P110716 - 3 - Regional Government Investment in Public Infrastructure in Indonesia

Contents

i

Chapter 1 1 Introduction

1 Objective and Scope of Work 2 Status and Contents of this Report

Chapter 2 3 Review of Regional Government Investment in Infrastructure

3 World Bank Public Expenditure Review 4 DSF Studies

Chapter 3 7 Framework for Analyzing Regional Government Investment

7 Regional Government Accounting Systems 10 Financial Reporting on Investment 12 Definition of Regional Government Investment 15 Data Sources

Chapter 4 17 Regional Government Investment in Fixed Assets

17 Provincial Government Investment in Fixed Assets 20 District Government Investment in Fixed Assets 23 Total Regional Government Investment in Fixed Assets

Chapter 5 25 Regional Government Investment in Financial Assets

26 Provincial Government Investment in Financial Assets 29 District Government Investment in Financial Assets 31 Total Regional Government Investment in Fixed Assets

Chapter 6 33 Sustainability of Regional Government Investment

33 Depreciation by Regional Governments in Indonesia 35 Potential Impact of Depreciation on Book Value of Fixed Assets 36 Gross vs. Net Investment in Fixed Assets 40 Results of Scenario Analysis

Chapter 7 45 Conclusions and Recommendations

45 Conclusions 46 Policy Recommendations

Regional Government Investment in Infrastructure Final Report (June 2009)

ii

Definitions

DSF Decentralization Support Facility Consultant André Oosterman Region A province (propinsi) or district (kabupaten or kota)District A municipality (kota) or regency (kabupaten)Study Period 2004-2007

Introduction

1

1

Chapter 1 Introduction

Background. The Decentralization Support Facility (DSF) has recently assisted the Ministry of Finance with an analysis of the possible causes of the rapid increase in sub-national government surpluses. The analysis was, to a large extent, based on financial reports audited by BPK for the period 2004-2006. A review of these reports suggests that sub-national government investment in public infrastructure in these years is comparable to estimates presented in Indonesia Public Expenditure Review 2007. It appears, however, that a significant portion of net new investment consists of pur-chases of land and government buildings, which do not directly contribute to improvements in social welfare. To better understand the composition of sub-national government investment, DSF has allocated a portion of its resources to hiring a Consultant (‘the Consultant’) to identify these investments, based on available audited financial data for 2004-2007

Objective and Scope of Work

Objective. The overall objectives of the study are the following:

To prepare estimates of sub-national government investment, in order to update the results of the latest Indonesia Public Expenditure Review.

To prepare a detailed analysis of the composition of sub-national government investment, with particular emphasis on the composition of investment in physical assets.

Scope of the study.

The study covers the period from 2004 (the first year in the majority of regional governments had prepared – or were in the process of preparing – balance sheets) through 2007 (the last year for which regional government investments are available).

The study covers all regional governments (provinces, kabupaten and kota)for which audited financial data were available during the study period1.

Outputs. This report presents:

A review of regional government investment in infrastructure since 2001.

A framework for analyzing these investments in detail.

Estimates of regional government investments in infrastructure by year, type of investment, and type of regional government.

An assessment of the sustainability of regional government investments in infrastructure.

1 In this report, the term ‘district government’ refers to a municipality (kota) or regency (kabupaten), whereas the term ‘regional government’ refers to a district or province.


2 Chapter 1 Introduction

Status and Contents of this Report

Status. This report is a final draft. The main findings, conclusions and recommendations were presented in a meeting with the Ministry of Finance that was held on 10 June 2009, and chaired by Mr. Heru Subiyantoro, Secretary to the Director-General of Fiscal Balancing.

Summary of contents. Chapter 2 gives an overview of investments in infrastructure by regional governments in Indonesia since 2001, based on a review of research undertaken by WB and DSF. Chapter 3 presents a framework for analyzing these investments in more detail than has hitherto been attempted. Chapter 4 assesses regional government investments in fixed assets, such as land, buildings and roads. Chapter 5 assesses invest-ments in financial assets, which largely consist of equity investments in muni-cipal enterprises. Chapter 6 assesses the sustainability of regional govern-ment investments by estimating to what extent current investment levels allow regional governments to maintain the service potential of their existing assets. The final chapter presents conclusions and policy recommendations.

Figure 1.2

REPORT STRUCTURE

Chapter 4Financing Municipal

Water Services

SITUATIONAL ANALYSIS

Chapter 2 Review of

RG Investment

Chapter 1 Introduction

Chapter 3Framework for

Analysis

REGIONAL GOVERNMENT INVESTMENT IN INFRASTRUCTURE

Chapter 4 RG Investment in

Fixed Assets

Chapter 5RG Investment in Financial Assets

Chapter 7Conclusions and

Recommendations

Chapter 6Sustainability of RG Investment

Review of Regional Government Investment

3Chapter 2 Review of Regional Government Investment

2

World Bank Public Expenditure Review

Overview. In 2007, the World Bank published a public expenditure review for Indonesia. Chapter 5 of the review discusses public spending on infrastruc-ture. It shows that infrastructure spending by regional governments remained at around 1.0 of GDP during 2002-2004 (figures for later years were not available), amounting to approximately IDR 23 billion in constant 2004 prices (Table 2.1). Infrastructure spending was broken down into investment and O&M. Because the data were processed from government budgets, it was assumed that they were not adjusted for depreciation charges (if only because regional governments did not start to produce balance sheets until 2003). Because regional government budgets were prepared cash-based until 2003, when GOI introduced accrual-based accounting (see Chapter 3), the estimates in the public expenditure review are not directly comparable to figures presented later in this report, which cover the period 2004-2007.

Table 2.1

INFRASTRUCTURE SPENDING BY REGIONAL GOVERNMENTS, 2002-2004 IDR trillion, constant 2004 prices

IDR trillion % GDP 2002 2003 2004 2002 2003 2004

Investment 12.4 16.6 15.0 0.6 0.8 0.7

O&M 7.2 8.0 7.5 0.3 0.4 0.3

Total 19.6 24.6 22.5 0.9 1.2 1.0Source: World Bank (2007)

Composition of regional government investment. The public expenditure review analyzed five infrastructure sectors in detail, and concluded that regional governments accounted for over half of total infrastructure spending in the transport sector (largely consisting to maintenance expenditure on local roads), and also accounted for significant shares in the water and sanitation and irrigation sectors. Regional government investment was insignificant in the two remaining sectors that were analyzed in details (electricity and telecommunications).

DSF Studies

Overview. In recent years, the Decentralization Support Facility has published a series of studies on the public finances of sub-national govern-ments in Indonesia. Two of these studies, both published in 2008, address the composition of investment expenditure at the regional government level:

Surplus Study. Based on a review of audited financial reports for 2004-2006, this study presents a breakdown a regional government investment in


4 Chapter 2 Review of Regional Government Investment

fixed and financial assets2. It does not contain a more detailed analysis of these investment categories, however.

Intercept study. The study presents an estimate of the proportion of total regional government revenue spent on investment in fixed assets. It also contains a breakdown of investments in fixed assets by major asset classes3.

Surplus Study

Investment of provincial government revenue in fixed and financial assets. From 2004 to 2005, the share of operational expenditure dropped from 80% to 69% of total provincial government revenue (Table 2.2). The combined share of investments in fixed and financial assets increased slightly, from 14% to 16%. As a result, provincial governments did not spend 11% of their total revenue in 2005, up from 3% in the previous year. This caused the combined cash balances of the provinces to increase by IDR 5.8 trillion (or over US$ 600 million). Cash balances also increased from 2005 to 2006, but by a much smaller margin than in the preceding year, because of a substantial increase in investment in fixed assets.

Table 2.2

UTILIZATION OF PROVINCIAL GOVERNMENT REVENUE, 2004-2006 IDR trillion

IDR trillion % Total 2004 2005 2006 2004 2005 2006

Operational expenditure 34.4 36.5 46.6 80 69 73

Net investment 6.2 8.6 13.1 14 16 21

Net financial transactions 0.9 1.6 1.9 2 3 3

Net other transactions 0.1 0.1 (0.1) 0 0 0

Unspent revenue 1.6 5.8 2.2 4 11 3

Total revenue 43.1 52.6 63.8 100 100 100Source: Consultant, based on BPK Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004)

Investment of district government revenue in fixed and financial assets.In 2004 and 2005, the expenditure pattern of district governments resembled that of provinces (Table 2.3). In 2005, revenues of kabupaten and kotaincreased faster than operational expenditure and investments in fixed assets, resulting in a major increase in unspent revenue, from 1% to 9% of total revenue. Unlike provinces, districts did not increase investments in fixed assets (as a percentage of total revenue) in 2006, so that unspent revenue remained higher and resulted in a substantial increase in cash balances.

2 Increases in Surpluses of Regional Governments in Indonesia: An Empirical Analysis – Final Report, DSF, Jakarta, June 2008.

3 The Central Government Transfer Intercept Mechanism - Interim Report, DSF, Jakarta, April 2008.


5Chapter 2 Review of Regional Government Investment

Table 2.3

UTILIZATION OF DISTRICT GOVERNMENT REVENUE, 2004-2006 IDR trillion

IDR trillion % Total 2004 2005 2006 2004 2005 2006

Operational expenditure 68.7 60.5 79.7 96 73 67

Net investment * 13.6 26.2 * 17 22

Net financial transactions 1.5 1.1 2.9 2 1 1

Net other transactions - (0.0) (0.2) 0 0 0

Unspent revenue 1.0 7.2 10.9 1 9 9

Total revenue 71.2 82.5 119.5 100 100 100Source: audited regional government financial reports * Included in operational expenditure Sample size: 220 of 434 districts (accounting for 69% of total population in 2004)

Intercept Study

Investment expenditure as a percentage of total revenue. The intercept study estimated the portion of total revenue a regional government would be expected to spend on investment in physical assets as the minimum percentage spent by 75% of the ‘best-performing’ regional governments (i.e. those that spent the highest portion of revenue on investment). In 2005 and 2006, this percentage varied from 10% to 15% (Table 2.4).

Table 2.4

UTILIZATION OF REGIONAL GOVERNMENT REVENUE, 2005 AND 2006 Percentage of total revenue

OPERATIONAL* INVESTMENT** 2005 2006 2005 2006

Provinces 80 89 10 11

Districts 85 76 11 15

All 85 76 10 15Source: Consultant, based on BPK * Highest percentage of bottom 75% in sample ** Lowest percentage of top 75% in sample Sample size: 27 of 33 provinces (accounting for 89% of total population in 2004), 220 of 434 districts (accounting for 63% of total population in 2004)

Basic needs investment as a percentage of investment expenditure. In 2006, regional governments spent, on average, about 40% of total invest-ment on fixed assets ‘directly related to the provision of basic public services’ (roads, irrigation works, bridges, installations and pipes). Three-quarters of all provincial governments in the sample spent at least 38% of total invest-ment expenditure on these items (Table 2.5). For districts, this percentage was 39%. The intercept study considered three scenarios for ‘basic needs investment’, which is loosely comparable to ‘regional government investment in infrastructure’, as defined in this study:


6 Chapter 2 Review of Regional Government Investment

Pessimistic. This scenario assumes that investment in fixed assets does not constitute a basic needs expenditure.

Moderate. This scenario assumes that only investment in roads, irrigation works, bridges, installations and pipes are basic needs expenditure.

Optimistic. It is likely that part of investment expenditure in ‘non-RIBIP’ assets could be considered as a basic need. For example, the category ‘buildings’ encompasses both school buildings and DPRD meeting halls. The ‘optimistic’ basic needs investment scenario assumes – perhaps optimisti-cally – that 50% of investment expenditure in ‘non-RIBIP’ assets are basic needs, or (30% + 0.5 x 70% =) 65% of total investment expenditure.

Table 2.5

COMPOSITION OF REGIONAL GOVERNMENT INVESTMENT, 2006 Percentage of total investment expenditure

Fixed Asset Category Provinces DistrictsLand 43 15

RIBIP* 38 39

Buildings 11 26

Other 8 19

Total 100 100Source: Consultant, based on BPK for 2005 and 2006 Sample size: 24 provinces and 223 districts * Roads, irrigation works, bridges, installations and pipes.

Analyzing RegionalGovernment Investment

7

3

Chapter 3 Framework for Analyzing Regional Government Investment

Background

Regional government accounting systems. Until 2003, regional govern-ments in Indonesia used a cash-based accounting system to record revenue and expenditure. With the issuance of KepMendagri 29/2002, regions have adopted an accrual-based accounting system, which does not only record revenue and expenditure, but also income and costs – thereby enabling the Government to measure regional government investments.

