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Asian Development Outlook 2004 : II. Economic Trends and Prospects in Developing Asia
Democratic Republic of Timor-Leste The economy continued to contract in 2003 as most activities were affected by the phaseout of the large international presence, though some signs of private sector activity are emerging. A major issue is the substantial reduction in Timor Sea oil and gas revenue projections due to development delays, and the resulting significant financing gap that will constrain potential growth. Economic Assessment The economy contracted by about 3% in 2003-according to IMF estimates-as the international presence was further reduced, reconstruction projects were executed at a slower pace than expected, and substantial flood damage to the crops (following a delayed 2002 rainy season) lowered agricultural production. The downturn was prominent in the construction and services sectors, especially in urban areas, as projects funded by multilateral and bilateral donors were gradually scaled down. However, the private sector showed some timid signs of improvement. The Timor-Leste Revenue Service reported significant growth in the number of Timorese taxpayers in 2003, and several new shops and restaurants catering to the needs of nationals were opened in Dili. Unemployment increased. According to World Bank estimates, at the end of 2003, unemployment among urban males was at least 20%, surpassing 40% among those aged between 15 and 24. Employment creation in the formal sector was mainly in the public administration, which by June 2003 employed about 18,000 people, including military and police. The capacity of the private sector to create new jobs remains weak because of limited opportunities for investment. Due to the tight local market, since 2001, many young Timorese in search of jobs have gone abroad, especially to Ireland and the United Kingdom, passing through Portugal. While this trend seems to have declined in 2003, due to stricter visa requirements by Portugal, an opportunity to ease the unemployment pressure through increased labor migration was offered by Malaysia, which declared its willingness to accept Timorese migrant workers. Data on the implementation of the FY2003 government budget under the Consolidated Fund for East Timor show that revenue collection exceeded estimates by 12%, as a result of higher Timor Sea oil and gas revenues. At the same time, actual expenditures fell short of budgeted figures as reconstruction projects were implemented more slowly than projected. In particular, while the public sector capacity to carry out projects increased from FY2002, the actual execution of capital development expenditures was only 81% of the budgeted figure. In the first quarter of FY2004, Timor Sea oil and gas revenues were, however, below estimates, as a result of modified tax provisions, while non-oil revenues were substantially higher, due to increased import duties. In contrast, expenditures grew faster than budget estimates. The financial sector underwent significant developments in 2003. In August, a new commercial bank started operations, inducing more local competition and a revision of lending policies by the two existing banks to provide better services to the public. The average interest rate on lending was lowered to around 15%. Operations of the Microfinance Institution have also expanded, both in terms of deposits-which reached the ceiling of $1 million-and loans. Major beneficiaries of lending schemes were small and microbusiness operators and public servants who could take advantage of programs that linked loan collection to employee payroll numbers. Several microfinancing schemes provided by nongovernment organizations were also available outside the formal sector. Though affected by poor collections, these schemes have a positive impact, especially in rural areas. The Banking and Payment Authority (BPA) of Timor-Leste reported that deposits increased by 30% during the year, reaching $72.9 million in December 2003. Credit provided by commercial banks to the private sector also expanded substantially from $6.0 million to $27.8 million during the year. As a consequence, the credit-to-deposit ratio increased from 10.7% in January to 38.2% in December 2003. The BPA introduced new local coins in small denominations, known as centavos, in November 2003, and these were put in simultaneous circulation with the US dollar coins. The main purpose of the new coins is to facilitate small transactions. During 2003, inflation was on a decelerating trend, with the price slowdown mainly attributable to an improvement in food supply following the harvesting of the 2002 crops. Inflation was 4.2% in December 2003, compared with 9.5% in December 2002. The external current account balance remained substantially negative, although fully financed through official transfers. According to IMF estimates, the current account deficit (excluding official transfers) was more than $206 million in 2003, or approximately 61% of GDP. This included a trade deficit of more than $160 million, while receipts originating from the Timor Sea oil and gas operations were estimated at $27 million. The value of imports continued a declining trend. Total imports were estimated at $168 million in 2003, compared with exports for a total value of only $7 million. The structural trade deficit for goods not directly related to external assistance increased in 2003, as the growth in the value of taxable merchandise imports exceeded that of exports, which, excluding oil and gas, were dominated by coffee (accounting for more than 85% of total exports). Policy Developments In December 2003, the Government informed its development