Timor-Leste Country Risk Analysis:

A Macroeconomic Risk

Author - Thomas Freitas  

Introduction

Theoretically, the basic circular flow of income is the interaction between household

and firm through factor of production and transaction of goods and services in the market,

(Frey, 1978). However, these days, in the modern capitalism economy, the basic circular

flows become huge and complex, and the leakages in the circular flow such as; paying taxes,

buying import goods, and saving, at some stage has to balance the injections by government

spending in health, education, agriculture, infrastructure and social security, including exports

of national production and investment.

This essay will use the Keynesian approach to analyse the complexity of circular flow

of income in the context of Timor-Leste. The analysis will investigate the injections and

leakages in the circular flow, and will present a conclusion on macroeconomic risk in Timor-

Leste. To justify the context, the paper will outline a few points such as the background of the

country, the transparency and accountability, the economic performance, and the elements of

GDP of the country.

Background

Timor-Leste gained Independence in 2002, and currently has a population of 1.2

million. Geographically Timor-Leste is located between the regions of the Pacific and South

East Asia; the country is divided into 13 districts with Dili as the capital. With guidance from

the United Nations, the World Bank and IMF, Timor-Leste still faces basic problems

common to those confronted by post conflict countries. The health sector is one example;

according to the Ministry of Health, every year 380 children die from diarrhoea (Ministry of

Health, 2011); the under five child mortality rate is 56 per 1000 births, compared to Indonesia

39 (UNDP, 2012); life expectancy is 62.5 years, compared to Indonesia at 69.4 years and

Papua New Guinea (PNG) at 62.8 years (UNDP, 2012).

Transparency and Accountability

Normally to call for foreign investment, a country has to apply several indicators, one

of which is to be accountable to ratings agencies. Unfortunately Timor-Leste does not apply

any ratings agencies such as Standard and Poor or Moody’s; however there are some

international institutions that actively monitor transparency and accountability in Timor-

Leste.

Transparency, accountability and corruption indexes, as well as other indexes

published by several institutions, have become significant sources of information for

investors before deciding to invest their money in particular country. For example, an

empirical study conducted in 40 countries over seven years identified that high corruption

and low transparency has become the main reason for investors to withhold investment

(Zhao, et al, 2003). In the case of corruption perceptions, the rating index has underpinned

Timor-Leste in position 143 out of 183 (Transparency International, 2012), which is

extremely high, and can be attributed to a lack of law enforcement. According to one of the

World Bank reports (2009) on enterprises in Timor-Leste, to get a construction permit more

than a third of large firms expected to pay bribes to government officials.

Economic Performance

According to the United Nations Development Program (UNDP) (2012), Timor-

Leste’s Growth National Income (GNI) per capita is about $3,005 million US Dollars.

Although Timor-Leste suffers from lack of investment from both sides, foreign investors and

the local private sector, it still performs well is comparison to two neighbouring countries

Indonesia, with GNI per capita of $3,716 US dollars and Papua New Guinea (PNG) with

$2,271 US dollars per capita. According to the International Monetary Fund (2011), Timor-

Leste’s Gross Domestic Product (GDP) per capita is about $3,949 US dollars, which is higher

than Indonesia with $3,508 and PNG $1,900. Timor-Leste’s GDP can be seen in Table 1

below:

Gross Domestic Product

Table 1. Source: International Monetary Fund (2012).

The table demonstrates that the percentages of GDP has dropped to -0.1% in 2003

after the United Nations administration terminated in 2002, and subsequently the oil revenue

began to filter in, increasing GDP to 4.3% in 2004 and 6.5% in 2005. In 2006 internal

political conflict negatively impacted GDP which fell to -3.1%; however it has since climbed

again to 11.6% in 2007. In 2008 GDP reached 14.6%, which was very different to the world

economy at the time which was experiencing a financial crisis. This insulation from the

global financial crisis was possible because Timor-Leste does not have any foreign debts,

local firms do not have any equities in financial markets, and the Petroleum Fund had at the

time invested 100% in Merrill Lynch 0-5 year government bond index (Central Bank of

Timor-Leste, 2008). In 2009 GDP dropped slightly, 1.8% from previous year, and then again

decreased 3.3% in 2010, with a small increase of 1.1% in 2011. The projection for 2012 is

that it will stay at 10%.

