THREE YEARS OF FISCAL DECENTRALIZATION IN INDONESIA : ITS IMPACTS ON REGIONAL ECONOMIC DEVELOPMENT AND

FISCAL SUSTAINABILITY

Bambang Brodjonegoro (Department of Economics, University of Indonesia) INTRODUCTION Toward the second general election in the “reformasi”(reformation) era in 2004, the issue of decentralization and regional autonomy has not been widely considered as critical issue in nation building, and hence as one of major platform of political parties. There could be many reasons for this circumstance. First, the process might have been considered as quite successful. At least, there was no real chaos occurring as a result of the decentralization process. Second, regardless of the effects of the process itself, Indonesians have adjusted well to the new condition and therefore, everything related to decentralization becomes routine activities. Third, the political parties could be more attracted to other issues such as corruption, law enforcement, economic recovery process, than the decentralization issues that might not be visible to many Indonesians. Fourth and the most dangerous one, there might be a tendency at central government and political elites to either slow down the decentralization process, or more extreme, go back to centralization system in the past. There might be many reasons to explain the lower tone of decentralization process but the fact is that only few parties are interested to raise the decentralization issues as one of their campaign theme. After three years of the decentralization process itself, it is still difficult to judge if the process is a successful one or not. The international community deemed the process as “still on the right track” citing that the Indonesians was able to manage the massive and drastic decentralization, and minimize the negative effects. The central government feels that they have managed the drastic change quite well but at the same time admits that they are still worried about the future and many have to be done in order to direct the decentralization on the right path including the revision of law 22/1999 and 25/1999. The local governments, however, are less satisfied than the central one. They are still suspicious that the central government is not fully supporting the process, and when the process is considered as a failure in the future, there will be a recentralization process. On the other hand, they admit that they have experienced a “freedom” that did not exist during the centralized era, and gradually, the learning process of managing and administering the local governments is working. The ordinary Indonesians, especially the local residents, might be the only one who keeps questioning the effects of the decentralization process. Some claimed that they do not feel any impact of the process, while some others felt only the negative impacts. They still believe that the current process is more on the decentralization from central to local governments than the decentralization from government to the local people or community. Among all types of impacts generated by the decentralization process, the economic (and fiscal) impacts are still considered the most crucial one since Indonesia is still on the recovery process after the 1998 financial and economic crisis. Together with political

1

reformation, most Indonesians had expectation that the decentralization process will contribute to the economic reformation especially reducing disparity between Jawa and outside Jawa or between the western and eastern part. Giving more economic policy decision making power to the local government is also considered as the expected output of successful decentralization process. Therefore, this paper is intended to evaluate the three years Indonesian decentralization process with the emphasis on the economic and fiscal impacts but the discussion will begin with the evaluation from political and administrative point of view since they will affect the economic side eventually. Special concern about fiscal sustainability that might relate to decentralization will be on the last part of this paper, and this might have further implication to future Indonesia economic development pattern. DEVOLUTION OF POWER AND POLITICAL APPROACH After three years of decentralization, it is not too surprising if there were problems due to multi-interpretation or lack of clarity of law 22/1999. In 1999, the law was drafted without a blue print or general design of decentralization scheme and without a white paper. Sequentially, the decentralization process should begin with the blue print followed by a white paper. The white paper should be then the foundation for the legal drafting. Due to political condition and limited time availability, the decentralization process in Indonesia jumped directly to the law drafting and as a result, when there is confusion about the law itself, no valid reference is available. Various groups, with their own argument, are competing to be the “true” interpreter of the law, especially law 22/1999. If one group is in verge of having enough power over the implementation and revision of the law, other groups will try very hard to undermine them through frequent and sometimes unfair critiques. Ironically, this possible conflict or rivalry sometimes takes place between groups in the ministry of home affairs (MOHA) that is clearly responsible for drafting and implementing the decentralization laws, especially from political and administrative point of view. Among many confusing and debatable issues in the law 22/1999, there might be three most crucial issues : devolution of government authorities, formation and amalgamation of new local governments, and the local executive-legislative relationship. At the first issue, the devolution of government authorities, the central government may claim that they have managed the devolution process quite well and after three years, the central government influence in the local government activities has significantly declined. However, the local government might not share the same opinion. They claimed that the devolution of authorities was far from clear, and eventhough it was clear, the line ministries at central government were obviously still interested in the authorities. Lack of clarity in the devolution process might come from two different extremes in the law. At one part, the law states that the central government will only be responsible for five functions plus planning and standardization. At the other part, the law also states that each local government has to be responsible for eleven obligatory sectors. The problem lies on the “gap” between the central government obligatory functions and the local government ones, and the inconsistency between functions for the central government and sectors for local governments. The government regulation (PP) 25/2000 was supposed to close the “gap” by giving more detailed direction to local government, but

