Auditing Economic Reform: The Nepalese Exeprience

- Ram Babu Nepal Nepal

Introduction

Developing nations are confronting the critical challenge of demonstrating better performance and effectiveness in managing public resources. Their economy is characterized by unequal distribution of economic opportunities, income disparity, under utilisation of available resources, poverty ridden mass, underdeveloped human capital, low productivity and lack of collective zeal for development. These inherent challenges are to be addressed effectively by making the management of national economy dynamic and responsive. Various reform measures are initiated to improve resource management and strengthen national economy. His Majesty's Government of Nepal (HMG/ N) has been more articulate to the challenges and prospects of national economy specially after the restoration of multi-party democratic system in 1990. However, the impact of awareness and concern have not been able to bring significant change due to lapses in economic philosophy and lack of commitment for cause endorsed by consensus.

The wide scope of government activities has expanded the responsibility of Supreme Audit Institutions (SAIs). Objective and timely evaluation of results and impact of reform measures would further contribute in accelerating the process of reform and securing optimum benefit from it. In this context, auditing, as an independent, impartial and objective examination and evaluation of financial and other operations contribute in reform process mainly by:

identifying strengths and weaknesses of reform measures;
attesting the reliability of the financial and performance reports;
evaluating impact, relevance and appropriateness of reform measures:
recommending measures of further improvement.

Objectives, Elements and Measures

Economic reform is not a single indivisible concept. It is continuous and comprehensive process embracing elements that can play both integrated and independent role in encouraging economic activities. Multiple measures are initiated to supplement its implementation. The general objectives of economic reform are: to create appropriate economic climate by correcting self-conflicting economic policies; to provide new direction for development planning and programming to address critical challenges of national economy; to reduce the burden on national economy; to improve government's financial position; and to reduce the economic burden of people.

The reform measures initiated in Nepal are focused ultimately to achieve sustainable growth with equity mainly by: (a) making national economic activities responsive to changing external environment, (b) ensuring best use of available resources, (c) establishing balance between different sectors of economy, (d) promoting transparency and accountability in public fiscal management, (d) providing reliable information on performance in time to initiate corrective actions. The major intents of economic reform are:

to redirect mobilization of resources to rural and underdeveloped area;
to enhance the efficiency of public and corporate sector;
to strengthen the process of economic openness and market friendly approach;
to alleviate poverty by increasing the opportunity of employment and development;
to improve the system of resource management;
to reduce fiscal deficit;
to strengthen revenue administration by making it simple and transparent;
> to maintain reasonable balance between different sectors of economy.

The major elements of economic reform are as follows:

Liberalization - It is the distinguished feature of economic reform. Liberalization is not just a specific policy but the sum total of policies that are initiated to make economic programs rewarding, open, flexible and responsive to market situation and external environment. This concept was introduced to direct policies and procedures towards openness to encourage market friendly approach. Its basic focus is to reduce state's control over economic processes. It is aimed to encourage free interplay of market forces. 'Economic liberalization has two dimensions: domestic and external. Domestic market liberalization usually refers to deregulation of capital and labor markets, removal of controls on price and privatization of government owned enterprises. Similarly, external liberalization consists of two components: trade liberalization and convertibility of domestic currency (Prof. Pushkar Bajracharya and Dr. Shankar Sharma - Impact of Economic Liberalization in Nepal, Institute for Integrated Development Studies, Undated, p.2). The role and responsibility of state does not diminish with the adoption of liberalized economic policy, rather it demands more dynamic, forward looking and benevolent approach so that larger sections of society can be benefited from it. State has to play leading role in promoting small, unorganized and traditional business community to enhance their competitiveness.
Tax Reform - Economic and tax reform play complimentary role. Taxation is not only a means of collecting revenue but also an important instrument of encouraging production, productivity, corporate sector and domestic economic activities. Economic reform focuses on making tax system progressive, productive and favorable to stabilization and growth. Hence, government has initiated various measures to improve tax system by making it economical, efficient and effective.
Privatization - It is a recent economic phenomenon and complimentary to liberalization. HMG/N has adopted the policy of privatization mainly with the objective of encouraging private sector in managing large manufacturing and commercial enterprises, enhancing efficiency and competitiveness of such enterprises, diverting public sector resources in social sector and making national economy dynamic and responsive. Privatization Act, 1993 prescribes the procedures to be followed in the privatization to make it more transparent.
Improvement in Resource Allocation Process - The deficiencies in the system of resource allocation have caused a number of developmental problems. Limited resources are allocated without proper appreciation of genuine concerns of people and capability to implement policies and programs. It has resulted time and cost overruns. Efficient and effective allocation of public resources have been a major thrust of reform process. Improvements in the system of budget formulation and management are directed towards making rational decisions in the allocation of resources and evaluation of performance.
Macroeconomic adjustment - Balanced growth of economy is fundamental to sustainable development. Developing nations are facing unique challenge of duality of economy. Urban economy is mainly based on modern system of production and rural economy is predominantly traditional and growth rate is even negative. There is a high need to make adjustment between activities effecting national economy. In this context, policy should focus in fostering rural economy to maintain critical balance between different sectors of economy.
Encouragement to local skill and resources - The ultimate objective of sustainable economic growth can be best achieved by encouraging the optimum use of indigenous resources (human skill and natural resources). Economic reform policies and measures have focused on the ways and means that encourage local resources and human talent.

