Global Policy Forum

Is Timor-Leste's Plan for Oil Fund Investments a Risk Worth Taking?

Timor-Leste is highly dependent on its oil revenues. In 2005, the country established a petroleum fund in order to avoid the “resource curse,” widespread corruption and inflation. But recently Timor-Leste has passed a law allowing higher-risk investments, thus changing the fund. Some experts fear that this bill will lead to higher financial risks and corruption while others argue that it will contribute to the development of the country.

October 24, 2011

A bill allowing more diversified investments by Timor-Leste's multi-billion dollar oil and natural gas sovereign fund, which underwrites the lion's share of the country's expenditure, has divided opinion. Some say the step is necessary to maintain current levels of development spending, others call the move risky.

The amendment, which was passed by parliament in August and recently approved by the president, allows for up to 50% of the country's petroleum fund, currently exceeding $8.7bn, to be invested in equities, including up to 5% in other forms of investments. Under the previous law, all but 10% of the fund had to be kept in dollar-denominated government-issued bonds, which traditionally have been a safe, but low-return, investment.

Timor-Leste is little more than a decade out of a violent occupation by Indonesia (1975-99), during which an estimated 180,000 people were killed. Hundreds of thousands of people were displaced, and the country's infrastructure was left in ruins.

Oil revenues have funded much of the rebuilding. More than 90% of government finances come from the petroleum fund, which makes it instrumental in the livelihoods of the country's 1 million inhabitants.

Any plans to alter the fund are therefore contentious.

Changing the model

Established in 2005, the fund was intended to help avoid the "resource curse" of corruption, wasteful spending and inflation. These factors have often caused people in developing countries to become worse off when their governments come upon sudden wealth from non-renewable natural resources – which discourages long-term planning, fiscal responsibility, and development of productive sectors of the economy, activists say.

Timor-Leste's petroleum fund was modelled on Norway's sovereign wealth fund, whereby the country uses its considerable oil revenues to cover pension payouts today.

An estimated sustainable income (ESI) formula – a guideline for the maximum amount the government should spend from its petroleum fund – is supposed to ensure annual withdrawals for public spending are limited to amounts that will allow the fund to last for many generations after oil and gas reserves are exhausted.

Originally, the fund's ESI had been set at 3% of the country's present and expected future oil and gas wealth. However, the government has been overspending: 3.8% in 2009, 4.8% in 2010, 4.3% in 2011. It proposes to spend 7.2% in 2012.

Proponents of the new bill, which was spearheaded by the finance ministry, say the only way to raise the fund's rate of return, and thus make current levels of government spending sustainable, is to invest a larger share in equities.

Financial exposure and corruption concerns

Tim Anderson, a professor of political economy at the University of Sydney and former adviser to Timor-Leste's consultative committee for the Petroleum Fund, said the changes invited financial risks – especially given recent volatility in international stock markets – and corruption, the consequences of which would ultimately fall on poor Timorese. Any amendments to the investment model should be more modest, he said.

In a written response to IRIN, the finance ministry said new equities would be acquired through a "controlled and high-quality process" undertaken gradually, with oversight by multiple government offices. Ensuring the fund's assets are highly diversified "is the antidote to many avoidable risks", the ministry said.

However, this is contradicted by another revision just made to the petroleum fund law, which exempts Timorese "external investment managers" from standards required of international companies entrusted to invest in the fund, activists say.

How much to spend

The Timorese government remains institutionally weak, and there are serious concerns about its ability to manage the fast-rising state budget. The annual budget has increased from $70m in 2004 and $650m in 2009, to $1.3bn in 2011 – with nearly all the monies coming from the petroleum fund.

Jeffrey Sachs, a professor at Columbia University, is among those encouraging the government to open its coffers at a faster rate to jump start the country's development.

"I'm less interested in building up international financial assets than I am in seeing children going to school, having proper nutrition, building up the health sector, making sure there's an education all the way through secondary [schooling] universally and tertiary for a rising proportion of students," he said in Dili, where he was attending a development conference. "I'm interested in there being a good power grid, safe drinking water, disaster preparedness and so forth."

However, there are concerns that sharp increases in spending will spur corruption, not to mention wasteful and misdirected mega-projects over the development of productive sectors of a non-oil economy, once the country's two producing oil fields are depleted.

"If you could spend more money well on health and education, you would have an excellent return," says David Hook, a governance specialist with the World Bank in Dili. But, he added, "the question is the capacity of state institutions to manage more money".

In recent years, allegations have increased of corruption in government contracts for foodstuffs, services and infrastructure projects.


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