IMF Concludes 2022 Article IV Consultation with Timor-Leste

Washington, DC : The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation [1] with Timor-Leste on August 24, 2022 and endorsed the staff appraisal without a meeting on a lapse-of-time basis. [2]

Timor-Leste is slowly emerging from several waves of COVID-19 outbreaks and from severe floods following cyclone Seroja in April 2021. Steady progress with vaccination has allowed the authorities to lift strict containment and travel restrictions. After a sharp contraction in growth in 2020, there was a moderate rebound in 2021. Inflation has been rising steadily since early 2021 driven by higher food and oil prices while non-tradable inflation remains muted.

Real non-oil GDP growth in 2022 is projected at 3.3 percent, underpinned by strong government support, a rebound in private consumption, and the reopening of borders. Inflation is projected to pick up, reflecting the increase in food and energy prices. A gradual recovery of private consumption and investment will underpin GDP growth at around 3 percent in the medium term.

Executive Board Assessment

In concluding the 2022 Article IV consultation with Timor-Leste, Executive Directors endorsed the staff's appraisal, as follows:

Timor-Leste's strong progress with vaccination has allowed for the lifting of strict containment restrictions, and the economy is expected to continue its recovery. Non-oil real GDP is projected to grow at 3.3 percent in 2022, after an estimated growth of 1.5 percent in 2021, supported by public spending and rebounding private consumption.

Large downside risks remain. An important near-term downside risk is a re-intensification of a health crisis. Ongoing geopolitical tensions pose additional risks through more prolonged and/or heightened high oil and food prices. Domestic political instability could stall reforms, and natural disasters could further slow the recovery.

Fiscal consolidation and structural reforms are needed to secure fiscal sustainability, strengthen the external sector position, and support a smoother transition to a private sector-led economy. The external sector position in 2021 was substantially weaker than implied by fundamentals and desirable policy settings. Active oil fields are drying up, with oil revenues expected to cease in 2023. The 2022 budget envisages large fiscal imbalances in the medium term that would deplete the Petroleum Fund in the long term, leading to a fiscal cliff. Domestic revenue mobilization and government expenditure rationalization are needed in future budgets to underpin fiscal consolidation. Government spending should prioritize investment projects to enhance the productive capacity of the economy and programs to protect the poor.

Addressing public financial management (PFM) weaknesses is essential for strengthening fiscal management and improving the quality of government spending. High priority areas of PFM reforms include budget credibility, public investment management, procurement performance and monitoring, and fragmentation caused by the proliferation of autonomous agencies. The authorities have adopted some PFM reforms and are committed to continuing their reform efforts with technical support from the Fund and other development partners. The introduction of a Fiscal Responsibility Law (FRL) can also help improve fiscal discipline by requiring the government to commit to a monitorable fiscal policy objective and to lay out a strategy to achieve that objective.

A significant number of structural barriers need to be lifted to facilitate diversification and generate inclusive and resilient growth. These include transforming the predominantly subsistence-oriented agricultural sector into a commercially viable sector, raising productivity, and enhancing food security. Improving the business environment and strengthening AML/CFT and anti-corruption effectiveness will foster private investment. So far, progress in private sector development and job creation has been tepid, as reforms have been slow and limited. Investing in climate-resilient infrastructure is key to building resilience to natural disasters, however, adaptation plans have not been integrated into the budgetary planning, and coordination amongst various public stakeholders and capacity constraints to access external grant-financing remain key challenges.