Timor-Leste is making good progress in nation-building and its emerging governance systems have progressively developed into a largely disciplined PFM system.  

However, critical development challenges remain as the country transitions out of the fragility agenda, with nascent human and institutional capacity amidst large infrastructure gaps. The main challenge facing Timor-Leste is to effectively manage its petroleum wealth to reduce public sector dependence, diversify the economy, generate jobs for a young and fast-growing population and raise living standards.

The main objective of this PEFA assessment is to establish a new baseline for Public Financial Management (PFM) performance measurement based on the 2016 PEFA framework.

The assessment provides the Government with an objective, evidence-based diagnostic of the national PFM systems. The assessment also offers an update of progress in PFM systems performance since the last PEFA exercise in 2013 (which was based on the previous 2011 PEFA framework). The diagnostic is expected to inform an updated and comprehensive Government-led reform action plan which will catalyse existing reform programs already in progress.

This PEFA assessment is a joint exercise of the World Bank and the Government of Timor-Leste.

The assessment was conducted by a team of consultants under the oversight of the World Bank with technical coordination and input provided by the Ministry of Finance (MoF) assessment team. The assessment was funded by the European Union (EU), the Millennium Challenge Corporation (MCC) and the World Bank. Quality assurance followed the ‘PEFA check’ requirements and the World Bank’s internal quality assurance procedures.

The assessment covers the Central Government of Timor-Leste, including all budget units under the Consolidated Fund of Timor-Leste.

The scope encompasses central institutions (mainly line ministries), autonomous public agencies, municipalities, and extra-budgetary units – part of Central Government and integrated in the Consolidated Fund of Timor-Leste (CFTL).1 All sectors have been included in the assessment (except information on aspects of defense, public order, and safety functions that have been left outside the scope for reasons of national security) with a focus on service delivery sectors. The 12 municipalities are considered first-tier government given the current stage of the decentralization process. However, the Special Administrative Region of Oecusse-Ambeno (RAEOA) meets the definition of a subnational government according to the PEFA guidelines.

The assessment was conducted between June 2018 and July 2019 and the period of analysis was 2015, 2016 and 2017.

Parliamentary elections were held in May 2017 leading to a minority government and subsequent elections in May 2018, affecting the budget process and calendar. The 2018 budget was promulgated only in September 2018, and the 2019 budget in February 2019. The cut-off date for consideration of data and other information for the assessment was defined as December 2018, and the last completed fiscal year considered for the assessment is 2017.

PFM performance assessment

Although reforms have gradually progressed since the last PEFA assessment, overall performance has stalled and even deteriorated in specific areas.

This assessment shows that nine of the 31 indicators score C or C+, which is considered as a basic alignment with the standards of good PFM practice. Seven indicators are above the basic standard (with a score of B or A), while 15 indicators signal a weak performance (with D or D+). Out of the 94 dimensions, 55 dimensions are scored at C or above and 38 are scored D – while one is not scored (NA). A comprehensive, country-owned and country-led PFM reform action plan is under discussion to address impediments to improved PFM performance. A summary of current scores can be seen in Tables A and B below.

Impact on the Main Objectives of Public Finance

“Aggregate fiscal discipline” is supported by a solid capacity to prepare budget projections of macroeconomic and fiscal performance, but affected by the lack of credibility of the budget process.

Revenue from the Petroleum Fund is efficiently collected. Accounting and reporting for revenue is supported by a robust integrated Treasury cash and expenditure management function, managed through a Treasury Single Account (TSA). However, original budget envelopes have been systematically circumvented using revised budgets and virements. High-level political decisions regarding public investment management through the Infrastructure Fund have led to significant increases in budget adjustments, followed by systemic under-execution of the budget. Some accounts are maintained outside the TSA and government reporting (e.g., Overseas Development Assistance, RAEOA-ZEESM). Medium-term planning framework and processes have yet to be established, and the budget adjustments, driven by weak planning and procurement mechanisms, affect the capacity to deliver plans at the sector level. Payroll and procurement functions, and

related internal controls, are fully decentralized to the line ministries and municipalities and suffer from a fragmented control function and a clear lack of integration and consolidation of information systems. Control activities exist relating to cash management, and payments systems under the Treasury department are generally strong, in particular regarding segregation of duties and reconciliation of accounts, with the exception of manual and irregular bank reconciliation. Ex-post budget scrutiny is supported by a relatively effective oversight performance between the external audit function and Parliament. The role of the Camara de Contas (CdC) in the oversight of government spending is essential and even if there is no audit opinion, covers all central agencies and line ministries’ budget execution, including RAEOA-ZEESM.

