Three Years of Fiscal Decentralization in Indonesia - Brodjonegoro (2004)

8/12/2019 Three Years of Fiscal Decentralization in Indonesia - Brodjonegoro (2004)

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THREE YEARS OF FISCAL DECENTRALIZATION IN INDONESIA :

ITS IMPACTS ON REGIONAL ECONOMIC DEVELOPMENT AND

FISCAL SUSTAINABILITY

Bambang Brodjonegoro (Department of Economics, University of Indonesia)

INTRODUCTION

Toward the second general election in the reformasi(reformation) era in 2004, the issueof decentralization and regional autonomy has not been widely considered as critical

issue in nation building, and hence as one of major platform of political parties. There

could be many reasons for this circumstance. First, the process might have beenconsidered as quite successful. At least, there was no real chaos occurring as a result of

the decentralization process. Second, regardless of the effects of the process itself,

Indonesians have adjusted well to the new condition and therefore, everything related to

decentralization becomes routine activities. Third, the political parties could be more

attracted to other issues such as corruption, law enforcement, economic recovery process,than the decentralization issues that might not be visible to many Indonesians. Fourth

and the most dangerous one, there might be a tendency at central government andpolitical elites to either slow down the decentralization process, or more extreme, go back

to centralization system in the past. There might be many reasons to explain the lower

tone of decentralization process but the fact is that only few parties are interested to raisethe decentralization issues as one of their campaign theme.

After three years of the decentralization process itself, it is still difficult to judge if theprocess is a successful one or not. The international community deemed the process as

still on the right track citing that the Indonesians was able to manage the massive anddrastic decentralization, and minimize the negative effects. The central government feels

that they have managed the drastic change quite well but at the same time admits that

they are still worried about the future and many have to be done in order to direct the

decentralization on the right path including the revision of law 22/1999 and 25/1999.The local governments, however, are less satisfied than the central one. They are still

suspicious that the central government is not fully supporting the process, and when the

process is considered as a failure in the future, there will be a recentralization process.On the other hand, they admit that they have experienced a freedom that did not exist

during the centralized era, and gradually, the learning process of managing and

administering the local governments is working. The ordinary Indonesians, especiallythe local residents, might be the only one who keeps questioning the effects of the

decentralization process. Some claimed that they do not feel any impact of the process,

while some others felt only the negative impacts. They still believe that the currentprocess is more on the decentralization from central to local governments than the

decentralization from government to the local people or community.

Among all types of impacts generated by the decentralization process, the economic (andfiscal) impacts are still considered the most crucial one since Indonesia is still on the

recovery process after the 1998 financial and economic crisis. Together with political

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reformation, most Indonesians had expectation that the decentralization process will

contribute to the economic reformation especially reducing disparity between Jawa andoutside Jawa or between the western and eastern part. Giving more economic policy

decision making power to the local government is also considered as the expected output

of successful decentralization process. Therefore, this paper is intended to evaluate the

three years Indonesian decentralization process with the emphasis on the economic andfiscal impacts but the discussion will begin with the evaluation from political and

administrative point of view since they will affect the economic side eventually. Special

concern about fiscal sustainability that might relate to decentralization will be on the lastpart of this paper, and this might have further implication to future Indonesia economic

development pattern.

DEVOLUTION OF POWER AND POLITICAL APPROACHAfter three years of decentralization, it is not too surprising if there were problems due to

multi-interpretation or lack of clarity of law 22/1999. In 1999, the law was drafted

without a blue print or general design of decentralization scheme and without a white

paper. Sequentially, the decentralization process should begin with the blue printfollowed by a white paper. The white paper should be then the foundation for the legal

drafting. Due to political condition and limited time availability, the decentralizationprocess in Indonesia jumped directly to the law drafting and as a result, when there is

confusion about the law itself, no valid reference is available. Various groups, with their

own argument, are competing to be the true interpreter of the law, especially law22/1999. If one group is in verge of having enough power over the implementation and

revision of the law, other groups will try very hard to undermine them through frequent

and sometimes unfair critiques. Ironically, this possible conflict or rivalry sometimestakes place between groups in the ministry of home affairs (MOHA) that is clearly

responsible for drafting and implementing the decentralization laws, especially frompolitical and administrative point of view.

Among many confusing and debatable issues in the law 22/1999, there might be threemost crucial issues : devolution of government authorities, formation and amalgamation

of new local governments, and the local executive-legislative relationship. At the first

issue, the devolution of government authorities, the central government may claim that

they have managed the devolution process quite well and after three years, the centralgovernment influence in the local government activities has significantly declined.

However, the local government might not share the same opinion. They claimed that the

devolution of authorities was far from clear, and eventhough it was clear, the lineministries at central government were obviously still interested in the authorities. Lack of

clarity in the devolution process might come from two different extremes in the law. At

one part, the law states that the central government will only be responsible for fivefunctions plus planning and standardization. At the other part, the law also states that

each local government has to be responsible for eleven obligatory sectors. The problem

lies on the gap between the central government obligatory functions and the local

government ones, and the inconsistency between functions for the central governmentand sectors for local governments. The government regulation (PP) 25/2000 was

supposed to close the gap by giving more detailed direction to local government, but

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instead the PP used the residual approach that listed only the detailed functions of central

and provincial government, and left the rest to local government. As a result, the localgovernment can define their functions at their will. It could be a broad range of function

but at the same time, it could be a small range. There are two predicted outcomes

generated from this condition, the conflicts of interests between central and local

governments, and lower quality of basic public services delivery for the local residents.

