sri lanka report and recommendation of the president to ... · since implementation of “big...

Sri Lanka Project Number: 42208 September 2011

Proposed Loan for Subprogram 2 Republic of Indonesia: Second Local Government Finance and Governance Reform Program

Report and Recommendation of the President to the Board of Directors

CURRENCY EQUIVALENTS (as of 22 August 2011)

Currency Unit – rupiah (Rp)

Rp1.00 = $0.0001 $1.00 = Rp8,571

ABBREVIATIONS

ADB – Asian Development Bank BAPPENAS – Badan Perencanaan Pembangunan Nasional

(National Development Planning Agency) DAK – Dana Alokasi Khusus (Specific Allocation Fund) DAU – Dana Alokasi Umum (General Allocation Fund) DGFB – Directorate General for Fiscal Balance DPOD – dewan pertimbangan otonomi daerah

(regional autonomy advisory council) FMIS – financial management information system GDP – gross domestic product GSFD – Grand Strategy for Fiscal Decentralization

LIBOR – London interbank offered rate

MDWPC – Ministry for the Development of Women and Protection of Children MOF – Ministry of Finance MOHA – Ministry of Home Affairs NAPFD – National Action Plan for Fiscal Decentralization NSPK – standard, prosedur, dan kriteria (norms, standards, procedures, and

criteria) PDAM – perusahaan daerah air minum (state-owned water supply company) PPPF – postprogram partnership framework RGPMS – regional government performance measurement system RPJMN – Rencana Pembangunan Jangka Menengah Nasional

(National Medium-Term Development Plan) TA – technical assistance

NOTES

(i) The fiscal year of the Government of Indonesia ends on 31 December. (ii) In this report, "$" refers to US dollars

Vice-President B. N. Lohani, Vice-President-in-Charge, Operations 2 Director General K. Senga, Southeast Asia Department (SERD) Director S. Hattori, Pubic Management, Financial Sector and Trade Division, SERD Team leaders J. L. Gomez, Senior Public Management Specialist, SERD

R. Hattari, Public Management Economist (Fiscal Management and Social Security), SERD

Team members K. Bird, Principal Economist, SERD E. Ginting, Senior Country Economist, Indonesia Resident Mission, SERD A. Qadir, Counsel, Office of the General Counsel L. Abenojar, Operations Assistant, SERD J. Mendez-Santos, Operations Assistant, SERD Peer reviewers T. Niazi, Principal Public Management Specialist, Regional and Sustainable

Development Department (RSDD) H. Van Rijn, Senior Public Management Specialist, RSDD

In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS Page PROJECT AT A GLANCE I. THE PROPOSAL 1 II. THE PROGRAM 1

A. Rationale 1 B. Impact and Outcome 3 C. Outputs 3 D. Program Costs and Financing 7 E. Implementation Arrangements 8

III. DUE DILIGENCE 8

A. Governance 8 B. Poverty and Social 9 C. Safeguards 9 D. Risks and Mitigating Measures 9

IV. ASSURANCES 10 V. RECOMMENDATION 10 APPENDIXES 1. Design and Monitoring Framework 11 2. List of Linked Documents 14 3. Development Policy Letter 15 4. Policy Matrix 18

PROJECT AT A GLANCE

1. Project Name: Second Local Government Finance and Governance Reform

Program, II

2. Project Number: 42208-013

3. Country: Indonesia 4. Department/Division: Southeast Asia Department/Public Management, Financial Sector, & Trade Division

5. Sector Classification:

Sectors Primary Subsectors

Public sector management √ Public expenditure and fiscal management

6. Thematic Classification:

Themes Primary Subthemes

Economic growth Promoting macroeconomic stability

Governance √ Economic and financial governance

Capacity development Institutional development

6a. Climate Change Impact

No Climate Change Indicator available.

6b. Gender Mainstreaming

Gender equity theme (GEN)

Effective gender mainstreaming (EGM) √

Some gender benefits (SGB)

No gender elements (NGE)

7. Targeting Classification:

General Intervention

Targeted Intervention

Geographic dimensions of

inclusive growth

Millennium development

goals

Income poverty at household

level

√

8. Location Impact:

National High

9. Project Risk Categorization: Low

10. Safeguards Categorization:

Environment C

Involuntary resettlement C

Indigenous peoples C

11. ADB Financing: Sovereign/Nonsovereign Modality Source Amount ($ Million)

Sovereign Program loan Ordinary capital resources 200.0

Total 200.0

12. Cofinancing:

No Cofinancing available.

13. Counterpart Financing:

No Counterpart Financing available.

14. Aid Effectiveness:

Parallel project implementation unit No

Program-Based approach Yes

I. THE PROPOSAL 1. I submit for your approval the following report and recommendation on a proposed loan to the Republic of Indonesia for subprogram 2 of the Second Local Government Finance and Governance Reform Program. The program will support government efforts to improve living standards and local service delivery by implementing an efficient and equitable system of intergovernment fiscal relations. The reform priorities include efforts to improve the policy framework for fiscal decentralization, strengthen the capacity of regional government officials, and develop performance-oriented management systems.1

II. THE PROGRAM A. Rationale 2. Indonesia has made significant progress implementing decentralization reforms. Since 2001, the government has effectively devolved key expenditure and revenue functions to regional governments; by 2010 they accounted for a third of total public expenditure. These reforms have had positive impacts on improving governance in terms of increased local participation in the budget process, greater transparency, and accountability. Some evidence indicates that decentralization has stimulated economic growth in local economies, at least in the medium term. It has also contributed to the government’s poverty reduction goals. Nevertheless, the government recognizes that fiscal decentralization is still in its early stages and continues to refine and advance its decentralization reform agenda. 3. Improved living standards are observed across the country, but significant challenges remain for inclusive development. As the country sustains high economic growth, the percentage of poor people in Indonesia has fallen from around 16.6% in 2007 to 13.3% in 2010.2 However, regional disparities in terms of poverty rates and access to basic services continue. In 2010, Maluku province reported a poverty rate of 27.7%, compared with 3.5% in Jakarta and 4.3% in Bali. Inequalities extend to other human development dimensions. East Maluku reported a human development index (HDI)3 of 70.96 in 2009, well below the Jakarta HDI of 77.36. The percentage of households with improved sanitation in Yogyakarta is more than 75%, compared with around 25% in Papua and Kalimantan Tengah. At least 12 provinces report that fewer than 70% of their households have access to electricity; about 12 provinces report almost full coverage. Future progress in reducing poverty and achieving the Millennium Development Goals will largely depend on improved access to, and quality of, basic services delivered to the local population. 4. Indonesia’s long-term decentralization policy objectives are to improve the delivery of basic services and infrastructure to local communities across the country (National Action Plan for Fiscal Decentralization [NAPFD] 2010–2014). Since implementation of “big bang” decentralization reforms in 2001, regional governments are responsible for the delivery of most basic services. Thus, improving the efficiency and equity of the system of intergovernmental fiscal relations is essential to achieve further gains in poverty reduction. The government aims to distribute available financing to regional governments to ensure comparable coverage of basic services across the country. Since 1 The design and monitoring framework is in Appendix 1; the list of linked documents is in Appendix 2; the development

policy letter is in Appendix 3; and the policy matrix, listing the triggers and milestones defined for this program, and including the postprogram partnership framework, is in Appendix 4.

