Document of The World Bank

- This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

FOR OFFICIAL USE ONLY

Report No: 32255-NG

PROJECT APPRAISAL DOCUMENT

ON A

PROPOSED CREDIT

IN THE AMOUNT OF SDR 12.0 MILLION (US$ 18.10 MILLION EQUIVALENT)

TO THE

FEDERAL GOVERNMENT OF NIGERIA

FOR A

STATE GOVERNANCE AND CAPACITY BUILDING PROJECT

May 31,2005

Public Sector Reform and Capacity Building Unit Country Department 12 Africa Region

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CURRENCY EQUIVALENTS (Exchange Rate Effective April 30,2005)

AEA AGS BATMIS CAS CF C F A A C o A CPAR CPS CRP CRS DflD E C ERGP FAD FCT FGN FM FMF FMR FPM GAAP HFD HR H R M I S I C R I C T IDA IFMIS IGR IPSAS JISU LAN LGA LGAD

Currency Unit = Nigerian Naira NGNl .O. = US$0.00752 US$ 1.0 = NGN 132.95043

FISCAL YEAR January 1 - December 31

ABBREVIATIONS AND ACRONYMS Activities Executing Agency Accountant General o f the State Budget and Treasury Management Information System Country Assistance Strategy Community Foundation Country Financial Accountability Assessment Chart o f Accounts Country Procurement Assessment Report Country Partnership Strategy Core Reform Program Cross River State The Department for International Development o f the UK Government European Commission Economic Reform and Governance Project Finance and Accounts Department Federal Capital Territory Federal Government o f Nigeria Financial Management Federal Ministry o f Finance Financial Monitoring Report Financial Procedures Manual Generally Accepted Accounting Principles Home Finance Department o f the Federal Ministry of Finance Human Resource Human Resource Management Information System Implementation Completion Report Information and Communication Technology International Development Association Integrated Financial Management Information System Internally Generated Revenue International Public Sector Accounting Standard Joint Bank Group Interim Strategy Update Local Area Network Local Government Authority Local Government Affairs Department o f the Ministry o f Inter-governmental Affairs, Youth Development, and Special Duties

MDA MDG MF MTEF MYBF N D D C NEEDS N P C U OAGF OAGS O & M OSAG PEM PETS PFM PFMU PHRD Grant PIM PPC SA S A D SAG SBD ssc SCoA SEEDS SGCB SHoA SOE SPCU TFIGC TOR UNDP VAT WAN WBI

FOR OFFICIAL USE ONLY Ministries, Departments and Agencies Mil lennium Development Goals Ministry o f Finance (at the state level) Medium Term Expenditure Framework Multi-Year Budget Framework Niger Delta Development Commission National Economic Empowerment and Development Strategy National Project Coordination Unit Office o f the Accountant General o f the Federation Office o f the Accountant General o f the State Operation and Maintenance Office o f the State Auditor General Public Expenditure Management Public Expenditure Tracking Survey Public Finance Management Project Financial Management Unit Japan Policy and Human Resources Development Fund. Project Implementation Manual Public Procurement Commission Special Account State Affairs Department in M o I G A State Auditor General Standard Bidding Documents State Project Steering Committee Standard Chart o f Accounts State Economic Empowerment and Development Strategy State Govemance and Capacity Building Project State House o f Assembly Statement o f Expenses State sub-proj ect Coordination Unit Task Force on Inter-governmental Collaboration Terms o f Reference United Nations Development Programme Value Added Tax Wide Area Network World Bank Institute

Vice President: Gobind T. Nankani Country Director: Hafez Ghanem

Sector Manager: Helga Mul ler Task Team Leader: Manga K u o h

This document has a restricted distribution and may be used by recipients only in the performance of their official duties. I t s contents may not be otherwise disclosed without World Bank authorization.

NIGERIA STATE GOVERNANCE AND CAPACITY BUILDING PROJECT

TABLE OF CONTENT

A . STRATEGIC CONTEXT AND RATIONALE .................................................................. 1 COUNTRY AND SECTOR ISSUES ............................................................................................. 1 RATIONALE FOR BANK INVOLVEMENT ................................................................................. 2 HIGHER LEVEL OBJECTIVES TO WHICH THE PROJECT CONTRIBUTES ..................................... 3

PROJECT DESCRIPTION .................................................................................................. 3 LENDING INSTRUMENT ......................................................................................................... 3 PROJECT DEVELOPMENT OBJECTIVES AND KEY INDICATORS ................................................ 3

1 . 2 . 3 .

1 . 2 .

B .

3 . 4 .

PROJECT COMPONENTS AND CAPACITY BUILDING STRATEGY ............................................. 4 LESSONS LEARNED AND REFLECTED IN THE PROJECT DESIGN ............................................... 7

5 . ALTERNATIVE CONSIDERED AND REASONS FOR REJECTION .................................................. 8 C . IMPLEMENTATION ........................................................................................................... 9

1 . PARTNERSHIP ARRANGEMENTS ............................................................................................ 9 2 . INSTITUTIONAL AND IMPLEMENTATION ARRANGEMENTS ..................................................... 9 3 . MONITORING AND EVALUATION OF OUTCOMES/RESULTS .................................................. 10 4 . SUSTAINABILITY ................................................................................................................ 11 5 . CRITICAL RISKS .................................................................................................................. 12 6 . LOANS/C.REDIT CONDITIONS AND COVENANTS ................................................................... 12

APPRAISAL SUMMARY .................................................................................................. 12 1 . ECONOMIC AND FINANCIAL ANALYSIS ............................................................................... 12 2 . TECHNICAL ........................................................................................................................ 13 3 . FIDUCIARY ......................................................................................................................... 13 4 . SOCIAL ............................................................................................................................... 14 5 . ENVIRONMENT ................................................................................................................... 14 6 . SAFEGUARD POLICIES ........................................................................................................ 15 7 . READINESS FOR IMPLEMENTATION .................................................................................... 15 8 . COMPLIANCE WITH BANK POLICIES ................................................................................... 15

D .

ANNEXES Annex 1: Country and Sector Background ........................................................................... 16 Annex 2: Major Related Projects Financed by the Bank and /or other Agencies ................ 23 Annex 3: Result Framework and Monitoring ...................................................................... 24 Annex 4: Detailed Project Description ................................................................................ 28 Annex 5: Estimated Project Costs ........................................................................................ 41 Annex 6: Institutional and implementation arrangements ................................................... 42 Annex 7: Financial Management and Disbursement Arrangements ................................... 45 Annex 8: Procurement Arrangements .................................................................................. 53

Annex 10: Safeguard Policy Issues ...................................................................................... 59 Annex 9: Economic and Financial Analysis ........................................................................ 58

Annex 11: Project Preparation and Supervision ................................................................. 60 Annex 12: Documents in Project File .................................................................................. 61

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Annex 13: Statement of Loans and Credits .......................................................................... 62 Annex 14: Country at a Glance ........................................................................................... 64

TECHNICAL APPENDIX: ACTIVITIES UNDER THE CORE REFORM PROGRAM .............................. 66

MAP IBRD NO . 33458

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Borrower Beneficiary States IDA Other Donors Financing Gap

NIGERIA

State Governance and Capacity Building Project

Project Appraisal Document

Afr ica Regional Office AFTPR

Local Foreign Total 0.00 0.00 0.00 0.00 0.00 0.00 6.30 11.80 18.10 0.00 0.00 0.00 0.00 0.00 0.00 06.30 11.80 18.10

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Telephone 09-2346291-4, 2346951-4 09-2346928,2346930

Addresses and ( Fax Director, MULT - 09-2343609

The Federal Minister o f Finance

Annual Cumulative

The Governor o f Bauchi State

5.6 5.8 4.3 2.0 0.4 5.6 11.4 15.7 17.7 18.1

The Governor o f Cross River State

The Governor o f Kaduna states

Intact Persons: Address: Federal Ministry o f Finance Ahmadu Bello Way, Central Business District, Abuja Office o f the Executive Governor, Government House, Yakubun Bauchi Road, Bauchi Office o f the Executive Governor, Governor’s Office, Hope Waddell Avenue, Calabar Office o f the Executive Governor, Sir Kashim Ibrahim House, Government House, Kaduna

Estimated Disbursements ( Bank FY/U$

077-543821,542611,542238 077-542611, 543843

087-232786,235050,236400 I 087-232786,

062-417232,417229,417817 1 062-410790

E-mail

dduke@crossriverstate.com

Project implementation period: October 2005 - September 2009 Expected effectiveness date: October 2005 Expected closing date: March 201 0

Significant, non-standard conditions, if any, for: None. Board presentation: None. Grant effectiveness: None.