Outline of this chapter. This chapter defines two types of investments by regional governments:

Investment in fixed assets, which is defined as the nominal increase in the book value of fixed assets (excluding ‘accumulated depreciation’ and ‘other assets’) between the end of two reporting periods.

Investment in financial assets, which is defined as the nominal increase in the book value of long-term investments (investasi jangka panjang), also between the end of two reporting periods.

This report does not consider increases in the book value of other balance sheet items (such as cash balances and contingency funds) as investments, because such increases will a priori not be allocated to maintain or increase public infrastructure, which is the primary concern of the Ministry of Finance.

Regional Government Accounting Systems

Cash-based accounting system. Until 2003, regional governments used a cash-based system to record revenue and expenditure. This system only recorded cash inflows and cash outflows, without making any distinction be-tween operational and non-operational expenditure. At any time, the cash balance would consist of cumulative cash revenue minus cumulative cash expenditure (Table 3.1). A major disadvantage of such a system is that it ignores the impacts of a financial transaction on the long-term financial posi-tion of a regional government. More specifically, a cash-based accounting system does not distinguish between cost and expenditure, or between inco-me and revenue. As will be shown, these are markedly different concepts.

Table 3.1

RECORDING OF INVESTMENT UNDER THE CASH-BASED SYSTEM

Budget Item* Cash balance, BOY Sisa anggaran tahun yang lalu

+ Revenue Pendapatan

– Operational expenditure

– Investment expenditure – Other expenditure

} Pengeluaran

= Cash balance, EOY Sisa anggaran tahun berjalanSource: Consultant * BOY = beginning of year, EOY = end of year


8 Chapter 3 Framework for Analyzing Regional Government Investment

Cost vs. expenditure. The cost of a financial transaction is the estimated decrease in the financial position of a regional government. In many cases, the estimated decrease is equal to the expenditure recorded by a cash-based accounting system. There are important exceptions, however. For example, a cash-based system does not distinguish between a IDR 200 mil-lion cash payment for the procurement of a fire engine and a IDR 200 million cash bonus for firefighters. Both are recorded in the same way (namely, as a IDR 200 million cash expenditure), even though the procurement of the fire engine will generate benefits to the regional government for many years, whereas the bonus does not. As a result, a cash-based accounting system will understate the financial position of the regional government (by recording a IDR 200 million expenditure in a single year, whereas the region will also benefit from the use of the fire engine in future financial years).

Income vs. revenue. Similarly, a cash-based accounting system may overstate the financial position of a regional government. If, for example, a region signs a loan agreement, the proceeds of the loan will be recorded as cash revenue in a single financial year. The system will not show that the loan has decreased the financial position of the regional government, which has contractually agreed to repay the loan in future years.

Accrual-based accounting system. In 2002, the Minister of Home Affairs issued a decree (better known as KepMendagri 29/2002) to address the deficiencies of a cash-based accounting system4. This decree, which became effective in 2003, required regional governments to adopt an accrual-based (or ‘double-entry’) accounting system, which does not only record cash revenue and cash expenditure, but also costs and income. The system was adopted by most provinces in 2004, and by most (but not all) kabupaten and kota in 2005. A substantial number of district government experienced difficulties with the preparation of balance sheets, which were not required prior to the issuance of the decree. (Almost 30% of district government financial reports for FY 2005 did not contain a balance sheet.) The absence of a balance sheet was almost invariably caused by the fact that the regional government had not timely recruited a certified independent institution to value its assets, as required by the decree.

Subsequent modifications to the accrual-based accounting system.KepMendagri 29/2002 was issued as an implementing guideline to UU 22/1999 and UU 25/1999. In 2004, these laws were replaced by UU 32/2004 and UU 33/2004, respectively. This necessitated the Minister of Home Affairs to replace KepMendagri 29/2002 by a new decree, PerMendagri 13/20065

(which, in turn, was based on PP58/2005 on Regional Government Financial Management). Many regional governments considered PerMendagri 13/2006

4 The full name of the decree is: ‘Keputusan Menteri Dalam Negeri No.29 Tahun 2002 tentang Pedoman Pengurusan, Pertanggungjawaban, dan Pengawasan Keuangan Daerah serta Tata Cara Penyusunan APBD, Pelaksanaan Tata Usaha Keuangan Daerah, dan Penyusunan Perhitungan APBD‘.

5 Peraturan Menteri Dalam Negeri No.13 Tahun 2006 tentang Pedoman Pengelolaan Keuangan Daerah.


9Chapter 3 Framework for Analyzing Regional Government Investment

as unnecessarily complicated and difficult to implement. In response, the Minister replaced the decree by PerMendagri 59/20076.

Regional government accounting standards. In June 2005, the Govern-ment issued PP24/2005 on government accounting standards7, which regional governments have been required to follow since the issuance of PerMendagri 13/2006. The regulation refers to a conceptual framework for government accounts, and a series of statements on government accounting standards (Pernyataan Standar Akuntansi Pemerintahan or PSAP). PSAP No. 01 describes in detail the financial reporting requirements of central and regional governments. It stipulates that the annual financial report of a central government ministry or regional must consist of: (i) budget realization reports (laporan realisasi anggaran), (ii) cashflow statements, (iii) balance sheets, and (iv) notes to financial reports. These requirements are largely consistent with those stipulated by KepMendagri 29/2002.

Budgeting under the accrual-based accounting system. Before the implementation of KepMendagri 29/2002, regional governments prepared a revenue budget and an expenditure budget. Since 2003, regional govern-ments are required to prepared budgets for:

Revenue (belanja daerah). These consist of: (i) own-source revenue (Penda-patan Asli Daerah or PAD), (ii) central government transfers, of which Shared Revenue (Dana Bagi Hasil or DBH), the General Allocation (Dana Alokasi Umum or DAU) and the Special Allocation (Dana Alokasi Khusus or DAK) are the most important, and (iii) other revenue, including incidental grants from higher-level governments and proceeds from the sale of physical assets.

Expenditure (belanja). These consist of: (i) operational expenditure (such as salaries and maintenance expenditure), and (ii) investment expenditure (better known as belanja modal).

Financing (pembiayaan). These consist: (i) income that needs to be repaid in current or future budget years, (penerimaan), and (ii) costs that will be recovered in current or future budget years (pengeluaran)8. The financing budget of a regional government typically includes income from loan disbursements, and the cost of loan repayments and equity investments.

A regional government budget (Anggaran Belanja Pendapatan Daerah or APBD) needs approval of the regional parliament (Dewan Perwakilan Rakyat Daerah or DPRD), the relevant provincial government and the Ministry of Home Affairs. (Refer to Figure 3.1 for the standard budget structure.)

6 Peraturan Menteri Dalam Negeri No.59 Tahun 2007 tentang Perubahan atas Peraturan Menteri Dalam Negeri No.13 Tahun 2006 tentang Pedoman Pengelolaan Keuangan Daerah.

7 Government Regulation 24 of 2005 on Government Accounting Standards (Peraturan Pemerintah Republik Indonesia Nomor 24 Tahun 2005 Tentang Standar Akuntansi Pemerintahan).

8 For a detailed definition of these terms, refer to Government Regulation 58 of 2005 on Regional Government Financial Management (Peraturan Pemerintah Republik Indonesia Nomor 58 Tahun 2005 Tentang Pengelolaan Keuangan Daerah).



Figure 3.1

STRUCTURE OF REGIONAL GOVERNMENT BUDGET

Source: Consultant Note: boxes reflect the relative sizes of main revenue and expenditure categories; extra-budgetary revenue and expenditure are not shown. * Including Dana Otonomi Khusus and incidental central government grants (which will

be classified in this report as ‘other revenue’)

Financial Reporting on Investment

Financial reporting under the accrual-based accounting system. When the cash-based accounting system was in place, regional governments were required to submit a single financial report (laporan realisasi anggaran),which compared actual cash revenue and cash expenditure against budg-eted amounts. With the issuance of KepMendagri 29/2002 (and its succes-sors PerMendagri 13/2006 and PerMendagri 59/2007), a regional govern-ment is now required to submit a financial report that consists of a:

Budget realization report (laporan realisasi anggaran)9. This report now consists of two parts: (i) a report that compares actual cash revenue and cash expenditure with budgeted amounts during the reporting period, and (ii) a report that makes this comparison for income and costs.

Balance sheet (neraca), stating the value of a regional government’s assets and liabilities at the end of the reporting period. Cashflow statement (laporan aliran kas or laporan arus kas), which states the sources and applications of funds during the reporting period. Notes to the above reports. Legally, these notes form an integral part of the financial report.

9 Formerly known as Laporan Perhitungan APBD.

REVENUEEXPENDITURE

AND FINANCING

Operational Expenditure(Belanja Non-Modal)

Own-Source Revenue (Pendapatan Asli Daerah)

Revenue from Central Government Transfers (Dana Perimbangan)

Dana Bagi Hasil Dana Alokasi Umum Dana Alokasi Khusus

Investment Expenditure(Belanja Modal)

Unspent RevenueOther Revenue*

(Pendapatan Lain-Lain)

Financing (Penerimaan/Pengeluaran)



Table 3.2

GOVERNMENT ACCOUNTING STANDARDS (PSAK)

PSAK Translation01 Penyajian Laporan Keuangan Preparation of the financial report

02 Laporan Realisasi Anggaran Budget realization report

03 Laporan Arus Kas Cashflow statement

04 Catatan atas Laporan Keuangan Notes on the financial report

05 Akuntansi Persediaan Accounting for inventories

06 Akuntansi Investasi Accounting for investment

07 Akuntansi Aset Tetap Accounting for fixed assets

08 Akuntansi Konstruksi dalam Pengerjaan Accounting for work in progress

09 Akuntansi Kewajiban Accounting for liabilities

10 Koreksi Kesalahan Correction of errors

11 Laporan Keuangan Konsolidasian Consolidated financial report Source: Consultant, based on PP24/2005

Financial reporting on investment expenditure. Unlike the cash-based accounting system, which did not require regional governments to report on investment expenditure, the accrual-based accounting system introduced in 2003 requires regional governments to report on investment expenditure in considerable detail. PSAK Nos. 02, 03 and 01 contain sample formats for budget realization reports, cashflow statements and balance sheets, respectively. Regional governments may use these formats as guidelines for the preparation of their financial reports.

Investment expenditure recorded in the budget realization report and cashflow statement. The sample formats attached to PSAK Nos. 02 and 03 list two types of investment expenditure:

Investment in fixed assets (belanja modal), consisting of investments in the following six categories: (i) land, (ii) equipment and machinery, (iii) buildings and structures, (iv) roads, irrigation works, and canals, (vii) other fixed assets, and (vi) other assets.

Investment in financial assets (pengeluaran), which consists of invest-ments in: (i) contingency funds, (ii) long-term investments, including partici-pations in regional government enterprises, (iii) loan repayments, and (iv) lending to other governments.

Both types of reports also record the divestment of fixed financial assets, and inverse transactions of financial assets (such as equity divestments or the utilization of contingency funds).

Investment expenditure recorded in the balance sheet. PSAK No. 01 contains a sample balance sheet. In addition to the investments recorded by the budget realization report and cashflow statement, the sample sheet also lists (vii) work in progress, and (viii) depreciation.



Availability of detailed investment expenditure data. Regional govern-ments are encouraged but not legally required to present financial informa-tion in the formats attached to the various PSAKs. A comprehensive review of audited financial reports shows that most regional governments follow the PSAK sample balance sheet, but usually not the sample budget realization report of cashflow statement.

Definition of Regional Government Investment

Minimum requirements of an operational definition of investment. For the purpose of this study, a definition of the term ‘regional government investment’ must be:

As detailed as possible. As mentioned above, only regional government balance sheets consistently provide a breakdown of investment expenditure over a series of standard asset classes. In addition, balance sheets list two highly relevant investment expenditure categories that are not shown in either budget realization reports or cashflow statements: work in progress and depreciation. For these reasons, regional government investments will be estimated by increases in book values of (relevant) balance sheet items.

Comparable over time. To meet this condition, it is necessary that invest-ment expenditure recorded in financial reports based on KepMendagri 29/2002 is readily comparable to investment expenditure recorded in accounts based on subsequent guidelines.

