## 1. The g7+ and Timor‑Leste

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### Context
- Timor‑Leste is a founding member of the g7+ group of 18 fragile and conflict-affected countries and pioneered the New Deal approach consistent with its Strategic Development Plan (SDP).
- The 13 year UN presence concluded in 2012; parliamentary and presidential elections were held in mid-2012 with Prime Minister Xanana Gusmão re-elected.
- Petroleum Fund (PF):
  - PF is compliant with the Extractive Industries Transparency Initiative and the Santiago Principles.
  - PF assets equivalent to over two times GDP.
  - Withdrawals limited by law to the Estimated Sustainable Income (ESI), calculated as 3 percent of estimated oil wealth; excess withdrawals are allowed under certain circumstances.
- Policy making conducted by a small technocratic elite; implementation capacity is weak.

### Recent developments in the non‑oil economy and macroeconomy
- Non‑oil economy growth:
  - Averaged over 12 percent from 2008 to 2011.
  - Authorities projected non‑oil GDP growth in 2012 at 10.6 percent (2013 Budget Book); staff projects a downward trend with significant under‑spending on capital projects (projection of around 8 percent).
- Inflation:
  - 2011: inflation touched 15.4 percent.
  - 2012: inflation moderated but was still running at well over 10 percent.
  - Food price inflation: 15.6 percent in June 2013.
- Fiscal outcomes and spending patterns:
  - Persistently large non‑oil deficits at over 70 percent of non‑oil GDP.
  - Excess withdrawals from the PF at over 100 percent of the ESI to finance spending.
  - 2012 and 2013 original budgets planned expenditures stabilizing at around $2 billion to 2018.
  - Preliminary 2012 data show significant under‑spending on capital items and continued rise in current spending.
- Growth composition:
  - Supply‑side growth led by government‑dependent sectors (e.g., construction).
  - Weak contributions from agriculture and manufacturing.
  - Living standards have not increased in line with GDP growth.

### Outlook and risks
- Medium‑term non‑oil GDP growth:
  - Staff projects real non‑oil GDP should average around 8.5 percent under baseline.
  - Higher‑growth scenario: non‑oil GDP growth averaging over 10 percent could be achievable with deeper reforms and rapid implementation of infrastructure projects.
- Key downside risks:
  - Weaker pace of structural reforms and fiscal consolidation.
  - Poor implementation of basic infrastructure projects (roads and ports).
  - High inflation and poor private sector investment response.
  - Long‑term fall in oil/gas prices reducing oil wealth and the ESI.
- External shock sensitivity:
  - Short‑term global spillovers likely limited.
  - Short‑term oil price volatility smoothed by the ESI rule; long‑term price declines pose larger risks.

### Policy discussions — three broad elements
- Fiscal policy: rein in public expenditure to be consistent with the fiscal rule, improve expenditure quality, and diversify revenues.
- Structural reforms: catalyze private sector to induce labor‑intensive growth and reduce poverty.
- Financial sector development: improve access to finance, regulation, and supervision to support private‑sector‑led growth.

### Bolstering the macroeconomic framework — findings and implications
- Macroeconomic imbalances:
  - Very high non‑oil fiscal deficits.
  - Inflation stabilizing at high levels.
  - Erosion of sustainability and decline in competitiveness (REER appreciation).
  - Very low non‑resource exports; lack of FDI in labor‑intensive sectors; rising imports.
- Assessment in a fully dollarized economy: fiscal stance has been too expansionary given absorptive capacities.
- Unsustainable dynamics under continuation of recent expenditure trends (Scenario A):
  - Net public sector assets would be significantly run down.
  - High inflation driven by government spending especially on current items including transfers.

### Bolstering the macroeconomic framework — policy outcomes under revised plans (the “Yellow Road”)
- Yellow Road fiscal adjustments adopted by the Council of Ministers in June 2013:
  - Budgeted expenditure (excluding donor projects) would stabilize at around $1.3 billion in the medium term (vs. around $2 billion in original 2013 budget).
  - Non‑oil revenues targeted to increase by 15 percent a year from a low base with tax reforms.
  - Result: non‑oil fiscal deficit falls from a budgeted 92 percent in 2013 to 27.5 percent by 2018.
- Under the Yellow Road baseline:
  - The authorities’ fiscal rule will be met.
  - Borrowing needs would steadily fall and end by 2023 (scenario C).
  - External and public debt would remain sustainable; PF value would stabilize in the medium term.
  - Lower expenditures and higher non‑oil revenues would reduce excess PF withdrawals, dampen inflationary pressures, and curtail REER appreciation.

### Text Table 1 — Illustrative scenarios (summary)
- Scenario A. 2013 Budget Framework:
  - Continuation of expenditures at 25 percent of GDP.
  - Gross PF assets steadily depleted; debt stock rises rapidly; net assets steadily depleted.
  - Higher expenditures raise GDP levels but reduce private sector development; risks of sharp slowdown when debt limits reached.
  - High inflation as absorptive capacity is exceeded. Not sustainable.
- Scenario B. Expenditures limited by ESI withdrawal rule:
  - PF value stabilizes in 2024 and is maintained in real terms.
  - No debt undertaken; intergenerational equity satisfied.
  - Growth substantially reduced until private sector picks up; low inflation beneficial for competitiveness.
  - Fully sustainable but basic infrastructure provision may be more limited.
- Scenario C. Yellow Road budget framework:
  - Expenditures stable at around $1.3 billion and limited concessional borrowing.
  - PF value stabilizes in 2024 and is maintained in real terms but slightly lower than in scenario B.
  - Intergenerational equity satisfied; slow pace of debt accumulation.
  - Growth can be higher than in scenario B if debt is used efficiently on growth‑enhancing projects.
  - Inflation falls toward target by 2018. Funding in excess of ESI assumed via concessional debt rather than excess ESI withdrawals.

### Expenditure path and quality (section 16)
- Expenditures stabilized at around current levels and will fall in GDP terms under revised plans.
- Prioritization aims:
  - Public investment on projects generating sustainable employment in the private sector (basic infrastructure: roads, ports; human capital: health and education).
  - Improve value‑for‑money in budget planning and execution.
- Trade‑offs and challenges:
  - Capital expenditures: balance between capital‑intensive projects and basic infrastructure with direct links to exports and employment.
  - Recurrent expenditures: need to restrain wage bill growth and better target subsidies and transfers to create space for operations, maintenance, and essential supplies.
  - Containment of electricity subsidies is important as de facto subsidies rise with new capacity; cuts must be measured to maintain social cohesion.

### Revenue, public financial management, and asset‑liability management
- Revenue priorities:
  - Support revenue diversification and strengthen tax administration capacity.
  - Introduce new taxes, e.g., a VAT in line with recent FAD TA advice, to broaden the tax base.
  - Main impediment to VAT: poor capacity at the Ministry of Finance (MoF); staffing reforms underway and further TA useful.
  - Ensure customers pay equitably for electricity usage as subsidies will rise with new capacity.
- Asset‑liability management and public liabilities:
  - Government balance sheet will become more complex with planned new debt and PPPs generating contingent liabilities.
  - Public debt: contract concessional debt from development partners; avoid non‑concessional debt.
  - Off‑budget investments: major projects should be transparent and subject to scrutiny by the Major Projects Secretariat and the Audit Court; avoid off‑balance sheet liabilities.
  - Petroleum Fund:
    - Revised PF Law allows a 50:50 split toward global equities.
    - New provision to allow the PF to guarantee government debts (up to 10 percent of the PF’s assets) is potentially risky and should be avoided.
- PPPs under development:
  - Dili Port (Tibar Bay) tender launched August 2013; estimated investment $300-400 million with significant private sector participation.
  - Airport project size not finalized; expected private investment likely much smaller.

### Private sector development and structural reforms
- Binding impediments: low human capital, bureaucratic obstacles, lack of contract enforcement, limited access to finance, and “Dutch disease” effects.
- Government initiatives: one‑stop shop for new businesses and development of PPPs.
- Staff recommendations:
  - Manage pervasive state role within a sound governance framework and cost‑benefit assessments.
  - Prioritize infrastructure, legal reforms, and complementary institutions.
  - Immediate gains in agriculture via roads, irrigation, and technical training.
  - Caution on SEZs and development banks—emphasize governance, transparency, accountability; TA from successful countries useful.
- Labor cost competitiveness:
  - Reduce general and wage inflation; align minimum wages with ASEAN peers.
  - Prioritize logistics (roads, ports, airport) with mixed funding (self‑funded, donor, PPPs); implement Land Law, reduce red tape, streamline Investment Law, increase contract enforcement certainty.

### Monetary and exchange rate policies
- Continued use of the U.S. dollar remains appropriate.
- Restoring competitiveness requires a restrained fiscal stance to lower inflation.
- SDP contemplates possible introduction of a national currency; two separable issues:
  - Issuing a national currency; and
  - Choice of exchange rate arrangement.
- Institutional prerequisites for currency reform are substantial; BCTL capacity enhancement required.
- Introduction of the 100 centavo coin (replacing the one U.S. dollar note) will provide learning for BCTL.

