ASIAN DEVELOPMENT BANK

ASIAN DEVELOPMENT BANK TAR: INO 35148 TECHNICAL ASSISTANCE TO THE REPUBLIC OF INDONESIA FOR SUPPORT FOR THE REGIONAL GOVERNMENT BORROWING SYSTEM October 2002

CURRENCY EQUIVALENTS (as of 15 September 2002) Currency Unit Rupiah (Rp) Rp1.00 = $0,000113 $1.00 = Rp8,843 ABBREVIATIONS ADB Asian Development Bank BAPPENAS Badan Perencanaan Pembangunan Nasional (National Development Planning Agency) KKPPI Komite Kebijakan Percepatan Pembangunan Infrastruktur (Committee for Accelerating Infrastructure Development) MOF Ministry of Finance MOHA Ministry of Home Affairs PDAM Perusahaan Daerah Air Minum (local water utility) Perekonomian Kantor Menteri Koordinator Bidang Perekonomian (Coordinating Ministry of Economic Affairs) PMU project management unit RDA Regional Development Account RPD Rekening Pembangunan Daerah (RDA own-sourced funds) SLA subsidiary loan agreement TA technical assistance NOTES (i) (ii) The fiscal year (FY) of the Government ends on 31 December. In this report, "$" refers to US dollars.

I. INTRODUCTION 1. Indonesia s ongoing decentralization process has entailed far-reaching changes in the fiscal systems of regional 1 governments, in particular the financing of development projects through borrowing. In response to the Government of Indonesia s request, in March 2002 ADB fielded a reconnaissance mission to formulate technical assistance (TA) to support the Government of Indonesia in establishing an effective regional government borrowing system. A fact-finding mission was fielded in May 2002. The mission included discussions with representatives of the Central Government, external support agencies, and consultants working on regional finance in Indonesia. The goal, purpose, scope, implementing arrangements, cost estimates, financing plan, and terms of reference for the TA are based on the understanding reached with the Government during the mission. The TA framework is attached as Appendix 1. 2 II. ISSUES 2. Indonesia s regional government borrowing system needs to be reformed. The mechanisms for multilateral and bilateral lending (and a large share of central government lending) to regional governments, most importantly the regional development account (RDA) and subsidiary loan agreements (SLAs), have not been efficient or effective conduits. The RDA was established in 1988 in the Ministry of Finance (MOF) and is administered by the Directorate General of Financial Institutions. The RDA was intended as a mechanism for the speedy delivery of demand-driven, smaller-sized loans to regional governments and their utilities. 3 Conceived as a revolving fund, the RDA offers state budget funds (RPD) 4 at standard terms. SLAs are used to on-lend to regional governments for financing as part of larger infrastructure projects. SLAs are also managed by the Directorate General of Financial Institutions. The onlending terms for RDA and SLA operations are the same. Expansion of the RDA was envisaged to arise through RPD and SLA repayments as well as mobilization of new foreign and domestic capital. However, as of December 1999 over 40% of the total RDA portfolio was in arrears, and new loans were being approved at an extremely slow pace against a large backlog of applications. Reliable data after 1999 is scarce; however, anecdotal evidence suggests a worsening of the portfolio in arrears to over 50%. The RDA is currently being audited by Indonesian state auditors. 3. SLAs were often negotiated between multilateral and bilateral development banks and the Central Government on behalf of regional governments. In some cases SLAs have not gained regional government ownership and, in many instances, could not be afforded. In addition, the very nature of the SLAs prevents them from being responsive to individual regional government needs since they were standardized and used to allocate large loans among many subprojects. Thus, the SLAs are supply driven, which goes against the spirit of demand driven projects needed for decentralized infrastructure investment. 1 In Indonesia, the term regional comprises the provincial and the district/city level while local covers the district/city and the village level. The term regional is henceforth used since villages do not form part of the borrowing system due to their small size. 2 The TA first appeared in ADB Business Opportunities (Internet Edition) on 05 February 2002. 3 About two thirds of RDA lending went to utilities, while one third was borrowed by regional governments. Among utilities, water enterprises represented about 80% of the total borrowing, with the balance going to public markets, bus terminals, and solid waste enterprises. 4 RDP refers to own-sourced funds or assistance from Central Government, some of which were derived from bilateral and multilateral funding.

