Manajemen | Fakultas Ekonomi Universitas Maritim Raja Ali Haji 00074910701286388
Bulletin of Indonesian Economic Studies
ISSN: 0007-4918 (Print) 1472-7234 (Online) Journal homepage: http://www.tandfonline.com/loi/cbie20
ON-LENDING IN INDONESIA: PAST PERFORMANCE
AND FUTURE PROSPECTS
Blane D. Lewis
To cite this article: Blane D. Lewis (2007) ON-LENDING IN INDONESIA: PAST PERFORMANCE
AND FUTURE PROSPECTS, Bulletin of Indonesian Economic Studies, 43:1, 35-58, DOI:
10.1080/00074910701286388
To link to this article: http://dx.doi.org/10.1080/00074910701286388
Published online: 08 Nov 2007.
Submit your article to this journal
Article views: 79
View related articles
Citing articles: 5 View citing articles
Full Terms & Conditions of access and use can be found at
http://www.tandfonline.com/action/journalInformation?journalCode=cbie20
Download by: [Universitas Maritim Raja Ali Haji]
Date: 18 January 2016, At: 20:01
Bulletin of Indonesian Economic Studies, Vol. 43, No. 1, 2007: 35–57
ON-LENDING IN INDONESIA:
PAST PERFORMANCE AND FUTURE PROSPECTS
Blane D. Lewis*
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
World Bank, Jakarta
On-lending to sub-national governments in Indonesia has a long and generally disappointing history. Among other noteworthy problems, an insufficient amount of
funds has been channelled through the system vis-à-vis capital financing needs, and
loan repayments have proved poor. Aid agencies and government have recently
invested substantial resources in attempts to improve the on-lending system; the resultant newly installed regulatory framework for sub-national borrowing is, however, unlikely to improve outcomes substantially. Developing sub-national government access to private capital markets would appear to constitute the way forward,
although this will not come quickly or easily. A positive step in the right direction
would be for government and aid agencies to embrace the anticipated change and
work together to make the transition a successful one, rather than continue to tinker
with reforms at the margin of a moribund system.
INTRODUCTION AND BACKGROUND
On-lending refers to the means by which international aid agencies and central governments channel long-term finance to sub-national governments.1 In this context,
aid agencies make loans to the central government and to (mostly) publicly owned
and managed financial institutions which, in turn, on-lend the funds to sub-national
governments. And central governments lend to their sub-nationals from their own
resources, either directly or via public financial institutions.2 On-lending is a commonly used tool to finance local public infrastructure in developing countries, especially in cases where capital markets are relatively under-developed.
* The author is Senior Adviser for Fiscal Decentralization at the World Bank in Jakarta under financing from the Dutch Trust Fund (TF050378). The views expressed here are those of
the author and should not be attributed to the World Bank or the government of the Netherlands. The author would like to thank Indonesia’s Ministry of Finance for access to data
used in this paper; Kutlu Kazanci for expert research assistance; and Sebastian Eckardt,
Andre Oosterman, Bill Wallace, David Woodward, two anonymous referees and the editor
for comments on earlier versions of the paper.
1 On-lending may also be used in some countries to channel finance to national stateowned enterprises. This paper considers only on-lending to sub-national governments
(and sub-national government enterprises).
2 Very occasionally, publicly sponsored financial intermediaries also access funds from
private capital markets, which are then on-lent to sub-nationals.
ISSN 0007-4918 print/ISSN 1472-7234 online/07/010035-23
DOI: 10.1080/00074910701286388
© 2007 Indonesia Project ANU
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
36
Blane D. Lewis
In Indonesia, international aid agencies lend to sub-national governments and
their enterprises through the central government’s mechanism for on-lending
foreign funds, the Subsidiary Loan Agreement (SLA). The most important aid
agencies involved in on-lending to sub-national units are the World Bank (WB)
and the Asian Development Bank (ADB), although other development assistance
agencies have also been involved.3 The central government makes loans to subnationals through its Regional Development Account (RDA).4 RDA loans are, for
the most part, sourced from own domestic public revenues, although a minimal
amount of funding has come from aid agency (ADB and United States Housing
and Environmental Credit Guarantee program) contributions.
Research focused specifically on on-lending is somewhat limited. In the only
widely available comparative study on the topic, Peterson (1996) evaluates the
performance of on-lending in 25 countries. The basic conclusion reached was that
on-lending has not worked satisfactorily. In this regard, three outcomes in particular appear to be the norm. First, insufficient funds are transferred through onlending mechanisms to meet sub-national infrastructure finance needs. Second,
various intermediation functions are performed poorly by the central government and other relevant financial institutions.5 Third, loan repayments are weak
(Peterson 1996).
In a study specific to Indonesia, Devas and Binder (1989) broadly examine early
SLA on-lending and that of RDA’s forerunners—Rekening Dana Investasi (RDI) and
the Inpres Pasar program,6 among others. The authors criticise the near exclusive
focus of such lending on revenue-generating projects, which they argue is inefficient
and inequitable.7 In Lewis (2003) I analyse the Indonesian experience of on-lending to
local governments through 1999, concentrating on the evident poor loan repayment
record. I find that frequent non-repayment of loans appears to result not from inabil-
3 Other aid agencies include, most importantly, those of France, Germany, Japan, the
Netherlands, Switzerland and the United States.
4 Throughout this paper, ‘RDA’ refers to lending carried out by the RDA, as well as that by
its predecessor programs, including the Investment Fund Account (Rekening Dana Investasi, RDI), Inpres Pasar, and others (Inpres stands for ‘Instruksi Presiden’, the name given to a
program of special grants from the central government; footnote 6 explains ‘Inpres Pasar’).
The RDI and Inpres Pasar programs’ loans have since been rolled into RDA operations.
5 In many cases these functions extend beyond the simple supply of credit and collection
of repayments, to include performing financial and economic project appraisals, blending grants with loans, overseeing project preparation and implementation, and providing
technical assistance in financial management (Peterson 1996).
6 RDI loans were used to finance various types of sub-national government infrastructure;
Inpres Pasar loans were exclusively for market construction.
7 It is usually argued that it is more economically efficient to borrow now in order to satisfy present needs or demand than it would be to wait until adequate funds can be accumulated over time. Borrowing for capital development is deemed equitable, since those who
actually use the generated services can be made to pay for them over the course of the life
of the infrastructure. (Note that the latter also supports the economic efficiency argument.)
Significant efficiency and equity improvements are forgone by restricting borrowing to
revenue-generating projects.
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
On-lending in Indonesia: past performance and future prospects
37
ity to repay but rather from a lack of willingness to do so.8 In addition, I argue that
neither the central government nor aid agencies have shown much interest in forcing
better repayment. The latter, at least, lack an incentive to do so, since their loans are
repaid by the centre regardless of whether local governments repay or not.9
A related strand of research examines the constraints that sub-national governments face in moving beyond the use of narrow on-lending mechanisms to access
private capital markets. Freire and Petersen (2004) discuss the basic requirements
of sub-national capital market development, focusing on the political, legal, and
financial regulatory environment and appropriate market-based borrowing instruments. They investigate the situation in 18 countries across Latin America, Africa,
Asia and Eastern and Central Europe. One of the countries reviewed is Indonesia.
The authors of the Indonesia chapter note that the lack of security provisions in law,
and uncertain legal requirements concerning sub-national financial reporting and
disclosure, such as existed during the period just after the launching of the government’s decentralisation program in 2001, were important constraints to the development of market-based approaches in Indonesia (Kehew and Petersen 2004).
Martell and Guess (2006) develop a framework for assessing the readiness of
sub-national governments to employ market-based debt financing, and apply the
framework to five countries, including Indonesia.10 Their general thesis is that the
successful development of sub-national capital markets is a function of the regulatory framework and financial institutions’ ability to evaluate credit risk, most
importantly, and sub-national governments’ capacity to properly manage debt,
to a secondary extent. The authors find that, among the countries examined, subnational governments in Indonesia show the least potential for accessing private
capital markets, judging from the institutional environment that existed during
the early years of decentralisation.
The broad objectives of this paper are to provide a historical review of onlending and to assess the near-term prospects for on-lending and alternative
methods of financing sub-national public capital development in Indonesia. To the
author’s knowledge there is no published research focused on the history of, and
prognosis for, on-lending in any country. And while there has been some work on
the possibilities surrounding the development of sub-national government access
8 Note that this statement pertains to local governments only and not necessarily to local
government water enterprises, which were not examined in the cited study. Many water
enterprises may be unable to service their loans; of course this inability to repay is in many
cases a function of tariffs being set at below cost-recovery levels. Improper setting of tariffs
for services is a significant problem in Indonesia. Further analysis of this problem is, however, beyond the scope of the present paper.
9 There has been a considerable amount of unpublished research and writing on onlending in Indonesia. These efforts describe the status of SLA and RDA portfolios at particular points in time (Lewis 1997a, 1997b; Woodward 2000, 2005); examine the regulatory
framework and procedural arrangements for on-lending (Woodward 2000; Oosterman and
Samiadji 2004; Oosterman 2005; and Lewis and White 2005); and explore the possibilities
for moving beyond on-lending to sub-national units (Research Triangle Institute 1999; Varley 2001; Weitz 2001; and Development Alternatives 2002).
10 Other countries included in the analysis are Mexico, the Philippines, Poland and South
Africa.
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
38
Blane D. Lewis
to capital markets in Indonesia (among other countries—see above), these analyses were based on a regulatory system that has now been replaced. As such, this
paper should help to fill a significant gap in the literature and also provide some
updated information on a research topic previously considered.
The focus of the historical investigation is on evaluating the magnitude and
performance of SLA and RDA on-lending from 1975 to 2004. In this regard, the
paper pays special attention to the influence of the major lenders in explaining
loan performance during this period; differential outcomes associated with central
government, WB and ADB lending are highlighted throughout the study. Government and major international aid agencies have, in recent years, focused their
resources on improving on-lending; relatively less attention has been paid to developing more market-based systems. The future prospects of on-lending in Indonesia
depend on the extent to which performance across a number of dimensions can be
enhanced. The paper examines the possibilities in this regard in light of the new and
still emerging regulatory framework for sub-national borrowing in general and onlending in particular. Successful development of alternative market-based methods
of sub-national finance also depends in part on the new regulatory framework, and
the study briefly explores the potential in this regard as well.
