## tarea2024017 ## Source details **Canonical URL:** [tarea2024017](https://www.imf.org/-/media/files/publications/tar/2024/english/tarea2024017.pdf) ## Other formats - [Markdown version](/-/media/files/publications/tar/2024/english/tarea2024017.pdf.md) - [Structured JSON version](/-/media/files/publications/tar/2024/english/tarea2024017.pdf.json) --- ### Preface: mission and participants - IMF Fiscal Affairs Department (FAD) mission visited Jakarta during August 14 to 29, 2023 to deliver technical assistance on establishment of local government endowment funds and a three-day workshop on “Local Government Endowment Fund”. - Mission leadership and team: - Led by Sailendra Pattanayak (Deputy Division Chief in FAD). - Team: Majdeline El Rayess, Gemma Preston, Clement Ncuti (Senior Economists, FAD) and John Gardner (FAD expert). - Key meetings: - Minister of Finance Ms. Sri Mulyani Indrawati; Mr. Febrio Kacaribu, Deputy Minister and Chairman of the Fiscal Policy Agency; Mr. Luky Alfirman, Director General of Fiscal Balance. - Technical meetings with Directorate of Fiscal Balance, Directorate of Investment Management in Directorate General of Treasury, Ministry of Home Affairs. - Local government officials from Aceh Province, Bojonegoro District, Riau Province, and East Kalimantan Province. - Workshop participants included officials from Directorate General of Fiscal Balance, LPDP, and Directorate General of Treasury. ### Executive summary — institutional context and core findings - Legal and constitutional context: - Indonesia is a unitary state under the 1945 Constitution with sub-national governments (SNGs): provinces (governor), regencies or cities (regent), municipalities or districts (mayor). - Law No.1 of 2022 (HKPD) updates fiscal relations and provides for regional endowment funds (Dana Abadi Daerah - DAD). - SiLPA context and DAD rationale: - Many SNGs carry forward unspent resources (SiLPA — Sisa Lebih Perhitungan Anggaran) with accumulated funds idle in banks. - HKPD foresees establishment of DAD for SNGs with high SiLPA and high quality of public service delivery. - Objectives and design clarity: - Motivations and objectives for DADs are mixed across stakeholders; clarity of objective is critical to inform fund architecture. - If objective is intergenerational wealth protection → IGWF (sovereign wealth fund characteristics). - If objective is development or sectoral financing → endowment, stabilization, or sinking fund features more appropriate. - International experience: imprecise objectives lead to operational problems and unnecessary risk (example: Alberta Heritage Savings Trust Fund). - Fiscal alignment and timing: - DADs should align with national fiscal policy; establish only when true fiscal surpluses exist. - Establishing funds during fiscal deficits implies a ‘borrowing-to-save’ approach and is sub-optimal. - Where cash surpluses result from weak budget execution, unrealistic revenue forecasts, or untimely transfers, these are not true surpluses and should not be saved in an IGWF. - Structure, integration, and operational flexibility: - DAD structure may evolve but must be fully integrated within the budget. - Inflow rules should not rigidly require continued capital contributions during deficits. - For genuine fiscal surpluses, an evolutionary approach with a distinct fund (MBFF) is appropriate; no UPP needed for MBFF. - Investment policy and restrictions: - Draft MoF regulations restrict investment to conform with HKPD and Government Regulation and to ensure investments are free from any risks of impairment loss — suitable for MBFF. - Prohibit asset encumbrance: no guarantees, borrowing, derivative contracts, pledging assets. - As skills and fund size develop, allow internationally diversified instruments and professional managers free from conflicts of interest. - Withdrawal rules and emergency provisions: - Draft MoF regulations allow capital withdrawal only under HKPD-defined ‘emergency’. - Locking assets away forever is impractical; MBFFs should permit use of yield and, as capacity improves, possible use of accumulated capital for social spending. - Broaden emergency withdrawal interpretation with safeguards so repayment will not be immediately required. - Implementation, transparency, and fiscal risks: - Draft reporting requirements are adequate but implementation support needed. - Review SNG public accounting standards to support transparent DAD implementation. - Clarify public disclosure, report frequency and timeliness in regulations or technical guidelines. - Strengthen fiscal risk management and coordination among ministries/agencies. - Communicate objectives, structure, and functioning to stakeholders and public. ### Key recommendations (summary) - Assess full cost of DAD proposals: - 2.1 Amend budget process rules so the full cost (including hidden cost) of proposals with balance sheet or below-the-line impact is presented upfront to decision makers. - 2.2 If SiLPA arises from weak budget execution, unrealistic revenue forecasts, or untimely transfers, identify and remedy underlying PFM weaknesses. - Design of DAD: - 3.1 Replace requirement to establish a DAD specifically for a particular budget sector with choice of establishing either a multi-year budget financing fund (MBFF) or an intergenerational wealth fund (IGWF). --- ### Section 3.2 — Include forecast requirement for IGWF eligibility - Recommendation: - Include requirement of a forecast of medium-term budget surpluses derived from natural resource revenues in eligibility criteria for establishing an IGWF. - Fund design, governance and withdrawals (selected): - Prioritize and utilize all income from DAD through normal budget channels; remove provision for creation of a UPP from RPMK. - Direct SNGs to consult MoF and Bank Indonesia (BI) when considering withdrawals above a specified amount from local banks within a short timeframe. - RPMK should envisage amending requirement for risk-free portfolio investments in an IGWF as objectives evolve. - Emergency withdrawal approvals for MBFF by Minister of Finance should consider enhanced SNG budget implementation capacity; replenishment only when SNG in fiscal position to do so. - Include evolutionary framework for IGWF allowing: - expansion beyond risk-free instruments; - consideration as a financing fund; - budgetary use of capital as natural resources are depleted. - Implementation recommendations: - Update and review accounting standards for SNGs. - DG Fiscal Balance should monitor SNG fiscal risks holistically. - Ensure IT systems and human capacity at SNGs support DAD implementation — could be prerequisite. - Establish framework to evaluate DAD proposals accounting for hidden costs and present full cost to decision makers. - Develop dissemination strategy to communicate DAD design and performance reports to public. ### Legal and institutional context highlights - Legal hierarchy: constitution (Undang-Undang Dasar Negara Republic Indonesia) → Tap MPR → laws (Undang-Undang) and Perppu → Government regulations (Peraturan Pemerintah or PP) → Presidential regulations (Perpres) → Provincial regulations (Perda) → Regency/Municipality regulations (Perda Kabupaten/Kota) → Ministerial decrees/regulations/circulars/agency regulations. - Key laws cited: law no 33 of 2004, law no 28 of 2009, law no 23 of 2014, law no 1 of 2022 (HKPD). - HKPD pillars: (i) reducing vertical and horizontal inequality; (ii) improving quality of spending; (iii) strengthening local taxing capacity; (iv) harmonizing central and regional spending. --- ### Motivations and objectives for regional endowment funds - Stated objectives: - HKPD: purpose is for "intergenerational benefit". - Government Regulation: "benefit and sustainability of future generations and to improve the quality of regional financial management". - Additional stakeholder objectives: - Help local governments understand saving, protect against wasteful spending, utilize idle cash for national development, emulate LPDP, provide extra revenue for public services, incremental improvements (e.g., Aceh allowing earnings to be spent). - Example: Aceh accumulated surpluses of IDR 1.3 trillion in term deposits; earnings cannot be used until enabling regulations finalized. ### Challenges from mixed objectives - Mixed objectives complicate selection of fund type and design. - Funds with mixed objectives risk poor design choices and operational failure (example: Alberta Heritage Savings Trust Fund — flows and outflows changed, investment mandate conflicted with intergenerational objective). ### Fund structure implications - Intergenerational objective: - Typical source: non-renewable resource exploitation. - Contributions preserved for future generations; longer horizon allows higher risk tolerance. - Development/service objective: - Perpetual funds less suited when nearer-term access is needed. - Evolutionary approach: - Provinces with resource wealth may begin with endowment-style and evolve to IGWF; requires reconsideration of benchmark returns and investment policies. ### Fiscal context and alignment - Indonesia national fiscal position (2023): overall deficit at the central level is around 3 percent of GDP and public debt is around 40 percent of GDP. - Principle: establish funds when fiscal surpluses exist and debt low (examples: Australian Future Fund in 2006; Alaska Permanent Fund in 1976). - Operational flexibility: inflow rules should allow cessation of contributions when deficits arise (Australian Future Fund ceased contributions once fiscal balance shifted). - Borrow-to-save is sub-optimal: increases financing task, gross debt, and interest costs; requires principles-based assessment of full cost. ### Sources of funding - Primary legislative identification favors natural resource revenues; few regions have resource wealth to support intergenerational objective. - Internationally, most funds originate from natural resource revenues (IFSWF data cited). - For MBFF, multi-year surpluses must be true surpluses — not due to execution weaknesses. ### Inflow and outflow rules - Perpetual preservation of capital is not well suited where development needs exist. - Draft proposes inflows permanent and outflows limited to earnings — may not fit contexts needing future capital drawdowns. - Consider conditional capital withdrawal tied to milestones, asset levels, or clearer emergency definitions with replenishment rules aligned to objectives. ### Investment policy - Proposed policy is highly conservative: term deposits, government-guaranteed project loans, government securities — yields low and may not reward locking capital in perpetuity. - Regions with resource wealth could tolerate