The World Bank FOR OFFICIAL USE ONLY...2010/05/06 · Document of The World Bank FOR OFFICIAL USE ONLY Report No: 53613-ID PROJECT APPRAISAL DOCUMENT ON A PROPOSED LOAN IN THE AMOUNT

Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No: 53613-ID

PROJECT APPRAISAL DOCUMENT

ON A

PROPOSED LOAN

IN THE AMOUNT OF US$ 220 MILLION

TO THE

REPUBLIC OF INDONESIA

FOR A

LOCAL GOVERNMENT AND DECENTRALIZATION PROJECT

April 23, 2010

Indonesia Sustainable Development Unit East Asia and Pacific Region

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

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CURRENCY EQUIVALENTS (Exchange Rate Effective April 23, 2010)

Currency Unit = Indonesian Rupiah (IDR) IDR 9,014 = US$1

US$ 1 = SDR 0.66

FISCAL YEAR January 1 – December 31

ABBREVIATIONS AND ACRONYMS

AMDAL AP APBD APBN Bappenas BPK BPKP

Environmental Impact Assessment Advance Payment Local Budget National / State Budget National Planning Agency State Audit Board State Finance and Development Supervisory Board

CPS COSU DAK

Country Partnership Strategy Central Operational Services Unit Specific Purpose Grants

DAU DBH DG DGFB DIPA DP DPR EIRR EMF EMP FMS FS FY GAC GFMRAP GoI GPOBA IBRD IDA IFR IFSA ILGRP IP IVP KDP Keppres

General Purpose Grants Revenue Sharing Directorate General Directorate General of Fiscal Balance Government Annual Budget Document Adjustment Fund Parliament Economic Internal Rate of Return Environmental Management Framework Environmental Management Plan Financial Management Specialist Fully Satisfactory Fiscal Year Government Anti-Corruption Plan Government Financial Management Reform Administration Project Government of Indonesia Global Partnership Output Based Aid International Bank for Reconstruction and Development International Development Association Interim Financial Report Integrated Fiduciary and Safeguards Assessment Initiatives for Local Governance Reform Project Indigenous People Isolated and Vulnerable People Kecamatan Development Program Presidential Decree

LG Local Government, comprising Provinces, Kabupaten and Kota MIS M&E MoF MoHA MPW NFI NPV OBA OBD OM OPCS

Management Information System Monitoring and Evaluation Ministry of Finance Ministry of Home Affairs Ministry if Public Works Net Fiscal Index Net Present Value Output Based Aid Output Based Disbursement Operations Manual Operations Policy & Country Services

OVR PDO PER

Output Verification Report Project Development Objective Public Expenditure Review

PFM PIU QP RD REOI RFP RKP RMR ROC SADC Satker SEB SIL SMERU SOP TA ToR ULP USDRP VFR VO VPR VQR VTR WBRS WBTMS WISMP

Public Financial Management Project Implementing Unit Qualifying Percentage Definitive Plan Request Expression of Interest Request for Proposal Government Work Plan Regional Management Review Regional Operation Committee Southern African Development Community Working unit Joint Circular Letter Specific Investment Loan Institution for Research and Public Policy Studies Standard Operating Procedure Technical Assistant Terms of Reference Procurement Service Unit Urban Sector Development Reform Project Value of Final Reimbursement Verification of Outputs Value of Potential Reimbursement Value of Qualifying Reimbursement Value of Total Reimbursement Web-Based Reporting System Web-Based Transfer Monitoring System Water Resources and Irrigation Sector Management Program

Vice President: James W. Adams

Country Director: Joachim von Amsberg Sector Director: John A. Roome Sector Manager: Sonia Hammam

Task Team Leader: Peter D. Ellis

INDONESIA

Local Government and Decentralization Project

CONTENTS

Page

I. STRATEGIC CONTEXT AND RATIONALE ................................................................. 1

A. Country and sector issues.................................................................................................... 1

B. Rationale for Bank Involvement ......................................................................................... 3

C. Higher level objectives to which the project contributes .................................................... 4

II. PROJECT DESCRIPTION ................................................................................................. 4

A. Lending Instrument ............................................................................................................. 4

B. Project Development Objective and Key Indicators ........................................................... 5

C. Project Components ............................................................................................................ 5

D. Lessons Learned and Reflected in the Project Design ........................................................ 9

E. Alternatives Considered and Reasons for Rejection ......................................................... 12

III. IMPLEMENTATION .................................................................................................... 13

A. Partnership Arrangements ................................................................................................. 13

B. Institutional and Implementation Arrangements .............................................................. 13

C. Monitoring and Evaluation of Results .............................................................................. 14

D. Sustainability..................................................................................................................... 14

E. Critical risks and possible controversial aspects ............................................................... 15

F. Loan/Credit Conditions and Covenants ............................................................................ 17

IV. APPRAISAL SUMMARY ............................................................................................. 17

A. Economic and Financial Analysis ..................................................................................... 17

B. Technical ........................................................................................................................... 18

C. Fiduciary ........................................................................................................................... 18

D. Social................................................................................................................................. 20

E. Environment ...................................................................................................................... 21

F. Safeguard policies ............................................................................................................. 22

G. Policy Exceptions and Readiness...................................................................................... 23

Annex 1: Country and Sector or Program Background ......................................................... 24

Annex 2: Major Related Projects Financed by the Bank and/or other Agencies ................. 31

Annex 3: Results Framework and Monitoring ........................................................................ 33

Annex 4: Detailed Project Description ...................................................................................... 35

Annex 5: Project Costs ............................................................................................................... 45

Annex 6: Implementation Arrangements ................................................................................. 46

Annex 7: Financial Management and Disbursement Arrangements ..................................... 49

Annex 8: Procurement Arrangements ...................................................................................... 62

Annex 8.1: Anti-Corruption Action Plan.................................................................................. 67

Annex 9: Economic and Financial Analysis ............................................................................. 69

Annex 10: Approaches in Environmental and Social Safeguards .......................................... 74

Annex 11: Project Preparation and Supervision ..................................................................... 83

Annex 12: Documents in the Project File ................................................................................. 85

Annex 13: Statement of Loans and Credits .............................................................................. 86

Annex 14: Country at a Glance ................................................................................................. 89

Annex 15: Maps IBRD 37778 ..................................................................................................... 91

PROJECT APPRAISAL DOCUMENT DATA SHEET

Date: April 23, 2010 Country Director: Joachim von Amsberg Sector Manager / Director: Sonia Hammam / John A. Roome Project ID: P111577 Lending Instrument: Specific Investment Loan

Team Leader: Peter D. Ellis Sectors: Sub-National Government (100%) Themes: Municipal Governance (67%), Decentralization (33%) Environmental Screening Category: B

Project Financing Data [ X ] Loan [ ] Credit [ ] Grant [ ] Guarantee [ ] Other: For Loans/Credits/Others: Total Bank Financing (US$m): 220

Proposed Terms (IBRD): US$ Variable Spread Loan, Grace period (years): 9, Years to maturity: 24.5

Financing Plan (US$m) Source Local Foreign Total

Borrower 500 0 500 International Bank for Reconstruction and Development

220 0 220

Total: 720 0 720 Borrower: Republic of Indonesia Responsible Agency: Ministry of Finance Address: Jl. Lapangan Banteng 2-4, Jakarta 10710, Indonesia Tel: (021) 384-1067, 381-4324 Fax : (021) 380-8395 Estimated Disbursements ( Bank FY/US$m): FY 2011 2012 2013 2014 Annual 15 60 70 75 Cumulative 15 75 145 220 Project implementation period: 4 years Expected effectiveness date: July 1, 2010 Expected closing date: June 30, 2014 Does the project depart from the CAS in content or other significant (Ref. PAD A.3)

No

Does the project require any exception from Bank policies ( Ref. PAD D.7) No Does the project include any critical risk rated “substantial” or “high” (Ref. PAD C.5)

No

Does the project meet the Regional criteria for readiness for implementation (Ref. PAD D.7)

Yes

Project Development Objective (Ref. PAD B.2, Technical Annex 3) The objective of the project is to improve the accountability and reporting of the central government’s Specific Purpose Grants (DAK) for the infrastructure sub-sectors within pilot local governments (LGs). This will be done through improved financial and technical reporting, and verification of outputs delivered by LGs with the DAK grants.

Project Description (PAD B.3.a, Technical Annex 4) The project will be designed using a reimbursement mechanism against physical outputs verified, with a focus on reimbursing a slice of the existing DAK for infrastructure (roads, water, sanitation, and irrigation), based on the delivery of physical outputs at the LG level. Safeguard policies triggered by the project (Ref. PAD D.6, Technical Annex 10). The project triggers Environmental Assessment (OP/BP 4.01), Involuntary Resettlement (OP/BP 4.12) and Indigenous Peoples (OP/BP 4.10). The project is classified as category B. Significant nonstandard conditions, if any (Ref. PAD C.7) Board Presentation - None Loan/Credit Effectiveness - The Additional Conditions of Effectiveness consist of the following: (i) the Ministry of Finance (MoF) shall have adopted the Operations Manual, in form and substance satisfactory to the Borrower and the Bank, and the Project Implementation Unit (PIU) has been established in a manner satisfactory to the Borrowerand the Bank; (ii) the Ministry of Public Works (MPW) shall have issued a Circular requiring the use of the Supplemental Technical Guidelines (Environmental and Social Safeguards) acceptable to the Borrower and the Bank to all Pilot Local Governments; and (iii) Verification of Outputs (VO) Terms of Reference have been agreed between the MoFand Indonesia’s State Finance and Development Supervisory Board (BPKP), and between the Bank and BPKP, and BPKP and the Bank shall have entered into a Verification Arrangement. Covenants applicable to project implementation — In addition to standard covenants applicable to output based disbursement projects, the following covenants are applicable. The MoF shall make available funds in an amount equivalent to not less than $8,500,000 for the carrying out of the activities under Component 2 of the Project and BPKP shall make available funds required for capacity building under Component 3 of the Project as set out in the Verification of Outputs Terms of Reference. In each year of Project implementation, the PIU (with respect to MoF, MPW and LGs) and the BPKP shall submit by October 31 and thereafter carry out a Work Plan satisfactory to the Bank, with respect to Component 2 and Component 3 of the Project, respectively. No withdrawal may be made from the Loan for any Outputs produced prior to January 1, 2011. In addition, the MoF shall not submit any application for withdrawal for any year of Project implementation unless: (i) the Bank has received a Verification Report on the fiscal year acceptable to the MoF and the Bank by April 30 of the subsequent year in accordance with the VO Terms of Reference; (ii) the MoF has made the technical assistance funds available for the Project in that year; and (iii) the BPKP remains as the VO for that Fiscal Year, the VO Terms of Reference remain in effect between BPKP and MoF, and between BPKP and the Bank, and BPKP has in place the required staffing and experts.

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I. STRATEGIC CONTEXT AND RATIONALE

A. Country and sector issues

1. Fiscal decentralization. With the “big bang” decentralization of 2001, Indonesia went from being one of the most centralized countries in the world in administrative, fiscal and political terms, to one of the most decentralized. Under Law 32/2004 (on Regional Autonomy) and Law 33/2004 (on Fiscal Balance), local governments (LGs) have assumed new responsibilities that were previously covered by the central government, as well as managing new financial resources that have been transferred from the central government or raised within their own localities. LGs have therefore experienced substantial increases in financial resources, mostly through increased transfers from the central level.

2. Transfers from the central government are currently the main source of LG finance. LGs now manage 38 percent of total public expenditure and carry out more than half of all public investment. However, Public Expenditure Reviews (PER) conducted at the LG level show that they are experiencing difficulty in managing and spending their resources. Some LGs have accumulated significant financial reserves, although reserves were not found to be excessive in general. Given the high investment needs in basic services, greater reserve accumulation can be seen as symptomatic of an inability to spend financial resources effectively. Fiscal decentralization in Indonesia still faces a number of major challenges, such as how to improve and speed up spending, and reduce LG dependency on central government transfers.

3. Capital investment after the onset of regional autonomy. Following the decentralization process of 2001, the responsibility for investment in most services was transferred to LGs. Indonesia’s more than 500 LGs (provincial, kabupaten and kota) are now in charge of delivering education, health and infrastructure services. When capital investment needs are taken into account, LGs have insufficient financial resources to meet their investment needs for basic services, which far exceed their revenues and surpluses.

4. LGs lack significant own-source revenue, which accounts for only about 15 percent on average of total revenues. This causes great reliance on central government transfers for capital expenditure purposes. In order to increase investments over time, LGs will need to have access to larger financial flows and the central government will need to strengthen its transfer mechanisms, especially its grants for investments. In terms of management of expenditure assignments, LGs have great autonomy, so strengthening the intergovernmental capital grant transfer system will not weaken decentralization, but will strengthen LGs’ ability to deliver services.

5. Intergovernmental transfers in Indonesia. The bulk of the intergovernmental transfers to LGs are constituted by the General Purpose Grants (Dana Alokasi Umum, DAU) and the Specific Purpose Grants (Dana Alokasi Khusus, DAK). In 2010, the DAU share of total intergovernmental transfers was 63 percent, while the share of DAK was around 7 percent. DAU is mainly used to fund salaries and other administrative costs. DAK funds investment expenditures that are also considered a national government priority. The total DAK allocation for 2010 is about US$2.3 billion.

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6. The Public Expenditure Review (2008) reported that public expenditure for infrastructure has been relatively under-funded compared with other sectors, such as education and health. The central government has tried to compensate by allocating significant amounts of its DAK transfers to infrastructure. There are currently 14 sectors eligible for DAK funds, including four infrastructure sectors of roads, irrigation, water supply, and sanitation. Total DAK among the four infrastructure sectors amounted to IDR 4.5 billion (US$490 million), representing about one-fifth of the total DAK in 2010. Within infrastructure, the road sector received the largest DAK allocation (62.5 percent), followed by irrigation (21.5 percent), and water supply (8.0 percent) and sanitation (8.0 percent).

7. Specific Purpose Grants (DAK). DAK is a grant from the national budget allocated to LGs with the purpose of financing specified activities that are aligned to national priorities and conducted under the jurisdiction of LGs. The amount of DAK allocation is determined on an annual basis within the national budget. There are three types of criteria that LGs must be satisfied in order to receive DAK, namely: general, specific, and technical criteria. General criteria refer to LGs’ net fiscal capacity. Specific criteria relate to whether LGs receive special autonomy funds or are categorized as disadvantaged areas, etc. Technical criteria assess conditions of the infrastructure, for example, the total road length and condition. These three criteria are used in a formula for determining the DAK allocation by sector and district.

8. The DAK allocation has been growing very rapidly, increasing from IDR 2.2 billion in 2003 to IDR 24.8 billion in 2009, and accounting for 0.7 percent to 2.4 percent of the national budget, respectively. In 2010, however, total DAK declined by 17.4 percent compared with 2009 as a result of global financial turmoil. Eligible recipient LGs are required to provide a 10 percent LG contribution (dana pendamping) for each DAK sector. Exceptions to this rule are allowed where regions have low fiscal capacity. 9. The MoF allocates the DAK to each sector and within the sectors LGs have the flexibility to determine which subprojects they invest in. The Ministry of Public Works (MPW) provides Ministry Decree No. 42/PRT/M/2007 for Technical Guidelines on the Implementation, Monitoring and Evaluation of the DAK for each infrastructure sector. MPW’s Technical Guidelines clearly specify the outputs on which the DAK grants can be spent, and these are mostly limited to maintenance, rehabilitation, and the upgrading or improvement of existing infrastructure. 10. Challenges in DAK implementation. Since the implementation of the fiscal decentralization policy in 2001, policies regarding DAK have been well established, although the monitoring and verification of use of funds, especially with regard to physical outputs, remains a challenge. A recent study undertaken by the National Planning Agency (Bappenas), Options for Improving DAK (2009), assesses DAK management over the past five years. The study reveals that improvements are needed in the financial, technical, institutional and governance areas. With regard to the financial aspect, the main problem is the mismatch between the amounts of DAK funds allocated and local needs. Financial reporting on the DAK from LGs to the Ministry of Finance (MoF) has improved significantly since the MoF started to impose sanctions by withholding future DAK in 1998. On technical issues, LGs formulate DAK investments as part of their annual planning and budgeting

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process. However, the link between longer-term development planning and annual DAK expenditures is still weak. Institutional issues revolve around the lack of coordination between the central and local governments on priorities for the DAK, and the lack of appropriate reporting and monitoring of DAK utilization, particularly on the verification of outputs delivered. These weaknesses in financial, technical, and institutional aspects all combine to impact the overall governance of the DAK in terms of transparency and accountability.

11. Monitoring and evaluation of DAK‐financed activities is still inadequate, according to a study by the SMERU Institute, The Specific Purpose Grants (DAK): Mechanisms and Uses (2008). In a number of ways, the findings of this study corroborate those of the Bappenas study. Focus group discussion participants (comprising local officials and non-governmental organizations) gave a relatively low ranking to the monitoring and evaluation aspect of DAK. One of the problems highlighted by participants was that both central and LGs do not allocate any funds in their budgets for monitoring and evaluation.

B. Rationale for Bank Involvement 12. The Bank’s engagement with LGs to date has focused on providing investments to districts across many provinces, and analytical work largely in the form of PERs in selected provinces. The proposed project would focus the Bank’s engagement on a selected few LGs, and allow the Bank to build strong partnerships, while strengthening LG institutions that deliver key basic services. The project would also strengthen government mechanisms, as it is designed to work with GoI systems for delivering DAK funds and monitoring the use of the delivery of outputs. 13. The MoF requested that the World Bank support LGs in improving their use of DAK, while strengthening GoI’s systems for reporting and monitoring of utilization of DAK. This will provide a concrete means for the Bank to engage in-depth at the LG level on issues related to improving planning, budgeting and investment execution, and the monitoring and verification of results.

14. Currently, the governance systems covering DAK fund utilization are weak. Reporting systems of the financial aspects of the DAK from LGs to the MoF are manual, with every LG submitting a summary of the DAK disbursement to the MoF in hard copy. Financial reporting requirements are complied with by all LGs, since the MoF is able to withhold scheduled DAK transfers should a LG fail to submit the required financial reports. The reporting systems from LGs to the line ministries, such as MPW, in terms of physical outputs resulting from spending the DAK, are also manual, and with minimal technical or physical output information. This means that the line ministries are unable to fully verify that outputs have actually been delivered. 15. In 2009, the MoF developed a Web-Based Transfer Monitoring Systems (WBTMS) for financial reporting, which LGs will start using in 2010. The system will monitor all transfers from the MoF to LGs, comprising revenue sharing (DBH), DAU, DAK, the Special Autonomy Fund (Otsus) and the Adjustment Fund (DP). With respect to DAK, the system will also monitor LG funds contributed to DAK-funded projects (dana pendamping), as well

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as disbursements. This initiative shows that the GoI is beginning to strengthen its governance system related to intergovernmental transfers to LGs, including the DAK. However, there are still no appropriate reporting systems on physical outputs, which ideally should include information on project location, GPS coordinates, technical data, physical progress and visual (picture) of the projects. The MoF, in collaboration with the MPW, intends to develop a web-based system of technical reporting of outputs. Notably, this project will build upon these systems and enhance, where appropriate, reporting methodologies especially related to the tracking of pre-defined outputs.

C. Higher level objectives to which the project contributes 16. The Bank’s current Country Partnership Strategy (CPS) for Indonesia FY 2009-2012 outlines a strategy whereby the Bank will develop a framework of engagement with the GoI in order to “support Indonesia in the implementation of its own programs and (provide) solutions in addressing its development challenges” (CPS, page 10). The two cross-cutting engagements in the CPS are to develop both national and LG institutions and systems. At the LG level, the CPS seeks to “support local governments by promoting well-targeted and sustainable public spending through the co-financing of sub-national expenditure programs” (CPS, page 17). 17. The Bank currently supports both cross-cutting engagements of the CPS by strengthening existing GoI and LG institutions, in order to increase the effectiveness of planning processes and the impact of budget expenditures. The proposed project will focus on improving the utilization of intergovernmental the DAK fund at both the central and local government levels. The project will contribute to the improvement of the current intergovernmental transfer mechanism, and work to strengthen LG systems for reporting and monitoring of DAK grants. The project will also support the development of one of the core engagements of the CPS, namely developing a program with LGs, while also strengthening central government institutions.

18. A key concern of the GoI is improvement of the functioning of the DAK system overall, especially with regard to utilization of funds at the LG level. Associating the DAK with defined outputs, if appropriately documented and verified, could allow the GoI to assess the development impacts of DAK expenditures over time. Strengthening the verification of outputs could therefore be an important element in creating a dataset for budget and development planning of both central and local governments. Improved monitoring and verification of outputs will allow the GoI to assess the effectiveness of DAK expenditures and could support systematic reform of the entire system.

II. PROJECT DESCRIPTION

A. Lending Instrument 19. The project will be designed as a Specific Investment Loan (SIL), with a proposed size of IBRD financing of US$220 million to be implemented over four years. It will be implemented using an Output Based Disbursement (OBD) approach supported by capacity building and technical assistance activities to strengthen the framework for improving the

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reporting and monitoring of DAK expenditures. The project will reimburse a slice of the existing DAK for infrastructure (roads, water, sanitation and irrigation) based on delivery of verified physical outputs by selected LGs. Technical assistance will finance activities in support of the institutional strengthening both at the central government and LG levels. 20. The project will be piloted in five provinces and all of their districts/LGs (Jambi, East Java, Central Kalimantan, West Sulawesi, and North Maluku). These provinces were selected by the GoI based on geographic diversity, and performance criteria related to current compliance with reporting, ability to absorb DAK, and success in delivering outputs financed by their DAK. These five provinces in total received DAK allocation for their infrastructure sub-sectors of US$110 million in 2009 and US$75 million 2010, which was reduced due the impacts of the global financial crisis. For these five provinces, DAK allocations for infrastructure are expected to be at least US$100 million per year over the next four years, although it figure is likely to increase significantly.

21. Should the MoF wish to change or add any provinces during project implementation, the substitution will have to be agreed between the MoF and the Bank. In addition, the change or addition in provinces will have to be made before January 1 in the year they will participate, so that all the requirements for the project will then be applied to the new province.

B. Project Development Objective and Key Indicators 22. The objective of the project is to improve the accountability and reporting of the central government’s Specific Purpose Grants (DAK) for the infrastructure sub-sectors within pilot local governments (LGs). This will be done through improved financial and technical reporting, and the verification of outputs delivered by LGs with the DAK. 23. The project will work with the existing mechanisms used for the transfer of the DAK. Existing GoI and LG systems for monitoring and reporting will provide baseline information and criteria for evaluating project performance. However, physical outputs and reporting on use of DAK funds are the benchmarks to measure project achievement. 24. Annex 3 contains the detailed intermediate outcome indicators for monitoring the project’s progress during implementation and achieving the Project Development Objective (PDO) during project implementation. The PDO will be monitored using the two Key Performance Indicators below:

i. Development and use of an information system to which LGs report information to the MoF and corresponding line ministries.

ii. Percentage of physical outputs reported, verified and meeting eligibility criteria. C. Project Components 25. The project consists of three components, namely: Component 1: DAK Reimbursement; Component 2: Institutional Strengthening for the Central Government and LGs, and Project Management Support; and Component 3: Verification of Outputs. The GoI

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will finance Component 2 and BPKP will finance Component 3 out of own budget resources. The Components are referred to as Parts 1, 2 and 3 in the project’s Loan Agreement. Component 1: DAK Reimbursement (US$220 million) 26. This component will be implemented using an Output Based Disbursement financing approach. Under this approach, the project will reimburse the existing DAK for infrastructure (roads, water, sanitation, and irrigation) based on reported and verified physical outputs delivered by participating LGs. The Verification of Outputs (VO) will be conducted by Indonesia’s State Finance and Development Supervisory Board (Badan Pengawasan Keuangan dan Pembangunan, BPKP). 27. Of the eligible 81 LGs, only those that have sent a Commitment Letter to the MoF will be considered to be participating in the project. A portion of the reimbursement will be transferred from the MoF to the LGs to reimburse them for the funding they contribute to the DAK outputs. The amount of LG reimbursement is based on current DAK funding requirements for LGs to contribute at least 10 percent. If this amount is increased by GoI regulation, it may be applied to the project if agreed between the GoI and the Bank. The amount transferred from MoF to the LGs will be a reward for the LGs meeting the eligibility criteria, and it is expected that this will also act as an incentive for increased compliance with eligibility criteria in future years.

28. The amount reimbursed by the project will be based on meeting eligibility conditions for outputs delivered, as specified in the table below. Outputs with or exceeding a contract value of US$400,000 will not be considered eligible for reimbursement.

Output Eligibility Criteria for Reimbursement of DAK Expenditures

i. Physical Realization of Outputs: Construction Completion Certificates, and Compliance with Technical Specifications (Form P-4, column 3, of Technical Guidelines).

ii. Compliance with National Procurement Law and regulations (Keppres 80/2003) in hiring of contractors.

iii. Compliance with Environment and Social Safeguards: Evidenced by a Compliance Indicators Form in the Operation Manual.

