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### Local Government — clarity, composition, and fiscal data
- Interim Constitution (effective January 2007) vests executive power in the Council of Ministers under the chairperson of the Prime Minister; legislature is a unicameral Parliament.
- Public Accounts Committee of Parliament and independent Auditor General (AG) oversee fiscal integrity.
- Concept of general government not used; focus exclusively on central government activities as defined in the budget, which does not cover all central government revenue and expenditure.
- Central government budgetary data based on national practice and does not fully accord with Government Finance Statistics (GFS) classification.
- Local government composition: 75 district development committees, 58 municipalities, and 3,913 village development committees.
- Social security institutions’ data not disclosed; many extra-budgetary activities exist as revolving funds under line ministries, autonomous entities (e.g., universities and colleges), and other public organizations.

### Local government functions, financing, and transfers
- Local Self-Government Act of 1999 defines detailed functions at village, municipal, and district levels (agriculture, drinking water, local infrastructure, irrigation/conservation, basic education and health, cultural affairs, tourism, cottage industries).
- Local revenue-raising powers include land revenue and house tax, rent tax, enterprise tax, vehicle tax, property tax, entertainment tax, commercial video tax, advertisement tax, parking and service charges.
- Estimated own-revenue collection by local governments: 6 billion Rupees.
- Central government grants:
  - FY 2002/03: local governments received 0.6 percent of GDP in operating subsidies and capital grants.
  - FY 2003/04: central government transferred about 13 billion Rupees to local governments, conditional or unconditional.
  - Total unconditional grants have been in the range of 3 billion Rupees annually.
- DDC grant distribution formula weighting: population, 20 percent; geographic area, 10 percent; Human Development Index, 50 percent; price level, 20 percent.
- Performance grant scheme since FY 2003/04 in 20 of 75 districts:
  - Districts meeting minimum conditions and achieving above 80 percent performance measures receive 25 percent additional grants.
  - Performance between 40 percent and 80 percent receive capacity development and performance grants.
  - DDCs with less than 40 percent achievement get only a capacity development grant.
- Local Self Government Act allows borrowing by local governments from banks and international organizations and does not define any debt limit. Central government provides loan guarantees only for foreign financed development projects.
- Inter-governmental fiscal relations are not based on stable principles; transfers determined annually in the budget process. Interim Constitution anticipates restructuring based on decentralization and devolution but leaves details to the Constituent Assembly.

### Public enterprises (PEs), quasi‑fiscal activities, and contingent liabilities
- PEs, public financial institutions, and Nepal Rastra Bank (NRB) pursue quasi-fiscal activities despite some deregulation of prices.
- No precise estimates of implicit subsidies, but described as significant.
- Regulated utilities and transportation prices are below cost; preferential interest rates to agriculture and some industrial sectors.
- Nepal Oil Company example: losses about 1 percent of GDP and arrears due to petroleum prices not reflecting international changes.
- Central government provides PEs current subsidies and capital grants of about 0.3 percent of GDP.
- PEs generally have low or negative rates of return due to price regulation, management problems, and overstaffing.
- Voluntary retirement schemes introduced in some PEs; several PEs potentially not viable and have accumulated large contingent liabilities, including debt service arrears to the budget.

### Nepal Rastra Bank (NRB) — independence and quasi‑fiscal activities
- NRB Act provides de facto central bank independence: Board appointed by Council of Ministers for five-year terms; dismissal of Governor, Deputy Governors, and Directors constrained.
- NRB conducts quasi-fiscal activities such as financial help via the “sick industry refinancing facility.”
- Law restricts NRB lending to government to short-term operations (up to six months) and payments related to international organization membership, though some overdraft lending has occurred recently.
- Profit/loss allocation rules: after deductions in favor of four reserve funds, remaining profit distributed to government; losses covered by government after resorting to reserve funds and the Bank’s capital (Articles 41 and 42 of NRB law).
- NRB does not pay interest on government cash balances nor charge for fiscal and debt agent services; provides commercial banking services to PEs.

### Financial sector oversight and public financial institutions
- Legislation guiding public and private financial institutions includes Bank and Financial Institution Act 2006; Insolvency Act 2006; Secured Transaction Act 2006; Company Act 2006. Money Laundering Control Act and Deposit and Guarantee Act under discussion.
- Government-owned public financial institutions: two commercial banks and four development banks (in addition to the central bank).
- Oversight responsibility lies with NRB but oversight is weak; loan default is endemic.
- Rastriya Banjya Bank and Nepal Bank Limited declared technically insolvent in 2002; large nonperforming assets in development banks (Agricultural Development Bank of Nepal and Nepal Industrial Development Corporation).
- Priority sector lending regulations (minimum percentages) are being phased out.

### Government equity holdings and PE reporting
- End of FY 2006/07: 36 enterprises under government ownership across six sectors: industrial (7), trading (6), service (7), social (5), utilities (3), public financial institutions (8).
- 2006/07 employment in these enterprises: about 38,000 people. Largest employers: Nepal Electricity Authority (10,320), Nepal Telecommunication Corporation (6,260), Rastriya Banijaya Bank (3,599).
- Since 2002 central government publishes annual data on financial performance of state enterprises with a one-year lag; number of enterprises with completed audits increased to 22 in 2006/07.
- MOF report “Targets and Performances of Public Enterprises” provides profit and loss, working capital, net worth, number of employees, and audit status but lacks causal analysis of low returns or links to government interventions.
- AG audits PEs 100 percent publicly owned and provides reports to Parliament; audits follow Nepal Standards on Auditing and related guidance documents.

### Privatization, regulation, and institutional capacity
- Privatization modalities: sale of assets and business (liquidation); sale of shares; sale cum lease (assets leased for 10–35 years). Privatization Committee determines modality.
- Tendering by MOF publicly announced 35 to 90 days prior to sale; instances of insufficient notice and lack of proper accounts/audited physical asset statements reported.
- AG audits the privatization process. Since 1992 government privatized 26 enterprises; three companies privatized between 2004 and 2006.
- BOT policy initiated in December 2000 to attract private capital into infrastructure, but no actions had been taken to date.
- Company Act of 1997 regulates accounting and auditing of private sector but key concepts not well defined, causing lack of clarity in accounting and auditing standards and practices.
- Institute of Chartered Accountants of Nepal (ICAN) created by the Chartered Accountants Act of 1997, but lacks human and financial resources to fulfill responsibilities.
- World Bank “Nepal: Doing Business in 2007” places Nepal near regional average in corporate governance and judicial efficiency; time to register a business is second lowest in the region but cost is second highest; employment regulation least developed.
- Nepal ranks poorly on access to credit (collateral, bankruptcy law, credit information sharing).