### Financial sector and supervision
- Financial sector characteristics:
  - Small with low penetration; four banks and several microcredit institutions.
  - Three banks are branches of international banks; one local government‑owned bank recently upgraded and is the only bank with its own capital base.
  - Banks maintain substantial excess liquidity placed abroad; lending is problematic; judicial enforcement weak; NPLs high at one bank.
  - Interest rate spreads are wide.
- Priorities:
  - Strengthen prudential supervision and develop a crisis management framework.
  - Address country, counterparty, and concentration risks from placements abroad.
  - Avoid lending risks from state‑owned bank directed to priority sectors.
  - Enhance AML/CFT framework per Asia/Pacific Group mutual evaluation (2012): enact legislation, establish a Financial Intelligence Unit, mobilize AML framework to support anti‑corruption.
- Authorities’ view: financial system has not supported growth; need legal changes (Land Law, electronic banking law), modernized payments system, improved BCTL oversight; a new Financial Sector Master Plan is planned and BCTL requested IMF TA Needs Assessment.

### Statistics, TA, and capacity building
- Data improvements:
  - National income accounts to 2011 now available for the first time.
  - CPI methodology improved; further work needed on poverty data timeliness and accuracy.
  - Fiscal reporting improvements under way in line with GFSM 2001.
  - Participation in GDDS in October 2012.
- TA needs and delivery:
  - High TA delivery to MoF and BCTL; need to boost knowledge transfer and train local officials.
  - IMF stands ready to continue TA in core areas: assistance to BCTL on supervision; estimating the ESI and PF asset management; asset‑liability management; integrating national accounts and balance of payments; statistics infrastructure and fiscal reporting.

### Staff appraisal and policy recommendations
- Strategic challenge: convert oil wealth into long‑term sustainable growth to generate broad‑based increases in living standards.
- Staff welcomed more prudent budgetary plans but stressed containing slippages to preserve sustainability and PF assets.
- Framework consistent with SDP and, if structural reforms accelerated, can support:
  - Strong growth in household consumption,
  - Lower inflation,
  - Declining poverty.
- Key policy choices:
  - Maintain expenditure on high priority programs that generate sustainable growth and poverty reduction.
  - Emphasize cost‑benefit analysis, value‑for‑money, and improved budgetary planning and execution.
  - Prioritize basic infrastructure (roads, port, airport) over capital‑intensive low‑employment projects.
  - Recurrent side: create space for operations, maintenance, health and education via restraint in the wage bill and better‑targeted subsidies and transfers.
- Risk note: outlook for gas prices highly uncertain; sustained fall would necessitate further fiscal restraint.

### Risk Assessment Matrix — main threats, likelihood, and expected impacts (staff subjective assessment)
- 1. Delays regarding Greater Sunrise Field
  - Overall Level of Concern: High
  - Likelihood of Severe Realization in the Next one–three Years: High
  - Expected Impact if Realized: High
- 2. Over investment in projects with low returns
  - Overall Level of Concern: Medium/High
  - Likelihood: High
  - Expected Impact: High
- 3. Higher inflation
  - Overall Level of Concern: Medium
  - Likelihood: Medium
  - Expected Impact: High
  - Note: inability to restrain current expenditures could raise inflation back to close to 20 percent.
- 4. Political Instability
  - Overall Level of Concern: Medium
  - Likelihood: Medium
  - Expected Impact: High
- 5. Global economic shocks
  - Overall Level of Concern: Medium
  - Likelihood: Low
  - Expected Impact: Low
- 6. Financial sector contagion
  - Overall Level of Concern: Medium
  - Likelihood: Medium
  - Expected Impact: Medium
- 7. Global oil price risk
  - Overall Level of Concern: Low
  - Likelihood: Medium
  - Expected Impact: Medium

### DSA update and debt sustainability conclusions
- DSA updated from 2011 to reflect new policy allowing buildup of external debt for developmental purposes; based on IMF staff report macro framework for the 2013 Article IV consultation.
- Analytical assumptions:
  - Debt accumulation reflects gap between revenues (ESI and non‑oil revenues) and expenditures; non‑oil fiscal deficit funded through external borrowing rather than excess PF withdrawals.
  - Public and external debt treated as essentially equivalent because public sector only borrows externally.
  - Oil reserves depleted by 2024 and no new reserves assumed during forecast horizon.
- DSA findings under Yellow Road:
  - Moderate accumulation of gross debt through 2021 with debt stock peaking at under 12 percent of GDP in present value terms in 2018.
  - High stock of public assets in the PF, at around $13 billion, and continued asset accumulation through 2024 → net public debt remains negative in nominal and present value terms throughout the period.
  - Debt amortization beginning in 2020 mitigates stock ratios as oil inflows end in 2024.
  - Debt service ratios remain within tolerances given concessionality and moderate accumulation pace.
- Stress tests and risks:
  - Most extreme shock: non‑debt creating flows shock; illustrates low debt‑carrying capacity.
  - Second worst: less favorable terms of new debt.
  - Permanent lower growth of about 1.5 percentage points relative to baseline worsens debt outlook.
- Policy prescriptions:
  - Eliminate excess PF withdrawals.
  - Enhance quality of expenditures to diversify the economy.
  - Adopt conservative PF investment strategy to avoid significant negative returns.
  - Avoid PF guarantees of government debt and non‑concessional borrowing; favor concessional financing.
- Assessment: under baseline and prudent fiscal framework, within the next ten years there is a low risk of debt distress.

### Select key numeric indicators (as reported)
- ESI: 3 percent of estimated oil wealth.
- Non‑oil economy growth average 2008–2011: over 12 percent.
- Staff baseline medium‑term non‑oil GDP growth: around 8.5 percent.
- Higher‑growth scenario: non‑oil GDP growth averaging over 10 percent.
- Inflation: 15.4 percent (2011); well over 10 percent (2012); Food price inflation 15.6 percent (June 2013).
- Non‑oil fiscal deficits: over 70 percent of non‑oil GDP.
- Excess PF withdrawals: over 100 percent of the ESI historically.
- Yellow Road budgeted expenditure (excluding donor projects): around $1.3 billion (medium term).
- Yellow Road non‑oil revenue target growth: 15 percent a year.
- Non‑oil fiscal deficit under Yellow Road: 92 percent (2013 budgeted) falling to 27.5 percent (2018).
- Petroleum Fund balance (May 2013): 13.6 billion US dollars; expected to reach 14 billion by January 2014 (authorities’ data).
- Public foreign assets (millions of U.S. dollars, end‑period): 12,652 (2012), 14,419 (2013 Proj.), 16,748 (2014 Proj.).
- Public foreign assets in months of imports: 91 (2012), 93 (2013 Proj.), 96 (2014 Proj.).
- Port at Tibar Bay estimated investment: $300-400 million.
- PF equity allocation allowed: 50:50 split toward global equities.
- PF guarantee provision limit in revised PF Law: up to 10 percent of PF’s assets.
- DSA peak PV public debt under Yellow Road: under 12 percent of GDP in present value terms in 2018.
- Projection: oil production in current JPDA fields estimated to have peaked in 2012 and likely cease by 2024.

*Source: IMF staff report — “1. The g7+ and Timor‑Leste” (content unit: _cr13338).*

### 1. The g7+ and Timor-Leste ______________________________________________________________________  18

### 1. The g7+ and Timor-Leste

### Context
- Timor-Leste is a founding member of the g7+ group of 18 fragile and conflict-affected countries and has taken a leadership role, pioneering the New Deal approach consistent with its Strategic Development Plan (SDP).
- The 13 year UN presence concluded in 2012; parliamentary and presidential elections were held in mid-2012 with Prime Minister Xanana Gusmão re-elected.
- The Petroleum Fund (PF) is well regarded, compliant with the Extractive Industries Transparency Initiative and the Santiago Principles, with assets equivalent to over two times GDP.
- By law, withdrawals from the PF are limited to the Estimated Sustainable Income (ESI), calculated as 3 percent of estimated oil wealth, although excess withdrawals are allowed under certain circumstances.
- Policy making is conducted by a small technocratic elite; implementation capacity is weak, constraining effectiveness of policies and outcomes.

### Recent Developments in the non-oil economy and macroeconomy
- Non-oil economy growth averaged over 12 percent from 2008 to 2011.
- Non-oil GDP growth in 2012: authorities projected 10.6 percent (2013 Budget Book); staff expects a downward trend with significant under-spending on capital projects (projection of around 8 percent).
- Inflation:
  - 2011: inflation touched 15.4 percent.
  - 2012: inflation moderated but was still running at well over 10 percent.
- Fiscal outcomes and spending patterns:
  - Persistently large non-oil deficits at over 70 percent of non-oil GDP.
  - Excess withdrawals from the PF at over 100 percent of the ESI to finance spending.
  - 2012 and 2013 original budgets planned expenditures stabilizing at around $2 billion to 2018.
  - Preliminary 2012 data show significant under-spending on capital items due to capacity constraints, but a continued rise in current spending.
- Growth composition:
  - Supply-side growth led by sectors dependent on government spending (e.g., construction).
  - Weak contributions from labor-intensive sectors such as agriculture and manufacturing.
  - Living standards have not increased in line with GDP growth, indicating lack of inclusion.