partners of considerable delays in the development of the Bayu-Undan oil and gas fields in the Timor Sea, resulting in significant reductions in the projected revenues from this source. As a consequence, the total budget financing gap for the period FY2005-FY2007 is projected to increase dramatically to $126.3 million, almost double that initially expected. As the perspective to increase non-oil revenues seems quite remote, cuts in expenditures will be required. In addition, the Government is considering selling assets, and requesting its development partners to increase budget support beyond the completion of the Transitional Support Program II, expected in FY2005. The Government may decide to revise its financing policy by making Timor Sea royalty receipts and interest income available, at least in part, for budgetary financing, or it may start to borrow from multilateral institutions. No financing gap is expected to emerge in FY2004, despite a downward correction of projected oil and gas revenues by $18 million. During the midyear budget revision, the Government introduced significant expenditure cuts through which the overall fiscal deficit was kept to a level at which increased external assistance and a drawdown of cash balances, combined with the effect of the US dollar, are projected to fully cover the higher financial requirements. A matter of concern rests, however, in the poor performance of the power authority in terms of revenue collections. Without a rigorous implementation of a reform program aimed at structural improvements in the power management and billing systems, the government financial position may be further jeopardized. While the issue of international maritime boundaries with Australia and permanent demarcation of the borders between the two countries is still under intense negotiation, an interim Timor Sea Treaty entered into forc Draft laws on commercial companies and private investment are at present under parliamentary scrutiny, and concrete measures have been taken to establish public agencies for administering state property and leasing of public and private property. A land and property registry and a cadastre registry have been introduced. The Government is also undertaking measures to create an industrial park to attract foreign investors and to start a pilot tourism venture. Early steps have been taken to develop a banking payment law to address the risk associated with the payments system, an insurance law to foster insurance service activities, and a related framework for insurance supervision. The security situation was under control in 2003. The Timor-Leste Defense Force was increased to about 1,400, and policing functions were completely transferred from the UN Police to the National Police of Timor-Leste, with an increased staff of 200. A major concern, though, is the expected pullout in May 2004 of the UN assistance, including peacekeeping forces. Given the limited local resources, the vacuum in technical and administrative capacities is expected to have a significant negative impact on government functions and services as well as on internal security, in addition to the related economic contraction. In view of the possible destabilizing effect of a premature pullout, the UN Secretary General has requested the UN Security Council to authorize an extension until May 2005 of the UN presence in Timor-Leste. Outlook for 2004-2005 After the substantial downward revision of the Timor Sea oil and gas revenue outlook, the GDP growth projections have been accordingly reduced. The figures in the midyear budget update indicate, respectively, a 2.0% and 3.0% decline for FY2004 and FY2005, followed by 2.0% growth in FY2006. However, more recent estimates indicate that, on a calendar year basis, GDP growth could be positive in 2004 (1.0%) and 2005 (3.0%). Given the limited role played by the private sector, the medium-term growth potential of the economy is largely dependent on the stimulus created by public expenditures. A major challenge is, therefore, to identify the right mix of policy measures to close the fiscal financing gap expected through FY2007 without excessive restraint on economic growth and, in turn, poverty reduction. Apart from appropriate expenditure cuts and additional requests for grant assistance from bilateral and multilateral donors, this mix encompasses the possible choice of a development path allowing for borrowing from international financial institutions. The medium-term outlook still largely depends on the level of external assistance to which development partners will be able to commit, and on the fiscal policy of the Government. The environment for private sector development and the results of efforts to build local capacity and institutions are also major factors affecting future growth. The tentative signs of economic activity shown by the domestic private sector in 2003 may be early indicators of a gradual increase in entrepreneurship that could help reduce the traditional heavy dependence on public expenditures.
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e in April 2003. The treaty, which defines a 90-10 split of tax and royalty revenues between Timor-Leste and Australia, allowed the production of natural gas from the Bayu-Undan field to start in mid-February 2004, with expectations to generate about $3 billion in revenues from gas and oil over the next 20 years (Figure 2.34). With the start of the Bayu-Undan project, the need to establish a petroleum fund has become a priority. Structural reforms were introduced in 2003 to strengthen the expansion of business activity and capacity for economic and financial management.
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