Statement at Donor Meeting

Donors Meeting on East Timor, December 17, 1999

December 17, 1999

I. Introduction and Background Developments

1. This is a meeting of historic importance for the people of East Timor as it marks the start of another key stage in their move towards a lasting solution to the difficulties they have faced. It is a great pleasure and honor for me to represent the Fund at such an historic event, and in the presence of so many distinguished delegates and guests. On behalf of the Fund team, I would like to thank the organizers for the opportunity to present this statement.

2. I would like to begin my remarks by briefly reviewing the economic situation in East Timor, both before, and then after the referendum. First, on the situation before the referendum, I have four points:

(i) The East Timorese economy was growing rapidly over the period 1994-1996, mostly driven by heavy budget-supported spending on roads and construction. Growth of real GDP averaged 10 percent annually over this period, while yearly inflation was below 10 percent. The economy remained predominantly agricultural with most of the population living in rural areas. Per capita GDP rose rapidly reaching $426 by end-1996. When the Asian Crisis hit Indonesia in 1997, output growth collapsed, but the intensity of the decline was less severe in East Timor than in other territories. However, interest rates (over 38 percent) and inflation (80 percent) rose to levels comparable to other parts of Indonesia.

(ii) Despite rapid growth in economic activity, the East Timorese banking system remained small and rudimentary. It comprised a branch of Bank Indonesia (BI-D) and eight commercial banks. Publicly owned banks (including one owned by the provincial government of East Timor) were the key players. Only about half of the banks' deposit liabilities were lent domestically, the rest being invested mainly with affiliate commercial banks. BI-D played a key role in the provincial payment system clearing arrangement. The rupiah was the legal tender and virtually the only currency in circulation. The amount of rupiah in circulation is estimated to be about Rp.500-700 billion at end-September 1999.

(iii) East Timor's public finances were heavily dependent on transfers from the central government in Jakarta. Official sources report revenues collected and spent locally in East Timor of about 2½ percent of GDP in FY 1997/98 and 3 percent in FY1998/99. However, in addition East Timor collected and transferred to Jakarta, other tax revenues that were as high as 5.7 percent of GDP in FY 1997/98 and 5 percent of GDP in FY 1998/99. Moreover, this figure did not include certain revenues¹ which could have accrued to East Timor had it been independent throughout these years. But even including these amounts, the net transfers from Jakarta (i.e., net of the revenues generated in East Timor but transferred to Jakarta) were significant as a share of both GDP and total expenditure.

(iv) The economy of East Timor was quite open and reliant on inter-island trade. Preliminary estimates show that exports (including exports to third countries as well as intra-Indonesian trade) averaged about 13 percent of GDP during the period 1996-98, while imports (same coverage) hovered around 37 percent of GDP. Agriculture, in particular coffee, and quarrying accounted for a large part of exports. The main imports included foodstuffs, petroleum products, and products used in the construction industry. An important number of imported goods were heavily subsidized, especially rice and petroleum products. The deficit on the services balance is believed to have been negligible. The main form of capital inflows were net official transfers from the Central Government of Indonesia, although there was limited foreign development aid from donors (rising from 8 to 12 million US dollars in 1995-1998 or about 3 percent of GDP).

II. The macroeconomic Situation after the referendum

3. Let me now turn to more recent developments, especially the situation after the referendum. Again, there are four points I would like to mention:

(i) The adverse spillover effects of the Asian crisis were aggravated by rising political uncertainty since the beginning of 1999, as the political debate about independence intensified. Thus, during the first few months of 1999, economic activity had already slowed down considerably. All these difficulties, however, did not provide a hint of the widespread violence and destruction that was to follow the announcement of the referendum results in favor of independence in early September 1999.

(ii) The economy of East Timor has been deeply and critically disrupted. Basically all retail trade, services and government activities have come to a standstill, and most agricultural activities have been affected by the disturbances. A large proportion of the public infrastructure and private property has been seriously damaged. The banking system has ceased functioning locally following the destruction of buildings and equipment. All transactions in East Timor are being conducted in cash, mostly in rupiah, although some foreign currencies are beginning to circulate. The structures and systems of government are no longer in place. There is no capacity to collect taxes, and public utilities, when available, are not being paid for. Perhaps more important is the fact that the massive displacement of the population may translate into a permanent loss of valuable human capital, particularly key civil servants and commercial bank officials.

