Local governance: Decentralisation has presented both challenges and opportunities

Since 1999 and the beginnings of the current democratic era in Indonesia, the country’s regions have had a much greater say in their own governance and economic development. A process of decentralisation begun in 1999 has continued to impact business and investment until today, with the results often controversial. At the same time, certain regions have emerged as important destinations in themselves, with the central government and other agencies anxious to spread economic development across the country and build a business-friendly culture in many new geographies.

NEW CENTRES: Currently, Indonesia has 33 provinces, seven of which were created after the year 2000. Each of these provinces is in turn subdivided into regencies and cities. In terms of political organisation, the province is headed by a governor, and has its own elected parliament, the Regional People’s Representative Council (Dewan Perwakilan Rakyat Daerah, DPRD). Meanwhile, each regency is headed by a regent (often referred to by the Indonesian title bupati) while each city is headed by a mayor (or walikota). Both regencies and cities also have their own elected assemblies.

Following the downfall of the Suharto regime, during the turmoil of the 1997-98 Asian financial meltdown, Suharto’s deputy, Bucharuddin Jusuf Habibie, took over as president. At that time, Indonesia was in deep crisis, with outbreaks of inter-ethnic violence threatening to destabilise the country. Long-standing separatist conflicts, in Aceh and Papua in particular, were also a major threat to the state’s integrity. Faced with these challenges, Habibie embarked on a radical programme of reform, with decentralisation as its centrepiece.

POWER SHARING: Two laws were passed in 1999 – one on regional governance and the other on the fiscal balance between regional and central government – that set the target of 2001 for complete decentralisation of the country. Indonesia thus underwent what is known as the “Big Bang”, when years of highly centralised Jakarta- and Java-based rule were replaced by a new system in which considerable financial, economic and political power was devolved to the regencies and cities. The provinces similarly received more authority, but the main beneficiaries were these previously third-tier local governments, a focus that most observers see as a political decision, aimed at both appeasing demands for local autonomy while also undercutting the ability of larger units – the provinces – to take the more drastic step of secession.

In that political context, one decade on, the results of decentralisation have been largely successful. Indonesia has retained its national integrity, and the violence of those years has been ended. Separatist movements have also largely died down, with the best organised, that in Aceh, now in power in the province and running municipal services, rather than an armed conflict.

GREY AREAS: Yet for many, the jury remains out on whether or not Indonesia’s decentralisation has been entirely successful in economic terms. Some regencies and cities have done better than others, while the decentralised system has caused headaches for some businesses and investors. Part of the difficulty was in the existence of certain grey areas in terms of allocating responsibilities between the regencies and the central government. In 2011 a survey by the Regional Autonomy Implementation Monitoring Committee (KPPOD) showed 1066 local business regulations nationwide did not conform with national legislation. This has been evident in sectors such as mining and forestry, where central government and local government licence decisions have sometimes been contradictory.

Another difficulty has been in terms of administrative capacity and political culture. As what was previously the lowest tier of government was given power, local leaders were often insufficiently experienced in dealing with their budgetary responsibilities. A tendency to install a rent-based local economy resulted in many regencies, with little awareness of the need to build investment and diversify economic activity. The fact that new regencies and cities also receive funds from the central government to finance their operations has led to some arguing that this has resulted in a proliferation of such local government units. In 1999 there were 299 regencies and cities, a number that had risen to 434 by 2005 and now stands at around 500.

FUNDING: There are several central funds that are extended to local government. A 2004 law on this mandates three types of fiscal transfers between the central and local authorities – revenue-sharing agreements from taxes and natural resources, Dana Bagi Hasil (DBH); a general-purpose grant, Dana Alokasi Umum (DAU); and a specific-purpose grant, Dana Alokasi Khusus (DAK). The DAU is mainly used to fund the salaries of local civil servants and for administrative costs, while the DAK goes to finance specific expenditures. These are often in infrastructure, such as sanitation, irrigation, roads and water supply projects.

These grants have increased in volume dramatically as the number of regencies and cities, as well as provinces, has grown. In 2010 local governments managed some 38% of public expenditure in Indonesia and around half of all public investment. Proportionately, however, the distribution among types has remained relatively constant, with Ministry of Finance figures showing the DBH accounting for around 29% of all fiscal transfers, the DAU 68% and the DAK 3% during the first five years of decentralisation, with this shifting to 20% DBH, 63% DAU and 7% DAK by 2010. A further criticism of the way decentralisation was carried out is that the provinces were too neglected, meaning that coordination of services – and the resultant economies of scale – across groups of regencies and cities suffered.

LEGISLATIVE FRAMEWORK: Yet 10 years on, for all the challenges, the decentralisation programme has also provided some significant opportunities, while also helping distribute wealth and economic activity around the country. The legislative framework has also been undergoing reform, with 2004 seeing new laws updating the two passed in 1999. The 2004 legislation introduced direct elections for regency and city heads, with the first of these held in 2005. Certain challenges in these elections are also being addressed via a draft law on the election of regional heads, which in 2011 was passing through parliament.

The government has drafted a Grand Strategy for the Implementation of Decentralisation. Under this plan, the criticisms levelled in the past are being addressed. Provincial governors will be given more power, enabling them to have a supervisory role over regencies and cities while liaising with the central government. The central government will be able to act more readily when a contradiction emerges between local and national laws, thanks to a stipulation that the central government can over-rule the local if the local law is contradictory to a national law or against the public interest – a concept that may be legally and politically challenged. Local governments will have clearer guidelines on what constitute minimum public service standards.

