Statement by Mr. Luis Valdivieso Senior Advisor, Asia & Pacific Department of the IMF at the Donors Conference for East Timor Brussels
December 6, 2000

Recent Developments and
Macroeconomic Assessment

Prepared by the Asia and Pacific Department
(In collaboration with the World Bank and in consultation with other Fund departments)
November 30, 2000


List of Acronyms and Abbreviations

  1. Introduction
  2. Growth and Inflation
  3. Employment and Wages
  4. Public Finance
  5. The Combined Sources Budget
  6. Banking Sector and Foreign Exchange Market
  7. External Sector and External Financial Assistance
  8. International Negotiations
  9. Economic Institutions and Regulatory Framework
  10. Technical Assistance

1.   Developments in the Power Sector

1.   Consumer Price Index for Dili
2.   Indonesian Rupiah/U. S. Dollar Exchange Rate Developments in Dili

1.   Key Economic Indicators, 1997-2002
2.   Fiscal Accounts of the Consolidated Fund for East Timor (CFET)
3.   Expenditure Priorities (CFET Budget), FY 2000/01
4.   Combined Sources Budget
5.   Balance of Payments
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Acronyms and Abbreviations

AsDBAsian Development Bank
BNUBanco Nacional Ultramarino
CFA Central Fiscal Authority
CFETConsolidated Fund for East Timor
CPOCentral Payments Office
DCUDonor Coordination Unit
EPDAEconomic Planning and Development Agency
ETRSEast Timor Revenue Service
ETTAEast Timor Transitional Administration
FADIMF Fiscal Affairs Department
IFIInternational Financial Institutions
MAEIMF Monetary and Exchange Affairs Department
NCBANational Cooperative Business Association
NCCNational Consultative Council
NGOnongovernmental organization
RpIndonesian rupiah
TFETTrust Fund for East Timor
UNTAET   United Nations Transitional Administration in East Timor
UNTFUnited Nations Trust Fund for East Timor

I. Introduction

1. This paper presents an overview of recent developments and an assessment of macroeconomic conditions in East Timor as of mid November 2000.1 There is little doubt that there have been many positive developments so far, but there also are questions about their sustainability over time. Favorable developments in output growth, consumer prices, trade and bank deposit flows, are in sharp contrast with the prevailing sizable unemployment, emerging wage distortions and a lagging response of private sector longer term investment. Domestic saving is beginning to rise slowly but there will be a need for continued, albeit declining, generous external financial support in the years to come. A basic economic institutional and legal framework has been established, but much remains to be done to create an enabling environment for private sector development. There is an encouraging measure of fiscal control and the foundations for the development of the financial sector have been established. However, there is growing political uncertainty as independence approaches, and there is a need to develop soon a commercial legal framework, land and property laws, a foreign investment law, a labor code, bankruptcy proceedings, and a mechanism for dispute resolution. Building an indigenous capacity in macroeconomic management will also be critical to ensure sustainability. Continued comprehensive technical assistance will be required as well as intensive training and skills development.

II. Growth and Inflation

2. There is an ongoing strong revival of economic activity, led by growth in construction, commerce and trade, and basic services.2 Real GDP growth is likely to reach at least 15 percent in 2000 (Table 1). The revival is largely driven by the demand created by the large UN and expatriate presence which has stimulated consumption and some private investment, mostly in the services sector. However, there is little evidence of permanent businesses being established outside the services sector. Private sector representatives have confirmed their preference for engaging in activities in which investments are recovered in the shortest possible period. The main factors underlying this behavior include political uncertainty on the road towards independence and a number of impediments, including the lack of a commercial legal framework, a land and property rights law, a labor code, mechanisms for the resolution and arbitration of disputes, proceedings for the bankruptcy of businesses, and a legal framework for foreign investment.3 The creation of an enabling environment for private sector activity is an essential complement to the effort being made at setting up an efficient public administration. The income effect of a favorable supply response of non-services sectors will also make it easier to absorb the decline in demand that will emerge as the large expatriate presence starts winding down after independence.

