INDONESIA RISING. Policy Priorities for 2010 and Beyond 53480 Effective Public Financial Management (PFM)1 for Enhanced Public Sector Performance Key Messages2 The basic framework for PFM reform has been established, the project components of major reforms are well underway and the government is poised to broaden and deepen the reform agenda. Key Action 1. Expand existing PFM reforms to improve the quality and level of service delivery, budget efficiency and disbursement. 2. Draft and implement a transparent and comprehensive procurement law underpinned by a professional development program for procurement staff based on modern business processes and IT systems. 3. Remove rigidities in the management of the civil service, to promote efficiency and performance-based human resource policies. 4. Expand the current focus on compliance to strengthened internal controls, and reorient audit and oversight functions to ensure the efficiency and effectiveness of government operations. 5. Coordinate and sequence the PFM reform agenda to promote understanding and ownership among all stakeholders including line ministries and the Parliament (DPR). 6. Develop an effective monitoring and evaluation system that ensures resources are expended to achieve the best possible outcomes improvement as overall manufacturing growth has been Where Indonesia Stands Now weak, the transition out of agriculture slow, and the mining 12 and energy sectors have performed poorly. The success of the Indonesian economy over the past several years reflects a restoration of sound PFM in Indonesia now compares favorably with its macroeconomic management, political stability, and up regional peers and those with comparable per capita GDP3, until recent times a favorable global context. Growth but significant challenges remain. Since 2002, Indonesia surpassed 6 percent for two consecutive years and exports has put critical pieces of its PFM foundation in place, more than doubled between 2003 and 2008 thanks in passing laws on State Finance, Treasury and Accounting, great part to the commodity price boom (see Fig 1). reorganizing the Ministry of Finance (MoF), issuing an Formal sector employment is expanding again, investment updated Presidential Decree on Procurement and forming has risen ­ particularly in the construction sector ­ and a National Public Procurement Agency. While subsequent there have been some pleasant surprises in manufacturing reform efforts have concentrated on implementation, exports like automobile parts. But there is room for including budget and treasury modernization, the quality of budget expenditures and the absorptive capacity of 1 This note draws on the Bank-Fund Red Cover Report on "Strength- budget users remain persistent problems. ening Budget Management", January 2009; and other sources. 2 This note covers PFM issues in the context of Central Government while PFM issues related to other levels of government are dealt with in 3 Indonesia, Public Expenditure and Financial Accountability, October the policy note on decentralization. 21, 2007 2 | INDONESIA RISING Civil service rules and current practices impede the Planning and Budget Formulation efficient operation of public institutions and the effective Despite progress, the budget preparation process implementation of reform measures, and make it difficult continues to discourage medium-term fiscal planning for managers to select, train, promote and motivate their and suffers from weak links to policy priorities. The staff.44 Modifications to existing organizational structures MoF and the Planning Ministry (BAPPENAS) have yet are laborious and time-consuming, since approval must be to develop budget capacity sufficient to anchor budget sought from the Ministry for State Apparatus. This rigid examination and to improve the quality and relevance of control system constrains the ability of public ministries the budget. Consequently, policies are not fully reflected and agencies to introduce Performance-Based Budgeting in the national budget, and decision-makers receive (PBB). The sustainability of sectoral reform is threatened inadequate information to inform their deliberations. by rigid HR management policies (related to recruitment and selection, promotion, rotation and training). These While procedures are improving, the extent of off- policies inhibit professionalism and improved performance, budget operations remains unknown with line ministries, and undermine capacity building efforts. At the same time, foundations, and the military continuing to operate the MoF and a few other public agencies, have successfully accounts outside the fiduciary scrutiny of the MoF, thus piloted measures aimed at modernizing their human allowing resources to be accrued and spent beyond the resource management and have introduced structural control of elected officials and the public. reorganization, to overcome these limitations. The oversight role of the Parliament (Dewan Perwakilan Public resources are often wasted because multi-year Rakyat - DPR) has been strengthened, however they projects are being implemented on an annual cycle in remain focused on budgetary details, at the expense of the absence of a medium-term expenditure framework. substantive policy issues. This is a result of the high level Projects are often delayed and/or rushed through at of detail provided in the budget documents combined with the end of the budget year due to skewed disbursement weak capabilities and inadequate technical support to DPR practices, implementation constraints and procurement members. problems. The strict adherence to annual budgeting in the absence of a credible medium-term expenditure framework is not conducive to resource management Budget execution related to the implementation of multi-year projects. The inefficiencies