Covenants applicable to project implementation:

A. STRATEGIC CONTEXT AND RATIONALE 1. Country and sector issues 1.1 Economic Situation and Poverty. Nigeria i s the largest country in West Africa with a GDP o f about US$50 bi l l ion (2003) and a per capita income o f about US$320. It i s highly dependent o n o i l which provides about seventy five percent o f government revenues and ninety five percent o f export earnings. Growth has been highly volatile and averaged just over 3 percent annually over the last decades-barely enough to keep up with population growth. Sixty percent o f Nigerians l ive on less than $1 per day. Nigeria services only about hal f o f its annual external debt obligations o f over $3 bi l l ion (20 percent o f o i l revenues). For several states, full debt service would leave l i t t le resources for other expenditures.

1.2 Political Developments and the New Emphasis on Reforms since 2003. The successful completion o f the 2003 presidential, gubernatorial, and legislative elections (at the national and state levels) was a landmark because, for the first time since the 1960’s, Nigeria achieved a transition from one civilian government to another civilian government through contested elections. Right after the 2003 elections, President Obasanjo announced ambitious reforms aimed at laying the foundations for economic growth, employment creation, poverty reduction and more transparency and accountability in the management o f public resources. In July 2003, he appointed a strongly reform minded economic team at the Federal level which quickly developed a comprehensive program: the National Economic Empowerment and Development Strategy (NEEDS). The NEEDS main elements include: (i) promoting macroeconomic stability; (ii) accelerating privatization and liberalization o f the economy; (iii) reforming the public service, including reforming public expenditure, budget and c iv i l service; (iv) fighting corruption, improving government transparency and accountability; and (v) strengthening basic service delivery. Important early measures have included deregulating the downstream petroleum sector and committing Nigeria to the Extractive Industries Transparency Initiative (EITI), reinvigorating the anti-corruption efforts through the establishment o f the Economic and Financial Crimes Commission (EFCC) to complement the work o f the Independent Corrupt Practices and other Related Offenses Commission (ICPC), and strengthening macroeconomic policies (adopting a fiscal pol icy rule, reducing the fiscal deficit, limiting recourse to monetary financing o f the government deficit, and preparing a Fiscal Responsibility Bill). The new Federal administration also intensified the dialogue with the states on economic development and poverty reduction issues encouraging each state to develop its own State Economic Empowerment and Development Strategy (SEEDS).

1.3 Federalism and Intergovernmental collaboration. Today, there are thirty six states in Nigeria, in addition to the Federal Capital Territory. The 1999 Constitution increased the responsibility to the states in the delivery o f social services and the provision o f infrastructure. However, most powers accorded to the states are exercised concurrently with the FGN. This Concurrent Legislative List continues to cause debates over which tier o f government, federal or state, is best placed to deal with various areas o f pol icy (e.g. education, police).

1.4 States Finance. In spite o f initiatives taken by a number o f states in recent years to increase revenue mobilization, the states remain dependent o n allocations o f o i l revenue through the Federation Account, the pool into which o i l and al l VAT revenues are paid prior to

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distribution to the three tiers o f government. They rely on Federation Account transfers for at least three quarters o f their total budget revenues. Since the late 1990’s, boosted by the o i l boom and the depreciation o f the Naira, states have enjoyed strong revenue growth. At the same time, expenditures have risen sharply as states have been obliged to fol low the FGN’s pay increases in 1998 and 2000 (totaling a two and hal f times increase o f c iv i l service pay and allowances), leading to a wage bil l increase exacerbated by overstaffing and payroll fraud.

1.5 W h i l e as a group, states do not appear to be in a fiscal crisis yet thanks to strong o i l revenues, their public finances are overextended, and highly vulnerable to a weakening o f o i l prices. A number o f states, in launching ambitious capital spending programs, have become committed to levels o f spending at times exceeding available resources, and have filled the gap through short term domestic borrowing, at high nominal interest rates. In their efforts to service their obligations, some states have built up fresh arrears to contractors and run late in meeting their monthly payrolls. What has been missing for effective fiscal pol icy has been clear and coherent development strategies for the states, which meets both poverty reduction and growth expectations o f the populations and addresses weaknesses in the machinery and capacity o f the state. However, this i s now changing with the development o f the SEEDS in particular.

1.6 The Need for a Sustained Capacity Building Effort. All states saw their governance capacity weakened over the years through failure to modernize public management systems, lack o f training, proliferation o f public agencies and enterprises, patronage based hiring policies, and systemic corruption. With excellence unrecognized, many performing c iv i l servants le f t the service and young graduates with solid education and professional ambitions looked for employment in the private sector and abroad. Even in a state l ike Cross River which appears to have resisted the erosion o f skills better thanks to a longer administrative tradition, the maintenance o f a sufficiently skilled c iv i l service has not been possible. One o f the reason is that state c iv i l service training institutions are in decay and have not kept up with the evolution o f business processes and techniques in modern public institutions. Also, in most states, the responsibility for setting training priorities and selecting people for training has been overly centralized in the Off ice o f the Head o f Service while it should rest more with the M D A s to facilitate a strong link between staff training and the skills required to meet the operational objectives o f the service.

1.7 The Need for a Comprehensive and Realistic Public Sector Reform Strategy. In face o f serious institutional capacity constraints, states seeking to implement coherent economic development strategies need to develop a comprehensive and yet realistic public sector strategy. This entails addressing: (a) ineffective planning and budgeting, and the lack o f transparency and accountability in the use o f public resources including inadequate procurement practices; (b) the weak human resource management system which l imits a state’s ability to keep the staff strength o f the c iv i l service in l ine with resources constraints and efficiency requirement; and (c) the need for a continuous effort to develop staff skills to enable good performance in the c iv i l service There is also a need for improvements in the broad area o f inter-governmental relations.

2. Rationale for Bank involvement 2.1 There are two principal reasons for the IDA to support public management reforms in the states. First, the state (and the local government which fal l under its purview) i s the tier o f

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government principally responsible for the delivery o f basic services to the population. Therefore, the attainment o f Nigeria poverty reduction objectives and more generally the MDGs, which the intemational community including the Bank are firmly committed to achieve, largely depends o n state governments’ capacity to discharge their basic service delivery mandates in an efficient and accountable manner.

2.2 Second, the Bank’s involvement wil l bring in wide-ranging intemational experiences and needed technical assistance to the reform efforts o f participating state governments. The Bank has accumulated substantial knowledge and experience on public sector reforms including public financial management and human resource management. State governments wil l benefit from IDA support to correct shortcomings o f existing approaches to public sector reforms.

2.3 Finally, the Bank’s involvement wil l bring needed financial resources to help fund the costs o f reforms. W h i l e state governments have put sizeable resources to improve their governance system in the past years, there st i l l exists considerable financing gap to meet the existing enormous governance challenges given the damages done through many years o f mil i tary rules and mismanagement o f resources. Therefore, the Bank financing is much needed to complement the own reform efforts o f the state governments.

3. Higher level objectives to which the project contributes 3.1 The Project falls squarely under the objective o f the NEEDS and has been developed in response to requests from some fifteen state governments. I t i s also fully consistent with the objectives and approach o f the CPS which (i) includes enhanced transparency and accountability for better governance as one o f the areas o f focus for partnership; (ii) emphasizes selectivity in Bank support to states; and (iii) recognizes the need for sequencing and phasing reforms.

B. PROJECT DESCRIPTION 1. Lending instrument 1.1 The lending instrument is a technical assistance/investment loan. The essence o f the Project i s on institution-building and capacity strengthening with the assistance o f various types o f expertise from outside the public service and the necessary accompanying information and communication technology. Hence the use o f a TA which i s best suited to help build capacity in organizations directly concerned with formulating and implementing economic and institutional reforms. A Leaming and Innovation Loan was discarded because i t would not have allowed the necessary broad coverage o f governance issues nor the total amount o f financing requested.