### Outlook and Risks
- Medium-term non-oil GDP growth:
  - Staff projects real non-oil GDP should average around 8.5 percent under baseline—notable decline from double-digit rates of 2008–2011.
  - A higher-growth scenario with non-oil GDP growth averaging over 10 percent might be achievable with deeper reforms and rapid implementation of basic infrastructure projects.
- Key downside risks:
  - Weaker pace of structural reforms and fiscal consolidation.
  - Poor implementation of basic infrastructure projects (especially roads and ports).
  - High inflation and a poor private sector investment response.
  - Long-term fall in oil/gas prices reducing oil wealth and the ESI, necessitating tighter fiscal stance and slower GDP growth.
- External shock sensitivity:
  - Short-term global spillovers likely limited given low integration into non-oil global trade and investment networks.
  - Short-term oil price volatility smoothed by the ESI rule; long-term price declines pose larger risks.

### Policy discussions — three broad elements
- Fiscal policy: rein in public expenditure to be consistent with the fiscal rule, improve expenditure quality to promote inclusive growth, and diversify revenues.
- Structural reforms: catalyze private sector to induce labor-intensive growth, reduce poverty.
- Financial sector development: improve access to finance, regulation, and supervision to support private-sector-led growth.

### A. Bolstering the Macroeconomic Framework — findings and implications
- Macroeconomic imbalances observed:
  - Very high non-oil fiscal deficits.
  - Inflation stabilizing at high levels.
  - Erosion of sustainability and significant decline in competitiveness.
  - Appreciation of the REER; very low level of non-resource exports; lack of FDI in labor-intensive sectors; rising imports.
- In a fully dollarized economy, these indicate the fiscal stance has been too expansionary given absorptive capacities.
- Unsustainable dynamics:
  - Continuation of recent expenditure trends would significantly run down net public sector assets (Text Table 1, scenario A).
  - Staff analysis shows strict adherence to the fiscal rule (scenario B) is fully sustainable.
  - Inflation has been driven by high government spending especially on current items including transfers, reducing competitiveness and exacerbating fragilities.

### A. Bolstering the Macroeconomic Framework — policy outcomes under revised plans
- Staff welcomed revised budgetary plans (the “Yellow Road”) adopted by the Council of Ministers in June 2013:
  - Budgeted expenditure (excluding donor projects) would stabilize at around $1.3 billion in the medium term compared with around $2 billion in the original 2013 budget.
  - Non-oil revenues are targeted to increase by 15 percent a year from a low base with more intensive tax reforms.
  - Result: non-oil fiscal deficit steadily falls from a budgeted 92 percent in 2013 to 27.5 percent by 2018.
- Under the Yellow Road baseline:
  - The authorities’ fiscal rule will be met.
  - Borrowing needs would steadily fall and end by 2023 (scenario C).
  - External and public debt would remain sustainable.
  - The value of the PF would stabilize in the medium term.
  - Lower expenditures and higher non-oil revenues would reduce excess withdrawals from the PF and/or debt accumulation, help dampen inflationary pressures, and curtail real effective exchange rate appreciation.

### Text Table 1 — Illustrative Scenarios (summary)
- Scenario A. 2013 Budget Framework:
  - Assumes continuation of expenditures at 25 percent of GDP.
  - Gross PF assets steadily depleted; debt stock rises rapidly; net assets steadily depleted.
  - Higher expenditures lead to higher GDP levels but reduced private sector development; risks of sharp slowdown when debt limits reached.
  - High inflation as absorptive capacity is exceeded; competitiveness undermined. Not sustainable.
- Scenario B. Expenditures limited by ESI withdrawal rule:
  - PF value stabilizes in 2024 and is maintained in real terms.
  - Intergenerational equity is satisfied; no debt undertaken.
  - Growth substantially reduced until private sector picks up.
  - Low inflation beneficial for competitiveness and poverty reduction. Fully sustainable but basic infrastructure provision may be more limited.
- Scenario C. Yellow Road budget framework:
  - Expenditures stable at around $1.3 billion and limited concessional borrowing.
  - PF value stabilizes in 2024 and is maintained in real terms but at a slightly lower level than in scenario B.
  - Intergenerational equity is satisfied; slow pace of debt accumulation.
  - Growth can be higher than in scenario B if debt is used efficiently on growth-enhancing projects.
  - Inflation falls toward target by 2018. Sustainable outcome with low inflation assuming debt is used for growth-enhancing investments.
  - Note: Funding in excess of ESI is undertaken via concessional debt rather than excess ESI withdrawals (assumed in scenario C).

### Authorities’ views and policy direction
- Authorities agreed with staff that previous budgetary plans were unsustainable and inflationary and built consensus on the need for restraint.
- Acknowledged positive outcomes from past spending (e.g., national electricity grid) but recognized capacity constraints and increased scope for rent seeking.
- New expenditure plans focus on projects with clear poverty-reduction impacts (basic infrastructure and human capital), value-for-money, and elimination of waste.
- Council of Ministers’ approval of the revised stance indicates political consensus to minimize fiscal slippage.

*Source: IMF staff report — “1. The g7+ and Timor-Leste” (content unit: _cr13338).*

### 16.      The new budget framework implies a sharply lower spending path than that envisaged

### 16.      The new budget framework implies a sharply lower spending path than that envisaged

### Expenditure path and quality
- Expenditures will be stabilized at around current levels and will fall in GDP terms.
- Revised plans aim to improve expenditure quality consistent with promoting efficiency and inclusive poverty reducing growth as per the SDP.
- Channels for rapid and sustainable benefits:
  - Greater prioritization of public investment on projects that will generate sustainable employment in the private sector (especially basic infrastructure such as roads and ports plus human capital enhancing projects especially on health and education).
  - Greater focus on value for money in budget planning and execution.
- Key trade-offs and challenges:
  - Capital expenditures: trade-off between high profile capital-intensive projects and increased funding of basic infrastructure (roads, port and airport) with direct links to export and high employment generating sectors (Box 5).
  - Recurrent expenditures: need to restrain growth of the wage bill and better target subsidies and transfers to create space for higher spending on operations and maintenance and provision of essential supplies in health and education.
  - Containment of electricity subsidies is important because the de facto large subsidy will rise as new capacity is utilized; cuts to subsidies and transfers must be at a measured pace to maintain social cohesion.

### Revenue and public financial management
- Authorities plan to raise non-oil revenues and continue reform of public financial management.
- Revenue priorities:
  - Support revenue diversification and strengthen capacity in tax administration to limit tax evasion.
  - Introduce new taxes, e.g., a VAT in line with recent FAD TA advice, to broaden the tax base, raise buoyancy, and limit dependence on (declining) oil revenues.
  - Main impediment to VAT introduction has been poor capacity at the Ministry of Finance (MoF); staffing reforms are underway and further TA on implementation would be useful.
  - Ensure customers pay equitably for electricity usage as subsidies will rise with new capacity.
- Progress and next steps:
  - Strengthening of expenditure and cash management at the MoF.
  - Next step: strengthen budget planning and implementation capacity in line ministries with TA donors working with the MoF.

### Asset-liability management and public liabilities
- Government balance sheet will become more complex with planned new debt liabilities and public-private partnerships (PPPs) that may generate contingent liabilities.
- Key considerations:
  - Public debt: contracting concessional debt from developmental partners is beneficial; non-concessional debt should be avoided.
  - Off-budget investments: major capital-intensive projects should be transparent and subject to full scrutiny by the Major Projects Secretariat and the Audit Court; off-balance sheet liabilities, including by state owned companies, should be avoided.
  - Petroleum Fund:
    - Revised Petroleum Fund Law allows a 50:50 split toward global equities with an intention to maximize returns.
    - New provision to allow the PF to guarantee government debts (up to 10 percent of the PF’s assets) is potentially risky and should be avoided, as should any domestic investments.
- PPP context:
  - PPP projects under development include the new Dili Port and enhancement of Dili Airport.
  - PPP tender for the new Port at Tibar Bay launched in August 2013; estimated investment in the Port will be $300-400 million with significant private sector participation.
  - Overall size of the airport project not yet finalized; expected private investment likely to be much smaller.

### Authorities’ priorities and views
- Authorities agree reprioritization of expenditures is warranted to align with SDP objectives of poverty reduction and sustainable growth, reduce waste, increase value-for-money, and improve employment generation.
- Planned focus areas:
  - Reduce subsidies (especially electricity), limit transfers, implement civil service reforms.
  - Assess capital budget carefully to prioritize high-return, high-employment projects; scope of the Tasi Mane project yet to be fully determined.
  - Raise non-oil tax revenues through better administration and introduction of a VAT in line with recent Fund TA; measures to improve tax administration capacity are underway.

### Private sector development and structural reforms
- Given fiscal retrenchment, growth must come through private sector development to improve competitiveness and address structural bottlenecks.
- Binding impediments: low human capital, bureaucratic obstacles, lack of contract enforcement, limited access to finance, and “Dutch disease” type issues.
- Government initiatives: one-stop shop for new businesses and development of PPPs.
- Staff recommendations:
  - Manage pervasive state role within a sound governance framework and cost-benefit assessments.
  - Prioritize development of fundamental prerequisites for growth: infrastructure, legal reforms, and complementary institutions.
  - Immediate gains possible in agriculture via roads, irrigation, and technical training.
  - Caution on SEZs and development banks—mixed international experience; emphasize governance, transparency, accountability, and national-wide reform coverage.
  - TA from countries with successful SEZ/development bank experience would be useful.

