## The Impact of Fiscal Policy on Growth in Timor-Leste (content unit 1tlsea2024001) ## Source details **Canonical URL:** [The Impact of Fiscal Policy on Growth in Timor-Leste (content unit 1tlsea2024001)](https://www.imf.org/-/media/files/publications/cr/2024/english/1tlsea2024001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2024/english/1tlsea2024001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2024/english/1tlsea2024001.pdf.json) --- ### Context and recent developments - Timor-Leste is a fragile post-conflict economy highly dependent on public spending financed primarily by offshore oil and gas proceeds. - Petroleum Fund (PF) balance: 1,043 percent of non-oil GDP in 2022. - Oil and gas production has halted; regular large PF withdrawals under current policies are expected to lead to full depletion by the end of the 2030s (staff baseline: full depletion in 2039; Ministry of Finance projection: depletion by 2034). - New coalition government (post-May 2023) prioritizes boosting growth, employment, reducing poverty, and fiscal sustainability. ### Recent macroeconomic performance and drivers - Real non-oil GDP growth: - 2022: 4 percent - 2023: 1½ percent - Inflation: - Headline inflation: 8.7 percent (y/y) in December 2023. - Food and non-alcoholic beverages, alcohol and tobacco account for approximately 90 percent of the peak inflation rate. - Fiscal developments: - Oil receipts through September 2023: $410 million (budgeted $115 million). - Fiscal deficit: declined to 41 percent of non-oil GDP in 2023 from 58 percent in 2022. - Reduction of import duties and sugar excises caused a revenue loss around ½ percent of GDP. - Fiscal impulse: contractionary of 17 percentage points of GDP in 2023. - External sector: - Current account deficit (excluding oil) around 43 percent of non-oil GDP in 2023. - Under current policies the current account deficit is expected to persist; net IIP projected to decline over time. ### Fiscal multipliers and spending quality - Fiscal multipliers for Timor-Leste are assessed as low due to low quality and high import content of public expenditure. - Recent expenditure composition and execution: - Recurrent spending comprised up to 90 percent of total expenditure. - Budget execution rate of capital expenditure below 50 percent for the past three years. - Multiplier estimates cited: - Around 0.1 (2022 Article IV staff report). - 0.2 (World Bank 2021). - Survey range for low-income countries: -0.3 – 0.8 (World Bank 2015). - Policy implication: improving spending quality (project selection and execution) could raise fiscal effectiveness; PFM reforms and IMF technical support recommended. ### Outlook and principal risks - Growth projections: - 2024: projected to recover to 3½ percent, supported by higher execution of public spending and stronger exports to key partners (e.g., Indonesia). - Long term: expected to remain at pre-pandemic average of 3 percent absent policy changes. - Inflation outlook: - 2024: expected to ease to 3½ percent. - Petroleum Fund and fiscal sustainability: - Staff baseline: full PF depletion in 2039. - Ministry of Finance projection: depletion by 2034. - Downside risks: global recession, commodity price volatility, extreme climate events; upside: development of Greater Sunrise natural gas field if agreement reached. ### Staff baseline and reform scenarios (summary) - Baseline: - Moderately expansionary fiscal stance during 2025–28 with deficits around 43 percent of non-oil GDP financed by PF withdrawals that far exceed Estimated Sustainable Income (ESI); PF exhausted by end-2030s (staff baseline: 2039). - Reform scenario: - Achieve fiscal balance aligned with PF sustainable income within 10 years via expenditure restraint, revenue mobilization, and structural reforms; reduces external imbalance and limits growth costs of consolidation. - Fast reform scenario (Box 2): - Achieve fiscal balance within five years; entails greater short-term output and poverty costs; yields small additional long-run gains versus 10-year reform. ### Key policy recommendations — near term - Use PF savings to support development objectives while achieving fiscal sustainability; prioritize human and physical capital and better-targeted social safety nets. - Contain current expenditure and shift support toward vulnerable households through better targeting. - 2024 budget execution assumptions (staff baseline): - Two-thirds of budgeted investment executed in 2024. - Goods and services execution rate: 70 percent. - Transfers, wages and salaries execution rate: ~95 percent. - IMF technical assistance to support PFM reforms and improve project execution. ### Key policy recommendations — medium term - Adopt a Fiscal Responsibility Law and formulate a medium-term fiscal framework. - Implement expenditure restraint and rationalization, including: - Reduce recurrent expenditures on wages, goods and services, and transfers while prioritizing health, education, and physical capital. - Reform poorly targeted subsidy schemes. - Mobilize domestic revenue: - Authorities’ goal: raise revenues from 10 percent to 15 percent of GDP over 5 years. - Staff recommend introducing a VAT in 2024 and a property tax once the land registry is complete; increase corporate income tax rates to regional peer levels. - Advance structural reforms: - Short-to-medium term: agriculture and tourism reforms. - Medium term: economic diversification, private sector development, deeper financial sector. - Improve public investment efficiency via better project selection and execution as part of broader PFM reforms. ### Box 2 — Selected measures underpinning the reform scenario - Expenditure reforms: prioritize human and physical capital; better-target social safety nets; contain wage bill; improve procurement; limit non-poverty‑safeguarding transfers; continue PFM reforms. - Domestic revenue mobilization: introduce VAT; increase corporate income tax rates; adopt property tax after land registry completion. - Tax administration: modernize operations; develop medium-term plan; institutional reforms; upgrade tax procedure code; promote e-tax filing. - Structural reforms: boost agriculture (expand coffee, shift to higher-value commodities); invest in airport capacity for tourism; regional integration (ASEAN accession); boost human capital and vocational training; improve business environment, land registry, governance, digital infrastructure. ### Public financial management, capacity development, and CD priorities - PFM priorities: - Strengthen top-down budgeting and macroeconomic forecasting tools. - Upgrade public investment management framework (use 2016 PIMA recommendations). - Establish governance safeguards and transparent fiscal reporting. - IMF CD: - 12 ongoing projects to implement growth-enhancing reforms (Annex IV). - Immediate CD priority: VAT introduction (institutional setting, legal drafting, tax design/modeling) and top-down budgeting. - Statistical and data priorities: - Improve GFS, national accounts, balance of payments, and Financial Soundness Indicators (FSI); enhance reporting frequency and quality. ### Financial sector and inclusion — state and recommendations - Key indicators: - Credit-to-GDP ratio: 24 percent in 2022. - Credit growth: 37 percent (y/y) in July 2023. - Aggregate NPL ratio: below 2.4 percent. - Banking sector loan-to-deposit ratio: 36 percent. - Central bank LDR measure: scheduled increase of minimum LDR to 35 percent by end-2023 (shortfalls placed in unremunerated central bank account). - Staff recommendation: do not raise LDR floor further until structural impediments to prudent lending are addressed. - Structural impediments: inadequate collateral framework; absence of common accounting standards; complex banking regulations; AML/CFT deficiencies. - Recommended actions: require common accounting standards for companies; complete new banking law; promote electronic payments and mobile money; adopt IFRS 9 and Basel III principles; complete supervisory framework for non-bank financial companies. ### Structural reforms for diversification and human capital - GNI per capita: $1,970 in 2022. - Staff estimate: ambitious reform agenda could boost growth to around 5 percent by 2030. - Sectoral priorities: - Agriculture: increase productivity, expand coffee production, shift to higher-value commodities. - Tourism: improve infrastructure, expand airport capacity. - Regional integration: remove non-tariff barriers and pursue ASEAN/WTO accession. - Digitalization: completion of submarine cable in 2024 expected to improve connectivity and support tax administration and e-tax filing. - Human capital: 40 percent of population below age 15; prioritize targeted education spending and vocational training. ### Fiscal and debt projections — selected figures (2020–2028) - Central government aggregates (millions of U.S. dollars): - Revenue: 910 (2020), 917 (2021), 959 (2022), 902 (2023), 915 (2024), 904 (2025), 896 (2026), 885 (2027), 875 (2028). - Domestic revenue: 182 (2020), 161 (2021), 172 (2022), 185 (2023), 202 (2024), 219 (2025), 237 (2026), 257 (2027), 280 (2028). - Expenditure: 1,318 (2020), 1,623 (2021), 1,931 (2022), 1,659 (2023), 1,760 (2024), 1,822 (2025), 1,887 (2026), 1,953 (2027), 2,023 (2028). - Recurrent spending: 975 (2020), 1,302 (2021), 1,538 (2022), 1,245 (2023), 1,294 (2024), 1,339 (2025), 1,386 (2026), 1,435 (2027), 1,485 (2028). - Net lending/borrowing: -409 (2020), -706 (2021), -973 (2022), -757 (2023), -845 (2024), -918 (2025), -991 (2026), -1,068 (2027), -1,148 (2028). - Petroleum Fund (millions of U.S. dollars): - ESI: 544 (2020), 576 (2021), 596 (2022), 525 (2023), 525 (2024), 503 (2025), 484 (2026), 462 (2027), 437 (2028). - Withdrawals: 886 (2020), 1,149 (2021), 1,404 (2022), 1,402 (2023), 1,517 (2024), 1,395 (2025), 1,463 (2026), 1,523 (2027), 1,568 (2028). - Excess withdrawal: 342 (2020), 573 (2021), 808 (2022), 877 (2023), 991 (2024), 892 (2025), 979 (2026), 1,061 (2027), 1,131 (2028). - Closing balance: 18,991 (2020), 19,732 (2021), 17,379 (2022), 17,503 (2023), 16,774 (2024), 16,134 (2025), 15,397 (2026), 14,566 (2027), 13,654 (2028). ### External sector and reserves — selected figures - Current account balance (millions of U.S. dollars): -281 (2020), 151 (2021), 273 (2022), -372 (2023), -832 (2024), -930 (2025), -1,027 (2026), -1,139 (2027), -1,238 (2028). - Trade balance (goods, millions of U.S. dollars): -607 (2020), -621 (2021), -853 (2022), -825 (2023), -885 (2024), -939 (2025), -995 (2026), -1,053 (2027), -1,115 (2028). - Public foreign assets (end-period, millions of U.S. dollars): 19,647 (2020), 20,667 (2021), 18,212 (2022), 18,331 (2023). - Reserves at end-2023: $830 million (equivalent to about 9 months of imports). - Net international investment position (NIIP) by Q3-2023: $17.9 billion (975 percent of non-oil GDP). ### Debt sustainability — key messages and risks - Baseline DSA: Petroleum Fund depleted in 2039 under staff baseline; depletion could be earlier with lower investment returns. - Mechanical DSA rating: high risk of debt distress due to breaches of PV external debt-to-exports and debt service-to-exports in the medium term; judgmental upgrade to Moderate based on large, liquid PF assets. - Under baseline: outstanding external debt (millions of U.S. dollars): 219 (2020), 235 (2021), 253 (2022), 275 (2023), 284 (2024), 311 (2025), 325 (2026), 333 (2027), 351 (2028). - Public sector debt (percent of GDP): 13.8 (2020), 15.1 (2021), 15.1 (2022), 15.0 (2023), 14.2 (2024), 14.5 (2025), 14.2 (2026), 13.6 (2027), 13.4 (2028), rising sharply after PF depletion to 178.0 (2043) in projections. ### Capacity development, IMF engagement, and coordination - Fund engagement: surveillance and CD; Timor-Leste is a major recipient of CD in the region with 12 projects in progress for FY2024 (PFTAC and other units). - CD priorities: VAT introduction, Fiscal Responsibility Law drafting, PFM improvements, tax administration modernization, macro-statistics enhancement, debt management, AML/CFT capacity. - Coordination: stronger coordination across development partners and within government recommended to improve sequencing and avoid overloading authorities. ### Implementation priorities and sequencing - Immediate: - Introduce VAT in 2024 with Fund CD support. - Strengthen tax administration; modernize operations and promote e‑filing. - Adopt Fiscal Responsibility Law and medium-term fiscal framework. - Improve top-down budgeting and public investment management. - Medium term: - Expenditure rationalization to reduce excess PF withdrawals and align withdrawals with ESI by 2033 (reform scenario target). - Advance agriculture and tourism reforms; pursue digitalization and financial deepening. - Strengthen governance, land registry, justice system, and AML/CFT compliance. - Longer term: - Diversify revenue base to raise domestic revenue toward 15 percent of GDP. - Preserve PF wealth while expanding sustainable non-oil private sector growth. *Source: IMF staff chapter "The Impact of Fiscal Policy on Growth in Timor-Leste" (content unit 1tlsea2024001).