P110716 - 2 - Increases in Regional Government Surpluses-An Empirical Analysis by Decentralization Support Facility

Executive Summary

Why have regional government bank accounts increased to almost IDR 70 trillion? By the end of 2006, bank deposits of provinces, kabupaten and kota were IDR 68.5 trillion, up from IDR 7.4 trillion in December 2000. This amounts to a tenfold increase in just six years. The increase in bank deposits, which are now substantially larger that the central government’s annual budget deficit, has coincided with a rapid increase in regional governments surpluses. The Ministry of Finance is increasingly concerned about these developments, and has requested the Decentralization Support Facility (DSF) to identify the causes of the substantial build-up of regional government surpluses, and the concurrent increase in bank deposits.

Underestimation, Underspending, Underfinancing Key finding #1: Increases in regional government bank deposits were largely unplanned. Regional governments did not plan to save, because net investments in contingency funds (dana cadangan) accounted for less than 5% of the IDR 47 trillion increase in bank deposits during 2004-2006. This suggests that, in recent years, regional government bank deposits have largely increased by accident, and not by design. Key finding #2: Regional governments have increasingly failed to execute their budgets. In recent years, regional government bank deposits have only increased because regional governments, taken together, have collected more and spent less revenue than they budgeted for. In addition, regional governments only spent a small portion of increases in operational surpluses on financial assets, such as shares in municipal enterprises, or loan repayment. Identifying potential causes for increases in regional government cash surpluses is therefore equivalent to identifying the causes of: Higher than expected revenue (underestimation of revenue) Lower than expected expenditure (underspending) Limited investment of operational surpluses (underfinancing) Key finding #3: Underestimation of DBH revenue and underspending are major causes of failure by regional governments to execute budgets. Higher than expected revenue from PAD and DBH, and lower than expected expenditure accounted for over 80% of the IDR 79 trillion difference between actual and budgeted surpluses during 2004-2006 (Table 1). Table 1 ACTUAL VS. BUDGETED OPERATIONAL SURPLUSES BY YEAR, 2004-2006 IDR trillion

2004

2005

2006

Higher than expected PAD

2.5

3.6

2.0

Higher than expected DBH

3.2

7.9

6.7

Other sources of revenue underestimation

0.8

1.0

1.1

Lower than expected operational expenditure

10.1

10.8

14.0

Lower than expected investment expenditure

0.5

3.0

11.6

Lower than expected (net) financing costs Total

(not significant) 17.0

26.2

35.4

Source: Consultant

Increases in Surpluses of Regional Governments Final Report (June 2008)

Key finding #4: regional governments chose not to invest cash surpluses in financial assets other than bank deposits. Lack of vision, riskaverse behavior, and the Government’s anti-corruption drive serve as major explanations for the limited investments in financial assets that regional governments have undertaken in recent years. Underfinancing may have been exacerbated because of administrative constraints to repayment (or pre-payment) of central government loans.

Policy Recommendations #1 – Use performance-based contracts to hire directors of tax collection agencies. At present, the head of a DIPENDA or a state-owned enterprise (the ‘agent’) does not have an incentive to provide accurate revenue estimates (which is a primary cause of revenue underestimation). To address this ‘agency’ problem, it is recommended that central and regional governments negotiate five-year contracts with the Head of DIPENDA and stateowned enterprises increase revenue against pre-set targets. #2 – Support resource-rich regions to establish trust funds for future generations. Resource-rich regions may continue to have more revenue at their disposal than they are able to spend in the short or medium term. To ensure that these funds will benefit citizens in the jurisdiction of these regional governments, it is proposed that the Ministry of Finance assist such regions to set up and manage trust funds for intergenerational transfers. #3 – Relax restrictions on spending of expenditure budgets. At present, implementing agencies are not allowed to make any changes to expenditure budgets without prior approval by DPRD. This does not only prevent a regional government from spending its budget in full (thereby increasing regional government surpluses), but is also likely to lead to inefficient spending behavior. Restrictions on the use of expenditure budgets should therefore only apply to the total budget of an organizational unit (such as Dinas PU or DIPENDA) and to the wages and salaries of a unit. Within these constraints, the Head of a unit would be allowed to spend as s/he sees fit. #4 – Improve the quality of investment and financing. If the Government would attempt to boost total spending by regional governments in order to reduce cash surpluses, it runs the risk that regions would primarily invest in ‘easy’ projects that absorb large amounts of funds (such as land or office buildings) that result in an immediate reduction in cash surpluses, but would not necessarily increase national welfare. It is therefore recommended that the Government should seek to improve the quality of the use of expenditure and financing budgets. Means to achieve this objective include: Disseminate best practices of regional government utilization of investment and financing. Make information on regional government surpluses available in the public domain, to allow citizens to compare fund utilization in their regional government with practices in neighboring regions. Commence a dialogue with regional development banks (BPD) to encourage these banks to invest part of regional government deposits in projects that contribute to regional development (instead of investing these deposits almost exclusively in SBIs and other low-risk securities).

Contents

Chapter 1

Chapter 2

Chapter 3

Chapter 4

Chapter 5

Chapter 6

Chapter 7

Chapter 8

Introduction

Objective and Scope of Work

Status and Contents of this Report

Definition of Regional Government Surplus

Regional Government Accounting Systems

Definition of Regional Government â&#x20AC;&#x2DC;Cash Surplusâ&#x20AC;&#x2122;

Review of Regional Government Surpluses

Increases in Regional Government Bank Deposits

Review of Provincial Government Surpluses

Review of District Government Surpluses

Review of Cash Surpluses vs. Expenditure Needs

Analyzing Causes of Increases in Regional Government Surpluses

Rationale for Increases in Surpluses

Actual vs. Budgeted Surpluses

Framework for Analysis

Analysis of Revenue

Actual vs. Budgeted Revenue

Potential Causes of Underestimation of Revenue

Analysis of Expenditure

Actual vs. Budgeted Expenditure

Potential Causes of Underspending

Analysis of Financing

Planning of Financial Transactions

Financial Transactions of Provincial Governments

Financial Transactions of District Governments

Potential Causes of Underfinancing

Conclusions and Recommendations

Conclusions

Policy Recommendations Appendixes

iii

Increases in Surpluses of Regional Governments Final Report (June 2008)

Definitions DSF Consultant Region District Study period

Decentralization Support Facility AndrĂŠ Oosterman and Bambang Tata Samiadji A province (propinsi) or district (kabupaten or kota) A municipality (kota) or regency (kabupaten) 2004-2006

Introduction

Background. According to Bank Indonesia, bank deposits of regional 1 governments have increased at very high rates in recent years. By the end 2006, bank deposits of provinces, kabupaten and kota were IDR 68.5 trillion, up from IDR 7.4 trillion in December 2000. This amounts to a tenfold increase in just six years. The increase in bank deposits has coincided with a rapid increase in regional governments surpluses. The Government of Indonesia, in particular the Ministry of Finance, is increasingly concerned about these developments, and has requested the Decentralization Support Facility (DSF) to identify the causes of the substantial build-up of regional government surpluses, and the concurrent increase in bank deposits. This report presents the initial findings of a consultant contracted by DSF to prepare the assessment.

Objective and Scope of Work Objective. The overall objective of the study is to identify potential causes to the rapid increase in regional government surpluses. Scope of the study. It will be shown that regional government surpluses have rapidly increased because of a confluence of three factors: (i) higher than expected revenue, (ii) lower than expected expenditure, and (iii) limited investments in financial assets. The study will identify potential causes for each of these three factors by analyzing differences in actual and budgeted amounts of revenue (pendapatan), expenditure (belanja) and investments in financial assets (known as ‘financing’ or pembiayaan). Actual and budgeted amounts were analyzed using audited financial reports for 2004-2006 (‘the Study Period’), for a sample of 27 provinces and 220 kota and kabupaten (covering 89% and 63% of the nation’s population, respectively). The findings of the empirical analysis were corroborated by interviews with officials of three provincial governments (DKI Jakarta, Bali and East 2 Kalimantan) and ten district governments . Outputs. This report presents: An operational definition of the term ‘regional government surplus’. A review of increases in regional government surpluses from 2004 to 2006. An empirical analysis of the potential causes of increases in regional government surpluses during that period. A series of policy recommendations aimed at reducing regional government cash balances.

1 In this report, the term ‘district government’ refers to a municipality (kota) or regency (kabupaten), whereas the term ‘regional government’ refers to a district or province. 2 Refer to Annex 1 for a summary of the results of these interviews.

Chapter 1

Introduction

Increases in Surpluses of Regional Governments Final Report (June 2008)

Status and Contents of this Report Status. This report was presented to representatives of the Ministry of Finance and DSF in a meeting held on 30 May 2008. Comments and corrections of the attendants are reflected in this version of the report. Summary of contents. Chapter 2 defines the term â&#x20AC;&#x2DC;regional government surplusâ&#x20AC;&#x2122;. Chapter 3 gives an overview of increases in regional government surpluses from 2004-2006. Chapter 4 presents a framework for analyzing potential causes of increases in regional government surpluses. It will be shown that, in recent years, most regional governments have unsuccessfullly attempted to reduce their surpluses. Chapters 5, 6 and 7 present an empirical analysis of increases in surpluses for major components of the regional government budget: revenue, expenditure and investment, and financial transactions. The final chapter presents conclusions and policy recommendations. Figure 1.2 REPORT STRUCTURE

Chapter 1 Introduction

SITUATIONAL ANALYSIS Chapter 2

Chapter 3

Chapter 4

Definition of Regional Government Surplus

Review of Regional Government Surpluses

Analyzing Causes of Increased Surpluses

ANALYSIS OF INCREASES IN SURPLUSES Chapter 5

Chapter 6

Chapter 7

Analysis of Revenue

Analysis of Expenditure

Analysis of Financing

Chapter 8 Conclusions and Recommendations Source: Consultant

Chapter 1

Introduction

Definition of Regional Government Surplus

Background Regional government accounting systems. Until 2003, regional governments in Indonesia used a simple cash-based accounting system to record revenue and expenditure. With the issuance of KepMendagri 29/2002, regional governments have adopted a modified cash-based accounting system, which does not only record revenue and expenditure, but also income and costs. As a result, surpluses registered by regional governments before 2003 are not readily comparable to surpluses afterward. Definition of regional government surpluses. This chapter defines two types of surpluses: Operational surplus, which is defined as “revenue – expenditure” and therefore equivalent to the term ‘surplus’ in KepMendagri 29/2002. Cash surplus, which is defined as “revenue – expenditure – net financial 3 costs” and equivalent to ‘SiLPA’ (Sisa Lebih Perhitungan Anggaran) . This report analyses increases in cash surpluses, because these are closely related to increases in regional government bank deposits, which remain a primary concern of the Ministry of Finance. In addition, ‘post-2002’ cash surpluses are directly comparable to cash balances generated by the simple cash-based accounting system.

Regional Government Accounting Systems The simple cash-based accounting system. Until 2003, regional governments used a cash-based system to record revenue and expenditure. This system only recorded cash inflows and cash outflows. At any time, the cash balance would consist of cumulative cash revenue minus cumulative cash expenditure (Table 2.1). A major disadvantage of such a system is that it ignores the impacts of a financial transaction on the long-term financial position of a regional government. More specifically, the system does not distinguish between cost and expenditure, or between income and revenue. As will be shown, these are markedly different concepts. Table 2.1 CASH BALANCES UNDER THE SIMPLE CASH-BASED SYSTEM Budget Item* Cash balance, BOY

Sisa anggaran tahun yang lalu

+ Revenue

Pendapatan

– Expenditure

Pengeluaran

= Cash balance, EOY (=CASH SURPLUS)

Sisa anggaran tahun berjalan

Source: Consultant * BOY = beginning of year, EOY = end of year

3 With the exception of extra-budgetary revenue and expenditure, which are not significant and therefore ignored in the remainder of this report.

Chapter 2

Definition of Regional Government Surplus

Increases in Surpluses of Regional Governments Final Report (June 2008)

Cost vs. expenditure. The cost of a financial transaction is the estimated decrease in the financial position of a regional government. In many cases, the estimated decrease is equal to the expenditure recorded by a simple cash-based system. There are important exceptions, however. For example, a simple cash-based system does not distinguish between a IDR 200 million cash payment for the procurement of a fire engine and a IDR 200 million cash bonus for firefighters. Both are recorded in the same way (namely, as a IDR 200 million cash expenditure), even though the procurement of the fire engine will generate benefits to the regional government for many years, whereas the bonus does not. As a result, such an accounting system will understate the financial position of the regional government (by recording a IDR 200 million expenditure in a single year, whereas the region will also benefit from the use of the fire engine in future financial years). Income vs. revenue. Similarly, a simple cash-based accounting system may overstate the financial position of a regional government. If, for example, a region signs a loan agreement, the proceeds of the loan will be recorded as cash revenue in a single financial year. The system will not show that the loan has decreased the financial position of the regional government, which has contractually agreed to repay the loan in future years. Modified cash-based accounting system. In 2002, the Minister of Home Affairs issued a decree (better known as KepMendagri 29/2002) to address 4 the deficiencies of a cash-based accounting system . This decree, which became effective in 2003, required regional governments to adopt an modified cash-based accounting system, which does not only record cash revenue and cash expenditure, but also costs and income. The system was adopted by most provinces in 2004, and by most (but not all) kabupaten and kota in 2005. In 2006, the Minister of Home Affairs replaced KepMendagri 29/2002 by a new decree (Box 2.1). Box 2.1 SUCCESSORS TO KEPMENDAGRI 29/2002

KepMendagri 29/2002 was issued as an implementing guideline to UU 22/1999 and UU 25/1999. In 2004, these laws were replaced by UU 32/2004 and UU 33/2004, respectively. This necessitated the Minister of Home Affairs to replace KepMendagri 29/2002 by a new decree, Permendagri 13/2006. Many regional governments considered this decree as unnecessarily complicated and difficult to implement. In response, the Minister replaced Permendagri 13/2006 by Permendagri 57/2007. Because neither decree was implemented during the Study Period, the analysis presented in this report was based on a review of regional government accounts that were prepared using KepMendagri 29/2002 only. Source: Consultant

4 The full name of the decree is: â&#x20AC;&#x2DC;Kepmendagri No.29 Tahun 2002 tentang Pedoman Pengurusan, Pertanggungjawaban, dan Pengawasan Keuangan Daerah serta Tata Cara Penyusunan APBD, Pelaksanaan Tata Usaha Keuangan Daerah, dan Penyusunan Perhitungan APBDâ&#x20AC;&#x2DC;.

Chapter 2

Definition of Regional Government Surplus

Increases inSurpluses of Regional Governments Final Report (June 2008)

Budgeting under the modified cash-based accounting system. Before the implementation of KepMendagri 29/2002, regional governments prepared a revenue budget and an expenditure budget. Since 2003, regional governments are required to prepared budgets for: Revenue (pendapatan). These consist of: (i) own-source revenue (Pendapatan Asli Daerah or PAD), (ii) central government transfers, of which Shared Revenue (Dana Bagi Hasil or DBH), the General Allocation (Dana Alokasi Umum or DAU) and the Special Allocation (Dana Alokasi Khusus or DAK) are the most important, and (iii) other revenue, including incidental grants from higher-level governments and proceeds from the sale of physical assets. Expenditure (belanja). These consist of: (i) operational expenditure (such as salaries and maintenance expenditure), and (ii) investment expenditure. Financing (pembiayaan). These consist: (i) income that needs to be repaid in current or future budget years, (penerimaan), and (ii) costs that will be 5 recovered in current or future budget years (pengeluaran) . The financing budget of a regional government typically includes income from loan disbursements, and the cost of loan repayments and equity investments. A regional government budget (Anggaran Belanja Pendapatan Daerah or APBD) needs approval of the regional parliament (Dewan Perwakilan Rakyat Daerah or DPRD), the relevant provincial government and the Ministry of Home Affairs. (Refer to Figure 2.1 for the standard budget structure.) Financial reporting under the modified cash-based accounting system. When the simple cash-based accounting system was in place, regional governments were required to submit a single financial report (laporan realisasi anggaran), which compared actual cash revenue and cash expenditure against budgeted amounts. With the issuance of KepMendagri 29/2002, a regional government is now required to submit a financial report that consists of a: Budget realization report (laporan realisasi anggaran). This report now consists of two parts: (i) a report that compares actual cash revenue and cash expenditure with budgeted amounts during the reporting period, and (ii) a report that makes this comparison for income and costs. Balance sheet (neraca), stating the value of a regional government’s assets and liabilities at the end of the reporting period. According to prevailing 6 accounting standards (Standar Akuntansi Pemerintahan or SAK) , which became applicable in 2006, regional governments are required to record depreciation of fixed assets. In that year, only three district governments (Kota Semarang, Kabupaten Bangli and Kabupaten Karangasem) accounted for depreciation of fixed assets.

5 For a detailed definition of these terms, refer to Government Regulation 58 of 2005 on Regional Government Financial Management (Peraturan Pemerintah Republik Indonesia Nomor 58 Tahun 2005 Tentang Pengelolaan Keuangan Daerah). 6 Government Regulation 54 of 2005 on Government Accounting Standards (Peraturan Pemerintah Republik Indonesia Nomor 24 Tahun 2005 Tentang Standar Akuntansi Pemerintahan).

