ASIAN DEVELOPMENT BANK RRP: INO 32367

Transcription

1 ASIAN DEVELOPMENT BANK RRP: INO REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE BOARD OF DIRECTORS ON PROPOSED LOANS AND TECHNICAL ASSISTANCE GRANT TO THE REPUBLIC OF INDONESIA FOR THE COMMUNITY EMPOWERMENT FOR RURAL DEVELOPMENT PROJECT September 2000

2 CURRENCY EQUIVALENTS (as of 15 September 2000) Currency Unit Rp1.00 $1.00 = = Rupiah (Rp) $ Rp8,880 For the purpose of calculations in this report, a rate of Rp8,000 = $1.00 was used. This was the approximate rate prevailing at loan appraisal. ABBREVIATIONS ACCSF Asian Currency Crisis Support Facility ADB Asian Development Bank BAPPENAS Badan Perencanaan Pembangunan Nasional (National Development Planning Agency) BCR benefit-cost ratio BPD Bank Pembangunan Daerah (regional development bank) CBSLO community-based savings and loan organization DGRCE Directorate General of Rural Community Empowerment EIRR economic internal rate of return FIRR financial internal rate of return IDT Inpres Desa Tertinggal (Program for the Development of Less Developed Villages) IEE initial environmental examination JBIC Japan Bank for International Cooperation LCB local competitive bidding MIS management information system MOF Ministry of Finance MOHA Ministry of Home Affairs NGO nongovernment organization OCR ordinary capital resources O&M operation and maintenance PCO project coordination office PIU project implementation unit PMO project management office PPMS project performance monitoring system SBI Sertifikat Bank Indonesia (Bank Indonesia Certificate) SFR special funds resources TA technical assistance NOTES (i) (ii) For 2000, the fiscal year of the Government covers 1 April to 31 December; for 2001, the fiscal year will cover 1 January to 31 December. In this report, $ refers to US dollars.

3 CONTENTS Page LOAN AND PROJECT SUMMARY MAP ii vi I. THE PROPOSAL 1 II. INTRODUCTION 1 III. BACKGROUND 1 A. Sector Description 1 B. Government Policies and Plans 5 C. External Assistance to the Sector 7 D. Lessons Learned 9 E. ADB s Sector Strategy 10 F. Policy Dialogue 11 IV. THE PROPOSED PROJECT 11 A. Rationale 11 B. Objectives and Scope 13 C. Cost Estimates 18 D. Financing Plan 19 E. The Executing Agency 20 F. Implementation Arrangements 20 G. Environmental and Social Measures 27 H. Technical Assistance 30 V. PROJECT JUSTIFICATION 30 A. Financial and Economic Analyses 30 B. Environment 32 C. Social Dimensions 32 D. Impact on Poverty 34 E. Risks 35 VI. ASSURANCES 36 A. Specific Assurances 36 B. Conditions for Disbursement to BPDs 37 VII. RECOMMENDATION 37 APPENDIXES 39

4 ii LOAN AND PROJECT SUMMARY Borrower Project Description Classification Environmental Assessment Rationale The Republic of Indonesia The proposed Project is designed to reduce poverty by increasing the incomes of about 425,000 people or 85,000 families. Of these, about 370,000 people, or 74,000 poor families, are expected to move above the poverty line in 11 districts in six provinces of Indonesia: Central Kalimantan, East Kalimantan, South Kalimantan, Central Sulawesi, North Sulawesi, and Southeast Sulawesi. Community-based savings and loan organizations (CBSLOs) will be formed and trained to support microenterprises and small enterprises, and needed rural infrastructure will be provided to promote rural urban linkages. The Project will revitalize poverty reduction efforts in the rural sector by supporting the Government s program to devolve development resources to local governments and strengthening the institutional and human resource capacity necessary to enable rural communities nationwide to plan and manage local development initiatives. About 40 more districts from 20 new provinces will benefit from the institutional and capacity-building program to support the Government decentralization efforts. Primary: Poverty reduction Secondary: Human resources development Category B. An initial environmental examination was undertaken and the summary is presented as a supplementary appendix. Government s successful poverty reduction program suffered a significant set back due to the recent economic crisis. Although the incidence of poverty has since returned to its pre-crisis level of 18.2 percent, the crisis demonstrated that economic shocks could cause high surges in the incidence of poverty. It also highlighted the need for a long-term strategy based on social inclusion and addressing capability deprivation of the poor to make a significant impact on poverty. Lack of formal financial services and institutional support from districts and urban business communities are particularly common impediments to increasing rural enterprise development. The Project aims to remove these constraints. Past experience indicates that decentralized decision making and devolving resources directly to local government significantly decreases the cost of development implementation and increases the direct benefits of development projects for local communities. From that perspective, the Project is intended to support the Government s renewed efforts since April 1999 to decentralize decision making and devolve development resources to local governments and communities. Two new laws that were passed in 1999 grant autonomy to district and village governments, in effect giving them their own resources with which to plan and manage their own development based on local needs. Such decision-making powers underscore the need for adequate institutional capacity to effect the democratic processes of decision making now entrusted to local governments and communities. Under this framework, the Project is aimed at supporting formal and informal training and decision-making processes that would give local communities and government the

