Review of the KDP Microcredit Approach

Transcription

1 PPK P rogram Pengembangan Kecamatan KDP K ecamatan D evelopment P rogram Review of the KDP Microcredit Approach Financial Management Unit UPK Telagasari, West Java Consultancy Report prepared for World Bank, Jakarta Office by Dr. Detlev Holloh Jakarta, September 2001

2 Review of the KDP Microcredit Approach Dr. Detlev Holloh, September 2001 KDP Microcredit System Review i CONTENTS Introduction 1 1. KDP Objectives, Strategy and Instruments Context and Objectives of the First Kecamatan Development Program (KDP I) KDP Organization, Technical Assistance and Implementation Responsibilities KDP I Project Strategy and Implementation Process KDP I Microcredit System and Revolving Fund Management Project Appraisal of the Second Kecamatan Development Program (KDP II) KDP Credit Performance and Experiences KDP Credit Performance: What Do Databases and Reports Say? Availability and Quality of Information General Performance and Allocation of Funds Credit Repayment Performance Credit and Financial Management Problems Findings of KDP Economic Studies Microcredit Approach and Management Governance and Management of Loan Funds Borrower Characteristics, Loan Use and Impact Reasons for Poor Repayment Performance KDP Relations to Banks and other Credit Programs Recommendations of the Economic Studies Field Visit Findings: Yogyakarta, Lampung, Karawang General Performance UPK Organization and Management Outreach and Financial Performance Financial Administration and Management Credit Management Project Support Preparing the Future of UPKs 56

3 KDP Microcredit System Review ii 3. Major Issues and Conclusions KDP Microcredit Performance: Design Matters Terminating Microcredit or Phasing-out Old Sub-districts? Alternatives to Managing Loan Funds by UPKs? Should Microcredit be Continued in KDP II? KDP Strategy and Process Vs. Sound Credit Management Microcredit & Revolving Funds Expertise and Consultancy Inputs Objectives-Oriented Planning for Microcredit & Revolving Funds Manuals and Instruments for Microcredit & Revolving Funds Management Training and Consultancy Systems for Microcredit & Revolving Funds Information and Supervision Systems for Microcredit & Revolving Funds Governance and Future of UPKs Target Groups, Credit Eligibility and Access to Credit Towards a New KDP II Microcredit Approach: A Proposal Principles for the New KDP II Microcredit Approach Proposal for a Preparatory Technical Taskforce 73 Annexes A. Detlev Holloh, ProFI Microfinance Study, Bank Indonesia and GTZ, Denpasar, March B. Regional Income Generation Project (RIGP-P4K): Information Materials C. Presentation of Preliminary Results of the Review Mission, 19 September 2001

4 KDP Microcredit System Review iii CURRENCY EQUIVALENTS Note: The report provides information in Rupiah only, as the exhange rate has been extremely volatile during the last years and the US Dollar does not reflect local financial intermediation exclusively done in Rupiah. End of Year Currency Unit: US Dollar Currency Unit: Indonesian Rupiah (Rp.) 1997 $ 1 = Rp. 4, $ 1 = Rp. 8, $ 1 = Rp. 7, $ 1 = Rp. 9,675 August 2001 $ 1 = Rp. 8,925 September, 22, 2001 $ 1 = Rp. 9,420 FISCAL YEARS Until March 31, 2000: April 1 to March 31 Until December 31, 2000: April 1 to December 31 From January 1, 2001: January 1 to December 31

5 KDP Microcredit System Review iv ABBREVIATIONS AND ACRONYMS BPD BPR BRI FD FK GTZ IDR IDT KDP KM-Kab KM-Prop LKMD NMC P2KP P4K PDM-DKE PHBK P3DT PjAK PjOK PMD BPM PPK ProFI RIGP/P4K TPK UDKP UED-SP UPK USD VIP Bank Pembangunan Daerah: Regional Development Bank Bank Perkreditan Rakyat: People s Credit Bank Bank Rakyat Indonesia: People s Bank of Indonesia, commercial state bank Fasilitator Desa: Village facilitator Fasilitator Kecamatan: Sub-district facilitator German Agency for Technical Cooperation Indonesian Rupiah Inpres Desa Tertinggal: Presidential Instruction on Backward Villages Kecamatan Development Project (PPK) KDP District Management Consultants KDP Provincial Management Consultants Lembaga Ketahanan Masyarakat Desa: village administrative body KDP National Management Consultants Proyek Penanggulangan Kemiskinan di Perkotaan: Poverty Alleviation Project in Urban Areas Proyek Peningkatan Pendapatan Petani-Nelayan Kecil: Small Farmers' Income Generating Project Pemberdayaan Daerah dalam Mengatasi Dampak Krisis Ekonomi: Local Empowerment by Overcoming the Impact of the Economic Crisis Proyek Hubungan Bank dengan Kelompok Swadaya Masyarakat: Project Linking Banks and Self-help Groups, also: linkage project Pembangunan Prasarana Pendukung Desa Tertinggal : Village Infrastructure Project (VIP) KDP sub-district administrator KDP sub-district project manager Pengembangan Masyarakat Desa: Village Community Development Agency, Ministry of Home Affairs (Now: Badan Pengembangan Masyarakat) Program Pengembangan Kecamatan: Sub-district Development Program Promotion of Small Financial Institutions Rural Income Generation Project, 3 rd phase of P4K KDP village implementation team Sub-district Council of Village Heads, includes more village representatives as the KDP planning and decision-making body. Unit Ekonomi Desa-Simpan Pinjam: Village Economic Unit-Savings and Credit Unit Pengelola Keuangan: Financial Management Unit of PPK US Dollar Village Infrastructure Project