29. Verification Process and Eligibility for Disbursements under Component 1. The verification of the agreed outputs is a core condition of disbursement, and a key project assurance from the GoI that loan funds have been used for the intended purposes, following principles of economy, efficiency and transparency. The project team has followed the OPCS Guidelines for OBD projects, which recommend that approval of disbursements be supported by output verification reports. It has also followed the approach to VO adopted in OBD and OBA projects in other regions (e.g. Brazil and Mexico). 30. Prior to the MoF submitting the request for disbursement to the Bank, the MoF will request the BPKP to verify, on a sampling basis, the timeliness and accuracy of the financial

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and technical reports submitted to the MoF and the MPW by participating LGs. The BPKP will work closely with the MPW in conducting the process of output verification. This verification will ensure that outputs for the specific allocation have been physically achieved, and are in compliance with agreed procedures and policies on procurement, financial management, and social and environmental safeguards.

31. First, the MPW will need to establish the reference unit costs (RUCs) for each of the eligible outputs at the beginning of the year; i.e. prior to the start of the DAK cycle. The RUCs should be provided from the MPW to the BPKP and the MoF by January 31 of each year, in order for the RUCs to be applied for the upcoming year’s outputs once completed. The MoF will then submit the agreed upon reference unit costs for the eligible outputs to the Bank by February 15 of each year.

32. All participating LGs will report to the BPKP the outputs that they have completed by December 31. BPKP will compile a list of completed outputs by LG by January 31 of the following year. The BPKP will calculate a value of potential reimbursement (VPR) for each LG by multiplying reported outputs by their reference unit costs. The BPKP will then randomly sample 20 percent of reported outputs in each province and verify compliance with the output eligibility criteria listed above. BPKP will conduct sampling in every LG. Based on the number of outputs in the sample that meet the eligibility criteria, the BPKP will then calculate the Qualifying Percentage (QP). For example, if half of the sampled contracts meet the eligibility criteria, the QP will be 50 percent.

33. The BPKP will then calculate the value of qualifying reimbursement (VQR) for each LG, by multiplying the QP by the VPR for that LG. Thus, if only half of the outputs in the sample meet the eligibility criteria, the BPKP will recommend reimbursing only half of the VPR for that LG. The BPKP will also calculate the value of total reimbursement (VTR) to be made from the Bank to the MoF, which is the sum across all LGs for the VQR by LGs. 34. Advance Payment. In order to shorten the time until the Bank’s first reimbursement, the MoF has requested an Advance Payment (AP). The AP will be equal to the sum of the values of the GoI’s first DAK payment to each LG that has received the first DAK payment by March 31. The AP would be at maximum 30 percent of total DAK allocated for the year, and equal to the current first DAK payment from the MoF to LGs. The AP will also be made in the second and third years to speed up the allocation of the first DAK payments to LGs. 35. Final Reimbursement. The Bank’s reimbursement of DAK expenditures will only occur once a year, as it is based on outputs delivered at year-end and verified in the first quarter of the calendar year. The amount of the Value of Final Reimbursement (VFR) will be the VTR minus the AP. However, the amount disbursed by the project in any year will not exceed the actual amount of DAK allocated by the MoF plus 10% (to cover LG contribution) to the infrastructure sector in that year. 36. In the event that the amount of the AP in a given year exceeds the total amount of DAK that can be reimbursed (i.e. the VTR) for that year based on the verification review by the BPKP, the Bank will not reimburse anything for the VFR. This will also require that the

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amount of the AP be reduced in the subsequent year by the amount of overpayment. If this situation occurs in either of the first or second year of the project, then the amount of the AP may be proactively reduced by the mid-term review, or the Bank may decide not to make APs in subsequent year, in order to avoid overpayment in the final year of the project. 37. Bank’s Payments: The BPKP will calculate all of the above variables and recommend the Bank to make only the following two payments to the MoF: (i) the Advance Payment; and (ii) the Value of Final Reimbursement. Both these values and associated reports should be provided from the BPKP to MoF by April 30, who will then submit the disbursement requests to the Bank.

38. LG Reimbursement. The amount of the LG Reimbursement will be the Value of the Qualifying Reimbursement times 10 percent summed for all LGs. This payment to the LGs will be the responsibility of the MoF. This percentage may be revised if agreed between the GoI and the Bank.

39. The BPKP will report its findings and recommendations in a combined Financial and Output Verification Report (OVR). The OVR will have a specific template, which will include the level of compliance with agreed indicators. The BPKP will submit the OVR to the Project Implementation Unit (PIU), which will use the OVR as the only basis to request Bank disbursements under this component. Annex 4 provides further details.

Figure 1: Reimbursement and Advance Payment

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May

GOI

BPKP

DAK 30%

Year n+1

WB

Year n

DAK 30% DAK 45% DAK 25%

Advanced Payment (AP)Reimbursement

Verification of DAK 1received by LGs Output

Verification

AP

DAK 1 to LGs

Component 2: Institutional Strengthening to Central and Local Governments and Project Management Support (US$8.5 million) 40. This component will support the strengthening of the basic institutional functioning of the project. It will be split into four sub-components: (i) Sub-component 2.1: Developing a Monitoring and Evaluation System; (ii) Sub-component 2.2: Web-Based Monitoring and Reporting System; (iv) Sub-component 2.3: Technical Assistance for Central Government

9

and LGs; and Sub-component 2.4: Project Management Support to implement and monitor the project. 41. Component 2 will be financed from the GoI’s national budget. The MoF will provide not less than US$8,500,000 equivalent from its budget to finance the activities under Component 2 of the project. The provision of these resources is a condition of DAK reimbursement under Component 1 of the project. Each year during project implementation, each participating agency—Bappenas, the MoF, and the MPW (including capacity building for LGs from MoF and MPW)—will submit a work plan for technical assistance (TA) to the Bank to support the planning, technical, procurement, financial management, social and environmental safeguards, and improve reporting capacity of both central agencies and LGs. BPKP will similarly submit a work plan and budget under Component 3.

42. In order to ensure adequate funding is available and that the TA is delivered, the following will be conditions for each year’s DAK to be eligible for reimbursement: (i) adequate funds are allocated in the national budget for the TA; and (ii) the work-plan is prepared and agreed upon with the Bank. In the event that the GoI does not provide the required documentation for the funds and the annual work plan for TA for any fiscal year by October 31 in the preceding GoI fiscal year, then the Bank has the right to not provide any Advance Payment or Reimbursement for that year. The TA funding and work plan for July – December 2010 is due 30 days after project effectiveness. Component 3: Verification of Outputs (US$ 4.5 million) 43. This component will constitute BPKP’s verification of outputs. BPKP will finance the VO function, plus any needed hiring of new staff and capacity enhancement from their own budget. An assessment of BKPK’s ability to do the VO function shows that they currently do technical audits for selected infrastructure outputs in LGs. However, in order to do the VO at the scale required for the project, the BPKP will require additional financial and human resources. BPKP will prepare an annual work plan to be discussed with the Bank regarding its VO tasks for the upcoming year. In the event that the BPKP fails to provide the required documentation for the budget and the work plan for any fiscal year by October 31 in the preceding fiscal year, then the Bank has the right to not make any Advance Payment or Reimbursement for that year. D. Lessons Learned and Reflected in the Project Design 44. Lessons learned for this project are drawn from three areas: (i) experience in Indonesia with two pilot local governance projects; (ii) pilot projects funded by the Global Partnership for Output-Based Aid; and (iii) Output Based Disbursement approaches in recent programs in Mexico and Brazil. 45. Indonesia Local Governance Projects. Two pilot projects on local governance in Indonesia are the Initiative for Local Government Reform Project (ILGRP) and the Urban Sector Development Reform Project (USDRP). Both the ILGRP and the USDRP were designed to support kabupaten and kota in improving transparency, accountability and public

10

participatory practices in order to undertake reforms in financial management and procurement. The ILGRP worked with the on-granting mechanism from the central government to LGs, while the USDRP was designed to promote on-lending to improve urban services. Both projects were designed to promote reform using parallel mechanisms to the GoI’s existing system, and this becomes an important lesson learned in designing successful reform projects.

46. In the case of the ILGRP, the on-granting mechanism could not be utilized fully work, as appropriate GoI decrees were not in place and the mechanism was not operational. The project thus became co-managed by the Ministry of Home Affairs (MoHA) and the LGs. The ILGRP invested in creating assets through investment sub-projects that are similar in nature to those funded by the DAK for infrastructure, especially roads and irrigation. With the USDRP, the process of sub-loan agreements proved complicated and GoI regulations limiting on-lending to revenue-generating projects limited the project’s ability to fund investments with public goods characteristics, such as roads, sanitation and irrigation.

47. More general lessons from LG projects were taken into account as the current project was designed. These lessons also reflect the result of the Integrated Fiduciary and Safeguards Assessment (IFSA) that was carried by the Central Operational Services Unit (COSU) for Indonesia’s LG projects.

(a) The geographic scope of the project was too vast, while the number of LGs covered were too few—nine and six provinces, and 14 and 11 LGs across these provinces in the ILGRP and the USDRP, respectively. The DAK project will be focused in five provinces and include all 81 of their LGs. This will give the project geographic concentration and scalability in the number of LGs covered, while also allowing some diversity across Indonesia’s regions.

(b) The complex reforms implemented by the LGs took a significant amount of time. Both projects adopted a staged approach, with restructuring at the mid-term review (MTR) to simplify reforms so that they remained manageable and implementable. The lesson is to start simple, show some improvements and results, then increase the complexity over time as LGs improve their ability to implement reforms and the investments required. (c) Greater reliance on government-driven reforms that also strengthen government systems was important in the sustainability of reforms. As reforms shifted increasingly to those that the GoI were also promoting and emphasis was placed more on LGs implementing reforms, rather than consultants, LGs started to internalize the reforms into their own processes. For example, in the ILGRP and the USDRP the projects support the GoI’s initiative to create procurement service units (ULPs) in all LGs. This also means aligning the Bank’s project with strengthening the GoI’s systems, such as procurement. (d) The bulk of investments made as part of the ILGRP, especially, were relatively small-scale, in the range of US$100,000 to US$500,000. Most contracts

11

fell within the Bank’s post-review limit, and very few contracts were subjected to prior review. Post review reports typically found a limited number of issues with the contracts. The contract management process between LGs and their contractors thus appear to be working reasonably well. This provides greater comfort on contracting for DAK funded infrastructure projects, which are typically less than US$400,000. (e) As LGs improve their capacity to implement programs, the central government should support decentralization by moving more intergovernmental transfers to LGs on-budget and on-treasury, rather than using line ministries to continue large-scale implementation at the LG level. Central government should therefore help LGs by improving the rules and regulations in the contract management process, strengthening compliance with the national procurement law (Keppres 80/2003), and safeguarding laws and regulations. The role of central government should transition from implementation to monitoring and evaluation.

48. Output Based Aid Projects. Important lessons were drawn from the methodology and experience in the design and implementation of Output-Based Aid (OBA) schemes to increase direct access of services to the poor from pilot projects funded by the Global Partnership on Output-Based Aid (GPOBA).

OBA Schemes in Bank Operations

The Bank’s knowledge and experience in structuring OBA schemes has grown in recent years. Since 2002, when OBA schemes were introduced in Bank operations, the Bank has developed 131 OBA projects (40 projects in the past two years), with a total value of about US$3.8 billion (US$2.6 billion Bank and US$1.1 billion government). Despite its growing use, Bank-financed OBA schemes in the WSS sector are currently limited, with a total of 33 OBA projects, 24 projects focused on water supply, three on sanitation, and six on providing both water and sanitation. The majority of projects identified tend to be small, as they are still in a pilot stage. The majority of projects involve piped water and one-off access fund schemes, with access usually defined as the delivery of working connections as demonstrated through a paid water bill. One project under implementation and another under design also involve wastewater connection, and two projects involve on-site sanitation facilities. Furthermore, thus far, OBA approaches have been tested mostly with private contracts that allocate the full risks to the private sector, including the responsibility to bear financing risks. Note that the 131 projects reported are OBA schemes in the sense that they target the poor.

Source: GPOBA/IDA-IFC Secretariat. 2009. Output Based Aid: A Compilation of Lessons Learned and Best Practice Guidance (Draft for discussion). Washington DC: GPOBA/IDA-IFC Secretariat.

49. Output Based Disbursement Operations. The project’s output based disbursement financing approach was designed to sharpen the focus on efficient, transparent results that move the risk to the LGs responsible for the implementation and operation of the corresponding DAK allocation. Instead of the traditional, ring-fenced infrastructure project based on inputs, the proposed project is focused on the broader concerns of achieving results, ensuring effective public expenditure and strengthening institutions. Lessons learned and incorporated in the specific design of the project’s OBD approach come from previously Bank-financed projects in the LAC region. 50. Mexico’s Decentralization Infrastructure Reform Project. During project preparation the team studied the experience of Mexico’s Decentralized Infrastructure Reform and Development Project (State of Guanajuato Project). In studying the Guanajuato project, the

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project team also considered the guidance provided to the team by the Financial Management Operations Review Committee (FMORC). FMORC guidance for the Guanajuato project has been followed consistently in the proposed project, allowing a more accurate assessment and control of the overall risk.

Mexico Decentralization Infrastructure Reform and Development Loan Project

The proposed project represents an improvement from the pioneer Guanajuato project on five accounts. First, while the Guanajuato project financed strategies in multiple sectors, the proposed project will finance specific WSS investment activities. Second, discussions with the Guanajuato project team revealed that reference unit costs were not pre-defined and had to be revised during project implementation. For the proposed project, the reference unit costs of outputs are based on historical contract prices. Third, unlike the Guanajuato project, there will be a mid-term review to assess the reference unit costs to ensure that they are in-line with actual costs (in a way resembling the regulatory agencies periodic assessment of the K factor). Fourth, the Guanajuato project revealed that the most important by-product of the use of an output-based financing mechanism was the establishment of a clear results framework. Under the proposed project, the results will be clearly defined in the performance agreements signed between SSE and the selected service providers. Fifth, to avoid the double accounting problems faced by the Guanajuato project, the proposed project will disburse funds not against individual expenditures on the input side, but against agreed outputs. However, to ensure that expenditures are eligible and that the funds are used for the intended purposes in line with the principles of economy, efficiency, transparency and competition, one of the initial concerns in the Guanajuato project, the BPKP will verify the outputs delivered by LGs.

Source: Performance-Based Budgeting in the Water Sector: The Case of Guanajuato. Mexico: Quality of Public Expenditure, Note No. 5, September 2008.

51. Brazil’s São Paulo Water Recovery Project (REAGUA). The project also builds upon the lessons from Brazil’s REAGUA project. The REAGUA Project, an initiative of the State of Sao Paulo, builds upon an OBD approach to partially subsidize wastewater treatment plants by paying for outputs. The proposed DAK project draws upon and will expand on this experience. Relevant lessons from REAGUA that have been incorporated in the design of the project include: (i) decentralizing responsibility of investments to the lowest level possible, such as provincial or local providers of WSS services, in order to increase accountability and improve investment quality; (ii) linking disbursement of loan proceeds to outputs to increase the efficiency of both executing agencies and public expenditure; and (iii) estimating reference unit costs of outputs, and defining and measuring appropriate standards and performance indicators for disbursements. Consistent with this lesson, the project team worked extensively with the MPW on clearly defining and simplifying outputs and unit costs using the REAGUA design model. REAGUA’s verification of outputs has also been incorporated into the project design. E. Alternatives Considered and Reasons for Rejection 52. Two options were considered for the delivery of this operation. First, a traditional stand alone input-based project was considered, whereby the GoI would finance specific inputs/capital investments based on completion of physical milestones. This option was rejected as the number of LGs targeted would be limited and the Bank would not be able to work with and strengthen the GoI’s DAK system of grants. Second, a DPL was considered. This option was rejected as it would only focus on higher level reforms and not provide the incentives and support needed by LGs to improve reporting and monitoring systems.

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53. Based on extensive discussions with the GoI, it was agreed that a project to support strengthening the GoI’s systems at both central and LG levels should be based on the achievement of results. The OBD approach, based on the achievement of results and delivery of outputs, is responsive to the GoI’s request to use this operation to make its own DAK system more effective. The project will therefore seek to make the current input-based financing model of DAK responsive to incentives based on the achievement of outputs. 54. The use of an OBD financing approach for the proposed project would allow: (i) working with the GoI’s inter-government finance and LG expenditure systems; (ii) focusing on the explicit definition of outputs against which funds would be disbursed would sharpen the targeting of results in a more transparent and accountable way than under a traditional input-based operation, and have a major impact on improving the performance of LGs; (iii) payments based on outputs that would shift financial and operational risks of service delivery to LGs, who would be considered best positioned to manage such risks and decide how to best reach performance targets; (iv) verification of outputs prior to disbursement of payments, which provides a critical fiduciary safeguard on the accurate targeting of funds, as well as evidence that public funding is being well spent; and (v) the potential of the scheme to be replicated in other sectors and other provinces. 55. The GoI expects that the use of an OBD financing approach will increase accountability at the LG level, as there will be greater transparency in reporting and verification of outputs delivered. Over time, this can support reforms focused more specifically on improving service quality through better planning by LGs. This understanding is aligned with the Bank’s current interest in eliminating the disconnect between the programmatic engagements in Indonesia, as reflected in the CPS, and the static stages of the basic project cycle. The current project supports the CPS as it directly ties disbursements with results (outputs and reports) and facilitates a programmatic engagement with the country by financing a share of an important LG program.

III. IMPLEMENTATION

A. Partnership Arrangements Not applicable. B. Institutional and Implementation Arrangements 56. The MoF will implement the project. The MPW will also be a key supporting agency for the implementation of the project. The operational execution and coordination of the project will be managed by the PIU, which will be formally established under the Directorate General of Fiscal Balance (DGFB) within the MoF. The PIU will report to Director of Balancing Funds and will be composed of career staff and supported by a group of specialized consultants. The structure and specific responsibilities of the PIU are defined in the Operations Manual. The DGFB will coordinate the project’s implementation. The DGFB has conducted, and will continue to conduct, consultations with potential LGs for the selection of activities to be financed by the project.

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Figure 2: Institutional Arrangements

MoF BAPPENAS MoHA MPW

NATIONAL STEERING COMMITTEE

Executing Agency

DGFB

MPW

Secretariat General

LG

PROV KAB KOT

BPKP

WB

Integrated Financial and Output Verification Reports

Outputs

DINAS/SKPDDGBM

DGSDA

DGCK

OVR

Reimbursement

ItJen

Monitoring & Evaluation of DAK Program

C. Monitoring and Evaluation of Results 57. The Results Framework for the project is outlined in Annex 3. The project will rely on one key report submitted to the Bank as part of the process of determining eligibility of expenditures incurred at the LG level, namely the combined Financial and Output Verification Report (OVR) produced by the BPKP in collaboration with the MPW. The OVR will be submitted to the DG Fiscal Balance in the MoF, which will then submit a report to the Bank for consideration regarding the amount to reimburse. 58. The MPW, in consultation with the PIU and Bappenas, will be responsible for continuous monitoring of the program and for conducting evaluation reports on the performance of the DAK program in the five provinces. The MPW will prepare annual monitoring and evaluation reports based on end-of-year outputs delivered, which should be finalized in the first quarter of the calendar year. The PIU, on behalf of the GoI, will conduct a mid-term review (MTR) of the project by the end of 2012. The annual M&E reports and MTR will form the basis for assessing any changes in the project design, implementation, and possible restructuring, if needed. D. Sustainability 59. The project is designed to work with the GoI system of inter-governmental transfers and strengthen the central government’s monitoring of funds, while also improving the effective delivery of outputs at the LG level. The project builds on the GoI’s existing mechanisms for monitoring and reporting, and will strengthen these structures, along with the enhanced verification of outputs delivered by LGs. The project presents a shift away from

15

financing individual investment sub-projects in a small number of LGs and focuses instead on improving the government framework within which investments take place. This places the emphasis on the achievement of results through the delivery of outputs, the verification of outputs, and compliance with GoI laws and regulations. 60. As part of the Project, the GoI will implement a capacity building program to improve the internal controls of LGs, including the planning process, project preparation and supervision, monitoring and reporting of outputs through web-based systems, and strengthening procurement and financial management. Such capacity enhancement of LG systems is expected to be sustained after the Project is completed.

E. Critical risks and possible controversial aspects Risk factors Description of risk Mitigation measures Ratinga

of residual risk

I. Risks to PDO BPKP financial and verification reports

The BPKP does not create adequate capacity and staffing to do verification of outputs (VO). The BPKP has difficulty executing the ToR and scope of work required for the VO.

The PIU will work closely with the BPKP to shorten the timeline of report received. BPKP will budget for capacity building to strengthen its role in VO and to ensure that it has appropriate staffing. TA will also be provided to LGs to improve the quality of both financial and technical reports.

H

Web-based reporting system (WBRS)

Accountability risk, such as fictitious project outputs and/or manipulated reports.

Opportunity for fictitious project outputs will be minimized by reporting outputs visually through the WBRS. The lower quality or less quantity output will be minimized through output verification by the BPKP, and the results of the verification will be uploaded to the WBRS.

M

II. Operation-specific Risks The GoI funding for TA components.

The GoI does not provide adequate funding for the TA components, and funding is allocated late in the year.

The availability every year of adequate funding and an agreed upon annual work plan for the TA will need to be in place for the next year’s DAK expenditures to be eligible for reimbursement.

H

Willingness of LGs to participate in the project.

LGs in the five pilot provinces might be reluctant to participate in this project.

Each LG will submit a binding Commitment Letter to MoF confirming their participation in the project.

L

The MPW experiences difficulty in providing reference unit costs and

The MPW does not provide reference unit cost and does not define eligible outputs for reimbursement for the infrastructure sector.

The Bank team is working directly with the relevant departments in the line ministry (MPW) to compile reference unit costs and define eligible outputs for reimbursement.

L

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Risk factors Description of risk Mitigation measures Ratinga of residual risk

definition of outputs LG reporting on physical outputs

LGs do not provide output data on time.

LG contribution (currently 10 percent of DAK expenditures) will be reimbursed to them for reporting outputs on-time.

M

Implementation capacity at both central and LGs

There is still lack of implementation capacity. This could delay the Bank’s reimbursement to the GoI.

TA will be required for central government to support the PIU in managing the project. TA will be required for LGs for the process of identifying and planning for DAK investment needs, strengthening procurement and financial management capacity, compliance with social and environmental safeguards, as well as improving the implementation and reporting of DAK expenditures and investments.

S

Fiduciary Requirements (Procurement and Financial Management)

In principle LGs use the same national public procurement system as regulated by Presidential Decree 80/2003 (Keppres 80) and financial management system (State Finance Law 17/2003, State Treasury Law 1/2004 and the Public Accountability Law 15/2004, which provide a legal basis for the country’s public financial management). These decrees already follow reasonably acceptable procurement and financial management principles. However, the performance of implementing agencies on procurement and financial management differs widely due to resources and capacity constraints; while concerns on collusive and corruption practices are high across country. The current oversight and performance monitoring system is weak with regard to procurement, at both in central and local governments.

The project will support the establishment of the procurement services unit (ULP) in each local government as the “procurement anchor”. The TA will support strengthening procurement and financial management capacity in LGs. The team will agree with government on the most efficient way of monitoring and collecting information systems related to procurement and financial management, and capacity issues both at central and LGs.

H

Social and environmental safeguards

LGs do not follow the environmental and social safeguards requirements acceptable to the Bank.

The MPW will issue a ministerial circular letter to supplement the Technical Guidelines and include environmental and social safeguard. Regular project supervision by the MoF to increase eligibility level for reimbursement.

L

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Risk factors Description of risk Mitigation measures Ratinga of residual risk

III. Overall Risk Overall Risk When the combination of risks is taken into account, the project has an

overall risk rating of “Substantial”. S

F. Loan/Credit Conditions and Covenants 61. Effectiveness conditions for the project include:

The MoF will have adopted the Operations Manual, in form and substance satisfactory to the MoF and the Bank, and the PIU has been established in a manner satisfactory to the Borrower and the Bank.

MPW will have issued a Circular Letter requiring the use of the Supplemental Technical Guidelines (Environmental and Social Safeguards) acceptable to the Borrower and the Bank to all Pilot Local Governments.

VO Terms of Reference have been agreed between the MoF and BPKP and between the Bank and BPKP, and BPKP and the Bank will have entered into a Verification Arrangement.

62. In addition to the standard covenants for output-based disbursement projects, the Project contains the following key covenants. The GoI will make available funds in an amount equivalent to not less than $8,500,000 for the carrying out of the activities under Component 2 of the Project, and the BPKP will make available funds required for capacity building under Component 3 of the Project as set out in the VO Terms of Reference. In each year of Project implementation, the Borrower (with respect to MoF, MPW and LGs) and BPKP shall submit by October 31 and thereafter carry out a Work Plan satisfactory to the Bank, with respect to Component 2 and Component 3 of the Project, respectively. No withdrawal may be made from the Loan for any Outputs produced prior to January 1, 2011. In addition, the MoF will not submit any application for withdrawal for any year of Project implementation unless: (i) the Bank has received a Verification Report acceptable to the MoF and the Bank of the subsequent year in accordance with the VO Terms of Reference; (ii) the MoF has made the TA funds for available for the Project in that year; and (iii) BPKP remains as the VO for that Fiscal Year, the VO Terms of Reference remain in effect between BPKP and MoF, and between BPKP and the Bank, and BPKP has in place the required staffing and experts.