higher risk over time. - Local capacity uneven; RPMK should initially restrict IGWF to risk-free instruments, then allow evolution once skills and size develop. - Safeguards: transparency, reporting, disclosure, inflation protection (examples: Future Fund and Medical Research Future Fund mandate provisions). --- ### Box — LPDP (Indonesia Endowment Fund for Education) key figures and governance - LPDP established 2010; Presidential Regulation Number 111 of 2021 mandates LPDP manage Endowment Fund in Education Sector comprising four funds: (i) Education Endowment, (ii) Research Endowment, (iii) Higher Education Endowment Fund, (iv) Culture Endowment Fund. - LPDP principal: IDR 134.1 trillion (about US$ 8.9 billion) as of July 2023 (starting allocation IDR 1 trillion in 2010). - LPDP investment policy allocation: debt securities (60 percent), time deposits (36 percent), equities for the rest. - Yields used for education-related programs; receipts reflected in budget as transfers and spending as direct LPDP spending or through line ministries. - Governance: oversight by Minister of Finance; board of trustees, board of supervisors, board of directors; national government investment committee oversees investment performance. - Reporting: annual government investment management report (audited by BPK); quarterly long term investment implementation report; annual report; performance report; annual business plan and budget. --- ### Draft regulations, establishment and management of DAD (selected) - Three-stage establishment: preparation, assessment, stipulation. - Preparation: draft regional regulation, determine sources and amounts, prepare fund manager, set up management facilities. - Assessment: administrative and substantive evaluation aligning with criteria (fiscal capacity, mandatory government affairs). - Stipulation: Minister of Finance approves/rejects SNG proposal with MoHA recommendation; approval within a specific timeframe. - Criteria to establish DAD: - SNG should have high or very high fiscal capacity and have fulfilled mandatory government affairs related to basic public services. - Fiscal capacity determined based on previous five years' fiscal capacity (subject to discussion). - Fund management roles: - UPD (fund management unit) and UPP (program implementation unit) under SNG head. - UPD responsibilities: propose policies, invest DAD, recommend yield utilization, prepare management reports. - UPP responsibilities: propose and oversee programs funded with yields, prepare program performance reports. - Investment orientation: safeguard principal while optimizing return; yields to improve/expand public services aligned with regional priorities (education, health, environment, tourism). - Reporting and oversight: - UPD and UPP prepare performance and program reports; supervision by SNG internal supervisory organs; monitoring/evaluation by MoF, MoHA, Regional Head, and DAD management unit. - Risk management to cover operational, market, liquidity, compliance, legal, reputation, and strategic risks. - Governance gaps: no explicit governing council or advisory/supervisory board in draft regulations; cooperation schemes with national/sub-national managers (e.g., LPDP) possible. ### Sources of funds and capitalization - Initial sources: SiLPA not earmarked for spending; other sources consistent with legislation. - Authorities exploring mobilizing donor and philanthropic resources. - DAD principal may be increased via unallocated yields and/or other budget sources; increases conducted through SNG financial management mechanisms without amendment to regional regulations. ### Investment policy and eligible assets (draft) - DAD investments must be "free from any risks of impairment loss" and "based on an optimal rate of return." - Law 63 of 2019 defines three government investment asset types: (i) equity, (ii) debt securities, (iii) direct investments (listed/unlisted shares; bonds and debentures; sukuk; loans/direct investments). - Draft regulations restrict DAD to: - (i) government securities (up to maturity), - (ii) project loans guaranteed by government, - (iii) deposits in healthy banks. ### Use of yields, principal protection and withdrawals (draft) - Yields: - Can be used for SNG expenditure and to improve/expand public services above SPM (education, health, environment, tourism). - Can be added to principal and used for mandatory government affairs consistent with DAD purpose. - Principal protection and emergency use: - Principal not reduced except under emergency circumstances. - Withdrawals from principal allowed only under emergency circumstances and subject to MoF approval with MoHA guidance. - Emergency circumstances may include: - significant downside deviations from targeted economic growth projections and other macro indicators; - projected significant (20 percent or more) decrease in SNG revenue or increase in SNG expenditures; - a threat endangering national economic and financial stability. - Approved withdrawals should be returned when emergency ends; failure to replenish results in deductions from DAU and/or DBH. ### Oversight - Shared oversight between MoF and MoHA for assessment of proposals, utilization of yields, and withdrawal requests. - MoHA advisory; MoF has final decision-making powers. --- ### Eligibility, financial stability and bank withdrawal considerations - Eligibility criteria broadly defined; stakeholder estimates range between 1 and 31 of 546 SNGs being eligible. - Capacity requirement: ensure only regions with capacity establish funds. - Exceptions: Aceh and Bojonegoro may benefit despite not meeting current criteria; provision for exception where natural resource wealth exists. - Bank stability risk: - SNGs hold surpluses in term deposits with regional banks; large withdrawals can pressure bank liquidity. - RPMK should require consideration of regional bank stability and promote gradual, consultative withdrawals. - Draft regulation allows transfer of a component of surplus (not all) to mitigate risk. --- ### Governance, reporting, transparency and fiscal risk management - Management options: regional general treasurers or regional public service agencies; inflows/outflows integrated within budget processes. - Accounting standards: - Valuation: assets need reporting at market/fair value rather than nominal. - Time of recording: accrual vs cash affects budget execution and cash matching. - Disclosure: - Draft RPMK lacks specification on public dissemination responsibility and frequency. - Reference: Santiago principle 18 (monthly asset and investment performance disclosure) and principle 11 (annual SWF report with audited financial statements). - IMF Fiscal Transparency Code indicator 3.3.1 suggests annual publication of subnational financial condition and performance. - Fiscal risk management: - DG Fiscal Balance needs a framework to monitor SNG-related risks: macro shocks, commodity price fluctuations, resource depletion, hidden costs, contingent liabilities (bank impacts from withdrawals, PPP risks). - SNGs should monitor inflows, outflow rules, budget integration, institutional arrangements, and operational risks. - Coordination and IT: - Harmonized reporting templates and communication reduce administrative burden. - IT systems and human capacity reviews/gap assessments essential before DAD establishment. - National-level support function recommended for capacity development, IT revision, PFM readiness, and public communication guidance. ### Implementation recommendations (numbered) - 4.1 Update and review accounting standards for SNGs to meet reporting requirements and increase transparency. - 4.2 DG Fiscal Balance should adopt a holistic approach to monitoring SNG fiscal risks beyond DADs. - 4.3 Ensure IT systems and human capacity at SNGs support DAD implementation — could be prerequisite. - 4.4 Establish framework for evaluating DAD proposals accounting for hidden costs and present full cost to decision makers. - 4.5 Develop dissemination strategy to communicate DAD design, concept, and performance reports to the public. --- ### Annex highlights — Australian case study and proposed RPMK amendments - Australian experience: strengthen budget circular rules for proposals involving investment funds; Cabinet must be presented with interest cost impacts and full justification (Box 4.1). - Suggested RPMK amendments (Annex 6) include: - Define MBFF and IGWF (new definitions 10a, 10b). - Add multi-year budget availability objective to Article 3 (1) c. - Allow DAD objective to be "to improve and/or expand public services; or save for intergenerational benefit" (Article 4 (1)). - For IGWF, require "an established plan for generating and saving revenue sharing surpluses" (Article 5 (1) c). - Limit types of DAD to MBFF or IGWF (Article 6 (3)). - Clarify inflow rules: "For a MBFF, SiLPA" (Article 6 (4) a) and "For either a MBFF or an IGWF, other sources" (Article 6 (4) b). - Delete multiple clauses restricting yields and UPP references to allow MBFF yields to be used in general budget execution and remove UPP administrative complexity. - Add prohibition on asset encumbrance (28 (7)): preclude guarantees, borrowing, derivatives, pledging assets. - Allow IGWF to expand investment guidelines once size and management experience are sufficient. - Amend Article 42 to require Minister to consider whether Region likely to create SiLPA in medium-term before forcing repayment; repayment obligation only when Region shows capacity to repay without reducing social commitments. - Macro-stability safeguard: require UPD manager to consult MoF and BI prior to withdrawing deposits in excess of IDR [75 billion]. - Administrative edits: shift some preparation responsibilities from UPP to Regional Government Budget Manager. --- ### Annex 7 — Fiscal Capacity Indices (selected highlights) - Provinces — top KFD: - DKI Jakarta: 6.207 — Very High - Jawa Barat: 4.676 — Very High - Jawa Tengah: 2.943 — Very High - Jawa Timur: 2.885 — Very High - Papua: 1.616 — High - Provinces — middle examples: - Kalimantan Selatan: 0.891 — Average - Banten: 0.847 — Average - Sulawesi Selatan: 0.799 — Average - Nusa Tenggara Timur: 0.786 — Average - Kalimantan Tengah: 0.776 — Average - Provinces — lowest KFD: - Papua Barat: 0.156 — Very Low - Gorontalo: 0.103 — Very Low - Maluku: 0.189 — Very Low - Maluku Utara: 0.215 — Very Low - Aceh: 0.220 — Very Low - Regencies/Cities — top KFD: - Surabaya: 7.676 — Very High - Tangerang (Regency): 7.509 — Very High - Bekasi (City): 5.873 — Very High - Badung (Regency): 4.880 — Very High - Bandung (City): 4.726 — Very High - Regencies/Cities — examples near boundaries: - Musi Banyuasin: 2.140 — High - Karawang: 2.104 — High - Banyumas: 2.080 — High - Grobogan: 2.053 — High - Mimika: 2.000 — High - Bantul: 1.167 — Average - Pacitan: 1.167 — Average - Tulungagung: 1.165 — Average - Langkat: 1.162 — Average - Mahakam Ulu: 1.159 — Average - Regencies/Cities — lowest KFD: - Aceh Selatan: 0.029 — Very Low - Bener Meriah: 0.032 — Very Low - Belitung Timur: 0.046 — Very Low - Asmat: 0.122 — Very Low - Aceh Timur: 0.185 — Very Low - Aceh Tamiang: 0.204 — Very Low - Bengkulu Tengah: 0.217 — Very Low - Sarong: 0.242 — Very Low - Banggai Kepulauan: 0.257 — Very Low - Bangka Barat: 0.259 — Very Low *IMF staff content from tarea2024017.