Regions and Countries

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Country Strategy and Program Update 2003-2004: Timor-Leste

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II. Current Development Trends and Issues

A. Recent Political and Social Developments

4. Coinciding with Timor-Leste’s independence, the mandate of the UNTAET ended on 20 May 2002, and United Nations (UN) Resolution of 17 May 2002 established the United Nations Mission of Support in East Timor (UNMISET) for the next 2 years. UNMISET’s mandate is to (i) provide assistance to core administrative structures critical to economic viability and political stability, (ii) provide interim law enforcement and assist in the development of a new police force, and (iii) contribute to the maintenance of the external and internal security of Timor-Leste. Peace and security remain fragile, as evidenced by riots in Dili in December 2002. The Timor Sea Treaty between Timor-Leste and Australia was ratified in March 2003, ensuring the development of the Bayu-Undan oil and gas field and ensuing substantial revenue flows.

5. The Government faces several challenges including the withdrawal of the UN Peace-Keeping Force (PKF) and handover of policing and peacekeeping responsibilities to Timor-Leste's national security forces, the development of the strategy and legislative framework required to legitimize local authorities and create Timor-Leste's systems for local governance, reconciliation with those who opposed independence, reintegration of former combatants, and
the establishment of a fund to manage oil and gas revenues. Foremost, however, is the contracting economy and growing unemployment.

B. Economic Assessment and Outlook

7. Exports, mainly coffee, have been depressed due to low international prices. With the prospect of oil and gas production rising sharply over the next few years, royalties and tax revenues are expected to increase from $15 million in 2002 to about $70 million by 2006. The overall deficit for fiscal year (FY) 2002/03 is estimated to be lower than budgeted, and revenues are expected to reach $44 million (12.4% of GDP), primarily from oil and gas.

8. The medium-term challenge is to mobilize local resources and foreign aid for economic growth. Domestic savings have improved, with bank deposits reaching $57 million (17% of GDP) by end-February 2003. However, domestic lending was only about 10% of total deposits (mostly for property development), and bank deposits are mainly invested offshore. So far, no foreign debt has been incurred. With aid support decreasing, and low levels of local and foreign investments, the Government may need to review its borrowing and investment policies to stimulate growth.

9. Prudent management and investment of oil and gas revenues are crucial to minimize negative economic effects and public waste, as has been the experience in some resource-rich developing countries. The Government has committed to the establishment of a petroleum fund with similar features to the Norwegian model, having the objectives of avoiding the potential negative economic impacts that revenue windfalls can cause ("Dutch disease"), and ensuring that long-term intergenerational benefits are obtained. The Government has committed to a high level of transparency in relation to the oil and gas revenues and has signed up to the Extractive Industries Transparency Initiative (known as the Blair Initiative).

10. The Government has achieved a balanced budget for 2003–2004, despite significant increases in allocations for the power utility, Electricity of Timor-Leste (EDTL), but predicts a financing gap for 2005/06 and 2006/07, largely as a result of uncertain Timor Sea revenues. Options for closing the gap include reducing expenditure, seeking additional funding agency financing, accessing the First Tranche Petroleum (FTP) savings, borrowing against future income, or a combination of these. The Government has indicated that it will be in a better position to clarify its plans for gap financing in December 2003 when it will have completed its roadmap and action plans and confirmed commitments from funding agencies. It is currently working on the development of an investment pipeline, which it will share with the funding agencies in December.

C. Implications for Country Strategy and Program

11. The Government’s no-borrowing policy for FYs 2003–2005 and intention to finalize its plans for gap financing only after December 2003 have resulted in a proposed program for 2003–2004 consisting of advisory technical assistance (TA) only. Because of the limited availability of TA grant funds, the program is focused on a narrow range of activities under two TA projects per year. ADB will seek to play more of a catalytic role, complementing and enhancing the efforts of Government, other funding agencies, and the private sector in the areas where ADB TA will be applied. The next programming cycle will provide the opportunity for discussions on a longer-term (3-year) pipeline of assistance.

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