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Why should Timor-Leste go into debt?

2009-2011 Background and history from La'o Hamutuk

4 December 2009, updated 5 March 2012

Pajina ida ne'e iha Lingua Tetum.

This page is about events in 2009-2011 which paved the way for Timor-Leste to borrow. Click here for current information.

During the last few months of 2009, Timor-Leste's Government began a number of legislative, diplomatic and financial actions to move the country toward borrowing money from foreign governments and institutions, which is likely to happen in 2012, as described on a separate page on this web site. La'o Hamutuk believes that this would bring huge risks to this country, especially to future generations. We are providing these links and analysis to help ensure that the decision is made with as complete information as possible.

Contents

For further reading (in various languages)

Diário Nasional
28-29 Setembru 2011

Guteriano Neves: Deve no Problema sira ba Timor-Leste

Presentations from La'o Hamutuk Public Meeting

15 April 2010

Kristin Sundell: Should Timor-Leste Go Into Debt? Lessons from Oil-Export Dependent Countries

Francisco Vasconcelos, KKFP: Tansa Timor-Leste Tengki Deve?

Juvinal Dias, La'o Hamutuk: Deve sei hadalan lalais Timor-Leste ba “Malisan Rekursu”

Karta La'o Hamutuk nian iha Timor Post, 8 Abril 2010

Tanba Sa Timor-Leste Tenke Deve?

Artigu Guteriano Nicolau nian iha Timor Post, 4 Des. 2009

Terjerumusnya Negara-Negara Berkembang ke dalam Utang Luar Negeri
Newly developed countries fall into borrowing from overseas

Artigu La'o Hamutuk nian iha Timor Post, 26 Nov. 2009

Timór-Leste atu Debe: Lojika ka La’e?
Timor Leste to Borrow: Logical or not?

Overview

The people of many undeveloped countries have found, to their horror and suffering, that previous governments signed contracts committing public funds to repay loans. Money flows out of the country to foreign governments or international financial institutions (IFIs), while at the same time the state cannot afford adequate levels of essential services for its citizens. The loans, which primarily benefited rich people or foreign companies, failed to support the people or to develop the economy. Even when loan interest rates are "concessional" (less than market levels), the legal obligation to repay the principal before spending money on local needs deprives people of health, education and security. This led to "debt crises" in the 1980s and 1990s, with some loans being cancelled and some reforms, but the basic dangers and economic injustice still exist. Future generations of poor people are obligated to pay for the financial and political benefits of the current generation of policy-makers.

Although Timor-Leste was fortunate to begin life as a sovereign state without owing anything to anybody, the nation was encouraged to borrow in 2004 to meet a predicted "gap" between oil revenues and necessary public expenditures. The Prime Minister at that time resisted the pressure, and the "gap" never occurred.

Today, the Government is planning to borrow to pay for its dreams, such as highways, airports and centralized electrical generation. Although these mega-projects built by foreign companies could make our leaders and people proud, there is no magic connection between building them and increasing the strength of the local Timorese economy.

Petroleum-dependent countries like Timor-Leste are particularly likely to borrow, as the state already receives money without much effort or planning. But they are also especially endangered, as petroleum revenues may decline while loans are still being paid back. When Timor-Leste's oil revenues run out in 15 years, and debts still must be repaid, our children and grandchildren will suffer the consequences.

The 2005 report Drilling into Debt: An Investigation into the Relationship Between Debt and Oil (download executive summary or full report (1MB)) by OilChange International discusses how these risks and consequences have affected other countries. Timor-Leste should learn from their unfortunate experiences.
 

Law No. 13/2009 on Budget and Financial Management

Article 20
Guarantees and borrowing by the State

1 – In the annual public revenue and expenditure estimates submitted to the Parliament, the Government shall specify the amount it expects to receive from borrowings and grants during the financial year, in order to fund State expenses.

2 – The Government shall only issue debt certificates when it has effectively received the amount or goods covered by the loan.

3 – The Minister of Finance is the only authority for lending or borrowing on behalf of the State, and:

a) Represents the Government in all lending or borrowing agreements;

b) Maintains the original documents and records regarding all lending or borrowing agreements, including guarantees and contingency obligations.

4 – All revenues obtained under the present article shall be transferred to the Consolidated Fund of Timor-Leste, being available to fund State expenses according to the State Budget Law.

5 – The Minister of Finance may issue a guarantee binding the Government, without a second authorization, provided that the amount in question does not exceed the unspent budget appropriations allocated to the Ministry of Finance and in the cases of specified amounts when duly authorized by law.

6 – The Government shall only be bound in relation to guarantees, insurances or financial instruments similar to the ones listed in paragraph 8 of the present article.

7 – Government expenses resulting from the compliance with guarantees and insurances are considered debt service expenses.

8 – In the annual public revenue and expenditure estimates submitted to the Parliament, the Government shall specify the necessary amount for meeting the cost of the operation of all borrowings under the present law, whether through the settlement of the capital or through the payment of interests or other fees in relation to the borrowings during the financial year to which these estimates relate.

9 – The settlement of borrowings and interests, as well as any other amounts to be paid provided that they do not concern guarantees or indemnities, is to be paid from the Public Fund, without any other appropriation.

Budget and Financial Management Law

On 21 October 2009, Timor-Leste published a new Budget and Financial Management Law, (also Port.), Law No. 13/2009, replacing UNTAET regulation 2001-13 which had defined budgetary processes for the last eight years. The UNTAET regulation previously in effect did not authorize Timor-Leste to borrow, because UNTAET did not want to burden the future independent state with debts incurred during the UN transitional administration. However, in the new law, Article 20 describes how the State can borrow,  and Article 21 creates a process for the State to make loans to people or businesses.

