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Democratic Republic of Timor-Leste:2019 Article IV Consultation—Press Release; Staff Report; and Statement by the Executive Director for the Democratic Republic of Timor-Leste

Author(s):
International Monetary Fund. Asia and Pacific Dept
Published Date:
May 2019
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Context

1. Timor-Leste has made significant progress since independence in 2002. By the end of its 25-year-long resistance struggle, Timor-Leste had lost over 70 percent of its infrastructure, a large portion of its population, and was Asia’s poorest nation.1 Since then, Timor-Leste has laid the foundation for political stability, improved living standards, and implemented a strong institutional framework for managing its petroleum wealth (Annex I). A Strategic Development Plan (SDP) was developed in 2011, with the goal to reach upper-middle income status by 2030. The SDP has also been aligned with the United Nations Sustainable Development Goals (SDGs) (Table 6).

Table 1.Timor-Leste: Selected Economic Indicators, 2015–24
2015201620172018201920202021202220232024
EstProj.
(Annual percent change)
Real sector
Real total GDP20.90.8-4.5-8.06.61.3-12.3-19.2-2.04.8
Real oil GDP46.5-4.0-4.4-18.39.0-3.7-38.3-81.3-100.0-
Real non-oil GDP4.05.3-4.60.85.04.84.84.84.84.8
CPI (annual average)0.6-1.50.52.32.53.23.73.94.04.0
CPI (end-period)-0.60.00.62.12.83.53.84.04.04.0
(In percent of total GDP, unless otherwise indicated)
Central government operations
Revenue33.236.630.730.027.123.724.125.223.221.9
Domestic revenue5.57.87.06.36.56.26.77.47.17.4
Estimated Sustainable Income (ESI)20.621.617.317.815.514.013.814.312.410.9
Grants7.27.26.45.95.23.53.53.53.73.7
Expenditure50.271.849.447.349.852.647.049.943.441.7
Recurrent33.240.833.528.533.532.334.537.836.234.5
Net acquisition of nonfinancial assets9.923.99.512.911.116.79.08.63.53.5
Donor project7.27.26.45.95.23.53.53.53.73.7
Net lending/borrowing-17.0-35.2-18.7-17.3-22.7-28.8-22.9-24.8-20.2-19.8
(Annual percent change, unless otherwise indicated)
Money and credit
Deposits76.711.912.92.99.38.46.88.27.87.6
Credit to the private sector10.5-1.824.8-3.813.010.310.912.813.39.1
Lending interest rate (percent, period average)13.514.013.313.5
(In millions of U.S. dollars, unless otherwise indicated)
Balance of payments
Current account balance 1/204-544-284-27956-6215-329-171-295
(In percent of GDP)6.6-21.6-10.2-9.01.8-1.80.5-10.4-4.9-7.6
Trade balance-635-546-615-626-652-714-694-734-717-760
Exports 2/18201722263036435060
Imports653567631648678744730777768820
Services (net)-583-569-344-398-291-397-311-389-299-271
Petroleum revenue1,2818722,034672899938890647677559
Overall balance220-157263261037979184151
Public foreign assets (end-period) 3/16,65516,12517,34416,37416,26215,86515,66715,19414,87014,396
(In months of imports)153160195172182151159138144130
Exchange rates
NEER (2010=100, period average)120.2120.1119.7119.9
REER (2010=100, period average)150.3146.2143.6146.3
Memorandum items (in millions of U.S. dollars):
GDP at current prices:3,1042,5212,7783,0903,1453,4133,3333,1663,4983,886
Non-oil GDP1,6091,7021,7301,8632,0862,3422,6433,0353,4983,886
Oil GDP1,4968201,0481,2281,0601,07168913100
GDP per capita2,6202,0802,2402,4352,4222,5692,4532,2792,4632,677
(Annual percent change)-25.0-20.67.78.7-0.56.1-4.5-7.18.18.7
Crude oil prices (U.S. dollars per barrel, WEO) 4/51435369595956575758
Petroleum Fund balance (in millions of U.S. dollars) 5/16,21815,84416,79915,80315,58815,11214,83414,34313,97913,453
(In percent of non-oil GDP)1,008931971848747645561473400346
Public debt (in millions of U.S. dollars)4677107168255303361457559666
(In percent of GDP)2.94.56.29.012.212.913.615.116.017.1
Population growth (annual percent change)2.42.32.32.32.32.32.22.22.22.2
Sources: Timor-Leste authorities; and IMF staff estimates and projections.

Excludes trade in goods and services of entities located in the Joint Petroleum Development Area, which are

considered non-resident.

Excludes petroleum exports, the income of which is recorded under the income account.

Includes Petroleum Fund balance and the central bank’s official reserves.

Simple average of UK Brent, Dubai, and WTI crude oil prices based on Jan 2019 WEO assumptions.

Closing balance.

Sources: Timor-Leste authorities; and IMF staff estimates and projections.

Excludes trade in goods and services of entities located in the Joint Petroleum Development Area, which are

considered non-resident.

Excludes petroleum exports, the income of which is recorded under the income account.

Includes Petroleum Fund balance and the central bank’s official reserves.

Simple average of UK Brent, Dubai, and WTI crude oil prices based on Jan 2019 WEO assumptions.

Closing balance.

Table 2.Timor-Leste: Summary of Central Government Operations, 2015–24 1/
2015201620172018201920202021202220232024
Est.Proj.
(In millions of U.S. dollars)
Revenue1,031.4927.1852.9926.2852.5810.1801.8797.4810.3852.6
Domestic revenue170.2201.0194.6194.1203.9211.9222.9234.3246.7286.4
Taxes119.7143.8132.6130.1136.4143.2150.2157.9165.7192.2
Of which: Taxes on income, profits, and capital gains53.364.254.759.061.664.767.871.274.889.5
Taxes on goods and services54.164.761.357.059.962.966.069.472.882.3
Taxes on international trade and transactions12.114.215.313.614.315.015.816.617.419.7
Non-tax revenue50.553.157.458.762.363.367.070.474.787.1
Estimated Sustainable Income638.5544.8481.6550.4486.0477.8461.3451.4434.9423.2
Donor Projects222.7181.3176.7181.7162.6120.4117.6111.7128.7143.0
Expenditure1,559.31,811.21,371.51,461.71,567.21,793.81,565.81,580.91,518.51,621.4
Expenditure excluding donor projects1,336.61,629.91,194.81,280.01,404.61,673.41,448.31,469.31,389.81,478.4
Expense1,252.31,209.11,108.21,062.91,217.71,222.41,267.31,309.51,395.31,484.5
Recurrent1,029.61,027.8931.5881.21,055.11,102.01,149.71,197.81,266.61,341.5
Compensation of employees173.3178.6197.2200.3214.0222.6231.5240.8266.1295.6
Goods and services423.8378.1328.4354.0478.3497.4517.3537.9563.0589.3
Current transfers432.5471.1405.8324.2355.1369.3384.1399.4415.4432.0
o/w ZEESM133.4217.9171.8129.7142.0147.7153.6159.8166.2172.8
Interest payment0.00.00.12.77.712.716.919.722.124.6
Donor projects222.7181.3176.7181.7162.6120.4117.6111.7128.7143.0
Net acquisition of NFA307.0602.1263.3398.8349.6571.5298.5271.4123.2136.9
Gross operating balance-220.9-282.0-255.4-136.7-365.1-412.3-465.6-512.1-585.0-631.9
Net lending/borrowing-527.9-884.1-518.7-535.5-714.7-983.7-764.1-783.6-708.2-768.8
Statistical discrepancy0.31.63.12.60.00.00.00.0-1.0-2.0
Net financial transactions-528.2-885.7-521.7-538.1-714.7-983.7-764.1-783.6-707.2-766.8
Net acquisition of FA-504.0-855.1-491.6-476.5-627.7-936.2-706.2-686.8-604.7-657.6
Foreign0.00.00.00.00.00.00.00.01.02.0
Domestic (net)-504.0-855.1-491.6-476.5-627.7-936.2-706.2-686.8-605.7-659.6
Equity-640.0-700.0-597.2-432.1-627.7-936.2-706.2-686.8-606.7-661.6
of which, Excess withdrawal from PF-640.0-700.0-597.2-432.1-627.7-936.2-706.2-686.8-606.7-661.6
Change in cash/deposit136.0-155.1105.6-44.40.00.00.00.00.00.0
Net incurrence of liabilities24.230.630.161.687.047.557.996.7102.6109.2
Foreign24.230.630.161.687.047.557.996.7101.6107.2
Domestic0.00.00.00.00.00.00.00.01.02.0
(In percent of total GDP)
Revenue33.236.830.730.027.123.724.125.223.221.9
Domestic revenue5.58.07.06.36.56.26.77.47.17.4
Taxes3.95.74.84.24.34.24.55.04.74.9
Of which: Taxes on income, profits, and capital gains1.72.52.01.92.01.92.02.22.12.3
Taxes on goods and services1.72.62.21.81.91.82.02.22.12.1
Taxes on international trade and transactions0.40.60.60.40.50.40.50.50.50.5
Non-tax revenue1.62.12.11.92.01.92.02.22.12.2
Estimated Sustainable Income20.621.617.317.815.514.013.814.312.410.9
Expenditure50.271.849.447.349.852.647.049.943.441.7
Expenditure excluding donor projects43.164.743.041.444.749.043.546.439.738.0
Expense40.348.039.934.438.735.838.041.439.938.2
Recurrent33.240.833.528.533.532.334.537.836.234.5
Compensation of employees5.67.17.16.56.86.56.97.67.67.6
Goods and services13.715.011.811.515.214.615.517.016.115.2
Current transfers13.918.714.610.511.310.811.512.611.911.1
o/w ZEESM4.38.66.24.24.54.34.65.04.74.4
Donor projects7.27.26.45.95.23.53.53.53.73.7
Net acquisition of NFA9.923.99.512.911.116.79.08.63.53.5
Gross operating balance-7.1-11.2-9.2-4.4-11.6-12.1-14.0-16.2-16.7-16.3
Net lending/borrowing-17.0-35.1-18.7-17.3-22.7-28.8-22.9-24.8-20.2-19.8
Statistical discrepancy0.00.10.10.10.00.00.00.00.0-0.1
Net financial transactions-17.0-35.1-18.8-17.4-22.7-28.8-22.9-24.8-20.2-19.7
Net acquisition of FA-16.2-33.9-17.7-15.4-20.0-27.4-21.2-21.7-17.3-16.9
Domestic (net)-16.2-33.9-17.7-15.4-20.0-27.4-21.2-21.7-17.3-17.0
Equity-20.6-27.8-21.5-14.0-20.0-27.4-21.2-21.7-17.3-17.0
of which, Excess withdrawal from PF-20.6-27.8-21.5-14.0-20.0-27.4-21.2-21.7-17.3-17.0
Change in cash/deposit4.4-6.23.8-1.40.00.00.00.00.00.0
Net incurrence of liabilities0.81.21.12.02.81.41.73.12.92.8
Memorandum item
Nominal GDP3,104.42,521.02,778.03,090.43,145.53,413.43,332.73,165.63,498.43,886.3
Nominal non-oil GDP1,608.71,701.51,729.71,862.72,085.92,342.32,643.43,034.73,498.43,886.3
Petroleum Fund
Opening balance16,538.716,217.715,844.316,799.215,803.015,588.215,112.014,834.714,343.413,978.1
Comprehensive investment income957.5871.42,033.7-13.7898.9937.9890.1647.0676.2557.4
Oil and gas receipts978.9223.9421.4389.4243.7321.5282.157.698.70.0
Investment returns326.7340.9340.0282.8655.2616.3607.9589.4578.5559.4
Valuation gains/losses-323.1331.11,295.9-685.90.00.00.00.00.00.0
(Minus ) Expenses and withholding tax25.024.423.70.00.00.00.00.01.02.0
Withdrawal1,278.51,244.81,078.8982.51,113.71,414.01,167.51,138.21,041.51,084.8
ESI638.5544.8481.6550.4486.0477.8461.3451.4434.9423.2
Excess withdrawal640.0700.0597.2432.1627.7936.2706.2686.8606.7661.6
Closing balance16,217.715,844.316,799.215,803.015,588.215,112.014,834.714,343.413,978.113,450.6
(In percent of non-oil GDP)1,008.1931.2971.2848.4747.3645.2561.2472.6399.6346.1
Sources: Timor-Leste authorities; IMF staff calculations.