2. Project development objectives and key indicators 2.1 DeveZopment objectives. The Project development objective i s to enhance efficiency and accountability in the management o f financial and human resources in participating states in l ine with state poverty reduction strategies.

2.2 following:

Key indicators. The key performance indicators at the end o f the Project are the

The target share o f budget allocations to priori ty poverty reducing sectors/programs as defined in SEEDS i s met.

0

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0

0

0

The deviation o f actual spending from approved budget in participating states does not exceed thirty percent. The time taken to prepare audited annual reports in participating states i s reduced to less than six months There i s no significant discrepancy between payroll and a clean nominal r o l l

3. Project Components and Capacity Building Strategy 3.1 The three participating states (Bauchi, Cross river and Kaduna) have been chosen among six states which where identified during Project preparation through a transparent competitive process based on init ial diagnostic/proposal documents presented by thirteen states out o f twenty four invited. The four criteria utilized in evaluating the init ial proposals were (i) the quality o f diagnosis o f existing constraints, (ii) the overall reform program for the state’s public sector, (iii) the relevance o f the activities proposed for IDA consideration, and (iv) track record between 1999 and 2002. The selection was further refined in light o f the states performance in 2003 and 2004 and the NEEDS and CPS which both required an even greater focus o n a small number o f performing states.

3.2 The Project i s designed around two components: a Core Reform Program (CRP) to be implemented in al l participating states; and State Specific Programs (SSP) selected by the states. Annex 4 provides a more detailed description o f the Project with costs summarized in Annex 5. In addition, a Technical Appendix presents the sets o f activities to be carried out under each subcomponent o f the CRP.

Project Component #1: The Core Reform Program (CRP)- US$ 13.8 million (average of US$4.6 per state)

3.3 This largest component o f the Project aims to increase the ability o f Bauchi, Cross River, and Kaduna states to improve the development and implementation o f public policies and programs. To that end, i t wil l (i) help rebuild basic systems o f public financial and human resource management that meet a minimum standard in terms o f efficiency, accountability and transparency; (ii) promote the standardization o f PFM procedures and o f financial data production among the states o f the Federation to allow appropriate data aggregation and analysis; and (iii) thereby, facilitate the formulation and implementation o f national fiscal policies.

3.4 In each participating state, the Project will finance an integrated package o f technical assistance, equipment and training to support the following set o f reforms:

0 Adopting a new public financial management legislation that meets the standards o f modem financial management in terms o f relevance, comprehensiveness, transparency, and accountability. The new legislation already drafted for the FGN will serve as a guide for the new state legislations;

0 Reforming the budget preparation. The Project wil l finance the development and institutionalization o f a simplified multi-year budgeting framework (MYBF) for annual budget preparation, leading to more sustainable budget implementation, less “feast or famine”, and no run up o f short term debt. The objective wil l be to present to the State

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House o f Assembly annual budgets which are part o f the MYBF starting from the budget for FY 2008 at the latest. The MYBF should state policies and priorities, and fiscal objectives clearly in a 3-year perspective for both revenue and expenditure (recurrent and capital). The first year o f the MYBF, which wil l include more detailed infomation, wi l l be the annual budget to be enacted for the corresponding year. In addition, budget monitoring wil l be enhanced by publishing monthly statements o n budget execution by ministries;

Strengthening the accounting, expenditure control, and financial reporting functions by (i) implementing the Standard Chart o f Account (SCoA) being developed by the states' Accountants General and the Accountant General o f the Federation; (ii) overhauling existing processes such as commitment controls and payment authorizatiodapproval; and ,(iii) improving financial reporting by the ministries and the State government as a whole.

Strengthening the external audit function. The Project will help modernize and strengthen external audit procedures and performance. This wil l include, adjusting the current legislations if necessary, clearing the backlog, and developing the capacity o f audit personnel with the assistance o f experienced auditors from the private sector;

0 Implementing a small to medium size financial management information system focusing o n the budget and treasury functions. The objective wil l be to improve efficiency, transparency and comprehensiveness using modern ICT. The Budget and Treasury M I S (BATMIS) wil l be implemented in a phased manner and, when hl ly in place, support planning and budgeting, transaction processing, and reporting o n the use o f financial resources. The system wil l be integrated in the sense that i t wil l offer a reliable and unified database to and from which al l financial data wil l f low and which wil l be shared by al l users. The B A T M I S will be a small to medium-range system using technologies that are simple and user friendly, utilizing o f f the shelf application software packages with appropriate customization.

0 Modernizing human resource management by focusing o n the basic functions o f personnel registry management and establishment control and in coordination with the Ministry o f Finance. The activities supported wil l include (i) staff audits and pay parades when necessary, (ii) cleaning and reorganization o f personnel records, and (iii) implementing an automated and unified human resource management information system (HRMIS) for the civil servants. The H R M I S will have a proper interface with the B A T M I S (if not one integrated module o f BATMIS) for consistency between nominal ro l l and payroll.

0 Implementing an extensive training program including (i) the adoption o f a training pol icy statement by the State Government; (ii) professional training for officers and middle managers f rom the central economic ministries and selected sector ministries, covering key areas o f economic and financial management in which the Project seeks substantial improvements (budgeting, accounting and reporting, payment management, and human resource and payroll), and (iii) a computer skills enhancement program for different categories o f c i v i l servants in the eight to ten M D A s associated in the Project.

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The training wil l be provided locally by Nigerian training institutions with the assistance o f consultants and Project staff.

Component #2: States Specific Reform Programs - US$1.9 million

3.5 During Project preparation, the states expressed a strong desire for support in areas o f reform not included in the CRP but which are important to improve govemance and service delivery in their particular context. This wil l consolidate the ownership o f the Project by the state governments. I t was agreed that the Project wil l support additional selected institutional reform and capacity building initiatives identified by the states (i) either before the beginning o f the Project (as indicated in the next paragraphs 3.6 and 3.7; or (ii) during Project execution as the needs emerge in the context o f the implementation o f their respective SEEDS. For the later, the Project includes a provision o f US$ 170 equivalent per participating state.

3.6. Bauchi and Kaduna states are committed to modemizing their tax payers identification and data management systems in order to strengthen internally generated revenues (IGR) which remain very l o w (8 percent and 17 percent o f total revenue in 2003 for Bauchi and Kaduna respectively). The Project wil l help the two states (i) verify and expand the existing tax payer database including through in-house verification and market surveys and assessments; and (ii) implement a basic I C T infrastructure and staff training necessary for maintaining a sound and reliable tax administration database.

3.7 Cross River State has selected: (a) strengthening o f the Management Development Institute as a key element o f CRS’s public service skills development program; and (b) improvement o f judicial service delivery through: (i) revision o f the rules o f c iv i l procedure applicable in Magistrate courts and High Courts in CRS; (ii) a comprehensive skills development program for judicial and administrative officers o f the High Courts and Magistrate Courts; and (iii) implementation o f a model court administration system in two pi lot courts (one Magistrate Court and one High Court).

Activities to be identified (national level)

3.8 In addition to financing the activities relating to the two Project components above, the Project includes a provision o f US$ 1 mi l l ion equivalent to meet two types o f needs. First, there wil l be a need to pave the way for reforms that other states will have to embark o n in line with their respective SEEDS. Indeed, in the growing number o f reformist states, meeting the challenges o f effective use o f public resources wil l require developing and implementing institutional and pol icy reforms similar to those included in the CRP. Second, there will be a need to finance selected studies and consensus building activities in the areas o f inter- governmental collaboration and fiscal federalism. The provision wil l be managed by the NPCU under the supervision o f the Federal Minister o f Finance and in consultation with IDA.

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Project Capacity Building Strategy

3.9 The Project has been designed with the belief that (a) capacity building requires a multi- faceted and integrated effort sustained over the medium to long term; and (b) solid first steps can be achieved in a reasonable period o f time provided the design o f operations includes (i) the creation o f an enabling environment through strengthening demand for change and good performance; and (ii) the strengthening o f the link between the development o f knowledge and sk i l ls and the operational deliveries o f organizations. The role o f the SHoA in the implementation o f key components such as budget reform and strengthening o f external audit in each participating state, the participation o f representatives o f the c iv i l society and the SHoA in state steering committees, and the participatory and decentralized nature o f the Project implementation arrangements (including within the States) are meant to consolidate the demand for change and good performance and to broaden the ownership o f the reforms.

