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Indonesia Fiduciary Review of the Second Sulawesi Urban Development Project Overview Report

This World Banks overview report on the fiduciary review of the Second Sulawesi Urban Development Project (Loan No. 4105-IND) is the outcome of a joint review by the World Banks Office in Jakarta and its Department of Institutional Integrity in Washington. This report is being released with the concurrence of the Government of Indonesia. The Project, initially approved in November 1996 for a total sum of US$155 million, but scaled back to US$88 million following the financial crisis, aims at improving the delivery of infrastructure services, strengthening operations and maintenance activities, and improving environmental management by local governments in some 40 cities on the Indonesian island of Sulawesi. Some US$76 million has been disbursed to date. The review was part of a program of work initiated by the World Bank, following its new Country Assistance Strategy approved in January 2001, to strengthen fiduciary controls and reduce corruption in World Bank-financed projects in Indonesia through a review of fiduciary practices in selected projects. Sulawesi Urban was selected from among those projects where the fiduciary risks were judged to be high and because it involved all aspects of procurement including civil works, goods, and consulting services. Because of the high fiduciary risks in Indonesia, the World Bank in its new Country Assistance Strategy has aimed at redesigning its portfolio to concentrate its lending on projects where strong community involvement could better monitor project implementation, and intensified its fiduciary work on ongoing operations. The Sulawesi Urban fiduciary review involved a broad overview of procurement, implementation and financial management practices accompanied by an intensive review of a sample of contracts in four cities. Despite a severe problem of missing documentation, the review found evidence of collusion among bidders, and common ownership of shell companies. The review also found inadequate project oversight by implementing agencies and consultants resulting in departures from compliance with the contracts, failure to complete work and changes in contracts without appropriate approvals. Similar problems were found in financial management. These issues are now being investigated thoroughly by the Investigation Unit of the World Banks Department of Institutional Integrity. Immediately after completion of field work in early March, the World Bank alerted the Government of Indonesia to its serious concerns and suggested that further expenditures on the project from the World Bank loan be halted until remedial actions have been taken. The Government concurred with this suggestion and has provided full cooperation to the World Bank in its current investigations. Since April, the World Bank has held several discussions with the Government on the findings of the fiduciary

2 review, and to reach an agreement on the future of the project. The Government has also consulted with local implementing agencies on future options for the project, taking into account that only six months remain before the loan is scheduled to close. Going forward, the Government and the World Bank have agreed on the following next steps: Expenditures on the Sulawesi Urban Project from the World Bank loan will remain on hold until a final decision on the future of the project is taken. The World Banks Department of Institutional Integrity will complete its work on follow up actions to the field investigations, and appropriate remedial actions will be taken, in accordance with the loan agreement. The World Bank will also declare misprocurement as appropriate. The Government of Indonesia will prepare with the World Banks support an action plan to address the issues raised by the fiduciary review so that such problems do not occur in any new urban project financed by the World Bank.

Until the Department of Institutional Integrity has completed its work, the World Bank intends to maintain confidentiality on the individual cases being investigated.

Mark Baird Country Director, Indonesia World Bank Office, Jakarta June 2002

INDONESIA
Fiduciary Review of the Second Sulawesi Urban Development Project
OVERVIEW REPORT

June 2002

The World Bank Office, Jakarta The World Bank Department of Institutional Integrity, Washington

INDONESIA
FIDUCIARY REVIEW OF THE SECOND SULAWESI URBAN DEVELOPMENT PROJECT OVERVIEW REPORT

Page Summary I. Introduction A. Objectives of the Fiduciary Review B. Basis for the Selection of a Pilot Project C. Methodology i 1

II.

Findings.. 5 A. Maintenance of Records B. Procurement Process C. Implementation D. Financial Management

Annex 1. Basic Project Information

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Summary
i. This fiduciary review is part of the World Banks program of work1 to strengthen its fiduciary controls in Bank financed projects. It has a limited focus -- a review of the Governments fiduciary practices in the implementation of the Second Sulawesi Urban Development Project (Sul2 UDP) in selected contracts in four of the 41 cities and towns under the project2. An assessment of the development impact of the project was therefore beyond the scope of this review. The Director General, Urban and Rural Development, supported the review as a way to ensure that borrowed funds were being used well and to draw lessons for future projects. ii. The review was hampered by the overwhelming amount of missing documentation for a majority of the contracts, relating to the administration of the procurement process and payments to contractors and other project related financial information. The methodology therefore involved three main steps: (i) an overall assessment of the entire population of the 277 contracts in the four cities which included an assessment of completeness and documentation quality; (ii) a detailed procurement review of 26 contracts with a value of $1.4 million; and (iii) a detailed financial management review of 85 contracts with a value of $5.9 million. The results of all three assessments indicated weak fiduciary practices in procurement, implementation and financial management systems. The overall conclusion of this limited review in the four cities is that the procurement process was manipulated in order to give the appearance of competition. It appears that the winners were pre-arranged in a majority of the contracts reviewed. Fiduciary weaknesses also occurred during contract management, implementation, and financial management (i.e., disbursements, accounting, record keeping and auditing). In addition, the review indicated shortcomings in the fiduciary oversight by the Government in the four cities, and poor performance of consultants who were expected to support the Government in project implementation, supervision and overall coordination of the project. iii. The contracts with significant fiduciary concerns are now being investigated by the Investigation Unit of the World Banks Department of Institutional Integrity, consistent with the Banks policy on fighting fraud and corruption. iv. Chapter I describes the objectives of the fiduciary review, selection of the project for the pilot, and the methodology for the review. Chapter II presents the findings of significant fiduciary concerns in a sample of the contracts reviewed, in four areas maintenance of records, procurement process, implementation, and financial management. v.
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Following presentation of the findings to the Government of Indonesia, the Bank and the
The World Banks Country Assistance Strategy for Indonesia, approved in January 2001, proposed a proactive strategy for fiduciary work. It is important to note that project implementation is the responsibility of the Borrower (in this case the Government of Indonesia), and the World Banks role is to supervise the Borrowers implementation of Bank-financed projects. The Government (and its project implementing agencies) is responsible for carrying out projects with due diligence and efficiency and in conformity with appropriate practices to achieve their development objectives. This includes responsibility for putting in place and maintaining adequate financial management systems (including accounting, financial reporting and auditing systems), and procurement and progress monitoring arrangements for the project as part of overall arrangements for project management. These systems should also be adequate to ensure that they can provide to the Bank accurate and timely information regarding project resources and expenditures.

