INTERNATIONAL DEVELOPMENT ASSOCIATION INTERNATIONAL MONETARY FUND DEMOCRATIC REPUBLIC OF TIMOR-LESTE Joint Bank-Fund Debt Sustainability Analysis – 2018 Update Prepared jointly by the staff of the International Development Association (IDA) and the International Monetary Fund (IMF) Approved by Lalita Moorty (IDA) and Paul Cashin (IMF) Timor-Leste’s risk of external debt distress is assessed as low, using judgment that takes account of the country’s financial assets in the Petroleum Fund (PF). The assessed risk is improved from the previous DSA’s finding of “moderate risk”, reflecting fuller considerations of risk mitigating elements. Timor-Leste’s Public and Publicly Guaranteed (PPG) external (and public) debt is small (5 percent of GDP in 2018), and debt indicators are projected to remain below their thresholds under the baseline scenario over the entire projection period through 2038. Standardized stress tests show that a shock to the primary balance is the most extreme shock to the debt trajectory, causing a short-lived and marginal breach of the threshold for the PV of PPG debt-to-exports ratio. However, the Petroleum Fund (PF)—estimated at 506 percent of GDP in 2018— is large relative to projected debt levels and debt service requirements; and its assets are liquid and accessible, prompting the use of judgment to upgrade the risk assessment. Beyond the 20-year projection horizon, debt is projected to rise quickly, creating risks to debt sustainability. The authorities should adopt prudent policies to address this risk. The DSA illustrates the benefits of such policies in an alternative scenario. PUBLIC DEBT COVERAGE 1. The coverage of public sector debt used in this report is public and publicly guaranteed (PPG) debt. Timor-Leste’s PPG external debt is held entirely by the central government. The coverage of public sector debt includes SOE debt. Under the Public Debt Regime Law, SOEs are not allowed to borrow for themselves and can only obtain financing via on-lending from the Ministry of Finance.1 The public sector only borrows externally, given a lack of domestic financing sources. The Timorese private sector has negligible medium- and long-term external liabilities. The debt definition of the DSA is currency-based and the legal tender is the US dollar. Subsectors of the public sector Check box 1 Central government X 2 State and local government 3 Other elements in the general government 4 o/w: Social security fund 5 o/w: Extra budgetary funds (EBFs) 6 Guarantees (to other entities in the public and private sector, including to SOEs) X 7 Central bank (borrowed on behalf of the government) 8 Non-guaranteed SOE debt BACKGROUND ON DEBT 2. Timor-Leste’s net public asset position is currently strong due to oil-related savings accumulated in the Petroleum Fund (PF). • Size of the PF. The PF balance at end-2018 stood at Size of Timor-Leste's Petroleum Fund US$15.8 billion (506 percent of total GDP and 848 (In percent) percent of total non-oil GDP), covering more than 166 600 120 SWF Assets Public Debt Asset-to-Debt Ratio (RHS) months of goods and services imports. This makes the 500 100 PF one of the largest Sovereign Wealth Funds (as 400 80 percent of GDP) in the world (see figure). The PF 300 60 closing balance of 2017 improved compared to 2016 on the back of higher inflow of oil and gas receipts, 200 40 favorable investment returns and valuation effects, and 100 20 lower government spending due to a political impasse. 0 0 However, heightened global financial market volatility Saudi Arabia Kuwait Norway Timor-Leste in late-2018 led to negative valuation effects and a Sources: IMF Staff Reports; Saudi Arabia (2018); Kuwait (2017); Norway (2018). Note: Saudi Arabia's assets consist of SAMA's net foreign assets and do not include the Public Investment decline in the closing balance at end-2018. Fund (PIF). 1 According to the Public Debt Regime Law No. 13/2011, the Government of Timor-Leste (GoTL), in particular, the Ministry of Finance, is the only entity that may engage in borrowing, motivated by financing needs generated by the need to execute the State’s priority tasks relating to the building of strategic infrastructures for the country’s development. 2 • Liquidity. The Petroleum Fund Law sets out Timor-Leste: Petroleum Targeted Asset Allocation, 2017 eligible investments, guidelines for asset (In percent) allocation, and risk limits for the PF. Given the annual withdrawals from the PF to the budget, the US Treasury Bonds 3-5 years PF’s targeted asset allocation reflects a preference 40% 40% US Treasury Bonds 5-10 years for highly liquid assets (see figure). Currently, the targeted asset allocation is 60 percent in Treasury Global Treasury Bonds - Developed Markets (excl. US) Bonds of developed countries and 40 percent in Developed Market Equities developed market equities.2 Since its inception, the 10% 10% average return on PF assets has been around 4.4 percent (as of end-2017).3 Source: Timor-Leste Petroleum Fund Annual Report (2017). • Accessibility. The PF constitutes the main financing source for the budget. The amount is guided by the Estimated Sustainable Income (ESI), which is set at 3 percent of total Petroleum Wealth4. Withdrawals in excess of the ESI can be made, provided that the Parliament approves the government’s explanation that this is made in the long-term interests of the country. Over the lifetime of the PF, the government has withdrawn a total of $9.6 billion (end-2017), with excess withdrawals accounting for about 63 percent of this amount. The parliament has yet to reject a request for excess withdrawals.5 3. Outstanding public external debt is projected at US$157.7 million (5.1 percent of total GDP and 8.5 percent of total non-oil GDP) at end-2018. External loans signed totaled US$355 million (12.8 percent of total GDP and 19 percent of total non-oil GDP) by end-2018, which constitutes twelve loans under eight packages Text Table 1. Timor-Leste: External Public Debt by Creditor Groups and will be disbursed (In millions of U.S. dollars) over the 4 years until 2016 2017 2018 2022. Timor-Leste’s Multilateral 271 355 355 external borrowings Bilateral Non-Paris Club 50 are Total 321 355 355 from the Asian Source: Timor-Leste Ministry of Finance Development Bank, Japan International Cooperation Agency (JICA) and the World Bank Group. These loan packages are to support infrastructure projects, primarily assigned for rehabilitation and upgrading of national roads (Text Table 1).6 The Asian Development Bank has the largest share of total external debt, comprising nearly two- thirds of total external debt of Timor-Leste in 2018 (Chart below). 