Vol. 5, No. 7, July 2024
E-ISSN: 2723-6692
P-ISSN: 2723-6595
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Jurnal Indonesia Sosial Sains, Vol. 5, No. 7, July 2024 1616
KEYWORDS
ABSTRACT
Deficits experienced by local governments can lead to financial
difficulty, often referred to as financial distress. Although local
governments experience deficits, local governments can avoid these
conditions with good regional financial management. This research
aims to determine regional financial management's effect on local
governments' financial distress in 2019-2022. The sample in this
research uses a total sampling technique at all provincial and local
government levels in 2019-2022. This research uses secondary data
with documentation techniques. Binary logistic regression was
obtained to perform data analysis. The results showed that financial
independence significantly negatively affects financial distress.
Financial flexibility has a significant negative effect on financial
distress. Operational solvency does not have a significant adverse
effect on financial distress. Short-term solvency has a significant
positive effect on finances. Service solvency has a significant
negative effect.
Attribution-ShareAlike 4.0 International (CC BY-SA 4.0)
1. Introduction
The purpose of regional autonomy is to provide rights to manage their own region, including
the region's financial management (Dwitayanti et al., 2020). Regional autonomy can help local
governments to know their regional ability to implement regional authority and freedom of
management in developing regions guided by applicable regulations. The success of regional
autonomy can be seen from various circumstances, such as regional independence, regional financial
performance, and the quality of public services (Tumija, 2022; Ningrum, 2022). However, the
implementation of regional autonomy needs to be monitored, considering that various obstacles must
be resolved, one of which is the problem of financial distress or financial difficulties (Indriaty et al.,
2019).
Jones and Walker (2007) and Wulandari (2020) describe financial distress as the inability to
provide services based on existing service standards. Financial distress in the government or public
The Effect of Regional Financial Management on
Financial Distress of Local Government in Indonesia
Moh. Haidar Nashrullah, Khomsiyah
Universitas Trisakti, Jakarta, Indonesia
Email: haidar.na74@gmail.com, khomsiyah@trisakti.ac.id
Correspondence: haidar.na74@gmail.com
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sector is defined as the government's inability to provide services and facilities caused by limited
resources due to being used for routine expenditures that are less productive (Sari & Arza, 2019).
Financial distress in provincial and local governments can occur due to several factors, including
imbalances between regional revenues and expenditures, inefficient financial management, and
improper debt management (Xie et al., 2011). A high dependence on fund transfers from the central
government often causes this imbalance. At the same time, Regional Original Revenue (PAD) has not
been able to support the increasing needs of regional spending. The financial distress experienced by
several provincial-level local governments in Indonesia shows structural problems in the regional
financial management system. For example, in (2023), the North Sumatra Provincial Government
experienced a significant budget deficit. This deficit was triggered by a decline in regional revenue
due to the COVID-19 pandemic, while regional spending on public services and infrastructure could
not be reduced. The impact is far-reaching, ranging from delayed payment of employee salaries and
disruption of public services to the inhibition of infrastructure development needed by the
community. Local governments can handle the deficit by applying for loans to various parties, often
called regional loans. Based on the Indonesian Public Sector Debt Statistics (SUSPI) released by Bank
Indonesia, Indonesia's Gross Local Government Debt position in Q2 2023 reached IDR78.26 trillion.
This figure tends to decrease from previous periods, but the debt interest rate continues to increase
until the interest payable in Q2 of 2023 reaches IDR531.82 billion. Increasing debt can disrupt
spending that supports community services. In the public finance literature, the condition where the
government cannot fulfil public services using its budget for several years is referred to as financial
difficulties or often referred to as financial distress (Kadafi & Amirudin, 2020).
The government's financial distress conceptual framework is an adoption of the financial
distress framework in the private sector where the debt repayment ability ratio, often referred to as
the Debt Service Coverage Ratio (DSCR), is used by creditors when providing loans to entities. DSCR
is an analysis to predict the ability of an entity to meet its obligations when receiving a loan (Udayana
et al., 2022). Government Regulation (PP) 56 of 2018 on Regional Loans explains that DSCR shows
the local government's capability to pay off its loans. Furthermore, Government Regulation No. 23 of
2003 on The Control of the Cumulative Amount of State Budget and Regional Budget Deficits and the
Cumulative Amount of Central Government and Regional Government Loans stated that one of the
requirements that local governments must meet to obtain a loan is having DSCR value of more than
or equal to 2.5. If a region's DSCR falls below 2.5, it is ineligible to apply for a regional loan due to
concerns about its ability to meet principal and interest payment obligations (Indriaty et al., 2019).
Thus, it is necessary to control the financial condition of a local government (Ningrum & Sholihah, 2023).
