Public Financial Governance and Socio-Economic Performance: Evidence from Local Government in Indonesia

Abstract:

Increasing the quality of government financial management is an important aspect of governance in order to improve the quality of public services and public welfare. In the era of fiscal decentralization, where local governments are given the authority to manage their own regional finances, transparency and accountability play important roles in regional financial management. The Supreme Audit Agency (Badan Pemeriksa Keuangan or BPK) routinely conducts an audit on local government financial reports and provide an audit opinion on the fairness of the financial information presented in the financial statements of each regional government. It is interesting to examine whether BPK's opinion on Regional Financial Reports (Laporan Keuangan Pemerintah Daerah or LKPD) has a significant relationship with socio-economic performance in each region. This study aims to see links, if any, between the status of BPK's opinion on regional financial statement with socio-economic performance of regions in Indonesia, such as income per capita, poverty level, and inequality. The methodology employed in this study is a panel data regression model using data from all district and city governments in Indonesia from 2015 to 2019. The provisional result of this study is that regions with better opinion status have better socio-economic performance compared to regions with lower audit opinion status. The estimation has considered control variables such as total local government spendings, local government spending on capital, and local government transfers from central government. The estimation results are robust when the area is divided into two categories, Java and outside Java. The findings in this study can contribute both to the existing literature and to relevant government policies in order to improve the quality of local government financial management and, ultimately, welfare of the people.

Keywords: Public Financial Management; Governance; Welfare; Local Government; Transparency; Accountability

Background

Transparency and accountability of local government is an important aspect of good governance that can support the government's efforts to improve welfare of the people. The concepts of transparency and accountability are interrelated whereby according to Maan (2009) "transparency is the freedom to obtain information" and "accountability is responsibility of the government to the public for every activity carried out". Furthermore, Kumorotomo (2019) stated that transparency is a manifestation of good governance which is needed in efforts to eradicate corruption and increase government accountability to the public. Increased government accountability to the public will strengthen and support the government's efforts to increase the effectiveness of government policies which, in turn, will improve people's welfare. In the era of fiscal decentralization where local governments are given the authority to manage their respective regional finances, the aspects of transparency and accountability becomes pertinent. Regional governments that are transparent and accountable openly provide financial information to inform and involve the public with regards to government budget policies which includes the process of planning, implementing, and impact evaluation (Hehanussa, 2015).

In the context of implementing aspects of transparency and accountability in the management of Regional Government Financial Reports (Laporan keuangan Pemerintah Daerah or “LKPD”), the opinion of the Supreme Audit Agency (Badan Pemeriksa Keuangan or “BPK”) on LKPD is very important. The BPK is responsible for supervising and auditing government financial reports, both at the national and regional level, and carries out regular inspections of LKPD. From the results of the audit, BPK produces a report containing an opinion which is a professional statement as the auditor's conclusion regarding the fairness of government financial information based on criteria such as conformity with government accounting standards, adequate disclosures, compliance with laws and regulations, and the effectiveness of the internal control system. There are four statuses of BPK's audit opinion on LKPD, ranking from best to worst are as follows: Wajar Tanpa Pengecualian (WTP), Wajar Dengan Pengecualian (WDP), Tidak Memberikan Pendapat (TMT), andTidak Wajar (TW).

The opinion of the Supreme Audit Agency (BPK) is thought to be closely related to the socio-economic performance of the region. Regional government which received the best audit opinion on its LKPD, namely WTP, is considered to have been able to manage its regional finances properly and in accordance with applicable regulations. Good regional financial management is likely to have a positive impact on the social and economic performance of that region. In order to find out the relationship between BPK's audit opinion on LKPD and regional socio-economic performance, this report will examine empirically the estimation of the relationship between the two variables using statistical and econometric methods. The data used in the estimation includes the results of BPK's opinion on LKPDs from 514 district/city between 2015 and 2019 as well as data on socio-economic indicators of district/city governments such as GRDP per capita, Human Development Index level, poverty levels, and inequality. Other government fiscal data that are also used in the estimation are local government expenditures per capita, local government revenues per capita, and regional transfers per capita.

Research Framework

The concept of good governance spans many aspects including financial, economic, and social. According to the World Bank, governance refer to “the manner in which power is exercised in the management of a country’s economic and social resources for development” (Sen, 1994). As mentioned by UN ESCAP, good governance is characterized by accountability, transparency, responsiveness, equitable and inclusivity, effectiveness & efficiency, following the rule of law, participatory, and consensus oriented. Good governance is thought to have a positive impact on a region’s financial performance which in turn will lead to better economic performance as governments which employ good governance are deemed to have more accountability and transparency as well as being more efficient and effective.