This table is in accordance with the GFS format, with some modifications, to facilitate policy discussion and analysis.

Sources: Timor-Leste authorities; IMF staff calculations.

This table is in accordance with the GFS format, with some modifications, to facilitate policy discussion and analysis.

Table 3.Timor-Leste: Balance of Payments, 2015–24
2015201620172018201920202021202220232024
Est.Proj.
(In millions of U.S. dollars)
Current account balance 1/204-544-284-27956-6215-329-171-295
Trade balance-635-546-615-626-652-714-694-734-717-760
Exports 2/18201722263036435060
of which: Coffee17191520222528323742
Imports-653-567-631-648-678-744-730-777-768-820
Services (net)-583-569-344-398-291-397-311-389-299-271
Receipts74779296104116141157169238
of which: Travel515873778291102110113161
Payments-656-645-436-494-394-513-452-546-468-510
Income (net)1,297544735657895931884640673556
of which: Investment income311320312266649607600581573554
Other primary income (oil/gas)97922442138924432228258990
Current transfers (net)12526-6189104119136154172181
Capital and financial accounts615335333054714064348211347
Official capital transfers29473424242424242424
Financial account324854992812411740324188323
Change in Portfolio Investment
Assets (incl. Oil/gas savings)1516903405938701,0928851,0819431,085
FDI30-7730203050505048
Inflow435730203050505050
External debt (net)3133558844455939590
Errors and omissions (net)-45-145150000000
Overall balance220-157263261037979184151
Financing
Change in net foreign assets-220157-263-26-103-79-79-18-41-51
(In percent of total GDP)
Current account6.6-21.6-10.2-9.01.8-1.80.5-10.4-5.4-8.4
Trade balance-20.5-21.7-22.1-20.3-20.7-20.9-20.8-23.2-22.7-21.7
Exports0.60.80.60.70.80.91.11.41.61.7
Imports-21.0-22.5-22.7-21.0-21.5-21.8-21.9-24.5-24.3-23.4
Services (net)-18.8-22.6-12.4-12.9-9.2-11.6-9.3-12.3-9.4-7.8
Income (net)41.821.626.521.328.527.326.520.221.315.9
Current transfers (net)4.01.0-2.22.93.33.54.14.95.45.2
Capital and financial accounts2.021.119.29.91.54.11.911.06.79.9
Overall balance7.1-6.29.50.93.32.32.40.61.31.5
(In millions of U.S. dollars, unless otherwise indicated)
Memorandum items:
Public foreign assets (end-period)16,65516,12517,34416,37416,26215,86515,66715,19414,87014,396
(In months of imports of G&S)153160195172182151159138144130
(In percent of non-oil GDP)1,0359481,003879780677593501490412
of which: Central bank reserves438281545571674753832851891943
Petroleum Fund balance 3/16,21815,84416,79915,80315,58815,11214,83414,34313,97913,453
(In percent of non-oil GDP)1,008931971848747645561473461385
Sources: Data provided by the Timor-Leste authorities; and IMF staff estimates.

Excludes trade in goods and services of entities located in the Joint Petroleum Development Area which are considered non-resident entities.

Excludes petroleum exports, the income of which is recorded under the income account.

Closing balance.

Sources: Data provided by the Timor-Leste authorities; and IMF staff estimates.

Excludes trade in goods and services of entities located in the Joint Petroleum Development Area which are considered non-resident entities.

Excludes petroleum exports, the income of which is recorded under the income account.

Closing balance.

Table 4.Timor-Leste: Monetary Developments, 2015–19
20152016201720182019
Proj.
(In millions of U.S. dollars)
Banking system 1/
Net foreign assets 2/1,0161,0961,2511,4121,441
Gross reserves435278541671674
Other foreign assets661876783823825
Foreign liabilities8058738158
Net domestic assets-373-362-428-563-491
Net credit to central government-339-420-472-531-531
Net credit to state and local government00-12-110
Net credit to public nonfinancial corporations0-1-1-500
Credit to private sector212208260250282
Other items (net)-246-149-202-221-242
Broad money642734823849950
Narrow money398464465525588
Currency in circulation 3/1215151820
Transferable deposits386450450507568
Other deposits245270358323362
Central Bank
Net foreign assets2/427271533663667
Gross reserves435278541671674
Foreign liabilities88888
Net domestic assets-214-179-359-486-486
Net credit to central government-238-215-279-342-342
Net credit to other depository corporations7590121717
Other items (net)-50-54-92-161-161
Monetary Base21391174177181
Currency in circulation1215151820
Other liabilities to depositary corporations20177159159161
Others 3/00000
(12-month percentage change)
Broad money growth7.114.312.13.112.0
Reserve money growth45.4-57.290.71.92.0
Credit to the private sector growth10.482-1.84524.843-3.75913.0
Memorandum items(In percent, unless otherwise indicated)
Credit/non-oil GDP13.212.215.013.413.5
Broad money/non-oil GDP39.943.147.645.645.6
Credit/deposits 4/33.628.935.531.732.0
Amounts of non-perfoming loans (in millions of U.S. dollars)43.728.031.012.3
Non-performing loans/total loans22.915.413.55.6
Loan rate 5/13.514.013.313.5
Deposit rate 6/1.01.00.70.6
Sources: Central Bank of Timor-Leste; and IMF staff estimates.

Includes the Central Bank, five commercial banks (including four branches of foreign banks).

An oil fund was created in September 2005 and the deposits were moved off-shore and onto the Government balance sheet.

Includes only coinage issued by the Central Bank. No data is available for notes due to dollarization of the financial system.

Excludes government deposits.

Rate charged by other depository corporations on loans in U.S. dollars. The rate is weighted by loan amounts.

Rate offered by other depository corporations on three-month time deposits in U.S. dollars. The rate is weighted by deposit amounts.

Sources: Central Bank of Timor-Leste; and IMF staff estimates.

Includes the Central Bank, five commercial banks (including four branches of foreign banks).

An oil fund was created in September 2005 and the deposits were moved off-shore and onto the Government balance sheet.

Includes only coinage issued by the Central Bank. No data is available for notes due to dollarization of the financial system.

Excludes government deposits.

Rate charged by other depository corporations on loans in U.S. dollars. The rate is weighted by loan amounts.

Rate offered by other depository corporations on three-month time deposits in U.S. dollars. The rate is weighted by deposit amounts.

Table 5.Timor-Leste: Medium-Term Scenario, 2015–24
2015201620172018201920202021202220232024
Est.Proj.
Real sector
GDP at current prices (in millions of U.S. dollars)3,1042,5212,7783,0903,1453,4133,3333,1663,4983,886
Non-oil GDP1,6091,7021,7301,8632,0862,3422,6433,0353,4983,886
Oil GDP1,4968201,0481,2281,0601,07168913100
Real non-oil GDP growth (percent change)4.05.3-4.60.85.04.84.84.84.84.8
CPI (percent change, period average)0.6-1.50.52.32.53.23.73.94.04.0
CPI (percent change, end-period)-0.60.00.62.12.83.53.84.04.04.0
Private sector credit (annual percent change)10.5-1.824.8-3.813.010.310.912.813.39.1
(In percent of total GDP)
Central government operations
Revenue33.236.830.730.027.123.724.125.223.221.9
Domestic revenue5.57.87.06.36.56.26.77.47.17.4
Estimated Sustainable Income (ESI)20.621.617.317.814.013.814.312.410.99.3
Grants7.27.26.45.95.23.53.53.53.73.7
Expenditure50.271.849.447.349.852.647.049.943.441.7
Recurrent expenditure33.240.833.528.533.532.334.537.836.234.5
Capital expenditure9.923.99.512.911.116.79.08.63.53.5
Donor project7.27.26.45.95.23.53.53.53.73.7
Net lending/borrowing-17.0-35.1-18.7-17.3-22.7-28.8-22.9-24.8-20.2-19.8
(In millions of U.S. dollars, unless otherwise indicated)
Current account balance 1/204-544-284-27956-6215-329-171-295
Trade balance-635-546-615-626-652-714-694-734-717-760
Exports 2/18201722263036435060
Imports653567631648678744730777768820
Services (net)-583-569-344-398-291-397-311-389-299-271
Petroleum revenue (incl. Petroleum Fund interest)1,2818722,034672899938890647677559
(In percent of total GDP, unless otherwise indicated)
Current account balance 1/6.6-21.6-10.2-9.01.8-1.80.5-10.4-4.9-7.6
Trade balance-20.5-21.7-22.1-20.3-20.7-20.9-20.8-23.2-20.5-19.6
Exports 2/0.60.80.60.70.80.91.11.41.41.5
Imports21.022.522.721.021.521.821.924.521.921.1
Services (net)-18.8-22.6-12.4-12.9-9.2-11.6-9.3-12.3-8.5-7.0
Public external debt
(In millions of U.S. dollars)4677107168255303361457559666
(In percent of total GDP)1.53.13.85.48.18.910.814.416.017.1
Memorandum items:
Petroleum Fund balance (in millions of U.S. dollars) 3/16,21815,84416,79915,80315,58815,11214,83414,34313,97913,453
(In months of imports)149157189166175144151130136121
(In percent of total GDP)522628605511496443445453400346
Crude oil prices (U.S. dollars per barrel, WEO) 4/51435368545556575758
Sources: Timor-Leste authorities; and IMF staff estimates and projections.

Excludes trade in goods and services of entities located in the Joint Petroleum Development Area which are considered non-resident entities.

Excludes petroleum exports, the income of which is recorded under the income account.

Closing balance.

Simple average of UK Brent, Dubai, and WTI crude oil prices; January 2019 WEO assumptions.

Sources: Timor-Leste authorities; and IMF staff estimates and projections.

Excludes trade in goods and services of entities located in the Joint Petroleum Development Area which are considered non-resident entities.

Excludes petroleum exports, the income of which is recorded under the income account.

Closing balance.

