Government of Karnataka - Public Financial Management Reform Roadmap - 2014 89023 v1 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 FINANCIAL MANAGEMENT UNIT - INDIA COUNTRY OFFICE - THE WORLD BANK May 1, 2014 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 CONTENTS Structure of the Report...................................................................................................................................3 Executive Summary ......................................................................................................................................5 Chapter 1: Background, Scope and Methodology.................................................................................. 18 Chapter 2: Overview of State Finances.................................................................................................. 22 Chapter 3: Accomplishments of 2004 Public Financial Management and Accountability Action Plan .. 27 Chapter 4: Analysis, Gaps, and Recommendations - 2014 ..................................................................... 34 Chapter 5: Way Forward ...................................................................................................................... 43 Annex 1: Proposed PFM Reform Action Plan - 2014 .................................................................................. 45 Annex 2: 2004 - PFMA Action Plan Accomplishments and Current Status ................................................ 55 | Structure of the Report 2 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 STRUCTURE OF THE REPORT 1. The Main Report comprises the following chapters: a. Executive Summary provides the overall view of the reform action plan. b. Chapter 1 outlines the background, scope and methodology for the study c. Chapter 2 outlines the overview of the state finances d. Chapter 3 describe the accomplishments made against the 2004 agreed PFMA action plan e. Chapter 4 provides an overview of the analysis, gaps and recommendations made in the study f. Chapter 5 describes the way forward for implementation of the action plan. g. Annex 1: PFM Reform Action Plan - 2014 contains a thematic-wise plan outlining the actions to be taken, the responsible department for the actions, and the expected timeframe for completing the actions. The detailed analysis of the issues and the logic for the action plan are provided in the respective sections of the Appendix. h. Annex 2: 2004 PFMA Action Plan - outlines the current status of action taken on 2004 PFMA Action Plan: This contains the action plan as proposed in the 2004 report, updated with the current status of actions in the identified areas. In case where the actions have been taken and completed by the Government of Karnataka, the impact has been documented. 2. The appendix comprises the following sections: a. Section 1: Theme One: Strengthening PFM Legal And Institutional Framework b. Section 2: Theme Two : Enhancing Comprehensiveness and Credibility of the Budget c. Section 3: Theme Three: Strengthening Accounting, Reporting, Controls, and Transparency d. Section 4: Theme Four: Improving Fiscal Assets and Liability Management System e. Section 5: Theme Five: Strengthening Audit and Legislative Oversight f. Section 6: Theme Six: Improving PFM in Local Self Governments g. Section 7: Theme Six: Improving PFM in Public Sector Undertakings (State Owned) Each section describes the various areas of public financial management in the Government of Karnataka grouped into thematic reform areas. Each proposed reform area has a discussion of the background, the reform actions proposed in the 2004 PFMA Action Plan, the progress of reforms over the last decade, the issues presently identified, and the rationale for the reform actions proposed. h. Section 8: 2014 Action plan: This section describes the action plan with next steps to be followed under each activity of the action plan. | Structure of the Report 3 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 ACRONYMS AG Accountant General (Accounts and Entitlement) KFC Karnataka Financial Code (A&E) ALMC Asset Liability Management Cell KFRA Karnataka Fiscal Responsibility Act AMS Audit Monitoring System KII Khajane II C&AG Comptroller and Auditor General (India's KIPA Karnataka Institute of Public Auditors Supreme Audit Institution) CCO Chief Controlling Officer KLAC Karnataka Legislative Assembly Council CoLB Committee on Local Bodies and Panchayati Raj KSAD Karnataka State Accounts Department Institutions CoPA Committee on Public Accounts KTTP Karnataka Transparency in Public Procurement Act CSS Centrally sponsored schemes LFAFRA Local Fund Authorities Fiscal Responsibility Act CTD Commercial Taxes Department MIS Management Information Systems MPAS Model Panchayat Accounting System DCB Demand Collection Balance MTFP Medium Term Fiscal Plan DDO Drawing and Disbursing Office NLTA Non-Lending Technical Assistance DMA Directorate of Municipal Administration OBB Off Budget Borrowings DoFP Delegation of Financial Powers PAC Public Accounts Committee DPAR Department of Personnel & Administrative PEFA Public Expenditure and Financial Accountability Reforms DPE Department of Public Enterprises PMS Project Management Software DOT Directorate of Treasuries PRI Panchayat Raj Institutions (Rural Local Governments) DRSC Departmentally Related Standing Committees PSU Public Sector Undertakings DMTFP Departmental Medium Term Fiscal Plan PWD Public Works Department DSA Debt Sustainability Analysis RBI Reserve Bank of India EIU Economic Intelligence Unit RDPR Department of Rural Development and Panchayati Raj FD Finance Department of GOK RE Revised estimates FMRC Fiscal Management Review Committee SOE State Owned Enterprises FY Financial Year PFMA State Finance Accountability Assessment GoI Government of India SPV Special Purpose Vehicles GOK Government of Karnataka TP Taluk Panchayats (Block level Rural Local Government) GP Gram Panchayats (Village-level Rural Local UC Utilization Certificates Government) HRMS Human Resource Management System UDD Urban Development Department IFA Internal financial advisors ULB Urban Local Bodies (Urban Local Governments) IFMIS Integrated Financial Management Information WRD Water Resources Department System IGAS Indian Government Accounting Standards ZP Zilla Panchayats (District-level Rural Local Government) KBM Karnataka Budget Manual | Structure of the Report 4 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 EXECUTIVE SUMMARY BACKGROUND 1. The Government of Karnataka (GOK) is a reform-oriented state and proactive in undertaking several initiatives to improve governance, accountability, and transparency through a mix of reforms in administration, service delivery, and public financial management (PFM). GOK has implemented various reforms like Sakala (Karnataka Guarantee of Services to Citizen Act 2011) for ensuring timely service delivery to citizens; has adopted a results framework as a tool to measure the outcomes of the funds used by the State; has implemented the Karnataka Fiscal Responsibility Act (KFRA) 2003 for fiscal consolidation and better fiscal management; and has ushered in transparency in procurement through implementation of the Karnataka Transparency in Public Procurement Act, 1999 and e-procurement system across the state. GOK has carried out e- governance initiatives in Commercial Taxes, Excise, Stamps and Registrations, Urban Local Bodies (ULBs), and Gram Panchayats (GPs) besides automating the Treasury and human resource functions to provide faster and hassle-free service to the end users and also to strengthen PFM systems. The objectives of the above reforms and e-governance initiatives are not only to improve the efficiency and effectiveness of service delivery to the citizens, but also to increase transparency in the process, reduce paperwork and time taken for responses, and to eliminate discretionary actions that can be carried out in a manual environment. The reforms undertaken by GOK have been recognized at various fora for their effectiveness in improving service delivery. 2. GOK has been carrying out fiscal reforms and PFM modernization since 2001, which is one of the strategic core elements of the overall GOK reform strategy1 — to improve transparency and service delivery in the state. The action plan 2 developed as part of the Public Financial Management and Accountability Study (Karnataka, February 2004),3 carried out by the World Bank in active collaboration with GOK, provided the necessary impetus for GOK to initiate PFM reforms. While GOK carried out reforms in many of the strategic areas highlighted in the 2004 study, there are areas in which significant challenges remain unaddressed. 3. GoK intends to address these challenges and further strengthen the PFM systems and enhance the accountability mechanism in the State. To achieve this objective several reforms are underway such as : (a) development and roll out of an upgraded Integrated Financial Management Information System across the state (Khazane II); (b) implementing an e-payment system to ensure quick and transparent disbursements; (c) upgrading its human resource management system; (d) strengthening financial reporting to make them real time and support decision making; (e) computerizing pension payment systems; (f) strengthening the State Accounts Department; (g) strengthening Internal Financial Advisor system; and (h) providing training and capacity building to all finance and accounts officers of the State. In this context, the GoK requested the Bank’s support to prepare a holistic PFM Reform Action Plan which it can implement in the medium term. Bank agreed to support this initiative through non-lending technical assistance (NLTA). The Bank along with the GOK took stock of the 2004 reform action plan and developed a PFM reform action plan, taking into account the various actions and initiatives currently under implementation. The output of the NLTA is the PFM Reform Action plan 2014. 1 Karnataka State Planning Board, Karnataka: A Vision for Development , December 2008. 2 Action Plan to Improve Public Financial Management and Accountability assessed the nature and degree of PFM risk, and the key actions to be taken to mitigate such risks. 3 This study examined Karnataka’s PFM system and covered the following key areas: (a) budget development, budget execution and monitoring; (b) fiscal transparency; (c) accounting; (d) financial reporting; (e) internal controls; and (f) external controls including auditing and legislative oversight. | Executive Summary 5 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 OVERVIEW OF STATE FINANCES 4. The GOK state finances have experienced a noticeable improvement since introduction of the Karnataka Fiscal Responsibility Act (KFRA). The KFRA has set fiscal targets (numerical rules) which have been achieved by GOK within the stipulated time frame and continues to maintain these targets over the years (Table 1). Table 1: Numerical Rules in Karnataka Fiscal Responsibility Act and status of compliance Numerical Target/Limit Remarks Rule Deficit Revenue Deficit4 to be nil by 2006 Revenue surplus achieved since 2004/05 Rules Reduce Fiscal Deficit5 to be no more than 3 percent of Fiscal Deficit maintained below 3 percent except GSDP during 2009/10 (with legislative approval), but reverted back to less than 3 percent in 2010/116 Debt Rules Guarantees not to exceed 80 percent of Revenue Limit achieved since 2000 Receipts of second previous year Reduce Total Liabilities7 as a percentage of GSDP and Achieved since 2010/11 bring it to no more than 25 percent of GSDP by 2015 5. In the recent past, the state government has improved its capabilities of estimation of expenditure and revenue, and the revenue and expenditure outturns have improved over the years. The variance has been less than 5 percent in two years on the expenditure side and less than 10 percent on the revenue side (Table 2). Table 2: Expenditure and Revenue out-turns Particulars/Year 2012-13 2011-12 2010-11 Actual Expenditure Deviation (as a percent of budget estimates) 93.7% 101.5% 104.1% Actual Revenue (Tax revenue and non-tax revenue) as a percent of budget 105% 106% 107% estimates 6. GOK’s fiscal position is largely influenced by the revenue side as two-thirds of the state’s revenue is from own sources. Simplification and rationalization of tax structure, along with simplification of process of filing tax returns and extensive use of technology, has ensured effective mobilization of resources from various taxes, which have helped GOK to maintain a better fiscal position. Though tax revenues have been consistently growing, GOK has not improved revenues on the non-tax front, which continues to decline. The state’s Fiscal Management Reform Committee has recognized this issue and suggested departments to be more proactive in identifying and collecting their non-tax revenue. 4 Defined as difference between revenue expenditure and revenue receipts 5 Defined as total disbursements from the Consolidated Fund (excluding debt repayment) over total receipts into the Consolidated Fund (excluding debt receipts) 6 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 7 Defined as the sum of liabilities under the Consolidated Fund and the Public Account of the state | Executive Summary 6 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 7. In terms of expenditure, generally the revenue expenditure has been below the revenue receipts leading to revenue surplus, which was used as one of the sources to fund capital expenditure. Over the years, revenue expenditure has been increasing mainly due to subsidies, which reduced the revenue surplus, and affected the outlay available for capital expenditure. Subsidies have increased from Rs.3,399 crore in 2008-09 (8 percent of the revenue receipts) to Rs.16,661 crore, which is 18 percent of the revenue receipts in the 2013-14 (revised estimate). The revenue surplus for the corresponding period declined from Rs.1,635 crore (which is 3.8 percent of revenue receipts) in 2008-09 to Rs.64 crore in 2013-14 (revised estimate), which is 0.1 percent of the revenue receipts. With the increasing coverage of subsidies, there are demands beyond the provisions made in the budget; most often these have to be accommodated through supplementary Subsidies, Revenue surplus and Fiscal Deficit estimates. GOK’s Medium-Term Fiscal 20,000 Plan (MTFP) 2014/18 recognizes that the challenge lies in ensuring that these 10,000 subsidies do not become a permanent source of additional support and - 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 thereby deter sectors from undertaking (10,000) (RE) reforms. GOK acknowledges that expenditure on subsidies needs to be (20,000) moderated in the medium-to-long term Explicit Subsidies Revenue Surplus Fiscal Deficit to make them fiscally sustainable through improving systemic efficiencies in sectors like energy, rationalize 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. 8Moreover, most of the revenue expenditure is in the nature of committed revenue expenditure like salaries, pensions, interest, subsidies, etc., which affects the maneuverability of the state to prioritize expenditure in this space. The state Fiscal Management Review Committee has advised GOK to re-evaluate expenditure commitments as well as relook at the subsidies and work on providing more target-based subsidy. 8. GOK has to create fiscal space for public investment spending (capital expenditures) 9 through the budgetary processes but within overall fiscal constraints which include - (a) budget envelope available after meeting revenue expenditure; (b) limits to fiscal deficits mandated by the KFRA; and (c) restrictions on gross public debt. Increasing revenue expenditure, reducing revenue surplus, and statutory limitations on borrowings affects the fiscal outlay available to the GOK for carrying out capital expenditure. 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 its overall impact on the fiscal position of the state and that GOK should ideally move to medium-term (3 to 5 years) appraisal and approval cycle for the schemes. Going forward, GOK needs to prioritize capital expenditure to achieve their fiscal targets as well as manage their public investment funding more systematically by adopting the above suggested approach. 8 During 2013-14 (revised estimate), 94 percent of the receipts are expected to fund committed revenue expenditure and only 6 percent is left for the GOK to fund other revenue expenditures. 9 GOK Capital spending has been about 40% of total government spending, and as compared to other states is relatively higher | Executive Summary 7 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 ACCOMPLISHMENT OF 2004 ACTION PLAN 9. A Public Financial Management and Accountability Assessment (PFMA) was carried out by the World Bank in active collaboration of the Government of Karnataka (GoK) in 2004. Drawing on the analysis and recommendations presented in the PFMA, GoK and the Bank jointly developed an Action Plan to improve PFMA (referred to as the 2004 PFMA Action Plan) to continue and deepen GOKs Public Financial Management (PFM) improvement program with the objective to improve PFM and Accountability for making government more effective, accountable and responsive ). The PFMA Action Plan was categorized into six strategic segments – Budget preparation and implementation, financial computerization and MIS, Accounting, Audit/PAC responsiveness and follow up, PFM in other Public Sector Agencies and Institutional Arrangements and Capacity Building – with several actions under each to achieve the objectives. The work done by GoK in terms of preparing the vision for the reforms, the strategy for planning and implementing the reforms is commendable. GoK accepted and addressed majority of the actions outlined in the action plan. The major areas of accomplishment which emanated from the 2004 report are summarized below:  Improved fiscal discipline and budget outturns;  Improved fiscal transparency in terms of availability of budget and other financial documents to public;  Implemented Computerized Treasury across the State which improved the overall decision making and control environment on the budget, cash flow and treasury management leading to better cash management and reducing the short term loans by the State.  Implemented e-governance initiatives in commercial taxes which have helped in improving revenue collections as well as to provide faster service to the users.  Implemented Human Resource Management System (HRMS) which has helped in timely payment of salaries and better control over this expenditure  Implemented e-procurement across the state which has improved competition as well as increased saving to the government;  Improved timelines in completion of accounts and audit reports  Improved recording and reporting of fiscal assets and liabilities of the government and  Implemented Fund based computerized accounting system in ULBs and Double entry based computerized accrual accounting system in Gram Panchayats (GPs) to improve local self-governments maintenance of accounts and completion of audits.  GoK has issued new cadre and recruitment rules for KSAD staff covering both entry-level qualifications and mandatory training for promotions which in the medium term will provide qualified staff at all levels and a training curriculum has been developed for accounting, financial and auditing training, currently under implementation.  Liberalized delegation of financial powers for release of funds to prioritize the funds release and usage  Phased out LOC payments and have made Treasury payments compulsory for all Departments 10. GOK has been a pioneer in the area of PFM reforms and has been pushing the boundaries to the next level in most of the PFM areas. GoK embraced reforms that included the 2004 PFMA Reform Action, as part of its strategy to improve PFM and accountability and gradually introduced necessary changes in systems and procedures to achieve its objective. They continue to improve PFM by strengthening their systems which includes policies, process, and people and are embarking on upgrading its PFM computerized systems (such as Khajane and HRMS) and GOK recognizes that still there are challenges in its pursuit for a strengthened PFM. These have | Executive Summary 8 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 brought in significant changes, but this was not accompanied with a comprehensive review of the PFM and accountability framework and its actual working to ascertain the current situation. An assessment of implementation of the 2004 PFMA Reform Action Plan (ibid) indicates accomplishments in some areas while calling for a need for further efforts in implementing reforms in others.. GoK, therefore, intends to build up an updated reform action plan to further strengthen PFM and accountability. For this purpose, a detailed understanding of the current PFM structures and the accompanying strengths, weaknesses, opportunities and threats (SWOT) has been done as part of this study (description, findings and analysis are detailed in the Appendix to this report). The assessment has been conducted at two levels: one, at the policy level and two, at the implementation level. The SWOT analysis was used as the base line for developing a new PFM reform action plan by GoK. The ongoing reforms, challenges, and opportunities have been duly recognized in the 2014 PFM reform action plan which is outlined below. SWOT ANALYSIS 11. The GOK PFM system presents both strength and weakness. The PFM framework can be examined at two broad levels: one at the policy level and another at the implementation level. On the assessment of the framework at both the levels, there are strengths and areas of improvement which are summarized below. 12. The PFM Framework in the state is guided by a set of acts, manuals, rules, and procedures supplemented through Government Orders issued from time to time . These manuals and handbooks are outdated; and with the imminent introduction of the modernized integrated financial management information system (IFMIS), Khajane II (KII), all the manuals and codes, including certain acts, need to be aligned with the revised business processes as planned in Khajane II. This is an opportune moment for GOK to update and revise its financial manuals taking into account the requirements of the state. 13. Capacity constraints in the finance cadre of the state inhibit implementation of the PFM framework. Internal Financial Advisors (IFA) were envisaged to play a major role in implementing the PFM framework in the state and supporting the departments (particularly large spending departments) in carrying out PFM tasks – however they are not being effectively utilized due to capacity constraints. The Karnataka State Accounts Department (KSAD), which is a key PFM institutional pillar at the state level and supports state accounting function to a large extent, is also affected with capacity constraints that influence the state’s overall PFM implementation. KSAD, therefore, needs to be strengthened as part of the reform strategy for improving the PFM framework. Recruitment of IFAs can preferably be from KSAD, and suitable officers have to be identified, trained, and groomed for this purpose. An extensive human resource and skills mapping exercise in KSAD should be carried out to identify skill gaps and develop strategy for enhancing competencies for taking up challenging tasks; organizational structure of KSAD has to be reviewed particular in terms of staffing and skill sets to carry out the accounts and audit function both timely and efficiently and staff to be identified and skilled to carry out the functions of PFM practitioners in the Finance Department. 