2 4. With the introduction of regional autonomy in January 2001 and the ensuing new laws and regulations, 5 the regional government borrowing system has effectively ceased to work. Onlending of foreign-sourced funds is virtually on hold because of, among others, a moratorium on regional borrowing until the rules are firmed up, and because Government Regulation 107 of 2000 allows borrowing by regional governments only for revenue-generating projects and requires the foreign exchange risk to be passed on to the regional governments. Reform of the borrowing system is urgently needed, taking into account the new responsibilities at the regional government level. 5. In a first attempt to reform the overall regional government financing system, the Directorate General of Central and Regional Fiscal Balance of MOF in June 2002 issued a proposal for an interim on-lending policy 6, which is currently being discussed with other ministries and major funding agencies. The policy essentially tries to revive an SLA-like mechanism and calls for a blending of loans and grants to be channeled to regional governments based on the type of project and the fiscal capacity of the regions. The new approach suggests that terms offered by lenders to the Central Government including interest rates, grace periods, and maturities will be passed on to the regions, and that the foreign exchange risk will be assumed by the Central Government but charged to regional governments by adding to the interest rate. The proposal has already gone through several rounds of discussions but has not yet been finalized. 6. Interim policies are being discussed, but the Government has not yet put in place a comprehensive policy and plan to deal with the RDA-SLA arrears. Restructuring the portfolio in arrears must be accomplished before starting any new regional government borrowing initiative. This is particularly important because a conducive environment should be in place to eventually attract private capital. Portfolio restructuring has been a major concern of external agencies since the onset of the Asian financial crisis and has been extensively reviewed (Appendix 2). However, little tangible results have been produced. The lack of repayment discipline is partly because in the past, loan agreements were uncollateralized and therefore virtually unenforceable. While Indonesian law prohibits forgiving the principal, there is in principle room to reschedule, restructure, or even forgive interest payments and penalties on principal and interest. 7. A large portion of the debt in arrears is owed by local water utilities (PDAMs) that are either unable or unwilling to serve principal, interest, and penalty obligations from loans contracted in the 1980s and 1990s. Since early 2002 there is considerable momentum to get at least the PDAM-related debt restructuring under way. As part of the World Bank s PDAM Rescue Program, nine PDAMs have received Directorate General of Financial Institutions approval to cancel penalties on both principal and interest, and to reschedule repayment. While these initiatives were useful, they were a time-consuming, one-off approach that does not substitute for a comprehensive solution. In February 2002, the President of Indonesia instructed the interministerial Committee for Accelerating Infrastructure Development (KKPPI), chaired by the Coordinating Ministry of Economic Affairs (Perekonomian), to devise a plan to restructure 5 In particular law 22 on regional governance; law 25 on fiscal balance; and government regulations related to regional government borrowing, such as regulation 107 of 2000, which outlines the appropriate sources and types of borrowing, the purposes for which loans may be utilized, restrictions on amounts that can be borrowed, and sanctions for nonpayment. 6 The term financing includes loans and grants, natural resource revenues, and own-source revenues of regional governments. MOF s new proposal deals with both grant and loan financing, thus the term interim on-lending policy is slightly misleading as it includes nonlending aspects of finance.

