## 1tlsea2019001

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---

### Recent developments and inflation
- Inflation:
  - Annual average CPI: 0.8 percent (2017).
  - CPI (end-period) rose to 2.1 percent (end-2018), largely due to higher prices of rice and tobacco and an increase in education fees.
  - Government’s desired medium target for inflation is 4 percent.
- Political and spending context:
  - Political uncertainty in 2017–18 compressed public spending and halted key economic reforms; snap elections in May 2018 ended the impasse.
  - Public expenditures fell by over one third in 2017; capital spending contracted by close to 60 percent.
  - Public spending picked up in Q4 2018 following budget approvals.

### Fiscal developments and Petroleum Fund (PF)
- Fiscal outcomes and PF balance:
  - Overall fiscal deficit improved to 19 percent of GDP in 2017 from 35 percent in 2016, and is expected to further improve in 2018.
  - Excess withdrawals from the Petroleum Fund fell significantly in 2017.
  - PF balance increased in 2017 for the first time since 2014 as petroleum revenue and investment returns exceeded total withdrawals.
  - Tighter global financial market conditions at the end of 2018 caused the PF balance to fall to US$16 billion.
- Fiscal sector statistics (selected):
  - Revenue (percent of non-oil GDP): 64.1 (2015), 54.2 (2016), 49.3 (2017), 49.7 (2018), 40.9 (2019).
  - Domestic revenue (percent of non-oil GDP): 10.6 (2015), 11.6 (2016), 11.3 (2017), 10.4 (2018), 9.8 (2019).
  - Expenditure (percent of non-oil GDP): 96.9 (2015), 106.4 (2016), 79.3 (2017), 78.5 (2018), 75.1 (2019).
  - Net lending/borrowing (percent of non-oil GDP): -32.8 (2015), -52.2 (2016), -30.0 (2017), -28.7 (2018), -34.3 (2019).
  - Petroleum Fund balance (closing, in millions of U.S. dollars): 16,218 (2015), 15,844 (2016), 16,799 (2017), 15,803 (2018), 15,588 (2019).

### External sector and current account
- Current account developments:
  - Current account deficit nearly halved to 10 percent of GDP in 2017 compared to 2016.
  - Current account balance (in millions of U.S. dollars): 204 (2015), -544 (2016), -284 (2017), -279 (2018), 56 (2019).
  - Current account balance (percent of GDP): 6.6 (2015), -21.6 (2016), -10.2 (2017), -9.0 (2018), 1.8 (2019).
  - Current account is expected to remain broadly unchanged in 2018.
- Trade and external flows (selected):
  - Trade balance (in millions of U.S. dollars): -635 (2015), -546 (2016), -615 (2017), -626 (2018), -652 (2019).
  - Exports (excluding petroleum, in millions): 18 (2015), 20 (2016), 17 (2017), 22 (2018), 26 (2019).
  - Imports (in millions): 653 (2015), 567 (2016), 631 (2017), 648 (2018), 678 (2019).
  - Petroleum revenue (in millions of U.S. dollars): 1,281 (2015), 872 (2016), 2,034 (2017), 672 (2018), 899 (2019).
- Exchange rate and competitiveness:
  - Real effective exchange rate depreciated in 2017 and appreciated in 2018 on the back of higher domestic inflation and a stronger US dollar.

### Financial sector and credit
- Credit and banking:
  - Credit growth slowed significantly in 2018 after rising sharply in 2017.
  - Non-performing loans (NPLs) reached an all-time low in early 2018 due to legacy NPL resolution, but started to rise in mid-2018 as firms faced delays in receiving government payments.
  - Ratio of credit-to-non-oil GDP estimated at 13 percent in 2018.
- Money and credit (selected figures):
  - Deposits (annual percent change): 76.7 (2015), 11.9 (2016), 36.1 (2017), 41.5 (2018), 29.8 (2019).
  - Credit to the private sector (annual percent change): 10.5 (2015), -1.8 (2016), 24.8 (2017), -3.8 (2018), 13.0 (2019).
  - Lending interest rate (percent, end-period): 13.5 (2016), 14.0 (2017), 13.3 (2018), 13.5 (2019).
- Financial soundness indicators (selected, in percent or millions of U.S. dollars):
  - Capital adequacy ratio (BNCTL): Dec-15 42.4; Dec-16 32.9; Dec-17 32.9; Dec-18 27.7
  - Non-performing loans to total gross loans: Dec-15 23.0; Dec-16 15.3; Dec-17 13.5; Dec-18 5.6
  - Provision for loan losses to total gross loans: Dec-15 29.8; Dec-16 21.9; Dec-17 16.7; Dec-18 8.1
  - Return on assets: Dec-15 0.7; Dec-16 1.0; Dec-17 1.4; Dec-18 1.1
  - Liquid assets to total assets: Dec-15 83.6; Dec-16 84.5; Dec-17 80.5; Dec-18 80.5
  - Total assets (memorandum, in millions of U.S. dollars): 928; 1,149; 1,170; 1,240
  - Total loans (memorandum, in millions of U.S. dollars): 191; 183; 227; 222

### Growth outlook and projections
- Real GDP and sectoral growth (annual percent change):
  - Real total GDP: 20.9 (2015), 0.8 (2016), -4.5 (2017), -8.0 (2018), 6.6 (2019), 1.3 (2020), -12.3 (2021), -19.2 (2022), -2.0 (2023), 4.8 (2024).
  - Real oil GDP: 46.5 (2015), -4.0 (2016), -4.4 (2017), -18.3 (2018), 9.0 (2019), -3.7 (2020), -38.3 (2021), -81.3 (2022), -100.0 (2023).
  - Real non-oil GDP: 4.0 (2015), 5.3 (2016), -4.6 (2017), 0.8 (2018), 5.0 (2019), 4.8 (2020–2024 each).
- Key projection notes:
  - Non-oil GDP growth expected to rebound to 5 percent in 2019 as public spending recovers.
  - Planned increase in petroleum production in 2019 causes an increase in overall GDP growth in 2019.
  - Petroleum-sector value added expected to continue declining until production ends in 2022, resulting in a sharp overall GDP contraction in 2023.
  - Inflation expected to rise, reaching 4 percent over the medium term.
  - Excess PF withdrawals will continue to finance fiscal deficits; the current account will be largely driven by fluctuations in investment income from the PF.

### Petroleum sector, maritime treaty, and fiscal implications
- Maritime boundary treaty with Australia signed on March 6, 2018, includes framework for joint development of the Greater Sunrise fields.
- Government set to finalize acquisitions of shares from two joint venture partners for a total of US$650 million to secure downstream development.
- Petroleum production from active fields is shrinking and will end in 2022.
- Given uncertainties, revenues from the Greater Sunrise oil/gas fields are not reflected in staff’s projections of the wealth of the PF, or in macroeconomic projections.

### Scenario analysis: PF and sustainable income (selected staff calculations)
- Impact from a Permanent 50 Percent Decline in WEO Oil Price Projections starting in 2019 (In millions of USD):
  - Baseline PF balances by year: 2018 15,803; 2019 15,338; 2020 15,001; 2021 14,697; 2022 14,141; 2023 13,737.
  - Low oil price scenario PF balances by year: 2018 15,803; 2019 15,310; 2020 14,924; 2021 14,553; 2022 13,955; 2023 13,543.
  - Baseline Estimated Sustainable Income by year: 2018 550; 2019 507; 2020 491; 2021 479; 2022 468; 2023 449.
  - Low oil price scenario Estimated Sustainable Income by year: 2018 550; 2019 499; 2020 483; 2021 471; 2022 460; 2023 443.
  - Loss of revenue entries (as presented): -78, 78, 7, 87.
  - Decline in PF balance (years shown, as presented): 29; 77; 143; 186; 194.

### Debt sustainability analysis (DSA): assumptions, scenarios, and results
- Macroeconomic and fiscal assumptions underpinning the DSA:
  - Political impasse beginning mid-2017 led to under-execution of capital spending in 2017 and contraction of real GDP in 2017.
  - Political uncertainty faded in mid-2018; growth expected to rebound in 2018 to 0.8 percent.
  - Oil production from active fields projected to cease in 2022.
  - Inflation expected to increase steadily to about 4 percent over the medium-term.
  - Primary fiscal balance projected to remain in deficit of about 13 percent of GDP in 2018 and narrow gradually to about 11 percent on average over the long-term (2028-2038).
  - External financing consists of concessional loans; private external borrowing assumed negligible.
- Baseline vs Reform scenarios (selected fiscal indicators, in percent of GDP or levels):
  - Total revenue (selected): 2017 30.7; 2018 30.0; 2020-23 24.0; 2024-38 16.6; 2020-23 (reform) 26.0; 2024-38 (reform) 22.5.
  - Domestic revenue: 2017 7.0; 2018 6.3; 2020-23 6.8; 2024-38 10.4; 2020-23 (reform) 8.7; 2024-38 (reform) 15.1.
  - VAT (as percent of GDP): projected 0.0 in 2017-2019; 1.9 in 2020-23 (reform); 4.7 in 2024-38 (reform).
  - Estimated Sustainable Income: 2017 17.3; 2018 17.8; 2020-23 13.6; 2024-38 4.3; 2020-23 (reform) 13.7; 2024-38 (reform) 5.5.
  - Petroleum Fund balance (in millions of US dollars): 2017 16,799; 2018 15,803; 2020-23 14,567; 2024-38 8,116; 2020-23 (reform) 14,724; 2024-38 (reform) 13,269.
- Projected medium-term fiscal funding gaps (Table 3, in millions of US Dollars):
  - Baseline funding gap (period averages): 2018 = 493.7; 2019 = 1,344.1; 2020 = 982.7; 2020-2027 = 839.9; 2028-2038 = 1,199.6.
  - Reform funding gap (period averages): 2018 = 493.7; 2019 = 1,344.1; 2020 = 982.7; 2020-2027 = 715.0; 2028-2038 = 805.6.
  - Components (excess PF withdrawal and borrowing) detailed year-by-year in source tables.
- DSA judgment:
  - Mechanical DSA rating: “moderate” debt distress risk.
  - Final judgment rating: upgraded to “low” debt distress risk based on large, liquid, and accessible PF assets (Petroleum Fund assets estimated at 848 percent of total non-oil GDP in 2018) and less front-loading of public spending in the 2019 budget.
  - PV of PPG debt-to-GDP ratio projected to increase from 4.3 percent in 2018 to 8.8 percent in 2025, then decline to 4.6 percent by 2038 under baseline.