IV. APPRAISAL SUMMARY

A. Economic and Financial Analysis 63. A detailed economic and financial analysis of the project was undertaken during project preparation. Cost estimates for the DAK investments under this project were based on the average of the four most recent years (2007 through 2010) of actual DAK allocations by province and sub-sector. Given the complexity of estimating future DAK investments in all 81 districts across the five pilot provinces, representative output types were chosen for

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each of the sub-sectors, based on outputs most commonly funded by DAK investments in these provinces. Unit costs for each output type in each province were obtained, based on actual unit cost data from the MPW. Expected output quantities were derived by dividing the planned investments by the unit costs. Annual operating costs for the resulting infrastructure were included in the analysis, assuming a service life of at least five years. 64. Expected benefits deriving from each unit of representative output were then estimated for this project using data from the 2009 study of the economic benefits arising from investments delivered under the Initiatives in Local Governance Reform Project (ILGRP). Annex 9 provides greater detail on the unit costs, calculated output quantities, and estimated benefits for the representative output types in each province. 65. The net present value (NPV) of the net economic benefits from the Project is thus estimated to be US$56.0 million, over a period of five years, using a discount rate of 12 percent. The internal rate of return, based on net economic benefits, is 40 percent, this being the discount rate at which NPV would be zero. B. Technical 66. Based on extensive discussions with the GoI, it was agreed that a project to support the strengthening of the GoI’s systems at both central and LG levels should be based on achievement of results. Through the DAK mechanism, the GoI and LGs finance outputs, which will be subject to Bank reimbursement, based upon delivery and verification of physical outputs. The GoI expects that the use of an OBD financing approach will increase accountability at the LG level, thereby leading to improved service quality by allowing LGs to use the information in their planning processes and by improving oversight by the central government. Furthermore, in addition to this economic analysis that shows these DAK investments to be economically sound, a benefit arising specifically from this project is the accountability and reporting in the use of DAK funds. While it is difficult to quantify the value of this benefit ex-ante, the positive impact of institutional strengthening in the use of DAK resources is expected to be substantial, particularly if there are positive spillover effects in other sectors and for other fiscal transfers.

C. Fiduciary 67. The arrangements for the project will focus on ensuring that the selected LGs have the capacity to procure, supervise, track expenditures, and report on agreed outputs. The Bank team conducted capacity assessments on selected LGs to verify that financial management and procurement systems ensure that: (i) expenditure on works and goods takes place in line with the principles of economy, efficiency, transparency, and competition; (ii) expenditure is productive; (iii) expenditure contributes to solutions within a fiscally sustainable framework; and (iv) acceptable internal oversight arrangements are in place. 68. Procurement. The procurement under sub-projects will be carried out by the participating LGs via the procurement services unit/ULP. The MoF, through its TA for Institutional Strengthening (not Bank financed), will provide the support and capacity building as required to ensure that procurement follows the agreed procedures. The

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procurement includes small works (below US$400,000 equivalent) for minor repairs, maintenance or rehabilitation of facilities/services, and output-based disbursement will be used. Despite the weaknesses in implementation, the national procurement procedures under Keppres 80/2003 generally have the elements of good international practice and have the minimum requirements that make them acceptable for this type of operation. In addition, the fact that no international bidders will be involved and that the project is using an output-based mechanism makes this the most reasonable approach for the project. The procurement for the proposed project would be carried out in accordance with Section 1 (excluding paragraph 1.16) and paragraphs 3.14 and 3.15 of the World Bank’s "Guidelines: Procurement Under IBRD Loans and IDA Credits" dated May 2004 revised October 2006; and the provisions stipulated in the Legal Agreement. Since the project will be using an output-based approach and will finance outputs and not specific contracts, and due to the straightforward and simple nature of the expected procurement, consistent with paragraph 3.14 of the Bank’s Procurement Guidelines, the procurement procedures for sub-projects under LGs will follow competitive procurement methods of Keppres 80/2003 acceptable to the Bank.

69. Under output-based disbursement, where payment is made based on outputs rather than inputs, the Bank neither reviews the procurement plans nor individual procurement. However, prior to the MoF submitting the request for reimbursement from the Bank, the BPKP will review the procurement process and contract documents on a sampling basis, in order to verify that agreed procurement procedures are strictly followed and that the national standard bidding documents are adopted. Samples will include all participating LGs at 20 percent of the total number of contracts in each Province in the particular review period. If the verification report shows non-compliance of reviewed contracts in a particular review period, then the respective LG outputs will not be eligible for Bank reimbursements. By the end of this project, covenants will need to be met by each participating LG with respect to improving its procurement management system and capacity, as follows: (i) improved procurement planning system and reporting; and (ii) establish and improve the capacity of the ULP. 70. The procurement of TA for Institutional Strengthening to support LGs in managing the sub-projects (including improving their procurement management system and capacity), as well as the TA for improving the capacity of BPKP are not Bank financed. GoI will ensure that adequate funds are made available for the TA. Since the GoI is financing the TA Component, the Bank’s Consultant Guidelines do not apply. 71. Financial Management. The financial management assessment concludes that the current DAK arrangements satisfy the Bank’s requirements for financial management as stipulated in OP/BP 10.02. The risk at the LG level is high given that payment verification mechanisms vary significantly across LGs. While the segregation of duties is in place, not all LGs have requested third party consultant(s) to verify payments made for infrastructure. At the central level, the DGFB (MoF) receives accountability reports on the use of DAK funds. However, the DGFB does not conduct verification on the use of the funds reported, hence the report is too general and does not provide enough information for traceability purposes. On the technical side, LGs send technical progress reports on DAK

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implementation, although the reporting requirement to the MPW has low compliance and the MPW also does not conduct output verification on the reports received.

72. There is currently no integrated management information system in place for the DAK program. The financial management risk is similar to the overall risk of the project, which is considered ‘High Risk’ before mitigation and ‘Substantial’ after mitigation. In order to overcome the risks regarding financial management, the mitigation measures include: (i) establishing an improved reporting format and integrated management information system for DAK, which provides better traceability on the use of DAK funds; (ii) conducting output verification on the reports received; (iii) and agreement between the BPKP and the Bank on the ToR for the BPKP as the output verifier for the project; (iv) a binding Commitment Letter from each participating LG to MoF; (v) TA to improve LG administration and internal audit of DAK; and (vi) improving the external audit arrangements for the DAK program.

73. Governance and Anti-Corruption (GAC). The project disbursement will be made based on the outputs of DAK at the LG level instead of on the process to produce outputs. Therefore, it will be very important to obtain reasonable assurance of the existence of the outputs. Higher assurance will be achieved through direct verification of the outputs by the BPKP. However, the BPKP will only reach some of the outputs depending on the number of samples. Therefore, an appropriate reporting system, one that will allow the assessment of the existence, quality, quantity, and timeliness in completion of the outputs, is required. Since the existing DAK reporting system does not have these capabilities, the WBRS will be developed. On the other hand, understanding fraud and corruption by DAK stakeholders, as well as the consequences of fraud and corruption if and when these occur, will contribute to preventing fraud and corruption in DAK funded projects. Therefore, the Bank guidelines on Preventing and Combating Fraud and Corruption will be socialized to officers and stakeholders of the DAK. D. Social 74. The DAK funds will mainly be used by LGs to finance the maintenance, rehabilitation and improvement of existing infrastructure. In some cases, however, there will be investments for new civil works but the scale will be relatively small. The project will only reimburse small civil works, with an investment size up to US$400,000, which is also the prior review threshold under some existing Bank LG projects (e.g. ILGRP).

75. The project is expected to positively impact the social and economic living standards of its beneficiaries, particularly those in poor communities, by improving existing infrastructure and other facilities serving these communities. Remote villages will have better access to other villages and towns/cities; agricultural productivity levels will increase through better access to markets; people will enjoy improved health through better access to water supply services and sanitation facilities; and improved infrastructure and other facilities will generally save costs and time for beneficiaries.

76. Past and ongoing DAK for the roads, water, sanitation and irrigation sub-sectors, have shown that the potentially adverse social risks have been minimized, as sub-project

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proposals were developed through participatory planning process using a “Musrenbang” mechanism that involved various stakeholders from the village level up to the central level. Land acquisition is likely to be insignificant, as the project will mainly finance the maintenance, rehabilitation and improvement of existing infrastructure and facilities. The expansion and extension of current networks and facilities will be limited. As the nature of the project is consistent with past and ongoing DAK in the four sub-sectors, it is likely that potentially adverse social risks will remain insignificant. The project design will ensure that the potential adverse social risks of sub-projects, including parts financed by other funding sources, will be better managed and addressed than in the past.

77. The BPKP will review the compliance of LGs in maintaining the social safeguards for sub-projects partly or wholly funded by the DAK. Compliance will be measured based on the requirements specified in the Supplement of the Technical Guidelines, as well as other performance indicators that will be developed and incorporated in the Operations Manual. The BPKP will create an additional layer of supervision and risk mitigation, since the project will not reimburse expenditures where safeguards are violated. In addition to relying on the BPKP report, the project will monitor its components through regular supervision in order to avoid and minimize potential non-compliance. 78. The MPW has confirmed it has adopted national regulations for land acquisition, including Perpres 36/2005, Perpres 65/2006, and BPN Regulation No. 3/2007 for sub-projects financed by DAK. However, these regulations are not explicitly included in the MPW’s current Technical Guidelines to LGs for the use of the DAK. Regardless, the project will have to ensure that requirements for land acquisition and consultation processes, grievance mechanisms, as well as livelihoods impacted by the project, are in line with the Bank’s involuntary resettlement policy (OP/BP 4.12). As Indonesia does not have specific regulations on IPs or IVPs, the project will follow the Bank’s policy on IPs (OP/BP 4.10). This will be done by the MPW issuing a Supplement to the Technical Guidelines that will specify in detail the GoI and the Bank’s social safeguards requirements.

E. Environment 79. Past and ongoing DAK in infrastructure sub-sectors have shown that potentially adverse environmental risks have been insignificant, as sub-projects are typically small in scale, limiting the associated potential level of environmental risk. Most environmental risk issues have their origins in apparent failures to follow best civil engineering practices. This can be addressed through: capacity building of engineering staff; providing technical advice to participating districts; and including environmental safeguard aspects into project planning and design. 80. The project will not require a stand-alone environmental impact assessment or Environmental Management Plan (EMP) or Framework (EMF). Instead the project will develop standard operating procedures for mitigating potential adverse environmental impacts for each of the above mentioned four types of investments. These procedures will be incorporated in the existing GoI Technical Guidelines and compliance process and indicators that will be developed and incorporated into the Operations Manual.

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81. The MPW has adopted national regulations for environmental management to sub-projects financed by DAK, i.e. government regulations (PP) 27/1999, and will follow the new environmental management and protection Law No. 32/2009 issued in October 2009. However, these regulations are not explicitly included in the MPW’s current Technical Guidelines to LGs for the use of DAK grants. The project will ensure that requirements for environmental management and monitoring processes, as well as community involvement, are in line with the Bank’s environmental assessment policy (OP/BP 4.01). The Supplement of the Technical Guidelines will also include a reporting system through which environmental and social safeguards will be covered. 82. The environmental safeguards compliance process (implementation, monitoring, and reporting) will be outlined in the Operations Manual, as well as described in detail in Annex 10 Approach to Environmental and Social Safeguards. F. Safeguard policies 83. The project is classified as a Category B project for environmental assessment. The project will incorporate three of the Bank’s safeguard policies, namely OP/BP 4.01 (Environmental Assessment), OP/BP 4.10 (Indigenous Peoples), and OP/BP 4.12 (Involuntary Resettlement). 84. The MPW has agreed that the GoI and the Bank’s environmental and social safeguard requirements, procedures and protocols will be incorporated as a Supplement of MPW’s Technical Guidelines to LGs for use of DAK. This means that safeguard compliance will be made part of the GoI DAK system by incorporating relevant standard operating procedures into the MPW’s Technical Guidelines, which will be applied to all investments for which reimbursement is allocated through the project (including parts of sub-projects financed by other resources, but linked and necessary for those particular sub-projects to function). This will also help expand this approach for the entire program including non-Bank financed operations. Safeguard Policies Triggered by the Project Yes No

Environmental Assessment (OP/BP 4.01) [X] [ ] Natural Habitats (OP/BP 4.04) [ ] [X] Pest Management (OP 4.09) [ ] [X] Physical Cultural Resources (OP/BP 4.11) [ ] [X] Involuntary Resettlement (OP/BP 4.12) [X] [ ] Indigenous Peoples (OP/BP 4.10) [X] [ ] Forests (OP/BP 4.36) [ ] [X] Safety of Dams (OP/BP 4.37) [ ] [X] Projects in Disputed Areas (OP/BP 7.60)* [ ] [X] Projects on International Waterways (OP/BP 7.50) [ ] [X] * By supporting the proposed project, the Bank does not intend to prejudice the final determination of the parties' claims on the disputed areas.

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Compliance with the Bank’s environmental and social safeguards will be made part of the eligibility criteria for reimbursement under this project. The revisions to the MPW’s Technical Guidelines will be in the form of a Supplement to be issued as a Circular Letter of the MPW. The MPW will disseminate and socialize the Supplement of the Technical Guidelines to all 81 LGs. 85. Borrower capacity. The MoF has limited experience in implementing the Bank’s environmental and social safeguard policies. The MPW, which is responsible for ensuring that the LGs comply with safeguards through the Supplement of the Technical Guidelines, has experience in many Bank-supported projects and therefore has a good understanding of the Bank’s environmental and social safeguard policies. However, its capacity in supervising, guiding and verifying the compliance of LGs in environmental and social safeguards as specified in the Supplement of the Technical Guidelines will need to be improved. To some extent, LGs have some capacity to implement environmental and social safeguards according to Indonesian regulations, but in general lack the understanding and capacity to implement the Bank’s environmental and social safeguards requirements. The MPW will need to socialize, train, and supervise the implementation of the Supplement of the Technical Guidelines by the LGs. The MPW will need to ensure that quarterly reports prepared by LGs include information on the implementation of the requirements, procedures and protocols of the environmental and social safeguards as specified in the Supplement of the Technical Guidelines. 86. Disclosure. The Draft Supplement of the MPW’s Technical Guidelines will be disclosed in the Infoshop and on the MPW’s website following the project’s effectiveness. The final version of the Supplement and the project Operations Manual will be disclosed in the Infoshop and on the MPW’s website prior to loan effectiveness. G. Policy Exceptions and Readiness 87. No policy exceptions found.

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Annex 1: Country and Sector or Program Background

INDONESIA: Local Government and Decentralization Project 1. Fiscal decentralization and intergovernmental transfers in Indonesia. With the “big bang” decentralization of 2001, Indonesia went from being one of the most centralized countries in the world in administrative, fiscal and political terms, to one of the most decentralized. Under Law 32/2004 (on Regional Finance) and Law 33/2004 (on Fiscal Balance), local governments (LGs) have assumed new responsibilities that were previously covered by the central government, as well as managing new financial resources that have been transferred from the central government or raised within their own localities.

2. The implementation of fiscal decentralization policies has resulted in a significant increase in transfers from the central government to LGs. These intergovernmental transfers consist of the General Purpose Grants (Dana Alokasi Umum or DAU), and the Specific Purpose Grants (Dana Alokasi Khusus or DAK), and Shared Revenue Fund (Dana Bagi Hasil or DBH). The bulk of these transfers is constituted by the DAU, which is mainly used to fund salaries and other administrative costs. In 2010, the DAU share of total intergovernmental transfers was 63 percent, while the share of DAK was around 7 percent, and DBH was 25 percent. Adjustment funds constitute the remaining balance of transfers.

3. By way of intergovernmental transfers, LGs have experienced substantial increases in financial resources. Provinces and districts manage 38 percent of total expenditures and half of all public investment revenue in Indonesia. Nevertheless, fiscal decentralization in Indonesia still faces a number of major challenges, such as how to better spend resources and how to reduce LG dependency on transfers from central government.

4. Capital investment after the onset of regional autonomy. The role of LGs in public investment and economic development has increased following the decentralization process begun in 2001. However, if capital investment needs are taken into account, LGs do not have sufficient financial resources to meet their investment needs for basic services, which far exceed their revenues and surpluses. This is evidenced from LGs’ lack of significant own-source revenue, which constitutes only 15 percent on average of total revenue.

5. In 2007, total investment (public and private) for infrastructure remained very low at a 4.1 percent of GDP, which is still below the 6-7 percent level achieved prior to the Asian financial crisis of 1997-98. Led principally by the LGs, public spending on infrastructure has been steadily increasing since 2006. However, the growth rate of public spending on infrastructure is still low. As a share of GDP, public spending stood still at just under 2 percent, compared with 1.3 percent in 2001.

6. Indonesia Public Expenditure Review (PER) 2008 mentions that public expenditure for infrastructure has been relatively under-funded compared with other sectors, such as education and health. In order to increase investments over time, LGs will need to have access to larger financial flows and the central government will need to strengthen intergovernmental transfer mechanisms, especially the grants allocated for investments, such as the DAK. In terms of management of expenditure assignments, as LGs now have

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significant autonomy to allocate their resources to ensure the quantity and quality of service delivery, strengthening the transfer system for intergovernmental capital grants will not weaken decentralization; if anything, it will strengthen LGs’ ability to deliver services.

7. Having identified that there is a lack of infrastructure investment, the central government has tried to compensate for this by allocating significant amounts of DAK transfers to infrastructure, especially for the purpose of maintaining existing infrastructure.

8. Specific Purpose Grants (DAK). The DAK is a grant funded by the national budget (Anggaran Pendapatan dan Belanja Negara or APBN) and allocated to a particular LG with the purpose of financing specified activities that are aligned to national priorities and conducted under the jurisdiction of LGs. General policy guidelines for DAK are set forth in the GoI’s work plan (Rencana Kerja Pemerintah or RKP), which is determined annually. For 2010, the GoI is directing the course of DAK general policy to support regions with low fiscal capacity in order to attain the minimum service standard for basic services by providing physical infrastructure for basic public service delivery.

9. Over the years, the DAK allocation has been growing very rapidly, increasing from IDR 2.2 billion in 2003 to IDR 24.8 billion in 2009, and accounting for 0.7 percent to 2.4 percent of the APBN, respectively. In 2010, total DAK allocation amounts to IDR 21,133 billion or 2.0 percent of APBN. This is a decline of 17.4 percent on 2009 as a result of global financial turmoil that started in late 2008.

10. Sectoral Allocation. Based on policy guidelines for DAK, the central government has established a sectoral allocation of DAK. The number of sectors funded by DAK grants increases each year according to the RKP. In 2010, 14 sectors are eligible for DAK, compared with 13 sectors in 2009. The additional sectors resulted from the split between water supply and sanitation sectors, which in 2009 were lumped into one sector. The sectoral allocations of DAK for FY2009 and FY2010 are presented on Table 1. DAK allocations for education, environment and family planning sectors were unchanged from 2009 to 2010. Forestry and rural infrastructure sectors saw huge improvement during the same period, as did the marine and fishery and agriculture sectors, although at a smaller level. DAK allocations for the rest of the sectors decreased during the same period, with infrastructure sectors, on average, declined by 37.5 percent.

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Table 1: DAK Allocation by Sector, 2009-10 (billion IDR)

11. Regional Allocations. The determination of the total amount of DAK, and its allocation to LGs, are based on the decision made between the Budget Committee of the Parliament (Dewan Perwakilan Rakyat or DPR) and the central government, including the MoF, MoHA, Bappenas, and technical ministries within sectors receiving DAK allocations. While the mechanism for the determination of total DAK involves several institutions, the final decision regarding the total amount of DAK and its allocation both by sector and by region is the responsibility of the Minister of Finance after consultations with the DPR (Figure 1). In order to be entitled for DAK allocations, LGs must meet: (a) general criteria based on the Net Fiscal Index (NFI); (b) specific criteria based on legislative regulation and regional characteristics, such as whether or not LGs receive special autonomy funds or whether they are categorized as disadvantaged areas, etc; and (c) technical criteria which assess conditions of the infrastructure based on technical indexes in the relevant sector.

Sector 2009 2010

Education 9,334.9 9,334.9

Health 4,017.4 2,829.8

Road Infrastructure 4,500.9 2,810.2

Irrigation Infrastructure 1,549.0 968.4

Water Supply 357.2

Sanitation 357.2

Governance Infrastructure 562.0 386.3

Marine and Fishery 1,100.4 1,207.8

Agriculture 1,492.2 1,543.6

Environment 351.6 351.6

Family Planning 329.0 329.0

Forestry 100.0 250.0

Rural Infrastructure 190.0 300.0

Trade 150.0 107.3

Total (IDR billion) 24,820 21,133

Total (USD million) 2,727 2,322

1,142.3

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Figure 1: DAK Regional Allocation Mechanisms

12. Disbursement. DAK allocations to recipient regions are transferred from the state general cash account to a region’s general cash account. The respective regional head should arrange the definitive plan (RD) and budget implementation statement (DIPA) based on a budget allocation document (SRAA) from the MoF through the National Treasury Regional Office and technical guidelines from related ministries.

13. Currently, the disbursement process of DAK is conducted in three stages. In the first stage, LGs receive 30 percent of their total DAK allocation (across all sectors) upon fulfillment of the following: finalization of their budgets (APBD), and submission of APBD and letter of declaration of LGs’ commitment to match 10 percent of DAK to the MoF. The first payment should be disbursed no later than February of each fiscal year. LGs can apply for a second payment, which amounts to 45 percent of total DAK, after they have spent 90 percent of the first payment and provided evidence that they have done so. The remaining 25 percent can be released after LGs supply evidence that they have spent 90 percent of the second payment.

14. DAK in the Infrastructure Sub-sectors. Total DAK for the four infrastructure sub-sectors in 2010 amounted to IDR 4.5 billion (US$490 million), representing about one-fifth of the total DAK in 2010. The road sector received the largest DAK allocation (62.5 percent), followed by irrigation (21.5 percent), and water supply (8.0 percent) and sanitation (8.0 percent). DAK allocations for the five pilot provinces are presented in Table 2.

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Table 2: DAK Allocation for Infrastructure Sectors in 5 Selected Provinces, 2010

15. The MPW provides Ministry Decree No. 42/PRT/M/2007 on Technical Guidelines for the Implementation, Monitoring and Evaluation of the DAK that serves as basic rules for the implementation and monitoring and evaluation of DAK-funded projects for the infrastructure sub-sectors. The decree is supplemented by an MPW Circular Letter on eligibility of works to be funded by the DAK, which is renewed on annual basis. For FY2010, the scope of activity within the road sub-sector includes routine maintenance/rehabilitation and improvement of roads, as well as routine maintenance/rehabilitation and replacement of bridges. The irrigation sub-sector works comprise rehabilitation and improvement of irrigation systems, including swamp reclamation networks along with their supporting structures. The water sub-sector projects are directed towards refinement of the existing systems or the development of new Drinking Water Facility Systems (Sistem Penyediaan Air Minum or SPAM). The sanitation sub-sector works cover Community-Based Environmental Sanitation programs (Sanitasi Lingkungan Berbasis Masyarakat or SLBM).

16. Monitoring and Evaluation. Monitoring and evaluation of projects/activities funded by DAK are integral to effective, efficient and transparent DAK implementation. Figure 2 depicts the reporting mechanism from LGs receiving DAK for infrastructure sub-sectors. In essence, LGs have to send reports to technical ministries and the MoF (through the DG of Fiscal Balance). The types and frequency of reporting requirements are set in accordance with the respective ministries’ decrees on DAK.

Province Road Irrigation Water Sanitation Total

Jambi 59,302.90 13,824.50 7,150.00 6,812.40 87,089.80

East Java 175,289.90 94,221.30 31,627.40 26,656.90 327,795.50

Central Kalimantan 107,977.60 30,273.40 8,827.80 6,884.80 153,963.60

West Sulawesi 23,842.60 15,772.40 3,435.90 3,498.10 46,549.00

North Maluku 54,017.40 18,212.80 6,042.70 6,684.90 84,957.80 Total (IDR million) 420,430.40 172,304.40 57,083.80 50,537.10 700,355.70

Total (USD million) 46.20 18.93 6.27 5.55 76.96

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Figure 2: DAK (Infrastructure Sector) Reporting Mechanism

17. According to a study by the SMERU Institute, the existing monitoring and evaluation of DAK-financed activities is still inadequate. In a number of ways, the findings of this study corroborate with those of the Bappenas study. Participants of focus group discussions (comprising of local officials and non-governmental organizations) gave a relatively low ranking to the monitoring and evaluation aspect of DAK. One of the problems highlighted by informants was that both central government and LGs do not allocate any funds in their budgets for monitoring and evaluation. In addition to the lack of funds, the superficial nature of monitoring and evaluation activities is related to the perceived benefit (or lack thereof) to the regions. A number of government staff in DAK-recipient LGs stated that they have never received any feedback on the reports they made for respective line ministries.

18. The findings of these studies suggest that significant problems exist on the monitoring and evaluation of DAK, and that these problems occur at different levels within the system of decentralization. Bappenas, together with the MoF, the MoHA, and the relevant ministries/agencies, has prepared a system for monitoring the technical implementation and evaluating the use of DAK, in the form of Guidelines for Monitoring Technical Implementation and Evaluating DAK‐Financed Activities through a Joint Circular Letter (SEB) of Bappenas, the MoF, and the MoHA on Guidelines for Monitoring Technical Implementation and Evaluating the Utilization of DAK. The SEB was socialized to LGs in August 2009. However, it is not yet effectively implemented. Bappenas will undertake a pilot implementation of DAK monitoring and evaluation as set forth by the SEB in four out of the five provinces participating in the project in 2010. The pilot implementation of DAK monitoring and evaluation focuses on the road and health sub-sectors. This project will benefit from the implementation of the pilot project to improve the readiness of LG staff in

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charge of managing the DAK for the road and health sub-sectors to comply with reporting obligations to the MPW.