5 iii required institutional capacity to better utilize the resources for poverty reduction and improvement of the quality of life in their communities. Objectives and Scope The development goal is to increase the real incomes of the poor and in particular, rural communities on the periphery of regional growth centers. The objectives of the Project are to (i) empower rural communities by strengthening their capacity to plan and manage their own development activities, and (ii) support investments, foster ruralurban linkages, and establish rural infrastructure to promote agricultural productivity and off-farm business enterprises. The Project will have four components. Part A will support (i) an institutional development process to improve community-based planning mechanisms to help local government and village communities plan and implement development programs according to the new decentralization laws, (ii) human resource development to support formal degree training for 1,773 staff of the Directorate General of Rural Community Empowerment (DGRCE) and local governments involved in community development, and (iii) a village grant to support the community training program. Part B will support the establishment of CBSLOs in the targeted areas of Kalimantan and Sulawesi (about 750 village communities) so that the targeted communities would have the capacity to obtain and service loans from financial institutions for microenterprise development. A credit line of $15.0 million from the loan will be provided through regional development banks or Bank Pembangunan Daerah (BPDs). Part C will support the construction of rural infrastructure for the targeted communities to link poor communities to markets. Part D will provide support for project management and monitoring. Cost Estimates The estimated total cost of the Project is $170.2 million equivalent, comprising about $45.5 million in foreign exchange costs and $124.7 million equivalent in local currency costs. Financing Plan 1 Source Asian Development Bank OCR ADF Subtotal Foreign Exchange Local Currency Total Cost ($ million) Percent 68 Government Total ADF = Asian Development Fund, OCR = ordinary capital resources. 100 Loan Amounts and Terms Two loans comprising (i) the loan in various currencies equivalent to Special Drawing Rights 38,752,000 from the Asian Development Bank s (ADB s) Special Funds resources (SFR), with an amortization period of 32 years, including a grace period of 8 years, and an interest charge at 1 Based on 80 percent financing of total Project cost for the first three years of Project implementation and 60 percent financing for the remaining three years.

6 iv the rate of 1 percent during the grace period and 1.5 percent thereafter, and (ii) the loan of $65 million equivalent from its ordinary capital resources (OCR), with interest to be determined in accordance with the ADB pool-based variable lending rate system for US dollar loans, with a maturity of 25 years, including a grace period of 6 years, a front-end fee of 1 percent of the OCR loan amount, and an annual commitment charge of 0.75 percent. Allocation and Relending Terms Most of the proceeds of the ADB loans will finance capacity building and training for communities and community institutions and local government workers; support the formation of CBSLOs in the rural areas for microenterprise and small enterprise investments and provide formal credit to CBSLOs through BPDs; and finance rural infrastructure to link rural enterprises to markets at urban growth centers. The Ministry of Finance will relend a part of the OCR funds to six BPDs under a subsidiary loan agreement at an interest rate of not less than the reference rate (defined as the average rate of interest prevailing for 90-day rupiah-denominated Bank Indonesia Certificate [SBI] over the most recent three months). The interest rate will be reviewed annually by ADB and the Government. The BPD will onlend to CBSLOs at an interest rate equivalent to the interest rate payable by BPD under the relevant subsidiary loan agreement plus a maximum of 8 percent margin, which is currently about 20 percent. The interest rate charged by each CBSLO to its borrowing members would be set by its members but would probably be between 30 and 33 percent, corresponding approximately to the market rates prevailing in the project area. Period of Utilization Until 30 June 2007 Executing Agency Implementation Arrangements Procurement The Directorate General of Rural Community Empowerment (DGRCE) of the Ministry of Home Affairs and Regional Autonomy. As Executing Agency, DGRCE, will be responsible for overall project implementation and coordination with the implementing agencies (IAs). It will establish a project management office (PMO) in Jakarta. Each participating province will coordinate and monitor project-related activities in several districts, and will establish a project coordination office (PCO). Project implementation at the district level will be the responsibility of the district government, which will serve as the IA in each district. Each district will establish a project implementation unit (PIU) for this purpose. A project steering committee will be set up for policy coordination at the national level. Each participating province will establish a provincial advisory group to provide full liaison and coordination with their PCOs and PIUs. Each participating district will establish a district advisory group to advise on measures to address problems affecting project implementation. Goods and services financed by ADB under the Project will be procured in accordance with ADB s Guidelines for Procurement. Simple and technically non-complicated civil works costing up to $50,000 will be constructed by villagers through community participation in accordance with procedures acceptable to ADB, while relatively complex civil works costing up to $500,000 will be carried out on the basis of local competitive bidding (LCB). Utility vehicles, motorcycles, computers, and