### Medium- and long-term risks and structural challenges
- Main risks:
  - Insufficient progress on fiscal and structural reforms would increase reliance on the public sector; hinder private sector job creation; put added pressure on public finances and risk long-run fiscal sustainability; deteriorate labor market outcomes.
  - Development of the Greater Sunrise fields is a significant upside risk conditional on technical and economic viability and proper safeguards to minimize funding risks.
- Near-term risks:
  - Elevated political risk could delay reform implementation and adversely affect public spending.
  - Inflationary pressure from sharp import price rises.
  - Equity price volatility and rising U.S. interest rates could affect the PF balance and associated income flows.
- Structural challenges:
  - Achieving greater economic diversification is the key challenge.
  - Need to reduce reliance on public-sector employment and generate more private-sector jobs.

### Labor market and growth scenario analysis
- Baseline and reform scenario projections for non-oil growth and labor market reforms:
  - Baseline: non-oil economy will grow at around 4.8 percent (annual real non-oil GDP growth).
  - Scenario: raising youth labor participation rate from 22 to 45 percent (gradually) → non-oil GDP growth would increase to about 5.7 percent by 2030.
  - Scenario: increasing labor productivity from 2 to 4 percent → annual real non-oil GDP growth would increase to about 7.5 percent by 2030.
  - Combined scenario: more job opportunity for youth and higher productivity yields higher growth (table excerpt reproduced in source).
- Table excerpt (Assumption (in 2030) / Projection — Annual growth rate (%)):
  - Baseline Scenario: Youth labor participation 14.2 21.9 2.0 → 4.9 4.8
  - More job opportunity for youth: 45.8 13.7 2.0 → 5.6 5.7
  - Higher productivity: 14.2 21.9 3.7 → 6.1 6.5
  - More job opportunity for youth and higher productivity: 45.8 13.7 3.7 → 6.7 7.5
- Labor market reform priorities:
  - Improve basic education outcomes; expand pre-school enrollment; improve infrastructure and teacher competence; strengthen governance of the education system.
  - Increase female labor force participation and job opportunities; improve female educational attainment; promote access to the formal sector; ensure access to social protection.
  - Address skilled labor shortages via TVET expansion and alignment with private sector demand.
  - Strengthen enforcement of labor regulations and review minimum wage policy.

### Policy recommendations (Executive Directors and staff)
- Fiscal policy:
  - Adopt a credible fiscal strategy to improve expenditure control and efficiency, mobilize domestic revenue, and commit to protecting Petroleum Fund assets.
  - Strengthen public financial management and promote good governance to ensure public investment efficiency and enhance quality of public services.
  - Introduce a value-added tax (VAT) by 2022 (reform scenario assumptions: VAT generating about 3¾ percent of GDP based on a VAT rate of 10 percent in the medium term; VAT increases to at least 5 percent of GDP in the long term).
  - Make effective use of concessional borrowing and commit to the ESI rule within a reasonable timeframe; staff recommends ending excess PF withdrawals by 2028 under reform scenario.
- Structural reforms to support diversification and jobs:
  - Increase labor productivity and enable diversification to generate jobs and private investment.
  - Improve quality of and access to education and healthcare, reduce skill gaps, encourage business formation, and promote private investment.
  - Address gender and rural-urban inequalities.
- Financial sector development:
  - Continue developing the financial sector to channel domestic savings to productive investments and expand access to financial services.
  - Ensure a strong and effective regulatory and supervisory framework as the financial sector develops.
  - Leverage the new Land Law and development of a secured transaction framework for movable property to improve financial intermediation.
- Capacity building and statistics:
  - Address capacity gaps in fiscal management, financial regulation and supervision, and statistics.
  - Continue to leverage technical assistance from the IMF, PFTAC, and other development partners; complete PEFA and implement a government-led, donor-partnered PFM reform strategy.
- Additional notes:
  - Directors agreed the use of the U.S. dollar as legal tender has served Timor-Leste well and emphasized maintaining low inflation and boosting labor productivity to increase international competitiveness.
  - Staff recommended next Article IV consultation on the standard 12-month cycle.

### Business environment and financial inclusion
- Business environment progress and planned reforms:
  - Authorities plan to increase the number of centers for business registration and licensing in rural areas.
  - Insolvency and Bankruptcy Law under consideration; a new Private Investment Law expected to help generate business formation and encourage investment.
  - Staff: business licensing processes and regulations need better coordination and harmonization; legal framework for property rights and contract enforcement should be strengthened.
- Payments system and financial inclusion:
  - BCTL developed a National Financial Inclusion Strategy (NFIS) 2017-22.
  - Important progress: establishment of R-TIMOR and launch of the National Switch in December 2018.
  - BCTL working with Ministry of Education to implement financial literacy programs in elementary schools.

### Petroleum Fund governance and transparency (Annex I)
- Governance structure and roles:
  - PF established in 2005; MoF responsible for overall management and sets investment policy; BCTL appointed by MoF as operational manager and holds the account.
  - MoF required to seek advice from and consult with the Investment Advisory Board (IAB) before decisions on investment strategy or management.
- Transparency and reporting:
  - MoF prepares the Petroleum Fund’s Annual Report and financial statements and the General State Budget statement including ESI calculations.
  - BCTL provides quarterly reports to the Minister of Finance; an internationally recognized external auditor issues and publishes an audit report on annual financial statements.
- Compliance with international frameworks:
  - 2018 EITI report assesses PF management as satisfactory.
  - PF is an active member of IFSWF and conducted a seventh annual self-assessment of adherence with the Santiago Principles as of 2018.
- PF metrics (selected):
  - PF balance at end-2018: US$15.8 billion (506 percent of total GDP and 848 percent of total non-oil GDP).
  - PF covers more than 166 months of goods and services imports.
  - Targeted asset allocation: 60 percent in Treasury Bonds of developed countries and 40 percent in developed market equities.
  - Average return on PF assets since inception: around 4.4 percent (as of end-2017).
  - Staff assumption for PF return when projecting the PF balance: 3.9 percent.
  - ESI set at 3 percent of total Petroleum Wealth.
  - Total withdrawals over the lifetime of the PF amounted to $9.6 billion (end-2017); excess withdrawals account for about 63 percent of total withdrawals to end-2017.

### Capacity building, statistics, and TA
- Identified needs:
  - Shorten lags in disseminating GDP data; remove inconsistencies between national accounts and balance of payments; address weaknesses in compilation and dissemination of government financial statistics.
  - Improve coverage and timeliness of monetary, financial, and external sector statistics.
- Technical assistance:
  - IMF/PFTAC committed to provide capacity building assistance in close collaboration with development partners.
  - STA/PFTAC/CDOT providing TA on GFS, national accounts, and external sector statistics.
  - Timor-Leste fully implemented e-GDDS by publishing the National Summary Data Page on February 15, 2019.
- PFM reform:
  - PEFA exercise ongoing (to be completed in first half of 2019) to feed into a consolidated government-led PFM reform strategy.

*Source: IMF staff report content provided in the supplied PDF chapter.*

### 0.8 percent (y/y), but rebounded to 2.1 percent (y/y) on the back of higher prices of rice and

### 1tlsea2019001 - 0.8 percent (y/y), but rebounded to 2.1 percent (y/y) on the back of higher prices of rice and

### Recent developments and inflation
- Inflation:
  - Annual average CPI: 0.8 percent (2017).
  - CPI (end-period) rose to 2.1 percent (end-2018), largely due to higher prices of rice and tobacco and an increase in education fees.
  - Government’s desired medium target for inflation is 4 percent.
- Political and spending context:
  - Political uncertainty in 2017–18 compressed public spending and halted key economic reforms; snap elections in May 2018 ended the impasse.
  - Public expenditures fell by over one third in 2017; capital spending contracted by close to 60 percent.
  - Public spending picked up in Q4 2018 following budget approvals.

### Fiscal developments and Petroleum Fund (PF)
- Fiscal outcomes:
  - Overall fiscal deficit improved to 19 percent of GDP in 2017 from 35 percent in 2016, and is expected to further improve in 2018.
  - Excess withdrawals from the Petroleum Fund fell significantly in 2017.
- Petroleum Fund balance:
  - PF balance increased in 2017 for the first time since 2014 as petroleum revenue and investment returns exceeded total withdrawals.
  - Tighter global financial market conditions at the end of 2018 caused the PF balance to fall to US$16 billion.
- Fiscal sector statistics (selected, as reported in table):
  - Revenue (percent of non-oil GDP): 64.1 (2015), 54.2 (2016), 49.3 (2017), 49.7 (2018), 40.9 (2019).
  - Domestic revenue (percent of non-oil GDP): 10.6 (2015), 11.6 (2016), 11.3 (2017), 10.4 (2018), 9.8 (2019).
  - Expenditure (percent of non-oil GDP): 96.9 (2015), 106.4 (2016), 79.3 (2017), 78.5 (2018), 75.1 (2019).
  - Net lending/borrowing (percent of non-oil GDP): -32.8 (2015), -52.2 (2016), -30.0 (2017), -28.7 (2018), -34.3 (2019).
  - Petroleum Fund balance (closing, in millions of U.S. dollars): 16,218 (2015), 15,844 (2016), 16,799 (2017), 15,803 (2018), 15,588 (2019).