2

instead the PP used the residual approach that listed only the detailed functions of central and provincial government, and left the rest to local government. As a result, the local government can define their functions at their will. It could be a broad range of function but at the same time, it could be a small range. There are two predicted outcomes generated from this condition, the conflicts of interests between central and local governments, and lower quality of basic public services delivery for the local residents. The second issue, the formation and amalgamation of new local governments is mostly treated exclusively as the political concerns. Whenever there is formation of new local government, the political flavor and interests are much more dominant than other consideration. It is no secret that the local elites are jockeying for the local executive position through the proposal of new local government formation. The law 22/1999 interpretation seems to fully support the formation without real and binding consequences. The government regulation (PP) that is supposed to back up the clauses about the formation already described the process in detail with the criteria. However, lack of political willingness at the central government side to manage and control the formation of new local governments caused the high influx of new districts and municipalities at more than 10% annual growth rate. Currently, with more than 410 districts and municipalities, it is not clear if the number will keep growing at the same rate after 2004 and how this number will contribute to economic efficiency. Many argue that the formation of new local governments in Indonesia has nothing to do with the economic efficiency and more on entertaining the local political interests. With the slow economic recovery process and acute corruption, it is quite ironic that Indonesians still give the opportunity for wasting the economic resources and for creating more corruption through the formation. There are two obvious wasted economic resources as results of new local government formation namely the relatively huge initial investment to set up the local administration system, and the higher dependency of local governments to the intergovernmental transfer, especially the general purpose grant (DAU). Brodjonegoro and Mahi (2003) noted that many new local governments had relatively insignificant local own revenue (PAD) and relied heavily on DAU. The third issue, the local executive – legislative relationship, becomes one of major obstacles in promoting good governance and effective local administration. The law 22/1999 somehow implied that the local parliament (DPRD) is the most powerful body at the local level. They basically have the authority to hire, evaluate, and fire the head of local executives. Their authority in determining the local budget also seems to be very powerful. Therefore, the local executive and legislative relationship is not a productive and conducive one from local resident point of view. They could either make collaboration between them or fight continuously. Each one of them will not be beneficial for the local resident and the latter even creates two bupatis (head of district) in Karanganyar District, central Jawa. The collusion between local executive and legislative tends to promote the corrupt behavior, and the local legislative tends to be the major player. There is relieving trend nowadays when many DPRD members become the suspect in the local corruption cases, and some of them have even stayed in the prison.

3

Any type of disruption in the local government politics and administrative system eventually leads to the disruption of basic public service delivery. Many Indonesians, nowadays, are quite skeptic about the decentralization process simply because they have not seen what they expected when the decentralization took place in 2001, a better local basic public service delivery. The World Bank report in 2003 might indicate that most Indonesians felt that the quality of public services during the decentralization era was better than the previous one, or at least the same. However, the coverage of the survey and sampling procedure might not reflect the reality and at the same time, national newspapers keep publishing how infrastructures are deteriorating all over Indonesia, and how the local governments pay little attention to the quality improvement of public service delivery. To ensure that every Indonesian will enjoy the minimum basic standard of public services, the central government through the ministry of home affairs (MOHA) coordination is trying to promote the implementation of the minimum service standard (MSS). While the MSS idea might be good from conceptual point of view, the possibility of becoming real success is highly questionable for two reasons. First, due to its complexity, even in the developed decentralized country MSS cannot be fully implemented. Second, the budget constraint seems to be non-existent when the line ministries are designing the MSS for their respective sectors. Current development shows that the MSS design in Indonesia is rather slow due to different perception of the word “minimum” itself that is interpreted by some ministries as without budget constraint. Furthermore, without proper preparation, the MSS implementation could lead to disaster when the local government budget cannot fulfill the MSS and eventually they will ask for more transfer from central government. To overcome or at least minimize the problems during decentralization era, the central government is trying to amend the law 22/1999 and law 25/1999. The basic substance of the amendment is the introduction of direct election for both local executives and legislatives. The direct election might bring better accountability at local level and somehow, reduce the absolute power of DPRD. Better accountability could lead to more responsive local governments in fulfilling the local resident needs. In terms of formation and amalgamation of new local governments, the amendment is trying to impose the evaluation of autonomous regions that could lead to status withdrawal by central government if local governments cannot fulfill certain criteria after a certain period of time. It is still doubtful if this mechanism could work in the current period of uncertainty where the central government is still considered weak. The proposed amendment is also trying to give significant contribution to better devolution of authorities by listing more detailed functions that have to be carried out by local governments. Instead of just saying that local government is responsible in education sector, for example, the amendment proposes that the local government is responsible in executing the function of providing basic education or elementary school for the residents. Although many local governments still suspect that the amendment could lead to re-centralization but it has to be admitted that the central government is trying seriously to make the decentralization process a success story. The re-centralization impression among the local governments may appear due to redefinition of provincial government role in the decentralization process. In fact, it

4

could be attributed as another significant contribution of law 22 amendment process where the provincial government has the authority to do monitoring and evaluation process over the districts and municipalities in their area. Some argue that with the amendment, the provincial government and the governor will become powerful again in the near future and that may explain why the governor election is still intense and interesting. By giving more power to the provincial government, the central government is trying to break the intense relationship between provincial and local governments that sometimes leads to the ignorance of local governments on the existence of provincial government. However, the amendment process of both law 22/1999 and law 25/1999 revealed the old and continuous problem at the central level, lack of coordination among the ministries and especially, rivalry between MOHA and ministry of finance (MOF). Lack of leadership at central level contributes significantly to the coordination and rivalry problems. Although the central government is trying very hard to create impression that decentralization is a nation agenda that has to be obeyed by everybody at central government, the perception that law 22/1999 is just a sectoral law belongs to MOHA still there. As a result, the conflict with other sectoral law such as mining law, forestry law still exists and it is far from easy to make other laws adjusted to the content of law 22/1999 (World Bank, 2003). The rivalry between MOHA and MOF seems to be endless when it comes to the question of who should be the authority of decentralization process. Each one of them proposes the amendment of law 22 and law 25 respectively and the bigger problem is that each one of them is working on overlapped issues differently. One example is the issue on how the local governments spend their budget. Both laws are trying to reach the issue that did not exist in the original version of both laws. However, each one of them approached the issues from different perspective with their own standards. MOHA claimed that they should be the authority in this issue since they have dealt with local expenditure issues for a long time, and for them, MOF should concentrate on the revenue side of local budget (APBD). On the other hand, MOF claimed that they should have authority over the expenditure side of APBD since they are responsible for accounting and financial reporting standard. The rivalry becomes intense when it comes to the idea of having only one law or legal act for decentralization like local government act in Philippine (Asanuma et al, 2003). They prefer to maintain the status quo by having one law under their responsibility but if there has to be one law, MOHA prefers that it has to be under their responsibility. That preference could lead to MOHA domination in drafting the future of decentralization while the decentralization process should be multi facet and takes into account other ministries interests. So far, MOHA is gaining the power while MOF is weakening, and currently, there is a tendency that MOHA is trying to take over some power over the intergovernmental transfer and other local finance issues. FISCAL DECENTRALIZATION AND REGIONAL DEVELOPMENT In addition to the democratization process, the slow economic recovery process is another circumstance that accompanied the decentralization process since 2001. While focus of the national budget (APBN) should be to overcome the crisis and maintain economic stability, at the same time APBN has to dedicate some amount for new scheme of fiscal