7 v office equipment will be procured by international shopping or, if valued under $100,000 equivalent, by direct purchase. Consulting Services Estimated Project Completion Date Project Benefits and Beneficiaries Technical Assistance About 1,054 person-months of consulting services (236 international, and 818 domestic) for supporting project implementation will be required. Consultants will be engaged in accordance with the ADB Guidelines on the Use of Consultants. Recruitment, training, and fielding of local trainers and facilitators will be contracted to qualified nongovernment organizations (NGOs) in accordance with procedures acceptable to ADB. 31 December 2006 The Project will directly increase the incomes of poor families, through microenterprise and small scale enterprise development in the rural areas, and improve linkages to markets, social and health services by improving rural infrastructure. About 370,000 people, or 74,000 poor families, will increase their incomes to levels above the poverty line. The Project will directly benefit about 550,000 people, or 110,000 families, in the project area, equivalent to 4 percent of the population, through capacity building for local government, employment, and enterprise development. About 1.1 million people, or 220,000 families, in 11 districts will benefit from improved rural infrastructure enabling them access not only to markets in nearby urban centers for their products but also to social and health services. The financial internal rate of return from the microenterprises and small scale enterprises is estimated at 45 percent, which adequately covers the 33 percent interest rate on capital investment. The economic internal rate of return is estimated at about 17 percent. Nonquantifiable benefits are expected from the capacity-building component of the Project: strengthened rural community and local government institutions and better trained community development workers. Women will benefit directly from training for local communities and financial services for microenterprises, most of which are expected to be women-owned. Advisory technical assistance (TA) for the financial management system will assist the DGRCE to develop a system for disbursement, monitoring, and accounting of funds in 11 districts in six provinces to ensure accountability and transparency. The TA will provide a total of 51 person-months of international (23) and domestic (28) consulting services, inclusive of 12 months of NGO consortium services. The total cost of the TA is estimated at $1.4 million equivalent. The Government has requested that $1.1 million be financed by ADB on a grant basis from the Asian Currency Crisis Support Facility (ACCSF).The grant was provided, given the strong focus of the TA on good governance and sound fiscal management in support of poverty reduction. The Directorate General of Rural Community Empowerment will be the Executing Agency.

8 vi

9 I. THE PROPOSAL 1. I submit for your approval the following Report and Recommendation on (i) two proposed loans to the Republic of Indonesia for the Community Empowerment for Rural Development Project, and (ii) proposed technical assistance for the Financial Management System. II. INTRODUCTION 2. In response to a request from the Government, the Asian Development Bank (ADB) provided two technical assistance (TA) grants to the Ministry of Home Affairs (MOHA) 1 Directorate General of Rural Community Empowerment (DGRCE) for formulating two projects that would address the need for capacity building for community development 2 and poverty reduction, 3 respectively. Subsequent discussions between the Government and ADB resulted in an agreement to combine the two studies to formulate the proposed Project. A Loan Reconnaissance Mission on February 2000 discussed with Government officials a number of issues related to the design and processing of the combined Project. A Loan Fact- Finding Mission was conducted on 21 March-14 April 2000 and an Appraisal Mission on 5-26 June During loan fact-finding, representatives of multilateral and bilateral funding agencies were consulted to inform them about the Project and to exchange views on decentralization, microfinance, and poverty reduction. This report is based on the findings of these missions; the consultants feasibility study reports; socioeconomic baseline surveys; an initial environmental report; and consultations with national, regional, and local governments, regional development banks (BPDs), beneficiaries, and nongovernment organizations (NGOs), and consultants. Workshops conducted with the target communities helped in determining the design, scope, and implementation arrangements for the Project. The project framework is in Appendix 1. III. BACKGROUND A. Sector Description 1. Poverty in the Rural Sector 3. Prior to the economic crisis in mid-1997, Indonesia had a sound record of rapid economic growth, steadily rising development indicators, and an impressive reduction in the incidence of poverty. Official figures show that poverty declined steadily over a 20-year period, from 40 percent in 1976 to 11.3 percent in February The record is impressive, but because of its large population base, in absolute terms, Indonesia has the largest number of poor people among the countries of Association of Southeast Asian Nations. Two thirds of the Indonesian poor are rural residents. 1 Starting on 23 August 2000, the Ministry of Home Affairs and the Ministry of Regional Autonomy have been merged to become the Ministry of Home Affairs and Regional Autonomy. 2 TA 2858-INO: Capacity Building for Community Development Project, for $970,000, approved on 8 September TA 3088-INO: Development of Rural-Urban Linkage Project, for $890,000, approved on 15 October The ADB team comprised A. T. Perez, Mission Leader; S.T. Chew, Senior Poverty Reduction Coordinator; W.H. Menninger, Senior Project Engineer; M. K. Mitchell, Project Economist; N. K. Jain, Programs Economist; O. Tiwana, Counsel; L. Kulp, Economist (Social Sectors); M. Sultana, Social Development Specialist; and J. Tokeshi, Project Economist, Rural Finance. 5 The consumption basket was revised in Under the revision, the incidence of poverty in 1996 was estimated at 17.7: 13.7 in the urban areas and 19.9 in the rural areas.