The second issue, the formation and amalgamation of new local governments is mostly

treated exclusively as the political concerns. Whenever there is formation of new localgovernment, the political flavor and interests are much more dominant than other

consideration. It is no secret that the local elites are jockeying for the local executive

position through the proposal of new local government formation. The law 22/1999interpretation seems to fully support the formation without real and binding consequences.

The government regulation (PP) that is supposed to back up the clauses about the

formation already described the process in detail with the criteria. However, lack of

political willingness at the central government side to manage and control the formation

of new local governments caused the high influx of new districts and municipalities atmore than 10% annual growth rate. Currently, with more than 410 districts and

municipalities, it is not clear if the number will keep growing at the same rate after 2004and how this number will contribute to economic efficiency. Many argue that the

formation of new local governments in Indonesia has nothing to do with the economic

efficiency and more on entertaining the local political interests. With the slow economicrecovery process and acute corruption, it is quite ironic that Indonesians still give the

opportunity for wasting the economic resources and for creating more corruption through

the formation. There are two obvious wasted economic resources as results of new localgovernment formation namely the relatively huge initial investment to set up the local

administration system, and the higher dependency of local governments to theintergovernmental transfer, especially the general purpose grant (DAU). Brodjonegoro

and Mahi (2003) noted that many new local governments had relatively insignificant

local own revenue (PAD) and relied heavily on DAU.

The third issue, the local executive legislative relationship, becomes one of major

obstacles in promoting good governance and effective local administration. The law

22/1999 somehow implied that the local parliament (DPRD) is the most powerful body atthe local level. They basically have the authority to hire, evaluate, and fire the head of

local executives. Their authority in determining the local budget also seems to be very

powerful. Therefore, the local executive and legislative relationship is not a productiveand conducive one from local resident point of view. They could either make

collaboration between them or fight continuously. Each one of them will not be

beneficial for the local resident and the latter even creates two bupatis (head of district) inKaranganyar District, central Jawa. The collusion between local executive and

legislative tends to promote the corrupt behavior, and the local legislative tends to be the

major player. There is relieving trend nowadays when many DPRD members become the

suspect in the local corruption cases, and some of them have even stayed in the prison.

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Any type of disruption in the local government politics and administrative system

eventually leads to the disruption of basic public service delivery. Many Indonesians,nowadays, are quite skeptic about the decentralization process simply because they have

not seen what they expected when the decentralization took place in 2001, a better local

basic public service delivery. The World Bank report in 2003 might indicate that most

Indonesians felt that the quality of public services during the decentralization era wasbetter than the previous one, or at least the same. However, the coverage of the survey

and sampling procedure might not reflect the reality and at the same time, national

newspapers keep publishing how infrastructures are deteriorating all over Indonesia, andhow the local governments pay little attention to the quality improvement of public

service delivery. To ensure that every Indonesian will enjoy the minimum basic standard

of public services, the central government through the ministry of home affairs (MOHA)coordination is trying to promote the implementation of the minimum service standard

(MSS). While the MSS idea might be good from conceptual point of view, the

possibility of becoming real success is highly questionable for two reasons. First, due to

its complexity, even in the developed decentralized country MSS cannot be fully

implemented. Second, the budget constraint seems to be non-existent when the lineministries are designing the MSS for their respective sectors. Current development

shows that the MSS design in Indonesia is rather slow due to different perception of theword minimum itself that is interpreted by some ministries as without budget constraint.

Furthermore, without proper preparation, the MSS implementation could lead to disaster

when the local government budget cannot fulfill the MSS and eventually they will ask formore transfer from central government.

To overcome or at least minimize the problems during decentralization era, the centralgovernment is trying to amend the law 22/1999 and law 25/1999. The basic substance of

the amendment is the introduction of direct election for both local executives andlegislatives. The direct election might bring better accountability at local level and

somehow, reduce the absolute power of DPRD. Better accountability could lead to more

responsive local governments in fulfilling the local resident needs. In terms of formationand amalgamation of new local governments, the amendment is trying to impose the

evaluation of autonomous regions that could lead to status withdrawal by central

government if local governments cannot fulfill certain criteria after a certain period of

time. It is still doubtful if this mechanism could work in the current period of uncertaintywhere the central government is still considered weak. The proposed amendment is also

trying to give significant contribution to better devolution of authorities by listing more

detailed functions that have to be carried out by local governments. Instead of just sayingthat local government is responsible in education sector, for example, the amendment

proposes that the local government is responsible in executing the function of providing

basic education or elementary school for the residents. Although many localgovernments still suspect that the amendment could lead to re-centralization but it has to

be admitted that the central government is trying seriously to make the decentralization

process a success story.

The re-centralization impression among the local governments may appear due to

redefinition of provincial government role in the decentralization process. In fact, it

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could be attributed as another significant contribution of law 22 amendment process

where the provincial government has the authority to do monitoring and evaluationprocess over the districts and municipalities in their area. Some argue that with the

amendment, the provincial government and the governor will become powerful again in

the near future and that may explain why the governor election is still intense and

interesting. By giving more power to the provincial government, the central governmentis trying to break the intense relationship between provincial and local governments that

sometimes leads to the ignorance of local governments on the existence of provincial

government.