* ### PREFACE _________________________________________________________________________________________ 6 ### tarea2024017 - PREFACE ### Preface: mission and participants - An IMF Fiscal Affairs Department (FAD) mission visited Jakarta during August 14 to 29, 2023 to deliver technical assistance on the establishment of local government endowment funds in Indonesia and a three-day workshop on “Local Government Endowment Fund”. - Mission leadership and team: - Led by Sailendra Pattanayak (Deputy Division Chief in FAD). - Team comprised Majdeline El Rayess, Gemma Preston and Clement Ncuti (all Senior Economists in FAD) and John Gardner (FAD expert). - Key meetings: - Met with the Minister of Finance Ms. Sri Mulyani Indrawati; Mr. Febrio Kacaribu, Deputy Minister and Chairman of the Fiscal Policy Agency; and Mr. Luky Alfirman, Director General of Fiscal Balance. - Multiple technical meetings with officials of the Directorate of Fiscal Balance, Directorate of Investment Management in the Directorate General of Treasury, and the Ministry of Home Affairs. - Meetings with local government officials from Aceh Province, Bojonegoro District, Riau Province, and East Kalimantan Province. - Workshop attendance included a broad set of officials from the Directorate General of Fiscal Balance, LPDP, and the Directorate General of Treasury (detailed participant list recorded in the source). - Acknowledgements: thanks to the Indonesian authorities for cooperation, to Mr. Dennis Botman (IMF Resident Representative in Indonesia) and Resident Representative office staff for support, and to interpreters Ms. Rika Agusmelda and Ms. Yulia Fitri Utami. ### Executive Summary — institutional context and core findings - Constitutional and legal context: - Indonesia is a unitary state under its 1945 Constitution but recognizes the authority of sub-national governments (SNGs): provinces (governor), regencies or cities (regent), municipalities or districts (mayor). - A new Law No.1 was enacted in 2022 (called HKPD) to further improve the legal framework underpinning fiscal relations between central government (CG) and SNGs. - SiLPA and the policy response: - Many SNGs have been carrying forward unspent resources called SiLPA (Sisa Lebih Perhitungan Anggaran – Excess of revenue receipts over expenditure payments), with accumulated funds lying idle in banks. - HKPD foresees the establishment of a regional endowment fund (Dana Abadi Daerah - DAD) for SNGs where SiLPA is high and there is high quality of public service delivery. - Objectives and design clarity: - Motivations and objectives for establishing DADs are mixed and diverge across SNGs and stakeholders. - Clarity of the objective and purpose of DAD is critical to inform the fund architecture: - If objective is to protect intergenerational wealth, DAD should have characteristics of a sovereign wealth fund in the form of an Intergenerational Wealth Fund (IGWF). - If purpose is to meet development objectives broadly or in a sector, DAD would adopt features of an endowment, stabilization, or sinking fund. - International experience shows that imprecise objectives lead to operational problems and unnecessary risk. - Fiscal alignment and timing: - DADs should take account of the fiscal context and align with national fiscal policy objectives. - Establishing funds during fiscal deficits implies a ‘borrowing-to-save’ approach and is not optimal; such funds should only be established when true fiscal surpluses exist. - Where cash surpluses reflect weak budget execution, unrealistic revenue forecasts, or untimely transfers, these are not true surpluses and should not be saved in an IGWF against elevated development needs. - Structure, integration, and operational flexibility: - DAD structure can evolve as objectives change or management matures, but regardless must be fully integrated within the budget. - Inflow rules should not be so rigid as to require continued capital contribution if the fiscal position moves into deficit. - For SNGs maintaining genuine fiscal surpluses, an evolutionary approach with a distinct fund structure is appropriate. - A multi-year budget financing fund (MBFF) would operate along lines similar to the existing draft MoF regulations and should be managed directly through the budget; there should be no need for a Program Management Unit of the DAD (UPP) for an MBFF. - Investment policy and restrictions: - Current draft MoF regulations restrict investment policy to conform with HKPD and Government Regulation and to ensure investments are free from any risks of impairment loss — these restrictions suit MBFF objectives. - Investment policy guidelines should ensure funds are not allowed to encumber assets (no guarantees, borrowing, derivative contracts, pledging assets). - Once financial skills and fund size develop, policy should allow internationally diversified instruments and engagement of professional investment managers free from conflicts of interest. - Withdrawal rules and emergency provisions: - Draft MoF regulations allow withdrawal of capital from a DAD only under an ‘emergency’ situation as defined in HKPD. - The concept of financial assets being locked away forever does not conform with practical operations or provide incentives for SNGs to invest in DADs. - The primary initial need for an MBFF is to pool cash resources not spent due to lack of SNG capacity; as capacity improves, use of yield and accumulated capital for social spending becomes appropriate. - Broadening the scope of ‘emergency’ capital withdrawal should include safeguards so repayment will not be immediately requested. - Implementation, transparency, and fiscal risks: - Reporting requirements are well covered in draft MoF regulations, but strengthening accountability and transparency will require further implementation support. - A review of public accounting standards at the SNG level is needed to ensure accounting architecture supports transparent implementation of DAD. - Disclosure to the public should be specified, and report frequency and timeliness clarified in regulations or technical guidelines. - Monitoring risks requires strengthening the fiscal risk management framework; a holistic approach to managing risks should be undertaken by both SNGs and CG. - Strengthening coordination among relevant ministries or agencies is crucial for successful implementation. - Communication of objectives, structure, and functioning to stakeholders and the public is important to set expectations. ### Key recommendations (summary and specific text from the report) - On assessing full cost of specific DAD proposal: - 2.1 The rules governing the budget process should be amended in consideration of DAD proposals involving a balance sheet or below-the-line impact, so that the full cost of such proposals (including the hidden cost) is presented upfront to decision makers as part of the evaluation of the policy merits (including its costs, benefits, and risks). - 2.2 If cash surpluses leading to SiLPA exist as a result of weak budget execution, unrealistic revenue forecasts and untimely transfers, the underlying weaknesses in budget execution and management should be identified and remedied. - On the design of the DAD: - 3.1 Replace the requirement to establish a DAD specifically for support of a particular budget sector with the choice of establishing either a multi-year budget financing fund or an intergenerational wealth fund. *IMF Fiscal Affairs Department mission, Jakarta, August 14 to 29, 2023.* ### 3.2 Include the requirement of the forecast of medium-term budget surpluses derived from natural resource ### tarea2024017 - 3.2 Include the requirement of the forecast of medium-term budget surpluses derived from natural resource revenues in the eligibility criteria for establishment of an Intergenerational Wealth Fund (IGWF) ### Recommendations on fund design, governance and withdrawals - Include the requirement of the forecast of medium-term budget surpluses derived from natural resource revenues in the eligibility criteria for establishment of an Intergenerational Wealth Fund (IGWF). - Ensure that all income from the DAD is prioritized and utilized through the normal budget planning and execution channels and remove the provision for creation of a UPP from the RPMK. - Direct SNGs to take advice from the MoF and the Bank Indonesia (BI) when considering withdrawing more than a specified amount from their local banks within a relatively short timeframe. - Envisage in the RPMK the future need to amend the requirement for risk-free portfolio investments in an IGWF in order to meet its different objectives from a MBFF-type of DAD. - Ensure that emergency withdrawal approvals from a MBFF by the Minister of Finance include consideration of the enhanced budget implementation capacity of the SNG and that replenishment should only occur when the SNG is in a fiscal position to do so without difficulty. - Include an evolutionary framework for establishment of an IGWF which includes the ability to: - expand its investment policy from purely risk-free instruments; - consider its use as a financing fund; - envisage budgetary use of its capital as the associated natural resources are depleted. ### Recommendations on implementation issues for the DAD - Update and review, where needed, the accounting standards for SNGs to ensure meeting the reporting requirements and increasing transparency. - DG Fiscal Balance should have a holistic approach to monitoring fiscal risks from SNGs in general, not only those related to the DAD. - Ensure that IT systems and human capacity at the SNGs would support the implementation of DAD – this could be a prerequisite for establishment of the DAD. - Establish a framework for evaluating proposals for DADs that take account of hidden costs and present the full cost of the proposal to decision makers. - Develop a dissemination strategy to communicate to the public both the design and concept of the DAD, as well as the reports related to the performance and function of the DAD. ### Legal and institutional context for DADs (highlights) - Indonesia’s legal hierarchy: constitution (Undang-Undang Dasar Negara Republic Indonesia), followed by Tap MPR; laws (Undang-Undang) and Perppu; Government regulations (Peraturan Pemerintah or PP); Presidential regulations (Perpres); Provincial regulations (Perda); Regency/Municipality regulations (Perda Kabupaten/Kota); other instruments include Ministerial decrees, regulations, circulars, and agency regulations. - The 1945 Constitution recognizes Indonesia as a unitary state and recognizes the authority of sub-national governments (SNG). - Key laws cited: law no 33 of 2004 (revenue sharing), law no 28 of 2009 (local taxes and levies), law no 23 of 2014 (regional governments), and law no 1 of 2022 (HKPD). - Law no 1 of 2022 (HKPD) pillars: (i) reducing vertical and horizontal inequality; (ii) improving the quality of spending; (iii) strengthening local taxing capacity; (iv) harmonizing central and regional spending. HKPD provides for establishment of regional endowment funds (Dana Abadi Daerah or DAD). ### Transfers, fiscal roles, and SNG financing rules - Three types of government affairs: (i) absolute government affairs, (ii) concurrent government affairs, (iii) general government affairs. Concurrent affairs devolved to SNG include mandatory and elective government affairs. - Mandatory government affairs related to basic public service include: (i) education, (ii) health, (iii) public works and spatial arrangements, (iv) public housing and residential areas, (v) community law and order, (vi) social affairs. Minimum service standards are Standard Pelayanan Minimum (SPM). - SNG funding sources: Pendapatan Asli Daerah (PAD), transfers from central government (Transfer Ke Daerah or TKD), and inter-regional transfers. TKD comprises: (i) Dana Bagi Hasil (DBH), (ii) Dana Alokasi Umum (DAU), (iii) Dana Alokasi Khusus (DAK), (iv) special autonomy funds, (v) privilege funds, (vi) village funds. - DAU allocation method: allocated to each SNG based on the fiscal gap for a year, calculated as the difference between the regional fiscal needs and revenue potential weighed at provincial and district/city level. - DBH includes revenue sharing from taxes (income tax, property tax, excises on tobacco) and natural resources revenue (including oil and gas revenue) redistributed to SNGs at province, regency, municipality, and district level using percentages determined by law. ### SNG SiLPA (excess funds) and HKPD provisions - SiLPA can arise from: (i) excess receipts in PAD and DBH, (ii) excess of actual revenue receipts over expenditure payments, (iii) excess financing, (iv) spending efficiency gains, (v) any unpaid amounts at the end of the year for goods/services which will paid next year, (vi) unused expenditures allocated to achievement of performance targets. - Audit Board (BPK) and Ministry of Finance analysis found an increase in SiLPA from 2009 to 2015 due to increases in SNG’s PAD and TKD not accompanied by ability to plan and execute spending. - HKPD recognizes three circumstances for SiLPA use: - SiLPA earmarked for spending based on laws and regulations in the previous fiscal year must be budgeted accordingly. - For SNG where SiLPA is high and public service delivery is low, Government can direct use of SiLPA for regional public service in infrastructure oriented towards regional economic development. - For SNG where SiLPA is high and there is high public service delivery, SiLPA can be invested and/or used for establishment of DAD with due regard of SNG priorities. ### Draft regulations, establishment process and management of DAD - Draft implementing regulations for HKPD: a draft government regulation on harmonization of national fiscal policy finalized and awaiting promulgation; a draft Minister of Finance regulation on procedures for establishment and management of DAD (RPMK) is being finalized. - DAD features: - Established as a perpetuity fund to manage finances for intergenerational benefit and sustainability and to improve regional finance management. - Three-stage establishment process: preparation, assessment, and stipulation. - Preparation stage: drafting regional regulations about the fund, determining sources and amount of funds, preparing a fund manager, setting up management facilities. - Assessment stage: evaluating application administratively and substantively to ensure alignment with criteria like fiscal capacity and mandatory government affairs. - Stipulation: Minister of Finance approves or rejects SNG proposal for establishing a DAD alongside recommendation from MoHA; approval granted within a specific timeframe. - Criteria to establish DAD: SNG should have a high or very high fiscal capacity and should have fulfilled needs of mandatory government affairs related to basic public services. Fiscal capacity is determined based on Ministerial Regulation regarding regional fiscal capacity, considering the previous five years' fiscal capacity (this is not final and is still under discussion). - Once approved, DAD is stipulated in a regional regulation and allocated as financing expenditure in the APBD (identifying sources and amounts, investment of DAD, and use of investment yields). - Fund management roles: planning, implementation, utilization of yields, additional funds, reporting, supervision, accountability, emergency withdrawals; fund management and program management established under supervision of the head of the SNG who appoints UPD and UPP. - Investment policy orientation: carefully selected investments to balance risk and return, focus on financial instruments that safeguard principal while optimizing returns. Yields utilized to improve and expand public services aligned with regional priorities (education, health, environment, tourism). - Reporting and oversight: UPD and UPP prepare reports on performance and program achievements; supervision by SNG internal supervisory organs; monitoring and evaluation conducted by Minister of Finance, Minister of Home Affairs, Regional Head, and DAD management unit. Risk management covers operational, market, liquidity, compliance, legal, reputation, and strategic risks. ### Boxed example — Indonesia Endowment Fund for Education (LPDP) (key figures and governance) - LPDP history and mandate: - Established in 2010 as a permanent national education development fund through allocations from the national budget. - Presidential Regulation Number 111 of 2021 mandated LPDP to manage the Endowment Fund in the Education Sector comprising four separate funds: (i) Education Endowment, (ii) Research Endowment, (iii) Higher Education Endowment Fund, (iv) Culture Endowment Fund. - LPDP size and asset allocation: - LPDP principal had grown to about IDR 134.1 trillion (about US$ 8.9 billion) as of July 2023 from a starting allocation of IDR 1 trillion in 2010. - LPDP investment policy allocation: debt securities (60 percent), time deposits (36 percent), equities for the rest. - Use of yields and budget reflection: - Large portion of yields used for education-related programs (scholarship, research, etc.). - LPDP receipts are reflected in the budget as transfers to the entity and spending are reflected on the budget as either direct spending by the LPDP or through line ministries. - Governance: - Ultimate oversight rests with the Minister of Finance. - LPDP governance organs: (i) a board of trustees providing strategic policy directions, (ii) a board of supervisors that supervises and advises the board of directors, (iii) a board of directors. - A government investment committee at the national level oversees LPDP’s investment performance. - Reporting: - LPDP prepares and publishes: an annual government investment management report including audited financial statements by BPK; a quarterly long term investment implementation report; an annual report; a performance report; and an annual business plan and budget. *Source: tarea2024017 - 3.2 Include the requirement of the forecast of medium-term budget surpluses derived from natural resource revenues in the eligibility criteria for establishment of an Intergenerational Wealth Fund (IGWF).* ### 17. The motivations and objective for establishing regional endowment funds at the sub- ### The motivations and objective for establishing regional endowment funds at the sub-national level in Indonesia ### Motivations and stated objectives - HKPD suggests the purpose of the Fund is for "intergenerational benefit". - Government Regulation suggests the Fund is for the "benefit and sustainability of future generations and to improve the quality of regional financial management". - Additional objectives articulated by stakeholders (MoF, MoHA, sub-national governments) include: - Helping local governments to understand the concept of saving. - Protecting against wasteful spending. - Better utilization of idle cash balances at the regional level to support national development goals. - Emulating the experience with the LPDP at national level. - Providing extra revenue for delivery of public services. - Incremental improvement of the status-quo (example: Aceh where the main benefit would be allowing earnings to be spent). - Aceh specific fact: accumulated surpluses of IDR 1.3 trillion are secured in term deposits in regional banks; earnings on these deposits cannot currently be used for spending until enabling regulations are finalized. ### Challenges from mixed and competing objectives - Mixed objectives make selecting appropriate fund characteristics challenging. - Sovereign wealth funds with intergenerational objectives differ materially from Development Funds, endowments (MTFF), stabilization or sinking funds in structure, funding sources, inflow/outflow rules, and investment policies. - International experience shows funds with mixed objectives tend not to be successful because conflicting objectives lead to poor design choices. - Example (Box 2): Alberta Heritage Savings Trust Fund - Established in 1976 to receive 30 percent of the province’s non-renewable resource revenue. - Created with three objectives: (i) to save for the future, (ii) to strengthen or diversify the economy, and (iii) to improve the quality of life of Albertans. - Investment mandate allowed investments in economic development projects—an investment policy better suited to a Development Fund than an Intergenerational Fund. - Inflow rule changes: contributions lowered to 15 percent in 1983 and then eliminated in 1987. - Outflows approved from the Fund in 1983 to meet budget spending pressures; interest income withdrawn and not replenished. - Result: misalignment between design (investment policies and drawdown rules) and objective to preserve intergenerational wealth. ### Fund structure