6 KDP Microcredit System Review v EXECUTIVE SUMMARY The Kecamatan Development Program (KDP) aims at alleviating poverty, improving local governance and strengthening local government and community institutions. KDP allocates block grants to poorer sub-districts for financing village infrastructure and economic activities through participative local planning and decision-making mechanisms. A Financial Management Unit (UPK) at the sub-district level provides either grants for infrastructure projects to villages or loans to community groups. UPKs use loan repayments to build up revolving funds managed. This report reviews KDP s current microcredit system to come up with recommendations for the second KDP project to be implemented between January 2002 and June The review focuses on examining the supply side of KDP s microcredit system. If credit management and services are wrong, loan use will most likely not be achieving the expected impact. Design Matters. KDP has been successful in involving communities in local planning and decision-making, making governments more responsive to local needs, and building low-cost infrastructure by participative planning and self-help. This success was based on a tailor-made project design. In contrast to this success, KDP s microcredit and revolving fund component has been performing poorly. The major conclusion of this review is that the very same design that brought about project success doomed KDP s microcredit component to failure. KDP Strategy Incompatible with Sound Credit Management. The core of the project is a participative planning and decision-making process by which funds are competed for between villages. This process is good for allocating funds earmarked for public goods. It is incompatible with the sound management of credit and revolving funds. Both participative forums and local government institutions are governed by logics other than required for good credit governance. Special Microcredit Planning and Inputs Matter. KDP did not make microcredit a focus of strategic planning. Consequently, the project has not been providing the inputs required for a successful microcredit program. There are no comprehensive financial & credit management manuals and instruments. Financial & credit management training modules do not exist. Neither training and consultancy systems nor effective information and supervision systems were established for both the UPK as the lender and the community groups as the borrowers. KDP financial intermediaries lack financial and credit management capabilities. Common bonds, internal control, organization and financial administration of community groups have been weak. Group members lack business planning and management capabilities. Alternatives? Executing program credit through banks, linking community groups to banks, or decentralizing revolving funds to the village level were discussed as alternatives to managing KDP loan funds by UPKs. This report comes to the conclusion that these alternatives are not viable, do not necessarily improve credit services to low-income households, do increase rather than decrease project burdens, or do not provide a generalized solution for all project areas. UPKs should be encouraged to graduate bankable borrowers to banks. However, the scarcity of both bankable KDP groups and banks able and willing to provide credit services to KDP s target groups, leaves no general option other than managing loan funds by UPKs.

7 KDP Microcredit System Review vi Continue Microcredit Operations? KDP II stakeholders are advised to continue credit and revolving fund operations only, if they are willing to make substantial changes to the current system. Elements of such substantial changes are: Targeting Low-income Households with Prudential Credit Services SEPARATE CREDIT MANAGEMENT. Credit management must be made subject to prudential banking principles. KDP process-oriented strategy needs to be maintained, but credit management should add output orientation and be separated from the overall process. The lender (UPK) should take and manage credit risks by commanding all credit procedures. DEMAND-DRIVEN AND SUPPLY-CONTROLLED CREDIT. KDP has been applying an approach driven by expressed needs. A demand-driven approach looks to effective credit demand, absorption and repayment capacity. Identifying real demand requires a supply-controlled approach. The lending institution rather than community forums has to appraise credit feasibility and to determine loan amounts, terms and conditions. CREDIT ALONE IS NOT ENOUGH. UPKs, community groups and individual borrowers must be trained before credit operations start, and they must have access to continued technical assistance and supervision services. NO FAST CREDIT. Credit operations must be prepared. Require sub-districts to finalize preparations before credit operations are started. NO EASY CREDIT. Access to credit is not a matter of course. Groups have to meet credit eligibility criteria. Borrowers have to pledge guarantees, measurable efforts of self-help and joint responsibility, to get access to credit; they must prove willingness to repay, to collect savings and to learn from KDP training. NO INSTANT CREDIT. One-time access to credit is not what low-income households need and what make borrowers repaying credit. Guarantee repeated and sustained access to credit for well-performing borrowers by thoroughly planning the allocation of UPK loan funds. NO CHEAP CREDIT. Interest rates should not undermine sustainable banking operations. The setting of interest rates has to take cost of funds, loan loss costs and credit risks, operating and inflation costs into account. Interest rates must cover costs and sustain the net value of loan funds. Making Self-help Groups and UPKs the Focal Points of the Microcredit Approach GROUP FOCUS. Make self-help groups the focal point for strengthening the demand side of the microcredit approach. Their capability of planning and managing microbusinesses, managing savings and credit activities, and bargaining and networking with third parties is a crucial factor for making the KDP microcredit program a success. Strengthening groups has to be accompanied by requiring borrowing groups and members to pledge self-help and guarantees, and to meet credit eligibility criteria.