### External sector and current account
- Current account:
  - Current account deficit nearly halved to 10 percent of GDP in 2017 compared to 2016.
  - Current account balance (in millions of U.S. dollars): 204 (2015), -544 (2016), -284 (2017), -279 (2018), 56 (2019).
  - Current account balance (percent of GDP): 6.6 (2015), -21.6 (2016), -10.2 (2017), -9.0 (2018), 1.8 (2019).
  - Current account is expected to remain broadly unchanged in 2018.
- Trade and external flows (selected):
  - Trade balance (in millions of U.S. dollars): -635 (2015), -546 (2016), -615 (2017), -626 (2018), -652 (2019).
  - Exports (excluding petroleum, in millions): 18 (2015), 20 (2016), 17 (2017), 22 (2018), 26 (2019).
  - Imports (in millions): 653 (2015), 567 (2016), 631 (2017), 648 (2018), 678 (2019).
  - Petroleum revenue (in millions of U.S. dollars): 1,281 (2015), 872 (2016), 2,034 (2017), 672 (2018), 899 (2019).
- Exchange rate and competitiveness:
  - Real effective exchange rate depreciated in 2017 and appreciated in 2018 on the back of higher domestic inflation and a stronger US dollar.

### Financial sector and credit
- Credit and banking:
  - Credit growth slowed significantly in 2018 after rising sharply in 2017.
  - Non-performing loans (NPLs) reached an all-time low in early 2018 due to legacy NPL resolution, but started to rise in mid-2018 as firms faced delays in receiving government payments.
  - Ratio of credit-to-non-oil GDP estimated at 13 percent in 2018.
- Money and credit (selected figures):
  - Deposits (annual percent change): 76.7 (2015), 11.9 (2016), 36.1 (2017), 41.5 (2018), 29.8 (2019).
  - Credit to the private sector (annual percent change): 10.5 (2015), -1.8 (2016), 24.8 (2017), -3.8 (2018), 13.0 (2019).
  - Lending interest rate (percent, end-period): 13.5 (2016), 14.0 (2017), 13.3 (2018), 13.5 (2019).

### Growth outlook and projections
- Real GDP and sectoral growth (annual percent change):
  - Real total GDP: 20.9 (2015), 0.8 (2016), -4.5 (2017), -8.0 (2018), 6.6 (2019), 1.3 (2020), -12.3 (2021), -19.2 (2022), -2.0 (2023), 4.8 (2024).
  - Real oil GDP: 46.5 (2015), -4.0 (2016), -4.4 (2017), -18.3 (2018), 9.0 (2019), -3.7 (2020), -38.3 (2021), -81.3 (2022), -100.0 (2023).
  - Real non-oil GDP: 4.0 (2015), 5.3 (2016), -4.6 (2017), 0.8 (2018), 5.0 (2019), 4.8 (2020–2024 each).
- Key projection notes:
  - Non-oil GDP growth expected to rebound to 5 percent in 2019 as public spending recovers.
  - A planned increase in petroleum production in 2019 causes an increase in overall GDP growth in 2019.
  - Petroleum-sector value added expected to continue declining until production ends in 2022, resulting in a sharp overall GDP contraction in 2023.
  - Inflation expected to rise, reaching 4 percent over the medium term.
  - Excess PF withdrawals will continue to finance fiscal deficits; the current account will be largely driven by fluctuations in investment income from the PF.

### Medium- and long-term risks and structural challenges
- Main risks:
  - Progress on implementing fiscal and structural reforms is critical; insufficient progress would:
    - Increase reliance on the public sector.
    - Hinder private sector job creation.
    - Put added pressure on public finances and risk long-run fiscal sustainability.
    - Deteriorate labor market outcomes.
  - Development of the Greater Sunrise fields is a significant upside risk conditional on technical and economic viability and proper safeguards to minimize funding risks.
- Structural challenges:
  - Achieving greater economic diversification is the key challenge.
  - Need to reduce reliance on public-sector employment and generate more private-sector jobs.

### Executive Board Assessment and policy recommendations
- Executive Directors’ main messages:
  - Commended progress since independence and noted projected near-term growth pickup.
  - Highlighted need to ensure long-run fiscal sustainability, strengthen institutional capacity, generate jobs for a young and rapidly-growing population, and continue financial system development.
- Policy recommendations (as summarized in the report):
  - Fiscal policy:
    - Adopt a credible fiscal strategy to improve expenditure control and efficiency, mobilize domestic revenue, and commit to protecting Petroleum Fund assets.
    - Strengthen public financial management and promote good governance to ensure public investment efficiency and enhance quality of public services.
  - Structural reforms:
    - Increase labor productivity and enable diversification to generate jobs and private investment.
    - Improve quality of and access to education and healthcare, reduce skill gaps, encourage business formation, and promote private investment.
    - Address gender and rural-urban inequalities.
  - Financial sector development:
    - Continue developing the financial sector to channel domestic savings to productive investments and expand access to financial services.
    - Ensure a strong and effective regulatory and supervisory framework as the financial sector develops.
    - Leverage the new Land Law and development of a secured transaction framework for movable property to improve financial intermediation.
  - Capacity building:
    - Address capacity gaps in fiscal management, financial regulation and supervision, and statistics.
    - Continue to leverage technical assistance from the IMF and other development partners.
- Additional notes:
  - Directors agreed that use of the U.S. dollar as legal tender has served Timor-Leste well and emphasized maintaining low inflation and boosting labor productivity to increase international competitiveness.
  - Directors called for continued efforts to improve statistical capacity.

*Source: DEMOCRATIC REPUBLIC OF TIMOR‑LESTE — STAFF REPORT FOR THE 2019 ARTICLE IV CONSULTATION (IMF).*

### 6. Non-oil GDP growth is expected to rebound in 2019 as public spending recovers. Non-oil

### 6. Non-oil GDP growth is expected to rebound in 2019 as public spending recovers. Non-oil

### Growth outlook and macro projections
- 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.
- A planned temporary increase in petroleum production in 2019 will cause 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 Petroleum Fund (PF) withdrawals are expected to continue to finance fiscal deficits leading to a slow but gradual reduction in the PF balance.
- The current account (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.

### Petroleum sector, maritime treaty, and fiscal implications
- The maritime boundary treaty with Australia 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.
- Petroleum production from active fields is shrinking and will end in 2022.
- Given 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.

### Scenario impacts on PF and sustainable income (selected figures from staff calculations)
- 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):
  - Baseline PF balances by year: 2018 15,803; 2019 15,338; 2020 15,001; 2021 14,697; 2022 14,141; 2023 13,737.
  - Low oil price scenario PF balances by year: 2018 15,803; 2019 15,310; 2020 14,924; 2021 14,553; 2022 13,955; 2023 13,543.
  - Baseline Estimated Sustainable Income (i.e., revenue to budget) by year: 2018 550; 2019 507; 2020 491; 2021 479; 2022 468; 2023 449.
  - Low oil price scenario Estimated Sustainable Income by year: 2018 550; 2019 499; 2020 483; 2021 471; 2022 460; 2023 443.
  - Loss of revenue entries: -78, 78, 7, 87 (as presented in the source table).
  - Decline in PF balance (years shown): 29; 77; 143; 186; 194 (as presented in the source table).

### Risks to the outlook
- Near-term risks:
  - Elevated political risk could delay reform implementation and adversely affect public spending.
  - Inflationary pressure could materialize if import prices rise sharply.
  - Adverse 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 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.
- Medium- and long-term risks:
  - Risks 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.

### Authorities’ views on recent developments and outlook
- Authorities recognized that the political impasse significantly impacted the economy.
- They 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.
- The contraction was mitigated by relatively robust household consumption—supported by government transfers—and an improved trade balance.
- Authorities estimated growth in 2018 to be slightly above zero, noting dependence on the growth impact from increased public expenditure at the end of the year.
- Authorities broadly agreed on the outlook and risks but projected medium-term growth at 7 percent compared to staff’s 5 percent, citing inclusion of positive feedback effects from Greater Sunrise development and expected private sector investment from large-scale projects (example projects cited: Tibar Bay Port, TL Cement, Pelican resort).
- Authorities aim 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).
- Authorities stressed commitment to improve public financial management (PFM) and regain reform momentum, piloting MTEF in health, education, and infrastructure.
- Authorities emphasized determination to fight corruption, including initiatives in the five-year Government Program and plans to develop a National Anti-Corruption Strategy and update the Anti-Corruption Law.