* ### 1. The Impact of Fiscal Policy on Growth in Timor-Leste __________________________________________ 6 ### The Impact of Fiscal Policy on Growth in Timor-Leste ### Context and recent developments - Timor-Leste remains a fragile post-conflict nation with high dependence on public spending financed primarily by offshore oil and gas proceeds. - The national Petroleum Fund’s (PF) balance stood at 1,043 percent of non-oil GDP in 2022, making Timor-Leste’s Net Foreign Asset (NFA) position one of the highest in the world as a share of the domestic economy. - Oil and gas production has recently come to a halt, and regular large withdrawals from the PF to finance fiscal deficits are expected to lead to its full depletion by the end of the 2030s. - A new coalition government was formed after May 2023 parliamentary elections with an agenda to boost growth, employment, reduce poverty, and achieve fiscal sustainability. ### Key macroeconomic indicators and trends - Real non-oil GDP growth: - 2022: 4 percent - 2023: 1½ percent - Inflation: - Headline inflation rose to 8.7 percent (y/y) in December 2023. - Inflation drivers: food and non-alcoholic beverages, alcohol and tobacco account for approximately 90 percent of the peak inflation rate. - Fiscal developments: - Oil receipts through September 2023: $410 million (budgeted $115 million). - Fiscal deficit: declined to 41 percent of non-oil GDP in 2023 from 58 percent in 2022. - A reduction of import duties and sugar excises to alleviate cost of living pressures led to a small loss of revenue (around ½ percent of GDP). - Fiscal impulse: contractionary of 17 percentage points of GDP in 2023. - External sector: - Current account deficit (excluding oil) remained large in 2023 (around 43 percent of non-oil GDP). - Under current policies the current account deficit is expected to persist; net IIP projected to decline over time. ### Fiscal multipliers and spending quality (Box 1) - Fiscal multiplier for Timor-Leste is thought to be low because of low quality and high import content of public expenditure. - Recent expenditure composition and execution: - Recurrent spending has comprised up to 90 percent of total expenditure. - Budget execution rate of capital expenditure has been below 50 percent for the past three years. - Multiplier estimates cited: - Around 0.1 (2022 Article IV staff report). - 0.2 (World Bank 2021). - Survey range for low-income countries: -0.3 – 0.8 (World Bank 2015). - Policy implication: improving quality and efficiency of spending (project selection and execution) could raise the effectiveness of fiscal policy; PFM reforms and IMF technical support recommended (¶18). ### Outlook and risks - Growth projections: - 2024: projected to recover to 3½ percent supported by higher execution of public spending and stronger exports to key partners (e.g., Indonesia). - Long term: expected to remain at the pre-pandemic average of 3 percent, though policy actions could accelerate it. - Inflation outlook: - 2024: expected to ease to 3½ percent, helped by projected easing of global commodity prices and reversal of 2023 tax increases on imports, cigarettes, and sugar. - Risks: persistent El Niño, adverse commodity price developments from geopolitical events. - PF and fiscal sustainability: - Staff estimate PF fully depleted by the end of the 2030s (baseline assumes full depletion in 2039). - Ministry of Finance projects depletion by 2034. - Downside risks (Annex III): global recession, commodity price volatility, extreme climate events which could require fiscal response and deplete PF; upside from Greater Sunrise natural gas field development if agreement reached. ### Policy discussions and staff recommendations - Overarching aim: utilize substantial PF savings to support development objectives while achieving fiscal sustainability; prioritize spending on human and physical capital and better-targeted social safety net. - Near-term fiscal stance and budget execution: - 2024 budget includes prioritization of capital expenditure; staff baseline assumes two-thirds of budgeted investment executed in 2024 (goods and services assumed execution rate 70 percent; transfers, wages and salaries ~95 percent). - Wage bill expected to remain high in 2024; recurrent spending to continue making up two-thirds of total expenditure, with poorly targeted subsidy schemes. - Staff recommend further containing current expenditure and shifting toward targeted support to vulnerable households. - Medium-term financing and PF withdrawals: - Deficits around 43 percent of non-oil GDP over 2025-28 will be financed by PF withdrawals that far exceed its Estimated Sustainable Income. - Staff project a mildly expansionary fiscal stance during 2025-28, keeping growth slightly above long-term rate of 3 percent, but requiring excess PF withdrawals and leading to eventual PF depletion. - Required reforms to avoid fiscal cliff: - Adopt a fiscal responsibility law and formulate a medium-term fiscal framework. - Implement expenditure restraint and rationalization. - Mobilize domestic revenue supported by tax administration improvements. - Advance structural reforms to boost growth, initially focusing on agriculture and tourism, and over the medium term on economic diversification, private sector development, and a deeper financial sector. - Improve public investment efficiency via better project selection and execution as part of broader PFM reforms (IMF technical support referenced). - Scenarios modeled by staff: - Baseline: moderately expansionary, PF exhausted by end-2030s (full depletion 2039 in staff baseline), financing shortfall risk if external borrowing cannot be scaled up. - Reform scenario: achieves fiscal balance (aligning the deficit with the PF’s sustainable income stream) within 10 years through expenditure restraint, revenue mobilization, and structural reforms; reduces external imbalance and limits growth costs of consolidation. - Fast reform scenario (Box 2): achieves fiscal balance within five years but entails greater short-term output and poverty costs and may be too ambitious given past reform pace; yields small additional long-run gains vs 10-year reform. ### Implementation priorities and capacity development - Public spending priorities: - Prioritize investment in physical and human capital. - Shift away from import-intensive, low-efficiency recurrent spending and poorly targeted subsidies. - Public financial management: - Improve project selection, execution, and overall PFM to raise capital-expenditure execution rates. - IMF capacity development: 12 ongoing projects to help implement growth-enhancing reforms (Annex IV). - Structural reforms: - Short-to-medium term: agriculture and tourism reforms to drive faster growth. - Medium-to-long term: broad reforms to facilitate diversification, private sector development, and deepen financial and regulatory/legal frameworks. *Source: IMF staff chapter "The Impact of Fiscal Policy on Growth in Timor-Leste" (excerpts).* ### 16. Fiscal reforms entail reducing public expenditure and improving its quality, including ### 16. Fiscal reforms entail reducing public expenditure and improving its quality, including ### Fiscal reforms: objectives and measures - Limit recurrent expenditures on wages (by restraining public employment), goods and services (by improving procurement), and transfers while prioritizing spending on human capital (health and education), physical capital, and a better-targeted social safety net (World Bank 2021). - Reform scenario: gradually reduce the wage bill and transfers to around their respective pre-pandemic levels by 2033. - Available costing estimates are not comprehensive but suggest priority spending—including projects and additional support to boost digitalization, the agriculture and tourism sectors—would fit within the proposed budget envelope. ### Domestic revenue mobilization - Authorities’ goal: raise revenues from 10 percent to 15 percent of GDP over 5 years. - Measures to achieve this: - Introduce a value added tax (VAT); staff recommend prioritizing introduction of the VAT in 2024. - Introduce a property tax once the land registry is complete. - Increase corporate income tax rates to levels more in line with regional peers. - Tax administration reforms recommended: - Modernize operations by upgrading human capacity and minimizing manual procedures in the tax administration system. - Develop a medium-term tax administration plan. - Implement institutional reforms to streamline the organizational structure of the tax authority. - Upgrade the tax procedure code. - Promote e-tax filing. ### Fiscal framework and public financial management (PFM) - Adoption of a Fiscal Responsibility Law (FRL) with IMF technical support could improve fiscal discipline by requiring government commitment to a monitorable fiscal objective and a strategy to achieve it. - Despite the Petroleum Fund Law providing a benchmark, excess withdrawals have been the norm. - Staff recommend proceeding with PFM reforms to: - Strengthen top-down budgeting and macroeconomic forecasting tools to improve budget credibility and boost execution rates. - Upgrade the framework used for public investment management to better select projects. - Establish strong governance safeguards and transparent fiscal reporting. - PFM reforms are essential after very low execution in 2023 (relative to the original budget). ### Box 2 — Recommended measures underpinning the reform scenario (selected) - Expenditure reforms: - (i) Prioritize spending on human capital (health and education) and physical capital; - (ii) prioritize improvements to social safety nets and manage costs through better targeting to the most vulnerable; - (iii) contain the rise in the wage bill by restraining public employment; - (iv) curb the budget for goods and services by improving procurement; - (v) limit public transfers that do not safeguard the poor; - (vi) Proceed with PFM reforms: strengthen top-down budgeting; upgrade public investment management; establish strong governance safeguards and transparent fiscal reporting. - Domestic revenue mobilization: - (i) Introduce a value-added tax; - (ii) increase corporate income tax rates to levels more in line with regional peers; - (iii) adopt a property tax once the land registry is complete. - Tax administration: - (i) Modernize operations by upgrading human capacity and minimizing manual procedures; - (ii) develop a medium-term tax administration plan; - (iii) institutional reforms to streamline the organizational structure of the tax authority; - (iv) upgrade the tax procedure code; - (v) promote e-tax filing. - Structural reforms to boost growth: - (i) Agriculture: improve productivity through targeted public support for expanding coffee production and the shift to higher-value commodities; - (ii) tourism: public investment to expand airport capacity; - (iii) progress in regional integration, including through ASEAN accession; - (iv) boost human capital (improving education quality) and strengthen vocational education and training; - (v) improve business environment by removing legal constraints, including the land registry; - (vi) stronger governance, better enforcement of legal contracts, and investment in digital infrastructure. ### Authorities’ views on fiscal reform - Ministry of Finance (MOF) priorities: - Strengthen budget credibility by improving execution rates and coordination with line ministries and development partners, and by strengthening the legal framework. - Prioritize upgrades to public procurement—including human resources—to improve efficiency of public expenditure. - Concurred with staff that further reforms and adopting a Fiscal Responsibility Law could help improve fiscal discipline. - MOF noted high recurrent spending in the 2024 budget partly due to ASEAN and WTO accession initiatives (wages and salaries) and measures to alleviate high inflation (transfers); these will be reviewed in the 2025 budget. ### Financial deepening and inclusion: current state and recommendations - Key indicators and recent developments: - Credit-to-GDP ratio at 24 percent in 2022. - Credit growth from the banking sector surged to 37 percent (y/y) in July 2023, with new lending mainly directed to a relatively narrow pool of high-quality borrowers by the state-owned commercial bank. - Aggregate ratio of non-performing loans (NPL) remains low (below 2.4 percent). - Banking sector loan-to-deposit ratio of 36 percent. - Central bank measure: - Introduced a scheduled increase of the minimum loan-to-deposit (LDR) ratio to 35 percent by end-2023, with any shortfall to be placed in an unremunerated account at the central bank. - Staff