(iii) Not everything is lost, however. First, there has been noticeable progress in restoring security conditions and providing relief to the most needy groups of the population, including those returning from their temporary exile. The efforts of the population have been supplemented in a timely manner by those of the International Force for East Timor (INTERFET), the United Nations Mission for East Timor (UNAMET), the UN Office for the Coordination of Humanitarian Affairs (OCHA) and several other governmental and nongovernmental organizations dedicated to providing humanitarian relief. Second, community organizations with the help of NGOs have started to emerge filling the vacuum of authority, and these efforts are likely soon to be complemented by the various committees being set up by the United Nations Transitional Administration for East Timor (UNTAET) and the East Timorese leadership. Third, there is some scope for putting the economy back to work. For example, coffee, the major export crop, has not been directly affected by the disturbances, except for its marketing which has been impaired by lack of transportation facilities and limited sale outlets. Some major roads, seaports and airports, although in urgent need of repair, are still partially functional and so are the fuel depots, some electricity generators, and selected sources of water supply. Selected commercial bank transactions with Indonesian commercial banks have continued to take place through Kupang, West Timor (where commercial banks have relocated) or through other branches across the Indonesian territory.

(iv) Nonetheless, we believe, and I am sure everyone here would agree, that the task ahead remains monumental. The incipient administrative and economic structure is likely to be under severe stress to ensure the continued provision of humanitarian relief while at the same time trying to progressively provide the population with increasing opportunities to have gainful employment through broad-based growth. In this context, it will be important to ensure (a) ensure that ad-hoc decisions taken for the sake of pragmatism will be consistent with setting the right foundations for East Timor's medium term development; and, (b) that key consultative bodies, such as the National Consultative Council (NCC), receive appropriate technical support so as to reduce the scope for the politicization of basic economic decisions.

III. Key features of a basic macroeconomic framework

4. I would now like to turn to the economic management for the period immediately ahead, and make a few points that we in the Fund consider vital.

(i) First, we believe that, it is essential for UNTAET to take clear and decisive steps mentioned below that would help establish the foundation of sound macroeconomic management. This is an essential precondition to ensure that the expenditures on humanitarian relief, reconstruction and development will be consistent with promoting and maintaining macroeconomic stability and creating an enabling environment for recovery. An early adoption of this framework would also help provide donors with reasonable assurances that their resources will be effectively used and properly accounted for. The areas requiring most immediate actions are those of payments, currency and banking, as well as the fiscal framework and fiscal management.

(ii) Second, regarding payments, currency and banking, the emerging consensus is that there is an urgent need to (a) create a transitory Central Payments Office (CPO) which would eventually evolve into a central bank; and (b) define a minimum regulatory framework. There also seems to be a fair degree of consensus that it will be difficult to replace at once the rupiah in circulation, and that the conditions for the introduction of an East Timorese currency are not in place at this stage. However, the decision about the foreign currency that will be used as the legal tender temporarily in parallel with the rupiah, seems to be taking longer than anticipated, as several considerations of both a political and technical nature are being taken into account. Every effort must be made to arrive at a decision on this issue in the NCC meeting before the end of the year.

(iii) Third, on the basic fiscal framework, there seems to be broad consensus on the need to create a Central Fiscal Authority (CFA) which will be responsible for administering public finances as well as enforcing fiscal legislation and ensure appropriate oversight. There is also awareness of the importance of formulating and adopting a budget (even if only preliminary) which is consistent with East Timor's short term absorptive capacity, particularly as there will be other major sources of expenditure which would contribute to fueling aggregate demand, and that is sustainable over the medium term.

(iv) Fourth, and in the context of what I have just mentioned, the IMF welcomes UNTAET's efforts in preparing the preliminary 2000 budget proposal for East Timor . It will be important to adopt and implement the policies underpinning the budget projections as soon as possible. While there is always scope for alternative policy formulations to achieve a given fiscal objective, it is important not to lose perspective of the main guiding principles that should be observed in situations like the one confronting East Timor. In particular, it will be important to (a) adopt a simple and easy-to-administer tax system, preferably based on indirect taxation; (b) define quickly an interim price structure of basic public utilities, which initially should cover at least all operational costs; (c) develop recruitment procedures for the civil service while proceeding cautiously in establishing the wage level and structure applicable to civil servants; (d) adopt transparent and competitive procurement procedures; and (e) ensure transparency and accountability.

