Completion Report

Project Number: 36172-063 Grant Numbers: 0305, 0306 and 0368 February 2018

Nepal: Strengthening Public Management Program This document is being disclosed to the public in accordance with ADB’s Public Communications Policy 2011.

CURRENCY EQUIVALENTS

Currency Unit – Nepalese rupee/s (NRe/NRs)

At Appraisal At Program Completion

23 February 2011 31 December 2016

NRe1.00 = $0.013 $0.009 $1.00 = NRs72.424 NRs108.592

ABBREVIATIONS

ADB – Asian Development Bank

CAC – citizen awareness center

CIAA – Commission for the Investigation of Abuse of Authority

CPA – Corruption Prevention Act DDC – district development committee

DFID – Department for International Development of the United Kingdom

DMF – design and monitoring framework

e-GP – e-government procurement

EU – European Union

FCGO – Financial Comptroller General’s Office

FRRAP – fiduciary risk reduction action plan

FY – fiscal year

GDP – gross domestic product GESI – gender empowerment and social inclusion

IPT – integrated property tax IT – information technology

KMC – Kathmandu Metropolitan City

LGCDP – Local Governance and Community Development Programme

MARS – municipal administration and revenue system

MC&PM – minimum condition and performance measure

MOF – Ministry of Finance

MOFALD – Ministry of Federal Affairs and Local Development

MTBF – medium-term budget framework

NNRFC – National Natural Resources and Fiscal Commission

NVC – National Vigilance Centre

OPMCM – Office of the Prime Minister and Council of Ministers PEFA – public expenditure and financial accountability

PETS – public expenditure tracking survey

PFM – public financial management

PPMO – Public Procurement Monitoring Office

RBIA – risk-based internal audit SNG – subnational government SPMP – Strengthening Public Management Program TA – technical assistance

VDC – village development committee

WCF – ward citizen forum

NOTES

(i) The fiscal year (FY) of the Government of Nepal ends on 15 July. FY before a calendar year denotes the year in which the fiscal year ends, e.g., FY2017 ends on 15 July 2017.

(ii) In this report, "$" refers to United States dollars.

Vice-President Wencai Zhang, Operations 1 Director General Hun Kim, South Asia Department (SARD) Director Bruno Carrasco, Public Management, Financial Sector and Trade

Division, SARD Team leader Çiğdem Akın, Senior Public Management Economist, SARD Team members Lindy Gamolo, Operations Assistant, SARD

Sheila M. Foronda-Mariano, Senior Operations Assistant, SARD Hanif A. Rahemtulla, Senior Public Management Specialist, SDTC-GOV Rachana Shrestha, Senior Public Management Officer, SARD Malika KC Thapa, Operations Assistant, SARD Raju Tuladhar, Senior Public Management Specialist (Governance), SARD

In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS

Page

BASIC DATA i

I. PROGRAM DESCRIPTION 1

II. EVALUATION OF DESIGN AND IMPLEMENTATION 2

A. Relevance of Design and Formulation 2 B. Program Outputs 2 C. Program Costs 6 D. Disbursements 6 E. Program Schedule 6 F. Implementation Arrangements 6 G. Conditions and Covenants 7 H. Related Technical Assistance 7 I. Consultant Recruitment and Procurement, and Peformance of Consultants Contractors, and Suppliers 7 J. Performance of the Borrower and the Executing Agency 8 K. Asian Development Bank and Confinancier Performance 8

III. EVALUATION OF PERFORMANCE 9

A. Relevance 9 B. Effectiveness in Achieving Outcome 10 C. Efficiency in Achieving the Outcome and Outputs 10 D. Preliminary Assessment of Sustainability 11 E. Development Impact 12

IV. OVERALL ASSESSMENT AND RECOMMENDATIONS 13

A. Overall Assessment 13 B. Lessons 14 C. Recommendations 14

APPENDIXES

1. Design and Monitoring Framework 16 2. Status of Compliance with First Tranche Policy Actions 20 3. Status of Compliance with Second Tranche Policy Actions 22 4. Status of Compliance with Grant Covenants 29 5. Technical Assistance Completion Report 33 6. Comparison between Nepal Subnational and National Public Expenditure and Financial Accountability (PEFA) Scores 36 7. Proposed Reforms under a Follow-on Policy-based Program 47 8. Findings of the Field Visits during the Project Completion Report Review Mission 48 9. Country Economic Indicators 51

BASIC DATA A. Grant Identification 1. Country 2. Grant Number 3. Program Title 4. Borrower 5. Executing Agency Implementing Agencies 6. Amount of Grant

7. Program Completion Report Number

Nepal 0305, 0306, and 0368 Strengthening Public Management Program Nepal Ministry of Finance Ministry of Federal Affairs and Local Development, Public Procurement Monitoring Office, and National Vigilance Centre $27,950,000 ($21 million for G0305, $4 million for G0306, and $2.95 million for G0368) 1672

B. Grant Data 1. Appraisal – Date Started – Date Completed 2. Grant Negotiations – Date Started – Date Completed 3. Date of Board Approval 4. Date of Grant Agreement 5. Date of Grant Effectiveness – In Grant Agreement – Actual – Number of Extensions 6. Closing Date – In Grant Agreement – Actual

– Number of Extensions

23 February 2011 4 March 2011 30 July 2012 31 July 2012 26 September 2012 (G0305 and G0306) 5 November 2013 (G0368) 27 December 2012 (G0305) 30 April 2013 (G0306) 28 March 2013 (G0305) 31 July 2013 (G0306) 26 August 2013 (G0305 and G0306) 3 31 October 2015 (G0305, G0306, and G0368) 6 April 2017 (G0305 and G0306) 1

7. Disbursements a. Dates

Initial Disbursement

9 September 2013 (G0305 and G0306)

Final Disbursement

9 December 2016 (G0305)

17 January 2017 (G0306)

Time Interval

39 months

40 months

ii

Effective Date

26 August 2013 (G0305 and G0306)

Original Closing Date

31 October 2015 (G0305 and G0306)

Time Interval

26 months

b. Amount ($ ‘000)

Category or Subloan

Original

Allocation

Last Revised

Allocation

Amount

Canceled

Net Amount

Available

Amount

Disbursed

Undisbursed

Balance

G0305 21,000 21,000 0 0 21,000 0 G0306 4,000 3,344 0 0 3,344 656 G03681 2,950 0 2,950 0 0 0

Total 27,950 24,344 2,950 0 24,344 656 1 The grant amount was canceled on 24 February 2014.

8. Local Costs (Financed) - Amount ($) 0.0 - Percent of Local Costs 0.0 - Percent of Total Cost 0.0 C. Program Data

1. Program Cost ($ ‘000)

Cost Appraisal Estimate Actual

Foreign Exchange Cost 27,950 24,344 Local Currency Cost Not applicable Not applicable Total

2. Financing Plan ($ ‘000)

Cost Appraisal Estimate Actual

Implementation Costs Borrower Financed Not applicable Not applicable ADB Financed 21,000 21,000 Other External Financing 6,950 3,344

Total 27,950 24,344

IDC Costs Not Applicable Not Applicable Borrower Financed ADB Financed Other External Financing

Total

ADB = Asian Development Bank, IDC = interest during construction.

iii

3. Cost Breakdown by Program Component ($ ‘000)

Component Appraisal Estimate Actual Date Disbursed

G0305 Tranche 1 11,000 11,000 9 September 2013 Tranche 2 10,000 10,000 9 December 2016 Total 21,000 21,000 G0306 Tranche 1 900 900 9 September 2013 Tranche 2 2,444 2,444 17 January 2017

Total 3,344 3,344

G0368 Total 2,950 0 Cancelled on

24 February 2014

4. Program Schedule (Not Applicable)

Item Appraisal Estimate Actual

Date of Contract with Consultants Completion of Engineering Designs Civil Works Contract Date of Award Completion of Work Equipment and Supplies Dates First Procurement Last Procurement Completion of Equipment Installation Start of Operations Completion of Tests and Commissioning Beginning of Start-Up Other Milestones

5. Program Performance Report Ratings (Not Applicable)

Implementation Period

Ratings

Development Objectives

Implementation Progress

iv

D. Data on Asian Development Bank Missions

Name of Mission

Date

No. of Persons

No. of Person-Days

Specialization of Members

Consultation 1 23 February–4 March 2011 5 9 a, c, e, f Fact-Finding 1 1–9 September 2011 8 8 a, c, d, e, f, h, j Fact-Finding 2 3–11 November 2011 8 8 a, b, c, d, e, f, h, j Consultation 2 21–26 February 2012 6 5 a, c, e, f, g Consultation 3 18–22 February 2013 1 4 a Negotiation and Consultation 4

23–27 July 2012 5 4 c, e, f, g

Review 1 27–31 May 2013 6 4 b, c, e, f, g, j Review 2 28–31 January 2014 4 3 b, c, e, g Review 3 1–10 December 2014 4 9 c, e, i Review 4 4–14 August 2015 1 10 b Review 5 6–27 June 2016 4 21 c, e, g, i Review 6 22–29 September 2016 4 7 c, e, g, i Review 7 21–25 November 2016 4 4 c, g Project Completion Report

30 October–3 November 2017 4 5 c, e, k

Total 101 a = finance sector economist, b = finance sector specialist, c = public management specialist, d = portfolio management specialist, e = public management officer, f = programs officer, g = procurement officer, h = young professional, i = economic analyst, j = director, k = operations assistant. Note: The review missions recorded here are those from the ADB headquarters in Manila, the Philippines, and exclude other monitoring and implementation meetings conducted by the Nepal Resident Mission following the delegation of the project on 13 September 2013.

I. PROGRAM DESCRIPTION

1. Nepal completed its complex and protracted political transition to democracy with the peace accord signed in April 2006, leading to the promulgation of an interim constitution in 2007. Following a nationwide Constituent Assembly election in 2008, the newly formed Assembly declared Nepal a federal democratic republic, abolished the monarchy, and elected the country's first president. The political reconciliation during 2012–2015 was uneasy, with the dissolution of the Constituent Assembly in May 2012 without finalizing the new constitution, subsequent elections, and frequent changes of government due to the fragmented political landscape. 2. On 20 September 2015, the new constitution was adopted, restructuring the government from unitary to a federal system.1 The two devastating earthquakes in April and May 2015, and floods and landslides in mid-2017 presented additional challenges to post-conflict reconstruction efforts. Madhesi2 political parties, critical of the constitutional provisions and demarcation of new states, caused unrest in the Terai region, resulting in the unofficial blockage of the Indian border and a change of government in August 2016. Following the resolution of the stalemate, Nepal moved ahead with provincial assembly elections, held for the first time in 20 years. The first round was completed in May 2017, the second round in June and September 2017, and the remaining state-level elections in November and December of 2017. Following the election for the National Assembly (the upper house of the federal parliament), the new prime minister of the coalition government took office in February 2018. While the elections and political negotiations were ongoing to form a new government, work has continued with the drafting of laws for operationalizing the federal system and restructuring the administration at all tiers of government. 3. The difficult political climate, the limited absorptive capacity of institutions, and the economic disruptions brought by natural disasters, have led to a large drag on the economy, leaving infrastructure and public service delivery in disarray. Poor accountability to citizens in the absence of locally elected officials, weak public financial management (PFM), high fiduciary risks, weak oversight, and corruption, particularly in public procurement, are manifestations of these economic and political shocks.3 Besides geographical and infrastructure-related difficulties, these weaknesses were identified as major constraints to development, leaving Nepal as the weakest performing economy in terms of gross domestic product (GDP) per capita in South Asia.4 4. In recognition of the federal structure that the Constituent Assembly was moving towards, and in view of the importance that local governments would be playing in the future structure, on 26 September 2012, the Asian Development Bank (ADB) approved the policy-based Strengthening Public Management Program (SPMP) with a grant of $25 million, consisting of two

1 The constitution envisages three-tiers of federal government—central, state (provincial), and local—with the creation

of a new second tier consisting of seven states (provinces) and the restructuring of existing local governments (former 75 district development committees [DDCs], one metropolitan city, 12 sub-metropolitan cities, 204 municipalities and 3,157 village development committees [VDCs]) into 744 local bodies (4 metropolitan cities, 13 sub-metropolitan cities, 246 urban municipalities and 481 rural municipalities). With nine new municipalities, local bodies increased to 753, effective from March 2017. The three tiers were given exclusive and concurrent executive, legislative, and judicial powers to make budget, raise tax and non-tax revenues, and carry out public expenditures within their jurisdictions in line with fiscal federalism. The constitution provisions for intergovernmental fiscal transfers by the National Natural Resources and Fiscal Commission, and revenue sharing and equalization grants from central to local governments.

2 Madhesi refers to people residing in the Terai region of Nepal near the border with India. 3 ADB. 2009. Country Diagnostic Studies. Nepal: Critical Development Constraints. Manila. 4 Nepal’s average per capita GDP during 2006-2016 was estimated at $595 compared with $853 for Bangladesh,

$2,181 for Bhutan, $1,318 for India, and $2,887 for Sri Lanka. World Bank. World Development Indicators.

2

tranches and a technical assistance (TA) grant of $6.55 million to the Government of Nepal. The aim of the program was to improve the effectiveness of the delivery of public goods and services by enhancing efficiency, transparency, and integrity of public finances at the national and subnational levels.5 The program was designed with the view that neither a policy-based grant nor TA alone could address the severe shortcomings of the local governments and that an integrated approach combining policies with investment and capacity development was required.

II. EVALUATION OF DESIGN AND IMPLEMENTATION

A. Relevance of Design and Formulation

5. The need to address governance and PFM challenges at the central and local government levels has been part of ADB’s reform agenda in Nepal. ADB supported the Government of Nepal’s flagship Local Governance and Community Development Programme I (LGCDP I, fiscal year (FY)2008–FY2013) with the implementation of the Governance Support Program, under cofinancing arrangement with five other development partners and in line with the PFM agenda of the Multi-Donor Trust Fund. 6 During the mid-term review of LGCDP I in 2012, the government conducted a fiduciary risk assessment, highlighting weak local PFM systems, political interference in budget allocations, poor accounting and reporting, noncompliance with procurement regulations, and the absence of internal and external audits. Thus, the government approved the Fiduciary Risk Reduction Action Plan (FRRAP) in March 2012 and updated it in July 2015,7 forming the basis for the follow-on LGCDP II (FY2014–FY2017). ADB’s SPMP was designed to support the PFM components of LGCDP II along with other development partners. Thus, both at appraisal and design, the SPMP was highly relevant and consistent with (i) the government’s own development objectives of improving investment through better governance and PFM;8 (ii) the inclusive delivery of public services through the subnational administration;9 and (iii) ADB’s Nepal Country Partnership Strategy, 2013–2017, focusing on building effective PFM, governance, and accountability mechanisms for inclusive growth.10 ADB’s program loan modality was appropriate since the SPMP used own-country systems for disbursing the budgetary support to the government accounts, which was a critical value addition not always provided by other development partners. The SPMP remained relevant at completion. B. Program Outputs

6. The SPMP had 23 policy actions under four outputs. All ten first tranche actions were fully complied with. Out of 13 second tranche actions, 11 were fully complied with, one was partially complied with, and one was a non-compliance. Details are in Appendixes 2 and 3.

5 ADB. 2012. Report and Recommendation of the President to the Board of Directors: Proposed Policy-Based Grant,

Administration of Grant, and Technical Assistance Grant to the Government of Nepal for Strengthening Public Management Program. Manila.

6 ADB. 2008. Report and Recommendation of the President to the Board of Directors: Proposed Program Cluster and Grant for Subprogram 1 to Nepal for the Governance Support Program. Manila.

7 Government of Nepal, Ministry of Federal Affairs and Local Development.2015. Fiduciary Risk Reduction Action Plan (FRRAP). July 2015-July 2017. Kathmandu.

8 Government of Nepal. National Planning Commission. 2014. Thirteenth Plan, FY2014–FY2016. Kathmandu. SPMP complemented the Government of Nepal’s initiatives to improve PFM, such as the “14 steps planning process”, minimum conditions and performance measures, public audit, internal audit, e-bidding, annual procurement plan.

9 Nepal Law Commission. 2008. Good Governance (Management and Operation Act), 2064. Kathmandu. 10 ADB. 2013. Country Partnership Strategy. Nepal 2013–2017. Manila.

3

7. Output 1: Local government budget and fiscal management improved. To promote predictable and timely fiscal transfers to the local governments, the Ministry of Federal Affairs and Local Development (MOFALD) issued guidelines and an action plan for the streamlined disbursement of block grants from the central government to local governments, and of small community-level grants based on participatory planning and procurement by ward citizen forums (WCFs) and citizen awareness centers (CACs). 11 These guidelines, effective until July 2017, have been replaced by the Local Governance Bill (September 2017) and Local Financial Procedures Bill (September 2017), regulating the budget process and grant allocation for the local governments under the new federal system. Under the SPMP, MOFALD approved amendments to the Local Bodies Resource Mobilization and Operations Management Guidelines (2012) to incorporate measures for enhancing existing own-sources of revenues for district development committees (DDCs), municipalities, and village development committees (VDCs).12

8. The Ministry of Finance (MOF) approved a 3-year medium-term budget framework (MTBF) for MOFALD for FY2017–FY2019 as part of the FY2017 national budget to strengthen planning and timely budget disbursements to local governments. 13 The MTBF ensured that the results-based budget for MOFALD was credible and consistent with the allocated resources and the priorities of the local governments, and provided greater fiscal discipline. MOFALD also enforced the provisions of earmarked funding for gender empowerment and social inclusion (GESI) activities (i.e., 15% for disadvantaged groups, 10% for women, and 10% for children) as per the block grant guidelines,14 and provided expenditure tracking reports through its minimum condition and performance measure (MC&PM) system in all local bodies. Exceeding the target of 25, 50 VDCs in 30 districts piloted the revised manual with performance measures for block grants in FY2013. The MC&PM assessment manual was revised based on the pilot, and in FY2014, MOFALD extended the MC&PMs to all VDCs, exceeding the scope of the policy action.