10 2 4. As a result of the economic crisis since the latter half of 1997, spiraling inflation and losses of employment opportunities plunged a large proportion of the population into transient poverty. The incidence of poverty peaked in December 1998 at 24.2 percent 6 (21.9 percent urban and 25.7 percent rural). However, starting in March 1999, Indonesia entered a period of price deflation, particularly in the price of rice. This, combined with the slow rise in nominal wages, reversed the trend and the incidence of poverty began to abate. By August 1999, the latest available official measurement of poverty indicated that poverty had returned to near precrisis levels of 18.2 percent (15.1 percent urban and 20.2 percent rural). The crisis amply demonstrated that economic shocks can cause dramatically high surges in the incidence of poverty costly to political and social stability, and long-term development. To make a significant impact on rural poverty, combating poverty in Indonesia must therefore involve prioritizing development goals developing a well thought-out and long-term strategy based on social inclusion and addressing capability deprivation among the poor. 5. Growth in the rural economy has contributed significantly to Indonesia s stable economic growth and in the decline of poverty over the past two decades. Growth in the rural sector increased the demand for labor and resulted in greater employment and higher real wages in the economy. A recent study of the real wage data for Indonesia demonstrates that in the 1990s, poverty declines were inversely related to real wage increases. 7 Between 1990 and1993, when real agricultural wages in Java increased by 19.2 percent, the number of poor people declined by 4.8 percent. The relationship was even stronger during when real wages increased by 14.2 percent and poverty declined by 13.1 percent. Conversely, as real wages declined sharply during the economic crisis, poverty incidence increased equally sharply. Mirroring the poverty trends, underemployment (working less than 35 hours a week) has remained a truly rural phenomenon. A recent study by the International Labour Organization found that, while underemployment affected nearly 60 percent of employed farm workers, only 25 percent of nonagricultural workers were underemployed in Furthermore, a larger proportion of underemployed rural workers were actively seeking work compared with their urban counterparts. Improvements in real wages and rapid creation of jobs for unskilled and semi-skilled workers are thus key to a long-term strategy for poverty reduction. 6. The economic crisis significantly aggravated the poverty situation, but the political turmoil that followed showed the weakness of focusing on income alone and not addressing also the issues of social exclusion, 9 which left the country susceptible to political unrest. The concept of social exclusion provides a good framework for discussing the factors affecting the capability deprivation of the rural poor. The rural poor have been excluded from many activities that could otherwise allow them to improve their income and quality of life. The political processes in rural communities have largely been driven by appointed officials. Decisions on development priorities emanating from central ministries not only exclude the poor from the process of setting development priorities, but also provide no accountability check on the performance of the responsible authorities. Given the remoteness of many rural areas, the poor can be physically excluded from markets, financial services, and social services (like health care and education) because the transaction cost to gain access to these markets or services is beyond their means. The rural poor are also excluded from a broad body of information ranging 6 Based on the data of the Central Bureau of Statistics, using the 1998 methodology. 7 Papanek, G. and B. Handoko The Impact on the Poor of Growth and Crisis: Evidence from Real Wage Data, presented at the conference on The Economic Issues Facing the New Government, August 18-19, Jakarta. 8 Ahmed, I. and S. Dhanani Indonesia s Recovery: Employment Optimism or Statistical Illusion? Occasional Discussion Paper Series No. 2, International Labour Organization. 9 Sen, A Social Exclusion: Concept, Application, and Scrutiny. Social Development Papers No.1, Office of Environment and Social Development, Asian Development Bank.