However, the amendment process of both law 22/1999 and law 25/1999 revealed the old

and continuous problem at the central level, lack of coordination among the ministriesand especially, rivalry between MOHA and ministry of finance (MOF). Lack of

leadership at central level contributes significantly to the coordination and rivalry

problems. Although the central government is trying very hard to create impression that

decentralization is a nation agenda that has to be obeyed by everybody at central

government, the perception that law 22/1999 is just a sectoral law belongs to MOHA stillthere. As a result, the conflict with other sectoral law such as mining law, forestry law

still exists and it is far from easy to make other laws adjusted to the content of law22/1999 (World Bank, 2003). The rivalry between MOHA and MOF seems to be endless

when it comes to the question of who should be the authority of decentralization process.

Each one of them proposes the amendment of law 22 and law 25 respectively and thebigger problem is that each one of them is working on overlapped issues differently. One

example is the issue on how the local governments spend their budget. Both laws are

trying to reach the issue that did not exist in the original version of both laws. However,each one of them approached the issues from different perspective with their own

standards. MOHA claimed that they should be the authority in this issue since they havedealt with local expenditure issues for a long time, and for them, MOF should concentrate

on the revenue side of local budget (APBD). On the other hand, MOF claimed that they

should have authority over the expenditure side of APBD since they are responsible foraccounting and financial reporting standard. The rivalry becomes intense when it comes

to the idea of having only one law or legal act for decentralization like local government

act in Philippine (Asanuma et al, 2003). They prefer to maintain the status quo by having

one law under their responsibility but if there has to be one law, MOHA prefers that it hasto be under their responsibility. That preference could lead to MOHA domination in

drafting the future of decentralization while the decentralization process should be multi

facet and takes into account other ministries interests. So far, MOHA is gaining thepower while MOF is weakening, and currently, there is a tendency that MOHA is trying

to take over some power over the intergovernmental transfer and other local finance

issues.

FISCAL DECENTRALIZATION AND REGIONAL DEVELOPMENT

In addition to the democratization process, the slow economic recovery process is another

circumstance that accompanied the decentralization process since 2001. While focus ofthe national budget (APBN) should be to overcome the crisis and maintain economic

stability, at the same time APBN has to dedicate some amount for new scheme of fiscal

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decentralization as mandated by law 25/1999. Fortunately, there were no significant

negative effects on the APBN created by that new scheme and most of local governmentscould understand that the relatively low amount of transfer is mostly due to heavy burden

of APBN rather than the lack of central government commitment in fiscal

decentralization. On the other hand, the intergovernmental transfer scheme itself is still

far from optimal due to heavy political interference especially in DAU, natural resourcesrevenue sharing (through the special autonomy of Aceh and Papua), and tax revenue

sharing.

The center piece of Indonesian fiscal decentralization is the general purpose grant (DAU)

that gives the full autonomy to local governments in spending and managing the grant.

Instead of ad-hoc basis, the DAU utilizes the formula to allocate the grant to allprovincial and local governments in Indonesia. In most local governments, DAU is

basically their budget since its role is very dominant as demonstrated in table 1 of

appendix. This heavy dependence to DAU creates disincentive for local governments in

raising or intensifying the collection local own revenue (PAD). While excessive local tax

collection and illegal charges might harm the local investment climate, the localgovernments still have to intensify the collection of legal local taxes and charges revenue

up to the optimal level through better local tax administration system and lawenforcement. Brodjonegoro and Martinez (2002) revealed the significant negative

correlation between the size of DAU and PAD.

The allocation of DAU itself is still full of political influence as indicated by the hold-

harmless provision that guarantees every local government to receive the grant not less

than the previous allocation. This clearly hurts the fiscal capacity equalization purposethat should be the DAU responsibility. The equalization problem, for now, is resolved

gradually by keeping the rich regions at the same level as in 2001 and at the same time,giving more to poor regions through the inflation effect of DAU or increasing domestic

revenue at APBN. Table 2 indicated that the ratio between the lowest and highest DAU

per capita increased from 15 in 2002 to 20 in 2003. This gradual attempt is still far fromthe ultimate purpose of fiscal capacity equalization since in 2002 the ratio between the

highest and lowest total local revenue per capita was still 7, a considerably high ratio.

Another problem of DAU allocation formula is the existence of lump-sum component (a

certain similar amount to all local government) that eventually triggered the formation ofnew local governments since the small lump-sum amount is still considered a significant

amount for the proponents of new local governments. MOF is planning to abolish this

component and incorporate it into a component that ensures the hold-harmless provision.

Another alternative way to pursue the equalization purpose of DAU is by setting

independent commission of grant allocation. The existence of independent commissionshould be effective in minimizing the political influence and in promoting the full

formula approach. However, the central government elites seem to have different

opinion regarding the mechanism of grant allocation. In the proposed amendment of law

25/1999, MOF is trying to introduce the idea of independent grant commission thatreports directly to the president. However, MOF has not given enough political power

yet to the commission since the main responsibility of the commission is just to propose

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the allocation formula to the minister of finance and national parliament (DPR) without

the guarantee that each one of them will only consider the commission proposal in thediscussion. There is a room for them to select proposals coming from another party.

MOHA, on the other hand, is trying to keep the role of regional autonomy advisory

council in the law 22/1999 amendment. Furthermore, MOHA proposed to have only one

secretariat in DPOD that handles both regional autonomy and fiscal decentralizationmatters. It implies that MOHA will be the authority for intergovernmental transfer issues

including DAU allocation formula. The national parliament has another idea in their

version of law 22/1999 amendment that gives the authority to DPR budget committee indetermining the DAU allocation formula. These conflicting ideas simply revealed that

money and politics are inseparable in Indonesia.