Chapter 2

Definition of Regional Government Surplus

Increases in Surpluses of Regional Governments Final Report (June 2008)

Cashflow statement (laporan aliran kas or laporan arus kas), which states the sources and applications of funds during the reporting period. Notes to the above reports. Legally, these notes form an integral part of the financial report. Figure 2.1 STRUCTURE OF REGIONAL GOVERNMENT BUDGET

REVENUE Own-Source Revenue (Pendapatan Asli Daerah) Revenue from Central Government Transfers* (Dana Perimbangan) ƒ Dana Bagi Hasil ƒ Dana Alokasi Umum ƒ Dana Alokasi Khusus Other Revenue (Pendapatan Lain-Lain)

EXPENDITURE & FINANCING Operational Expenditure (Belanja Non-Modal)

Investment Expenditure (Belanja Modal)

Chapter 4

Operational Financing Financing Municipal Surplus (Pembiayaan) Water Services Unspent Revenue

Cash Surplus (SiLPA)

Source: Consultant Note: boxes reflect the relative sizes of main revenue and expenditure categories; extra-budgetary revenue and expenditure are not shown. * Not including Dana Otonomi Khusus and incidental central government grants (which will be classified in this report as ‘other revenue’)

Definition of Regional Government ‘Cash Surplus’ Minimum requirements of an operational definition of surplus. For the purpose of this study, a definition of the term ‘surplus’ must allow for: Analysis of increases in surpluses over time. To meet this condition, it is necessary to ensure that the surpluses recorded by the modified cash-based regional government accounting system are directly comparable to cash surpluses that were generated by the simple cash-based system. Comparison of increases in surpluses with increases in bank deposits. To meet this condition, it is necessary that the (to be defined) surplus can, in principle, be deposited into a bank account. Simple cash-based surplus. When simple cash-based accounting systems were in use, the ‘surplus’ of a regional government was calculated as: SPC = (REV –EX)

[2-1]

where SPC = simple cash-based surplus REV = revenue EX

= expenditure

Chapter 2

Definition of Regional Government Surplus

Increases inSurpluses of Regional Governments Final Report (June 2008)

Modified cash-based surplus. KepMendaGri 29/2002 defines the term ‘surplus’ as follows: SP

= (REV – OEX) – (AEX –AREV)

[2-2]

where SP

surplus as defined by KepMendaGri 29/2002

REV

revenue

OEX

operational expenditure, such as salaries and O&M

AEX

expenditure on investment in fixed assets

AREV

revenue from the sale of fixed assets

In the terminology used by KepMendaGri 29/2002, the term ‘REV – OEX’ is equivalent to the operational cashflow (aliran kas dari aktivitas operasi), which is also called ‘surplus’ in regional government financial accounts. The term ‘AEX –AREV’ is equivalent to the investment cashflow (aliran kas dari aktivitas investasi). Financial cashflows and extra-budgetary cashflows. A surplus as defined by KepMendaGri 29/2002 is not directly comparable to a surplus under the simple cash-based system. This is because the ‘KepMendaGri surplus’ ignores financial cashflows (aliran kas dari aktivitas pembiayaan), the most important of which are: Income from loan proceeds (which are not recorded as revenue from ownsources or central government transfers). Investments in financial assets (such as shares in municipal enterprises). Repayment of long-term debt. Transfers from or to contingency funds (dana cadangan). In addition, the KepMendaGri definition of surplus ignores extra-budgetary cashflows, such as corrections to previous’ years accounting errors. To correct for financial and extra-budgetary cashflows, Equation [2-2] can be rewritten as: SP*

= SP – (FEX – FREV) – (XEX – XREV)

[2-3]

where SP*

surplus corrected for financial and extra-budgetary cashflows

surplus as defined by KepMendaGri 29/2002

FEX

expenditure on financial assets

FREV

revenue from financial assets

XEX

extra-budgetary expenditure

XREV

extra-budgetary revenue

Definition of surplus. The remainder of this report will ignore revenue from the sale of fixed assets because these were insignificant during the Study Period (AREV=0). For the same reason, extra-budgetary transactions will be

Chapter 2

Definition of Regional Government Surplus

Increases in Surpluses of Regional Governments Final Report (June 2008)

excluded from the analysis (XEX – XREV =0). This means that equation [2-3] can be simplified to: SP** = (REV–OEX–AEX) – (FEX–FREV)

[2-4]

The data required to calculate surpluses (as defined above) are readily available from the regional government’s standardized cashflow statement (Table 2.2). Cash surplus vs. operational surplus. To avoid confusion between the term ‘surplus’ used in this report, and the (operational) ‘surplus’ used in regional government accounts, two types of surpluses are distinguished: Operational surplus, which is defined as “revenue – expenditure” and equivalent to the term ‘surplus’ in KepMendagri 29/2002. Cash surplus, which is defined as “revenue – expenditure – net financial costs” and equivalent to ‘SiLPA’ (Sisa Lebih Perhitungan Anggaran), with the exception of revenue from the sale of physical assets and extra-budgetary revenue and expenditure (these revenue and expenditure items were not material during the Study Period, and are therefore ignored in the remainder of this report). Cash balance. The term ‘cash balance’ is used to refer to the total of cash surpluses that a regional government has accumulated during its existence. As will be shown in the next chapter, the cash balance of a regional government is, at any given time, broadly comparable to total bank deposits held by that regional government. Table 2.2 CASH BALANCES UNDER THE MODIFIED CASH-BASED SYSTEM Budget Item + Operational revenue – Operational expenditure + Revenue from sale of fixed assets* – Expenditure on fixed assets

}

Operational cashflow (aliran kas dari aktivitas operasi)

}

Investment cashflow (aliran kas dari aktivitas investasi)

= Surplus according to KepMendagri 29/2002 (=OPERATIONAL SURPLUS) + Revenue from financial transactions

Financial cashflow } (aliran kas dari aktivitas pembiayaan) – Expenditure on financial transactions + Revenue from other transactions*

}

– Expenditure on other transactions*

Extra-budgetary cashflow (aliran kas dari aktivitas nonanggaran)

= Increase (decrease) in cash balance + Cash balance, BOY = Cash balance, EOY (=CASH SURPLUS) / SiLPA Source: Consultant * Ignored in the remainder of this report

Chapter 2

Definition of Regional Government Surplus

Increases inSurpluses of Regional Governments Final Report (June 2008)

Chapter 2

Definition of Regional Government Surplus

Review of Regional Government Surpluses

Increases in Regional Government Bank Deposits Background. The high level of cash surpluses accumulated by regional governments is a relatively recent phenomenon. It has attracted the interest of the central government authorities in an indirectly way, through the accumulation of bank deposits held by regional governments, as reported by Bank Indonesia. From December 2001 to December 2006, regional government bank deposits increased from IDR 18.6 trillion to IDR 68.5 trillion, and increased to IDR 85.1 trillion in January 2007 (Figure 3.1). Deposits increased sharply in 2005 and 2006 (the second and third year of the Study Period), especially deposits held by district governments (Figure 3.2). Figure 3.1 END-OF-YEAR REGIONAL GOVERNMENT BANK DEPOSITS, 2000-2006 IDR trillion

0 2000

2001

2002

2003

Provinces

2004

2005

2006

Districts

Source: Bank Indonesia (2007)

Regional government bank deposits vs. cash balances. Although Bank Indonesia does not publish information on bank deposits held by individual regional governments (which it considers as confidential), a review of audited financial reports suggests that the EOY cash balance of a region is a good approximation of the EOY bank deposits of that region, given that: Regional governments hold most of their cash balances in current accounts or short-term deposits, and the remainder in cash. Net increases in contingency funds do not form part of a regional government cash surplus, but are normally deposited in a bank account. Cash vs. bank deposits. Most regional governments invest a major portion of their cash balances in current accounts and short-term deposits, and retain a small amount in cash, usually not more than IDR 1 billion. Assuming that this amount is kept as ‘cash in hand’ by each regional government, provincial governments held IDR 33 billion in cash, or 0.2% of the EOY cash balance. For the sample of 220 districts governments, this figure was 1.5%.

Chapter 3

Review of Regional Government Surpluses

Increases inSurpluses of Regional Governments Final Report (June 2008)

This means that virtually the entire cash balance is available for investment in bank accounts. (This report will continue the use the commonly accepted term ‘cash balance’ even though ‘bank balance’ would be more appropriate.) Increases in contingency funds (dana cadangan). From 2004 to 2006, a sample of 247 regional governments invested approximately IDR 1.5 trillion in contingency funds. This amount represented 5% of the combined increase in the total cash balance during that period. This suggests that the bank deposit of a regional government is, on average, (5% - 1.5% =) 3.5% higher than its cumulative cash surplus, as defined in this report. Figure 3.2 END-OF-YEAR REGIONAL GOVERNMENT BANK DEPOSITS, 2000-2006 31 December 2004 = 100

400

300

200

100

0 2000

2001

2002

2003

Provinces

2004

2005

2006

Districts

Source: Bank Indonesia (2007)

Review of Provincial Government Surpluses Overview of provincial government surpluses. From 2001 to 2006, EOY cash surpluses of provincial governments covered by this report increased from IDR 3.7 trillion to almost IDR 16 trillion (Table 3.1). The increase was lowest in 2003, which was also a year of unusually low revenue growth. Table 3.1 PROVINCIAL GOVERNMENT CASH BALANCES, 2001-2006 IDR trillion

2001

2002

Cash balance, BOY

3.7

Increase in cash balance

2.1

Cash balance, EOY

3.7

5.8

2003*

2004

2005

2006

5.8

6.3

7.8

13.7

0.4

1.6

5.8

2.2

6.3

7.8

13.7

15.8

Sources: SIKD (2001-2002), audited regional government financial reports (2004-2005) Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004) * Data for 2003 were estimated from EOY balances in 2002 and BOY balances in 2004

Chapter 3

Review of Regional Government Surpluses

Increases in Surpluses of Regional Governments Final Report (June 2008)

Build-up of provincial government surpluses. From 2004 to 2006, provincial government revenue increased by IDR 20.7 trillion (Table 3.2). Most of the increase was absorbed by increases in operational expenditure and investment in fixed assets. Of the remainder, about IDR 4.5 trillion was spent on equity investments, loan repayment, and other financial transactions. Net expenditure on extra-budgetary transactions was negligible. Table 3.2 BUILD-UP OF PROVINCIAL GOVERNMENT CASH BALANCES, 2004-2006 IDR trillion

Budget Item

2004

2005

2006

43.1

52.6

63.8

– Operational expenditure

(34.4)

(36.5)

(46.6)

– Net expenditure on fixed assets

(6.2)

(8.6)

(13.1)

+ Operational revenue

= Surplus (deficit)

2.6

7.5

4.0

(1.0)

(1.6)

(1.9)

– Net expenditure on other transactions

0.0

(0.1)

0.1

= Increase (decrease) in cash balance

1.6

5.8

2.2

+ Cash balance, BOY

6.3

7.8

13.7

= Cash balance, EOY

7.8

13.7

15.8

– Net expenditure on financial transactions

Source: Consultant, based on BPK Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004)

Utilization of provincial government revenue. From 2004 to 2005, the share of operational expenditure dropped from 80% to 69% of total revenue (Table 3.3). The combined share of investments in fixed and financial assets increased slightly, from 14% to 16%. As a result, provincial governments did not spend 11% of their total revenue in 2005, up from 3% in the previous year. This caused the combined cash balances of the provinces to increase by IDR 5.8 trillion (or over US$ 600 million). Cash balances also increased from 2005 to 2006, but by a much smaller margin than in the preceding year, because of a substantial increase in investment in fixed assets. Table 3.3 UTILIZATION OF PROVINCIAL GOVERNMENT REVENUE, 2004-2006 IDR trillion

IDR trillion

% Total

2004

2005

2006

2004

2005

2006

34.4

36.5

46.6

Net investment

6.2

8.6

13.1

Net financial transactions

0.9

1.6

1.9

Net other transactions

0.1

(0.1)

Operational expenditure

Unspent revenue Total revenue

1.6

5.8

2.2

43.1

52.6

63.8

100

Source: Consultant, based on BPK Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004)

Chapter 3

Review of Regional Government Surpluses

Increases inSurpluses of Regional Governments Final Report (June 2008)

Geographical distribution of provincial cash balances. In 2006, five provinces accounted for over two-thirds of the total provincial cash balance of IDR 15.8 trillion (Table 3.4). With the exception of DKI Jakarta, these provinces are rich in natural resources. In contrast, the â&#x20AC;&#x2DC;bottom fiveâ&#x20AC;&#x2122; provinces accounted for less than 2% of total cash balances. Four of these five provinces were located in Sulawesi. Table 3.4 CASH BALANCES OF TOP-5 AND BOTTOM-5 PROVINCES, 2006 IDR trillion

Top 5

IDR trn

Bottom 5

IDR trn

Aceh

3.42

Nusa Tenggara Barat

0.07

East Kalimantan

3.05

Sulawesi Utara

0.06

DKI Jakarta

2.03

Sulawesi Barat

0.05

Riau

1.11

Sulawesi Tenggara

0.05

Papua

1.00

Sulawesi Tengah

0.03

Total

10.63

Total

0.26

Source: audited regional government financial reports Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004)

Review of District Government Surpluses Overview of district government surpluses. From 2001 to 2006, the combined cash balances of the sample districts increased at much higher rates than provincial cash balances, and were estimated at IDR 25.7 trillion by the end of 2006, a twentyfold increase over the end-of-year cash balance in 2001 (Table 3.5). Table 3.5 DISTRICT GOVERNMENT CASH BALANCES, 2001-2006 IDR trillion

2001

2002

Cash balance, BOY

1.3

Increase in cash balance

3.5

Cash balance, EOY

1.3

4.8

2003*

2004

2005

2006

4.8

6.5

7.8

14.7

1.7

1.0

7.2

10.9

6.5

7.5

14.7

25.7

Sources: SIKD (2001-2003), audited regional government financial reports (2004-2005) Sample size: 220 districts (accounting for 63% of total population in 2004)

Build-up of district government surpluses. During the Study Period, district government revenue increased by almost IDR 50 trillion (Table 3.6). About two-thirds of the increase was absorbed by increases in operational expenditure and investment in fixed assets. Of the remainder, about IDR 5.5 trillion was spent on equity investments in municipal enterprises, loan repayment, and other financial transactions. Net expenditure on extra-budgetary transactions was negligible, as was the case for provincial governments.

Chapter 3

Review of Regional Government Surpluses

Increases in Surpluses of Regional Governments Final Report (June 2008)

Table 3.6 BUILD-UP OF PROVINCIAL GOVERNMENT CASH BALANCES, 2004-2006 IDR trillion

2004

2005

2006

+ Operational revenue

Budget Item

71.2

82.5

119.5

– Operational expenditure

(68.7)

(60.5)

(79.7)

(13.6)

(26.2)

2.5

8.3

5.7

– Net expenditure on fixed assets = Surplus (deficit) – Net expenditure on financial transactions

(1.5)

(1.1)

(2.9)

– Net expenditure on other transactions

–

0.0

0.2

= Increase (decrease) in cash balance

1.0

7.2

10.9

+ Cash balance, BOY

6.5

7.5

14.7

= Cash balance, EOY

7.5

14.7

25.7

Source: Consultant, based on BPK * Included in operational expenditure Sample size: 220 of 434 districts (accounting for 63% of total population in 2004)

Utilization of district government revenue. In 2004 and 2005, the expenditure pattern of district governments resembled that of provinces (Table 3.7). In 2005, revenues of kabupaten and kota increased faster than operational expenditure and investments in fixed assets, resulting in a major increase in unspent revenue, from 1% to 9% of total revenue. Unlike provinces, district governments did not increase investments in fixed assets (as a percentage of total revenue) in 2006, so that unspent revenue remained higher and resulted in a substantial increase in cash balances. Table 3.7 UTILIZATION OF DISTRICT GOVERNMENT REVENUE, 2004-2006 IDR trillion

IDR trillion

Operational expenditure Net investment Net financial transactions

2004

2005

2006

2004

2005

2006

68.7

60.5

79.7

13.6

26.2

1.5

1.1

2.9

Net other transactions Unspent revenue Total revenue

% Total

(0.0)

(0.2)

1.0

7.2

10.9

71.2

82.5

119.5

100

Source: audited regional government financial reports * Included in operational expenditure Sample size: 220 of 434 districts (accounting for 69% of total population in 2004)

Geographical distribution of district government cash balances. In 2005, six kabupaten and four kota in a sample of 220 districts accounted for over 30% of the combined cash balance of IDR 25.7 trillion (Table 3.8). At the end of that year, Kabupaten Natuna alone recorded a higher cash balance than the province of West Java. With the exception of Kota Surabaya, all

Chapter 3

Review of Regional Government Surpluses

Increases inSurpluses of Regional Governments Final Report (June 2008)

districts with ‘top 10’ cash balances are located in the provinces of East Kalimantan, Riau, or Kepulauan Riau. Of the ten districts with the lowest cash balances in the sample, six were located in Sulawesi. The combined cash balance of these district governments was estimated at IDR 87.9 billion. Table 3.8 CASH BALANCES OF TOP-10 AND BOTTOM-10 DISTRICTS, 2006 IDR billion

