## 1tlsea2022001 — 2021. A well-progressing vaccination campaign has allowed the authorities to gradually ## Source details **Canonical URL:** [1tlsea2022001 — 2021. A well-progressing vaccination campaign has allowed the authorities to gradually](https://www.imf.org/-/media/files/publications/cr/2022/english/1tlsea2022001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2022/english/1tlsea2022001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2022/english/1tlsea2022001.pdf.json) --- ### Context and recent developments - Institutional and development context: - Rebuilt institutions and infrastructure since independence in 2002 after major disruption in 1999. - Major challenges: depleting oil revenues (active oil fields expected to cease producing oil revenues in 2023); underdeveloped non-oil private sector with informal and low-productivity employment; significant gaps in health and education; high youth unemployment; high vulnerability to natural disasters posing fiscal risk. - Parliamentary elections in 2023 increase importance of political consensus on reforms. - COVID-19 and vaccination: - As of June 21, 2022: "close to 72 percent of the adult population are fully vaccinated" and "85 percent have received at least one dose." - National state of emergency lifted on November 30; all COVID-related international travel restrictions lifted in March 2022. - Growth and prices: - Non-oil real GDP estimated to have grown by 1.5 percent in 2021 after a contraction of -8.6 percent in 2020. - Headline inflation reached 7.4 percent y/y in May 2022, the highest since 2012; inflation projected at 7 percent in 2022. - Fiscal and external: - Fiscal deficit expanded from 30 percent of non-oil GDP in 2019 to 43 percent in 2021. - COVID-19-related spending explains about half of the increase in current spending in 2021 compared to 2019. - Underlying non-oil current account deficit estimated at 42.7 percent of non-oil GDP in 2021, about 8.3 percent of non-oil GDP above the "norm" (Annex I). - International reserves at historically high levels; 2021 SDR allocation covered more than 11 months of prospective imports in 2022; authorities reported no intention to use the SDR funds. - Financial sector: - Private sector credit growth at 5.8 percent y/y in 2021, mainly lending to households. - Credit moratorium scheme ended in March 2022. - Nonperforming loan ratio at 2.5 percent at end-2021. - Capital adequacy and liquidity ratios remain comfortably above regulatory thresholds. ### Outlook, projections, and risks - Baseline projections and near-term outlook: - Staff projects non-oil real GDP to grow 3.3 percent in 2022. - Oil revenues from active oil fields projected to cease in 2023. - Development of Greater Sunrise fields excluded from baseline projections (no approved development plans). - Fiscal deficit expected to remain broadly constant at 43 percent of non-oil GDP in 2022 and increase sharply in 2023–24 due to front-loading of public spending per the 2022 budget. - Current account balance to shift back to deficit in 2022 and in the medium term. - Inflation projected at 7 percent in 2022, reflecting higher food prices. - Fiscal and external sustainability are at high risk in the long term; Petroleum Fund financing is depleted under current policies in the long term. - Authorities’ projections: - Real non-oil GDP growth: 2.9 percent in 2022 and 3.1 percent in 2023. - Authorities project inflation at 6.7 percent in 2022 and expect it to decline to 3 percent in 2023. - Authorities intensifying efforts to develop the Greater Sunrise fields but significant uncertainties remain. - Risks (tilted to the downside): - Re-intensification of the pandemic; geopolitical tensions causing prolonged/high oil and food prices; persistent high inflation tightening global financial conditions; domestic political instability; natural disasters. ### Fiscal assessment, sustainability, and key fiscal statistics - Fiscal sustainability: at high risk in the long term; baseline projects Petroleum Fund depletion by 2038 assuming annual investment return of 5 percent (depletion in 2034 with a 3 percent return). - Concerns on 2022 budget choices: - 2022 expenditure ceiling is $2.1 billion, 75 percent higher than average actual spending in 2017–2019, and three times larger than the estimated sustainable sources of revenue of $705 million. - Creation of a $1 billion Fund for Veterans from the Petroleum Fund reduces financing sources for the government. - 2022 budget includes a large increase in government transfers that are not targeted to the most vulnerable nor increase productive capacity. - Selected macro-fiscal figures (preserve numeric values exactly): - Fiscal deficit: 2019: 30 percent of non-oil GDP; 2021: 43 percent of non-oil GDP. - Petroleum Fund balance ($ million): 2021: 18,949; 2022: 17,446; 2023–27 (Baseline): 16,553; 2023–27 (Reform Scenario): 15,217; 2028–42 (Baseline): 17,768; 2028–42 (Reform Scenario): 4,707. - PF excess withdrawals (percent of non-oil GDP): 2021: 35.3; 2022: 52.9; 2023–27 (Baseline): 26.7; 2023–27 (Reform Scenario): 51.1; 2028–42 (Baseline): 3.0; 2028–42 (Reform Scenario): 25.0. - Net lending/borrowing (percent of non-oil GDP): 2021: -43.2; 2022: -54.9. ### External sector assessment (Annex I) — key findings - Overall assessment: - External position in 2021 substantially weaker than level implied by fundamentals and desirable policies; reflects large fiscal imbalances and underdevelopment of the non-oil economy. - NIIP and reserves: - Net international investment position by end-2021: $19.8 billion (1,179 percent of non-oil GDP). - External assets: $21.1 billion (1,258 percent of non-oil GDP); Portfolio investment (Petroleum Fund): $19.0 billion (1,131 percent of non-oil GDP). - Reserves at end-2021: $935 million, equivalent to about 12 months of imports. - Current account: - Current account excluding oil revenues in 2021: -40.3 percent of non-oil GDP; underlying current account deficit excluding oil revenues in 2021: about 42.7 percent of non-oil GDP. - Assessment: current account gap in 2021 estimated at -8.3 percent of non-oil GDP. - Policy implication: fiscal consolidation and structural reforms to promote private sector development and diversify the economy should help external rebalancing. ### Reform scenario and structural reforms - Reform scenario objectives and mechanics: - Transition to sustainable fiscal position over 10 years with withdrawals from the Petroleum Fund equal to 3 percent of resource wealth. - Revenue mobilization: domestic revenues reach 12 percent of non-oil GDP by 2027 and average close to 15 percent in 2028–42 (aligned with peer experiences). - Expenditure moderation: government expenditure declines gradually to 2019 level; averages 63 percent of non-oil GDP in 2023–27 and 29 percent in 2028–42 (about 21 percentage points lower than baseline). - Public investment averages 16 percent of non-oil GDP in 2022–27 requiring better project selection. - Growth implications: - Real non-oil GDP growth lower than baseline averaging 1.6 percent over 2023–27 due to output costs of consolidation. - Long-term (2028–2042) growth under reform scenario projected to hover around 5-6 percent, significantly higher than baseline, driven by higher private investment. - Structural reform priorities: - Improve agricultural productivity; enhance the business environment; strengthen governance; tackle youth unemployment; facilitate financial deepening; invest in climate-resilient infrastructure. - Quantified scenario comparisons (selected indicators): - Real non-oil GDP growth (in percent): 2021: 1.5; 2022: 3.3; 2023–27: 1.6 (Baseline), 3.0 (Reform Scenario); 2028–42: 5.5 (Baseline), 3.0 (Reform Scenario). - Domestic revenue (percent of non-oil GDP): 2021: 9.6; 2022: 9.6; 2023–27: 10.7 (Baseline), 9.7 (Reform Scenario); 2028–42: 14.8 (Baseline), 10.5 (Reform Scenario). - Government expenditure (percent of non-oil GDP): 2021: 85.8; 2022: 95.3; 2023–27: 62.5 (Baseline), 85.0 (Reform Scenario); 2028–42: 29.1 (Baseline), 50.8 (Reform Scenario). - Current account balance (percent of non-oil GDP): 2021: 2.5; 2022: -15.3; 2023–27: -31.6 (Baseline), -37.0 (Reform Scenario); 2028–42: -9.8 (Baseline), -39.9 (Reform Scenario). ### Domestic revenue mobilization and tax policy (paragraph 16) - Domestic revenue averaged 11 percent of non-oil GDP during 2015–21; tax revenues have hovered around 8 percent since 2011. - Recommended tax policy measures: - Introduce a value-added tax. - Increase corporate income tax rates to levels more in line with regional peers. - Adopt a property tax once the land registry is complete. - Complementary administrative reforms: - Improve taxpayer registration and declaration filing; strengthen accountability and transparency; build human capacity; upgrade the tax procedure code. - Fiscal multiplier context: - Timor-Leste’s fiscal multiplier estimated to be close to 0.1-0.15; literature range 0.08-0.17. - Structural reforms impact: - Estimated positive impact on real GDP growth around 0.3 percentage points in the medium-term, and 2.5 percentage points over the long run. ### Public financial management, FRL, and governance - PFM weaknesses and reform priorities (Annex IV): - Large discrepancies between budget plans and execution. - Weak appraisal of public investment projects; lack of cost-benefit analysis. - Deficiencies in procurement management; e-procurement portal needs upgrading. - Proliferation of autonomous agencies undermines scrutiny and accountability. - Fiscal Responsibility Law (FRL): - Rationale: current fiscal framework failed to ensure sustainability; spending exceeding Petroleum Fund Law benchmark has been the norm. - Suggested FRL features: require commitment to a monitorable fiscal policy objective; require a strategy to achieve that objective; annual fiscal strategy; regular reporting; Minister of Finance to present written justification for changes invoking escape clauses. - "Finally, FRL provisions should, over time, be integrated with public finance legislation." - Transparency: - COVID-19 spending in 2021–22 should be reported in a full and timely manner, including online publication of its ongoing audit. ### Financial sector and regulatory reforms - Progress: - Transition from Basel I to Basel III regulatory framework is underway. - Central bank implemented a minimum loan-to-deposit ratio requirement of 35 percent by end-2023. - IFRS 9 adoption by banks expected to be completed by end-2022. - Financial inclusion and digitization: - Implementation of interbank electronic system P24 and approval of e-wallet operators; Digital Village Program launched in November 2020 to improve financial digital literacy. - Shortcomings: - Credit guarantee scheme viewed as unsuccessful. - No quarterly public reporting of financial soundness indicators. - No progress on cybersecurity, consumer protection, and data privacy legislation. ### Debt sustainability, stress tests, and contingency planning - DSA findings and stress tests: - Staff projects Petroleum Fund depleted by 2038 under baseline with 5 percent nominal return (2034 with 3 percent). - Under baseline, present value of external debt-to-exports and debt service-to-exports breach indicative thresholds in the medium term. - Tailored stress tests included commodity price shocks and a natural disaster scenario (assumes a natural disaster occurs in 2023 increasing public debt-to-GDP by 14 percent and GDP/exports decline). - Mechanical DSA rating "high" due to breaches; judgement upgrades to "moderate" given large Petroleum Fund assets mitigating near-term risk. - Policy recommendations from DSA: - Fiscal consolidation via expenditure rationalization and domestic revenue mobilization. - Structural reforms to improve business environment and competitiveness. - Strengthen public debt management, prepare MTDS, and improve monitoring of fiscal risks. ### Authorities’ views and recent fiscal actions - Authorities recognize the risk of depleting the Petroleum Fund and are committed to reforms but note difficulties in achieving political consensus. - Immediate 2022 fiscal measures responding to war in Ukraine spillovers (May 2022 revised budget): - Fuel subsidy for road, air, and maritime transport operators and for agricultural and fishing activities. - One-off universal family subsidy of $200 per household. - Expanded social protection payments for expectant mothers and children; expanded scholarships; more agriculture subsidies; more support for housing improvements. - Political economy: - Ministry of Finance’s proposed expenditure ceiling was 25 percent lower than the approved budget but was increased during parliamentary discussions. - Significant fraction of government spending is rigid and driven by legal obligations. - Institutional steps: - Major Planning Options Law and program budgeting expected to bring more predictability. - New procurement law effective January 2023. - Launched National Single Window of ASYCUDA World with UNCTAD support to improve revenue collection. ### Staff appraisal and sequencing - Fiscal consolidation should be gradual to balance sustainability with growth costs. - Complementary structural reforms can mitigate short-term growth costs and boost long-term private sector development. - Improve targeting of transfers and strengthen social safety nets to protect the vulnerable during consolidation. - Emphasize expenditure quality, prioritize growth-enhancing sectors (health, education, agriculture, tourism, digitalization), and continue public financial management reforms. *Italic: Source — 1tlsea2022001 (IMF staff report excerpts and annexes).