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r 2009 Public Financial Publications, Inc.

The Impact of Decentralization on SubnationalGovernment Fiscal Slack in Indonesia

BLANE D. LEWIS and ANDRE OOSTERMAN

Since Indonesia began implementing its decentralization program in 2001,subnational unspent balances have grown rapidly and have reached levels thatmany officials find unreasonably high. But the extent to which subnationalgovernment reserves are excessive, in general, is not obvious. A not implausibledecrease in the price of oil would reduce transfers to subnationals significantlyand, if sustained, could possibly eliminate reserves in a relatively short time.Central government should not take any immediate action to reducesubnational slack resources directly but should instead focus on removing theunderlying causes of such.

INTRODUCTION

A significant literature exists on subnational government slack revenues in more devel-

oped countries, especially the United States.1 Most of this research focuses on the cre-

ation, use, and impact of budget stabilization funds and similar fiscal mechanisms. A

major preoccupation of this work has been to examine the extent to which subnationals

maintain sufficient reserves to stabilize expenditures during economic downturns. Issues

related to the slack resources of subnational governments in developing countries have

not yet been addressed in the academic literature. This is not surprising given the typical

lack of accessible data on key variables. This paper focuses on the slack resources of

Blane D. Lewis, Associate Professor, Lee Kuan Yew School of Public Policy, National University of

Singapore, 469C Bukit Timah Road, Singapore 259772, Singapore.

Andre Oosterman, Consultant, World Bank, Jakarta Stock Exchange Building, Tower 2, 12th floor, Jl.

Jenderal Sudirman, Kav. 52–53, Jakarta 12180, Indonesia.

1. See Justin Marlowe, ‘‘Fiscal Slack and Counter-Cyclical Expenditure Stabilization: A First Look at

the Local Level,’’ Public Budgeting & Finance 25, no. 3 (2005): 48–72 and Rebecca Hendrick, ‘‘The Role of

Slack in Local Government Finances,’’ Public Budgeting & Finance, 26, no. 1 2006: 14–46, for brief reviews

and comprehensive citations.

Lewis and Oosterman / Impact of Decentralization on Subnational Government Fiscal Slack 27

subnational governments in Indonesia and would appear to be the first of its kind for a

developing country.2

Indonesian subnational governments comprise provinces and districts. Starting in

2001, these second- and third-tier governments began operating in a much more decen-

tralized environment than had been the case before that date. Fiscal decentralization in

Indonesia is characterized by a significant devolution of spending responsibility to sub-

national governments, especially at the district level. However, control over major

sources of revenue remains highly centralized. By the end of 2007, subnationals ac-

counted for about 38 percent of total public sector expenditure but only about 8 percent

of total public revenues. As a result, transfers from the central government have been

called upon to finance the bulk of expenditure decentralization to the subnational level.

This is not an uncommon situation in developing countries that are decentralizing their

public sectors.3

Indonesian subnationals have accumulated substantial unspent balances since the

government launched its decentralization program. 4 At their recent peak, subnational

reserves reached just over Rp 110 trillion or about 3 percent of GDP.5 The size of

subnational unspent balances has caused significant concern among some central gov-

ernment officials, especially as the center has struggled to reduce its own fiscal deficit.6

Policy discussions have focused on possible methods for encouraging subnationals to

spend more of the resources available to them and, less feasibly given the current legal

framework, on schemes for reducing transfers to subnationals if they don’t increase

spending.

Three sets of questions about subnational reserves in Indonesia immediately present

themselves. As indicated above, it is well known that it is sensible for subnationals to

keep some funds in reserve in order to stabilize expenditures when economic activity

slows and public revenues decline. This suggests a first question of significance: do

Indonesian subnationals save too much from this point of view? A second set of in-

teresting questions concerns the determinants of subnational savings. That is, do sub-

national governments save purposively or has the recent buildup of unspent revenues

2. Another reason for the relative dearth of research on subnational fiscal slack in developing countries

may be that many subnationals, due to extremely limited revenues, have simply not saved much; that is,

slack is nonexistent in many places. As transfers to and own-source revenues of subnationals grow, as they

are in many developing countries, slack resources may become of greater concern.

3. Roy Bahl and Sally Wallace, ‘‘Public Financing in Developing and Transition Countries,’’ Public

Budgeting & Finance, Silver Anniversary Edition (2005): 83–98, and Paul Smoke, ‘‘Local Revenues under

Fiscal Decentralization in Developing Countries: Linking Policy Reform, Governance and Capacity,’’ in

Fiscal Decentralization and Land Policies, eds. Gregory Ingram and Yu-Hung Hong (Cambridge, MA:

Lincoln Institute of Land Policy Press, 2008).

4. We use the terms slack revenues, reserves, and unspent balances interchangeably in this paper.

5. Some government officials now refer to the increase in subnational reserves as the ‘‘100 trillion rupiah

problem.’’

6. The cumulative central government budget deficit during 2001–2007 is estimated to be just 4Rp 213

trillion.

Public Budgeting & Finance / Summer 200928

been largely inadvertent? If the latter is the case, what then explains the unintended

increase in reserves? A third important question is: What should be done about sub-

national government savings? This is the policy question on which many central gov-

ernment officials are fixated.

The paper proceeds as follows. First, we use available aggregate central bank data on

deposits to describe the growth, size, and geographic distribution of subnational reserves

across provinces from 2001 through 2007. Second, using deposit and national budget

data we simulate the impact of a decrease in the price of oil on subnational fiscal slack.

This analysis is carried out in order to shed some light on the degree to which sub-

national reserves are ‘‘excessive.’’ Third, using the same data combined with information

on the main intergovernmental transfers, among others, we specify and estimate a simple

econometric model to investigate some of the main potential determinants of subnational

government surpluses, during the period 2001–2006. Fourth, we examine a significant

number of audited subnational government budgets for 2004–2006 with a view to further

specifying the causes of surpluses. In addition, in this section of the paper we highlight

the results of some limited field work recently undertaken on relevant issues as the

analysis and discussion proceed. Finally, we conclude the paper with a summary of the

main points and offer some conclusions of relevance for fiscal decentralization policy-

making in Indonesia.

GROWTH, SIZE, AND DISTRIBUTION OF SUBNATIONAL RESERVES

This section of the paper uses subnational government bank deposits to indicate reserve

funds. Subnational governments are not (yet) known to invest in central government

certificates of deposit (SBI), treasuries, or other similar financial instruments to store

their funds.7 So most if not all slack funds are on deposit in commercial banks. In

addition, subnationals have not borrowed much since decentralization to finance the

development of infrastructure.8 Instead, they mostly use own-source revenues and

transfers for public capital expenditure. As such, funds on deposit do not include bor-

rowed amounts. Finally, subnational governments are not allowed to maintain deposits

in banks located outside the country. All things considered, the use of national deposits

as a proxy for aggregate subnational reserves seems reasonable under the present cir-

cumstances.

