ASIAN DEVELOPMENT BANK RRP:INO 35144

REPORT AND RECOMMENDATION

OF THE

PRESIDENT

TO THE

BOARD OF DIRECTORS

ON PROPOSED LOANS

TO THE REPUBLIC OF INDONESIA

FOR THE

STATE AUDIT REFORM SECTOR DEVELOPMENT PROGRAM

November 2004

CURRENCY EQUIVALENTS (as of 15 November 2004)

Currency Unit – rupiah (Rp) Rp1.00 = $0.000111

$1.00 = 8,980

ABBREVIATIONS

ADB − Asian Development Bank ADF − Asian Development Fund AusAID − Australian Agency for International Development BAKUN − Badan Akuntansi Keuangan Negara (Accounting Board) BAPPENAS − Badan Perencanaan Pembangunan Nasional (National Development

Planning Agency) BAWASDA − Badan Pengawasan Daerah (regional internal audit body) BPK − Badan Pemeriksa Keuangan (Audit Board of the Republic of Indonesia) BI − Bank Indonesia (Indonesian central bank) BPPK − Badan Pendidikan dan Pelatihan Keuangan (the training center in MOF) BPKP − Badan Pengawasan Keuangan Dan Pembangunan (central internal

government auditor) CIU − component implementation unit DPR − Dewan Perwakilan Rakyat (House of Representatives of the Parliament) DPRD − dewan perwakilan rakyat daerah (regional parliament) EA − executing agency IDP − institutional development plan IG − inspector general ILMU − investment loan monitoring unit IMC − interministerial committee IMF − International Monetary Fund INTOSAI − International Organization of Supreme Audit Institutions ISC − interagency steering committee IT − information technology MenPAN − Menteri Negara Pendayagunaan Aparatur Negara (State Ministry for

Administrative Reform) MOF − Ministry of Finance MOHA − Ministry of Home Affairs MSRI − Ministry of Settlements and Regional Infrastructure PERDA − peraturan daerah (local regulation) PLMU − program loan monitoring unit PPMS − project performance monitoring system PROPENAS − Medium-Term Planning Document PSC − project steering committee SAI − supreme audit institution SK − surat keputusan (decision letter) STARSDP − State Audit Reform Sector Development Program TA − technical assistance

NOTES

(i) The fiscal year (FY) of the Government ends on 31 December. (ii) In this report, “$” refers to US dollars.

This report was prepared by a team consisting of F. Ahmed (team leader), A. Barend Frielink, S. Hitojo, R. O’Sullivan, H. Purnomo, R. Subramaniam.

CONTENTS

PageLOANS AND PROGRAM SUMMARY ii

I. THE PROPOSAL 1

II. THE SECTOR: PERFORMANCE, PROBLEMS, AND OPPORTUNITIES A. Sector Description and Performance B. Issues and Opportunities

112

III. THE PROPOSED SECTOR DEVELOPMENT PROGRAM A. Objectives and Scope B. Important Features C. The Program Loan D. The Project Loan

889

1015

IV. TECHNICAL ASSISTANCE 23

V. PROGRAM BENEFITS IMPACTS AND RISKS A. Expected Impacts B. Risks and Safeguards

232323

VI. ASSURANCES A. Specific Assurances B. Conditions of Loan Effectiveness C. Conditions for Disbursement

25252626

VII. RECOMMENDATION 26

APPENDIXES 1. Sector Analysis 2. Problems/Constraints Analysis 3. Development Coordination Matrix 4. Program Framework 5. Development Policy Letter 6. Policy Matrix 7. Program Management Structure 8. Ineligible items 9. Project Cost Estimates and Financing Plan 10. Implementation Schedule 11. Summary of Contract Packages 12. Summary Poverty Reduction and Social Analysis 13. Technical Assistance 14. District Selection Criteria

SUPPLEMENTARY APPENDIXES (available on request) A. Summary Terms of Reference for Consultants B. Analysis of World Bank BPK Audit Modernization Project C Physical Aggregation Data D. BAWASDA Survey E. Project Objectives and Impacts by Component Subactivity F Schematic Diagram and Description of Scholarship Component G. Funds Flow by Component

2734353844475556576062646570

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LOAN AND PROGRAM SUMMARY

Borrower Republic of Indonesia The Proposal Two loans from the Asian Development Bank (ADB): (i) a program

loan and (ii) a project loan in support of the State Audit Reform Sector Development Program (STARSDP). In addition there will be technical assistance (TA) given to assist in the implementation of the Program.

Rationale

An effective state audit function is key to an effective and well-functioning accountability framework for parliaments, the executive, the judiciary, and civil society.. As part of the overall control of public sector management, the function provides an independent, objective, and professionally conducted assessment on the veracity, accuracy, credibility, and reliability of information on the economy, effectiveness, and efficiency of government. While Indonesia has had institutional arrangements for public sector audit since the early 1940s the legal, policy, and institutional frameworks have not significantly evolved to promote transparency and accountability. First, a weak legal framework exacerbates the lack of clarity between internal and external audit functions. Second, the allocation of resources has not always been in line with policy and legal mandates. Third, parliamentary oversight has been deficient. Fourth, public awareness of the benefits of audit has been very low, and fifth, capacity has been weak. Due to decentralization, the enormous transfer of resources has necessitated strengthening the regional audit institutions to effectively fulfill their internal control and audit functions. The STARSDP will support selected policy interventions, adjustment measures, and critical investments that may otherwise be hampered by resistance to change or adversely affected by budgetary constraints.

Classification

Targeting classification: General intervention Sector: Law: Economic Management and Public Policy Themes: Public Governance

The Sector Development Program

The goal of the STARDSP is to enhance governance, and the efficiency, economy, and effectiveness of public sector audit through strengthened audit institutions operating to internationally accepted standards. The objectives are (i) an improved policy and legal framework for state audit institutions, (ii) a strengthened and efficiently aligned operating framework for external and internal audit, (iii) enhanced accountability and oversight of the audit function at all levels of government, and (iv) increased public awareness of the benefits of audit and what it can deliver.

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The program loan of the STARSDP will facilitate critical reforms affecting the entire audit sector, while the project loan will support key investments to enhance capacity building and strengthen sector management practices. Through these measures, the Program aims to help the Government achieve the milestones stipulated in the Government’s post-International Monetary Fund (IMF) reform agenda as outlined in the Government’s 2003 White Paper, Economic Policy Package, Pre and Post IMF. The medium-term policy framework of the STARSDP is described in narrative terms in the development policy letter (Appendix 5), and a policy matrix (Appendix 6) outlines the specific actions agreed on with the Government.

The STARSDP includes several salient features. It will catalyze an existing Government public expenditure management (PEM) reform agenda by providing the required focus on the audit function. While support from ADB and other external funding agencies has been institution specific the proposed Program takes a sector-wide approach to strengthen PEM. The reform agenda has resulted from an integrated consultative process involving all key stakeholders, supported by a project preparatory technical assistance (TA). The agenda’s overall design has benefited from an in-depth national survey done of regional audit capability in around 460 districts. The Program will help rationalize the legal framework for State audit functions. The Program will support the reorganization of external and internal audit institutions and help ensure allocation of adequate resources based on their legal mandates. The Program will support Indonesia in modernizing its audit standards in line with international practices, and help the external and internal audit institutions adopt a strategic and risk-based approach. The Program will strengthen technical support to central and regional parliaments to carry out their oversight function, and promote public awareness of the State audit functions at the central and regional levels.

The Program Loan Objectives The objectives of the program loan are to (i) strengthen the legal

and regulatory framework for public sector audit, (ii) initiate the realignment of national auditing resources to enable audit institutions to fulfill their mandate, (iii) support measures to enhance the parliamentary oversight on public audit institutions, and (iv) provide strategies to increase public awareness of audit and audit institutions.

Loan Amount and Terms

It is proposed that ADB support the STARSDP by providing a loan of $200 million from its ordinary capital resources. The Borrower will be the Republic of Indonesia. The loan will have an amortization period of 15 years, including a grace period of 3 years, with interest to be determined in accordance with ADB’s London interbank offered rate (LIBOR)-based loan facility.

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Program Monitoring and Tranching

The Government, through a STARSDP coordinating unit, made up of program loan monitoring unit (PLMU) and investment loan monitoring unit (ILMU) members, will provide a coordination function with the units in the executing agencies (EAs). A project performance monitoring system will be developed. Activities under the program component will be carried out over 42 months from January 2004 to June 2007. The program loan will be released in two tranches. To obtain their release, the Government will be required to carry out actions specifically identified as conditions for tranche release in the policy matrix, and to demonstrate satisfactory progress in implementing other actions in the policy matrix. The first tranche, $100 million, will be released upon loan effectiveness. The second tranche, $100 million, is expected to be released by June 2006.

Executing Agency and Implementation Arrangements

The Ministry of Finance (MOF) will be the EA of the program loan through the PLMU. MOF will chair a program interagency steering committee to coordinate the program loan activities.

Procurement, Disbursement, and Counterpart Funds

The loan proceeds will finance the foreign exchange costs of eligible items produced in and procured from ADB’s member countries. Procurement of eligible items financed under the program loan will be carried out in accordance with standard Government procedures or normal private sector commercial practices acceptable to ADB. The Government will use the counterpart funds to be generated from the loan proceeds to finance the costs of implementing the audit reform package.

The Project Loan Objectives and Scope

The objectives of the project loan are to enhance the capability of the audit institutions by building upon past support, and by introducing techniques and approaches that will allow the institutions to operate effectively and efficiently and to incorporate international best practices. Investment support is expected to result in a strengthened external auditor able to effectively operate at the national level, and an enhanced internal audit function and institutions across central and regional governments. The Project will enhance the oversight capability of central and regional parliaments as well as public awareness of the audit function. The investment project comprises five main components:

(i) project management; (ii) introduction of new systems and practices for effective

external audit; (iii) institutional enhancement and repositioning through new

regulatory structures and practices for effective internal audit covering, as applicable, the inspectorate generals (IGs), BAWASDAs, and BPKP;

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(iv) establishment of a formal and nonformal education and certification program for internal auditors; and

(v) introduction of new practices for parliamentary oversight of public sector audit covering national and regional parliaments.

Loan Amount and Terms

It is proposed that ADB provide a loan in various currencies equivalent to Special Drawing Rights 16,680,000 to the Republic of Indonesia from the Asian Development Fund (ADF) and $5 million from a Government of the Netherlands cofinancing grant, as part of the investment project under the STARSDP. The loan will have an amortization period of 32 years, including a grace period of 8 years, with interest determined in accordance with ADB’s based ADF loan facility, and such other terms and conditions as set forth in the Loan Agreement.

Cost Estimates

The total project cost is estimated at $42.7 million equivalent (including taxes and duties $3.0 million equivalent), consisting of $11.5 million (26.9%) in foreign exchange cost including $0.63 million in interest during construction/project implementation. Local currency cost is $31.2 million equivalent (73.1%).

Financing Plan

Item Foreign Local Total Percent ($ '000)

ADB-ADF 7,906 17,095 25,001 58 Cofinanced 3,586 1,415 5,001 12 Regional Govt. 0 4,225 4,225 10 Central Govt. 0 8,504 8,504 20 Total 11,492 31,239 42,731 100

Executing Agency and Implementation Arrangements

BAPPENAS will be the project EA and will coordinate the work of component implementing units. This task will be undertaken through the establishment of the ILMU for all the day-to-day aspects of project management and coordination between implementing agencies. For each project component and subcomponent, implementation responsibilities will be devolved to implementing agencies according to their mandates and capacities.

Procurement, Disbursement, and Consulting Services

The Project will provide consulting services, equipment, and block grants for scholarships and institutional upgrading. International and domestic consultants will be engaged in accordance with ADB’s Guidelines on the Use of Consultants and other arrangements satisfactory to ADB and GOI. Procurement of goods and services financed under the ADB loan will be undertaken in accordance with the ADB’s Guidelines for Procurement. Civil works for project institutions will be fully financed by the Government, and will be carried out in accordance with the Government’s standard procurement procedures acceptable to ADB.

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An imprest account, with a ceiling of $2.5 million, will be established, managed, replenished, and liquidated in accordance with ADB’s Loan Disbursement Handbook, January 2001, and with detailed arrangements agreed upon by the Government and ADB. The imprest account will be used to finance eligible small project expenditures.

Time Frame The Project will be implemented over 5 years, with completion

expected by 31 December 2009. Risks and Safeguards

Smooth sector development program implementation rests on the assumption that the Government will (i) maintain its commitment to carry out the reforms at the anticipated pace; (ii) provide counterpart funds and staff on time; (iii) ensure transparent, accessible, and reliable data for monitoring implementation of the state audit reform program; and (iv) administer the loans in an efficient and coordinated manner. Risks such as delayed implementation of policy actions and Project activities have been mitigated by a number of safeguards. Policy actions within the Program are linked with interventions of the Project and other ADB operations. Project activities have been phased realistically.

Technical Assistance

Two TA grants totaling $5 million will be provided by the Government of the Netherlands to support the PLMU and ILMU. Support of $1.3 million will help the PLMU ensure that the deliverables under the policy matrix are achieved. ILMU support of $3.7 million will enhance project monitoring and quality assurance reviews of investment loan activities.

I. THE PROPOSAL 1. I submit for your approval the following report and recommendation on proposed loans to the Republic of Indonesia for the State Audit Reform Sector Development Program (STARSDP), including (i) a program loan, (ii) a project loan, and (iii) proposed administration of technical assistance (TA) for program loan coordination and monitoring, and investment loan monitoring and quality assurance.

II. THE SECTOR: PERFORMANCE, PROBLEMS, AND OPPORTUNITIES

A. Sector Description and Performance

1. Macroeconomic Context

2. Indonesia has reached a critical juncture in its transition from a centralized authoritarian state to a decentralized democracy. The 2004 elections for the Parliament (DPR) and regional parliaments (DPRD) including the regional representative bodies, has proceeded smoothly. In July 2004, for the first time the country elected its President through direct vote, and a new government was in place by October 2004. Democratization is gradually maturing and the Government of Indonesia is now keen to maintain macroeconomic stability achieved, and consolidate the decentralization process so that benefits from democracy and decentralization are effectively shared by population at large. 3. Decentralization has presented a completely different domestic paradigm for macroeconomic management in Indonesia. The growth potential of the country is, among others, dependent on how regionalization impacts economic development. Under Laws 32 and 33 of 2004,1 which underpin decentralization, all functions other than foreign policy, defense, security, judiciary, monetary and fiscal matters, and religious affairs have been devolved to regional governments.2 Law 32 gives broad autonomy to the regions; with that authority goes resources. The regional share in government spending is soon likely to exceed 40%, a sharp contrast with the average 15% in the 1990s. Much of the Government apparatus has been transferred to the regional governments: 250 provincial offices of the central Government, 4,000 local offices, and more than 16,000 service facilities. The regional governments and legislatures are now responsible for a wide range of political, economic, and social development policies as well as exercising fiduciary controls. Their success will directly affect the lives and well being of more than 220 million citizens. This enormous transfer of resources and authority underscores the need to strengthen regional governance and capacities to ensure optimal use of resources. 4. The Government is determined to continue sound macroeconomic policies by introducing measures, among others, to strengthen the fiduciary aspects of public expenditure management (PEM). These measures are reflected in the medium-term planning document, (PROPENAS) 2000-2004. Consistent with this paper, the Government’s 2003 White Paper, which consolidates an ambitious agenda to achieve high and sustainable growth,3 recognizes the widespread concern about poor governance and weak fiduciary controls. The State Audit Reform Sector Development Program (STARSDP) will support these measures. 1 Law 32/2004 on Regional Autonomy was previously Law 22/1999 on Regional Government, and Law 33/2004 on

Fiscal Balance between the Central Government and the Regional Governments was previously Law 25/1999 on Fiscal Balance between the Center and the Regions.

2 Regional government refers to provincial and district governments, which are either regencies or cities. 3 The Presidential Instruction (Inpres No.5/2003) about the MOF paper, Economic Policy Package Pre and Post IMF

(better known as the White Paper), was issued on 15 September 2003 as a presidential instruction (Inpres No.5/2003) on 15 September 2003.

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5. The STARSDP is a major step in the long-term partnership between the Government and ADB. Building upon its collaboration experience, the STARSDP is an integral part of a cluster of programs being formulated by ADB to support aspects of budget formulation at decentralized levels; strengthen intergovernmental fiscal relations; and the controls and checks related to budget execution, financial management, and public oversight. This Program is in part the outcome of the intensive policy dialogue between ADB and the Government, which started in December 2002 and was maintained throughout the project preparatory technical assistance (TA), and the STARSDP preparation missions.4

2. Sector Description 6. Efficient and well-structured state audit institutions are integral to an effective and well-functioning accountability framework. As a critical check on public sector management, audit provides an independent, objective, and professionally conducted assessment on the veracity, accuracy, credibility, and reliability of information. State auditing arrangements need an external audit function (reporting to the legislature) and an internal audit function (reporting to the executive). The external audit function ensures full accountability to the citizens, and the external auditor of government is traditionally the country’s supreme audit institution (SAI)5. The internal audit function is integral to the internal control system under the executive and hence complements and facilitates external audit, which utilizes its findings.6 A schematic of the institutional arrangement is shown in Figure 1. 7. The Audit Board of the Republic of Indonesia (BPK), established by the 1945 Constitution, is the external auditor and Indonesia’s SAI.7. Throughout the world, modern governments depend on public accountability and rely heavily on their SAIs to ascertain that public funds are spent judiciously; that public programs achieve their intended goals; and that areas of waste, fraud, and inefficiency are identified and eliminated. SAIs has become important tools of good government and powerful agents of change. Following decentralization, the 2003 constitutional amendment stipulated BPK as the only external auditor of central and regional governments.8 8. For internal audit, at the central level the IG in each ministry reports directly to the minister.9 At the regional government level, regional internal audit agencies (BAWASDAs), formed as part of the implementation of Laws 32 and 33, report to the respective chief executive10. In addition, at the central level, there is also Badan Pengawasan Keuangan dan Pembangunan (BPKP), another internal audit institution established by Presidential Decree, and reporting directly to the President. B. Issues and Opportunities 9. Public sector audit institutions require a number of key attributes to make the audit sector efficient and effective. These include: a strong legal and institutional framework, 4 ADB. 2003. Preparing the Support to State Audit Reform Project. Manila (INO-TA 4107). 5 SAIs are the highest level of public sector audit in a country, and their role is often prescribed in law and the

constitution. The International Organization of Supreme Audit Institutions (INTOSAI) guides them. 6 In particular, INTOSAI recommends that SAIs assess and, where reliable, use the work of internal audit. 7 BPK is a member of INTOSAI and the Asian Organization of Supreme Audit Institutions (ASOSAI). 8 On 9 November 2001, Indonesia enacted the Third Amendment to its 1945 Constitution. Article 23 of the Third

Amendment refers to BPK as the external auditor of the Government. 9 Most nondepartmental government agencies maintain an internal audit function, and each state-owned enterprise

maintains an internal audit unit. 10 Under a recent decree issued by the State Ministry of Administrative Reform the BAWASDAs have been given the

option to change their name to Inspectorates in line with the central government ministries. (MenPAN decree B/2009/M.PAN/10/2004).

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adequate capacity in the institutions commensurate with their mandate, an efficient allocation of resources between the institutions, effective oversight by parliament and follow up by the executive, and full transparency of the audit process and its outputs11. A fully developed, well-functioning public audit system has strong external auditing capability, is constitutionally authorized to audit the accountability of all levels of government, and has equally strong internal audit capability complementing the external auditor’s. 10. While Indonesia has had experience with public sector auditing for several decades, the system suffers from a clear lack of accountability, as evident from issues surrounding the substance and quality of critical public sector institution audits. Domestically and internationally, Indonesia is regarded as burdened with widespread corruption12 and—notwithstanding democracy, growing transparency, and serious attempts to put together a firm accountability framework—the impact of that accountability remains weak. Corruption occurs at all levels of government, and is largely a symptom of the failure of accountability. Responsibility for this failure partly rests with the public audit sector function, which has been unable to deliver on its mandate. Weak accountability at the regional audit institution level severely hampers the effective implementation of decentralization. With a BPK that has weak capacity and limited presence, central departmental internal audit bodies (IGs) and regional internal audit bodies (BAWASDAs) that are generally weak, inexperienced regional executives and legislatures that cannot fulfill an oversight function, and the presence of another central government internal auditor (BPKP) with an overlapping mandate with the other internal audit institutions. Indonesia has an audit sector that is costly, ill structured, ineffective, and inefficient. A sector analysis is in Appendix 1, and a problem-and-constraint matrix in Appendix 2. 11. Unclear Legal and Institutional Framework. Traditionally, countries have a law recognizing the audit function as a core component of public expenditure accountability. The constitution and other laws elaborate the institutional role and organization of the SAI as the external auditor of government. In Indonesia, the audit function has until recently been defined only as part of an antiquated law concerning the overall PEM framework.13 For more than 30 years, the legal and regulatory framework governing BPK’s mandate and operations (Law 5/73) has remained unchanged, while the economic, political, and social environment has been altered dramatically. The law is not sufficiently strong for BPK to operate efficiently and effectively in a decentralized environment (Appendix 1, Table A1.2). 12. In general, executive decrees rather than laws regulate the internal audit function. Countries traditionally have, at the central level, internal audit in each ministry reporting to the minister, and at the regional level, a regional internal audit reporting to the regional executive. A less common alternative at the central level seen in countries with centralized authoritarian regimes is an internal auditor covering all ministries and reporting directly to the chief executive.14 In Indonesia, the institutional arrangement for internal audit is complex, as it has, at the central level, the IG, which is an internal auditor in each central government ministry, as well as a BPKP, which is a centralized internal auditor outside a ministry but reporting directly to the

11 These attributes are reflected in the Lima Declaration of Guidelines on Auditing Precepts, INTOSAI, IX INTOSAI

Congress, Lima, Peru, October 1977. Derived from the Lima Declaration, the Organisation for Economic Co-operation and Development (OECD) has, in cooperation with the European Commission, developed Public Management System Baselines for Good Governance, which were used as the basis of the assessment in the TA.

12 Partnership for Governance Reform in Indonesia released a national survey of corruption in December 2001: 75% of respondents felt corruption was very common in the public sector. In Transparency International’s 2003 corruption perception index, Indonesia ranked near the bottom alongside the most corrupt countries in the world.

13 Indische Compatibilitie Weit, enacted in 1925. The clauses were elaborated in the instruction and regulation for the General Court of Accounts 1933.

14 Most countries have the ministerial version, though a few countries have centralized arrangements, such as Argentina and Mongolia. Countries do not normally have both.

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President, as chief executive. BPKP has a physical presence in almost every province. BPKP’s role has thus sometimes been misconstrued as an external as well as an internal auditor. BPKP was the favored audit institution in the New Order administration, and a number of presidential decrees assign BPKP mandates overlapping directly with those of BPK and other internal audit agencies.15 Under an authoritarian and centralized government, such a lack of clarity provided control and flexibility to the central government, and allowed the audit process to be stalemated. 13. Democratization and decentralization, however, have strengthened central ministries and given independence to regional governments, emphasizing the roles of the respective internal audit institutions, IGs, and BAWASDAs, which now find their roles overlapping with those of BPKP in their audit universe. Consistent with the decentralization process, recent regulations and decrees have significantly reduced BPKP’s mandate to undertake central and regional audits (Appendix 1, Table A1.3). The central and regional governments therefore need to work together to clearly elucidate the institutional arrangement for internal audit, and stipulate further the mandates and responsibilities through the requisite regulations and decrees. BPKP clearly now needs a new role with an appropriate alignment of resources, particularly at the regional level, commensurate with its mandate. At the same time, the BAWASDAs and IGs need to have their position, structure, and responsibilities clarified through decrees and regulations across regional governments and central government departments, respectively. Doing so would allow for a clear institutional and regulatory framework for internal audit. 14. Inadequate Capacity, and Inefficient Allocation of Resources between the Institutions. Under the New Order, BPK was perceived a threat to the executive, and was deprived of the resources commensurate to its constitutional and legal mandate. Democratization and decentralization have expanded BPK’s audit mandate, and the 2001 Constitutional amendment requires BPK to have field presence in each province. The State Finance Law (Law 17/03), passed in March 2003, details the entities over which BPK has audit jurisdiction. In all, about 10,000 auditable entities are spread across the country, including Parliament, the Supreme Court, 70 Government departments and agencies, some 480 regional governments and as many regional parliaments, and approximately 8,500 central and regional state-owned enterprises.16 Notwithstanding some direct help from external funding agencies, BPK has an insufficient number of qualified auditing staff, particularly those required to carry out the various specialized audits now considered integral to effective auditing. BPK can audit only 12% of the entities from its estimated audit universe and, in particular, only 30% of the regional governments.17 A weak BPK, particularly one with little regional presence, leaves the public sector without an effective external auditor. BPK cannot meet the State Finances Law requirement that, by 2007, the financial accountability statements of some 480 regional governments have to be audited within 6 months of the end of the financial year. Given the significant resource transfers after decentralization, this weak fiduciary environment needs to be addressed urgently. 15. The ability of the central and regional governments to manage their internal control systems is severely hampered by weak and ineffective internal audit functions. This hinders the work of the external auditor, which traditionally judges, and relies on, an effective internal audit function to reduce the extent of its own audit. Under the New Order, BPKP was given significantly more resources compared to the IGs and BAWASDAs.

