Report and Recommendation of the President to the Board of Directors

Project Number: 50168-003 October 2019

Proposed Policy-Based Loan for Subprogram 3 Republic of Indonesia: Fiscal and Public Expenditure Management Program Distribution of this document is restricted until it has been approved by the Board of Directors. Following such approval, ADB will disclose the document to the public in accordance with ADB’s Access to Information Policy.

CURRENCY EQUIVALENTS (as of 2 October 2019)

Currency unit – rupiah (Rp) Rp1.00 = $0.000070

$1.00 = Rp14,214

ABBREVIATIONS

ADB BAPPENAS DAK DID FPEMP

– – – – –

Asian Development Bank Badan Perencanaan Pembangunan Nasional (National Development Planning Agency) Dana Alokasi Khusus (Specific Allocation Fund) Dana Insentif Daerah (Regional Incentive Fund) Fiscal and Public Expenditure Management Program

GDP KEMPPKF KRISNA LIBOR MOF NEET

– – – – – –

gross domestic product Kerangka Ekonomi Makro Dan Pokok-Pokok Kebijakan Fiskal (Macroeconomic and Fiscal Policy Framework) Kolaborasi Integrasi System Perencanaan (unified planning and budget system) London interbank offered rate Ministry of Finance not in employment, education, or training

P3F PEFA PEM PKH RPJMN SAKTI SDG TA

– – – – – – – –

post-program partnership framework Public Expenditure and Financial Accountability public expenditure management Program Keluarga Harapan (conditional cash transfer program) Rencana Pembangunan Jangka Menengah Nasional (National Medium-Term Development Plan) spending unit application developer Sustainable Development Goal technical assistance

NOTE

In this report, “$” refers to United States dollars.

Vice-President Ahmed M. Saeed, Operations 2 Director General Ramesh Subramaniam, Southeast Asia Department (SERD) Director Jose Antonio Tan III, Director, Public Management, Financial Sector

and Trade Division, SERD Winfried Wicklein, Country Director, Indonesia Resident Mission, SERD

Team leaders Mohd Sani Mohd Ismail, Senior Financial Sector Specialist, SERD Aekapol Chongvilaivan, Economist (Public Finance), SERD

Team members Priasto Aji, Senior Economics Officer, SERD Emma Allen, Country Economist, SERD

Cristina de Vera, Senior Operations Assistant, SERD Shinsuke Kawazu, Senior Counsel, Office of the General Counsel

Arief Ramayandi, Senior Economist, Economic Research and Regional Cooperation Department

Jhelum T. Thomas, Senior Public Management Specialist, SERD Peer reviewer Gambhir Bhatta, Advisor and Chief Knowledge Advisory Services

Center, Sustainable Development and Climate Change Department In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS Page

PROGRAM AT A GLANCE

I. THE PROPOSAL 1

II. PROGRAM AND RATIONALE 1

A. Background and Development Constraints 1

B. Policy Reform and ADB’s Value Addition 4

C. Impacts of the Reform 9

D. Development Financing Needs and Budget Support 9

E. Implementation Arrangements 9

III. DUE DILIGENCE 9

IV. ASSURANCES 10

V. RECOMMENDATION 10

APPENDIXES

1. Design and Monitoring Framework 11

2. List of Linked Documents 13

3. Development Policy Letter 14

4. Policy Matrix 19

Project Classification Information Status: Complete

PROGRAM AT A GLANCE

Source: Asian Development BankThis document must only be generated in eOps. 17092019112357053334 Generated Date: 02-Oct-2019 9:34:35 AM

1. Basic Data Project Number: 50168-003Project Name Fiscal and Public Expenditure Management

Program (Subprogram 3)Department/Division SERD/SEPF

Country Indonesia Executing Agency Fiscal Policy Office-Ministry of Finance

Borrower Republic of Indonesia

Country Economic Indicators

https://www.adb.org/Documents/LinkedDocs/?id=50168-003-CEI

Portfolio at a Glance https://www.adb.org/Documents/LinkedDocs/?id=50168-003-PortAtaGlance

2. Sector Subsector(s) ADB Financing ($ million)Public sector management

Public expenditure and fiscal management 500.00

Total 500.00

3. Operational Priorities Climate Change InformationAddressing remaining poverty and reducing inequalities

Accelerating progress in gender equality

Tackling climate change, building climate and disaster resilience, and enhancing environmental sustainabilityStrengthening governance and institutional capacity

Climate Change impact on the Project

Low

ADB Financing

Adaptation ($ million) 57.29

Mitigation ($ million) 26.04

Sustainable Development Goals Gender Equity and MainstreamingSDG 1.5SDG 4.6SDG 5.aSDG 9.1SDG 13.aSDG 16.6

Effective gender mainstreaming (EGM)

Poverty TargetingGeographic Targeting

4. Risk Categorization: Complex .

5. Safeguard Categorization Environment: C Involuntary Resettlement: C Indigenous Peoples: C.

6. Financing

Modality and Sources Amount ($ million)

ADB 500.00 Sovereign Program (Regular Loan): Ordinary capital resources 500.00

Cofinancing 553.70 KfW Bankengruppe - Program loan (Not ADB Administered) 553.70

Counterpart 0.00 None 0.00

Total 1,053.70

Currency of ADB Financing: US Dollar

I. THE PROPOSAL 1. I submit for your approval the following report and recommendation on a proposed policy-based loan to the Republic of Indonesia for subprogram 3 of the Fiscal and Public Expenditure Management Program (FPEMP). 2. FPEMP is a key pillar of Asian Development Bank (ADB) support to the government’s focus on reducing poverty and household income inequality. It supports critical fiscal and public expenditure management (PEM) reforms to improve the quality of government spending on health, education, social protection, and infrastructure. It is consistent with the government’s reform priorities to (i) align medium-term expenditure with the National Medium-Term Development Plan, 2015–2019 (RPJMN)1 and the Sustainable Development Goals (SDGs); (ii) complete the national public expenditure framework; and (iii) improve fiscal transfers and spending of subnational governments.2 The program is aligned with ADB’s country partnership strategy, 2016–2019.3 Subprogram 3 is included in ADB’s country operations business plan 2019–2021 for Indonesia.4 The proposed subprogram is aligned with the operational priorities of ADB’s Strategy 2030 to (i) strengthen governance and institutional capacity (operational priority 6), (ii) accelerate progress on gender equality (operational priority 2), and (iii) mainstream climate in national development plans (operational priority 3).5

II. PROGRAM AND RATIONALE A. Background and Development Constraints 3. Programmatic approach and budget support. FPEMP uses a programmatic approach, which aligns ADB’s support with the government’s reform program over a medium- to long-term horizon. The ADB Board of Directors approved the programmatic approach, comprising three subprograms, and subprogram 1 in September 2016. Subprogram 1, totaling $500 million and consisting of 12 policy actions, mapped the government’s medium-term expenditure with the RPJMN and SDGs and improved national and subnational PEM.6 Subprogram 2, totaling $500 million and comprising 13 policy actions, was approved in June 2018.7 It supported reforms linking spending with targets under the RPJMN and SDGs, and strengthened PEM reforms by synchronizing planning with the budget cycle. All completed policy actions in subprograms 1 and 2 have been maintained, with no reversals. The focus of subprogram 3 is on (i) implementing SDG-related reforms, including climate mainstreaming, social assistance, and labor market activation programs; and (ii) making fiscal transfers to subnational governments more performance-based. The inclusion of the post-program partnership framework (P3F), 2020–2025 will enable ADB to continue supporting reforms in these areas and provide a platform to support the government’s focus on human capital development.

