Statement by the PalestinianDelegation

on the Monitoring and Audit Report of May 23, 1997

presented to the AHLCmeeting

Washington, DC.

June 5, 1997

The objective of this statementis to address the concerns that have been raised lately by somedonor countries in the wake of media reports on the PalestinianPublic Monitoring and Audit Department's recent report (hereinafterthe Report) which was issued on Friday May 23, 1997.

At the outset, the Palestiniandelegation would like to assure donor countries that we take theirconcerns seriously, out of our interest in maintaining the highlevel of mutual trust and understanding which we have so diligentlybuilt over the past four years. We interpret donors' concernsnot as looking to find fault with our newly established systemof financial management, but as a genuine interest on their partin seeing their development aid and financial contributions toPalestine managed efficiently and used productively. This is agoal that we, in Palestine, strongly share with the donor community.It is precisely in this spirit that the Report was commissionedin the first place, and it is in this spirit that this statementis presented today.

In this statement, we would liketo clarify to the donor community and the public at large thatthe extent and gravity of financial mismanagement reported inthe local and international media has been grossly over-represented.Figures cited in the Report were quoted with only superficial,and often erroneous, interpretations, giving a distorted impressionof poor financial management and performance by the PalestinianNational Authority (PNA) in the use of its own resources and particularlythose contributed by donors.

We, the Palestinians, see thecommissioning and issuance of the Report as one step inour on-going efforts to establish the highest possible standardsof efficiency, accountability, and transparency by putting inplace effective public auditing procedures. We are likewise determinedto undertake a critical examination of the sources and uses ofpublic funds to search for ways and means of rationalizing ourpublic expenditures and of optimizing public revenues by continuingto strengthen revenue administration and exploiting previouslyuntapped sources of government revenues. By so doing, our objectiveis to minimize, and shortly to eliminate, the recurrent deficit,and thereby to provide a key element of the appropriate policyenvironment for private sector-led economic development.

We would like now to presenta summary of the main findings of the Report. Thiswill help clarify the precise elements of the Report,and will highlight the extent to which allegations of mismanagementand misuse of public funds as recently reported in the news media.Bur first, a few words on the Report's nature, objectives,and mandate.

The Report

• The Report was preparedby the Public Monitoring and Audit Department (PMAD), which wasestablished in 1994 by a presidential decree (presidential orderNo. 22/1994).

• As a result of this presidentialorder, and of subsequent instructions by President Arafat, a committeeheaded by Mr. Jarrar Al-Kidwa launched the work with the objectiveto "monitor the public funds and to guarantee its efficientuse through continuous financial, administrative, and legal auditing".

• Under the mandate bestowedto PMAD, all 22 PNA ministries, along with 37 public institutions,354 municipalities and village councils, 360 civil associationspartially funded by public funds, and all NGOs were subject toauditing procedures by the PMAD. The actual auditing coverage,however, was limited to 22 ministries, 30 municipalities and villagecouncils, and 12 public agencies and civil associations. Non ofthe NGO offices operating in the Palestinian areas were coveredin the Report.

• The coverage varied in depthand breadth, with most of the geographical coverage concentratingon the Gaza area. The Report covered the first year ofoperation up to the end of 1995 in most cases. The Reportdid not cover any spending financed directly by foreign donors,nor did it cover institutions that are entirely financed by foreigndonations such as PECDAR or the Water Authority.

Report Findings

The following are the principlecontentious items addressed in the Report recently presentedto President Arafat, the PNA cabinet, and the Palestinian LegislativeCouncil. The Report includes the results of two types of studies:

1. Standard audit reports ofsome of the ministries, particularly those whose central officesare in Gaza. Some of these audit reports resulted in a positiveresponse by the ministries involved explaining their treatmentof some accounts, or introducing changes in their systems to providecorrective actions. These explanations and corrections were notduly reported by the Report.
2. Techno-economic office studiesbased mostly on hypothetical assumptions designed to find otherways of generating revenues and reducing the cost of governmentoperations. Most of the figures adding up to the US$310.9 millionwere derived from these studies and not from the audit reports.Furthermore, these studies did not utilize marginal or differentialanalysis, typical of the "make-or-buy" decisions involvedin these study areas. Instead, the assumptions were made thatthe alternate investment and operations would have zero costs,making the potential savings equal to the total amount of thepresent operation.

