized at the ministry/department under supervision of Uttarakhand Internal Audit Strategy Internal audit wing has been setup under the the Comptroller General of Accounts while majority of the Finance Department. Director audit heads the wing states prefer a centralized structure. The practices at the central and is a senior officer from the government level and in some states are discussed in annexure 11.2: government/deputed from AG (Audit). All Internal Audit Practices in Government of India and State government agencies are covered under internal Government in this report. Whatever the structure assumed, the audit. ABC risk categorization determines common thread is that the function needs to have a centralized frequency of audit. Category A- annual audit; Category B – once in two years and Category C- command to guidance and monitoring. While Internal Audit once in 3 years. An audit plan is prepared each mechanism is being strengthened across the states, the audit year and approved by the government. A Manual methodology is still largely transactional and compliance-based, of Internal Audit has been prepared and with risk based or system audit being done only sparingly. A few implemented. states such as Bihar and Chhattisgarh have embarked upon reforming their internal audit strategies with support from the World Bank. Uttarakhand has enacted Uttarakhand Audit Act, 2012 and the Development of Internal Audit Strategy responsibility of Internal Audit is placed upon a Director – Audit Chhattisgarh: Development of an overall strategy is in process for the internal audit function (currently on deputation from C&AG) under the Finance Department including i) setting up of an internal audit unit supported by state staff. within the Finance department, ii) train a core team for undertaking internal audits on a pilot basis 318. Considering the state of the function, the overall conclusion including risk based audits and, iii) prepare an is that there is no effective internal audit function in GoK. Internal Audit Manual and train its staff to handle Departments having established IAWs are short of staff resulting in the internal audit function. inadequate coverage in terms of scope and numbers and compliance Bihar: A roadmap to modernize and strengthen to audit reports is also not adequate, and internal audit is usually Internal Audit function in government through a strategic plan has been developed. The strategy and conducted after the close of the financial year. Such internal audit the audit manual is now being field tested along arrangements are not commensurate to the risk and the nature of with transfer of skills to the core staff. business carried out by these entities. There are major revenue- earning and spending departments that have not instated a mechanism of internal audit. Effectiveness of Internal audit function is assessed in terms of the following parameters. The status in GoK mapped to these parameters is briefed in Table 50. It is well recognized that regular and adequate feedback to management is required on the performance of the internal control systems, through an internal audit function that meet international standards. Table 50: Effectiveness of Internal Audit Parameter for assessing effectiveness of Internal Status in GoK Audit Appropriate structure particularly with regard to There is no central guideline for setting-up an IAW. The IAWs, professional independence wherever established, is located within the department and functionally reporting to the head of the department that does not provide sufficient independence. There is no central oversight of the function. Sufficient breadth of mandate, access to information There are no formal written guidelines as to the scope of audit or the and power to report powers and responsibilities of the function and functionaries. The function is fragmented and not under a central umbrella. Use of professional audit methods, including risk Internal audit is largely transactional and use of professional audit assessment techniques methods or risk based audits is virtually non-existent. Some headway has been in the CTD. There is no focus on high risk areas and reporting on significant systemic issues. Mechanism for action by management on the C&AG has observed that the mechanism for follow up on internal internal audit findings audit findings is inadequate and needs considerable strengthening. | Theme Five: Strengthening Audit and Legislative Oversight 116 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 319. Benchmarking the current internal audit function in GoK with the good practices in PEFA indicates that the current Internal Audit system in GoK needs to broaden its scope and modernize its audit methodologies to enhance its effectiveness and efficiency. Dimension/Good Practice Current Status Coverage and quality of the internal audit function The function is operational in only few government Internal audit is operational for all government entities, and entities, does not undertake systems review and would not generally meet professional standards. It is focused on systemic meet recognized professional standards issues (at least 50% of staff time) Frequency and distribution of reports Reports are either non-existent or very irregular and not Reports adhere to a fixed schedule and are distributed to the submitted to the Finance Department or the C&AG audited entity, ministry of finance and the SAI Extent of management response to internal audit findings Internal audit recommendations are usually not followed Action by management on internal audit findings is prompt and up effectively and timely comprehensive across central government entities 320. Based on the above discussion, the following actions, if implemented are expected to strengthen the Internal Audit function in the state and are suggested for inclusion in the 2014 PFM Reform Action Plan. a. Conduct a situational analysis of current internal audit arrangements in GoK departments to study the existing organizational structure, the skills and capacity of existing staff, and current audit methodologies and procedures. This inventorying will help in a SWOT analysis which can then feed into the internal audit strategy. This study should also document the “proxy� internal audit mechanisms in the departments and dovetailed with the core function and also study the systems on other jurisdictions. b. Develop risk based strategy for implementing internal audit function in the state. The strategy will suggest the institutional model for Internal Audit – centralized or departmental; staffing; implementation strategy; audit committees; capacity enhancement; internal audit approach, methodologies and procedures including reporting; liaison with external auditors etc. for maximum effectiveness and efficiency of the function. c. Carry out ABC categorization of the departments based on budget spent, revenue earned, and the risk perception based on earlier AG audit reports and start the IA in gradual manner targeting the larger departments d. Develop and implement Internal Audit Manual at the state level with sub-manuals for specific revenue and spending departments. | Theme Five: Strengthening Audit and Legislative Oversight 117 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 5.2 EXTERNAL AUDITING - RESPONSIVENESS 321. The external independent auditor of the State Government is the Comptroller & Auditor General of India (C&AG, India’s Supreme Audit Institution), through its field Role of C&AG in regard to audit office in Karnataka (the Principal Auditor General or PAG)128; this The C&AG is the sole authority prescribed in the Constitution entrusted with the responsibility of is similar to the arrangement in all states. The CAG’s functions audit of accounts of the Union and the States. It is and powers are derived from the Constitution of India and the duty of the C&AG to audit receipts and specified in a national audit act - the C&AG’s (Duties, Powers and expenditure of the Union and each State/Union Conditions of Service) Act, 1971 129 . The Constitution of India Territory. The audit reports of the C&AG are (Articles 148 to 151) guarantees C&AG’s independence from the placed before Parliament or the Legislature of the executive - the C&AG is appointed by the President of India.; on a State/Union Territory. The duties of the C&AG also fixed non-renewable tenure of six years; the C&AG can be extend to audit of Government companies and corporations and bodies and authorities in removed from office only by the Parliament by a process of accordance with the laws made by the legislature impeachment; and C&AG’s budget is “charged� and not voted by and rules made there-under. Source: Regulations on the Parliament130. The C&AG, however, does not have the power Audit and Account, 2007 or authority to prosecute. 322. The C&AG primarily conducts three types of Reports of the C&AG audits – Financial, Compliance and Performance and can  Report on State Finances: Review of annual also conduct Special audits. Its audit processes are guided by Finance Accounts and Appropriation Accounts and Auditing Standards (2002) based on The International compliance with legislations and financial rules  Report on Revenue Sector: Audit of the revenue Organisation of Supreme Audit Institutions (INTOSAI) departments and receipts standards. These are supplemented by the Regulations on  Report on Economic Sector: Audit of departments Audit and Accounts, 2007, Internal Controls Evaluation under the Economic Services category Manual, Financial Attest Audit Manual and Information  Report on Social and General Sector: Audit of Technology Audit Manual supplemented by several departments under the Social and General Services guidelines/guidance notes and practice guides. The C&AG sectors submits six types of audit reports that are tabled in the  Report on Public Sector Enterprises: Audit of Legislature (see box) public sector undertakings  Report on Local Bodies: Audit of urban and rural local bodies 323. The 2004 PFMA expressed concern over lack of responsiveness to external audit reports and identified it as the single biggest problem affecting the impact of the audit. The track record had been poor and responses to audit observations and reports were negligible. The report further identified that since the government’s response was not provided for most audit observations, its position on these observations was largely unknown. Equally important, action was not taken on systemic issues arising out of the audit observations. 324. There are clear and well-defined rules and processes for responding to and follow up on audit reports. These are described in Hand Book of Instructions for the Speedy Settlement of audit Observations, Inspection Reports, Speedy Disposal of Audit Paragraphs. The various stages when the departments get the opportunity to respond to the audit observations and the status and adequacy of follow up is discussed in this section followed by a discussion on the audit database Audit Monitoring System. 128 The C&AG has 136 offices all over the country and a staff of 46000 129 The Act lays down the service conditions to secure the autonomous nature of the C&AG and also gives him a wide mandate and puts almost every spending, revenue collecting or aid/grant receiving unit of the Government under his audit domain. 130 The C&AG’s budget was Rs. 2804 crore during 2013/14 | Theme Five: Strengthening Audit and Legislative Oversight 118 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Stage 1-Half Margin Reports: During the course of audit, the local audit party issues “half -margin� audit observations that provide the first opportunity to the auditee-unit to provide clarifications. An exit conference is usually held with the head of office to explain and validate the audit observations and also to seek responses. Stage 2- Inspection Report: Audit observations not cleared or responded during the course of audit are then reported in Inspection Reports (IR) that pertains to each individual auditee-unit. The IRs are copied to the head of office of the concerned auditee-unit and to the next higher authority. Initial or first reply on the rectification of the defects and compliance is to be submitted within one month to the PAG and final action taken within three months. The PAG keeps track of the follow up of the inspection reports. Table 51 provides the status of pending IRs in the revenue sector. Table 51: Status of Compliance of Inspection Reports – Revenue Sector Particulars As of June (for reports issued up to As per 2004 December of previous year) PFMA as of June 2013 2012 2011 2010 2002 Number of outstanding IRs (no.) 3363 3115 3738 3554 8079 Number of outstanding audit observations (no.) 7283 6668 7610 7106 3693 Amount involved (Rs. in crore) 1,550 1,589 2,205 1,701 First reply not provided (no.) 86 73 25 Source: C&AG Report on Revenue Receipts/Revenue Sector Stage 3: Proposed Draft Audit Paras: Audit observations of a serious nature deserving to be included in the main audit report of the C&AG and results of the Performance Audits are shared with the Principal Secretaries of concerned departments and the Head of Departments, copied to the Finance Secretary. Reply to these Draft Audit Paras is to be provided within six weeks of receipt. Table 52 provides a bird’s eye view of the status of reply to the Draft Audit Paras by the auditee. As of October 2002, responses for 44 of the 52 paras (85%) included in the Civil Audit Report for 2000-01 had not been provided (2004 PFMA) Table 52: Status of reply to Draft Audit Paras Particulars Revenue Sector Social Sector Economic Sector 2012/13 2011/12 2012/13 2011/12 2012/13 2011/12 Draft audit paras shared 36 25 24 15 14 11 Reply provided 11 21 5 6 5 7 Reply not provided 25 (69%) 4 (16%) 19 (79%) 9 (60%) 9 (64%) 4 (36%) Source: Reports of the C&AG Stage 4: Action Taken Notes: The Reports of the C&AG are tabled in the Legislature and another opportunity is available to take action to comply with the audit observation. The departments are required to prepare and submit to Karnataka Legislative Assembly Secretariat their Action Taken Reports or Departmental Notes (detailed replies) on audit paras within 4 months from tabling the audit reports in the Legislature (and before they are taken up by the Legislative committees for examination). Prior to submission of these ATNs, these are required to be vetted by the PAG. Table 53 briefs the status of submission of ATNs (pending) after the reports of the C&AG are tabled in the Legislature. Table 53: Status of pending Action Taken Reports Particulars Revenue Sector Social Sector Economic Sector 2012/13 2011/12 2012/13 2011/12 2012/13 2011/12 No. of paras 126 105 51 45 24 18 No. of departments 11 9 15 21 6 4 | Theme Five: Strengthening Audit and Legislative Oversight 119 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Period/s involved 1992/93 1992/93 1995/96 1995-96 2001/02 2002/03 to 2011/12 to 2010/11 to 2011/12 to 2010-11 to 2011/12 to 2010/11 Source: Reports of the C&AG 325. Besides the above, there are other mechanisms available to provide compliance and settle the audit observations.  There is a mechanism of constitution of an “Ad Hoc Committee� in each of the major departments was introduced in 1968 comprising of the Secretary, Administrative Department, Head of Department, Budget Officer Finance Department (or any other representative) and Deput y Accountant General from PAG’s office. The objective is to expedite clearance of audit observations in the IRs with at least one meeting every quarter. The PAG forwards a half yearly report of pending IRs to the Secretary of the Department to facilitate monitoring of the audit observations. Although Ad Hoc Committees have been formed, they are not proactive and their meetings are irregular (see Table 54). Table 54: Status of Meetings of Audit Ad Hoc Committees Particulars Commercial Taxes Geology and Land Revenue Transport Mines 2012/13 2010/11 2012/13 2010/11 2011/12 2010/11 No. of Meetings 3 3 1 4 1 2 Paras settled 38 277 162 9 46 Source: Reports of the C&AG  One of the roles of the Internal Financial Advisor (IFA) is to monitor follow-up and compliance on the C&AG audit reports. For this purpose, the IFAs maintain a manual Watch Register. The IFA circulates the audit paras to the respective sections through the HoD, consolidates the compliance/action taken and after obtaining approval of the Secretary, forwards the compliance to the AG. The IFAs however do not use the AMS for data updation nor use the reports from the application. Moreover, the IFAs do not follow up on Inspection Reports. 326. Significant pendency in recovery of accepted cases of Revenue leakage reported by the C&AG is another area of concern. For instance, Table 55 provides the status of recovery of revenue leakage reported by the C&AG in the revenue sector in GoK – the recovery percentage is quite low and hence the amounts pending recovery is quite huge. Table 55: Pendency of Revenue leakage reported by C&AG in Commercial Tax Department Particulars as of Sep 2013 as of Sep 2012 No. Amount No. Amount (Rs. in crore) (Rs. in crore) Period of pendency 2007/08 to 2011/12 2006/07 to 2010/11 Total cases reported by C&AG 50,671 4,887.00 43526 1,708.00 Accepted by the Department 25036 1,870.00 23148 600.00 Recovered 2381 39.00 2331 33.00 %age recovered of accepted cases 9.5% 2.1% 10.1% 5.5% Source: C&AG, Report on Revenue Sector 327. The Controller (Accounts Management) under the Finance Department has created, in July 2005) a database of Central Audit Report Management Systems audit and inspection reports and response of the departments. Karnataka is perhaps the first state to have an online The database captures the information as given below. The audit report management system. Other states that application has drill-down capability – so one can see the reports have recently implemented similar systems are year-wise and department-wise. This is an extremely useful Rajasthan and Odisha (Odisha Central Audit application for monitoring and also improves transparency as the Management Portal) database reports are available in public domain. The following | Theme Five: Strengthening Audit and Legislative Oversight 120 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix reports are available from this application -  Audit Objections/Observations in Inspection Reports  Draft Audit Paragraphs/Reviews Proposed for inclusion in the C&AGs Audit Report (Civil, Commercial, Revenue Receipts, ZP)  Departmental Notes to Paragraphs/ Reviews included in the C&AGs Audit Report (Civil, Commercial, Revenue Receipts, ZP)  Departmental Notes to Excess over voted grants/charged appropriations requiring regularization  Action Taken Notes to PAC/CoPU Reports 328. Data in AMS, however, is not complete and updated and analysis done based on this data may not provide the correct picture. A review of the AMS data indicates that although information on audit para has been filled up to 2011/12 or 12th Assembly, yet data on paras cleared may not be up to date. For instance, in case of Action Taken Reports, the AMS (accessed on May 2, 2014) shows that all paras pertaining to reports issued by the PAC and the CoPU of the 10 th, 11th and 12th Assembly (and also 4th Assembly) are pending. In case of Departmental Notes pending to C&AG audit paras, the data in AMS indicates pendency of 60%, 42% and 66%, respectively for 2011/12, 2010/11 and 2009/10. While the quantitative data is there, the qualitative aspects are not captured by the system. The AMS currently does not have a system to classify the observations into various types so that systemic and recurrent issues can be identified and addressed by the GoK. AMS only captures the audit reports issued by the C&AG while reports for ULBs and PRIs are issued by KSAD which is not recorded or monitored in any system. Even KSAD do not have a database on the pending audit paras and compliance received from the field. AMS should have a separate module for tracing KSAD audit reports also. 329. Despite the above, the AMS is a strong tool as it captures the full observation itself although it does not capture the action taken. The AMS can be further upgraded to capture the nature of the observation so that a classified list of audit observations are available that could provide insight into the most significant areas of weakness or systemic issues. 330. Based on available data, although efforts have been made but it appears that not much headway has been achieved in enhancing responsiveness to audit and improvement in compliance or follow-up with audit observations. In terms of evidence of follow up on audit observations, the status in GoK when benchmarked against good practices under PEFA indicates need for improvement. Dimension/Good Practice Current Status Evidence of follow up on audit recommendations. A clear and comprehensive system of follow up on There is clear evidence of effective and timely follow up audit observations exists. A formal response is made often delayed and compliance is not effective. 