Timor-Leste's Macroeconomic Risk Analysis by Thomas Freitas

1. 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).

2. 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:

3. 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

4. 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

5. 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

6. 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.

7. 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)

8. 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

9. 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

10. 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

13. 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