Timor-Leste’s uncertain future | Lowy Institute

Like many developing nations, Timor-Leste has undergone significant demographic change and has an overwhelmingly young and growing population, with 73 per cent estimated to be under 35 years of age.

The ramifications of this demographic change are only starting to materialise but will reverberate in the years to come.

If one travels to Suai, on Timor-Leste’s south coast, they will see the makings of Tasi Mane, a megaproject intended to provide the necessary infrastructure for processing liquefied natural gas (LNG) from the Greater Sunrise gas field.

So far, the project includes the first leg of the Suai Highway, Kay Rala Xanana Gusmão International Airport, and new housing, mainly for residents displaced due to construction. The geopolitical undertones are impossible to miss, with signage from Indonesian and Chinese state-owned companies dotting the landscape.

Tasi Mane personifies the promise and peril that oil and gas hold for Timor-Leste. On one hand, oil and gas have catalysed economic growth and, since regaining independence, allowed the country to achieve a level of development that has markedly improved the lives of its young population. On the other hand, it has afflicted the country with the so-called “resource curse” — a predicament of social, political, and financial instability that has bedevilled oil and gas-dependent countries worldwide. Despite some level of domestic awareness around the issue, it may still spell trouble for Timor-Leste’s future.

Timor-Leste’s resource curse

With a 2022 GDP of US$2.02 billion ($1,500 per capita),

Timor-Leste is one of the world’s smallest economies. Its dominant petrochemical sector accounts for the vast majority of GDP, with remittances, agriculture, coffee, and tourism making up much of the rest. At 4.9 per cent,

the official unemployment rate is low but does not reflect the realities of labour markets. With a poverty rate of 42 per cent,

nearly half the population still gets by on the bare minimum.

Much of the country’s wealth is concentrated in and around its growing capital Dili, and those who live in rural areas face starker poverty than their urban compatriots. Someone residing in Laga, a coastal town located in the country’s east, or Maliana, an interior town near the border with Indonesia, lives a fundamentally different life than one does in Dili, where access to job opportunities, consumer goods, and mobile phone coverage is more abundant than in the rest of the country.

For the country to prosper beyond its capital city, economic development and diversification will be crucial. As a December 2022 World Bank report notes, “Timor-Leste remains overly reliant on hydrocarbon production for sustaining its economy…without the oil revenues, the undiversified economy of the country will solely rely on the rapidly depleting Petroleum Fund to bridge the considerable fiscal gap in its annual budget”.

Timor-Leste is staring at a potential budgetary catastrophe that, under current projections, will occur between the late-2020s

and mid-2030s,

when the state’s Petroleum Fund — the sovereign wealth fund from which more than 90 per cent of government revenue is derived

— is projected to run dry. If nothing is done to change this trajectory, Timor-Leste will eventually see its state coffers completely depleted.

This is a worst-case scenario, and it is one that can be avoided by acknowledging its possibility. It can be fended off in one of two ways: by developing the Greater Sunrise gas field in time to produce substantive royalties for the Timorese state, or by diversifying the economy so it is no longer dependent on oil and gas for state revenue and economic growth.

The politics of Greater Sunrise

One gas field more than any other — Greater Sunrise, located just off the south coast — has come to dominate the conversation about economic development in the country. Other oil and gas deposits in surrounding areas are being explored, but Greater Sunrise is the only one that holds concrete promise thus far. It has the potential to generate tens of billions of dollars in royalties for the Timorese state, and to fill the gap being left by dwindling royalties from the country’s existing Bayu–Undan gas field, the productive life cycle of which will end this year and on which the Petroleum Fund has depended since 2006 for financial inflows.

Timor-Leste’s President José Ramos-Horta claims that financial windfalls from Greater Sunrise could turn his country into “the next Dubai or Singapore”.

Others are sceptical, with one energy industry commentator calling the project “an eternal long shot” in which “the odds of progress look as difficult as ever”.

Polarised views have long characterised the debate over the field’s development, and progress remains stalled due to a disagreement between the field’s three joint venture partners — Timor Gap (a state-owned Timorese oil company), Woodside Energy (an Australian petroleum producer), and Osaka Gas (the Australian arm of a Japanese gas supplier). The three entities have yet to agree on whether gas from the project should be processed at to-be-completed facilities in Timor-Leste or existing facilities in northern Australia. There is intermittent talk of a floating offshore platform as a third option, but it does not appear to be under serious consideration.