### Box 2 — Government Regulation of the Private Sector (highlights)
- Banking sector governance monitored by Registrar of Companies; operational supervision by NRB. Registrar monitors governance aspects for all registered companies.
- Companies required to have accounts compiled and audited according to internationally accepted accounting standards; company secretaries required to be duly qualified.
- Sector-specific legislation exists or is forthcoming (example: Petroleum Act).
- Regulatory agencies include Environment Protection Council; Civil Aviation Authority; Insurance Committee; Nepal Standards and Metrology Department; Accounting Standards Board; Auditing Standards Board; Drug Management Department; University Grants Commission.
- Taxation legal base and regulation generally clear; public outreach measures by IRD and customs (printed materials, website guidance, toll-free calling, forthcoming SMS service).
- IRD Large Taxpayer Office (LTO) communicates with approximately 220 large taxpayers; further work needed to improve operational performance, particularly in audit.
- Government revenues about 13 percent of GDP: tax revenue 10½ percent of GDP; nontax revenue 2½ percent of GDP.
- Revenue administration weaknesses: no legal protection for tax/customs staff from political interference; incentive schemes for staff performance exist; MOF concerns about excise revenue leakage and evasion.
- Customs deficiencies: weak administration of import exemptions, concerns about smuggling, inefficient clearance procedures, stalled computerization project now expected to mobilize.
- Fiscal management framework is detailed but fragmented; legal rights to create extra-budgetary funds exist but acts do not require transparency in operation and reporting.
- Examples of extra-budgetary fund issues: Tourism Board directly receives Tourism Development Fee; Army Welfare Fund (AWF) receives UN reimbursements, accounts not published and outside Consolidated Fund oversight.
- Donor coordination problems: aid may not enter government accounts; FPA stipulates all assistance should be part of the Appropriation Act.
- Chart of accounts introduced in FY 2004/05 has deficiencies (unsuitable for double entry, misses debt issuance accounts, treats financing as revenue/expenditure).
- Performance-based budgeting legal framework exists but in practice focus remains on financial compliance; fund release for development projects linked to progress but physical verification limited by staff shortages.
- Public servants: about 88,000 civil servants; annual asset declaration required since 2003 even for staff of commercial enterprises with minority government holding; unclear usage of declarations to detect unexplained wealth.
- Anticorruption: Commission for the Investigation of Abuse of Authority (CIAA) established 1990; Anticorruption Act 2002 expands powers. CIAA FY 2005/06: 4,759 new complaints, 98 cases filed. As of end FY 2006/07 cumulative 680 cases filed; 460 decided with 85 percent decisions in favor of CIAA. All decided cases appealed to Supreme Court which has not decided on appeals.
- Publication gaps: many fiscal execution details not published (contingent liabilities, quasi-fiscal activities); MOF releases quarterly budget execution info on FCGO website; no advance release calendars; Nepal subscribes to GDDS since 2001.
- MOF budget documents cover only central government budget and lack analysis of prior-year implementation, do not separate new vs existing programs, and present data for two previous years only.
- MTEF prepared but not available to Parliament before budget approval; published after budget, limiting Parliamentary scrutiny. Budget presented in last month of fiscal year, limiting debate time.
- MOF estimate at beginning of FY 2005/06: contingent liabilities of PEs amounted to 10.3 billion Rupees (2 percent of GDP).
- Tax expenditures not estimated; quasi-fiscal activities not estimated but noted as significant (fuel, electric energy price subsidies, concessional interest rates).
- Externally funded defense expenditures usually not included in budget; AWF receipts from UN not channeled through budget.

### Debt reporting, financial statements, and fiscal classification
- Gross public debt information published as part of the annual Consolidated Financial Statements.
- Separate tables for domestic and foreign borrowings include for each loan payments of principal and interest, and outstanding balance.
- No information published on government financial assets.
- Financial statements published by MOF within seven months of financial year close and one month after submitting to AG.
- Financial statements pertain essentially to the Consolidated Fund and exclude many extra-budgetary funds and activities; do not fully include foreign aid components (direct payments, commodity grants) that do not pass through the accounting system.
- Statements include tabular comparison of total expenditure against budget provision for each budgetary unit and show virements separately; data reconciliation statement included (DTCO and line ministry figures reconciled by Financial Comptroller General’s Office; if unreconciled, DTCO figure used).
- Economic classification does not comply with GFSM 2001; repayment of debt classified as expenditure; repairs and maintenance and new capital expenditure classified together.
- Functional classification not in accordance with UN COFOG.
- Accounting is wholly on a cash basis; accrued expenses shown when paid. Financial Comptroller General does not maintain records on commitments or liabilities (including arrears).

### Budget preparation, execution, and transparency issues
- Broad fiscal objectives included in budget speech but longer-term sustainability not examined.
- No disclosure of basis of revenue forecasts, underlying assumptions, risks, or mitigating measures.
- No formal fiscal rules except monetary financing by central bank limited to 10 percent of previous year’s total revenue.
- MTEF introduced in 2002; MTEF and budget provide three-year assumptions. Example inconsistency: MTEF projected GDP growth for 2007/08 as 6 percent while IMF projections expected 4½ percent.
- Revenue and expenditure projections based on past trends and revenue-raising measures.
- Budget calendar published and Budget Formulation Manual circulated; no legal provision governing the budget calendar.
- Mid-term budget evaluation report published since FY 2002/03; public reporting on program performance during implementation is weak.
- Article 93 of Interim Constitution requires ministries state whether objectives of prior-year expenses achieved; in practice reports indicate funds expended and some performance information.
- Mid-term review and aggregate figures released to press; supplementary budgets rarely used; unanticipated shortfalls met by domestic borrowing. No effective borrowing constraint other than MOF-central bank letter of agreement.

### Internal controls, procurement, arrears, and audit
- Disbursements made by District Treasury Officers through local banks or NRB branches based on payment orders authorized by line ministry officials; reported monthly to Financial Comptroller General’s Office.
- No ex ante control of expenditure commitments by field offices or budgetary units; cash basis accounting prevents identification of arrears at any time.
- Since FY 2002/03 Financial Comptroller General’s Office prepares annual statement of all expenditure arrears; process being refined but needs improvement. Only permissible arrears reported; many agency expenditures with accruals not permitted by law are not reported.
- Procurement procedures clear in Financial Administration Regulations; new Procurement Act expected to become law in 2007.
- Internal audit of procurement patchy and weak; National Vigilance Centre (NVC) established in 2002 to receive complaints; NVC has no investigative capacity and refers cases to CIAA.
- IRD and Customs not legally protected from political interference; key positions filled at MOF discretion.

### Audit, Auditor General (AG) independence, and follow-up
- No legally prescribed time limit for publication of audited financial statements. Ministries generally submit accounts to AG within three months; Financial Comptroller General required to submit consolidated statements within six months.
- Audited financial statements of government issued about 13 months after fiscal year close in recent years.
- AG has complete and unfettered independence under the Interim Constitution; AG’s budget charged to consolidated fund but routed through MOF which can restrict staffing.
- AG has full access to government accounts and PEs except partially owned PEs where AG must recommend a chartered accounting firm as auditor.
- AG audits not fully in accordance with international standards; AG does not provide an audit opinion on consolidated financial statements.
- Audit standards broadly based on INTOSAI and ISA; AG does not highlight systemic issues or provide remedy recommendations consistently.
- Internal quality review process exists. Audit coverage broad: Consolidated Fund, extra-budgetary funds receiving government funding, and wholly state-owned PEs; partially owned PEs not audited by AG.
- AG’s remit broadened to include performance audit of large donor-financed projects.
- Formal follow-up system for AG recommendations exists but effectiveness unproven. AG must submit annual report to Prime Minister who must submit to Parliament. AG can bring irregularities to concerned ministry but lacks enforcement authority.

### Statistical independence and realism of budget data
- Central Bureau of Statistics (CBS) legislatively independent under the Statistics Act and linked to the National Planning Commission.
- CBS unable to institutionalize a modern statistical system and not able to coordinate collection and production of statistics fully.
- Consolidated National Statistical Plan formulated; decision making exercised by National Statistical Council.
- Budget data not realistic; variance with actual outcomes is high. Example FY2005/06: foreign grants and capital spending overestimated by about 30 percent; foreign loans overestimated by more than 75 percent.
- External scrutiny of macroeconomic models and assumptions not routinely undertaken.

