## _cr05245 — Executive Summary and Staff Report Highlights

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### Economic and Policy Developments
- A moderate economic recovery is underway, while inflation remains subdued.
  - Post drought rebound in agriculture and expansion in banking activity offset a further decline in donor activity in 2004.
  - The official dollar-based monetary and exchange regime helped keep inflation in check.
- Fiscal policy has remained cautious despite large oil/gas revenue inflows.
  - Onset of oil production in 2004 resulted in a large fiscal surplus, an increase in the external current account surplus (including international aid) and accumulation of international reserves equivalent to about 15 months of imports (March 2005).
- Constraints on growth:
  - Slow execution of public investment projects and limited progress in attracting private sector investment.
  - Poor budget execution particularly for capital projects and in rural areas.
  - Incomplete legal and regulatory framework for private sector activity.

### Recent Economic Developments (2004–2005) — key statistics
- Non-oil activity and prices:
  - Non-oil GDP growth recovered in 2004.
  - Inflation leveled off at about 2 percent (year-over-year) since August 2004.
- External sector and fiscal balances:
  - External current account surplus (including international assistance) widened to 35 percent of non-oil GDP in 2004.
  - Central government surplus (including grants) for FY 2004/05 expected to be 68 percent of non-oil GDP, versus 33 percent expected in the revised FY04/05 budget.
  - On a “combined sources” basis, the fiscal balance will move into a surplus of 30 percent of GDP in FY04/05.
  - Authorities have no debt and avoid domestic or external borrowing.
- Banking and reserves:
  - Bank lending to the private sector tripled to 21 percent of non-oil GDP at end 2004.
  - Net foreign assets of the BPA reached US$285 million at end-March (more than 15 months of projected imports for 2005).
- Social context:
  - Cumulative growth over the last three years was negative—mainly reflecting the drawdown in the international presence.
  - 40 percent of the population lives below the poverty line.
  - Human capital scarce; physical infrastructure inadequate; financing opportunities limited.

### Petroleum policy, Petroleum Fund, and fiscal framework
- Petroleum Fund:
  - Petroleum Fund Act drafted and submitted to Parliament and expected to become operational as of July 1, 2005.
  - Fund integrated into central government budget; transfers only to finance the non-oil fiscal deficit and subject to a parliamentary ceiling based on the fiscal sustainability policy.
  - Fund assets to be invested abroad; operational management by BPA with an investment advisory board and a parliamentary council; annual external audits; disclosure guided by EITI standards.
- Fiscal sustainability policy:
  - Government adopted a long-term fiscal sustainability policy for intergenerational equity.
  - Key element: a saving rule under which only interest income will be used to finance the non-oil fiscal deficit.
  - Annual budget “sustainable” spending set equal to sum of annual non-oil revenue and estimated permanent income from total oil/gas wealth.
- Oil prospects and revenue estimates:
  - Bayu Undan revenue estimated at $3.2 billion (NPV terms) over 20 years.
  - An agreement on Greater Sunrise could add up to $5 billion in revenue.
  - Recent seismic surveys suggest considerable additional resources offshore; government to open bids later this year.
  - Upside and downside oil price sensitivity:
    - A US$10 decline in world oil prices would reduce revenue by US$150 million on average each year, requiring expenditure cuts of US$54 million on average each year over the medium-term under the government’s saving policy.
  - Authorities used conservative oil price assumptions in FY05/06 budget with a 15 percent discount off revenue projections derived on the basis of NYMEX future price minus 5 U.S. dollars.

### Sector Investment Programs (SIPs) and public investment
- SIPs prepared for FY 2004/05–2008/09 in 15 sectors linking priorities to NDP objectives and MDGs.
- SIPs role:
  - Define sector priorities; establish links between policies, programs and expenditure; identify shortfalls; provide donor coordination setting.
- Financing and risks:
  - SIPs’ spending proposals for 2005/06–2008/09 as a share of non-oil GDP similar to average “combined sources” expenditure over previous 4-year period; portion financed by central government revenue is higher.
  - If SIPs executed in full while honoring oil saving policy, government will need significant additional financing from donors; prioritization required if additional financing does not materialize.
- SIPs Combined Sources Expenditure and Financing (Percent of non-oil GDP) — tabulated averages and projections:
  - Total SIPs planned expenditure 1/ 2/69.5 62.3 69.8 70.4 67.2 55.1
  - financed by:
    - Timor Leste revenue 3/10.2 14.9 29.9 26.4 27.6 30.0
    - Budget support grants 8.8 8.9 2.9 2.8 2.6 0.1
    - Off-budget committed donor financing 50.3 38.5 16.1 8.3 3.4 1.5
    - Additional financing requested 4/0.0 0.0 20.9 32.9 33.6 23.5

### Budget outlook, execution challenges, and Box 5 measures
- Budget trajectory and staff view:
  - Staff projections and draft budget figures (tabulated):
    - Sustainable spending 1/...131.9 136.1 140.8 145.8
    - Draft budget proposed spending 2/78.7 119.5 106.2 112.0 109.6
    - Staff's projections 2/74.3 107.6 99.3 109.3 115.1
      - 1/ On the basis of the new fiscal sustainability and oil fund policy.
      - 2/ For FY 2005/06 includes US$ 10.5 million for the final capitalization of the BPA.
  - Proposed one-step spending increase by 10 percentage points of GDP in FY05/06 seen as ambitious; staff recommended more gradual movement toward sustainable spending given capacity constraints.
  - Authorities indicated about 3 percentage points of the increase in central government capital spending in FY05/06 was for final capitalization of the BPA.
- Budget execution problem and FY 2004/05 outcomes:
  - Complex and over-centralized treasury and procurement processes, weak human resources, and high fiduciary accountability resulted in very low budget execution—particularly capital and rural spending.
  - FY 2004/05 cumulative budget expenditure Q1-Q3 (In percent of annual budget allocation) — tabulated execution/commitment indicators (as provided).
- Measures introduced:
  - Creation of a committee reporting to the Prime Minister to monitor budget execution.
  - Earlier start to budget process, posting of technical advisors to key ministries, improved coordination between treasury and procurement, liaison officers, and more detailed capital spending specifications.
- Additional steps next fiscal year:
  - Reorganization to relieve Education and Public Works of other responsibilities.
  - Creation of regional state ministers reporting to the Prime Minister.
  - Easing procurement approval requirements and further education of line ministries on procurement.
- SIPs financing risk and prioritization:
  - 80 percent of proposed donor support still uncommitted over FY05/06-08/09; authorities encouraged to strengthen prioritization and cap central government spending at sustainable level under the saving policy.
- Petroleum fund operational recommendations (Box 5):
  - Staff suggested transfer of bulk of past accumulated cash balances to petroleum fund: assume US$30 million kept for cash flow and remaining US$217 million transferred to petroleum fund; draft budget technically assumed all cash balances remain intact.
  - Cautious management urged as oil fund resources could jump from US$60 to US$400 million in first year; recommended joint MOPF-BPA oversight and full time advisor for investment and reserve management.