While the draft law was being debated in Parliament, La'o Hamutuk and other NGOs suggested improvements (also Tetum). Regarding borrowing, the NGOs recommended the following, although most of our suggestions were not incorporated in the law:

  1. Fundamental reason for the Government to borrow. Timor-Leste already has five billion dollars in our Petroleum Fund, and the Government needs to explain why it wants to borrow. This law only defines how to borrow and how to manage this debt in the state budget. Timor-Leste does not need to take a loan from an international financial institution or another nation. We recommend that the National Parliament has the right and obligation to audit and monitor, and must discuss, know about and ratify loan agreements, including the conditions of the loan and how it will be repaid, limitations on increasing the debt, the capacity to pay it back, and the consequences for Timor-Leste if it is not paid.

  2. Capacity to pay back loans, and sources of revenues to pay the loans. Many nations in the Third World have fallen into financial crisis because they do not have the capacity to repay loans, and the borrowed money wasn’t used to develop sustainable sectors of their economy which produced a return. The National Parliament should insist that the Government demonstrate that it will be able to repay the loan without placing a heavy burden on future generations. Government also must show the results from investing the loan in sustainable development and their good returns, the conditions for using the money, and real indicators of implementing the development program, so that Timor-Leste is not made to fall into the resource curse, with a heavy, long-term debt. 

  3. The Petroleum Fund cannot be collateral for borrowing. This law does not mention what money will be used to pay back loans. The Petroleum Fund Law states that petroleum revenues cannot be used as debt security. With this Budget and Financial Management Law, perhaps we will use the Petroleum Fund as a debt guarantee, which contradicts the PF Law. This law also does not have good provisions for transparency and public consultation. We suggest that this law should follow the example of the Petroleum Fund law, which contains provisions for transparency and accountability for using petroleum revenues. If the BFM Law does not refer to the PF Law, it will create legal confusion and increase institutional instability, opening the way for political polemics and court cases.

  4. Article 20: Guarantees and borrowing by the State. We recommend that Parliament use its legislative power to amend the draft law so that future Parliaments will have the right to know and approve debt agreements, the conditions for borrowing and repayment, the schedule for repayment and an estimate of how much it will cost. We suggest that the National Parliament eliminate this article, because Timor-Leste has enough sources of revenue to finance our state.

While the draft BFM law was being discussed, the World Bank prepared a comparison of it with the UNTAET regulation. When it was nearly enacted, the IMF wrote a summary of its highlights. Neither of these documents has been publicly circulated; La'o Hamutuk is providing them to help people understand the implications of this new legislation.

Law No. 9/2005 on the Petroleum Fund

Article 20
No Encumbrances on the Assets of the Petroleum Fund

20.1 Any amount that is invested [in the Petroleum Fund] shall, at all times, remain the property of Timor-Leste.

20.2 Any contract, agreement or arrangement, to the extent that it purports to encumber the assets of the Petroleum Fund, whether by way of guarantee, security, mortgage or any other form of encumbrance, is null and void.

Repaying loans from Petroleum Revenues

Article 20 of the Petroleum Fund Law (also Portuguese) says that the Petroleum Fund cannot be used as collateral for borrowing. As all petroleum revenues to Timor-Leste must be deposited into the Petroleum Fund, some have interpreted this to mean that debts cannot be repaid from petroleum revenues.

Unfortunately, this is incorrect. Once money has been transferred from the Petroleum Fund to the Treasury, it can be used for any purpose included in the General State Budget. Since 98% of Timor-Leste's state income comes from petroleum revenues, and since debt repayments have the first claim on the Budget, it is inevitable that money transferred from the Petroleum Fund will be used to repay debts. To put it another way, who would expect Timor-Leste to be able to repay $3 billion dollars if we didn’t have any oil resources?

La'o Hamutuk's March 2005 submission
on the draft Petroleum Fund Law

We welcome the prohibition of the use of the Petroleum Fund as collateral for borrowing. We agree with the current Government that Timor-Leste should not borrow with one hand while saving with the other, but are concerned that [this law] may not provide adequate protection.

If a future Government decides to borrow money, the lender would expect interest and principal to be paid out of the budget. Since the Fund automatically pays for any budget deficit, it is in effect guaranteeing the loan, as collateral without encumbrance. The best course is not to borrow at all, so the Fund should be designed not to facilitate debt. Fund money should be prohibited from paying for debt service. Furthermore, the Estimated Sustainable Income could be lowered by the annual debt service payments, and the calculated Petroleum wealth reduced by the outstanding debt.

When the Petroleum Fund Law was being debated five years ago, La'o Hamutuk made the suggestions at right. Unfortunately our advice wasn't followed, and any nation or IFI considering lending money to Timor-Leste knows that the money in the Petroleum Fund will pay off the loan, after being transferred to the state. If Timor-Leste fails to repay and goes into default, the lender might not be able to take money directly out of the Petroleum Fund, but neither would the Government of Timor-Leste, as the lender would be able to seize any money transferred into the Treasury.

The Ministry of Finance plans to revise the Petroleum Fund law during 2010. One reason for this is to enable a riskier investment strategy which could produce a higher return on investing the Petroleum Fund, but once the law is open for revision, any part of it could be changed. If this revision process is undertaken, we hope that Government and Parliament will incorporate the suggestions La'o Hamutuk made in 2005. However, we are concerned that the current Government appears more interested in spending money rapidly than in protecting the long-term interests of Timor-Leste's people, and hope that they will not weaken the already limited protections of the Petroleum Fund Law.

Proposed 2010 General State Budget

Part 6: Financing

Overview

Timor-Leste is a post-conflict low income country where about 50% of the population lives below the poverty line. Literacy rates are below 50% and there is a high infant mortality rate and population growth is around 3.2% per annum. The work force continues to increase every year about 15,000 whilst jobs are limited both in public and especially in private sector.

