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Bulletin of Indonesian Economic Studies
ISSN: 0007-4918 (Print) 1472-7234 (Online) Journal homepage: http://www.tandfonline.com/loi/cbie20
Restructuring Indonesia's sub-national public
debt: reform or reversion?
Blane Lewis & David Woodward
To cite this article: Blane Lewis & David Woodward (2010) Restructuring Indonesia's subnational public debt: reform or reversion?, Bulletin of Indonesian Economic Studies, 46:1,
65-78, DOI: 10.1080/00074911003642245
To link to this article: http://dx.doi.org/10.1080/00074911003642245
Published online: 17 Mar 2010.
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Date: 18 January 2016, At: 19:25
Bulletin of Indonesian Economic Studies, Vol. 46, No. 1, 2010: 65–78
RESTRUCTURING INDONESIA’S
SUB-NATIONAL PUBLIC DEBT: REFORM OR REVERSION?
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Blane Lewis
National University of Singapore
David Woodward
World Bank, Jakarta
Borrowing can be an efficient way for sub-national governments to acquire capital
assets, but it also carries risks of fiscal distress and insolvency for borrowers. To
minimise these risks, many governments around the world have developed ex-post
insolvency remedies, including, most importantly, debt-restructuring mechanisms.
In an effort to resurrect borrowing for local infrastructure development, the Indonesian government has designed and begun to implement debt-restructuring programs for sub-national government and sub-national government-owned water
supply company defaulters. These programs constitute a major effort to reform an
important, long-neglected and problematic aspect of sub-national public finances in
Indonesia. There are a number of potential difficulties with the design and execution of the reforms, however, which collectively do not inspire much optimism for
rapid progress in reviving financial flows to the sub-national public sector. Still,
even halting advances in debt restructuring can substantially increase local infrastructure investment in the long run.
INTRODUCTION
Borrowing is a common method of financing sub-national public capital spending. All across the world, sub-national governments borrow from banks and other
financial institutions or issue bonds to acquire non-financial assets of various
kinds (such as fixed assets and land) for use in delivering public services and
stimulating economic development. Usually such borrowing is uneventful from a
financial point of view. But sub-national borrowing does create at least some risk
of fiscal distress and insolvency among debtors. Fiscal distress occurs when a subnational government’s fiscal position deteriorates significantly – for example, as
a result of large and growing annual debt repayment obligations. A sub-national
becomes insolvent if it is unable to make good on some financial obligation, such
as a loan repayment that falls due.
Fiscal distress may well result in the need for some kind of debt restructuring. Debt restructuring is a key element in the design of any broader insolvency
resolution mechanism. But the latter may include other components as well, such
as bankruptcy procedures and fiscal adjustments. Bankruptcy is a legal status
that formally connotes fiscal insolvency. A sub-national may be insolvent but not
necessarily bankrupt. The former is simply a (sometimes loosely defined) fiscal
condition of government, while the latter requires a court decision and is a legal
condition. The term ‘fiscal adjustments’ refers to the changes in a sub-national
ISSN 0007-4918 print/ISSN 1472-7234 online/10/010065-14
DOI: 10.1080/00074911003642245
© 2010 Indonesia Project ANU
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Blane Lewis and David Woodward
government’s financial management practices that are needed to overcome its
insolvency. Some kind of fiscal adjustment is typically necessary for successful
debt restructuring (Liu and Waibel 2008).
Fiscal insolvency mechanisms in general and debt-restructuring efforts in particular are of two general types: administrative and judicial. Higher-level governments assume the lead in organising administrative insolvency remedies, while
the courts take priority in implementing judicial insolvency procedures. The
benefit of administrative procedures is that higher-level governments are typically well positioned to structure and execute any fiscal adjustments needed at
the lower level; the disadvantage of such efforts is that they may become overtly
political. For judiciary-led mechanisms, the situation is reversed: the courts are
typically seen as more neutral in their dealings with creditors and debtors, but
they are at a disadvantage in insisting on sub-national fiscal adjustments (Liu and
Waibel 2008).
There is a small but growing academic literature on sub-national insolvency
remedies.1 Most of the literature focuses on specific case studies, including,
most prominently, those of Brazil (Dillinger 2002), Hungary (Jokay, Szepesi and
Szmetana 2004), South Africa (Glasser 2005) and the United States (Laughlin
2005). Liu and Waibel (2008) provide a review and synthesis of these cases and
suggest some broad best practices in the development of insolvency procedures.
In this regard, the authors stress that well planned insolvency mechanisms
encourage voluntary participation, are perceived as fair to all parties involved
and make apparent to future debtors the risks of borrowing. Most importantly,
however, the review makes clear that the appropriate design and implementation of sub-national insolvency and debt-restructuring mechanisms is necessarily very specific to the history, economies, financial systems and institutions of
the particular countries undertaking the reforms. Thus, while broad guidelines
may have some utility for the development of insolvency mechanisms, much
depends on context.
Indonesia has recently begun to implement its own administrative program of
debt restructuring for sub-national governments – known collectively as ‘regional
governments’ (pemerintah daerah, or Pemdas) and including the governments of
both provinces and districts/municipalities (kabupaten/kota) – and for local government water supply companies (Perusahaan Daerah Air Minum, PDAMs), whose
borrowing represents a large share of total regional borrowing. At this stage, the
restructuring framework focuses just on the default on loans made to Pemdas and
PDAMs by the central government (often acting as an intermediary in respect of
loans from international donors). These loans constitute the vast majority of such
lending. The government plans to broaden the scope of the procedures in the near
future by developing a more comprehensive set of insolvency mechanisms, and
by introducing sub-national public sector bankruptcy regulations.
This paper provides a description and analysis of current debt-restructuring
efforts. As such, it makes a contribution to the emergent academic literature on a
topic of considerable importance in sub-national public finance. In addition, the
1 Insolvency measures are referred to as ex-post remedies, as distinguished from ex-ante
controls. Ter-Minassian and Craig (1997) provide a discussion and some examples of exante borrowing mechanisms.
Restructuring Indonesia’s sub-national public debt: reform or reversion?
67
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paper provides some detailed information on, and analysis of, Indonesia’s subnational debt-restructuring program that may be of use to various stake-holders
working in this area.
The paper proceeds as follows. First, it presents some background information
on sub-national government and water supply company borrowing in Indonesia.
Second, it describes recent past and current efforts at sub-national debt restructuring, and highlights the current status of implementation. Third, it enumerates and
discusses some unresolved problems, and offers a near-term prognosis for success. The last section of the paper summarises the main points and draws some
conclusions related to decentralisation policy making in Indonesia.
BACKGROUND: SUB-NATIONAL BORROWING
AND REPAYMENT ARREARS
Sub-national governments in Indonesia are allowed to take out long-term loans
for capital development subject to several conditions.2 First, borrowing must be
used to finance infrastructure that directly generates sub-national own-source
revenue. This precludes Pemdas from borrowing to build non-toll roads or flood
control systems, for example. It is understood that the Ministry of Finance (MOF)
is at the time of writing preparing a regulation to overturn this stipulation. Second, the outstanding debt of a sub-national government may not exceed 75% of
the previous year’s general revenues (defined as all revenues except special purpose grants and emergency grants), and its 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. Collectively, sub-national
governments may not borrow more than the maximum amount determined by
the central government annually in the context of the budget law. For example,
consolidated sub-national borrowing may not exceed 0.35% of projected national
GDP in 2010.3 Finally – and most importantly for this paper – sub-national governments may not borrow if they have arrears on past loans. This (reasonable) legal
restriction has limited Pemda and PDAM borrowing and thus constrained public
capital spending at local government level. Sub-nationals have taken out only 10
loans from the MOF on-lending channel since decentralisation began in 2001.4
This low level of borrowing has had highly negative consequences for investment
in infrastructure and for the delivery of public services – especially water.
Historically, sub-national governments in Indonesia have not borrowed much
to finance their capital spending. Lewis (2007) estimates that the cumulative borrowing (in real terms) of sub-national governments and their water supply companies between 1975 and 2004 was less than 1% of GDP in 2004. Since the vast
bulk of these loans have been from the central government, there has been only
a small amount of borrowing from other financial institutions such as state or
2 The ex-ante borrowing framework for sub-national governments is discussed in more
detail in Lewis (2007).
3 GDP is projected to be approximately Rp 6,050 trillion in 2010. As at 18 January 2010,
$1 = Rp 9,225.
4 A further five Pemdas have arranged to borrow from the central government, but had
not yet drawn down on these loans at the time of writing.
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Blane Lewis and David Woodward
TABLE 1 Pemda and PDAM Borrowing as at 31 December 2007
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Number
Principal
(Rp billion)
Borrowers
Loans
Total
Outstanding
Pemdas
PDAMs
182
241
290
409
1,666.4
4,490.0
493.7
2,012.7
Total
423
699
6,156.4
2,506.4
Source: Ministry of Finance.
commercial banks, or regional development banks owned by the provincial governments themselves. 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).
Table 1 sets out the most recent information available about Pemda and PDAM
borrowing from the central government. As at December 2007, 423 borrowers
had taken on 699 loans from the central government, amounting to just under
Rp 6.2 trillion. Most borrowing was by water enterprises: PDAM borrowing
comprised almost three-quarters of the total amount. Outstanding principal (not
including arrears) was just over Rp 2.5 trillion, a sum equal to just below 0.1% of
GDP in 2007.