Relevant to public infrastructure services. The purpose of this report is to identify the composition of regional government investments to identify what portion of this investment is allocated for maintaining or improving public infrastructure services. Investment expenditure that is a priori unlikely to result in a change in the stock of public infrastructure should therefore be ignored.

As detailed as possible. At present, regional government financial reports do not classify investments by function (such as health, environment, or public services), as central government agencies do. In addition, such financial reports no longer categorize regional government expenditure by sector (such as roads, education or irrigation), as was the case when the case-based accounting system was in force. This means that investment expenditure data are only available by the cost categories mentioned above (such as land, buildings and structures).

Comparable over time. PSAK No. 04 recommends regional governments to classify balance sheet items in the same broad classes as those mentioned in KepMendagri 29/2002. Because asset valuation methods have remained unchanged since 2003, that balance sheets prepared under KepMendagri 29/2002 are readily comparable – without the need for adjustments – to those prepared based on KepMendagri 13/2006 and 59/2007. The main difference between the two accounting regulations is the level of detail: under KepMendagri 29/2002, regional governments were required to provide a more detailed breakdown of fixed assets than is presently the case.



Relevant to public infrastructure services. The balance sheet of a regional government in (up to) eight classes of fixed assets, and up to four classes of financial assets. Changes to the book value of four of these 12 classes should be excluded from estimated regional government investment:

Accumulated depreciation. At present, only a small number of regional governments accounts for depreciation of fixed assets. To maintain consis-tency with data for other regions, accumulated depreciation will initially be excluded from the estimated investment for all regional governments. Chapter 6 will present estimates of minimum required depreciation levels that are needed to maintain the service potential of regional government assets.

Other assets. This asset class consists of items of a temporary or exceptio-nal nature, and was therefore excluded from the analysis.

Outstanding loans. A regional government normally uses the proceeds of a loan to finance fixed assets. Reductions (or increases) in outstanding loans will therefore already be reflected in changes to fixed assets.

Outstanding borrowings. To date, few (if any) regional governments have lent funds to other regions or to central government agencies. For this reason, this balance sheet item will be ignored in the remainder of this report.

Table 3.3

BALANCE SHEETS ITEMS USED TO ESTIMATE REGIONAL INVESTMENT

Balance Sheet Item Included in Definition? Comment

Fixed assets Land Yes

Equipment and machinery Yes

Buildings and structures Yes

Roads, irrigation works, canals Yes

Work in progress Yes

Accumulated depreciation SeeChapter 6

Most regions do not depreciate; Chapter 6 presents estimates to correct for this omission

Other fixed assets Yes

Other assets No Not a fixed asset, and therefore unlikely to have a lasting impact on public infrastructure services

Financial assets Contingency funds No By definition unallocated

Long-term investments Yes Increase may result in improved public services (if invested in water company or hospital)

Outstanding loans (reductions to) No Excluded to avoid double-counting

Outstanding borrowings No Unknown in Indonesia Source: Consultant



Operational definition of regional government investment. This report defines the investment of a regional government as the sum of:

Investment in fixed assets, which is defined as the nominal increase in the book value of fixed assets (excluding ‘accumulated depreciation’ and ‘other assets’) between the end of two reporting periods.

Investment in financial assets, which is defined as the nominal increase in the book value of long-term investments, also between the end of two reporting periods.

The exclusion of accumulated depreciation has an important implication for the interpretation of estimates presented in this report: unless noted otherwise, all figures refer to gross investment in current prices (adjusted for asset sales between two reporting periods, which are usually negligible).

Example. Table 3.4 illustrates the calculation of the annual investment of a regional government. The table summarizes the book value of the assets on the balance sheet of Kabupaten Karangasem, at the end of the reporting periods 2006 and 2007. To calculate the total investment of the kabupaten in 2007, two steps need to be taken:

Step 1: calculate the nominal increase in the book value of all assets. In the case of Kab. Karangasem, this is (1068.1 – 1066.0 =) IDR 2.1 billion.

Step 2: correct for irrelevant balance sheet items. These corrections consist of changes to the book values of current assets (29.7), accumulated depreciation (-/- 135.1), contingency funds (0.3) and other assets (2.4). Thus, the estimated investment is (2.1 – [29.7–135.1+0.3+2.4] =) IDR 104.8 billion.

Table 3.4

BALANCE SHEETS OF KABUPATEN KARANGASEM, 2006 AND 2007 IDR billion

Balance Sheet Item 31 Dec 2007

31 Dec 2006

Net Increase

Invest-ment

Current assets 103.8 74.1 29.7 –Long-term investments 44.4 42.0 2.4 2.4Fixed assets Land 74.3 73.9 0.4 0.4 Equipment and machinery 87.9 68.9 19.0 19.0 Buildings and structures 208.8 179.4 29.4 29.4 Roads, irrigation works, canals 903.4 853.9 49.5 49.5 Work in progress – 0.2 (0.2) (0.2) Accumulated depreciation (385.5) (250.4) (135.1) – Other fixed assets 14.5 10.2 4.3 4.3

Contingency funds 12.1 11.8 0.3 –Other assets 4.4 2.0 2.4 –TOTAL 1,068.1 1,066.0 2.1 104.8Source: Consultant, based on BPK (2008)



Data Sources

Audited financial data for 2004-2007. Regional government investment in public infrastructure was estimated based on an analysis of all available audited financial reports (with balance sheets) of individual provinces, kabupaten and kota for the period 2004-2007. This dataset comprised a total of over 1,300 financial reports. Because of new region creation (pemekaran),the number of regional governments in Indonesia increased from 402 in 2004 to 467 at the end of the Study Period. The key characteristics of the dataset can be summarized as follows:

Provincial governments. Audited financial reports were available for virtually all provincial governments during the Study Period, although balance sheets were missing for ten provinces in 2004.

District governments. In 2004 and 2005, coverage of kabupaten and kotagovernments was substantially lower than for provincial governments, particularly in Eastern Indonesia because of logistical problems. Since 2006, BPK has achieved nearly complete coverage for both districts and provinces. The preparation of balance sheets started later at the district government level than in provinces, and by 2006 about 10% of districts (mainly kabu-paten) had not published a balance sheet (Table 3.5).

Limitations to data for 2007. The record for 2007 is incomplete. By law, BPK needs to make the results of its auditing schedule for the second half of 2008 publicly available by 31 March 2009. At the time of completing this report (on 30 April 2009), these data were not yet published on the BPK website. As a result, the analysis presented in this report cover about 70% of provincial governments and slightly more than half of districts in FY 2007.

Table 3.5

AVAILABILITY OF REGIONAL GOVERNMENT AUDITED DATA, 2004-2007

2004 2005 2006 2007* Provincial governments Number of provinces, EOY 32 33 33 33

- financial report available 30 32 33 23

- balance sheet available 21 31 33 23

% Provinces with balance sheet 66 94 100 70

District governments Number of districts, EOY 370 410 434 434

- financial report available 248 314 426 252

- balance sheet available 183 298 393 247

% Districts with balance sheet 49 73 91 57Source: Consultant (based on BPK) * Until 30 June 2007



Figure 3.2

PROVINCIAL GOVERNMENTS WITH AUDITED BALANCE SHEETS, 2004-07* Number of provinces

0

10

20

30

40

2004 2005 2006 2007

With Balance Sheet Without Balance Sheet

Source: Consultant (based on BPK) * Until 30 June 2007

Figure 3.3

DISTRICT GOVERNMENTS WITH AUDITED BALANCE SHEETS, 2004-2007* Number of kabupaten and kota

0

100

200

300

400

500

2004 2005 2006 2007


Source: Consultant (based on BPK) * Until 30 June 2007

Regional Investment in Fixed Assets

17

4

Chapter 4 Regional Government Investment in Fixed Assets

Background

Outline of this chapter. This chapter presents estimates of regional government investment in fixed assets during the period 2005-2007. For both types of sub-national governments – provinces and districts – estimates are provided of total investments in fixed assets, the composition of investments over the asset classes introduced in Chapter 3, an analysis of regional variation in investment levels, and an analysis of revealed preferences for investments in particular asses classes.

Provincial Government Investment in Fixed Assets

Total investment in fixed assets. As described in Chapter 3, provincial government balance sheets were not available for all four years during the Study Period 2004-2007 (in 2004 some provinces had not prepared balance sheets, whereas BPK has not yet released the part of the audits for 2007). For this reason, total investment in fixed assets was estimated in two steps:

Step 1: Identify investment by provincial governments for which balance sheets were available for subsequent reporting periods. This group consisted of 20 provinces in 2005, 30 in 2006 and 23 in 2007.

Step 2: estimate investment for the remaining provincial governments, assuming that per capita investments in fixed assets are the same as for provinces for which investment figures are known.

During the Study Period, total investment in fixed assets increased at very high rates, from IDR 10.8 trillion in 2005 to over IDR 22 trillion in 2007 (Table 4.1 and Figure 4.1). The rapid increase from 2005 to 2006 coincided with a 60% increase in DAU and very high increases in shared revenue from oil and gas, which – taken together – account for over half of total provincial govern-ment revenue.

Table 4.1

PROVINCIAL GOVERNMENT INVESTMENT IN FIXED ASSETS, 2005-2007 All provinces (gross investment in nominal prices, net of asset sales)

2005 2006 2007 Known investment in fixed assetsNumber of provinces (#) 20 30 23

Population (% total) 65 97 83

Investment in fixed assets (IDR trillion) 7.03 17.70 18.36

Assumed investment in fixed assetsNumber of provinces (#) 12 3 10



Total investment in fixed assets 10.84 18.26 22.13Source: Consultant, based on BPK (2004-2007) and SUPAS (2005)


18 Chapter 4 Regional Government Investment in Fixed Assets


19Chapter 4 Regional Government Investment in Fixed Assets

Figure 4.1

PROVINCIAL GOVERNMENT INVESTMENT IN FIXED ASSETS, 2005-2007 IDR trillion (gross investment in nominal prices, net of asset sales)

0

5

10

15

20

25

2005 2006 2007

Known Investment Assumed Investment

Source: Consultant (based on BPK)

Composition of investment in fixed assets. For 15 provinces, accounting for 56% of the population in 2005, balance sheets were available for all four years of the Study Period. This enabled the preparation of a breakdown of investments in fixed assets for the years 2005-2007. Investment in fixed assets by the 15 provincial governments increased from about IDR 6 trillion in 2005 to over IDR 11 trillion in 2006, before leveling off to IDR 9.8 trillion in 2007 (Table 4.2)10. In all three years, investments in roads, irrigation works and canals (hereafter also referred to as RIC) accounted for about a third of total investment in fixed assets, followed by land. Surprisingly, investments in buildings and structures dropped dramatically, from about a quarter of total investments in fixed assets in 2005 and 2006 to 2% in 2007. This drop may partially be explained by a substantial increase in work in progress during the same period.

Regional distribution of investment patterns. Throughout 2005-2007, three provinces (DKI Jakarta, Jawa Timur and Sumatera Selatan) accounted for a major share of investments in fixed assets by the sample of 15 prov-inces. In all three years, annual investments by DKI Jakarta were in the order of IDR 4-5 trillion (or about US$ 500 million). The province of Sumatera Selatan increased its investments from IDR 0.3 trillion in 2005 to over IDR 1 trillion in 2007. The investment pattern of other provinces in the sample was highly erratic: a fourfold increase from 2005 to 2006 was followed by a drop of over 40% in the subsequent financial year (Table 4.3). This finding is consistent with anecdotal evidence that most provinces (other than DKI

10 The apparent discrepancy between trends shown in Table 4.1 (which shows an increase in investment from 2006 and 2007) and Table 4.2 (which shows a decrease) is caused by a very large investment of Kalimantan Selatan in land purchases during 2007. This province is not included in the sample of 15 provincial governments, because no balance sheet was available for 2004.



Jakarta) do not have a long-term investment plan that is systematically executed.