2 Badan Pusat Statistik. 2011. Indonesia Poverty Data (http://dds.bps.go.id/eng/aboutus.php?tabel=1&id_subyek=23)

3 HDI is a composite statistic used to rank provinces by level of "human development" and separate "very high human

development," "high human development," "medium human development," and "low human development" provinces. The Center Bureau of Statistics prepares the provincial HDI in Indonesia. The statistics comprise data on life expectancy, education, and per-capita gross national income (as an indicator of standard of living or income) collected by subnational governments.

http://dds.bps.go.id/eng/aboutus.php?tabel=1&id_subyek=23

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2003, ADB has been actively supporting fiscal decentralization with a combination of technical assistance (TA) and program and project loans.4

5. The last decade of decentralization reforms has transformed Indonesia’s service delivery systems. The 524 subnational governments (33 provinces and 491 districts) currently account for about 33% of total public expenditure, up from barely 7% in 2000. The reforms launched in 2001 involved a massive delegation of responsibility for the provision of public services and the reassignment of two-thirds of central government civil servants and more than 16,000 service delivery facilities to regional governments. Ensuring an efficient assignment of expenditure responsibilities to subnational governments is a long-term process requiring regular monitoring and review.

6. Local service delivery is mostly financed with central government grants, with growing contributions from local revenue and borrowing. Currently, the largest unconditional grant available to regional governments (the General Allocation Fund [DAU]) accounts, on average, for 50% of total subnational government revenues. The provincial and regional government share of revenues from extractive industries (the dana bagi hasil [revenue sharing]) represents 17% of their revenues; an additional 7% is accounted for by the infrastructure development grant (the Specific Allocation Fund [DAK]). Total grants to subnational governments have more than doubled since 2005, from an estimated Rp150 trillion to around Rp350 trillion in 2010. Local revenue, from limited taxes and charges, represented about 16% of total subnational government revenue. However, recent assignments of new sources of revenue to subnational governments are likely to increase the importance of this building block of subnational financing. The government has taken a cautionary approach to the development of subnational borrowing powers. As a result, total outstanding subnational debt was reportedly just around 0.15% of gross domestic product (GDP) in 2010. 7. Rationalizing criteria for new local government formation. From 1999 to 2008, as a consequence of previously repressed demands for regional autonomy, seven new provinces and about 190 new regional governments were created. The creation of new local governments requires the application of sound technical criteria. On that basis, the government is reviewing the current regulatory framework to include minimum population and administrative capacity requirements, together with adequate assessments of local fiscal capacity, prior to granting new jurisdictional status. In addition, the design of grants and revenue-sharing mechanisms is being evaluated to avoid introducing perverse incentives to new government formation.

8. Mainstreaming gender in policy and budget formulation. Policy formulation and regulatory developments for fiscal decentralization continue to incorporate gender considerations. In addition, budgetary allocations at all levels of government are starting to reflect the importance endowed to gender aspects of strategic policy formulation. The government has taken several important steps, but the rollout of gender-sensitive budget formulation to regional governments is the next critical challenge. 9. New approach to decentralization. Earlier Asian Development Bank (ADB) support to decentralization in Indonesia assisted the development of the policy and institutional framework for reforms, including the creation of the Directorate General for Fiscal Balance (DGFB) at the Ministry of Finance (MOF), the definition of clearer expenditure assignments (e.g., issuance of Government

4 ADB. 2005. Report and Recommendation of the President to the Board of Directors: Proposed Program Loan and

Technical Assistance Grant to the Republic of Indonesia for the Local Government Finance and Governance Sector Development Program. Manila (Loans 2192-INO and 2193-INO for $330 million); and ADB. 2008. Report and Recommendation of the President to the Board of Directors: Proposed Program Cluster and Loan for Subprogram 1 to the Republic of Indonesia for the Second Local Government Finance and Governance Reform Program. Manila (Loan 2478-INO for $350 million).

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Regulation 38/2007), and the enhanced equalizing power of the system of intergovernmental grants (with the elimination of the “hold harmless” clause for the DAU for instance). The draft ADB 2011–2015 country strategy and program for Indonesia identifies fiscal decentralization as key to efficient public service delivery, and essential for more inclusive growth and improved living standards. As the system of intergovernmental fiscal relations in Indonesia matures, and regional governments adopt the central government procurement process, future ADB support in this area will likely be more targeted to specific policy areas such as the devolution of the land and building tax. B. Impact and Outcome 10. The expected impact of the program is more efficient, effective, and equitable regional government spending. The expected outcome is improved organizational capacity of regional governments, which operate in a more transparent, effective, and efficient policy and legal environment for fiscal decentralization, financial management, and service delivery. The latter is facilitated via efficient local government support systems, human resource capacity, and system development. C. Outputs 11 The program supports government’s efforts in six core reform areas: (i) strengthening management and coordination of fiscal decentralization; (ii) clarifying regional administration arrangements to improve services and accountability; (iii) enhancing equalization, predictability, and transparency in release of fiscal transfers and shared revenue; (iv) reducing dependency on fiscal transfers by developing more buoyant sources of local revenue; (v) strengthening management of regional reserves and debt; and (vi) improving capacity development for gender budgeting and gender mainstreaming, public financial management, and accountability. The program is fully aligned with the decentralization goals defined under the NAPFD. 12. The report and recommendation of the President for subprogram 1 of the Local Government Finance and Governance Reform 2 identified 14 policy triggers for subprogram 2 (footnote 4). In the process of assessing implementation progress, the government proposed four additional triggers (Appendix 12): the implementation of gender responsive budgeting, strengthening oversight and coordinating role of provincial governors, improved transparency in DAU allocation, and the starting of devolution of property transfer tax to the region. All 58 measures (18 triggers and 40 milestones) included in the program’s policy matrix were accomplished by the end of August 2011 (Appendix 4). The immediate and medium-term challenges are briefly outlined in the post program partnership framework (PPPF) in the program’s policy matrix (Appendix 4). The PPPF reflects the main recommendations from ADB’s special evaluation study5 and: (i) advocates for continued support to the development of the policy framework and institution building (with a particular emphasis on demand-side aspects of decentralization), (ii) identifies government priorities for reform and emphasizes needed improvements to the policy coordination framework, and (iii) has been discussed with major development partners.6

1. Strengthened Management and Coordination of Fiscal Decentralization

13. Substantial progress has been achieved in the review and completion of the policy and regulatory framework for fiscal decentralization, including finalization of the draft Grand Strategy for Fiscal Decentralization (GSFD) and the NAPFD 2010–2014. The GSFD has been used to set long-term directions for fiscal decentralization, influencing draft amendments to Law 33 on Fiscal

5 ADB. 2010. Special Evaluation Study: Asian Development Bank Support for Decentralization in Indonesia. Manila.

6 The proposed project will be supported by an associated capacity development TA for Second Local Government

Finance and Governance Reform Program, which is being separately processed for expected approval in 2011.

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Balance.7 The policy framework for decentralization has been strengthened with two additional components: (i) the National Medium-Term Development Plan (RPJMN) 2010–2014; and (ii) completion of academic papers for the preparation of amendments to Law 328 and Law 33. The latter documents (for which female representation was ensured in the drafting teams) have mainstreamed gender equity during their formulation, a process facilitated by the Ministry for the Development of Women and Protection of Children (MDWPC). Future challenges, as outlined in the PPPF, include the deepening of regular consultation mechanisms with subnational governments, civil society organizations, and private sector representatives in order to assess policy implementation and enrich dialogue among institutions.