3.10 O n the supply side, the Project acknowledges the erosion o f the training capacity within the state c iv i l services over the years. Building on recent efforts, the Project (i) stresses the need for a wel l thought through training pol icy as a condition for effective skills development; (ii) includes training o f trainers in areas where training capacity i s limited; (iii) focuses on training locally which i s more cost effective than training abroad; and (iv) seeks to support the rehabilitation o f one training institution (the Management Development Institute in Calabar, CRS) which has a vocation to serve several states in the Eastern parts o f Nigeria. The main Project training activities are indicated in the Technical Appendix.

3.11 Finally, the Project establishes a strong link between training, institutional changes and operational objectives. Whi le the states have developed large staff training proposals for the c iv i l service, the Project has chosen to focus on M D A s and functions that are directly concerned by the reforms targeted in the various components. This i s in l ine with the findings o f training need assessments conducted during Project preparation in Cross River and Kaduna States. The knowledge and sk i l ls development activities under the Project (combining on-the-job traininghoaching, specific technical skills development workshop and seminars, knowledge sharing and dissemination activities etc.) are not packaged as isolated and discrete “training components” but rather integrated in each component as one element necessary to bring about lasting changes in the aspects o f public management addressed by the Project. As a consequence, the ten percent o f project costs grouped under the “training column” o f the costing tables is only partly representative o f the sk i l ls enhancement effort planned under the Project.

4. Lessons learned and reflected in the project design 4.1 The Project i s the first o f i t s kind for the Bank in Nigeria and, at the federal level, the ERGP, approved o n December 14, 2004, is only in i t s first year o f implementation’. However, the Bank has been involved in state level sector projects in Nigeria over a long time (especially rural development, education, infrastructure, health). I t has also capitalized from experience sharing with other donors who have been supporting state level governance reforms, most notably DFID and the EC. A number o f lessons learned have been incorporated in the Project.

’ The ERGP supports financial management and procurement reforms, the restructuring and rightsizing o f selected k e y federal agencies, the reform o f the pension management system, and the strengthening o f statistics.

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4.2 Selecting committed partners. The Bank’s global experience is that governance reforms are unlikely to b e sustained without strong political commitment. In Nigeria, while some states remain captive to patrimonial politics and are s t i l l trapped in the systemic corruption paradigm, this picture i s by no means uniform, and there i s an increasing number o f states which are attempting to modernize and improve service delivery. This lesson has been built directly into the Project through the selection process o f the participating states which included the review o f reforms engaged by the states and political commitment to further reforms.

4.3 Focusing on the basics first and phasing institutional changes. Experience elsewhere in Afkica points to the importance o f getting the basics o f public management and governance right before embarking on ambitious reforms such as performance management in the civil service or program budgeting. In addition, the preparation o f the Project and the preparation and launching o f the ERGP have confirmed the strong need for technical expertise from outside the civil service (federal and state levels alike) in order to achieve significant institutional changes while steps are being taken to build the staff capacity within the public service. An underlying bel ief i s that a second generation o f reforms wil l be needed in the participating states upon effective implementation o f the basic reform package included in the CRP.

4.4 Capitalizing on similarities and implementing common reform packages. The Project economizes o n resources by supporting the development o f common systems across states, in key areas o f PFM. The development o f common systems will also facilitate the subsequent rol l ing out o f the reforms into a large number o f states. Finally, the experience o f the SLGP supported by DfID has shown that state officials who are presented with a coherent set or menu o f reforms are more focused and effective in their reform efforts than those who have to develop and sell reform packages in their political environment totally by themselves.

4.5 Managing the in formation and communication technology (IClJ properly. The global experience also points to the shortcomings o f technology driven institutional development efforts characterized by oversized and too complex I C T solutions; and insufficient involvement o f key operational units and staff training. Thus, the Project (i) stresses the pol icy reforms and institutional changes that the new I C T will support; (ii) emphasizes the need to design the I C T solutions realistically in l ine with the actual needs o f the states and the roles o f the concerned operational units; and (iii) considers sk i l ls development and technical support from a central I C T team as key elements of success o f change management.

5. 5.1 Given the widespread pol icy and institutional weaknesses in public service in Nigerian states, a key strategic choice has been to focus o n some o f the more amenable problems where there i s a higher probability o f achieving lasting results. Hence the Project focuses on basic public finance management sub-systems together with establishment control and payroll. An alternative project concept considered included a wider core reform package tackling procurement, debt management, and revenue mobilization as we l l as full fledged state c iv i l service reform including the streamlining o f mandates and organizational structures o f MDAs and the overstaffing o f state administrations. In principle, this would have given more coherence to the design o f a state public management reform as a whole. However, such an

Alternative considered and reasons for rejection A wider CRP.

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approach would have been over ambitious from an operational point o f view and politically unfeasible in many cases.

5.2 A project with a larger number of participating states. I t has been rightly observed that there should be a “critical mass” o f states embarking on common key governance reforms in order to achieve substantive and lasting changes in the way state governments function and deliver public services, and in the way fiscal federalism i s practiced in Nigeria. During Project preparation, i t was envisaged to include six to eight participating states, knowing that the reforms included in the C W need to be implemented in many more State governments. However because Bank and other donors’ experience with projects involving a large number o f states point to implementation and supervision difficulties resulting largely f rom low institutional capacity, i t was felt that this f i rst project o f its kind should be limited to three states and that a similar lending operation should be considered a year or two after the launching o f this project.

C. IMPLEMENTATION

1. Partnership arrangements 1.1. Nigeria and Bank dialogue on state level public policies and governance intensified in 2004 with the launching o f the preparation o f SEEDS. This dialogue i s conducted jo int ly with other donors and the Bank has the opportunity to continue to share experience especially with the DFID, which i s already working on improving governance in four states (Benue, Jigawa, Ekiti and Enugu) and the E C which i s seeking to support governance capacity in further five (Abia, Cross River, Gombe, Kebbi, and Osun).

1.2 The Project wil l complement the efforts being deployed in several sectors with the support o f the intemational community including other Bank assisted projects (education, health, infrastructure - see Annex2). Indeed, the institutional reforms (including increased transparency, predictability, and accountability), and capacity enhancement activities that the Project will support at the center in state c iv i l service are designed to provide a more coherent and effective pol icy framework and more efficient operational processes that service delivery oriented sector program wil l benefit from. For instance, the reforms in budget preparation and execution will be instrumental in improving resource allocation among (and within) sectors and monitoring the effectiveness o f public spending in the social and infrastructure sectors.

2. Institutional and implementation arrangements 2.1 Arrangements for the Individual State Public Sector Management Reforms component. The states wil l have the primary responsibility for the implementation o f the public management reforms included in their respective subprojects. Activities wil l be carried out by existing agencies according to their respective areas o f responsibility. To guide, support and coordinate the Activities Executing Agencies (AEAs) in each participating state, there wil l be (i) a State Steering Committee (SSC) on governance reforms chaired by the Govemor and including representatives o f the legislature and the c iv i l society; and (ii) a State Project Coordination Unit (SPCU) located in one o f the lead AEAs. The SPCU wil l be responsible for the day-to-day monitoring o f Project implementation in the state. It wil l be headed by a Coordinator with the rank o f a Director or above and will be supported by a team with expertise in project

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management, procurement, ICT, and office management. implemented over a period o f four years.

State Project components wi l l be

2.2 A generic presentation o f the implementation responsibilities for each component o f the CRP is indicated in Annex 4. Because skilled staff are in limited number in the states civil service, the Project makes resource available to finance non c iv i l service staff and consultants who wil l support the SPCUs in the implementation o f their respective subprojects. This wil l be in addition to the Project resources allocated for the equipment, travel and the functioning o f the SPCU during the four years o f Project implementation. The average allocation under the Credit for the equipment, staffing, consultants support, travel and functioning o f a SPCU during a period o f four years i s estimated at U S $ 360,000 equivalent per state.

2.3 With respect to financial management, the Project Financial Management Unit (PFMU) which has been established in the Office o f the Accountant General o f each state wil l be responsible for managing the financial affairs o f the Project at the state level, including ensuring compliance with the financial management requirements o f the Bank and the state government. The PFMUs are also staffed with Intemal Auditors who wil l be responsible for the Project internal audit.