2 The 2011 Petroleum Fund Law specifies that no more than 5% of the Petroleum Fund should be invested in other eligible investments. The Council of Ministers recently approved a resolution to use these 5 percent to enable the purchase of the stakes of ConocoPhillips and Shell in the Greater Sunrise Joint Venture ($650m). 3 Staff assumes a 3.9 percent return on assets when projecting the PF balance. 4 Petroleum Wealth comprises the balance of the Petroleum Fund and the Net Present Value of expected future petroleum revenue 5According to the constitution, the President has the right to veto a budget that has been approved by the parliament. However, within 90 days, the Parliament can overrule the veto by an absolute majority of its members in full exercise of their functions (see Section 88, paragraph 2 of the Constitution of The Democratic Republic of Timor-Leste). 6In December 2015, the loan agreement signed by the Government of Timor-Leste and China EXIM Bank did not obtain the approval of the Audit Court due to legality issues on the project for the upgrade of the drainage infrastructure in Dili. 3 Timor-Leste: External Public Debt by Creditors in 2018 JICA 13% World Bank 27% Asian Development Bank 60% Sources: Timor-Leste Ministry of Finance BACKGROUND ON MACRO FORECASTS 4. This DSA is based on the macroeconomic projections underlying the 2019 Article IV consultation. To illustrate the impact of different policy options on debt sustainability, two scenarios — baseline and reform—are considered. 5. Compared to the previous DSA,7 there have been some changes (in some cases, substantial) in assumptions underlying the current DSA, due to factors that altered staff’s macroeconomic and fiscal assumptions. First, political impasse beginning mid-2017 prevented a supplementary budget for 2017 from passing and resulted in a delay of the 2018 budget approval process. As a result, capital spending envisaged for 2017 under the 2017 budget was not fully executed, leading to a contraction of real GDP in 2017. Second, under the 2018 and 2019 budgets, the medium-term trajectory of government spending is substantially lower than was laid out in the 2017 budget. In particular, a front-loading of capital expenditure with ambitious infrastructure project plans in the 2017 budget was significantly reduced. These factors explain deviations of the baseline assumptions on macroeconomic and fiscal assumptions from the previous DSA exercise (Table 1). • Real non-oil GDP for 2017 is expected to have contracted significantly, due to lower government capital spending and failure to pass a supplementary budget. Political uncertainty faded in mid-2018, and growth is expected to rebound in 2018 to 0.8 percent. Over the long-term, growth is projected to stabilize at around about 5 percent, only marginally lower than in the previous DSA. Oil production from active fields is projected to cease in 2022. • Inflation is expected to increase steadily to about 4 percent over the medium-term on account of higher global food and fuel prices and spillovers from public investment activity. • The current account balance is projected to remain in deficit over the medium term. Declining income from oil and gas receipts contributes to the deficit. Overall, the current account balance deficit between 2018-2023 is projected to be less severe compared to the previous DSA. This is due to a lower public 7 See Timor-Leste 2017 Article IV Staff Report, IMF Country Report No. 17/360. 4 expenditure trajectory under the 2019 budget, which translates into lower demand for imports and an improved trade balance. • The primary fiscal balance is projected to remain in deficit of about 13 percent of GDP in 2018. The primary deficit is projected to narrow gradually to about 11 percent on average over the long-term (2028- 2038). Capital spending is projected to grow to fill the significant infrastructure gap. • External financing consists of concessional loans from official creditors. Private external borrowing is assumed to remain negligible. Timor-Leste does not have exceptional financing such as accumulation of arrears. • Fiscal financing consists of (i) PF withdrawals in excess of ESI and (ii) external borrowing. • The grant element of loans is assumed to decline moderately over the medium-term as the economy develops. • Other assumptions include that no off-budget debt is accumulated including by state-owned enterprises in line with existing legislation. Table 1. Timor-Leste: Key Macroeconomic and Fiscal Assumptions Current (2019 Article IV) Previous (2017 Article IV) 2017 2018 2018-23 2024-38 2016 2017 2017-22 2023-37 Real GDP growth (in percent) -4.5 -8.0 -5.6 4.8 -7.9 -8.0 -3.7 5.2 Real non-oil GDP growth (in percent) -4.6 0.8 4.2 4.8 5.5 3.0 5.0 5.2 Inflation (CPI annual average, percent) 0.5 2.3 3.2 4.0 -1.3 1.0 3.2 4.0 Revenues (excluding grants, percent of GDP) 30.7 29.7 26.3 19.1 27.5 24.2 22.3 15.9 Current expenditure (percent of GDP) 33.5 28.2 35.8 24.6 36.3 33.4 35.1 23.1 Net acquisition of non-financial assets (percent of GDP) 9.5 12.8 10.4 4.7 22.1 10.9 20.2 5.4 Net lending/borrowing (percent of GDP) -18.7 -17.2 -24.3 -14.1 -30.8 -20.1 -33.3 -12.9 Net incurrence of liabilities (percent of GDP) 1.1 2.0 2.3 2.6 1.1 0.4 5.0 2.1 Exports of G&S (y/y growth) 12.6 8.4 12.5 17.5 5.7 -1.6 14.6 20.8 Imports of G&S (y/y growth) -11.9 7.0 2.9 7.3 -11.1 -0.2 6.1 6.1 Current account balance (percent of GDP) -10.2 -8.9 -4.1 -6.5 -18.9 -3.4 -15.9 -4.1 5 Box 1. Macroeconomic Assumptions Underlying the DSA Update The macroeconomic assumptions underpinning the current DSA incorporate the economic impacts of the political stalemate beginning 2017, which led to a failure to pass a rectification budget for 2017 and a delay in the approval of the 2018 budget. As a result, the macroeconomic assumptions used for the current DSA exhibit significant deviations from those used for the previous DSA. Macro Indicators Last Historic Year (2017) First Forecast Year Medium- and Long-Term (2018) Averages GDP growth Real non-oil GDP growth for Growth is expected to Over the long-term, growth is 2017 is estimated to be -4.6 recover mildly in 2018, as expected to stabilize at around percent. Public spending the political situation 5 percent, slightly lower than experienced an abrupt halt in the improved after the snap in the previous DSA. second half of the