1. The spill-over effects of the war on terror and the natural calamities in the years 2005 (earthquake) and 2010 (floods) deeply affected the province of Khyber Pakhtunkhwa (KP), impeding its socioeconomic development. Large-scale military operations ensued the security challenges in the neighboring tribal areas leading to internal migration, mainly to KP. As a result, the resource focus diverted to absorb the fiscal impact of the war on terror. Although the security situation has improved, in an effort to avoid recurrence of security challenges particularly originating from the tribal areas with profound impact on KP, the state institutions have to ensure provision of rights, social services, and an enabling environment for the economic growth. 

2. Efforts by the Government of Khyber Pakhtunkhwa (GoKP) focused on improving governance in the province; and among a wide array of reforms, it took measures for strengthening public financial management (PFM). The GoKP has been a forerunner in PFM reforms. Under the World Bank-funded Project for Improvement in Financial Reporting and Auditing (PIFRA), KP was the first province to automate the District Accounts Offices (DAOs). The Public Expenditure and Financial Accountability (PEFA) assessment (2007) and Fiduciary Risk Assessment (2010) by the U.K. Department for International Development (DFID) created a stimulus for the first PFM reforms strategy adopted in 2010 to improve budget formulation, execution, and fiscal disclosures. 

3. The 18th Amendment (2010) to the Constitution (1973) of the Islamic Republic of Pakistan enhanced the service delivery responsibilities. The increase in resource envelope and responsibilities created an impetus for strengthening PFM, which led to a number of reform measures (Section 5). To assess the strengths, weaknesses, and opportunities resulting from its reform measures, the GoKP partnered with the World Bank to take stock of the impact of the reform efforts by conducting a PFM assessment. 

4. In the last decade, the GoKP has taken concrete steps to build the foundations for improved PFM. The reforms gained further momentum with the surge in resource envelope owing to the increased share in the National Finance Commission Award (2009).1 The increased share of the provinces in the divisible pool, allocation of additional share for KP in recognition of the fiscal impact of the war on terror, and the decision on enhanced profits from hydel power generation more than doubled the resource envelope. Although the federal transfers increased, provincial own source revenue has not responded with a corresponding pace. The increase in provincial own source revenues reflected in the budget books in the last two fiscal years is the result of devolution of general sales tax on services to the provinces. Other provincial taxes did not increase correspondingly. 

5. The GoKP initiated consultations for the formulation of the second round of the PFM reforms strategy. To facilitate informed and evidence based policy making, GoKP approached the World Bank to collaborate in taking stock of the prior reform efforts, diagnose the gaps and provide recommendations to bridge the gaps. It was agreed to conduct PFM assessment on the updated PEFA Framework (2016) and based on the findings of the PEFA review further diagnosis will be planned to explore the gaps and find remedial measures. PEFA assessment was carried out as a joint government and donors initiative. Key development partners engaged with the GoKP in supporting PFM reform collaborated in the review. It was agreed that the World Bank, on behalf of the donors would administer the review. GoKP notified a high level Steering Committee chaired by the Secretary Finance (GoKP) while the Donors’ PFM working group remained active during the assessment. A Team headed by the Practice Manager and represented by the financial management and public sector specialists at the World Bank was formed and consultants recruited to conduct the exercise in partnership with the GoKP (Details available at Section 1.2 of the report). An elaborate quality assurance mechanism was put in place comprising of the sector specialists at the World Bank as well as external peer reviewers comprising of the representatives of the; PEFA Secretariat, participating development partners and the Government of Khyber Pakhtunkhwa. The PEFA assessment was financed under the multi donor trust fund (MDTF) initiatives. 

6. The cutoff date for the assessment was set at 30 June 2015 (the last day of the last fiscal year) for which the audited financial statements were available. Since the GoKP is a subnational government (SNG), the assessment applied the PEFA Framework 2016 and guidance for subnational assessment (2016). The coverage of the assessment is the provincial government fiscal operations. The public sector enterprises and the extra-budgetary units are covered to the extent of financial reporting against budget allocated.

Aggregate fiscal discipline 

7. The assessment highlighted the inadequacies in fiscal discipline evidenced in the expenditure and revenue out-turns, eventuated by fluctuations in the federal transfers and aggravated with the deficiencies in PFM practices in KP. The weaknesses in pillars (II-VII) weigh in on the overall performance of Pillar I (Budget reliability). 