14. The well-established budget preparation and approval processes still need to be strengthened. GOK presents the budget before the start of the year, but obtains approval on a Vote on Account for the first four months; the full budget is passed well within the fiscal year. GOK should aim to pass the entire budget before the beginning of the fiscal year as a good practice and to enhance predictability of availability of funds. | Executive Summary 9 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 15. The budget outturn for revenue and expenditure has significantly improved over the years, but there are substantial compositional variances and large savings in budget allocations due to significant adjustments through supplementary budgets. There are multiple in-year adjustments by way of three supplementary budgets and re-appropriation of significant amounts. Supplementary budgets are not “fiscally neutral� as required by the KFRA; and commitments of significant amounts are included as a part of these estimates, which affects the budget-execution process. Too many supplementary budgets could affect fiscal discipline as over-reliance is placed on the supplementary budget rather than the original budget. GOK should aim to reduce the number of supplementary estimates passed through the year to ideally one and also have enhanced control over increasing re-appropriations. There is therefore a need to improve budget credibility in these areas. Predictability in availability of funds has improved by way of enhanced delegation of powers in respect of providing sanctions at the departmental level, and release of funds without repeated recourse to the finance department with good success in improving pace of spending and some reduction in rush of expenditure at the year end. 16. Budgeting could be further improved by a review of the manner in which provisions are made for certain items such as salaries, capital commitments and public investment funding. GOK should move toward providing budget only for filled posts and planned additional recruitment, which could release unnecessary budget provision of around Rs.1,000 crore, which can be utilized to budget for other productive purposes in the original budget itself thus avoiding in-year adjustments. GOK needs to have better control on the capital commitments since internal control in this area is weak and leads to unfunded commitments and unpaid bills that affect the fiscal situation of the state. Budget priority should be made for payment of arrears, then for completion of ongoing works, and lastly for adding new works. During the past two years, the Public Works Department (PWD) has accumulated more than Rs.1,000 crore (~US$200 million) of unpaid bills. Full provision for payment arrears if made could adversely affect the fiscal indicators of GOK. Over-commitment without adequate budget leads to arrears, which is not in line with the KFRA. PWD also required significant supplementary provisions, about 40 percent of original budget estimates during 2010/11 and 2011/12 and 80 percent during 2012/13. GOK needs to develop a strategy to clear the outstanding arrears of payment and control them in future through better monitoring of commitments for capital works. In case of capital commitments, GOK needs to follow the recommendation of Fiscal Management Review Committee for moving to medium-term (3 to 5 years) appraisal and approval cycle for the schemes and prioritize capital expenditure based on fiscal sustainability of such schemes. GOK needs to ensure that no new capital commitments or ad hoc arrears payments are proposed in the supplementary budget, except in case of natural disasters; as such additions distort the fiscal management of the state. It would be prudent if MTEF (rolling forecast) was introduced in PWD and a proper scheduling of works is carried out to work out the budget requirements. Going forward, GOK has to link the budget process with the procurement plans, monthly programme implementation calendar and also move towards performance based budgeting/results based budgeting and align the budgeting process with the results framework document. 17. There exists appropriate controls on transaction-level expenditure, which are largely exercised. Most of these controls are documented in the various manuals and handbooks, updated and supplemented through Government Orders as required by the GOK from time to time, and also automated through the Treasury system. The GOK accounting and reporting systems primarily revolve around the framework applicable nationally, and automation of the Treasury function has strengthened the accounting, reporting, and control framework over the years. Yet, there are weak areas such as reconciliation, compliance with controls, and accounting treatment that need mitigation. While the details are available from treasury on a timely basis, reconciliation is not being timely. | Executive Summary 10 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 These systemic issues are also highlighted in the audit findings that need to be followed up and addressed so that the system in these areas can be improved. Accounting issues such as reversal of earlier year expenditure as well as reversal of amounts from public deposit (to the consolidated fund) need to be addressed. The GOK in consultation with Accountant General (AG) needs to develop the policy and procedures for such reversals. 18. The recent change in fund flow mechanism of centrally sponsored schemes through the state budget as to various implementing agencies would require changes and strengthening to the state accounting and reporting requirements. GOK needs to rework the fund flow arrangement with GOI and envisage using state treasury system/public deposit accounts in place of the bank accounts being used by the implementing agencies which would provide enhanced control and better cash management for the state. 19. GOK has implemented HRMS integrated services register and pay bill software which has improved the payroll process and system in the state. GOK is now upgrading the Payroll system to HRMS II within the next two years. GOK needs to ensure that data validation of all the records is completed and payroll audit is carried out across the state, before the data is migrated to HRMS II. In case of procurement, GOK has successfully implemented KTTP across the state as well as the e-procurement function has been rolled out in more than 200 departments across the state. In case of e-procurement, though the functions have been automated though there are issues in the underlying control mechanisms and data validation; these need to be addressed. The key actions for strengthening e-procurement are (a) CAG IT audit of the e-procurement software and (b) implementation of contract management module. 20. GOK is in an advanced stage of implementing an integrated financial management information system Khajane II (KII). KII is planned to be implemented in two phases: phase 1 covering 12 core treasury modules, and phase 2 covering functionalities of other departments. Piloting of the core treasury modules is expected to be completed by September 2014, all modules are expected to go live from FY15 and rolled out across the state. Key features include budget preparation through the system, electronic payments as a default mode, computerization of the functions of the Drawing and Disbursing Officers (DDO) and bill processing through the system, control over works commitment and payment, accounting for other state owned entities which are not using treasury systems and complete accounting hitherto done on the systems of the Accountant General. Of significant note, the Accountant General is an internal stakeholder and will have access rights to KII. As a system KII is expected to address several of the state’s current reconciliation and accounting issues. In case of way forward a data migration strategy, change management strategy, HR strategy, training plan, and rollout plan has to be developed and implemented by GOK. A GO outlining the timelines and the transition process has to be issued by GOK. Uncoordinated development of various applications across departments using a fragmented approach has proliferated, and there is a need to integrate these to K II so that these are mainstreamed and used for decision- making process. 21. There are improvements in the asset and liability management by GOK with setting up of the dedicated Asset Liability Management Cell (ALMC) for collecting, collating, and maintaining data on guarantees, investments, and loans, and advances The ALMC, however, has staffing, capacity and data constraints that affect its functions. Appointing core finance professionals or staff from Finance Department and training to existing staff would strengthen this cell handling a significant portfolio. A stronger linkage with and more frequent reporting to the Finance Department would ensure that issues are discussed and resolved more frequently. There are serious reconciliation and data integrity issues in investment in public companies and loans | Executive Summary 11 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 and advances provided by GOK – an amount of Rs. 21,287 crore is yet to be reconciled between the records maintained by the state and its agencies and the finance accounts published by the Accountant General. This could affect the overall asset portfolio of the Government and needs to be resolved on a priority basis – a strategy to address these could include: constituting dedicated teams for working on the reconciliation exercise, and focusing on the “big ticket� items starting with the latest accounts and going back to earlier years. As a part of the asset-liability management, GOK needs to setup a dedicated integrated office to for cash and debt management functions of the state. The level of unencashed cheques have been increasing, and has reached Rs. 6,820 crore (March 2013); accumulation of such cheques adversely impacts the adequacy of internal controls and is open for potential misappropriation. GOK needs to review and clear the public account as well as work out a strategy to address the issue of unencashed cheques. 22. Controls in the area of loans and advances are weak. This is characterized by loans made without finalizing terms and conditions; further loans given despite default in repayment of old loans; and, in most cases, the data on loans and advances are not readily available. A policy decision is needed for addressing loans to government entities that have neither repaid the loans nor the interest on such loans and where the possibility of recovery of such amounts is very limited due to the precarious financial situation of such entities. The GOK needs to decide on a case-to-case basis if such loans should be allowed to exist in the books or should be converted either into equity or grant. 23. The well-established system of external audit of the state’s accounts and local self-governments and legislative scrutiny can be made more effective through enhanced responsiveness and compliance of audit findings. External audit by the Supreme Audit Institution (SAI) is now more comprehensive and regular with a good proportion of performance and IT audits. Reports are now also available on a timely basis - the audit report for FY 2012/13 has been published and submitted to the Legislature by February 2014. On the other hand, the audits for local bodies (ULBs and Gram Panchayats, the third tier of rural local bodies) are delayed due to, capacity constraints of Karnataka State Accounts Department (KSAD) as well as non-submission of accounts by GPs. The effectiveness of audit is undermined due to weak follow up on the audit reports and legislative committee reports by the auditee who more often fail to provide responses on a timely manner. An Audit Monitoring System has been established for the external audit reports of the SAI, but its use is limited taking into consideration that it has only quantitative details; qualitative/systemic details are not captured; and data, particularly with respect to action taken, are not regularly updated. GOK needs to strengthen the audit compliance mechanism and also enhance the Audit Monitoring System to capture data for all audits and systematic data so as to analyze and take actions on them. Going forward, GOK needs to work with State AG to facilitate them to carry out audit of the state accounts through KII system and issue audit reports through the system. 24. Legislative scrutiny of audit reports has seen significant enhancement. External audit reports are tabled in the state Legislature and are subject to scrutiny by the separate legislative committees on state accounts (including departments), public sector entities and local bodies. The committees are well functioning and have adopted the approach of taking up the latest reports first and simultaneously clearing the backlog of the department taken up for hearings. Audit findings taken up for examination are selected on basis of materiality, contemporary relevance and systemic issue. However, noncompliance to the recommendations by the departments undermines the efficiency of this review process. | Executive Summary 12 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 25. KSAD’s role as auditor needs to be strengthened to improve its efficiency and effectiveness. Audit practices followed by KSAD are not modern and the audit institution suffers from staff capacity. KSAD should implement modern audit practices including risk based audit, co-sourcing, along with implementation of the audit software to improve the timeliness and quality of the audit. KSAD needs to be strengthened through continuous training and capacity building measures to perform the role of auditor in a faster and efficient way. KSAD audit capacity has to be augmented by recruiting staff, continuous training, IT implementation, and outsourcing in the short run to address arrears of audit. 26. Internal audit mechanism in the state is highly dispersed, lacks leadership and its effectiveness is virtually absent. The function is woefully short of staff (in particular skilled staff) and uses antiquated audit techniques not conducive for audit in a highly automated environment in Karnataka. A ray of hope is the system of IT and risk-based review mechanism instituted in the Commercial Tax Department as an example of “proxy internal audit� - its principles could be replicated in other departments. There is, therefore, a need for a formal modern Internal Audit system, at least in the high revenue-earning and high spending departments, to promote effective internal controls contributing to improved level of compliance and better expenditure management. 27. Local Self Governments every year handle around Rs.22500 crores, making it imperative that these institutions have strong PFM systems – but assessments often find gaps in PFM framework and compliance. The respective legislation underlying these institutions and accompanying manuals define the PFM environment. Significant efforts have been directed towards strengthening PFM in local self-governments (particularly accounting reforms) for ULBs and GPs, and a similar strategy is needed for ZPs and TPs. Delayed completion of audits; low revenue collection ratio; a not-so-strong system of internal controls, including internal audit; and low capacity and shortage of finance staff are key areas that need immediate attention. Own source revenue can be improved by encouraging e-payments and collection through banks to improve controls and collection efficiency as well as preparing Demand Collection Balance and carrying out timely reconciliation. Effective and adequate internal controls, including internal audit and timely audit compliance are areas that must be part of an improvement agenda and these must be institutionalized in these organizations. While ULB’s have up to date accounts, audits are pending due to capacity constraints of the auditors – KSAD which needs to be addressed at the earliest. ZPs and TPs have up to date accounts as well as audits have been completed by the CAG. GPs suffer from backlog of accounts and audits, though the situation can be controlled with concerted effort, and the priority area therefore is clearance of backlog of accounts and audits for GPs. Accounting reforms in local self-governments are underway, which needs to be completed and mainstreamed into the overall system. GOK has to review the accounts and finance staffing in these institutions both in terms of staff numbers and skill sets and has to develop a strategy for recruiting them. 28. State Owned Enterprises contribute to 7.2% of the GSDP and GOK investments in them are Rs.69,810 crores and the budgetary support for the FY 12-13 was Rs.15,059 crores. 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 but assessments often find gaps in PFM framework and compliance. While the scenario has improved in comparison to 2004, the following issues are persistent: (a) delay in completion of accounts and audits; (b) lack of effective internal audit; (c) lack of response to systemic audit issues and reconciliation problems; (d) non adoption of a corporate governance framework; and (e) absence of a nodal office to monitor and support the SOEs. A stronger corporate governance framework for government companies and corporations must be established - the | Executive Summary 13 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 model code of corporate governance prescribed for central public sector undertakings could be adopted. Effective and adequate internal controls, including internal audit and timely audit compliance are areas that must be part of an improvement agenda and these must be institutionalized in these organizations. Another priority area is to have a concentrated effort for clearance of backlog of accounts and audits which can be achieved within a short timeframe with external technical assistance as well as consider accounting reforms for entities which are yet to move to computerized accounting. Institutionalizing a stronger nodal agency would benefit the GOK to support and monitor the SOEs. PFM REFORM ACTION PLAN - 2014 29. The overall objective of the 2014 PFM Reform Action Plan is to improve and strengthen public financial management so that it efficiently and effectively promotes accountability and transparency and thereby improves service delivery. This Action Plan would support GOK to further accelerate reforms in the PFM arena in order to improve and enhance transparency and accountability. The Reform Action Plan recognizes the fact that Karnataka is not in the early stages of reform process but has over the past decade undertaken a range of reforms. 30. The Action Plan revolves around a thematic approach. Six themes have been identified as priorities for PFM reforms over the next five years. These themes and their elements relate to legal and institutional framework, budgeting, accounting and reporting, management of financial assets and liabilities, auditing and legislative oversight besides reforms in the government enterprises and local self-governments (Figure 1). All these themes are interlinked and the benefits of change in one theme would support better performance in another theme, leading to overall improvement in the PFM of the state. Figure 1: Thematic Approach to PFM Reforms in Karnataka | Executive Summary 14 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 31. Each reform area that is proposed has been discussed in the Analysis Report (Part II) . The Analysis Report provides the background, the reform actions proposed in the 2004 Action Plan, the progress of reforms over the last decade, the issues presently identified, and the rationale for the reform actions proposed. For the purpose of comparison of the status of the various PFM areas, the status in GOK has been (broadly) benchmarked against the good practices under the Public Expenditure and Financial Accountability (PEFA) Assessment tool and good practices followed by GOI and other Indian states. The Action Plan takes cognizance of the ongoing reforms and, their linkages and dependencies with the proposed reform actions. For each reform area, the priorities of the proposed action points and the responsible department/agency that will spearhead and implement the reform/s have been suggested. It is also suggested that the reforms be mainstreamed with GOK’s own work processes so as to ensure sustainability. 32. Client engagement and ownership: GoK constituted a high level committee headed by the Principal Secretary (Finance) to oversee this study and has appointed nodal officer to support this activity. The counterpart team was fully involved in the study and they supported the Bank team in all aspects of the study. Most of the comments and suggestions from the study have emanated from various officers in GoK and the Bank team has been acting a facilitator and sounding board to discuss and deliberate these suggestions and finalize them in as the reform action plan. KEY ACTIONS 33. The detailed action plan is provided in the following section of this report. Some of the key actions proposed for GOK are outlined below. 34. Short-term action. Immediate action to be completed within one year:  Pass full budget before fiscal year and make budget provision for only filled posts;  Carry out one time exercise to resolve reconciliation issues, clean public account, clear unencashed cheques, and reconcile investments, loans and advances, and debt;  Develop a rollout plan for Khajane II, including data migration, change management, switchover to computerized accounting, and training plan;  Develop strategy to clear unpaid bills;  Move toward e-receipts/collection through banks for local self-governments;  Clear the backlog of accounts and audits in various sectors;  Develop disclosure guidelines for amounts devolved and utilized by the local self-governments.  Initiate special audit in the area of loans and advances maintained by the department to review the controls and compliance mechanisms; and  Develop guidelines for accounting and disclosing amounts received, transferred and spent on centrally sponsored schemes. 35. Medium-term actions to be completed within next three years:  Enhance internal financial advisor, KSAD, and ALMC capacity through recruitment and training;  Improve budget realism by reducing compositional variance and reducing number of supplementary budgets, including the quantum of additional budget sought; | Executive Summary 15 Government of Karnataka - Public Financial Management Reform Action Plan - 2014  Review subsidies and introduce targeting of subsidies through mechanisms for specific identification of beneficiaries and a system of tracking and monitoring to provide fiduciary assurance;  Move to medium-term appraisal and approval cycle for the schemes/capital works and prepare rolling forecast of the works for budgeting purpose;  Develop and implement medium-term expenditure projections in large departments like Public Works Department.  Implement Khajane II and carry out the switchover to computerized accounting across the state;  Develop and implement contract management module across the state;  Develop and implement a guarantee policy for the state;  Set up a combined debt and cash management office for the state;  Develop and institutionalize internal audit for high-spending departments to improve the quality of spending;  Capacitate KSAD to provide internal financial advisor and PFM professionals in the future;  Conduct study on corporate governance and consider application of the framework for state-owned enterprises; and  Switchover to computerized accounting in urban local bodies and Gram Panchayats (village-level rural local government). 36. The GOK has already started taking action on some suggestions along with the progress of the study. A couple of key actions already taken by GOK are:  Disclosing additional information on the Finance Department Website;  Withdrawing provision for unfilled posts in urban local bodies;  Approved audit cell creation in DMA;  Approved a central audit monitoring cell in KSAD;  Reviewing the need for vacant post provisioning for the state; and  Reviewing of fund flow differences in urban local bodies and Panchayat Raj Institutions.. INSTITUTIONAL ARRANGEMENTS FOR IMPLEMENTING THE PFM REFORM ACTION P LAN 37. The next step would be to have stakeholder consultations to agree on the action plan, sequencing the reform, and institutionalizing the Reform Action Plan. 38. The 2014 Action Plan needs to be approved by the GOK and included in the Medium-Term Fiscal Plan of the Government. This will provide the necessary mandate for implementation and the instrument for disseminating the Plan, as well as review of the implementation on an on-going basis. 39. A high-level committee needs to be formed at the level of Principal Secretary (Finance) so that reforms can be reviewed on a regular basis and coordination across departments can be achieved. The prioritization of the actions and the timelines needs to be reviewed on a holistic basis by GOK and the sequencing of reforms needs to be worked out as most of the reforms are interlinked and benefits would accrue if related reforms are addressed simultaneously. A quarterly progress report on the achievements made and challenges faced should be presented to the committee for their monitoring and advice. Considering the magnitude of the reform actions, a | Executive Summary 16 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 system of continuous monitoring is essential to ensure that the implementation goes as planned and course corrections are identified, approved, and applied in a timely manner. 