www.dsfindonesia.org
Policy Briefs The Impact of Decentralization on SubNational Government Fiscal Slack in Indonesia1 No. 8 - 2008
Policymakers in Indonesia have become increasingly concerned at the rapid and significant build-up of unspent balances at the sub-national level since decentralization. Nominal sub-national reserves grew at an annual rate of 37 percent between end 2000 and end 2007. As of 2007, reserves amounted to just less than Rp 70 trillion, an order of magnitude larger than in 2000. During the period in question, district reserves grew even more swiftly, almost 50 percent per year. District slack resources now comprise about 60 percent of the total, up from 30 percent just before decentralization.
Do Sub-National Governments Save Too Much? The extent to which sub-national reserves are, in fact, excessive is unclear, however. The optimal amount of reserves that Indonesian sub-nationals should maintain is a function of potential revenue volatility. That is, sub-nationals need to have sufficient funds on reserve that they
can use to keep expenditures at constant levels, in the event of a down-turn in public revenues. In Indonesia, sub-national revenues from all sources have consistently grown since decentralization and, as such, it is difficult to estimate the potential near-term revenue declines. One apparent down-side risk to sub-national revenues concerns the price of oil. Three of the most important sources of sub-national revenue — oil sector property tax, revenue sharing from oil, and block grants — are a function of the oil price. While recently the price of oil has increased significantly and has remained at historically high levels, it is not impossible that the price might at some point decline. The analysis in this paper has shown that sub-national governments have more than sufficient funds to adjust to 10 percent decline in the price of oil, as long as such a decrease is of short duration. But if the oil price were to decline by 10 percent and remain at such levels for a sustained period of time, say five years, sub-national reserves could be depleted to a considerable degree. Even small and temporary
Policy Briefs
reductions in the oil price may result in revenue losses that exceed existing reserves of subnationals. This study finds that the accumulation of reserves by sub-national governments has been largely inadvertent. Very few provinces and districts have set up formal reserve accounts of the kind that the central government intends for the management of slack funds. In fact, sub-national governments appear, in the recent past at least, to have planned for reasonably sized deficits, as opposed to the substantial surpluses that have actually obtained. The analysis here has shown that the underestimation of shared natural resource revenues, to a certain extent, and the overestimation of current and capital spending, more importantly, have both led to unplanned sub-national savings. Underlying causes of shared revenue underestimation relate to the inherent difficulties that the central government has in accurately estimating the oil price and the related size of transfers to regions and also to the delays that sub-nationals experience in getting access to their shared revenues. Overestimation of spending appears to be a function of restrictions on the execution of expenditure budgets, worries over corruption charges and related difficulties in setting up tender committees, and, perhaps most importantly, lack of sub-national capacity to design and implement capital projects.
Policy Recommendations The question that confronts Indonesian policymakers is: what should be done about the build-up of sub-national reserves? This paper argues that the central government need not take any major action at the moment to directly limit or reduce sub-national reserves. As noted above,
2
the extent to which reserves are, in fact, excessive is not clear. Moreover, there is some evidence that sub-national governments are starting to learn how to spend their resources more fully. In 2007, provinces and districts both ran small deficits, for example. If sub-nationals should continue to accumulate reserves, because of further and sustained increases to the price of oil, for instance, then policymakers might consider developing a formal centrally-managed stabilization fund. In that case the central government could opt to compel sub-nationals to contribute resources to the fund. The purpose of the fund would be to smooth out sub-national expenditures in the event of an unexpected and severe economic down-turn or as needed at such a time when the country’s oil reserves become depleted. In the meantime, the central government should concern itself with better equalizing the distribution of current fiscal resources across sub-national governments and thus the stock of reserves across regions. In this regard, the center should finally and completely remove the so-called hold harmless condition attendant to DAU distributions, which assures all sub-national governments that they receive block allocations not smaller than they did the previous year. By law, the government was required to have eliminated the hold-harmless rule starting in 2008. It did not do so completely, however, but instead put in place a transitional arrangement that cushioned the expected revenue losses of regions. Of course, there is a limit to the equalization that can be achieved via the DAU, given the large size and extreme geographic concentration of natural resource revenue transfers, unless the government is prepared to revisit the allocation procedures of the latter. It seems unlikely that the central government will take on this politically sensitive issue in the near future.
The Impact of Decentralization on Sub-National Government Fiscal Slack in Indonesia
Policy Briefs
Central government should adopt more realistic forward estimates of the price of oil in forecasting revenue to be shared with sub-nationals. The central government has recently tended to underforecasted the price by a significant margin. The underestimation is partly purposeful, of course. Government obligations regarding DAU transfers to sub-nationals are a function of planned domestic revenues, not actual revenues. When the center underestimates the price of oil in the state budget at the beginning of the fiscal year, planned domestic revenues are lower than they would otherwise be, and thus the center’s fiscal obligations to the regions are reduced. The cost is that regions with significant natural resource shares underestimate their revenues, thereby resulting in a further build-up of their reserves. The government may have already considered this tradeoff and decided to continue with the deliberate underestimation of the oil price. But then central officials should not complain too vociferously about the resulting build-up of unspent balances. In addition, the center should make an effort to distribute natural resource revenues in a timelier manner. There is some cause for optimism on this count as the Ministry of Finance has recently issued a regulation (Minister of Finance Decree 7/08) that permits it to allocate natural resource revenue shares quarterly, on an estimated basis, even if the treasury has not yet received the actual revenues itself. The regulation is a positive step
1
forward. But many such regulations go unheeded in Indonesia. The proof will be seen in national budget implementation starting in 2009. The Ministry of Home Affairs is currently planning to revise national legislation that regulates subnational budgets. A useful reform here would be to reduce restrictions on the execution of sub-national expenditure budgets. Some leeway should be given to sub-national governments to spend in limited amounts greater than approved budget ceilings, or allow departments to shift budgets across spending categories, without having to obtain official approval from their parliaments. Finally, it would be helpful for the central government to provide more guidance to subnationals on the development of formal reserve accounts and assist in building capacity in the use of such funds. Moreover, the central government needs to redouble its efforts to build capacity at the sub-national level in the areas of capital project planning, design, and implementation. Both actions should help sub-nationals to spend more of the resources available to them. But just increasing sub-national spending will not be sufficient, of course. Sub-national governments need assistance in spending more efficiently, as well. There is considerable evidence to suggest that inefficient sub-national spending in Indonesia is at least as problematic as the lack of spending.
Lewis, B. D. and Oosterman, A. The Impact of Decentralization on Sub-National Government Fiscal Slack in Indonesia. DSF, September 2008. The full report can be downloaded from www.dsfindonesia.org. The views expressed in this paper are solely those of its author(s).
The Impact of Decentralization on Sub-National Government Fiscal Slack in Indonesia
3
www
rg
Decentralization Support Facility Indonesia Stock Exchange Building Tower I 17th Suite 1701 | Jl. Jend. Sudirman Kav. 52-53 | Jakarta 12190 Tel: +62 21 5299-3199 | Fax: +62 21 5299-3299 | Email: info@dsďŹ ndonesia.org