While DAU becomes the center of attention for most of local governments, another

serious issue in the local finance, the local own revenue, seems to be neglected. The law

25/1999 and law 34/2000 obviously do not give significant local taxing power since the

Indonesian decentralization was designed to be the expenditure-led decentralization

financed by transfer. However, after three years of decentralization, the aspiration ofhigher local taxing power emerged. One important indicator of regional autonomy

should be the ability of the local governments to find their own sources of revenue and toreduce the dependence to the transfer. As mentioned briefly, that is not the case in

Indonesia since most of local governments are spoiled by the existence of DAU and do

not pay enough attention to optimize the local own revenue. Comparison between annualgrowth rate of local own revenue during 1994-1996 period and 2001-2002 period

indicated that prior decentralization growth (20%) is much higher than decentralization

growth (5%). On the other hand, the central government is highly reluctant to give morelocal taxing power by transferring one or more of their taxes to the local government.

The latest failure to transfer the authority of property tax to the local government wasgood example on how difficult an old paradigm shifts to the new paradigm. It is true that

the local governments might not have the capability to collect the property tax optimally

and it is also true that the local governments might be reluctant to impose direct taxes totheir residents. However, the new paradigm of decentralization will move toward the

more accountable local government and local parliament to the local residents. The

introduction of property tax as local tax is one of accountability instruments. If the local

governments are deemed incapable of collecting the property tax revenue, then theycould focus on the tax rate setting and let the more capable central government body

handling the collection and administration.

The weak local taxing power has another negative implication regarding the local

investment climate. Since most of local governments realized that the amount of transfer

is far from enough to fulfill their needs as a result of slow economic recovery, and at thesame time they do not have alternative from existing local taxes and charges, they are

trying to find other sources that unfortunately are illegal and disruptive. Imposing new

charges, levies or fees has become the favourite tools for local governments to generate

additional revenue and ensure a stable cash-flow management. The easiest targets forthose new additional revenues are unfortunately the local businesses that seem to be

powerless in that situation.. It is not surprising to find plantation companies in Sumatra

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complaining about the extra fees and levies. Combined with the fact that Indonesia is

considered not conducive yet for foreign investment, the decentralization processbecomes one of major factors discouraging new investment in Indonesia. The illegal and

excessive new charges, levies, or fees were some of major factors but more than that, the

local government in Indonesia is not business friendly yet. The KPPOD survey (KPPOD,

2003) revealed that the major concern for investors to locate their activities at localitieswas the institutional factors that cover the certainty, law enforcement, licensing process,

and local regulation. In fact, the local governments create disincentives rather than

incentives for incoming investment. This lack of incentives comes from a combination ofpolitical structure, economic structure and the relationship between central and local

governments. In the current relationship between local executives and legislatives, the

latter has becomes the more powerful party. Local executives have to follow the guidancefrom the legislative. However, due to their weak capabilities, the evaluation of executive

performance is mostly based on what happens to the APDB budget, especially the total

amount and its allocation. It is very rare to hear the local legislatives (DPRD) go beyond

the APBD itself and evaluate the executive performance on how the APBD stimulates the

local economic development and growth, and subsequently generates jobs and reduceslocal unemployment. In other words, it is APBD that matters for both local legislatives

and executives, while the GRDP is seen as a factor that will follow automatically thenational economic conditions (Brodjonegoro, 2003). The lack of local elected officials

accountability to their voters, due to the current election system, is another reason why

local economic growth and local unemployment are not perceived to be as important asincreasing the revenue in the APBD.

The lack of local government focus in promoting the output and employment growthleads to lower economic development activities in the regions. It should be noted,

however, that the impacts of economic crisis might play significant role in slow economicgrowth both at national and local level. At this stage, it is hard to separate the effects of

economic crisis and decentralization on the regional economic growth. Comparing the

decentralization period with the crisis period, it is obvious that there has been economicgrowth improvement as indicated by GRDP, investment, and export growth by province

in table 4,5, 6 and 7. However, the economic growth in decentralization era is still far

below the economic boom (and centralized) era. The difference for all provinces is quite

significant and it has to be examined further the reason of the difference apart from thenational macroeconomic condition. Table 4 7 should also alarm the central government

that the less impressive performance of export and investment at national level might be

due to problems at regional level that may require more local oriented actions than theuniform macroeconomic policy. Decentralization may play a role in that local oriented

economic policy. Another alarming finding is de-industrialization all over Indonesia as

indicated by table 7. The minus growth at some regions plus almost zero growth at otherregions indicated slow or even declining manufacturing growth that has to be anticipated

as early as possible by both local and national policy makers. KPPOD survey (KPPOD,

2003) indicated that manufacturing is the main victim of illegal and excessive charges or

levies. This might effect the manufacturing activities at the local level and eventually atthe national level. An integrated national economic policy that incorporates the local

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specifics has to be the first priority together with the GRDP, rather than APBD,

orientation from local governments.

FISCAL SUSTAINABILITY

One major complain from most of Indonesian local governments is insufficient DAU and

other types of transfer to support the regional development, especially related to newinfrastructure provision. As table 1 in the appendix indicates that most of local

governments spent their budget for routine expenditure, especially government

employees salary and left a little for development expenditure. With that limited amount,it is hard to imagine that the local governments will do some new major projects that

improve the infrastructure quality in the region. Maintenance of existing infrastructures

might be the maximum they can do but in reality, infrastructures are deteriorating all overIndonesia. It means that the local budget is simply not enough to cover any effort to

promote local economic growth and improvement of public service delivery. There

could be some reasons behind this condition. First, The Indonesian government that still

works on slow economic process focuses the budget (APBN) on the debt payment and

their routine expenses with little left for development. Second, most of localgovernments with limited sources of revenue have not been able to manage themselves

efficiently due to current political situation that makes any efficiency program unpopularand not politically acceptable. Third, most of line ministries at central level still have

significant power of the projects located on the regions while according to law 22/1999,

the authority should have been moved to the local level.