year, as the election in May. However, minority government failed to with a moderate spending pass a rectification budget. envisioned for 2018 under the budget, the recovery is expected to be weak, at around 0.8 percent. CPI Inflation (annual CPI inflation in 2017 was CPI inflation is expected to CPI inflation is projected to average, percent) generally weak at 0.5 percent. reach 2.3 percent in 2018, stabilize at around 4 percent due to higher import over the medium-term. prices. Current Account The estimated current account The current account deficit The current account balance is balance for 2017 is revised is expected to narrow in expected to remain in deficit downward from -3.4 percent in 2018. over the medium term with the 2017 DSA to -10.2 percent. lower oil and gas receipts and imports of goods and services generated by demand from capital expenditure. Fiscal Position The primary deficit in 2017 is 7 The primary deficit in The primary deficit is percent of GDP, (33 percent in 2018 is projected to be 13 projected to narrow gradually previous DSA). This reflects a percent of GDP. to about 3 percent in the long- much lower level of actual public term. spending executed for 2017 than the spending scheduler under the 2017 budget. 6. The new realism tools suggest that macroeconomic and fiscal assumptions are reasonable (Figure 4). The three-year adjustment in the primary balance is expected to be a loosening of 5 percent of GDP, between 2017 and 2020. This represents significant stimulus to the economy and lies near the bottom of the distribution of the realism tool. With regards to the realism tool on fiscal adjustment and growth, a high fiscal multiplier for 2019 partly shows the low base effect of growth in 2018. Lastly, we do not have relevant data (stocks of government capital) to test other sets of realism tools, and efforts will be made to collect the data for the next DSA. 6 7. The reform scenario illustrates staff’s proposed strategy to safeguard fiscal sustainability. The scenario is broadly similar to staff’s recommendations in the 2016 and 2017 Article IV consultation Staff Reports (see section A in the Staff Report for more details). The reform scenario includes: • Less front-loading of public expenditure. The less ambitious front-loading of capital investment as laid out in the 2019 budget is maintained. • Domestic revenue. A value-added tax (VAT) is implemented by 2022. The VAT is estimated to generate revenue of about 3¾ percent of GDP based on a VAT rate of 10 percent in the medium term. VAT revenue increases to at least 5 percent of GDP in the long term. • Concessional borrowing and PF excess withdrawals. PF withdrawals in excess of the ESI are not be permitted from 2028 and onwards. The resulting financing gap is met by external borrowing. • Under this reform scenario, higher domestic revenue coupled with no excess withdrawal from 2028 reverse the decline in PF assets, with the PF balance increasing to close to US$13.5 billion (385 percent of total GDP) in 2023 and reaching around US$12.8 billion (75 percent of total GDP) in 2038. • Overall, external borrowing under the reform scenario is higher than in the baseline in the long-term. In the medium-term (until 2028 when excess withdrawals are permitted), the financing gap under the reform scenario is smaller than the baseline scenario starting 2022, due to the revenue collected from VAT. As a result, the average excess withdrawals over Baseline the medium-term Scenario (2020-2027) are Scenario from US$740.7 reduced Reform million (baseline) to US$618.3 million (reform scenario). From 2028, external borrowing 2017 2018 2018-23 2024-38 2017 2018 2018-23under the reform 2024-38 Revenues (percent of GDP) 30.7 29.7 25.9 16.6 30.7 29.7 27.1 22.5 increases scenario(percent Current expenditure of GDP)despite domestic revenue 33.6 from 28.2 VAT,34.1 as the excess withdrawals 25.9 33.5 from the 28.2 34.1 Petroleum 25.9 Fund Net acquisition are no of non-financial longer allowed. assets (percent As aof GDP) the average result, -17.7 -15.3 -20.6 borrowing over-11.6 the long-term-17.7 -12.4 (2028-2038) -25.7 rises to-3.3 US$805.6 Net lending/borrowing (percent of GDP) -18.7 -17.2 -22.9 -14.2 -18.7 -17.2 -21.6 -10.0 million, Net incurrence higher of liabilities than (percent ofthe GDP) projected borrowing 2.5 2.0 US$279 of 2.3 million2.6 under the baseline 1.1 2.0 scenario 2.3 (Table 6.7 3). Borrowing (in millions of USD, period average) 70.0 61.6 75.5 237.2 30.1 61.6 52.0 516.5 Exports of G&S Table(y/y growth) 2. Timor-Leste: Macroeconomic 12.6 Assumptions: 8.4 12.5 Baseline 17.5 and Reform 12.6 Scenarios 8.4 12.5 17.5 Imports of G&S (y/y growth) -11.9 7.0 2.9 10.2 -11.9 7.0 2.9 10.2 Current account balance (percent of GDP) -10.2 -11.2 -5.3 -15.2 -10.2 -11.2 -5.2 -13.0 External Debt (percent of GDP) 3.8 5.1 10.4 21.4 3.8 5.1 10.4 41.3 Petroleum Fund Balance (in millions of USD) 16,799 15,803 14,943 8,116 16,799 15,803 15,004 13,187 7 Table 3. Timor-Leste: Projected Medium-Term Fiscal Funding Gaps: Baseline and Reform Scenarios (In millions of US Dollars) 2018 2019 2020 2020-2027 2028-2038 Baseline Scenario Funding Gap 493.7 1344.1 982.7 839.9 1199.6 Excess Petroleum Fund withdrawal 432.1 1257.1 935.1 740.7 920.6 Borrowing 61.6 87.0 47.5 99.2 279.0 Reform Scenario Funding Gap 493.7 1344.1 982.7 715.0 805.6 Excess Petroleum Fund withdrawal 432.1 1257.1 935.1 618.3 0.0 Borrowing 61.6 87.0 47.5 96.7 805.6 Memorandum item 2019 Budget Framework Funding Gap 493.7 1099.4 1451.0 n.a n.a Excess Petroleum Fund withdrawal 432.1 1012.4 1411.0 n.a n.a Borrowing 61.6 87.0 40.0 n.a n.a COUNTRY CLASSIFICATION AND DETERMINATION OF SCENARIO STRESS TESTS 8. The country’s debt-carrying capacity applied in the 2019 DSA is medium. The Composite Indicator (CI) index, which has been calculated based on the October 2018 WEO and the 2017 Country Policy and Institutional Assessment (CPIA), is 2.72, indicating that the country’s debt-carrying capacity is medium. Prior to this update, the thresholds for previous DSAs were based on the CPIA index, where Timor-Leste was classified as “weak” in terms of policy performance. 