Supplementation of the General Budget of the State 2004-05
(Mid-Year Budget Update)

(Excerpts)

Information Document

December 2004

Prepared by the Ministry of Planning and Finance
Democratic Republic of Timor-Leste

PDF of unabridged document

Part 2 - Executive Summary

The purpose of the mid year review is to enable the Government to review and supplement the General Budget of the State 2004-05 on the basis of any new information and developments in the first part of 2004-05. 

The Fiscal Position

The fiscal position of the Government has improved significantly since the release of the General Budget of the State for 2004-05.  This has been primarily due to improvements in the revenue from activities in the Timor Sea.  The estimated total revenue for the next four years (2004-05 to 2007-08) has nearly doubled. Total revenue to the Government from all sources for this period is now estimated at $756.0m, an increase of $315.8m. This is mainly due to the large contribution from the activities in the Timor Sea.

Increases in forecasts of Timor Sea revenue will have positive implications for total revenue over the next four years. In the next four years Timor Sea revenue will increase due to several factors:

  • a significant increase in the world oil price;

  • later implementation of the tax depreciation schedules; and

  • good progress with the development of the Bayu Undan field.

Tables 2.1 and Table 2.2 summarise the current fiscal position of the Government. 

 Table 2.1[1] [2]
General Budget of the State for the Whole of Government 2003-04 to 2007-08 ($m)

 

2003-04
Act

2004-05
Est

2005-06
Act

2006-07
Est

2007-08
Est

Total
Est

General Government
Total Revenue

105.4192.3176.8179.4166.0714.6
  Domestic Revenue29.231.633.535.236.9137.1
    Domestic Taxes24.827.028.429.831.3116.4
    Other Domestic Revenue4.54.65.15.45.620.7

  Timor Sea Revenue

41.4129.8143.4144.2129.2546.6

    Timor Sea Tax

38.093.9104.9106.291.5396.5

    Timor Sea Royalties and Interest (FTP)

3.435.938.438.037.6150.0
  Grants (TSP)34.830.9---30.9
Total Expenditure71.877.878.481.383.4320.9
  Salaries24.027.328.929.530.0115.7
  Goods and Services38.539.637.839.640.4157.4
  Minor Capital2.82.12.42.12.08.7
  Major Capital6.58.79.310.110.939.1
General Government Budget Balance33.6114.598.498.182.6393.7

Investments (BPA)

0.4-0.50.60.81.9

General Government Fiscal Balance

33.2114.598.498.182.6393.7

Non Financial Public Authorities

      

  Non Financial Public Authorities Revenue

5.77.610.311.512.241.6
  Non Financial Public Authorities Expenditure10.113.915.615.916.261.7
Non Financial Public Authorities Balance(4.4)(6.3)(5.3)(4.4)(4.0)(20.1)

Whole of Government Fiscal Balance

28.8108.292.693.177.8371.7

 

Table 2.2[3]
General Budget of the State Total Savings for the Whole of Government 2003-04 to 2007-08 ($m)

 

2003-04
Act

2004-05
Est

2005-06
Act

2006-07
Est

2007-08
Est

Consolidated Fund for East Timor

50.450.450.450.450.4
FTP Fund13.9122.1214.7307.8385.6
Total Fiscal Savings64.3172.5265.2358.3436.1

 

Part 3 - Fiscal Policy Issues

Table 3.1[4][5]
Combined Sources Budget 2003-04 to 2007-08 ($m)

 

2003-04
Act

2004-05
Est

2005-06
Act

2006-07
Est

2007-08
Est

Total
Est

Total Combined Sources Revenue

243.9305.5237.6221.7192.3957.1 
  Whole of Government Revenue76.3169.0187.1190.9178.2725.2

    Timor Sea Revenue

41.4129.8143.4144.2129.2546.6
    Domestic Revenue29.231.633.535.236.9137.1

    Autonomous Agency Revenue

5.77.610.311.512.241.6
  Grants from Other Governments167.6136.550.530.814.1231.8
    TSP Revenue (Direct Budget Support)34.830.9---30.9