331. The following actions are suggested for the 2014 PFM Reform Action Plan. a) At the outset GoK needs to re-iterate the seriousness of compliance with audit paras and prescribe action against those who fail to take action to recover loss/outstanding demand in a time bound manner. The nature of recourse to be taken by GoK for non-compliance should be pre-determined in consultation with the AG. b) At the first stage, the role of the IFA vis-a-vis follow up of audit reports needs to be clarified and enhanced. Training should be provided to the IFAs in the process of follow up and also in the use of AMS. They should also be entrusted the responsibility of monitoring the follow up of Inspection Reports. c) At the second stage, strengthen the institution of Ad Hoc Committees. GoK to ensure that Ad hoc Committee Meetings are convened periodically for effective and expeditious settlement of outstanding paragraphs. The minutes of the meetings should be posted on the website of the concerned department. GoK may consider adding functionality in AMS to capture the meetings held and the minutes. | Theme Five: Strengthening Audit and Legislative Oversight 121 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix d) Constitute a state-level Apex Audit Committee to oversee the status of compliance and also the working of the Ad Hoc Committee. The apex committee could have the Chief Secretary as the Chairperson, the Secretary of the Finance Department as the convener with representations from the office of the AG and some external professionals such as the Finance Controllers of large SOEs and well-known Chartered Accountants from the state. e) The C&AG has recommend that GoK takes measures to ensure expeditious recovery of revenue at least in respect of the cases that have been accepted by the Departments. This is a good suggestion and proposed for inclusion in the Action Plan. Considering the amounts involved, the concerned departments should develop a plan including deploying special manpower to recover amounts that they have accepted are recoverable. f) GoK should make data updating (both audit observations and clearance) in AMS compulsory and the Controller (Accounts Management) should monitor this on a more frequent basis. Enhance the functionality of AMS by including other aspects such as meetings of the Ad Hoc Committees and integrate the digital database of the Karnataka Legislative Assembly Secretariat with AMS to avoid duplication. g) Systemic issues need to be captured in AMS. The AMS can be further upgraded to capture the nature of the observation so that a classified list of audit observations are available that could provide insight into the most significant areas of weakness or systemic issues. h) KSAD Reports to be captured in AMS: AMS should have a separate module to monitor the KSAD audit reports and the level of compliance made by the departments in respect of this report. Going forward this would be important as KSAD would be submitting a consolidated report on ULBs and PRIs to the Legislature. i) Linking AMS to KII: The AMS is being developed as a module under the KII – Audit compliance management module. The above recommendations on the software having feature for classification needs to be incorporated in KII. 5.3 STRENGTHENING KARNATAKA STATE ACCOUNTS & AUDIT DEPARTMENT (KSAD) 332. KSAD is a key pillar of PFM of GoK: KSAD is one of the key departments of GoK which supports both accounting and auditing functions131 for GoK. KSAD functions under the direct control of the Finance Department and is headed by a Controller who is a senior KSAS staff. The sanctioned staff strength of KSAD is 4326. Nearly 84% (3687 staff) of the staff are on deputation to various departments for carrying out accounting function while 16% (639 staff) of the staff are carrying out the audit function. 333. Accounting functions in the state is supported by 3687 KSAD staff 132 : KSAD provides majority of the accounting and finance workforce who carry out accounting function of the state. KSAD deputes its officers to work as financial advisors, chief accounts officers and accountants in various Government Departments, Boards, City Corporations and other Institutions. The key roles of these officials are to assist in preparation of budget, maintenance and compilation of accounts, conduct internal audit and to provide opinion on financial matters as Financial Advisors. The accounting functions of officers/staff of KSAD who are deputed to Government departments and quasi government institutions are detailed in GO issued in 1961133. Only 9% of the staffs are in the cadre of IFA or chief accounts officers which have advisory function to the departments, while other staffs are in the level of audit officer/accounts superintendent which are support function to the departments. With the evolving changes in the PFM environment like PPP, double entry accounting, introduction of IT 131 KSAD also functions as the treasurer for 309 charitable endowments. KSAD is the authorized agency for calculating and approving the pensionary benefits to the municipal employees. 132 45% of the staff are deputed to PRIs, 38% are deputed to PWD, and about 17% are deputed to other organizations. 133 Order no: FD 142 PSA 61 dt: 27th Nov 1961 | Theme Five: Strengthening Audit and Legislative Oversight 122 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix systems, and increasing needs from the organizations/departments, the functions and the expected outputs from these staff are increasing which needs to be addressed. 334. Statutory auditor for 6637 auditee institutions carried out by 639 staff: KSAD is the local audit office for all key offices and organizations (which are not audited by the C&AG). The Controller, KSAD is designated by the provisions of various Acts or by Government Orders as the auditor of accounts of local bodies like Urban Local Bodies, Gram Panchayats, as well as Universities, Muzrai Institutions, Urban Development Authorities and other specified autonomous Boards and Authorities. The audit of the entities is carried out through the 29 Local Audit Circles (LAC) at the District level. These LACs audit Local Bodies and other entities within its division. In case of City corporations and Universities, Chief Auditors are attached to the City Corporations and Audit officers are attached to various Universities to conduct concurrent/post audit of the respective Institutions. Every year they have to cover all the auditee institutions, but due to limited staff all audits don’t get completed on time. There is a disproportionate allocation and deployment of staff for accounting and auditing functions. 335. In keeping with the evolution of government systems over the years and expanding PFM requirements, KSAD responsibilities have increased too. GoK and KSAD have recognized the challenges due to changes and have been working on strengthening the department. As part of the ongoing reforms the following actions have been taken: 336. New vision for KSAD: KSAD should strive to be a model department in providing timely and efficient services of accounting, auditing, and IFA Function supporting public financial management in the state . The new vision envisages KSAD to have an enhanced role in the areas of accounting, auditing, providing services of IFA, new roles for providing services of PFM specialist to FD and act as internal auditors in PFM Audit entities where KSAD is not the statutory auditor. While Function Function the KSAD currently provides the accounting and auditing function, there is a lot of scope for KSAD improvement to address the challenges faced in these areas. Currently KSAD contributes to the IFA function134 to a limited extent as only 3 IFAs of the GoK are provided by KSAD. KSAD is required to identify staff and develop talent through training and capacity Internal Accounts building so that in future all IFA staff could be provided Audit Function by KSAD. Similarly KSAD is required to identify staff and develop their talent to carry out the function of PFM practitioners who can work in the Finance department. These two areas are immediate requirements of GoK and needs to be addressed by KSAD at the earliest. The role of internal audit for the government is still evolving. KSAD is ideally suited to take on this role in those cases where it is not the statutory auditor. As the internal audit function evolves in GoK, KSAD needs to develop capacity and support this function. (Also refer internal audit section) Table 56: KSAD strengths and weakness Areas of Support Strengths Limitations Way forward Accounting Services More than 80% staff provides Staff has very limited exposure to Staff identified for accounts accounting services. Staff double entry basis of accounting cadre should be provided 134 Only three departments namely RDPR, PWD, and WRD have IFA from KSAD while others are employed from the secretarial services. Refer to IFA note | Theme Five: Strengthening Audit and Legislative Oversight 123 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Areas of Support Strengths Limitations Way forward are generally well versed in as well as computerized intensive training on double government accounting accounting system which is now entry accounting aspects along followed in ULBs, PRIs and with operation of government companies. computerized accounting Most staff are placed in same software. sector/organization which does Staff should be rotated to not help in broad basing their support them in broad basing knowledge their skill sets. Auditing Services Staff are well versed with Staff has no exposure to double Train auditors for carrying out manual auditing currently entry accounting or carry audit audit through the system carried out through system, while most of Training auditors on double their clients have moved to double entry accounting aspects along entry computerized accounting with operation of system. computerized accounting Inadequate staff and increasing software. number of auditee leading to To reduce arrears, in the short piling up of arrears term do outsourcing of audit and in the long term look at compulsory rotation of staff from accounts to audit, co- sourcing and risk based audit. IFA Services Currently only three staff Identify staff and develop provided from KSAD talent through training and capacity building so that in future all IFA staff could be provided by KSAD. IFA rules to be changed to ensure that IFA can be sourced only from KSAD. PFM Services This is a new line of service to be supported by KSAD. KSAD is required to discuss with FD, identify staff and develop their talent to carry out the function of PFM practitioners who can work in the Finance department. Internal audit This is a new line of service to services be supported by KSAD. KSAD should create a separate set of staff for carrying out internal audit. Depending on the governments model of internal audit KSAD should develop the staffing plan and support this function. 337. New Cadre & Recruitment (C&R) rules issued135: KSAD has introduced a new C&R Rules effective from 2011 which covers both the qualifications needed and the training which should be completed by the staff for promotions. The C&R has prescribed commerce graduate with computer training as minimum qualification for recruitment for cadres starting 135 GoK has also issued State training policy 2011 and computer literacy rules 2012 which mandates staff to attain computer literacy. | Theme Five: Strengthening Audit and Legislative Oversight 124 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix from Accounts Assistant, while for promotion, completion of training on accounts and computers is mandatory. At the cadre level of assistant controller and accounts officer 50% of the staff will be hired through direct recruitment and another 50% will be hired through promotions. The percentage of direct recruitment is higher in the lower cadre levels. While this is a step in the right direction, the government needs to develop a training strategy and plan for the new staff. 338. Training for KSAD officers: GoK has developed a detailed training plan for KSAD officers in the areas of accounting, auditing and financial management, and as a part of this plan has identified institutes like Institute for Financial Management and Research (IFMR), Institute of Public Enterprise (IPE), National Institute of Financial Management (NIFM), and CAG for training the staff. The state has developed a detailed curriculum of training with these institutions and has signed MOU for conducting these training programs. These trainings would cover a wide range of financial management subjects helping KSAD staff to understand and appreciate the PFM environment and linkages in a holistic manner. 339. IDF assistance to KSAD: An IDF grant has been provided to GoK to strengthen KSAD. The objectives of this IDF to strengthen the accounting and auditing services of the KSAD so that it evolves into an effective service department in providing efficient and timely accounting and auditing services. The IDF is supposed to develop deliverables like a) audit manual; b) HR manual; and c) provide training and handholding to KSAD staff. While this activity is delayed and still on going, GoK needs to ensure that these studies are completed and adopted by them. 340. Challenges before KSAD: Even though KSAD has carried out some reforms in the last decade the organization strength, and capability of resources have not kept pace with the changes. In this context, following are some challenges faced by the KSAD: Capacity issues: a. GPs & ULBs have switched over to the Double Entry computerized System of accounting. Having traditionally worked in cash based single entry system of accounting, the KSAD’s staff faces serious capacity constraints while taking up either preparation of accounts or auditing of accounts prepared on double entry accrual accounting basis. b. Further, increasingly the governments as well as local bodies are moving towards computerized maintenance of their accounts in which KSAD needs to develop its capabilities to account as well as audit using computers. There is an increasing need for qualified finance managers both the state level and at department level which has to be provided by SAD. c. KSAD has been traditionally carrying out transaction and compliance audit and has not carried out financial attest audit due to nature of accounts and statements which were prepared by entities before. However now ULBs and GPs are producing financial statements and KSAD has not been able to carry out financial attest audit function for these entities. The financial attest function is carried out by CA firm, and this audit report is not used by KSAD. Audit issues: d. KSAD does not have an enabling audit act which provides them with powers and responsibilities. KSAD derives it powers to audit from various statutes and the aspects of responsibility of the auditee both in terms of producing the records and compliance required to address the audit issues. Also there is no penalty for non-compliance for the audit findings. KSAD initiated formulating such an Act in 2002 but it was not taken forward. e. KSAD is following the Mysore Local Fund Audit Manual 1959 and Official Memorandum No. CSA 6 CIR 76 dated 4th April 1977. Even though KSAD has prepared a revised manual in 2000 it was not approved. f. KSAD audit methodology of carrying out 100% audit of all transactions coupled with manual audit and limited staff capacity contributes to backlog of audit. Such traditional practices are not considered good practices for an auditing agency and they need to move to new audit methodologies. g. KSAD is required to place before the Legislature every year a consolidated report on the ULBs and PRIs in a time bound manner, however this is delayed due to non-production of records and completion of audit on a timely basis. | Theme Five: Strengthening Audit and Legislative Oversight 125 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix h. One area of concern is the delay in completion of audit and pending audits. As on 31-03-2014 the pending audit periods are 2167 audits (refer Table 57). This backlog needs to be viewed seriously with the closure of FY 13-14 the pendency of audits would increase. Concerns about quality of audit, as well as poor compliance by organizations to audit observations/findings need to be addressed. Table 57: Status of outstanding audits as on 31.03.2014 Not audited Not audited Number of Number of audit Name of the Total Audit Due to Non Due to Sl. No institutions reports to be institutions entities completed production of shortage of not audited completed reasons staff 1 Gram Panchayats 5630 5168 462 220 242 1319 Urban Local 2 220 200 20 0 20 68 Bodies 3 Universities 24 13 11 5 6 30 4 Other Institutions 765 429 336 0 336 750 Total 6639 5810 829 225 604 2167 Staffing and other issues: i. There has been a massive increase in the scale, as well as variety of schemes being implemented by the local bodies in recent years. New entities are being brought under the purview of SAD audit over time without corresponding increase in KSAD staffing therefore leading to backlog of accounts and audit. Also skewed allocation of persons between accounting and auditing function is affecting the efficiency of department in providing timely audit services. j. Currently IT infrastructure available in KSAD and the LAC offices is very minimal. The department as of now does not even have a repository of all audit reports issued in soft form nor any database is available for this purpose. 341. The following priorities have been identified for 2014 PFM Reform Action Plan: Capacity building on accounting and PFM:  Training for staff on commercial accounting : Specialized training for accounting staff on deputation is required in the areas of accrual based system of accounts, financial management and analysis, computerized accounting, and public financial management so as to equip them to handle the challenges faced in the changing PFM environment. The current training program envisaged by the GoK needs to be continued. Refresher and advanced accounting and financial management training needs to be provided to the staff on regular basis.  Identify train and groom core group of staff for IFAs and PFM profile: KSAD in discussion with FD, should identify core group of staff who could be trained and groomed for the post of IFA in departments and PFM staff to work with the FD. The identified staff should be provided specific training on financial management and PFM depending on the roles envisaged for them. Enablers for improving audit efficiency  Enact KSAD Audit Act to provide a legal status to KSAD: GoK can consider framing an audit act for KSAD on the lines of act issued by other state like Uttarakhand, Kerala, AP and Odisha and can frame rules and manuals to support the act. Such an act would provide mandate, independence and powers to KSAD to carry out audit as well as the follow up on compliance. In this regard GoK should also revisit the provision of payment of fees for carrying out audit which is currently on the lower side. | Theme Five: Strengthening Audit and Legislative Oversight 126 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix  Develop and implement a comprehensive audit manual: KSAD should develop an audit manual covering all the entities for which audit are carried out by KSAD. The audit manual should have the audit policies, audit procedures, a sample audit plan, operation area wise risk perception and the extent of checking to be carried out by the auditor, detailed audit checklist, audit reporting format and formats for tracking audit compliance. The manual should be developed and piloted in one or two LAC and the rolled out across the department.  Enhancing audit capacity and capability through training: KSAD needs to provide continuous training on audit methodologies and techniques to staff. KSAD has identified a core curriculum of training and has also identified CAG office as one of the trainers for audit. Institute of Chartered Accountants of India (ICAI) can be enrolled as another trainer to provide training on a regular basis to the staff. Apart from audit, staff need to be trained in the following areas: (a) sector wise trainings for audit entities covered by KSAD, (b) audit report writing and presentation, (c) financial statement attest audit, (d) auditing through computer records, (e) training on CAAT and (f) audit of double entry based accounting records. Going forward KSAD can design an audit certification course for their staff in consultation with CAG and ICAI.  Centralized Audit monitoring cell to improve compliance: A centralized audit monitoring cell is to be created at the central level. This would help KSAD in audit planning, monitoring, as well as ensuring quality assurance of reports issued and improving efficiency of reporting. 136 IT Interventions to support faster and efficient audit  Implement Audit management software to increase efficiency: KSAD should consider implementing audit management software which would help them from audit planning up to audit report preparation and follow up. The software would help KSAD in carrying out risk assessment and preparing a risk based audit plan. Based on the plan, the audit can be carried out and the software would support KSAD in both resource scheduling and tracking the progress of work in terms of time and resources spent. The application would facilitate filing of working papers electronically and would be useful for report generation. This would help KSAD to have a uniform and structured reporting and have a database of all reports issued which would help in analyzing and tracking the reports for compliance. The reports and working papers would be available for audit in the subsequent year.  