2.4 Arrangements for Coordiizatioiz and Support at the National Level. The overall Project coordination and the support to participating states in the implementation of their respective subprojects wil l be the responsibility o f a National Project Coordination Unit (NPCU) located in the Multilateral Institutions Department o f the Federal Ministry o f Finance (FMF/MULT). The Project includes a provision o f US$ 263,000 equivalent for the hnct ioning o f the NPCU. The N P C U wil l (i) provide technical support as requested by the states; (ii) conduct implementation monitoring missions and mid-term reviews; and (iii) coordinate, consolidate, and disseminate the information fi-om various components implementing agencies. The N P C U will include public finance management/ICT specialists to assist the states specify, procure and implement the BATMIS and HRMIS and, together with the contractors, provide training and technical support to the state subproject implementation teams. Staff dedicated from the Finance and Accounts Department o f the FMF wil l be responsible for managing the financial affairs o f the Project at the NPCU level, including ensuring compliance with the financial management requirements o f the Bank and the FGN. FAD/FMF will be staffed by relevant qualified accountants. They wil l maintain adequate FM arrangements to support the deployment o f Project resources in an economic, efficient and effective manner to achieve the stated development objectives. The Project Intemal Auditors at the FMF will perform modem internal audit functions for the N P C U activities.

3. Monitoring and evaluation of outcomes/results 3.1 Monitoring and evaluation is a specific area o f focus o f the Project, due to i t s importance in strengthening public administration, and the nature o f the Project that involves multiple AEAs. Performance monitoring will be based o n performance indicators as included in Annex3, as wel l as work programs to be transmitted to the N P C U annually. Special attention wil l be given to monitoring progress on staff sk i l ls development. In each participating state, the Office o f the Head o f C iv i l Service will have primary responsibility for monitoring the training activities and to report annually on achievements. Moreover, annual reports o n sub-project implementation

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will be transmitted to the SHoA. Finally, another feature o f the monitoring arrangements wil l be a peer review mechanism through which progress Project implementation in a participating state will be assessed by a team including officers from the NPCU and representatives o f other participating states to facilitate experience sharing.

3.2 The Project wil l be subject to a Mid-Term Review and Implementation Completion Report (ICR), which wil l both be joint ly prepared by IDA, the NPCU, and the SPCUs. Results o f these reviews will be discussed in each state before being presented to the State govemors and the FGN.

4. Sustainability 4.1 The reforms supported by the Project are expected to have a lasting impact on public management in the participating states and to showcase the benefit o f increased accountability and transparency. The Project design provides reasonable assurances regarding the sustainability o f the activities supported in three ways: (i) the proposed new public management systems and policies are relevant to the needs o f the states in the medium to long term as they face increasing development challenges and a more vocal citizenry that expects results and quality public service; (ii) the modular nature o f the changes to be supported enable a phased approach and a pace adjustable to local circumstances without backtracking; and (iii) the emphasis on staff training and internalization o f new processes and systems in each component and sub-component o f the Project will consolidate the ownership o f the reforms by the state administrations.

4.2 In spite o f the above, two sustainability issues remain. First, whether the States will maintain a strong political commitment for reforms through the Project implementation period, given that nationwide elections are to be held in 2007. A mitigating factor is that while the govemors o f the participating States wi l l not be eligible because o f the constitutional two-terms limit provision, their respective successors are likely to be members o f their teadparty because o f the general good perception o f the current administrations in these states. Also, the involvement o f the SHoAs in the Project will l ikely provide for a steady demand for reforms from the legislature after the elections.

4.3 The second issue relates to the financing o f recurrent costs. For the gains from the investments in modem public management systems to be sustainable, governments wil l have to devote more resources than in the past to the running o f government, particularly to regular maintenance and renewal o f equipment, and the allocation o f funds for regular staff training. This i s especially true in the area o f I C T where there are license fees to be paid, periodic updating o f applications to be financed, and the capacity o f system operating staff maintained in an environment where I C T specialist trained by the state administration wil l find it difficult to ignore more attractive compensation in the private sector. However, the Project’s support for improved budgeting should increase state governments’ capacity to make provision for Operation and Maintenance (O&M) which are traditionally under funded. I t was also agreed that the implementation o f the MYBF and the B A T M I S will require the recruitment o f young university graduates in a number and under arrangements that facilitate their retention.

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Elections scheduled for 2007 brings less re fo rm minded teams to power in the states

Commitment to re fo rm within a State i s uneven, and bureaucratic stakeholders favoring the status quo s low implementation Highly variable o i l revenues derail re form because o f l o w state revenues or by leading to excessive increases in spending

5. Critical risks

Med ium Careful selection o f the three participating states which have a longer track record o f re form initiatives. Participation o f representatives o f the legislature and the c i v i l society in the SSC. Broad participation and empowerment o f state officials including through intensive training to new business processes and change management.

Enactment o f the Fiscal Responsibility L a w at the national level et applicability o f the l a w in the states. Development o f a MYBF that encourages states to smooth o i l price cycle by saving excess revenues.

Substantial

Substantial

6. Loandcredit conditions and covenants 6.1 Conditions of disbursement to support public sector reforms in a participating state under the Credit include (i) the signing o f a subsidiary agreement between the government o f a participating state and the FGN; and (ii) the adoption o f the PIM by the participating state.

D. APPRAISAL SUMMARY

1. Economic and financial analysis 1.1 Expected benefits o f operations o f this kind in terms o f fiscal savings, effectiveness and efficiency will only fully materialize in the medium term and cannot be attributed to a single action, but a combination o f reforms. However, the positive contribution the Project will have o n state finances and economic conditions can be summarized as follows.

0 The Project provides a means to better budgeting, and thus potentially better use o f public resources. The advantage o f a MYBF is that i t provides a fi-amework within which overall budget magnitudes and sector allocations can be planned, enabling govemments

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to escape from the incremental budgeting followed by actual cash budget at the execution stage with substantial discrepancies with initially stated priorities. The MYBF will become an essential tool for governments once i t becomes normal practice in al l tiers o f government to save excess o i l revenues. The MYBF is also a tool to enable SEEDS priorities to be better reflected in annual budgets, and also to rebalance as between current and capital spending and between the wage bil l and non-wage O&M. There i s a significant pay-off implementing modem I C T based HR management systems when the transfer o f data to the new system i s accompanied by an independent staff audit and followed by appropriate control mechanisms. For example, in one o f the DFID supported states, HR system reform revealed payroll fraud o f the order o f 25 percent o f the total wage bill, in the form o f ghost workers, improper hires and allowance abuse.

2. Technical 2.1 The Project concept and the design o f the main project components are based on analytical work included in the State and Local Governance Study and the State Finance Stud?. Bo th reports provided the analytical framework o f reforms to be supported by the Project. Regarding the Project management, the discussions with officials from the state governments and the FGN, and the input from national consultants have been critical in developing institutional and implementation arrangements that facilitate the necessary technical leadership and support f rom the center and yet respect the principles o f federalism and the provisions o f the Nigerian Constitution.

3. Fiduciary 3.1 Financial Management. Staff dedicated from the Finance and Accounts Department (FAD) o f the FMF and the PFMUs will be responsible for managing the financial affairs o f the Project at the N P C U and the state level respectively. FAD/FMF and PFMU will be staffed by relevantly qualified accountants. They will maintain adequate FM arrangements to support the deployment o f Project resources in an economic, efficient and effective manner to achieve the stated development objectives. Specifically, they wil l be responsible for ensuring compliance with the financial management requirements o f the Bank and the government, including forwarding the quarterly Financial Monitoring Reports and audited annual financial statements to IDA. The Internal Auditors at the FMF and PFMUs will perform modem internal audit functions for the Project. A generic Financial Procedures Manual (FPM) has been developed for Bank financed projects in Nigeria. This wil l be reviewed and made specific to the Project with an addendum to set out the Chart o f Accounts for the Project. A specific F P M has been developed for the PFMUs. Regarding f low o f funds and banking arrangements, the Project will follow disbursement procedures described in the World Bank Handbook. IDA will disburse the credit through four Special Accounts (SAs) i.e. one maintained by the N P C U for the Project coordination, and one each by the PFMUs in the three participating states. The Project wil l prepare and submit quarterly Financial Monitoring Report (FMR) and annual project financial statements to the Bank and relevant oversight government agencies. The arrangements wil l also provide relevant information to the N P C U and the SPCUs to facilitate the performance o f their oversight functions. Experienced and well-qualified external auditors will be appointed (on TOR

The World Bank - State and Local Governance in Nigeria. Report N o 2447-UNI, July 2002 The World Bank - Nigeria State Finance Study. Report No 29147-NG April 2003

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acceptable to IDA) to audit the Project accounts, financial statements and transactions irrespective o f the source o f financing.