The paper proceeds as follows. First, some background material on SLA and
RDA on-lending is presented, the data used in the analysis are briefly described,
and basic empirical facts about on-lending are provided. Second, information on
the number of loans, the amount of loan finance, and loan repayment performance, organised according to borrower characteristics and by lender, is supplied; in
addition, this section of the paper examines government and aid agency allocation
of loan finance across borrower types and locations. Third, a prognosis for continued on-lending is offered and alternative options are briefly considered. Finally,
the paper summarises the main points of the investigation and offers some policy conclusions relevant to lending to sub-national governments in Indonesia. An
appendix provides a formal empirical examination of the relationship between loan
repayment and certain loan and borrower characteristics and major lenders.
SLA AND RDA ON-LENDING
AND SOME PRELIMINARY EMPIRICAL EVIDENCE
SLA and RDA on-lending11
SLA and RDA on-lending mechanisms have been used to channel long-term finance
for infrastructure development to provinces, local governments12 and local water
enterprises (perusahaan daerah air minum, PDAMs).13 Interest rates on both SLA
and RDA loans have varied quite significantly over the years, ranging from zero
to around 13%. Since the early 1990s, however (until very recently), SLA and RDA
loan rates have been fixed at 11.5% (although SLA loans typically carry an extra
11 This section draws heavily on Research Triangle Institute (1999) and Lewis (2003).
12 Local governments comprise municipalities (kota) and districts (kabupaten).
13 Most on-lending to provinces and local governments has gone towards financing the
construction of transport terminals and markets and, to a somewhat lesser extent, roads
and drainage systems.
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
On-lending in Indonesia: past performance and future prospects
39
0.25% interest charge remitted to commercial banks responsible for collections—see
below). Loan grace periods and maturities have usually been set at 3–5 years and
18–20 years, respectively, for both SLAs and RDAs. SLA loan interest is capitalised
during grace periods, while RDA loan interest accumulates during grace periods;14
both SLA and RDA loan funds are disbursed at regular intervals during grace periods against evidence of project expenditures. Repayment schedules typically comprise equal instalments on principal, and interest is paid on the declining balance;15
repayments are due every six months after the grace period expires. The Ministry of
Finance (MOF) oversees both SLA and RDA on-lending mechanisms.
Three issues regarding the implementation of SLA and RDA on-lending merit
attention. The first relates to the relative demand orientation of SLA and RDA
lending. In years past, SLA lending, particularly as associated with the multi-lateral aid agencies’ Integrated Urban Infrastructure Development Program (IUIDP),
was frequently criticised for being ‘supply-driven’. Many sub-national government officials argued that IUIDP projects were, in large measure, designed by
aid agency-financed consultants, without much local government or community
involvement. In addition, it has been asserted that loans were often just ‘assigned’
to the local government by the centre as the means by which the projects would
(at least partially) be financed. In some cases, local officials claimed not even to
have understood that they were signing loan agreements.
The RDA was created in 1988 in part to be more responsive to sub-national government demand for infrastructure finance than SLA lending was perceived to be.
As such, RDA lending was from the start based on individual project proposals
from sub-national governments and enterprises, rather than on integrated infrastructure projects designed and promoted by aid agencies. Whether RDA lending
has actually achieved more of a demand orientation than SLA lending is a matter
of some dispute, however. At least some research has argued that many projects
designed by the Department of Public Works and financed by RDA loans seem
also to have followed a supply-led approach (Research Triangle Institute 1999).
Second, obtaining SLA and RDA project and loan approvals has proven burdensome for borrowers. SLA projects can take three to five years to be developed and
begin implementation. IUIDP project development, approval and start-up was
especially time consuming. Those projects were multi-sectoral and therefore relatively complicated by nature; attendant loans were usually part of a larger financing
package, which needed to be approved in its entirety before project implementation
could begin. RDA project approval and start-up has typically been less onerous
than that for SLAs, but may still take up to two years. The shorter time line for RDA
lending is mainly a function of the simpler nature of the projects themselves; that is,
loans have exclusively financed single, stand-alone projects.
The third issue of note concerning SLA and RDA on-lending relates to loan
administration. The disbursement of SLA loans is initiated by the Directorate of Budget Administration in MOF’s Directorate General of Budget; RDA
14 Capitalised interest refers to the compounding of annual interest charges against principal and accrued interest during the grace period. Accumulating interest means that annual interest charges are applied only to the original principal during grace.
15 Occasionally repayment schedules of RDA loans have been based on fixed principal
and interest instalments.
40
Blane D. Lewis
FIGURE 1 On-lending to Sub-nationals, 1975–2004
(Rp trillion, constant 2004 prices)
4.5
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
3.0
1.5
0.0
1975
1980
1985
1990
1995
2000
Source: Ministry of Finance Regional Finance Information System.
disbursement orders are given by the Directorate of On-lending, which is (now)
located in the Directorate General of Treasury, MOF. Each directorate has tended
to keep relevant disbursement information to itself. This has sometimes caused
difficulties for the Directorate of On-lending, which is charged with compiling
repayment schedules for both SLA and RDA loans, for which precise information on the amount and timing of disbursements is required. More important for
the present examination are the differences related to loan repayment collection.
Collection of SLA loan repayments is the responsibility of local ‘handling’ banks,
typically local branches of state banks, which are nominated in the individual
loan agreements between aid agencies and the government. As noted above, the
handling bank charges an annual fee, amounting to 0.25% of the outstanding loan
amount. Collection of RDA loan repayments, on the other hand, is administered
entirely by the Directorate of On-lending, Directorate General of Treasury, MOF,
and no additional charges are levied (Woodward 2000).
Data and preliminary empirical evidence
The data used in this paper are from the Directorate of On-lending, MOF. The data
set comprises all SLA and RDA loans to sub-national governments and PDAMs
from 1975 through 2004. A total of 838 loans were extended over the period to 426
borrowers. For each loan, information is available on the name of the borrower;
the source of funds (i.e. the lender); and the year, amount, interest rate and maturity of the loan. In addition, repayments due, made and in arrears are recorded for
each loan, as well as the outstanding principal.
In aggregate, lending to sub-national units through the SLA and RDA mechanisms has not been very significant. By the end of 2004, the total outstanding debt of
sub-national governments and water enterprises was Rp 4.2 trillion; by comparison,
the outstanding debt of the central government at the end of 2004 was Rp 1,291.3
On-lending in Indonesia: past performance and future prospects
41
FIGURE 2 Histogram of Loans by Arrears Rate, as at 2004
No. of loans
400
300
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
200
100
0
0
20
40
60
80
100
Arrears rate (%)
Source: As for figure 1.
trillion. The cumulative amount lent through SLA and RDA mechanisms from 1975
through 2004 was Rp 5.7 trillion in nominal terms or Rp 26.2 trillion in constant 2004
terms; these figures represent about 0.2% and 0.9% of 2004 GDP, respectively.16
While aggregate on-lending to sub-national governments has not been substantial, it does constitute the vast bulk of such lending to sub-nationals. There
has been only a very small amount of lending from other financial institutions,
such as regional development, state, or commercial banks, and most of this has
been to assist provinces and local governments in the management of cash flow.
An early study (Lewis 1991) estimated that less than 5% of total sub-national government borrowing was derived from sources other than the central government
(or foreign aid agencies via the central government).
The amount of on-lending to sub-national governments and their PDAMs has
varied significantly over time. Figure 1 shows on-lending disbursements over the
period in constant 2004 price terms. As the figure shows, after a relatively slow
and uneven start, lending grew quickly, beginning in the mid-1980s and reaching
a peak in the mid-1990s. Lending declined precipitously thereafter, and has not
recovered since. Lending under the central government’s decentralisation program, which began operations in 2001, has been near zero.
Repayment of loans has been generally poor (figure 2). At the end of 2004, total
payments due were Rp 7.1 trillion, of which only Rp 3.4 trillion had been paid—
16 By contrast, consider that the World Bank (2004) has estimated that Indonesia needs
to invest around 5% of GDP annually in public infrastructure, much of which is local in
character, in order to sustain a 6% medium-term economic growth target.
42
Blane D. Lewis
TABLE 1 Borrowing and Arrears by Type of Borrower
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
Type
Loans
Amount
(Rp billion)
Amount
(%)
Arrears Rate
(%)
Province
Kabupaten
Kota
PDAM
81
204
116
437
931
379
702
3,735
16.2
6.6
12.2
65.0
9.9
29.2
41.8
61.9
Total
838
5,747
100.0
48.0
Source: As for figure 1.
an arrears rate of 48%.17 Repayment varies significantly across loans, however.
Figure 2 shows the size distribution of loans by their respective arrears rates. On
the one hand, 321 loans have been have been repaid in full and on time (including
a few for which repayments exceed payments due). On the other hand, amounts
due on 305 loans have been repaid only partially, and repayments on 212 loans
are fully in arrears.
LOAN AMOUNTS AND LOAN PERFORMANCE:
BORROWERS AND LENDERS
The amount of borrowing and loan repayment performance varies notably by
certain borrower characteristics and by lenders. Table 1 shows the number of
loans, loan amounts, and loan repayment arrears by type of borrower. Borrowing by PDAMs makes up the vast bulk of sub-national borrowing, comprising
nearly two-thirds of the total. PDAM loan repayments are also substantially
poorer than those of other borrowers; arrears rates for PDAMs are 62%. Borrowing by provinces, kabupaten and kota makes up 16%, 7% and 12% of overall amounts; arrears rates of those types of borrowers are 10%, 29% and 42%,
respectively.
Borrowing and repayment also vary considerably by location of borrower.