implications - Clarity of objective is critical to inform fund architecture: type of fund, structure, funding source, inflow/outflow rules, investment policy. - If objective is intergenerational: - Typical source: exploitation/extraction of non-renewable wealth. - Contributions preserved for future generations (not necessarily in perpetuity). - Longer-term perspective allows higher risk tolerance to seek higher earnings vs. low-yield government bonds and cash deposits. - If objective is to provide extra revenue for public services or national economic development: - Perpetual funds are not well suited when nearer-term access to funds is needed. - The structure can evolve as objectives or management experience changes: - Provinces with natural resource wealth might begin with an endowment style fund and evolve into intergenerational wealth funds over time. - Evolving would require reconsideration of benchmark rates of return and investment policies to broaden instruments beyond term deposits and government bonds. ### Fiscal context and alignment with fiscal policy objectives - Indonesia national fiscal position (2023): overall deficit at the central level is around 3 percent of GDP and public debt is around 40 percent of GDP. - Principle: funds should be established when fiscal surpluses exist and there are low levels of government debt. - Example: Australian ‘Future Fund’ in 2006 and Alaska Permanent Fund in 1976 were established under such conditions. - Australian example: debt level was 4.9 percent of GDP at establishment. - Operational design should allow flexibility if fiscal circumstances change: - Inflow rules should not rigidly require continued capital contributions during fiscal deficits. - Example: Australian Future Fund ceased contributions when fiscal balance shifted to a deficit. - NSW Generations Fund contributions continued despite a fiscal deficit in the pandemic and ceased only in 2021 after scrutiny. - Borrowing to finance capital contributions (the "borrow-to-save" principle) is sub-optimal: - Leads to inefficiency, higher gross financing task, and increased risks from assets and liabilities. - Expands balance sheet for financial assets and gross debt. - Increases borrowing costs—government pays interest on borrowings to capitalize the fund (ongoing cost). - Australia established a principles-based framework to consider full cost, including opportunity cost of borrowing. - Indonesia’s decentralization and transfer mechanism complicate borrow-to-save: - Pre-determined transfers to sub-national governments are required even if they cannot be spent, leading to accumulated sub-national surpluses and idle cash balances that do not support optimal fiscal outcomes. ### Sources of funding - Legislation identifies intergenerational objective, but few regions have resource wealth to support that objective. - Bojonegoro is a potential candidate, but no fund with intergenerational characteristics has been proposed for it. - Internationally, majority of funds established have natural resource revenues as the source (Figure 4; IFSWF membership data includes 23 members in 2018). - Unique Indonesian case: declining special revenue streams for regions with "special autonomous status" (e.g., Aceh) could motivate saving to preserve revenues akin to intergenerational rationale. - If multi-year fiscal surpluses are the source, the reason for those surpluses matters: - Surpluses from weak budget execution, poor/unrealistic revenue forecasts, or untimely transfers are not true surpluses and should not be saved in an intergenerational fund. - Such surpluses signal PFM weaknesses that should be remedied; temporary solutions that enable access to resources for development as spending capacity improves are preferable. ### Inflow and outflow rules - Preserving capital contributions in perpetuity is not well suited to the Fund objectives and may disincentivize regional governments. - Indonesian proposal suggests inflows are permanent and outflows limited to earnings only. - This design is not well suited to intergenerational objectives or contexts with significant development needs where drawdown of capital may be appropriate in future. - Considerations for draft regulations: - Allow capital to be withdrawn under certain conditions aligned with objectives (e.g., when milestone, target asset level, or other condition is reached). - Better define the "emergencies" clause and required replenishment of drawdowns, ensuring fit with overall fund objectives. ### Investment policy - Proposed investment policy is highly conservative: term deposits, government guaranteed project loans, and government securities. - Yields on these instruments are very low and may not adequately compensate sub-national governments for locking capital in perpetuity (examples: East Kalimantan; Bojonegoro; Jakarta). - Regions with natural resource wealth could tolerate higher risk over time owing to longer investment horizon. - International experience shows asset holdings vary by fund objective and investment horizon (Box 2, Annex 2). - Regional financial capacity in Indonesia is uneven and may not currently support investment in more complex, higher-yield instruments; capacity may grow over time. - Example: Alaska Permanent Fund broadened from 100 percent bonds in 1980 to 60 percent in 1990 to 20 percent in 2002 as experience grew. - Important safeguards for riskier arrangements: transparency in management, reporting, and disclosure. - Need for inflation protection to preserve purchasing power of capital: - Example: Future Fund and Medical Research Future Fund in Australia include provisions in investment mandates to account for inflation. *Source: IMF Staff (tarea2024017).* ### Box 2. Example of Differences in the Asset Allocation of Funds with Different Objectives ### Box 2. Example of Differences in the Asset Allocation of Funds with Different Objectives ### Differences in asset allocation: Future Fund vs Medical Research Future Fund - The intergenerational fund (the Future Fund) and the Endowment Fund (the Medical Research Future Fund) have different objectives, leading to differences in the benchmark rate of return, risk tolerance and investment policy. - Future Fund characteristics: - Longer-term horizon (intergenerational) allowing higher risk tolerance. - Low cash and government securities holdings: 20 percent. - Higher developing markets equities allocation: 17 percent. - Higher propensity to hold illiquid assets. - Medical Research Future Fund characteristics: - Endowment fund with the need to finance outflows from earnings, implying lower risk tolerance. - High cash and government securities holdings: 55 percent. - Lower developing markets equities allocation: 7 percent. - Lower propensity to hold illiquid assets. *Source: IMF Staff, Future Fund | Portfolio updates - https://www.futurefund.gov.au/investment/investment-performance/portfolio-updates.* ### Eligibility Criteria (section G) - Current status: - Eligibility criteria for regional endowment funds in Indonesia are very broadly defined and interpreted differently by stakeholders. - Estimates vary between 1 and 31 as to how many of the 546 subnational governments would be eligible. - Capacity concerns: - A certain level of capacity is required to manage fund structures and additional reporting and governance to ensure credibility. - Criteria should be strengthened to ensure only regions with capacity can establish funds. - Exceptions and special cases: - Some regional governments interested in establishing a fund (Aceh and Bojonegoro) do not meet current criteria despite potential benefits: - Aceh: a fund-like structure could improve the status quo and allow earnings to be spent on development needs. - Bojonegoro: a fund could save natural resource wealth for future generations. - Possible provision: an exception for regions with natural resource wealth where the objective is to preserve this wealth for future generations. - Allowing such funds would require the fund’s features to evolve over time. ### Consideration of the Financial Stability of the Local Banking Sector (section H) - Current practice and risk: - Sub-national governments reportedly hold accumulated surpluses in term deposits with regional banks. - Establishment of regional endowment funds would entail moving these deposits to other investments. - Large withdrawals without notice or consultation can cause banks to face financial and liquidity pressure, with potential risk of collapse. - Regulatory and operational recommendations: - Avoid large and rapid flows of capital out of regional banks to the endowment fund. - Include regulatory provisions requiring consideration of regional bank financial stability before cash transfers to the endowment fund. - Promote discussion between the regional government and the local bank on planned timing and size of withdrawals and emphasize a gradual approach. - The draft regulations include a provision allowing regional governments to transfer a component of their surplus (as opposed to all) to the fund, which helps mitigate this risk. ### Recommendations (section I) - 2.1. Amend rules governing the budget process for DAD proposals involving a balance sheet or below-the-line impact so the full cost (including the hidden cost) is presented upfront to decision makers as part of evaluation of policy merits (including costs, benefits, and risks). - 2.2. If cash surpluses leading to SiLPA exist due to weak budget execution, unrealistic revenue forecasts, and untimely transfers, identify and remedy the underlying weaknesses in budget execution and management. ### Improving the Draft Regulation of Ministry of Finance — General Considerations (III.A) - Core issues: - HKPD and the Government Regulation provide confusing objectives for proposed DADs; unclear objectives lead to operational problems and unnecessary risk. - Inflow and outflow rules should follow directly from a clearly specified objective; investment policy and parameters then define acceptable degree of risk. - Draft RPMK issues: - Stated objective remains both financially supporting provision of public services and saving surplus cash for future generations, perpetuating confusion. - Draft RPMK should incorporate requisite objectives through separate and targeted channels given existing HKPD and Government Regulation constraints. - Draft RPMK chapter overview (high level): - i. General provisions: mostly workable but Article 3 should add maintaining cash resources for multi-year budget availability. - ii. Establishment: prescriptive eligibility criteria, administrative requirements for approval, appears to restrict any DAD to a single sectoral financing