Timorese leaders have long asserted that Chinese state-linked entities will bankroll Tasi Mane if Australia and its partners do not. However, they have not yet done so.

Since the release of Timor-Leste’s Strategic Development Plan in 2011,

successive Timorese governments and Timor Gap have insisted on Tasi Mane — the colloquial name for the new processing and related facilities in Timor-Leste — as the way forward. Broadly speaking, proponents view the northern Australia option as holding less economic promise and representing an affront to their sovereignty, reflecting a lingering mistrust of the Australian government that stems from a scandal in which Australian intelligence services were caught spying on Timorese officials during contentious oil and gas negotiations in the mid-2000s.

Domestically, supporters of Tasi Mane, led by independence hero and current Prime Minister Xanana Gusmão, have tied the project to a wider effort to “reorient a national identity of resistance to one mobilised around the goals of national development”.

By doing so, they have politicised the issue in their favour, but also created circumstances under which they could lose face if they change their position.

The Australian-owned Woodside has taken the opposite tack, arguing that Timor Gap’s preferred option is economically unviable and that it makes more sense to use facilities in northern Australia that are able to bring production on-line quicker. Woodside’s position has frustrated the Timorese, who see the Australian government as complicit, despite Canberra’s insistence that it is a decision to be made purely by the joint venture partners and not by governments.

At this stage, the northern Australia option is more likely than Tasi Mane to produce revenue for the Timorese state before the late 2020s, thus providing the inflows necessary to avoid a financial crunch. If Tasi Mane is delayed or not producing revenue by then, the country is at risk of fiscal calamity.

Globally, infrastructure projects frequently encounter delays, and if the proposed gas pipeline comes to Timor-Leste, it is unlikely Tasi Mane will be an exception. The first leg of Timor-Leste’s Chinese-built Suai Highway took two years longer to complete than promised,

and its sub-par construction became evident mere weeks after it opened, with a stretch of the road rendered impassable by weather-related damage, which then took months to repair.

This raises the question of how technically complicated and fragile LNG processing infrastructure would be built and maintained in the country.

The longer the joint venture partners take to come to an agreement, the closer the fiscal cliff comes.

Further, prospective investors are not queuing up with the necessary capital, despite proponents’ claims to the contrary. Timorese leaders have long asserted that Chinese state-linked entities will bankroll Tasi Mane if Australia and its partners do not. However, they have not yet done so.

At a time when China is re-evaluating its Belt and Road Initiative investments and reducing its risk exposure,

it seems unlikely — but not impossible — that Beijing will change tack to invest in Tasi Mane.

Timor-Leste held parliamentary elections on 21 May 2023, which saw Xanana Gusmão returned to power as prime minister. Gusmão, who was the country’s first president from 2002 to 2007 and its prime minister from 2007 to 2015, maintains remarkable sway over the nation’s politics. He has long been the lead advocate for Tasi Mane, and his return to power will see the country double down on its stance — at least on the surface. While Gusmão seems likely to maintain his position regarding the megaproject, it is worth remembering that he is arguably the only person who holds the political legitimacy necessary to change direction on the matter.

The longer the joint venture partners take to come to an agreement, the closer the fiscal cliff comes. But there is now a sense of urgency on both sides that may induce action. In February 2023, the stakeholders announced the undertaking of a concept selection study, the results of which are expected in late 2023 or early 2024. In addition, under the terms of the Maritime Boundary Treaty, any development concept will need to be approved by the Australian and Timorese governments.

In May 2023, Timor Gap’s CEO Antonio De Sousa stated that production at the new field could start around 2030

— a timeframe that does not encourage optimism regarding the country’s financial situation. Irrespective of currently held positions, domestic and international actors will need to get behind whatever option is agreed upon and ensure it works for Timor-Leste, as the country needs to draw financial royalties from the field as soon as realistically possible. In the meantime, they should seek to support diversification of the country’s economy.

Economic diversification

Alongside Greater Sunrise, Timor-Leste needs to accelerate economic diversification to create alternative streams for growth, thus reducing its dependence on oil and gas for revenue in an attempt to reverse the “resource curse”. Over the past two decades, this diversification has focused on growing the coffee, agriculture, and tourism sectors — all of which have received substantial international support. To date, the results have not been encouraging.