15 The New Order refers to the administration under President Soeharto. 16 BPK sources. 17 BPK’s own analysis as reflected in the project preparatory TA report.

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Government Boundary

MPR(People’s Assembly)

Supreme Court DPR(Parliament)

Minister

Echelon 1Echelon 1Echelon 1Echelon 1

Echelon 1Echelon 1Echelon 1Line Units

CentralGovernment

RegionalGovernment

Government Boundaries

Governor

Echelon 1Echelon 1Echelon 1Line Units

BAWASDA

Secretary

Bupati/Mayor

Echelon 1Echelon 1Echelon 1Line Units

Secretary

State Ministry for Administrative Reform

BPKP

President And

Vice President

DPD(Regional

Representative Assembly)

BPK(Supreme Audit)

Ministry of Home Affairs

Audit institutions Audit mandate Audit reporting Command Coordination

BAWASDA = Regional Internal Auditor; BPK = Audit Board of Indonesia; BPKP = Central Government Internal Auditor; MPR = People’s Assembly;DPD = Regional Representative Assembly; DPR = Parliament.

BAWASDA

Inspectorate General

Government Boundary

MPR(People’s Assembly)

Supreme Court DPR(Parliament)

Minister

Echelon 1Echelon 1Echelon 1Echelon 1Echelon 1Echelon 1Echelon 1Echelon 1

Echelon 1Echelon 1Echelon 1Line UnitsEchelon 1Echelon 1Echelon 1Line Units

CentralGovernment

RegionalGovernment

Government Boundaries

Governor

Echelon 1Echelon 1Echelon 1Line UnitsEchelon 1Echelon 1Echelon 1Line Units

BAWASDA

Secretary

Bupati/Mayor

Echelon 1Echelon 1Echelon 1Line UnitsEchelon 1Echelon 1Echelon 1Line Units

Secretary

State Ministry for Administrative Reform

BPKP

President And

Vice President

DPD(Regional

Representative Assembly)

BPK(Supreme Audit)

Ministry of Home Affairs

Audit institutions Audit mandate Audit reporting Command CoordinationAudit institutions Audit mandate Audit reporting Command Coordination

BAWASDA = Regional Internal Auditor; BPK = Audit Board of Indonesia; BPKP = Central Government Internal Auditor; MPR = People’s Assembly;DPD = Regional Representative Assembly; DPR = Parliament.

BAWASDA

Inspectorate General

Figure 1: Schematic Representation of the Audit Institutions in 2004

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16. Given their role in reporting to the executive, independence is always a problem for the IGs and BAWASDAs; but the more significant challenge is the inability to carry out financial and operational audits, as most staff members do not have an educational or professional background in accounting or auditing (only 38% of BAWASDA staff even have a degree), and turnover of qualified staff is high. The IGs and BAWASDAS thus have difficulty demonstrating their relevance. Table A1.5 (Appendix 1) summarizes a comprehensive survey undertaken by the TA of all the BAWASDAs, and clearly highlights capacity deficiencies in a number of areas. Similar issues were highlighted for the IGs through a sample study of six IGs. 17. In stark contrast to BPK and the IGs, BPKP has auditors who are more qualified (over 65% have a degree) and able to carry out financial and specialized audits. Notwithstanding its reduced mandate, BPKP is still by far the best funded and equipped of all the audit institutions. BPKP has about 6,700 staff members in 25 provincial offices, including an overseas office in Germany, compared to BPK’s 2,700 staff members in 7 regional offices. The fact that BPKP has carried out some audit work of the IGs and BAWASDAs reflects the mismatch between mandate and resources. More significant is that the BAWASDAs and IGs, given their increasing independence, now consider the this method of undertaking audit work as suboptimal, as they perceive a clear conflict of interest given that BPKP reports to the central executive and they report to the regional executive. 18. In summary, while BPK, IGs, and BAWASDAs can be strengthened notwithstanding BPKP’s resources, the general consensus is that efficiency within the public sector audit universe can be considerably enhanced by reallocating potentially redundant resources within the Government internal audit institutions to those audit institutions, internal or external, that can better utilize them.18. However, given BPKP’s 20-year existence, its size and geographical spread, such a transition should be gradual. 19. Ineffective Oversight by Parliament and Follow-up by the Executive. After an audit, the executive should follow up on the external auditor’s findings. This oversight function is normally performed by Parliament and regional parliaments, which receive the audit reports from the SAI. At the central level, the Parliament (DPR) reviews BPK’s reports. However, the members lack the specific background or training in financial management, and need technical support from a skilled secretariat similar to what prevails in other democracies. Studies indicate, however, that the Parliamentary secretariat staff has inadequate training, and needs to develop a better client-service ethos with members.19 Usage of secretariat services by the Parliament is low, dependency on short-term consulting support is great, and concerted measures to upgrade the supporting infrastructure are lacking. Consequently, BPK’s reports are considered as information only and are neither discussed nor followed up comprehensively. Parliamentary members point to the clear lack of experience and technical skills required to interpret the audit findings that are often hidden in voluminous reports. At the regional level, the lack of oversight by regional parliaments (DPRDs) is of particular concern, exacerbated by the fact that regional parliaments and their members are new to their responsibilities under a decentralized and democratic system. However, they have received no guidelines or technical support either from BPK or from a qualified secretariat on how to review such reports. Although oversight responsibilities are difficult to impose on a politicized legislature, the secretariats should be brought up to international standards of operations so they can provide analytic support. Interaction with BPK needs to be enhanced. 18 The Country Financial Accountability Assessment 2001 recognized this issue. The assessment was supported by

in-depth sector study undertaken by the ADB STAR project preparatory TA, where alternatives were presented for BPKP, and supported by the steering group of the project preparatory TA. Figure A1.1 (Appendix 1) shows the increased cost of the audit sector.

19 ADB’s sector study (February 2004) highlighted DPR issues. The findings were confirmed in the AusAID and World Bank review (April 2004) in which ADB participated.

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20. Lack of Transparency and Accountability in the Audit Process. The public has a critical role in ensuring accountability of the government and legislature.20 However, legislative and institutional barriers, together with the general lack of experience in transparency, have meant that the public, including civil society, has limited understanding of the role of the various audit institutions, the information that audit can provide, and the benefits of an efficient and effective audit function. Without this information, the public cannot demand accountability. Internal audit reports from BPKP, IGs, and BAWASDA s are not normally made public, and even BPK until recently did not disclose its reports to the public. Transparency in the institutions’ operations is weak. BPK has never been subject to an external audit and is going through its first peer review by the New Zealand Supreme Audit Institution.21 Internal audit has not been subject to peer review, and international exposure of internal audit staff is limited.

1. Government Strategy 21. The Government has a clear agenda to improve PEM’s fiduciary aspects (para. 4). Even before the 2003 White Paper, the Ministry of Finance (MOF) established, in 2000, the Financial Management Reform Committee to initiate and supervise a series of financial management reforms. The Government of Indonesia in 2001, introduced the state treasury, finance, and audit bills into Parliament, of which now have been enacted as Laws Given the long menu of items to tackle, the emphasis has primarily been on the issues covered by the state treasury and finance bills rather than the audit function. Because of the considerable support provided by the STARSDP project preparatory TA, and after substantial amendments to the original draft, the State Audit Law was recently approved.22 Other support to the audit institutions has been selective. BPK’s budget has been increased, BPKP’s mandate has been diminished through other laws and regulations, and Parliament is now considering a revised BPK law (Appendix 1). However, this has been in the absence of an overall framework or long-term vision, thus impacting on the economy, efficiency, and effectiveness of the audit sector. The STARSDP brings in a comprehensive program that addresses these concerns. 22. Studies such as the joint ADB–World Bank 2001 Country Financial Accountability Assessment and the ADB Country Governance Assessment have highlighted the poor capability of the audit sector. However, external assistance to the audit sector has been modest, intermittent, and directed to capacity building in individual institutions of the central Government in the absence of a policy framework to deal with a decentralized Indonesia. BAWASDAs have been given virtually no support. A summary of support by the international community to the audit sector is in Appendix 3.

2. Lessons Learned 23. Given the scarce number of projects directly focused on the audit sector, lessons learned have been drawn from a broad perspective of experiences in public sector management projects and from decentralization initiatives. The STARSDP’s design has benefited from the lessons learned:

(i) Government commitment and the pace of reform. The Government’s political commitment is critical for comprehensive reforms but, in a country that has democratized and decentralized almost simultaneously, the commitment must be consistent with the pace of reforms.

20 Asia Foundation. 2003. Indonesia Rapid Decentralization Appraisal, Third Report. Jakarta. 21 This is an exercise supported by the World Bank under its Audit Modernization Project for BPK. 22 The State Audit Law was approved on 19 June 2003.

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(ii) Holistic approach to the sector. Effective audit sector reform requires a

focused, holistic approach to the whole sector, rather than relying on the marginal impact of strengthening individual institutions, which excludes a legal and institutional framework, interdependence of the institutions, the important role of oversight, and public participation. In a decentralized environment, focus should not be just on the central Government if a sustainable reform agenda is to be properly defined. Regional governments need to be included as well.

(iii) Complementarity with other initiatives. Reforms in an area like financial

management in general and audit in particular should complement other initiatives. In Indonesia, which has adopted commendable but hastily implemented decentralization reforms, strengthening systems for the planning and budgeting and then also the accountability of expenditure need to go hand in hand to improve local governance.

(iv) Proper sequencing. Generating a sound sequence of reform measures is as

critical as the reforms themselves, particularly where capacity is weak and resources limited. Legal and regulatory reforms ought to precede institutional change, which has to happen before results are achieved. In the absence of a proper sequencing of reforms, particularly in financial management, audit and other public institutions have not been able to function efficiently.

(v) Complexity of a reform program. Given weak capacity to implement program

initiatives, the complexity of programs needs to be thoroughly examined to ensure that deliverables can be met.

(vi) Role of the public. In emerging economies, public sector accountability is

constrained by weak capacity of oversight institutions and lack of awareness of the public of the role of government institutions such as the audit institutions. Coming out of a centralized and an authoritarian regime, the Parliament and other public sector institutions are only now beginning to become transparent and accountable.

III. THE PROPOSED SECTOR DEVELOPMENT PROGRAM

A. Objectives and Scope 24. The goal of the STARSDP is to enhance governance, and the efficiency, economy, and effectiveness of public sector audit function through strengthened audit institutions operating to internationally generally accepted standards. The STARSDP pulls together various existing initiatives, together with new ones, to catalyze the Government’s PEM reform agenda holistically. Appendix 4 summarizes the STARSDP logical framework. 25. The STARSDP establishes the foundations for a strong audit sector through a mixture of policy and capacity-building initiatives. To leverage these reforms, the combination of policy-based and investment-lending support is considered appropriate and timely at the present stage of public expenditure reform. The STARSDP aims to support the strong commitment of the Government to accelerate policy and institutional changes in public sector audit functions; the high adjustment costs of, and compensatory measures for, reforms; and the high level of investments required to improve audit quality and expand audit coverage

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26. Program Loan. The objectives of the program loan are to (i) improve the policy and legal framework for state audit institutions, (ii) strengthen external and internal audit functions by providing adequate resources to institutions in line with their legal mandate, (iii) put in the policy measures to enhance accountability and oversight of the audit function at all levels of government, and (iv) put in strategies to increase public awareness of the benefits of a well-functioning state audit system and what it can deliver. The implementation of actions under the policy matrix will be carefully phased, reflecting the preferred gradual approach to change, and acknowledging the constraints and risks associated with implementing adjustment measures. The medium-term policy framework is in the development policy letter (Appendix 5), and the related set of policy actions are listed in the policy matrix (Appendix 6). 27. Investment Loan. The objectives of the project loan are to enhance the capability of the audit institutions by building upon past support and by introducing techniques and approaches that will allow the institutions to meet their immediate mandates by operating effectively and efficiently, and incorporating international best practices. Investment support is expected to; build a strong external auditor able to effectively operate at the national level, enhance the capability of the internal audit function and institutions, enhance the oversight capability of central and regional parliaments, and increase the public awareness of the audit function. B. Important Features 28. Ownership and Stakeholder Consensus on the STARSDP. The STARSDP reform agenda was formulated in partnership with an interagency steering committee chaired by BAPPENAS, which included key central Government departments such as the Ministry of Finance (MOF), the Ministry of Home Affairs (MOHA), and BAPPENAS, all the central and regional audit institutions as well as parliamentary secretariat staff. A key feature of ADB’s support was that at the start of the TA four fundamental principles were agreed upon by the steering committee, as criteria for resolving some contentious audit issues: (i) a clear delineation between internal and external audit institutions and functions, (ii) recognition and respect for the decentralization process, (iii) elimination of overlap in the mandates of the public sector audit institutions, and (iv) achievement of overall cost-efficiency. The ability to address reform issues can be credited to the upfront consensus on the above principles. 29. Consensus-building activities included not only the Government but also the other aid agencies. The STARSDP’s policy dialogue helped evolve, early on in the project preparatory TA, a common vision, amongst all stakeholders, on the policy agenda, and a focus of the capacity building issues. The holistic approach was extensively discussed as a part of the coordination with external funding agencies, and a number of these agencies have shown interest in cofinancing the capacity-building measures, particularly at the decentralized level. 30. Modality of Assistance. The STARSDP introduces a new approach to the sound development of the audit function by advocating the simultaneous packaging of policy reforms and the investment component, initially on a pilot basis to assess their efficacy, and then modified before promulgation. Wherever possible, on issues such as audit standards, a national perspective is taken without allowing for regional versions; in areas such as the local regulations for internal audit, national consistency is supported, with some limited regional flexibility, economies of scale are encouraged through the use of umbrella procurement contracts; and capacity-building activities are tailored to institutional development plans, so that the specific needs of the institutions can be supported. 31. Public Accountability of the Audit System. The Program recognizes clearly that the sustainability of the reform agenda depends on the close interrelationship between demand and supply on the audit sector’s outputs. While the audit sector institutions can be provided with an

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adequate legal and institutional framework, and capacity to deliver, the accountability framework requires other partners such as parliamentary bodies, the executive, the judiciary, and, most important, the public, to be equally effective players. The key beneficiaries must be in a position to appreciate any deficiencies, demand appropriate action, and further refine the responsiveness of the sector to society’s needs. This forms the basis of a solid partnership that can allow institutions to develop together and respond to each other’s changing requirements. 32. Selection Criteria for Regional Governments. The following principles will be used to select regional governments for capacity building support: (i) selectivity and open competition, to ensure that districts committed to good governance are chosen; based on specific actions undertaken (ii) strong support from the heads of the regions and the Bawasdas, as demonstrated through the submission of a letter of interest expressing the region’s interest to participate in the Program; (iii) lack of adequate human resource and infrastructure capacity to conduct effective audit 33. Public-Private Partnership Development for Public Sector Audit. Public-private sector partnerships are encouraged where appropriate and mutually beneficial. They will enhance quality assurance by exposing public sector institutions to the latest auditing techniques, and allow the sector to increase its qualified auditing personnel. Partnerships will encourage private sector firms to compete for audit work as well as build the firms’ capacity. C. The Program Loan

1. Components and Outputs 34. The program loan will involve the following: (i) rationalization of the policy, legal, and regulatory framework for state audit institutions; (ii) alignment and provision of resources to enable audit institutions to fulfill their mandate; (iii) enhanced oversight of audit recommendations and of the central and regional audit function; (iv) and enhanced transparency and public awareness of the central and regional state audit function. 35. Key outputs of the program loan are (i) submissions of audit laws that will define the role of audit in public sector financial management, and the organization and structure of the external auditor; (ii) submissions of draft central and regional government regulations and presidential decrees to reorganize internal audit institutions; (iii) realignment and efficiency in budgetary resource use; (iv) a BPK regulation on adopting international auditing standards; (v) regulation on certification for internal auditors based on international standards; (vi) a clear vision statement for BPK as the SAI; (vii) Parliament and regional parliament (DPR and DPRDs) action plans to strengthen technical support to central and regional parliaments to carry out their oversight function; and (viii) the adoption of a public awareness strategy for audit at central and regional levels.

a. Rationalization of the Policy, Legal, and Regulatory Frameworks for State Audit Institutions

36. Strengthening Regulatory Framework for External Audit. As part of the modernization of the legal framework for PEM, the Government in 2000 introduced bills on state finance, treasury, and audit to replace the century-old Dutch colonial laws. At the same time, following the 2002 constitutional amendment that expanded BPK’s role, Parliament, through its Commission IX, reviewed and revised the BPK Law (Law 5/73) to clarify BPK’s roles and

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responsibilities and take into account the impact of decentralization23. The TA identified deficiencies in the state audit and the BPK bills, and has underscored with the Government and BPK that these laws need to be in line with international best practices. As part of the STARSDP, the Government submitted amendments to the earlier draft state audit bill in early 2004. The State Audit Law was recently approved on 19 June 2004, and enacted in July 2004. 37. Under the Program, BPK will submit, through the Government, to Parliament amendments to the draft BPK bill. The agreed amendments were discussed in detail with the project preparatory TA team, which provided inputs based on international best practice. Among others, these amendments relate to the scope of BPK’s authority; use of auditing standards that are compatible and reconcilable to international standards; indemnity from court actions of SAI staff to include all relevant SAI staff; minimum relevant qualification criteria for Board candidates, appointment of Board members by Parliament; and length of tenure of the Board or Board members that should not end coinciding with an election year. To settle any duplication or overlaps in the mandates, BPK will review clauses in existing laws, regulations, and decrees concerning the audit function and will submit to Parliament and the Government a report on inconsistencies and conflicts with the state audit and proposed BPK laws. After these issues are resolved, the Government will review this report as the basis for nullifying the conflicting clauses. 38. Strengthen Internal Control Systems, including Realignment of Internal Audit Institutions. Consistent with the Treasury Law, the Government will establish the institutional framework for internal audit, and clarify the position of the IGs and BAWASDA s. An interministerial committee (IMC), made up of representative branches of the Government, will be established to review the internal control systems and review and clarify the role of the internal audit institutions. The IMC will review the role of all internal audit institutions to avoid overlap and increase cost-efficiency, focusing on the more effective internal audit function in the regional level and, in parallel, the need to expand BPK’s physical presence in the regions. The IMC will draft a Government regulation on internal control systems, and recommend a presidential decree on aspects of the internal control systems, including the role of internal audit institutions. An institutional development plan (IDP) will be developed for the restructured BPKP, to define its new role. Resources may be redeployed to other audit institutions, particularly BPK regional offices. 39. To enhance the role of IGs and to mainstream the internal audit function into ministry or department operations, an MOF circular will be promulgated for all line ministries to ensure that all IGs review the annual statements of accountability produced by the departments. As a first step to improve aid effectiveness, the MOF-IG will review all annual and midterm project accountability statements of ADB projects.24 The IG reports on ADB projects will be submitted to BPK and ADB. Along the same lines and consistent with the State Finances Law, MOF will adopt an IDP for effective internal financial management, including clear definition of the position of chief financial officer. This IDP is to be drafted as a model for other line ministries to adopt.

23 New laws can be originated either by the Government or by the legislature. All laws are passed by consensus

between the two after discussion. The state audit bill was an initiative of MOF, whereas the BPK bill was initiated in Parliament, with the support of BPK. Commission IX is one of several parliamentary committees established for oversight of and communication with government agencies. The portfolio of agencies reviewed by the commission includes, among others, BPKP, MOF, and BAPPENAS. Commission IX and BPK have a formal process of communication based on a written agreement

24 Once the results of the ADB project audit reviews by the IGs are shared, other members of the lending community are expected to want their projects audited similarly.

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40. The central Government will, through MOHA, help local governments clarify the roles and responsibilities of the BAWASDA s. In addition, MOF will undertake a similar activity with respect to the local chief financial officer. The chief financial officer is responsible for producing the accountability statements of the regional government for BPK to audit, and is thus an important part of the internal control systems. To ensure national consistency in these standards, MOHA will establish an intergovernmental team to draft model regional regulations (Perda or SK) to be adopted by the BAWASDAs. The regulations will, amongst others, require BAWASDAs to review regional governments’ accountability statements. The team will include representatives from the BAWASDAs, academia, professional audit bodies, and BPK. MOHA will disseminate the draft nationwide as the basis for formal adoption by the regional governments, and will track its adoption. About 50 regional governments will be targeted, based on selection criteria (Appendix 14) that allow for selectivity and competition among regional governments willing to be part of the reform program. 41. Public Sector Standards on Auditing and Certification Established. The STARSDP promotes the establishment of external and internal public sector auditing standards. BPK has traditionally tried to follow INTOSAI standards whereas internal audit, through BPKP, has followed, at varying times, the United States General Accounting Office (GAO) and the Australian Auditing Standards. Under the Program, external audit standards drafted by the SAI (BPK), and consistent with international standards will be introduced. BPK will take responsibility for this exercise by involving representatives from the government, professional audit organizations, and academia to establish these standards. BPK will replace the existing standards through a BPK Board resolution. The internal audit standards will be introduced through the IMC draft regulation on internal control systems. 42. MOF-IG will coordinate with selected IGs, BKN, BPKP, BPK officials and BAWASDAs to (a) review the recommendations of the IMC concerning the certification procedures of internal auditors and (b) draft the necessary revisions or a new Presidential decree which adopts the recommendations regarding certification of internal auditors25 and submit the draft to the State Secretariat.

b. Alignment and Provision of Resources to Enable Audit Institutions to Fulfill their Mandate

43. The STARSDP emphasizes the need for the efficient use of national resources dedicated to audit, consistent with the mandates of the various audit institutions and the supportive rules and regulations. The efficient allocation of resources requires effective planning and prioritization. Given BPK’s mandate to audit several thousand institutions and government programs at the central and regional levels of government, an institutional development plan (IDP) will be developed. The plan will clearly define BPK’s audit universe. This plan will be made public and thus form the basis of BPK’s annual budget submission and its resource allocation. BPK needs to take a risk-based approach in deciding which entities must be audited every year, which audited by outside firms, and which audited only periodically. This will strengthen BPK’s basis for annual budget allocation irrespective of changes in the administration. MOF has agreed to support and act upon the annual budgetary allocation to reflect and effect the necessary changes. Of particular importance are the extra-budgetary resources required for BPK to expand its presence in the regions. BPK will incorporate the findings of the IMC on internal control systems and, as an interim measure, will request supplementary funding to be able to carry out the 2006 deadline audit of all regional governments. As part of BPK’s long-term

25 This will give certification authority to a body outside the internal audit function as decided by the IMC, with the

certification to be in line with international certification standards such as those provided by the Institute of Internal Auditors.

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quality assurance program, to ensure cost-efficiency, and to encourage public private partnerships, BPK has agreed that a percentage of its audit work should regularly be carried out by private sector auditing firms. A BPK regulation will be passed to enable such contracting out. 44. The Program will review the effectiveness and relevance of the financial management training at the various training centers.26 MOF will establish a team of relevant stakeholders to review the existing training, of financial management and auditing staff for the public sector. This assessment will identify measures to improve the effectiveness and relevance of the various programs, and the opportunities for economies of scale in the use of the physical assets.

c. Enhanced Oversight on Audit Recommendations, and Increased Accountability of the Audit Function Nationwide.