19. Challenges in DAK implementation. Since the fiscal decentralization process began in 2001, policies regarding DAK and the application of such policies have been inconsistent and increasingly unclear. A recent study undertaken by Bappenas reveals that DAK management over the past five years has encountered financial, technical, institutional and good governance problems. From the financial aspect, the main problem is regions’ less-than-optimal DAK performance due to a mismatch between the amounts of allocation and local needs. From technical stance, LGs do not have clear guidance on the appropriate use of DAK or the timeline of achievements of DAK-funded projects. From an institutional standpoint, the problems include: weak or less-than-optimal institutional coordination between the central and the regions; non-existence of a coordination team established in the center and provinces; and less-than-optimal performance of coordination teams in the districts. From a good governance point of view, the main problem arises in relation to the application of the principles of transparency, accountability and participation in DAK management.

20. As previously mentioned, in addition to these challenges, the monitoring and evaluation of DAK-financed activities is still inadequate. This finding is in accordance with that mentioned in the Medium-Term National Development Planning 2010-2014: the document mentions that the DAK management (a) lacks of collaboration and coordination in term of its monitoring and evaluation, (b) lacks of commitment from LGs in delivering DAK implementation reports to the central government, and (c) the regions can only conduct limited monitoring for DAK activities.

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

INDONESIA: Local Government and Decentralization Project

Sector Issues Projects/Loans Latest Supervision (ISR/ICR) Ratings Implementation

Progress Development

Objective Agriculture and Rural Development ILGR (P076174)

Initiatives for Local Government Reforms

MS MS

WISMP (P059931) Water Resources and Irrigation Sector Management Program

S S

Urban Development USDRP (P071296)

Urban Sector Development and Reform Project

MU MS

PNPM UPP (P096921) National Program for Community Empowerment in Urban Areas

S S

PNPM II UPP (P109196) National Program for Community Empowerment in Urban Areas

n/a n/a

PNPM Urban II (P118113) National Program for Community Empowerment in Urban Areas

n/a n/a

Social Development National Program for

Community Empowerment in Rural Areas (P105002)

S S

Second National

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Sector Issues Projects/Loans Latest Supervision (ISR/ICR) Ratings Program for Community Empowerment in Rural Areas (P108757)

PNPM Rural III (P115052) National Program for Community Empowerment in Rural Areas

n/a n/a

Water Supply UWSSP (P090991)

Urban Water Supply and Sanitation

n/a n/a

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Annex 3: Results Framework and Monitoring


PDO Project Outcome Indicators Use of Project Outcome

Information The objective of the project is to improve the accountability and reporting of the central government’s Specific Purpose Grants (DAK) for the infrastructure sub-sectors within pilot local governments (LGs). This will be done through improved financial and technical reporting, and verification of outputs delivered by LGs with the DAK.

Development and use of an information system to which LGs report information to the MoF and the MPW. Percentage of physical outputs reported, verified and meeting eligibility criteria.

Improve the DAK system by: (i) LG reporting DAK outputs; (ii) use of web-based systems; and (iii) greater transparency in use of DAK funds.

Intermediate Outcomes Intermediate Outcome Indicators

Use of Intermediate Outcome Monitoring

a. DAK Transfers / Payments MoF transfers DAK to Districts in timely manner.

i. Percentage of LGs that receives DAK

payment 1 from the MoF by March 31.

LGs able to start process of procurement earlier, speed up investments and complete outputs on time; i.e. by December 31.

b. Monitoring & Reporting Improve central government monitoring and district government reporting systems.

ii. MoF and MPW Web-Based

Reporting Systems (WBRS) fully operated.

iii. Percentage of LGs reporting financial

information and outputs through MoF and MPW web-based systems.

iv. Supplement of the MPW’s Technical Guidelines on Environmental and Social Safeguards issued by MPW Ministerial Circular Letter.

v. The MoF will produce annual M&E

reports for the project on the DAK in the five provinces, a mid-term evaluation report and end of project final evaluation report.

Improve public information on DAK spending and outputs delivered. Strengthen the central government’s monitoring and evaluation on use of DAK funds and service improvements. Social and environment safeguards processes incorporated into LG planning processes. Assess the project’s progress and success in implementation and reporting of DAK. The M&E reports will be used to adjust project design as needed.

c. LG Budgeting & Expenditure Districts announce budget (APBD) in time to use DAK first payment.

vi. Percentage of LGs that have passed

their budgets and allocated contribution for the DAK by February 28.

vii. Number of eligible outputs completed by LGs by December 31.

LG budget and investment planning completed in a more timely manner. Improve timeliness of outputs delivered by LGs and quality of basic infrastructure services.

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Arrangements for results monitoring Target Values Data Collection and Reporting

Project Outcome Indicators Baseline YR1 YR2 YR3 YR4 YR5 Frequency and Reports

Data Collection Instruments Responsibility for Data Collection

Development and use of an information system to which LGs report information to the MoF and the MPW.

Percent of physical outputs reported, verified and meeting eligibility criteria.

Annual Annual

Web-based MIS in both the MoF and the MPW. BPKP Reports, LGs, MPW and MoF Reports

MoF, MPW MoF, MPW

Intermediate Outcome Indicators DAK Transfers / Payments Percentage of LGs that receives DAK payment 1 from the MoF by March 31.

Annual

DIPA

MoF

Monitoring & Reporting The MoF and the MPW Web-Based Reporting Systems (WBRS) fully operated. Percentage of LGs reporting financial information and outputs through the MoF and MPW wed-based systems.

Supplement of the MPW’s Technical Guidelines on Environmental and Social Safeguards issued by MPW Ministerial Circular Letter. The MoF will produce annual M&E reports for the project on the DAK in the five provinces, a mid-term evaluation report and end of project final evaluation report.

Annual Annual Once Annual

MoF MPW At the start of the project Bappenas

MoF, LGs MPW, LGs MPW Bappenas, LGs

LG Budgeting & Expenditure Number of eligible outputs completed by LGs by December 31.

Percentage of LGs that have passed their budgets and allocated contribution for the DAK by February 28.

Annual Annual

LGs LGs

MoF MoF

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Annex 4: Detailed Project Description


I. General

1. The project will be designed as a Specific Investment Loan, with a proposed size of IBRD financing of US$220 million, to be implemented over four years. It will be implemented using an Output Based Disbursement (OBD) financing approach supported by technical assistance activities to strengthen the framework for improving the quality of DAK expenditures. The project will be a pilot in five provinces and their districts (Jambi, East Java, Central Kalimantan, West Sulawesi, and North Maluku). Should the Ministry of Finance (MoF) wish to change or add any provinces during project implementation, the substitution will have to be agreed between the MoF and the Bank. In addition, the change or addition in provinces will have to be made before January 1 in the year they will participate, so that all the requirements for the project will then be applied to the new province. 2. The project will work with the existing mechanisms for transfer of DAK. Existing Government of Indonesia (GoI) and local government (LG) systems of monitoring and reporting will provide baseline information and criteria for evaluating project performance. II. Project Components 3. The project consists of three components: Component 1: Reimbursement of the Specific Purpose Grants (DAK); Component 2: Institutional Strengthening of Central and Local Governments, and Project Management; and Component 3: Verification of Outputs (VO). The MoF will finance Component 2 out of the GoI’s own budget resources, and BPKP will finance their verification of outputs function in Component 3 out of their own budget as well. The provision of these resources is a condition of DAK reimbursement under Component 1. A. Component 1: DAK-Reimbursement (US$220 million) 4. This component will be implemented by applying an output based disbursement financing approach, whereby the project will reimburse the existing DAK for infrastructure (roads, water, sanitation, and irrigation) based on reported and verified physical outputs delivered by selected LGs. The MoF will therefore be reimbursed for DAK transfers to the pilot LGs on the basis of reported and verified outputs. 5. The OBD approach will explicitly link the cost of each output to the amount of DAK financing allocated through reference unit costs to be determined at the beginning of each year by an in-depth analysis of MPW data for each DAK infrastructure sub-sector. The Operations Manual will provide the list and description of eligible outputs per sector, and the corresponding reference unit costs, performance, and reporting indicators. 6. The executed DAK will be reimbursed on the basis of the existing disbursement structure of the DAK. The effectiveness in the implementation of DAK-funded programs at the

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LG level will directly affect the amount of DAK reimbursement to the GoI. Under the existing DAK disbursement scheme: (i) a first payment is made to LGs corresponding to 30 percent of the total DAK allocation once they submit their budget and provide 10 percent matching funds; (ii) a second payment corresponding to 45 percent of the total DAK allocation is made after the LGs have spent 90 percent of the first payment; and (iii) a third payment equal to 25 percent of the total DAK allocation is made after the LGs have spent 90 percent of the second payment. 7. The reimbursement will be made to the MoF which, in turn, will transfer 10 percent of the funds to LGs in order to reimburse them for the share of funding they contribute to the DAK outputs. The amount of LG reimbursement is based on current DAK requirements for LG to finance 10 percent of DAK outputs. If DAK regulations are revised to increase the LG contribution above 10 percent, such an increase may be made applicable to the project by agreement between the GoI and the Bank. The amount transferred from MoF to the LGs will be a reward for the LGs meeting the eligibility criteria, and it is expected that this will also act as an incentive for increased compliance with eligibility criteria in future years. Of the eligible 81 LGs, only those that sent a Commitment Letter the MoF will be considered to be participating in the project. 8. The amount reimbursed by the project will be based on meeting eligibility conditions for outputs delivered, as specified in the table below. Outputs with or exceeding a contract value of US$400,000 will not be considered eligible for reimbursement, and will therefore not be part of the project.

Output Eligibility Criteria for Reimbursement of DAK Expenditures

i. Physical Realization of Outputs: Construction Completion Certificates, and Compliance with Technical Specifications (Form P-4, column 3, of Technical Guidelines).

ii. Compliance with National Procurement Law and regulations (Keppres 80/2003) in hiring of contractors.

iii. Compliance with Environment and Social Safeguards: Evidenced by Compliance Indicators Form in the Operation Manual.

9. Verification Process and Eligibility for Disbursements under Component 1. The verification of the agreed outputs is a core condition of disbursement, and a key project assurance from the GoI that loan funds have been used for the intended purposes, following principles of economy, efficiency and transparency. The role and functions of the verification of outputs will be performed by the State Finance and Development Supervisory Board (Badan Pengawasan Keuangan dan Pembangunan, or the BPKP). 10. First, the Ministry of Public Works (MPW) will need to establish the reference unit costs for each of the eligible outputs at the end on each DAK cycle. The reference unit costs should be provided from the MPW to the BPKP and the MoF by January 31 of each year, in order to be applied for the upcoming year’s outputs. The MoF will then submit the agreed upon reference unit costs for the eligible outputs to the Bank by February 15 of each year.

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11. Prior to the MoF submitting the request for disbursement to the Bank, the MoF will request the BPKP to verify, on a representative sample basis, the timeliness and accuracy of the financial and technical reports submitted to the MoF and the MPW by participating LGs. The BPKP will work closely with the MPW in conducting the VO process, although responsibility for the verification process will be with the BPKP. This verification will ensure that outputs for the specific allocation have been physically achieved, and are in compliance with agreed standards, procedures and policies on procurement, financial management, and social and environment safeguards.

12. All participating LGs will report to the BPKP the outputs that they have completed by December 31 in the year being verified. The BPKP will compile the list of completed outputs by LG by January 31 of the following year. The BPKP will calculate a value of potential reimbursement (VPR) for each LG by multiplying reported outputs by their reference unit costs. The BPKP will then randomly sample 20 percent of reported outputs within each province and verify compliance with output eligibility criteria listed above. BPKP will undertake verification in every LG. Based on the number of outputs in the sample that meet the eligibility criteria, the BPKP will then calculate the Qualifying Percentage (QP). For example, if half of the sampled contracts meet the eligibility criteria, the QP will be 50 percent.

13. The BPKP will then calculate the value of qualifying reimbursement (VQR) for each LG, by multiplying the QP by the VPR for that LG. Thus, if only half of the outputs in the sample meet the eligibility criteria, then the BPKP will recommend reimbursing only half of the VPR for that LG. The BPKP will calculate the value of total reimbursement (VTR) to be made from the Bank to the MoF, which is the sum across all LGs for the VQR by LGs. 14. Advance Payment. In order to shorten the time until the Bank’s first reimbursement, the MoF has requested an Advance Payment (AP). The AP will be equal to the sum of the values of the GoI’s first DAK payment to each LG that has received the first DAK payment by March 31. The AP will be at maximum 30 percent of total DAK allocated for the year, equal to the current first DAK payment from the MoF to LGs. The AP will also be made in the second and third year to speed up the allocation of the first DAK payments to LGs. For example, if half of the LGs in the five pilot provinces have received their first DAK by March 31, then the project will make an advance payment equal to the value of the first DAK allocated to those LGs. The BPKP will verify the request for an AP from the MoF and whether the LGs have received their first DAK, and submit the report to the MoF, which will then submit the AP request to the Bank. 15. Final Reimbursement. The Bank’s reimbursement of DAK expenditures will only occur once a year, as it is based on outputs delivered at year-end and verified in the first quarter of the calendar year. The amount of the Value of Final Reimbursement (VFR) will be the VTR minus AP. However, the amount disbursed by the project in any year will not exceed the actual amount of DAK allocated plus 10% (to cover the LG contribution) to the infrastructure sector in that year from the central budget. 16. LG Reimbursement. The MoF will transfer to the LGs a share of DAK funds reimbursed for all eligible outputs, which is currently set at 10 percent. The amount of the LG Reimbursement will be the Value of the Qualifying Reimbursement times 10 percent summed

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for all LGs. DAK regulations currently set the LG contribution requirement at 10 percent of sub-project costs. This percentage may be revised by the GoI from time to time and any revision may be made applicable to reimbursement under the project if agreed between the MoF and the Bank.

Table 1: Definitions of Reimbursement

Calculation Definition Calculated for each LG Value of Potential Reimbursement (VPR) Sum of reported outputs by their reference unit

costs. Qualifying Percentage (QP) Number of outputs in the sample that meet the

eligibility criteria, expressed as a share of sampled outputs.

Value of Qualifying Reimbursement (VQR) QP multiplied by VPR. Summed across LGs Value of Total Reimbursement (VTR) Sum of Value of Qualifying Reimbursement

(VQR) across all LGs. Payments to be made by the World Bank: Advance Payment (AP) Sum of the values of the GoI’s first DAK

payment to each LG that has received its first DAK payment by March 31.

Value of Final Reimbursement (VFR) VTR – AP LG Reimbursement 10 percent (currently) of VQR 17. Bank’s Payments. The BPKP will calculate all of the above variables. The BPKP reports will recommend for the Bank to make only the following two payments to the MoF: (i) Advance Payment; and (ii) Value of Final Reimbursement. Both of these values should be submitted to the MoF by April 30, which will submit the reports to the Bank. Figure 1 provides an illustration of the component’s disbursement flow.

Figure 1: Reimbursement and Advance Payment

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May

GOI

BPKP

DAK 30%

Year n+1

WB

Year n

DAK 30% DAK 45% DAK 25%

Advanced Payment (AP)Reimbursement

Verification of DAK 1received by LGs Output

Verification

AP

DAK 1 to LGs

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18. In the event that the amount of the AP in a given year exceeds the total amount of DAK that can be reimbursed (i.e. the VTR) for that year based on the verification review by the BPKP, then the Bank will not reimburse anything for the VFR. This will also require that the amount of the AP be reduced in the subsequent year by the amount of overpayment. If this situation occurs in either of the first or second year of the project, then the amount of the AP may be proactively reduced by the mid-term review, or the Bank may decide not to make APs in subsequent years, in order to avoid overpayment in the final year of the project. The Bank will also reserve the right decline to provide any Advance Payment in subsequent years if this situation occurs. 19. The BPKP will report its findings and recommendations in a combined Financial and Output Verification Report (OVR). The OVR will have a specific template that will include the level of compliance with agreed indicators. The BPKP will submit the OVR to the PIU, which will use it as the only basis to request Bank disbursements under this component. The Bank’s reimbursement of DAK expenditures will only occur once a year, as it is based on outputs delivered at year-end and verified in the first quarter of the calendar year. B. Component 2: Institutional Strengthening to Central and Local Governments, and

Project Management Support (US$8.5 million) 20. This component will support the strengthening of the basic institutional functioning of the project. It will be split into four sub-components, which are described below. Component 2 will be financed from the GoI’s national budget. The GoI will provide not less than US$8,500,000 equivalent from its budget to finance the activities under Component 2 of the project. The provision of these resources is a condition of DAK reimbursement under Component 1 of the project. Each year during project implementation, each participating agency—the BPKP, Bappenas, the MoF, the MPW (including TA for LGs from the MoF and the MPW)—will submit to the Bank a work plan for technical assistance to support the planning, technical, procurement, financial management, social and environmental safeguards, and improving reporting capacity of both central agencies and LGs. 21. In order to ensure adequate funding is available and that the TA is delivered, the following will be conditions for each year’s DAK to be eligible for reimbursement: (i) agreed upon funds are allocated in the APBN for the TA; and (ii) the work-plan is prepared and agreed upon with the Bank. In the event that the GoI has not provided the required funds and work plan for technical assistance for the fiscal year being verified, then the Bank has the right to not provide the Advance Payment or Reimbursement for that year. For 2010, the GoI will provide the Bank with its TA work program and budget within 30 days of project effectiveness. B.1 Sub-Component 2.1: Developing a Monitoring and Evaluation System 22. This sub-component will support the design and implementation of a monitoring and evaluation (M&E) system for financial and technical/output reporting. Such a system will constitutes a key element of the basic architecture of the program, and one that the GoI has made a top priority as part of this project. This sub-component will support the following activities: (i) strengthening of the MoF’s monitoring of financial reports and building LGs’ capacity in developing an integrated system of financial and physical reports that can be automatically

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generated and linked to the MoF’s Web-Based Transfer Monitoring System; (ii) development of a strategy for the overall M&E system and support for capacity building in the MPW, and strengthen the MPW’s management information system (MIS), which will provide up-to-date information on program activities and physical outputs; and (iii) development of instruments to monitor program processes to provide feedback on the quality of service delivery and program implementation, and to detect problems for timely correction. B.2 Sub-Component 2.2: Web-Based Monitoring and Reporting System 23. This sub-component will support the expansion and enhancement of the existing MoF Web-Based Transfer Monitoring System (WBTMS) to become a Web-Based Reporting System (WBRS), which will be used to report all transfers from the MoF to LGs, including the DAK allocations, and to report the disbursement of the transfers. It will cover financial aspects, as well as output aspects, such as information on project location, GPS coordinate, technical data, physical progress and visual (picture) of the projects. The data of the WBRS will be input by the MoF (allocation and transfer information), LGs (local fund contribution, disbursement, output information), and the BPKP (verification results of every project). The users of the WBRS will include the MoF, LGs, BPKP, MPW, MoHA and Bappenas, and other relevant agencies. 24. The WBRS will be designed not only to cover DAK, but also other types of transfers for all LGs. However, following the piloting approach, in the short term for this project, the WBRS will be used only for the infrastructure DAK transfers for the 81 participating LGs. This sub-component will need intensive training support for around 1,000 officers from all 81 LGs, as well as relevant officers from the MoF, the MoHA, Bappenas, and line ministries. In addition, this sub-component will need intensive on-site assistances for 81 LGs to implement the WBRS. Both intensive training and on-site assistance will be provided under sub-component 2.3. B.3 Sub-Component 2.3: Technical Assistance for Central and Local Governments 25. This sub-component will finance technical assistance to be provided in terms of: (i) strengthening of the operational institutional framework at the central level, including revision of some regulations, as needed (technical guidelines, ministerial decrees, or other government regulations); and (ii) strengthening LGs’ ability to meet requirements for DAK planning, utilization and reporting. The BPKP will finance any required internal capacity building and training of staff from its own budget. The Bank will work with the BPKP and assess annually the adequacy of its proposed capacity building program. B.4 Sub-Component 2.4: Project Management Support 26. This component will finance the operating costs of the PIU at the MoF to implement and monitor the project. Each year during Project implementation, each participating agency—the BPKP, Bappenas, the MoF, the MPW (including TA for LGs from the MoF and the MPW)—will submit to the Bank a work plan for technical assistance to support the planning, technical, procurement, financial management, social and environmental safeguards, and improving reporting capacity of both central agencies and LGs. The work plans will be submitted by the date which is 30 days after the effectiveness of the loan agreement for the July – December 2010

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period, and by October 31 in each year for the upcoming year (beginning with October 31, 2010). The PIU will consolidate the work plans of the MoF, the MPW and Bappenas. The BPKP will submit its work plan separately under Component 3, and the requirements will be set out in the VO Terms of Reference. C. Component 3: Verification of Outputs (US$ 4.5 million) 27. This component will constitute BPKP doing the verification of outputs. BPKP will finance the VO function, plus any needed hiring of new staff, which includes technical (engineering), procurement, and environment and social safeguards, as well as capacity enhancement from their own budget. An assessment of BKPK’s ability to do the VO function shows that they currently do technical audits for selected infrastructure outputs in LGs. However, in order to do the VO at the scale required for the project, the BPKP will require additional financial and human resources. 28. In order to ensure adequate funding is available for BPKP, the following will be conditions for each year’s DAK to be eligible for reimbursement: (i) agreed upon funds are allocated by BPKP as set out in the VO Terms of Reference; and (ii) the work-plan is prepared and agreed upon with the Bank. In the event that the BPKP has not provided the budget and work plan for the fiscal year being verified, then the Bank has the right not to make Advance Payment or Reimbursement for that year. The verification of the agreed outputs is a core condition of disbursement, and a key project assurance from the GoI that loan funds have been used for the intended purposes, following principles of economy, efficiency and transparency. 29. Prior to the MoF submitting the request for disbursement to the Bank, the MoF will request the BPKP to verify the timeliness and accuracy of the financial and technical reports submitted to the MoF and the MPW by participating LGs. This verification process will ensure that outputs for the specific allocation have been physically achieved, and are in compliance with the agreed procedures and policies on procurement, financial management, and social and environment safeguards. 30. The BPKP will report its findings and recommendations in an Output Verification Report (OVR). The OVR will have a specific template that will include the level of compliance with agreed indicators. The BPKP will submit the OVR to the PIU, which will use it as the only basis to request Bank disbursements under this component. 31. The BPKP will carry out the output verification process on a representative sample basis for projects in LGs and for the different sub-sectors (e.g. roads, irrigation, water, and sanitation). The representative sample be suggested by the BPKP and agreed by the PIU and the Bank prior to the verification process commencing. The Operations Manual will describe in detail the role and functions of the BPKP. 32. Eligible Outputs for Reimbursement. The eligible outputs are defined as single sub-projects to be carried out by the selected LGs and funded by the DAK. An output is defined as a contracted sub-project or paket pekerjaan represented by a line item in various obligatory reports

42

sent by the LG to the MPW. Eligible outputs are defined in the MPW’s Circular Letter No. KU.01.01-Mn/678 on The Scope of the Utilization of DAK Infrastructure Grants, as follows:

a. Road Sub-Sector: The scope of this activity includes periodic maintenance and improvement/rehabilitation of provincial, district/city roads and bridges within the LG’s.

b. Irrigation Sub-Sector: The scope of this activity includes improvement, rehabilitation, and development of irrigation networks, including swamp reclamation networks, and village irrigation networks under the jurisdiction of the selected districts/cities and provinces, to support the national food security program.

c. Water Sub-Sector: The scope of this activity covers development of: water intake from

surface water; water intake from wells; small water treatment plants (SPAM); water pipe networks; housing connections; and development of public water hydrants. The projects must be outside the Perusahaan Daerah Air Minum (PDAM) network.

d. Sanitation Sub-Sector: The scope of this activity focuses on the development of

community sanitation facilities; community waste drainage facilities; and solid waste facilities, public toilets and small waste water treatment plants for 100-200 households.

33. The following steps constitute the details of the verification process:

a. Condition 1: Reference Unit Costs and Eligible Outputs: The MPW will provide the Bank with the reference unit costs (RUCs) for the associated outputs by February 15. The reference outputs for roads, water, sanitation, and irrigation are as follows: periodic maintenance and improvement; rehabilitation; water covers various investments related to housing connections for drinking water; public sanitation facilities; and drainage systems. The RUC is derived from historical data of DAK contracts. The RUCs for 2010 per infrastructure sub-sector in each selected province are listed below.