### Financial sector, BPA capacity, and reserves
- BPA capacity building:
  - All managerial positions at the BPA now held by Timorese; resident foreign assistance limited to an MFD central bank advisor to the General Manager.
  - Central bank law, payment system and anti-money laundering legislation in final stages; financial intelligence unit planned for BPA by year-end.
- Monetary and financial sector stance:
  - Current dollarization remains appropriate and will be maintained for foreseeable future; removal of constraints should be preconditions for introducing a national currency.
  - Need for vigilance over rapid growth and sector concentration of bank credit; plans for a bank credit registry.
  - BPA requested technical assistance on reserve management given petroleum fund responsibilities.
- Key reserve figures:
  - Net foreign assets of the BPA: US$285 million at end-March (Box earlier noted US$284 million end-March in PIN table).
  - Treasury cash balances and petroleum fund balances (tabulated, millions of US dollars):
    - Total non-oil domestic revenue and grants table: Total 64.0 64.0 46.9 42.4 (with components: Direct taxes 6.6 7.6 7.7 7.7; Indirect taxes 18.1 19.5 19.2 19.2; Non tax revenue 1/ 4.5 6.1 9.5 5.0; Grants 34.8 30.8 10.5 10.5)
    - Memorandum items: Treasury cash balances 62.5 247.0 242.6 30.0; Petroleum fund balances 13.9 63.1 149.3 376.2

### Private sector development, legal framework, and employment
- Progress and gaps:
  - Land-lease legislation, investment laws, and insurance law advances; “one-stop shop” under Investment and Export Promotion Agency imminent.
  - Overall legal framework incomplete; complex regulations, ineffective administration and weak judiciary discourage private activity.
- Required actions to attract private investment:
  - Streamline business registration practices; reduce set-up costs; simplify administration interaction.
  - Establish comprehensive land-titling system to enable land improvement and use of land as collateral.
  - Regulatory framework for company incorporation, mediation and arbitration; finalization of bankruptcy legislation; licensing of insurance companies; strengthened independent judiciary.
- Growth and employment statistics and implications:
  - Unemployment roughly estimated at about 20 percent of the labor force.
  - Rapid annual population growth of about 3 percent; 60 percent of population 16 and under.
  - Staff estimates about 20,000 new entrants added each year to the labor force.
  - Employment-to-growth elasticities suggest:
    - Non-oil growth of about 7 percent needed to keep unemployment from rising.
    - Growth of 10 percent needed to help halve unemployment over the medium term.

### Risks to the outlook
- Upside risks:
  - Stronger private sector response to reform; accelerated reform implementation and capacity improvement could trigger more rapid non-oil growth.
- Downside risks:
  - Oil price volatility: US$10 decline → US$150 million revenue loss per year on average; requires US$54 million average annual expenditure cuts under saving policy.
  - Dependence on coffee in non-oil exports exposes to price or weather shocks.
  - Further delays in reform deterring private investment.
  - Too rapid increases in fiscal spending—particularly wage bill—could create demand pressure on prices.
  - Prolonged weak administrative capacity curbing development spending.

### Data, statistical capacity, and surveillance
- Significant weaknesses in macroeconomic data for surveillance, especially national accounts and balance of payments.
- Historical disruptions in 1999 destroyed databases; compilation efforts since late 1999 supported by international technical assistance.
- Recent and planned statistical capacity:
  - Long-term resident statistical advisor attached November 2001–February 2004; new resident advisor in post since October 2004 focusing on national accounts and balance of payments.
  - National accounts estimates for 1999–2003 produced by Fund staff with BIDE assistance; robustness limited by scarce data and extrapolation.
  - No comprehensive official balance of payments; many BOP items estimated by Fund staff.
- Timor-Leste: Table of Common Indicators (As of April 30, 2005) — selected reporting frequencies and dates include:
  - International Reserve Assets and Reserve Liabilities: Date of latest observation 03/2005; Date received 05/2005; Frequency M; Frequency of Reporting M; Frequency of publication Q.
  - GDP/GNP: 2003; 10/2004; ...
- PIN and Executive Board summary:
  - PIN release date: July 20, 2005; Executive Board concluded consultation on June 15, 2005.
  - Board encouraged moving toward sustainable spending without inflationary pressures; supported petroleum fund and transparency measures; cautioned on ambitious FY2005/06 spending increase given absorptive capacity.

### Multilateral donor coordination and World Bank / AsDB involvement
- World Bank Transition Support Programs (TSPs):
  - TSP I: July 2002; IDA financing $5 million grant (FY2003).
  - TSP II: July 2003; IDA financing $4 million grant (FY2004).
  - TSP III: October 2004; IDA financing $5 million grant (FY2004).
  - TSPs mobilized total of $99 million over three years from 10 bilateral donors.
  - Government requested extension of budget support through FY2008 under Consolidation Support Program (CSP).
- TFET and AsDB:
  - TFET pledges total $178 million (donors’ contributions $169 million including $10 million by World Bank; investment income $8.7 million); $148 million disbursed by end-March 2005; TFET projects expected to wind down by end-2007.
  - Timor-Leste joined AsDB on July 24, 2002; no lending to date given authorities’ policy to avoid external borrowing.
  - AsDB co-managed TFET and prepared consolidation program with Asian Development Fund grants $15.2 million over 4 years and technical assistance about $4.0 million over 4 years.
  - AsDB-managed TFET projects total funding $53 million; disbursements $45 million at end-March 2005.

*Source: Executive Summary and IMF staff report content from _cr05245.*

### Executive Summary ......................................................................................................

### Executive Summary

### Economic and Policy Developments
- A moderate economic recovery is underway, while inflation remains subdued.
  - A post drought rebound in agriculture and expansion in banking activity offset the impact of a further decline in donor activity in 2004.
  - The official dollar-based monetary and exchange regime helped keep inflation in check.
- Fiscal policy has remained cautious despite large oil/gas revenue inflows.
  - The onset of oil production in 2004 resulted in the emergence of a large fiscal surplus, an increase in the external current account surplus (including international aid) and accumulation of international reserves equivalent to about 15 months of imports (March 2005).
- Growth prospects are hampered by slow execution of public investment projects and limited progress in attracting private sector investment.
  - Budget execution has been poor particularly for capital projects and in rural areas.
  - The private sector remains inactive as establishment of a legal and regulatory framework is not yet complete.

### Key Policy Issues
- Harnessing new oil/gas wealth while preserving macroeconomic stability, higher growth, and reduced poverty.
  - Creation of a Norwegian-style petroleum fund and adoption of a cautious saving policy are major steps in the right direction.
  - Efforts needed to ensure productive use of oil/gas revenue proceeds in parallel with safeguarding long-term fiscal sustainability.
- Improving expenditure execution and administrative capacity.
  - Recent measures to improve administrative capacity and remove obstacles to smooth budget execution are important, but more remains to be done.
  - Articulation of the sector investment programs should improve planning and focus spending on feasible investment projects and better align donor activity with government priorities.
  - Further efforts are needed to reorient expenditure toward improving human capital, infrastructure, and other development needs. Investment spending remains relatively low in the current medium-term fiscal framework.
- Accelerating and coordinating measures to establish an attractive environment for non-oil private sector activity.
  - The basic legal and regulatory framework for the private sector remains incomplete, although progress has been made in key areas including the adoption of investment laws and land related legislation.