The financial condition of local governments can be seen in various analyses. Article 6 of the
Regulation of the Minister of Home Affairs (Permendagri) Number 19 of 2020 on The Measurement
of the Regional Financial Management Index explains that the Regional Financial Management Index
(IPKD) is measured by six dimensions, namely the alignment of planning and budgeting documents;
the composition of the budget in the APBD; openness of regional financial management; budget use;
regional financial conditions; and the opinion of the Financial Audit Board on the LKPD (Regional
Government Financial Statements). Furthermore, Article 11 explains that regional financial
conditions consist of indicators, which are financial independence, financial flexibility, operational
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solvency, short-term solvency, long-term solvency, and service solvency. These indicators can inform
the public about the condition of a Regional Government.
Local government financial ratios can be used to assess the government's financial health,
especially in the context of accountability for the implemented regional autonomy (Wulandari, 2020).
Furthermore, Wulandari (2018) explained that financial ratio analysis can describe the capability to
carry out government operations and predict potential financial difficulties. On the other hand, the
ability of a region to carry out regional autonomy can be reflected in its level of financial
independence. Financial independence describes the level of dependence of local governments on
assistance from the central government. Local governments with greater financial independence will
be more capable of surviving and avoiding financial crises (Ilahi et al., 2021). Local governments'
ability to increase PAD and develop their government can be reflected in fiscal decentralisation. The
need for funds from other sources will arise if the local government has a low PAD (Ilahi et al., 2021).
Pranoto et al. (2022) explained that the contribution of PAD, as measured by the degree of
decentralisation, can indicate potential financial distress for local governments.
This research was developed from similar previous studies. Previous research used private
company ratios, which aimed at generating profits from their operations, to predict financial distress
in Indonesia's local government. Indriaty et al. (2019) found that the current ratio, debt to equity,
operating revenues to total revenues ratio, return on assets, return on equity, population, and
regional status significantly influence predicting financial distress. Revenue growth does not predict
financial distress. For this reason, this study aims to examine the influence of regional financial
management identified through the dimension of regional financial conditions. This study must at
least answer some basic questions to conclude that regional financial management influences
financial distress.
Based on current conditions, many local governments are experiencing significant deficits. The
researcher aims to examine ratios that depict regional financial conditions, precisely financial
independence, financial flexibility, operational solvency, short-term solvency, long-term solvency,
and service solvency, as stated in Permendagri Number 19 of 2020 on The Measurement of IPKD. This
research seeks to predict the financial distress of local governments in Indonesia by utilizing these
variables, setting it apart from previous studies that did not use the ratios listed in Permendagri
Number 19 of 2020. Therefore, this research is titled "The Influence of Regional Financial
Management on Financial Distress of Local Governments in Indonesia."
2. Materials and Methods
This study aims to measure the influence of independent variables on the dependent variable.
Therefore, the appropriate research models are correlation and regression studies. Correlation
studies help identify relationships between variables, while regression measures the strength of these
relationships. The independent variables in this study are financial independence, financial flexibility,
operational solvency, short-term solvency, and service solvency. The dependent variable is financial
distress. The hypothesis in this research can be described as follows:
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The Effect of Financial Independence on Financial Distress
Permendagri on IPKD explains that financial independence is the level of sensitivity to sources of
funds local governments outside their control, either from the country or abroad. Independence
means that a region can generate revenue independently and manage it to fulfill obligations and
perform regional operations. The higher the level of financial independence, the more independent
the region is in fulfilling its regional activities. This allows the region to allocate more funds to capital
expenditure so that the government has sufficient assets to provide services and improve public
welfare. Thus, the higher the level of financial independence, the more likely the local government
will be released from financial distress (Sari & Arza, 2019).
H1: Financial independence has a negative effect on the financial distress of local governments in
Indonesia.
The Effect of Financial Flexibility on Financial Distress
Permendagri on IPKD explains that financial flexibility is the local government's capability to face
increased commitments caused by internal and external local governments, either through increased
revenue or debt capacity. Commitments refer to events that must be completed by the local
government (Putri, 2022). In this case, financial flexibility refers to the availability of funds to handle
an unexpected event increase. The higher the financial flexibility, the more funds are available to
handle unexpected events. Thus, the higher the level of financial flexibility of the local government,
the more likely the local government will be released from financial distress.
H2: Financial flexibility hurts the financial distress of local governments in Indonesia.
The Effect of Operational Solvency on Financial Distress
Permendagri on IPKD explains that operational solvency is the level of local government revenue that
can cover operational expenses during the budget period. The definition states that "revenue to cover
operating expenses", so it is related to the accrual system reported in the Operational Report.