    Current Project Funding

132.9105.650.530.814.1200.9

Total Combined Sources Expenditure

211.7250.3259.3253.5192.5955.6
  Whole of Government Expenditure75.386.497.2104.897.0385.5
    General Government71.877.878.481.383.4320.9
    Proposed Increase in Expenditure from SIPs006.910.6017.5
    Non Financial Public Authorities 3.58.711.912.913.647.1
  Bilateral and Multilateral Expenditure2.82.12.42.12.08.7
    Current Donor Programmes132.9105.650.530.814.1200.9
    Unfunded SIP Activities049.799.7104.967.8322.0

Other Financial Transactions and Investments

3.7108.293.193.778.6373.6
  Payments into Petroleum Fund3.4108.292.693.177.8371.7
  Investments0.400.50.60.81.9
  Changes to CFET Reserves000000

Combined Sources Financing Gap

28.4-53.1-114.8-125.5-78.8-372.1

Main Messages for Development Partners

Expenditure and Savings Policy

Timor-Leste is adopting two policies to manage its petroleum wealth for the benefit of current and future Timorese.  First, it has determined a policy on how much petroleum revenue to save or spend.  Second, it is establishing a Petroleum Fund as an instrument to invest those savings, as described in the next section. 

Experiences from other countries show that petroleum wealth can easily become a curse instead of a blessing. In fact, many countries have ended up poorer and societies more divided after oil and gas discoveries. In order for Timor-Leste to achieve good management of the petroleum resources, it is important that the public is well informed and that a strategy can be established with as broad an agreement as possible. It is crucial to develop a clear sense of ownership of [these policies] amongst the Timorese people.

Timor-Leste possesses substantial wealth in the form of petroleum reserves in the Timor Sea. If managed wisely, this petroleum can be a catalyst to further wealth creation and deliver higher living standards to the Timorese people. However, the petroleum reserves are finite and may be exhausted within a period of just 20-30 years. Furthermore, the income from the extraction of petroleum is uncertain and is likely to fluctuate a lot in the future.

At the same time, Timor-Leste faces substantial economic and social expenditure demands. It is crucial that the right balance is struck between current expenditures that can help deliver economic growth, social services and political stability over the medium term, and the entitlements and choices of future generations. In this effort, a Petroleum Fund can be a useful instrument to conduct economic policy consistent with wise management of the petroleum wealth.

The Government has adopted a policy to determine how much of Timor-Leste’s revenue to save and how much to spend now on investments and the delivery of services to the community. 

The Government has adopted a savings/expenditure policy based on the Prime Minister’s speech announced in June 2003 in London at the Extractive Industry Transparency Initiative.  When discussing the Petroleum Fund, the Prime Minister explained “The Fund’s objective is to maintain the real value of petroleum wealth (both financial assets from petroleum already produced and estimated revenues from petroleum still in the ground)”.

This policy will ensure intergenerational equity and will promote a sustainable level of government expenditure in the long-term in Timor-Leste.

Maintaining the real value of petroleum wealth is equivalent to spending the estimated sustainable income from petroleum.  The sustainable income is the amount that the Government can spend each year forever.  (The estimated sustainable income from petroleum is often referred to by economists as the permanent income.)

The latest estimate of sustainable income from petroleum is about $70 million per year.  This is calculated from estimated future petroleum revenues.[6]

Current estimates for 2004-05 are for domestic revenue of about $31 million and permanent income from petroleum of about $70 million.  That gives a sustainable level of expenditure equal to about $100 million.  Inflation and the expected increase in domestic revenues will see this rising to about $113 million in 2007-08.

Therefore, a level of expenditure of about $113 million by 2007-08 is responsible and fully consistent with the Government’s policy.  However, there are concerns about the Government’s capacity to spend the additional funding wisely without compounding existing execution problems.

Accordingly, the Government will adopt a phased approach to allocating additional funding over the medium term.  The rate at which this phasing will proceed will be determined primarily by the success of Ministries in the process of planning and executing Government policies.  That is, the quality of expenditure proposals will determine the level of expenditure because the Government does not want to waste the petroleum resources of Timor-Leste.  This will be the focus of the 2005-06 Budget.

The previous policy was to save only First Tranche Petroleum (FTP) and associated interest, and to spend all petroleum taxes.  Charts 2.1 and 2.2 compares the estimated petroleum savings and expenditure from petroleum revenues under the old policy and under the proposed policy of spending the estimated sustainable income from petroleum. 