The data used in this analysis come from the Indonesian Central BankFBank

Indonesia (BI). BI has information on all subnational government (demand, savings, and

7. The banks in which subnationals hold their reserves do, however, invest significantly in such in-

struments.

8. Christine R. Martell and George M. Guess, ‘‘Development of Local Government Debt Financing

Markets: Application of a Market Based Framework,’’ Public Budgeting & Finance 26, no. 1 (2006): 88–119

and Blane D. Lewis, ‘‘On-Lending in Indonesia: Past Performance and Future Prospects,’’ Bulletin of

Indonesian Economic Studies 43, no. 1 (2007): 35–57.


time) deposits in commercial banks in the country. The subnational government deposit

data employed in this investigation have been aggregated at the provincial level. That is,

for each province in the country, deposit data comprise those for the provincial gov-

ernment and all district governments within the province. The individual government

level data have not been made available for use in this study due to BI’s concerns about

customer confidentiality.9

Figure 1 details the rise of subnational reserves since 2001. Before the start of de-

centralization, subnational governments held approximately Rp 7 trillion in reserve

funds. Between the start of 2001 and the end of 2007, subnational reserve funds ex-

panded by an order of magnitude, reaching just under Rp 70 trillion. Reserves grew at an

annual rate of 37 percent during the indicated period, in nominal terms and at a rate of

just 425 percent per year in real terms.

Observe the pattern of subnational government savings during any given fiscal year.

Subnationals tend to increase their deposits during the first three quarters of the year and

then draw down on reserves in the last quarter, the period during which most provincial

and district government spending takes place. Among other things this shows that cen-

tral government anxiety about the ‘‘100 trillion rupiah problem’’ that subnational re-

serves supposedly represent is perhaps needlessly exaggerated, since the figure in question

was just the peak in the year on year savings cycle. That is, what matters in this regard is

70,00080,00090,000

100,000110,000120,000

010,00020,00030,00040,00050,00060,000

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Current Rupiah Constant Rupiah

FIGURE 1

Subnational government bank deposits, 2001–2007

9. With a view to increasing transparency and monitoring subnational fiscal activity and performance,

the Ministry of Finance formally requires subnational governments to report their reserve funds (and other

assets, as well as liabilities). Unfortunately, most subnationals do not provide the relevant information as

required and the Ministry of Finance has yet to employ available sanctions in an attempt to force them to

do so.


the end of year balance, which in this case was approximately Rp 70 trillion, a con-

siderably smaller amount.

Table 1 shows provincial and district reserve funds at the aggregate level over the

period in question. Note that at the end of 2000, provincial reserves exceeded those of

districts. Provinces held 72 percent of total reserves compared with just 28 percent for

districts. During the period, district reserves grew at a pace of almost 50 percent per year,

whereas the reserve funds of provinces grew at only 23 percent per annum. At the end of

the period districts maintained about 60 percent of total slack funds and provinces only

40 percent.

It is common to examine total reserves as a percent of general revenues or expen-

ditures or some similar standard. Since reserves are ostensibly to be used to smooth out

revenues and spending, the normalization gives a better idea of the fiscal importance and

relative magnitude of reserves, over time and across units of government. Table 1 also

shows provincial, district, and total subnational reserves as a percentage of spending,

from end 2000 to end 2007. Total reserves were just 15 percent of expenditure before

decentralization, rose to 19 percent in 2002, declined to 14 percent in 2003, increased

steadily to 29 percent in 2006, and finally, declined slightly to 25 percent at the end of

2007. Over the period, district reserves increased from just 8 percent of expenditures to

around 25 percent. On the other hand, provincial reserve funds decreased from 36 to 26

percent of expenditures.

Figure 2 provides a view of end 2007 reserves as a percentage of expenditures, across

provinces.10 Reserves and expenditures refer to those of the particular province in ques-

tion along with those of all district governments within the province. (Within provinces,

the data do not allow us to separate provincial from district reserves.) The distribution of

funds is quite skewed. Subnational governments in Aceh, Kalimantan Timur, and Riau

TABLE1

Subnational Reserves, Nominal and as Percent of Expenditure

2000 2001 2002 2003 2004 2005 2006 2007

Provincial (Rp Bln) 4,471 7,762 8,507 8,103 9,851 15,761 19,517 19,146

District (Rp Bln) 2,940 10,796 13,592 13,350 14,595 25,949 49,009 48,734

Total (Rp Bln) 7,411 18,558 22,099 21,453 24,446 41,710 68,526 67,880

Provincial (% Exp) 36.2 33.8 26.4 20.8 23.4 32.5 30.1 26.4

District (% Exp) 7.9 15.1 15.1 11.6 12.3 19.0 26.8 24.8

Total (% Exp) 14.9 20.1 18.6 14.4 16.1 24.2 28.6 25.3

Source: Authors’ own calculations based on Bank of Indonesia and Ministry of Finance Data.

10. At the time of this paper was written, disaggregated subnational government expenditures were not

yet available for 2007. As such we divide 2007 reserves by 2006 expenditures. Since 2007 expenditures are

likely to have exceeded those for 2006, Figure 1 probably overestimates the reserves to spending ratio.


all hold reserves in amounts well over 50 percent of expenditures.11 Subnational gov-

ernments in these provinces are the principal beneficiaries of shared natural resource

revenues, especially those from oil and gas. Subnationals in these three locations possess

more than 30 percent of total subnational reserves. At the other end of the scale, sub-

nationals in Nusa Tenggara Barat, Sulawesi Tenggara, Lampung, and Sulawesi Utara all

have reserves comprising o10 percent of total expenditures. Subnationals in these lo-

cations are among the fiscally poorest in all of Indonesia.

SUBNATIONAL FISCAL SLACK: SIZE RELATIVE TO NEED

In order to discern the extent to which the level of subnational government reserves

reported above represents excess savings it is necessary to define an objective standard

against which such reserves can be compared. A rule of thumb in the United States

suggests that state governments should keep in reserve an amount of funds equivalent to

about 5 percent of current expenditures. Most analysts argue that municipalities in the

United States may, in fact, need more reserves because their revenues are more volatile.12

0 10 20 30 40 50 60 70 80

FIGURE 2

Subnational reserves as percentage of expenditure, 2007

11. The overall average reserves to expenditure ratio decreases from around 25 percent to o20 percent

when Aceh, Kalimantan Timur, and Riau are excluded from the calculation.