A number of measures contribute in the process of economic reform. However, prominent measures are: realistic objectives for national economic management, improved budgetary practice, performance reporting and measurement system, encouragement to economy, efficiency and effectiveness in resource management.

Reform measures have influenced every aspects of public life although, it may not be possible to determine its exact magnitude. The general implications of economic reform are as follows.

The competitiveness of business and commercial enterprises have significantly expanded. Enhancement of capability of human resources and managerial systems are essential to secure benefit from reform process.
Economic reform implies encouragement to economic and business community. Therefore, administrative procedures are to be simplified and made transparent but without defeating the norms of value of social justice and equity. It poses serious challenge in maintaining proper balance between autonomy and regulatory framework. Government control is to be reduced and regulatory practice properly justified.
Accountability obligations are to be discharged more efficiently and relationships among cooperating institutions strengthened.
The system of financial and performance reporting has to be improved to facilitate decision making and analyze impact.

Audit Objective, Criteria and Methodology

SAIs have the basic responsibility of providing accountability report highlighting physical and financial performance, compliance with regulation and status of internal control. Introduction of performance auditing concept as a reliable means of evaluating programs/projects to identify existing and potential weaknesses and recommending measures of improvement have added its value. It provides useful support in identifying critical measures that enhance reform process and pitfalls in implementation. In this context, audit undertakes a detailed and empirical study of: working relationships between planning and implementation process, allocation, management and control of resources, performance reporting, monitoring and evaluation system. It is to be supported by performance related information that can be obtained through financial management based on objectives, programs, projects, functions, activities and well structured reporting system.

Defining audit objective clearly and precisely is basic to ensure its credibility. The objective of audit of economic reform may be described as:

To examine and evaluate the systems designed to ensure economy, efficiency and effectiveness in managing resources, translating economic objectives and polices into programs, projects, procedure and operational systems, establishing institutional linkage between policy planning and implementation, communicating of the results of performance and their use in making decisions.

Its objectives may be further described as to determine whether:

there is clear institutional linkage between planning and budgeting to ensure
best possible use of available resources;
policies are properly translated into programs, projects and activities;
administrative procedures are clearly spelled to avoid confusion and conflict in implementation of policy measures;
budgetary disbursement process is smooth and based on actual requirements of programs and projects;
financial information and performance reporting system are sufficient to make decisions regarding resources management;
systems, role and responsibilities of executing agencies are clearly defined;
accountability relationships between executing agencies and responsible officials is clearly spelled out and operating efficiently; and
system of performance reporting is sufficient and appropriate.

Audit of economic reform is a government wide study. It requires comprehensive appraisal of implementation of policy measures. Mixed application of process and results oriented approach might be useful for the audit of economic reform. As reform measures are comprehensive, its application covers almost every organization, detailed study of all organization may not be feasible. System based auditing is a practical means to obtain representing facts and figures that might provide a reasonable basis for further examination of critical and risk areas. Such approach focuses on the examination and evaluation of systems and processes that support smooth execution of reform measures.