Simple average of UK Brent, Dubai, and WTI crude oil prices; January 2019 WEO assumptions.

Table 6.Timor-Leste: Sustainable Development Goals Monitoring
Goals200220072016
Poverty 1/
Income share held by lowest 20%7.39.59.4
Poverty gap at $1.90 a day (2011 PPP) (%)1312.56.7
Poverty headcount ratio at $1.90 a day (2011 PPP) (% of population)42.54730.3
Poverty headcount ratio at national poverty lines (% of population)36.350.441.8
Hunger 2/
Prevalence of overweight, weight for height (% of children under 5)5.71.5
Prevalence of stunting, height for age (% of children under 5)55.753.950.2
Prevalence of undernourishment (% of population)32.232.927.4
Prevalence of underweight, weight for age (% of children under 5)40.648.637.7
Prevalence of wasting, weight for height (% of children under 5)13.724.511
Good Health and Well-being
Births attended by skilled health staff (% of total)24
Mortality rate, under-5 (per 1,000 live births)97.672.949.7
Mortality rate, neonatal (per 1,000 live births)34.827.821.6
Demand for family planning satisfied by modern methods (% of married women)46.1
Adolescent fertility rate (births per 1,000 women ages 15–19)70.165.845.6
Smoking prevalence, males (% of adults) 3/92.678.1
Source data assessment of statistical capacity (scale 0 – 100)5070
Gender Equality 4/
Proportion of women subjected to physical and/or sexual violence in the last 12 months ( % of women age 15–49)30.4
Women who were first married by age 15 (% of women ages 20–24)3
Women who were first married by age 18 (% of women ages 20–24)18.9
Clean Water and Sanitation 5/
People using basic drinking water services (% of population)52.058.970.2
People using basic sanitation services (% of population)34.037.444.0
Affordable and Clean Energy
Access to electricity (% of population)25.036.663.4
Access to clean fuels and technologies for cooking (% of population)2.53.66.9
Decent Work and Economic Growth
Account ownership at a financial institution or with a mobile-money-service provider (% of population ages 15+)13.4
Peace, Justice and Strong Institution 6/
Completeness of birth registration (%)53.055.2
Global Partnerships for the Sustainable Development
Individuals using the Internet (% of population)0.01.025.2
Source: UN SDG Indicators Global Database, Timor-Leste State Budget Book 2018.

2002 data as of 2001, 2016 data as of 2014

2016 data as of 2013

2002 data as of 2000

2016 data as of 2010

2016 data as of 2015

2002 data as of 2003, 2016 data as of 2010

Source: UN SDG Indicators Global Database, Timor-Leste State Budget Book 2018.

2002 data as of 2001, 2016 data as of 2014

2016 data as of 2013

2002 data as of 2000

2016 data as of 2010

2016 data as of 2015

2002 data as of 2003, 2016 data as of 2010

Human Development Progress since Independence

(Poverty gap at $1.90 a day (2011 PPP) as a percentage of the poverty line)

Source: UNDP, Timor-Leste State Budget Book 2018.

2. Timor-Leste faces a challenging environment to achieve its development objectives. Petroleum production from active fields is projected to end in 2022, but the economy still grapples with overreliance on public expenditure for growth and employment. Going forward, Timor-Leste will need to continue to carefully manage its accumulated wealth from past petroleum production to close remaining gaps in infrastructure, health, and education; strengthen institutional capacity; create jobs for a young and growing population; and foster a conducive environment for private sector diversification and inclusive growth.

Recent Developments, Outlook, and Risks

3. The recent breakdown of consensus politics has increased uncertainty and slowed reform efforts. The minority government elected in 2017 failed to obtain parliamentary approval for its five-year Government Program and 2017 supplementary budget. The consequent political stalemate resulted in the sharpest economic downturn since 2006 and a halt to key economic reforms. Snap elections in May 2018 ended the political impasse after the Alliance for Change and Progress (AMP) coalition formed a majority government and put forth a new government program with a continued focus on the key pillars of the SDP. The political stalemate also compressed budget preparations, with the 2018 and 2019 budgets approved in September 2018 and February 2019, respectively.

4. Political uncertainty adversely affected Timor-Leste’s economic activity in 2017 and for most of 2018. Real output in 2017 is estimated to have contracted by close to 5 percent as public expenditures fell by over one third. Most of the decline was related to capital spending, which contracted by close to 60 percent. Public spending continued to be restrained during most of 2018 due to the duo-decimal regime.2 However, non-oil growth is expected to have recovered somewhat in 2018 as public spending picked up in Q4 2018 following the approval of the 2018 budget. Inflation remained low in 2017 at 0.8 percent, but reached 2.1 percent at the end of 2018, largely due to higher prices of rice and tobacco and an increase in education fees.3

5. Lower public spending narrowed the fiscal deficit, improved the current account, and slowed credit growth.

  • Fiscal deficit and Petroleum Fund (PF) balance.4 The fiscal deficit improved from 35 to 19 percent of GDP in 2017 and is expected to have further improved in 2018. As a result, excess withdrawals from the PF fell significantly. With petroleum revenue and investment returns exceeding total withdrawals, the PF balance increased in 2017 for the first time since 2014. However, tighter global financial market conditions at the end of 2018, caused the PF balance to drop to US$16 billion.
  • Current account (CA). The current account improved in 2017 as imports fell amid weaker public spending. A bad coffee harvest led to a decline in non-oil exports, but petroleum export receipts improved as oil prices rose. The current account deficit is estimated to remain broadly unchanged in 2018. The real effective exchange rate depreciated in 2017, but appreciated in 2018 on the back of higher domestic inflation and a stronger US dollar.
  • Financial sector. After rising sharply in 2017, partly in anticipation of public investment spending, credit growth slowed significantly in 2018. Non-performing loans (NPLs) reached an all-time low in early 2018 due to the resolution of legacy NPLs. However, they started to rise in mid-2018 as firms faced delays in receiving government payments. Overall, the size of the financial sector remains small with the ratio of credit-to-non-oil GDP estimated at 13 percent in 2018.

Petroleum Fund Balance

Sources: Timor-Leste Authorities; and IMF staff estimates.

Balance of Payments

(In percent of GDP)

Source: Timor-Leste Authorities.

Loans to Private Sector Contribution to Growth

(In percent, year-on-year)

Source: Central Bank of Timor-Leste.

6. Non-oil GDP growth is expected to rebound in 2019 as public spending recovers. Non-oil growth is expected to increase to around 5 percent in 2019, as government spending regains momentum. Over the medium term, non-oil growth is projected to remain around 5 percent. Apart from a planned temporary increase in petroleum production in 2019—causing an increase in overall GDP growth in 2019—value added from the petroleum-sector will continue to steadily decline until production ends in 2022, resulting in a sharp overall GDP contraction in 2021–2023. Inflation is projected to rise, reaching 4 percent over the medium term. Excess PF withdrawals are expected to continue to finance fiscal deficits leading to a slow but gradual reduction in the PF balance. The CA balance will on average be negative over the medium term, but is expected to be substantially smaller than fiscal deficits due to investment income from the PF.

7. Petroleum production from active fields is shrinking and will end in 2022, but a new maritime boundary treaty with Australia could open a pathway for future oil and gas revenues. The treaty was signed on March 6, 2018, and includes a framework for the joint development of the Greater Sunrise fields. To secure the development of a downstream industry on the South Coast of Timor-Leste, the government is set to finalize acquisitions of shares from two joint venture partners for a total of US$650 million (Box 1).

8. Risks to the outlook are broadly balanced (Annex II).

  • Near-term risks. Elevated political risk could delay reform implementation and adversely affect public spending in the near-term. Inflationary pressure could also materialize if import prices rise sharply. Ad verse spillovers from global developments are likely to be marginal due to Timor- Leste’s limited integration into global non-oil trade, but equity price volatility and rising U.S. interest rates could affect the PF balance and associated income flows. With most of the accumulated petroleum wealth already above ground, a sharp permanent decline in global oil prices would have minimal impact on fiscal revenues and the PF balance going forward (text table).
  • Medium- and long-term risks. Risks are tied to progress on fiscal and structural reforms. Insufficient progress to reduce public sector reliance and generate increased private-sector jobs would put added pressure on public finances, risk long-run fiscal sustainability due to large excess PF withdrawals, and further deteriorate labor market outcomes. Over the long run, development of the Greater Sunrise fields constitutes a significant upside risk, conditional on technical and economic viability and proper safeguards being taken to minimize funding risks.5
Impact on the ESI and PF Balance from a Permanent 50 Percent Decline in WEO Oil Price Projections starting in 2019(In millions of USD)
201820192020202120222023
Estimated Sustainable income(i.e. revenue to budget)
Baseline550507491479468449
Low oil price scenario550499483471460443
Loss of revenue-78787
Petroleum Fund Balance
Baseline15,80315,33815,00114,69714,14113,737
Low oil price scenario15,80315,31014,92414,55313,95513,543
Decline in PF balance-2977143186194
Source: IMF staff calculations.
Source: IMF staff calculations.

Authorities’ Views

9. The authorities recognized that the political impasse has had a significant impact on the economy. The authorities highlighted that the contraction of non-oil GDP in 2017 was driven in part by low public capital expenditure due to the duo decimal regime. However, the decline was mitigated by relatively robust household consumption—supported by government transfers—and an improved trade balance. The authorities estimated growth in 2018 to be slightly above zero, but emphasized that this will depend on the growth impact from increased public expenditure at the end of the year.

10. The authorities broadly agreed on the outlook and risks, but projected higher medium-term growth. The authorities projected medium-term growth at 7 percent compared to staff’s 5 percent. The authorities highlighted that the main reason for the divergence was the inclusion of positive feedback effects from the development of the Greater Sunrise fields and associated capital investments, and they also expressed confidence that private sector investment will emerge as an important growth driver over time, partly due to large-scale projects (e.g., Tibar Bay Port, TL Cement, and Pelican resort) and ongoing structural and legal reforms to improve the overall business environment.

Policy Discussions

The ramping-up of public spending over the past decade has been warranted given post-conflict infrastructure gaps and drastic social development needs. But this has also led to public sector-driven growth with employment gains concentrated in construction and public services (Annex III). To achieve high, sustainable, and inclusive private sector growth, it will be crucial to (i) ensure fiscal sustainability and strengthen institutional capacity, (ii) capitalize on the demographic dividend and promote private sector investment, and (iii) strengthen financial intermediation and enhance financial inclusion.

A. Fiscal Sustainability and Institutional Capacity

11. In comparison with its predecessor, the 2019 budget envisions a modest frontloading of public spending and lower excess PF withdrawals. The medium-term expenditure plan (2019- 23) shows a significant moderation in spending compared to the 2017 budget, and is more in line with staff’s recommended fiscal reform plan laid out in the 2017 Article IV Staff Report. Nevertheless, under the current baseline, the PF balance will still gradually decline, leading to rising debt financing needs in the long-run (text table and DSA).

Total Public Expenditure, 2008–2037

(In percent of GDP)

Source: IMF staff estimates.

Petroleum Fund Balance, 2008–2037

(In billions of US dollars)

Source: IMF staff estimates.

