Introduction

Indonesia has experienced strong economic growth and steady poverty reduction over the past decade, but the end of the commodity boom, accompanied by slowing poverty reduction and rising inequality, has put pressure on the country’s overall economic development. Indonesia’s average annual growth rate was 5.6 percent in the period 2001-12, equivalent to a GDP per capita of about US$3,500. The national poverty rate was halved to 11.2 percent in the period from 1999 to 2015, largely through sustained growth and job creation. However, the decline in commodity prices and demand slowed growth to 4.8 percent in 2015 and 5.1 percent in 2016. The pace of poverty reduction also began to stagnate around this time, with a near zero decline in 2015, accompanied by rising inequality, from 30 points in 2000 to 41 points by 2014, as measured by the Gini coefficient.

The downturn in economic growth underscores the importance of the overall public financial management (PFM) reform agenda to ensure that the delivery of public services continues to function effectively.Indonesia fi rst embarked on a broad-based reform of its PFM systems more than a decade ago. Following the 2002 Government White Paper, a new legal framework was adopted through Law No. 17/2003 on State Finance, Law No. 1/2004 on State Treasury, and Law No. 15/2004 on State Finance Accountability and Audit. These laws created a new institutional framework for budget management and a major reorganization of the Ministry of Finance (MOF). The reforms that were started included, among others: (i) consolidation of the treasury single account (TSA), and improvements in cash and debt management, and cash-flow forecasting; (ii) improvement in asset management (an automated asset management registration system is being completed, as is a stocktaking system and an appraisal of government assets); (iii) unifi cation of the routine (recurrent) and development budgets; (iv) enhancing public sector procurement; and (v) strengthening of the audit and accounting functions.
The monitoring and evaluation of PFM reform has been supported and monitored, including through Public Expenditure and Financial Accountability (PEFA) performance assessments. This PEFA assessment is the third such assessment in Indonesia, with previous assessments having taken place in 2007 and 2012. As agreed with the government, the two primary objectives of the assessment are: (i) to establish a new baseline based on the upgraded 2016 PEFA framework for measuring PFM progress going forward; and (ii) to provide a basis for dialogue with the government on its future PFM reform needs and for development partners to plan their programs of support accordingly.
The scope of the PEFA exercise covers the general central government budgetary institutions receiving budget allocations from the central government’s budget, i.e., the line ministries and agencies, oversight institutions and parliament. The activities of public corporations, public-private partnerships (PPP) and social security funds are covered only to the extent that they receive central government budget allocations and from the perspective of fiscal risks and contingent liabilities to the central government. Similarly, subnational governments are covered through the central government transfers they receive and oversight practices.
The assessment analysis period covers the previous three completed fiscal years (2014, 2015 and 2016), with a cut-off  date of August 2017, and with audited accounts for 2016. The three-year fi scal period from 2014 to 2016 was marked by a political transition and a change of government composition that aff ected the policy agenda. For this reason, additional to the PEFA framework requirement, this report introduces the recent and ongoing reform actions undertaken by the government, with a view to updating all the corrective and normative policy decisions taken to improve the system. It offers a perspective on the progress still to be made, for example, regarding public investment management, public asset management, fiscal strategy and results-oriented information, all of which represent critical areas that the government intends to strengthen.

This assessment was carried out by the Government of Indonesia together with the World Bank, in coordination with development partners and international donors, to promote full ownership by the government through an iterative consultation and validation process, both at technical and political levels. This was both to ensure the government’s endorsement and build a constructive dialogue on relevant international PFM standards and performance improvements.

Assessment of PFM System Performance

The assessment demonstrates that Indonesia has already established a strong legal and regulatory framework that aligns with most international standards on PFM, but the eff ectiveness of the PFM systems in place and the monitoring of performance can still be strengthened. Overall, the average PEFA performance score is slightly below B, which is above the basic level of performance broadly consistent with good international practices.
PFM in Indonesia has important strengths, primarily associated with the development of instruments that have allowed prudent fiscal management and control of budget execution. The recent introduction of fiscal rules to support major development initiatives has been eff ectively followed. The roll-out of the financial management information system (FMIS), together with the implementation of strict cash consolidation management rules, a welldefined treasury management system at the central government level, consistency between the accounting and budgetary classifications, and the convergence of national accounting with international accounting standards for the public sector, have created a solid platform for automation and integration of PFM processes for the improved quality of financial reporting and oversight.
However, there are still some weaknesses related to the strategic allocation of resources, the accountability of budget implementation and the efficient delivery of public services. These are areas in which reform eff orts are being made but where these eff orts have yet to realize full performance based on this assessment. Among the most important of these ongoing eff orts are: (i) improving budget credibility by strengthening the budget forecast, establishing consistent budgeting framework, and increasing revenue mobilization and compliance of tax and non-tax collection; (ii) improving the system capacity to deliver infrastructure outcomes by harmonizing the selection, implementation and monitoring of capital expenditure with formal guidelines and oversight, effi cient management of public assets, as well as consolidation and monitoring of public procurement operations; (iii) the inclusion in the budget of performance information, linking resource planning in the most appropriate manner for better service delivery; (iv) promoting effective reporting of subnational budget execution; and (iv) strengthening internal audit and external audit, and control measures.