The audit reform may be carried out at following three levels to arrive at objective conclusion about its effectiveness.

Policy Level - Policy bridges the gap between overall objective of national development and objectives of specific programs or projects. Auditing of policy focuses mainly on the structure of policy, clarity and efficiency in translating policy measures into specific program, projects and activities. It helps in identifying the gaps between policy objectives and measures for implementation.
Multi-agency/Sectoral Level - Multiple agencies are required to work coherently to achieve the objective of economic reform. Regulatory, developmental, promotional and protective role of government have to be discharged in complimentary manner to secure the benefits from reform measures. Autonomous bodies, public corporations and professional institutions work together to promote economic activities. Audit looks into the procedures established to maintain cooperation between participating institutions, clarity of their roles, responsibilities, communication and performance reporting practice. It provides useful insight into the organizational network through which government's commitment are met effectively.
Organization Level - Audit at this level focuses on the performance of a particular agency. In-depth study of the performance along with the audit of financial transaction provide true and fair picture of operation and delivery of services.

The comparison of advantages and limitations of these three approaches are as follows.

Approaches	Advantages	Limitations
1. Policy Level	Provides deeper understanding of the situation which encouraged to adopt specific policy measure or develop a particular system. Its findings may have comprehensive impact in the management of national economy. It helps identifying key issues that have lasting impact.	Difficult in determining performance indicators and criteria due to comprehensive policy. Difficulty in monitoring the progress of audit work Complication in precisely specifying accountability obligation and agency/ official contributing to success and effectiveness. Difficulties in obtaining consolidated information on performance
2. Multi-agency/ sectoral level	It helps in understanding the critical issues in managing projects to be implemented in a coordinated way. It provides sound basis to appreciate the role of various agencies and importance of information in achieving developmental objectives.	Problem in specifying agency/official responsible for specific accomplishment.
3. Organisational level	Easy to identify accountable units and accountability relationships; Easy to manage audit and evaluation activities Relatively simpler to determine efficiency and effectiveness indicators and criteria.	Does not provide comprehensive picture of issues and challenges. Focused only on limited area.

identification of performance indicators and criteria are crucial in course of planning performance auditing, setting its objective, determining scope and methodology. As economic reform covers wide range of issues, auditor should be able to determine criteria which supports to arrive at conclusion that is both representative and relevant. Determination of specific and general criteria assumes special importance in evaluating economic reform. Criteria is the reasonable and attainable standards of performance and control against which the adequacy of systems and practices are assessed. It reflects a normative (that is, desirable) control model for the subject matter under review. Criteria for audit of economic reform should be determined by considering expected improvement from reform measures.

There may be specific criteria to audit a particular policy. However, the general criteria applied in auditing economic reform are as follows.

There must be clearly defined institutional relationships between agencies responsible to implement reform measures;
Reporting and follow-up system clearly spelled out;
There should be harmony between policy, programs and laws;
Resources required to implement reform should be sufficiently justified and made available in time.

Some of the common methods used in the evaluation of the efficiency and effectiveness of reform measures are as follows.

Attesting Credibility of Financial and Performance Reports - The prime responsibility of audit is to attest credibility of financial statement or report irrespective of its organizational status (internal or external), nature and scope. Introduction of modern concepts of auditing made auditor's role much wider by making the responsibility of attesting performance report as an integral part of his job. The function of attestation is intended to judge the efficiency and rationality in the execution of reform measures. It alone can not provide comprehensive picture on the effect of reform process. However, it gives an useful insight into the management direction, efficiency and reliability of information system. Auditor can express reasonable conclusion and opinion on the basis of credible financial and performance report. This function can be best performed by combining the elements of regularity and financial auditing.
Evaluating the Impact of Policy Measures - Auditor has to express conclusion over the impact of reform measures in different sphere of public life. In this context, auditor has to evaluate the contribution in meeting the objectives of state. The Constitution of the Kingdom of Nepal, 1990 states the economic objective of state as follows.