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Table 2: Reference Unit Costs for Eligible Outputs

Jambi East JavaCentral

KalimantanWest Sulawesi North Maluku

A Road Sub-sectorA.1 Road: Periodic Maintenance

1 Pavement width 3,00 - 5,00 m km 559,518,000 523,190,000 24,449,000 23,316,000 26,354,000 2 Pavement width 5,00 - 7,00 m km 775,167,000 724,970,000 54,877,000 52,417,000 59,169,000 3 Pavement width 7,00 - 14,00 m km 1,465,544,000 1,374,292,000 81,942,000 78,428,000 88,330,000

A.2 Road: Betterment from Soil to AC-WC1 Pavement width 3,00 - 5,00 m, km 2,221,553,000 2,095,329,000 2,117,334,000 2,033,748,000 2,398,456,000 2 Pavement width 5,00 - 7,00 m, km 3,098,824,000 2,923,663,000 2,945,502,000 2,829,886,000 3,351,901,000 2 Pavement width 7,00 - 14,00 m km 5,942,582,000 5,622,564,000 5,650,731,000 5,431,068,000 6,467,602,000

A.3 Bridge: Periodic Maintenance1 Bridge A class, pavement width 7,00 m m' 5,325,949.00 4,792,855 5,644,418 5,335,118.41 6,466,549.00 2 Bridge B class, pavement width 6,00 m m' 4,468,466.00 4,009,702 4,739,699 4,470,072.93 5,427,702.00 3 Bridge C class, pavement width 4.5 m m' 3,703,959.00 3,313,297 3,933,934 3,698,176.45 4,483,581.00

B Irrigation Sub-sector1 Light and Medium Rehabilitation ha 1,500,000 1,250,000 2,250,000 3,000,000 4,250,000 2 Heavy Rehabilitation and Upgrading ha 2,500,000 2,250,000 3,500,000 7,500,000 10,000,000

C Water Sub-sector 2010*)1 Water Intake Rehabilitation l/s 157,719,100 174,379,700 174,379,700 209,284,900 209,284,900 2 Deep Well l/s 200,531,100 205,166,500 205,166,500 257,813,600 257,813,600 3 Water Treatment Instalation l/s 1,355,092,200 1,364,121,000 1,364,121,000 1,412,955,500 1,412,955,500 4 Pipeline Network m 170,940 173,360 173,360 252,120 252,120 5 House Connection unit 4,874,100 5,308,600 5,308,600 7,305,100 7,305,100 6 Public Hydrant/ Water Tank unit 9,990,200 10,830,600 10,830,600 13,564,100 13,564,100

D Sanitation Sub-sector1 Public Toilet**) unit 280,000,000 350,000,000 378,000,000 490,000,000 700,000,000 2 Communal Waste Water Treatment Plan**) unit 240,000,000 300,000,000 324,000,000 420,000,000 600,000,000 3 Drainage***) ha 142,400,000 178,000,000 192,240,000 249,200,000 356,000,000 4 Solid Waste Treatment Facility unit TBD TBD TBD TBD TBD

**) for 100 - 150 house hold

***) new treatment for third drainage connection

*) segregattion based on the AB-K2 form by Cipta Karya

No Output UnitProvince (IDR)

b. Condition 2: Construction Completion Certificate: The BPKP will request from the

specific LGs the construction completion certificate for each sub-project completed. If there is no completion certificate the BPKP will not proceed with verification. This implies that a particular subproject will be deemed to be non-compliant regardless of whether it meets the other three eligibility conditions.

c. Condition 3: Physical Outputs: The BPKP will visit each location to assess that physical

outputs, as stated in the Construction Completion Certificate, have been achieved. This will include ensuring that the physicality of the output has been achieved; i.e. a kilometer of road has been constructed to the agreed specification, an irrigation cannel rehabilitated, or that water connections have been delivered and are in working order.

d. Condition 4: Procurement: The BPKP will verify that the tenders and award processes under which the given sub-project has been executed have followed the procurement conditions established in Keppres 80/2003, as well as the use of the national standard bidding documents agreed with the Bank at appraisal. In this regard, the BPKP will validate from the LG that the contract packages required to produce the outputs were awarded following principles with respect to transparency and fair competition. This will include review of public notice and advertisement of the sub-project, and confirmation of actual existence of the bidders and the contractors who have been awarded.

e. Condition 5: Safeguards: The implementing LG agencies will be responsible for ensuring that all aspects related to safeguards have been complied with, such as social and

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environmental, as well as indigenous peoples. The BPKP, with the assistance of the MPW, will confirm whether LGs are in compliance with the environmental and social safeguards as specified in the Supplement of the MPW’s Technical Guidelines.

f. Condition 6: BPKP Reports. The combined Financial and Output Verification Report for the DAK for the infrastructure sector will be conducted by the BPKP and submitted to the MoF, which in turn submits the report to the Bank for reimbursement.

34. Bank disbursements under Component 1 will be made based on meeting the eligibility criteria for reimbursement outlined above. The BPKP review will be based on a sample of projects in each LG, which will be extrapolated for reimbursement. If Condition 1 (eligible outputs and reference unit costs defined by February 15) is not met, the sub-project’s reported output is deemed to achieve zero compliance for the year. Compliance for Conditions 2 through 6 will be judged based on completed outputs delivered by LGs and verified by the BPKP. 35. The MPW, in consultation with the PIU and Bappenas, will be responsible for continuous monitoring of the program, and for conducting evaluation reports on the performance of the DAK program in the five provinces. The PIU will prepare annual monitoring and evaluation reports based on end-of-year outputs delivered, which should be finalized in the first quarter of the calendar year. The PIU will conduct a mid-term review (MTR) of the project by the end of 2012. The annual M&E reports and MTR will form the basis for assessing any changes in the project design, implementation, and possible restructuring, if needed.

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Annex 5: Project Costs


Project Cost By Component and/or Activity Local

US$ million Foreign

US$ million Total

US$ million Payments for Outputs of Sub-projects under Component 1 of the Project (DAK Reimbursement)

220.00

Institutional strengthening: Developing monitoring and evaluation system

8.501

Technical Assistance to Central and LGs Verification of Outputs

4.502

Total Baseline Cost 233.00

Physical Contingencies Price Contingencies

Total Project Costs 233.00 Interest during construction

Front-end Fee

Total Financing Required 233.00

1 GoI financed. 2 BPKP financed.

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Annex 6: Implementation Arrangements

INDONESIA: Local Government and Decentralization Project 1. The Government of Indonesia (GoI) will implement the project through the Ministry of Finance (MoF). The MoF and the Ministry of Public Works (MPW) will be the key institutions for the implementation of the project. The implementation arrangements for the proposed project are organized in two parts: (i) operational execution and coordination of the project; (ii) the structure of the Output-Based Disbursement (OBD) financing approach to be applied for the implementation of Component 1. Operational Execution and Coordination of the Project 2. General Coordination. The GoI will from a steering committee with representatives from MoF, MPW, BAPPENAS and MOHA. Overall coordination of the project will be provided by the MoF through a Project Implementation Unit (PIU) that will be formally established under the Director of Balancing Funds, Directorate General of Fiscal Balance. The PIU will be coordinated by a MoF staff member who will report to the MoF’s Director of Balancing Funds. The structure and specific responsibilities of the PIU will be defined in the Operations Manual (OM). 3. Project Implementation Unit. The PIU consists of MoF staff, including the following core team: (i) a general coordinator and administrative staff. Experts in the following areas will be hired; (i) an environmental-social-technical coordinator; (ii) a civil works monitoring/supervising engineer; (iii) a financial management specialist; (iv) a procurement specialist. The PIU will be assisted by individual consultants, which will be responsible for supporting the PIU on technical, operational, administrative, financial, procurement, safeguard, and monitoring and evaluation aspects of the implementation of the project. 4. Operations Manual (OM). The purpose of the OM is to guide and instruct management and ensure good implementation practices and performance by the executing entities. The OM will describe the concept, scope, objectives, components, and funding mechanisms of the project. In addition, it will contain an overall implementation schedule, and organizational details (management structure and responsibilities), which will include: (i) review of the selection criteria, requirements and operating guidelines applicable to the activities financed by the project (from a technical, financial, social, environmental/safeguard perspective); (ii) implementation of all components, including the TA funding requirements of the project; (iii) oversight and compliance with social and environmental safeguards of the Bank by LGs; (iv) application of Bank guidelines and policies for procurement of works, goods and services, as well as for financial management, disbursement and audits of the project and respective forms, reports and guidelines required for project implementation; and (v) implementation of a monitoring and evaluation system for the results of the activities.

5. Bank Supervision Responsibilities. The Bank task team leader and its team will be responsible for supervising implementation and for coordinating the dialogue between the MoF and the Bank during implementation, with support from the PIU. The Bank team will carry out, as a minimum, bi-annual supervision missions to follow-up on implementation progress.

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Structure and Implementation of Component 1 6. Output Based Disbursement Financing Approach. Component 1 of the project will be implemented using an output based disbursement financing approach. Annex 4 provides a detailed description of this approach. Loan proceeds for this component will be withdrawn by the MoF using the reimbursement method. The MoF will submit reimbursement requests to the Bank task team leader for No Objection, supported by an OVR. Figure 1 below outlines the institutional and implementation arrangements that will govern the execution of the project.

Figure 1: Institutional and Implementation Arrangements

MoF BAPPENAS MoHA MPW

NATIONAL STEERING COMMITTEE

Executing Agency

DGFB

MPW

Secretariat General

LG

PROV KAB KOT

BPKP

WB

Integrated Financial and Output Verification Reports

Outputs

DINAS/SKPDDGBM

DGSDA

DGCK

OVR

Reimbursement

ItJen

Monitoring & Evaluation of DAK Program

7. LG Commitment Letters. All selected LGs will be required to submit binding commitment letters to the MoF in order to be considered part of the Project and for the MoF to receive reimbursement of outputs in the LGs or for an LG to receive LG Reimbursement. These Commitment Letters will set forth the obligations in the implementation of the activities and include, inter alia: First, LGs’ obligations to: (i) deliver the outputs in accordance with the financial and technical conditions and the standards for budgeting, planning, procurement, contract management and financial management set out in the Technical Guidelines; (ii) comply with environmental and social safeguards technical and reporting requirements set out in the Technical Guidelines and the Supplemental Guidelines; and the Bank’s Anti-corruption Guidelines; (iii) monitor outputs, indicators, and comply with the reporting requirements applicable to each activity, including the WBRS; (iv) enable the required audits and the BPKP verification of the outputs and performance conditions; and (v) enable the MoF and the Bank to review the documents related to the entire project and enter the sites to review the implementation of the sub-projects. Second, that any if Sub-project is not implemented in

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accordance with the Technical Guidelines and the Supplemental Guidelines, then outputs from that Sub-project will not be eligible for Advance Payment or Reimbursement. 8. DAK Budgeting. Each DAK allocation will have been budgeted and formally approved by the selected LG legislatures, appearing with a budget code in the Commitment Letter. LGs’ financial systems will be used to track and report DAK budget estimates and actual expenditures for purposes of Bank financial management. Selected LGs’ estimated annual budgets will be included in the Commitment Letter and a rule will be enforced requiring each LG to allocate DAK budget (as approved by the legislature) in its local budget (APBD). 9. Pre-financing and Performance Risk. The MoF, through the DAK allocation, will pre-finance the total cost of qualifying expenditure items for goods, works and services required by selected LGs to produce the agreed outputs, and bear the associated performance risks, particularly the risk of cost overruns or shortfalls due to non-delivery of outputs or delivery of inappropriate or insufficient outputs. 10. Independent Verification of Outputs. The BPKP will be responsible for verification of physical outputs delivered by the LGs. For disbursement purposes, the BPKP will review supporting documentation of eligible expenditures, and conduct physical verification of outputs. The BPKP will review documents and other evidence showing that expenditures in the budget line items supported by the DAK are eligible. 11. Compliance with laws and regulations. The LGs will be wholly responsible to the MoF for ensuring compliance with the requirements of relevant national laws and regulations pertaining to procurement, environmental, and technical and quality standards, in accordance to highest ethical standards and professional integrity. 12. Anti-corruption. The October 2006 Guidelines on Preventing and Combating Fraud and Corruption in Projects Financed by IBRD Loans and IDA Credits and Grants will be part of the Commitment Letters between the MoF and LGs. The Bank will have the right to inspect and audit the selected LG accounts, records and documents related to contract performance, as well as in all those contracts procured by the selected LGs with suppliers and contractors. Under the Commitment Letters, the MoF will be authorized to use remedies if the Bank were to exercise remedies in case of fraudulent and corrupt practices.

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Annex 7: Financial Management and Disbursement Arrangements


Overview 1. The MoF has requested that the World Bank support LGs in improving their use of the DAK, while strengthening the GoI’s systems on reporting and monitoring the utilization of the DAK. Since the implementation of the fiscal decentralization policy in 2001, policies regarding the DAK have been well established, although the monitoring and verification of the use of funds, particularly with regard to physical outputs remains a challenge.

2. A recent study undertaken by the National Planning Agency (Bappenas), Options for Improving DAK Grants (2009), assessed the DAK management over the past five years. The study reveals that improvements are needed in financial, technical, institutional and governance aspects of the DAK.

3. This report documents the financial management assessment of the existing DAK. The purpose of the assessment is to determine whether the financial management system of DAK grants has the capacity to produce timely, relevant and reliable financial information on the project activities, and if the accounting system for the project expenditures and underlying internal controls are adequate to meet fiduciary objectives and satisfy the Bank’s OP/BP 10.02, and allows the Bank to monitor compliance with agreed implementation procedures and appraise progress towards its objectives.

4. The project is designed as a Specific Investment Loan (SIL) to be implemented using an Output-Based Disbursement (OBD) approach. Under the proposed OBD approach, the project will reimburse the existing DAK for infrastructure (roads, water, sanitation, and irrigation) based on delivery of independently verified physical outputs by selected LGs. The project will be implemented in five provinces and their districts, with a proposed size of IBRD financing of US$220 million, and to be implemented over four years. This is a pilot and will impact the design of future DAK arrangements.

5. The financial management assessment concludes that the current DAK grant arrangements satisfy the Bank’s requirements for financial management as stipulated in OP/BP 10.02. The risk at the LG level is high given that payment verification mechanisms vary significantly across LGs. While the segregation of duties is in place, not all LGs have requested third party consultant(s) to verify payments made on infrastructure. At the central level, the DGFB (MoF) receives accountability reports on the use of DAK funds. However, the DGFB does not conduct verification on the use of the funds reported, hence the report is too general, and it does not provide enough information for traceability purposes. On the technical side, LGs send technical progress reports on DAK implementation, although the reporting requirement to the MPW has low compliance and the MPW also does not conduct output verification on the reports received.

6. There is currently no integrated management information system in place for the DAK program. The financial management risk is similar to the overall risk of the project, which is

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considered ‘High Risk’ before mitigation and ‘Substantial’ after mitigation. In order to overcome the risks regarding financial management, the mitigation measures include: (i) establishing an improved reporting format and integrated management information system for DAK, which provides better traceability on the use of DAK funds; (ii) conducting output verification on the reports received; (iii) and establishing arrangements between the BPKP and the Bank on the ToR for the BPKP as the output verifier for the project; (iv) a binding Commitment Letter from the participating LG to MoF; (v) TA to improve LG administration and internal audit of DAK; and (vi) improving the external audit arrangements for the DAK program.

Country Issues 7. The recently concluded PEFA assessment indicates that in recent years Indonesia has made significant changes in the way public finances are managed, with increasing transparency and independent oversight. In almost all areas of public financial management, a sound regulatory framework is in place. Advances have been made in budget preparation, and with instituting a state budget that combines the previously separated recurrent and development budgets. However, internal control in the execution of budget by spending agencies has not scored well overall. Internal audits exist in all ministries but generally lack the capacity to carry out risk based auditing.

8. The Bank and several other development partners are engaged with the GoI in providing assistance in several areas. The Government Financial Management and Revenue Administration Project (GFMRAP) is the Bank’s primary channel for assisting the GoI on these issues. The Bank is also working with internal auditors of two line ministries (including the MPW), the BPKP and the external independent auditor, the State Audit Board (BPK), to strengthen their capacity. Implementation experience with the MoF and the MPW suggests that although most of these country issues apply, the MoF and the MPW are relatively better performing ministries in terms of compliance with the finance and treasury laws. Implementation experience at the LG level varies. After the decentralization, the MoHA only provides general guidelines, while detailed implementation depends on initiatives in each LG.

9. Since DAK is an existing program of the GoI, most of the strengths and weaknesses of the PFM environment are relevant to the program. The risk-mitigating measures proposed for the program have been designed taking the assessment of the country level PFM issues in account.

Strengths and Weaknesses Strengths Extensive guidelines are available on DAK implementation:

o MPW’s regulation, Permen MPW no. 42/PRT/M2007 regarding technical guidelines on use of DAK to for infrastructure funding;

o MoF’s regulation, Permenkeu no. 175/PMK.7/2009 regarding allocation and general guidelines for DAK FY 2010 implementation;

o MoHA’s regulation, Permendagri no. 20 FY 2009 regarding guidelines on financial management of DAK implementation for local government; and

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o Joint circular letter from the MoF, Bappenas and the MoHA on DAK implementation, No. 0239/ M. PPN/11/2008 which discusses a joint forum for monitoring. The circular letter has not been implemented yet. Pilot implementation of the joint circular letter is financed by DSF, and is in the preparation stage. The implementation will take place at the same time as the project.

The LG inspectorate has covered DAK expenditures as part of its internal audit program of each respected LG although the report does not differentiate the DAK program from the rest of each LG’s expenditures.

The DAK program is part of LG expenditures. Although no separate audit is available in the program, the DAK has been audited by the BPK as part of its local government audit.

Weaknesses None of the 81 participating LGs received an unqualified opinion from the BPK in FY 2007

and 2008. Some 54 percent of the participating LGs received an adverse opinion from BPK in FY 2007 audit. This condition improved in FY 2008 audit, with 61 percent of the participating LGs receiving a qualified opinion from the BPK.

Not all LG financial units have an accounting background. The capacity(s) to produce reliable financial report on DAK implementation varies.

The current applicable reporting requirement are: o The reporting requirement under MPW regulation, Permen MPW No. 42/ 2007

mandates all LGs’ Public Works Dinas to send physical progress reports to the MPW on a quarterly basis.

o MoF regulation, Permenkeu No. 21/ 2009 mandates all LGs to submit financial progress of DAK implementation to the MoF when 90 percent of the DAK funds have been spent prior to any further tranche.

The timely compliance is higher for the MoF reporting than the MPW’s. No remedies are applied for non-compliance with the requirement of reporting of physical progress to the MPW. There is risk that financial compliance is not in line with physical compliance since both reports are not integrated.

The project internal control will follow the GoI’s internal control mechanism. o Although the segregation of duties is in place, not all payment (technical) verification is

supported by independent verification of the physical progress. o DAK accounts are not kept in LG’s computerized book of account. They are kept in

secondary records such as separate files, separate register books with ‘DAK’ stamped or written on invoices, to segregate DAK spending and account for the expenditures separately. There is the risk that DAK expenditure may be reported both under DAK and the other expenditures of the LGs. There is also risk that regular LG expenditures could be reported under DAK expenditures.

o Since DAK funds are transferred to a common account (for transfer from the central government), reconciliation of DAK funds is difficult and has never been prepared.

The current reporting format from participating LGs to the MoF does not have sufficient detail(s) to allow for traceability and better monitoring. However, currently the MoF is still in

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the process of building an integrated management information system for DAK implementation.

The BPK audit of LGs does not provide a separate opinion on DAK implementation. In addition, the BPKP reviews DAK implementation as requested by the MoF, but the BPKP also does not provide an opinion on it.

Financial Management Capacity Assessment 10. A financial management capacity assessment was also conducted for the DGFB, MoF. During the assessment, FMS and consultants had several meetings with DGFB staff. Field visits were also conducted to eight LGs (of the potentially 81 participating LGs) for the financial management capacity assessment—these were Ngawi, Lamongan, Gresik and Mojokerto in East Java; Tidore in North Maluku; Merangin in Jambi; Palangkaraya and Kapuas in Central Kalimantan. These eight LGs were selected as they have a history of significant DAK allocations and ability to absorb the DAK.

11. During these visits, meetings were held with the Public Works Dinas, the finance unit, the planning unit and the LG inspectorate. The rest of the assessment was conducted through interviews and discussions via phone, fax and email.

12. The Bank team also reviewed: (i) FY 2007 and 2008 BPKP reports on DAK, (ii) the BPK report for selected LGs; and (iii) all existing regulations related to DAK implementation3. All interviews and discussions related to this assessment have been filed in IRIS. Risk Assessment Summary 13. A detailed analysis of the financial management risks arising from the country situation, the proposed project entities, and specific project features and related internal controls was completed during the assessment, and is summarized below. These risks have been rated on a scale of high, substantial, moderate and low.

3 MPW’s regulation, Permen MPW no. 42/PRT/M2007 regarding technical guidelines on use of DAK to

for infrastructure funding. MoF’s regulation, Permenkeu no. 175/PMK.7/2009 regarding allocation and general guidelines for DAK

FY 2010 implementation. MoHA’s regulation, Permendagri no. 20 FY 2009 regarding guidelines on financial management on DAK

implementation for local government. Joint circular from MoF, Bappenas and MoHA on DAK implementation, no. 0239/ M. PPN/11/2008 which

talks about a joint forum for monitoring.

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Risks Risk rating before mitigation

Mitigation measures Residual Risks

Condition of Negotiations/of Effectiveness (Y/N?)

A. Inherent Risks Country Level 1. Public Financial

Management Government system has significant weaknesses especially in the area of budget execution and internal control as reflected in PEFA assessment of 2008. .

S Government is committed to improving its performance in public financial management, including through the Bank-financed project (GFMRAP). However, making substantial progress on the country issues has been challenging and is likely to remain so.

S N

Overall Country Risk S S Entity Level 1. Implementing Entity/Organization The project will be implemented by the DG Fiscal Balance (DGFB), Ministry of Finance (MoF). DGFB has never implemented World Bank and or donor funded projects. The capacity of participating local governments (81 districts in 5 provinces) in adequately accounting for funds received and used varies.

S The PIU (Project Implementation Unit) will be set up in DGFB, MoF. The PIU will have fulltime staff assignments, who will be responsible for project implementation. The PIU will include financial a management specialist and an individual financial consultant. Most of DGFB staff have sufficient capacity to perform good financial management practices for the project Most LGs have finance units with sufficient capacity to produce reliable financial reports on the DAK implementation.

M Y, MoF letter SK appointing PIU by effectiveness

Overall Entity Risk S M

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Project Complexity 1. The project will be

implemented by applying an Output-Based Disbursement (OBD) financing approach. The OBD approach was designed to sharpen the focus on efficient, transparent results of DAK implementation, instead of traditional ring-fenced infrastructure project based on inputs. There is a risk that (a) OBD approach is being used for the first time by Government for DAK; and (b) BPK may not have the capacity to adequately play the role of output verification agent.

2. The role and functions of

the verification of outputs will be performed by BPKP. This role requires BPKP to hire consultant to be able to deliver the work. Since all of the DAK reimbursement will be roads, water and sanitation and irrigation, which under MPW’s responsibility. There should be close coordination between BPKP and MPW.

H

1. There should be close

coordination among MPW, BPKP and MoF.

2. There will be separate Verification Arrangement between the BPKP and the Bank agreeing on the framework for output verification, ToR and responsibility of the BPKP for output verification.

3. There will be arrangement between the MoF and the BPKP to undertake verification of outputs (VO) for the Project in accordance with the VO Terms of Reference.

4. There will be binding commitment letter from each participating LG to the MoF to ensure participating local governments carry out activities and deliver outputs in accordance with the timeframe and financial and technical conditions.

S Y, Scope of Work for the BPKP by negotiations, and Arrangement between the Bank and the BPKP (including ToR acceptable to the Bank) by effectiveness

Overall Project Risk H H B. Control Risk

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1. Budget There is risk that there will be a delay in issuance of the local government budget. There is a risk that DAK activities might not be known.

M To anticipate delay following are the action taken by the MoF: 1. In October, the MoF inform local

government on the sectoral budget allocation on DAK for the following year. This arrangement will allow LGs to have sufficient time to put in the LG’s budget.

2. The MoF requires payment of DAK first tranche made only when DAK activities and the LGs contribution included in the local government budget (APBD) for the year available and submitted to the DGFB, MoF. This will allow the use of the DAK funds right away after its receipt.

M N

2. Accounting Local Government has its own accounting system in place. The accounting system is operational and able to produce local government financial statement. DAK transactions are not differentiate from the LG’s accounting system. They are kept manually in separate records such as separate files, separate register books, DAK stamps, DAK remarks (written on invoices), etc to segregate DAK spending and account for the expenditures separately. Not all local government financial units have a staff with accounting background. The capacity(s) to produce reliable financial report on DAK implementation varies. DAK funds transfer into a common account (for transfer from central government), reconciliation of DAK funds is difficult.

H To improve the capacity of local government’s finance unit; TA would be required to: 1. Provide training especially for the

DAK administration to produce reliable financial report on DAK.

2. Require all finance unit(s) to maintain separate register books (by sector) for the DAK transactions or install a system that enables separate coding for the DAK in their computerized system.

S N

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3. Internal Control The project will faced the risk that payments will be made without properly verifying (technical verification) that work paid for is completed and is eligible for funding, since not all local government require independent physical verification to support payment. In addition, not all local governments conduct reconciliation between SPM (payment voucher) issued by its Public Works dinas and SP2D (payment remittance order) issued by finance unit. At the central level, DGFB, MoF and MPW received report from LGs but do not conduct verification on the report received.

H 1.Participating local governments will

be assisted by TA in the following: a. Requiring all DAK payments to

be supported by physical verification from an independent party.

b. Requiring monthly reconciliation between SPM (payment voucher) issued by its Public Works dinas and SP2D (payment remittance order) issued by finance unit.

2. The DGFB, MoF will require the

BPKP to conduct output verification on DAK expenditures based on the ToR acceptable to the Bank. In addition to the request made by the MoF to the BPKP to do the VO, there will also be separate Verification Arrangement between the BPKP and the Bank agreeing on the framework and ToR for the VO.