11 3 from current market prices and trends to ways of organizing into more efficient groups to gain access to markets and financial services. 7. A widely held belief is that the centralized and top-down approaches that characterize development planning and investments in Indonesia have not been cost-efficient; they have socially excluded the community, particularly the poor, and have had the unintended effect of creating large pockets of underserviced areas. Overly centralized planning structures tend to favor over-generalized selection criteria so that local demands and needs of socially vulnerable groups are often overlooked. As a result of exclusion, many poverty-reduction programs are not designed with sufficient sensitivity to the poor so that services often miss their intended targets. Many programs are unsustainable for lack of local demand and ownership. In an effort to make the system inclusive, bottom-up planning was introduced in Indonesia in 1981: village proposals were formulated by village committees representing each sector. However, studies show that only 5-10 percent of the proposals generated at the village level and forwarded to higher levels were funded. The reasons given for this lack of success included the lack of human resources to conduct the participatory processes adequately, lack of local planning skills, and dominance of district sectoral agencies in decision making. 8. Poor rural communities were cut off from economic growth in the past. They are, as noted above, physically excluded or inadequately linked to the transportation and marketing networks that serve growth centers. Hence, lack of adequate rural infrastructure is a good proxy for the many related constraints faced by such communities, including the lack of social services. Experience shows that communities can be relied upon to identify crucial linkages to markets, and are capable of planning and implementing the construction of small scale rural infrastructure. Leaving the decision-making powers with communities, which can also have a substantial role in constructing infrastructure, fosters community ownership and transparency in implementing project activities. Similar insights were drawn from experience elsewhere in Asia lack of rural infrastructure underlies the disadvantaged economic position of the rural poor. 10 In a recent World Bank survey of poverty in Indonesia, the poor unanimously cited lack of income generation opportunities as an underlying cause of their disadvantaged economic position. 11 In short, groups that are physically excluded from the mainstream economy are deprived of the opportunity to expand their capabilities and remain trapped in a cycle of poverty. 2. Financial Institutions 9. The communities in the rural areas targeted by the Project show a wide range of capabilities to produce goods and services. However, lack of credit and lack of social preparation suppress the entrepreneurial initiatives of the poor. The vast majority of communities, especially their poorer members, have no access to formal financial services. Even schemes such as those operated by Bank Rakyat Indonesia (BRI) through its village unit network do not reach most villages and tend to cater to those with incomes well above the poverty line. It may also be noted that where BRI operates in the rural areas of Kalimantan and Sulawesi, it has a complete or near monopoly which, naturally, it is reluctant to share. Another successful approach to finance is the privately based credit unions (para. 13), but these are not yet active in the project area. Although there are savings groups (arisan) in the project area, almost always they are organized by women, whose members by choice are limited to 25 to 30. The money from such a savings group is not enough to meet the business capital needs of all members or the needs for their children s education. As a result, a larger group community- 10 TA 5767-REG: A Study of Rural Asia, for $1.8 million, approved on 29 December The World Bank survey of poverty in Indonesia (1999) was part of a global research effort entitled Consultations with the Poor.

12 4 based savings and loan organization (CBSLO), composed of men and women, and open to all members of the community has been designed to address the need for rural financial institutions in the project area. Special care will be taken to ensure that poor members of the community are accorded equal opportunity to become members of, and benefit from, CBSLO activities. 10. At present, the services of commercial banks are not available in the project area. Nevertheless, six regional development banks (BPDs), have expressed interest in participating in the Project. 12 In the past, BPDs were essentially involved with the financing of local government and government employees salaries, together with collateral-backed commercial lending and some subsidized credit schemes. Recently, their role has started to change and they are becoming more involved in the commercial development of their respective provinces. Potentially, they could develop into very useful alternative financial institutions as wholesalers of credit to small organizations such as CBSLOs in the project area. The BPDs recognize that taking part in a project of this nature is challenging, and could lead to a much stronger contribution to the development of financial services and an improvement in their skills in lending on a commercial risk-bearing basis. The BPDs have solid financial expertise; however, they will need training in risk assessment in relation to small organizations engaged in savings and lending, such as the envisaged CBSLOs. As part of this training, the BPDs will be exposed to existing, successful primary credit unions or similar organizations to experience at firsthand the process of initial formation and first stage development, the membership rules that have to be established, and possible legal structures. From this process, they will develop the skills not only for taking part in the project but also for continuing such activities after project completion. 11. It is noted that the six BPDs have limited experience in providing wholesale credit to nonbank organizations whose members are the ultimate borrowers. These funds were obtained from Bank Indonesia. One BPD, BPD South Kalimantan, has had broader and longer experience in wholesaling credit, being a participant in the ADB Microcredit Project 13 since the start of the Project in Although the BPDs have their main headquarters in the provincial capitals, they have a branch or subbranch in almost all of the project districts. 12. Many NGOs have been effective in facilitating social preparation of communities and formation of self-help groups able to access formal credit and to plan and implement village rural infrastructure projects, assisted by ADB, the World Bank and Japan Bank for International Cooperation (JBIC). Such experience will be useful in forming the CBSLOs proposed under the Project. The participation of NGO facilitators has been incorporated in the project design. The consultants who prepared the feasibility study identified 166 NGOs 14 in six provinces. 15 Between four and eight have been assessed as suitable to serve as facilitators in three Sulawesi provinces. The capability of NGOs in three Kalimantan provinces will be assessed during implementation. 13. The formation of any savings and loan organization or credit union such as the envisaged CBSLOs depends, first and foremost, on the commitment of the membership. Hence, 12 The six are BPD Central Sulawesi, BPD North Sulawesi, BPD Southeast Sulawesi, BPD Central Kalimantan, BPD East Kalimantan, and BPD South Kalimantan. The name identifies the province that owns the BPD and where it is located. 13 Loan 1327-INO, for $25.7 million, approved on 25 October TA 3088-INO: Development of Rural-Urban Linkages Project, for $890,000, approved on 15 October Of the total, 11 NGOs each are found in East Kalimantan and Central Kalimantan, 12 in South Kalimantan, 23 in North Sulawesi, 72 in Central Sulawesi, and 37 in South East Sulawesi. 15 The six provinces are Central Sulawesi, North Sulawesi, Southeast Sulawesi, Central Kalimantan, East Kalimantan, and South Kalimantan.