Table 2 provides the same information as the previous table, organised by major
geographic area of borrower. Borrowing in Java–Bali has dominated, making up
over two-thirds of the total amount. Borrowers on Java–Bali have also repaid
their loans to a relatively better extent than those in other locations. The arrears
rate of Java–Bali borrowers is about 40%. Borrowing in other geographic regions
has been much more limited, and repayment performance has been significantly
poorer. Borrowers in Sumatra, Sulawesi, Kalimantan, and Eastern Indonesia
17 The arrears rate is equal to total payments in arrears divided by total payments due.
Its use as a performance measure is standard in Indonesia. Loan repayment is not the only
infrastructure finance outcome that matters, of course. Other important performance indicators include the extent to which projects were completed and the quality of infrastructure
created via the loan finance, for example. Unfortunately, however, there are no data on
these features of loan and project performance.
On-lending in Indonesia: past performance and future prospects
43
TABLE 2 Borrowing and Arrears by Location of Borrower
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
Location
Loans
Amount
(Rp billion)
Amount
(%)
Arrears Rate
(%)
Java–Bali
Sumatra
Sulawesi
Kalimantan
Eastern
418
239
116
41
24
3,881
990
429
341
107
67.5
17.2
7.5
5.9
1.9
39.5
61.4
79.5
56.9
71.3
Total
838
5,747
100.0
48.0
Source: As for figure 1.
have carried out 17%, 8%, 6% and 2% of total borrowing, respectively; attendant
arrears rates are 61%, 80%, 57%, and 71%, respectively.
Finally, table 3 presents borrowing and arrears information by source of funds.
The central government (GOI) has lent more to sub-national governments and
enterprises than other lenders (34% of the total amount), followed by the WB
(27%) and the ADB (15%); all other lenders combined make up about one-quarter
of all lending. At 36%, the arrears rate on WB loans is noticeably lower than that
on loans from other lenders. The arrears rates on ADB loans and all other aid
agencies’ loans combined are both around 51% while that of loans from the central government is 54%.
The remainder of this section of the paper examines how the major lenders have allocated their loan finance across borrowers of various kinds. Among
other things, this analysis may assist in explaining differences in arrears rates
across lenders. It is not the contention here that lenders have selected borrowers with a view to optimising loan repayments; indeed it is clear that lenders
have not paid much attention at all to borrower creditworthiness in their credit
allocation decisions. Nonetheless, a lender’s choice of borrowers does, inadvertently at least, determine the overall repayment performance of loans in its
portfolio.
TABLE 3 Borrowing and Arrears by Source of Funds
Source
Loans
Amount
(Rp billion)
Amount
(%)
Arrears Rate
(%)
GOI
ADB
WB
Other
431
218
145
44
1,965
847
1,535
1,400
34.2
14.7
26.7
24.4
54.4
50.9
36.0
51.3
Total
838
5,747
100.0
48.0
Source: As for figure 1.
44
Blane D. Lewis
TABLE 4 Lender Allocation of Finance across Borrower Types
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
Type
Arrears
Rate
(%)
Share of Total Lending
(%)
All
GOI
ADB
WB
Province
Kabupaten
Kota
PDAM
9.9
29.2
41.8
61.9
16.2
6.6
12.2
65.0
19.3
9.3
9.4
62.0
2.1
12.9
17.8
67.2
22.0
5.6
21.9
50.5
Total
48.0
100.0
100.0
100.0
100.0
Source: As for figure 1.
Table 4 shows lender allocation of finance across borrower types. As the table
shows, the WB allocates a substantially higher percentage of its finance to provinces (22%) than the ADB (2%) and a significantly lower percentage of its loan
portfolio to PDAMs (51%) than either the ADB (67%) or the government (62%)
does. That is, compared with other lenders, the WB allocates a higher percentage
of its funds to borrowers with the best repayment records (provinces) and a lower
percentage to those with the worst repayment histories (PDAMs).
Table 5 provides information on the distribution of lender portfolios across
borrower locations. The table shows that WB lending has been concentrated in
Java–Bali to a relatively larger extent (86%) than either ADB (63%) or government lending (53%). Note also that WB lending to borrowers on Sumatra has been
insignificant (1% of total amounts), whereas both ADB and the government have
devoted substantial proportions of their loan finance to such borrowers (36% and
26%, respectively). As shown in the first column of the table, sub-national government and enterprise borrowers in Java–Bali have repaid relatively better than
others, while those in Sumatra have repaid their loans less well.
TABLE 5 Lender Allocation of Finance across Borrower Locations
Location
Arrears
Rate
(%)
Share of Total Lending
(%)
All
GOI
ADB
WB
Java–Bali
Sumatra
Sulawesi
Kalimantan
Eastern
39.5
61.4
79.5
56.9
71.3
67.5
17.2
7.5
5.9
1.9
53.0
25.5
10.0
6.8
4.7
62.6
35.9
0.0
0.0
1.5
85.7
1.1
5.2
7.8
0.2
Total
48.0
100.0
100.0
100.0
100.0
Source: As for figure 1.
On-lending in Indonesia: past performance and future prospects
45
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
In summary, whatever the underlying reasons, the WB has been more inclined
than the government and the ADB to focus its allocations on borrowers that repay
relatively well. The overall conclusion, however, must be that government and
foreign aid agencies alike have not allocated infrastructure finance as a function
of the creditworthiness of borrowers to a satisfactory extent; nor have they paid
sufficiently close attention to collection of loan repayments.
PROGNOSIS FOR ON-LENDING
AND ALTERNATIVE MARKET-BASED METHODS
The government has recently put in place a new regulatory framework for
sub-national borrowing, in general, and for on-lending, in particular.18 Major
international aid agencies have supplied substantial resources to support the
development of the new framework, especially as concerns on-lending. Success
in improving the performance of on-lending will depend on the extent to which
the new system is able to correct current shortcomings. In this regard, the analysis
above highlighted five particular and inter-related areas of concern that warrant
attention: supply driven project development and finance; time-consuming loan
approvals; the limited volume of funds channelled through the system vis-à-vis
infrastructure finance needs; inattention to credit risk in the allocation of finance;
and poor repayment of loans.
New regulatory system for sub-national borrowing and on-lending
The new regulatory framework lays out the basic principles of sub-national borrowing and on-lending. At the broadest level it covers, among other matters,
sources, types and uses of borrowing; conditions and limits on borrowing; and
attendant reporting requirements. A brief description of the main principles of the
new regulatory system follows.
Sub-national units may borrow from the central government, from other subnationals, from domestic banks and non-bank financial institutions, and from
Indonesian citizens. Borrowing from the central government includes that via aid
agency on-lending. Borrowing from citizens is intended to refer to the issue of
sub-national bonds.
Types of borrowing include short-term borrowing (maturities shorter than one
year), medium-term borrowing (maturities longer than one year but less than the
remaining term in office of the executive of the borrowing sub-national government), and long-term borrowing (maturities longer than one year and extending
beyond the term of the executive). Borrowing uses are tied to types. Short-term,
medium-term and long-term borrowing are to be used, respectively, for cash flow
management, finance of infrastructure that does not directly generate revenues,
and finance of infrastructure that does directly generate revenues.
18 The new legal framework is effectively provided by Law 33/2004 on Intergovernmental Finance, Government Regulation 54/2005 on Regional Borrowing, and two ministerial
decrees, including one for the submission and review of project proposals and one related
to rules and regulations for on-lending. The new system as codified in these legal instruments supplants the old framework, which was developed in conjunction with the initiation of Indonesia’s decentralisation program, launched in 2001.
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
46
Blane D. Lewis
Limits and other conditions placed on borrowing include both ‘micro’ and
‘macro’ restrictions. Micro restrictions apply to the amounts that may be borrowed
by any individual sub-national government. Outstanding debt of a sub-national
government may not exceed 75% of the previous year’s general revenues. In addition, a sub-national government’s debt service coverage ratio (defined as general
revenues net of civil servant salaries and local parliament expenditures divided by
debt service obligations) must be at least 2.5. Finally, a sub-national government
may not borrow if it is in arrears on its debt repayments to the central government.
Sub-national borrowing must also comply with certain macro aggregate restrictions. There are two such limits. Consolidated public sector debt must not exceed
60% of GDP, and the consolidated public sector annual deficit (which may be
financed by borrowing) must not exceed 3% of GDP. The central government may
use the above aggregate restrictions to set overall borrowing limits for provinces
and local governments, as well as those for individual sub-national governments
(i.e. above and beyond those described in the preceding paragraph) if it sees fit
to do so.
In addition to the above borrowing restrictions, other conditions apply to subnational government borrowing. Sub-national governments are prohibited from
borrowing directly from foreign sources, and they must receive the approval of
their parliaments to engage in medium- and long-term borrowing. Importantly,
sub-national units are prohibited from pledging their revenues or assets to guarantee loans. An exception to the latter concerns the issue of bonds; sub-nationals
may use the asset constructed via bond finance, and pledge associated revenues,
as security. Lastly, sub-national governments may not guarantee the loans of third
parties (such as their water enterprises, for example).19
Finally, the regulatory framework stipulates certain reporting requirements
related to sub-national borrowing. Sub-national governments are required to
report their debt positions and other financial information twice each fiscal year
both to their parliaments and to the central government. No provisions have yet
been made for sub-nationals to disclose their financial positions to other than the
central government and local parliaments. Neither the central government nor
local parliaments make such data publicly available.
Sub-national governments that contravene any of the above principles are
subject to sanctions. In particular, the centre may ‘intercept’ (i.e. delay or cut)
a region’s intergovernmental transfers if it fails to comply with restrictions and
other conditions. The central government may also intercept a sub-national government’s transfers if it fails to make repayments on loans that it has taken from
the centre (this applies only to loans taken out since 2001).
In terms of attempting to improve on-lending outcomes, four features of the
new framework stand out. The first relates to the new mechanism for submitting
and reviewing project proposals and approving loans. This is referred to as the
‘blue book’ system, named after the document that contains the current list of
projects that have been reviewed by the National Development Planning Agency,
Bappenas, and deemed ready for implementation. Under the emerging system,
19 Law 33/2004 also asserts that the central government will not guarantee revenue bonds
issued by sub-national governments. The centre continues to provide a sovereign guarantee for aid agency on-lending.