 Chart 2.1
Previous Savings Policy

Chart 2.2
New Savings Policy

 

Petroleum saving is much higher under the proposed policy of spending the estimated sustainable income from petroleum, which maintains the real value of the petroleum wealth (the sum of the Petroleum Fund and estimated revenues from petroleum still in the ground).  If the Government continues to only save FTP and spend petroleum taxes then it will consume most (about three quarters) of the petroleum wealth.  The higher levels of expenditure in the next decade under the previous policy are unsustainable because sufficient funds will not be saved – this would then lead to large falls in expenditure beyond 2011.

Accordingly, the Government’s policy is to maintain the real value of petroleum wealth. Therefore, the Government’s savings/expenditure policy is to both:

  • increase the desired medium-term level of expenditure to a sustainable level, based on current estimates of petroleum revenue; and

  • adopt a strong savings policy that will maintain the value of petroleum wealth.

This policy complements and is consistent with the establishment of the Petroleum Fund.  These savings will be put into the Petroleum Fund that is being established.

Establishment of a Petroleum Fund

It is the intention of the Government to establish a Petroleum Fund for Timor-Leste. A discussion paper on the key policy issues was released in October 2004, followed by broad public consultations. The public will be invited to comment on a draft law in early 2005, before the Government submits the act establishing the Petroleum Fund to Parliament Subject to the approval by Parliament and promulgation by the President, the Petroleum Fund can be operational from 1 July 2005 (the start of the 2005-2006 fiscal year).

The aim is that the Petroleum Fund will be a tool that can contribute to the wise management of Timor-Leste’s petroleum resources, for the benefit of both current and future generations.

The Petroleum Fund proposed in the discussion paper builds on international best practice. It is based on the Petroleum Fund model used in Norway and is currently referred to as the ”Norway Plus” model, reflecting additional transparency and information features. The “plus” in Timor-Leste will be a guideline that only sustainable income from our petroleum wealth should be spent, and also incorporates a range of accountability mechanisms, including an independent Council to oversee the operations of the Fund.

This Petroleum Fund reflects the circumstances of Timor-Leste. The Fund maintains the sovereignty of Parliament as given in the Constitution, and gives the Parliament exclusive power to authorise outflows from the Fund. The Fund also allows for a further strengthening of key government institutions like the Ministry of Planning and Finance and the Banking and Payments Authority. And there is to be a high degree of transparency in the operations of the Petroleum Fund, with comprehensive and accessible reporting.

The Fund is to be a tool that contributes to sound fiscal policy. The design of the Fund acknowledges that good planning and execution of public sector budgets are key to avoiding the resource curse found in so many petroleum producing countries. The Petroleum Fund is to be coherently integrated into the budget process. The government budget decides the level of domestic tax revenues and spending – be it on current public consumption or on investment in infrastructure and human capital. The budget thereby also determines (as a residual) the net allocation to the Petroleum Fund that gets invested in financial assets. As described in the previous section, the Government is at the same time adopting a savings/expenditure policy, outlining how much money should flow out of the Fund. Spending the estimated sustainable income from petroleum strikes a good balance between the interests of current and future generations.

  • The Fund’s income: all of Timor-Leste’s petroleum revenues will flow into the Fund, as well as the return on the Funds’s investments;

  • The Fund’s expenditure: the outflow from the Fund will be the amount necessary to finance the Government’s budget deficit (excluding petroleum revenues);

  • The management of the Fund: the savings in the Fund are to be invested securely in low risk financial assets abroad..

  • Measures to safeguard a wise management of the petroleum wealth: there will be a high degree of transparency of operations, including comprehensive and accessible reporting requirements – both on the management of the Fund and on whether the spending of petroleum revenues is consistent with long-term considerations. One can also consider establishing an independent Council of Eminent Persons to inform Parliament on the operations of the Fund, acting as a “watchdog” and contributing to an informed public debate and a sound management of the petroleum wealth.

The Petroleum Fund does not guarantee wise management of the petroleum wealth, but it can be a useful tool – provided it goes hand in hand with a fiscal policy framework that strikes the right balance between current consumption, investing in physical assets (infrastructure and human development) and saving in financial assets.

While the discussion paper focuses on the establishment of a Petroleum Fund as a savings instrument, the Government has also outlined its savings policy that will determine the balance between saving and spending.