8. Poor revenue estimation can be attributed to the lack of a robust fiscal strategy defined in quantitative and qualitative terms. The deficiencies in the revenue administration ranging from risk management to arrears monitoring to revenue audits have kept the dependence on the federal transfers high. The expenditure estimation is based on inflated revenue targets, rendering the development budget formulation unrealistic, evident from the repeated budget cuts and revisions. Disintegrated budgeting overshadows the impact of development budget on recurrent; as a result, a holistic view of the budget is not available. The GoKP has recently piloted internal audit and its functionalization is critical for strengthening internal controls. 

9. The many budget adjustments, though legally provided for but without a limit on the number of adjustments; the lack of systems and capacity for legislative oversight; and the lack of compliance with the instructions and guidelines of the Finance Department (FD) and Planning and Development (P&D) Department at the budget formulation stage has impacted the fiscal discipline and resulted in high-revenue and expenditure out-turns.

10. The internal controls framework notified is quite robust, but issues remain with its application. Audit reports point at weak internal controls at the line departments. The Public Accounts Committee (PAC) has repeatedly observed the lack of interest of the Executive to comply with its directions. Also, the GoKP has piloted the internal audit in key departments: however, due to lack of capacity, the focus of internal audit is largely on financial compliance rather than strengthening of systems through evaluations and quality assurance. The lack of management response on internal audit reports is mirrored in PAC’s finding indicating “weak tone at the top”. 

Strategic allocation of resources

11. The GoKP has adopted output-based budgeting and provided a medium-term perspective to budgeting to ensure prudent use of fiscal resources. Also, efforts are geared for improving fiscal disclosures and making budget process participatory, besides attempting to link policy planning to budget. The GoKP, having provided an enabling environment is now focusing on systems development and capacity building to entrench these reforms.

12. The practices that are hindering strategic allocation of resources are the vulnerabilities in project planning, costing, prioritization, and screening. Additionally, the incremental increases in the Annual Development Program (ADP), conveyed in the P&D guidelines undermine the utility of the medium-term and output-based budgeting. The provincial development portfolio impinges on the devolved functions; as a result, the ADP includes projects that if analyzed on the principles of subsidiarity should rest with the local governments. Redirecting the ADP’s focus to strategic public investments would contribute to appropriate allocation of resources, keep the ADP size manageable, address the issue of inclusion of unapproved schemes (project proposals) in the budget, and reduce the throw-forward effect. Finally, achieving the potential of the medium-term frameworks entail balancing the political considerations with an informed iterative process to ensure demands articulated from various forums are channeled through the notified mechanism and processes.

Efficient use of resources for service delivery 

13. The overall development budget utilization rate has averaged around 70 percent. However, unfurling the monthly spending pattern shows the inconsistencies. In the last 5 years (2010-11 to 201415), the fund utilization rate ranged between 15-18 percent of the total budget execution in the first six months of the fiscal year. In the last month of the fiscal year, it rises to 38 percent. Complexities in budget execution originating from procedural deficits leads to delays in project approvals; procurement process completion and fluctuations in cash releases impact the efficient use of resources. 

14. The GoKP is endeavoring to link planning with budgeting. It has provided a medium-term perspective to budgeting, introduced decentralization reforms to improve service delivery, and enacted the right to information: however, these measures have yet to gain traction. The procedural complexities, lack of integrated systems and capacity, and non-segregation of funds at primary service delivery unit level are hampering the efficient use of resources and innovations in the service delivery. 

15. The output-based budgeting and other PFM reforms have provided a foundation for improving the budgeting process; however, the use of these tools particularly for legislative scrutiny is almost non-existent. A key result of PFM reforms is procedural improvements. These can be entrenched with interest articulation by all stakeholders. The lack of a robust legislative scrutiny of budget and fiscal operations dilutes the oversight on the Executive. Greater interest and deeper involvement of the legislature will ensure utility and entrenchment of the reform measures. 

16. The GoKP has also taken significant measures to improve fiscal disclosure. The Right to Information Act (2013) is a step in this direction; however, the PEFA Framework focuses on proactive disclosure rather than public registering and requesting for information disclosures. The proactive disclosures and the change in the criteria for transparency in the public finances in the PEFA Framework lend a lower rating to the transparency pillar in this assessment. The FD lacks a methodical system for collection and review of the financial position of the public sector entities and is currently negotiating support with development partners for capturing the off-budget foreign-funded expenditure and establishment of system at Finance to monitor expenditure outside the government’s financial reports. 