13 5 the beginning of the process requires an extensive introduction of prospective members (including poor and women members) to the concept and the objectives involved. Visits to existing organizations or by members of such organizations can help enormously. The introduction and training process are best conducted by those who have direct experience elsewhere, especially NGOs or others independent of government. Indonesia has had a strong cooperative movement for about 30 years. The Credit Union Federation is the national-level organization of the Indonesian credit union movement. It has 27 regional chapters nationwide, including three regional credit unions in the project area: one each in North Sulawesi, South Sulawesi, and Central Sulawesi. They comprise 53 local credit unions with a total savings of Rp4,852 million ($585,000 equivalent). Although there are no credit unions in the three Kalimantan provinces, there is one regional chapter in West Kalimantan, which has 27 local credit unions with savings of Rp14,288 million ($517,000 equivalent). 14. The basic rules and principles that a savings and loan organization (such as the CBSLO) need to incorporate into its founding documentation can easily be drawn from the Credit Union Federation with wide experience in the field, but the members themselves should have the final say. The same applies to procedures for making and recording savings, and later loans, as the organization develops. The level of deposits, membership, and activity required before drawdown can be made by CBSLO will be subject to project guidelines, but will also depend on the agreement reached with the BPD itself. 3. Women in Development 15. Women in the rural areas of the Project contribute to economic development in many ways. They are involved in agricultural work, participating in production and postharvest activities. To augment farm income, women conduct petty trading by selling snacks and meals they prepare at home, and selling vegetables and fruits from their gardens. Many are also involved in cottage industries such as making rattan mats and finishing local semiprecious stones. They also seek employment as farm workers or daily work as laborers in local construction projects. However, women in the project area suffer from low wages and lack of access to capital, skills training, appropriate technology, extension services, and market facilities. Due to lack of access to formal credit, women depend on private moneylenders and borrow funds at exorbitant interest rates. As noted, the resources of the small arisan savings group are not sufficient to meet all of its members needs; however, the social capital that has been developed in forming these groups can be tapped in forming CBSLOs. B. Government Policies and Plans 16. In the mid-1990s, the Government committed itself to eradicating poverty. At the start of the sixth Five-Year Development Plan (REPELITA VI), FY1994/ /99, the Government launched a special program, the Inpres Desa Tertinggal (Presidential Instructions for Less Developed Villages [IDT]), 16 which supported infrastructure development and economic activities in targeted IDT villages. The program benefited about 28,000 villages with an estimated 13 million people or about half of the population identified to be living below the poverty line. The IDT program consisted of direct grant, village infrastructure and technical guidance. MOHA supported by BAPPENAS (National Development Planning Agency) administered the direct grant scheme and the infrastructure support program. Grants of Rp20 million ($8,500 equivalent at that time) were given to each IDT village per year, depending on the village populations, for three years to help create and expand economic opportunities for 16 Through Presidential Instruction No. 5/1993.

14 6 poor community members. The village infrastructure program sought to increase market access and break the isolation of IDT villages, improve health standards, promote employment opportunities, build the capacity of village institutions, and improve the capability of villagers to plan, implement, and maintain village infrastructure. The IDT program had some difficulties due to insufficient institutional support and shortage of sustainable financial services, but its impact has been recognized. 17. Laws 22 and 25 which were passed in 1999, hold the promise of a decentralized administrative system that will strengthen institutional links between civil society as represented by elected village bodies and the subdistrict and district governments. 17 They are necessary measures to address regional economic disparities and to transfer resources for development programs. When fully implemented, the laws will convert Indonesia s districts into autonomous areas with fully elected government authority to address the interests of their rural constituencies. Village communities themselves would be given new powers as indigenous autonomous areas to elect through democratic processes representatives for village councils, replacing the previously government-appointed village heads and committees. These changes are expected to spawn local government-sponsored development initiatives more attuned to local community needs. Viewed in the context of social exclusion, the two laws constitute a critically important initiative. They give communities, including the poor within the communities, the power to hold local leaders accountable. 18. The Government s development priorities are contained in its medium-term development program (PROPENAS), which describes the Government agenda for PROPENAS contains five broad development objectives aimed at (i) ensuring national cohesion and social stability, (ii) achieving good governance and rule of law, (iii) accelerating economic recovery and strengthening the foundations for sustained growth, (iv) developing the social sectors and human welfare, and (v) strengthening regional autonomy, rural and urban development and structural poverty programs. PROPENAS also addresses a range of cross-cutting issues covering poverty, gender, and environmental sustainability. Economic recovery, good governance, infrastructure rehabilitation to support production, regional autonomy through decentralization, poverty reduction, and women in development, which are key components of the Government s medium-term strategy and which address cross-cutting issues, are also major concerns of the Project. 19. In preparing to implement the two laws on decentralization in 2001, the Government is reorganizing and restructuring the entire administrative system. The mandates of key ministries formerly responsible for regional government administration, including MOHA, have been changed to accord with the provisions of the laws. MOHA s new mandate is to facilitate the role of regional governments as they assume their new responsibilities and is confined to policy matters stemming from the new relationship between the regional and the Central governments. In effect, MOHA will have a much-reduced role in regional government affairs. 20. The MOHA reorganization has involved specific changes in the function and staff of the Directorate General of Rural Community Development (DGRCD). First, DGRCD was renamed Directorate-General of Rural Community Empowerment (DGRCE). The new name reflects DGRCE s new mission to support and facilitate (rather than lead, as was previously the case) community development planning and coordinate with local government and sectoral agencies in implementing programs. Second, as of January 2001, DGRCE staff serving at provincial, district, and subdistrict levels will become the staff of the respective levels of regional 17 Law No. 22/1999 on Regional Government and Law No. 25/1999 on Fiscal Balance.