1 National Development Planning Agency. 2014. National Medium-Term Development Plan 2015–2019. Jakarta. 2 The design and monitoring framework is in Appendix 1. 3 ADB. 2016. Country Partnership Strategy: Indonesia, 2016–2019: Towards a Higher, More Inclusive and Sustainable

Growth Path. Manila. 4 ADB. 2019. Draft Country Operations Business Plan: Indonesia, 2019–2021. Jakarta. 5 ADB. 2018. Strategy 2030: Achieving a Prosperous, Inclusive, Resilient, and Sustainable Asia and the Pacific.

Manila. 6 ADB. 2016. Report and Recommendation of the President to the Board of Directors: Proposed Programmatic

Approach and Policy-Based Loan for Subprogram 1 to the Republic of Indonesia for the Fiscal and Public Expenditure Management Program. Manila.

7 ADB. 2018. Report and Recommendation of the President to the Board of Directors: Proposed Policy-Based Loan for Subprogram 2 to the Republic of Indonesia for the Fiscal and Public Expenditure Management Program. Manila.

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4. Macroeconomic context. Indonesia’s gross domestic product (GDP) grew at an average annual rate of 5.0% between 2014-2018, continuing a strong economic expansion since the Asian Financial Crisis of 1997-98.8 The government has maintained a prudent fiscal stance, with deficits below the statutory limit of 3.0% of GDP and debt estimated at 30.0% of GDP in 2018. Inflation moderated from 6.4% in 2014 to 3.2% in 2018 and is expected to remain subdued. As of 2017, all three major credit rating agencies put Indonesia's sovereign credit rating at investment grade due to strong growth prospects, supportive macroeconomic policy, and structural reform agenda. However, the current account has remained in deficit since 2012, with reliance on portfolio capital flows for its financing, which exposes the country to external uncertainties. 5. Development problem. The proposed subprogram 3 comes at a critical juncture for Indonesia. It is designed to maintain the momentum of its development efforts at a time when the quality of public spending is critical to realize development outcomes under the RPJMN and SDGs. Since 2015, the government has made substantial progress in terms of increased and better targeted public spending on SDG-related sectors such as infrastructure, health, education, and social protection. Income inequality, as measured by the Gini coefficient, improved from 0.41 in 2014 to 0.39 in 2016 at the beginning of subprogram 2, and 0.38 in 2019. Moreover, the national poverty rate declined from 11.3% in 2014 to 9.4% in 2019. However, several development indicators still lag behind the established targets. The Gini coefficient remains higher than the target of 0.36 in the RPJMN, with inequality of opportunity a key challenge. The poverty rate has not met the target of 7.0%ꟷ8.0% set in the RPJMN. About 20.8% of the total population, or 56 million people, are clustered marginally above the poverty line (Rp361,496 per month in 2017).9 These people are vulnerable to economic shocks such as natural disasters and fluctuations in food and commodity prices, which erode their ability to earn incomes, and are at risk of being pulled back into poverty.10 While the unemployment rate declined to 5.0% in 2019 from 6.2% in 2015, job growth is predominantly in low-productivity, low-wage informal sectors. In 2019, 22.6% of youth are not in employment, education, or training (NEET), and the proportion is higher among young women (28.7%).11 Those categorized as NEET tend to come from low-income families and face job entry barriers, perpetuating cycles of poverty and inequality. 6. Increased investment in people and regional development needed. Recognizing the need to optimize fiscal spending for inclusive growth and development, the government has strengthened its fiscal policy framework and decentralization efforts to improve the quality of spending and service delivery, with emphasis on the poorest 40% of households. The energy subsidy reform in 2015 has resulted in a substantial reduction of budget allocation for energy subsidies. In the 2019 State Budget, the budget allocation for energy subsidies amounted to $9.9 billion (Rp140.3 trillion)—less than half of $25.6 billion (Rp362 trillion) in 2014 (Figure). This reform, coupled with tax administration reforms, created fiscal space for increased pro-poor spending, especially in infrastructure and social protection programs. During subprogram 2 (2018), despite lower fiscal deficits, budget allocations were increased as follows: (i) education, from $26.2 billion to $30.8 billion; (ii) health, from $6.5 billion to $7.6 billion; (iii) social protection, from $9.8 billion to $11.4 billion; and (iv) infrastructure, from $19.0 billion to $29.0 billion. However, to reach the government’s Gini coefficient target of 0.36, reduce the poverty rate further, and meet the various SDG targets, stronger economic and fiscal performance as well as continuous targeted spending on education, health, infrastructure, and social protection programs will be

8 ADB forecasts growth of 5.1% for 2019 and 5.2% for 2020, with external uncertainty a key risk to the outlook. 9 World Bank. 2019. Poverty and Equity Brief: Indonesia. Washington, DC. 10 The government spends $300 millionꟷ$500 million annually on post-disaster reconstruction. 11 Statistics Indonesia. 2019. Labour force situation in Indonesia: February 2019. Jakarta.

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required. Further, programs targeting youth unemployment and boosting the productivity of human capital through skills upgrading need to be effectively designed and implemented.