12. See Kenneth Kriz ‘‘The Optimal Level of Local Government Fund Balance: A Simulation Ap-

proach,’’ State Tax Notes, January, 2003. He estimates that municipalities in Minnesota should maintain

reserve fund balances of between 16 and 91 percent of annual revenues in order to assure a 3-percent rate of

growth of annual expenditures, given various scenarios regarding revenue volatility.


Many observers in the United States claim that, in practice, states do not maintain

reserve fund balances of sufficient size, even according to the somewhat crude 5 percent

rule.13 Others contend that they do.14 Interestingly, it appears that most analysts are

more comfortable with the magnitude of reserve holdings of U.S. municipalities. It’s

certainly clear that, in the event, municipalities do maintain reserves in relatively larger

sums.15

The above observations may not be particularly relevant for Indonesian subnationals,

since the size and composition of revenues is significantly different from those of U.S.

states and municipalities. Moreover, it is not productive to attempt to generalize about

the reserve fund requirements of Indonesian subnational governments, as a whole. Ul-

timately the optimal size of any subnational’s reserves depends on the potential (future)

volatility of the public revenues of the particular government in question. In Indonesia

since decentralization, the most important subnational revenues have consistently grown

and have not yet experienced declines of any significant magnitude.16 As such, it is

difficult to estimate the future volatility (especially on the downside) of major subna-

tional sources of public revenue, either in the aggregate or for individual provinces or

districts.

This is not to say, however, that subnational revenues will not necessarily experience a

significant downturn at some point in the future. Perhaps the most significant risk for

regional revenues relates to the price of oil. The pools of finance of three of the major

sources of subnational government revenueFproperty tax receipts from the oil sector,

nontax oil revenue sharing, and block grants (DAU)Fare all derived as a direct or

indirect function of the price of oil. The following paragraphs discuss the manner in

which oil helps determine these major sources of revenue and simulate the impact of

decreases in the price of oil on revenues.

13. Alan Berube and Iris J. Lav ‘‘When it Rains it Pours: A Look at the Adequacy of State Rainy Day

Funds and Budget Reserves,’’ State Tax Notes, May, 1999, and Phillip G. Joyce, ‘‘What’s So Magical

about Five Percent? A Nationwide Look at Factors that Influence the Optimal Size of State Rainy Day

Funds,’’ Public Budgeting & Finance 21, no. 2 (2001): 62–87.

14. Gary C. Cornia and Ray D. Nelson ‘‘Rainy Day Funds and Value at Risk,’’ State Tax Notes,

August, 2003 and Christian Gonzalez and Arik Levinson ‘‘State Rainy Day Funds and the State Budget

Crisis of 2002,’’ State Tax Notes, August, 2003.

15. Charlie B. Tyer, ‘‘Local Government Reserve Funds: Policy Alternatives and Political Strategies,’’

Public Budgeting & Finance 13, no. 2 (1993): 75–84 and Michael Shelton and Charlie B. Tyer (with Holly

Hembree). ‘‘Local Government Reserve Funds and Fund Balance: Some Applications of Business Con-

cepts,’’ Municipal Finance Journal 21, no. 1 (2000): 1–18, have demonstrated, for example, that the majority

of municipalities in North and South Carolina hold reserves in amounts greater than 50 percent of general

expenditures. And Justin Marlowe, ‘‘Balance, Net Assets, and Working Capital,’’ in Handbook of Public

Financial Management, ed. Howard Frank (New York: Taylor & Francis, 2006), provides some evidence to

show that a recent sample of municipalities in Michigan and Minnesota also hold reserves in amounts at

least 50 percent of general fund spending.

16. The most important own-source revenues for provinces are taxes on vehicle registration and change

of title while those for districts are taxes on electricity consumption and hotel and restaurant sales.


Domestic nontax revenue from the oil sector is shared with regions. In 2008, the

regional share of state oil revenues was 15 percent of total realized nontax revenues in the

sector. The shared revenues are returned to the provincial point of origin and distributed

among both producing and nonproducing districts within the province. Recent World

Bank estimates put the elasticity of shared oil revenues with respect to changes in the

dollar price of oil at 1.28.17

The DAU pool of finance is calculated each budget year as 26 percent of total planned

domestic revenues (net of amounts shared). Oil revenues are, of course, a major source of

national revenues and thus have a major impact on the size of the DAU. World Bank

staff estimate that the elasticity of oil sector-based DAU revenues with respect to changes

in the budgeted price of oil is approximately 1.21.18

Property tax in Indonesia derives from five sectors: urban, rural, estates, forestry, and

mining (in particular, oil). Central government retains 9 percent of total property tax

revenues as an administrative charge and distributes the remaining 91 percent to regions

in various manners depending on the sector. Property taxes from the oil sector amount to

about 75 percent of the total property taxes shared with subnational governments.19 We

have no specific information on the elasticity of subnational property taxes from oil with

respect to changes in the price of oil and so we simply assume the elasticity to be one.

While the price of oil has recently risen significantly and remained at historically high

levels, it may not do so in perpetuity, of course. And if the price oil were to drop in world

markets so too would subnational public revenues in Indonesia. Table 2 simulates the

impact of changes to the price of oil on oil sector property taxes shared with regions,

TABLE 2

Impact of Change in Oil Price on Regional Revenues (Rp Blns)

Revenue source

Rp (Blns) Rp (Blns) Rp (Blns)

Oil price5 $100 Oil price5 $90 Rev loss

Oil Sector Property Tax Shared with Regions 19,947 17,952 1,995

Nontax Oil Revenue Shared with Regions 37,728 32,914 4,814

DAU Dervied from Oil Revenue 50,675 44,518 6,157

Total Regional Oil-Based Revenue 108,350 95,384 12,966

Source: World Bank, Jakarta. Simulations assume 2007 cost structure and tax rates, 923 thousand barrels per day

oil production, and an exchange rate of $15Rp 9,150.

17. Tim Bulman ‘‘A Note on Oil Prices and Intergovernmental Transfers,’’ mimeo, World Bank, Ja-

karta, Indonesia (2008).

18. Ibid.

19. The oil sector property tax operates somewhat like a sales tax, where property owners’ liabilities are

derived as a percentage of total sales in the sector and not based on capital value of structures. See Blane D.