Timor-Leste’s GDP performance is contributed to by the injection of Gross National

Income, as per Table 2 below: Year Gross National Income

Per capita in US Dollar

Gross Domestic Product

Per Capita in US Dollar

2002 330 319.89

2003 330 319.75

2004 480 317.54

2005 730 328.51

2006 950 314.67

2007 1490 374.79

2008 2460 461.14

2009 2020 543.69

2010 2220 623.66

Table 2. Source: The World Bank Statistic database (2010)

Table 2 demonstrates that GNI per capita is more than GDP per capita, which is ideal

because it is better to have some leftover income. The difference between the two variables

GNI and GDP per capita from 2002 to 2003 is only 3.1%. However, from 2004 to 2010 when

oil revenue began to inject state expenditure, the difference between GNI and GDP per capita

in an average year became 65.2%.

Fiscal

Year

Consumption

Based on

Consumer Price

Index in Million

US Dollar

Investment

Capital Asset

In Million US

Dollar

Government Expenditure

in Million US Dollar

Social Security

Exports

in Million

US Dollar

Imports

in Million

US Dollar

Trade

Balance

2004-05 107.5 - 52.3 79.0 105,645 146,108 -40,454

2005-06 107.5 - 46.1 112.0 43,451 109,127 -65,676

2006-07 120.0 - 142.9 328.6 60,685 100,802 -40,117

Transition 134.1 - 72.9 116.4 19,179 206,133 -186,954

2008 145.6 - 208.7 483.9 49,207 268,584 -219,377

2009 146.4 - 355.1 603.6 34,512 295,096 -260,584

2010 - 54 458.8 758.7 - - -

2011 - - 365.0 1,306.0 - - -

2012 - - 423.9 1,674.1 - - -

Table 3. Sources: National Directorate Statistic, Central Bank of Timor-Leste and Ministry of Finance (2012).

Table 3 shows the elements of GDP which are based on the expenditure approach as

described in the formula GDP = C + I + G + (M-X).

Consumption

Looking at consumption in Table 3, household consumption has gradually increased

7.3% every year on average. The question is: who is the consumer? Where is the income

coming from? If we check proportions of income distribution in Table 4 below, we can see

Total Expenditure for entire budget  

Health, Education, Agriculture, and Social security

 

that 37.3% of jobs are provided by the government and public sectors such as civil servants

and soldiers in the military, followed by non-government organisations (NGOs) at 16.2% and

private individuals (such as taxi drivers, maids etc) at 16%. Private companies stand at only

9.9%. For circular flow of income, companies need to be key actors in providing income to

households, but in Timor-Leste this is not the case. According to a Business Survey Report

published by the National Directorate Statistic (2010, 5) total employment in Timor-Leste is

46,700 thousand, comprised of 32,700 males and 13,900 females. See Table 4:

Employer with the wages National % The majority of livelihoods National

%

Private company, enterprises or cooperative 9.9 Peasants and Farmers 84.4

Rural public works program 13.8 Industry 0.9

Government, public sector, army 37.3 Wholesale trade, retail, restaurants and hotel 2.2

State-owned enterprise 4.3 Public administration, military 2.2

Private individual 16.0 Health 0.9

NGO 16.2 Education 2.8

Other 2.5 Community and social service 1.9

Table 4. Source: National Directorate Statistic (2007).

This only represents 15% of the total livelihoods in Timor-Leste, because the majority

of the population (85%) are farmers who work without wages in the agriculture sectors, with

minimal income because food production cannot compete with food imports which are cheap

and dominant the market.

Investment

Lack of investment from external and internal firms has affected local factors of

production. According to the Ministry of Finance (2012), the country has struggled to

stimulate job creation. High unemployment in the rural area which is about 80% compared to

urban areas at 42% has indicated that there is a concentration of jobs in the capital. Looking

back at Table 4, if we combine the livelihood sectors of industry and wholesale trade,

retailers, restaurants and hotels, this accounts for only 3.1%. Why is the predominance of

companies so very low?

According to Joseph Stiglitz (2000), Foreign Direct Investment (FDI) is one of the

most important factors that need to be addressed in order to propel the economy, because FDI

not only brings resources, but also technology, access to markets, and improvements in

labour skills. If so, what then are the factors that slow down FDI in Timor-Leste?

