UNCLAS SECTION 01 OF 03 DILI 000474

SIPDIS

DEPT FOR EAP/MTS
PACOM FOR POLAD AND JOC
NSC FOR HOLLY MORROW
SIPDIS

E.O. 12958: N/A
TAGS: PGOV ECON EPET EFIN TT
SUBJECT: 06-07 BUDGET USES PETROLEUM FUND TO TARGET POVERTY

REF: A) 2005 DILI 406, B) DILI 161

DILI 00000474 001.2 OF 003



1. Summary: Following Parliamentary approval last month, the
Government of East Timor (GOET) FY 2006-2007 budget went into
effect in early September, two months after the beginning of the
fiscal year on July 1. At $315.9 million this budget reflects
an increase of more than 100 percent over the previous year and
is primarily funded by East Timor's Petroleum Fund, established
in July 2005. The budget's overarching theme is promoting
economic growth as the key to fighting poverty, with significant
infrastructure investment as the main mechanism to be employed.
Submitted by the current government in August, it is nonetheless
essentially the budget of former Prime Minister Mari Alkatiri
and therefore reflects his priorities. However, Prime Minister
Jose Ramos-Horta has taken on the anti-poverty emphasis as his
own and his government added several items reflecting his own
priorities. The key challenge for the budget will be the
difficulties the GOET faces in executing its budgets. Last
year's budget, at less than half the size, was only 70 percent
executed, and this year's budget must be implemented in much
less time. End summary.

Despite spirited debate, Parliament passed budget with few
changes
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2. The National Parliament passed the budget for FY 2006-2007 on
August 14. Following final revisions, the President promulgated
the budget in late August and it went into effect early this
month. There was spirited Parliamentary debate over the budget.
Members of Parliament complained that it devoted insufficient
resources to the needs for rebuilding, justice, and
reconciliation created by the recent political and security
crisis. However, they ultimately made only a few modest
changes, all related to entitlements for Members of Parliament.
Ramos-Horta required all ministers and vice ministers to be
available for the duration of the Parliamentary debate, in sharp

contrast to Alkatiri who was notoriously reluctant to make his
ministers available to be called by Parliament. All ministers
will also be required this fiscal year to deliver monthly
reports to Parliament on the work of their respective ministries.

Huge increases in spending underwritten by Petroleum Fund
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3. The $315.9 million budget for FY 2006-07 is more than double
the size of last year's budget. It is also significantly higher
than the budget of $210 million budget that had been planned
before the recent crisis. This significant increase is made
possible by a transfer of $260 million from the Petroleum Fund,
the first use of the Fund to supplement the state budget since
its establishment last year. The $260 million Fund transfer is
somewhat lower than the amount that could be withdrawn within
GOET's previously announced guidelines for sustainable
withdrawals from the Fund ($283 million). Withdrawals on this
scale have been made possible by the rapid growth of the Fund
over the last year, which far outstripped early projections. As
of the most recent quarterly report, dated June 30, the Fund
stood at $649.7 million, having grown from $507.9 million the
previous quarter. It is expected soon to exceed a billion
dollars and will be the most significant source of budget growth
for the foreseeable future.

Budget planning focus on poverty reduction
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4. The Prime Minister and other GOET officials presented the
budget's primary theme as poverty reduction, with increasing
non-petroleum economic growth identified as the central strategy
for addressing this. The budget narrative states a goal of
between 7 and 8 percent annual growth by 2010. (Current
non-petroleum growth is about 2 percent.) The main mechanism
identified for achieving this is a massive increase in
infrastructure investment (capital development spending), which
has been increased from $24 million in last year's budget to
$120 million this year. However, poverty reduction strategies

DILI 00000474 002.2 OF 003


have been integrated across the budget into all categories of
spending, with particular emphasis on agriculture, health,
education, and water and sanitation. The Government also
announced its intention to spend substantially more in "the
districts" (that is, outside the capital city) in an effort to
combat the Dili-centered development trends of recent years.