40. A dedicated 2014 Reform Action Management Cell needs to be constituted by the GOK to implement these reforms. The cell would be headed by Principal Secretary (Finance) with his team of Secretary (B&R), Secretary (Expenditure), and Secretary (FR) and secretaries from the respective Administrative departments. The office of the Secretary (Fiscal Reforms) can be nominated to co-ordinate and follow up on agreed action points. This office needs to be strengthened with adequate resources – human, financial, and IT as well as provided with sufficient powers to monitor the reform. 41. The Finance Department needs to exercise strong leadership in implementing the PFM reform . This is especially pertinent for activities relating to budget formulation and execution, accounting, financial reporting, auditing, and internal controls. PFM reforms needs to be led by the Finance Department, but it involves all departments like the Public Works Department (PWD), Rural Development and Panchayat Raj Department (RDPR), Urban Development Department (UDD), Water Resource Department (WRD), the Directorate of Municipal Administration (DMA), and the Department of Public Enterprises Reform and Disinvestment (DPE). All departments will need to cooperate for PFM modernization to happen. As a part of further actions, GOK can consider institutional review of key departments (PWD, RDPR, WRD, and UDD) and support them in strengthening their institutional framework, which would help improving the overall PFM framework of the state to a large extent. 42. Once the report is accepted by the GOK, based on the requirements of the GOK, a technical assistance project to support the dissemination and implementation can be developed. As a part of further dialogue, the possibility to carry out assessments like PEFA review, Public Expenditure Review, and other detailed economic assessments can be discussed with GOK. 43. In conclusion, Karnataka’s performance compares favorably to that of other Indian states and indeed scores well on the international PEFA measurement framework. This is due to the continued PFM reforms carried out by GOK during the last decade and other initiatives which are under progress. Karnataka is fortunate to have a strong bureaucracy, a reforming political leadership, and a demanding civil society. Continued progress on the PFM agenda will pay rich dividends for Karnataka by making the government in the state more effective, accountable, transparent, and responsive. | Executive Summary 17 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 Chapter 1: BACKGROUND, SCOPE AND METHODOLOGY 1.1 BACKGROUND 1. The Government of Karnataka (GoK) is reform oriented, and has been actively engaged in Public Financial Management (PFM) modernization from 2001 in co-ordination with donor agencies. The GoK and the Bank in 2004 jointly prepared the State Financial Accountability Assessment (PFMA) report and a comprehensive PFM action plan10. This report and action plan paved the way for many reforms in Karnataka. Most reform actions outlined in the PFM action plan have been implemented or are underway. GoK intends to further strengthen PFM and accountability of the State and to achieve this objective has initiated various reforms. Reforms in governance and PFM have been at the forefront in Karnataka and some of the key reforms undertaken are outlined below: a. Implemented Sakala (Karnataka Guarantee of Services to Citizens) Act, 2011 for ensuring timely service delivery to its citizens. b. Enacted and implemented the Karnataka Fiscal Responsibility Act, 2003, and that heralded a rule-based system which GoK has been following it for fiscal consolidation and better fiscal management. c. Ushered in transparency in procurement through enactment and implantation of The Karnataka Transparency in Public Procurement Act, 1999 which enabled implementation of e-procurement system across the state presently covering 227 departments/agencies handling procurement worth Rs.1,61,300 crore cumulatively ($ 27 billion). GoK has made it mandatory for all its departments and organizations to procure goods and services exceeding Rs.5 lakhs in each case on the e-procurement portal. d. Implemented e-governance initiatives in commercial taxes (e-administration of the underlying legislation) across the state which has helped in improving revenue collections as well as to provide faster service to the users. Vendors can register and pay their taxes online and also file their returns online with the Department. e. Implemented Khazane I (Computerized Treasury) across the State: The state treasuries have been computerized and treasuries now handle all Budget allocation, Treasury bill processing and payments, issue of cheque, e-payments, budget control and reallocation. Treasuries are rendering monthly compiled accounts to the State’s Accountant General, as well as provide monthly reports to the officers responsible for financial accountability and reconciliation. Khajane improved the overall control environment on the budget, cash flow and treasury management. f. Implemented electronic receipts of government dues for major revenues including commercial taxes and excise. For specified payments, this mechanism has been made mandatory. g. Implemented Human Resource Management System (HRMS): HRMS a centralized web based application has been implemented across the state which covers all employees of the state government. Service Registers of all employees are now available in electronic form and pay bill is generated by the system. E-payments of salaries have been implemented in 15 districts. h. Improved audit compliance through institutionalizing and maintaining a transparent web based Audit Monitoring System i. Improved fiscal discipline and budget outturns: The budgeting process has improved in line with the 2004 report and the GoK has achieved good budget outturns in the recent years. The revenue receipts are generally more than the budgeted amount while expenditure has been around the budgeted amount. 10 The study assessed the nature and degree of PFM risk, and the key actions to be taken to mitigate such risks | Background, Scope and Methodology 18 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 j. Adopted RFD (Results Framework Document) as a tool to measure the outcomes of the funds used by the State. k. Improved timelines in completion of accounts and audit reports: With Khajane I, the accounting and reporting timelines to AG have improved which has resulted in faster completion of accounts by AG (A&E) and completion of audit by the AG (Audit). The audit reports are normally placed before the Legislature around 9 months from the end of the financial year (FY). l. Phased out LOC payments and have made Treasury payments compulsory for all Departments. m. Liberalized delegation of financial powers for release of funds to the Principal Secretaries\Secretaries of the administrative department which would help the departments to prioritize the funds release and usage. n. Implemented Fund based computerized accounting system in ULBs and Double entry based computerized accrual accounting system in Gram Panchayats (GPs) to improve local self-governments maintenance of accounts and completion of audits. o. Regularized expenditure aggregating of Rs. 9565 crore in excess of the budget approved by the state Legislature through Public Accounts Committee (PAC) which is considered a significant achievement compared to other states. 2. GoK intends to further strengthen the PFM systems and enhance the accountability mechanism in the State. To achieve this objective several reforms are underway such as : (a) development and roll out of an upgraded Integrated Financial Management Information System across the state (Khazane II); (b) implementing an e-payment system to ensure quick and transparent disbursements; (c) upgrading its human resource management system; (d) strengthening financial reporting to make them real time and support decision making; (e) computerizing pension payment systems; (f) strengthening the State Accounts Department; (g) strengthening Internal Financial Advisor system; and (h) providing training and capacity building to all finance and accounts officers of the State. In this context, the GoK requested the Bank’s support to prepare a holistic PFM Reform Action Plan which it can implement in the medium term. Bank agreed to support this initiative through this NLTA. 1.2 SCOPE AND METHODOLOGY 3. The scope of the NLTA was to review the core state government PFM functions such as (a) budget development and execution, (b) budget and accounts related fiscal transparency, (c) financial reporting and accounting, (d) treasury systems, (e) internal controls, (f) external auditing, (g) legislative review of budget execution, and (h) procurement. The next step was to suggest a suitable medium-term PFM reform action plan for the state. The components of the PFM system examined for developing the PFM Reform Action Plan are depicted in Figure 2: Public Financial Management System. | Background, Scope and Methodology 19 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 Figure 2: Public Financial Management System 4. The methodology for developing the Medium term PFM Reform Action Plan (Figure 2) is as follows: a. Current situation analysis was carried out through fieldwork (discussions/interviews, data collection); and desk reviews of materials.11 The information collected was validated with the key stakeholders. b. Review of 2004 reforms. Details of reforms carried out by the state were collected through discussion with key stakeholders, which were compared with the recommendations of 2004 PFMA report. These reforms were assessed against the actions taken, sustainability, continuation, and quality. The reforms were categorized into following areas and were used as the baseline for the 2014 action plan: i. Reforms which have been successfully implemented and continuing in the field; ii. Reforms which have been implemented but have been discontinued; and iii. Reforms which have never been taken up and the relevance of these reforms in the present PFM context. c. Benchmarking, gap analysis and suggested actions. For the purpose of comparison of the status of the various PFM areas, the status in GOK was (broadly) benchmarked against the good practices under the Public Expenditure and Financial Accountability (PEFA) Assessment tool and good practices followed by the Government of India (GOI) and other Indian states. Based on the above review, the issues identified both at policy level and at implementation level were discussed and deliberated with stakeholders and suitable actions to address the gaps were developed in coordination with the stakeholders. 11 Reports of the CAG, State Budget, and MTEF; various Government financial manuals such as Financial Rules, Treasury Codes, Budget Manual, Account Code, Acts; Accounts and Audit Reports; and existing Government studies. | Background, Scope and Methodology 20 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 d. Develop PFM action plan. Based on the above, an action plan for each area of discussion was developed, which was later grouped into themes so that the inter-linkages and benefits across the various PFM areas could be understood and harnessed. The individual actions were prioritized and integrated into a medium- term action plan, with clear roles of responsibility and timelines. Figure 3: Methodology for developing PFM Reform action plan Develop Suggest Current Review of Benchmark Carry out integrated Actions to Situation 2004 with Good Gap PFM address Analysis reforms practices analysis reforms Gaps action Plan 5. Client engagement and ownership: This study emanated from GoK since they were moving to IFMIS and they wanted this study to complement their reform agenda. GoK constituted a high level committee headed by the Principal Secretary (Finance) to oversee this study and has appointed nodal officer to support this activity. The counterpart team was fully involved in the study and they supported the Bank team in all aspects of the study. Most of the comments and suggestions from the study have emanated from various officers in GoK and the Bank team has been acting a facilitator and sounding board to discuss and deliberate these suggestions and finalize them in as the reform action plan. GoK has been continuously apprised of the study and notes and findings have been constantly shared with the client. Some of the reforms mentioned in the report have already been initiated by the GoK. Once the report is accepted by GOK, they would make it a formal document by adopting the reform action plan as a part of the MTFP. | Background, Scope and Methodology 21 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 Chapter 2: OVERVIEW OF STATE FINANCES 6. The state government has been on the fiscal consolidation path since passing of Fiscal Responsibility Legislation such as the Karnataka Ceiling on Government Guarantee Act, 1999 and the Karnataka Fiscal Responsibility Act 2002 (KFRA). KFRA mandates the State to gradually eliminate the revenue deficit and limit the Fiscal deficit to the extent of 3 percent of GSDP while the guarantee act mandates limiting of contingent liabilities such guarantees to 80 percent of Revenue Receipts of the previous year and ensuring that the government places the details of Contingent liabilities and Statement of Public Debt in the Legislature for scrutiny. KFRA provides for a mandatory Medium Term Fiscal Plan (MTFP), which sets forth the fiscal policy of the state government for at least next three years. 7. Karnataka state finances have experienced a noticeable improvement consequential up on introduction of rule based Fiscal Correction Mechanism by the state government. The fiscal targets, fiscal and revenue deficits have been achieved well within the stipulated time frame. The global slowdown has not spared Karnataka and the economy has experienced a slight slowdown in the real estate market and registration of vehicles. However the state has experienced satisfactory fiscal recovery. The summary overview of state finances is outlined in Table 3 and Table 4 which follow. Table 3: Summary Overview of State Government Finances: Flows (Rs. in crores) Particulars 2012/13 2011/12 2010/11 RECEIPTS Own tax revenues 53,754 46,476 38,473 Own non-tax revenues 3,966 4,087 3,358 Share of central government taxes 12,647 11,075 9,506 Grants from central government 7,809 8,168 6,869 Net borrowings (excluding off-budget borrowings) 9,738 6,038 3,907 TOTAL RECEIPTS 87,914 75,844 62,113 DISBURSEMENTS Revenue expenditure 76,293 65,115 54,034 (including interest Rs. 6,833 cr, Rs. 6,062 cr, Rs. 5,641 cr) Capital expenditure (net of receipts) 15,445 15,417 13,283 Loans and advances (net of repayments) 944 1,576 1,577 TOTAL DISBURSEMENTS 92,682 82,108 68,894 Revenue (current) surplus 1,883 4,521 4,172 Fiscal deficit (excludes impact of off-budget borrowings) (-) 14.506 (-) 12,302 (-) 10,688 Source: Government of Karnataka, Finance Accounts | Overview of State Finances 22 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 Table 4: Summary Overview of State Government Finances: Stocks (Rs. in crores) As of As of As of Particulars 31-Mar-13 31-Mar-12 31-Mar-11 BORROWINGS (on-budget) Borrowings from GoI and financial institutions 75,052 65,315 59,277 Borrowing from employees’ Provident and Insurance Funds 15,914 14,182 12,784 Borrowings from other Public Account 36,270 32,299 25,550 FINANCIAL ASSETS Cash and Bank 10,511 9,609 7,667 Capital Expenditure and Investments in government companies/corporations, 119,513 104,035 88,525 other companies, and Cooperative Societies and Banks Loans made by the State Government 12,143 11,198 9,623 DEBT GUARANTEES PROVIDED (to government companies /corporations, urban local governments, Co-operative Banks and Societies, 6,688 6,515 6,618 other companies, Boards/Authorities and universities) 8. Karnataka has been a revenue surplus state for a considerable period due to adherence of KFRA, buoyancy in revenues particularly in VAT, and prudent fiscal management. Fiscal deficit of Karnataka has been continuously below 3 percent of GSDP for the last five years except for the year 2009-10. Though it has been a revenue surplus state, the revenue surplus has reduced from 1.39 percent of GSDP to 1.08 percent of GSDP between 2007-08 and 2011-12. Decline in revenue surplus and tab of 3% on fiscal deficit has limited the capital expenditure to around 3.5 percent of GSDP. The global crisis though affected the state of Karnataka as well; the impact was limited only to one year (2008-09). The state started recovering from a dip in its fiscal indicators in 2008-09. The crisis affected its revenues to decline from 15.17% of GSDP in 2007-08 to 14.33% in 2008-09 to marginally recover in 2009-10 to 14.64%. The finances came back to original position of 2007-08 in 2010-11. Improvement in finances of Karnataka in 2009-10 was mainly due to increase in revenues from the federal government than its own revenues. | Overview of State Finances 23 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 Table 5: Finances of GoK based on Accounts (as a percentage of GSDP) 2007-08 2008-09 2009-10 2010-11 2011-12 Revenue Receipts 15.17 14.33 14.64 15.28 16.07 Own Revenues 10.82 10.20 10.10 10.98 11.64 Tax Revenue 9.58 9.15 9.11 10.10 10.70 Non tax Revenue 1.24 1.05 0.99 0.88 0.94 Shared Revenues 4.35 4.13 4.54 4.30 4.43 Tax Devolution 2.50 2.37 2.19 2.50 2.55 Grants In Aid 1.85 1.76 2.35 1.80 1.88 Revenue Expenditure 13.78 13.79 14.16 14.19 14.99 Interest Payments 1.66 1.50 1.55 1.48 1.40 Capital Outlay 3.19 3.27 3.61 3.51 3.57 Net Lending 0.26 0.22 0.13 0.41 0.36 Gross 0.28 0.24 0.29 0.46 0.42 Recoveries 0.02 0.02 0.17 0.04 0.06 Total Expenditure 17.23 17.28 17.90 18.11 18.93 Revenue Surplus/ Deficit 1.39 0.54 0.48 1.10 1.08 Fiscal Deficit -2.06 -2.95 -3.26 -2.82 -2.85 Primary Deficit -0.40 -1.45 -1.71 -1.34 -1.46 GSDP (Rs. Million) 2712460 3021460 3357470 3808710 4342700 Source: Budget Documents, GoK, Study of State Budgets, RBI and MTFP statements of GoK (various Years). 9. The GOK fiscal position is largely influenced by the revenue side. Two-thirds of the state’s revenue is from own sources. Simplification and rationalization of tax structure, along with simplification of process of filing tax returns and extensive use of technology, has ensured an effective mobilization of resources from various taxes, which have helped the GOK to maintain a better fiscal position. Though tax revenues have been consistently growing, GOK has not improved revenues on the non-tax front, which continues to decline. The state’s Fiscal Management Reform Committee has recognized this issue and suggested departments to be more proactive in identifying and collecting their non-tax revenue. 10. In terms of expenditure, generally the revenue expenditure has been below the revenue receipts leading to revenue surplus, which was used as one of the sources to fund capital expenditure. Over the years, revenue expenditure has been increasing mainly due to subsidies, which reduced the revenue surplus, and affected the outlay available for capital expenditure (Figure 3). Subsidies have increased from Rs.3,399 crore in 2008-09 (8 percent of the revenue receipts) to Rs.16,661 crore, which is 18 percent of the revenue receipts in the 2013-14 (revised estimate). The revenue surplus for the corresponding period declined from Rs.1,635 crore (which is 3.8 percent of revenue receipts) in 2008-09 to Rs.64 crore in 2013-14 (revised estimate), which is 0.1 percent of the revenue receipts. With the increasing coverage of subsidies, there are demands beyond the provisions made in the budget; most often these have to be accommodated through supplementary estimates. The GoK Medium-Term Fiscal Plan (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 sectors from undertaking reforms. GoK acknowledges that expenditure on subsidies needs to be moderated in the medium-to-long term to make them fiscally sustainable | Overview of State Finances 24 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 through improving systemic efficiencies in sectors like energy, rationalize 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. Figure 4: Revenue surplus, subsidies and fiscal deficit 20,000 15,000 10,000 Rs. in crores 5,000 - (5,000) (10,000) (15,000) (20,000) 2013-14 2008-09 2009-10 2010-11 2011-12 2012-13 (RE) Explicit Subsidies 3,399 4,118 6,303 7,390 10,709 16,661 Revenue Surplus 1,635 1,629 4,172 4,691 1,883 64 Fiscal Deficit (8,732) (10,875) (10,688) (12,300) (14,507) (17,959) Primary Deficit (4,200) (5,662) (5,047) (5,696) (7,053) (10,159) 11. Moreover, most of the revenue expenditure is in the nature of committed revenue expenditure like salaries, pensions, interest, subsidies, etc., which affects the maneuverability of the state to prioritize expenditure in this space. During 2013-14 (revised estimate), 94 percent of the receipts are expected to fund committed revenue expenditure and only 6 percent is left for the GOK to fund other revenue expenditures. The state Fiscal Management Review Committee has advised GOK to re-evaluate expenditure commitments as well as relook at the subsidies and work on providing more target-based subsidy. 12. The public investment spending (capital expenditures) 12 are ones that have sustainable impact on growth and income generation provided they are made effectively. GOK has to create fiscal space for public investment spending through the budgetary processes but within overall fiscal constraints which include - (a) budget envelope available after meeting revenue expenditure; (b) limits to fiscal deficits mandated by the KFRA; and (c) restrictions on gross public debt. Increasing revenue expenditure, reducing revenue surplus, and statutory limitations on borrowings affects the fiscal outlay available to the GOK for carrying out capital expenditure. 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. 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. Going forward, 12 GOK Capital spending has been about 40% of total government spending, and as compared to other states is relatively higher | Overview of State Finances 25 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 GOK needs to prioritize capital expenditure to achieve their fiscal targets as well as manage their public investment funding more systematically. 13. Fiscal Marksmanship: Fiscal Marksmanship essentially reflects the degree of accuracy between the estimate and actual expenditure of the budget data. It is desirable that the finance department has good fiscal marksmanship while forecasting the revenues and expenditures for the next fiscal year. The state government has improved in recent past in their estimation of expenditure and revenue. Many times the revenues and expenditures realized are closer to the estimated ones. The expenditures have overshot the estimates sometimes marginally due to allocations in supplementary budgets which are not included in the budget estimates. Increases in expenditures are mainly due to including large expenditure commitments, subsidy payments and payments of arrears in supplementary budgets which are not included in the original budget. FMRC has advised the GoK not to encourage new capital commitments in the supplementary except in case of natural calamities; as such additions distort the fiscal management of the state. The budget outturn for revenue and expenditure has significantly improved over the years, yet there are substantial compositional variances and large savings in budget allocations indicating the need to improve “budget realism�. Good buoyancy in tax revenues and central transfers has ensured that the macro aggregates such as revenue deficit and fiscal deficit are closer to the estimated one. 14. Fiscal scenario in Karnataka reveals that, the state finances have improved particularly due to implementation of KFRA. Though major indicators are sound, the state has to balance the requirement of providing adequate funds to critical sectors of the economy while adhering to fiscal targets. GoK needs to give more emphasis on reducing less productive expenditures and prioritizing capital expenditure. | Overview of State Finances 26 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 Chapter 3: ACCOMPLISHMENTS OF 2004 PUBLIC FINANCIAL MANAGEMENT AND ACCOUNTABILITY ACTION PLAN 15. Karnataka had a foundation for a satisfactory basic PFMA system substantially built on centralized, detailed, input-based controls. This system was working reasonably well and derived its strengths from a well- established and sound legal framework for PFMA, a robust fiscal policy framework for aggregate fiscal management, tight control over departmental spending through the annual budget, an independent auditor and well-established framework of legislative approval of budget execution. 