45. The STARSDP supports strengthening of oversight of audit institutions in a number of ways. For the external audit function, a Parliament secretariat committee will be established in the DPR, comprising the elected DPR members (where possible), members of the secretariat, and BPK staff members. The committee will review the capabilities of the secretariat, the interaction with parliamentary members and BPK, and the follow-up on BPK’s audit reports. Based on the review, DPR will prepare and adopt an action plan, which the ADB project investment component will support. The long-term aim is to foster a closer working relationship between the secretariat, members of parliament, and BPK. The audit committee will be a possible precursor to a public accounts committee, which exists in other democracies. BPK will harness the benefits of information technology (IT) to give the DPR access to a select part of BPK’s management information system that contains the BPK reports and the follow-up actions. Regionally, the MOHA-IG will initiate a similar DPRD secretariat committee in 50 selected regional governments (para. 40) made up of BPK, and members of the executive. The action plan adopted will be the basis of further ADB’s investment support. 46. Under the Program, BPK will be subject to an annual financial audit. An operational review, by a Parliament-appointed external SAI, will be conducted every 5 years. BPK will audit internal audit institutions as part of its normal audit function, and will periodically review internal audit at the central and regional levels. An overseas IG performing a similar function, with a report issued to the finance minister, BPK, and ADB, will also undertake a peer review of the MOF-IG. This is to be the basis of similar peer reviews by other ministries. The MOHA-IG will organize a peer review of selected regional governments.

d. Enhanced Transparency and Public Awareness of the State Audit Function at the Central and Regional Levels

47. The audit sector will remain relevant to public sector accountability only through public interest and involvement. The community needs to understand the audit function and to work in a partnership to ensure that the follow-up actions occur. The community is a rich source of information on issues such as corruption. Under the Program, BPK will develop a model program for public awareness, with inputs provided from academics, private sector, media, NGOs, and professional accounting associations. The primary objective will be to enhance public awareness of the roles and responsibilities of the public sector audit institutions and to understand the audit reports issued. This model program will be the basis of further action to trial with 50 selected regional administrations (para. 40) a public awareness campaign on the role of external and internal audit using BPK’s model program. 26 Sekolah Tinggi Akutansi Negara, a college of state accounting, BPK, BPKP, and IGs.

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48. BPK will seek expert assistance to design a format for “public-friendly” reports that clearly identify the issues, and the follow-up actions required. These formats will be tested on a pilot basis through newspapers in selected regions for a range of reports. Public hearings will obtain feedback from, among others, individuals, the private sector, NGOs, and the media. Pilot results will be published on the BPK Web site and submitted to DPR, DPRDs, selected NGOs, and the media. 49. To obtain feedback on the audit sector, the BPK board will fund a series of annual surveys to assess the public’s understanding of the public sector audit role. The reports will be submitted to DPR and DPRDs and published on the BPK Web site with the first survey results published in December 2005. These will establish the baseline for future surveys.

2. Financing Plan 50. It is proposed that ADB support the Government’s state audit reform program by providing a loan of $200 million from its ordinary capital resources. The Borrower will be the Republic of Indonesia. The loan will have an amortization period of 15 years, including a grace period of 3 years, with interest to be determined in accordance with ADB’s London interbank offered rate (LIBOR)-based loan facility, and such other terms and conditions as are substantially in accordance with those set forth in the Loan Agreement presented to the Board. The loan is expected to be utilized over 3 years and will be disbursed in two tranches of $100 million each. 51. Factors considered in determining the amount of the program loan are (i) the magnitude of the audit sector (in public spending and number of civil servants) and the impact of decentralization; (ii) the scope and strength of the reform package in the audit sector, particularly the acceleration of reforms in the past few years; and (iii) the estimated short- and medium-term adjustment costs of the reforms. 52. The loan amount is in line with the adjustment costs of the measures included in the policy matrix during the program period and not yet initiated by the Government. The breakdown of the estimated adjustment costs of the principal policy measures comprises BPK’s regional expansion from 7 to 33 provinces ($105.1 million); salary increases, allowances, and incentive schemes for reallocation of staff between institutions ($33.7 million); provision for the use of external auditors as an interim measure ($40.3 million); adoption and enforcement of national auditing standards ($10.3 million); establishment of regional networks ($5.0 million); national certification for internal auditors ($6.5 million); rationalization costs for the various audit training institutions ($18.5 million); and nationwide dissemination of draft local regulations ($15.0 million). The Government is anticipated to incur significant additional costs for leveraging reforms, including passage of laws and regulations, research, studies, and consultations related to the legal and institutional restructuring, audit quality monitoring, and audit report evaluation.

3. Implementation Arrangements 53. Program Management. MOF will be the Executing Agency of the program loan. MOF will initiate withdrawals under the loan, and allocate and monitor the use of counterpart funds. A program loan-monitoring unit (PLMU) will be established in the Directorate of Information and Accounting in MOF. This directorate will establish an interagency steering committee (ISC) made up of echelon-1 staff members from each component implementing unit to oversee the implementation of the program components and to facilitate interagency coordination. The ISC will comprise representatives of BPK, DPR secretariat, MOHA, BPKP, and MenPAN. The STARSDP coordination unit, established by MOF and BAPPENAS, will coordinate between the PLMU and ILMU. The overall STARSDP management structure is depicted in Appendix 7.

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54. Procurement and Disbursement. The loan proceeds will be used to finance the foreign exchange costs of items produced in and procured from ADB’s member countries. The loan will not finance items specified in Appendix 8, or imports financed by other bilateral and multilateral sources. Disbursement of loan proceeds will be permitted based on a certification provided by the Borrower. Procurement of eligible items financed under the program loan will be carried out in accordance with standard public sector procedures of the Government or normal private sector commercial practices acceptable to ADB. The proceeds of the loan will be withdrawn in accordance with ADB’s standard disbursement procedures. Before submitting the first application to ADB for withdrawal from the loan account, the Borrower will open a deposit account at Bank Indonesia or another bank acceptable to ADB, into which all withdrawals from the loan account will be deposited. 55. Monitoring and Tranching. Throughout implementation, the ISC, STARSDP coordinating unit, and PLMU will monitor quarterly the implementation of policy and institutional reforms envisaged under the STARSDP. In cooperation with the PLMU, ADB will carry out semiannual review missions to assess implementation of the policy agenda and discuss major policy developments with the ISC and concerned agencies. Such missions will be fielded to assess whether conditions for the release of the second loan tranche have been fulfilled. 56. The first tranche will be released upon loan effectiveness, expected in December 2004. The second tranche is expected to be released by June 2006 (or about 18 months after the first tranche). To obtain the release of the loan tranches, the Government will be required to carry out actions identified in the policy matrix as conditions for tranche release, and to demonstrate satisfactory progress in implementing other actions listed and in the overall Program. 57. Accounting, Auditing, and Reporting. Separate accounts and records with respect to the deposit account will be maintained in accordance with consistently maintained sound accounting principles. Upon ADB’s request, the Borrower will have the deposit account audited by independent auditors in accordance with appropriate auditing standards. Promptly after their preparation, certified copies of such audited accounts and records will be furnished to ADB. 58. The Government will use the counterpart funds generated from the loan proceeds to finance the costs of implementing the state audit reform program under the STARSDP. The PLMU will prepare and submit to ADB and the ISC, within 21 days after the quarter, quarterly progress reports in a format acceptable to ADB. The reports will analyze institutional and legal developments in the audit sector as well as the evolution of key indicators, emphasizing areas and measures outlined in the policy matrix. At the end of the Program, the PLMU will submit the completion report to ADB within three months of physical completion of the program loan conditions. D. The Project Loan

1. Components and Outputs 59. The investment project of the STARSDP comprises five main components: (i) establishment of sector development project management in the form of an Investment Loan Monitoring Unit (ILMU) in BAPPENAS, which will be the Executing Agency for the investment component; (ii) introduction of new systems and practices for effective external audit; (iii) institutional enhancement and repositioning through new regulatory structures and practices for effective internal audit covering, as applicable, the inspectorate generals (IGs), BAWASDAs, and BPKP; (iv) assistance to a professional formal education and nonformal certification

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program for internal auditors; and (v) introduction of new practices for parliamentary oversight of public sector audit. The major activities under each component are listed below. 60. Establishment of an Investment Loan Monitoring Unit. This component will support the implementation arrangements detailed below. In particular, expert staff will be provided for project accounting and reporting, procurement, project monitoring, and financial management. This unit will be headed by an senior staff member, who will be given funds to consolidate quarterly reporting from the component implementation unit (CIUs) of the investment component, complete midterm reviews, carry out surveys, hire external auditors for annual audits, and prepare the project completion report. 61. Introduction New Systems and Practices for Effective External Audit. The key activities will be to establish a component implementation management unit in BPK, develop new systems and work procedures consistent with an enhanced legal and regulatory framework, develop a strategic approach for human resource management, implement a staff development program, introduce a new strategic approach for information resources management, pilot new audit procedures for selected audits, and develop a program for public awareness and support for effective audit. 62. Establishing new systems and work procedures will include helping the new BPK board learn through a study tour how other SAIs operate; help BPK develop a new approach to audit planning and management, including how to manage the decentralized offices; develop a revised code of ethics in line with international standards; train BPK in the rudiments of risk-based auditing procedures; help develop and train staff in specialized audits such as performance, IT, military, and forensic audits; develop techniques for introducing recommended actions for audit findings into audit reports; and develop new techniques for presenting audit reports. When new techniques are introduced, current conditions will be analyzed, new procedures piloted, and a workshop held to validate the experiences before these are incorporated into procedures and manuals. 63. A strategic human resource development plan will provide new audit manuals, guidelines, and training programs to introduce the new procedures to BPK staff as well as career development plans. Staff members will be selected to undertake specialized certification overseas or in Indonesia to obtain the necessary internationally recognized certification such as IT, forensic, military, and commercial and central bank audits. Staff members will be sent on selected secondment in comparable SAIs to acquire practical experience in a number of areas. About 200 BPK staff members will benefit from certification and secondment experience. 64. IT management will establish an IT policy for acquisition, support, replacement, and asset management. Recognizing that the considerable capital investment in IT systems that BPK requires will need to be managed, the policy will include a disaster recovery plan, and a system for electronic archiving of audit files and reports. To provide a basis for further use of IT, pilots will be undertaken on the use of videoconferencing, distance-learning techniques, and the use of electronic tools for audit team management. Computers will be provided to staff members in a staged manner so they can use IT-based audit techniques, onsite and offsite, in field locations. 65. The new techniques will be piloted through supervised applications on selected audits to test their practical applicability and the usefulness of the manuals, and will be revised where necessary. This piloting is essential as it will mainstream techniques adopted into the standard work program, and avoid the risk that the development of new techniques and manuals will simply be a theoretical exercise. Peer reviews will be funded during the component’s implementation to assess the Project’s progress.

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66. The model public relations program will be developed through workshops to develop models for the use of print, television, and radio media, and through pilot studies to publicize BPK reports and post the reports on the Internet, thus raising public awareness. 67. Introduction of New Regulatory Structures and Practices for Effective Internal Audit. BAWASDA support will be coordinated through the MOHA-IG, where a CIU will be established. Under Articles 6 and 9 of Government Regulation 20/01, MOHA is responsible for coordinating regional governments and fostering their development. The MOHA-IG CIU will coordinate the work, and facilitate the development, of the BAWASDAs through implementing units established in each BAWASDA and staffed by secondment from the BAWASDA. The implementing unit in turn will work with a regional government committee made up of members of the BAWASDA, the regional chief executive, and members of the implementing unit The BAWASDA function in approximately 50 regional governments will be supported under this project. Eligibility criteria for selecting districts and provinces to be supported are in Appendix 14. 68. This component will also support the development of the draft regulations (SKs /PERDAs) for the BAWASDA function. In addition, this component will develop a model IDP that will help the BAWASDAs assess themselves and establish a long-term perspective on their capacity needs. The draft SK, PERDAs, and IDP will be disseminated nationwide through the existing BPK regional centers as templates for all regional government. The CIU will develop a database to track the adoption of the regulations. The adoption of the regulations and IDP will be supported, as a pilot project, in initially 16 regional governments that are willing to adopt the regulations. The lessons learned will then be used by the other 34 regional governments supported by the project. 69. Lump-sum capacity building grants, disbursed in two or three installments, of up to a total of $115,000 for each BAWASDA will be allocated to help regional governments strengthen the BAWASDA function. Conditions for disbursement of the first installment will be a Letter of Readiness signed by the Bupati and verified by the MOHA IG CIU confirming that the following has been undertaken, (i) adoption of the local regulation (SK or PERDA) on the BAWASDA function, (ii) completion of an IDP drawn up by the MOHA-IG implementing unit and approved by a regional government committee, on the utilization of the lump sum grants, (iii) the signing of an implementation agreement between the chief executive and the MOHA -IG implementation unit and (iv) confirmation that counterpart funds and facilities have been provided by the local government chief executive. The first installment request cannot exceed 50% of the total grant allocation. In addition, the second and third installments will be released on receipt of an unqualified annual audit report from the STARSDP auditor, and the commitment of at least 70% of the previous installments. An additional requirement of the second installment will be the MOU required for the scholarship component as detailed in para. 72 below. Only 20% of the total value of this lump sum can be used to purchase equipment. Additional lump sums will be given to provide educational and certification support for the BAWASDAs through local education providers. These scholarships are detailed below in the formal education and nonformal certification component. Finally, the BAWASDAs will be supported through the development of standardized work procedures and manuals, which will be disseminated nationwide and adopted through the utilization of the capacity building grants. 70. The IG function (approximately 16 ministries have been identified) will be similarly supported through establishment of a CIU in the MOF-IG. Key activities will be to develop new financial audit work procedures consistent with the IG mandate, develop risk-based audit procedures; develop specialized auditing techniques, pilot the use of peer reviews, develop

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relevant audit manuals and guidelines, and provide computer equipment to each IG.27 Educational and certification support for IG staff will be provided through local universities, as detailed below in the professional education and certification component. 71. BPKP will be supported to develop an IDP reflecting its new mandate. Guidelines and manuals will be developed, and computer hardware and software provided. 72. Designing a Professional Formal Education and Nonformal Certification Program for Internal Auditors. This component will be implemented through the Ministry of Education IG for the formal education program and, the training center in MOF (BPPK), for nonformal education courses. This component’s key output will be to design education and certification courses that IG internal audit staff and BAWASDA staff can take, on scholarship, and cost-effectively at local educational institutions. This component recognizes the need to use the existing local education infrastructure; the fact that BAWASDA staff need education ranging, from a tertiary degree to specialized audit and accounting certification; the need for courses to be affordable and sustainable beyond the project; and the fact that IG and BAWASDA staff cannot be away from their positions for long. The key activities will be a review of the current education and certification programs for government sector accounting and auditing, development of new curricula for public sector accounting and auditing that can be mainstreamed into existing degree and certification courses, development of non-formal vocational education courses, promulgation of courses to various educational establishments, establishment of mechanisms to select the institutions to deliver education support as well as eligible candidates to receive the support. 73. Lump-sum scholarships (up to $50,000 for each of the 50 BAWASDAs, and up to $100,000 for each of the 16 IGs) will be allocated to the local universities providing the courses. Once the suite of appropriate courses is developed, eligible regional universities, as identified by the Ministry of Education, will be requested to present a plan, developed with the local governments and IGs, that will indicate how the courses can be used by the local governments and IGs. This will result eventually in an implementation MOU between the university and the local government/IG. These scholarship plans will include details of the courses to be provided, indicative number of students, student eligibility criteria and the costing, and tracking and reporting methodology on the scholarships provided. No funds will be given directly to the IG or BAWASDA for this component, as money will be transferred directly through direct payment to the university. For each participating Bawasda the university will open a separate bank account to receive the scholarship funds. Each IG and BAWASDA will be required to certify that 80% of staff benefiting from this support are existing staff of the internal audit function, and have been working in that capacity for the prior two years. Up to 20% of the training costs can be allocated to staff from outside the internal audit function if the courses are certified relevant for the job function. All courses have to be completed within the STARSDP project period. A schematic diagram of how this component will operate is in Supplementary Appendix F. The objective is to build a strong base of individuals qualified in various aspects of financial management. 74. Introduction of New Practices for Parliamentary Oversight of Public Sector Audit. This component will enhance the capability of the Parliament and regional parliaments’ secretariats to help parliamentary members perform their oversight function effectively. Parliament support will be coordinated through the Parliament secretariat, and regional parliament support, through the MOF-IG. MOUs will be established between the Parliament secretariat and BPK, and between the regional parliament secretariats and BPK. This

27 Reference will be made to the audit manual prepared under an ADB TA. ADB 2004. Strengthening the Capacity of

Ministry for Settlements and Regional Infrastructure to Control Fraud and Corruption. Manila (INO-3842-INO).

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component will be undertaken in a consultative manner involving the Parliament and regional parliament secretariat staff, BPK, and select Parliament and regional parliament members.28 75. For DPR support, the three main components will be the establishment of the CIU, development of a plan for the submission of BPK audit findings and recommendations to DPR members, and development of client-friendly audit reporting formats for a range of BPK audits. The intention is to develop intelligible summarized audit reporting formats that can be readily used and understood by the Parliament’s committees, thus ensuring that appropriate follow-up action is agreed on and actions monitored. These reports will be published in the Parliament and BPK Web site. 76. For the regional parliament secretariats, a similar approach will be taken. A plan will be developed for the secretariats for the submission of BPK audit findings and recommendations to DPRD members, and BPK findings will be produced in short reports for regional parliament members. Regional parliament secretariats in 50 eligible local governments (based on BAWASDA selection criteria) will receive up to $30,000 each to build capacity to help regional parliament members understand and identify the appropriate follow-up action to BPK’s audit reports. The MOHA-IG will be helped to deploy the model public relations and awareness program developed under the BPK component. This program will disseminate information regionally on the role of internal and external audit and include the publication of BPK audit reports in local media.

2. Financing Plan 77. The total project cost is estimated at $42.7 million, consisting of $11.5 million (26.9%) in foreign exchange cost and $31.2 million (73.1%) equivalent in local currency cost. Table 1 summarizes the indicative financing plan for the Project, and Table 2, the cost estimates. 78. It is proposed that ADB provide a loan of in various currencies equivalent to Special Drawing Rights 16,680,000 to the Republic of Indonesia from the Asian Development Fund (ADF). The Government has requested grant cofinancing from the Government of the Netherlands for $5 million. The ADB loan will have an amortization period of 32 years, including a grace period of 8 years, with interest, and such other terms and conditions as are substantially in accordance with those set forth in the Loan Agreement presented to the Board. ADB and the Government of the Netherlands will finance around 70.0% of the Project, including 100.0% of the foreign exchange cost and 54.7% of the local currency cost. Details of the cost estimates and financing plan are in Appendix 9.

3. Implementation Arrangements 79. The Project will be implemented over 5 years. An annual project implementation schedule is in Appendix 10. It is proposed that BAPPENAS be the Executing Agency for the investment Project, and that this component supports an ILMU. In addition to having full-time local staff for project management, financial management accounting and procurement, and translation, the unit will be given external consultants in procurement and financial management, who will establish the project performance monitoring system (PPMS). The component will support the midterm review, annual project audits, and surveys. 80. An ILMU will be established in BAPPENAS to coordinate a number of CIUs established in each agency implementing all or part of a component. The CIUs are detailed in Table 3. 28 The project team has worked closely with the Technical Assistance Monitoring Facility of Australian Aid Agency

(AusAid).

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BAPPENAS will establish an interagency project steering committee (ISC) made up of echelon-1 staff from each CIU to oversee component implementation and to facilitate interagency coordination.

Table 1: Financing Plan ($ ‘000)

ADB=Asian Development Bank, ADF=Asian Development Fund. Sources: ADB. 2003. Preparing the Support to State Audit Reform Project. Manila (INO-TA 4107).

4. Procurement and Disbursement 81. Consultant Services. The project will provide 96 person-months of international and 902 person-months of domestic consulting services (Supplementary Appendix C). The international and domestic consultants will be engaged through consulting firms in accordance with ADB’s Guidelines on the Use of Consultants and other arrangements satisfactory to ADB. The procurement unit under the ILMU in BAPPENAS will be responsible for all the administrative requirements for procurement. All master contracts will be maintained by the ILMU. Procurement committees will be established for each procurement package and chaired by the project manager of the CIU to which the package belongs. The outline terms of reference are in Supplementary Appendix A. 82. Computer Equipment. The Project will finance the computer hardware and related IT equipment required. Goods financed under the ADB loan will be procured in accordance with ADB’s guidelines for procurement. Items of similar type will be grouped together as far as possible to permit bulk procurement and to encourage international competitive bidding. Prior ADB approval of lists and specifications of equipment will be required. All computers and related IT equipment will be procured under an umbrella procurement contract negotiated by the ILMU under international competitive bidding. The ILMU will notify the details of the umbrella contract to the respective CIU, which will ensure that all computer equipment is purchased using the contract. Deliveries will be made directly to the beneficiary, who will acknowledge receipt of the items. BPK, IG, DPR, and BPKP payments to the contractor will be by direct payment from ADB. For equipment purchased by the local governments and DPRD, payments will be made directly from lump-sum contributions (para. 73 and para.74). 83. Disbursement Arrangements. To facilitate project implementation, BAPPENAS will channel part of the loan proceeds into an imprest account to finance eligible small expenditures. The imprest account will be solely for the Project’s purposes and will be established at the Bank Indonesia (BI). The imprest account will be established, managed, replenished, and liquidated in accordance with the ADB’s Loan Disbursement Handbook, January 2001, and with detailed arrangements agreed upon by the Government and ADB. The ceiling of the imprest account will be $2.5 million. The SOE procedure will not be used, and all replenishment will be fully substantiated.

Item Foreign Local Total Percent

ADB-ADF 7,905.6 17,095.2 25,000.8 58.5 Cofinanced 3,585.9 1,415.4 5,001.3 11.7 Regional Government 0.0 4,224.7 4,224.7 9.9 Central Government 0.0 8,503.6 8,503.6 19.9 Total 11,491.6 31,238.9 42,730.4 100.0

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Table 2: Cost Estimates by Project Component ($ ‘000)

BPK=Audit Board of Indonesia, BPKP= central government internal auditor, BPPK= MOF training institute, DPR=Parliament, DPRD=Regional Parliament, MOHA=Ministry of Home Affairs, IG= Inspectorate General, MONE= Ministry of National Education a Taxes are at an average of 10% on selected materials, equipment. b At 3% for materials, equipment. c At 1.0% for foreign exchange costs for each year of the Project, based on projections for the MUV index for

inflation in US dollar terms and at 6.2% per year for local currency costs. d For funds from ADB’s Special Resources interest at 1% during project implementation. Source :ADB. 2003. Preparing the Support to State Audit Reform Project. Manila (INO-TA 4107).

5. Project Performance Monitoring and Evaluation 84. Reports, Accounts, and Auditing. The Government will ensure the maintenance of records and accounts to adequately identify goods and services financed from the loan proceeds. Separate accounting records for the Project will be maintained by each CIU. Independent auditors whose qualifications, experience, and terms of reference are acceptable to ADB will audit the imprest accounts and project financial statements annually. To assist the external auditor provided to the ILMU, BAPPENAS will enter in to a contract with an external auditing firm to undertake the audit of the project, including the periodic audits of the grants to the regional governments and the grants for the scholarship and to the DPRD. Certified copies of audited financial statements, and the auditors’ observations on compliance with the loan covenants will be submitted to ADB within six months after the close of each fiscal year. All

Foreign Local Total

A. SDP Coordination and Investment Monitoring Unit (BAPPENAS) 234.2 2,691.5 2,925.7B. Introduce New Systems and Practices for Effective External Audit (BPK) 5,885.7 4,999.2 10,884.9C. Introduce New Regulatory Structures and Practices for Effective Internal Audit

Regional Supervisory Boards (MOHA IG) 2,498.0 10,353.6 12,851.6 Inspectorate General New Audit Procedures (MOF-IG) 844.6 1,072.6 1,917.2 Central Government Internal Auditor (BPKP) 94.0 513.4 607.4

Subtotal 3,436.6 11,939.7 15,376.3D. Establish a Professional Education Program for Internal Auditors

Degree Program for Internal Auditors (MONE IG) 165.1 4,369.5 4,534.6 Non-Degree Education for Internal Auditors (BPPK) 173.3 323.2 496.5

Subtotal 338.4 4,692.6 5,031.0E. Introduce New Practices for Parliamentary oversight

of Public Sector Audit DPR (DPR Sectretariat) 220.5 646.9 867.4 DPRD (MOHA-IG) 168.0 1,991.0 2,159.0

Subtotal 388.5 2,637.9 3,026.4Total Baseline Costs 10,283.4 26,960.9 37,244.3

Taxesa 0.0 2,991.1 2,991.1Physical Contingenciesb 312.5 437.7 750.1Price Contingenciesc 268.2 849.2 1,117.4

Total Project Costs 10,864.1 31,238.9 42,102.9Financial Charges During Implementationd 627.5 0.0 627.5

Total Costs to be Financed 11,491.6 31,238.9 42,730.4

Item

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other reports will be submitted as per an agreed timetable. All such reports and statements will be submitted in English.