- Labor cost competitiveness measures:
  - Reduce general and wage inflation; lower spending plans will help.
  - Minimum wage levels should be brought in line with peers in the ASEAN region.
  - Priorities: logistics (roads, ports, airport) with mixed funding including self-funded, donor funded, and PPPs; structural reforms such as implementation of the Land Law, reducing red tape, streamlining the Investment Law, and increasing legal certainty for contract enforcement.

### Monetary and exchange rate policies
- Continued use of the U.S. dollar remains appropriate.
- To restore competitiveness eroded by high inflation, a restrained fiscal stance is required.
- SDP raises the possibility of introducing a national currency longer-term; two separable issues: (i) issuing a national currency; and (ii) the exchange rate arrangement.
  - A national currency linked to the U.S. dollar in a hard peg would be conceptually similar to full dollarization; softer pegs or flexible arrangements would allow more independent monetary policy.
- Institutional prerequisites for currency reform are substantial and time-consuming; sustained enhancement of BCTL capacities required.
- Introduction of the 100 centavo coin (replacing the one U.S. dollar note) and its usage will provide useful learning for the BCTL.

### Financial sector and supervision
- Financial sector is small with low penetration and limited access to finance; banking sector comprises four banks and several micro credit institutions.
  - Three banks are branches of international banks (Australia, Indonesia, Portugal); one local government-owned bank recently upgraded from a micro credit institution and is the only bank with its own capital base.
  - Banks maintain substantial excess liquidity placed abroad; lending is problematic. Judicial enforcement of problem loans is poor and NPLs are high, especially at one bank due to 2006 political violence. Interest rate spreads are wide.
- Priorities:
  - Strengthen prudential supervision and develop a crisis management framework.
  - Address country, counterparty, and concentration risks arising from placement of deposits abroad.
  - Avoid lending risks from state-owned bank directed to priority sectors.
  - Enhance anti-money laundering and combating financing of terrorism framework per Asia/Pacific Group mutual evaluation (2012): enact appropriate legislation, establish a Financial Intelligence Unit, and mobilize AML framework to support anti-corruption efforts.
- Authorities’ views:
  - Agreement that financial system has not supported growth; need legal changes (Land Law, electronic banking law), modernized payments system, improved BCTL oversight.
  - New Financial Sector Master Plan will address weaknesses; BCTL requested IMF TA Needs Assessment mission.

### Statistics, TA, and capacity building
- Data shortcomings due to limited capacity hinder analysis; strides made:
  - National income accounts to 2011 now available for the first time, though revisions and timeliness issues remain.
  - Inflation methodology improved; further work needed on accuracy and timeliness of poverty data.
  - Fiscal reporting improvements under way in line with GFSM 2001.
  - Participation in the Fund’s General Data Dissemination System (GDDS) in October 2012 welcomed by staff.
- TA needs and delivery:
  - High TA delivery to MoF and BCTL; next step is boosting knowledge transfer to reduce dependence on expatriate staff through training of local officials.
  - IMF stands ready to continue TA in core areas: assistance to BCTL to strengthen supervision; estimating the ESI and Petroleum Fund asset management; asset-liability management framework; integrating national accounts and balance of payments; statistics infrastructure and fiscal reporting.

### Staff appraisal and policy recommendations
- Strategic challenge: convert oil wealth into long-term sustainable growth to generate broad-based increases in living standards given the high poverty rate.
- Staff welcomed the more prudent budgetary plans but stressed containing potential slippages to preserve sustainability and PF assets.
- The framework is consistent with SDP objectives and, if structural reforms are accelerated, can support:
  - Strong growth in household consumption,
  - Lower inflation,
  - Declining poverty.
- Key policy choices to realize the new expenditure path:
  - Maintain expenditure on high priority programs that generate sustainable growth and poverty reduction.
  - Emphasize cost-benefit analysis, value-for-money, and improved budgetary planning and execution.
  - Prioritize funding of basic infrastructure (roads, port and airport) over capital-intensive projects with low employment generation.
  - On recurrent side: generate space for higher operations, maintenance, health and education spending via greater restraint in the wage bill and better targeted subsidies and transfers.
- Risk note: the outlook for gas prices remains highly uncertain; a sustained fall would necessitate further fiscal restraint.

*IMF staff report (section 16).*

### 36.      To protect wealth for future generations, the government needs to strengthen the

### _cr13338 - 36.      To protect wealth for future generations, the government needs to strengthen the

### Asset‑liability management, Petroleum Fund (PF), and public participation in projects
- Finding: The government is planning to take on debt for the first time and enter into PPPs that may generate contingent liabilities; these need to be comprehensively assessed.
- Finding: Plans to take equity positions in major capital projects require careful evaluation to ensure public participation is justified.
- Recommendation: Strengthen the asset‑liability management framework as the government balance sheet becomes more complex.
- Recommendation: Manage the shift in strategic asset allocation toward equities by the PF with the priority toward capital preservation rather than maximizing returns.

### Private sector development, competitiveness, and structural reforms
- Policy priority: Catalyze an organic private sector to shift the economy from public to private‑sector led growth.
- Key steps identified:
  - Improve competitiveness and address structural bottlenecks.
  - Enhance living standards especially in the rural sector.
  - Reduce inflation so that wage levels align with peers in the ASEAN region to improve labor cost competitiveness.
  - Prioritize investments in basic transport infrastructure.
- Institutional observation: Structural reforms need advancement; piecemeal implementation via SEZs is unlikely to be optimal.

### Central banking capacity, dollarization considerations, and financial sector soundness
- Finding: The BCTL needs to enhance capacity for core central banking activities; deeper TA engagement with the Fund is welcome.
- Financial stability: Safeguarding the soundness of the banking system will become increasingly important as it develops; TA in this area will be valuable.
- Currency strategy: Considerable further work is required regarding the pros and cons of issuing a national currency and the associated exchange rate arrangement in any possible move away from full dollarization.
- Operational note: The introduction of the 100 centavo coin is a welcome step and a learning opportunity for the BCTL.

### Statistics, data development, and living standards indicators
- Finding: Further work is needed to address statistical data shortcomings due to capacity constraints.
- Progress noted:
  - Production of disaggregated national accounts and improved CPI statistics are positive steps.
  - Recent participation in the GDDS is welcome.
- Gaps and recommendations:
  - Improve timeliness and accuracy of disaggregated national accounts and CPI.
  - Develop a broader range of economic and social indicators, particularly on trends in living standards, to enhance analysis and guide policies.

### Consultation cycle
- Expectation: The next Article IV consultation with Timor‑Leste will be held on the standard 12‑month cycle.

### Risk Assessment Matrix — main threats, likelihood, and expected impacts (staff subjective assessment)
- 1. Delays regarding Greater Sunrise Field
  - Overall Level of Concern: High
  - Likelihood of Severe Realization in the Next one–three Years: High
  - Expected Impact if Realized: High
  - Note: Maritime boundary demarcation with Australia is subject to international arbitration that could delay project development; long‑term growth prospects would be curtailed; lower future revenues limit spending plans to maintain fiscal sustainability.
- 2. Over investment in projects with low returns
  - Overall Level of Concern: Medium/High
  - Likelihood: High
  - Expected Impact: High
  - Note: Could stem from capital‑intensive projects with overly ambitious cost‑benefit analysis; strong oil prices may heighten trend; high opportunity cost and limited job creation/linkages.
- 3. Higher inflation
  - Overall Level of Concern: Medium
  - Likelihood: Medium
  - Expected Impact: High
  - Note: Inability to restrain current expenditures could raise inflation back to close to 20 percent; hurts the poor and limits diversification; higher subsidies and transfers would pressure spending.
- 4. Political Instability
  - Overall Level of Concern: Medium
  - Likelihood: Medium
  - Expected Impact: High
  - Note: Could be triggered by perceptions that oil wealth is not trickling down; may increase rent seeking, pressure to raise current expenditures, lower quality of public investments, and discourage foreign investment.
- 5. Global economic shocks
  - Overall Level of Concern: Medium
  - Likelihood: Low
  - Expected Impact: Low
  - Note: Sources include euro area tensions, slowdown in emerging markets, or a sharp slowdown in China; limited impact due to low non‑oil trade and capital account integration.
- 6. Financial sector contagion
  - Overall Level of Concern: Medium
  - Likelihood: Medium
  - Expected Impact: Medium
  - Note: Main banks are foreign branches; excess liquidity placed with parents; renewed shocks could impact local liquidity; no crisis management or contingency planning frameworks in place.
- 7. Global oil price risk
  - Overall Level of Concern: Low
  - Likelihood: Medium
  - Expected Impact: Medium
  - Note: High price scenario (e.g., oil prices to $140 per barrel) or low prices from new supply technologies; PF acts as stabilizer but fiscal discipline could be harder in high price scenarios; downward trends would require scaled back expenditure plans.

### Box summaries — substantive analysis and implications

- Box 1: The g7+ and Timor‑Leste
  - Finding: Timor‑Leste is a key member of the g7+ (formed in 2010, comprising 18 countries).
  - Policy relevance: The New Deal for Engagement in Fragile States (Busan, 2011) prioritizes country‑led transitions and Peace‑Building and State‑Building Goals (PSGs) including Legitimate Politics, Security, Justice, Economic Foundation, and Revenue and Services.
  - Status: Timor‑Leste was assessed in mid 2012; Security showed biggest improvement; Legitimate Politics and Revenue and Services made good progress; more work needed on Justice and Economic Foundations.
  - Note: Piloting of the New Deal implementation will be assessed in 2015.