Timor-Leste’s infrastructures are also in poor conditions. Roads are difficult to travel on, especially during the rainy season and limited maintenance has been carried out since 1999 when Indonesians left the country amid the destruction and economic contraction. Most of the irrigation facilities, especially in the southern coast still need.

These are a few examples of challenges that Timor-Leste is facing in its development process. The agenda is large and resources are limited. Pressure is building up to improve road conditions, housing primary school students in rural areas in appropriate buildings, and locating health facilities closer to the population. Even if prioritizing is done properly, the resources needed to undertake such development activities will still be extremely large both monetary terms as well as human resource needs.

To not address these issues, particularly those of core infrastructure and employment quickly and systematically risks social instability as well as the continuation of economic hardship for most of the Timorese people.

The key revenue of Timor-Leste is petroleum revenues, which come mainly from Bayu Undan in Timor Sea. The revenues are deposited in US Treasury Bills in the Federal Reserve Bank of New York and every year the Government withdraws 3% of Estimated Sustainable Income (ESI) to finance the State Budget according to the Petroleum Fund Law. As a result of this prudent policy, by mid 2009, the Petroleum Fund had already reached above $5 billion dollars. Given the total petroleum wealth, it is estimated that ESI will be around half billion over the coming years. Adding the domestic revenues that may reach $100 million in the near future, resources available for sustaining state activities and developing the country is about $600 million every year.

With a country size of one million people, the above budget seems to be enough if it is managed properly based on the right priorities and spending efficiently. However, given the needs of development, and the extensive damage inflicted to core infrastructure (both human and physical) the investment levels associated with the current budget may not be enough to overcome the immediate needs of the nation. The Petroleum Fund Law allows the government to withdraw more than 3% every year. However, withdrawing significantly more than ESI could deplete the Petroleum Fund in few years such that it could put Timor-Leste into the path of unsustainability and risk the return of social violence and economic crisis.

Therefore, if Timor-Leste can tap into other resources to raise domestic revenues from non-petroleum sources then this could be a potential solution and this is an avenue that every responsible Government would need to at least explore - both in terms of providing the necessary investment and in addition, improving the enabling environment for private sector development in order to generate revenues in the future.

So far domestic revenues have been too small to cover any single major budget expenditure category. On the other hand, donor funds have been shrinking since 2002. After ten years of reconstruction and priorities in other parts of the world, Timor-Leste can no longer rely on development partners to finance its development activities like the first few years of reconstruction of the country.

Given these circumstances, Timor-Leste will have to examine the possibility to tap into other sources to finance development programs like borrowing. The Petroleum Fund Act does not allow the Government to borrow against money held in this fund, however, that does not mean that the Government cannot borrow at all.

The National Parliament recently passed a law on Budget and Financial Management that provides legal framework for Timor-Leste to borrow. Nevertheless, to enable the Government to borrow, the law requires that the Government produce a directive on borrowing.

Another challenge is the capacity of Timor-Leste to manage public debts. For this purpose, the Ministry of Finance is establishing a Debt Management Unit and seeking technical assistance to build the capacity of the unit to manage public debts.

[Click here for table of Summary of Financing in GSB 2010]

Sources of funds

The Government of Timor-Leste is pursuing discussions with a range of funds providers including Governments such as China and Portugal. However, since the amount is not known yet, borrowing is not included in the 2010 Budget submission to the National Parliament.

There are several loan options which the Government will explore, including but not limited to the following:

  • Commercial / Private Borrowing – these are loans offered by commercial entities such as Banks, this can happen through negotiation or though the issuing of bonds

  • Bilateral Loans – these are loans that are negotiated between two governments, one of whom gives the loan and the other being the recipient of the loan.

  • Multilateral Loans – are loans given by a group of countries, multilateral agencies or an international financial institution. The repayment terms and rates of interest are usually much lower than those offered commercially.

  • Concessional Loans – These are loans that are given at interest rates that are much lower than those offered by commercial financial institutions or some governments or international financial institutions which offer loans at the prevailing market rates. Concessional loans are normally given for specific purposes, but the terms of repayment are very generous. Typically rates of interest are in the region of 0.75%.

  • EXIM Bank – Export Import Bank of a country often offers loans for a specific project. These loans are often ‘tied loans’ and are usually given at commercial rates of interest. The repayment period is shorter than either multilateral loans or concessional loans and the borrowing Government is expected to procure goods and services from the country of origin of the EXIM Bank.

However, rates, terms and conditions can vary significantly for all of the categories listed above and this is why it is important to conduct careful analysis and consultations to understand exactly what is available to a country like Timor-Leste.

Nevertheless, the Government will seek approval of the National Parliament when an amount of borrowing at the appropriate time, however, for now the Government is seeking more information so that any presentation to Parliament is done so with the full range of documentation and information necessary.

At this stage it is envisaged that loans will be used to finance infrastructure projects which are national priorities. The value of these projects is likely to be around $3bn over the term of the project life, which will be several years.

2010 State Budget

In October 2009, Timor-Leste's Government presented its proposed General State Budget for 2010 for Parliamentary approval. This is the first budget to be enacted under the new Budget and Financial Law, and the first to include a chapter on Financing, reproduced at right.

The budget does not include authorization for Timor-Leste to borrow, but indicates that Government will present a mid-year "budget rectification" to revise the budget. The rectification proposed at the end of May 2010 does not include borrowing, although it does increase state expenditures by $177 million for the year, and authorizes withdrawing $811 million from the Petroleum Fund.

The 2010 State Budget drastically reduces the appropriation for the Heavy Oil Electricity Generation and national distribution network, from $375 million to $73 million over the life of the project. At the same time, the Prime Minister has made several "corrections" to the project which will significantly increase its cost. It seems likely that at least half a billion dollars of proposed borrowing will be a loan from China which will be used to pay Chinese Nuclear Industry Construction Company No. 22 for the ill-conceived heavy oil project.