9. Given the heavy reliance of oil and gas exports in Timor-Leste’s total exports, commodity price shocks are introduced in a tailored stress test. Lack of export diversification and weak external competitiveness results in excessive reliance of Timor-Leste’s external position on petroleum and gas receipts. In 2018, oil and gas exports comprised of 77 percent of total exports of goods and services. No adjustments have been made to the default settings regarding the scenario stress testing. Calculation of the CI Index Components Coefficients (A) 10-year average values CI Score components Contribution of (B) (A*B) = (C) components CPIA 0.385 2.921 1.12 41% Real growth rate (in percent) 2.719 3.151 0.09 3% Import coverage of reserves (in percent) 4.052 49.189 1.99 73% Import coverage of reserves^2 (in percent) -3.990 24.196 -0.97 -35% Remittances (in percent) 2.022 0.011 0.00 0% World economic growth (in percent) 13.520 3.579 0.48 18% CI Score 2.72 100% CI rating Medium 8 DEBT SUSTAINABILITY A. External Debt Sustainability Analysis 10. Under the baseline scenario, all external PPG debt indicators remain below the policy relevant thresholds for the next twenty years (Figure 1). Given that fiscal sustainability concerns can arise well-beyond the standard ten-year DSA horizon, debt dynamics for each scenario are presented over the next twenty years. The PV of the PPG debt-to-GDP ratio is expected to increase gradually from 4.3 percent in 2018 to 8.8 percent in 2025 due mainly to new disbursements of loans for key infrastructure projects, and thereafter decline gradually to reach 4.6 percent by 2038. The residual in debt-creating flows is financed through excess withdrawals from the PF (Figure 3). As shown in Table 1, there is no breach for any debt indicators under the baseline scenario over the 20-year projection horizon. 11. The size of the export shock was customized to account for the structural production cycle, and that oil and gas exports will end in 2022. Petroleum production rose sharply between 2005 and 2012, only to fall between 2012 and 2018 as petroleum deposits were gradually declining. To prevent this structural production cycle from inflating the export shock and to account for the fact that petroleum production will cease in 2022, the export stress test was customized.8 12. Another issue affecting the export revenue shock is the existence of the PF. By law, all petroleum income is required to initially enter the PF, which is then invested in foreign assets. Hence, a negative shock to petroleum export revenue (price or quantity) automatically leads to a reduced accumulation of foreign assets and not an increase in additional external borrowing as assumed by the DSF under the stress scenario. However, to maintain evenhandedness of the DSF, the customized export stress test was maintained, and no adjustment was made to account for these PF rules. 13. Standardized stress tests show that a shock to the primary balance is the most extreme shock to the debt trajectory, causing a short-lived and marginal breach of the threshold for the PV of PPG debt- to-exports ratio. This reflects a highly volatile historical path of the primary balance, generating a large shock. The breaches are short-lived and marginal. The first breach occurs in 2022 (202 vs. threshold value of 180), while debt burden indicator returns to below threshold by 2023. The breach re-occurs for the second and the last time in 2024 (210 vs. threshold value of 180). The stress scenario assumes that public external debt would increase by US$183 million per year in 2019-20 to cover the financing gap. However, historically, the government has typically not resorted to debt financing, but instead relied on excess withdrawals from the PF (see paragraph 2). Between 2012-2017, excess withdrawals averaged US$478 million per year, which is well above the funds needed to cover the financing gap under the stress scenario. 8 Paragraph 66 of the Guidance Note on the Bank-Fund Debt Sustainability Framework for Low Income Countries (2017) specifies that “…under some exceptional circumstances, default stress parameters may not be appropriate as they ma y fail to capture structural breaks or idiosyncratic features in the country. In such circumstances the size of the shock and the interactions among the main variables can be customized.” The export shock for Timor-Leste was customized as follows: (i) the historical standard deviation of petroleum exports was scaled by a factor equal to the ratio of future average petroleum exports (2019-2022) and past average petroleum exports (2008-2018); (ii) the standard deviation of non-oil export was not scaled; and (iii) the average of the two standard deviations was weighted by the average share of petroleum exports in 2019 and 2020 (the two years for which the shock applies). The customization implied that the initial standard deviation of 50.3 was scaled down to 10.3. 9 B. Public Debt Sustainability Analysis 14. Under the baseline scenario, the PV of total PPG debt-to-GDP ratio remains below the threshold level for the next twenty years (Figure 2). Under the 2019 budget, the PV of the debt-to-GDP remains well below the benchmark. The standardized sensitivity analysis shows that the largest shock is a commodity price shock, which leads to a sustained breach with the highest debt-to-GDP figures in 2034. However, as previously mentioned in paragraph 12, a fall in petroleum export revenue only results in a reduced accumulation of foreign assets of the PF and does not directly impact the primary fiscal balance (which is a main channel for the assumed shock in the public DSA).9 Second, petroleum production from active fields is projected to end in 2022. Hence, as shown in the Staff Report (paragraph 8), even an oil price shock larger and more permanent than assumed in the DSF has only a marginal impact on the PF balance, and hence the ESI.10 C. External and Public Debt Sustainability Analysis under the Reform Scenario 15. The reform scenario does not lead to substantial changes in the results of debt sustainability analysis. The ending of excess withdrawals from the PF in 2028 leads to higher external borrowing. While the introduction of a VAT improves debt dynamics over the medium- and long-term by filling the financing gap from 2022 onwards, the net effect is an increase in the debt level over time. It is therefore relevant to conduct a debt analysis on the reform scenario as well. The result shows that the reform scenario does not fundamentally alter the debt analysis as debt levels remain contained. Importantly, under the reform scenario, the PF balance will not continue to fall but broadly stabilize (see Table 2). RISK RATING AND VULNERABILITIES 16. While the DSA assigns Timor-Leste a mechanical rating of “moderate” debt distress risk, judgment is applied to improve the rating to “low”. The judgement reflects the country’s large, liquid, and accessible net foreign assets, serving as a strong mitigating factor in Timor-Leste’s ability to carry and service debt. The less ambitious frontload of public spending in the 2019 budget also improves the debt sustainability outlook. • External debt. Under the baseline, both solvency ratios (i.e., PV of PPG debt-to-GDP ratio and PV of PPG debt-to-exports) remain low and well below the DSA thresholds over the twenty-year projection horizon. The PV of debt is projected to climb from 6 percent of total non-oil GDP in 2017 to 24 percent in 2038. However, the PV of debt-to-exports exhibits a short-lived and marginal breach of the benchmark under extreme shock scenario (primary balance shock)—generating a mechanical debt distress rating of “moderate.” 