### IMF staff commentary — priority directions and recommendations
- Recognize government progress: creation of CIAA and NVC; taxpayer guidance; public hearings in tax/customs; reclassification into recurrent and capital; simplified MTEF; publication of mid-term budget review; publication of PE financial performance; AG Annual Report public.
- Staff emphasize need to implement systematic approach to meet international standards of fiscal transparency. Finance Minister announced intention to enact a Transparency Act in 2006/07 and to provide periodic accounts of budget execution and physical project progress; staff urge swift realization.
- Short-term measures (within twelve months):
  - Publicly announce timeframe for publication of fiscal information.
  - Timely publication of AG’s Report and follow-up mechanisms.
  - Make macroeconomic assumptions realistic and explicit; specify broad fiscal policy objectives publicly.
  - Begin reforming economic classification to conform with GFSM 2001.
  - Increase MOF ownership of MTEF and responsibility for macroeconomic assumptions.
  - Use comprehensive definition of central government activities for budget preparation, execution, reporting.
  - Disclose contingent liabilities, tax expenditures, and quasi-fiscal activities with corresponding budget estimates.
  - Subject all extra-budgetary activities to rules of accounting, audit, and publication.
  - Disclose full information on amount and structure of debt and financial assets from existing memorandum records.
  - Initiate commitment control system to report, control, avoid expenditure arrears.
  - Initiate staff training programs and develop human resource management improvements.
- Medium-term measures (one to three years):
  - Strengthen macro-fiscal unit of MOF and allow external scrutiny of macroeconomic assumptions.
  - Adopt functional classification in budget.
  - Implement commitment control system to report and control arrears.
  - Strengthen internal audit functions.
  - Integrate all extra-budgetary activities into central government budget.
  - Report fiscal activities on General Government basis including central and local governments.
  - Make financial relationship between central and local government transparent and define borrowing limits for local governments.
  - Improve governance of PEs to reduce contingent liabilities.
  - Introduce legal requirements for publication of regular and timely reports of all public sector institutions.
  - Eliminate quasi-fiscal activities and, if necessary, replace them with explicit subsidies.
  - Reduce tax expenditures as much as possible.
  - Introduce human resource management policies based on international best practice.
- PE-specific urgent measures:
  - Externally audit all PEs to international standards; hold Boards and Chief Executives accountable; take legal action against errant officials.
  - Improve financial data quality in comprehensiveness and timeliness.
  - Estimate, analyze, and report quasi-fiscal activities; subject to Corporation Coordination Division scrutiny and include in fiscal reports.
  - Publish financial results of each PE quarterly or semi-annually; MOF to summarize in annual PE report.
  - Strengthen Corporation Coordination Division of MOF for effective PE oversight.
- Accounting and audit reforms:
  - Rationalize accounting system and phase move towards accrual accounting beginning with financial assets and liabilities.
  - Adapt budget legal framework accordingly.
  - Institute and observe clear rules for timely publication of audit reports and actions on irregularities.
  - Ensure AG staffing (quality and numbers) appropriate; AG to audit all PEs controlled by government (more than 50 percent ownership) and increase training in performance auditing.

### Enforcement, revenue administration, and budget coverage (recommendations)
- Enforcement of existing laws and regulations needs strengthening to improve transparency, fiscal policy effectiveness, and end anti-social practices (e.g., nonrepayment by well-connected borrowers).
- Revenue administration modernization required: integrity of staff; recruitment, career development, training; discipline, accountability, performance management; refocus HR towards strategic audit and cross-checking.
- Tax and customs priorities: review and simplify exemptions; improve large taxpayer and VAT audits; improve income tax dispute resolution and refund management; identify and recover from VAT-registered entities trading outside VAT; mobilize customs computerization and build valuation/audit/risk management capacity.
- Budget coverage should be widened to include all central government activities:
  - Review rationale for revolving funds outside budget; subject them to same rules and widen Financial Comptroller General mandate to integrate their accounting.
  - Include autonomous entities (boards, universities, colleges, some hospitals) in budget or documentation.
  - Army Welfare Fund receipts from UN should be credited to Consolidated Fund and disclosed; similar for Police Welfare Fund.
  - If immediate inclusion not possible, disclose these items in budget documents.
  - Aim for Consolidated General Government Budget covering all central and local government units and nonprofit institutions controlled and mainly financed by government.

*Source: Draft IMF staff report (excerpt).*

### 1. Local Government. ...................................................................................................

### 1. Local Government

### Clarity of roles and responsibilities
- The Interim Constitution (effective January 2007) defines roles of the executive, legislative, and judicial branches; executive power is vested in the Council of Ministers under the chairperson of the Prime Minister, and the legislature is a unicameral Parliament.
- A Public Accounts Committee of Parliament and an independent Auditor General (AG) are charged with ensuring the integrity of fiscal information.
- The concept of general government is not used; focus is exclusively on central government activities as defined in the budget, which does not cover all central government revenue and expenditure.
- Data collected for central government budgetary purposes is based on national practice and does not fully accord with Government Finance Statistics (GFS) classification.
- Local government composition: 75 district development committees, 58 municipalities, and 3,913 village development committees.
- Social security institutions exist but their data is not disclosed. A large number of extra-budgetary activities exist as revolving funds under line ministries, autonomous entities (e.g., universities and colleges), and other public organizations.

### Local government functions, financing, and transfers
- The Local Self-Government Act of 1999 defines detailed functions for village, municipal, and district levels, including agricultural development, drinking water projects, local infrastructure and maintenance, irrigation and conservation, basic education and health services, cultural affairs, tourism, and cottage industries.
- Local governments are permitted to levy taxes and charges such as land revenue and house tax, rent tax, enterprise tax, vehicle tax, property tax, entertainment tax, commercial video tax, advertisement tax, and parking and service charges.
- Estimated own-revenue collection by local governments: 6 billion Rupees.
- Central government grants to local governments:
  - In FY 2002/03 local governments received 0.6 percent of GDP in operating subsidies and capital grants.
  - In FY 2003/04 the central government transferred about 13 billion Rupees to local governments, conditional or unconditional.
  - Total unconditional grants have been in the range of 3 billion Rupees annually.
- Distribution of DDC grants uses a formula with weighting: population, 20 percent; geographic area, 10 percent; Human Development Index, 50 percent; price level, 20 percent.
- Since FY 2003/04 a performance grant scheme in 20 of 75 districts: districts meeting minimum conditions and achieving above 80 percent performance measures receive 25 percent additional grants; performance between 40 percent and 80 percent receive capacity development and performance grants; DDCs with less than 40 percent achievement get only a capacity development grant.
- The Local Self Government Act allows borrowing by local governments from banks and international organizations and does not define any debt limit. The central government provides loan guarantees only for foreign financed development projects.
- Inter-governmental fiscal relations are not based on stable principles; transfers from central to local governments are determined annually in the budget process. The Interim Constitution anticipates restructuring based on decentralization and devolution but leaves details to the Constituent Assembly.

### Public enterprises, quasi‑fiscal activities, and contingent liabilities
- Public enterprises (PEs), public financial institutions, and Nepal Rastra Bank (NRB) pursue quasi-fiscal activities despite some deregulation of prices.
- No precise estimates of implicit subsidies, but described as significant.
- Utilities and transportation prices are regulated and below cost; interest rates on lending to agriculture and some industrial sectors are below market rates.
- Example: Nepal Oil Company records substantial losses (about 1 percent of GDP) and arrears due to petroleum prices not reflecting international changes.
- Central government provides PEs current subsidies and capital grants of about 0.3 percent of GDP, without compensating for losses; PEs generally have low or negative rates of return due to price regulation, management problems, and overstaffing.
- Voluntary retirement schemes have been introduced in some PEs; a number of PEs are potentially not viable and have accumulated large contingent liabilities, including debt service arrears to the budget.

