NATIONAL BUDGET PLAGUED BY EXECUTION CHALLENGES AND

UNCLAS SECTION 01 OF 03 DILI 000166

SIPDIS

DEPT FOR EAP/MTS
TOKYO FOR HANS KLEMM
SIPDIS

E.O. 12958: N/A
TAGS: PGOV ECON EPET EFIN TT
SUBJECT: NATIONAL BUDGET PLAGUED BY EXECUTION CHALLENGES AND
POLITICAL UNCERTAINTY

REF: A) 2005 DILI 406, B) 2006 DILI 474

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1. Summary: During an informal briefing for donors last week,
the International Monetary Fund's Resident Representative in
East Timor painted a bleak picture of budget execution to date
for the fiscal year (FY) 2006-2007. Of a $329 million budget,
while $211 of it has been committed, only $84 million (about 25
percent) has actually been spent. The picture is worse
regarding spending on capital development, the budget's single
biggest category and a key component of the government's
anti-poverty priorities, where only $3 million of $120 million
budgeted has been spent. With large amounts of carryover from
previous years still coming on line, the FY 06-07 numbers are
not the whole picture, but nonetheless starkly demonstrate the
barriers to progress on a development and anti-poverty agenda.
Meanwhile, planning has begun for the FY 07-08 budget, but is
overshadowed by preparation for elections and the uncertainty
regarding the next government. Plans for the new budget are
similar to FY 06-07, but some new categories as well as
innovations to improve execution are being discussed. Available
revenue from the Petroleum Fund to subsidize the next budget is
expected to be around $330 million. Post expects that even if
planned budget proposal preparation proceeds on schedule, the
current parliament is unlikely to pass a budget prior to the end
of its mandate. Operation on the resulting equivalent of a
continuing resolution, however, would restrict the GOET's
ability to begin new programs and commitments, delaying once
again desperately needed progress on numerous issues. End
summary.

Execution of 2006-2007 budget
--------------


2. During an informal briefing for donors last week, the
International Monetary Fund's Resident Representative in East
Timor painted a bleak picture of budget execution to date for
the fiscal year 2006-2007. (The fiscal year ends on June 30.)
While $211 million has been committed, and thus is counted as
"executed" according to the government's accounting, actual cash
expenditures stand at $84 million out of a $329 million budget.
This is an improvement over this time last year when only $60
million had been spent, but most of this reflects increases in
recurrent costs, such as salaries, that are the easiest
categories to spend. The major focus of the 2006-2007 budget, a
massive increase in capital development investment designed to
address anti-poverty priorities, is where the inability to
execute stands out. Of $120 million allotted for the year, only
$3 million has been spent to date.


3. The gap between what the Timorese government defines as
execution, i.e. the commitment of funds, versus the actual
expenditure of those funds, has resulted in large amounts of
each year's budget being carried over for spending in future
fiscal years. In fact, the government still has carryover
commitments on the books as far back as the FY02-03 budget.. At
present the IMF reports a total of at least $150 million in
outstanding carryover commitments from previous years,
encompassing some 600 items. These carryovers are in many cases
the source of larger spending currently taking place. For
example, in contrast to only $3 million spent out of the FY
06-07 budget on capital development, carryover spending in this
category is estimated to be around $12-15 million.

Planning for new budget
--------------


4. Development of next year's budget, which according to East
Timor's current fiscal year cycle is due to begin July 1,
formally commenced this week and ministries are now working on
their respective proposals. These proposals are due to Ministry
of Planning and Finance (MOPF) by May 7. MOPF plans to forward
the draft to the Council of Ministers in early June in order to
reach Parliament by June 15 so that it can be voted on and
approved before the end of this parliament and before the start
of the new fiscal year (parliamentary elections will be on June
30; the fiscal year runs from July 1 - June 30).


5. Observers at the IMF and the World Bank note that this is an

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extremely tight timeframe. The process is also overshadowed to
a large extent by election-related activities-many ministers and
ministry staff are taking regular leave to campaign-along with
the uncertainty of the election outcome. Moreover, there
remains significant disagreement regarding whether the existing
Parliament legally can or should pass a budget for a government
not yet in power. Separately, Post has also been informed that
some political actors favor changing the fiscal year to align
with the calendar year. How and whether this will impact budget
planning and the date at which a new budget comes on line is
unclear at this point.