Table 3: Component Implementation Unit by Component

Component A SDP Coordination and Investment Monitoring Unit BAPPENAS B Introduce New Systems and Practices for Effective External Audit BPK C Introduce New Regulatory Structures and Practices for Effective Internal

Audit

1. Inspectorate General MOF-IG 2. Regional Supervisory Boards MOHA-IG 3. Central Government Internal Auditor BPKP

D Establish Formal Education and Non Education Programs 1. Inspectorate General Establish a Professional Education and

Certification Program for Internal Auditors MONE-IG

2. Establish a Professional Non Formal Education for Public Sector Auditors

BPPK

E Introduce New Practices for Parliamentary Oversight of Public Sector Audit

1. DPR DPR Secretariat 2. DPRD MOHA-IG

MOF = Ministry of Finance,; IG = Inspector General, MOHA = Ministry of Home Affairs, MONE = Ministry of National Education, BPPK= Badan Pendidikan Pembangunan Kantor, MenPan = State Ministry for Administrative Reform, SDP = . Source: ADB. 2003. Preparing the Support to State Audit Reform Project. Manila (INO-TA 4107). 85. A reporting system will be established to highlight reported financial and operational information. The reports will indicate, among other things, progress made against established targets, problems encountered during the quarter, steps taken and proposed to resolve the problems, compliance with loan covenants, and proposed project activities to be undertaken during the following quarter. All reports will be in English. Each CIU will submit monthly reports, and the ILMUs and PLMUs will submit quarterly consolidated reports to ADB within 20 days from the end of each quarter, using formats detailed in the project administration manual. The PLMU and ILMU will prepare a project completion report within three months of project completion. 86. Project Reviews. ADB and the Government will jointly undertake annual reviews of the Project to assess progress and to identify constraints. During the first two years of implementation, semiannual reviews are required. The Government and ADB will undertake a comprehensive midterm review of the Project in the third year of its implementation. The midterm review will (i) review the scope, design, and implementation arrangements of the Project; (ii) identify changes needed since the time of project appraisal; (iii) assess progress of the project implementation against performance indicators; (iv) review compliance with loan covenants; and (v) if necessary, recommend changes in the design or implementation arrangements. The ILMU will collate the peer review and overseas study tour reports under the various components to determine lessons learned. These will be consolidated as appropriate into reports and submitted to the relevant agencies and to ADB. 87. Information System. The PLMU, ILMU, and CIUs will develop, with the assistance of consultants, a PPMS to assess the project impact and its effectiveness. The ILMU monitoring and evaluation officer will maintain the system and collect and analyze data in cooperation with the project implementing agencies. Key system indicators will be used in the ILMU’s quarterly progress reports. The monitoring and evaluation system will endeavor to include participation by

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beneficiary communities and individuals. An indication of the types the outcomes for each component can be seen in Supplementary Appendix E, with specific outcomes highlighted in the logical framework in Appendix 4.

IV. TECHNICAL ASSISTANCE 88. Technical assistance (TA) grants will be provided to the PLMU to help ensure that the deliverables on the policy matrix are achieved, and to the ILMU to provide in-depth project monitoring and reporting assistance, as well as additional quality assurance through the establishment of regional monitoring teams. The TAs will be funded by the Government of the Netherlands up to $5.0 million, with $1.3 million going to the PLMU and $3.7 million to the ILMU. Appendix 13 has further details of the terms of reference and costing for the TAs.

V. PROGRAM BENEFITS, IMPACTS, AND RISKS A. Expected Impacts 89. Social Benefits. The STARSDP will reduce poverty in a sustainable way by improving the public sector audit function, which is economic, efficient, effective, and in accordance with good institutional practice and standards. Transparency in financial management, and public participation in the process, will increase. A holistic approach will increase integration and complementarity between the audit institutions, and interaction between the audit sector and civil society, thus strengthening the accountability framework in the public sector. This approach will provide the checks and balances for increased public confidence and participation in the public sector. Appendix 12 highlights the summary poverty reduction and social analysis. 90. Economic Benefits. The nature of the Project does not allow quantitative financial and economic analyses to be carried out. However, the STARSDP will contribute significantly to the overall reform agenda for a democratic and decentralized Indonesia, which is still in transition from an autocratic, centralized form of government. Improved financial management will mean that scarce government resources will be better used and more effectively deployed than before. General economic benefits will accrue from increased regional and central government efficiency through improved performance, transparency, and increased public-private partnerships. Investor confidence will improve owing to strengthened governance. 91. Technical Benefits. The Program provides significant technical improvements in auditing practices, including the use of IT-based systems and exposure to international systems and practices. The Indonesian audit sector will be better integrated with the international audit community, thus allowing it to meet international trends. Through the scholarship and training programs, the STARSDP will increase the number of qualified financial management staff at the central and regional levels. By creating uniform certification and training standards, the STARSDP will improve the mobility of individuals and thus their job opportunities. At the same time, the educational institutions will be able to increase their focus on providing the requisite training for the public sector, thus ensuring the sustainability of the training programs developed. 92. Involuntary Resettlement, Indigenous People, and Environmental Benefits. The Project has no direct or indirect involuntary resettlement, and will not affect indigenous peoples. It does not require an initial environmental examination or environmental impact assessment under Indonesian laws and regulations. The Program is expected to have no adverse impact on the environment.

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B. Risks and Safeguards 93. Low government commitment to reform, weak ownership of the policy package, insufficient consultation with the Government, and overly complex and ambitious policy conditionalities are considered the major risks of policy-based lending. The STARSDP formulation process attempted to minimize these risks in several ways: (i) the policy framework has been well articulated with the Government, and has received political commitment at the central and regional levels; (ii) the duration of the program loan activities, number of tranches, and phasing of policy actions conform with the gradual approach to change adopted in Indonesia; and (iii) consultation on a detailed policy matrix started at an early stage of STARSDP preparation, concentrated on a few core reforms, and involved a wide range of Government counterparts, most of which remained involved throughout the process. The articulation between policy actions and project interventions of the STARSDP increases the safeguards for reform implementation. Institutional or legal measures indispensable to implement the Project have been inserted into the policy matrix. Conversely, the Project will support activities to ensure that policy changes are appropriately designed and their feasibility fully assessed from the financial and institutional perspectives. The policy matrix articulates STARSDP reform actions with interventions supported by other ongoing ADB operations. 94. The greatest threat of poor audit performance is in regional government accountability. Given limited funds, the investment program is designed to build up a critical mass of regional internal audit institutions supported by a strengthened external audit. The design of the local regulation template will be disseminated nationwide to establish a consistent national legal and regulatory framework for internal audit. The focus on 50 BAWASDAs will clearly identify a package of measures provided through lump-sum grants for institutional capacity and education that can easily be duplicated by other aid agencies either through cofinancing of this project or separately. This additional funding will benefit from the legal and institutional framework put in place during the STARSDP. 95. The risk of late provision of counterpart funds and staff has been minimized by requiring the Government to establish the project management and monitoring structure (ISC, PCMU, PLMU, and ILMU). Qualified personnel will fill the expert positions, already endorsed by the Government, so that the additional burden on the Government budget will be minimal. The Government has carefully identified and reviewed the STARSDP’s recurrent cost implications. 96. Transparency and accuracy of data for monitoring purposes constitute another major problem as poor quality and low policy relevance of indicators may lead to inaccurate analyses and possible mis-targeting of interventions. In the STARSDP, this risk is considered limited in view of the assistance provided for auditing and monitoring. In addition, a self-check mechanism is being built into the project with BPK and the IGs, besides the external auditor, auditing aspects of the project. The aim is to induce Government ownership and better benchmarking of the implementation and audit issues arising out of development projects rather than wait for an external auditor to highlight them in an annual audit. 97. In spite of recent progress, the project implementation capacities of central agencies remain weak, and could seriously delay implementation. Staff of executing agencies needs to be adequately trained in all areas of project management, and particular guidance is required to ensure compliance with ADB procedures. The upfront appointment and training of PCMU, PLMU, and ILMU staff, and the engagement of international individual consultants to assist the PCMU in project administration, constitute essential safeguards of the STARSDP. 98. Deficient intra-governmental coordination and decision-making processes are other noted project implementation risks. The characteristics of the STARSDP management structure

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help minimize these risks by facilitating concerted action and information sharing among agencies while respecting the existing hierarchical lines. Implementation arrangements and responsibilities are shared among several agencies and to avoid overloading any single agency. The ILMU and PCU have been placed under BAPPENAS through a consensus decision. The ISC, composed of high-level government officials representing the main implementation agencies, will ensure interagency coordination and facilitate the resolution of important project and program implementation issues. Senior officials have been entrusted with the functions of overall STARSDP, ILMU, and PLMU directors. 99. The specific risk associated with the possibility that the BPKP’s position will not be realigned has been addressed in a number of ways. The risk itself has been mitigated by ensuring that the legal and institutional framework, and the capacity of the internal and external institutions that form the core of the state audit sector (BPK, IG, and BAWASDA) will be clearly defined and strengthened. Furthermore, the other audit institutions have begun to assert themselves at the central or regional level. The Government has already initiated this process through various laws and regulations, but this project will clearly establish the end state for the institutional framework, leaving the lesser risk of BPKP remaining as an internal audit institution with significant resources and overlapping mandates. This situation then becomes less easy to defend internally, and the consensus for change already exists. Even BPKP is looking at different ways to realign itself. Significantly, BPKP has agreed to be part of the interministerial committee that the policy agenda has delineated. The concerns over any potential impact on staff within BPKP arising from the possible realignment have been mitigated by the ability and needs of other audit institutions to absorb any displaced BPKP staff. This is particularly important at the regional level. The demographics of the key audit organizations are such that retirements in the next few years will allow for a natural rationalization of size.

VI. ASSURANCES A. Specific Assurances 100. The Government has given the following specific assurances, in addition to the standard assurances, which have been incorporated into the legal documents. The Government will (i) fulfill conditions agreed upon and specified in the policy matrix for the release of the first and second tranches of the program loan, and will promptly adopt other policies and undertake actions as described in the development policy letter and the policy matrix; (ii) ensure that ISC and PSC meet quarterly throughout the STARSDP implementation period for the purpose of monitoring, and that ad hoc PSC meetings are convened promptly to settle project implementation issues requiring high-level decisions; (iii) ensure that timely and accurate quarterly progress reports are produced and that adverse audit findings are followed up effectively and on time; (iv) ensure that civil servants to be trained under the Project—primarily BAWASDA and IG staff—will be selected according to criteria agreed upon with ADB and will be released from regular duties to permit their participation in training activities; (v) implement a bonding system to ensure that staff members trained overseas under the Project agree to remain in the audit function of the Government for at least 2 full financial years as a condition for undertaking the study; (vi) bear all recurrent costs, during and after implementation of the STARSPD, incurred to establish the various audit activities, including staff salaries and related payments, maintenance of equipment and facilities, communications, transportation, supplies and materials, and other operating expenses; (vii) take reasonable measure to ensure that, throughout the duration of the STARSPD, all personnel contributing to its implementation receive remuneration commensurate with their responsibilities and workload; (viii) ensure the timely release of counterpart funds; and (ix) complete the establishment, within three months of loan effectiveness of a PPMS, for the STAR-SDP.

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B. Conditions of Loan Effectiveness 101. In addition to standard conditions for effectiveness, before effectiveness of (i) the program loan, (a) the Government will establish the deposit account at the BI; and (b) the project loan agreement will have been duly executed and delivered on behalf of the Borrower, and all conditions precedent to its effectiveness shall have been fulfilled; and (ii) the project loan: (a) the committee for the recruitment of the consultants to support the operations of the ILMU will be established; and (b) the program Loan Agreement will have been duly executed and delivered on behalf of the Borrower, and all conditions precedent to its effectiveness fulfilled. C. Conditions for Disbursement 102. Disbursement on the Program Loan will take place once the Government has carried out actions specifically identified as conditions for tranche release in the policy matrix, and has demonstrated satisfactory progress in implementing other actions in the policy matrix. For each tranche release the Government will submit, for ADB approval, a withdrawal application, in the format and conditions as specified in the ADB Loan Disbursement Handbook, June 2001. Disbursement on the investment loan will be made once the project specific imprest account has been established, and on approval of withdrawal applications submitted in the format specified in the ADB Loan Disbursement Handbook, June 2001.

VII. RECOMMENDATION 103. I am satisfied that the proposed loans would comply with the Articles of Agreement of the Asian Development Bank (ADB), and recommend that the Board approve:

(i) the loan of $200,000,000 to the Republic of Indonesia for the Program Component of the State Audit Reform Sector Development Program (STARSDP) from ADB’s ordinary capital resources, with interest to be determined in accordance with ADB’s London interbank offered rate (LIBOR)-based loan facility; a term of 15 years, including a grace period of 3 years, and such other terms and conditions as are substantially in accordance with those set forth in the draft Program Loan Agreement presented to the Board;

(ii) the loan in various currencies equivalent to Special Drawing Rights 16,680,000 to

the Republic of Indonesia for the Project Component of the STARSDP from ADB’s Special Funds resources, with an interest charge at the rate of 1.0% per annum during the grace period and 1.5% per annum thereafter; a term of 32 years, including a grace period of 8 years; and such other terms and conditions as are substantially in accordance with those set forth in the draft Project Loan Agreement presented to the Board, and

(iii) the administration by ADB of technical assistance not exceeding the equivalent

of $5,000,000 to the Government of Indonesia to be financed on a grant basis by the Government of the Netherlands for program and project monitoring.

Tadao Chino

President 17 November 2004

Appendix 1

27

SECTOR ANALYSIS 1. The sector analysis serves to illustrate through diagrams and tables some of the issues raised in the main text 2. Staff Allocation. Table A1.1 illustrates (i) the large anomaly between internal and external audit, including the geographical coverage; and (ii) the large number of staff in BPKP in relation to its mandate, particularly in the regions.

Table A1.1: Estimate of Public Sector External and Internal Auditors in Indonesia Item 2003 2002 2001 BPK: Central Regions Total External Auditors

1,800 955

2,755

1,800 955

2,755

1,800 955

2,755

BPKP: Central Regions Subtotal Inspectorates General:

MSRI Education Finance Communication Home Affairs Estimate of IGs of other 12 entities1 Inspector Utama in Nondepartmental Agencies1 Estimated SPIs2 BAWASDA3

Total Internal Auditors

1,662 5,104

6,766

195 400 450 210 256

2,000

450

3,000

* 16,277

31,515

1,662 5,104

6,766

245 350 450 210 256

2,100

500

3,000

Unknown

13,877

1,662 5,104

6,766

250 350 453 210 256

2,177

558

3,000

Unknown

14,020

BAWASDA, Internal auditor in regional government, BPK (State Audit Board of Indonesia), BPKP (Government Internal Audit Agency), IGs Inspector Generals of government departments, SPI(s) Internal auditors in state owned enterprises Notes:

1 Estimate based on a July 2000 confidential BPK document, summarized in Appendix 2, Part A. 2 An estimate provided by the chair of the Internal Auditing Training Foundation, and corroborated by the chair of

Forum Komunikasi of the state owned enterprises. 3 Extrapolation, from data from 20 provinces and 272 districts prepared by the project preparatory technical

assistance based on a survey of 32 provinces and 442 districts. Source: Prepared by the technical assistance, based on information provided by BPK, BPKP, IGs, and the survey of BAWASDA, conducted jointly by the Asian Development Bank and the Ministry of Home Affairs.

28 Appendix 1

3. Summaries of Issues by Institution. The tables below summarize the main issues that were highlighted in the State Audit Reform Sector Development Program (STARSDP) sector study. Other than, on the Audit Board of Indonesia (BPK) and Government internal audit agency (BPKP), there are no readily available statistics on the Inspector Generals (IGs) or the regional government internal auditors (BAWASDAs). The study examined five representative IGs to glean the issues facing their role and mandates. These IGs were MSRI, MONE, MOF, Ministry of Communication, and MOHA. The Asian Development Bank (ADB) conducted a nationwide survey of BAWASDAs through a standardized questionnaire. Over 76% of the 32 provincial and 442 district BAWASDAs responded. A number of workshops were held with the IGs and representative BAWASDAs to identify the main issues.

Table A1.2: External Audit: Issues Related to BPK

Condition Emerging Issues Mandate The primary issue concerning BPK, Indonesia’s supreme audit agency, is whether or not it has

the staff, facilities, and other resources necessary to fulfill its expanded mandate under the recently enacted Third Amendment to the 1945 Constitution, Law 17/03, and implementing regulations. An important addition is the requirement for BPK to audit the financial accountability statements of central and regional governments within 6 months of the end of the financial year. Other laws such as the Clean Government Law (Law 28/99) and the Anticorruption Law (Law 31/1999) provide that BPK will carry out further investigations as required. Law 5/73 is considered deficient as it fails to provide for • a clear definition on the scope of BPK’s audits; • the apolitical election process for the members of the board; • indemnity from prosecution for BPK staff members conducting audit; • BPK’s administrative independence, and the use of auditing standards consistent with

international best practice; • effective follow-up of recommendations; • BPK’s relationship to Parliament, and its freedom to release report findings to the public; • adequate authority to access information from those audited; • BPK’s relationship with internal auditors; and • BPK’s role in a decentralized Indonesia.

Oversight

• Parliament does not usually receive or have regular access to individual BPK audit reports; Parliament receives summaries of edited versions of individual reports.

• Ministries appear to have no legislated or policy-based obligation to address issues raised in reports.

• Reports are not generally made public. • Regional Parliaments oversight authority has increased since the enactment of Law

22/1999, and Article 18 gives DPRD the right to approve the audited annual accountability report of the head of the local executive: the governor in the province, and the chief executive in the districts. However, they do not have the skills to carry out that oversight function.

Operational Staff Resources Types of Audits Conducted Recruiting

• BPK estimates total resources needed at about 5,000 staff members, about twice its

current staffing. • The executive branch, specifically the State Personnel Board, allocates staff resources,

which are usually well below requested needs. • Too few types of audits are conducted. Financial audits comprise most of them, and

performance audits make up some. Other types such as forensic, contract, compliance, program, computer, public debt, environmental, export/import, policy, and privatization audits are not being conducted.

• Recruiting requirements that limit hiring to accountants and exclude multidisciplinary candidates may be impeding expansion of the nature and types of audits that can be conducted.

Appendix 1

29

Condition Emerging Issues Computerization and Enhanced Information Technology Audit Quality and Internal Quality Assurance Reporting Training

• The system does not adequately track audit recommendations so they can be followed up. Audit follow-up may be limited because of an inadequate tracking system.

• Substantive follow-up on fraud audit cases referred to the Attorney General’s Office are lacking and do not result in an affirmative prosecutorial action. An electronic system for tracking compliance with continuing professional education requirements is still under development, and responsibility for managing that system has yet to be decided.

• Some audits and the resultant audit reports lacked quality. • Some audit reports did not comply with a model comprising best practices and related audit

report standards, reflecting on the internal systems in place to assure quality audits and quality audit reports.

• Audit managers and auditors in charge, rather than organization officials such as the chair or other officials, sign reports.

• Training has not been adequate to increase performance audits and/or the variety of types

of audits that could be conducted. • Training has not kept pace with the movement to increase use of computerization and

enhanced information technology. • Training has been unable to correct deficient audit and report quality or to strengthen the

internal quality assurance system. International Practice (benchmarking)

• SAI audit results should be used to improve government. Ministries appear to have no legislated or policy-based obligation to address issues raised in reports.

• In line with concepts of accountability, transparency, and oversight, audit reports should be made readily available to the public and widely distributed. Audit reports are not generally made public.

• Audit organizations, to gauge the effectiveness of their impact on government activities, should monitor the actions taken by those audited in connection with the conclusions and recommendations stated in audit reports. The system does not adequately track audit recommendations and thus audit follow-up may be limited.

• To help make certain that audit work is of an acceptable quality and competence, SAIs should develop quality measures for their audit work, supported by policies and procedures that help assure that audit standards are consistently and uniformly applied. Deficiencies in audit execution and reports demonstrate that the quality assurance system may not be adequate.

BPK State Audit Board of Indonesia, SAI Supreme Audit Agency. ADB. 2003. Preparing the Support to State Audit Reform Project. Manila (INO-TA 4107)

Table A1.3: Internal Audit: Issues Related to BPKP

Condition

Emerging Issues

Mandate • Certain new regulations have reduced BPKP’s mandate. BPKP can no longer • initiate audit activities in regional governments ( Presidential Decree 74/01, which

assigns only regional internal audit organizations the right to audit local governments’ budgets);

• perform financial audits of state-owned enterprises (Law 19/03); and • perform financial audits of private limited liabilities entities (Law 1/95).

• The original Presidential Decree 31/83 was revoked but its replacement (Law 42/01) and

associated Presidential Decree (103/2001)1 did not sufficiently define BPKP’s objectives scope, organizational structure, or staffing, and is unclear about BPKP’s duties and functions in a decentralized Indonesia.

• BPKP has retained residual responsibilities ideally situated in the other audit institutions. It still has the mandate to certify public sector internal auditors; it has some responsibility for the performance accountability reports of government entities and is still considered the external auditor on most ADB and World Bank lending projects

Oversight • Reports are not routinely shared with either the President or Parliament. They periodically receive only report summaries.

• No audit committee oversees the management and execution of BPKP’s work.

1 Presidential Decree 103/2001, Position, Duty, Function, Authority, Organizational Structure and the Working Order

of Nondepartmental Government Institutions.

30 Appendix 1

Condition

Emerging Issues

• BPK does not scrutinize BPKP. Operational Coordination Standards Risk-based Value-adding Audits Reporting Training

• Certain BPKP audits overlap with similar IG audits. • BPKP does not use one set of recognized internal audit standards; it uses “standards” it has

developed from a number of other recognized standards for one type of audit, and another set of standards for other types of audits.

• BPKP does not now use risk-based audit target selection. • It does not have a system for routinely compiling the cost of its audits to determine whether

they are adding value. • The signature authority for BPKP reports has been vested in the 25 regional chairpersons in

as many regional offices. This raises a question as to how BPKP is able to assure quality in its audit work and generate and maintain a uniform, consistent institutional product—an audit report—in light of this dispersion.

• All except one of a sample of 15 BPKP audit reports did not fully comply with generally accepted reporting practices.

• BPKP does not usually make its reports public, and its reports are not distributed outside the audited entity.

• Few regional governments are sending auditors to BPKP training, partly because they do not know about the need for the training.

International practice (benchmarking)

BPKP may not be fully compliant with some of the benchmarks as shown in chapter 3. For example, while BPKP is considered an internal audit organization by law, it does not use one set of recognized internal audit standards, such as those promulgated by the IIA. It uses “standards” it has developed from a number of other recognized standards for one type of audit, and another set of standards for other types of audits. It does not now use risk-based audit target selection as recommended in internal audit standards.

Primary Issue The primary issue concerning BPKP is whether its staff, facilities, and other resources are appropriate for its mandate, in accordance with Law 32/04 and Law 33/04.

BPKP Government Internal Audit Agency ADB. 2003. Preparing the Support to State Audit Reform Project. Manila (INO-TA 4107))

Table A1.4: Internal Audit: Issues Related to Inspectorates General

Condition Emerging Issues Mandate Oversight

Other than being reported to the minister, IG audit activities appear not to be vetted, examined, or monitored.

Recruiting

• There is no one recruiting standard. One IG recruits mostly accountants or person having accounting background; other IGs recruit staff with various backgrounds. This can impede some IGs’ ability to expand the nature and types of audits that can be conducted.

Skill levels • IG staff may not possess the skills needed to conduct all types of audits. Many IGs require the assistance of BPKP to conduct audits. Routine technical performance audits, as well as financial and special audits, are sometimes carried out with BPKP’s assistance.

Types of audits • At least one IG did not conduct financial audits. It relied on BPKP to do it. Standards

• IGs used audit standards inconsistently; few used the same standards or those promulgated by a standard-setting body such as the IIA or those reconcilable with audit standards.

• Some IGs used no audit standards at all. • One IG (MOF-IG) has issued its own audit standards

Productivity • The ratio of IG audit staff members to audit reports issued ranged from about one report for each staff member to almost seven a year.