### Nepal Rastra Bank (NRB) and quasi‑fiscal activities
- NRB Act provides de facto central bank independence: Board of Directors appointed by Council of Ministers for five-year terms; Governor, Deputy Governors, and Directors can be dismissed only after due process in well-defined circumstances.
- NRB engages in quasi-fiscal activities such as financial help to Nepal Industrial Development Corporation and industries via the “sick industry refinancing facility.”
- The law restricts NRB lending to the government to short-term operations (up to six months) and payments related to international organization membership, though some overdraft lending to the government has occurred recently.
- There are clear rules for allocating the Bank’s net profits or net losses: after deductions in favor of four reserve funds, remaining profit should be distributed to the government; losses should be covered by the government after resorting to reserve funds and the Bank’s capital (Articles 41 and 42 of NRB law).
- NRB does not pay interest on cash balances in the government’s accounts, nor charges the government for fiscal and debt agent services. NRB provides commercial banking services to PEs.

### Public financial institutions and financial sector oversight
- Public and private financial institutions are guided by the same legislation, notably Bank and Financial Institution Act 2006; Insolvency Act 2006; Secured Transaction Act 2006; Company Act 2006. Money Laundering Control Act and Deposit and Guarantee Act are under discussion.
- Government-owned public financial institutions include two commercial banks and four development banks (in addition to the central bank).
- Oversight responsibility lies with NRB but oversight is weak; loan default is endemic.
- Rastriya Banjya Bank and Nepal Bank Limited were declared technically insolvent in 2002; large nonperforming assets are present in development banks (Agricultural Development Bank of Nepal and Nepal Industrial Development Corporation).
- Financial sector reform efforts have improved loan recovery and branch rationalization, but changing the culture of nonrepayment is difficult.
- Regulations have required minimum percentages of lending to priority and deprived sectors; these priority sector lending regulations are being phased out.

### Government equity holdings and public enterprise reporting
- At end of FY 2006/07, 36 enterprises were under government ownership; PEs operate in six sectors: industrial (7 companies), trading (6), service (7), social (5), utilities (3), and public financial institutions (8).
- In 2006/07 these enterprises employed about 38,000 people. Largest employers: Nepal Electricity Authority (10,320), Nepal Telecommunication Corporation (6,260), and Rastriya Banijaya Bank (3,599).
- Since 2002 the central government regularly publishes annual data on financial performance of state enterprises with a one-year lag; only some enterprises have completed audits (number increased to 22 in 2006/07).
- MOF report “Targets and Performances of Public Enterprises” provides profit and loss, working capital, net worth, number of employees, and audit status but does not analyze causes of low returns or losses, nor link government interventions (e.g., administrative prices) to profitability.
- The Auditor General audits PEs that are 100 percent publicly owned and provides all reports to Parliament. AG conducts audits according to Nepal Standards on Auditing and guidance including Government Standards on Auditing, General Audit Guide, Procurement Audit Guide, Project Account Audit Guide, Revenue Audit Guide, Administrative Expenditures Audit Guide, and Directives to the Auditors of the Public Sector Enterprises.

### Privatization and regulation of the private sector
- Privatization modalities under the privatization law: sale of assets and business (liquidation); sale of shares (firm not liquidated, shares auctioned); sale cum lease (business sold and assets leased for 10–35 years). The Privatization Committee determines modality.
- Tendering is carried out by MOF and publicly announced through the media with announcements required 35 to 90 days prior to sale; instances of too-short notice and lack of proper accounts/audited physical asset statements have been reported.
- AG is responsible for auditing the privatization process. Government privatized 26 enterprises since 1992; three companies were privatized between 2004 and 2006.
- BOT (Build, Operate, and Transfer) policy was initiated in December 2000 to attract private capital into public infrastructure projects, but no actions had been taken to date.
- Company Act of 1997 regulates accounting, financial reporting, and auditing of private sector organizations, but key concepts are not well defined, creating lack of clarity in accounting and auditing standards and practices.
- Institute of Chartered Accountants of Nepal (ICAN) created by the Chartered Accountants Act of 1997, but severe lack of human and financial resources limits its ability to fulfill responsibilities and reach most accountants.
- Auditing is somewhat better controlled than accounting. World Bank “Nepal: Doing Business in 2007” places Nepal close to regional average in corporate governance, judicial efficiency and costs in enforcing contracts, and time required for bankruptcy process; time to register a business is second lowest in the region but cost is second highest; employment regulation is least developed.
- Nepal ranks poorly on access to credit in terms of collateral and bankruptcy legislation and credit information sharing.

*Source: Draft IMF staff report (excerpt).*

### Box 2. Government Regulation of the Private Sector

### Box 2. Government Regulation of the Private Sector

### Regulatory framework for private sector and specific sectors
- Banking sector governance monitored by the Registrar of Companies; operational supervision by the Nepal Rastra Bank (the central bank).
- Registrar of Companies monitors governance aspects for all registered companies.
- Companies are required to have accounts compiled and audited according to internationally accepted accounting standards.
- Company secretaries are required to be duly qualified.
- Large companies in certain sectors are sometimes governed by specific legislation. Example: All companies in the petroleum sector will soon be governed by the Petroleum Act, which is currently under enactment.
- Regulatory agencies established for certain subsectors and activities include:
  - Environment Protection Council
  - Civil Aviation Authority
  - Insurance Committee
  - Nepal Standards and Metrology Department
  - Accounting Standards Board
  - Auditing Standards Board
  - Drug Management Department
  - University Grants Commission

### Taxation legal base, public outreach, and large taxpayer engagement
- The legal base and regulation for taxation are in place and are generally clear.
- The government has introduced measures to improve public understanding of the tax and customs systems:
  - The Inland Revenue Department (IRD) and customs publish printed materials to inform and help train smaller taxpayers and importers/exporters.
  - The IRD and customs publish regulations and guidelines concerning tax and customs administration on their websites.
  - Toll-free calling has been introduced and an SMS messaging service will be implemented shortly.
- The IRD is making progress in establishing a modern and effective Large Taxpayer Office (LTO), which communicates with approximately 220 large taxpayers, although further work is needed to improve operational performance, particularly in audit.

### Revenue administration weaknesses and integrity concerns
- Government revenues amount to about 13 percent of GDP, of which tax revenue accounts for 10½ percent of GDP and nontax revenue (e.g., passport fees, etc.) 2½ percent of GDP.
- Weaknesses remain despite improvements:
  - No legislation specifically protects tax and customs staff from political interference in the conduct of their duties (e.g., establishing tax liabilities or selecting taxpayers for audit).
  - The LTO has a staff performance incentive scheme that pays an additional proportion of base salary for revenue collections from audits which exceeds targets.
  - A similar scheme has been on trial in one customs office for about 6 months.
  - These schemes are funded from departmental budget allocations, and not from revenues.
  - Additional revenues resulting from income tax, VAT, and excise audits are credited to the Consolidated Fund and are not used for performance incentives or to defray administrative expenses.
  - A proportion of proceeds from sale of smuggled goods confiscated by customs or the revenue investigation department is used for monetary incentives to persons who provided tips or information about the smuggling to the authorities.
- IRD remains weak and the MOF has serious concerns about excise revenue leakage and evasion.
- In customs:
  - Administration of tax exemptions on imports is weak, with concerns about revenue loss.
  - Stakeholders are concerned at customs’ inability to counter reportedly large-scale smuggling.
- Internal audit systems in IRD and customs are basic, focused on financial flows, and performance is not audited.
- Authorities indicated that both tax and customs departments have implemented a system of monthly and annual performance indicators to monitor the performance of respective offices.