6. Nonetheless, the process is moving forward and some aspects
of what the new budget will likely include are emerging. An
advisor in the MOPF relayed to Emboff that the present
expectation is for the new budget to reflect similar
anti-poverty priorities as the current budget. The advisor also
noted that the current process is based on the expectation that
recurrent funding (salaries, goods and services, minor capital,
transfers) will remain at similar levels to FY 06-07, while
capital development funding is to be reviewed to ensure its
achievability and alignment with anti-poverty priorities.
According to the IMF, this budget will incorporate some
innovations particularly regarding the handling of carryovers
from previous fiscal years. Specifically, most items that are
committed but not obligated by the end of June 2007 will lapse
and have to be re-appropriated to remain active. Obligated
items will then be subject to deadlines for actual spending, by
December 31, 2007 for most categories and by June 30, 2008 for
capital development.


7. New items that are reportedly being proposed for the FY 07-08
budget include:
-- $45 million to the Millennium Challenge Account Program for
Accelerated National Development (PAND),mostly for a hydropower
project;
-- $28 million for new veterans' pensions;
-- increased electricity costs;
-- a ferry subsidy (for the ferry that provides the only public
transportation between Dili and the Oecusse enclave as well as
Atauro island);
-- food security;
-- and costs for a new career development and promotion
regulation, the financial implications of which remain unclear.


8. If Parliament and the President are unable to agree on a
budget before the start of the fiscal year on June 1, then the
government will follow the 1/12th rule, which in absence of an
approved budget allows ministries to spend 1/12 of the previous
year's budget per month on current expenditures and minor and
major capital that has already been obligated. The government
cannot transfer monies from the Petroleum Fund without a budget,
but this is unlikely to be a problem, as $200 million has just
been transferred and another $60 million is expected to be
transferred before the end of the fiscal year. Given the low
rate of current spending and available cash on hand, government
will not be running into a liquidity problem for some time.

Revenue status
--------------


9. The Petroleum Fund, the single largest source of revenue for
the GOET, is currently increasing at a rate of approximately
$100 million per month, with a current balance of $1.2 billion.
The fall in oil prices means that the ceiling for withdrawal
from the Petroleum Fund is slightly lower than last year, but
the limit for FY 07-08, at approximately $330 million, still
stands at more than the FY 06-07 budget. However, if a
significant amount of unspent commitments need to be
re-appropriated, and are thus incorporated in the FY 07-08
budget, budget demand could then exceed the amount available to
be withdrawn from the Petroleum Fund. This could constrain the
amount available for capital development, but should not be a
major issue in light of the many projects in the pipeline. The
prospect of Millennium Challenge Corporation (MCC) funds coming
on line does not at this time appear to be included in
calculations for the new fiscal year, as government officials

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now appear to understand that MCC's due diligence requirements
will take significantly more time and that continued eligibility
is not a foregone conclusion.

Comment
--------------


10. The GOET's ongoing dismal budget execution demonstrates the
fundamental difficulties Timor faces in translating its cash
riches into national development and prosperity for the wider
population. Even with previous years' commitments coming
on-line, the extreme shortfall on actual spending arguably
represents East Timor's greatest barrier to effective
development and poverty reduction. Regarding the prospect for
the new budget, Post assesses that Parliament is unlikely to
pass a budget by June 30 despite the current efforts underway.
The more likely scenario is that the MOPF will move forward with
preparing a budget proposal for consideration by the new
government, but differences over the start of the budget year,
spending priorities, and the June 30 parliamentary elections
will result in no budget being enacted. After the end of the
fiscal year June 30, the government would then operate under the
rules that allow it to spend 1/12th of the previous year's
budget on recurring expenses. The new government, once in place,
would either accept the MOPF's proposal with limited changes or
choose to operate for a sustained period without a new budget in
order to develop a new proposal. Operation on the resulting
equivalent of a continuing resolution, however, would restrict
the GOET's ability to begin new programs and commitments,
delaying once again desperately needed progress on numerous
issues. One further dynamic to watch will be the role of the
new parliament. The current parliament, dominated by the ruling
Fretilin party, has with few exceptions served as a rubber stamp
on previous years' budget processes. The new parliament is
expected to be far less dominated by any single party and so may
introduce a much more interesting -if less efficient-budget
approval process. End comment.
NAGY