La'o Hamutuk's submission to Parliament on the 2010 State Budget explained our concerns about borrowing, including the following:

The proposed 2010 State Budget does not ask Parliament to approve Timor-Leste taking out a loan, but it implies that such approval has already been granted, and that only a “directive” is required before the Government can borrow. It also discusses an already-signed MoU with Portugal which would “arrange and pay for agreed infrastructure projects” to be “repaid at a later date” but which “would not be part of the General Budget of the State.” Another paragraph says that the Government will “seek approval” from Parliament when it decides how much to borrow, which is expected to be around $3 billion over a project life of several years.

It makes no sense to take out a loan while oil revenues are coming in, only to have to repay it after the oil is used up. Although Article 9 of the Budget and Financial Management Law pays respect to equity between current and future generations, the borrowing that it enables does the opposite – wasting our children’s future to pay for current-day whims. It undercuts the basic objective underlying the Petroleum Fund – to use today’s non-renewable resources for lasting benefit, rather than squandering them now and imposing the burden of loan repayments on our grandchildren.

The important question is not how to borrow, but why:

  • What will the money be used for?
    Is it guaranteed to increase economic growth and domestic revenues enough to repay the loan?

  • Does the money have to be used to buy from the country which gave the loan?
    If hiring a Portuguese company makes the road twice as expensive as it would have been to hire someone else, we will effectively pay 100% total interest.

  • How much has to be repaid? When?

  • Where will the money to repay come from?

  • If Timor-Leste cannot repay, what are the consequences?

Even at concessional interest rates, repaying a loan will permanently lower the amount of money Timor-Leste has to use from the Petroleum Fund. For example, suppose we borrow $3 billion in 2010 at 2% interest, and pay it back over 30 years. When the loan is fully repaid in 2044, we will have paid back $4.14 billion. We will have depleted our Petroleum Fund, reducing the long-term ESI by $125 million every year after that. In other words, Timor-Leste will be deprived of another $3 billion in ESI revenues every 24 years forever, as shown in the following graph (click on it to see it larger):


Pressure to borrow

On 21-22 October 2009, Parliament Committee C held a workshop on Central Bank, Government Borrowing and Lending, and General Budget of the State 2010.

Speakers from the World Bank, Banking and Payments Authority, the Japan International Cooperation Agency (JICA) and others encouraged Timor-Leste to, in the Bank's words, "Assess options for creating fiscal space and  financing the budget deficit, ensuring quality of expenditure." Only  La'o Hamutuk (also Tetum) reminded participants that the important question is not how to borrow, but why. Several presenters argued that Timor-Leste should borrow because the interest rate might be low, but even a zero-interest loan has to be repaid. Nobody discussed the paradox of borrowing when oil revenues are high, only to have to repay when they are low or zero.

On 11 November 2009, the Asian Development Bank (ADB) gave a similar pitch to parliament, which they repeated during the visit of ADB Vice President Larry Greenwood in April 2010.

La'o Hamutuk does not have access to private conversations between the IFIs, other nations, and Timor-Leste's Government. But we imagine that what they say in private is similar to what they say in public, and that technocratically-oriented economists are pushing Timor-Leste to go into debt. Long after these highly-paid "experts" have gone home, generations of Timor-Leste citizens will suffer from the consequences of their advice, which serves their employers rather than this country.

 

2010 Strategic Development Plan

In April 2010, the Prime Minister began public consultation on a draft Strategic Development Plan for Timor-Leste for the years 2010-2030. Follow these links for:

As the excerpts at right explain, the Government proposes to achieve the Plan's ambitious goals by spending approximately $1 billion every year until 2015, approximately twice as much as the Estimated Sustainable Income from the Petroleum Fund.

In table 2.7 (page 2-22), the Plan anticipates a shortfall of nearly $6 billion will have been accumulated by 2020, presumably to be financed by borrowing.

The plan projects 2020 annual state expenditures at $2.2 billion, increasing about $300 million every year (click on graph above). After 2020, very optimistic projections of growth in non-oil GDP and state revenues are expected to provide enough income, although debt repayment appears not to be considered in the plan's budgets.

The Strategic Development Plan was eventually published and approved in July 2011. Although it does not contain concrete information about financing, some believe that it will require $10 billion in loans to implement.

Excerpts from Chapter 2 (Macroeconomic Framework) of the draft Strategic Development Plan (emphasis added)

To finance the SDP expenditure programme, the Government proposes, for expediency, additional withdrawals from the Petrol Fund, at least for the initial phase. The possibility of multilateral and bilateral loans to fund the latter part of the expenditure programme will be examined. In the long run, when the financial sector is more developed, the issuance of government debt could also be part of its fiscal armoury in future. Private finance, through the implementation of public-private partnerships, could be an option to fund some of the government capital projects. Realistically, this is likely to be a longer term development, requiring careful planning beforehand

We anticipate a rate of public-sector investments during 2011-2015 in the order of 30% of GNP, counting outlays on public health and public education mostly within the investment budget. The rest of the public sector budget would be around 20% of GNP. Total public spending would therefore be in the order of 50 percent of GNP which would amount to approximately $1 billion per year in the first years of this new decade.

Private-sector investment will add another 15% of GNP per year, perhaps 10% international investment and 5 percent domestic. With the total public investment plus the private investments, approximately 50% of GNP, and an incremental-capital-output ratio (ICOR) of around 5, the national investment rates would be consistent with GNP growth of around 12% per annum or higher.

Government revenues, including petroleum revenues, will support public spending of around $1 billion per year, with the remainder accumulating in the Petroleum Fund. The total Petroleum Fund balance will rise between 2011-2015 to around $9 billion from $5.5 billion in 2010. The government intends to benchmark the "3% rule" to current outlays and transfers, not consuming or transferring more than the sustainable consumption level equal to 3% of the sum of the Estimated Sustainable Income, (ESI) calculated as the sum of the Fund balances plus estimated NPV of future Fund revenues from petroleum. The government is currently exploring options towards funding strategic public investments including withdrawing in excess of the ESI or borrowing at concessional rates.

