Indonesian Economy: Week 7

Decentralisation Policy by Caroline Velenthio A. 22/492311/EK/23737

Local Governance in Focus: Analyzing Indonesia's Fiscal Decentralization Strategies

Introduction: The Reformation and Evolution of Decentralisation Law

Fiscal decentralization has played a pivotal role in Indonesia's governance landscape
over the past two decades. This transformative journey began with the enactment of Law
Number 22 of 1999 on Regional Government and Law Number 25 of 1999 on Financial
Balance between Central and Regional Governments, marking the onset of what is often
referred to as the "Big Bang" of fiscal decentralization (Anwar Nasution, 2017). These laws
ushered in an era of regional autonomy, granting local governments the authority to manage
their fiscal budgets. While central control over revenue remains, local governments have been
empowered to explore local revenue sources (PAD) as stipulated by law.
The implementation of fiscal decentralization in Indonesia commenced in 2001 when
transfer funds from the central government to sub-national governments saw a significant
increase of 145.06%, rising from IDR 33.07 trillion in 2000 to IDR 81.05 trillion in 2001 (see
Image 1). Over the subsequent two decades, transfer funds continued to grow substantially,
reaching IDR 812.97 trillion in 2019. However, this trend witnessed a slight dip to IDR
762.54 trillion in 2020 due to the COVID-19 pandemic. On average, transfer funds within the
state budget (APBN) increased by 13.03% annually (BKF & USAID EGSA, 2021). To refine
transfer management, policies addressing APBN posture transformation and transfer
reformulation were introduced, aiming to optimize the functions of various transfer types.

Image 1. Transfer Fund 1996-2020

Source: BKF & USAID EGSA, 2021

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Challenges in Transfer Fund Formulation: Special Allocation Funds (DAK) and Special
Autonomy Funds
According to BKF & USAID EGSA (2021), one of the challenges associated with
transfer funds is the General Allocation Fund (DAU) formula, which incorporates regional
civil servants' salaries (PNSD) as a variable in the basic allocation. This integration has the
potential to lead to over-recruitment of PNSD, and the strong correlation between DAU and
personnel expenditure indicates a need for revisiting this relationship. The Revenue Sharing
Fund (DBH) transfers, based on the current year's actual revenue, have introduced
uncertainty in regional revenues, thereby impacting regional budgets. In 2020, a majority of
regions (73%) found themselves in a quadrant with low DBH and low PAD, highlighting the
limited fiscal capacity of most regions.
Physical Special Allocation Funds (DAK) have significantly contributed to regional
infrastructure development and national priority achievement. Recent improvements in
allocation determination through proposal-based mechanisms and the use of the Collaborative
Planning and Budget Performance Information (KRISNA) application have enhanced the
harmonization of central and regional development planning (BKF & USAID EGSA, 2021).
Nonetheless, the allocation of non-physical DAK remains challenging due to data accuracy
issues and the struggle to define appropriate performance indicators.
Additionally, BKF & USAID EGSA (2021) showed that the Special Autonomy Fund
for Papua and West Papua, active for two decades, has yet to fulfill its allocation objectives,
particularly in education and healthcare, which continue to lag behind national averages.
Accountability in public financial management remains a concern. Extending the allocation
period and reformulating policies for these funds is seen as a potential solution. The Aceh
Special Autonomy Fund, introduced in 2008, has incentivized revenue generation (PAD) but
faces distribution and transparency challenges.
On the other hand, within the same report, BKF & USAID EGSA (2021) denotes that
the Privileges Fund for DI Yogyakarta has experienced significant growth, primarily
allocated to cultural affairs and spatial planning. However, optimizing fund utilization
remains a challenge. The Local Incentive Fund (DID) has seen a tenfold increase over a
decade, yet its role as an incentive should be further emphasized to drive regional
performance. The Village Fund, rising from IDR 20.8 trillion in 2015 to IDR 72.0 trillion in
2020, has shown high realization rates. However, equitable distribution, village readiness,
and program coordination are areas needing improvement.

Role of Regional Budget (APBD): Challenges and Regional Disparities

Regional budgets (APBD) play a critical role in fiscal decentralization, with
intergovernmental transfers contributing significantly, though decreasing in dependency over
the years (see Image 2). Proactive efforts to expand the regional tax base and optimize local
revenue collection have resulted in increased own-source revenue (PAD). However,
personnel expenditure dominance has shifted to greater expenditures on goods and services,
with capital expenditure still below its potential.
Challenges persist in the education sector, with the need for improved quality
highlighted by declining PISA scores and deteriorating classroom conditions. Regional health
expenditure surpasses the mandatory 10% at the district/city level but falls short at the

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provincial level (Anwar Nasution, 2017). Indonesia's health ranking in the Global Health
Index remains moderate. Infrastructure spending, though increasing, remains relatively low
and varies across regions, impacting Indonesia's global competitiveness.

Image 2. Disequalisation of the current transfer system

Source: A. Nasution, 2016

Conclusion: Promoting Policy Alignment and Cooperation

Fiscal decentralization has achieved substantial progress in Indonesia but is marked
by several areas of improvement. Policy suggestions include enhancing transfer fund
management, promoting local taxation, optimizing regional expenditure, strengthening public
financial management, aligning fiscal policies, and emphasizing performance-based
assessment.
Indonesia's journey with fiscal decentralization has witnessed remarkable
transformations over the past two decades, impacting the nation's economic development,
poverty alleviation, and regional welfare. However, persistent challenges and disparities
necessitate continuous policy refinements, enhanced accountability, and an unwavering
commitment to the principles of decentralization for sustained growth and improved public
services. It is evident that fiscal decentralization is an ongoing process that requires vigilance
and dedication to improving the lives of all Indonesians across the archipelago.

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Reference

Anwar Nasution. (2016). Government Decentralization Program in Indonesia. Asian

Development Bank, 601.
https://www.adb.org/publications/government-decentralization-program-indonesia
(Acessed: 27 Sep 2023).

Ehtisam Ahmad and Ali Mansoor. (2002). Indonesia: Managing Decentralization. IMF
Working Paper. https://www.imf.org/external/pubs/ft/wp/2002/wp02136.pdf
(Acessed: 27 Sep 2023).

Fiscal Policy Agency, Ministry of Finance Republic of Indonesia, & United States Agency
for International Development Economic Growth Support Activity (USAID EGSA).
(2021). TWO DECADES OF FISCAL DECENTRALIZATION
IMPLEMENTATION IN INDONESIA TWO DECADES OF FISCAL
DECENTRALIZATION IMPLEMENTATION IN INDONESIA. Retrieved from
https://fiskal.kemenkeu.go.id/files/buku/file/1670915701_2_dekade_desentralisasi_fis
kal_letter_-_eng.pdf (Acessed: 27 Sep 2023).