Even though borrowing has been quite limited, repayment of loans has been
more than a little problematic. Lewis (2007) estimates that the arrears rate was
nearly 50% in 2004.5 Table 2 provides some information on sub-national payment arrears at the end of 2007. The total amount of arrears is approximately
Rp 5.0 trillion. About one-third of the total is arrears on principal; the remainder
comprises arrears on interest, service charges, and penalties. Perhaps surprisingly,
the arrears on penalties alone make up nearly 30% of the total. Penalties, charged
by the central government for late payment or non-payment, have been an item
of significant contention between the sub-national and central governments over
the years. Total outstanding debt, which includes outstanding principal and total
arrears, amounts to Rp 7.5 trillion.
Of the 182 Pemda borrowers, 124 have arrears.6 The arrears are concentrated
in a small number of borrowers, however. Just five Pemdas – the municipalities
of Medan, Palembang, Banjarmasin, Makassar and Manado – account for nearly
two-thirds of total arrears. And 90% of total arrears are held by just 23 Pemda borrowers. The vast bulk of Pemda borrowers’ arrears are quite small; 101 Pemdas
have less than Rp 5 billion each in arrears.
Of the 241 PDAM borrowers, 201 have arrears. The arrears are heavily concentrated in 41 PDAMs, each with arrears greater than Rp 20 billion; the arrears
of these PDAMs comprise nearly 80% of the total. This category of defaulters
5 The arrears rate is equal to total payments in arrears divided by total payments due.
6 As at 31 December 2009, there are 33 provinces, 492 kabupaten/kota and 320 PDAMs.
Restructuring Indonesia’s sub-national public debt: reform or reversion?
69
TABLE 2 Pemda and PDAM Arrears and Outstanding Debt as at 31 December 2007
(Rp billion)
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Principal
Arrears
Total
Arrears
Total
Outstanding
Pemdas
205.6
627.2
1,120.9
PDAMs
1,432.6
4,394.4
6,407.1
Total
1,638.2
5,021.6
7,528.0
Source: As for table 1.
includes PDAMs in all major and secondary cities in Indonesia with the exception
of Surabaya and Balikpapan.
Why has loan repayment been so poor? Many kabupaten and kota officials have
complained that the loans were ‘supply-driven’ by international aid agencies and
the Ministry of Public Works; in extreme cases, they claim that loans were simply
assigned to them by the centre during the pre-decentralisation era. PDAM managers have similar grievances. In addition, they assert that tariff increases needed to
cover costs were not approved by Pemdas and local parliaments (DPRDs), largely
for political reasons. These and other contentions created significant disappointment among local officials about loans from the central government. There is no
evidence, however, that Pemdas, in general, were unable to repay their loans
because of fiscal constraints. It is more likely that Pemdas did not repay simply
because they were unwilling to do so, and because the MOF was unwilling to
force them to repay (Lewis 2003). The PDAMs may have been unwilling to make
good on their loans as well, but in this case the point is moot. Most PDAMs were
financially unable to repay their loans: tariffs did not cover costs, so they could
not repay even if they were willing to do so.7
In any case, the poor loan repayment record has had negative consequences
for investment in infrastructure and the delivery of public services, because of the
prohibition on borrowing by sub-national governments and water supply companies that have arrears on past loans.
In response to this situation, the central government has, after many years
of neglect, embarked upon a new program of debt restructuring. The next section of the paper describes the basic elements of the early and more recent debtrestructuring efforts, outlines the basic sanction mechanism embodied in the new
debt-restructuring process and describes the experience so far in implementing
the procedures.
7 See Woodward (2008, available on request from edw92114@attglobal.net) for a full discussion of possible reasons for arrears among Pemdas and PDAMs.
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Blane Lewis and David Woodward
DEBT-RESTRUCTURING FRAMEWORK AND STATUS
Early efforts
The laws passed by the national parliament (DPR) in 2003 and 2004 included one
on State Finances (Law 17/2003) and another on the State Treasury (Law 1/2004).
Among other things, these provided a legal basis for writing off public debt under
certain circumstances; the detailed framework is provided in Government Regulation 14/2005. Also in 2005 the MOF produced a decree (MOFD 107/2005) for
the restructuring of PDAM debt. PDAMs were accorded priority because their
borrowing is such a large portion of the total, because their arrears position is far
more serious than that of the Pemdas and because of the urgency of increasing
investment in the water sector.
MOFD 107/2005 proposed a write-off of up to 40% and 100% of arrears associated with interest payments and penalties, respectively. This seemingly generous scheme was made less so, however, by the very restrictive conditions it set
for PDAM eligibility to participate.8 Furthermore, the scheme required eligible
PDAMs to submit very complicated financial recovery action plans as part of the
process. This latter stipulation necessitated the production of a separate MOF
Treasury decree (MOFTD 53/2006) to guide PDAMs in the preparation of these
plans. Many of the plans produced suggest that PDAM managers did not find
these guidelines particularly helpful in clarifying the process.
Nevertheless, over the 12-month period following the issue of MOFD 107/2005,
the outstanding debt of 12 PDAMs (comprising 16 loans) was fully paid off. The
debt was retired not by PDAMs, however, but by their Pemda owners, in return
for a small (2%) discount on the loan principal, as provided for in the decree.
An additional seven PDAMs (or their Pemda owners) retired a sub-set of their
loans with arrears. A year after the issue of MOFTD 53/2006, 40 PDAMs were at
various stages of the restructuring process. However, by late 2007, not one PDAM
had completed a rescheduling or restructuring pre-qualification exercise up to the
stage of obtaining the required approval of the Minister of Finance. At this point
all parties came to recognise fully the rigidities of MOFD 107/2005 and the consequent difficulties for PDAMs in complying with MOFTD 53/2006.
In April 2008 Vice President Jusuf Kalla put forward a new debt-restructuring
proposal. In this scheme, 100% of non-principal arrears for both PDAM and Pemda
borrowers would be written off, with a view to stimulating investment in urban
infrastructure services and to meeting the United Nations Millennium Development Goals for piped water supply. It was expected that 175 PDAMs would
benefit from some Rp 3.0 trillion of write-offs, and that the government would
provide grant funding for an additional 10 million piped water supply household
connections to be installed over the next five years. Given that only 7.5 million
new connections had been installed since independence in 1945, this was certainly an ambitious plan (Bisnis Indonesia, 4 October 2008). In response to the vice
8 Among other things, the regulation required that, for a PDAM to be eligible for the
scheme, its financial health had to be classified as something less than ‘good’ (baik). Moreover the classification was based on an evaluation system developed by the Ministry of
Home Affairs (MOHA) (codified in MOHAD 47/1999), which is known to provide flawed
assessments of fiscal capacity. This eligibility restriction severely limited the number of
PDAMs that could participate.
Restructuring Indonesia’s sub-national public debt: reform or reversion?
71
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president’s proposal, and to other internal suggestions, MOF issued new debtrestructuring decrees for both PDAMs (MOFD 120/2008, issued 19 August 2008)
and Pemdas (MOFD 153/2008, issued 22 October 2008). A third decree (MOFD
129/2008, issued 4 September 2008), which specifies sanctions in the case of continued non-repayment, was also promulgated. The substance of these decrees is
outlined next. The section concludes with a brief account of the status of implementation.
New PDAM debt restructuring
The new framework for restructuring PDAM debt distinguishes between arrears
on principal and non-principal (interest, service charges and penalties). Arrears
on principal will not be written off, either in whole or in part. Rather, the framework provides for the full write-off of non-principal arrears for those PDAMs that
are classified as financially ‘sick’ (sakit) or ‘less than healthy’ (kurang sehat) by the
Finance and Development Supervisory Agency (Badan Pengawasan Keuangan
dan Pembangunan, BPKP) in the context of its annual performance audit reports.9
For those PDAMs classified as ‘healthy’ (sehat), non-principal arrears will be
treated through a combination of write-offs and ‘debt swaps’ for new investment
in the PDAMs. In this context, ‘debt swaps’ refers to debt that is forgiven on the
condition that the borrower undertakes a similar amount of new investment.10
The relative importance of PDAM debt write-offs and debt swaps is determined
by the fiscal capacity of the Pemda owners. More specifically, PDAMs owned by
Pemdas with ‘high’ (tinggi) fiscal capacity will be able to write off 40% of their
non-principal arrears, with the remaining 60% being swapped for new PDAM
investment; PDAMs owned by Pemdas with a ‘medium’ (sedang) fiscal capacity
will be able to write off 50%, with the remaining 50% being swapped; and PDAMs
owned by Pemdas with a ‘low’ (rendah) fiscal capacity will be able to write off
60%, with the remaining 40% being swapped. The debt-for-new-investment swap
can be funded by PDAMs, Pemdas or both – hence the focus on Pemda fiscal
capacity in determining the write-off/debt swap ratios.11
Unlike the initial regulatory effort, the new framework does not limit access
to the restructuring program. Any PDAM can join, as long as it meets certain
pre-conditions, including: the adoption of a cost-recovery tariff; a declaration
by the Pemda that PDAM management has been subjected to a fit-and-proper
test; and the submission of a five-year business plan, approved by the head of
the Pemda. PDAM participants must also provide a financial audit report from
9 BPKP uses its own criteria for establishing the financial health of PDAMs, rather than the
MOHA criteria referred to in footnote 8.