“Strategic allocation of resources” is supported by Parliamentary scrutiny over budget formulation and execution and is based on comprehensive reporting and public access to fiscal information.

However, accountability has slightly deteriorated since the last assessment. Budget ceilings are defined and the pakote fiscal provides line ministries with the necessary information to set their priorities through their own budgeting processes. The programmatic mapping structure of the Annual Action Plans proposes a tentative framework for line ministries to advocate for funding outputs and outcomes for service delivery. However, the lack of a comprehensive medium-term budget planning framework and updated and operational strategic sector plans prevent the strategic prioritisation of sector spending. The budget allocation mechanism is annual and largely incremental. The situation is aggravated by the impact of budget adjustments often motivated by political decisions and not based on absorption capacity.

“Efficient service delivery” is hampered by the fragmentation in the management of public investments and lack of monitoring and oversight on the decentralized procurement and contract management systems.

This leads to a lack of accountability in the use of available resources to achieve value for money and optimal levels of public services. As a result, the Public Investment Management (PIM) framework shows inadequacies in the entire cycle – project preparation, appraisal, execution, monitoring and evaluation. Weaknesses in payroll management and capacity constraints limit the effectiveness of public sector services. Insufficient qualifications and skills limit the capacity of government institutions. The lack of effective internal control and internal audit function in line ministries and across all government institutions permits further suboptimal use of resources. The role of CdC in the oversight of government spending is essential but poor follow-up on external audit recommendations weakens the overall budgeting process. Externally funded projects are monitored separately and there are no systems to track allocations received by service delivery units.

Comparison with last PEFA Assessment

This PEFA has also been evaluated using the previous 2011 framework in order to compare both sets of scores and measure progress since 2013.

Performance changes between 2013 and 2018 on the 28 indicators reflect a mix of improvements (7 indicators), deterioration of performance (9 indicators), no performance change (9 indicators), while the remaining 3 indicators have been rated for the first time. This result supports the perception that PFM reform stalled in many areas over recent years as attention was diverted towards new areas with political exposure, such as the execution of the public investment portfolio or the municipal decentralization agenda, or affected by new priorities such as the budgetary governance reform and the creation of autonomous public agencies (APAs).

Improvements are noted in the specific areas where systems and procedures have been strengthened through new regulatory provisions.

This is particularly evidenced in the areas of treasury controls over expenditures arrears, non-salary expenditures and internal audit with the establishment of the internal audit function in MoF.

Aggregate fiscal discipline deteriorated due to adjustments to the original budget and reduced control over spending during budget execution.

The lack of credibility of the budget process and reliability of initial allocations result in significant adjustments made throughout execution. This also puts pressure on line ministries and other public entities to spend the additional resources without the necessary safeguards on the quality of spending decisions. The lack of timeliness of the budget preparation, with the late release of budget circulars and decision on ceilings, affected the orderliness and transparency of the budget process. Nevertheless, the absorption capacity improved as budget deviations were reduced despite an increase in budget levels. However, forecasts for non-oil revenue were still not realistic. Even if non-oil revenue has only a minor impact on overall government income, it signals the need for a more cost-effective and efficient revenue mobilization strategy in the future. The lack of an effective tax system undermines the credibility of revenue collection. On the positive side, the comprehensiveness of the budget is improving despite the increase of fiscal risks due to the growing number of APAs and a lack of systematic monitoring of the timeliness reporting of public corporations. Control of contractual commitments is still effective, although the information reporting and monitoring on arrears by MoF only started formally in 2016. Internal controls are being strengthened in the FreeBalance Government Resource Planning (GRP)system, and efforts are underway to systematically enforce them across decentralized and fragmented execution mechanisms.

The multi-year perspective in the planning and budgeting processes did not improve due to the negative impact of investment budgets and the lack of direct linkage with MoF reporting and accounting systems.

The budget documentation and public access to budget information remains high. The introduction of performance information in the budget promotes the transparency of expenditure policy, but the lack of adequately costed sector strategies reduces the relevance of the budget formulation process, while reporting on performance remains weak. More predictable and effective investment management would ensure that recurrent costs implications are factored in the budget in the longer term.

The consolidation of treasury systems and reporting procedures at the level of line ministries and agencies has improved, but information on transfers to RAEOA remains inadequate. The fiscal impact of new policies beyond the upcoming budget year and the reporting on fiscal outcomes remain weak. As a result, the scrutiny of the external audit and Parliament over the budget allocation and execution remains limited.

The weaknesses identified in the procurement system and the lack of independence of the external audit function are significant constraints on the accountability mechanisms in place, and do not support efficient service delivery.