15 7 government. The devolved staff, particularly those currently serving at the districts and subdistricts are expected to retain their functions as the interface between the district and subdistrict government administration and the village community. 21. The Government has assigned to MOHA the task of reorienting and retraining DGRCE staff and the devolved staff for their new responsibilities as the sponsors of community development interests in the central and regional government administration, respectively. In turn, Central Government will assist the regional governments as they assume their new responsibilities and absorb the new staff, particularly at the districts and subdistricts where they are currently the weakest. These are the levels where, at present, the existing DGRCE staffing levels are only 43 percent of the 81 positions gazetted per district, and where the educational attainment of the staff is generally lower than that in other agencies of the same level. Most of the field staff are graduates of technical high schools. The new responsibilities entrusted to DGRCE staff at these levels may be beyond their skills level to undertake well. DGRCE staff have fewer women than men at both the provincial and central levels: an average of 22 percent covering the three provinces in Kalimantan and 25 percent for the three provinces in Sulawesi, compared with about 34 percent at the central level. 22. To augment its limited staff resources, DGRCE has used NGO community facilitators to assist in promoting community participation, increasing income, and implementing rural development projects. Considerable human resource and institutional strengthening efforts are required for the central-to-regional-government resource transfer to bear fruit, and should be viewed as a priority in forging the new relationship and instituting good governance practices. The Government s request for ADB assistance in addressing this issue in the context of a rural development project reflects well its commitment to effecting the new decentralized system. C. External Assistance to the Sector 23. The major internationally funded projects directed at reducing poverty under the IDT program through rural infrastructure development and microfinance are those supported by ADB, World Bank, and JBIC. A summary of the progress made is presented in the supplementary appendix. 24. The first phase of the Government of Japan-financed Rural Areas Infrastructure Development Project, which started in 1995, supported infrastructure development in 3,447 IDT villages in 21 provinces outside Java and Bali. The second phase began in 1997 and is estimated to have provided infrastructure to 7,500 IDT villages outside Java and Bali. The second phase was extended to three years due to the economic crisis. The third phase will be implemented during in about 2,500 villages in 550 subdistricts. Most of the funds were used for improving access road infrastructure in a cluster of neighboring villages, and water supply and sanitation facilities. Although the village infrastructure development took the district as the unit of planning, the subproject proposals originated from the village and were approved at the district level. Community-based organizations were used to construct village subprojects, assisted by contractors who supplied skilled labor, and equipment, and carried out works beyond the capacity of the local people. The third phase would place more emphasis on the planning process and implementation of subprojects than on the simple outcome of the construction of the infrastructure, through the active participation of local community organizations. The process approach will focus on capacity building for local community organizations and community development. Underlying the reorientation of the approaches in the third phase is the experience in the first two phases, which demonstrated the key role that community involvement in decision making plays in the success of the project. The third phase,