16. The state had initiated several important improvements to strengthen its PFMA system - yet significant challenges remained. In this environment, a Public Financial Management and Accountability Assessment (PFMA) was carried out by the World Bank in active collaboration of the Government of Karnataka (GoK) in 2004. Drawing on the analysis and recommendations presented in the PFMA, GoK and the Bank jointly developed an Action Plan to improve PFMA (referred to as the 2004 PFMA Action Plan) to continue and deepen GOKs Public Financial Management (PFM) improvement program with the objective to improve PFM and Accountability for making government more effective, accountable and responsive). 17. The 2004 PFMA Action Plan was developed in the backdrop of: a not so impressive record of budget implementation; low predictability of flows to department with cash rationing and economy drives being common; a cash management system constrained by limited cash flow smoothing options and lumpiness in inflows from the central government; significant off-budget borrowings; lack of timely and reliable information from the accounting system to facilitate fiscal monitoring and transparency, cash management, and departmental budget monitoring; there was a need for strengthening budgetary and internal controls and enhancing effectiveness of audit and legislative review through enhanced follow up of audit reports and legislative reviews. 18. The 2004 PFMA Action Plan was categorized into six strategic segments – Budget preparation and implementation, financial computerization and MIS, Accounting, Audit/PAC responsiveness and follow up, PFM in other Public Sector Agencies and Institutional Arrangements and Capacity Building – with several actions under each to achieve the objectives. The PFMA and the 2004 Action Plan were officially recognized by GoK in the Medium Term Fiscal Plan of 2006-2010. 19. There was, however, no review of the implementation of the 2004 PFMA Action Plan. The current study endeavors to take stock of the progress of implementation of these measures during the last decade since 2004 and its impact on PFMA largely based on the situation during the 3-4 most recent years. The status of implementation of each of the activity included in the 2004 PFMA Action Plan is briefed in Section 10 of the Appendix. A summary of reforms implemented and continuing, reforms implemented but could not be sustained and reforms not carried out though remaining relevant as of today are outlined below. 20. Budget preparation and implementation: The key reform actions envisaged in this segment were: ensuring budget passage at start of fiscal year, phasing out off-budget borrowings, improving budgetary realism, introducing departmental budgeting for more accountability and flexibility, strengthening performance orientation of departments, improving budgetary expenditure allocation and screening process, simplification of budget implementation and improving cash flow, strengthening internal controls and increasing fiscal transparency. | Accomplishments of 2004 Public Financial Management and Accountability Action Plan 27 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 21. Significant achievements were made in implementing many of the reform activities for strengthening budget preparation and implementation. a. GoK’s record of implementing the budget has shown significant progress since the 2004 PFMA – wide variations from budget estimates in both revenues and expenditures at that time has now largely been contained – revenue and expenditure outturn has been within 5-7% variation in the recent years. b. Significant sophistication has been built in the framework of revenue forecasting which has helped in cash planning providing greater predictability during budget execution. To achieve more efficiency in revenue forecasting and realization, the Commercial Tax Department is presently in the process of setting up an Economic Intelligence Unit, akin to a Fiscal Intelligence Unit in Finance Department as suggested in the 2004 Action Plan. Efforts, however, are still needed to enhance non-tax revenues. c. GoK has curtailed its Off Budget Borrowings and has been successful in reducing the outstanding and interest costs (to Rs. 1,455 crore and Rs. 166 crore, respectively by 2013) – the 2004 Action Plan targeted eliminating this item at the earliest opportunity – but still, this is a significant achievement. Also, approval of borrowings and issue of guarantees have now been centralized with the Finance Department. d. Significant progress has been made to enhance individual clearance limits and delegation of powers both (a) for release of funds without recourse to the Finance Department and (b) internal delegation to HoDs – this was to strengthen predictability of availability of funds, avoiding year- end rush of expenditure and improving quality of expenditure. These have been gradually enhanced and GoK departments can release funds for the first three quarters, subject to some restrictions. Contribution was also made through revision of re-appropriation powers. Actual expenditure data indicates more increased expenditure outturn (pace of expenditure) during the first two quarters of the financial year, and significant decline in rush of expenditure during the last month of the financial year from 26% in 2002 to 19% in 2014 (including in Plan expenditure), although expenditure during last quarter at 1/3rd of total can be further evenly spaced. e. Fiscal transparency has improved. Budget documentation continues to be comprehensive disclosing significant information and full set is made available to the public as compared to only Overview of the Budget and Budget Speech earlier. Monthly accounts and fiscal indicators are now available more timely, a half-year review of state finances is published and available in public domain (done up to September 2013), audit findings and responses are available on the web (though not up to date and full reports of the Legislative Committees are yet to be placed on the web), year-end financial statements are now tabled in Legislature immediately in the next session from receipt and are more easily available to the public and stock of pending bills for on- going works is available in the Finance Accounts. 22. Some actions were taken up but could not be sustained or are still underway and further efforts are needed to implement them. a. GoK was the first state to introduce Departmental Medium Term Fiscal Plans and in 2002/03. This was implemented in 20 departments and continued with this exercise till 2009/10. But due to | Accomplishments of 2004 Public Financial Management and Accountability Action Plan 28 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 various reasons, this could not be sustained and was discontinued and presently just one department prepares the medium term fiscal plan. b. In 2003, GoK endeavored to reduce the number of schemes and budget detailed codes and some success in rationalization was achieved at the time. The PFMA suggested enhanced budget flexibility to departments for better performance through reduced dependency on overly detailed line budgeting and large number of schemes and budget heads restricting moving towards this goal. The number of schemes, however, showed increase over the years and a system of periodic review was not instituted – as on date there are over 1800 active schemes (out of total over 15000). c. In respect of management of public funding of investments (as detailed through an Appendix E), the 2004 PFMA Action Plan made two recommendations – (a) give priority in budgeting to payment of arrears, then for completion of ongoing works and lastly for adding new works and (b) computerization of such works and tracking committed liabilities for better budget control and implementation. 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 today. Though GoK has put in place these instructions, yet compliance is wanting resulting in payment arrears which is not strictly in line with the fiscal responsibility legislation which requires timely payment of current dues and a formal and clear definition of payment arrears is required as suggested in the PFMA. Timeliness and adequacy of Appendix E still falls short of expectations and action point for computerization of Appendix E remains to be taken up. d. The PFMA suggested basing expenditure projects on realistic scenarios particularly in case of budgeting for salaries13. It suggested that each department should project salaries in line with recruitment rules and plans, instead of budgeting for vacant posts which are unlikely to be filled. This practice continues and budget includes substantial lump sum provision for the entire sanctioned staff strength though not all of these posts would have been planned for recruitment during the year – which is also not in accordance with the Budget Manual. This not only resulted in substantial savings, but also required a supplementary budget for transferring required budget to the concerned demand for grants. Most importantly, such hidden provisions not utilized restricted provision for developmental expenditure. While GoK has discontinued this practice in urban local bodies, it continues to pursue this for the government sector. 23. And there is unfinished agenda that needs to be pursued. a. GoK continues to obtain Vote on Account although a full budget is present in the Legislature in February/March, and the situation remains as in 2004. The full budget is passed only during June/July when the Legislature meets again. If GoK ensures passing of budget before start of the year, it will be at par with over 20 other states that have achieved this. b. Reliance on supplementary budgets is maintained and the number of supplementary budgets presented continues to be three every year, like in 2004. The quantum of supplementary estimates has increased from about 8% at the time of 2004 report to 18% now, and is higher compared to many other Indian states. Many schemes and expenditure are introduced in-year outside the 13 This, however, was not included in the 2004 PFMA Action Plan. | Accomplishments of 2004 Public Financial Management and Accountability Action Plan 29 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 budget cycle. This coupled with the situation that the unutilized budget (“savings� i. e. actual expenditure falling short of revised budget) being more than the supplementary undermines the budget realism in GoK. The supplementary budgets are also not fiscally neutral and significant supplementary estimates remain unfunded. Large supplementary budgets also affects the original expenditure composition. c. Not much progress is visible in legislative scrutiny of the budget. The Committee of Estimates continues to be inactive and the Subject Committees constituted to examine budget proposals are no longer in existence. The Legislature spends less time on discussions and voting. d. 2004 Action Plan recommended revision of the core PFM documents (the budget manual, treasury code and financial rules). A revised Treasury Code was prepared along with the implementation of Khajane (computerized treasury system). However, it was not formally adopted and notified by the GoK – the aim now is to re-revise the KTC incorporating the changes warranted due to implementation of upgraded Khajane. Although the Local Fund Authorities Fiscal Responsibility Act was passed in 2003, it had to be operationalized and this was an action in the 2004 PFMA Action Plan which is to be pursued and hence the objective of prudent PFM in a number of ways in the local bodies is yet to be realized. 24. Financial Computerization and MIS: Treasury computerization (Khajane), Capital Works Control (Appendix E) computerization, Payroll computerization, computerization of Drawing and Disbursing Officers (DDO), and accelerating Monthly Accounts preparation schedule were the key reforms envisaged under this segment. This segment has exhibited marked progress and many of the reform actions were implemented while others are underway /planned. a. Treasury computerization (Khajane) was achieved in 2004 and core functions of GoK were computerized, all Treasuries networked and non-bank treasuries were also phased out. This led to improvement in overall controls, reduced delay in submission of periodic reports to the Departments and the Accountant General, availability of daily fund position and expenditure reports and introducing passing of bills on first-in first-out principle. Following the action included in the 2004 Plan, GoK phased out the Letter of Credit system and brought all public works departments within the direct purview of the Treasury and the latter is now single payment point. GoK is now upgrading Khajane to include computerization of the office of the Drawing and Disbursing officers and the function of capital works, actions included in the 2004 PFMA Action Plan. Risk audit of Khajane has been conducted providing inputs for upgrading process of Khajane. b. A significant achievement of GoK is full automation of its payroll (integrating service register and pay bill) - a centralized web based application (the Human Resource Management System HRMS) has been successfully implemented and covers nearly all employees of the state government (almost 26% of state’s revenue expenditure excluding debt servicing) thereby strengthening controls in this area. GoK is now pursuing upgrading this application to the next level HRMS II and also integration with Khajane. | Accomplishments of 2004 Public Financial Management and Accountability Action Plan 30 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 c. Although not part of the 2004 Action Plan, it is pertinent to note that the initial implementation of the Karnataka Transparency in Public Procurement Act, 1999 that enabled e-Procurement was further expanded across all government departments and organizations and now barring some exceptions, all goods and services are under the ambit of e-Procurement – this is a progressive step and e-procurement platform is being further strengthened. 25. Accounting: Two key reforms were planned: Public Account clean up and Reconciliations against the backdrop of arrears in reconciliation, non-adherence to accounting controls, weaknesses in systems for recording, reporting and monitoring of fiscal assets and liabilities, and reporting of transfers of other public sector entities. Many of these are relevant for implementation even today, not because GoK did not take steps to implement them, but because these items have built-up over time in terms of volume and there is basic shortcoming in compliance and inadequate reconciliation process. Some major achievements and areas that remain a challenge follow – many of these are expected to be addressed with the planned rollout of the next level of Khajane.  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 – implementation of Khajane II is likely to address this issue.  The quantum of outstanding Abstract Contingent Bills has been contained at a reasonable level and showing a decreasing trend over the years in both outstanding as well as fresh drawls during the year. Similar achievement has been made in reducing backlog of obtaining Utilization Certificates and submission of those currently due and suspense accounts have been significantly cleaned up – the challenge is to sustain these achievements.  Control over personal deposit accounts requires another round of tightening of controls - significant balances are carried forward, nearly half of the accounts are inoperative while some have adverse balances and reconciliation of balances with the Treasury and the Accountant General is in backlog. Similarly, control over reserve funds and booking of large amounts under miscellaneous heads of account still requires particular attention.  The PFMA identified that reliable information on the amount of unencashed cheques was not available (at that time) as bank accounts were not reconciled regularly and full information was not available. GoK targeted to reconciled these and do one-time clean up and included this as an actionable point in the 2004 Action Plan. This is a challenge that remains to be addressed – the level of unencashed cheques has not only increased substantially (outstanding as of March 2013 was Rs. 6,820 core as compared to Rs. 1,160 crore in 2001/02), but there are significant information gaps and the process of reversing such cheques is not pursued.  There has been good progress since 2004 in recording and reporting of fiscal assets and liabilities covering loans and advances, guarantees and investments in government entities, as well as debt. For the first three items, a dedicated cell has been formalized under Finance Department for data collection, collation, reconciliation and reporting. Yet, significant challenges remain in loans and advances and investments in terms of reconciliation issues (this is work in progress) and accounting and reporting controls have not kept pace with the significant increase in the portfolio. Accounts of loans and advances | Accomplishments of 2004 Public Financial Management and Accountability Action Plan 31 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 maintained at departmental level are inadequate and there are differences in investments between Finance Accounts and investee records.  The PFMA concluded that practically there was no internal audit system in GoK (including local governments) barring internal audit wings (IAW) in some revenue earning departments. Introducing a small, focused internal audit function to improve the effectiveness of the system was suggested. GoK has not travelled far in strengthening the internal audit arrangements in government and no significant reform interventions are visible in this vital function. Other than the Commercial Tax Department, no other department has shown any visible initiative to establish or strengthen this function. 26. Audit and PAC responsiveness and follow up: The PFMA expressed concern over lack of responsiveness to external audit reports and legislative reviews and identified it as the single biggest problem undermining the effectiveness and impact of audit and legislative review. This continues to be an area of challenge for GoK as progress has not been very satisfactory – this is still categorized by inadequate and delayed response by the auditees – the executive needs to effectively implement the audit recommendations. The online Audit Management System has been established, but data updating is in backlog and the system is yet to be institutionalized. A significant achievement since 2004 has been regularization of expenditure in excess of Legislative approval that had been pending since 1989-90 aggregating over Rs. 9,000 crore. Implementation of measures to improve the effectiveness of the Legislative committees has progressed well – there is much improvement in the working of the Legislative committees with increased number of meetings and larger number of reports taken up for review, and a change in approach by taking up recent reports first and selection of observations for review on the basis of materiality and risk, contemporary relevance and systemic issues. 27. PFMA in Local self-government and Public sector entities: The 2004 PFMA Action Plan also had several measures for public sector entities (other than department). Significant progress has been made so far as the local bodies are concerned, but improvement in the PFM of government companies and corporations needs to be pursued further.  In respect of the rural local governments, accounting reforms and computerization were two key areas for reforms included in the 2004 action plan - there has been significant progress in these areas, yet challenges remain. Double entry accrual basis of accounting has been introduced in both Village Panchayats and urban local bodies and accounting is now done on computerized applications (Panchatantra for Panchayats and e-Gov Financials for urban bodies) supported by respective manuals. However these systems have not been mainstreamed and are being maintained parallel to the current manual system. The accounts and audit of the Zilla and Taluk Panchayats are now up to date (with some delay) and this is a significant improvement since 2004. Yet, accounts and audit of Village Panchayats are perennially in backlog. Computerization of ZP/TP has not happened over the years and the situation is the same as it existed at the time of 2004 PFMA. Payment and reconciliation of electricity dues still remains an area of concern.  Progress in implementing recommendations made by the 2004 report on state owned enterprises to address major shortcomings has not been very effective and several of these remain relevant even as on date – the areas of concern included timely preparation and audit of annual financial statements, unreliable and inconsistent public sector data, inadequate responses and follow up of external audit reports and legislative Reports, weak monitoring and enforcement of PFM requirements and issue in governance. | Accomplishments of 2004 Public Financial Management and Accountability Action Plan 32 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 28. Institutional Arrangements and Capacity Building: The 2004 PFMA Action Plan envisaged recruitment of qualified Internal Financial Advisors (IFA) in equal numbers from the office of the Accountant General, Karnataka State Accounts Department (KSAD) and the Secretariat – GoK has mandated this rule though in actual practice, majority of the IFAs are from the Secretariat and some from KSAD. Also, IFAs have been deployed in the major spending department. The quality of the skills set of the IFAs drawn from other than KSAD leaves much to be desired and effective utilization of the IFAs has been hampered. 29. The PFMA identified strengthening the capacity of KSAD. In terms of capacity enhancements of KSAD staff, GoK has issued new cadre and recruitment rules (2011) covering both entry-level qualifications and mandatory training for promotions which in the medium term will provide qualified staff at all levels and a training curriculum has been developed for accounting, financial and auditing training, currently under implementation. Further, GoK has mandated computer literacy for all staff under a State Training Policy (2011) and Computer Literacy Rules (2012). Fiscal Policy Institute has been nominated as a key training institute on PFM and frequent trainings to staff of other departments have organized. These are recent steps and effect would be visible later. However, it is important that capacity building measures are continued in the full PFM domain. 30. In conclusion, the current study factors in the achievements made in implementing the 2004 PFMA Action Plan, and builds upon the reforms actions that are relevant today by taking forward the unfinished agenda. The study also proposes reform actions that are needed to further GoK’s objective of strengthening PFM and accountability. The details of achievement against 2004 PFM reform action plan is outlined in Annex 2. | Accomplishments of 2004 Public Financial Management and Accountability Action Plan 33 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 Chapter 4: ANALYSIS, GAPS, AND RECOMMENDATIONS - 2014 31. The overall objective of the 2014 PFM Reform Action Plan is to improve and strengthen public financial management so that it efficiently and effectively promotes accountability and transparency and thereby improves service delivery. This Action Plan would support GOK to further accelerate reforms in the PFM arena in order to improve and enhance transparency and accountability. The Reform Action Plan recognizes the fact that Karnataka is not in the early stages of reform process but has over the past decade undertaken a range of reforms. 