The last reason might reflect what local governments are always suspicious to the central

government, the reluctance of the part of central governments to devolve their power tothe local level. In other words, the old problem of the tug of war between

deconcentration and decentralization still exists. Although, the period since 2001 islabeled as decentralization period, it is not that easy to just change the paradigm from

strong deconcentration in the past. Most of line ministries had the power in their fields

during the deconcentration period, and the decentralization period basically threatenstheir power. Using many types of arguments such as national priority programs, national

interest, people interests, and others, they are still trying to justify their authority over the

execution of programs and projects at the local level. Although they are involving the

local government units during the activities, the sense that the project belongs to thecenter rather than local creates the impression that the central government does not want

to devolve the authority. There have been some discussions about this issue but

whenever it comes to the real action, the question from a line ministry will be who shouldinitiate the policy and if other ministries will follow the policy. Other ministries would

argue that they do not have trust in local government of delivering the minimum basic

services that they used to do it in the past. Some also proposed that part of DAU shouldbe earmarked for certain activities related to basic service delivery such as education,

health, and basic infrastructure.

While the debate of deconcentration v decentralization might be endless, there is onestrategic policy to gradually shift the central government paradigm and minimize the

deconcentration activities. The specific purpose grant (DAK) that theoretically should be

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devoted to handle the jurisdictional spill-over effects, ensure minimum service standard,

and to pursue the national interest, is the best instrument to gradually devolve the lineministries power. With the scheme of DAK that still involves the central government

ministries and agencies, the local government will own the projects or programs but they

will be under the monitoring and evaluation from respective central ministries and central

ministries will still have the decision on the types of programs or projects to be financed.The shift from DIP (central government programs and projects) to DAK could be

designed in medium term perspective to make smooth adjustment both at central and

local level. With greater DAK, the local governments will have higher opportunity todevelop the regions based on their plans and assessment. As many agree, the local

governments know better the local needs than the central ministries.

From fiscal sustainability point of view, this kind of shift will not affect the APBN much

since the transaction is basically transfer from development expenditure account to

intergovernmental transfer account, in this case DAK. Such a move will also ensure the

fiscal sustainability at national level. Currently, there are requests from local

governments to central government in allocating more than 25% net domestic revenue forthe DAU. For first three years, the government always imposed the minimum amount of

25% net domestic revenue and because of that request, the central government willallocate 25.5% for 2004 DAU. This slight increase might not affect the national fiscal

sustainability but the idea from one of influential ministry to increase the DAU to be 30%

of net domestic revenue might threaten the sustainability. That threat becomes moresignificant if there is no shift from DIP to DAK since the central government is forced to

find additional revenue or to cut other types of expenditure. The move to increase the

DAU up to 30% of net domestic revenue will not affect the sustainability if accompaniedby the shift from DIP to DAK and by defining the better the devolution of authorities.

Without proper management of this matter, there could be a condition where the centralgovernment runs out of money while they are still responsible for many government

authorities.

Another potential disruption of fiscal sustainability that relates to fiscal decentralization

process is the disbursement of natural resources revenue sharing. The central

government has committed to avoid the late disbursement program in the past that caused

the large surplus at natural resources rich regions due to inability of absorbing the budgetclosed to the end of budget year. This late disbursement also caused the uncertainty in

the local government cash flow management with few regions have to borrow from

external sources to anticipate the incoming revenue. Beginning in 2004, thegovernment will allocate the budgeted amount rather than the actual amount that caused

the delay. With the budgeted amount that was based on the last year actual transfer, the

central government has a risk of transferring money to the regions more than they aresupposed to be. The fluctuation of both natural resources commodity production and

price could increase the risk that may eventually affect the fiscal sustainability at central

level. The sustainability becomes a more significant issue since the APBN has the

obligation to pay the debt that was about 17.5% of the total budget in 2003 (table 8 ofappendix). This proportion was lower than in 2001 and 2002. Quite interestingly, the

debt payment proportion in 2003 was lower than the DAU proportion and

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intergovernmental transfer proportion. In 2001-2002, the debt proportion was higher

than DAU but lower than intergovernmental transfer. Any proportion increase of debtpayment together with DAU proportion pattern (and other transfer instrument) will

certainly put the national budget in danger.

To finance the development in decentralized era, there are possibilities that both central

and local governments have to look for external sources. The internal sources shouldcome from tax revenue intensification and higher economic growth that leads to higher

tax revenue. Due to current difficulties in expanding the tax base and promoting

economic growth because of lack of investment, the external sources should beprioritized but with cautions. The central government already issues government bonds

for sources of funding and it will imply in debt payment burden of the budget in the near

future. The foreign loan is still there but its importance might decline a little bit due tounpopularity among Indonesians. Local government, on the other hand, is still prohibited

to borrow from external sources, especially from foreign sources. There have been

discussions that the prohibition might be lifted in the near future, and the central

government has already amended the law 25/1999 by introducing the on-lending concept

for local governments. With this on-lending concept, the international agencies will haveto negotiate and make an agreement with central government on behalf of local

governments that need foreign borrowing. The central government will then lend themoney to the local governments and supported by an agreement, the central government

can charge the local governments through the intergovernmental transfer if the local

governments are in default position. This might minimize the bigger risk of threateningthe fiscal sustainability. Another possibility is the issuance of local government bonds. It

might take some years before the local governments can really issue the bonds and get

the financial sources they need. The risk to fiscal sustainability is there if the localgovernments are allowed to issue the bond, especially if the central government might

have to bail out. To minimize the risk, the local government bankruptcy law has to beready together with the secondary bond market. But first of all, there has to be trust

toward the local government management from the market and it has to be developed by

local governments themselves through good governance practices and ability to managethe local economic development process.

