Bad debts in provinces hurting investment

The Jakarta Post, Jakarta

About half the money that provincial and regency administrations owe to Jakarta has not been paid back, according to a recent study which adds that poor debt records on top of security and legal concerns contributed to the weak investment climate in the regions.

A study by Asian Development Bank (ADB) consultants, Tasman Economics and Monash International showed that debt repayments by local governments had fallen behind their due dates by between 40 percent and 50 percent.

As of December 2001, local governments' total debt to Jakarta amounted to Rp 5.14 trillion (about US$571 million).

"We note the local government arrears -- poorly documented but approximating 40 percent to 50 percent -- create an atmosphere where banks and investors refuse to commit funds despite sound potential investments," said Tasman Economics chairman Michael Porter in his paper distributed during a seminar on fiscal decentralization on Tuesday.

Tasman Economics and Monash International's study focused on the impact fiscal decentralization had since it went into effect in January 2001.

"The problem here is that debt servicing is so poor that even central government lending to local governments is deemed risky," Porter said.

George Fane of the Australian National University, noted in his paper that only 29 percent of defaults were loans channeled to local governments. The bulk, or 64 percent, were loans channeled to local state-owned companies, dominated by water companies.

Porter said water companies defaulted on their loans mainly because they charged prices that were too low, as councillors were averse to raising them.

The concern over the huge number of defaults, however, rests not so much with the missing money as with the effect it had in keeping much-needed investors away from the country.

"Given the poor infrastructure in most provinces and the contribution that good infrastructure could be for local economic development, this does suggest a central concern with financing and repayment issues," Porter said.

Even without the regions' poor repayment record, investors have been wary about the impact the autonomy laws might have on their investments.

Under the 1999 autonomy laws, regions receive a bigger share of revenue as well as the authority to manage it.

But a glut of local taxes and other fees have sprung up as well, as regional autonomy compels regions to boost their own revenues.

Legal uncertainties have surfaced over contracts signed with Jakarta yet which fate now rests more with the local governments.

Reports of security problems like illegal logging and mining, unruly labor movements and armed separatist groups adds to the unfavorable investment climate.

Porter estimated that local revenues had more than doubled thanks to fiscal decentralization. But much of the revenue, he said, had gone into routine spending such as civil servant salaries since regional autonomy had shifted many of them to local government.

This came at the expense of development spending on needed infrastructure investments like roads, water and energy, he said.

According to him, Indonesian private investors are capable of developing these sectors but must be assured of the return on their investments.

"What is needed is a basis for lenders viewing the borrowing entity as having the capacity and the willingness and the obligation to repay," he said.

This capacity, he added, depended on the pricing structure with which companies generate revenue to pay back investors.

Several recommendations to curb defaults by local governments:

- Establish a debt servicing culture - with use or withdrawal of the General Allocation Fund (DAU) as a penalty, for example.

- Forcing local governments to guarantee the borrowing of local state-owned companies and have them pledge their receipts of DAU as collateral for loans to these companies.

- Reward local governments that have not defaulted with a 5 percent reduction on their outstanding debts. Restructure debts that are in default.

- Independent regulatory bodies for setting infrastructure service charges to encourage private investments into the water and electricity sectors.

- Local state-owned companies should borrow from state banks while also requiring them to place their deposits in these banks.