OFFICIALDOCUMENTS 1

Amendment toVerification Arrangement

(Local Government and Decentralization Project)

between

BADAN PENGAWASAN KEUANGAN DAN PEMBANGUNAN

and

INTERNATIONAL BANK FOR RECONSTRUCTIONAND DEVELOPMENT

Dated February 13, 2013

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AMENDMENT TO THE VERIFICATION ARRANGEMENT

With reference to the Arrangement dated December 20, 2010 ("Arrangement"), entered into betweenBADAN PENGAWASAN KEUANGAN DAN PEMBANGUNAN, the Financial and DevelopmentSupervisory Board of the Republic of Indonesia ("BPKP") and INTERNATIONAL BANK FORRECONSTRUCTION AND DEVELOPMENT ("Bank"), related to the Loan Agreement, dated June23, 2010, as amended on December 2, 2011 (Loan No. 7914-ID) for the Local GovernmentDecentralization Project ("Project") between the Republic of Indonesia and the Bank, the BPKP andthe Bank hereby agree to amend such Arrangement as set out below ("Amended Arrangement").

1. Definitions. Unless the context requires otherwise, the capitalized terms used in thisArrangement have the meanings ascribed to them in the Loan Agreement.

2. Verification Terms of Reference. BPKP will carry out the activities set out in the Verificationof Outputs (VO) Terms of Reference, as amended and set forth in the Attachment to this AmendedArrangement.

3. Term of Arrangement. This Amended Arrangement shall enter into effect as of the date firstwritten above upon countersignature by the Bank and BPKP. Except as may be otherwise notified byeither Party in writing, this Arrangement will terminate on the Closing Date of the Loan, as extendedin accordance with the terms of the Loan Agreement. Should any disputes arise under thisArrangement, they will be resolved in accordance with the dispute resolution provisions applicable tothe Loan Agreement.

4. Contact Information. The Bank's address is: International Bank for Reconstruction andDevelopment, ISEB Tower 2, Jl. Jend. Sudirman Kay. 52-53, Jakarta 12190, Telephone: (62-21)52993000, Facsimile: (62-21) 52993111. The Bank's representative for the purposes of thisArrangement is the Indonesia Country Director. BPKP's address is: Jl. Pramuka No. 33, JakartaTimur 13120 Telp 72-21-859-10031 Fax: 62-21-859-10030. BPKP's representative for the purposesof this Arrangement is the Head of BPKP.

5. Except as specifically amended by this Amended Arrangement, all terms of the Arrangementremain in effect.

AGREED at Jakarta, Indonesia, as of the day and year first above written.

BADAN PENGAWASAN INTERNATIONAL BANK FORKEUANGAN DAN PEMBANGUNAN RECONSTRUCTION AND

DEVELOPMENT

Mardiasmo Stefan G. KoeberleAuthorized Representative Authorized Representative

ATTACHMENT

Local Government (LG) & Decentralization (DAK Reimbursement) Project

the Financial and Development Supervisory Board (BPKP)

Verification of Outputs: Terms of Reference

I. Project Background

1. Project Development Objective. The objective of the LG & Decentralization (DAKReimbursement) Project (the Project) is to improve the financial and technical accountability andreporting of the central government's Specific Purpose Grants (DAK). This will be achieved throughthe application of an Output-Based Disbursement (OBD) financing approach, whereby the Projectwill reimburse a slice of the existing DAK for Infrastructure (roads, irrigation, water and sanitation)based on reported and verified physical outputs delivered by participating local governments (LGs).

Components. The Project consists of three components: Component 1: Reimbursement of theSpecific Purpose Grants (DAK); Component 2: Institutional Strengthening of Central and LocalGovernments, and Project Management; and Component 3: Verification of Outputs (VO). TheProject will be piloted in five provinces, namely Jambi, East Java, Central Kalimantan, WestSulawesi, and North Maluku, and all of their corresponding districts (81 LGs).