Impact on the Main Objectives of Public Finances

The strengths and weaknesses identified in this PEFA assessment illustrate how the performance of PFM systems impact on the three main budgetary outcomes, as discussed below:

Aggregate Fiscal Discipline is supported by: a clearly defi ned fi cal strategy; the capability to prepare robust projections of macroeconomic and fiscal performance; the proper reporting of revenue and expenditure operations outside the budget; and suffi  cient control over fiscal risks and commitments to maintain expenditures during budget execution.
The government’s capacity to defi ne a solid macro-fiscal framework using modeling instruments aligned with international practices and to follow strict fiscal rules supports a consistent and sustainable fi scal strategy. The medium-term fi scal framework (MTFF) provides a medium-term approach with forward estimates and fi scal outcomes and follows the fi scal rules on the total annual budget deficit, set at a maximum 3 percent of GDP and the outstanding (foreign and domestic) debt at not more than 60 percent of GDP. Operations outside the government’s financial reporting comprise insignificant amounts, representing less than 1 percent of the total budgeted revenue and expenditure. Detailed fi nancial reports of the extra budgetary units (BLUs)—de facto included in their line ministries’ budgets, but with some spending fl exibility—are submitted within three months of the end of the fiscal year. The management of commitments and payments of the main expenditures through DG Treasury is set against hard commitment ceilings from the approved state budget. Expenditure arrears are strictly controlled by disbursement rules and commitment control systems and, as a result, the amount of arrears or accounts payable is limited.
Fiscal risks to the central government budget are identifi ed and disclosed in considerable depth in the notes to the budget proposal and fi nancial statement. Fiscal risks related to SOEs’ operations are monitored. SOEs report on a quarterly basis to the MOSOE and send their audited financial statements to the MOF. Meanwhile, control over subnational governments’ risks is improving, with 100 percent of districts and provinces submitting their budget realization reports for FY 2015.

However, this generally positive aggregate fiscal discipline outcome is partially limited by weaknesses in contingent liabilities and revenue administration.

Contingent liabilities are identifi ed and provide a clear and comprehensive overview of the exposure to all significant risks, although the types of risks to which the budget is exposed in the case of PPP-related guarantees are not adequately covered at present. Meanwhile, there is a lack of information pertaining to explicit contingent liabilities outside the infrastructure sector, for example those relating to health and social security schemes, with no data available on these liabilities. In addition, data on the quantification of, and provision for, implicit contingent liabilities, some of which may be considerable, are unavailable, for example the potential need to bail out large SOEs with non-guaranteed debts.
Revenue administration in Indonesia is an area where alignment to international practice is particularly needed. The tax administration is piloting an integrated risk-based Compliance Improvement Plan but has not fully implemented a structured and systematic risk assessment process for assessing, ranking and quantifying taxpayers’ compliance risks.  The application of risk criteria is conditioned by the access to reliable and comprehensive data from internal and external sources through a proper tax information management system, which has still to be developed. In addition, the monitoring and the ageing of arrears are complex due to the definition of collectability of tax obligations, and a signifi cant amount of uncollectable tax debts have to be written off .
Strategic Allocation of Resources is led by the existence of budget rules and circulars that assign predictable budget ceilings for the annual budget formulation; ensure the submission of timely, complete and relevant information in the draft budget submission for consideration by parliament;  ensure the regular and timely approval of the annual budget law before the eff ective date of the corresponding fiscal year; the bottom-up and top-down budget formulation process and adoption of a fi ve-year national strategic plan defi ning priorities in the allocation of public funds among sectors and institutions; and regular monitoring and assessment of performance information of the line ministries.
The budget calendar is detailed and strictly adhered to, and provides the budgetary units with approved expenditure ceilings before their own budgeting processes start so that they can set their priorities. The budget preparation process is clearly defi ned, planned and implemented in a timely and participatory manner. Parliamentary scrutiny over budget formulation and execution is based on comprehensive information, with detailed revenue and expenditure estimates.
However, these outcomes are being undermined by poor budget reliability, inconsistent implementation of the medium-term expenditure framework (MTEF) and annual budgeting process, and the absence of consolidated performance information by sector in the budget as a whole.