 

 

MoU and negotiations with Portugal

On 21 September 2009, the Ministers of Finance of Portugal and Timor-Leste signed a Memorandum of Understanding for a "Soft Line of Credit" which is the basis for Timor-Leste to borrow up to €500 million Euros (US$ 750 million), in installments of €100 million. Details of the loan will be worked out in a "Framework Agreement." Although this Agreement was to be signed in January 2010, it has been indefinitely delayed due to Portugal's economic and political problems.

Although the MOU has not been made public, some information was posted on a Portuguese website encouraging Portuguese companies to apply for contracts. In addition, we have learned that loans from Portugal will be used for yet-to-be-defined infrastructure projects and are likely to be tied, with 40% of the loan paying for companies and goods from Portugal, 40% from Timor-Leste, and the remainder unrestricted.

RDTL Council of Ministers approves borrowing from Portugal

On 16 September 2009 the Council approved a Memorandum of Understanding with Portugal for attribution of a line of credit. According to the Government's press release:

"This line of credit aims to finance the investment projects in Timor-Leste, by involving the acquisition of Portuguese goods and services or the participation of Portuguese companies (without prejudice of the associated local component).

"The areas intended to this Line of Credit will be: construction and rehabilitation of roads and bridges; construction and rehabilitation of physical infrastructures, including Health and Education; construction and rehabilitation of infrastructures of transport and communications; and the production, transportation and distribution of energy and water."

Portugal grants €100 million credit line

Dili, 22 Sept 2009 (macauhub) ­ The Portuguese government has granted a €100 million credit line to East Timor for projects to be chosen by the East Timor government.

The initial amount of the Aid Credit Line may be increased up to €500 million according to a memorandum signed Monday in Dili

The credit line is for funding infrastructure investment projects in East Timor with the participation of Portuguese companies, especially small and medium-sized enterprises (SMEs), in the areas of energy, transport and communications, health and education.

The two sides also signed a memorandum on double taxation, the convention of which is due to be signed by the end of January 2010, as both East Timor and Portugal consider it important to fight tax evasion and to stimulate private enterprise and create a favourable business climate.

A third memorandum also signed Monday created a technical cooperation programme which includes a visit by technicians from the Portuguese Finance Ministry in October.

The governments of Portugal and East Timor in September signed the Indicative Cooperation Program (PIC) for the next four years, estimated at €60 million.

 

Consideration of China

The government of China, which has a lot of money because of its large exports to Europe and North America, is short of natural resources to supply its huge population and industrial base.

In mid-October, Timor-Leste's Prime, Finance and Foreign Ministers, Secretary of State  for Natural Resources and other officials visited China, discussing loans, which the Prime Minister called "investment."

One logical destination of Chinese loans is the Heavy Oil electricity project, but Chinese companies could also be contracted to build highways, dams, airports, ports and other infrastructure here, importing Chinese workers and using Timorese only for low-paid manual labor. It remains unclear whether such projects would expand Timor-Leste's domestic economy enough to repay the loans, and what other conditions China would require in return for lending money to Timor-Leste.

China has been going around the world, especially in Africa, offering loans to countries rich in oil and minerals. Often, these loans are designated for infrastructure projects to be built by Chinese companies. And often, the repayment and conditions of these loans get countries into trouble. Here are a few examples from the end of 2009:

East Timor to negotiate loan from China for infrastructures

Dili, 15 Oct 2009 (macauhub) – East Timor’s Foreign Affairs Minister, Zacarias da Costa, has said that East Timor is negotiating a loan from China to fund the country’s large infrastructure projects.

The minister also told Portuguese news agency Lusa that the issue would be discussed Friday during a meeting between Prime Minister Xanana Gusmão and his Chinese counterpart Wen Jiabao in the Chinese city of Chengdu.

During the official visit by Gusmão to China, East Timor plans to boost bilateral cooperation.

Minister da Costa also told Lusa that “China’s interest in access Timorese oil resources,” would also be discussed.

China’s interest in Timor’s fossil fuels, according to da Costa, reinforces the conclusion that construction of a pipeline from the offshore “Sunrise” oil field to East Timor and not to Australia is commercially viable.

“We have feasibility studies from several companies that prove it is technically viable,” da Costa said.

“We have been in contact not only with China, but also with Korea and international companies that clearly show that, from a commercial point of view, it is viable to bring the pipeline to East Timor and that is what we have to show to the Australians and the companies that are in the area,” he noted.

According to da Costa, “there is interest and all the options have to be considered and laid out on the table for discussion," noting that, according to the joint Timor Sea oil exploration treaty, signed by Australia and East Timor, the two governments have the final say on the pipeline. 

Ecuador, November 2009

Ecuador has put on hold its plans for a USD 1 billion credit from China due to disagreements over conditions of the deal, Ecuador's Economic Policy Minister Diego Borja said last week. “They were asking for unacceptable conditions, such as import guarantees,” Borja told reporters. “Ecuador does not accept impositions, not from China, not from the IMF, not from anyone.” (Reuters, Dow Jones)

 

Africa, November 2009

"There have been allegations for a long time that China has come to Africa to plunder its resources and practice neo-colonialism. This allegation, in my view, is totally untenable."

 -- Wen Jiabao, China’s premier, following a pledge of USD 10 billion in cheap loans to Africa over the next three years,
and refuting claims that the Asian powerhouse is only looking to exploit Africa’s resources.