7. Binding constraints. The government has identified the challenges it needs to address to meet its RPJMN and SDG targets.12 They include (i) insufficient implementation of the medium-term framework and SDG programs, (ii) incomplete national public expenditure management, and (iii) fiscal transfers to subnational governments that are not performance-based. 8. Insufficient implementation of the medium-term framework and Sustainable Development Goal programs. Aligning the medium-term expenditures with the RPJMN and SDG targets is a work in progress. Under subprogram 2 (footnote 7), the National Coordination Team for SDGs, chaired by the President of Indonesia, was established. The team is mandated to undertake coordination, planning, monitoring, and reporting on SDG implementation, using a unified results framework, including mapping the SDGs against RPJMN targets. Despite progress, several constraints must be overcome to fully integrate the national development agenda into the existing medium-term framework. First, although the government has issued a national SDG action plan, the absence of financing, gender and climate mainstreaming strategies, and regional action plans, hampers SDG implementation. Consequently, the government’s SDG priorities have not been fully translated into actions at the national line agencies and subnational governments. Second, the difficulty in meeting the SDG targets is reflected in the ad hoc implementation of social assistance and labor market activation programs to address poverty, inequality, and unemployment. Despite the focus on social assistance programs, implementation is often on a per program basis, making the programs less efficient and effective. Similarly, labor market activation programs are in their infancy and do not specifically target youth and girls to shorten the school-to-work transition. 9. Incomplete national public expenditure management framework. Although important progress has been made during earlier subprograms (footnotes 6 and 7), the national public

12 Sector Assessment (Summary): Public Sector Management (accessible from the list of linked documents in Appendix

2).

0

200

400

600

800

1,000

1,200

1,400

2014 2015 2016 2017 2018 2019

Rp

trilli

on

Figure: Budget Reallocation of Energy Subsidies to Social Sectors and Infrastructure

Education Health Infrastructure Social protection Energy subsidy (fuel and LPG)

LPG = liquefied petroleum gas. Sources: Government of Indonesia, Ministry of Finance; Asian Development Bank estimates.

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expenditure framework is still incomplete, which weakens the quality and efficiency of public service delivery, ultimately undermining development outcomes. The constraints are (i) lack of detailed operating guidance for the use of multiyear contracts, (ii) the absence of legal certainty for the Macroeconomic and Fiscal Policy Framework (KEMPPKF), and (iii) underutilization of the unified planning and budget system (KRISNA). The 2018 Presidential Regulation on Public Procurement of Goods and Services issued under subprogram 2 is an important milestone to improve the efficiency of public procurement. The regulation aimed to address issues of multiple procurement contracts and delayed disbursements, especially capital expenditure through the implementation of multiyear contracts. However, this implementation is limited until the Ministry of Finance (MOF) issues the implementing regulations, including defining the approval threshold for multiyear contracts. Similarly, the KEMPPKF, which provides the framework to synchronize budget preparation with the medium-term expenditure framework, is based on internal guidelines and lacks legal certainty. This reduces the accountability of the budget process. Finally, although the KRISNA system was launched for the preparation of the 2018 budget under subprogram 2, the system has not been fully utilized to review budget allocation, including for national priorities such as climate change and gender mainstreaming. 10. Fiscal transfers to subnational governments are not performance-based. Intergovernmental fiscal transfer mechanisms are an integral part of fiscal decentralization and have seen important improvements during subprograms 1 and 2. 13 Under the earlier subprograms, the channels for fiscal transfers were expanded and allocation increased significantly. The government also introduced reporting requirements to increase accountability of subnational government spending. However, the intergovernmental fiscal transfer system has not addressed widening regional disparities as it is not performance-based. For example, in 2018 the per capita income in Jakarta is about $17,571 (Rp248 million), almost 14 times higher than in East Nusa Tenggara. Three constraints are present. First, no systematic procedures are in place in the disbursement of the Specific Allocation Fund (DAK) to synchronize activities across sectors and line ministries to avoid overlapping results. Second, the methodology for allocation of the Village Fund is generic and does not consider the different levels of development among villages, thus failing to address regional disparity. Third, although the performance indicators of the Regional Incentive Fund (DID) have been refined, they are still not directly linked to SDG targets such as reducing stunting and maternal mortality rates. These constraints have led to delays in disbursement and inefficiencies in subnational government spending. B. Policy Reform and ADB’s Value Addition 11. Government’s reform agenda. The government’s medium-term strategy is to create sustainable and equitable economic growth by optimizing revenue, improving spending quality, reorienting subsidy schemes to targeted social assistance programs, and decentralizing fiscal authority. Together with the commitment to increase spending in pro-poor sectors, the government is also increasing the quality of expenditure through PEM reforms. On the revenue side, Indonesia seeks to increase its tax-GDP ratio from about 10.0% in 2016 to 12.7%–13.3% by 2021, eventually reaching 15%. To achieve this, the government implemented tax administration reforms, including broadening the coverage of taxpayers. The reforms contributed

13 The main channels of intergovernmental fiscal transfers in Indonesia are (i) the General Allocation Fund to support

recurring spending; (ii) the Specific Allocation Fund (DAK) for specific investment expenditures aligned with national priorities; (iii) the Revenue-Sharing Fund, which covers natural resources; and (iv) the Regional Incentive Fund (DID), which provides an incentive to subnational governments to improve their performance. In addition, a fifth channel, the Village Fund, was introduced in 2015 to help the lowest level of governments finance development.

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to increased tax collection of about $7 billion, equivalent to a tax-GDP ratio of 11.5%, in 2018. The government is committed to sustain these reforms with support from development partners. 12. Reform accomplishments. At the inception of the programmatic approach, the government agreed to accomplish six prior actions (triggers) and seven policy milestones as the basis for subprogram 3.14 During the processing of subprogram 3, three prior actions (2, 7, and 11) were strengthened to enhance their legal status and improve the governance of DAK fiscal transfer. Subprogram 3 comprises 13 policy actions, all of which have been accomplished. 13. Medium-term expenditure aligned with National Medium-Term Development Plan and Sustainable Development Goal targets. This reform area supports SDG 3 (good health), SDG 4 (quality education), SDG 5 (gender equality), SDG 8 (decent work), and SDG 13 (climate action). The reforms also build on accomplishments under subprograms 1 and 2, including the issuance and implementation of presidential regulations on SDGs, which established the National Coordination Team for SDGs. There were four key accomplishments in subprogram 3. First, the government launched the SDG road map, which included a financing chapter for SDG implementation. This is critical, as the financing chapter assessed the costs of the various SDG programs, available government resources, and innovative means to crowd in private sector financing. Climate change mitigation and adaptation, and gender mainstreaming strategies, including sex-disaggregated data, were also incorporated in the road map. Second, the government’s commitment to SDGs is reflected in its increased budget allocation for pro-poor expenditure. From 2018 to 2019, budget allocations have increased as follows: (i) education, from $30.8 billion to $34.9 billion; (ii) health, from $7.6 billion to $8.7 billion; (iii) social protection from $11.4 billion to $14.2 billion; and (iv) infrastructure from $29.0 billion to $29.4 billion.15 14. Third, supplementing the budget increase, the government enhanced the efficiency and targeting of its social assistance programs by combining the food assistance and conditional cash transfer (PKH) programs into one smart card. The food assistance program, pilot tested during subprogram 1 and extended to 1.4 million households during subprogram 2, has been expanded to 15.6 million households. The government also doubled the amount of benefit for the 10 million households of the PKH from Rp1.2 million in 2016 to Rp2.4 million in 2019. In addition, the benefit structure of the PKH was improved from a flat annual rate to a basic assistance rate, with additional benefits added according to family conditions such as the presence of pregnant women, children under five, elderly, and family members with disabilities. The National Team for Acceleration of Poverty Reduction estimated that reforms in the social assistance programs have the potential to bring the national poverty rate down to about 6% and reduce the Gini coefficient to 0.376.16 Analysis of the shift from the rice subsidy program to noncash social assistance showed that inclusion of poor households in the bottom 25% improved by 3% in 2018, and inclusion of non-targeted households decreased from 9% in 2017 to 5% in 2018. Finally, to address youth unemployment and enhance human capital development through skills upgrade of employees, the government pilot tested several labor market activation programs, including vocational training facilities for religious schools and skills development centers to inform the