Government are jointly discussing the following: implications and actions related to the contracts specifically reviewed in the four cities; implications and actions for the project; and other lessons and possible actions. The Bank also plans to do an in depth implementation completion report3 for the project to assess the projects development impact.

The Bank prepares an implementation completion report for all projects it finances within six months of completion of the activities financed under the loan. In this case, a more in depth study will be undertaken.

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I. Introduction
A. Objective of the Fiduciary Review 1. The main purpose of this work was to review the fiduciary practices in a project. It was done as part of the World Banks program of work4 to strengthen its fiduciary controls in Bank financed projects. B. Selection of the Project 2. The Second Sulawesi Urban Development Project (Loan Number 4105-IND) or Sul2 UDP was chosen for this review. The World Bank had assessed the project to be performing satisfactorily most of the time since the project start up, but had also considered that the fiduciary risks in the project were high. The project was also selected because it involved all aspects of procurement, namely, civil works and goods in a decentralized setting, and a very large component of consultants services (Annex 1)5. One allegation of fraud and corruption had been brought to the attention of the World Bank in one location in Central Sulawesi6. The Director General, Urban and Rural Development, supported the review of Sul2 UDP as a way to ensure that borrowed funds were being used well, and to draw lessons for future projects. 3. Sul2 UDP covers 41 cities and towns in Sulawesi. Only four cities were selected for the review to allow an in-depth assessment Makassar and Pare Pare in South Sulawesi, and Manado and Bitung in North Sulawesi. The idea behind the four locations in two provinces was to allow the learning to be spread across different environments -- administrative systems, project management and implementing units and staff, government officials and elected leaders overseeing the implementation of the project, consultants, and business associations that would not be connected. C. Methodology 4. The methodology for the fiduciary review of Sul2 UDP in the four cities involved the following steps: A broad review of the project information provided by the implementing agencies in an attempt to capture as many indicators of fiduciary concerns as possible.7 Selection of 26 contracts based, in part, on the availability of documentation, and with relatively more significant and obvious indicators of fiduciary concerns for a more detailed

The World Banks Country Assistance Strategy for Indonesia, approved in January 2001, proposed a proactive strategy for fiduciary work. Annex 1 provides basic information on the project and the role and responsibilities of the various consultants for project implementation support. The Bank has received an allegation of corruption in the Sul-2 UDP program in Central Sulawesi, which was referred to the World Banks Department of Institutional Integrity, Investigation Unit (INTIU) for investigation, but due to security issues related to travel in Central Sulawesi this investigation was deferred. In addition, there have been several complaints related to the procurement process in other cities not included in the fiduciary review. Two cases of misprocurement ($46,800 on September 28, 1998, and $170,474 on August 3, 2001) also occurred. The broad overview involved a cursory review of all 253 procurement packets and contracts available for review (Table 1). This excluded 24 contracts in Manado for which no information, even copies of the contracts, was available. See footnote 14.

analysis8. The analysis was based upon three core areas: procurement, implementation and financial management.

Selection of 78 goods and services contracts and 7 consulting contracts for a detailed financial management analysis.9 As required under Bank policy, where serious indicators of fiduciary concerns were noted, an immediate referral was made to a separate Investigation Team of the World Banks Department of Institutional Integrity, Investigation Unit (INTIU)10.

5. The initial review, and subsequent detailed review, was hampered by the overwhelming amount of missing documentation from the procurement packets11. The missing documentation related to the administration of the procurement process and payments to contractors and other project related financial information. This problem made a more complete analysis by the fiduciary review team impractical. The sample of high-risk contracts could therefore be selected only from a fraction of the total population of procurement packets which were substantially complete, as not even a single packet in any of the four cities contained all the required information. As summarized in Table 1, about two-thirds and more of the packets listed in each city did not have bid proposals including those of the losing bidders. Similarly, a very large share of the packets did not include contract document details such as bid evaluation reports, bid opening attendance sheets, bid price read-out sheets, Owners Estimates, bid prices, pre-qualification details, and technical specifications and drawings indicating the scope of work. 6. The extent of the missing bid proposals and contract document information varied from city to city. For example, of the 79 contracts awarded in Manado, only 55 contract documents were made available to the fiduciary review team. In addition to missing information in the contract documents, 49 of packets for the 55 contracts reviewed did not have bids of the losing bidders, further limiting the ability of the fiduciary review team for its assessment. The agency responsible for managing the project indicated that many of the documents were lost during the flooding of the offices in December 2000. 7. The sample size of 26 contracts for a detailed analysis was 9% of the total 277 contracts in the four cities (Table 1). The total value of the sample was Rp. 14.1 billion ($1.4 million)12 or 15% of the total value of Rp. 96.6 billion ($9.7 million) of all contracts for civil works and goods in the four cities (Table 2). The 78 contracts for civil works and goods selected for a detailed review of financial

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This detailed analysis included interviewing government officials, consultants responsible for project implementation, contractors and members of the community, reviewing project related financial information, conducting site visits, and reviewing the detailed project specifications. In addition, further analysis of company ownership patterns and other activities indicating significant fiduciary concerns, was conducted where sufficient information allowed. In total 26 contracts were selected for a detailed analysis (Table 1) and this selection tried to ensure that at least one sub-project, from each Sul2 UDP sector, was chosen. There is an overlap between the 26 contracts selected for the procurement, implementation and financial management detailed analysis and the 85 contracts selected for the financial management detailed analysis only. The fiduciary review team briefed the Director General of Urban and Rural Development, in Jakarta, on February 8, 2002, on progress of the fiduciary review in one city, and informed him that the team was going to refer cases of serious fiduciary concerns to INTIU for immediate investigation. A procurement packet consists of the information regarding the pre-qualification process, the selection process and the contract document. Each of these items is comprised of numerous other documents and information. Assuming an exchange rate of Rp. 10,000 per US dollar.