The loan pledge for Africa was double a USD 5 billion commitment made in 2006. Wen said eight new Chinese policy measures aimed at strengthening relations with Africa were "more focused on improving people's livelihoods," underlining what he called Beijing's "selfless" engagement in Africa, the Washington Post reported. The IMF has expressed concern about African governments taking on too much debt from Chinese lenders. But Wen said China would write off some loans it had made to the poorest and most heavily indebted countries. African heads of state, including Zimbabwe's Robert Mugabe and Sudan's Omar Hassan al-Bashir, lauded China's support. But others said African nations needed to devise their own development plans to take full advantage of Chinese finance. Last year, European Union lawmakers assailed China for courting “oppressive” African governments, such as Sudan, to satisfy its soaring demand for oil and raw materials. The pattern of trade -- raw materials going to China and Chinese finished goods flooding Africa -- has angered some Africans. “We are sick and tired of the old model, where China comes to Africa and extracts raw materials and goes back to China,” Zimbabwean Deputy PM Arthur Mutambara said in the Zimbabwe Times in September. “We are not now interested in that.” (Global Development Briefing)

 

Philippines, 2007-8

One of the most high-profile private sector corruption cases in 2007/8 involved the National Broadband Network (NBN) project. The NBN deal involved contracting a China-based telecommunications company to set up a broadband network connecting government offices throughout the country. On 21 April 2007 the US$329.5 million NBN contract was signed between the Department of Transportation and Communications and ZTE, funded by the Export-Import Bank of China.

Controversy began to surface when Representative Carlos Padilla disclosed in a privilege speech on 29 August 2007 that the then chairman of the Commission on Elections, Benjamin Abalos, had allegedly served as a broker for the Chinese company, playing golf and meeting with ZTE executives several weeks before the NBN contract was signed in China. Abalos admitted to travelling to China and playing golf, but he denied playing middleman for the firm. ...

In the meantime, the fallout from this case has been dramatic. In recognition of the growing public unease, in September 2007 the president set up the Chinese Projects Oversight Panel to oversee Chinese projects. Nevertheless, in February 2008, former Senator Jovito Salonga filed a criminal complaint against the president in relation to her involvement in the case.  In response, in February 2008, the president halted all ‘fresh borrowings from China and other lenders of big infrastructure projects’. As a result, alternative sources of  funding would have to be sought for the eleven outstanding projects for which no contract had yet been signed.

This case illustrates how the involvement of foreign companies, often supported by state loans and guarantees, can pose substantial corruption risks. Although it is encouraging that the Philippines has conducted extensive investigations into the allegations of bribery, it is disconcerting that the company at the centre of this debacle has not been held accountable for its part in the activities. When funding is sought from abroad and foreign companies are used in contracts, this apparently decreases the Philippines’ ability to manage its affairs openly and transparently. (Transparency International Global Corruption Report 2009)

 

Borrowing from Japan

In December 2009, the Japanese aid agency JICA completed a Study on Support for Development Fund Planning in the Democratic Republic of Timor-Leste, which identified 19 "key issues" for the Government and donors to address before implementing external borrowing. In mid-2010, the list was narrowed to nine key actions:

  1. Setting SDP and effective coordination between donors and the strategy

  2. Establishment of legal background for external debt

  3. Capacity and institutional development of implementation agencies to manage and monitor the operation and maintenance

  4. Capacity and institutional development for disbursement operation

  5. Institutional and capacity development for the Debt Management Unit (DMU)

  6. institutional development for Anti Corruption and enhancement of governance

  7. Clarifying differences between the environmental guidelines and the decree and clarifying the requirement to issue the environment license

  8. Strengthening debt sustainability

  9. Establishment of PMU for efficient project implementation

JICA finalized their 77-page "Timor-Leste: An Assessment of Macroeconomic Prospects, Future Borrowing Capacity and Debt Sustainability" in October 2010, before the 2011 State Budget was available, and it underestimates future Government spending plans. (La'o Hamutuk does not yet have permission to post the report on this website.) After discussing and forecasting the country's economic situation in depth, JICA concluded that Timor-Leste could be eligible to borrow, but suggested that limits of $40-$45 million per year "may be considered appropriate from the viewpoint of safeguarding debt sustainability." The report also identified key challenges for Timor-Leste, including "improve absorptive capacity, strengthen public expenditure management, establish public debt management policies and institutions, introduce policies to expand the non-oil revenue and export bases, and expeditiously implement the structural reforms required for a vibrant private sector."

Other possibilities

In early 2010, the Government advised it is considering concessional borrowing for investment projects envisioned in the Strategic Development Plan, which normally would be from the bilateral donors and the multilateral banks. Before the multilateral banks will finance large projects, Timor-Leste would need to be reclassified from a grant-receiving country to a mixed (grant and loan) receiving country. For the World Bank and Asian Development Bank, this would require Timor-Leste to undergo a process that would include establishing that it is credit worthy -- that it can manage loans well and will be able to repay them. Bilateral donors have similar processes. The Government of Timor-Leste asked for such a reclassification in mid-2010, which is expected to be completed by the end of the year.

In September 2010, the process of revising the Petroleum Fund law accelerated, and in mid-October the Council of Ministers discussed removing the prohibition on using the Fund as collateral for loans. This was not included in the draft circulated for public consultation, but the revision as enacted in August 2011 allows up to 10% of the Fund to be used as collateral, further weakening safeguards against Timor-Leste falling into the resource curse.

More traditional lenders, such as the World Bank, IMF, ADB, Japan and other nations, are also attracted by Timor-Leste's petroleum wealth, inexperience, and appetite for mega-projects. However, the World Bank's International Development Association (IDA) won't make any loans to Timor-Leste before July 2011, with the situation to be re-examined at that time. Some potential bilateral lenders have concerns about whether Timor-Leste will be able to manage and repay the debt.

In April 2010, Timor-Leste NGOs expressed their thoughts in a joint statement to the annual Timor-Leste and Development Partners Meeting: "We are concerned by the Government’s plans to borrow billions of dollars later this year, to pay for centralized physical infrastructure and other projects. Although revenues from our only producing oil and gas field will end by 2024, debt repayment will continue. It will be difficult to provide education, health and other services to our growing population when debt service will have first claim on our smaller revenues."