With this in mind, a region which received WTP audit opinion from BPK on its LKPD can be assumed to have implemented good governance given that its financial reporting is considered accountable, transparent, and in accordance with the national accounting standard. Hence, according to the hypothesis above, regions with good governance are more likely to have better financial and economic performance. However, it is interesting to note that the relationship between good governance of a region and its financial and economic performance may not be a one-way relationship. The better the social and economic performance of a region indicates the more developed of a region. Then, the more developed a region is predicted to have better capacity or resources to manage its own budget effectively and efficiently so that it gives a positive impact on the quality of governance. In this case, the quality of governance is indicated by the quality of government financial report based on criteria such as conformity with government accounting standards, adequate disclosures, compliance with laws and regulations, and the effectiveness of the internal control system.

Figure 1. The Relationship between Governance of a Region and its Financial and Economic Performance

Literature review regarding the relationship of BPKs opinion status with regional socio-economic performance

Several existing studies have observed the relationship between BPK's Opinion Status with social, economic, and government financial indicators. Studies conducted by Suryaningsih and Sisdyani (2016) and Masdiantini and Erawati (2016) observed the effect of BPK's opinion status on LKPD on local government financial performance. In contrast, other studies such as Akhmad Hafidzan and Dwi Martani (2014), Nur Anita and Rudy Badrudin (2017), and the World Bank (2017) observe the influence of social, economic, and financial indicators on the status of BPK's opinion on LKPD. The study conducted in this report focuses on observing the effect of BPK's audit opinion on LKPD on the socio-economic performance of regions in Indonesia.

On one hand, several studies have found that BPK's audit opinion on LKPD has a positive influence on the financial performance of regional governments. Masdiantini and Erawati (2016) conducted a study in which it aims to look at the factors affecting the financial performance of district and city governments in Bali Province. One of the factors considered is BPK's audit findings and opinions on the LKPD of each district and city in Bali Province. Regional financial performance is measured through four financial ratios, namely the ratio of independence, economic ratio, efficiency, and effectiveness. The results of this study show that BPK's audit opinion on LKPD has a significant positive effect on local government financial performance. With a wider scope, Suryaningsih and Sisdyani (2016) conducted a similar study using data from all districts and cities in Indonesia. The study also found that BPK's audit opinion on LKPD had a significant positive effect on the financial performance of district and city governments.

On the other hand, several other studies conducted research that look at socio-economic factors that influence the status of BPK's audit opinion on LKPD. A study by Akhmad Hafidzan and Dwi Martani (2014) aims to see the influence of human development (measured by Human Development Index, education level, health, and welfare level) and political factors on the status of BPK's opinion on LKPD. The results of the study show that human development has a positive impact on the status of BPK's opinion on LKPD. Meanwhile, political dynasty and whether LKPD is released close to regional head election have a negative impact on BPK's audit opinion. Meanwhile, Nur Anita and Rudy Badrudin (2017) conducted a study on the effect of local government financial performance on the status of BPK's audit opinion on LKPD in the Special Region of Yogyakarta. The results of the study found that the financial performance of local governments had a positive and significant effect on the status of BPK's opinion on LKPD.

Moreover, a World Bank study in 2017 found that local governments participating in the Local Government and Decentralization pilot project (Proyek Pemerintah Daerah dan Desentralisasi or “P2D2”) or pilot project for transfer of funds (Dana Alokasi Khusus or “DAK”) had a positive and significant impact on increasing accountability. From 2011 to 2014, the Government of Indonesia with support from the World Bank carried out a P2D2 or DAK pilot project which are based on performance. The project with output-based disbursement scheme encourages local government to achieve better targets in terms of quality public service. Participating local governments are required to conform to compliance standards which includes aspects of financial management, procurement, environmental, social, and technical. At the start of the program, five provinces and 78 districts/cities participated in the project. Some findings related to accountability indicators from local government’s participation on the P2D2 project participation are as follows: i) Local governments have a 5.5% probability of obtaining or maintaining a WTP opinion; ii) There is a probability of 2.1% for local government to get a WDP opinion; iii) The probability of the local government not getting a TMP opinion is 1.1%; and iv) There is a 5.6% probability that the local government will not receive a TW opinion or disclaimer. From this analysis it can be concluded that participation on the pilot project have a positive and significant impact for the local government.