S N

4. Flow of Funds The flow of funds in the project has two levels: firstly, a disbursement of DAK allocation from MoF to participating local governments; and secondly, the reimbursement of DAK allocation from the Bank to MoF. The Project will also finance local government contribution. Reimbursement to participating local governments contingent on the timely delivery of prescribed outputs.

M It has been agreed that the DAK reimbursement of LGs contribution will be made from the MoF to LGs using existing transfer mechanisms.

M N

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5. Reporting The current reporting format from participating local governments to MoF does not contain sufficient detail(s) to allow for traceability and monitoring. DAK accounts are not kept in local government’s computerized book of account. They are kept in secondary records such as separate files, separate register books with ‘DAK’ stamped or written on invoices, to segregate DAK spending and account for the expenditures separately. There is the risk that DAK expenditure may be reported both under DAK and the other expenditures of the local governments. There is also risk that regular LG’s expenditures get reported under DAK expenditures.

H 1. The MoF circular letter covering

the new reporting format from LGs to the MoF has been agreed to cover list of SP2Ds issued for DAK funds.

2. Participating LGs will be assisted

by TA in the following areas: a. All DAK payment to be

supported by physical verification from an independent party.

b. Monthly reconciliation between SPM (payment voucher) issued by its Public Works dinas and SP2D (payment remittance order) issued by finance unit.

c. There will be integrated management information system for DAK implementation.

S N

6. Internal Audit Local Inspectorate from participating local government currently conducted internal audit on DAK implementation as part of local government budget, although no separate report issued on DAK internal audit. The current internal audit conducted merely focus only on administrative aspects, while the technical aspects of infrastructure work and internal control has not been effectively covered.

H TA to improve local government inspectorate capacities to be able to cover technical aspects of infrastructure work and internal control of DAK implementation. Regular internal audit report on reviews conducted and issues identified will be issued by local government inspectorate. Management of LGs will be accountable for the implementation of the recommendation.

S N

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7. External Audit The program will be audited by BPK4 according to standards acceptable to the Bank including disclosure of activities financed by the Bank.

H The Bank will share with the BPK an audit framework for Bank financed operations to be acknowledged by the BPK by effectiveness. The audit report should be submitted to the Bank within 6 months after the end of fiscal year.

S N

Overall Control Risk H S

Overall Risk H S Budgeting 14. The DAK program is budgeted at the DGFB, MoF (DIPA) in bulk for each LG. The budget is then transferred to the LG budget (APBD). The budget is then transferred to the local government budget (APBD). Detailed budgets on infrastructure packages are available at each APBD for each sector, including the Public Works Dinas.

Funds flow 15. The figure below illustrates the flow-of-funds for DAK and the reimbursement.

a. The DGFB, MoF, is responsible for distributing DAK funds to LGs. For DAK, funds are released to LGs in three tranches to the LG general account (Rekening Kas Umum Daerah):5

i. The first tranches can only be made after evidence of: (i) availability of APBD; and (ii) availability of LG contribution funds in APBD. The amount of first tranches will be 30 percent of total allocated DAK for the respective LG.

ii. The second tranches can only be made after the MoF receives accountability reports of 90 percent use of the first tranches. The amount of the second tranches will be 45 percent of the total allocated DAK for the respective LG.

iii. The third tranches can only be made after the MoF receives accountability reports of 90 percent use of the second tranches. The amount of the third tranches will be 25 percent of the total allocated DAK for the respective LG.

iv. Payments from LGs to contractors take place through the LG working unit (Public Works Dinas).

b. LGs report to the MoF progress on DAK expenditures. The MoF consolidates provincial and districts reports. The BPKP verifies conditions for reimbursement. The BPKP

4 BPK is member of INTOSAI. BPK reports directly to the parliament. 5 MoF regulation, PMK 21/PMK.07/2009 regarding Implementation and Accountability of Transfer to Local Governments, article 24.

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reports to the MoF on LG performance. The MoF prepares a reimbursement application for the Bank. The Bank reimburses the DAK expenditures.

16. Any remaining balance of DAK funds at the end of the fiscal year can be used for activities in the following year, as stipulated in article 9(3) of the MoF’s regulation, Permenkeu No. 175/PMK.7/2009, regarding allocation and general guidelines for DAK FY 2010 implementation.

17. The Bank will only finance DAK reimbursement (including reimbursement of LGs’ contributions). Flow of funds of reimbursement for LGs’ contributions will follow the DAK flow of funds. Flow of funds for TA and IOC components will follow the ordinary funds flow of government mechanism since these will be financed by the GoI. The TA components will be financed by the GoI.

Accounting 18. The accounting policies and procedures for this project will follow the government accounting standards (PP No. 24, 2005). All financial transactions will be recorded in the government accounting system and included in government accountability reports. Participating LGs will follow MoHA regulation No. 20/ 2009 regarding financial management for DAK implementation at the LG level. To improve the capacity of the LG’s finance unit, TA would be required to (i) provide training especially for DAK administration to produce reliable financial report on DAK and (ii) require all finance unit(s) to maintain separate register books for DAK transactions or install a system that enables separate coding for DAK in their computerized system.

Internal control 19. The project internal control will follow the GoI’s internal control mechanism. Segregation of duties is in place and all payments are made through transfer payment. However, the project still faces the risk that payments will be made without proper verification that work paid for has been completed and is eligible for funding, since not all LG mandates oversight consultant report to support payment.

20. In addition, not all LGs conduct reconciliation between SPM (payment voucher) issued by their Public Works Dinas and SP2D (payment remittance order) issued by the finance unit. Furthermore, since DAK funds transfer into a common account, reconciliation of DAK funds is difficult. In order to overcome the above issues, participating LGs will be assisted by TA:

i. Requiring that all DAK payments must be supported by a supervision consultant’s report. ii. Requiring monthly reconciliation between SP2D of DAK expenditures issued by the

finance unit and SPM issued by the Public Works Dinas 21. At the central level, the DGFB, the MoF and the MPW receive report from LGs but do not conduct verification on the report received. In order to strengthen the control mechanism of the DAK implementation, the DGFB MoF will require the BPKP to conduct output verification on DAK expenditures based on ToR acceptable to the Bank. This verification will ensure that

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DAK outputs have been physically achieved and are in compliance with agreed procedures and policies on procurement, financial management, and social, environment and safeguard.

Internal Audit 22. The Inspectorate from participating LGs conduct internal audits on DAK implementation as part of the LG budget, although no separate reports are issued on this DAK internal audit. 23. The current internal audit conducted merely focuses on the administrative aspects, while the technical aspects of infrastructure work and internal control are not effectively covered. In order to improve LG inspectorate capacities, there will be TA to cover technical aspects of infrastructure work and internal control of DAK implementation.

24. Regular internal audit reports on reviews conducted and problems identified will be issued by the LG inspectorate. The LGs will be accountable for the implementation of the recommendations made in the reports.

Reporting and Monitoring 25. The current reporting format from participating LGs to the MoF only covers the total amount of DAK funds used by sector. The report does not have sufficient detail to allow for traceability and better monitoring. In addition, DAK accounts are not kept in LG computerized book of accounts. They are kept in separate records such as separate filling, separate register books, DAK stamps, DAK remarks (written on invoices), etc to segregate DAK spending and account for the expenditures separately. There is the risk that DAK expenditures may be reported both under DAK and other expenditures of the local governments. There is also risk that regular LG expenditures could be reported under DAK expenditures. To overcome the above problem, the MoF should issue a circular letter covering the new reporting format from LGs to the MoF to include a list of SP2Ds issued for DAK funds.

26. Participating LGs will be assisted by TA as follows:

Requiring all DAK payment to be supported by physical verification from an independent party.

Requiring monthly reconciliation between SPMs (payment vouchers) issued by the Public Works Dinas and the SP2D (payment remittance order) issued by the finance unit.

Requirement to have separate filling of the SP2D for DAK expenditures. There will be an integrated management information system for DAK implementation.

27. The new reporting format from LGs to the MoF will serve as the IFR contribution. The IFR will then be compiled by the DGFB and submitted to the Bank in a summary. 28. Currently, monitoring of the DAK program is limited. The BPKP was assigned to conduct DAK reviews for FY2007 and FY2008. The reviews revealed similar concerns, such as poor dissemination, and reporting and evaluation mechanism, which led to possible misuse of DAK funds. The reports suggested intensifying oversight and control over DAK utilization, establishing an adequate system control, in particular financial information.

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29. Since all of the DAK reimbursements will be for roads, water, sanitation and irrigation, which are under the MPW’s responsibility, there will be close coordination between the MPW, the BPKP and the DG Fiscal Balance. There will be an arrangement between the MoF and the BPKP to undertake verification of outputs (VO) for the project in accordance with VO Terms of Reference. There will also be a separate Verification Arrangement between the BPKP and the Bank agreeing on the scope of work, the ToR and responsibility of the BPKP as output verification agent for DAK. Furthermore, each participating LG will submit a binding Commitment Letter to MoF to ensure that the LGs carry out activities and deliver outputs in accordance with the required financial and technical conditions. Disbursement 30. The Bank’s reimbursement of DAK expenditures will be made based on the BPKP’s report(s). The Bank’s reimbursement of DAK expenditures will only occur once a year, as it is based on outputs delivered at year-end and verified in the first quarter of the calendar year of the following year. The first disbursement will be based on outputs delivered at the end of FY 2011, which will be verified by March 2012. 31. MoF has requested Advance Payment (AP). The AP will be equal to the sum of the values of the GoI’s first DAK payment to each LG. The AP will be at maximum 30 percent of total DAK allocated for the year, equal to the current first DAK payment from the MoF to LGs. The first DAK payment will be made in March 31 at the latest. However, the amount disbursed by the project in any year will not exceed the actual amount of DAK allocated for the infrastructure sector in that year. The amount of the value of final reimbursement will be the Value of Total Reimbursement minus AP. 32. On reimbursement of an LG’s contribution, the MoF will transfer to the LGs its 10 percent share of DAK funds for all eligible outputs. The amount of the LG reimbursement will be the value of the actual reimbursement times 10 percent. External Audit Arrangements 33. The DAK program will be audited annually by the State Audit Board (BPK), which is a key accountability institution. The audit will focus on reviewing the underlying controls at the LG level. The annual audit reports will be given to the Bank not later than six months after the end of the government fiscal year (June 30 of the following year). The audit will be conducted in accordance with audit standards acceptable to the Bank.6

TYPE OF AUDIT REPORT EXECUTING

AGENCY DUE DATE

DAK program audit DG Fiscal Balance, MoF

Six months after the end of the Government fiscal year

6 BPK follows international standards as issued by INTOSAI. INTOSAI standard acceptable to the Bank.

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Annex 8: Procurement Arrangements

INDONESIA: Local Government and Decentralization Project A. General 1. Project Background: Following the effective implementation of the Regional Autonomy Law in 2004, the central government has provided annual block funds to LGs (referred to as "DAK") to support development. The use of DAK is limited to small and operational works below USD 400,000 equivalent, such as: maintenance, small repairs, small rehabilitation, simple constructions etc. Each LG carries out procurement following Keppres 80/2003. 2. In practice, the central government uses a formula to calculate the allocation to each LG. The funds are channeled directly to the LGs’ accounts and budgeting systems, under the full control of the LGs. Under this scheme, once the funds are approved and transferred to the accounts of LGs, the central government does not have the authority to intervene in the planning and implementation, except in providing "technical advice", as well as setting "technical standards". At the end of fiscal year, the LG submits a financial report to the MoF, as a pre-requisite prior to the allocation and disbursement of the DAK for the following fiscal year. 3. During implementation, the respective sectoral ministries provide very limited monitoring and technical guidance, mostly on obtaining physical progress from the field. Under the current implementation, the LGs’ internal auditor (i.e. Bawasda), audits the DAK. In general, the quality of the Bawasda reports is low. In addition, the BPKP (the GoI’s auditor) carries out audits as needed. 4. This project will reimburse the DAK based on physical outputs. This is limited to the following four sub-sectors: roads, water, sanitation, and irrigation, in pilot provinces/LGs. The reimbursement will be based on verification reports, verifying that the outputs have been delivered, the procurement has been carried out in accordance with national procedures, and the agreed financial management and safeguards are in place. It is expected that there will only be one reimbursement annually. 5. The project also intends to improve the DAK mechanism through the following, which will be wholly financed out of the government’s resources:

i. Introducing verification functions; and ii. Providing TA to improve the capacity of both central and mostly LGs in the areas of

procurement, financial management, planning, and project management, referred to as TA for Institutional Strengthening.

6. The procurement for the proposed project would be carried out in accordance with Section 1 (excluding paragraph 1.16) and paragraphs 3.14 and 3.15 of the World Bank’s "Guidelines: Procurement Under IBRD Loans and IDA Credits" dated May 2004 revised October 2006; and the provisions stipulated in the Legal Agreement. Since the GoI is financing the TA Component, the Bank’s Consultant Guidelines do not apply.

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7. Since the project will be using an output-based approach and will finance outputs and not specific contracts under the LG component, and due to the straightforward and simple nature of the expected procurement, consistent with paragraph 3.14 of the Bank’s Procurement Guidelines, the procurement procedures for sub-projects under LGs will follow competitive procurement methods of Keppres 80/2003 acceptable to the Bank. 8. Procurement under Component 1 (Output-Based Disbursement for Sub-Projects at the LG Level): The procurement under sub-projects will be carried out by the participating LGs (81), via the procurement services unit/ULP. The MoF through its TA for Institutional Strengthening (not Bank financed) will provide the support and capacity building as required to ensure that procurement follows the agreed procedures. 9. The procurement includes small work (below US$400,000 equivalent) for small constructions/repairs, maintenance or rehabilitation of facilities/services, and output-based disbursement will be used. No prior review or ICB is envisaged under this Project. Despite the weaknesses in implementation, the national procurement procedures under Keppres 80/2003 have many elements of good international practice and the minimum requirements in terms of competition and transparency, making them acceptable for this type of operation. 10. Taking into consideration that there have been updates on the regulations and practices and that no foreign bidders will be interested in these low value contracts, several of these provisions will not be triggered under this operation. The remaining provisions relate mainly to requiring 30 days for the submission of bids, availability of bidding documents up to 24 hours prior to deadline for submission of bids, accepting bid securities from insurance companies and repeating the bidding process if there are less than three participating bids etc. The costs of enforcing these remaining provisions are not possible under the current design of the project as the costs will outweigh any possible benefits. 11. The fact that no international bidders will be interested makes an output-based approach most suitable for the project. With this consideration, it is expected that procurement under this Component will follow competitive procedures in Keppres 80/2003 with its recent amendments. 12. With the assistance of a separate MDTF financing for improving public financial management, the central government via the National Public Procurement Agency (LKPP) is currently finalizing a set of national standard bidding documents, which are expected to be issued and adopted by all implementing agencies in January 2011. Until such bidding documents are issued and mandated nationally, each participating LG will use its own bidding documents in each sector, which are mostly driven by the sample bidding documents developed by the MPW for these four sub-sectors under DAK. Although they vary in form and substance, in general the existing bidding documents have satisfactory elements to ensure the application of the relevant procurement procedures. Therefore, they will temporarily be used pending the issuance of the national standard bidding documents. 13. Under output-based disbursement, where payment is made based on outputs rather than inputs, the Bank does not review either the procurement plans or individual procurements.

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However, prior to the MoF submitting the request for reimbursements to the Bank, the BPKP will periodically review procurement process and contract documents on sampling basis, to verify that agreed procurement procedures are strictly followed and the national standard bidding documents (when applicable) are adopted. Samples will include all participating LGs at 20 percent of the total number of contracts in each participating LG in the particular review period. If the verification report shows non-compliance of reviewed contracts in the particular review period, then the respective LG outputs will not be eligible for Bank reimbursements. For participating LGs with a compliance degree of more than 90 percent of the total number of reviewed contracts in the review period, they may be eligible for Bank reimbursements for the physical outputs which have been delivered, provided that the measures against the non-compliance portion (as highlighted in the BPKP verification report) is addressed in the subsequent verification/review period. 14. At the end of the project, covenants will need to be met by each participating LG with respect to improving their procurement management systems and capacity, with the following details and indicators: (i) Covenant 1: Improving the procurement planning system of LG. Description: With the assistance of TA for Institutional Strengthening (financed out of the government’s own resources), each participating LG is responsible for developing an annual procurement plan stating at least the following information: contract packages and amount, procurement methods, and procurement schedule prior to commencing any procurement process. The procurement plan, together with documents pertaining to the procurement and contracting process, will be retained in the LG’s project files for the BPKP review. Indicators: By 2011, the agreed procurement plan template will have been adopted. By 2012, the annual procurement plan for DAK implementation will be available in form and substance. (ii) Covenant 2: Establishment and improving the capacity of ULP. Description: In its national plan and as stated in the new revision of presidential decree on national procurement regulation, the GoI intends to foster the use of ULP. For this purpose, with the assistance of TA for Institutional Strengthening (financed out of the government’s own resources), each participating LG is expected to establish a ULP to carry out procurement. Indicators: By 2011, the decree for establishing a ULP will have been issued by the head of participating LGs. By 2012, the ULPs will have been properly staffed and budgeted. By December 31, 2013, all procurement of DAK funds will be carried out by the ULP. 15. As part of its output verification report, the BPKP will verify whether the above covenants have been satisfactorily met. 16. Selection of Consultants under Component 2 and Component 3: All TA for supporting the capacity of the BPKP in exercising the verification function, and one TA for institutional strengthening, will be financed out of the GoI’s own resources, and no Bank financing is involved.

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B. Assessment of the agency’s capacity to implement procurement 17. Procurement activities under Component 1 (output based under sub-projects) will be carried out by each participating LG through its procurement services unit (ULP). For LGs that have still to establish ULPs, it is agreed that they will establish ULPs by the end of this project. The TA for Institutional Strengthening (not Bank-financed) will be hired by the MoF to assist each LG in improving their capacity including in establishing ULP. 18. Based on the assessment made to some sampled LGs, experience from the two Bank financed projects working with LGs, USDRP and ILGRIP, and the review of contracts financed by DAK, it appears that most LGs have adequate capacity in carrying out procurement of small works following competitive procedures of Keppres 80/2003. 19. Two remaining risks are as follows: a. Non-standard procurement/bidding documents are used in different units under each LG. In

order to address this risk, until the national standard bidding documents are available, the project will use the currently available bidding documents, which are acceptable to the Bank.

b. No procurement planning is practiced. The list of contract packages will only appear after the confirmation of allocated DAK is received. This creates inefficient contract packaging or non-coordinated works/contract packages with related works financed by other sources. In order to address this, a standard form of procurement plan and reporting must be applied under the project.

20. The BPKP will produce output verification reports including whether the national procurement procedures are strictly followed. Although the BPKP has carried out similar exercises with the Bank before, the current BPKP capacity is inadequate for this project. Therefore, the BPKP is expected to hire a number of additional experts/individual consultants—financed from the BPKP’s own resources—to compliment its current capacity. 21. With regard to the selection of the TA for Institutional Strengthening, since this TA will be financed out the GoI’s own resources, there is a risk of GoI not making the budget available in a timely manner. 22. The overall project risk for procurement is High. C. Procurement Plan 23. Since Component 1 (sub-projects at the LG level) will be output-based, and Component 2 and Component 3 will not be financed by the Bank, the MoF does not need to prepare a procurement plan. D. Frequency of Procurement Supervision 24. The Bank reserves the right to carry out annual ex-post procurement reviews of contracts under the sub-projects. The Bank will use the output verification report produced by the BPKP

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as the basis for the ex-post reviews, as this will cover all participating districts and will contain a sample of 20 percent of contracts by Province. The Bank may carry out additional reviews in the case of High risk contracts and for agencies with lower capacity or those with a history of procurement problems. In addition, the Bank will also make use of output verification reports to assess whether the agreed covenants on improving LGs’ procurement management systems and capacity have been achieved. E. Details of the Procurement Arrangements Involving International Competition 1. Goods, Works, and Non-Consulting Services (a) List of contract packages to be procured following ICB: No ICB is anticipated in this project 2. Consulting Services (a) List of consulting assignments with short-list of international firms. This is not applicable, since the TA component is not funded by the Bank.

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Annex 8.1: Anti-Corruption Action Plan

INDONESIA: Local Government and Decentralization Project 1. The Anti-Corruption Action Plan (ACAP) is based on the October 2006 World Bank Guidelines on Preventing and Combating Fraud and Corruption in Projects Financed by IBRD Loans and IDA Credits and Grant. The objective of Local Government and Decentralization Project ACAP is to identify corruption risks and mitigation measures beyond the standard control systems employed by the Bank. While more detailed program specific control systems are outlined in Annex 7: Financial Management & Disbursement Arrangements and Annex 8: Procurement Arrangements, this Action Plan presents program activities to address these potential risks of corruption. 2. Corruption Risk Mapping. The corruption risk mapping matrix used as the basis to develop this Action Plan identifies potential risks of corruption and specifies appropriate mitigation measures agreed to by the Executing Agency of the GoI. The corruption risk mapping matrix will be placed on the Operations Manual (OM). 3. Action Plan. Specific mitigation actions are presented in the Corruption Risk Mapping Matrix. The following provides a summary of the action plan:

i. Enhanced Disclosure Provisions and Transparency. The PIU will expand and enhance the existing WBTMS to become WBRS to make the project financial and outputs transparent to project internal stakeholders such as the MoF, the MoHA, Bappenas, the BPKP, the World Bank, line ministries, and LGs. Access control to the WBRS will be arranged by the MoF. The WBRS will be developed by the MoF supported by the MPW and will link to the MPW MIS. Under the WBRS, the MoF will upload data on DAK allocations and transfers, the LGs will upload data on local fund contributions, disbursements, and DAK outputs. In addition to the WBRS, the World Bank guidelines on Preventing and Combating Fraud and Corruption will be socialized with officers and stakeholders responsible for managing all aspects of the DAK, including the MoF, MPW, related LG officials, and the BPKP.

Information on DAK outputs will comprise project location, GPS coordinates, technical data, physical progress and visuals (pictures) of the projects. The BPKP will upload verification results of verified projects. Success in running the WBRS will lead to relevant parts of the WBRS being opened for public access.

In order to enable the WBRS to operate as a formal reporting system, required

MoF, MPW or other agency regulations will be established. In order to assure that the WBRS runs properly, intensive training and in-the-field assistance will be provided to LG officers on reporting and uploading output data to the WBRS for the first year. On line and on call support for LG officers will be provided by the MoF and the MPW in the following years.

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ii. Civil Society Participation in Oversight. The participation of civil society will start after WBRS implementation and the data have been uploaded. Some socialization on accessing the WBRS will be conducted when the system is ready aimed at DPRD members, universities located in the LGs, NGOs and people around the project locations, as well as relevant interest groups. iii. Complaints-Handling Mechanism. As part of the control system, a complaints-handling mechanism will be established and integrated with the WRBS. A complaints address mechanism will be established, complaint-handling procedures will be developed, a complaints database will be maintained at each appropriate level and the follow-up actions will be monitored. These complaints will be acted upon in a professional and timely fashion, and without risk of reprisal to 'whistleblowers' from the public. The complaints-handling procedures also will be connected to the respective inspectorate. The complaints and their follow-up actions will be presented on the WBRS once the system is operational. iv. Sanctions and Remedies. Clear sanctions and remedies are an important final step in the effort to fight against corruption. This project has a low tolerance for corruption. Any person (government, non-government, consultant, facilitator, contractor etc.) can be sanctioned if sufficient evidence is available. Outputs tainted with fraud and corruption will not be eligible for reimbursement. v. Mitigating Collusion, Fraud and Nepotism. Opportunities for fictitious project outputs will be minimized by reporting outputs visually through the WBRS. In order to minimize lower quality or fewer quantity outputs there will be output verifications by the BPKP, with the results of the verification and audit uploaded to the WBRS.

4. Corruption Risk Mapping Matrix. Limiting the occurrence of corruption in this project starts with identifying potential corruption areas, i.e. corruption mapping. For every area of corruption, the potential opportunities for corruption will be identified. An assessment of the level of risk will then be made on every opportunity of corruption identified. Based on the identified opportunities for corruption and their risk levels, a set of mitigating actions will be formulated. The corruption risk mapping matrix will be placed on the Operations Manual acceptable to the Bank. 5. Opportunities for corruption and their level of risk may change during the project. These changes may require changes in mitigating actions. Therefore, the corruption risk mapping matrix formulation will be repeated every six months as the project progresses and lessons are learned.

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Annex 9: Economic and Financial Analysis

INDONESIA: Local Government and Decentralization Project A. Project Objectives 1. The objective of the project is to improve the accountability and reporting of the central government’s Specific Purpose Grants (DAK) for the infrastructure sub-sectors within pilot local governments (LGs). This will be achieved through improved financial and technical reporting, and verification of outputs delivered by LGs with the DAK. 2. Based on independent verification of physical outputs, Component 1 of the project will reimburse up to the full DAK expenditure allocations in four infrastructure sub-sectors (roads, water, sanitation, and irrigation), including the minimum 10 percent matching fund from LG resources. 3. Working with existing mechanisms for the transfer of DAK resources, Component 2 and Component 3 of the project will support institutional strengthening at both the central and local levels, by improving technical guidelines on DAK expenditures from line ministries, and enhancing existing systems for monitoring and verifying DAK implementation. This is expected to have a positive impact beyond the four infrastructure sub-sectors supported under this project, since greater capacity at central and local levels will also improve the utilization of DAK resources and investments in other sectors. B. Project Costs 4. Table 1 below summarizes the estimated project costs, by project component, sub-sector, and location. The cost estimates under Component 1 are based on the average of the four most recent years (2007 through 2010) of actual DAK allocations by province and sub-sector. The overall budget envelope for Component 1 is such that the annual DAK allocations to individual provinces and sub-sectors are at a level similar to the actual DAK allocation for 2010, assuming the project’s investments are evenly distributed over four years. 5. In order to analyze the full economic costs and benefits, annual operating costs for the infrastructure resulting from DAK investments under the project were included in the analysis, expressed as a percentage of the DAK investment outlays (Roads: 5 percent; Water: 2 percent; Sanitation: 2 percent; and Irrigation: 5 percent). It was assumed that project investments would have a service life of at least five years.