of the procurement process are compounded The execution of the capital budget remains a particular by the administrative procedures that require annual problem (Fig. 1). More than half the capital expenditures reauthorization of financial management teams in budget are incurred in the last three months of the fiscal year. execution units. Budget execution at the beginning of Primarily, as a result of this, overall budget realization is the year is also delayed as the legislature often withholds below the initially-budgeted capital expenditures and the budget disbursements of certain line items pending skewed pattern challenges timely and effective project administrative clarifications, even after the budget has been implementation. appropriated. Progress has been made on public procurement in recent years but the reform goals remain unfulfilled and Audit and Control procurement remains an obstacle to effective spending. The newly established Organization for Government Good progress has been made in recent years to Procurement Policy [LKPP] is developing simplified strengthen control and audit functions, but the system procurement regulations and making standard bidding remains prone to abuse. Payroll controls remain weak. documents mandatory for all government and partner Internal controls for the execution of non-salary payments agencies. However, capacity and institutional constraints are not fully effective, producing incomplete audit trails continue to hamper effective procurement. Professional and accounting evidence. The current paper-intensive procurement service units are needed in line ministries and business process fosters inefficiencies and governance districts to replace the ad-hoc procurement committees. concerns. Payments and accounting operate under different LKPP has developed a system for electronic Government systems requiring separate inputs that produce deviations Procurement (e-GP) now used by several implementing between the Treasury accounting records, and those of agencies and ministries including the Ministry of Public Works. However the development of other systems leaves 4 Issues related to civil service reform are covered in more detail in a the issue of a consistent E-GP platform unresolved. separate policy note. Policy Priorities for 2010 and Beyond | 3 the line ministries. These in turn raise concerns about the reliability of accounting information in budget execution Budget formulation reports. Most audits are on compliance issues and system Preparations for reform of the budget formulation reviews are rarely performed. process have begun and implementation is envisaged for the 2010 budget and beyond. The first budget of the next five-year planning period will outline the Monitoring and Evaluation new administration's policy priorities. BAPPENAS, The recent creation of the Directorate of Performance in coordination with the MoF will review and revise Evaluation (DPE) under BAPPENAS has strengthened the existing program structure. The new structure will the potential for performance assessment and evaluation be embedded in the five-year plan covering the period functions within the system. Once fully operational, the between 2010 and 2014. The intention is to align unit (established in late 2007), will enable the planning programs with organizational structures to create a tighter agency to carry out its M&E mandate in relation to the accountability framework. government's development planning documents, the RKP (Rencana Kerja Pemerintah) or annual development plan, A unified budget presentation is a good start, but fully and the RPJM (Rencana Pembangunan Jangka Menengah integrating planning and budgeting remains the ultimate Nasional) or medium-term development plan. This will objective. Business process re-engineering initiated as part help improve service delivery and resource allocations, of the new budget and treasury system will help integrate based on demonstrated results. However, moving towards various planning and budgeting processes. In the long implementing this objective will require the review of run, the authorities should create an integrated budget regulations, capacity building, and the definition of short- function with a single entity responsible for budgeting for and medium-term action plans. discretionary and nondiscretionary expenditure. The government also intends to build a medium-term Reform Management expenditure perspective into the planning system Indonesia's PFM reform effort, launched in 2001, has through a performance-based budget framework. The continued to suffer from the lack of a well coordinated annual government planning document lays out the and prioritized/sequenced strategy. The timely and priorities that guide resource allocations in the budget successful completion of some components of the reform process. To strengthen links between medium-term agenda has suffered because of the limited understanding planning and the budget process, the next five-year plan and ownership among stakeholders including line will be based on a projected medium-term resource ministries and the DPR. envelope and indicative multi-year ceilings for key programs. This should allow the government to better reflect medium-term priorities in annual budgeting. Program targets and expenditure ceilings will need to be How Indonesia Can Rise Further updated annually to reflect changes in the fiscal and policy environment. The framework to link those ceilings to the The 2001 White Paper and the modernization of the annual budget process has been being developed with a regulatory framework in 2002/2003 identified the Medium Term Expenditure Framework [MTEF] and following reform priorities for PFM: Performance Based Budgeting [PBB]. Operational unification of the budget process. Looking ahead, implementation