### Taxpayer compliance, administrative capacity, and procedures
- Taxpayers’ attitudes towards the IRD remain somewhat negative and the level of compliance remains below the degree hoped for by policy makers.
- Taxpayers are aggrieved by the compulsory nature of recent changes, and compliance for these measures is still low.
- Some staff reluctant to adopt new procedures and a low integrity level among staff (although measures have been introduced to address this issue).
- Absence of capacity to deal with human resource management issues.
- Outmoded processes in excise control procedures and in key areas of income tax such as:
  - dispute resolution
  - refund management
  - audit

### Customs operational deficiencies and reform plans
- Important operational procedures are outmoded and technical capacity is low despite recent training in valuation, audit, and risk management.
- Import and export clearance procedures are inefficient and poorly supported by the existing computer system.
- Ability to administer the valuation law and to audit declarations of importers remains limited.
- Undesirable level of interaction between officials and clearance agents, causing integrity concerns and lower compliance.
- Improved procedures are being trialed at one customs site; if successful they will be implemented more widely.
- Customs has a three-year reform plan but has limited capacity for improvement without technical support.
- A project under the reform plan to upgrade and extend the computer system has been stalled for some years and is now expected to mobilize shortly; this will allow more efficient clearance procedures and reduce interactions between customs agents and customs staff.

### Fiscal management framework and extra-budgetary funds
- Legal and administrative framework to define roles and responsibilities for fiscal management is fairly detailed but fragmented.
- Part 9 of the Interim Constitution provides detailed provisions on financial procedures for the Consolidated Fund and for other government funds such as revolving funds.
- Financial Procedures Act of 1999 and its regulations lay out roles of different institutions in the central budget process.
- Right to create extra-budgetary funds is stipulated in the Revolving Fund Act; other funds instituted under the Administrative Procedures Act or their own acts.
- Financial procedures related to extra-budgetary funds are codified in various acts such as the Revolving Fund Act, the Road Board Fund Act, the Peace Fund Act, and the Judiciary Revolving Fund Act.
- Acts do not require transparency in the operation and reporting of individual funds.
- These funds provide flexibility to raise and utilize resources outside the budgetary process and some receive transfers from the Consolidated Fund and certain earmarked tax revenues.
- No coordination of extra-budgetary activities with the budget although such activities receive transfers and/or a direct diversion of certain taxes.
  - Example: Tourism Board directly receives the Tourism Development Fee collected by Revenue Offices.
- Extra-budgetary activities are not subject to the government’s accounting procedures, but most are audited by the AG.
- Minister of a line ministry usually chairs committee administering respective fund, providing some consistency with government policy.
- Army Welfare Fund (AWF):
  - Revenues from the UN for Nepali military personnel service are not channeled through the budget but directly deposited with the AWF.
  - Accounts of the AWF are neither published nor open to public scrutiny.
  - Since AWF is outside the Consolidated Fund, the Financial Comptroller General’s Office does not have direct oversight.
- Police Welfare Fund created with proceeds from rent of government property.

### Donor coordination and aid recording
- Problems coordinating donor activities:
  - Aid comes as financial and nonfinancial aid and does not always enter government accounts and budget.
  - In some cases government provides manpower while donors provide commodity aid; these activities frequently not well coordinated, so appropriated funds are disbursed but intended output not achieved.
  - Some donors agree to provide cash to the government’s budget while others insist on disbursing outside the budget.
- Fiscal Procedure Act (FPA) stipulates that all assistance in cash or in kind, including from international organizations, shall be part of the Appropriation Act.

### Chart of accounts and budget classification issues
- Attempt to improve budget classification in FY 2004/05 by introducing a new chart of accounts (COA); the new COA has serious deficiencies:
  - COA not suitable for double entry accounting because it does not contain necessary bank and cash accounts.
  - COA is incomplete because it misses accounts to record proceeds from issuance of debt.
  - COA treats financing items such as debt and lending as revenue and expenditure.

### Performance-based budgeting and execution
- Legal framework demands achievement-related budgeting.
- Government developed strategies, objectives, and indicators in a number of sectors enabling performance-based budgeting and execution.
- Release of funds for development projects formally linked to progress in physical implementation.
- Physical verification often cannot take place due to lack of competent staff and timely information; fund release is based mainly on written statements of executing agency or ministry.
- In practice main focus is on financial compliance with use of appropriated funds.

### Public servants' conduct and asset declarations
- Public servants total about 88,000 civil servants working in line ministries and subsidiary units, and other employees in public entities such as the Nepal Rastra Bank and PEs.
- All civil servants are governed by the Civil Service Act and regulations framed under the Act, including a code of behavior with disciplinary sanctions ranging from a warning to dismissal.
- Public entities and PEs have similar codes of behavior.
- Requirement to declare annually all property and financial assets applies to all public servants.
  - Since 2003, this requirement has been applied even to staff of commercial enterprises in which the government has a minority holding.
  - While staff seems to comply, it is not clear if information is used in practice to assess consistency between earnings and increase in wealth.
- Cases of suspected corruption may be referred to the Commission for the Investigation of Abuse of Authority (CIAA).

### Box 3. Anticorruption Measures — key facts
- Commission for the Investigation of Abuse of Authority (CIAA) is an autonomous, financially independent constitutional body established in 1990; only institution mandated to prosecute cases of corruption in public life.
- Anticorruption Act of 2002 gives the CIAA powers to seize goods and documents, issue warrants for arrest and detention, and involve police and other government authorities in investigations.
- CIAA latest Annual Report: received 4,759 new complaints in FY 2005/06 and filed 98 cases.
- As of end of FY 2006/07, cumulative number of 680 cases filed by the CIAA with the specially constituted court; of these 680 cases, 460 have been decided with 85 percent of decisions in favor of the CIAA.
- All decided cases have been appealed to the Supreme Court, which is yet to make a single decision on appeal.
- Charges of corruption against Judges of the Court of Appeals and the District Courts are investigated by the Judicial Council (established in 1990); Judicial Council headed by the Chief Justice of the Supreme Court and comprises the Minister of Law and three judges of the Supreme Court as members.
- Charges against military personnel handled in accordance with special military regulations.