3. Consumer price inflation appears to have slowed down and regional price differences for key staples have narrowed. Following an 8 percent increase in May, rupiah denominated consumer prices in Dili increased at a very low average monthly rate between June and October (an annualized rate of about 2 percent) (Figure 1). Over the same six month period, the rupiah depreciated by 13 percent in relation to the U.S. dollar. There is evidence that rice prices have converged across and within East Timor regions and rice is now being sold at levels close to or below those prevailing in mid 1999 throughout the territory.4 The favorable price performance reflects the increased availability of goods in domestic markets, despite the persistence of supply shortages for certain products.

III. Employment and Wages

4. In the absence of comprehensive estimates of employment, the consensus view is that the agricultural sector continues to provide most of the employment in East Timor. In addition, about 6,000 full time jobs are currently provided by East Timor Transitional Administration (ETTA) and there are several programs providing temporary employment, including those financed through the Trust Fund for East Timor (TFET). Finally, although there is no information on employment provided by the emerging private sector, indications are that a large number of temporary positions have been created by construction and transport companies, as well as by restaurants and hotels. There is no information available on unemployment. There are also renewed doubts about the estimated size of the total population, following the completion of the recent registration of 240,000 students for the 2000/01 school year, compared to an estimate of 175,000 used for preparing the budgetary estimates for the education sector.5 Deficiencies in the information about population and employment need to be addressed; to this end, efforts are being made to ensure that the household survey to be jointly conducted by the World Bank and AsDB and ETTA's Economic Planning and Development Agency (EPDA) will be completed before the end of the current fiscal year.6

5. Wages paid to the locally hired employees of the UN, the International Financial Institutions (IFIs), and to those working in the provision of services to the large group of expatriates and foreign representations have been putting upward pressure on wages in the rest of the economy. The pressure to raise wages seems to be more acute in urban areas, but there are also indications that wages in the coffee sector for the 2000 harvest trebled in U.S. dollars compared to the minimum daily wage of about $1 paid under the Indonesian administration. As envisaged in the June IMF report,7 the emerging labor market distortions are making it difficult to recruit civil servants not only because of sizable average wage differentials compared to UN and IFIs wages, but also due to the lack of flexibility in ETTA's current wage scale which does not permit extending differential wages to workers with various levels of experience within each skill category. This issue requires urgent attention, and a comprehensive review is planned for early next year.8

IV. Public Finance

6. The execution of the ETTA budget (CFET) for FY00/01 has proceeded at a slower pace than anticipated. During the first quarter of FY 2000/01, the deficit amounted to $1 million, compared with a pro-rata estimate of about $11 million (Table 2). Over the same period, the collection of tax revenues and user fees has been weaker than anticipated but has since started to pick up rapidly. Collections on custom duties, excise taxes, and the sales tax on imported goods were robust, despite a larger than anticipated level of exemptions from taxes on imported goods. Collection from the newly-introduced service tax on restaurants, hotels, and car rentals was initially low, but rose faster in September and October. User fees for power and water have not been collected at all, mostly due to long delays in the installation of power meters (see box 1). Port and airport fee collections commenced in September. Expenditure has also fallen short of the pro-rata target. In terms of commitments, around 60 percent of the target has been reached. However, in cash terms, outlays were only 20 percent of the target. Underspending reflects delays in making the spending agencies operational as well as management problems (many agencies have not yet produced detailed work plans for FY00/01). Only few agencies have overspent, the largest being the power sector.

Box 1. East Timor: Developments in the Power Sector

The power sector has overspent its budget in the first quarter of FY00/01, and continues to overspend during the second quarter. For the first half of FY00/01, costs are expected to exceed budget projections (of $7.8 million for FY00/01) by $1.6 million: Fuel prices are higher than anticipated ($0.35/l instead of $0.25/l), amounting to an extra spending of $0.8 million. Power consumption is also higher than anticipated, leading to additional spending of $0.5 million. An additional $0.3 million is needed to install power meters for consumers. For the second half of FY00/01, costs are expected to continue to exceed budget projections by $1.3 million. Hence, total overspending for the fiscal year as a whole would amount to $3 million.