9. To enhance local revenue mobilization, MOFALD also piloted the municipal administration and revenue system (MARS), which is a web-based resource planning software, in 35 wards of the Kathmandu Metropolitan City (KMC).15 MOFALD took various measures (Appendix 3) to promote integrated property tax (IPT), enabling municipalities to objectively valuate houses and land parcels and assess taxes based on automated property data. The IPT was introduced into 97 municipalities in FY2016, exceeding the target of 45 municipalities. 10. Output 2: Fiduciary risk management strengthened at the local government level. As part of the government’s FRRAP—implemented under LGCDP II—MOFALD approved a strategy and integrated action plan to strengthen PFM and address fiduciary risks in local governments. MOFALD also introduced a results-based reporting system in DDCs to monitor

11 Grants from the central government to local bodies, e.g., conditional and unconditional recurrent and capital block

grants, administrative grants, and matching grants for projects, accounted for 9% of the national budget in FY2015. 12 The guidelines will be revised in line with the Local Governance Bill (2017) for three tiers of the federal government. 13 The earlier process of bottom-up budgeting for local governments lacked effective coordination, and consolidated

budgets coming from VDCs and DDCs lacked prioritization and often exceeded the allocated resources. This led to arbitrary selection of projects and undermined the credibility of budgets.

14 The guidelines included gender and children participation in local planning and governance structures and gender responsive budgeting and audit as performance measures. By FY2017, 23 DDCs out of 75 conducted GESI audits.

15 MARS enables local governments to effectively manage their budget, expenditures, and revenues for better service delivery. It has nine integrated modules, including (i) revenue management, (ii) financial management and accounting, (iii) budget monitoring and planning, (iv) fixed assets accounting, (v) citizen interface, (vi) personnel information, (vii) payroll information, (viii) office management, and (ix) decision support systems.

4

capital expenditures and approved guidelines for external audits of municipalities and VDCs. These measures aimed to promote transparency and accountability of public expenditures. 11. MOFALD carried out the subnational public expenditure and financial accountability (PEFA) assessment for the first time in 2015, examining the 28 indicators included in the national PEFA report.16 Given the weak capacity at the local level, prolonged absence of elected officials and frequent turnover of local governments, the PEFA assessment showed that subnational PFM systems were relatively poor (16 measures were worse than the national PEFA). Weaknesses were attributed to (i) inadequate own-source revenue collection, (i) inefficient budget execution, lack of developed budget guidelines, and disconnect between capital and recurrent operation and maintenance expenditures; (ii) poor quality of financial reporting; and (iii) insufficient financial controls and poor coverage of internal and external audits (Appendix 6).17 12. To promote financial accountability, MOFALD rolled out a uniform accounting and financial management software in 1,352 VDCs in 51 districts. By FY2016, 695 VDCs had functional accounting software, and 2,709 VDC staff received user training. However, only 300 VDCs were effectively using it compared with the target of at least 1,000 VDCs, and of these, 46 VDCs were restructured into municipalities, requiring a different accounting system and making the software no longer applicable under the federal system. The lower than targeted usage was because of (i) a shortage of trained accountants and technical staff in VDCs and frequent staff turnovers, (ii) the destruction of offices after the 2015 earthquakes, (iii) limited information technology (IT) infrastructure, (iv) administrative uncertainty with merging of VDCs into municipalities, (v) weak accountability due to absence of elected officials, and (vi) insufficient technical support from MOFALD in remote areas. Thus, compliance with this policy action was only partial. Although the VDC accounting software is no longer used because of the restructuring of subnational governments in 2017, familiarity of the local governments with IT-based PFM platforms improved. 13. MOFALD approved the guidelines and tools for the conduct of risk-based internal audits (RBIA) for DDCs, VDCs, and municipalities on 20 October 2016. These were aligned with the internationally accepted integrated control model using risk-based sampling techniques, representing an improvement to the outdated 100% transaction compliance model. MOFALD provided training on RBIA guidelines and fraud auditing at the local level. 14. Output 3: Public procurement system enhanced. SPMP targeted improvements in the public procurement system to promote transparency and efficiency in public procurement, and to reduce fiduciary risks associated with corruption, fraud, and waste in line with the FRRAP. The Public Procurement Monitoring Office (PPMO) conducted a joint technical review with ADB and

16 Based on central PEFA assessments,19 out 31 indicators improved, 10 remained the same and only 2 deteriorated

from 2008 to 2014. Budget credibility, comprehensiveness and transparency of fiscal processes, and policy-based budgeting strengthened, while predictability and control of budget execution, and quality and timeliness in accounting and reporting of annual budget and financial statements stayed the same due to weak coordination between budgeting, procurement planning and spending. External scrutiny and audit scored lower given weak performance-based audits and corrective measures against irregularities (Appendix 6).

17 MOFALD completed public expenditure tracking surveys (PETS) for 111 projects in 35 local bodies under the SPMP. The PETS Supervision and Facilitation Committee in February 2017 revealed no leakage of funds at the local bodies because of the use of Treasury Single Account by DDCs, compared with previous cases of such leakages. The 2014 central PEFA report recorded improvement in scores from C to A for resources received by service delivery units using PETS in health and education sectors (Appendix 6). However, project design and annual fund utilization were found to be weak at local bodies. Thus, the PEFA report recommended strengthening of project management, MC&PMs to incentivize expenditures across trimesters, and allocation of funds for operations and maintenance.

5

the World Bank on 23–27 January 2012 and prepared a roadmap for establishing an electronic government procurement (e-GP) system. With SPMP’s TA support specifically designed for the development of a full-fledged e-GP covering all aspects of the public procurement cycle, the PPMO developed the e-GP software in December 2015, followed by a successful pilot in five major infrastructure departments on 14 April 2016.18 The Public Procurement Act was amended in July 2016. The Prime Minister inaugurated the nationwide roll out of the e-GP system on 1 January 2017. All DDCs and municipalities prepared procurement plans in FY2017 under MC&PMs. The PPMO completed the e-GP training of 20 ministries and 75 districts, including municipalities, and exceeded the target of at least 8 ministries and 35 districts. 15. Output 4: Institutions for oversight and accountability strengthened. To strengthen anti-corruption and accountability institutions in line with the National Strategy against Corruption (2012), the Chief Commissioner and commissioners of the Commission for the Investigation of Abuse of Authority (CIAA) were appointed. In 2013, the National Vigilance Center (NVC) submitted a proposal to the cabinet to elevate its status to an independent body to have more authority for technical audits and an increased role in advocacy for corruption prevention.19 In February 2015, the NVC submitted to the Office of the Prime Minister and Council of Ministers (OPMCM) a separate proposal for establishing a National Vigilance Commission to prevent corruption and irregularities in public institutions. Under the new constitution relating to jurisdiction over “improper acts”, the government has so far prioritized the Corruption Prevention Act and the CIAA Act before deciding on NVC’s status, which remains an oversight and prevention body with no punitive powers for noncompliance. The proposed act to upgrade the NVC status and clarify its overlapping mandates with the CIAA and the Office of the Auditor General (in the case of technical audits) is still waiting for OPMCM’s decision as of February 2018, and this delayed process has impacted NVC’s effectiveness. 16. In February 2016, the NVC, through the OPMCM, submitted to the cabinet a draft bill proposing amendments to the NVC-related Article 38 of the Corruption Prevention Act (2002) for compliance with the United Nations Convention against Corruption and effectiveness of technical auditing for development projects. Between 2013 and 2016, NVC submitted additional proposals to the OPMCM for strengthening its legal and institutional framework, independence, and effectiveness as an oversight agency and for establishing a framework for technical audit standards: (i) proposed draft bill under Article 83 (1) of the Interim Constitution of Nepal 2007 for establishment of a National Vigilance Commission (submitted on 2 February 2015) and (ii) proposal on institutional restructuring (submitted on 17 August 2016) in line with the new constitution. Submission to the cabinet and enactment of these amendments have been awaiting broader legislative and administrative reforms under the federal system. Thus, the policy action was not complied with at the time of the program completion. To improve fraud and investigation competencies, the NVC organized a training program on 26–27 July 2016 where 65 senior officials from leading anti-corruption, good governance, and oversight agencies participated. The NVC prepared the proceedings of the training, highlighting international best practices and policy recommendations, and submitted to the OPMCM. 17. While there may not have been a concrete decision under the NVC-related policy action, SPMP contributed to creating awareness within the government on the importance of oversight

18 ADB. June 2016. Instituting e-Government Procurement in Nepal. Knowledge Showcases. Issue 66. Manila. 19 NVC conducts 50-60 technical audits per year on infrastructure-related, donor-funded and “national pride” projects.

Technical audit is not compulsory for all projects and done at the request of the concerned agency.

6

and accountability mechanisms as a key PFM building block and the need for the NVC to have its own act for greater effect. Several deliberations with TA specialists along with capacity building helped build dialogue on reform priorities to strengthen oversight and audit institutions, which need to be followed up under the federal system. The need and recommendations for strengthening technical audits were highlighted for enhancing public sector investments. C. Program Costs 18. At appraisal, the program size was estimated at $30 million, comprising reforms for (i) local government budget and fiscal management, (ii) local government fiduciary risk management, (iii) public procurement, and (iv) oversight and accountability capacity building. On 26 September 2012, ADB approved a grant of $21 million from the Asian Development Fund and $4 million cofinancing from the Department for International Development of the United Kingdom (DFID). The Government of Nepal financed the remaining cost from its own budget. The program size remained the same during implementation. The European Union (EU) originally envisaged a €4.5 million grant ($5.9 million equivalent), of which $2.95 million was for the SPMP and the remaining $2.95 million was for the TA. However, the EU canceled the additional program cofinancing due to its policy rule that program-related funds could not be delegated to another multilateral development partner using a budget support approach. D. Disbursements 19. The SPMP provided a $25 million grant in two tranches. As per ADB guidelines, the first tranche of $11.9 million was disbursed on 9 September 2013. Of the second tranche amount of $13.1 million, ADB's portion of $9.1 million was fully disbursed on 9 December 2016. Only $3.344 million out of DFID cofinancing ($4 million) was disbursed on 17 January 2017 due to exchange rate fluctuations and administrative expenses. The cumulative disbursement was $24.344 million. E. Program Schedule 20. The SPMP was designed for 3 years starting from approval on 26 September 2012 until the original completion on 31 October 2015. It was extended until 31 December 2016 on 28 October 2015 primarily due to (i) political stalemate related to the formation of the Constituent Assembly during 2012–2013 and protracted constitution drafting process until September 2015; (ii) frequent changes in government and elections, creating rapid turnover of government officials both at the central and local levels; (iii) institutional, legal, and administrative restructuring under the federal system; (iv) setbacks due to earthquakes and natural disasters; and (v) delays in TA implementation supporting the policy actions (para. 24). F. Implementation Arrangements 21. The implementation arrangements designed at appraisal were satisfactory with no changes during the program despite some coordination issues (paras. 26 and 28). The MOF was the executing agency responsible for (i) implementation of policy actions; (ii) coordination with other reform initiatives; and (iii) administration, disbursements, and maintenance of records. The MOF received policy guidance from the PEFA Secretariat under the Financial Comptroller General’s Office (FCGO), which was the program steering committee. MOFALD, PPMO, and NVC were the implementing agencies. MOFALD implemented outputs 1 and 2 through the

7

LGCDP II and FRRAP. The PPMO implemented output 3, and the NVC implemented output 4. The PPMO and the NVC established their program coordination units, while MOFALD’s LGCDP coordination unit served for SPMP and enabled coordination among development partners. G. Conditions and Covenants 22. The covenants on program management in the grant agreements were fully complied with. Most of the covenants on implementation were fully complied with. Although a separate program completion report was not submitted, the government made its assessment of LGCDP II, including activities under SPMP. The findings are aligned with this completion report. While critical program staff remained, general staff turnover occurred during the political transition (Appendix 4). H. Related Technical Assistance 23. An attached TA grant of $3 million, comprising $500,000 from ADB’s Technical Assistance Special Fund (TASF-IV) and $2.5 million cofinancing from DFID and administered by ADB, was provided on 26 September 2012. The TA supported three outputs: (i) key PFM diagnostic tools, comprising (a) two PETS conducted at the midterm and end of the program, (b) local PEFA assessment, and (c) MC&PMs for VDCs; (ii) MARS design, including piloting in KMC; and (iii) development of e-GP system and rolling out its modules to at least eight ministries. An additional grant cofinancing of $2.95 million from the EU, administered by ADB, was approved on 5 November 2013 to (i) strengthen RBIA at the local governments, (ii) improve technical audit and corruption vulnerability diagnostics by the NVC to assess public investment projects, (iii) support the PEFA Secretariat, (iv) support piloting of MARS, and (v) capacity building for the e-GP system. On 10 December 2015, DFID provided an additional $600,000, bringing the total TA amount to $6.55 million for capacity building activities, preparation of RBIA manual, VDC accounting software manuals, MTBF for MOFALD, and fraud and investigation tools. 24. The TA is rated successful although the original completion of three years from 28 December 2012 was extended three times until 30 June 2017 due to (i) delay in the signing of the externally-financed grant agreement with the Government of Nepal, involving DFID cofinancing, and effectivity of the SPMP;20 (ii) impact of the transition to federalism; (iii) force majeures (i.e., earthquakes in 2015 and unofficial blockage of Indian border until early 2016); and (iv) delays in completion of e-GP, MARS, VDC, and RBIA related TA activities and capacity building. There were three consulting packages related to PFM tools, development and procurement of hardware and software for MARS and e-GP system, selected based on a quality-cost ratio of 90:10. The performance of all firms, consultants (except for the change management consultant), and suppliers for procurement was satisfactory.21 The TA completion report is in Appendix 5. I. Consultant Recruitment and Procurement, and Performance of Consultants,

Contractors, and Suppliers 25. The SPMP had no consultant recruitment, procurement, advance contracting or retroactive financing.

20 The externally financed grant agreement was signed on 30 April 2013. SPMP became effective on 26 August 2013. 21 The consultant recruitment and procurement were in line with ADB’s Guidelines on Use of Consultants (2013, as

amended from time to time) and the Procurement Guidelines (2015, as amended from time to time).

8

J. Performance of the Borrower and the Executing Agency 26. The performance of the Government of Nepal and the executing agency was satisfactory. Although the comprehensive nature of the SPMP at times overwhelmed the local level institutional capabilities during the political transition and the challenges caused by the earthquakes, the government showed genuine commitment to carry out the SPMP and the TA. As the responsibility of program outputs laid with several agencies, it was difficult to locate a single institution and/or an official, who could perform as the program champion and assume the leadership role at all levels. The coordination mechanism between the executing agency and implementing agencies was not ideal, and there was some disconnect between the implementing agencies for PFM reforms at the central and local government levels. The PEFA Secretariat under FCGO, as the program steering committee, did not conduct regular (quarterly) meetings to oversee implementation except for two meetings about the central PEFA assessment and the PFM reform plan in 2016. Although MOFALD carried out the subnational PEFA assessment and initially consulted the PEFA Secretariat on the design, inadequate communication between the two agencies delayed the finalization of the assessment. Similarly, inadequate coordination between the National Planning Commission, MOF, and MOFALD led to delays in the preparation of MTBF. Although leading a national program and coordinating with all local bodies were complex tasks, MOFALD’s performance was adequate despite lapses in communication, supervision, and administrative and technical support to local bodies. K. Asian Development Bank and Cofinancier Performance

27. ADB’s overall performance is rated satisfactory. The SPMP was a continuation of ADB’s long-term commitment to PFM and governance reforms as a leading development partner under LGCDP I and II. The SPMP received a strong endorsement from development partners, evidenced by DFID and the EU cofinancing. The program was delegated to ADB’s Nepal Resident Mission on 13 September 2013 to improve implementation and development partner coordination. Activities were jointly supervised from ADB headquarters and monitored through (i) seven review missions from HQ during May 2013–November 2016; (ii) review meetings between ADB, implementing agencies, and TA consultants; (iii) periodic reviews by development partners participating in LGCDP II and other PFM policy working groups; (iv) bilateral review meetings with cofinancing partners; and (v) field visits. Continual “One ADB” engagement, including the availability of staff from the Nepal Resident Mission with expertise in PFM and governance, was crucial for successful implementation. Knowledge products of the SPMP were effectively disseminated to increase awareness about the program. An ADB consultant conducted an independent SPMP midterm review and ADB shared the assessment with the government and development partners in November 2015. Equally important, ADB, particularly the Nepal Resident Mission, successfully administered the TA and coordinated across the executing agency, implementing agencies, and development partners. ADB demonstrated sufficient flexibility to accommodate the government’s requests for additional funding and changes in the TA scope.

28. The performance of the joint cofinanciers (DFID and the EU) were satisfactory as they provided resources and expertise to expand the PFM and governance reforms under the TA (Appendix 5). Better coordination among development partners could have resulted in (i) time savings in the processing of the increased grant amount and the subsequent cancellation of the program portion, had it been clear earlier that delegation of EU grants for policy-based programs was not allowed, and (ii) the timely signing of the externally financed grant agreement with the government, involving DFID cofinancing, resulting in a reduced delay of program effectivity and

9

the prompt utilization of TA funds for e-GP and MARS-related procurement. Possible reallocation of the canceled EU program grant into TA could have expanded piloting of MARS in another municipality and provided additional training on e-GP, MARS, and RBIA. However, no steps were taken in this direction because (i) the EU’s budget was not flexible for such a change, (ii) these activities were not envisaged earlier under the cofinancing agreement to justify a larger TA, and (iii) ADB and the EU went through an institutional discussion on new cofinancing templates with changes to the EU guidelines, which temporarily put EU cofinancing for ADB projects on hold in Nepal, and thus funds could not have been reallocated during SPMP implementation. 22 Differences in operational modalities between ADB and DFID also affected timely implementation.