Table 4.2

PROVINCIAL GOVERNMENT INVESTMENT IN FIXED ASSETS, 2005-2007 Sample of 15 provinces (gross investment in nominal prices, net of asset sales)

IDR trillion % Total Asset Class

2005 2006 2007 2005 2006 2007Land 1.56 2.39 2.70 26 21 28

Equipment and machinery 0.98 1.22 1.53 16 11 16

Buildings and structures 1.66 2.83 0.16 28 25 2

RIC* 1.97 4.41 3.72 33 38 38

Work in progress (0.43) 0.39 1.29 (7) 3 13

Other fixed assets 0.27 0.24 0.38 4 2 4

Total 6.01 11.48 9.80 100 100 100Source: Consultant, based on BPK (2004-2007) Sample size: 15 provinces, accounting for 56% of total population of Indonesia in 2005 * Roads, irrigation works and canals

Table 4.3

PROVINCIAL GOVERNMENT INVESTMENT IN FIXED ASSETS, 2005-2007 Top three provinces (gross investment in nominal prices, net of asset sales)

IDR trillion % Total Province

2005 2006 2007 2005 2006 2007Sumatera Selatan 0.31 0.75 1.02 5 7 10

DKI Jakarta 4.51 4.85 5.38 75 42 55

Jawa Timur (0.10) 0.58 0.45 (2) 5 5

Other provinces (n=12) 1.30 5.31 2.95 22 46 30


Revealed investment priorities. There is substantial variation in provincial government investment level, both over time (with substantially higher levels of investment in 2006 and 2007 than in 2005) and among provinces. To better understand the relative investment priorities of provincial governments, a sample of 28 provinces was divided in four quartiles. The top quartile consisted of the seven provinces with the highest proportion of revenue allocated to investment in 2006 (the year for which most data were avail-able); the bottom quartile consisted of those seven provinces where investment in fixed assets, as a percentage of total revenue in that year, was lowest. As shown in Table 4.4, provinces in the bottom-quartile spent a significantly higher proportion of investments on equipment and machinery than provinces in higher brackets. At the other extreme, provincial govern-ments in the ‘top 50%’ quartiles spent almost 40% of total investment in fixed assets on RIC, against 25% of less for provinces in the bottom 50%. This suggests that decision makers treat investments in roads, irrigation works and canals as ‘luxury’ expenditure. There was no clear relation observed



between relative investment levels and investment in land, buildings and structures or other fixed assets.

Table 4.4COMPOSITION OF PROVINCIAL GOVERNMENT INVESTMENT BY QUARTILE, 2006*

Quartile Land Equipment/ Machinery

Buildings/ Structures RIC** Other

1 (top 25%) 20% 5% 21% 38% 4%

2 (25-50%) 11% 11% 17% 35% 14%

3 (50-75%) 6% 27% 19% 29% 6%

4 (bottom 25%) 20% 29% 16% 23% 0%

All quartiles 16% 21% 21% 35% 7% Source: Consultant, based on BPK Sample size: 28 provinces, accounting for 95% of total population of Indonesia in 2005 * Unweighted averages by quartile ** Roads, irrigation works and canals

District Government Investment in Fixed Assets

Total investment in fixed assets. Total investment in fixed assets by kabupaten and kota was estimated, based on the two-step method that was also used for estimating provincial government investment levels. During 2005-2007, total investment in fixed assets tripled from about IDR 21 trillion in 2005 to over IDR 64 trillion, before leveling off to about IDR 50 trillion in 2007 (Table 4.5 and Figure 4.2). Investments increased at higher rates than at provincial government level, possibly because kabupaten and kota derive a much higher proportion of total revenue from DAU and shared revenue from oil and gas, which – as mentioned before – increased dramatically from 2005 to 2006. Unlike provincial governments, however, investments in fixed assets by districts decreased from 2006 to 2007.

Table 4.5DISTRICT GOVERNMENT INVESTMENT IN FIXED ASSETS, 2005-2007 All districts (gross investment in nominal prices, net of asset sales)

2005 2006 2007 Known investment in fixed assetsNumber of districts (#) 103 268 239



Assumed investment in fixed assetsNumber of districts (#) 267 142 195



Total investment in fixed assets 20.83 63.75 50.42Source: Consultant, based on BPK (2004-2007) and SUPAS (2005)



Figure 4.2

DISTRICT GOVERNMENT INVESTMENT IN FIXED ASSETS, 2005-2007 IDR trillion (gross investment in nominal prices, net of asset sales)

0

15

30

45

60

75

2005 2006 2007



Composition of investment in fixed assets. For 118 districts, accounting for 39% of the population in 2005, balance sheets were available for all four years of the Study Period. Investment in fixed assets by the 118 district governments increased from about IDR 7 trillion in 2005 to over IDR 21 trillion in 2006, before dropping to IDR 16.7 trillion in 2007 (Table 4.6). In all three years, investments in buildings and structures, and roads, irrigation works and canals accounted for at least 60% of total investment in fixed assets, followed by land. Surprisingly, investments in land and structures dropped from about a quarter of total investments in fixed assets in 2005 and 2006 to 6% in 2007 (similar to the drop in buildings and structures observed at provincial government levels).

Table 4.6

DISTRICT GOVERNMENT INVESTMENT IN FIXED ASSETS, 2005-2007 Sample of 118 districts (gross investment in nominal prices, net of asset sales)

IDR trillion % Total Asset Class

2005 2006 2007 2005 2006 2007Land 1.64 5.69 1.06 22 27 6

Equipment and machinery 0.53 3.00 2.77 7 14 17


RIC* 2.08 6.15 7.32 28 30 44

Work in progress 0.05 0.49 0.86 1 2 5

Other fixed assets 0.31 (0.74) (1.58) 4 (4) (9)

Total 7.32 20.78 16.71 100 100 100Source: Consultant, based on BPK (2004-2007) Sample size: 118 districts, accounting for 39% of total population of Indonesia in 2005 * Roads, irrigation works and canals



Regional distribution of investment patterns. Unlike provincial govern-ment investments in fixed assets, which are highly concentrated in DKI Jakarta, district government investment is fairly evenly spread over the country. In the sample of 118 districts, only Kab. Musi Banyuasin accounted for more than 4% of total investments in fixed assets throughout 2005-2007 (Table 4.7). Contrary to expectations, most of the ten biggest investors in fixed assets were located in Java, and not in resource-rich provinces such as Riau or Kalimantan Timur (with the exception of Kota Bontang)11. As was the case for provincial governments, the investment pattern of the districts in the sample was highly erratic. Apart from Kab. Tangerang, Kota Bontang and Kota Bekasi, a large increase in investment was typically followed by a sharp reduction in the subsequent financial year.

Table 4.7

DISTRICT GOVERNMENT INVESTMENT IN FIXED ASSETS, 2005-2007 Top ten districts (gross investment in nominal prices, net of asset sales)

IDR trillion % Total District

2005 2006 2007 2005 2006 2007Kab. Musi Banyuasin 0.28 0.78 0.76 4 4 5

Kota Bogor (0.55) 1.86 0.19 (7) 9 1

Kota Semarang 0.79 0.10 0.41 11 <1 2

Kab. Cianjur 0.07 0.16 0.97 1 1 6

Kab. Indramayu 0.07 1.04 0.08 1 5 <1

Kab. Tangerang 0.30 0.36 0.49 4 2 3

Kota Bontang 0.21 0.35 0.41 3 2 2

Kab. Malang 0.06 0.25 0.57 1 1 3

Kab. Sinjai 0.05 0.51 0.31 1 2 2

Kota Bekasi 0.24 0.31 0.31 3 1 2

Other districts (n=108) 5.79 15.07 12.21 79 73 73


Revealed investment priorities. There is substantial variation in district government investment level, both over time (with substantially higher levels of investment in 2006 than in 2005 or 2007) and among districts (with districts in Java spending, on average, a larger proportion of total revenue on investment). To better understand the relative investment priorities of district governments, a sample of 220 districts was divided in four quartiles. The top quartile consisted of the 55 districts with the highest proportion of revenue

11 This finding is to some degree caused by the fact that kabupaten and kota in Java have had better coverage of BPK audits, and were therefore more likely to be included in the sample. It should be pointed out, however, that only 47 of the 118 districts were in fact located in Java.



allocated to investment in 2006 (the year for which most data were avail-able12); the bottom quartile consisted of those 55 districts where investment in fixed assets, as a percentage of total revenue in that year, was. As shown in Table 4.8, districts in the bottom-quartile spent a significantly higher proportion of investments on equipment and machinery than districts in higher brackets. At the other extreme, district governments in the ‘top 50%’ quartiles spent almost 40% of total investment in fixed assets on RIC, against less than 30% of less for districts in the bottom quartile. This suggests that decision makers treat investments in roads, irrigation works and canals as ‘luxury’ expenditure, whereas equipment and machinery (car, motorcycles, photocopy machines, etc) apparently constitute a ‘basic need’. As was the case for provincial government, there was no clear relation observed between relative investment levels (as a percentage of total district govern-ment revenue) for investments in land, buildings and structures.

Table 4.8

COMPOSITION OF DISTRICT GOVERNMENT INVESTMENT BY QUARTILE, 2006*

Quartile Land Equipment/ Machinery

Buildings/ Structures RIC** Other

1 (top 25%) 8% 17% 30% 37% 8%

2 (25-50%) 11% 22% 29% 37% 2%

3 (50-75%) 10% 20% 32% 36% 2%

4 (bottom 25%) 6% 38% 31% 29% (4%)

All quartiles 9% 24% 30% 35% 2% Source: Consultant, based on BPK Sample size: 220 districts, accounting for 67% of total population of Indonesia in 2005 * Unweighted averages by quartile ** Roads, irrigation works and canals

Total Regional Government Investment in Fixed Assets

Gross investments in fixed assets by provincial and district govern-ments. The World Bank estimated total regional government investment in infrastructure at IDR 22.5 trillion in 2004. The estimates presented in this chapter were in the same order for 2005 (IDR 31.6 trillion). However, estimated investments increased at very high rates in 2006, when total central government transfers increased by IDR 75 trillion (or almost US$ 8 billion). In that year, investments in fixed assets accounted for almost 30% of total revenue, up from 16% in 2005. In 2007, coinciding with a reduction in the growth rate of central government transfers, gross investments in fixed assets dropped to 24% of total revenue (Table 4.9).

12 A small number of district governments revalued their assets in that year. These districts were ignored because asset revaluations were not considered as genuine investments in public infrastructure.



Table 4.9

REGIONAL GOVERNMENT INVESTMENT IN FIXED ASSETS, 2005-2007 IDR trillion (gross investment in nominal prices, net of asset sales)

IDR trillion 2004* 2005 2006 2007

Total revenue 165.1 196.7 279.0 305.0

Investment in fixed assets

- Provincial governments NA 10.8 18.3 22.1

- District governments NA 20.8 63.8 49.7

Total investment in fixed assets 22.4 31.6 82.1 71.8Gross investment as % of revenue 14% 16% 29% 24%Sources: Consultant, based on BPK (2004-2007), WB (2007) and MoF (2008) * World Bank (2007), other data calculated from BPK audited financial reports

Composition of investments in fixed assets. The financial reporting requirements of regional governments do not allow for a breakdown of investments in fixed assets by sector or function, as is the case for accounts prepared by central government agencies. The only publicly available details are given for investments in seven broad accounting categories (such land, and buildings and structures). Both provincial and district governments spend most of their fixed investment budgets on assets in two classes: (i) roads, irrigation works and canals, and (ii) buildings and structures (except in 2006, when provinces invested relatively small sums in the latter category).

Regional distribution of investment patterns. DKI Jakarta and regional governments on Java account for a major share of investments in fixed assets. The investment pattern of both provinces and districts is highly erratic, which suggests that few regions are systematically executing a long-term investment plan.

Revealed investment priorities. The asset class ‘roads, irrigation works and canals’ appears to be more closely related to public infrastructure servi-ces than other classes. Regions that spend a higher proportion of total revenue on investment tend allocate a higher proportion of their investments on fixed assets on this category, Conversely, regions that spend a relatively small portion of total revenue on investment allocate most of their fixed asset budgets to the asset class ‘equipment and machinery’. This suggests that decision makers at the regional government level treat investments in RIC as ‘luxury’ expenditure, whereas equipment and machinery (car, motorcycles, photocopy machines, etc) apparently constitute a ‘basic need’.

Regional Investment in Financial Assets

27Chapter 5 Regional Government Investment in Financial Assets

5

Background

Financial vs. fixed assets. As described in Chapter 4, regional governments have invested substantial sums in fixed assets (notably in roads, canals, buildings and other structures), which are normally employed to provide public infrastructure services. All these newly created assets are owned and managed by the regional government itself, and therefore recorded on its balance sheet. Regional governments also invest in enterprises that have been established to provide a public service. Such investments, which are almost exclusively undertaken in the form of equity participations (penyertaan modal), can therefore be seen as ‘indirect’ investments in fixed assets. For this reason, an estimate of the total investment of a regional government should also include an estimate of its investment in financial assets – to the extent that such investments are a priori likely to result in maintaining or improving public infrastructure service delivery.