### Policy discussions and recommendations
A. Fiscal Sustainability and Institutional Capacity
- The 2019 budget envisages modest frontloading of public spending and lower excess PF withdrawals; medium-term expenditure plan (2019-23) shows significant moderation in spending compared to the 2017 budget.
- Under the current baseline, the PF balance will still gradually decline, leading to rising debt financing needs in the long-run.
- Key recommended actions:
  - Improve expenditure control: capital investment should reflect targeted selection criteria based on a rigorous appraisal process while taking capacity constraints into account; adopt a comprehensive medium-term budgeting framework; consider limited use of supplementary budgets and the adoption of an expenditure rule.
  - Enhance spending efficiency and composition: improve capital spending efficiency and invest adequately in human and social capital given demographic trends.
  - 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.
  - Make effective use of concessional borrowing and commit to the ESI rule within a reasonable timeframe: use concessional borrowing for specific projects; commit to ending excess PF withdrawals by 2028.
- Debt and fiscal metrics presented (in percent of GDP and levels):
  - Total revenue (selected values): 2017 30.7; 2018 30.0; 2020-23 24.0; 2024-38 16.6; 2020-23 (reform) 26.0; 2024-38 (reform) 22.5.
  - Domestic revenue: 2017 7.0; 2018 6.3; 2020-23 6.8; 2024-38 10.4; 2020-23 (reform) 8.7; 2024-38 (reform) 15.1.
  - VAT (as percent of GDP): projected 0.0 in 2017-2019; 1.9 in 2020-23 (reform); 4.7 in 2024-38 (reform).
  - Estimated Sustainable Income: 2017 17.3; 2018 17.8; 2020-23 13.6; 2024-38 4.3; 2020-23 (reform) 13.7; 2024-38 (reform) 5.5.
  - Total expenditure: 2017 49.4; 2018 47.3; 2020-23 48.2; 2024-38 30.8; 2020-23 (reform) 48.2; 2024-38 (reform) 30.8.
  - Net borrowing and lending: 2017 -18.7; 2018 -17.3; 2020-23 -24.2; 2024-38 -14.2; 2020-23 (reform) -22.2; 2024-38 (reform) -8.3.
  - Financing—PF excess withdrawal: 2017 21.5; 2018 14.0; 2020-23 21.9; 2024-38 11.6; 2020-23 (reform) 20.0; 2024-38 (reform) 3.3.
  - Outstanding public debt (percent of GDP): 2017 3.8; 2018 5.4; 2020-23 12.5; 2024-38 21.4; 2020-23 (reform) 12.5; 2024-38 (reform) 41.4.
  - Petroleum Fund balance (in millions of US dollars): 2017 16,799; 2018 15,803; 2020-23 14,567; 2024-38 8,116; 2020-23 (reform) 14,724; 2024-38 (reform) 13,269.
- The debt sustainability analysis (DSA) suggests a low risk of debt distress and an improved risk rating compared to 2017; public external debt is projected to increase from 5 percent of GDP in 2018 to about 17 percent of GDP in the medium term.
- A government-led, donor-partnered PFM reform strategy is essential; a World Bank-led PEFA exercise (2018) is ongoing and will feed into an updated consolidated PFM reform strategy. IMF and PFTAC stand ready to provide technical assistance.

B. Private Sector Growth and Job Creation
- Demographics:
  - Growing working-age population is an important growth source but job creation is lagging job market entrants.
  - Less than a quarter of the labor force is formally employed.
  - About four out of every ten jobs created over the past decade have been in the public sector.
  - 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.
- Recommended actions to capture the demographic dividend and raise productivity:
  - Improve quality of and access to basic education and healthcare to increase productivity and reduce gender and rural-urban inequalities.
  - Strengthen technical and vocational education and training to address skill shortages.
  - Explore opportunities for Timorese workers to gain experience abroad (example: joining Australia’s Pacific Labor Scheme).
  - Enhance coverage and enforcement of labor regulations to reduce vulnerable employment, particularly for women.
  - Review minimum wage policy to balance increasing formal employment of unskilled workers and ensuring a fair living wage.
  - Assess the impact of public employment and wage setting on the private sector.
- Improve the business environment to encourage business formation and private investment:
  - Private investment averaged about 3 percent of GDP between 2010 and 2016.
  - Recent reforms include a new Land Law and a private investment law; however, business regulations need better coordination and harmonization.
  - Strengthen legal framework for property rights and contract enforcement and enhance court system capacity.
  - Develop a comprehensive and actionable strategy to boost domestic and foreign investment in productive economic sectors based on Timor-Leste’s comparative advantage.

_Italic: Source: IMF staff report content provided in the supplied PDF chapter._

### 23. The authorities acknowledged that strengthening the business environment is

### 1tlsea2019001 - 23. The authorities acknowledged that strengthening the business environment is

### Business environment: progress and planned reforms
- Authorities recognized room for further streamlining of licensing and business regulations, but highlighted significant improvements in the business environment over the past years.
- Plans to increase the number of centers for business registration and licensing in rural areas.
- Legal and regulatory initiatives under consideration or planned:
  - An Insolvency and Bankruptcy Law is under consideration.
  - A new Private Investment Law is expected to help generate business formation and encourage investment.
- Expected economic impact:
  - Authorities expect improvements in the business environment will support diversification through development of tourism, agriculture, petroleum and manufacturing.
- Staff appraisal summary:
  - Enhancing the business environment will help raise private investment and generate demand for labor.
  - Business licensing processes and regulations need better coordination and harmonization to facilitate market entry.
  - The legal framework for establishing property rights and enforcing contracts should be strengthened; court system capacity needs enhancement.
  - A comprehensive and actionable strategy to boost domestic and foreign investment in productive sectors is essential for sustainable diversification of the non-oil economy.

### Financial sector development and stability
- Policy priority:
  - Boosting financial intermediation is crucial to increase private investment and facilitate diversification.
- Current behavior of banks:
  - Despite an ample deposit base and a net interest margin of more than 10 percent, banks are reluctant to extend credit.
  - 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:
  - (i) a weak collateral system;
  - (ii) difficulty in assessing borrowers’ credit risk;
  - (iii) a low level of financial literacy.
- Reforms and support underway:
  - The new Land Law should help improve the collateral system, although registering land ownership and settling land disputes is likely to be a multi-year process.
  - Establishment of a secured transaction framework for movable property is in process with assistance from the Asian Development Bank.
  - Progress has been made towards implementation of the national credit guarantee system; BCTL is working with banks to review procedures and guidelines before implementation.
  - IMF/PFTAC plan 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.
- Payments system and financial inclusion:
  - BCTL 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 availability of financial products and services in rural areas;
    - (iii) improve financial literacy and consumer protection frameworks.
  - Important progress includes establishment of R-TIMOR and ongoing implementation of the National Switch. 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.
  - BCTL is working closely with the Ministry of Education to implement financial literacy programs in elementary schools.
- Regulatory and supervisory framework:
  - Macro-financial risks appear modest given the small size of the financial system and banks’ relatively conservative balance sheets (high liquidity and well -capitalized).
  - The regulatory and supervisory framework for banks needs to be upgraded.
  - 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.

- Selected Financial Soundness Indicators (FSIs), 2015-18 (In percent; memorandum items in millions of U.S. dollars)
  - Capital adequacy ratio (covers BNCTL only): Dec-15 42.4; Dec-16 32.9; Dec-17 32.9; Dec-18 27.7
  - Non-performing loans to total gross loans: Dec-15 23.0; Dec-16 15.3; Dec-17 13.5; Dec-18 5.6
  - Provision for loan losses to total gross loans: Dec-15 29.8; Dec-16 21.9; Dec-17 16.7; Dec-18 8.1
  - Return on assets: Dec-15 0.7; Dec-16 1.0; Dec-17 1.4; Dec-18 1.1
  - Return on equity: Dec-15 1; Dec-16 3.5; Dec-17 6.6; Dec-18 13.9; Dec-18 6.8 (table formatting preserved as in source)
  - Liquid assets to total assets: Dec-15 83.6; Dec-16 84.5; Dec-17 80.5; Dec-18 80.5
  - Total assets (memorandum): 928; 1,149; 1,170; 1,240 (in millions of U.S. dollars)
  - Total loans (memorandum): 191; 183; 227; 222 (in millions of U.S. dollars)

### External sector assessment and competitiveness
- 2018 assessment:
  - The 2018 external sector position is assessed to be substantially weaker than suggested by medium-term fundamentals and desirable policies.
  - 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.
  - The REER-model suggests the REER is broadly in line with fundamentals.
- Medium-term outlook:
  - The external current account is expected to remain in deficit, financed by withdrawals from the PF (Petroleum Fund).
  - Despite waning petroleum production, Timor-Leste’s low debt burden and sizable public asset position make the country relatively resilient to external shocks.
- Competitiveness and policy needs:
  - Increasing international competitiveness is crucial for diversification.
  - 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 help increase competitiveness.
- Exchange rate regime:
  - The U.S. dollar as legal tender continues to serve Timor-Leste well.
  - Dollarization can reduce external competitiveness when domestic inflation increases, and the U.S. dollar appreciates against trading partners.
  - Dollarization remains appropriate given limited financial sector development, low institutional capacity, and U.S. dollar-denominated major exports (coffee and petroleum).
- Authorities’ stance:
  - Authorities acknowledge that addressing the weak external sector position will require improved international competitiveness and successful diversification.
  - They emphasized that the current exchange rate regime has contributed to stabilize inflation expectations and price pressures, but stressed the need to review advantages and disadvantages of maintaining the current regime.

### Capacity building and statistics
- Identified needs:
  - Addressing capacity gaps is key to support implementation of policies and reforms, particularly in fiscal management, financial regulation and supervision, and strengthening compilation and dissemination of statistics.
  - Priority statistical improvements include shortening lags in disseminating GDP data, removing inconsistencies between national accounts and balance of payments, and addressing weaknesses in compilation and dissemination of government financial statistics.
- Technical assistance:
  - IMF/PFTAC committed to provide capacity building assistance in close collaboration with development partners.
  - Authorities appreciate ongoing TA and training (mostly delivered by PFTAC, also CDOT and IMF staff) and conveyed interest in continued TA, including in public financial management, tax policy, and statistics.
- Public Financial Management (PFM) reform (Box 2 summary):
  - Since independence, Timor-Leste has undertaken multiple PFM reform initiatives with donor support; progress noted in governance of petroleum sector, budget process, donor reporting, integrated financial management information system, and a treasury single account.
  - Weaknesses remain: low budget credibility, weak procurement processes, insufficient internal audit and non-payroll controls.
  - A PEFA exercise is ongoing to assess PFM weaknesses and feed into a government-led PFM reform strategy; the PEFA is to be completed in the first half of 2019.