III. EVALUATION OF PERFORMANCE A. Relevance

29. The SPMP is rated as relevant. The SPMP was aligned with LGCDP II and provided timely support to strengthen PFM and governance systems at the subnational level. While the scope of the policy actions and the design and monitoring framework (DMF) were ambitious, they were indispensable to addressing the priority PFM needs diagnosed by the PEFA assessments and the FRRAP. Although the government initially lacked the technical capacity to carry out complex and multidimensional PFM measures, SPMP introduced innovative and pioneering initiatives with transformative potential to Nepal’s institutional capacity. In particular the TA supported the IT-based e-GP system, the piloting of MARS, the broadening of IPT, the subnational PEFA assessment, and the development of RBIA guidelines. 30. The overall program design was appropriate at approval although the output for oversight and accountability lacked synergy with other outputs, focusing heavily on NVC. This output could have avoided legislative amendments to the Corruption Prevention Act and benefited from a stronger political buy-in. During the political transition, ADB and the cofinancing development partners did not make changes to the scope of the SPMP while the program implementation was ongoing given that the exact timing of the shift to federal system was not fully foreseeable. There were still uncertainties associated with the fluid political milieu related to the federal restructuring, which needed to be resolved at the national level and outside of the program. As PFM reforms continue to be essential even after the adoption of the federal constitution, the program outcome remains unchanged and is still relevant.

31. The SPMP remains relevant after completion as the achievements have occurred at an opportune time when Nepal is empowering the SNGs following the 2017 elections. ADB’s partnership with the government continues under the policy and advisory TA, providing assessments of the reform priorities for the fiscal federalism, change management strategies based on political economy analysis, and a roadmap for the subnational PFM and governance architecture under the federal system.23 The SPMP remains consistent with the government’s development goals and ADB’s focus on governance as a key driver of change.24

22 Instead, the EU reallocated the unused funds to the World Bank’s component under the PFM financing agreement

signed with MOF with equal contributions from the World Bank and ADB. 23 ADB. 2016. Policy and Advisory Technical Assistance for Nepal: Strengthening Subnational Public Management.

Manila. This will support the design of a follow-on program to the SPMP (paras. 52–53). 24 Government of Nepal. National Planning Commission. 2016. Fourteenth Plan, FY2017–FY2019. Kathmandu; ADB.

2017. Country Operations Business Plan for Nepal 2018–2020. Manila.

10

B. Effectiveness in Achieving Outcome 32. The SPMP was effective in achieving the outcome of enhancing the efficiency, transparency, and integrity of Nepal’s public finances at the national and local government levels. 25 As per DMF outcome indicators (Appendix 1), a total of 1,848 local governments published annual audit reports electronically in FY2016 from a baseline of zero in FY2015 with all DDCs having their own websites. The recovery rate of disallowed funds reached 52.8% in FY2016 from a baseline of zero. A total of 1,343 public procurement entities out of 4,500 (30% coverage, exceeding the 25% target) have used the e-GP system in 2017, and this is expected to increase. 33. The SPMP was effective in achieving full compliance of 10 first tranche and 11 second tranche policy actions along with one partial compliance and one non-compliance of two second tranche policy actions. All DMF output indicators for budget and fiscal management were fully achieved with (i) MOFALD’s nationwide MTBF for FY2017–FY2019; (ii) a system of fiscal transfers to local governments; and (iii) performance guidelines and measures, including GESI indicators, for allocating block grants to VDCs. Three out of five output indicators for strengthening fiduciary risk management were achieved: (i) MARS was piloted in all wards of the KMC; (ii) community-level project selection through WCFs and CACs reached 80%, exceeding the target of 33%; and (iii) 2,869 DDC and VDC staff were trained in basic accounting and internal audit as of FY2016 compared with a baseline of no training. Due to delays in piloting MARS, disruptions from the earthquakes and local elections, and underutilization of MARS, information is not yet available to measure the change in taxpayer compliance against 80% target. Although MOFALD developed the RBIA guidelines and provided training, regular internal audits by VDCs were not achieved and internal audit data is not available due to the restructuring of local governments. 34. The SPMP achieved all output indicators for public procurement: (i) the procurement plans of all ministries and public entities were published on the e-GP website, (ii) the e-GP system was rolled out, (iii) all DDCs and municipalities prepared procurement plans, and (iv) the PPMO and MOFALD organized training programs for central and local procurement agencies. The indicators for strengthening oversight and accountability were achieved. The chief commissioner and five other commissioners of the CIAA were appointed for a term of 6 years. In 2014, NVC established an automated complaint management system was established. The senior civil servants’ compliance with asset declarations increased from 63% in 2011 to 93.3% in 2015 (Appendix 1). C. Efficiency in Achieving the Outcome and Outputs 35. The implementation of the SPMP was efficient. 97.4% of the program grant proceeds were disbursed. A one-time extension of the program by 14 months was primarily due to external factors as described in para.20. Better coordination among cofinancing partners could have avoided the delays in the utilization of TA funds for e-GP and MARS-related procurement. Better sequencing with LGCDP II could have avoided the delay in grant effectiveness caused by the late

25 Based on Transparency International, the corruption perception index improved from 27 in 2012 to 29 in 2016, putting

Nepal at 131st out of 176 countries. Based on the National Integrity System Assessment in 2014, Nepal received “moderate” rating across 11 pillars of governance and accountability standards. The judiciary, the supreme audit institution, anti-corruption agencies, and media pillars received a relatively higher score in the evaluation. Nepal’s 2017 score in four out of six World Bank Governance Indicators improved from 2011 to 2016, i.e., voice and accountability (32 to 39), political stability and absence of violence (8 to 19), government effectiveness (18 to 20), and control of corruption (23 to 24), while regulatory quality (25 to 24) and rule of law (21 to 20) declined. Nepal continues to be at the bottom quartile of the global ranking.

11

submission of documents for first-tranche policy action no.4, requiring approval of an action plan to strengthen PFM and address fiduciary risks in local bodies. D. Preliminary Assessment of Sustainability 36. Overall, the SPMP is likely to be sustainable given the institutional changes achieved by the program and the government’s commitment to continue PFM and governance reforms under the federal system. MOFALD’s implementation of FRRAP, results-based reporting for capital expenditures in DDCs, and improvements in external audits will serve as a basis to promote transparency and accountability of expenditure management at the SNGs. The adoption of MC&PMs, PFM guidelines, and streamlined disbursement of central government grants through (i) GESI indicators; (ii) earmarked funds for disadvantaged groups, women, and children; and (iii) participatory planning for small community grants through WCFs and CACs had a significant institutional effect on the efficiency of resource allocation to local bodies and compliance with the performance benchmarks for socioeconomic targets. Overall, SNGs gained greater access to fiscal resources; and empowerment of citizens and community-based organizations strengthened accountability in the absence of elected officials (Appendixes 6 and 8). The MC&PMs and PFM reforms will need to be revised following the new Local Governance Bill (2017), the Local Financial Procedures Bill (2017) and the Intergovernmental Fiscal Management Bill (2017). SPMP’s experience will be valuable for designing a new intergovernmental transfer system under the National Natural Resources and Fiscal Commission (NNRFC), established in October 2017. Several actions are needed for the operationalization of RBIA guidelines, including (i) a change of the internal control framework from compliance audit to risk-based audit, (ii) strengthening of institutional and human resources for public financial reporting at all tiers of the federal system, (iii) piloting of RBIA in key sectors, and (iv) enhancing the independence of auditors. 37. It took almost 2 years for MOFALD to formulate the MTBF due to the government’s lack of familiarity with the MTBF concept at the sectoral level and inadequate coordination across concerned agencies. However, once in place, the results-based MTBF strengthened the predictability of resource allocations at the local level and the integration of a top-down policy and planning with a bottom-up budgeting approach with well-defined targets. The government is planning to expand the medium-term expenditure framework in all ministries from FY2017 and will modify the MTBF based on the devolution of expenditure and revenue powers to SNGs and increasing role of intergovernmental fiscal transfers under the fiscal federalism. Once the piloted MTBF framework is widely used, this will have a sustainable institutional impact on streamlined fiscal planning and prioritization and execution of budget at all tiers of the government. 38. The successful piloting of MARS at KMC could potentially bring larger transformative benefits to SNGs upon full system roll-out, including (i) higher revenue collection with automated tax administration, (ii) streamlined budgeting and financial management processes, (iii) improved municipal decision-making, and (iv) online citizen service delivery. However, the roll out of MARS in KMC was put on hold in 2017 primarily because of (i) the need to upgrade the system with latest federal procedures; (ii) absence of clear guidelines from MOFALD to streamline IT platforms and encourage MARS; and (iii) inadequate standard operating procedures, training, and IT support. To standardize SNG functions and financial reporting via MARS, with ADB support, in 2017, MOFALD formulated a nation-wide MARS roll-out strategy to be carried out in a phased manner after customization of the system as per the capacities and needs of SNGs. MOFALD

12

issued a directive on 17 March 2017 requiring all local bodies to refrain from purchasing any software with the intention of rolling out MARS, indicating strong government ownership.26 39. A strong foundation was laid for revenue mobilization by SNGs with the expansion of IPT, (Appendix 8). With the restructuring of municipalities, realizing the full potential of IPT and other taxes requires improvements in the property databases and increasing the technical and human resources in tax collection efficiency by SNGs. Thus, MOFALD’s intention to roll out MARS, which has the capability to streamline local revenue administration, is a critical step in the right direction. 40. The subnational PEFA assessment established benchmarks for the first time, against which the government can analyse the progress of the local PFM indicators. Based on the national PEFA assessments, Nepal has made progress in strengthening its central PFM systems with 19 out of 31 indicators improving from 2008 to 2014. Nepal also compared well with 15 fragile states, and 27 low-income countries with its overall PEFA score increasing from 2.2 in 2008 to 2.7 in 2014 (Appendix 6). The subnational PEFA assessment diagnosed key PFM weaknesses, and could help formulate a subnational fiduciary risk reduction action plan under the federal system. 41. The nationwide roll-out of the e-GP system was a key institutional development, receiving the South Asia Procurement Innovation Awards in November 2016.27 There are already positive signs that the e-GP system has (i) increased national and international competition; (ii) reduced turnaround time with the automated procurement workflow; (iii) facilitated regulatory compliance and effective auditing; (iv) increased transparency and minimized collusion, which used to be a major risk; and (v) promoted effective decision making by the PPMO (Appendixes 6 and 8). E. Development Impact 42. The DMF impact indicators (Appendix 1) show progress in delivery of public goods and services, especially at the local level, contributed by (i) more predictable and efficient fiscal resource allocation through improved local revenue mobilization with IPT and budget and fiscal management, including the MTBF for MOFALD; (ii) lower fiduciary risks and enhanced accountability due to results-based capital expenditures, external audits of municipalities, and the e-GP system; and (iii) inclusive growth and poverty reduction measures using MC&PMs, GESI grants, and mobilization of almost a million citizens via WCFs and CACs.28 The original DMF had two impact indicators: (i) population with access to basic health services increased to 90% by 2015 and (ii) adult literacy rate improved to 60% by 2015. Due to unavailable data for the first indicator, proxy indicators measure the progress in the DMF. Population with access to health services, measured as births attended by skilled health personnel improved from 36% in 2011 to 58% in 2016. The share of population using sanitation improved from 37.3% in 2010 to 46.1% in 2015, population using basic drinking water services improved from 85.1% in 2010 to 87.7% in 2015, and rural population with access to electricity increased from 62.1% in 2010 to 81.7% in 2014. Adult literacy increased from 48% in 2004 to 63.7% in 2015, exceeding the 60% target. Average GDP growth was modest at below 4% during FY2013–FY2017 (Appendix 9), reflecting development constraints. SPMP has likely contributed to inclusive economic growth measured by 26 There have been instances whereby even development partners have inadvertently supported alternatives to MARS.

The FCGO, MOF, developed a simpler IT platform to standardize basic public accounting by local governments, linked with the central systems. Until MARS is customized, FCGO’s basic system can be used.

27 The award was launched by the World Bank, ADB, South Asia Regional Public Procurement Network, and Procurement iNEt. https://www.procurementinet.org/wp-content/themes/inet/img/WB_Award_Book.pdf

28 SPMP is categorized as C (no impact) on the environment, involuntary settlement, or indigenous peoples.

13

a decline in population below the international poverty line from 53.1% in 2003 to 24.8% in 2011 and an improvement in the human development index from 0.4 in 2005 to 0.6 in 2015.29 43. Notwithstanding such achievements, the infrastructure gap resulting from low capital expenditures remains a major obstacle to the effective delivery of public services. 30 Poor execution of capital expenditures has been prevalent, with only 73% of planned expenditures spent during 2012–2016 due to (i) unrealistic planning of projects, (ii) delays during the project implementation cycle, (iii) institutional and procedural barriers, (iv) shortage of capital goods and skilled labor force, and (v) concentration of spending under the capital budget at the end of the year (61% released in the last quarter), undermining the quality of delivery and the maintenance of physical infrastructure (footnotes 16–17). 31 SPMP’s e-GP system, results-based MTBF, MC&PMs, and the future roll-out of MARS will help improve capital expenditures at the local level. 44. Delivery of public goods and services is likely to face new challenges with Nepal’s transition to a federal system. It is essential to (i) clearly demarcate functional assignments across tiers of government to prevent duplication and lack of accountability, (ii) create adequate fiscal autonomy at SNGs to match expenditure mandates with robust revenue mobilization and intergovernmental transfers,32 and (iii) enhance administrative and human resource capacities of newly elected local governments. While SPMP has achieved satisfactory development impact by enhancing effectiveness of PFM and governance institutions and practices, the program was never meant to be a one-off intervention. In the context of fiscal federalism, the achievements would need to be continued, adapted, and scaled up for sustainability. ADB’s proposed follow-on program (paras. 52–53) will be instrumental to reach this goal.

IV. OVERALL ASSESSMENT AND RECOMMENDATIONS A. Overall Assessment 45. Overall, the SPMP is rated successful. 33 It was relevant to improving subnational PFM and governance systems, and it was effective in achieving the targeted outcome. The program was efficient despite a delay in program completion mainly due to external and unforeseeable factors. The program is likely to be sustainable given its institutional and governance-related achievements, and the Government of Nepal’s continuous commitment to PFM reforms under the federal system with support from development partners.

29 ADB. 2017. Nepal Macroeconomic Update. September. Vol. 5(2). Kathmandu. International poverty line represents

the threshold value of goods in dollars necessary to sustain an adult. The human development index comprises measures for life expectancy, education, and gross national income per capita.

30 Gross fixed capital formation to GDP ratio improved from 22.6% in 2013 to 25% in 2016; however, Nepal was behind Bangladesh (29.7%), Sri Lanka (27.6%), and India (27.1%) in 2016. (World Bank, World Development Indicators; https://data.worldbank.org/data-catalog/world-development-indicators).

31 The government’s actual capital expenditures stood at 8% of GDP (compared with planned 12%) in FY2017, an increase from 5.4% in FY2016 (ADB. 2017. Nepal Macroeconomic Update. September. Vol. 5(2). Kathmandu).

32 Nepal’s fiscal federalism is marked by asymmetry between expenditure decentralization at SNGs and concentration of tax collection at central level, creating a large vertical imbalance. There is also big horizontal imbalance among the SNGs. Despite increasing IPT revenues, on average only 2% of government revenues were collected by SNGs and direct subnational spending was 12% of government spending during FY2013–FY2016. Central transfers represented 80% of SNG’s revenues and on average around 10% of government spending during FY2013–FY2016. (World Bank. 2017. Nepal Development Update. Kathmandu.)

33 The evaluation is based on ADB. 2016. Guidelines for the Evaluation of Public Sector Operations. Manila.

14

B. Lessons

46. ADB strategically targeted its efforts at the subnational level at a time when there were few development partners engaged in this space. Through ADB’s efforts, the SPMP galvanized support from other development partners. ADB was visionary in seizing this vacuum by emphasizing subnational PFM and governance reforms in anticipation of the events leading to the federal system, and this served as an important balance to an overemphasis on central level initiatives supported by most development partners. The SPMP was innovative in its focus on fiscal and budget management reforms, integrating a top-down policy and planning with a bottom-up implementation approach. 47. Policy reforms cannot take place in isolation and need to be well coordinated and have strategic linkages both at the national and subnational level. It is essential to effectively develop two levels of coordination, i.e., horizontally within the government between implementing agencies, and vertically between the central and local governments and across development partners, both of which have been challenging during SPMP. Despite the absence of an interlinked coordination mechanism, successful implementation makes the program results even more remarkable. 48. Policy reforms, particularly on PFM at the local level, where capacities and resources are limited, take longer and require concerted efforts. Policy reforms, when backed by institutional decision-making process with relevant policies, strategies, and plans rather than driven by individuals, make a more sustainable impact even when the political environment is uncertain. 49. Reforms should be carefully sequenced by first setting the prerequisites right, followed by a focused but gradual approach in consideration of multi-speed in absorption at different tiers of the government. Even though PFM initiatives such as MARS, e-GP, RBIA, and MTBF were advanced concepts for local governments to absorb, SPMP validated their applicability with pilots, motivated the stakeholders before scaling up and provided capacity building under the attached TA. By its very definition, piloting cannot on its own achieve a desired level of sustainability but is part of a process, requiring stocktaking and tailoring before effective roll-out. 50. IT-based governance investments, such as the e-GP, MARS, and VDC accounting software, is effective for standardizing and enhancing the quality and accessibility of service delivery. When introducing IT systems at SNGs, the government should consider the varying levels of readiness in staff skills, data and resource requirements, and adjust implementation timelines. IT systems become more accepted when supported by clear operating guidelines, necessary physical facilities, training and IT support from the central government. To improve accountability, a more beneficial approach is to strengthen anti-corruption systems in a holistic manner, rather than only training and advocacy, and engage with the CIAA and Office of the Auditor General, given their resources and enforcement powers in financial and technical audits.

C. Recommendations 1. Program Related 51. Covenants. The covenants were relevant and ADB should retain them in the existing form.