management aspects represented 28% of the total number of contracts awarded in the four cities. Table1: Sul-2 UDP Available Population of Procurement Packets for Sampling (Civil Works and Goods Contracts)
Total No. of Packets13 Period Covered No. of Packets with Missing Bid Proposals 49 30 74 65 218 % of Packets with Missing Bid Proposals 68 64 94 82 79 No. of Packets with Missing Contract Document Details 43 19 62 74 198 % of Packets with Missing Contract Document Details 60 40 78 94 71 Sample Size for Detailed Review Sample Size for Detailed Review (as % of Total Packets) 10 26 5 4 9

Makassar Pare Pare Manado Bitung Total

72 47 7915 79 277

19982000 19982000 19972001 19972001

714 12 416 317 26

8. High-risk contracts were selected18, initially focusing on procurement and financial management issues, based upon the following risk indicators: Indication of different firms being owned by the same party and bidding on the same contract. Similarity of the bid proposals between the winning and losing bidders. Inconsistencies noted in the documentation of the bidding process.19 The lowest qualified bidder not being accepted. Implementation or financial management issues noted in the auditor's working papers.

9. The implementation analysis in a few contracts involved a review of the original contract specifications in comparison with the as-built drawings, back-up data calculation sheets, site visits and core samples. 10. For the purposes of the financial management analysis, the various Provincial Project Management Units (PPMUs), Project Management Units (PMUs), and Project Implementation Units (PIUs) did not provide a large number of payment vouchers and related accounting records to the Banks fiduciary review team. The team however made arrangements to obtain many of the required payment vouchers from alternative and independent sources, including the Central Treasury Offices
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The number of packets equals the number of contracts awarded. Includes one consultants services contract. Out of these, no information was available for 24 contracts including even copies of the contracts. A broader analysis with respect to the cross-ownership patterns and bidding practices and its affect on the entire procurement process in Manado and Bitung was also performed. See footnote 15 above. The selection of high-risk contracts was also based, in part, on the availability of documentation. The inconsistencies noted include similarities in the formatting of the bids and the signatures of various parties involved in the bid process varying from one document to another.

in the provinces (KPKN). The financial management analysis included a review of KPKNs disbursement procedures and control structure. The team then focused on tracing disbursements and supporting documents for the contracts selected. Additional contracts were also sampled as part of the financial management review based on comments in the audit reports, aide memoirs of the Bank supervision missions, and reports produced by the consultants. The expanded sample size for the financial management analysis is summarized in Table 2. 11. The analysis of procurement, implementation and financial management aspects of the contracts was further supplemented by interviews with officials of the Provincial Project Management Units (PPMUs), Project Management Units (PMUs) and Project Implementation Units (PIUs) in the cities and towns, representatives of the Director General, Urban and Rural Development (Project Officer located in Makassar, and Sub-Directors), and consultants. 12. It should be noted that the plan for the overall fiduciary review had allowed approximately one week in each of the four cities for the fiduciary review. The separate Investigation Team also spent approximately one week in each location. Table 2: Sul-2 UDP -- Expanded Sample Size of Contracts for the Financial Management (FM) Analysis
Total No. of Packets (Civil Works and Goods) Sample Size of Packets Selected for the FM Analysis No. Rp. Billion (US$ millions) 10.6 8.8 7.6 3.0 30.0 28.7 ($1.1 mil) ($0.9 mil) ($0.8 mil) ($0.3 mil) ($3.0 mil) ($2.9 mil) Sample Size of Packets for the FM Analysis (as % of Total Packets for Civil Works and Goods) % No. % Rp.

No.

Rp. Billion (US$ millions) 44.6 ($4.6 mil) 14.2 ($1.4 mil) 14.520 ($1.4 mil) 23.3 ($2.3 mil) 96.6 ($9.7 mil)

Makassar Pare Pare Manado Bitung Subtotal Consultants services contracts Sample size for FM analysis20

72 47 79 18 79 277

17 22 20 19 78 7

24% 47% 25% 24% 28%

24% 62% 52% 13% 31%

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58.7 ($5.9 mil)

13. Chapter II summarizes the findings of the fiduciary review of a sample of the contracts in the four cities.

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Of these, no information (even the contracts) was available for 24 contracts. The amount of Rp. 14.5 billion refers only to 55 contracts for which the contracts were available. Includes 7 consultants services contracts in South and North Sulawesi and Jakarta (amount reviewed Rp. 28.7 billion)

II. Findings
14. The main findings of the fiduciary review of Sul-2 UDP in the four cities are organized into the following four areas: Maintenance of records. Procurement process. Contract management and implementation. Financial management, including disbursements, accounting, record keeping and auditing.

A. Maintenance of Records 15. In the four cities under the fiduciary review, the problem of missing documents and incomplete information relating to procurement is significant (Table 1). Even the substantially complete contracts did not have all the information they should have (e.g., bid proposals of unsuccessful bidders, bid evaluation reports, bid opening attendance sheets, bid price read-out sheets, Owners Estimate, bid prices, pre-qualification details, and technical specifications and drawings indicating the scope of work). This problem is also applicable to the implementation of contracts and financial management (e.g., the lack of proper analysis, authorizations and appropriate records to support contract amendments, proper documents verifying actual performance prior to the payments being made, the lack of information showing the recipients of the payments made, findings of Governments supervision of the contractors and consultants work, and restrictions on the scope of audits). 16. The findings of the fiduciary review have raised concerns about the authenticity and integrity of the documents. In addition to non-compliance with the loan agreement for the project, the nonavailability of adequate records is a significant risk to the integrity and accountability of the project management process. . B. Procurement Process 17. The overall conclusion of this limited review is that the procurement process, in the sample of 26 contracts reviewed in detail in the four cities, was manipulated in order to give the appearance of competition. It appears that the winners were pre-arranged in a majority of the contracts reviewed. The main findings of a detailed review of the sample of contracts, and a review of other contracts where sufficient information was available for the analysis, which lead to this conclusion are summarized below. 18. Similarities between bid prices: Bid prices (total and unit prices) of the winning bidder and of losing bidders were similar and clustered around the Owners Estimate almost universally in all contracts in the sample. In many cases, the lowest evaluated bid differed by only a minute fraction from the Owners Estimate. In one case, the difference was 0.01% on a contract size of some Rp. 440 million. In another case of a similar size, the difference between the prices of the three lowest evaluated bids was 0.2%. In another contract over Rp. 1 billion, the difference between the Owners Estimate and the lowest evaluated bid was 0.05%, and the difference between the highest and lowest bids was 0.2%. In most contracts different bidders shared the same unit prices, which, for most items, were identical to the unit prices in the Owners Estimate. In several cases, the arithmetic mistakes in the Owners Estimate were carried over to the bids. The extent of these findings suggest 5

