Draft 29039 Initial Project Information Document

Country Name: The Democratic Republic of Timor-Leste Region: East Asia and Pacific Project Name: Third Transition Support Program (FY2005) Sector: Poverty Reduction Project ID Number: P083894 Implementing Agency: Ministry of Planning and Finance GPA Compound Dili, Democratic Republic of Timor-Leste Contact: Maria Madalena Brites Boavida, Minister Phone: 670-390-3339510 Email: [email protected] Environmental Category: C (Not Required) Date PID Prepared: April 20, 2004 Appraisal Date: April 19 to May 7, 2004 Projected Board Date: September, 2004

Country and Program Background 1. Timor-Leste became independent on May 20, 2002, following 25 years of conflict, a violent transition from Indonesian rule in September 1999 and two and half years of United Nations administration. The country now faces the challenges of nation-building with very limited human resources, embryonic institutions, a stagnant economy, high levels of poverty and unemployment. 2. The gradual winding down of the international presence following independence and slow- down in reconstruction programs has led to contraction in economic activity, particularly in urban areas. At the same time, agricultural production has been adversely affected by a drought. IMF estimates point to a decline in GDP of around 2 percent in 2003. Non-oil exports increased to about US$7 million in 2003, of which US$6 million is coffee. Imports continue to decline, to US$174 million in 2003, as the international presence winds down: in 2000 imports by humanitarian and UN agencies accounted for more than 50 percent of imports, today they account for less than ten percent. From late 2002 through to mid-2003 inflation hovered around 8-10 percent due to a drought induced scarcity of agricultural goods. Inflationary pressures have since abated, with year-on-year inflation in January 2004 reported at 4 percent. There is some evidence that private sector wages have started to fall. Nevertheless, the overall wage level remains relatively high in comparison with neighboring countries, undermining competitiveness. At the same time, unemployment rates are high, particularly among the young. 3. The Government continues to actively promote overseas investment in Timor-Leste, particularly from the ASEAN region. Even though some interest has been shown in concessions for exploitation of natural resources, such as fisheries and forestry – which the Government has wisely deferred pending further review – there has still been no significant foreign direct investment since Independence. 4. Production of liquids at the Bayu-Undan field in the Timor Sea Joint Petroleum Development Area began in February 2004. The project is expected to generate about US$3 billion in revenues over a twenty-year period from 2004. However, recent changes in the project tax regime and production profile have led to delays in the revenue stream. Projections presented in the FY2004 Mid-Year Budget Update (MYBU) point to a financing gap of US$126 million for the period FY2005 to FY2007, on the basis of current savings and expenditure policies and taking into account programmed TSP III (FY2005) financing (see Table 1). More recent estimates, yet to be finalized, point to slightly higher revenues over this period, with a reduction in the FY2005 to FY2007 financing gap to around US$70 million1. 5. The National Development Plan, prepared through a broad consultative process and approved by Parliament shortly after Independence, provides the overall framework for national development. The strategy for FY2003 to FY2007 has two overriding goals: to promote rapid, equitable and sustainable economic growth and to reduce poverty. These concerns are reflected in the Government’s prioritizing and sequencing exercise, which provides a “Road Map” for the implementation of the NDP and the basis for the FY2005 government program and budget. Progress under TSP I (FY2003) and TSP II (FY2004) 6. The Government’s first and second Transition Support Programs were intentionally ambitious both in the range and number of actions and timing of milestones. While this approach obviously entails the risk that many programmed actions will not be completed, the annual TSP has provided Government with a framework for coordinating and monitoring its overall program. It has also served as a framework for harmonizing external partners support around the Government program. Now that Government systems have been put in place, notably the preparation and routine monitoring of agency annual action plans and quarterly reporting matrices, and the Government has made progress in policy development and strategic planning at the sector level, attention can turn from in-year scheduling to a medium-term perspective. These changes in approach are reflected in the design of TSP III (FY2005). 7. Broad progress has been made in the implementation of the programs identified under TSP I (FY2003) and TSP II (FY2004). Progress has tended to be slowest in the area of governance, particularly as regards the establishment of oversight and internal control mechanisms. There have also been significant delays in the preparation of legislation across the program, though these delays have often allowed time for consultations and led to more appropriate design. Of particular concern are the slow pace of budget execution, particularly in priority sectors such as education, and the slow pace of capacity building and institutional development. These issues will be addressed directly in TSP III (FY2005) and successor operations. The Proposed Grant 8. The annual Transition Support Program (TSP) provides a framework for multi-donor budgetary support to the implementation of the NDP. Initially, three annual TSP operations were foreseen, covering the period FY2003 to FY2005. The Government has now requested that the Bank schedule two further TSP operations in FY2006 and FY2007. Financing for each TSP is agreed on the basis of annual program laid out in the Government’s Letter of Development Policy and Action Matrix. These actions constitute a sub-set of the activities presented in the Government’s internal Annual Action Plans, prepared by all agencies as part of the annual planning and budget process. The sub-set reflects both Government’s and development partners’ appreciation of policy and operational priorities for the year ahead.

1 There remains considerable uncertainty as regards Timor Sea revenues over the medium-term arising from production and price factors. Current estimates of Timor Sea revenues amounting to US$151.1 million over the next three years are based on an oil price of about US$25/barrel and the company’s baseline production volumes. However, a scenario with higher oil prices (US$28/barrel) and higher production could give revenues of US$271.4 million. A scenario with lower oil prices (US$22/barrel) and lower production could give revenues of only US$43.3 million.

9. The TSP III (FY2005) will focus on three thematic areas, reflecting NDP and Stability Program priorities: a) Good Governance, including strengthening State institutions, public sector management and public expenditure management; strengthening administrative capacity in the justice sector; and, possibly, capacity building in the police; b) Service Delivery for Poverty Reduction, particularly improvements in the efficiency and effectiveness in the health and education sectors; and c) Job Creation, especially through private sector development and agriculture. Building on the experience of previous TSP exercises and the Government’s policy and planning initiatives, TSP III (FY2005) will seek to focus on systems performance by making greater use of quantitative performance indicators; introduce a medium-term perspective; place a greater focus on integrated capacity building efforts; mainstream gender issues throughout the program; and strengthen stakeholder dialogue on TSP design and process. 10. Nine bilateral donors provide parallel budgetary support financing for the Transition Support Program through Bank administered Trust Funds for the three years through FY2005, amounting to approximately US$77 million: the United Kingdom (US$20.2 million); Australia (US$16.1 million); the United States of America (US$12 million); Norway (US$11.1 million); Finland (US$4.4 million); Ireland (US$2.8 million); Canada (US$1.7 million); Sweden (US$1.4 million); and New Zealand (US$1.2 million). Portugal provides parallel budgetary support financing, amounting to US$9 million directly, rather than through Bank administered Trust Funds. Additional contributions for the period FY2005 through FY2007 are currently under review. All donors, including the UN system partners, have participated in TSP design and monitoring, regardless of whether they provide budget support or channel funds through Bank administered funds. 11. The Bank financing for Transition Support Program III (FY2005) will be provided as an IDA grant of SDR 3.4 million. Contacts: 12. The Bank contact point is: Adrian Fozzard (Task Team Leader) The World Bank 1818 H Street NW Washington DC 20433

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