Top 10

Bottom 10

IDR b

Kab. Rokan Hilir

1,550

IDR b

Kab. Bima

14.1

Kab. Kutai

1,173

Kab. Mamuju Utara

13.0

Kab. Kampar

1,018

Kota Pontianak

10.9

Kota Surabaya

865

Kota Palu

9.9

Kab. Natuna

865

Kab. Minahasa Utara

9.8

Kab. Berau

790

Kota Manado

7.4

Kota Tarakan

603

Kab. Lombok Timur

6.4

Kota Samarinda

486

Kab. Melawi

5.8

Kota Balikpapan

455

Kota Palopo

5.5

Kab. Malinau

345

Kab. Bone Bolango

5.0

Total

8,151

Total

87.9

Source: audited regional government financial reports Sample size: 220 districts (accounting for 63% of total population in 2004)

Review of Cash Surpluses vs. Expenditure Needs Rationale for holding cash balances. Households and businesses retain cash balances, which consists of ‘cash in hand’ (bank notes and coins) and ‘near cash’ (such as current accounts that can be converted into cash at short notice, at little or no cost). They do so for two specific purposes: To meet short-term expenditures, which may be expected (such as the monthly electricity bill) or unexpected (such as car repairs or aspirin) To meet long-term expenditures, such as car or a home The sum of cash required for the above purposes is defined as the ‘minimum required cash balance’. This amount varies with: (i) the total expenditure of a household or business (a supermarket needs a higher balance than a momand-pop shop), (ii) the predictability of these expenditures (a fire insurance company needs a higher cash balance than a water utility), and (iii) the propensity of the household or business to save for long-term expenditure. Minimum required cash balances of regional governments. Regional governments need to retain cash balances for the same reasons as households. Because the expenditure patterns of provincial and district governments are similar (Table 3.3, Table 3.7), it was assumed that the predictability of expenditures is, on average, equal for all regional governments. Because investments in contingency funds were insignificant during the Study Period,

Chapter 3

Review of Regional Government Surpluses

Increases in Surpluses of Regional Governments Final Report (June 2008)

it was furthermore assumed that regions do not save to meet expenditure needs in the long run. This means that minimum required cash balance will only systematically vary with the total expenditures of a regional government. Average cash balances of regional governments. Average cash balances of regional governments were defined as the average of BOY and EOY cash balances. As expected, actual cash balances are closely related to total expenditure. In 2006, the average cash balance of about 75% of a sample of 220 districts was equivalent to a maximum of 3.4 months of operational expenditure, up from 2.7 months in 2005 (Table 3.9). In 2006, the average cash balance of a similarly constructed sample of provinces decreased from 4.6 months in 2005 to 3.6 months in 2006. Table 3.9 REGIONAL GOVERNMENT CASH BALANCES, 2005 AND 2006 Months of operational expenditure / Average cash balance

2005

2006

Provinces

4.6

3.6

Districts

2.7

3.4

All

2.9

3.4

Source: Consultant, based on BPK * Highest cash balance of bottom 75% in sample

Implications of the cash balance analysis. These are as follows: The increase in regional government cash surpluses is a more pervasive problem for districts than for provinces. As shown in Figure 3.3, the number of provinces with cash balances of at least 3 months of operational expenditure decreased from 2005 to 2006. In contrast, the number of districts in this category decreased, except in the ‘5-6 months’ bracket (Figure 3.4). Increases in cash surpluses cannot be explained by increases in the need for long-term expenditure (which are virtually non-existent) or short-term expenditure, because average cash balances are already higher than necessary for meeting operational expenditures (Figure 3.10). Table 3.10 EXCESS CASH BALANCES BY REGIONAL GOVERNMENT, 2005-2006 IDR trillion

Operational Expenditure/ Average Cash Balance

PROVINCES 2005

DISTRICTS

2006

2005

2006

–

0.4

3-6 months (excessive)

3.5

1.1

2.8

5.4

> 6 months (excessive)

4.5

7.0

4.2

8.6

Total

8.0

8.6

7.4

14.3

58%

54%

50%

< 2 months (normal)

Excessive / Total

56%

Source: Consultant, based on audited regional government financial reports Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004) and 220 of 434 districts (accounting for 63% of total population in 2004)

Chapter 3

Review of Regional Government Surpluses

Increases inSurpluses of Regional Governments Final Report (June 2008)

Figure 3.3 HISTOGRAM OF PROVINCIAL GOVERNMENT CASH BALANCES, 2005-2006 Months of operational expenditure / Average cash balance

12 10 8 6 4 2 0 <1

1–2

2–3

3–4

2005

4–5

5–6

2006

Source: Consultant Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004)

Figure 3.4 HISTOGRAM OF DISTRICT GOVERNMENT CASH BALANCES, 2005-2006 Months of operational expenditure / Average cash balance

100 80 60 40 20 0 <1

1–2

2–3

2005

3–4

4–5

5–6

2006

Source: Consultant Sample size: 220 districts (accounting for 63% of total population in 2004)

Chapter 3

Review of Regional Government Surpluses

Analyzing Causes of Increased Surpluses

Rationale for Increases in Surpluses Rationale for regional government surpluses worldwide. In some countries, national and sub-national governments deliberately build up ‘excess’ cash balances, which are substantially higher than would be required to meet short-term operational expenditures. The main reasons for doing so are: Macroeconomic management. Some governments build up reserves in times of high economic growth. The purpose of these reserves is to increase government expenditure during a recession, thereby shortening the duration of a period of low economic growth. Intergenerational transfers. Many resource-rich (sub-) national governments have created sovereign wealth funds to share current revenue from resources with future generations. For example, the provincial government of Alberta in Canada has established a fund financed from profits from the oil and gas sectors to be used once revenue from these sectors drops below a statutory level. Rationale for regional government surpluses in Indonesia. Since 2004, few regional governments in Indonesia have deliberately attempted to build up excess cash balances to meet long-term expenditure needs. As described in Chapter 3, investment in earmarked funds (dana cadangan) have not been significant when compared to recent increases in cash balances. Moreover, the vast majority of provinces, kabupaten and kota have attempted to reduce cash surpluses by approving sizeable budget deficits, both in ‘original’ and revised budgets. In 2006, for example, 26 of 31 provinces and 289 of 331 district governments (for which data were available) expected to have an operational deficit. In reality, 28 provinces and 271 districts realized a surplus in that year (Table 4.1). During 2004-2006, approved operational budget deficits were substantial, accounting for over 8% of total budgeted regional government revenue (Table 4.2). Table 4.1 ACTUAL VS. BUDGETED REGIONAL GOVERNMENT SURPLUSES, 2006 PROVINCES

Deficit

DISTRICTS

Budget*

Actual

Budget* 289

Actual 50

Balanced

–

Surplus

271

No data

113

434

Total

Sources: Audited financial reports for 2006 * Figures refer to operational deficits in APBD-P (unless the regional government did not issue an APBD-P)

Chapter 4

Analyzing Causes of Increased Surpluses

Increases inSurpluses of Regional Governments Final Report (June 2008)

Table 4.2 REGIONAL GOVERNMENT BUDGET DEFICITS, 2004-2006 IDR trillion

PROVINCES

DISTRICTS

2004

2005

2006

2004

2005

2006

Revenue

39.9

46.2

60.7

68.0

76.5

112.0

Expenditure

44.9

50.2

68.4

74.5

82.8

122.9

5.0

4.0

7.7

6.5

6.3

10.1

12.5

8.7

12.6

9.6

8.3

8.9

Operational deficit As % of revenue

Source: Consultant, based on BPK Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004) and 220 of 434 districts (accounting for 63% of total population in 2004)

Impact of budget realization on regional government surpluses. From 2003 to 2006, the end-of-year cash balances of 27 provinces and 220 districts increased from a total of IDR 12.8 trillion to IDR 41.5 trillion (Figure 4.1). If these regional governments would have achieved the revenue and expenditure targets in their operational budgets, the total cash balances at the end of 2006 would have been minus IDR 37.1 trillion 7. Figure 4.1 CUMULATIVE REGIONAL GOVERNMENT END-OF-YEAR CASH SURPLUSES – ACTUAL VS. BUDGETED AMOUNTS*, 2003-2006 IDR trillion

0 2003

2004

2005

2006

-20

-40 Budget

Actual

Source: Consultant Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004) and 220 of 434 districts (accounting for 63% of total population in 2004) * Budgeted EOY cash surplus = BOY cash surplus – cumulative operational surplus since December 2003

7 This calculation ignores differences between actual and budgeted financial transactions; such differences were approximately zero during 2004-2006.

Chapter 4

Analyzing Causes of Increased Surpluses

Increases in Surpluses of Regional Governments Final Report (June 2008)

Actual vs. Budgeted Surpluses What happened to IDR 79 trillion? In December 2006, the regional governments in the sample had accumulated a cash surplus of IDR 41.5 trillion, instead of reporting a cash deficit of IDR 37.1 trillion. The difference of IDR (41.5 + 37.1 =) 78.6 trillion, or US$ 8.7 billion, can be broken down in two components: Underestimation of revenue. During 2004-2006, most regional governments collected more revenue than indicated in their budgets. In other words, revenue budget realization ratios usually exceeded 100% (Box 4.1). Underspending. Government Regulation 58 of 2005 on Regional Government Financial Management prohibits regional governments to spend more than the amounts stipulated in their (original or revised) expenditure budgets, so that budget realization ratios remained below 100%. Box 4.1 BUDGET REALIZATION RATIOS

A budget realization ratio is defined as: “the ratio between the actual amount and budgeted amount for a budget item at the end of the budget period”. If, for example, a regional government has an expenditure budget for salaries of 100 for 2007, and spends 93 on salaries during that year, the budget realization ratio for that item is 93% during the budget period. Budget realization ratios can be classified as follows: 100%. The actual amount is identical to the budgeted amount. This figure indicates perfect budget execution (on budget). > 100%. The actual amount is higher than the budget (over budget) < 100%. The actual amount is lower than the budget (under budget). Source: Consultant

Underestimate of revenue. Throughout the Study Period, most provincial governments collected more revenue than the budgeted amount. Only a small number of provinces did not meet their revenue target (Figure 4.2). This pattern was also exhibited by district governments, the difference being that actual revenue collection deviated, on average, by a smaller margin from the budgeted amount when compared to provincial governments (Figure 4.3).

Chapter 4

Analyzing Causes of Increased Surpluses

Increases inSurpluses of Regional Governments Final Report (June 2008)

Figure 4.2 ACTUAL VS. BUDGETED PROVINCIAL GOVERNMENT REVENUE, 2006 12 < Under budget

Over budget >

10 8 6 4 2 0 <75%

80-85%

90-95%

100-105%

110-115%

120-125%

Number of Provincial Governments Source: Consultant Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004)

Figure 4.3 ACTUAL VS. BUDGETED DISTRICT GOVERNMENT REVENUE, 2006 120 < Under budget

Over budget >

100 80 60 40 20 0 <75%

80-85%

90-95%

100-105%

110-115%

120-125%

Number of District Governments Source: Consultant Sample size: 220 of 434 districts (accounting for 63% of total population in 2004)

Underspending. For obvious reasons, regional governments are allowed to collect more revenue that they budgeted for. They are, however, not allowed to spend more than the amount stipulated by DPRD in the approved budget (or revision thereto). This means that the expenditure budget acts as a â&#x20AC;&#x2DC;spending limitâ&#x20AC;&#x2122;. As a result, actual expenditure of all regional governments was lower than the expenditure budget (Figure 4.4, Figure 4.5). The most common expenditure budget realization ratios ranged from 90% to 95%.

Chapter 4

Analyzing Causes of Increased Surpluses

Increases in Surpluses of Regional Governments Final Report (June 2008)

Figure 4.4 ACTUAL VS. BUDGETED PROVINCIAL GOVERNMENT EXPENDITURE, 2006 12 < Under budget

Over budget >

10 8 6 4 2 0 <75%

80-85%

90-95%

100-105%

110-115%

120-125%

Number of Provincial Governments Source: Consultant Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004)

Figure 4.5 ACTUAL VS. BUDGETED DISTRICT GOVERNMENT EXPENDITURE, 2006 120 < Under budget

Over budget >

100 80 60 40 20 0 <75%

80-85%

90-95%

100-105%

110-115%

120-125%

Number of District Governments Source: Consultant Sample size: 220 of 434 districts (accounting for 63% of total population in 2004)

Impacts of underestimation of revenue and underspending on regional government surpluses. During 2004-2006, most regional governments collected more revenue than they budgeted for. At the same time, they did not spend their expenditure budgets in full. As a result, most regions reported an operational surplus (as opposed to an operational deficit). Figure 4.6 and Figure 4.7 illustrate the differences between budgeted and actual surpluses for 2006. This pattern is also observable for 2004 and 2005 (not shown in the figures).

Chapter 4

Analyzing Causes of Increased Surpluses

Increases inSurpluses of Regional Governments Final Report (June 2008)

Figure 4.6 ACTUAL VS. BUDGETED PROVINCIAL GOVERNMENT SURPLUSES*, 2006 12 < Operational Deficit

Operational Surplus >

10 8 6 4 2 0 <-25%

-10-15%%

-5-10%

Actual

0-5%

+10-15%

+20-25%

Budgeted

Source: Consultant * Operational surplus only Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004)

Figure 4.7 ACTUAL VS. BUDGETED DISTRICT GOVERNMENT SURPLUSES*, 2006 120 < Operational Deficit

Operational Surplus >

100 80 60 40 20 0 <-25%

-10-15%%

-5-10%

Actual

0-5%

+10-15%

+20-25%

Budgeted

Source: Consultant * Operational surplus only Sample size: 220 of 434 districts (accounting for 63% of total population in 2004)

Chapter 4

Analyzing Causes of Increased Surpluses

Increases in Surpluses of Regional Governments Final Report (June 2008)

Framework for Analysis Operationalizing the study objective. As stated in Chapter 1, the objective of this study is to “identify potential causes for increases in regional government cash surpluses [during 2004-2006]”. However, cash surpluses would not have increased if regional governments had realized their revenue and expenditure budgets in full. Stated differently, regional government cash surpluses have only increased because regional governments, taken together, have collected more and spent less revenue than they budgeted for. In theory, regional governments could have spent the increases in operational surpluses on financial assets, such as shares in municipal enterprises, or (early) repayment of debt. However, during 2004-2006 only a small portion of the increase was spent on financial assets (see also Table 3.3 and Table 3.7). Identifying potential causes for increases in regional government cash surpluses is therefore equivalent to identifying the causes of: Differences between actual and budgeted revenue Differences between actual and budgeted expenditure Limited allocations of operational surpluses in financial assets Box 4.2 OPERATIONAL STUDY OBJECTIVES

Identify potential causes of positive differences between actual and budgeted revenue (underestimation of revenue) Identify potential causes of negative differences between actual and budgeted expenditure (underspending) Identify potential causes of limited allocations of operational surpluses to financial assets (depressed investment in financial assets, hereinafter also referred to as underfinancing) Source: Consultant

Revisiting the definition of regional government surplus. As described in Chapter 2, this study defines the cash surplus of a regional government as: SP** = (REV–OEX–AEX) – (FEX–FREV)

[4-1]

where SP**

cash surplus

REV

revenue (other than revenue from the sale of fixed or financial assets)

OEX

operational expenditure

AEX

expenditure on investment in fixed assets

FEX

expenditure on financial assets

FREV

revenue from financial assets

Analysis of differences between actual and budgeted surpluses. The potential causes of increases in regional government surpluses will be investigated by analyzing differences between actual and budgeted cash surpluses. These are given by:

Chapter 4

Analyzing Causes of Increased Surpluses

Increases inSurpluses of Regional Governments Final Report (June 2008)

SP**A – SP**B = (REVA–REVB) – (EXA–EXB) – (NFEXA–NFEXB)

[4-2]

where EX

non-financial expenditure (=OEX + AEX)

NFEX

net financial expenditure (=FEX – FREV)

A, B

denote ‘actual’ and ‘budgeted’ amounts, respectively

Revenue, expenditure and financing. The differences between actual and budgeted cash surpluses can be broken down into three components, each of which corresponds with one of the three operational study objectives. The term ‘REVA–REVB’ refers to underestimation of revenue, ‘EXA–EXB’ assesses the extent of underspending, whereas ‘NFEXA–NFEXB’ denotes the difference between actual and budgeted (net) expenditure on financial assets, such as equity investments and loan repayment.