Lewis, ‘‘Property Taxation in Indonesia: Measuring and Explaining Administrative (Under-) Perfor-

mance,’’ Public Administration and Development 23, no. 3 (2003): 227–239.


nontax oil revenue sharing, and the DAU.20 We consider an oil price of US$100 per

barrel as the base case.21 The table shows the impact of a decrease in the price of oil from

US$100 per barrel to US$90 per barrel.22

As can be seen in the table, potential reductions in regional revenue due to a decrease

in the oil price are not insignificant. A decrease in the price of oil from US$100 per barrel

to US$90 per barrel results in a loss of revenue of Rp 1,995 billion, Rp 4,814 billion, and

Rp 6,157 billion from property taxes, revenue sharing, and the DAU, respectively. The

total decline in revenue under the simulated circumstances is just oRp 13 trillion. This

sum amounts to about 20 percent of end 2007 subnational reserves (Rp 68 trillion).

Thus, in the aggregate, subnationals would appear to have more than sufficient funds

on reserve to smooth out expenditures in the event of a one time 10 percent drop in the

price of oil. Longer-term declines in the oil price would be more problematic for sub-

nationals, however. The results here suggest, for example, that a 10 percent drop in the

price of oil, sustained for 5 years, would eliminate total provincial and district reserves, if

subnationals were to use the slack resources to maintain revenues at current levels, all

other things remaining equal.23 Larger decreases in the price of oil would eliminate fiscal

reserves more quickly.

The impact of an oil price decrease (limited and temporary, or otherwise) on the

revenues of individual subnational governments would differ, of course. It is possible

that even reasonably small and transitory decreases in the price of oil may reduce the

revenues of some subnationals, those at or near the bottom of Figure 2, say, to a point at

which they could not be covered by reserves. All things considered, the main problem

with stock of subnational reserves in Indonesia would not appear to be one of excess

level but to its uneven distribution across regions of the country.

AN ECONOMETRIC EXPLANATION OF SUBNATIONAL SURPLUSES

The approach used in this paper to econometrically explain subnational surpluses and

reserves has a long history.24 In broad terms, the (Gramlich-Galper) method posits that

the subnational government surplus is a positive function of major (untied) fiscal trans-

20. A small amount of revenue from gas is also included in the simulations. The price of gas is pegged to

the price of oil. As of 2008, the subnational share of nontax gas revenue was 30 percent.

21. The oil price assumption in the revised 2008 state budget was US$95 per barrel. The oil price for

fiscal year 2009 is budgeted as US$100 per barrel (and may be subject to further revision). We use the latter

figure for convenience.

22. The simulations assume that the 2007 cost structure of and tax rates in the oil sector prevail, a

constant production level of 923,000 barrels per day, and an exchange rate of US$15Rp 9,150.

23. Among other things, this assumes no additional accumulation of subnational reserves in the interim.

24. E. Gramlich and H. Galper, ‘‘State and Local Fiscal Behavior and Federal Grant Policy,’’ Brook-

ings Papers on Economic Activity (1973) 1: 15–65 and E. Gramlich, ‘‘The 1991 State and Local Fiscal

Crisis,’’ Brookings Papers on Economic Activity 2 (1991): 249–287.


fers to subnational units and a negative function of subnational expenditure needs. In

this scheme, the subnational surplus is but one part of a larger fiscal model comprising

subnational spending and taxes, as well, both of which are also a function of transfers

and expenditure needs.25 We use the methods here to determine subnational surplus

during the period 2001–2006.

Table 3 supplies aggregate data on variables of interest in this analysis. It shows the

amount of the major transfers to subnational governments, that is, revenue sharing and

the general purpose block grant, along with data on subnational reserves, GDP, the

GDP deflator, and population for the period 2001–2007. The data are shown for back-

ground purposes only and are not discussed in much depth. Three points are worth

highlighting, however.

First, it should be emphasized that both revenue sharing and the general purpose

block grants are untied. That is, the expenditure of those funds is completely at the

discretion of subnational governments. While subnationals do receive some tied funds in

the form of a special purpose capital grant (DAK), those transfers are very limited in

amount and have not been included in this analysis.

Second, notice the sizable real increase in shared revenues in 2005 and then

again in 2006. This growth was largely driven by the significant rise in the oil price during

those 2 years, which forces increases in subnational oil-based revenues, as described

above.

Third, note the substantial increase in block grants in 2006. This is also a function of

the rising price of oil, as well as the fact that government adopted a reasonable estimate

of that price in the state budget for the first time in many years. Previously, the gov-

ernment purposefully underestimated the price of oil in the national budget in order to

TABLE 3

Subnational Data, Totals, 2001–2007 (Constant Rupiah)

2001 2002 2003 2004 2005 2006 2007

Revenue Sharing (Rp Blns) 33,367 37,726 45,251 49,862 57,210 69,184 68,461

Block Grants (Rp Blns) 100,638 104,852 111,042 110,704 102,194 155,278 164,787

Reserves (Rp Blns) 30,949 33,504 30,946 32,957 48,020 73,049 67,872

GDP (Rp Trns) 2,306 2,479 2,588 2,861 3,197 3,338 3,782

GDP deflator 60.0 66.0 69.3 74.2 86.9 93.8 100.0

Population (Mlns) 206 211 214 217 221 224 227

Source: Authors’ own calculations based on Ministry of Finance data.

25. Blane D. Lewis, ‘‘Indonesian Local Government Spending, Taxing, and Saving: An Explanation of

Pre- and Post-Decentralization Fiscal Outcomes,’’ Asian Economic Journal 19, no. 3 (2005): 291–317,

employed the general Gramlich-Galper framework to study Indonesian local government spending, taxing,

and savings just before and after decentralization.


reduce its transfer obligations to the regions.26 All other things being equal, a higher

budgeted price of oil drives up planned domestic revenues, which serve as the basis for

determining the pool of finance for the general purpose block grants.

In any case, the considerable increase in revenue sharing and block grants in 2005 and

2006 corresponds closely with the significant rise in subnational surplus during those 2

years, as shown in Figure 1. This suggests at least one possible factor that might help

determine the annual subnational surplus and thus the accumulation of reservesFin-

creases in untied intergovernmental transfers, as the Gramlich-Galper model indeed

posits. This is investigated in more detail below.

We specify a simple two-way fixed effects model to operationalize the methods de-

scribed above. More particularly, it is assumed that:

yit ¼ a0 þ ai þ gt þ b0xit þ eit ð1Þwhere y is per capita subnational government surplus, defined as the difference between

per capita reserves in the present and just previous periods. In addition, x is a vector of

explanatory variables, a, g, and b are parameters to be estimated, e is the usual error term(with mean and variance equal to zero and s2, respectively), and subscripts i and t refer

to the province in which subnational governments are located and the year, respectively.