16 8 in addition to constructing access infrastructure, water supply and sanitation facilities, will finance agriculture production, postharvest, processing, and marketing support. 25. The World Bank has implemented two village infrastructure projects (VIPs). VIP I begun in 1995 and completed in 1996, benefited 1,230 IDT villages in Java. VIP II, which began in 1997, benefited an additional 4,500 IDT villages in Java and Sumatra. The key features of the VIP strategy include village participation, decentralization, and transparency. Each village received a one-time grant of Rp120 million ($54,000 equivalent for VIP I and $50,000 for VIP II at the corresponding periods) to build infrastructure of its choice from a menu. About 87 percent of the village grant under VIP I was used for road and bridge works, and the remaining 13 percent for drinking water and sanitation. Except for Rp20 million advanced for materials, the grant was disbursed based on work progress. Villagers were empowered to decide priority uses of the grant and implemented the subproject themselves with limited reliance on contractors. The services of domestic engineers were provided for planning, designing, and implementing the subprojects. The implementation of the first project was assessed to be highly satisfactory. The second project is still being evaluated. 26. The World Bank s Kecamatan Development Project (KDP), approved in 1998, adapts the VIP principles but differs from it in three ways: (i) the KDP provides a block grant to each selected subdistrict, which will select from among competing investment proposals submitted by villages; (ii) the KDP funds economic activities, in addition to infrastructure, which are financed through credit at market rates at a maximum of Rp150 million ($18,000 equivalent) per group, and (iii) the KDP provides NGO facilitators in addition to engineering assistance. 27. In 1999, ADB approved the Community and Local Government Support Sector Development Program, involving a policy loan of $200 million and an investment project loan of $120 million. The investment project loan provides village grants to poorer districts for improving basic services through labor-intensive infrastructure development and improvement. The amount of the block grant ranges from Rp8 million ($1,000 equivalent) to RP 80 million ($10,000 equivalent) depending on the population of the village. The implementation of the program is progressing satisfactorily. The first 37 districts in Java have been identified and a second batch of 15 districts in Sumatra is under consideration. 28. ADB has two ongoing microfinance projects in Indonesia. The Microcredit Project 18 (MCP) targets the poor and near poor for microenterprise development by providing credit and mobilizing savings in five provinces. 19 MCP targets primarily non-idt villages. Credit is provided through five BPDs, including BPD South Kalimantan, which onlend to small financial institutions and group organizations. NGO facilitators provided training. Most subborrowers are individuals, but self-help group subborrowers are also included. The poor are targeted by the loan size (less than Rp500,000) and through NGOs. The Rural Income Generation Project (RIGP) 20 differs from the MCP in emphasizing the provision of microfinance services to poor people living below the poverty line, and in giving priority to IDT villages through credit provided by Bank Rakyat Indonesia. Under the RIGP, rural savings are also mobilized, and training is provided by the Agency for Agricultural Education and Training. Field extension workers and NGO facilitators assist in forming self-help groups and preparing business proposals. The MCP has demonstrated significant benefits to the final borrowers and in developing skills in the small financial intermediaries. The RIGP has demonstrated that a large number of self-help groups 18 Loan 1327-INO, for $25.7 million, approved on 25 October MCP s five provinces are West Java, Central Java, East Java, South Kalimantan, and West Nusa Tenggara. 20 Loan 1583-INO, for $78.6 million, approved on 25 November 1997.

17 9 can be rapidly mobilized and that facilitators can play an effective role in the process. Implementation of the two projects is considered satisfactory. 29. The block grant approach in Indonesia is well-tested in externally funded programs. The World Bank and JBIC have successfully implemented it in a number of recent projects. Under a series of VIPs, communities or villages identified the needed roads, water supply facilities, etc., to be built, which they constructed themselves, assisted by project field engineers and later by NGO facilitators. Labor from the participating villages was utilized, which generated employment. Regarding credit lines to BPDs, ADB has more than five years of successful experience involving BPDs in providing credit. In the ADB MCP, five BPDs, including BPD South Kalimantan, successfully provided village subborrowers with credit for microenterprise development in five provinces, among others, through small nonbank financial institutions. These institutions are similar to the CBSLOs that will be formed under the Project. Since such nonbank financial institutions do not exist in the project area, the challenge to the Project is to establish viable savings and loan organizations. D. Lessons Learned 30. Formulating the Project has benefited from the experience and lessons learned from many completed or ongoing projects assisted by the ADB, 21 JBIC, and World Bank. A summary of valuable lessons learned follows: (i) (ii) (iii) (iv) (v) More active participation of traditional rural communities in the mainstream formal economy should begin with empowerment of the communities through social mobilization, organization, and improved access to adjoining growth centers where there is a market for the goods and services that the villages can produce. Emphasis on developing human resources at the local level is the key to community empowerment. The villages that receive block grants should have considerable control over the details of how their grants are spent. The block grant system is demonstrably successful in spurring communities to prioritize their needs and to allocate available resources to these activities reflecting their priorities and potential (KDP, footnote 21). Increased participation of ordinary people, including poor people, in the decisionmaking process and the corresponding pressure from them for transparency have greatly assisted in combating the dangers from malfeasance and corruption. Election of local officials allows communities to hold the officials accountable. If the villages have to compete for infrastructure funds, the rules of competition should favor small-scale labor-intensive projects that will provide facilities for use by the local communities. Substantial savings are made using village-based 21 ADB loans: Loan 1605-INO: Central Sulawesi Integrated Area Development and Conservation Project, for $32.0 million, approved on 27 January 1998; Loan 1678-INO: Community and Local Government Support Sector Development Program, for $120 million, approved on 25 March World Bank loans: Loan 3888-IND: Village Infrastructure Project, for $72.5 million, approved on 29 June 1995; Loan 4100-IND:Village Infrastructure Project II, for $140.1 million, approved in 1997; Loan 4330-IND: Kecamatan Development Project, for $225.0 million, approved on 3 June 1998.