Virtually no user charges were collected in the first quarter of FY00/01, because no power meters were installed with consumers. The 300 major users have been sent bills for August and September based on presumptive levels of consumption, and more recently, they have had meters installed. As a result of the steps recently taken, revenue is expected to pick up. Nevertheless, by the end of FY00/01, only 20 percent cost recovery is expected (60 percent after FY01/02 and 90 percent after FY02/03). In an effort to increase revenues, the Central Fiscal Authority (CFA) intends to raise the tariff from 12.5 cents per kWh to 25 cents per kWh., which at current oil prices, would roughly equal production costs in the Dili area. However, this increase would not cover production costs in rural areas, which are estimated to be as high as 50 cents per kWh. There are also plans for installing up to 3,000 meters by January through private contractors. Efforts at reducing costs include laying off 50 employees so as to reduce staff below 200. The authorities are considering to establish the power sector as a separate entity by the end of FY00/01. Technical assistance is being provided by the Asian Development Bank.

7. The ETTA budget for FY00/01 was revised in November to introduce new revenue measures to strengthen revenue performance. The National Council has recently endorsed the Cabinet's proposal to introduce a wage withholding tax and an income tax, to reduce exemptions from customs duty, excise, and sales tax, and to increase the number of goods subject to excise taxes. Pending final approval by the legal department of the UN, the corresponding regulations will be issued shortly.9 The main revenue measures include:

  • The wage income tax, which would become effective January 1, 2001 and would be withheld by the employer. Monthly wage income below $100 would be tax exempt; between $100 to $650 would be subject to a 10 percent tax rate; and above $650 would be subject to a 30 percent tax rate. The projected annual yield, assuming that UN locally hired employees will be exempt from paying this tax, would range between $0.5 and 0.7 million.

  • The income tax, which adapts the Indonesian income tax law to the limited administrative capacities in East Timor, would apply to all other taxable income. The income tax rates will vary according to the source of income, and range from 20 percent on the income earned by non-residents, and 15 percent for dividends, interest, and royalties, to 2 percent for income from construction and building activities. The revenue generating capacity of the income tax is difficult to project as a business register is only expected to be compiled at the end of 2000. The income tax does not apply to income associated with Timor Gap activities, which remain subject to production sharing agreements and the Indonesian tax regime as applicable in October 1999. These arrangements affecting Timor Gap activities should be seen as transitory and are part of the ongoing discussions with Australia (See section VIII below).

  • The reduction in exemptions from customs duties, excises, and the sales tax would be implemented through a more limited list of exempt persons and organizations. Charitable organizations will be asked to register in order to be eligible for an exemption. This measure may yield as much as $2 million for every 5 percentage points reduction in the level of exempted imports. No significant additional revenue is expected from the increase in the number of goods that will be subject to excise taxes.

8. On the expenditure side, the budget revision endorsed by the National Council will increase overall expenditure in FY00/01 by a small amount (Table 3). The proposed revisions change the structure of expenditure in favor of the power sector (higher than anticipated consumption and oil prices), police and security (hiring police trainees at a faster rate and establishing the Timor Lorosa'e Defense Force), and public administration (increases for cabinet of the transitional administration, central administration, and foreign affairs). To offset these increases, the remaining unallocated budgetary funds were appropriated, and expenditure for roads, agriculture, health, border service, environment protection and census and research were reduced, among others. The expenditure cuts either reflect expenditure items that should have been carried out in the first four months but were not (e.g. improvement of roads before the rainy season), or tasks being taken over by the UNTAET's (United Nations Transitional Administration in East Timor) assessed contribution budget (e.g., border control).

9. As a result of the revenue and expenditure measures, the cash deficit for FY00/01 is now projected at about $36 million, compared with $42 million in the original budget. Revenue is projected at $25 million, of which $6 million will come from royalties and taxes associated with the Timor Gap. Expenditures are budgeted at $61 million. The budget deficit is expected to be fully financed by grants and assumes that $14 million in pledges will be disbursed in the remainder of the year. There is, however, a need to clarify further the financing available to the budget, as the UN has not provided yet a full and detailed accounting of the United Nations Trust Fund for East Timor (UNTF). If the projected revenues materialize and the budget is fully executed, which requires speedy resolution of operational and management problems in spending agencies,10 the CFA will close FY00/01 with total assets of $10 million, of which $6 million would be held in the special sub-account for the Timor Gap. A cabinet decision provides that any Timor Gap revenue in excess of the $2 million allocated to the budget be saved until a policy on the utilization of those revenues is defined after independence.