Remainder of this report Summary. This chapter described a methodology to analyze the increases in cash surpluses of regional governments during 2004-2006. The next three chapters will identify potential causes for underestimation of revenue, underspending and depressed investment in financial assets, respectively (Table 4.2). The final chapter presents conclusions and policy recommendations. Table 4.2 DIFFERENCES BETWEEN ACTUAL AND BUDGETED AMOUNTS Term in Equation [4-3]

Description

Covered In

REVA – REVB

Differences between actual and budgeted revenue (underestimation of revenue)

Chapter 5

EXA – EXB

Differences between actual and budgeted expenditure (underspending)

Chapter 6

NFEXA – NFEXB

Differences between actual and budgeted net financial transactions (underfinancing)

Chapter 7

Source: Consultant

Chapter 4

Analyzing Causes of Increased Surpluses

Analysis of Revenue

Actual vs. Budgeted Revenue Composition of regional government revenue. Regional governments have two main sources of revenue at their disposal: Own-source revenue. Revenue from Pendapatan Asli Daerah (PAD) largely consists of regional taxes (pajak daerah), regional service charges (retribusi daerah) and revenues from regional government enterprises. Central government transfers. Revenue from Dana Perimbangan consists of DBH, DAU, DAK, and contingency funds. Of these, DBH, DAU and DAK are by far the most important. Taken together, PAD and Dana Perimbangan accounted for over 90% of total regional government revenue during 2004-2006 (Table 5.1). Most of the remainder consisted of borrowings, and incidental grants from higher-level governments. Table 5.1 COMPOSITION OF REGIONAL GOVERNMENT REVENUE, 2004-2006 Percentage of total revenue

PROVINCES

Revenue Category

DISTRICTS

2004

2005

2006

Own source revenue (PAD)

Revenue sharing (DBH)

General allocation (DAU)

Special allocation (DAK)

–

Other*

100

Total

2004

2005

2006

Source: Consultant Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004), 220 of 434 districts (accounting for 63% of total population in 2004) * Including Dana Otonomi Khusus

Provincial vs. district government revenue. Provinces derive a much higher share of total revenue from PAD than district governments, because 8 Government Regulation 65 of 2001 grants provincial governments a share in three high-yielding regional government taxes (the motor vehicle tax, the motor vehicle transfer tax, and the motor vehicle fuel tax). In addition, methods for distributing shared revenue favor provincial governments. Provinces are normally entitled to at least 20% of shared revenue allocated to sub-national governments, against 10% of total Dana Alokasi Umum. Budget realization ratios by revenue category. During 2004-2006, actual revenue both provincial and district governments exceeded budgeted revenue by margins ranging from 5% to 14%. Budget realization ratios were highest for PAD, DBH, and ‘other revenue’ (Table 5.2). Actual revenue from

8 Peraturan Pemerintah Republik Indonesia 65 Tahun 2001 tentang Pajak Daerah.

Chapter 5

Analysis of Revenue

Increases inSurpluses of Regional Governments Final Report (June 2008)

DAU transfers was nearly ‘on budget’ throughout the Study Period. This observation also applies to DAK transfers to district governments. Table 5.2 BUDGET REALIZATION RATIOS BY REVENUE SOURCE, 2004-2006 Actual revenue as a percentage of budgeted revenue

PROVINCES

Revenue Category

DISTRICTS

2004

2005

2006

2004

2005

2006

Own source revenue (PAD)

112

114

103

104

105

112

Revenue sharing (DBH)

109

125

110

123

135

125

General allocation (DAU)

102

100

102

101

107

125

112

110

107

108

114

105

108

106

Special allocation (DAK) Other** All Revenue Categories

Source: Consultant Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004), 220 of 434 districts (accounting for 63% of total population in 2004) * Not shown (most provinces did not receive DAK during the Study Period) ** Including Dana Otonomi Khusus

Major sources of ‘underestimation of revenue’ During 2004-2006, actual revenue collected by regional governments was substantially higher than budgeted revenue. In all three years, higher than expected collections of PAD and DBH accounted for over 80% of total ‘underestimation’ (Table 5.3, Table 5.4). Regional governments were able to predict revenue from DAU and DAK transfers with a much higher degree of accuracy (as evidenced by budget realization ratios close to 100%). As a result, underestimation of these sources did not contribute significantly to the total difference between actual and budgeted revenue, even though DAU and DAK transfers accounted for over two-thirds of total district government revenue, and for about 20% of provincial government revenue (Table 5.5). Table 5.3 ACTUAL VS. BUDGETED PROVINCIAL GOVERNMENT REVENUE, 2004-06 IDR trillion

Revenue Category

Actual – Budget

% Total

2004

2005

2006

2004

2005

2006

Own source revenue (PAD)

2.3

3.2

0.9

Revenue sharing (DBH)

0.9

3.0

1.7

General allocation (DAU)

0.1

(0.0)

0.0

(0)

Special allocation (DAK)

(0.0)

(0.5)

(0)

(18)

Other*

(0.1)

0.3

1.0

(2)

Total

3.2

6.4

3.1

100

Source: Consultant Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004) * Including Dana Otonomi Khusus

Chapter 5

Analysis of Revenue

Increases in Surpluses of Regional Governments Final Report (June 2008)

Table 5.4 ACTUAL VS. BUDGETED DISTRICT GOVERNMENT REVENUE, 2004-06 IDR trillion

Revenue Category

Actual – Budget

% Total

2004

2005

2006

2004

2005

2006

Own source revenue (PAD)

0.3

0.4

1.0

Revenue sharing (DBH)

2.3

4.9

5.1

General allocation (DAU)

(0.0)

0.1

(2)

(1)

Special allocation (DAK)

0.0

0.1

Other

0.7

0.5

Total

3.2

6.0

6.7

100

Source: Consultant Sample size: 220 of 434 districts (accounting for 63% of total population in 2004)

Table 5.5 ACTUAL VS. BUDGETED REGIONAL GOVERNMENT REVENUE, 2004-06 IDR trillion

Revenue Category

Actual – Budget

% Total

2004

2005

2006

2004

2005

2006

Own source revenue (PAD)

2.5

3.6

2.0

Revenue sharing (DBH)

3.2

7.9

6.7

DAU, DAK and Other

0.8

1.0

1.1

Total

6.5

12.5

9.8

100

Source: Consultant Sample size: 220 of 434 districts (accounting for 63% of total population in 2004)

Actual vs. Budgeted Own-Source Revenue Collection of regional government own-source revenue. About 90% of provincial government own-source revenue and almost half of the PAD of district government revenue is collected by state-owned enterprises, and not by the regional governments themselves (Table 5.6). With respect to thirdparty collection, the following arrangements are currently in place: PERTAMINA collects the motor vehicle fuel tax, a 10% surcharge on the price of fuel of motorized vehicles. The motor vehicle tax and the motor vehicle transfer tax, which account for over 70% of provincial own-source revenue, are administered jointly by the provincial revenue department (DIPENDA Propinsi), the National Police and PT. Jasa Raharja, a state-owned insurance company. PT. PLN, the national electricity company, collects the street lighting tax (Pajak Penerangan Jalan Umum or PPJU), which is levied as a 10% surcharge on the electricity bill.

Chapter 5

Analysis of Revenue

Increases inSurpluses of Regional Governments Final Report (June 2008)

Table 5.6 COMPOSITION OF REGIONAL GOVERNMENT REVENUE, 2005 Percentage

Provinces

Districts

Central government transfers Own-source revenue - Collected by regional governments

Other

Total

100

- Collected by state-owned enterprises

Source: Consultant Sample size: 30 of 33 provinces (accounting for 99% of total population in 2004), 292 of 434 districts (accounting for 81% of total population in 2004)

Sources of PAD underestimation by provincial governments. In 2006, actual collection of own-source revenue exceeded budgeted PAD in 22 of 27 provinces in the sample (Figure 5.1). This suggests that the state-owned enterprises that are responsible for the collection of most provincial government own-source revenue consistently provided provincial governments with highly conservative estimates of tax revenue. Because over 90% of provincial government own-source revenue consists of revenue from taxes on motorized vehicles, it is not surprising that the four provinces with most motorized vehicles in Indonesia (West Java, Central Java, East Java and DKI Jakarta) accounted for over 70% of total underestimation of provincial government own-source revenue PAD (Table 5.7). Figure 5.1 BUDGET REALIZATION RATIOS FOR PROVINCIAL GOVERNMENT OWN-SOURCE REVENUE (PAD), 2006 12 < Under budget

Over budget >

10 8 6 4 2 0 <75%

80-85%

90-95%

100-105%

110-115%

120-125%

Number of Provincial Governments Source: Consultant Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004)

Chapter 5

Analysis of Revenue

Increases in Surpluses of Regional Governments Final Report (June 2008)

Table 5.7 ACTUAL VS. BUDGETED PROVINCIAL GOVERNMENT OWN-SOURCE REVENUE, 2004-06 IDR trillion

Actual – Budget

Province

% Total

2004

2005

2006

2004

2005

2006

West Java

0.54

0.64

0.30

East Java

0.51

0.71

0.43

Central Java

0.28

0.37

0.07

DKI Jakarta

0.30

0.52

(0.84)

Other provinces

0.64

0.97

Total

2.27

3.22

0.92

100

Source: Consultant Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004) * Excluded (outlier)

Sources of PAD underestimation by district governments. In 2006, actual PAD exceeded budgeted PAD in over 75% of sample districts (Figure 5.2). Primary sources of underestimation of PAD at the district level include: Conservative estimates about PPJU revenue by PT. PLN. Conservative estimates about other tax revenue by DIPENDA (Box 5.1). Higher than expected interest revenue (as a direct result from having higher than expected bank deposits). Unexpected ‘other revenue’, recorded as PAD (this serves as the main explanation for the rightmost bar in Figure 5.2). Figure 5.2 BUDGET REALIZATION RATIOS FOR DISTRICT GOVERNMENT OWN-SOURCE REVENUE (PAD), 2006 120 < Under budget

Over budget >

100 80 60 40 20 0 <75%

80-85%

90-95%

100-105%

110-115%

120-125%

Number of District Governments

Source: Consultant Sample size: 220 of 434 districts (accounting for 63% of total population in 2004)

Chapter 5

Analysis of Revenue

Increases inSurpluses of Regional Governments Final Report (June 2008)

Box 5.1 HOW LOW CAN YOU GO?

A local parliament (DPRD) usually judges the performance of a revenue agency (Dinas Pendapatan Daerah or DIPENDA) against two targets: (i) the budgeted revenue, and (ii) the percentage increase in annual revenue. A major disadvantage of the first measure is that it encourages a Head of DIPENDA to negotiate a revenue budget that is relatively easy to achieve, in order to meet DPRD expectations. Although DPRD may be aware of this strategy, it has no objective information at its disposal to judge the quality of a budget proposal prepared by (better-informed) DIPENDA staff. Source: Consultant (2004)

Actual vs. Budgeted Shared Revenue (DBH) Sources of DBH underestimation by provincial governments. In 2006, actual DBH collections were 50% higher than budgeted DBH collections in more than half of all provinces in the sample (Figure 5.3). Three major oil and gas producing provinces (East Kalimantan, Riau and Kepulauan Riau) accounted for a substantial share of total underestimation of DBH, especially in 2005 and 2006, when world market prices for oil and gas rapidly increased (Table 5.8). The reasons for this are known. During the Study Period, the following arrangements were in place: At the end of a financial year (t), the Ministry of Finance provided regional governments with estimates of DBH revenue, which were based on prevailing world market prices. Regional governments used these estimates for the preparation of budgets for the next financial year (t+1). In the third quarter of t+1, regional governments received the first transfer from shared oil and gas revenue. (Meanwhile, world market prices of oil and gas – which directly affect transfers of shared revenue in oil and gas, and in the land and buildings tax – had typically increased by a substantial margin.) In the last quarter of t+1, the Ministry of Finance informed regional governments of an increase in DBH transfers to which they were entitled, and transferred the additional amount. This usually happened after a regional government had already approved a budget revision (APBD-P), so that it was no longer possible to spend the increased amount. A regional government would, in any case, have difficulties to spend a substantial increase in DBH revenue – in a single quarter – on activities for which no budget was prepared. As a result, most additional DBH revenue was unspent and included as SiLPA in the budget for t+2. To some extent, these ‘mis-targeting’ problems also existed for shared revenue from sources other than oil and gas. To 9 address these problems, the Minister of Finance issued PMK 7/2008 . This

9 Peraturan Menteri Keuangan Republik Indonesia Nomor 04/Pmk.07/2008 Tentang Pelaksanaan Dan Pertanggungjawaban Anggaran Transfer Ke Daerah.

Chapter 5

Analysis of Revenue

Increases in Surpluses of Regional Governments Final Report (June 2008)

decree allows the treasury to quarterly disburse a stipulated percentage of total estimated DBH transfers to regional governments. It is hoped that this measure, the implementation of which started in February 2008, would reduce differences between actual and budgeted DBH, and thereby the underestimation arising from this source. Figure 5.3 BUDGET REALIZATION RATIOS FOR PROVINCIAL GOVERNMENT SHARED REVENUE (DBH), 2006 18 < Under budget

Over budget >

15 12 9 6 3 0 <75%

80-85%

90-95%

100-105%

110-115%

120-125%

Number of Provincial Governments Source: Consultant Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004)

Table 5.8 ACTUAL VS. BUDGETED PROVINCIAL GOVERNMENT SHARED REVENUE (DBH), 2004-06 IDR trillion

Province East Kalimantan

Actual â&#x20AC;&#x201C; Budget

% Total

2004

2005

2006

2004

2005

2006

(0.16)

1.09

1.55

(18)

Riau

0.23

0.28

0.34

Kepulauan Riau

0.10

0.09

0.19

DKI Jakarta

0.25

0.51

(0.14)

(9)

Other provinces

0.46

0.99

(0.28)

(17)

Total

0.89

2.96

1.65

100

Source: Consultant Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004)

Sources of DBH underestimation by district governments. Factors responsible for large differences between actual and budgeted DBH collections by provincial governments also apply to districts. Because of conservative DBH estimates, and relatively late transfers (usually not starting in the second or third quarter), many district governments were unable to

Chapter 5

Analysis of Revenue

Increases inSurpluses of Regional Governments Final Report (June 2008)

spend actual DBH transfers in the financial year in which they were received. Differences between actual and budgeted DBH collections were especially significant in districts located in major oil and gas producing provinces (Table 5.9). Figure 5.4 BUDGET REALIZATION RATIOS FOR DISTRICT GOVERNMENT REVENUE SHARING (DBH), 2006 120 < Under budget

Over budget >

100 80 60 40 20 0 <75%

80-85%

90-95%

100-105%

110-115%

120-125%

Number of District Governments Source: Consultant Sample size: 220 of 434 districts (accounting for 63% of total population in 2004)

Table 5.9 ACTUAL VS. BUDGETED DISTRICT GOVERNMENT SHARED REVENUE (DBH), 2005-06 IDR trillion

District

Actual â&#x20AC;&#x201C; Budget

% Total

2005

2006

2005

2006

Kab. Kampar

0.37

0.58

Kab. Kutai Kartanegara

0.17

0.37

Kab. Rokan Hilir

0.41

0.36

Kab. Berau

0.20

0.29

Kota Tarakan

0.17

0.27

Kab. Musi Banyuasin

0.28

0.16

Other districts

3.32

3.02

Total

4.92

5.05

100

Source: Consultant Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004) * Including Dana Otonomi Khusus

Chapter 5

Analysis of Revenue

Increases in Surpluses of Regional Governments Final Report (June 2008)

Actual vs. Budgeted Revenue from DAU, DAK and Others DAU. Realization ratios for DAU budgets were close to 100% for most provinces and districts (Figure 5.5 and Figure 5.6). Interviews confirmed that regional government officials consider DAU transfers as the most reliable source of revenue and often designate the DAU as the source for payment of wages and salaries. Figure 5.5 BUDGET REALIZATION RATIOS FOR PROVINCIAL GOVERNMENT REVENUE FROM THE GENERAL ALLOCATION (DAU), 2006 30 < Under budget

Over budget >

25 20 15 10 5 0 <75%

80-85%

90-95%

100-105%

110-115%

120-125%

Number of Provincial Governments Source: Consultant Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004)

Figure 5.6 BUDGET REALIZATION RATIOS FOR DISTRICT GOVERNMENT REVENUE FROM THE GENERAL ALLOCATION (DAU), 2006 240 < Under budget

Over budget >

200 160 120 80 40 0 <75%

80-85%

90-95%

100-105%

110-115%

120-125%

Number of District Governments Source: Consultant Sample size: 220 of 434 districts (accounting for 63% of total population in 2004)

Chapter 5

Analysis of Revenue

Increases inSurpluses of Regional Governments Final Report (June 2008)

DAK. Provincial governments normally do not receive DAK . For district governments, DAK budget realization ratios are similar to those for DAU. Actual revenue from this source is normally equal to the budgeted amount provided by MoF at the time of budget preparation. Other. By its very nature, ‘other revenue’ consist of revenue that is difficult to predict (if not, a regional government would have classified the sources already). Even though there was a substantial difference between actual and budgeted ‘other revenue’, it was not possible to identify factors that explain a major portion of these differences.

Potential Causes of Underestimation of Revenue Underestimation of PAD. These can be summarized as follows: Conservative estimates about regional tax revenue by PERTAMINA, the National Police and PT. Jasa Raharja (provincial governments only). Conservative estimates about PPJU revenue by PT. PLN (districts only). Conservative estimates about non-PPJU regional tax revenue by DIPENDA (districts only). Higher than expected interest revenue, as a direct result from having higher than expected bank deposits (both). Unexpected ‘other revenue’, recorded as PAD (both). Underestimation of DBH. The primary causes for underestimation from this source, which accounted for more than half of total underestimation of revenue, were: (i) conservative DBH estimates, and (ii) relatively late transfers. Taken together, these factors prevented district governments with significant DBH revenue (especially shared revenue from oil and gas) to spend the difference between budgeted and actual DBH in the same financial year. To address these mis-targeting problems, the Minister of Finance issued a decree in January 2008 that allows the treasury to transfer to quarterly disburse a stipulated percentage of total estimated DBH transfers to regional governments. Underestimation of DAU, DAK and other revenue. Throughout the Study Period, actual revenue from DAU and DAK transfers was ‘on budget’. This observation did not apply to the category ‘other revenue’, but no potential causes could be identified to explain underestimation in this category.