9 The only channel through which reduced oil prices affects budget revenue is through the ESI – which is calculated based on the total petroleum wealth, which consists of the PF balance and the projected net present value of future petroleum revenue. 10 Moreover, the DSF assumes that the persistence of the commodity price shock is 6 years, which is well beyond the assumed end of petroleum production (i.e., 2022). 10 • Public debt. Under the baseline, both solvency ratios (i.e., PV of PPG debt-to-GDP ratio and PV of PPG debt-to-revenue) remain low and well below the DSA benchmark over the twenty-year projection horizon. As discussed above, while an extended breach of the debt-to-GDP benchmark occurs under the extreme commodity price shock scenario, the PF will insulate the budget from commodity price volatility. Also, petroleum production is projected to cease in 2022. • Availability of the Petroleum Fund as a buffer. Timor-Leste has a large stock of liquid assets that should be considered as a buffer for the country’s debt sustainability (see paragraph 2). The PF has assets at 848 percent of total non-oil GDP in 2018 and is PV of Debt-to-Petroleum Fund Balance Ratio estimated to be of a high multiple of (Percent) the present and projected debt. 70 Moreover, the PF is highly liquid with 60 50 percent of its assets invested in 50 Baseline Reform Extreme Shock Case U.S. Treasuries. The recent history of 40 annual excess withdrawals for budget 30 financing (in accordance with the Petroleum Fund Law) indicates that 20 these funds would be readily 10 available to service debt if needed 0 (see paragraph 2).11 Indeed, the PV of 2017 2019 2021 2023 2025 2027 2029 2031 2033 2035 2037 debt does not exceed more than one Sources: IMF staff calculations. Footnote: 'Extreme Shock Case' refers to the primary-balance shock to PV of debt-to-exports ratio. third of the projected value of the PF over the next 20 years under the baseline scenario (see figure).12 Under the scenario of the most extreme shock case where the PV of debt-to-exports breaches the threshold, the PV of debt-to-Petroleum Fund assets remains stable, reaching close to 60 percent only towards the end of the projection periods. • Overall low risk of debt distress. With this, risk of debt distress is assessed as low, which is an improvement from the previous rating of “moderate” risk. The change reflects fuller consideration of risk mitigating elements, in line with the use of judgment in the revised LIC DSF methodology. 17. Towards the end of and beyond the 20-year horizon, the coverage of the PF deteriorates, highlighting the need to develop a fiscal strategy to ensure long-term fiscal sustainability and safeguard the assets of the Petroleum Fund. Under current policies, the PF will deplete beyond the 20- year horizon, as the revenue base is low and capital spending is expected to increase to fill the country’s much-needed infrastructure gap. Depletion of highly liquid financial assets reinforces the need for a reform strategy, which entails improving expenditure control and efficiency, mobilizing domestic revenue, and committing to protecting the wealth of the Petroleum Fund. 11The Petroleum Fund Law allows withdrawals in excess of the ESI provided that the Parliament approves the Government’s explanation that this is made in the long-term interests of the country. The law does not impose a limit on the size of the withdrawals. 12The value of the PF excludes the US$650 million that are planned to be used to buy-out shares from joint venture partners in the Greater Sunrise. 11 AUTHORITIES’ VIEWS 18. The authorities concurred with the overall rating of low risk of external debt distress. They welcomed the improved rating on external debt, highlighting the low level of external borrowing and the availability of the Petroleum Fund as a buffer. Furthermore, the authorities are committed to the mobilization of domestic revenues in order to protect the Petroleum Fund balance and ensure long-term debt sustainability. 12 Table 4. Timor-Leste: External Debt Sustainability Framework, Baseline Scenario, 2015-2038 (In percent of GDP, unless otherwise indicated) Actual Projections Average 8/ Historical Projections 2015 2016 2017 2018 2019 2020 2021 2022 2023 2028 2038 External debt (nominal) 1/ 1.5 3.1 3.8 4.6 6.0 7.1 8.7 10.3 10.9 12.0 6.8 0.9 9.8 Definition of external/domestic debt Currency-based of which: public and publicly guaranteed (PPG) 1.5 3.1 3.8 4.6 6.0 7.1 8.7 10.3 10.9 12.0 6.8 0.9 9.8 Is there a material difference between the two No criteria? Change in external debt 0.9 1.6 0.8 0.7 1.4 1.1 1.7 1.6 0.6 -0.2 -0.6 Identified net debt-creating flows -7.4 22.2 9.7 8.2 -2.4 0.9 -1.0 10.7 4.0 -0.9 -0.3 -9.3 1.3 Non-interest current account deficit -6.6 21.6 10.2 8.9 -1.6 1.7 -0.5 10.2 4.9 -0.3 -0.2 -24.6 2.0 Deficit in balance of goods and services 7.5 35.3 19.3 20.3 22.2 23.7 22.3 33.9 26.2 18.8 16.9 -11.5 23.7 Exports 34.7 12.7 19.1 16.3 11.9 14.0 14.2 8.2 9.1 11.2 14.2 Imports 42.2 48.1 38.4 36.6 34.1 37.7 36.4 42.1 35.3 30.0 31.1 Debt Accumulation 9/ Net current transfers (negative = inflow) -4.0 -1.0 2.2 -2.8 -3.3 -3.6 -4.2 -4.9 -4.9 -3.5 -1.7 7.0 35 -6.2 -4.0 of which: official -7.2 -7.2 -6.4 -5.8 -5.2 -4.9 -5.0 -5.2 -4.6 -2.7 -1.0 35 6.0 Other current account flows (negative = net inflow) -10.1 -12.7 -11.3 -8.6 -20.6 -18.4 -18.6 -18.8 -16.4 -15.6 -15.4 -7.0 -17.7 34 Net FDI (negative = inflow) -1.0 0.3 -0.2 -1.0 -0.6 -0.9 -1.5 -1.6 -1.4 -0.3 0.0 -0.7 -1.0 5.0 34 Endogenous debt dynamics 2/ 0.2 0.3 -0.3 0.3 -0.1 0.1 1.1 2.1 0.5 -0.2 -0.2 Contribution from nominal interest rate 0.0 0.0 0.0 0.0 0.2 0.2 0.2 0.4 0.4 0.3 0.2 33 4.0 Contribution from real GDP growth -0.1 0.0 0.1 0.3 -0.3 -0.1 0.9 1.7 0.2 -0.5 -0.3 33 Contribution from price and exchange rate changes 0.3 0.4 -0.4 … … … … … … … … 3.0 Residual 3/ 8.3 -20.7 -8.9 -7.5 3.8 0.2 2.6 -9.1 -3.4 0.7 -0.2 10.0 -0.6 32 of which: exceptional financing 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 32 2.0 31 Sustainability indicators 1.0 PV of PPG external debt-to-GDP ratio ... ... 