Regional government enterprises. At the end of the Study Period, 467 provincial and district governments owned over 800 regional government enterprises (Table 5.1). Most district governments, and some provinces, wholly own a municipal water utility (Perusahaan Daerah Air Minum or PDAM). Two other important categories are regional development banks (Bank Pembangunan Daerah or BPD) and community savings institutions (Bank Perkreditan Rakyat or BPR), which normally operate in a single province and are co-owned by the provincial and district governments in that province. Taken together, these enterprises account for about half of the total. At least in theory, all these companies – as well as the remaining enterprises in the category ‘other’ – have a statutory objective to provide public services on profitable basis.

Table 5.1

REGIONAL GOVERNMENT ENTERPRISES, 31 DEC 2007

Regional Government Enterprise Number % Total Water Utility (PDAM) 322 40

Regional Development Bank (BPD) 25 3

Micro-finance Institution (BPR) 30 4

Other* 435 54

Total 812 100Sources: Consultant, based on BPK (2008) * Wastewater enterprises, toll road operators, investment corporations,

savings banks, insurance companies and other municipal enterprises

Outline of this chapter. This remainder of this chapter presents estimates of regional government investment in financial assets during the period 2005-2007. For both types of sub-national governments – provinces and districts – estimates are provided of total investments in financial assets, the composi-tion of these investments, and an analysis of regional variations in invest-ment levels.


28 Chapter 5 Regional Government Investment in Financial Assets

Provincial Government Investment in Financial Assets

Total investment in financial assets. Total investment in financial assets by provincial governments was estimated using the same method that was employed for estimating regional government investments in fixed assets. During the Study Period, total investment in financial assets was about 5% of investment level in fixed assets. Unlike investments in fixed assets, which fluctuated dramatically during 2005-2007, investments in fixed assets remained stable, ranging from IDR 1.3 trillion to IDR 1.7 trillion (Table 5.2 and Figure 5.1).

Table 5.2

PROVINCIAL GOVERNMENT INVESTMENT IN FINANCIAL ASSETS, 2005-07 All provinces (gross investment in nominal prices, net of asset sales)

2005 2006 2007 Known investment in financial assetsNumber of provinces (#) 20 30 23


Investment in financial assets (IDR trillion) 0.90 1.68 1.11

Assumed investment in financial assetsNumber of provinces (#) 12 3 10



Total investment in financial assets 1.39 1.73 1.33Source: Consultant, based on BPK (2004-2007) and SUPAS (2005)

Figure 5.1

PROVINCIAL GOVERNMENT INVESTMENT IN FINANCIAL ASSETS, 2005-07 IDR trillion (gross investment in nominal prices, net of asset sales)

0.0

0.5

1.0

1.5

2.0

2005 2006 2007





Composition of investment in financial assets. The sample balance sheet attached to PSAK No. 01 suggests regional governments to classify investments in financial assets as permanent or non-permanent. Permanent investments entirely consist of equity investments in regional government enterprises13. Non-permanent investments consist of:

Loans to other regions. As mentioned in Chapter 3, such loans are extremely rare in Indonesia.

Loans to government enterprises. Such investments are also rare, because regional governments do not lend to state-owned enterprises and prefer to invest in regional government enterprises in the form of equity participations.

Other non-permanent investments. This sub-class largely consist of investments in revolving funds, which are normally established to promote the development of small and medium-sized enterprises and were therefore considered as a potential investment in public service delivery.

As shown in Table 5.3, permanent investments (i.e. equity participations in regional government enterprises) accounted for at least 85% of provincial government investment in financial assets. Investments in non-permanent financial assets largely consist of addition to revolving funds established by two provinces (Jawa Timur and Maluku). Contrary to popular belief, regional governments do not invest in treasury notes or government bonds.

Table 5.3

PROVINCIAL GOVERNMENT INVESTMENT IN PERMANENT AND NON-PERMANENT FINANCIAL ASSETS, 2005-2007 All provinces (estimated gross investment in nominal prices, net of asset sales)

2005 2006 2007 Permanent investments (equity participations) 1.28 1.48 1.19

Non-permanent investments 0.11 0.25 0.15

Total investment in financial assets 1.39 1.73 1.33Permanent investments as % of total 8% 15% 11% Source: Consultant, based on BPK (2004-2007)

Regional distribution of investment patterns. Throughout 2005-2007, three provinces (DKI Jakarta, Jawa Timur and Jawa Tengah) accounted for a major share of investments in financial assets (Table 5.4). In all three years, annual investments by Jawa Timur were at least IDR 200 billion (US$ 20 million). With the exception of DKI Jakarta, which did not invest in financial assets in 2007, provincial governments normally maintain a stable level of investment.

13 PSAK No. 01 also provides for the sub-class ‘other permanent investments’ (investasi permanen lainnya), but this sub-class was rarely (if ever) used by regional governments during the Study Period.



Table 5.4

PROVINCIAL GOVERNMENT INVESTMENT IN FINANCIAL ASSETS, 2005-07 Top three provinces (gross investment in nominal prices, net of asset sales)

IDR trillion % Total Province

2005 2006 2007 2005 2006 2007Jawa Tengah 0.39 0.26 0.15 28 15 11

Jawa Timur 0.21 0.32 0.26 15 19 19

DKI Jakarta 0.11 0.22 0.00 8 13 0

Other provinces 0.68 0.93 0.93 49 54 70

Total 1.39 1.73 1.33 100 100 100Source: Consultant, based on BPK (2004-2007)

Revealed investment priorities. As shown in Table 5.3, most provincial government investments are classified as permanent, and virtually all permanent investment consists of equity participations in regional govern-ment enterprises. With the exception of DKI Jakarta, which has a clear-cut strategy for investing in (or divesting of) its enterprises14, almost half of the equity investments of most provincial governments consist of automatic reinvestment of dividends of Bank Pembangunan Daerah (Table 5.5). These transactions are recorded by the provinces as a receipt in own-source revenue (PAD) and a (simultaneous) equity investment in the pengeluaranbudget, but the funds themselves actually never pass through the regional government treasury. Most of the remainder is invested in other enterprises, mainly investment corporations. In 2007, only two provinces (Bangka-Belitung and Kalimantan Selatan) invested in municipal water supply.

Relevance lost. In theory, a BPD could invest reinvested dividends in public infrastructure services (as its role of development bank suggests). In recent years, however, BPDs have largely invested their funds in (relatively low-risk) treasury notes and government bonds, and not in the regional development of infrastructure. This, in turn, means that most provincial government invest-ments in permanent financial assets do not contribute to maintaining or improving public infrastructure services. At the same time, it also explains the apparent stability of investment in financial assets and the large shares of Jawa Tengah and Jawa Timur (who happen to own the country’s largest and most profitable BPDs). Investments in other regional enterprises are also not necessarily related to providing public infrastructure services (for example, in 2007 the province of Sumatera Selatan invested IDR 6 billion in a local football team, whereas NTT allocated its entire investment in financial assets to fortify the shareholder capital of Hotel Flobamor).

14 Oosterman, A. and B.T. Samiadji, Increases in Surpluses of Regional Governments in Indonesia: An Empirical Analysis, DSF, Jakarta 2008



Table 5.5

PROVINCIAL GOVERNMENT INVESTMENTS IN REGIONAL GOVERNMENT ENTERPRISES, 2007

Regional Government Enterprise IDR billion % Total # ProvincesWater Utility (PDAM) 34 3 2

Regional Development Bank (BPD) 478 48 13

Micro-finance Institution (BPR) 54 6 7

Other* 421 43 18

Total 988 100 23Sources: Consultant, based on BPK (2008) Sample size: 23 of 33 provinces (accounting for 83% of total population in 2005)

District Government Investment in Financial Assets

Total investment in financial assets. Total investment in financial assets by district governments was estimated using the same method that was employed for estimating provincial government investments in such assets. During the Study Period, total investment in financial assets was about 5% of investment level in fixed assets. Unlike investments in financial assets by provincial government, which remained stable during the Study Period, estimated district government investments almost doubled from IDR 1.5 trillion in 2005 to IDR 2.9 trillion in 2007 (Table 5.6 and Figure 5.2).

Table 5.6

DISTRICT GOVERNMENT INVESTMENT IN FINANCIAL ASSETS, 2005-2007 All districts (gross investment in nominal prices, net of asset sales)

2005 2006 2007 Known investment in financial assetsNumber of districts (#) 103 268 239



Assumed investment in financial assetsNumber of districts (#) 267 142 195



Total investment in financial assets 1.50 2.06 2.89Source: Consultant, based on BPK (2004-2007) and SUPAS (2005)

Composition of investment in financial assets. Many district governments do not distinguish between permanent and non-permanent investment. A review of a sample of audited financial reports indicates that kabupaten and kota allocate most of their investments in financial assets as equity participa-tions in municipal enterprises (as is the case for provinces).



Figure 5.2

DISTRICT GOVERNMENT INVESTMENT IN FINANCIAL ASSETS, 2005-2007 IDR trillion (gross investment in nominal prices, net of asset sales)

0

1

2

3

2005 2006 2007



Table 5.7

DISTRICT GOVERNMENT INVESTMENT IN FINANCIAL ASSETS, 2005-2007 Top ten districts (gross investment in nominal prices, net of asset sales)

IDR billion % Total District

2005 2006 2007 2005 2006 2007Kab. Musi Banyuasin 21 117 76 5 17 9

Kab. Badung 11 21 49 2 3 6

Kab. Tangerang 17 25 35 4 4 4

Kab. Muara Enim 1 17 41 <1 2 5

Kab. Sleman 29 9 17 7 1 2

Kota Cimahi 5 30 18 1 4 2

Kota Surabaya 24 14 8 5 2 1

Kota Bontang 5 18 22 1 3 3

Kab. Bantul 11 6 26 2 1 3

Kab. Wonogiri 5 23 14 1 3 2

Other districts (n=108) 129 280 306 70 59 63

Total 437 691 831 100 100 100Source: Consultant, based on BPK (2004-2007) Sample size: 118 districts, accounting for 39% of total population of Indonesia in 2005 * Roads, irrigation works and canals

Regional distribution of investment patterns. District government invest-ment in financial assets is more highly concentrated than investment in fixed assets. In a sample of 118 districts, Kab. Musi Banyuasin accounted for 17% of total investment in 2006, and for 9% in 2007 (Table 5.7). Also here, most of the ten biggest investors in fixed assets were located in Java, and not in Riau, Kalimantan Timur or other resource-rich provinces (again with the exception of Kota Bontang). District that tend to spend large sums on fixed



assets are often also major investors in financial assets. Although total investment in financial assets by districts seems to have increased at an even pace, this increase masks substantial year-on difference at district government level.

Revealed investment priorities. It is rare for district governments to invest in enterprises other than BPDs. The passive nature of the investment strategy of a typical district (or provincial) government is aptly summed up in an audited financial report. This report states that the district investment in BPD shares should be seen ‘as a consequence’ (sebagai konsequensi) of the profitability of the BPD. Even though most districts in Indonesia own a municipal water enterprise, fewer than 10 districts recorded an investment in their PDAM in 2007.

Total Regional Government Investment in Financial Assets

Total investment in financial assets. During 2004-2007, the book value of long-term investments held by district and provincial governments, increased by IDR 10.9 trillion. Because regional governments are not allowed to revalue or depreciate such investments, this amount can be interpreted as the cumulative total investment of regional government in Indonesia during the study period (net of any sales of such investments). Total investments in financial assets increased from IDR 2.9 trillion to IDR 3.8 trillion from 2005 to 2006 (a year-on increase of 31%), and to IDR 4.2 trillion in 2007 (Table 5.8).

Table 5.8

REGIONAL GOVERNMENT INVESTMENT IN FINANCIAL ASSETS, 2005-2007 All regions (estimated gross investment in nominal prices, net of asset sales)

2005 2006 2007 Provincial governments 1.39 1.73 1.33

Districts governments 1.50 2.06 2.89

All regional governments 2.89 3.79 4.22Year-on increase 31% 11% Source: Consultant, based on BPK (2004-2007)

Relevance of investment in financial assets for public infrastructure services. During the Study Period, regional governments mainly invested in three types of financial assets. These are, in order of increasing relevance for public service delivery:

Shares in regional development banks. These largely consisted of automatic reinvestments of dividends. The share of provincial and district government investment in financial assets in BPD shares was estimated at 50% and 80%, respectively. Because BPDs normally do not invest in public infrastructure services (or, indeed, in regional development), these invest-ments are unlikely to benefit the delivery of public infrastructure services.