10 The decrees on sub-national debt restructuring use the English terms ‘write-off’ to refer
to the portions of arrears that are completely forgiven and ‘swap’ to refer to those forgiven
in exchange for the promise of new investment. We use the terms in the same manner in
this paper.
11 MOF evaluates the fiscal capacity of Pemdas on an annual basis, classifying them as
having low, medium or high fiscal capacity. Fiscal capacity is defined as the sum of ownsource revenues, shared revenues, block grant and other legal revenues net of employee
salaries, divided by population. The most recent ‘fiscal capacity map’ can be found in
MOFD 224/2008.
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Blane Lewis and David Woodward
the previous financial year;12 the previous year’s performance audit, conducted
either by the Supreme Audit Agency (Badan Pemeriksa Keuangan, BPK) or by
BPKP; the PDAM budget and business plan from the previous year; and a letter
signed by the head of the Pemda and co-signed by the chair of the DPRD, to the
effect that if, for any reason, the PDAM cannot meet its new debt payments, the
Pemda will provide financial support to enable it to fulfil its obligations under the
rescheduled loan agreements.13
Of the total arrears on PDAM loan repayments (Rp 4.4 trillion), about two-thirds
– Rp 3.0 trillion – are non-principal arrears. Early indications are that any PDAM
borrower with arrears will be categorised as ‘sick’ or ‘less than healthy’. If so, up
to Rp 3.0 trillion could possibly be written off under the vice president’s proposal.
The government intends to compensate those PDAMs that had responded positively to the earlier restructuring effort as outlined in MOFD 107/2005. This compensation takes two forms under the new framework. First, those PDAMs that
fully retired their debt some time between the dates of issue of MOFD 107/2005
and MOFD 120/2008 will receive (in addition to the 2% discount provided for
in MOFD 107/2005) an incentive payment under arrangements to be decided
separately. Second, those PDAMs that made payments according to the schedules specified in their loan agreements after the date of issue of MOFD 107/2005
and up to the date of issue of MOFD 120/2008 will receive a 2% reduction in the
interest rate on their loan(s) up to the final loan payment, plus technical assistance under arrangements to be determined separately. There are no stipulated
sanctions against those PDAMs with arrears that do not join the restructuring
program.
The restructuring process is to be carried out in two stages. Initially, over a twoyear period, any write-off is ‘conditional’ – that is, temporary. After this two-year
period, if PDAMs continue to pay their rescheduled loans on time and in full,
write-offs become ‘unconditional’ or permanent.
New Pemda debt restructuring
As was the case for PDAMs, the new framework for restructuring Pemda debt
distinguishes between principal and non-principal arrears, and arrears on repayment of principal will not be written off. Non-principal arrears will be only
partially written off, with the remainder being swapped for infrastructure investment. The amount written off is determined by multiplying the proportion of
non-principal arrears to total arrears by Rp 5 billion. The remaining non-principal
arrears are swapped for Pemda investment in schools, health clinics, roads, irrigation, bridges and water supply facilities.
The period over which repayment of principal arrears is rescheduled depends
on the amount of arrears. If arrears are less than Rp 15 billion, they must be repaid
within four years; if they total Rp 15–25 billion, they must be repaid within six
years; and if they are greater than Rp 25 billion, they must be repaid within eight
12 A disclaimer by the auditor disqualifies a PDAM from entry, unless the disclaimer relates to the ‘technical insolvency’ of the PDAM due to its arrears.
13 This latter condition is somewhat puzzling. According to Law 33/2004, Pemdas are prohibited from guaranteeing third-party debt, including that of their PDAMs. As such, this
stipulation would appear to require Pemdas to break the law or at least the spirit of it.
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Restructuring Indonesia’s sub-national public debt: reform or reversion?
73
years. The debt swaps are to be implemented over the same period as the principal arrears repayment, irrespective of amount, although some extension (as yet
undefined) may be granted in the event of financial capacity difficulties. If the
debt swap plan is not maintained to full effect, then the value of the debt swap not
implemented is returned to arrears status.
There are only limited pre-conditions for Pemda entry into the program. All
Pemdas are invited, provided they make available the required documentation.
The latter includes an action plan for implementing the debt swap; a letter agreeing to give priority to the repayment of debt and to allocate the required funds
in the sub-national budget until the loan has been entirely paid off; and a letter
consenting to the use of an intercept mechanism, described below, in the event of
loan arrears. All plans and letters must be prepared and approved by the head of
the Pemda and co-signed by the chair of the DPRD.14
Pemdas collectively hold Rp 421 billion in non-principal arrears. This sum constitutes the upper bound on the total amount that can be written off or swapped.
Given the size distribution of the arrears across Pemdas, it seems probable that
most could settle their arrears problems without the intervention of the MOF,
although it is not clear that they would do so in the absence of effective sanctions.
In any case, we understand that the restructuring program will focus on the 23
Pemdas that account for 90% of the arrears.
As is the case with PDAMs, Pemdas making early loan repayments will be
rewarded with non-principal arrears write-offs equivalent to 2% of the advance
repayments made. There is no mention of any sanction for non-participation in
the program. The write-off and debt swap must go through the same conditional
and unconditional stages as for PDAM debt restructuring.
Sanctions: a new intercept mechanism
The original decentralisation legislation of 1999 and its subsequent amendment
in 2004 made provisions for the central government to delay or cut transfer payments to Pemdas under a variety of circumstances, the most noteworthy of which,
in the present circumstances, is the non-repayment of loans from the central
government. This intercept mechanism was never employed in the case of nonrepayment of loans, although it was in other circumstances. A number of regulatory issues, which ostensibly prevented its full implementation, have now been
addressed.
The new framework for implementing the intercept mechanism is codified in
MOF decree 129/2008, issued in September 2008. On the basis of internal MOF
legal opinion, it was determined that the intercept as originally defined in law
could not be set against central government transfers to Pemdas in the case of
non-performing loans that had been made to Pemdas before the decentralisation
legislation of 1999, or in the case of non-performing loans made to PDAMs.15 Following the issue of the new decree in 2008, the intercept is henceforth applicable
14 A 12-month deadline was imposed on Pemda applications to enter the debtrestructuring program. PDAMs have not been subjected to a deadline for joining their
debt-restructuring program.
15 In these instances, the MOF’s only recourse against PDAMs and Pemdas with nonperforming loans is through the courts under the civil code.
74
Blane Lewis and David Woodward
TABLE 3 Status of PDAM and Pemda Debt-Restructuring Proposal Submissions
as at 31 October 2009
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Status
PDAM
Pemda
Submissions requiring revision
Under consideration by the working group
Under consideration by the technical committee
Under consideration by the policy committee
Under consideration by the Minister of Finance
8
32
36
0
15
0
8
18
0
0
Total
91
26
Source: As for table 1.
against any arrears resulting from loans made by MOF to Pemdas since October
1999, and against any arrears associated with loans made following issue of the
decree. It is important to note that the latter include those loans made for water
supply investment, which must now be made through the Pemdas (for potential
on-lending to PDAMs).
A prime concern of MOF in developing the 2008 decree was to ensure that
the intercept could be applied without unduly constraining Pemda finances and
service delivery. To this end the decree sets maximum amounts of block grant
(Dana Alokasi Umum, DAU) and revenue-sharing (Dana Bagi Hasil, DBH) transfers that can be intercepted during a fiscal year. The limits are based on the fiscal capacity of Pemdas as determined annually by MOF. More specifically, the
intercept limits for low, medium and high fiscal capacity Pemdas are 10%, 15%
and 20%, respectively, of annual DAU and DBH transfers. In the event that these
ceilings are insufficient to recover all arrears, the balance is to be carried over and
subjected to intercept in the following fiscal year. In most cases, DAU transfers
will be the primary target for the intercept, since the vast bulk of Pemdas receive
DAU and the transfers are made in 12 equal monthly instalments per year. For
those Pemdas that do not receive DAU, however, the intercept mechanism will be
applied to the DBH.
Current status of implementation
Table 3 summarises the status of debt-restructuring proposals by PDAMs and
Pemdas as at October 2009. The approval process is one that is typical in Indonesia, comprising reviews by a working group, a technical committee and a
policy committee. MOF chairs the working group and technical and policy committees; other members include representatives of BPKP, MOHA, the Ministry
of Public Works, and the national development planning agency, Bappenas. Proposals are ostensibly subject to increasingly rigorous review as they move up
the hierarchy from the working group to the policy committee. The final stage
is Minister of Finance approval, which is based on the recommendation of the
policy committee.
As at October 2009, 91 PDAMs had submitted proposals for debt restructuring.
Of these, eight proposals were found to be problematic in some way and were
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sent back for revision; 32 had been accepted as valid proposals and were under
review by the working group; 36 had been approved by the working group and
were under consideration by the technical committee; and 15 had already been
considered and approved by the policy committee. Pemdas had submitted 26 proposals, including eight that were under initial review by the working group and
18 that were under consideration by the technical committee. More than a year
after the debt-restructuring regulations were issued, not one proposal, whether
from a PDAM or a Pemda, had been approved by the Minister of Finance.