that the bidders in the four cities had access to the detailed calculations of the Owners Estimate and that they colluded in preparing bids. 19. Other similarities in the bids: The bid proposals generally used the same formatting and language. Documentation contained in the bids appeared to be photocopies of information from competing bid documents. Bidders propose common items (i.e., the same make and model). These similarities and other problems noted in the procurement process strongly suggest active collusion among bidders. It also appears that these practices continued throughout project implementation despite government and consultant oversight. 20. Contractor ownership issues: More than one contractor being affiliated at the same address, and bidding on the same procurement package, was common to the majority of bids in the four cities where sufficient information was available to make such comparisons. In one city, 18 instances of contractors sharing the same address were found. Several cases of contractors sharing the same address and even telephone numbers and bidding against each other on the same procurement packet were noted. In some cases, different contractors maintained the same bank account. Further analysis of contractor ownership in another city revealed that 7 clusters21 of companies were involved in 29 or 57% of the contracts reviewed, and in 28% of these contracts companies from the same ownership cluster were both winning and losing bidders on the same procurement packet. 21. In another city, the analysis of a portion of the total number of the contracts showed that five groups of companies for which common ownership could be established were involved in 70% of the procurement packets and were awarded 37 contracts. In many cases, firms from the same ownership group were both awarded the contract and submitted losing bids for the same procurement packet. 22. The Indonesian Contractors Association (GAPENSI) has been responsible for certifying the classification of contractors in Indonesia, including in the four cities covered by this fiduciary review. Large contractors are generally prominent members of GAPENSI and hold key Office positions in the GAPENSIs Offices in the provinces, cities, and other branch offices. 23. Similarities in the membership of the tendering committees were noted in all four cities. In one city, the membership of the tendering committees has generally remained unchanged over time, and across sectors and procurement packets. 24. Authenticity of documentation in the bids: The above concerns and others discussed in this paragraph have raised questions about the authenticity and validity of the bids and the procurement process in the sample of contracts in the four cities. For example, the signatures of the same individual vary across documents in the same bid documents such as on the bid read-out sheet and the bid opening attendance sheet. The dates at which different events have taken place in the procurement process are inconsistent or out of order. The bid prices are reported differently in the bid evaluation reports. It appears that bid prices may have been altered in some cases after the submission of bids. There are also concerns about the authenticity of the bid bonds. 25. Bid evaluation: The detailed review of the 26 contracts and a review of other contracts where possible have raised concerns about the quality of the bid evaluation process. In some cases, based on the information available in the bid proposals, a bidder should have been disqualified. In other
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A cluster of companies is a group of companies that are owned by the same person.

cases, the bid evaluation reports where available did not provide explanation for not awarding the contract to the lowest evaluated bidder. Information necessary to evaluate the appropriateness of the procurement process was however missing in many cases examined by the fiduciary review team. 26. Conclusions on the Procurement Process: The overall conclusion of the fiduciary review is that the procurement process for the 26 contracts reviewed in detail was manipulated to give the appearance of competition. The winners appear to have been pre-selected in most cases. For example, the findings of the fiduciary review in the four cities, included the following: The large number of companies within a single ownership cluster appears to be consistent with the creation of shell companies. A shell company involves the appointment of nominal directors who are without any real organizational powers or functions, and merely sign documents on behalf of the company. The similarities between the bid proposals of the winning and losing bidders is consistent with the possibility of government contracts having pre-arranged winners. The fiduciary review noted that all bidders were members of GAPENSI, and certification from GAPENSI is a condition of participating in the bidding process for government contracts. Furthermore, the similarities between the bid prices is likely to be indicative of the bidders having access to the unit price details of the Owners Estimate in advance of preparing their bids. The inconsistencies noted in the bid documents are indicative that all bidders are not individually represented at the pre-qualification or bid selection meetings. In such circumstances a single representative could be acting for multiple companies, which is consistent with the finding that companies from the same ownership cluster submitted both the winning and losing bids for the same contract. Instances were noted where the most competitive bidder was excluded from further evaluation. This is consistent with the possibility that administrative or weak technical grounds could be found to exclude competitive bidders from the selection process.

C. Implementation 27. A review of the contract management aspects of a few contracts in the four cities has raised questions about the quality of technical work, performance of the consultants, and project management, as summarized below. 28. Inability to verify contract performance: The as built22 drawings for a few contracts reviewed in detail in the four cities generally did not contain the information necessary to evaluate whether or not the actual work performed was consistent with the contracts. The use of the as built measurements enables a calculation of the volume of different items of work executed by the contractor necessary to evaluate the actual work performed. 29. Technical specifications vs. actual work completed: A detailed review of the back up data sheets in a few contracts indicates that the actual work performed as stated in the documents is not supported by actual field survey data. The purpose of the survey information is to demonstrate that
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As built drawings are provided by the contractor at the completion of the work verifying the details of the work done.

