IMF Executive Board Concludes 2016 Article IV Consultation with Timor-Leste
Non-oil real GDP growth is estimated to have declined to 4.3 percent in 2015 from 5.5 percent in 2014, due to weaker government spending. Both headline and core inflation eased to below 1 percent in 2014 and 2015, reflecting lower commodity prices, a stronger U.S. dollar against Timor-Leste’s trading partners’ currencies, and some improvement in supply bottlenecks.
The fiscal position weakened in 2015 due largely to lower petroleum revenue. Petroleum revenue fell by 40 percent in 2015 mainly on account of the slump in global oil prices. Staff’s estimate points to an overall fiscal surplus of 4.2 percent of GDP in 2015, a considerable reduction from the large surpluses in previous years. Prudent saving of its oil wealth in the Petroleum Fund (PF), Timor-Leste’s sovereign wealth fund, has provided a financial cushion to help offset revenue losses. Withdrawals from the PF remained above the level consistent with the estimated sustainable income, in part to finance front-loaded capital investments. This, coupled with lower oil receipts and negative net investment returns due largely to foreign exchange valuation losses, saw the balance of the PF decline for the first time, to \\$16.2 billion as of end-2015.
The external current account surplus was halved to 25 percent of GDP in 2014 and is estimated to have shrunk further to 17 percent of GDP in 2015. This is largely due to lower income from declining oil and gas receipts and weak investment returns on the PF portfolio against weak global equity market performance in 2015. The banking system is highly liquid and well capitalized. Growth of private sector credit picked up to 10.5 percent (y/y) in December 2015 from 5.5 percent in December 2014. Excess liquidity in the banking system and banks’ overseas placements of deposits have remained high.
The medium-term growth outlook depends critically on economic diversification and ensuring a sustainable fiscal position. Average non-oil real GDP growth in the medium-term is projected at 5.5 percent, supported by increasing public spending and foreign direct investment. This hinges on successful prioritization of government expenditures to facilitate high-return infrastructure investments in tandem with structural reforms that catalyze non-oil private sector growth.
The main sources of risk over the medium- to long-term are higher fiscal spending, public investments not yielding adequate returns and enhanced growth, and inadequate mobilization of domestic revenues.
Executive Board Assessment2
Executive Directors commended the authorities for the progress made in nation building and economic and social development. However, Directors noted that Timor-Leste faces difficult policy challenges from the fall in oil revenue and the country’s large development needs. Going forward, they emphasized the importance of achieving fiscal sustainability and economic diversification.
Directors saw a need for continued fiscal consolidation. They encouraged the authorities to strengthen non-oil revenue, rationalize current spending, and adhere to a medium-term adjustment plan. Recognizing the need for capital spending, Directors encouraged the authorities to prioritize public investment plans, focusing on high-return infrastructure projects through rigorous investment appraisal, so that such spending is in line with implementation capacity and debt sustainability. Directors stressed that optimizing the composition and quality of spending to help close Timor-Leste’s infrastructure gap will be key to long-term fiscal sustainability and inclusive growth.
Directors welcomed the authorities’ commitment to preserving the assets of the Petroleum Fund. In this context, they supported higher use of concessional financing for large infrastructure projects, which would reduce reliance on withdrawals from the Petroleum Fund and support greater discipline in investment spending. Directors also welcomed plans to introduce a value-added tax, which will help achieve the government’s target of raising non-oil revenues.
Directors supported the efforts to improve financial inclusion, underscoring the importance of striking the right balance with safeguarding financial stability. They saw a need for continued efforts in strengthening regulatory and supervisory capacity and improving central bank functions. Directors called for a strategy to fully resolve legacy non-performing loans.
Directors concurred that the use of the U.S. dollar as legal tender has served Timor-Leste well. They supported the authorities’ plan to pursue further financial sector and institutional development to pave the way for any potential change in the monetary and exchange rate regime.
Directors emphasized that medium-term growth will depend critically on economic diversification. In this context, they agreed that priority should be given to boosting the private sector by building infrastructure, improving the business climate and enhancing competitiveness. Improvement in social conditions and investment in human capital will also be necessary. Directors called for continued efforts to improve statistical capacity as well as the quality and timeliness of data, which are crucial for policy formulation. They encouraged the authorities to further leverage technical assistance from the Fund and other development partners.