10. For FY01/02 and FY02/03, the overall expenditure targets have so far been revised upwards only marginally. Expenditure is now targeted at $57 million in FY01/02 and $59 million in FY02/03. Consistent with the budget document presented in Lisbon, the CFA still targets revenue collection at $30 million in FY01/02 and $40 million in FY02/03. However, on current policies, domestic tax and non-tax revenues (excluding Timor Gap revenue) are expected to fall short of these targets by $8 million in FY01/02 and $18 million in FY02/03, indicating that additional measures would be needed. If the original revenue targets were not met, the projected financing requirements would reach $31 million in FY01/02 and $34 million in FY02/03. Moreover, if the policy of not using Timor Gap revenue in excess of $2 million to fund budget expenditures is pursued, the budgetary financing requirements would reach $33 million in FY01/02 and $37 million in FY02/03. In view of the above, it will be very important that revenue estimates be updated before the budget discussion for FY01/02 and if needed, steps be taken to raise revenues. In this context, it will be also important to define the medium-term policy on the use of Timor Gap revenues.

11. The expenditure revisions have implications for future fiscal sustainability. While current projections are based on the original appropriations, the introduction of new agencies and spending priorities has led to an increase in public sector employment by more than 2,000 workers this fiscal year.11 Maintaining the new agencies and the higher level of public servants in coming years will require spending cuts, if overall spending is to remain in line with the projected expenditure targets. For FY01/02, the CFA estimates that expenditure on wages and salaries would need to be cut by 6.5 percent for all agencies in existence before the November revisions. Likewise, expenditure on goods and services would need to be cut by 13 percent. Similar expenditure cuts will need to be made for FY02/03. In the budget process for FY01/02, ETTA should introduce a sustainable wage level and structure, consider options for increasing domestic revenue (including to offset the impact that a reduction in the UN led foreign presence may have on the tax base), and assess possible grant flows.

V. The Combined Sources Budget

12. The combined sources budget attempts to summarize all fiscal and quasi-fiscal activities carried out in East Timor directly by the ETTA budget, and with the financial support of TFET, UNTAET's assessed contributions budget,12 and bilateral donors whether directly or through implementing agencies, including from the UN (Table 4). The objective is to provide a comprehensive view of the current level of public spending on goods and services. This exercise requires some judgment to determine what is quasi-fiscal expenditure, but serves as a good starting point for a discussion of long-term fiscal sustainability. In particular, it will be important to determine as a matter of some urgency the current level of public goods and services that an independent East Timorese government will be able to afford as the provision of external financial assistance by donors starts declining. The combined sources budget is intended to serve as background information for the FY01/02 budget exercise, allowing the National Council to get a better picture of sectoral expenditure priorities.

13. In the early stages, all entities engaged in East Timor drew up their individual budgets independently. At the Lisbon meeting, a CFET current and capital budget was presented, together with a projection for the Reconstruction and Development Program. The IMF presented a preliminary estimate of a combined sources budget and there was agreement that efforts should be made to move toward a comprehensive budget format, to facilitate internal discussions and decision making, as well as Donors' reviews. More recently, the CFA has started to integrate the CFET and the TFET as well as the assessed contribution budget and individual donor projects.13 Completion of this task requires detailed information from bilateral donors, regarding spending plans and execution. The bulk of non-CFET quasi-fiscal expenditure has been classified as capital expenditure. However, some expenditure items are of a recurrent nature, and future budget exercises should identify their likely impact on the path and composition of expenditures.

14. Based on existing information from various sources of external financial assistance, the capital expenditure that could be supported for FY00/01 would amount to $130 million (or about 45 percent of GDP), of which $15 million would be executed through the ETTA budget and about $70 million under the TFET.14 The expenditure levels are expected to decline gradually in FY01/02 and FY01/02 and FY02/03, reflecting a winding down of UNTAET quasi-fiscal operations and a decline in bilateral support in the form of quasi-fiscal expenditures. For the three fiscal years under review, the deficit is expected to be fully financed by grants.