Repeated deviation between the original planned budget and outturns reflects the lack of political consensus over revenue and expenditure projections. The regular budget formulation process is undermined by systematic in-year budget revisions (APBN-P) that impact the alignment with strategic planning and funding predictability, which ultimately affects the quality of spending. The systemic issue stems from the signifi cant overestimation of revenue forecasts, indicating interference with the forecasting model, thereby undermining the revenue collection performance.
 

Inconsistencies can be seen in the preparation of the MTEF on a sectoral basis, which aff ects the estimates used in the MTFF. The medium-term ceilings are defi ned for the subsequent years but only for reference purposes and are subject to change in the fi scal or sectoral policies, or in adjustments to the costing parameters. As a result, the budget submission fails to establish the linkages with the previous years’ estimates, and to describe the range of scenarios underlying the government’s risk management strategy and the fi scal impact of new budget policy proposals.
There is less transparency on the performance information of service delivery. This information is formally available but requires quality improvement to facilitate accountability on the outputs of f nancial execution through the delivery of public services. Evaluation reports on line ministries’ performance and execution at the subnational level are currently not published.
Efficient Service Delivery is supported by: the transparency of key budgeting and fi scal information; the transfer of revenue collections to the TSA system, which allows the availability of funds for the commitment of expenditures; and the systems for allocating inter-governmental transfers, which are defined through a rule-based system with a formula and data calculation that allow for some transparency and predictability for subnational governments.
However, these are undermined by weaknesses in subnational government reporting, and a weak public investment management, public procurement and oversight system. 
The weakness in public investment projects starts in the upstream phase, where the planning capacity is limited and pre-feasibility and selection criteria are not systematically applied, and continues into the downstream phase, where the consolidated monitoring of decentralized implementation is lacking and processes for the costing, quality assurance and reporting on value-for-money (VFM) and fi duciary integrity are not harmonized. Detailed technical and costing guidelines are missing at the central government level. The management of public investments is decentralized to the line ministries, with no standardized quality assurance for socioeconomic and environmental evaluations, and pre-feasibility studies. Project selection involves Bappenas and the MOF mostly on budgetary criteria, and project monitoring is devolved to the implementing agency.
In procurement, the system suff ers from a lack of central monitoring and reporting. Procurement operations are managed through e-procurement, but this does not include all contracts. Competitive procurement methods are estimated to cover about 70 percent of total contracting value. The procurement indicator is aff ected by the absence of an independent administrative complaints mechanism or appeals process to settle disputes effi  ciently. Data on single-source procurement operations, the resolution of complaints and procurement statistics are not published.
Weak monitoring of subnational government spending. The inter-governmental fi scal transfer system lacks predictability and is still not fully transparent, undermining the quality of local spending. For example, the underlying weight and data of the DAU formula are only made available to subnational governments after the allocations have been made. The DAK Fisik allocation is volatile and the criteria for proposal-based allocations is unclear. Meanwhile, the system for publishing a subnational budget realization summary is not well established as there are no regular and systematic procedures in place on publishing the report.
Eff ective external audit and scrutiny by parliament reveal a mixed oversight performance between the external audit function and parliament on ex-post budget scrutiny. The line ministries’ budget execution is audited and audit opinions consolidated in BPK public reports, but not published separately. The response rate by the government to audit recommendations is low (less than 50 percent) and not monitored on an annual basis. On the parliamentary side, scrutiny on the follow-up to budget execution audits is less eff ective than the ex-ante budget review. Hearings are often not held with the authorities of the agencies concerned and no conclusions on the audit recommendations are issued. Given the lack of comprehensive, transparent and eff ective followup on external audit and budget reports, parliamentary scrutinity cannot be deemed effective and conductive to transprent accountability.

Evolution of the PFM System Performance

The broad evolution of PFM performance, or “where did the needle move” between 2011 and 2016, was assessed based on the comparable review at the indicator level using the same framework to the data available in 2017. The results are shown in Annex 5.
The assessment over time shows signifi cant improvements in the PFM systems linked to predictability and control over budget execution, particularly for treasury and cash management with the roll-out of SPAN. The performance linked to the fiscal strategy and policy-based budgeting is also sustained over time, with improvements in fi scal sustainability and the debt management strategy.