1. Undervaluation of PublicLand. The Report found that 988 Dunamsof public land had been sold to local developers and cooperativesocieties for housing and tourist projects (81 housing projectsand 18 tourist projects) and other private sector projects ata 40% below their market value in 1994. The Report claims thatUS$72 million of potential revenues were forgone because of thisaction.

Clarification. This actionby the PNA was part of a policy which aimed to revitalize privateinvestment in Palestine by alleviating the constraints of skyrocketingland prices, particularly in 1994-1995 when the euphoria producedby the peace process led to a heated land speculation which almostchoked development projects. This policy of sale of governmentland at reduced prices and the promise of establishing industrialzones helped to bring down land prices. Clearly, the short- andlong-term positive impact of such a policy on the Palestinianeconomy was overlooked by the Report.

2.Smuggling of Productsfrom Israel. The Report estimated that US$72 million in potentialimport duties and VAT have been lost as a result of the smugglingof goods from Israel into the Palestinian Territories throughthe Israeli settlements in the West Bank and Gaza Strip. The problemis probably more acute in the West Bank in which Israel remainsin control of all border areas and roads in Area C.

3. Exemption of Returnees Private Vehiclesfrom Import Duties. The Report estimatedthat US$45.5 million in potential revenues were forgone as a resultof exemptions from import duties on 1,656 private vehicles broughtto Gaza Strip and West Bank by Palestinian returnees.

Clarification: This exemptionis a privilege that was given by the PNA to all Palestinian returnees,a prerogative that is similar to most countries in the world.Furthermore, the figure cited in the Report is grossly inflated.On average, each car, according to the Report figures, was givena US$27,500 in import tax exemption; a figure that is quite highand unrealistic. There was also an implicit assumption in theReport that this figure would have been collected had it not beenfor the exemption granted by PNA to the returnees. This is simplya wrong assumption on three counts: First, few returnees wouldhave been able to bring private cars if there were no exemptions.Second, there is no guarantee that these import duties would becollected since these duties are usually collected first by Israeland never passed on to PNA. It is worth mentioning in this regardthat Israel still owes PNA about 200 million Shekels (US$60 million)in idon imported cars to the Palestinian territories. Third, returneeswould have bought used Israeli cars instead. In this case, alltax benefits would have accrued to Israel and Palestine wouldbecome the dumping ground for used and polluting Israeli vehicles.

4. Losses in Electricity Tariff Revenues.The Report estimated these losses to be about US$44 millions.These losses mainly reflect unpaid electricity bills by low-incomesegment of the population and some businesses, and because ofthe waste in power usage as a result of a deteriorating and outdatedelectricity grid network in the Palestinian territories. Theselosses are quite unavoidable in the present situation of decliningeconomic conditions and declining standards of living.

5. Other Expenditures and Forgone Revenues.The Report found that US$30.2 million in public funds had beenforgone or partly mismanaged either because they were spent improperlyby some ministries and public institutions (US$4.14 million),or because of forgone public revenues (US$26.8 million). Morespecifically, at the revenue side, US$14.9 million were forgoneas a result of uncollected taxes, fees, and import duties; US$8.0million were spent by some revenue collecting agencies to financedirectly their budget lines -instead of transferring it firstto the Ministry of Finance (MOF) account and then requesting MOFto finance these budget lines. Out of these accounts US$1.7 millionwere directly spent without prior approval of the MOF; US$2.1million are outstanding debts and dues for PNA; and US$0.1 millionwere other uncollected tax revenues. At the expenditure side,the report revealed that US$2.8 million were overspent becausesome PNA ministries and public institutions have exceeded theirspending limits as set out at the beginning of the 1996 fiscalyear; US$1.3 million were spent on procurement without tendering;US$0.02 million were spent without proper documents; and US$0.02million resulted from accounting discrepancies.