### Recent Economic Developments (2004–2005)
- Non-oil activity and prices
  - Non-oil GDP growth recovered in 2004 despite a further decline in donor activity.
  - Inflation declined over the course of 2004, leveling off at about 2 percent since August (year-over-year).
- External sector and fiscal balances
  - The external current account surplus (including international assistance) widened sharply to 35 percent of non-oil GDP in 2004, due to large oil/gas tax and royalty income.
  - Central government surplus (including grants) for FY 2004/05 is now expected to be 68 percent of non-oil GDP, compared with the surplus of 33 percent of non-oil GDP expected in the revised FY04/05 budget.
  - On a “combined sources” basis, the fiscal balance will move into a surplus of 30 percent of GDP in FY04/05.
  - The authorities continue to follow a policy of avoiding domestic or external borrowing and have no debt.
- Banking and reserves
  - Bank lending to the private sector increased rapidly during 2004; as a share of non-oil GDP, credit tripled to 21 percent at end 2004.
  - Net foreign assets of the Banking and Payment Authority (BPA) reached US$285 million at end-March, more than 15 months of projected imports for 2005.
- Social and structural context
  - Cumulative growth over the last three years was negative—mainly reflecting the drawdown in the international presence.
  - 40 percent of the population lives below the poverty line.
  - Human capital remains scarce, physical infrastructure inadequate, and financing opportunities limited; administrative capacity is weak in the public and private sectors.

### Petroleum Policy and Fiscal Framework
- Petroleum Fund (Box 1)
  - The Petroleum Fund Act has been drafted and submitted to Parliament and is expected to become operational as of July 1, 2005.
  - The fund will be integrated into the central government budget; transfers from the fund will only be made to finance the non-oil fiscal deficit and are subject to a parliamentary ceiling based on the fiscal sustainability policy.
  - Fund assets are to be invested abroad; operational management handled by the BPA with an investment advisory board and a parliamentary council for monitoring; annual external audits by internationally recognized accounting firms; disclosure guided by EITI standards.
- Fiscal Sustainability Policy
  - Government adopted a long-term fiscal sustainability policy for intergenerational equity.
  - Key element: a saving rule under which only interest income will be used to finance the non-oil fiscal deficit.
  - Annual budget “sustainable” spending is set equal to the sum of annual non-oil revenue and the estimated permanent income from the total oil/gas wealth.

### Sector Investment Programs (SIPs) and Public Investment
- SIPs overview (Box 2)
  - SIPs prepared for FY 2004/05–2008/09 in 15 economic sectors including health, education, public works and agriculture.
  - SIPs: (i) define sector priorities linked to NDP objectives and MDGs; (ii) establish links between policies, programs and expenditure; (iii) identify shortfalls between planned expenditure and available funding; and (iv) provide an institutional setting for donor coordination.
  - The FY05/06 draft budget and medium-term fiscal plans are cast in a “combined sources” budget framework based on the SIPs.
  - SIPs’ spending proposals for 2005/06–2008/09 as a share of non-oil GDP are similar to the average “combined sources” expenditure over the previous 4-year period; the part financed by central government revenue is higher.
  - If SIPs proposals are to be executed in full while honoring the oil saving policy, the government will need to raise significant additional financing from donors; the government should be prepared to further prioritize spending if additional financing does not materialize.

### Financial Sector and Institutional Capacity
- BPA capacity building
  - All managerial positions at the BPA are now held by Timorese; resident foreign assistance limited to an MFD central bank advisor to the General Manager.
  - A central bank law, payment system and anti-money laundering legislation are in final stages of preparation.
  - A financial intelligence unit is planned for the BPA by the end of the year.
- Financial intermediation and access
  - Financial intermediation remains concentrated in Dili; access to financing in rural areas is limited to a few rural cooperatives and microcredit institutions.

### Private Sector Development and Legal Framework
- Progress and gaps
  - Pace of establishing necessary environment to encourage private sector activity has accelerated.
  - Key land legislation, the insurance law, and the domestic and foreign investment laws have been approved or submitted to Parliament.
  - Overall legal framework remains incomplete; complex regulations, ineffective administration and weak judiciary continue to discourage private activity and create opportunities for weak governance.
  - Administrative skill levels are improving slowly but local capacity remains thin.

*Source: Executive Summary, _cr05245 - Executive Summary._*

### 10.      The 2005 discussions focused on strategies for harnessing Timor-Leste’s new

### The 2005 discussions focused on strategies for harnessing Timor-Leste’s new oil/gas resources within a policy framework supportive of higher economic growth and reduced poverty, and consistent with macroeconomic stability over the long term

### Key policies and institutional stance
- Adoption of a long-term strategy for effective management of the oil/gas wealth through the petroleum fund and a fiscal sustainability policy.
- Implementation of a public investment program focused on human capital accumulation, infrastructure provision, and basic services to urban and rural areas.
- Establishment of the legal, regulatory and institutional framework needed to promote private sector activity in the non-oil sector.
- Continued commitment to maintain the official dollarized monetary and exchange rate regime, acknowledged as essential in ensuring low inflation.
- Differences with past Fund advice have largely related to the pace of policy implementation due to institutional and capacity constraints.
- Authorities generally found recommendations from past Article IV consultations useful.

### Economic outlook (near-term and medium-term)
- Under current policies and trends, outlook is for a pick up of growth in 2005 and a doubling of growth in 2006 to 5 percent.
- Improvement mainly reflects the start of increased investment spending in the second half of 2005 and the full year effect in 2006.
- Private sector activity expected to respond to higher public spending, particularly in the construction and service sectors.
- Expanded provision of technical extension services to subsistence farmers, development of nascent agro-business and the start of fishing licensing should result in above average growth in the agriculture sector, assuming normal weather prevails.
- Staff suggested that under current policies the authorities’ medium-term growth objective of 6 percent will be difficult to achieve given:
  - Continued difficulties in budget execution.
  - Tapering off of donor activity.
  - Incomplete legislative and regulatory framework needed to attract private investment.
- Even a more rapid growth rate may be needed to absorb likely new entrants to the labor force.

### Private sector development and public investment (Box 3) — findings and policy steps
Findings:
- Early recovery driven by UN presence (emergency reconstruction, humanitarian aid, consumption from expatriates) in 2000-01; since 2002 declining UN staff numbers paralleled declining economic activity.
- Low pre-1999 development levels and limited physical asset stock after 1999 destruction imply well-targeted public and private investment could trigger significant growth.
- With transition from emergency status over, public investment could become more growth-oriented; SIPs focus on human capital and infrastructure appropriate but execution must accelerate to offset declining donor financing.
- Macroeconomy stable and liberal trade regime are preconditions for private sector development, but incomplete legal/regulatory framework, ineffective administration and weak judiciary have discouraged investment.

Recent positive steps:
- New land-lease legislation should encourage property rental.
- New investment laws establish broad legal framework needed to attract investment despite potential fiscal-incentive drawbacks.
- Imminent establishment of a “one-stop shop” for business registration under the new Investment and Export Promotion Agency.
- Prospective enactment of the insurance law to set stage for insurance market development.
- Establishment of a regular dialogue between government and business on urgent legal and administrative impediments.

