Democratic Republic of Timor-Leste

High government expenditure, largely funded by revenue from petroleum production, supported moderate
but slower growth in 2009. The economy is forecast to pick up in 2010, again driven by government
spending. Inflation is likely to rise from last year’s low levels. The government plans to borrow, for the
first time, to accelerate investment in infrastructure. Sound investment of borrowed funds and prudent
management of national savings are central to the achievement of sustainable economic growth.

ECONOMIC PERFOMANCE

Momentum from a buildup in government spending over recent years
underpinned economic growth in 2009. GDP, excluding offshore
petroleum production, expanded by 5.0% . That was around
half the 10.5% average expansion in the preceding 2 years because the rate
of increase in government expenditure slowed.
Government spending dominates this economy, with its ratio to
nonpetroleum GDP close to 168% . A large portion of
the buildup in public outlays has been in public sector wages, minor
capital works, and cash transfers to the elderly, internally displaced
persons, ex-combatants, and others. Such expenditure has fed quickly
into the economy and generated multiplier effects that have further lifted
aggregate demand. Poverty, however, remains widespread.
Up-to-date economic data are limited, though the uptrend in various
indicators of demand suggests a significant rise in private consumption in
recent years. For example, there was one cell phone subscriber for every
9.3 adults in mid-2007; by end-2009, there was one for every 1.7 adults.
Over 11,000 new motor vehicles were registered in 2009, more than
double the number in 2008. Private electricity consumption is also on a
rising trend .
While aggregate demand rose on average in 2009 relative to 2008, it
softened during the year, as illustrated by a trending down in imports
. By December 2009, their real value was down by 38.1%
from the prior-year period. The value of merchandise exports, mainly
coffee and excluding petroleum, fell by around a third, as the volume
of coffee exports fell sharply. Exports are less than 3% of the value of
merchandise imports, leaving a huge trade deficit.
The government allocated $681 million of its own funds for budget
spending in 2009, up 23% from its own-funded spending in 2008. But
continuing problems in carrying out budget projects meant that actual
spending, of about $500 million, fell short of the allocation. Including
donor-funded activities, total government expenditure is estimated to
have declined slightly in 2009 from 2008.

The government’s income from offshore petroleum production in
2009 was $1.65 billion. That amount lifted savings held in the nation’s
Petroleum Fund to almost $5.4 billion by year-end, equivalent to about
nine times annual GDP (excluding petroleum production). The annual
sustainable drawdown is estimated at about $500 million, which is
enough to fund 80% of the government’s own contribution to the budget.
Still, the authorities budgeted to draw down more than the sustainable
income in 2009. The estimate of sustainable income was revised up later
in the year as higher energy prices were factored in, to levels close to the
2009 drawdown rate.
Owing to the large inflows of petroleum income, the budget surplus
was about 145% of nonpetroleum GDP in 2009, and the external current
account recorded a very large surplus equivalent to nearly 300% of GDP.
Lower global oil and food prices suppressed inflation to just 0.1% on
average last year, as it decelerated from about 8% in 2008. The consumer
price index fell on a year-on-year basis from May through November.
The direction of inflation has generally followed that of Indonesia,
Timor-Leste’s primary trading partner, in the past 2 years .
Large deposits by international agencies and rising incomes continued
to inject liquidity into the banking system. Broad money supply expanded
by about 30% in 2009. Bank lending, however, was sluggish and the
ratio of nonperforming loans remained high at about 28% of total loans.
(Banks hold adequate provisions against nonperforming loans.)
The climate for development of the private sector remains very difficult.
Timor-Leste is one of the weakest performers in the World Bank’s Doing
Business 2010 report, with a rank of 164 out of 183 countries in 2010 (a slight
improvement from 170 in 2009). Issues concerning land, credit, contracts,
and setting up a business are paramount concerns. In one area, tax reform,
considerable progress has been made. A reduction in taxes on business
boosted the ranking in this indicator from 79 in 2009 to 19 in 2010.

ECONOMIC PROSPECT

The economic outlook remains highly dependent on the budget. In
this context, a budgeted increase of 27.3% in own-funded government
expenditure (all funding excluding donor support) in 2010 over actual
spending last year (Figure 3.34.6) is expected to more than offset a
decline in donor funding, leaving a small overall increase in budgeted
expenditure.
As in earlier years, the own-funded part of the budget is unlikely
to be fully spent. But the higher level of funding, coupled with gradual
improvements in implementation capacity, will likely lead to an increase
in spending in 2010. This is forecast to lift economic growth slightly to
about 7.0% this year. Capital expenditure by the government is expected
to gather momentum in 2011, helping to maintain growth at about 7.0%.
The presence of international police and security forces in
Timor-Leste under the auspices of the United Nations has been extended
until at least early 2011. This will help safeguard security, and spending
by the United Nations forces will support aggregate demand. Next year,
though, their presence is scheduled to decline, with a reduction in the
number of police personnel from 1,608 to 1,280 by midyear.

Higher prices of imported commodities are forecast to contribute to a
step up in inflation to 3.2% in 2010 and to 3.8% in 2011. Inflows of petroleum
income will produce another large current account surplus in 2010.
Savings in the Petroleum Fund are projected to rise steadily to about
$9 billion by 2013 (Figure 3.34.7), providing substantial funding for the
budget in the years ahead. Initial steps were taken last year to increase the
return from the Fund by diversifying a small part of its investments from
US government bonds into other governments’ bonds and into various
other currencies.

DEVELOPMENT CHALLENGES

The main challenge is to use revenue generated from petroleum
production to develop the human and physical capital needed to
generate private sector–led growth, which should expand employment
and reduce poverty. At the same time, substantial national saving of
petroleum revenue need to be preserved for future generations. A national
strategic plan being prepared will provide for an integrated approach
to development, and will be central to guiding decisions on the use of
petroleum revenue.
The latest national poverty survey shows that the share of the
population living below the poverty line increased to about 50% in 2007,
from 36% in 2001. Most of the population relies on agriculture, but low
output, high postharvest losses, and limited alternative sources of income
have resulted in rising numbers of poor people in rural areas. High
population growth rates of over 3% annually, rapid urbanization, and a
small formal sector have resulted in slow rates of job creation in urban
areas and have also pushed up poverty rates there.
In an effort to bring forward public investment and accelerate the rate
of development, the government has initiated plans to secure concessional
loans. In September 2009, Parliament approved legislative amendments
that enable the government to borrow, for the first time. (Assets in the
Petroleum Fund cannot be used as security, however.)
Also in September, the government agreed to a credit line from
the Government of Portugal. The 5-year line will, with parliamentary
approval, enable concessional borrowing of up to €100 million a year. The
funds will be used for construction and rehabilitation of health care and
education facilities and for infrastructure. The 2010 budget foreshadows
total borrowing of as much as $3 billion over the medium to long term.
Projections of petroleum revenue suggest that future budgets will
have the capacity to service a prudent level of concessional borrowing. To
ensure that the fiscal and debt positions are sustainable, borrowed funds
must be used efficiently to raise the productive capacity of the economy,
and not for consumption purposes.
Achieving this outcome will require a sound process for selecting
high returning investment projects; an emphasis on investment in human
capital and productive physical capital; and efforts that investments pay
for themselves through user charges, as much as feasible. The formulation
of the national strategic plan provides an opportunity to lock in these
three elements of a successful fiscal and debt strategy.

source : ADB (Asian Development Bank).