14. DGFB was established as the leading national agency for fiscal decentralization reforms. It has led consultative mechanisms for policy and regulatory reforms with government agencies and been largely in charge of aid coordination. The latter included the preparation, through the tim asistensi (assistance team), of the GSFD, and the ongoing review of Law 33. DGFB also co-chairs meetings of the Regional Autonomy Advisory Council. It has provided leadership to ADB’s Local Government Finance and Governance Reform Program (it has been the executing agency for several ADB TA projects)9 and other development partner programs,10 and has coordinated through formal and informal arrangements with key central ministries and regional governments. DGFB provides regular information on fiscal decentralization matters, especially through a chapter on fiscal decentralization in the Financial Notes for the 2011 Annual Budget. Decentralization policy design and coordination remains a challenge. The current government regulatory review is assessing the central government’s institutional framework for policy coordination and is reconsidering the role of all relevant stakeholders. Of particular importance will be the definition of the role of provincial administrations as a key element of the system of central–subnational fiscal relations.

2. Clarified Regional Administration Arrangements to Improve Services and Accountability

15. The effort devoted to the refinement of expenditure assignments in Indonesia has been constant and significant. The framework for the definition and review of functional assignments is now complete with four main elements: (i) Law 32 on Regional Autonomy; (ii) Government Regulation 38/2007 dealing with functional assignments across tiers of government; (iii) standard, prosedur, dan kriteria (norms, standards, procedures, and criteria) for service delivery by line ministries; and (iv) the standard prosedur minimum (minimum service standards). The Dewan Perwakilan Rakyat (House of Representatives) is scheduled to discuss amendments to Law 32, including a review of expenditure assignments by tiers of government, in 2011. Upon approval, such amendments will form the core of the revision of GR 38/2007. About 40 norms, standards, procedures, and criteria have already been completed by key social sectors including education and health, and the process to clarify responsibilities in service delivery will continue in the remaining ministries over the next few years. Furthermore, 13 ministries11 have developed minimum standard

7 Law 33 importantly outlines the system of regional financing, including transfer mechanisms from the central to regional governments.

8 Among other aspects, Law 32 provides a first statement of expenditure responsibilities by tier of government and

regulates procedures for new regional government creation. 9 ADB. 2008. Technical Assistance to the Republic of Indonesia for Local Government Finance and Governance Reform.

Manila (TA 7184-INO); and ADB. 2009. Technical Assistance to the Republic of Indonesia for Support to Local Government Finance and Governance Reform. Manila (TA 7452-INO).

10 Most notably the Decentralization Support Facility managed by the World Bank and financed largely by Department for International Development.

11 The Ministry of Health, Ministry of Environment, Ministry of Home Affairs, Ministry of Social Welfare, Ministry of Housing, Ministry of Women Affairs, Ministry of Education, Ministry of Public Works, Ministry of Manpower, Ministry of Agriculture, Ministry of Information and Technology, Ministry of Tourism, and National Family Planning Coordinating Board.

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services for various services. The latter include basic education and health services, and the integration of gender issues on domestic violence against women and children.

16. The uncontrolled proliferation of new subnational governments, prevalent during the first few years of decentralization reforms, has been stopped. A moratorium on the processing of applications for new regions has been in place since mid-2009 and pending further legal reforms will remain in effect until 2014, as stated in the RPJMN for 2010–2014. Draft amendments to Law 32 incorporate sound criteria to guide the processing of applications for the creation of new jurisdictions. In addition, the recently approved Desain Besar Penataan Daerah (Grand Design on Regional Autonomy) proposes tightening the administrative procedures for establishing new regions, including a 3-year evaluation period prior to granting local government status.

17. The government has taken important steps to strengthen the oversight and coordinating role of provincial governors in the framework of intergovernmental fiscal relations. They have revised the government regulation on the roles and responsibilities of provincial governor to strengthen the role of governor (Government Regulation 23/2011); issued a joint circulation letter between MOF, the Ministry of Home Affairs (MOHA), and the National Development Planning Agency (BAPPENAS) on the implementation of the GR 23/2011; and, reflected changes in the desired role of provincial governors in the draft amendments to Law 32/2004.

3. Enhanced Equalization, Predictability, and Transparency in Release of Fiscal Transfers and Shared Revenue

18. The equalization potential of the DAU has been improved. Presidential Decree 5/2010 (RPJMN 2010–2014) instructs the government to provide greater flexibility in the allocation of DAU funds by delinking wage payments from DAU allocations, thus releasing additional resources for poorer regions. In practice, the government has pegged the amount devoted to wage payments from the DAU to below 50% of the total allocation. The process will need to be completed with amendments to Law 33, legally delinking the wage component from the DAU formula. Improved transparency in DAU allocation is now achieved by the recent publication of the national formula and weights used for the distribution of the DAU to provinces in the annual supplementary budget documents. Future reforms should consider removing adjustments that make grant allocation discretionary, thereby improving overall effectiveness of public expenditure.

19. Predictability in fiscal transfers is improved with the progressive incorporation of a system of forward estimates for all major grants into the budget formulation process. Although their importance varies greatly across jurisdictions, on average central government transfers (including grants and revenue sharing from national taxes on resource industries) account for more than 80% of regional government revenue. With limited discretionary power over their own revenue sources, regional governments require predictability over the medium-term on the assignment of central government transfers (both in terms of regular financial flows and the stability of the estimated annual amounts received). Acknowledging the importance of adequate fiscal information, the new budget manual requires the implementation of forward estimates for 3 years. The 2009 national budget already contained forward estimates of transfers to regions as a percentage of GDP. Further, MOF has included nominal forward estimates for each major transfer as part of the formulation of its medium-term expenditure framework. Future work will require improving available annual budgetary information of regional governments to allow for effective implementation of the RPJMN for 2010–2014.

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20. Efficiency in regional government budgetary appropriations has been enhanced. Significant “incorrectly” deconcentrated expenditures12 were identified for the Ministry of National Education (approximately Rp20 trillion in 2008 values). 13 The main transgressing education program (the School Operational Assistance Program, which constitutes more than 50% of the Ministry of National Education deconcentrated expenditure) was moved from government deconcentrated funding to alternative funding, and thus devolved to the regional governments. This has improved the discretionary expenditure power of regional administrations from conditional education transfers.

4. Reduced Dependency on Fiscal Transfers by Developing More Buoyant Sources of Local Revenue

21. During the program, the government assigned important revenue sources to subnational governments, progressing beyond the originally defined policy goals in this area of reform. Gradual devolution of the land and building tax and the property transfer tax started in January 2011, upon enactment of Law 28/2009 on Regional Government Revenues and Charges. The government plans to fully devolve the property transfer tax by the end of 2011 and expects to complete the devolution of the land and building tax by 2014. Significant supporting regulation in the form of a joint ministerial decree between MOF and MOHA (Joint Ministerial Decree 53/2010) clarifies transfer of the property transfer tax to regional governments, detailing the responsibilities of each ministry to ensure a smooth transition. The effective decentralization of both taxes to regional governments is one of the most important reform challenges facing the decentralization process and will require sustained reform efforts from the government and development partners.

5. Strengthened Management of Regional Reserves and Debt 22. Overall risk of fiscal instability from regional government financial liabilities was reduced with the implementation of the debt management and financial analysis system of the United Nations Conference on Trade and Development for the management of regional debt. The system has been operating fully since 2010, providing useful data for the analysis of regional debt. The system receives data from the accounts receivable system and a Microsoft Excel-based system that is used to manage on-lending of regional governments. 23. The restructuring and rescheduling of nonperforming debts of state-owned water supply companies (PDAMs) is progressing adequately. Overall, Rp4.3 trillion of debt was restructured or rescheduled amounting to 58% of the total debt as of December 2010. Data from the Directorate General of Treasury shows that of 164 PDAMs eligible for debt restructuring, 115 had prepared restructuring or rescheduling plans for MOF consideration. Of these about 68 have passed through the two required committees and were approved by MOF. A further 22 are still undergoing processing and may be finalized in late 2011. Some 25 plans were resent to the PDAMs for review and resubmission, and the Directorate General of Treasury of MOF expects to complete the approval process of an additional 10 of these revisions. 24. The regulatory framework for subnational borrowing has been significantly improved with the revised regulation on local government borrowing, which includes municipal bond issuance (GR 30/2011). The City of Jakarta initiated the process of municipal bond issuance, and DGFB and the Capital Market and Financial Institution Supervisory Agency have approved two local regulation templates. The first defines procedures for issuing the bond and the second outlines procedures for

12

Incorrect Dekon are budgetary allocations still under the control of line ministries for functions devolved to regional governments.