- Box 2: Recent Developments in the Petroleum Sector
  - Fact: Production at 65 million barrels of oil (equivalent) per year; oil and gas sector accounts for around 78 percent of GDP and 95 percent of exports of goods and services.
  - PF rule: The ESI is set at three percent of the present value of oil wealth (PF assets plus reserves with production agreements) and is based on conservative assumptions.
  - Revenue dependence: Flows from the PF account for around 95 percent of government (non grant) revenues.
  - Structural characteristics: Production is offshore; raw natural gas is piped to Australia for LNG processing; the sector directly accounts for virtually no on‑shore employment.
  - Uncertainties:
    - Complex interim arrangements in the Timor Sea; three interlocking treaties with Australia covering JPDA and Greater Sunrise; Greater Sunrise subject to international arbitration.
    - Production in current JPDA fields estimated to have peaked in 2012 and likely cease by 2024.
    - No contribution of Greater Sunrise is assumed in the ESI or PF calculations or in macro projections by Fund staff or the authorities.
  - Implication: Inflows from oil revenues into the PF will steadily decline as output falls; investment income contribution to PF assets will steadily increase, increasing the premium on asset safety and strategic asset allocation.

- Box 3: Economic Growth and Living Standards in Timor‑Leste
  - Data development: Disaggregated national accounts produced for the first time in 2012.
  - Finding: Real per capita non‑oil income rose at an average of close to 10 percent growth per year between 2007 and 2011.
  - Data limitation: Methodological problems with the recent living standards survey prevented calculation of a new poverty rate.
  - Observation: Overall living standards appear not to have increased; real consumption of food per capita has shown a downward trend.
  - Structural diagnosis:
    - Government spending boosted public sector and construction and has been highly import intensive with little wider impact.
    - Employment‑intensive sectors such as agriculture (relied on by over 50 percent of households for income) and labor‑intensive manufacturing have been hampered, limiting poverty reduction in rural areas.
    - Inflation, mainly driven by government spending, has undermined living standards outside the small formal sector and reduced competitiveness.
  - Policy implication: A greater focus on poverty reduction under a high quality growth scenario, with sustainable employment growth in agriculture, manufacturing, and services (tourism), and lower inflation under a prudent fiscal framework, should improve living standards and reduce poverty.

- Box 4: Inflation and Government Spending
  - Fact: Inflation has remained in double digits since early 2011.
  - Specific data point: Food price inflation was 15.6 percent in June 2013.
  - Empirical result: Statistical analysis suggests a one percent increase in recurrent expenditure as a percent of GDP causes 0.20 percent increase in the inflation rate.
  - Diagnosis: Inflationary pressures stem from excess demand driven by expansionary fiscal policy and structural barriers to trade (e.g., poor infrastructure).
  - Policy outcome: The more restrained medium‑term budget framework (the Yellow Road budget) calling for real cuts in recurrent expenditures should significantly reduce inflation; staff analysis suggests this would allow inflation to fall toward the targeted level by 2018.
  - Complementary action: Supply‑side policies to reduce the high cost structure would boost the rate of deceleration of inflation, aiding poverty reduction and diversification.

- Box 5: Development Strategy and Industrial Policy
  - Strategy: SDP includes strong focus on industrialization to reach upper middle income status and reduce poverty; diversification via industrial sectors (e.g., petrochemicals) leveraging oil resources.
  - Instruments: Infrastructure fund, human capital fund, a number of SEZs, and a development bank; establishment of national oil company Timor Gap.
  - Tasi Mane project (south coast development): Plans for three industrial clusters (supply base and industrial estates; refinery and petrochemical complex; LNG plant complex) and supporting infrastructure (major highway, seaport, airport, heliport).
  - Implementation note: Timor Gap is lead on Tasi Mane; contracting for supply base and part of highway underway; final costs not yet determined.
  - Budget projection: The 2013 Budget Report forecasts that developmental expenditures would account for almost half of total infrastructure spending by 2017.
  - Viability caveat: Many aspects are independent of Greater Sunrise, but timing, implementation of new fields, and onshore pipeline decisions could be important to overall viability.

*Italic: International Monetary Fund — content unit _cr13338 (excerpts provided).*

### Box 6. Implementation of Past IMF Policy Recommendations

### Box 6. Implementation of Past IMF Policy Recommendations

### Fiscal policy and budgetary framework
- Recent Article IV missions emphasized the need for fiscal restraint.
- Staff welcomed the planned investment in infrastructure but advised slowing planned increases in spending to better align expenditures with the absorptive capacity of the economy and administrative constraints.
- Staff highlighted the inflationary consequences of the rapid spending strategy and the adverse consequences for the poor.
- Staff set out a path for reducing expenditures but the authorities have hitherto preferred to maintain high expenditures given the large developmental needs.
- The continuation of high inflation and the slow pace in poverty reduction has led to an increased acceptance of Fund advice.
- The revised budgetary framework approved by the Council of Ministers in June 2013 is in line with Fund advice on a tighter fiscal envelope.
- Policy recommendation: the next stage is to ensure a reprioritization of expenditures to increase their effectiveness.

### Public financial management and public investment
- Public financial management has improved in line with Fund recommendations.
- New institutions have been established to manage large public investment programs.
- The operations of the Petroleum Fund (PF) have been improved consistent with Fund advice.
- Previous missions highlighted the need to contain subsidies especially regarding electricity consumption, but consensus on reforms has been slow to emerge.
- Policy recommendation: continue strengthening PFM institutions and prioritize expenditure toward projects with higher absorptive capacity and development impact; accelerate consensus-building on subsidy reform, particularly electricity subsidies.

### Structural reforms and private sector development
- Advice on structural reforms has been broadly followed.
- Steps taken in line with recommendations on reducing impediments to business include establishing a one stop shop for business investors and promoting PPPs.
- Policy recommendation: continue reforms that reduce impediments to business and focus on measures that enhance competitiveness and private-sector-led job creation.

### Financial sector development and legal framework
- Fund advice on financial sector development has been accepted by the authorities.
- The authorities are planning to implement a new Financial Sector Master Plan and have requested Fund TA on enhancing the capacities of the BCTL (Central Bank of Timor-Leste).
- A number of crucial laws have yet to be passed, for example the Land Law that would allow development of the mortgage market; reaching consensus on land issues has proved difficult.
- Policy recommendation: prioritize passage of key laws (including the Land Law) to enable mortgage market development and broader financial deepening; accelerate implementation of the Financial Sector Master Plan and capacity-building for BCTL.

### Risks and implementation challenges
- The authorities have preferred to maintain high expenditures given large developmental needs, creating tension with Fund advice for restraint.
- The main challenges to long-term debt sustainability and policy effectiveness include slippages to the revised budgetary plans, an inefficient investment program, and the maintenance of high current spending that does not enhance growth prospects.
- Off-balance sheet operations are likely to become more complex; risks from these operations should be closely monitored and assessed.
- Policy recommendation: ensure consistent implementation of the revised fiscal framework, limit borrowing to concessional terms from multilateral and bilateral donors, and closely monitor off-balance-sheet activities.

*Source: Box 6. Implementation of Past IMF Policy Recommendations, IMF staff report (excerpt).*

### 1.      The assessment has been updated from the previous DSA work undertaken in 2011

### _cr13338 - 1.      The assessment has been updated from the previous DSA work undertaken in 2011

### Updated scope, assumptions, and framework
- DSA updated from 2011 and 2010 work to reflect new policy allowing buildup of external debt for developmental purposes.
- Based on macroeconomic framework in the IMF’s staff report for the 2013 Article IV consultation.
- Revised medium-term fiscal framework reflects more conservative spending plans consistent with macroeconomic and debt sustainability.
- Analytical assumption: debt accumulation reflects the gap between revenues (ESI and non-oil revenues) and expenditures; the non-oil fiscal deficit is funded through external borrowing rather than excess withdrawals from the Petroleum Fund (PF).
- Public and external debt sustainability treated as essentially equivalent because:
  - Public sector only borrows externally;
  - Private sector does not incur medium- or long-term external liabilities;
  - Public sector external debt is partially illustrated in net terms.

Key modeling and conceptual choices
- Timor-Leste assigned a weak Country Policy and Institutional Assessment (CPIA) performance rating → lowest set of indicative debt thresholds.
- Gross national disposable income (GNDI) replaced by gross domestic product (GDP) for debt-servicing capacity measurement.
- Exports concept includes exports of goods and services plus primary oil-related income.
- Total public sector revenue = non-oil tax revenues + estimated sustainable income (ESI) from the PF.
- All debt undertaken by the central government; no off-balance sheet debt accumulated, including by state owned enterprises such as Timor Gap.
- Oil reserves are depleted by 2024 and no new reserves come on stream during the forecast horizon.

### Fiscal framework, Yellow Road vs 2013 Budget
- Authorities’ fiscal framework (the "Yellow Road") cuts expenditure growth over the medium term relative to the 2013 Budget, lowering financing needs from external borrowing or excess PF withdrawals.
- Under the Yellow Road, staff projects external borrowing ceases by 2022, yielding stable long-term public asset dynamics in gross and net terms.
- Contrasts with the 2013 Budget scenario which projected large excess PF withdrawals and debt accumulation, implying rapid drawdown of public assets after 2024.
- Text box projection (Projected Medium-Term Fiscal Funding Gaps under 'Yellow Road' and the 2013 Budget) contains figures (in millions of US$ and percent of GDP) for 2013–2018; differences between scenarios are substantial (example differences in percent of GDP: -3.6, -6.8, -6.8, -6.9, -8.3, -9.6 for 2013–2018 respectively).