10 Minor exceptions exist (for example, the Province of Sulawesi Barat, which was legally established in 2004, received a DAK-financed establishment grant in 2005).

Chapter 5

Analysis of Revenue

Analysis of Expenditure

Actual vs. Budgeted Expenditure Classification of regional government expenditure. According to KepMendagri 29/2002, regional governments are required to classify expenditures by function and by type, as follows: Function. KepMendagri 29/2002 distinguishes four functions: (i) regional government apparatus (aparatur daerah), (ii) public services (pelayanan publik), (iii) financial support (bagi hasil dan bantuan keuangan), and (iv) other (tak tersangka). Expenditures on aparatur daerah and pelayanan publik are classified either as general administration (administrasi umum), operations and maintenance (operasi dan pemeliharaan) or investment (investasi). Type. Expenditures on aparatur daerah and pelayanan public are broken down into five expenditure types: (i) salaries and wages, (ii) goods and services, (iii) duty travel, (iv) maintenance, and (v) investment. Classification of regional government expenditure by function. There is substantial variation among regional governments in the classification of expenditures on aparatur daerah and pelayanan publik. This is illustrated with audited financial data for the kabupaten of Asahan and Sleman. In 2005, Kabupaten Sleman spent 50% of its total expenditure on general administration for pelayanan publik (Table 6.1). In contrast, Kabupaten Asahan did not spend anything on this category, but classified almost 70% of its expenditure on general administration for aparatur daerah. The two kabupaten classified a similar portion of total expenditure as ‘financial support’ or ‘other expenditure’. These observations, which apply to most regional governments (including provinces), suggest that data on functional expenditure are not sufficiently reliable for use in analyzing budget realization ratios. Table 6.1 COMPOSITION OF REGIONAL EXPENDITURE BY FUNCTION (ILLUSTRATED BY TWO SAMPLE REGIONAL GOVERNMENTS) Percent of total expenditure

Kab. Asahan Kab. Sleman 2.1

Regional Government Apparatus 2.1.1 General Administration

2.2

2.1.2 Operations and Maintenance

2.1.3 Investment

2.2.1 General Administration

–

2.2.2 Operations and Maintenance

Public Services

2.2.3 Investment

2.3

Financial support

2.4

Other expenditure

100

TOTAL EXPENDITURE Sources: Audited financial reports for 2005

Chapter 6

Analysis of Expenditure

Increases inSurpluses of Regional Governments Final Report (June 2008)

Classification of regional government expenditure by type. As illustrated by expenditure data for Kabupaten Asahan and Kabupaten Sleman, there is limited variation among regional governments in the classification of expenditures by type (wages and salaries, duty travel, etc.). In 2005, both kabupaten spent over 60% of total expenditure on wages and salaries, and about 15% on investment (Table 6.2). These types of expenditure, as well as expenditure on the functions ‘financial support’ and ‘other expenditure’ were therefore used for analyzing regional government expenditure. Table 6.2 COMPOSITION OF REGIONAL EXPENDITURE BY TYPE (ILLUSTRATED BY TWO SAMPLE REGIONAL GOVERNMENTS) Percent of total expenditure

Kab. Asahan Kab. Sleman 2.1/2 Regional Gov. Apparatus / Public Services - Wages and salaries (belanja pegawai)

- Goods and services (belanja barang & jasa)

- Duty travel (belanja perjalanan)

- Maintenance (belanja pemeliharaan)

2.3

- Investment (belanja modal) Financial support (bagi hasil b. keuangan)

2.4

Other expenditure (belanja tak tersangka)

100

TOTAL EXPENDITURE Sources: Audited financial reports for 2005

Operational vs. investment expenditure. An analysis of budgeted and actual provincial government expenditure in 2006 indicates that budget realization ratios for all major expenditure categories were in the order of 90%, with the exception of investment expenditure (belanja modal), for which 11 the realization ratio was 80% (Table 6.3) . Random sampling of budget realization ratios of regional governments in 2004 and 2005 suggests that budget realization ratios of all expenditure categories have remained around 90%, whereas the budget realization ratio of belanja modal has dropped in recent years. Based on this analysis, two assumptions were made: For the purpose of identifying potential causes of ‘overspending’, it was deemed sufficient to distinguish between two expenditure categories: (i) investment expenditure (belanja modal), and (ii) operational expenditure (which consists of all other regional government expenditure). The budget realization ratio of operational expenditure was assumed to remain at 90% throughout the Study Period.

11 The budget realization ratio for ‘other expenditure’ was 53% in 2006, but such expenditures usually account for less than 1% of total expenditure, and ‘underspending’ in this category will therefore have a priori little impact on increases in regional government surpluses.

Chapter 6

Analysis of Expenditure and Investment

Increases in Surpluses of Regional Governments Final Report (June 2008)

Table 6.3 BUDGET REALIZATION RATIOS FOR PROVINCIAL GOVERNMENT EXPENDITURE CATEGORIES, 2006 Actual expenditure as percent of budgeted expenditure

Actual as % of Budget 2.1/2 Regional Gov. Apparatus / Public Services - Wages and salaries (belanja pegawai)

- Goods and services (belanja barang dan jasa)

- Duty travel (belanja perjalanan)

- Maintenance (belanja pemeliharaan)

- Investment (belanja modal)

2.3 2.4

Financial support (bagi hasil bantuan keuangan)

Other expenditure (belanja tak tersangka)

TOTAL EXPENDITURE

Sources: Audited financial reports for 2006 Sample size: 19 of 33 provinces (accounting for 64% of total population in 2004)

Composition of regional government expenditure. From 2004 to 2006, investment expenditure increased from 15% to 22% of total provincial government expenditure. Districts also allocated a increasing proportion of their expenditure budgets to belanja modal, which accounted for 25% of total expenditure in 2006 (Table 6.4). A likely explanation for the increase is the rapid increase in regional revenue during the Study Period, coupled to the ‘sticky’ nature of a large portion of operational expenditure (which mainly consists of wages and salaries – items that cannot be increased at short notice). Table 6.4 COMPOSITION OF REGIONAL GOVERNMENT EXPENDITURE, 2004-2006 Percentage of total expenditure

Expenditure Category

PROVINCES

DISTRICTS

2004

2005

2006

2004

2005

2006

Operational Expenditure

Investment Expenditure

100

Total

Source: Consultant Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004), 220 of 434 districts (accounting for 63% of total population in 2004)

Budget realization ratios by expenditure category. During 2004-2006, realization ratios for total expenditure budgets decreased for both provincial and district governments. Assuming that realization ratios for operational expenditure budgets remain unchanged during these years, these decreases must have been caused by a drop in the realization ratios of investment expenditure budgets. Based on this assumptions, it is estimated that provincial governments spent 79% of investment expenditure budgets in 2006, down from 93% in 2004. Districts experienced a drop from 88% in 2005 to 76% in 2006 (Table 6.5).

Chapter 6

Analysis of Expenditure

Increases inSurpluses of Regional Governments Final Report (June 2008)

Table 6.5 BUDGET REALIZATION RATIOS BY EXPENDITURE CATEGORY, 2004-2006 Actual expenditure as a percentage of budgeted expenditure

Expenditure Category

PROVINCES

DISTRICTS

2004

2005

2006

2004

2005

2006

Operational Expenditure*

Investment Expenditure

Both Categories

Source: Consultant Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004), 220 of 434 districts (accounting for 63% of total population in 2004) * Assumption based on a complete review of provincial government expenditure for 2006, and random sampling of regional government expenditure for 2004 and 2005

Major sources of ‘underspending’. Investment, as a percentage of total expenditure, increased by a substantial margin from 2004 to 2006. At the same time, budget realization ratios of investment expenditure decreased significantly. The confluence of these factors resulted in a rapid increase in underspending of investment expenditure budgets. The provincial governments in the sample did not spend an estimated IDR 3.4 trillion in 2006, a sevenfold increase from 2004 (Table 6.6). Similarly, districts did not spend over IDR 8 trn of budgeted investment, up from IDR 2 trn in 2005 (Table 6.7). As a result, underspending of investment expenditure budgets accounted for about half of total underspending in 2006, even though actual investment expenditures accounted for less than 25% of total expenditure in that year (Table 6.8). Table 6.6 BUDGETED VS. ACTUAL PROVINCIAL GOVERNMENT EXPENDITURE, 2004-06 IDR trillion

Expenditure Category

Budget – Actual

% Total

2004

2005

2006

2004

2005

2006

Operational Expenditure

3.8

4.1

5.2

Investment Expenditure

0.5

1.0

3.4

Total

4.3

5.1

8.6

100

Source: Consultant Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004)

Table 6.7 BUDGETED VS. ACTUAL DISTRICT GOVERNMENT EXPENDITURE, 2004-06 IDR trillion

Expenditure Category

Budget – Actual

% Total

2004

2005

2006

2004

2005

2006

Operational Expenditure

6.7

8.9

Investment Expenditure

1.9

8.2

Total

7.6

8.7

17.0

100

Source: Consultant Sample size: 220 of 434 districts (accounting for 63% of total population in 2004)

Chapter 6

Analysis of Expenditure and Investment

Increases in Surpluses of Regional Governments Final Report (June 2008)

Table 6.8 BUDGETED VS. ACTUAL REGIONAL GOVERNMENT EXPENDITURE, 2004-06 IDR trillion

Expenditure Category

Budget – Actual 2004

2005

2006

% Total 2004

2005

2006

Operational Expenditure

10.8

14.0

Investment Expenditure

3.0

11.6

12.0

13.8

25.6

100

Total

Source: Consultant Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004) and 220 of 434 districts (accounting for 63% of total population in 2004)

Potential Causes of Underspending Underspending according to regional governments. During January and February 2008, the Consultant interviewed representatives of three provinces and ten district governments to discuss potential causes of increases in regional government surpluses. These representatives mentioned two main explanations for underspending: Difficulties in implementing Keppres 80/2003. Delays in budget approval. Box 6.1 SUMMARY OF KEPPRES 80/2003

In 2003, the President replaced Keppres 18/2000 with Keppres 80/2003 in an attempt to improve transparency in bidding for contracts awarded by central and regional governments and their enterprises. Unlike its predecessor, Keppres 80/2003 imposes restrictions on regional governments (and other government agencies) with respect to: Public disclosure (a government agency must announce a tender in a newspaper). Financing of the tendering procedure (a government agency must allocate a budget to undertake a tender). Bid evaluation (a government agency must evaluate bids using a prescribed procedure that involves 51 steps). Source: Consultant, based on Keppres 18/2000 and Keppres 80/2003

Keppres 80/2003. This presidential decree was issued in 2003 and prescribes the procedures that a regional government (as well as central government agencies and government-owned enterprises) must follow to procure goods or services from third parties with a contractual value of at least IDR 50 million (US$ 5,600). This means that Keppres 80/2003 primarily affects the implementation of the investment expenditure budget because operational expenditure largely consists of salaries and wages (which are not paid to third parties) or expenditure on items with a value below the IDR 50m threshold (such as office supplies). Most regional government officials

Chapter 6

Analysis of Expenditure

Increases inSurpluses of Regional Governments Final Report (June 2008)

interviewed by the Consultant mention Keppres 80/2003 as the single most important constraint on spending investment expenditure budgets, ostensibly because the Keppres has introduced a series of administrative requirements that have led to delays in the award of contracts (Box 6.1). Keppres 80/2003 may have caused a reduction in the budget realization ratio of investment expenditure budgets in 2004, the first year in which the decree was implemented. This does not explain, however, why budget realization ratios continued to decline from 2005 to 2006 (Table 6.5). Delays in budget approval. Government Regulation 56 of 2005 stipulates that each regional government must submit its annual budget to SIKD in the Ministry of Finance latest on 31 January of the year to which the budget applies. In the second half of 2005, the Minister of Finance temporarily suspended DAU transfers to regional governments that had not submitted budgets to SIKD by 1 July of that year. Unsurprisingly, this measure has resulted in a significant reduction of the time between APBD approval by DPRD and receipt of the budget by SIKD. It appears that the measure has also reduced the budget approval time required by DPRD itself. From 2006 to 2007, the number of DPRDs that approved a budget before April of the ongoing budget year increased from 76% to 85% of all provinces for (which data were avai12 lable) and from 68% to 77% of all districts (Table 6.9) . Even though SIKD data were not available for budget approval dates for 2005, the temporary suspension of DAU transfers strongly suggests that such a reduction also took place from 2005 to 2006. These observations indicate that expenditure budget realization ratios should have increased, instead of decreased (as suggested by some regional government officials). In addition, delays in budget approval do not explain differences in budget realization ratios between operational expenditure and investment expenditure, because such ratios would presumably be equally affected by delays in budget approval. Table 6.9 APBD APPROVAL DATES, 2006 AND 2007 Budget Approval Date*

PROVINCES 2006

December (preceding year)

2007

DISTRICTS 2006

2007

198

306

April-June

July-September

â&#x20AC;&#x201C;

No data

â&#x20AC;&#x201C;

104

Total

434

% Approved before April**

January-March

Source: SIKD (2008) * Date of signing of the local by-law (Peraturan Daerah) issued to legalize the budget ** Excluding regional governments for which no data were available

12 These figures apply to preliminary budget approvals by DPRD, not to final approval of budgets reviewed by higher level governments.

Chapter 6

Analysis of Expenditure and Investment

Increases in Surpluses of Regional Governments Final Report (June 2008)

Alternative explanations for underspending. Neither the implementation of Keppres 80/2003, nor delays in budget approval, appear convincing explanations for the recent increases in regional government cash surpluses. Alternative explanations for underspending include: Administrative difficulties in awarding multi-year contracts. Increase in PAD to avoid breaching the ‘PP109’ limit. Limited flexibility in spending of expenditure budgets. The central government’s recent anti-corruption drive. Limited capacity in project development at the regional government level. Administrative difficulties in awarding multi-year contracts. Some observers have questioned the ability of regional governments to award and manage multi-year contracts. Field visits indicate that this is not considered a constraint at the regional government level, given that: Few regional governments finance investment projects that take more than one year to complete. Regional governments that do undertake multi-year investment projects normally finance such projects from a series of single-year contracts. This avoids the need to seek DPRD approval, which is required for each individual multi-year contract, whereas single-year contracts are included in the annual budget, which DPRD needs to approve in any case. Increase in PAD to avoid breaching the ‘PP109’ limit. Government 13 Regulation 109 of 2000 limits the operational expenditure of the Head and Vice-Head of a regional government to a specified percentage of own-source revenue (PAD). It may be argued that regional governments are encouraged to refrain from spending to boost its cash balance in order to increase its annual interest revenue and thereby, indirectly, its own-source revenue. For three reasons, it is unlikely that regional government spending behavior is influenced by PP109/2000: According to the PP, the maximum portion of PAD that may be spent by the Head and Vice-Head on operational expenditure decreases with the absolute amount of PAD. This regressive structure discourages regional governments from artificially boosting own-source revenue. The increase in operational expenditure of the Head and Vice-Head of the wealthiest regional governments is limited to 0.15% of increases in PAD. Assuming an interest rate of 8% per year, this means that such regions would need to increase cash balances by IDR (1 / 0.08 / 0.15 =) 8.3 trillion to increase operational expenditure of the Head and Vice-Hear by IDR 1 billion. According to audited financial reports, a substantial number of regional governments has been violating the provisions of the PP109/2000 without

13 Peraturan Pemerintah Republik Indonesia Nomor 109 Tahun 2000 Tentang Kedudukan Keuangan Kepala Daerah Dan Wakil Kepala Daerah.

Chapter 6

Analysis of Expenditure

Increases inSurpluses of Regional Governments Final Report (June 2008)

facing adverse consequences. As long as the regulation is not enforced, it is unlikely that the regional governments will go through the trouble of artificially increasing PAD to comply with the spending limits prescribed by the PP. Limited flexibility in spending of expenditure budgets. Regional government expenditure budgets are prepared in great detail. According to Article 27 of PP58/2005 on regional financial management, each organizational unit that forms part of a regional government (such as Dinas Pendidikan or BAPPEDA) must prepare an expenditure budget by function (aparatur daeah, pelayanan publik) and type (salaries, O&M, etc.). Once the budget is approved by DPRD, a unit is not allowed to spend more on an individual budget item than the amount in the budget (Box 6.2). For example, if the Department of Education has not used most of its travel budget at the end of the budget year, and wishes to reallocate part of this unspent budget to urgent repairs of school buildings, it is not allowed to do so without prior approval from DPRD. To obtain this approval, the Department is required to first modify its budget and apply for a budget revision (APBD Perubahan or APBD-P). However, applying for a budget revision is a time-consuming process and needs to be synchronized with requests for revisions by other units, since DPRD is only allowed to revise a budget once a year (Art. 81, PP58/2005). The fact that most (though not all) regional governments approve a revised budget suggests a need for more flexibility in expenditure budgets. The lack of flexibility also explains, to some extent, why regional governments are unable to spend their (operational and investment) expenditure budgets in full. Box 6.2 RESTRICTIONS ON SPENDING OF EXPENDITURE BUDGETS

In 2000, the Government issued PP105/2000 on regional government financial management. Article 10(2) of this decree stipulates that “all expenditures in the regional government budget constitute maximum limits for each expenditure type” (emphasis added). These restrictions remained in place after 2005, when PP105/2000 was replaced by PP 58/2005. Source: Consultant, based on PP105/2000 and PP58/2005

The central government’s recent anti-corruption drive. In recent years, the Government has taken a series of measures to attempt to reduce misuse of public funds. The majority of regional government officials visited by the Consultant reported that it has become increasingly difficult to find officials who are willing to form part of a tender committee (as required by Keppres 80/2003). In some cases, government officials have been visited by the police after having been appointed as member of a tender committee but before the first meeting of that committee had taken place. It appears that the anti-corruption drive in the wake of Keppres 80/2003 – but not the implementation of the Keppres itself – has stifled the creation of tender committees. This, in turn, has resulted in the observed decreased in the investment budget realization ratios.