15

52. Future monitoring and additional assistance. As the federal system provides greater mandates to SNGs, a new generation of reforms under a follow-on program is critical for continuity. A policy-based program will be more effective in creating the enabling policy and legal

environment to operationalize the fiscal federalism in comparison to an investment project or TA.34 Such a program would benefit from (i) focused analysis of priority areas with the strongest buy-in from the government and development partners,35 (ii) a flexible range of policy options in case of changes in the political–economy context, and (iii) an institutionalized coordination mechanism led by a program champion. To make the program sustainable, it would need to focus on (i) addressing the root causes of local governance challenges with risk mitigation measures and (ii) generating lasting changes in (a) policies, laws, and regulations; (b) processes; (c) systems; (iv) institutional and human resource capacities; and (d) behaviors of the government and the public. 53. Further action or follow-up. Given that the recommendations of the policy and advisory TA were accepted by the government, to sustain the momentum of reform, ADB should approve a follow-on policy-based program with TA support in 2018, which prioritizes (i) expanding subnational revenue capacity; (ii) designing an equitable intergovernmental fiscal transfer system and institutions including re-evaluation of MC&PMs; (iii) promoting fiscal discipline and access to project financing by SNGs; (iv) adapting the results-based budgeting frameworks to the federal system; (v) enhancing subnational internal, external, and technical audit capabilities along with incentives to use RBIA and audit management software; (vi) customizing and rolling out MARS to other municipalities; and (vii) aligning e-GP with the federal procurement system (Appendix 7). MOFALD would need to be strongly involved as a champion of reform, given the local government focus, in close coordination with and under the leadership of MOF and NNRFC. 54. Timing of the program performance evaluation report. ADB’s independent evaluation department could assess the cumulative effect of the two interrelated governance programs more effectively if the evaluation report is prepared within 2 years of completion of the follow-on program. 2. General 55. ADB should carefully assess political will, infrastructure requirements, commitment of financial, technical, and human resources, and institutional readiness during the program design to avoid over-ambitious reforms. Addressing all major constraints within one program should be avoided by focusing on core reform priorities. The policy-based programs should be flexible and adaptive to changing political dynamics. ADB’s and development partners’ involvement typically strengthens the stakeholders’ acceptance of politically difficult reforms when capacity constraints are severely binding. ADB should strengthen the coordination mechanisms between cofinanciers for project preparation and confirmation of fund availability. Effective programs tailor international best practices to local conditions and set realistic performance targets. Implementation arrangements should not be complex for coherence and effective coordination. The integration of political economy analysis (drivers of change and vested interests) early on into change management strategies, as done by the policy and advisory TA, is critical to align stakeholders’ motivations with those of the program. Both ADB and the executing agency need to communicate the rationale for reforms proactively to strengthen buy-in from the civil society, elected and appointed government officials at the central and local levels, and development partners.

34 The proposed Strengthening Subnational Public Management Program is currently listed as a standby policy-based

program for 2019 under ADB. 2017. Country Operations Business Plan Nepal 2018–2020. Manila. 35 The policy and advisory TA (footnote 23) recommended a clear direction for continuity in local government reforms.

16 Appendix 1

DESIGN AND MONITORING FRAMEWORK

Design Summary

Performance Targets and Indicators with Baselines Achievement

Impact Public goods and services are delivered more effectively in Nepal, especially at local government levels.

Population with access to basic health services increased to 90% by 2015 (2010 baseline: 78.8%)

On track towards achievement. Recent data on access to basic health services is not available.a Proxy indicators have been used to assess progress:

• Health expenditure per capita, PPP (constant 2011 international $) increased from $125.8 in 2010 to $137.4 in 2014.

• Public health expenditure as % of GDP fell from 2.9% in 2010 to 2.3% in 2014.b

• Coverage of births attended by skilled health personnel improved from 36% in 2011, 56% in 2014 and 58% in 2016.c

• Percentage of total population using basic sanitation services improved from 37.3% in 2010 to 46.1% in 2015.

• Percentage of total population using basic drinking water services improved from 85.1% in 2010 to 87.7% in 2015. Percentage of total population using safely managed drinking water services improved from 25.9% in 2010 to 26.8% in 2015.

• Percentage of rural population with access to electricity improved from 62.1% in 2010 to 81.7% in 2014.d

Adult literacy rate improved to 60% by 2015 (2010 baseline: 56%)

Exceeded. Adult literacy rate (15 years and above) increased from 48% in 2004 to 61.6% in 2014 and 63.7% in 2015.e

Outcome The efficiency, transparency, and integrity of Nepal’s public finances at the national and local government levels are enhanced.

Annual audit reports of local government bodies are published electronically by October 2015 (baseline: none)

Achieved. As of FY2016, 1,095 local bodies published their income and monthly expenditure statement and 1,848 local bodies published their final audit reports on their websites.f All DDCs have their own websites.

Amount of disallowed funds by the auditor-general recovered by government grows by July 2015 (baseline: none)

Achieved. The recovery rate of disallowed funds was 49% in FY2015 and 52.8% in FY2016.

The proportion of government procurement entities that use the e-GP system reaches 25% by November 2015 (2011 baseline: 0%)

Exceeded. A full-fledged e-GP system was rolled out on 1 January 2017. Usage of e-GP in both phases reached 1,257 public entities out of a total of 4,500 (28% coverage), exceeding the target of 25% as of end October 2017. As of 31 December 2017, a total of 1,343 public entities (668 in Phase I and 675 in Phase II) are using the e-GP system, increasing the coverage to 30%.g As of 31 October 2017, 787 public procurement entities, including municipalities, and 4,300 bidders were registered, and 22,150 bids were processed in phase I. In phase II, 470 public procurement entities and 1,245 bidders were registered with 1,123 bids published, of which 953 were works contracts, 163 were goods, and 6 were consultancy services.

Appendix 1 17

Outputs 1. Local government budget and fiscal management improved

A medium-term budget framework at the national level for local development is in place by July 2015 (baseline: none)

Achieved. MOFALD prepared a 3-year medium-term budget framework for FY2017–FY2019. It came into effect from FY2017 following MOF’s approval on 22 August 2016.

Comprehensive reporting system of fiscal transfers established, including data on disbursement of funding for GESI activities as per block grant guidelines for local government bodies—i.e., 15% for disadvantaged groups, 10% for women, and 10% for children by July 2015 (baseline: none)

Achieved. MOFALD had established an effective system of allocating grants to local governments based on the MC&PM system, including a system of MC&PM assessment, computation of grant amounts based on performance, and proper recording of the grants allocated and disbursed to the local governments. This system will be replaced by a new and yet to be fully developed system under the new constitution. The incorporation of the MC&PM system will be redefined by the Local Financial Procedures Bill (2017) and the Intergovernmental Fiscal Management Bill (October 2017).

Performance guidelines and measures (including GESI indicators) developed for allocating block grants to VDCs by July 2013 (baseline: none)

Achieved. The Local Bodies Resource Mobilization and Operations Management Guideline (2012)h mandated local governments to allocate 15% of the grants for disadvantaged groups, 10% for women, and 10% for children. In addition, the performance measures included GESI audit of budgets for 75 DDCs. The performance measures include mandatory provisions for gender and children participation in planning and governance structures besides the earmarked fund allocation. By FY2017, 23 DDCs out of 75 conducted GESI audits.i This system is currently under review as per the new constitution.

2. Fiduciary risk management strengthened at the local government level

A pilot municipal administration and revenue system (MARS) established by October 2015 (baseline: manual system)

Achieved. MARS was developed and piloted in all the wards of Kathmandu Metropolitan City as of July 2017.

Compliance rate of taxpayers in MARS pilot municipality increases by 80% by October 2015 (baseline: 30%)

Not achieved. Due to the delay in piloting MARS (due to the disruption caused by the 2015 earthquakes, new constitution, and local level elections) and underutilization of MARS, the information on taxpayer compliance is not yet available as of end 2017.

More VDCs are regularly subject to internal audits by July 2015 (baseline: none)

Not achieved. MOFALD has developed risk-based internal audit guidelines and developed training programs to disseminate and roll-out the new guidelines at the local level. MOFALD has planned to pilot the new guidelines in selected local governments. However, regular internal audits have not been achieved and internal audit data is not available as of end 2017.

Proportion of community-level projects selected through the ward citizen forums and citizen awareness centers increased to 33% by July 2014 (2011 baseline: less than 10%)

Exceeded. The proportion of community-level project selection through WCFs and CACs increased to 80%, exceeding the target of 33%. Out of 145,819 approved community-level projects, citizens were involved in selecting 117,095 projects through WCFs and CACs in FY2016. Citizen participation in local government budget and planning involved 250,000 citizens, with 31% women representation.

18 Appendix 1

As of June 2016, 31,280 WCFs were formed in all VDCs and municipalities with 771,112 citizens actively engaged in local development planning and governance activities. A total of 10,976 CACs were formed with 7,083 yet to be achieved and the cumulative membership reached 294,811.j

Number of DDC and VDC staff trained in basic accounting and internal audit increases by July 2014 (baseline: none)

Achieved. A total of 2,869 DDC and VDC staff trained as of FY2016.k

3. Public procurement system enhanced

Procurement plans of ministries published electronically by July 2015 (baseline: none)

Achieved. All public entities prepare procurement plans and publish them on the e-GP home page, which is accessible to all.

Software for e-government procurement is developed by October 2014 (baseline: none)

Achieved. Development of the e-GP system was completed in December 2015 and pilot tested on 14 April 2016 in five major infrastructure departments. The system was rolled out across the country on 1 January 2017.

Procurement plans prepared for DDCs and municipalities by July 2014 (baseline: none)

Achieved. In FY2016, 72 DDCs (96%) and 146 municipalities (67%) prepared procurement plans and this expanded to all DDCs and municipalities in FY2017. All ministries prepared procurement plans.l

Number of DDC and municipality staff trained in applying the Procurement Act and Regulation grows by July 2014 (baseline: none)

Achieved. The PPMO conducted more than 150 training events on public procurement and e-GP in 20 ministries and 75 districts. More than 6,000 officials from major procurement agencies participated in the training.m

4. Institutions for oversight and accountability strengthened

The chief commissioner and commissioners of CIAA are appointed by October 2015 (baseline: positions vacant)

Achieved. The chief commissioner and the commissioners are appointed by the President of Nepal on the recommendation of the Constitutional Council and after the Parliamentary Special Hearing Committee approves their recommendation. The chief commissioner was appointed in May 2017 and five other commissioners were appointed in April 2015. They were appointed for a term of 6 years.

Complaints response system is established in the NVC by July 2014 (baseline: none)

Achieved. A complaints management system was established and strengthened in 2014, by introducing a procedure for screening complaints by an oversight committee within NVC. NVC also developed an automated complaint recording system. By FY2016, NVC received a total of 7,133 complaints, of which it settled 6,553 complaints. In FY2016, NVC received 772 complaints, of which it settled 686.

Proportion of senior civil servants who comply with asset declaration grows by July 2013 (baseline: 63% in July 2011)

Achieved. 93.3% of officials who are required to submit an assets declaration declared their assets in FY2015. There was an increase of 37,327 asset declarations (about 10%) from the previous years.

ADB = Asian Development Bank; CAC = citizen awareness center; CIAA = Commission for the Investigation of Abuse of Authority; DDC = district development committee; e-GP = e-government procurement; GESI = gender equality and social inclusion; LGCDP II = Local Governance and Community Development Programme II; MARS = municipal administration and revenue system; MC&PM = minimum condition and performance measure; MOF = Ministry of Finance; MOFALD = Ministry of

Appendix 1 19

Federal Affairs and Local Development; NVC = National Vigilance Centre; PPMO = Public Procurement Monitoring Office; VDC = village development committee; WCF = ward citizen forum. a Government of Nepal, Ministry of Health and Population. 2015. Nepal Health Sector Strategy 2015–2020. Kathmandu. b United National Development Programme. 2016. Human Development Report 2016. New York. c World Health Organization. 2017. Health Sustainable Development Goal Profile: Nepal. http://www.searo.who.int/entity/health_situation_trends/nep-2017-cp.pdf d World Bank. 2017. World Development Indicators. https://data.worldbank.org/data-catalog/world-development-indicators e ADB. 2017. Country Macroeconomic Update, Nepal. Kathmandu. September Vol.5 (2). f Government of Nepal, Ministry of Federal Affairs and Local Development 2016. LGCDP II Annual Progress Report – 2072/73. Kathmandu. g Government of Nepal Office of the Prime Minister and Council of Ministers. Public Procurement Monitoring Office. Kathmandu. h Government of Nepal, Ministry of Federal Affairs and Local Development. 2012. Local Bodies Resource Mobilization and Operations Management Guideline. Kathmandu. i-m Government of Nepal, Ministry of Federal Affairs and Local Development. 2017. LGCDP II Annual Progress Report – 2073/74. Kathmandu.

Source: Asian Development Bank.

20 Appendix 2

STATUS OF COMPLIANCE WITH FIRST TRANCHE POLICY ACTIONS

Tranche Condition Status of Compliance

1. MOFALD shall have developed, approved, and issued guidelines and a time-bound action plan for timely and streamlined disbursement of block grants from the central government to local bodies.

Complied with until it was replaced by the Local Governance Bill (September 2017) under the new federal structure, developed based on the lessons of the earlier guidelines and tailored to the needs of the federal system. The guidelines for disbursement of grants developed in 2012 were used continually until July 2017. The Government of Nepal revised the guidelines with the restructuring of local governments in 2017. As per the constitution, state governments will be responsible for functional assignments such as state level police, higher education, health, highways, electricity, and irrigation and water resources, while local governments will provide basic education, health, sanitation, rural roads, and local services, among others. As per the revenue assignments of the constitution, the central government collects revenues such as value-added tax, customs, and income and corporate taxes. The state governments collect agro-income tax, tourism tax, and royalty from natural resources, and local governments collect vehicle tax, house rent tax, business tax, property tax, and local service charges and fees, among others. Some of these taxes are concurrent between central government and states, and states and local governments. As a constitutional body, the NNRFC determines the fiscal transfers and revenue distribution among three tiers of government and recommends equalization grants to SNGs. The law for the establishment of the NNRFC and the Intergovernmental Fiscal Management Bill passed in October 2017. The Local Governance Bill (approved in September 2017) will guide local governments—elected following elections on 26 November and 07 December 2017—on the use of different grants from the central and state governments.

2. MOFALD shall have approved and issued guidelines for allocation and disbursement of small community-level grants.

Complied with until it was replaced by the Local Governance Bill (September 2017) and Local Financial Procedures Bill (September 2017), which guide local governments on the use of different grants from the central and state governments under the federal structure.

3. MOFALD shall have prepared and approved amendments to the local bodies’ resource mobilization guidelines that shall incorporate measures to enhance existing own-sources of revenues of local bodies.

Complied with until it was replaced by the Local Governance Bill (2017) and Local Financial Procedures Bill (2017). Building on the Local Bodies Own-Source Revenue Collection Guidelines, 2012, MOFALD prepared the Local Body Revenue Administration Regulation, focusing on strengthening revenue mobilization in local governments. With the new revenue assignments in the constitution, these guidelines have been tailored to the requirements of the federal system.

Appendix 2 21

Tranche Condition Status of Compliance

4. MOFALD shall have completed and approved a strategy and an integrated action plan to strengthen PFM and address fiduciary risks in local bodies.

Complied with. Most of the actions under the FRRAP 2012 were implemented. MOFALD updated the FRRAP in 2015, and it was implemented as part of the LGCDP II, which was completed in July 2017. After restructuring local bodies in 2017 and elections taking place in November and December 2017, the enactment of the Local Governance Bill (2017) and the Local Financial Procedures Bill (2017) will provide the basis for a new PFM reform plan at the local level based on the learnings of the earlier action plan.

5. MOFALD shall have developed and introduced a results-based reporting system in DDCs for monitoring capital expenditures.

Complied with until July 2017 and has now been replaced after the restructuring of the local governments in March 2017. The Local Governance Bill (2017) will guide local governments on the reporting requirements, and a relevant system will be developed and tailored based on the learnings of the earlier one.

6. MOFALD shall have developed and approved guidelines for external audits of municipalities and VDCs.

Complied with until July 2017 and these guidelines have been revised under the new constitution and the Local Governance Bill (2017). The new constitution has provisioned a mandate for the Office of the Auditor General to conduct external audits of all local bodies.

7. The PPMO shall have conducted a joint technical review with ADB and the World Bank of public procurement in Nepal.

Complied with. The PPMO has been progressively implementing the recommendations of the joint technical review, conducted on 23–27 January 2012, including strengthening the PPMO, capacity building, collaborating with the local training institute, preparing technical manuals, and establishing an e-GP unit.

8. The PPMO shall have prepared an implementation roadmap on the development and installation of e-GP in line with its e-Submission operations.

Complied with. The automation of the procurement system started with the Public Procurement Act and Regulation (2007) and the e-GP readiness assessment in 2007. The roadmap was prepared in August 2011, and the PPMO adopted a phased approach to develop, roll-out, and implement the e-GP system based on the roadmap.

9. The Recipient shall have completed a roster of shortlisted candidates for the posts of Chief Commissioner and Commissioners of the CIAA.

Complied with. The chief commissioner of the CIAA was appointed in May 2017 and five commissioners in April 2015 for 6 years.

10. The NVC shall have submitted a proposal to cabinet to elevate its status to an independent body to give it greater authority in its conduct of technical audits and its advocacy for corruption prevention.

Complied with. Further to the proposal submitted in 2013, NVC submitted to OPMCM in February 2015 a separate proposal act for establishing a National Vigilance Commission to ensure good governance for the prevention of corruption and irregularities in public institutions.

ADB = Asian Development Bank; CIAA = Commission for the Investigation of Abuse of Authority; DDC = district development committee; e-GP = e-Government Procurement System; FRRAP = Fiduciary Risk Reduction Action Plan; FY = fiscal year; LGCDP = Local Governance and Community Development Programme; MOFALD = Ministry of Federal Affairs and Local Development; NNRFC = National Natural Resources and Fiscal Commission; NVC = National Vigilance Center; OPMCM = Office of the Prime Minister and Council of Ministers; VDC = village development committee. Source: Asian Development Bank.

22 Appendix 3

STATUS OF COMPLIANCE WITH SECOND TRANCHE POLICY ACTIONS

Tranche Condition Status of Compliance

1. The MOF shall have developed and approved a Medium-Term Budget Framework (MTBF) for MOFALD, which shall be presented as part of the national budget for FY2014 and thereafter.