UNRESOLVED ISSUES AND NEAR-TERM PROGNOSIS
There are a number of technical and substantive issues that may hinder the successful execution of the debt-restructuring program described above. This section
highlights the major constraints associated with PDAM and Pemda debt restructuring, and potential difficulties with the implementation of the intercept mechanism. It closes with a tentative prognosis for near-term execution of the effort.
The adoption of cost-recovery tariffs by PDAMs is the sine qua non for entry
into the water supply company debt-restructuring program. Some PDAMs have
expressed confusion about the appropriate manner of calculating a cost-recovery
tariff. Current MOHA guidelines define the cost-recovery tariff as operating, interest and depreciation costs, divided by the volume of water produced after deduction of an allowance for non-revenue water (that is, leakages or other ‘lost’ water
that does not generate revenue). Previously MOHA had used a similar definition,
but one in which the denominator was the volume of water sold less non-revenue
water. Presumably the change was introduced in recognition of the earlier definition’s erroneous twice-over allowance for non-revenue water, which yielded a
higher (rupiah per unit) cost-recovery tariff than the current definition does. A
second issue concerns the extent to which the cost-recovery tariff must be put into
effect. That is, the regulation mentions only that the tariff should be ‘ditetapkan’
(‘set’), the precise meaning of which is somewhat ambiguous. One presumes the
tariff must be codified in a local regulation (peraturan daerah, Perda), but the extent
to which the tariff actually has to be applied is not obvious: one can envision all
kinds of gaming behaviour on the part of PDAMs in ‘setting’ tariffs. Finally – and
more significantly – the political acceptability of cost-recovery tariffs must surely
be in doubt. Pemdas and DPRDs have always proved more than a little reluctant
to agree to PDAM cost-recovery tariffs, and it is far from certain that concerned
officials have changed their position on this. Of course, Pemdas could choose to
keep tariffs below cost-recovery levels and subsidise the difference from their
budgets, but this would represent a significant departure from usual behaviour.
The current arrangements for PDAM preparation of business plans seem much
more flexible than those required under the earlier regulatory effort. Among other
things, the required format in which the plan must be submitted is simpler. In
addition, the new procedures allow PDAMs to set their own annual performance
targets instead of these being prescribed, as was the case previously. This is more
sensible, because PDAMs start their recovery plans from different baselines. Thus
the adequacy of the annual targets will be evaluated by the technical committee as
part of the overall review process. However, while the preparation of the business
plan is a less onerous task than before, many PDAMs will still find difficulty in
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Blane Lewis and David Woodward
responding to the requirements – as evidenced by the fact that some have already
begun to ask for technical assistance from the Ministry of Public Works and various aid agencies. In addition, if past experience is suggestive of future outcomes,
the multi-level and multi-institutional nature of the review process will almost
certainly cause significant delays in implementation.
A final important issue as yet unresolved in the context of PDAM debt restructuring is the treatment of arrears write-offs for tax purposes. The Companies
Law (Law 40/2007) prohibits the conversion of loan write-offs into equity; consequently, as matters stand, any PDAM write-offs would be treated as non-operating
income and therefore be taxable in the year they are credited as such. Obviously,
this would defeat a major purpose of restructuring. Originally, MOF had planned
to take the matter to the DPR with a view to requesting special dispensation for
PDAMs in this specific regard. This has apparently not happened yet. Another
way to overcome the problem would be for MOF itself to pay any taxes due.16
The Pemda debt-restructuring program is more straightforward than that for
the PDAMs. The major constraint in its successful implementation would seem
to be persuading the Pemdas to participate in the program in the first instance.
The incentive to join the program is clear enough, at least in theory: restructuring
would permit Pemdas to resume borrowing to finance investment in needed infrastructure, and this would allow improvements to local public service delivery. It is
not obvious, however, that most Pemdas place a high priority on delivering quality services to their constituents. As there are no sanctions for not participating in
the restructuring program, full Pemda participation is therefore in some doubt.
Finally, at least two issues have the potential to de-rail the implementation of the
intercept mechanism, which constitutes the restructuring programs’ only method
for assuring compliance with future loan repayments. One possible problem concerns the legality of intercepting DAU transfers after the allocations have been
codified in the annual presidential decree (as they are required to be before the
start of the fiscal year). A presidential decree holds the force of law in Indonesia;
in theory the allocations cannot be changed after the issue of the decree, whether
a lower-order decree authorises such cuts or not. Perhaps this is one reason for
requesting Pemdas’ prior agreement to the use of the intercept. But if consent to
the application of the intercept against its transfer revenues is voluntary, then it is
reasonable to predict that there will be few volunteers.
Just as important a problem concerns the political will of MOF actually to
employ the intercept, even if it is available for use. On the one hand, the ministry
has, in recent years, delayed payments of DAU to those Pemdas that have not
submitted their budgets in a timely manner to the ministry as required by law.
This is cause for optimism. On the other hand, MOF has not yet cut any Pemda’s
DAU to sanction non-payment of loans, despite having the legal justification and
opportunity to do so.17 This casts some doubt on the ministry’s political will to
16 This would perhaps require an internal-to-MOF transfer from the Directorate General
for the Treasury to the Directorate General for Tax.
17 Since October 1999 – the legal start date for possible application of the intercept – 11
Pemdas have defaulted on their loans, resulting in Rp 16 billion arrears as of the end of
2007.
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employ the more severe measure of cutting DAU allocations – as opposed to just
delaying their payment.
In sum, it is apparent that implementation of the two debt-restructuring programs will be far from straightforward. At best the reforms will be executed in
fits and starts and, in any case, completion of the programs is likely to take several years at least. At worst, the programs might stall completely, in which case
PDAMs and Pemdas would be extremely likely to revert to their past questionable fiscal practices.
SUMMARY AND CONCLUSIONS
Sub-national government borrowing is ubiquitous around the world. While borrowing can be an efficient way to finance capital assets, it also carries some risks,
especially potential fiscal distress and insolvency of the debtor. Given the inherent dangers, many governments have developed ex-post insolvency remedies for
their sub-national borrowers. Debt restructuring is typically a key element of such
reforms.
Indonesian sub-national governments and the water supply companies that
they own have borrowed for infrastructure development for nearly 30 years. The
total amount of borrowing has been very small, however. More to the point in
the current context, sub-national loan repayment has generally been weak. Poor
repayment performance has led to a lack of creditworthiness among sub-national
governments and water supply companies, and has constrained new borrowing
for needed improvements to deteriorating infrastructure.
After many years of neglect, the Indonesian government has finally started
to address the sub-national borrowing and repayment problem. Among other
things, the Ministry of Finance has designed and begun to implement a debtrestructuring program for sub-national defaulters. There are separate efforts for
Pemdas and PDAMs, and both programs involve a combination of debt writeoffs and swaps. Sanctions in the form of an inter-governmental transfer intercept
mechanism have also been developed to guard against future non-repayment.
The debt-restructuring program is a significant attempt at reform.
Nevertheless there are a number of problems that might prevent the programs’
timely and successful execution. For PDAMs, the major constraints relate to
difficulties in setting and applying cost-recovery tariffs, capacity constraints in
developing and implementing sensible business plans, and the potential negative
effects of central government taxation of loan write-offs. For Pemdas, the most
significant problem relates to a possible lack of voluntary participation, given
the dearth of incentives and sanctions to encourage involvement. As regards the
intercept mechanism, potential difficulties relate to the possible illegality of cutting transfers after allocations have been formally set by presidential decree at
the beginning of the fiscal year, and a lack of political will on the part of MOF to
employ the device. At the very least, such problems are likely to cause significant
delays in implementation, and they may halt the programs entirely.
The debt-restructuring efforts described in this paper are in many ways
quintessentially Indonesian. As is often the case, early design of the relevant regulatory framework was carried out in a rather casual and haphazard manner,
and the devised procedures proved, not surprisingly, to be unworkable. More
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positively, the government has demonstrated once again that it is (belatedly) willing to face up to its miscalculations, and formally revise wayward plans and processes. Only time will tell the extent to which another of Indonesia’s typical public
sector behaviours – muddling through – will obtain, or whether the reform efforts
will just wither away. Although muddling through is, of course, a sub-optimal
process, it at least pushes sub-national public finances in a desirable direction.
Even halting advances in debt restructuring have the potential substantially to
increase borrowing for local infrastructure investment in the long run.
REFERENCES
Dillinger, William (2002) Brazil: issues in fiscal federalism, Unpublished paper, World
Bank, Washington DC.
Glasser, Matthew (2005) Legal framework for local government insolvency, Presentation at
a World Bank seminar, 8 March, World Bank, Washington DC.
Jokay, Charles, Szepesi, Gabor and Szmetana, Gyorgy (2004) ‘Municipal bankruptcy framework and debt management experiences 1996–2000’, in Intergovernmental Finances: A
Decade of Experience, eds Mihaly Kopanyi, Deborah L. Wetzel and Samir El Daher, World
Bank Institute, Washington DC.
Laughlin, Alexander (2005) ‘Municipal insolvencies: a primer on the treatment of municipalities under chapter 9 of the US bankruptcy code’, Wiley, Rein and Fielding LLP,
Washington DC.
