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p. 52 of 68 BACK | NEXT I. Developing Asia and the World II. Economic Trends and Prospects in Developing Asia East Asia Southeast Asia South Asia Central Asia The Pacific Cook Islands Fiji Islands Kiribati Republic of the Marshall Islands Federated States of Micronesia Nauru Papua New Guinea Samoa Solomon Islands Democratic Republic of Timor-Leste Tonga Tuvalu Vanuatu III. Competitiveness in Developing Asia Statistical Appendix

Asian Development Outlook 2003 : II. Economic Trends and Prospects in Developing Asia

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Democratic Republic of Timor-Leste

As the international presence in the country continued to scale down in 2002, the economy contracted and public program implementation encountered difficulties. Weak conditions are expected to continue in 2003 before a possible turnaround in 2004. The main risks in the medium term come from continued delays in implementing public programs and, to a lesser extent, from a resurgence of civil unrest.

Macroeconomic Assessment

The country's GDP is estimated to have contracted anywhere between 1% and 3% in 2002 (Figure 2.32). The first figure is an estimate of IMF and the second of the Banking and Payments Authority of Timor-Leste. Statistical collection in Timor-Leste is extremely limited and making precise estimates is an almost impossible task. The contraction is inferred from the fact that domestic demand declined, following 2 years of high demand and high growth as the economy was rebuilt after the violence of 1999.

United Nations-funded activities and numbers of staff from international organizations were being progressively reduced and the implementation of development projects suffered severe delays during the year. These factors reduced the injection to the economy provided by the expenditure of individuals from international organizations present in the country and the contribution to demand from public programs.

The decline in activity in 2002 has been most marked in construction, where the slow pace of development project implementation and, to a lesser extent, the tapering off of reconstruction work in the private sector took its toll. The services sector, particularly the restaurant and hotel subsectors concentrated in Dili, was also adversely affected by the winding down of the international presence. However, the agriculture, commerce, and transport sectors are estimated to have expanded in 2002, stimulated by the infrastructure and transport systems, increased availability of seeds, and the major repairs to farming equipment. It is estimated that in 2002 output of important food crops (excluding rice) had returned to pre-violence levels.

With only 3.2% of the labor force employed in the public sector and only 6.1% in private, formal businesses, most people rely on the informal sector for their livelihood. The contraction in the formal sector is expected to have increased the unemployment rate, estimated at 16.8% in 2001. Unemployment among young people is particularly high and is estimated to be in the order of 40% in the main urban centers.

There are indications of a reduction in typical working hours over the year and a gradual downward adjustment in wage rates. Nonetheless, wage rates remain substantially higher than before the violence and than those prevailing in neighboring countries—a consequence of the large injection to demand provided by the international presence since 1999. This labor market situation, combined with a risky investment environment, has hindered expansion in the formal sector.

The inflation rate is estimated to have decelerated to around 1.0% in 2002, the fall attributable to the increased availability of locally produced food items and the easing in demand as the international sector contracted.

Gross investment is estimated to have fallen from 25% to 21% of GDP in 2002, with much of the decline explained by the contraction in donor-funded public sector investment.

Preparation for the adoption of normal central bank functions continued in 2002, focusing on the implementation of the financial and institutional autonomy of the Banking and Payments Authority (BPA) of Timor-Leste. Interim appointments have been made to the BPA's governing board. Bank deposits are estimated to have grown over the year by 15.4%, but the formal financial sector remains small and largely limited to two foreign-owned commercial banks and currency exchange bureaus. Given the limited local investment opportunities, most bank deposits are invested offshore. An ADB-administered project in microfinance is helping meet local lending needs.

Government internal revenue collections and grant funds that are provided as budget support are channeled through the Government's Consolidated Fund. Expenditures from this Fund were estimated at about 14% of GDP in FY2002 (ended 30 June 2002), and include 3.0% of GDP in capital expenditures. Additional funds are provided by the international community through the medium of the Trust Fund for East Timor (TFET) and bilateral development projects under the broad category of UN Assessed Contributions. The latter includes UN-funded activities that are not taken up by the Government, such as peacekeeping costs and commissions to the World Bank. In FY2002, Consolidated Fund expenditures accounted for $53 million or 6.5% of the total estimated public expenditures of $810 million. A further $57 million was to be funded from the TFET, $110 million from bilateral development projects, with the remainder from the UN Assessed Contributions.