3 PDAM debt arrears as soon as possible. At present, the Subcommittee for PDAM Restructuring 7 under KKPPI is surveying the PDAM borrowers in arrears to develop a comprehensive approach to restructuring their debt. However, these efforts are hampered by a lack of human and financial resources at Perekonomian. Moreover, they need to be accelerated and broadened to cover debt restructuring of the entire RDA-SLA portfolio in arrears to provide a comprehensive solution. The TA s main contribution will be to directly assist in these efforts. 8. Debt restructuring will be crucial to establishing local government creditworthiness and to enable local governments to eventually access long-term funds from public and private markets. Indonesia s regional governments have virtually no experience with borrowing longterm funds outside of the Central Government, except for short-term cash-flow borrowing from banks. However, in the medium-term the demand for regional capital investment cannot be met only by public sources, and local governments will need to access sources of private capital. 9. Given the urgent need to come up with a new and more effective regional finance system as soon as possible, it is necessary to provide tailor-made, short-term training modules for staff at the Central Government level, who are part of the decision-making and implementation process of the new regional government finance system. Such training will facilitate informed decisions and smooth implementation of a system that reflects the best international practices and is suitable for Indonesia. 10. The TA and loan projects (Appendix 2) have resulted in several detailed studies on institutional reform options, including (i) establishing a municipal development fund; (ii) attaching a regional borrowing window to commercial banks; (iii) strengthening institutions like regional development banks; and (iv) developing a regional government bond market. These options should be fully reviewed over the medium term to assess their applicability to Indonesia. However, before any of these options can be considered, Indonesia has to create human resource capacity and restructuring of the nonperforming loans that will enable regional government borrowing. This TA will help create these preconditions. 11. The TA is part of an indicative 3 year pipeline of ADB loans and TAs relevant for the development of an effective regional government finance system. The activities envisaged under this TA are designed to create the preconditions needed to implement any of the institutional option given in paragraph 10. The proposed project pipeline 2002 2004 is given in Appendix 2. III. THE TECHNICAL ASSISTANCE A. Purpose and Output 12. The long-term goal of ADB s assistance for the development of regional government finance in Indonesia is to enable regional governments to finance their infrastructure investments through a well-functioning system of public and private borrowing as well as by issuing bonds. The purpose of this TA is to help the Government prepare and implement the necessary preconditions for an appropriate system for providing concessionary and nonconcessionary loans to creditworthy regional governments. 7 Effective 18 June 2002, the Subcommittee on PDAM Restructuring was set up under KKPPI to work on PDAMrelated issues, most notably PDAM debt but also institutional reform, financial management, and regulation, among others. The subcommittee members consist of director general and directors of Perekonomian, MOF, Ministry of Home Affairs (MOHA), Ministry for Settlement and Regional Infrastructure (MSRI), National Development Planning Agency (BAPPENAS), and Indonesia s Water Supply Association (Perpamsi).

4 13. The TA will comprise two interrelated components: (i) designing a policy, methodology, and implementation action plan for restructuring the existing RDA-SLA portfolio; and (ii) providing capacity building and training on regional finance for staff of government agencies involved in setting up a new regional government financing system. B. Methodology and Key Activities 14. Portfolio Restructuring. Given the current high level of arrears of RDA and SLA loans, the development of a comprehensive policy and methodology for restructuring these will be key to restoring the creditworthiness of regional governments. Arrears data needs to be reconciled between MOF accounts and the borrowers books before loans can be categorized according to their size, maturity, and likelihood of recovery, and other factors. The categorization will help devise for each group a strategy for resolving debt, consisting of debt rescheduling, restructuring, and recovery, based on a transparent and consistent methodology. The output of this component will be the policy and methodology for RDA-SLA portfolio restructuring and a detailed implementation action plan that can help prepare a follow-on regional government finance project (Appendix 2). 15. Regional Finance Training. Setting up of a new regional finance system is partly hampered by a lack of knowledge of how the best international practices could be applied in Indonesia. Targeted training for concerned staff of involved institutions will support and accelerate the establishment of a new system. The training will be based on a training needs assessment and will cover topics such as regional borrowing and municipal finance markets, models of and experience with regional finance systems in other countries, alternatives and complementary structures to borrowing (such as municipal bonds), and assessment and improvement of regional government creditworthiness. In addition, basic financial management training will be necessary, covering topics such as public investment programming, economic rationale for public provision and modes of finance for different types of urban services, and regional debt and risk management. Training will be designed for in-country use, which can be made available on a continuing basis by training trainers of a domestic institution to be identified in close cooperation with the proposed ADB loan for local government capacity building for decentralization. The output of this component will be short-term training modules for central government staff involved in establishing a well-functioning regional government finance system, and the training of selected trainers who can carry out similar training modules on a continuing basis through a domestic training institution. C. Cost and Financing 16. The total cost of the TA is estimated at $625,000 equivalent, comprising $373,000 in foreign exchange and $252,000 equivalent in local currency. ADB will provide a grant of $500,000 to cover the entire foreign exchange cost and $127,000 equivalent of the local currency costs. The TA will be financed on a grant basis by ADB s TA funding program. The Government will finance $125,000 equivalent of the local costs, through the provision of office accommodation and facilities, use of equipment, administrative support, counterpart staff remuneration and per diem, counterpart staff travel, and other miscellaneous expenses. A detailed cost estimate is provided in Appendix 3.