5

decentralization as mandated by law 25/1999. Fortunately, there were no significant negative effects on the APBN created by that new scheme and most of local governments could understand that the relatively low amount of transfer is mostly due to heavy burden of APBN rather than the lack of central government commitment in fiscal decentralization. On the other hand, the intergovernmental transfer scheme itself is still far from optimal due to heavy political interference especially in DAU, natural resources revenue sharing (through the special autonomy of Aceh and Papua), and tax revenue sharing. The center piece of Indonesian fiscal decentralization is the general purpose grant (DAU) that gives the full autonomy to local governments in spending and managing the grant. Instead of ad-hoc basis, the DAU utilizes the formula to allocate the grant to all provincial and local governments in Indonesia. In most local governments, DAU is basically their budget since its role is very dominant as demonstrated in table 1 of appendix. This heavy dependence to DAU creates disincentive for local governments in raising or intensifying the collection local own revenue (PAD). While excessive local tax collection and illegal charges might harm the local investment climate, the local governments still have to intensify the collection of legal local taxes and charges revenue up to the optimal level through better local tax administration system and law enforcement. Brodjonegoro and Martinez (2002) revealed the significant negative correlation between the size of DAU and PAD. The allocation of DAU itself is still full of political influence as indicated by the hold-harmless provision that guarantees every local government to receive the grant not less than the previous allocation. This clearly hurts the fiscal capacity equalization purpose that should be the DAU responsibility. The equalization problem, for now, is resolved gradually by keeping the “rich” regions at the same level as in 2001 and at the same time, giving more to “poor” regions through the inflation effect of DAU or increasing domestic revenue at APBN. Table 2 indicated that the ratio between the lowest and highest DAU per capita increased from 15 in 2002 to 20 in 2003. This gradual attempt is still far from the ultimate purpose of fiscal capacity equalization since in 2002 the ratio between the highest and lowest total local revenue per capita was still 7, a considerably high ratio. Another problem of DAU allocation formula is the existence of lump-sum component (a certain similar amount to all local government) that eventually triggered the formation of new local governments since the small lump-sum amount is still considered a significant amount for the proponents of new local governments. MOF is planning to abolish this component and incorporate it into a component that ensures the hold-harmless provision. Another alternative way to pursue the equalization purpose of DAU is by setting independent commission of grant allocation. The existence of independent commission should be effective in minimizing the political influence and in promoting the full formula approach. However, the central government elites seem to have different opinion regarding the mechanism of grant allocation. In the proposed amendment of law 25/1999, MOF is trying to introduce the idea of independent grant commission that reports directly to the president. However, MOF has not given enough political power yet to the commission since the main responsibility of the commission is just to propose

6

the allocation formula to the minister of finance and national parliament (DPR) without the guarantee that each one of them will only consider the commission proposal in the discussion. There is a room for them to select proposals coming from another party. MOHA, on the other hand, is trying to keep the role of regional autonomy advisory council in the law 22/1999 amendment. Furthermore, MOHA proposed to have only one secretariat in DPOD that handles both regional autonomy and fiscal decentralization matters. It implies that MOHA will be the authority for intergovernmental transfer issues including DAU allocation formula. The national parliament has another idea in their version of law 22/1999 amendment that gives the authority to DPR budget committee in determining the DAU allocation formula. These conflicting ideas simply revealed that money and politics are inseparable in Indonesia. While DAU becomes the center of attention for most of local governments, another serious issue in the local finance, the local own revenue, seems to be neglected. The law 25/1999 and law 34/2000 obviously do not give significant local taxing power since the Indonesian decentralization was designed to be the expenditure-led decentralization financed by transfer. However, after three years of decentralization, the aspiration of higher local taxing power emerged. One important indicator of regional autonomy should be the ability of the local governments to find their own sources of revenue and to reduce the dependence to the transfer. As mentioned briefly, that is not the case in Indonesia since most of local governments are spoiled by the existence of DAU and do not pay enough attention to optimize the local own revenue. Comparison between annual growth rate of local own revenue during 1994-1996 period and 2001-2002 period indicated that prior decentralization growth (20%) is much higher than decentralization growth (5%). On the other hand, the central government is highly reluctant to give more local taxing power by transferring one or more of their taxes to the local government. The latest failure to transfer the authority of property tax to the local government was good example on how difficult an old paradigm shifts to the new paradigm. It is true that the local governments might not have the capability to collect the property tax optimally and it is also true that the local governments might be reluctant to impose direct taxes to their residents. However, the new paradigm of decentralization will move toward the more accountable local government and local parliament to the local residents. The introduction of property tax as local tax is one of accountability instruments. If the local governments are deemed incapable of collecting the property tax revenue, then they could focus on the tax rate setting and let the more capable central government body handling the collection and administration. The weak local taxing power has another negative implication regarding the local investment climate. Since most of local governments realized that the amount of transfer is far from enough to fulfill their needs as a result of slow economic recovery, and at the same time they do not have alternative from existing local taxes and charges, they are trying to find other sources that unfortunately are illegal and disruptive. Imposing new charges, levies or fees has become the favourite tools for local governments to generate additional revenue and ensure a stable cash-flow management. The easiest targets for those new additional revenues are unfortunately the local businesses that seem to be powerless in that situation.. It is not surprising to find plantation companies in Sumatra