* ### 2021. A well-progressing vaccination campaign has allowed the authorities to gradually ### 1tlsea2022001 - 2021. A well-progressing vaccination campaign has allowed the authorities to gradually ### Context - Timor-Leste rebuilt institutions and infrastructure since independence in 2002 after major disruption in 1999. - Major challenges: - Depleting oil revenues; active oil fields expected to cease producing oil revenues in 2023. - Underdeveloped non-oil private sector with informal and low-productivity employment. - Significant gaps in health and education; high youth unemployment. - High vulnerability to natural disasters posing fiscal risk. - Parliamentary elections in 2023 raise the importance of political consensus on reforms. - Response to Fund’s past advice has been mixed with slow progress in some areas (Annex VII). ### Recent developments - Vaccination and COVID containment: - As of June 21, 2022: "close to 72 percent of the adult population are fully vaccinated" and "85 percent have received at least one dose." - National state of emergency lifted on November 30; all COVID-related international travel restrictions lifted in March 2022. - Growth and output: - Non-oil real GDP is estimated to have grown by 1.5 percent in 2021, after a contraction of -8.6 percent in 2020. - Fiscal developments: - Fiscal deficit expanded from 30 percent of non-oil GDP in 2019 to 43 percent in 2021. - COVID-19-related spending explains about half of the increase in current spending in 2021 compared to 2019. - Prices and inflation: - Headline inflation reached 7.4 percent y/y in May 2022, the highest since 2012. - Government adopted a fuel subsidy in April 2022. - External and reserves: - Underlying non-oil current account deficit estimated at 42.7 percent of non-oil GDP in 2021, about 8.3 percent of non-oil GDP above the "norm" (Annex I). - International reserves at historically high levels; 2021 SDR allocation supplemented existing reserve assets, covering more than 11 months of prospective imports in 2022. - Authorities reported no intention to use the SDR funds. - Financial sector: - Private sector credit growth at 5.8 percent y/y in 2021, mainly lending to households. - Credit moratorium scheme ended in March 2022. - Nonperforming loan ratio at 2.5 percent in end-2021. - Capital adequacy and liquidity ratios remain comfortably above regulatory thresholds. ### Outlook and key projections (Baseline) - Near-term outlook: - Staff projects non-oil real GDP to grow 3.3 percent in 2022, supported by public spending and rebounding private consumption. - Oil revenues from active oil fields projected to cease in 2023. - Development of Greater Sunrise fields excluded from baseline projections (no approved development plans). - Fiscal deficit expected to remain broadly constant at 43 percent of non-oil GDP in 2022 and increase sharply in 2023–24 due to front-loading of public spending per the 2022 budget. - Current account balance to shift back to deficit in 2022 and in the medium term. - Inflation projected at 7 percent in 2022, reflecting higher food prices. - Fiscal and external sustainability are at high risk in the long term; Petroleum Fund financing is depleted under current policies in the long term. - Authorities’ projections: - Real non-oil GDP growth projected by authorities at 2.9 percent in 2022 and 3.1 percent in 2023. - Authorities project inflation at 6.7 percent in 2022 and expect it to decline to 3 percent in 2023. - Authorities are intensifying efforts to develop the Greater Sunrise fields but significant uncertainties remain. ### Risks - Risks are tilted to the downside (Annex II). Main risks include: - Re-intensification of the pandemic domestically or globally leading to reinstatement of COVID-19 restrictions. - Geopolitical tensions causing prolonged and/or heightened high oil and food prices (war in Ukraine effects). - Persistent high inflation in advanced economies tightening global financial conditions and impacting the Petroleum Fund balance. - Domestic political instability that could stall reforms. - Natural disasters that could slow the recovery. ### Policy recommendations — Fiscal sustainability and social protection - Fiscal sustainability is at high risk in the long term; recommended policy actions: - Reduce the level of government spending while protecting the most vulnerable. - Sustain vaccination efforts and safeguard investment crucial to development. - Anchor fiscal reforms on expenditure rationalization and revenue mobilization. - Improve quality of spending to enhance productive capacity and strengthen social safety nets for the most vulnerable. - Vaccination efforts should be sustained to mitigate impact of potential COVID-19 outbreaks. - Concerns on recent budget choices: - 2022 expenditure ceiling is $2.1 billion, 75 percent higher than average actual spending in 2017–2019, and three times larger than the estimated sustainable sources of revenue of $705 million. - Creation of a $1 billion Fund for Veterans from the Petroleum Fund reduces financing sources for the government. - 2022 budget includes a large increase in government transfers that are not targeted to the most vulnerable nor increase productive capacity. - Medium-term projections and risks: - Medium-term plans envisage persistent fiscal deficits leading to Petroleum Fund depletion over the long term. - Baseline projects fiscal deficit hovering between 30 and 68 percent of non-oil GDP during 2022–41, mainly financed by the Petroleum Fund. - Depletion of the Petroleum Fund by 2038 (assuming annual investment return of 5 percent) could force an abrupt reduction of the fiscal deficit by more than 30 percent of non-oil GDP; with a 3 percent return depletion occurs in 2034. ### Reform scenario and structural reforms - Staff reform scenario to transition to sustainable fiscal position over 10 years: - Target: withdrawals from the Petroleum Fund equal to 3 percent of resource wealth (Petroleum Fund balance plus projected NPV of petroleum revenues with approved development plans). - Revenue mobilization: - Domestic revenues reach 12 percent of non-oil GDP by 2027 and average close to 15 percent in 2028–42 (aligned with peer country experiences after tax reforms). - Expenditure moderation: - Government expenditure declines gradually to the 2019 level in the medium term and averages 63 percent of non-oil GDP in 2023–27 and 29 percent of non-oil GDP in 2028–42 (about 21 percentage points lower than baseline). - Public investment averages 16 percent of non-oil GDP in 2022–27, requiring better project selection. - Growth implications: - Real non-oil GDP growth is lower than the baseline averaging 1.6 percent over 2023–27 due to output costs of consolidation. - Long-term (2028–2042) growth under reform scenario projected to hover around 5-6 percent, significantly higher than baseline, driven by higher private investment and development of non-oil private sector. - Structural reform priorities to support private sector development: - Improve agricultural productivity. - Enhance the business environment. - Strengthen governance. - Tackle youth unemployment. - Facilitate financial deepening. - Invest in climate-resilient infrastructure. - Additional fiscal governance measures: - Better selection of investment projects and rigorous cost-benefit analysis (see ¶19 and Annex IV). - Improve tax policy and tax administration to mobilize domestic revenues (references to peer experiences). ### Staff appraisal and recommended sequencing - Fiscal consolidation should be gradual to balance fiscal sustainability with growth costs. - Complementary structural reforms can mitigate the short-term growth costs of consolidation and boost long-term growth and private sector development. - Improved targeting of transfers and strengthening social safety nets are crucial to protect the vulnerable during consolidation. - Emphasis on expenditure quality, prioritization of growth-enhancing sectors (health, education, agriculture, tourism, digitalization), and public financial management reforms. *DEMOCRATIC REPUBLIC OF TIMOR-LESTE — International Monetary Fund, July 28, 2022* ### 16. Domestic revenue mobilization should underpin fiscal consolidation. This includes ### 16. Domestic revenue mobilization should underpin fiscal consolidation. This includes ### Domestic revenue situation and tax policy recommendations - Domestic revenues averaged 11 percent of non-oil GDP during 2015–21. - Tax revenues have hovered around 8 percent since 2011. - Recommended tax policy measures (in line with previous IMF technical assistance): - Introduce a value-added tax. - Increase corporate income tax rates to levels more in line with regional peers. - Adopt a property tax once the land registry is complete. - Complementary administrative reforms recommended: - Improve taxpayer registration and declaration filing. - Strengthen accountability and transparency. - Build human capacity. - Upgrade the tax procedure code. ### Spending: level, quality, and policy priorities - Government expenditure should be reduced and the quality of spending improved to: - Enhance the productive capacity of the economy. - Protect the poor through targeted social safety nets. - World Bank Public Expenditure Review–aligned recommendations: - Prioritize spending on human capital (health and education) and strengthen social safety nets to protect the most vulnerable. - Contain the rise in the wage bill by restraining public employment. - Curb the budget for goods and services by improving procurement. - Cut public transfers that do not safeguard the poor. - Enhance selection of investment projects with robust cost-benefit analysis. - Fiscal multiplier context: - Timor-Leste’s fiscal multiplier (change in real non-oil GDP growth rate induced by a unit change in the primary balance, % GDP) is estimated to be close to 0.1-0.15, consistent with literature range of 0.08-0.17. Low multipliers indicate leakage into imports and/or low-quality spending reflecting supply-side constraints. - Structural reforms impact: - Estimated positive impact on real GDP growth around 0.3 percentage points in the medium-term, and 2.5 percentage points over the long run. ### Key macro-fiscal indicators (selected figures from baseline and reform scenarios) - Real non-oil GDP growth (in percent): - 2021: 1.5 - 2022: 3.3 - 2023-27: 1.6 (Baseline), 3.0 (Reform Scenario) - 2028-42: 5.5 (Baseline), 3.0 (Reform Scenario) - Revenue (excl. grants, percent of non-oil GDP): - 2021: 42.6 - 2022: 40.4 - 2023-27: 33.6 (Baseline), 31.8 (Reform Scenario) - 2028-42: 25.7 (Baseline), 15.3 (Reform Scenario) - Domestic revenue (percent of non-oil GDP): - 2021: 9.6 - 2022: 9.6 - 2023-27: 10.7 (Baseline), 9.7 (Reform Scenario) - 2028-42: 14.8 (Baseline), 10.5 (Reform Scenario) - Estimated Sustainable Income (percent of non-oil GDP): - 2021: 33.0 - 2022: 30.8 - 2023-27: 22.9 (Baseline), 22.1 (Reform Scenario) - 2028-42: 10.9 (Baseline), 4.8 (Reform Scenario) - Government expenditure (percent of non-oil GDP): - 2021: 85.8 - 2022: 95.3 - 2023-27: 62.5 (Baseline), 85.0 (Reform Scenario) - 2028-42: 29.1 (Baseline), 50.8 (Reform Scenario) - Recurrent expenditure (percent of non-oil GDP): - 2021: 77.5 - 2022: 79.0 - 2023-27: 46.9 (Baseline), 62.3 (Reform Scenario) - 2028-42: 21.9 (Baseline), 43.7 (Reform Scenario) - Capital expenditure (percent of non-oil GDP): - 2021: 8.3 - 2022: 16.3 - 2023-27: 15.6 (Baseline), 22.6 (Reform Scenario) - 2028-42: 7.3 (Baseline), 7.1 (Reform Scenario) - Net lending/borrowing (percent of non-oil GDP): - 2021: -43.2 - 2022: -54.9 - 2023-27: -28.9 (Baseline), -53.2 (Reform Scenario) - 2028-42: -3.5 (Baseline), -35.5 (Reform Scenario) - Financing (percent of non-oil GDP): - PF excess withdrawals: - 2021: 35.3 - 2022: 52.9 - 2023-27: 26.7 (Baseline), 51.1 (Reform Scenario) - 2028-42: 3.0 (Baseline), 25.0 (Reform Scenario) - Net incurrence of liabilities: - 2021: 1.1 - 2022: 2.0 - 2023-27: 2.2 (Baseline), 2.1 (Reform Scenario) - 2028-42: 0.5 (Baseline), 10.5 (Reform Scenario) - Petroleum Fund balance ($ million): - 2021: 18,949 - 2022: 17,446 - 2023-27: 16,553 (Baseline), 15,217 (Reform Scenario) - 2028-42: 17,768 (Baseline), 4,707 (Reform Scenario) - Current account balance (percent of non-oil GDP): - 2021: 2.5 - 2022: -15.3 - 2023-27: -31.6 (Baseline), -37.0 (Reform Scenario) - 2028-42: -9.8 (Baseline), -39.9 (Reform Scenario) ### Fiscal framework and Fiscal Responsibility Law (FRL) - Rationale for an FRL: - Current fiscal framework has failed to ensure sustainability; spending exceeding the Petroleum Fund Law benchmark has been the norm. - Discussion of an FRL in Parliament could raise awareness and catalyze action on fiscal sustainability. - Suggested FRL features (with IMF technical support): - Require government commitment to a monitorable fiscal policy objective (achieve a sustainable fiscal position at a specified point in time). - Require a strategy to achieve that objective (Annex III). - Annual fiscal strategy detailing fiscal developments, fiscal measures, and fiscal projections consistent with fiscal targets. - Regular reporting and explanation of fiscal outcomes and any strategy changes. - Minister of Finance must present written justification for changes in fiscal targets or temporary suspensions when escape clauses are invoked, including planned corrective actions and a timeline to return to targets. ### Public financial management (PFM) weaknesses and reforms - PFM progress to date: - Adoption of program budgeting. - New PFM law providing a structure for a more disciplined budget. - Ministry of Finance prepared an action plan for PFM reforms over the next four years. - Higher priority PFM reform areas: - Budget execution closer to budget plans. - Public investment management. - Procurement performance and monitoring. - Reducing fragmentation caused by proliferation of autonomous agencies (Annex IV). - Transparency and reporting: - COVID-19 spending in 2021–22 should be reported in a full and timely manner, including online publication of its ongoing audit on a specified and easily accessible website. ### Authorities’ views and recent fiscal actions - Immediate responses to war in Ukraine spillovers (2022 revised budget adopted in May): - Fuel subsidy for road, air, and maritime transport operators and for agricultural and fishing activities. - One-off universal family subsidy of $200 per household. - Expanded social protection payments for expectant mothers and children. - More support for housing improvements. - Expanded scholarships for all levels of education. - More agriculture subsidies to promote national production and reduce reliance on imports. - Political economy challenges: - Authorities agree on the need for more sustainable fiscal policy but note difficulties in reaching political consensus. - The 2022 budget and the Major Planning Options Law include a baseline scenario where the Petroleum Fund is depleted around 2035, leading to a fiscal cliff. - The Ministry of Finance’s proposed expenditure ceiling was 25 percent lower than the approved budget but was increased during parliamentary discussions. - A significant fraction of government spending is rigid and driven by legal obligations. - Authorities plan to explore adopting an FRL with IMF technical support. - PFM and institutional improvements underway: - Major Planning Options Law and program budgeting expected to bring more predictability to the budget process. - New procurement law effective January 2023 consolidates previous legislation to increase transparency and simplify procurement. - Launched National Single Window of ASYCUDA World with UNCTAD support to improve revenue collection and the environment for foreign investment. - COVID-19 spending for 2021–22 to be published after parliamentary approval of reports. *Italic: Source — 1tlsea2022001 - 16. Domestic revenue mobilization should underpin fiscal consolidation. This includes* ### 32. The authorities agreed that structural reforms and fiscal consolidation are needed to ### 1tlsea2022001 - 32. The authorities agreed that structural reforms and fiscal consolidation are needed to ### Agricultural sector and external position - Authorities view structural reforms and fiscal consolidation as needed to strengthen the external sector position. - Agricultural sector seen as crucial to increase exports and reduce imports. - Despite designation as a key productive sector and efforts over more than a decade, progress in increasing productivity has been very slow. - Planned investments to address structural issues: road connectivity, technology, and marketing of products. - Promotion of national agricultural production through the food basket distribution program is an important tool to increase domestic output. - Authorities’ view: a strong agricultural sector will be key to improving food security and protecting the economy from future crises. ### Anti-corruption progress and challenges - Community involvement in anti-corruption efforts is much stronger than in the past; many people send anonymous letters to the Anti-Corruption Commission motivated by campaigns. - Anti-Corruption Commission has been growing, but human and financial resource constraints remain a constraint for effective oversight and enforcement. - The second cycle of the United Nations Convention Against Corruption (UNCAC) is almost complete; a draft document is ready to be shared with the UN in coming weeks. - Procedural constraint: the Anti-Corruption Commission is required by the penal procedure code to seek approval of the Office of the Prosecutor General to start investigations; a higher number of prosecutors would help expedite the process. - The Anti-Corruption Commission requested technical assistance from the Fund to support implementation of their new anti-corruption law. ### Financial sector, digitization, and inclusion - Central bank priorities: promoting digitization and improving access to finance. - Implementation of interbank electronic system P24 and approval of e-wallet operators viewed as game changers for financial inclusion. - Digital Village Program launched in November 2020 to improve financial digital literacy. - Credit guarantee scheme viewed as unsuccessful; lack of awareness amongst borrowers seen as underlying cause. - Authorities believe banks should relax lending requirements and that the new minimum bank LDR requirement will help facilitate credit access. - IFRS 9 adoption by banks is expected to be completed by end-2022. - Plans to move from Basel I to Basel III are progressing. - Confirmation: Timor-Leste did not face any correspondent banking relationship pressures. ### Youth employment, education, and land reform - Authorities and staff agree on importance of providing good quality jobs to the large and growing youth population. - Vocational training centers established and have contributed to improving young people’s skills. - Efforts scaled up for youth workers to acquire work experience abroad; this has become an important employment strategy and source of remittances. - Creating long-term jobs requires improving quality of education and providing an enabling environment for entrepreneurship and private sector growth. - A new land registry reform, scheduled to come into effect next year, is expected to ease one of the main bottlenecks to access to finance for businesses. ### Climate change adaptation financing - Authorities stressed more support from the international donor community for climate change adaptation is needed in the form of grants. - Limited capacity makes fulfilling requirements to access such funds a challenge. - Authorities welcomed staff’s recommendation to build expertise and set up a dedicated unit to tap external climate grant-based financing. ### Dollarization: benefits and drawbacks - Authorities concurred that official dollarization has contributed to macroeconomic stability in Timor-Leste. - Perceived advantages: stabilizing inflation expectations, absence of exchange rate risk, potential benefits for importers if U.S. dollar appreciates, and promotion of fiscal discipline since there is no deficit financing from the central bank. - Perceived disadvantages: lack of monetary policy, loss of seigniorage, and high lending rates despite using the U.S. dollar as the official currency. - Authorities agreed it would be beneficial to consider the option of de-dollarization. ### Staff appraisal — economic recovery and projection - Progress with vaccination allowed lifting of strict containment restrictions and the economy is expected to continue its recovery. - Projection: Non-oil real GDP is projected to grow at 3.3 percent in 2022, after an estimated growth of 1.5 percent in 2021, supported by public spending and rebounding private consumption. ### Downside risks - Large downside risks remain, including: - Re-intensification of a health crisis. - Ongoing geopolitical tensions that could prolong and/or heighten high oil and food prices. - Domestic political instability that could stall reforms. - Natural disasters that could further slow the recovery. ### Fiscal sustainability, consolidation, and policy priorities - Fiscal consolidation and structural reforms needed to secure fiscal sustainability, strengthen the external sector position, and support smoother transition to a private sector-led economy. - External sector position in 2021 was substantially weaker than implied by fundamentals and desirable policy settings. - Active oil fields are drying up; oil revenues expected to cease in 2023. - The 2022 budget envisages large fiscal imbalances in the medium term that would deplete the Petroleum Fund in the long term, leading to a fiscal cliff. - Needed actions: domestic revenue mobilization and government expenditure rationalization in future budgets to underpin fiscal consolidation. - Government spending should prioritize investment projects to enhance productive capacity and programs to protect the poor. ### Public financial management (PFM) and structural reforms - Addressing PFM weaknesses is essential for strengthening fiscal management and improving quality of government spending. - High priority PFM reform areas: budget credibility, public investment management, procurement performance and monitoring, and reducing fragmentation from proliferation of autonomous agencies. - Authorities have adopted some PFM reforms and are committed to continuing with technical support from the Fund and other development partners. - Introduction of a Fiscal Responsibility Law (FRL) can help improve fiscal discipline by requiring the government to commit to a monitorable fiscal policy objective and lay out a strategy to achieve it. - Structural barriers to diversification and inclusive, resilient growth include: - Need to transform subsistence-oriented agricultural sector into a commercially viable sector, raise productivity, and enhance food security. - Improving the business environment and strengthening AML/CFT and anti-corruption effectiveness to foster private investment. - So far, private sector development and job creation progress has been tepid due to slow and limited reforms. - Investing in climate-resilient infrastructure is key, but adaptation plans have not been integrated into budgetary planning. - Coordination among public stakeholders and capacity constraints to access external grant-financing remain key challenges. *IMF staff report excerpt from the Democratic Republic of Timor-Leste country report section provided in the source content.