13 Analysis of expenditures by the Ministry of Environment, ADB’s second pilot ministry, did not render any significant cases of incorrect Dekon.

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managing the bond. The dissemination of these templates to regional governments is an important step in the provision of government support to municipal bond issuance.

6. Improved Capacity Development for Gender Budgeting and Gender Mainstreaming, Public Financial Management, and Accountability

25. Gender concerns are, for the first time, being incorporated in strategic policy formulation and budget formulation processes. MOF has instructed line ministries to implement gender-responsive budgeting in the budget proposals for 2010 and 2011, and a gender budget statement is now included in the annual budget documents. A draft manual offering guidance to regional governments on implementing gender-responsive budgeting will support the rollout of gender-responsive budgeting to subnational governments. 26. The government will continue to invest in the training of regional government officers on public financial management. Training for human resources and system development in regional governments, including the preparation of training materials, has increased, on average, by 25% over the last 3 years through MOHA and MOF. In addition, a financial management information system (FMIS) has been fully implemented in 53 regional governments; partially implemented in 41; and initiated in 25, with free software available for expansion to all regional governments. Work in this area has included the training of 5,657 officials in FMIS usage. In addition, gender mainstreaming is being institutionalized for line ministry training through MOHA in coordination with MDWPC. 27. Time delays in publishing consolidated regional government financial information have been progressively reduced. Budget approval information for regional governments is available for 100% of jurisdictions up to 2010, effectively reducing the delay in publication to one year. Publication of budget realization data is also timely. The most recent web-published data indicates that close to 100% of regional government reports for 2008 and around 60% of reports for 2009 are available, displaying good performance in this particular area of the policy matrix.

28. A regional government performance measurement system has been developed with a centralized database fully functioning in 40 regional governments. The system was developed and trialed in 40 regional governments. Information and implementation kits and the software package (which runs on Microsoft Excel) have now been provided to almost all regional governments throughout the country. The system includes gender-related indicators in areas like female representation in local authorities and targets for capacity building. D. Program Costs and Financing 29. The government has requested a loan of $200 million equivalent from ADB’s ordinary capital resources to help finance the program. The loan will have a 15-year term, including a grace period of 3 years, an annual interest rate determined in accordance with ADB’s London interbank offered rate (LIBOR)-based lending facility, a commitment charge of 0.15% per year, and such other terms and conditions as set forth in the draft program loan agreement. The government has provided ADB with (i) the reasons for its decision to borrow under ADB’s LIBOR-based lending facility based on these terms and conditions, and (ii) an undertaking that these choices were its own independent decision and not made in reliance on any communication from ADB. 30. The size of the program is based on a number of factors required to support implementation of program reforms (Appendix 4). The key considerations include (i) the relative importance of the sector to the economy, the weight and benefits of the reform program, and the leverage necessary to counter resistance from interest groups; (ii) the policy adjustment costs incurred by the

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government and stakeholders in implementing and complying with reforms; and (iii) the need to conform to the overall financing requirement during the country partnership strategy period. ADB staff estimate that the direct benefits of program reforms over the medium term are approximately $820 million to GDP (in 2011 prices). These economic benefits include (i) gains to local economies of approximately $410 million arising from increased state budget allocative efficiency due to improvements in the public financial management systems of regional governments, and (ii) gains of at least $410 million to the economy arising from efficiency improvements in collection of property taxes that will be devolved to regional governments from 2011 to 2014. Other potential economic gains to the economy arising from fiscal decentralization are difficult to quantify. In particular, efficiency gains in service delivery from decentralizing expenditure assignments could be substantial. The policy adjustment costs to national and subnational governments are conservatively estimated as a discounted present value lump sum of about $310 million. These adjustment costs include the administrative, investment, and fiscal costs to the government in implementing the reforms and capacity development including strengthening regional FMIS systems, training staff in subnational government offices, restructuring debt of the PDAMs, and developing databases and other coordination mechanisms. The reforms also have important distribution effects between the national and regional governments. In particular, in 2011 the devolution of property taxes will transfer approximately $4.1 billion of national government budget revenue to regional governments. The increased flow of funds will aim to address unfunded mandates for service delivery. Further, as own local revenue collection increases, pressure on additional central government transfers will reduce. E. Implementation Arrangements 31. DGFB (MOF) is the executing agency, and the relevant directorates of MOF, MOHA, and BAPPENAS are the implementing agencies for the program. A local government finance and governance reform steering committee (with an implementation committee), formed under the Local Government Finance and Governance Reform Program, subprogram 1, 14 will coordinate implementation of the program reform actions. The implementation period extends from September 2009 to August 2011. The steering committee is chaired by the director general of DGFB, and includes MOHA and BAPPENAS officials as members. The program loan of $200 million will be disbursed in a single tranche upon loan effectiveness. The loan proceeds will be disbursed in accordance with ADB’s Loan Disbursement Handbook (2007, as amended from time to time) and detailed arrangements between the government and ADB. 15 The reforms supported under the program will be met through local currency counterpart funds generated from the loan proceeds. Prior to withdrawal, the government will nominate a deposit account at Bank Indonesia to receive all loan proceeds. The government will use its own procurement procedures for the procurement of eligible items to be financed from the loan proceeds.

III. DUE DILIGENCE A. Governance 32. Through its efforts on overall public financial management reform, the government is strengthening the legal and regulatory architecture to achieve better fiscal synergy between national and regional governments. Current reforms emphasize the need for improved transparency on the allocation of fiscal transfers to the regions, with the recent introduction of the medium-term expenditure framework and performance-based budgeting by the government. In addition, the

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ADB. 2008. Report and Recommendation of the President to the Board of Directors: Proposed Program Loan and Cluster for Subprogram 1 to the Republic of Indonesia for the Second Local Government Finance and Governance Reform Program. Manila (Loan 2478-INO, for $350 million, approved on 4 December).