2. Eligible Outputs. For the purposes of the Project's Component 1, eligible outputs are singlesub-projects (Paket Pekerjaan) to be carried out by participating LGs and financed by DAK grants.The eligible outputs are defined by Ministry of Public Works (MPW) through the TechnicalGuidelines and the additional Circular Letter for Safeguards requirements, and may include:

i. Road Sub-Sector: The scope of this activity includes periodic maintenance, improvement,and rehabilitation of provincial, district, or city roads and bridges.

ii. Irrigation Sub-Sector: The scope of this activity includes improvement, rehabilitation, anddevelopment of irrigation networks, including swamp reclamation networks, and villageirrigation networks.

iii. Water Sub-Sector: The scope of this activity covers the development of water intake fromsurface water, water intake from wells, small water treatment plants (SPAM), water pipenetworks, housing connections, and development of public water hydrants. The sub-projectsmust be outside the Perusahaan Daerah Air Minum (PDAM) network.

3. Disbursement Modalities and Conditions. The Project will disburse funds using twomodalities: (i) Advance Payment (AP) and (ii) Value of Final Reimbursement (VFR). The AP will beequal to the sum of the values of Government of Indonesia (GOI's) first DAK payment to each LGthat has received its first DAK payment By March 31 of that year. The VFR will be equal to the sumof the values resulting from the verification of compliance with the conditions of eligibility ofreported outputs by LGs (Figure 1 provides an illustration of the disbursement flow). The Project willreimburse both the AP and the VFR values on the basis of the report and recommendation of

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Indonesia's Financial and Development State Auditor (Badan Pengawasan Keuangan danPembangunan, BPKP) to be submitted to the Ministry of Finance (MOF) by April 30 of each year.

Figure 1. Advance Payment (AP) and Value of Final Reimbursement (VFR)

GOI

devi-IAIBPKP

WB

Id~c w4~ I Reimbursemenit

II. Scope of the Assignment

Objective. BPKP is expected to undertake two tasks: Task 1: conduct the verification of reportedoutput eligibility; and Task 2: based on verified output eligibility, provide the assessment andrecommendation of the disbursement amounts. BPKP will issue and submit to MOF and the Bankverification reports, which should include: (i) recommendation on the amount of reimbursement andincentive to LGs; and (ii) qualitative report based on results from the verification check list.

1. Task 1: Verification of Reported Outputs. This task will require the following:

1.1 Capacity Building. In the beginning of each year, BPKP will provide sufficient capacitybuilding to the BPKP representatives in each Province on the Verification Check List and its Manual.This capacity building should be provided to all the verificators that will go to the field. During thecapacity building, the BPKP will involve MPW, Inspectorate General (IG) MPW, and SocialSafeguards specialists to be the resource person for providing description on technical and safeguardsrequirements, respectively.

1.2 Certification of Reference Unit Costs (RUC). By February 15 of each year, BPKP will submitto the MOF and the Bank a certification that the RUCs (as provided by in the MPW Guidelines forthe list of agreed upon outputs): (i) were timely issued; and (ii) represent a reasonable estimate of thecost by province for each output category (See, Annex 1 for 2012 RUCs).

1.3 Advance Payment Verification Report (APVR). By April 30 of each year, BPKP will submitto the MOF and the Bank a certification on (i) the number of LGs that have received the DAKpayment I from the MOF by March 31 of that year, and (ii) the estimated value of the AP.

1.4 Output verification. BPKP will create a uniform working paper for the verification agent at theProvincial level and the result of their verification of outputs should be recorded to the database of

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BPKP at the central level. BPKP will randomly sample 20 percent of reported outputs in eachKabupaten/Kota.

Assessing compliance with eligibility criteria. BPKP will verify, for each reported output in thesample, compliance with the output eligibility criteria as follows:

Eligibility Criteria for Reimbursement of DAK Expenditures

i. Reference Unit Costs (RUCs) for defined Outputs completed by February 15.ii. Physical Realization of Outputs: Construction Completion Certificates, and Compliance with

Technical Specifications (Form P-4, column 3, of Technical Guidelines).iii. Compliance with national procurement guidelines Perpres 54/2010, through competitive

procedures, i.e Pelelangan Umum dan Pemilihan Langsung only with post qualification inhiring of contractors.

iv. Compliance with Environment and Social Safeguards (Reference to supplement of the MPWTechnical Guidelines).

