arun arya blog banner

Why Indonesia needs to prioritize its capital budgets to meet development goals?

March 18, 2021

Prior to 2020 when the COVID-19 pandemic hit, Indonesia’s economy had shown relatively robust growth over the last couple years,  averaging at around 5 percent year-on-year. Infrastructure investment is one high potential area Indonesia can further support growth and reduce inequality. Underinvestment in this sector has left the country with a large infrastructure gap that needs additional financing – as much as 3-4% of GDP in capital investments – as well as building effective partnership with the private sector to help share the financing burden.  There needs to be a significant improvement in budget execution practices to match the ambitious infrastructure development set by the central government. 

While the central government aims to increase the target of their average capital budget expenditure contribution to 1.7-2.3% of GDP each year throughout FY 2020-24, two key constraints remain. First, limited fiscal space constrains the allocation of sufficient funds. Second, public financial management challenges may prevent higher and faster capital budget execution. While the former may reflect the government’s ability to perform its income-generating power through available revenue sources, the latter may showcase technical inefficiency that persists within the government bodies that can be addressed if we understand the underlying issues.

Poor execution of capital budget expenditure is a potential lost opportunity to achieve better economic growth and equality. For instance, between 2017 – 2019, the average capital budget execution only reached 85% of allocated budget, of which 45% was executed in the last quarter (Figure 1). These consistently low and slow capital budget execution motivated an in-depth analysis into its causes. The analysis building on previous World Bank analysis of both upstream and downstream aspects of public financial management.

Figure 1 Capital Expenditure Realization, 2019

Using survey responses from across spending units in Indonesia as well as field visits and econometric analysis, the study found that the slow pace and low level of capital budget execution performance is caused by interrelated factors that can be grouped into five areas. First, there are general issues that include the fragmentation of capital expenditure (CapEx) proposals and the frequent rotation of spending units’ heads. The latter meant that there was a limited time for the heads of the projects to familiarize themselves with the unique characteristics of the work before they are moved to other roles. It also leads to lack of motivation as persons in charge of projects have less incentive to finish the project in time. 

Second, issues in budgeting processes such as short periods for preparation of CapEx proposals, gaps between bottom-up proposals and top-down allocation, frequent budget (DIPA) revisions, weak linkages between planning and budgeting, and late issuance of regulations affect processes in subsequent areas. The magnitude of the effect of these factors varies, but we found that spending units that report these challenges consistently have lower and slower execution rates compared with those that do not (Figure 2).

Figure 2 Effects of issues in budgeting processes

Third, procurement processes, especially delays in such processes, play a significant role in affecting budget execution. For instance, early tender announcement can improve the pace of realization by 18 percentage points, compared to those that do not announce early.  Other factors such as lack of qualified staff to evaluate bidders’ proposals. The lack of utilization of the regulation permitting early procurement process and the lack of use of multiyear contracts are also critical to spending the capital budget on time (Figure 3).

Figure 3 Effects of issues in procurement processes

Fourth, budget implementation processes are also crucial. CapEx budget disbursements are skewed at the end of FY because of delays in starting project implementation and processing contractors’ invoices. These negatively impact both the levels and pace of capital budget spending. Other factors such as lack of transparency and accountability and low capacity of staff to process payment claims are also lead to the delays. (Figure 4).  

Figure 4 Effects of issues in budget implementation processes

Finally, other factors such as financial management and user friendliness of financial applications are also important. These include some external factors such as delays from contractors.

These factors have caused preventable delays in planning, budgeting, and decision-making activities and the results have clear policy implications. Some of these causes are behavioral, which require changes in behavior of key personnel in spending units and the staff of Line Ministries in their headquarters. This requires reviewing and revising their roles and building capacity. The full report has been presented to Indonesia Ministry of Finance and is available here.

The World Bank team that conducted this study includes Arun Arya (Task Team Leader/ Senior Public Sector Specialist), Hari Purnomo (Senior PFM Specialist), Angella Faith Montfaucon (Economist/ Young Professional), Tajuddin Mabaning Ismail (Consultant/ Senior IT Systems Specialist), Budi Permana (Senior Procurement Specialist), Novira Asra (Senior Financial Management Specialist), and Assyifa Szami Ilman (Consultant/ Economics Analyst). The team worked under the strategic guidance of Alma Kanani (Practice Manager, Governance, East Asia and Pacific Region) and Satu Kahkonen, (Country Director, Indonesia).