8 KDP Microcredit System Review vii Credit eligibility develops. KDP II should apply a gradual approach to providing credit access. This includes, i.e., limiting individual loan sizes and making higher loan sizes dependent on repayment performance and the members business planning and management capabilities. This approach should also guarantee repeated and sustained credit access for well performing borrowers. UPK FOCUS. Make the UPK the focal point for strengthening the supply side of the microcredit approach. The proper setup of the UPK system and the training of UPK staff is crucial for ensuring prudential financial and credit management. The new UPK governance should be based on: o Full credit management responsibilities. o Direct relationships of UPKs to borrowing groups. o By-laws that determine objectives, operations, supervision, liability of managers. o Staffing with capable and motivated persons. o UPK staff graduating from KDP training. o Setup of accounting & financial management system before starting credit operations. o Village credit officers as UPK staff and responsible to the UPK. o Effective supervision and auditing. o UPK association building for cooperation and networking with service providers. o UPK cooperation with special local consultants. Preparatory Steps for the KDP II Microcredit Approach Designing basic approach and policy decision. Objectives-oriented planning of the microcredit component. Developing UPK accounting system / financial management instruments and manual. Designing credit management instruments and manual. Designing training manuals and training management system. Designing UPK consultancy system. Preparing procurement of local trainers and consultants. Designing microcredit/upk information and supervision systems. Designing credit eligibility and group development concept. Preparing the setup of the KDP II long-term microcredit consultancy team. Ensuring Preparations and Enabling Preparations to Become Effective To ensure fast preparation of the new microcredit system, an independent small technical task force of microcredit experts should be assigned. Sub-districts should prepare phasing-in plans that include all preparatory steps and requirements for starting microcredit operations. Sub-districts should be required not to start credit operations before preparations are finalized, UKPs are set up, and UPK staff and groups are trained.

9 KDP Microcredit System Review Introduction The Kecamatan Development Program (KDP) aims at alleviating poverty, improving local governance and strengthening local government and community institutions by allocating block grants to poorer sub-districts as sources of funds for financing village infrastructure and economic activities through participative local planning and decisionmaking processes. A special Financial Management Unit (UPK) at the sub-district level manages KDP funds. The UPK finances village infrastructure projects in the form of grants and economic activities of community group members in the form of loans. Loan repayments flow back to the sub-district level to be managed as revolving funds through the project s planning and decision-making mechanisms. The First Kecamatan Development Program (KDP I) has been implemented since August Its third annual cycle of local project planning and implementation was planned to end on 31 August 2001, but preparations for the third cycle are still under way and loan repayment of the third disbursement cycle may reach well into The appraisal of the Second Kecamatan Development Program (KDP II) was finalized in May KDP II implementation is planned to commence in January 2002 and to last until June The consultant was assigned to review KDP s current microcredit system with the objective to prepare a proposal for the KDP II microcredit approach. The consultancy was carried out between 2 August 2001 and 21 September It included three weeks of field travel in West Java, Yogyakarta and Lampung. The consultancy report is based on field findings, the review of current project designs, formats, databases, reports and studies, meetings with various project stakeholders and related parties, and intensive discussions with the National Management Consultant s (NMC) financial management team. The consultant is greatly indebted to Mr. Azlim Fitra, NMC Social and Economic Monitoring Expert, and Mr. Agung H. Budi, NMC Credit Specialist, for supporting his field visits and providing valuable inputs for his report. Project studies in the field of microcredit have been focusing on loan use and impact, the demand side of KDP s microcredit approach. While these studies are used as important sources of information, this report focuses on the supply side of KDP s microcredit system. Experience from other microcredit programs shows that design matters and its transformation into practice through project instruments and inputs are crucial for either project success or failure. If credit management and services are wrong, loan use will most likely not be achieving the expected impact.