14 Prior actions are considered to be loan disbursement conditions, and policy milestones strengthen the program. A

comparison of the original and the revised subprogram 3 reform actions is in Summary Assessment of Policy Actions Under Subprogram 3 (accessible from the list of linked documents in Appendix 2).

15 During subprogram 3 (from April 2018 to August 2019), the budget allocation for education, health, social assistance, and infrastructure had a real increase of 5.6% on an aggregate basis.

16 The National Team for The Acceleration of Poverty Reduction. 2018. The Future of The Social Protection System in Indonesia: Social Protection for All. Jakarta.

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launch of a pre-employment card in 2020. ADB is providing inputs through pilot testing “JobStart” and “enterprise-led learning networks,” drawing on best practices in the Philippines.17 15. National public expenditure framework completed. This reform area contributes to the implementation of SDG 9 (industry, innovation, and infrastructure). It aims to strengthen the alignment of budget planning with the medium-term fiscal objectives and to address the bottlenecks of state budget disbursement, by providing greater control over and flexibility of public expenditures. The reforms also build on accomplishments under subprograms 1 and 2, including improved budget transparency, issuance of presidential regulations on multiyear contracts, and development of the KRISNA system for coherence between planning of national priorities and budgeting. In subprogram 3, reforms were undertaken to improve the efficiency and effectiveness of public spending. First, more efficient disbursement of capital expenditures by line ministries was achieved with the issuance of implementing rules and regulations for multiyear contracts by the MOF and National Public Procurement Agency. The regulation provided flexibility and enabled line ministries to approve their own multiyear contracts of up to $14 million for construction work and $1.4 million for the procurement of goods and services. Flexibility is also provided, so that line ministries can request to extend the duration and increase the ceiling of the multiyear contracts, as well as reallocate the composition within the contract. 16. Second, efficiency, disbursement, and financial reporting at the spending unit level was enhanced through automated payment and online monitoring of financial management. To achieve this, the MOF integrated the features of electronic budget requests and payment into one application and expanded its use from 322 spending units in 2018 to more than 1,000 spending units in 2019. Third, the government strengthened the effectiveness of the budget process with the full implementation of KRISNA in the MOF, National Development Planning Agency (BAPPENAS), all line ministries, and subnational governments to prepare the 2019 budget. KRISNA was also used to review gender-responsive and climate adaptation allocations in the 2019 budget, which strengthened linkage with national priorities. The government also enhanced the medium- to long-term effectiveness of public spending by including the long-term fiscal sustainability assessment and framework (up to 2045) as part of the KEMPPKF. This enabled the government to plan its long-term fiscal commitment to include factors such as demographic transition and long-term contingent liabilities. Further, the accountability of the KEMPPKF was improved with the upgrade of its legal status to ministerial decree. 17. Fiscal transfers and subnational governments’ spending for service delivery improved. This reform area strengthened the PEM of subnational governments. These reforms cut across several SDGs at the subnational level, including good health (SDG 3), quality education (SDG 4), and infrastructure (SDG 9). The reforms build on accomplishments under subprograms 1 and 2, including increased and more targeted intergovernmental fiscal transfers, and the introduction of a compliance mechanism to strengthen monitoring and disbursements. There were three key accomplishments in subprogram 3. First, the government increased budget allocations for the Village Fund from Rp60 trillion in 2018 to Rp70 trillion in 2019, and reformulated allocations toward poor and lagging villages.18 Subsequent disbursements of the Village Fund are performance-based and subject to implementation progress.

17 ADB. 2015. Technical Assistance to the Republic of the Philippines for Support for the Nationwide Rollout of JobStart

Philippines. Manila; and Skillnet Ireland. https://www.skillnetireland.ie/. 18 The basic allocation, which provides uniform budget allocation to each village, was reduced to 72% in 2019 from

90% in 2017. The formula allocation, which depends on various characteristics of villages, including poverty rates, was increased to 25% in 2019 from 10% in 2017. The government also introduced affirmative allocation, which provides additional allocations to villages in the three poorest income deciles, accounting for 3% of total allocations.

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18. Second, the government implemented reforms to enhance the efficiency and governance of DAK for local infrastructure. Subnational governments were required to utilize KRISNA to synchronize programs, projects, and activities to avoid overlapping end results across sectors, line ministries, and subnational governments. The disbursements of DAK are also conditional on project performance. An independent internal control body, which reports directly to the city mayor, was introduced to undertake an oversight role in DAK utilization and disbursements. These reforms improved budget absorption of the subnational governments from 84.2% in 2017 to 88.1% in 2018. Third, the government continued to increase DID transfers from Rp8.5 trillion in 2018 to Rp10 trillion in 2019 and strengthened the linkages between DID allocations and SDG outcomes. In 2019, the criteria for DID allocations included SDG-related performance indicators such as: (i) infant immunization, (ii) childbirth receiving professional services at medical facilities, (iii) reduced incidence of stunting, and (iv) climate-resilient infrastructure. This is critical to incentivize subnational governments to implement programs to meet the SDGs. 19. Post-program partnership framework. The P3F provides for a structured dialogue in the medium term and represents ADB’s commitment to continue supporting the government’s SDG reform agenda via technical assistance (TA).19 Through the FPEMP, the government has developed the SDG implementation framework and has implemented reforms to improve the quality of spending through PEM reforms in the national and subnational governments. These reforms enabled the government to focus on implementing SDG initiatives to address inequality of opportunity. The P3F reflects the government’s commitment to sustain reform and will enable ADB to support specific initiatives including the conditional cash transfer program and programs to address unemployment. Key activities include implementing labor market activation programs to address youth unemployment and skills development, and better targeting the conditional cash transfer program. This may lead to a new program to support the government’s focus on human capital development. 20. ADB’s experience. ADB has supported reforms in PEM and social assistance programs by recognizing the need for a building block approach in the medium term. In 2001, ADB provided TA to set up the public financial management and PEM framework at the national and subnational levels.20 This was followed by support for the government to build a modern national public financial management system, including a public debt management office, in 2005.21 In the second phase, ADB provided support to introduce financial management information systems in 147 local governments and to decentralize the tax framework.22 Since 2012, ADB has provided TA to improve the fiscal sustainability of social security, strengthen the fiscal decentralization framework, and improve fiscal risk management of contingent liabilities arising from accelerated infrastructure investment. ADB also supported the government’s reform agenda to improve its investment climate, develop the capital market, and improve access to finance.23

