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Why Local Government Needs Alternative Development Funding
Limited funding remains a major constraint on local infrastructure development. The allocation of local government expenditure, which tends to remain unchanged every year, makes it difficult for local governments to allocate activities related to improving their local public infrastructure services, especially on government capex for large- scale infrastructure.
In 2018–2022, the average portion of transfer funds to regions (TKD) from the central govt. to total regional govt. revenue reached 83.2%1 . This indicates that the region has a high dependence on TKD and has not optimized the utilization of other funding sources outside TKD.
Finding alternative sources of infrastructure funding other than relying on TKD is an important step to overcome funding limitations, increase the flexibility of its use, and encourage the realization of infrastructure development.
Knowing Regional Bonds
Regional Bonds are debt securities issued by local governments to raise funds from the public or investors in the capital market. The issuance of these bonds aims to finance infrastructure projects or public services that have long-term benefits for the region.
As one of the medium or long term loan instruments, Regional Bonds require the local government to repay the principal at maturity along with periodic interest to the holder. The legal basis for the issuance of regional bonds involves regulations from the central government related to regional finance and supervision from the Financial Services Authority (OJK).
In preparing for a bond issuance, local governments need to prepare a special management unit to manage the implementation of the issuance of good debt securities, including the preparation of all needs before submitting registration to OJK (Pre-filling). Because it is related to funding through debt, local governments still need to apply for consideration to the central government.
Once the registration review has been approved by the OJK, the bonds will be listed on the Indonesia Stock Exchange (IDX) and publicly announced. During the public offering (sale); settlement (end of transaction); and listing of bonds; the local management’s unit requires assistance from selling agent. Selling agents, which are usually financial institutions such as banks or securities companies, have a wide network to reach investors, both individuals and institutions, and assist in the bond sales process.
Funds obtained from the sale of bonds can then be used by local governments to carry out funding for regional programs, especially those related to development.
Later on, the local government will periodically allocate a portion of the Local Govt. Budget (APBD) for the payment of principal and interest on bonds through the selling agent in accordance with the agreed amount.
Regional Bond Potential on Regional/Provincial-Scale Funding
The need for alternative funding schemes will increase as infrastructure development needs continue to grow, while local fiscal capacity is limited. With alternative schemes such as regional bonds, local governments can be more independent in designing and implementing priority infrastructure projects that have a direct impact on the welfare of the community.
Therefore, optimizing regulations and increasing the capacity of local governments in issuing and managing local bonds are crucial steps in supporting the acceleration of infrastructure development and sustainable regional economic growth.
From the investor’s perspective, regional bonds are generally considered a relatively safe instrument and profitable investment, also provide an opportunity for both investors or the public to take part in regional development and activities.
The existing state bonds are only issued by the Central Government. but there are several regions in Indonesia that have the potential to issue these bonds. In 2023, it is known that the United Nations Development Program (UNDP) and the United Nations Children's Fund (UNICEF)2 have conducted an assessment of Indonesian regions that are recommended to implement regional bonds.
Based on the bond rating map above, it is known that DKI Jakarta and West Java Provinces are the 2 provinces with the highest recommendation to issue regional bonds. Meanwhile, the provinces of West Sumatra, South Sumatra, Central Java, East Java, and South Kalimantan are included in the category of provinces that are also recommended to issue regional bonds.
Table I Summary of Local Government Capacity Fulfillme
The assessment takes into account several indicators such as the implementation of the Regional Government Agency Performance Accountability System (SAKIP), regional economic growth, financial market depth, democratic institution capacity index, social and environmental aspects, the value of the region's ability to repay loans (DSCR), BPK Audit (Unqualified Rating), and the absence of loan arrears.
This is supported by the maximum loan amount (adjusting the provisions of MoF Regulation No. 87 of 2024) owned by DKI Jakarta Province which is known to be the largest in Indonesia reaching Rp.10.3 Trillion and followed by West Java Province at Rp.6.2 Trillion. The cycle of economic activity in DKI Jakarta and West Java Province tends to be the largest when compared to other provincial areas in Indonesia.
Risk And Challenge on Issuing Regional Bond
The readiness of debt management and human resources are important considerations before issuing regional bonds. Local governments must ensure robust debt governance, including the availability of competent human resources in managing debt and regional fiscal instruments. Local governments must be careful in making regional bonds a financing option. This decision should be supported by an in-depth study.
Bond management should establish a new debt management unit (DMU) in charge of prioritizing debt levels, planning cost requirements, reviewing alternative principal and interest payments, and administrative readiness for the issuance of regional bonds.
The issuance of Regional Bonds requires careful planning and careful calculations. Issuing bonds haphazardly or in a hurry, without carefully considering the fiscal capacity of the region, the potential of the projects financed, and the ability to repay principal and interest, can pose a great risk to regional finances.
Instead of being a funding solution, this impulsive action has the potential to burden the Regional Budget (APBD) in the future, disrupt budget allocations for essential public services, and even plunge regions into prolonged financial difficulties. Therefore, every step in issuing regional bonds must be based on comprehensive analysis and evaluation as well as prudent financial governance.
Based on the Regulation of the Minister of Finance of the Republic of Indonesia Number 87 of 2024 concerning Procedures for Issuing and Repurchasing Regional Bonds and Regional Sukuk by Regional Governments, the value of regional bonds must not exceed the Regional Original Revenue (PAD) and must be in accordance with the local government's ability to pay at maturity. These limits are crucial to maintain fiscal sustainability.
Furthermore, total local government debt, including potential withdrawals, should not exceed 75% of the APBD, and this should be a reference in the issuance of local bonds. This limit is based on real needs and ability to pay.
In addition, the ratio of local financial ability to repay loans (DSCR) is a maximum of 2.5%. This limit is an important indicator in assessing the feasibility of issuing bonds.
Stakeholders’s Role on Supporting The Issuance of Municipal
In general, several stakeholder roles related to the issuance of regional bonds are described in the following table.
Despite the absence of comparable implementation at the sub-national (provincial) level, the regional bond scheme offers a promising alternative solution for a more flexible development financing framework for its government. The realization of this potential is highly dependent on the regional government's comprehension of its resources and debt management practices, alongside the assistance of consultants skilled in bond funding structuring.
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