10 Introduction KDP Microcredit System Review 2 One of the first observations of the consultant was that project stakeholders and various project documents communicate different objectives and expectations with regard to KDP s microcredit and revolving fund approach. Assuming that project objectives and design determine the strategies and instruments applied in local project implementation, the consultant placed much emphasis on examining the relationship between the KDP s credit and revolving fund management approach as reflected in its design, strategy, guidelines and instruments, on the one hand, and KDP s credit and revolving funds performance, on the other hand. This report consists of four chapters: The first chapter describes KDP s project design, strategy and instruments. What does the project want to achieve, which strategy is applied to achieve project objectives, and which inputs and instruments are provided in support of the project strategy? Special attention is given to examining KDP s credit and revolving fund management system. The second chapter looks to the output side of KDP s microcredit system. Findings presented here are based on a) national databases and local reports, b) economic and microcredit studies carried out by the project, and c) the consultant s field visits to West Java, Yogyakarta and Lampung. The third chapter presents the major issues and conclusions of the consultancy. The major conclusion is that microcredit has become KDP s problem child because of the very same design that made the project successful in improving participative local planning and decision-making processes for infrastructure investments. KDP II is advised to continue credit and revolving fund operations only, if substantial changes to the current system are made. The fourth chapter presents principles that may guide KDP towards a new microcredit approach and proposes setting up a microcredit technical taskforce that can is capable of preparing the KDP II microcredit and revolving fund system. The consultant refrained from providing a detailed proposal, because technical preparations are highly dependent on policy decisions to be taken for substantially changing the current KDP microcredit approach.

11 KDP Microcredit System Review 1. KDP Objectives, Strategy and Instruments This review of KDP s microcredit system starts from the current project design and its rationale as documented in various project documents. What does the project want to achieve, which strategy is applied to achieve project objectives, and which inputs and instruments are provided in support of the project strategy? This chapter summarizes the KDP I project design and the KDP II project appraisal document as far as relevant for the discussion of KDP s microcredit system. It is based on the following references: A. The World Bank, Rural Development and Natural Resources Sector Unit, Indonesia Country Department, East Asia and Pacific Region: Project Appraisal Document on a Loan in the Amount of US$ 225 Million to the Republic of Indonesia for a Kecamatan Development Project, World Bank Report No.: IND, April 21, B. Departemen Dalam Negeri Republik Indonesia, Tim Koordinasi Program Pengembangan Kecamatan: Petunjuk Teknis Operasional Program Pengembangan Kecamatan (PPK), Tahun Anggaran 1999/ , Jakarta (Implementation guidelines) C. National Management Consultants for the KDP National Secretariat: Kecamatan Development Program. Second Annual Report 1999/2000, Jakarta, September D. Departemen Dalam Negeri dan Otonomi Daerah Republik Indonesia, Tim Koordinasi PPK Pusat: Kebijakan Penyempurnaan Petunjuk Pelaksanaan dan Petunjuk Teknis Operasional Program Pengembangan Kecamatan (PPK) Tahun 2001, Jakarta (Collection of circular letters improving provisions made in the implementation guidelines) This document includes guidelines for KDP s revolving fund: a. Menteri Dalam Negeri Republik Indonesia, Surat Edaran Nomor 414.2/1098/PMD, Petunjuk Teknis Perguliran Dana PPK, Jakarta, 5 Agustus b. Menteri Dalam Negeri Republik Indonesia, Surat Edaran Nomor 412.2/1663/PMD, Penegasan Prinsip-prinsip Teknis Perguliran Dana PPK, Jakarta, 27 Desember E. Departemen Dalam Negeri dan Otonomi Daerah Republik Indonesia, Tim Koordinasi PPK Pusat: Formulir Isian Program Pengembangan Kecamatan (PPK) Tahun 2001, Jakarta (Collection of instruments and forms applied in project implementation) F. The World Bank, Environment and Social Development Unit East Asia and Pacific Region: Project Appraisal Document on a Proposed Loan in the Amount of US$ Million and Proposed Credit in the Amount of SDR 87.5 Million (US$ Million Equivalent) to the Republic of Indonesia for a Second Kecamatan Development Project, World Bank Report No IND, May 23, 2001.

12 Objectives, Strategy and Instruments KDP Microcredit System Review Context and Objectives of the First Kecamatan Development Program (KDP I) The formulation of development objectives and project strategies depends on the perception and analysis of problems the target population or institutions are exposed to. The project documents available to the consultant do not include a systematic problem analysis with regard to microcredit, but they describe the strategic context from which the project and its microcredit intervention emerged. The IDT and P3DT Projects as KDP Predecessors With the issuance of Inpres Desa Tertinggal (IDT), or Presidential Instruction on Backward Villages, in 1993 poverty alleviation was made a political top priority. IDT became an ambitious poverty alleviation program that targeted 44% of Indonesia s villages in three financial years (1994/1995 to 1996/97). As of March 1997, the program had injected IDR 1.3 trillion into 28,376 villages and 123,000 community groups. The IDT design already included the major KDP components: a) capital grants to be used as revolving funds for income-generating activities of the poor; b) capital grants to be used for improving the physical infrastructure of poor villages, and c) technical support provided by program facilitators. As a crash program that hastily formed community groups to channel loans at highly subsidized interest rates, however, IDT represented a break with good practices of developing viable self-help groups of the poor and sustainable microfinance systems accessible by the poor. Focusing on distributing money in short time rather than on the self-reliance of community groups and the sustainability of microcredit services, and lacking a proper monitoring and supervision system, about half of credit channeled was not repaid. Pembangunan Prasarana Pendukung Desa Tertinggal (P3DT) or the Village Infrastructure Project (VIP) was added to the IDT program and, financially and technically assisted by the World Bank, has been working through one-time block grants to poor villages and has been. Launched in the financial year 1995/96, the project is reported to have been successful in introducing participative mechanisms for planning, building and maintaining low-cost village infrastructure. Both the unsatisfactory IDT performance and the satisfactory VIP performance contributed to rethinking future project designs. The World Bank s project appraisal document used the lessons learned from VIP, but enabled greater decision-making, especially by (a) introducing block grants at the sub-district level to accommodate differing local needs; (b) establishing an open menu policy for funding proposals from the village level; and (c) aiming at strengthening local government capacity and developing a sustainable local mechanism for participative fund management. KDP as a Reaction to the Financial Crisis, Poverty and Bad Governance The long-term financial and economic crisis since mid-1997, accompanied by the El Nino drought, revealed that the majority of the Indonesian population had remained highly vulnerable to expenditure poverty. It was estimated that the poverty incidence in the second half of 1998 was more than two times the estimated pre-crisis low, and that, taking into account the various dimensions of poverty, that poverty confronted more than half of all Indonesians.

