World Bank Background Paper for the Timor-Leste and Development Partners Meeting
Dili, 25-26 April 2005
Executive Summary (excerpts)
Timor-Leste has made impressive progress in implementing the National Development Plan since the last TLDPM in May 2004. Most prominently, following broad-based consultations, the Government has completed a state-of-the-art policy and legislative framework for petroleum production, taxation, and revenue management. The associated texts are currently being debated by the National Parliament. The framework was praised at a high-level meeting of the Extractive Industries Transparency Initiative in March. The specific arrangements for petroleum sector management will only be successful in safeguarding public resources for both current and future generations when combined with continued strengthening of the overall governance framework and a focus on the fight against corruption.
Bayu Undan petroleum production is benefiting from historically high oil prices and Timor-Leste can now fully finance an annual budget at the level of the sustainable income. Petroleum revenues are significantly higher than expected, increasing from USD 41 million in FY04 to a projected USD 243 million in FY05 and as compared to a budget of about USD 79 million – they are expected to remain around 200 million for the next four years. Domestic revenues have also increased – the result of much improved tax and customs administration. Consistent with the savings policy, Government will save the lion’s share of these revenues and allocate only the sustainable portion to the annual budget. Annual sustainable spending equals the sum of domestic non-oil revenue and the permanent income from petroleum wealth. These are estimated at USD 30 and 100 million, respectively, though the latter part remains highly vulnerable to oil price changes.
DEVELOPMENTS SINCE LAST MEETING AND PLANS FOR THE FURTHER IMPLEMENTATION OF THE NATIONAL DEVELOPMENT PLAN
Macro-economic Developments and Outlook
Liquids production at the Bayu Undan oil and gas field began in April 2004 and is fully operational. Following the approval of the petroleum production regime by Parliament, licensing for the exploration of reserves on-shore and in non-disputed waters along Timor-Leste’s southern coast is expected to begin before the end of 2005. Finally, negotiations with Australia over the petroleum reserves in areas of overlapping claims are progressing at a faster pace, improving the prospects for the exploitation of the Greater Sunrise field.
With the initiation of petroleum production, Gross National Income is rising considerably. At the same time, non-oil Gross Domestic Product (GDP) is expected to grow only modestly. A recent revision of national accounts indicates that non-petroleum GDP has fallen by about 6 percent in both 2002 and 2003, following growth of about 16 percent in 2001. It is estimated that non-oil GDP has grown modestly at about 2 percent in 2004, reflecting an increase in agricultural productivity following a period of drought as well as a significant expansion in banking sector activity. At the same time the 2004 census and the 2003 Demographic and Health Survey point to a population growth rate well above 3 percent – considerably higher than previously projected. Hence it is clear that per-capita GDP – currently measured at USD 405 – is decreasing and poverty is in all likelihood increasing.
The Government has developed a state-of-the-art policy and institutions for the prudent management of oil and gas revenues based on the Norwegian model. This framework is consistent with the Extractive Industries Transparency Initiative, for which Timor-Leste is a pilot country. Broad-based consultations, both external and internal, have contributed to the creation of a national consensus over the policy and law. True to stated principles, the Government has adhered to a provisional savings policy for petroleum revenues ahead of the adoption of a more permanent savings policy and has thus already demonstrated its capacity to implement a savings rule. The Petroleum Fund legislation has been approved by the Council of Ministers and submitted to Parliament. Once the law is promulgated, it will be necessary to establish the Investment Advisory Board and the Consultative Council called for in the law. Important progress has also been made in developing a legislative framework for petroleum production, with the Mining Code and Model Production Sharing Contract for the Joint Petroleum Development Area and a Petroleum Law and model contract for onshore and offshore production currently being considered by Parliament.
RESOURCE UTILIZATION AND MOBILIZATION
The Medium Term Combined Sources Budget and Financing Options
At the time of the last TLDPM it was projected that there would be a financing gap of about USD 30 million over FY05-08, though significant uncertainties in price and production indicated a “low case” scenario with a deficit of USD 138 million and a “high case” scenario with a surplus of USD 90 million. Taking a cautious approach, the Government requested an extension of multi-donor budget support for an additional three years.
Now, with Bayu Undan in full production and oil prices at historically high levels, the financing gap as previously defined no longer exists (see table 4). Based on appropriately conservative projections of oil and gas revenue over the life of Bayu Undan, and taking into account the Government’s prudent savings policy for petroleum revenues as well as improvements in domestic revenue collection, the sustainable income is estimated at USD 100 to 130 million – a 27 to 65 increase from the current budget of USD 79 million. This range takes into account the risks associated with high oil price volatility and capacity limitations. Approximately USD 30 million of the sustainable income is expected to come from non-petroleum revenues.
The Government’s model framework for petroleum revenue management, consistent with the Extractive Industries Transparency Initiative, will safeguard these revenues for the benefit of current and future generations. A savings policy has been adopted to preserve the real value of petroleum wealth by spreading expenditures over an infinite time horizon, maintaining a sustainable budget in perpetuity. The conditions under which the Government can withdraw funds above the estimated sustainable income will be restricted. A Petroleum Fund will be established to collect all direct and indirect petroleum revenues, which will flow into an earmarked account. Expenditures funded from petroleum revenues will be integrated into the budget process. In each fiscal year, transfers from the Fund cannot exceed a ceiling set by Parliament as part of the approval of the regular Government budget. Revenue and expenditure figures are recorded as part of Government’s consolidated reporting and made publicly available. Assets will be managed prudently in safe, offshore investments, under the oversight of an Investment Advisory Board. An independent Consultative Council will be established as a watchdog over the operation and allocation of the Fund.
5 These numbers are still provisional and will be updated on the basis of draft budget papers currently under revision by Government.