IT infrastructure to improve efficiency: KSAD should engage an IT consultant to work out the IT infrastructure to address the immediate needs so that the current functions could be done faster and better in an IT environment as well as work on the medium term needs for implementing audit management software. Introduce new audit practices  Risk based audit: Risk based audit needs to be introduced by KSAD at the transaction level. Currently KSAD is Risk Based Audit : ULB carrying out 100% audit of all transactions. KSAD needs to For ULB, more efforts should be focused on identify the key business processes for each type of audit checking revenue collection, and remittance of entities, and then determine the risks and the systems control such collections into the Bank, and can limit checking of salaries and other benefits which are available in these areas. Based on the risk perception the being handled by HRMS. transactions sample would be determined which would be audited and based on the results of audit, KSAD would 136 GoK has sanctioned posts and budget for creation of this cell during this FY. | Theme Five: Strengthening Audit and Legislative Oversight 127 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix decide on whether to expand the testing further or not. For carrying out such audits clear procedures and guidelines need to be laid down in the audit manual. The risk parameters and sample size can be set in the audit manual initially for first two years and going forward it can be calibrated by KSAD based on field experience.  Encourage co-sourcing137: Co-sourcing means KSAD would appoint a CA firm and share with them the audit methodology Supplementary Audit: CAG and the required reporting requirements, based on which the For Government companies CAG appoints the auditor from an empaneled list of CA firm. These CA firm would provide the inputs to KSAD. Then KSAD can firms carry out the audit in accordance with ICAI use the CA audit reports, and if required KSAD can carry out standards and submit the report to the CAG. CAG supplementary audit 138 , and then issue a combined report. on perusal of the report either decides to carry out Under this system the final report will be issued by KSAD by the supplementary audit or accepts the audit using the work of the CA firm. At the entity level KSAD can report in total. CAG then issues the categorize the risk ratings for the type of auditee entities. The supplementary report to the audit entities. risk can be assessed based on the budget handled, transactions carried out, audit arrears, seriousness of the previous audit observations, and inherent risks of such organizations. Once the risk is assessed KSAD can decide if some of the entities ULB Audits: Issue of Duplication ULB audits are being carried out both by CA firms can be audited through co-sourcing. Also in future, KSAD (financial attestation audit) and KSAD (transaction can empanel the CA firms, who can work under their audit). The CA firms financial attest report is not supervision and guidance and produce reports are required used by KSAD. KSAD carries out transaction audit by KSAD which can be used by them for issuing a and provides a separate audit report which is then combined report. In case of ULB, this practice is followed to consolidated and presented to the legislature. Going limited extent. While CA firms have been appointed to carry forward, it would be ideal that KSAD issues one out financial statements audit, KSAD carries out its own audit report for the ULB covering both the transaction audit and financial audit reports (using transaction audit and issues a separate report. This could be reports given by CA firms) an ideal case for pilot testing.  Carry out ULB and GPs audit through computer: ULBs and GPs139 have implemented computerized accounting system and are generating books of account from the software. Going forward manual records in these entities would be withdrawn and only computerized accounts would be available. KSAD should use the accounting software and start auditing these entities. As a first step KSAD should be trained on this software’s by the respective departments and then KSAD can do pilot audits of some of the good districts for the FY 13-14. Based on the results of the pilot this exercise can be rolled out to all the entities. From FY 14-15 all entities books and records should be audited through the computer 140.  Carry out Financial Attest Audit: Financial141 (Attest) Audit means expressing an audit opinion on a set of financial statements. It includes a. examination and evaluation of financial records and expression of opinions on financial statements; b. Audit of financial systems and transactions including an evaluation of compliance with only those applicable statutes and regulations which affect the accuracy and completeness of accounting records; and 137 Uttarakhand Act provides provision for state government to conduct audit through outsourced agency 138 If the CA report is unqualified or does not indicate major issues, KSAD at its discretion can accept the report and may not carry out supplementary audit. However if on the perusal of the audit report, KSAD opines to carry out additional testing then they can carry out a supplementary audit. 139 ULBs and GPs represent 88% of the auditee covered by KSAD.ULBs have implemented e-gov financials while GPs have implemented Panchatantra accounting software. 140 KSAD has already started working on this action plan. 141 Source CAG Financial attest audit manual | Theme Five: Strengthening Audit and Legislative Oversight 128 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix c. Audit of internal control and evaluation of adequacy of internal audit functions that assist in safeguarding assets and resources and assure the accuracy and completeness of accounting records. KSAD in the short term can carry out financial attest audit using co-sourcing model and in the next 3-4 years should develop its capability to carry out financial attest audit. For that staff with adequate knowledge of commercial accounting needs to be identified and trained to carry out his function. Staffing and other interventions  One time reduction of audit arrears: KSAD audit arrears as on date is more than 2000 audit reports. KSAD should analyze the reasons for these arrears into two major areas (a) where accounts have not been submitted; and (b) where accounts have been submitted but audit has not been completed. In the first case, KSAD needs to submit the list of defaulting entities to the administrative departments and agree on a time frame by which the accounts would be completed. In terms of arrears of audit, KSAD should constitute special teams to complete the audit back log and also hire CA firms to carry out audit on their behalf to reduce this backlog within the next two financial years.  Increase cadre strength: KSAD should rework the cadre strength based on the current workload of audits and the expected new services to be provided by them to GoK. KSAD should carry out an extensive HR and skills mapping exercise and prepare a revised organization structure along with the required staff numbers to carry out the accounts and audit function both timely and efficiently. KSAD can also create policies on rotations and compulsory working of staff in the audit wing to broad base their knowledge and capabilities. 5.4 LEGISLATIVE REVIEW – EXTERNAL AUDIT 342. GoK has established a system of Legislative oversight over external audit reports through three Committees of the State Legislature. These are the Committee on Public Accounts (CoPA), Committee on Public Undertakings (CoPU also called the Public Accounts Committee or PAC) and Committee on Local Bodies and Panchayati Raj Institutions (CoLP), each comprising of 20 members of the State Legislature. Each committee is constituted for a year and no Minister can become a member of any of these committees. The CoPA and CoPU each are supported by two officials of the Indian Accounts and Audit Services. In examining the reports, regular technical assistance is available from the State Accountant General. 343. The mandate and functioning of these committees are defined in the Karnataka Budget Manual and the business rules of the State Legislature (summarized in Table 58). While the budget manual describes the roles and process to be followed for these committees, the Karnataka Rules of Procedures and Conduct of Business in the Legislative Assembly (amended April 2011) define their constitution, term, quorum and functions. The work of each of these committees is mutually exclusive. The reports of the C&AG and the Karnataka State Accounts Department (KSAD) 142 once tabled in the State Legislature are referred to one of the above committees based on their mandate. These committees examine the external audit reports and seek response from responsible parties about the findings of the examination. The committee may also recommend actions and sanctions to be implemented by the executive, in addition to adopting the recommendations made by the external auditors. 142 KSAD has the mandate to audit Gram Panchayats, the third tier of rural local bodies while the C&AG conducts the audit of Zilla Panchayats and Taluk Panchayats | Theme Five: Strengthening Audit and Legislative Oversight 129 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Table 58: Mandate of Legislative Committees for review of external audit reports Committees143 Roles Committee on Public Accounts – Examination of: PAC (Rules 264 to 266):  State’s Finance and Appropriation Accounts and other accounts laid before the assembly  Accounts of state corporations and autonomous/semi-autonomous bodies and the reports of the C&AG  Expenditure spent in excess of the amounts granted by the Assembly and making recommendations Committee on Public Undertakings – Examination of: CoPU (Rules 270-271)  Reports and accounts of public undertakings specified in Schedule III of the Rules  Reports of the C&AG of public undertakings  In the context of autonomy and efficiency of public undertakings, whether their affairs are managed in accordance with sound business principles and prudent commercial practices Committee on Local Bodies and Examination of Panchayat Raj Institutions – CoLP  Finance and Appropriation Accounts and other accounts laid before the (Rule 266A) assembly for the expenditure of local bodies and PRIs  Reports of the C&AG (pertaining to local bodies)  Whether the local bodies and PRIs are performing their duties in accordance with the law bearing in mind the autonomy of these institutions Source: Compiled from the Karnataka Budget Manual and Rules and Procedures and Conduct of Business in Karnataka Legislative Assembly, 2011 Note: The CoPU and the CoLP do not have the mandate to examine and investigate matters of major government policy, day to day administration and in respect of which provision is made in any special statute. Detailed discussions on the working of the Legislative committees are provided in Annex 11.3. 344. The Committees undertake regular hearings for examination of the C & AG audit reports and action taken notes submitted by the departments (see Annex 11.3). They have the power to make criticism or offer suggestions and recommendations. The reports prepared by the committees are required to be presented before the Legislature and copied to Administrative Department, the AG, Finance Secretary and the C&AG. Similarly, the action taken by the departments are sent to the Legislature Department, AG and the Finance Secretary. The Committee can also send advance recommendations for immediate implementation. 345. In 2004, the biggest factors affecting the impact of the Legislative review were delays by departments in providing to the PAC their responses to the audit reports and retroactive approval of expenditure that exceeded approved appropriation. Action Taken Reports on the PAC’s observations were usually delayed, sometimes for years and this still remains an area of concern despite clear and detailed rules and deadlines for follow up to address the outstanding paras. 346. The 2004 PFMA recommended measures to be taken to improve the effectiveness of the Legislative committees and GoK has progressed well in implementing many of these measures. Besides, the GoK also constituted a separate Legislative Committee for Local Bodies and Panchayati Raj Institutions in 2010.  The most significant achievement since 2004 has been regularization of expenditure in excess of Legislative approval that had been pending since 1989-90. The issue of requesting retroactive approval of expenditures 143 Clause 65 of the Manual defines the “Public Accounts Committee� or “Committee on Public Accounts� as a Committee of the Legislature constituted for the purpose of scrutinizing the Finance Accounts, the Appropriation Accounts and the Audit Reports thereon and such other accounts laid before the Assembly as the Committee may think fit. There is no equivalent definition for COPU. | Theme Five: Strengthening Audit and Legislative Oversight 130 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix that exceeded approved appropriations has been addressed by the PAC regularizing excess expenditure aggregating Rs. 9575 crore up to year 2010-11 (Rs. 4782 crore regularized by January 2011 and Rs. 4793 crore by February 2013). The C&AG reported no expenditure in excess of Legislative approval for 2011-12 and only Rs. 494 crore for 2012-13, pending regularization indicating that budgetary provision had been made for all expenditure.  The CoPA and CoPU have adopted the approach of taking up the latest reports first and simultaneously clearing the backlog of the department taken up for hearings. Moreover, the selection of audit paras for hearing is now done on the basis of materiality and risk and the seriousness and financial impact of the matter observed. There is, therefore, more emphasis on taking up contemporary and relevant issues.  Data in respect of total recommendations issued by the CoPA and CoPU (but not the CoLB) and the action taken by the departments are now captured on the online “Audit Monitoring System� – however the data is not regularly updated. Other recommendations like increasing tenure of PAC members and opening up of PAC hearings to the public are yet to be implemented. 347. While the provisions in Karnataka in respect of the Legislative Committees are elaborate and GoK has taken measures to improve the effectiveness of the committees and casting more responsibility on the departments, yet there remain some areas of concern. a) In spite of continuous follow up from Finance Department and instructions in the Budget Manual (clause 301), the number of unsettled audit observations continue to be on the increase and the Legislative Committees have taken serious note of this situation.  In the first instance, the Administrative Departments are required to submit explanatory notes, on the corrective or remedial action taken on the C &AG observations, within 3 months of the report being placed in the Legislature. As of December 2013, in case of CoPU four departments had yet to submit explanatory notes for 6 out of 39 paragraphs/reviews pertaining to the years 2009-10 to 2011-12.  In the next stage, compliance to Action Taken Notes/Reports with recommendations from the CoPA/CoPU is to be furnished within six months of the report being placed in the Legislature. As of December 2013, in case of CoPU 5 reports between Dec 2011 and Nov 2013 had yet to be complied. The CoPU reports that as of July 2013, 430 Departmental Notes were pending (since 1995-96) in respect of civil reports and 131 in case of revenue (since 1992-93).The procedure for action to be taken on the reports of the CoPA and CoPU is provided in one paragraph in a Handbook issued by the GoK (hosted on the AMS website) 144 . These instructions neither provide timelines nor the consequences of non-compliance. b) The workload of CoPA has increased as the single audit report has now been segregated into three reports. From the financial year 2011, the single Civil Report (audit report on government departments) has been segregated into three reports namely Civil, Economic Sector and General & Social Sector and this has increased the number of reports to be reviewed by the CoPA (on the other hand, the CoPU and the CoLB have too review only one report per year). Presently (May 2013), there are 45 paras on which the COPA has not received departmental notes (termed as “external arrears�) and in respect of 161 paras, the PAC itself has not yet considered the departmental notes submitted (termed as “internal arrears�). It is felt that staffing is presently not commensurate with the increased 144 Hand Book of Instructions for the Speedy Settlement of audit Observations, Inspection Reports, Speedy Disposal of Audit Paragraphs and Timely Action on Matters pertaining to the Public Accounts Committee and Committee on Public Undertaking | Theme Five: Strengthening Audit and Legislative Oversight 131 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix number of audit reports and roles for the CoPA resulting in increasing internal arrears. The CoPA in particular needs additional human resources to cope with the increased workload and to clear the backlog. c) The online “Audit Monitoring System� (AMS) managed by the Controller (Accounts Management), Finance Department (http://ams.kar.nic.in) captures data in respect of total Action Taken Reports pending in respect of reports of the CoPA and CoPU (and not the CoLB). The data in the online database is outdated and no change in status has been recorded since May 2013 (when this study commenced). The data updated for CoPA and CoPU is up to the 12th Assembly145 and only for number of paras issued by the CoPA and CoPU. The CoPA also maintains its own standalone computerized database. d) Other issues include – (a) the current procedures do not mandate any timeline for review of the audit reports by the committees; (b) The Action Taken Reports are not placed in public domain; (c) the Finance Department is required to bring up-to-date an Epitome of the reports of the CoPA at intervals ordinarily of five years (clause 343), but this has yet to be implemented. 348. GoK’s current system for Legislative scrutiny of external audit reports, as described above, assessed against the best practices under PEFA indicates scope for improvement. Dimensions/Good Practice Current Status Timeliness of examination of audit reports by the Examination of audit reports by the Legislative committees Legislature usually takes more than 12 months to complete Scrutiny of audit reports is usually completed by the Legislature within 3 months from receipt of the reports Extent of hearings on key findings undertaken by the In-depth hearings on key findings take place with responsible Legislature officers from the audited entities, and covers many of the In-depth hearings on key findings take place consistently entities (those selected by the CoPU with responsible officers from all or most audited entities, which receive a qualified or adverse audit opinion Issuance of recommended actions by the Legislature and The Legislative Committees issue recommendations on the implementation by the executive audit observations to the Executive which are generally The Legislature usually issues recommendations on action to implemented according to available evidence, though the be implemented by the executive, and evidence exists that implementation could be delayed they are generally implemented. 349. The following priorities have been identified for the 2014 PFM Reform Action Plan to improve the efficiency and effectiveness of the Legislative committees a. The procedure for speedy reply to the reports of the Legislative committee should be strengthened prescribing strict timelines and action for delayed or non-compliance. The Handbook should be further strengthened in this area. Since the CoLB is now fully functional, all documents should also include the CoLB. The role of the IFA to strengthen this area and as a focal point for coordinating audit compliance and response to the Legislative committees could be increased (the role of the IFA has been discussed in section 1.4). b. Increase the technical human resources at the disposal of CoPA. This will enable timely examination of a larger number of reports and Action Taken Reports submitted by the departments with the target of completing the Legislative scrutiny within 12 months from tabling the audit reports in the Legislature. The resources provided could be variable in tenure – short term to cope with increased workload when the audit reports are typically available in December-January each year and longer term for clearing of backlog. c. The database in the Audit Monitoring System needs to be updated. The data on reports issued by the Legislative Committees and the action taken submitted by the departments should be concurrently updated on the Audit 145 Subsequent to elections held in Karnataka in May 2013, the current Assembly is the 14th Assembly | Theme Five: Strengthening Audit and Legislative Oversight 132 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Monitoring System. The data of the CoLB too should be uploaded on the Audit Monitoring System. The application used by the CoPA to maintain its own database could be integrated with the AMS. d. The General Rules and Procedures and Internal Rules of the CoPA are under review and revision by the Rules Committee to strengthen the Legislative committees. This should be pursued and expedited to improve the efficiency of these committees. e. Place the Action Taken Reports in public domain after they are laid before the State Legislature. Reports of the PAC in Andhra Pradesh are placed on the website of the Legislature146 f. An epitome of the recommendations of the Legislative committees should be published say once in 3 years. An epitome is brought out by the Government of Odisha on the reports of the state’s CoPA and also by the Government of India. 