Operational Solvency describes the level of revenue that can be used to cover local government
operational expenses, so the higher the degree of operational solvency, the more excess funds
remaining after covering operational expenses during the budget period. The remaining funds can be
used to finance other activities. Thus, the higher the level of operational solvency, the more likely the
local government will be released from financial distress.
H3: Operational solvency has a negative effect on the financial distress of local governments in
Indonesia.
The Effect of Short-Term Solvency on Financial Distress
Permendagri on IPKD explains that short-term solvency is the level of ability of local governments to
meet their obligations in less than 12 months. The higher the level of short-term solvency, the greater
the liquid assets remaining after settling current liabilities. Thus, the higher the short-term solvency,
the more likely the local government will be released from financial distress.
H4: Short-term solvency has a negative effect on the financial distress of local governments in
Indonesia.
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Effect of Service Solvency on Financial Distress
The Permendagri on IPKD explains that service solvency is the value of the local government's
capability to provide and maintain the quality of services that the public needs and desires. Before
local governments provide services, local governments need assets to perform service operations. So,
service solvency is illustrated by the ratio between the source of facilities owned by the government
and the total population that can get these services. The more assets owned by the local government,
the more services the local government is able to provide than local governments with lower assets.
Thus, the higher the solvency of the service, the more likely the local government is to be free from
financial distress.
H5: Service Solvency has a negative effect on the financial distress of local governments in Indonesia.
The analysis unit in this research is an organisational unit, namely, provincial governments in
Indonesia. The data population in this research will be all provincial governments from 2019 to 2022.
This research uses a total sampling technique. Thus, all the populations are used for the data sample.
This study utilizes a panel data approach that combines time series and cross-sectional data.
Secondary data are used in this study, as well as the Financial Report on Local Government (LKPD)
obtained from the Audit Board of the Republic of Indonesia (BPK), data from the Central Statistics
Agency (BPS), and the official provincial government website. The data covers 34 of the 38 provinces
in Indonesia, excluding Papua Pegunungan, Papua Selatan, Papua Tengah, and Papua Barat Daya, as
these provinces were established in 2022. The research employs binary logistic regression performed
with SPSS 25 to evaluate the hypothesis. The dependent variable is binary, where 0 describes the local
government having a DSCR of less than or equal to 2.5, indicating it is in financial distress, and 1
describes the local government having DSCR above 2.5, indicating it is not in financial distress.
3. Result and Discussion
Table 1
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Table 2
In the third outlier test, three outlier data were identified with a ZResid value
or less than -2.5. The outliers are case numbers 47, 106, and 120; those.
Table 3
In the fourth outlier test, no outlier data were identified due to no case data from datasets with
a Zresid of more than 2.5 or less than -2.5.
Table 4
Based on the outlier test, 12 cases were identified as outliers. Those data were excluded from
hypothesis testing. Therefore, the data for the next steps are 136-12 or 126.
Multicollinearity testing indicates that independent variables have little or no multicollinearity.
If the tolerance value is less than 0.1, it can be indicated that the predictor variable is highly correlated
with other predictor variables in the model. The results of this test showed that all predictor variables
had a tolerance value of more than 0.1. The tolerance value of financial independence (KK) is 0.869.
The tolerance value of financial flexibility (FK) is 0.408. The tolerance value of the operational
solvability (SO) is 0.471. The tolerance value of short-term solvency (SJP) is 0.439. The tolerance
value of service solvency (SL) is 0.515.
Table 5
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Table 6
Table 7
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Table 8
research
Table 9
Table 10
The Omnibus Test of Model Coefficients is evaluated through its significance value. With
a confidence level of 95%, the significance value obtained from the test is 0.00, which is well
below the threshold of 0.05. This result indicates that the independent variable has a
simultaneous significant impact on the predicted variable.
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Table 11
Table 12
Based on the Wald Test, the coefficient of each variable and the constant can be obtained
to form an equation. The equations obtained based on the Wald test are as follows:
Discussion
Financial independence negatively affects the financial distress of local governments in
Indonesia
The first hypothesis test (H1) is that financial independence negatively affects local government
financial distress. Based on the Wald Test, financial independence has a significance value of 0.001
with a coefficient value of -68.404, indicating that this variable has an inverse or negative effect. The
significance value of the test was smaller than the significance value of 0.05, so it can be concluded
that financial independence has a significant effect inversely related to the financial distress of the
local government. Thus, H1 is accepted.
The results of this research align with several previous studies, one of which is the study by
Pranoto et al. (2022), which described that the degree of decentralisation is inversely related to
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financial distress conditions. In Pranoto's research, the degree of decentralization was calculated
using the same formulation as the financial independence used in this research.