Complied with. In consultation with MOF and the NPC, MOFALD developed the MTBF for FY2017–FY2019. MOF approved the MTBF as part of the FY2017 national budget presented in parliament on 28 May 2016. Parliament passed the appropriation bill on 9 July 2016. The appropriations took effect on 16 July 2016. Budget estimates for MOFALD under the MTBF are NRs117 billion for FY2017, NRs122 billion for FY2018, and NRs128 billion for FY2019 (11% of the national budget).

2. MOFALD shall have enforced the provisions of earmarked funding for gender empowerment and social inclusion (GESI) activities as per block grant guidelines of local governments (i.e., 15% for disadvantaged groups, 10% for women, and 10% for children) and provide expenditure tracking reports.

Complied with until July 2017 and was replaced by the Local Governance Bill (2017) under the new federal structure. MOFALD enforced the earmarking and spending for GESI activities as provisioned in the Local Bodies Resource Mobilization and Operations Management Guidelines (2012) through its MC&PM system in all local bodies—DDCs, municipalities, and VDCs—until July 2017. With the restructuring of local governments and approval of the Local Governance Bill (2017) and the Local Financial Procedures Bill (2017), new guidelines will be provided to local governments on the use of different grants from the central and state governments. MOFALD reports show that of the 58 municipalities, 85% made prescribed allocations for GESI budgets in FY2014 and 90% in FY2015. Of the 75 DDCs, compliance with GESI provisions improved from 77% in FY2014 to 83% in FY2015. A total of 60% of the municipalities and 68% of the DDCs spent more than 80% of their respective GESI budgets in FY2014 and FY2015. In the case of VDCs, 47% allocated and spent 100% and another 22% spent more than 50% of their GESI budgets in FY2015. MOFALD extended the performance measures for block grants to all VDCs in FY2014. Of the 2,324 VDCs selected from 54 districts, 85% complied in FY2015.a

3. MOFALD shall have identified and oriented 25 VDCs for the piloting of the revised manual with PMs for block grants in FY2014.

Complied with until July 2017 and was replaced by the Local Governance Bill (2017) under the new federal structure. In FY2013, MOFALD identified and oriented 50 VDCs in 30 districts for the piloting of the revised manual with performance measures for block grants and in FY2014, MOFALD extended the performance measures to all VDCs. With the restructuring of the local governments under the new federal structure and approval of the Local Governance Bill (2017), the MC&PM system will be reincorporated as part of the PFM reform plan of local governments.

Appendix 3 23

Tranche Condition Status of Compliance

4. MOFALD shall have piloted the Municipal Administration and Revenue System (MARS) in one municipality.

Complied with. MOFALD piloted the MARS—a web-based enterprise resource planning software with nine-integrated modules covering key municipal operations, management, and service delivery systems—in 35 wards of KMC as of 7 October 2016. Under MOFALD’s and KMC’s supervision, MARS was developed by a professional developer over the course of 18-months. MOFALD issued a user-acceptance certificate following the successful piloting of MARS in KMC. The developer organized 18 orientation and training programs on the operation of the system for staff of the KMC. KMC established an IT support unit and training room in the City Hall in Kathmandu Metropolitan City. As part of the digitization of municipal records, KMC has loaded personnel information into MARS.b The roll-out of MARS in the KMC was put on hold in 2017 because of (i) the need to upgrade the system with the latest procedural and legislative changes under the federal system, (ii) high staff turnover with new staff needing training, (iii) lack of ownership by the new local government officials following the elections in 2017 due to unfamiliarity, (iv) staff continuing to use the old IT systems due to the absence of clear operating guidelines from MOFALD to encourage use of MARS, (v) inadequate standard operating procedures and IT support for software and hardware since the expiry of the annual maintenance contract in 2017, and (vi) insufficient digitization and data integration with old systems. Based on the pilot experience, with the support from ADB, MOFALD has been formulating a strategy for rolling out the MARS to other municipalities across the country in a phased manner and following customization of the system in line with needs and IT capabilities. MOFALD issued a directive on 17 March 2017 requiring all local bodies to refrain from purchasing any software with the intention of rolling out MARS, indicating government ownership. A realistic implementation strategy with a phased roll-out plan would bring uniformity among local bodies.

5. MOFALD shall have approved introduction of an integrated property tax (IPT) in 45 municipalities.

Complied with. MOFALD implemented various administrative, technical, and fiscal measures to promote the increased adoption of IPT by municipalities. For example, MOFALD (i) prepared and issued an IPT directive to clarify the legal provisions and facilitate implementation of IPT, (ii) adopted IPT as one of the performance measure indicators in the MC&PM system and awarded additional points to municipalities that introduced IPT and demonstrated increased IPT collections, and (iii) provided orientation and training on IPT to municipalities.

24 Appendix 3

Tranche Condition Status of Compliance

The IPT was introduced in 73 municipalities in FY2015 and 97 in FY2016. IPT collections have steadily increased in absolute amounts and as a share of municipalities’ total revenue. IPT collection in FY2014 totalled NRs141 million (21% of the municipalities’ total OSR). This increased to NRs292 million in FY2015 (31% of total OSR), and NRs380 million in FY2016 (30% of total OSR). The collection doubled from FY2014 to FY2015, and increased by 32% from FY2015 to FY2016.

6. MOF shall have completed a Public Expenditure and Financial Accountability (PEFA) assessment at the subnational level to establish benchmarks on the key fiscal indicators at the subnational level.

Complied with. With increased central grants to local bodies and given their critical role in public service delivery, a PEFA assessment at the subnational level was carried out for the first time in 2015 with the TA support of the SPMP. The subnational PEFA examined all 28 main indicators and associated sub-indicators used in the national PEFA assessment. The National PEFA Steering Committee approved the final subnational PEFA assessment report on 19 October 2016.

7. MOFALD shall have rolled out the uniform accounting software to at least 1,000 VDCs.

Partially complied with. The local restructuring under the new federal structure has changed the composition of local bodies. MOFALD had VDC accounting and financial management software within the financial devolution framework of the Local Bodies Financial Administration Regulation, 2007. The software was installed in 1,352 VDCs covering 51 of 75 districts. It had also prepared a training manual and provided training to 157 trainers of DDCs using 24 master trainers. A total of 2,709 VDC staff received training on the use of accounting software during FY2015 and FY2016. A total of 695 VDCs (85 in FY2014, 440 in FY2015, 170 in FY2016) had functional accounting software. However, only 300 VDCs were effectively using the software, and of these, 46 VDCs have been restructured into municipalities under the new federal system. c With the restructuring of local bodies under the federal system, VDCs have been merged into larger local governments and VDCs operate as wards of the rural municipalities. These local governments now follow a different accounting system. Thus, the VDC accounting software is no longer applicable.

8. MOFALD shall have developed guidelines, criteria and tools for the conduct of risk-based internal audits (RBIAs) for DDCs, VDCs, and municipalities.

Complied with until July 2017 and will be replaced with a new set of internal control guidelines under the federal system with the enactment of the Local Financial Procedures Bill (2017). As part of reform initiatives to reduce fiduciary risks at the local government level through a robust and effective internal control system, in consultation with audit professionals at the central and local government level MOFALD developed the RBIA guidelines, building on existing internal audit guidelines for DDCs and VDCs (2008), and approved them on 20 October 2016.

Appendix 3 25

Tranche Condition Status of Compliance

A total of 160 internal auditors from local bodies participated in the training, while 145 DDCs and municipalities established internal audit sections in FY2016. MOFALD established a Financial Compliance Monitoring Unit headed by the chief of the financial administration section, which conducted compliance monitoring in five DDCs, nine municipalities and five VDCs as of FY2016. With the stronger audit unit, the settlement in the audit arrears of MOFALD improved from 40.6% in FY2014 to 43.3% in FY2016. d With the enactment of the Local Financial Procedures Bill (2017), a new set of internal control guidelines will be put in place under the federal system. The transition to the RBIA, however, needs to be gradual, ensuring that support systems, particularly institutional and human resource capacities, develop at an equal pace.

9. PPMO shall have completed development of electronic government procurement (e-GP) software.

Complied with. The PPMO developed e-GP in two phases, which were launched in August 2013 and April 2016. Development of the full-fledged e-GP system was completed in December 2015. The Government Integrated Data Center https://bolpatra.gov.jp/egp hosts the e-GP system. The PPMO has published a Gazette notice for the use of the national e-GP system. It also prepared and made publicly available e-GP Operating Guidelines and user manuals. The system was piloted on 14 April 2016 in five major infrastructure departments, (i) Department of Roads, (ii) Department of Local Infrastructure Development and Agricultural Roads, (iii) Department of Water Supply and Sewerage, (iv) Department of Irrigation, and (v) Department of Water Induced Disaster Management, carrying out 70% of procurement-related transactions. The full-fledged system was rolled out nation-wide on 1 January 2017. The e-GP system is a single web portal, covering all stages of the public procurement cycle, including (i) centralized registration, (ii) e-bidding, (iii) e-contract management, (iv) e-instrument verification banking modules, (v) procurement management information, (vi) system and security administration, (vii) workflow management, and (viii) administrative management console. A single-stage two-envelope procedure and consultant management module were also added. The public entities were required to use the system for all procurement above NRs6 million. The PPMO established an e-GP help desk and developed operating guidelines and manuals. e-GP is also linked with the Government of Nepal’s other systems like the Inland Revenue Department and the Nepal Rastra Bank. A separate banking module was developed, and a memorandum of understanding was signed with 29 commercial banks for banking instruments used in procurement.

26 Appendix 3

Tranche Condition Status of Compliance

10. PPMO shall have completed the development e-GP training module.

Complied with. e-GP training modules with system workflow have been prepared and approved by the PPMO. A dedicated training environment has been set up.

11. PPMO shall have conducted public procurement training for relevant procurement officials of at least 8 ministries and 35 districts

Complied with. As of 31 October 2017, PPMO conducted more than 150 training events on public procurement and e-GP to government staff of 20 ministries and 75 districts, including local government staff in district development committees and municipalities. More than 6,000 officials from major procurement agencies participated in the training. The PPMO engaged accredited national trainers from the Federation of Contractors Association of Nepal as well as the Capacity Development Resource Center of the Nepal Administrative Staff College to expand the capacity building programs to a wider audience, including banks and private sector for sustainability.

12. The National Vigilance Center (NVC), through the Office of the Prime Minister and Council of Ministers (OPMCM), shall have submitted to cabinet amendments to the Corruption Prevention Act (CPA) of 2002 and subordinate regulations to ensure compliance with the United Nations Convention against Corruption (UNCAC) that Nepal ratified in February 2011.

Not complied with. The NVC submitted to the OPMCM in February 2016 a draft bill proposing amendments to the NVC-related Article 38 of the Corruption Prevention Act (CPA), 2002 (the umbrella anti-corruption law). Article 38 stipulates NVC’s role in promotional and preventive activities to deter corruption. The proposed amendments sought to enhance (i) the disciplinary measures for officials who violate codes and against whom complaints have been registered, (ii) the right to seek compensation against the improper acts of public officials that have resulted in losses to the government, (iii) measures to remediate the effects of improper acts or corruption, (iv) measures towards corruption control and monitoring effectiveness of development projects through technical auditing, (v) training for technical auditors, and (vi) investigation into cases of “improper acts” and disciplinary mechanisms. The proposed amendments are part of the government’s overall legislative reforms and align with articles 5, 6, 8.6, 19, 34, and 35 of the UNCAC. These articles relate to the obligations under the Preventive (Chapter II) and Criminalization and Law Enforcement (Chapter III) of the UNCAC. Amendments to the subordinate regulations will be formulated upon enactment of the amendment to the CPA. The Government of Nepal has taken concrete steps for complying with the broader UNCAC obligations since their ratification in 2011. Between 2013 and 2016, NVC prepared and submitted additional proposals to OPMCM aimed at strengthening its legal and institutional framework, independence, and effectiveness as an oversight agency. These included (i) a draft bill under Article 83 (1) of the Interim Constitution of Nepal 2007 for the establishment of a National Vigilance Commission (submitted on 2 February 2015) and (ii) a proposal on institutional restructuring (submitted on 17 August 2016) in line with the new constitution.

Appendix 3 27

Tranche Condition Status of Compliance

These proposals sought to (i) strengthen NVC’s legal and institutional framework with a broader mandate, duties, and rights; (ii) adopt measures to promote awareness about integrity and ethical values among citizens and public administration; (iii) strengthen information collection, monitoring of asset declarations, surveillance and surprise checks, complaint handling for good governance, and investigations into and disciplining of improper conduct; (iv) establish a framework for standards in development projects through technical auditing; and (v) develop mechanisms for sharing of best practices. However, submission to the cabinet and subsequent enactment of these proposed amendments to the CPA, NVC Act, and other laws has been awaiting the broader legislative reforms during the transition to the federal system. This process involves amendments to and enactment of more than 200 laws, administrative restructuring, and institutional reorganization, including anti-corruption laws, institutions, and procedures. Thus, policy action was not complied with at the time of the program completion.

13. The government shall have provided basic and advanced-level training for relevant staff of concerned agencies on fraud audit and investigation competencies.

Complied with. NVC organized a training program entitled “NVC Investigation Training—Combating Fraud and Corruption” on 26–27 July 2016. About 65 senior officials from leading anti-corruption, good governance, and oversight agencies participated. These included the Commission for the Investigation of Abuse of Authority, NVC, Department of Money Laundering Investigation, Department of Revenue Investigation, National Investigation Department, Central Investigation Bureau, Office of the Auditor General, Financial Information Unit of Nepal Rastra Bank, Financial Comptroller General’s Office, Office of Company Registrar, PPMO, and OPMCM. The training had basic and advanced formats, with nine technical sessions led by experts from within the government and external practitioners. The NVC training familiarized officials with (i) strategic planning and conducting an inquiry, surveillance, and investigation; (ii) methodologies in evidence handling and preservation, and framing of charges that can stand trial in court; (iii) strategies to strengthen surveillance and monitoring to identify corruption-prone zones through corruption vulnerability assessments; (iv) methodology to identify red flags in development projects through technical auditing; and (v) strategies for leveraging resources, intelligence, and a response system to curtail corruption. The NVC prepared proceedings—Investigation Training: Summary and Conclusions—highlighting recommendations based on the training, and submitted them to OPMCM for future training and policy reforms. NVC is determined to sustain such trainings as part of the legal and institutional reform agenda.

28 Appendix 3

Tranche Condition Status of Compliance

NVC developed a strategy to enhance its advocacy and preventive anti-corruption work in 2016 with a dissemination workshop. A diagnostic report was developed to improve technical audits. NVC benefitted from a study tour to the Malaysian Anti-Corruption Commission in 2016. The SPMP supported NVC during the Annual Day presentation to OPMCM, government agencies, and civil society in August 2016.

ADB = Asian Development Bank; CIAA = Commission for the Investigation of Abuse of Authority; CPA = Corruption Prevention Act; DDC = district development committee; e-GP = e-Government Procurement System; GESI = gender empowerment and social inclusion; FRRAP = Fiduciary Risk Reduction Action Plan; IPT = Integrated Property Tax; KMC = Kathmandu Metropolitan City; LGCDP = Local Governance and Community Development Programme; MC&PM = minimum condition and performance measure; MOFALD = Ministry of Federal Affairs and Local Development; NPC = National Planning Commission; NVC = National Vigilance Center; OPMCM = Office of the Prime Minister and Council of Ministers; OSR = own-source revenue, PPMO = Public Procurement Monitoring Office; RBIA = Risk based internal audit; SPMP = Strengthening Public Management Program; UNCAC = United Nations Convention against Corruption; VDC = village development committee. a-c-d Government of Nepal, Ministry of Federal Affairs and Local Development. 2016. LGCDP II Annual Progress Report – 2072/73. Kathmandu. b Kathmandu Metropolitan City. Annual Report FY2015/2016. Kathmandu. p. 5. Source: Asian Development Bank.

Appendix 4 29

STATUS OF COMPLIANCE WITH GRANT COVENANTS

Covenant

Reference in Grant

Agreement Status of

Compliance

G0305 – NEP (SF)

Section 4.01. In the carrying out of the Program, the Recipient shall perform, or cause to be performed, all obligations set forth in Schedule 4 to the Special Operations Grant Agreement.

Article IV (Particular Covenants)

Complied with.

Section 4.02 (a). The Recipient shall maintain, or cause to be maintained, records and documents adequate to identify the Eligible Items financed out of the proceeds of the Grant and to record the progress of the Program.

Article IV (Particular Covenants)

Complied with.

Section 4.02 (b). The Recipient shall enable ADB's representatives to inspect any relevant records and documents referred to in paragraph (a) of this Section.

Article IV (Particular Covenants)

Complied with.

Section 4.03 (a). As part of the reports and information referred to in Section 6.04 of the Grant Regulations, the Recipient shall furnish, or cause to be furnished, to ADB all such reports and information as ADB shall reasonably request concerning (i) the Counterpart Funds and the use thereof; and (ii) the implementation of the Program, including the accomplishment of the targets and carrying out of the actions set out in the Policy Letter.

Article IV (Particular Covenants)

Complied with.

Section 4.03 (b) Without limiting the generality of the foregoing or Section 6.04 of the Grant Regulations, the Recipient shall furnish, or cause to be furnished, to ADB quarterly reports on the carrying out of the Program and on the accomplishment of the targets and carrying out of the actions set out in the Policy Letter.

Article IV (Particular Covenants)

Complied with. Annual reports were submitted.

G0306 – NEP (EF)

Section 4.01. In the carrying out of the Program, the Recipient shall perform, or cause to be performed, all obligations set forth in Schedule 4 to the Special Operations Grant Agreement.

Article IV (Particular Covenants)

Complied with.

Section 4.02 (a). The Recipient shall maintain, or cause to be maintained, records and documents adequate to identify the Eligible Items financed out of the proceeds of the Grant and to record the progress of the Program.

Article IV (Particular Covenants)

Complied with.

Section 4.02 (b). The Recipient shall enable ADB's representatives to inspect any relevant records and documents referred to in paragraph (a) of this Section.