32. The Action Plan revolves around a thematic approach. Six themes have been identified as priorities for PFM reforms over the next five years. These themes and their elements relate to legal and institutional framework, budgeting, management of financial assets and liabilities, accounting and reporting, auditing and legislative oversight besides reforms in the government enterprises and local self-governments (Figure 4). All these themes are interlinked and the benefits of change in one theme would support better performance in another theme, leading to overall improvement in the PFM of the state. Figure 4: Thematic Approach to PFM Reforms in Karnataka 44. Each reform area that is proposed has been discussed in the Analysis Report (Part II) . The Analysis Report provides the background, the reform actions proposed in the 2004 Action Plan, the progress of reforms over the last decade, the issues presently identified, and the rationale for the reform actions proposed. For the purpose of comparison of the status of the various PFM areas, the status in GOK has been (broadly) benchmarked against the good practices under the Public Expenditure and Financial Accountability (PEFA) Assessment tool and good practices followed by GOI and other Indian states. The Action Plan takes cognizance of the ongoing reforms and, their linkages and dependencies with the proposed reform actions. For each reform area, the priorities of the proposed action points and the responsible department/agency that will spearhead and implement the reform/s have been suggested. It is also suggested that the reforms be mainstreamed with GOK’s own work | Analysis, Gaps, and Recommendations - 2014 34 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 processes so as to ensure sustainability. The synopsis of each theme along with the key reform objectives and actions are outlined below. Theme 1: Strengthening PFM Legal and Institutional Framework Overall Reform Objective: To ensure relevant and updated PFM legal framework supported by adequate and effective institutional mechanisms to implement them. 33. The PFM framework is embodied in the state’s budget manual, treasury code and financial rules guided by the principles embodied in the Constitution of India. These are supplemented by legislations such as the KFRA and KTTP Act. An institutional framework to implement the PFM is also in place. This is a cross-cutting theme that would impact the working of PFM across all stakeholders. 34. The major issues under this theme are: (a) compliance in certain areas that are not in line with the Acts, (b) capacity constraints in the finance cadre of the state which inhibits implementation of the PFM framework, and (c) updated PFM manuals and codes to reflect the changes in the PFM environment of the state. 35. The key actions proposed are: a. Revise PFM manuals and codes to make it contemporary particularly to take into account the changes in business processes brought about by major revamp of its financial information systems (for instance, treasury computerization, e-payments, and online HR management). b. Strengthen the capacity of the IFAs to provide leadership in public financial management, act as a support to the head of offices in discharging their fiduciary responsibilities at the departmental level, and providing expertise to the Finance Department in the discharge of functions at the state level. c. Strengthen the capacity of KSAD and ALMC cell to support the PFM functions of the state. d. Operationalize LFARA and improve compliance to meet the requirements of the fiscal law in areas such as for instance timely payment of current liabilities and minimizing fiscal risks in public sector undertakings. 36. It is envisioned that implementing the reform activities in this area would lead to achieving the following:  Up to date and modernized PFM manuals and codes in place, and implemented, that would be contemporary incorporating the changed circumstances brought about by the automation of major PFM systems  A stronger institution of IFAs with skills set that match the current and planned PFM environment and the enhanced responsibilities that are associated with sophisticated systems  Meeting the requirements of the fiscal responsibility legislation in all material aspects (included in respective thematic area) Theme 2: Enhancing Comprehensiveness and Credibility of the Budget Overall Reform Objective: To ensure an efficient and effective budgeting formulation and execution process, including system for in-year review and amendments, with effective and timely legislative scrutiny | Analysis, Gaps, and Recommendations - 2014 35 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 37. GoK’s budget processes flow from its Budget Manual based on the principles in the Constitution of India supplemented by annual budget circulars. Budget documentation is comprehensive. The fiscal responsibility legislation binds GoK to budget within certain fiscal rules that GoK has followed and legislative approvals for deviations have been obtained and status quo maintained after the event has passed. The budget outturn for revenue and expenditure has significantly improved over the years. Predictability in availability of funds has improved by way of enhanced delegation of powers in respect of providing sanctions at the departmental level, and release of funds without repeated recourse to the finance department with good success in improving pace of spending. The major issues under this theme are: a. GoK presents the budget before the start of the year, but obtains approval on a Vote on Account for the first four months - the full budget is passed well within the fiscal year. b. There are multiple in-year adjustments by way of supplementary budgets and re-appropriation of significant amounts. c. Supplementary budgets are not “fiscally neutral� as required by the fiscal responsibility legislation. d. There are substantial compositional variances and large savings in budget allocations indicating the need to improve “budget realism�. e. Budgeting could be further improved by a review of the manner in which provisions are made for certain items such as salaries and capital commitments/public investment funding. f. Departmental budgeting commenced earlier but was discontinued and schemes rationalization has not been carried out periodically. g. Legislative scrutiny is another area that needs strengthening. 38. The key actions proposed are: a. Pass the full budget before beginning of the financial year. b. Reduce the number of SEs presented to GoK every year from 3 to 2 (and to 1 in the long term). c. Supplementary Budgets should be Fiscally Neutral in accordance with the KFRA. d. Reduce expenditure composition variance from the present high level in phases. e. Integrate salary estimation with actual salaries as per HRMS and make budget provision for filled posts along with recruitments to be made during the year. f. Introduce capital commitments, MTEF, for large spending departments and ensure arrears are paid first, then existing works are budgeted, and finally new works are taken up in the budget. g. Introduce departmental budgeting with more flexible budgets in line items for larger departments to link it with the results framework document of the state. h. Implement Departmentally Related Standing Committee mechanism and legislature to devote more time on discussion and voting of grants. 39. It is envisioned that implementing the reform activities in this area would lead to achieving the following:  Passing the budget before the start of the fiscal year  Reducing the number of supplementary budgets and achieving more judicious supplementary and re- appropriation  Ensuring fiscal neutrality in supplementary budgets  Adopting analytical tools and strengthening capacity to achieve better budget estimation such as use of revenue forecasting and public works project management software, and following pre-defined principles particularly in case of salaries and capital commitments | Analysis, Gaps, and Recommendations - 2014 36 Government of Karnataka - Public Financial Management Reform Action Plan - 2014  Introducing Departmental Budgeting/MTFP  Enhancing the legislative scrutiny of the budget by strengthening the institution of sub-committees for budget scrutiny, and increased time devoted to discussions Theme 3: Strengthening Implementation of Financial Rules in Accounting, Reporting and Controls and Enhanced Transparency Overall Reform Objective: To ensure accurate and timely accounting and reporting, compliance with and strengthening related controls, including payroll and procurement controls, and to improve transparency of fiscal information 40. The accounting and reporting systems in GoK primarily revolve around the framework applicable nationally, based on the principles in the Constitution of India and guidelines issued by the Government of India. Around these principles and guidelines, GoK has developed its systems with controls, checks and balances imbibed in its PFM legal framework. Significant adoption of IT systems has strengthened the accounting, reporting and control framework over the years, and GoK continuously strives to upgrade and modernize these applications. GOK can consider taking over the responsibility of ownership of accounts gradually and also prepare consolidated statements for all tiers of government. Going forward, GOK can decide to implement accrual accounting and adopting new chart of accounts based on the recommendations of the GOI. There are weak areas such as reconciliation, compliance with controls, and accounting treatment that need to be mitigated. These recurring features also indicate the need for better compliance with the audit findings in these areas. Many of these issues are expected to be addressed by KII after its implementation and hence these issues are transitory in nature and needs to be attended in the short term. Payroll and procurement functions have been automated though there are issues in the underlying control mechanisms and data validation, and these needs to be plugged. Uncoordinated development of various financial applications using a fragmented approach has proliferated, and there is a need to integrate these to the Khajane II so that these are mainstreamed and used for decision making process. 41. The key issues under this theme are as follows: a. Delay in timeliness of reconciliation of expenditure with the AG, submission and reconciliation of utilization certificates. b. Change in CSS funding mechanism which requires reworking budget, fund flow, accounting and disclosure requirements related to CSS and ULBs transfers, expenditure, and balance. c. Khajane II implementation would require data migration and change management strategy. Also standalone software’s needs to be integrated and mainstreamed with KII. d. A cash management and forecasting tool has not been developed and implemented. e. Issue in tracking and monitoring subsidies. f. Issues in HRMS data validation and audit paras to be addressed before migration to HRMS II. g. Non implementation of contract management module, non-availability of certain functionalities of e-procurement and its comprehensive IT evaluation. 42. The key activities under this theme are as follows: a. Designate a central nodal office for monitoring of utilization certificates and improve reconciliation of expenditure. b. Develop guidelines and disclosure norms for CSS projects along with change in the fund flow to manage funds through the treasury rather than bank accounts. | Analysis, Gaps, and Recommendations - 2014 37 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 c. Develop a data migration strategy, change management strategy, HR strategy, training plan, and rollout plan for implementation. A GO outlining the timelines and the transition process has to be issued by GOK. Also integrate all other software’s used by the government with KII. d. Carry out study on cash and debt management practices, develop a cash forecasting model for monitoring cash management and integrate with MPIC and KII. e. Create web based information system for tracking and monitoring of subsidies linked to KII. f. Ensure data validation of all the staff and payroll records is completed and payroll audit is carried out across the state, before the data is migrated to HRMS II. g. Develop and implement contract management module as part of KII and enhance the functionalities of e-procurement software. Carry out IT audit of the software through AG office. 43. This theme seeks to build upon reforms underway and address weaknesses in accounting and reporting and strengthen internal controls. It is envisioned that implementing the reform activities in this area would result in a stronger PFM environment and systems exhibiting the following characteristics:  An effective system of identification of old outstanding balances and a regular system of reconciliation and adjustment of differences  Enhanced compliance with the financial rules as for instance timely submission of utilization certificates, adjustment of advance bills, reversal of amounts in public account balances, management of reserve funds  Proper classification of government transactions to reflect the correct fiscal position and indicators  Strengthened controls in IT systems and integration of the multiple financial applications to the Khajane II to form one coherent eco-system  Enhanced transparency and disclosure in the financial statements  Enhance transparency and disclosure in procurement Theme 4: Strengthening Fiscal Assets and Liabilities Management, Recording, Reconciliation and Monitoring Systems Overall Reform Objective: To strengthen the systems of management, recording, reconciliation and monitoring of fiscal assets and liabilities 44. The theme envisages resolving the challenges associated with the present systems of management, recording, reconciliation and monitoring of fiscal assets and liabilities, which have significant shortcomings and thereby strengthen the institutional and staff capacity to improve efficiency, allow for correct reporting and remove backlog. A related outcome would be better knowledge of and control over fiscal risks. 45. The key issues under the theme are: a. Non availability of a government guarantees policy. b. Reconciliation issues in case of Investments, Loans and advances and Debt data. c. Capacity constraints in the asset liability management cell handling this portfolio. d. Loans issued without prescribed terms and non-repayment of loans and interest taken by GOK entities. e. Issues in monitoring of arrears of payments. f. Reconciliation issues and backlog in case of unencashed cheques. 46. The following key activities are provided n this theme to significantly improve the systems: | Analysis, Gaps, and Recommendations - 2014 38 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 a. Develop policies and guidelines such as a Guarantee Policy and Operational Guidelines for Investments. b. Prioritize reconciliation efforts on big ticket items of investments, loans and advances, debt pertaining to recent years and carry out a focused reconciliation exercise with support from external consultants. c. Appoint core finance professionals or staff from Finance Department and train existing staff of the asset liability management cell. d. Develop a policy for addressing loans to government entities. e. Establish a Cash and Debt Management Office and deploy adequate resources in term of manpower support and IT systems. f. Establish of more formal and established procedures for monitoring and accounting arrears of payments. g. Initiate a special study to identify the causes for accumulation of unencashed cheques and carry out one time special exercise to clear the backlog of unencashed cheques. 47. It is envisioned that implementing the reform activities in this area would result in a PFM environment with the following characteristics:  Existence of formal and consolidated procedures for management, recording, reporting and monitoring of fiscal assets and liabilities  A more robust and empowered institutional mechanism to carry out these functions  Clearance of backlog of differences and reconciliation between memorandum records and state accounts  Availability of updated and validated database of assets and liabilities  Improved compliance with financial rules and the fiscal responsibility legislation 48. The benefits achieved under this theme will also accrue to Theme 3. GoK is currently upgrading its integrated financial management system (Khajane to Khajane II) and this system can be effective only if the legacy data is updated and clean and the level of compliance with financial rules is enhanced. Themes 3 and 4 are also expected to contribute to the migration of data with high level of integrity to Khajane II and to ensure that the weaknesses in the current system do not replicate in Khajane II. Theme 5: Strengthening Audit Institutions and Systems, Enhancing Responsiveness to Audit Reports, and Improving Effectiveness of Legislative Oversight Overall Reform Objective: To ensure accountability and oversight of public resources through stronger audit institutions, timely compliance and effective legislative oversight 49. External audit by the Supreme Audit Institution (SAI) is now more comprehensive and regular with a good proportion of performance and IT audits. Reports are now also available on a timely basis - the audit report for FY 2012/13 has been published and submitted to the Legislature by February 2014. Legislative scrutiny of audit reports has seen significant enhancement. External audit reports are tabled in the state Legislature and are subject to scrutiny by the separate legislative committees on state accounts (including departments), public sector entities and local bodies. The committees are well functioning and have adopted the approach of taking up the latest reports first and simultaneously clearing the backlog of the department taken up for hearings. Audit findings taken up for examination are selected on basis of materiality, contemporary relevance and systemic issue. 50. The effectiveness of audit is undermined due to weak follow up on the audit reports and legislative committee reports by the auditee who more often fail to provide responses on a timely manner. An Audit Monitoring System has been established for the external audit reports of the SAI, but its use is limited taking into consideration that it | Analysis, Gaps, and Recommendations - 2014 39 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 has only quantitative details; qualitative/systemic details are not captured; and data, particularly with respect to action taken, are not regularly updated. GOK needs to strengthen the audit compliance mechanism and also enhance the Audit Monitoring System to capture data for all audits and systematic data so as to analyze and take actions on them. Going forward, GOK needs to work with State AG to facilitate them to carry out audit of the state accounts through KII system and issue audit reports through the system. 51. Audit practices followed by KSAD are not modern and the audit institution suffers from staff capacity. KSAD should implement modern audit practices including risk based audit, co-sourcing, along with implementation of the audit software to improve the timeliness and quality of the audit. The audits for local bodies (ULBs and Gram Panchayats, the third tier of rural local bodies) are delayed due to, capacity constraints of Karnataka State Accounts Department (KSAD) as well as non-submission of accounts by GPs. 52. Internal audit mechanism in the state is highly dispersed, lacks leadership and its effectiveness is virtually absent. The function is woefully short of staff (in particular skilled staff) and uses antiquated audit techniques not conducive for audit in a highly automated environment in Karnataka. There is a need for a formal modern Internal Audit system, at least in the high revenue-earning and high spending departments, to promote effective internal controls contributing to improved level of compliance and better expenditure management. 53. The key issues under this theme are: a. Internal audit is highly dispersed, lacks leadership and its effectiveness is virtually absent. b. Audit compliance is not timely to both the audit reports as well as the legislative scrutiny c. Audit monitoring system does not cover the qualitative issues and the entire process of audit settlement d. KSAD capacity constraints affects the PFM functions of the state and outdated audit methodology affects the timeliness of audit for the third tier of governments 54. The key focus of this thematic area will be on strengthening audit and oversight functions in the state through a. Conduct a situational analysis of the internal audit system, develop and implement risk based internal audit in high spending departments b. Improve effectiveness of audit via higher responsiveness and follow up on audit reports. c. Enhance the functionality of the audit monitoring systems to cover all audits, generate qualitative classification of audit, and capture the entire process of audit from inspection report to the final resolution of the audit by PAC. d. Strengthen KSAD through continuous training and capacity building measures, and augment capacity by recruiting staff, IT implementation, and outsourcing in the short run to address arrears of audit. Introduce modern audit practices like risk based audit, co-sourcing of audit, auditing through systems in KSAD to improve the overall audit timelines and quality. 55. It is envisioned that implementing the reform activities in this area would bring the following changes and benefits to GoK:  Establishment of a formal Internal Audit System, at least in the revenue and high spending departments, for promote effective internal controls. | Analysis, Gaps, and Recommendations - 2014 40 Government of Karnataka - Public Financial Management Reform Action Plan - 2014  Increased level of responsiveness to audit reports particularly at the initial stages of audit (half margin or inspection reports), faster compliance to audit reports, including substantial clearance of arrears, and reduction in the stock of outstanding audit observations.  Improved functionality and capability of the audit monitoring application including coverage of all audit reports and compliances and availability of updated audit database to improve the monitoring capability of the controlling officers.  Emergence of a strengthened and modernized state auditing institution, KSAD with increased efficiency in its work and effectiveness of its function undertaking its activities in a more meaningful manner.  High level of Legislative scrutiny of budget and audit reports to effectively undertake PFM oversight functions and enforce accountability.  Overall improvement in transparency by placing audit reports and action taken in public domain. Theme 6: Improving PFM systems in Government Enterprises and Local Self Governments Overall Reform Objective: To improve PFM in government enterprises and local self-governments through strengthening governance, improving internal controls including internal audit, and enhancing timeliness of accounts and audit to manage fiscal risks arising from these bodies 56. Local Self Governments every year handle around Rs.22500 crores, making it imperative that these institutions have strong PFM systems – but assessments often find gaps in PFM framework and compliance. The respective legislation underlying these institutions and accompanying manuals define the PFM environment. Significant efforts have been directed towards strengthening PFM in local self-governments (particularly accounting reforms) for ULBs and GPs, and a similar strategy is needed for ZPs and TPs. The key issues under this area are: a. Low revenue collection ratio and weak control over own source revenue; b. Backlog of accounts in GPs and audits in ULBs and GPs c. A not-so-strong system of internal controls, including internal audit; and d. Low capacity and shortage of finance staff are key areas that need immediate attention. 57. The key activities proposed under this area are: a. Improve Own source revenue by encouraging e-payments and collection through banks to improve controls and collection efficiency as well as preparing Demand Collection Balance and carrying out timely reconciliation. b. Develop and implement strategy to clear backlog of accounts and ensure full migration from manual systems of accounting to computerized systems. c. Design and implement effective and adequate internal controls, including internal audit. d. Review the accounts and finance staffing in these institutions both in terms of staff numbers and skills sets and develop a strategy for recruiting them. 58. State Owned Enterprises contribute to 7.2% of the GSDP and GOK investments in them are Rs.69,810 crores and the budgetary support for the FY 12-13 was Rs.15,059 crores. 