VI. Banking Sector and Foreign Exchange Market

15. Financial intermediation is yet to be restored. Bank current account deposits as of end June 2000 have been estimated at about $14 million (a level similar to that held by Indonesian banks in September 1999), but there has not been any build up of time or savings deposits yet, except for some TFET deposits.15 Despite the favorable evolution of current bank deposits, no commercial bank credit has been extended due to the lack of adequate collateral. The only loans extended so far are those under the Small Enterprise Project funded by the TFET. Loans fully processed as of end September were equivalent to $0.8 million16 and carried an interest rate of 10 percent per year. Most loans have been extended with a maturity of 36 months and a three-month grace period. Loan performance has been good so far, but it is still too early to draw definite conclusions. In addition, three microfinance institutions have started operating, one of which has already made 350 small loans-ranging between US$50 and US$100-70 percent of which have been repaid.

16. There is growing interest among foreign banks to start operating in East Timor. Banco Nacional Ultramarino (BNU) is the only bank offering payment services and a wide range of banking facilities. Westpac Bank, which until recently had been engaged in foreign exchange operations only, is now in the process of formalizing a broadening of its operations to include banking activities. The licensing procedures for another Australian bank (ANZ) are in the final stages and there have been recent inquiries by an Indonesian bank to reestablish operations in Dili. In addition, a foreign exchange dealer license has been recently granted to an Australian firm.

17. The Dili foreign exchange market is growing rapidly and the exchange rate of the U.S. dollar vis-à-vis the Indonesian Rupiah has continued to track developments in the Jakarta market closely, albeit with a lag (Figure 2). Between September 15 and October 30, the foreign exchange market turnover (i.e., the total value of sales and purchases of foreign exchange) was close to $19 million, of which 60 percent was settled in U.S. dollars, 25 percent in Australian dollars and the rest in Indonesian rupiah and Portuguese escudos. In Dili, the buying rate for dollars offered by street vendors tends to be consistently higher than the rate offered by financial institutions. The spread between the buy/sell rate of the rupiah vis-à-vis the U.S. dollar has remained stable (at around 6 percent), whereas the margin between the mid-point exchange rate in Dili and that in Jakarta has continued to display some volatility.17

Figure 2. EAST TIMOR: Indonesian Rupiah/U.S. Dollar
exchange Rate Developments in dili

18. The use of the U.S. dollar, although still low, is gradually starting to pick up in line with rising domestic fiscal outlays, continued efforts at educating the population in the use of the legal tender, and improved availability of low denomination notes and coins. Executing agencies of TFET projects are increasingly making payments in U.S. dollars and there is evidence that employees in the private sector (including in agriculture) are requesting their salaries to be set and paid in U.S. dollars. Anecdotal evidence also suggests that the use of the U.S. dollar as a store of value is rapidly becoming important. The Central Payment Office (CPO) needs to continue to encourage NGOs, Diplomatic Missions, UN agencies, and other institutions to make their disbursements/payments in U.S. dollars, without prejudice for the freedom of private parties to settle contracts in the currency of their choice.

19. The Indonesian Rupiah continues to be widely used as a means of payment throughout the territory, while the Australian dollar circulates mainly in Dili. In August, demonetization by Bank Indonesia of certain rupiah notes led some businesses in East Timor to stop accepting the demonetized rupiah notes which were still in circulation in the territory and a secondary market for such notes with a steep discount soon emerged. As a result, the CPO negotiated temporary arrangements with BNU to exchange the demonetized notes and a potential disruption of the payments system was avoided. A permanent arrangement for exchanging old and demonetized rupiah notes between CPO and Bank Indonesia should be sought as soon as possible.