19 ADB. 2016. Technical Assistance for Support to the Association of Southeast Asian Nations Economic Community.

Manila. 20 ADB. 2001. Technical Assistance to the Republic of Indonesia for Supporting Country Financial Accountability.

Manila. 21 ADB. 2005. Report and Recommendation of the President to the Board of Directors: Proposed Loans and Technical

Assistance Grant to the Republic of Indonesia for the Local Government Finance and Governance Reform Sector Development Program. Manila.

22 ADB. 2008. Report and Recommendation of the President to the Board of Directors: Proposed Program Cluster and Loan for Subprogram I to the Republic of Indonesia for the Second Local Government Finance and Governance Reform Program. Manila.

23 ADB. 2018. Report and Recommendation of the President to the Board of Directors: Proposed Policy-Based Loan for Subprogram 3 to the Republic of Indonesia for the Stepping Up Investments for Growth Acceleration Program. Manila; ADB. 2018. Report and Recommendation of the President to the Board of Directors: Proposed Policy-Based

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21. Lessons learned. ADB’s experience, particularly through its support of the Millennium Development Goals, provided three key lessons that have been incorporated in the program design.24 First, PEM reforms are successful when they are linked to a country’s commitment to international goals. The program linked reforms to SDGs. Such linkage provided an overarching framework for these reforms and obtained high-level commitment from the government. Second, ADB learned that meeting SDG targets requires implementing reform programs at the subnational level.25 Implementation can be made more effective by providing an incentive framework for local governments to meet SDG indicators. This program linked DID to indicators on stunting and maternal mortality. Third, gender mainstreaming reforms, including the determination of sex-disaggregated indicators, should be integrated in the national strategy and action plan. The program incorporated gender mainstreaming in the SDGs road map and regional action plans. 22. ADB’s value addition to program design and implementation. ADB’s long-term engagement and structured policy dialogue with the government helped prioritize and sequence legal, policy, regulatory, and institutional reforms. ADB’s value addition spans all three reform areas. In the area of SDG implementation, ADB supported development of the SDGs Roadmap which included the financing chapter and integrated gender mainstreaming strategy (footnote 19). The Roadmap estimated that Indonesia needs to spend over $700 billion for SDG-related programs from 2020 to 2030 and provided the strategy for the government to finance this including through private sector financing. In addition, ADB began pilot testing labor market activation programs for youth unemployment and skills upgrades, based on experience from successful implementation of similar programs in the Philippines such as the JobStart program (footnote 17). In the area of national PEM reforms, ADB provided support for the government to draft the long-term fiscal framework report, which was attached to the KEMPPKF. The 2019 budget benefited from such analysis. ADB also improved governance by supporting capacity development of government internal auditors and public finance officers. 26 At the subnational level, ADB supported capacity building for PKH supervisors on case management, complaints handling, and implementation of PKH in remote and disadvantaged areas.27 23. Development partner coordination. The government leads development partner coordination in the areas of PEM reforms and SDG implementation. ADB coordinates dialogue and activities closely with the IMF and the World Bank. ADB joined the IMF’s Public Investment Management Assessment mission in 2019 and the PEM reforms under the program are complementary to the World Bank’s Third Fiscal Reform Development Policy Loan approved in May 2019.28 Following cofinancing of subprograms 1 and 2, German development cooperation through KfW approved cofinancing of €500 million for subprogram 3. ADB and KfW conducted joint missions to discuss the policy matrix, and coordinated SDG reforms with the United Nations Development Programme. ADB also coordinated with the bilateral development agencies of the governments of Australia, France, and the United States on PEM reforms.29

Loan for Subprogram 3 to the Republic of Indonesia for the Financial Market Development and Inclusion Program. Manila.

24 Independent Evaluation Department. 2017. Validation Report: Poverty Reduction and Millennium Development Goals Acceleration Program in Indonesia. Manila: ADB.

25 Independent Evaluation Department. 2017. Validation Report: Second Local Government Finance and Governance Reform Program (Subprograms 1 and 2) in Indonesia. Manila: ADB.

26 ADB. 2012. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to the Republic of Indonesia for the State Accountability Revitalization Project. Manila.

27 ADB. 2018. Technical Assistance to the Republic of Indonesia for Building Inclusive Social Assistance. Manila. 28 The World Bank’s development policy lending aims at improving tax administration efficiency. It will help the

government increase fiscal space for spending on priority sectors, which is the focus of FPEMP. 29 Development Coordination (accessible from the list of linked documents in Appendix 2).

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C. Impacts of the Reform 24. Economic impacts of the program. Three out of four outcome indicators in the Design and Monitoring Framework have been achieved early. The proportion of targeted national and subnational spending has increased by 22.3% from the baseline of Rp995.0 trillion ($70.4 billion) in 2015 to Rp1,216.6 trillion ($86.1 billion) in 2019. The 2017 Public Expenditure Financial Accountability (PEFA) report showed improvement in the indicator on expenditure composition outturn, which rose from a D in 2012 to C+ in 2017.30 This target is now revised upward to B. The rating for aggregate expenditure outturn remained the same, as budget realization was 88.6% for 2015 and 89% for 2016. However, there have been significant improvements for the budget realization which recorded 94% for 2017 and 99% for 2018, respectively. In addition to the PEFA, the Open Budget Index reported improved scores for transparency and budget oversight. Likewise, the IMF reported improvements in the quality and efficiency of public investment.31 The program impact assessment estimates that the economic and social benefits of the program were $4.8 billion–$7.6 billion.32 The benefits are derived from increased and targeted public spending, equivalent to adding an annual average of 6.5%ꟷ10.4% to priority sector spending. D. Development Financing Needs and Budget Support 25. The government has requested a single tranche loan of $500 million from ADB’s ordinary capital resources to help finance subprogram 3.33