Lewis, Blane (1991) Regional government borrowing in Indonesia, Unpublished report to
the Harvard Institute for International Development‘s Urban Project, Jakarta.
Lewis, Blane (2003) ‘Local government borrowing and repayment in Indonesia: does fiscal
capacity matter?’, World Development 31 (6): 1,047–63.
Lewis, Blane (2007) ‘On-lending in Indonesia: past performance and future prospects’, Bulletin of Indonesian Economic Studies 43 (1): 35–57.
Liu, Lili and Waibel, Michael (2008) ‘Subnational insolvency: cross-country experiences and lessons’, World Bank Policy Research Working Paper 4496, World Bank,
Washington DC, available at .
Ter-Minassian, Teresa and Craig, Jon (1997) ‘Control of subnational borrowing’, in Fiscal Federalism in Theory and Practice, ed. Teresa Ter-Minassian, International Monetary
Fund, Washington DC.
Woodward, David (2008) Restructuring loans to PDAM and Pemda, Unpublished report,
Decentralization Support Facility, World Bank, Jakarta.
ISSN: 0007-4918 (Print) 1472-7234 (Online) Journal homepage: http://www.tandfonline.com/loi/cbie20
Restructuring Indonesia's sub-national public
debt: reform or reversion?
Blane Lewis & David Woodward
To cite this article: Blane Lewis & David Woodward (2010) Restructuring Indonesia's subnational public debt: reform or reversion?, Bulletin of Indonesian Economic Studies, 46:1,
65-78, DOI: 10.1080/00074911003642245
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Bulletin of Indonesian Economic Studies, Vol. 46, No. 1, 2010: 65–78
RESTRUCTURING INDONESIA’S
SUB-NATIONAL PUBLIC DEBT: REFORM OR REVERSION?
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Blane Lewis
National University of Singapore
David Woodward
World Bank, Jakarta
Borrowing can be an efficient way for sub-national governments to acquire capital
assets, but it also carries risks of fiscal distress and insolvency for borrowers. To
minimise these risks, many governments around the world have developed ex-post
insolvency remedies, including, most importantly, debt-restructuring mechanisms.
In an effort to resurrect borrowing for local infrastructure development, the Indonesian government has designed and begun to implement debt-restructuring programs for sub-national government and sub-national government-owned water
supply company defaulters. These programs constitute a major effort to reform an
important, long-neglected and problematic aspect of sub-national public finances in
Indonesia. There are a number of potential difficulties with the design and execution of the reforms, however, which collectively do not inspire much optimism for
rapid progress in reviving financial flows to the sub-national public sector. Still,
even halting advances in debt restructuring can substantially increase local infrastructure investment in the long run.
INTRODUCTION
Borrowing is a common method of financing sub-national public capital spending. All across the world, sub-national governments borrow from banks and other
financial institutions or issue bonds to acquire non-financial assets of various
kinds (such as fixed assets and land) for use in delivering public services and
stimulating economic development. Usually such borrowing is uneventful from a
financial point of view. But sub-national borrowing does create at least some risk
of fiscal distress and insolvency among debtors. Fiscal distress occurs when a subnational government’s fiscal position deteriorates significantly – for example, as
a result of large and growing annual debt repayment obligations. A sub-national
becomes insolvent if it is unable to make good on some financial obligation, such
as a loan repayment that falls due.
Fiscal distress may well result in the need for some kind of debt restructuring. Debt restructuring is a key element in the design of any broader insolvency
resolution mechanism. But the latter may include other components as well, such
as bankruptcy procedures and fiscal adjustments. Bankruptcy is a legal status
that formally connotes fiscal insolvency. A sub-national may be insolvent but not
necessarily bankrupt. The former is simply a (sometimes loosely defined) fiscal
condition of government, while the latter requires a court decision and is a legal
condition. The term ‘fiscal adjustments’ refers to the changes in a sub-national
ISSN 0007-4918 print/ISSN 1472-7234 online/10/010065-14
DOI: 10.1080/00074911003642245
© 2010 Indonesia Project ANU
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Blane Lewis and David Woodward
government’s financial management practices that are needed to overcome its
insolvency. Some kind of fiscal adjustment is typically necessary for successful
debt restructuring (Liu and Waibel 2008).
Fiscal insolvency mechanisms in general and debt-restructuring efforts in particular are of two general types: administrative and judicial. Higher-level governments assume the lead in organising administrative insolvency remedies, while
the courts take priority in implementing judicial insolvency procedures. The
benefit of administrative procedures is that higher-level governments are typically well positioned to structure and execute any fiscal adjustments needed at
the lower level; the disadvantage of such efforts is that they may become overtly
political. For judiciary-led mechanisms, the situation is reversed: the courts are
typically seen as more neutral in their dealings with creditors and debtors, but
they are at a disadvantage in insisting on sub-national fiscal adjustments (Liu and
Waibel 2008).
There is a small but growing academic literature on sub-national insolvency
remedies.1 Most of the literature focuses on specific case studies, including,
most prominently, those of Brazil (Dillinger 2002), Hungary (Jokay, Szepesi and
Szmetana 2004), South Africa (Glasser 2005) and the United States (Laughlin
2005). Liu and Waibel (2008) provide a review and synthesis of these cases and
suggest some broad best practices in the development of insolvency procedures.
In this regard, the authors stress that well planned insolvency mechanisms
encourage voluntary participation, are perceived as fair to all parties involved
and make apparent to future debtors the risks of borrowing. Most importantly,
however, the review makes clear that the appropriate design and implementation of sub-national insolvency and debt-restructuring mechanisms is necessarily very specific to the history, economies, financial systems and institutions of
the particular countries undertaking the reforms. Thus, while broad guidelines
may have some utility for the development of insolvency mechanisms, much
depends on context.
Indonesia has recently begun to implement its own administrative program of
debt restructuring for sub-national governments – known collectively as ‘regional
governments’ (pemerintah daerah, or Pemdas) and including the governments of
both provinces and districts/municipalities (kabupaten/kota) – and for local government water supply companies (Perusahaan Daerah Air Minum, PDAMs), whose
borrowing represents a large share of total regional borrowing. At this stage, the
restructuring framework focuses just on the default on loans made to Pemdas and
PDAMs by the central government (often acting as an intermediary in respect of
loans from international donors). These loans constitute the vast majority of such
lending. The government plans to broaden the scope of the procedures in the near
future by developing a more comprehensive set of insolvency mechanisms, and
by introducing sub-national public sector bankruptcy regulations.
This paper provides a description and analysis of current debt-restructuring
efforts. As such, it makes a contribution to the emergent academic literature on a
topic of considerable importance in sub-national public finance. In addition, the
1 Insolvency measures are referred to as ex-post remedies, as distinguished from ex-ante
controls. Ter-Minassian and Craig (1997) provide a discussion and some examples of exante borrowing mechanisms.
Restructuring Indonesia’s sub-national public debt: reform or reversion?
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paper provides some detailed information on, and analysis of, Indonesia’s subnational debt-restructuring program that may be of use to various stake-holders
working in this area.
The paper proceeds as follows. First, it presents some background information
on sub-national government and water supply company borrowing in Indonesia.
Second, it describes recent past and current efforts at sub-national debt restructuring, and highlights the current status of implementation. Third, it enumerates and
discusses some unresolved problems, and offers a near-term prognosis for success. The last section of the paper summarises the main points and draws some
conclusions related to decentralisation policy making in Indonesia.
BACKGROUND: SUB-NATIONAL BORROWING
AND REPAYMENT ARREARS
Sub-national governments in Indonesia are allowed to take out long-term loans
for capital development subject to several conditions.2 First, borrowing must be
used to finance infrastructure that directly generates sub-national own-source
revenue. This precludes Pemdas from borrowing to build non-toll roads or flood
control systems, for example. It is understood that the Ministry of Finance (MOF)
is at the time of writing preparing a regulation to overturn this stipulation. Second, the outstanding debt of a sub-national government may not exceed 75% of
the previous year’s general revenues (defined as all revenues except special purpose grants and emergency grants), and its 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. Collectively, sub-national
governments may not borrow more than the maximum amount determined by
the central government annually in the context of the budget law. For example,
consolidated sub-national borrowing may not exceed 0.35% of projected national
GDP in 2010.3 Finally – and most importantly for this paper – sub-national governments may not borrow if they have arrears on past loans. This (reasonable) legal
restriction has limited Pemda and PDAM borrowing and thus constrained public
capital spending at local government level. Sub-nationals have taken out only 10
loans from the MOF on-lending channel since decentralisation began in 2001.4
This low level of borrowing has had highly negative consequences for investment
in infrastructure and for the delivery of public services – especially water.
Historically, sub-national governments in Indonesia have not borrowed much
to finance their capital spending. Lewis (2007) estimates that the cumulative borrowing (in real terms) of sub-national governments and their water supply companies between 1975 and 2004 was less than 1% of GDP in 2004. Since the vast
bulk of these loans have been from the central government, there has been only
a small amount of borrowing from other financial institutions such as state or
2 The ex-ante borrowing framework for sub-national governments is discussed in more
detail in Lewis (2007).