1.4.1 Review on DAK Allocation, Requirements for Reimbursements, Financial, and TechnicalReporting. BPKP will certify, for each reported output in the sample, the following:

* The DAK allocation has been made to the given LG being reviewed.* Conformity of reported output with MPW's Technical Guidelines and its revision (Source:

Approval of RK by MPW at Consultation Agenda between LGs and MPW);* Provision Hand Over (PHO) certificate with published date December 31 (Source:

Modified Form P-2)* For 2012 Outputs, the Paket Pekerjaan (source: Form P-2, Col. 6) has been documented

in the form of contracts and has a total ceiling price (i.e. DAK + matching fund) of lessthan USD 400,000; and for outputs between USD 400,001 and USD500,000 (Source:Form RK, Col. 12), with additional requirement for showing availability on procurementplan; and for outputs between USD 500,001 and USD 1 million, with additionalrequirement for showing availability on Procurement Plan and Procurement Service Unit(ULP) decree.

* For 2013 outputs, everything has to comply with the procurement covenants as mentionedin the Loan Agreement. This include: (i) availability of procurement plan by the end of theyear; (ii) ULP decree; and (iii) ULP staffed and budgeted.

* LG has sent to MOF the financial reports related to the usage of DAK from MOF (Source:Directorate General of Fiscal Balance (DGFB), MOF).

* All reports as mandated by the MPW Technical Guidelines have been submitted andaccepted by MPW.

1.4.2 Verification on Procurement and Safeguards compliance conditions. BPKP will certify,for each reported output in the sample, the following:

* Compliance with competitive procedures as stated in Perpres 54/2010, through competitiveprocedures, i.e Pelelangan Umum dan Pemilihan Langsung, only with post qualification inhiring of contractors. MPW will verify that the tenders and award processes under which thegiven output has been executed have followed the procurement conditions established in

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Perpres 54/2010, through competitive procedures, i.e Pelelangan Umum dan PemilihanLangsung only with post qualification in hiring of contractors. This will include review of thecomplete procurement cycle, starting from bid advertisement, preparation of biddingdocuments, bid evaluation process until contract award. In this regard, the BPKP willvalidate from the LG that the contract packages required to produce the outputs wereawarded following principles with respect to transparency and fair competition. Further,BPKP verification should include also confirmation of eligibility for reimbursement based onthe existing criteria as well as on fulfillment of the legal covenants by the concerned agency.

* BPKP's report should indicate the level of compliance with procurement procedures at thecontract level.

* The final report should include information about each individual contract included in thesample reviewed by BPKP as well as an assessment of their level of compliance with theGovernment's procedures, which will be beneficial for the Government to be informed forthe purpose of monitoring procurement performance under the overall DAK project.

* BPKP and MOF will discuss and decide on appropriate remedies if the review findscontracts that failed to comply with local rules and procedures. The same will apply ifphysical verification find contracts without the corresponding deliverables or whendeliverables could not be made available for inspection by the auditors.

* Compliance with Environment and Social Safeguards; evidenced by Supplement ofTechnical Guidelines. The implementing LG agencies will be responsible to ensure that allaspects related to safeguards such as environmental, indigenous peoples, and involuntaryresettlements have been complied with. Depending on the project the BPKP will verify ifthese safeguards are in compliance.

1.4.3 Verification on Physical Conditions and Site Visit. BPKP will certify, for a sample ofreported outputs, the following:

* Involve IG MPW and/or technical experts on roads, water, irrigation, and safeguardsspecialist during the verification to all five Provinces. BPKP should confirm the involvementof IG MPW in the beginning of each year through an agreement such as an MOU or signedminutes of meeting or assignment letter from IG MPW that they will provide technicalexperts for the verification of outputs to 5 Provinces.

* Conduct site visits to selected sub-projects to evaluate the status and certify both technicalfunctionality and service delivery to end users.

* Review the standard compliance reports submitted by contractors to LGs and assessment oftheir completeness and appropriateness vis-A-vis scheduled payments, and compliance withother contract obligations.

* Obtain visual photographic evidence of the status of reported outputs.* Verification Check List well documented in all BPKP representatives at the Provinces and

send to BPKP at the central level.