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
On-lending in Indonesia: past performance and future prospects
47
both sub-national governments and central departments may develop on-lending
project proposals. Provinces and local governments submit project proposals
directly to Bappenas for initial review. Central departments may also put forward
on-lending project proposals, although they must coordinate their submissions
with relevant sub-national governments. But the fact that central departments
may initiate proposals for local projects to be financed by on-lending raises the
concern that a supply orientation in project development may still obtain under
certain circumstances.
After project proposals are reviewed and the blue book is issued, a variety of
additional tasks must be undertaken and completed before implementation can
begin. A decision must be made as to which projects in the blue book should be
prioritised to start in the given fiscal year; sub-national governments must make
formal proposals to secure finance and those proposals must be evaluated; subnationals must demonstrate that they have satisfied a number of government
‘readiness criteria’;20 aid agency loans must be negotiated and agreement reached;
and sub-loan agreements (with the sub-national borrower) must be drawn up.
Bappenas, MOF and the Ministry of Home Affairs, as well as relevant technical
departments, are all involved at various stages in the process. A recent review
of the new system (Lewis and White 2005) concluded that while it may, in fact,
represent an improvement over its predecessor, significant delays in the development of sub-national on-lending projects and the disbursement of funds are likely
to remain the norm.
Second, as noted above, the new arrangements insist that any long-term lending to sub-national governments may only be used to finance public infrastructure that directly yields revenues for sub-national government budgets. This
stipulation will necessarily limit potential lending to sub-national governments
to levels lower than might be justified and than might otherwise be achieved.21
The requirement is arguably wrong-headed. Sub-national governments should be
permitted to borrow to finance public capital development regardless of whether
the infrastructure that is created generates revenues directly or not, as long as
they have the ability and willingness (as demonstrated by past repayment experience, for example) to repay. To disallow on-lending as a means of financing nonrevenue generating public infrastructure suggests that such infrastructure would
have to be financed either through own sources or through intergovernmental
grants instead. The use of these funding sources is less satisfactory from adequacy,
efficiency and equity points of view.
The third pertinent characteristic of the new framework concerns the existence
of repayment arrears of potential sub-national government and water enterprise
20 Sub-national borrowers must ensure that project performance indicators are in place
and necessary data to measure them available; that local counterpart funds for the first
year of the project have been allocated in the relevant year’s budget; that land procurement and/or resettlement plans, to the extent they are needed, have been finalised; that
project management and project implementation units have been formed; and that project
management plans and guidelines have been prepared.
21 The fact that the government has not precisely defined what kinds of projects are
‘directly revenue generating’ compounds the problem; while it has promised to produce a
list of such projects, it has not yet done so.
48
Blane D. Lewis
TABLE 6 Classification of Potential Sub-national Borrowers
Provinces
Kabupaten/Kota
PDAMs
Past borrowers without arrears
Never borrowed
Past borrowers with arrears
10
6
16
85
192
107
24
107
189
Total
32
384
320
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
Source: As for figure 1.
borrowers. Specifically, government and aid agencies will only be allowed to lend
to those provinces and local governments without arrears on repayments of past
loans from the central government. And lenders may only lend to PDAMs as long
as both the PDAMs and their associated local governments are free of arrears
on prior SLA or RDA loans. Insisting that potential borrowers be free of arrears
before they are allowed to borrow is a useful pre-condition from the point of view
of encouraging government and aid agencies to lend to creditworthy borrowers.
It essentially forces lenders to pay more attention to credit risk, albeit in a somewhat crude fashion.
Based on the no-arrears criterion, two types of potential sub-national government borrowers immediately present themselves: those that have borrowed and
have repaid their obligations in full and those that have never borrowed. There
are just 95 sub-national governments (10 provinces and 85 local governments)
that have borrowed from the centre in the past and that are free of arrears. The
second group is significantly larger than the first: 198 sub-national governments
have never borrowed (six provinces and 192 local governments). The situation is
slightly more complicated for water enterprises. As noted, both PDAMs and their
associated sub-national governments must be free of arrears before the former
would be allowed to borrow. There are only 24 PDAM past borrowers without
arrears and eight of their respective local governments have repayment arrears
on past loans from government. On the other hand, 107 PDAMs have never taken
out a loan; seven of their associated local governments have borrowed from the
centre and are in arrears on loan repayments. These data are summarised in the
first two rows of table 6.
If on-lending to sub-national governments is to be sufficiently increased it
will not be adequate to rely on past borrowers with good repayment records;
sub-national governments and enterprises that have never borrowed will need
to be encouraged to do so. In the present environment, the extent to which this is
possible is quite unclear. The government has no plan in place to stimulate credit
demand among sub-national units that have no experience with borrowing.
Increasing the number of potential borrowers further would require that
those sub-national governments and water enterprises with repayment arrears
on past loans clear away those arrears (see the third row of table 6). There are
123 sub-national government borrowers with arrears (16 provinces and 107 local
governments); in addition, there are 189 PDAM borrowers with arrears (and an
additional associated 93 local government borrowers with arrears).
On-lending in Indonesia: past performance and future prospects
49
TABLE 7 Aggregate Borrower Arrears and Reserves
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
Arrears
(Rp billion 2004)
Reserves
(Rp billion 2005)
Provinces
Kabupaten/Kota
PDAM
122
560
2,751
15,761
25,949
n.a.
Total
3,433
41,710
n.a. = not applicable.
Source: As for figure 1.
Two plausible means exist for sub-national governments and their enterprises
to eliminate their loan repayment arrears. First, sub-national governments could
use their accumulated unspent revenues, or ‘reserve funds’, to pay off their (and
their water enterprises’) arrears immediately. Second, sub-national borrowers
could have their debt repayment obligations (including any arrears) restructured,
rescheduled or written off by the central government.
Sub-national governments have substantial reserve funds. By the end of 2005,
provinces and local governments together had accumulated about Rp 41.7 trillion
in reserves.22 By contrast, total provincial, local government and PDAM repayment arrears amounted to only around Rp 3.4 trillion (at the end of 2004) (table 7).
In the aggregate therefore, provinces and local governments would appear to
have more than enough funds to clear away easily the entire stock of sub-national
government and water enterprise arrears.23
The aggregate data offer only an approximate appraisal of the extent to which
sub-national government reserves might be used to cover repayment arrears,
however. A more accurate picture of the sufficiency of reserves to cover arrears
would be provided by a comparison of reserves with arrears at the individual
sub-national government level (table 8).
As the table shows, most individual sub-national governments have sufficient
reserves to cover their arrears and those of their water enterprises. Over 85% of
individual borrowers could have their arrears cleared away by the relevant subnational government’s stock of reserves. Of course, sub-national government
22 The sub-national stock of reserves at the end of 2005 amounted to about 21.5% of total
sub-national expenditure that year and approximately 1.6% of GDP (in 2005). As of the end
of November 2006, sub-national government reserves had grown to Rp 95 trillion.
23 The magnitude of such reserves may raise the question as to why sub-national governments should bother to borrow at all, when they could simply use their reserves to finance
infrastructure. Such reserve funds could, in fact, appropriately be used to finance capital
expenditure, of course. But reserves might legitimately be required for other purposes as
well, including addressing cash flow problems and contingency or emergency needs (Tyer
1993). This suggests that it would not be prudent for sub-national governments to use the
entire stock of their reserves to finance public capital development.
50
Blane D. Lewis
TABLE 8 Individual Borrower Arrears and Reserves
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
Borrowers with Arrears
Borrowers with Sufficient
Reserves to Cover Arrears
Provinces
Kabupaten/Kota
PDAM
16
107
189
15
99
154a
Total
312
268
a Local government reserves sufficient to cover both PDAM arrears and any arrears of local governments.
Source: As for figure 1.
willingness to use reserves in such a manner cannot be guaranteed. The reasons
for such unwillingness are surely varied. Without doubt sub-national governments benefit from the interest earnings on their stocks of reserves. In some cases,
sub-nationals might have legitimate alternative expenditure plans for such funds.
Finally, while there is (as yet) no direct evidence of specific corrupt practices associated with reserve funds, clearly this is a possibility, given the insufficient controls that exist at the sub-national level.
While the central government is aware of the general issue, officials have not
yet thought much about how they might encourage sub-nationals to use their
reserves to pay off their stocks of arrears. Indeed, in the new decentralised environment it is not clear what the government could do to stimulate use of reserves
in this way, barring a decision directly to mandate some action by legal means.
Such an act would certainly prove highly controversial; it is probably politically
infeasible.
Separate from new on-lending arrangements, the central government has
recently authorised covering legislation that provides the beginnings of a framework for restructuring, rescheduling and writing off loan repayments associated
with PDAM debt. Technical guidelines for the PDAM debt work-out agenda are
currently being prepared, but implementation has not yet begun. Similar legislation for provincial and local government debt work-outs is planned, but relevant
work has not yet commenced.
The final feature of the regulatory environment of interest concerns the government’s intergovernmental transfer intercept mechanism. As noted above, government may cut any sub-national’s transfers if it fails to meet loan repayment
obligations to the centre. Actually, this is not a new attribute of the intergovernmental framework; the intercept has been in place since 2001. The main problem
with the tool is simply the government’s apparent and unfortunate reluctance to
employ it: there have been numerous instances since 2001 when the government
might have legitimately used the transfer intercept, but so far it has chosen not to
do so.