### Public availability of fiscal information and transparency gaps
- Large amount of information is published and made available on websites, but important information about budget execution is not available.
  - Publications are printed in small numbers and not always available in print form.
  - Important information such as impact of contingent liabilities, quasi-fiscal activities, and other complementary budget information are neither produced nor published.
- Publication of fiscal information is not a legal obligation, but government has public commitment to publish fiscal information.
  - MOF releases quarterly information on budget execution on the FCGO’s website.
  - No advance release calendars for fiscal reporting to the public, although Nepal subscribes to GDDS since 2001.
- Information on fiscal activities confined to the central government’s budget:
  - Budget documents do not contain information on any other general government component or on extra-budgetary funds.
  - Documents include revenue and expenditure summary tables, breakdown by ministry distinguishing recurrent and capital expenditure, and indication of prioritized expenditures by sector.
  - Data presented in economic and administrative classification and in classification defined as regular and development.
  - Since FY 2003/04, budget document contains provisions for clearance of utility arrears and liabilities of PEs to be liquidated or divested.
  - Budget document identifies amounts expected from additional revenue measures and discusses relevant measures.
  - Budget does not separate expenditures for new programs from existing ones.
  - Budget documentation contains information about the two previous years but no analysis or review of preceding year’s budget implementation in the budget speech nor comparison between budgeted and actual numbers.
- Medium-term expenditure framework (MTEF) prepared but not available to Parliament before budget approval:
  - MTEF contains detailed information about capital expenditure and sectoral development strategies but has same deficiencies as the budget regarding insufficient coverage and lack of information on quasi-fiscal activities, contingent liabilities, and macroeconomic sustainability.
  - MTEF preparation is the Planning Commission’s responsibility and the budget is the MOF’s; MTEF is published after the budget has been approved, so Parliament cannot examine macroeconomic assumptions used.
  - Budget presented to Parliament in the last month of the fiscal year, giving almost no time for appropriate discussion.
- No comprehensive information on contingent liabilities in any budget document:
  - MOF estimated that at beginning of fiscal year 2005/06 contingent liabilities of PEs amounted to 10.3 billion Rupees (2 percent of GDP).
  - Budget contains no provisions for these or other contingencies.
- Tax expenditures are not estimated:
  - Authorities claim no major tax expenditures; some small reductions on tax rates apply for taxpayers in remote places.
  - Most agricultural income is exempt from taxation and the income tax law contains other concessions for special industries.
  - Implementation of the Special Economic Zones Act will reintroduce tax holidays already provided for in the income tax law.
  - Minimal taxation of certain employee benefits (cars and housing) also amounts to tax expenditure.
  - Estimates on impact of new tax measures on tax collection are made by IRD and customs, but only for internal use.
- Quasi-fiscal activities are not estimated but significant:
  - Extensively carried out by financial and nonfinancial PEs.
  - Prominent examples: price subsidies to fuel, electric energy, and interest rate subsidies for agriculture and other priority economic sectors.
- Some defense expenditures are reported in the budget with detail, but substantial amounts remain outside the budget:
  - Externally funded defense expenditures usually not included in the budget and amounts are unknown.
  - Substantial resources deposited in the extra-budgetary Army Welfare Fund (AWF), mainly reimbursements from UN for Nepali armed forces participation in peace-keeping activities abroad.
  - Reimbursements directed to the AWF even though services are primarily supported with budget funds.

*Source: _cr07346 - Box 2. Government Regulation of the Private Sector*

### 29.      Information on gross public debt is published as part of the annual Consolidated

### _cr07346 - 29.      Information on gross public debt is published as part of the annual Consolidated

### Debt reporting and financial statements
- Information on gross public debt is published as part of the annual Consolidated Financial Statements.
- Separate tables for domestic and foreign borrowings include for each loan the payments of principal and of interest, and outstanding balance.
- No information is published on the government’s financial assets.
- The financial statements are published by the MOF within seven months of the close of the financial year and one month after submitting them to the AG.
- The financial statements essentially pertain only to the Consolidated Fund and do not contain the accounts of a significant number of extra-budgetary funds and activities.
- The financial statements also do not fully include all foreign aid components (e.g., direct payments and commodity grants) as they do not pass through the accounting system.
- The statements include a tabular comparison of total expenditure against the budget provision for each budgetary unit and show virements separately; expenditures by line item are shown on the basis of economic classification consistent with the budget.
- A statement on data reconciliation is included: expenditure figures from the District Treasury and Control Offices (DTCO) and the line ministries are reconciled by the Financial Comptroller General’s Office; if unreconciled, the DTCO figure is used.

### Fiscal classification and accounting basis
- The economic classification does not comply with the GFSM 2001, although revenue and expenditure components can be related to GFS categories.
- Differences exist in the breakdown of revenues and the composition of expenditures; repayment of debt is classified as expenditure.
- Expenditure on repairs and maintenance and new capital expenditure are classified together.
- The functional classification used is not in accordance with the UN Classification of Functions of Government (COFOG).
- The accounting is wholly on a cash basis; accrued expenses from a previous year are shown as expenditures in the year in which they are paid.
- The Financial Comptroller General does not maintain records on commitments or liabilities (including arrears).

### Budget preparation, transparency, and medium-term framework
- Broad objectives of fiscal policy have been recently included in the budget speech but sustainability over the longer term is not examined.
- There is no disclosure of the basis of revenue forecasts, their underlying assumptions, risks (e.g., realization of contingent liabilities, impact of exchange rate fluctuations on debt servicing), or mitigating measures and provisions.
- The government is not bound by formal fiscal rules except monetary financing by the central bank (overdraft) limited to 10 percent of previous year’s total revenue.
- There are no fiscal rules such as a balanced budget requirement or general borrowing limits. The MTEF does not contain guidance related to fiscal rules.
- The government makes a de facto attempt to contain recurrent expenditures within projected revenues.
- An MTEF was introduced in 2002 in line with the long-term plan. The MTEF and budget documents provide assumptions including economic growth and inflation for the coming three years.
- Example of inconsistent assumptions: the MTEF projected GDP growth for 2007/08 as 6 percent, while IMF projections expected it to be 4½ percent.
- Revenue and expenditure projections are based on past trends and augmented by amounts from revenue raising measures.
- The annual budget contains investment projects scrutinized and prioritized by the National Planning Commission in cooperation with line ministries and the MOF.
- A budget calendar is published and the Budget Formulation Manual has been printed and circulated; no legal provisions govern the budget calendar so it can change year to year.
- The budget speech highlights new policy initiatives, but they cannot be identified in attached tables; results of prior-year policy initiatives are not identifiable from the budget speech or attached data.
- The budget is not transparent regarding revenues diverted to extra-budgetary funds.
- The overall deficit of the central government’s budget is the main focus of fiscal policy; no other analytical indicators are used.

### Budget execution, reporting, and performance monitoring
- Public reporting on program performance during budget implementation is weak.
- Expenditures are not linked to specified goals; budget codes do not reflect activities.
- Apart from the financial quarterly report and the mid-term budget evaluation report (published by the MOF since FY 2002/03), no detailed information is published during the year on budget implementation.
- The mid-term evaluation examines progress towards new policies and select high priority programs/projects but does not review success of major budget programs in achieving announced objectives.
- Article 93 of the Interim Constitution requires ministries to state whether objectives of prior-year expenses have been achieved; in practice ministry reports indicate funds expended and some performance information.
- Performance auditing by the AG is undertaken to a limited extent in terms of contents and coverage.
- A mid-term review is undertaken and aggregate figures are released to the press; supplementary budgets are rarely used and unanticipated shortfalls are met by domestic borrowing.
- There is no effective borrowing constraint other than a letter of agreement between the MOF and the central bank.