(v) Fifth, and lastly, we believe the employment requirement estimates prepared by the Civil Administration Work Group of the JAM are broadly appropriate. The Group envisaged hiring close to 3,900 people by the end of the first six months of operation, rising to over 7,700 by the end of the first year. On wages, we believe that new civil servants should be hired for the new administration initially at an average base wage comparable to the one prevailing in July 1999, especially because there will be a sizable generalized indirect income support embedded in the humanitarian assistance program. It is clear, however, that the appropriateness of both the level and the structure of wages must be monitored closely and should be the subject of a review during the second quarter of 2000, as part of a more comprehensive review of all budgetary projections.

IV. Financing, Technical Assistance, And Training Requirements

5. Mr. Chairman, before concluding may I make a few remarks regarding East Timor's financing and technical assistance requirements.

(i) First, we believe that the magnitude of the shock endured by the people of East Timor, together with the need to set the basis for a sustainable recovery, make it critical that resources be available to implement the comprehensive programs for humanitarian aid, reconstruction and development, and to fund the UNTAET administration. Since it is not desirable for a transitional government to incur debts to discharge its responsibilities, and given that domestic resource mobilization is likely to be very difficult initially, it would be expected that the international community will be receptive to the request for grants which has been presented in the various documents circulated for this conference.

(ii) On current estimates, total external financing requirements for East Timor in the 15 months ending December 31, 2000 would amount to $218 million, which comprises (a) the $92 million deficit of the East Timorese consolidated budget before official transfers and after taking into account domestic revenue collection of $15 million (5½ percent of GDP); and (b) the special plea for additional humanitarian assistance coordinated by OCHA of $126 million. The Fund accepts these estimates, and we hope donors present here will feel able to meet the external financing requirement. Please note that the latter number (that relates to the special plea) excludes $57 million in medium- to long-term projects that need to be started immediately which has been included as part of the East Timorese consolidated budget. Please also note that the estimated external financing requirements of $218 million exclude an additional $225 million in rehabilitation development expenses proposed by the JAM for 2001-2002, and the associated recurrent expenses for those years which could not be covered by East Timor's own fiscal resources, and that remain to be estimated.

(iii) The establishment and management of a sound macroeconomic framework, including development of a supporting institutional and legislative apparatus, will require substantial and continued technical assistance, secondment of resident experts, and intensive training of local counterparts, both on-the-job as well as in more structured settings. The areas where most immediate assistance will be required include payments, currency and banking, fiscal policy design, management and enforcement. Given that the number of local counterparts is quite small, it will be important to establish from the outset very clear coordination mechanisms for all technical assistance initiatives. The IMF stands ready both to provide direct technical assistance and to help coordinate technical assistance efforts in the macroeconomic and financial policies area, if so requested by UNTAET and donor countries.

V. Conclusion

6. Mr. Chairman, I would now like to conclude by stressing that the difficulties faced by the people of East Timor call for a compassionate and coordinated effort to provide them with the additional means to forge a lasting and sustainable solution to their problems. The needs are evident, and so is the requirement for the organization and managerial skills to handle additional humanitarian financial support. UNTAET efforts at establishing a framework for decision making and developing institutional and legal structures are also steps in the right direction.

7. In this context, I would like to reiterate that the IMF supports both OCHA's special appeal and UNTAET's request for financial support for the preliminary East Timorese consolidated budget for 2000, as well as the 3-year request put forward by the JAM. The IMF pledges to work in close coordination with other international and national agencies to provide the required policy advice and technical support to develop further the macroeconomic framework to guide economic decision making.

Thank you.

¹ The exploitation of the oil fields of the Elang/Kakatua project (Timor Sea) is accruing royalties and taxes at an annual rate of US$ 4 million. If paid to East Timor, this would have raised fiscal revenue by the equivalent of 1½ percent of GDP at an annualized rate.