In summary, it would not appear that the new regulatory framework for onlending will be of much assistance in facilitating improved on-lending performance. The new project review and loan approval process provides some rather
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
On-lending in Indonesia: past performance and future prospects
51
unfortunate scope for central departments to force the development of local
projects that they consider are of the highest priority (but that sub-nationals may
not). In any case, it is likely to remain cumbersome and time consuming. The
amount of finance channelled through the system is likely to remain significantly
lower than is justified, at least in part because on-lending is restricted to financing
revenue generating projects. While the new framew
ISSN: 0007-4918 (Print) 1472-7234 (Online) Journal homepage: http://www.tandfonline.com/loi/cbie20
ON-LENDING IN INDONESIA: PAST PERFORMANCE
AND FUTURE PROSPECTS
Blane D. Lewis
To cite this article: Blane D. Lewis (2007) ON-LENDING IN INDONESIA: PAST PERFORMANCE
AND FUTURE PROSPECTS, Bulletin of Indonesian Economic Studies, 43:1, 35-58, DOI:
10.1080/00074910701286388
To link to this article: http://dx.doi.org/10.1080/00074910701286388
Published online: 08 Nov 2007.
Submit your article to this journal
Article views: 79
View related articles
Citing articles: 5 View citing articles
Full Terms & Conditions of access and use can be found at
http://www.tandfonline.com/action/journalInformation?journalCode=cbie20
Download by: [Universitas Maritim Raja Ali Haji]
Date: 18 January 2016, At: 20:01
Bulletin of Indonesian Economic Studies, Vol. 43, No. 1, 2007: 35–57
ON-LENDING IN INDONESIA:
PAST PERFORMANCE AND FUTURE PROSPECTS
Blane D. Lewis*
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
World Bank, Jakarta
On-lending to sub-national governments in Indonesia has a long and generally disappointing history. Among other noteworthy problems, an insufficient amount of
funds has been channelled through the system vis-à-vis capital financing needs, and
loan repayments have proved poor. Aid agencies and government have recently
invested substantial resources in attempts to improve the on-lending system; the resultant newly installed regulatory framework for sub-national borrowing is, however, unlikely to improve outcomes substantially. Developing sub-national government access to private capital markets would appear to constitute the way forward,
although this will not come quickly or easily. A positive step in the right direction
would be for government and aid agencies to embrace the anticipated change and
work together to make the transition a successful one, rather than continue to tinker
with reforms at the margin of a moribund system.
INTRODUCTION AND BACKGROUND
On-lending refers to the means by which international aid agencies and central governments channel long-term finance to sub-national governments.1 In this context,
aid agencies make loans to the central government and to (mostly) publicly owned
and managed financial institutions which, in turn, on-lend the funds to sub-national
governments. And central governments lend to their sub-nationals from their own
resources, either directly or via public financial institutions.2 On-lending is a commonly used tool to finance local public infrastructure in developing countries, especially in cases where capital markets are relatively under-developed.
* The author is Senior Adviser for Fiscal Decentralization at the World Bank in Jakarta under financing from the Dutch Trust Fund (TF050378). The views expressed here are those of
the author and should not be attributed to the World Bank or the government of the Netherlands. The author would like to thank Indonesia’s Ministry of Finance for access to data
used in this paper; Kutlu Kazanci for expert research assistance; and Sebastian Eckardt,
Andre Oosterman, Bill Wallace, David Woodward, two anonymous referees and the editor
for comments on earlier versions of the paper.
1 On-lending may also be used in some countries to channel finance to national stateowned enterprises. This paper considers only on-lending to sub-national governments
(and sub-national government enterprises).
2 Very occasionally, publicly sponsored financial intermediaries also access funds from
private capital markets, which are then on-lent to sub-nationals.
ISSN 0007-4918 print/ISSN 1472-7234 online/07/010035-23
DOI: 10.1080/00074910701286388
© 2007 Indonesia Project ANU
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
36
Blane D. Lewis
In Indonesia, international aid agencies lend to sub-national governments and
their enterprises through the central government’s mechanism for on-lending
foreign funds, the Subsidiary Loan Agreement (SLA). The most important aid
agencies involved in on-lending to sub-national units are the World Bank (WB)
and the Asian Development Bank (ADB), although other development assistance
agencies have also been involved.3 The central government makes loans to subnationals through its Regional Development Account (RDA).4 RDA loans are, for
the most part, sourced from own domestic public revenues, although a minimal
amount of funding has come from aid agency (ADB and United States Housing
and Environmental Credit Guarantee program) contributions.
Research focused specifically on on-lending is somewhat limited. In the only
widely available comparative study on the topic, Peterson (1996) evaluates the
performance of on-lending in 25 countries. The basic conclusion reached was that
on-lending has not worked satisfactorily. In this regard, three outcomes in particular appear to be the norm. First, insufficient funds are transferred through onlending mechanisms to meet sub-national infrastructure finance needs. Second,
various intermediation functions are performed poorly by the central government and other relevant financial institutions.5 Third, loan repayments are weak
(Peterson 1996).
In a study specific to Indonesia, Devas and Binder (1989) broadly examine early
SLA on-lending and that of RDA’s forerunners—Rekening Dana Investasi (RDI) and
the Inpres Pasar program,6 among others. The authors criticise the near exclusive
focus of such lending on revenue-generating projects, which they argue is inefficient
and inequitable.7 In Lewis (2003) I analyse the Indonesian experience of on-lending to
local governments through 1999, concentrating on the evident poor loan repayment
record. I find that frequent non-repayment of loans appears to result not from inabil-
3 Other aid agencies include, most importantly, those of France, Germany, Japan, the
Netherlands, Switzerland and the United States.
4 Throughout this paper, ‘RDA’ refers to lending carried out by the RDA, as well as that by
its predecessor programs, including the Investment Fund Account (Rekening Dana Investasi, RDI), Inpres Pasar, and others (Inpres stands for ‘Instruksi Presiden’, the name given to a
program of special grants from the central government; footnote 6 explains ‘Inpres Pasar’).
The RDI and Inpres Pasar programs’ loans have since been rolled into RDA operations.
5 In many cases these functions extend beyond the simple supply of credit and collection
of repayments, to include performing financial and economic project appraisals, blending grants with loans, overseeing project preparation and implementation, and providing
technical assistance in financial management (Peterson 1996).
6 RDI loans were used to finance various types of sub-national government infrastructure;
Inpres Pasar loans were exclusively for market construction.
7 It is usually argued that it is more economically efficient to borrow now in order to satisfy present needs or demand than it would be to wait until adequate funds can be accumulated over time. Borrowing for capital development is deemed equitable, since those who
actually use the generated services can be made to pay for them over the course of the life
of the infrastructure. (Note that the latter also supports the economic efficiency argument.)
Significant efficiency and equity improvements are forgone by restricting borrowing to
revenue-generating projects.
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
On-lending in Indonesia: past performance and future prospects
37
ity to repay but rather from a lack of willingness to do so.8 In addition, I argue that
neither the central government nor aid agencies have shown much interest in forcing
better repayment. The latter, at least, lack an incentive to do so, since their loans are
repaid by the centre regardless of whether local governments repay or not.9
A related strand of research examines the constraints that sub-national governments face in moving beyond the use of narrow on-lending mechanisms to access
private capital markets. Freire and Petersen (2004) discuss the basic requirements
of sub-national capital market development, focusing on the political, legal, and
financial regulatory environment and appropriate market-based borrowing instruments. They investigate the situation in 18 countries across Latin America, Africa,
Asia and Eastern and Central Europe. One of the countries reviewed is Indonesia.
The authors of the Indonesia chapter note that the lack of security provisions in law,
and uncertain legal requirements concerning sub-national financial reporting and
disclosure, such as existed during the period just after the launching of the government’s decentralisation program in 2001, were important constraints to the development of market-based approaches in Indonesia (Kehew and Petersen 2004).
Martell and Guess (2006) develop a framework for assessing the readiness of
sub-national governments to employ market-based debt financing, and apply the
framework to five countries, including Indonesia.10 Their general thesis is that the
successful development of sub-national capital markets is a function of the regulatory framework and financial institutions’ ability to evaluate credit risk, most
importantly, and sub-national governments’ capacity to properly manage debt,
to a secondary extent. The authors find that, among the countries examined, subnational governments in Indonesia show the least potential for accessing private
capital markets, judging from the institutional environment that existed during
the early years of decentralisation.
The broad objectives of this paper are to provide a historical review of onlending and to assess the near-term prospects for on-lending and alternative
methods of financing sub-national public capital development in Indonesia. To the
author’s knowledge there is no published research focused on the history of, and
prognosis for, on-lending in any country. And while there has been some work on
the possibilities surrounding the development of sub-national government access
8 Note that this statement pertains to local governments only and not necessarily to local
government water enterprises, which were not examined in the cited study. Many water
enterprises may be unable to service their loans; of course this inability to repay is in many
cases a function of tariffs being set at below cost-recovery levels. Improper setting of tariffs
for services is a significant problem in Indonesia. Further analysis of this problem is, however, beyond the scope of the present paper.
9 There has been a considerable amount of unpublished research and writing on onlending in Indonesia. These efforts describe the status of SLA and RDA portfolios at particular points in time (Lewis 1997a, 1997b; Woodward 2000, 2005); examine the regulatory
framework and procedural arrangements for on-lending (Woodward 2000; Oosterman and
Samiadji 2004; Oosterman 2005; and Lewis and White 2005); and explore the possibilities
for moving beyond on-lending to sub-national units (Research Triangle Institute 1999; Varley 2001; Weitz 2001; and Development Alternatives 2002).
10 Other countries included in the analysis are Mexico, the Philippines, Poland and South
Africa.
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
38
Blane D. Lewis
to capital markets in Indonesia (among other countries—see above), these analyses were based on a regulatory system that has now been replaced. As such, this
paper should help to fill a significant gap in the literature and also provide some
updated information on a research topic previously considered.
The focus of the historical investigation is on evaluating the magnitude and
performance of SLA and RDA on-lending from 1975 to 2004. In this regard, the
paper pays special attention to the influence of the major lenders in explaining
loan performance during this period; differential outcomes associated with central
government, WB and ADB lending are highlighted throughout the study. Government and major international aid agencies have, in recent years, focused their
resources on improving on-lending; relatively less attention has been paid to developing more market-based systems. The future prospects of on-lending in Indonesia
depend on the extent to which performance across a number of dimensions can be
enhanced. The paper examines the possibilities in this regard in light of the new and
still emerging regulatory framework for sub-national borrowing in general and onlending in particular. Successful development of alternative market-based methods
of sub-national finance also depends in part on the new regulatory framework, and
the study briefly explores the potential in this regard as well.