Specific operational considerations and recommendations
- Public debt:
  - Contracting concessional debt from developmental partners is beneficial as it could improve quality and returns of capital projects.
  - Non-concessional debt should be avoided.
- Off-budget investments and PPPs:
  - Major capital projects have complex financing; public participation cost-benefit can be difficult to assess.
  - Such projects should be transparent and subject to full scrutiny by the Major Projects Secretariat and the Audit Court; capacity of these bodies needs strengthening.
  - Off-balance sheet liabilities, including by state owned companies such as newly established oil company Timor Gap, should be avoided.
- Petroleum Fund (PF):
  - Revised PF Law allows strategic asset allocation shift toward equities with a 50:50 split allowed to increase returns.
  - The PF provision allowing guarantees of government debts (up to 10 percent of the PF’s assets) is potentially risky and should be avoided.
- Asset-liability management:
  - Government will need a strong asset-liability management framework as balance sheet becomes more complex (new debt, PPPs, equity positions in capital projects).
  - Avoid contingent liabilities and government guarantees (explicit or implicit); Ministry of Finance capacity to monitor such liabilities needs strengthening.

### DSA findings and projections
- Under the authorities’ revised fiscal framework (Yellow Road):
  - Moderate accumulation of gross debt through 2021 with debt stock peaking at under 12 percent of GDP in present value terms in 2018 (see Table 1, Figure 1).
  - High stock of public assets in the PF, at around $13 billion, and continued asset accumulation through 2024 → net public debt remains negative in nominal and present value terms throughout the period (see Table 2, Figure 2).
  - Debt amortization beginning in 2020 mitigates stock ratios even as oil inflows are projected to end in 2024.
  - Debt service ratios remain well within debt stability tolerances given concessionality of the debt and moderate accumulation pace.
- Main risk to debt sustainability: not harnessing resources to stimulate long-term growth as petroleum production ends.
- Gross public external assets projected to increase throughout the forecast period based on assumption of ending excess PF withdrawals.

### Stress tests, risks, and scenario outcomes
- Most extreme shock: non-debt creating flows shock → illustrates economy’s low debt-carrying capacity given narrow base; in stress scenario the stock equals the threshold.
- Second worst shock: less favorable terms of new debt → underscores importance of borrowing only on concessional terms.
- Permanent lower growth shock:
  - A lower permanent growth of about 1.5 percentage points relative to baseline consistently worsens debt outlook.
  - Worsening net debt-to-GDP ratio as of 2024 under baseline is driven by GDP declining faster than accumulation of public foreign assets when oil inflows end.
- Maintaining prudent fiscal policies is critical:
  - Eliminate excess PF withdrawals;
  - Enhance quality of expenditures to diversify the economy;
  - Avoid significant negative returns on the PF by adopting a conservative and carefully considered investment strategy.

### Risk monitoring and institutional recommendations
- Risks from off-balance sheet liabilities (PPPs, state-owned companies, guarantees) need careful monitoring and full Ministry of Finance scrutiny.
- Strengthen capacity of the Major Projects Secretariat and the Audit Court to ensure transparency and assess cost-benefit of public participation in major projects.
- Avoid PF guarantees of government debt and non-concessional borrowing; favor concessional financing for development projects.

### Assessment of debt distress risk and authorities’ views
- Under the baseline and prudent fiscal framework, within the next ten years there is a low risk of debt distress.
- Authorities agreed with the DSA conclusions and recognized adopting the Yellow Road framework would stabilize long-term PF balance and external debt outlook, implying a low risk of debt distress.

*Document: _cr13338 - 1.      The assessment has been updated from the previous DSA work undertaken in 2011*

### 11.      Critical to Timor Leste’s debt sustainability is the adoption of a prudent fiscal policy

### 11.      Critical to Timor Leste’s debt sustainability is the adoption of a prudent fiscal policy

### Summary assessment
- The revised fiscal framework, Yellow Road, replaces the 2013 Budget Book and is designed to ensure debt sustainability, but consistent implementation will be critical to maintaining sustainability.
- Fiscal slippages would increase risks to the external debt outlook given Timor-Leste’s narrow economic base and low debt servicing capacity.
- Achieving sustainability requires higher-quality growth in the non-oil sector through structural reforms, prioritized public investment, and optimized public asset-liability management.

### Policy recommendations (explicitly stated)
- Implement structural reforms to stimulate the private sector.
- Carefully prioritize complementary public investments that efficiently support the development of labor-intensive and export orientated sectors.
- Establish a public asset-liability management framework that optimizes the financing mix from the PF and development partners.
- Avoid non-concessional financing and the buildup of contingent liabilities.

### Debt-sustainability scenarios and stress testing (high-level)
- Multiple alternative scenarios and stress tests are presented for 2013-2033, with the "most extreme stress test" defined as the test that yields the highest ratio in 2023.
- Several panels attribute the most extreme shocks to "Non-debt flows shock" or to shocks such as "new debt on less favorable terms" and "an export shock of historical average growth minus one standard deviation in 2014-2015."
- Indicators tracked over 2013-2033 include: Debt accumulation; PV of debt-to-GDP ratio; PV of debt-to-exports ratio; PV of debt-to-revenue ratio; Debt service-to-exports ratio; and Debt service-to-revenue ratio.

### Key statistics and projections (selected figures from the baseline and projections)
- Public sector debt (estimate series): 0.0; 0.0; 0.0; 0.7; 4.7; 9.2; 13.0; 15.0; 16.0; 11.2; 2.5 (series for 2010–2018 and 2013-18 Average shown).
- PV of external debt (selected projections): 0.0; 0.5; 3.4; 6.6; 9.4; 11.0; 11.8; 8.5; 1.9 (projection years within 2013–2033 table).
- PV of PPG external debt in percent of exports (selected): 0.0; 1.0; 5.8; 11.8; 16.1; 18.6; 21.3; 21.2; 9.5.
- PV of PPG external debt in percent of government revenues (selected): 0.0; 4.4; 24.2; 45.8; 62.0; 67.9; 67.7; 53.5; 22.1.
- PPG debt service-to-revenue ratio (in percent, selected): 0.0; 0.0; 0.1; 0.0; 0.3; 0.7; 1.0; 1.3; 1.8; 2.5; 2.7.
- Grant-equivalent financing (in percent of GDP, selected): 4.1; 5.3; 5.5; 5.3; 4.8; 4.4; 3.0; 1.1; 2.4.
- Grant-equivalent financing (in percent of external financing, selected): 88.2; 65.3; 62.8; 65.9; 73.7; 85.4; 100.0; 100.0; 98.9.
- Government revenues (excluding grants, in percent of GDP, selected): 6.9; 9.6; 9.8; 12.3; 14.1; 14.5; 15.2; 16.2; 17.4; 15.8; 8.6; 13.5.
- Real GDP growth (in percent, historical and projected series): -1.4; 7.3; 5.7; 26.4; 44.5; -3.2; -6.9; 1.7; -2.1; -1.1; -5.3; -2.8; -1.6; 8.0; 3.5.
- Nominal GDP (Billions of US dollars, selected): 4.2; 5.8; 6.3; 6.1; 5.7; 5.7; 5.7; 5.9; 5.9; 8.2; 21.5.
- PV of PPG external debt (in Billions of US dollars, selected): 0.0; 0.0; 0.2; 0.4; 0.5; 0.6; 0.7; 0.7; 0.4.
- Debt service of PPG external debt (in percent of exports + remittances, selected): 0.0; 0.0; 0.0; 0.0; 0.1; 0.2; 0.3; 0.4; 0.6; 1.0; 1.2.
- Gross financing need (percent of GDP, selected): 12.8; 9.3; 8.2; 7.3; 8.2; 8.8; 8.0; 6.5; 5.3; 2.8; 1.0.

### Noted risks and caveats
- Timor-Leste’s narrow economic base and low debt servicing capacity amplify risks from policy slippages.
- The most extreme stress test outcomes arise from shocks to non-debt-creating flows or to export performance, depending on the panel/scenario.
- The authorities should avoid increasing exposure to non-concessional borrowing and the buildup of contingent liabilities.

_Italic: Sources: Country authorities; and staff estimates and projections._

### 1. Bank Work

### 1. Bank Work

### Program activities and timing
- Ministry of Finance Strategic Plan: November/December 2011; Completed June 2012.
- Ministry of Finance PFM Program: Ongoing; January 2014 (program closes).
- Participation in the Timor-Leste Development Partners Meeting: June 2013 and 2014.
- Co-hosting Conference on Harnessing Natural Resource Wealth for Inclusive Growth and Economic Development: September 2013.
- Public Expenditure Review of Infrastructure: February 2014.
- Support on Public Investment Management: January 2014; June 2014.
- Parliamentary seminars on lending, social transfers, infrastructure financing, Private Sector Development: Ongoing.