* ### 43. It is proposed that the next Article IV consultation with Timor-Leste takes place on the ### It is proposed that the next Article IV consultation with Timor-Leste takes place on the standard 12-month cycle. ### Real Sector Developments - Oil production is part of GDP since September 2019, post the treaty on maritime boundaries with Australia. - The economy is showing signs of moderate recovery from the dual COVID-19 and natural disaster shocks in 2021. - Non-oil GDP dynamics: - Real Non-Oil GDP (annual percentage change): 2015: 2.8; 2016: 3.4; 2017: -; 2018: 3.1; 2019: -; 2020: 0.7; 2021 Est.: 2.1; (chart shows earlier years including -8.6 and 1.5 in other intervals). - Production contributions to Non-oil GDP growth (In percent): agriculture, manufacturing, construction, public administration, other* (2016–2020 series shown). - Inflation: - CPI (annual average) in Table 1: 2018: 2.3; 2019: 0.9; 2020: 0.5; 2021 Est.: 3.8; 2022 Proj.: 7.0; 2023 Proj.: 4.0. - CPI (end-period) in Table 1: 2018: 2.1; 2019: 0.3; 2020: 1.2; 2021 Est.: 5.3; 2022 Proj.: 7.0; 2023 Proj.: 4.0. - After remaining mute for several years, inflationary pressures have risen sharply in recent months reflecting increases in both domestic and international food and oil prices. - Food and non-food price indicators: - Food and Non-food Prices (In percent, y/y) series: monthly points 2017M5–2022M5 show rising headline, food, and non-food inflation. ### Fiscal Sector Developments - Summary points: - Non-oil domestic revenue has been financing a small fraction of government spending. - Share of capital spending has continued to fall, partly driven by low budget execution. - Recurrent spending has been increasing steadily since 2018 and jumped in 2021, driven by higher spending on transfers. - The execution rate for capital spending fell significantly in 2020-21 due to the pandemic and flood related disruptions. - With oil and gas receipts depleting in 2023, there is an urgent need to increase domestic revenues and pursue expenditure rationalization and prioritization to reduce excess withdrawals and avoid depleting the PF. - Key fiscal numbers (Table 1, percent of Non-oil GDP unless noted): - Revenue: 2018: 57.6; 2019: 51.6; 2020: 57.0; 2021 Est.: 54.1; 2022 Proj.: 51.9; 2023 Proj.: 46.9. - Domestic revenue: 2018: 12.0; 2019: 11.0; 2020: 11.4; 2021 Est.: 9.6; 2022 Proj.: 9.6; 2023 Proj.: 9.6. - Estimated Sustainable Income (ESI): 2018: 34.8; 2019: 31.0; 2020: 34.1; 2021 Est.: 33.0; 2022 Proj.: 30.8; 2023 Proj.: 25.8. - Grants: 2018–2023: 10.8; 9.5; 11.5; 11.5; 11.5; 11.5. - Expenditure: 2018: 84.0; 2019: 81.9; 2020: 82.6; 2021 Est.: 97.2; 2022 Proj.: 106.8; 2023 Proj.: 114.4. - Recurrent expenditure: 2018: 51.8; 2019: 54.0; 2020: 61.1; 2021 Est.: 77.5; 2022 Proj.: 79.0; 2023 Proj.: 62.4. - Net acquisition of nonfinancial assets: 2018: 21.4; 2019: 18.4; 2020: 10.0; 2021 Est.: 8.3; 2022 Proj.: 16.3; 2023 Proj.: 40.6. - Net lending/borrowing: 2018: -26.4; 2019: -30.3; 2020: -25.6; 2021 Est.: -43.2; 2022 Proj.: -54.9; 2023 Proj.: -67.6. - Petroleum Fund and projections (figures shown): - Revenue sources projections through 2027 include Domestic revenue, Petroleum Fund interest (after expense and tax, - valuation), Oil and gas receipts, Grants. - Petroleum Fund Balance (In millions of US dollars) series shown 2018–2027 with a projected decline after 2021. ### External Sector Developments - Current account and financing: - The current account deficit narrowed in 2021 due to higher-than-anticipated oil revenues. - Current account deficits have largely been financed by withdrawals from the PF (portfolio investment). - Balance of payments numbers (Table 1, $ million unless noted): - Current account balance: 2018: -191; 2019: 133; 2020: -308; 2021 Est.: 43; 2022 Proj.: -284; 2023 Proj.: -821. - Current account balance (In percent of Non-oil GDP): -128; -193; -15; -40 (series in table). - Trade of Goods: 2018: -589; 2019: -566; 2020: -510; 2021 Est.: -569; 2022 Proj.: -647; 2023 Proj.: -726. - Exports of goods: 2018: 25; 2019: 26; 2020: 17; 2021 Est.: 32; 2022 Proj.: 35; 2023 Proj.: 39. - Imports of goods: 2018: 613; 2019: 592; 2020: 527; 2021 Est.: 601; 2022 Proj.: 682; 2023 Proj.: 765. - Primary Income: 2018: 843; 2019: 1,126; 2020: 620; 2021 Est.: 925; 2022 Proj.: 718; 2023 Proj.: 305. - Other primary income (oil/gas): in Table 1 footnote series 1/ with values 5,10,7,5,6,3,2,4,7,2 (presented as varying entries across years in the table). - Overall balance: 2018: 129; 2019: -180.2; 2020: 78; 2021 Est.: 62; 2022 Proj.: 153. - External sector composition: - Non-oil exports rebounded in 2021 but remain volatile due to fluctuations in coffee exports. - Coffee Exports Value series (In millions of US dollars) shown for 2017–2022 with variability. - Goods imports composition: Fuels, Cereals (incl. rice), Other food, Machinery, Transportation, Metals, Garment, Other; fuel and food account for more than one-half of merchandise imports. - Real Effective Exchange Rate dynamics: NEER and REER contributions shown; REER had been appreciating since 2021H2 as the U.S. dollar strengthened vis-à-vis trading partners. - Public foreign assets (end-period) and import coverage (Table 1): - Public foreign assets: 2018: 16,477; 2019: 18,348; 2020: 18,946; 2021 Est.: 19,884; 2022 Proj.: 18,442; 2023 Proj.: 17,654. - Public foreign assets (In months of imports): 2018: 187; 2019: 212; 2020: 270; 2021 Est.: 275; 2022 Proj.: 218; 2023 Proj.: 181. ### Monetary and Financial Sector Developments - Banking sector and liquidity: - Both deposit and private sector credit growth remained strong. - Private sector credit growth largely driven by lending to individuals in public administration jobs. - Precautionary savings by the private sector during the pandemic increased deposits. - The banking sector is highly liquid with a large overseas placement of bank assets; overseas placement constitutes a significant share of banking sector assets. - NPLs continue to remain low. - Monetary aggregates and rates (Table 1 and charts): - Deposits (annual percent change): 2018: 2.8; 2019: -7.5; 2020: 10.1; 2021 Est.: 29.3; 2022 Proj.: 10.5; 2023 Proj.: 9.9. - Credit to the private sector (annual percent change): 2018: -3.8; 2019: 5.5; 2020: 10.1; 2021 Est.: 4.6; 2022 Proj.: 8.9; 2023 Proj.: 5.8. - Lending interest rate (percent, end of period) in Table 1: 2018: 14.5; 2019: 16.3; 2020: 11.3; 2021 Est.: 11.3; 2022 Proj.: 11.3; 2023 Proj.: 11.3. - Liquidity and placement indicators: Loans/deposit ratio, Overseas placement/total assets, Liquidity Ratios series shown (percent). ### Business Environment and Governance - Governance and resource management: - The governance of Timor-Leste’s Petroleum Fund is satisfactory by international standards. - Perceived governance of the public sector is improving but lags peers, with some vital areas of weaknesses. - Competitiveness and constraints: - Education and infrastructure gaps undermine competitiveness. - Political instability and limited financial access are major business constraints perceived by firms. - Top ten business environment constraints (percent of firms choosing as their biggest obstacles, 2021) include: Political instability; Access to finance; Electricity; Labor regulations; Practices of the informal sector; Tax administration; Transportation; Corruption; Customs and trade regulations; Tax rates. - Structural indicators and labor productivity: - Employment and Real GDP share (2016) show a large share of population employed in agriculture and services but their GDP share remains small, driven by very low labor productivity. - Global and regional indicators presented: Resource Governance Index (Timor-Leste: 49); Governance Indicators rescaled (Voice and Accountability, Political Stability, Government Effectiveness, Regulatory Quality, Rule of Law, Control of Corruption) for 2017 and 2020. ### Challenges to Growth — Comparison with Regional Peers - Infrastructure and services: - Access to electricity improved considerably and electricity tariffs are largely subsidized, but losses due to electrical outages are high. - The perceived quality of infrastructure is lower than regional peers. - Digital and connectivity: - Mobile penetration is high but digital adoption in business is at a low level. - Access to the internet is low and service quality is poor. - Comparative indicators: - Access to Electricity (In percent of population, 2019) and Value of Loss due to Electrical Outages (In percent of sales of affected firms, 2015) show Timor-Leste’s relative position against peers. - Quality of Infrastructure (Score 1–7) and Digital Adoption Index (Rank out of 183, 2016) presented with comparative ranks. ### Social and Human Development - Human development and education: - Timor-Leste’s Human Development Index (HDI) improved steadily until mid-2010s but has been stagnating recently. HDI series: 2000–2019 plotted versus regional and world averages. - HDI Components (2019) show lags in mean years of schooling and expected years of schooling versus peers. - Youth literacy and primary completion milestones: Youth literacy (% of total, 2018) and primary completion rate (2010–20 average) with Timor-Leste 2018 primary completion rate: 100%. - Health and poverty: - Health expenditure (In percent of GDP, 2019) comparative chart includes Timor-Leste and selected developing Asian economies. - Poverty Headcount Ratio at $1.90 a Day (Percent of population, 2011 PPP) indicates poverty levels among the highest in the region. - Labor force: - Labor force participation has increased over the years but there is significant scope for further improvements. ### Key Macroeconomic Indicators and Projections (selected from Table 1) - Non-oil GDP at current prices (2020): US$1.595 billion. - Population (2020): 1.318 million. - Non-oil GDP per capita (2020): US$1,210. - Quota: SDR 25.6 million. - Nominal Non-oil GDP (in millions of U.S. dollars): 2018: 1,584; 2019: 1,704; 2020: 1,595; 2021 Est.: 1,681; 2022 Proj.: 1,858; 2023 Proj.: 2,043. - Annual percent change: -3.9; 5.5; -8.2; 3.4; 8.5; 7.9 (2018–23). - Crude oil prices (U.S. dollars per barrel, WEO) 3/: 68, 61, 41, 69, 10, 69, 5 (table entries presented across years). - Petroleum Fund balance (in millions of U.S. dollars) 4/: 2018: 15,803; 2019: 17,692; 2020: 18,289; 2021 Est.: 18,949; 2022 Proj.: 17,446; 2023 Proj.: 16,504. - (In percent of Non-oil GDP): 2018: 998; 2019: 1,038; 2020: 1,146; 2021 Est.: 1,127; 2022 Proj.: 939; 2023 Proj.: 808. - Public debt (in millions of U.S. dollars): 2018: 145; 2019: 193; 2020: 218; 2021 Est.: 237; 2022 Proj.: 274; 2023 Proj.: 321. - (In percent of Non-oil GDP): 9.1; 11.3; 13.7; 14.1; 14.7; 15.7. - Population growth (annual percent change): 2018–23 series: 2.0; 2.0; 2.0; 1.9; 1.9; 1.9. *Source: IMF staff estimates, projections, and Timor-Leste authorities (content unit: 1tlsea2022001).* ### Annex I. External Sector Assessment ### Annex I. External Sector Assessment ### Overall Assessment - The external position of Timor-Leste in 2021 was substantially weaker than the level implied by fundamentals and desirable policies. - The weak external sector position reflects large fiscal imbalances and the underdevelopment of the non-oil economy. - The prospect of large and persistent current account deficits put external sustainability at risk. - Potential policy responses: Fiscal consolidation and structural reforms to promote private sector development and the diversification of the economy should help external rebalancing and reduce the current account gap. ### Foreign Assets and Liabilities: Position and Trajectory - Net international investment position (NIIP) by end-2021: $19.8 billion (1,179 percent of non-oil GDP), $1.0 billion higher than by end-2020. - External assets: $21.1 billion (1,258 percent of non-oil GDP). - Portfolio investment (Petroleum Fund): $19.0 billion (1,131 percent of non-oil GDP). - Direct investment assets: $0.06 billion (3 percent of non-oil GDP). - Currency and deposits: $1.1 billion (67 percent of non-oil GDP). - Foreign reserves (central bank): $0.9 billion (56 percent of non-oil GDP). - External liabilities: $1.3 billion (79 percent of non-oil GDP). - Foreign direct investment liabilities: $0.9 billion (55 percent of non-oil GDP). - Loans: $0.26 billion (15 percent of non-oil GDP). - Other liabilities: 9 percent of non-oil GDP. - Petroleum Fund financial market composition (end-2021): 30 percent stocks, 64 percent bonds, 6 percent U.S. dollar cash. - NIIP change during 2016–21: increased by $3.2 billion, explained by $1.1 billion flows from the financial account and $2.1 billion from valuation effects. - Assessment: NIIP is projected to decline in 2022 and in the medium term under current policies as large and persistent current account deficits will steadily erode the NIIP. ### Current Account - Historical balances: - Current account balance: improved from -33 percent of non-oil GDP in 2016 to 8 percent in 2019; declined to -19 percent of non-oil GDP in 2020. - Current account balance excluding oil revenues: averaged -42.1 percent of non-oil