5 D. Implementation Arrangements 17. The Executing Agency will be Perekonomian. The TA will be overseen by a steering committee, the Subcommittee for PDAM Restructuring of KKPPI, which is also the steering committee for other related ADB projects. 8 It will provide policy guidance and advice in the conduct of the TA and its linkages to similar ongoing activities. Perekonomian will establish a project management unit (PMU) that will be responsible for all technical and administrative aspects of the TA, provide appropriate office space and PMU staff to support the consultants, and facilitate the consultants work by ensuring their access to relevant data and documents. The TA consultants will report to the head of the PMU. 18. The TA will require inputs of approximately 11 person-months of international and 20 person-months of domestic consultants with expertise in regional finance; banking, in particular strategies to solve loan arrears; institutional development; financial analysis; capacity building and training; and legal affairs. Using the simplified technical proposal format, the consultants will be engaged by ADB as a firm in accordance with its Guidelines on the Use of Consultants and other arrangements satisfactory to ADB for the engagement of domestic consultants. Equipment for the use of the TA consultants will be procured by the consultants in accordance with ADB s Guidelines for Procurement and transferred to Perekonomian at TA completion. The consultants will be based in Jakarta and will be expected to travel as necessary to the regions. The outline terms of reference for consultants are included in Appendix 4. 19. The TA is expected to commence in January 2003, be implemented during 9 months, and completed in September 2003. The consultants will produce (i) an inception report at the end of the first month; (ii) an interim report, including a draft restructuring policy and methodology and a training needs assessment, at the end of the fourth month; (iii) a draft final report, including a restructuring implementation action plan, at the end of the eighth month; and (iv) a final report at the end of the assignment. Regional workshops will be held to discuss and get feedback on the proposed restructuring policy and methodology. Tripartite reviews will be held at the inception, midterm, and draft final report stages. IV. THE PRESIDENT'S DECISION 20. The President, acting under the authority delegated by the Board, has approved the provision of technical assistance in an amount not exceeding the equivalent of $500,000 on a grant basis to the Government of Indonesia for Support for the Regional Government Borrowing System, and hereby reports this action to the Board. 8 Including TA 3761; TA 3782; and TA 3804 (Appendix 2) and projects by other agencies. Since KKPPI s mandate goes beyond the water sector and covers infrastructure in general, the Subcommittee s PDAM restructuring efforts can be extended to deal with all RDA-SLA debt in arrears.