The results of this study are also in line with the research of Elfiyana and Arza in 2022, which
shows that the degree of decentralization is inversely related to conditions of financial distress. In
Elfiyana's research, the degree of decentralization is calculated using the same formulation as the
financial independence used in this research.
Financial flexibility negatively affects the financial distress of local governments in Indonesia.
The results of the second hypothesis test (H2), financial flexibility negatively affects local
government financial distress, has a significance value of 0.001 with a coefficient value is -4.136 and
has an inverse or negative effect. The significance value of the test is smaller than the significance
value of 0.05 so it can be concluded that financial flexibility has a significant impact inversely related
to the financial distress condition of the local governments. Thus, H2 is accepted.
Operational solvency negatively affects the financial distress of local governments in
Indonesia
The results of the third hypothesis test (H3), operational solvency negatively affects local
government financial distress, has a significance value of 0.449 with a coefficient value is -3.757 and
has an inverse or negative effect. The significance value is greater than 0.05, so it can be concluded
that financial solvency does not have a significant impact on the financial distress of local
governments but has an inverse relationship with the financial distress of local governments is still
in sync with the hypothesis. Thus, H3 is rejected.
This study's results align with Waninda and Arza's (2019) statement that the ratio of operating
income to operating expenses cannot predict financial distress. The local government financial
statements explain that the ability of local governments to fulfil the requirements of operating
expenses does not guarantee that local governments will experience financial distress, considering
the relatively small amount of revenue compared to the operating expenses that must be covered.
Short-term solvency negatively affects the financial distress of local governments in Indonesia.
The results of the fourth hypothesis test (H4), short-term solvency negatively affects local
government financial distress, has a significance value of 0.002 with a coefficient value of 1.1030, and
has a direct or positive effect. The significance value of the test is smaller than the significance value
of 0.05, so it can be concluded that short-term solvency has a significant impact on the financial
distress condition of local governments, but the resulting relationship is positive for the financial
distress condition of local governments, which is not in sync with the hypothesis. Therefore, H4 is
rejected.
This research is in line with the research of Indriaty et al. (2019), which shows that the current
ratio can predict financial distress. Research by Winarna, et al. (2017) stated that Cash Quick Ratio
have a positive significant impact as a predictor of financial distress.
The result of this research is also different from the developed hypothesis. This can be
explained starting from the formula used, which compares cash, cash equivalents, and short-term
investments to short-term liabilities. The higher value of the short-term solvency ratio can trigger the
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occurrence of financial distress for local governments and indicates that local governments have too
many liquid assets, which are cash, cash equivalents, and short-term investments. This illustrates that
the local government has not been able to manage liquid assets to be used for spending that can
support public services. Large number of liquid assets increases the risk of corruption or fraud on
cash, so local governments lose assets that can be used to support public services. This opinion is also
supported by the analysis in the private sector, if a private company has liquid assets more than 3
times its short-term liabilities, the company is indicated to be unable to maximize the available money
to make a profit.
Solvency of services negatively affects the financial distress of local governments in Indonesia
The results of the fifth hypothesis test (H5), service solvency negatively affects local
government financial distress, has a significance value of 0.013 with a coefficient value of -0.0000009
or 9x10
-7
and has an inverse or negative effect. Thus, H5 is accepted. The significance value of the test
is smaller than the significance value of 0.05 so it can be concluded that financial solvency has a
significant impact inversely related to the financial distress of the local governments.
Limitations
The research is not separated from some limitations. The main limitation of this research is that
the long-term solvency variable cannot be calculated and analysed according to the Regulation of the
Minister of Home Affairs on IPKD because not every local government has long-term debt, so no data
is available for research. Another limitation is that this research is still at the provincial local
government level, has not considered the level of district/city local governments, and has not yet
considered the policies or strategies taken by each local principal.
4. Conclusion
Based on the research that has been performed, several conclusions can be made that can
answer the formulation of the problems that have been formulated at the beginning, namely as
follows: 1) Financial independence has a significant effect and is negatively correlated with the
financial distress of local governments in Indonesia in 2019-2022. This is shown by a significance
value of 0.001, less than 0.05. 2) Flexibility has a significant effect and is negatively correlated with
the financial distress of local governments in Indonesia in 2019-2022. This is shown by a significance
value of 0.001, less than 0.05. 3) Operational solvency has no significant effect and is negatively
correlated with the financial distress of local governments in Indonesia in 2019-2022. This is shown
by a significance value of 0.449, more than 0.05. 4) Short-term solvency has a significant effect and is
positively correlated with the financial distress of local governments in Indonesia in 2019-2022. This
is shown by a significance value of 0.02 which is less than 0.05. 5) Service solvency has a significant
effect and negatively correlates with local government financial distress in Indonesia in 2019-2022.
This is shown by a significance value of 0.013 which is less than 0.05.
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