13 Objectives, Strategy and Instruments KDP Microcredit System Review 5 KDP was designed under the impression of this crisis and poverty incidence. In line with Government and World Bank policies, the project intended to address these problems with labor-intensive work programs and fast cash transfers to the poor. The project appraisal stated: KDP is expected to become the government's umbrella for community-based poverty relief. The rapid transformation of the financial into a political crisis also highlighted that decades of authoritarian centralized rule had undermined local initiative, planning and decision-making, the accountability of the local administrative system and its responsiveness to the needs of the poor. While bad governance had become a major constraint for economic recovery and poverty alleviation, in general, the KDP design recognized that the effective delivery of services to the poor and the village level requires improving the capacity, transparency, and responsiveness of local government and strengthening community institutions through participative planning and decisionmaking processes. The KDP project design may be regarded as a response to the inter-related problems of poverty and bad governance. This response fitted into the reform and stabilization program the Government embarked upon in 1998, which included a range of social safety net and credit programs in order to cushion the impact of the crisis as well as efforts to improve public accountability and local decision-making. Risks and Assumptions Related to the Strategic Project Context The project appraisal rated the risk of fast project scale-up high. Facing the pressure of mass poverty, however, it opted for covering 725 sub-districts within two years, also because it assumed that the VIP had provided a successful test of basic project mechanisms: Once a tested system of this type is in place, the success of any one village/kecamatan is independent of the number of kecamatans in the program. The project appraisal pointed to the persisting risk of unaccountable and unresponsive local governments. It also pointed to the lesson that government should concentrate on providing adequate frameworks rather than direct involvement in local project implementation. Nonetheless, it opted for providing financial resources through local administrative structures, especially LKMDs, the village councils that have managed VIP programs with such success. Project Objectives and Expected Outputs The project appraisal defines KDP s development objectives as to a) raise rural incomes, b) strengthen kecamatan and village government and community institutions, and c) build public infrastructure through labor-intensive methods. Direct financing of community activities through participatory planning and decision-making mechanisms at the sub-district and village levels is thought to shorten the lag between planning requests and funding availability, to ensure implementation of local priorities, and to improve local transparency and ownership. KDP s implementation guidelines define the general project objective as to accelerate the alleviation of poverty and strengthen community and government institutions via the provision of funds for the development of productive businesses and infrastructure in rural areas.

14 Objectives, Strategy and Instruments KDP Microcredit System Review 6 Specific project objectives/outputs mentioned are: To increase community participation in planning, implementation and sustaining rural economic activities. To increase business activities, employment opportunities and income sources of the rural population. To provide infrastructure for developing the people s economy in rural areas. Increase the capacity of community and government institutions at the village and sub-district level for facilitating people s empowerment in implementing development programs. The project appraisal formulates the following project outputs that are supposed to contribute to KDP s development objectives: a) improved planning of villages, b) public infrastructures proposals implemented, and c) economic investments proposals implemented. Key performance indicators mentioned are a) participation of 350 subdistricts in the first and of 725 sub-districts in the second financial year; b) 2000 new villages participating each of the three financial years; funds disbursed per financial year (IDR 227 billion, 450 billion, 450 billion); economic returns on sub-projects higher than 20% per financial year; loan repayment rates better than 80% per financial year; and a percentage of revolving funds with increased capital higher than 80% per financial year. Note: The project objectives imply funding of infrastructure and microbusinesses. However, microcredit and revolving loan funds were not directly made an integral part of project objectives and outputs. Sustainability of microcredit services was did not become a focus of the project design, though one if the key performance indicators mentioned expects that revolving funds will be growing. While the project appraisal assumes that KDP will phase out credit activities after three years of project implementation, the project s implementation guidelines explicitly mention the necessity of sustaining the revolving fund. After the general presentation of the project concept in the appraisal document, KDP appears not to have developed a comprehensive logical framework through which the role of its microcredit system is clearly defined through a hierarchy of objectives, outputs, and indicators. 1.2 KDP Organization, Technical Assistance and Implementation Responsibilities At the national level, KDP is currently carried out under the responsibility of the Community Development Agency (PMD) of the Ministry of Home Affairs. PMD s Project Secretariat, headed by the national project manager and assisted by an advisory team, manages the project budget, contracts consultants, determines the project policy, and issues project regulations and guidelines. A National Management Consultant (NMC) team provides technical assistance. Currently, it consists of 42 consultants but has only one recently employed credit specialist. At the provincial and district level, KDP secretariats and coordination teams are responsible for project coordination. Technical assistance comes through provincial management consultants (KMProp) and district management consultants (KMKab),