6 Appendix 1 TECHNICAL ASSISTANCE FRAMEWORK Design Summary Performance Indicators/Targets Monitoring Mechanisms Assumptions and Risks Goal To enable regional government to finance their infrastructure investments through a well-functioning system of public and private borrowing as well as by issuing bonds Well-designed regional finance system in place in the next 2 years Legal document (government regulation or ministerial decree) to establish new system Revision of current legal documents conflicting with or impeding establishment of new system Purpose To help the Government prepare and implement the necessary preconditions for an appropriate borrowing system for providing concessionary and nonconcessionary loans to creditworthy regional governments Outputs 1. RDA-SLA portfolio restructuring policy and methodology with detailed implementation plan to serve as project preparatory basis for regional government finance project in 2003 2. Training modules on regional finance for central government staff, which can be offered to other stakeholders on a continuing basis through a domestic training institution Preparatory work, most importantly debt workout, is being implemented Restructuring policy and methodology implemented by mid- 2003 Training on pilot basis completed by September 2003 Evaluation by Government, Asian Development Bank (ADB), and other lending agencies Consultant reports and ADB review missions Consultant reports, training workshops, ADB review missions Government s willingness to seriously overhaul the regional finance system instead of merely reforming the Regional Development Account (RDA) and subsidiary loan agreement (SLA) mechanisms Establishment of regional government creditworthiness Private financial institutions participation in new system Comprehensive workout plan is delayed due to delayed decisions at ministerial level

Appendix 1 7 Design Summary Performance Indicators/Targets Monitoring Mechanisms Assumptions and Risks Activities 1. Arrears issue a. reconcile arrears data for RDA-SLA portfolio between Ministry of Finance and borrowers books b. categorize arrears according to size, maturity, likelihood of recovery, etc. c. devise a strategy to remedy loan arrears for each borrower group, consisting of debt rescheduling, restructuring, and recovery, based on transparent methodology d. hold workshops at central and regional government level to discuss strategy e. design a detailed implementation action plan for debt restructuring that can serve as project preparatory basis for sector development project in 2003 2. Training a. assess specific training needs in regional finance for government staff involved in decision making process of devising an new regional finance system b. design short-term training modules tailored for staff c. implement training modules at central government level Updated and reconciled RDA-SLA loan database Loan categorization based on updated database Draft workout strategy Completion of workshops Action plan based on agreed strategy Training needs assessment Training modules Completion of training workshops Consultant progress reports, ADB review missions, field visits, and workshops Data access is occasionally obstructed at regional government level Government delays agreement on loan categorization and strategy, stalling agreement on implementation action plan Inadequate participation of stakeholders involved Training is not deemed necessary or relevant by either management or staff of respective ministries Training needs vary too much to combine adequate topics into a few short-term courses Ministries do not send the staff for who the courses are designed

8 Appendix 1 Design Summary Performance Indicators/Targets Monitoring Mechanisms Assumptions and Risks d. cooperate with domestic training institution to offer training courses on a continuing basis for other interested stakeholders Inputs Agreement with domestic training institution is reached Training lessons will not be incorporated into work activities International and domestic consulting services ADB financing 11 person-months of international and 20 person-months of domestic consulting services $500,000, of which $373,000 for foreign currency and $127,000 for local currency expenses

Appendix 2 9 EXTERNAL FUNDING FOR REGIONAL FINANCE Table A2.1: Asian Development Bank (ADB) Funding Past and Ongoing Projects Type Loan ADTA ADTA ADTA Number, Date, Status 1501-INO (1996, ongoing) 2699-INO (1996) 3214-INO (1999) 3777-INO (2001, ongoing) Title Regional Development Account (originally $50 million, now $17 million) Strengthening of Regional Development Account Improving the Management of Government Onlending Operations Fiscal Decentralization Description Objectives are to (i) provide long-term credit to local governments and enterprises through RDA; (ii) support and strengthen RDA; and (iii) strengthen the technical and financial management capacity of local governments and enterprises. Due to financial crisis and a new decree in 2000 effectively eliminating PDAMs with outstanding arrears from potential borrower list, loan amount has been progressively reduced to $17 million. Loan portion to strengthen capacity of RDA staff has been reduced considerably by MOF. Development of RDA into sustainable revolving financing facility as envisaged under loan is highly unlikely. Recommended a 20-point action plan divided into urgent action (reviewing arrears, enforcing mechanisms to solve loan arrears), transition actions (revising loan approval criteria, preparing a more self-sustaining credit mechanism), and transformation actions (setting up an autonomous financial intermediary outside MOF). Parts of the action plan were implemented, although major recommendations, such as enforcing workout mechanisms and virtually all actions under transformation, were not. Assisted the Directorate of Subsidiary Loan Management in MOF in carrying out its mandate to comprehensively review regional loans and prepare recommendations for improving accountability and debt service recovery. EA only implemented a few operational recommendations made by TA. Supports the government in identifying key constraints in the current intergovernmental fiscal relations by providing districtwide fiscal profiles and conducting detailed regional public expenditure review in selected areas. Based on these, the TA will provide baseline information to formulate a new grant-transfer and/or onlending policy ADTA advisory technical assistance PDAM local water utility EA Executing Agency RDA Regional Development Account INO Indonesia TA technical assistance MOF Ministry of Finance