7

complaining about the extra fees and levies. Combined with the fact that Indonesia is considered not conducive yet for foreign investment, the decentralization process becomes one of major factors discouraging new investment in Indonesia. The illegal and excessive new charges, levies, or fees were some of major factors but more than that, the local government in Indonesia is not business friendly yet. The KPPOD survey (KPPOD, 2003) revealed that the major concern for investors to locate their activities at localities was the institutional factors that cover the certainty, law enforcement, licensing process, and local regulation. In fact, the local governments create disincentives rather than incentives for incoming investment. This lack of incentives comes from a combination of political structure, economic structure and the relationship between central and local governments. In the current relationship between local executives and legislatives, the latter has becomes the more powerful party. Local executives have to follow the guidance from the legislative. However, due to their weak capabilities, the evaluation of executive performance is mostly based on what happens to the APDB budget, especially the total amount and its allocation. It is very rare to hear the local legislatives (DPRD) go beyond the APBD itself and evaluate the executive performance on how the APBD stimulates the local economic development and growth, and subsequently generates jobs and reduces local unemployment. In other words, it is APBD that matters for both local legislatives and executives, while the GRDP is seen as a factor that will follow automatically the national economic conditions (Brodjonegoro, 2003). The lack of local elected officials accountability to their voters, due to the current election system, is another reason why local economic growth and local unemployment are not perceived to be as important as increasing the revenue in the APBD. The lack of local government focus in promoting the output and employment growth leads to lower economic development activities in the regions. It should be noted, however, that the impacts of economic crisis might play significant role in slow economic growth both at national and local level. At this stage, it is hard to separate the effects of economic crisis and decentralization on the regional economic growth. Comparing the decentralization period with the crisis period, it is obvious that there has been economic growth improvement as indicated by GRDP, investment, and export growth by province in table 4,5, 6 and 7. However, the economic growth in decentralization era is still far below the economic boom (and centralized) era. The difference for all provinces is quite significant and it has to be examined further the reason of the difference apart from the national macroeconomic condition. Table 4 – 7 should also alarm the central government that the less impressive performance of export and investment at national level might be due to problems at regional level that may require more local oriented actions than the uniform macroeconomic policy. Decentralization may play a role in that local oriented economic policy. Another alarming finding is de-industrialization all over Indonesia as indicated by table 7. The minus growth at some regions plus almost zero growth at other regions indicated slow or even declining manufacturing growth that has to be anticipated as early as possible by both local and national policy makers. KPPOD survey (KPPOD, 2003) indicated that manufacturing is the main victim of illegal and excessive charges or levies. This might effect the manufacturing activities at the local level and eventually at the national level. An integrated national economic policy that incorporates the local

8

specifics has to be the first priority together with the GRDP, rather than APBD, orientation from local governments. FISCAL SUSTAINABILITY One major complain from most of Indonesian local governments is insufficient DAU and other types of transfer to support the regional development, especially related to new infrastructure provision. As table 1 in the appendix indicates that most of local governments spent their budget for routine expenditure, especially government employees salary and left a little for development expenditure. With that limited amount, it is hard to imagine that the local governments will do some new major projects that improve the infrastructure quality in the region. Maintenance of existing infrastructures might be the maximum they can do but in reality, infrastructures are deteriorating all over Indonesia. It means that the local budget is simply not enough to cover any effort to promote local economic growth and improvement of public service delivery. There could be some reasons behind this condition. First, The Indonesian government that still works on slow economic process focuses the budget (APBN) on the debt payment and their routine expenses with little left for development. Second, most of local governments with limited sources of revenue have not been able to manage themselves efficiently due to current political situation that makes any efficiency program unpopular and not politically acceptable. Third, most of line ministries at central level still have significant power of the projects located on the regions while according to law 22/1999, the authority should have been moved to the local level. The last reason might reflect what local governments are always suspicious to the central government, the reluctance of the part of central governments to devolve their power to the local level. In other words, the old problem of the “tug of war” between deconcentration and decentralization still exists. Although, the period since 2001 is labeled as decentralization period, it is not that easy to just change the paradigm from strong deconcentration in the past. Most of line ministries had the power in their fields during the deconcentration period, and the decentralization period basically threatens their power. Using many types of arguments such as national priority programs, national interest, people interests, and others, they are still trying to justify their authority over the execution of programs and projects at the local level. Although they are involving the local government units during the activities, the sense that the project belongs to the center rather than local creates the impression that the central government does not want to devolve the authority. There have been some discussions about this issue but whenever it comes to the real action, the question from a line ministry will be who should initiate the policy and if other ministries will follow the policy. Other ministries would argue that they do not have trust in local government of delivering the minimum basic services that they used to do it in the past. Some also proposed that part of DAU should be “earmarked” for certain activities related to basic service delivery such as education, health, and basic infrastructure. While the debate of deconcentration v decentralization might be endless, there is one strategic policy to gradually shift the central government paradigm and minimize the deconcentration activities. The specific purpose grant (DAK) that theoretically should be