Shares in regional government enterprises not aimed at public service delivery. Regional governments owned several hundreds of enterprises that seek to provide a commercial service in competition with the private sector counterparts. Examples of such enterprises are: airlines, hotels, football teams, insurance companies, and graphic design bureaus. The share of provincial and district government investment in financial assets in such ventures was estimated at 40% and 10%, respectively.

Shares in regional government enterprises aimed at delivering a public infrastructure service. These large consist of equity participations in PDAMs. In 2007, only two provinces and fewer than 10 districts invested in such companies, of which there are currently more than 300. It is conserva-tively estimated that the share of regional government investment in enterprises that provide public infrastructure services is in the order of 10%.

What next? This chapter concludes that recorded investments in financial assets overstate actual financial commitments of regional governments to public infrastructure financing. The same conclusion will be drawn in Chapter 6 with respect to the recording of fixed assets – which, as mentioned earlier, are expressed in gross nominal terms without due regard for depreciation.

Sustainability of Regional Government Investment

35Chapter 6 Sustainability of Regional Government Investment

6

Background

Investments in fixed assets: overstatement of service potential. Since the start of the implementation of Law 22/1999 (and its successor Law 32/2004), a primary objective of regional governments in Indonesia is to provide citizens in their jurisdictions with services that are normally not provided by the private sector (such as primary education, local roads and flood control systems). Regional governments invest in assets to provide such services in order to: (i) to maintain existing service levels, and (ii) to increase service levels (Table 6.1). Most accrual accounting systems require its users to account for reductions in the service potential of existing assets through normal wear and tear. For example, many car owners write off their investment in ten years, recognizing that the service potential of their car has been reduced to zero at the end of the ten-year period. At present, most regional governments in Indonesia do not write off (or ‘depreciate’) their assets, even though they are allowed to do so. For this reason, the vast majority of regional government accounts overstates the service potential of existing assets on their books. Stated differently, most regional governments only record investments in new fixed assets and ignore the reduction in value of their existing fixed assets.

Table 6.1

CLASSIFICATION OF INFRASTRUCTURE INVESTMENT

Goal Type of Investment Examples Maintain existing service levels

Replacement of exis-ting infrastructure stock

Replacement of water pipes, periodic road maintenance

Increase service levels

Increase of infrastruc-ture stock

Construction of new bridge, increa-sed production capacity of PDAM

Source: Consultant

Outline of this chapter. The purpose of this chapter is to estimate deprecia-tion expenses that regional government should have incurred during the Study Period to correctly account for decreases in the service potential of their existing infrastructure assets. In order to do so, it first gives an overview of current depreciation practices by regional governments in Indonesia, which are presently only followed by a small number of districts. It then shows to what extent the absence of depreciation expenses is likely to distort estimates of investments in fixed assets. The chapter concludes with a presentation of net (as opposed to gross) investment by regional govern-ments from 2005 to 2007, based on three different depreciation methods.

Depreciation by Regional Governments in Indonesia

Depreciation. According to PSAK No. 01, all fixed assets, except land and work in progress, may be depreciated (dapat disusutkan) in accordance with the type and characteristics of the assets. Also under KepMendagri 29/2002, depreciation of fixed assets was allowed, but not required. In 2007, only 12


36 Chapter 6 Sustainability of Regional Government Investment

of 246 district governments with audited balance sheets had elected to depreciate fixed assets, up from seven regions in 200515. Most of these districts were located in the provinces of Bali and Sulawesi Tenggara (Box 6.1). No depreciation was recorded by district governments in 2004, and during 2004-2007, not a single provincial government depreciated fixed assets. In contrast, virtually all central government agencies – as well as state-owned enterprises and regional government-owned companies – account for the depreciation of their fixed assets.

Depreciation methods. Although PSAK No. 07 on “Accounting of Fixed Assets” allows three different methods of depreciation methods (straight line, double declining balance, unit of production method), all regional govern-ments that depreciated assets during the Study Period had elected to use the straight-line method. Using this method, a reduction in the economic benefits (or service potential) of an asset is assumed to be directly proportional with the economic lifetime of that asset. For example, if the lifetime of an asset is assumed at 20 years, the economic benefits of the assets are assumed to decrease by (1/20 =) 5% per year of the value of that asset at the beginning of its economic lifetime. Regional government that depreciated assets applied similar economic lifetimes to the asset classes (Table 6.2).

Table 6.2

ASSUMED ECONOMIC LIFETIME BY ASSET CLASS, SELECTED REGIONAL GOVERNMENTS (2007) Years

Province / District

Equipment & Machinery

Buildings & Structures

Roads, Irriga-tion & Canals

Other

Bali Kab. Bangli 5-12 25 10-20 5Kab. Buleleng 8-12 10-25 10-20 5Kab. Gianyar 5-12 25 10-20 5Kab. Karangasem 5-12 25 10-20 5

Sulawesi TenggaraKota Bau-Bau 10 20 20 10Kab. Buton 10 20 20 10Kab. Konawe 10 20 20 10

Other provinces*Kab. Bangkalan 5-10 15 15 5Kota Bima 8-15 25 10-20 5Kab. Sanggau 5-10 10-20 5-10 5-10

Most common 10 25 20 5Source: Consultant, based on BPK (2004-2007) * No data for Kota Semarang and Kab. Lombok Barat

15 Financial assets are not depreciated because these consist of shareholdings and other long-term investments, which are not subject to wear and tear.



Box 6.1

REGIONAL DIFFERENCES IN ACCOUNTING TREATMENT

Eight of 13 regional governments that depreciated assets during 2005-2007 are located in just two provinces (Bali and Sulawesi Tenggara). All three regions in Sulawesi Tenggara used precisely the same assumptions, which were different from assumptions in Bali (which were precisely the same in four of five Balinese regions that depreciated assets). These observations suggest that there exist strong regional differences in accounting practices. These differences may well be caused by policies of BPK’s regional offices, which usually cover more than one province (this is suggested by the fact that Kabupatan Bima and Kabupaten Lombok Barat – which are not in Bali, but are audited by the same BPK office as regional governments in Bali – have also commenced depreciation).

Source: Consultant

Potential Impact of Depreciation on Book Value of Fixed Assets

Asset valuation. Investments in new fixed assets are valued at historical cost price or, in exceptional circumstances, at “fit and proper value” or replacement value16. Regional government may depreciate assets to record decreases in economic benefits of fixed assets, but most regions have elec-ted not to depreciate (and are indeed not legally required to do so). The vir-tual absence of depreciation, coupled to historically high levels of price infla-tion, will inevitably cause a high and rising difference between asset values that are actually recorded and asset values that a balance sheet is suppose to record according to PSAK No. 01 (economic benefits or service potential).

Example: base case. In 2005, Kabupaten ABC procures a dump truck for its solid waste management department at a historical cost price of IDR 350 million. The economic lifetime of the truck is estimated at 7 years, even though the kabupaten does not intend to record depreciation of the truck’s economic value. As a result, the truck remains valued at IDR 350 million until the end of 2012, when the truck is scrapped and replaced by a new truck.

Example: impact of depreciation at historical cost price. Kabupaten ABC decides to depreciate the value of the truck, in recognition of expected reductions in its service potential, by IDR 50m per year (Table 6.3). As a result, the net book value (i.e. the book value after depreciation) will be lower than under the ‘base case’ scenario. The differences in value are highest just before the truck is scrapped. On 31 December 2012, the truck is valued at IDR 350m under the base case, but fully depreciated under this scenario.

16 In 2006, a small number of district governments (mostly in West and Central Java) revalued their assets.



Example: impact of increases in replacement value. Even if Kabupaten ABC has fully depreciated the truck at historical cost price, it may nonethe-less have not set sufficient funds aside to replace the vehicle in December 2012 if the price of the truck is higher than IDR 350 million. If prices increase by 10% p.a., the nominal cost price of a replacement truck would be about IDR 680 million, or almost twice the price paid in 2005. However, total depreciation from 2006-2012 of IDR 350 million would not reflect the reduction in service potential of the truck, because it would cost more than IDR 50 million per year to undo that reduction because of the increase in the cost price of a new truck. The correct amount of depreciation needed to maintain this part of public infrastructure at its existing service level would be higher: the regional government would not only need to depreciate for normal wear and tear, but also to compensate for price increases in the truck.

Table 6.3

ESTIMATED BOOK VALUES, THREE SCENARIOS (EXAMPLE)

Scenario 2005 2006 2007 2008 2009 2010 2011 2012Scenario #1 – Base caseDeprecation – – – – – – – –Book value 350 350 350 350 350 350 350 350

Scenario #2 – With depreciationDeprecation – 50 50 50 50 50 50 50Book value 350 300 250 200 150 100 50 –

Scenario #3 – With revaluationDeprecation – 55 61 67 73 81 89 97Book value, BOY – 350 385 424 466 512 564 620Revaluation – 35 39 42 47 51 56 62Book value, EOY 350 385 424 466 512 564 620 682Source: Consultant

Gross vs. Net Investment in Fixed Assets

Definition of net investment. The net investment of a regional government is defined as the increase in the book value of the fixed assets other than land and work in progress (hereafter also referred to as ‘eligible fixed assets’) of a regional government between two reporting periods, corrected for revaluations and depreciation. In formula:

NIt = (BVt – BVt-1) – REVt – DEPt [6-1]

where NIt net investment in fixed assets during period t (BVt – BVt-1) the increase in the book value of fixed assets during t REVt revaluations of fixed assets during t DEPt assumed depreciation of eligible fixed assets during t



To simplify matters, the estimation of net investment will not be performed for regional governments that have applied revaluation, so that equation [6-1] can be written as:

NIt = (BVt – BVt-1) – DEPt [6-2]

For comparison, gross investment was previously defined as:

GIt = (BVt – BVt-1) [6-3]

Interpretation of net investment. In any given year, the assumed deprecia-tion charge is an estimate of the amount a regional government needs to maintain the service potential of its existing assets at its current level. For example, if the book value of fixed assets of a regional government in-creased by 100 in a given year, and the estimated depreciation was 70 in that year, it was assumed that 70 of the investment was in effect used to maintain infrastructure in its current condition, and the remainder of 30 to expand the quantity and/or quality of the infrastructure. In more general terms, if the net investment of a regional government is positive, this means that the region has funds left over to increase its infrastructure stock, thereby increasing service levels. Negative net investment indicates that the invest-ment in fixed assets by a region is not sufficiently high to maintain the existing service level of its infrastructure stock (Table 6.4).

Table 6.4

INTERPRETATION OF NET INVESTMENT

Case Interpretation

NIt > 0 Net investment is positive. The region has invested sufficient funds to maintain the service level of its existing assets, and is able to finance an increase in service levels.

NIt = 0 Net investment is zero. The region has invested sufficient funds to maintain the service level of its existing assets, but is unable to finance an increase in service levels.

NIt < 0 Net investment is negative. The region has invested insuffi-cient funds to maintain the service level of its existing assets.

Source: Consultant

Estimating Depreciation

Starting balance and incremental assets. Depreciation charges were estimated for 15 provincial governments and 118 kabupaten and kota, for which balance sheets were available for each year of the Study Period 2004-2007 (and which did not revaluate their assets). Fixed assets on the balance sheet of a regional government consist of two items:

Assets valued at “fit and proper” value at the time the starting balance was prepared (starting balance assets).

Assets valued at historical cost price, obtained in later years (incremental assets).



The economic lifetime of incremental assets can be estimated with reason-able accuracy. If, for example, the book value of the asset class “buildings and structures” increases from IDR 200b to IDR 250b in first year after the starting balance was prepared, the increase of (250-200=) IDR 50b repre-sents the purchase of an additional building, and should be depreciated at (50/25=) IDR 2 billion per year, assuming an economic lifetime of 25 years. It is, however, not possible to derive the economic lifetime of assets on the starting balance from audited financial reports (these lifetimes are recorded in the regional government’s asset register, for which there is no central repository). It is only known that the lifetime of such assets will range from less than a year (for assets just purchased before the starting balance was prepared) to over sixty years (for assets transferred to the region shortly after independence in 1945).