### Internal controls, procurement, and arrears
- Disbursements are made by District Treasury Officers through local banks or NRB branches based on payment orders authorized by line ministry officials; these are reported monthly to the Financial Comptroller General’s Office.
- No provision exists to control, ex ante, expenditure commitments by field offices or budgetary units; accounts are maintained wholly on a cash basis, so arrears cannot be identified at any given time.
- Since FY 2002/03 the Financial Comptroller General’s Office has prepared an annual statement of all expenditure arrears; the process is being refined but still needs substantial improvement.
- Only permissible arrears are reported; many spending agencies incur expenditures for which accruals are not permitted by law and thus are not reported through Treasury Offices. Commitments (encumbrances) are outside the reporting system. Revenue arrears are reconciled and reported.
- Procurement and contracting procedures are clear and currently contained in the Financial Administration Regulations. A new Procurement Act, prepared with World Bank assistance, is close to finalization and expected to become law in 2007; it will specify detailed procurement procedures and financial thresholds.
- Internal audit of public procurement is patchy and weak: inspections often conducted by junior nontechnical staff, often on a sample basis and after payment; no systematic follow-up to impose penalties or withhold earnest monies from noncompliant contractors.
- A National Vigilance Centre (NVC) was established in 2002 to receive public complaints; a Technical Audit Section is being set up with ADB assistance. The NVC has no investigative capacity and refers corruption cases to the Commission for the Investigation of Abuse of Authority. An annual report is published by the NVC.

### Revenue and tax administration independence
- The Internal Revenue Department and the Customs Administration are not given legal protection from political interference; both are subordinated to the Revenue Department of the MOF.
- Key positions in both departments are filled at the discretion of the Ministry; there is no law defining special appointment procedures or terms.

### Audit, AG independence, and follow-up
- There is no legally prescribed time limit for publication of audited financial statements. Ministries are generally required to submit accounts to the AG within three months of fiscal year close; the Financial Comptroller General is required to submit consolidated financial statements within six months.
- In recent years audited financial statements of the government have been issued about 13 months after the close of the fiscal year.
- The AG has complete and unfettered independence under the Interim Constitution; the AG’s budget is charged directly to the consolidated fund, though routed through the MOF which can restrict staffing demands.
- The AG has full access to documents related to government accounts and PEs, except for PEs not fully owned by government; for partially owned PEs the AG must recommend a firm of chartered accountants as auditor.
- The AG’s audit is not fully in accordance with international standards; the AG does not provide an audit opinion on the consolidated financial statements of the government.
- Audit standards are broadly based on INTOSAI and ISA; despite many audit documents, the AG does not highlight systemic issues or provide recommendations on how to address them.
- An internal quality review process exists whereby one unit reviews another.
- Audit coverage is broad: all revenues and expenditures of the Consolidated Fund, extra-budgetary funds receiving government funding, and PEs wholly owned by government; partially owned PEs are not audited by the AG.
- The AG’s remit has broadened to include performance audit of large donor-financed projects.
- A formal system exists to follow-up on AG recommendations, but in practice its effectiveness is unproven. With the Interim Constitution of 2007 the Public Accounts Committee resumed functions; the AG must submit an annual report to the Prime Minister who must submit it to Parliament.
- The AG brings major financial irregularities to the concerned ministry but lacks authority to ensure corrective action; absence of an effective follow-up and reporting system prevents assurance that irregularities are rectified.

### Statistical independence and capacity
- The Central Bureau of Statistics (CBS) has legislative assurance of independence under the Statistics Act and is organizationally linked to the National Planning Commission.
- The CBS has been unable to institutionalize a modern statistical system and is not able to coordinate the collection and production of statistics.
- A Consolidated National Statistical Plan was formulated; decision making under the plan is exercised by the National Statistical Council.

### Independent assurances of realism and scrutiny
- Budget data is not realistic and the variance with actual budget data is high; in general revenues and expenditure are overstated in the budget compared to the actual outcome. In recent years the budget deficit has tended to be overestimated.
- Example: in FY2005/06, foreign grants and capital spending were overestimated by about 30 percent, foreign loans by more than 75 percent.
- External scrutiny of macroeconomic models and assumptions is not made; there is no discussion with universities or think-tanks on the macroeconomic framework of the budget.
- The published financial statements include statements of accounting policy; the basis of accounting is provided in the final financial statements.
- The final financial statements are published by the MOF within seven months of the close of the financial year and one month after submitting them to the AG; they are also made available on the Financial Comptroller General’s website.
- The statements include a tabular comparison of total expenditure against budget provision for each budgetary unit and show virements separately; certain heads not subject to parliamentary vote total 12 such heads.

### IMF staff commentary and recommended direction
- The government has made efforts to increase transparency and accountability: creation of the CIAA and NVC; published guidance for taxpayers; public hearings in tax and customs administrations; reclassification of expenditures into recurrent and capital; discontinuation of separate recurrent and development budgets; simplified MTEF implementation with documentation; publication of mid-term budget review; publication of financial performance of state enterprises; Annual Report of the AG available to the public.
- Staff emphasize the need to use this momentum to implement a systematic approach to meet international standards of fiscal transparency, noting transparency is important for good governance, macroeconomic stability, and high-quality growth.
- The Finance Minister announced intention to enact a Transparency Act in 2006/07 and to provide periodic accounts of budget execution and physical progress in project implementation; staff stress swift realization of these announcements.
- The government is pursuing public sector reforms with donor support.

*Source: IMF staff report content provided in the supplied PDF excerpt.*

### 56.      More effective enforcement of the laws, rules and regulations is necessary for the

### _cr07346 - 56.      More effective enforcement of the laws, rules and regulations is necessary for the

### Enforcement and legal framework
- Nepal has by and large a good legal framework and a large number of rules and regulations which, if enforced, would result in a significant improvement in the transparency and accountability of public financial management.
- More effective enforcement is necessary to:
  - Make fiscal policy more effective.
  - End anti-social practices such as the culture of well-connected borrowers not repaying bank loans and the depletion of the capital of PEs.

### Revenue administration
- Government efforts to improve revenue administration should be supplemented by modernizing personnel management, requiring firm, transparent and significant action in areas including:
  - Integrity of staff.
  - Management of recruitment, career development and training.
  - Discipline, accountability, and performance management.
- Human resources should be refocused towards more productive activities (e.g., away from traditional assessment and into strategic audit and cross-checking).
- Tax and customs administration should be strengthened; specific priorities:
  - Review and simplify excise and tax and customs duty exemptions that are complex and difficult to administer.
  - Improve large taxpayer and VAT audits, income tax dispute resolution, and management of refunds.
  - Identify and take recovery action against VAT taxpayers whose registration has been suspended but who continue to trade outside the VAT system.
  - Mobilize the computerization project in customs and continue to build technical capacity in valuation, audit, and risk management.

### Budget coverage
- The coverage of the central government budget should be widened to include all central government activities; good practice recommendations include:
  - Revolving funds:
    - Review the rationale for keeping revolving funds outside the budget.
    - At minimum, subject these funds to the same rules and regulations as the Consolidated Fund.
    - Widen the mandate of the Financial Comptroller General to integrate accounting of these funds into the main system.
    - Include budgets relating to revolving funds and information about their execution in budget documents and present a truly Consolidated Central Government Budget.
  - Autonomous entities (boards and organizations including universities, colleges, and some hospitals) controlled by the central government should be included in the budget or at least in the budget documentation.
  - Army Welfare Fund:
    - Income of this fund (receipts from the UN) should be credited to the Consolidated Fund and accounted for in the budget; expenditures financed from these revenues should also be disclosed.
  - Similar considerations apply to the Police Welfare Fund.
- If inclusion in the budget is not immediately possible, these items should at least be disclosed in the budget documents.
- A consolidated budget incorporating all budgetary and extra-budgetary activities should be prepared and included in the budget documents.
- The government should present information about all other general government activities (as defined in the GFSM 2001) and make reporting mandatory for all general government units, defining standards, periodicity, and timing of reporting.
- Objective: Consolidated General Government Budget covering all central and local government units and nonprofit institutions controlled and mainly financed by the government.