The Government’s savings policy aims to maintain the real value of the petroleum wealth. This policy suggests a gradual increase in government expenditures based on current estimates of the petroleum wealth. The room for fiscal maneuvering should be used wisely to invest in human capital and infrastructure, which can deliver stronger economic growth and improved public services. This policy would at the same time ensure that sufficient financial savings are deposited in the Petroleum Fund so that in later years one is able to withdraw an equal amount from the Fund. Such a savings policy can therefore be seen to strike a good balance between the interests of current and future generations.

An illustration of how the Petroleum Fund is envisaged to operate is shown at illustration 3.1 and table 3.2,

Illustration 3.1
How the petroleum fund of Timor-Leste is envisaged to operate

Petroleum Revenues + Return on Investments

 

Petroleum Fund

Budget

Transfer to budget deficit (excluding petroleum)

 

Domestic Revenues



 

Expenditures

Consumption

Investment (Infrastructure / Human Capital)



 

 

 

 

Table 3.3
Illustrative Example of the Operation of the Petroleum Fund ($m)

 

2004-05
$m

2005-06
$m

2006-07
$m

2007-08
$m

  General Government Domestic Revenue31.633.535.236.9
    Domestic Taxes27.028.429.831.3
    Other Domestic Revenue4.65.15.45.6
  Grants (TSP)30.9000
Total Expenditure71.874.278.481.3
  General Government Expenditure71.874.278.481.3
  Salaries24.027.328.929.5
  Goods and Services33.233.134.837.0
  Subsidies (Mainly EDTL)5.33.73.02.6
  Interest 0000
  Minor Capital2.81.72.42.1
  Capital and Development6.58.49.310.1
General Government Budget Balance-9.3-40.7-43.3-44.4

Non Financial Public Authority Revenue

12.914.514.514.8

  General Government Subsidy

5.33.73.02.6
  Own Source Revenue7.610.311.512.2
Non Financial Public Authorities Expenses8.39.810.911.5
Non Financial Public Authorities Balance (Excl. Subsidy)-0.70.50.60.7

General Government Investments (Equity Injection into BPA)

00.50.60.8

Whole of Government Non Petroleum Fund Fiscal Balance

-10.0-40.7-43.3-44.5

Transfer from the Petroleum Fund

10.040.743.344.5

    Sustainable Income Drawdowns

10.040.743.344.5

    Unsustainable Drawdowns

0000

Whole of Government Non Petroleum Fund Fiscal Balance (Post PF)

0000

 

 

2004-05
$m

2005-06
$m

2006-07
$m

2007-08
$m

  Timor Sea Revenue

129.8143.4144.2129.2

    Timor Sea Revenue

93.9104.9106.291.5

    Timor Sea Interest

35.938.438.037.6

Less Domestic Whole of Government Fiscal Balance

10.040.743.344.5
Total Petroleum Fund Savings119.8102.7100.984.7
 

Part 4 - Economy

Since the 2004-05 General Budget of the State there have been two significant new sources of information that increase the Government’s understanding of the Timor-Leste economy, the estimates of Gross Domestic Product (GDP) and the SIPS process.

Estimates of Gross Domestic Product

Petroleum GDP

Petroleum GDP, or the contribution to total GDP made by the petroleum industry on the production side of the National Accounts, has been a small but significant proportion due to the operation of the Elang Kakatua Kakatua North (EKKN) field. However, the operation of the much larger Bayu Undan field will lead to very large increases in Petroleum GDP in 2004-05. This increase in Petroleum GDP is reflected by the large increase in petroleum revenues.

While this increase in Petroleum GDP is welcome, it will only directly affect the lives of a few people in Timor-Leste.  The largest and most general benefits of Petroleum GDP will come from the petroleum revenue that is funding government services and employment. 

Part 5 - Revenue

Total Revenue

Table 5.1 shows that estimated revenue for Timor-Leste in the medium term 2004-08 will experience a relatively high increase in all areas, such as

  • Timor Sea taxes;

  • Domestic taxes;

  • Fees, User Charges and Other, and

  • Autonomous Agencies.

From this perspective, total revenue for Timor-Leste in 2004-05 will experience a significant increase but fluctuations will follow in 2005-06. The highest increase in revenue received by the Government of Timor-Leste will come from the Timor Sea.

Table 5.2 shows the difference between the estimates for total revenue in 2004-05 at the time of the Budget and the Mid Year Review.