Chapter 6

Analysis of Expenditure and Investment

Increases in Surpluses of Regional Governments Final Report (June 2008)

Limited capacity for project development at the regional government level. This is perhaps the most important constraint on the utilization of expenditure budgets, and thereby a primary explanation of the rapid increases in regional government surpluses. Unfortunately, it is notoriously difficult to measure a regional government’s capacity for project development. The following general observations were derived from interviews with officials of 13 regional governments: There is a major difference between planned investment projects (which are usually aimed at improving public services, such as roads and hospitals) and investment projects completed in recent years (which often consist of government and religious buildings). There is no apparent relationship between investment projects contained in regional development plans (RPJM-D) and investments projects under consideration by the region government itself. There appears to be no relationship between the amount of cash balance of a regional government and the ‘innovativeness’ of a region to utilize the cash balance. For example, Kabupaten Bima (a poor kabupaten in the province of Nusa Tenggara Barat) has utilized its cash surplus to securitize airplane seats. With this strategy, it has been successful in enticing a local airline (Merpati) to establish a fixed route to Bima, thereby opening up the kabupaten for trade with other regions. In contrast, the provincial government of East Kalimantan – which, in 2006, had the highest cash balance of all regional governments in Indonesia – is utilizing its surplus to finance sports complexes for the National Olympic Games (PON), which will be held in June 2008. It has no plans to invest in provincial roads or hospitals (indeed, it expects that such investments would partly be financed by central government grants).

Chapter 6

Analysis of Expenditure

Increases inSurpluses of Regional Governments Final Report (June 2008)

Chapter 6

Analysis of Expenditure and Investment

Analysis of Financing

Planning of Financial Transactions Overview. A regional government is required to indicate, in its annual budget, how it intends to finance a budgeted operational deficit. (In the unlikely event that a regional government has budgeted an operational surplus, it should indicate how it plans to utilize the surplus.) This part of the regional government budget where such financial transactions are recorded is called ‘financing’ (pembiayaan) and consists of: Financial inflows (penerimaan). Financial outflows (pengeluaran). Financial inflows. Existing cash surpluses are by far the most important source of financing of operational deficits. (Indeed, several regional governments informed the Consultant that operational deficits were budgeted for the explicit purpose of reducing cash surpluses.) If existing cash surpluses are not sufficient to cover operational budget deficits, a regional government may seek external financing to finance the deficit (or reduce planned financial outflows, if any). During the Study Period, very few regions borrowed longterm, although short-term borrowing (to cover temporary cash deficits) was common. (However, short-term loans are repaid in the same budget year and therefore do not affect the annual financing budget.) Financial outflows. These consist of regional government expenditures on financial assets, of which repayment of outstanding loans and equity investments in regional government enterprises are the most common. Any excess of financial inflows over operational deficits and financial assets is recorded as ‘cash surplus in current year’ (sisa anggaran perhitungan tahun berkenaan). Execution of the financing budget. Each individual financing decision requires separate DPRD approval. For this reason, actual financing amounts may exceed budgeted financing amounts. (Unlike expenditures, which are subject to limits stipulated in the original budget or APBD Perubahan.) Example: the case of Kota Yogyakarta. The following example illustrates how a typical regional government plans its financial transactions. The 2006 budget for Kota Yogyakarta assumed that the city would run an operational deficit of about IDR 84.5 billion (Table 7.1). The city planned to finance the deficit from its existing cash surplus (IDR 76.9b) and from new loans (IDR 17.9b). Part of the financial inflows would be used to finance loan repayment, equity investments, and other transactions (totaling about IDR 9b). This way, the cash surplus would be reduced from IDR 76.9b to IDR 1.4b. In reality, the city recorded a cash surplus of IDR 22.3 billion, and therefore did not need to borrow to finance its planned financial outflows of IDR 9b. As a result, by the end of 2006 the cash surplus of Kota Yogyakarta had increased from IDR 76.9b to approximately IDR (76.9+22.3-9=) 90.6 billion.

Chapter 7

Analysis of Financing

Increases inSurpluses of Regional Governments Final Report (June 2008)

Table 7.1 FINANCIAL TRANSACTIONS OF KOTA YOGYAKARTA, 2006 (EXAMPLE) IDR billion

Budget Item

Budget

Actual

A–B

(84.5)

22.3

106.8

Cash surplus from previous year (SiLPA)

76.9

Borrowings

17.9

–

Operational surplus Financial Inflows

– (17.9)

Financial Outflows Loan repayment

(5.1)

–

Equity investment

(2.5)

(2.3)

0.2

Other financial transactions

(1.4)

(1.3)

0.1

Cash surplus in current year

(1.4)

(90.6)

(89.2)

Net Financial Transactions

84.5

(22.3)

(106.8)

Source: BPK (2007)

Cash surpluses: and unplanned quantity. Regional governments typically mention cash surpluses as sources of financing that are actively used for planning purposes. In reality, cash surpluses are a result (and not a building block) of the financial planning process (Table 7.2). This means that, in order to understand how financial transactions may affect regional government surpluses, it is only necessary to consider those elements that are actively planned by regional governments, i.e. all items in the financing budget except previous and current year’s cash surpluses. Table 7.2 PERSPECTIVES ON PLANNING OF FINANCIAL TRANSACTIONS Sector

Regional Government Perspective

Consultant’s Perspective

Previous year’s cash (is part of financial inflows) surplus (SiLPAt)

Result of previous year’s planning process

Financial inflows

= SiLPAt + Borrowing

= Borrowing

Financial outflows

= Loan repayment + Equity = Loan repayment + Equity investments + Other investments + Other financial outflows + SiLPAt+1 financial outflows

Current year’s cash surplus (SiLPAt+1)

(is part of financial outflows) Result of this year’s planning process. SiLPAt+1 = SiLPAt + Financial Inflows – Financial Outflows

Source: Consultant

Chapter 7

Analysis of Financing

Increases in Surpluses of Regional Governments Final Report (June 2008)

Financial Transactions of Provincial Governments Provincial government financial inflows. During 2004-2006, about half of the provinces in the sample recorded a financial inflow of some kind (other than the use of last year’s cash surplus). In most cases, these inflows consisted of transfers from contingency funds (Table 7.3). In 2004 and 2005, repayments of loans from the province of Aceh to lower-level governments accounted for over a third of total provincial financial inflows. Provincial government financial outflows. During the Study Period, over three-quarters of the outflows of provincial governments consisted of: Loan repayments. From 2004 to 2006, provincial governments repaid IDR 2.7 trillion on outstanding loans, mostly to Bank Pembangunan Daerah (for comparison, the total amount payable on central government loans was approximately IDR 0.15 trillion on 30 September 2006). Transfers to contingency funds. In 2004 and 2005, provincial governments added IDR 0.28 trillion to contingency funds. Most of this amount was utilized in 2006, so that net additions to dana cadangan were approximately zero during the Study Period. Equity investment. With the exception of DKI Jakarta, which has a clear-cut 14 strategy for investing in (or divesting of) its enterprises , equity investments of most provincial governments consist of automatic reinvestment of dividends of Bank Pembangunan Daerah. These transactions are recorded by the provinces as a receipt in own-source revenue (PAD) and a (simultaneous) equity investment in the pengeluaran budget, but the funds themselves actually never pass through the regional government treasury. Table 7.3 PROVINCIAL GOVERNMENT FINANCIAL TRANSACTIONS, 2004-2006 IDR trillion

Budget item*

2004

2005

2006

Financial Inflows (FI)

0.22

0.61

0.09

Financial Outflows (FO)

1.14

2.24

2.02

Loan repayment

0.51

0.77

1.45

Net additions to contingency funds

0.20

0.08

(0.27)

Equity investment

0.15

0.75

0.29

Other financial outflows

0.28

0.62

0.55

0.92

1.63

1.93

Net Financial Outflows (= FO –FI)

Source: Consultant, based on BPK Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004) * Excluding previous and current year’s cash surpluses

14 Interview with the Head of the financing department of DKI Jakarta, 17 Jan 2008.

Chapter 7

Analysis of Financing

Increases inSurpluses of Regional Governments Final Report (June 2008)

Cash surpluses allocated to provincial government financial outflows. In recent years, actual financial outflows were far lower than funds available to finance such outflows. To some extent, this may be explained by the fact that provincial governments have generally underestimated revenue and overestimated expenditure for reasons described in Chapters 5 and 6. It seems, however, that many provincial governments never planned to spend total funds that were known to be available at the beginning of a financial year. In January, when a budget is approved, estimated funds available for financing consist of: Previous year’s cash surplus (SiLPA) minus Budgeted operational deficit From 2004 to 2006, actual (net) financial outflows dropped from 73% to 32% of funds estimated to be available at the beginning of the financial year (Table 7.4). It should be noted that, for most provincial governments, actual financial outflows were higher than budgeted financial outflows (so that lower-than-expected budget realization cannot serve as an explanation). Table 7.4 SHARE OF FUNDS AVAILABLE IN JANUARY ALLOCATED TO (NET) FINANCIAL OUTFLOWS BY PROVINCIAL GOVERNMENTS, 2004-2006 IDR trillion

Budget item* Cash surplus from previous year

2004

2005

2006

6.26

7.83

13.66

(5.00)

(4.01)

(7.65)

Available for financial outflows (A)

1.26

3.82

6.01

Allocated to financial outflows, net (B)

0.92

1.63

1.93

Addition to cash surplus (=A – B)

0.34

2.19

4.07

% Allocated to financial outflows

73%

43%

32%

Operational deficit (budget)

Source: Consultant, based on BPK Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004) * Excluding previous and current year’s cash surpluses

Financial Transactions of District Governments District government financial inflows. During the Study Period, about half of the districts in the sample recorded a financial inflow of some kind (excluding the use of last year’s cash surplus). As was the case for provinces, most financial inflows consisted of repayments of loans by lower-level governments. District government financial outflows. In 2005 and 2006, over threequarters of district government outflows consisted of: Loan repayments. In 2005 and 2006, district governments repaid IDR 1.7 trillion on outstanding loans, mostly to repay central government loans (total

Chapter 7

Analysis of Financing

Increases in Surpluses of Regional Governments Final Report (June 2008)

debt of district governments to the central government such loans was estimated at IDR 6.9 trillion on 30 September 2006). Transfers to contingency funds. Table 7.5 only shows net additions to contingency funds. These additions were the most important outflow in 2006, even though net investments in dana cadangan were negative during the preceding year. Equity investment. It is extremely rare for district governments to invest in enterprises other than BPDs. The nature of the investment strategy of a typical district (or provincial) government is aptly summed up in an audited financial report. This report states that the district investment in BPD shares should be seen as a consequence (sebagai konsequensi) of the profitability of the BPD. Even though most districts in Indonesia own a municipal water enterprise (Perusahaan Daerah Air Minum or PDAM), few district invest in PDAMs. None of the districts officials interviewed by the Consultant was planning to do so, citing priorities to invest in other sectors. Table 7.5 DISTRICT GOVERNMENT FINANCIAL TRANSACTIONS, 2005 AND 2006 IDR trillion

Budget item*

2005

2006

Financial Inflows (FI)

0.68

0.69

Financial Outflows (FO)

1.79

3.51

0.58

1.20

Loan repayment Net additions to contingency funds

(0.01)

1.29

Equity investment

0.75

0.65

Other financial outflows

0.47

0.36

1.11

2.92

Net Financial Outflows (= FO –FI)

Source: Consultant, based on BPK Sample size: 220 of 434 districts (accounting for 63% of total population in 2004) * Excluding previous and current year’s cash surpluses

Cash surpluses allocated to district government financial outflows. In 2004, district governments planned to spend total funds that were known to be available at the beginning of that financial year, which (as mentioned before) consist of the previous year’s cash surplus, net of the budgeted operational deficit. In 2005 and 2006, actual (net) financial outflows accounted 92% and 63% of funds estimated to be available at the beginning of the financial year (Table 7.6). In other words, during the Study Period districts spent a higher proportion of available funds on (net) financial outflows, but the proportion decreased significantly in 2005 and 2006. (Also for districts, actual financial outflows were higher than budgeted financial outflows, so the decrease cannot be explained by lower-than-expected budget realization).

Chapter 7

Analysis of Financing

Increases inSurpluses of Regional Governments Final Report (June 2008)

Table 7.6 SHARE OF FUNDS AVAILABLE IN JANUARY ALLOCATED TO (NET) FINANCIAL OUTFLOWS BY PROVINCIAL GOVERNMENTS, 2004-2006 IDR trillion

Budget item*

2004

2005

2006

Cash surplus from previous year

6.50

7.53

14.74

Operational deficit (budget)

(6.50)

(6.33)

(10.07)

Available for financial outflows (A)

0.00

1.21

4.67

Allocated to financial outflows, net (B)

1.47

1.11

2.92

Addition to cash surplus (=A – B) % Allocated to financial outflows

(1.46) > 100%

0.10

1.75

92%

63%

Source: Consultant, based on BPK Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004) * Excluding previous and current year’s cash surpluses

Potential Causes of Underfinancing Underfinancing of public services. From 2003 to 2006, EOY cash balances of regional governments in the sample increased from IDR 12.8 trillion to IDR 41.5 trillion. Regional governments could have used a substantial portion of the increase of IDR 28.7 trillion (or US$ 3.2 billion) to invest in regional government enterprises dedicated to the provision of public services for which they are legally responsible. In recent years, few regions have done so. Underutilization of the financing budgets for investment in public services can be broken down in two components: Underutilization of available funds Underutilization of actual financial outflows Underutilization of available funds. From 2005 and 2006, net financial outflows of the 247 regional governments in the sample increased were approximately IDR 7.5 trillion. Regional governments would have been able to spend an additional IDR 8 trillion during these two years, had they allocated all funds known to be available at the beginning of the financial year (Table 7.7). Underutilization of available funds did not occur in 2004. Table 7.7 INCREASES TO CASH SURPLUSES ATTRIBUTED TO UNDERFINANCING, 2004-2006 IDR trillion

2004

2005

2006

0.34

2.19

4.07

Districts

(1.46)

0.10

1.75

Total

(1.12)

2.29

5.82

Provinces

Source: Consultant, based on BPK Sample size: 27 of 33 provinces and 220 of 434 districts

Chapter 7

Analysis of Financing

Increases in Surpluses of Regional Governments Final Report (June 2008)

Underutilization of actual financial outflows. A detailed analysis of net financial outflows suggests that only a small portion of actual financial outflows could be considered as having a potential impact on public service delivery. As mentioned before, most equity investments of regional governments consist of automatic reinvestment of BPD profits, which does not affect public service delivery (if only because most Indonesian citizens do not have a BPD account). In addition, an increase in dana cadangan does not constitute an investment in public service delivery, but an increase in an earmarked bank account. Excluding increases in contingency funds and investments in BPD shares (assumed to consist of 90% of equity investments), only two-thirds of financial outflows appears to be associated with public service delivery (Table 7.8). Table 7.8 REGIONAL GOVERNMENT FINANCIAL OUTFLOWS, 2005 AND 2006 IDR trillion

Outflow

IDR trillion

% Total

2005

2006

2005

2006

Loan repayment

1.35

2.65

Additions to contingency funds

0.07

1.02

Equity investment

1.50

0.94

Other financial outflows

1.09

0.91

Total

4.01

5.52

100

Public service delivery*

2.59

3.65

Source: Consultant Sample size: 27 of 33 provinces and 220 of 434 districts * Total outflows, net of 90% of equity investment and additions to contingency funds

Potential explanations for ‘underfinancing’. It should be emphasized that ‘underestimation of revenue’ and ‘underspending’ cannot be considered as explanations for depressed investments in financial assets. As mentioned before, from 2005 onward regional governments did not plan to fully utilize funds that were known to be available in the beginning of the financial year, at the time of budget approval. Potential explanations include: Lack of vision. This explanation is similar to the explanation for limited investment in physical assets (using belanja modal budgets). Interviews with regional government officials indicate that many regions do not use (or are aware of the contents of) medium or long-term investment plans. Anti-corruption drive. Keppres 80/2003 also applies to procurement from third parties by regional government owned enterprises. Staff of PDAMs and other such enterprises may be reluctant to spend investment budgets for the same reasons as regional government officials. This observation is consistent with the fact that underutilization of available funds did not start in 2004, the first year of the implementation of the Keppres, but in 2005, when the Government’s anti-corruption drive gained force (Table 7.7). This explanation, together with ‘lack of vision’, also explains the recent increase in ‘riskfree’ investments in loan repayment and contingency funds.