Further rapid actions needed:
- Additional steps to streamline business registration practices, reduce set-up costs and simplify interaction with the administration.
- Establishment of a comprehensive land-titling system to enable land improvement and use of land as collateral.
- A regulatory framework for company incorporation, mediation and arbitration.
- Finalization of bankruptcy legislation to address creditor rights in insolvency.
- Licensing of insurance companies.
- Renewed efforts to develop a strong and independent judiciary to enforce contracts consistently.

### Growth and employment — key statistics and implications
- Unemployment is roughly estimated at about 20 percent of the labor force.
- Rapid annual population growth of about 3 percent; youthful population with 60 percent 16 and under.
- Staff estimates about 20,000 new entrants would be added each year to the labor force.
- Based on employment-to-growth elasticities from cross-country studies:
  - Non-oil growth of about 7 percent would be needed to generate enough jobs to keep unemployment from rising further.
  - Growth of 10 percent would be needed to help halve unemployment rates over the medium term.

### Inflation and fiscal balances
- Inflation expected to remain moderate, barring major external shocks and assuming continuation of the current monetary and exchange rate regime.
- Based on anticipated oil/gas production from existing fields, current WEO oil price projections, and some progress in improving spending capacity, large fiscal surpluses averaging 32 percent of non-oil GDP should emerge over the medium-term.

### Oil prospects (Box 4) — resource context and revenue estimates
- Known oil/gas resources concentrated in the Timor Sea in an area of disputed sovereignty with Australia.
- Sharing in the Joint Development Area (JPDA), where Bayu Undan is located, follows bilateral agreement favoring Timor-Leste with a 90/10 split.
- Recent negotiations on revenue-sharing for the Greater Sunrise field reportedly went well; Greater Sunrise revenue potential significantly larger than Bayu Undan.
- Bayu Undan revenue estimated at $3.2 billion (NPV terms) over 20 years, more than nine times Timor-Leste’s 2004 non-oil GDP.
- An agreement on Greater Sunrise could add up to $5 billion in revenue for Timor-Leste.
- Recent seismic surveys reportedly suggest considerable additional resources offshore (in undisputed areas); government to open bids later this year.
- Some as yet unexplored onshore resources also exist.
- Source: Timor Sea Office.

### Risks to the growth outlook and scenario sensitivity
- Upside risks: stronger private sector response to reform; accelerated and pronounced reform implementation and capacity improvement could trigger more rapid non-oil growth.
- Downside risks:
  - Vulnerability to changes in world oil prices: a US$10 decline in world oil prices would reduce revenue by US$150 million on average each year, requiring expenditure cuts of US$54 million on average each year over the medium-term under the government’s saving policy.
  - Dominance of coffee in non-oil exports: negative price or weather shock in coffee sector could worsen non-oil export performance.
  - Further delays in reform deterring private investment.
  - Too rapid increases in fiscal spending—particularly in the wage bill—creating demand pressure on prices.
  - Prolonged weak administrative capacity curbing needed development spending.
- Authorities discussed a low-oil price scenario in the FY05/06 budget documents; budget based on conservative oil price assumptions with a 15 percent discount off revenue projections derived on the basis of NYMEX future price minus 5 U.S. dollars.
- Authorities noted potential for additional revenue from new oil fields over the longer term to offset lower oil prices.

### Fiscal policy stance, budget framework and concerns
- Authorities’ past success in maintaining fiscal discipline under tight revenue constraint will be tested by large oil/gas revenue inflows.
- Staff emphasized need to resist expenditure pressure for non-priority objectives and keep control of growing non-oil fiscal deficit while raising expenditure.
- FY05/06 and medium-term central government budget framework show a shift toward spending to improve human capital and basic infrastructure and to meet development needs.
- Concern that capital expenditure as a share of GDP or total expenditure has been declining and will level off over the medium-term after a one-step increase in FY05/06.
- Staff cautioned that full maintenance costs of increased investment spending should be incorporated into projections for current expenditure.
- Medium-term development spending path not yet fully elaborated; to be reassessed based on meeting targets in the next year.

Budget specifics and spending trajectory:
- Central government budget outlook based on maintaining public sector wage levels and employment ceiling broadly at current levels; authorities intend to keep the wage bill in check.
- Difficulties in filling high-level managerial positions due to wage compression and limited suitable candidates; authorities reluctant to raise high-level salaries to avoid pressure for low-skill wage increases.
- Proposed one-step spending increase by 10 percentage points of GDP in one year (FY05/06) raises concerns despite government expenditure remaining below the estimated “sustainable” level.
- Staff view: a more gradual movement toward sustainable spending focused on development expenditure is more realistic given administrative and absorptive capacity constraints.
- Authorities noted about 3 percentage points of the increase in central government capital spending in FY05/06 was for the one-off final capitalization of the BPA.
- Overall public sector spending envelope, including donor-financed off-budget SIPs projects, would be roughly unchanged compared with earlier years although an increasing share would be brought on-budget.

Tabulated figures (as presented):
- Sustainable spending 1/...131.9 136.1 140.8 145.8
- Draft budget proposed spending 2/78.7 119.5 106.2 112.0 109.6
- Staff's projections 2/74.3 107.6 99.3 109.3 115.1
  - 1/ On the basis of the new fiscal sustainability and oil fund policy.
  - 2/ For FY 2005/06 includes US$ 10.5 million for the final capitalization of the BPA.

### Budget execution, capacity constraints and reforms (Box 5 references)
- Even modest central government spending increases require:
  - Improvements in administrative capacity.
  - Removal of obstacles to smooth budget execution.
  - Careful prioritization.
- Authorities announced measures with the new budget cycle to address capacity problems at line ministries; staff encouraged additional reforms to ease bottlenecks at the treasury and procurement stages.
- Increased and strengthened ex-post auditing recommended to help prevent misappropriation.
- In response to authorities’ request, FAD agreed to provide a resident advisor to the head of the treasury directorate in the MOPF to assist in establishing a modern treasury system with a well-defined regulatory framework and developing adequate capacity in the Ministry of Finance and line ministries.
- Staff welcomed strengthening of links between development needs, the medium-term central government budget and donor activity through the SIPs.
- Integration of SIPs into budget planning and increased donor-government coordination expected to improve focus on feasible projects and align donor activity with government priorities.
- Staff encouraged establishment of an effective reporting mechanism for execution of off-budget expenditure in coordination with donors.
- Staff noted maintenance and operations related to investment spending under off-budget donor projects will require increasing allocations for recurrent spending which are not yet incorporated in the medium-term budget plan.

*Source: IMF staff summary of the 2005 discussions and associated boxes as contained in the provided chapter.*

### Box 5. Meeting the Budget Execution Challenge

### Box 5. Meeting the Budget Execution Challenge

### Budget execution problem and FY 2004/05 outcomes
- A combination of complex and over-centralized processes in the treasury and procurement offices, weak human resource and institutional capacity, and a high level of commitment to fiduciary accountability has resulted in very low levels of budget execution.
- A high percentage of budgeted resources remain unspent—particularly for capital projects and spending for rural areas.

- FY 2004/05: Cumulative budget expenditure Q1-Q3 (In percent of annual budget allocation)
  - Executed 1/Committed 2/Total
  - Total 3/48 1664
  - Salary and Wages 67067
  - Goods and Services 461662
  - Capital (minor) 163147
  - Capital Development 65864
  - Notes:
    - 1/ Goods or service delivered and payment executed.
    - 2/ Spending request approved by treasury, but procurement process not yet completed.
    - 3/ Some spending may overflow to the following year.
  - Source: Timor-Leste Treasury.