The fundamental objective of the state shall be to transform the national economy into an independent and self-reliant system by preventing the available resources and means of the country from being concentrated within a limited section of society, by making arrangements for the equitable distribution of economic gains on the basis of social justice, by making such provisions as will prevent economic exploitation of any class or individual, or by giving preferential treatment and encouragement to national enterprise, both private and public.

The salient features of national economic objectives are:

transformation of national economy;
equitable distribution of economic gain on the basis of social justice;
prevention of economic exploitation; and
promotion of national, private and public enterprises.

Auditor has to consider these objectives in evaluating the impact of reform measures. In this context, it is essential for the auditors to appraise the focus of sectoral policies and determine whether they are in consonance of broad national objectives. It is certainly a mental exercise that need exposure to policy framework.

Improvement in Public Resources Management - There are certain premises related to the management of public resources. It is expected to serve purposes such as promoting administrative and managerial accountability, encouraging rational allocation of resources, supporting management of national economy and providing reliable information related to actual condition on different aspects of resource management. Budgetary system plays prominent role in managing public resources. Evaluation of the contribution of economic reform in managing public resources require comparative study of resource allocation, practice of determining priority, monitoring and reporting system. In recent years, auditors have carried out comparative study of the system of determining priority in the program/project and budgetary allocation. In addition, detailed study of the system of budget formulation both at field and central level, approval, disbursement, virement, monitoring and evaluation have provided useful information related to the decision making process in resources management.

Application of program budgeting concept is an important step towards improving public resource management. Determining practical objective, target, major activities, performance reporting and periodic review and monitoring system are the major ingredients of program budgeting. Right application of the program budgeting concept contributes in ensuring effectiveness of resource management system. Hence, audit has to evaluate the efficiency in implementing program budgeting to determine whether stipulated budget objectives are achieved.

Support to macroeconomic stability - One of the expected contributions of economic reform is to support in achieving macro-economic stability. Developing economies are vulnerable to instability due to external economic environment. Changes in price level, international trade policy and technological innovation have significantly influenced developing economies. Making tax policies flexible and responsive to the changes inspired either by domestic or external economic environment might be one of the useful instrument in encouraging macroeconomic stability. Budget should allow reasonable flexibility that safeguards interest of domestic economic activities from external changes to the possible extent. Auditor can not arrive at valid conclusion regarding the support of reform in macroeconomic reform only by looking into books of accounts. In this context, auditor has to carry out certain extent of research work. He has to rely on the statistics related to macroeconomic indicators. In Nepal, there is a practice of comparing and analyzing the statistics published in the Economic Survey (submitted annually by the Minister of Finance in Parliament prior to the presentation of budget), publications of the central bank, Central Bureau of Statistics and other institutions.
Control of budget deficit - Increasing trend of budget deficit is one of the major challenge facing most of the developing economy. It has serious negative implication on national economy. In Nepal, the amount of deficit is increasing and future trend is anticipated to be more critical mainly due to debt servicing, difficulties in enhancing efficiency of revenue administration, controlling unproductive expenditure and lack of commitment. Budget should have specific proposal to reduce deficit and executed efficiently. For many years various measures are being proposed to control unproductive expenditure and increase revenue by improving the quality of administration. However, the results have not been effective due to various factors specially failure to implement austerity measures, corrupt practices and inefficiency in revenue administration.

Audit looks into the efficiency in controlling deficit from two basic perspectives, i.e.,

whether genuine efforts are being made to contain regular expenditure within reasonable limit;
whether accrued income have been realized in time; and
whether projects are selected, approved and implemented in accordance with approved guidelines.

Salient Features of the 1998 Report

The thirty fifth report of the Auditor General of Nepal submitted to His Majesty's King in August 28, 1998 has touched upon various aspects of economic reform in a systematic way. Although many more issues are yet to be addressed, this report has highlighted significant matters policies and practices of discharging accountability requirements and relationships of administrative units (supervisory, policy making and operating), ensuring transparency in financial reporting system. This report was very well received by stakeholders and commended the boldness and clarity of subject matters. At the outset of the report the Auditor General on his introductory remark has highlighted the contribution of auditing as follows.