Depreciation of eligible incremental assets. The gross annual investment in such assets – as well as their composition (land, buildings and structures, etc.) – is known for all regional governments in the sample. All eligible incremental assets of regional governments in the sample were depreciated using the straight-line method, based on the assumed economic lifetimes shown in Table 6.5. These lifetimes were selected because they reflect the most common practices by the few regional governments that currently already depreciate their assets (Table 6.2). Annual rates of depreciation were applied to the increase in the average book value in a year (and not to increases in end-of-year book values), for the simple reason that regional governments create assets throughout their reporting periods. Refer to Table 6.6 for an example of estimating deprecation on investments in buildings and structures.

Table 6.5

ASSUMED ECONOMIC LIFETIMES OF ELIGIBLE FIXED ASSETS

Asset Class Eligible Asset?

Economic Lifetime

Annual Rate of Depreciation

Land No – –Equipment and machinery Yes 10 10%Buildings and structures Yes 25 4%Roads, irrigation works, canals Yes 20 5%Work in progress No – –Accumulated depreciation No – –Other fixed assets Yes 5 20%Source: Consultant

Depreciation of eligible fixed assets on the starting balance. Accrual accounting is relatively new to regional governments in Indonesia. The first audited regional government balance sheets were prepared for 2003, and many regional governments – especially kabupaten governments in the eastern part of the country – did not prepare their first balance sheets until 2006. According to PSAK No. 01, assets on the starting balance of a regional government should be valued at historical cost prices or at their “fit and



proper value” (nilai wajar) in the event that historical cost prices were not available. Even though KepMendagri 29/2002 does not specify a valuation basis, it is likely that most fixed assets on balance sheets prepared before PerMendagri 13/2006 came into force were also valued on this basis, if only because evidence of historical cost prices was presumably no longer available for assets that were procured many years ago (such as local roads or irrigation works). In other words, a major portion of assets on the balance sheets of most regional government consist of assets that have already used up a significant portion of the economic lifetime, and for which the valuation basis is not clear. Unfortunately, estimated depreciation changes that apply to eligible assets on the starting balance of a regional government are highly sensitive to assumptions about the economic lifetime of these assets. For example, if the remaining economic lifetime of the buildings and structures on the starting balance shown of Table 6.6 is five years, the annual deprecia-tion charge is (1000/5=) 200 IDR billion, which is more than ten times as high as the estimated depreciation on incremental assets in 2007. If the assumed economic lifetime is increased to 10 years, the annual depreciation drops to IDR 100 billion.

Table 6.6

REGIONAL GOVERNMENT NET INVESTMENT IN BUILDINGS AND STRUCTURES (EXAMPLE), 2004-2007 IDR billion

2004 2005 2006 2007 Book value, EOY 1,000 1,100 1,700 2,000

Increase in EOY book value (=gross inv.) 100 600 300

Book value, average 1,050 1,400 1,850

Increase in average book value 50 350 450

Depreciation on incremental assets- Eligible assets created in 2005 (=4% x 50) 2 2 2

- Eligible assets created in 2006 (=4% x 300) – 12 12

- Eligible assets created in 2007 (=4% x 100) – – 4

- Total depreciation on incremental assets 2 14 18

Net investment (= gross inv. – depreciation) 98 586 282Source: Consultant, based on BPK (2004-2007) and SUPAS (2005)

A special problem: large regional variation in valuation of assets in the starting balance. As mentioned before, KepMendagri 29/2002 required regions to recruit a certified independent institution to assess the value of assets on the starting balance. There is reason to believe that there is enormous variation in the valuation methods employed by such institutions – and therefore in the book values of otherwise similar assets. This is best illustrated by comparing the book values of provincial government roads (using RIC values as a proxy) in Java and Bali – which have comparable road networks – with the total length of these roads according to records of the Ministry of Public Works. As shown in Table 6.7, book values ranged from IDR 0.1 billion per km in Central Java to over IDR 15b in DKI Jakarta.



Table 6.7

BOOK VALUES OF PROVINCIAL GOVERNMENT ROADS, 2004 Sample of six provinces

Book Value Length Value/kmProvince

(IDR billion) (km) (IDR b) DKI Jakarta 17,041 1,124 15.2

Jawa Tengah 155 2,550 0.1

DI Yogyakarta 1,189 690 1.7

Jawa Timur 8,323 1,439 5.8

Banten 551 372 1.5

Bali 548 840 0.7 Source: Consultant, based on BPK (2005) and Ministry of Public Works (2005)

Three scenarios. To deal with the considerable uncertainties associated with the calculation of depreciation charges on starting balance items, three scenarios were considered17:

Low: depreciation of incremental assets only. This scenario implicitly assumes that eligible assets at the starting balance do not need to be depreciated. (This is admittedly not realistic because assets that have been fully depreciated should not be shown on the balance sheet in the first place; the estimated provided by this scenario are provided for comparison with the other two scenarios only.)

Medium: depreciation of incremental assets + depreciation of starting balance assets at average economic lifetimes. Under this scenario, depreciation of starting balance items is calculated by assuming that all eligible items are at the mid-point of their economic lifetimes18. For example, all buildings and structures are assumed to have a lifetime of (50% x 25=) 12.5 years. When applied to the starting balance in Table 6.6, the estimated depreciation in 2005 would be (98 + [1000/12.5] =) IDR 178 billion.

Depreciation of incremental assets + depreciation of starting balance assets at 75% of economic lifetimes. This scenario is identical to the ‘medium’ scenario described above, except for the estimated lifetimes of assets on the starting balance, which is 75% instead of 50% of the economic lifetimes. Based on this scenario, the estimated depreciation of buildings and structures in Table 6.6 would be (98 + [1000/6.25] =) IDR 258 billion in 2005. This is likely to be the most realistic scenario (Box 6.2), even though it will result in the highest depreciation charge, and therefore in the largest difference between gross and net investment.

17 None of the scenarios presented here considers asset revaluation to account for increases in replacement values. This is because PSAK No. 01 only allows asset revaluation in exceptional circumstances, and not as a matter of routine.

18 The class ‘other assets’ is exempted from this treatment under the ‘medium’ and ‘low’ scenarios, because a reduction of the assumed economic lifetime below the length of the Study Period would lead to modeling complications, which is not justified given its negligible share in total regional government investment.



Box 6.2

IMPACTS OF KRISMON ON ECONOMIC LIFETIME OF ASSETS

It is likely that the age of a large number of major depreciable fixed assets (roads, irrigation works and buildings) is at least ten years, because regional government investment in infrastructure had come to a virtually standstill in the aftermath of the 1997/98 monetary crisis and – as de-scribed in the 2007 WB public expenditure review – remained significantly below pre-crisis level levels. Depreciating assets at the percentages used for the first scenario is therefore likely to understate actually required depreciation. If, for example, the buildings on the starting were, on average, ten years old, the remaining economic lifetime of these buildings would be (25-10=) 15 years. The annual depreciation of these buildings is estimated at (1/15=) 6.7% per year, which is higher than the (1/25=) 4% for building obtained subsequently.

Source: Consultant

Results of Scenario Analysis

Net Investment by Provincial Governments

Estimated depreciation of incremental assets. Estimated required depreciation increased from IDR 0.13 trillion in 2005 to about IDR 0.40 trillion in 2007. The sums are relatively small when compared to the gross invest-ment by the 15 provincial governments in the sample (which was about IDR 10 trillion in 2007). Because gross investment in buildings and structures came to a virtual standstill in 2007, the share in incremental depreciation charges also dropped (Table 6.8).

Table 6.8

PROVINCIAL GOVERNMENT DEPRECIATION OF INCREMENTAL ELIGIBLE FIXED ASSETS, 2005-2007 Sample of 15 provinces

IDR trillion % Total Eligible Asset Class

2005 2006 2007 2005 2006 2007Equipment and machinery 0.05 0.11 0.14 37 31 34


RIC** 0.05 0.16 0.20 37 44 51


Estimated depreciation of starting balance assets. Estimated required depreciation charges on starting balance sheet items were far higher than incremental depreciation: IDR 5.9 trillion and IDR 11.7 trillion under the ‘medium’ and ‘high’ scenarios, respectively (Table 6.9).



Table 6.9

PROVINCIAL GOVERNMENT DEPRECIATION OF STARTING BALANCE FIXED ASSETS Sample of 15 provinces

IDR billion Eligible Asset Class

Medium HighEquipment and machinery 1.18 2.36

Buildings and structures 0.83 1.65

Roads, irrigation works and canals 3.84 7.68

Total 5.85 11.69 Source: Consultant, based on BPK Sample size: 15 provinces, accounting for 56% of total population of Indonesia in 2005

Net investment by provincial governments. Table 6.10 shows investment levels of the 15 sample provinces after correcting for depreciation charges. Under the ‘low’ scenario, which ignores assets on the starting balance, depreciation accounts for less than 5% of gross investment in all three years. Under the medium scenario, depreciation was almost equal to gross investments in 2005, which suggests that the sample provinces just invested enough to maintain their public infrastructure services at its current level in that year. In 2006 and 2007, over half of gross investments was needed to maintain existing service levels – with the remainder assumed to be invested in an expansion of service levels. If the ‘high’ depreciation scenario would apply, provincial governments were unable to prevent a reduction in public infrastructure service levels that existed at the beginning of the Study Period.

Table 6.10

GROSS VS. NET INVESTMENT IN FIXED ASSETS BY PROVINCIAL GOVERNMENTS, 2005-2007 Sample of 15 provinces

IDR trillion Index (GI = 100) 2005 2006 2007 2005 2006 2007

Gross investment (GI) 6.01 11.48 9.80 100 100 100Depreciation (DEP) - Low depreciation 0.13 0.36 0.40 2 3 4

- Medium depreciation 5.98 6.20 6.25 99 54 64

- High depreciation 11.82 12.05 12.09 197 105 123

Net investment (=GI-DEP)- Low depreciation 5.88 11.12 9.40 98 97 96


- High depreciation (5.81) (0.57) (2.29) (97) (5) (23)Source: Consultant, based on BPK (2004-2007) Sample size: 15 provinces, accounting for 56% of total population of Indonesia in 2005



Net Investment by District Governments

Estimated depreciation of incremental assets. Estimated required depreciation increased from IDR 0.13 trillion in 2005 to about IDR 0.87 trillion in 2007. The sums are relatively small when compared to the gross invest-ment by the 118 district governments in the sample (IDR 16.7 trn in 2007).

Table 6.11

DISTRICT GOVERNMENT DEPRECIATION OF INCREMENTAL ELIGIBLE FIXED ASSETS, 2005-2007 Sample of 118 districts

IDR trillion % Total Eligible Asset Class

2005 2006 2007 2005 2006 2007Equipment and machinery 0.03 0.18 0.29 20 31 33


RIC** 0.05 0.21 0.34 39 37 39


Estimated depreciation of starting balance assets. As was the case for provincial governments, estimated required depreciation charges on starting balance sheet items were several multiples higher than incremental depre-ciation: IDR 8.6 trillion and IDR 17.3 trillion under the ‘medium’ and ‘high’ scenarios, respectively (Table 6.12).

Table 6.12

DISTRICT GOVERNMENT DEPRECIATION OF STARTING BALANCE FIXED ASSETS Sample of 118 districts

IDR billion Eligible Asset Class

Medium HighEquipment and machinery 1.80 3.59

Buildings and structures 2.10 4.20

Roads, irrigation works and canals 4.73 9.46

Total 8.63 17.25Source: Consultant, based on BPK Sample size: 118 districts, accounting for 39% of total population of Indonesia in 2005

Net investment by district governments. Table 6.12 shows investment levels of the 118 district governments in the sample after correcting for depreciation charges. Under the ‘low’ scenario, which ignores assets on the starting balance, depreciation accounts for less than 5% of gross investment in all three years. Under the medium scenario, depreciation exceeded to gross investments in 2005, which suggests that the sample districts did not



invest enough to maintain their public infrastructure services at its current level in that year. In 2006 and 2007, about half of gross investments was needed to maintain existing service levels – with the remainder assumed to be invested in an expansion of service levels. If the ‘high’ depreciation scenario would apply, district governments were unable to prevent a reduction in public infrastructure service levels that existed at the beginning of the Study Period in both 2005 and 2007. Only in 2006 would the districts government be able to invest a small portion (estimated at 14% of gross investment) in an improvement of existing public infrastructure services.