Chapter 7

Analysis of Financing

Increases inSurpluses of Regional Governments Final Report (June 2008)

Â&#x192; Limited options for loan repayment. In recent years, regional governments have spent increasing amounts on loan repayment. Some regional governments have expressed an interested to prepay loans to the central government, or to settle outstanding arrears. Because of regulatory uncertainties and time-consuming debt resolution procedures in the Ministry of Finance, few regional governments have done so. (This explanation is especially relevant to districts governments; in September 2006, district governments and their enterprises owed the central government IDR 6.9 trillion including arrears.) Â&#x192; Reluctance to share budgets with BUMDs. An equity investment in a regional government enterprise is equivalent to a transfer of an expenditure budget from the regional government itself to a separate legal entity. Regional government may be reluctant to transfer an expenditure budget to a third party for fear that it loses control over the allocation of (part of its) budget.

Chapter 7

Analysis of Financing

Conclusions and Recommendations

Conclusions Increases in regional government bank deposits: a glorious accident. By the end of December 2006, regional governments held IDR 68.5 trillion in bank deposits, up from IDR 21.5 trillion in December 2003, an increase of over 300% in just three years. Regional government expenditure also increased during the three-year period, but at a much lower rate, so that the major increase in bank deposits cannot be explained by the need for regional governments to maintain higher cash balances to meet short-term routine expenditure (such as monthly salary payments). Regional governments did not plan to save either, because investments in contingency funds (dana cadangan) accounted for less than 5% of the IDR 47 trillion increase in bank deposits. At first sight, this suggests that during 2004-2006 regional government bank deposits have increased by accident, and not by design. Increases in regional government cash surpluses: a failure to execute budgets. With two minor exceptions (changes to investments in dana cadangan, and cash in hand), regional governments invest cash surpluses in bank accounts. The increase in 2004-2006 bank deposits is therefore approximated by the increase in cash surpluses that regional government accumulated during the same period. From December 2004 to December 2006, the cumulative cash surplus of 27 provinces and 220 districts increased from IDR 12.8 trillion to IDR 41.5 trillion (Figure 8.1). If these regions had realized their revenue and expenditure budgets, the total cash balances at the end of 2006 would have been minus IDR 37.1 trillion, a difference of IDR 79 trillion. Figure 4.1 CUMULATIVE REGIONAL GOVERNMENT END-OF-YEAR CASH SURPLUSES â&#x20AC;&#x201C; ACTUAL VS. BUDGETED AMOUNTS*, 2003-2006 IDR trillion

0 2003

2004

2005

2006

-20

-40 Budget

Actual

Source: Consultant Sample size: 27 of 33 provinces and 220 of 434 districts * Budgeted EOY cash surplus = BOY cash surplus â&#x20AC;&#x201C; cumulative operational surplus since December 2003

Chapter 8

Conclusions and Recommendations

Increases inSurpluses of Regional Governments Final Report (June 2008)

What happened to the IDR 79 trillion? Regional government cash surpluses have only increased because regional governments, taken together, have collected more and spent less revenue than they budgeted for. Regional governments only spent a small portion of increases in operational surpluses on financial assets, such as shares in municipal enterprises, or loan repayment. Identifying potential causes for increases in regional government cash surpluses is therefore equivalent to identifying the causes of: Higher than expected revenue (underestimation of revenue) Lower than expected expenditure (underspending) Limited investment of operational surpluses (underfinancing) Causes of underestimation of revenue. Higher than expected revenue from own sources and from DBH transfers accounted for over 80% of revenue underestimation, and almost one third of the IDR 79 trillion difference between actual and budgeted surpluses during 2004-2006 (Table 8.1). The most important potential causes of these differences are: Artificially depressed revenue estimates. Low estimates by DIPENDA and by state-owned enterprises (mainly PERTIMINA and PT. PLN), who are tasked with the collection of the most important regional government taxes, make it easier for these agencies to meet revenue targets. In addition, stateowned enterprises (which do not form part of the regional government apparatus) may submit artificially low revenue budgets in increase interest income. Because such enterprises are required to pay regional governments a monthly or quarterly advance against budgeted revenue, there is an obvious financial advantage in providing lower-than-expected estimates. Rapid increases in world prices for oil and gas. Such increases resulted in substantial differences between budgeted and actual DBH transfers. (The Ministry of Finance has since issued PMK 7/2008, in order to improve the predictability of central government transfers by regional governments.) Table 8.1 ACTUAL VS. BUDGETED OPERATIONAL SURPLUSES, 2004-2006 IDR trillion

Provinces Districts

TOTAL

Higher than expected PAD

6.4

1.7

8.1

Higher than expected DBH

5.5

12.2

17.8

Other sources of underestimation of revenue

0.8

2.1

2.9

Lower than expected operational expenditure

13.1

21.8

34.9

Lower than expected investment expenditure*

4.9

10.1

15.0

Lower than expected (net) financing costs Total

(not significant) 30.7

47.9

78.6

100

% Total

Source: Consultant * District investment expenditure included in operational expenditure (2004 only)

Chapter 8

Conclusions and Recommendations

Increases in Surpluses of Regional Governments Final Report (June 2008)

Causes of underspending. This category accounted for two-thirds of differences between actual and budgeted operational surpluses. Underspending of investment expenditure increased at a higher rate than any other component, from IDR 0.5 trillion in 2004 to IDR 11.6 trillion in 2006 (Table 8.2). The most important potential causes of underspending are: Limited flexibility in spending of expenditure budgets. Once a budget is approved by DPRD, a regional government unit is not allowed to spend more on an individual budget item than the amount in the budget without prior approval from DPRD. To obtain this approval, the department is required to first modify its budget and apply for a budget revision (APBD-P). The fact that most (though not all) regional governments approve a revised budget suggests a need for more flexibility in expenditure budgets. The lack of flexibility also explains, to some extent, why regional governments are unable to spend their expenditure budgets in full. The Government’s anti-corruption drive. Regional government officials find it increasingly difficult to recruit officials to form part of a tender committee. It appears that the Government’s anti-corruption drive in the wake of Keppres 80/2003 (but not as a result of the implementation of the Keppres itself) serves as the primary explanation of the rapid increase in regional government surpluses, because it has reduced investment expenditure. Limited capacity for project development at the regional government level. Field visits indicate that regional governments usually do not execute their medium-term investment plans. Most investment expenditure is allocated to small-scale projects or to projects that have little or no relation with improving public service delivery (such as government offices and motor vehicles). This is perhaps the most important constraint on the utilization of expenditure budgets, and thereby a primary explanation of the rapid increases in regional government surpluses. Table 8.2 ACTUAL VS. BUDGETED OPERATIONAL SURPLUSES BY YEAR, 2004-2006 IDR trillion

2004

2005

2006

Higher than expected PAD

2.5

3.6

2.0

Higher than expected DBH

3.2

7.9

6.7

Other sources of ‘overcollection’

0.8

1.0

1.1

Lower than expected operational expenditure

10.1

10.8

14.0

Lower than expected investment expenditure*

0.5

3.0

11.6

Lower than expected (net) financing costs Total

(not significant) 17.0

26.2

35.4

Source: Consultant * District investment expenditure included in operational expenditure (2004 only)

Chapter 8

Conclusions and Recommendations

Increases inSurpluses of Regional Governments Final Report (June 2008)

Causes of underfinancing. Lack of vision and the Government’s anticorruption drive also serve as major explanations for the limited investments in financial assets that regional governments have undertaken in recent years. Underfinancing may have been exacerbated because of: Administrative constraints to loan repayment. During 2004-2006, regional governments have spent increasing amounts on loan repayment. Some regional governments have expressed an interested to prepay loans to the central government, or to settle outstanding arrears. Because of regulatory uncertainties and time-consuming debt resolution procedures in the Ministry of Finance, few regional governments have done so. Reluctance to share budgets with BUMDs. In recent years, few regional governments have invested in enterprises (except BPDs), possibly because regions are reluctant to transfer an expenditure budget to a third party for fear that it loses control over the allocation of (part of its) budget. Putting regional government surpluses in perspective. Because of a combination of underestimation of revenue, underspending and underfinancing, regional governments had accumulated almost IDR 70 trillion in bank deposits by the end of December 2006. In that year, this sum was equal to: Twice the central government budget deficit. Almost 50% of total DAU transfers to provincial and district governments. Six times total own-source revenue (PAD) collected by kabupaten and kota. Over IDR 1,500,000 per household (counting all households in Indonesia).

Chapter 8

Conclusions and Recommendations

Increases in Surpluses of Regional Governments Final Report (June 2008)

#3 – Relax restrictions on spending of expenditure budgets. The right to approve an expenditure budget rightly rests with DPRD. At present, however, implementing agencies are not allowed to make any changes to expenditure budgets without prior approval by DPRD. This does not only prevent a regional government from spending its budget in full (thereby increasing regional government surpluses), but is also likely to lead to inefficient spending behavior. (For example, a unit is encourages to use up its full travel budget in full, even though it does not need the entire budget, for fear that it would otherwise face a budget cut in the next financial year.) For these reasons, restrictions on the use of expenditure budgets should therefore only apply to total budgeted amounts for an organizational unit (such as Dinas Pendidikan or DIPENDA) and to the wages and salaries of a unit. Within these constraints, the Head of a unit would be allowed to spend as he or she sees fit. The implementation of this recommendation would require a change to PP58/2005 on Regional Government Financial Management. #4 – Improve the quality of investment and financing. If the Government would attempt to boost total spending by regional governments in order to reduce cash surpluses, it runs the risk that regions would primarily invest in ‘easy’ projects that absorb large amounts of funds (such as land or costly government buildings), and not in ‘difficult’ projects (such as small-scale sanitation systems or health campaigns), that do result in an immediate reduction in cash surpluses, but may result in long-term benefits to national welfare. It is therefore recommended that the Government should seek to improve the quality of the use of belanja modal and pengeluaran budgets. Means to achieve this objective: Disseminate best practices of regional government utilization of investment and financing (see Annex 1 for examples). Make information on regional government surpluses available in the public domain. Citizens should be able to compare fund utilization in their regional government with practices in neighboring regions, as part of an objective basis to judge the quality of the management of that region. Commence a dialogue with BPDs. At present, most regional government bank accounts are held by BPDs, who normally invest these deposits in treasury notes (SBI or Sertifikat Bank Indonesia) or other low-risk securities. It is recommended that the Ministry of Finance, together with Bank Indonesia, start a dialogue to encourage BPDs to invest part of these deposits in projects that contribute to regional development – which is the original objective of the banks.

Chapter 8

Conclusions and Recommendations

Increases inSurpluses of Regional Governments Final Report (June 2008)

Chapter 8

Conclusions and Recommendations

Results of Field Visits

Overview. The initial findings of this study were verified (and, where required, updated) on the basis of a series of field visits. This Annex describes the methodology that was used to collect information from regional government representatives, and presents the results of the field visits.

Methodology Definition of expected outcomes. The field visits were planned to: Obtain a better understanding of financial planning and cash management practices at the sub-national government level. The outcomes of the three initial visits were used to prepare a structured questionnaire to collect information on these issues in a systematic fashion. Detailed information on financial planning and cash management practices in a sample of ten sub-national governments. This outcome will be used to verify causes of increases in BPD deposits (and possibly discover causes not covered identified by the Desk Study). Interview methodology. The Consultant, together with representatives of the Ministry of Finance, first conducted open-ended interviews with the head of finance of each sub-national government in three sub-national governments (refer to Table A1.1 for interview pointers). The team then visited ten sub-national governments and to conduct structured interviews with the head of finance of these government, using a standard questionnaire that was prepared on the basis of the three open-ended interviews (Table A1.2). Table A1.1 INTERVIEW POINTERS • Obstacles faced in transition from simple cash to modified cash system • Timing of cash receipts (PAD, DBHP, DBHBP, DAU, DAK, and others) • Critical moment in cash flow planning • Solutions to address (or avoid) cope with temporary cash deficits • Realization of expenditures per quarter • Expenditure procedures • Developments in cash surpluses • Factors that affect cash surpluses • Deficit budgeting mechanism • Sources of financing other than surpluses (loans, contingency funds, etc.) • Utilization of surplus • Contingency funds • Placing of cash (bank deposit, SBI, direct investment, etc.) • Role of BPD • Financing and investment (loans, priority investments, local economic development, etc.) Source: Consultant

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Increases inSurpluses of Regional Governments Final Report (June 2008)

Table A1.2 STANDARD QUESTIONNAIRE (PAGE 1 OF 3)

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Table A1.2 STANDARD QUESTIONNAIRE (PAGE 2 OF 3)

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Increases inSurpluses of Regional Governments Final Report (June 2008)

Table A1.2 STANDARD QUESTIONNAIRE (PAGE 3 OF 3)

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Results of Field Visits

Increases in Surpluses of Regional Governments Final Report (June 2008)

Selection of sub-national governments. From 19 January 2008 to 18 February 2008, the Consultant and MoF officials visited three provincial governments and ten kabupaten and kota (Table A1.5). The three provinces were selected for the following reasons: DKI Jakarta is the only province that has reduced its surpluses since 2005 Bali has one of the lowest levels of per capita surpluses, even though its per capita revenues are relatively high, and East Kalimantan has higher per capita surpluses than any other region. Five of ten kabupaten and kota were selected from Shortlist 1 (high average cash balances in 2006), and five from Shortlist 2 (low average cash balances in 2006) to ensure that the field visits would obtain a balanced view of the potential causes of increases in regional government surpluses (Table A1.3, Table A1.4). For logistical reasons, kabupaten and kota in the provinces of Aceh, Maluku, Maluku Utara, Papua and Irian Jaya Barat were not visited. Table A1.3 SHORTLIST 1: DISTRICTS WITH HIGH CASH BALANCES IN 2006 Rankings in brackets (highest cash balance = 1)

Kabupaten / Kota

Province

Kota Tarakan (2)

Kalimantan Timur

Kab. Rokan Hilir (3)

Riau

Kab. Natuna (4)

Kepulauan Riau

Kab. Berau (5)

Kalimantan Timur

Kab. Kampar (6)

Riau

Kab. Bulungan (8)

Kalimantan Timur

Kab. Penajam Paser Utara (9)

Kalimantan Timur

Kab. Pelalawan (10)

Riau

Kab. Lingga (11)

Kepulauan Riau

Kab. Luwu Timur (12)

Sulawesi Barat

Kab. Belitung (13)

Bangka-Belitung

Kota Prabamulih (14)

Sumatera Selatan

Kab. Bangka Tengah (15)

Bangka-Belitung

Kab. Bangka Selatan (16)

Bangka-Belitung

Kab. Malinau (17)

Kalimantan Timur

Kab. Bangka Barat (18)

Bangka-Belitung

Kab. Belitung Timur (19)

Bangka-Belitung

Kab. Tanah Laur (20)

Kalimantan Selatan

Kab. Balangan (21)

Kalimantan Selatan

Kota Tegal (22)

Jawa Tengah

Source: Consultant, based on a sample of 220 kabupaten and kota (excluding districts located in Aceh, Irian Jaya Barat, Papua, Maluku or Maluku Utara) Notes: Cash balances were defined as: [Cash balance on 31 Dec 2006] / [Months of operating expenditure]. Highlighted kabupaten/kota were visited by the Consultant.

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Increases inSurpluses of Regional Governments Final Report (June 2008)

Table A1.4 SHORTLIST 2: DISTRICTS WITH LOW CASH BALANCES IN 2006 Rankings in brackets (lowest cash balance = 1)

Kabupaten / Kota

Province

Kab. Lombok Timur (3)

Nusa Tenggara Barat

Kota Manado (4)

Sulawesi Utara

Kab. Polewali Mandar (5)

Sulawesi Barat

Kab. Garut (7)

Jawa Barat

Kota Pontianak (8)

Kalimantan Barat

Kab. Melawi (9)

Kalimantan Barat

Kab. Bolaang Mengondow (10)

Sulawesi Utara

Kota Palopo (11)

Sulawesi Selatan

Kab. Lampung Tengah (12)

Lampung

Kab. Bone Bolango (14)

Gorontalo

Kota Palu (15)

Sulawesi Tengah

Kab. Tabanan (16)

Bali

Kab. Mamuju (17)

Sulawesi Barat

Kab. Bima (18)

Nusa Tenggara Barat

Kab. OKU Timur (19)

Sumatera Selatan

Kab. Kuningan(20)

Jawa Barat

Kab. Minahasa Utara (21)

Sulawesi Utara

Kab. Kudus (22)

Jawa Tengah

Kab. Minahasa (23)

Sulawesi Utara

Kab. Sumedang (24)

Jawa Barat

Results Summary of findings. The findings of the field visits were classified as: Revenue management practices Expenditure management practices Management of surpluses and deficits For details, refer to Tables A1.6 to A1.7 at the end of this Annex.