The data set comprises 176 observations on 30 provinces over the period 2001–2006.27

Explanatory variables comprise, among others, tax and nontax shared revenues and

the DAU.28 Transfer variables are measured in per capita terms. We expect per capita

surplus to rise along with increases in intergovernmental transfers, all other things being

equal. Prices faced by subnational governments are perhaps the broadest indicator of

subnationals’ differential expenditure needs and we use the government’s geographic

price index as a proxy for those prices-cum-expenditure needs.29 We hypothesize that per

capita surplus would decline as the price index increases due to increasing cost of inputs

and higher spending. All variables used in the econometric analysis are defined more

precisely in Table 4.

26. As noted, the pool of finance for the DAU is based on planned domestic revenues. However, if

realized domestic revenues exceed 130 percent of planned revenues at the time of midyear budget amend-

ments, then amounts in excess of that 130 percent are transferred to the regions. Revenues shared with

subnational governments are determined as a function of actual national revenues.

27. Data are available for 29 provinces for all 6 years and for one recently recreated province (Sulawesi

Barat) for 2 years. Jakarta is excluded from the analysis due to lack of information on transfers.

28. Tax and nontax shared revenues are combined in the empirical analysis here. Estimation of the

model with the two types of transfers treated separately resulted in severe problems of multicollinearity.

Specific-purpose grants (DAK) are not considered as a possible explanatory factor of surpluses. As noted,

such grants are very small in comparison with others and are of less interest in the current context.

29. The government geographic price index is based on consumer price information gathered in 50 cities

across Indonesia, where each of the 30 provinces is represented by at least one city. In cases where a

province is represented by only one city, that city’s index value is used for the province; where a province is

represented by more than one city, the average of the price indices is used. The base year of the index is 2002

and the cross provincial average in that year is equal to 100.


Table 5 provides the regression results. In addition to the output for the two-way fixed

effects model in equation (1), for comparison purposes, the table also shows the results

for the one-way (i.e., provincial) fixed effects, and the simple OLS (i.e., with no fixed

effects) versions of the model. For each of the models, the table provides the estimated

coefficients of the independent variables, the relevant t statistics, and an indication of the

statistical significance of the estimated coefficients. In addition, the number of obser-

vations, log-likelihood function, restricted log-likelihood function, w2, and adjusted R2

values are shown at the bottom of the table.

The usual likelihood ratio and F tests indicate that the two-way fixed effects model

performs best among the three.30 We restrict discussion of the output to the two-way

model. As the table shows, the marginal effects of an increase in per capita shared

revenues and per capita block grants are 0.62 and 0.14, respectively; both coefficients

have the expected signs and are statistically significant. At the margin, therefore, an extra

rupiah of revenue sharing leads to nearly four and a half times as much savings as does

an additional rupiah of block grants.

At the point of means of relevant variables, these marginal effects lead to estimates of

elasticities of per capita surplus with respect to per capita revenue sharing and per capita

block transfers of 0.98 and 1.17, respectively. In other words, a percentage increase in

block grants would lead to higher subnational savings than same percentage increase in

revenue sharing would. This is not a trivial matter from a policy perspective. Increases in

the pools of finance for transfers are typically implemented in percentage terms. In 2008,

for example, the government increased the subnational pool of finance for the DAU

from 25.5 to 26 percent of planned domestic revenues. In 2009, it will increase the

region’s share of national oil revenue from 15 to 15.5 percent. The estimation results here

TABLE 4

Variable Names and Definitions

Name Definition

Dependent variable

SPLSPC Total subnational government surplus, within province, per capita

Explanatory variables

SHRVPC Total revenue sharing transfers to subnational governments, within

province, per capita

BLKTRPC Total block grants to subnational governments, within province, per

capita

GPI Geographic price index

30. More specifically, the tests indicate that the one-way fixed effects model does not improve on the fit

of the simple OLS model but that the two-way fixed effects model performs better than either the one-way

or the OLS model. Detailed results are available from the authors upon request.


imply that the percentage increase in block grants will have led to larger subnational

savings than the percentage increase in oil revenue sharing, all other things being

equal.

Note also that the coefficient of GPI is negative and statistically significant, as hy-

pothesized. The outputs implies that a one point increase in the price index results in

nearly Rp 80,000 decline in the per capita surplus, all else remaining the same.

It is instructive also to consider the two sets of fixed effects from the estimation of

equation (1) in more detail. Table 6 provides the estimated fixed group and time effects.

The group effects are ranked from lowest to highest. Note that the provinces with the

some of the smallest fixed group effectsFRiau and Kalimantan Timur, especiallyFare

also those with the largest reserves. This implies that subnationals in those provinces

actually tend to spend more and save less than would typically be the case, holding

transfers (and prices) constant. On the other hand, the fixed effects for some provinces on

JavaFJava Tengah, Banten, and Java TimurFare among the largest. The interpreta-

tion here is that subnationals in those provinces actually spend less and save more than is

usual, given transfers (and prices). More generally, we might conjecture that those sub-

nationals with large positive fixed group effects could be suffering from some kind of

capacity constraints regarding the spending of available funds.

The results for the fixed time effects are also illuminating. As the table shows, these

fixed effects continuously increase over time until 2006 at which point they decline

precipitously. This may indicate that subnational governments are perhaps finally be-

ginning to learn how to spend their resources to a fuller extent. It’s worth noting that the

slight decline in reserves in 2007, as seen in Figure 1 and Table 1, is at least consistent

with this hypothesis.

TABLE5

Surplus Regression Outputa

Variable

OLS One-way fixed effects Two-way fixed effects

Coefficient t stat Coefficient t stat Coefficient t stat

Constant 2,279,000 7.032* F F 4,355,800 3.044*

SHRVPC 0.411 12.683* 0.592 6.139* 0.619 6.987*

BLKTRPC 0.058 3.248* 0.092 2.432 0.141 3.939*

GPI � 42,099 � 7.578* � 44,866 � 7.288* � 79,983 � 3.781*

No. Observations 176 176 176

Log likelihood � 2,299.7 � 2,291.9 � 2,172.3

Restr log likelihood � 2,393.8 � 2,393.8 � 2,393.8

Chi square 188.3 203.8 253.0

Adjusted R2 0.649 0.613 0.694

aDependent variable is SPLSPC.*Coefficient is statistically significant at the 0.01 level.