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Table 1: Estimated project costs (US$ million)

Jambi Central Kalimantan

East Java West Sulawesi

North Maluku

National Total

Component 1 Roads 19.2 29.5 54.5 10.3 20.9 - 134.4

Water and Sanitation

5.0 7.8 20.0 2.8 4.7 - 40.3

Irrigation 5.3 8.6 21.5 5.1 5.0 - 45.3 Component 2 - - - - - 8.5 8.5 Total 29.4 45.9 96.1 18.1 30.6 8.5 228.5

C. Overview of Project Benefits 6. The benefits arising from the project include those benefits that are readily quantifiable in monetary terms, and non-market benefits—such as from lives saved due to faster road access to health facilities and a lowered water-borne disease burden—for which monetary values cannot be quantified directly. Furthermore, because this project will help to strengthen government institutions and mechanisms for managing DAK funding and implementation, substantial positive externalities are likely in the accountability and reporting of DAK utilization in other sectors, and potentially in the management of other categories of fiscal transfers to LGs. The overall benefits from this project are therefore likely to be greater than the estimated monetary value of the benefits given below. 7. The general types of direct benefits from the project are described by project component below. Specific benefits may vary from province to province and within a province, depending on the unique circumstances of, and specific investments in, each location. Component 1: DAK Reimbursement

Roads: Transport cost savings from reduced fuel consumption and maintenance costs; Time savings from smoother road travel; Gains from better market access for goods; Increased income of transport operators arising from greater demand for

transport services; Enhanced capital values of property made more accessible by improved roads.

Water Supply:

Time savings in obtaining clean water; Cost savings for purchase of clean water;

Sanitation:

Lower health expenditures from reduced incidence of water-borne disease. Irrigation:

Increase in crop yields (per unit area); Increase in area under cultivation; Cultivation of higher value crops and higher yielding crop varieties;

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Increase in farmer incomes (from increased productivity factors above); Reduced risks of, and costs arising from, extreme events such as droughts or

floods; Enhanced capital values of agricultural land with improved irrigation.

Component 2: Technical Assistance for Central and Local Governments and Component 3: Verification of Outputs

Improved rate of completion and quality of outputs obtained from infrastructure investments funded by DAK;

Reduced inefficiencies and irregularities in use of DAK funds; Greater accountability and transparency in the use of DAK funds.

D. Valuation of Project Benefits 8. The first step in estimating project benefits was to estimate the quantity of outputs expected from DAK investments under this project in each sub-sector and province. Given the complexity of estimating future DAK investments in all 81 districts across the five pilot provinces, representative output types were chosen for each of the sub-sectors, based on outputs most commonly funded by DAK investments in these provinces:

Roads: kilometers of roads upgraded (peningkatan) to a standard width of 5.5 meters. Water supply: number of houses connected to a clean water supply with a 2-inch

diameter pipe connection. Sanitation: number of wash and toilet (MCK–mandi, cuci, kakus) facilities installed. Irrigation: hectares of cropland irrigated as a result of upgrading (peningkatan) of

irrigation infrastructure. 9. Unit costs for each output type in each province were obtained, based on actual unit cost data from the MPW. The value of DAK investments was then divided by the unit costs in order to obtain the quantity of representative outputs that notionally would be delivered by these DAK investments in each province and sub-sector. 10. Expected benefits deriving from each unit of representative output, according to the categories identified in Section C above, were then estimated for this project using data from the Evaluation of Economic Feasibility and Cost Effectiveness of ILGR Infrastructure Investment study. This study was undertaken in 2009 under the Initiatives in Local Governance Reform Project (ILGRP), with data obtained through field surveys and interviews in Sumatra, Java and Sulawesi. Care was taken to ensure that data selected from this ILGRP study were reasonably applicable for the purposes of analysis for this project, by excluding ILGRP output types not covered by DAK, and aligning locations from which data were derived with the analysis for pilot provinces under this project. 11. Table 2 below summarizes the unit costs obtained, calculated output quantities, and estimated unit benefits, for the representative output types in each province. The exchange rate used throughout the analysis presented here is US$1 = IDR 9,000.

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Table 2: Unit costs, output quantities and unit benefits for representative outputs

Unit costs (US$) Output quantities Unit benefits (US$) Roads Water

supply Irrigat. Roads

(km) Water supply Irrigat.

(ha) Roads Water

supply Irrigat

. Jambi 94,827 492 278 202 10,109 18,903 47,222 206 142 Cent. Kal. 122,792 536 389 240 14,515 22,029 63,889 206 139 East Java 100,302 536 250 544 37,322 86,022 50,000 206 90 W. Sulawesi 89,442 738 833 115 3,747 6,070 53,333 206 161 N. Maluku 161,595 738 1,111 129 6,434 4,465 63,889 206 272

E. Cost-Benefit Analysis 12. The net present value (NPV) of the project investments were then calculated for the project as a whole, over a period of five years (2011-15). The discount rate used was 12 percent. For illustrative purposes, the internal rate of return (based on net economic benefits) was also calculated, to show the discount rate at which net present value would be zero. It should be noted that the cost and benefit figures for each province do not take into account the national-level TA for Components 2 and 3 of the project. These are, however, included in the analysis and results shown for the project overall. 13. The results of the cost-benefit analysis are summarized in Table 3 below. The project NPV over five years, at a discount rate of 12 percent, is estimated at US$56,019,544, with an economic internal rate of return (EIRR) of 40 percent. 14. Furthermore, in addition to this economic analysis, which shows these DAK investments to be economically sound, a benefit arising specifically from this project is to improve accountability and reporting in the utilization of DAK funds. While it is difficult to quantify the value of this benefit ex-ante, the positive impact of institutional strengthening in the use of DAK resources is expected to be substantial.

Table 3: Benefits, costs and net present value for project investments (US$ million)

Jambi Central Kalimantan

East Java West Sulawesi

North Maluku

National Total

Benefits Roads 38.2 61.4 108.7 24.5 33.0 - 265.9 Water and Sanitation

10.7 12.2 31.0 3.9 4.9 - 62.7

Irrigation 8.3 11.9 30.7 3.1 5.3 - 59.3 Total benefits 57.2 85.6 170.4 31.4 43.2 - 387.9

Costs Project investments

29.4 45.9 96.1 18.1 30.6 8.5 228.5

Infrastructure operation

5.3 8.2 16.8 3.3 5.6 - 39.2

Total costs 34.7 54.1 112.9 21.4 36.2 8.5 267.7 NPV (at 12%) 56.0

Economic Internal Rate of Return 40%

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F. Sensitivity Analysis 15. The sensitivity of the program’s net benefits was analyzed with respect to two key variables: unit costs, and estimated unit benefits. The results of this sensitivity analysis are presented in Table 4 below in terms of switching values, i.e. the percentage change in the values of the selected variables at which NPV becomes zero, for each of the infrastructure sub-sectors supported by this project, as well as for the three sub-sectors taken together. 16. The results of the sensitivity analysis reveal that the overall net economic benefits of the project are relatively insensitive to changes in either average unit costs or average unit benefits in the water and sanitation and in the irrigation sub-sectors alone, and in no case would changes in unit costs or benefits in these sub-sectors alone result in the project’s NPV being reduced to zero. This is because the baseline unit costs in the roads sub-sector are, in every province, at least ten times greater than the baseline unit costs for the other three sub-sectors, with a similar difference in magnitude for unit benefits across sub-sectors. Moreover, the share of DAK funding for the roads sub-sector is also greater than half the total DAK allocation in each province. 17. The main conclusion to be drawn from the sensitivity analysis, therefore, is not so much that the roads sub-sector is singularly important for this project—each sub-sector generates positive net economic benefits of its own. However, given the dominance of the roads sub-sector in the overall quantification of costs and benefits for this project, any substantial variability in the actual unit costs and unit benefits in the roads sub-sector experienced during project implementation should be closely monitored.

Table 4: Switching values of selected key variables

Roads Water and Sanitation

Irrigation All four sub-sectors

Average unit costs +40% - - +24.5%

Estimated average unit benefits −29% - - −20%

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Annex 10: Approaches in Environmental and Social Safeguards


Summary of Key Environmental and Social Safeguard Issues 1. The project will mainly finance investment of small civil works for existing road, water, sanitation and irrigation networks, with the investment size of a sub-project ranging between US$50,000 and US$250,000. The project will not reimburse sub-projects that have an investment size of or higher than US$400,000 and other than the four above-mentioned project types. New civil works, and expansion and extension of current networks and facilities, will be limited. The project may finance parts of larger infrastructure networks and facilities, complement with those financed by other funding resources such as local budgets (districts/cities, as well as provinces’ APBD), to provide the intended service level. Experience in past and on-going DAK for roads, water, sanitation and irrigation networks suggested that the scale of land needed by sub-projects is relatively small and negative environmental impacts, which in most cases take place during construction, are also on a small scale, on-site, non-irreversible and manageable by the LGs. Information on whether Indigenous Peoples (IPs) or Isolated and Vulnerable Peoples (IVPs) were affected by the previous and on-going DAK projects is not available.

2. As the project will finance the same scope and nature of the ongoing DAK, whereby the size of sub-projects will be relatively small-scale and mainly include maintenance, rehabilitation, and improvement of existing networks and facilities, (involuntary) land acquisition for a sub-project is likely to be insignificant. Some of the investments may require temporary or some permanent land for some minor adjustment in the alignment. Experience from similar types of project, such as PNPM Mandiri Urban and Rural, show that land needed or acquired by rehabilitation and improvement of existing roads and irrigation sub-projects is relatively small. Similar situations occurred in the new construction of public water facilities (wells, water tanks/hydrants, etc) and sanitation facilities (public toilets). Learning from the PNPM Mandiri and past and ongoing DAK, it is anticipated that there would be two types of approaches in acquiring the needed land. The most common one is the voluntary contribution from the beneficiaries. The second approach, which may take place in a few cases, is that of involuntary land acquisition, whereby the sub-project has to acquire land through compensation. Similarly, potential adverse environmental impacts will be small-scale, on-site, not irreversible, and most likely they can be managed locally. It is envisaged that environmental impacts will take place during the construction. Over the longer term, improving roads, water supply, sanitation, and irrigation infrastructure and facilities will have positive environmental impacts for the beneficiaries.

3. List of potential environmental risks related to DAK sub-project activities:

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Environmental risks related to rehabilitation of roads and bridges activities: The major direct environmental impact associated with roads and bridges activities is erosion, especially from disturbance of unstable soils that are sensitive to landslides and/or from changes in the flow of water. Activities in the rainy season, or improper construction methods that leave soils unnecessarily exposed, can also cause erosion. Improper drainage from roads in areas of high precipitation can ruin roads and have impacts on adjacent lands. In addition, health issues (e.g. water related vector-borne disease) can emerge when there is lack of planning for the overall drainage setting to keep the drainage system connected either with subsurface drainage or surface drainage canal outlets. There is a close link between the presence of excess water (due to lack of adequate drainage/blocked drainage) and the transmission of water related vector-borne diseases. Improper design (contributing to low and irregular flow velocities, low embankment slopes, high seepage, and uncontrolled water access) and lack of maintenance are the two main reasons why drainage structures are often associated with environmental health problems. Environmental risks related to sanitation and water supply activities: Water supply and sanitation projects (public MCK – Mandi/Bath, Cuci/Wash and Kakus/Toilet) are two of the main sources of public health issues. In previous World Bank UPP projects, it was found that some communities built MCK without septic tanks or near to water sources. These types of projects carry the possibility of increasing contamination. (For example, contamination of a water source by surface water entering from outside, or contamination of groundwater by a poorly designed or constructed waste control system.) Environmental risks related to irrigation activities: Potential negative environmental impacts may include increased erosion, temporary deterioration of water quality, scouring of canals, and other construction related impact. Positive impacts include more effective water resources management (including water quality/pollution management) at basin, irrigation system and community levels, higher water use efficiency, improved water delivery services, higher capacity in adapting to climate change and hydro-met variability, and reduced vulnerability of farmer communities to climate risks. 4. As the project will cover 81 districts/cities in the provinces of Jambi, East Java, Central Kalimantan, West Sulawesi, and North Maluku, it is likely that investment will take place in villages where Indigenous Peoples (IPs) or Isolated and Vulnerable Peoples (IVPs) are living. IPs in these provinces includes, among others, suku Anak Dalam (Jambi), suku Tobaru and Galela (North Maluku), Dayak (Kalimantan), and Binggi (West Sulawesi). In addition, there are also ethnic minorities in East Java, namely Osing and Tengger.7 The project will have positive impacts on the social and economic living conditions of these groups as the service levels of these infrastructure and facilities are improved. Remote villages will have better access to other villages and towns or cities; agricultural productivity will increase with better access to markets; people will have better health; and the improved infrastructure and facilities will save costs and time for the beneficiaries, particularly the poor, in carrying out their social and economic activities. At the same time, the project may increase their exposures to a more advanced cultural, social and economic ways of life, which could be different from their current practices.

5. The project is classified as a Category B for environmental assessment. The project triggers three of the Bank’s safeguard policies, namely OP/BP 4.01 (Environmental Assessment),

7 The location of IPs in the five provinces is available upon request.

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OP/BP 4.10 (Indigenous Peoples), and OP/BP 4.12 (Involuntary Resettlement). These policies apply for sub-projects that are partly or wholly financed by the project. Mainstreaming Environmental and Social Safeguards in the Project Design and Implementation 6. Discussion with the MPW suggested that adverse environmental and social impacts of the past and on-going DAK for road, water, sanitation, and irrigation projects have been insignificant, although the quarterly reports submitted by the LGs do not include information on the implementation of environmental and social safeguards aspects. The project will ensure that sub-projects will avoid potential impacts (including land acquisition and IPs or IVPs), or if they are unavoidable, minimize the adverse impacts at the planning stage and during construction. LGs are expected to improve their participatory planning process of “Musrenbang”, implement the screening process as required by the regulations (and specified in the MPW’s Technical Guidelines—refer to paragraph below), adjust the sub-project design, and monitor the implementation of the mitigation measures during the construction. LGs are required to follow these actions as per the environmental and social safeguards specified in the Supplement of the MPW’s Technical Guideline. The first of the BPKP’s reviews during project implementation will provide baseline information on the performance of the LGs in implementing environmental and social safeguards thus far.

7. The MPW confirmed that LGs have adopted the GoI’s regulations in addressing environmental and involuntary resettlement issues in the past and on-going DAK for roads, water, sanitation, and irrigation. However, the MPW’s Technical Guidelines to the LGs for the use of DAK does not explicitly include the requirements, procedures, and protocols for addressing environmental and social issues. Since the GoI does not have specific regulations for IPs or IVPs, issues regarding these groups have not been addressed in the DAK. Furthermore, quarterly reports submitted by LGs do not cover environmental and social safeguard aspects.

8. The project will adopt the GoI’s regulations pertaining to the environment and land acquisition8 and the Bank’s environmental and social (including IPs) safeguard requirements, procedures and protocols in the case that there are gaps between the two. This will be incorporated into the MPW’s current Technical Guideline to LGs for the use of DAK, in the form of a supplement to the Technical Guidelines that will be issued through a Ministerial Circular Letter signed by the MPW. This means that safeguards compliance will be made a part of the GoI DAK system by incorporating relevant standard operating procedures into the MPW’s Technical Guideline. This will be applied to all investments for which reimbursement will be made under the project (including parts of sub-projects financed by other resources but linked and necessary for those particular sub-projects to function). This will also help expand this approach for the entire program including non-Bank financed operations. The compliance with the Bank’s environmental and social safeguards is to be part of the eligibility criteria for reimbursement under this project.

8 Regulations for land acquisition are Perpres 36/2005 and Perpres 65/2006 and BPN Regulation No. 3/2007, and for environment are Government Regulations or PP No. 27 of 1999, Ministry of Environment Decree No. 11 of 2006 and KEPMEN MPW- 17/KPTS/M/2003.

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9. The Supplement of the MPW’s Technical Guideline, approved by the Bank, will be socialized to all LGs through training workshops to be held in each of the five provinces. The compliance of the LGs in implementing the Supplement of the Technical Guidelines will be regularly monitored and supervised by the MPW as part of its project management, with assistance of its advisory consultant team. The BPKP will review the compliance of the LGs in implementing the environmental and social safeguards aspects as specified in the Supplement of the Technical Guidelines. Compliance performance indicators will be detailed in the project Operations Manual. The project will develop a set of simple monitoring and tracking compliance indicators as part of the overall project design. The Supplement of the Technical Guideline will also require the LGs to include the environmental and social safeguards implementation in their quarterly report.

10. The BPKP will review the LGs’ compliance in implementing environmental and social safeguard requirements as specified in the Supplement of the MPW’s Technical Guidelines. It will review the LGs’ quarterly reports and undertake field checking based on performance indicators that will be specified in the Operations Manual. The BPKP will undertake a 20 percent sample of outputs or contracts by Province, which will include verification in all LGs. In addition, large DAK investments should also be given special review by the BPKP to ensure compliance with safeguards. This will create an additional layer of supervision and risk mitigation, since the project will not reimburse expenditures where safeguards are violated. Any local investment that is found through this sampling and review process not to comply with the safeguards arrangements set out in MPW’s Supplement of the Technical Guidelines will be excluded from reimbursement. The project will review the safeguard compliance of all sub-projects that have investment size higher than a certain threshold, for example US$150,000. Random sample checking will be carried out for sub-projects with investment size less than US$150,000.

11. Institutional arrangement and capacity building. The MPW will oversee the overall implementation of the project in terms of the technical aspect, including environmental and social safeguards. It will carry out regular monitoring and supervision, provide training to LGs, and prepare consolidated reports of the LGs’ quarterly reports. The MPW has experience in many Bank supported projects over the past three decades and therefore has a good understanding of the Bank’s environmental and social safeguards policies. However, its capacity to supervise and verify the participating LGs in implementing the environmental and social safeguards requirements as specified in the Supplement of the Technical Guidelines will need to be improved. The MoF has a very limited awareness and experience in implementing the Bank’s environmental and social safeguards policies. LGs have some capacity in implementing environmental and social safeguards instruments according to Indonesian regulations. However, their understanding and capacity to implement the Bank’s requirements on environmental and social safeguards will have to be improved. In addition to socialization of the Supplement of the Technical Guideline and the project Operations Manual to all LGs, the project will also provide environmental and social safeguards training to the technical agency (MPW) and the MoF, as well as to LG beneficiaries. The MPW, with the assistance of its advisory consultant team, will provide trainings to the LGs. Trainings to LGs will be delivered on a regional basis and regularly during the project period. The project will have to ensure that quarterly reports prepared by LGs include the implementation of the requirements, procedures and protocols of

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the environmental and social safeguards specified in the Supplement of the MPW’s Technical Guidelines to LGs for use of the DAK. Areas of Improvement for Technical Guidelines and of the Development of the Project Operations Manual 12. The purpose of incorporating the requirements, procedures and protocols of environmental and social safeguards aspects in the current MPW’s Technical Guidelines is to provide LGs with clear and detailed guidance in addressing potential adverse environmental and social impacts at the design, construction, and operation stage of a sub-project.

13. The project Operations Manual will specify in detail key indicators of environmental and social safeguards that will be used by the BPKP to measure the LGs’ performance in implementing the requirements, procedures, and protocols of the environmental and social safeguards as specified in the Supplement of the MPW’s Technical Guideline.

14. The following are the minimum areas of environmental and social safeguards aspects that will be included in the Supplement to the current MPW’s Technical Guidelines:

(a) Environment. The Supplement of the Technical Guidelines will at least include: (1) Environmental screening criteria and instruments required, sub-projects will be

checked against GoI screening criteria. In an initial screening, the project type, scale, location, sensitivity, and the nature and magnitude of potential impacts, will be identified to classify the proposal in one of four categories: i. Those that require AMDAL (full Environmental Impact Assessments) for which

the Ministry of Environment has set criteria (see below). No sub-projects are expected to fall under this criteria

ii. Those that require environmental management and monitoring plans (UKL and UPL) based on limited but site specific studies. The Ministry of Environment and MPW has set criteria to determine the need for UKL/UPL (see below). It is expected that a small number of the DAK proposals submitted will fall under these criteria.

iii. Those for which standard operating procedures (SOP) suffice, where generic good practice will protect the environment adequately. The DG Bina Marga, DG Human Settlements, and DG Water Resources have SOP guidelines for some types of projects (including measures to control dust, noise and traffic at construction sites; specifications for backfilling and re-vegetating disturbed areas to prevent erosion; and procedures to control negative impacts at solid waste transfer stations; etc.). It is expected that most sub-projects will fall into this category.

iv. Those that require no environmental study, where no construction, disturbance of land or water or discharge of pollutants are involved. It is expected that some sub-projects may fall into this category.

v. Additional screening criteria (exclusion list): Ozone-depleting substances, pesticides, tobacco or tobacco products: No

subprojects using or producing these materials will be financed.

79

Hazardous materials and wastes. No sub-project will be financed that uses, produces, stores or transports hazardous materials (toxic, corrosive or explosive) or generates "B3" (hazardous) wastes.

Development in protected areas. No sub-project will be financed that is located in a protected area or might change the purpose and/or designation of a protected area. Protected areas are identified in the Minister of the State for the Environment Decree Number KEP-11/MENLH/2006, entitled Concerning the Types of Businesses Activities Required to Complete an Environmental Impact Assessment. The list includes notably: forest protection area; marine/freshwater conservation areas; nature tourism park; areas surrounding lakes and reservoirs; coastal mangrove areas; national parks; coastal edges; forest parks; cultural reserves; areas surrounding springs; scientific research areas; and nature conservation areas.

No sub-project will be financed that involves conversion of critical natural habitats.

No sub-project will be financed that degrades or damages cultural property, including not only physical artifacts and structures, but also sites considered sacred or otherwise having spiritual importance.

No sub-project will be financed for new swamp reclamation network or continuation of existing swamp reclamation network.

(2) Monitoring and reporting (3) Design specifications including environment management consideration for water

supply, sanitation, roads and bridges, and irrigation will be applied to DAK in the form of SOP. The program will make use of relevant technical and operation manuals and other environmental best practice guidelines. Sources that can be considered are: Infrastruktur Baik dan Buruk, PPK (Infrastructure good and bad, KDP). An

illustrative and photographic manual of good and bad construction techniques: Roads and Bridges, Water, Sanitation, Irrigation.

Manual Teknis (Technical Manuals) PAMSIMAS for water supply and sanitation, 2009.

Formulir Petunjuk Teknis Operasional, PPK (Environmental Assessment Form from the technical Operation Manual, KDP).

Other international resources such as Southern African Development Community (SADC), Guideline Low-volume Sealed Roads.

(b) Involuntary resettlement covers land acquisition, relocation, and livelihood impacted by a sub-project. The Supplement of the Technical Guideline will at least include: (1) screening of whether there will be land acquisition and to what extent; (2) identification of project affected persons/land owners and scale of land acquisition needed by the sub-project; (3) schemes for land acquisition, relocation and livelihood rehabilitation;

80

Table 1: Government Environmental Screening Criteria

Sectors and Projects Units AMDAL UKL/UPL Water Supply Raw water intake L/s ≥ 250 50 to < 250 Roads New construction: a. Medium towns km; or ha ≥ 10 3 to < 10; or 5 to < 10 b. Small towns (kelurahan) km ≥ 30 5 to <30 Widening (large towns) km ≥ 10 (if land

acquisition) Bridges m ≥ 500 Bridges in small towns m - ≥ 60 Wastewater & sanitation IPAL ha ≥ 3 < 3 Irrigation Rehabilitation ha - > 1,000 Extension of irrigation area ha ≥ 1,000 500 to < 1,000 Sources: Decree of the Minister of State for the Environment of the Republic of Indonesia. KEP-11/MENLH/2006 for AMDAL (Concerning Types of Businesses Activities Required to Complete an Environmental Impact Assessment); and KEPMEN MPW- 17/KPTS/M/2003 for UKL/UPL (Concerning Decisions on Types of Activities in the Field of Public Works that are Required to Prepare UPL and UKL).

(4) instruments used; (5) forms and defining compensation level or other forms of compensation; (6) consultation process; (7) grievance mechanisms; (8) disclosure; (9) agencies involved; (10) financing and payment; and (11) timing for implementation of the agreements/instruments. In addition, the Supplement of the Technical Guideline will have to specify the required report, records and documentation for the process and completion of land acquisition, including among others: (1) instruments; (2) minutes of meetings and agreements; (3) records and proves of land transfers and implementation of agreements; (4) consolidated report for the LGs for all DAK sub-projects in the roads, water and sanitation, and irrigation sectors. The Supplement of the Technical Guidelines will also provide formats for records and proves of transfer of land, and reports, which can use the practice in the “PNPM Mandiri Perkotaan” as a reference.