The paper proceeds as follows. First, some background material on SLA and
RDA on-lending is presented, the data used in the analysis are briefly described,
and basic empirical facts about on-lending are provided. Second, information on
the number of loans, the amount of loan finance, and loan repayment performance, organised according to borrower characteristics and by lender, is supplied; in
addition, this section of the paper examines government and aid agency allocation
of loan finance across borrower types and locations. Third, a prognosis for continued on-lending is offered and alternative options are briefly considered. Finally,
the paper summarises the main points of the investigation and offers some policy conclusions relevant to lending to sub-national governments in Indonesia. An
appendix provides a formal empirical examination of the relationship between loan
repayment and certain loan and borrower characteristics and major lenders.
SLA AND RDA ON-LENDING
AND SOME PRELIMINARY EMPIRICAL EVIDENCE
SLA and RDA on-lending11
SLA and RDA on-lending mechanisms have been used to channel long-term finance
for infrastructure development to provinces, local governments12 and local water
enterprises (perusahaan daerah air minum, PDAMs).13 Interest rates on both SLA
and RDA loans have varied quite significantly over the years, ranging from zero
to around 13%. Since the early 1990s, however (until very recently), SLA and RDA
loan rates have been fixed at 11.5% (although SLA loans typically carry an extra
11 This section draws heavily on Research Triangle Institute (1999) and Lewis (2003).
12 Local governments comprise municipalities (kota) and districts (kabupaten).
13 Most on-lending to provinces and local governments has gone towards financing the
construction of transport terminals and markets and, to a somewhat lesser extent, roads
and drainage systems.
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
On-lending in Indonesia: past performance and future prospects
39
0.25% interest charge remitted to commercial banks responsible for collections—see
below). Loan grace periods and maturities have usually been set at 3–5 years and
18–20 years, respectively, for both SLAs and RDAs. SLA loan interest is capitalised
during grace periods, while RDA loan interest accumulates during grace periods;14
both SLA and RDA loan funds are disbursed at regular intervals during grace periods against evidence of project expenditures. Repayment schedules typically comprise equal instalments on principal, and interest is paid on the declining balance;15
repayments are due every six months after the grace period expires. The Ministry of
Finance (MOF) oversees both SLA and RDA on-lending mechanisms.
Three issues regarding the implementation of SLA and RDA on-lending merit
attention. The first relates to the relative demand orientation of SLA and RDA
lending. In years past, SLA lending, particularly as associated with the multi-lateral aid agencies’ Integrated Urban Infrastructure Development Program (IUIDP),
was frequently criticised for being ‘supply-driven’. Many sub-national government officials argued that IUIDP projects were, in large measure, designed by
aid agency-financed consultants, without much local government or community
involvement. In addition, it has been asserted that loans were often just ‘assigned’
to the local government by the centre as the means by which the projects would
(at least partially) be financed. In some cases, local officials claimed not even to
have understood that they were signing loan agreements.
The RDA was created in 1988 in part to be more responsive to sub-national government demand for infrastructure finance than SLA lending was perceived to be.
As such, RDA lending was from the start based on individual project proposals
from sub-national governments and enterprises, rather than on integrated infrastructure projects designed and promoted by aid agencies. Whether RDA lending
has actually achieved more of a demand orientation than SLA lending is a matter
of some dispute, however. At least some research has argued that many projects
designed by the Department of Public Works and financed by RDA loans seem
also to have followed a supply-led approach (Research Triangle Institute 1999).
Second, obtaining SLA and RDA project and loan approvals has proven burdensome for borrowers. SLA projects can take three to five years to be developed and
begin implementation. IUIDP project development, approval and start-up was
especially time consuming. Those projects were multi-sectoral and therefore relatively complicated by nature; attendant loans were usually part of a larger financing
package, which needed to be approved in its entirety before project implementation
could begin. RDA project approval and start-up has typically been less onerous
than that for SLAs, but may still take up to two years. The shorter time line for RDA
lending is mainly a function of the simpler nature of the projects themselves; that is,
loans have exclusively financed single, stand-alone projects.
The third issue of note concerning SLA and RDA on-lending relates to loan
administration. The disbursement of SLA loans is initiated by the Directorate of Budget Administration in MOF’s Directorate General of Budget; RDA
14 Capitalised interest refers to the compounding of annual interest charges against principal and accrued interest during the grace period. Accumulating interest means that annual interest charges are applied only to the original principal during grace.
15 Occasionally repayment schedules of RDA loans have been based on fixed principal
and interest instalments.
40
Blane D. Lewis
FIGURE 1 On-lending to Sub-nationals, 1975–2004
(Rp trillion, constant 2004 prices)
4.5
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
3.0
1.5
0.0
1975
1980
1985
1990
1995
2000
Source: Ministry of Finance Regional Finance Information System.
disbursement orders are given by the Directorate of On-lending, which is (now)
located in the Directorate General of Treasury, MOF. Each directorate has tended
to keep relevant disbursement information to itself. This has sometimes caused
difficulties for the Directorate of On-lending, which is charged with compiling
repayment schedules for both SLA and RDA loans, for which precise information on the amount and timing of disbursements is required. More important for
the present examination are the differences related to loan repayment collection.
Collection of SLA loan repayments is the responsibility of local ‘handling’ banks,
typically local branches of state banks, which are nominated in the individual
loan agreements between aid agencies and the government. As noted above, the
handling bank charges an annual fee, amounting to 0.25% of the outstanding loan
amount. Collection of RDA loan repayments, on the other hand, is administered
entirely by the Directorate of On-lending, Directorate General of Treasury, MOF,
and no additional charges are levied (Woodward 2000).
Data and preliminary empirical evidence
The data used in this paper are from the Directorate of On-lending, MOF. The data
set comprises all SLA and RDA loans to sub-national governments and PDAMs
from 1975 through 2004. A total of 838 loans were extended over the period to 426
borrowers. For each loan, information is available on the name of the borrower;
the source of funds (i.e. the lender); and the year, amount, interest rate and maturity of the loan. In addition, repayments due, made and in arrears are recorded for
each loan, as well as the outstanding principal.
In aggregate, lending to sub-national units through the SLA and RDA mechanisms has not been very significant. By the end of 2004, the total outstanding debt of
sub-national governments and water enterprises was Rp 4.2 trillion; by comparison,
the outstanding debt of the central government at the end of 2004 was Rp 1,291.3
On-lending in Indonesia: past performance and future prospects
41
FIGURE 2 Histogram of Loans by Arrears Rate, as at 2004
No. of loans
400
300
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
200
100
0
0
20
40
60
80
100
Arrears rate (%)
Source: As for figure 1.
trillion. The cumulative amount lent through SLA and RDA mechanisms from 1975
through 2004 was Rp 5.7 trillion in nominal terms or Rp 26.2 trillion in constant 2004
terms; these figures represent about 0.2% and 0.9% of 2004 GDP, respectively.16
While aggregate on-lending to sub-national governments has not been substantial, it does constitute the vast bulk of such lending to sub-nationals. There
has been only a very small amount of lending from other financial institutions,
such as regional development, state, or commercial banks, and most of this has
been to assist provinces and local governments in the management of cash flow.
An early study (Lewis 1991) estimated that less than 5% of total sub-national government borrowing was derived from sources other than the central government
(or foreign aid agencies via the central government).
The amount of on-lending to sub-national governments and their PDAMs has
varied significantly over time. Figure 1 shows on-lending disbursements over the
period in constant 2004 price terms. As the figure shows, after a relatively slow
and uneven start, lending grew quickly, beginning in the mid-1980s and reaching
a peak in the mid-1990s. Lending declined precipitously thereafter, and has not
recovered since. Lending under the central government’s decentralisation program, which began operations in 2001, has been near zero.
Repayment of loans has been generally poor (figure 2). At the end of 2004, total
payments due were Rp 7.1 trillion, of which only Rp 3.4 trillion had been paid—
16 By contrast, consider that the World Bank (2004) has estimated that Indonesia needs
to invest around 5% of GDP annually in public infrastructure, much of which is local in
character, in order to sustain a 6% medium-term economic growth target.
42
Blane D. Lewis
TABLE 1 Borrowing and Arrears by Type of Borrower
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
Type
Loans
Amount
(Rp billion)
Amount
(%)
Arrears Rate
(%)
Province
Kabupaten
Kota
PDAM
81
204
116
437
931
379
702
3,735
16.2
6.6
12.2
65.0
9.9
29.2
41.8
61.9
Total
838
5,747
100.0
48.0
Source: As for figure 1.
an arrears rate of 48%.17 Repayment varies significantly across loans, however.
Figure 2 shows the size distribution of loans by their respective arrears rates. On
the one hand, 321 loans have been have been repaid in full and on time (including
a few for which repayments exceed payments due). On the other hand, amounts
due on 305 loans have been repaid only partially, and repayments on 212 loans
are fully in arrears.
LOAN AMOUNTS AND LOAN PERFORMANCE:
BORROWERS AND LENDERS
The amount of borrowing and loan repayment performance varies notably by
certain borrower characteristics and by lenders. Table 1 shows the number of
loans, loan amounts, and loan repayment arrears by type of borrower. Borrowing by PDAMs makes up the vast bulk of sub-national borrowing, comprising
nearly two-thirds of the total. PDAM loan repayments are also substantially
poorer than those of other borrowers; arrears rates for PDAMs are 62%. Borrowing by provinces, kabupaten and kota makes up 16%, 7% and 12% of overall amounts; arrears rates of those types of borrowers are 10%, 29% and 42%,
respectively.
Borrowing and repayment also vary considerably by location of borrower.