The loan will have a 15-year term, including a grace period of 3 years with a straight-line repayment method and an annual interest rate determined in accordance with ADB’s London interbank offered rate (LIBOR)-based lending facility; a commitment charge of 0.15% per year; and such other terms and conditions set forth in the draft loan agreement. The average loan maturity is 9.25 years, and there is no maturity premium payable to ADB. KfW approved cofinancing of €500 million. The loan size is based on Indonesia’s financing needs, the development impact of the policy reform package, and development spending arising from the reforms. For 2019, the government’s projected total gross borrowing requirement is estimated at $59.6 billion. To finance the deficit, the government plans to raise about $53.4 billion from the issuance of securities, $5.9 billion from official development assistance, and $0.3 billion from nonofficial development assistance sources. Climate mitigation is estimated to cost $26.04 million, and climate adaptation is estimated to cost $57.29 million. E. Implementation Arrangements 26. The MOF’s Fiscal Policy Agency, as the executing agency, is responsible for coordinating program-related reforms. Implementing agencies include the directorates general of budget, treasury, and fiscal balance in MOF; and BAPPENAS. The implementation period for subprogram 3 is from April 2018 to August 2019. The proceeds of the policy-based loan will be withdrawn in accordance with ADB’s Loan Disbursement Handbook (2017, as amended from time to time).

III. DUE DILIGENCE 27. Safeguards. Subprogram 3 will not entail any involuntary resettlement or affect indigenous people or the environment. It is classified category C for environment, involuntary resettlement, and indigenous people.

30 World Bank. 2018. Indonesia: Public Expenditure and Financial Accountability (PEFA) Assessment Report 2017.

Washington, DC. 31 IMF. Forthcoming. Indonesia: Public Investment Management Assessment Draft Report. Washington, DC. 32 Program Impact Assessment (accessible from the list of linked documents in Appendix 2). 33 The loan may be disbursed in one or more installments.

10

28. Poverty and social. Subprogram 3 is categorized as effective gender mainstreaming at entry. Key reforms that mainstreamed gender included integrating gender strategy into the SDG Roadmap, improvement of the PKH to provide additional benefit for families with pregnant women, elderly and people with disabilities, and inclusion of indicator to reduce maternal mortality for the regional incentive fund. In addition, increased expenditure in education, health, and infrastructure will reduce poverty and help the bottom 40% of the population. 29. Governance. In 2017, Indonesia scored either A or B (both considered above basic alignment with international good practice) on 17 out of 31 indicators in the World Bank’s PEFA report (footnote 30). Indicators with particularly good assessment results include transparency of public finance, and accounting and reporting. Government regulations issued in 2017 strengthened the legal and regulatory frameworks for public financial management, mandating coordination between BAPPENAS and the MOF in planning, budgeting, and subsequent regulations. ADB’s Anticorruption Policy (1998, as amended to date) was explained to and discussed with the government. 30. Risk and mitigating measures. Two key risks have been identified in the program.34 The first pertains to macroeconomic risks, particularly in relation to tighter global financial conditions. This is mitigated by Indonesia’s sound macroeconomic fundamentals, and appropriate monetary and fiscal policies. Second is the inadequate capacity, especially at the subnational level. ADB is providing TA to improve subnational government capacity for SDG implementation (para. 22). Moderate risks include ineffective implementation of the medium-term expenditure framework and performance-based budgeting, and lower revenue that may hamper critical expenditure for SDG implementation.

IV. ASSURANCES 31. The government has assured ADB that implementation of the program shall conform to all applicable ADB policies including those concerning anticorruption measures, safeguards, gender, procurement, consulting services, and disbursement as described in detail in the loan agreement.

V. RECOMMENDATION 32. I am satisfied that the proposed policy-based loan would comply with the Articles of Agreement of the Asian Development Bank (ADB) and recommend that the Board approve the loan of $500,000,000 to the Republic of Indonesia for subprogram 3 of the Fiscal and Public Expenditure Management Program, from ADB’s ordinary capital resources, in regular terms, with interest to be determined in accordance with ADB’s London interbank offered rate (LIBOR)-based lending facility; for a term of 15 years, including a grace period of 3 years; and such other terms and conditions as are substantially in accordance with those set forth in the draft loan agreement presented to the Board.

Takehiko Nakao President

2 October 2019

34 Risk Assessment and Risk Management Plan (accessible from the list of linked documents in Appendix 2).

Appendix 1 11

DESIGN AND MONITORING FRAMEWORK Country’s Overarching Development Objective Household income inequality reduced (National Medium-Term Development Plan, 2015–2019)a

Results Chain Performance Indicators with

Targets and Baselines

Data Sources and Reporting

Mechanisms Risks

Effect of the Reform Social sector and infrastructure spending improved

By 2021: a. Aggregate expenditure outturn compared with originally approved budget improved by one grade (2012 baseline: PEFA report rating of C) b. Composition of expenditure outturn compared with originally approved budget improved by two grades (2012 baseline: PEFA report rating of D)b

c. Extent of central government monitoring of subnational governments improved by one grade (2012 baseline: PEFA report rating of C) d. Proportion of targeted national and subnational spending increased (2015 baseline: Rp995.5 trillion)

a. Government statistics and official budget data (annually) b–c. PEFA report (every 3 to 4 years) d. Government statistics and official budget data (annually)

Normalization of interest rates and uncertainty in global trade may result in macroeconomic risk.

Reform Areas under Subprogram 3 1. Medium-term expenditure aligned with RPJMN and SDG targets

Key Policy Actions By 2019: 1a. SDG road map incorporating a financing chapter with gender and climate change mainstreaming strategy finalized (2018 baseline: no SDG road map) 1b. Two social assistance programs integrated into smart card, which reduced leakage to non-targeted households. (2018 baseline: social assistance programs not integrated)

1a. Indonesia’s voluntary report to the United Nations (annually) 1b. Report of the vice president’s office (annually)

Lower budget revenue results in lower spending on infrastructure and critical social sectors.