the work was actually completed and in accordance with the scope of work. In one packet selected for a detailed review of one back up data sheet, the review revealed that the actual work appeared to be less than that described in the scope of work, and therefore the Government may have been invoiced beyond the actual work performed. 30. Site visit observations indicate problems in contract performance: Site visits of the contracts selected for a more detailed review indicated that the scope of work may not have been properly implemented, and the percentage of completion of works indicated in invoices was beyond the actual work performed. Some facilities as constructed did not to conform to the bid drawings, and there were no change orders available for the design changes. For example, (i) in a drainage subproject, drain covers were missing despite the scope of work indicating that such work was included in the contract23; (ii) in a roads project, coring analysis indicated that hot asphalt may not have been applied as per specifications on a particular road surface, however, such work was included in the invoices; (iii) in a subproject for footpaths, the work on a footpath had not been properly completed; (iv) in a water treatment subproject, equipment appeared to be missing or not properly installed despite the scope of work indicating that such work was included in the contract; and (v) in another water treatment subproject, the inside of water storage tanks did not seem to have been properly finished, and the equipment was not operating. 31. Based on the site visits concerning two contracts for the construction of a water treatment facility, the descriptions of the scope of work in these contracts were inadequate for the purpose of determining specifically what work was to be performed, and thereby making the evaluation of performance difficult. However, items included in the scope of work of the contracts were already in existence at the site. In addition, an item included in the scope of work of one contract was likely to have been added to the scope of work of the second contract. As a result it appears that the Government was invoiced beyond the actual scope of work performed and goods supplied by approximately 11% of the contract value. 32. Contract splitting: Review of the various contracts in the four cities has raised concerns about the criteria used in procurement planning, whether adequate attention was given to the need for economy and efficiency in project implementation and technical and operational aspects of the facilities to be constructed under the project, and the adequacy of design, technical specifications and drawings. In one city, procurement of goods and civil works required for the construction of a water treatment facility was split into four separate contracts. Although it was anticipated that the four contracts would complete the sub-project, the water treatment facility is not operational and additional work is necessary. The four contracts did not include all of the equipment and materials, and the work required according to the overall detailed engineering design drawings did not appear to have been performed. Furthermore, the addition and deletion of various items of work appears to have occurred during contract execution without appropriate authorization or an assessment of the overall impact to the project completion and ultimate functionality. None of the contracts seemed to contain the support drawings for the separate contract work although this was the responsibility of the consultants. 33. In another city, a sub-project involved a solid waste disposal facility. Following the design work, procurement of goods and civil works required for the facility was split in four separate
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In addition, no documentation was available to support the changes that were made in the field to change the scope of work.

contracts. The work performed did not appear to be in accordance with the scope of work or technical specifications for any of the four contracts reviewed. In addition, as constructed it did not appear that the facility would be functional upon completion. In this case also, none of the contracts contained the supporting drawings for the separate contract work. 34. It is not clear whether the practices of splitting contracts were due to: (i) the desire to award contracts to several contractors for non-economic reasons; (ii) a practice of limiting bidding to companies domiciled in the geographical area of works/goods; (iii) inadequate technical capacity in the implementing agencies; (iv) poor performance of the consultants; (v) weak oversight; and/or (vi) problems with the current system of budgeting whereby Government funds are made available on an annual basis and counterpart funds can not be carried forward from one year to the next year. 35. Consultants performance21: Despite the very large component for consultants services in the project to support the agencies responsible for project implementation and coordination at the various levels of the Government (Central, Provincial and Local Governments), the overall conclusion of the fiduciary review team is that the performance of the consultants has been generally poor. This is amply demonstrated in the four cities by the amount of missing documentation, poor quality of technical specifications and bid documents, the lack of or poor verification of the works in the field, issuance of completion certificates for incomplete works, and weak reporting on the status of project progress. 36. One consultants firm in one of the two provinces reviewed was required to certify the progress reports and completion certificates verifying that the work by the contractors had been properly completed. Site visits indicated instances where the progress reports and completion certificates were not signed by the consultants, indicating a possible lack of verification that the contracts had been satisfactorily executed prior to disbursements. The Management Letter attached to the audit report for the fiscal year 2000, received in December 2001, contain references to lapses in the supervision of the implementation of the project in many cities, including the four cities covered by the fiduciary review. 37. The addition and deletion of various items of work during contract implementation allows contractors to charge for goods provided and civil works performed without the safeguards of a competitive tendering process. The consultants were to ensure that all of the scopes of work were fully detailed in the technical specifications and bid drawings such that after the work was completed, the actual work performed could be verified. This did not appear to be the case in a majority of the contracts reviewed in detail.
21

As shown in Annex 1, Sul2 UDP included a substantial component for consultants services to support project implementation and management ($16.2 million or 18% of the net loan commitments excluding $2 million for training). There were four types of consultants services: (i) project implementation coordination (PCO) and project implementation support (PIS) consultants to support the Central Government in overall coordination, technical matters, oversight and monitoring in all areas of project implementation, including financial management implementation, and regular reporting on the project progress; (ii) provincial project implementation support (PPIS) consultants in each of the four provinces in Sulawesi to provide technical expertise to provincial and local governments in project implementation (i.e., in engineering, financial management, capacity building and operations and management), and report regularly on the project progress status; and (iii) detailed engineering design and supervision (DED) consultants for roads and non-roads components of the project in each province to prepare bid documents including bid drawings, supervise the implementation of works, certify the progressive and final measurements of the completed sub-projects, and ensure that contracts are completed according to contract specifications. They were to also review and suitably endorse the actual physical progress in implementation of the sub-projects in order to support requests for payments.