recommend against raising the LDR floor further until structural impediments to prudent lending are addressed and banks and supervisors can better evaluate credit risk. - Structural impediments to lending identified: - Inadequate framework for securing collateral for loans. - Absence of common accounting standards for corporate financial statements. - Complex and incomplete framework of banking regulations. - AML/CFT deficiencies need addressing to ensure compliance with FATF standards. - Recommended actions to support financial deepening: - Require companies to prepare financial statements under a common accounting standard. - Continue work on a new banking law to modernize the regulatory framework. - Promote effective electronic payment systems and mobile money accounts (e.g., P24/e-wallet networks and the Digital Village Program). - Complete the supervisory framework for non-bank financial companies. - Continue adopting IFRS 9 and Basel III regulatory principles, informed by capacity development on financial sector supervision. ### Structural reforms for sustainable growth and diversification - Context and targets: - GNI per capita of $1,970 in 2022. - Pre-pandemic growth averaging around 3 percent; staff believe an ambitious reform agenda could boost growth to around 5 percent by 2030. - Timor-Leste is vulnerable to climate change and natural disasters; investing in climate-resilient infrastructure remains a priority. - Sectoral priorities: - Agriculture: increase productivity via targeted public support for expanding coffee production and shifting to higher-value commodities (World Bank 2023). - Tourism: facilitate private investment by addressing legal constraints and invest in expanding Dili’s international airport capacity. - Regional integration: prioritize removal of non-tariff barriers, including as part of ASEAN and WTO accession. - Digitalization and human capital: - Boosting digitalization (including completion of a submarine cable) would improve productivity, support financial development and inclusion, and facilitate tax administration and e-tax filing. - Human capital reforms needed: 40 percent of the population is below the age of 15 years; staff recommend better-targeted spending on education and human capital, and strengthening vocational education and training. - Governance and business environment reforms: - Address incomplete licensing requirements; poorly-defined property rights due to lack of a land registry; costly contract enforcements; lack of an insolvency framework. - Complement with continued development of the justice system, including training more lawyers and judges. ### Statistics and capacity development - Data and statistics needs: - Improvements needed in Government Financial Statistics (GFS) to resolve discrepancies between non-financial and financial transactions. - Improvements to the quality and frequency of national accounts and balance of payments data to meet international standards for External Sector Statistics (ESS). - Some key FSIs (e.g., non-performing loan ratio) are not periodically provided. - Authorities have requested IMF CD assistance to enhance Financial Soundness Indicators (FSI) and Monetary and Financial Statistics (MFS). *Source: IMF staff.* ### 32. The IMF’s continuous engagement is essential to overcome the challenges of fragility, ### 1tlsea2024001 - 32. The IMF’s continuous engagement is essential to overcome the challenges of fragility, ### IMF engagement and authorities’ views - The IMF’s continuous engagement is essential in the context of the Country Engagement Strategy (Annex I). - Implementation of past Fund advice has been partial, with the most traction in reforms of the financial sector regulatory and supervisory framework (Annex V). - The new government’s policy priorities closely align with past Fund advice in VAT implementation, PFM reforms, and digitalization. - Coordination across stakeholders is crucial given active participation of many international development partners in Timor-Leste; coordination should be improved. - Deepening bilateral engagement could center on the development of a medium-term fiscal framework, with the Country Engagement Strategy fostering this engagement. Authorities’ perspectives - Authorities broadly shared staff’s diagnosis of structural impediments to inclusive growth and committed to an investor-friendly reform agenda. - They concurred that initial reforms should focus on agriculture and tourism, while recognizing the need for concrete plans and efficient implementation. - Internet connectivity is expected to improve upon completion of the submarine cable in 2024. - On the labor market, authorities agreed on the need to improve education quality and strengthen vocational education and training, but stressed budget and capacity constraints. - Authorities envisage improved regional integration following accession to ASEAN and the WTO. - They welcomed CD support from the IMF and other development partners, including on improvements to macroeconomic statistics. - They saw value in the Country Engagement Strategy’s assessment of fragility drivers and IMF policy priorities and underscored the importance of greater coordination across development partners. ### Staff appraisal — growth, inflation, and external position - Prioritization of public capital expenditure is expected to support growth in 2024. - Growth path: - 2023: slowdown due to election-related fiscal drag. - 2024: growth will recover to 3½ percent, supported by an increase in public capital expenditure in the 2024 budget. - Long run: growth is expected to remain modest at around 3 percent. - Inflation: - A projected decline in global commodity prices will help ease inflation to 3½ percent in 2024. - External sector: - The external sector position in 2023 was substantially weaker than implied by fundamentals and desirable policy settings. ### Risks to the outlook - Overall risks are tilted to the downside. - Near-term downside risks to growth include: - An abrupt onset of a global recession. - Heightened commodity price volatility. - Possible consequences of adverse shocks: - Could require a fiscal response, posing obstacles to expenditure restraint and adversely affecting the PF’s balance. - Political commitment to rationalize public expenditure would reduce uncertainty around the medium-term outlook. - Upside risk: - Developing the Greater Sunrise oil field presents a large upside risk in the medium term. ### Fiscal sustainability and medium-term outlook - To achieve sustainable development, an ambitious agenda of reforms is required to align the budget with the economy’s absorptive capacity. - Key policy priority: ensure Timor-Leste’s substantial savings are best utilized to support development objectives while achieving fiscal sustainability. - Fiscal position and risks: - Although the PF remains sizable for now and Timor-Leste remains at moderate risk of overall and external debt distress, large fiscal imbalances over the medium term would fully deplete the PF by the end of the 2030s. - Fiscal and structural reforms are needed to secure fiscal sustainability, strengthen the external sector position, and help overcome fragility. ### Policy recommendations - Public expenditure and revenue - Public expenditure should be reduced, and its quality further improved, while domestic revenue should be gradually mobilized. - While the 2024 budget includes an expansion of capital spending, public expenditure should be shifted to support growth and protect the vulnerable. - Revenue mobilization priorities include: - Introduction of the VAT in 2024. - Measures to strengthen tax administration. - Fiscal framework and governance: - Adopt a fiscal responsibility law. - Formulate a medium-term fiscal framework. - Structural reforms to boost growth and resilience - Combine fiscal efforts with structural reforms to boost growth, promote healthy financial deepening, and encourage diversification. - Initial reforms should remove bottlenecks in the agriculture and tourism sectors and foster digitalization to boost productivity. - Address legal and regulatory constraints that hinder business operations and financial development. - Continue efforts to strengthen the rule of law, including addressing AML/CFT deficiencies, as progress would help reduce fragility (Annex I). - Continue efforts to strengthen provision of digital financial services. - Over the medium term, pursue broad-based reforms including: - Progress in regional integration through reduction of non-tariff barriers. - Boosting human capital by improving education quality and strengthening vocational education and training. *Source: 1tlsea2024001 - 32. The IMF’s continuous engagement is essential to overcome the challenges of fragility,* ### 39. 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 included in GDP since 2019 following the Maritime Boundaries Treaty with Australia. - Non-oil GDP has been historically driven by government spending on the demand side. - Non-oil GDP growth contributions (selected sectors): construction and public administration are notable contributors on the supply side. - Headline inflation remains elevated, largely reflecting rising food and alcohol prices, and inflation remains substantially higher than other Asian economies. ### Fiscal sector developments, projections, and policy signals - The report emphasizes a greater need to increase domestic revenues and to reduce excess withdrawals to avoid depleting the Petroleum Fund. - Recurrent spending surged, amounting to nearly 90 percent of non-oil GDP in 2022. - Execution rate for capital spending has been below 50 percent since 2020. - Central government fiscal aggregates (selected annual levels, in millions of U.S. dollars): - Revenue: 910 (2020), 917 (2021), 959 (2022), 902 (2023), 915 (2024), 904 (2025), 896 (2026), 885 (2027), 875 (2028). - Domestic revenue: 182 (2020), 161 (2021), 172 (2022), 185 (2023), 202 (2024), 219 (2025), 237 (2026), 257 (2027), 280 (2028). - Taxes: 119 (2020), 119 (2021), 143 (2022), 153 (2023), 168 (2024), 182 (2025), 197 (2026), 215 (2027), 234 (2028). - Expenditure: 1,318 (2020), 1,623 (2021), 1,931 (2022), 1,659 (2023), 1,760 (2024), 1,822 (2025), 1,887 (2026), 1,953 (2027), 2,023 (2028). - Recurrent spending: 975 (2020), 1,302 (2021), 1,538 (2022), 1,245 (2023), 1,294 (2024), 1,339 (2025), 1,386 (2026), 1,435 (2027), 1,485 (2028). - Net lending/borrowing: -409 (2020), -706 (2021), -973 (2022), -757 (2023), -845 (2024), -918 (2025), -991 (2026), -1,068 (2027), -1,148 (2028). - Petroleum Fund (selected balances and flows, in millions of U.S. dollars): - Opening balance: 17,692 (2008 listed in table context) and detailed series: 17,692; 18,991; 19,732; 17,379; 17,503; 16,774; 16,134; 15,397; 14,566. - Estimated Sustainable Income (ESI): 544 (2020), 576 (2021), 596 (2022), 525 (2023), 525 (2024), 503 (2025), 484 (2026), 462 (2027), 437 (2028). - Withdrawals: 886 (2020), 1,149 (2021), 1,404 (2022), 1,402 (2023), 1,517 (2024), 1,395 (2025), 1,463 (2026), 1,523 (2027), 1,568 (2028). - Excess withdrawal (mem. item / of which): 342 (2020), 573 (2021), 808 (2022), 877 (2023), 991 (2024), 892 (2025), 979 (2026), 1,061 (2027), 1,131 (2028). - Closing balance: 18,991 (2020), 19,732 (2021), 17,379 (2022), 17,503 (2023), 16,774 (2024), 16,134 (2025), 15,397 (2026), 14,566 (2027), 13,654 (2028). ### External sector developments and projections - A sharp decline in oil revenues has pushed the current account into deficit; current account deficits have largely been financed by withdrawals from the Petroleum Fund (portfolio investment). - Current account balance (in millions of U.S. dollars): -281 (2020), 151 (2021), 273 (2022), -372 (2023), -832 (2024), -930 (2025), -1,027 (2026), -1,139 (2027), -1,238 (2028). - Trade in goods (levels, in millions of U.S. dollars): trade balance -607 (2020), -621 (2021), -853 (2022), -825 (2023), -885 (2024), -939 (2025), -995 (2026), -1,053 (2027), -1,115 (2028). - Exports of goods: 321 (2020), 295 (2021), 363 (2022), 738 (2023), 395 (2024), 109 (2025), 125 (2026). - Imports of goods: -639 (2020), -749 (2021), -906 (2022), -887 (2023), -958 (2024), -1,022 (2025), -1,091 (2026). - Non-oil exports remain volatile and small relative to the economy; coffee is the largest export product after oil/gas (coffee: 122, 82, 63, 13, 64, 24, 85, 56, 62 across years shown in figure/table context). - Goods imports composition (selected categories, in millions of U.S. dollars, 2018–2023 series shown): Fuels and food account for more than half of total goods imports. - Petroleum Fund balance (projections) and public foreign assets indicate diminished buffers over the projection period (see Petroleum Fund closing balances above). ### Monetary and financial sector developments - Private sector credit growth has surged recently, driven by lending by the state-owned