3.2 The C F A A for Nigeria assessed the risk o f waste, diversion and misuse o f funds in the country as high. Overall, the Project risk i s considered as substantial and i s mitigated by ensuring that adequate financial management arrangements wil l be in place. The banking and funds f low arrangements include measures to safeguard Project funds. Also, adequate arrangements for Bank supervision will be made (see Annex 7).

3.3 Procurement. The Budget Monitoring and Price Intelligence Unit (BMPIU), established at the Presidency, has submitted approval and payment o f contracts at the federal level to a strict due process review, which i s in accordance with Bank financed procurement procedures. This has strengthened procurement discipline. Moreover, the procurement environment o f the Federal Government o f Nigeria (FGN) has improved when FGN was accorded an IDF Grant to help launch the procurement reform at the federal level. BMPIU has prepared and submitted to Parliament a procurement law, and the Government has issued circulars to establish procurement units in government agencies and create a procurement cadre. Similar effort are yet to take place in the state governments.

3.4 The SPCU in each State wil l have overall responsibility for coordination o f procurement activities at the state level. The SPCU wil l be staffed with appropriate technical Staff which wil l include a person with expertise in procurement. Procurement capacity assessments o f the SPCUs has been conducted in l ine with the OPCS guidelines, and were found to be weak. To build the needed procurement capacity in each agency, a variety o f measures are envisaged and planned under the Project as enumerated in Annex 8. Each State SPCUs which does not have an experienced Procurement Officer in its team, wil l engage Procurement Consultants to assist and mentor the SPCU designated Procurement Officer for a period o f 1 year from project effectiveness. The consultants’ contracts will make adequate provision for capacity building and transfer o f knowledge to relevant agency staff. There are no existing procurement manuals at any o f the implementing agencies. Therefore, the Borrower will adopt the Generic Procurement Manual already developed for Bank assisted projects in Nigeria as part o f the Project Implementation Manual (PIM).

4. Social N o t applicable

5. Environment 5.1 The environmental Category o f this project i s C. The activities planned under the Project do not include major construction or utilization o f materials that present substantial environmental risks.

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6. Safeguard policies N o safeguard policies are triggered by this project.

Safeguard Policies Triggered by the Project Yes N o Envirdnmental Assessment (OP/BP/GP 4.01) [-I [ X I Natural Habitats (OPIBP 4.04) [ - I [ X I Pest Management (OP 4.09) [-I [ X I Cultural Property (OPN 1 1.03, being revised as OP 4.11) [-I [ X I Involuntary Resettlement (OPBP 4.12) [-I [ X I Indigenous Peoples (OD 4.20, being revised as OP 4.10) [ - I [ X I Forests (OP/BP 4.36) [ - I [ X I Safety o f Dams (OP/BP 4.37) [ - I [ X I Projects in Disputed Areas (OP/BP/GP 7.60) [ - I [ X I Projects on International Waterways (OPIBP/GP 7.50) [-I [ X I

7. Readiness for Implementation 7.1 The terms o f reference o f the major positions at the state and national levels were finalized at Appraisal and recruitmenthelection o f candidates wil l be initiated upon Board approval. The procurement plans for the f i rs t eighteen months o f the Projects components were also agreed upon at Appraisal.

8. Compliance with Bank Policies The Project complies with al l World Bank policies and no exceptions are necessary.

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Annex 1 : Country and Sector Background

NIGERIA: State Governance and Capacity Building Project

Geography and population. Nigeria has a land area o f 924,000 sq. km and i s the most populous country in Sub Saharan Afr ica with an estimated population o f about 132 million, growing at about 2.6 percent annually. Nigeria’s population comprises many different ethnic and language groups, the most populous being the Yoruba in the South West, Igbo in the South East, and HausaRulani in the North. The practice o f Islam is predominant in the North while Christianity i s predominant in the South3. The climate varies greatly, from tropical rain forest in the South to dry savannah in the North which is flat and sparsely vegetated with river flows that are generally seasonal. The land i s hilly and mountainous in the South East, along the border with Cameroon, and also in the center where the Jos Plateau rises to one thousand meters. The Niger River, one of Africa’s largest, bisects the country Nor th to South. I t converges with the other main river, the Benue, in the central region, and thereafter flows south as the Niger to discharge into the Atlantic Ocean through an extensive delta area. The average rainfall ranges from about 500 m d y e a r in the north to over 2,000 “/year in the south.

Economic conditions and Poverty. Nigeria is the largest country in West Afr ica and the second largest economy in Sub-Saharan Afr ica with a GDP o f about US$58.4 bi l l ion (2003). I t i s highly dependent o n oil--the 6th biggest exporter o f o i l in the world--which provides about 75 percent o f government revenues, 95 percent o f export earnings and represents about 30 percent o f GDP. Growth has been highly volatile and averaged just over 3 percent annually over the last three decades-barely enough to keep up with population growth. Per capita income was estimated at about US$300 at the end o f 2003. Nigeria’s total external debt (which represented about 60 percent o f GDP in 2003) i s estimated at about US$32.8 billion, 83.5 percent o f this owed to the Paris Club, and there are large external arrears.

In spite o f Nigeria’s considerable economic potential, the country has suffered the effects o f poor macroeconomic management for decades (including over-valued exchange rates, high levels o f inflation, large aggregate public spending associated with ill-judged investment o f o i l revenues and bloated c iv i l service), and outright theft o f public monies. Nigeria i s in many ways two economies. Part o f i t i s a middle-income oil-producing economy covering a small percentage o f the population, with a per capita income o f about US$2,200. The rest o f the population i s part o f a very poor non-oil producing economy, o f whom as many as two-thirds l ive below the income poverty line. The fundamental cause o f poverty in Nigeria i s the economic stagnation that the country has experienced for almost two decades. Substantial poverty reduction would require annual growth o f around five percent in agriculture and eight to ten percent in the non- agricultural economy (excluding government and the o i l and gas sectors).

Political developments and the new emphasis on reforms. At Independence in October 1960, Nigeria was a multi-party democracy with a federal constitution. I ts parliamentary system and

There i s nevertheless a sizeable Christian population in the North and there i s a large population o f Muslims in the South West.

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the independence that the judiciary enjoyed gave promise o f evolution toward a stable pluralistic political system in a law abiding society. This system was soon undermined by political forces driven by ethno-regionalism and growing corruption fuelled by the o i l economy. Nigeria experienced two long periods o f military rule from 1966 to 1979 and from 1984 to 1999, and a costly c i v i l war in the late 1960s over the attempted secession o f Biafra. The return to democratic governance in 1999 with the new constitution o f the Third Republic gave rise to three political parties which s t i l l dominate Nigeria politics today: the People’s Democratic Party (PDP), the All People’s Party (APP) and the Alliance for Democracy (AD).

Elected for the f i rs t time in 1999, President Olusegun Obansanjo was reelected in 2003 for a second term. The successful completion o f the 2003 round o f presidential, gubernatorial, and legislative elections (at the national and state levels) was an historic landmark because, for the first time since the 1 9 6 0 ’ ~ ~ Nigeria achieved a transition from one civi l ian government to another civilian. government through contested elections. The party in power, the PDP, increased its controls over the two houses o f the National Assembly as well as over State Assemblies and State governments. The determination shown by the Nigerians in the political front since 1999 to make democracy work has been a key appeasing factor in the face o f continuous social unrest that includes ethnic violence (especially conflicts between farmers and herders on land issues), labor disputes, and riots in the oil-rich Niger Delta region.