• The proportion of auditors on IG staff ranged from 67% to 42%. Reporting

• A review of audit reports at selected ministries disclosed that none of the reports fully complied with “best practices” audit-reporting techniques.

• There are various signatory authorities for IG reports. At one IG, the chief of the team that conducted the audit signs the report. At that ministry, the inspector general does not sign any audit reports. At another ministry, the inspector general signs all the reports.

Appendix 1

31

Condition Emerging Issues Training Fraud investigations Audit recommendation follow-up.

• The extent of auditor training was sporadic, depending on the budget, and unsystematic and inconsistent. Data on auditor training—amount spent on it and other details—were often not readily available, and what was available was sometimes inaccurate.

• Training in forensic auditing does not appear to be required, and some auditor training was not especially directed at enhancing audit skills. Some IGs had no special auditor-oriented training programs, and did not conduct forensic audit training.

• At one IG, the ministry had conducted no auditor training for IG auditors in several years. • The number of forensic audits that result in affirmative enforcement or judicial action is

insignificant. Little is known as to why the results of forensic audits, referred to judicial authorities, do not result in affirmative enforcement or judicial action.

• Most IGs did not have an adequate system for tracking audit recommendations and thus may not be able to efficiently follow up on actions taken with respect to audit recommendations.

International practice (benchmarking

The lack of adherence by IGs to internationally recognized audit standards, as reinforced by the evidence presented in this table, argues for the need for major changes in the way IGs manage and execute their audits.

Primary Concern The primary issue concerning the IGs is whether they should more fully develop the capability to independently carry out financial audits in addition to the performance and special-purpose audits they conduct.

IG Inspector Generals Source: ADB. 2003. Preparing the Support to State Audit Reform Project. Manila (INO-TA 4107)

Table A1.5: Internal Audit: Issues Related to BAWASDAs

Condition Emerging Issues Mandate The regional internal audit institutions, the BAWASDAs, were formed under Laws 32 and

33, and were strengthened with the subsequent implementing Government Regulations 84/00, 20/01, and 8/03, and Regulation 105/2000 on Financial Management and Accountability in Regions. However, regional laws do not require local regulations to provide for the specific legal and institutional issues.

Oversight BPK is presumed to exercise some degree of oversight over the BAWASDA audit activities it is about to conduct an audit at the BAWASDA level.

Operational Overview

Fiscal and other Resources

The amounts budgeted for provincial and regional audits appear to be smaller than their estimated needs: the number of regional audits is about 10 times greater than provincial audits, but the amounts budgeted for regional audits is only about three times greater. While audit is labor-intensive, only about 50% of the audit budget is for salaries.

Recruiting Skill and Education Levels Standards Productivity

• More physical resources, including computers, are needed. The ratio of computers to staff members is 1:7 one for every seven staff members at the provincial level, and 1:9 one for every nine at the regional level.

• The STAR Project was told that training equipment, trained instructors, and training materials were also needed.

• Many BAWASDA respondents think they are understaffed by more than 3,200 auditors: over 500 at the provincial level, and about 2,700 at the regional level.

• About 40% of the staff did not go beyond high school. • Only 6% of the staff had academic training in accounting. • Standards issued by BPKP and modified for use were used during some audits.

Guidance issued by MOHA was used during other audits. • BAWASDAs appear not to have either the resources or the skills to complete all their

required audits. • A survey showed that almost 15% of the provincial audits were either conducted with

assistance from another audit organization or were not audited.

32 Appendix 1

Condition Emerging Issues Training Fraud Investigations

• The total amount budgeted for district and provincial training is an average of 2.1% of the budget, ranging from 2.2% for the districts to 1.9% for the provinces.

• Eighty-one percent of district respondents and 90% of provincial respondents agreed that financial training was their greatest training need.

• BAWASDA report the results of an audit that indicates the commission of a criminal offense to regional government officials without assurance that such matters will receive appropriate police or judicial review. We were advised that the results of fraud investigations are given to the mayor for ultimate disposition.

International Practice (benchmarking)

The lack of adequate physical and staff resources, qualified and academically trained accountants, essential training in finance, and complete independence indicates that total compliance with generally accepted internal audit standards might be unlikely.

Primary Concern The primary issue concerning BAWASDA is whether or not they have the independence, requisite capable staff, facilities, and other resources necessary to fulfill their mandate under Indonesia’s decentralization laws (Laws 22/99 and 25/99).

BAWASDA Regional Government Internal Auditor. Source: ADB. 2003. Preparing the Support to State Audit Reform Project. Manila (INO-TA 4107) 4. Options for BPKP. Based on international practice, the role of BPK as external auditor is clear and no alternative scenarios were developed. Likewise, the clear role of the IGs within ministries also does not warrant the development of alternatives. However, BPKP’s diminished role raises an important question regarding its future role. 5. A presentation given at the steering committee meeting on 24 May 2004 included setting out the following alternative roles for BPKP that had been brought to the project preparatory technical assistance project team’s attention by others:

(i) status quo, (ii) total dissolution or merger with other bodies, and (iii) split central and regional.

6. Given the considerable expansion of BPK’s responsibilities and its limited resources, it seemed to make sense for the Government to consider the reassignment of BPKP’s 25 regional offices and over 5,000 staff to BPK. 7. Should this take place, the question is what role BPKP and its central staff of about 1,700 could fulfill at the central level of Government. The following suggestions were presented for discussion:

(i) Pre-audit services for Government. Article 58 of Treasury Law 01/04 requires the establishment of an internal control system, of which pre-audit could be a strong element.

(ii) Government support for anticorruption measures. BPKP has contributed to this effort by providing expertise and personnel to help conduct investigative audits.

(iii) National training center. Given BPKP’s training facilities and experience, it could serve as an independent training center for internal auditors.

(iv) Service provider. Two aspects were outlined: (a) appointing an internal auditor to central Government bodies that are too small to warrant establishing their own internal audit function, and (b) providing demand-based internal audit services to help other internal auditors overcome peak period or specialized needs. Such services would be carried out on a cost-recovery or profit basis.

Appendix 1

33

8. The role of internal audit institutions will be considered by the interministerial steering committee. 9. Figure A1 was formulated to reflect the increasing costs of the state audit function resources not be allocated between BPKP and BPK.

Figure A1: Graph of Potential Costs of Audit Sector Maintaining the Status Quo of BPKPa

BPK (State Audit Board of Indonesia), BPKP (Government Internal Audit Agency), IGs Inspector Generals of government departments. Source: ADB. 2003. Preparing the Support to State Audit Reform Project. Manila (INO-TA 4107).

Chart of Internal Audit Costs (Rupiah billions)

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

2000 2001 2002

Year

Billion rupiah

Total Inspector General (Routine & Development)BPKP (Routine & Development) BPK (Routine & Development)

34 Appendix 2

STATE AUDIT REFORM PROJECT – PROBLEMS/CONSTRAINTS ANALYSIS

Limited implementation of standards that are

consistent withinternational practices

Outdated human resource management code of ethics

and inadequate implementation

Inability of staff to undertake specialized audits such as

value for money, performance , information

technology, banking , forensic

Inadequate use of information technology to improve audit processes

Audit reporting needs improvement to enable recipients to understand

them

Poor match between mandates of, and resources for, external and

internal audit

Limited coverage of audit universe

Inability of external audit to fulfill constitutional

requirement for presence in region

No public access to audit reports

Inadequate public awareness and

understanding of audit role and audit

reports

Inability of civil society/ press to

exercise appropriate influence

Outdated legal and institutional framework

subsequent to decentralization

Confusion regarding public sector internal

and external audit

Inadequate operational and

financial independence

Inadequate oversight and follow up

Weak legal and institutional framework

Poor transparencyand public awareness

Uneven allocation of audit resources

Insufficient to ensure professionalism

and adherence to international practices

Constraints

State audit sector unable to respond adequately to mandatesin an efficient and effective manner

To establish a clear legal and regulatory framework

for State audit in Indonesia

To strengthen oversight over executive branches of government and over audit

institutions

To ensure public access to audit reports and to help civil society understand and use audit reports

To achieve an improved allocation of public

resources devoted to State audit

To strengthen capabilities and professionalism of

audit institutions consistent with international practices

The strengthened State audit sector will contribute directly to improved governance and, as a resultof more effective oversight and more efficient audit, impact positively towards poverty reduction

Opportunities

Outcome

CurrentState

Problems

Inadequate technical support in parliaments to

assist awareness and understanding of audit role and audit reports

Inability of Parliaments to hold executive

branches accountable

Lack of access by Parliaments to all audit

reports

Lack of overview of audit institutions

Poor follow-up on audit reports by executive,

Parliament and judiciary

Limited implementation of standards that are

consistent withinternational practices

Outdated human resource management code of ethics

and inadequate implementation

Inability of staff to undertake specialized audits such as

value for money, performance , information

technology, banking , forensic

Inadequate use of information technology to improve audit processes

Audit reporting needs improvement to enable recipients to understand

them

Poor match between mandates of, and resources for, external and

internal audit

Limited coverage of audit universe

Inability of external audit to fulfill constitutional

requirement for presence in region

Poor match between mandates of, and resources for, external and

internal audit

Limited coverage of audit universe

Inability of external audit to fulfill constitutional

requirement for presence in region

No public access to audit reports

Inadequate public awareness and

understanding of audit role and audit

reports

Inability of civil society/ press to

exercise appropriate influence

No public access to audit reports

Inadequate public awareness and

understanding of audit role and audit

reports

Inability of civil society/ press to

exercise appropriate influence

Outdated legal and institutional framework

subsequent to decentralization

Confusion regarding public sector internal

and external audit

Inadequate operational and

financial independence

Outdated legal and institutional framework

subsequent to decentralization

Confusion regarding public sector internal

and external audit

Inadequate operational and

financial independence

Inadequate oversight and follow up

Weak legal and institutional framework

Poor transparencyand public awareness

Uneven allocation of audit resources

Insufficient to ensure professionalism

and adherence to international practices

Constraints

State audit sector unable to respond adequately to mandatesin an efficient and effective manner

To establish a clear legal and regulatory framework

for State audit in Indonesia

To strengthen oversight over executive branches of government and over audit

institutions

To ensure public access to audit reports and to help civil society understand and use audit reports

To achieve an improved allocation of public

resources devoted to State audit

To strengthen capabilities and professionalism of

audit institutions consistent with international practices

To establish a clear legal and regulatory framework

for State audit in Indonesia

To strengthen oversight over executive branches of government and over audit

institutions

To ensure public access to audit reports and to help civil society understand and use audit reports

To achieve an improved allocation of public

resources devoted to State audit

To strengthen capabilities and professionalism of

audit institutions consistent with international practices

The strengthened State audit sector will contribute directly to improved governance and, as a resultof more effective oversight and more efficient audit, impact positively towards poverty reduction

Opportunities

Outcome

CurrentState

Problems

Inadequate technical support in parliaments to

assist awareness and understanding of audit role and audit reports

Inability of Parliaments to hold executive

branches accountable

Lack of access by Parliaments to all audit

reports

Lack of overview of audit institutions

Poor follow-up on audit reports by executive,

Parliament and judiciary

Inadequate technical support in parliaments to

assist awareness and understanding of audit role and audit reports

Inability of Parliaments to hold executive

branches accountable

Lack of access by Parliaments to all audit

reports

Lack of overview of audit institutions

Poor follow-up on audit reports by executive,

Parliament and judiciary

Appendix 3 35

DEVELOPMENT COORDINATION MATRIX 1. Although good governance in Indonesia has been a key issue for the funding community for some years, the public audit function has not been a priority for assistance. The need for strong fiduciary arrangements has been stressed in the joint Asian Development Bank (ADB)-World Bank 2001 Country Financial Accountability Assessment, and the ADB country governance assessment carried out in preparation of the Country Strategy and Program for Indonesia 2003-2005. Over the past 5 years, a limited amount of external assistance has been provided to help the Government strengthen individual audit organizations, primarily the Audit Board of Indonesia (BPK) and the central government internal auditor (BPKP). However, no external assistance has been provided to the public sector audit function as a whole. While the specific institution-based capacity-building efforts have been useful, there is also an unmet need to establish a clear vision for the future institutional framework for Indonesia’s audit function. Further, the significant changes and requirements brought about by democratization and decentralization have yet to be addressed. 2. In summary, the limited amount of external assistance provided to the Government has been focused on strengthening individual audit organizations, whereas this proposed ADB loan is aimed at the public sector audit function as a whole.

Table A3: Past, Ongoing, and Expected Projects

Reference Approval EA Amount ($ million)

Description Status of Support for

Audit Asian Development Bank ADB 2002. Local Government Capacity Building for Decentralization. Manila (INO -1964

Dec 2002 MOHA 42.220 The Project will support regional governments to improve their capacities by helping them develop effective strategies for capacity building and by providing adequate resources to implement them. An approach based on the development of capacity-building action plans, and their implementation through a set of domestic capacity-building service providers supervised by a national capacity-building review board and managed through a system of regional boards is proposed. Where plans specify a need for support for internal audit, they will be considered for funding under the STAR project.

Possible, where identified in the Capacity Building Action Plan, the audit function will be supported through the STARSDP. (Ongoing)

ADB 2001. Financial Governance Reform Program. Manila (INO- 1620:

Sep 2001 BPKP 12.00 Three components funded: performance audit techniques, anticorruption, and audit process and human resource development

Yes. Internal audit. (Complete)

ADB 2002. Support to Strengthen the capacity of Ministry of Roads and Infrastructure (MSRI) to Combat Fraud

Sept, 2002

MSRI 0.700 Support to strengthen the capacity of MSRI to combat fraud and corruption, specifically to improve auditing procedures, skills, and techniques within the MSRI-IG.

Yes. MSRI-IG. (Complete)

36 Appendix 3

Reference Approval EA Amount ($ million)

Description Status of Support for

Audit and Corruption. Manila (INO-TA 3842)

ADB 2003.Strengthen Governance in Regional Administration and Legislature, Manila (INO TA 3909)

Aug 2002 MOA 0.100 Strengthen governance in regional administration and legislature.

Indirect. (Complete)

ADB 2001. Support to Decentralization. Manila (INO-SSTA 3764)

Nov 2001 BAKUN 0.300 The TA will. (i) help forge a sound political and technical consensus across the concerned government institutions on the measures to be adopted and on the related action plan, (ii) prepare a human resource development plan for MOF and a new treasury organization to implement the reforms, (iii) draft the implementing regulations and a blueprint of systems and procedures, and (iv) recommend a uniform accounting information system and public accounting standards to enable effective implementation of the state finance laws.

Issues related to audit function identified for follow up action. (TCR complete)

ADB 2000. Support to Enhanced Public Expenditure Management. Manila (INO-ADTA 3394)

Jan 2000 MOF 0.225 The TA had four objectives: (i) analyze the implications of different institutional arrangements and sets of implementing regulations for desired public expenditure outcomes; (ii) help build the Government’s internal capacity to guide PEM reforms and help other Government agencies implement such reforms; (iii) expose Government officials from key ministries to the linkages between PEM and decentralization; and (iv) build a network of technical staff with a common understanding of PEM and decentralization, to guide future reforms.

Indirect. (TCR complete)

World Bank-Audit Modernization Project

Aug 1997 BPK 14.600 Objectives were to help BPK better assess the accountability of state finances by enhancing its performance and financial audit capabilities. The complementarity with the STARSDP Project is highlighted in Supplementary Appendix D.

Yes. External audit. (Dec 2003 closing date extended to Sep 2004)

World Bank-Proposed Government Financial Management and Revenue Administration Project (GFMRAP)

Not approved

MOF-IG TBD Focus is on the measures required to build an integrated financial management information system and assist the budget setting and oversight process in the Parliament. As part of that process, some assistance will be given to the MOF-IG.

Yes. IG. (TBD)

Appendix 3 37

Reference Approval EA Amount ($ million)

Description Status of Support for

Audit Australian Aid (AusAID) Various grants through the TAMF facility

Various BPK Various Assistance to a variety of government institutions, including BPK (mainly training in audit planning, performance audit, and investigative audit) with phase 2 ending in December 2003, and phase 3 starting in 2004 and continuing for 5 years. Particular focus has been given to military audits, and AusAID has indicated interest in parallel cofinancing to assist the DPR in its audit oversight activities.

Yes, in specific areas. (Ongoing)

United States Agency for International Development (USAID)

Various MOF Implementing a project with the MOF-IG, focusing on the customs and taxation divisions. Not involved directly with audit. Uses the services of the Financial Services Volunteer Corps.

Indirect. (Ongoing)

INO = Indonesia, TA = technical assistance, ADTA = advisory technical assistance, EA = Executing Agency, SSTA = small scale technical assistance, BPKP = Centralized Internal Audit, BAKUN = the State Financial Accounting Agency of MOF, MOA = Ministry of Agriculture, MOF = Ministry of Finance, MOHA – Ministry of Home Affairs, MSRI-Ministry of Settlements and Regional Infrastructure, PCR= Project Completion Report, PEM= Public Expenditure Management, TBD = to be decided. Source(s): Various.

38 Appendix 4

PROGRAM FRAMEWORK1

Design Summary Performance Indicators/Targets Monitoring Mechanisms

Assumptions and Risks

Goal Enhance governance, and the efficiency, economy, and effectiveness of the public sector audit function through strengthened audit institutions operating to internationally accepted standards

Participating central and regional government institutions meet benchmarks on operational capability and minimum service standards.

Government budget and service delivery data National, regional, and local budget and socioeconomic surveys International Corruption Assessment Report (Transparency International) Investment climate assessments

Strong commitment from central and regional governments on good governance. Political will exists in the central and regional parliaments

Project Purposes Strengthened audit institutions working under strengthened legal and regulatory framework, with better resource allocation, greater oversight, and better public awareness

Rationalization of the policy, legal and regulatory framework for state audit institutions State audit law, by June 2004

BPK law by the end of the Program

50 local regulations passed by December 2009

Government regulation and presidential decree on internal control systems adopted by December 2005 External audit standards established by June 2005 Internal audit standards established by the end of the Program Alignment and provision of resources to enable audit institutions to fulfill their mandate Strategic development plan for BPK completed by September 2005 BPK resolution on outsourcing completed by December 2005 Assessment of training institutes completed Budgetary allocations for 2006, 2007, 2008 reflect mandates Physical presence of BPK: 2004—8 provinces, 2006—15, 2007—18, 2009—24

Peer reviews Project completion reports Public surveys Project review missions by ADB and the Government BPK reports External audit reports on BPK

Strong commitment from central and regional governments to support an effective state audit function Political will exists in the central and regional parliaments Existence of sound accounting systems using standards consistent with international accounting standards Appropriate civil service reform Resistance from vested interests overcome Judicial sector follows up appropriately on BPK’s submissions on illegal activities. Resource allocation given commensurate with mandate DPR and Government continue to cooperate on passing relevant audit legislation. Political will by DPR

1 Supplementary Appendix E gives some details behind the outcomes at a subcomponent level.

Appendix 4 39

Design Summary Performance Indicators/Targets Monitoring Mechanisms

Assumptions and Risks

Audit Coverage

Regional accountability statements audited by BPK: 2004—50%; 2005—65%; 2006—85%; 2007—100% Regional accountability reports reviewed by Bawasdas: FY2005—10 Districts; FY2006—30 Districts 2007—50 Districts; 2009—50 Districts Enhanced oversight on audit recommendations and of the audit function at the central and regional level, and action plan for DPR/DPRD secretariats completed by September 2005 Peer reviews undertaken of MOF-IG and Bawasda by June 2006 Enhanced transparency and public awareness of the state audit function at the central and regional level Public awareness campaign undertaken in 50 regional governments by September by 2009 By 2005, weekly press conference by BPK in Jakarta By 2006, regional office press conferences held monthly

and DPRD members

Outputs 1. New systems and practices for effective external audit (BPK) introduced

New systems and work procedures consistent with new legal and regulatory framework adopted and in place by 2008 A strategic approach for human resources management developed and implemented by 2008 A new strategic approach for information resources management approved by 2007 Pilot-testing of new procedures in selected audits Public awareness campaign designed and completed by 2006, implemented by 2007

Project completion reports Public surveys Project review missions By ADB and the Government BPK reports External audit reports on BPK

Commitment within the executive and BPK for change Qualified consultants support the activities

40 Appendix 4

Design Summary Performance Indicators/Targets Monitoring Mechanisms

Assumptions and Risks

2. New systems and practices for effective internal audit (Bawasda and IGs) introduced

Model IDP adopted for 50 Bawasdas by 2007, 16 IGs by 2006 New work procedures adopted consistent with legal and regulatory framework by 2007

Peer reviews Project review missions By ADB and the Government BPK reports External audit reports on BPK

Continued commitment by central ministries/regional executives to the Bawasda function Good cooperation between BPK and Bawasda, and BPK and IG No political influence in BPK’s operations No resistance to change Adequate training facilities accessible

3. New systems and practices for BPKP to fulfill its new mandate introduced

IDP for BPKP developed by 2006 IDP copy provided to ADB Project review missions by ADB and the Government BPK reports External audit reports on BPK

BPKP’s new role adequately defined No resistance to change Continued commitment by Government for BPKPs new role Adequate training facilities accessible

4. Professional education program for internal auditors (IG department of education) established

New programs and curricula developed by 2006 Scholarship program designed and implemented by 2006 Scholarship program funded based on MOUs established between 50 regional governments and local universities

CPMU and PIU project quarterly reports

Qualified staff leave Bawasda. Adequate training facilities accessible

5. New practices for Parliament and regional parliament (DPR and DPRD) oversight of BPK audit reports introduced

IDP for regional secretariats implemented by 2008

CPMU and PIU project quarterly reports Surveys of regional parliament (DPRD) members

Continued cooperation between BPK and DPR

6. Public awareness of the public sector audit function established

Survey shows clear awareness of audit function. By 2009, 75% of survey respondents (the public) at the central and regional level think audit is useful.