9

devoted to handle the jurisdictional spill-over effects, ensure minimum service standard, and to pursue the national interest, is the best instrument to gradually devolve the line ministries power. With the scheme of DAK that still involves the central government ministries and agencies, the local government will own the projects or programs but they will be under the monitoring and evaluation from respective central ministries and central ministries will still have the decision on the types of programs or projects to be financed. The shift from DIP (central government programs and projects) to DAK could be designed in medium term perspective to make smooth adjustment both at central and local level. With greater DAK, the local governments will have higher opportunity to develop the regions based on their plans and assessment. As many agree, the local governments know better the local needs than the central ministries. From fiscal sustainability point of view, this kind of shift will not affect the APBN much since the transaction is basically transfer from development expenditure account to intergovernmental transfer account, in this case DAK. Such a move will also ensure the fiscal sustainability at national level. Currently, there are requests from local governments to central government in allocating more than 25% net domestic revenue for the DAU. For first three years, the government always imposed the minimum amount of 25% net domestic revenue and because of that request, the central government will allocate 25.5% for 2004 DAU. This slight increase might not affect the national fiscal sustainability but the idea from one of influential ministry to increase the DAU to be 30% of net domestic revenue might threaten the sustainability. That threat becomes more significant if there is no shift from DIP to DAK since the central government is forced to find additional revenue or to cut other types of expenditure. The move to increase the DAU up to 30% of net domestic revenue will not affect the sustainability if accompanied by the shift from DIP to DAK and by defining the better the devolution of authorities. Without proper management of this matter, there could be a condition where the central government runs out of money while they are still responsible for many government authorities. Another potential disruption of fiscal sustainability that relates to fiscal decentralization process is the disbursement of natural resources revenue sharing. The central government has committed to avoid the late disbursement program in the past that caused the large surplus at natural resources rich regions due to inability of absorbing the budget closed to the end of budget year. This late disbursement also caused the uncertainty in the local government cash flow management with few regions have to borrow from external sources to anticipate the “incoming” revenue. Beginning in 2004, the government will allocate the budgeted amount rather than the actual amount that caused the delay. With the budgeted amount that was based on the last year actual transfer, the central government has a risk of transferring money to the regions more than they are supposed to be. The fluctuation of both natural resources commodity production and price could increase the risk that may eventually affect the fiscal sustainability at central level. The sustainability becomes a more significant issue since the APBN has the obligation to pay the debt that was about 17.5% of the total budget in 2003 (table 8 of appendix). This proportion was lower than in 2001 and 2002. Quite interestingly, the debt payment proportion in 2003 was lower than the DAU proportion and

10

intergovernmental transfer proportion. In 2001-2002, the debt proportion was higher than DAU but lower than intergovernmental transfer. Any proportion increase of debt payment together with DAU proportion pattern (and other transfer instrument) will certainly put the national budget in danger. To finance the development in decentralized era, there are possibilities that both central and local governments have to look for external sources. The internal sources should come from tax revenue intensification and higher economic growth that leads to higher tax revenue. Due to current difficulties in expanding the tax base and promoting economic growth because of lack of investment, the external sources should be prioritized but with cautions. The central government already issues government bonds for sources of funding and it will imply in debt payment burden of the budget in the near future. The foreign loan is still there but its importance might decline a little bit due to unpopularity among Indonesians. Local government, on the other hand, is still prohibited to borrow from external sources, especially from foreign sources. There have been discussions that the prohibition might be lifted in the near future, and the central government has already amended the law 25/1999 by introducing the on-lending concept for local governments. With this on-lending concept, the international agencies will have to negotiate and make an agreement with central government on behalf of local governments that need foreign borrowing. The central government will then lend the money to the local governments and supported by an agreement, the central government can charge the local governments through the intergovernmental transfer if the local governments are in default position. This might minimize the bigger risk of threatening the fiscal sustainability. Another possibility is the issuance of local government bonds. It might take some years before the local governments can really issue the bonds and get the financial sources they need. The risk to fiscal sustainability is there if the local governments are allowed to issue the bond, especially if the central government might have to bail out. To minimize the risk, the local government bankruptcy law has to be ready together with the secondary bond market. But first of all, there has to be trust toward the local government management from the market and it has to be developed by local governments themselves through good governance practices and ability to manage the local economic development process. CONCLUDING REMARKS The three years period of decentralization process could be labeled as a “mild” success. The success could be demonstrated by how the Indonesians quickly adjusted to massive and drastic changes from a very strong centralized government, given only one year of preparation. The relatively smooth transfer of 2 millions civil servants might be the symbol of smooth devolution process that did not create significant social or political unrest. The central government, especially some line ministries, is still trying to be involved more in the local activities, and it is understandable given their almost absolute power in the past. The local governments might be still in the learning process on how to rely on their own but they are learning quickly and given the limited budget, they can still manage the government administration relatively well. The amendment of both law 22/1999 and law 25/1999 should be treated as a significant improvement of decentralization process with the emphasis on better monitoring from central government and accountability at local level. On the fiscal side, there might be a problem of less than