CONCLUDING REMARKSThe three years period of decentralization process could be labeled as a mild success.The success could be demonstrated by how the Indonesians quickly adjusted to massive

and drastic changes from a very strong centralized government, given only one year of

preparation. The relatively smooth transfer of 2 millions civil servants might be thesymbol of smooth devolution process that did not create significant social or political

unrest. The central government, especially some line ministries, is still trying to be

involved more in the local activities, and it is understandable given their almost absolutepower in the past. The local governments might be still in the learning process on how to

rely on their own but they are learning quickly and given the limited budget, they can still

manage the government administration relatively well. The amendment of both law

22/1999 and law 25/1999 should be treated as a significant improvement ofdecentralization process with the emphasis on better monitoring from central government

and accountability at local level. On the fiscal side, there might be a problem of less than

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equal DAU but it is improving albeit gradually. Some efforts to separate the political

influence from DAU allocation should give a hope of more equal allocation based onindependent judgement. The central government also improves the natural resources

revenue sharing disbursement that could neutralize the restless local governments. On

the fiscal sustainability perspective, the central government has relatively managed the

debt well so that the proportion for the intergovernmental transfer is higher in APBN. Aprudent and cautious national budget management is the key to success but the latest

request to increase the DAU portion might have to be observed carefully.

Aside from relatively success stories, the decentralization process could still lead to a

failure if the local governments and central government are not practicing their proper

behavior in new paradigm of decentralization. At the local government side, thetendency to prioritize local budget rather than local GRDP will still discourage the

potential investors that want to stay away from illegal and excessive charges or levies.

Local budget (APBD) should be treated as a local economic stimulator than the final

purpose itself. Local parliament (DPRD) should share the same spirit and in order to

support that, accountability of both local legislative and executive to the local votersshould be promoted, and everyone has to support the first direct election in 2004 for local

legislative. It it fails, then the accountability mechanism might have to wait another fiveyears. Accountability of local governments to voters should ensure a better basic public

service delivery and local government should begin to formulate how to build an

effective local government that will not spend too much on routine activities. On theborrowing issue, the local governments have to convince the central government and

potential lenders that they are capable in managing the borrowing without jeopardizing

the current fiscal sustainability. As many agree, the local borrowing is a best localrevenue collection instrument since it will create a win-win condition for both borrower

and lender.

At the end, the success of decentralization process will lie on the central government that

designs the process and commits to the implementation. Although it is not visible, thereis a tendency that decentralization is not one of priorities of central government. The

decentralization activities are already considered as routine activities. It might be a good

one if all the process is perfect and smooth, but it is dangerous if everything is not in

place yet. That could lead to the impression that the central government is not so seriousanymore in promoting decentralization and prefers to go back to old paradigm. Lack of

coordination and intense rivalry among central ministries do not help the situation with

the impression that the decentralization process is no longer a national interest but aministry interest. The strong national leadership should handle this matter, and it could

start from the amendment process of law 22/1999 and law 25/1999 that seems to go

separate ways and it ends up in tug of war rather than a vision for decentralizationprocess itself. At the fiscal side, the central government still has to manage the fiscal

sustainability that has effects on decentralization process and most importantly,

Indonesians should avoid a large scale of economic crisis due to local government

behavior in borrowing and managing their budgets as in the case of Brazil.

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REFERENCES

Asanuma, Shinji, and Bambang Brodjonegoro (2003),Indonesias Decentralization

Policy : Origins, Issues, and Prospects, presented at the International Symposium onIndonesias Decentralization Policy : Problems and Policy Directions, Hitotsubashi

University, Tokyo.

Brodjonegoro, Bambang (2002), Fiscal Decentralization in Indonesia, in Hadi Susastro,

Anthony L Smith, and Han Mui Ling (eds), Governance in Indonesia: Challenges

Facing the Megawati Presidency.Singapore: The Institute of Southeast Asian Sudies.

Brodjonegoro, Bambang (2003),Decentralization and Business, presented at the

Indonesian Update, Research School of Asian Pacific Studies, Australian National

University, Canberra.

Brodjonegoro, Bambang (2003),Decentralization and Urbanization in Indonesia : The

Concept of Metropolitan Area, presented at the Asian Development Conference,

Kitakyushu, Japan.

Brodjonegoro, Bambang and Jorge Martinez (2002),An Analysis of IndonesiasTransfer System : Recent Performance and Future Prospects, presented at The

Andrew Young School of Policy Studies sponsored conference on Can

Decentralization Help Rebuild Indonesia ?,Georgia State University, Atlanta.

Brodjonegoro, Bambang and Shinji Asanuma (2000), The Regional Autonomy and

Fiscal Decentralization in Democratic Indonesia, Hitotsubashi Journal of

Economics, Vol. 41 No.2, pp.111-122.

Ford, J. Fitz G, and Bambang Brodjonegoro (2004), Inter-Governmental Fiscal Relations

and State Building: The Case of Indonesia, in R.M. Bird (ed.), Asymmetric Fiscal

Decentralization: Glue or Solvent?World Bank, Washington DC, forthcoming

KPPOD(2003), Regional Investment Attractiveness: Business Perception,Jakarta:

Komite Pemantauan Pelaksanaan Otonomi Daerah (KPPOD) and Asia Foundation.