VII. External Sector and External Financial Assistance

20. One year into its post-conflict recovery, East Timor's trade flows are dominated by the substantial official aid flows (including UNTAET). These have assisted in the rehabilitation and reconstruction of the economy but, because of the large import component, have also resulted in a substantial deterioration in the trade and current account deficits. The current account deficit, excluding transfers, is expected to deteriorate sharply in 2000 and to peak at around $166 million (55 percent of GDP) in 2001 (Table 5). Merchandise imports are expected to reach about $126 million in 2000, despite an expected cessation of imports related to humanitarian assistance and a moderation of other aid-related flows, including from UNTAET. The surge in imports, however, is not likely to be reflected in border tax revenues since the bulk of them will continue to be aid-related and, as such, are tax-exempt.

21. Private sector imports are beginning to rise steadily. Private sector imports, which had been running at about $2-3 million per month in the second quarter of 2000, rose to about $5-6 million per month thereafter. It is not clear to what extent stronger private imports reflect a strengthening of the local economy rather than the increased activity of temporary businesses, mostly run by expatriates, servicing the large international community. Rice imports have increased rapidly reflecting in part a decline in the cost competitiveness of domestic rice producers following the discontinuation of production subsidies.

22. Exports have weakened further and export earnings in 2000 are likely to be well below the pre-conflict average. Limited data suggests that earnings from coffee, the main export commodity, are likely to reach about $8 million in 2000, significantly lower than the average of about $25 million recorded before the conflict. The weak coffee export values reflects both the 30 percent decline in world coffee prices this year as well as a sharp drop in recorded export volumes to a third (2.5 thousand tons) of the pre-conflict average.18 The recovery of exports will depend critically on the rehabilitation of the transportation and processing infrastructure since damage in these sectors has led to significant crop spoilage, sharply reducing income especially for the high quality segment of the export crop. For a large proportion of the coffee crop, which is of lower quality, exports have remained hampered by the continued disruption of distribution channels, especially to Indonesia, East Timor's traditional market.19

23. At the Lisbon meeting, donor pledges to the UN Trust Fund totaled $43 million. The administration of the UN Trust Fund was transferred to the CFA in October 2000, at which time contributions to the fund totaled $40.6 million. However, a full accounting of the Trust Fund remains to be received from the UN trustees in New York. Donors are currently committed to make further contributions for a cumulative total of $55.4 million by the end of FY00/01.

24. Donors also pledged $166 million to the Trust Fund for East Timor (TFET). The level of project spending commitments for FY00/01 is fully funded. However, commitments by the end of FY02/03 are projected to reach $218 million, which given the expected level of donor contributions of about $172 million, would leave TFET with unmet financing needs of about $46 million.

25. Bilateral donors were expected to pledge $149 million for the three year period ending in FY02/03 to fund capital expenditure needs identified in May 2000 by UNTAET and the NCC in May, 2000 with the cooperation of the World Bank. A recent review of bilateral donors spending commitments has served to confirm bilaterals' commitments for about $173 million through to end-FY02/03 and $191 million through to end-FY03/04. However, the Donor Coordinating Unit of the National Planning and Development Agency (DCU/NPDA) needs to clarify whether these spending commitments match the amounts and types of needs identified by the NCC. As a result, it is not possible yet to determine whether or not the capital expenditure needs identified by the NCC are fully funded. Moreover, many projects to be funded by bilateral sources are of a quasi-fiscal nature and have longer-term fiscal implications which need to be evaluated. This evaluation has not been done in a number of cases and needs to be pursued. In future, it will be important that the signing of bilateral agreements be preceded by a careful evaluation of its medium term fiscal implications. To this end, a clear line of authority for signing bilateral agreements must be established and a formal institutional process developed.

VIII. International Negotiations

26. Discussions with Indonesia have continued on a wide range of issues. Discussions have proceeded slowly on the settlement of financial claims and liabilities of the banking sector, on ensuring a transit corridor between Oecussi and the main territory of East Timor, and on maintaining educational opportunities for East Timorese in Indonesia. Negotiations on the delineation of land and maritime borders have been more successful and a Joint Border Committee has been established. In addition, some progress has been made on rebuilding East Timor's archives and records, including restoring information on land and property. Progress also has been made on the regularization of payment of state pensions to retired East Timorese public employees. UNTAET officials expect a lump sum transfer of about $2.5 million in December 2000, covering pensions that should have been paid since August 1999, as well as benefits under the Indonesian housing saving scheme. Payments will be made in U.S. dollars and are expected to continue until independence. The payment of pensions after independence is a matter for future negotiations. Although residual pension obligations owed to former civil servants are likely to be sizeable (at least $20 million), no understanding has been reached on the amount to be paid and on the modalities for the payment of these benefits.