3 GDP is projected to be approximately Rp 6,050 trillion in 2010. As at 18 January 2010,
$1 = Rp 9,225.
4 A further five Pemdas have arranged to borrow from the central government, but had
not yet drawn down on these loans at the time of writing.
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Blane Lewis and David Woodward
TABLE 1 Pemda and PDAM Borrowing as at 31 December 2007
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Number
Principal
(Rp billion)
Borrowers
Loans
Total
Outstanding
Pemdas
PDAMs
182
241
290
409
1,666.4
4,490.0
493.7
2,012.7
Total
423
699
6,156.4
2,506.4
Source: Ministry of Finance.
commercial banks, or regional development banks owned by the provincial governments themselves. 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).
Table 1 sets out the most recent information available about Pemda and PDAM
borrowing from the central government. As at December 2007, 423 borrowers
had taken on 699 loans from the central government, amounting to just under
Rp 6.2 trillion. Most borrowing was by water enterprises: PDAM borrowing
comprised almost three-quarters of the total amount. Outstanding principal (not
including arrears) was just over Rp 2.5 trillion, a sum equal to just below 0.1% of
GDP in 2007.
Even though borrowing has been quite limited, repayment of loans has been
more than a little problematic. Lewis (2007) estimates that the arrears rate was
nearly 50% in 2004.5 Table 2 provides some information on sub-national payment arrears at the end of 2007. The total amount of arrears is approximately
Rp 5.0 trillion. About one-third of the total is arrears on principal; the remainder
comprises arrears on interest, service charges, and penalties. Perhaps surprisingly,
the arrears on penalties alone make up nearly 30% of the total. Penalties, charged
by the central government for late payment or non-payment, have been an item
of significant contention between the sub-national and central governments over
the years. Total outstanding debt, which includes outstanding principal and total
arrears, amounts to Rp 7.5 trillion.
Of the 182 Pemda borrowers, 124 have arrears.6 The arrears are concentrated
in a small number of borrowers, however. Just five Pemdas – the municipalities
of Medan, Palembang, Banjarmasin, Makassar and Manado – account for nearly
two-thirds of total arrears. And 90% of total arrears are held by just 23 Pemda borrowers. The vast bulk of Pemda borrowers’ arrears are quite small; 101 Pemdas
have less than Rp 5 billion each in arrears.
Of the 241 PDAM borrowers, 201 have arrears. The arrears are heavily concentrated in 41 PDAMs, each with arrears greater than Rp 20 billion; the arrears
of these PDAMs comprise nearly 80% of the total. This category of defaulters
5 The arrears rate is equal to total payments in arrears divided by total payments due.
6 As at 31 December 2009, there are 33 provinces, 492 kabupaten/kota and 320 PDAMs.
Restructuring Indonesia’s sub-national public debt: reform or reversion?
69
TABLE 2 Pemda and PDAM Arrears and Outstanding Debt as at 31 December 2007
(Rp billion)
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Principal
Arrears
Total
Arrears
Total
Outstanding
Pemdas
205.6
627.2
1,120.9
PDAMs
1,432.6
4,394.4
6,407.1
Total
1,638.2
5,021.6
7,528.0
Source: As for table 1.
includes PDAMs in all major and secondary cities in Indonesia with the exception
of Surabaya and Balikpapan.
Why has loan repayment been so poor? Many kabupaten and kota officials have
complained that the loans were ‘supply-driven’ by international aid agencies and
the Ministry of Public Works; in extreme cases, they claim that loans were simply
assigned to them by the centre during the pre-decentralisation era. PDAM managers have similar grievances. In addition, they assert that tariff increases needed to
cover costs were not approved by Pemdas and local parliaments (DPRDs), largely
for political reasons. These and other contentions created significant disappointment among local officials about loans from the central government. There is no
evidence, however, that Pemdas, in general, were unable to repay their loans
because of fiscal constraints. It is more likely that Pemdas did not repay simply
because they were unwilling to do so, and because the MOF was unwilling to
force them to repay (Lewis 2003). The PDAMs may have been unwilling to make
good on their loans as well, but in this case the point is moot. Most PDAMs were
financially unable to repay their loans: tariffs did not cover costs, so they could
not repay even if they were willing to do so.7
In any case, the poor loan repayment record has had negative consequences
for investment in infrastructure and the delivery of public services, because of the
prohibition on borrowing by sub-national governments and water supply companies that have arrears on past loans.
In response to this situation, the central government has, after many years
of neglect, embarked upon a new program of debt restructuring. The next section of the paper describes the basic elements of the early and more recent debtrestructuring efforts, outlines the basic sanction mechanism embodied in the new
debt-restructuring process and describes the experience so far in implementing
the procedures.
7 See Woodward (2008, available on request from edw92114@attglobal.net) for a full discussion of possible reasons for arrears among Pemdas and PDAMs.
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Blane Lewis and David Woodward
DEBT-RESTRUCTURING FRAMEWORK AND STATUS
Early efforts
The laws passed by the national parliament (DPR) in 2003 and 2004 included one
on State Finances (Law 17/2003) and another on the State Treasury (Law 1/2004).
Among other things, these provided a legal basis for writing off public debt under
certain circumstances; the detailed framework is provided in Government Regulation 14/2005. Also in 2005 the MOF produced a decree (MOFD 107/2005) for
the restructuring of PDAM debt. PDAMs were accorded priority because their
borrowing is such a large portion of the total, because their arrears position is far
more serious than that of the Pemdas and because of the urgency of increasing
investment in the water sector.
MOFD 107/2005 proposed a write-off of up to 40% and 100% of arrears associated with interest payments and penalties, respectively. This seemingly generous scheme was made less so, however, by the very restrictive conditions it set
for PDAM eligibility to participate.8 Furthermore, the scheme required eligible
PDAMs to submit very complicated financial recovery action plans as part of the
process. This latter stipulation necessitated the production of a separate MOF
Treasury decree (MOFTD 53/2006) to guide PDAMs in the preparation of these
plans. Many of the plans produced suggest that PDAM managers did not find
these guidelines particularly helpful in clarifying the process.
Nevertheless, over the 12-month period following the issue of MOFD 107/2005,
the outstanding debt of 12 PDAMs (comprising 16 loans) was fully paid off. The
debt was retired not by PDAMs, however, but by their Pemda owners, in return
for a small (2%) discount on the loan principal, as provided for in the decree.
An additional seven PDAMs (or their Pemda owners) retired a sub-set of their
loans with arrears. A year after the issue of MOFTD 53/2006, 40 PDAMs were at
various stages of the restructuring process. However, by late 2007, not one PDAM
had completed a rescheduling or restructuring pre-qualification exercise up to the
stage of obtaining the required approval of the Minister of Finance. At this point
all parties came to recognise fully the rigidities of MOFD 107/2005 and the consequent difficulties for PDAMs in complying with MOFTD 53/2006.
In April 2008 Vice President Jusuf Kalla put forward a new debt-restructuring
proposal. In this scheme, 100% of non-principal arrears for both PDAM and Pemda
borrowers would be written off, with a view to stimulating investment in urban
infrastructure services and to meeting the United Nations Millennium Development Goals for piped water supply. It was expected that 175 PDAMs would
benefit from some Rp 3.0 trillion of write-offs, and that the government would
provide grant funding for an additional 10 million piped water supply household
connections to be installed over the next five years. Given that only 7.5 million
new connections had been installed since independence in 1945, this was certainly an ambitious plan (Bisnis Indonesia, 4 October 2008). In response to the vice
8 Among other things, the regulation required that, for a PDAM to be eligible for the
scheme, its financial health had to be classified as something less than ‘good’ (baik). Moreover the classification was based on an evaluation system developed by the Ministry of
Home Affairs (MOHA) (codified in MOHAD 47/1999), which is known to provide flawed
assessments of fiscal capacity. This eligibility restriction severely limited the number of
PDAMs that could participate.
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president’s proposal, and to other internal suggestions, MOF issued new debtrestructuring decrees for both PDAMs (MOFD 120/2008, issued 19 August 2008)
and Pemdas (MOFD 153/2008, issued 22 October 2008). A third decree (MOFD
129/2008, issued 4 September 2008), which specifies sanctions in the case of continued non-repayment, was also promulgated. The substance of these decrees is
outlined next. The section concludes with a brief account of the status of implementation.
