RECENT ECONOMIC REPORTS

November 30, 2000:  

  GOVERNMENT ISSUES FISCAL DECENTRALIZATION REGULATIONS

With one month remaining until regional autonomy goes into effect on January 1, 2001, the Government of Indonesia is hurrying to finish work on the regulatory framework that will govern the transfer of authority and revenues to the regions.  On November 21 the government released four long-awaited regulations governing the implementation of Law No. 25/1999 on fiscal decentralization.  These key decrees resolve some but not all of the concerns about the economic and budgetary impacts of Indonesia's sweeping regional autonomy laws.  

The four government regulations were dated November 10 but were not released until November 21.  The President's office sent a fifth regulation regarding local financial data-gathering requirements back to the ministerial level for re-drafting.  Among other things, the new regulations (PP Nos. 104-107/2000) spell out how much each local government will receive from the center in FY 2001.  Analysts believe that many regions may not receive enough funding to cover all of their new responsibilities, some of which may have to be shouldered by the central state budget.  The regulations also place limits on local government borrowing, though not as extensively as international donors had urged.  While they represent a welcome clarification of the nebulous decentralization process, the regulations still leave local governments, foreign donors, and foreign investors with many unresolved concerns.

THE LAWS

In an effort to meet regional demands for greater local autonomy and a greater share of income generated from local natural resources, in May 1999 the Habibie administration secured the passage of Law No. 22/1999 on Regional Political Autonomy and Law No. 25/1999 on Fiscal Decentralization.  The government compressed the process into a two-year implementation schedule culminating in May 2001.  The deadline was later moved up to January 1, 2001 to accommodate the shift from an April-March to a January-December fiscal year.  Despite the misgivings of many experts, the Wahid Administration has held to this schedule.

Law 22 set up guidelines for the election of governors, district heads (regents), and mayors, all of whom were in the past appointed by Jakarta.  It also ordered that all central government functions except foreign policy, defense and security, justice, monetary and fiscal affairs, and religious affairs be fully devolved to the local level.  Thus local government will have control over a broad range of areas, including education, health, public works, investment, domestic trade and industry policy, labor, agriculture, and the environment.

Law No. 25/1999 on regional fiscal balance reverses the extreme centralization of Soeharto's New Order when central government spending accounted for over 80 percent of total government spending.  It mandates that a minimum of 25 percent of domestic revenue be transferred to local governments through a budget grant mechanism called the General Allocation Fund (the Dana Alocasi Umum, or DAU).  In addition, the producing localities, their host provincial governments and other local governments within that province will receive 15 percent of oil, 30 percent of natural gas, and 80 percent of mining, fishing, and forestry net after-tax revenues.  All regions will also receive the bulk of centrally collected property tax revenues.

The two laws largely bypassed the country's 26 provinces, devolving most political and fiscal authority all the way to the more than 350 districts and cities (the two sub-provincial administrative divisions).  In conformity with this, 90 percent of the General Allocation Fund and 80 percent of natural resource funds will go directly to the district/city level.

REGULATIONS ON FISCAL DECENTRALIZATION

The most eagerly awaited of the four new regulations is No. 104/2000 on Balance Funds.  It contains the formulae used to distribute Rp 74.9 trillion (US$ 8.3 billion) in transfers from the center to the regions.  This is divided into natural resource revenues from oil and gas, mining, forestry, and fisheries (Rp 18.3 trillion), the General Allocation Fund or block grants (Rp 56.0 trillion), and special discretionary funds (Rp 0.6 trillion).  These funds are to cover routine expenditures and some development spending.  No local government will get less than it is receiving in FY 2000, but all of them will have a host of newly decentralized responsibilities to pay for. 

The formula that the government used to determine the block grant allocations is slightly skewed to the benefit of resource-rich regions like Aceh, Riau, East Kalimantan and Irian Jaya that already stood to gain from the natural resource allocations.  There may be a political rationale to this choice, but it puts poorer regions at risk of a funding shortfall that will have to be borne by the central government. 

Foremost among the new budgetary burdens facing local governments are the 1.9 million central government civil servants being transferred to their payrolls.  Some districts and cities will likely not have enough to pay all of them, while others might simply refuse to bring some of them on board.  In either case the central state budget would bear the burden.  The proposed FY 2001 budget contains a Rp 6 trillion contingency fund which is thought to be sufficient to cover roughly half of these personnel transfers.  In addition, regions that refuse to accept the transfer of civil servants will have their block grants docked by an equivalent amount.

Government Regulation No. 106/2000 on deconcentrated tasks deals with the important issue of central government spending on development, which totals Rp 33.4 trillion (US$ 3.7 billion) in the draft 2001 budget submitted to Parliament in October.  Almost all of this amount comes from development projects that are funded by foreign donors and partly co-financed by the central government.  The regulation does not cede control over the disbursement and administration of this money to the regions.  Jakarta is to retain the development funds and subcontract ("deconcentrate") projects to the regions as it judges fit, thereby maintaining administrative control.  Although Law No. 25/1999 had not mandated transfer of control over these funds to the regions, the government did not consult widely with local governments about this issue and many local officials found the news an unpleasant surprise.

Government Regulation No. 107/2000 sets limits to local borrowing.  Local governments can not finance more than one-sixth of a year's expenditures with borrowed funds, total debt can never exceed 75 percent of the previous year's revenue, and the ratio of revenues to debt service payments in a given year must be at least 2.5:1.  Local governments can borrow from foreign sources only with central government approval.  In addition, Jakarta imposed a one-year moratorium on local borrowing from commercial banks, domestic or foreign.  This provision, which does not appear in the regulation, will not prevent local governments from borrowing from Regional Development Banks owned by the provincial governments.  The legal structures required for a local government bond market will not be in place for some time, but the government is already taking steps to create it.  Local short-term borrowing to cover cash flow is already happening in several regions.

 Government Regulation No. 105/2000 on management and accountability in regional finance contains guidelines for the drawing up of local government budgets, procurement of goods and services, and standards of financial management for local officials.  The aim of the regulation is to ensure transparency and accountability, but the auditing provisions contained in it are vague.  As an anti-corruption safeguard, the regulation requires local officials to ensure that the goods and services they procure are really necessary for the implementation of public policy.  It does not, however, establish the verification procedures for this requirement.

While the regulations should alleviate some donor and investor fears regarding fiscal decentralization, there is still the potential for widespread confusion in the areas of local taxation, local borrowing, personnel transfers, resource management, and budgetary record-keeping.  Disputes between the center and the regions over fiscal matters are almost certain to multiply after

January 1, and there are few mechanisms in place to deal with them.  Furthermore, the two key issues of bond issuance and local taxation remain unresolved.  The revisions to the local taxation law (Law No.18/1997) are due to be passed by parliament before the December recess.  Finally, by waiting this long to issue the regulations, the government has hampered the ability of local governments to finalize their budgets, which can only contribute to the confusion that is sure to characterize the opening months of decentralization.

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