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November 24, 2010

Timor Leste in Full View

Posted by Eliko Pedastsaar

The IMF recently published two PFM assessments carried out for the Democratic Republic of Timor-Leste (TLS), available here and here: http://www.imf.org/external/pubs/cat/longres.cfm?sk=24376.0 and http://www.imf.org/external/pubs/cat/longres.cfm?sk=24377.0. The first report is an assessment of fiscal transparency performed on the basis of the IMF’s fiscal module of the Report on the Observance of Standards and Codes (ROSC), an exercise usually referred to as the fiscal ROSC. The second one is an evaluation based on the PEFA (Public Expenditure and Financial Accountability) Framework. The PEFA analysis was a collaborative effort between the country authorities, an IMF technical team and the donor community. The publication of these two assessments is important milestone for TLS and represents a commitment by the country to make improvements in fiscal transparency and functioning of its PFM systems an integral part of the country’s development strategy.

For the authorities the two reports will provide an overview of the strengths and weaknesses of the PFM system. The diagnostics will be an important input in the review of the PFM development strategy that the World Bank and authorities are planning to undertake given the pending renewal of the large PFM support project funded by a multi-donor, Bank-managed TA project. For the IMF’s Fiscal Affairs Department the use of both diagnostics allowed assessment of synergies and complementarity between both instruments. 

Timor-Leste is situated on the eastern part of the island of Timor and has a young and fast-growing population of around 1 million. In 2002 TLS became the first new state of the 21st century after a long independence struggle with Indonesia. Although the Timorese economy has been growing rapidly over the last few years and TLS is now a lower-middle-income economy, it still remains one of the least developed countries in the world, with 50 percent of the population living in poverty in 2007.

Since 2004 the main source of the economic growth has been the production of oil and gas discovered in the Timor Sea between TLS and Australia.  Economic growth has been driven by rapidly growing public expenditure made possible by very strong increases in petroleum revenues. TLS has, nevertheless, been parsimonious with its petroleum revenues thus far. It has set up a Petroleum Fund that collects all petroleum revenues and only distributes a sustainable share of the value of the fund to the budget.1 The main policy challenge for TLS is to balance the need of sustainable exploitation with stimulating the growth of the non-oil sector and supporting poverty reduction. Transfers from the Petroleum Fund have allowed an exceptionally high growth of public sector spending.2

The ROSC and PEFA assessments for TLS were conducted as part of a comprehensive diagnostic exercise to evaluate the fiscal strengths and vulnerabilities and identify weaknesses of the public financial management (PFM) system. Although both assessment frameworks focus on the evaluation of PFM systems, they do it from a different angle and complement each other, rather than overlap. There is however a significant overlap in the informational needs of both instruments.

Since independence Timor-Leste has made significant progress in improving fiscal transparency and strengthening PFM systems in just a very few years. Below, I discuss the main findings of the fiscal ROSC, a discussion of the PEFA results will be done in a subsequent blog post. One of the main positives on the transparency side is the governance framework of the Petroleum Fund which is transparent and fiscally sustainable. The framework assures comprehensive reporting and audit of revenues from the petroleum sector both for the executive and the legislature. The annual budget process is also relatively well-structured and although the budget documentation is basic, it is quite comprehensive in coverage and adequate for review and approval of the budget by the legislature. A comprehensive integrated financial management information system enables timely and accurate fiscal reporting both within the executive and towards Parliament. Almost all expenditures and revenues are transacted through a Treasury Single Account.

Despite these impressive achievements for a post-conflict nation, substantial weaknesses remain in the fiscal transparency area. These include: a) the linkage between policy objectives and budget is weak; b) the budget calendar does not allow line ministries enough time for preparation of investment projects, and for the Ministry of Finance enough time for adequate review of rationale, costing, and impact of public investment; c) macroeconomic projections are not extended to the medium term and there is no medium-term fiscal framework that could act as frame for medium-term expenditure plans; d) reporting on donor funded expenditure is quite weak and not part of government financial statements; e) internal audit is almost nonexistent and an independent State Audit institution is not operational yet; f) lack of a uniform regulatory framework defining and managing autonomous entities and public corporations; g) tax and customs administration is not a well-equipped and transparent; h) procurement has been in state of administrative flux for many years.

Addressing these weaknesses and implementing corresponding recommendations proposed in the ROSC and PEFA assessments may be challenging for TLS because of weak capacity in public sector institutions. However in order to cope with growing expenditures and at the same time improve the quality of government expenses, it is very important to define the priority fields. More effective public sector institutions will help to achieve sustainable, socially and regionally balanced economic growth, and will bring along a better quality of public services and raise welfare of citizens. The ROSC and PEFA evaluation reports can be used as input in the development of a comprehensive PFM reform strategy by the government of TLS. However, it should be remembered that PFM development is a process measured in decades, not in weeks or months.

1 The value of the Petroleum Fund includes both financial assets held by the Fund and the value of petroleum reserves in production. Three percent of this total value is provided to the budget every year.
2 Since 2002 total expenditure has increased from US$61 million to US$681 million in 2009—i.e., by 1016 percent.


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