11

equal DAU but it is improving albeit gradually. Some efforts to separate the political influence from DAU allocation should give a hope of more equal allocation based on independent judgement. The central government also improves the natural resources revenue sharing disbursement that could neutralize the restless local governments. On the fiscal sustainability perspective, the central government has relatively managed the debt well so that the proportion for the intergovernmental transfer is higher in APBN. A prudent and cautious national budget management is the key to success but the latest request to increase the DAU portion might have to be observed carefully. Aside from relatively success stories, the decentralization process could still lead to a failure if the local governments and central government are not practicing their proper behavior in new paradigm of decentralization. At the local government side, the tendency to prioritize local budget rather than local GRDP will still discourage the potential investors that want to stay away from illegal and excessive charges or levies. Local budget (APBD) should be treated as a local economic stimulator than the final purpose itself. Local parliament (DPRD) should share the same spirit and in order to support that, accountability of both local legislative and executive to the local voters should be promoted, and everyone has to support the first direct election in 2004 for local legislative. It it fails, then the accountability mechanism might have to wait another five years. Accountability of local governments to voters should ensure a better basic public service delivery and local government should begin to formulate how to build an effective local government that will not spend too much on routine activities. On the borrowing issue, the local governments have to convince the central government and potential lenders that they are capable in managing the borrowing without jeopardizing the current fiscal sustainability. As many agree, the local borrowing is a best local revenue collection instrument since it will create a win-win condition for both borrower and lender. At the end, the success of decentralization process will lie on the central government that designs the process and commits to the implementation. Although it is not visible, there is a tendency that decentralization is not one of priorities of central government. The decentralization activities are already considered as routine activities. It might be a good one if all the process is perfect and smooth, but it is dangerous if everything is not in place yet. That could lead to the impression that the central government is not so serious anymore in promoting decentralization and prefers to go back to old paradigm. Lack of coordination and intense rivalry among central ministries do not help the situation with the impression that the decentralization process is no longer a national interest but a ministry interest. The strong national leadership should handle this matter, and it could start from the amendment process of law 22/1999 and law 25/1999 that seems to go separate ways and it ends up in “tug of war” rather than a vision for decentralization process itself. At the fiscal side, the central government still has to manage the fiscal sustainability that has effects on decentralization process and most importantly, Indonesians should avoid a large scale of economic crisis due to local government behavior in borrowing and managing their budgets as in the case of Brazil.

12

REFERENCES Asanuma, Shinji, and Bambang Brodjonegoro (2003),”Indonesia’s Decentralization

Policy : Origins, Issues, and Prospects”, presented at the International Symposium on Indonesia’s Decentralization Policy : Problems and Policy Directions, Hitotsubashi University, Tokyo.

Brodjonegoro, Bambang (2002), ‘Fiscal Decentralization in Indonesia’, in Hadi Susastro, Anthony L Smith, and Han Mui Ling (eds), Governance in Indonesia: Challenges Facing the Megawati Presidency. Singapore: The Institute of Southeast Asian Sudies.

Brodjonegoro, Bambang (2003),“Decentralization and Business”, presented at the Indonesian Update, Research School of Asian Pacific Studies, Australian National University, Canberra.

Brodjonegoro, Bambang (2003),“Decentralization and Urbanization in Indonesia : The Concept of Metropolitan Area”, presented at the Asian Development Conference, Kitakyushu, Japan.

Brodjonegoro, Bambang and Jorge Martinez (2002),“An Analysis of Indonesia’s Transfer System : Recent Performance and Future Prospects”, presented at The Andrew Young School of Policy Studies sponsored conference on “Can Decentralization Help Rebuild Indonesia ?”, Georgia State University, Atlanta.

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

Fiscal Decentralization in Democratic Indonesia’, Hitotsubashi Journal of Economics, Vol. 41 No.2, pp.111-122.

Ford, J. Fitz G, and Bambang Brodjonegoro (2004), ‘Inter-Governmental Fiscal Relations and State Building: The Case of Indonesia’, in R.M. Bird (ed.), Asymmetric Fiscal Decentralization: Glue or Solvent? World Bank, Washington DC, forthcoming

KPPOD (2003), “Regional Investment Attractiveness: Business Perception”, Jakarta: Komite Pemantauan Pelaksanaan Otonomi Daerah (KPPOD) and Asia Foundation.

Mahi, Raksaka, and Bambang Brodjonegoro (2003),”The Indonesian Political Economy of Decentralization”, presented at the International Symposium on Indonesia’s Decentralization Policy : Problems and Policy Directions, Hitotsubashi University, Tokyo.

Matsui, Kazuhisa, and Mudrajad Kuncoro (2003),”The Role of Local Governments in Indonesia : A Survey of Recent Development”, presented at the International Symposium on Indonesia’s Decentralization Policy : Problems and Policy Directions, Hitotsubashi University, Tokyo.

Sato, Motohiro, Bambang Brodjonegoro, and Hamid Paddu (2003),”Intergovernmental Transfer and Tax Sharing in Indonesia : Theories, Practices, and Political Recommendation”, presented at the International Symposium on Indonesia’s Decentralization Policy : Problems and Policy Directions, Hitotsubashi University, Tokyo.

13

Suwandi, Made (2002),”The Implementation of Regional Autonomy : The Indonesian Experience”, presented at The Andrew Young School of Policy Studies sponsored conference on “Can Decentralization Help Rebuild Indonesia ?”, Georgia State University, Atlanta.