GDP during 2016–20. - Current account balance in 2021: surplus of 2.5 percent of non-oil GDP driven by higher-than-expected oil revenues. - Current account excluding oil revenues in 2021: -40.3 percent of non-oil GDP (around 1.8 percentage points higher than the 2016–20 average). - Oil revenues from active fields expected to decline fast and vanish in 2023. - Preferred current account norm approach (annuity of total wealth): - Net foreign assets by end-2020: $18.8 billion. - Present value of oil revenues by end-2020: $0.5 billion. - Total wealth: $19.3 billion. - Implicit real return on total wealth assumed: 3 percent. - Current account deficit (excluding oil revenues) norm in 2021: around $579 million (34.4 percent of non-oil GDP). - Actual current account deficit excluding oil revenues in 2021: 40.3 percent of non-oil GDP. - Underlying current account deficit excluding oil revenues in 2021: about 42.7 percent of non-oil GDP (actual 40.3 percent plus deviation from recent trends -2.5 percent). - EBA-Lite regression results (2021): - Current account gap: -29.8 percent of non-oil GDP. - Current account norm (EBA-Lite): 28.0 percent of non-oil GDP. - Policy gap (part of EBA-Lite result): -12.0 percent of non-oil GDP. - Unexplained residual from EBA-Lite: 17.8 percent of non-oil GDP. - Residual mean squared error (2008–21): 195 percent. - 90-percent confidence band around EBA-Lite current account norm of 28.0 percent of non-oil GDP encompasses the preferred estimate of a current account norm of 8.4 percent of non-oil GDP. - Note: a current account norm of 8.4 percent of non-oil GDP equals the current account deficit norm excluding oil revenues of 34.4 percent of non-oil GDP plus oil revenues of 42.8 percent of non-oil GDP. - Assessment: Current account gap in 2021 estimated at -8.3 percent of non-oil GDP, indicating the external sector was substantially weaker than fundamentals and desirable settings. - Policy implication reiterated: Fiscal consolidation and structural reforms to promote private sector development and diversify the economy should help improve competitiveness and reduce the current account gap. ### Real Exchange Rate (REER) - REER movements: - REER appreciated by about 2 percent during 2016–20 amid a nominal effective exchange rate (NEER) appreciation of about 5 percent. - CPI inflation in Timor-Leste was lower relative to trading partners, offsetting some REER appreciation from a stronger U.S. dollar. - REER in 2021: depreciated 0.1 percent year over year. - NEER in 2021: appreciated 2.2 percent year over year. - Assessment: Using a standard trade elasticity of -0.17, a current account gap at -8 percent of GDP is equivalent to a REER gap of about 48 percent. ### Capital and Financial Accounts: Flows and Policy Measures - Background: - Portfolio inflows have been the main source of financing of current account deficits since 2016 and consist of withdrawals from the Petroleum Fund. - FDI inflows since 2016 have been small (excluding 2019 one-off big outflow), averaging 2 percent of non-oil GDP. - Assessment: No major vulnerabilities related to capital flows in the short and medium term given the large size of the Petroleum Fund. Nonetheless, the current account deficit projected under the baseline is unsustainable in the long term. ### FX Intervention and Reserves Level - Reserves at end-2021: $935 million. - Equivalent to about 12 months of imports of goods and services. - 84 percent of broad money. - 395 percent of external debt. - 56 percent of non-oil GDP. - Assessment: - Template to Assess Reserve Adequacy in Credit-Constrained Economies indicates the optimal level of reserves for Timor-Leste is around 12 months of imports, much higher than the traditional metric of 3 months of imports. - The template’s benefit calculation depends on the fiscal deficit, which for Timor-Leste is very large. - The template does not account for the Petroleum Fund worth 240 months of imports. - Non-oil GDP estimate for 2021: about $1.7 billion. ### Key Policy Recommendations and Actions - Fiscal consolidation to reduce large fiscal imbalances and persistent current account deficits. - Structural reforms to promote private sector development and diversify the non-oil economy. - Mobilize domestic revenue to reduce reliance on the Petroleum Fund for financing government spending. - Carefully assess benefits, costs, and risks before committing to large public investments, especially if new significant oil revenues (e.g., Greater Sunrise) materialize. - Strengthen project appraisal, public financial management, and transparency to limit off-budget fiscal risks and improve fiscal sustainability. *Source: Annex I. External Sector Assessment (content unit: 1tlsea2022001).* ### 7. Finally, FRL provisions should, over time, be integrated with public finance legislation. ### 1tlsea2022001 - 7. Finally, FRL provisions should, over time, be integrated with public finance legislation. ### Fiscal Responsibility Legislation (FRL) and Public Finance Law Integration - A case can be made for consolidating all or some of FRL provisions into umbrella budget or public finance laws, since FRLs are, for the most part, a response to shortcomings of such laws. - Incorporating the procedural rules of an FRL into a budget or public finance law would streamline and simplify legislation and constitute good transparency practice. *Annex IV. Public Financial Management Reform Priorities* ### Public Financial Management (PFM) — overall assessment - The Public Expenditure and Financial Accountability assessment (PEFA) has been conducted several times; the latest assessment from 2020 showed that the overall performance has stalled and even deteriorated in specific areas. - Public Financial Management systems have multiple dimensions; Timor-Leste has room for improvement in each dimension. Prioritization of reform efforts is important given limited absorptive capacity and technical assistance resources. ### Outstanding PFM issues (enumerated) - 1. Large discrepancies between budget plans and budget execution. - The aggregate spending outturn is usually well below the aggregate spending planned in the budget. - The composition of government spending outturns deviates from budget plans because of budget rectifications and virements. - These discrepancies undermine the reliability of the budget as a policy instrument. - 2. Weak appraisal of public investment projects. - Many projects are not subject to cost-benefit analyses, leading to low returns from public investment. - The budget for public investment projects is prepared by the Ministry of Planning while the budget for recurrent spending is prepared by the Ministry of Finance. - This separation leads to unfunded recurrent costs (e.g., operations and maintenance) of public investment projects. - 3. Deficiencies in procurement management. - About 40 percent of government spending comprises goods, services, and capital goods and is done via procurement. - An e-procurement portal has been in place since 2011 to increase access to procurement information and promote transparency. - The portal does not provide a complete and reliable record in real time of the contracts awarded. - Upgrading the e-procurement portal is warranted for more efficient procurement. - 4. Proliferation of autonomous agencies. - Since 2015, several autonomous agencies were created to support line ministries aiming to make public services delivery more efficient. - Resources transferred to those agencies are not scrutinized with the same degree of detail and their spending is not subject to the same reporting requirements as are line ministries, undermining governance and accountability. *Annex V. Assessment of the Exchange Rate Regime* ### Exchange rate regime — summary judgment - Timor-Leste’s adoption of the US dollar as legal tender has eliminated exchange rate volatility, facilitated trade, and supported macroeconomic stability over the last 20 years. - Dollarization also has disadvantages including the inability to use monetary and exchange rate policy. - While it would be premature for Timor-Leste to adopt a national currency, there are merits in exploring necessary steps. ### Key points on dollarization and implications (enumerated) - 1. Rationale for adopting the US dollar. - After the independence referendum in 1999 there were at least three currencies in circulation: the Australian dollar, the US dollar, and the Indonesian rupee. - Under the UN Transitional Administration—and following advice from the IMF—it was decided to adopt a full dollarization regime. - The US dollar as legal tender had at least three advantages: i) stable value, ii) wide international use, and iii) facilitator of trade in an economy in which the export base is concentrated in a few volatile commodities, including oil and coffee, that are priced in US dollars. - 2. Dollarization outcomes. - Dollarization helped achieve price stability and eliminated exchange rate volatility and risks of any sudden, sharp devaluation of the country’s exchange rate. - Average annual inflation during 2001–21 was 4.5 percent. - The real effective exchange rate has been relatively stable over the past few years and domestic inflation has been low. - 3. Disadvantages of using the U.S. dollar as legal tender. - Absence of monetary policy as an instrument for macroeconomic stabilization, leaving fiscal policy as the only instrument. - Seigniorage revenue forgone from the monopoly power to print money. - Developing countries in East Asia and the Pacific region that rely on monetary policy to respond to shocks and restore equilibrium in the domestic economy usually collect seigniorage revenues of about 1-2 percent of GDP. - Inability to rely on exchange rate policy to mitigate the adverse impact from external shocks (e.g., higher food prices) to facilitate the adjustment of the real exchange rate and restore external equilibrium without causing domestic deflation. - 4. Merits of laying groundwork for a national currency. - Setting up a monetary policy framework can build knowledge about legal basis, and the design, implementation, and communication practices of monetary policy. - Need to develop data and analytics for implementing monetary policy; exploring and setting up the technical framework to conduct interest rate policy would induce a significant learning curve and capacity building. - Strengthening expertise and capacity at the central bank to conduct independent monetary policy effectively is needed. - Beneficial to get fiscal position back on a sustainable footing before adopting a national currency; otherwise an unsustainable fiscal stance would make it very challenging for the central bank to manage monetary policy consistent with price stability. - 5. Practical steps and operational challenges for currency introduction. - The central bank could start developing a strategy—such as in the form of a White Paper—to explore the necessary steps to introduce a national currency and raise awareness. - Decisions include production of a new national currency: design, choice of printer and its location, initial value of the currency, and the denomination of the bank notes. - Conversion metrics to set include the choice of date to begin circulation of the new currency, the conversion period, how to deal with potential speculative inflows and limits on the conversion of bank notes, and the operations of the foreign exchange market. *Annex VI. Integration of Capacity Development and Surveillance* ### Area-specific surveillance recommendations and capacity development links (bullet list format) - Tax Policy - Surveillance recommendation: Adopt a single rate VAT (paragraph 16). - Capacity development: The Fund is ready to provide technical assistance through the Pacific Financial Technical Assistance Center (PFTAC). - Tax Administration - Surveillance recommendation: Strengthen tax administration to improve tax compliance (paragraph 16). - Capacity development: The Fund provided a diagnostic review of tax administration in November 2021 and is following up with short-term expert assistance. - Fiscal Responsibility Legislation - Surveillance recommendation: Adopt a well-designed Fiscal Responsibility Law to improve fiscal discipline (paragraph 18). - Capacity development: The Fund is ready to provide technical assistance through the Fiscal Affairs Department. - Public Financial Management (PFM) - Surveillance recommendation: Address PFM weaknesses to improve the quality of government spending (paragraph 19). - Capacity development: The Fund