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 but assessments often find gaps in PFM framework and compliance. While the scenario has improved in comparison to 2004, the following issues are persistent: | Analysis, Gaps, and Recommendations - 2014 41 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 a. Delay in completion of accounts and audits; b. Lack of effective internal audit, Lack of response to systemic audit issues and reconciliation problems; c. Non adoption of a corporate governance framework; and d. Absence of a nodal office to monitor and support the SOEs. 59. The key activities proposed under this area are: a. Conduct specific studies on corporate governance and establish a stronger corporate governance framework for government companies and corporations - the model code of corporate governance prescribed for central public sector undertakings could be adopted. b. Clear backlog of accounts and audits through external technical assistance as well as consider accounting reforms for entities which are yet to move to computerized accounting. c. Review external audit findings, including functioning of internal audit and audit committee d. Institutionalize a stronger nodal agency would benefit the GOK to support and monitor the SOEs. 60. It is envisioned that implementing the reform activities in this area would result in a strengthened PFM environment:  A stronger corporate governance in case of companies and corporations  Clearance of backlog of accounts, and a system in place to ensure timely preparation of accounts  A system of effective and adequate internal controls including internal audit in place  Clearance of backlog of audits, and a system in place to ensure that accounts are rendered timely for audit  A system for timely follow up of audit compliance. 61. The detailed PFM reform action plan for 2014 is outlined in the annex 1. | Analysis, Gaps, and Recommendations - 2014 42 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 Chapter 5: WAY FORWARD 62. GOK has been a pioneer in the area of PFM reforms and has been pushing the boundaries to the next level in most of the PFM areas and continue to improve PFM by strengthening their systems which includes policies, process, and people and are embarking on upgrading its PFM computerized systems (such as Khajane II and HRMS). Implementing the PFM reforms will require substantial commitment and sustained effort. Karnataka’s strength is that it has already embarked on a major fiscal and governance reform process, and has initiated several PFM improvements. It has the potential to go a long way, and become a pioneer in this field for India. This section outlines critical factors that are equally important for implementing the PFM reform action plan. 63. The 2014 Action Plan needs to be approved by the GOK and included in the Medium-Term Fiscal Plan of the Government. This will provide the necessary mandate for implementation and the instrument for disseminating the Plan, as well as review of the implementation on an on-going basis. 64. A high-level committee needs to be formed at the level of Principal Secretary (Finance) so that reforms can be reviewed on a regular basis and coordination across departments can be achieved. The prioritization of the actions and the timelines needs to be reviewed on a holistic basis by GOK and the sequencing of reforms needs to be worked out as most of the reforms are interlinked and benefits would accrue if related reforms are addressed simultaneously. A quarterly progress report on the achievements made and challenges faced should be presented to the committee for their monitoring and advice. Considering the magnitude of the reform actions, a system of continuous monitoring is essential to ensure that the implementation goes as planned and course corrections are identified, approved, and applied in a timely manner. 65. A dedicated 2014 Reform Action Management Cell needs to be constituted by the GOK to implement these reforms. The cell could be headed by Principal Secretary (Finance) with his team of Secretary (B&R), Secretary (Expenditure), and Secretary (FR) and secretaries from the respective Administrative departments. The office of the Secretary (Fiscal Reforms) can be nominated to co-ordinate and follow up on agreed action points. This office needs to be strengthened with adequate resources – human, financial, and IT as well as provided with sufficient powers to monitor the reform. 66. The Finance Department needs to exercise strong leadership in implementing the PFM reform. This is especially pertinent for activities relating to budget formulation and execution, accounting, financial reporting, auditing, and internal controls. PFM reforms needs to be led by the Finance Department, but it involves all departments like the Public Works Department (PWD), Rural Development and Panchayat Raj Department (RDPR), Urban Development Department (UDD), Water Resource Department (WRD), the Directorate of Municipal Administration (DMA), and the Department of Public Enterprises Reform and Disinvestment (DPE). All departments will need to cooperate for PFM modernization to happen. As a part of further actions, GOK can consider institutional review of key departments (PWD, RDPR, WRD, and UDD) and support them in strengthening their institutional framework, which would help improving the overall PFM framework of the state to a large extent. 67. Capacity is limited and needs to be developed. The capacity of the Finance Department needs to be developed both to manage the PFM system and to support departments implement their own PFM-strengthening activities. This includes the capacity of all parts of Finance dealing with budget development, implementation | Way Forward 43 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 and monitoring, the Controller (Accounts Management)’s office, KSAD, and the Treasury. Capacity in other departments also needs to be enhanced. Attention needs to be paid to meet the capacity constraints through the use of existing staff, hiring new staff, or the retention of consultants. Training, study tours, exposure visits, and the recruitment of finance, accounting and economics professionals will all help to develop capacity. 68. Technical assistance will likely be required to help in implementing this agenda. A “process consultancy� arrangement may be useful, i.e., a small team of specialists could be engaged to provide continuous support to the Finance Department. This team could prepare the necessary detailed technical papers and documents, carry out the necessary background work for the improvements, and help to progressively move the improvement agenda forward. The Bank could partner and potentially help in this regard. 69. Partnerships. Establishing a close working relationship with various national and state-level institutions is important. Many of the reforms may have to be led at the national level; others may involve coordination or consultation with national-level institutions. Such institutions include the CAG’s office, the Controller General of Accounts (CGA) of the Central Government, the Government Accounting Standards Advisory Board, and the Legislative Secretariat and Legislative Committees of the State Government. Partnerships with various agencies or organizations outside Government would be helpful in moving the reform agenda forward. They could include organizations such as the Institute of Chartered Accountants of India, National Institute of Public Finance and Policy, National Institute Financial Management, Institute for Financial Management Reforms and Institute of Public Enterprises. The specific areas of partnership could be worked out in consultation with these organizations. These partnerships will also help promote the demand for good PFM. 70. Learning from the Government of India’s practices and experiences and reforms in other states, in addition to other countries, is particularly important. Peer to peer learning workshops between state and study tours would help and support the process of PFM improvements. Several other states are implementing improvements in various aspects of the PFM agenda, which is outlined in the relevant sections. More advanced countries (e.g., South Africa’s public financial accountability reforms, Brazil’s model of consolidation and disclosure practices, Korea’s IFMIS implementation and open budget data, Russia IFMIS implementation and data disclosure) offer a variety of models of PFMA reforms and practices and also offer lessons and ideas. At the same time Karnataka has much to offer to other states. The various initiatives that Karnataka has taken are good examples to be shared with other Indian states. 71. Annual plans indicating the initiatives that would be implemented during each year should also be prepared, and performance targets and indicators to monitor the implementation of the agenda developed. Such an action plan should cover both the technical and institutional improvements (as discussed in previous sections) and the aspects previously discussed in this section. Ideally, it would be integrated into the Medium Term Fiscal Plan published by GoK and updated every year. | Way Forward 44 Government of Karnataka - Public Financial Management Reform Roadmap - 2014 ANNEX 1: PROPOSED PFM REFORM ACTION PLAN - 2014 This section contains the thematic-wise PFM Reform Action Plan, proposing the actions to be taken, the responsible department for the actions, and the expected timeframe for completing the actions. The detailed analysis of the issues and the logic for action plan are provided in the respective sections in the Appendix to this Report. Based on this, GoK may decide the actions to be implemented and their sequencing. Priority area/ Strategy Priority Timeframe Responsibility Target objective Theme 1: Strengthening PFM Legal and Institutional Framework (Section 1 of the Appendix) Strengthen implementation of fiscal responsibility legislation High March 2015 Finance Department  Create awareness and ownership amongst all departments towards (FD) Karnataka Fiscal Responsibility Act (KFRA) High March 2015 FD LFAFRA Strengthen fiscal  Operationalize the Local Fund Authorities Fiscal Responsibility Act Urban Development operationalized responsibility (LFAFRA) Department (UDD) legislation and Rural Development and update core PFM Panchayati Raj documents Department (RDPR) Revise and update core PFM Manuals and implement them High March 2016 FD KBM, KFC,  Revise Karnataka Budget Manual (KBM), Karnataka Financial Code KTC and MCE (KFC), Karnataka Treasury Code (KTC), Manual on Contingent revised/updated Expenditure and approved Provide Legal Mandate High March 2016 FD Roles and  Include IFA and ALMC roles and responsibilities in the KFC and responsibilities KBM so that Departments recognize their roles included in the updated KFC Strengthen and KBM institutional Appoint skilled staff High Ongoing FD Majority of capacity of  Recruit IFAs from KSAD IFAs deputed Internal Financial Advisors (IFA)  Address resource constraints in ALMC through training and from KSAD in appointing finance personnel from FD all major and Asset departments Liability and IFAs Management Cell providing high- level PFM services in FD Provide capacity building to staff Medium Ongoing FD  Provide extensive training to IFAs and ALMC including computer skills Government of Karnataka - Public Financial Management Reform Action Plan - 2014 Priority area/ Strategy Priority Timeframe Responsibility Target objective  Provide staff and IT support to IFA and ALMC  Monitor work of IFA and ALMC and provide time to time guidance Theme 2: Enhancing Comprehensiveness and Credibility of the Budget (Section 2 of the Appendix) Pass the full budget before beginning of the financial year. High Budget Year FD and State legislature Full budget 15-16 passed before start of year Reduce the number of Supplementary Budgets to at least two (from the Medium Budget year FD Supplementary present three) and to one in the long term 2015-16 budgets reduced to two Enhance Budget Credibility Medium Budget year FD Expenditure  Reduce the expenditure composition variance, from the present high 2016-17 Commercial Tax Dept. composition Strengthen Budget level, in phases say over a two-year period to bring it close to original (CTD). variance Process approved budget Excise Dept. (ED) reduced to less  Establish Economic Intelligence Unit in major revenue departments than 10% in and Implement a Revenue Forecasting Tool in Finance Department phase 1 and to less than 5% in phase 2 Strengthen supplementary process through enhanced disclosure Medium Budget year FD No unfunded  Prepare Supplementary Budgets which are Fiscally Neutral and in 2015-16 expenditure in accordance with the KFRA and present Fiscal Neutrality table supplementary  Provide details of actual expenditure and surrenders per demand in the budgets Supplementary Budgets Rationalize re-appropriation process High March 2015 FD Re-  Identify reasons for high level of re-appropriation orders (including appropriation injudicious and defective) and develop strategy to control the rising orders trend gradually  Review and revise re-appropriation delegation to more contemporary reduced to half Improve levels of 2013 level predictability of Provide capacity building to staff High Annual FD availability of  Organize workshops to disseminate rules and procedures of re- funds appropriations and Delegation of Financial Powers (DoFP) on fund releases Enact DoFP as rules High March 2015 FD Provision  Issue DoFP as rules on the lines followed by GOI and some states included in  Consider rush of expenditure as breach of financial propriety and KFC include provision in KFC Estimate budget Improve budget process for salaries estimation Medium Budget year HRMS Cell Appendix B | Annex 1: Proposed PFM Reform Action Plan - 2014 46 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 Priority area/ Strategy Priority Timeframe Responsibility Target objective provision of  Integrate Appendix B 14 preparation with the Human Resource 2015-16 FD generated from salaries on Management System HRMS realistic basis  Estimate salary for actual filled posts based on HRMS and posts expected to be recruited during the year Strengthen commitment controls by management of capital works Medium Budget year FD, Public Works Commitment  Prepare Appendix E15 timely, fully and submit along with budget for 2015-16 Department (PWD) control legislative approval and include all works covering all major heads Water Resources established  Prepare Appendix E on a rolling forecast model for 3 years Department (WRD) Full Appendix  Introduce MTEF in major spending departments (e.g. PWD) E generated Improve budget and tabled in process and Legislature controls over along with capital works budget Implement Project management software in works departments High Budget year FD, PWD, KII team Appendix E  Develop capability in project management software (PMS) to prepare 2015-16 KII generated from Appendix E implementation PMS  Mainstream PMS and integrate with upgraded Khajane (KII) plan Institute system Review the process of schemes, merge schemes and weed out nonexistent High FD for periodic scheme heads on a regular basis Administrative rationalization of departments Schemes Implement Implement DMTFP and results based budgeting in larger departments Desirable Departmental  Adopt DMTFP in larger departments like PWD MTFP  Provide departments with more flexible budgets  Link budgets to RFD and desired results Enhance Strengthen legislative scrutiny of budget Medium Budget Finance Department/ DRSCs Legislative  Implement Departmentally Related Standing Committee (DRSC) 2016/17 Karnataka Legislative constituted and scrutiny of budget mechanism Secretariat functioning  Build capacity of the Legislative Committee on Estimates and provide adequate technical support  Legislature to devote more time on discussion and voting of grants Theme 3: Strengthening Accounting, Reporting, Controls and Transparency (Section 3 of the Appendix) Strengthen Provide Capacity building to staff High Ongoing FD Accounting and  Reiterate the requirements and rules of KFC for areas identified in the 14 Appendix B is the budget document that contains full details of sanctioned, filled and vacant posts and estimation of salaries 15 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 | Annex 1: Proposed PFM Reform Action Plan - 2014 47 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 Priority area/ Strategy Priority Timeframe Responsibility Target objective Reporting for report enhanced PFM  Provide regular training to accounts staff on requirements of the acts compliance and rules Strengthen monitoring and reconciliation of utilization certificates High Ongoing FD  Designate a nodal office with adequate staff to collate and monitor compliance of submission of Utilization Certificates (UC) with the concerned departments and agencies  Plan one-time exercise to clear and clean up the backlog of reconciliation of expenditure, and UCs  Reduce the periodicity of submission of UCs Strengthen accounting process and disclosure requirements for CSS High March 2016 FD  Clarify roles and reporting requirements of GOI, GOK and Implementing agencies in respect of CSS funds routed through the state budget  Disclose transfers and actual expenditure of each centrally sponsored scheme  Move CSS projects funds to Public Deposit accounts instead of Bank accounts (in consultation with GoI) Strengthen accounting process and disclosure requirements for ULBs High March 2016 Finance Department and PRIs DMA  Constitute MIS cell to collect financial data RDPR  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)  Prepare link documents using uniform object codes Implement recommendations of the Central Finance Commissions on Desirable Finance Department disclosure as outlined in the report Adopt accrual based accounting system Desirable Finance Department Develop a roadmap for transition from cash based accounting to accrual accounting Include all public sector entities in fiscal reports as sub-sectors of GoK Desirable Finance Department Enhance Treasury Implement Khajane II (KII) with full computerization at the level of Ongoing K II rolled out processes, controls Drawing and Disbursing Officers (DDO) and reports Develop implementation plan for KII High March 2015 KII team through  Develop a roll out plan for KII and cutoff date for completing the implementation of switchover and withdrawal of manual books Khajane II  Develop and implement a data migration strategy to capture legacy | Annex 1: Proposed PFM Reform Action Plan - 2014 48 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 Priority area/ Strategy Priority Timeframe Responsibility Target objective data in key areas  Develop a HR staffing plan, change management strategy and training plan for all DDOs, Chief Controlling Officers and Treasury officials Build capability in Khajane II to High As per KII  Integrate/link the software’s outlined in the report implementation  Develop modules outlined in the report plan Improve cash  Carry out a study on cash management practices and debt scheduling. High As per KII Finance Department Cash management  Develop a cash forecasting model for monitoring cash management implementation forecasting and integrate with KII. plan module  Integrate cash balance and forecasting mechanism with debt developed and scheduling decision implemented  Link cash management projections with the Monthly Programme Implementation Calendar and procurement plans Enhance controls Create web-based information system for tracking and monitoring of High As per KII KII over Subsidies subsidies and interlink to KII implementation team/FD/Administrative plan departments Enhance interface Upgrade HRMS to advanced version of HRMS II Ongoing HRMS Cell HRMS II rolled capability, out scalability, and Address systemic audit issues and initiate payroll audit High Before roll out HRMS Cell Payroll audit integrity of the  Analyze C&AG audit report on HRMS and prepare mitigation plan of HRMS II conducted Human Resource  Initiate a comprehensive payroll audit for validating the database prior Management to migration to and roll out of HRMS II System Roll out e-payment of salaries across all districts. High March 2015 HRMS Cell 100% e- application FD payment of salaries Provide capacity building to departments on KTTP and e-procurement  Conduct capacity building programs, trainings and workshops for staff across departments Medium March 2016  Provide user guidance manual and share with the procuring entities working on KTTP and e-procurement E-procurement Cell Address systemic audit issues and conduct IT audit (DPAR) Strengthen e- Procurement  Analyze C&AG audit report on procurement and prepare mitigation FD High March 2015 E-procurement Cell systems plan for issues noted in case of violation of KTTP/e-procurement  Initiate audit of the e-procurement software by C&AG (DPAR) Enhance functionalities of e-procurement software Include: Functionalities  Online Bid Evaluation Process Medium March 2016 included in the  Issue of work order in the system (or this function needs to be software | Annex 1: Proposed PFM Reform Action Plan - 2014 49 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 Priority area/ Strategy Priority Timeframe Responsibility Target objective captured in KII)  Provisions for Expression of Interest  Contract Management Module Enhance Fiscal Disclose information on all major contracts awarded on the e-Procurement Major Transparency website. Contracts High March 2015 awarded, as defined, in public domain Theme 4: Improving Fiscal Assets and Liability Management System (Section 4 of the Appendix) Strengthen Controls over Issuance, Recording and Reporting of High March 2016 ALMC/FD Guarantee Guarantees Policy issued Enhance controls  Develop Government Guarantee Policy over Guarantees  Operationalize Guarantee Redemption Fund  Strengthen guarantee database and reconciliation efforts  Establish system for tracking, recording and reporting Further enhance controls over Off-Budget Borrowings High Annual FD Off-budget  Ensure that budgetary funds directed towards debt servicing are borrowings Phase out Off utilized for the intended purposes by the PSU/SPV. This will ensure gradually Budget better cash management phased out Borrowings  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  Phase out Off-budget borrowings Strengthen system Government’s Investment Portfolio is reconciled to reflect correct Immediate March 2015 Asset Liability Differences up of Recording, position Management Cell to March 2013 Consolidation,  Develop Operational Guidelines, in consultation with the AG to (ALMC) gradually Reconciliation and provide clear norms for determination, timing of accounting and FD reconciled and Reporting of the reporting of investments no current Investment  Issue clear-cut Government orders indicating intent when authorizing reconciliation Portfolio investment issues are  Strengthen efforts for identification and reconciliation of differences allowed to between state accounts and investee-company accounts accumulate Institutionalize Institutionalize the function of debt management, strengthen debt data High March 2015 FD Integrated Cash Debt recording and reporting and Debt Management,  Set up a combined Cash and Debt Management Office for cash and Management Recording and debt management recording and reporting. office | Annex 1: Proposed PFM Reform Action Plan - 2014 50 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 Priority area/ Strategy Priority Timeframe Responsibility Target objective Reporting  Reconcile debt data with the AG on priority functional functions  Disclose debt data and DSA on the website of the Finance Department. Strengthen system Strengthen system of Recording, Consolidation and Reporting High March 2016 CCO/ALMC Differences up of Recording,  Initiate special audit of detailed records of loans and advances to March 2013 Consolidation, maintained departmentally gradually reconciliation and  Strengthen efforts for identification and reconciliation of differences reconciled and Reporting of between state accounts and balance maintained by GOK no current Loans and  Develop strategy to address significant arrears in repayment of loans reconciliation Advances  Disseminate rules governing sanction and monitoring of loans and issues are advances and ensure compliance allowed to accumulate Decline in stock of Strengthen system of Recording, Consolidation and Reporting and High March 2016 FD Arrears, as Arrears of Monitoring defined, Payment  Develop a strategy for clearance of arrears as on a cut-off date reduced to not  Provide a formal definition of payment arrears for its due recognition more than 2%  Institute a system for recording and reporting arrears across GOK of total  Disclose expenditure payments outstanding in the mid-year report and expenditure budget documents. Strengthen Institute measures to clear backlog and avoid recurrence High September Finance Department/ Unencashed internal controls,  