Usui, Norio, and Armida Alisjahbana (2003),”Local Development Planning and Budgetting in Decentralized Indonesia”, presented at the International Symposium on Indonesia’s Decentralization Policy : Problems and Policy Directions, Hitotsubashi University, Tokyo.

World Bank (2003),”Decentralizing Indonesia : A Regional Public Expenditure Review Overview Report”, East Asia Poverty Reduction and Economic Management Unit, Jakarta.

APPENDIX TABLE 1: Percentage of Prefectures /Municipalities Distribution Based on Elements of Budget Shares to Total Local Budget (APBD), Year 2002

Source: APBD 2002

14

TABLE 2 : DAU per capita 2002 - 2003

DAU/population (million Rp) Province (including districts and

municipalities) 2002 2003 Sumatra Sumatra: Dista Aceh 484.05 489.74 Sumatra: North Sumatra 315.03 344.16 Sumatra: West Sumatra 460.24 520.29 Sumatra: Riau 468.96 382.45 Sumatra: Jambi 508.31 564.91 Sumatra: South Sumatra 295.03 316.88 Sumatra: Bengkulu 485.02 569.81 Sumatra: Lampung 284.38 318.25 Java Java: DKI Jakarta 77.68 73.00 Java: West 191.58 563.05 Java: Central 266.82 339.63 Java: DI Yogyakarta 418.84 458.65 Java: East 251.64 273.19 Bali 490.67 525.01 Nusa Tenggara Nusa Tenggara: West 355.16 389.23 Nusa Tenggara: East 527.84 640.07 Kalimantan Kalimantan: West 437.97 512.48 Kalimantan: Central 650.19 807.68 Kalimantan: South 443.59 545.31 Kalimantan: East 449.21 457.65 Sulawesi Sulawesi: North 571.87 585.33 Sulawesi: Central 600.38 655.29 Sulawesi: South 426.35 483.77 Sulawesi: South East 593.67 755.03 Maluku 584.84 806.62 Irian Jaya 1,192.27 1,490.65

2002 :

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

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

15

TABLE 3 : Local Revenue per Capita 2002

Province (including

districts and municipalities)

APBD revenue/population (in million Rp)

Sumatra Sumatra: Dista Aceh 1,219.62 Sumatra: North Sumatra 474.85 Sumatra: West Sumatra 640.08 Sumatra: Riau 2,027.54 Sumatra: Jambi 685.82 Sumatra: South Sumatra 461.95 Sumatra: Bengkulu 575.56 Sumatra: Lampung 383.41 Java Java: DKI Jakarta 939.45 Java: West 320.48 Java: Central 356.13 Java: DI Yogyakarta 582.50 Java: East 378.99 Bali 952.42 Nusa Tenggara Nusa Tenggara: West 476.61 Nusa Tenggara: East 622.16 Kalimantan Kalimantan: West 574.02 Kalimantan: Central 1,065.17 Kalimantan: South 663.27 Kalimantan: East 1,746.75 Sulawesi Sulawesi: North 674.91 Sulawesi: Central 714.20 Sulawesi: South 569.51 Sulawesi: South East 705.99 Maluku 734.41 Irian Jaya 2,260.10

Highest : Irian Jaya : Rp 2,260.10 Lowest : DKI Jakarta : Rp 320.48

Ratio : highest/lowest : 7.05

16

TABLE 4 : Average Annual GRDP Growth by Province

Source : LPEM FEUI

Average Annual Growth (%) PROVINCE 1994-1996 1999-2000 2001-2002

NANGGROE ACEH DARUSSALAM 0.02 -0.04 0.00 SUMATERA UTARA 0.09 0.02 0.02 SUMATERA BARAT 0.08 0.02 0.02 R I A U 0.05 0.03 0.02 J A M B I 0.09 0.03 0.02 SUMATERA SELATAN 0.08 0.02 0.02 KEP. BANGKA BELITUNG - - 0.02 B E N G K U L U 0.07 0.02 0.02 L A M P U N G 0.09 0.02 0.03 D K I JAKARTA 0.09 0.02 0.02 JAWA BARAT 0.09 -0.04 0.02 BANTEN - - 0.03 JAWA TENGAH 0.07 0.02 0.02 D I YOGYAKARTA 0.08 0.02 0.02 JAWA TIMUR 0.08 0.02 0.02 B A L I 0.08 0.02 0.02 NUSA TENGGARA BARAT 0.08 0.14 0.02 NUSA TENGGARA TIMUR 0.09 0.02 0.03 KALIMANTAN BARAT 0.10 0.01 0.01 KALIMANTAN TENGAH 0.10 0.01 0.02 KALIMANTAN SELATAN 0.10 0.02 0.02 KALIMANTAN TIMUR 0.07 0.02 0.02 SULAWESI UTARA 0.09 0.03 0.02 GORONTALO - - 0.03 SULAWESI TENGAH 0.08 0.02 0.03 SULAWESI SELATAN 0.08 0.02 0.02 SULAWESI TENGGARA 0.07 0.03 0.03 M A L U K U 0.07 -0.01 0.01 MALUKU UTARA - - 0.01 P A P U A 0.17 0.01 0.04