146 http://www.aplegislature.org/legislativeassembly-committees-publicaccounts1 | Theme Five: Strengthening Audit and Legislative Oversight 133 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Section 6. THEME SIX: IMPROVING PFM IN LOCAL SELF GOVERNMENTS 6.1 LOCAL SELF GOVERNMENTS - OVERVIEW 350. Local Self Governments play an important part in the State PFM environment as they handle funds up to 42% of net own revenue receipts of the GoK besides taxes and fee that they levy. Local Self Governments (LSG) are constitutional bodies formed under their respective legislation. These entities have their own legal existence, have their own Acts and Rules, have their own policy making process and are distinct from the state government and are often referred to as the third tier of government. The executive functions of these Local governments are normally carried out by State officials. In Karnataka there are two major types of LSGs – Urban Local Bodies (ULBs) 147 and Rural Local Bodies referred to collectively as Panchayati Raj Institutions148 (PRI). 351. Karnataka has 219 ULBs. These comprise of eight City Corporations (CCs) for the state’s largest cities, 44 City Municipal Councils, 94 Town Municipal Councils, 68 Town Panchayats for smaller towns and 5 Notified Area Centers. Unlike PRIs, ULBs are not hierarchical in nature and each ULB is independent of the other. The CCs are governed by the Karnataka Municipal Corporations Act, 1976 (KMC Act) and the other ULBs are governed by the Karnataka Municipalities Act, 1964 (KM Act). Each ULB has a Council that is comprised of the ULB’s own public (elected) representatives. The Council is the policy-making and oversight body of the ULB. The executive officer of each ULB is a Commissioner or Chief Officer appointed by GoK. The executive reports to the Council and to the State Government. The PFM requirements are covered by the KMC Act and KM Act. ULBs report administratively to the Directorate of Municipal Administration (DMA) under the Department of Urban Development. 352. Karnataka established a three-tier Panchayati Raj Institutions (PRIs) system These comprise of 30 Zilla Panchayats (ZP) at District level, 176 Taluk Panchayats (TP) at Block level and 5630 Gram Panchayats (GP) at Village level in a hierarchical order with representation of the lower PRI in the body of the next higher PRI. The PRIs are governed by the Karnataka Panchayati Raj Act, 1993 (KPR Act). Each PRI has an elected body and headed by a person nominated as “Adhayaksha�, supported by standing committees. These committees are the policy-making and oversight bodies of the PRI. All PRIs have executive officers from GoK - ZP has a Chief Executive Officer assisted by a Chief Planning Officer, Deputy Secretary and Chief Accounts Officer; TPs have an Executive Officer supported by accounts officer; while GPs have a Panchayat Secretary and/or a Panchayat Development Officer. The executive reports to the committees and the State Government. The PFM requirements in PRIs are covered by the KPR Act, ZP (Finance and Accounts) Rules 1996, TP (Finance and Accounts) Rules 1996 and GP (Budgeting and Accounts) Rules 2006. PRIs report administratively to the Department of Rural Development and Panchayati Raj (RDPR). 353. Local self-government, particularly PRIs, largely depend on the public funds as their own resource base is low. The resource base of ULBs and PRIs are mainly from (a) own sources (tax and non-tax revenue149), (b) devolution/grant in aid from state government, and (c) scheme funds provided by GoK and GOI. While all ULBs have power to collect property taxes which forms major part of own source revenue (OSR), in case of PRIs, only GPs has power to levy taxes while TP have very minimal OSR from non-tax revenue. 26 subjects (or functions) provided in the 11 th Schedule of the 73rd Constitutional Amendment have been transferred to the PRIs based on Activity Mapping in 2003. 354. The amount of devolution from the state to ULBs and PRIs has increased in the past decade . The Third State Finance Commission (TSFC) recommended devolution of 10% of Non-Loan Net Own Revenue Receipts (NLNORR) of GoK for ULBs and 32% of NLNORR of GoK for PRIs, which has been accepted by the GoK. The devolution to ULBs ranged between 8-10% of the NLNORR of GoK - the government has agreed to gradually increase the devolution to 10% by 147 Created as per 74th Constitutional Amendment 148 Created as per 73rd Constitutional Amendment 149 Non-tax revenue includes rents, plan approval fees, water charges, etc. | Theme Six: Improving PFM in Local Self Governments 134 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix FY 2014-15150. The devolution to PRIs is currently 32% of the NLNORR of GoK which is as per the recommendations of the TSFC. (Refer Table 59). GoK has introduced performance based allocation of grants for the ULBs as per the recommendation of the XIII Finance Commission. Seven parameters151 have been identified by the GoK for grading and providing the performance based grant to the ULBs which is a step in the right direction as it would encourage better performing ULBs to receive more grants. Similar performance based grant should be introduced in case of PRIs. Table 59: Financial assistance to ULBs & PRIs (Rs. in crores) 2001-02* 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 ULBs 560 2468 2339 2472 2976 4248 4009 PRIs 4400 9122 10804 11406 12554 15211 18532 Source State Finance Accounts, Statement No. 8; * Source 2004 PFMA Report Brief of PFM arrangements for ULBs and PRIs and Issues 355. The Karnataka Local Fund Authorities Fiscal Responsibility Act, 2003 though enacted is yet to be operationalized. This is a fiscal responsibility act for the local bodies (which includes both ULBs and PRIs). The Act, aimed at improving the fiscal and financial management framework of these bodies, though enacted in 2003 has not yet been operationalized. As already recommended in section 1.2, the Act if operationalized and implemented at the local bodies would help in improving the fiscal and financial management framework of these bodies. 356. Budgeting : ULBs are required to prepare and pass an annual budget in the Council by 15th January and submitted to the DMA for compilation and inclusion in the state budget. After the state budget is passed, each ULB is informed of their respective allocations, based on which they prepare an action plan (within the approved outlay) which is approved by its Council in April/May152. Similarly, the PRIs are required to prepare an annual budget containing detailed estimates of income and expenditure for the ensuing year based on proposals from the executive authorities. The budget is finalized by the Finance, Audit and Planning Committee and placed before the governing body not later than the tenth day of March every year. The approved budgets are required to be submitted consolidated by the ZPs and submitted to RDPR for consideration in the state budget153. On finalization of the outlay, the Council revises the budget.  While both the ULB and PRI Acts clear elaborate the budget preparation process, compliance is lacking and needs to be strengthened. Finalization of the budgets by the LSGs is delayed thus hampering consolidation of the budgets for consideration for the state budget. The respective departments should issue circulars and provide training to the office bearers on the budgeting process and submission of timely budgets.  GoK from this budget have taken a policy decision to only transfer such amounts required for the filled up posts 154 . For the preparation of Appendix B (Estimates of Salaries), the extant practice is to make budgetary provision for salaries for the entire sanctioned posts, irrespective of whether these are planned to be filled up during the year. Moreover, the entire allocation is released upfront. even for vacant positions not planned to be filled up, which led to increased booking of expenditure in the state accounts and transferring the balance from consolidated fund to the public account. There has been a change in this system – for instance, the Finance Department has made 150 Devolution was around 3% at the time of the 2004 SFAA 151 Seven parameters are: (1) Collection on account of Property Tax; (2) Collection on account of Water Tax; (3) Expenditure on account of 13th FC grants; (4) Expenditure on account of SFC untied grants; (5) Expenditure on account of Nagarottana Yojana grants; (6) Expenditure on account of 22.75% SC/ST schemes; and (7) Conduct of General Body Meetings. 152 The state budget literature has a separate document “Budget Allocation for Urban Local Bodies� 153 The budget allocation for PRIs is made under the major head of the concerned department under minor heads 196, 197 and 198. The state budget literature has four volumes (division-wise) “Budget Allotment for Zilla Panchayat� having details of budget for the PRIs. This is a link document that give scheme-wise provision for each District under Plan and Non-Plan respectively under the different Major Heads. The state budget codes are linked to the codes for PRIs. 154 This study has worked as a catalyst for this change. This has led to saving of Rs.220 crores for the GoK under this specific head | Theme Six: Improving PFM in Local Self Governments 135 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix budgetary provisions of Rs. 100 crore and has authorized DMA to utilize this amount only when staff is actually employed. This is a good initiative both in terms of budgeting as well as cash management. Going forward, this provision is planned to be moderated from year to year depending on the actual need of this amount. 357. Fund Flow: Funds to ULBs are transferred from the state treasury to the Personal Deposit (PD) accounts including one for salaries and another for all other payments. All taxes collected by the ULBs are initially deposited in local bank account/s and then periodically transferred to the PD Account. The balances in the PD accounts are not lapsable, but closing unspent balance is considered for release of funds for subsequent year 155. 358. Fund flows to the PRIs are through a mix of transfer to the PRI Bank account or through the Treasury PD accounts.  In case of ZPs and TPs, Grants in Aid are provided by the State under minor heads 196 & 197 156 respectively and transferred to PD accounts. ZPs and TPs have three types of fund accounts maintained in the Public Account157: (a) Fund 1: Grants from GOI and State share of such schemes; (b) Fund 2: funds under State plan schemes and (c) Fund 3: Own resources. While Funds 1 and 3 do not lapse at the financial year end, fund 2 lapses at the yearend (see discussion in section 5.1). ZPs and TPs use bank accounts only to handle CSS or funds received directly for central schemes.  In case of GPs, all operations are carried out through bank accounts. Grants in Aid are provided under minor head 198 and are transferred to the respective bank accounts. GoK has simplified the fund flow to the GPs and now all transfers are directly sent to GPs Bank accounts through e-payments. Normally the SFC grants and other payments are transferred to the GPs on a quarterly basis by the GoK. Own resources are also kept in bank accounts. 359. Accounting and Reporting: The KMC Act details the accounting and reporting requirements for ULBs. Accounting in all ULBs, except Bruhat Bangalore Mahanagar Palike (BBMP), is computerized and double entry fund based accounting system (FBAS) has been implemented. The Act mandates that accounts should be completed within 3 months from the close of the FY. While there is delay in completion of accounts, presently there is no backlog and all ULBs have completed their accounts for FY 12-13. The account statements and other financial statements are available on the individual web site of each ULB which also has key statistics and other information required by the stakeholders from time to time. 360. Accounts of ZPs and TPs are up to date (significant improvement since the 2004 PFMA), but there is a perennial backlog of accounts in case of GPs. In case of ZPs and TPs, the accounts are prepared as per the ZP Finance and Accounts rules 1996 and TP Finance and Accounts Rules 1996. The KPR Act stipulates that annual accounts are to be passed by the General Body of the PRIs within three months from the closure of the financial year. On an average, ZP/TPs take six months to provide the accounts to AG for audit. While there is marginal delay in submission of accounts, there is no pendency in case of ZPs and TPs. Computerization of ZP/TP has not happened over the years and the situation is the same as it existed during 2004 report. ZPs and TPs still follow manual system of accounting but they have adopted the Model Panchayat Accounting System (MPAS)158 , including the reporting formats. Bridge software has been created for ZPs and TPs which downloads the data from the Treasury system Khajane and generates accounts for the ZPs/TPs. With this report the ZPs and TPs have to incorporate the banking transactions to finalize the accounts and produce the financial 155 For instance, Unspent balances of ULBs as of Mar 31, 2013 (Rs. 125 crore) were adjusted while making budgetary provision for 2013/14 156 Based on 11 FC a new minor head was introduced for the TPs. 157 G.O. No. FD 07 ZPA dated 8th September 2004 158 MPAS suggests presentation of financial statements of the PRIs in eight formats. This has been prescribed by the C&AG for all PRIs across the country. | Theme Six: Improving PFM in Local Self Governments 136 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix statements. The PRI Module proposed in Khajane II will cater to the accounting and reporting requirements of the ZPs and TPs, including computerization. 361. On the other hand, GPs follow double entry accrual based accounting system (DEAS) since 2007 and are required to prepare the accounting reports following DEAS. However, both manual and computerized systems are currently being followed in the GPs. In case of GP accounts, the pendency in the state is not encouraging - 220 GPs have not completed and submitted their accounts for audit to KSAD as on 31-3-2014. Some of the GPs have not finalized their accounts for 2-3 years. RDPR needs to analyze these cases and work out a strategy with KSAD to bring these accounts up to date. The delay in preparation of accounts would also affect timely completion of audits and submitting consolidated report to the Legislature. 362. For ZPs and TPs, accounting for their own expenditure is not a complicated one. However the inherent business design creates lot of control issues in terms of accounting and reconciliation - managing DDOs of multiple departments under their jurisdiction, transferring the budget to these DDOs, ensuring that expenditure is properly accounted for and is reconciled on a timely basis. In terms of treasury controls over the budget there is an issue as the treasury maintains only overall control on the fund account and there is no line item or entity wise budget control. This could led to over-drawal of funds by DDOs and control on this aspect is not available in the current treasury system. This issue is being addressed in the proposed KII design. . 363. External Auditing: KSAD is the statutory auditor for ULBs and GPs and the C&AG is the statutory auditor for ZPs and TPs. Besides, GoK has entrusted the audit of ULBs and GPs to C&AG under the Technical Guidance and Support module from the year 2011-12 159 . In case of ZP a separate audit report is issued for each ZP, and in case of TPs, a consolidated audit report covering all the TPs is issued by the C&AG. The current pendency situation is as follows:  ULBs: As on 31-03-2014, 68 audit reports are pending to be issued by KSAD which represents 30% of the state ULBs. While the accounts have been submitted KSAD is yet to take up the audit.  GPs: As on 31-3-2014, 1319 audit reports are pending to be issued which represents 23% of the state GPs. . The backlog audits are increasing; hence, KSAD need to work on a strategy to complete the audit at the earliest.  ZPs and TPs: All audits have been completed up to FY 11-12. For FY 12-13 the audit of all ZPs and 140 TPs have been completed by C&AG. This is a significant improvement since the 2004 PFMA - the pendency at that time ranged up to 4 years. The Act requires that the audit report should be completed within six months of the closure of the FY. While there is delay in audit of around 12 months, there is no pendency. 364. Audit compliance and follow-up: There are no formal systems of audit compliance both in ULBs and PRIs. While DMA and RDPR collect data on the accounts and audit status, no follow up on audit compliance is evident at the state level.  The completion of audit reports is followed up by the Joint Director (Administration) in the DMA. Details in respect of audits conducted and pending, audit reports remaining unresolved etc. are readily not available at the DMA. There is no system of concurrent audit in ULBs. DMA needs to have an audit cell to monitor the progress of accounts, audits and the compliance status of audits across ULBs . 159 The C &AG have submitted report on local bodies covering ULBs up to 2011/12 which was placed before the Legislature on Jun 6, 2013 | Theme Six: Improving PFM in Local Self Governments 137 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix  While IFA (RDPR) monitors the status of accounts and audit of the PRIs, the compliance is not monitored 160 161 at the state level . Some of the issues highlighted in the audit report are systemic and has been repeated 162 every year by the auditors for non-compliance . A separate audit cell should be constituted in RDPR under the IFA to monitor the receipt of accounts, audit reports and submission of compliance to the audit reports on a timely basis. 365. Internal Audit: The Chief Accounts Officer (CAO) of ZP is required to carry out the internal audit of the TPs and the line departments functioning under the ZP, while TPs are required to carry out internal audit of GPs. However, internal audit is delayed and carried out only for a handful of units primarily due to shortage of staff. A study conducted under an Institutional Development Grant (2013) has suggested creation of a separate internal audit wing to carry out the internal audit of PRIs and an Internal Audit Manual has been developed. RDPR and the Finance Department now have to decide the design of internal audit systems for PRIs, including the location of the internal audit function, taking into account the number of such institutions as well as the amount of budget which is being handled by them. Similar study needs to carried out for developing and implmenting internal audit in ULBs. 366. Legislative Scrutiny: KSAD is required to submit a yearly consolidated report on the accounts and audit status of ULBs and GPs to the Legislature and this need to be done within a time bound manner. This is in line with the amendments to the Act and XIII CFC recommendations and augurs well for the accountability at the third tier of the government. KSAD has submitted the first audit report for 2009/10 to the Legislature during the last FY 2012/13 – this is delayed, yet a start has been made. A Committee on Local Bodies including ULBs and PRIs has been formed in the Legislature in 2010 which would be reviewing these audit reports. Both the ZP separate audit reports and the TP consolidated audit reports are presented to the Legislature every year – there is delay in tabling these reports and some reports are yet to be presented. The C&AG’s Report on Local Bodies is also tabled for Legislative scrutiny – report for 2011/12 was tabled on June 6, 2013. 367. Summary: Overall, GoK has carried out substantial improvements in the PFM arrangements in ULBs and PRIs compared to status present at the time of 2004 PFMA report. Accounting reforms and computerization has been carried out by GoK for ULBs and GPs; and ZPs and TPs prepare their respective accounts - these were the key recommendations of the 2004 PFMA and has been implemented by the GoK. Currently, accounts for all ULBs, ZPs and TPs have been finalized up to FY 2012/13 and there is no pendency (in 2004, the backlog ranged from one to four years). Similarly, there is substantial improvement in audit as well. Audit reports for all ZPs up to the FY 2012/13 have been issued while more than 80% of the audit reports for FY 2012/13 have been completed for TPs; and nearly 50% of the ULBs audit has been completed. The key area of concern is that GPs lag behind both in terms of completion of accounting as well as finalization of audits. Internal audit and audit compliance needs to be strengthened as highlighted in the 2004 report. In conclusion, while the total amount handled by ULBs and PRIs have increased manifold, the internal controls and strengthening of financial management has not kept pace with the increased outlay. 6.2 URBAN LOCAL BODIES AND PRIS – COMMON ISSUES AND RECOMMENDATIONS 160 As of March 2012, 3,301 Inspection Reports (IRs) containing 11,949 paragraphs were outstanding in various ZPs. 161 Unreconciled expenditure with treasury, non-reconciliation of bank accounts, earlier write backs not reflected in accounts. 