### Staff appraisal: priorities and recommendations
- Principal risks and challenges:
  - Recent political breakdown increased uncertainty, slowed reforms, and weighed on the non-oil economy in 2017-18.
  - With production from active petroleum fields ending in 2022, insufficient progress on PFM, diversification, job creation, and private investment would put growth at risk, worsen labor market outcomes, and jeopardize long-run fiscal sustainability.
- Recommended priorities:
  - Develop a fiscal strategy to ensure long-term fiscal sustainability and safeguard Petroleum Fund assets; focus on strengthening control and efficiency of spending, developing a comprehensive medium-term budgeting framework, mobilizing domestic revenue, effective use of concessional borrowing, and committing to the ESI rule within a reasonable timeframe.
  - Strengthen institutional capacity via a government-led, donor-partnered PFM reform strategy to raise capacity and close infrastructure gaps while keeping overall capital spending under control.
  - Continue developing labor force: implement a comprehensive action plan to raise labor productivity, improve education and healthcare quality and access, reduce skill shortages, and address gender and rural-urban inequalities; review minimum wage policy and assess impact of public employment and wage setting on the private sector.
  - Continue efforts to develop the financial sector to channel domestic savings into productive investments and expand access to financial services; ensure a strong and effective regulatory and supervisory framework to safeguard financial stability.
  - Increase international competitiveness by maintaining low inflation, increasing labor productivity, and implementing structural reforms.
  - Strengthen compilation and dissemination of statistics to support surveillance and policymaking.
- Process recommendation:
  - It is recommended that the next Article IV consultation takes place on the standard 12-month cycle.

*Source: IMF staff report excerpt (1tlsea2019001), Timor-Leste country report text provided.*

### Box 3. Integration of Surveillance and Capacity Building

### Box 3. Integration of Surveillance and Capacity Building

### Overview of IMF engagement
- 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 focused on establishing core economic institutions in 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.
- Capacity development efforts have gradually transitioned into more traditional areas of IMF competency and become more integrated with policy advice in Article IV consultations.

### Fiscal sector: surveillance and capacity building
- Fiscal sustainability has continued to be a key issue in surveillance.
- Capacity building efforts have focused on:
  - expenditure management,
  - developing non-oil revenues,
  - ESI calculation (the latter is the largest revenue source in the budget).
- 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: strengthening financial sector capacity
- 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—laying the basis for a multi-year TA work program.
- The IMF/PFTAC is in the process of helping BCTL with:
  - reviewing and revising the legal framework for banking regulation and supervision,
  - developing a comprehensive credit risk management regulation,
  - strengthening banking supervision capacity.

### Macro-structural issues: diversification and private sector development
- 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: data gaps and TA priorities
- 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,
  - 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.

*Prepared by Naoya Adachi (APD).*

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

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

### Governance Structure
- The Petroleum Fund (PF) was established in 2005 to ensure a fair and equitable use of state-owned natural resources and to establish a mandatory financial reserve.
- Institutional roles and responsibilities (as defined by the PF Law):
  - Parliament:
    - Sets broad objectives for the Fund, including asset allocation guidelines and risk limits.
  - Ministry of Finance (MoF):
    - Responsible for the overall management of the PF.
    - Sets the investment policy and strategy and guidelines for new investments.
    - Exercises oversight of the Fund.
    - Is required to 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.
  - Banco Central de Timor-Leste (BCTL):
    - Appointed by the MoF as the operational manager of the PF and holds the account.
    - Delegated operational management and obliged to adhere to guidelines established by the MoF.
    - Can be directly and indirectly involved with investments.
    - For indirect investments, delegates investments to global investment management firms that it selects and monitors.
- The PF is formed as an account of the Ministry of Finance (MoF) and various institutions are accountable to the government and overseen by the MoF.

### Transparency
- Reporting and disclosure practices:
  - The MoF prepares the Petroleum Fund’s Annual Report and financial statements, and prepares 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.
  - An internationally recognized external auditor is appointed to issue and publish an audit report on the Fund’s annual financial statements.

### International Standards and Assessments
- Extractive Industries Transparency Initiative (EITI):
  - The 2018 EITI report assesses Timor-Leste’s management of the Petroleum Fund to be satisfactory.
  - The report indicates the PF meets international standards in governance, transparency of production and revenue schedules, and allocation of revenue.
- International Forum for Sovereign Wealth Funds (IFSWF) and Santiago Principles:
  - The Petroleum Fund of Timor-Leste is an active member of the IFSWF.
  - As of 2018, the Fund has conducted a seventh annual self-assessment of adherence with the Santiago Principles to ensure continued alignment with international best practice in fund governance.

*Prepared by Gee Hee Hong (APD).*

### 4.      The scenario analysis shows that if Timor-Leste can reach labor market outcomes

### 4.      The scenario analysis shows that if Timor-Leste can reach labor market outcomes 

### Scenario analysis: non-oil growth projections and assumptions
- Baseline: non-oil economy will grow at around 4.8 percent (annual real non-oil GDP growth).
- Scenario: raising youth labor participation rate from 22 to 45 percent (gradually)  
  - Non-oil GDP growth would increase to about 5.7 percent by 2030.
- Scenario: increasing labor productivity from 2 to 4 percent (third scenario)  
  - Annual real non-oil GDP growth would increase to about 7.5 percent by 2030.
- Combined scenario: more job opportunity for youth and higher productivity yields higher growth (table values reproduced below).
- Table excerpt (Assumption (in 2030) / Projection — Annual growth rate (%)):
  - Baseline Scenario: Youth labor participation 14.2 21.9 2.0 → 4.9 4.8
  - More job opportunity for youth: 45.8 13.7 2.0 → 5.6 5.7
  - Higher productivity: 14.2 21.9 3.7 → 6.1 6.5
  - More job opportunity for youth and higher productivity: 45.8 13.7 3.7 → 6.7 7.5
- Notes and assumptions:
  - The labor participation rate and unemployment rate are available for every five-year age group and every ten-year age group, respectively.
  - Under all the reform scenarios, linear changes for all variables are assumed. Example: when assuming 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.
  - The labor participation rate for aged 15-20 is kept constant as the low rate partly reflects school attendance.
  - Due 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.
- Source of projections: IMF staff projections.

### Labor market reform priorities (to capture growth dividends from a rapidly-growing working population)
- Improve basic education outcomes:
  - Expand pre-school enrollment.
  - Improve infrastructure (quality and quantity of school facilities).
  - Enhance teacher competence.
  - Strengthen governance of the education system.
- Increase female labor force participation and job opportunities:
  - Improve female educational attainment.
  - Promote access to the formal sector and enforce existing labor regulations (only 26 percent of women have employment contracts compared with 74 percent for men).
  - Ensure access to social protection.
  - Eliminate discrimination in recruitment and promotion.
- Address skilled labor shortages:
  - Expand Technical and Vocational Education and Training (TVET).
  - Ensure close coordination between TVET systems and the private sector to align supply of skilled labor with sectoral demand.
  - Expand opportunities for Timorese workers to gain experience abroad to facilitate knowledge spillovers.
- Strengthen implementation of labor regulations:
  - Strengthen capacity to enforce labor regulation to improve worker rights.
  - Consider establishing a minimum wage policy that balances reducing earnings inequality and increasing formal employment of unskilled workers.

### Annex V — External sector assessment: key findings
- External position (2018) is substantially weaker than that consistent with medium-term fundamentals and desirable policy settings.
- Structural change: expected depletion of the active oil and gas fields in 2022.
- Current account (CA) developments:
  - CA turned to a deficit in 2016, improved in 2017-18 due to lower imports (from lower fiscal expenditure) and higher oil/gas prices.
  - The CA deficit is projected to remain in the medium term, averaging about 4 percent of GDP.
  - Drivers of the deficit: higher imports related to capital spending, falling oil/gas receipts, and fluctuations in the PF’s investment returns.
- Petroleum Fund (PF) role:
  - Active oil/gas fields expected to be depleted in 2022, but the PF will continue to provide investment returns in the medium term.
  - CA deficit will be financed largely by divestment from the PF, together with external borrowing and FDI inflows.
- Real effective exchange rate (REER) dynamics:
  - REER appreciated by about 7 percent annually during 2010-2015 due to high inflation differential with trading partners and an appreciation of the NEER from a stronger U.S. dollar.
  - REER started to depreciate in 2016 due to low domestic inflation, but started to appreciate again in 2018 as inflation picked up and the U.S. dollar strengthened.
- EBA-Lite framework assessment (mixed results):
  - CA-model: CA gap suggests an external position substantially weaker than fundamentals and desirable policy settings; most of the CA gap (23 percentage points) is unexplained by the model; CA norm changed substantially (from a deficit of 8 percent to a surplus of 13 percent) compared to the 2016 assessment.
  - Caveats: regression database does not include Timor-Leste and does not account for time-invariant country-fixed effects; may not adequately account for depletion of active oil fields, immature financial markets, demographic trends, and infrastructure gaps; sensitive to sample periods and assumptions; data limitations affect estimation of output gap and cyclically adjusted fiscal balance.
  - REER-model: suggests Timor-Leste’s REER is overvalued by 3 percent, indicating it is broadly in line with fundamentals and desirable policies; REER-gap largely explained by the policy gap, primarily reflecting too high real interest rate.
- International reserves and Petroleum Fund metrics:
  - Net international reserves (NIR) 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 optimal reserves for Timor-Leste around 9.5 months of imports.
  - Petroleum Fund 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.
  - Foreign liabilities at end-2017: 19.3 percent of GDP (FDI liabilities 12.2 percent and external debt 3.8 percent of GDP).