3.4 4.0 5.0 5.7 6.9 8.0 8.2 8.6 4.6 31 PV of PPG external debt-to-exports ratio ... ... 17.8 24.4 41.7 40.4 48.4 97.6 90.4 76.4 32.6 0.0 30 PPG debt service-to-exports ratio 0.0 0.0 0.5 0.0 1.3 1.3 1.7 4.3 3.9 4.3 2.8 2018 2020 2022 2024 2026 2028 PPG debt service-to-revenue ratio 0.0 0.0 0.4 0.0 0.7 0.9 1.1 1.6 1.8 3.3 2.8 Gross external financing need (Million of U.S. dollars) -233.9 551.7 280.1 248.6 -66.2 31.6 -60.0 283.2 134.1 -9.8 38.1 Rate of Debt Accumulation Grant-equivalent financing (% of GDP) Key macroeconomic assumptions Grant element of new borrowing (% right scale) Real GDP growth (in percent) 20.9 0.8 -4.5 -8.0 6.6 1.3 -12.3 -19.2 -2.0 4.8 4.8 0.0 -0.9 GDP deflator in US dollar terms (change in percent) -36.5 -19.5 15.4 22.1 -5.6 4.8 11.0 19.9 13.5 6.0 6.0 3.3 8.7 Effective interest rate (percent) 4/ 0.0 0.0 0.2 0.0 3.5 3.2 3.3 3.9 3.8 2.8 2.4 0.0 3.0 External debt (nominal) 1/ Growth of exports of G&S (US dollar terms, in percent) -43.5 -70.2 65.5 -4.4 -26.5 25.3 -1.7 -44.1 23.8 16.6 11.8 3.8 5.0 of which: Private Growth of imports of G&S (US dollar terms, in percent) 1.8 -7.5 -11.9 7.0 -6.2 17.3 -6.0 11.9 -6.6 7.6 14.4 13.9 5.0 14 Grant element of new public sector borrowing (in percent) ... ... ... 32.2 32.4 33.3 33.3 31.7 34.4 34.6 34.6 ... 33.7 Government revenues (excluding grants, in percent of GDP) 26.1 29.6 24.3 23.8 22.6 20.7 21.1 21.8 19.4 14.5 14.4 18.2 19.1 12 Aid flows (in Million of US dollars) 5/ 222.7 181.3 176.7 184.2 175.1 134.9 131.6 121.9 140.1 176.3 121.1 Grant-equivalent financing (in percent of GDP) 6/ ... ... ... 6.2 5.6 4.1 4.1 4.0 4.3 3.0 0.7 ... 4.3 10 Grant-equivalent financing (in percent of external financing) 6/ ... ... ... 88.7 85.2 81.1 80.8 81.8 80.2 79.1 72.2 ... 81.3 Nominal GDP (Million of US dollars) 3,104 2,521 2,778 3,122 3,143 3,335 3,246 3,144 3,498 5,918 16,939 8 Nominal dollar GDP growth -23.3 -18.8 10.2 12.4 0.7 6.1 -2.7 -3.1 11.3 11.1 11.1 3.4 7.3 6 Memorandum items: 4 PV of external debt 7/ ... ... 3.4 4.0 5.0 5.7 6.9 8.0 8.2 8.6 4.6 In percent of exports ... ... 17.8 24.4 41.7 40.4 48.4 97.6 90.4 76.4 32.6 2 Total external debt service-to-exports ratio 0.0 0.0 0.5 0.0 1.3 1.3 1.7 4.3 3.9 4.3 2.8 PV of PPG external debt (in Million of US dollars) 94.3 123.6 155.6 189.1 222.4 250.7 287.8 506.7 784.0 0 (PVt-PVt-1)/GDPt-1 (in percent) 1.1 1.0 1.1 1.0 0.9 1.2 0.8 0.1 2018 2020 2022 2024 2026 2028 Non-interest current account deficit that stabilizes debt ratio -7.5 20.0 9.5 8.2 -3.0 0.6 -2.2 8.6 4.3 -0.1 0.4 Sources: Country authorities; and staff estimates and projections. 0 1/ Includes both public and private sector external debt. 2/ Derived as [r - g - ρ(1+g)]/(1+g+ρ+gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and ρ = growth rate of GDP deflator in U.S. dollar terms. 3/ Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes. 4/ Current-year interest payments divided by previous period debt stock. 5/ Defined as grants, concessional loans, and debt relief. 6/ Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt). 7/ Assumes that PV of private sector debt is equivalent to its face value. 8/ Historical averages are generally derived over the past 10 years, subject to data availability, whereas projections averages are over the first year of projection and the next 10 years. 9/ The grant element may be overestimated due to debt projections. 13 Table 5. Timor-Leste: Public Sector Debt Sustainability Framework, Baseline Scenario, 2015-2038 ESTE DEMOCRATIC REPUBLIC OF TIMOR-LESTE (In percent of GDP, unless otherwise indicated) Actual Projections Average 6/ 2015 2016 2017 2018 2019 2020 2021 2022 2023 2028 2038 Historical Projections Public sector debt 1/ 1.5 3.1 3.8 4.6 6.0 7.1 8.7 10.3 10.9 12.0 6.8 0.9 9.8 Definition of Currency- of which: external debt 1.5 3.1 3.8 4.6 6.0 7.1 8.7 10.3 10.9 12.0 6.8 0.9 9.8 external/domestic debt based of which: local-currency denominated Change in public sector debt 0.9 1.6 0.8 0.7 1.4 1.1 1.7 1.6 0.6 -0.2 -0.6 Is there a material difference Identified debt-creating flows 0.1 4.3 2.6 -1.9 5.9 8.6 11.1 13.3 12.4 10.8 3.6 -0.8 9.6 No between the two criteria? Primary deficit -0.1 4.0 2.8 -1.4 5.8 8.7 10.7 12.7 13.1 11.7 4.2 -4.9 10.0 Revenue and grants 33.2 36.8 30.7 29.7 27.8 24.3 24.7 25.4 23.2 17.1 14.9 24.4 22.9 of which: grants 7.2 7.2 6.4 5.8 5.2 3.6 3.6 3.6 3.7 2.6 0.6 Public sector debt 1/ Primary (noninterest) expenditure 33.2 40.8 33.5 28.2 33.6 33.0 35.4 38.1 36.3 28.8 19.2 19.5 33.0 Automatic debt dynamics 0.2 0.3 -0.3 -0.4 0.1 -0.2 0.4 0.6 -0.7 -0.9 -0.6 of which: local-currency denominated Contribution from interest rate/growth differential -0.1 0.0 0.1 0.3 -0.2 0.0 1.1 2.3 0.4 -0.5 -0.3 of which: foreign-currency denominated of which: contribution from average real interest rate 0.0 0.0 0.0 -0.1 0.1 0.1 0.1 0.2 0.2 0.1 0.0 of which: contribution from real GDP growth -0.1 0.0 0.1 0.3 -0.3 -0.1 1.0 2.1 0.2 -0.6 -0.3 14 Contribution from real exchange rate depreciation 0.3 0.4 -0.4 ... ... ... ... ... ... ... ... 12 Other identified debt-creating flows 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 10 Privatization receipts (negative) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 8 Recognition of contingent liabilities (e.g., bank recapitalization) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Debt relief (HIPC and other) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 6 Other debt creating or reducing flow (please specify) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 4 Residual 0.8 -2.8 -1.8 1.9 -4.2 -7.6 -10.1 -13.3 -12.9 -11.4 -4.5 1.5 -9.4 2 Sustainability indicators 0 PV of public debt-to-GDP ratio 2/ ... ... 3.4 4.0 5.0 5.7 6.9 8.0 8.2 8.6 4.6 2018 2020 2022 2024 2026 2028 PV of public debt-to-revenue and grants ratio … … 11.1 13.3 17.8 23.3 27.7 31.4 35.5 50.1 31.0 Debt service-to-revenue and grants ratio 3/ 0.0 0.0 0.3 0.0 0.6 0.7 1.0 1.4 1.5 2.8 2.7 Gross financing need 4/ -0.1 4.0 2.9 -1.4 5.9 8.9 10.9 13.0 13.5 12.1 4.6 of which: held by residents of which: held by non-residents Key macroeconomic and fiscal assumptions 1 Real GDP growth (in percent) 20.9 0.8 -4.5 -8.0 6.6 1.3 -12.3 -19.2 -2.0 4.8 4.8 0.0 -0.9 1 Average nominal interest rate on external debt (in percent) 0.0 0.0 0.2 0.0 3.5 3.2 3.3 3.9 3.8 2.8 2.4 0.0 3.0 1 Average real interest rate on domestic debt (in percent) 57.5 24.2 -13.2 -18.1 9.6 -1.5 -6.9 -13.3 -8.5 -3.0 -3.4 15.4 -4.8 1 1 Real exchange rate depreciation (in percent, + indicates depreciation) 60.3 25.5 -12.2 … ... ... ... ... ... ... ... 