commercial bank; recent private sector credit growth has mainly been directed to high-quality borrowers. - Banking sector liquidity is high with a large overseas placement of bank assets; overseas placement constitutes a significant share of banking sector assets. - Non-performing loans (NPLs) remain low but vigilance is needed. - Selected monetary aggregates and indicators (banking system, in millions of U.S. dollars, 2020–2023): - Net foreign assets: 1,574 (2020), 1,928 (2021), 2,242 (2022), 2,233 (2023). - Gross reserves: 657 (2020), 935 (2021), 788 (2022), 829 (2023). - Credit to private sector: 290 (2020), 304 (2021), 408 (2022), 487 (2023). - Broad money: 869 (2020), 1,119 (2021), 1,215 (2022), 1,373 (2023). - Broad money growth: 10.2 (2020), 28.7 (2021), 8.6 (2022), 13.0 (2023) (12-month percentage change). - Non-performing loans (amounts in millions of U.S. dollars): 9.1 (2020), 6.7 (2021), 6.7 (2022), 8.4 (2023). - Non-performing loans/total loans (percent): 3.8 (2020), 2.4 (2021), 2.2 (2022), 2.2 (2023). ### Business environment, governance, and competitiveness - Governance of the Petroleum Fund is satisfactory by international standards. - Perceived governance of the public sector is improving (2017 to 2022) but with areas of weakness. - Education and infrastructure gaps undermine competitiveness; political instability and limited financial access are major business constraints perceived by firms. - Labor productivity is very low: despite large shares of employment in agriculture and services, their GDP shares are small. ### Challenges to growth and infrastructure/digital gaps - Access to electricity has improved considerably; access to electricity: 59.2 percent of population (reported figure). - Losses due to electrical outages are high (value of loss due to outages shown as a notable percent of sales for affected firms). - Perceived quality of infrastructure is lower than regional peers; mobile penetration is high but digital adoption in business is low. - Access to the internet is low; Individuals using the Internet series: 11.0 (earlier year) rising across years to 39.5 (latest year shown). ### Labor market indicators - School enrollment rates increased significantly in recent years; secondary enrollment is better or comparable with peers, while pre-primary enrollment lags. - Labor force participation is the lowest among peers; youth labor force participation is very low with a sizable NEET share. - Youth Not in Education, Employment, & Training (NEET) is shown as a notable share (Timor-Leste 2021 survey reference). ### Human capital and social indicators - Human Development Index (HDI) improved until mid-2010s but has stagnated recently. - Poverty and social indicators (selected): - Poverty headcount ratio at $1.90 a day (2011 PPP): 24.4 (reported figure). - Poverty headcount ratio at national poverty lines: 41.8 (reported figure). - People using at least basic drinking water services: series rising to 87.0 (latest year shown). - People using at least basic sanitation services: series rising to 58.4 (latest year shown). - Access to clean fuels and technologies for cooking: series rising to 15.2 (latest year shown). - Health expenditure (selected comparison): Timor-Leste with historical series noted; specific values shown in figure. - Informal sector employment constitutes a relatively high share of total employment and is higher among less-educated groups. ### Key balance-sheet and external vulnerability indicators - Public foreign assets (end-period, in millions of U.S. dollars): 19,647 (2020), 20,667 (2021), 18,212 (2022), 18,331 (2023), with projected declines thereafter. - Public foreign assets in months of imports of goods & services: 263 (2020), 266 (2021), 196 (2022), 198 (2023), and projected declines thereafter. - Nominal non-oil GDP (in millions of U.S. dollars): 1,581 (2020), 1,560 (2021), 1,672 (2022), 1,833 (2023), 1,992 (2024), 2,140 (2025), 2,292 (2026), 2,453 (2027), 2,625 (2028). *Source: IMF staff compilation and Timor-Leste authorities (figures and tables as presented in the source content).* ### Annex I. Country Engagement Strategy ### Annex I. Country Engagement Strategy ### A. Background and Context - Timor-Leste is a lower middle-income country (GNI per capita in 2022: $1,970) with presumed blender status for General Resources Account (GRA) and Poverty Reduction and Growth Trust (PRGT) resources. - Small Development State (SDS) characteristics: population of 1.3 million; since independence in 2002 Timor-Leste has achieved significant growth, yet 48 percent of the population remains multidimensionally poor (UNDP Global Multidimensional Poverty Index). - Petroleum Fund (PF) history and size: - Petroleum Fund law passed in 2004; all oil and gas revenues flow into the fund, used for budget financing. - PF balance of 1,043 percent of non-oil GDP as of end-2022. - Staff estimate the fund generates about 29 percent of GDP in sustainable income. - Withdrawals to finance large fiscal deficits have far exceeded sustainable income and the PF is being depleted over time. ### B. Drivers of fragility - Political instability - Rooted in recent history and civil unrest, notably the 2006 turmoil. - Political instability has caused significant delays in budget approvals (example: post-election 2017) and constrained government capacity and policy continuity. - Timor-Leste ranks among the lowest in the Asia-Pacific region in the Worldwide Governance Indicators for political stability and rule of law. - Lack of governance and rule of law - Weaknesses include corruption, underdeveloped licensing requirements, unclear property rights, weak contract enforcement, and lack of an insolvency framework. - Justice sector capacity is limited; training more lawyers and judges is needed. - Limited economic diversification - Heavy dependence on offshore oil and gas; limited non-oil domestic revenue (domestic tax revenue covered about 9 percent of public expenditure in 2022). - Over 60 percent of the workforce is employed in agriculture, much of it subsistence farming. - Active oil fields now depleted and PF projected to be exhausted by the end of the 2030s, creating urgency for private sector growth and diversification. - Natural disaster and climate change risks - High vulnerability: 14 natural disasters have hit the economy since 2001. - Public expenditure on climate-related initiatives has been declining in recent years. - IMF’s Climate-driven INFORM Risk Indicator indicates Timor-Leste faces higher climate-driven hazards than peers. ### C. Major economic challenges (resulting from fragility drivers) - Large fiscal and external imbalances - Fiscal deficit projected to remain above 40 percent of non-oil GDP for the next decade without major reforms. - Public expenditure around 100 percent of non-oil GDP, largely transfers, boosting imports. - Current account deficit expected to approach 50 percent of non-oil GDP in 2033. - Risk of fiscal cliff if PF depletion leads to abrupt spending cuts by the end of the 2030s. - Risk of debt distress assessed as moderate, but long-term risks are underscored by large deficits financed via PF withdrawals that far exceed investment income. - Utilization of the demographic and gender dividend - NEET (age 15-24 not in employment, education, or training): 31 percent in 2021 (Asia-Pacific regional average: 23 percent). - Female labor force participation is lower than male participation. - World Bank Human Capital Index: 0.45 (East Asia and Pacific average: 0.6). - Low enrollment in early childhood and secondary education; poor teaching quality and facilities, high repetition and dropouts. - Low agricultural productivity and food insecurity - Agriculture value added per worker dropped by 21 percent from 2010 to 2021 (World Bank 2023). - 22 percent of the population faces high levels of acute food insecurity (IPC 2023). - Food accounts for 54 percent of the consumer price index; heavy reliance on food imports and climate vulnerability increase price instability risks. ### D. Constraints to reform and policies to address sources of fragility - Public sector management capacity constraints - World Bank CPIA and PEFA findings: Timor-Leste ranks among the lowest in Asia-Pacific peers. - PEFA 2020: Ministry of Finance lacks capability for policy-based fiscal strategy and budgeting and predictability and control in budget execution; more than 60 percent of indicators in these areas scored "D". - Fragmented responsibilities across ministries and public enterprises hinder budget capacity and structural reform progress. - Negative feedback loops: political instability → delayed budget execution/policy implementation → weakened capacity → drag on growth → renewed political instability. - Macroeconomic policy priorities (tailored to Timor-Leste) - Enhancing fiscal sustainability - Establish a well-defined medium-term fiscal framework as the foundation of fiscal strategy. - Rationalize expenditure and improve composition, focusing more on capital spending. - Modernize tax administration and enhance revenue mobilization to raise non-oil domestic revenue to peer-aligned levels in the medium to long term. - Improving human capital - Targeted investment in early childhood education, school construction, and teacher hiring. - Strengthen vocational training with focus on youth and women. - Increase health investment for routine services and emergency resilience; consider telemedicine to improve rural delivery. - Promoting private sector development (immediate actions and medium-term goals) - a. Establish robust governance and sound business environment by addressing: (i) incomplete licensing requirements; (ii) poorly defined property rights, including lack of a land registry; (iii) costly contract enforcement; and (iv) lack of an insolvency framework. - b. Strengthen tourism via infrastructure (roads, airports), foreign investor attraction, and international coordination to invite tourists. - c. Increase agricultural productivity by assisting larger-scale coffee production and shifting to higher-value commodities. - d. Broaden access to formal credit by removing impediments, including absence of requirements for companies to prepare financial statements under a common accounting standard and a complex/incomplete patchwork of banking regulations. - e. Foster digitalization of government services and the banking/payment system to enhance financial development and inclusion. - Enhancing resilience to natural disasters and climate change - Improve budget planning with realistic cost estimation. - Pursue grants or concessional borrowing over the medium term to strengthen climate-adaptive capacity given narrowing fiscal space. ### E. Fund engagement in capacity development priorities - Recent engagement focus: surveillance and capacity development (CD). - Timor-Leste is one of the largest recipients of the Fund’s CD in the region. - 12 projects are in progress for FY2024, with most provided through the Pacific Financial Technical Assistance Centre (PFTAC) in Fiji. - Timor-Leste has not undertaken a Fund-supported program since independence. - Major CD areas and recent activities - Public Financial Management (PFM) - Early focus: establishing operational fiscal authorities post-conflict. - Shift toward expenditure management, treasury operations, and fiscal reporting. - 2016: Fund conducted a Public Investment Management Assessment (PIMA). - April 2022: Fund mission assisted sequencing and prioritization of PFM reforms, leading to PFM Reform Strategy 2022-2027 and a new comprehensive public finance law. - PFTAC supports top-down budgeting CD. - Revenue administration and mobilization - PFTAC support for taxpayer registration, tax segmentation, taxpayer services strategy. - November 2021: diagnostic review of tax mobilization and administration; follow-up expert assistance ongoing. - Macro statistics - PFTAC reviewed national accounts methodology and compilation with Australian authorities. - Assistance on GFS: compiling annual GFS data for FY2020-2021 and identifying discrepancies with MFS. - Balance of Payments Statistics (BOPS): assistance to improve compliance with BPM6 and offshore oil/gas presentation. - Debt management - Ministry of Finance steps to formalize debt management, but operational framework remains fragmented across agencies. - PFTAC supports capacity strengthening. - Macro-financial forecasting - ICD supports operationalization of macroeconomic framework in policy making. - February 2023: first phase to introduce accounting-based Macroeconomic Projection Tool (MPT) completed. - June 2023: second phase started to help authorities use MPT in the budget process. - AML/CFT - LEG carried out CD during 2021-2023. - Proposed review of AML/CFT framework was not completed. - April 2023: last mission supported the financial intelligence unit to strengthen AML/CFT