162 Audit report 2012: GoK in June 2007 withdrew the LOC system in Panchayat Raj Engineering Divisions and Forest Divisions and cheque drawing powers of DDOs. The balances outstanding under suspense heads should be cleared after due reconciliation as the cheques drawn are not valid anymore. GoK dispensed with (September 2004) the operation of TP and GP suspense accounts by ZPs in the annual accounts. However, 16 ZPs had not taken any action to clear the suspense accounts. It was also observed that in respect of six ZPs, adverse balances of `100.70 crore and `14.94 crore under TP and GP suspense accounts, respectively were exhibited in the annual accounts 2011-12 which was irregular and was fraught with the risk of misuse. | Theme Six: Improving PFM in Local Self Governments 138 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 368. Strengthen collection, recording and reconciliation controls over revenue. Collection efficiency of ULBs and GPs, particularly over property taxes which is the main own source of revenue, is low which affects the level of generation of OSR. The collection of taxes is partly through banking system and partly through direct collection by revenue staff. The weakness in the current system is that the assesse pays taxes, but most of these entries do not get reflected in the assesse’ accounts and the total collections are not reconciled to the party wise balances indicating weak internal controls with potential for frauds and late credits to the assesse. Moreover, the local bodies do not maintain up dated Demand Collection Balance (DCB) Register duly reconciled – hence, the actual dues are also not known fully. ULBs and GPs should improve controls on the collection and remittance of revenue, and reconciliation of party accounts on a regular basis to reduce leakage of revenue. GoK should move towards e-payments and collections through banks for all tax and non-tax revenue like CTD to improve the collections as well as improve the internal controls. Daily collections must be posted automatically to the assesse’ accounts and reconciliation should be carried out on a monthly basis. The accounting software should have capability to issue online receipts to the assesse. ULBs/GPs should focus on preparation of Demand Collection Balance register on a timely basis and reconciled every month. DMA/RDPR should issue a GO stating that all ULBs/GPs should update and complete the DCB before 31st December 2014. Once the database is completed and finalized, balance verification with the customers must be carried out by the ULB/GPs to correct any missing entries and finalize the DCB database which would be then be the baseline for future demand and collections. 369. Electricity dues are pending which needs reconciliation and payment. This issue was highlighted in the 2004 PFMA and is yet to be fully addressed. The fund flow and accounting treatment is in respect of electricity dues is different as compared to other transactions. For instance, in case of ULBs an annual allocation for electricity dues is made in the budget, the DMA submit bills for drawl to the Treasury which issues cheques to three designated banks and the proceeds are transferred to the bank accounts of the ULBs for electrical payments. Since electricity payments are done at the State level, the ULBs/PRIs are not in a position to account for this expenditure correctly leading to reconciliation problems DMA/RDPR needs to evolve the accounting policy and procedure for electricity payments. The electricity payments as and when made should be informed to the ULBs/PRIs which should account for the payments. 6.3 URBAN LOCAL BODIES – RECOMMENDATIONS 370. The following are the priority actions identified for the 2014 PFM Reform Action Plan: a. A strategic plan needs to be worked out by KSAD to reduce the pendency of audits . KSAD need to analyze the reasons for audit pendency in each of the ULBs and work on a strategy to update the audits to the current year. Since most of the pendency is due to shortage of staff at KSAD, KSAD should nominate special teams or employ external auditors to address the backlog of audits at the earliest and furnish the audit report. b. Audit Cell to be constituted in DMA for audit management for which GoK has already provided the sanction. This would be responsible for follow up on the completion of accounts, completion of audit and compliance provided on the audit reports. This would help improve the monitoring of ULBs compliance in terms of completing the accounts and audit. As a part of the audit cell, an MIS unit for consolidation of ULB finances can also envisaged which would be helpful for monitoring of the finances of ULB. c. DMA needs to review the issues in internal control systems highlighted by KSAD and AG and work with KSAD to institute an internal audit function to cover key business areas like revenue collection and other areas highlighted by the auditors. 6.4 PANCHAYAT RAJ INSTITUTIONS –RECOMMENDATIONS | Theme Six: Improving PFM in Local Self Governments 139 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 371. Significant improvements in PFM have been made since the 2004 PFMA, yet there are certain priority actions which GoK needs to take to further strengthen the PFM System. The priority actions are : a. One time cleanup of old balances and suspense account: GoK needs to constitute a special team to address the issue of old balance and suspense account highlighted in the audit reports which needs to be rectified in Treasury and ZP accounts. b. A separate audit cell should be constituted in RDPR under the IFA to monitor the receipt of accounts, audit reports and submitting compliance to the audit reports on a timely basis. c. GoK should implement the internal audit manual Internal Audit Manual for Taluk Panchayats prepared under the IDF study, set up an internal audit An Internal Audit Manual for the audit of Taluk wing and work on the strategy for creating and Panchayats in Karnataka has been developed implementing internal audit in PRIs. Finalize and establish (2013) – this provides a detailed framework for the Internal Audit structure for the Taluk Panchayats conducting internal audit in the context of a suggested by consultants under the IDF Grant supported computerized environment. Strengthening Public Financial Management and Accountability of the Taluk Panchayats in Karnataka Project. d. Account rules are to be changed to include creation of MPAS reports and reports on the banking transactions in the financial statements of ZP and TP. e. A DDO level control on expenditure needs to be incorporated at the PRI level and this needs to be developed as a part of the KII system. ZP and TP computerization including the banking transactions needs to be developed as part of the KII system. f. A strategy and follow up plan needs to be worked out by KSAD and RDPR to reduce the pendency of audits. RDPR and KSAD need to analyze the reasons for audit pendency in each of the GPs and work on a strategy to update the audits to the current year. RDPR should nominate special team to follow up on the cases and complete the accounting records so that audit can be carried out at the earliest. 6.5 ACCOUNTING REFORMS - URBAN LOCAL BODIES 372. GoK has adopted and implemented Fund Based Accounting System for all ULB’s across the State. Based on the National Municipal Accounts Manual (NMAM), the Karnataka Municipal Accounting and Budgeting Rules were enacted in 2006, and accounting manual has been developed and implemented across the State. This was one of the key recommendations in 2004 report and has been carried out by GoK. GoK has created a dedicated Municipal Reforms Cell to carry out the accounting reforms. E-gov financials a computerized financial system was developed and implemented across all ULBs. GoK has issued a GO in 2013, requiring all ULBs to carry out accounting using the Municipal accounting software. All accounts have been completed till FY 11-12, while financial audit is under progress. Table 60: Accounts and audit report – Current Status FY Target Accounts completed Balance of Audit Completed Balance of audit accounts to be to be completed completed 2006-07 51 51 0 51 0 2007-08 124 124 0 124 0 | Theme Six: Improving PFM in Local Self Governments 140 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 2008-09 128 128 0 126 2 2009-10 213 213 0 208 5 2010-11 213 213 0 206 7 2011-12 213 213 0 139 74 2012-13 213 185 28 0 213 Total 1155 1127 28 854 301 373. GoK should aim to complete the backlog of accounts for FY 2012-13 and FY 2013-14, before September 2014. All ULBs have implemented E-Governance software (computerized accounting system) from FY 10-11, however the issue is that these accounts are not yet audited. So as of now parallel systems (both manual and computerized) are being maintained in the ULBs. KSAD and DMA needs to devise a strategy to finalize these audit at the earliest so that in future only computerized accounts can be maintained. While most of the accounts are prepared in the computerized system, the following issues are still persistent: a. Party wise DCB is not being generated by the computerized system . The current accounts package deployed in the ULB does not have a working DCB module. Without DCB, the entire accounting reforms would not yield the desired results. b. Audit of software: The e-gov financials have been developed and implemented over the past five to six years. The software has undergone many changes and in terms of functionalities and modules implemented. The IT and functional audit of the software needs to be carried out by GoK. c. Linkage to KII: There is currently no strategy to link the ULB accounting software with KII. d. Multiplicity of audits: The ULB audits are being carried out both by CA firms (financial attestation audit) for the financial statements generated from the system and KSAD (transaction audit). Going forward, it would be ideal that KSAD issues one audit report for the ULB covering both the transaction audit and financial audit reports (using reports given by CA firms). (refer section on KSAD) 374. The following are the priority actions identified for the 2014 PFM reform action plan: a. A strategy and action plan needs to be worked out by KSAD to audit the books of ULB through the system, and thereafter carry out all auditing in the system only. KSAD needs to work with Municipal Reforms Cell to understand the software and then carry out audit through the software for all ULBs. (also refer section on KSAD) b. DMA needs to work with the KII team and MRC to ensure that the e-gov financials are linked to the KII so that in future there is seamless transfer of data between the software’s. 6.6 ACCOUNTING REFORMS – GRAM PANCHAYATS 375. GoK enacted GP (Budgeting and Accounting) Rules 2006, and has adopted double entry accrual based accounting system for all GPs across the state with effect from April 2007. Karnataka is one of the few states who have adopted double entry accrual based accounting system for GPs. Panchatantra – GP software which also covers accounting has been implemented across the state. The software implementation started in 2010, and as on date all 5630 GPs accounts are computerized. This was one of the key recommendations in 2004 report and has been carried out by GoK. The overall progress as on date is summarized in the Table 61. Table 61: GPs Accounts Current Status in Panchatantra FY Overall GPs Total Final Accounts Completed Final accounts completed Pending August 2013 by March 2014 2010-11 5630 5630 5630 0 | Theme Six: Improving PFM in Local Self Governments 141 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 2011-12 5630 5622 5630 0 2012-13 5630 4220 5572 58 376. The implementation has been carried out very well by the GoK and constant monitoring has led to reduction in backlog of accounts. All GPs have implemented Panchatantra software (computerized accounting system) from FY 10-11, however the issue is these accounts are yet to be audited. So as of now parallel systems (both manual and computerized) are being maintained in the PRIs. KSAD and the RDPR needs to devise a strategy to finalize these audit at the earliest so that in future only computerized accounts can be maintained. 377. The GPs prepare accounts based on DEAS, receipts and payment account, balance sheet, cash book and other ledgers as mandated by the rules are generated from the system. MPAS formats have been introduced for GPs from the last FY and now GPs are also preparing MPAS formats along with the financial statements being prepared under DEAS. 378. The priority reform actions are : a. GoK should ideally switch over to only computerized accounting from April 2015 and RDPR should devise a strategy for the switchover. The state should issue a circular in this regard as issued by the Urban Development Department (UDD). b. The RDPR should work with KSAD to conduct audit of GP books through Panchatantra. c. Audit of software: A software audit including both functional audit and IT audit should be carried out by a third party or C&AG to identify issues and functional requirements which can be developed as a part of the future versions. | Theme Six: Improving PFM in Local Self Governments 142 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Section 7. THEME SIX: IMPROVING PFM IN STATE OWNED ENTERPRISES (SOE) 379. GoK has a large number of companies and statutory corporations receiving substantial public funds. 163 Government Companies are incorporated under the Indian Companies Act while the Statutory Corporations are formed under a specific central or state statute (collectively referred to as SOEs). The SOEs handle substantial public funds by way of share capital, loans and grants/subsidies besides the GoK providing guarantees for borrowings of these SOEs. Hence, these SOEs should have a strong PFM system to account for and report on the use of public funds. A brief profile of SOEs in Karnataka during the last two years is presented below in Table 62. Total turnover is presently about 7.2 % of the state’s GDP, but is showing a continuous decline from over 10% in earlier years. Table 62: Profile of SOEs in Government of Karnataka Particulars 2012-13 2011-12 Number of SOEs Working companies: 73 Working companies: 70 Non-working companies: 14 Non-working companies: 14 Statutory corporation: 6 Statutory corporation: 6 Total: 93 Total: 90 Turnover Rs. 37,867 crore Rs. 34,491 crore Profitability Cumulative: Rs. 1,388 crore During the year: Rs. 1,126 crore Cumulative: Rs. 1,369 crore GoK Investments in SOEs164 Share Capital: Rs. 42,376 crore Share Capital: Rs. 37,515 crore Long Term Loans: Rs. 27,434 crore Long Term Loans: Rs. 29,197 crore Total: Rs. 69,810 crore Total: Rs. 66,712 crore Budgetary Support Share Capital: Rs. 4,661crore Share Capital: Rs. 4,443 crore Long Term Loans: Rs. 11 crore Long Term Loans: Rs. 47 crore Grants/Subsidies: Rs. 10,387 Grants/Subsidies: Rs. 7,365 crore Total Funded support: Rs. 15,059 crore Total Funded support: Rs. 11,854 crore Guarantee Commitment: Rs. 3,501 crore Guarantee Commitment: Rs. 3,354 crore Source: C A&G Report on PSEs 2012-13 and 2011/12 380. GoKs policy on PSEs is detailed in the document Policy on Public Sector Enterprises Reforms in Karnataka of 2005. This policy was originally conceived in 2001 and was titled Policy on State Public Sector Reforms and Privatization in 165 Karnataka . Salient features of this Policy vis-à-vis PFM that also provides the intent of GoK are summarized below. 163 In which at least 51% of the share capital is held by the government and includes a subsidiary of such a company 164 85% of the share capital accounted for by 6 PSEs namely Karnataka Road Development Corporation, Karnataka Bhaghya Jal Nigam, Karnataka Neeravari Nigam, Cauvery Neeravari Nigam, Karnataka Power Corporation and Karnataka Power Transmission Company Limited 165 The policy was formed in the background of several PSUs becoming “sick� due to severe market competition and drastic change in the purpose of these PSUs and a justification of investments in the public sector and relative priorities on investment to the social sectors was recognized. The policy also recognized the need for appraisal of investments in PSUs from the perspective of privatization, rationalization, restructuring, merger, winding up, closure etc. The policy was up to March 2008. | Theme Six: Improving PFM in State Owned Enterprises (SOE) 143 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Summary of GoK Policy on State SOEs (2005-2008)  To encourage adoption of Corporate Governance principles for effective management including introducing best practices in audit committees, independent directors, disclosure norms etc.  PSEs to enter into Memorandum of Understanding with their respective Administrative Departments  To introduce professionalism by having a fixed tenure of the Chief Executive Officers and an independent selection committee inter alia to induce effective governance in the PSEs 381. Institutionally, the PSEs are under the control of 18 Administrative Departments with overall control role envisaged for the Department of Public Enterprises (DPE). Through a 2008 government order, the DPE was entrusted two broad terms of reference – a. All Administrative Departments to consult the DPE on specified proposals166 before soliciting the approval of the Cabinet or otherwise; b. The DPE will be an arm of the Government and function as an overseeing, coordinating and monitoring authority in respect of matter relating to functioning of PSEs with a view to guide the PSEs in various issues 382. In actual practice, the role of the DPE is much limited to organize training and coordinate studies and primarily consultative on other matters The DPE has been declared the Secretariat for all PSEs and has policy making role on two matters – one, general policy relating to privatization of the PSEs; and two, policy guidelines in the areas of financial management, wage settlement, human resource and performance appraisal. Besides, DPE’s representatives are also appointed as nominee directors on the Board. This role of the DPE envisaged is broadly in line with the roles of the DPE at the central level, but not actually implemented. 383. The governance and financial management framework of the SOEs are contained in the underlying statutes i. e. the Indian Companies Act and the specific statute for the corporations. The main features of the framework are profiled below. 166 Specified matters include investment of share capital, amendment to memorandum and articles of association, major restructuring, increase in project costs of PSEs beyond a threshold, facilitating execution of MoUs between the Administrative Department and the PSEs etc | Theme Six: Improving PFM in State Owned Enterprises (SOE) 144 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Governance and PFM Framework of PSEs  The relevant statutes mandate the management of the PSEs through a Board of Directors appointed by GoK (in some cases the GoI is represented). The functioning of the Board is described in the statute including meetings, powers and responsibilities including delegation, committees of the Board, reporting requirements etc.  The Companies Act provides an elaborate and comprehensive framework of financial management including maintenance of accounts on accrual basis, accounting standards to be followed, format of the financial statements including disclosure, timelines for various functions, audit requirements including reporting powers and duties of the auditors.  Statutes of corporations also have similar provisions though not as elaborate as the Companies Act  Audit of government companies is conducted by Chartered Accountants appointed by the C&AG. For four statutory corporations, the C&AG is the sole auditor and for the other two, audit is conducted by Chartered Accountants. The C&AG has the right to conduct supplementary audit including performance audits. Based on the audit, the C&AG issues a separate report on the PSUs that is laid before the State Legislature  An Annual General Meeting has to be held within six months of close of financial year inter alia to adopt the audited financial statements  The Annual Reports of the PSEs including the audited financial statements are tabled in the State Legislature and examined by the Legislative oversight body – the Committee on Public Enterprises 384. The 2004 PFMA Report highlighted major shortcomings in the working of the SOEs many of the recommendations made have not been fully addressed and continue to be relevant. The key issues identified in the 2004 PFMA and the present status of each of the issue is presented in Table 63. Table 63: PFM Issues in Karnataka PFM – Status of 2004 PFMA Recommendations Issue in 2004 PFMA Report Present Status Annual financial statements not prepared timely (i. As per C&AG Report on SOEs for 2012/13 (2011/12), 36 (37) e. within 6 months from close of FY) working SOEs had not rendered accounts for audit for the years 28 of the 70 companies and all six corporations failed to 2010/11 and/or 2011/12. The point of concern is that the number meet the deadline including major entities of SOEs in arrears that had declined to 16 in 2006 is showing a continuous increase from that year onwards. Unreliable and inconsistent public sector numbers The differences in stock and flows of shares and loans between the PSE accounts and Government accounts continue to be significant167. Inadequate responses and follow up of C&AG’s Action taken on the statutory audit reports/the C&AG audit reports and Legislative Reports report/Legislative reports has improved. More efforts need to clear the outstanding Inspection Reports - 2680 audit paragraphs pertaining to 577 Inspection Reports issued by the C&AG remained outstanding, the earliest being for the year 2003/04 and 70% outstanding Inspection Reports pertained to just two sectors – Energy and Irrigation Monitoring and enforcement of PFM requirements The areas of internal controls particularly internal audit continue was weak to exhibit weaknesses and shortcomings. Auditors observed weak Issues such as timely audited financial reports and the or ineffective internal audit in several PSEs and have reported follow-up on the weaknesses/qualifications indicated in cases of non-existence of internal audit besides Audit Committee audit reports, e.g., on accounting, internal controls, not formed or not functional. The 2004 PFMA expressed concern budgeting need to be monitored and enforced. Little or over the quality of accounts and that auditors had reported non- unsatisfactory monitoring by administrative compliance with the prescribed accounting standards. These areas departments; weak enforcement of PFM requirements continue to be remain weak as can be gauged from the number of by the Board; state does not sufficiently hold the Board SOEs qualified audit opinions on their accounts (Table below) accountable 167 It is pertinent to mention that the figures provided in the C&AG Report on PSUs also are not matching with the corresponding figures in the Finance Accounts. | Theme Six: Improving PFM in State Owned Enterprises (SOE) 145 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Issue in 2004 PFMA Report Present Status Financial Nature of audit opinion (no. of SOEs) Year Unqualified Qualified Adverse Disclaimer 2012-13 26 49 4 2 (81) 2011-12 10 45 2 1168 (58) 2010-11 12 45 3 0 (60) In case of companies, the cumulative net effect of the audit observations for 2012-13 resulting in decrease in net profit was Rs. 324 crore and for 2011/12 was Rs. 1087 crore which was almost three times that of the previous year. Issues of Governance The Board of Directors and the Chairperson continue to be Considered as the factor underlying all the weaknesses political or ex-officio appointees undermining the government’s above; Board dominated by political or official ability to fix accountability. GoK Administrative Departments nominees; frequent intervention by the government in have a lot of say in the operational management of the PSEs under operational management; frequent turnover and short their ambit – appointment of directors and top management tenure of top management. positions, borrowings, dividend, capital expenditure etc. Independent directors being retired government officials have been inducted on the Board, but there is an absence of functional directors. 