38. The consultants issued the quarterly progress reports entitled Summary of Program Activities, to support project implementation at the provincial level. The purpose was to report the rates of progress for the individual contracts awarded. However, the reports only provided some subjective analysis and overall conclusions. One section of these reports entitled Problems and Issues was generally limited in size22. None of the reports referred to any significant problems in the implementation of the project in the four cities or the overall project. 39. Conclusions on the implementation process: There is little evidence based on a review of the 26 contracts to suggest that an appropriate amount of project oversight was conducted by Government and its various agencies, and the supervisory and advisory consultants in the implementation of the project in the four cities. There were a number of cases where (i) the work performed was not in accordance with the technical specifications included in the contract; (ii) subprojects were either not complete or functional; (iii) there were errors or duplicate entries in the back up data sheets; (iv) the detailed drawings necessary to determine that the actual work was in accordance with that required in the contracts, were not complete; and (v) the contract change orders appear to have been made without appropriate approvals. 40. The lack of documentation needed to evaluate the implementation process or verify the completion of work prior to releasing payments is a significant problem in the sample of the contracts reviewed. There is evidence to conclude that some disbursements under the sample of contracts in the four cities were made without the required supporting evidence of contract completion. 41. Furthermore, despite the elaborate institutional structure to support and monitor project implementation at the various levels of the Government and a large contingent of the consultants with specific roles and responsibilities, which include project oversight, there does not seem to be a reporting of the significant problems observed by this fiduciary review in the sample of contracts in the four cities. D. Financial Management 42. The sample findings of the financial management review indicate that some project related disbursements were made in the absence of adequate and appropriate supporting documentation. This violates a fundamental financial management requirement of Governmental oversight, which is to ensure that the activities of Government are auditable. The findings, which lead to this conclusion, are summarized below. 43. Completion of civil works contracts: Civil works contracts typically include a detailed list of sub-components for which estimated volumes and unit prices are specified in the contract and in related documents. In one city, in each case the fiduciary review team analyzed, the actual volume of works completed was stated in payment documents to be exactly equal to contracted volumes with respect to each sub-component activity. The construction of a road, drainage, and a solid waste disposal facility is unlikely to occur exactly in accordance with the estimated quantities contained in the contract, bid documents and the detailed engineering design drawings. In some cases, the contract change orders appeared to have been issued recognizing significant variations in actual volumes compared to original contracts in some sub-components, yet it seems that compensating changes may have been recorded in other parts of the job such that there was no change in the total
22

In several cases, to a maximum of three sentences.

10

value of the contract. This could raise questions whether the documentation may have been adjusted in order that the actual amounts would match the amount included in the contract documents, and concerning the validity of the documents showing that the civil works contracts were completed. 44. Unsupported project disbursements: In one city, there were numerous instances where appropriate supporting documentation including the back up data sheets duly certified by the supervising consultants was not available to assess the basis for disbursements under the contracts reviewed. As a result, it was not possible to assess whether the actual work performed was consistent with the contractual scope of work. According to staff of the auditor, they have estimated that back up data sheets were not provided for about 60% of the disbursements under civil works contracts. In these instances, the only document to support the work done is generally a written statement signed by the concerned project manager or pimpro stating the completion of work. 45. In one city, in every contract reviewed, appropriate supporting documentation was not provided, and in each case disbursements appeared to have been made based upon a claim written out on a plain piece of paper, without the formal, sequentially numbered invoice from the contractor on their letterhead. This is a financial management weakness, though Central Government guidelines do not specifically require such documentation. In the same city, contracts relating to a sub-project required the procurement of goods. None of the payment vouchers included: (i) the transit or transportation documents for the delivery of goods received; (ii) the evidence of physical counts being performed to determine quantities actually received; (iii) documentary evidence of quality or technical capacity verification conducted with respect to the goods received; and (iv) the manufacturers warranty documents where the equipment was branded or procured by the contractors from other manufacturers. 46. Based on a site visit to a sub-project, none of the four contracts appeared to have been fully implemented. The contractors and the pimpro themselves estimated that only 80% of the work had been completed. However, the financial records seem to indicate that in each of these four contracts 100% of the contract disbursements had been made. In another contract of Rp. 900 million for a major equipment in the same city, documents -- the certificate of origin and the manufacturers warranty do not appear to have been submitted in support of the payment claim, even though they were required under the contract. In addition, it seems that no other documentation was obtained from the manufacturer to substantiate the specification of the goods supplied. From the disbursement records, it was therefore not possible to assess whether the goods were delivered in accordance with the contract. 47. Invoicing by contractors beyond the scope of work performed: A detailed review of disbursements under a roads contract was undertaken because of the concerns raised by the implementation review of the contract that actual was less than that specified by the scope of work. It indicated that about Rp. 211 million or 17.5% of the value for a roadwork contract might have been invoiced beyond the scope of work performed. A similar analysis on a drainage contract resulted in similar findings of invoicing beyond the scope of work performed. Similar cases have been reported in a majority of the Kabupatens audited by the auditor in one province in their audit reports for the fiscal year 2000, received in December 2001. According to staff of the auditor, their requests for authorization to further audit a case in one Kabupaten have been twice denied. The fiduciary review team did not have access to the documentation necessary to make such an assessment on a wider sample of the contracts. Supporting calculations for the completed work were unavailable for review whenever the fiduciary review team made such requests. 11