Initiate a special study to identify the underpinning causes 2016 Directorate of cheques as of accounting,  Formulate and implement a strategy to clear backlog Treasuries March 2013 reporting and  Commence monthly reporting of lapsed cheque to AG and finalize reverted and adjustments over accounting treatment of cancelled cheques no current Unencashed  Reduce the periodicity of cancellation of unencashed cheques to 3 build up are Cheques months allowed to accumulate Theme 5: Strengthening Audit and Legislative Oversight (Section 5 of the Appendix) Institutionalize Strengthen and modernize internal audit to improve internal controls High March 2016 Finance Department Strategy for Internal Audit in  Conduct a situational analysis of current internal audit arrangements in with support from select internal audit GOK GOK departments high spending revenue function  Develop risk-based strategy for implementing internal audit function and spending developed in the State; departments  Carry out categorization of departments and initiate internal audit in high spending departments and implement gradually | Annex 1: Proposed PFM Reform Action Plan - 2014 51 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 Priority area/ Strategy Priority Timeframe Responsibility Target objective  Develop and implement Internal Audit Manual Improve Strengthen mechanisms for follow up of external audit findings and High March 2016 FD Outstanding Responsiveness to recommendations replies to External Audit  Re-iterate the seriousness of non-compliance with audit paras and Inspection prescribe action for continuous failure to take action Reports and  Strengthen the institution of Ad Hoc committee at department level Audit Paras as and Apex Committees at state level of March 2013  Clarify and enhance role of the IFA in follow up of audit reports submitted  Take measures to ensure expeditious recovery of revenue at least in cases accepted by the Department Enhance functionality of the Audit Monitoring System for effective High March 2015 Controller Accounts AMS data, monitoring of compliance Management including  Mandate data input in the Audit Monitoring System as compulsory responses, up and Controller to monitor on a frequent basis to December  Integrate Audit Monitoring System with database maintained by 2014 updated CoPA by March 2015  Include KSAD audit reports and response in the system  Include qualitative aspects to assess systemic issues Develop strategy and carry out one time reduction of audit arrears High March 2015 KSAD Audit of FY 2013/14 completed by March 2015 Enhance staffing and improve skill sets through capacity building High Ongoing KSAD Number of  Increase cadre strength of KSAD staff deputed to  Organize training for KSAD staff on commercial accounting and IFA, Finance modern audit practices Department for Strengthen KSAD  Identify train and groom core group of KSAD staff to take up role of PFM services to improve PFM IFAs and enhance their PFM capabilities to take up enhanced role to services support FD Enablers for improving audit effectiveness and efficiency High March 2016 KSAD Audit Act and  Enact KSAD Audit Act to provide a legal status to KSAD FD Manual  Develop and implement a comprehensive audit manual implemented  Monitor and improve compliance through a Centralized Audit monitoring cell Implement modern audit practices to improve efficiency High March 2016 KSAD  Risk based audit  Co-sourcing | Annex 1: Proposed PFM Reform Action Plan - 2014 52 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 Priority area/ Strategy Priority Timeframe Responsibility Target objective  Financial Attest Audit  Audit Management software  Audit of ULBs and GPs through their computerized systems Strengthen effectiveness of Legislative Committee High March 2016 FD Action Taken Strengthen  Prescribe strict timelines for response to reports of the Legislative AG Reports Legislative Committee by the departments, and action for delayed or non- Legislative Secretariat outstanding as Scrutiny of compliance of March 2013 External Audit  Increase the technical human resources at the disposal of the submitted Reports Committee on Public Accounts (CoPA)  Place the Action Taken Reports in public domain after they are laid before the State Legislature Theme 6: Improving PFM in Local Self Governments and PSUs (Section 6 and 7 of the Appendix) Enhance controls to increase Own Source Revenue High March 2015 UDD and DMA Progressive  Update Demand Collection Balance Register to monitor and reconcile RDPR increase in own own source revenue GPs tax collections  Move towards e-receipts and collections through banks for all taxes ULBs by a specified % each year Increase in e- collections Improve timeliness of accounts in ULBs and GPs High March 2016 UDD and DMA All accounts  Develop and implement strategy to clear backlog of accounts RDPR for FY 2015/16  Ensure full migration from manual systems of accounting to GPs submitted for computerized systems ULBs audit by Jun Improve PFM in 2016 Local Self All ULBs and Governments GPs fully migrated to computerized accounting Enhance integrity of accounts in ZPs and TPs High March 2016 RDPR  Carry out one time cleanup of old balances and suspense account, FD bank accounts and closure of inactive accounts  Include MPAS reports and reports on banking transactions in the financial statements through amendment in Municipal Financial Rules Improve timeliness and responsiveness of audits in ULBs and GPs High March 2016 KSAD All audits up to  Develop and implement strategy to clear the backlog of pending audits UDD and DMA FY 2015/16 in ULBs and GPs RDPR completed by | Annex 1: Proposed PFM Reform Action Plan - 2014 53 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 Priority area/ Strategy Priority Timeframe Responsibility Target objective  Constitute Audit Cell in DMA and RDPR for audit follow up and September management 2016 Institute internal audit to strengthen internal controls High March 2015 UDD and DMA Audit Wings  Set up an internal audit wing with mandate and staff RDPR established  Finalize and establish Internal Audit structure in TPs (based on study FD within already completed) UDD/DMA and RDPR Enhance accounting and auditing High March 2015 Department of Public Clear all  Develop and implement strategy to clear the backlog of accounts Enterprises backlog of all  Review external audit findings, including functioning of internal audit Concerned accounts by FY and audit committee Administrative 2015. Strengthen PFM Establish effective nodal agency for SOEs High March 2015 Departments DPE and Corporate  Enhance the role of the DPE as an effective nodal agency for State State Owned designated as Governance in Owned Enterprises Enterprises (SOE) nodal agency State Owned for SOEs Enterprises Enhance corporate governance framework High Central Model  Conduct a SWOT analysis of existing corporate governance practices Code of in GOK and develop strategy for improving corporate governance Corporate considering the extant framework applicable to central PSUs Governance implemented in 10 major companies | Annex 1: Proposed PFM Reform Action Plan - 2014 54 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 ANNEX 2: 2004 - PFMA ACTION PLAN ACCOMPLISHMENTS AND CURRENT STATUS This section contains the action plan as proposed in 2004 report, updated with the current status of actions in the identified areas. In case where the action have been taken and completed by the GoK, the impact has been documented. The 2004 baseline and the reforms carried out are documented in the Analysis Report under respective sections. 2004 Action Plan – Accomplishment and Current Status 2004 Reform Plan Agreed Action Accomplishment/Current Status Impact I. Budget preparation and implementation (a) Ensure budget passage at start of fiscal year Present budget in early Feb so that it can Issue revised budget calendar The budget is presented by March of the The full budget is passed in be passed by end-March. previous year, but only a Vote on Account is June/July during the second phase passed before the start of the Financial Year of the budget session that is 3-4 (FY). months into the FY. This action needs to be implemented by GoK. Revise MTFP production schedule to MTFP is presented along with the budget finalize by time of budget passage (since 2008). Instructions to provide inputs to (2004-05) or presentation (2005/06). the MTFP are detailed in the budget calendar. Include MTFP production in revised budget calendar. (b) Phase out off-budget borrowing (OBB) Reduce off-budget borrowing every year, Reduce to Rs 1,140 crore in 2004-05 There were no fresh OBBs during 2008/09 to The total fiscal liabilities, and eliminate at earliest opportunity and Rs 720 crore in 05/06, as per 2010/11 and fresh OBBs raised during including OBB, are within the MTFP. Eliminate in 06/07. 2011/12 and 2012/13 were less than the limits prescribed by the XIIIth repayments. The outstanding OBB as at the Central Finance Commission. close of FY 2012/13 was Rs. 1,455 crore reduced from Rs. 5,582 in 2008/09. (c) Improve budget realism Improve tax forecasting Prepare pro forma for tax forecasts to The budget circulars require Estimating quantify impact of growth and reform Officers to present a 3-year forward estimate for all tax departments revenue and assumptions made. The circulars provide guidance on estimating revenues. Publish pro forma tax forecasts with Tax forecasts for the next three years are budget outlined in the MTFP. Fiscal intelligence cell to be The Commercial Tax Department (CTD), the This recommendations needs to established in FD. biggest revenue department has floated be followed by GoK | Annex 2: 2004 - PFMA Action Plan Accomplishments and Current Status 55 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 2004 Reform Plan Agreed Action Accomplishment/Current Status Impact consultancy tender for setting up an Economic Intelligence Unit to improve inter alia the analytical capabilities of CTD Base budget on realistic resource Start budget process with updating This practice is being followed during budget envelope. and agreement on total resource preparation. However, there are significant in- envelope (realistic revenue & year budget amendments. affordable borrowing) for the budget, approved by Government, and stick to this. Base budget on realistic expenditure Line Departments and Finance to Arrears of payments including electricity are This recommendations needs to estimates prioritize and fully-fund existing not being budgeted fully while drawing up the be followed by GoK commitments (e.g. electricity budget and the outstanding is increasing over payments, retained schemes) over new the years. Data on arrears are partially programs during budget preparation. available. There are also incomplete projects. Ensure schemes announced in the In respect of schemes, the Finance Budget are properly screened and Department has issued guidelines for their fully budgeted. approval and for making budgetary provisions. Limit Supplementary Budgets and Develop Pro forma for all Pro forma for collecting the revised estimates schemes introduced outside the budget supplementary budget requests and for supplementary is issued along with the cycle new policy initiatives coming to budget circular, which is followed. Cabinet to indicate off-setting fiscal measures as per FRA From next supplementary budget on, The position in respect of SEs remains the The impact on the fiscal include “fiscal neutrality� table same as was the situation in 2004. The indicators is not stated in the SE. showing, per grant, amount funded percentage of aggregate SEs to original This is not strictly in line with the through tied grants, adjustments, estimates has increased from 8-10% then to KFRA Act. expenditure cuts, revenue increases between 14-18% now. Fiscal neutrality table etc. is not explicitly shown per grant and it is displayed at an aggregate level. Though the SEs provides overall sources of financing, this includes “cash outgo� and the impact of the SEs is not offset through reduction of expenditure or revenue augmentation. This is apparent as such details are not provided in | Annex 2: 2004 - PFMA Action Plan Accomplishments and Current Status 56 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 2004 Reform Plan Agreed Action Accomplishment/Current Status Impact the SE document. Some of the departments show significant requirements of supplementary demands. Reduce number of supplementary Each year three SEs are prepared and A heavy reliance on budgets presented to the State Legislature. supplementary budgets to 1 undermines the discipline and sanctity of the budget process. Even now these estimates come without offsets in other expenditures to ensure that deficit targets were met. (d) Introduce Departmental budgeting for more accountability and flexibility Consolidate Plan and non-Plan budget Finance and Plan to agree on Plan and non-plan ceilings are worked out by GoK should target implementing allocations into Departmental resource Departmental ceilings (both Plan and Finance and Plan and agreed, DMTFP are DMTFP at least in high spending envelopes. non-Plan) to be issued for each presently not being developed to guide the departments like PWD, WRD and Department at start of budgetary discussion. RDPR so that budgeting and process (to be included in new budget MTFP can be drawn more calendar). realistically and departmental DMTFP ceilings to be used as starting ceilings can be fixed by the FD. point for next year’s budget negotiations Reduce number of line-items (schemes, Further reduction in schemes in 2003- While object heads has been reduced, the FD should review the number of and object heads) in budget 04 numbers of schemes have not reduced –there schemes with each administrative are still some 1600 schemes presently. department and reduce the number of schemes. This exercise should be carried out at least once in every three years. Department of Agriculture carried out such an exercise and significantly reduced the number of schemes. Budget by broad departmental programs Prepare dummy budget along program Such an exercise has presently not been (groups of related individual schemes) lines for 2003-04, and then prepare adopted. and by broad expenditure categories and present 04-05 budgets along these (groups of related object heads). lines. Treasury MIS to report to Departments by Reporting by grants Such a reporting system has been | Annex 2: 2004 - PFMA Action Plan Accomplishments and Current Status 57 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 2004 Reform Plan Agreed Action Accomplishment/Current Status Impact Grants and Program Reporting by programs implemented. (e) Strengthen performance orientation of Departments Evaluate performance of department Hold workshops to evaluate Departments commenced preparation of the against agreed output/outcome targets departmental performance with DMTFPs but have since been discontinued DMTFPs as basis. DMTFPs to be produced with budget and submitted to Subject Committees Incentivize Departments to raise revenue Introduce performance against non-tax (non-tax revenues, and CSS expenditures) revenue and CSS expenditure targets as performance criteria for DMTFPs, with monthly monitoring using Treasury data. Reward Departments with good revenue performance through increased allocation. (f) Improve budgetary expenditure allocation and screening process For civil works departments, prioritize Include full maintenance requirements Guidelines on such lines are provided in the GoK needs to give priority in non-salary spending in order of: (i) as committed expenditure in the budget circular. However, in actual practice budget to arrears and ongoing arrears; (ii) maintenance; (iii) existing budget. this is not being strictly followed in view of projects over new projects capital projects (in order of degree of For capital projects, give priority in significant arrears of payments. This issue is completion); (iv) new capital projects budget to arrears and ongoing still relevant and the practice has broadly projects over new projects remained the same as assessed in 2004. Avoid spreading capital funds thinly Budget only to include only capital Instructions have been issued by GoK on GoK to ensure Appendix E is projects which are (i) fully funded; (ii) these lines and norms for budget provisions submitted to the Legislature with have passed cost-benefit analysis; and have also been determined. However the delay the budget and only those works (iii) have received administrative in preparation and clearance of Appendix E approved by the Legislature is approval. (list of works) is negating the benefits of these executed and paid No projects in Appendix E with token changes. provision. Include in Appendix E expected completion dates. Avoid introduction of new schemes Budget only to include new schemes As above. This issue is still relevant and the unless well-justified and fully-funded. which (i) have been approved by practice has not changed. Expenditure Review Committee and (ii) are fully funded. (g) Simplify budget implementation and improve cash flow | Annex 2: 2004 - PFMA Action Plan Accomplishments and Current Status 58 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 2004 Reform Plan Agreed Action Accomplishment/Current Status Impact Reduce financial clearances required post- FD to further enhance individual Individual clearance limits (powers for There is a perceptible Budget approval clearance limits. financial sanction and also release of funds) improvement in the pace of Departments to enhance delegation of have been continuously enhanced since 2006 expenditure, and decline in rush financial powers of Heads of and departments now have more flexibility in of expenditure during the last Departments (HODs) terms of release of funds without recourse to quarter/month thus improving the the Finance Department and more clarity on quality of public expenditure. different types of funds flow. Powers at the level of HoDs and below have also been enhanced and codified and power to re- appropriate at the level of HoD has also been enhanced. Improve cash flow management to avoid Budget cuts, if required, to be issued There have been no significant budget cuts payment delays. early. during the last few years. Review recommendations of Box 6 of PFMA report on cash flow requirements (h) Strengthen internal controls Strengthen budgetary controls over Treasury to provide and Departments Treasury provided monthly statements to the outlays and commitments to use monthly receipts and payments departments which can be used for monitoring MIS to monitor budgets. Quarterly budget. However the issue is that departments review of expenditure vis-à-vis budget don’t do reconciliation on a regular basis. by Expenditure Committee. IFAs to be strengthened to support budget monitoring and internal controls (see VI). Strengthen control over capital works LoC system has been withdrawn and all Computerization of Appendix E is by capital works (App. E) payments are being made through treasury. a suggestion which is relevant computerization, and extension of Appendix E computerization has not been even today and GoK needs to Treasury computerization to include done. PWD has started implementing works develop and implement software LoC. software from last year and the results are yet in this regard. to be seen. Computerization of DDOs (see II d) to This is planned under the upgraded Khajane enable commitment controls. (KII) new IFMIS system under development Remove open-ended obligation in power Implementation of purchaser-provider sector. model. | Annex 2: 2004 - PFMA Action Plan Accomplishments and Current Status 59 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 2004 Reform Plan Agreed Action Accomplishment/Current Status Impact Revision of Treasury Code, Financial Revise Financial Code. This action is yet to be done Code, Budget Manual and related Codes/Manuals to modernize, and Revise other Codes and Manuals This action is yet to be done simplify Strengthen borrowing and guarantee All Departments to refer all All debt is now raised centrally by the FD. controls borrowings to FD for prior approval. Debt is now raised with the approval of the FD and monitored. Individual departments do not have the power to negotiate loans directly. Strengthen guarantee controls GoK has centralized the maintenance of the A database of Guarantees is data in respect of Guarantees with DSS in available with GoK The process 2005. The DSS collects annual information on of recording and reconciliation of guarantees from the respective institutions on Guarantees has been whose behalf the guarantee was issued in institutionalized and reporting of prescribed form and updates its database that Guarantees has been formalized. is presently maintained on spreadsheets. FD to sign guarantee issuance to FD issues the concurrence for giving of This action is deemed complete as enable control over guarantees. Guarantees through a GO and authorizes the the authority to sign the guarantee Principal Secretary/ Secretary of the has been formalized. concerned Administrative Department to sign the guarantee document. (i) Increase fiscal transparency Make more fiscal data available to public. Table Finance Accounts in Assembly During the last three years (2009-2012) the Timely scrutiny of the finance session following their receipt from audited Finance Accounts were placed before accounts by the PAC, leading to AG. the Legislature within 2-3 months (the next faster action and faster session of the Legislature) as compared to one availability of information to the year in 2004. public. Reduction of time lag by 9 months. Place Finance Accounts and Accounts Finance Accounts is available on the website at a Glance on the Web and make of AG Karnataka after they are tabled in available in electronic form (CD) . Legislature Publish full budget on Web and in Full set of budget documents are available on electronic form (CD). the website of Finance Department after they are presented in the State Legislature | Annex 2: 2004 - PFMA Action Plan Accomplishments and Current Status 60 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 2004 Reform Plan Agreed Action Accomplishment/Current Status Impact Ensure monthly data on Web up to Monthly Accounts at Glance and Monthly date. Civil Accounts are available on the website of AG Karnataka The monthly reports are available within 1-2 months. Publish half-yearly review as per FRA Prepare review for April-September The mid-year review is done regularly and 03 and table in Assembly tabled in the Legislature and available in public domain within 2 months from the close of the half-year. Treasury to establish Web with MIS Underway. This action has been completed. Treasury provides all the MIS reports Publish data on stock of pending bills. Publish on FD website stock of This is presently not being done. pending Treasury bills on monthly basis. Ensure bills paid on first-in, first-out Monitor queue jumping in Loc bills by These actions have been completed by GoK (FIFO) principle publishing individual pending and paid bills on Finance Website in dated order. Extend Treasury computerization to include LoC payments Put audit reports and responses on the Place PAC reports on the Web Full reports of the Legislative oversight This action is relevant now also Web Consider placing audit responses on committees 16 are not placed on the Web. and GoK needs to put the reports the Web However, parts of the reports in respect of and response in the Web. which an Action Taken Report is required from a department, are available on the Audit Monitoring System. II. Financial Computerization and MIS (a) Treasury computerization (Khajane) Use Treasury computerization to develop Review and improve MIS reports All these reports are available with treasury Treasury as single-point payment agency, (e.g., Departmental expenditure and departments. and to develop financial MIS. monitoring reports, exceptions/ Phase out LoC system variance reports) Introduce computerized receipt for bills (tokens). 