Article IV (Particular Covenants)

Complied with.

Section 4.03 (a). As part of the reports and information referred to in Section 6.04 of the Grant Regulations, the Recipient shall furnish, or cause to be furnished, to ADB all such reports and information as ADB shall reasonably request concerning (i) the Counterpart Funds and the use thereof; and (ii) the implementation of the Program, including the accomplishment of the targets and carrying out of the actions set out in the Policy Letter.

Article IV (Particular Covenants)

Complied with.

Section 4.03 (b) Without limiting the generality of the foregoing or Section 6.04 of the Grant Regulations, the Recipient shall furnish, or cause to be furnished, to ADB quarterly reports on the carrying out of the Program and on the accomplishment of the targets and carrying out of the actions set out in the Policy Letter.

Article IV (Particular Covenants)

Complied with. Annual reports were submitted.

30 Appendix 4

Program Implementation and Other Matters Reference in

Grant Agreement

Status of Compliance

Implementation Arrangements

1(a). The Recipient shall be responsible for coordination and execution of the Program with various concerned departments and agencies of the Recipient.

Schedule 4 Complied with.

1(b). The PEFA steering committee, chaired by the Secretary of MOF, shall be the steering committee for and shall provide policy guidance to the Program (PSC). The PSC shall meet, as and when necessary, but at least once every quarter to discuss the progress of the Program and review macroeconomic conditions to ensure continued stability.

Schedule 4 Partially complied with. Though PSC was set up, its engagement in program implementation was not very effective. The meetings were not regular. In 2016, only two meetings took place, the national PEFA assessment and a follow-up meeting to discuss PFM reform plan.

1(c). The MOF shall be the Program Executing Agency and shall be responsible for the overall implementation of the Program, including compliance with all policy actions, facility administration, disbursements and maintenance of records. The MOF shall receive support from the PEFA Secretariat at the FCGO, which shall serve as the PMU, and provide: (i) technical guidance to the Implementing Agencies, (ii) periodically review the progress of program implementation, and (iii) ensure coordination of the Program with other reform initiatives.

Schedule 4 Complied with.

1(d). The MOFALD, PPMO, and NVC shall be the Implementing Agencies. MOFALD shall implement components 1 and 2 of the Program, PPMO shall implement component 3 of the Program and NVC shall implement component 4 of the Program. PPMO and NVC, respectively, shall establish a PCU to implement their respective components. The existing program coordination unit for LGCDP in MOFALD shall serve as the PCU for MOFALD. Each PCU shall have a manager and shall: (i) supervise the implementation of activities under their respective component, (ii) prepare and submit progress reports to the Program Executing Agency and PMU, and (iii) liaise with the PEFA Secretariat in the implementation of the Program. The PCUs shall be supported by consultants to be engaged by MOFALD in consultation with ADB following the existing LGCDP process.

Schedule 4 Complied with. However, coordination issues were observed among the executing agency and implementing agencies.

1(e). The Recipient shall (i) use its best endeavor to ensure that critical Program staff shall remain in their position on a full-time basis for a reasonable duration to ensure continuity in the implementation of the Program; and (ii) ensure that all Implementing Agencies shall be adequately staffed and provided with the necessary financial, technical, and other resources to perform their functions under the Program.

Schedule 4 Complied with. Critical program staff remained. However, there was general staff turnover due to the fluid political

Appendix 4 31

Program Implementation and Other Matters Reference in

Grant Agreement

Status of Compliance

context and transition to the federal system.

Policy Actions and Dialogue

2. The Recipient shall ensure that all policies adopted and actions taken under the Program as set forth in the Policy Letter and the Policy Matrix, continue to be in effect for the duration of the Program.

Schedule 4 Complied with. Appendices 2 and 3 provide the status of the policy actions in the Policy Matrix.

3. The Recipient shall keep ADB informed of policy discussions with other multilateral and bilateral aid agencies that may have implications for the implementation of the Program and shall provide ADB with an opportunity to comment on any resulting policy proposals. The Recipient shall take into account ADB’s views before finalizing and implementing any such proposal.

Schedule 4 Complied with.

Counterpart Funds

4. The Recipient shall ensure that the Counterpart Funds are used to finance the local currency cost relating to the implementation of the Program and other activities consistent with the objectives of the Program and shall provide the necessary budget appropriation to finance costs relating to the implementation of reforms under the Program.

Schedule 4 Complied with.

Governance and Anticorruption

5. The Recipient, the Program Executing Agency, and the Implementing Agencies shall: (a) comply with ADB’s Anticorruption Policy (1998, as amended to date) and acknowledge that ADB reserves the right to investigate directly, or through its agents, any alleged corrupt, fraudulent, collusive or coercive practice relating to the Program; and (b) cooperate with any such investigation and extend all necessary assistance for satisfactory completion of such investigation.

Schedule 4 Complied with.

6. The Recipient shall ensure that immediately upon the reconstitution of the Parliament, the Recipient shall commence the process for and, subject to the recommendation of the CC, shall appoint the Chief Commissioner and Commissioners of the CIAA. In the event of the Recipient’s Parliament has not been reconstituted by the time of the Program midterm review, this condition will be reassessed.

Schedule 4 Complied with. The Government of Nepal appointed the chief commissioner in May 2017 and five commissioners in April 2015. They were appointed for a term of 6 years.

Program Review

7. The Recipient shall undertake periodic reviews during Program implementation to evaluate the scope, implementation arrangements, progress and achievement of the objectives of the Program. In addition to the periodic reviews, a Program review shall take place prior to the Second Tranche release. The Recipient shall ensure that ADB shall have the opportunity to participate in these reviews.

Schedule 4 Complied with. An ADB consultant conducted an independent midterm review of the SPMP, and ADB shared the findings of the assessment report with the Government of Nepal and development partners in November 2015.

32 Appendix 4

Program Implementation and Other Matters Reference in

Grant Agreement

Status of Compliance

Program Performance Monitoring and Evaluation

8. The Recipient shall monitor the implementation and outcome of the Program using a set of indicators and targets that has been agreed between the Recipient and ADB to assess progress towards meeting the objectives of the Program. For each of the agreed indicators, progress shall be measured against a baseline of FY2012. The responsible Implementing Agencies shall review the agreed frameworks every quarter to determine progress and identify constraints.

Schedule 4 Complied with.

Program Reporting

9. The Recipient shall prepare a quarterly consolidated progress report on policy and institutional reforms implementation and shall forward the same to ADB. The reports shall describe progress made in the Program and any changes to the implementation schedule, and shall also identify any problems encountered and remedial actions taken.

Schedule 4 Partially complied with. The Government of Nepal did not prepare any separate quarterly reports for SPMP. However, reports prepared under LGCDP included SPMP activities.

The Recipient shall submit a Program completion report not later than 3 months after Program completion.

Partially complied with. The Government of Nepal did not submit a separate program completion report; however, it undertook a focused evaluation of LGCDP, which included some of the SPMP activities (under the Fiduciary Risk Reduction Action Plan). The findings of are aligned with this program completion report.

ADB = Asian Development Bank; CC = Constitutional Council; CIAA = Commission for the Investigation of Abuse of Authority; FCGO = Financial Comptroller General Office; LGCDP = Local Governance and Community Development Programme; MOF = Ministry of Finance; MOFALD = Ministry of Federal Affairs and Local Development; NVC = National Vigilance Center; PCU = program coordination unit; PEFA = public expenditure and financial accountability; PMU = program management unit; PPMO = Public Procurement Monitoring Office; PSC = program steering committee; SPMP = Strengthening Public Management Program. Source: Asian Development Bank.

Appendix 5 33

TECHNICAL ASSISTANCE COMPLETION REPORT

TA Number, Country, and Name: Amount Approved: $3,000,000

TA 8173-NEP: Supporting the Strengthening Public Management Program

Revised Amount: $6,550,000

Executing Agency: Ministry of Finance, Government of Nepal

Source of Funding:1 ADB Technical Assistance Special Fund (TASF-IV); Government of the United Kingdom; European Union

Amount Undisbursed: $1,126,282 (as of 8 January 2018)

Amount Utilized: $5,423,718

TA Approval Date: TA Signing Date: Fielding of First Consultants:

TA Completion Date Original: 31 October 2015

Actual: 30 June 2017

26 September 2012 28 December 2012 18 September 2013 Account Closing Date Original: 31 October 2015

Actual: 31 December 2017

Description In 2012, ADB approved the Strengthening Public Management Program (SPMP)2 to (i) improve local government budget and fiscal management, (ii) strengthen fiduciary risk management at the local government level, (iii) enhance Nepal’s public procurement system, and (iv) strengthen institutions for oversight and accountability. The first two outputs support the Government of Nepal’s Local Governance and Community Development Programme Phase II (LGCDP II).3 The attached technical assistance (TA) was approved with the SPMP on 26 September 2012 (TA 8173-NEP). The TA was initially estimated to cost $3,000,000, of which $500,000 was financed on a grant basis by ADB’s Technical Assistance Special Fund (TASF-IV), and $2,500,000 from the Government of the United Kingdom acting through the Department for International Development (DFID). On 5 November 2013, an additional grant amounting to $2,950,000 was provided by the European Union (EU) under Grant 0368-NEP. On 10 December 2015, DFID further provided an additional $600,000, which brought the total TA amount to $6,550,000. The TA was initially expected to be implemented over a period of 3 years starting 28 December 2012, but implementation was extended until 30 June 2017. The executing agency was the Ministry of Finance. MOFALD, the PPMO, and the NVC were the implementing agencies.

Expected Impact, Outcome, and Outputs The TA provided support for the implementation of the SPMP. The TA’s objectives were aligned with the program’s impact on effective delivery of public goods and services in Nepal, especially at the local government level. Its outcome was enhanced efficiency, transparency, and integrity of public finances at the national and sub-national levels. The TA had three major outputs: (i) development and revision of key PFM diagnostic tools and undertaking of surveys, (ii) development of MARS and capacity building, and (iii) development of an e-GP system and capacity building.

Delivery of Inputs and Conduct of Activities The TA was originally approved on 26 September 2012 with a completion date of 31 October 2015. The completion date was extended three times. The first extension followed the contract end date of one of the consulting firms, which was negotiated to close on 27 April 2016. The second extension to 31 December 2016 was done to provide continued technical support to the Government of Nepal for the successful implementation of the SPMP’s policy actions following delays in implementation.4 The third and last extension date of 30 June 2017 was to provide continued support to the

1 The TA funding consists of $500,000 from TASF-IV, $3,100,000 from the Government of the United Kingdom, and

$2,950,000 from the European Union. 2 ADB. 2012. Report and Recommendation of the President to the Board of Directors: Proposed Policy-Based Grant,

Administration of Grant, and Technical Assistance Grant Strengthening Public Management Program (Nepal). Manila. ADB grant of $21 million under Grant 0305-NEP and Department for International Development (DFID), Government of United Kingdom cofinancing grant under Grant 0306-NEP were approved.

3 MOFALD. 2016. LGCDP II Annual Progress Report – 2072/73. Kathmandu. 4 The SPMP only became effective on 26 August 2013 because of the delays in (i) signing the externally financed

grant agreement with the Government of Nepal, involving DFID cofinancing and (ii) the government’s submission of satisfactory documentation as evidence of compliance with the first tranche policy action no.4, requiring approval of an integrated action plan to strengthen PFM and address fiduciary risks in local bodies. Originally, the EU considered cofinancing of €4.5 million ($5.9 million equivalent) subject to EU Parliamentary approval, but the full amount did not materialize with the cancellation of $2.95 million for the program portion. The April and May 2015 earthquakes, the unofficial border blockage with India in 2016, the evolving and complex political situation, the frequent changes of government and its preoccupation with drafting and promulgating the new constitution, and the broader restructuring of the government in line with the new federal system also affected the timely implementation of TA. The extension was deemed critical for the effective completion of SPMP activities.

34 Appendix 5

implementing agencies for the implementation of TA outputs for sustainability. There were seven review missions (58 days) from 2013 to 2016.

A minor change in implementation arrangement was approved in May 2013 for the engagement of a local governance expert and local governance PFM expert to ensure integration and coordination of the SPMP’s PFM outputs with the LGCDP II. A national program manager was also assigned for better coordination. Consultants such as a program management specialist, a business-process re-engineering specialist, and a system engineering specialist were also added for the effective implementation of MARS. In December 2015, a change in scope and implementation arrangement was approved for additional TA activities such as a larger sample size of PETS, review of the MC&PM system, updating of the government’s Fiduciary Risk Reduction Action Plan, and provision of ‘single-stage two-envelope procedure in the e-GP system. Another minor change in implementation arrangements was approved in March 2016 for the engagement of a national public management specialist to improve the draft MTBF, and an international change management consultant to analyze the changes in the political and governance structure in Nepal with the adoption of the new constitution and provide policy and technical advice on how to integrate the findings into the forthcoming reform programs. In November 2016, another change in implementation arrangement was approved for further technical support for MARS; modification, training, and roll-out of e-GP to public entities; and to institutionalize PFM reforms.

ADB recruited a total of three consulting firms for each of the outputs through quality and cost-based selection with a quality-cost ratio of 90:10 due to highly technical nature of activities in accordance with ADB’s Guidelines on the Use of Consultants (2013, as amended from time to time). For PFM reforms (output 1), 12 international consultants (56.5 person-months) and 15 national consultants (89.8 person-months) were engaged under the consulting firm GHK Consulting Limited, in association with Dege Consult Aps, for a total of 146.3 person-months (41.9 person-months in the field and 104.4 person-months in the home office). An international public management specialist (25 working days) and a PFM specialist (94 working days) were also hired separately to provide support in the implementation of output 1, involving a PEFA assessment and PETS survey at the subnational level, development of RBIA and VDC accounting software manuals, preparation of MTBF for MOFALD, and development of training materials on fraud and investigation competencies.

For output 2, involving development and piloting of MARS software in KMC, five international consultants (62.5 person-months) and four national consultants (47.75 person-months) were engaged under the consulting firm Communications, Ltd., in a joint venture with Solutions Consultant Pvt. Ltd. Nepal, for a total of 110.25 person-months (51.5 person-months in the field and 58.75 person-months in the home office).

For output 3, involving pilot and roll out of a full-fledged e-GP system, 11 international consultants (111 person-months) and four national consultants (34 person-months) were engaged under the consulting firm PricewaterhouseCoopers for a total of 145 person-months (45 person-months in the field and 100 person-months in the home office). An international e-GP advisor (154 working days), a national e-GP coordinator (502 working days), and an international e-Procurement system expert (20 working days) were also hired separately to support the implementation of output 3.

Except for the change management specialist, whose contract was terminated due to unsatisfactory quality of the analysis in the consultant report, the performance of all firms and consultants was satisfactory. The TA followed ADB’s Procurement Guidelines (2015, as amended from time to time). The Government of Nepal retained software and equipment purchased.

The performance of ADB was satisfactory. ADB effectively coordinated with the implementing agencies, consultants, DFID, EU, and related agencies, and successfully accommodated requests for additional funding, changes in scope and implementation arrangements. The performance of MOF in carrying out the TA activities was also satisfactory.

Evaluation of Outputs and Achievement of Outcome The TA achieved its outcome of enhanced efficiency, transparency, and integrity of Nepal’s public finances. Output 1 of the TA was achieved through the following activities: (i) PEFA assessment was conducted in September 2014 and completed in June 2015; (ii) PETS conducted in 6 DDCs, 5 municipalities, and 24 VDCs, draft PETS manual prepared, and PETS Supervision and Facilitation Committee formed and internalized in MOFALD; (iii) MTBF for FY2017–2019 prepared, and training of MOFALD staff and related departments on MTBF preparation conducted; (iv) RBIA guidelines developed, and training of DDC and VDC staff on basic accounting and internal audit conducted; (v) accounting software installed and made functional in 300 VDCs, and accounting software and basic financial management training provided to 1,560 VDC staff; (vi) MC&PM system reviewed; and (vii) training materials on fraud and investigation, and VDC accounting developed. Under output 2, MARS software was successfully developed and piloted in KMC along with training of KMC staff. Under output 3, the e-GP system was successfully piloted in April 2016, and rolled out nationwide on January 2017. Capacity building of ministries, departments, and local governments were conducted. A growing number of public entities are using the system.

Appendix 5 35

Overall Assessment and Rating Overall, the TA is rated successful.5 The TA was relevant because (i) it was in line with Nepal’s Country Partnership Strategy, 2010–2012; (ii) it supported the ongoing governance reform programs in Nepal; and (iii) it successfully supported the implementation of the SPMP. The TA was effective as evidenced by the successful delivery of all three TA outputs. The TA was key in the successful compliance of tranche conditions under the SPMP. However, some of the reforms need to be revisited because of the legal, administrative, and institutional changes under the federal system and need to be aligned with the new constitution, the Local Governance Bill (2017), the Local Financial Procedures Bill (2017), and the Intergovernmental Fiscal Management Bill (2017). The TA is less than efficient given the delay in TA effectivity, delay in the mobilization of cofinancing funds for procurement packages related to MARS and e-GP, as well as various additions in consultancy inputs and changes in TA implementation arrangements, which could have been identified earlier. The delay in the development of MARS was also due to the government’s change of decision to opt for a custom-built solution with source code retained by MOFALD, which resulted in a reassessment of the consultants’ work. Most of the undisbursed amount was from the EU cofinancing (76%), mainly because of the underspent equipment budget for the consulting firm and the effect of $/€ exchange rate fluctuations (excluding contingency and administrative costs). Re-allocation and utilization of these funds was not possible mainly due to the earlier completion date (5 December 2016) of the EU financed portion of the TA. Requests from the government for additional activities related to MARS also came only after this completion date. The TA is likely to be sustainable given government commitment to continue key reforms such as the integration of MC&PMs into public resource allocation practices, subnational PEFA assessments, e-GP system, and plans to roll-out MARS in KMC and other municipalities. Although the VDC accounting software itself is no longer applicable due to the restructuring of local bodies, e-governance was introduced for VDCs with basic PFM training.