4.2 ... 1 n.a. Inflation rate (GDP deflator, in percent) -36.5 -19.5 15.4 22.1 -5.6 4.8 11.0 19.9 13.5 6.0 6.0 3.3 8.7 0 Growth of real primary spending (deflated by GDP deflator, in percent) 76.6 23.9 -21.5 -22.5 26.9 -0.3 -6.0 -13.1 -6.7 0.2 0.8 20.2 -2.0 0 Primary deficit that stabilizes the debt-to-GDP ratio 5/ -1.0 2.4 2.1 -2.2 4.4 7.6 9.0 11.1 12.5 11.8 4.8 1.2 9.3 0 PV of contingent liabilities (not included in public sector debt) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0 0 2018 2020 2022 2024 2026 2028 Sources: Country authorities; and staff estimates and projections. 1/ Coverage of debt: The central government. Definition of external debt is Currency-based. 2/ The underlying PV of external debt-to-GDP ratio under the public DSA differs from the external DSA with the size of differences depending on exchange rates projections. 3/ Debt service is defined as the sum of interest and amortization of medium and long-term, and short-term debt. 4/ Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period and other debt creating/reducing flows. 5/ Defined as a primary deficit minus a change in the public debt-to-GDP ratio ((-): a primary surplus), which would stabilizes the debt ratio only in the year in question. 6/ Historical averages are generally derived over the past 10 years, subject to data availability, whereas projections averages are over the first year of projection and the next 10 years. 14 Table 6. Timor-Leste: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2018-2028 (In percent) Projections 1/ 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 PV of debt-to GDP ratio Baseline 4 5 6 7 8 8 9 9 9 9 9 A. Alternative Scenarios A1. Key variables at their historical averages in 2018-2038 2/ 4 -11 -28 -43 -65 -85 -100 -116 -131 -145 -159 0 #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A B. Bound Tests B1. Real GDP growth 4 7 10 12 14 15 15 16 16 16 15 B2. Primary balance 4 9 13 15 17 16 16 16 15 15 14 B3. Exports 4 6 9 10 12 12 12 12 12 11 11 B4. Other flows 3/ 4 8 13 14 16 16 16 15 15 14 13 B5. Depreciation 4 6 0 1 2 3 4 4 5 6 6 B6. Combination of B1-B5 4 10 6 7 9 10 10 10 11 11 11 C. Tailored Tests C1. Combined contingent liabilities 4 8 9 10 12 12 12 12 12 11 11 C2. Natural disaster n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. C3. Commodity price 4 7 10 11 11 10 9 7 6 5 4 C4. Market Financing n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Threshold 40 40 40 40 40 40 40 40 40 40 40 PV of debt-to-exports ratio Baseline 24 42 40 48 98 90 112 98 89 82 76 A. Alternative Scenarios A1. Key variables at their historical averages in 2018-2038 2/ 24 -90 -197 -301 -799 -929 -1309 -1300 -1322 -1360 -1416 0 24 27 18 13 13 5 0 -6 -12 -17 -21 B. Bound Tests B1. Real GDP growth 24 42 40 48 98 90 112 98 89 82 76 B2. Primary balance 24 73 93 105 202 178 210 177 154 137 125 B3. Exports 24 59 79 91 178 161 193 165 145 130 119 B4. Other flows 3/ 24 71 91 102 196 174 205 171 147 129 116 B5. Depreciation 24 42 -1 5 17 22 36 37 40 42 43 B6. Combination of B1-B5 24 71 28 40 82 79 100 88 82 77 73 C. Tailored Tests C1. Combined contingent liabilities 24 70 64 73 144 130 156 134 119 108 99 C2. Natural disaster n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. C3. Commodity price 24 80 85 89 163 120 121 89 67 51 39 C4. Market Financing n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Threshold 180 180 180 180 180 180 180 180 180 180 180 Debt service-to-exports ratio Baseline 0 1 1 2 4 4 5 5 5 4 4 A. Alternative Scenarios A1. Key variables at their historical averages in 2018-2038 2/ 0 1 -2 -5 -12 -17 -26 -36 -46 -54 -65 0 0 1 1 0 1 0 0 -2 -3 -4 -5 B. Bound Tests B1. Real GDP growth 0 1 1 2 4 4 5 5 5 4 4 B2. Primary balance 0 1 2 3 7 6 8 9 10 9 8 B3. Exports 0 2 2 3 7 6 8 8 9 8 7 B4. Other flows 3/ 0 1 2 3 7 6 7 9 10 9 8 B5. Depreciation 0 1 1 1 2 2 3 3 1 1 1 B6. Combination of B1-B5 0 1 2 2 4 4 5 7 4 4 4 C. Tailored Tests C1. Combined contingent liabilities 0 1 2 2 5 5 6 6 5 5 5 C2. Natural disaster n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. C3. Commodity price 0 2 2 3 7 5 6 7 7 6 5 C4. Market Financing n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Threshold 15 15 15 15 15 15 15 15 15 15 15 Debt service-to-revenue ratio Baseline 0 1 1 1 2 2 2 3 3 3 3 A. Alternative Scenarios A1. Key variables at their historical averages in 2018-2038 2/ 0 1 -1 -3 -5 -8 -11 -19 -28 -38 -50 0 0 1 0 0 0 0 0 -1 -2 -3 -4 B. Bound Tests B1. Real GDP growth 0 1 2 2 3 3 4 5 5 6 6 B2. Primary balance 0 1 1 2 3 3 3 5 6 6 6 B3. Exports 0 1 1 2 2 2 3 3 4 5 5 B4. Other flows 3/ 0 1 1 2 3 3 3 5 6 6 6 B5. Depreciation 0 1 1 0 1 1 2 2 0 1 1 B6. Combination of B1-B5 0 1 2 1 2 2 3 5 3 4 4 C. Tailored Tests C1. Combined contingent liabilities 0 1 1 2 2 2 3 3 3 4 4 C2. Natural disaster n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. C3. Commodity price 0 1 1 2 2 2 3 3 4 4 3 C4. Market Financing n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Threshold 18 18 18 18 18 18 18 18 18 18 18 Sources: Country authorities; and staff estimates and projections. 1/ A bold value indicates a breach of the threshold. 2/ Variables include real GDP growth, GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows. 3/ Includes official and private transfers and FDI. 15 Table 7. Timor-Leste: Sensitivity Analysis for Key Indicators of Public Debt, 2018-2028 (In percent) Projections 1/ 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 PV of Debt-to-GDP Ratio Baseline 4 5 6 7 8 8 9 9 9 9 9 A. Alternative Scenarios A1. Key variables at their historical averages in 2018-2038 2/ 4 -2 -11 -20 -31 -42 -53 -65 -78 -91 -105 0 #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A #N/A B. Bound Tests B1. Real GDP growth 4 13 29 43 59 67 74 80 84 87 90 B2. Primary balance 4 9 13 15 17 16 16 16 15 15 14 B3. Exports 4 6 9 10 12 12 12 12 11 11 11 B4. Other flows 3/ 4 8 13 14 16 16 16 15 15 14 13 B5. Depreciation 4 5 4 4 4 3 3 2 2 1 1 B6. Combination of B1-B5 4 8 8 12 13 13 13 13 13 13 13 C. Tailored Tests C1. Combined contingent liabilities 4 8 9 10 12 12 12 12 12 11 11 C2. Natural disaster n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. C3. Commodity