East Timor moves to establish foundations of sound macroeconomic management

• Author: Luis Valdivieso
• Position: IMF Asia and Pacific Department
• Pages: 276-278

Page 276

East Timorese money changers offer their services in a Dili market. Inefficiencies and distortions have arisen from the use of multiple currencies.

In the year since the August 1999 referendum on its political future and the subsequent violence, East Timor— aided by significant official, bilateral, and multilateral resources—has sought to lay the foundations for a stable, functioning economy. This article, based on a forthcoming publication by Luis Valdivieso of the IMF’s Asia and Pacific Department and others, examines East Timor’s progress to date, the IMF’s role, and the challenges ahead.

Background

After more than four centuries of Portuguese rule, Indonesia annexed East Timor in 1975. In the mid-1990s, East Timor ranked among Indonesia’s poorest provinces, with a per capita income of about $350. Its economy grew rapidly, however, driven by capital outlays on infrastructure funded largely by transfers from the Indonesian central budget. Real GDP growth averaged about 10 percent and inflation was in single digits.

Output growth collapsed with the onset of the Asian crisis in 1997. The decline was partially offset by growth in agriculture, the financial sector, public administration, defense, and public utilities. Per capita GDP reached $424 in 1998, and inflation increased to about 80 percent (see table, page 277).

In East Timor’s small and rudimentary banking system, publicly owned banks were key players. Public finances depended heavily on transfers from Jakarta, with tax revenues amounting to only 6–8 percent of GDP (excluding revenues related to oil concessions), while expenditures represented 40–75 percent of GDP. The economy was quite open and heavily reliant on interisland trade. Exports averaged about 13 percent of GDP during 1995–98, while imports averaged about 36 percent of GDP.

After the referendum

Following an agreement among the United Nations, Indonesia, and Portugal, a referendum was held on August 30, 1999, on the future status of the territory. The referendum provided an overwhelming mandate for independence, but the outcome also triggered widespread violence that seriously disrupted East Timor’s economy and institutional structure.

The destruction affected all sectors of the economy. Real GDP is estimated to have declined by almost 40 percent in 1999 and inflation increased sharply.

The banking and payments system ceased functioning, and all transactions were conducted in cash— mostly in rupiah, although other currencies also started circulating. Public administration also stopped functioning, revenue collection came to a halt, and budgetary transfers from Jakarta ceased.

The disruption in...