This paper portrays a case study in Yogyakarta, Indonesia, looking at the dynamic relationship between communities and the effectiveness of implementation of community-based forest management (CBFM) policies and its programme, and particularly how local institutions deal with the shifting dynamics of these policies. As there is currently an absence of research in this area, this research, therefore, focuses on how the local community implements policy, builds relationships with other stakeholders and strengthens local community institutions. CBFM has been performed in Yogyakarta since 1995 and during that time, the central government has been changing the policy for five times. At this point, this paper argues that CBFM should rely on local institutions and deal with shifting dynamics of policies. The terms of institutions can be considered to include formal institutions, such as Constitution, government laws, charter, decree and statutes, and informal institutions, such as code of conducts, customs, local knowledge and social expectations. Furthermore, in selected communities, it is clear that the local communities can apply their informal institutions as an important component and value of traditional systems and significantly involved in forest management sustainability and establish the formal institutions simultaneously.