### Budget preparation and execution
- Published budget documentation should contain more analytical information, including macroeconomic assumptions, evaluation of risks, and other explanations. Immediate inclusions for next year’s budget presentation:
  - Basic macroeconomic assumptions and indicators (a macroeconomic framework has been developed under the Poverty and Growth Reduction Facility).
  - Contingent liabilities:
    - Arise from government guarantees and other arrangements that could imply future government liability.
    - Include costs from poor financial performance of PEs and nonperforming loans held by financial institutions financed by government borrowing from international banks.
    - Potential risks should be disclosed in an annex to the budget document.
    - PPP arrangements such as build-operate-buy (BOT) should be evaluated for likelihood and appropriate provision.
  - A statement on tax expenditures (forgone revenues from concessions, e.g., exemptions of large parts of the agricultural sector); include as an annex to the budget documents.
  - An estimation of quasi-fiscal activities (concessional interest rates, price regulation deviations from market pricing).
  - A statement on risks indicating possible impact on the overall fiscal position of changes in key assumptions or contingent events, together with mitigating measures.
  - A distinction between ongoing and new initiatives.
  - Information on future commitments under multi-year projects and contracts.
  - A systematic review of implementation of initiatives announced in the previous year’s budget speech, including reference to declared objectives and achievement measured by relevant output and outcome indicators.
- The MTEF can be further developed to strengthen policy accountability; it should:
  - Use realistic macroeconomic indicators and distinguish between new and ongoing projects.
  - Be expanded to analyze sustainability of current macroeconomic and sectoral policies; trend of recurrent expenditures; debt sustainability; success and failure in program implementation; and consequences for resource allocation and sectoral strategy.
  - Be developed into a medium-term budgetary framework to give the annual budget a true medium-term outlook.
  - Make macroeconomic assumptions the exclusive responsibility of the MOF; MOF should prepare the MTEF with realistic approach.
  - Require all ministries to produce periodic progress reports available to Parliament at the time of budget discussion; objectives and indicators should be consistent with timely availability of information.
- Expenditure arrears need to be monitored and reported; the current cash accounting system should be supplemented with an effective, ex ante, commitment control.

### Fiscal reporting
- Reports on budget execution should be improved in quality, timeliness, frequency, and coverage. Government actions should include:
  - Widen coverage of in-year reports to include revolving funds outside the budget, other extra-budgetary funds such as the Police Welfare Fund, and other nonprofit institutions such as universities and boards.
  - Initially aim to produce in-year reports no more than 60 days after the end of the quarter and progressively reduce this timing.
  - Make these reports available on the MOF website in both Nepali and English.
  - Report with the same frequency on the consolidated position of financial assets and on the debt stock, including comprehensive information on valuation methods and maturity structure; commence reporting initially from existing memorandum records and consider an accrual accounting system in the medium term.
  - Include summary data on local government budget execution; first year limited to collection, consolidation and reporting of annual data, from the second year align with in-year reporting on central government fiscal operations.

### Public enterprises (PEs)
- Urgent systematic measures to strengthen transparency of PEs are needed; measures include:
  - Externally audit all PEs according to international standards; Boards of Directors and Chief Executives should be held accountable for producing and maintaining good-quality, regular, and timely accounts and subjecting them to audit; legal action should be taken against errant officials.
  - Improve quality of financial data in comprehensiveness and timeliness.
  - Estimate, analyze and report quasi-fiscal activities carried out by PEs; subject them to scrutiny by the Corporation Coordination Division of the MOF and include in fiscal reports (budget and annual financial statements).
  - Publish an analysis of the financial results of each PE quarterly or semi-annually; the MOF should include a summary of these publications in its annual report on PEs.
  - Strengthen the Corporation Coordination Division of the MOF to ensure effective oversight of PEs.

### Accounting and audit
- Accounting system reform:
  - Rationalize the accounting system to serve as a basic tool for financial management with periodic reporting from which key data can be easily extracted.
  - Staff suggest a phased move towards accrual accounting, with the first step being the adoption of accrual concepts for financial assets and liabilities.
  - Adapt the budgetary legal framework to accommodate these changes.
- Audit reforms:
  - A strong and effective audit is critical for fiscal transparency; financial integrity requires publication of audit reports and timely implementation of audit recommendations.
  - The rectification of specific financial irregularities identified by the AG is crucial; the last three annual Audit Reports submitted by the AG have not been published.
  - Staff emphasize:
    - Institute and observe clear rules for timely publication of audit reports and appropriate action on reported irregularities, supported by effective deterrents for noncompliance.
    - Staffing of the AG (quality and numbers) should be appropriate to the role of audit; current staffing and technical skills are inadequate.
    - The AG should be in charge of the audit of all PEs, including those not fully owned by the government; even when a private sector audit firm is appointed, it should be at the discretion of the AG who should monitor the audit and take responsibility for it. International best practice indicates the AG should be responsible for auditing all PEs that are controlled by the government (more than 50 percent of ownership).
    - Sharply increase staff training in the AG to make available more audit staff capable of performance auditing.
    - Extend the limited performance audit of large projects currently performed by the AG to all major projects.

### Publication and sequencing of reforms
- Government should commit to publishing comprehensive information on its operations, preferably enshrined in law specifying timing and content of publications.
- Reform should follow proper sequencing; focus initially on issues realizable in the near future with positive impact on transparency.

### Short-term measures (within a twelve month period)
- Publicly announce a timeframe for publication of fiscal information, including an indication as to each publication’s nature and contents.
- Enhance integrity and credibility by timely publication of the AG’s Report and implementation of follow-up mechanisms on recommendations.
- Make macroeconomic assumptions of the budget realistic, explicit and specify broad fiscal policy objectives in publicly available budget documents.
- Commence reforming economic classification of the budget to fully conform with GFSM 2001.
- Increase MOF’s ownership of the medium-term expenditure framework through enhanced participation in development and exclusive responsibility for macroeconomic assumptions.
- Use a comprehensive definition of central government activities for better budget preparation, execution and reporting.
- Disclose information on areas where contingent liabilities, tax expenditures and other quasi-fiscal activities occur, and provide corresponding budget estimates.
- Make all extra-budgetary activities subject to general rules of accounting, audit, and publication.
- Disclose full information on the amount and structure of debt and financial assets from existing memorandum records.
- Initiate measures for developing a commitment control system to report, control, and avoid expenditure arrears.
- Initiate training programs to increase technical and operational abilities of staff and develop a program to improve human resource management practices.

### Medium-term measures (one to three years)
- Strengthen the macro-fiscal unit of the MOF and allow external scrutiny of macroeconomic assumptions.
- Adopt a functional classification in the budget.
- Implement a commitment control system to report and control expenditure arrears.
- Strengthen internal audit functions.
- Integrate all extra-budgetary activities into the central government budget.
- Report fiscal activities on the basis of General Government, including all activities of central and local governments.
- Ensure the financial relationship between central government and local government is transparent and systematic, and define borrowing limits for local governments.
- Improve governance of PEs to reduce government contingent liabilities.
- Introduce legal requirements for publication of regular and timely reports, based on internationally accepted standards, of all public sector institutions.
- Eliminate quasi-fiscal activities and replace them, if necessary, with explicit subsidies.
- Reduce tax expenditures as much as possible.
- Introduce human resource management policies based on international best practice.

*Source: _cr07346 - 56.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2007/_cr07346.pdf_