48. A portion of contract payments made to the Regional Governments bank accounts: Financing of sub-projects in the project includes a Government portion ranging from 10% to 35% under contracts for civil works and goods, depending upon the actual expenditure category being financed, and a portion from the Bank loan. In many contracts in every city, the Governments portion of financing did not appear to have been paid directly to the contractors. It appeared to be a common practice for the Governments portion of each payment to be made by the Central Treasury (KPKN) to bank accounts in a Regional Development Bank (BPD), whereas the payments from the Bank loan for the same payment voucher were transferred to the contractors account at a private bank. Payments remittances of the Governments portion of contract financing to these bank accounts specified the contractor as the payee. However, in a few instances, these bank accounts were held in the name of the Regional Government Treasury. In a few other instances, the amounts deposited into the BPD account in the name of the Project Treasurer were withdrawn in cash the same day of the deposit. In one city, none of the payment vouchers issued by the Regional Treasury for the Governments portion of the contract financing, listed the payees bank account. Representatives of the Finance Division of the Regional Administration in that city indicated that it was a standard practice to issue payment vouchers on a bearer basis, which could be cashed at the local BPD. 49. The KPKN representatives explained to the fiduciary review team that the practice of paying the Governments portion of contract financing to the accounts in BPD is followed at or near the end of the fiscal year in order that the Central Government funding for the project would not lapse. The rationale being that the Central Government project funding may not be available if the contract completion was delayed into the following fiscal year, whereas the regional budgeting systems allowed carry forward of unexpended but committed budgeted expenditures to the next fiscal year. Thus such transfers were made on the basis of documents that certified full completion of the works, when the works had not been fully completed. It was also noted that this practice occurred even at times unrelated to the end of the fiscal year period. 50. Audits: The auditor did not audit all expenditures under the project in one province as not all local governments in that province had completed their financial statements for the fiscal year 2000, for which the audit report was issued in December 2001. As a result, the auditor did not include 6.7% of the total project expenditures in that province in their financial statement audit. In addition, staff of the auditor indicated that they were not provided access to the assets and facilities of the project in 11 local governments for the fiscal year 2000, and, therefore, these locations did not form a part of their audit for that fiscal year, issued in December 2001. The denial of access of 11 Kabupatens financial records and project facilities (out of a total of over 40 Kabupatens in that province) is a significant limitation to the scope of any financial audit. Similar limitations to the audit of the project occurred in the second province for the same fiscal year. In total, the auditor did not include 12% of total project expenditures in the province in their financial statement audit because not all local governments permitted an audit of their project financial records, by the auditor appointed by the Central Government. In addition, staff of the auditor indicated that they were not provided access to a number of sites for the physical verification of project implementation. 51. Such limitations were noted in a Management Letter, appended to the audit report for the fiscal year 2000, received in December 2001. The consolidated audit report also suitably contained a qualified audit opinion. The audit report also reported that many of the matters raised in the previous years audit reports had still not been resolved as of July 2001. This included matters dating back to the 1998/99 audit. 12

52. Financial issues relating to payments to selected consultants: In one large consultants contract, the out-of-pocket expenses claimed by the consultants were not consistently supported, and in some instances the utility bills attached to the invoices were visibly altered. It appears that the outof-pocket expenses were invoiced beyond those actually incurred under the contract concerned (approximately Rp. 352 million or 55% of the total reimbursable expenses did not appear to have been supported through documentation). 53. In a different province, invoices for only four billing periods were provided with respect to a consultants contract for the fiscal year 2000. A set of photocopies of the supporting documents appeared to be a random selection and was not related to the four invoices in question. The fiduciary review team could not obtain further documents from the implementing agency. In the same province, invoices and payment vouchers were provided with respect to another consultants contract for the period between March 1998 and December 2000. Disbursements for about 70% of the items reviewed under this contract23 seem to have been made without supporting documentation. 54. Other significant financial risks observed during the fiduciary review include the following: (i) retention money was released before the end of the retention period without adequate explanation; (ii) the payee bank accounts were common to more than one contractor/supplier; (iii) payments were made at times to accounts different from those in the contract without proper authorization from the concerned contractor/supplier; (iv) disbursement approvals made by junior staff or senior government officials, under a single signature authority; (v) limitations were placed by Government agencies on the scope of audit by the appointed auditor; and (vi) the weaknesses noted in the audit reports with respect to the projects procurement, implementation or financial management were not followed up effectively. 55. Conclusions on financial management: The payment of the Governments portion of financing under the project to an account in the name of the Project Treasurer, in the cities covered by the fiduciary review, is disturbing. In addition, the ultimate disbursement of those funds in cash is a weak fiduciary practice. This is inconsistent with the fundamental financial management principles that Government transactions must be supported by appropriate and auditable documentation. 56. Following presentation of the findings of this review to the Government of Indonesia, the Bank and the Government are now jointly discussing the following: Implications and actions related to the contracts specifically reviewed in the four cities. Implications and actions for the project. Other lessons and possible actions.

The Bank has also recommend that the findings of this review be made public. 57. The Bank also plans to do an in depth implementation completion report24 for the project to assess the projects development impact.

23

24

Mobilization and demobilization, staff travel, office, field and lab expenses, housing allowances, and report preparation. The Bank prepares an implementation completion report for all projects it finances within six months of completion of the activities financed under the loan. In this case, a more in depth study will be undertaken.

13

Annex 1

Basic Project Information 1. Project objectives: The main development objective of the project is to improve the delivery of urban infrastructure services by local governments on a sustainable basis. The more specific operational objectives include: (a) Improving urban services through economic investments in physical infrastructure (roads, water supply, sanitation, drainage and flood control, solid waste management, markets and transport terminals); (b) Strengthening operations and maintenance activities for urban services, and improving planning, programming, budgeting, financial management and local revenue generation by local governments; and (c) Improving urban environmental management and reducing local environmental impacts. 2. During implementation in January 1998, the project was amended to also support small-scale urban infrastructure works including rehabilitation of urban neighborhoods (Kampung) and improvement of conditions in low-income communities. 3. Loan amount and disbursement: The loan of $155 million was approved in November 1996 and became effective in April 1997 with the closing date of December 31, 2001. The closing date of the loan was extended to December 31, 2002. A total of $67 million was cancelled in August 1998 and December 1999 as part of restructuring of the entire portfolio in Indonesia. An amount of $217,274 was also cancelled due to two misprocurement actions. The net loan commitments are $87.8 million. Of this, $76 million has been disbursed (Table 1). 4. Procurement and disbursement arrangements: Procurement of goods, civil works and consultants services was to be in accordance with the Banks guidelines. All civil works were to be procured through national competitive bidding (NCB) procedures except for small civil works contracts less than $50,000 equivalent per contract up to an aggregate amount of $21.6 million, which may be procured under lump-sum, fixed price contracts awarded on the basis of quotations from three qualified domestic contractors in response to a written invitation. Except for some specialized vehicles and equipment for waste management, goods contracts for less than $200,000 each up to an aggregate amount of $11.6 million were to be procured through NCB procedures. Goods contracts less than $50,000 each up to an aggregate total of $3 million may be procured through national shopping procedures. The first contract for works and the first contract for goods for each implementing agency, and thereafter each contract for civil works estimated to cost $1 million or more, and for goods estimated to cost $200,000 or more were to be prior reviewed by the Bank. Consultants services contracts estimated to cost $100,000 equivalent or more for firms, and $50,000 or more for individuals were to be prior-reviewed by the Bank. All other contracts were to be postreviewed selectively by the Bank.