BPK/IG/Bawasda records Public surveys

Adequate commitment to transparency by the Parliament, BPK, and the executive

Appendix 4 41

Design Summary Performance Indicators/Targets Monitoring Mechanisms

Assumptions and Risks

Activities 1. Introduce new systems and practices for effective external audit (BPK) 1.1 Study tour conducted for new BPK board; BPK audit planning, including risk-based auditing strategy completed; revised code of ethics approved; specialized audit training undertaken; and new auditing reports designed and ready for inclusion in operating manuals

Various activities Start 2005 End 2008 By 2007, auditing manuals completed, incorporating new procedures and practices

1.2 Adopt and implement new HRM plan, skills standards, and staff development curriculum; implement staff development program

Start 2005 End 2007 New HRM plan adopted in 2006 200 staff members to benefit from specific certification and secondment programs by 2007

CPMU and PIU project quarterly reports Peer review Peer review report

Commitment by BPK board to implement changes and adopt the plans Adequate counterpart funds available. No resistance to change from within BPK staff Adequate technical support Adequate skills in BPK to absorb changes

1.3 Formulate IT strategy, including disaster recovery plan and electronic archiving Equip 1,800 staff members with computers Pilot electronic tools for distance learning, electronic report archiving audit team management validated and ready for use by 2008. Prepare report prepared on cost- benefit analysis Develop online access by DPR/DPRD of BPK reports

Start 2005 End 2009 Review existing strategy; 2006—draft strategy based on international standards; 2007—adopt and implement strategy; 2009—major targets implemented 2005—600 staff; 2006—600 staff; 2007—600 staff Start 2007 End 2008 Cost estimation of potential costs for full implementation completed Start 2005 Assess DPR requirements; 2006—refine user-friendly reports and put on the Web site; 2007—technical aspects of online access reviewed and on line access implemented

CPMU and PIU project quarterly reports Pilot reports by consultants CPMU and PIU project quarterly reports

No resistance to change from BPK staff Adequate technical support Adequate skills in BPK to absorb changes

42 Appendix 4

Design Summary Performance Indicators/Targets Monitoring Mechanisms

Assumptions and Risks

1.4 Pilot new audit procedures/ techniques for selected audits Conduct peer reviews and submit report to BPK board and ADB

Start 2005 with assessment, 2006 with pilot-testing, and 2007 with implementation New procedures and techniques tested, validated, and ready for dissemination in at least the 5 largest national state-owned enterprises, 1 national bank, 5 state ministries, 10 regional governments, and 10 regional state-owned enterprises by 2007 Two peer review reports (2006 and 2008) completed, based on agreed-on terms of reference that address management practices, work procedures, human resource management, and quality of selected audit reports

Pilot reports by consultants Peer review reports

Adequate support from those audited Adequate skills of BPK staff Qualified consultants and peer reviewers selected

1.5 Conduct program for public awareness and support for effective audit

Publicity programs and public awareness techniques validated and ready for implementation Program conducted annually: 2006, 2007, 2008 in 50 regional districts

CPMU and PIU project quarterly reports Survey reports

Qualified consultants selected

2. Introduce new systems and practices for effective internal audit (Bawasda IGs) Develop IDPs in 50 regional governments and 16 central ministries Develop new work procedures consistent with new legal and regulatory framework

Start 2005 Identify 50 regional governments and 16 IGs, needs assessments in each entity, IDP prepared; 2006—IDP submitted for funding Start 2006 Review existing procedures, hold workshops to identify and propose changes; 2007—new work procedures identified End 2007

Sample surveys CPMU and PIU project quarterly reports CPMU and PIU project quarterly reports

Commitment of regional governments and legislature Regional governments satisfy district selection criteria Continued commitment by Head of the district/governors to develop Bawasdas

3. Introduce new systems and practices for BPKP to fulfill its new mandate Develop new institutional and work procedures consistent with new mandates Introduce new work procedures into regular BPKP work practices

Start 2006 End 2007

Sample surveys CPMU and PIU project quarterly reports

Quality of technical support

4. Establish a formal and nonformal education program for internal auditors BPPK and MONE Develop new programs and curricula Introduce courses into competitively selected regional universities and institutes

Start 2005 End 2009 80% of staff members in selected Bawasda in 50 regional governments have achieved graduate degree/ certification by 2009

CPMU and PIU project quarterly reports Sample surveys CPMU and PIU project quarterly reports

Universities /training providers willing to work together Scholarship program candidates selected on merit and relevance of scholarship to

Appendix 4 43

Design Summary Performance Indicators/Targets Monitoring Mechanisms

Assumptions and Risks

Establish guidelines for scholarship programs Provide funds for scholarships to competitively selected Bawasda and IG staff

90% staff in selected IG staff have achieved graduate degree/ certification by 2009

existing job function Appropriate courses designed and adopted effectively

5. IDP for Parliament and regional parliament secretariats Develop IDP for Parliament and regional parliament secretariats

Start 2006 Establish committee to assess requirements, conduct needs analysis; 2007—prepare draft IDP End 2008

CPMU and CIU project quarterly reports Satisfaction surveys among DPRD members BPK reports on follow up actions

Commitment of central governments and legislature Professionalism of audit report production Quality of technical support

Inputs. IT equipment: $4.7 million Consultants, workshops, and counterpart staff: $18.5 million Training and overseas tours: $11.0 million Scholarships: $4.5 million Recurrent maintenance: $1.5 million

Start 2005 End 2009 900 computers provided 660 hours of domestic consultants 150 hours of international consultants

CPMU reports Signed Loan Agreement, RRP Inception mission, Back to Office Report (BTOR)

Consultants not recruited on time Counterpart funds available Adequate cooperation among key government agencies Adequate skilled staff Loan negotiated successfully Loan approved Conditions for effectiveness and assurances met Loan tranche conditions met

BAWASDA, Internal auditor in regional government, BPK (State Audit Board of Indonesia), BPKP (Government Internal Audit Agency), BTOR, Back to Office Report, CPMU Central Project Monitoring Unit IGs Inspector Generals of government departments, MOU Memorandum of Understanding, PIU, Project Implementation Unit, SPI(s) Internal auditors in state owned enterprises Source: ADB. 2003. Preparing the Support to State Audit Reform Project. Manila (INO-TA 4107).

44 Appendix .5

No. : S~352/MK.O6/2004Mr. Tadao ChinoPresidentAsian Development Bank

Dear Mr. Chino,

1. Over the last 2 years, the Government of Indonesia (the Government) has focused oncore areas of macroeconomic reforms. Fiscal consolidation has received priority attentionamong them. The White Paper adopted in September 2003, to smoothen the transition followingIndonesia's em from the International Monetary Fund-supported Program, supported theformulation of a sound policy, institutional, legal and regulatory framework to achieve fiscalconsolidation. The Government and Parliament worked closely to enact three major laws in aspan of 15 months: the State Finance Law (Law 17/2003), the State Treasury Law (Law 1/2004)and the State Audit Law (Law 15/2004). The aim of these laws is to promote fiscal responsibilityand enhance accountability and transparency in public financial management.

2. Concurrently, the Government has been working closely with the Asian DevelopmentBank (ADB) in operationalizing the new legal and regulatory framework for the Public Auditfunctions. With the support provided under a project preparatory technical assistance (PPTA),an inter-agency Steering Committee established by the Government has assessed thestrengths and weaknesses of state audit institutions in Indonesia. Our premise in undertakingsuch an assessment jointly with the ADB is that efficient and well-structured state auditinstitutions are an integral part of an effective and well functioning accountability frameworkincluding the executive, Parliament, and civil society. As an ex post exercise on public sectormanagement, audit provides an independent, objective and a professionally conductedassessment on the veracity, accuracy. credibility I and reliability of information on the economy Ieffectiveness, and efficiency of Government. State auditing arrangements need sound externalaudit (reporting to the legislature) and internal audit (reporting to the executive) functions.

3. By way of background, in Indonesia, the Badan Pemeriksa Keuangan (BPK) is theexternal auditor and Indonesia's Supreme Audit Institution (SAI). For internal audit, at thecentral level of government, there is the Inspectorate General (IG) in each ministry that reportsdirectly to the minister. At the same time there is also Badan Pengawasan Keuangan danPembangunan (BPKP) that reports directly to the President but outside of any particularministry. At the regional government level, regional internal audit agencies (Bawasdas) report tothe respective chief executive. In 2001, amendments to the Indonesian Constitution significantlyexpanded BPK's mandate, to cover virtually the entire public sector at the central as well aslocal government levels.

4. Public sector audit institutions require a number of critical attributes to promote theoverall objective of fiscal transparency and accountability at ex ante as well as ex post levels.Among these are: a strong legal and institutional framework; adequate capacity in theinstitutions commensurate with their mandate; an efficient allocation of resources between

DEVELOPMENT POLICY LETTER

Novenber 10, 2004

t.

different institutions; effective oversight by Parliament and follow up by the Executive; and full. transparency in the audit process. While Indonesia has had experience with public sector

auditing for several decades, our assessment as part of the PPT A has shown that some ofthese attributes were lacking in Indonesia.

5. The Government has made a conscious attempt to address some of the legalweaknesses through the adoption of the 3 major laws that I have outlined in para.1 above. It isthe Government's understanding that there are efforts within the Parliament as well as the BPKto strengthen the legal framework for BPK. The Ministry of Finance (MOF), in line with itsauthority to ensure overall public sector financial accountability, shall be the coordinator onbehalf of the Executive to liaise with Parliament in the adoption of a revised BPK Law.

6. In order to address the other areas of weaknesses in our auditing framework, theGovernment requested ADB to formulate a Sector Development Program. We appreciate thatADB has worked closely with the Government over the past year to formulate the proposedState Audit Reform Sector Development Program (STAR-SDP). The Government teamendorses the overall goal of the proposed program, which is to enhance governance, and theefficiency, economy and effectiveness of public sector audit through strengthened auditinstitutions operating to internationally accepted standards. Based on our discussions with ADB,we have agreed that the objectives of the Program will be: an improved policy and legalframework for state audit institutions; a strengthened and efficiently aligned operating frameworkfor external and internal audit; enhanced accountability and oversight of the public audit functionat all levels of government; and increased public awareness of the benefits of audit and what itcan deliver.

~

7. The fundamental principles on which the STAR-SOP is based are critical to note, fromthe Government's point of view: (i) a clear delineation between the intemal and external auditinstitutions and functions; (ii) the restructuring of the audit institutions and functions, torecognize and align them with the ongoing decentralization process; (iii) the elimination ofoverlap in the mandates of the public sector audit institutions; and (iv) the achievement ofoverall cost efficiency.

8. In line with these principles, the Government has agreed that the policy component ofthe SOP should focus on: (i) rationalization of the policy, legal and regulatory framework forstate audit institutions; (ii) alignment and provision of resources to enable audit institutions tofulfill their mandate; (iii) enhanced oversight on audit recommendations and of the audit functionat the central and regional level; and (iv) enhanced transparency and public awareness of thestate audit function at the central and regional levels.

9. The government is particularly cognizant of the need to strengthen the external andinternal audit functions at the regional level. The Government accepts the need to expand thepresence of BPK as the external auditor in line with the 2002 constitutional amendments.Further, the Government is aware of the stipulation in the State Finances Law for BPK to auditthe accountability statements of all the regional governments beginning with the fiscal year2006. At the same time the Govemment is also aware of redundancy in the central internal auditinstitutions, following the creation of the Bawasda, and the latter will necessitate acomprehensive review of the current institutional arrangement in intemal audit in order to ensurean effective and cost efficient utilization of resources in the audit sector. The Government hasestablished an interministerial committee to look into the intemal control systems, which will,amongst other matters, look into and make recommendations on the optimal institutionalarrangements for internal audit at the regional level. A Govemment regulation will be producedthat will delineate the need for further Govemment decrees on this matter.

Appendix 5 45

46 Appendix 5

10. Mr. Chino, through this letter outlining our development policy in the state audit sector,the Government indicates its strong commitment to pursuing all the reform measures outlined inthe Policy Matrix {Attachment 1}. Through these measures, the Government aims to achieve themilestones in the White Paper. We believe the adoption of the 3 framework laws has set thetone for reforms to enhance the quality of internal controls within the public sector. The otherlegal, regulatory and institutional measures to be achieved as part of STAR-SOP will improvethe quality of external oversight and the level of public participation relative to fiscaltransparency. More importantly, it will help the Government address the over-riding concernswith regard to the misalignment of resources. This would be in line with the Government's focuson fiscal consolidation as a priority area, as part of which we have increasingly stressed theimportance of sound public expenditure management to ensure fiscal sustainability and reappublic sector efficiency gains and budgetary savings. The Investment Component of the SOPwill help enhance the public sector audit capacity and improve the quality of the oversight

process significantly.

11. Let me thank you and the Asian Development Bank, on behalf of the Government ofIndonesia, for your commitment and support for structural, policy and sectoral reforms inIndonesia in a number of areas. I also wish to reiterate the Government's full commitment incarrying out all the policy measures of ST AR-SDP .

Jusuf AnMinister of FinanceGovernment of IndonesiaDate: October 27. 2004

Appendix 647

STATE AUDIT REFORM SECTOR DEVELOPMENT PROGRAM (STARSDP) POLICY MATRIX

Program Goal and Objectives: The goal of the proposed State Audit Reform Sector Development Program (STARSDP) is to enhance governance, and the efficiency, economy and effectiveness of public sector audit through strengthened audit institutions operating to internationally accepted standards. The objectives are: an improved policy and legal framework for state audit institutions, a strengthened and efficiently aligned operating framework for external and internal audit, enhanced accountability and oversight of the audit function at all levels of government, and increased public awareness of the benefits of audit and what effective audit can deliver. The STARSDP is built on four fundamental principles: (i) a clear delineation between the internal and external audit institutions and functions, (ii) the restructuring of the audit institutions and functions to recognize and align them with ongoing decentralization processes, (iii) the elimination of overlap in the mandates of the public sector audit institutions and (iv) the achievement of overall cost efficiency. The STARSDP will comprise the following;

(i) Rationalization of the policy, legal and regulatory framework for state audit institutions; (ii) Alignment and provision of resources to enable audit institutions to fulfill their mandate; (iii) Enhanced oversight on audit recommendations and of the audit function at the central and regional level; and (iv) Enhanced transparency and public awareness of the state audit function at the central and regional level.

Policy Sub-Components Policy Actions First Tranche Actions1

Second-Tranche2

Program End

Condition I. Rationalization of the Policy, Legal and Regulatory Framework for State Audit Institutions I (a). Strengthening regulatory framework for external audit: Revised Bills to define the role of external audit and the role of BPK as the External Audit Institution

1 Ministry of Finance (MOF) to coordinate among all stakeholders, deliberations to consolidate different versions of the existing audit bills into two distinct bills; (a) a revised State Finance Accountability Bill (State Audit Law)3 clarifying the role of

external audit in public sector expenditure management, and (b) a revised BPK Bill (BPK Law) to clarify the organizational structure, roles and

responsibilities of the Audit Board of Indonesia (BPK) as the Supreme Audit Institution.

January 2004

State Audit Bill enacted 2 MOF to submit to Parliament the amendments to the existing State Audit Act consistent with the deliberations in Policy Action 1 and containing at a minimum the provisions noted in footnote 4 below.4

April 2004

1 First tranche actions are to be completed before ADB Board consideration of the STARSDP. 2 From the date of Board approval, the Program will be implemented over a period of 36 months. 3 This revised bill to replace the existing BPK Law introduced in 1973 (Law 5/73). 4 The State Audit Law to contain clear provisions on: definition of audit, the auditor, and the external and internal auditors; broad scope of audit; broad types of

audits; audit standards (reconcilable to international standards); operational independence of BPK with regard to budget and human resource management; free and clear access to information; right of the Supreme Audit Institution (SAI) to assess internal control and internal audit procedures; and reporting and transparency requirements.

48 Appendix 6

Policy Sub-Components Policy Actions First Tranche Actions1

Second-Tranche2

Program End

Condition 3 State Audit Law approved and enacted July 2004 Revised BPK Bill finalized

to replace existing BPK Law (5/73)

4 BPK to submit to Parliament, through the Government, amendments to the existing BPK Bill consistent with the deliberations in Policy Action 1 above and containing at a minimum the provisions noted in footnote 5 below.5

July 2005

5 Government to appoint appropriate counterpart for Parliamentary deliberations of the draft BPK Law, within 60 days of receiving request from Parliament. Program

End Condition

6 (i) BPK to draft regulations to implement the State Audit Law; (ii) BPK to issue at least 3 regulations relating to (i) above; and (iii) BPK to commence drafting regulations to implement the BPK Law, when enacted.

September 2005 for (i)

Program End Condition for (ii) and (iiii)

7 BPK to conduct a legal review and prepare a report on any laws or regulations that inhibit

BPK from fulfilling its legal mandate as guaranteed in the Constitution and the State Audit and BPK Laws6 and bring the report to the attention of the relevant ministries.

December 2005

I (b). Strengthening of Internal Control Systems including realignment of Internal Audit Institutions

Institutional and regulatory framework for Internal Control Systems, including internal Audit at the Central Level

8 MOF, through a Ministerial decree, to establish an Inter-Ministerial Committee (IMC) with a mandate to (i) draft a government regulation on internal control systems,7 including clarifying the role of the internal audit function at the central level with recommendations for internal audit institutions at the regional level, in line with their legal mandates; and (ii) make recommendations for drafting necessary Presidential decree(s).

Sept 2004

5 The BPK Law to contain clear provisions on: the scope of BPK’s authority; use of auditing standards that are compatible and reconcilable to international

standards; indemnity from court actions of SAI staff to include all relevant SAI staff; minimum relevant qualification criteria for Board candidates, appointment of Board members by Parliament; and length of tenure of the Board or Board members should not end coinciding with an election year.

6 Notwithstanding the review conducted during the formulation of the BPK Law, this review will help the Government identify conflicting clauses in other legislation that may need to be amended,

7 The scope of detail required to describe the internal control and audit systems shall contain at a minimum, the following information: definition of internal audit; scope and range of audits; structural position of Internal Auditors in the Government; adoption of code of ethics; use of Auditing Standards; certification requirements and processes for Internal Auditors; reporting responsibilities; independence of the audit function; relationship of internal audit institutions with the SAI; and appointment procedures and relationship between the internal audit unit and the Chief Financial Officers (Kepala Biro Keunagan at the central level and the Pejabat Keuangan Daerah at the regional level

Appendix 649

Policy Sub-Components Policy Actions First Tranche Actions1

Second-Tranche2

Program End

Condition 9 IMC to submit to the State Secretariat a draft government regulation on internal control systems that, amongst others, (i) specifies the structure, roles, and mandates of the internal audit institutions responsible for undertaking the public internal audit function8 at the central level with appropriate indications for internal audit institutions at regional levels of government (ii) nullifies and revokes any conflicting decrees or regulations covering the mandate, roles and responsibilities of internal audit institutions; (iii) provides requirements for the certification of internal auditors; and (d) takes into account the recommendations of the STARSDP Steering Committee.9

July 2005

10 MOF to (i) coordinate the adoption of the government regulation on Internal Control Systems; and (ii) implement the regulation as far as it relates to MOF.

December 2005 for (i)

Program end condition for (ii)

11 MOF to co-ordinate (i) with the appropriate ministries, the drafting of the necessary Presidential Decree(s) based/recommended on the government regulation on internal control systems and submit to the State Secretariat and (ii) the adoption of the Presidential Decree(s).

June 2006

Enhanced Internal Control Systems at a central ministerial level including the roles of the IGs

12 MOF to adopt and commence implementation of a time bound Institutional Development Plan (IDP) for ensuring effective internal financial management, in line with the State Finances Law, and which includes the role and responsibilities of the Chief Financial Officer (Kepala Biro Keuangan) and the Inspectorate General.

September 2005

13 MOF to issue a circular to the 2004 Guidelines on financial accountability statements requiring Inspectorate Generals (IG) in each ministry to confirm that the annual financial accountability statements are in accordance with the MOF guidelines.10

October 2004

14 MOF to ensure that all necessary measures are undertaken for an MOU to be signed between the MOF IG and the ADB in order for MOF IG to carry out interim reviews of ADB assisted projects.

October 2005

15 MOF to ensure the interim reviews of ADB-supported projects within MOF are conducted, and disseminate methodologies and experiences to other ministries. Reports copied to ADB.

Program end condition

8 The regulation is to include, amongst others, references to the organization of the in internal audit institutions and financial bureaus: the internal audit structure;

and technical support proposals. 9 The recommendations are outlined in the Committee’s final report dated 18 June 2004, which envisages the repositioning and rationalization of the internal audit

institutions. 10 The MOF ministerial financial reporting guidelines were issued in June 2004 by Directorate of Information and Accounting (previously BAKUN).

50 Appendix 6

Policy Sub-Components Policy Actions First Tranche Actions1

Second-Tranche2

Program End

Condition Clarification of roles, of regional internal audit institutions (BAWASDAs) and the Regional Chief Finance Officer (PPKD).

16 (i) MOHA-IG, with inputs from a consultative team,11 to draft standardized model local regulation12 that address the roles and responsibilities of BAWASDAs (ii) MOF to draft a model regulation outlining the roles, responsibilities, and position of the Chief Finance Officer (PPKD).

July 2005 for (i) June 2006 for (ii)

17 MOHA-IG to (i) disseminate the standardized regulation (developed under Policy Action16 (i), nationwide; and (ii) establish a tracking system to monitor the adoption of regional regulations by regional governments, and (iii) to co-ordinate the adoption of a regulation13 as follows; (a) by 2005 in at least 16 regional governments (b) by 2006 in at least 35 regional governments (c) by 2007 in at least 50 regional governments

August 2005 for (i) and (ii) December 2005 for (iii) a

January 2006 for (iii) b, January 2007 for (iii) c

Identification of appropriate regional governments to participate in the Investment Loan of STARSDP

18 MOHA-IG to (i) formulate criteria for the selection of about 50 regional governments for participation in the STARSDP project; and (ii) disseminate the criteria through workshops to ascertain commitment and (iii) to have an indicative list of all those regional governments suitable for support under the STARSDP project.

October 2004

19 MOHA to (i) provide guidelines on the review the accountability statements of local government prior to audit by BPK (based on those produced for the Central Government departments by MOF) to at least 50 BAWASDAs involved in the STARSDP Project, (ii) to co-ordinate review as follows; (a) by 2005 in at least 16 Regional Governments; (b) by 2006 in at least 35 regional governments (c) by 2007 in at least 50 regional governments and (iii) experiences learned under the STARSDP Project are disseminated to all regional governments as a learning exercise.

December 2005 for (i) and (ii) a January 2006 for (ii)b

January 2007 for (iii)

11 The team is to comprise of regional government officials -- predominantly provincial and district based Bawasda officials; academia, MOF, BPK, the Institute of

Internal Auditors (IIA), and the Indonesian Institution of Accountants (IAI). 12 These are to specifically address key areas such as auditing standards, code of ethics, roles and responsibilities within the structure of regional government,

public awareness and comments, reporting responsibilities (BPK, DPRD)- all to be further specified in a regional audit manual. . The model to be adopted either as local regulation (SK or PERDA).

13 The adoption of the regulation (either SK or PERDA) will be the a criteria for selection of districts for investment support under the STARSDP.

Appendix 651

Policy Sub-Components Policy Actions First Tranche Actions1

Second-Tranche2

Program End

Condition Revised Institutional Development Plan for BPKP based on Government Regulation and Presidential Decree

20 BPKP to develop a 5-year IDP formulated in a manner consistent with the regulation on internal control systems . July 2006

I (c) Public Sector Standards on Auditing and Certification established

Public Sector Audit Standards consistent with generally recognized international standards developed and promulgated through out the public sector.

21 BPK to: (i) initiate revisions to the 1995 Auditing Standards to bring them in line with International standards; (ii) submit a draft to the Government (through MOF), academia and the IAI, for consultation, to finalize the revised public sector external auditing standards, and draft the related regulations.

October 2004 for (a)

July 2005 for (b)

22 BPK to issue external auditing standards as required by the State Audit Law. December

2005

Certification of Internal Auditors reviewed.

23 MOF to (i) coordinate with selected IGs, BKN, BPKP, BPK officials and BAWASDAs to review the recommendations of the IMC concerning the certification procedures of internal auditors and (ii) draft the necessary revisions to the existing regulation or a new Presidential decree which adopts the recommendations regarding certification of internal auditors14 and submit the draft to the State Secretariat.

June 2006

II. Alignment and provision of resources to enable audit institutions to fulfill their mandate; Comparative assessment of BPK with SAIs of other countries.

24 BPK to complete a comparative study of the organizational structure, staffing, duties and responsibilities of fully developed, well-functioning SAIs in comparable countries and issue a report to Parliament on the comparisons between BPK and SAIs of other countries.

July 2005

Strategic Development Plan and Institutional Development Plan for BPK.

25 BPK to prepare and adopt a medium term Strategic Development Plan (SDP) to establish a long term vision and perspective for BPK, and a 5 year Institutional Development Plan (IDP) for the period 2006-2010 with time-bound monitorable milestones.15

September 2005

BPK to propose operating budget in line with the

26 BPK to; (i) seek, as an interim measure, additional supplementary budget in 2005 to enhance its coverage in the regions; and (ii) propose an adequate budget for 2006 to fulfill its responsibilities under the State Finances Act.

October 2004 for (i)

August 2005 for (ii)

14 This will give certification authority to a body outside the internal audit function as decided by the IMC. 15 The IDP will include plans on how to fulfill BPK’s obligations to complete the audits of Statements of Accountability at central and regional level within six months

after financial year (FY) end, commencing with FY 2006.

52 Appendix 6

Policy Sub-Components Policy Actions First Tranche Actions1

Second-Tranche2

Program End

Condition legal mandate

Introduce risk-based methodology to assist resource allocation

27 BPK to issue a regulation, requiring audit planning to be based on risk based methodology to allow BPK to selectively target its audits.16 December

2006

Public -private partnerships developed for more efficient resource allocation.

28 BPK, as part of longer term resource planning, to: (i) issue a regulation to competitively outsource a selected percentage of its audit work to suitably qualified private sector accounting firms; (ii) undertake pilot joint reviews of selected audits undertaken with the external firms to help identify best practice techniques in audit; and (iii) issue reports recording the findings of the pilot joint reviews.

January 2006 for (i)

September 2006 for (ii) and (iii)

Assessment of use of various Public Sector Management Training Institutes under BPK, BPKP, IGs and including STAN, on principles of economy, efficiency and effectiveness.

29 (i) MOF Secretary general to: issue a Decision Letter to establish a team, comprising relevant stakeholders, to review the existing training of financial management and auditing staff for the public sector; and (ii) the reviewing team to issue a report on the assessment and the recommendations.

November 2004 for (a)

June 2006 for (ii)

III. Enhanced oversight on audit recommendations and of the audit function at the central and regional level

Enhanced capacity of National Parliament’s (DPR’s) Secretariat to support Parliament in oversight of BPK’s reports at the central level.