15 ADB. 1998. Simplification of Disbursement Procedures and Related Requirements for Program Loans. Manila.

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government has taken important strides toward efficient financial management with the introduction of public procurement offices at national and subnational levels. Lastly, progress has been achieved in (i) disclosing relevant fiscal information to the public, specifically improving the transparency of the consolidated general government financial statements; and (ii) strengthening the role of the external audit function. However, challenges remain, including the need to (i) improve internal controls in budget execution by spending agencies; and (ii) complete the government financial management information system, which provides information for budget management at all levels of government. ADB’s Anticorruption Policy (1998, as amended to date) was explained to and discussed with the government and DGFB. B. Poverty and Social 33. Reforms under the program are expected to assist the government in its poverty reduction agenda through three channels. First, the recent boost in regional government public spending from larger fiscal transfers has contributed to economic growth in local economies and poverty reduction. ADB staff estimate that the fiscal expansion from 2007 to 2010 could have reduced the number of people living below the poverty line by 0.5%. Second, enhancing the effectiveness and efficiency of delivering basic public services to the poor is believed to have contributed to poverty reduction. Third, decentralization of expenditure assignments combined with the shift in community-based poverty mapping and targeting has improved the effectiveness of the national government’s poverty reduction programs. This is reflected in increased social spending (education and health) across most districts. 34. Noticeable reductions in poverty since 2007 are reported in the resource-rich provinces in Kalimantan, Riau, and other parts of Sumatra. Java and Bali also achieved a substantial reduction in poverty. The fiscal autonomy granted to subnational governments is expected to be exercised more efficiently, initially by those regions with better managerial capacity and with more solid economic bases. Nevertheless, significant poverty exists in large parts of eastern Indonesia and regional income disparities have been persistent. Many of the poorer provinces have seen only modest reduction in poverty since 2002. The poorer provinces also tend to spend less on social sectors than more advanced regions. Importantly, economic development in east Indonesia (measured by per capita income) lags that of the leading regions of Indonesia (parts of Bali, Java, Kalimantan, and Sumatra). Increased efforts are needed to accelerate development in lagging regions, strengthen pro-poor elements of regional budgets, and improve public financial systems and governance. 35. This program is classified as effective gender mainstreaming. The program supports effective implementation of gender-responsive budgeting at all tiers of government. Gender budget statements are now being included in annual budget statements. C. Safeguards 36. The program will have (i) no adverse environmental impacts, (ii) no involuntary resettlement impacts, and (iii) no impact on indigenous peoples. It is classified as category C for involuntary resettlement, indigenous peoples, and the environment. The program is a general intervention aimed at supporting sustainable economic growth. In that respect, it is expected to have an indirect positive effect on poverty reduction. D. Risks and Mitigating Measures 37. The program design will mitigate all risks by providing a strong broad-based governance framework, with transparency and accountability elements for central and regional governments. The program has three potential risks (Table 1).

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Table 1: Summary of Risks and Mitigating Measures

Risks Mitigating Measures

Weak regional government leadership and capacity

This risk will be mitigated with improvements to (i) bottom–up accountability through more efficient public financial management, (ii) improved vertical organization structures and hierarchical responsibilities, (iii) accountability of regional governments to oversight and coordination agencies and to the public, (iv) accountability through the electoral process, and (v) the regional civil service.

Horizontal imbalances between regions

Improved analysis and transparency in intergovernmental financial flows will increase accountability and create a larger constituency in favor of further equalization.

Inefficient national policy coordination

This risk has been mitigated by the participation of key stakeholders in formulating the NAPFD and GSFD, the leadership role played by DGFB in policy coordination, and the participation of regional governments in annual national development planning meetings.

DGFB = Directorate General of Fiscal Balance, GSFD = Grand Strategy for Fiscal Decentralization, NAPFD = National Action Plan for Fiscal Decentralization. Source: Asian Development Bank.

IV. ASSURANCES 38. The government and DGFB have assured ADB that implementation of the program will conform to all applicable ADB policies including those concerning anticorruption measures, safeguards, gender, procurement, consulting services, and disbursement. In addition to the standard assurances, the government has given the following assurances, which will be incorporated in the loan agreement:

(i) The government will ensure that the local government finance and governance reform steering committee previously constituted under the Local Government Finance and Governance Reform Program, subprogram 1 will meet semiannually and if needed, on ad hoc basis, to (a) monitor progress of the program cluster, in particular, the PPPF; and (b) provide guidance and direction to DGFB, the implementing agencies, and the relevant line ministries for PPPF implementation and future finance- and governance-related reforms. The local government finance and governance reform steering committee may invite ADB to participate in its meetings as an observer.

(ii) The government will ensure that a gender-responsive regional government budgeting system is adopted and implemented in a timely manner, and that adequate resources are allocated for this purpose.

V. RECOMMENDATION

39. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Asian Development Bank (ADB) and recommend that the Board approve the loan of $200,000,000 to the Republic of Indonesia for subprogram 2 of the Second Local Government Finance and Governance Reform Program from ADB’s ordinary capital resources with interest to be determined in accordance with ADB’s London interbank offered rate (LIBOR)-based lending facility; a term of 15 years, including a grace period of 3 years; and such other terms and conditions as are substantially in accordance with those set forth in the draft program loan agreement presented to the Board.

Haruhiko Kuroda President

8 September 2011

Appendix 1 11

DESIGN AND MONITORING FRAMEWORK

Design Summary

Performance Targets and/or Indicators with

Baselines Update on Status of

Performance Targets

Data Sources and/or Reporting

Mechanisms Assumptions and

Risks

Impact

More efficient, effective, and equitable regional government spending

Over 60.0% citizen satisfaction with health and education services (versus 58.1% satisfaction rating for health and 50.3% for education in 2007) Less than 15.0% of the total population is poor (from 16.6% in 2007) 1 million more households gain access to piped water connection yearly, from a baseline of 9,449,505 in 2005

No new available data from GDS since 2007 Percentage of poor is 13.33% in 2010 Total number of households served by water supply establishments in 2010: 10,370,451

GDS BPS BPS

Assumptions

Stronger bottom–up accountability with improved public financial management and reporting transparency Stronger vertical organization structures and hierarchical responsibilities Increased accountability through the electoral process Risk

Insufficient leadership and ownership in regional governments to translate institutional capacity improvements into better services and reduced poverty

Outcome

Improved organizational capacity of regional governments so that they operate in a more transparent, effective, and efficient policy and legal environment for fiscal decentralization, financial management, and service delivery

Increase in total DAK to 0.80% of GDP by 2011 from a baseline of 0.46% in 2008, at the expense of incorrectly deconcentrated funds Decrease in regional government reserves in local bank accounts to 2.5% of GDP or less by December 2010 from a baseline of 3.1% in November 2006 Gradual increase in shares of regional government sector spending for health (7.0% of total regional budget in 2004), agriculture (4.0%), infrastructure (17.0%), and environment and special planning (1.0%), at the expense of government administration spending (32.0%)

The DAK in 2011: 0.40% of GDP. Adjustment fund allocations to RG increased from 0.10% of GDP (2008) to 0.70% of GDP (2011) Reserves to regional GDP ratio went down from 16.6% in 2008 to 13.2% in 2009. Local revenues from own sources = 17.9% of expenditures (up from 15.0% in 2008) In 2010: health (8.8%), agriculture (2.0%), infrastructure (17.0%), and environment and special planning (2.0%). The share for government administration spending is 35.0% due to increased number of local governments.

MOF reports MOF and Bank of Indonesia reports MOF database

Assumption

Growing political and bureaucratic momentum of reforms with emergence of reform champions; policies are, therefore, not expected to be completely reversed, but flexibility for changes must be maintained at the margin. Risk

Diminished support for reforms from new governments

12 Appendix 1

Design Summary



Performance Targets



Risks

Outputs

1. Strengthened management and coordination of fiscal decentralization matters 2. Clarified arrangements for regional administration to improve services and accountability 3. Enhanced equalization, predictability, and transparency in release of fiscal transfers and shared revenue 4. Reduced dependency on fiscal transfers by developing more buoyant sources of local revenue

Issuance of the NAPFD 2010–2014 in 2011 Regular meetings of the DPOD board and technical team Female representation in the drafting committee for major policy documents Framework for addressing lack of clarity in expenditure assignments finalized with implementation started Norms and standards for service delivery incorporate domestic violence issues involving women and children Strengthened oversight and coordinating role of provincial governors Progressive delinking of wage allocations from the DAU Latest formulas and weights used in determining fiscal capacity and needs published Forward estimates prepared for all major transfers and shared revenues 50% reduction in incorrectly deconcentrated expenditure in education by 2011 Devolution of property tax and land transfer tax Revenue collection increases by 10% by 2015

