RRT ERBIL: IMPROVING BUDGET EXECUTION IN THE KRG

UNCLAS SECTION 01 OF 02 BAGHDAD 001262

SIPDIS
SENSITIVE

E.O. 12958: N/A
TAGS: EAID PGOV EBUD IZ
SUBJECT: RRT ERBIL: IMPROVING BUDGET EXECUTION IN THE KRG

REF: Baghdad

This is an Erbil Regional Reconstruction Team (RRT) cable.


1. (SBU) SUMMARY: Acknowledging deficiencies in public finance
management, the Kurdistan Regional Government (KRG) has committed to
an ambitious UNDP-supported Public Finance Management Plan for
improving transparency, planning execution and oversight. While the
project is aligned with the national Public Finance Management
Action plan and has elements which link the KRG budget process more
closely to the GoI budget, it does not specifically address the
issue of late and unpredictable transfers from the GoI which are a
significant obstacle to KRG budget planning and execution. The KRG
has committed $500,000 of its own resources to the $4.5 million
project; the World Bank has also agreed to fund $2 million. A
budget gap of $2 million must still be met. U.S. funding for this
project would support an important step towards increasing
transparency and accountability - important anti-corruption and good
governance indicators for the Kurdistan Region. End summary.

Public Finance Management Action Plan
--------------

2. (U) The KRG invited donors and other international organizations
on May 6 to witness the signing of the KRG's Regional Public Finance
Management Action Plan and the roll-out of UNDP's $4.5 million
Budget Execution Support Project which underpins the Action Plan.


3. (U) Described as a complement to the GoI Financial Management
Plan (which has some overlap, but does not specifically address the
needs in the the KRG),the three-year KRG PFM Action Plan
acknowledges serious weaknesses in the current public finance system
(see paras 6-12 for discussion) and aims to strengthen internal and
external control systems and increase accountability over the use of
public resources. Areas addressed are budget policy, planning and
formulation, budget execution, public procurement and payment
systems, public finance reporting and controls and building
sustainable capacity in public finance management. Donor countries
will be invited to sit on a KRG PFM Advisory Board.

GoI-KRG cooperation on Public Finance Management
-------------- ---

4. (U) Mr. Adhmed Mahdi of the Baghdad Ministry of Planning
Development and Coordination signed a Memorandum of Understanding
between the GoI and the KRG in which both sides agreed to implement
their respective PFM Action plans, collaborate to mobilize resources
and technical assistance and establish a Joint PFM Working Group.
In his comments Mr. Mehdi noted areas of convergence with the KRG,
including the KRG's commitment to use the central government Budget
Call Circular being developed and the KRG's commitment to implement
the new GoI procurement law and regulations, which should be
approved soon in the Council of Representatives.

Funding from KRG and World Bank
--------------

5. (U) The KRG announced that it would commit $500,000 of its own
resources as well as additional in-kind contributions to the UNDP
project. World Bank country Director Jean Michelle Happi noted that
a USD 20 million facility was funding the national PFMAP and
announced that the World Bank would cover $2 million of the KRG
project. Mr. Happi stated that where elements of the KRG PFM's
action plan overlapped with the GoI's PFM items, the World Bank
would provide assistance, financial and technical, to ensure these
items are fully integrated. Other donors (France, Germany, Japan,
Korea, US, Italy) expressed support for the project's aims, and
promised to study the proposal. (Note: UNDP has already committed
Qpromised to study the proposal. (Note: UNDP has already committed
$850,000 "Trac-1" resources to the project preparation.)

Weaknesses in KRG Financial Management
--------------

6. (U) The Kurdistan Regional Government (KRG) derives over 97
percent of its revenues from transfers from the Central
Government and shares the GoI's vulnerability to fluctuating oil
prices. Transfers are made up of the Divisible Pool (the Region's
17% share of the Federal Budget after deduction for in-kind
transfers and sovereign expenditures),In-kind Expenditures (food
basket, fuel, pharmaceuticals),the Regional Development Fund (of
which the KRG receives only 11.3 percent of the total fund) and the
Regional Development Banking Fund. KRG authorities claim that
earmarked fuel subsidies and some food ration subsidies have been
withheld.