15 Objectives, Strategy and Instruments KDP Microcredit System Review 7 which were contracted through various consulting firms. The project currently employs 20 provincial and 215 district consultants. These consultants have general project implementation and monitoring responsibilities. Microfinance or credit experts are not hired at the provincial and district levels. Project Implementation at the Sub-district Level The locus of project implementation is the sub-district level. The sub-district head has the overall responsibility for project implementation, legitimizes fund allocation to villages based on decisions taken the sub-district development forum (UDKP), and legalizes the latter s financial management unit (UPK). Operational responsibility is assigned to a sub-district project manager (PjOK), a local PMD official assisted by another civil servant responsible for project administration (PjAK). Both officials cooperate with project staff in facilitating the functions of the UDKP and UPK. UDKP Sub-district Development Forum. The allocation of KDP funds to selected sub-districts given, the UDKP becomes KDP s core decision-making body. The UDKP is originally a forum headed by the sub-district head and made up of village leaders and sub-district officials in order to communicate local development issues. In the framework of KDP, UDKP participants are additionally made up of project personnel and three members per village who were elected in or chosen from the village meeting. Other community members and the public in general are also invited to participate in the forum. Though the UDKP is its final decision-maker, KDP s implementation guidelines do not specify its institutional role and functions, especially with regard to supervising the financial and credit management of UPKs, as it does for other stakeholders. Expected outputs and procedures of the forum are explained as part of KDP s planning process. There are two UDKP meetings during each project cycle. The first meeting takes place after information on KDP had been disseminated to the villages. Outputs expected from the meeting are: selecting participating villages, fixing rules and sanctions for project implementation, planning of village meetings and village facilitator training. The second meeting is the place where competition between villages takes place, and funding proposals of villages are discussed and decided upon. The meeting is also responsible for forming a financial management unit (UPK) and electing its staff members based on proposals of each participating village. UPK Sub-district Financial Management Unit. The Unit Pengelolaan Keuangan (UPK) or Financial Management Unit is formed by and responsible to the UDKP forum. An appointment letter of the sub-district head legitimizes its operation. The UPK is usually a small room, either provided by the sub-district government or rented in a private house, which is equipped with tables, chairs, white boards displaying project information, a typing machine or computer. UPK staff usually consists of a chairperson, an accountant and a secretary. For covering its operational costs the UPK receives 2% (maximum) of KDP funds allocated to the sub-district. The UPK is the central body through which the revolving funds of sub-districts are managed. KDP s implementation guidelines make it responsible for the entire administration of the project as well as for credit administration and supervision,

16 Objectives, Strategy and Instruments KDP Microcredit System Review 8 ensuring repayment, and providing technical support to LKMDs, village implementation teams and community groups. A more detailed description of the UPK can be found in the following chapters. FK - Sub-district Facilitators. Technical assistance at sub-district level is provided by sub-district facilitators (FK), which were procured through consulting firms other than those of the management consultants. KDP currently employs 1,329 of these facilitators. Besides general communication and facilitation functions, the project s implementation guidelines assign the following tasks relevant for microcredit activities to FK: Identify local sources of funds and credit as alternative choices. Carry out training for village facilitators in cooperation with the PjOK. Assist village facilitators in facilitating the collection of funding ideas. Monitor the preparation of funding proposals, ensuring the preparation of loan repayment schedules for groups and members. Provide technical assistance to village implementation teams in cooperation with the PjOK. Carry out and facilitate training for UPK in cooperation with the PjOK. Assist UPK, LKMD and village implementation teams with respect to credit management and repayment. Assist UPK with respect to business development and revolving fund management. Recently, FK have been provided with assistants, who share the general burden of socialization and facilitation functions, and are also supposed to assist villages with regard to microcredit activities and loan repayment. Project Implementation at the Village Level The village head has the overall responsibility for project implementation at the village level. According to KDP s implementation guidelines the village head has to stimulate group meetings, hamlet meetings and community participation in preparing funding proposals as well as to supervise project implementation and the use of funds. The LKMD is made responsible for project steering through village meetings. It is given the tasks to disseminate project information, carry out village meetings, prepare project administration documents, and to record loan repayments as well as to collect loan installments, if they were not paid on time. For covering operational costs during project implementation LKMD receive 3% (maximum) of KDP funds allocated to the village. A special village implementation team (TPK) is set up to assist the LKMD in project administration and to manage the entire project planning and implementation process at the village level. Note: The LKMD is given a core function in project implementation. Originally, it is a body of village leaders and officials who had to assist the village head in implementing governmental village development programs under the centralistic rule of the New Order Government. As this institution has usually not been responsive to community needs, villagers usually regard it as part of the government machinery. Though times