27. Formal negotiations between East Timor, represented by UNTAET, and Australia on the Timor Gap have been initiated. The first round of negotiations took place in early October and focused on the tax regime and product sharing agreements. The calendar for future discussions has not been decided.

IX. Economic Institutions and Regulatory Framework

28. Work to establish the institutional and regulatory framework in the financial sector has progressed on schedule. The CFA and the CPO are close to being fully operational. Regulations for a budget and taxation framework were adopted, allowing the budget to be developed and executed in an accountable and transparent manner, and empowering the East Timor Revenue Service (ETRS) to collect taxes and fees. In addition, the treasury has made significant progress in completing the first stage of computerizing budget execution, which should facilitate the monitoring and control of cash and commitment expenditures. With respect to the CPO, a prudential regulatory framework for the banking system is being finalized, based on the Basel Core Principles. Instructions on bank licensing, capital requirements and liquidity have recently been adopted. Additional instructions are expected to be approved before the end of the year, including instructions on qualifications of administrators, large credit exposures, credit to employees of banks, on bank reporting and publication of balance sheets, on audits and publication of auditor's opinion and annual report, and on transactions with related persons, related banks and financial institutions and affiliates. Credit unions and several microfinance institutions that are accepting deposits will be allowed to operate under the current banking regulation. A specific regulation for non-bank financial institutions is under preparation, but is not expected to be ready for approval until early next year. Although there were delays in filling international staff positions for the CFA and the CPO early in the year, key managerial positions are now filled, but the process of building up East Timorese managerial capacity has been slow. Eighty East Timorese staff are being trained to fill positions in the CFA and 14 to fill positions in the CPO (with 23 more to be hired soon).

29. The financial autonomy of the CPO is a matter that needs to be addressed in the near term. The CPO is dependent on budget resources to carry out its operations. While these resources appear to be consistent with the CPO's role of fiscal agent (including carrying out some functions typically done by a Treasury Department), serious thought should be given to making available funds to permit it to develop the payments system, regulate and supervise the financial system, and address unanticipated problems which may put at risk the credibility and stability of the payments and banking system. Because CPO's financial autonomy is a key step towards the development of an independent central bank, options to provide such autonomy should start to be explored as soon as possible, in case the East Timorese government decides to create a central bank after independence.

30. The rationalization of Economic Institutions requires urgent attention. The recent creation of a National Planning and Development Agency has raised concerns of duplication in regard to the economic analysis and policy advice functions of existing agencies such as CFA and CPO, as well as the Department of Economic Affairs. In a severely human-resource-constrained situation such as that of East Timor, it is crucial that each institution's role be clearly defined, so as to avoid costly duplication of services.

X. Technical Assistance

31. The requirements for technical assistance and training in the macroeconomic management area are expected to remain high in the foreseeable future. Coordinated assistance between the World Bank and the IMF in the area of statistics is expected to begin shortly. Training in basic macroeconomic policy and analysis will intensify, and the first course especially designed for 12 Timorese civil servants will be delivered by the IMF Institute in January 2001 at the IMF-Singapore Regional Training Institute. IMF technical assistance by FAD and MAE to the CFA and the CPO, respectively, will also continue, including advice on taxation of oil and gas (starting in early December 2000) and further training of CFA and CPO officials. The World Bank's Economic Institutions Capacity Building project will provide training and skills development in economic management and will generate a baseline set of macroeconomic aggregates. This project also will provide assistance in setting up an integrated accounting system which will help with budget management. The needs for technical assistance on macroeconomic management, policy design and analysis, and the creation of economic databases are very large so additional efforts at meeting these needs will be also coordinated with the AsDB and other bilateral providers of technical assistance.