385. Corporate Governance in Central SOEs is guided by the “Guidelines on Corporate Governance for Central Public Sector Enterprises� that are mandatory since 2010. These guidelines issued by the Ministry of Heavy Industries and Public Enterprises are considered model framework. The salient features of these guidelines are enumerated in Box given below. Each CPSE submits quarterly and annual reports of compliance with these guidelines. 168 Karnataka Neeravari Nigam Limited 2010/11 | Theme Six: Improving PFM in State Owned Enterprises (SOE) 146 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Salient Features of Central Guidelines on Corporate Governance Board of Directors  shall have an optimum combination of functional, nominee and independent directors  number of functional directors (including CMD/MD) should not exceed 50% of actual Board strength  number of nominee directors shall be restricted to a maximum of two  For non-listed PSEs, at least one third of the board members shall be independent directors  Board to lay down Code of Conduct for Board and senior management and annually affirmed  Training to new Board members Qualified and independent Audit Committee shall be set with terms of reference approved by the Board  minimum 3 directors of which 2/3 shall be independent directors; Chairman shall be an independent director  members shall have knowledge of financial matters of company and at least one member shall have good knowledge of accounting and related financial management expertise  shall meet at least 4 times in a year and not more than 4 months shall elapse between two meetings Risk management strategies and their oversight shall be one of the main responsibilities of the board and management.  Board to ensure integration and alignment of the risk management system with corporate and operational objectives  risk management is undertaken as a part of normal business practice and not as a separate task at set times  lay down procedures to inform board members about the risk assessment and minimization procedures  Disclosure on risks and concerns shall from part of Director’s report. | Theme Six: Improving PFM in State Owned Enterprises (SOE) 147 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 386. Besides the continued relevance of issues identified during the 2004 PFMA, the following areas of improvement emerge in governance and PFM in SOEs in Karnataka. a. A policy on Corporate Governance has not been developed and an assessment of the actual Corporate Governance status in the PSEs has not been done. GoK’s intent is to encourage good Corporate Governance practices in SOEs. A contemporary data bank is not available centrally in respect of such aspects as composition of the Board and its functioning, convening of the annual general meeting, constitution of an audit committee and its functioning etc. b. Assessment of fiscal risks of the PSEs is done on a stand-alone basis by the concerned Administrative Department. The methodology of the assessment is not documented and could be disparate inter se departments and the concerned officer doing the assessment. The C&AG report provides some elements of the fiscal risks of the PSEs but that is historical and available at least 9-12 months after close of the financial year. A contemporary data bank collating fiscal risks such as contingent liabilities, cash losses, capital commitments etc. is currently not available. c. The present role of the DPE is limited to organize training and coordinate studies and primarily consultative in other matters. The role of the DPE needs to be revisited and reiterated so as to make it a more proactive institution and in actual practice a nodal agency for all matters related to PSEs. d. There are arrears of finalization of accounts that needs to be cleared . Presently, the backlog is for the two years 2011/12 and 2012/13 and hence not acute (relative to some states where companies have not rendered accounts for several years) and therefore are capable of being cleared under a specified plan. Delays in finalization of accounts and audit increase the risk of leakage of public money besides a violation of the Companies Act or relevant statute. Moreover, delayed or non-completion of accounts and audit also affects the effectiveness of the Parliamentary oversight body – the Committee on Public Undertakings – as their examination also is delayed. e. The quality of accounts of the SOEs needs further improvement particularly addressing the recurring or systemic audit observations including continuous non-compliance with accounting standards. Although the value of objectionable amounts (by auditors) had reduced in 2012/13, yet the amount remains high in terms of percentage of aggregate net profits earned by the SOEs (and in fact the objectionable amounts were over Rs. 1000 crore in 2011/12). f. Internal controls including Internal Audit as essential element of PFM has not been accorded due importance . The areas of internal controls particularly internal audit continue to exhibit weaknesses and shortcomings. Auditors observed weak or ineffective internal audit in several PSEs and have reported cases of non-existence of internal audit besides Audit Committee not formed or not functional. 387. The above issues identified in corporate governance and PFM arrangements in SOEs can be addressed by including the following priorities in the 2014 PFM Reform Action Plan. Recommendations made in the 2004 PFMA report are still relevant and reiterated. a. Draw out a plan to clear the arrears in the backlog of accounts 169. This should be done in consultation with the state AG. Depending upon the requirement, engage external help to complete the accounts and prepare financial statements. b. Enhance the role of the DPE as an effective nodal agency for SOEs in Karnataka. A larger role of the DPE was envisaged through the 2008 government order, but in practice the DPE’s role is presently limited to organizing trainings and engaging consultants for studies. Therefore, the role of the DPE as a nodal agency for all PSEs in Karnataka with well-defined roles, human resources and budgetary provisions can be strengthened. 169 XIII FC has also recommended outsourcing preparation of accounts to qualified personnel. | Theme Six: Improving PFM in State Owned Enterprises (SOE) 148 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix c. Conduct specific studies on corporate governance and financial accountability . The DPE has initiated some studies in respect of the working of the PSEs that would provide inputs for policy formulation. DPE should also initiate a study on (a) corporate governance practices in Karnataka PSEs and best practices from other jurisdictions; and (b) the observations made by statutory auditors and C&AG and steps for their adequate resolution. The objective of the studies would be to provide an AS IS analysis (focusing on larger and critical SOEs) and recommend the way forward which can be considered by GoK for deciding the course of action. d. GoK may consider application of the framework of corporate governance for central SOEs as framework for state SOEs. This can be done in a phased manner – starting with the PSEs with share capital of Rs. 1000 crore and above and then extending it to PSEs with share capital of Rs. 500 crore. The central guidelines are in practice for over a decade now and have been framed according to the best practices. e. Review of Internal audit issues and audit committee. GoK should conduct a study to review the practices of internal audit and the effectiveness of the audit committee in at least the major SOEs and take action to strengthen these critical aspects of the SOEs. f. The recommendations made in the 2004 PFMA in respect of corporate governance are re-iterated for implementation. | Theme Six: Improving PFM in State Owned Enterprises (SOE) 149 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Section 8. 2014 REFORM ACTION PLAN – SUGGESTED NEXT STEPS This section contains the PFM Reform Action Plan, proposing the actions to be taken, and the suggested next steps for implementation. The detailed analysis of the issues and the logic for action plan are provided in the respective sections in the Report. Based on this, GoK may decide the actions to be implemented and their sequencing. Table 64: Action and suggested next steps for implementation Priority area/ Action Suggested next steps for implementation objective Strengthen Create awareness and ownership amongst Fiscal Policy Institute can carry out capacity-building fiscal all departments towards Karnataka Fiscal measures, workshops, and provide fliers on compliance to responsibility Responsibility Act (KFRA) the KFRA. legislation and Operationalize the Local Fund Authorities Issue a Government Order to operationalize the LFAFRA. update core PFM Fiscal Responsibility Act (LFAFRA) Provide mitigating measures in case of any fiscal hardship documents on account of implementation of the LFAFRA. Carry out workshops and trainings to disseminate and build capacity to implement the provisions of LFAFRA Produce Report on Review of State This requires amendment to Section 6.2 of KFRA Finances on a quarterly basis. Examine the need for broadening the scope of the Escape Clause in the KFRA Revise and Revise Karnataka Budget Manual (KBM), Formalize and re-activate committee of experts constituted update core Karnataka Financial Code (KFC), to work on the revision of manuals. PFM Karnataka Treasury Code (KTC), Manual Manuals to be based on changes planned in the business documents on Contingent Expenditure processes envisaged under Khajane II. Improved KII team should be represented on this committee. compliance with Disseminate revised and approved manuals PFM to all stakeholders through training and requirements workshops. (Section 3.2) Strengthen Include IFA roles and responsibilities in the Initially issue GO for amending the KFC/KBM and institutional KFC and KBM so that Departments subsequently include them in the revised KFC and KBM capacity of recognize the role of IFA Internal Recruit IFAs mandatorily from KSAD Suitable officers would need to be identified, trained and Financial groomed for the role of IFA. The IFA recruitment rules for Advisors (IFA) this purpose should be amended and Asset  Provide extensive training to IFAs Liability including computer skills Management  Provide staff and IT support to IFA Cell Pass the full budget before beginning of the Amend the Budget Manual to mandate this target and Strengthen financial year. exceptional use of Vote on Account. Budget Process Annual Budget Calendar also to recognize passing of budget before commencement of fiscal year. Reduce the expenditure composition Analyze the reasons for variance in select departments and | 2014 Reform Action Plan – Suggested Next Steps 150 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Priority area/ Action Suggested next steps for implementation objective variance, from the present high level, in include remedial measures in the budget circular phases say over a two-year period Establish Economic Intelligence Unit in CTD has engaged consultants to establish EIU and develop major revenue departments and Implement a forecasting tool. Based on the results obtained similar a Revenue Forecasting Tool. model could be replicated in Excise department. Reduce the number of Supplementary The first supplementary should be presented in Budgets to at least two (from the present November/December coinciding with the tabling of the three) and to one in the long term Mid-Year Report in the legislature.  Prepare Supplementary Budgets which Avoid and moderate inclusion of large expenditure are Fiscally Neutral and in accordance commitments in SE with the KFRA Full scrutiny of proposals/expenditure proposed in SE.  Prepare and Present Fiscal Neutrality table Provide details of actual expenditure and Format for reporting by departments needs to be surrenders per demand in the developed. Supplementary Budgets Improve Revise the financial limits of delegation for predictability re-appropriation to contemporary of availability requirements of funds Identify reasons for high level of re- This study should specifically include injudicious and appropriation orders and develop strategy defective orders being reported by the C&AG. to control the rising trend Organize refresher workshops to Workshops should be held post completion of the above disseminate rules and procedures of re- study. appropriations Issue circular authorizing release of funds for any quarter prior to commencement of the quarter Organize Workshops to disseminate the The workshops should explain the importance of Delegation of Financial Powers (DoFP) on- enhancement in the DoFP and its relation to year end rush fund releases for better understanding of expenditure. Issue DoFP as rules on the lines followed by GOI and some states Consider rush of expenditure as breach of financial propriety and include provision in KFC Integrate Appendix B170 preparation with Include data on sanctioned and filled posts in HRMS to Estimate HRMS/HRMS II enable preparation of Appendix B from the same data budget source. provision of Estimate salary for actual filled posts based Base estimation on filled posts and posts to be filled during salaries on on HRMS and posts expected to be the year realistic basis recruited during the year Discontinue the practice of providing for full vacant posts 170 Appendix B is the budget document that contains full details of sanctioned, filled and vacant posts and estimation of salaries | 2014 Reform Action Plan – Suggested Next Steps 151 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Priority area/ Action Suggested next steps for implementation objective Prepare Appendix E171 timely and submit PWD and Irrigation Department to work with the Finance along with budget for legislative approval Department to analyze the bottlenecks in the timely submission and adequate preparation of Appendix E as per the budget calendar.  Prepare Appendix E on rolling forecast PMS can generate financial reports based on milestones for model for 3 years the contracts already issued by PWD and this feature can Improve  Develop capability in project be used for resource scheduling for the next 2-3 years. budget process management software (PMS) to and controls prepare Appendix E over capital  Introduce MTEF in PWD works Prepare Appendix E and include all works Review this requirement and modify Budget Manual to covering all major heads, Externally Aided explicitly include this provision if accepted Projects, and State Government Companies Implement PMS in Irrigation Department Consider adopting the Tamil Nadu model Provide priority in budget for payment of arrears, then for for estimating civil works. completion of ongoing works and lastly for new works. Mainstream PMS and integrate with KII Institute Review the process of schemes, merge Every 3 years a comprehensive review of the schemes system for schemes and weed out nonexistent scheme needs to be carried out by the respective departments to periodic heads on a regular basis weed out the non-existing schemes. rationalization of Schemes Implement Review if DMTFP can be adopted in Departmental certain larger departments like PWD MTFP Provide departments with more flexible A common code structure would apply to budgeting and budgets accounting, but the more detailed codes would be used for accounting, and only the aggregate codes would be used for budgeting. Enhance Implement the Departmentally Related DRSCs could be sub-committees of the main Committee Legislative Standing Committee (DRSC) mechanism on Estimates. This may need amendment to the Budget scrutiny of Manual and the Rules of Procedure and Conduct of budget Business Build capacity of the Legislative Organize capacity building programs in the area of budget Committee on Estimates and provide scrutiny adequate technical support Devote more time on discussion and voting of grants Strengthen Reiterate the requirements and rules of Can be done through workshops, trainings and GOs. Accounting KFC for areas identified in the report and Reporting Designate a central nodal office with The ALMC could be entrusted with this function for enhanced adequate staff to collate and monitor PFM compliance of submission of Utilization compliance Certificates (UC) with the concerned departments and agencies Plan a one-time exercise to clear and clean Constitute a dedicated team to study the underlying issues 171 Appendix E is the budget document that contains details of ongoing works and those planned during the year by the Irrigation and Public Works Departments. Only works that are administratively approved are included | 2014 Reform Action Plan – Suggested Next Steps 152 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Priority area/ Action Suggested next steps for implementation objective up the backlog of public accounts, and causes, suggest remedial measures and monitor the reconciliation of expenditure, and UCs exercise. Reduce the periodicity of submission of Constitute a dedicated team to study the existing timelines, UCs and reporting unencashed cheques benchmark with other states suggest an appropriate timeline and process. Resolve accounting issues such as Constitute an expert team to study the audit reports and classification under miscellaneous heads, consult with the Accountant General for adequate solution. operation of reserve funds, Alteration Memos for lapsed cheques with Accountant General  Issue circular clarifying roles and Develop and implement a mechanism of reporting this reporting requirements of GOI, GOK information by implementing agencies and designating a and Implementing agencies in respect nodal office for collating and compiling the expenditure. of CSS funds routed through the state budget; and  Develop disclosure norms for expenditure incurred by the implementing agencies under CSS funding routed through the state budget Disclose grants released to and expenditure incurred by urban and rural local bodies (ULB/PRI) and PSUs Take policy decision on fund II balance treatment for Zilla and Taluk Panchayats (ZP/TP) Move CSS projects funds to Public Deposit accounts instead of Bank accounts MIS Cell to be constituted in DMA and RDPR for collecting financial data Carry out one time cleanup of bank accounts and closure of inactive accounts in ZP/TP Prepare link documents using uniform object codes Develop a roadmap for transition from cash This activity is to be carried out after GOI mandates based accounting to accrual accounting accrual accounting implementation. Implement recommendatio GoK to develop a strategy for implementation of accrual ns of the accounting including piloting across a sample of Central Finance departments, building functionality in Khajane II to Commissions on facilitate accrual accounting, capacity building and final disclosure roll out. External consultants may be engaged to provided technical guidance Include all public sector entities in fiscal Set up mechanism for collecting, consolidating and reports as sub-sectors of GoK disseminating financial data on all public sector entities (local governments, companies and corporations and SPVs implementing CSS) Provide object heads for segregation of maintenance expenditure into salary and non-salary components. | 2014 Reform Action Plan – Suggested Next Steps 153 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Priority area/ Action Suggested