*Source: IMF staff projections and analysis as presented in the document.*

### 6.      Structural reforms remain crucial to

### 6.      Structural reforms remain crucial to

### Structural reform priorities and competitiveness
- Implementation of needed structural reforms of the non-oil economy should:
  - Reduce import dependence.
  - Increase the export base.
- Maintaining low inflation and increasing labor productivity through investments in education and health should also help increase competitiveness.

### Fiscal and sovereign wealth context (Petroleum Fund)
- Size and liquidity of the Petroleum Fund (PF):
  - PF balance at end-2018: US$15.8 billion (506 percent of total GDP and 848 percent of total non-oil GDP).
  - PF covers more than 166 months of goods and services imports.
  - Targeted asset allocation (currently): 60 percent in Treasury Bonds of developed countries and 40 percent in developed market equities.
  - Average return on PF assets since inception: around 4.4 percent (as of end-2017).
  - Staff assumption for PF return when projecting the PF balance: 3.9 percent.
- Access and withdrawal rules:
  - Estimated Sustainable Income (ESI) is set at 3 percent of total Petroleum Wealth.
  - Government withdrawals in excess of the ESI have been allowed with parliamentary approval; total withdrawals over the lifetime of the PF amounted to $9.6 billion (end-2017).
  - Excess withdrawals account for about 63 percent of the total withdrawals to end-2017.
- Recent valuation and balance dynamics:
  - The PF closing balance of 2017 improved compared to 2016 due to higher oil and gas receipts, favorable investment returns and valuation effects, and lower government spending.
  - Heightened global financial market volatility in late-2018 led to negative valuation effects and a decline in the closing balance at end-2018.

### Public debt and borrowing
- Outstanding public external debt at end-2018:
  - US$157.7 million (5.1 percent of total GDP and 8.5 percent of total non-oil GDP).
- External loan commitments signed by end-2018:
  - US$355 million (12.8 percent of total GDP and 19 percent of total non-oil GDP).
  - Constitutes twelve loans under eight packages to be disbursed over 4 years until 2022.
  - Lenders include the Asian Development Bank, Japan International Cooperation Agency (JICA) and the World Bank Group.
  - Primary purpose: support infrastructure projects, primarily rehabilitation and upgrading of national roads.

### Debt sustainability assessment and policy implications
- Risk assessment:
  - Timor-Leste’s risk of external debt distress is assessed as low, improved from a prior “moderate risk” finding.
  - Public and publicly guaranteed (PPG) external (and public) debt is small: 5 percent of GDP in 2018.
  - The Petroleum Fund is estimated at 506 percent of GDP in 2018 and is large, liquid, and accessible, which was a key judgment factor in upgrading the risk assessment.
- Projections and risks:
  - Debt indicators are projected to remain below thresholds under the baseline scenario through 2038.
  - Standardized stress tests show a shock to the primary balance as the most extreme shock, causing a short-lived and marginal breach of the PV of PPG debt-to-exports threshold.
  - Beyond the 20-year projection horizon, debt is projected to rise quickly, creating risks to debt sustainability.
- Policy recommendation:
  - The authorities should adopt prudent policies to address the medium- and long-term risks to debt sustainability; the DSA illustrates benefits of such policies in an alternative scenario.

### Statistical and data limitations affecting surveillance and analysis
- General assessment:
  - Data provision to the Fund has serious shortcomings that significantly hamper surveillance.
  - Enhancement of the General Directorate of Statistics (GDS) within the Ministry of Finance is an ongoing priority.
- National accounts and petroleum sector measurement:
  - GDP is compiled annually with a 2015 base and methods reasonably consistent with the 2008 System of National Accounts, but estimates are not timely.
  - The oil sector presently accounts for up to 80 percent of total GDP (based on GDS assumption that 90 percent of JPDA activity is resident in Timor-Leste).
  - This conflicts with Banco Central de Timor-Leste (BCTL) balance of payments estimates, which assume all JPDA production is non-resident.
  - IMF staff work to align these statistics is underway and could result in significant, though likely largely offsetting, revisions to GDP and GNI.
- Price statistics:
  - Monthly national CPI uses expenditure weights from the 2014-15 Living Standard Survey.
  - Starting 2018 August, basket weights were updated and CPI was rebased with an August 2018 reference period (i.e., August 2018=100).
- Government finance statistics (GFS):
  - Annual GFS is compiled and disseminated; 2017 general government data submitted as latest for the GFS database.
  - Quarterly GFS compilation and dissemination has been deferred due to data discrepancies; last quarterly GFS publication covered April–June 2016.
  - Ongoing technical assistance from PFTAC to improve GFS compilation and dissemination practices including Public Sector Debt Statistics (PSDS).
  - Timor-Leste does not report to the Quarterly Public Sector Debt database (QPSD).
- Monetary and financial statistics:
  - BCTL compiles monetary statistics generally following the Monetary and Financial Statistics Manual, but data are incomplete due to absence of official data on public currency holdings and banks’ positions with public nonfinancial corporations.
  - Detailed monthly monetary data for the central bank and other depository corporations are reported using standardized report forms (SRFs); data for other financial corporations (mainly insurance companies) are not compiled.
- Financial sector surveillance:
  - Only basic market-based indicators are available; coverage, valuation and timeliness vary.
  - Data are not sufficiently available to conduct stress tests of the banking system or Balance Sheet Approach analysis.
  - Cross-border exposure data for financial corporations are not available; financial soundness indicators are not reported to STA.
- External sector statistics (ESS):
  - Progress has been made, but accurately measuring non-Petroleum Fund-related current account transactions remains a work in progress.
  - Monthly merchandise trade data are now published regularly but have significant gaps in the series for 2006 and 2007.
  - Monthly merchandise exports and imports are based on ASYCUDA; service transactions are largely estimated and limited to official and tourism sectors.
  - Quarterly balance of payments and international investment position (IIP) data available for 2006–Q3/2018.
  - Improvements verified by the October 2015 ESS TA Mission include integrated IIP classification and treatment of PF and IMF-related accounts; however, recommendations to improve coverage of the direct investment survey to include JPDA companies’ equity and to align ESS treatment of JPDA companies’ activities with national accounts remain pending due to data source difficulties.

### Data dissemination and standards
- Timor-Leste began participating in the IMF’s General Data Dissemination System (enhanced GDDS) in 2012.
- On February 15, 2019, Timor-Leste fully implemented e-GDDS by publishing the National Summary Data Page.

*Source: IMF staff report for the 2019 Article IV Consultation — informational annex (March 8, 2019).*

### 4. This DSA is based on the macroeconomic projections underlying the 2019 Article IV

### 1tlsea2019001 - 4. This DSA is based on the macroeconomic projections underlying the 2019 Article IV

### Macroeconomic and fiscal assumptions underpinning the DSA
- Political impasse beginning mid-2017 prevented a supplementary budget for 2017 and delayed the 2018 budget approval, leading to under-execution of capital spending in 2017 and a contraction of real GDP in 2017.
- Political uncertainty faded in mid-2018; growth is expected to rebound in 2018 to 0.8 percent.
- Oil production from active fields is projected to cease in 2022.
- Inflation is expected to increase steadily to about 4 percent over the medium-term due to higher global food and fuel prices and spillovers from public investment activity.
- The current account balance is projected to remain in deficit over the medium term; declining income from oil and gas receipts contributes to the deficit. The current account balance deficit between 2018-2023 is projected to be less severe compared to the previous DSA due to a lower public expenditure trajectory under the 2019 budget.
- The primary fiscal balance is projected to remain in deficit of about 13 percent of GDP in 2018 and narrow gradually to about 11 percent on average over the long-term (2028-2038). Capital spending is projected to grow to fill the infrastructure gap.
- External financing consists of concessional loans from official creditors; private external borrowing is assumed to remain negligible.
- Fiscal financing consists of (i) Petroleum Fund (PF) withdrawals in excess of the ESI and (ii) external borrowing.
- The grant element of loans is assumed to decline moderately over the medium-term as the economy develops.
- Other assumptions include that no off-budget debt is accumulated including by state-owned enterprises in line with existing legislation.

### Key historical and projected macro-fiscal figures (selected from Table 1)
- Real GDP growth (in percent): 2017 = -4.5; 2018 = -8.0; 2018-23 = -5.6; 2024-38 = 4.8; (previous columns: 2016 = -7.9; 2017 = -8.0; 2017-22 = -3.7; 2023-37 = 5.2)
- Real non-oil GDP growth (in percent): 2017 = -4.6; 2018 = 0.8; 2018-23 = 4.2; 2024-38 = 4.8; (other columns shown in source)
- Inflation (CPI annual average, percent): 2017 = 0.5; 2018 = 2.3; 2018-23 = 3.2; 2024-38 = 4.0
- Revenues (excluding grants, percent of GDP): 2017 = 30.7; 2018 = 29.7; 2018-23 = 26.3; 2024-38 = 19.1
- Current expenditure (percent of GDP): 2017 = 33.5; 2018 = 28.2; 2018-23 = 35.8; 2024-38 = 24.6
- Net acquisition of non-financial assets (percent of GDP): 2017 = 9.5; 2018 = 12.8; 2018-23 = 10.4; 2024-38 = 4.7
- Net lending/borrowing (percent of GDP): 2017 = -18.7; 2018 = -17.2; 2018-23 = -24.3; 2024-38 = -14.1
- Net incurrence of liabilities (percent of GDP): 2017 = 1.1; 2018 = 2.0; 2018-23 = 2.3; 2024-38 = 2.6
- Current account balance (percent of GDP): 2017 = -10.2; 2018 = -8.9; 2018-23 = -4.1; 2024-38 = -6.5

### Realism tool assessment
- The three-year adjustment in the primary balance is expected to be a loosening of 5 percent of GDP between 2017 and 2020, representing significant stimulus and lying near the bottom of the distribution of the realism tool.
- A high fiscal multiplier for 2019 partly reflects the low base effect of growth in 2018.
- Lack of data (stocks of government capital) prevents testing other realism tools; efforts will be made to collect the data for the next DSA.