Table 6.12

GROSS VS. NET INVESTMENT IN FIXED ASSETS BY DISTRICT GOVERNMENTS, 2005-2007 Sample of 118 districts

IDR trillion Index (GI = 100) 2005 2006 2007 2005 2006 2007

Gross investment (GI) 7.32 20.78 16.71 100 100 100Depreciation (DEP) - Low depreciation 0.13 0.56 0.87 2 3 5


- High depreciation 17.38 17.81 18.13 238 86 108

Net investment (=GI-DEP)- Low depreciation 7.19 20.22 15.83 98 97 95

- Medium depreciation (1.44) 11.59 7.21 (20) 56 43

- High depreciation (10.07) 2.97 (1.42) (138) 14 (8)Source: Consultant, based on BPK (2004-2007) Sample size: 118 districts, accounting for 39% of total population of Indonesia in 2005

Conclusions andRecommendations

47

7

Chapter 7 Conclusions and Recommendations

Conclusions

Summary of regional government investment. From 2005 to 2007, regional governments invested substantial sums in fixed assets (notably in roads, canals, buildings and other structures), as well as financial assets, mainly consisting of shareholdings in regional government enterprises. During this period, gross investment in fixed assets increased at very high rates, from about IDR 35 trillion in 2005 to IDR 76 trillion in 2007 (Table 7.1). The rapid increase from 2005 to 2006 coincided with a 60% increase in DAU and very high increases in shared revenue from oil and gas, which – taken together – account for over half of total provincial government revenue, and for more than 80% of the revenue of most kabupaten and kota. Investments in financial assets were in the order of IDR 3-4 trillion per year.

Table 7.1

GROSS REGIONAL GOVERNMENT INVESTMENT, 2005-2007 IDR trillion

2005 2006 2007Fixed assets 31.6 82.1 71.8

Financial assets 2.9 3.8 4.2

Total 34.5 85.9 76.0Source: Consultant, based on BPK

Allocation or regional government investment to public infrastructure services. In theory, regional government investment in fixed and financial assets is expected to result in an increase in the level of provide public infra-structure services (through, for example, the construction of a new bridge or the expansion of the production capacity of a municipal water utility). In prac-tice, however, reported investment figures presently do not reflect a regional government’s effort to increase the delivery of such services, given that:

Most regional governments in Indonesia do not depreciate their fixed assets, even though they are allowed to do so. For this reason, the vast majority of regional government accounts overstates the service potential of the existing assets on their books (see Figure 7.1 overleaf).

Most investments in financial assets consist of equity participations in regional government enterprises that do not invest in public service delivery.

Conclusions. Although regional government investments have rapidly increased in recent years, a major portion of these investments should actually have been depreciated to account for normal wear and tear. In addition, a significant portion of financial (and perhaps also fixed) assets is currently not employed to provide public infrastructure services. This means that, at present, the central government does not have access to relevant information on investments in public infrastructure services by regional governments. The limited information that is available from audited financial reports – the only primary source of information on regional government finances – suffers from two major drawbacks:


48 Chapter 7 Conclusions and Recommendations

Investment figures overstate investment in public infrastructure services, firstly because most regional governments do not account for depreciation, and secondly because a significant portion of regional government invest-ments appears to be unrelated to the provision of public services.

Investment figures are presented by asset class (such as land or buildings), which is useful for accountants, but not for policy makers or the public.

Figure 7.1

GROSS VS. NET REGIONAL GOVERNMENT INVESTMENT, 2005-2007 IDR trillion (‘medium’ depreciation scenario)

0

30

60

90

2005 2006 2007

Gross Investment Net Investment (after depreciation)

Source: Consultant (based on BPK); see Chapter 6 for details

Policy Recommendations

#1: Start a dialogue with the accounting profession to improve the relevance of regional government financial reports. The purpose of this dialogue is to advocate a change to government accounting standards (on which PerMendagri 59/2007 is based), with the aim of requesting regional government financial reports to classify investments by function (such as health, environment, or public services) and sectors (such as roads, education or irrigation), as central government agencies currently do.

#2: Start a dialogue with BPK to encourage depreciation of fixed assets by regional governments. Current government accounting standards already allow depreciation. In addition, BPK has a mandate to ensure that balance sheets of government agencies that are subject to its audits accura-tely reflect the financial position of these government agencies.

#3: Discourage regional government investment in assets unrelated to public infrastructure services. The Ministry of Finance may consider issuing a ‘negative list’ of investments. Examples of investments on this list are: hotels, football teams, graphic design bureaus, trading companies, etc. If, according to its audited financial report, a regional government has under-taken an investment on the negative list, its DAK transfers would be reduced in the next financial year.

Glossary

Glossary

APBD Anggaran Pendapatan dan Belanja Daerah (regional government revenue and expenditure budget)

APBN Anggaran Pendapatan dan Belanja Negara (national government revenue and expenditure budget)

BPD Bank Pembangunan Daerah (regional development bank) BPK Badan Pemeriksa Keuangan (National Auditing Agency) BPR Bank Perkreditan Rakyat (community credit bank) DAK Dana Alokasi Khusus (Special Allocation Fund) DAU Dana Alokasi Umum (General Allocation Fund) DBH Dana Bagi Hasil (revenue sharing) DSF Decentralization Support Facility GOI Government of Indonesia IDR Indonesian Rupiah Kab. Kabupaten (district government) KepMendagri Keputusan Menteri Dalam Negeri (decision of the Minister

of Home Affairs) LKPP Laporan Keuangan Pemerintah Pusat (central government

financial report) MoF Ministry of Finance MoHA Ministry of Home Affairs PAD Pendapatan Asli Daerah (regional government own-source

revenue) PDAM Perusahaan Daerah Air Minum (regional drinking water

company) PerMendagri Peraturan Menteri Dalam Negeri (decree of the Minister of

Home Affairs) PSAK Pernyataan Standar Akuntansi Pemerintahan (government

accounting standards) PP Peraturan Pemerintah (government regulation) RIC Roads, irrigation works and canals SUPAS Survei Penduduk Antar Sensus (intercensal population

survey) UU Undang-undang (law)

June 2009 | Decentralization Support Facility

Regional Government Investment in Infrastructure:

An Empirical Analysis

Summary of Findings


Agenda

3. RG Investment in Fixed Assets

5. Sustainability of RG Investment

1. Background of the Study

4. RG Investment in Financial Assets

6. Conclusions and Policy Recommendations

2. Framework for Analaysis


Research Questions

1. Background

1. How much do regional governments invest in public infrastructure?

2. What is the composition of RG investment inpublic infrastructure?


Geographical scope: all provinces and kabupaten/kota for which data were available

Data sources: over 1,300 regional government financial reports audited by BPK

What does the study cover?

1. Background

Study period: 2004-2007

Context: macro-economic (impacts on the nation)


What is Regional Government Investment?

2. Framework for Analysis

Belanja Non-Modal

Belanja Modal

Penerimaan

Pengeluaran

Pendapatan

PEMBIAYAAN

BELANJA

PerMendagri 59/2007


What part of Belanja Modal is investment?


Land

Equipment and machinery

Buildings and structures

Work in progress

Depreciation

Item Included?

Roads, irrigation works, canals

Yes

Yes

Yes

Yes

Later

Yes

Other Yes


What part of Pengeluaran is investment?


Additions to contingency funds

Long-term investment in equity

Extension of loans

Item Included?

Loan repayments

No, unallocated

Yes

No

No (double!)


What source?


BudgetRealization Report

KepMendagri 29/2002,PerMendagri 13/2006,PerMendagri 59/2007

BeforeKepMendagri 29/2002

BudgetRealization Report

Balance Sheet

Cashflow Statement


RG Investment in Fixed Assets and Financial Assets


Fixed AssetsFinancial Assets

Book value 31 Dec X1

Book value 31 Dec X2 A

B

A-BInvestmentBook value 31 Dec X1

Book value 31 Dec X2 A

B

A-BInvestment

+ Revaluation (excluded) -

- Depreciation (later)


Available Balance Sheets (until 30 April 2009)


0

10

20

30

40

2004 2005 2006 2007


Provincial Governments


Available Balance Sheets (until 30 April 2009)


Kabupaten/Kota Governments

0

100

200

300

400

500

2004 2005 2006 2007





Total Investment in Fixed Assets

Rp

trn

0

5

10

15

20

25

2005 2006 2007



Provincial Governments (continued)


Distribution of Investment in Fixed Assets




Composition of Investment in Fixed Assets




Revealed Investment Priorities

Top 25% 38%

25-50% 35%

50-75% 29%

Bottom 25% 23%

Quartile* % Fixed Investment in roads, irrigation and canals

*Top quartile spends highest share of revenue on fixed assets





Top 25% 5%

25-50% 11%

50-75% 27%

Bottom 25% 29%

Quartile* % Fixed Investment in equipment and machinery





Total Investment in Fixed Assets

Rp

trn

0

15

30

45

60

75

2005 2006 2007



Kabupaten/Kota Governments (continued)


Distribution of Investment in Fixed Assets



Composition of Investment in Fixed Assets





Top 25% 37%

25-50% 37%

50-75% 36%

Bottom 25% 29%

Quartile* % Fixed Investment in roads, irrigation and canals






Top 25% 17%

25-50% 22%

50-75% 20%

Bottom 25% 38%

Quartile* % Fixed Investment in equipment and machinery




Regional Government Enterprises, Dec 2007


PDAM 322

BPD 25

BPR 30

Other 435




Total Investment in Financial Assets

Rp

trn

0.0

0.5

1.0

1.5

2.0

2005 2006 2007




Distribution of Investment in Financial Assets




Composition of Investment in Financial Assets


- BPDs invest in SBIs, not in public infrastructure- Other BUMDs often invest in private services



Total Investment in Financial Assets

Rp

trn


0

1

2

3

2005 2006 2007




Distribution of Investment in Financial Assets


- Same as provinces (erratic, driven by BPD profit)

Composition of Investment in Financial Assets

- Same as provinces (mainly BPDs and BUMDs that do not necessarily deliver public services)


- Not compulsory (dapat disusutkan)

- Only possible for fixed assets except land

Gross vs. Net Investment

Depreciation of RG assets according to PSAK:


- Three methods allowed: straight line, doubledeclining, unit of production

- Revaluation only allowed in exceptional circumstances (rule: historical cost accounting!)


- None

Who depreciated during 2004-2007?

Provincial governments


- 2004: none- 2005: 7- 2006: 10- 2007: 12

Kabupaten/kota governments


Kabupaten/Kota depreciation methods



Estimating Depreciation on RG Fixed Assets


1. Low: depreciation of incremental assets only

Three scenarios

(incremental assets: created during 2004-07)

2. Medium: depreciation of incremental assets+ starting balance assets @50% of lifetime

2. High: depreciation of incremental assets+ starting balance assets @75% of lifetime


The Problem with Starting Balances…


DKI Jakarta 15.2

Jawa Timur 5.8

DI Yogyakarta 1.7

Banten 1.5

Bali 0.7

Jawa Tengah 0.1

(Rp billion/km)

Book Value of Provincial Government Roads


Results of Scenario Analysis for 2007


Provinces Kab/Kota

Low MediumHigh

Net Investment as % of Gross Investement

Low Medium High

100%

0%


No clarity, no depreciation, not always for public

6. Conclusions

Regional governments rapidly increasedgross investments in infrastructure

…moreover, very few regions depreciated, so that net investments are much lower

…and many regions invest in infrastructure that do not always result in better public services

…but we don’t know for what kind of infrastructure


Gross vs. Net Investment, 2005-07

6. Conclusions

0

30

60

90

2005 2006 2007

Gross Investment Net Investment (after depreciation)

Rp

trn

Medium Scenario


Time for Social Accounting

6. Recommendations

1. Start dialogue with accounting profession toimprove relevance of RG financial reports-> breakdown by sector, function, etc.

PP24/2005

PerMendagri59/2007

New PerMendagri?

AccountingProfession

Depdagri

DepKeu?


Start depreciation, avoid non-essential investment

6. Recommendations

2. Start dialogue with BPK to encourage depreciation of fixed assets

3. Discourage RG investment in infrastructurenot related to public service delivery-> prepare negative list-> reduce DAK in next year if RG invests in

items on negative list


Thank you!

P110716 - 3 - Regional Government Investment in Public Infrastructure in Indonesia

Documents

Transcript of P110716 - 3 - Regional Government Investment in Public Infrastructure in Indonesia