Regional Bonds: Between Financing Innovation and Fiscal Discipline

The DKI Jakarta Provincial Government’s plan to issue regional bonds worth IDR 3.5 trillion with a seven-year tenor is not merely about introducing a new financing instrument. If realised, this move will become a new milestone in regional financial management in Indonesia, while paving the way for other local governments with adequate fiscal capacity to enter the bond market. Regional governments indeed have the authority to issue bonds as an alternative for development financing. In many countries, regional bonds have become a common instrument used to finance infrastructure projects with long-term economic benefits. For Indonesia, as this is a first experience, it is natural that the plan has sparked various discussions regarding its benefits, risks, and implications for national fiscal management. The question that then arises is whether debt-based financing has become a necessity. In public financial management, loans are a financing instrument used when there is a mismatch between revenues and expenditure needs. Government spending cannot simply be cut, especially when economic growth targets and development goals have been set. On the other hand, some strategic infrastructure projects cannot be postponed or built in stages through multi-year schemes. For Jakarta, partial project completion could potentially prolong traffic congestion, increase economic costs, and worsen public stress levels due to overly long construction periods. This is why the idea of creative financing finds its relevance. Bond issuance allows the government to obtain a large amount of funds upfront, so projects can be completed more quickly and the economic benefits can be felt by the public sooner. However, bond issuance is not the end goal, but rather a financing instrument. Debt should only be used to finance projects capable of generating economic and social benefits that exceed the costs incurred. Financing through bonds is certainly not without risk. In its guidance on managing fiscal risks from subnational governments, the IMF emphasises that a key principle in maintaining fiscal discipline is that regional government debt is not guaranteed by the central government. This principle is based on various international experiences where regional governments faced financial difficulties due to excessive debt accumulation. Interestingly, the IMF also acknowledges that economically, the central government almost always has an implicit guarantee for regional government loans. Legally, there is no obligation to bail out regional governments, but in practice, the central government often intervenes to ensure the continuity of public services, economic stability, and financial system stability. Such interventions can include taking over regional government debt, restructuring loans, increasing transfers to regions, or providing emergency loans. Simply put, issuing regional bonds not only creates obligations for the regional government but also potentially creates a contingent fiscal risk for the central government. Another noteworthy observation from the IMF is that central governments in various countries often focus more on controlling the amount of debt drawn by regional governments rather than examining the quality of spending financed by that debt. In fact, the root of fiscal problems often lies not in the size of the loan, but in the effectiveness of the use of the funds. Debt used to build productive infrastructure has different characteristics from debt that merely finances routine spending. Therefore, fiscal oversight should not stop at setting a maximum debt ceiling, but must also ensure that every rupiah of debt can increase the region’s economic and fiscal capacity in the future. The debate on regional bonds should not stop at the question of whether regional governments are allowed to borrow, but rather how to ensure that the debt remains productive without increasing fiscal risk for the central government. Apart from these ongoing discussions, the presence of regional bonds will also affect the dynamics of the national debt market. Regional bonds will likely offer slightly higher yields compared to Government Securities (SBN) as compensation for the relatively greater credit risk. This yield spread could potentially attract some investors who currently invest in central government securities. Admittedly, in the initial stages, the issuance value of regional bonds is still relatively small compared to the state budget’s financing needs. However, if more regional governments follow Jakarta’s lead, the domestic bond market will have a new investment instrument with a relatively low-risk profile yet offering more attractive coupon rates. This condition is one aspect that the central government needs to consider when formulating its state budget financing strategy. On the other hand, the existence of a regional bond market could also serve as a catalyst for deepening the domestic financial market. Investors will have more investment instrument choices, while regional governments gain access to more diverse financing.