2. National public expenditure framework completed

By 2019: 2a. Ministry of Finance decree on multiyear contract developed specifying threshold for approval (2018 baseline: Presidential regulation on procurement issued with no decree to guide implementation) 2b. KRISNA system used to review budget allocation for national priorities, including gender mainstreaming and

2a. Report of Fiscal Policy Agency, Ministry of Finance (annually) 2b. Report of Directorate General Budget, Ministry of Finance (annually)

12 Appendix 1

Results Chain Performance Indicators with

Targets and Baselines

Data Sources and Reporting

Mechanisms Risks

climate change (2018 baseline: KRISNA system launched) 2c. Electronic budget request system integrated with financial accounting applications and rolled out to more than 1,000 spending units (2018 baseline: electronic budget request system implemented by 322 spending units)

2c. Report of Directorate General of Treasury, Ministry of Finance (annually)

3. Fiscal transfers and subnational governments’ spending for service delivery improved

By 2019: 3a. Village Fund allocation increased to Rp70 trillion and allocation reformulated to support lagging villages (2018 baseline: Village Fund allocation of Rp60 trillion with flat distribution allocation for all villages) 3b. DAK fiscal transfer implemented with independent verification mechanism (2018 baseline: DAK fiscal transfer implemented with no verification mechanism) 3c. DID aligned with indicators on stunting, maternal mortality, and climate-resilient infrastructure (2018 baseline: indicators not aligned to SDGs)

3a. Report of Directorate General of Fiscal Balance (annually) 3b. Directorate General of Fiscal Balance report (annually) 3c. Directorate General of Fiscal Balance report (annually)

Budget Support Asian Development Bank: Subprogram 3: $500,000,000 (loan) Assumptions for Partner Financing German development cooperation through KfW: €500,000,000

BAPPENAS = Badan Perencanaan Pembangunan Nasional (National Development Planning Agency), DAK = Dana Alokasi Khusus (Specific Allocation Fund), DID = Dana Insentif Daerah (Regional Incentive Fund), KRISNA = Kolaborasi Integrasi System Perencanaan (unified planning and budget system), PEFA = Public Expenditure Financial Accountability, RPJMN = Rencana Pembangunan Jangka Menengah Nasional (National Medium-Term Development Plan), SDG = Sustainable Development Goal. a Government of Indonesia, National Development Planning Agency (BAPPENAS). 2014. National Medium-Term

Development Plan (RPJMN), 2015–2019. Jakarta. b This indicator was met in 2017 as the grade improved from D to C+. Hence, the target is revised upward to specify

improvement by two grades (from D to B). The revision is based on projections and trend analysis. Evaluation of the fulfillment of the new target should consider the risks identified in the design and monitoring framework.

Source: Asian Development Bank.

Appendix 2 13

LIST OF LINKED DOCUMENTS http://www.adb.org/Documents/RRPs/?id=50168-003-3

1. Loan Agreement

2. Sector Assessment (Summary): Public Sector Management

3. Contribution to the ADB Results Framework

4. Development Coordination

5. Country Economic Indicators

6. International Monetary Fund Assessment Letter

7. Summary Poverty Reduction and Social Strategy

8. Risk Assessment and Risk Management Plan

9. List of Ineligible Items

10. Climate Change Assessment

Supplementary Documents

11. Report and Recommendation of the President to the Board of Directors: Fiscal Policy and Expenditure Management Program (Subprogram 1)

12. Program Impact Assessment

13. Public Financial Management Assessment

14. ADB Support for Decentralization and Sustainable Development Goals

15. Comparison of Original and Revised Subprogram 3

14 Appendix 3

Appendix 3 15

16 Appendix 3

Appendix 3 17

18 Appendix 3

Appendix 4 19

POLICY MATRIX Outputs Subprogram 2

September 2016 – March 2018 (Prior Actions are in bold)

Subprogram 3 April 2018 – August 2019 (Prior Actions are in bold)

Post Program Partnership Framework (2020–2025)

Output 1: Medium Term Expenditure Aligned with RPJMN and SDGs Targets

1.1 The government adopted strategic policies to align budget planning with RPJMN and SDGs targets

ADB TA 9341: Strategies for Financing Social Protection to Achieve Sustainable Development Goals in Developing Member Countries.

The government implemented budget plans to achieve RPJMN and SDGs targets. Accomplishments include: 1. The government implemented SDGs strategy by (i) approving Presidential regulations which established national coordination team chaired by President to monitor progress and provide annual reporting on achievement of targets (including gender related targets) and (ii) developing a National Strategy for Accelerating Gender Mainstreaming.

The government completed legal and planning framework to align the budget with SDGs implementation. Accomplishments include: 1. The government finalized financing strategy, regional action plans and integrated strategy for gender and climate change mainstreaming into the SDG Road map.

1. The government endorses and implements recommendations from the fiscal gap assessment including gradually increasing budget allocation for social assistance programs.

2. The government synchronized national development priorities with budget preparation, execution, monitoring and reporting under a unified results framework.

2. The government (i) issued regulations to implement synchronization of national development priorities with the budget cycle by setting up a synchronization committee chaired by the Minister of the National Development Planning Agency, and (ii) built capacities of line ministries.

1.2 The government increased expenditures and improved targeting in critical social sectors and infrastructure ADB TA 9609:

The government continued to allocate spending to critical sectors. Accomplishments include: 3. The government enhanced its social assistance program by:

The government increased budget allocation to critical sectors and focused on social assistance including labor market activation programs. Accomplishments include: 3. The government made its social assistance programs

2.The government improves capacities of PKH supervisors

20 Appendix 4

Outputs Subprogram 2 September 2016 – March 2018

(Prior Actions are in bold)

Subprogram 3 April 2018 – August 2019 (Prior Actions are in bold)

Post Program Partnership Framework (2020–2025)

Building Inclusive Social Assistance.

(i) expanding the coverage of the non-cash social assistance programs (smart card) to 1.4 million households and conditional cash transfer program from 3.5 million to 10 million families (including pregnant mothers); (ii) establishing a monitoring team headed by the Minister of Coordinating Ministry of Human and Cultural Development; and (iii) providing flexibility in the frequency of accessing assistance based on beneficiary needs.

more efficient and expanded their coverage by: (i) combining the food assistance program with the conditional cash transfer program into one smart card, (ii) expanding coverage of the food assistance program from 1.4 million to 15.6 million households, (iii) doubling the amount of the conditional cash transfer program for the 10 million households, and (iv) increasing the number of poor students receiving scholarships from 19.6 million to 20.1 million.

and implementation in remote and disadvantageous areas. 3. The government launches a web-based application for the conditional cash transfer program to enhance communication with beneficiaries.

ADB Regional TA 8905: Enhancing Association of Southeast Asian Nations Economic Community.

4. The government piloted labor market activation programs to address unemployment amongst youth and upgrade skills of existing employees.

4. The government endorses the joint ADB-OECD study on labor market activation programs for subnational governments. 5. The government fully implements labor market activation programs targeting youth (with 50% target for girls) and upgrading skills.

ADB Regional TA 8983: Universal Health Coverage for Inclusive Growth: Supporting the Implementation of the Operational Plan for Health, 2015–2020.

4. The government increased budget allocation in real terms in education, health, social assistance and public infrastructure by 7% from 2016 to 2018, including funding to support mandatory primary education for 12 years.

