IMF Executive Board Concludes 2009 Article IV Consultation with the Democratic Republic of Timor-Leste

Public Information Notice (PIN) No. 09/88
July 24, 2009

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2009 Article IV Consultation with Timor-Leste is also available.

On July 22, 2009, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Democratic Republic of Timor-Leste.1

Background

The Timorese economy has posted high economic growth over the past two years, driven by rapid increases in government spending and a recovery in agriculture from a 2007 drought, and underpinned by improved security conditions. Non-oil real GDP growth reached almost 13 percent in 2008. However, private investment remains small, and Timor-Leste is still among the least developed countries in the world. The global crisis has had little immediate impact on Timor-Leste, as key transmission channels (trade, investment and finance) remain limited. The key adverse impact has been through lower oil prices, which if persistent would reduce the sustainable level of public spending. Inflation peaked at over 10 percent year-on-year in mid-2008, but has since declined significantly, along with international food prices. The real exchange rate appreciated, reflecting a weakening of the Indonesian and Australian currencies vis-à-vis the U.S. dollar, and helped reduce inflationary pressures.

Central government spending rose sharply in 2008, reflecting efforts to address pressing development needs and secure social cohesion. Increases in capital spending, current transfers, and rice subsidies were particularly large. However, petroleum revenue soared on the back of high oil/gas prices and an increase in production volumes, leading to an expansion of the fiscal and external surpluses.

The commercial banking sector, consisting of three foreign bank branches, remains very small, and has not been adversely affected by the global financial crisis. Credit has remained stagnant, hampered by a high share of non-performing loans and the lack of effective contract enforcement. Only a small, state-owned microfinance institution has experienced significant credit growth.

The near-term outlook is still positive, with real non-oil GDP growth expected to moderate somewhat but remain at high levels. However, oil prices are expected to remain below their 2008 average, prompting a sharp decline in the fiscal and external surpluses. The medium-term outlook is highly uncertain. Key but hard-to-predict determinants include the path of oil and gas revenue, security conditions, the magnitude and quality of public spending, and progress on reforms to improve the business climate.

Executive Board Assessment

Executive Directors welcomed Timor-Leste’s strong economic growth over the last two years, supported by public spending and improved security, and noted that the global crisis has not had a major impact on the economy given the limited external linkages. Going forward, the key challenge remains to use oil and gas revenue to develop a sustainable non-oil economy and alleviate poverty, while maintaining macroeconomic stability.

Directors welcomed the recently announced moderation in government spending and recommended that expenditure be brought in line with sustainable income as soon as existing commitments allow. They looked forward to the forthcoming Strategic Development Plan, which should provide guidance for a medium-term budget framework aimed at ensuring fiscal sustainability, improving the quality of government spending and public financial management, and strengthening transparency and controls. Directors noted that spending should be carefully prioritized so as to create room for essential infrastructure, health and education expenditure, and better-targeted poverty-reducing transfers. They saw scope to enhance fiscal revenue by improving tax administration, broadening the tax base, and charging appropriate tariffs for utilities, including electricity.

Directors believed that the Petroleum Fund should remain the cornerstone of the country’s public financial management. By insulating the budget from petroleum revenue volatility and setting high standards for transparency, they viewed the Petroleum Fund as safeguarding fiscal sustainability and promoting macroeconomic stability. Directors supported a prudent approach toward widening the fund’s investment portfolio. They recommended that any foreign borrowing be subject to parliamentary approval and proper justification, be on concessional terms, and deliver a net positive rate of return.

Directors noted that official dollarization has served the country well and has provided a strong nominal anchor for inflation expectations. They observed that fiscal policy needs to be consistent with the exchange rate regime to ensure external sustainability and reduce pressures on the real exchange rate. To boost competitiveness, productivity should be enhanced and business climate reforms introduced. Directors recommended passage of the pending land law, strengthening of contract enforcement through judicial reform and adoption of alternative dispute resolution mechanisms, and introduction of eased business regulation, including by simplifying registration and licensing procedures.