Several areas are still not fully aligned with international good practices that had been identified in the previous assessment. In the area of planning and budgeting, the gap between the strategic framework and the medium-term horizon in the 5-year plan and the annual budget process is still an issue that has an impact on the eff ectiveness of service delivery and the reporting on budget performance.  The need for further integration of the payroll and procurement platforms confi rms the necessity for further IT integration and interface of the government database systems. The lack of reporting on aggregate resources and the allocation of resources at the frontline delivery unit level is still identified. Tax administration systems have been strengthened and are in the process of adopting international practices. The risk-management approach focusing on the large taxpayers’ offi ce and the overall tax compliance improvement strategy has not yet been fully implemented. Information on competition in procurement is still not fully consolidated. The audit standards integrating risk-management elements are derived from a broad tax compliance improvement plan. Finally, line ministries’ performance reports and audit findings by external auditors are still not circulated and followed up on, and ex-post legislative scrutiny still lacks effectiveness.

The Ongoing and Planned Reform Agenda

The PEFA assessment highlights PFM reform areas that have already been identified by the government as priorities.
The most recent push for further PFM reforms has been set out in President Joko Widodo’s development goals—the Nawa Cita. To achieve these goals, the RPJMN 2015-2019 emphasizes the need to: (i) strengthen state revenue administration capacity and improve tax policy in order to increase state revenue from taxation and nontax sources; and (ii) strengthen planning and budgeting institutions to improve efficiency of budget allocation, the composition of spending and the eff ectiveness (in terms of impact) of public expenditure.

Meanwhile, the MOF, as Indonesia’s main PFM institution, introduced 20 strategic initiatives based on fi ve principles: (i) achieving high levels of tax, excise and duty compliance through excellent service and rigorous law enforcement; (ii) implementing prudent fi scal policies; (iii) managing the central balance sheet with minimum risk; (iv) ensuring that revenue funds are distributed effi ciently and effectively; and (v) attracting and developing bestin-the-class talent by offering competitive employee packages. The decree also spans over three strategic areas that cover PFM issues—revenue, treasury and budgeting.

Collecting more revenue is a top priority for the government. The recent tax administration reform actions include: (i) restructuring DG Tax’s organization based on functions and taxpayer segments; (ii) streamlining business processes by utilizing appropriate information technologies to ensure certainty in the delivery of taxpayer services; (iii) improving human resource management based on job competency and performance; and (iv) strengthening governance by introducing a code of conduct for all 32,000+ employees of DG Tax. Since 2016, many reform initiatives have been launched and are ongoing, and should lead to performance improvements. The Tax Reform Team (Tim Reformasi Perpajakan) was also established in December 2016 to oversee a comprehensive tax administration and policy reform program aimed at boosting Indonesia’s tax-to-GDP ratio to 16 percent by 2019.

Most recently, reforms have been implemented to improve coordination between Bappenas and the MOF to address the issue on the effective functioning of planning and budgeting. Finance Minister Regulation PMK 163/2016 covers the process of rolling over and updating the forward estimates and indicative ceilings and has been used in the preparation of the 2018 budget based on the fi rst year forward estimate included in the previous budget. A special IT application on the MTEF has been developed by the Australia Indonesia Partnership for Economic Governance (AIPEG) to support the roll-over of the forward projections, and the tracking of changes in the forward estimates between budgets. Early in 2017, the government issued Government Regulation No. 17/2017 on the Harmonization of Planning and Budgeting for the National Development Process. This regulation provides a framework to synchronize the planning and budgeting processes between Bappenas and the MOF. The regulation is already eff ective for the 2018 budget cycle. The government’s ambitious cascading strategic-planning framework also has a potential to strenghten the effectivenes of program based budgeting, together with the reliability of budget allocation to the ministries  and sectors to achieve a more effi  cient use of resources.
Development partners have actively supported the government’s initiatives by backing PFM reforms. The multi-donor trust fund, PFM MDTF, was established in 2007 to support the government’s PFM reforms in general and the implementation of the World Bank-financed Government Financial Management and Revenue Administration Project (GFMRAP) in particular. The trust fund has been in operation for a decade and has contributed signifi cantly to the government’s PFM reform agenda. The next steps will need to focus on articulating the fi ndings of the PEFA assessment and other lessons learned into a strategic plan and road map for the implementation of PFM-MDTF reform activities.