Execution will be key challenge
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5. Attaining the budget's anti-poverty goals will depend, of
course, on effective budget execution, and many observers are
skeptical about the Government's ability to succeed in
implanting much of the 2006-2007 budget. A significant amount
of each previous year's budget has been unexecuted. Last year
the official execution rate was approximately 70 percent.
However, this figure is calculated on the basis of
"commitments", which earmark the money so that it is not lost at
the end of the fiscal year but do not actually spend the money
or even legally commit it. Thus the real execution rate last
was far lower than the announced figure, and some money that was
committed as long ago as FY 2003-2004 remains unspent.


6. Execution of this year's budget will be made more difficult
by the fact that the largest increase in the budget is in
capital development, traditionally the most difficult to spend
because of the scope and complexity of GOET procurement
processes. Also of concern is the short time during which the
budget must be implemented. In addition to being promulgated
two months after the beginning of the fiscal year, the budget is
tied to the Ramos-Horta government's mandate which runs out on
May 20, 2007, leaving less than nine months for its
implementation.


7. The GOET has acknowledged the urgent need to improve budget
execution. There is thus an effort underway to address key
structural issues underlying budget execution difficulties.
These include an overly centralized decision-making structure
and a procurement process that has previously required almost
all spending to go through the underresourced and overburdened
procurement office in the Ministry of Planning and Finance. The
procurement law has already been changed to allow individual
ministries to approve expenditures up to $10,000 without going
through the procurement office, but this change has not yet been
fully implemented and will require extensive training on the new
procedures before it can be.

Mostly Alkatiri's budget
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8. The budget as passed is essentially the same budget as that
submitted by the former government prior to Alkatiri's
resignation. The overall budget strategy --- capital investment
designed to create the infrastructure necessary for future
growth --- was outlined in a major policy speech delivered by
Alkatiri at the annual Timor-Leste Development Partners Meeting
on April 4 (Ref B). Although there were accusations at the time
that Alkatiri's anti-poverty drive was a politically cynical
move in preparation for the 2007 elections, most international
observers have evaluated the strategy itself positively.


9. There have, however, been substantive criticisms of some
aspects of the budget. Critics have pointed out that the armed
forces (F-FDTL), whose conduct during late April and May is
generally regarded as among the principal causes of the
political and security crisis, are being funded at a level of
about twice that dedicated to the national police service
(PNTL), which is also troubled but most of whose members are
generally regarded as having behaved honorably during the
crisis. Another focus of criticism is that the budget allocates
the vast majority of funds for the 2007 elections to the
Secretariat for Election Administration (STAE), which reports

SIPDIS
directly to the highly partisan Ministry for State
Administration. The National Elections Commission (CNE)
mandated by the Constitution requires to supervise the election
process is funded only at about one-tenth the level of STAE.

DILI 00000474 003.2 OF 003



Some changes reflect Ramos-Horta's priorities
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11. While the budget submitted by Ramos-Horta retained all
elements of the original Alkatiri budget, it did include some
additional items. The most significant single addition is a
transfers and grants category, funded at $18.2 million. This
funding will be directly transferred to recipients, mostly in
the districts, for projects related to education, agricultural
development, health, crisis recovery, and civil society support.
Other additions in the Ramos-Horta budget include a 30 percent
cost of living increase for civil servants, a $7 million fund
for rebuilding of homes destroyed during the recent unrest,
additional funds for food security, and funds for the
replacement of government property lost or stolen in recent
months.


12. Comment: It is important to note the significant role the
Petroleum Fund is playing in the budget. In Ref A, we expressed
some concern that the Fund legislation left important loopholes
that could allow GOET to draw down the Fund in excess of
legislated limits. In light of the rapid growth of the fund,
that now seems an unlikely risk for the foreseeable future.
Rather, the amounts that GOET can withdraw within the set limits
are so large in relation to the economy that they could
contribute to the "resource curse" of overreliance on petroleum
revenue leading to weak development in other areas of the
economy. End comment.
REES