### Scenarios considered
- Two scenarios are modeled: baseline and reform.
- Baseline scenario: reflects macro-fiscal projections underlying the 2019 Article IV consultation and the 2019 budget with less front-loading of capital expenditure relative to the 2017 budget.
- Reform scenario: illustrates staff’s proposed strategy to safeguard fiscal sustainability, broadly similar to staff recommendations in the 2016 and 2017 Article IV Staff Reports. Key elements and impacts:
  - Less front-loading of public expenditure is maintained as in the 2019 budget.
  - Value-added tax (VAT) implemented by 2022; estimated to generate about 3¾ percent of GDP based on a VAT rate of 10 percent in the medium term; VAT revenue increases to at least 5 percent of GDP in the long term.
  - PF withdrawals in excess of the ESI are not permitted from 2028 onwards; resulting financing gap met by external borrowing.
  - Under the reform scenario, PF balance increases to close to US$13.5 billion (385 percent of total GDP) in 2023, and reaches around US$12.8 billion (75 percent of total GDP) in 2038.
  - Average excess withdrawals over the medium-term (2020-2027): Baseline = US$740.7 million; Reform = US$618.3 million.
  - Average borrowing over the long-term (2028-2038): Reform = US$805.6 million; Baseline = US$279 million.
- Table 2 highlights differences in macro variables between baseline and reform (selected figures):
  - Revenues (percent of GDP) 2018-23: Baseline = 25.9; Reform = 27.1
  - Net acquisition of non-financial assets (percent of GDP) 2018-23: Baseline = -20.6; Reform = -25.7
  - Net lending/borrowing (percent of GDP) 2018-23: Baseline = -22.9; Reform = -21.6
  - Net incurrence of liabilities (percent of GDP) 2018-23: Baseline = 2.3; Reform = 2.3
  - Borrowing (in millions of USD, period average) 2018-23: Baseline = 75.5; Reform = 52.0
  - Petroleum Fund Balance (in millions of USD) 2018-23: Baseline = 14,943; Reform = 15,004

### Projected medium-term fiscal funding gaps (Table 3, in millions of US Dollars)
- Baseline Scenario funding gap (period averages):
  - 2018 = 493.7
  - 2019 = 1,344.1
  - 2020 = 982.7
  - 2020-2027 = 839.9
  - 2028-2038 = 1,199.6
  - Components: Excess Petroleum Fund withdrawal (2018 = 432.1; 2019 = 1,257.1; 2020 = 935.1; 2020-2027 = 740.7; 2028-2038 = 920.6); Borrowing (2018 = 61.6; 2019 = 87.0; 2020 = 47.6; 2020-2027 = 99.2; 2028-2038 = 279.0)
- Reform Scenario funding gap (period averages):
  - 2018 = 493.7
  - 2019 = 1,344.1
  - 2020 = 982.7
  - 2020-2027 = 715.0
  - 2028-2038 = 805.6
  - Components: Excess Petroleum Fund withdrawal (2018 = 432.1; 2019 = 1,257.1; 2020 = 935.1; 2020-2027 = 618.3; 2028-2038 = 0.0); Borrowing (2018 = 61.6; 2019 = 87.0; 2020 = 47.5; 2020-2027 = 96.7; 2028-2038 = 805.6)

### Country classification and tailored stress testing
- Composite Indicator (CI) index = 2.72 based on October 2018 WEO and the 2017 CPIA, indicating medium debt-carrying capacity.
- Given heavy reliance on oil and gas exports (77 percent of total exports of goods and services in 2018), an export shock was customized to account for the structural production cycle and projected cessation of petroleum production in 2022. Customization reduced the initial standard deviation from 50.3 to 10.3 (method detailed in source footnote).
- No adjustments were made to default DSF settings regarding scenario stress testing beyond the export shock customization.

### Debt sustainability results
- External debt (baseline):
  - All external PPG debt indicators remain below policy-relevant thresholds for the next twenty years.
  - PV of PPG debt-to-GDP ratio projected to increase from 4.3 percent in 2018 to 8.8 percent in 2025 due mainly to new loan disbursements for infrastructure, then decline to 4.6 percent by 2038.
  - PV of debt-to-exports ratio experiences short-lived, marginal breaches under an extreme primary balance shock (first breach in 2022: 202 vs. threshold 180; re-occurs in 2024: 210 vs. threshold 180).
  - Residual debt-creating flows are financed through excess withdrawals from the Petroleum Fund.
- Public debt (baseline):
  - PV of total PPG debt-to-GDP ratio remains below threshold for next twenty years.
  - Standardized sensitivity analysis: the largest shock is a commodity price shock leading to a sustained breach with highest debt-to-GDP figures in 2034; however, PF buffers and projected end of petroleum production in 2022 limit budget impact.
- Reform scenario:
  - Ending excess PF withdrawals in 2028 leads to higher external borrowing; VAT introduction improves debt dynamics from 2022 onwards but net effect is an increase in debt level over time.
  - Reform scenario does not fundamentally alter debt analysis; debt levels remain contained and the PF broadly stabilizes.

### Risk rating and vulnerabilities
- Mechanical DSA rating: “moderate” debt distress risk.
- Final judgment rating: upgraded to “low” debt distress risk based on:
  - Large, liquid, and accessible net foreign assets (Petroleum Fund assets estimated at 848 percent of total non-oil GDP in 2018).
  - PF liquidity: 50 percent of PF assets invested in U.S. Treasuries.
  - Less ambitious front-loading of public spending in the 2019 budget improves sustainability outlook.
  - Historical precedent: between 2012-2017, excess withdrawals averaged US$478 million per year—well above funds needed to cover financing gaps under stress scenarios.
- Under extreme shock case where PV of PPG debt-to-exports breaches the threshold, PV of debt-to-Petroleum Fund assets remains stable and approaches close to 60 percent only towards the end of the projection period.

*Source: 1tlsea2019001 - 4. This DSA is based on the macroeconomic projections underlying the 2019 Article IV*

### 17. Towards the end of and beyond the 20-year horizon, the coverage of the PF deteriorates,

### 1tlsea2019001 - 17. Towards the end of and beyond the 20-year horizon, the coverage of the PF deteriorates,

### Main findings and outlook
- The coverage of the Petroleum Fund (PF) deteriorates towards the end of and beyond the 20-year horizon, underscoring the need for a fiscal strategy to ensure long-term fiscal sustainability and safeguard PF assets.
- Under current policies, the PF will deplete beyond the 20-year horizon as the revenue base is low and capital spending is expected to increase to fill the country’s infrastructure gap.
- Depletion of highly liquid financial assets reinforces the need for a reform strategy that entails:
  - improving expenditure control and efficiency,
  - mobilizing domestic revenue, and
  - committing to protecting the wealth of the Petroleum Fund.

### Authorities’ views
- The authorities concurred with the overall rating of low risk of external debt distress.
- They welcomed the improved rating on external debt, citing the low level of external borrowing and the availability of the Petroleum Fund as a buffer.
- The authorities are committed to the mobilization of domestic revenues in order to protect the Petroleum Fund balance and ensure long-term debt sustainability.

### External debt: key DSA indicators and projections (selected)
- External debt (nominal), selected values (in percent of GDP): 1.5; 3.1; 3.8; 4.6; 6.0; 7.1; 8.7; 10.3; 10.9; 12.0; 6.8; 0.9; 9.8.
- Identified net debt-creating flows (selected series, in percent of GDP): -7.4; 22.2; 9.7; 8.2; -2.4; 0.9; -1.0; 10.; 7; 4.0; -0.9; -0.3; -9.3; 1.3.
- Non-interest current account deficit (selected series, in percent of GDP): -6.6; 21.6; 10.2; 8.9; -1.6; 1.7; -0.5; 1; 0.2; 4.9; -0.3; -0.2; -24.6; 2.0.
- PV of PPG external debt-to-GDP ratio (selected values): 3.4; 4.0; 5.0; 5.7; 6.9; 8.0; 8.2; 8.6; 4.6.
- PV of PPG external debt-to-exports ratio (selected values): 17.8; 24.4; 41.7; 40.4; 48.4; 97.6; 90.4; 76.4; 32.6.
- PPG debt service-to-exports ratio (selected values): 0.0; 0.0; 0.5; 0.0; 1.3; 1.3; 1.7; 4.3; 3.9; 4.3; 2.8.
- PPG debt service-to-revenue ratio (selected values): 0.0; 0.0; 0.4; 0.0; 0.7; 0.9; 1.1; 1.6; 1.8; 3.3; 2.8.
- Gross external financing need (Million of U.S. dollars), selected series: -233.9; 55; 1.7; 280.1; 248.6; -66.2; 31.6; -60.0; 283.2; 134.1; -9.8; 38.1.

### Macroeconomic and fiscal assumptions used in projections (selected)
- Real GDP growth (in percent), selected values: 20.9; 0.8; -4.5; -8.0; 6.6; 1.3; -12.3; -19.2; -2.0; 4.8; 4.8; 0.0; -0.9.
- GDP deflator in US dollar terms (change in percent), selected values: -36.5; -19.5; 15.4; 22.1; -5.6; 4.8; 11.0; 19.9; 13.5; 6.0; 6.0; 3.3; 8.7.
- Effective interest rate (percent), selected values: 0.0; 0.0; 0.2; 0.0; 3.5; 3.2; 3.3; 3.9; 3.; 82.8; 2.4; 0.0; 3.0.
- Growth of exports of G&S (US dollar terms, in percent), selected values: -43.5; -70.; 2; 65.5; -4.4; -26.5; 25.3; -1.7; -44.1; 23.8; 16.6; 11.8; 3.8; 5.0.
- Growth of imports of G&S (US dollar terms, in percent), selected values: 1.8; -7.5; -1; 1.9; 7.0; -6.2; 17.3; -6.0; 11.9; -6.6; 7.6; 14.4; 13.9; 5.0.
- Government revenues (excluding grants, in percent of GDP), selected values: 26.1; 29.6; 24.3; 23.8; 22.6; 20.7; 21.1; 21.8; 19.4; 14.5; 14.4; 18.2; 19.1.
- Nominal GDP (Million of US dollars), selected values: 3,104; 2,521; 2,778; 3,122; 3,143; 3,335; 3,246; 3,144; 3,498; 5,918; 16,939.