17

TABLE 5 : Average Annual Inv stment Growth by Province

Source

e

Average Annual Growth (%) PROVINCE

1994-1996 1994-1996 NANGGROE ACEH DARUSSALAM 0.02 -0.04 0.03 SUMATERA UTARA 0.13 0.02 0.01 SUMATERA BARAT 0.10 0.01 0.01 R I A U 0.08 0.01 0.01 J A M B I 0.07 0.04 0.01 SUMATERA SELATAN 0.13 0.02 0.02 KEP. BANGKA BELITUNG - - 0.03 B E N G K U L U 0.02 0.02 0.02 L A M P U N G 0.21 0.05 0.01 D K I JAKARTA 0.11 0.01 0.01 JAWA BARAT 0.21 0.00 0.03 BANTEN - - 0.03 JAWA TENGAH 0.08 0.03 -0.08 D I YOGYAKARTA 0.08 0.03 0.08 JAWA TIMUR 0.11 -0.03 0.00 B A L I 0.09 0.01 0.01 NUSA TENGGARA BARAT 0.12 -0.02 0.01 NUSA TENGGARA TIMUR 0.08 0.04 0.02 KALIMANTAN BARAT 0.20 0.02 -0.02 KALIMANTAN TENGAH 0.07 -0.02 0.13 KALIMANTAN SELATAN 0.10 0.08 -0.03 KALIMANTAN TIMUR 0.02 0.00 0.07 SULAWESI UTARA 0.17 0.27 0.20 GORONTALO - - 0.01 SULAWESI TENGAH 0.06 0.02 0.02 SULAWESI SELATAN 0.18 -0.03 0.02 SULAWESI TENGGARA 0.05 0.03 0.04 M A L U K U 0.16 0.00 0.14 MALUKU UTARA - - 0.03 P A P U A 0.15 0.07 0.05

: LPEM FEUI

18

TABLE 6 : Average Annual Export Growth by Province Average Annual Growth (%) PROVINCE

1994-1996 1994-1996 NANGGROE ACEH DARUSSALAM 0.00 0.00 -0.10 SUMATERA UTARA 0.11 0.02 0.07 SUMATERA BARAT 0.07 -0.05 0.00 R I A U 0.07 0.10 0.04 J A M B I 0.10 0.01 0.00 SUMATERA SELATAN 0.16 0.08 0.00 KEP. BANGKA BELITUNG - - -0.01 B E N G K U L U 0.17 0.02 0.02 L A M P U N G 0.07 0.06 -0.27 D K I JAKARTA 0.12 0.02 0.09 JAWA BARAT 0.12 -0.06 0.00 BANTEN - - 0.02 JAWA TENGAH 0.08 0.07 -0.09 D I YOGYAKARTA 0.07 0.01 0.03 JAWA TIMUR 0.09 0.06 -0.05 B A L I 0.09 0.01 0.01 NUSA TENGGARA BARAT 0.12 1.02 0.04 NUSA TENGGARA TIMUR 0.11 -0.13 0.10 KALIMANTAN BARAT 0.04 0.01 -0.12 KALIMANTAN TENGAH 0.10 0.00 -0.10 KALIMANTAN SELATAN 0.01 0.01 -0.05 KALIMANTAN TIMUR 0.11 0.05 0.01 SULAWESI UTARA 0.12 0.01 0.05 GORONTALO - - 0.07 SULAWESI TENGAH 0.03 0.02 0.02 SULAWESI SELATAN 0.01 0.01 0.04 SULAWESI TENGGARA 0.19 0.35 0.01 M A L U K U 0.01 -0.16 0.02 MALUKU UTARA - - 0.05 P A P U A 0.25 0.00 -0.11

Source : LPEM FEUI

19

TABLE 7 : Average Annual Manufacturing Growth by Province

Source : LPEM-FEUI

Average Annual Growth (%) PROVINCE 1994-1996 1994-1996

NANGGROE ACEH DARUSSALAM 0.01 -0.15 -0.01 SUMATERA UTARA 0.09 0.02 0.04 SUMATERA BARAT 0.12 0.03 0.01 R I A U 0.12 0.05 0.02 J A M B I 0.15 0.01 0.02 SUMATERA SELATAN 0.10 0.02 0.01 KEP. BANGKA BELITUNG - - 0.02 B E N G K U L U 0.12 0.03 0.03 L A M P U N G 0.09 0.01 0.01 D K I JAKARTA 0.09 0.02 0.01 JAWA BARAT 0.15 0.02 0.02 BANTEN - - 0.02 JAWA TENGAH 0.08 0.02 0.02 D I YOGYAKARTA 0.07 -0.01 0.02 JAWA TIMUR 0.12 0.01 -0.01 B A L I 0.11 -0.01 0.03 NUSA TENGGARA BARAT 0.09 0.03 0.03 NUSA TENGGARA TIMUR 0.05 0.02 0.02 KALIMANTAN BARAT 0.08 0.02 0.01 KALIMANTAN TENGAH 0.03 -0.06 0.01 KALIMANTAN SELATAN 0.11 -0.03 -0.01 KALIMANTAN TIMUR 0.03 0.03 -0.01 SULAWESI UTARA 0.10 0.03 0.03 GORONTALO - - 0.01 SULAWESI TENGAH 0.08 0.01 0.02 SULAWESI SELATAN 0.08 0.04 0.01 SULAWESI TENGGARA 0.21 0.03 -0.01 M A L U K U 0.06 -0.16 0.00 MALUKU UTARA - - 0.00 P A P U A 0.14 -0.04 0.04

20

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

Year

DAU/Total Expenditure (%)

Transfer/Total Expenditure (%)

Interest + Principal Debt Payment/Total

Expenditure (%)

2001 17.67 23.73 20.86 2002 20.00 27.21 22.71 2003 20.77 29.01 17.46

Sumber : Departemen Keuangan RI

21