EXAMINATION OF AUDITED SUBNATIONAL GOVERNMENT BUDGETS

The regulatory framework for subnational government budgeting is found in Law 32/04,

Government Regulation 58/05, and Ministry of Home Affairs Decree 59/07. The reg-

ulations do not treat the development, use, and management of formal reserve funds

(dana cadangan) in much depth. Subnational governments are simply informed that they

may create such funds and that to do so they must issue a local regulation, noting the

TABLE 6

Fixed Group and Time Effects

Group/province Fixed effects Time/year Fixed effects

Riau � 438,349 2001 � 35,270

Sumatra Barat � 376,634 2002 22,186

Kalimantan Timur � 300,637 2003 31,900

Papua � 202,296 2004 35,051

Sumatra Selatan � 110,912 2005 107,968

Aceh � 47,182 2006 � 160,039

Sulawesi Tengah � 35,017

Malluku Utara � 27,228

Sulawesi Tenggara � 22,125

Maluku � 19,627

Kalimantan Tengah � 15,049

Sumatra Utara � 9,226

Sulawesi Barat 4,993

Gorontalo 5,321

Sulawesi Utara 13,104

Bengkulu 21,410

Kalimantan Selatan 28,283

Lampung 35,198

Sulawesi Selatan 36,530

NTT 36,603

Yogyakarta 37,186

Kalimantan Barat 39,590

Bali 45,797

Java Barat 46,864

NTB 51,449

Java Tengah 53,731

Banten 65,518

Bangka Belitung 82,750

Java Timur 86,364

Jambi 198,051


general intent of the dana cadangan, along with its size, source of funds,31 and the kinds

of activities that will be financed from the formal reserves. Subnational governments

must create special bank accounts for reserve funds. In the event that reserve funds are

not put to immediate use they may be invested in financial instruments with ‘‘steady

return’’ and ‘‘low risk.’’32 Any earnings from such investments are to be channeled back

into dana cadangan. Finally, subnational governments are required to report their re-

serves on their balance sheets, which must be sent to the Ministry of Finance for review

annually.

In the event, it appears that very few subnational governments create formal reserve

funds of the kind outlined in regulation and described above. Our review of subnational

audited budgets revealed that o5 percent of total subnational government funds on

deposit in commercial banks were held in formal reserve fund accounts. This, by itself,

suggests that the accumulation of subnational reserves may be adhoc and inadvertent.

If subnational governments do not plan for budget surpluses, then they generate

surpluses unintentionally, either by underestimating revenue, by overestimating expen-

diture, or by some combination of the two.33 We explore the extent to which subnational

governments misestimate their revenues and expenditures just below. We base the anal-

ysis on the audited budgets and budget out-turns of 27 (out of 31) provinces and 220 (out

of 440) districts over the 2004–2006 period. The provincial and district budgets used for

this analysis were not chosen randomly but selected based exclusively on the availability

of information. Overall, the selected provinces and districts cover 89 and 63 percent of

the total population, respectively. In addition, we highlight key results from some limited

field work carried out in conjunction with this study. The field work comprised struc-

tured interviews with subnational government finance officials from three provinces and

10 districts.34

Table 7 presents information on planned and realized revenues, by major source, and

expenditures, by main type, for provinces and districts in our sample of subnational

governments for 2006. (The results for 2004 and 2005 are similar and are not shown

here.) The initial point to be gleaned from the table concerns the subnational deficit/

surplus. As the table shows, while both provinces and districts planned for fiscal deficits,

in the event they ran quite significant fiscal surpluses. As can be readily be determined

from information in the table, provinces planned for a deficit in the amount of just over

11 percent of (planned) expenditures but in the end ran a surplus of 7 percent of (re-

31. Regulations assert that all regional revenues may be used to fund such reserves, except the special

purpose grant. Furthermore, subnationals may not use borrowed funds to create reserves.

32. As examples of such financial instruments the regulations cite bank deposits, government treasuries,

and other government secured investments.

33. Tyer (1993).

34. Andre Oosterman and Bambang Tata Samiadji ‘‘Increases in Surpluses of Regional Governments in

Indonesia: An Empirical Analysis,’’ mimeo, Final Report Ministry of Finance. Decentralization Support

Facility, Jakarta, Indonesia, 2008.


alized) expenditures; and districts planned for a deficit in the amount of 8 percent of

expenditures but ran a surplus of 13 percent of spending.

Table 7 also shows the difference between planned and realized revenues and expen-

ditures. These differences are shown in nominal terms and as a percentage of the differ-

ence between the planned deficit and realized surplus (in absolute value). We term the

latter the total forecasting error. The percentage figures show the contribution of the

revenue and expenditure forecasting errors to the total forecasting error.

The revenue forecasting error determines about 26 and 28 percent of the total fore-

casting error of provinces and districts, respectively. In both cases, underestimated

shared revenue makes up the bulk of the problem; it is important to note that most of the

difficulty in this regard relates to revenue sharing in the natural resources sectors, par-

ticularly oil. Forecasting errors related to own-source revenues and other revenues are

considerably less problematic. And such errors associated with DAU and DAK are

trivial.

Inaccurate subnational planning associated with shared revenues in the oil sector is a

function of two main underlying problems. The first concerns the general difficulty the

central government has in correctly forecasting the price of oil and the impact that such

inexact forecasts have on subnational revenue planning. The Ministry of Finance pro-

vides estimated revenue sharing distributions to subnational governments for a given

year at the end of the before fiscal year, based on the forecasted price of oil at the time.

Recently the price of oil used by government at the end of one fiscal year for such

purposes has been significantly less than the actual average price in the following fiscal

TABLE 7

Planned and Realized Subnational Revenues and Expenditures, 2006 (Blns Rp)

Provinces Districts

Planned Realized Difference |%| Planned Realized Difference |%|

Revenues

Own-Source 27,308 28,232 � 925 7.8 8,294 9,322 � 1,028 4.3

Shared 16,758 18,412 � 1,655 14.0 20,436 25,488 � 5,052 21.1

DAU 11,959 11,961 � 1 0.0 71,358 71,422 � 64 0.3

DAK 10 10 0 0.0 5,758 5,817 � 59 0.2

Other 4,676 5,154 � 478 4.1 6,979 7,493 � 515 2.2

Total 60,711 63,770 � 3,059 25.9 112,825 119,542 � 6,716 28.1

Expenditures

Current 52,027 46,491 5,536 47.0 88,572 79,532 9,039 37.8

Capital 16,337 13,145 3,192 27.1 34,323 26,170 8,153 34.1

Total 68,364 59,636 8,728 74.1 122,894 105,702 17,192 71.9

Deficit/surplus � 7,653 4,134 � 11,787 100.0 � 10,069 13,840 � 23,909 100.0

Source: Authors’ own calculations based on audited provincial and district budgets for 2006.


year. In 2005, for example, the end of year forecast for oil revenue sharing with regions

was about Rp 16.5 trillion; in the event, realized revenue sharing in the sector was closer

to Rp 19 trillion in 2006 (representing a 15 percent forecasting error). It is the former

figures that work their way into subnational revenue budgets and the latter that account

for realized revenues of subnationals. As such, it is easy to see how provinces and

districts underestimated their revenues from this source during 2006.