10 Appendix 2 Project Pipeline 2002-2004 2002 Type Responsible ADB Office Table A2.2: Proposed ADB Activities for 2002-2004 Title ADTA SESS Support for Regional Government Borrowing System SSTA SEGF Support for Good Local Government Governance Loan IRM Local Government Capacity Building for Decentralization 2003 ADTA SEGF Implementation of Fiscal Decentralization ADTA SEGF Development of Indicators for Local Government Performance PPTA SESS/SEGF Creation of New Local Government Financing Institution (LGFI) Phase I Loan IRM Support for Public Audit Reform SDP Loan (standby) Loan (standby) 2004 SESS/SEGF SEGF Legal Framework for Regional Finance and RDA Workouts Implementing Accrual Accounting in Provinces and Districts PPTA SESS/SEGF Monitoring and Design of LGFI Phase II ADTA IRM Policy Issues in Decentralization PPTA SEGF Regional Development Authority Description Prepare policy and methodology for restructuring nonperforming regional loans and provide tailored training on regional finance. Strengthen governance in regional administration and legislature. Provide capacity building in financial management, planning and development, and general administration focusing on good governance. Create a sound legal framework for the development of a regional government credit and bond market. Prepare credit rating system for regional governments. Prepare the establishment of regional government finance institution for selected province. Build capacity and capability of state auditors for auditing regional governments. Prepare the legal framework (program component) and implement RDA debt restructuring (investment component). Support introduction of accrual accounting by supplying computers, software, training, and nationwide network for accounting, financial management, and procurement. Monitor implementation of phase I and designs expansion of project into phase II. To be determined To be determined Loan SESS/SEGF LGFI Phase I Establishes LGFI and starts operating EA Executing Agency SEGF Governance, Finance and Trade Division, Southeast IRM Indonesia Resident Mission Asia Department PPTA project preparatory technical assistance SESS Social Sectors Division, Southeast Asia Department SDP Sector Development Program SSTA small scale technical assistance TA technical assistance

Appendix 2 11 Table A2.3: Funding of Other Agencies World Bank 1999 TA 2001 TA (ongoing) PDAM Rescue Program Strengthening Indonesia s Framework for Decentralization Objective was to support the development of a PDAM rescue program (loan) that did not materialize. Participating PDAMs were required to prepare a time-bound financial recovery action plan and financial projections, which were the basis for requesting rescheduling of existing loans with MOF and/or requesting new loans. At the end of the program in March 2002, 9 PDAMs had signed loan rescheduling agreements with MOF, all of them during the last few months of the program when MOF finally decided to sign off on these few. Financed by a Dutch Trust Fund established at the World Bank, the program is to support Indonesia s decentralization process and institutions. Under program area 2, Intergovernmental Fiscal Framework, studies are developed, among others, to analyze the implementing regulations and institutional design for regional borrowing and local bonds. United States Agency for International Development 1994 TA 2002 TA (ongoing) Regional Development Account: Policy and Operational Issues Local Government Finance Policy Framework Study Study was the response to early difficulties of RDA such as demand outstripping available resources, delays and high transaction costs, a lax policy in handling late payment and arrears, and the lack of an intercept mechanism. Final report recommended seeing RDA as transition mechanism and that no new loans should be made to borrowers in arrears. Analyzes the strengths and weaknesses of the current system of local government borrowing for capital investment and develops a policy framework, strategy, and action plan for enabling local governments to increasingly access credit for capital investment from capital markets and private sources of financing. Japan Bank for International Cooperation 2002 TA (to start soon) Study on Transfer Mechanism for Local Government Borrowing Will review and analyze on-lending and grant transfer schemes to assist the Central Government in ensuring a more effective implementation of foreign loan projects. MOF Ministry of Finance RDA regional development account PDAM local water utility TA technical assistance