The government has also drawn up a Grand Design on Regional Establishment, which seeks to work out in advance the optimal number and distribution of regencies and cities, with this plan running through to 2025.

There have been attempts to improve the spending of DAK and DAU and make the grants into more effective forms of local stimulus, such as a $200m World Bank project that improved accountability and reporting in the expenditure of these grants. These moves constitute an important revision of the 2004 laws and the result should be a strengthening of the system of governance and additional clarity for investors.

VOX POPULI: With one of the fundamental goals of decentralisation that of bringing government closer to the people, election results should provide one clear assessment of the policy’s efficacy. Indeed, with the leaderships and representatives of so many regencies, cities and provinces now subject to popular vote, there is almost always an election going on somewhere in Indonesia. So far, there have been some impressive results obtained by the local leadership and officials that are widely seen to provide better services and a more robust economy for their constituents.

The city of Solo in Java is often put forward as an example. There, Mayor Joko Widodo was re-elected in 2010 with some 91% of the votes. The city’s economy, badly damaged during the riots of 1998, has revived partly via the fostering of growth in the traditional batik trade. Yet this has been achieved in the non-traditional governmental way – without subsidies. The local authority exists explicitly to facilitate investment and private sector initiatives, while applying its close local knowledge of the city and its people in picking likely winners. This is similar to the model in use in other more successful areas, with the strategy of generating a true local economy being preferred over sometimes longstanding cultures of dependency on central resources.

The regencies, cities and provinces are also regularly assessed by KPPOD. This most recently reported in June 2011 that the city of Blitar in East Java was best in Indonesia for local governance. KPPOD used the criteria of infrastructure, private enterprise development, access to land, interaction between local administrators and private business, business licensing, local taxes and fees, security and business conflict resolution, capacity and integrity of regional heads, and quality of local regulations in making its assessments.

Eleven of the top 20 cities and regencies in the survey were located in East Java, while the bottom 20 were dominated by regencies in Papua and Maluku, although Papua’s Sorong regency came in fifth in the whole country. Many of the difficulties faced by regencies away from Java are related to the long neglect of these areas by previous central governments, with transportation networks still largely concentrated away from the periphery, forcing up costs and building in delays for businesses in regions such as Papua and Maluku.

REGIONAL CHAMPIONS: At the same time, certain provinces have been selected by the Indonesia Investment Coordinating Board (BKPM) on an annual, competitive basis for promotion as “Regional Champions”. In 2010 those selected were the provinces of East Kalimantan, Nusa Tenggara Barat (NTB), Papua, West Java, South Sumatra, East Java and Riau. In October 2011 results from a second round of contests to become one of seven new Regional Champions were also announced – Aceh, Central Java, West Kalimantan, South Sulawesi, Central Sulawesi, North Sulawesi and West Sumatra were the winners. The seven provinces which won in 2010 were excluded from the second round, although they continue to bask in Champion status.

QUICK IMPACT: The BKPM’s strategy is to identify provinces where the interest and institutional quality are sufficiently in place for quick impact projects. Thus, for East Kalimantan the 287-km Samarinda-Botang, Sangatta-Maloy toll road is undergoing an improvement project. The upgrade is expected to cost some Rp481bn ($57.5m). For NTB, geothermal power plants were targeted with two possible sites promoted – at Hu’u, with a plant there valued at $400m, and at Sembalun, with a plant valued at $410m.

For Papua, opportunities in gold mining at Wabu and the “Son of Grassberg” mine, with around $7bn-8bn of investment, were targeted, coal prospecting in the Kepala Burung district, with coal mining at Mamberano valued at $7.9bn-8.9bn, and oil and gas the targets. In West Java, the $800m Kertajati International Airport project and the Tampomas Geothermal Power Plant were highlighted. In South Sumatra, integrated port facilities at Tanjung Api-Api valued at around Rp516bn ($61. 9m) are targeted, while in East Java, another geothermal power plant at Blawan and/or Ijen worth $900m and the $870m Tanjung Bulupandan Port Development were highlighted. Finally, in Riau, railway system development was the high-impact project being promoted, with two stretches planned – from Dumai-Duri-Rantau Prapat and Duri-Pekanbaru, with these valued at $366m and $748m, respectively. These projects are all considered eminently realisable, given the existing infrastructure, in terms of transportation, communications and utilities, as well as in terms of the necessary social and commercial under-pinning, plus the investment-friendly policies of the province. The BKPM also considers the availability of human and natural resources and the province’s general economic level when deciding which provinces to promote. The seven winners in 2010 received the full backing of the BKPM, with the board promoting projects in these provinces – particularly with foreign investors in mind. The projects selected would also serve on their completion as catalysts for enhanced economic activity, while also all being large enough to pull in major investors (see analysis).

OUTLOOK: While decentralisation’s first decade has been a chequered one, the system is likely to be strengthened in the years ahead. Best practices are being shared, with a growing awareness in many regencies and cities that the policy means more responsibility on local shoulders, as well as opportunity. With the government taking steps to resolve some long-standing complaints about the system, the relations between the centre and the regions should become clearer and more streamlined. For businesses, this means a more decentralised approach is necessary too, if they are to catch some of the opportunities that lie beyond traditional areas.