Commitment and cash management systems are solid and effective. The strength of the process for consolidated annual financial statements enables effective oversight by the Camara de Contas (CdC) and Parliament, and it allows formal checks and balances mechanisms on the actual use of resources albeit with delay in case of elections. However, loopholes in the reporting systems (e.g., RAEOA) and delay in the last quarterly in-year budget execution reporting need to be addressed to maintain oversight of the budget execution. The lack of consistent and adequate performance information produced by the performance budgeting process fails to provide clear incentives to service delivery units.

The reporting of information on development partners’ support to service delivery sectors has improved, but it is not yet on-budget and fully integrated into Government systems.

PFM Reform Agenda

Timor-Leste has been undergoing a continual process of PFM reform since it became independent in 2002 and its approach to PFM reforms mirrors the remarkable commitment and good progress achieved in nation-building.

Despite the post-conflict transition and numerous development challenges, PFM reform has generally progressed incrementally, supported by a sustained effort from Government and the donor community. The path of progress varied over the past 15 years as the approach to supporting PFM reform shifted from individual donor projects, such as the Ministry of Planning and Finance Capacity Building Project (MPFCBP), to a more coordinated and integrated multi-donor programme, such as the Planning and Financial Management Capacity Building Programme (PFMCBP), and more country-led and targeted assistance through the EU Budget support operation in PFM since 2013. PEFA assessments, among other diagnostics, such as World Bank Public Expenditure Reviews and OECD analysis, have served over the years to advise on the pace and priorities of PFM reform.

Between 2014 and 2017, the Ministry of Finance focused on three reform initiatives: fiscal reform, performance management reform, and program-based budgeting.

The fiscal reform was approved in 2015 with the objective of diversifying revenue sources and supporting fiscal sustainability. It was focused on reforming the revenue and customs administration and their respective legal frameworks. The Government is aware of the need to strengthen human resources in these areas, and a special regime for customs and tax staff is waiting to be implemented, including merit-based recruiting and targeted competency trainings.

Performance management reform was initiated in 2015.

The goal was to tackle the capacity gap among PFM professionals. In order to manage human resources in the PFM setting, a team comprising several units (e.g. PBPEO, HRU, PFMCBC, TACU and Legal unit) was established to regulate the reform. The PFM Capacity Building Center (PFMCBC) was established to execute the reform process, manage, organize and develop specialized, differentiated and targeted PFM training for all PFM professionals.

The program-based budgeting reform started in 2015 as an initiative of the Prime Minister’s Office to focus the Government’s strategic priorities on service delivery.

In March 2017, a budgetary governance roadmap drawn up by OECD was approved through Government Resolution 17/2017. In 2018 and 2019, line ministries reported on their annual action plans (AAP) on a quarterly basis using the program-based structure. However, the link between budget and planning remains weak as the Chart of Accounts (CoA) and core financial reporting system is still operating on the economic classification. Moreover, the programmatic framework of the line ministries, structured around the program-based mapping exercise, does not rely on an adequately costed, comprehensive medium-term expenditure framework (MTEF).

The administrative decentralization and financial deconcentration process initiated in 2013 is still ongoing.

This has been a Government priority since 2014 (DL 4/2014 on Pre-Deconcentration Structure provides the legal framework for administrative decentralization), but effectively financial de concentration was initiated in 2015. The successive governments completed the deconcentration of most PFM functions to line ministries, APAs and municipalities between 2016 and 2018.

Despite a strong commitment to PFM reform, development partners’ support has generally been fragmented with a low level of coordination inside and outside Government.

There appears to be broad support among the main development partners for a more coordinated approach to PFM reform, and to support a unified reform program under the MoF’s leadership. A refreshed and fully coordinated donor engagement on PFM reform would be timely and support the ambitions of the Government.

This PEFA exercise, conducted with the support and participation of a wide range of stakeholders, is a step taken by Government towards better coordination and alignment of existing and future PFM support initiatives.

The PEFA assessment itself is not meant to include recommendations on the ongoing reforms, but it will contribute to a unified PFM reform action plan led by Government institutions.

Important gaps and challenges exist for the successful implementation of the upcoming PFM agenda.

Important challenges lie ahead as the MoF designs and implements a prioritized reform programme in a capacity-constrained environment. Institution building is still high on the PFM reform agenda, including supporting the goal of fiscal consolidation and centralization of fiscal monitoring. Setting the right expectations for the upcoming reform programme will require closer coordination and collaboration with MoF stakeholders, line ministries, other key PFM oversight and audit institutions, and civil society.