Table 2 provides the same information as the previous table, organised by major
geographic area of borrower. Borrowing in Java–Bali has dominated, making up
over two-thirds of the total amount. Borrowers on Java–Bali have also repaid
their loans to a relatively better extent than those in other locations. The arrears
rate of Java–Bali borrowers is about 40%. Borrowing in other geographic regions
has been much more limited, and repayment performance has been significantly
poorer. Borrowers in Sumatra, Sulawesi, Kalimantan, and Eastern Indonesia
17 The arrears rate is equal to total payments in arrears divided by total payments due.
Its use as a performance measure is standard in Indonesia. Loan repayment is not the only
infrastructure finance outcome that matters, of course. Other important performance indicators include the extent to which projects were completed and the quality of infrastructure
created via the loan finance, for example. Unfortunately, however, there are no data on
these features of loan and project performance.
On-lending in Indonesia: past performance and future prospects
43
TABLE 2 Borrowing and Arrears by Location of Borrower
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
Location
Loans
Amount
(Rp billion)
Amount
(%)
Arrears Rate
(%)
Java–Bali
Sumatra
Sulawesi
Kalimantan
Eastern
418
239
116
41
24
3,881
990
429
341
107
67.5
17.2
7.5
5.9
1.9
39.5
61.4
79.5
56.9
71.3
Total
838
5,747
100.0
48.0
Source: As for figure 1.
have carried out 17%, 8%, 6% and 2% of total borrowing, respectively; attendant
arrears rates are 61%, 80%, 57%, and 71%, respectively.
Finally, table 3 presents borrowing and arrears information by source of funds.
The central government (GOI) has lent more to sub-national governments and
enterprises than other lenders (34% of the total amount), followed by the WB
(27%) and the ADB (15%); all other lenders combined make up about one-quarter
of all lending. At 36%, the arrears rate on WB loans is noticeably lower than that
on loans from other lenders. The arrears rates on ADB loans and all other aid
agencies’ loans combined are both around 51% while that of loans from the central government is 54%.
The remainder of this section of the paper examines how the major lenders have allocated their loan finance across borrowers of various kinds. Among
other things, this analysis may assist in explaining differences in arrears rates
across lenders. It is not the contention here that lenders have selected borrowers with a view to optimising loan repayments; indeed it is clear that lenders
have not paid much attention at all to borrower creditworthiness in their credit
allocation decisions. Nonetheless, a lender’s choice of borrowers does, inadvertently at least, determine the overall repayment performance of loans in its
portfolio.
TABLE 3 Borrowing and Arrears by Source of Funds
Source
Loans
Amount
(Rp billion)
Amount
(%)
Arrears Rate
(%)
GOI
ADB
WB
Other
431
218
145
44
1,965
847
1,535
1,400
34.2
14.7
26.7
24.4
54.4
50.9
36.0
51.3
Total
838
5,747
100.0
48.0
Source: As for figure 1.
44
Blane D. Lewis
TABLE 4 Lender Allocation of Finance across Borrower Types
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
Type
Arrears
Rate
(%)
Share of Total Lending
(%)
All
GOI
ADB
WB
Province
Kabupaten
Kota
PDAM
9.9
29.2
41.8
61.9
16.2
6.6
12.2
65.0
19.3
9.3
9.4
62.0
2.1
12.9
17.8
67.2
22.0
5.6
21.9
50.5
Total
48.0
100.0
100.0
100.0
100.0
Source: As for figure 1.
Table 4 shows lender allocation of finance across borrower types. As the table
shows, the WB allocates a substantially higher percentage of its finance to provinces (22%) than the ADB (2%) and a significantly lower percentage of its loan
portfolio to PDAMs (51%) than either the ADB (67%) or the government (62%)
does. That is, compared with other lenders, the WB allocates a higher percentage
of its funds to borrowers with the best repayment records (provinces) and a lower
percentage to those with the worst repayment histories (PDAMs).
Table 5 provides information on the distribution of lender portfolios across
borrower locations. The table shows that WB lending has been concentrated in
Java–Bali to a relatively larger extent (86%) than either ADB (63%) or government lending (53%). Note also that WB lending to borrowers on Sumatra has been
insignificant (1% of total amounts), whereas both ADB and the government have
devoted substantial proportions of their loan finance to such borrowers (36% and
26%, respectively). As shown in the first column of the table, sub-national government and enterprise borrowers in Java–Bali have repaid relatively better than
others, while those in Sumatra have repaid their loans less well.
TABLE 5 Lender Allocation of Finance across Borrower Locations
Location
Arrears
Rate
(%)
Share of Total Lending
(%)
All
GOI
ADB
WB
Java–Bali
Sumatra
Sulawesi
Kalimantan
Eastern
39.5
61.4
79.5
56.9
71.3
67.5
17.2
7.5
5.9
1.9
53.0
25.5
10.0
6.8
4.7
62.6
35.9
0.0
0.0
1.5
85.7
1.1
5.2
7.8
0.2
Total
48.0
100.0
100.0
100.0
100.0
Source: As for figure 1.
On-lending in Indonesia: past performance and future prospects
45
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
In summary, whatever the underlying reasons, the WB has been more inclined
than the government and the ADB to focus its allocations on borrowers that repay
relatively well. The overall conclusion, however, must be that government and
foreign aid agencies alike have not allocated infrastructure finance as a function
of the creditworthiness of borrowers to a satisfactory extent; nor have they paid
sufficiently close attention to collection of loan repayments.
PROGNOSIS FOR ON-LENDING
AND ALTERNATIVE MARKET-BASED METHODS
The government has recently put in place a new regulatory framework for
sub-national borrowing, in general, and for on-lending, in particular.18 Major
international aid agencies have supplied substantial resources to support the
development of the new framework, especially as concerns on-lending. Success
in improving the performance of on-lending will depend on the extent to which
the new system is able to correct current shortcomings. In this regard, the analysis
above highlighted five particular and inter-related areas of concern that warrant
attention: supply driven project development and finance; time-consuming loan
approvals; the limited volume of funds channelled through the system vis-à-vis
infrastructure finance needs; inattention to credit risk in the allocation of finance;
and poor repayment of loans.
New regulatory system for sub-national borrowing and on-lending
The new regulatory framework lays out the basic principles of sub-national borrowing and on-lending. At the broadest level it covers, among other matters,
sources, types and uses of borrowing; conditions and limits on borrowing; and
attendant reporting requirements. A brief description of the main principles of the
new regulatory system follows.
Sub-national units may borrow from the central government, from other subnationals, from domestic banks and non-bank financial institutions, and from
Indonesian citizens. Borrowing from the central government includes that via aid
agency on-lending. Borrowing from citizens is intended to refer to the issue of
sub-national bonds.
Types of borrowing include short-term borrowing (maturities shorter than one
year), medium-term borrowing (maturities longer than one year but less than the
remaining term in office of the executive of the borrowing sub-national government), and long-term borrowing (maturities longer than one year and extending
beyond the term of the executive). Borrowing uses are tied to types. Short-term,
medium-term and long-term borrowing are to be used, respectively, for cash flow
management, finance of infrastructure that does not directly generate revenues,
and finance of infrastructure that does directly generate revenues.
18 The new legal framework is effectively provided by Law 33/2004 on Intergovernmental Finance, Government Regulation 54/2005 on Regional Borrowing, and two ministerial
decrees, including one for the submission and review of project proposals and one related
to rules and regulations for on-lending. The new system as codified in these legal instruments supplants the old framework, which was developed in conjunction with the initiation of Indonesia’s decentralisation program, launched in 2001.
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
46
Blane D. Lewis
Limits and other conditions placed on borrowing include both ‘micro’ and
‘macro’ restrictions. Micro restrictions apply to the amounts that may be borrowed
by any individual sub-national government. Outstanding debt of a sub-national
government may not exceed 75% of the previous year’s general revenues. In addition, a sub-national government’s debt service coverage ratio (defined as general
revenues net of civil servant salaries and local parliament expenditures divided by
debt service obligations) must be at least 2.5. Finally, a sub-national government
may not borrow if it is in arrears on its debt repayments to the central government.
Sub-national borrowing must also comply with certain macro aggregate restrictions. There are two such limits. Consolidated public sector debt must not exceed
60% of GDP, and the consolidated public sector annual deficit (which may be
financed by borrowing) must not exceed 3% of GDP. The central government may
use the above aggregate restrictions to set overall borrowing limits for provinces
and local governments, as well as those for individual sub-national governments
(i.e. above and beyond those described in the preceding paragraph) if it sees fit
to do so.
In addition to the above borrowing restrictions, other conditions apply to subnational government borrowing. Sub-national governments are prohibited from
borrowing directly from foreign sources, and they must receive the approval of
their parliaments to engage in medium- and long-term borrowing. Importantly,
sub-national units are prohibited from pledging their revenues or assets to guarantee loans. An exception to the latter concerns the issue of bonds; sub-nationals
may use the asset constructed via bond finance, and pledge associated revenues,
as security. Lastly, sub-national governments may not guarantee the loans of third
parties (such as their water enterprises, for example).19
Finally, the regulatory framework stipulates certain reporting requirements
related to sub-national borrowing. Sub-national governments are required to
report their debt positions and other financial information twice each fiscal year
both to their parliaments and to the central government. No provisions have yet
been made for sub-nationals to disclose their financial positions to other than the
central government and local parliaments. Neither the central government nor
local parliaments make such data publicly available.
Sub-national governments that contravene any of the above principles are
subject to sanctions. In particular, the centre may ‘intercept’ (i.e. delay or cut)
a region’s intergovernmental transfers if it fails to comply with restrictions and
other conditions. The central government may also intercept a sub-national government’s transfers if it fails to make repayments on loans that it has taken from
the centre (this applies only to loans taken out since 2001).
In terms of attempting to improve on-lending outcomes, four features of the
new framework stand out. The first relates to the new mechanism for submitting
and reviewing project proposals and approving loans. This is referred to as the
‘blue book’ system, named after the document that contains the current list of
projects that have been reviewed by the National Development Planning Agency,
Bappenas, and deemed ready for implementation. Under the emerging system,
19 Law 33/2004 also asserts that the central government will not guarantee revenue bonds
issued by sub-national governments. The centre continues to provide a sovereign guarantee for aid agency on-lending.