12. Developing a credible fiscal strategy should help protect the PF balance and ensure long-run fiscal sustainability. Specifically, fiscal policy should be anchored in a stable real balance of the PF and long-run debt sustainability.

  • Improve expenditure control. Capital investment should reflect targeted selection criteria based on a rigorous appraisal process while taking capacity constraints into account. Moreover, a comprehensive medium-term budgeting framework would improve policy predictability, ensure resource availability, and create a stronger link between budgets and medium-term goals. To this end, the costing of policy priorities in the SDP will be important. Limited use of supplementary budgets and the adoption of an expenditure rule should be considered to increase budget credibility and control.
  • Enhance spending efficiency and composition. Improving capital spending efficiency should be a priority and will help close large infrastructure gaps while keeping overall capital spending under control. Adequate investment in human and social capital will be crucial given demographic trends and associated high potential growth returns (Annex IV).
  • Mobilize domestic revenue. Introduction of a value-added tax (VAT) by 2022 accompanied by potential increases in excise duties and other taxes, and improved tax compliance should help raise non-oil revenues over the medium term.
  • Make effective use of concessional borrowing and commit to the ESI rule within a reasonable timeframe. The use of concessional borrowing for specific projects reduces the need for excess PF withdrawals and generates knowledge transfers in project appraisal and implementation. Committing to the ESI rule by ending excess PF withdrawals by 2028 should further strengthen fiscal discipline.
Timor-Leste: Illustrative Revenue and Expenditure Reform Strategy vs. Baseline Forecasts1,2
Baseline ScenarioReform Scenario
201720182020–232024–382020–232024–38
Proj.Proj.
Total revenue30.730.024.016.626.022.5
Domestic revenue7.06.36.810.48.715.1
Tax revenue4.84.24.67.06.511.7
Direct tax2.01.92.14.12.14.1
VAT0.00.00.00.01.94.7
Other indirect tax2.82.32.53.02.53.0
Estimated Sustainable Income17.317.813.64.313.75.5
Total expenditure49.447.348.230.848.230.8
Recurrent spending33.528.535.225.835.225.8
Wages and salaries7.16.57.27.67.27.6
Goods and services11.811.515.810.315.810.3
Public transfers14.610.511.77.311.77.3
Capital spending9.512.99.43.19.43.1
Gross operating balance-9.2-4.4-14.7-11.2-12.8-5.3
Net borrowing and lending-18.7-17.3-24.2-14.2-22.2-8.3
Financing:
PF excess withdrawal21.514.021.911.620.03.3
Borrowing1.12.02.32.62.36.7
Outstanding public debt3.85.412.521.412.541.4
Petroleum Fund balance (in millions of US dollars)16,79915,80314,5678,11614,72413,269

In percent of GDP, unless otherwise specified.

The reform scenario assumes the following: (1) less ambitious front-loading of public spending, (2) VAT to be implemented starting 2022, which will generate revenue of about 3.75 percent of GDP over the medium term and of about 5 percent of GDP over the long-term and (3) no excess withdrawal from the Petroleum Fund beginning 2028.

In percent of GDP, unless otherwise specified.

The reform scenario assumes the following: (1) less ambitious front-loading of public spending, (2) VAT to be implemented starting 2022, which will generate revenue of about 3.75 percent of GDP over the medium term and of about 5 percent of GDP over the long-term and (3) no excess withdrawal from the Petroleum Fund beginning 2028.

13. The debt sustainability analysis (DSA) suggests a low risk of debt distress. This constitutes an improvement in the risk rating compared to the last assessment in 2017. The improvement reflects fuller considerations of country-specific factors and risk mitigating elements such as the existence of the Petroleum Fund, currently estimated at over 5 times the size of GDP (figure). Public external debt is projected to increase from 5 percent of GDP in 2018 to about 17 percent of GDP in the medium term.

Size of Timor-Leste’s Petroleum Fund

(In percent of GDP)

Sources: IMF Staff Reports; Saudi Arabia (2018); Kuwait (2017); Norway (2018).

Note: Saudi Arabia’s assets include SAMA’s net foreign assets and does not include the Public Investment Fund (PIF).

14. A government-led, donor- partnered public financial management (PFM) reform strategy will be essential to generate sustained reform momentum (Box 2). While important progress has been made in several PFM areas, efforts to address remaining weaknesses have stalled amid the political stalemate. Moreover, fragmented PFM support from multiple development partners has resulted in coordination issues within and outside the government. However, a World Bank-led Public Expenditure and Financial Accountability (PEFA) exercise to assess PFM weaknesses is ongoing. The 2018 PEFA is jointly conducted with the government and is expected to feed into an updated and consolidated government-led PFM reform strategy, with the intent to improve donor coordination. The IMF-World Bank 2016 Public Investment Management Assessment (PIMA) will also be considered in the PEFA exercise. The IMF and Pacific Financial Technical Assistance Centre (PFTAC) stands ready to provide needed technical assistance (TA) in areas where the IMF has a comparative advantage.6

15. Improving public governance and combating corruption will help raise the quality of public services. The economic importance of public services and contracts in Timor-Leste makes it crucial to address vulnerabilities to rent-seeking. Governance in the petroleum sector is strong and steps have been taken to improve the institutional framework to combat corruption (e.g., the establishment of the Commission on Anti-Corruption, CAC). However, the institutional framework suffers from weak coordination and a deficit of technical, human, and financial resources. Moreover, the legal framework needs to be strengthened, the capacity of the court system raised, and corruption awareness enhanced. To this end, staff is encouraged by the government’s intention to revitalize efforts to develop a National Anti-Corruption Strategy and update the anti-corruption law that has been pending in parliament since 2011. Strengthening public financial management, especially procurement, and reforming business regulation will also be key to reducing vulnerabilities to corruption.

Corruption Control and Perception Indices, 2013–20171

1 Upper and lower baunderies reflect one standard deviation.

Source: Worldwide Governance Indicators.Transparency International.

Authorities’ Views

16. The authorities agreed that there is a need to improve spending efficiency and mobilize domestic revenue. They stressed that the scale-back of capital spending in the 2019 budget reflects a recognition of capacity constraints and efforts to rationalize and prioritize spending to ensure fiscal sustainability. They also noted that public spending on education, health, and agriculture continues to be a main priority. However, appropriate infrastructure is required to allow these sectors to grow. Moreover, the authorities are aiming to increase the ratio of domestic revenue to non-oil GDP to around 15 percent by 2022 through improvements in tax compliance, implementation of a VAT, and diversification of revenues (such as fishery, mining, and forestry).

17. The authorities underscored that PFM reforms are now regaining momentum following commitments for improving public finance over the medium to long-term. The authorities highlighted that there are ongoing efforts to simplify and streamline program budgeting, Medium-Term Expenditure Framework (MTEF), and procurement processes by consolidating coordination mechanism, systems and legal framework. Moreover, they are piloting MTEF in the areas of health, education, and infrastructure.

18. The authorities expressed a strong determination to fight corruption and highlighted several ongoing efforts. They stressed that the five-year Government Program—approved by the parliament in 2018—contains a number of initiatives to address corruption, including investing in the capacity of oversight institutions and conducting anti-corruption campaigns to raise public awareness. The newly established Ministry of Legislative Reforms and Parliamentary Affairs will coordinate the initiative to develop a National Anti-Corruption Strategy and update the Anti-Corruption Law. Timor-Leste is in the process of implementing the second cycle of its UNCAC review.7

B. Private Sector Growth and Job Creation

Selected Asian Economies: Median Age and Population Growth

Source: UNDP.

19. The growing working-age population constitutes an important growth source, but efforts to capture the demographic dividend face significant challenges. Job creation is lagging the number of job market entrants, contributing to low labor force participation and high unemployment, particularly for youth and women. Less than a quarter of the labor force is formally employed, and rural-urban inequalities are large. Moreover, about four out of every ten jobs created over the past decade have been in the public sector. This reflects both a preference amongst job seekers for public employment as well as difficulties by the private sector to match public sector wages, working conditions, and job security. Staff analysis shows that non-oil growth could be raised by over 2.5 percentage points per year if labor productivity growth and job opportunities for the youth can reach average levels of middle-income countries by 2030 (Annex IV).

20. A comprehensive action plan is needed to raise labor productivity and address labor market inequalities. Improving both the quality of and access to basic education and healthcare will be critical to increase the productivity of future cohorts and reduce gender and rural-urban inequalities. Meanwhile, strengthening technical and vocational education and training should help address existing and emerging skill shortages. Further exploring opportunities for Timorese workers to gain experience abroad (such as the recent decision to join Australia’s Pacific Labor Scheme) should also help.8 Moreover, coverage and enforcement of labor regulations should be enhanced to reduce vulnerable employment—the incidence of which is particularly high for women. Reviewing the minimum wage policy is also appropriate to help find the right balance between increasing formal employment of unskilled workers and ensuring a fair living wage. Finally, given the role of the public sector as a major employer, there is a need to assess the impact of public employment and wage setting on the private sector.

Labor Force Participation Rate 1

(In percent of population ages 15+, 2017)

1 ILO Estimates.

21. Improving the business environment should encourage business formation, promote private investment, and generate employment opportunities. Weak business regulation poses challenges for commercial activity and private investment. Private investment remains low, averaging about 3 percent of GDP between 2010 and 2016. Recent progress to address these barriers includes a new Land Law that clarifies the legal status of land ownership, and a private investment law that aims to align national legislation with the Global Investment Agreement of Asian countries and streamline investment licensing. Nevertheless, business regulations need to be better coordinated and harmonized to facilitate easy market entry for new firms. Moreover, the legal framework for establishing property rights and enforcing contracts should be strengthened to encourage business formation and improve access to finance. The capacity of the court system also needs to be enhanced to ensure effective and timely enforcement of laws and regulations. Importantly, a comprehensive and actionable strategy to boost domestic and foreign investment in productive economic sectors—based on Timor-Leste’s comparative advantage—will be essential for sustainable diversification of the non-oil economy.

Doing Business Indicators 2018 1

(Distance to frontier score 2)

Source: World Bant

1 These indicators should be interpreted with caution due to a limited number of respondents, a limited geographical coverage, and standardized assumptions on business constraints and information availability.

2 On a scale of 0 to 100; 100 is the frontier and 0 is the furthest from the frontier.

3 CLMV countries Cambodia, Lao PDR, Myanmar, Vietnam.

Authorities’ Views

22. The authorities recognized the urgency to provide job opportunities for its young population and reduce vulnerable employment. The increase in public expenditures in 2019 for education and health is a continued commitment to raise labor productivity. Moreover, the authorities underscored that they are committed to the 2017 National Strategy for Employment, which lays out a blueprint for how to increase the labor supply and demand, as well as strengthen labor market institutions. In addition, efforts to provide job opportunities abroad have continued, including through the recent invitation to join Australia’s Pacific Labor Scheme.

23. The authorities acknowledged that strengthening the business environment is important and highlighted significant progress in a number of areas. While recognizing that there is room for further streamlining of licensing and business regulations, the authorities pointed to significant improvements in the business environment over the past years. They stressed that there are plans to increase the number of centers for business registration and licensing in rural areas. The authorities also mentioned that an Insolvency and Bankruptcy Law is under considerations, and that the new Private Investment Law should help generate business formation and encourage investment. The authorities expect that improvements in the business environment will support diversification of the economy through development of tourism, agriculture, petroleum and manufacturing.