Mahi, Raksaka, and Bambang Brodjonegoro (2003),The Indonesian Political Economyof Decentralization, presented at the International Symposium on Indonesias

Decentralization Policy : Problems and Policy Directions, Hitotsubashi University,

Tokyo.

Matsui, Kazuhisa, and Mudrajad Kuncoro (2003),The Role of Local Governments inIndonesia : A Survey of Recent Development, presented at the International

Symposium on Indonesias Decentralization Policy : Problems and Policy Directions,Hitotsubashi University, Tokyo.

Sato, Motohiro, Bambang Brodjonegoro, and Hamid Paddu (2003),IntergovernmentalTransfer and Tax Sharing in Indonesia : Theories, Practices, and Political

Recommendation, presented at the International Symposium on Indonesias

Decentralization Policy : Problems and Policy Directions, Hitotsubashi University,

Tokyo.

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Suwandi, Made (2002),The Implementation of Regional Autonomy : The Indonesian

Experience, presented at The Andrew Young School of Policy Studies sponsoredconference on Can Decentralization Help Rebuild Indonesia ?, Georgia State

University, Atlanta.

Usui, Norio, and Armida Alisjahbana (2003),Local Development Planning and

Budgetting in Decentralized Indonesia, presented at the International Symposium onIndonesias Decentralization Policy : Problems and Policy Directions, Hitotsubashi

University, Tokyo.

World Bank (2003),Decentralizing Indonesia : A Regional Public Expenditure Review

Overview Report, East Asia Poverty Reduction and Economic Management Unit,Jakarta.

APPENDIX

TABLE 1: Percentage of Prefectures /Municipalities Distribution Based on Elements of

Budget Shares to Total Local Budget (APBD), Year 2002

Source:APBD 2002

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TABLE 2: DAU per capita 2002 - 2003

DAU/population (million Rp)Province (including

districts and

municipalities) 2002 2003

Sumatra

Sumatra: Dista Aceh 484.05 489.74Sumatra: North Sumatra 315.03 344.16

Sumatra: West Sumatra 460.24 520.29

Sumatra: Riau 468.96 382.45

Sumatra: Jambi 508.31 564.91

Sumatra: South Sumatra 295.03 316.88

Sumatra: Bengkulu 485.02 569.81

Sumatra: Lampung 284.38 318.25

Java

Java: DKI Jakarta 77.68 73.00

Java: West 191.58 563.05

Java: Central 266.82 339.63

Java: DI Yogyakarta 418.84 458.65

Java: East 251.64 273.19

Bali 490.67 525.01

Nusa Tenggara

Nusa Tenggara: West 355.16 389.23

Nusa Tenggara: East 527.84 640.07

Kalimantan

Kalimantan: West 437.97 512.48

Kalimantan: Central 650.19 807.68

Kalimantan: South 443.59 545.31

Kalimantan: East 449.21 457.65

Sulawesi

Sulawesi: North 571.87 585.33

Sulawesi: Central 600.38 655.29

Sulawesi: South 426.35 483.77

Sulawesi: South East 593.67 755.03

Maluku 584.84 806.62

Irian Jaya 1,192.27 1,490.65

2002 :

Highest : Irian Jaya : Rp 1,192.27Lowest : DKI Jakarta : Rp 77.68Ratio : Highest/Lowest : 15.3

Tahun 2003 :Highest : Irian Jaya : Rp 1,490.65Lowest : DKI Jakarta : Rp 73Ratio : Highest/Lowest : 20.4

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TABLE 3: Local Revenue per Capita 2002

Province (including

districts andmunicipalities)

APBD revenue/population(in million Rp)

Sumatra

Sumatra: Dista Aceh 1,219.62

Sumatra: North Sumatra 474.85

Sumatra: West Sumatra 640.08

Sumatra: Riau 2,027.54

Sumatra: Jambi 685.82

Sumatra: South Sumatra 461.95

Sumatra: Bengkulu 575.56

Sumatra: Lampung 383.41

Java

Java: DKI Jakarta 939.45

Java: West 320.48

Java: Central 356.13

Java: DI Yogyakarta 582.50

Java: East 378.99

Bali 952.42

Nusa Tenggara

Nusa Tenggara: West 476.61

Nusa Tenggara: East 622.16

Kalimantan

Kalimantan: West 574.02

Kalimantan: Central 1,065.17

Kalimantan: South 663.27

Kalimantan: East 1,746.75

Sulawesi

Sulawesi: North 674.91

Sulawesi: Central 714.20

Sulawesi: South 569.51

Sulawesi: South East 705.99

Maluku 734.41

Irian Jaya 2,260.10

Highest : Irian Jaya : Rp 2,260.10Lowest : DKI Jakarta : Rp 320.48Ratio : highest/lowest : 7.05

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TABLE 4 : Average Annual GRDP Growth by Province