Political economy perspective

17. In the past decade a number of reforms were introduced to improve budget planning, budget execution, and transparency (see Section 5); and to provide greater legitimacy and leadership, the PFM Reforms Oversight Committee was constituted and chaired by the Minister of Finance with membership of Senior Minister Local Government and Ministers of Health and Education, Advisor to the Chief Minister for P&D, and the Secretaries of FD, P&D Department, and local government departments. The high-level participation by key departments (ministers and secretaries) can yield multiple benefits. It leads to cross fertilization of ideas and prioritization and sequencing of reforms, while consensus building facilitates the reforms rollout. 

18. However policy orientations and structural transformation have to be practiced in a political economy where varied interests can tend to slow down the progress or otherwise, if inadequately incentivized. The OECD2 concludes it is very hard to classify successes or failures. What may look initially like a failure to reform may provide the necessary impetus for a subsequent major policy change. And what looks like a successful reform may eventually be reversed. In Pakistan, albeit on a wider spectrum, the introduction of the autonomous local government system (2001) and the Government Financial Management Information System (GFMIS) (1998) provides evidence to the latter and the former. 

19. The literature on governance reforms acknowledges the long gestation period 3 of the reforms, to gain traction. In KP it has been a time consuming but ongoing process. The GoKP leadership has demonstrated stewardship and perseverance, evident from the continuity of reform efforts, however the focus has primarily been on the establishment of the institutions (for example, procurement and revenue authorities, internal audit cells, and so on), introduction of advanced tools (like a mediumterm fiscal framework [MTFF], output-based budgeting, internal audit), and policy and strategy formulations. Efforts are now needed to coordinate these efforts among the stakeholders (Line Departments, Audit, and Legislature) to ensure its application by all, which could be accomplished with a capacity development response reaching out to a broader group for wider knowledge transfer. With the introduction of modern tools the GoKP needs to focus on building analytical capacity of the individuals to help appreciate the utility of these tools and its implementation. Continuous efforts are required through advocacy and dialogue for attitudinal change and it is imperative that the practices (manual processing, annual budgeting approach, and so on) prevailing before the introduction of modern methods are discontinued to realize the potential of the modern tools and the automated systems.

Comparison with last PEFA assessment 

20. The last PEFA assessment of KP province was conducted in 2007 using the PEFA Framework 2005. Annex 4 provides the performance trajectory based on the PEFA Framework 2005 applied in 2017. The comparison shows that the budget credibility improved as the variance between budgeted and actual expenditure decreased over the years, at aggregate level as well as by composition. The overall budgeting process remained well organized and participatory with extensive guidance to line departments and the general adherence to budget calendar by the line departments. The multiyear perspective in fiscal planning, expenditure policy, and budgeting improved with the approval and implementation of the KP Integrated Development Strategy. Public access to key fiscal information improved with the release of in-year, budget execution reports. The promulgation of KP Public Procurement Regulatory Authority (KP-PPRA) Act 2012 and KP-PPRA Rules 2014 yielded improvements in the procurement regime. The comprehensive rollout of the GFMIS enhanced the quality of information in the budget execution reports.

21. Deficiencies were noted in oversight of fiscal policy and tax administration. The institutional mechanism for fiscal reporting did not improve in capturing the extra-budgetary operations and information on off-budget donor-funded projects. Neither was improvement noted in the oversight of aggregate fiscal risk from public sector entities/autonomous entities. There has been no significant improvement in tax administration performance, particularly in the areas of transparency of taxpayer obligations and liabilities, registration, and assessment and collection of taxes. In 2013, the GoKP established the Khyber Pakhtunkhwa Revenue Authority (KPRA) to collect sales tax on services, which is now the largest provincial tax but is still in the process of developing systems and capacity for revenue-compliance risk management. The predictability regarding availability of funds declined because of the practices followed in the cash releases for development budget, significant in-year budgetary adjustments and the absence of commitment accounting. Internal controls continue to pose challenges for the GoKP. The performance with regard to the scope and coverage of the payroll audit declined and non-salary expenditure commitment controls deteriorated largely owing to the lack of commitment accounting. Although the GoKP piloted internal audit, the focus of internal audit on financial compliance and lack of management response continues to undermine the deepening of fiduciary controls. 

22. The following table provides the summary ratings of the current assessment conducted on the PEFA Framework 2016. Details of the assessment and the narrative are available in Section 3.