investigation capacity and international cooperation. - Lessons from CD delivery in Timor-Leste - Long-term resident advisors were instrumental in establishing fundamental fiscal reforms, such as the Petroleum Fund law. - Very low absorption capacity can lead CD to substitute for local resources in the short term; CD should focus on daily management of PFM functions when capacity is limited, while concurrently working to improve authorities’ capabilities and ownership. - In the medium to long term, CD should transition toward strategic planning and prioritization; formulating a medium-term CD strategy with authorities is key (example: April 2022 engagement). *Annex I. Country Engagement Strategy* ### 10. CD priorities should remain focused on areas where the Fund can leverage its expertise ### 10. CD priorities should remain focused on areas where the Fund can leverage its expertise ### Immediate priorities and overall focus - Prioritize technical assistance (CD) where the Fund can alleviate fragility and binding constraints in the economy, with immediate emphasis on support for a medium-term fiscal framework and domestic revenue mobilization (PFM reform, adoption of a Fiscal Responsibility Law, and implementing the VAT). - Immediate priority: introduction of VAT. The Fund’s CD roles: institutional setting, legal drafting, and tax design/modeling; share experiences of Asian peers. ### Fiscal framework and expenditure quality - Establish a well-defined fiscal framework as the foundation of a robust fiscal strategy; near-term priority is support for adoption of a Fiscal Responsibility Law requiring a monitorable fiscal policy objective and a strategy with flexibility. - Fiscal framework should include: - effective expenditure ceilings; - better prioritization based on realistic cost-benefit analysis; - a credible budget baseline. - These measures aim to reduce excess withdrawals from the Petroleum Fund (PF). - Improve expenditure quality to address fragility drivers: - Near-term: limit recurrent expenditures on wages, goods and services, and transfers while prioritizing spending on human capital (health and education) and physical capital. - Strengthen top-down budgeting to improve budget credibility. - Upgrade public investment management framework using the 2016 PIMA to better select projects. - Establish strong governance safeguards and transparent fiscal reporting. - Rationalize employment spending given the high wage bill (17 percent of GDP) and expenses of temporary contracts; provide CD on employment policies and human resource planning. - Over the medium term, digitalization of government to facilitate efficiency and equity of expenditure. ### Revenue mobilization and revenue administration - Revenue mobilization is a long-standing issue requiring near-term progress. - The Fund has peer-reviewed a draft VAT law in 2016; the new government plans to implement VAT though no clear timeframe exists. - Immediate priority: introduction of VAT with Fund CD on institutional setting, legal drafting, and tax design/modeling. - Medium-to-long-term CD options: property taxation, digital services taxation, environmental taxation, international tax issues, fiscal incentives, and tax system progressivity. - Revenue administration priorities in the near term: - Support tax authority to improve efficiency and effectiveness of tax registration, filing, collections, and enforcement. - Specific actions requested: - (i) modernize operations by upgrading human capacity and minimizing manual procedures in the tax administration system; - (ii) develop a medium-term tax administration plan; - (iii) implement institutional reforms to streamline the organizational structure of the tax authority; - (iv) upgrade the tax procedure code. - Digitalization, including enforcement of e-tax filing, will expedite reforms. ### Debt management, SDGs, and public financial planning - Debt management will be increasingly critical over the medium to long term as public debt is expected to rise with the cessation of oil production. - Need enhanced capabilities in debt reporting and monitoring, including regular publication of debt statistics. - Financial sector development should accompany these initiatives to make deficit financing more market-oriented through government securities issuance. - Pursue Sustainable Development Goals (SDGs) with better costing: - Provide CD on costing SDGs to inform authorities and development partners about resources required within long-term fiscal sustainability. ### Macroeconomic statistics and forecasting - Urgent need to enhance quality and frequency of macroeconomic statistics: - Improve national accounts and key standard statistics: GFS, BOPS, MFS, and FSI to support effective CD and surveillance. - Operationalize and institutionalize macro-financial forecasting tools: - Fully operational forecasting capabilities will improve fiscal policy decisions and budget planning/execution efficiency. - Fund should ensure coordination among fiscal, monetary, and statistical authorities when providing technical assistance. ### Governance, transparency, and AML/CFT - Continue efforts to strengthen legal and institutional frameworks for auditing. - Address AML/CFT deficiencies to ensure compliance with FATF standards. ### Coordination arrangements - Close coordination with development partners (World Bank, ADB, United Nations agencies, European Union, bilateral partners, IFC) is essential to leverage the Fund’s mandate and expertise and to avoid duplication. - Examples of collaboration: World Bank on PFM and structural reforms; IFC on financial deepening and inclusion; ADB on public investment management and revenue administration; United Nations on digital finance, gender, and AML/CFT. - Improve internal coordination across government ministries (particularly MOF) to manage size and number of aid projects and to prevent overloading authorities. - Close coordination across Fund departments and regional offices is essential: - Each project team should coordinate with area departments and each other on timing and sequencing. - PFTAC plays a major role but remoteness creates high flight costs and long travel times. - More accessible regional offices (e.g., Capacity Development Office in Thailand, CDOT) could scale up on-the-ground CD delivery. ### Risks to IMF engagement and policy outcomes - Key risks and implications: - Political instability: may delay or suspend policy initiatives. - Faster-than-expected depletion of the Petroleum Fund: could force abrupt fiscal adjustment and hinder investment in human and physical capital. - Accelerated climate change: could exacerbate natural disaster impacts, including in the Dili urban area, a few meters above sea level. ### Selected external sector and macro-financial statistics (as reported) - Net international investment position (NIIP) by Q3-2023: $17.9 billion (975 percent of non-oil GDP). - External assets Q3-2023: $19.4 billion (1,058 percent of non-oil GDP). - External liabilities Q3-2023: $1.5 billion (83 percent of non-oil GDP). - Petroleum Fund asset composition (Q3-2023; percent of total assets in financial market): Cash in U.S. dollar 15 percent; Equity securities 29 percent; Debt securities 56 percent. - Bank holdings of currency and deposits: $1.3 billion (71 percent of non-oil GDP). - Foreign reserves held by central bank: $0.8 billion (46 percent of non-oil GDP). - Petroleum Fund: about 189 months of imports (noted in reserve adequacy discussion). - Net foreign assets by end-2023 used in staff calculations: $18.7 billion; no oil revenues expected from 2024 onward following exhaustion of oil production at end-2023. - Staff assumption for implicit real return on total wealth: 3 percent. - Oil revenues in 2023: $0.4 billion (22 percent of non-oil GDP). - Current account balance in 2023: -20.4 percent of non-oil GDP; current account norm estimated at -8 percent of non-oil GDP; current account gap estimated at -12 percent of non-oil GDP (staff preferred estimate). - Alternative EBA-Lite estimates (2023): current account gap -45.5 percent of non-oil GDP; current account norm 24.4 percent of non-oil GDP; policy gap -15.4 percent of non-oil GDP. - Current account balance (excluding oil revenues) improved from -50 percent of non-oil GDP in 2022 to -43 percent of non-oil GDP in 2023. - REER appreciation: about 10 percent during 2016–22; additional 5 percentage points in first three quarters of 2023. Using a trade elasticity of -0.14, a current account gap at -12 percent of GDP is equivalent to a REER gap of about 83 percent. - Reserves at end-2023: $830 million, equivalent to about 9 months of imports, 60 percent of broad money, 302 percent of external debt, and 45 percent of non-oil GDP. - Non-oil GDP estimate in 2023: about $1.8 billion. *Source: IMF staff chapter "10. CD priorities should remain focused on areas where the Fund can leverage its expertise" (content unit 1tlsea2024001).* ### Annex IV. Integration of Capacity Development and Surveillance ### Annex IV. Integration of Capacity Development and Surveillance ### Surveillance Recommendations and Capacity Development Activities - Tax Policy - Surveillance recommendation: Adopt a single rate VAT (¶17). - Capacity development (CD): The Fund started supporting CD to prepare for VAT implementation through the PFTAC in October 2022. - Tax Administration - Surveillance recommendation: Strengthen tax administration to improve tax compliance (¶17). - CD: 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 (¶18). - CD: The Fund is ready to provide technical assistance through the Fiscal Affairs Department (FAD). - Public Financial Management (PFM) - Surveillance recommendation: Address PFM weaknesses to improve the quality of government spending (¶18). - CD: The Fund supported CD through FAD and PFTAC to improve the authorities’ Public Financial Management Strategy and is supporting CD on strengthening top-down budgeting. - Governance and AML/CFT - Surveillance recommendation: Strengthen the AML/CFT regime (¶22). - CD: The AML/CFT framework is currently being assessed by APG in the context of Timor-Leste’s third mutual evaluation. - Banking Sector Regulation and Financial Supervision - Surveillance recommendation: Enhance prudential standards and risk assessment methodologies to capture emerging risks in the financial sector (¶21). - CD: The Fund is ready to provide technical assistance through PFTAC. - Macroeconomic statistics - Surveillance recommendation: Improve the quality and frequency of macroeconomic statistics (¶31). - CD: The Fund reviewed the methodology and the compilation system of national accounts in collaboration through PFTAC, with the Australian statistical authorities. The Fund is supporting CD on external sector statistics and on government finance statistics through the Statistics Department (STA). - Financial Soundness Indicators (FSI) - Surveillance recommendation: Release FSI data without delay (¶31). - CD: The Fund is ready to provide technical support through the STA. - Macroeconomic Analysis - Surveillance recommendation: Develop stronger analytical skills and better macroeconomic forecasting and policy analysis (¶8). - CD: The Fund’s Institute for Capacity Development (ICD) is supporting CD through the Singapore Training Institute and PFTAC to build a Financial Programing model for own use by the authorities. ### Recent Actions and Plans (selected) - VAT implementation CD began through PFTAC in October 2022. - Diagnostic review of tax administration: November 2021, with short-term expert follow-up. - Fiscal Affairs Department (FAD) stands ready to provide TA on Fiscal Responsibility Law and PFM improvements. - PFTAC and FAD supported development of Public Financial Management Strategy and top-down budgeting. - AML/CFT: Undergoing APG third mutual evaluation. - STA: Support provided for external sector statistics and government finance statistics; readiness to support FSI reporting. - ICD: Supporting development of a Financial Programming model via Singapore Training Institute and PFTAC. ### Responses to Past Fund Advice (Annex V highlights) - Fiscal Policy - Fiscal consolidation and gradual elimination of Petroleum Fund (PF) excess withdrawals - Outcome: The fiscal balance improved by 15 percent in 2022. - Policy action: The budget ceiling was lowered by 9 percent in the 2023 rectification budget. - Gap: No medium-term fiscal framework to underpin continuous fiscal consolidation. - Revenue mobilization and expenditure rationalization - Outcome: The new government decided to reduce import duties and eliminate the tax on sugar and confectionary products; announced plan to implement a VAT. - CD status: CD for preparation for a VAT and top-down budgeting is in progress. - Strengthen public financial management (PFM) - Outcome: The authorities are revising their PFM Reform Strategy to