provided technical assistance through the Fiscal Affairs Department and PFTAC in April 2022 to finalize a Public Financial Management Strategy and Action Plan. - Governance in AML/CFT - Surveillance recommendation: Strengthen the AML/CFT regime (paragraph 24). - Capacity development: The Fund is providing technical assistance through the Legal Department. - Banking Sector Regulation and Financial Supervision - Surveillance recommendation: Enhance prudential standards and risk assessment methodologies to capture emerging risks in the financial sector (paragraph 27). - Capacity development: The Fund is ready to provide technical assistance through PFTAC. - Statistics for BOP and GFS - Surveillance recommendation: Improve the quality of external sector statistics and government finance statistics (paragraph 31). - Capacity development: The Fund provided technical assistance on external sector statistics in May–June 2021 and June 2022 and on government finance statistics in March–April 2022 through the Statistics Department. - Financial Soundness Indicators (FSI) - Surveillance recommendation: Release FSI data without delay (paragraph 31). - Capacity development: The Fund is ready to provide technical support through the Statistics Department. - Macroeconomic Analysis - Surveillance recommendation: Develop stronger analytical skills and better macroeconomic forecasting and policy analysis (paragraph 31). - Capacity development: The Fund’s Institute for Capacity Development (ICD) is providing technical assistance through the Singapore Training Institute and PFTAC to build a Financial Programing model for own use by the authorities. *Annex VII. Responses to Past Fund Advice* ### Selected Fund recommendations and observed policy actions - Fiscal Policy - Fund recommendation: Fiscal consolidation and gradual exit from Petroleum Fund (PF) excess withdrawals. - Policy action: The medium-term fiscal plans in the 2022 budget continue to envisage persistent fiscal deficits financed by large PF excess withdrawals. - Revenue mobilization and expenditure rationalization - Fund recommendation: Revenue mobilization and expenditure rationalization. - Policy actions: - Raised taxes on alcohol and tobacco. - Launched the National Single Window of ASYCUDA World to improve revenue collection. - Working on a VAT draft legislation and a new tax procedure code. - The 2022 budget includes a large increase in public transfers that are not targeted to the most vulnerable and do not increase the productive capacity of the economy. - Implemented a new PFM law and program budgeting. - Strengthen public financial management (PFM) - Fund recommendation: Strengthen PFM. - Policy actions: - Adopted the Major Planning Options Law to help bring more predictability to the budget process. - A new Procurement and Public Contract Law, effective January 2023, aims to increase transparency and simplify the procurement process. - Financial Policies - Fund recommendation: Upgrade the financial sector regulatory and supervisory framework. - Policy action: IFRS 9 implementation is expected to be completed by end- *Source: 1tlsea2022001 - 7. Finally, FRL provisions should, over time, be integrated with public finance legislation.* ### 2022. Progress is being made to switch from Basel I to Basel ### 2022. Progress is being made to switch from Basel I to Basel III regulatory framework. ### Financial sector reform and access to finance - Progress: Transition from Basel I to Basel III regulatory framework is underway. - Credit guarantee scheme: Implemented in 2019-20 has been ineffective. - Regulatory policy: The central bank implemented a minimum loan-to-deposit ratio requirement of 35 percent by end-2023 for all financial institutions. - Financial soundness reporting: No quarterly public reporting of financial soundness indictors. ### Digital financial inclusion, cybersecurity, and consumer protection - Digital literacy: Launched the Digital Village Program to improve financial digital literacy. - Cybersecurity and data protection: No progress on cybersecurity, consumer protection, and data privacy legislation. ### Structural reforms and governance - Priority reform areas recommended: - Investment in human capital. - Raise productivity in the agriculture sector. - Create a conducive business environment including simplified licensing requirements and land registration. - Stronger governance and better enforcement of legal contracts. - Labor market reforms. - Investment in digital infrastructure. - Progress status: - A new anti-corruption law is in place. - A new land registry reform is scheduled to come into effect in 2023. - Other reform areas lack progress. ### Statistics and data quality - Overall assessment: Progress remains slow and incomplete. - Specific issues and status: - Improve the quality of data for informed policy making. - Interagency coordination and data sharing remain weak. - No quarterly public reporting of financial soundness indictors. - Data adequacy for surveillance (As of June 2022): - General: Data provision to the IMF is broadly adequate for surveillance, with concerns including incomplete incorporation of petroleum-related transactions in the balance of payments compilation following the new Maritime Boundary Treaty, weaknesses in compilation and dissemination of government finance statistics, and no public reporting of financial soundness indicators. - National Accounts: GDP compiled annually using base period 2015 and methods consistent with the 2008 System of National Accounts. 2019 national accounts published in October 2020; preliminary 2020 GDP estimates published in April 2021; preliminary 2021 GDP estimates published in March 2022. National accounts assume oil production at the Joint Petroleum Development Area (JPDA) is resident in Timor-Leste since September 2019 as a result of the Maritime Boundary Treaty signed in August 2019. - Price Statistics: Monthly national CPI uses expenditure weights derived from 2014–15 Living Standard Survey. Basket rebased to August 2018 (i.e., August 2018 = 100). - Government Finance Statistics (GFS): Annual GFS has not been compiled and disseminated; 2019 central government data are the latest submitted. A GFS technical assistance mission in March-April 2022 assisted compilers. Quarterly GFS compilation and dissemination deferred; last publication of quarterly GFS data was Q3/2016. Timor-Leste does not report to the Quarterly Public Sector Debt database. - Monetary and Financial Statistics: Central bank compiles MFS generally following the Monetary and Financial Statistics Manual and Compilation Guide. Detailed monthly monetary data for the central bank and other depository corporations are reported timely. Data for other financial corporations (mainly insurance companies) are not compiled. - Financial Sector Surveillance: Only basic market-based indicators are available; data insufficient to conduct stress tests of the banking system or Balance Sheet Approach analysis. Cross border exposure data for financial corporations are not available. - External Sector Statistics: Central bank published balance of payments data until Q4/2021 reflecting the new treatment of JPDA companies’ activities and the Greater Sunrise project. Treatment appears incomplete and does not properly incorporate contra entries on imports of goods and services, direct investment income payments, and direct investment. Monthly merchandise trade data published regularly based on the Automated System for Customs Data. Service transactions are largely estimated with limited data collection. Quarterly balance of payments available for 2006–Q1/2022; international investment position for 2008–Q1/2022. - Remittances: Publicly available information on remittances from Timorese working abroad is limited; improvement in estimation and compilation procedures recommended. CDOT TA mission in June 2019 provided guidance on remittance estimation models and data collection from money transfer operators. ### Fund relations and macro-financial context (selected facts) - Membership Status: Joined July 23, 2002; Article VIII. - Quota: 25.60 SDR Million (100.00 percent of Quota). - IMF Holdings of Currency (Holdings rate): 21.25 SDR Million (83.01 percent). - Reserve Tranche Position: 4.35 SDR Million (17.00 percent). - SDR Department Net Cumulative Allocation: 32.26 SDR Million (100.00 percent); Holdings 27.93 SDR Million (86.55 percent). - Outstanding Purchases and Loans: None. - Latest Financial Commitments: None. - Projected Payments to Fund (SDR Million; based on existing use of resources and present holdings of SDRs): - Charges/Interest: 2022 0.02; 2023 0.04; 2024 0.04; 2025 0.04; 2026 0.04. - Total: 2022 0.02; 2023 0.04; 2024 0.04; 2025 0.04; 2026 0.04. - Exchange rate arrangement: Exchange arrangement with no separate legal tender. The U.S. dollar is legal tender and circulates freely. Monetary authority does not undertake foreign exchange transactions; handled by commercial banks. Timor-Leste has accepted obligations under Article VIII, Sections 2(a), 3 and 4. - Article IV consultations: Last consultation concluded July 9, 2021. Timor-Leste is on the standard 12-month consultation cycle. ### Debt sustainability and macro-fiscal outlook (selected findings and projections) - Risk ratings (Joint Bank-Fund Debt Sustainability Analysis): - Risk of external debt distress: Moderate. - Overall risk of debt distress: Moderate. - Granularity in the risk rating: Limited space to absorb shocks. - Application of judgement: Yes. Petroleum sovereign wealth fund is a strong mitigating factor for the country’s debt sustainability in the next 10 years. - Key fiscal and debt facts: - Petroleum Fund balance at end-2021: $18.9 billion (1,127 percent of non-oil GDP), covering 240 months of prospective goods and services imports. - Petroleum Fund balance increased by $0.7 billion in 2021 as investment income ($1.1 billion) and oil revenues ($0.7 billion) more than compensated for transfers to the budget ($1.2 billion). - Average nominal return on Petroleum Fund assets during 2017–21: 7.4 percent. - Fiscal deficit: Increased from 26 percent of non-oil GDP in 2020 to 43 percent in 2021. - Outstanding public external debt in 2021: $237 million (14 percent of non-oil GDP); outstanding public external debt increased by $18 million in 2021. - External loans signed 2012–2021 totaled $708 million (concessional loans from ADB, World Bank Group, and JICA). - Share of external debt held by Asian Development Bank: nearly 67 percent of total external debt agreements to date. - Average maturity of existing loans: 25.5 years, with grace periods ranging from 5 to 10 years. - Debt service payments on existing debt average $20 million (close to 1.2 percent of non-oil GDP) per annum in the medium term, and declines thereafter. - Staff assessment and outlook: - Timor-Leste remains at moderate risk of overall and external debt distress, unchanged from the 2021 Article IV DSA when applying judgement. - The present value of external debt-to-exports ratio and the debt service-to-exports ratio under the baseline are projected to breach their respective indicative thresholds in the medium-term, triggering a high-risk mechanical rating for external and overall debt. - The Petroleum Fund is large relative to projected debt levels and debt service requirements in the medium-term, acting as a mitigating factor and prompting the use of judgement to upgrade the risk assessment. - Long-term risks to debt sustainability have increased compared to the 2021 Article IV DSA, reflecting higher projected fiscal deficits and a faster depletion of the Petroleum Fund. - Staff projects that the Petroleum Fund will be depleted in 2038, triggering a breach of all debt indicators towards the end of the twenty-year projection horizon. - Staff’s alternative scenario illustrates how fiscal consolidation and structural reforms can ensure both fiscal and debt sustainability in the long term. - Macroeconomic and fiscal assumptions (selected entries from Text Table 2; Current (2022 Article IV) vs Previous (2021 Article IV)): - Real non-oil GDP growth (in percent): 2021 1.5; 2022 3.3; 2023-27 2.9; 2028-42 3.0 (previous: 2020 -7.6; 2021 1.8; 2022-26 2.8; 2027-41 3.0). - CPI inflation: 2021 5.3; 2022 7.0; 2023-27 2.5; 2028-42 2.0 (previous: 2020 1.2; 2021 2.0; 2022-26 2.3; 2027-41 2.0). - Revenue (excl. grants, percent of non-oil GDP): 2021 42.6; 2022 40.4; 2023-27 30.0; 2028-42 15.3 (previous: 2020 46.4; 2021 47.1; 2022-26 39.3; 2027-41 22.1). - Government expenditure (percent