Major Lessons The Government of Nepal’s strong commitment to the reforms, as well as ADB’s regular monitoring and flexibility in accommodating requested changes, contributed to the successful completion of the TA. However, TA implementation could have benefited from having a broader range of local government counterparts such as a focal contact person in each local body from the onset of the TA and until completion, for better coordination and communication between all stakeholders. Better coordination among the cofinancing partners (DFID and EU) in the approval and mobilization of TA funds, could have also resulted in the timely recruitment of consultants and procurement of IT equipment, which, in turn, could have resulted in the earlier completion of MARS and roll-out of the e-GP system. Lastly, the TA could have benefitted from physical and technical preparedness, especially for IT-based systems, and further capacity building activities. Streamlining various IT platforms and dissemination of operating guidelines on the use of MARS could have resulted in better acceptance by the users. Poor record keeping of the manual systems and frequent transfer of dedicated staff affected implementation of activities involving PEFA assessment and MARS.

Recommendations and Follow-Up Actions The Government of Nepal needs support in its transition to fiscal federalism. ADB can provide this support through a follow-on program and attached TA, which could prioritize the continuation of the following reforms: (i) expansion of the revenue base at the subnational level; (ii) design of intergovernmental fiscal transfers; (iii) customization and roll out of MARS to other municipalities; (iv) adaptation of the results-based budgeting frameworks (MTBF and MTEF) to the new federal system; (v) re-evaluation of the MC&PM system; (vi) strengthening internal, external, and technical audit capabilities at the subnational level along with incentives to use RBIA and IT-based audit management software; and (vii) modification of the e-GP to align with the federal procurement system. Strong capacity building on IT-based PFM systems at the local level is also recommended.

ADB = Asian Development Bank; DDC = district development committee; DFID = Department for International Development; e-GP = electronic government procurement; GSP = Governance Support Program; IT = information technology; KMC = Kathmandu Metropolitan City; LGCDP = Local Governance and Community Development Programme; MARS = municipal administration and revenue system; MC&PM = minimum condition and performance measure; MOFALD = Ministry of Federal Affairs and Local Development; MTBF = medium-term budget framework; NVC = National Vigilance Center; PEFA = public expenditure and financial accountability; PETS = public expenditure tracking survey; PFM = public financial management; PPMO = Public Procurement Monitoring Office; RBIA = risk-based internal audit; SPMP = Strengthening Public Management Program; TA = technical assistance; VDC = village development committee. Prepared by: Çiğdem Akın Designation and Division: Senior Public Management Economist, SAPF Sheila Foronda-Mariano Senior Operations Assistant, SAPF

In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

5 TA evaluation is based on the criteria in ADB. 2016. Guidelines for the Evaluation of Public Sector Operations. Manila.

36 Appendix 6

COMPARISON BETWEEN NEPAL SUBNATIONAL AND NATIONAL PUBLIC EXPENDITURE

AND FINANCIAL ACCOUNTABILITY (PEFA) SCORES

A. Comparison between Local and Central PEFA Scores of 2014

PEFA Performance Indicators

Local PEFA Score 2014 Scoring Method

Central PEFA Score

2014

Reasons for Variation between

Local and Central DDC VDC MUN KMC

A: PFM Outturns I: Credibility of the Budget

PI-1 Aggregate expenditure outturns compared to original approved budget

D D D D M1 A Heavy reliance of local government on CG transfers 80 to 95% of funding exposes LGs to significant shortfalls in CG core grants. Improvement recorded over 3-year period especially in FY2012-FY2013.

PI-2 Composition of expenditure outturns compared to original approved budget

D+ D+ D+ D+ M1 C+ LG budgets are compiled on a program basis, so significant reallocations in CG funding for new programs generate large differences.

PI-3 Aggregate revenue outturns compared to original approved budget

D D D D M1 A Unlike CG, local taxes contribute a relatively small amount of revenue (except Kathmandu municipality). Reliance on contracting out to third parties sometimes contributes to lower than expected yield and weak incremental estimations are a contributory factor. Forecasting errors are larger in % terms when small amounts are involved, so low scores are misleading indicators of predictability.

PI-4 Stock and monitoring of expenditure payment arrears

B+ D+ B+ D+ M1 B+ SNGs, excluding KTM, have low arrears but do not complete a Statement of Arrears as required by financial rules.

B: Cross-cutting Issues II: Comprehensiveness and Transparency

PI-5 Classification of the budget

D D D D M1 A LBFAR are GFS/COFOG S-compliant, but SNGs do not adhere to them for expenditure financed by own source revenue.

P1-6 Comprehensiveness of information included in the budget

B B B B M1 A Less information is required than for CG budgets, no debt (except for KMC), but the stock of

Appendix 6 37

documentation financial assets and analysis of financial implications of policy measures are missing.

PI-7 Extent of unreported government operations

A A A B+ M1 D+ SNGs do not operate off-budget entities, and most donor funding is now channeled through the government.

P1-8 Transparency of inter-governmental fiscal relations

B N/A N/A N/A M1 C+

Municipalities and VDCs do not have subordinate levels, so this indicator is for DDC transfers only. Funds distributed are small, and the basis for distributions is not clear.

PI-9 Oversight and aggregate fiscal risk from other public sector entities

C N/A N/A N/A M1 C Not relevant as SNGs do not operate AGAs or public entities, only DDCs have a responsibility to monitor subordinate VDCs.

PI-10 Public access to key fiscal information

A

A A A M1 A Strong performance in line with CG partly due to influence of citizen charter criteria included in MC&PM grants

C: Budget Cycle III: Policy-based Budgeting

PI-11 Orderliness and participation in the annual budget process

A B+ A A M2 B+ CG provides SNGs with budget guidelines in October well before ceilings are available. However, there is participation and timeliness in budget submissions

PI-12 Multi-year perspective in fiscal planning, expenditure, policy, and budgeting

D+ D D D M2 B Unlike CG, there has been no MTEF process; medium term budgeting is not currently mandated by LBFAR. Periodic plans are not backed up with financial projections.

IV: Predictability and Control in Budget Execution

PI-13 Transparency of taxpayer obligations and liabilities

B C B B M2 A Low number of taxes, which are collected on PAYG basis; some issues with transparency over DDC taxes collected by agencies.

PI-14 Effectiveness of measures for taxpayer registration and tax assessment

C D D+ C+ M2 A Invoice driven system for property tax not in place; but DDC PAYG satisfactory; VDC revenues negligible in most cases.

PI-15 Effectiveness in collection of tax payments

D+ D+ D+ D+ M1 D+ Revenue collection and banking is satisfactory in DDCs and municipalities, but like CG, there is no tax

38 Appendix 6

audit. VDCs lack nearby banking facilities.

PI-16 Predictability in the availability of funds for commitment of expenditures

D+ D+ D+ D+ M1 C+ SNGs are not mandated by LBFAR to prepare cash flows and do not operate a commitment allocation system as they do not have cost centers. In-year budget variations are limited and reallocations driven largely by the Government of Nepal’s programming changes.

PI-17 Recording and management of cash balances, debt, and guarantees

D D B C+ M2 C+ Not relevant to DDCs and VDCs apart from cash balances. Practice varies in terms of calculating balances, but central TSA does not cover local level, and no offset arrangements are mandated.

PI-18 Effectiveness of payroll controls

C+ D+ C+ C+ M1 C+ Payrolls are small, locally managed, and do not include significant allowances that are part of the central government payroll.

PI-19 Competition, value for money, and controls in procurement

B C+ B B M2 B Relatively low-value procurement at local level; the default procurement method is through a user committee, which is legally mandated.

PI-20 Effectiveness of internal controls for non-salary expenditures

D+ D+ D+ C+ M1 C Similar score to CG, rules are generally in place and observed, but there are no commitment controls, except for KMC.

PI-21 Effectiveness of internal audit

D D D D M1 D+ Similar score; ineffective audit in DDCs, limited audit in municipalities, and no audits in VDCs.

V: Accounting, Recording, and Reporting

PI-22 Timeliness and regularity of accounts reconciliation

D D C+ C M2 C+ Poorer score; advance accounting and bank reconciliation not generally carried out as per LBFAR and poor control over advance retirements.

PI-23 Availability of information on resources received by service delivery units

D N/A D D M1 A Not relevant. Most frontline service units are under the control of line ministries.

P1-24 Quality and timeliness of in-year budget reports

D+ D C+ C+ M1 C+ Similar score to the Government of Nepal, but problematic area in light of the absence of accounts

Appendix 6 39

committees for which in-year reports would be prepared. Reports not generally supported by analysis.

PI-25 Quality and timeliness of annual financial statements

C+ D+ D+ C+ M1 C+ Similar score to the Government of Nepal. Timeliness good but quality could be improved. No alignment between LBFAR and NEPSAS; some DDCs do not produce an overall consolidated account.

VI: External Scrutiny and Audit

P1-26 Scope, nature, and follow-up of external audit

C+ C+ D+ D+ M1 C+ Lower score than the Government of Nepal. Timeliness good but quality poor, especially for municipalities.

PI-27 Legislative scrutiny of annual budget law

D+ D+ D+ D+ M1 D Different score because the council meeting of citizen acts as the legislature in the absence of an elected SNG representative council. Scrutiny is of a general nature.

PI-28 Legislative scrutiny of external audit reports

C+ D+ C+ C+ M1 D Similar to PI-27, SNG council provides an overall endorsement of the report but no specific time-bound actions on individual recommendations.

HLG-1 Predictability and timeliness of transfers from higher level of government

NS NS NS NS NA The mirror score for PI-8 at CG level; significant variations in amount from original allocations and in the timeliness of funds’ flow.

Note: Scoring methodology is explained in detail in the PEFA Assessment Report. AGA = autonomous government agency; CG = central government; COFOG = Classification of Functions of Government; DDC = district development committee; GFS = government finance statistics; LG = local government; KTM = Kathmandu Metropolitan City; LBFAR = Local Bodies Financial Administration Rules; MC&PM = minimum condition and performance measure; MTEF = medium-term expenditure framework; NEPSAS = Nepal Public Sector Accounting Standards; SNG = subnational government; TSA = treasury single account; VDC = village development committee. Source: Government of Nepal, Ministry of Federal Affairs and Local Development. 2016. Subnational PEFA Assessment Report. Kathmandu. Annexure 3.

Summary of Local PEFA Scores

compared to Central PEFA Number of Indicators % Indicators

Better Than 5 31

Worse Than 16 57

Same As 6 (1 not rated) 14

Total 27 (1 not rated) (Does not add up to 100 due to rounding) Source: Government of Nepal, Ministry of Federal Affairs and Local Development. 2016. Subnational PEFA Assessment Report. Kathmandu. Annexure 3 Table ES1-2.

40 Appendix 6

B. Summary of Major Findings and Recommendations of Local PEFA Assessment

• Budget Credibility. Budget credibility in terms of both aggregate expenditure and composition is poor. This is primarily due to the late payment of grants and reallocation of program grants during the fiscal year by the central government. The credibility of local revenue budgets is better in some local governments although there is room for considerable improvement.

• Budget Comprehensiveness. There have been improvements in budget comprehensiveness driven partly by legal requirements and ‘minimum conditions and performance measures’ grant allocation system requirements as well as in channeling development partner aid through multi-donor support programs such as the Local Governance and Community Development Programme (LGCDP).

• Budget Formulation Process. Local government budgets are prepared and approved 6 months before the start of the fiscal year. But in the absence of reliable financial information on the level and nature of grants, budgets are subject to significant reallocation at the revision stage. Local government budget guidelines are not formally developed. Although most district development committees (DDCs) and municipalities have prepared periodic development plans, these have not been linked to the budgeting process. A particular issue is an apparent disconnect between recurrent and capital expenditures. The government places great emphasis on the need to provide more public services at the local government level. This implies the need for higher recurrent and capital expenditure (e.g., on roads), but the emphasis has tended to be on the recurrent side. This is ultimately to the detriment of the quality of planned public services if the supporting infrastructure investments are not sufficiently funded. Conversely, the operating and maintenance costs associated with newly constructed infrastructures tend to be under-budgeted, also to the detriment of the public services that the government wants to provide.

• Budget Execution. Rules and regulations guide budget execution, but weak enforcement of these rules has impeded achieving sound control. Non-observation of the rules regarding granting and retirement of advances and the preparation of bank reconciliation statements on a regular basis are particularly significant. The absence of an effective internal audit function has also weakened internal control, particularly with regard to DDCs’ supervision of village development committees (VDCs).

• Accounting and Reporting. The absence of regular finance committee meetings involving elected officials has undermined the process of developing in-year budget execution reports and analyzing their implications. Non-compilation of the required schedules undermines the value of annual financial statements. Municipalities are required to produce annual accounts on an accruals basis (3 years after their incorporation), but none appear to have done so. Useful supplementary information in the form of notes, schedules, and statements of accounting practices, is not included.

• Audits. The Office of the Auditor General’s external audit coverage of DDCs and their quality has improved, although they would benefit from the consistent targeting of key ‘control’ indicators every year. However, external audit of municipalities and VDCs is very weak and, in some cases, appears to be carried out largely off-site. Although there is usually overall citizen endorsement of audit report recommendations, which can be found in the minutes of council meetings, the absence of local finance committees precludes a detailed follow-up.

Appendix 6 41

Major Recommendations:

• Improving the public financial management (PFM) framework. Existing PFM frameworks need to be strengthened to comply with modern PFM practices, e.g., cash-flow forecasting or multi-year budgeting, a chart of accounts with modern accounting frameworks, and controls such as archiving and storage of documents, and maintenance of authorizations. The revised framework needs to substantially simplify the requirements for VDCs, given their lack of adequate resources, both human and otherwise.

• Improving compliance with basic financial control procedures. Internal control needs to be strengthened by (i) specific allocations of duties to accounts and administration staff rather than reliance on generic job descriptions; (ii) a more routine system of reporting on financial affairs to local management, including when accounts committees of locally elected representatives are reconstituted; and (iii) an enhanced role for internal auditing, which should include short monthly summaries on internal audit activities and proper trimester reporting.

• High-level management of resources. A proper linkage between the periodic plans and annual and multi-year budgets, and a shift away from the planning mindset governed by the annual financial horizon are needed. This requires a strengthened local government medium-term financial framework aimed at guaranteeing resource availability in the amounts and times envisaged in the grant guidelines, and leaving local bodies responsible for ensuring that requisite release documentation is submitted on time. Initial medium-term budgeting initiatives should focus on ensuring availability of funds to meet the capital costs of longer-term and more sophisticated capital projects, as well as making sure adequate recurrent funds are budgeted each year to maintain existing and new infrastructure.

• Investment in financial management capacity. Investment in financial management capacity needs to be increased in (i) information technology (IT) systems focusing on locally designed systems using open source code for adaptation to the local environment; (ii) financial management training, including on the use of IT systems; and (iii) organizational structures and allocations of duties.

• Investment in design and implementation of IT systems. There is a need to develop, implement, and adequately resource an IT strategy for effective PFM. Such a strategy should also consider the development of central IT finance systems as well as the likely degree of independence of local bodies from the central government under a federal structure.

Source: Summary provided by ADB. 2016. Second Tranche Release Progress Report for Nepal: Strengthening Public Management Program. Manila, based on the Government of Nepal, Ministry of Federal Affairs and Local Development. 2016. Subnational PEFA Assessment Report. Kathmandu.

42 Appendix 6

C. Comparison between Central PEFA Scores in 2008 and 2014

PEFA Performance Indicators

Central PEFA Score

2008

Central PEFA Score

2014

Scoring Method

Comparable Ratings

Change since 2008

A: PFM Outturns I: Credibility of the Budget

PI-1 Aggregate expenditure outturn compared to original approved budget.

B A M1 Yes Variances reduced

PI-2 Composition of expenditure outturns compared to original approved budget

C C+ M1 Changed methodology

No direct comparability

PI-3 Aggregate revenue outturns compared to original approved budget

A A M1 Change methodology

Performance unchanged

PI-4 Stock and monitoring of expenditure payment arrears

D+ B+ M1 Yes Stock of arrears below 2% and system in place to generate arrears data.

B: Cross-cutting Issues II: Comprehensiveness and Transparency

PI-5 Classification of the budget

C A M1 Yes Expanded budget classification – comprehensive

P1-6 Comprehensiveness of information included in the budget documentation

B A M1 Yes Performance improvement regarding information benchmark 3: deficit financing, describing anticipated debt composition

PI-7 Extent of unreported government operations

C D+ M1 Yes Higher number of extra-budgetary operations than before

P1-8 Transparency of inter-governmental fiscal relations

C C+ M2 Yes SNG’s fiscal data reporting strengthened

PI-9 Oversight and aggregate fiscal risk from other public sector entities

D+ C M1 Yes Performance improves regarding benchmark 2: subnational net fiscal position monitored and audited.

PI-10 Public access to key fiscal information

B A M1 Yes Performance of benchmark 4 improved: Reports on central

Appendix 6 43

government consolidated are made public within 6 months of completed audits.

C: Budget Cycle III: Policy-based Budgeting

PI-11 Orderliness and participation in the annual budget process

C+ A M2 Yes Issuance and adherence to budget discussion as per budget calendar

PI-12 Multi-year perspective in fiscal planning, expenditure, policy, and budgeting

C+ B M2 Yes Debt sustainability analysis conducted annually

IV: Predictability and Control in Budget Execution

PI-13 Transparency of taxpayer obligations and liabilities

C+ A M2 Yes Performance improved on the following: a) Tax obligation is clear and discretionary power limited. b) Taxpayer’s access to information is comprehensive, clear, and expanded.

PI-14 Effectiveness of measures for taxpayer registration and tax assessment

C A M2 Yes Overall improvement in taxpayer registration and tax assessment

PI-15 Effectiveness in collection of tax payments

D+ D+ M1 Yes Performance unchanged

PI-16 Predictability in the availability of funds for commitment of expenditures

C+ C+ M1 Yes Improvement in cash flow forecast, information to MDAs on expenditure ceilings and transparency of adjustment to budget allocations

PI-17 Recording and management of cash balances, debt, and guarantees

C+ C+ M2 Yes Performance unchanged

PI-18 Effectiveness of payroll controls

C+ C+ M2 Yes Performance unchanged

PI-19 Competition, value for money, and controls in procurement

C B M2 New dimensions, cannot be compared.

