Opportunity knocks for Indonesia

Wolfgang Fengler, Soekarno Wirokartono, Andrew Steer, Jakarta

A revolution is underway in Indonesia's finances, creating immense opportunity for a better future. After almost a decade of successful macroeconomic management, Indonesia is finally in a position of fiscal strength.

As a result of the sharp reduction in fuel subsidies last year, coinciding with declining debt service payments and increasing revenues, Indonesia has created additional "fiscal space" of US$15 billion in 2006 (out of a total national budget of some $70 billion). Equivalent to around 7 percent of gross domestic product (GDP), this is the largest increase in additional fiscal resources since the 1973-74 oil revenue wind fall, providing a tremendous window of opportunity for Indonesia to upgrade its creaky public services.

However, the challenges have changed since the 1970s and 1980s, when Indonesia first expanded its basic services, particularly in education and health. Today, Indonesia needs to invest more in the quality of its public services and better infrastructure. If Indonesia is to stay competitive, then it is crucial that some of these precious additional resources are channeled towards higher quality and more accessible secondary and tertiary education, an improved and more equitable health system and better infrastructure provision.

The central government is no longer in the driver's seat in delivering the bulk of public services. Indonesia's move to decentralization in 2001 has changed the fiscal fundamentals of the country, and it is particularly regional governments that need to spend money, not save it.

In 2006, Indonesia has experienced a "second big bang" when transfers increased by another $8 billion to a record $25 billion. This is projected to rise further to $28 billion this year. With such large sums now flowing to the regions, the challenge is no longer primarily to ensure that adequate resources reach the poorest regions, but rather to ensure that the poorest regions spend the resources well.

As the Indonesia 2007 Public Expenditure Review produced by the government and the World Bank highlights, the size and ranking of spending in key sectors has changed significantly since 2001.

Of the three key sectors covered in the 2007 review, education is the one that stands out as having benefited most from the recent changes in expenditure patterns. Spending on education is now higher in Indonesia than for any other sector, accounting for more than 17 percent of the government's total budget.

Meanwhile, although its nominal spending share of spending has increased from 2.6 percent in 2001 to 4.5 percent in 2006, health still ranks in a lowly eighth position in total government spending. Infrastructure too is only slightly above its post-crisis low of 9.2 percent and only accounts for 11.1 percent of total spending. This is not sufficient if Indonesia is to catch up on the "lost decade" of investment in infrastructure since the economic crisis and stay competitive with its regional peers. This concern is echoed by the fact that infrastructure spending has fallen back from fourth position in 2001 to only sixth position today.

Also noteworthy, while debt service payments have fallen, as would be expected, from first position (24.6 percent) in 2001 to fifth position today, there is concern that the proportion of spending on government apparatus has risen from 9.0 percent in 2001 to more than 15.3 percent today. This is a far higher share of spending on the bureaucracy than observed in similar developing countries and suggests that precious resources are not being used as effectively as they could in particular, on the provision on front-line services to the poor.

Indonesia is poised to spend its resources in ways that could greatly influence and accelerate the country's development over the next decade. If these resources are spent wisely Indonesia will be able to make the most of the financial opportunities now available to it after so much recent hardship.

Not only might devastating floods in Jakarta become a thing of the past. So too could poverty levels of 17.8 percent, poor quality and inaccessible public services, and the inadequate provision of infrastructure that all combine to hold Indonesia back from achieving its ambitious development goals and, ultimately, its full potential.

With the changes already underway and fiscal opportunities these changes create, there is reason to hope that Indonesia will be under the international spotlight for the right reasons, not the wrong ones.

Wolfgang Fengler is World Bank Senior Economist, and lead author of the Indonesia Public Expenditure Review 2007, Soekarno Wirokartono, Former Deputy for Macro-economy, BAPPENAS and Andrew Steer, Country Director, World Bank Indonesia