of non-oil GDP): 2021 85.8; 2022 95.3; 2023-27 82.9; 2028-42 50.8 (previous: 2020 72.5; 2021 93.1; 2022-26 81.6; 2027-41 53.2). - Recurrent expenditure (percent of non-oil GDP): 2021 77.5; 2022 79.0; 2023-27 59.0; 2028-42 43.7 (previous: 2020 62.3; 2021 74.6; 2022-26 57.4; 2027-41 42.5). - Capital expenditure (percent of non-oil GDP): 2021 8.3; 2022 16.3; 2023-27 23.9; 2028-42 7.1 (previous: 2020 10.2; 2021 8.6; 2022-26 24.2; 2027-41 10.8). - Net lending/borrowing (percent of non-oil GDP): 2021 -43.2; 2022 -54.9; 2023-27 -52.9; 2028-42 -35.5 (previous: 2020 -26.1; 2021 -46.1; 2022-26 -42.3; 2027-41 -31.2). - Net incurrence of liabilities (percent of non-oil GDP): 2021 1.1; 2022 2.0; 2023-27 2.1; 2028-42 10.5 (previous: 2020 1.6; 2021 3.8; 2022-26 2.8; 2027-41 0.5). - Petroleum Fund balance ($ million): 2021 18,949; 2022 17,446; 2023-27 14,771; 2028-42 4,707 (previous: 2020 18,991; 2021 18,785; 2022-26 17,553; 2027-41 10,415). - Current account balance (percent of non-oil GDP): 2021 2.5; 2022 -15.3; 2023-27 -41.4; 2028-42 -39.9 (previous: 2020 -19.3; 2021 -31.6; 2022-26 -39.4; 2027-41 -32.2). *Prepared by Staff of the International Monetary Fund and the International Development Association* ### 5. The macro-fiscal outlook has worsened significantly compared to the 2021 Article IV ### 5. The macro-fiscal outlook has worsened significantly compared to the 2021 Article IV ### Key revisions and recent developments - Petroleum Fund outstanding balance at end-2020 lowered by about USD$701 million (close to 4 percent of the Petroleum Fund balance) as the investment in the Greater Sunrise oil fields by Timor-Gap (the national oil company) financed by the Petroleum Fund was written down to zero. - The 2022 budget envisages much larger fiscal deficits in the medium term compared to the previous debt sustainability analysis, mainly financed by withdrawals from the Petroleum Fund. - In May 2022, the government approved the creation of the National Liberation Combatants Fund worth $1 billion with a transfer from the Petroleum Fund to finance support programs for war veterans. ### Macroeconomic assumptions - Real non-oil GDP: - Projected to grow by 3.3 percent in 2022. - Projected to hover in the range of 2.4–4.2 percent in the medium term (2022–27). - Over the long term (2028–2042), growth projected to stabilize at around 3 percent. - Oil production from active fields projected to decline sharply in 2022 and cease in 2023. - Inflation: - Increased to 5.3 percent y/y by end-2021. - Expected to pick up further in 2022–23 and then converge to 2 percent over the medium and long term. - Fiscal balance: - Projected to remain in deficit of about 53 percent over 2023–27. - Fiscal deficit projected to increase from 43 percent of non-oil GDP in 2021 to 55 percent in 2022. - Over 40 percent of the total budget is for government transfers. - Fiscal deficit projected to narrow gradually to about 35 percent on average over 2028–42. - Current account: - Expected to shift back to a deficit in 2022 and in the medium term; long-term deficit gradually declines. - External financing: - Consists of concessional loans from official creditors; private external borrowing assumed negligible. - No exceptional financing such as accumulation of arrears; no domestic financing. - Grant element of loans assumed to decline moderately over the medium term. - No off-budget debt is accumulated including by state-owned enterprises in line with existing legislation. ### Baseline fiscal scenario and projections - Spending assumptions: - Baseline assumes lower spending than planned under the 2022 budget, reflecting historical execution rates. - Capital and recurrent spending in 2022–26 assumed on average close to 70 percent and 85 percent of the planned amount in the 2022 budget, respectively. - Petroleum Fund: - Annual nominal investment return on the Petroleum Fund assumed to be around 5 percent. - Petroleum Fund falls to $13.2 billion by 2027. - Petroleum Fund completely depleted by 2038; after depletion the government assumed to rely on external debt. - In the previous debt sustainability analysis, the Petroleum Fund was not depleted during the 20-year projection horizon. - Revenues and spending: - Government revenues projected to decline from 43 percent of non-oil GDP in 2021 to about 30 percent on average over 2023–27 and to 15 percent on average over 2028–42. - Domestic revenues currently at 10 percent of non-oil GDP assumed to grow broadly in line with nominal non-oil GDP. - Government has signaled intention to raise non-oil revenues to around 15 percent of non-oil GDP in the medium term. - Recurrent spending in the long-term projected to increase by 3.8 percent each year. - Capital spending in the long term projected to increase in line with inflation. - External debt: - Net external borrowing projected at about 2.1 percent of non-oil GDP during 2023–27. - Outstanding external debt projected to increase from 14 percent of non-oil GDP in 2020 to 20 percent in 2027. - Once Petroleum Fund depletes in 2038, external borrowing assumed to increase to 140 percent of non-oil GDP by 2042 to finance fiscal plans under the baseline. ### Realism tools and historical context - A smaller primary deficit in 2016–21 than projected under the previous vintage DSA largely explains unexpected changes in debt. - The three-year primary balance adjustment (between 2021 and 2024) is projected to be 19 percent. - Sluggish execution of capital spending in 2021 led to a significant drop in public investment; public investment projected to pick up with reopening and 2022 budget plans. - Contribution to growth from public investment expected to be lower than the previous DSA, but overall growth similar due to higher government consumption. ### Reform scenario: policy actions to safeguard long-term fiscal sustainability - Domestic revenue mobilization: - A VAT adopted by 2023 to generate additional revenue of about 3 percent of GDP over the medium term, reaching 13 percent of non-oil GDP by 2028. - Further tax administration reforms and tax policy measures (revision of excise tax rates, increase in statutory income tax rate, adopting a property tax) to increase domestic revenue to about 17 percent of non-oil GDP in the long term. - Expenditure moderation: - Government expenditure declines gradually to the 2019 level in the medium term and remains broadly at that level until 2033 when excess withdrawals from the Petroleum Fund are eliminated. - Improve quality of spending by curbing growth in rigid expenditures (salaries, pensions), allocating more to human capital, strengthening social safety nets, and improving growth dividend from capital spending through rigorous cost-benefit analysis. - Target and outcomes: - Target to achieve a sustainable fiscal position by 2033. - Under the reform scenario the Petroleum Fund balance will gradually increase to close to $20 billion in the long run and the estimated sustainable income will decline more slowly in percent of non-oil GDP. - Fiscal deficits over the medium-term (2023–27) would average 30 percent of non-oil GDP under the reform scenario, instead of 53 percent under the baseline. - Petroleum Fund preserved from 2033 onwards under the reform scenario; external borrowing significantly lower in 2028–42 relative to baseline. ### Structural reforms and private sector development - Structural reforms to improve business environment, raise productivity, and promote private sector development include: - Facilitating ease of doing business. - Shifting from subsistence to commercial agriculture. - Addressing digital infrastructure and connectivity bottlenecks. - Increasing financial access. - Building human capacity and closing labor skill gaps. - Strengthening the justice sector to improve governance and reduce corruption vulnerabilities. - The authorities set out medium-term measures in the Economic Recovery Plan 2020–23 but no concrete actions have been taken yet. ### Macro-fiscal and external outlook under reform scenario - Real non-oil GDP: - Lower than baseline in the medium term, averaging 1.6 percent over 2023–27 owing to output costs of fiscal consolidation. - With structural reforms, long-term growth (2028–2042) projected to hover around 5-6 percent. - Current account: - Deficit over medium and long term considerably smaller than baseline due to higher exports and lower imports. ### Debt-carrying capacity, thresholds, and stress test customizations - Debt-carrying capacity: - Assessed to be weak with Composite Indicator index of 2.69 (based on April 2022 World Economic Outlook and the 2020 Country Policy and Institutional Assessment). - Applicable DSA thresholds for Timor-Leste: - 30 percent for the present value of external debt-to-GDP ratio. - 140 percent for the present value of external debt-to-exports ratio. - 10 percent for the external debt service-to-exports ratio. - 14 percent for the external debt service-to-revenue ratio. - 35 percent for the present value of public debt-to-GDP ratio. - Stress test customizations: - FDI shock adjusted to account for a large outflow of $575 million in 2019 due to Petroleum Fund’s investment in Timor-Gap to purchase the 56 percent stake in the Greater Sunrise joint venture; historical average and standard deviation correspond to 2011–21 (excluding 2019). - Export shock customized to account for petroleum production ceasing in 2023 and aligned with the 2021 Article IV DSA. - Current transfers-to-GDP shock based on historical average and standard deviation corresponding to 2017–21 to reflect shift from net inflows to net outflows of remittances. ### Selected numeric highlights from Text Table 4 (baseline vs. reform scenario excerpts) - Real non-oil GDP growth: - 2021: 1.5 - 2022: 3.3 - 2023–27 (baseline): 1.6 - 2028–42 (baseline): 3.0 - Revenue (excl. grants, percent of non-oil GDP): - 2021: 42.6 - 2022: 40.4 - 2023–27 (baseline): 33.6 - 2028–42 (baseline): 25.7 - Domestic revenue: - 2021: 9.6 - 2022: 9.6 - 2023–27 (baseline): 10.7 - 2028–42 (baseline): 14.8 - Estimated Sustainable Income: - 2021: 33.0 - 2022: 30.8 - 2023–27 (baseline): 22.9 - 2028–42 (baseline): 10.9 - Government expenditure (percent of non-oil GDP): - 2021: 85.8 - 2022: 95.3 - 2023–27 (baseline): 62.5 - 2028–42 (baseline): 29.1 - Recurrent: - 2021: 77.5 - 2022: 79.0 - 2023–27 (baseline): 46.9 - 2028–42 (baseline): 21.9 - Capital: - 2021: 8.3 - 2022: 16.3 - 2023–27 (baseline): 15.6 - 2028–42 (baseline): 7.3 - Net lending/borrowing (percent of non-oil GDP): - 2021: -43.2 - 2022: -54.9 - 2023–27 (baseline): -28.9 - 2028–42 (baseline): -3.5 - PF excess withdrawals (percent of non-oil GDP): - 2021: 35.3 - 2022: 52.9 - 2023–27 (baseline): 26.7 - 2028–42 (baseline): 3.0 - Net incurrence of liabilities (percent of non-oil GDP): - 2021: 1.1 - 2022: 2.0 - 2023–27 (baseline): 2.2 - 2028–42 (baseline): 0.5 - Petroleum Fund balance ($ million): - 2021: 18,949 - 2022: 17,446 - 2023–27 (baseline): 16,553 - 2028–42 (baseline): 17,768 - Under reform scenario: 2028–42 Petroleum Fund balance reported as 15,217 and then 4,707 in the table excerpt. - Current account balance (percent of non-oil GDP): - 2021: 2.5 - 2022: -15.3 - 2023–27 (baseline): -31.6 - 2028–42 (baseline): -9.8 *Source: IMF staff estimates and calculations as presented in the chapter.