Supreme Audit institution supports in strengthening public financial affairs mainly by:

Promoting accountability and transparency in public fiscal management;
Encouraging economy and efficiency in the mobilisation of public resources;
Making public organisations effective in achieving their objectives
enhancing and ensuring integrity and discipline in the operation of public fiscal activities; and
complying with existing rules and regulations and initiating required charges.

The issues explicitly highlighted in this report are as follows.

Privatization - Part - 2 of the report (containing Performance Audit Reports) contain a special chapter on privatization. It contains comprehensive information related to the privatization initiative since 1991 and appraisal on the impact of this measure and the deficiencies in procedural matters.
Budgetary management - Analysis of budgetary management comprises system related to approval of development budget, programs, revisions and alterations in program/project components, reappropriation (inter and intra sub-head transfer), efficiency in disbursing budget, flow of financial and performance report etc. Information contained in this report regarding budgetary management provides comprehensive picture of the pitfalls in managerial decision making and actual condition of budget implementation.
Efficiency in controlling misuse of public resources - Waste, abuse and mismanagement of public resources have been a serious problem in Nepal. It has resulted several deficiencies in delivering public services and increased the cost of such service. In addition, frequent transfer of key personnel has severely affected the performance of programs and projects. 1998 report has highlighted major cases of waste, abuse and mismanagement of resources and non-compliance with existing policy framework.
Efficiency of revenue authority in implementing revenue proposals - For many years, revenue realization has been substantially below target. It has negative impact mostly on development expenditure because revenue surplus was insufficient. This report has highlighted the situation in implementing the revenue proposals of government. The cases mentioned in the report indicate that required initiatives were not taken in implementing some proposals. In addition, lack of coordination among administrative units was clearly observed in executing of the revenue proposals
Efficiency and effectiveness of the organizations entrusted with promotional responsibilities - The effectiveness of economic reform measures specially liberalization and free market operation demands encouragement to small enterprises to make them competent to face competition with limited resources and capability. Therefore, government has initiated various promotional measures such as training, information, incentives. Audit has evaluated the sufficiency of promotional measures and efficiency in the system of delivering services to users and beneficiaries.
Integrity, wisdom and faithfulness - The value of integrity, wisdom and faithfulness in promoting good governance and securing public confidence over the institutions of governance is well recognized. Audit has been assessing the application of the ideals of integrity, wisdom and faithfulness in management of public resources. This report has also highlighted a number of cases relating to the negligence in safeguard and use of public resources. The audit findings have clearly indicate that there is high need to pay special attention in these issues to enhance public confidence over the institutions of governance.

This report has highlighted several case of violation of the austerity measures by senior public officials including ministers.

Common Challenges in Auditing Economic Reform

Auditing of economic reform is certainly an emerging concept. The Office of the Auditor General of Nepal has no long experience of auditing economic reform. In addition, it is not as easy as auditing a specific project. Comprehensive appraisal of the results of .reform require multi-disciplinary audit team and multidimensional approach. However, the experience gained so far has made it clear that determining actual impact of reform is very critical because of multiple factors influencing reform measures and vulnerability of changes due to external economic environment. The major challenge is related to inadequacy in feedback mechanism. In addition, lack of comprehensive coverage in the system of financial and performance reporting, appropriate focus on goals and programs, clarity in defining public expenditure plan, and qualified manpower to analyze policy impact and failure to integrate financial information with policy/planning function have made examination function not only difficult but also irrelevant.

Concluding Remarks

The significance of audit in encouraging improvement in the public sector financial management is well recognized. It is very essential to receive feedback from independent agency on the impact of reform measures to optimize the results from the resources employed. In this connection, economic reform measures deserve special attention. Reform measures are manifested in several forms and at different times. Multiplicity of reform measures have made inevitable to carry out periodic examination to reduce adverse effect from any measure that is not time tested but generally perceived as relevant. Constant endeavor to obtain benefits from the application of reform measures might be very useful in encouraging learning by doing concept.