1.5 Output Verification Report (OVR). Based on the verification activities undertaken undersection 1.4, BPKP will prepare the OVR. Prior to the submission of final OVR to the MOF, BPKPshould invite the Bank and the Project Implementation Unit (PIU) for a technical meeting to presentthe draft of OVR and to agree on the structure of the report. By April 30 of each year, BPKP willsubmit to MOF an OVR certifying: (i) compliance with the eligibility criteria of the outputs deliveredby each LG; (ii) recommending the reimbursement amount from the Project; and (iii) a report on thequalitative information based on the results from the verification check list and sampling to the field.

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The MOF will submit the OVR to the Bank in order to request for reimbursement. The qualitativereport will be the basis for Technical Assistance (TA) in the following year, provide information onthe challenges and improvement needed at the LGs on delivering the DAK outputs, and provideinformation on the compliance of covenants in the Loan Agreement i.e. procurement covenants.

2. Task 2: Assessment and Recommendation of Reimbursement Amounts. This task willrequire the following:

2.1 BPKP will provide a detail description on the result of their calculation for reimbursement,including the incentive for LGs. The BPKP recommendation to the MOF should include the totalamount that the MOF should request from the Bank for reimbursement and incentive.

2.2 BPKP will provide feedback to the LGs after conducting the VO. These feedbacks will beuseful for the LGs to improve the implementation of DAK activities. Besides providing feedbacks tothe LGs, as mentioned in the OVR section, BPKP should provide a qualitative report on findingsbased on each requirement in the Verification Check List, provide recommendations on possible TAneeded for the LGs based on challenges and LG needs, and provide information on qualitativereports of each category in the verification check list.

2.3 Value of Potential Reimbursement. Each participating LG will report to BPKP the outputs thatthey have completed by December 31. BPKP will check that each LG has a Commitment Letter.BPKP will compile a list of reported outputs by each LG by January 31. BPKP will calculate a Valueof Potential Reimbursement (VPR) for each LG by multiplying reported outputs by their referenceunit costs.

2.4 Qualifying Percentage. Based on the number of outputs in the LG sample that meet theeligibility criteria, BPKP will then calculate the Qualifying Percentage (QP). For example, if half ofthe sampled contracts meet the eligibility criteria, the QP will be 50% (or 0.5).

2.5 Value of Qualifying Reimbursement. By multiplying the QP by the VPR for each LG, BPKPwill calculate the value qualifying of reimbursement (VQR) for each LG.

2.6 Value of Total Reimbursement. BPKP will calculate the value of total reimbursement (VTR)to be made from the Project to MOF, which is the sum across all LGs for the Value of QualifyingReimbursement (VQR) by LG.

2.7 Value of Advance Payment. The Advance Payment (AP) will be equal to the sum of the valuesof GOI's first DAK payment to each LG that has received its first DAK payment by March 31. TheAP would be at maximum 30% of total DAK allocated for the year, which equal to the current firstDAK payment from MOF to LGs.

2.8 Value of Final Reimbursement. The amount of the Value of Final Reimbursement (VFR)should be the VTR minus AP, provided that the amount disbursed by the project in any year shouldnot exceed the actual amount of DAK allocated plus 10% for the infrastructure sector in that year. Inthe event that the amount of the AP in a given year exceeds the total amount of DAK that can bereimbursed (i.e. the VTR) for that year based on the verification review by the BPKP, then the Bankwill not reimburse anything for the VFR. This will also require that the amount of the AP be reducedin the subsequent year by the amount of overpayment.

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2.9 Value of Local Government Reimbursement. The amount of the LG Reimbursement will bethe VQR times 10% summed for all LGs. This percentage may be revised by the GOI from time totime and any revision may be made applicable to reimbursement under the Project if agreed betweenGOI and the Bank.

The following table provides a summary of steps for Task 2 (Assessment of ReimbursementAmounts)

Calculation DefinitionSTEP 1: Calculate for each LGValue of Potential Reimbursement (VPR) Sum of reported outputs by their reference unit

costs.Qualifying Percentage (QP) Number of outputs in the sample that meet the

eligibility criteria, expressed as a share ofsampled outputs.