Annex 1

Results of Field Visits

Increases in Surpluses of Regional Governments Final Report (June 2008)

Table A1.5 FIELD TRIPS AND PARTICIPANTS Regional Government

Participants

Prov. DKI Jakarta (19 Jan 2008)

• André Oosterman, Consultant • Bambang Tata S., Consultant • Erny Murniasih, Ministry of Finance • Syouki Yahya, Head of Finance Dept. • Representative of Finance Dept. • Representative of Regional Planning Board • Representative of Accounting Dept.

Kab. Sumedang (24 Jan 2008)

• Bambang Tata S., Consultant • M. Rifa, Ministry of Finance • Drs. Suhara Msi, Head of BPUD • Suryana, B.Sc, Head of Budgeting Dept. • Mulyasmi Rejeki, Head of Treasury Dept.

Kota Tegal (25 Jan 2008)

• Bambang Tata S., Consultant • M. Rifa, Ministry of Finance • Iman Sudaryanto, Head of BPUD • Kadarwiningsih, Head of Treasury Section • Ratih Nuraini Dewi, Head of Accounting Section • Djoko Baharuddin, Head of Budgeting Section

Prov. Bali (28 Jan 2008)

• André Oosterman, Consultant • Bambang Tata S., Consultant • M. Mu’am, Ministry of Finance • Cahyanta, Assistant to Governor on Development • Made Rasma, Head of Regional Revenue • Narya, Finance Bureau • Nyoman Supraginata, Head of Treasury Section • Ngurah, Bank Pembangunan Daerah Bali • Ari Djaya, Head of Provincial Planning Board

Kab. Tabanan (29 Jan 2008)

• André Oosterman, Consultant • Bambang Tata S., Consultant • M. Mu’am, Ministry of Finance • Drs. Suhara, Msi, Head of BPUD • Suryana, B.Sc, Head of Budgeting Dept. • Mulyasmi Rejeki, Head of Treasury Dept.

Kab. Penajem Paser Utara (30 Jan 2008)

• Bambang Tata S., Consultant • M. Rifa, Ministry of Finance • Sutiman, Secretary of the Region (SekWilDa) • Suharjono, Head of Revenue Dept. • Hairan Yusni, Head of Finance Dept. • Saidin, Head of Treasury Section, • Yulia Misdawati, Head of Accounting Section • Sapuana, Head of Planning and Budgeting Section

Prov. Kalimantan Timur • André Oosterman, Consultant (1 Feb 2008) • Bambang Tata S., Consultant • Fathul Halimi, Head of Accounting Section • Syaiful Basri, Head of Budgeting Section • Lasapada, Head of Treasury Section Source: Consultant

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Increases inSurpluses of Regional Governments Final Report (June 2008)

Table A1.5 FIELD TRIPS AND PARTICIPANTS (CONTINUED) Regional Government

Participants

Kab. Belitung Timur (5 Feb 2008)

• Bambang Tata S., Consultant • M. Nafi, Ministry of Finance • Henri, SE, Head of Accounting Section • Zuhri, Head of Treasury Section • Ferizal, Head of Budgeting Section • Ekawati Wibowo, Head of Revenue Dept. • Ibrahim Saman, Secretary of Finance Dept. • Sukardi, staff of Regional Planning Board • Harzana, Head of General Affairs Section

Kab. Bima (12 Feb 2008)

• Bambang Tata S., Consultant • M. Rifa, Ministry of Finance • Wafdin, Head of Finance Dept. • Fahrul Rachman, Head of Budgeting Section • Iwan Setiawan, Head of Accounting Section

Kab. Kampar (13 Feb 2008)

• Bambang Tata S., Consultant • M. Rifa, Ministry of Finance • Bustami Hy, Head of Regional Finance Dept. • Edward Anwar, Head of Budgeting Section

Kota Prabamulih (14 Feb 2008)

• Bambang Tata S., Consultant • M. Mu’am, Ministry of Finance • S. Sobri, Head of Finance Dept. • Bustomi, Head of Treasury Section • Muslimin, Head of Budgeting Section • Umi Kalsum, Head of Accounting Section

Kota Pontianak (15 Feb 2008)

• Bambang Tata S., Consultant • M. Nafi, Ministry of Finance • Harun Rasyid, Head of Budgeting Section • Rapsidi, Head of Treasury Section

Kota Manado (18 Feb 2008)

• Bambang Tata S., Consultant • Erny Murniasih, Ministry of Finance • Weni Wowor, Head of Bureau of Finance • Ivan Saleh, Head of Budgeting Section • Non Kaligis, Head of Sec. Accounting

Source: Consultant

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Annex 1

Results of Field Visits

Increases inSurpluses of Regional Governments Final Report (June 2008)

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Results of Field Visits

Increases in Surpluses of Regional Governments Final Report (June 2008)

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Results of Field Visits

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Annex 1

Results of Field Visits

Elements of a Performance-Based Contract for the Head of a DIPENDA

Overview. A contract between a regional government and a Head of 15 DIPENDA should contain the following elements : An objective basis for setting quantitative targets against which the performance of the Head will be evaluated Provisions to ensure that the Head has a clear incentive to achieve these objectives within the shortest possible time Provisions to ensure that the Head will only be rewarded for achieving targets that are under his control Provisions to ensure that the Head has the managerial flexibility to do so Monitoring provisions Element 1: objective basis for setting quantitative targets. A regional government will want its DIPENDA to operate in an effective and efficient manner. To understand the current performance of the agency, and the opportunities for further performance improvements, it needs information. This information should not be provided by DIPENDA (which has an incentive to exaggerate its present performance and downplay opportunities for further revenue growth), but by an independent auditor. The findings of the auditor will form the basis of contract negotiations. Element 2: incentives. It is suggested that the Head of DIPENDA will be paid a flat fee for achieving the pre-agreed annual net revenue target (the fee) and a fixed percentage on the amount collected in excess (the bonus). This provides a clear incentive to achieve revenue growth in the shortest possible time rather, instead of manipulating collections to achieve annual revenue increases in the order of 10% per year (as is presently the case). Using net revenue (i.e. revenues from taxes and charges net of DIPENDA running costs) provides an incentive to reduce costs and encourages investment in cost-saving technologies. The Head would not be allowed to pay himself incentives and a contractual limit would be placed on his perks (car, house, medical insurance, etc.). If not, his incentive to achieve the agreed targets would be diluted. His bonus would be paid in two installments, at mid-term review and upon satisfactory completion of the contract. Element 3: controllable performance increases. The DPRD should only hold the Head of DIPENDA accountable for (net) revenue increases that are under his or her control. Increases in revenues from the street lighting tax, for example, should be excluded from the contract. This also applies to increases due to tariff hikes. The upshot of this arrangement is that DIPENDA managers will focus on operational improvements, and not on tariff increases (which do not affect their fees or bonuses).

15 This Annex draws heavily on Improving Local Tax and Service Charge Administration (World Bank, August 2005).

Annex 2

Performance-Based Contract for the Head of a DIPENDA

Increases inSurpluses of Regional Governments Final Report (June 2008)

Element 4: managerial flexibility. As mentioned earlier, the Head of DIPENDA has better knowledge about tax collection the organization than the local parliaments. To benefit from this expertise, the parliament should give the Head the managerial freedom to manage his DIPENDA to the best of his knowledge. Although local parliaments will be reluctant to give up their powers, they may set contractual limits within which the Head may operate without interference from the local parliament or the Kepala Daerah. Examples of areas where DPRD could set such limits are: financial budgets (which will be carefully considered by the Head in any case, because his bonus is based on net revenue increase); administrative sanctions (e.g. DPRD may allow the Head to impose a flat fine or to increase the monthly interest rate to a maximum of 5 percent); personnel policy (e.g. the Head may hire at will, but not fire more than 20 percent of the labor force within the first three years). It is crucial that contract guarantees managerial freedom (however defined) until mid-term review. If not, the contract will lose its credibility, and the Head of DIPENDA will no longer believe that he has the means to achieve the agreed targets. Element 5: monitoring procedures. The contract, as agreed between the Head of DIPENDA and the regional government, will form the basis for monitoring his performance. Every year, a committee will compare preagreed targets to actual net revenues (corrected for uncontrollable factors). Net revenues will be derived from audited DIPENDA reports. During the contract period, the local parliament may only fire the Head if he has not achieved the pre-agreed targets, or in circumstances which are explicitly listed in the contract (severe disease, imprisonment, insanity, etc.).

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Results of Field Visits

Glossary

APBD APBN BI BPHTB BPK BPS BUMD BUMN DAK DAU DBH DJ (DitJen) DP DPR DPRD DSF GRDP GOI IDR Kab. KMK LKPP MoF MoHA PAD PBB PLN PMK PP SIKD UU

Glossary

Anggaran Pendapatan dan Belanja Daerah (regional government revenue and expenditure budget) Anggaran Pendapatan dan Belanja Negara (national government revenue and expenditure budget) Bank Indonesia Bea Perolehan Hak atas Tanah dan Bangunan (Land and Building Title Transfer Fee) Badan Pemeriksa Keuangan (National Auditing Agency) Badan Pusat Statistik (Central Bureau of Statistics) Badan Usaha Milik Daerah (regional government enterprise) Badan Usaha Milik Negara (state-owned enterprise) Dana Alokasi Khusus (Special Allocation Fund) Dana Alokasi Umum (General Allocation Fund) Dana Bagi Hasil (revenue sharing) Direktorat Jenderal (directorate-general) Dana Penyesuaian (adjustment funds) Dewan Perwakilan Rakyat (national government legislative assembly) Dewan Perwakilan Rakyat Daerah (regional government legislative assembly) Decentralization Support Facility gross regional domestic product Government of Indonesia Indonesian Rupiah Kabupaten (district government) Keputusan Menteri Keuangan (decision of the Minister of Finance) Laporan Keuangan Pemerintah Pusat (central government financial report) Ministry of Finance Ministry of Home Affairs Pendapatan Asli Daerah (regional government own-source revenue) Pajak Bumi dan Bangunan (land and buildings tax) Perusahaan Listrik Nasional (national electricity company) Peraturan Menteri Keuangan (decree of the Minister of Finance) Peraturan Pemerintah (government regulation) Sistem Informasi Keuangan Daerah (regional financial information system) Undang-undang (law)

Increases inSurpluses of Regional Governments Final Report (June 2008)

Annex 1

Results of Field Visits

Increases in Regional Government Surpluses: An Empirical Analysis Summary of Findings

May 2008 | Decentralization Support Facility

Agenda 1. Background of the Study 2. Why did Bank Deposits increase? 3. Analysis of Revenue Underestimation 4. Analysis of Underspending 5. Analysis of Underfinancing 6. Conclusions and Policy Recommendations

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1. Background What does the study cover?

Study period: 2004-2006 Context: macro-economic (impacts on the nation) Geographical scope: 27 provinces and 220 kabupaten/kota for which data were available Data sources: SIKD, BPK, BPS, interviews with three provinces and 10 kabupaten/kota

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1. Background What is a Regional Government Surplus?

Revenue (pendapatan)

Expenditure (belanja)

Operational surplus (surplus)

A-B

Income (penerimaan)

Costs (pengeluaran)

Cash surplus (SiLPA)

A-B+C-D

¨Cash surplus § ¨Bank deposit May 2008 | Decentralization Support Facility

1. Background EOY Regional Government Bank Deposits (Rp trn) 80

STUDY PERIOD

+47 trn

0 2000

2001

2002

2003

Provinces

2004

2005

2006

Districts

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2. Why did RG Bank Deposits Increase? Standard Explanations

1. Regional governments savings increased 2. Regional government expenditure increased, therefore bank deposits must also increase

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2. Why did RG Bank Deposits Increase? No evidence for increase in deliberate savings Provinces

Kab/Kota

10 trn

2004

2005

2006

2004

2005

2006

Increase in bank deposits (Rp trn) Net additions to dana cadangan (Rp trn) May 2008 | Decentralization Support Facility

2. Why did RG Bank Deposits Increase? Provincial cash balances: high, but decreasing Months of Expenditure/Average Cash Balance 12

standard

PROVINCES 10 8 6 4 2 0 <1

1–2

2–3

3–4

2005

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2006

4–5

5–6

2. Why did RG Bank Deposits Increase? Kab/Kota cash balances: high, and increasing Months of Expenditure/Average Cash Balance 100

standard

KAB./KOTA 80 60 40 20 0 <1

1–2

2–3

2005

3–4

4–5

5–6

2006

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2. Why did RG Bank Deposits Increase? Standard Explanations Don’t Work

1. Regional governments savings increased Regions don’t try to save (low additions to dana cadangan) 2. Regional government expenditure increased, therefore bank deposits must also increase Cash balances already much higher than needed, and increasing for kab/kota

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2. Why did RG Bank Deposits Increase? An Alternative Explanation

Regional governments don’t want to save …but are unable to spend their revenue …and, as a result, end up saving.

Thus, regional governments save by accident, not by design

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2. Why did RG Bank Deposits Increase? Actual vs. Budgeted District Revenue, 2006 120 < Under budget

Over budget >

100 80 60 40 20 0 <75%

80-85%

90-95%

100-105%

110-115%

Number of District Governments

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120-125%

2. Why did RG Bank Deposits Increase? Actual vs. Budgeted District Expenditure, 2006 120 < Under budget

Over budget >

100 80 60 40 20 0 <75%

80-85%

90-95%

100-105%

110-115%

120-125%

Number of District Governments

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2. Why did RG Bank Deposits Increase? Actual vs. Budgeted District Surplus, 2006 120 < Operational Deficit

Operational Surplus >

100 80 60 40 20 0 <-25%

-10-15%%

-5-10%

Actual

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0-5%

Budgeted

+10-15%

+20-25%

2. Why did RG Bank Deposits Increase? Cumulative EOY Surpluses, 2003-2006 60

0 2003

2004

2005

2006

-20

-40 Budget

Actual

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2. Why did RG Bank Deposits Increase? Three Types of Causes

Higher than Expected Revenue: Underestimation Lower than Expected Expenditure: Underspending Limited use of Operational Surplus: Underfinancing

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3. Underestimation of Revenue Actual vs. Budgeted Revenue, 2004-06 Provinces

Kab/Kota

5 trn

2004

2005

2006

2004

2005

2006

Higher than expected PAD (Rp trn) Higher than expected DBH(Rp trn) Higher than expected other revenue (Rp trn) May 2008 | Decentralization Support Facility

3. Underestimation of Revenue Potential Causes 1. Higher than expected PAD: - no incentive to BUMNs/DIPENDA to provide accurate estimates 2. Higher than expected DBH: - increase in world market prices (low estimates) - late transfers (triwulan IV), no time to spend

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4. Underspending Expenditure Budget Realization Ratios, 2006

Financial support

95%

Wages and salaries

93%

Duty Travel

90%

Maintenance

90% 87%

Goods and services

80%

Investment

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4. Underspending Actual vs. Budgeted Expenditure, 2004-06 Provinces

Kab/Kota

10 trn

2004

2005

2006

2004

2005

2006

Lower than expected operational expenditure (Rp trn) Lower than expected investment expenditure (Rp trn)

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4. Underspending Potential Causes according to the Regions 1. Keppres 80/2003 difficult to implement - BUT: surpluses increase faster in 2005 and 2006 than in 2004 (first year of Keppres 80) 2. DPRD does not approve budget on time - BUT: budget preparation faster in 2005 and 2006 than in 2004

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4. Underspending Potential Causes according to the Consultant 1. Governmentâ&#x20AC;&#x2122;s anti-corruption drive - Regional governments have difficulties finding members of tender committees 2. No flexibility in use of expenditure budget - Every minor change requires APBD-P (time-consuming, once a year only) 3. Lack of vision - Lack of ideas, no implementation of MT plans May 2008 | Decentralization Support Facility

5. Underfinancing Actual Use of Operational Surplus, 2004-06 Provinces

Kab/Kota

1 trn ? 2004

2005

2006

2004

2005

2006

Loan repayment (Rp trn) Equity investment â&#x20AC;&#x201C; mostly BPD (Rp trn) Other financial outflows, net (Rp trn) May 2008 | Decentralization Support Facility

5. Underfinancing Potential Causes according to the Consultant 1. Governmentâ&#x20AC;&#x2122;s anti-corruption drive 2. Lack of vision

Same as for underspending

3. Reluctance to share budgets with BUMDs - Penyertaan modal means loss of control 4. Administrative difficulties in loan repayment - Prepayment of loans to DPPP not allowed - Arrears repayment not enforced

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5. Conclusions and Recommendations Actual vs. Budgeted Operational Surplus, 2004-06 Rp. trillion

Higher than expected PAD

8.1

Higher than expected DBH

17.8

Higher than expected other revenue

2.9

Lower than expected operating exp.

34.9

Lower than expected investment

15.0

Total

78.6

100

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5. Recommendations Key: Remove Barriers to Underspending

1. Sign performance-based contracts with head of DIPENDA/BUMN to provide incentives for giving accurate revenue estimates (PAD) 2. Support resource-rich regions with establishing trust funds for future generations (DBH)

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5. Recommendations Key: Remove Barriers to Underspending

3. Relax restrictions on using expenditure budgets -> revision to PP58/2005 (expenditure) 4. Promote investment and financing through -> dissemination of best practices -> dialogue with BPDs (development bank!) -> fiscal means to reward compliance of regions with minimum service standards

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Thank you!

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