be published in early 2024. - Financial Policies - Upgrade the financial sector regulatory and supervisory framework - Outcome: The central bank issued the IRFS 9 and Basel III instructions, and private banks started appropriate training. Full compliance is expected by December 2024. - Policy action: With help of development partners, the central bank is drafting a new banking law to incorporate regulatory changes. - Strengthen digital literacy, cybersecurity, and data/consumer protection and privacy - Policy action: The new government plans to formulate and implement a national broadband plan, national cyber security plan, e-Government plan, and digital economy infrastructure plan. - Structural Reforms - Recommendations include investment in human capital, raise productivity in agriculture, simplify licensing and land registration, strengthen governance, better enforcement of legal contracts, labor market reforms, investment in digital infrastructure. - Status: Authorities plan to have TA from IMF and World Bank on legal reforms for financial sector development. AML/CFT assessment by APG is ongoing. Other reform areas lack progress. - Statistics - Recommendation: Improve the quality of data for informed policy making. - Status: Progress has been made, but further improvements are required in quality and frequency of official statistics, including national accounts, GFS, BOPS, MFS, and FSI. ### Statistical Issues and Data Adequacy (as of January 2024) - Overall assessment: Data provision to the IMF is broadly adequate for surveillance, with concerns: - Incomplete incorporation of petroleum-related transactions and foreign direct investment in the balance of payments after the Maritime Boundary Treaty. - Weaknesses in compilation and dissemination of government finance statistics. - No public reporting of Financial Soundness Indicators (FSI). - National Accounts - GDP compiled annually using base period 2015 and methods reasonably consistent with the 2008 SNA. - Publication improvements: 2019 national accounts published October 2020; preliminary 2020 GDP published April 2021; preliminary 2021 and 2022 GDP estimates published in March of the following years. - Assumption: National accounts assume oil production at the Joint Petroleum Development Area (JPDA) is resident in Timor-Leste since September 2019 due to the Maritime Boundary Treaty signed in August 2019. - Price Statistics - CPI uses expenditure weights from the 2014–15 Living Standard Survey. - CPI rebased with reference period August 2018 (August 2018 = 100); basket weights updated in August 2018. - Government Finance Statistics (GFS) - Recent TA helped resume regular annual GFS reporting for the central government to IMF STA (suspended since 2019). - STA assisted with compilation of quarterly GFS (suspended since 2016); data discrepancies between non-financial and financial transactions remain. - Public Sector Debt Statistics compiled for central government (external loans). - Monetary and Financial Statistics (MFS) - Central bank compiles MFS generally following the Manual and reports detailed monthly monetary data for central bank and other depository corporations. - Official data on currency holdings are difficult under U.S. dollar currency regime. - Data for other financial corporations (mainly insurance) are in preparation for reporting to STA. - Central bank reports some Financial Access Survey indicators including mobile money and UN SDG indicators (commercial bank branches per 100,000 adults; ATMs per 100,000 adults). - Financial Sector Surveillance - Only basic market-based indicators are available; coverage, precision, and timeliness vary. - Bank-specific balance sheet and outstanding loan data insufficient for stress tests. - Cross border exposure data for financial corporations not available. - FSIs are not reported to STA. - External Sector Statistics (ESS) - ESS TA mission July 2023 (Capacity Development Office in Thailand) enabled central bank to publish balance of payments through Q3/2023 consistent with BPM6 and the Maritime Boundary Treaty. - Weak institutional settings and inter-institutional data sharing procedures significantly affect ESS compilation. - Major source data shortages: cross-border transactions in oil and gas sector; direct investment liabilities including intercompany debt; large infrastructure projects by foreign contractors; services. - Recommended solution: high-level engagement to facilitate statistical and administrative data exchange between government institutions and the BCTL. - Monthly merchandise trade data published regularly from the Automated System for Customs Data; service transactions largely estimated with limited data outside official and tourism sectors. - Quarterly balance of payments available for 2006–Q3/2023; international investment position available for 2008–Q2/2023. - Publicly available information on remittances is limited; work needed to fine-tune estimation models and collect data from money transfer operators. ### Data Standards and Dissemination - Timor-Leste participates in the IMF’s Enhanced General Data Dissemination System (e-GDDS) and launched a National Summary Data Page in February 2019; dissemination has delays and limited coverage. ### Table of Common Indicators (as of November 30, 2023) — selected entries - Exchange Rates: Date of latest observation 10/2023; Date received 10/2023; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M. - International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Date of latest observation 09/2023; Date received 10/2023; Frequency M/M/M. - Reserve/Base Money: 09/2023; 10/2023; M/M/M. - Broad Money: 09/2023; 10/2023; M/M/M. - Central Bank Balance Sheet: 09/2023; 10/2023; M/M/M. - Consolidated Balance Sheet of the Banking System: 09/2023; 10/2023; M/M/M. - Interest Rates: 09/2023; 10/2023; M/M/M. - Consumer Price Index: 09/2023; 10/2023; M/M/M. - Revenue, Expenditure, Balance and Composition of Financing – General Government: Date of latest observation 2022; Date received 01/2023; Frequency A/A/A. - Central Government and Central Government-Guaranteed Debt: 2022; 01/2023; A/A/A. - External Current Account Balance: Q3/2023; 10/2023; Q/Q/Q. - GDP/GNP: 2022; 08/2023; A/A/A. - Gross External Debt: Q3/2023; 10/2023; Q/Q/Q. - International Investment Position: Q3/2023; 10/2023; Q/Q/Q. ### Debt Sustainability (summary) - Risk assessment: Timor-Leste remains at moderate risk of overall and external debt distress, with application of judgement, unchanged from the 2022 Article IV debt sustainability analysis. - Projection and judgment: - Baseline: The present value of the 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 mechanical rating of high risk. - Mitigant: The Petroleum Fund is large relative to projected debt levels and debt service requirements; assets are liquid and accessible, prompting judgmental upgrade to moderate risk. - Long-term projection: Staff projects the Petroleum Fund will be depleted in 2039, triggering a breach of all debt indicators towards the end of the twenty-year projection horizon. - Policy conclusion: There is time to adopt necessary policy adjustments; staff’s alternative scenario illustrates how fiscal consolidation and structural reforms can ensure fiscal and debt sustainability in the long term. - Official risk ratings in the joint Bank‑Fund DSA: - 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. *Source: Annex IV. Integration of Capacity Development and Surveillance — Staff Report for the 2023 Article IV Consultation (informational annex), Democratic Republic of Timor-Leste.* ### 1. The coverage of public sector debt used in this report is public and publicly ### 1tlsea2024001 - 1. The coverage of public sector debt used in this report is public and publicly ### Coverage of public sector debt - Coverage used in this report is public and publicly guaranteed debt. - Timor-Leste’s public and publicly guaranteed external debt is held entirely by the central government. - Coverage of public sector debt includes state-owned enterprise debt. - Under the Public Debt Regime Law, state-owned enterprises: - are not allowed to borrow for themselves, - can only obtain financing via on-lending from the Ministry of Finance. - Currently, there are no guarantees granted by the state to state-owned enterprises. - The Social Security Fund does not issue debt on its own. - The public sector only borrows externally, given a lack of domestic financing sources. - The debt definition of the debt sustainability analysis is currency-based, and the legal tender is the U.S. dollar. ### Design of contingent liability stress tests - Contingent liability stress test settings were customized. - The default shock to contingent liabilities from: - state-owned enterprises debt is reduced to zero (because it is already included in the baseline public debt), - Public Private Partnerships is reduced to zero (because the latter is negligible). ### Background on debt and assets - Timor-Leste’s net public asset position is currently strong due to oil-related savings accumulated in Petroleum Fund assets and low levels of public debt. - Petroleum Fund balance at end-2022: - $17.4 billion (1,039 percent of non-oil GDP), - covering 187 months of prospective goods and services imports. - The Petroleum Fund balance decreased by $2.4 billion in 2022 as unfavorable market revaluations ($-2.4 billion; -11.9 percent) and a large withdrawal ($1.4 billion; more than double the Fund’s Estimated Sustainable Income) exceeded interest and dividend income ($596m) and oil revenues ($1.1 billion). - The average nominal return on Petroleum Fund assets during 2017–22 was 4.5 percent. - Fiscal and debt indicators in 2022: - Fiscal deficit increased from 45 percent of non-oil GDP in 2021 to 58 percent in 2022 due to significantly higher recurrent expenditure. - Outstanding public external debt increased by $23 million and reached 15 percent of non-oil GDP ($258 million) in 2022. - All external loans signed since 2012 are concessional loans from the Asian Development Bank, the World Bank Group, and the Japan International Cooperation Agency. - Asian Development Bank share of total external debt at end-2022: nearly 65 percent. - 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 decline thereafter. ### Macroeconomic context and projections (basis of DSA) - The debt sustainability analysis is based on macroeconomic projections underlying the 2023 Article IV consultation. - Two scenarios considered: baseline and reform. - Selected projections and historical figures (2020–28, as provided): - Nominal Non-oil GDP (in millions of U.S. dollars): 1,581; 1,560; 1,672; 1,829; 1,979; 2,124; 2,277; 2,439; 2,613 (2020–2028). - Real Non-oil GDP growth (percent change): -7.2; 1.6; 4.0; 1.5; 3.5; 3.2; 3.1; 3.0; 3.0 (2020–2028). - CPI (percent change, period average): 0.5; 3.8; 7.0; 8.4; 3.5; 2.2; 2.0; 2.0; 2.0 (2020–2028). - Petroleum Fund balance (in millions of U.S. dollars) (closing balance): 18,991; 19,732; 17,379; 17,503; 16,772; 16,130; 15,391; 14,560; 13,646 (2020–2028). - Public external debt (In millions of U.S. dollars): 219; 235; 253; 275; 284; 311; 325; 333; 351 (2020–2028). - Public external debt (In percent of Non-oil GDP): 13.8; 15.1; 15.1; 15.0; 14.3; 14.7; 14.3; 13.6; 13.4 (2020–2028). - Crude oil prices (U.S. dollars per barrel, WEO): 42; 69; 96; 81; 79; 75; 72; 72; 72 (2020–2028). ### Recent revisions and fiscal developments - Revisions since the 2022 Article IV DSA: - Petroleum Fund outstanding balance at end-2022 included a valuation of about $701 million (close to 4 percent of the Petroleum Fund balance) for the investment in the Greater Sunrise oil fields by Timor-Gap, restored in the 2021 Petroleum Fund account. - The 2022 budget’s planned large fiscal deficit spending on expanded capital expenditures was abandoned in the 2023 rectification budget. - Courts blocked the transfer of $1 billion from the Petroleum Fund to finance support programs for war veterans via the National Liberation Combatants Fund, which had been included in the 2022 DSA baseline. ### Key macro-fiscal assumptions and projections (highlights) - Growth and inflation: - Real non-oil GDP growth projected to slow from 4.0 percent in 2022 to 1.5 percent in 2023; recover to 3.5 percent in 2024; hover around 3.0 percent in medium and long term. - Inflation peaked at almost 10 percent y/y in 2022; expected to ease to 3.5 percent in 2024 and return to 2 percent in the medium term. - Fiscal balance and revenues: - Fiscal deficit projected to decrease from 58 percent of non-oil GDP in 2022 to 42 percent in 2023 and remain around that level until 2030. - Government revenues (including ESI) projected to decline from 46 percent of non-oil GDP in 2022 to about 39 percent in 2023 and average around 32 percent (2024–28) and 17 percent (2029–43). - Authorities’ target to raise