12 Appendix 3 COST ESTIMATES AND FINANCING PLAN ($'000) Foreign Local Total Item Exchange Currency Cost A. Asian Development Bank Financing a 1. Consultants a. Remuneration and Per Diem i. International Consultants 288.0 0.0 288.0 ii. Domestic Consultants 0.0 75.0 75.0 b. International and Local Travel 20.0 8.0 28.0 c. Reports and Communications 1.0 4.0 5.0 2. Equipment 0.0 5.0 5.0 3. Training, Seminars, and Conferences a. Facilitators 10.0 2.0 12.0 b. Training Program 5.0 8.0 13.0 4. Miscellaneous Administration and 0.0 8.0 8.0 Support Costs 5. Representative for Contract Negotiations 5.0 0.0 5.0 6. Contingencies 44.0 17.0 61.0 Subtotal (A) 373.0 127.0 500.0 B. Government Financing 1. Office Accommodation and Transport 0.0 50.0 50.0 2. Remuneration and Per Diem 0.0 55.0 55.0 of Counterpart Staff 3. Others 0.0 20.0 20.0 Subtotal (B) 0.0 125.0 125.0 Total 373.0 252.0 625.0 a Financed by the ADB-funded TA Special Fund. Source: Asian Development Bank estimates.

Appendix 4 13 OUTLINE TERMS OF REFERENCE FOR CONSULTANTS A. Consulting Tasks 1. The scope of work under the technical assistance (TA) comprises two components: (i) designing a policy, methodology, and implementation action plan for restructuring the existing Regional Development Account (RDA) and subsidiary loan agreement (SLA) portfolio; and (ii) providing capacity building and training on regional finance for staff of government agencies involved in setting up a new regional government financing system, and for trainers of domestic training institution(s) who can carry out the training on a continuous basis. The consultants will use a participatory approach throughout the assignment by involving key stakeholders and by providing on-the-job training to counterparts involved. 1. Design of a Policy, Methodology, and Implementation Action Plan for Portfolio Restructuring 2. The consultants tasks will include the following: (i) Review the current legal and political situation with regard to regional borrowing and potential for solving debt, taking into account the current moratorium on borrowing and how this will or could be relaxed gradually, the RDA-SLA history and its impact on the current situation, and past and current attempts to resolve the debt issue, among others. (ii) Analyze RDA-SLA portfolio for completeness of loan inventory, and reconcile arrears data for the RDA-SLA portfolio between the Ministry of Finance s records and those being held by the regional debtors. This will require selected field visits where data discrepancies are most evident. Draw on the groundwork on local water utility (PDAM) debt restructuring carried out by the Asian Development Bank (ADB) and the World Bank. 9 Update the RDA-SLA portfolio database accordingly, and advise defaulting borrowers of the extent of their arrears, disaggregated into principal, interest, commitment charges, and penalties. (iii) Categorize and prioritize arrears according to their size, maturity, and likelihood of recovery, among others. Categorization, and the criteria to be applied, has to be agreed upon with the TA steering committee, and should be transparent and simple (i.e., 3-4 groups of defaulting borrowers only). (iv) Review relevant good international practice for similar debt solutions in other developing countries which can be applied in Indonesia, and present these at a workshop for the TA steering committee. (v) Devise a debt solution strategy for each borrower group. Review appropriate debt rescheduling, restructuring, and recovery methods, such as stretching out original loan repayment periods and introducing more accommodating debt service structures, and assess which ones would apply best. The strategy should be based on a transparent and simple methodology. Model agreements with borrowers in arrears should take into account the economic crisis situation during the last 5 years but must be based on willingness to repay and repayment record, and should include management covenants, mandatory business plans, and a repayment enforcement mechanism, among others. (vi) Conduct workshops at the central government level to accelerate the decisionmaking process with regard to debt restructuring, and at the regional government 9 ADB loan 1501-Regional Development Account; World Bank PDAM Rescue Program of 1999.