Use of open competition and operation of independent administrative procurement compliant system.

44 Appendix 6

PI-20 Effectiveness of internal controls for non-salary expenditures

C C M1 Yes Performance unchanged

PI-21 Effectiveness of internal audit

D+ D+ M1 Yes Performance unchanged

V: Accounting, Recording, and Reporting

PI-22 Timeliness and regularity of accounts reconciliation

C+ C+ M2 Yes Reconciliation issues on revenue accounts

PI-23 Availability of information on resources received by service delivery units

C A M2 Yes Improvement on resources made available to service delivery units, including PET survey

P1-24 Quality and timeliness of in-year budget reports

C+ C+ M1 Yes The system is able to show a direct comparison between the original budget and expenditure. There is no material evidence of data accuracy. The system is unable to depict commitments on a monthly basis.

PI-25 Quality and timeliness of annual financial statements

C+ C+ M1 Yes Performance unchanged

VI: External Scrutiny and Audit

P1-26 Scope, nature, and follow-up of external audit

D+ C+ M1 Yes Audit coverage expanded and timely submission of audit reports

PI-27 Legislative scrutiny of annual budget law

D+ D M1 Yes No parliament

PI-28 Legislative scrutiny of external audit reports

D D M1 Yes No parliament

D: Donor Practices

D-1 Predictability of direct budget support

D D+ M1 Yes Improvement in timelines of donor disbursements

D-2 Financial information provided by donors for budgeting and reporting on project and program aid

D C+ M1 Yes Improvement on donor information on project support

D-3 Proportion of aid that is managed by use of national procedures

D C M1 Yes Greater use of national procedures

Note: Scoring methodology is explained in detail in the PEFA Assessment Report. MDA = ministries, departments and agencies; PET = public expenditure tracking; SNG = subnational government. Source: Government of Nepal, Ministry of Finance. 2015. PEFA Assessment: Nepal PFM Performance Assessment II as of FY2013/14. Kathmandu. Table 1.

Appendix 6 45

Summary of Changes from Central PEFA scores of 2008

Number of Indicators

% Indicators

Better Than 19 61

Worse Than 2 7

Same As 10 32

Total 31 100 Source: Government of Nepal, Ministry of Finance. 2015. PEFA Assessment: Nepal PFM Performance Assessment II as of FY2013/14. Kathmandu. Table 2.

D. International Comparison of the Central PEFA ratings

Figure 1. Comparison of 2014 Central PEFA ratings

Country Credibility of budget

Comprehensiveness and transparency

Policy-based

budgeting

Predictability and control of budget execution

Accounting, recording,

and reporting

External scrutiny

and audit

Nepal 3.5 2.7 3.25 2.5 2.6 1.5

15 fragile states 2.0 2.0 2.3 1.9 2.0 1.7

26 Low-income countries

2.4 2.4 2.5 2.4 2.1 1.8

52 Middle-income countries

2.8 2.8 2.8 2.5 2.5 2.3

Source: Government of Nepal, Ministry of Finance. 2005. PEFA Assessment: Nepal PFM Performance Assessment II as of FY2013/14. Kathmandu. Figure 1.

46 Appendix 6

Figure 2. International Comparison of Nepal Central PEFA ratings 2008 and 2014

Source: Government of Nepal, Ministry of Finance. 2015. PEFA Assessment: Nepal PFM Performance Assessment II as of FY2013/14. Kathmandu. Figure 2.

Appendix 7 47

PROPOSED REFORMS UNDER A FOLLOW-ON POLICY-BASED PROGRAM 1. The follow-on policy-based program to the Strengthening Public Management Program (SPMP) proposes the following reforms to realize SPMP’s envisaged benefits and to ensure sustainability under the federal system. These reforms are in line with recommendations of the subnational public expenditure and financial accountability (PEFA) assessment in Appendix 6:

(i) Strengthening subnational revenue mobilization through (i) enacting model laws for subnational taxes and (ii) building of administrative and human resource capacity to mobilize tax and non-tax revenues with high revenue potential and improve the tax base, collection efficiency, and compliance for the greater fiscal autonomy of subnational governments (SNGs).

(ii) Establishing effective intergovernmental fiscal transfers through (i) tax sharing arrangements (i.e., value-added tax, excise, payroll taxes) between the federal government and SNGs, (ii) strengthening the National Natural Resources and Fiscal Commission, and (iii) setting up a formula-based fiscal transfer system, incorporating incentives for revenue collection and minimum conditions and performance measures for gender empowerment and social inclusion related targets to correct vertical and horizontal imbalances.

(iii) Promoting subnational fiscal discipline and access to borrowing through (i) enforcing fiscal responsibility and budget management rules against politically motivated spending by the elected SNGs and (ii) restructuring of the Town Development Fund for on-lending and financing of subnational projects based on robust public financial management (PFM) practices.

(iv) Developing subnational public-sector budgeting through (i) strengthening financial procedures and revenue and expenditure management along with fiscal discipline, (ii) preparing results-based medium-term fiscal, budget, and expenditure frameworks with guidelines for prioritization of resources for projects and performance monitoring, and (iii) piloting these practices in key sectors in SNGs.

(v) Strengthening audit and controls through (i) enhancing external, internal, and technical audit capabilities for fiduciary risk management at SNGs; (ii) strengthening legislation for public accounts and audit committees; (ii) creating an independent internal audit function at SNGs; (iii) implementing an internal control framework for planning, budgeting, fund management, and procurement; (iv) building capacity on the RBIA framework and piloting in key sectors; and (v) introducing an information technology (IT)-based audit management system.

(vi) Introducing an IT-based integrated and comprehensive PFM system through a phased national roll-out of the municipal administration and revenue system (MARS) following customization of modules as per the needs and capacity of the SNGs. The roll-out of basic (i) financial management and accounting, (ii) revenue management, and (iii) budget monitoring and planning modules could be prioritized across all SNGs, integrating them with other central PFM systems. Modification of the electronic government procurement (e-GP) system to align with the federal procurement system is also essential, along with the enhanced capacity building of procurement agencies at the SNGs. A robust capacity building program is critical to sustain IT-based PFM systems.

2. The exact coverage of SNGs (states and municipalities) to be included in the proposed follow-up program will be discussed in detail with the Government of Nepal during the program design. Proposed reforms will be prioritized based on the needs and sophistication of the selected SNGs.

48 Appendix 8

FINDINGS OF THE FIELD VISITS DURING THE PROJECT COMPLETION REPORT REVIEW MISSION

1. Two field visits were conducted to communities in Nepal that have benefitted from the Asian Development Bank’s Strengthening Public Management Program (SPMP), supporting local governments as part of the broader public management reforms undertaken by the Government of Nepal. The SPMP has been making significant strides and is potentially transformative in supporting important decentralization reforms under the new federal constitution. The field visits helped confirm that the SPMP has contributed to strengthening (i) public financial management (PFM) and governance institutions at the local government level in Nepal, aligned with the Government’s Local Governance and Community Development Programme II (LGCDP II), and (ii) public procurement practices with the roll-out of the electronic government procurement (e-GP) system. 2. The first mission, conducted in October 2017, met with the deputy mayor and executive director of Dhulikhel municipality and ward officials of Banepa municipality to see the improvements. Under SPMP, the adoption of minimum conditions and performance measures (MC&PMs) has led to progress in local government budgeting practices, preparation of municipal financial statements, results-based capital expenditure planning for better service delivery and more regular external auditing of municipal accounts to lower fiduciary risks. These improvements are reflected in the LGCDP II reports and latest 2014 public expenditure and financial accountability (PEFA) assessments with a higher score. Both municipalities expressed their desire to continue gender empowerment and social inclusion (GESI) grants and other social programs as per their new mandates under the constitution. The central PEFA assessment (Appendix 6) shows an improvement in score for scope, nature, and follow-up of external audits from D+ in 2008 to C+ with the expansion of audit coverage and timely submission of audit reports.

3. Local revenue mobilization and tax collection efficiency through integrated property tax (IPT), introduced under SPMP, has improved. Many municipalities are moving towards greater digitization for tax collection. With computerized revenue collection and up-to-date assessment of land and property values and the tax base, IPT collection increased from 21% of municipalities’ total own-source revenues in FY2014 to 29% in FY2016 based on Ministry of Federal Affairs and Local Development’s data for 42 municipalities. As of FY2016, 45 district development committees (DDCs) and 30 municipalities received a grant of NRs100,000 each for institutional development of their revenue sections, and 300 local bodies prepared revenue improvement action plans. As a result, out of 3,449 local bodies, the number of local bodies whose own source revenues increased by 10% increased to 723 in FY2016 compared to 570 in FY2014.1 4. As the review mission observed, the Banepa and Dhulikhel municipalities have developed revenue mobilization plans for IPT, rental tax, and business tax with (i) public awareness using radio to improve compliance, (ii) rebates for timely payment, (iii) partnership with the chamber of commerce for business tax collection, and (iv) property registration linking IPT with service provision. These would help reduce the property registration gap and facilitate property tax collection, leading to a reduction in the payment gap. Tax compliance in these municipalities is estimated at 40%–60%. It was also observed that the IPT is levied in a way that provides significant revaluation of property for tax purposes. Property valuation increased by 500% with the application of IPT in Banepa municipality.

1 Government of Nepal, Ministry of Federal Affairs and Local Development (MOFALD). 2016. LGCDP II Annual

Progress Report – 2072/73. Kathmandu.

Appendix 8 49

5. Although the accounting software introduced for the village development committees (VDCs) is no longer used because of the restructuring of subnational governments in 2017, familiarity of the local governments with information technology-based PFM platforms improved during the SPMP. Banepa and Dhulikhel municipalities confirmed that the VDC accounting software helped computerization and digitization of municipal data and functions, especially tax collection, and increased staff familiarity with e-governance.2 Building on it, a comprehensive system such as municipal administration and revenue system (MARS) could be introduced. Municipalities have been informed about the government’s intention for a nation-wide roll-out of MARS. 6. Based on consultations with beneficiaries and local government officials, the review mission observed that under SPMP, allocative efficiency of resources to local bodies improved. A significant institutional impact on compliance with the PFM guidelines, meeting performance benchmarks, and availability of public resources for socioeconomic targets was achieved with the

adoption of MC&PMs, and streamlined disbursement of central government grants through (i) GESI indicators; (ii) earmarked funds for disadvantaged groups, women, and children; and (iii) participatory planning for small community grants through ward citizen forums (WCFs) and citizen awareness centers (CACs). Of the 75 DDCs, compliance with GESI provisions reached 83% in FY2015. As of end 2016, over 700,000 citizens were engaged in 31,280 WCFs formed in all village development committees and municipalities. A total of 10,976 CACs were formed with cumulative membership reaching almost 300,000 citizens. WCFs and CACs selected 117,095 community-level projects out of 145,819 projects in FY2016. Citizen participation in local government budget and planning involved 250,000 citizens, including 31% women. The ward citizen forums have been effective in distributing earthquake relief funds (NRs100,000 per ward) with strong community oversight. 7. During the field visit, ADB team met with 25 members of the CAC in Mahendrajoyti village, benefiting from the livelihood improvement grants (NRs30,000 per year) and 52-week skill-building training programs given to the poorest and marginalized members of the community. The funds helped create a village-level garment production facility and develop a small revolving fund for lending to purchase livestock and improve basic infrastructure. Improvements in the incomes of the community, especially of single women, helped more children to attend school in the community. Personal stories of the beneficiaries revealed that gender and poverty-focused interventions improved the self-reliance of this community. 8. Overall, empowerment of citizens and community-based organizations strengthened public accountability in the absence of elected officials. In the 2014 subnational PEFA report, consultative budgeting and procurement involving communities received a score of D+ higher than the 2014 central PEFA score of D (Appendix 6), recognizing the success of inclusive and participatory policies. The experience under SPMP will be valuable for the design of the PFM, governance institutions, and the intergovernmental transfer system under the federal system. 9. The nation-wide roll-out of the electronic government procurement (e-GP) system, beginning in 2017, was an important institutional change under the SPMP. A full-fledged e-GP system was developed with SPMP’s TA support and rolled out nation-wide on 1 January 2017.

10. The second field visit was conducted in November 2017 to the offices of Roads, Irrigation, and Water Supply and Sewerage Departments in Kaski, Baglung, Parbat, and Tanahun districts to see the improvements in public procurement practices under the e-GP system. There are

2 Other computerized municipal accounting software systems are also used in Nepal on an ad hoc and scattered basis.

50 Appendix 8

positive signs that the e-GP system has (i) increased national and international competition; (ii) reduced turnaround time with automated procurement workflow; (iii) facilitated regulatory compliance and effective auditing; (iv) increased transparency and minimized collusion, which used to be a major risk; and (v) promoted effective decision making by procurement offices. 11. In Kaski and Baglung districts, from 2015 (before e-GP) to 2017 (with e-GP), time savings reached about 20% from bid invitation to contract award, based on a comparison of 18 sample contracts (with a possibility to increase time savings up to 30% with online bidding). The average number of bid submissions per package also increased from 5 to 12, based on a comparison of 11 sample packages, and the average cost saving compared to estimated bid prices reached 25%, based on a comparison of 11 sample bid prices during the same period, suggesting a potential reduction in collusion. 12. The government budget for FY2018 provides for a total capital expenditure of $1.4 billion, and government procurement is about 80% of this ($1.1 billion).3 For public entities that have been using the e-GP system since the rollout in January 2017, the procurement cost savings reached up to 20% compared to the manual system. Notable improvements were already observed in value for money and controls in procurement under a competitive system, increasing the related central PEFA score from C in 2008 to B in 2014 (Appendix 6). The full-utilization of the e-GP system will further raise the PEFA score. In the future, capacity building across all tiers of the federal structure, integration of e-GP system with other information technology platforms, scaling up the server capacity, technical support, and adoption of international best practices and new procedures are needed.4

3 Nepal’s annual public procurement expense in the national budget was estimated at about $750 million in ADB’s

Country Governance Risk Assessment and Risk Management Plan (ADB. Nepal Country Partnership Strategy, 2013–2017.Manila).

4 ADB supports interfacing of e-GP system with banking transactions in Nepal under ADB. 2015. Regional Capacity Development Technical Assistance for Enhancing Governance and Capacity Development as Driver of Change. Manila.

Appendix 9 51

COUNTRY ECONOMIC INDICATORS Fiscal Year

Item 2013 2014 2015 2016 2017P 2018 Proj

A. Income and Growth 1. GDP per Capita ($, current) 709.0 725.0 766.0 745.0 851.0 a - 2. GDP Growth (%, in basic prices) 3.8 5.7 3.0 0.01 6.9 a 4.8 a. Agriculture 1.1 4.5 1.1 0.03 5.3 a - b. Industry 2.7 7.1 1.4 (6.3) 10.9 a - c. Services 5.7 6.2 4.6 2.1 6.9 a - B. Saving and Investment (current and market prices, % of GDP)

1. Gross Domestic Investment b 22.6 23.5 28.0 28.8 33.8 - 2. Gross National Saving 40.7 45.7 44.1 40.0 43.8 - C. Money and Inflation

1. Consumer Price Index (average annual % change)

9.9 9.1 7.2 9.9 4.5 c -

2. Total Liquidity (M2) (annual % change) 16.4 19.1 19.9 19.5 15.5 c - D. Government Finance (% of GDP)

1. Revenue and Grants 19.5 20.6 20.8 23.2 24.6 d - 2. Expenditure and On-lending 18.8 20.0 21.8 23.7 30.0 d -

3. Overall Fiscal Surplus (Deficit) e 0.8 0.9 (0.7) (0.3) (5.2) d - E. Balance of Payments

1. Merchandise Trade Balance (% of GDP)

(27.2) (30.3) (31.1) (30.3) (34.5) c -

2. Current Account Balance (% of GDP) 3.4 4.6 5.1 6.2 (0.4) c - 3. Merchandise Export ($) Growth

(annual % change) (2.9) 5.1 (3.9) (28.8) 9.8 c -

4. Merchandise Import ($) Growth (annual % change)

10.9 13.9 8.0 (7.1) 29.4 c -

5. Remittances (% of GDP) 25.6 27.7 29.0 29.6 26.8 c - F. External Payments Indicators

1. Gross Official Reserves ($ million) 5,613.7 6,938.6 8,147.7 9,736.8 10,495.1 c - Months of current year’s imports of goods and services)

10.1 10.0 11.2 14.1 11.4 c -

2. External Debt Service (% of exports of goods and services)

9.5 8.9 8.1 9.9 f - -

3. Total External Debt (% of GDP) 19.7 17.7 16.1 17.3 f - - G. Memorandum Items 1. GDP (current prices, NRs billion) 1,695.0 1,964.5 2,130.2 2,247.4 2,599.2 a - 2. Exchange Rate (NRs/$, average) 87.7 98.0 99.2 106.1 105.9 c - 3. Population (million) 27.3 27.6 28.0 28.4 28.8 -

- = no data available, GDP = gross domestic product, P = provisional, Proj = projections. Note: FY2017 starts on 16 July 2016 and ends on 15 July 2017. a Based on FY2017 National Accounts Statistics from Central Bureau of Statistics. b Refers to gross fixed investment and does not include a change in stocks. c Based on FY2017 annual data from Nepal Rastra Bank. d Based on FY2017 preliminary annual data from Financial Comptroller General Office. e Includes cash balance of the previous year. f Based on FY2016 annual data from Financial Comptroller General Office. Sources: ADB. 2017. Macroeconomic Update. Nepal. Vol 5 (2). September. Manila; Government of Nepal, Ministry of Finance. FY2017 Budget Speech. Kathmandu; Nepal Rastra Bank. 2016. Macroeconomic Situation. Kathmandu; Government of Nepal, Central Bureau of Statistics. 2017. FY2017 National Accounts Statistics. Kathmandu; Government of Nepal, Central Bureau of Statistics. 2014. National Population and Housing Census 2011 (Population Projection 2011–2031). Kathmandu; Financial Comptroller General Office.