While general and sector import programs were designed to strengthen weak balance-of-payments positions, structural adjustment support provided budget aid to support sound macroeconomic management and implementation of economic and social reforms. The funds were targeted and made available in two steps. First, a tranche in the relevant foreign exchange was deposited into a government account at the central bank. Second, funds were converted into local currency and deposited in a treasury double-signature account. Use of the funds required the authorization of the head of the EC delegation and the government official nominated as the national authorizing officer. Counterpart funds generated by structural adjustment support are considered targeted budget support aimed primarily at protecting social expenditures in the face of stabilization programs developed by the World Bank and IMF.

Although counterpart funds are the property of the beneficiary country and responsibility for their management and use lies with the national authorizing officer, the European Commission has a control responsibility through its co-signature on the account containing the funds. These roles and responsibilities are set out in broad terms in financing agreements and implementation agreements, with further details provided in a memorandum of understanding, implementation agreement, or framework of mutual obligations signed by the European Commission and the national authorizing officer. Financing agreements, signed by the EC commissioner and the national authorizing officer, constitute the legally binding bilateral agreement, while implementation agreements define responsibilities for managing, monitoring, and controlling counterpart funds. The use of EC structural adjustment support has traditionally been audited annually by independent auditing firms.

The purpose of these audits is to determine whether the use of funds is consistent with their objectives, as set out in the financing agreements and implementation agreements. With the evolution of EC structural adjustment support, the purpose of and approach to auditing and controlling the use of EC resources have also evolved. Since 1992 EC audits have been carried out in 32 countries, including audits of General Import Programs, targeted budget aid (including food support), and internal debt and institutional assessment of financial control procedures and agencies in some African, Caribbean, and Pacific countries. In the case of general and sector import programs the audits focused on the use of foreign exchange and generated counterpart funds, particularly the legality and regularity of expenditures. Many audit results were used to impose corrective measures

and sanctions on the countries concerned, including suspensions of structural support, based on identified irregularities in managing the foreign exchange or counterpart funds.

With the shift toward targeted budget support, EC audit procedures were adjusted to reflect the fact that use of generated counterpart funds became subject to national budget rules and procedures. Hence a more comprehensive approach to audits was developed to provide a broad evaluation of beneficiary governments public financial management systems, with a focus on the legal framework, budget execution, procurement, and financial accountability and control. In addition, materiality checks were introduced in EC audits to assess the value for money of the expenditures concerned. The methodology of the EC audit approach developed gradually, building on the principles and methodology of the UNDP CONTACT instrument (see below) and on lessons from previous audits. However, the evolved EC audit methodology has not been recorded in a formal document.

In response to proposals by the European Parliament on the use of EC development resources, the European Commission committed to carrying out a series of special multiyear audits of budget support and food aid in various African, Caribbean, and Pacific countries. These audits were managed by the Commissions Internal Audit Service and conducted under contract by the French firm 2AC between 1998 and 2002. The audits were based on methods developed since 1996 in auditing the use of generated counterpart funds in line with national budget rules and procedures. 2AC examined whether the counterpart funds held in double-signature accounts were used as agreed in the financing agreements and implementation agreements in terms of eligibility in line with mutually agreed purposes and conformity with government budget rules. Follow-up audits were carried out using a sample of transactions to test the initial assessments of countries public expenditure management systems.

In conducting these audits, the Commission started by examining the quality of the systems in place and the legal framework (systems audit), analyzed transactions based on a representative sample (financial audit), and looked at the efficiency and effectiveness of the systems (performance audit). The audits identified major weaknesses in public expenditure management in the beneficiary countries that had not been apparent before, including a lack of conformity with prevailing rules, excessive payments for goods and services procured, weak administrative arrangements for records management, and inadequate institutional arrangements for internal control and external audit. If ineligible expenditures were found and agreed by

the Commissions and the country, the amounts involved were redeposited into the double-signature account and kept for use during the next budget cycle-subject to confirmation that progress was being made in implementing an action plan of corrective measures. The emphasis was on fiduciary aspects: the eligibility and conformity of expenditures, and materiality (for example, whether planned investments were made and goods and services were procured as intended).

This approach had several weaknesses. Because memorandums of understanding included preconditions for disbursements, the release of funds was sometimes severely delayed. Although the annual audits produced action plans to correct identified weaknesses, the Commission was not systematic in its follow-up-so progress was not carefully tracked by subsequent audits. And there was little positive development impact.

The Commission recently adopted a new approach for providing budget aid. Within the context of the Poverty Reduction Strategy Paper, untar-geted budget support is being made available on a multiyear basis, subject to annual assessments of progress against performance indicators identified in the papers priority areas-including the quality of public expenditure management. Annual budget support is divided into two tranches: a fixed tranche that reflects conformity with IMF conditions for macroeconomic management and a variable tranche based on agreed performance indicators for public expenditure management and social sectors.

To support this new approach, the Commission has developed guidelines for a new instrument, called the Public Financial Management Assessment, that consists of:

A desk review of existing diagnostic work on public expenditure management-usually Bank and IMF reports (PERs, CFAAs, CPARs, HIPC AAPs, Fiscal ROSCs) and previous EC audits. This review includes identifying gaps in the existing work that should be addressed in follow-up work, including an EC compliance test (see below), and defining performance indicators to measure progress over time.

A compliance test that provides empirical evidence on the performance of the public expenditure management system, to supplement the findings and recommendations of the ex ante diagnostic work. For example, weaknesses in public expenditure, procurement, and financial accountability identified in CFAAs and CPARs could be verified based on a sample audit in priority areas (such as health and education). The results of a compliance test can also provide a baseline for measuring progress over time.