5. The government provided real increases in budget allocation for education, health, social protection and public infrastructure by 5.6% from 2018 to 2019.

6. The government maintains spending of 20% for education, 5% for health and increases allocation for social protection programs, infrastructure and human capital development. 7. The government establishes a digital health inter-operability laboratory to facilitate

Appendix 4 21

Outputs Subprogram 2 September 2016 – March 2018

(Prior Actions are in bold)

Subprogram 3 April 2018 – August 2019 (Prior Actions are in bold)

Post Program Partnership Framework (2020–2025)

interlinkages of the different health information systems.

Output 2: National public expenditure framework completed

2.1 The government adopted best practices in budget preparation

The government implemented enhanced budget system. Accomplishments include: 5. The government enhanced the multi-year budgeting approval process to provide line ministries greater authority to plan their public investment program by: (i) providing guidance on the approval and endorsement process; and (ii) issuing a Presidential regulation allowing the use of multi-year contract for projects and service contract that would benefit from using multiyear contract.

The government implemented best practices in budget preparation. Accomplishments include: 6. The government issued implementing regulations for the Presidential regulation on multi-year contract, including determination of approving authority based on the size of the multi-year contracts.

6. The government expanded the operations of the State Asset Management Agency by issuing the organizational framework and standard operating procedures for the management of $2.8 billion of idle assets.

ADB Regional TA 8905: Enhancing Association of Southeast Asian Nations Economic Cooperation

7. The government promoted transparency in budget process by (i) publishing medium-term fiscal framework in the Macroeconomic and Fiscal Policy Framework including background analysis, forward challenges, and reforms to strengthen budget functions; (ii) publishing budget data in a dedicated portal; and (iii) disaggregating budget tagging into thematic areas including climate change and gender responsive budgeting.

7. The government enhanced accountability of the budget process by: (i) upgrading the legal basis for the Macroeconomic and Fiscal Policy Framework (KEMPPKF) through the Minister of Finance decree, and (ii) including a long term fiscal framework to the KEMPPKF to inform the budget deliberation with the parliament.

8. The government includes best practices in preparation of KEMPPKF into regulations, including preparation of a long-term fiscal framework as part of budget analysis.

22 Appendix 4

Outputs Subprogram 2 September 2016 – March 2018

(Prior Actions are in bold)

Subprogram 3 April 2018 – August 2019 (Prior Actions are in bold)

Post Program Partnership Framework (2020–2025)

8. MOF and BAPPENAS jointly developed and implemented a new system (KRISNA) which integrates planning, budgeting, execution and performance monitoring of public expenditures and implemented the system for the 2018 budget.

8. The government utilized KRISNA to review the 2019 budget allocation for the purpose of aligning budget process with national priorities including gender mainstreaming and climate change.

2.2 The government strengthened budget execution and cash management

The government improved budget disbursements on timely basis. Accomplishments include: 9. The government expedited budget realization by: (i) implementing automated payment (e-payment) and roll out of accounting modules to 322 spending units; and (ii) issuing a Presidential regulation which allow line ministries to engage procurement agents and which allow tender process to begin when estimated budget is approved.

The government utilized information technology systems to improve budget disbursements. Accomplishments include: 9. The government integrated the financial account applications into the electronic budget request system (SAKTI) and expanded use of SAKTI from 322 to over 1,000 spending units.

Output 3: Fiscal transfers and subnational governments’ spending for service delivery improved

The government implemented reforms to inter-government transfer mechanisms. Accomplishments include: 10. MOF expanded the use of OM SPAN to cover DAK and Village Fund to strengthen accountability at subnational government level.

The government made fiscal transfers performance-based. Accomplishments include: 10. The government increased allocation to the Village Fund from Rp60 trillion to Rp70 trillion, reformulated the criteria to provide more allocation to poor and lagging villages and made the disbursement performance-based for better service delivery at the district level.

9. The government makes the Village Fund allocation primarily based on formula instead of generic allocation, and increases the focus on lagging villages.

Appendix 4 23

Outputs Subprogram 2 September 2016 – March 2018

(Prior Actions are in bold)

Subprogram 3 April 2018 – August 2019 (Prior Actions are in bold)

Post Program Partnership Framework (2020–2025)

ADB TA 9288: Strengthening Government and Civil Society Cooperation in Open Government Partnership to Improve Public Services.

11. MOF enhanced its fiscal transfers to improve service delivery and increase infrastructure spending by: (i) requiring 25% of DAU and regional sharing fund be allocated for local infrastructure; (ii) increasing allocations for community health care and family planning from Rp4.6 trillion in 2016 to Rp10.4 trillion in 2018; and (iii) improving monitoring and evaluation of the specific allocation grant by requiring reporting of output achievements for subsequent disbursements.

11. The government enhanced the governance of the specific allocation grant (DAK) through: (i) synchronizing funded activities across sectors and line ministries to avoid overlapping end results, (ii) performance-based disbursement (achieving targets and physical outputs), and (iii) implementing independent review of fund utilization through the internal control body to verify output achievements.

12. The government refined local government performance indicators to improve the selection criteria for recipients of DID by covering (i) fiscal health and financial management, (ii) public service delivery (education, health and infrastructure), (iii) social welfare (Human Development Index).

12. The government linked the regional incentive fund (DID) to SDG indicators including stunting, immunization, birth attended by skilled health personnel, and climate-resilient infrastructure.

10. The government links the DID allocation to SDG indicators related to human capital development.

13. The government addressed idle funds by postponing subsequent disbursement of the general allocation fund and the revenue sharing fund subject to timely submission of monthly reports.

13. The government reduced idle funds at the subnational government level by: (i) increasing frequency of disbursement; and (ii) providing regular training on cash management for subnational governments.

ADB = Asian Development Bank, BAPPENAS = Badan Perencanaan Pembangunan Nasional (National Development Planning Agency), DAK = Dana Alokasi Khusus (Specific Allocation Fund), DAU = Dana Alokasi Umum (General Purpose Transfer), DID = Dana Insentif Daerah (Regional Incentive Fund), KEMPPKF = Kerangka Ekonomi Makro Dan Pokok-Pokok Kebijakan Fiskal (Macroeconomic and Fiscal Policy Framework), KRISNA = Kolaborasi Integrasi System Perencanaan (unified planning and budget system), MOF = Ministry of Finance, OECD = Organisation of Economic Co-operation and Development, OM SPAN = Online Monitoring-Sistem Perbendaharaan dan Anggaran Negara (National Financial Management Information System), Rp = rupiah, RPJMN = Rencana Pembangunan Jangka Menengah Nasional (Medium-Term Development Plan), SAKTI = electronics budget request system, SDGs = Sustainable Development Goals, TA = technical assistance.