Right after the 2003 elections, President Obasanjo announced ambitious reforms aimed at laying the foundations for economic growth, employment creation, poverty reduction and more transparency and accountability in the management o f public resources. In July 2003, h e appointed a strongly reform minded economic team at the Federal level which quickly developed a comprehensive program: the National Economic Empowerment and Development Strategy (NEEDS). The NEEDS main elements include: (i) promoting macroeconomic stability; (ii) accelerating privatization and liberalization o f the economy; (iii) reforming the public service, including reforming public expenditure, budget and c iv i l service; (iv) fighting corruption, improving government transparency and accountability; and (v) strengthening basic service delivery. Important early measures have included deregulating the downstream petroleum sector and committing Nigeria to the Extractive Industries Transparency Initiative (EITI), reinvigorating the anti-corruption efforts through the establishment o f the Economic and Financial Crimes Commission (EFCC) to complement the work o f the Independent Corrupt Practices and other Related Offenses Commission (ICPC), and strengthening macroeconomic policies (adopting a fiscal pol icy rule, reducing the fiscal deficit, limiting recourse to monetary financing o f the government deficit, and preparing a Fiscal Responsibility Bill). The new Federal administration also intensified the dialogue with the states o n economic development and poverty reduction issues encouraging each state to develop i t s own State Economic Empowerment and Development Strategy (SEEDS).

Many o f the challenges highlighted in the NEEDS were signaled by President Obasanjo during his f i rst term but political pressures, the need to minimize tension that could threaten the then nascent democratic institutions, and, perhaps, insufficient realization by the leadership o f the depth o f public institutional erosion, prevented the development o f a strong reform effort and delayed the implementation o f important measures. The second term administration o f President Obasanjo Government has embraced the reform agenda with more vigor, focusing on the

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NEEDS priorities. Political pressures though st i l l present are mitigated by a larger number o f members o f the National Assembly and governors who share the view that major economic and institutional reforms should not be further delayed. There i s a greater recognition o f the importance o f the quality o f spending in terms o f developmental impact as opposed to the mere size o f current and capital expenditures.

Nigerian Federalism. Since Independence, i t has been commonly accepted that federalism is the most suitable framework for keeping Nigeria as a single political entity. Today there are thirty six states in the Federation o f Nigeria, in addition to the Federal Capital Territory. Some are recent creations, carved out o f existing states by the military regimes. Others trace their origins back to the Regional Governments that existed at the time o f Independence.

The 1999 Constitution gave increased responsibility to the states in the delivery o f economic and social services and for the provision o f infrastructure, both directly and jointly with local governments, while the Federal Government remains responsible for setting standards, coordinating policy, and discharging national functions such as security, foreign affairs, macroeconomic management. However, most powers accorded to the states in the Second Schedule o f the constitution are exercised concurrently with the Federal Government. This situation o f “concurrent list” continues to cause confusion and sometimes intense debates over which t ier o f government, federal or state, i s best placed to deal with various areas o f pol icy (e.g. education, police). Also, while the functions o f local government are specified in the Fourth Schedule, local government authorities (LGAs) can exercise their responsibilities only in accordance with enabling legislation passed by the states. LGAs are therefore subject to state oversight and control to a large extent.

The Constitution provides for the proceeds o f mineral revenues and major taxes to be paid into the Federation Account, and for the net proceeds, after certain deductions, to be distributed directly to al l three tiers o f government based o n a formula determined by the National Revenue Mobil izat ion and Fiscal Allocation Commission every five years. Under the current formula, the Federal Government receives 54.68 percent, states governments 24.70 percent, and local governments 20.62 percent o f distributable proceeds. In addition, o i l producing states receive an additional “derivation” allocation. Due to the automatic pass through o f revenues to states, fluctuations in international o i l prices have resulted in large swings in state finances. At the time o f transition from mil i tary to democratic rule (1999-2000), o i l prices were low, but then proceeded to rise strongly. States generally increased budgets in l ine with revenues, and in some cases faster, through recourse to domestic borrowing.

The federal authorities have sought to limit the automatic pass through o f o i l revenues to state spending, for reasons o f macro economic management. At first, this was done by withholding allocations, and then, when this practice was successfully challenged by states in the Supreme Court, the Federal Government has sought to stabilize spending by mutual agreement. Most recently, the Federal Government has tabled a Fiscal Responsibility Law which seeks to sterilize revenues in excess o f the estimated long run sustainable price o f oil, and save the proceeds in a special account in the Central Bank for distribution when o i l prices weaken. Many states, however, have resisted federal efforts to limit their access to Federation Account resources, partly because they view the present share o f states in Federation Account transfers as too low (it

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was increased slightly in 2002 ), partly because they believe the return to democracy requires an immediate dividend in terms o f rehabilitation and new development spending, and partly because o f lack o f trust - that funds sterilized in a central bank account might somehow be pre-empted and unavailable for distribution later when o i l prices have weakened. In tum, it could be said that states have also demonstrated that the success o f any efforts to achieve overall macro stability in Nigeria must recognize states as key players and wil l depend, to a good degree, on ensuring that states are fiscally disciplined and set fiscal targets for themselves consistent with macroeconomic stability objectives.

The pressure f rom the states for large spending has been exacerbated by the example o f the FGN’s own capital budget spending during the f i rst three years after the retum to democratic governance in 1999, when large executive capital budgets were proposed to the National Assembly and further increased. Underlying these large capital budgets, mirrored in states, has been a belief by federal and state officials that sizeable capital budgets are necessary to repair existing and build new infrastructure and enhance public service delivery, regardless o f either the macroeconomic implications o f large spending, the absorptive capacity o f governments, and the efficiency o f spending and the capacity to meeting operating and maintenance costs o f the programs launched and assets created. Large public spending has also been seen as a way to sustain support from the National Assembly and the State Assemblies.

Intergovernmental Collaboration. Ineffective arrangements for intergovernmental collaboration including in development matters has been a major shortcoming o f Nigeria’s federal system since independence especially with the mil i tary leaders’ practice o f top-down commands and unilateral decisions which was a disincentive for the states in terms o f proper planning o f development activities and fiscal responsibility. Also, i t i s widely acknowledged that states could learn much more from each other and should j o i n forces more systematically in tackling common developmental problems in such areas as capacity building in the public sector, maintenance o f infrastructure, and the provision o f social services.

Today, the attitude o f the leadership has changed at the federal and state level even if the “concurrent legislative l is t ” remains a major issue and governors continue to argue that the share o f revenue given to the states and the local governments i s not in l ine with the responsibilities o f the sub-national tiers o f government for delivering public services. One o f the result o f the 2003 elections has been a more cohesive National Executive Council that allows more effective collaboration between the State Governors and senior Ministries o f the FGN. W h i l e the federal c iv i l service i s s t i l l often perceived by the states as imposing constraints o n their ability to fulfill their responsibilities, recent federal government initiatives (e.g. increased timeliness and transparency in revenue distribution to the states and LGs, greater involvement o f state representatives in the development o f major draft bills) have confirmed that the current federal executive authorities are clearly supportive o f intergovernmental relations in which states increase their capacity to fulfill their responsibilities, and committed to facilitating experience sharing and development o f synergies among the states. In sum, the ability o f both federal and state governments to deliver the services expected from them and contribute effectively to the national development effort will depend to a large extent on the extend to which their roles and mandates are clearly delineated, and they can collaborate effectively to achieve common goals.

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Public Management and Institutional Capacity. One o f the findings o f Bank analytical work in recent years4 i s that while there is a great deal o f variation across states in the performance o f their public service, al l states saw their governance capacity weakened during the years o f military rule, through lack o f training, failure to modernize public management systems, loss o f key staff, proliferation o f organizational structures and patronage based hiring policies, failure to maintain equipment and buildings, systemic corruption, and generally, the substitution o f informality for established rules and procedures. In addition, steps were taken at the Federal level to deliberately reduce the independence o f the c iv i l service, in particular the job security o f career professionals. Inevitably this had an impact o n state c iv i l services, which became vulnerable to arbitrary actions by military governors. The retum to democracy offered an opportunity to reverse the deterioration in state services, and begin rebuilding capacity. In some states there has been a meaningful effort to control wasteful spending, improve procurement and limit patronage hiring etc. A new and younger generation o f governors, typically with a private sector background, came to power in 1999 and their number increased after the 2003 elections. Albeit s t i l l a minority, they have initiated (or are initiating) a genuine effort to restore dilapidated structures and improve services.