30 Secretary General of DPR Secretariat to: (i) establish a consultative group comprising staff from the Parliament Secretariat, the Secretary General’s Office, and BPK with external audit experts invited as necessary, to assess necessary capacity building for the Parliament Secretariat to enable it to provide appropriate support to Parliament DPR Committees and Commissions on the review and analysis of BPK reports; and (ii) draft a report on the assessment findings; and submit the report and recommendations to the Speaker of Parliament for Parliament’s consideration.

June 2006

Enhanced capacity of regional parliaments oversight capabilities at the regional level

31 MOHA (IG) to (i) facilitate the formulation and execution of letter of readiness by the 50 regional governments involved in the STARSDP Project, (ii) for BPK to perform a comprehensive review to assess necessary capacity building for the DPRD Secretariats to enable them to provide support to Regional Parliament (DPRD) members to review and analyze BPK reports; (iii) provide and disseminate guidance in the preparation of an institutional development plan for regional Regional Parliament Secretariats as a basis for support under the STARSDP investment project as follows;

September 2005 for (i) (ii) and (iii) a June 2006 for (iii) b

July 2007 for (iii) c

16 This will support the budget setting exercise in Policy Action 24 above.

Appendix 653

Policy Sub-Components Policy Actions First Tranche Actions1

Second-Tranche2

Program End

Condition (a) by 2005 in at least 16 Regional Governments

(b) by 2006 in at least 35 regional governments (c) by 2007 in at least 50 regional governments

Enhanced accountability of BPK through external audit and peer review

32 BPK to (i) organize a periodic institutional effectiveness peer review to be undertaken in 2004; and (ii) adopt a regulation that commits to an annual external audit of its financial statements with effect from FY 2005.

October 2004 (a)

June 2006 (b)

Enhanced accountability of IGs and BAWASDAs through review by BPK and peer review

33 BPK to (i) draft technical guidelines to integrate assessments of internal control systems as a standard part of the external audit process; (ii) adopt and implement the technical guidelines; and (iii) submit a report to Parliament on the global assessment of the internal control systems and functions at a national and regional level, with suggestions for improvements.

September 2004 (i)

July 2005 for (ii) June 2006 for (iii)

34 MOF-IG, to: (i) authorize a Peer review of the MOF (IG) function with a report issued to the Minister, BPK and ADB; and (ii) disseminate the relevant parts of the peer review report to other ministries for similar reviews to be undertaken by those ministries.

June 2006

35 MOHA-IG to organize a peer review of selected regional BAWASDAs by a similar institution from a comparable country, with a report issued to the local chief executives.

June 2006

IV. Enhance Transparency and Public Awareness of the State Audit Function at the Central and Regional Level Public Awareness Strategy for Audit Function designed and implemented through a campaign at the central and regional level.

36 BPK, with inputs from relevant stakeholders including internal audit institutions, to formulate a model program for public awareness, aimed at enhancing public awareness of the roles and responsibilities of the public sector audit institutions and public understanding of the audit reports issued at the central and regional levels.

December 2005

37 BPK to: (i) design a format for ‘public friendly” reports that identify major issues in the BPK audit reports, with a clear presentation of the follow-up actions required; (ii) test the format on a pilot basis through publication in newspapers in selected regions of a range of audit reports; (iii) organize public hearings to obtain feedback from stakeholders, including individuals, private sector and NGOs representatives, and the media; and (iv) disseminate the results of the pilot on the BPK website, and circulate to Parliament, Regional Parliament, selected NGOs, and the media.

September 2005 for (i), December 2005 for (ii), March 2006 for (iii) June 2006 for (iv)

38 BPK to: (a) undertake a series of annual surveys to assess the impact of public’s understanding of the public sector audit role; and (b) submit the survey reports to Parliament and Regional Parliament and publish the same on BPK website.

December 2005

54 Appendix 6

Policy Sub-Components Policy Actions First Tranche Actions1

Second-Tranche2

Program End

Condition BPK to undertake targeted audits of key entities with key findings issued to the public

39 BPK to carry out: (i) audit and submit to Parliament the key findings of the financial audits on at least 2 large state owned enterprises including compliance with regulations and internal controls for FY 2003;

) (ii) audits and submit to Parliament the key findings of the financial audits of at least 3 large public institutions for FY 2004; (iii) audits and release the findings of at least 4 large public institutions and/or programs in 2005 and develop a plan to repeat the activities in 2006. (iv) selective performance audits of activities of at least 8 of the 50 local governments selected under the STARSDP Project and submit reports to the respective DPRD.

October 2004 for (i)

July 2005 for (ii)

October 2006 for (iii)

December 2006 for (iv)

40 BPK to publish the list of public sector entities that are subject to BPK audit together with BPK’s indicative audit plan for FY 2006 and FY2007, including dissemination through its website.

October 2005

ADB=Asian Development Bank, INO = Indonesia, BPKP = Centralized Internal Audit, BAKUN = the State Financial Accounting Agency of MOF, IDP= Institutional Development Plan, IMC=Interministerial Committee MOF = Ministry of Finance, MOHA – Ministry of Home Affairs, PPKD= Chief Financial Officer, SAI= Supreme Audit Institution, STARSDP= State Audit Reform Sector Development Program.

Appendix 7 55

STARSDP PROGRAM MANAGEMENT AND COORDINATION

ADB=Asian Development Bank, INO = Indonesia, BPKP = Centralized Internal Audit, BAKUN = the State Financial Accounting Agency of MOF, IDP= Institutional Development Plan, ILCIUIMC=Interministerial Committee MOF = Ministry of Finance, MOHA – Ministry of Home Affairs, STARSDP= State Audit Reform Sector Development Program

STARSDP Coordinating Unit (STARSDPCU)

BAPPENAS

Executing Agency-Program Loan

Ministry of Finance

Director General Treasury

Program Loan Monitoring Unit(PLMU)

BAPPENAS

Deputy of Political Defense and Security

Executing Agency-Investment Loan

Ministry of Home Affairs

PLCIUPLCIU PLCIU PLCIU PLCIU

Ministry of Finance BPKP BPK DPR

Directorate of

Information and

Technology

Inspector General TBD Project Unit Secretariat

Investment Loan Component Implementation Units (ILCIU)

ILCIU ILCIU ILCIU ILCIUILCIU ILCIU ILCIU

Ministry of Finance

Ministry of Education BPK DPRMinistry of

Home Affairs BPKP BPPK

Inspector General

Inspector General Project Unit SecretariatProject Unit TBD Project Unit

Program Loan Component Implementation Units (PLCIU)

Investment Loan Monitoring Unit (ILMU)

STARSDP Coordinating Unit (STARSDPCU)

BAPPENAS

Executing Agency-Program Loan

Ministry of Finance

Director General Treasury

Program Loan Monitoring Unit(PLMU)

BAPPENAS

Deputy of Political Defense and Security

Executing Agency-Investment Loan

Ministry of Home Affairs

PLCIUPLCIU PLCIU PLCIU PLCIU

Ministry of Finance BPKP BPK DPR

Directorate of

Information and

Technology

Inspector General TBD Project Unit Secretariat

Investment Loan Component Implementation Units (ILCIU)

ILCIU ILCIU ILCIU ILCIUILCIU ILCIU ILCIU

Ministry of Finance

Ministry of Education BPK DPRMinistry of

Home Affairs BPKP BPPK

Inspector General

Inspector General Project Unit SecretariatProject Unit TBD Project Unit

Program Loan Component Implementation Units (PLCIU)

Investment Loan Monitoring Unit (ILMU)

56 Appendix 8

INELIGIBLE ITEMS

1. The proceeds of the loan will be utilized to finance the foreign currency expenditures for the reasonable cost and imported goods (excluding any duties or taxes) required during implementation of the Financial Sector Program. All imported goods financed from the proposed loan must be produced in, and produced from, member countries of the Asian Development Bank (ADB). 2. Notwithstanding the provision in para.1, no withdrawals will be made for

(i) expenditures for goods included in the following groups or subgroups of the United Nations Standards International Trade Classification, Revision 3, or further revisions as designated by ADB by notice to the Borrower:

Table A8: Ineligible Items

Group Subgroup Description of Items

112

121

122

525

667

718

897

971

- - - - -

718.7

897.3 -

Alcoholic beverages Tobacco, unmanufactured tobacco refuse Tobacco, manufactured (whether or not containing tobacco substitutes) Radioactive and associated materials Pearls; precious and semiprecious stones, unworked or worked Nuclear reactors and parts thereof, fuel elements (cartridges), nonirradiated for nuclear reactors Jewelry of gold, silver, or platinum group metals (except watches and watch cases); goldsmiths’ or silversmiths’ wares (including set gems) Gold, nonmonetary (excluding gold ores and concentrates

Source(s): United Nations Standards International Trade Classification, Revision 3.

(ii) expenditures for goods intended for military and paramilitary purposes or for luxury consumption;

(iii) expenditures for pesticides categorized as extremely hazardous or highly hazardous in Class 1a or 1b, respectively, of the World Health Organization’s Classification of Pesticides by Hazard and Guidelines to Classification;

(iv) expenditures for goods supplied or to be supplied under any contract that a

national or international financing institution or any other financial agency has financed or agreed to finance, including any contract financed or to be financed under any loan from ADB; and

(v) expenditures incurred more than 180 days before loan effectiveness.

Appendix 9

57

COST ESTIMATES AND FINANCING PLAN

The base project costs are at mid-2004 prices. Physical contingency has been provided at an average of 3%, with no physical contingency for certain consulting contracts. Prices have been provided for based on an average inflation of 1.2 % for foreign costs and 6.2% for local costs. Taxes and duties have been provided for on the basis of the items concerned, but average at around 10%. Interest during construction has been calculated at the 1%. No front-end fee has been computed.

Table A9.1: Components by Financiers ($ ‘000)

SDP=Sector Development Program Source: ADB. 2003. Preparing the Support to State Audit Reform Project. Manila (INO-TA 4107).

Amount % Amount % Amount % Amount % Amount %

A.658.5 19.4 515.8 15.2 0 0 2,222.2 65.4 3,396.4 8.0

B.

6,432.6 50.7 3,170.5 25.0 0 0 3,079.2 24.3 12,682.2 29.9C.

Regional Supervisory Boards (MOHA IG) 8,309.3 61.4 32.9871 0.2 4,224.7 31.2 973.3 7.2 13,540.3 31.9Inspectorate General New Audit Procedures (MOF-IG) 1,079.1 48.2 331.454 14.8 0 0 827.3 37.0 2,237.9 5.3Finance and Development Supervisory Board (BPKP) 365.7 51.9 0 0 0 0 338.3 48.1 704.0 1.7 Subtotal 9,754.2 59.2 364.441 2.2 4,224.7 25.6 2,138.9 13.0 16,482.2 38.9

D.

Degree Program for Internal Auditors (MONE IG) 5,055.1 92.6 0 0 0 0 405.2 7.4 5,460.3 12.8Non-Degree Education for Internal Auditors (BPPK) 238.3 40.8 220.5 37.7 0 0 125.5 21.5 584.3 1.4 Subtotal 5,293.3 87.6 220.5 3.6 0 0 530.7 8.8 6,044.5 14.1

E.DPR (DPR Sectretariat) 0 0 730.2 73.0 0 0 270.5 27.0 1,000.7 2.4DPRD (MOHA-IG) 2,234.8 89.5 0 0 0 0 262.0 10.5 2,496.8 5.9 Subtotal 2,234.8 63.9 730.2 20.9 0 0 532.5 15.2 3,497.5 8.2 Total Project Cost 24,373.3 57.9 5,001.3 11.9 4,224.7 10.0 8,503.6 20.2 42,102.9 98.5

627.5 100.0 0 0 0 0 0 0 627.5 1.5 Total Disbursement 25,000.8 58.5 5,001.3 11.7 4,224.7 9.9 8,503.6 19.9 42,730.4 100.0

Establish a Professional Education Program for Internal Auditors

Interest During Implementation

Introduce New Practices for

SDP Coordination and Investment Monitoring Unit (Bappenas)Introduce New Systems and Practices for Effective 'External Audit (BPK)

Introduce New Regulatory Structures and Practices for Effective Internal Audit

CentralGovernment Total

ItemADB-ADF Cofinanced

RegionalGovernment

58 Appendix 9

Table A9.2: Expenditure Category by the Components Implementation Unit ($ ‘000)

Source: ADB. 2003. Preparing the Support to State Audit Reform Project. Manila (INO-TA 4107).

Introduce Establish a New Systems Professional Education

SDP and Introduce New Regulatory Structures Program for InternalCoordination Practices and Practices for Effective Internal Audit Auditors

and for Inspectorate Finance and Degree Non-DegreeInvestment Effective Regional General New Development Program for EducationMonitoring External Supervisory Audit Supervisory Internal for Internal

Unit Audit Boards Procedures Board Auditors Auditors DPR DPRD (BAPPENAS) (BPK) (MOHA IG) (MOF-IG) (BPKP) (MONE IG) (BPPK) (DPR Secr) (MOHA-IG) Total

I. Investment Costs A. IT equipment 25.4 3,962.5 18.0 339.5 34.8 14.4 13.9 21.1 0.0 4,429.6B. Office equipment 335.0 8.8 8.8 94.7 15.6 8.1 1.6 3.4 0.0 475.8C. Piloting and scaling-out new practices 0.0 813.2 11,644.8 182.5 20.1 236.3 71.4 50.9 1,545.1 14,564.4D. Manuals 0.0 261.2 44.3 67.2 110.7 0.0 166.0 0.0 0.0 649.3E. Training

1. Consulting services Indonesian experts 729.8 472.8 423.1 101.4 181.1 125.9 90.5 438.8 704.4 3,267.8Indonesian contract staff 1,669.3 556.4 451.3 469.9 260.6 285.9 66.7 136.0 0.0 3,896.2International experts 45.3 1,249.0 0.0 226.2 0.0 40.2 20.1 123.2 247.3 1,951.3 Subtotal 2,444.3 2,278.2 874.4 797.5 441.7 452.1 177.4 698.0 951.7 9,115.3

2. Workshops 129.9 212.4 177.6 44.5 17.8 56.4 48.7 73.3 0.0 760.73. Training 0.0 2,627.5 53.4 261.2 21.4 0.0 95.1 0.0 0.0 3,058.64. Tours 51.5 155.8 0.0 186.0 0.0 0.0 0.0 75.5 0.0 468.7 Subtotal 2,625.8 5,273.8 1,105.4 1,289.2 480.9 508.6 321.1 846.7 951.7 13,403.2

F. Scholarship 0.0 0.0 0.0 0.0 0.0 4,544.4 0.0 0.0 0.0 4,544.4G. PIU operating costs

1. Travel 188.7 161.7 410.0 161.7 21.5 97.0 5.3 27.0 0.0 1,072.82. Office expenses 221.5 693.8 309.1 103.0 20.5 51.5 5.0 51.5 0.0 1,456.1 Subtotal 410.2 855.4 719.1 264.7 42.0 148.5 10.3 78.6 0.0 2,528.9

Total Investment Costs 3,396.4 11,174.9 13,540.3 2,237.9 704.0 5,460.3 584.3 1,000.7 2,496.8 40,595.7II. Recurrent Costs

Operations 0.0 1,507.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 1,507.3 Total Recurrent Costs 0.0 1,507.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 1,507.3 Total Project Costs 3,396.4 12,682.2 13,540.3 2,237.9 704.0 5,460.3 584.3 1,000.7 2,496.8 42,102.9

Introduce

Item

New Practicesfor Parliamentary

oversight of PublicSector Audit

Appendix 9 59

Table A9.3: Project Components by Year ($ ‘000)

Source: ADB. 2003. Preparing the Support to State Audit Reform Project. Manila (INO-TA 4107).

Table A9.4: Expenditure Item by Year ($ ‘000)

Source: ADB. 2003. Preparing the Support to State Audit Reform Project. Manila (INO-TA 4107).

2005 2006 2007 2008 2009 Total

A. SDP Coordination and Investment Monitoring Unit (BAPPENAS) 788.3 626.6 661.9 641.7 677.9 3,396.4B. Introduce New Systems and Practices for Effective External Audit (BPK) 2,390.3 3,470.0 3,643.5 1,770.4 1,408.1 12,682.2C. Introduce New Regulatory Structures and Practices for Effective Internal Audit

Regional Supervisory Boards (MOHA IG) 1,105.7 4,476.2 4,289.8 3,428.0 240.6 13,540.3Inspectorate General New Audit Procedures (MOF-IG) 716.0 533.4 346.1 287.7 354.5 2,237.9Finance and Development Supervisory Board (BPKP) 430.7 111.9 80.26259 81.226 0 704.0 Subtotal 2,252.4 5,121.5 4,716.2 3,797.0 595.1 16,482.2

D. Establish a Professional Education Program for Internal Auditors

Degree Program for Internal Auditors (MONE IG) 328.4 1,539.3 1,818.9 1,624.9 148.7 5,460.3Non-Degree Education for Internal Auditors (BPPK) 584.3 0 0 0 0 584.3 Subtotal 912.7 1,539.3 1,818.9 1,624.9 148.7 6,044.5

E. Introduce New Practices for Parliamentary oversight of Public Sector Audit

DPR (DPR Sectretariat) 297.6 211.0 162.1 164.0 166.0 1,000.7DPRD (MOHA-IG) 33.2 741.2 842.8 727.8 151.9 2,496.8 Subtotal 330.8 952.2 1,004.8 891.8 317.9 3,497.5 Total Project Costs 6,674.5 11,709.6 11,845.4 8,725.7 3,147.7 42,102.9

Item

2005 2006 2007 2008 2009 Total

I. Investment Costs A. IT equipment 1,632.5 1,360.2 1,322.4 112.1 2.4 4,429.6B. Office equipment 125.1 87.1 88.1 89.2 86.3 475.8C. Piloting and scaling-out new practices 996.9 4,834.0 4,812.1 3,815.8 105.5 14,564.4D. Manuals 354.1 67.2 113.3 114.7 0 649.3E. Training

1. Consulting services Indonesian experts 1,051.5 712.9 585.4 467.3 450.8 3,267.8Indonesian contract staff 827.5 770.0 779.2 788.6 730.9 3,896.2International experts 467.8 509.0 659.4 125.1 189.9 1,951.3 Subtotal 2,346.8 1,991.9 2,024.0 1,381.0 1,371.6 9,115.3

2. Workshops 387.3 161.8 56.1 103.2 52.2 760.73. Training 206.0 795.6 714.0 722.6 620.4 3,058.64. Tours 156.9 102.8 104.1 52.1 52.8 468.7 Subtotal 3,097.0 3,052.1 2,898.2 2,258.9 2,097.0 13,403.2

F. Scholarship 0 1,389.7 1,676.8 1,478.0 0 4,544.4G. PIU operating costs

1. Travel 294.7 192.4 194.7 197.1 193.9 1,072.82. Office expenses 174.0 370.6 291.6 310.7 309.2 1,456.1 Subtotal 468.7 563.0 486.3 507.8 503.0 2,528.9

Total Investment Costs 6,674.5 11,353.3 11,397.2 8,376.5 2,794.3 40,595.7II. Recurrent Costs

Operations 0 356.3 448.2 349.3 353.5 1,507.3 Total Recurrent Costs 0 356.3 448.2 349.3 353.5 1,507.3 Total Project Costs 6,674.5 11,709.6 11,845.4 8,725.7 3,147.7 42,102.9

Item

60 Appendix 10

POLICY MATRIX IMPLEMENTATION SCHEDULE

I. Rationalization of the Policy, Legal and Regulatory Framework for State Audit InstitutionsIa. Strengthening of External Audit Functions

1 MOF to finalize draft State Audit Bill and submit to Parliament for enactment2 MOF to submit amendments to the Parliamentary-final amendments to the State Audit Law3 Enact the State Audit Law (Bill was approved by Parliament on 9 June 2004)4 BPK to submit amendments to the Parliamentary-drafted bill intended to replace Law 5/73. 5

6 BPK to draft and adopt regulation to implement the State Audit Law and new BPK Law7 BPK to conduct legal review and initiate amendments to inhibit laws and/or regulations

Ib. Strengthening of Internal Audit Functions Including Realignment Audit Institutions8

9 IMC to draft Government Regulation on Internal Control System to the State Secretary10 MOF to coordinate the adoption of Gov't Reg. on control system 11

12 MOF to adopt and commence IDP, for effective internal financial management13

14 MOU between MOF IG and ADB for MOF IG to carry out interim review of ADB project15 MOF to ensure interim reviews of ADB assisted project are conducted16 MOHA to draft model regulation for Bawasda, develop dissemination plan17 MOHA to disseminate model regulation to all regional governments18

19

20 BPKP to adopt a 5 year IDP consistent with its new mandate

LEGEND:

MOHA guidelines on review of accountability statements.50 selected Bawasdas to review the accountability statement of LG and disseminate experience to all LG

MOF to adobt a Ministrial Decree for inspectorate generals, circulate the draft to all ministry for adoption (by Jan 2005)

MOHA to formulate criteria for the selection participating regional governments in the STAR Project and disseminate

MOF to established an IMC to draft Gov't Reg. on internal control and to draft a Presidential Dec. for BPKP

MOF to coordinate draft Presidential Dec. for internal control institution and submit to the State Secretariat

Government to appoint a Government Counterpart for Parliamentary deliberations of the draft BPK Law

2005 2006 20072004ItemQ2 Q3 Q2 Q3 Q4Q4 Q2 Q3 Q4 Q1

Monitorable Third-Tranche Conditions

Action Completed Before Board Consideration

Monitorable Second-Tranche Conditions

Q1 Q2 Q3 Q4 Q1 Q1

Appendix 10 61

Ic. National Standards on Auditing and Certification Established21 BPK board to initiate revision to 1995 Audit Standards , submit a draft for consultation22 Presidential Decree on External Audit Standards issued23

II. Realignment of National Auditing Resources To Enable Audit Institutions To Fulfill Their Mandate24 BPK Board to complete a Comparative Study and issue a report to Parliament25 BPK Board to prepare and adopt a 10 year SDP and a 5 year IDP 26 BPK to (i) seek additional budget in 2005; and (iii) propose budget for 2006 27 BPK to issue a regulation requiring risk-based methodology audit planning28 BPK to issue regulation on outsourcing, undertake pilot joint reviews with the auditors and

issue reports29 MOF to issue Decision Letter to establish a team to review existing education & training

III. Enhanced Oversight On Audit Recommendations and Increased Accountability of The Audit Function At the Central and Regional Levels

30

31 MOHA IG to facilitate Letter of Readiness in 50 Regional Govts 32

33

34 MOF to authorize a Peer Review and disseminate the peer review35 MOHA to organize peer review of selected Bawasda

IV. Enhace Transperancy and Public Awareness of The State Audit Function At The Central and Regional Levels36 BPK Board formulate a model program public awareness37 BPK to design format for public reports, test the format, organize public hearings38

39 BPK to carry out key audits in 2005 and 200640 BPK to publish list of sector entities subject to BPK audit through its website

LEGEND:

BPK Board to undertake annual survey with NGOs and submit the survey reports to DPR and DPRD

Sec. Gen. of DPR Secretariat to appoint an committee to assess capacity of Parliamentary Secretariat and issue Report

BPK Board to adopt regulation that commits to a periodic peer review every 5 year and annual external auditBPK Board to adopt regulation to integrate assessment of internal control system and submit report

MOF to coordinate the drafting and issuance of a New Presidential decree on certification of internal auditors

2005 2006 20072004ItemQ2 Q3 Q2 Q3 Q4Q4 Q2 Q3 Q4 Q1

Monitorable Third-Tranche Conditions

Action Completed Before Board Consideration

Monitorable Second-Tranche Conditions

Q1 Q2 Q3 Q4 Q1 Q1

62 Appendix 11

MAJOR CONTRACT TO BE NEGOTIATED AND PROPOSED DISBURSEMENT PROCEDURE

BPK=Audit Board of Indonesia, BPKP= central government internal auditor, BPPK= MOF training institute, DPR=Parliament, DPRD=Regional Parliament, MOHA=Ministry of Home Affairs, IG= Inspectorate General, MONE= Ministry of National Education Source: ADB. 2003. Preparing the Support to State Audit Reform Project. Manila (INO-TA 4107)

Central /Dutch Reg Gov't

Cofinancing FinancingContract SpecialAmount QCBS DP/N/ST Scholar Account TOTAL Amount NBF (incl. tax)

BAPPENAS PCU 2,862.4 201.0 201.0 494.5 2,166.8Contract 101.1.1: PCU individual consultant for senior financial expert 185.5 166.9 166.9 0.0 18.5Contract 101.1.2: Computers & Printers for PCU 23.7 0.0 0.0 21.3 2.4Contract 101.1.3: PCU individual consultant for conducting mid-term review 27.8 25.0 25.0 0.0 2.8Contract 101.1.4: PCU individual consultant for preparing PCR 28.5 25.6 25.6 0.0 2.8Contract 101.2: PCU consultant BAPPENAS 78.7 68.5 68.5 0.0 10.3Contract 101.3: PCU consultant for project audit 185.5 166.9 166.9 0.0 18.5BPK CIU 1,059.2 211.5 211.5 152.7 695.0BPK Pilots 188.0 168.6 168.6 0.0 19.4BPK National Courses 310.6 278.2 278.2 0.0 32.5BPK International Certification 1,847.0 0.0 0.0 1,847.0 0.0Contract 201.1.1: Computers & Printers for BPK CIU 13.1 11.8 11.8 0.0 1.4Contract 201.1.2: Vehicles for BPK CIU 26.4 0.0 0.0 23.8 2.6Contract 201.1.3: BPK individual consultant for auditing standard 100.6 85.5 85.5 0.0 15.1Contract 201.1.4: BPK individual consultant for auditing process 1 60.4 54.3 54.3 0.0 6.0Contract 201.1.5: BPK individual consultant for auditing process 2 15.5 13.9 13.9 0.0 1.5Contract 201.1.6: BPK individual consultant for peer review 208.5 0.0 0.0 177.3 31.3Contract 201.2: BPK consultant for auditing & management 2,039.4 1,810.6 1,810.6 0.0 228.8Contract 201.3: BPK consultant for IT 1,066.3 942.4 942.4 0.0 123.9Contract 201.4: BPK consultant for public awareness 382.6 344.2 344.2 0.0 38.4Contract 201.5: BPK consultant for public awareness - II 488.9 440.0 440.0 0.0 48.9Contract 201.6.1: Computers 600 units - phase 1 1,077.4 0.0 969.7 107.7Contract 201.6.2: Computers 600 units - phase 2 1,043.6 934.6 0.0 109.0Contract 201.6.3: Computers 600 units - phase 3 1,056.1 945.8 0.0 110.3MOHA BAWASDA CIU 1,166.4 356.2 356.2 0.0 810.2MOHA BAWASDA Overhead 4,224.7 0.0 0.0 4,224.7Lumpsump: BAWASDA 6,055.4 6,055.4 6,055.4 0.0 0.0Contract 301.1.1: Computers & Printers for Bawasda CIU 17.2 15.4 15.4 0.0 1.8Contract 301.1.2: MOHA individual consultant for legal expertise 36.7 0.0 33.0 3.7Contract 301.2: MOHA BAWASDA consultant 2,004.9 1,847.3 1,847.3 0.0 157.7

Direct Payments

ADB Loan Financing

Appendix 11 63

MAJOR CONTRACT TO BE NEGOTIATED AND PROPOSED DISBURSEMENT PROCEDURE (continued)

BPK=Audit Board of Indonesia, BPKP= central government internal auditor, BPPK= MOF training institute, DPR=Parliament, DPRD=Regional Parliament, MOHA=Ministry of Home Affairs, IG= Inspectorate General, MONE= Ministry of National Education Source: ADB. 2003. Preparing the Support to State Audit Reform Project. Manila (INO-TA 4107).