### Measures introduced in the current budget cycle
- Creation of a committee reporting to the Prime Minister to monitor progress on budget execution.
- An earlier start of the budget process to allow more planning time for ministries.
- Posting of technical advisors to key ministries during the planning process.
- Improved coordination between the treasury and procurement division.
- Establishment of a liaison officer from key ministries in the procurement office.
- More detailed specification of capital spending by project and geographic location to permit closer monitoring.

### Additional steps to take effect next fiscal year
- A reorganization to relieve the two ministries facing the most difficulties in executing capital spending, Education and Public Works, of other responsibilities.
- The creation of regional state ministers reporting directly to the Prime Minister to ensure adequate spending to rural areas takes place.
- Some easing of procurement approval requirements.
- Further education of line ministries on the procurement process.

### SIPs financing risks and prioritization
- SIPs expenditure proposals appear ambitious—with 80 percent of proposed donor support still uncommitted over the FY05/06-08/09 period—encouraged the authorities to strengthen prioritization given the risk of a shortfall in expected donor contributions and the need to adhere to sustainable spending identified under the saving policy.
- Authorities indicated shortfalls in external support would be met by greater prioritization and that central government spending would be capped at the sustainable spending level identified under the oil saving policy.

- SIPs Combined Sources Expenditure and Financing (Average 2000-2004 2004/05 2005/06 2006/07 2007/08 2008/09) (Percent of non-oil GDP)
  - Total SIPs planned expenditure 1/ 2/69.5 62.3 69.8 70.4 67.2 55.1
  - financed by:
    - Timor Leste revenue 3/10.2 14.9 29.9 26.4 27.6 30.0
    - Budget support grants 8.8 8.9 2.9 2.8 2.6 0.1
    - Off-budget committed donor financing 50.3 38.5 16.1 8.3 3.4 1.5
    - Additional financing requested 4/0.0 0.0 20.9 32.9 33.6 23.5
  - Source: Timor-Leste authorities and staff estimates.
    - 1/ Includes off-budget sector projects which the government has identified as necessary to achieve NDP and MDG objectives.
    - 2/ In 2005/06 excludes capitalization of the BPA.
    - 3/ Includes petroleum fund transfers in line with savings policy, net of increase in government cash balances.
    - 4/ New commitments requested from donors for the implementation of the SIPs to achieve NDP and MDG objectives.

### Petroleum fund progress and recommendations
- Major progress has been made toward introducing the petroleum fund; remaining efforts should focus on ensuring the smooth start of its operations with the next fiscal year.
- If delays occur in passage of the law, staff suggested oil revenue should nonetheless be treated in a manner consistent with the key principles of transparency and accountability.
- Authorities intend to establish promptly the investment advisory board and the petroleum fund consultative council, and set up the framework for regular reporting in time to support the launch of the petroleum fund.
- Staff encouraged transfer of the bulk of past accumulated cash balances from FY04/05 oil/gas tax revenue to the new petroleum fund. Staff projections assume that US$30 million (40 percent of current spending) would be kept for cash flow management purposes and the remaining US$217 million would be transferred to the petroleum fund. Pending a decision by the government, the draft budget uses the technical assumption that all cash balances remain intact.
- Staff encouraged cautious management of oil fund resources, which could jump from US$60 to US$400 million in the first year, and recommended joint Ministry of Planning and Finance (MOPF)-BPA oversight and assistance of a full time advisor for investment and reserve management during the fund’s first year.

### National oil company intentions
- Authorities intend to establish a national oil company to capture a larger share of the oil wealth.
- Staff recommended weighing costs and benefits given limited capacity and that the company’s structure be fully consistent with the central principles of the petroleum fund legislation.
- Authorities assured all oil income would be transferred directly to the fund and that subsequent transfers to the oil company would be explicitly detailed in the central government budget.
- The company’s organization and governance structures would be transparent and operations run on market principles; authorities aim to avoid creating a large company that could produce distortions or an alternative public-sector power base.

### Non-oil revenue and tax administration
- Non-oil revenue—at about 10 percent of non-oil GDP—is relatively low and under current policies is expected to taper off over time as a share of non-oil GDP.
- Recovery of past-due tax liabilities in FY04/05 contributed to a one-off boost in tax revenue; however, poor compliance, smuggling, and tax incentives in new investment laws point to difficulties in raising revenue levels over the medium term.
- Recommendations:
  - Further modernization of customs procedures—including extension of ASYCUDA outside Dili and additional training—to curtail undervaluation and misclassification of imports.
  - Improvement of enforcement capacity to combat smuggling.
  - Ensure the revenue service is adequately staffed in auditing, collection and tax counsel positions.
  - Introduce monitoring procedures to limit potential abuses of investment tax incentives and identify foregone revenue explicitly in the budget.

- Composition of non-oil domestic revenue (FY 2003/04 Staff est.; FY 2004/05 Draft budget; FY 2005/06 Staff Proj.) (millions of US dollars)
  - Total 64.0 64.0 46.9 42.4
  - Direct taxes 6.6 7.6 7.7 7.7
  - Indirect taxes 18.1 19.5 19.2 19.2
  - Non tax revenue 1/ 4.5 6.1 9.5 5.0
  - Grants 34.8 30.8 10.5 10.5
  - Memorandum items:
    - Treasury cash balances 62.5 247.0 242.6 30.0
    - Petroleum fund balances 13.9 63.1 149.3 376.2
  - Note: 1/ The difference in non tax revenue relates to interest earned on treasury cash balances. Staff assumes bulk of cash balances are transferred to petroleum fund. The draft budget is based on the technical assumption that accumulated cash balances are maintained as of end-June 2005.

### Power authority and sector finances
- Power authority has progressed toward financial independence but continues to rely on budget transfers.
- Revenue collection improved markedly in the second half of 2004 but remains below target.
- Problems persist: unreliable billing system, user non-payment, controlled tariffs, heavy interference in management.
- Regulatory framework for the electricity sector near finalization; authorities viewed tariffs as already high and did not plan increases.
- Continued reform recommended to allow the power authority to gain financial independence.

### Monetary and financial sector
- The current monetary and exchange rate regime (dollarization) remains appropriate and will be maintained for the foreseeable future as a credible nominal anchor given limited institutional capacity and absence of a well-developed foreign exchange market.
- Removal of these constraints should be considered preconditions for introduction of a national currency.
- Staff noted need for vigilance to possible risks due to rapid growth and sector concentration of bank credit.
- BPA requested technical assistance on reserve management given pending petroleum fund responsibilities.
- Plans to create a bank credit registry would help limit credit risk.

### Private sector development and capacity building
- High growth and job creation targets under the NDP require accelerated efforts to establish an attractive environment for private investment and stimulate non-oil private activity; job creation should come mainly from small and medium-size private enterprises.
- Visible progress with pending economic legislation and faster issuance of simple implementing regulations are needed to signal that Timor-Leste is “open for business.”
- With departure of UN technical experts, authorities have taken a pragmatic approach to strengthen administrative capacity:
  - Consolidation Support Program (multi-donor budget support coordinated by the World Bank) will assist capacity building across the public sector.
  - Planning and financial management capacity building project designed to build institutional capacity at the MOPF and other agencies; project consistent with SIPs and supported by donor financing.
- Authorities appreciated outreach and capacity building during the Article IV mission, including a two-day workshop for Parliamentarians and a workshop for civil society on measures to improve private sector activity.