IMF/World Bank Debt Sustainability Assessment

The debt sustainability assessments (DSA) of the International Monetary Fund and the World Bank are an important guide as to whether a country is credit worthy. A DSA is based on assessment of whether key debt thresholds will be met over time. Key thresholds relate to the ratios of public external debt to GDP, government revenue, exports, and of debt servicing costs to exports and government revenue. The levels of the thresholds are  linked to results of the Country Policy and Institutional Assessment (CPIA) undertaken by the World Bank. This is undertaken annually and evaluates the strength of a country's policy and institutional environment using a questionnaire that is the same across all countries (link to 2007 background and questionnaire for CPIA). A country with a low score against the CPIA has lower thresholds, meaning it should borrow less as it has less capacity to repay debt.

Timor-Leste undergoes an annual assessment by the International Monetary Fund, usually in June and July. The 2010 assessment wasn't released until March 2011, and includes a DSA exploring whether Timor-Leste meets international standards of credit worthiness. Although this appears to be an objective statistical process, Timor-Leste's unique situation (oil income four times larger than non-oil GDP, new and fragile state institutions, no borrowing/repayment history, large Petroleum Fund), as well as the need to estimate not-yet-discovered oil reserves, means that opinions will strongly influence the outcome. If the DSA and CPIA support Timor-Leste's request to borrow, loan processing could begin 2011.

The IMF published their December 2010 IMF/WB Debt Sustainability Analysis in March 2011. They summarized: "The medium-term fiscal path for Timor-Leste is subject to uncertainties regarding spending commitments and income prospects from petroleum, which complicates the Debt Sustainability Analysis (DSA). The baseline macroeconomic scenario assumes a significant scaling-up of public spending, future petroleum income only from fields with approved development plans, and a moderate borrowing envelope. Under this scenario, the external low income country DSA indicates a low risk of debt distress. The public DSA suggests that overall public sector debt dynamics are sustainable in light of a gradual approach of moderate borrowing and substantial savings in the Petroleum Fund."

The IMF/WB analysis assumes that Timor-Leste will borrow less than $1 billion, which could be repaid from the Petroleum Fund. They concluded:
"A key challenge for Timor-Leste is to use its petroleum wealth effectively and sustainably to develop non-oil economy.  Given the flexibility embedded in the PF Law and the calculations of the ESI, a major constraint on boosting growth through scaling-up public investment comes from weak policy and institutional capacity rather than from the availability of financing. Therefore, an appropriate level of public expenditure should be commensurate with the government’s capacity to plan, implement, and review investment projects, and with the ability of private sector producers to take advantage of public capital. Close cooperation with the World Bank, the Asian Development Bank, and other development partners would help prioritizing, sequencing, and managing expenditures. The decision of how to finance development projects—through borrowing or more withdrawals from the PF—is of second order. A gradual approach to borrowing is advisable to allow time for building up debt management capacity from scratch. Moreover, preference should be given to concessional loans rather than commercial loans to contain the risk of debt distress."

In February 2012, the IMF/WB updated their Debt Sustainability Assessment (see below).

Borrowing Law passed by Council of Ministers, approved by Parliament

At its 3 June 2011 meeting, the Council of Ministers approved (also Tetum or Portuguese) a Public Debt Policy to establish a basis for foreign loans to Timor-Leste "to supplement the financing needs of the first five years of the impending Strategic Development Plan."  The Policy includes the following:

  • justification for contracting loans

  • general principles to which the Government must adhere, including debt sustainability and transparent management

  • management of costs and risks from contracting of loans, including sound fiscal sustainability (the contract amount, the terms and conditions)

  • establishment of a framework conducive to contracting of loans (it is necessary to implement legal and institutional provisions to ensure proper debt management).

As the same meeting, the Council of Ministers approved a proposed Law on the Constitution, Issuance and Management of Public Debt which was sent to Parliament three weeks later with a request for urgent approval. In an attempt to manage debt in a balanced and efficient way, the proposed law adopts some principles:

  • public debt should not be used to finance current State expenditures, but only expenses that contributes to strategic development.

  • public debt must be motivated by financing needs from executing the State’s priority tasks, related to construction of strategic infrastructure.

  • the cost of public debt cannot be above the economic return of public investment.

The proposed law and an explanatory memorandum (also Portuguese) were presented to Parliament on 28 June. Committee C scheduled a public hearing for 6 July, but it was delayed in the rush to approve legislation before the Development Partners Meeting.

In early August, the ADB posted information on its website about a proposed $8.15 million loan (later revised to $9.15 million) to Timor-Leste to upgrade the national road network, which we understand is the initial part of hundreds of millions of dollars in projected ADB loans for road construction.

Soon thereafter, Parliament held a quick discussion on the proposed law, approving it in an extraordinary plenary session on 24 August with 31 votes in favor, 4 against, 2 abstentions and 28 not voting or absent, with one minor change to the Council of Ministers versionLaw No. 13/2011 (also Port.) was published on 28 September 2011.

During the same week, Parliament also approved revising the Petroleum Fund Law to allow 10% of the Fund to be used as collateral for borrowing.

Two days after that, La'o Hamutuk distributed some thoughts to the EITI conference (PDF), suggesting more careful deliberation:

So far, Timor-Leste has no external debt. Although we began nationhood in 2002 with an uncertain economy, Timor-Leste resisted pressure from the ADB and World Bank -- the same institutions which support EITI -- to take out loans to finance state spending.

In 2006, Timor-Leste began receiving large petroleum revenues. Since 2007, oil revenues dominate the state budget. Unfortunately, this condition has not reduced the temptation to borrow.