price 4 16 37 62 90 105 116 123 128 132 135 C4. Market Financing n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Public debt benchmark 55 55 55 55 55 55 55 55 55 55 55 PV of Debt-to-Revenue Ratio Baseline 13 18 23 28 31 36 39 42 46 48 50 A. Alternative Scenarios A1. Key variables at their historical averages in 2018-2038 2/ 13 -8 -44 -82 -122 -182 -243 -310 -392 -482 -580 0 0 0 0 0 0 0 0 0 -1 -1 -2 B. Bound Tests B1. Real GDP growth 13 44 106 158 210 258 299 338 384 428 469 B2. Primary balance 13 31 54 60 65 70 74 76 79 81 82 B3. Exports 13 22 36 41 45 50 53 56 59 61 62 B4. Other flows 3/ 13 30 52 58 63 68 72 74 75 76 76 B5. Depreciation 13 18 18 17 15 14 12 10 8 6 3 B6. Combination of B1-B5 13 27 32 47 51 56 60 63 67 70 73 C. Tailored Tests C1. Combined contingent liabilities 13 30 37 42 46 51 55 58 61 63 65 C2. Natural disaster n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. C3. Commodity price 13 64 166 272 368 454 514 557 625 689 748 C4. Market Financing n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Debt Service-to-Revenue Ratio Baseline 0.0 0.6 0.7 1.0 1.4 1.5 1.8 2.1 2.4 2.6 2.8 A. Alternative Scenarios A1. Key variables at their historical averages in 2018-2038 2/ 0.0 0.6 0.0 -0.8 -1.6 -2.8 -4.0 -7.3 -11.6 -16.7 -22.4 0 0.0 0.5 0.4 0.3 0.2 0.0 -0.4 -0.5 -1.0 -1.4 -1.8 B. Bound Tests B1. Real GDP growth 0.0 0.7 1.9 3.5 5.3 6.6 7.9 10.9 14.8 18.4 21.8 B2. Primary balance 0.0 0.6 1.1 1.8 2.3 2.4 2.6 3.8 5.1 5.2 5.3 B3. Exports 0.0 0.6 0.9 1.3 1.7 1.9 2.1 2.7 3.5 3.7 3.8 B4. Other flows 3/ 0.0 0.6 1.1 1.8 2.2 2.4 2.6 3.7 4.9 5.0 5.1 B5. Depreciation 0.0 0.6 0.8 0.9 1.2 1.2 1.4 1.2 1.0 0.7 0.5 B6. Combination of B1-B5 0.0 0.6 0.8 1.1 1.6 1.8 2.0 2.4 2.7 3.0 3.2 C. Tailored Tests C1. Combined contingent liabilities 0.0 0.6 1.1 1.4 1.8 1.9 2.2 2.4 2.7 3.0 3.1 C2. Natural disaster n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. C3. Commodity price 0.0 0.6 2.4 5.4 8.5 10.8 12.5 17.3 24.5 30.8 36.1 C4. Market Financing n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Sources: Country authorities; and staff estimates and projections. 1/ A bold value indicates a breach of the benchmark. 2/ Variables include real GDP growth, GDP deflator and primary deficit in percent of GDP. 3/ Includes official and private transfers and FDI. Figure 1. Timor-Leste: Indicators of Public and Publicly Guaranteed External Debt under Alternative Scenarios, 2018-2038 PV of debt-to GDP ratio PV of debt-to-exports ratio 45 250 40 Most extreme shock is Primary Balance 35 200 Most extreme shock is Primary Balance 30 150 25 20 100 15 10 50 5 0 0 2018 2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2018 2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 Debt service-to-exports ratio Debt service-to-revenue ratio 16 20 18 14 16 12 Most extreme shock is Primary Balance 14 Most extreme shock is Primary Balance 10 12 8 10 8 6 6 4 4 2 2 0 0 2018 2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2018 2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 Baseline Most extreme shock 1/ Threshold Reform Scenario Customization of Default Settings Borrowing Assumptions for Stress Tests* Size Interactions Default User defined Shares of marginal debt No No External PPG MLT debt 100% Tailored Tests Terms of marginal debt Combined CLs Yes Avg. nominal interest rate on new borrowing in USD 1.9% 1.9% Natural Disasters n.a. n.a. USD Discount rate 5.0% 5.0% Commodity Prices 2/ No No Avg. maturity (incl. grace period) 26 26 Market Financing n.a. n.a. Avg. grace period 5 5 Note: "Yes" indicates any change to the size or * Note: All the additional financing needs generated by the shocks under the stress tests interactions of the default settings for the stress are assumed to be covered by PPG external MLT debt in the external DSA. Default terms of tests. "n.a." indicates that the stress test does not marginal debt are based on baseline 10-year projections. apply. Sources: Country authorities; and staff estimates and projections. 1/ The most extreme stress test is the test that yields the highest ratio in or before 2028. Stress tests with one-off breaches are also presented (if any), while these one-off breaches are deemed away for mechanical signals. When a stress test with a one-off breach happens to be the most exterme shock even after disregarding the one-off breach, only that stress test (with a one-off breach) would be presented. 2/ The magnitude of shocks used for the commodity price shock stress test are based on the commodity prices outlook prepared by the IMF research department. 17 Figure 2. Timor-Leste: Indicators of Public Debt under Alternative Scenarios, 2018-2038 18 Figure 3. Timor-Leste: Drivers of Debt Dynamics – Baseline Scenario - External Debt Gross Nominal PPG External Debt Debt-creating flows Unexpected Changes in Debt 1/ (in percent of GDP; DSA vintages) (percent of GDP) (past 5 years, percent of GDP) Current DSA 60 80 Residual 150 Previous DSA proj. 40 70 DSA-2013 Interquartile range 100 (25-75) Price and 60 exchange rate 20 50 50 Real GDP growth 0 Change in PPG 40 debt 3/ 0 30 Nominal -20 interest rate 20 -50 Median -40 Current 10 account + FDI -100 -60 0 Change in PPG 5-year 5-year Distribution across LICs 2/ 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 Contribution of debt 3/ historical projected -150 unexpected change change Public Debt Gross Nominal Public Debt Debt-creating flows Unexpected Changes in Debt 1/ (in percent of GDP; DSA vintages) (percent of GDP) (past 5 years, percent of GDP) Residual 50 Current DSA Previous DSA proj. 40 DSA-2013 Interquartile range 80 Other debt 30 (25-75) creating flows 70 20 Real Exchange 60 rate depreciation 10 50 0 Real GDP growth 0 Change in debt 40 -10 30 Real interest rate 20 -20 Primary deficit 10 -30 -50 Median 0 Change in debt 5-year 5-year -40 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 Distribution across LICs 2/ historical projected Contribution of unexpected -50 changes change change 1/ Difference between anticipated and actual contributions on debt ratios. 2/ Distribution across LICs for which LIC DSAs were produced. 3/ Given the relatively low private external debt for average low-income countries, a ppt change in PPG external debt should be largely explained by the drivers of the external debt dynamics equation. 19 Figure 4. Timor-Leste: Realism Tools 1/ 1/ The data needed to conduct the investment growth realism tool is not available for the current DSA exercise. Efforts will be made to collect the data for the next DSA. 20