of PBB and the Reform of the budget program structure. MTEF /multi-year Budget framework will ensure that Introduction of performance-based budgeting and a expenditures better reflect the government's policy and medium-term expenditure framework. program priorities. With the implementation of PBB, Strengthening of the Fiscal Policy Office's managers should be given the flexibility to optimize the macroeconomic forecasting capability. use of their resources including human resources. Better Implementation of the Treasury Single Account. quality, timelier budget execution data is essential to ensure Reorientation and streamlining of the Chart of that policy orientation remains on track during budget Accounts. implementation. Implementation of a new budget and treasury system (SPAN). A DPR performance enhancement team, comprising Strengthening the external audit function (BPK). members representing all parties and headed by the 4 | INDONESIA RISING Speaker was established to propose budget management increased authority for budgeting to the regional offices and performance improvements. The performance and line ministries. Steps should be taken in tandem enhancement team has suggested establishing a Public to ensure that the reporting system is not compromised. Accounts Committee (PAC) and a Parliamentary Budget This will relieve the systemic congestion due to an annual Office (PBO) to provide better quality state budget budgeting cycle. While annual budget laws permit analysis to the Budget Committee. The MoF should budget managers and users the flexibility to manage their initiate a high-level dialogue with the DPR to streamline budget resources, the associated processes are excessively the involvement of the parliament in the budget process cumbersome. Greater effort should be made to provide with informal mechanisms agreed upon and launched until advance information of possible bottlenecks in budget more formal structures can be established. disbursement. The appointment of budget users should coincide either with the project or with their term of duty. DG Treasury should find ways to provide incentives to Budget execution budget users to improve in-year budget disbursement performance. The Director General (DG) Treasury has taken several major steps towards improving budget execution. A Progress has been made on public procurement in recent structural Treasury Transformation Directorate has been years but the reform agenda remains vast. The highest established to help implement better business processes. It priority is to move from the current ad-hoc approach of is overseeing the implementation of the new budgeting and procurement committees to a sustainable procurement treasury system (SPAN), revising the Chart of Accounts management function coupled with a national capacity and has already completed the first wave of modernization building program. The second priority area is to of regional treasury offices. The consolidation of the improve the regulatory framework by anchoring it to a Treasury Single Account system to include revenue comprehensive national public sector procurement law. accounts is continuing. Steps to remove obstacles to The interface between the private sector and system users effective budget disbursement include eliminating the will improve with national standard bidding documents, annual appointment of heads of budget implementing an efficient e-GP system, and an independent complaint- units, promoting timely procurement processes, providing handling mechanism. Efforts should also be directed for budget carryover for certain categories of socially towards strengthening the procurement audit function. sensitive expenditures, and the development of an action plan to level out the disbursement of capital expenditure Reform in procurement should prioritize efforts that have over the fiscal year. a significant impact and produce rapid results including the revision and simplification of Kepress 80, the mandatory To increase flexibility available to budget holders use of national standard bidding documents, and the in managing their resources, MoF should delegate development of a procurement manual. Capacity building activities are needed in partnership with universities and/ Figure 1. Budget execution remains challenging or training institutions. Development of a monitoring system can be rolled out on a pilot basis and linked to 50% e-GP. Establishing national standards for e-GP systems is a must. 41% 40% 36% Monthly Disbursement 2006 Monthly Disbursement 2007 Monthly Disbursement 2008 35% Audit and control 30% The government has issued a regulation on internal control and internal auditing (PP 60/2008), adopted the 20% Committee of Sponsoring Organizations (COSO) (www. coso.org) control framework, and clarified the roles and responsibilities of different players involved in the internal 10% audit process function. The State Audit Agency or BPKP (Badan Pengawasan Keuangan dan Pembangunan) is now 0 responsible for coordinating and developing Indonesia's Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec internal audit function. The Inspector Generals in line ministries and Bawasdas (Badan Pengawas Daerah) Note: Monthly disbursement of capital expenditure as a share (%) of total budgeted capital expenditure Source: Ministry of FInance and World Bank staff estimates or audit units in local governments will have direct Policy Priorities for 2010 and Beyond | 5 responsibility for the internal audit of their ministry/ local government. The resources available to the Supreme How The World Bank Can Help Audit Agency (Badan Pemeriksa Keuangan or BPK) have increased significantly, and BPK is now present in 33 provinces. Currents Program Effective implementation of the COSO framework The World Bank supports PFM reform through the