### Data, trade, and staff appraisal highlights
- Data provision for surveillance is adequate overall but domestic capacity to compile national accounts and balance of payments does not yet exist; additional donor assistance is being sought.
- Timor-Leste maintains an open trade regime and exchange system free of restrictions on payments and transfers for current international transactions.
- Staff appraisal key points:
  - Timor-Leste has made good progress establishing the basis for a stable and healthy economy.
  - Key remaining areas: realization of a public investment strategy focused on basic services and infrastructure, sharp improvements in capacity to design and execute expenditure programs, and intensified efforts to create an environment to attract private investment and stimulate non-oil activity.
  - Support moving toward the sustainable spending level as quickly as possible without aggravating nonpriority spending or inflation pressure.
  - Proposed FY05/06 spending increase appears ambitious given limited administrative and absorptive capacity; downside risks on revenue from oil price volatility remain.
  - Recent measures to improve administrative capacity and remove obstacles to budget execution are important, but additional measures needed to build capacity at line ministries and MOPF and to prevent treasury and procurement bottlenecks.
  - Progress in linking SIPs and the budget is welcomed; further reorientation of expenditure toward human capital and infrastructure is recommended.
  - Establishing legislative framework for the petroleum fund to start with the new fiscal year is welcome; key supporting steps include the investment advisory board, petroleum fund consultative council, and framework for regular public reporting.
  - Consolidation of progress in non-oil revenue and power sector finances is needed.
  - Current monetary and exchange regime remains appropriate; continuation of prudent fiscal and wage policies is critical to avoid erosion in external competitiveness.

*Source: IMF staff report content from Box 5 as provided in the supplied PDF content.*

### 39.      Further improvement in financial intermediation remains critical for future

### 39.      Further improvement in financial intermediation remains critical for future

### Financial intermediation and banking supervision
- The Banking and Payments Authority (BPA) has made good progress in developing a strong supervision and regulatory environment.
- Continued vigilance over bank portfolios is needed to ensure continued soundness despite the recent increase in financial intermediation.
- Legislative agenda items that should be quickly completed:
  - Approval of the central bank legislation.
  - Approval of payment system legislation.
  - Approval of anti-money laundering legislation.

### Attracting private investment and stimulating non-oil private activity
- Accelerated efforts are needed to establish an environment to attract private investment and stimulate non-oil private activity.
- Policy actions recommended:
  - Rapid enactment of remaining economic legislation.
  - Issuance of streamlined implementing regulations that are simple to administer.
  - Ensure tax incentives under the investment laws are well-targeted to avoid unwarranted revenue loss.

### Institutions, local capacity, and macroeconomic data
- Developing strong institutions and local capacity is essential for effective economic management and Timor-Leste’s economic development.
- The authorities’ planning and capacity building program under development is an important step forward as the international presence declines.
- Gaps in macroeconomic data continue to create difficulties for surveillance and policy decision-making.
- The authorities are urged to take early steps to build domestic capacity to compile:
  - The national accounts.
  - The balance of payments.

### Consultation cycle
- It is proposed that the next Article IV consultation be conducted on the standard 12-month cycle.

*Source: IMF staff report content (section 39–42) from the provided document.*

### 3.      In addition to its involvement through the TFET, the World Bank has also been

### _cr05245 - 3.      In addition to its involvement through the TFET, the World Bank has also been

### World Bank role and Transition Support Programs (TSPs)
- World Bank has been playing a key role in mobilizing budgetary assistance for the post-independence period through the annual multi-donor Transition Support Program.
- Transition Support Program approvals and IDA financing:
  - The first Transition Support Program (TSP I) was approved by the World Bank Board in July 2002 and focused on creating institutions, establishing a legislative and regulatory framework, and strengthening the management systems required for core government functions. IDA financing consisted of a $5 million grant in support of the FY2003 budget.
  - The second Transition Support Program (TSP II) was approved in July 2003. IDA financing consisted of a $4 million grant in support of the FY2004 budget.
  - The third Transition Support Program (TSP III) was approved in October 2004. IDA financing consisted of a $5 million grant in support of the FY2004 budget.
- Thematic focus of TSP II and TSP III:
  - (1) good governance, including developing a legal framework for governance and the judiciary and strengthening public expenditure management;
  - (2) service delivery for poverty reduction, particularly in education and health;
  - (3) job creation, especially through private sector development, agriculture, and improvements in basic infrastructure.
- The TSPs have been used as a unifying framework for donors’ budget support, mobilizing a total of $99 million over three years from 10 bilateral donors (including parallel financing from Portugal).
- The Government has requested the extension of budget support for an additional three years, through FY2008, under the Consolidation Support Program (CSP) to reflect the shift from post-conflict transition to consolidation of gains made thus far.

### Trust Fund for East Timor (TFET) contributions and status
- Pledges to the TFET were made by 12 donor countries, the European Commission, and the World Bank, with the total amount of funds reaching $178 million.
- Composition of TFET funds:
  - donors’ contributions of $169 million (including $10 million by the World Bank);
  - investment income of $8.7 million.
- Disbursement and wind-down:
  - Of this total, $148 million was disbursed by end-March 2005.
  - TFET projects are expected to wind down by end-2007.

### Donor coordination and meetings
- Prior to Timor-Leste’s independence, the World Bank co-chaired six bi-annual donors’ meetings with the UN.
- After independence, the World Bank has co-chaired the Timor-Leste and Development Partners Meeting (TLDPM) with the Government of Timor-Leste.
- The TLDPM took place in December 2002, June 2003, December 2003, May 2004, and April 2005.
- Bilateral donors who have participated in one or more TSPs: Australia, Canada, Finland, Ireland, New Zealand, Norway, Portugal, Sweden, the United Kingdom, and the United States.
- Additional technical assistance providers supporting the TSP: China, Japan, Malaysia, ADB, UNMISET, UNDP, and UNICEF.

### Asian Development Bank (AsDB) involvement (as of April 30, 2005)
- Membership and lending stance:
  - Timor-Leste joined the Asian Development Bank (AsDB) on July 24, 2002.
  - To date, there has been no lending to the country, reflecting the authorities’ policy to avoid external borrowing.
- Role in TFET and consolidation program:
  - AsDB co-managed with the World Bank the Trust Fund for East Timor (TFET), established in December 1999.
  - AsDB is preparing its “consolidation” phase program to be funded predominantly from Asian Development Fund grants ($15.2 million over 4 years) and technical assistance (about $4.0 million over 4 years).
- TFET-managed projects and disbursements:
  - Under the TFET, the AsDB has managed six projects with total funding of $53 million, which aimed at the rehabilitation of physical infrastructure (rural power, rural roads, ports, and water and sanitation) and the development of microfinance.
  - At end-March 2005, disbursements for AsDB-managed projects totaled $45 million.
  - Most projects were completed at the end of 2004. Only one project (EIRP-2) is ongoing, with completion expected by November 2006.
- AsDB technical assistance:
  - The AsDB has approved 24 technical assistance programs totaling $10 million.
  - As of end-March 2005, 14 technical assistance programs were completed and 10 programs continued.
  - Technical assistance focused on project preparation and sector-specific capacity/institution building essential for project implementation, including development of regulatory and legislative frameworks, analysis of sectoral policy issues, poverty assessment and statistics, and strategies for economic and social development and planning.
- TFET projects managed by AsDB (amounts as stated):
  - Emergency Infrastructure Rehabilitation Project ($29.8 million);
  - Emergency Infrastructure Rehabilitation Project 2 ($9 million);
  - Water Supply and Sanitation Rehabilitation Project ($4.5 million);
  - Water Supply and Sanitation Rehabilitation Project 2 ($4.5 million);
  - Hera Fisheries Port Facilities Rehabilitation Project ($1 million);
  - Microfinance Development Project ($4 million).