17 Objectives, Strategy and Instruments KDP Microcredit System Review 9 are slowly changing, this feature is more persistent than apparently assumed by the project design and guidelines, which refer to LKMDs as community institutions. Village Development Forum. The major decision-making power at the village level is given to the Village Development Forum (Musbangdes), in which village officials, project staff, group representatives and other community members are supposed to participate. The project s implementation guidelines do not specify its institutional role and functions, but they mention outputs expected from three village meetings during a planning and implementation cycle. The first meeting elects the village facilitator and agrees upon a schedule for collecting funding ideas from hamlets and groups. The second meeting is to agree upon funding proposals to be forwarded to the UDKP, elects three village representatives (besides the village head and the chairman of the LKMD) for the UDKP meeting, and forms a team responsible for preparing funding proposals. The third meeting discusses the results of UDKP decisions, elects the village implementation team, and should agree upon sanctions and loan repayment schedules. Community groups. The ultimate target population of the project is poor community members organized in groups that should have been existent for one year. It is important to note that the project s implementation guidelines have not established clear eligibility criteria and responsibilities for community groups, although KDP credit funds are channeled to and loan repayment is expected from them. Village Facilitators and Engineers. Technical assistance at the village level is to be provided through two Village Facilitators (FD) and one Village Engineer (TTD) per village. Village engineers are employed by the LKMD for preparing technical proposals and supporting the technical implementation of funding proposals, mainly for infrastructure activities. Village Facilitators are elected by the village meeting and have to members of the village community. KDP s implementation guidelines assign the following tasks to the village facilitators: Participate in training provided by FK and PjOK. Stimulate community participation in group meetings and activities. Collect funding ideas from the community and groups. Assist community groups in preparing proposals. Assist LKMD in carrying out village development meetings. Assist in preparing reports of groups and village implementation team. Assist groups in developing cooperation with respect to economic activities. Assist FK in facilitating community groups and timely loan repayment. 1.3 KDP I Project Strategy and Implementation Process Project Principles. According to the project s implementation guidelines, the KDP strategy is guided by the principles of decentralization, transparency, participation of the poor and women, healthy competition for funds between villages, self-help and selfreliance, sanctions and sustainability. KDP s annual project report emphasizes community participation and empowerment of the poor, transparency and sustainability as key principles of project implementation. Empowerment is defined as community ownership in all aspects of the project. Transparency is explained as open decision-

18 Objectives, Strategy and Instruments KDP Microcredit System Review 10 making and financial management shared with the entire community. Sustainability refers to community self-reliance and village management of all activities. The project documents do not clarify the substance and implications of these principles for KDP s microcredit system. Are participation and competition between villages really elements of managing revolving funds according to good practice standards? What is the substance of self-reliance, empowerment and sustainability with regard to finance and microenterprise development? Target Population and Targeting. The implementation guidelines state that project s main target group and beneficiaries are the poor. It is important to understand that the project does not directly target the poor. Targeting is limited to the selection of subdistricts with high proportions of poor villages. The project appraisal suggests that subdistricts are relatively homogenous in terms of poverty, and thus form a good basis for project targeting. Self-targeting mechanisms such as wages at local rural minimum for works and repayment with interest for economic activities are supposed to orient project funds towards the poor. This assumption is based on experiences of the Village Infrastructure Project. Note that requiring loan repayment with interest is most probably not a sufficient condition to reach the poor with credit services through mechanisms applied for infrastructure services. Direct Fund Transfer and Open Menu Policy. KDP starts with selecting eligible subdistricts and disbursing annual block grants over a three-years period to them through direct transfers from the national level through the local treasury office to a collective village account at a local bank. Depending on population size annual block grants ranged from IDR 350 million to IDR 1 billion per sub-district for the first two financial years. In order to strengthen local decision-making and choice KDP applies an open menu policy allowing funding proposals for infrastructure and economic activities except those on a negative short list. The Open Menu policy is an important element of KDP. It allows villagers themselves to decide what they want. The minimum amount per proposal is IDR 15 million for women groups or otherwise IDR 35 million, and the maximum amount approved per proposal is IDR 150 million. Project Cycle, Planning and Decision-making Process. The allocation of funds to villages either in the form of grants for infrastructure proposals or in the form of loans provided to community groups is result of a long planning and decision-making process that takes at least four months until final decisions are taken by the UDKP forum and funds are released by the UKP to villages and community groups. This process is preceded by a phase in which KDP information is disseminated at all project levels and is followed up by implementation, supervision and evaluation phases. One project cycle consists of the following phases and activities as documented in the project s implementation guidelines and annual report: Socialization and dissemination of Information: Provincial and district workshops; Selection and training of sub-district facilitators; UDKP I meeting to select participating villages and plan project implementation; First village development forum (Musbangdes I) to elect village facilitators and prepare a schedule for collecting funding ideas; Training of village facilitators.