14 Appendix 4 level to discuss draft workout strategy and receive feedback from stakeholders. Based on the discussions at workshops, the debt solution strategy should be revised if appropriate. (vii) Revise loan agreements based on the rescheduling and restructuring strategy. Loan agreements will have to be amended by a number of financial and contractual clauses to provide greater clarity and scope for enforcement of loan compliance. Amendment clauses need to be identified and provided in a model for revised loan agreements. (viii) Based on the agreed upon methodology, design a detailed implementation action plan for debt restructuring, including responsibilities for tasks involved at central and regional government levels, detailed inputs and cost estimates for implementing the plan through the follow-on sector development project in 2003, and a project framework describing project design and goals and purpose, among others. 2. Regional Finance Capacity Building and Training 4. The consultants tasks will include the following: (i) Identify relevant staff at the central government level who require regional finance training. Since the decisions on a new regional finance system are made at the interministerial level, it is important to select staff from MOF and from Ministry of Home Affairs (MOHA), National Development Planning Agency (BAPPENAS), Coordinating Ministry of Economic Affairs (Perekonomian), and other agencies as appropriate. (ii) Conduct a training needs assessment for staff identified to tailor training modules appropriately. Assess whether it is appropriate to set up separate training either based on government hierarchy levels involved or on knowledge on the topic, taking into account any previous in-country or outside training received. (iii) Design short-term training modules for staff identified. Modules should cover topics such as regional borrowing and municipal finance markets, models of and experience with regional finance systems in other countries, alternatives and complementary structures to borrowing (such as municipal bonds), and assessment and improvement of regional government creditworthiness, among others. Basic financial management training will also be necessary, covering topics such as public investment programming, economic rationale for public provision and modes of finance for different types of urban services, and regional debt and risk management. Preference should be given to provide in-country training, but if necessary selective training abroad could be considered. (iv) Implement pilot training modules with staff, and revise modules as necessary based on feedback received. (v) Identify domestic training institution(s) that could carry out training on a continuing basis for other stakeholder groups. The institution(s) should be identified in close cooperation with the proposed loan for local government capacity building under decentralization. Ideally, training modules should become an integral part of training modules under the proposed loan. (vi) Train trainers of identified institution(s) to deliver modules for other interested stakeholder groups.

Appendix 4 15 (vii) Throughout the whole TA period, maintain close involvement and cooperation with relevant staff and provide continued on-the-job training to enhance their capacity and knowledge. B. Schedule and Reporting 5. The duration of the TA will be 9 consecutive months. The following reports will be prepared in English and will be provided in hard copy and in electronic form in a format satisfactory and suitable for use by the recipients: (i) an inception report, at the end of the first month, outlining initial progress, and recommending any changes required to the agreed work plan; (ii) an interim report, including a draft restructuring policy and methodology and a training needs assessment, at the end of the fourth month, to be revised following workshops at the central and local government level; (iii) a draft final report, including the revised restructuring policy and methodology, a restructuring implementation action plan, and a capacity building and training report, at the end of the eighth month; and (iv) a final report, at the end of the assignment, including revisions to the draft final report and outlining follow-up activities for projects identified in ADB s 3 year pipeline of TA and loan projects (Appendix 2).