In 2009, the Government began looking for loans to finance infrastructure projects, and has enacted several laws to enable borrowing, including the 2009 Budget and Financial Management Law. Just this week, Parliament approved revisions to the Petroleum Fund Law and enacted a new Public Debt Law.

Borrowing is unwise. Experience shows that many nations who borrow end up failing. Petroleum-export-dependent countries are often tempted to use their oil as collateral for borrowing. Many countries borrowed against their oil wealth in the 1970s and 1980s, when IFIs and rich countries gave big loans to oil producers. Indonesia, Congo, Ecuador, Nicaragua, the Philippines, Argentina and others collapsed when debt became unsustainable -- the loans had provided benefits for a few dictators and cronies, but most people were still poor.

Timor-Leste enters risky territory by weakening Article 20 of the Petroleum Fund Law to allow use of part of the Fund as collateral. We all agree that investing money to develop human resources, education, health and agriculture can help bring Timor-Leste out of poverty, but we are unhappy that the Government wants to borrow billions of dollars only for physical infrastructure.

Therefore, we urge Timor-Leste to think carefully before borrowing. Even if interest rates are low, we will have to repay the principal -- after our oil wealth is spent. Repayments may obligate the state to reduce expenditures for public assistance, health, education and other essential services.

In early September, more than 100 Timorese and international organizations issued a statement urging debt-free Timor-Leste not to borrow. They concluded their statement: "The Democratic Republic of Timor-Leste began life in 2002 without owing money to anyone. For the sake of an equitable, prosperous, and environmentally sound future for today’s and tomorrow’s children Timor-Leste should remain debt-free. We urge Timor-Leste’s leaders and international institutions to use other ways to finance the country’s much-needed development."

They are following up with a global internet petition, which you can read and sign here.

2012 Budget will start borrowing with $160 million, including $43 million in 2012

As presented to Parliament on 30 September 2011, the proposed State Budget for 2012 will spend $33.1 million in borrowed money for Dili sanitation and national roads during 2012, with more in future years. This is the first time the Government has asked Parliament to approve borrowing. Budget Book 1 contains less than a page about borrowing and doesn't mention the lenders or the terms of the loans, explaining that the budget "does not show repayment because most of the loans have a ten year grace period." The memorandum explaining the Budget Law says that for "the first time in the history of Timor-Leste, the Government is proposing a ceiling to the National Parliament to authorize the Government to contract loans, which by legal obligation must be intended only for the construction of strategic infrastructure development the country." However, the proposed budget law indicates only how much borrowed money will  be spent in each year, rather than how much will be borrowed, which is inconsistent with Article 20.1 of the Budget and Financial Management Law.

The table at right, revealing a plan to borrow $477 million over the next four years, is much less than the Government thinks will be needed to implement the Strategic Development Plan. For example, a consultant recently submitted a design for the Suai-Beacu highway which could cost more than the $220 million in loans and $547 million in Timor-Leste's money listed in the budget documents. We hope that the Government will provide full project cost information, rather than repeating the cost overruns of the heavy oil power plants and the MDG-suco housing project.

The Parliamentary plenary debate on the proposed 2012 State Budget began on 9 November 2011, and many MPs spoke about borrowing. On the morning of 14 September, Parliament voted down an amendment which would have removed the authorization to borrow $33.1 million, and proceeded to increase the amount to be borrowed in 2012 to $43.1 million by financing the Maubisse-Ainaro/Same road in 2012 instead of 2013. Following a heated debate on how much borrowing Parliament should approve, the budget law was amended at the Government's request to authorize $160 million in 40-year loans. Although the opposition walked out for the vote on the debt amendment, Parliament passed the budget on 25 November and the President promulgated it in late December.

Promulgated 2012 Budget Law, Article 5
Maximum Amount of Authorised Borrowing

1. In order to meet the financing needs related to the construction of strategic infrastructure for the development of the Country , the Government is authorised under Article 20 of Law no. 13/2009 of 21 October and Article 3 of Law no. 13/2011 of 28 September, to resort to concessional external borrowing to the maximum amount of $160 million, with a maximum term of 40 years.

2. Without prejudice to the above provision, in 2012 the financing derived from borrowing shall not exceed $43.1 million.

On 19 November, Parliament Committee C organized a conference with representatives from international  institutions to discuss ways to finance Timor-Leste's development, with presentations from UNMIT, the IMF on Fiscal Strategy, the World Bank on borrowing and the ADB on Public-Private Partnerships (also Tetum). The IMF recently interviewed commercial bankers operating in Timor-Leste, finding that "Nonperforming loans in Timor-Leste are very high, even compared with other Less-Developed Countries." They suggested that Parliament consult with the banks to see if there is a culture of non-repayment which could make it more difficult for the state to manage borrowed funds.

The ADB and the Ministry of Infrastructure are moving rapidly to lend and spend the borrowed money. In late November, the Ministry invited submissions of Expression of Interest for the Consulting Services for the Feasibility Study, Design and Supervision of the Proposed Loan for Road Network Upgrading (Sector) Project for the loan-financed Dili-Liquica, Tibar-Ermera and Manatuto-Natarbora roads. The ADB had approved "advance action for procurement" in late September, and bids from international engineering companies were due by 5 January 2012, with work expected to begin in the second quarter of the year.

By the beginning of 2012, Timor-Leste's Government had established the legal framework and plans to borrow from international lenders. Click here for information and analysis on developments from 2012 onward.

 

The Timor-Leste Institute for Development Monitoring and Analysis (La’o Hamutuk)
Institutu Timor-Leste ba Analiza no Monitor ba Dezenvolvimentu
Rua dos Martires da Patria, Bebora, Dili, Timor-Leste
P.O. Box 340, Dili, Timor-Leste
Tel: +670-3321040 or +670-77234330
email: 
info@laohamutuk.org    Web: http://www.laohamutuk.org    Blog: laohamutuk.blogspot.com