Restructuring Indonesia's sub-national public debt: reform or reversion?

Abstract

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.

Notes

¹Insolvency 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 ex-ante borrowing mechanisms.

²The ex-ante borrowing framework for sub-national governments is discussed in more detail in Lewis (2007).

³GDP is projected to be approximately Rp 6,050 trillion in 2010. As at 18 January 2010, $1 = Rp 9,225.

⁴A 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.

⁵The arrears rate is equal to total payments in arrears divided by total payments due.

⁶As at 31 December 2009, there are 33 provinces, 492 kabupaten/kota and 320 PDAMs.

⁷See Woodward (2008, available on request from [email protected]) for a full discussion of possible reasons for arrears among Pemdas and PDAMs.

⁸Among 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.

⁹BPKP uses its own criteria for establishing the financial health of PDAMs, rather than the MOHA criteria referred to in footnote 8.

¹⁰The 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.

¹¹MOF 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 own-source 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.

¹²A disclaimer by the auditor disqualifies a PDAM from entry, unless the disclaimer relates to the ‘technical insolvency’ of the PDAM due to its arrears.

¹³This 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.

¹⁴A 12-month deadline was imposed on Pemda applications to enter the debt-restructuring program. PDAMs have not been subjected to a deadline for joining their debt-restructuring program.

¹⁵In these instances, the MOF's only recourse against PDAMs and Pemdas with non-performing loans is through the courts under the civil code.

¹⁶This would perhaps require an internal-to-MOF transfer from the Directorate General for the Treasury to the Directorate General for Tax.

¹⁷Since 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.