Value of Qualifying Reimbursement (VQR) QP multiplied by VPR.STEP 2: Sum across LGsValue of Total Reimbursement (VTR) Sum of Value of Qualifying Reimbursement

I (VQR) across all LGs.STEP 3: Determine World Bank reimbursement:Advance Payment (AP) Sum of the Gol's first DAK payment to each

LG that has received its first DAK payment.Value of Final Reimbursement (VFR) VTR - APLG Reimbursement 10 percent (currently) of VQR

III. Organization and Resources

1. The verification of the agreed outputs (VO) under Component 3 is a core condition ofdisbursement, and a key project assurance from GOI that Project funds have been used for theintended purposes, following principles of economy, efficiency and transparency. BPKP willestablish a working unit at the national level to manage and oversee the VO functions. BPKP willdetermine its needs with regard to additional financial and human resources at both the national andLG levels in order to do the VO functions, and communicate this officially to the MOF.

2. BPKP will maintain adequate staffing arrangements (including in technical, procurement,financial management and environmental and social safeguards capacity) with qualified personnel,technical assistance consultants and/or arrangements with personnel of IG MPW, MPW or otheragencies of the Borrower in order to accomplish the verification of Outputs in accordance with theVO Terms of Reference. At the LG level, the technical team should comprise engineers withknowledge and experience on implementation of infrastructure projects (i.e. road, irrigation, andwater), procurement specialist, and environment and social safeguards specialists.

3. BPKP will work in close coordination with IG MPW staff in doing the VO task. BPKP andIG of MPW will have an MOU and/or minutes of meeting signed by both BPKP and IG MPW and/orassignment letter of IG MPW for the involvement of IG MPW during the verification of outputs toall LGs. The institutional structure and working relationship between BPKP and MPW will becommunicated to MOF and the Bank.

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4. BPKP will provide to the Bank by no later than October 31 of each year a satisfactory WorkPlan for institutional strengthening for verification activities, including technical and environmentaland social safeguards capacity, for the upcoming year. Such plan should include the needsassessment, work plan, staffing, procurement plan and budget. In the staffing plan for verification,the BPKP will provide list of qualifications of the verificators and their area of expertise, whichshould include technical staff from IG MPW or other agencies as well as safeguards specialists.

5. BPKP and the Bank should cooperate in the furtherance of the verification activities. To thatend, BPKP and the Bank should from time to time, at the request of any one of them, exchange viewson the Project and the VO Terms of Reference, and furnish to the other party all such informationrelated to such matters as it should reasonably request, and promptly inform each other of anycondition which interferes with, or threatens to interfere with, such matters.

6. In order to ensure adequate funding is available for BPKP, the following will be conditionsfor each year's DAK to be eligible for reimbursement: (i) agreed upon funds are allocated by BPKPto do the VO function; and (ii) the work-plan is prepared and agreed upon with the Bank byDecember 31 of each year. In the event that the BPKP has not provided the budget and work plan forthe fiscal year being verified, then the Bank has the right not to make Advance Payment orReimbursement for that year.

7. BPKP will provide reasonable and sufficient time and budget allocation for BPKPrepresentative to conduct the VO to the field. This will have a significant impact on the quality ofverification and outcome of the VO.

8. The Bank extends an offer to BPKP to organize a workshop and training to discuss tools andstrategies for exercising procurement oversight and risk management.

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Annex 1: Reference Unit Costs (RUCs)INDONESIA: Local Government and Decentralization Project

The reference outputs for roads, water, and irrigation are as follows: periodic maintenance andimprovement; rehabilitation; water covers various investments related to housing connections fordrinking water; public sanitation facilities; and drainage systems. The RUC is derived fromhistorical data of DAK contracts. The example of 2012 RUCs per infrastructure sub-sector in eachselected province are as follows:

RUC JALAN ASPAL 2012

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år_s_7_ P 40 4710375V3 561M-s fMM 5413WM1.PLbe~ks 4 m, MB_» 9063__ 12921

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af_- P s4 T5 7972 538 72 74 3 37 U223r

b2 .fr Pmi5 km 8d5m e R4168 9»T4 1 075 6 231U2 2 03 61

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Y.SNkiI953 mo MW MSWW 77MZI Må9A k@ ACW

cT Lbrk~ 5m ¯ .. 2110~1 1232 1.

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