Financing the Regions

1. Financing the Regions Workshop on Water Resources and Irrigation Sector Reforms Jakarta, October 3-4, 2000

2. Financing The Regions • Main Features of Decentralization • Overview of Financing Mechanisms • Own revenues • Revenue Sharing • Dana Alokasie Umum • Dana Alokasie Khusus • Borrowing • Key issues

3. Indonesia’s decentralization • The current legal framework (Laws 22 and 25 of 1999) will give Indonesia substantial decentralization. • Over time some 45-50 percent of general government spending done by the regions. • The districts/cities will manage most of the Government services , including health, education, and infrastructure • PP25/2000 specifies remaining functions of the center • The Government will start implementation in 2001 • The Law says “Big Bang” • MPR Decree and “Ten Point Program” calls for gradual implementation

4. Indonesia’s decentralization • Regions will get most resources through a general grant allocation • Regions must implement functions of Pasal 11 of Law 25 (education, health, agriculture, etc.) • Regions must follow national law • Center can set guidelines for service delivery • Districts can “give back” functions to the province--but the receive less resources

5. Decentralization will shift much spending to the regions

6. Overview of Regional Finance • Own revenues • Revenue sharing • Alokasie Umum • Alokasie Khusus • Borrowing

7. Own revenues • Definition: regions can set own rate and or base • Currently about 1 percent of GDP • Law 18/1997--Tax Revenues • Law 20/1997--Non-Tax revenues • Revision of Law 18 1997 likely: • Regions could introduce tax on “no objection” basis rather than approval • Regions may get authority over land and real estate transfer tax

8. Revenue sharing • Oil, gas, forestry, fishery, mining, personal income tax, • 1.3 percent of GDP in 2001 • Mainly to 6 provinces--and within those 8 districts (oil, gas, forestry) • Issue for fiscal equalization • Issue for fiscal management, due to volatile prices

9. Alokasie Umum • >25 percent of Domestic Revenues • 4 percent of GDP in 2001 • 90 percent to District/City; 10 to Province • Distribution per formula (not yet completed) • Grant=f(Needs-/-Revenue capacity)*a • Needs=g(population, area, #poor, price level) • Revenue=h(regional GDP, others) • a=adjustment factor, to ensure at least FY00 allocation • No one worse off than before DAU>SDO+ INPRES

10. Alokasie Khusus • Negligible in 2001 • Should become the main instrument of central government policy • Can be used to correct for spill-overs among regions • Line Ministries determine factors for Khusus--MOF determines total • Over time larger • Perhaps vehicle for donor funds--see below

11. Regional Borrowing • Regions are allowed to borrow--with restrictions • Restrictions on purpose • Law: Infrastructure, high financial return • (draft) regulations: also social investment • Restrictions on regional total • Debt service restriction--future debt service<revenues • Debt restriction: debt<x% of revenues

12. Regional Borrowing (cont.) • Possible restrictions on total of all regions • Possible restrictions on guarantees, BUMND borrowing • Borrowing mechanisms: • Approval of DPRD • Domestic: direct from banks, public • Foreign: not yet decided • either direct (but many donors would ask for guarantee from central government) • or indirect--through on-lending agreements, or a grant from the center

13. Key outstanding issues • How fast will implementation be? • How equalizing will the alokasie umum be? • What if there is a shortfall of funds in the regions? • What will happen with existing projects? • Who will provide the counterpart funds? • Who will have the authority over tax and levy rates?