Final draft approved by BAPPENAS; the GDFD approved by DGFB Conducted regularly with advice issued to senior management Progress in incorporating gender perspective in planning and budget processes Framework complete with implementation started in all components. Close to 40 NSPKs and 13 minimum standard services produced by different line ministries Draft amendments to Law 32 and other government regulations clarify the role of governor The legal base for reform, and a de facto limitation on DAU wage share developed Publication of national formulas and weights in 2011 Preparation as percentage of GDP and in nominal terms Accomplished with the reassignment of School Operational Assistance Program funding in education New Law 28 on Local Own Revenues passed and property tax devolution ongoing

BAPPENAS, MOF DPOD minutes of meetings RPJMN 2010–2014; Law 32, the GDFD and NAPFD Draft amendments to Law 32, NSPKs and minimum service standards 40 NSPKs and 13 minimum standard services Draft amendments to Law 32 and Joint Decree MOF, MOHA, and BAPPENAS Note on national budget and RPJMN 2010–2014 Supplementary budget notes 2011 Budget documents, MOF reports MOF reports Law 28 and MOF’s Implementation plans

Assumptions

Leadership provided by new DGFB in MOF Additional capacity-building support for DPOD The NAPFD revised with participation of all key stakeholders Momentum for reform of several provisions of the DAU continues as analysis and transparency improves Devolution of land and building tax proceeds after enactment of the new law of regional taxes and charges Gradual medium-term approach to devolution approved and implemented Risks

Persistent problems of coordination between key national agencies despite improvements, delaying program implementation More equitable distribution of transfers and shared revenues delayed by political and other pressures, to the benefit of better-off regions Further devolution of taxing powers stalled by political and

Appendix 1 13

Design Summary



Performance Targets



Risks

5. Strengthened management of regional reserves and debt 6. Improved capacity development for gender mainstreaming and gender budgeting, public financial management, and accountability

58% of PDAM debts restructured, 68 plans approved Develop gender-responsive budgeting processes at various levels of administration RGPMS performance data generated in 40 pilot districts by 2011 25% of yearly growth in allocations for human resources and systems development in regional governments

Over 100 PDAMs at different stages of restructuring MOF Decree 2010 instructing gender responsive budgeting RGPMS implemented and fully functioning Annual average growth of 25% by MOF and MOHA

MOF reports MOF guidelines on implementing gender responsive budgeting MOHA reports MOF and MOHA budget reports

bureaucratic opposition in central government

Activities with Milestones Inputs

1.1 Ensure continued implementation of medium- and long-term decentralization agenda. 1.2 Streamline and strengthen coordination functions of relevant central government agencies. 2.1 Improve policy and legal framework to rationalize number of regional governments. 2.2 Clarify the intermediate roles of provinces and governors. 2.3 Clarify expenditure assignments and service responsibilities across levels of government. 3.1 Improve the equalizing power and transparency in distribution of the DAU. 3.2 Make provision for forward estimates of major transfers. 3.3 Continue to identify and reduce incorrectly deconcentrated expenditures. 3.4 Review design and management of the DAK. 3.5 Test performance- and sanction-based elements for transfers. 3.6 Ensure smooth cash releases of shared revenue transfers. 4.1 Approve new Law 28/2010 on regional taxes and charges. 4.2 Develop a medium-term road map for decentralized tax reform. 4.3 Gradually devolve the property tax to the regions. 5.1 Improve monitoring and analysis of reserve accumulation in all locations and develop policy responses. 5.2 Develop improved data systems for monitoring subnational debt. 5.3 Pursue effective restructuring of PDAM debt. 5.4 Finalize and implement MOF decree on the use of dana bagi hasil (revenue sharing) and/or DAU

intercept mechanism to repay debts. 5.5 Support development of the subnational bond market in selected pilot locations. 6.1 Continue efforts to compare and publish benchmarked performance in service delivery (and other areas)

between regions. 6.2 Develop gender-responsive budgeting processes at various levels of administration. 6.3 Improve funding and coordination of central and development partner efforts to develop and roll out

resources to support human and system capacity building in the regions. 6.4 Improve coordination in collection and analysis of regional financial data. 6.5 Develop coordinated approach to performance monitoring and evaluation.

ADB $350 million equivalent for subprogram 1 $2.5 million in technical assistance (Local Government Finance and Governance Reform and Support for Local Government Finance and Governance Reform 2) to support implementation of reform measures in subprogram 2 ADB $200 equivalent for subprogram 2

ADB = Asian Development Bank; BAPPENAS = Badan Perencanaan Pembangunan Nasional (National Development Planning Agency); BPS = Badan Pusat Statistik (Central Bureau of Statistics); DAK = Dana Alokasi Khusus (Specific Allocation Fund); DAU = Dana Alokasi Umum (General Allocation Fund); Dekon = Dana Dekonsentrasi (Deconcentrated Fund); DGFB = Directorate General of Fiscal Balance in MOF; GDFD = Grand Design for Fiscal Decentralization; GDP = gross domestic product, GDS = governance and decentralization survey, DPOD = dewan pertimbangan otonomi daerah (regional autonomy advisory council); MOHA = Ministry of Home Affairs; MOF = Ministry of Finance; NAPFD = National Action Plan for Fiscal Decentralization; NSPK = norms, standards, procedures, and criteria; PDAM = Perusahaan Daerah Air Minum (regionally owned water supply company); RGPMS = regional government performance measurement system; RPJMN = Rencana Pembangunan Jangka Menengah Nasional (National Medium-Term Development Plan); TA = technical assistance. Source: Asian Development Bank.

14 Appendix 2

LIST OF LINKED DOCUMENTS http://www.adb.org/Documents/RRPs/?id=42208-013-3

1. Loan Agreement

2. Sector Assessment (Summary): Public Sector Management

3. Contribution to the ADB Results Framework

4. Development Coordination

5. Country Economic Indicators

6. International Monetary Fund Assessment Letter (to follow)

7. Summary Poverty Reduction and Social Strategy

8. Risk Assessment and Risk Management Plan

9. List of Ineligible Items

Supplementary Documents

10. Macroeconomic Assessment and Debt Sustainability Assessment

11. Summary Program and Poverty Impact Assessment

12. Performance of LGFGR II Subprogram 2 Triggers

http://www.adb.org/Documents/RRPs/?id=42208-013-3

Appendix 3 15

DEVELOPMENT POLICY LETTER

16 Appendix 3

Appendix 3 17

18 Appendix 4

POLICY MATRIX

No. Policy Accomplishments under Sub-Program 2

2009-2011 (as of August 2011) Triggers are in Bold

Post-Program Partnership Framework

1. Decentralization Framework and Program Management: Strengthening management and coordination of fiscal decentralization matters.

1.1 Ensure continued implementation of medium and long-term decentralization agenda.

The Government of Indonesia (GoI) has enriched and updated the policy framework guiding decentralization reforms through a number of activities: a. Revised version of National Action Plan for Fiscal Decentralization (NAPFD), covering the medium term 2010–2014, is finalized. (RM) b. Draft Grand Design for Fiscal Decentralization (GDFD), setting out long-term directions for fiscal decentralization finalized and submitted to Minister for Finance. (RT) (Accomplished)

c. Presidential Instruction No.5/2011 (RPJMN 2010-14) mainstreams gender issues in medium term development priorities. (NM) d. Women representation on the drafting teams for the GDFD, NAPFD and amendments of Law 32. (NM)

Regular assessments of implementation of NAPFD conducted. (Bappenas, MOF and MOHA) Further development of regular consultation mechanisms with RGs and CSOs in order to assess policy formulation and reform and enrich inter-institutional dialogue. (Bappenas, MOF and MOHA) GDFD to provide guiding principles for the amendment of Law 33 on Fiscal Balance.