purpose. - iii. Management: specifies operating requirements; will need amendment if objectives are to be separated (type of DAD, need for Program Implementation Unit (UPP), restrictions on investment instruments, specified uses of yield, withdrawal capabilities and repercussions). - iv. Risk management: risks are excessively considered given constrained proposed portfolio investments. - v. Monitoring and evaluations: analyzed in later sections. - Main medium-term DAD objective: - Pool regional government cash resources not used for public service delivery in a fiscal year. - DAD should collect funds deriving from SiLPA or budgeted surpluses but exclude specific and earmarked expenditures not yet made. - Draft MR behavior: - Refrains from incorporating future generation saving concept after the first chapter. - Describes use of DAD yield for a specified sector and treats principal outflow only under emergency withdrawal. - Recommendations on objectives separation: - RPMK should separate multi-year budget financing funds from sovereign wealth fund concepts. - For MBFF objective: define operations as currently drafted but provide a way to withdraw capital once capacity to use resources responsibly exists. - For SNGs maintaining genuine fiscal surplus (e.g., from natural resource revenue sharing), define a different SWF-type fund objective focused on intergenerational equity. ### Type of Fund (III.B) - Current draft RPMK: - Deals with establishment of a single fund with a single financing purpose but prescribes identical rules and investment policies for all funds. - Suggested approach: - Require SNGs to set up either: - Multi-year budget financing fund (MBFF) — objective: provide financing for socially beneficial expenditure within SNG budget framework; no need to restrict yield to a single sector. - Intergenerational wealth fund (IGWF) — objective: receive planned budget surpluses (particularly from natural resource revenue sharing) and invest over the forecast lifetime of natural resource availability; returns reinvested to maintain/increase real value of the fund over the long term as a replacement for depleted natural resources. ### Eligibility Criteria (III.C) - MBFF: - Existing eligibility criteria in draft RPMK remain applicable. - IGWF: - In addition to meeting current criteria, SNG should be expected to maintain a budget surplus for medium- to long-term through substantial natural resource revenue sharing inflows. ### Utilization of Fund Yield (III.D) - MBFF: - No need to restrict the use of yield to a single sector; manage yield directly through the budget. - Estimated amount available from the fund over the following year shown as revenue in the SNG budget and utilized through normal budget prioritization guidelines. - No need for a Program Implementation Unit (UPP); remove UPP requirement from RPMK to avoid administrative complexity and fragmentation. - Ensure DAD Management Unit (UPD) has no role in determining use of fund yield. - IGWF: - No use of fund yield; returns should be reinvested in the fund over its expected lifetime. ### Portfolio Investment Policies (III.E) - MBFF investment restrictions: - Draft RPMK restricts investments to conform with Law #1 and Government Regulation: investments should be free from any risks of impairment loss. - Confining investments to Government Securities, government-guaranteed project bonds, and deposits at ‘heathy’ banks satisfies this requirement if defined to be denominated only in IDR. - Funds should not be allowed to encumber assets (no guarantees, borrowing, derivatives, pledging assets). - Bank withdrawal threshold and coordination: - Legislation classifies ‘healthy’ banks via MoF-approved list. - RPMK should prescribe that withdrawals proposed over a certain amount (e.g., IDR 75 billion or USD 5 million, say) from a single bank within a relatively short timeframe should be discussed with the Ministry of Finance and, if appropriate, the BI to assess banking stability risk. - IGWF investment policy divergence: - IGWF objectives require different investment policies: reinvest yields and protect assets from inflation, credit, and political risks via high diversification and international investments, which are subject to capital risk. - Long-term internationally diversified investments have been shown to increase value in line with, or in excess of, inflation. - Given low investment management and financial skills at local level, RPMK should initially restrict IGWF investment policies to the same risk-free instruments specified for MBFFs. - RPMK should specify that, once skills and size of IGWF are sufficiently developed, policies may allow internationally diversified instruments and engagement of professional managers. - Selection of investment managers should be free from conflict of interest. - This embodies an evolutionary approach in the RPMK. ### Fund Lifetime and Withdrawals (III.F) - Current draft RPMK: - Allows withdrawal of capital from a DAD only under an ‘emergency’ situation as defined in HKPD. - Any such withdrawals must be replenished, or replenishment will be made by central government through deduction from transfers. - This aligns with DADs described in legislation as eternal or perpetual without reducing principal. - Practical considerations and suggested flexibility: - Concept of locking financial assets away forever is impractical and reduces incentive for SNGs to invest. - Suggest widen interpretation of emergency definitions and allow, under specified circumstances, withdrawn amounts not to be replenished within a rigid timeframe. - MBFF operational rationale: - Primary need: pool cash resources not spent due to lack of SNG capacity (overestimation of planned expenditures or underestimation of revenue). - As SNG capacity and forecasting improve, SiLPA and unanticipated surpluses should diminish. - Once SNGs can implement social spending fully and forecast revenue accurately, it makes sense to utilize both yield and accumulated capital. - Emergency definition and withdrawal policy: - HKPD notes define ‘emergency’ in terms of fiscal difficulty, including a ‘significant increase in regional spending’ making budget operation ineffective or inefficient. - This definition could encompass provision of basic socially beneficial services when insufficient revenues are available. - If an SNG has capacity to implement all social programs but lacks cash, it should be able to withdraw principal from the DAD. - If SNG maintains implementation capacity over time, it should not be required to replenish withdrawn capital. - Minister of Finance approval should be required for withdrawal, and the Minister should not force repayment at a particular time through threat of deducting it from transfers. *Italic source attribution: IMF staff content from tarea2024017 - Box 2. Example of Differences in the Asset Allocation of Funds with Different Objectives* ### 63. A SWF-type fund such as the IGWF has a natural lifetime and a pre-defined methodology ### A SWF-type fund such as the IGWF has a natural lifetime and a pre-defined methodology for withdrawal ### Natural lifetime and withdrawal methodology - An SWF-type fund (IGWF) has a natural lifetime that coincides with depletion of the natural resources which provide its capital. - During the resource-rich phase, the normal business of the government or SNG runs at a surplus due to natural resource revenues until those revenues decline to the point that the budget surplus is extinguished. - Once resource depletion reaches that point, the budget will need continual support by withdrawals from the fund to operate in the same capacity as before resource depletion. - An IGWF can be structured as a “financing fund” (a budget stabilization mechanism) that: - Automatically receives all non-earmarked budget surpluses generated by high resource revenues. - Supports expenditures via withdrawals when natural resource prices fall and the budget moves into deficit. - Requires legislation to clarify that such financing-fund withdrawals fall within the emergency definition to be approved by the Minister. - Anticipates automatic replenishment of withdrawals once resource prices rise sufficiently again. ### Evolutionary aspects for SNGs and IGWFs - RPMK should permit LGs to develop more flexibility in DAD management as public financial management capacity improves. - Conditions for relaxing investment management restrictions on an IGWF: - LGs must show sufficient surpluses to build up IGWF resources. - LGs need not have direct investment management experience but must demonstrate: - Understanding of the risks inherent in expanded investment approaches. - Ability to contract, monitor, and manage professional fund managers free from conflicts of interest. - Public support that long-term wealth preservation measures are in citizens’ interests. - Use of DAD principal: - Once an LG develops PFM capacity to execute budgets without creating SiLPA, the RPMK could allow utilization of DAD principal. - The MR should direct the Minister of Finance to approve emergency withdrawal requests from LGs with a recent record of little or no SiLPA generation and clear socially beneficial expenditure needs above projected revenues. - This consideration also applies where an LG owns an IGWF that it operates as a financing fund or is in final stages of resource depletion. - Repayment/replenishment treatment: - RPMK should imply the Minister would not require replenishment of approved withdrawals until the LG is generating budget surpluses that are not SiLPA-related. - For IGWFs, by the time resources are depleted, HKPD would be amended to ensure no replenishment is necessary or expected. ### Principal recommendations (section H) - Amendments to the draft Ministerial Regulation should: - 3.1 Replace the requirement to establish a DAD specifically for support of a particular budget sector with the choice of establishing either a multi-year budget financing fund or an intergenerational wealth fund. - 3.2 Include the requirement of the forecast of medium-term budget surpluses derived from natural resource revenues in the eligibility criteria for establishment of an IGWF. - 3.3 Ensure that all income from the DAD is prioritized and utilized through the normal budget planning and execution channels and remove the provision for creation of a UPP from the RPMK. - 3.4 Direct SNGs to take advice from the Ministry of Finance and the BI when considering withdrawing more than a specified amount from their local banks within a relatively short timeframe. - 3.5 Envisage in the RPMK the future need to amend the requirement for risk-free portfolio investments in an IGWF in order to meet its future-generation