(c) Indigenous Peoples (IPs) or Isolated and Vulnerable Peoples (IVPs). The Supplement of

the Technical Guidelines will at least include the following: (1) identification of the affected IPs or IVPs; (2) process of free, prior informed participatory consultation; (3) assessment of the potential impacts; (4) measures to mitigate impacts; (5) incorporation of the agreements in the sub-project design, construction and operation stage; (6) grievance mechanisms, and disclosure; (7) financing; and (8) responsible agencies. The Guidelines will also elaborate the formats and requirements of the reporting, records for the consultation meetings, records for the agreement and complaints, etc. The project will take the experience and manual from the PNPM rural in addressing the issues related to IPs or IVPs.

15. Compliance Indicators will be included in the Operations Manual.

81

16. The Operation Manual will detail the criteria or indicators for compliance of the LGs in implementing the environmental and social safeguards during preparation, construction, and post construction/reporting, to be reviewed (due diligence) by the BPKP, and to be monitored and supervised by the MPW as part of the project management. The Operations Manual will also include a Standard Operating Procedure for the BPKP to verify the implementation of the environmental and social safeguards aspects by the LGs. The BPKP will review and verify the performance of the LGs in implementing environmental and social safeguards through two activities for at least in the following areas:

(a) Reviewing the Quarterly Report. The BPKP will review the report for the sufficiency of the following information: List of sub-projects that have environmental and social impacts (land acquisition and

IPs or IVPs). Explanation of the types and scale of environmental and social impacts (including

land acquisition, livelihood, and IPs or IVPs). Explanation on the instruments used to avoid, mitigate and remedy negative

environmental and social impacts. Instruments for acquiring the needed land and for involving IPs or IVPs (if any). Options for acquiring land and addressing livelihood. Defining compensation level. Consultation process for environmental and social (including land acquisition and IPs

or IVPs) management. Grievance procedures for handling environmental and social issues. Status of the implementation of the instruments. Costs, financing and responsible local agencies of the implementation of the

instruments. Availability of documentation: minutes of meetings, records for complaints, records

for land transactions/transfers, instruments for environmental management, instruments for land acquisition, instruments to involve IPs or IVPs, pictures as necessary.

(b) Field checking by the BPKP. In addition to reviewing the quarterly report, the BPKP will

visit selected sites (based on sample) as part of the overall verification activities to verify information provided in the report. A Standard Operating Procedure (SOP) and requirements for each aspect that will be reviewed and verified by the BPKP will be specified in detail in the project Operations Manual. The BPKP will visit the sub-project sites and look at the physical condition on how environmental and social impacts were addressed and managed. In addition, the BPKP will have to interview and discuss with the relevant local agencies, contractors, and the project affected persons on the key environmental and social issues and impacts that took place in the sub-projects, and verify the process and mitigation measures to avoid, minimize and remedy such impacts. The BPKP will have to verify the instruments used for environmental management, land acquisition and for the involvement of the IPs or IVPs; minutes of meetings, agreements reached, and records of complaints and unsolved issues. In addition, records on land transfers and implementation of the agreements will have to be checked and verified. Furthermore, the BPKP will have to check whether sufficient measures and activities are

82

covered in the contract of the contractors to mitigate and remedy potential negative environmental and social impacts. All of these aspects will be evaluated against the compliance indicators specified in the Operations Manual for defining the LGs’ eligibility for DAK reimbursement.

(c ) Regular project monitoring and supervision. The MPW will carry out regular monitoring

and supervision for the implementation of the environmental and social safeguards by the LGs, as part of the overall project activities. The main purpose of monitoring and supervision is to ensure that the process and documentation pertaining safeguards-related activities follow the requirements, procedures and protocols for environmental and social safeguards as specified in the Supplement of the MPW’s Technical Guidelines. The indicators that the MPW will look at during the monitoring and supervision will be similar to those of the BPKP (refer to point b above). Close monitoring and supervision will increase the likelihood of LGs complying with the requirements, procedures, and protocols on environmental and social safeguards as specified in the Supplement of the MPW’s Technical Guidelines and therefore secure their eligibility for reimbursement from the Bank.

83

Annex 11: Project Preparation and Supervision

INDONESIA: Local Government and Decentralization Project Planned Actual PCN review 05/15/2009 04/23/2009 Initial PID to PIC 05/26/2009 Initial ISDS to PIC 05/26/2009 Appraisal 04/09/2010 4/09/2010 Negotiations 04/20/2010 04/23/2010 Board/RVP approval 05/25/2010 Planned date of effectiveness 07/01/2010 Planned date of mid-term review 12/31/2012 Planned closing date 06/30/2014 Key institutions responsible for preparation of the project: DG Fiscal Balance MoF, GoI Bank staff and consultants who worked on the project include: Name Title Unit Peter Ellis Sr. Urban Economist EASIS Luis Tineo Sr. Infrastructure Specialist GPOBA Cledan Mandri-Perrott Sr. Infrastructure Specialist FEUFG Andri Wibisono Infrastructure Specialist EASIS Thalyta Yuwono Economist EASIS Arlan Rahman Water and Sanitation Specialist EASIS Indira Dharmapatni Sr. Operations Officer EASIS Andrew Sembel Environmental Specialist EASIS Paulus van Hofwegen Irrigation Specialist EASIS Marcus Lee Gregorius Pattinasarany

Economist Sr. Economist

FEUUR EASPR

Yogana Prasta Operations Adviser EACIF Melinda Good Sr. Counsel LEGES Rizal Rivai Sr. Procurement Specialist EAPPR Imad Saleh Lead Procurement Specialist EAPPR Rajat Narula Sr. Financial Management Specialist EAPFM Novira Asra Sr. Financial Management Specialist EAPFM Amien Sunaryadi Sr. Operations Officer EACIF Eduardi Prahara Engineer EASIS Griya Rufianne Operations Analyst EASIS Santo Dewatmoko Institutional Development Specialist EASIS Arief Ramadhian Urban Planner EASIS Adri Poesoro Rentanida Simatupang

Economist Municipal Finance Specialist

EASIS EASIS

Ira Marina Team Assistant EACIF

84

Bank funds expended to date on project preparation: 1. Bank resources: US$186,000.00 2. Trust funds: n/a 3. Total: US$186,000.00

Estimated Approval and Supervision costs:

1. Remaining costs to approval: US$50,000.00 2. Estimated annual supervision cost: US$200,000.00

85

Annex 12: Documents in the Project File

INDONESIA: Local Government and Decentralization Project Project Documents:

Draft Project Operations Manual Draft Supplement to the MPW Technical Guidelines Scope of Work for BPKP Data Persebaran Komunitas Adat Terpencil Tahun 2006 yang dimutakhirkan tahun 2008

(Contains lists of Indigenous Peoples). Ministry of Social Affairs, Indonesia, 2008 Other Documents:

Implementation of Fiscal Decentralization in Indonesia. Pelengkap Buku Pegangan Penyelenggaraan Pemerintahan dan Pembangunan Daerah, Ministry of Finance, Indonesia, 2009.

Indonesia Development Policy Review: Enhancing government effectiveness in a democratic and decentralized Indonesia. World Bank Report, November 2009.

Managing Resources for Better Outcomes in a Special Autonomy Region: Aceh Public Expenditure Analysis Update. World Bank Report, 2008.

Ministry of Finance Decree No. 175/PMK.07/2009 Allocation and General Guidelines for DAK FY 2010. Ministry of Finance, Indonesia, 2009.

Ministry Decree No. 42/PRT/M/2007 Technical Guidelines DAK Infrastructure sector. Ministry of Public Works, 2007.

Ministry of Public Works Circular Letter No. KU.01.01-Mn/678 Scope of DAK utilization for infrastructure sector FY 2010. Ministry of Public Works, Indonesia, December 2009.

National Road Sector Assessment 2005-2009 and Strategic Plan 2010-2014. Sub Directorate of General Planning, Directorate of Planning, Directorate General of Highways, Ministry of Public Works, Indonesia, November 2009.

Options for Improving DAK Grants. The Poverty Reduction and Millennium Development Goals Acceleration Program (PRMAP) HICKLING Discussion Paper, February 2009.

Policy Framework for Special Grants and Institutional Arrangements for Grant Administration. CIDA-KPMG (LP) HICKLING Report, May 2003.

Service Delivery and Financial Management in a New Province. Gorontalo Public Expenditure Analysis. World Bank Report, 2008.

Spending for Development: Making the Most of Indonesia’s New Opportunities. Indonesia Public Expenditure Review 2007, World Bank Report, 2007.

The Specific Purpose Grant (DAK): Mechanisms and Uses. SMERU Report, April 2008.

86

Annex 13: Statement of Loans and Credits


Original Amount in US$ million

Difference between expected and actual

disbursements

Project ID

FY Purpose IBRD IDA SF GEF Cancel. Undisb. Orig. Frm. Rev’d

P090991 2010 ID-URBAN WATER SUPPLY

23.56 0.00 0.00 0.00 0.00 23.56 0.00 0.00

P115199 2009 Public Expend. Supp. Facility (DPL-DDO)

2,000.00 0.00 0.00 0.00 0.00 1,995.00 0.00 0.00

P107661 2009 ID-BOS KITA Project 600.00 0.00 0.00 0.00 0.00 416.89 -181.61 0.00

P092218 2009 ID- Indo Infrastructure Finance Facility

100.00 0.00 0.00 0.00 0.00 100.00 0.00 0.00

P096532 2009 ID: Dam Operational Improvement (DOISP)

50.00 0.00 0.00 0.00 0.00 50.00 0.00 0.00

P100740 2009 PINTAR 110.00 0.00 0.00 0.00 0.00 109.73 0.00 0.00

P096921 2008 ID - National UPP (PNPM UPP)

167.68 125.00 0.00 0.00 0.00 165.68 -121.68 0.00

P097104 2008 ID-BERMUTU 24.50 61.50 0.00 0.00 0.00 74.32 23.23 0.00

P105002 2008 National Program for Community Empower

341.19 190.00 0.00 0.00 0.00 373.21 50.00 0.00

P079906 2007 ID-Strategic Roads Infrastructure

414.46 0.00 0.00 0.00 174.98 206.38 95.17 21.91

P083742 2007 ID-Farmer Empower. Agric.Tech.&Info

32.80 60.00 0.00 0.00 0.00 71.04 19.63 0.00

P089479 2006 ID-Early Childhood Education and Dev

0.00 67.50 0.00 0.00 0.00 52.17 6.23 0.00

P085375 2006 ID-WSSLIC III (PAMSIMAS) 0.00 137.50 0.00 0.00 0.00 92.89 5.31 0.00

P077175 2006 ID-Domestic Gas Market Development Proj.

80.00 0.00 0.00 0.00 0.00 38.29 24.12 0.00

P071296 2005 ID-USDRP 45.00 0.00 0.00 0.00 0.00 31.97 21.17 0.00

P076174 2005 ID-Initiatives for Local Govern. Reform

14.50 15.00 0.00 0.00 0.00 15.68 14.27 0.00

P078070 2005 ID-Support for Poor and Disadvant Areas

138.00 35.00 0.00 0.00 0.00 34.19 24.99 0.00

P084583 2005 ID-UPP3 67.30 71.40 0.00 0.00 0.00 17.53 -33.76 0.00

P085133 2005 Govt Finl Mgt & Revenue Admin Project

55.00 5.00 0.00 0.00 0.00 51.95 50.15 42.80

P092019 2005 ID Kecamatan Development Project 3B

80.00 203.00 0.00 0.00 0.00 1.41 -126.97 8.39

P085374 2005 ID-HIGHER EDUCATION 50.00 30.00 0.00 0.00 0.00 53.78 39.22 0.00

P074290 2004 ID-Eastern Indonesia Region Transp. 2

200.00 0.00 0.00 0.00 1.00 89.14 90.14 0.00

P071316 2004 ID - Coral Reef Rehab and Mgmt Prog II

33.20 23.00 0.00 0.00 0.17 28.46 24.62 0.00

P064728 2004 ID-LAND MANAGEMENT &POLICY DEVT

32.80 32.80 0.00 0.00 0.16 27.92 23.85 0.00

P079156 2003 ID-KECAMATAN DEV. 3 45.50 45.50 0.00 0.00 0.00 2.26 0.97 0.00

P063913 2003 ID-Java-Bali Pwr Sector & Strength

141.00 0.00 0.00 0.00 0.00 43.62 43.62 43.62

P059931 2003 ID-Water Resources & Irr.Sector Mgt Prog

45.00 25.00 0.00 0.00 0.00 34.58 32.10 1.99

87

P072852 2002 ID-UPP2 29.50 206.00 0.00 0.00 0.00 3.94 -146.62 -11.12

P059477 2000 ID-WSSLIC II 0.00 77.40 0.00 0.00 3.95 3.34 -0.39 0.00

Total: 4,920.99 1,410.60 0.00 0.00 180.26 4,208.93 - 22.24 107.59

INDONESIA STATEMENT OF IFC’s

Held and Disbursed Portfolio US$ million

Committed Disbursed

IFC IFC

FY Approval Company Loan Equity Quasi Partic. Loan Equity Quasi Partic.

2006 Bank Danamon 155.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

2004 BonaVista School 1.00 0.00 0.00 0.00 1.00 0.00 0.00 0.00

2006 Buana Bank 5.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

2006 Centralpertiwi 45.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

2004 Medan NP School 1.75 0.00 0.00 0.00 0.00 0.00 0.00 0.00

2002 P.T. Gawi 11.05 0.00 0.00 3.49 4.90 0.00 0.00 3.49

1989 PT Agro Muko 0.00 2.20 0.00 0.00 0.00 2.20 0.00 0.00

1997 PT Alumindo 2.73 0.00 0.00 0.00 2.73 0.00 0.00 0.00

1989 PT Astra 0.00 0.20 0.00 0.00 0.00 0.20 0.00 0.00

1994 PT Astra 0.00 0.19 0.00 0.00 0.00 0.19 0.00 0.00

2003 PT Astra 0.00 0.12 0.00 0.00 0.00 0.12 0.00 0.00

PT Astra Otopart 0.00 0.70 0.00 0.00 0.00 0.70 0.00 0.00

2005 PT Astra Otopart 24.00 0.00 0.00 0.00 24.00 0.00 0.00 0.00

2000 PT Bank NISP 0.00 2.85 2.86 0.00 0.00 2.85 2.83 0.00

2002 PT Bank NISP 0.00 2.04 0.00 0.00 0.00 2.04 0.00 0.00

2004 PT Bank NISP 35.00 0.00 0.00 0.00 35.00 0.00 0.00 0.00

1997 PT Berlian 0.00 3.35 0.00 0.00 0.00 0.00 0.00 0.00

1993 PT Bina Danatama 0.05 0.00 0.00 0.00 0.05 0.00 0.00 0.00

1996 PT Bina Danatama 0.00 0.00 2.58 4.81 0.00 0.00 2.58 4.81

2004 PT Ecogreen 30.00 0.00 0.00 0.00 30.00 0.00 0.00 0.00

2005 PT Ecogreen 25.00 0.00 0.00 0.00 20.00 0.00 0.00 0.00

PT Grahawita 0.00 0.00 3.75 0.00 0.00 0.00 3.75 0.00

1991 PT Indo-Rama 0.00 3.82 0.00 0.00 0.00 3.82 0.00 0.00

1995 PT Indo-Rama 0.00 1.57 0.00 0.00 0.00 1.57 0.00 0.00

1999 PT Indo-Rama 0.00 0.81 0.00 0.00 0.00 0.81 0.00 0.00

2001 PT Indo-Rama 20.00 0.00 0.00 0.00 0.33 0.00 0.00 0.00

2004 PT Indo-Rama 48.00 0.00 0.00 0.00 41.00 0.00 0.00 0.00

1992 PT KIA Keramik 0.23 0.00 0.00 2.00 0.23 0.00 0.00 2.00

1996 PT KIA Keramik 1.65 0.00 0.00 53.49 1.65 0.00 0.00 53.49

1995 PT KIA Serpih 4.50 0.00 0.00 49.50 4.50 0.00 0.00 49.50

1997 PT Kalimantan 9.38 0.00 0.00 0.00 9.38 0.00 0.00 0.00

PT Karunia (KAS) 16.45 0.00 0.00 3.56 16.45 0.00 0.00 3.56

2006 PT Karunia (KAS) 20.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

PT Makro 0.00 2.34 0.00 0.00 0.00 2.34 0.00 0.00

88

2000 PT Makro 0.00 1.21 0.00 0.00 0.00 0.71 0.00 0.00

2006 PT Makro 0.00 0.66 0.00 0.00 0.00 0.66 0.00 0.00

1998 PT Megaplast 0.00 2.50 0.00 0.00 0.00 2.50 0.00 0.00

1993 PT Nusantara 0.00 0.00 10.16 7.90 0.00 0.00 10.16 7.90

2004 PT Prakars (PAS) 15.36 0.00 0.00 3.20 15.36 0.00 0.00 3.20

1997 PT Sayap 0.83 0.00 0.00 0.00 0.83 0.00 0.00 0.00

2001 PT Sigma 0.00 1.03 0.00 0.00 0.00 1.03 0.00 0.00

2006 PT TAS 7.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

1995 PT Viscose 7.81 0.00 0.00 0.00 7.81 0.00 0.00 0.00

2004 PT Viscose 8.31 0.00 0.00 0.00 8.31 0.00 0.00 0.00

1997 PT Wings 0.72 0.00 0.00 0.00 0.72 0.00 0.00 0.00

2001 Sunson 11.62 0.00 0.00 7.35 11.62 0.00 0.00 7.35

2005 WOM 0.00 15.82 0.00 0.00 0.00 15.74 0.00 0.00

2006 WOM 20.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

2004 Wilmar 33.33 0.00 0.00 0.00 33.33 0.00 0.00 0.00

Total portfolio: 560.77 41.41 19.35 135.30 269.20 37.48 19.32 135.30

Approvals Pending Commitment

FY Approval Company Loan Equity Quasi Partic.

2005 Bank NISP SELF 0.03 0.00 0.00 0.00

2006 Bank NISP Swap 0.00 0.00 0.00 0.00

2006 Orix Indonesia 0.08 0.00 0.00 0.00

Total pending commitment: 0.11 0.00 0.00 0.00

89

Annex 14: Country at a Glance


East Lo wer-P OVER T Y and SOC IA L A sia & middle-

Indo nesia P acif ic inco me2007Population, mid-year (millions) 225.6 1,914 3,437GNI per capita (Atlas method, US$) 1,650 2,180 1,887GNI (Atlas method, US$ billions) 373.1 4,174 6,485

A verage annual gro wth, 2001-07

Population (%) 1.3 0.8 1.1Labor force (%) 1.9 1.2 1.5

M o st recent est imate ( latest year available, 2001-07)

Poverty (% of population below national poverty line) 17 .. ..Urban population (% of to tal population) 50 43 42Life expectancy at birth (years) 68 71 69Infant mortality (per 1,000 live births) 26 24 41Child malnutrition (% of children under 5) 24 13 25Access to an improved water source (% of population) 80 87 88Literacy (% of population age 15+) 90 91 89Gross primary enro llment (% of school-age population) 114 110 111 M ale 116 111 112 Female 112 109 109

KEY EC ON OM IC R A T IOS and LON G-T ER M T R EN D S

1987 1997 2006 2007

GDP (US$ billions) 75.9 215.7 364.5 432.8

Gross capital formation/GDP 30.2 31.8 25.4 24.9Exports of goods and services/GDP 23.9 27.9 31.0 29.4Gross domestic savings/GDP 31.7 31.5 30.8 28.9Gross national savings/GDP 26.8 29.0 27.9 26.1

Current account balance/GDP -2.8 -4.6 2.7 2.5Interest payments/GDP 3.4 2.4 0.8 ..Total debt/GDP 69.2 63.2 35.9 ..Total debt service/exports 37.0 30.0 16.6 ..Present value of debt/GDP .. .. 35.4 ..Present value of debt/exports .. .. 104.7 ..

1987-97 1997-07 2006 2007 2007-11(average annual growth)GDP 7.8 3.7 5.5 6.3 6.4GDP per capita 6.1 2.3 4.3 5.1 5.2Exports of goods and services 9.0 5.1 9.4 8.0 7.6

ST R UC T UR E o f the EC ON OM Y

Indonesia

Lower-middle-income group

D evelo pment diamo nd*

Life expectancy

Access to improved water source

GNIpercapita

Grossprimary

enro llment

Indonesia

Lower-middle-income group

Eco no mic rat io s*

Trade

Indebtedness

Domesticsavings

Capital formation

1987 1997 2006 2007(% of GDP)Agriculture 23.3 16.1 12.9 13.8Industry 36.3 44.3 47.0 46.7 M anufacturing 16.9 26.8 28.0 27.0Services 40.4 39.6 40.1 39.4

Household final consumption expenditure 58.8 61.7 60.6 62.8General gov't final consumption expenditure 9.4 6.8 8.6 8.3Imports of goods and services 22.4 28.1 25.6 25.3

1987-97 1997-07 2006 2007(average annual growth)Agriculture 3.1 2.8 3.4 3.5Industry 9.8 3.1 4.5 4.7 M anufacturing 10.9 4.2 4.6 4.7Services 8.2 4.6 7.4 8.9

Household final consumption expenditure 8.7 3.6 5.7 8.6General gov't final consumption expenditure 3.8 6.2 9.6 3.9Gross capital formation 10.0 1.5 1.2 2.0Imports of goods and services 12.0 4.1 8.6 8.9

Note: 2007 data are preliminary estimates.

This table was produced from the Development Economics LDB database.

* The diamonds show four key indicators in the country (in bo ld) compared with its income-group average. If data are missing, the diamond will be incomplete.

-10

0

10

20

02 03 04 05 06 07

GCF GDP

Gro wth o f capital and GD P (%)

-10

0

10

20

30

02 03 04 05 06 07

Exports Imports

Gro wth o f expo rts and impo rts (%)

90

Indonesia

P R IC ES and GOVER N M EN T F IN A N C E1987 1997 2006 2007

D o mestic prices(% change)Consumer prices 8.8 6.1 13.1 6.5Implicit GDP deflator 15.4 12.6 13.6 11.5

Go vernment f inance(% of GDP, includes current grants)Current revenue 16.3 17.2 18.1 16.3Current budget balance -4.0 5.2 6.6 5.2Overall surplus/deficit -0.8 -1.2 -0.9 -1.2

T R A D E1987 1997 2006 2007

(US$ millions)Total exports (fob) .. 53,444 100,799 114,101 Fuel .. 13,154 27,619 29,210 Estate crop .. 3,785 5,483 6,329 M anufactures .. 21,268 42,764 46,140Total imports (cif) .. 41,680 79,777 91,724 Food .. 2,983 4,709 6,884 Fuel and energy .. 4,047 19,028 21,994 Capital goods .. 17,573 15,411 19,038

Export price index (2000=100) .. 88 68 65Import price index (2000=100) .. 71 83 68Terms of trade (2000=100) .. 124 82 95

0

25,000

50,000

75,000

100,000

125,000

01 02 03 04 05 06 07

Exports Imports

Expo rt and impo rt levels (US$ mill.)

0

5

10

15

20

02 03 04 05 06 07

GDP def lator CPI

Inf lat io n (%)

B A LA N C E o f P A YM EN T S1987 1997 2006 2007

(US$ millions)Exports o f goods and services 18,271 63,239 115,032 130,439Imports o f goods and services 16,972 62,830 95,493 108,458Resource balance 2,598 818 19,539 21,981

Net income -7,308 -12,664 -14,465 -15,875Net current transfers 257 1,034 4,863 4,904

Current account balance -2,098 -9,890 9,937 11,010

Financing items (net) 3,357 -6,385 -3,035 1,533Changes in net reserves -1,259 16,275 -6,902 -12,543

M emo :Reserves including gold (US$ millions) 4,814 17,396 43,083 55,626Conversion rate (DEC, local/US$) 1,643.8 2,909.4 9,159.3 9,143.4

EXT ER N A L D EB T and R ESOUR C E F LOWS1987 1997 2006 2007

(US$ millions)Total debt outstanding and disbursed 52,535 136,273 130,956 .. IBRD 7,391 9,991 7,423 6,821 IDA 865 715 1,318 1,550

Total debt service 7,001 19,737 20,434 .. IBRD 875 1,848 1,827 1,803 IDA 12 26 37 38

Composition of net resource flows Official grants 195 210 1,071 .. Official creditors 2,523 534 54 .. Private creditors 301 5,992 4,776 .. Foreign direct investment (net inflows) 385 4,677 5,580 .. Portfo lio equity (net inflows) 0 -4,987 1,898 ..

World Bank program Commitments 1,418 810 749 1,383 Disbursements 1,374 899 1,012 986 Principal repayments 361 1,165 1,430 1,396 Net flows 1,013 -266 -418 -409 Interest payments 525 709 434 445 Net transfers 488 -975 -852 -855

Note: This table was produced from the Development Economics LDB database. 9/24/08

0

5

10

15

01 02 03 04 05 06 07

C urrent acco unt balance to GD P (%)

G: 33,000

A: 7,423

D: 9,505

B: 1,318

F: 41,023

E: 38,687

A - IBRDB - IDA C - IM F

D - Other mult ilateralE - BilateralF - PrivateG - Short-term

C o mpo sit io n o f 2006 debt (US$ mill.)

91

Annex 15: Maps