will strengthen internal controls. The internal audit Development Policy Loan (DPL) series, via investment function across all levels (BPKP, IGs in line ministries and loans, public expenditure reviews and a related PFM local government Bawasdas) need to move to a systemic, trust fund. The DPL-anchored PFM policy dialogues risk-based approach that is in line with international best leverage the World Bank's convening power and technical practices. assistance. Investments like the Government Financial Management and Revenue Administration Program Monitoring and Evaluation (GFMRAP) and the recent Project for Indonesian Tax Administration Reform (PINTAR) provide support The M&E function within government is still evolving for various reforms and related investments. The Public and will require capacity building and support for the Financial Management Multi Donor Trust fund finances DPE unit in BAPPENAS. Assessing whether or not a program of public expenditure reviews, technical a program is being implemented according to plan and assistance packages, long- and short-term advisors on with the desired outcomes is an integral part of sound budget formulation and treasury reforms, and other aspects expenditure management. Developing an effective of PFM reform. The Trust Fund has also assisted by monitoring system based on a cohesive short- and long- financing the 2007/2008 Public Expenditure and Financial term strategy will ensure that DPE can effectively take on Accountability (PEFA) survey. this important mandate. The goal is a combined framework that reviews whether resources were mobilized and utilized, activities were undertaken, and intended outputs Future Support and outcomes achieved. With the basic framework for PFM reform established, and major reforms underway, the government is Reform management poised to move into a more substantive and difficult A comprehensive and integrated PFM reform agenda/ phase of the reform agenda. Through the provision of strategy document including realistic timelines is continued advisory services the World Bank will assist the needed. This strategy will balance implementation government's realization of core reforms such as SPAN capacities, align reform activities with government with additional advisory services to guide budgetary priorities, ensure reforms are properly sequenced given reforms including the implementation of PBB and MTEF. dependencies, clarify responsibilities and serve as an Through its management of the MDTF, the World Bank instrument for outreach and communication. Successful will ensure that capacity building within the government implementation will require a dedicated, high-level allows it to absorb reforms and M&E initiatives in a steering committee to provide coherence and drive. manner that best advances the administration's goals. Additional outreach and training to line ministries and The cornerstone of future PFM reform lies in the the DPR will increase the possibility of sustainable budget and treasury system (SPAN) that has now PFM reform. Traditionally, DG Budget, DG Treasury moved through the design and procurement stages and BAPPENAS have directed line ministries that have into implementation. The World Bank will continue only become involved in the latter stages of the reform to support this process with critical stakeholder capacity implementation process. A better budget reform strategy building and technical assistance. The support will ensure will include early consultation and communication with, that the technical competence generated through SPAN and the training of line ministries and executing agencies. is adequately leveraged to meet the demands of strategic reforms such as decentralization, PBB, MTEF, accrual accounting and reporting, and efficient management of resources such as cash. 6 | INDONESIA RISING The World Bank will support the government's efforts to assist with the development of a strategy and action to ensure that policies and systems continue to deliver. plan on development of the internal audit function, and This will include support on public expenditure reviews strengthening the Supreme Audit Institution. It will also as Indonesia moves to address service deficiencies in help on-going initiatives to improve financial management critical areas: current reviews are underway or planned in line ministries and their subordinate institutions. in agriculture, social protection and infrastructure. The World Bank proposes to work with the new M&E Deputy Support on procurement reform for the LKPP, line at BAPPENAS to close the cycle on budget, (bring ministries and others will be provided to facilitate the evaluation of programs to bear on program development). implementation of e-procurement. It will ensure that government is an informed participant in the market for As the core budget systems and reforms roll out it will goods and services, and generating economies of scale be important to extend the PFM engagement to line in government procurements. Continued reforms in ministries and subordinate budget units where critical procurement will be interfaced with systems developed in decisions are made. Most immediately this should include the areas of revenue administration, treasury payments and pilot implementation of the COSO framework of internal government accounting and reporting. controls in line ministries. The World Bank is prepared The World Bank Office Jakarta for more information, please contact: Indonesia Stock Exchange Building Tower 2, 12th floor Mr. Vijay Ramachandran Jl. Jenderal Sudirman Kav. 52-53, Jakarta 12190, Indonesia Sr Public Sector Management Specialist ph. + 62 21 5299 3000 | fax. + 62 21 5299 3111 vramachandran1@worldbank.org http://www.worldbank.org/id Investing in Indonesia's Institutiond for Inclusive and Sustainable Development