Local government borrowing and repayment in Indonesia: Does fiscal capacity matter?

Most regional government borrowing in Indonesia has been conducted via central government mechanisms. While the terms and conditions of central lending have been highly favorable to regional borrowers, repayment of debt has been very poor. The empirical evidence suggests that local governments have borrowed well within their fiscal capacities to repay and that repayment problems are largely a function of unwillingness to repay debts and of central government acquiescence. Regional borrowing must significantly increase in the years ahead in order to meet growing demand for infrastructure services and lending to regions will have to become more market-based. Reducing systemic credit risk and improving the creditworthiness of regional borrowers are prerequisites to increased and sustained market-based lending.