Almost al l states are heavily dependent on allocations from the Federation Account, the pool into which o i l and al l VAT revenues are paid prior to distribution. Allocations among the states are determined by the National Revenue Mobilization and Fiscal Allocation Commission, based on five criteria: equality, population, social development, land mass and terrain, and internal revenue generating effort. States have enjoyed strong revenue growth - about three fold in real terms for states as a whole - between 1997 and 2001 boosted by the o i l boom, by depreciation o f the naira and by stricter adherence to constitutional provisions for sharing revenues between the different tiers o f government. In some states - Akwa Ibom and Delta -revenue increases have been as high as about f ive fo ld in real terms. The accompanying ratcheting up o f spending has increased states’ exposure and hence vulnerability to o i l price shocks. The share o f statutory allocations from o i l revenues in states’ receipts has increased to about 82 percent in 2001 from about 66 percent in 1997.

On the other hand, as o f FY 2003, internally generated revenues (IGR) constituted only a margin o f the states’ annual revenue (e.g., 8% for Bauchi and 17% for Kaduna) making i t impossible for the states to fund basic expenditure obligations f rom their own resources. The share o f personnel costs covered by internally generated revenues was as l o w as 13 percent in Bauchi state in 2000, before recovering substantially to reach 23 percent in 2003. This reflects rapid growth in personnel obligations driven by large size o f states’ c iv i l service, and by two wage increases enacted by the federal government in late 1998 and 2000. Although states are free to set their own government pay scales, there is a long established practice o f harmonized c iv i l service pay and pensions across a l l tiers o f government, strongly reinforced by union expectations. This has been a further factor behind state spending. The Federal Government has made decisions on i t s

The Bank produced two reports in FY03, the State and Local Governance in Nigeria report, which assessed the existing capacity o f the states in fulfilling their constitutional responsibilities, and the Nigeria State Finance Study, that provided a better understanding o f the public finance picture in Niger ian states. B o t h studies pointed to institutional and pol icy reforms that could help states better deliver o n their mandate and manage their publ ic finances in a more efficient and fiscally responsible manner.

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scales o f pay and allowances, and most recently pensions, without consultation with states, and this has become an issue in the discussion between state governments and civi l service unions.

Exceptionally strong o i l prices during 2004 and the beginning o f 2005 have again buoyed state finances, and states as a group are not in crisis. But in many states, the underlying position i s highly vulnerable to a down turn in international o i l markets. Before this happens, states need to rein in spending, and develop tools that wil l enable them to better manage budgets throughout the o i l price cycle.

Fearing a severe fiscal crisis caused by a weakening o f o i l revenues and a high wage bill, progressive governors are keenly aware o f the need to control the wage bill and strengthen financial management while striving to restore the capacity o f c iv i l service. There has been some progress but, on the whole, few have been able to tackle effectively the more difficult challenge o f removing the institutional constraints to sustainable service delivery. The ability to define and carry out a coherent strategy for economic growth and poverty reduction i s limited, and those governors who genuinely desire to make a difference, are confronted by machinery o f government which i s dysfunctional and, for a large part, unresponsive to calls for improved service delivery. Indeed, a key constraint remains the performance o f the public service. At the federal and state levels alike, the public service has become bloated, de-skilled and unable to perform wel l either the key regulatory functions o f government, supply classic public goods such as law and order, and deliver key social services. Building on diagnostics started during the f i rst term, the Federal Government has launched a Public Service Reform Program (PSFW), the f i rst phase o f which, comprising the restructuring o f p i lot ministries and the strengthening o f payroll and personnel systems, is being supported by the Bank through the Economic Reform and Governance Project, approved on December 14,2004. The federal level governance project has provided stimulus to reformist governors.

The issues to be addressed under the Project. Given widespread pol icy and institutional weaknesses in public service in Nigeria, the key strategic choice for the Bank i s to support the rebuilding o f basic systems o f public management and governance at both state and federal level; such as financial management, the c iv i l service, procurement, and mechanisms to ensure transparency and accountability. The issues to be addressed under the Project fa l l in the fol lowing broad categories;

The low institutional capacity and the lack of transparency and accountability in the use of public financial resources. In spite o f initiatives taken by some state governors since 1999, there i s an urgent agenda o f system modemization and capacity building in public sector management, especially the way public resources are managed and spent. Many problems with public management in Nigerian States stem from institutional weaknesses including out o f date or incomplete statutes and regulations, poor prioritization associated with incremental budgeting, unrealistic budgets that result in poor budget performance, ineffective expenditure controls resulting from organizational and behavioral deficiencies, poor maintenance o f accounting records, and delays in producing financial reports, which are often o f poor quality. Moreover, internal and extemal audit arrangements are weak, and audited financial statements in many States are in arrears o f several years. In essence, the systems do not function in a manner that provides assurance o f proper financial accountability for public funds, and significant risks o f

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misuse o f funds and waste remain. Also, the current information and operating systems tend to be hagmented technologically with overlapping responsibilities, affecting the quality o f economic and financial information and the accountability o f government departments and agencies. These deficiencies are combined with an insufficiently skilled personnel at the lower, middle, and senior levels alike.

The ineffective management of human resource (including training policies and practices) which limits the state ability to develop and apply polices that keep the staff strength o f the c iv i l service in line with resources constraints and efficiency requirement while maintaining appropriate ski l l levels in various fields in the public service. In most States, there is a need to formulate a coherent c iv i l service training pol icy whose principles and identified funding sources would enable the necessary sustained effort in staff s k i l l development.

The still maturing nature of Nigerian federalism under a democratic system o f government explains the existing room for improvements in the broad area o f inter-governmental relations both between the Federal Government and the States and between the States and the Local Governments. The ability o f public organizations to deliver the services expected from them and contribute to the national development effort effectively will depend to a large extend on the extent to which their roles and mandates are clearly delineated and understood and they are put in a position where they can collaborate effectively. This would be facilitated by enhanced fiscal responsibility in the states and increased experience sharing among the states and between the states and the FGN.

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World Bank

World Bank

Other development agencies

Annex 2: Major Related Projects Financed by the Bank and /or other Agencies

NIGERIA: State Governance and Capacity Building Project

Economic Reform and Governance Not Yet Rated No t Yet Rated (approved: 12/14/2004)

[Lagos Metropolitan Development In the Pipeline In the Pipeline Project (approved 513 1/2005) ]

EU

DFID

DFID

Economic Management and n.a. n.a. Technical Assistance Project Economic Reform, Debt n.a. n.a. Management, Poverty Monitoring State and Local Government n.a. n.a. Programme

n.a. = not applicable

3

E v1

2s E - 2'

0 0

5 3

E

e 2s E - 0 0 * z

E .- C x Z.

.C - - $ 5

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Component

Component # I : Core Reform Program (CRP)

Component #2: State Specific Programs

State Subproject Coordination and Monitoring

Total Individual States Public Sector Reforms of which

Project Coordination, Implementation Support and Monitoring (national level)

Annex 4: Detailed Project Description

Bauchi Cross Kaduna Total

4.6 4.5 4.7 13.8

0.4 1.1 0.4 1.9

0.4 0.4 0.3 1.1

5.4 6.0 5.4 16.8

River

0.3

NIGERIA: State Governance and Capacity Building Project

Total

Overall Component Design. The Project i s designed to finance a set o f public management reforms aimed at modemizing basic systems o f public financial management, and human resource management. Because states are similar in the ways their public sectors are run, are accustomed to adopting approaches similar to the Federal Government, and common or similar solutions can be developed and deployed across al l states, the Project will support a core reform program (CRP) in the three participating states (Bauchi, Cross river, and Kaduna). In each state, the CRP will be supplemented by a state specific program (SSP) that addresses a limited number o f challenges specific to the state. The CRP and the SSP wil l be implemented by the state government under arrangements spelled out in a subsidiary agreement with the Federal Government o f Nigeria (FGN). The overall architecture o f the Project is as follows.

-1 Activities to be identcj?ed (national level)

States selection. The participating states have been chosen among six states which were identified during Project preparation through a transparent competitive process based on init ial diagnostic/proposal documents presented by thirteen states out o f twenty four invited. The four criteria utilized in evaluating the init ial proposals were (i) the quality o f diagnosis o f existing constraints, (ii) the overall reform program for the state's public sector, (iii) the relevance o f the activities proposed for IDA consideration, and (iv) track record between 1999 and 2002. The selection process was further refined in light o f the states performance in'2003 and 2004 and the demonstrated commitment to reforms o f their respective executive and legislative leadership bodies. Another factor has been the new approach o f the NEEDS and Bank assistance strategy which both require to pi lot the reforms in a small number o f states before supporting