1.2 Streamline and Strengthen

coordination functions of relevant national government agencies.

The GoI has continued to evaluate the institutional framework for policy coordination on decentralization reforms, strengthening key advisory and executive agencies. The following activities were accomplished under Subprogram 2: a. Directorate General of Fiscal Balance (DG FB), MOF, continues program leadership, including: (1) regular consultations with all stakeholders; and (2) transparent circulation of fiscal decentralization information, on a regular basis, including annual reports on fiscal decentralization reforms. (RT) (Accomplished)

b. DPOD stakeholders regularly discussed and provided advice on fiscal decentralization reforms. (RM)

Regular review of the institutional framework for coordination of inter-governmental fiscal relations and proposals for reform. (MOF)

2. Regional Autonomy and Local Governance: Clarifying arrangements for regional administration to improve services and accountability.

2.1 Improve policy and legal framework to rationalize number of regional governments to increase efficiency while still providing for local representation.

The GoI undertook a series of activities to rationalize the process for new local government formation. The following activities were accomplished under Subprogram 2: a. Uncontrolled proliferation of new local governments stopped. (RT) (Accomplished)

b. Efficient criteria for new local government formation included in the draft amendments of Law 32. (NM) c. Grand Strategy on Regional Autonomy (Penataan Daerah) approved including administrative guidelines for processing and evaluation of applications for new local government formation. (NM)

Continued development of the legal, policy and administrative framework for local government formation for efficient evaluation of new applications. (MOHA)

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2.2 Increase clarity in the intermediate roles of provinces and governors.

The GoI carried out activities to clarify the role of intermediate levels of governments in service delivery. The activities accomplished during Subprogram 2 included: a. Strengthened oversight and coordination role of Provincial Governors in the framework of intergovernmental fiscal relations. (NT) (Accomplished)

b. Joint Circular Letter issued by MOF, MOHA and BAPPENAS on the roles and responsibilities of Provincial Governors. (NM) c. Draft amendments to Law 32/2004 include changes in the desired role of Provincial Governors. (NM)

Continue to define and strengthen the capacity of Provincial Governors to perform their coordination and oversight role. (Bappenas, MOHA and MOF)

2.3 Reform decentralized civil service arrangements to enhance flexibility and to shift resources to more productive activities.

a. MOF implemented systems of performance incentives aimed at improving efficiency in public financial management. (RM)

2.4 Improve clarity of expenditure assignments and service responsibilities across levels of government to

improve efficiency and equity of expenditures.

The GoI undertook a series of activities aimed at clarifying the roles and responsibilities for service delivery of all tiers of administration. The activities accomplished in Subprogram 2 are: a. Framework for addressing lack of clarity and excessive overlapping in expenditure assignments across tiers of government finalized with implementation started. (RT) (Accomplished)

b. Draft amendments to Law 32/2004 include revisions in expenditure responsibilities across tiers of government. (NM) c. Norms, Standards, Procedures and Criteria (NSPKs) developed for basic service delivery. (NM) d. 13 Ministries prepared minimum service standards (SPMs) for delivery of basic services, including the integration of issues on domestic violence against women and children. (NM)

Continue to review the legal and policy framework for functional assignments (including review of Government Regulation 38/2007 and continued progress on NSPKs and SPMs formulation). (MOHA)

3. Inter-governmental fiscal system: Enhancing equalization, predictability and transparency in release of fiscal transfers and shared revenues.

3.1 Improve equalization and transparency of the DAU, which is the major transfer mechanism used

The GoI has carried out a series of actions geared towards increasing transparency in the allocation of grants, and towards improving the discretionary capacity of RG in their use. The accomplishments during Subprogram 2 include: a. Presidential Decree No.5/2010 on the Medium

Improve the equalization power of the system of inter-governmental fiscal grants, removing adjustments that make allocations discretionary, improving overall effectiveness of public expenditure, and increasing its transparency and predictability for

20 Appendix 4




in the Indonesian system of inter-governmental financing.

Term Development Plan 2010-2014 instructs the Government to provide for greater flexibility in the DAU by de-linking the wage payments from the DAU. (NT) (Accomplished)

b. The GoI has pegged the amount devoted to wage payments from DAU to below 50%. (NM) c. Improved transparency in the DAU by publishing the latest national formula and weights used for the distribution of the DAU to provinces in the annual supplementary budget documents. (NT) (Accomplished)

d. Regular review of DAU formula made part of long-term capacity building of DG FB, MOF in the context of budget discussions with the National Assembly. (RM)

RGs over the medium term. (MOF)

3.2 Make provision for forward estimates of major transfers to enhance capacity for medium-term planning and budgeting.

The GoI has taken steps towards the implementation of a Medium Term Expenditure Framework that assists medium term planning at the subnational level. Progress during this sub-program included: a. Forward estimates progressively prepared and incorporated into the national budget formulation process for all major transfers and shared revenues. (RT) (Accomplished)

Continue to improve available annual budgetary information at the regional government level that allows for effective Medium Term Development Plan 2010-2015 implementation. (MOF)

3.3 Gradually reduce levels of central government funding in relation to activities that are legally regional government responsibilities to provide space for higher priorities.

The GoI continues to improve efficiency of budgetary allocations, aligning them with fiscal decentralization principles. Achievements under this subprogram included: a. At least 50% reduction in incorrect Dekon expenditure identified in the Ministry of Education. (RT) (Accomplished)

b. Ongoing identification of incorrect Dekon expenditure in other ministries. (RM)

3.4 Improve design and management of DAK funding, allowing improved targeting of investment expenditure to priority sectors in the regions.

a. Review of systems and procedures and management of DAK transfers prepared and disseminated to inform DAK reform. (NM). b. Implementation of a Minister Finance Decree (PMK 21/2008) on the disbursement of DAK with a view towards facilitating absorption of funds by RGs and aligning disbursements with expenditure needs. (NM)

Improvements to sectoral and RG targeting of DAK over the medium term and consider options to strengthen performance evaluation and financial and physical audit mechanisms. (MOF)

3.5Test performance and sanctions-based elements of transfers.

The GoI has achieved important progress in the definition and implementation of performance related mechanisms for fiscal transfers. Steps taken under this subprogram include: a. Agreed new incentives and sanctions implemented on a trial basis. (OM)

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b. Sanctions relating to timely submission of budgets and SIKD information from RGs are implemented. Regulation on debt intercept issued. (RM)

3.6 Ensure smooth cash releases of shared revenue transfers to address delays and unevenness in regional government budgeting.

a. Shared revenue funds flow to all regional governments in a timely and predictable manner. (NM)

4. Own Source Revenues: Reducing dependency on fiscal transfers by developing more buoyant sources of local revenues.

4.1 Amend Law 34/2000 on regional taxes and charges.

The GoI has assigned important own revenue sources to regional governments, improving their collection capacity and fiscal discretionary powers. Major steps in that direction included: a. New Law 28/2009 on Local Own Revenues enacted and disseminated. (NM)

Continued implementation of the decentralization of the Property Transfer Tax and Land and Building Tax to RGs, identifying alternatives for improved implementation that lead to improved revenue collection and efficient and transparent tax administration practices. Review of regulatory framework for user charges with a view towards increasing economic efficiency and revenue collection potential. (MOF)

4.2 Develop a medium term roadmap for decentralized tax reform.

a. Medium term roadmap for decentralized tax reform incorporated into the NAPFD and GDFD. (NM) b. Implementation plan for Property Transfer Tax developed. (NM)

4.3 Gradually devolve the property tax to the regions.

a. Decentralization of Land and Building Tax piloted. (RT) (Accomplished) b. Joint Ministerial Decree 53/2010 dealing with the devolution of the Property Transfer Tax to RGs is approved. (NT) (Accomplished)

5. Regional Reserves and Debts: Strengthening management of regional reserves and debts.

5.1 Improve monitoring and analysis of reserves accumulation in all locations and developed policy responses to recent high growth in reserves.