* ### 13. The contingent liability stress test settings were also customized (Text Table 6). The ### 13. The contingent liability stress test settings were also customized (Text Table 6). ### Stress test customizations - Default shock to contingent liabilities from state-owned enterprises debt and Public Private Partnerships is reduced to zero because the former is already included in the baseline public debt, and the latter is negligible. - Customization implied: - Historical average of the net non-debt creating flows (foreign direct investment)-to-GDP ratio revised from -1.5 to 2.8 and the standard deviation reduced from 13.5 to 2.2. - Initial standard deviation of 56.5 of the export shock scaled down to 11.3. - Historical average of the current official transfers-to-GDP ratio revised from 3.9 to -5.4 and the standard deviation reduced from 13.7 to 2.2. ### Tailored commodity price and natural disaster shocks - Commodity price shock tailored by adjusting the share of fuel in total exports of goods and services to match Timor-Leste’s high reliance on petroleum and gas receipts: - Share of commodity exports in Timor-Leste’s total exports is 92 percent on average over 2019–21. - Projected to decline to close to 70 percent on average over 2022–24 as petroleum production from active fields ends in 2023. - Natural disaster tailored stress test captures April 2021 cyclone and floods experience: - Assumes a natural disaster occurs in 2023 and new debt is contracted to finance damages, increasing the public debt-to-GDP ratio by 14 percent in 2023 (equivalent to estimated damages from the April 2021 floods). - Real GDP and exports growth decline by 2 percent and 4 percent in FY2023, respectively, relative to the baseline. - Damages from Tropical Cyclone Seroja in April 2021 are estimated at US$245 million; previous disasters ranged from US$4 million to US$20 million. ### External Debt Sustainability Assessment (key findings) - Under the baseline scenario, two external debt indicators breach DSA thresholds in the medium-term: - Present value of external debt in percent of exports breaches the indicative threshold of 140 percent between 2024 and 2032. - Debt service to exports ratio breaches the indicative threshold of 10 percent between 2023–29. - Other indicators remain well below thresholds for the next fifteen years. - Debt dynamics drivers: - Increase in debt service payments as grace periods on existing loans end. - Government strategy of increasing public external borrowing via concessional loans to reduce Petroleum Fund withdrawals for projected public investment expansion. - Present value of external debt projected to increase from 10 percent of non-oil GDP in 2021 to 13 percent in 2032. - Standardized stress tests identify primary balance and exports shocks as most extreme for debt trajectory, causing breaches of debt service-to-exports and present value of debt-to-exports thresholds. ### Public Debt Sustainability Analysis (key findings) - Under baseline, present value of total public and publicly guaranteed debt-to-GDP ratio remains below threshold for next fifteen years. - Indicator vulnerable to commodity price shocks and expected to breach threshold under stress starting in 2024. - Petroleum Fund projected to be depleted towards the end of the twenty-year projection horizon, leading to all debt indicators breaching thresholds and a substantial jump in external borrowing beyond 2038. ### Reform scenario - Reform scenario combines fiscal consolidation and structural reforms: - External concessional loans broadly in line with baseline. - Reforms significantly improve debt dynamics over twenty years; duration of medium-term breaches of present value of external debt-to-exports and debt service-to-exports is shorter than baseline. - Petroleum Fund is eventually preserved under the reform scenario. ### Risk rating, vulnerabilities, and timing - Mechanical DSA rating is “high” debt distress risk due to breaches of present value of debt-to-exports and debt service-to-exports over 2023-33; judgement upgrades rating to “moderate.” - Judgement rationale: large, liquid, and accessible net foreign assets in the form of the Petroleum Fund mitigate ability to carry and service debt until 2036, even under the most extreme shock (primary balance shock). - Present value of debt does not exceed more than 25 percent of the projected Petroleum Fund until 2036 under the baseline. - Under the primary balance shock, present value of debt-to-Petroleum Fund assets reaches close to 44 percent by 2036. - The Petroleum Fund is projected to be depleted by 2038 under current policies; with a nominal investment return of 3 percent, depletion would occur by 2034. - Debt rated “moderate” with limited space to absorb shocks; assessment unchanged from the 2021 DSA rating. ### Policy recommendations and priorities - Fiscal consolidation to achieve a sustainable fiscal position in a 10-year horizon through: - Expenditure rationalization. - Domestic revenue mobilization. - Decreasing withdrawals from the Petroleum Fund to preserve it. - Structural reforms to: - Improve the business environment and governance. - Enhance competitiveness and strengthen the external sector position. - Prioritize climate adaptation investment and enhance resilience to natural disasters and climate change. - Manage political risks: lack of political consensus is a high-probability risk that could impede reforms, though implementation is judged to have higher probability. - Public debt management strengthening: - Embed external borrowing in an institutional framework with best-practice debt management policies and procedures. - Strengthen organization and capacity of the debt management unit, prepare a medium-term debt management strategy (MTDS), and upgrade debt recording software. - Produce comprehensive and realistic debt servicing projections for existing debt. - Improve monitoring and reporting of fiscal risks, including contingent liabilities related to credit guarantees, pensions, public corporations, and public-private partnerships. ### Technical assistance and international support - Authorities requested extensive technical assistance from the IMF for ambitious fiscal reforms. - Ongoing and planned support: - IMF Fiscal Affairs Department: public financial management reforms. - IMF Pacific Financial Technical Assistance Center: revenue administration. - IMF Legal Department: governance in anti-money laundering. - Assistance on a Fiscal Responsibility Law and adoption of Major Planning Options Law to improve budget predictability. - New procurement law effective January 2023 to increase transparency and simplify procurement. - World Bank and IFC plans to provide technical assistance for private sector development in ease of doing business, agriculture, and tourism. *Source: 1tlsea2022001 - 13. The contingent liability stress test settings were also customized (Text Table 6).* ### 24. The authorities recognize the risk of depleting the Petroleum Fund and are committed ### 1tlsea2022001 - 24. The authorities recognize the risk of depleting the Petroleum Fund and are committed ### Authorities' views and policy intentions - The authorities recognize the risk of depleting the Petroleum Fund and are committed to implementing reforms to ensure long-term fiscal sustainability. - They acknowledged that the Petroleum Fund should be preserved to avoid the risk of a fiscal cliff and ensure intergenerational equity. - They are still evaluating options for developing the Greater Sunrise fields and highlighted uncertainty around it, with potential revenues from the project at least a decade away. - They agreed with staff’s call for fiscal consolidation but noted difficulties in reaching political consensus to do that. - They underscored ongoing efforts to improve public financial management aiming to make government spending more efficient. - Domestic revenue reform plans in the pipeline—which include the introduction of the value-added tax (VAT) and a revised tax procedures code—are expected to gradually boost domestic revenue. - They shared staff’s view on the urgent need for diversification. ### Fiscal and debt mechanics (institutional note) - The residual in debt-creating flows is financed through excess withdrawals from the Petroleum Fund. - Identified net debt-creating flows and residuals in both the external and public DSA incorporate exceptional financing, changes in gross foreign assets, valuation adjustments, and for projections also include contribution from price and exchange rate changes. ### Key external debt indicators (selected series, in percent of GDP unless otherwise indicated) - External debt (nominal), 2019–2042 (historical and projections): 11.3, 13.7, 14.1, 14.7, 15.7, 17.0, 18.0, 18.9, 19.7, 19.7, 142.1, 6.4, 18.7 - Change in external debt: 2.1, 2.4, 0.4, 0.7, 1.0, 1.3, 0.9, 0.9, 0.8, -0.6, 20.3 - Identified net debt-creating flows: 25.3, 15.5, -7.2, 11.1, 36.1, 39.2, 38.5, 36.5, 37.9, 38.9, 30.2, 0.1, 35.7 - Non-interest current account deficit: -8.0, 19.1, -2.8, 15.0, 39.9, 42.7, 41.9, 39.8, 41.1, 41.6, 33.4, -42.0, 39.0 - Exports: 51.2, 23.9, 46.1, 39.0, 8.6, 6.6, 6.6, 9.7, 7.1, 7.4, 9.1, 13.9 - Imports: 61.0, 52.8, 51.7, 54.6, 57.3, 56.1, 53.9, 50.7, 50.8, 47.5, 42.3 - Net FDI (negative = inflow): 33.8, -4.5, -4.0, -3.7, -3.5, -3.4, -3.2, -3.1, -3.0, -2.5, -1.7, 1.3, -3.0 - Residual (of debt-creating flows): -23.2, -13.1, 7.6, -10.4, -35.1, -37.9, -37.6, -35.6, -37.0, -39.4, -9.9, 1.7, -35.2 - Sustainability indicators: PV of PPG external debt-to-GDP ratio (selected): 10.2, 10.3, 10.7, 11.3, 11.8, 12.2, 12.7, 12.9, 89.9 - PV of PPG external debt-to-exports ratio (selected): 22.1, 26.5, 124.4, 171.4, 171.4, 171.1, 171.0, 141.9, 646.6 - PPG debt service-to-exports ratio (selected): 0.8, 2.1, 1.6, 2.4, 12.0, 15.7, 15.4, 14.4, 11.9, 8.6, 17.1 - PPG debt service-to-revenue ratio (selected): 1.0, 1.1, 1.7, 2.3, 2.9, 3.2, 3.6, 3.8, 3.5, 4.4, 21.1 - Gross external financing need (Million of U.S. dollars, selected): 445.7, 239.6, -101.9, 227.7, 765.3, 884.7, 926.4, 936.2, 1037.6, 1497.6, 2548.6 ### Key public sector debt indicators (selected series, in percent of GDP) - Public sector debt 2019–2042: 11.3, 13.7, 14.1, 14.7, 15.7, 17.0, 18.0, 18.9, 19.7, 19.7, 142.1, 6.4, 18.7 - Change in public sector debt: 2.1, 2.4, 0.4, 0.7, 1.0, 1.3, 0.9, 0.9, 0.8, -0.6, 20.3 - Identified debt-creating flows: 29.7, 26.4, 42.5, 53.5, 66.2, 61.1, 52.1, 39.7, 39.1, 36.5, 19.8, 35.4, 45.4 - Primary deficit (as percent of GDP): 30.2, 25.4, 42.9, 54.6, 67.3, 61.9, 52.9, 40.5, 40.1, 37.5, 26.1, 33.6, 46.4 - Revenue and grants (percent of GDP): 51.5, 57.0, 54.1, 51.9, 46.9, 43.7, 41.1, 38.8, 35.6, 23.3, 12.9, 64.0, 36.1 - Grants (of revenue and grants): 9.5, 11.5, 11.5, 11.5, 11.5, 11.5, 11.5, 11.5, 10.2, 5.6, 1.7 - Primary (noninterest) expenditure (percent of GDP): 81.7, 82.4, 97.0, 106.5, 114.2, 105.6, 94.0, 79.4, 75.7, 60.8, 39.0, 97.6, 82.5 - Residual (public DSA): -27.7, -24.0, -42.1, -52.9, -65.6, -60.1, -51.5, -39.2, -38.7, -37.4, -1.9, -33.7, -45.2 - PV of public debt-to-GDP ratio (selected projection): 10.2, 10.3, 10.7, 11.3, 11.8, 12.2, 12.7, 12.9, 89.9 - Debt service-to-revenue and grants ratio (selected): 0.8, 0.9, 1.4, 1.8, 2.2, 2.4, 2.6, 2.6, 2.5, 3.3, 18.3 - Gross financing need (selected): 30.3, 25.6, 43.7, 55.6, 68.3, 62.9, 54.0, 41.5, 41.0, 38.3, 28.5 ### Key macroeconomic assumptions (selected) - Real GDP growth (in percent): 2.1, -8.6, 1.5, 3.3, 4.2, 2.6, 2.4, 2.4, 3.0, 3.0, 3.0, 1.0, 3.0 - GDP deflator in US dollar terms (change in percent): 5.4, 2.4, 3.8, 7.0, 5.5, 4.5, 4.0, 4.0, 4.0, 4.0, 4.0, 3.9, 4.5 - Effective interest rate (percent) 4/: 2.7, 2.0, 2.0, 1.8, 1.8, 1.7, 1.7, 1.6, 1.6, 1.5, 1.6, 2.2, 1.6 - Growth of exports of G&S (US dollar terms, in percent): 38.2, -56.4, 103.7, -6.6, -75.7, -17.7, 10.6, 10.6, 11.4, 11.6, 12.0, 1.2, -0.9 - Growth of imports of G&S (US dollar terms, in percent): -1.9, -19.0, 3.2, 16.8, 15.4, 4.9, 2.4, 0.1, 7.2, 5.7, 6.0, -6.7, 6.8 - Grant element of new public sector borrowing (in percent): 40.5, 40.5, 40.5, 40.5, 40.5, 40.5, 40.5, 40.1, 39.8, ...40.5 ### Selected nominal magnitudes - Nominal GDP (Million of US dollars, selected years): 1,704; 1,595; 1,681; 1,858; 2,043; 2,190; 2,332; 2,484; 2,661; 3,753; 7,465 - PV of PPG external debt (in Million of US dollars, selected): 171.1, 192.3, 218.6, 247.9, 274.1, 302.7, 337.0, 483.0, 6714.3 ### Stress tests and sensitivity results (high-level) - Sensitivity analyses include alternative scenarios, bound tests (Real GDP growth, Primary balance, Exports, Other flows, Depreciation, and combinations), and tailored tests (Combined contingent liabilities, Natural disaster, Commodity price, Market Financing). - Selected bound-test outcomes illustrate the range of impacts on key indicators such as PV of debt-to-GDP ratio, PV of debt-to-exports ratio, debt service-to-exports ratio, and debt service-to-revenue ratio under adverse shocks through 2042. - For example, under the Commodity price tailored test, projections for some indicators show sharp adverse movements (tables and figures present quantitative paths for 2022–2042). ### Diagnostic and realism tools - Figures present drivers of debt dynamics (contributions of primary deficit, real interest rate, real GDP growth, real exchange rate, other debt-creating flows), realism tools comparing government and private investment in previous vs current DSA vintages, and fiscal adjustment/growth trade-offs using fiscal multipliers (Multiplier = 0.2, 0.4, 0.6, 0.8). - Figure series illustrate that the most extreme stress tests for different ratios are driven by different shocks (e.g., Primary Balance, Exports, Commodity price). *Sources: Country authorities; and staff estimates and projections.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1tlsea2022001.pdf_