While banks have not been adversely affected by the global financial turmoil, Directors welcomed continued efforts to strengthen financial sector supervision and promote financial development. They noted that clearly defined property rights and contract enforcement are needed for financial deepening. Directors underlined the importance of strengthening cooperation with home supervisors of foreign banks and passing legislation to safeguard the Banking and Payment Authority’s autonomy.

Directors commended the progress made on the compilation of financial and balance of payments statistics. They encouraged improved monitoring of real sector activity through annual surveys and the compilation of national accounts.


Democratic Republic of Timor-Leste: Selected Economic Indicators, 2004-2010

 
  2004 2005 2006 2007 2008 2009 2010
            Proj. Proj.
 

Output and prices

             

GNI at current prices (US$ million)

460 695 972 1,728 2,915 2,198 2,312

Non-oil GDP at current prices (US$ million)

309 332 327 398 499 590 659

Real non-oil GDP growth (percentage change)

4.2 6.2 -5.8 8.4 12.8 7.4 7.5

Including United Nations 1/

0.4 2.3 -3.4 16.8 12.2 8.0 2.0

Inflation (CPI, percentage change, end-period)

2.5 1.0 6.7 7.6 6.1 2.3 4.0

Inflation (CPI, percentage change, period average)

3.2 1.8 4.1 8.9 7.6 1.3 4.0
  (In percent of non-oil GDP)

Investment-saving balance

             

Gross investment 2/

21 21 23 26 46 51 54

Gross national savings

42 99 188 322 451 242 225

External savings

-21 -78 -165 -296 -405 -191 -171

Central government finances

   

Revenues

67 128 205 343 490 279 257

Domestic revenues

10 11 10 11 9 10 9

Petroleum revenue

46 107 195 330 481 269 248

Grants

11 10 0 3 0 0 0

Expenditure (cash basis)

20 26 32 59 106 101 94

Recurrent expenditure

17 19 27 46 70 63 53

Capital expenditure

3 7 5 13 36 38 41

Overall balance

46 102 174 284 384 178 162

Non-oil fiscal balance

1 -5 -21 -46 -97 -91 -85

Combined sources fiscal operations 3/

             

Domestic revenue and budget grants

23 24 13 15 11 12 11

Expenditure

66 67 73 88 144 136 126

Recurrent expenditure

50 47 55 66 103 92 80

Capital expenditure

17 20 18 22 41 44 47

Overall balance

-43 -43 -60 -73 -134 -125 -115

Money and credit

             

Broad money (end-period) 4/

21 23 31 36 39

Net domestic assets (end-period)

-38 -24 -3 -43 -37
  (In millions of U.S. dollars)

External sector

             

Current account

64 260 540 1,177 2,021 1,127 1,127

Merchandise exports 2/

8 8 9 7 14 10 13

Merchandise imports

122 112 101 176 353 440 469
  (In percent of non-oil GDP)

Current account

21 78 165 296 405 191 171

Merchandise exports 2/

3 2 3 2 3 2 2

Merchandise imports

40 34 31 44 71 75 71

Memorandum item:

             

Petroleum Fund balance (percent of non-oil GDP) 5/

5 112 310 525 841 866 940
 

Sources: Data provided by the Timor-Leste authorities; and IMFaff estimates.
1/ Includes locally paid compensation of UN peacekeeping mission staff.
2/ Excludes oil/gas sector.
3/ Includes autonomous agencies and quasi-fiscal expenditure by donors outside the central government budget. The revenue decline in 2005 reflects the creation of the Petroleum Fund to which all oil revenue now accrues. Income from the fund and donor assistance finances the deficit.
4/ Excludes currency holdings by the public, for which no data are available.
5/ End-period. Figure for 2004 refers to the Timor-Sea account, which preceded the August 2005 establishment of the Petroleum Fund.


1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.



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