In this paper, we examine the decentralization reforms now underway in Indonesia, focusing on their effects on local government borrowing. Our general conclusion is that the laws and their implementing regulations seem designed mainly to deal with macroeconomic considerations of the central government, and not to create a system to allow local governments to gain access to credit markets. Indeed, this seems likely to be a reasonable immediate goal, given that the pre-conditions for successful local government borrowing are not currently present in Indonesia. However, the long run goal must remain the creation of a viable framework in which local governments face hard budget constraints but are still able to have access to capital markets. It is here where the current framework in Indonesia is inadequate. To this end, we suggest a number of policies that will help in a transition period from the current reliance on direct administrative control of local borrowing to a greater reliance on market discipline policy.
In the next section, we briefly discuss the current macroeconomic conditions of Indonesia, and outline the major features of Laws No. 22/1999 and 25/1999, including their provisions that deal with local government borrowing. In section III, we present a general "framework" that establishes some conditions under which different approaches to local government borrowing can be successful, and we apply this framework to local governments in Indonesia in the section IV. We conclude in section V.