The GoI has progressed significantly in the implementation of financial systems of debt and reserve management that allow for efficient use of funds by regional governments. Achievements during this subprogram include: a. Improved systems in place for monitoring accumulation of financial reserves. (OM)

Evaluation and development of incentives for the efficient use of idle reserves. (MOF)

5.2 Develop improve data systems for monitoring subnational debt.

a. Comprehensive information on regional government debt is available on the Web and transparently published in line with MOF decree 45/2006. (OM)

22 Appendix 4




b. Fully operational DMFAS providing useful data for comprehensive analysis of regional debt. (OT) (Accomplished)

5.3 Pursue effective restructuring of PDAM debts to improve the climate for new investment in water supply facilities.

The GoI has taken critical steps toward achieving financially healthy regional governments that are unburdened by financial liabilities from local economic enterprises. Achievements include: a. All available debt recovery and write-off mechanisms used to support rescheduling and repayment of PDAM debts. (OM) b.58% of PDAMs non-performing debts restructured/rescheduled and paying on time in relation to newly agreed arrangements; restructuring/rescheduling plans of 68 PDAMs fully approved and 21 more in the process of approval. (RT) (Accomplished)

Further development of the regulatory regime of local economic enterprises with a view towards improving accountable financial management and reducing central government financial risks. (MOF)

5.4 Finalize MOF decree providing for use of DBH and DAU intercept mechanisms to repay debts.

a. MOF decree on intercept mechanism is passed. (RM)

5.5 Support development of subnational bond market including enhanced support in selected pilot locations.

The GoI has strengthened support systems for the use of regional governments’ borrowing powers, allowing for enhanced options for project financing. Achievements include: a. Government Regulation (PP 30/2011) enacted, establishing system for regional bond issuance. (RT) (Accomplished)

b. City Municipality of Jakarta initiates the process of municipal bond issuance.

Efficient implementation of PP54 on local government borrowing. (MOF)

6. Capacity Development for Gender Budgeting and Gender Mainstreaming, Public Financial Management and Accountability: Developing human and systems capacities and strengthening public financial management.

6.1 Enhance involvement at presidential level to improve funding and coordination of central and donor efforts to develop and roll out resources to support greatly needed human and systems capacity building in the regions.

The GoI has taken steps towards the improved coordination of capacity building initiatives in PFM. Progress under the subprogram includes: a. Presidential Decree No. 5 (RPJMN 2010-14) requiring synchronization of public financial management capacity in the regional governments. (RM) b. Memorandum of Understanding signed between the Ministry of Women’s Affairs and various provincial governments to advance women empowerment and protection of children. (NM)

Assistance to the implementation of gender responsive budgeting processes at the sub-national level of government, including capacity building of local officials.(MOF)

6.2 Develop gender responsive budgeting

The GoI has made substantial progress towards the mainstreaming of gender aspects in policy formulation and towards the implementation of gender responsive

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processes at various levels of administration.

budgeting systems: a. MOF issues decree instructing line Ministries to implement Gender Responsive Budgeting. (NT) (Accomplished)

b. Gender budget statement included in the annual budget documents. (NM) c. Draft manual prepared offering guidance to RGs on the implementation of gender responsive budgeting. (NM)

6.3 Develop comprehensive plan to support implementation of the newly formed PFM regulatory regime in regional government.

The GoI has continued to invest on capacity building and system development at both the central and subnational levels. Progress under this subprogram includes: a. The Government is committed to annual growth of at least 25% in funding over the next 3 years through MOHA and MOF (compared with actual 2008 levels) to support training for human resources and systems development in regional governments, including central training materials preparation. (OT) (Accomplished)

b. Regional training on SIPKD prepared and implementation started, with access to training and capacity development initiatives for regional governments. (RM) c. Computerized FMIS fully implemented in 53 RGs; partially implemented in 41; and initiated in 25 RGs, with software available free for expansion to all RGs. (RM) d. Training of 5,657 officials in FMIS usage completed. (RM)

Sustained capacity development program efforts through active usage of LKD/KKD (MOF).

6.4 Improve systems and coordination in collection and analysis of regional financial data.

The GoI has improved coordination in the collection of financial information from subnational administrations. Achievements include: a. PMK issued requiring local governments to submit electronic data followed by a circular letter from the DG FB, MOF, outlining a mechanism for electronic data submission through National Data Management and Communication System for SIKD (Komandan SIKD). (NM) b. Easy access to National Data Management and Communication System for SIKD (Komandan SIKD) for RGs established in DG FB’s website. (NM) c. Time delays in publishing consolidated RG information progressively reduced from about 3 years to a year. (OT) (Accomplished)

24 Appendix 4




6.5 Continue efforts to compare and publish benchmarked performance in service delivery (and other areas) between regions.

The GoI continues to develop and implement wide ranging, gender sensitive performance monitoring mechanisms for regional governments to assess efficiency of service delivery and overall governance and financial management standards. a. RGPMS developed with centralized database fully functioning in 40RGs. (OT) (Accomplished)

b. Regional performance benchmark analysis conducted and results published and widely circulated. (RM) c. RGPMS includes gender indicators on female representation in local authorities and targets for capacity building. (NM)

BAPPENAS = Badan Perencanaan Pembangunan Nasional (National Development Planning Agency); CSO = Civil Society Organizations; DAK = Dana Alokasi Khusus (Specific Allocation Fund); DAU = Dana Alokasi Umum (General Allocation Fund); Dekon = Dana Dekonsentrasi (Deconcentrated Fund); DG FB = Directorate General of Fiscal Balance in MoF; DMFAS = Debt Management Financial Assessment System; DPOD = Dewan Pertimbangan Otonomi Daerah (Regional Autonomy Advisory Council); FMIS = Financial Management Information System; GDFD = Grand Design for Fiscal Decentralization; Government = Government of Indonesia; LKDD = Lembaga Kebijakan Pengadaan Barang/Jasa Pemerintah (National Public Procurement Office) ; MoHA = Ministry of Home Affairs; MoF = Ministry of Finance; NAPFD = National Action Plan for Fiscal Decentralization; NM = New Milestone; NSPK = Norma, Standard, Prosedur, dan Kriteria (Norms, Standards, Procedures and Criteria); NT = New Trigger; OM = Original Milestone; OT = Original Trigger; PDAM = Perusahaan Daerah Air Minum (Regional-owned Water Supply Company); PFM = public financial management; PMK = Peraturan Menteri Keuangan (Minister of Finance Decree); PP = Peraturan Pemerintah (Government Regulation); RG = Regional Government; RGPMS = Regional Government Performance Measurement System; RM = Revised Milestone; RPJMN = Rencana Pembangunan Jangka Menengah Nasional (National Medium-Term Development Plan); RT = Revised Trigger; SIKD = Sistem Informasi Keuangan Daerah (Regional Financial Information System); SIPKD = Sistem Informasi Pengelolaan Keuangan Daerah (Regional Financial Management Information System) ; SPM = Standard Prosedur Mininum (Minimum Standard Service); UKP4 = Unit Kerja Presiden Bidang Pengawasan dan Pengendalian Pembangunan (The Presidential Working Unit for Supervision and Management of Development).