The second problem relates to the timing of natural resource revenue payments to

regions. The payment of revenue shares has recently been made to subnationals rather

late in the fiscal year. In 2006, the central government did not make any natural resource

revenue transfers to regions until the third quarter. It seems that this problem may

be related in the first instance to cash flow difficulties of the central government. That is, the

central government itself typically does not get access to much natural resource revenue

itself until somewhat late in the year and it simply chooses to wait until a convenient time to

transfer onward to subnational governments their respective shares of the revenue. In any

case, subnational revenue received late in the fiscal year is difficult to spend in full.

Expenditure forecasting errors explain most of the total forecasting error of both

provinces and districts. As Table 7 shows overestimated expenditure makes up 74 and 72

percent of the total error of provinces and districts, respectively. Provinces apparently

have more difficulty in forecasting current expenditures while districts seem to under-

forecast current and capital spending to about the same extent.

Three main problems drive the overestimation of spending: inflexible budget rules, the

national anticorruption program, and insufficient subnational capacity in project devel-

opment and implementation. Subnational governments are required to prepare very

detailed expenditure budgets. Each unit (dinas) of the province or district develops a

budget, according to exhaustive spending categories, including those by type (or object)

and (economic) function. The budget is subsequently approved (by the relevant higher

level government and the subnational parliament) and expenditures are then authorized.

However, no provincial or district government dinas is allowed to spend more than the

budget ceiling, or even reallocate planned spending from one budget category to another,

unless it undertakes to formally revise its budget, something that requires subnational

parliamentary approval. Thus, all subnational government unit requests for additional

spending must be coordinated and presented to the subnational parliament for approval.

This is a time consuming process that some but not all subnational governments manage

to carry out a maximum of one time each year. The end result is, invariably, less spend-

ing than originally envisioned.

The recent and ongoing national program against government corruption has been a

positive force. At the same time, however, it also appears to have played a role in

constraining investment spending by subnationals. The basic problem seems to be in the

formation of local tender committees, which are required by government regulation to

review proposals and award construction contracts. Subnationals appear to have found

it increasingly difficult to find officials willing to take part in such committees. In a

number of cases, officials have been visited by police immediately after their names have


been proposed as tender board members but even before meetings have take place. The

implicit suggestion is that the police are acting in an overzealous manner in seeking out

potential corruptors. Of course they may also be searching for opportunities to partic-

ipate in fraudulent activities. In any case, this has made many subnational government

officials wary of participating in tender committees. The resulting delays in forming

committees (if they are formed at all) have adversely affected public investment in in-

frastructure.

Finally, perhaps the most important cause of underspending concerns the lack of

subnational government capacity to plan and implement development projects. It is

difficult to provide objective measures of this lack of this rather intangible phenomenon.

However, capacity constraints came out clearly in the interviews conducted as part of

this research. It seems that many subnational government officials have a limited un-

derstanding of their roles as providers of public infrastructure services. Officials that do

have some appreciation that their main function is to spend on public capital and deliver

services often have in mind infrastructure of rather limited scale, believing that major

public expenditures should be made by the central government instead. In this case, they

appear to see their role as one relegated to lobbying appropriate central officials to make

needed public investments rather than arranging to undertake these investments them-

selves.35

SUMMARY AND POLICY IMPLICATIONS

Policymakers in Indonesia have become increasingly concerned at the rapid and signifi-

cant buildup of unspent balances at the subnational level since decentralization. Nominal

subnational reserves grew at an annual rate of 37 percent between end 2000 and end

2007. As of 2007, reserves amounted to just oRp 70 trillion, an order of magnitude

larger than in 2000. During the period in question, district reserves grew even more

swiftly, almost 50 percent per year. District slack resources now comprise about 60

percent of the total, up from 30 percent just before decentralization.

It is difficult, however, to determine the extent to which subnational reserves are, in

fact, excessive. While Indonesian provinces appear to maintain reserves in larger pro-

portions of total expenditure than their state counterparts in the United States, for

example, district governments in Indonesia do not seem to hold slack funds in amounts

exceeding those of many U.S. municipalities. In the end, the optimal amount of reserves

that Indonesian subnationals should maintain is a function of potential revenue vola-

tility, not what transpires in other countries. That is, subnationals need to have sufficient

funds on reserve that they can use to keep expenditures at constant levels, in the event of

a downturn in public revenues. In Indonesia, subnational revenues from all sources have

35. Blane D. Lewis and Jasmin Chakeri, ‘‘Central Development Spending in the Regions Post Decen-

tralization,’’ Bulletin of Indonesian Economic Studies 40, no. 3 (2004): 379–394.


consistently grown since decentralization and, as such, it is difficult to estimate the

potential near-term revenue declines.

One apparent downside risk to subnational revenues concerns the price of oil. Three

of the most important sources of subnational revenueFoil sector property tax, revenue

sharing from oil, and block grantsFare a function of the oil price. While recently the

price of oil has increased significantly and has remained at historically high levels, it is

not impossible that the price might at some point decline. The analysis in this paper has

shown that subnational governments have more than sufficient funds to adjust to 10

percent decline in the price of oil, as long as such a decrease is of short duration. But if

the oil price were to decline by 10 percent and remain at such levels for a sustained period

of time, say 5 years, subnational reserves could be depleted to a considerable degree.

Even small and temporary reductions in the oil price may result in revenue losses that

exceed existing reserves of subnationals.

Not surprisingly, the annual subnational surplus and the accumulation of reserves are

strongly associated with increases in intergovernmental transfers. Revenue sharing with

regions increased significantly in 2005 and 2006 and the DAU also grew substantially in

2006. Subnationals increased their reserve holdings considerably during those 2 years.

More generally, the empirical evidence in this paper suggests that the subnational gov-

ernment marginal propensities to save out of revenue sharing and DAU are 0.62 and

0.14, respectively. The elasticity of the subnational government surplus with respect to

revenue sharing is 0.98 and with respect to the DAU is 1.17.