1This report was prepared by an IMF mission (in close collaboration with World Bank staff) that visited Dili from October 31 to November 14, 2000. The IMF staff team comprised Messrs. Valdivieso (head), and Lopez-Mejia (both APD), Schimmelpfenning (FAD), Staines (PDR), and Ms. Otswald (Administrative Consultant). The mission was assisted by Mr. van Houten, the Fund's Senior Resident Representative. Messrs. Braz, Chand, Dhar, and Talati participated in the mission on behalf of the World Bank.
2The staff of the IMF and the World Bank met with a wide range of individuals and organizations that provided useful insights about recent economic developments activity. An evaluation of the information obtained has led the mission to believe that real GDP in 1999 may have declined by less than previously estimated. Although the projected 15 percent rate of GDP growth still seems reasonable, the projected level of GDP for 2000 may therefore turn out to be somewhat conservative. Instead of attempting to modify the GDP estimates, the mission decided that a revised set of figures should be adopted in the context of the forthcoming program of technical assistance on statistics to be jointly developed by the World Bank and the IMF.
3For a detailed analysis see, Foreign Investment Advisory Service, A Review of the Impediments to the Generation and Implementation of FDI in East Timor, International Finance Corporation, and the World Bank.
4For an assessment of crop and food supplies in East Timor during 2000, see United Nations, Food and Agriculture Organization, and World Food Program, special report: East Timor, April 19, 2000.
5This issue is under review, as there are questions about the accuracy of the registration records.
6The fiscal year in East Timor runs from July 1 to June 30.
7International Monetary Fund, East Timor: Establishing the Foundations of Sound Macroeconomic Management, Washington, D.C., 2000.
8The current remuneration structure presents other problems as well. By establishing a lower limit that is in excess of regional market levels, some potential private sector activity (and employment) will be not be viable. At the upper end of the pay scale, wage compression interferes with the establishment of appropriate incentives.
9The discussions on whether or not UN locally hired employees will be subject to the wage withholding tax as well as the precise definition of the UN imports to be exempted from customs duty have been particularly protracted. It is not clear what will be the breath of exemptions from the wage withholding tax that will be included in the final version of the regulations.
10The CFA is focusing on these issues with a view to shorten the lag between commitments and cash payments.
11Of this number, about 700 represent an acceleration of hiring already planned for the subsequent two fiscal years.
12The expenditures funded by the UNTAET's assessed contributions budget that have been included in the combined sources budget relate to rebuilding of roads and next years' elections cost; they exclude expenditures related to peacekeeping operations and administration and humanitarian assistance.
13For further reference see background document CFA, "Combined Sources Budget", Dili, East Timor, November 2000.
14It is likely that TFET cash outlays will be somewhat smaller than the accounts committed reflecting the lag between commitments and cash payments; it should be noted, however, that this lag has shortened in recent months.
15Based on an incomplete set of data, the deposit liabilities of Indonesian banks previously operating in East Timor to East Timor residents appear to have declined sharply from Rp 450 billion at end September 1999 to about Rp 120 billion at end July 2000.
16An amount of $1.2 million in TFET funds has been deposited with BNU, the on-lending agency.
17Few observations available in the exchange rate between the rupiah and the U.S. dollar in Kupang, West Timor, suggests that the differential between the mid point exchange rate in that market and the mid point exchange rate in Dili would be very small and relatively stable. The CPO has initiated contacts with the Bank Indonesia branch in West Timor to obtain a regular reporting of the exchange rates in Kupang, but the information has not been made available yet.
18Data from the Dili Port Authority indicates that coffee shipments for the first ten months of 2000 have been about 1.6 thousand tons valued at about $2.7 million. There is also anecdotal evidence that significant shipments may have gone unrecorded. Discussions with the National Cooperative Business Association (NCBA) representatives in Dili indicated that NCBA shipments alone were 1.2 thousand tons. Production estimates for 2000 vary considerably, ranging from 2.5 to 8.0 thousand tons. For an overview of the coffee industry in East Timor, see: J. Pomeroy, "Coffee and the Economy of East Timor," draft mimeo, the World Bank, May 2000, and M. Moreno, "The East Timor Coffee Industry Overview," UNTAET, draft mimeo, August 2000.
19Key Indonesian traders and segments of the community of small traders-who traditionally bought an important part of the crop-remain absent from the market. See Pomeroy, J., op.cit.


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