16 Committee on Public Accounts, Committee on Public Enterprises and Committee on Local Bodies | Annex 2: 2004 - PFMA Action Plan Accomplishments and Current Status 61 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 2004 Reform Plan Agreed Action Accomplishment/Current Status Impact Develop service standards for bill This has been implemented. The treasury is payment by Treasury required to make payments on FIFO basis within 5 days of the entry of the bill in the system. Eliminate non-Bank treasuries, and This action has been completed reliance on RBI as agency bank. Carry out risk audit of Khajane. Risk and IT audit has been completed in 2009 and on the recommendations, KII an advanced IFMIS is being implemented Computerize civil service payments: Pension computerization is under progress. Develop computerized database, compute pension amounts through the computerized system, and make direct payments to the Bank accounts of individual civil pensioners Extend computerized Treasury to Except Appendix E all other action have been include all LoC payments, and extend completed. Treasury payment budgetary control module to cover Appendix E projects and non-plan civil works. Obtain and include information on non-treasury flows (e.g., direct transactions at RBI Nagpur, inter-governmental and other adjustments in AG’s Office) in computerized system. Generate daily information on State Government’s Bank balance from the Treasury system. (b) Capital Works Control (Appendix E) computerization Computerization to enable better control Develop implementation plan; There is delay in preparation of Appendix E This action is relevant and needs of budgeting and implementation of complete software development and and is presently not presented in Legislature to be carried out by GoK capital or civil works for Appendix E hardware procurement. along with the budget. Appendix E is also Departments (PWD, MI, WRD) with link 2003-04 Appendix E of budget incomplete as not all works under all major to the Treasury payment system. produced using computerized system. heads are being included. This budget document is not tabled in the State | Annex 2: 2004 - PFMA Action Plan Accomplishments and Current Status 62 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 2004 Reform Plan Agreed Action Accomplishment/Current Status Impact Legislature. This action is yet to be done. Implement in the 3 major capital As above. This action is yet to be done. This action is relevant and needs works Departments. to be carried out by GoK (c) Payroll Computerization (linked to HR Database and Treasury) Computerize payroll to enable central Pilot computerized payment of Development of HRMS commenced in 2005, generation of monthly payroll and salaries at Secretariat level. after piloting was rolled out in the entire state payment of salaries, as well as in a phase manner. The secretariat was management of employee-related covered in 2009/10 accounts (e.g. insurance) Complete HR database and initiate A computerized Human Resource HRMS covers all employees of payroll computerization (complete Management System (HRMS) as a centralized the state government plan. award contracts) web based application has been implemented (approximately 5.5 lacs including across the State. HRMS covers both service teachers) besides covering records and pay bill generation. It comprises employees of Taluk Panchayats the following seven modules – Service and urban local bodies, 70,000 Register, Pay Bill, Transfers, Promotion, employees of fully aided Suspension, Compliant Monitoring and educational institution and of Reports. some public sector undertakings and about a lac Anganwadi workers. This is a major achievement as expenditure on salaries (excluding district and block panchayats 17 ) constitute about 20% of revenue receipts and about 14% of total revenue expenditure during 2011/12.18 Start issuing cheque to individual E-payments to staff directly from treasury Faster payments and better employees rather than each DDO. have been rolled out in 15 districts while in internal controls thus reducing other districts the payment is made by the burden of data entry and Treasury to the DDO in form of cheque which reconciliation. is further handed over to the staff. In Khajane II, the default mode of payment is planned to be electronic transfers to the 17 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. 18 Report on State Finances for the year ended Mar 31, 2012, C &AG | Annex 2: 2004 - PFMA Action Plan Accomplishments and Current Status 63 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 2004 Reform Plan Agreed Action Accomplishment/Current Status Impact accounts of the payee. (d) DDOs computerization Computerize DDOs to enable Initiate preparatory work (procedures This is being done as a part of the KII commitment controls, recording and study, linkages with Treasury and implementation reporting; computerized bill preparation other systems, computerization plan) (machine readable at Treasury); receipts and payments record keeping; sub- Initiate computerization (award This is being done as a part of the KII accounts/detailed accounts for loans, contracts) implementation advances, etc.; records and registers at DDOs; bills payable/arrears recording and reporting; fixed assets (stores and stock) registers (e) Accelerating Monthly Accounts preparation schedule Use Treasury computerization to enable Revise target dates for Monthly The LoC system has been discontinued. The This action has been completed. AG to accelerate production of monthly Accounts: rendering of accounts by current target date for submission of monthly Accounts from treasury are share accounts. treasury and LoC Departments to compiled accounts by Treasuries to the AG is with AG (A&E) in soft copy AG’s Office by 10th of next month; 9th of the next month (except that State Huzur which is imported by AG (A&E). Monthly Accounts by AG to State Treasury submits by 18th). There are instances A&E finalizes the accounts based Government by 25th of next month. of delayed submission of monthly accounts by on the treasury accounts and the Treasuries19. inputs from RBI. The Voucher Monthly Accounts by AG to the Government level entry has been dispensed is usually made available between 25 to 55 with by AG. days from close of the month. III. Accounting Issues (a) Public Account clean-up Reduce backlog of public accounts and Focus first on large funds, and take The balances in these accounts as at the year- One time action was carried out prevent build-up in future. measures for one-time clean-up and to end are required to be transferred back to the by GoK. But this action still prevent build up in the future. Consolidated Fund. This rule is not strictly remains relevant and needs to be PRI and municipal funds: one-time being followed in Karnataka and significant done on a periodical basis. clean up, annual closure in the future balances are carried forward to the subsequent to prevent build-up. year/s. Nearly half of the PD accounts are 19 The AG (A&E) has reported delays in 2011-12 of up to 15 days on 294 occasions and over 15 up to 30 days on 18 occasions and over 30 days on 1 occasion. Persistent delays are from State Huzur, Bangalore (Urban) and Bangalore (Rural) Treasuries - PAG (A&E), Karnataka Report on the Annual Review of the Working of the Treasuries for the year 2011-12 (April 5, 2013). | Annex 2: 2004 - PFMA Action Plan Accomplishments and Current Status 64 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 2004 Reform Plan Agreed Action Accomplishment/Current Status Impact KBJNL Deposits: Close???? inoperative, some have adverse balances and PDAs: Backlog: Prepare break-down none of the Administrators have reconciled One time action was carried out as on March 31, 2003 (individual the balances with the Treasury and the AG by GoK. But this action still item/entity wise, if necessary year- (A&E). remains relevant and needs to be wise). Reconcile with totals in done on a periodical basis. Finance Accounts. Write-back amounts as appropriate (e.g., amounts lapsed/expired, differences between totals and individual items). Prevent further build-up: Regularly prepare break-down and match with total accounts (monthly); review and close regularly (comprehensive GO to be issued) Reduce number of PDAs. Ban use of One time action was carried out PDAs for budget carry-forward by GoK. But this action still purposes. remains relevant and needs to be done on a periodical basis. Extend above process for PDAs to One time action was carried out other deposits and accounts by GoK. But this action still remains relevant and needs to be done on a periodical basis. Suspense and Miscellaneous One time action was carried out Accounts. Backlog: Prepare by GoK. But this action still breakdown for all these accounts as on remains relevant and needs to be March 31, 2003 and close as done on a periodical basis. appropriate. Prevent further build-up: Regularly prepare breakdown (monthly), review and close (quarterly). Prepare monitoring database for This action has not been public accounts. completed and it is relevant even in today’s context. (b) Reconciliations Reduce unreconciled amounts at all levels Unencashed Checks and LoC The procedure for identification, reporting and The Treasuries/DDOs are not | Annex 2: 2004 - PFMA Action Plan Accomplishments and Current Status 65 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 2004 Reform Plan Agreed Action Accomplishment/Current Status Impact of the system. Remittance accounts cancellation/write-back of unencashed complying with the internal  Backlog: Prepare Break-down (lapsed) cheques prescribed in the Karnataka controls prescribed in this area. (cheque-wise details) on March 31, Financial Code appears not to be working Unpaid cheques are not 2003. Write-back and close expired effectively as the quantum of unencashed considered as part of the cash cheques. Identify how differences cheques is showing an increasing trend over position of the state. In terms of between total amount and individual the years - The outstanding as at March 2013 accounting, if unpaid cheques are cheques if any would be addressed is at a level of Rs. 6,820 crore compared to reversed with delay in subsequent (e.g. write back). Rs. 1,120 crore in 2001/02. This level is also year/s, it affects the  Regularly reconcile from April 2003 considerably high when compared to some revenue/expenditure of the year in (monthly) – match totals with other states Such as Gujarat, MP, Odisha and which write-back is done. individual cheques, and write-back Kerala. There is also a delay in requesting for The balance in unencashed expired cheques. Alteration Memos by the Treasuries and issue cheques is shown in the Public by the AG (A&E). Account and is not considered as  Establish and implement monitoring cash balance of the state. mechanisms to ensure that reconciliations are done regularly in From an internal control all Treasury offices and LoC offices perspective also, it is imperative that cheques remaining unencashed should be identified, document and reversed. The 2004 action point has not been adequately addressed and remains relevant. Matching of total accounts with While GoK has achieved more than 90% in individual/sub-accounts in DDOs terms of reconciliation of revenue figures, (e.g., loans, advances, deposits). achievement in terms of reconciliation of Reconciliations of CCOs with AG’s expenditure is only 58% (FY 2013) and there numbers, and DDOs with Treasury is slippage over the last few years. numbers PD accounts have not been reconciled since  Reiterate requirements regarding last several years. Issues in reconciliation of these reconciliations (issue Circular) loans and advances continue.  Establish and implement monitoring mechanisms -- develop and implement web-enabled application | Annex 2: 2004 - PFMA Action Plan Accomplishments and Current Status 66 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 2004 Reform Plan Agreed Action Accomplishment/Current Status Impact for monitoring  Improve controls over expenditure The quantum of outstanding AC Bills are Settlement of AC Bills need to be advances (AC Bills/MPWA Debits contained at a reasonable level and showing a followed scrupulously less they and Credits/ DC Bills) decreasing trend over the years in both accumulate which inflates the  Reiterate requirements regarding outstanding as well as fresh drawls during the expenditure as the amount drawn prompt submission of DC Bills and year - as at March 2013, the outstanding AC is already accounted for in the penalties for non-submission (such Bills were Rs. 122 crore of which Rs. 45 crore final head of account. as no further AC bills/MPWA were drawn in March 2013 itself. AC Bills advances if AC Bills are not aggregating Rs. 67 crore are outstanding prior cleared) to FY 2012-13 (i. e. more than 1 year) for want of submission of DC Bills.  Establish and implement monitoring arrangements IV. Audit/PAC responsiveness and follow-up (a) Audit Reports Set up mechanisms to ensure prompt Continue to monitor using database, Web enabled application (Audit Monitoring A large number of audit response to State Government audit and follow up with Departments; System - AMS) developed and implemented. observations including those with reports and Inspection Reports develop web-enabled application. The AMS captures information on inspection financial implications as well as Extend database to inspection reports. reports, draft audit paras and action taken systemic issues are pending Departments to identify systemic reports – this however is not complete and adequate resolution. issues in the 2001-02 and 2002-03 updated. Reports are available for all stages GoK should improve AMS to Audit Reports and Inspection Reports, except inspection reports. AMS also presently capture systemic issues which and initiate improvements to address does not cover the audit observations of would support the management in these. KSAD. addressing thematic issues rather However the important point on identifying than individual issues. This is and reporting systemic issues has not been being addressed in the proposed carried out in AMS. audit module of KII. (b) PAC Reports Set up mechanisms to ensure prompt Coordinate with PAC Secretariat to PAC has its own database of status of audit response to PAC Reports include PAC Reports in the audit paras, but is not linked with the AMS. This is response monitoring database; initiate being addressed in the proposed audit module development of web-enabled of KII. application. Identify systemic issues in the 2001- The PAC is following the approach of This has reduced the backlog. 02 and 2002-03 PAC Reports and reviewing latest audit reports first and Review of CAG report on state | Annex 2: 2004 - PFMA Action Plan Accomplishments and Current Status 67 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 2004 Reform Plan Agreed Action Accomplishment/Current Status Impact initiate improvements to address these focusing more on systemic issues. The finances up to 2009/10 has been selection of audit paras for hearing is done on completed. Review of ATR for the basis of materiality and risk. There is more 2010/11 and 2011/12 is emphasis on taking up contemporary and underway. Finance and relevant issues. Appropriation Accounts have been reviewed till 2010/11. Civil reports are taken up department – wise. PAC has regularized excess expenditure aggregating Rs. 9565 crores up to year 2010-11. V. Other Public Sector Agencies (a) Government Companies/Corporations Monitor compliance with core PFMA Continue monitoring of accounts and The accounts and audit backlog have reduced FD should have a cell to monitor requirements (accounts and audits, audit backlog. over the years. The individual administrative the accounts and audit backlog of responses and follow-up on audits and departments and the AG monitor the the government companies. COPU reports, audit committees, completion of accounts and conduct of audit. reconciliations, internal control issues in Reiterate need for reconciliation of ALMC has been designated to carry out the Accounting and control in this audit reports) amounts relating to transfers from reconciliation. This issue still persists and this area has not kept pace with the State Government reflected in the suggestion is relevant in the current scenario growth in the investment Companies’/Corporations’ accounts also. portfolio. The Finance Accounts and State Government’s accounts; and may not disclose the correct monitor compliance (issue Circular) investments of GoK (b) Statutory Boards and Authorities (SBAs), and Societies Establish monitoring mechanisms and Start monitoring accounts and audit monitor compliance with core PFMA backlog (C(AM)). requirements (accounts and audits, Reiterate need for reconciliation of responses and satisfactory follow-up on amounts relating to transfers from audit reports State Government; and monitor compliance (issue Circular). Use Local Funds Authority Fiscal The act has not been Responsibility Act to develop standard No steps have been taken to develop the operationalized and needs to be PFMA framework (drawing on the PFMS framework as the Act has not been implemented. Indian Companies Act framework), operationalized.. and make applicable for all SBAs (c) Panchayat Raj Institutions (PRIs) | Annex 2: 2004 - PFMA Action Plan Accomplishments and Current Status 68 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 2004 Reform Plan Agreed Action Accomplishment/Current Status Impact Clear backlog of accounts and audits and Continue monitoring of accounts and Since ZP/TP are audited by C&AG, RDPR RDPR-IFA and ZP-Special officer ensure regularity and timeliness of audit backlog. monitors the accounts closure on a regular should monitor the status of accounts and audit, and satisfactory basis, the accounts and audit backlog for accounts and audit on a regular follow-up on audit reports. ZP/TP has considerably reduced. In case of basis. GPs the accounts and audit backlog and GoK needs to prepare a strategy to address this issue. Stipulate preparation of TP This action has been carried out. Based on the accounts/audits at TP not ZP level; 2004 report the ZP/TP accounting rules where make necessary amendments to PRI modified and separate accounts where to be Act. furnished by the TP. Now TPs prepares their own accounts and statements. PFMA modernization agenda for PRIs Complete ZP/TP accounting ZP/TP accounting yet to be computerized and ZP/TP accounting is being computerization (linked to Treasury); linked to Treasury. computerized as a part of the KII GP account strengthening: (i) All action except financial audits regarding implementation. Finalize GP accounting rules; (ii) GPs have been completed (i) new accounting KSAD needs to carry out initiate pilots of financial audits of rules have been issued in 2006 (ii) financial audit which is still a GPs by Chartered Accountants computerization has been completed for all relevant action. (under supervision of KSAD); (iii) GPs across the State and (iii) RTI has been initiate GP computerization operationalized across the state. On basis of computerized database, Scheme rationalization for PRIs as per GO (GO under modification) Operationalize RTI at local level (incl. public boards with works/beneficiary/financial info.) (d) Urban Local Governments (ULBs) Clear backlog of accounts and audits and Start monitoring accounts and audit ensure regularity and timeliness of status for 6 City Corporations under accounts and audit, and satisfactory current statute. follow-up on audit reports. Start monitoring accounts and audit New fund based accounting system has been backlog for other ULBs under current implemented across ULBs. statute (clarify that accounts would be monitored using new receipts and payments statement). | Annex 2: 2004 - PFMA Action Plan Accomplishments and Current Status 69 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 2004 Reform Plan Agreed Action Accomplishment/Current Status Impact PFMA modernization agenda for ULBs Complete first phase accounting New fund based accounting system has been computerization of 32 ULBs with implemented across all ULBs, except in the population greater than 1 lakh. Bangalore municipal corporation (BBMP) Complete BMP FBAS ; Develop This action has been completed revised accounting guidelines based on BMP experience Improve accounting capacity by Accountant posts have been created recruited recruiting qualified accountants in nearly 140 ULBs while for 70 ULBs it is (initially on contract in 32 ULBs) yet to be done. Initiate pilots of financial audits of 6 Financial audits for all ULBs are being carried CCs by Chartered Accountants (under out by CA firms thought there is backlog in supervision of KSAD) completion of audit. (e) Incentivize compliance by government bodies with accounting and audit requirements On selective basis, introduce compliance Operationalize Local Fund Authority The Act is still to be operationalized The Act was to apply to local with basic PFMA requirements as Fiscal Responsibility Act bodies under state control and prerequisite for release of government handling public funds including funds. urban and rural local bodies. Application of the Act would also have paved the way for preparation of MTFP as every local authority would be obliged to prepare a MTFP 20 . Also, the Act would have enforced PFM principles including submission of accounts, setting up a Local Fund Audit Overseeing Authority and provide enhanced participation of the citizens in budget and planning. Link fund transfers to public sector This action has not been agencies from State Government to implemented and it is still adherence to stipulated PFMA relevant for GoK to implement 20 The Act prescribed that the Medium Term Fiscal Plan shall be the source document for the preparation of the annual budget and shall address the prime needs of the citizens as relevant to the specific local fund authority such as water supply, construction of road, education, public health, solid waste management and the like. | Annex 2: 2004 - PFMA Action Plan Accomplishments and Current Status 70 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 2004 Reform Plan Agreed Action Accomplishment/Current Status Impact requirements (e.g., preparation of this. accounts and audits, responses and follow-up action on audits, reconciliations, other PFMA requirement in the respective statute ) Require utilization certificates for Establish mechanism to monitor Monitoring of submission of UCs is done by To further reinforce this government grants prior to release of submission of Utilization Certificates individual departments – a centralized achievement, GoK should further grants. for institutions which receive grants mechanism for follow up is not in place. The establish a centralized database of from governments Accountant General provides data on outstanding UCs. A one-time outstanding UCs in the Finance Accounts. Efforts to reduce the outstanding UCs have paid off as backlog has significantly reduced. Link fund transfers from State This has been mandated through GOs, though Government to submission of in actual practice, further grants may be Utilization Certificates. provided pending UCs for previous releases. VI. Institutional Arrangements and Capacity Building Strengthen financial oversight of All 3 employee insurance schemes to ?? government insurance schemes. be handled in single office (transfer Group Insurance Scheme/Savings Fund to KGID.). Eliminate remaining accounts/audit backlog. Computerize operations. Subsequently include employee accounts maintenance in computerized payroll. Ensure better management of government Government to review and decide Senior level executive appointments are This action has not been bodies through competitive selection of mechanism for mandatory, generally made by the Administrative implemented and it is still top management ) competitive selection of senior level Department (in consultation with the relevant for GoK to implement executive appointments for concerned Minister in charge) and competitive this. Government Companies and SBAs selection is an exception. and Societies – Directors, MDs and Chairmen. (e.g., Public Enterprises Selection Board as in GOI and Kerala) Develop financial management capacity Ensure IFAs qualified (apply existing All major departments have IFAs. The within Government rule of 1/3 from AG office, 1/3 from existing rule of appointment is followed. KSAD; 1/3 from Secretariat). Ensure However the quality of non KSAS IFA’s | Annex 2: 2004 - PFMA Action Plan Accomplishments and Current Status 71 Government of Karnataka - Public Financial Management Reform Action Plan - 2014 2004 Reform Plan Agreed Action Accomplishment/Current Status Impact that all major spending departments needs to be reevaluated by the GoK. (e.g., Water Resources) have IFAs. Appoint 10 Chartered Accountants for This action has not been implemented and it is State Accounts Department (initiated). still relevant for GoK to implement this. Identify other required capacity This action has not been implemented and it is enhancements for other Departments. still relevant for GoK to implement this. Review Accounts Management and modify if required. | 72