domestic revenue from 10 percent currently to around 15 percent of non-oil GDP in the medium term; baseline assumes domestic revenue rises from 10 percent to about 12 percent by 2043. - Petroleum Fund and external financing: - Annual nominal investment return on the Petroleum Fund assumed around 4.5 percent during 2023–30, then 4 percent thereafter. - Petroleum Fund falls to $13.6 billion by 2028 and is completely depleted by 2039 under baseline (one year later than previous DSA); thereafter government relies on external debt to finance fiscal deficits. - External borrowing projected at about 1.5 percent of non-oil GDP during 2023–28; private external borrowing assumed negligible. - Outstanding external debt as share of non-oil GDP projected to decline slightly from 15 percent in 2022 to 13.5 percent in 2028, but to rise to around 180 percent of non-oil GDP by 2043 under the baseline. ### Baseline assumptions on execution and spending - Baseline fiscal scenario assumes lower spending than planned budgets due to historical execution rates: - 2023 execution rate assumed close to 90 percent of the planned amount in the 2023 rectification budget. - 2024 execution rate assumed about 85 percent of the planned amount in the 2024 budget. - Long-term spending paths: - Recurrent spending projected to increase by 3.5 percent each year in the long term. - Capital spending projected to increase by around 8 percent during 2024–28 and around 5 percent in the long term. - External loan characteristics: - Baseline incorporates access to IDA Shorter Maturity Loans (SMLs) during 2023–25; SMLs have a 12-year final maturity, a 6-year grace period, and zero interest or service charge. ### Assessment of baseline realism and risks - The baseline scenario is identified as potentially unrealistic but not adjusted because of plausible mitigating factors. - The three-year primary balance adjustment between 2022 and 2025 is projected to be 15 percent of non-oil GDP; much of the consolidation already occurred in 2023 via low budget execution, particularly in public investment. - A low fiscal multiplier of 0.1 is assumed; if actual multiplier is larger, growth could be lower or negative in the short term. ### Baseline and Reform scenario comparisons (selected indicators) - Baseline (selected): - Real non-oil GDP growth: 1.5 percent (2023), 3.5 percent (2024). - Revenue (excl. grants): 38.5 percent (2023). - Expenditure: 78.9 percent (2023). - Net lending/borrowing: -41.6 percent (2023). - PF closing balance ($ million): 17,503 (2023). - Reform (Recommended) (selected): - Real non-oil GDP growth: 1.5 percent (2023), 3.5 percent (2024). - Revenue (excl. grants): 36.5 percent (2023). - Expenditure: 78.9 percent (2023). - Net lending/borrowing: -41.6 percent (2023). - PF closing balance ($ million): 17,503 (2023). - Financing and outcome differences between baseline and reform are outlined in Text Table 5 (as provided). *Source: 1tlsea2024001 - International Monetary Fund* ### 9. Under staff’s reform scenario—which is broadly consistent with the scenario that has ### 1tlsea2024001 - 9. Under staff’s reform scenario—which is broadly consistent with the scenario that has ### Reform scenario overview - Policy actions are adopted to safeguard long-term fiscal sustainability. - The reform scenario is broadly consistent with scenarios previously presented in the 2021 and 2022 DSAs. ### Domestic revenue mobilization - A VAT is adopted by 2024 to generate additional revenue of about 3 percent of GDP, raising domestic revenue to about 13 percent of non-oil GDP by 2025. - Over the medium term, tax administration reforms and further tax policy measures (e.g., revision of excise tax rates, increase in statutory income tax rate, adopting a property tax) increase domestic revenue to about 15.5 percent of non-oil GDP. - Structural reforms (¶11) are estimated to yield additional revenue growth of about 6 percent (annualized average) during 2024-43 relative to the baseline. ### Expenditure moderation and composition - Government expenditure declines gradually to the 2019 level as a share of non-oil GDP, allowing elimination of excess withdrawals from the Petroleum Fund by 2033. - Quality of government spending is improved by curbing growth in salary, goods, and services expenditures and allocating more spending towards human capital development and a strengthened social safety net. - Capital expenditure is kept stable as a share of non-oil GDP—at higher levels than in the baseline—and its growth dividend is boosted through rigorous cost-benefit analysis. ### Fiscal sustainability target and Petroleum Fund dynamics - Target: achieve a sustainable fiscal position by 2033 via more moderate spending and higher domestic revenue, aligning withdrawals from the Petroleum Fund with its sustainable income. - 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 (2025–28) would average 23 percent of non-oil GDP, instead of 44 percent of non-oil GDP under the baseline. - In the reform scenario the Petroleum Fund is preserved from 2033 onwards and generates a permanent level of investment income to support government expenditures. ### Public external borrowing and investment - Government strategy of increasing public external borrowing via concessional loans to finance public investment and preserve Petroleum Fund wealth continues. - Overall external borrowing is significantly lower in 2038–43 as the Petroleum Fund is preserved and public spending increases in line with higher sustainable sources of revenue. ### Structural reforms and private sector development - Structural reforms implemented to improve the business environment, raise productivity, and promote private sector development include: - facilitating the 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 system to improve governance and reduce corruption vulnerabilities. - Authorities laid out medium-term measures in the Economic Recovery Plan 2020–23 focusing on these priorities. ### Macro-fiscal outlook under reform scenario - Real non-oil GDP is somewhat lower than in the baseline in the short run owing to the output costs of fiscal consolidation, mitigated by reprioritization and structural reforms. - Structural reforms are estimated to have a positive impact on real GDP growth of around 0.3 percentage points in the medium-term, and 2.5 percentage points over the long run. - With sustained improvement, long-term growth (2031–2043) is projected to hover around 5-6 percent—significantly higher than under the baseline—driven by higher private investment, development of the non-oil private sector, reduced import dependence, and a larger export base. - The current account deficit over the medium and long term is projected to be considerably smaller than the baseline due to higher exports and lower imports. ### Debt-carrying capacity and applicable DSA thresholds - Debt-carrying capacity is assessed as Weak; Composite Indicator index: 2.68 (barely below 2.69 threshold). - Applicable thresholds for Timor-Leste: - PV of external debt-to-GDP ratio: 30 percent; - PV of external debt-to-exports ratio: 140 percent; - External debt service-to-exports ratio: 10 percent; - External debt service-to-revenue ratio: 14 percent; - PV of public debt-to-GDP ratio: 35 percent. ### Customizations to stress tests - Foreign direct investment-to-GDP shock customization: historical average and standard deviation correspond to 2011–21 (excluding 2019) to account for a one-off $575 million outflow in 2019 due to Petroleum Fund’s investment in Timor-Gap. - Export shock customization: aligned with 2021 and 2022 Article IV consultation DSAs to reflect end of petroleum production in 2023. - Current transfers customization: historical average and standard deviation correspond to 2017–21 to reflect shift from net inflows to net outflows. - Commodity price shock tailored by adjusting the share of fuel in total exports of goods and services. - Natural disaster tailored stress test: - Assumes a natural disaster occurs in 2024 and new debt is contracted to finance damages; - Increases public debt-to-GDP ratio by 14 percent in 2023 (equivalent to estimated damages from April 2021 floods); - Real GDP and exports growth decline by 2 percent and 4 percent in FY2023, respectively, relative to the baseline. ### External debt sustainability assessment - Under the baseline: - PV of external debt in percent of exports breaches the 140 percent threshold between 2024 and 2028. - Debt service-to-exports ratio breaches the 10 percent threshold between 2024–30. - All other indicators remain well below their relevant thresholds for the next fifteen years. - Debt dynamics drivers: increase in debt service as grace periods end; projected disbursement of external loans; government strategy of concessional external borrowing to expand public investment. - Present value of external debt projected to decline from 17 percent of non-oil GDP in 2023 to 14 percent in 2032, then increase as the Petroleum Fund is depleted. ### Public debt sustainability assessment - Under the baseline, PV of total public and publicly guaranteed debt-to-GDP ratio remains below threshold for next fifteen years but is vulnerable to commodity price shocks and expected to breach under stress starting in 2026. - Petroleum Fund depletion toward end of twenty-year horizon leads to breaches of all DSA thresholds and substantial jump in external borrowing beyond 2039. ### Reform scenario effects on debt dynamics - Reform scenario significantly improves debt dynamics over the next twenty years. - Duration of breaches of PV external debt-to-exports and debt service-to-exports in the medium-term is smaller compared to the baseline. - Petroleum Fund is stabilized and generates a sustainable stream of resources to finance the budget. ### Risk rating, vulnerabilities, and policy urgency - Mechanical DSA rating: high risk of debt distress (due to PV debt-to-exports and debt service-to-exports breaches over 2024–30). - Judgment applied to upgrade rating to Moderate, citing large, liquid, and accessible net foreign assets in the Petroleum Fund as a mitigating factor. - Present value of debt does not exceed more than 25 percent of projected Petroleum Fund until 2036 under the baseline. - Under the primary balance shock, PV debt-to-Petroleum Fund assets reaches close to 43 percent by 2036. - Projected Petroleum Fund depletion by 2039 under current policies (could be as early as 2037 with nominal investment return of 2.5 percent) makes urgent fiscal consolidation and structural reforms necessary. - Recommended policy mix: - Fiscal consolidation to achieve a sustainable fiscal position in a 10-year horizon; - Expenditure rationalization and domestic revenue mobilization to reduce withdrawals from the Petroleum Fund; - Structural reforms to improve business environment and governance, enhance competitiveness, strengthen external sector position, and prioritize climate adaptation investment. - Risks: - Lack of political consensus could impede reforms (assessed as high probability of materializing); - Implementation of reforms has higher probability than non-implementation. - Uncertainty around development of the Greater Sunrise fields due to difficulties in finding a commercially viable option acceptable to all stakeholders. *Source: IMF staff estimates and analysis as presented in the content unit.