### Statistical issues and data capacity
- Significant weaknesses remain in the macroeconomic data available for surveillance, especially regarding balance of payments and national accounts.
- Historical compilation and disruptions:
  - Prior to 1999, macroeconomic data in Timor-Leste (including national accounts, prices, labor, provincial budget, and money and credits) were compiled by the Indonesian Central Bureau of Statistics (Badan Pusat Statistik, BPS) and the Central Board of Statistics of the East Timor Province.
  - The most serious data problem lay in the balance of payments statistics, which were almost nonexistent as Timor-Leste was previously treated as one of the Indonesian provinces.
  - Compilation of macroeconomic data was seriously disrupted in 1999, as the post-referendum turmoil led to the destruction of databases and the collapse of institutional capacity as a result of the departure of most Indonesian statistical officers.
- Restoration efforts:
  - Under the economic reconstruction process beginning in late 1999, efforts have been made to begin the compilation of key macroeconomic data through technical assistance provided by international financial institutions and bilateral donors.
  - A multi-sector Fund statistics mission visited Dili in November 2000 and assisted the authorities in establishing short- and long-term objectives for the restoration of economic statistics and in setting up a Statistical Division in the Ministry of Planning and Finance in

*Document content as provided in the source PDF.*

### 2001. Also, a long-term resident statistical advisor was attached to the Statistical Division

### _cr05245 - 2001. Also, a long-term resident statistical advisor was attached to the Statistical Division

### Statistical capacity and data quality
- A long-term resident statistical advisor was attached to the Statistical Division during November 2001-Februray 2004 to lay a basis for compilation of macroeconomic data while developing local capacity; a new resident advisor has been in post since October 2004 focusing on national accounts and balance of payments data.
- Institutional capacity remains very limited, constraining progress in collection and compilation of macroeconomic data.
- Availability, coverage, and quality of data remain very weak.
- Additional assistance and substantial data collection/elaboration across economic sectors are needed for further progress.

### National accounts
- Under a World Bank-financed project, national accounts data for 2000 (both type of activity and expenditure basis) were estimated by the Boston Institute for Developing Economies (BIDE).
- Fund staff produced estimates for 1999-2003 based on information from various missions.
- In late 2004 BIDE produced methodologically sound national account estimates for 2001-2003 under a follow-up World Bank project.
- Robustness of new estimates is limited by scarce data and substantial extrapolation.
- Given limited skills and human resources, the Division of Statistics may not be able to replicate the BIDE estimation exercise for 2004 without additional assistance.
- Need: plan and execute substantial data collection and elaboration for different economic sectors.

### Prices, employment, and wages
- After 1999 disturbances, a consumer price index (CPI) was compiled monthly for Dili and quarterly for Timor-Leste with April 2000 base; the index initially used a weighting scheme based on a BPS Jakarta household expenditure survey and suffered problems.
- Commodity basket and weighting scheme were revised in mid-2003 under donor-supported project; a new monthly CPI for Dili has been compiled with December 2001 as base period.
- Public sector employment and wages data: available annually through fiscal data.
- Private sector employment and wages: no official regular compilations; some partial data available through household surveys conducted jointly by UNDP, AsDB, and World Bank.

### Government financial statistics
- Official central government revenue and expenditure data are published semi-annually as part of budget preparation and review; monthly data available on request through budget, treasury, and revenue services.
- Compilation follows GFSM 1986 classification (including functional and economic classifications); steps needed to compile data on the basis of GFSM 2001.
- Data on financing are incomplete and are estimated by Fund staff using various sources.
- Limited data on fiscal and quasi-fiscal activities by bilateral donors and special funds (e.g., Trust Fund for East Timor).
- Three non-financial public enterprises exist; only partial data on their operations.
- No data currently reported for the GFS Yearbook and the International Financial Statistics.

### Monetary accounts
- Monetary statistics on the banking system are compiled by the Banking and Payments Authority (BPA), generally following Fund-recommended classification.
- Scope exists for BPA to collect more detailed data on banking system’s assets and liabilities with nonresidents and better sectorization of domestic institutional units.
- Monetary survey data are incomplete because of absence of official data on currency holdings by the public (difficult under current currency regime).
- Statistics on key monetary aggregates are published monthly on the BPA website and yearly in the BPA annual report.
- Compilation of comprehensive data on interest rates (deposit and lending) and bank lending/investment began only recently; availability is extremely limited due to BPA concerns about revealing confidential information given only four banks in the system.
- No monetary data are currently reported to STA for publication in International Financial Statistics.

### Balance of payments
- No official balance of payments data are available except merchandise exports and imports.
- Merchandise trade data compiled from customs with breakdown by major commodity categories; monthly series available starting March 2000.
- Merchandise trade data are incomplete; commodity and partner classification need improvement; large unrecorded border trade not included.
- Oil/gas revenue recorded under income account (royalties) and under transfers (tax revenue) based on fiscal data; no comprehensive production and investment information for oil/gas sector available.
- All other major BOP items (services, transfers, capital and financial account transactions) are estimated by Fund staff using information from staff visits and bilateral donors.

### Timor-Leste: Table of Common Indicators (As of April 30, 2005) — selected reporting frequencies and dates
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Date of latest observation 03/2005; Date received 05/2005; Frequency of Data M; Frequency of Reporting M; Frequency of publication Q.
- Reserve/Base Money (excludes currency in circulation): 03/2005; 05/2005; M; M; M.
- Broad Money (excludes currency in circulation): 03/2005; 05/2005; M; M; M.
- Central Bank Balance Sheet: 03/2005; 05/2005; M; M; M.
- Consolidated Balance Sheet of the Banking System: 03/2005; 05/2005; M; M; M.
- Interest Rates: 03/2005; 3/2005; A; A; ...
- Consumer Price Index: 03/2005; 05/2005; M; M; M.
- Revenue, Expenditure, Balance and Composition of Financing – Central Government: 03/2005; 04/2005; M; M; M.
- Exports and Imports of Goods and Services: 03/2005; 03/2005; M; M; M.
- GDP/GNP: 2003; 10/2004; ...; ...; ...
- Notes: item footnotes indicate exclusions (e.g., currency holdings by the public not available), and that some series include only goods or exclude oil/gas revenue.