### Public sector debt: key DSA indicators and projections (selected)
- Public sector debt (in percent of GDP), selected values: 1.5; 3.1; 3.8; 4.6; 6.0; 7.1; 8.7; 10.3; 10.9; 12.0; 6.8; 0.9; 9.8.
- Revenue and grants (in percent of GDP), selected values: 33.2; 36.8; 30.7; 29.7; 27.8; 24.3; 24.7; 25.4; 23.2; 17.1; 14.9; 24.4; 22.9.
- Primary (noninterest) expenditure (in percent of GDP), selected values: 33.2; 40.8; 33.5; 28.2; 33.6; 33.0; 35.4; 38.1; 36.3; 28.8; 19.2; 19.5; 33.0.
- Primary deficit that stabilizes the debt-to-GDP ratio (selected values): -1.0; 2.4; 2.1; -2.2; 4.4; 7.6; 9.0; 11.1; 12.5; 11.8; 4.8; 1.2; 9.3.
- PV of public debt-to-GDP ratio (selected values): 3.4; 4.0; 5.0; 5.7; 6.9; 8.0; 8.2; 8.6; 4.6.
- PV of public debt-to-revenue and grants ratio (selected values): 11.1; 13.3; 17.8; 23.3; 27.7; 31.4; 35.5; 50.1; 31.0.
- Debt service-to-revenue and grants ratio (selected values): 0.0; 0.0; 0.3; 0.0; 0.6; 0.7; 1.0; 1.4; 1.5; 2.8; 2.7.
- Gross financing need (selected values): -0.1; 4.0; 2.9; -1.4; 5.9; 8.9; 10.9; 13.0; 13.5; 12.1; 4.6.

### Sensitivity analysis and stress tests
- Sensitivity tables and bound/tailored tests are presented for 2018-2028 across scenarios A (alternative scenarios), B (bound tests), and C (tailored tests).
- The most extreme stress test for key public and external debt indicators is identified as the Primary Balance shock.
- Stress-test outcomes indicate breaches of various thresholds under alternative historical-average and combined shocks scenarios (tables show multiple bold values indicating threshold breaches in some scenarios).
- Commodity price shock magnitudes are based on the commodity prices outlook prepared by the IMF research department.
- Note on stress-test borrowing assumptions: all additional financing needs generated by stress-test shocks are assumed to be covered by PPG external MLT debt in the external DSA.

### Drivers of debt dynamics and realism tools
- Figures show contributions to debt dynamics from: primary deficit, real interest rate, real GDP growth, price and exchange rate changes, and other debt-creating flows.
- A realism tool is noted; however, the data needed to conduct the investment growth realism tool is not available for the current DSA exercise and will be collected for the next DSA.

### Policy implications and recommendations (from text)
- Develop a fiscal strategy to ensure long-term fiscal sustainability and safeguard PF assets.
- Improve expenditure control and efficiency.
- Mobilize domestic revenue to protect the Petroleum Fund balance.
- Commit to protecting the wealth of the Petroleum Fund to avoid depletion beyond the 20-year horizon.

*Sources: Country authorities; and staff estimates and projections. Statement by Alexandre Tombini, Executive Director for Timor-Leste and Pedro Fachada, Alternate Executive Director, March 27, 2019.*

### 1. On behalf of our Timorese authorities, we thank the new mission chief and his team

### 1. On behalf of our Timorese authorities, we thank the new mission chief and his team

### Opening remarks and engagement
- Authorities thank the new mission chief and his team for "constructive engagement and policy advice" during this year’s Article IV consultation.
- Authorities also thank the IMF for "valuable technical assistance" Timor-Leste has received through the years.

### Political progress and governance
- Timor-Leste is "one of the youngest countries in the world" and has made "impressive progress in state-building and human development" since independence "seventeen years ago."
- Democratic institutions consolidated: "pluralist democratic society, based on transparent elections, broad representation, separation of powers and rule of law."
- Legislative elections in July 2017 produced no clear majority; political impasse led to new elections in May 2018 and formation of a majority government in mid-2018.
- New administration (inaugurated mid-2018) committed to the Strategic Development Plan 2011-2030 aiming to transform Timor-Leste "into a medium-high income country by the end of the next decade."
- Authorities emphasize need to "diversify the economy and to improve infrastructure and human capital" and plan public policies and structural reforms to improve education, health, quality of life, and the business environment.

### Medium-term economic prospects
- Political impasse in 2017/2018:
  - Prevented adoption of a supplementary budget in 2017 and delayed approval of the 2018 budget.
  - Government operated under the duodecimal regime for most of 2018 (monthly spending restricted to 1/12 of the budget line of the previous year).
  - Postponed decisions on oil industry development and medium-term public capital spending.
  - Data released after the staff report finalization: "non-oil GDP contracted by 3.5 percent in 2017."
- Recovery began with the new government in mid-2018.
- Oil outlook and Greater Sunrise:
  - "The current oil fields are expected to be depleted by 2022."
  - Signing in "March 2018" of a comprehensive maritime border agreement with Australia laid foundation for development of the Greater Sunrise fields.
  - Fields have "substantial" potential "even under conservative oil price assumptions."
  - Government determined to develop oil and gas industry in the south.
- Growth projections:
  - Authorities project medium-term non-oil GDP growth of "7 percent per annum."
  - Staff estimates medium-term non-oil GDP growth of "5 percent."
  - Difference attributed to authorities' expectation of positive spillovers from Greater Sunrise and public capital spending, and emergence of private sector activity from large-scale investments in infrastructure, manufacturing and tourism.

### Fiscal policy, public finance, and debt sustainability
- Petroleum Fund and fiscal prudence:
  - At end-January 2019, the Petroleum Fund balance was "US$16.4 billion, or about 530 percent of estimated 2018 GDP."
  - This position makes the Petroleum Fund "one of the largest sovereign wealth funds relative to GDP in the world."
- Commitment to prudent fiscal stance: preserve Petroleum Fund resources while addressing development needs.
- Public financial management (PFM) reforms:
  - Authorities committed to PFM reforms to improve budget execution and fiscal outturns.
  - Conducting, with World Bank support, a Public Expenditure and Financial Accountability (PEFA) assessment to prioritize and sequence PFM reforms.
  - Simplifying and streamlining budgeting and procurement processes; improving the Medium-Term Expenditure Framework.
- Revenue mobilization:
  - Agreement with staff on need to "increase domestic non-oil revenue mobilization."
  - Continuing to improve tax compliance and increase efficiency of tax administration.
  - Over the medium-term, "a value-added tax (VAT) is expected to be introduced."
- Debt distress assessment:
  - Authorities appreciate staff’s revised assessment of risk of debt distress, improved from "moderate to low."
  - This returns the risk level "back to the prevailing level prior to the 2016 Article IV."
  - Authorities assert the 2016 deterioration was "an unnecessary false alarm" given "very low gross public and external debts and comfortable assets position of the public sector."
  - Authorities welcome that the new Debt Sustainability Analysis (DSA) framework recognizes "country-specific circumstances" and allows more latitude in judgment.

### Monetary regime and financial sector development
- Monetary regime:
  - Timor-Leste is "a dollarized economy."
  - Authorities agree with staff that "the monetary regime continues to serve the country well."
  - Recent domestic inflation "has been low and close to trading partners inflation," with inflation expectations "well anchored."
  - Authorities continue to "carefully assess the merits of maintaining the current monetary system."
- Financial sector development:
  - Commitment to further develop Timor-Leste’s financial system.
  - Banking system is "well-capitalized," but credit levels remain "relatively low for international standards."
  - Weak collateral regime cited as an obstacle to credit expansion; expected improvements from the new Land Law and a secured transaction framework for movable property.
  - Need for a strong regulatory and supervisory framework to complement development.
  - Payment system modernization:
    - Central Bank of Timor-Leste (BCTL) launched a real time transfer network ("R-Timor") and the National Switch system, "which will soon be integrated with other regional payment systems."
  - BCTL working to foster financial education.

### Social development and human capital
- Demographics:
  - Population "is growing fast and remains remarkably young."
  - Timor-Leste expected to "profit from a demographic dividend over the next decades."
  - Key challenge: integrate the young population into a modern, dynamic and internationally connected economy.
- Staff recommendations (to be considered):
  - Provide high quality education and technical training to address skilled labor shortages and enhance productivity.
  - Reduce gender inequalities in the labor market to positively impact growth and development.
  - Promote regional and local development initiatives targeting rural areas where most of the population lives, productivity is low, and infrastructure is lacking.
- Authorities' commitments:
  - Advance structural reforms, attract foreign investment, and foster private-sector job creation.
  - Improve basic infrastructure to promote economic opportunities, attract private investment, and improve living standards.
  - Substantial progress made toward the "2030 Sustainable Development Goals," as attested by staff.
  - Emphasize investing in human capital to provide opportunities for new generations.

*Source: 1tlsea2019001 - 1. On behalf of our Timorese authorities, we thank the new mission chief and his team*

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_Source: https://www.imf.org/-/media/files/publications/cr/2019/1tlsea2019001.pdf_