next steps for implementation objective Determine a benchmark rate of return for Constitute an expert committee for this exercise. investment in PSUs. Provide a list of PSUs providing rate of return lower than the benchmark rate in the Budget and Finance Accounts. Issue instructions to all departmental and ALMC could be entrusted with collation and consolidation non-departmental undertakings to provide of this information an annual return of vacant land with area and estimated market value and disclose full information on vacant land in the Budget. Consider disclosing information on number of employees in the Finance Accounts based on the information collected for Appendix B of the Budget. Disclose implicit subsidies in the Finance Information already appears in the Overview of the Budget Accounts Enhance Continue to upgrade Khajane I to Khajane Treasury II (KII) with full computerization at the processes, level of Drawing and Disbursing Officers controls and (DDO) reports  Develop a HR staffing plan, change Review staffing structure at Treasuries and DDOs through management strategy and training plan Review the number of DDO and if there are synergies for implementatio for all DDOs, Chief Controlling combining them n of Khajane II Officers and Treasury officials Prepare training modules and curriculum of training  Review the number of DDOs and work out a strategy for rationalizing them. Develop and implement a data migration Identify key areas where data needs to be migrated to KII. strategy to capture legacy data in key areas Reconcile and validate legacy data for incorporation in KII Develop a roll out plan for KII and cutoff Carry out pilot as envisaged in September and attempt date for completing the switchover and switchover in April 2015 withdrawal of manual books Build capability in Khajane II to integrate/link the following software’s  Budget Management Information System  Supplementary Estimate Information System  E-receipts System (CTD and ED)  E-Procurement  HRMS  Project Management Software – PWD  Beneficiary monitoring system of departments  ULB and GP software Build Capability to develop the following modules  Contract management module  Cash management and forecasting | 2014 Reform Action Plan – Suggested Next Steps 154 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Priority area/ Action Suggested next steps for implementation objective module  Audit compliance management module (link to Audit Monitoring System)  Guarantees  Investments  Debt management  Loans and Advances  ZP/TP Module Improve Cash  Carry out a study on cash management Carry out a study on cash management practices and the Management practices and debt scheduling. amount of cash deposited with entities outside the treasury  Develop a cash forecasting model for and options on how cash management could be made monitoring cash management and better. This study should also look at how the debt integrate with KII. scheduling is being pursued by the GOK. Review if the  Integrate cash balance and forecasting cash parked with entities outside treasury could be reverted mechanism with debt scheduling back to the treasury. This study should be led by FD and decision can be supported by external consultants  Link cash management projections with the Monthly Programme Implementation Calendar and procurement plans Enhance Create web-based information system for controls over tracking and monitoring of subsidies and Subsidies interlinked to KII Enhance Analyze C&AG audit report on HRMS and This will feed into development of HRMS II interface prepare mitigation plan capability, Upgrade HRMS to advanced version of GOK has already initiated steps for developing HRMS II. scalability, and HRMS II integrity of the Initiate a comprehensive payroll audit for Consultants to be engaged for carrying out the audit. Human Resource validating the database prior to migration to Additionally, provide web enabled interface to employees Management and roll out of HRMS II to view their data and propose rectifications for System inconsistencies in their legacy data. application Develop and institutionalize a Disaster Recovery Plan Provide interface for transfer of Pay bill electronically to Khajane Roll out full transfer of Employee Payment of employee dues through ECS already initiated payments through electronic mode in 4 talukas of 15 districts Provide web enabled access interface to employees to view their master data and propose rectifications Analyze C&AG audit report on procurement and prepare mitigation plan for issues noted in case of violation of Strengthen e- KTTP/e-procurement Procurement Consider changes to the KTPP as suggested systems in the report Conduct capacity building programs, trainings and workshops for staff across | 2014 Reform Action Plan – Suggested Next Steps 155 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Priority area/ Action Suggested next steps for implementation objective departments on KTTP and e-procurement Prepare a user guidance manual and share with the procuring entities working on KTTP and e-procurement Initiate audit of the e-procurement software Request AG for an IT audit of the system by CAG Review Contract Management Module and its implementation progress so that it can be developed in KII Provide adequate delegation of powers as suggested by the departments Enhance functionalities of e-procurement software to include-  Online Bid Evaluation Process  Issue of work order in the system (or this function needs to be captured in KII)  Provisions for Expression of Interest Enhance Fiscal Disclose information on contracts awarded Initially this can be done voluntarily and later on mandated Transparency on the e-Procurement website. in the KTPP Act. Enhance Develop a Government Guarantee Policy controls over Operationalize the Guarantee Redemption Guarantees Fund Discontinue book adjustment of Guarantee commission so as to be in compliance with Guarantee Act Strengthen guarantee database and Database to include details of Performance Guarantees, and reconciliation efforts fields for capturing information such as due date for guarantees and no dues from lending institution for deleting expired guarantees Phase out Off Ensure that budgetary funds directed GOK to assess the uncommitted financial resources Budget towards debt servicing are utilized for the available with the PSU/SPV prior to release of funds for Borrowings intended purposes by the PSU/SPV. This debt servicing. will ensure better cash management Make adequate disclosure of OBB on account of ULBs in the Budget document and MTFP, include the amount outstanding for the computation of Total liabilities Strengthen Develop Operational Guidelines, in . system of consultation with the AG to provide clear Recording, norms for determination, timing of Consolidation, accounting and reporting of investments Reconciliation and Reporting Strengthen efforts for identification and Prioritize reconciliation efforts on “big ticket� items of the reconciliation of differences between state pertaining to recent years Investment accounts and investee-company accounts Expedite issue of necessary GO’s for corrective action Portfolio Engage external consultant as required | 2014 Reform Action Plan – Suggested Next Steps 156 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Priority area/ Action Suggested next steps for implementation objective Issue clear Government orders when The GO must state whether it is investment or grant and authorizing investment mention the correct head of account. Institutionalize Set up a combined Cash and Debt Adequately staffed office to be setup within FD Debt Management Office for cash and debt Management, management recording and reporting. Recording and Reconcile debt data with the AG on priority Constitute a dedicated expert team to identify the Reporting functions differences and follow up to resolve the issues. Continue contribution to the Consolidated Provision to be made in yearly budget Sinking Fund maintained by the Reserve Bank of India Examine alternate models for Debt Sustainability Analysis (DSA) and adopt an appropriate model Disclose debt data and DSA on the website Gujarat model for disclosure can be followed of the Finance Department. Develop and implement an application for This is to be done only when implementation of ALM maintaining Debt data module in Khajane II takes more than 2 years. Strengthening Copy all GOs authorizing the issue of and building guarantees, sanction of loans and capacity in investments directly to the ALMC Assets Liability Address resource constraints in ALMC Engage consultants in the short term Management through training and appointing finance Augment staffing in the long term Cell personnel from FD Develop suitable application compatible to This is to be done only when implementation of ALM KII for recording and reporting of module in Khajane II takes more than 2 years. guarantees, investments and loans and advances by ALMC Reconcile and validate legacy data for Guarantees/Investments/Debt//Loans and advances for incorporation in KII Asset Liability Management module Strengthen Strengthen efforts for identification and Constitute dedicated team in ALMC for reconciliation and system of reconciliation of differences between state engage external consultant as required Recording, accounts and balance maintained by GOK Prioritize reconciliation efforts on “big ticket� items Consolidation, pertaining to recent years reconciliation and Reporting To facilitate reconciliation GOK to direct all CCO of Loans and maintaining detail accounts to provide timely information Advances to the team Institute Reporting System to meet Indian Formalize reporting system through issue of a GO Government Accounting Standards (IGAS 3) requirements in consultation with AG Initiate a special audit of the detailed Constitute a dedicated expert team from KIPA or retired records of Loans and Advances maintained audit officers from AG to carry out this audit departmentally Issue GO reiterating rules governing the The GO should specifically cover the following aspects: | 2014 Reform Action Plan – Suggested Next Steps 157 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Priority area/ Action Suggested next steps for implementation objective sanction and monitoring of loans and Loans should be made only after the terms and conditions advances and ensure compliance have been agreed No loans to be given when earlier loans are in arrears Develop a strategy to address the Identify the reason for arrears significant arrears in repayments of loans Decline in Provide a formal definition of payment stock of arrears for its due recognition Arrears of Institute a system for recording and The system should capture payments outstanding across all Payment reporting arrears across GOK departments and para statals distinguishing between current outstanding and arrears Develop a strategy for clearance of arrears GOK to (a) determine strategy to clear payment arrears by as on a cut-off date setting a time table, (b) make adequate budgetary provision and (c) avoid buildup of further arrears Priority in budget should be made for payment of arrears, then for completion of ongoing works and lastly for adding new works Disclose expenditure payments outstanding in the mid-year report and budget documents. Strengthen Initiate a special study to identify the Constitute a dedicated expert team from KIPA or retired internal underpinning causes of accumulation of audit officers from AG to carry out this audit controls, uncashed cheques to formulate a strategy to accounting, clear backlog and avoid recurrence reporting and adjustments Carry out a one-time special exercise to Treasuries to identify cheques not paid for more than a over clear the backlog of unencashed cheques year, confirmation of non payment from DDO and submit Unencashed request to AG for alteration memo Cheques Reiterate instructions through GO to all Lapsed cheques should be reversed within the same FY. Treasuries and DDOs forthwith to follow the procedure prescribed in the KFC Reduce the periodicity of cancellation of This would require amendment to KFC. unencashed cheques to 3 months Commence monthly reporting of lapsed Develop a process for reporting to the AG for issue of cheque to AG and finalize accounting Alteration Memos on a priority basis treatment of cancelled cheques Institutionalize Conduct a situational analysis of current Study existing organizational structure, skills and capacity Internal Audit internal audit arrangements in GOK of existing staff, and current audit methodologies and in GOK departments procedures and SWOT analysis.  Develop risk-based strategy for Suggest institutional model for Internal Audit ; staffing; implementing internal audit function in implementation strategy; audit committees; capacity the State; enhancement; internal audit approach, methodologies and  Carry out categorization of procedures including reporting; departments and initiate internal audit in high spending departments and Could consider creating a high level Internal Audit Task implement gradually Force to spearhead the reform Categorize based on budget spent, revenue earned, and the risk perception based on earlier AG audit reports Develop and implement Internal Audit | 2014 Reform Action Plan – Suggested Next Steps 158 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Priority area/ Action Suggested next steps for implementation objective Manual Improve Re-iterate the seriousness of non- Issue GOs and organize workshops Responsiveness compliance with audit paras and prescribe to External action for continuous failure to take action Audit Clarify and enhance role of the IFA in Organise training for follow up and use of Audit follow up of audit reports Monitoring System Strengthen the institution of Ad Hoc Meetings to be convened periodically and minutes of Committees at departmental level meeting to be posted on the website of the concerned department Constitute a state-level Apex Audit Committee to oversee the status of compliance and working of the Ad Hoc Committees Take measures to ensure expeditious recovery of revenue at least in cases accepted by the Department Mandate data input in the Audit Monitoring System as compulsory and Controller to monitor on a frequent basis Enhance the functionality of the Audit Include aspects such as meeting of ad-hoc committee; Monitoring System classification of audit observations and KSAD reports and integrate with database of KLA. Strengthen Prescribe strict timelines for response to The Handbook should be further strengthened in this area Legislative reports of the Legislative Committee by the which includes COLB. Scrutiny of departments, and action for delayed or non- External Audit compliance Reports Increase the technical human resources at Provide more technical resources so that larger number of the disposal of the Committee on Public reports could be taken up for examination and action taken Accounts (CoPA) submitted by the departments can be reviewed expeditiously Integrate Audit Monitoring System with database maintained by CoPA Place the Action Taken Reports in public domain after they are laid before the State Legislature Publish Epitome of recommendations of the legislative committee every 3 years Organize training for KSAD staff on Continue training courses which are being conducted commercial accounting currently Strengthen Make rotations between audit and accounts compulsory to KSAD to broad base knowledge improve PFM Identify train and groom core group of services KSAD staff to take up role of IFAs and enhance their PFM capabilities to take up enhanced role to support FD | 2014 Reform Action Plan – Suggested Next Steps 159 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Priority area/ Action Suggested next steps for implementation objective Enablers for improving audit efficiency  Enact KSAD Audit Act to provide a legal status to KSAD  Develop and implement a comprehensive audit manual Enhance audit capacity and capability of KSAD staff through training Monitor and improve compliance through a This action has already been approved by FD Centralized Audit monitoring cell Implement Audit management software and IT infrastructure to increase efficiency Introduce new audit practices Study of risk,  Risk based audit Procedures and guidelines for carrying such audit to be laid  Encourage co-sourcing down in the audit manual.  Carry out Financial Attest Audit Training to be provided carry out such audit Carry out audit of ULBs and GPs through Train staff on the software’s of ULBs and GPs and audit their computerized systems through computer Carry out pilot testing for one district Carry out full state audit after pilot. Develop strategy and carry out one time Review internal and external arrears. reduction of audit arrears Agree with entities on a timeframe for completion of accounts Constitute a special team to clear back log either through staff or consultants. Increase cadre strength of KSAD Carry out HR and skills mapping exercise; prepare revised organization structure with staff requirements. Improve PFM Update Demand Collection Balance in Local Self Register to recognize own source revenue Governments Move towards e-receipts and collections through banks for all taxes Develop accounting policy and procedure for electricity payments Develop and implement strategy to clear Engage external help to complete the accounts and prepare the backlog of accounts financial statements Develop and implement strategy to clear Engage external help to complete the audits the backlog of pending audits in ULBs and GPs Constitute Audit Cell in DMA and RDPR This action has already been approved in the budget for for audit management DMA Conduct audit of ULBs and GPs software (e-gov financials and Panchatantra) Carry out one time cleanup of old balances and suspense account, bank accounts and closure of inactive accounts in ZP/TP Set up an internal audit wing and | 2014 Reform Action Plan – Suggested Next Steps 160 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Priority area/ Action Suggested next steps for implementation objective implement the internal audit manual Finalize and establish the Internal Audit structure for the Taluk Panchayats Update Municipal Account Rules to include MPAS reports and reports on banking transactions in the financial statements of ZP and TP Build fund control in KII for PD accounts related to ZP/TP Ensure full migration from manual systems A cutoff date for switchover needs to be decided of accounting and financial reporting to All legacy date to be entered before cutoff date computerized systems for ULBs and GPs GO to be issued clarifying the timelines and actions to be taken Strengthen Develop and implement strategy to clear Engage external help to complete the accounts and prepare PFM and the backlog of accounts financial statements Corporate Enhance the role of the DPE as an effective Operationalize the 2008 GO Governance in nodal agency for State Owned Enterprises State Owned Enterprises Conduct specific studies on corporate governance Consider adopting framework of corporate governance applicable to central PSUs Review the external audit findings, Engage external help to complete the study. including functioning of internal audit and audit committee Implement recommendations of 2004 report . | 2014 Reform Action Plan – Suggested Next Steps 161 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Section 9. ANNEXURES 9.1 ASSESSMENT OF INTERNAL AUDIT FUNCTION IN KARNATAKA – C&AG Department/ Functioning IAW Adequacy of Audit Compliance with What the C&AG Agency Staff audit reports recommends Commercial Functioning up to 2004/05 but IAW should be made Tax abolished on introduction of functional and VAT and re-established from effective. June 2011. Offices actually Action may be taken covered under internal audit to strengthen IAW and during 2011-12 were 5% and increase the coverage 2012-13 were 7% of audit, fix annual target for coverage of audits and settlement of observations Excise Yes, IAW established. 