New PDAM debt restructuring
The new framework for restructuring PDAM debt distinguishes between arrears
on principal and non-principal (interest, service charges and penalties). Arrears
on principal will not be written off, either in whole or in part. Rather, the framework provides for the full write-off of non-principal arrears for those PDAMs that
are classified as financially ‘sick’ (sakit) or ‘less than healthy’ (kurang sehat) by the
Finance and Development Supervisory Agency (Badan Pengawasan Keuangan
dan Pembangunan, BPKP) in the context of its annual performance audit reports.9
For those PDAMs classified as ‘healthy’ (sehat), non-principal arrears will be
treated through a combination of write-offs and ‘debt swaps’ for new investment
in the PDAMs. In this context, ‘debt swaps’ refers to debt that is forgiven on the
condition that the borrower undertakes a similar amount of new investment.10
The relative importance of PDAM debt write-offs and debt swaps is determined
by the fiscal capacity of the Pemda owners. More specifically, PDAMs owned by
Pemdas with ‘high’ (tinggi) fiscal capacity will be able to write off 40% of their
non-principal arrears, with the remaining 60% being swapped for new PDAM
investment; PDAMs owned by Pemdas with a ‘medium’ (sedang) fiscal capacity
will be able to write off 50%, with the remaining 50% being swapped; and PDAMs
owned by Pemdas with a ‘low’ (rendah) fiscal capacity will be able to write off
60%, with the remaining 40% being swapped. The debt-for-new-investment swap
can be funded by PDAMs, Pemdas or both – hence the focus on Pemda fiscal
capacity in determining the write-off/debt swap ratios.11
Unlike the initial regulatory effort, the new framework does not limit access
to the restructuring program. Any PDAM can join, as long as it meets certain
pre-conditions, including: the adoption of a cost-recovery tariff; a declaration
by the Pemda that PDAM management has been subjected to a fit-and-proper
test; and the submission of a five-year business plan, approved by the head of
the Pemda. PDAM participants must also provide a financial audit report from
9 BPKP uses its own criteria for establishing the financial health of PDAMs, rather than the
MOHA criteria referred to in footnote 8.
10 The decrees on sub-national debt restructuring use the English terms ‘write-off’ to refer
to the portions of arrears that are completely forgiven and ‘swap’ to refer to those forgiven
in exchange for the promise of new investment. We use the terms in the same manner in
this paper.
11 MOF evaluates the fiscal capacity of Pemdas on an annual basis, classifying them as
having low, medium or high fiscal capacity. Fiscal capacity is defined as the sum of ownsource revenues, shared revenues, block grant and other legal revenues net of employee
salaries, divided by population. The most recent ‘fiscal capacity map’ can be found in
MOFD 224/2008.
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Blane Lewis and David Woodward
the previous financial year;12 the previous year’s performance audit, conducted
either by the Supreme Audit Agency (Badan Pemeriksa Keuangan, BPK) or by
BPKP; the PDAM budget and business plan from the previous year; and a letter
signed by the head of the Pemda and co-signed by the chair of the DPRD, to the
effect that if, for any reason, the PDAM cannot meet its new debt payments, the
Pemda will provide financial support to enable it to fulfil its obligations under the
rescheduled loan agreements.13
Of the total arrears on PDAM loan repayments (Rp 4.4 trillion), about two-thirds
– Rp 3.0 trillion – are non-principal arrears. Early indications are that any PDAM
borrower with arrears will be categorised as ‘sick’ or ‘less than healthy’. If so, up
to Rp 3.0 trillion could possibly be written off under the vice president’s proposal.
The government intends to compensate those PDAMs that had responded positively to the earlier restructuring effort as outlined in MOFD 107/2005. This compensation takes two forms under the new framework. First, those PDAMs that
fully retired their debt some time between the dates of issue of MOFD 107/2005
and MOFD 120/2008 will receive (in addition to the 2% discount provided for
in MOFD 107/2005) an incentive payment under arrangements to be decided
separately. Second, those PDAMs that made payments according to the schedules specified in their loan agreements after the date of issue of MOFD 107/2005
and up to the date of issue of MOFD 120/2008 will receive a 2% reduction in the
interest rate on their loan(s) up to the final loan payment, plus technical assistance under arrangements to be determined separately. There are no stipulated
sanctions against those PDAMs with arrears that do not join the restructuring
program.
The restructuring process is to be carried out in two stages. Initially, over a twoyear period, any write-off is ‘conditional’ – that is, temporary. After this two-year
period, if PDAMs continue to pay their rescheduled loans on time and in full,
write-offs become ‘unconditional’ or permanent.
New Pemda debt restructuring
As was the case for PDAMs, the new framework for restructuring Pemda debt
distinguishes between principal and non-principal arrears, and arrears on repayment of principal will not be written off. Non-principal arrears will be only
partially written off, with the remainder being swapped for infrastructure investment. The amount written off is determined by multiplying the proportion of
non-principal arrears to total arrears by Rp 5 billion. The remaining non-principal
arrears are swapped for Pemda investment in schools, health clinics, roads, irrigation, bridges and water supply facilities.
The period over which repayment of principal arrears is rescheduled depends
on the amount of arrears. If arrears are less than Rp 15 billion, they must be repaid
within four years; if they total Rp 15–25 billion, they must be repaid within six
years; and if they are greater than Rp 25 billion, they must be repaid within eight
12 A disclaimer by the auditor disqualifies a PDAM from entry, unless the disclaimer relates to the ‘technical insolvency’ of the PDAM due to its arrears.
13 This latter condition is somewhat puzzling. According to Law 33/2004, Pemdas are prohibited from guaranteeing third-party debt, including that of their PDAMs. As such, this
stipulation would appear to require Pemdas to break the law or at least the spirit of it.
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73
years. The debt swaps are to be implemented over the same period as the principal arrears repayment, irrespective of amount, although some extension (as yet
undefined) may be granted in the event of financial capacity difficulties. If the
debt swap plan is not maintained to full effect, then the value of the debt swap not
implemented is returned to arrears status.
There are only limited pre-conditions for Pemda entry into the program. All
Pemdas are invited, provided they make available the required documentation.
The latter includes an action plan for implementing the debt swap; a letter agreeing to give priority to the repayment of debt and to allocate the required funds
in the sub-national budget until the loan has been entirely paid off; and a letter
consenting to the use of an intercept mechanism, described below, in the event of
loan arrears. All plans and letters must be prepared and approved by the head of
the Pemda and co-signed by the chair of the DPRD.14
Pemdas collectively hold Rp 421 billion in non-principal arrears. This sum constitutes the upper bound on the total amount that can be written off or swapped.
Given the size distribution of the arrears across Pemdas, it seems probable that
most could settle their arrears problems without the intervention of the MOF,
although it is not clear that they would do so in the absence of effective sanctions.
In any case, we understand that the restructuring program will focus on the 23
Pemdas that account for 90% of the arrears.
As is the case with PDAMs, Pemdas making early loan repayments will be
rewarded with non-principal arrears write-offs equivalent to 2% of the advance
repayments made. There is no mention of any sanction for non-participation in
the program. The write-off and debt swap must go through the same conditional
and unconditional stages as for PDAM debt restructuring.
Sanctions: a new intercept mechanism
The original decentralisation legislation of 1999 and its subsequent amendment
in 2004 made provisions for the central government to delay or cut transfer payments to Pemdas under a variety of circumstances, the most noteworthy of which,
in the present circumstances, is the non-repayment of loans from the central
government. This intercept mechanism was never employed in the case of nonrepayment of loans, although it was in other circumstances. A number of regulatory issues, which ostensibly prevented its full implementation, have now been
addressed.
The new framework for implementing the intercept mechanism is codified in
MOF decree 129/2008, issued in September 2008. On the basis of internal MOF
legal opinion, it was determined that the intercept as originally defined in law
could not be set against central government transfers to Pemdas in the case of
non-performing loans that had been made to Pemdas before the decentralisation
legislation of 1999, or in the case of non-performing loans made to PDAMs.15 Following the issue of the new decree in 2008, the intercept is henceforth applicable
14 A 12-month deadline was imposed on Pemda applications to enter the debtrestructuring program. PDAMs have not been subjected to a deadline for joining their
debt-restructuring program.
15 In these instances, the MOF’s only recourse against PDAMs and Pemdas with nonperforming loans is through the courts under the civil code.
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Blane Lewis and David Woodward
TABLE 3 Status of PDAM and Pemda Debt-Restructuring Proposal Submissions
as at 31 October 2009
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Status
PDAM
Pemda
Submissions requiring revision
Under consideration by the working group
Under consideration by the technical committee
Under consideration by the policy committee
Under consideration by the Minister of Finance
8
32
36
0
15
0
8
18
0
0
Total
91
26
Source: As for table 1.
against any arrears resulting from loans made by MOF to Pemdas since October
1999, and against any arrears associated with loans made following issue of the
decree. It is important to note that the latter include those loans made for water
supply investment, which must now be made through the Pemdas (for potential
on-lending to PDAMs).
A prime concern of MOF in developing the 2008 decree was to ensure that
the intercept could be applied without unduly constraining Pemda finances and
service delivery. To this end the decree sets maximum amounts of block grant
(Dana Alokasi Umum, DAU) and revenue-sharing (Dana Bagi Hasil, DBH) transfers that can be intercepted during a fiscal year. The limits are based on the fiscal capacity of Pemdas as determined annually by MOF. More specifically, the
intercept limits for low, medium and high fiscal capacity Pemdas are 10%, 15%
and 20%, respectively, of annual DAU and DBH transfers. In the event that these
ceilings are insufficient to recover all arrears, the balance is to be carried over and
subjected to intercept in the following fiscal year. In most cases, DAU transfers
will be the primary target for the intercept, since the vast bulk of Pemdas receive
DAU and the transfers are made in 12 equal monthly instalments per year. For
those Pemdas that do not receive DAU, however, the intercept mechanism will be
applied to the DBH.