19 Objectives, Strategy and Instruments KDP Microcredit System Review 11 Socialization in hamlets and collection of funding ideas: Hamlet and group meetings to disseminate KDP information and encourage submission of ideas; Special meetings with women's groups to discuss women's proposal ideas; collection of funding ideas. Selection and preparation of village proposals: Second village development forum (Musbangdes II) to discuss and agree upon funding proposals, elect village representatives for UDKP II, and form the team responsible for preparing funding proposals; Technical preparation and application of village proposals. Feasibility / Verification Stage: Formation of verification teams; Examination of completeness of proposals; Crosscheck by district consultant; Field visit to all applicants to assess feasibility of proposals, preparation of recommendations. Funding Decisions: Second UDKP meeting to discuss and select village proposals for funding; Election of UPK staff members. Preparations for Implementation: Third village development forum (Musbangdes III) to discuss results of UDKP II meeting, elect the village implementation team, agree upon sanctions and loan repayment schedules; Recruitment of village technical assistance; Training for implementation teams, UPK, village engineers; Transfer of funds from the state treasury to collective village bank accounts. Implementation: Mobilization of village laborers; Procurement of materials and equipment; Withdrawal of funds from collective village bank account and loan disbursements; Implementation of village activities; Supervision, monitoring, and reporting. Post Implementation Stage: Maintenance of infrastructure; Handover of completed projects; Collection of loans with a maximum maturity of 18 months; Sustainability and growth of revolving fund; Strengthening of UPK, LKMD and village implementation team as well as of community institutions at the sub-district and village levels. Project Training Services. The project has not developed a comprehensive system of planning, implementing and evaluating training for its stakeholders, especially in the fields of financial management, microcredit, self-help group development and microenterprise development. Training modules in these fields are not available. The implementation guidelines hold that the project strategic training consists of technical skill training and project planning training for UPKs, village facilitators, village implementation teams and village engineers. UPK training is to comprise financial administration and management, loan collection, business development, networking and other not specified topics. The duration of training should be 5 days. Training for Village Facilitators should comprise information on KDP, responsibilities and tasks of FD, techniques for collection of funding ideas, use of flip charts, and work planning. Training materials consist of the project guidelines and a FD handbook. The training is to be carried out by FK and PjOK during 5 days.

20 Objectives, Strategy and Instruments KDP Microcredit System Review 12 Training for the village implementation teams and engineers should comprise KDP principles, organization, administration, and reporting. Further specifications are not made. Neither training for community groups and their members, the users of KDP funds, nor training for sub-district facilitators, who are supposed to provide training to UPK, to FK assistants and at the village level, are subjects of KDP s implementation guidelines. The annual KDP report mentions that the national management consultants carried out a needs assessment and have begun to organize financial management training for UPK. There is, however, no training plan and manual available, and training implementation seems not to make great strides. Project Monitoring. Both involved government institutions and the consultants and facilitators at each project level carry out project monitoring. The project has a large monitoring and data processing team at the national level regularly paying monitoring visits to project areas and handling the KDP reporting system. The project s monitoring and reporting forms book consists of 164 pages comprising short guidelines and 65 forms to be used from the first step of collecting funding ideas to the monitoring of maintenance activities. Monthly reports on the basis of these forms are to be prepared at the kecamatan, district and province level, and to be forwarded to the national project secretariat. The project s implementation guidelines and forms book specify local monitoring and reporting requirements. They neither include a description of the monitoring system nor do they specify the tasks of the national monitoring team. Special reference to credit monitoring requirements and procedures are not made. The project has also not developed a special financial and credit management manual. Credit and revolving fund monitoring forms included in the forms book will be discussed in the next chapter. 1.4 KDP I Microcredit System and Revolving Fund Management KDP has not developed a comprehensive manual for revolving fund and credit management. The project s implementation guidelines are structured according to KDP s project cycle with special emphasis on the participative planning process. Provisions made for revolving funds and credit management are scattered through various chapters such as the introduction, preparation and verification of funding proposals, and the notes on sustainability. Technical guidelines for revolving funds, comprising only 14 pages, were issued separately and focus on general process guidelines without establishing good quality standards and including standard instruments for financial and credit management. Forms to be used for revolving fund activities are included in a book containing all forms used for project implementation General Provisions and Objectives Objectives. KDP s implementation and revolving fund guidelines define the objectives of revolving funds as to increase capital accumulation and to sustain the poor s access to credit for economic activities. Outputs expected are: a financial institution that is easily to access; the growth of microbusinesses; and increased decision-making capabilities of the community with regard to the management of business capital. Circular letter 138/1047/SJ of the Ministry of Home Affairs states that the UPK may be developed into a unit capable of managing various development funds for the