104 Working strength of During 2005/06 to Take appropriate steps offices out of 311 were only one Senior Audit 2009/10, IAW raised for speedy clearance planned for audit during Officer and two 506 observations of outstanding 2009/10 and 108 offices were Assistant Audit involving Rs. 33.79 objections, particularly actually audited Officers crore. Only 8% of the those pending for total objections more than five years cleared during 2005/06 to 2009/10 Motor Yes since 1960; Internal audit 3 posts of First Compliance is delayed Effective action may Vehicle was completed for about 94%, Division Assistants – settlement rate is be taken by the 82% and 73% of the offices out of sanctioned 8 under 25% Department to settle selected for audit during were vacant the pending 2011/12, 2010/11 and 2012- paragraphs 13, respectively Stamps & There is no IAW in the Proposal made by C Registration department. GoK is yet to &AG in 2009/10 to Fees decide on the proposal expedite the setting up submitted by the Department of IAW is pending; in July 2008. recommendation reiterated in 2010/11 to 2012/13. Fisheries Exclusive IAW not Audit team from the Non-establishment of established; huge shortfall in Directorate conducted the IAW exposed the coverage of field offices in audit of the field Society to the risk of audit during 2007/08 to offices and reported financial irregularities, 2011/12 the findings to the if any, remaining Director undetected and continued non- detection of irregularities Forest Established in 1977/78; Internal audit was Non-compliance to Internal Audit Manual not largely non-existent on internal audit reports prepared; out of 124 auditee account of vacancies reflects the inadequacy units in the department, the amongst key staff and lack of shortfall in internal audit effectiveness of ranged from 80 to 90% during internal audit; | Annexures 162 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Department/ Functioning IAW Adequacy of Audit Compliance with What the C&AG Agency Staff audit reports recommends 2009 to 2012 Government should take necessary action would be taken to prepare internal audit manual and to fill up the vacancies Mining Internal Audit Manual codifying the practices and procedures relating to conduct of internal audit may be prepared by the Department. The coverage of internal audit may be enlarged and timely compliance ensured Social No internal audit of residential Shortfall in internal Welfare schools/colleges conducted audit to lack of audit Department during t 2008/09 to 2010/11. staff - Karnataka For 2011/12, against the target Residential of 542 schools fixed for Educational internal audit the achievement Institutions was only 243 schools in 10 Society districts (45%). For 2012/13, development of Audit program is in progress Sericulture IAW functioning since 1984. Shortfall in coverage As of March 2013, Internal control During 2010/11 and 2011/12, of Internal Audit to 12,283 paragraphs ineffective as there shortfall in audit coverage inadequate staff with money value of were shortfall in (number of offices not strength Rs. 96.38 crore Internal Audit covered) was 28% and 55%, outstanding for coverage during 2010- respectively settlement, of which, 11 and 2012-13 and Rs. 69.51 crore Departmental manuals pending for more than were not revised since 5 years. Recoverable 1954 amount aggregated to Rs. 7.83 crore Karnataka No; its voluminous One post each of State Drugs transactions had never been Accounts Officer and Logistics and subject to any internal audit so Accounts Warehousing far Superintendent created Society Bangalore Regular internal audit not part Water of the internal control Supply and mechanism Sewerage Board under Urban Development Department Karnataka No IAW set up in the Board The Board should put Building and and hence no internal audit in place an effective | Annexures 163 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Department/ Functioning IAW Adequacy of Audit Compliance with What the C&AG Agency Staff audit reports recommends Other conducted during 2008/13 internal audit Construction mechanism to guard Worker’s against irregularities in Welfare the implementation of Board welfare schemes GoK has agreed to introduce a dedicated independent IAW Source: Compiled from Reports of the C &AG 2010/11, 2011/12 and 2012/13 | Annexures 164 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 9.2 NOTE ON INTERNAL AUDIT PRACTICES IN GOI AND OTHER STATES Central Government Government of India, Ministry of Finance prescribes setting up of an efficient internal audit organization to ensure both accuracy in accounts and efficiency in the operation of the accounts set up 172. The scope and function of internal audit includes checking the initial accounts maintained in executive offices with a view to ascertain as to how far they are following the rules in financial matters covering checking of all accounts records including those relating to fund accounts, loan and advances and records of physical verification of stores, equipment’s, tools and plants, etc. Internal audit at the central level is driven by the Internal Audit Division of the Comptroller General of Accounts (CGA). According to its website, Internal Audit has been recognized as an aid to the higher management for monitoring the financial performance and effectiveness of various programs, schemes and activities. Since 2007, the CGA seeks to change the approach to internal audit in ministries and departments from a control focus to a management-support function, thus recognizing a shift from compliance to risk based approach . A number of developments have taken place at the central level for improving internal audit procedures and standards and bring them in line with international best practices and build capacity of the internal audit staff.  Recommendations on strengthening internal audit made by the 14th Report of the 2nd Administrative Reform Commission (April 2009) was accepted by the GoI  A decentralized model is being followed at the central level where internal audit is carried through the Internal Audit Wings (IAW) in the Principal Accounts Office of the ministries/ departments under the Controller of Accounts, but under overall guidance of the CGA  Guidance for Planning, Performing and Reporting on Internal Audit Engagements in the Government was issued in August 2007.  Central ministries/departments have their own Internal Audit Manuals based on the above Guidance (e. g. Ministry of Home Affairs, Ministry of Road Transport and Highways,  A Centre of Excellence for Internal audit was established in 2007 under the CGA with the objective to - (i) develop into a repository of technical resource and guidance center for advising internal audit wings of line Ministries on effective, independent and objective internal audit functions, procedures, and "best practices"; (ii) enhance the quality of internal audit so that the result of internal audit become an input into the processes of planning, project formulation and implementation and (iii) provide an assurance to the management that the "controls" in place provide adequate protection against likely "risks".  An Internal Audit Report Template based on a risk based approach to internal audit engagements was issued in December 2012  Greater emphasis is on training the internal audit staff  An Annual Review Report on the performance of Internal Audit Wings is brought out by some departments, highlighting major irregularities observed during the course of internal audit. Ministries/departments such as Ministry of Home Affairs and the Central Board of Excise and Customs have published their annual review up to 2011/12 and these are available in public domain. CGA is endeavoring to achieve a Level 4 as per the Internal Audit Capability Model (IA-CM), for the public sector developed by the IIA implying that internal audit is undertaken so as to integrate information from across the organization to improve governance and risk management Rajasthan (centralized function as a Directorate under Finance Department; internal audit manual not developed) The Finance Department has an Audit and Inspection Division that deals with amongst others Internal Audit, Special Audit and Physical Verification Reports of the Director Inspection. Within the Finance Department, matters pertaining to the Directorate of Inspection is examined by an Officer on Special Duty and disposed of by the Secretary Finance. There is a system of rolling program of internal audit inspections and the audit program issued by the Director of Inspection are published on the website of the Finance Department173. However, it seems that there is no internal audit manual or guidelines defining the objective, scope, reporting requirements, duties and powers etc. 172 Chapter 12 of Civil Accounts Manual, Controller General of Accounts, Ministry of Finance, Government of India 173 http://finance.rajasthan.gov.in/grpresult.asp?grpid=24&grpname=INSPECTIONDEPTT | Annexures 165 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Andhra Pradesh (centralized function in Finance Department; internal audit manual developed) The state started strengthening its internal audit function from 2003 by constituting internal audit committees at the state and district level, entrusting internal audit of some departments to the Director State Audit and creating a cell in the Finance Department to oversee the activities of internal audit. An Internal Audit Manual has been developed 174 and implemented that details the role of the function, planning and conducting the audit and reporting requirements supplemented by checklists and questionnaires. Delhi (centralized function as a Directorate of Audit; internal audit manual developed) The union territory set up an internal audit organization in 1977 as one of the branches of Principal Accounts Organization. In 1981, a Directorate of Audit was constituted as an independent entity headed by Principal Secretary (Finance) as ex-officio Director of Audit and assisted by Spl. Secretary Finance and Controller of Accounts (Audit). The terms of reference of the Directorate have been detailed 175 and an Internal Audit Manual was developed in 1989 and revised in 2008. 176 The Directorate does not aim to cover 100% transactions, but makes a selective approach but does a random audit for a few selected months, but efforts are made to cover all units at least once a year. Overall, the Directorate of Audit is guided by the Chapter 12 of the Civil Accounts Manual. Kerala (decentralized function under supervision of an Internal Audit Cell in the Finance Department; Internal Audit Manual developed) The state had established an Internal Audit Cell in the Finance Department in the 1989s to supervise and oversee the working of the Internal Audit. Each department has an Internal Audit Wing under the head of department. An Internal Audit Manual has been developed in 2008. The Government of Kerala reviewed the working of the Internal Audit Wings in 2003 and 2005 based on the observations of the State Accountant General and initiated a number of steps to strengthen the function. Internal audit reports are submitted to the Finance Department. West Bengal (centralized function) An Internal Audit Wing under Finance Department was created 1998 subsequently re-named as Finance (Internal Audit) Department and now functions as a Directorate of Internal Wing. West Bengal claims to be the first state in the country to create an Internal Audit under Finance Department to improve financial discipline in various departments, local bodies and Government undertakings. Odisha (centralized function with decentralized audit units) The internal audit system is called the Common Cadre Audit established in 22 out of the 38 administrative departments under the control of the Finance Department. The Common Cadre Audit Organization consists of 114 Assistant Audit Officers and 359 Auditors. Besides, there is an Efficiency Audit Organization that conducts evaluation studies. Uttarakhand (centralized function) An Uttarakhand Audit Act, 2012 has been enacted and the responsibility of Internal Audit is placed upon a Director – Audit under the Finance Department supported by a staff of about 100. All government agencies are covered under internal audit and an ABC categorization has been according to the level of revenue earned or spending of each department and this determines the periodicity of the audit –  Category A – revenue/expenditure over Rs. 300 crore – annual audit  Category B - revenue/expenditure between Rs. 200 to Rs. 300 crore – once in two years  Category C - revenue/expenditure less than Rs. 200 crore – once in three years An audit plan is prepared each year and approved by the government. A Manual of Internal Audit has been prepared and implemented. Audit observations are settled at the level of the head of department, Secretary and Chief Secretary Level with representation from the Accountant General at all levels. Department-wise audit committees have been constituted. 174 By the Center for Good Governance 175 http://www.delhi.gov.in/wps/wcm/connect/doit_audit/Directorate+of+Audit/Home/Function+and+Services 176 By the Financial Management Research and Resource Society | Annexures 166 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 9.3 NOTE ON LEGISLATIVE COMMITTEES 1. Committee of Public Accounts (CoPA) a. The Budget Manual (clause 300 and 334) describes that after the Appropriation Accounts, Finance Accounts and the Audit Reports are laid on the table of the Houses of the Legislature, they shall be referred to the PAC. The reports of the C&AG once tabled in the State Legislature are referred to CoPA of the Legislature. The CoPA examines these reports, may recommend actions and sanctions to be implemented by the executive, in addition to adopting the recommendations made by the external auditors. In addition, the CoPA examines special subjects that are assigned to it by the Legislature (suo moto examination). The AG and Finance Secretary (to render advise), Heads of Departments, Secretaries to the Government (for eliciting information on any matter pertaining to their departments) are invitees to these committees. The concerned Secretary to Government will have to appear as witness before the Committee when it examines the particular paragraph in the Report (clause 332 of the Budget Manual). b. The CoPA may take up review of some audit reports and/or may take up only selected audit observations in a particular audit report and selection of audit reports may not follow any chronological order. During 2008-2013, the CoPA held 147 meetings, covered 502 paragraphs (audit observations), and issued 19 reports (see Table below) containing 634 recommendations, which was tabled before the State Legislative Assembly. This review covered about 15 departments. The State’s Finance and Appropriation Accounts have been reviewed from 1998-99 to 2010-11. The new CoPA of the 14th Assembly constituted in August 2013 (post elections) have held 14 meetings and is about to issue its first report. Disposal of Action Taken Notes for 2010-11 and 2011-12 is under process (as of November 2013). In July 2011, the CoPU constituted a Sub Committee specifically for the purpose of discussing Action Taken Report on the recommendations of the CoPU. The Sub Committee has submitted to Legislature two reports on the ATR (Forest and Urban Departments). Table 65: Year wise Number Reports issued by CoPA Year 2009 2011 2012 2013 No. of Reports 5 10 3 1 Departments  Forest, Ecology and  Public Works  Forest, Ecology and  Finance Covered Environment  Finance Environment (ATR)  Health and Family  Irrigation (Minor)  Urban Development Welfare  Industries and Commerce (ATR)  Home  Revenue  Food and Civil Supplies c. In depth hearings177 on selected key audit findings are held by the CoPA for examining the officers of the departments whose audit reports are taken up for review (but not for all departments having audit observation). Table 66: Year wise Number of Hearings held by CoPA Year 2008 2009 2010 2011 2012 2013 (up to Jun) No. of Hearings Held 11 22 37 33 34 5 2. Committee of Public Undertakings (CoPU) 177 Detailed procedure for appearance before the PAC is described in the Budget Manual (clause 332). | Annexures 167 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix a) The CoPU was separately constituted for the first time in 1969 in view of the increased investments in public sector undertakings and there was a call for specific committee to review their audit reports. The Secretaries of the Administrative Departments are responsible to furnish replies to the CoPU and they and the Chief Executives of the SOEs may have to appear in person before the Committee to tender evidence. The Accountant General, Principal Secretary Department of Public Enterprises and the Finance Secretary are invitees to the deliberations of the b) The CoPU has so far submitted 129 reports (since 1973) before the Legislatures. Reports of the C &AG up to 2008-09 have been examined while examination of reports for 2009-10 and 2010-11 are in process and 2011-12 is to be taken up. In depth hearings are held by the CoPU for examining the officers of the SOEs whose audit reports are taken up for review. Table 67: Year wise Number of Hearings held by CoPU Year 2008-09 2009-10 2010-11 2011-12 Up to Dec Jan 2013 to 2013 Nov 2013 No. of Hearings Held 33 37 58 23 40 20 3. Committee of Local Bodies and Panchayati Raj Institutions (CoLB) a) CoLB was first constituted in March 2010 to examine the C&AG audit reports on Municipal Corporations and Municipalities and rural local bodies (the Panchayats). About 33 hearings have been held till December 2013 and the CoLB is supported by officers from the secretariat, and of the Finance Department as required. b) CoLB has completed the examination of audits reports for 2007 and 2008 and Action Taken Reports are to be prepared and examination of 2009 report in under process (as of January 2014). c) KSAD is required to submit a consolidated report on the accounts and audit of the ULBs and GPs in the State. This requirement is required from FY 2009-10 and KSAD has submitted the report for this period to the CoLB. CoLB would be reviewing this report along with the reports on local bodies provided by the AG. | Annexures 168 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix 9.4 NOTE ON IFMIS 1. Financial Management Information Systems (FMIS): Financial management information systems (FMIS) can be defined as a set of automation solutions that enable governments to plan, execute, and monitor the budget by assisting in the prioritization, execution, and reporting of expenditures, as well as the custodianship and reporting of revenues. Accordingly, FMIS solutions can contribute to the efficiency and equity of government operations. FMIS (refer chart) is usually built around a core treasury system which supports key budget execution functions such as, accounts payable and receivables, commitment and cash management, the general ledger and financial reporting, combined with budget formulation (multi-year), debt management and public investment management modules. The non-core PFM systems linked with FMIS solutions are personnel management/ payroll, revenue administrations (tax and customs), market operations/securities, public procurement, inventory and property management, and performance monitoring. When FMIS and other PFM information systems are linked with a central data warehouse (DW) to record and report all daily financial transactions, these offer reliable consolidated results for budget analysis, decision support, performance monitoring and web publishing. Internationally, countries have moved beyond core treasury computerization and have adopted the concept of implementing FMIS. 2. Approach & Timeframe: The development of integrated FMIS solutions is a major challenge in many developing countries, including several large economies similar to India (e.g., Brazil, China, Indonesia, Republic of Korea, and Russian Federation). The continuity of political commitment and leadership, the scale of investment on technology and capacity building, change management activities, design and implementation methodology, and the duration of system development and deployment are important parameters, affecting the successful completion of these initiatives. A comparison of the IFMIS initiatives in selected APEC economies is also presented below: | Annexures 169 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix Figure 5: Comparison of the initiatives for transition to integrated FMIS solutions in APEC (Nov 2012) Source: Cem Dener’s presentation (“A tour around the world: Transition to integrated FMIS solutions�) - APEC FMIS Workshop in Bogor, Indonesia (Nov 2012). 3. Trends in FMIS ICT solutions: The type of information and communication technology (ICT) solution selected for FMIS projects plays an important role in project implementation. Until the early 2000s, most countries developed their FMIS ICT solutions as distributed database applications based on a client-server model, with application software, database and servers installed in every office. FMIS applications run locally (off-line) and the consolidation of data is achieved by replicating all databases at a central location on a daily basis through a network. This approach was abandoned after 2000, with the advent of centralized web-based solutions. 4. Starting from the early 2000s, FMIS projects were designed as centralized database applications based on web-based solutions in parallel to the advances in telecommunications infrastructure and the expansion of broadband networks. In web-based systems, application software, database and servers are located centrally, and online access is provided to all users through a countrywide network. A backup center is established to replicate all central databases automatically. Web-based solutions reduce the duration and cost of FMIS implementation providing effective centralized systems supporting decentralized operations. 5. Regarding the type of application software (ASW) developed for FMIS needs; two main types of solutions exist. Until the early 2000s, FMIS capabilities were implemented mostly through Custom Developed Software (CDSW) mainly because of the technical limitations of commercial packages (originally designed for private sector needs) and also the lack of adequate ICT infrastructure in many regions. Since the introduction of web-based applications after 2000, a shift toward customized Commercial off-the-shelf Software (COTS) packages (tailored to public sector needs) began. Nevertheless, no single package can provide all the FMIS functionality needed for country/state specific needs. Hence, most of the new FMIS solutions designed after 2005 integrate customized COTS packages with specific CDSW modules (including open-source software) to cover a broader spectrum of PFM functions. Possible country/state specific options | Annexures 170 Government of Karnataka - Public Financial Management Reform Action Plan – 2014 – Appendix (COTS / CDSW) for FMIS application software development need to be clarified based on a detailed system design and realistic cost/benefit analysis (considering the total cost of ownership). | Annexures 171