As mentioned previously, Timor-Leste is not engaged with any rating agencies, such

as Standard and Poor’s or Moody’s, which are very important for investors to decide whether

or not to invest in Timor-Leste. However, there are several institutions which independently

survey transparency and accountability in Timor-Leste. According to the Transparency

International index (2012), the effectiveness of rule of law in Timor-Leste is only 10%; the

independence of judicial system is ranked 86 of 142; and the capacity of oversight institutions

such as the Ombudsman, the Anti Corruption Commission and anti corruption NGOs is only

18%.

Government Expenditure

According to the data shown in Table 3, of the total budget over eight years, the

government has spent 38.5% on health, education, agriculture, infrastructure and social

security. According to local NGO Luta Hamutuk (2007), the majority of six infrastructure

projects investigated by the NGO including road rehabilitation, primary school and health

centre rehabilitation, were of very poor quality (Luta Hamutuk, 2007). This investigative

project was on a very small scale; it is not known what has been the case for other projects

not yet investigated.

There is lack of information in rural areas about infrastructure projects, which are

often carried out by private companies and do not involve local labour. Rural communities

also do not feel ownership of projects because they do not pay any direct taxes, such as

income tax, withholding tax, or even wages tax; on the other hand the community do not

realise that they do contribute through indirect taxes such as when purchasing goods they are

contributing to import tax, sales tax and excise taxes. Lack of ownership of these projects has

affected accountability and means that the community do not report mistakes or bad quality

of the projects.

Trade Balance

According to Table 3, exports and imports from 2004 to 2009, have show us that the

value of exports is not equal to the value of imports - the average of imports value every year

is around 400% more than exports value. So, what commodities are used for exports and

imports? Data from the National Directorate of Statistics regarding merchandise exports and

imports can be seen in Table 5 below. Merchandise Imports of major commodities Commodity Value

in US Dollar Commodity Value

in US Dollar Vehicles (Cars & Motorbikes) 58,486,000 Construction materials 4,075,138 Rice 35,069,475 Tractors for Agricultures 3,186,171 Fuels 30,715,395 IT & Computers 2,972,124 Electrical Machinery (Heavy Fuel Generators)

25,198,000 Household furniture's 655,676

Aerials & Aerial reflectors , Boilers, Machinery

22,770,000 Medicines, Antibiotics & equipments

524,934

Alcohol & Tobacco 7,456,999 Vegetables, Fruits & Cooking oil

85,766

Table 5. Source: National Directorate Statistic (2010)

Merchandise Exports of major commodities

Commodity Quantity (in Kg)

Value (in USD)

Coffee 9,941,963 8,290,612 Re Exports Heavy Containers 26,021,000

Table 6. Sources: National Directorate Statistic (2010)

The data shows that the only commodity exports that Timor-Leste produces are coffee

beans and heavy containers, which are empty containers that are sent back after being used

for packing goods from imports. Coffee is only produced by three districts on the western

side of the island. Ermera is the largest coffee producing district. Table 7 below shows us a

district lifestyle comparison comparing the district of Ermera with three other districts,

including Manatuto from the Eastern region, Dili the Capital and Manufahi from the Southern

region.

Issues status Manatuto

in %

Dili

in %

Ermera

in %

Manufahi

in %

Food Consumption Less than adequate 32.0 27.7 71.3 28.9

Housing Less than adequate 27.7 23.1 62.6 45.4

Clothing Less than adequate 16.0 21.2 31.8 21.2

Health Care Less than adequate 19.2 15.1 56.2 22.5

Children education Less than adequate 22.2 28.4 54.4 20.2

Household income Less than adequate 69.0 56.2 86.8 69.1

Table 7. Sources: National Directorate Statistic (2007, page 234 & 237)

The data demonstrates that the people of Ermera district are far below the others in

terms of lifestyle factors. So who actually exports the coffee beans? The National

Cooperative Business Association (NCBA) has been involved in Timor-Leste coffee exports

since 1994, with financial support from the United States Agency for International

Development (USAID) (NCBA, 2011). NCBA actually monopolises the market. This gives

no option to the coffee farmers who must become members and sell their coffee to NCBA.