7. (U) The KRG collects revenues from customs at the borders of
Turkey and Iran, and to a lesser extent from rent incomes and fees.
Revenues were estimated at $162 million in 2007 and $177 million in
2008 (less than 2.2 percent of transfer levels.) In 2007 the
Central Government deducted estimated customs revenues from the
KRG's 17% transfer.

Expenditures
--------------

8. (U) Wage bills and non-wage recurring expenditures accounted for
over 65 percent of total KRG spending in 2007 - putting heavy

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pressures on fiscal sustainability and contributed to crowding out
capital expenditures. (The urgent need to reform the civil service
and provide an alternative "social safety net" is not addressed in
the UNDP project, but has been highlighted elsewhere by KRG leaders
as a priority. )

Deficiencies in planning, execution and oversight
-------------- ---

9. (U) Kurdistan Regional strategies and policies are not linked to
KRG budget planning and execution, leading to mismatches between
what is promised and what is affordable. In addition, according to
UNDP, capital budgets are subject to political priorities identified
by the KRG Council of Ministers without clearly identified rules and
priorities. Execution is also heavily disadvantaged by the
uncertainties of the timing and amounts of transfer and cash flows
released to the KRG's Central Bank from the Central Bank of Iraq,
making it difficult for ministries to effectively plan and implement
programs. The KRG Ministry of Finance has reported that average
delays exceeded three months during 2008. The KRG Authorities have
reportedly sought cooperation from the Central Ministry of Finance
and the CBI to make cash flows available at the beginning of the
month based on clearly defined policy, in order to be able to plan
and execute the budget more accurately.


10. (U) According to the UNDP analysis, the KRG operates a
cash-based system of accounting which does not fully identify,
capture and record commitments. Reporting is limited to preparation
of trial balance which is essentially a book balancing tool.
Oversight and internal controls are carried out within each spending
unit by internal auditors. However, procedures are not clear,
predictable or standardized.

Board of Supreme Audit
--------------

11. (U) The KRG Board of Supreme Audit (BSA) provides overall
guidance for maintaining a system of internal controls and conducts
the external audits after the implementation of the budget. However,
the BSA does not receive the consolidated financial statements
transmitted to the Kurdistan Parliament by the KRG Ministry of
Finance in a consistent and timely fashion, which has caused delays
in auditing accounts. Although plans are underway for unification,
the existence of two BSA structures (one in Erbil and one in
Sulaimaniyah) stand in the way of a unified procedure and auditing
framework for the region. Other challenges facing the BSA relate to
the lack of qualified staff; the need to upgrade auditing practices
in order to meet sound international standards; and the need to
affiliate the BSA with regional and international auditing
institutions, such as INTOSAI, ARABSAI and ASOSAI.

Procurement
--------------

12. (U) Public procurement in KRG broadly follows Iraq's national
standards. According to UNDP, current procedures have a number of
features that are not in line with generally accepted standards of
good practice. These range from inadequate requirement for
registration of suppliers and contractors, an absence of adequate
bidding documents to insufficiently transparent bid submission,
opening and evaluation procedures, and contract award procedures as
well as lack of effective bid protest mechanisms and publicity on
contract awards. However, a new procurement law and standard
bidding documents are now being developed at the national level.
The draft law and regulations (which the KRG will follow) were
signed off by the Government of Iraq in 2008 and are under review by
the Shura Council, before being submitted to Parliament for
approval.

Comment:
QComment:
--------------

13. (SBU) Like the rest of Iraq, the Kurdistan Region must adapt to
the fact that oil price fluctuation will always impact planning, and
must put in place mechanisms to "smooth out" year to year
volatility. But the region faces an additional challenge, the fact
that cash transfers are late and unpredictable, and the region's
budget must always wait on the final Baghdad budget numbers. Most
of these problems can be mitigated by preparing contingencies, and
improving planning, but it is clear that discussion between Baghdad
and Erbil on these issues needs to be deepened in order to put in
place better mechanisms. The MOU signed on May 5 may be a useful
first step, but we note that the key player on these issues - the
Ministry of Finance - was not present at the meeting.


14. (SBU) The USG has provided relatively little support to the KRG
to improve public finance management (primarily Brinkley Task
Force-funded procurement support) and nothing to support
anti-corruption activities. Funding the UNDP project either
directly or through in-kind contributions would support an important
step towards greater professionalism, transparency and
accountability in KRG budget execution - objectives which are key to
larger USG goals of good governance for the region. We strongly
urge consideration of such support.
BUTENIS