Source : LPEM FEUI

Average Annual Growth (%)PROVINCE

1994-1996 1999-2000 2001-2002

NANGGROE ACEH DARUSSALAM 0.02 -0.04 0.00SUMATERA UTARA 0.09 0.02 0.02

SUMATERA BARAT 0.08 0.02 0.02

R I A U 0.05 0.03 0.02

J A M B I 0.09 0.03 0.02

SUMATERA SELATAN 0.08 0.02 0.02

KEP. BANGKA BELITUNG - - 0.02

B E N G K U L U 0.07 0.02 0.02

L A M P U N G 0.09 0.02 0.03

D K I J AKARTA 0.09 0.02 0.02

J AWA BARAT 0.09 -0.04 0.02

BANTEN - - 0.03J AWA TENGAH 0.07 0.02 0.02

D I YOGYAKARTA 0.08 0.02 0.02

J AWA TIMUR 0.08 0.02 0.02

B A L I 0.08 0.02 0.02

NUSA TENGGARA BARAT 0.08 0.14 0.02

NUSA TENGGARA TIMUR 0.09 0.02 0.03

KALIMANTAN BARAT 0.10 0.01 0.01

KALIMANTAN TENGAH 0.10 0.01 0.02

KALIMANTAN SELATAN 0.10 0.02 0.02

KALIMANTAN TIMUR 0.07 0.02 0.02

SULAWESI UTARA 0.09 0.03 0.02

GORONTALO - - 0.03

SULAWESI TENGAH 0.08 0.02 0.03

SULAWESI SELATAN 0.08 0.02 0.02

SULAWESI TENGGARA 0.07 0.03 0.03

M A L U K U 0.07 -0.01 0.01

MALUKU UTARA - - 0.01

P A P U A 0.17 0.01 0.04

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TABLE 5 :Average Annual Inv stment Growth by Province

Source

e


1994-1996 1994-1996NANGGROE ACEH DARUSSALAM 0.02 -0.04 0.03

SUMATERA UTARA 0.13 0.02 0.01


R I A U 0.08 0.01 0.01

J A M B I 0.07 0.04 0.01



B E N G K U L U 0.02 0.02 0.02

L A M P U N G 0.21 0.05 0.01

D K I J AKARTA 0.11 0.01 0.01

J AWA BARAT 0.21 0.00 0.03BANTEN - - 0.03

J AWA TENGAH 0.08 0.03 -0.08


J AWA TIMUR 0.11 -0.03 0.00

B A L I 0.09 0.01 0.01

NUSA TENGGARA BARAT 0.12 -0.02 0.01


KALIMANTAN BARAT 0.20 0.02 -0.02

KALIMANTAN TENGAH 0.07 -0.02 0.13

KALIMANTAN SELATAN 0.10 0.08 -0.03

KALIMANTAN TIMUR 0.02 0.00 0.07SULAWESI UTARA 0.17 0.27 0.20

GORONTALO - - 0.01


SULAWESI SELATAN 0.18 -0.03 0.02


M A L U K U 0.16 0.00 0.14


P A P U A 0.15 0.07 0.05

: LPEM FEUI

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TABLE 6 :Average Annual Export Growth by Province


1994-1996 1994-1996

NANGGROE ACEH DARUSSALAM 0.00 0.00 -0.10


SUMATERA BARAT 0.07 -0.05 0.00

R I A U 0.07 0.10 0.04

J A M B I 0.10 0.01 0.00


KEP. BANGKA BELITUNG - - -0.01

B E N G K U L U 0.17 0.02 0.02

L A M P U N G 0.07 0.06 -0.27

D K I J AKARTA 0.12 0.02 0.09

J AWA BARAT 0.12 -0.06 0.00

BANTEN - - 0.02

J AWA TENGAH 0.08 0.07 -0.09


J AWA TIMUR 0.09 0.06 -0.05

B A L I 0.09 0.01 0.01


NUSA TENGGARA TIMUR 0.11 -0.13 0.10

KALIMANTAN BARAT 0.04 0.01 -0.12

KALIMANTAN TENGAH 0.10 0.00 -0.10

KALIMANTAN SELATAN 0.01 0.01 -0.05

KALIMANTAN TIMUR 0.11 0.05 0.01


GORONTALO - - 0.07




M A L U K U 0.01 -0.16 0.02


P A P U A 0.25 0.00 -0.11

Source : LPEM FEUI

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TABLE 7 :Average Annual Manufacturing Growth by Province

Source : LPEM-FEUI


1994-1996 1994-1996

NANGGROE ACEH DARUSSALAM 0.01 -0.15 -0.01



R I A U 0.12 0.05 0.02

J A M B I 0.15 0.01 0.02



B E N G K U L U 0.12 0.03 0.03

L A M P U N G 0.09 0.01 0.01

D K I J AKARTA 0.09 0.02 0.01

J AWA BARAT 0.15 0.02 0.02

BANTEN - - 0.02

J AWA TENGAH 0.08 0.02 0.02

D I YOGYAKARTA 0.07 -0.01 0.02

J AWA TIMUR 0.12 0.01 -0.01

B A L I 0.11 -0.01 0.03



KALIMANTAN BARAT 0.08 0.02 0.01

KALIMANTAN TENGAH 0.03 -0.06 0.01

KALIMANTAN SELATAN 0.11 -0.03 -0.01

KALIMANTAN TIMUR 0.03 0.03 -0.01


GORONTALO - - 0.01



SULAWESI TENGGARA 0.21 0.03 -0.01

M A L U K U 0.06 -0.16 0.00


P A P U A 0.14 -0.04 0.04

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TABLE 8 :Intergovernmental Transfer, Debt Payment, and National Budget

Year

DAU/TotalExpenditure (%)

Transfer/TotalExpenditure (%)

Interest + Principal DebtPayment/TotalExpenditure (%)

2001 17.67 23.73 20.862002 20.00 27.21 22.71

2003 20.77 29.01 17.46

Sumber : Departemen Keuangan RI

Documents

Three Years of Fiscal Decentralization in Indonesia - Brodjonegoro (2004)