C. Financial Sector Development and Stability

24. Boosting financial intermediation is crucial to increase private investment and facilitate diversification. Despite an ample deposit base and a net interest margin of more than 10 percent, banks are reluctant to extend credit. Instead, banks primarily lend to government contractors and individuals with secure wages (e.g., public sector employees), and provide low-cost funding to international banks. Main obstacles to stronger financial intermediation include: (i) a weak collateral system; (ii) difficulty in assessing borrowers’ credit risk; and (iii) a low level of financial literacy. While the new Land Law should help improve the collateral system, registering land ownership and settling land disputes is likely to be a multi-year process. The establishment of a secured transaction framework for movable property is in the process with the assistance of the Asian Development Bank, and progress has been made towards the implementations of the national credit guarantee system.

Sources of Financing for Investment

(In percent of total financing)

Sources: Enterprise Survery (Timor-Leste as of 2015; others latest available).

25. Significant progress has been achieved in terms of the development of the payments system and the implementation of the financial inclusion agenda. The central bank (BCTL) has developed a National Financial Inclusion Strategy (NFIS) 2017–22, with an action plan and timeline. Main components include measures to: (i) modernize the payment system; (ii) increase the availability of financial products and services in rural areas; and (iii) improve financial literacy and consumer protection frameworks. Important progress has been made in modernizing the payment system, including through the establishment of R-TIMOR, and the ongoing implementation of the National Switch. Increasing financial literacy will also be crucial to expand the use of financial services and access to credit.

26. A strong regulatory and supervisory framework should underpin financial sector development. Macro-financial risks appear modest given the small size of the financial system and banks’ relatively conservative balance sheets (high liquidity and well-capitalized). However, the regulatory and supervisory framework for banks needs to be upgraded. The IMF/PFTAC are planning to assist BCTL in reviewing and revising the legal framework for banking regulation and supervision, developing a comprehensive credit risk management regulation, and strengthening banking supervision capacity.

Timor-Leste: Selected Financial Soundness Indicators (FSIs), 2015–18(In percent)
Dec-15Dec-16Dec-17Dec-18
Asset Quality
Capital adequacy ratio 142.432.932.927.7
Non-performing loans to total gross loans23.015.313.55.6
Provision for loan losses to total gross loans29.821.916.78.1
Earnings and Profitability
Return on assets0.71.01.41.1
Return on equity 13.56.613.96.8
Liquidity
Liquid assets to total assets83.684.580.580.5
Memorandum items (In millions of U.S. dollars):
Total assets9281,1491,1701,240
Total loans191183227222
Source: Central Bank of Timor-Leste.

Covers BNCTL only.

Source: Central Bank of Timor-Leste.

Covers BNCTL only.

Authorities’ Views

27. The authorities emphasized important progress in modernizing the payment system and enhancing financial inclusion. They noted that the weak collateral regime remains a significant obstacle to credit expansion, but that the implementation of the new Land Law and development of a secured transaction framework for movable property should help in this regard. Moreover, the BCTL is currently working with banks to review procedures and guidelines of the Credit Guarantee System before entering the implementation phase. The authorities also stressed that the modernization of the payment system is key to enhancing access to financial services and promoting a stable and competitive financial sector. In this regard, the launch of the National Switch in December 2018 was a major achievement. The system is expected to be integrated with other regional payment systems in the near future. The BCTL is also working closely together with the Ministry of Education in implementing financial literacy programs in elementary schools in order to enhance financial inclusion. Furthermore, the authorities underscored the importance of ongoing efforts to improve the regulatory and supervisory framework. In particular, the BCTL is in the process of implementing IFRS9 and is reviewing all prudential regulations to accommodate this change, including a review of the banking law.

D. External Sector Assessment and Competitiveness

28. The 2018 external sector position is assessed to be substantially weaker than suggested by medium-term fundamentals and desirable policies (Annex V). According to the CA-model and External Sustainability model, the 2018 CA-balance of negative 9 percent is substantially lower than the level assessed to be consistent with medium-term fundamentals and desirable policies. However, it is important to recognize that the assessment may not adequately account for ongoing structural changes in Timor-Leste (e.g., depletion of active oil fields), demographic trends, immature financial markets, and large infrastructure gaps. Unlike the CA-model, the REER-model suggests that the REER is broadly in line with fundamentals. In the medium-term, the external current account is expected to remain in deficit, financed by withdrawals from the PF. Despite its waning petroleum production, Timor-Leste’s low debt burden and sizable public asset position make the country relatively resilient to external shocks.

29. Increasing international competitiveness will be crucial for the success of diversification efforts. Implementation of needed structural reforms of the non-oil economy should reduce import dependence and increase the export base. Maintaining low inflation and increasing labor productivity should also help increase competitiveness.

30. The U.S. dollar as legal tender continues to serve Timor-Leste well. Use of the U.S. dollar can reduce external competitiveness when domestic inflation increases, and the U.S. dollar appreciates against trading partners (e.g., in the presence of ongoing U.S. monetary policy normalization). However, dollarization remains appropriate given Timor-Leste’s limited financial sector development, low institutional capacity, and its U.S. dollar-denominated major exports (coffee and petroleum).

Authorities’ Views

31. The authorities acknowledge that addressing the weak external sector position will require improved international competitiveness and successful diversification. The authorities also emphasized that the current exchange rate regime has contributed to stabilize inflation expectations and price pressures. Nonetheless, they stressed the need to review, in depth, the advantages and disadvantages of maintaining the current regime.

E. Capacity Building and Statistics

32. Addressing capacity gaps will be key to support the implementation of needed policies and reforms. This is particularly true with respect to fiscal management, financial regulation and supervision, while strengthening compilation and dissemination of statistics will be essential to improve surveillance and inputs into policymaking. IMF/PFTAC is committed to provide capacity building assistance in close collaboration with development partners (text table and Box 3).

Authorities’ Views

33. The authorities agreed on the assessment to strengthening statistics and expressed appreciation for ongoing IMF TA and training. The authorities appreciate the current TA support (mostly delivered by PFTAC, but also the Capacity Development Office in Thailand, CDOT, and IMF staff) and conveyed interest in continued TA, including in the areas of public financial management, tax policy, and statistics.

Timor-Leste: Integration Matrix of Surveillance Issues and Capacity Building
Surveillance IssuesIMFWorld BankOther Development Partners
Past2018Planned/ongoingPastPlanned/ongoingPastPlanned/ongoing
Fiscal Sector
Public Financial Management
Expenditure framework
Revenue framework
Macro-Financial Issues
Financial supervision and regulation
Financial market development
Macro-structural issues
Environmental Sustainability
Infrastructure
Private sector development
Governance issues
Poverty/Gender/ Inequality
Climate change
Statistics
Data Enhancement
Sources: IMF; World Bank; Asian Development Bank (ADB); Japan International Cooperation Agency (JICA); United Nation Development Programme (UNDP); Millenium Challenge Corporation Agency (MCC); Australian Department of Foreign Affairs and Trade (DFAT); Organization for Economic Co-operation and Development (OECD); European Union (EU).
Sources: IMF; World Bank; Asian Development Bank (ADB); Japan International Cooperation Agency (JICA); United Nation Development Programme (UNDP); Millenium Challenge Corporation Agency (MCC); Australian Department of Foreign Affairs and Trade (DFAT); Organization for Economic Co-operation and Development (OECD); European Union (EU).

Staff Appraisal

34. Timor-Leste has made impressive strides since independence, but the country faces significant challenges to achieve its development objectives. The recent breakdown of consensus politics has increased uncertainty, slowed reform efforts, and weighed heavily on the non-oil economy in 2017–18. While non-oil growth is expected to regain momentum once government spending picks up, there is a pressing need to address medium-term challenges. With production from active petroleum fields ending in 2022, insufficient progress to strengthen public financial management, diversify the economy, create private-sector jobs, and increase private sector investment, would put growth at risk, worsen labor market outcomes, and jeopardize long-run fiscal sustainability.

35. A fiscal strategy is needed to ensure long-term fiscal sustainability and safeguard the assets of the Petroleum Fund. The strategy should focus on strengthening control and efficiency of spending, developing a comprehensive medium-term budgeting framework, mobilizing domestic revenue, making effective use of concessional borrowing, and committing to the ESI rule within a reasonable timeframe.

36. Strengthening institutional capacity will be critical to ensure the effective use of public resources. Developing a government-led, donor-partnered PFM reform strategy is key to raise institutional capacity and help close large infrastructure gaps while keeping overall capital spending under control. Ongoing efforts to develop a National Anti-Corruption Strategy, review the pending anti-corruption law, and raise the capacity of oversight institutions are crucial to combat corruption and raise the quality of public services.

37. Investing in a rapidly-growing workforce should provide needed growth dividends over the medium-term. A comprehensive action plan is needed to raise labor productivity and address labor market inequalities. To this end, it will be vital to improve quality of and access to education and healthcare, reduce existing and emerging skill-shortages, and address gender and rural-urban inequalities. Moreover, there is a need to review the minimum wage policy and assess the impact of public employment and wage setting on the private sector.

38. Enhancing the business environment will help raise private investment, and generate demand for labor. Business licensing processes and regulations need to be better coordinated and harmonized to facilitate easy market entry for new firms. The legal framework for establishing property rights and enforcing contracts should be strengthened, and the capacity of the court system needs to be enhanced. Importantly, a comprehensive and actionable strategy to boost domestic and foreign investment in productive economic sectors will be essential for sustainable diversification of the non-oil economy.

39. Recent improvements to the payments system and financial inclusion are impressive, but financial intermediation remains weak. Continued efforts to develop the financial sector should help channel domestic savings to productive investments, while expanding access to financial services will be essential to facilitate diversification and promote inclusive growth. Ensuring a strong and effective regulatory and supervisory framework will be important to safeguard financial stability as the financial sector develops

40. The 2018 external sector position is assessed to be substantially weaker than the level implied by fundamentals and desirable policies. While dollarization remains appropriate there is a need to increase international competitiveness. In this regard, maintaining low inflation, increasing labor productivity, and implementing needed structural reforms are essential.

41. Stregthening capacity will facilitate the implementation of needed policies and reforms. In particular, strengthening the compilation and dissemination of statistics is essential for surveillance. Priority should be given to shortening the lags in disseminating GDP data, removing inconsistencies between national accounts and balance of payments, and address weaknesses in the compilation and dissemination of government financial statistics. The IMF stands ready to provide further TA and training to assist the authorities.

42. It is recommended that the next Article IV consultation takes place on the standard 12-month cycle.

Box 1.The Future of Timor-Leste’s Petroleum Industry1

The Greater Sunrise fields were discovered in 1974, but have remained undeveloped for over two decades. The fields (Sunrise and Troubadour) are positioned in the Timor sea. The initial joint venture partners were Woodside (the main operator, 33 percent), ConocoPhillips (30 percent), Royal Dutch Shell (27 percent), and Osaka Gas (10 percent). Estimates from Timor Gap suggest that Greater Sunrise holds 6.63 trillion cubic feet of gas and 273 million barrels of oil/condensate, estimated at a value of US$56 billion. 2,3 While potential profits from the Greater Sunrise fields would depend on needed capital investment and operating cost, Timor Gap estimates that the fields could generate $22 billion in profit over multi-decade project life.