### 2. Fund Work

### Program activities and timing
- 2014 Article IV Consultations: Staff visit in January 2014 and Article IV mission in June 2014.
- Participation in the Timor-Leste Development Partners Meeting: June 2013 and 2014.
- Co-hosting Conference on Harnessing Natural Resource Wealth for Inclusive Growth and Economic Development: September 2013.
- TA: PF investment management: Ongoing.
- TA: Needs Assessment at BCTL: October 2013.
- TA: ESI and fiscal regime for petroleum: August 2013.
- TA: Government Finance Statistics: Ongoing.
- TA: Monetary and Financial Statistics: Ongoing; Staff visits January 2014 and September 2014.
- Other engagements: June 2013 and 2014; September 2013; November 2013; September 2013 (timing entries present in source).

### 3. Joint Work

### Program activities
- DSA update: June 2014–October 2014.

### Relations with the Asian Development Bank (AsDB)

### Nature and focus of engagement
- Timor-Leste joined the AsDB in 2002.
- AsDB engagement guided by country partnership strategy (CPS), 2011–2015, aligned with Timor-Leste’s Strategic Development Plan, 2011–2030.
- CPS supports infrastructure, financial services, skills training, private sector development, governance and capacity development, gender equity, knowledge solutions, and regional integration.

### Major AsDB support and financing
- Timor-Leste first accessed the Asian Development Fund (ADF) in 2005; ADF provided grants for road rehabilitation, water supply, and technical and vocational education and training projects.
- Infrastructure Project Management TA: $15 million six-year package, co-financed with AusAID, to help plan, prepare, and execute the government’s capital development program.
- Indicative ordinary capital resources allocation for 2013–2015: $60 million (actual allocation depends on demand and portfolio performance).
- ADF resources for 2013–2015: $50.32 million available as loans only.
- In 2012, Timor-Leste received $68.7 million loan cofinancing from the government of Japan for the Road Network Upgrading Project.
- AsDB co-hosted the conference on Harnessing Natural Resource Wealth for Inclusive Growth and Economic Development, held in Dili in September, 2013.

### Statistical Issues (As of June 2013)

### I. Assessment of Data Adequacy for Surveillance — key shortcomings and progress
- General: Data provision to the Fund has shortcomings due to capacity constraints that significantly hamper surveillance. Most affected areas are national accounts and trade statistics. TA is being provided by the Fund and other donors.
- National Accounts:
  - National accounts developed for 2004–11, with details of GDP and its components available.
  - Methodology reviewed in May 2013; assessed as broadly compliant with the System of National Accounts 2008.
  - Recommended: identify areas for simplification of the compilation system to facilitate future compilation by the General Directorate of Statistics and reduce reliance on external assistance; longer-term redevelopment with ABS support possible.
- Price Statistics:
  - CPI rebased starting 2013; basket weights updated using Household Income and Expenditure Survey (HIES) conducted in 2011.
  - Data released monthly for Dili; national data available quarterly.
  - Shortcomings in data collection, especially in rural areas; products and outlets should be updated.
- Government Finance Statistics:
  - Compilation of revenue and expenditure moving toward GFSM 2001 approach but hampered by capacity constraints.
  - STA providing ongoing technical assistance to facilitate migration to GFSM 2001.
  - Early 2013 TA mission updated chart of accounts (COA) classifications and public sector delineation.
  - Only partial data available on fiscal and quasi-fiscal activities undertaken by bilateral donors outside the central government budget.
- Monetary and Financial Statistics:
  - Monetary statistics compiled by the BCTL generally follow the Monetary and Financial Statistics Manual methodology.
  - Data incomplete due to absence of official data on public currency holdings and banks’ positions with public nonfinancial corporations.
  - Detailed monthly monetary data available from July 2002 onward following introduction of standardized report forms (SRFs) for central bank and other depository corporations (ODCs).
  - Current needs: (i) introduce SRFs for the central bank based on the new chart of accounts and for the ODCs based on the revised call report form; (ii) include the credit unions in the institutional coverage of the ODCs; (iii) introduce the SRF for other financial corporations.
- Balance of payments:
  - Progress made, but measuring non-Petroleum Fund related current account transactions accurately remains a work in progress.
  - Monthly merchandise trade data published regularly but significant gaps in series for 2006 and 2007.
  - Monthly merchandise exports and imports data based on tariff system – ASYCUDA.
  - Significant underestimation of transactions due to large unrecorded border trade; exemption of some goods from customs duties; undervaluation of declared goods, particularly for imports.
  - Service transactions largely estimated, with data collection largely limited to official and tourism sectors.
  - Primary and interest oil/gas revenues currently recorded as current income based on fiscal data.
  - With IMF Statistics Department TA, annual BOP data available for 2006–12.
  - Further development work needed to address merchandise trade statistics and service transactions; ensure consistency between current account data and new National Accounts Statistics, particularly related to exports of commodities and imports of services.
  - Authorities considering recording primary oil/gas income as an export to mirror National Accounts Statistics in forthcoming TA missions.
  - Coverage of survey of foreign direct investment enterprises needs expansion; exploration and extraction activities in the Joint Petroleum Development Area and in the exclusive territory require ongoing monitoring.
  - Limited information on remittances from Timorese working abroad; improvement in estimation and compilation procedures recommended.
  - Since October 2012, Timor-Leste participates in the Japan Administered Account for Selected IMF Activities (JSA) Project on the Improvement of External Sector Statistics in the Pacific Region; TA under this project has resulted in dissemination of annual IIP data on the central bank’s website and improved periodicity and timeliness of external sector statistics.

### II. Data Standards and Quality
- Participant in the Fund’s General Data Dissemination System (GDDS) since October 31, 2012.
- No Data ROSC is available.

### III. Reporting to STA
- No data on government finance statistics currently reported for the GFS Yearbook and the International Financial Statistics (IFS).
- Monetary data are reported to the IMF for publication in the IFS on a regular monthly basis.

### Timor-Leste: Table of Common Indicators Required for Surveillance (As of August 21, 2013)

- Exchange Rates: Date of latest observation 7/2013; Date received 8/2013; Frequency of Data D; Frequency of Reporting D; Frequency of Publication D.
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Date of latest observation 1/2013; Date received 5/2013; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- Reserve/Base Money: Date of latest observation 6/2013; Date received 8/2013; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- Broad Money: Date of latest observation 6/2013; Date received 8/2013; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- Central Bank Balance Sheet: Date of latest observation 6/2013; Date received 8/2013; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- Consolidated Balance Sheet of the Banking System: Date of latest observation 6/2013; Date received 8/2013; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- Interest Rates: Date of latest observation 6/2013; Date received 8/2013; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- Consumer Price Index: Date of latest observation 6/2013; Date received 7/2013; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- Revenue, Expenditure, Balance and Composition of Financing – General Government: entries not available in table (represented as "...").
- Revenue, Expenditure, Balance and Composition of Financing – Central Government: Date of latest observation 2012; Date received 2013; Frequency of Data A; Frequency of Reporting A; Frequency of Publication A.
- Stocks of Central Government and Central Government-Guaranteed Debt: Date of latest observation 2012; Date received 6/2013; Frequency of Data A; Frequency of Reporting A; Frequency of Publication A.
- External Current Account Balance: Date of latest observation 2012; Date received 6/2013; Frequency of Data A; Frequency of Reporting A; Frequency of Publication A.
- Exports and Imports of Goods and Services: Date of latest observation 6/2013; Date received 8/2013; Frequency of Data Q; Frequency of Reporting Q; Frequency of Publication Q.
- GDP/GNP: Date of latest observation 2011; Date received 6/2013; Frequency of Data A; Frequency of Reporting A; Frequency of Publication A.
- Gross External Debt: Date of latest observation 2012; Date received 6/2013; Frequency of Data A; Frequency of Reporting A; Frequency of Publication A.
- International Investment Position: Date of latest observation 2012; Date received 2013; Frequency of Data A; Frequency of Reporting A; Frequency of Publication A.

### Statement by the IMF Staff Representative on Timor-Leste (October 23, 2013)

- Following the revision of the discount rate approved by the IMF and World Bank Boards on October 11, 2013, staff has recalculated the debt sustainability assessment for Timor-Leste using the new five percent discount rate.
- This results in a slightly more favorable outlook for the calculated net present value of debt in relation to GDP and exports.
- The overall assessment of risk of debt distress and debt vulnerabilities discussed in the staff report and DSA remains unchanged.

*Source: _cr13338 - 1. Bank Work (IMF PDF content provided).*

### 2. The budget for 2014 remains under preparation but discussions with the authorities

### 2. The budget for 2014 remains under preparation but discussions with the authorities

### Budget planning and fiscal stance
- Actual expenditures for 2014 are planned to be stable in line with the framework agreed with Fund staff in June 2013.
- The revised medium-term budgetary plans (the “Yellow Road” process), adopted by the Council of Ministers in June 2013, scaled back spending plans starting in 2013.
- The Yellow Road framework:
  - Strikes a balance between strict adherence to the Estimated Sustainable Income (ESI) and the need to scale up infrastructure.
  - Has been reflected in the revised 2013 budget and in the preparation of the 2014 budget.
  - Is assessed as consistent with non-oil GDP growth, falling inflation, poverty reduction and fiscal sustainability.
- Risks highlighted:
  - Contingent and off-balance sheet liabilities need to be avoided.
  - Withdrawals from the Petroleum Fund need to be aligned with fiscal sustainability and absorptive capacities.
  - Recourse to concessional borrowing and public-private partnerships (PPPs) will increase complexity for public financial management.