Current status of implementation
Table 3 summarises the status of debt-restructuring proposals by PDAMs and
Pemdas as at October 2009. The approval process is one that is typical in Indonesia, comprising reviews by a working group, a technical committee and a
policy committee. MOF chairs the working group and technical and policy committees; other members include representatives of BPKP, MOHA, the Ministry
of Public Works, and the national development planning agency, Bappenas. Proposals are ostensibly subject to increasingly rigorous review as they move up
the hierarchy from the working group to the policy committee. The final stage
is Minister of Finance approval, which is based on the recommendation of the
policy committee.
As at October 2009, 91 PDAMs had submitted proposals for debt restructuring.
Of these, eight proposals were found to be problematic in some way and were
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sent back for revision; 32 had been accepted as valid proposals and were under
review by the working group; 36 had been approved by the working group and
were under consideration by the technical committee; and 15 had already been
considered and approved by the policy committee. Pemdas had submitted 26 proposals, including eight that were under initial review by the working group and
18 that were under consideration by the technical committee. More than a year
after the debt-restructuring regulations were issued, not one proposal, whether
from a PDAM or a Pemda, had been approved by the Minister of Finance.
UNRESOLVED ISSUES AND NEAR-TERM PROGNOSIS
There are a number of technical and substantive issues that may hinder the successful execution of the debt-restructuring program described above. This section
highlights the major constraints associated with PDAM and Pemda debt restructuring, and potential difficulties with the implementation of the intercept mechanism. It closes with a tentative prognosis for near-term execution of the effort.
The adoption of cost-recovery tariffs by PDAMs is the sine qua non for entry
into the water supply company debt-restructuring program. Some PDAMs have
expressed confusion about the appropriate manner of calculating a cost-recovery
tariff. Current MOHA guidelines define the cost-recovery tariff as operating, interest and depreciation costs, divided by the volume of water produced after deduction of an allowance for non-revenue water (that is, leakages or other ‘lost’ water
that does not generate revenue). Previously MOHA had used a similar definition,
but one in which the denominator was the volume of water sold less non-revenue
water. Presumably the change was introduced in recognition of the earlier definition’s erroneous twice-over allowance for non-revenue water, which yielded a
higher (rupiah per unit) cost-recovery tariff than the current definition does. A
second issue concerns the extent to which the cost-recovery tariff must be put into
effect. That is, the regulation mentions only that the tariff should be ‘ditetapkan’
(‘set’), the precise meaning of which is somewhat ambiguous. One presumes the
tariff must be codified in a local regulation (peraturan daerah, Perda), but the extent
to which the tariff actually has to be applied is not obvious: one can envision all
kinds of gaming behaviour on the part of PDAMs in ‘setting’ tariffs. Finally – and
more significantly – the political acceptability of cost-recovery tariffs must surely
be in doubt. Pemdas and DPRDs have always proved more than a little reluctant
to agree to PDAM cost-recovery tariffs, and it is far from certain that concerned
officials have changed their position on this. Of course, Pemdas could choose to
keep tariffs below cost-recovery levels and subsidise the difference from their
budgets, but this would represent a significant departure from usual behaviour.
The current arrangements for PDAM preparation of business plans seem much
more flexible than those required under the earlier regulatory effort. Among other
things, the required format in which the plan must be submitted is simpler. In
addition, the new procedures allow PDAMs to set their own annual performance
targets instead of these being prescribed, as was the case previously. This is more
sensible, because PDAMs start their recovery plans from different baselines. Thus
the adequacy of the annual targets will be evaluated by the technical committee as
part of the overall review process. However, while the preparation of the business
plan is a less onerous task than before, many PDAMs will still find difficulty in
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Blane Lewis and David Woodward
responding to the requirements – as evidenced by the fact that some have already
begun to ask for technical assistance from the Ministry of Public Works and various aid agencies. In addition, if past experience is suggestive of future outcomes,
the multi-level and multi-institutional nature of the review process will almost
certainly cause significant delays in implementation.
A final important issue as yet unresolved in the context of PDAM debt restructuring is the treatment of arrears write-offs for tax purposes. The Companies
Law (Law 40/2007) prohibits the conversion of loan write-offs into equity; consequently, as matters stand, any PDAM write-offs would be treated as non-operating
income and therefore be taxable in the year they are credited as such. Obviously,
this would defeat a major purpose of restructuring. Originally, MOF had planned
to take the matter to the DPR with a view to requesting special dispensation for
PDAMs in this specific regard. This has apparently not happened yet. Another
way to overcome the problem would be for MOF itself to pay any taxes due.16
The Pemda debt-restructuring program is more straightforward than that for
the PDAMs. The major constraint in its successful implementation would seem
to be persuading the Pemdas to participate in the program in the first instance.
The incentive to join the program is clear enough, at least in theory: restructuring
would permit Pemdas to resume borrowing to finance investment in needed infrastructure, and this would allow improvements to local public service delivery. It is
not obvious, however, that most Pemdas place a high priority on delivering quality services to their constituents. As there are no sanctions for not participating in
the restructuring program, full Pemda participation is therefore in some doubt.
Finally, at least two issues have the potential to de-rail the implementation of the
intercept mechanism, which constitutes the restructuring programs’ only method
for assuring compliance with future loan repayments. One possible problem concerns the legality of intercepting DAU transfers after the allocations have been
codified in the annual presidential decree (as they are required to be before the
start of the fiscal year). A presidential decree holds the force of law in Indonesia;
in theory the allocations cannot be changed after the issue of the decree, whether
a lower-order decree authorises such cuts or not. Perhaps this is one reason for
requesting Pemdas’ prior agreement to the use of the intercept. But if consent to
the application of the intercept against its transfer revenues is voluntary, then it is
reasonable to predict that there will be few volunteers.
Just as important a problem concerns the political will of MOF actually to
employ the intercept, even if it is available for use. On the one hand, the ministry
has, in recent years, delayed payments of DAU to those Pemdas that have not
submitted their budgets in a timely manner to the ministry as required by law.
This is cause for optimism. On the other hand, MOF has not yet cut any Pemda’s
DAU to sanction non-payment of loans, despite having the legal justification and
opportunity to do so.17 This casts some doubt on the ministry’s political will to
16 This would perhaps require an internal-to-MOF transfer from the Directorate General
for the Treasury to the Directorate General for Tax.
17 Since October 1999 – the legal start date for possible application of the intercept – 11
Pemdas have defaulted on their loans, resulting in Rp 16 billion arrears as of the end of
2007.
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employ the more severe measure of cutting DAU allocations – as opposed to just
delaying their payment.
In sum, it is apparent that implementation of the two debt-restructuring programs will be far from straightforward. At best the reforms will be executed in
fits and starts and, in any case, completion of the programs is likely to take several years at least. At worst, the programs might stall completely, in which case
PDAMs and Pemdas would be extremely likely to revert to their past questionable fiscal practices.
SUMMARY AND CONCLUSIONS
Sub-national government borrowing is ubiquitous around the world. While borrowing can be an efficient way to finance capital assets, it also carries some risks,
especially potential fiscal distress and insolvency of the debtor. Given the inherent dangers, many governments have developed ex-post insolvency remedies for
their sub-national borrowers. Debt restructuring is typically a key element of such
reforms.
Indonesian sub-national governments and the water supply companies that
they own have borrowed for infrastructure development for nearly 30 years. The
total amount of borrowing has been very small, however. More to the point in
the current context, sub-national loan repayment has generally been weak. Poor
repayment performance has led to a lack of creditworthiness among sub-national
governments and water supply companies, and has constrained new borrowing
for needed improvements to deteriorating infrastructure.
After many years of neglect, the Indonesian government has finally started
to address the sub-national borrowing and repayment problem. Among other
things, the Ministry of Finance has designed and begun to implement a debtrestructuring program for sub-national defaulters. There are separate efforts for
Pemdas and PDAMs, and both programs involve a combination of debt writeoffs and swaps. Sanctions in the form of an inter-governmental transfer intercept
mechanism have also been developed to guard against future non-repayment.
The debt-restructuring program is a significant attempt at reform.
Nevertheless there are a number of problems that might prevent the programs’
timely and successful execution. For PDAMs, the major constraints relate to
difficulties in setting and applying cost-recovery tariffs, capacity constraints in
developing and implementing sensible business plans, and the potential negative
effects of central government taxation of loan write-offs. For Pemdas, the most
significant problem relates to a possible lack of voluntary participation, given
the dearth of incentives and sanctions to encourage involvement. As regards the
intercept mechanism, potential difficulties relate to the possible illegality of cutting transfers after allocations have been formally set by presidential decree at
the beginning of the fiscal year, and a lack of political will on the part of MOF to
employ the device. At the very least, such problems are likely to cause significant
delays in implementation, and they may halt the programs entirely.
The debt-restructuring efforts described in this paper are in many ways
quintessentially Indonesian. As is often the case, early design of the relevant regulatory framework was carried out in a rather casual and haphazard manner,
and the devised procedures proved, not surprisingly, to be unworkable. More
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positively, the government has demonstrated once again that it is (belatedly) willing to face up to its miscalculations, and formally revise wayward plans and processes. Only time will tell the extent to which another of Indonesia’s typical public
sector behaviours – muddling through – will obtain, or whether the reform efforts
will just wither away. Although muddling through is, of course, a sub-optimal
process, it at least pushes sub-national public finances in a desirable direction.
Even halting advances in debt restructuring have the potential substantially to
increase borrowing for local infrastructure investment in the long run.
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