wealth preservation objective. - 3.6 Ensure that emergency withdrawal approvals from a MBFF by the Minister of Finance include consideration of future enhanced budget implementation capacity of the SNG and that replenishment should only occur when the SNG is in a fiscal position to do so without difficulty. - 3.7 Include an evolutionary framework for establishment of an IGWF which includes the ability to expand its investment policy from purely risk-free instruments; to consider its use as a financing fund; and to envisage budgetary use of its capital as the associated natural resources are depleted. ### Implementation considerations (overview) - Main implementation areas: (a) management structure of the fund, (b) transparency and reporting requirements, (c) fiscal risks monitoring and management, and (d) supporting systems. A. Management structure - Draft Government Regulation on Harmonization of National Fiscal Policies (Article 7 and draft RPMK “Management of the Fund”) defines DAD management options: regional general treasurers or regional public service agencies. - All inflows and outflows of the DAD must be integrated within budget processes to preserve governance and accountability. - If DADs are separate institutional units, they must follow the same public financial management processes at the SNG level. B. Transparency and reporting - Strengthening transparency needs attention to accounting standards and public disclosure. - Accounting standards issues: - Valuation of assets: DAD financial statements need assets reported at market value or fair value rather than nominal value. - Time of recording: recording yield on an accrual versus cash basis affects budget execution and cash matching. - Disclosure gaps: - Draft RPMK does not specify public dissemination or which government sector is responsible for dissemination (central vs. subnational). - Principle 3.3.1 “Fiscal coordination” would require publication of fiscal condition and performance of the subnational government. - Santiago principle 18 indicates assets and investments performance reports are often disclosed monthly; Santiago principle 11 suggests an annual SWF report with financial statements and external audit. - Reporting frequency and timeliness could be clarified in RPMK or MoF technical guidelines; indicator 3.3.1 of the IMF’s Fiscal Transparency Code suggests annual publication of subnational financial condition and performance. C. Fiscal risks - Fiscal risk management requires a more holistic framework covering SNG and central government perspectives. - Central government perspective: - DG Fiscal Balance needs a framework to monitor risks related to SNGs, including macroeconomic shocks, commodity price fluctuations, resource depletion, hidden costs (e.g., borrowing to meet DAD inflow requirements), and contingent liabilities (e.g., bank impacts from withdrawals, PPP fiscal risks). - SNG perspective: - SNGs should comprehensively monitor risks affecting DADs including inflows, outflow rules, budget integration, institutional arrangements, and operational risks. D. Other considerations - Coordination among ministries/agencies is crucial; harmonized reporting templates and communication channels reduce administrative burden on limited SNG capacities. - IT systems at SNGs must support DAD establishment and functioning; a review and gap assessment is essential prior to DAD establishment. - A national-level support function during initial DAD phases should: - Provide capacity development at the SNG level (DG Fiscal Balance or other directorate) for training, IT revision, and PFM process readiness. - Provide guidance on public communication strategy to explain DAD objectives, structure, and functioning early in implementation. E. Implementation recommendations (numbered) - 4.1 Update and review, where needed, the accounting standards for SNG to ensure the reporting requirements and increase transparency. - 4.2 DG Fiscal Balance should have a holistic approach to monitoring fiscal risks from SNGs in general, not only those related to the DAD. - 4.3 Ensure that IT systems and human capacity at the SNGs would support the implementation of DAD – this could be a prerequisite for establishment of the DAD. - 4.4 Establish a framework for evaluating proposals for DAD that take account of hidden costs and present the full cost of the proposal to decision makers. - 4.5 Develop a dissemination strategy to communicate to the public both the design and concept of the DAD, as well as the reports related to the performance and function of the DAD. *Source: tarea2024017 - 63. A SWF-type fund such as the IGWF has a natural lifetime and a pre-defined methodology for withdrawal* ### 7. The draft regulations identify sources of funds to be used for the establishment of the ### tarea2024017 - 7. The draft regulations identify sources of funds to be used for the establishment of the ### Sources of funds and capitalization - Identified initial sources include SiLPA whose use has not been earmarked for spending, and other sources consistent with provisions of the legislations. - Authorities are exploring the possibility of mobilizing resources from donors and philanthropists. - In years following establishment, the DAD principal may be increased using: - unallocated yields from investment of DAD, and/or - other sources from the budget. - Increases to the principal would not require approval or amendments to the regional regulations and would be conducted through the SNG financial management mechanisms as stipulated in laws and regulations. ### Investment policy and eligible assets - Draft regulations stipulate DAD is invested in financial assets "free from any risks of impairment loss" and "based on an optimal rate of return." - Law 63 of 2019 on government investments defines three government investment asset types: (i) equity, (ii) debt securities, and (iii) direct investments (including listed/traded or unlisted/non-traded shares; bonds and debentures; Islamic finance instruments (sukuk); loans or other forms of direct investments). - Draft regulations restrict DAD investment to three asset types: - (i) government securities (up to maturity), - (ii) project loans guaranteed by government, - (iii) deposits in healthy banks. ### Use of yields, principal protection, and withdrawals - Yields from DAD investment: - Can be used for SNG expenditure. - Can be used to improve and/or expand public services that are regional priorities and above and beyond the SPM. - Regional priorities listed: (i) education, (ii) health, (iii) environment, and (iv) tourism. - Can also be used to add to the principal and for expenditures in fulfillment of mandatory government affairs only if consistent with the purposes for which the DAD was established and regional priorities. - Principal protection and emergency use: - Principal would not be reduced except under emergency circumstances. - Withdrawals from DAD principal allowed only under emergency circumstances and subject to approval of MOF with guidance from MOHA. - Emergency circumstances as stipulated in HKPD may include: - (i) significant downside deviations from targeted economic growth projections and other macroeconomic indicators, - (ii) projected significant (20 percent or more) decrease in SNG revenue or increase in SNG expenditures, - (iii) a threat endangering the national economic and financial stability. - A SNG can submit a proposal for withdrawal of the DAD principal; when approved it should be returned when the emergency ends, taking into consideration the SNG financial capacity. - Failure to replenish the DAD would result in deductions from the DAU and/or DBH. ### Governance and institutional arrangements - Institutional design envisages two units under supervision of the head of the SNG: - Fund management unit (UPD): comprising a head of unit and fund manager. - Program implementation unit (UPP): comprising a head of unit and program implementation manager. - Appointment and reporting: - Heads of units appointed by the head of the SNG. - Fund and program implementation managers appointed by and report to the head of their respective units. - Governance gaps and alternatives: - No explicit provisions in draft regulations for governance organs such as a governing council (board of trustees) and/or advisory or supervisory board, though supervision is provided by SNG internal supervisory organs. - Two management schemes envisaged: - UPD within the SNG, or - Cooperation scheme where SNG’s UPD cooperates with other endowment fund managers at national or sub-national levels (e.g., with the LPDP), regulated by fund management cooperation agreements. - Staffing: - UPD functions may be conducted by the SNG general treasurer (BUD) or a SNG public service agency (BLUD). - UPP functions may be conducted by an identified regional unit/agency or a BLUD. ### Roles, responsibilities, and reporting - UPD responsibilities include: - Proposing general policies and strategic plans for management of DAD and ensuring alignment with regional planning documents. - Investing the DAD. - Recommending utilization of the yields. - Preparing DAD fund management reports. - UPP responsibilities include: - Proposing and overseeing implementation of programs and activities funded with yields. - Preparing program performance reports. - Reporting mechanisms: - Fund management report must include at least information on investment portfolio performance and risks management, among other relevant information. - Program performance report must include at least information on programs and activities funded with yields and their performance, among other relevant information. - DAD reports are part of the SNG’s regional government financial reports and are prepared and submitted in compliance with regional government financial reporting procedures. - Reports submitted through existing reporting digital platforms to the Minister of Finance for the attention of the Directorate General of Fiscal Balance. ### Oversight - Shared oversight responsibility between MOF and MOHA for: - Assessment of SNG proposals for establishment of a DAD, - Utilization of the yields from investment of DAD, - Assessment of requests for withdrawals from the DAD principal. - MOHA plays an advisory role; final decision-making powers on these aspects are vested with MOF. ### Fiscal capacity measurement (Box summary) - Regional Fiscal Capacity Indices are calculated in two stages at provincial and district/city level: first calculate regional fiscal capacity (K....) then the fiscal capacity index (IKFD). - Equations provided (1)–(4) define: - Regional Fiscal Capacity of a Province and of a District/City, - Regional Fiscal Capacity Index of a Province and of a District/City. - Definitions: - R...