### Inflation, monetary framework, and dollarization
- Inflation remains above 10 percent despite recent appreciation of the U.S. dollar against regional currencies.
- Historical inflation observations:
  - Peaked at over 15 percent in 2011.
  - Fell to 10.8 percent in 2012.
  - Continued to be in double digits as of the report.
- Table 1 values:
  - CPI - Timor Leste (annual average): 0.1 (2009), 4.5 (2010), 11.7 (2011), 13.1 (2012), 10.6 (2013 Est.), 9.5 (2014 Proj.)
  - CPI - Timor Leste (end-period): 1.1 (2009), 8.0 (2010), 15.4 (2011), 10.8 (2012), 10.4 (2013 Est.), 8.5 (2014 Proj.)
- Monetary policy framework:
  - Staff asserts “full dollarization remains appropriate for now given limited capacity for independent monetary and exchange rate policies.”
  - The Strategic Development Plan (SDP) contemplates the possibility of introducing a national currency; studies have been and are planned (including by the Central Bank of Timor-Leste - BCTL).

### Fiscal and external positions (key statistics)
- Petroleum Fund and assets:
  - Petroleum Fund balance as of May 2013: 13.6 billion US dollars.
  - Expected to reach 14 billion by January 2014 (according to official data reported by authorities).
  - Public foreign assets (Petroleum Fund + central bank official reserves): 5,627 (2009), 7,303 (2010), 9,765 (2011), 12,652 (2012), 14,419 (2013 Proj.), 16,748 (2014 Proj.) (in millions of U.S. dollars, end-period).
  - Public foreign assets in months of imports: 58 (2009), 65 (2010), 63 (2011), 91 (2012), 93 (2013 Proj.), 96 (2014 Proj.)
- Fiscal balances and government operations (in percent of GDP):
  - Revenue: 62.6 (2009), 64.9 (2010), 66.5 (2011), 69.1 (2012), 59.7 (2013 Est.), 63.6 (2014 Proj.)
  - Domestic revenue: 2.8 (2009), 2.3 (2010), 1.9 (2011), 2.2 (2012), 2.4 (2013 Est.), 3.3 (2014 Proj.)
  - Petroleum revenue: 51.3 (2009), 55.3 (2010), 59.7 (2011), 62.9 (2012), 53.4 (2013 Est.), 56.1 (2014 Proj.)
  - Grants: 8.5 (2009), 7.3 (2010), 4.9 (2011), 4.0 (2012), 3.9 (2013 Est.), 4.2 (2014 Proj.)
  - Expenditure: 31.3 (2009), 27.0 (2010), 23.8 (2011), 22.1 (2012), 23.5 (2013 Est.), 26.5 (2014 Proj.)
  - Recurrent expenditure: 12.0 (2009), 12.0 (2010), 8.8 (2011), 10.7 (2012), 10.8 (2013 Est.), 11.1 (2014 Proj.)
  - Capital expenditure: 10.8 (2009), 7.6 (2010), 10.1 (2011), 7.3 (2012), 8.8 (2013 Est.), 11.2 (2014 Proj.)
  - Donor project: 8.5 (2009), 7.3 (2010), 4.9 (2011), 4.0 (2012), 3.9 (2013 Est.), 4.2 (2014 Proj.)
  - Overall balance: 31.3 (2009), 37.9 (2010), 42.7 (2011), 47.0 (2012), 36.2 (2013 Est.), 37.1 (2014 Proj.)
  - Non-oil overall balance (in percent of non-oil GDP): -79.8 (2009), -78.3 (2010), -87.5 (2011), -73.7 (2012), -65.2 (2013 Est.), -56.7 (2014 Proj.)
- Balance of payments (in millions of U.S. dollars / percent of GDP):
  - Current account balance: 1,287 (2009), 1,676 (2010), 2,340 (2011), 2,738 (2012), 2,105 (2013 Proj.), 1,819 (2014 Proj.)
  - Current account (in percent of GDP): 39.0 (2009), 39.8 (2010), 40.4 (2011), 43.5 (2012), 34.3 (2013 Proj.), 32.1 (2014 Proj.)
  - Trade balance (in millions): -320 (2009), -277 (2010), -349 (2011), -639 (2012), -731 (2013 Proj.), -829 (2014 Proj.)
  - Exports (excluding petroleum exports): 15 (2009), 29 (2010), 25 (2011), 33 (2012), 37 (2013 Proj.), 42 (2014 Proj.)
  - Imports: 335 (2009), 306 (2010), 374 (2011), 672 (2012), 769 (2013 Proj.), 871 (2014 Proj.)
  - Services (net): -774 (2009), -961 (2010), -1,415 (2011), -921 (2012), -1,004 (2013 Proj.), -1,118 (2014 Proj.)
  - Petroleum revenue (in millions): 1,692 (2009), 2,331 (2010), 3,461 (2011), 3,960 (2012), 3,273 (2013 Proj.), 3,183 (2014 Proj.)
  - Overall balance (in millions): 39 (2009), 156 (2010), 55 (2011), 422 (2012), -194 (2013 Proj.), 122 (2014 Proj.)
- Other monetary and financial indicators:
  - Deposits (annual percent change): 38.7 (2009), 9.8 (2010), 8.9 (2011), 26.2 (2012), 21.2 (2013 Proj.), 21.7 (2014 Proj.)
  - Credit to the private sector (annual percent change): 1.1 (2009), 5.9 (2010), 21.1 (2011), 20.5 (2012), 21.2 (2013 Proj.), 21.7 (2014 Proj.)
  - Lending interest rate (percent, end-period): 11.2 (2009), 11.0 (2010), 11.0 (2011), 12.2 (2012), ... (2013), ... (2014)
  - NEER (2005=100, period average): 95.4 (2009), 89.3 (2010), 84.2 (2011), 86.4 (2012), ... (2013), ... (2014)
  - REER (2005=100, period average): 105.2 (2010), 102.3 (2011), 105.6 (2012), 118.1 (2013), ... (2014)

### Growth outlook and structural reforms
- Recent growth performance:
  - Non-oil economy growth averaged close to 12 percent from 2008 to 2011.
  - Non-oil GDP growth in Table 1: 12.8 (2009), 9.5 (2010), 12.0 (2011), 8.3 (2012), 8.1 (2013 Est.), 8.0 (2014 Proj.)
  - Real total GDP (annual percent change): -6.7 (2009), -1.4 (2010), 7.3 (2011), 5.7 (2012), -3.2 (2013 Est.), -6.9 (2014 Proj.)
- Medium-term staff projection:
  - Real non-oil GDP growth expected to remain robust, averaging about 8.5 percent (staff projection cited in the authorities’ statement).
  - Authorities project a medium-term outlook somewhat better than staff’s projections.
- Structural reform priorities to catalyze private sector development:
  - Improve business climate and address structural bottlenecks through infrastructure improvements and productivity-enhancing reforms.
  - Priorities include implementation of the Land Law, streamlining the Investment Law, and improving contract enforcement.
  - Development of the one-stop shop for investors and progress on National Electrical Grid phase two.
  - PPPs planned for improvement of Dili airport and construction of the new port at Tibar Bay.
- The Land Law is expected to reduce legal uncertainties related to use and ownership of real estate and support mortgage market development.

### Poverty, social policies, and public expenditure quality
- Poverty remains high and fragilities persist despite substantial progress.
- High inflation in a dollarized economy negatively affects low-income households and hampers diversification and employment growth.
- Social policy measures:
  - Bolsa da Mãe cash transfer program directed to poor families.
  - Welfare benefits to the elderly and other vulnerable groups.
  - Increased vaccination coverage; decreases in infant and maternal mortality.
  - Expansion in number of schools and enrolled children; increased financing for higher education (domestic and abroad).
- Expected benefits of revised fiscal stance:
  - Reduction in inflationary pressures, helping reduce poverty.
  - Elimination of excess withdrawals from the Petroleum Fund to place budget financing on a long-term sustainable path.
  - Opportunity to improve overall quality of public expenditure through reprioritization toward growth-enhancing investments in basic infrastructure and away from transfers and subsidies.

### Executive Board and authorities’ views
- Directors welcomed Timor-Leste’s progress: end of 13-year UN presence, successful 2012 elections, and accumulation of Petroleum Fund assets.
- Directors supported the Strategic Development Plan’s goals of upper-middle income status and substantial poverty reduction by 2030.
- Directors emphasized:
  - The need to catalyze private sector growth through business climate reforms.
  - Strengthening central bank prudential supervision, developing a crisis management framework, and addressing anti-money laundering weaknesses.
  - Monitoring Petroleum Fund withdrawals and asset allocation strategy.
  - The important role of Fund technical assistance in achieving development goals.
- Authorities’ assessment highlighted:
  - Strong fiscal indicators: Petroleum Fund balance 13.6 billion US dollars (May 2013) and expected to reach 14 billion by January 2014.
  - Current account surplus of 43.5 percent of GDP in 2012 (staff estimate).
  - Public foreign assets rose from 58 to 91 months of imports from 2009 to 2012.

*IMF Press Release No. PR/13/430 — IMF Executive Board Concludes 2013 Article IV Consultation with Timor-Leste (November 7, 2013).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13338.pdf_