Table 5.1
Revised Estimates of Total Timor-Leste Whole of Government Revenue ($m)

The comparison between estimated revenue for the 2004-05 revision and the 2004-05 General Budget indicates a significant change. The estimated total revenue for the next four years (2004-05 to 2007-08) has nearly doubled. Total revenue for this period is now estimated at $756.1m, an increase of $315.8m. This is mainly due to the large contribution from the activities in the Timor Sea, see Table as shown in Table 5.3. 

Table 5.2[7]
Change since Budget 2004-05 total Timor-Leste Whole of Government Revenue ($m) excluding Grants

 

Timor Sea Revenue

Increases in forecasts of Timor Sea revenue will have positive implications for total revenue over the next four years. In the next four years Timor Sea revenue will increase due to several factors:

  • a significant increase in the world oil price;

  • later implementation of the tax depreciation schedules

  • good progress with the development of the Bayu Undan field

Table 5.3
Revised Estimates of
Timor Sea Revenues

Chart 5.1 shows the revised estimates for petroleum revenues and the estimates in the 2004-05 Budget. As mentioned previously, there are significant upward revisions to revenue estimates until 2013, which to a large extent reflect higher oil price assumptions.

Chart 5.1
Estimated Petroleum Revenues (Petroleum Taxes and FTP)

Chart 5.2 illustrates the volatility of oil prices shows the oil price assumptions that have been used in the revenue estimates. In the base case the oil price is assumed to develop in line with the NYMEX forward prices minus $5. To illustrate the sensitivity of petroleum revenue estimates to changes in oil prices, there is also a high case and a low case where oil prices are assumed to remain $5 higher and lower than the base case.

Chart 5.2 also illustrates that Timor-Leste’s petroleum revenues are very sensitive to oil prices, showing the estimated petroleum revenues under the different oil price scenarios provided in Chart 5.2.

Chart 5.3
Historical and Assumed Oil prices per Barrel ($ per Barrel) Scenarios for Estimated Petroleum Revenue (Petroleum Taxes and FTP)

...

Annex A – The Whole of Government Fiscal Balance

The fiscal balance on a Whole of Government (WOG) relates to the resources available to the Government for budgetary purposes.  The following table indicates illustrates how this is calculated.

Table A.1
Whole of Government Fiscal Balance Calculation

 

Annex F – Acronyms

ADB                  Asian Development Bank

BPA                  Banking and Payments Authority

CFET                Consolidated Fund for Timor-Leste

CoM                  Council of Ministers

EAN                  Expenditure Authorisation Notices

EKKN                Elang Kakatua Kakatua North

TLRS                 Revenue Service of Timor-Leste

FTP                  First Tranche Petroleum

GG                    General Government

GDP                  Gross Domestic Product

IFI                    International Financial Institutions

IMF                   International Monetary Fund

MDG                 Millenium Development Goal

MTFF                Medium Term Fiscal Framework

NDP                  National Development Plan

NGO                 Non-Government Organisation

NFPC                Non Financial Public Corporations

PFC                  Public Financial Corporations

SIP                   Sector Investment Package

TFET                Trust Fund for East Timor

TSP                  Transition Support Programme

UN                    United Nations

UNDP                United Nations Development Programme

UNMISET           United Nations Mission in Supoort of East Timor          

UNTAET            United Nations Transitional Administration in East Timor

WB                   World Bank

WOG                 Whole of Government


[1] Includes changes as a result of the Supplementary Budget

[2] Salaries figure for 2004-05 differs from that at Budget as it includes the amount sequestered by the Ministry for Planning and Finance  in the first quarter of 2004-05 for salaries ($0.93m) which were not realised.

[3] The CFET balance differs from that shown at the end of year accounts for 2003-04 as it reflects the immediate finances available to the Government excludes the equity invested within the BPA which at the end of 2003-04 was $6.6m.

[4] Whole of Government Revenue differs from table 2.1 as TSP budget support has been included in grants from other Governments.

[5] Non Financial Public Authorities expenditure differs from Table 2.1 due to subsidy

[6] An accountant would define this sustainable income as the Net Present Value of petroleum wealth multiplied by the real rate of return.
 The Net Present Value of petroleum wealth is calculated as the accumulated petroleum savings plus the stream of expected petroleum revenues discounted for the fact that money is worth less in the future than now.
  A real rate of return of 3 per cent and an inflation rate of 2.5 per cent are being assumed

[7] Includes all revenue from Timor Sea, Domestic Taxes and Public Authorities and excludes TSP grants