Central /Dutch Reg Gov't

Cofinancing FinancingContract SpecialAmount QCBS DP/N/ST Scholar Account TOTAL Amount NBF (incl. tax)

MOF IG CIU 1,026.2 0.0 0.0 331.5 694.8Contract 302.1.1: MOF IG CIU individual consultant for peer review 125.1 106.4 106.4 0.0 18.8Contract 302.1.2: MOF IG CIU individual consultant for project design 6.0 5.4 5.4 0.0 0.6Contract 302.1.3: Computers & Printers for MOF-IG CIU 13.1 11.8 11.8 0.0 1.4Contract 302.2: Computers & Printers for IGs 301.3 269.8 269.8 0.0 31.5Contract 302.3: MOF IG consultant 731.5 651.2 651.2 0.0 80.2BPKP CIU 318.5 18.7 18.7 0.0 299.8Contract 303.1.1: Computers & Printers for BPKP CIU 32.4 29.0 29.0 0.0 3.4Contract 303.2: BPKP consultant 339.3 304.2 304.2 0.0 35.1MONE CIU 440.3 84.3 84.3 0.0 355.9Scholarship 1: BAWASDA 2,575.2 2,575.2 2,575.2 0.0 0.0Scholarship 2: Inspectorate General 1,752.8 1,752.8 1,752.8 0.0 0.0Contract 401.1.1: Computers & Printers for MONE CIU 13.1 11.8 11.8 0.0 1.4Contract 401.1.2: MONE individual consultant for quality assurance 65.4 58.9 58.9 0.0 6.5Contract 401.2: MONE consultant 388.8 347.5 347.5 0.0 41.4BPPK CIU 78.6 4.6 4.6 0.0 74.0Contract 402.1.1: Computers & Printers for BPPK CIU 13.1 11.8 11.8 0.0 1.4Contract 402.2: BPPK consultant 232.0 206.3 206.3 0.0 25.7Contract 402.3: BPPK consultant for TOT 245.0 0.0 0.0 220.5 24.5DPR CIU 268.8 0.0 70.2 198.7Contract 501.1.1: Computers & Printers for DPR CIU 21.1 0.0 19.0 2.1Contract 501.2: DPR consultant 710.7 0.0 641.0 69.7Contract 502.1.1: MOHA IG (DPRD) pilot 1,545.1 1,390.6 1,390.6 0.0 154.5Contract 502.2: MOHA IG (DPRD) consultant 951.7 844.2 844.2 0.0 107.5Recurrent costs 1,507.3 0.0 0.0 1,507.3Unallocated 519.1 519.1 0.0 0.0 Total 42,102.9 7,806.4 1,070.2 4,328.0 8,769.2 24,373.3 5,001.3 12,728.3Financial Charges During Implementation 627.5 627.5 0.0 0.0 Total Costs to be Financed 42,730.4 25,000.8 5,001.3 12,728.3

Loan amounts financed by ADB-ADF

Direct Payments

ADB Loan Financing

64 Appendix 12

SUMMARY POVERTY REDUCTION AND SOCIAL STRATEGY A. Linkages to the Country Poverty Analysis

Is the sector identified as a national priority in country poverty analysis?

Yes

No

Is the sector identified as a national priority in country poverty partnership agreement?

Yes

No

Contribution of the sector/subsector to reduce poverty in Indonesia: Poor governance is recognized as a key obstacle to poverty reduction in Indonesia. Poverty reduction has been persistently slow following the financial crisis and remains at near 1996 levels.1 Following decentralization in 2001, local government became the principle agent for poverty reduction and achieving of millennium development goals (MDGs). Local governments are responsible for delivery of most basic services required by the poor.2 The principal instrument used by local government is the budget, but inadequate safeguards, including the audit framework, prevent its effective use. The Government is preparing a poverty reduction strategy.3 The draft paper calls recognizes weak governance as one of the primary cause of poverty and calls for efficient and service-oriented government and pro-poor budgeting. The Government-ADB Poverty Reduction Partnership Agreement also recognized the need to “enhance local government transparency, accountability to reflect local aspirations and needs.”

B. Poverty Analysis Targeting Classification: General intervention

The STARSDP addresses the key obstructions to poverty reduction by enabling central and local governments to effectively plan, budget, and deliver poverty reduction initiatives by rationalizing the audit framework, strengthening the audit institutions, increasing oversight on audit recommendations and accountability, and increasing public awareness of audit results and their meaning. Reform of the state audit functions ensures provides feedback on budgetary implementation of policy and how to increase its efficiency, prevents and corrects improper use of the budget, and provides information about program operations and results for future policy and budget planning. Transparency of audit functions and audit results enables the legislature and public to determine whether the Government is delivering on its promises and whether policy platforms have been turned into action. The STARSDP will enable the Government to deliver its mandate more effectively. In itself, the program does not reduce poverty, but it establishes a fundamental basis for accountability in the public sector. Other concomitant efforts such as preparation of local poverty reduction strategies raise poverty awareness within government and civil society to ensure the pro-poor content of that mandate.

C. Participation Process

Is there a stakeholder analysis? Yes No Is there a participation strategy? Yes No

D. Potential Issues

Subject Significant, Not Significant, Uncertain,

None

Strategy to Address Issues

Output Prepared

Resettlement None None Gender None None Affordability None None Labor None None Indigenous People None None Others Risks/ Vulnerabilities

None None

1 Estimated at 15.1% in 2003, which is comparable with 15.7% in 1996. 2 Water supply, sanitation, health, education, local roads. 3 Submitted by the task force to the Poverty Reduction Secretariat on 28 May 2004.

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TECHNICAL ASSISTANCE 1. To help complete the policy matrix conditions and increase project reporting and project monitoring assistance, the Investment Loan Monitoring Unit (ILMU) and Program Loan Monitoring Unit (PLMU) will receive technical assistance (TA). A. Technical Assistance to PLMU ($1.3 million) 2. TA will be provided to the PLMU through a range of experts to assist in the four main policy matrix components. 3. The total cost of the TA will be $1.6 million, of which the grant from the Government of the Netherlands will finance $1.3 million, and the Government of Indonesia, $0.3 million.

Table A13.1 Financing Plan ($ ‘000)

Source: ADB 2004. Project Preparatory Technical Assistance (INO TA 4107).

Table A13.2 Cost Estimates ($ ‘000)

PMU = Project Monitoring Unit Source:ADB. 2003. Preparing the Support to State Audit Reform Project. Manila (INO-TA 4107).

Item Local Foreign Total

I. Investment CostsA. Consulting services, workshops, and training

1. Consulting servicesIndonesian experts 285.0 0.0 285.0International experts 177.9 415.1 593.0 Subtotal 462.9 415.1 878.0

2. Workshops 223.8 95.9 319.73. Tours 0.0 60.0 60.04. Travel 58.4 87.5 145.9 Subtotal 745.1 658.6 1,403.7

B. PMU operating costs1. Indonesian contract staff 94.0 0.0 94.02. Office expenses 80.0 0.0 80.0 Subtotal 174.0 0.0 174.0

Total Investment Costs 919.1 658.6 1,577.7II. Recurrent Costs

Total Baseline Costs 919.1 658.6 1,577.7Physical Contingencies 11.1 7.9 19.0Price Contingencies 16.7 11.5 28.2

Total Project Costs 946.9 678.0 1,624.9

Item Foreign Local Total Percent

Cofinanced 678.0 622.1 1,300.0 80.0 Government of Indonesia 0.0 324.8 324.8 20.0 Total 678.0 946.9 1,624.9 100.0

66 Appendix 13

4. The TA will fund 38 person-months of international experts and 43 person-months of domestic experts. 5. An international public sector audit specialist (8 person-months) and a domestic audit specialist (16 person-months) will be responsible for assisting

(i) Ministry of Finance (MOF) with the technical aspects of the State Audit Law; (ii) Audit Board of Indonesia (BPK) with the technical aspects of the amendments to

the BPK Law; (iii) the Interministerial Committee (IMC) with the technical aspects of the

Government regulation on internal audit and presidential decree on the central government internal auditor (BPKP);

(iv) BPK in developing a strategic development plan (SDP) and an institutional development plan (IDP) to include, e.g., mission and vision statements and an implementation action plan with a schedule for completion;

(v) BPK in undertaking a comparative study of the organizational structure, staffing, duties, and responsibilities of a fully developed, well-functioning supreme audit institution;

(vi) BPK to prepare and circulate a survey to assess the capabilities of BPK’s existing staff and the needs of the organization to fulfill its expanded mandate; the assessment will be expanded to develop (a) mechanisms to improve the rewards/sanctions system, (b) criteria to be used to evaluate professional staff, and (c) the implementation of a time reporting system; and

(vii) BPKP to develop an IDP corresponding to its new mandate. 6. The international legal specialist and team leader (15 person-months), supported by a domestic legal specialist (27 person-months) and an international institutional specialist (9 person-months), will be responsible for assisting

(i) MOF with the legal aspects of the State Audit Law; (ii) BPK with the legal aspects of the amendments to the BPK Law; (iii) the Interministerial Committee with the legal aspects of the Government

regulation on internal audit and presidential decree on BPKP; (iv) MOF, BPK, and Interministerial Committee in drafting regulations to implement

the State Audit Law, BPK Law, the Government regulation, and the presidential decree on internal control systems and internal audit respectively (v) BPK in conducting a legal review of, and prepare a report concerning, laws or regulations that inhibit BPK from fulfilling its Constitutional mandate in accordance with the newly enacted State Audit Law and BPK Law;

(vi) Ministry of Home Affairs (MOHA) and the intergovernmental drafting team in (a) considering and drafting a standardized model local regulation ((SK, PERDA) that addresses the roles and responsibilities1 of BAWASDAs; and (b) developing an action plan to disseminate the standardized SK and PERDA through a series of familiarization workshops2 conducted in BPK’s seven regional offices;

1 This will specifically address key areas such as auditing standards, code of ethics, roles and responsibilities within

the structure of regional government, public awareness and comments, reporting responsibilities (BPK, Parliament)—all to be further specified in a regional audit manual.

2 These workshops will be held in the BPK’s existing regional offices. The latter offices undertake audits in a geographical grouping of provinces.

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(vii) MOF with the legal aspects under its consideration, and with preparation of a report on whether or not to transfer the certification mandate for internal auditors to internationally recognized audit certification bodies such as IIA;

(viii) MOHA in organizing Memorandum of Understanding (MOU) with the regional chief executives, DPRD secretariat, and BPK, whereby the parties agree on institutional, regulatory, and administrative arrangements relating to the accountability, oversight, and public awareness activities under the STARSDP Project and

(ix) BPK with the legal aspects, if any, of the issuance of a regulation requiring audit planning to be based on risk-based methodology that will allow BPK to selectively target its audits.

7. The international consensus building facilitator (6 person-months) will be responsible for assisting

(i) BPK in considering alternative SDPs and IDPs, (ii) the Interministerial Committee in drafting recommendations concerning the

repositioning of BPK at the central level of Government, (iii) BPKP in considering alternative IDPs, and (iv) in designing the regional workshops.

B. Technical Assistance to the ILMU ($3.7 million) 8. TA will be provided to assist the ILMU team conduct in-depth project reporting and monitoring and liaison with the component implementation units (CIUs) at the central level. Regional monitoring teams will be established to assist in quality assurance and monitoring at the regional Bawasda level. The BAWASDA will work closely with the MOHA-CIU. 9. The total cost of the TA will be $4.6 million, of which the grant from the Government of the Netherlands will finance $3.7 million, and the Government of Indonesia $0.8 million. Tables 13.3 and 13.4 below provide the financing plan and the costing details respectively.

Table A13.3 Financing Plan

($ ‘000) Item Foreign Local Total Percent

Cofinanced 890.2 2,814.8 3,705.0 80.0 Central Government 0.0 927.6 927.6 20.0 Total 890.2 3,742.4 4,632.6 100.0

Source: ADB. 2003. Preparing the Support to State Audit Reform Project. Manila (INO-TA 4107

10. The TA will fund two groups of experts. Each group will be made up of one international expert supported by a team of domestic experts. One group will help the ILMU coordinate in-depth overall financial and operational (including quality assurance) reporting at the central level. The second group will help the ILMU and MOHA-IG coordinate financial and operational reporting and review (including quality assurance) at the regional level. 11. The central-level financial monitoring and quality assurance experts will comprise an international expert and team leader (60 person-months) and domestic experts (320 person-months). Terms of reference will be as follows:

68 Appendix 13

(i) In accounting, reporting, and auditing:

(a) become familiar with the procedures of loan preparation, and procurement and disbursement processes, and apply the procedures and process for financial management in accordance to the Asian Development Bank (ADB) Loan Disbursement Handbook, 2001

Table A13.4 Costing Estimates

($ ‘000)

IT=Information Technology, PIU=Project Implementation Unit Source: ADB. 2003. Preparing the Support to State Audit Reform Project. Manila (INO-TA 4107).

(b) review and update the project administration memorandum and set up the financial management, reporting, and overall financial control systems;

(c) establish a project performance management system (PPMS) so that the key information can be highlighted in ADB’s project performance, and reporting (PPR) system;

(d) conduct training at PIUand EA level;

Local Foreign Total

I. Investment CostsA. IT Equipment 2.2 3.3 5.5B. Office Equipment 77.0 0.0 77.0C. Piloting and Scaling-out New Practices 0.0 0.0 0.0D. Manuals 0.0 0.0 0.0E. Training

1. Consulting ServicesIndonesian Experts 2,568.0 0.0 2,568.0Indonesian Contract Staff 324.0 0.0 324.0International Experts 247.5 577.5 825.0 Subtotal 3,139.5 577.5 3,717.0

2. Workshops 70.0 30.0 100.03. Training 0.0 0.0 0.04. Tours 0.0 0.0 0.0

Subtotal 3,209.5 607.5 3,817.0F. PIU Operating Costs

1. Travel 158.0 237.0 395.02. Office Expenses 157.0 0.0 157.0

Subtotal 315.0 237.0 552.0 Total Investment Costs 3,603.7 847.8 4,451.5

II. Recurrent CostsOperations 0.0 0.0 0.0

Total Recurrent Costs 0.0 0.0 0.0 Total Baseline Costs 3,603.7 847.8 4,451.5

Physical Contingencies 18.9 15.0 33.9Price Contingencies 119.8 27.4 147.2

Total Project Costs 3,742.4 890.2 4,632.6

Item

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(e) supervise peer reviews, conduct midterm reviews, report on project completion, and run workshops and surveys;

(f) review withdrawal applications and carry out imprest account and other accounting reconciliations

(g) review and maintain a project administration manual (PAM); (h) prepare, monitor, and report on CIU budgets monthly; (i) prepare consolidated financial and operational reporting monthly,

quarterly, and annually; (j) review the scholarship programs established for the inspector generals in

universities in and around Jakarta; (k) ensure that the project Web site consultant is given correct and timely

information; and (l) liaise with the project auditors and review and report on project audit

findings and project follow-up as part of the consolidated reports. (m) In procurement: follow up on the procedures established by the

procurement expert in the ILMU and ensure that ADB procurement procedures are well understood;

(n) review and report monthly on all procurement activities at the central level, particularly adherence to agreed-on procedures;

(o) produce a quarterly consolidated procurement report on all contracts; (p) update the Project Administration Manual and the master procurement

contracts list by each implementing unit, including the CIU; (q) assist the CIUs as required in the procurement process and

administration thereof; (r) ensure that adequate procurement records and contract ledgers are

maintained at each CIU; (s) conduct procurement audit, if necessary; and (t) review the terms of reference of all the consultants.

(i) The regional financial monitoring and quality assurance experts will comprise an international expert and team leader (60 person-months), together with local experts (540 person-months), organized in regional teams to cover activities similar to those listed above. The focus will be on the regional project implementation units established for each BAWASDA and regional parliament and the scholarship funds established at the universities.

70 Appendix 14

REGIONAL GOVERNMENT SELECTION CRITERIA 1. With over 13,000 and more than 220 million citizens, the Republic of Indonesia is the world’s largest archipelago and the fourth most populous nation. Indonesia is divided into 30 provinces and over 400 districts. Average population per province is slightly less than 7 million, and about 0.5 million per district. However, there are significant variations: the province of Gorontalo has less than 1 million people, while East Java is home to over 35 million; and districts show variability between 20,000 to over 4 million. 2 At present there is no universal approach among the external funding agencies on the selection of districts though there is general agreement conceptually that, to varying degrees good governance, competition and selectivity must be part of that process. There are at present no standard governance filters, and there is discussion as to whether it is possible to establish nationwide governance filters. It is also recognized that given that decentralization is still at a nascent phase technical assistance support may be required so as not to exclude those regional governments who have the desire but not the resources to achieve the desired governance standard for further support. 3 Asian Development Bank (ADB) is currently utilizing the above principles to design a more robust regional selection framework as part of the second tier filter. A draft paper has been prepared and some staged criteria have been developed. The draft also reviewed and incorporated elements of the current World Bank selection framework and its application in two proposed investment projects. The STARSDP incorporated the key elements of the above and will identify districts utilizing the elements in Table A14.1 below in the following way.

Table A14.2: STARSDP Criteria for Selection of Regional Governments

Phase Detailed Requirements Verification/Support Identification Phase

Regions to be selected having strong support from the head of regions to strengthen Bawasda functions. Further, another criteria for the identification of candidates to participate in the STAR project are:

(i) BAWASDA that has strong interest to participate in the project (ii) BAWASDA that has insufficient infrastructure to conduct effective audit. (iii) BAWASDA that has inadequate Human Resources quality to conduct supervision functions. (iv) Head of Regions (Governor, Bupati, Walikota) then to submit a “letter of interest”, expressing Regions interest to participate in the STARSDP program.

MOHA-IG to (i) Advertise the STAR SDP project highlighting the three type of funds (grants) to be given to the regional governments namely -Capacity Building for Bawasda $115,000 -Educational Scholarship for Bawasda $ 50,000 -Capacity building for DPRD $30,000 (ii) Verify fiscal capacity and certify the eligibility of the local governments (iii) Compile letters of agreement from the local governments (to cover Bawasda and DPRD Secretariat)

Pre-Investment-Second Phase

To qualify getting s support from the STARSDP, MOHA-IG has to ensure regions have fulfilled requirement as follows: (i) Submission of the draft local regulation (PERDA or SK Bupati) within 6months after receipts the guidance from MOHA about the strengthening roles of

MOHA IG to (i) review content of draft local regulations, and certify eligibility before submission to ADB. (ii) Eligibility will verify that the local regulation was submitted, that there were public hearings and minutes of the meetings, that public comments were considered, and that content satisfies the objectives of the original draft.

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Phase Detailed Requirements Verification/Support Bawasda. (ii) Assessment needs of BAWASDA submitted within the same time identifying physical and human resources requirements of the BAWASDA, including plans on how to sustain BAWASDA’s operations and maintenance, training, education and certification of investment support that is to be provided. Detailed budget to be provided including monitoring. (iii) Assessment needs of regional parliament secretariat submitted within the same time identifying physical and human resources requirements of the DPRD secretariat, including plans on how to sustain the operations and maintenance, training, education and certification of investment support that is to be provided. Detailed budget to be provided including monitoring.

(iii) Review the needs assessment, budget and development plan and certify feasibility of the proposals.

Investment phase-Third Phase-

Prior to receiving ADB funds a letter of readiness signed by the Head of Regions stating that:

(i) The Local Government has issued a new local regulation (PERDA and/or SK i) to strengthening Bawasda roles and authority. (ii) Chief Executive of the regional government has agreed to carefully review the BAWASDA’s audit findings and agrees to follow up actions on the findings. (iii) Chief Executive of the regional government has approved a mechanism for public access to the audit report from BPK (iv) Chief Executive of the regional government has allocated sufficient activity (counter-part) funds (v) MOHA-IG has set up PIU to manage the project implementation (vi) BAWASDA has developed Institutional Development Plan (IDP) as a guideline in utilizing the ADB loan funds. (vii) BAWASDA has opened a special account for ADB funds, detach from their regional budget account, to be monitored during the project implementation period. (viii) BAWASDA agreeing to fully participate in an external audit of funds used. (ix) Implementation signed between the participating university and the BAWASDA on the use of the scholarship grant First 50 to qualify for ADB support.

MOHA IG to (i) submit copies of the legislation to ADB certifying that the they are satisfactory in form and substance. (ii) submit institutional development plans for BAWASDA and DPRD Secretariat. (iii) submit copy of the letter of readiness indication the satisfaction of conditions listed under the letter of readiness.(iv) to log the submission in a database

Post Investment Phase

Audit undertaken, by BPK, of the first tranche of funds utilized for requirement to

MOHA IG to (i) Review the audit reports and submit

72 Appendix 14

Phase Detailed Requirements Verification/Support get the following tranche of the funds (grant) and scholarships

summary and reports to ADB identifying any issues of concern or interest.

(ii) Regional governments with qualified reports, reports with substantial issues registered in the database and made available to ADB and other external funding agencies

BAWASDA,=Internal auditor in regional government, BPK=State Audit Board of Indonesia, BPKP=Government Internal Audit Agency, MOHA=Ministry of Home Affairs, MOU= Memorandum of Understanding, PIU=Project Implementation Unit, Source: ADB. 2003. Preparing the Support to State Audit Reform Project. Manila (INO-TA 4107).