Those who sell more than 1000kg a year to NCBA will receive free services from NCBA

clinics; if selling less than that, members still can access the clinics but have to pay (Lao

Hamutuk, 2002):

“More recently, one of our most successful projects is in East Timor. NCBA/CLUSA’s Cafe

Coopertiva Timor has become the largest supplier of single source coffee to Starbucks and the

primary health services provider of the island nation”, (NCBA, 2011).

Ironically, the above quote is contradicted by data from the National Directorate of

Statistics (see Table 7) in which Ermera district has the highest percentage of less than

adequate health care from among the three comparison districts. Table 6 shows that the value

of coffee exports in 2009 is about 8.2 million US dollars, however, according to Lao

Hamutuk (2002) the NCBA or CCT buy Timorese coffee at 10 to 12 cents per kilogram, and

now the coffee market is around 15 cents per kilogram. It is clear therefore who benefits from

this business partnership in coffee exports.

All the elements of GDP as described above, including consumption, investment,

government spending and trade balance, can be simplified by drawing two charts below:

Circular Flow of Income (normal) Timor-Leste

Circular Flow of Income

Markets of Goods & Services

Government Firms

Household Factor of production

Oil Revenue

Global Market

Banking

There are two differences between a normal and a Timor-Leste circular flow of

income: first, in the normal circular flow of income, companies and households together

create a factor of production where companies provide jobs to households and in return

households provide labour to companies, with households receiving income and companies

receiving goods from labour. In Timor-Leste there is no factor of production - the

government acts like companies by recruiting 37.3% of civil servants and creating temporary

jobs (13.8%) in rural public works programs (National Directorate Statistic, 2007). On the

other hand, the oil revenue has played a very crucial role, becoming the only factor running

the economy of the country.

Second, not only households spend their income on imports of goods and services;

government and private sector also does. For example in the 2010 state expenditure, the

government spent 23.250 Million US Dollar just for importing rice directly from Laos,

Vietnam, Thailand and Indonesia (Ministry of Finance, 2010). The local private sector also

spends money on importing goods and services, for example when the private sector wins a

bidding contract from government for the building of an infrastructure project, almost 90% of

construction material will be imported from the global market. If the Timor-Leste economy

remains as is for another 10 years, the country will face a great disaster because the oil

resources from Bayu Undan will only last until 2022 (Lao Hamutuk, 2012). If the volume of

oil resources can be predicted, the government of Timor-Leste should think about how to find

another alternative in order to continue to run the economy. There are two options that the

government can take to anticipate the transition from oil revenue into a real economy before

the oil runs out.

First, if foreign investment or the local private sector is still unwilling to invest their

money because of corruption and accountability, the government should avoid direct import

activity, meaning that it should not buy rice directly from the global market, but let the

private sector or retailers deal with that, and the government can then buy from the private

sector or retailers. While the price will be more than the original price, the private sector will

employ more labour just for unloading the rice from containers, which is positive for the

employment sector.

Second, the government should think about creating more community based

cooperatives; the goal is to anticipate foreign business such as NCBA which has taken more

advantage of coffee farmers rather than helped them. If the government wants to attract

foreign investment, it should be proactive and ensure that investors do not engage in business

practices that disadvantage farmers or community.

Conclusion

This paper has explored macroeconomic risk for Timor-Leste. A number of factors

have been discussed. An increase in the percentage of GDP does not mean that the economy

is doing well. Transparency and accountability is always a question for investors before

making any decision about investment. High consumption can be reflected as stability of

income but it does not mean that everyone has equal income to consume. Solving

unemployment issues does not mean making an urgent call to foreign direct investment, but

rather first addressing enforcement of the rule of law and judicial independence. Investing in

government expenditure in infrastructure projects in terms of budget allocation does not mean

that enough has been done. A trade balance deficit does not mean increasing the volume of

exports or commodities, but can also mean reducing some items of import commodities. In

terms of circular flow of income, it appears that the Timor-Leste government is heading in

the wrong direction; this is a macroeconomic risk.

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3

Thomas Freitas is a former a Founder and Former Director of Luta Hamutuk Institute,

and a Former member of Petroleum Found Consultative Council. This article was written in

2012, and the author is willing to have more discussion on this issue. The author can be

reached through email thomas_freitas@yahoo.com