The recently signed maritime boundary treaty between Timor-Leste and Australia will pave the way for the future development of the Greater Sunrise fields. The development of Greater Sunrise has been hindered in part because of the maritime boundary dispute between Timor-Leste and Australia and the decision as to whether to process the extracted petroleum in Timor-Leste or Australia. On March 6, 2018, a maritime boundary treaty was signed between the countries and included an agreement on the joint development, exploitation, and management of petroleum from the Greater Sunrise fields. The treaty is to be ratified by the respective parties’ parliaments.

The government has made clear its intention to develop a downstream refining industry on the south coast of Timor-Leste. The transformation of the south coast as a regional petroleum center—the Tasi Mane project—is a key part of the government’s development strategy. To bring the pipeline from the Greater Sunrise to Timor-Leste, the government reached agreements with ConocoPhillips (Oct 2, 2018) and Shell Australia (Nov 21, 2018) to acquire their respective shares in the joint venture for a combined US$650 million. The purchase is to be financed by the Petroleum Fund. To facilitate the purchase, the Petroleum Activities Law was amended in January 2019 to allow the state to participate in a joint venture with a total share of 56.6 percent. When the upstream and downstream industry is developed, the government expects it to contribute more broadly to the development of the economy and the south coast, generating over 10,000 direct jobs and more than 50,000 indirect jobs.4

1 Prepared by Naoya Adachi (APD) and Gee Hee Hong (APD).2 See Strategic & Business Plan, 2016–2035, Timor Gap. The estimated value of the Greater Sunrise assumes an oil price of US$39/barrel.3 Timor Gap is an autonomous government agency with the mandate to conduct oil and gas business on behalf of the Timor-Leste Government.4 See the Program of the Eighth Constitutional Government of Timor-Leste, 2018

Box 2.Public Financial Management Reform in Timor-Leste1

Since independence, Timor-Leste has undertaken several PFM reform initiatives with the support of multiple development partners. Donor supported reforms include, an initial PFM capacity building program (2003–2008), a sector budget support program on PFM and fiscal reforms (2013–2017), a Planning and Financial Management Capacity Building Program (PFMCBP) (2006–2014), and more recently, a roadmap budget support program.2 A major obstacle to these reform initiatives, however, has been the fragmented support from development partners, limited local implementation capacity, and the consequent low level of coordination within and outside government.

While PFM reforms in Timor-Leste have led to improvements in a number of areas, significant weaknesses still exist. Three Public Expenditure and Financial Accountability (PEFA) assessments have taken place (2007, 2010, 2013). The 2013 PEFA highlighted progress from previous PFM reforms, including (i) a transparent and sustainable framework for the governance of the petroleum sector, (ii) a relatively well-structured budget process, (iii) adequate reporting of donor-funded activities, (iv) use of a modern integrated financial management information system, and (v) a treasury single account. However, the PEFA also identified several weaknesses, including low budget credibility, weak procurement processes, and insufficient internal audit and non-payroll controls. A number of other diagnostic assessments have also been carried out, including a 2016 Public Investment Management Assessment (PIMA) by the IMF and the World Bank. The PIMA recommended a prioritized action plan, focusing on more rigorous appraisal processes, cost-benefit analysis, and risks assessments, as well as more competitive procurement processes.

A PEFA exercise is ongoing with the objective to assess PFM weaknesses and to feed into a government-led PFM reform strategy. The WB-led exercise is the first joint PEFA assessment with the government, and will benefit from inputs from other developments partners (including the IMF/PFTAC).3 Apart from assessing PFM systems, the exercise is also intended to feed into an updated and consolidated government-led PFM reform strategy with improved coordination and alignment of existing and future PFM support initiatives. The PEFA is to be completed in the first half of 2019. There are tentative plans between the government and development partners to conduct a consultation exercise following the PEFA exercise. This should help apply a country-specific lens to the PEFA findings, and lead to greater prioritization and sequencing of critical PFM reform issues.

1 Prepared by Gee Hee Hong (APD), based on previous PEFA exercises and the concept note for the 2018 PEFA joint assessment.2 See “Budgeting for a sustainable future: Towards a Roadmap of Budgetary Governance Reform, OECD 2017.3 Other donors include Millennium Challenge Corporation (MCC); and European Union (EU).

Box 3.Integration of Surveillance and Capacity Building1

The IMF has provided capacity building assistance in Timor-Leste since end-1999—two and a half years prior to becoming an IMF member. Initial efforts primarily focused on helping establish core economic institutions in the fiscal and monetary areas, including tax revenue administration, monetary authorities, and Petroleum Fund. At one point, Timor-Leste was one of the largest recipients of IMF TA. However, gradually, capacity development efforts have transitioned into more traditional areas of IMF competency and became more integrated with policy advice in Article IV consultations:

  • Fiscal sector: Fiscal sustainability has continued to be a key issue in surveillance. Capacity building efforts have focused on expenditure management, developing non-oil revenues, and ESI calculation. The latter is the largest revenue source in the budget, and IMF assistance has had an important role in maintaining the credibility of the fiscal rules-based approach. A public investment management assessment (PIMA) was conducted in 2016 with the aim to improve capital spending efficiency. Going forward, and in particularly, following the conclusion of the PEFA in mid-2019, the IMF/PFTAC continues to stand ready to provide TA in PFM related issues, as well in the implementation of a VAT.
  • Macro-financial issues: Financial capacity building assistance has concentrated on strengthening financial stability as the financial sector develops. In 2013, an MCM TA mission to the BCTL assessed gaps in institutional capacity in key areas—banking supervision, crisis management, payments system, and research and analysis. This laid the basis for a multi-year TA work program. The IMF/PFTAC is in the process of helping BCTL in reviewing and revising the legal framework for banking regulation and supervision, developing a comprehensive credit risk management regulation, and strengthening banking supervision capacity.
  • Macro-structural Issues: Economic diversification and improvement of the non-oil private sector have been increasingly covered by IMF surveillance. Capacity development related to such macro-structural reforms has traditionally been provided by other developing partners, given their expertise. In 2015, representatives from Timor-Leste participated in a high-level dialogue, hosted by the IMF and the government of Fiji, on strategies and policies to make the Pacific Islands more resilient to natural disasters.
  • Statistics: Weak compilation and dissemination of statistics are hampering surveillance. Areas of concern include, lagged dissemination of GDP data, inconsistency between national accounts and balance of payments on petroleum-related transactions, and weaknesses in compilation and dissemination of government financial statistics (GFS). STA/PFTAC/CDOT are currently providing technical assistance on GFS, national accounts, and external sector statistics. Timor-Leste has fully implemented e-GDDS by publishing the National Summary Data Page on February 15, 2019.
1 Prepared by Naoya Adachi (APD).

Figure 1.Timor-Leste: Real Sector Developments

Sources: General Directorate of Statistics; and IMF staff estimates and projections.

Figure 2.Timor-Leste: Fiscal Developments

Sources: Ministry of Finance of Timor-Leste; IMF staff calculations and estimates.

Notes: ESI= Estimated Sustainable Income; PF= Petroleum Fund.

Figure 3.Timor-Leste: External Developments

Sources: Central Bank of Timor-Leste; and IMF, Integrated Monetary Database.

Figure 4.Timor-Leste: Monetary and Financial Developments

Sources: Central Bank of Timor-Leste; and IMF, Integrated Monetary Database.

Figure 5.Timor-Leste: Business Environment and Governance1

Sources: World Bank Doing Business 2019; Labor Market Survey, 2013; Worldwide Governance Index, 2016; Natural Resource Governance Institute, Resource Governance Index 2017; the World Economic Forum Global Competitiveness Index 2014–2015; World Bank Enterprise Survey, 2015 and World Bank Development Indicators, latest available data.

1 Note that a certain degree of uncertainty exists around point estimates with respect to governance indicators.

Figure 6.Timor-Leste: Challenges to Growth – Comparison with Regional Peers

Sources: World Bank Development Indicators; World Bank Doing Business 2019; World Economic Forum Global Competitiveness Index 2014–2015; ILO STAT latest data available; and IMF staff calculations.

Note: CLMV denotes Cambodia, Lao PDR, Myanmar, and Vietnam.

Figure 7.Timor-Leste: Social and Economic Development

Sources: Human Development Report, 2017; World Bank Development Indicators, latest available data; and IMF staff calculations.

Annex I. Governance of the Petroleum Fund of Timor-Leste 1

The Petroleum Fund (PF) was established in 2005 to ensure a fair and equitable use of state-owned natural resources in accordance with the national interest, and that the income derived from the exploitation of these resources should lead to the establishment of a mandatory financial reserve.

1. Governance Structure. The PF Law defines the roles and responsibilities of various institutions involved (text figure) who are accountable to the government and overseen by the Ministry of Finance. The PF is formed as an account of the Ministry of Finance (MoF). The Banco Central de Timor-Leste (BCTL) is appointed as the operational manager of the PF by the MoF and holds the account. The Parliament sets broad objectives for the Fund, including asset allocation guidelines and risk limits. The MoF is responsible for the overall management of the PF. This includes setting the investment policy and strategy, guidelines for new investments as well as exercising oversight. In this process, it is mandatory that the Minister of Finance seek advice from and consult with the Investment Advisory Board (IAB) before making decisions on any matter relating to the investment strategy or management of the Fund. The operational management of the Fund is delegated to and carried out by the BCTL, who can directly and indirectly be involved with the investment. In this process, the BCTL is obliged to adhere to the guidelines established by the MoF. For indirect investment, the BCTL delegates investments to global investment management firms that it selects and monitors.

Petroleum Fund’s Governance Structure

Source: Timor-Leste Petroleum Fund Report, 2017.

2. Transparency. The MoF prepares the Petroleum Fund’s Annual Report and financial statements, as well as the General State Budget statement for the National Parliament, which includes the Estimated Sustainable Income (ESI) calculations. The BCTL provides quarterly reports to the Minister of Finance on the Fund’s performance. For the audit process, an internationally recognized external auditor is appointed to issue and publish an audit report on the Fund’s annual financial statements.

3. International Standards. Timor-Leste’s management of the Petroleum Fund is assessed to be satisfactory, according to the 2018 report of the Extractive Industries Transparency Initiative (EITI). This report shows that the PF meets the international standards, not only in terms of the governance, but also in terms of the transparency of production and revenue schedules and allocation of revenue. In addition, the Petroleum Fund of Timor-Leste is an active member of the International Forum for Sovereign Wealth Funds (IFSWF). As of 2018, it has conducted a seventh annual self-assessment of the Petroleum Fund’s adherence with the Santiago Principles to ensure that the Fund continues to exemplify international best practice with regards to fund governance.

Annex II. Risk Assessment Matrix 1
Sources of Risks (Horizon)Relative Likelihood (high, medium or low)Expected Impacts if Realized (high, medium or low)Recommended Policy Responses
1. Weaker-than-expected global growth (short and medium term)High/Medium

Euro: Adverse financial market reaction to debt sustainability concerns and/or disorderly Brexit cause market disruption and dampens growth. In the medium term, rising sovereign yields for high-debt countries could adversely impact confidence and growth. (High).