α = Regional Revenue of a Province or District/City - R...β = Specific Regional Revenue of a Province or District/City - EEE R... γ = Specific Regional Expenditure of a Province or District/City - IKFD index ranges and labels for Provinces and Districts/Cities: - Provinces: IKFD < 0.277 Very Low; 0.277 ≤ IKFD < 0.564 Low; 0.564 ≤ IKFD < 0.934 Average; 0.934 ≤ IKFD < 1.920 High; IKFD ≥ 1.920 Very High - Districts/Cities: IKFD < 0.517 Very Low; 0.517 ≤ IKFD < 0.747 Low; 0.747 ≤ IKFD < 1.168 Average; 1.168 ≤ IKFD < 2.145 High; IKFD ≥ 2.145 Very High - Source for the index methodology: Minister of Finance Regulation 120/PMK.07/2020. *Source: https://www.imf.org/-/media/files/publications/tar/2024/english/tarea2024017.pdf* ### Annex 5. Strengthening Decision Making for ### Annex 5. Strengthening Decision Making for ### Case Study: Australian Experience — Fully evaluating investment fund proposals through the budget process - When the budget is in a deficit position and additional borrowings are required, the Ministry of Finance derived principles to guide decisions on establishing investment funds. - Principles aim to ensure: - Funds are not established if the principal objective can be delivered through direct allocation of resources in the budget. - The full costs (including hidden costs) are taken fully into account. - Management arrangements are efficient. - Budget process rules (budget circular) strengthened for policy decisions involving the balance sheet, particularly transactions in financial assets and the establishment of investment funds. - Cabinet must be presented with: - The impact of interest costs over the life of the policy proposal. - Evidence that the cost is fully offset by savings elsewhere. - Full justification of the benefits of establishing a Fund. ### Box 4.1: Australian Government Investment Fund Principles - Definition: Investment funds involve the purchase and management of financial assets to fund a particular policy objective by subsequently drawing on earnings and / or capital. - The establishment of an investment fund should consider: 1. Is there a clear need to hypothecate funding outside the normal Budget process? - Unless there is a case to hypothecate resources, the Budget is the primary means for the allocation of resources. 2. Is there a clear need to hold financial assets (can a Special Account be used)? - Consideration should be given to the direct and indirect cost associated with investment funds, and the acquisition of financial assets. 3. What is the most efficient management arrangement for investment of financial assets, and who is best placed to manage these arrangements, taking into account the investment horizon, liquidity needs and risk appetite? - The acquisition and management of financial assets requires expertise, including risk and liquidity management expertise. - Budget Rules for Proposals involving Investment Funds: - Entities must comply with the requirements of the Commonwealth Investment Framework and must: (a) assess the financial impacts, including on underlying cash and fiscal balance, net debt, gross debt, and Public Debt Interest (PDI) over the life of the policy proposal. - When proposing the creation of an investment fund, be able to clearly justify the benefits of investing the principal and using the fund to meet ongoing spending. - Offset any impact on underlying cash, including any PDI costs associated with an increase in gross debt over the forward estimates. ### Annex 6: Suggested Amendments to the Minister of Finance Regulations to Establish an Endowment Fund for Regional Government — Key changes and rationales - Additions to definitions and fund types: - New definition 10a: "Multi-year Budget Financing Fund (MBFF) is a DAD which originates from accumulated SiLPA." - New definition 10b: "Intergenerational Wealth Fund (IGWF) is a DAD which originates from accumulated revenue sharing surplus." - Objective and eligibility changes: - Article 3 (1) c: Add "Regional Government to have the opportunity to manage finances for multi-year budget availability" as an additional objective of DAD. - Article 4 (1): Change "to improve and/or expand one or a number of specific public services" to "to improve and/or expand public services; or save for intergenerational benefit" — generalize MBFF and include IGWF. - Article 5 (1) c: For an IGWF, require "an established plan for generating and saving revenue sharing surpluses." — include IGWF in eligibility criteria. - Article 6 (3): Limit "type of DAD" to "type of DAD - either MBFF or IGWF only" — two objectives and types of DAD. - Article 6 (4) a: Change "SiLPA" to "For a MBFF, SiLPA" — inflow rule for MBFF. - Article 6 (4) b: Change "other sources" to "For either a MBFF or an IGWF, other sources" — inflow rules. - Use of yields and budget execution (major deletions and clarifications): - Multiple clauses and articles that previously limited or specified compatibility and use of yields (e.g., Articles 8 (3) e, f; 8 (5) letters e,f,g; 12 (2) e,f,g; 12 (4); 14 (1) e,f; 19–22; 24 (1); 30; 31; 45 (5)) are amended to delete references to restricting yields, with rationale "Yields used for general budget execution" or "UPP not needed." - Specific edits change references to "yields of the Regional Endowment Fund" to "yields of the Regional Endowment Fund which is a MBFF" — only MBFF yields used in budget. - New insertion after Article 33: "The yields from investments of an IGSF are to be reinvested in the fund." — different objective for IGWF. - Risk management and evolving investment approach: - New clause at 28 (7): "The DAD is precluded from any encumbrance on its assets through such activities as providing guarantees, borrowing, entering into derivative contracts, or pledging assets" — avoidance of non-standard risks. - New Article following Article 29: For an IGWF, once the size of the DAD and the financial management experience of the UPD are sufficiently well established, the Regional Government may apply to the Minister to expand the investment guidelines of Article 28 to include risk-bearing assets to better match the fund objective — evolving investment management for IGWFs. - Withdrawal, repayment, and budget interaction: - Article 42 (8) amended to require the Minister to take into account whether the Regional Government is likely to create SiLPA in the medium-term and, if not, whether the withdrawn funds will be required to meet socially productive expenditure plans as provided for in its budget — relaxing the 'emergency' interpretation of Law#1, 2022; allows evolutionary use of capital as PFM improves. - Article 42 (9) amended: Repayment obligation will only come into force once the Region has shown financial capacity to repay the withdrawn amount as an expenditure item in its budget without reducing social commitments — repayment only if the budget is in surplus or SiLPA exists; recognizes that as IGWF inflow reduce to zero, the fund can be run down to continue LG public services. - Macro-stability safeguard: - New Article following Article 44: "Prior to withdrawing fund deposits from banks in excess of IDR [75 billion] the UPD manager will consult with the Ministry of Finance and the BI to ensure that banking stability risk is minimized." - Rationale: Macro-stability risk. If a [ceiling] is used in the Article, it should be discussed with the BI before deciding its value. - Administrative edits: - Article 24 (1) and related clauses: change responsibility from "UPP prepares" to "Regional Government Budget Manager prepares" — reflects yields used for general budget execution. - Multiple explicit deletions of UPP references: rationale "UPP not needed." *IMF Technical Assistance Report* ### Annex 7. Fiscal Capacity Indices ### Annex 7. Fiscal Capacity Indices ### Provinces — Regional Fiscal Capacity Indices (selected highlights) - Top 5 provinces by KFD: - Province of DKI Jakarta: 6.207 — Very High - Province of Jawa Barat: 4.676 — Very High - Province of Jawa Tengah: 2.943 — Very High - Province of Jawa Timur: 2.885 — Very High - Province of Papua: 1.616 — High - Middle-range examples: - Province of Kalimantan Selatan: 0.891 — Average - Province of Banten: 0.847 — Average - Province of Sulawesi Selatan: 0.799 — Average - Province of Nusa Tenggara Timur: 0.786 — Average - Province of Kalimantan Tengah: 0.776 — Average - Lowest 5 provinces by KFD: - Province of Papua Barat: 0.156 — Very Low - Province of Gorontalo: 0.103 — Very Low - Province of Maluku: 0.189 — Very Low - Province of Maluku Utara: 0.215 — Very Low - Province of Aceh: 0.220 — Very Low ### Regencies/Cities — Regional Fiscal Capacity Indices (selected highlights) - Top 10 regencies/cities by KFD: - City of Surabaya: 7.676 — Very High - Regency of Tangerang: 7.509 — Very High - City of Bekasi: 5.873 — Very High - Regency of Badung: 4.880 — Very High - City of Bandung: 4.726 — Very High - Regency of Bekasi: 4.686 — Very High - Regency of Bogar: 4.343 — Very High - City of Semarang: 4.146 — Very High - City of Makassar: 3.658 — Very High - City of Medan: 3.384 — Very High - Examples around the High/Average boundary: - Regency of Musi Banyuasin: 2.140 — High - Regency of Karawang: 2.104 — High - Regency of Banyumas: 2.080 — High - Regency of Grobogan: 2.053 — High - Regency of Mimika: 2.000 — High - Regency of Bantul: 1.167 — Average - Regency of Pacitan: 1.167 — Average - Regency of Tulungagung: 1.165 — Average - Regency of Langkat: 1.162 — Average - Regency of Mahakam Ulu: 1.159 — Average - Examples around the Average/Low boundary: - Regency of Tegal: 0.744 — Low - Regency of Lanny Jaya: 0.744 — Low - Regency of Banggai: 0.743 — Low - City of Banda Aceh: 0.742 — Low - Regency of Tanah Datar: 0.742 — Low - Lowest 10 regencies/cities by KFD: - Regency of Aceh Selatan: 0.029 — Very Low - Regency of Bener Meriah: 0.032 — Very Low - Regency of Belitung Timur: 0.046 — Very Low - Regency of Asmat: 0.122 — Very Low - Regency of Aceh Timur: 0.185 — Very Low - Regency of Aceh Tamiang: 0.204 — Very Low - Regency of Bengkulu Tengah: 0.217 — Very Low - Regency of Sarong: 0.242 — Very Low - Regency of Banggai Kepulauan: 0.257 — Very Low - Regency of Bangka Barat: 0.259 — Very Low ### Ratings observed in the tables - Rating categories used (as presented): Very High, High, Average, Low, Very Low. - KFD score ranges (examples preserved exactly as listed in the tables above) span from: - Highest: 7.676 (City of Surabaya) - Lowest: 0.029 (Regency of Aceh Selatan) *Annex 7. Fiscal Capacity Indices — IMF Technical Assistance Report* --- _Source: https://www.imf.org/-/media/files/publications/tar/2024/english/tarea2024017.pdf_