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
On-lending in Indonesia: past performance and future prospects
47
both sub-national governments and central departments may develop on-lending
project proposals. Provinces and local governments submit project proposals
directly to Bappenas for initial review. Central departments may also put forward
on-lending project proposals, although they must coordinate their submissions
with relevant sub-national governments. But the fact that central departments
may initiate proposals for local projects to be financed by on-lending raises the
concern that a supply orientation in project development may still obtain under
certain circumstances.
After project proposals are reviewed and the blue book is issued, a variety of
additional tasks must be undertaken and completed before implementation can
begin. A decision must be made as to which projects in the blue book should be
prioritised to start in the given fiscal year; sub-national governments must make
formal proposals to secure finance and those proposals must be evaluated; subnationals must demonstrate that they have satisfied a number of government
‘readiness criteria’;20 aid agency loans must be negotiated and agreement reached;
and sub-loan agreements (with the sub-national borrower) must be drawn up.
Bappenas, MOF and the Ministry of Home Affairs, as well as relevant technical
departments, are all involved at various stages in the process. A recent review
of the new system (Lewis and White 2005) concluded that while it may, in fact,
represent an improvement over its predecessor, significant delays in the development of sub-national on-lending projects and the disbursement of funds are likely
to remain the norm.
Second, as noted above, the new arrangements insist that any long-term lending to sub-national governments may only be used to finance public infrastructure that directly yields revenues for sub-national government budgets. This
stipulation will necessarily limit potential lending to sub-national governments
to levels lower than might be justified and than might otherwise be achieved.21
The requirement is arguably wrong-headed. Sub-national governments should be
permitted to borrow to finance public capital development regardless of whether
the infrastructure that is created generates revenues directly or not, as long as
they have the ability and willingness (as demonstrated by past repayment experience, for example) to repay. To disallow on-lending as a means of financing nonrevenue generating public infrastructure suggests that such infrastructure would
have to be financed either through own sources or through intergovernmental
grants instead. The use of these funding sources is less satisfactory from adequacy,
efficiency and equity points of view.
The third pertinent characteristic of the new framework concerns the existence
of repayment arrears of potential sub-national government and water enterprise
20 Sub-national borrowers must ensure that project performance indicators are in place
and necessary data to measure them available; that local counterpart funds for the first
year of the project have been allocated in the relevant year’s budget; that land procurement and/or resettlement plans, to the extent they are needed, have been finalised; that
project management and project implementation units have been formed; and that project
management plans and guidelines have been prepared.
21 The fact that the government has not precisely defined what kinds of projects are
‘directly revenue generating’ compounds the problem; while it has promised to produce a
list of such projects, it has not yet done so.
48
Blane D. Lewis
TABLE 6 Classification of Potential Sub-national Borrowers
Provinces
Kabupaten/Kota
PDAMs
Past borrowers without arrears
Never borrowed
Past borrowers with arrears
10
6
16
85
192
107
24
107
189
Total
32
384
320
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
Source: As for figure 1.
borrowers. Specifically, government and aid agencies will only be allowed to lend
to those provinces and local governments without arrears on repayments of past
loans from the central government. And lenders may only lend to PDAMs as long
as both the PDAMs and their associated local governments are free of arrears
on prior SLA or RDA loans. Insisting that potential borrowers be free of arrears
before they are allowed to borrow is a useful pre-condition from the point of view
of encouraging government and aid agencies to lend to creditworthy borrowers.
It essentially forces lenders to pay more attention to credit risk, albeit in a somewhat crude fashion.
Based on the no-arrears criterion, two types of potential sub-national government borrowers immediately present themselves: those that have borrowed and
have repaid their obligations in full and those that have never borrowed. There
are just 95 sub-national governments (10 provinces and 85 local governments)
that have borrowed from the centre in the past and that are free of arrears. The
second group is significantly larger than the first: 198 sub-national governments
have never borrowed (six provinces and 192 local governments). The situation is
slightly more complicated for water enterprises. As noted, both PDAMs and their
associated sub-national governments must be free of arrears before the former
would be allowed to borrow. There are only 24 PDAM past borrowers without
arrears and eight of their respective local governments have repayment arrears
on past loans from government. On the other hand, 107 PDAMs have never taken
out a loan; seven of their associated local governments have borrowed from the
centre and are in arrears on loan repayments. These data are summarised in the
first two rows of table 6.
If on-lending to sub-national governments is to be sufficiently increased it
will not be adequate to rely on past borrowers with good repayment records;
sub-national governments and enterprises that have never borrowed will need
to be encouraged to do so. In the present environment, the extent to which this is
possible is quite unclear. The government has no plan in place to stimulate credit
demand among sub-national units that have no experience with borrowing.
Increasing the number of potential borrowers further would require that
those sub-national governments and water enterprises with repayment arrears
on past loans clear away those arrears (see the third row of table 6). There are
123 sub-national government borrowers with arrears (16 provinces and 107 local
governments); in addition, there are 189 PDAM borrowers with arrears (and an
additional associated 93 local government borrowers with arrears).
On-lending in Indonesia: past performance and future prospects
49
TABLE 7 Aggregate Borrower Arrears and Reserves
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
Arrears
(Rp billion 2004)
Reserves
(Rp billion 2005)
Provinces
Kabupaten/Kota
PDAM
122
560
2,751
15,761
25,949
n.a.
Total
3,433
41,710
n.a. = not applicable.
Source: As for figure 1.
Two plausible means exist for sub-national governments and their enterprises
to eliminate their loan repayment arrears. First, sub-national governments could
use their accumulated unspent revenues, or ‘reserve funds’, to pay off their (and
their water enterprises’) arrears immediately. Second, sub-national borrowers
could have their debt repayment obligations (including any arrears) restructured,
rescheduled or written off by the central government.
Sub-national governments have substantial reserve funds. By the end of 2005,
provinces and local governments together had accumulated about Rp 41.7 trillion
in reserves.22 By contrast, total provincial, local government and PDAM repayment arrears amounted to only around Rp 3.4 trillion (at the end of 2004) (table 7).
In the aggregate therefore, provinces and local governments would appear to
have more than enough funds to clear away easily the entire stock of sub-national
government and water enterprise arrears.23
The aggregate data offer only an approximate appraisal of the extent to which
sub-national government reserves might be used to cover repayment arrears,
however. A more accurate picture of the sufficiency of reserves to cover arrears
would be provided by a comparison of reserves with arrears at the individual
sub-national government level (table 8).
As the table shows, most individual sub-national governments have sufficient
reserves to cover their arrears and those of their water enterprises. Over 85% of
individual borrowers could have their arrears cleared away by the relevant subnational government’s stock of reserves. Of course, sub-national government
22 The sub-national stock of reserves at the end of 2005 amounted to about 21.5% of total
sub-national expenditure that year and approximately 1.6% of GDP (in 2005). As of the end
of November 2006, sub-national government reserves had grown to Rp 95 trillion.
23 The magnitude of such reserves may raise the question as to why sub-national governments should bother to borrow at all, when they could simply use their reserves to finance
infrastructure. Such reserve funds could, in fact, appropriately be used to finance capital
expenditure, of course. But reserves might legitimately be required for other purposes as
well, including addressing cash flow problems and contingency or emergency needs (Tyer
1993). This suggests that it would not be prudent for sub-national governments to use the
entire stock of their reserves to finance public capital development.
50
Blane D. Lewis
TABLE 8 Individual Borrower Arrears and Reserves
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
Borrowers with Arrears
Borrowers with Sufficient
Reserves to Cover Arrears
Provinces
Kabupaten/Kota
PDAM
16
107
189
15
99
154a
Total
312
268
a Local government reserves sufficient to cover both PDAM arrears and any arrears of local governments.
Source: As for figure 1.
willingness to use reserves in such a manner cannot be guaranteed. The reasons
for such unwillingness are surely varied. Without doubt sub-national governments benefit from the interest earnings on their stocks of reserves. In some cases,
sub-nationals might have legitimate alternative expenditure plans for such funds.
Finally, while there is (as yet) no direct evidence of specific corrupt practices associated with reserve funds, clearly this is a possibility, given the insufficient controls that exist at the sub-national level.
While the central government is aware of the general issue, officials have not
yet thought much about how they might encourage sub-nationals to use their
reserves to pay off their stocks of arrears. Indeed, in the new decentralised environment it is not clear what the government could do to stimulate use of reserves
in this way, barring a decision directly to mandate some action by legal means.
Such an act would certainly prove highly controversial; it is probably politically
infeasible.
Separate from new on-lending arrangements, the central government has
recently authorised covering legislation that provides the beginnings of a framework for restructuring, rescheduling and writing off loan repayments associated
with PDAM debt. Technical guidelines for the PDAM debt work-out agenda are
currently being prepared, but implementation has not yet begun. Similar legislation for provincial and local government debt work-outs is planned, but relevant
work has not yet commenced.
The final feature of the regulatory environment of interest concerns the government’s intergovernmental transfer intercept mechanism. As noted above, government may cut any sub-national’s transfers if it fails to meet loan repayment
obligations to the centre. Actually, this is not a new attribute of the intergovernmental framework; the intercept has been in place since 2001. The main problem
with the tool is simply the government’s apparent and unfortunate reluctance to
employ it: there have been numerous instances since 2001 when the government
might have legitimately used the transfer intercept, but so far it has chosen not to
do so.
In summary, it would not appear that the new regulatory framework for onlending will be of much assistance in facilitating improved on-lending performance. The new project review and loan approval process provides some rather
Downloaded by [Universitas Maritim Raja Ali Haji] at 20:01 18 January 2016
On-lending in Indonesia: past performance and future prospects
51
unfortunate scope for central departments to force the development of local
projects that they consider are of the highest priority (but that sub-nationals may
not). In any case, it is likely to remain cumbersome and time consuming. The
amount of finance channelled through the system is likely to remain significantly
lower than is justified, at least in part because on-lending is restricted to financing
revenue generating projects. While the new framew