US: The unwinding of the fiscal stimulus triggers a global growth slowdown (medium).

China: Trade tensions and/or a housing market downturn prompt a slowdown, Insufficient progress in deleveraging and rebalancing reduces growth lead to negative spillovers on the global economy through trade volumes, commodity prices, and financial markets (medium)
Medium/Low

The impact via lower commodity and oil prices is limited by the insulating role of the Petroleum Fund (PF) and low levels of non-oil trade and capital account integration. Nonetheless, weaker growth in Timor-Leste’s trading partners may slow down the growth in tourism and FDI inflows, hampering economic diversification.
Government expenditure plans need to be scalable to mitigate sharp slow-downs in growth. Efforts to raise non-oil revenues need to be intensified and the PF should be maintained at an adequate level as an ongoing revenue source and to provide a fiscal buffer.
2. Sharp tightening of global financial conditions(Short-term)High/Medium

Sharp tightening of global financial conditions causing higher debt service and refinancing risks; stress on leveraged firms, households, and vulnerable sovereigns; capital account pressures; and a broad-based downturn.
Medium/Low

Higher global interest rates would raise income from PF but also incur capital losses. Renewed global shocks that affect international banking operations could impact local liquidity conditions.
The BCTL’s regulatory and supervisory framework and crisis management toolkit need to be enhanced. Address weak financial intermediation would reduce overseas placement of dollar-denominated deposits.
3. Large swings in energy prices (medium term)Low

Risks to prices are broadly balanced, but uncertainty surrounding shocks translates to elevated price volatility, complicating economic management and adversely affecting investment in the energy sector.
Low

Lower and more volatile energy prices may delay investment decisions in new oil fields and reduce profit. The impact on PF saving is limited.
As for 1 above.
4.Higher domestic inflation (medium-term)Medium

Inability to moderate the scaling up of public expenditures raises inflation as the absorptive capacity of the economy is limited.
Medium

High inflation adversely affects the poor and vulnerable. Fiscal pressure increases due to higher transfers and public-sector wages.
Fiscal policy needs to be adaptable to maintain macro-stability, preserve competitiveness and better protect the poor.
5.Over-investment in projects with low returns (medium-term)Medium

This could arise due to the implementation of capital-intensive projects with ambitious cost-benefit analyses.
High

Capital-intensive projects with small economic linkages have a limited impact on job creation and poverty reduction while depleting PF and risk fiscal sustainability.
Projects should be subject to transparent and realistic cost benefit assessments and risk analysis, and only go ahead if the social returns are higher than the opportunity costs.
6.Failure to secure inclusive growth (medium-term)Low/Medium

Discontent could be triggered by the public perception of a low growth dividend, that oil wealth is not trickling down and not reducing poverty.
High

Pressures to raise expenditures may lower the expected return and quality of public investments. Foreign investment, may be discouraged.
Sound policy frameworks and governance structures to be reinforced, especially through more transparency and accountability.
7. Development of Greater Sunrise or other oil fields (medium-term)Low

Upside risk if petroleum production from the Greater Sunrise fields come on line earlier than expected (i.e., within the medium-term horizon)
High

Higher fiscal spending could be supported and to some extent, help enhance long-term growth prospects.
Ensure that the project is technical and economic viability and that proper safeguards are taken to minimize funding risks.
Annex III. Public Sector Dependency and Diversification 1

Timor-Leste is one of the most natural resource-dependent countries in the world. As revenue from ongoing petroleum production has been declining, investment returns from the Petroleum Fund are gradually becoming the main source of finance for the government. The public sector, in turn, plays a dominant role in the economy – not only because of the scale of spending but also because of its role as a major employer. With oil and gas extraction from active fields projected to end in 2022, economic diversification is of the highest priority. Achieving high, sustainable and inclusive private sector growth will be crucial to improve living standards, mobilize domestic revenues for the government, and generate jobs for Timor-Leste’s rapidly-growing population.

1. The public sector is the main driver of non-oil growth. Since 2011, public spending averaged 40 percent of GDP and 106 percent of non-oil GDP. A significant share of spending has been dedicated to investing in infrastructure (roads, ports, airports, and bridges) and public institutions—in part due to the destruction that occurred during the occupation years. This has been financed predominantly by revenues from resources, namely, oil and gas receipts. Petroleum revenue accounts for nearly 75 percent of total revenue and 40 percent of total GDP. This makes Timor-Leste one of the most natural resource-dependent countries in the world. Since 2015, the reliance on the Petroleum Fund as financing source has increased, as the total withdrawal from the Petroleum Fund has been considerably above the Estimated Sustainable Income (ESI),2 where ESI is a measure of the level of resources that can be sustainably withdrawn every year.

Real non-oil GDP growth vs. Capital Expenditure growth

(annual growth in percent, time horizon: 2002–2017)

Sources: IMF staff calculations

Resource Revenue Dependence

(percent)

Sources: IMF staff calculations

2. Public sector-driven activities are the dominant drivers of the Timor’s economy, both in terms of value-added and employment.

  • Gross-Value Added. Diversification in Timor-Leste in value-added terms has mainly been driven by the expansion of public services and construction. In addition, the economic importance of agriculture in Timor-Leste has gradually fallen. To some extent, this is to be expected as the economy develops. However, in Timor-Leste, the reduced importance of agriculture has not been driven by growth in other private sectors, but rather by the increased importance of public services3 and construction. Between 2004 and 2015, the share of gross value added by the agriculture sector fell from 30 to 18 percent while that of construction and public services rose from 16 to 42 percent. Today, the public service sector is the largest contributor to the non-oil economy, followed by commerce and construction.4
  • Employment. While most workers continue to rely on subsistence agriculture, employment in agriculture has fallen since independence. Meanwhile, public sector employment has increased substantially over the same time period. The non-agricultural private sector is still relatively small, but employment in construction and manufacturing has shown impressive growth since 2004 (over 20 percent per year) – mainly because of low initial levels.

Sectoral Share of Gross Value Added, 2015

(Percent)

Sources: MOF-DSG

Change in Sectoral Shares of Gross Value Added, 2004–2015

(percent change)

Source: MOF-DSG

Sectoral Share of Employment, 2015

(percent)

Source: MOF-DGE

Change in Sectoral Shares of Employment, 2004–2015

(percent change)

Source: MOF-DSG

3. Sectoral shifts of labor have been the key driver of overall labor productivity, while within-sector productivity gains have been low. Overall labor productivity increased by approximately 60 percent between 2004 and 2015. The main driver of this growth was between-sector labor reallocation. That is, labor moved away from low-productivity sectors (e.g., agriculture) to higher productivity sectors (e.g., construction, commerce, and public services). Altogether, between-sector gains accounted for well over 90 percent of total labor productivity growth. Meanwhile, within-sector productivity growth has been disappointing. In fact, over the past decade, agriculture and construction are the only two sectors with positive labor productivity growth. The high productivity gains in the construction sector likely reflect the high capital-intensity of large public infrastructure projects.

Contribution to Labor Productivity Growth by Sector

(Percentage share of aggregate labor productivity growth, 2004–2015)

Sources: MoF-DSG and IMF Staff calculations

4. Waning petroleum production combined with a rapidly-growing working-age population highlight the urgent need for diversification. Continued excess withdrawals from the Petroleum Fund will eventually affect the capacity of the government to support growth through public spending. Mobilizing non-oil domestic revenue and limiting the excess withdrawals should, therefore, be a priority. Moreover, Timor-Leste is one of the youngest and fastest growing countries in Asia in terms of population. Nonetheless, job insecurity and unemployment are high, and labor force participation low—particularly among younger and female workers. Without private sector growth and successful economic diversification, a rising gap between a growing labor force and the availability of decent jobs risk creating social and economic challenges.

5. Economic diversification and reduced dependence on public spending will require three broad objectives.

  • Macroeconomic stability. Public confidence in government institutions is a prerequisite for stable economic development. This would entail ensuring long-term fiscal sustainability by mobilizing domestic revenue, strengthening public financial management, and combating corruption.
  • Private sector growth and job creation (Annex IV). Boosting investment in human capital (education, vocational training, nutrition) and improving and enforcing labor regulations will be key. In addition, strengthening business regulations and developing a private investment strategy should also help channel private investment into productive sectors where Timor-Leste has a comparative advantage.
  • Financial sector development. Developing a financial system that is supportive of private sector growth is imperative -both by removing obstacles to financial intermediation (e.g., strengthening the collateral system), and enhancing financial inclusion (e.g., expand access to financial services and improve financial literacy).
Annex IV. Growth Dividend from Labor Market Reforms1

Timor-Leste’s population is the youngest and fastest growing in Asia. With proper policies and reforms, the growing working-age population should generate significant growth dividends. Staff calculations suggest that if Timor-Leste can raise labor productivity and improve labor market outcomes for its youth, then non-oil growth could be raised to above 7 percent by 2030, more than 2 percent higher than under the current baseline scenario.

1. Timor-Leste’s population is the youngest and fastest growing in Asia. Between 2010 and 2015 the population grew at an average annual rate of 2.2 percent – well above the regional average of 1.3 percent. Moreover, half the population in Timor-Leste is below the age of 18, while the average median age in Asia is about 30. Based on United Nation’s World Population Prospects in 2017, the country’s population is expected to continue to grow throughout the 21st century, with the share of working-age people (i.e., aged 15 to 64) rising until the 2060s.2 Total population is projected to increase from 1.3 million in 2017 to 1.9 million by 2030.

Median Age and Population Growth

Source: United Nations.

2. Weak labor market outcomes and low productivity growth suggest difficulties to absorb job market entrants. The latest numbers from the 2013 Labor Force Survey show that the labor participation rate in Timor-Leste is about 30 percent, and the overall unemployment rate is around 11 percent. However, 26 percent of the working age population classifies as subsistence food producers and 93 percent of subsistence food producers are not counted in the labor force. The situation appears to be even more dire for female and young workers. Female labor force participation is as low as 21 percent and youth unemployment is as high as 22 percent. Moreover, over the last five years, labor productivity has grown at an annual average rate of by 2.0 percent, well below the average of lower middle-income countries (3.8 percent). Indeed, most of the productivity gains have come from labor shifting to high-productivity sectors, rather than from within-sector productivity (see Annex III).

3. To quantify the potential growth dividends from improving labor market outcomes and raising productivity four scenarios are considered.