6. Medical Treatment in Israeli, Jordanian, andEgyptian Hospitals. The Report estimatedthat between 1/01/1995 and 31/07/1996, US$23.7 million were paidto Israel, Jordan, and Egypt in return for the treatment of Palestinianpatients in their specialized and more advanced clinics and hospitals.The Report estimates that US$30 million would have been requiredto build a medical center to treat all sorts of sicknesses andperform all operations. The assumption is that such amount wouldbe financed by the donors.

Clarification. Given thepresent state of health care services in the Palestinian territoriesand the lack of advance and sophisticated medical treatment ofserious illnesses, this sort of public expenditure was quite unavoidable.Furthermore, the operating economic opportunity cost of the proposeddonor-funded medical center was not calculated by the Report.

7. PNA Printing and Publishing Expenses.The Report estimated that the PNA pays about US$7 millions annuallyto print and publish materials which could have been saved ifthe PNA had its own publishing house.

Clarification. Given thelimited resources available to PNA, and the fact that most, ifnot all, of its capital expenditure comes from donor countries,and the fact that demand for such money is needed to meet otherpressing priorities, it was not possible to build a governmentpublishing house in the present time or to convince donors ofsuch a need. The government, therefore, resorted to the privateenterprise printers to perform these functions. Again, the Reportdid not calculate the cost of the alternate public method suggested.

8. The Use of Government Vehicles.The Report estimated that the US$5.6 million incurred in the lasttwo years, 1994-1996, in maintaining and operating governmentvehicles indicate inefficiency in the use of public vehicles.Inefficiency is defined in the Report as the excessive use ofvehicles and the high level of maintenance expenses.

Clarification: The figurewhich was mentioned in the Report is related to 1,463 vehiclescurrently in use by PNA ministries and other public institutionsand encompasses all sorts of expenses (fuel, maintenance, insurance,etc.) A simple calculation reveals that each vehicle, on average,cost about US$160 a month to operate; a quite reasonable and normalcost for a car in our area; and given the bad shape of the roadsin the Palestinian areas, this cost is even below normal.

9. Use of Cellular Phones.The Report estimated that more than 5,000 cellular phones arein use by PNA ministries and agencies. The unrestricted and uncontrolleduse of these phones by the government officials is identifiedas a source of waste for public funds that costs the PNA budgetabout US$5.5 million annually.

Clarification. The numberof cellular phones used by the PNA ministries and agencies isquite exaggerated. According to the Ministry of Finance, the numberof cellular phones in use by PNA institutions does not exceed300. Furthermore, the figure of US$5.5 million is a gross figureand includes the cost of purchasing the equipment, monthly subscriptionrates as well as call charges, thus does not reflect in its totalitythe exact amount of possible excessive use of these phones. Itshould be mentioned here that the police forces used these mobilephones prior to installing their own telecommunication system.

10. Monetary Dues onthe Israeli Side. The Report found that financial obligationsby the Israeli government to selected Palestinian municipalitiesand village councils amount to an estimated US$2 million. Theactual claims on Israel vastly exceed this amount particularlyif excise duties are considered.

11. Motorola Cellular Phone Expenses.The Report estimated that the PNA overpaid US$1.5 million annuallyin usage fees to the local agents of the Motorola cellular phonecompany owing to its failure to obtain a "large customer"discount to which it should have been entitled.

Clarification. Again,the total number of cellular phones used by PNA officials, accordingto the Ministry of Finance data, is much below the number citedby PMAD. Hence savings from discounts are much smaller than suggestedby the Report.