This study finds that the accumulation of reserves by subnational governments has

been largely inadvertent. Very few provinces and districts have set up formal reserve

accounts of the kind that the central government intends for the management of slack

funds. In fact, subnational governments appear, in the recent past at least, to have

planned for reasonably sized deficits, as opposed to the substantial surpluses that have

actually obtained. The analysis here has shown that the underestimation of shared nat-

ural resource revenues, to a certain extent, and the overestimation of current and capital

spending, more importantly, have both led to unplanned subnational savings. Under-

lying causes of shared revenue underestimation relate to the inherent difficulties that the

central government has in accurately estimating the oil price and the related size of

transfers to regions and also to the delays that subnationals experience in getting access

to their shared revenues. Overestimation of spending appears to be a function of re-

strictions on the execution of expenditure budgets, worries over corruption charges and

related difficulties in setting up tender committees, and, perhaps most importantly, lack

of subnational capacity to design and implement capital projects.

The question that confronts Indonesian policymakers is: what should be done about

the buildup of subnational reserves? We would argue that the central government need

not take any major action at the moment to directly limit or reduce subnational reserves.

As noted above, the extent to which reserves are, in fact, excessive is not clear. Moreover,

there is some evidence that subnational governments are starting to learn how to spend

their resources more fully. In 2007, provinces and districts both ran small deficits, for


example. If subnationals should continue to accumulate reserves, because of further and

sustained increases to the price of oil, for instance, then policymakers might consider

developing a formal centrally managed stabilization fund. In that case the central gov-

ernment could opt to compel subnationals to contribute resources to the fund. The

purpose of the fund would be to smooth out subnational expenditures in the event of an

unexpected and severe economic downturn, such as the recent financial crisis, or as

needed at such a time when the country’s (current) oil reserves become depleted, which in

around 13 years time it is estimated that they will.36

In the meantime, the central government should concern itself with better equalizing

the distribution of current fiscal resources across subnational governments and thus the

stock of reserves across regions. In this regard, the center should finally and completely

remove the so-called hold harmless condition attendant to DAU distributions, which

assures all subnational governments that they receive block allocations not smaller than

they did the previous year. By law, the government was required to have eliminated the

hold-harmless rule starting in 2008. It did not do so completely, however, but instead put

in place a transitional arrangement that cushioned the expected revenue losses of regions.

Of course, there is a limit to the equalization that can be achieved via the DAU, given the

large size and extreme geographic concentration of natural resource revenue transfers,

unless the government is prepared to revisit the allocation procedures of the latter. It

seems unlikely that the central government will take on this politically sensitive issue in

the near future.

Central government should use more sensible forward estimates of the price of oil in

forecasting revenue to be shared with subnationals, which the latter use for their own

planning purposes. Although the difficulties with accurately estimating the future oil

price are well known, the central government has thus far consistently underforecasted

the price by a significant margin. The underestimation is partly purposeful, of course.

Government obligations regarding DAU transfers to subnationals are a function of

planned domestic revenues, not actual revenues. When the center underestimates the

price of oil in the state budget at the beginning of the fiscal year, planned domestic

revenues are lower than they would otherwise be, and thus the center’s fiscal obligations

to the regions are reduced. The cost is that regions with significant natural resource

shares underestimate their revenues, thereby resulting in a further buildup of their re-

serves. The government may have already considered this tradeoff and decided to con-

tinue with the deliberate underestimation of the oil price. But then central officials should

not complain too vociferously about the resulting buildup of unspent balances.

In addition, the center should make an effort to distribute natural resource revenues in

a timelier manner. There is some cause for optimism on this count as the Ministry of

Finance has recently issued a regulation (Minister of Finance Decree 7/08) that permits it

36. Cut R. D. Agustina, Javier Arze del Granado, Tim Bulman, Wolfgang Fengler, and Mohamad

Ikhsan, ‘‘Black Hole or Black Gold? The Impact of Oil and Gas Prices on Indonesia’s Public Finances,’’

World Bank Policy Research Working Paper WPS4718 (Washington, DC: World Bank, 2008).


to allocate natural resource revenue shares quarterly, on an estimated basis, even if the

treasury has not yet received the actual revenues itself. The regulation is a positive step

forward. But many such regulations go unheeded in Indonesia. The proof will be seen in

national budget implementation starting in 2009.

The Ministry of Home Affairs is currently planning to revise national legislation that

regulates subnational budgets. A useful reform here would be for the ministry to reduce

restrictions on the execution of subnational expenditure budgets. Some leeway should be

given to subnational governments to spend in limited amounts greater than approved

budget ceilings, or allow departments to shift budgets across spending categories, with-

out having to obtain official approval from their parliaments.

Furthermore, it would be helpful for the central government to provide more guidance

to subnationals on the development of formal reserve accounts and assist in building

capacity in the use of such funds. Moreover, the central government needs to redouble its

efforts to build capacity at the subnational level in the areas of capital project planning,

design, and implementation. Both actions should help subnationals to spend more of the

resources available to them. But just increasing subnational spending will not be suffi-

cient, of course. Subnational governments need assistance in spending more efficiently, as

well. There is considerable evidence to suggest that inefficient subnational spending in

Indonesia is at least as problematic as the lack of spending.37

Finally, the existence of significant subnational reserves may, of course, be indicative

of broader governance concerns related to citizen demand for public services and/or

government accountability for the provision of services, as well. That is, unspent fiscal

resources may be interpreted as foregone public service delivery; and the latter, in turn,

may be a function, at least in part, of fragile demand for services or, perhaps, under-

developed accountability mechanisms through which to channel existing service de-

mands. To the extent that this is the case, then subnational reserves are representative of

more a complex set of problems, requiring longer term solutions of a more political

nature. The analysis of the political economy aspects of subnational reserves in Indonesia

is a potentially useful avenue of further research.

NOTES

The authors would like to thank Bank of Indonesia and Ministry of Finance officials for access to

data used in the analysis and Wolfgang Fengler, Sonia Hammam, and Bill Wallace for comments on

an earlier version of the paper. The research reported on in this paper was funded in part by a grant

from Britain’s Department for International Development (DFID TF 070582).

37. Blane D. Lewis and Daan Pattinasarany, ‘‘The Cost of Public Primary Education in Indonesia: Do

Schools Need More Money?’’ Working Paper (Jakarta: Decentralization Support Facility, World Bank,

2008).