14

Table 1: Sul-2 UDP -- Loan Status by Broad Disbursement Categories Net Loan Amount ($ mil.) Civil works including labor intensive works 58.8 % of Net Loan Amount 67 Disbursed ($ mil.) % of Disbursed Amount 66 % of Expenditures to be Financed from the Loan

49.9

- 90% under subsidiary loan agreements. - 80% for other civil works. - 100% for labor intensive small works as of 1/1/98 - 90% under subsidiary loan agreements. - For other goods, 100% of foreign expenditures, 100% of local expenditures (ex-factory cost), and 65% of other items procured locally.

Goods

10.8

12

8.5

11

Consultants services & training 1. Engineering services 2. Implementation support services 3. Training Net deposit, Special Account Total

18.2 (12.3) (3.9) (2.0)

21 (66) (21) (11)

13.4 (9.3) (2.6) (1.5) 4.2

18 (70) (19) (11) 6 100 100% 100% 100%

$87.8

100

$76

5. Disbursements were to be on the basis of statement of expenditures (SOE) for the following contracts: (a) first contract for goods and civil works for each implementing agency, and thereafter for goods contracts below $200,000 and civil works contracts below $1 million; and (b) consultants services contracts with firms below $100,000 and with individuals below $50,000. Under SOE procedures, all documentation was to be retained by the implementing agencies and made available to the Bank for review upon request. 6. Analysis of disbursements by prior and post reviews of procurement: Of the total amount disbursed , $54 million was disbursed approximately under contracts subject to ex-post review (and SOE procedures), and $18 million under contracts that were prior reviewed by the Bank. In addition, an amount of $4.2 million is a net deposit in the Special Account. A breakdown is shown in Table 2 on the following page.

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Table 2: Sul-2 UDP -- Disbursements by Prior and Post Reviews of Procurement25

Disbursements under Contracts subject to Prior Review ($ million) Civil works Goods Consultants services including Training Total 4 2 12

Disbursements under Contracts subject to Post Review (SOE procedures) ($ million) 46 7 1

Total Disbursed ($ million)

50 9 13

18

54

7226

7. Implementation arrangements and role and responsibilities of consultants: A simplified organization chart for project coordination and management and implementation arrangements is attached. The Sul-2 UDP included a large component for consultants services to support project implementation and coordination, provide oversight and report on project status progress. An amount of $18.2 million or 21% of the total net loan commitments was for consultants services (including $2 million for training). The role and responsibilities of major consultants at the national and provincial levels of the government are summarized below. 1. Project Implementation Coordination Office (PCO) Consultant 8. Under the contract, the role and responsibilities of the PCO Consultants were the following: (i) overall project implementation coordination; (ii) financial management coordination; (iii) overall construction progress, supervision and quality control/management, including the coordination and evaluation of urban road implementation; (iv) KIP monitoring and benefit evaluation; and (v) technical and financial audit support. The PCO consultant was also required to prepare quarterly reviews of the progress of implementation of the overall project for the Central Government. 2. Project Implementation Support (PIS) Consultant 9. Under the contract, the role and responsibilities of the PIS Consultants were the following: (i) overall project implementation, budgeting and financial management; (ii) overall program monitoring, evaluation and reporting; and (iii) overall training program and material development. As a part of the supervision activities, the PIS consultant was also to prepare accounts and financial reports of the overall project for the Central Government. 3. Provincial Project Implementation Support (PPIS) Consultants 10. Under the contract, the role and responsibilities of the PPIS Consultants in each of the four provinces of Sulawesi were the following: (i) providing experienced municipal engineering, planning
25

Rounded. In addition, there is a net deposit of $4.2 million in the Special Account.

26

16

and budgeting/finance practitioners to support planning, budgeting and financial management by local governments and the Provincial Project Management Unit (PPMU); (ii) building capacity within local governments through on-the-job training and ensuring that results are achieved rather than merely reporting those results; and (iii) strengthening operation and maintenance activities for the services being created under the project. As a part of the supervision activities, the PPIS consultants were to also prepare quarterly project reviews of the progress of implementation of the project in their respective provinces. 4. Detailed Engineering Design and Supervision (DED) Consultants 11. Under the contract, the role and responsibilities of the DED Consultants in each of the provinces were the following: (i) preparation of the bid documents for tenders, including preparation of bid drawings and ensuring the completeness of individual bid packages; (ii) supervision of the implementation of the engineering works under its charge, including the certification of the progressive and final measurements of the completed sub-projects; and (iii) ensuring that the works are completed and goods are delivered according to the contract specifications. As a part of the supervision activities, the DED consultants were to also review and suitably endorse the actual physical progress in implementation of each sub-project in order to support requests for all payments. This aspect of the responsibilities of the DED consultants was reiterated by the PPMU of South Sulawesi in a letter, dated November 15, 1999, to all project personnel.

17

Simplified Organization Chart for Project Coordination and Management

Executing Agency (EA) Directorate General of Urban and Rural Development (former name: Directorate General of Human Settlements/Cipta Karya), Ministry of Settlement and Regional Infrastructure (KIMPRASWIL)

Project Coordination and Project Implementation Support Advisors (PCO and PIS) based in Jakarta and Makkasar

Project Officer (representing EA) based in Makassar

Provincial Project Management Unit (PPMU) in respective Provinces (based in capital cities of Provinces: Makassar, Kendari, Palu, Manado)

Provincial Project Implementation Support (PPIS) Consultants for respective Provinces

Contractual relationship

Project Management Unit (PMU) in respective Kota/Kabupaten, based in Kota/capital of Kabupatens

Detailed Engineering Design (DED) Consultants for respective Provinces

Project Implementation Unit (PIU) for each project component (Water Supply, Drainage, Sanitation, Roads, KIP, MIP, Solid Waste)

18