12. Rental Expenses for Ministries' and otherPublic Agencies' Buildings. The Reportestimated that US$1.1 million of public funds were expended duringthe first half of 1995 to rent premises for PNA ministries andother public institutions in West Bank and Gaza. The Report arguesthat these expenses could have been used to build , instead ofrenting, public buildings.

Clarification. The choiceto rent or to build for ministries and public institutions wasnot available when the authority moved in to Gaza Strip and WestBank in 1994. The PNA had to act quickly to establish its institutionsand had no choice then but to rent premises for its institutions.Furthermore, it is questionable whether it is a priority investmentto construct government building at this time. The cost of buildingand maintaining these offices is certainly not zero.

13. Unpaid Registration Fees and Fines on High-RiseBuildings. The Report estimated that US$0.7million in potential revenues were forgone as a result of uncollectedfines levied on the owners of these buildings as a result of violationof standards, as well as of uncollected registration fees on thesebuildings in Gaza Strip and West Bank.

Summary Table

Main items of probableforgone revenues and of spending

as reported bythe Public Monitoring Department Report

Item Millions of

No. US Dollars

Remarks on the Report Findings

As is evident from the summaryof the Report's findings, most of the US$310 million identifiedin the PMAD Report can be classified as: (a) forgonerevenues resulting from PNA policies to encourage private investment(item 1) or to grant certain common prerogatives to Palestinianreturnees (item 4); (b) expenses in response to exogenousshocks and continuous institution build-up (item 3 and 5.2.1).(c) expenses related to institution building (items 7 and12); (d) public expenses attributable to the lack of advancedhealth care services (item 6) or deteriorating infrastructure(parts of items 8, 9, and 11), and finally, (e) uncollectedtaxes and debts (items 2, 5.1.1, 5.1.4, 5.1.5, 6 and 13).

Most of the components in item# 5 in the summary table, either spending or forgone revenues,are arguably related to the heavy burden resulting from the extendedIsraeli closure and its damaging impact on Palestinian societyduring 1996. This later phenomenon explains in large part whysome of PNA ministries and public agencies has exceeded theirspending limits on wages and salaries that year. In addition toa continuing build-up of their capacities, these institutionswere forced to act to mitigate the negative impact of the closureby providing local employment opportunities or implementing someemergency relief programs. The same phenomenon also explains whyPNA , in spite of its success beyond expectations in revenue collectionin that year, was not able to exert too much pressure in collectingtaxes from business and household sectors which were both strangledby an air-tight closure for most of that year.

While it is clear that the PNA'sinstitutions cannot be completely absolved of error or blame,it is equally clear that serious violation or mismanagement donot come anywhere near the figure cited in the media. Nowheredoes the Report even mention a large-scale fraud, corruptionand mismanagement of financial resources or a diversion of publicfunds to private accounts. The financial mismanagement on thepart of some ministries, public institutions, municipalities andvillage councils is, by and large, small in magnitude, and isthe result of inexperience on the part of these institutions inrunning a system which is not yet fully established, and is certainlynot confined to the Palestinian experience.

Final Note

The objective of this statementwas to present to the donor community the Report for whatit is, not for what some would like to see it, and to explainits nature and contents and not to merely provide some justifications.After all, the Report was produced by a Palestinian committeefollowing a request by the head of the political leadership inPalestine and not by outside parties. Its contents were firstrevealed and debated in two consecutive 90-minute live programson the state-run TV station, and not by the foreign media.

The Report is currentlythe subject of widespread debate in the West Bank and Gaza Stripboth at the public and the private levels and, by order of thePresident, a committee has been formed to study its findings.Notwithstanding clear shortcomings in the Report concerningthe accuracy of the information and data collected, as well asthe methodology followed by the PMAD in conducting its analysisand arriving at its recommendation, we would like to assure thedonor community of our intention to take all necessary measuresto rectify any sources of violation and mismanagement revealedby the Report, and we will continue to work in close partnershipwith the donor countries and multilateral agencies to establisha fully accountable, transparent, and sound public fiscal system.