* ### 22. The IMF and the World Bank stand ready to support the authorities in their efforts to ### 22. The IMF and the World Bank stand ready to support the authorities in their efforts to ### Fiscal and debt sustainability: assessments and authorities' requests - The authorities are aware of the challenge of ensuring fiscal and debt sustainability and requested extensive technical assistance from the IMF for ambitious fiscal reforms aiming to secure fiscal sustainability. - The adoption of the Major Planning Options Law as specified in the new basic PFM law aims to bring more predictability to the budget process. - The approval of a new procurement law that came into effect in January 2023 is intended to increase transparency and simplify the procurement process. - The authorities welcomed Fund assistance on a Fiscal Responsibility Law to help improve fiscal discipline. ### Ongoing and planned technical assistance - IMF support: - Ongoing technical assistance on public financial management reforms by the IMF Fiscal Affairs Department. - Technical assistance on revenue administration by the IMF Pacific Financial Technical Assistance Center. - Technical assistance on governance in anti-money laundering by the IMF Legal Department. - World Bank and IFC support: - Plans to provide technical assistance to improve the prospects for private sector development including ease of doing business, agriculture, and tourism. ### Public debt management: capacity gaps and priority actions - Public debt management needs to be strengthened. - External borrowing should be embedded in a suitable institutional framework, supported by best practice debt management policies and procedures. - Key capacity-building areas: - Strengthening the organization and capacity of the debt management unit, including preparing a medium-term debt management strategy (MTDS). - Upgrading debt recording software. - Near-term priority: - Produce comprehensive and realistic debt servicing projections for the existing debt. - Fiscal risk monitoring and reporting should be improved, including risks related to: - Contingent liabilities related to credit guarantees. - Pensions. - Public corporations. - Public-private partnerships. *Source: 1tlsea2024001 - 22. The IMF and the World Bank stand ready to support the authorities in their efforts to* ### 24. While the authorities broadly agreed with staff’s debt sustainability analysis and on ### Timor-Leste: Debt Sustainability Analysis and Fiscal Outlook ### Authorities’ views and fiscal planning - Authorities broadly agreed with staff’s debt sustainability analysis and on the need to achieve fiscal sustainability. - Authorities emphasized urgent development needs and the importance of accelerating growth and development to achieve fiscal sustainability. - Over the medium term, authorities will calibrate fiscal policy to achieve the government’s development objectives, including through prioritizing investment in infrastructure. - Authorities agreed on the need to mobilize domestic tax revenues and improve tax administration, and will prioritize VAT implementation, but agreed with staff on the need to proceed gradually. ### Petroleum Fund (PF) and projected depletion - Authorities agreed that their spending plans would lead to the eventual depletion of the Petroleum Fund (PF). - Under the spending plans and forecasts outlined in the latest budget, depletion could occur by 2034. - Authorities noted that the PF’s balance remains large and that sustaining development will depend on accelerating growth and development. ### Data coverage and public debt management - "There have not been any noteworthy improvements in data coverage and public debt management since the 2019 Article IV." ### Key macroeconomic and fiscal assumptions (selected exact series) - Nominal GDP (Million of U.S. dollars): - 2020: 1,581 - 2021: 1,560 - 2022: 1,672 - 2023: 1,833 - 2024: 1,992 - 2025: 2,140 - 2026: 2,292 - 2027: 2,453 - 2028: 2,625 - 2033: 3,689 - 2043: 7,408 - Real GDP growth (in percent), selected projection years: - 2020: -7.2 - 2021: 1.6 - 2022: 4.0 - 2023: 1.5 - 2024: 3.5 - 2025: 3.2 - 2026: 3.1 - 2027: 3.0 - 2028: 3.0 - 2029: 3.0 - GDP deflator in US dollar terms (change in percent), selected series: - 2020: 1.2 - 2021: -2.9 - 2022: 3.1 - 2023: 8.0 - 2024: 5.0 - 2025: 4.1 - 2026: 3.9 - 2027: 3.9 - 2028: 3.9 - 2029: 4.0 - 2030: 5.0 - Effective interest rate (percent), selected series: - 2020: 0.9 - 2021: 2.0 - 2022: 3.8 - 2023: 3.3 - 2024: 3.2 - 2025: 3.3 - 2026: 2.8 - 2027: 2.7 - 2028: 3.6 - 2029: 4.9 - 2030: 1.7 ### External and public debt headline numbers (selected) - Public sector debt (percent of GDP), selected years: - 2020: 13.8 - 2021: 15.1 - 2022: 15.1 - 2023: 15.0 - 2024: 14.2 - 2025: 14.5 - 2026: 14.2 - 2027: 13.6 - 2028: 13.4 - 2033: 18.0 - 2043: 178.0 - External debt (nominal) (percent of GDP), same series as public sector debt (coverage includes both public and private sector external debt). - PV of public debt-to-GDP ratio (selected projection values shown in Public DSA): - Projections include values such as 18.3; 17.5; 16.4; 16.2; 15.5; 14.7; 14.2; 14.5; 115.9 (table lists these as PV series across projection horizon). - Gross external financing need (Million of U.S. dollars), selected series: - 2020: 934.2 - 2021: -76.5 - 2022: -231.9 - 2023: 416.2 - 2024: 883.5 - 2025: 984.4 - 2026: 1083.3 - 2027: 1188.4 - 2028: 1277.7 - 2033: 1778.1 - 2043: 2705.0 ### Fiscal flows and composition (selected exact figures) - Government revenues (excluding grants, in percent of GDP), selected values: - 2020: 45.9 - 2021: 47.2 - 2022: 46.0 - 2023: 38.6 - 2024: 36.5 - 2025: 33.7 - 2026: 31.4 - 2027: 29.3 - 2028: 27.3 - 2029: 19.0 - 2030: 14.0 - Aid flows (in Million of US dollars): - 2020: 183.1 - 2021: 181.0 - 2022: 190.0 - 2023: 202.0 - 2024: 192.8 - 2025: 191.6 - 2026: 185.1 - 2027: 172.8 - 2028: 170.0 - 2029: 153.0 - 2030: 679.2 ### Identified debt-creating flows and residual financing - Identified net debt-creating flows (selected series, percent of GDP): 59.6; -5.1; -15.6; 21.8; 43.1; 44.8; 46.0; 47.3; 47.7; 47.3; 31.2; -18.1; 44.5 (as shown in the external DSA table). - Non-interest current account deficit (selected series, percent of GDP): 17.6; -10.0; -16.9; 19.9; 41.6; 43.3; 44.7; 46.0; 46.3; 46.0; 32.4; -22.9; 43.1. - Residual (the residual in debt-creating flows is financed through excess withdrawals from the Petroleum Fund), selected series include values such as -57.2; 6.4; 15.7; -21.9; -43.8; -44.5; -46.4; -47.9; -47.9; -45.6; -12.0; 19.6; -44.3. ### Stress tests and sensitivity analysis — summary of outcomes - The DSA presents extensive sensitivity and stress-test exercises (Alternative Scenarios; Bound Tests B1–B6; Tailored Tests C1–C4). - Thresholds and test notes: - PV of debt-to-GDP ratio threshold shown as 30 (Table 3). - Public debt benchmark for Table 4 shown as 35. - Selected indications from sensitivity tables and figures: - Table 3 and Figure 1–3 show multiple stress tests where key indicators (PV of debt-to-GDP, PV of debt-to-exports, debt service-to-exports, debt service-to-revenue) rise substantially under shocks (examples in the tables include multi-decade projection values and large increases under adverse scenarios). - The most extreme single stress test results identified include primary balance shocks and export shocks as the most extreme in different indicators (figures label "Most extreme shock is Primary Balance" and "Most extreme shock is Exports" for specific series). ### Policy implications and priorities (drawn from authorities’ statements and DSA mechanics) - Prioritize investment in infrastructure while calibrating fiscal policy to ensure medium-term fiscal sustainability. - Mobilize domestic tax revenues and improve tax administration; prioritize VAT implementation but proceed gradually. - Manage Petroleum Fund withdrawals to avoid premature depletion, noting the PF could be depleted by 2034 under current spending plans. - Strengthen data coverage and public debt management systems — no noteworthy improvements since the 2019 Article IV were reported. *Source: Country authorities; and staff estimates and projections.* ### 1990. The size of 3-year adjustment from program inception is found on the horizontal axis; the ### 1tlsea2024001 - 1990. The size of 3-year adjustment from program inception is found on the horizontal axis; the ### Recent economic developments and outlook - Growth outlook: - Authorities’ 2023 growth estimate: 2.2 percent. - Staff projection for 2024: 3.5 percent. - Authorities’ projection for 2024: 4.1 percent. - Drivers of stronger growth in 2024 cited by authorities: - Increased public investment prioritized in the 2024 budget. - Donor-financed projects: aid disbursements expected to more than double in 2024, to around $180 million. - Tourism: tourist visa issuance surged 129 percent in the first half of the year. - Remittances: 25 percent higher in the first three quarters of the year. - Projected deficit (before excess withdrawals and other financing sources) for 2024 is lower than the projection in the original 2023 budget. ### Budget credibility, composition, and public financial management - Improvements in 2024 budget quality: - Capital expenditure increased, with development capital expanding by 54 percent relative to the rectified budget. - Allocation for transfers reduced relative to the 2023 original budget. - Fiscal Risk Statement improved by including data on cash balances for public enterprises. - Expenses related to accession to ASEAN and the WTO expected to exert less pressure on the budget next year. - Policy intent: - Authorities seek to strengthen budget credibility, transparency, and planning role. - Continued emphasis on improving public procurement and broader PFM reforms. - Authorities aim to develop a robust Fiscal Responsibility Law and a Medium-Term Fiscal Framework with Fund and partner support. ### Inflation and external price exposure - Inflation dynamics: - Timor-Leste uses the US dollar as its currency anchor. - High import-content of the price-index basket yields a passthrough from international food and fuel prices on the upper end among peers. - Despite recent persistence, inflation is expected to decline significantly in 2024 with accommodation in international prices. ### Financial sector, intermediation, and inclusion - Financial sector soundness: - Low delinquency rates. - Credit growth picked up in the prior year. - Financial intermediation statistics: - Loans as a share of deposits remain below 40 percent. - Overseas placements represent 60 percent of bank assets. - Policy measures and constraints: - Authorities want to stimulate domestic financial intermediation while preserving financial soundness. - Commitment to increase financial inclusion (expand access to bank accounts and credit). - Legal and institutional reforms needed: resolve impediments to securing collateral for loans; harmonize accounting standards for corporate financial statements. - Digitalization and improved payment systems (submarine cable completion this year) expected to support financial deepening. ### Short-term risks and upside factors - Downside risks: - Exposure to exogenous shocks, including natural disasters. - Potential adverse developments in partners reducing concessional resource inflows and affecting investment project implementation. - Reversal of a soft global landing could affect Petroleum Fund returns. - Higher commodity prices could worsen inflation and the current account. - Upside risks: - Improved execution of capital spending and better coordination with development partners could boost growth. - Greater political consensus could accelerate reforms and improve investor confidence. - Well-designed exploration of the Greater Sunrise and other potential fields could positively affect sentiment and investment. ### Medium-term challenges: avoiding a fiscal cliff and moving out of fragility - Central medium-term risk: possibility of a fiscal cliff caused by depletion of the Petroleum Fund (PF), which would force an abrupt adjustment. - Authorities’ strategy: - Efficient utilization of PF savings to foster diversification, private sector development, and higher potential growth while maintaining social cohesion. - Gradual consolidation toward a sustainable level of spending, in tandem with business environment reforms and private-sector development. - Build consensus for a fiscally responsible approach to economic and social development. - Domestic resource mobilization: - Authorities committed to implementing VAT to boost revenue mobilization. - Draft proposals for a new Tax and Duties Act to improve revenue collection. - Domestic revenue mobilization contingent on a robust non-oil economy and successful diversification. ### Diversification priorities and sectoral strategies - Sectors prioritized by authorities and staff for diversification: - Agriculture: - Shift from low-productivity/subsistence models to import-replacing crops and niche exports (example: gourmet coffee). - Binding constraints: access to credit, clarity on land ownership, improved transport infrastructure to reduce post-harvest losses. - Tourism: - Investment in infrastructure and human capital to leverage adventure, history, culture, nature, and biodiversity attractions. - Sequencing and implementation: - Several priority reforms need near-simultaneous implementation; others can be sequenced to build on prior successes. - Given small size and limited integration into global value chains, Timor-Leste should pursue a niche strategy for competitiveness. ### Fund engagement and capacity development - Authorities’ view of IMF engagement: - Welcome the Country Engagement Strategy and broad capacity development (CD) support. - Value Fund surveillance, candid policy advice, and CD delivered through PFTAC. - Call to strengthen involvement of the Capacity Development Office in Thailand (CDOT) given distance to Fiji. - Emphasis on coordination among partners and within government to prioritize, sequence, and avoid duplication. - Areas of ongoing support sought: - Public financial management, procurement, fiscal frameworks, and legal/accounting reforms to support financial intermediation and revenue mobilization. *Sources: Country authorities; and staff estimates and projections.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1tlsea2024001.pdf_