  • Baseline scenario. The number of workers is assumed to grow by about 3.2 percent annually, on average. Moreover, the labor force participation and unemployment rates (for every five-year age cohort) remain constant, and labor productivity continues to grow at 2.0 percent. 34
  • More job opportunities for young workers. This scenario assumes that the labor participation rate for those aged 20–24 increases (currently at 22 percent) to the average youth labor participation rate of a middle-income country (i.e., 46 percent) and the youth unemployment rate falls to the average of a middle-income country (i.e., 14 percent).5,6
  • Boosting labor productivity. This scenario assumes that labor productivity increases to the average rate of a middle-income county (i.e., 4 percent)—holding both the labor participation rate and unemployment constant.
  • More job opportunities for young workers and higher productivity. The final scenario combines the two previous scenarios.
Potential Growth Gains from Improving Labor Market Outcomes and Productivity
Assumption (in 2030)Projection
Youth labor participationYouth unemploymentLabor productivity growthAnnual growth rate (%)
2021–252026–30
Baseline Scenario14.221.92.04.94.8
Reform Scenarios
More job opportunity for youth45.813.72.05.65.7
Higher productivity14.221.93.76.16.5
More job opportunity for youth and higher productivity45.813.73.76.77.5
Source: IMF staff projections.
Source: IMF staff projections.

4. The scenario analysis shows that if Timor-Leste can reach labor market outcomes similar to those in middle-income countries, non-oil growth could be increased from 5 to 7.5 percent per year. Under the baseline, the non-oil economy will grow at around 4.8 percent. However, if the youth labor participation rate is gradually raised to from 22 to 45 percent, non-oil GDP growth would increase to about 5.7 percent by 2030. In addition, if labor productivity increases from 2 to 4 percent (third scenario), then annual real non-oil GDP growth would increase to about 7.5 percent by 2030.

5. To capture growth dividends from the rapidly-growing working population, labor market reforms should focus on the following areas:

  • Improve basic education outcomes. Educational attainment remains low when compared with other countries in the region (e.g., Indonesia and Malaysia). Pre-school enrollment needs to be expanded, infrastructure improved (both in terms of quality and quantity of school facilities), teacher competence enhanced, and governance of the education system strengthened.7
  • Increase female labor force participation and job opportunities. Important measures include, improving female educational attainment, promote access to the formal sector and enforcing existing labor regulations (only 26 percent of women have employment contracts compared with 74 percent for men), ensuring access to social protection, and eliminate discrimination in recruitment and promotion.
  • Address skilled labor shortages: Expanding Technical and Vocational Education and Training (TVET) and ensuring close coordination between TVET systems and the private sector is crucial to align the supply of skilled labor with sectoral demand. Expand opportunities for Timorese worker to gain experience abroad should also help facilitate knowledge spillovers.
  • Strengthen implementation of labor regulations. Strengthening capacity to enforce labor regulation should help improve job worker rights. Finally, establishing a minimum wage policy that strikes the right balance between reducing earnings inequality and increasing formal employment of unskilled workers should also be considered.
Annex V. External Sector Assessment1

The external position of Timor-Leste in 2018 is substantiaiiy weaker than that consistent with medium-term fundamentals and desirable policy settings. The oil-dependent economy is facing a large structural change due to the expected depletion of the active oil and gas fields in 2022. The current account (CA) deficit narrowed in 2017–18, mainly due to lower imports along with fiscal consolidation and higher oil/gas prices. Improving external competitiveness is key to advancing economic diversification and promoting non-oil private sector development, warranting fiscal adjustment and steady implementation of structural reforms.

1. The external CA deficit is projected to remain in the medium term. The CA turned to a deficit in 2016, but improved in 2017–18 due to lower imports resulting from lower fiscal expenditure and higher oil and gas prices. The CA deficit is projected to remain in the medium term, averaging about 4 percent of GDP. The deficit will mainly be driven by higher imports related to capital spending, falling oil/gas receipts, and fluctuations in the PF’s investment returns.

2. The Petroleum Fund (PF) will work as a buffer and provide the lion’s share of funding over the medium term. Active oil/gas fields are expected to be depleted in 2022, but the PF will continue to provide investment returns in the medium term. The CA deficit will be financed largely by divestment from the PF, together with external borrowing and FDI inflows.

3. The real effective exchange rate (REER) has appreciated since 2010. The REER appreciated by about 7 percent annually during 2010–2015, resulting from Timor-Leste’s high inflation differential with trading partners and an appreciation of the nominal effective exchange rate (NEER) due to a stronger U.S. dollar. The REER started to depreciate in 2016 due to a low domestic inflation, but started to appreciate again in 2018 as inflation picked up and the U.S dollar strengthened.

Effective Exchange Rates

(2010=100)

Sources: Country authorities; and IMF staff calculation.

4. The revised EBA-Lite framework provides mixed results on the REER, but points to a current account level substantially weaker than the level implied by fundamentals and desirable policies.23 This assessment is based on the IMF standard methodology using the CA model, the REER model, and External Sustainability approach (ES).4

  • CA-model. The CA gap (i.e., the difference between CA-actual and the CA norm) suggests an external position that is substantially weaker than current fundamentals and desirable policy settings. However, most of the CA gap (23 percentage points) is unexplained by the model and the estimated policy gap is small. Compared to the assessment for 2016 (derived using the previous version of the EBA-Lite) the CA norm has changed substantially (from a deficit of 8 percent to a surplus of 13 percent). It is important to note that the regression database underpinning the CA-model does not include Timor-Leste and does not account for time-invariant country-fixed effects. Hence, the assessment may not adequately account for ongoing structural changes in Timor-Leste (e.g., depletion of active oil fields), immature financial markets, demographic trends, and large infrastructure gaps. Moreover, the results are sensitive to sample periods and underlying assumptions and does not take into account data limitations (e.g., difficulties in estimating output gap and cyclically adjusted fiscal balance due to the short period of available data).
  • REER-model. The REER model directly estimates the equilibrium REER based on variables that affect the REER through changes to the CA balance. The result from the REER-model suggests that Timor-Leste’s REER is overvalued by 3 percent, indicating that it is broadly in line with fundamentals and desirable policies. Unlike the CA-model, the REER-gap is to a large extent explained by the policy gap, primarily reflecting too high real interest rate.
2018 External Balance Assessment Results(In percent of GDP, unless otherwise indicated)
CA model1REER modelES model 2
Actual CA-9.0
CA norm13.4
CAgap-22.4-10.4
Policy gap0.9
Unexplained-23.3
REER gap362.02.972.4
Policy gap3.5
Unexplained-0.6

With team’s desirable policy level.

ES model used 2016 NFA data.

Gap between In(REER) Actual and In(REER) Norm, implying over(+)/under(-) valuation.

Source: IMF staff estimates.

With team’s desirable policy level.

ES model used 2016 NFA data.

Gap between In(REER) Actual and In(REER) Norm, implying over(+)/under(-) valuation.

Source: IMF staff estimates.

5. International reserves adequacy is met due to the significant buffers provided by the PF.5 NIR is estimated at US$0.6 billion at end 2018, amounting to an import coverage of 6.4 months. Reserve adequacy metrics for credit-constrained LICs suggest that the optimal level of reserves for Timor-Leste is around 9.5 months of imports, much higher than the traditional metric of 3 months. The estimated adequacy threshold largely reflects the inflexibility of a dollarized economy in adjusting the exchange rate to absorb shocks. While a fully dollarized economy does not face exchange rate fluctuation risk, liquidity is needed to protect the financial system from liquidity shocks and as a fiscal buffer for the financing gap. In this context, the PF provides significant buffers, with foreign assets at US$16 billion (506 percent of GDP with the allocation of 40 percent in equities and the remaining in bonds) equivalent to 166 months of goods and services imports. In contrast, according to the latest numbers foreign liabilities remain relatively small, at 19.3 percent of GDP at end-2017, mostly consisting of FDI liabilities and external debt (12.2 percent and 3.8 percent of GDP, respectively).

Real Effective Exchange Rate: Contribution to Change

(In percent; y/y)

Source; IMF. Information Notice System

6. Structural reforms remain crucial to improve external competitiveness and diversify the economy. Implementation of needed structural reforms of the non-oil economy should reduce import dependence and increase the export base. Maintaining low inflation and increasing labor productivity through investments in education and health should also help increase competitiveness.

1The Commission for Reception, Truth and Reconciliation in East Timor, CAVR 2006.
2The duo decimal regime allows public spending to continue without a budget in place. However, monthly spending is restricted to 1/12 of each budget line of the previous approved budget.
3The government’s desired medium target for inflation is 4 percent.
4The PF (a type of sovereign wealth fund), which was created in 2005, provides budget financing through the Estimated Sustainable Income (ESI) rule—which is set at 3 percent of the petroleum wealth (i.e., a net present value of petroleum-related revenues)—and any excess withdrawals (which exceeds the ESI and are subject to parliamentary approval).
5Given the numerous uncertainties, revenues from the Greater Sunrise oil/gas fields are not reflected in staff’s projections of the wealth of the PF, or in any macroeconomic projections.
6PFTAC participated in a PFM seminar hosted by the Timorese Fiscal Reform Commission titled “Strengthening the Expenditure Framework for Sustainable Growth and Development” in Dili on 14–15 February 2019.
7UNCAC stands for the United Nations Convention Against Corruption.
8The Pacific Labor Scheme officially commenced on 1 July 2018. The scheme is designed to help fill labor shortages in Australia while providing opportunities for workers from the Pacific to earn income and develop skills.
1Prepared by Gee Hee Hong (APD).
1The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent; “medium” a probability between 10 and 30 percent; and “high” a probability of 30 percent or more). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities.
1Prepared by Gee Hee Hong (APD) and Pedro Miguel Gaspar Martins (World Bank).
2The Estimated Sustainable Income (ESI) is calculated as 3 percent of the net present value of petroleum wealth.
3Public services comprise public administration & defense, education, health, and social work activities.
4Commerce includes wholesale & retail trade, transportation & storage, and accommodation & food services.
1Prepared by Naoya Adachi (APD).
2United Nations, Department of Economic and Social Affairs, Population Division (2017). World Population Prospects: The 2017 Revision.
3The labor participation rate and unemployment rate are available for every five-year age group and every ten-year age group, respectively.
4Under all the reform scenarios, linear changes for all variables are assumed. For example, when assuming the labor productivity will increase by 1.7% from 2015 to 2030, the changes are allocated equally over 15 years and the assumed change from 2015 to 2020 is 0.5.
5The labor participation rate for aged 15–20 is kept constant as the low rate partly reflects school attendance.
6Due to the data limitation, the average of youth labor participation rate of a middle-income country is from 2010, while that of the youth unemployment rate is from 2017.
7See “Regaining Momentum,” 2018, Timor-Leste Economic Report, World Bank.
1Prepared by Naoya Adachi (APD)
2The revision to the EBA-Lite CA model includes: (i) eliminating aid, aging speed, and remittances from explanatory variables and adding outward migrant shares; (ii) adding natural disasters and armed conflict dummies; (iii) incorporating social insurance policies; and (iv) separating cyclical factors from structural financial policies. Given Timor-Leste’s young and fast-growing population, (i) makes large differences from the previous model, and as a result, CA norm turned from negative to positive.
3A similar revision was made to the EBA-Lite REER model: the addition of the public health policy, and the credit growth variables; the indicators for natural disasters and militarized conflicts; and the REER model uses the indicative policy norms for the credit-to-GDP ratio, credit growth, and public health policy. In contrast, the REER model keeps using aid and remittances as an explanatory variable.
4Since Timor-Leste is a large net creditor and does not appear to have external sustainability concerns, the focus is on the CA and REER models.
5See IMF (2015), Assessing Reserve Adequacy – Specific Proposals.

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