Press Release No. 14/478

IMF Executive Board Concludes 2014 Article IV Consultation with Timor-Leste

October 22, 2014

On September 15, 2014, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation¹ with Timor-Leste.

Timor-Leste has made good progress in building its economy since regaining independence in 2002. Achievements include the build-up of savings from oil wealth, greater political stability, access to international networks, and adhering to principles of fiscal transparency and good governance. The oil revenues have been saved through the Petroleum Fund and this internationally well-regarded institution has now accumulated assets of over $16 billion, or approximately four times the country’s GDP. However, the initial conditions of an extreme lack of infrastructure and human capital means that a long-term horizon is necessary to reach the overarching goals of the Strategic Development Plan 2011–2030 (SDP).

Timor-Leste remains one of the most oil dependent countries and declining oil production has focused attention on ensuring medium-term sustainability and inclusive growth that tackles poverty in a still fragile environment. This implies the need to smooth fiscal spending over the long term to avoid a fiscal cliff. Accordingly, the authorities have scaled back ambitious expenditure plans and the outlook is for a stable expenditure path that is consistent with longer-term sustainability and preservation of the Petroleum Fund’s assets. This is important as investment income from the Petroleum Fund replaces oil revenues by the end of this decade.

With an easing of the fiscal impulse, future prospects critically depend on the rise of the nascent private sector. This requires, inter alia, that the authorities continue to promote a stable macroeconomic environment and strive to deepen structural reforms while maintaining appropriate investments in infrastructure and human capital. The medium-term outlook is for non-oil growth in the 5 to 7 percent range. While lower than in the past, such growth rates will still be high by international standards and in line with the trend in emerging Asia. With growth led by the private sector, it should be more inclusive and less inflationary than in the past.

The key to inclusive and sustainable growth is fostering potentially job-rich sectors in line with Timor-Leste’s fundamentals, such as agriculture, tourism and energy niches. Development of these sectors will ensure higher quality growth by increasing employment opportunities and expanding the tax base. Given missing and incomplete markets and large positive externalities, a public sector role in development is warranted, but this needs to be well-targeted and judicious. The authorities’ proactive stance in integrating into a number of global networks may also present growth opportunities by facilitating trade and investment in areas where Timor-Leste has comparative advantages. The sound development of the small financial sector will also help improve access to finance and promote inclusive growth.

Risks include: (i) excessive spending depletes the Petroleum Fund (PF) in the absence of new revenue sources; (ii) the private sector fails to develop momentum leading to lower non-oil growth as public spending stabilizes; (iii) insufficient regulation of activities in the newly established Special Economic Zones (SEZs); and (iv) increased gas production elsewhere in the region limits investment in new fields. Poor data limit the analysis of macroeconomic and poverty developments due to methodological issues and capacity constraints that are being slowly tackled.

Executive Board Assessment²

Executive Directors noted the progress made by Timor Leste in developing its economy and commended the authorities for good management of its oil wealth. Given the challenges posed by the prospective path of oil production, Directors encouraged the authorities to persevere with prudent policies aimed at underpinning macroeconomic stability and addressing development needs, in line with their Strategic Development Plan. Continued implementation of structural reforms is also necessary to boost private sector development, diversify the economy, reduce poverty, and foster sustainable growth.

Directors welcomed Timor Leste’s strong fiscal position. They encouraged the authorities to safeguard sound public finances by scaling back public expenditure to a more sustainable level and improving its composition. Spending on critical infrastructure, human capital, and well targeted social programs remains a priority. Directors also advised the authorities to broaden the non oil tax base with a view to limiting excessive withdrawals from the Petroleum Fund. More broadly, they saw a need for further improvements in public financial management, including the public sector’s balance sheet, and a closer alignment of expenditure allocations with implementation capacity to help contain fiscal risks.

Directors encouraged the authorities to continue to strengthen the central bank’s capabilities in the context of continued full dollarization. They welcomed plans to improve the prudential oversight of the financial system and the efforts geared toward greater financial inclusion. As the financial system develops, Directors also recommended addressing gaps in the anti money laundering framework.

Directors stressed that deeper structural reforms are needed to support sustainable growth and poverty reduction. They encouraged the authorities to further enhance the business climate, including by reforming the land law to support collateralized credit. Initiatives for regional and global integration should also continue. Directors encouraged the authorities to ensure adequate control over the special economic zones whose fiscal and financial activities should be incorporated in the national budget. Improving the quality and dissemination of economic statistics remains critical for policy planning and surveillance.