Consolidated Fund expenditures have steadily increased over time. However, in terms of the aggregate impact on GDP, this expansion has been neutralized by contraction in other sources of public expenditures. The Consolidated Fund was officially reported as having a deficit in FY2002 equivalent to 5.6% of GDP. However, this estimated deficit is calculated on the assumption that grants are a financing item. When the budget balance is defined according to standard international practice, the budget is seen to have been in surplus in FY2002, equivalent to 3.0% of GDP. This surplus is consistent with the accumulation over FY2002 of both cash reserves in the Consolidated Fund and assets in the Timor Sea Account, a trust fund in which royalties and interest income from oil developments are being accumulated.

Imports are estimated to have fallen by 28.6% in 2002 to $170 million as domestic demand contracted. While merchandise exports, excluding oil, are estimated to have risen by 25.0%, they are low at approximately $5 million, and largely limited to one crop—coffee. The lower level of imports led to a narrower deficit on the trade balance, though the current account deficit increased.

Policy Developments

The Government has been successful in achieving a prudent fiscal stance despite strong pressures to spend. Much of this success can be traced to the effort to keep the confidence of the international community that has provided a substantial commitment to funding over the medium term. The Government has secured foreign grants of about $20 million to $30 million per year, to be provided as direct budget support. These grants, combined with internal revenue collections, are projected to provide a substantial budget surplus on the Consolidated Fund over the medium term, when the budget balance is defined in accordance with standard international practice. An implication is that the Government is in the position of being a net saver, and will continue to accumulate assets in the Timor Sea Account over the medium term. This accumulation is expected to allow for a steady decline in foreign grant support.

The Government has also had significant success in managing the composition of expenditures, with a high share of its Consolidated Fund allocated to the priority areas of education and health. It is expected that in FY2003, 35% of the core budget will be allocated to these two sectors, with almost half the education budget going to primary education and some 45% of the health budget spent on hospital care.

The planning and budgeting system is still in the early stages of development and some problems are being faced in implementing the Government's policy framework, particularly in reducing high subsidies to the power sector. The power sector was restarted under the UN administration, prior to a mechanism for revenue recovery being put in place, and the sector has relied on large budget subsidies. This arrangement has proven strongly regressive and mainly benefits richer members of the community in the large urban areas. In FY2002, of the 20% of the government expenditures allocated to economic services, more than half went to power. Difficulties in implementing a cost recovery program and in introducing an external operator are expected to almost double the subsidies in FY2003 from $3.6 million to $6.1 million. This increased call on government funds is having the adverse effect of displacing expenditures on wages as well as goods and services (excluding those relating to health and education).

Difficulties are also being faced in the execution of the Government's expenditure programs. Over the first 4 months of FY2003, expenditures from the Consolidated Fund on goods and services and capital expenditures were 62% and 25% of expected levels, respectively. These shortfalls are attributed to expected delays in the preparation and presentation of capital expenditure plans, poor procurement planning, and an unsound understanding of procurement procedures. Increased training of line agency staff and technical support is planned for FY2003, so as to increase the rate of commitment.

Outlook for 2003-2004

While the continued phasing down in international presence is expected to induce a further contraction in economic activity in 2003 by about 2%, the medium-term economic outlook depends heavily on both the level and efficiency of public sector expenditures. Improved conditions are expected in 2004, with IMF-projected expansion in GDP of approximately 1% and an inflation rate of 2-3%.

The main risk to this outlook is the prospect of a shortfall in public expenditures. One potential cause will be any delay in the implementation of relevant public programs. Delays appear likely in government-funded activities, due to a lack of familiarity of government employees with expenditure systems and the reallocation of funds to the power sector subsidy. The finalization of donor country strategies is likely to take some months and to delay the execution of bilateral projects, which amount to close to 25% of GDP.

Revenue pressures may also lead to some reduction in expenditures. Some indications appeared in early FY2003 of a shortfall in domestic revenues arising from the slowdown in economic activity. In particular, indirect tax collections were adversely affected by the fall in import demand. To help correct for the shortfall, a supplementary allocation planned by the Government was cut by some 50% to $4 million.

A further risk to the medium-term outlook is the potential disruption to agricultural production caused by drought. The rainy season started late, in December 2002, and this may adversely affect the planting cycle for the main staples of maize and rice. Food shortages are widespread during the wet season, and delayed and low-quality planting may add to the seasonal difficulties. A decline in food production would also tend to raise inflation and exacerbate the expected contraction in GDP.

Long-term investment has been difficult to secure due to the economy's high cost structure and a poorly developed legal framework. Any recurrence of violence and sporadic public disturbances will further dampen prospects for investment. Civil unrest in early December 2002 saw a state of emergency declared, the deaths of several protestors, and the destruction of some property in Dili. Addressing the internal tensions that fueled this incident and providing a stable environment of law and order will be crucial in creating a business-friendly atmosphere in the country and in attracting the foreign investment needed to redevelop the economy.

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