### Public Information Notice (PIN) — 2005 Article IV consultation key findings and context
- Date of PIN release: July 20, 2005; Executive Board concluded consultation on June 15, 2005.
- Context and near-term outlook:
  - Five years after post-referendum violence, security broadly restored and macroeconomic stability re-established via U.S. dollar legal tender and cautious fiscal management.
  - Cumulative growth over last three years was near zero—mainly reflecting drawdown of international agencies.
  - Unemployment is high; 40 percent of the population lives below the poverty line; human capital scarce; physical infrastructure inadequate; financing opportunities limited.
  - Winding down of international support while domestic capacity is weak and large oil/gas revenue is coming on stream presents challenges and opportunities.
- 2004 developments:
  - Modest recovery in non-oil economic activity in 2004.
  - Inflation leveled off at about 2 percent since August 2004 (year-over-year).
  - External current account surplus (including international assistance) widened to 35 percent of non-oil GDP in 2004 due to large oil/gas tax and royalty income.
  - Bank lending to private sector tripled as a share of non-oil GDP to 21 percent at end 2004.
  - Net foreign assets of the BPA reached US$284 million at end-March (more than 15 months of projected imports for 2005).
- Fiscal 2004/05 expectations:
  - Central government surplus (including grants) of 68 percent of non-oil GDP expected, compared with 33 percent expected in revised FY04/05 budget.
  - On a “combined sources” basis, the fiscal balance expected to be a surplus of 29 percent of GDP in FY04/05.
- Policy actions:
  - Norwegian-style petroleum fund on track to be operational by July 2005; long-term fiscal savings policy adopted.
  - Under savings policy, annual “sustainable” spending equals sum of non-oil revenue and estimated permanent income from oil/gas wealth.
  - Authorities committed to transparency and accountability principles in line with the Extractive Industries Transparency Initiative (EITI).
  - Preliminary Sector Investment Programs (SIPs) set public investment strategy financed by domestic revenue and donor funds.
  - Central bank law, payment system, and anti-money laundering legislation in final stages; financial intelligence unit planned for BPA by year-end.
  - Progress on land, insurance, domestic and foreign investment laws; overall legal framework incomplete, with complex regulations, ineffective administration, and weak judiciary remaining constraints.

### Executive Board assessment and recommendations (summarized)
- Commendations and overall view:
  - Directors welcomed progress toward a stable economy and commended prudent macroeconomic policies during transition.
  - Emphasized that effective management of oil/gas wealth and an environment conducive to private investment are critical for development.
- Fiscal policy and public investment:
  - Supported authorities’ objective of moving toward sustainable spending without creating inflationary pressures or undertaking non-priority expenditure.
  - Noted proposed spending increase for FY2005/06 appears ambitious given limited administrative and absorptive capacity; suggested consideration of spreading spending commitments over a longer period.
  - Called for early additional steps to eliminate bottlenecks, particularly for capital spending; welcomed Fund technical assistance.
  - Encouraged shifting spending toward human capital and basic infrastructure; welcomed intention to maintain restraint on wage bill.
- Petroleum fund and hydrocarbon policy:
  - Commended progress establishing petroleum fund and adoption of transparent governance arrangements (investment advisory board and consultative council); cautioned on creating a national oil company.
  - Directors encouraged strengthening of tax and customs administration and careful administration of tax incentives in new investment laws.
- Monetary and financial sector:
  - Endorsed maintaining current monetary and exchange rate regime; agreed stronger institutional capacity and a well-developed foreign exchange market are preconditions for a national currency.
  - Welcomed progress at BPA on supervisory and regulatory environment; encouraged vigilance over bank portfolios and early approval of central bank, payment system, and anti-money laundering legislation.
  - Encouraged supporting expansion of financial institutions to rural areas.
- Structural reforms and governance:
  - Urged accelerating efforts to establish environment conducive to private investment and non-oil private sector activity; called for early enactment of pending economic legislation and issuance of transparent, simple regulations.
  - Stressed priority of finalizing bankruptcy legislation, developing strong and independent judiciary, and establishing comprehensive land-titling system.
  - Urged prompt implementation of planning and capacity building program and close coordination with donor community.
- Data and statistical capacity:
  - Encouraged authorities to seek additional assistance to strengthen domestic capacity, particularly for compilation of national account and balance of payments statistics.

### Selected economic indicators (high-level figures from Timor-Leste: Selected Economic Indicators, 2000–2005)
- Non-oil GDP (levels): 2000: 316; 2001: 368; 2002: 343; 2003: 336; 2004: 339; 2005 Est./Proj.: 349.
- Real non-oil GDP growth (percentage change): 2000: 15.4; 2001: 16.6; 2002: -6.7; 2003: -6.2; 2004: 1.8; 2005: 2.5.
- Inflation (percentage change; end-period, CPI for Dili): 2000: 3.0; 2001: -0.3; 2002: 9.5; 2003: 4.2; 2004: 1.8; 2005: 2.5.
- Central government revenues (percent of non-oil GDP): 2000: 17; 2001: 15; 2002: 24; 2003: 31; 2004: 90; 2005: 57.
  - Domestic revenues: 2000: 4; 2001: 6; 2002: 6; 2003: 9; 2004: 10; 2005: 9.
  - Oil/gas revenues: 2000: 4; 2001: 3; 2002: 9; 2003: 12; 2004: 71; 2005: 45.
  - Grants: 2000: 9; 2001: 6; 2002: 10; 2003: 10; 2004: 9; 2005: 3.
- Central government expenditure (percent of non-oil GDP): 2000: 15; 2001: 15; 2002: 21; 2003: 21; 2004: 22; 2005: 30.
  - Recurrent expenditure: 2000: 9; 2001: 12; 2002: 17; 2003: 19; 2004: 19; 2005: 20.
  - Capital expenditure: 2000: 6; 2001: 3; 2002: 4; 2003: 3; 2004: 2; 2005: 10.
- Central government overall balance (percent of non-oil GDP): 2000: 2; 2001: 0; 2002: 3; 2003: 10; 2004: 68; 2005: 27.
- Combined sources fiscal operations (percent of GDP): revenues 2000: 18; 2001: 16; 2002: 25; 2003: 33; 2004: 92; 2005: 15. Expenditure 2000: 69; 2001: 70; 2002: 73; 2003: 66; 2004: 62; 2005: 70. Overall balance 2000: -52; 2001: -53; 2002: -48; 2003: -33; 2004: 29; 2005: -55.
- Broad money (end-period, percent change): 2000: 6; 2001: 14; 2002: 16; 2003: 22; 2004: 25; 2005: 28.
- External sector (millions of U.S. dollars): Merchandise exports 2000: 5; 2001: 4; 2002: 6; 2003: 7; 2004: 8; 2005: 10. Merchandise imports 2000: -242; 2001: -284; 2002: -266; 2003: -221; 2004: -202; 2005: -214.
- Current account incl. international assistance (percent of non-oil GDP): 2000: 12; 2001: 13; 2002: 8; 2003: 5; 2004: 35; 2005: 43.
- Notes and data sources: data provided by Timor-Leste authorities and IMF staff estimates; non-oil GDP and national accounts data for 2000–2003 based on BIDE estimates prepared in October 2004; CPI for Dili; fiscal year basis (July-June); exclusions and footnotes apply (see table notes).

*Source: IMF staff report and Public Information Notice relating to the 2005 Article IV consultation with Timor-Leste (text and tables provided).*

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