As the National Coffee Sector Development Plan states, “The coffee industry is a central part of Timor-Leste’s economy, society and history”,

accounting for 85 per cent to 90 per cent of Timor-Leste’s annual non-oil merchandise exports since independence. In 2021, the country exported US$16.3 million worth of coffee

— a figure that may grow as global consumer habits and trade flows recover from the disruption of the Covid-19 pandemic.

More than 70 per cent of Timorese draw income from the agriculture sector,

primarily through subsistence farming. But, due to international market access hurdles and inefficient farming practices, much of what is produced is consumed domestically and exports remain a drop in the bucket. In fact, according to the World Food Programme, Timor-Leste imports 60 per cent of its food.

Tourism has long been touted as a growth sector, with the country’s biodiversity, scuba diving, and natural beauty all potential draws for visitors. Signs of progress were evident prior to 2020, with tourist arrivals increasing to 74,800 in 2019.

But the sector was decimated by the Covid-19 pandemic and has yet to fully recover. In addition, practical factors such as limited air access present formidable barriers to tourism.

Collectively, these three sectors are unlikely to grow to the point where they can fill the revenue gap if Greater Sunrise does not pan out. Nonetheless, they are meaningful pieces of the diversification puzzle — especially agriculture, which would be imperative to a sustainable domestic food supply under a worst-case economic scenario. A number of these scenarios will be explored in the conclusion of this paper.

As demonstrated by several Pacific Island states, labour migration causes a brain drain that can sabotage economic, political, and social development.

In addition to the coffee, tourism, and agriculture sectors, several industries such as fisheries and carbon capture and storage (CCS) could fill part of the economic gap, and are currently being pursued to varying degrees. In May 2023, the Australian oil and gas exploration company Santos announced plans for CCS at Bayu-Undan,

but the revenue potential and technology remain unproven. Industries including financial services and gaming have also been floated as possible sources of additional revenue, but seem largely fanciful at present.

One source of economic growth that is here to stay, however, is remittances, which are presently the country’s second-largest source of income.

Young Timorese, frustrated by the lack of jobs and opportunity at home, are increasingly seeking work overseas, often sending money to their families back home. This provides an important injection of currency into the economy that, in turn, is used to purchase goods and services, often from local businesses.

However, the downsides of remittances are many. As demonstrated by several Pacific Island states, labour migration causes a brain drain that can sabotage economic, political, and social development. At a time when Timor-Leste must attract much-needed financial capital, an exodus of its most skilled and accomplished people is the last thing it needs.

Yet labour migration is only set to grow, especially as opportunities emerge in the region, such as through the expanded Pacific Australia Labour Mobility (PALM) scheme

and South Korea’s recent “embrace” of foreign labour amid domestic shortages.

Further afield, Timorese may continue to migrate to destinations such as Portugal and Northern Ireland, where sizeable Timorese diaspora communities reside.

Basic manufacturing, another oft-discussed sector, has been subject to fits and starts that are perhaps best symbolised by the arrival of global brewer Heineken in Timor-Leste in 2018, with the Dutch-owned company making “the first foreign investment in the [country’s] manufacturing sector”.

Some news reports bullishly claimed that the multinational’s entry could “open taps on foreign investment”.

The brewery on Dili’s outskirts has weathered an arduous operating environment and holds lessons about the challenges and opportunities facing foreign investors.

Heineken encountered issues long familiar to the country’s nascent private sector, such as workforce capacity and regulatory uncertainty. It reportedly did not meet domestic production commitments,

and there were questions about whether the Timorese market was large enough for it to turn a profit. But the factory remains open, and the company has been able to sustain its operations.

Timor-Leste’s export potential

To compensate for Timor-Leste’s market size, companies may need to export to external markets to turn a profit and sustain operations. The country’s coffee sector provides a good example. In 2017, Starbucks, the world’s largest coffee company, exported beans from Timorese producers to feature in specialty blends carried at locations worldwide,

making Timorese coffee accessible in cities such as Washington, DC, where it had never previously been available at scale.

For a host of reasons, Indonesia is the most likely market for exports, which the Timorese are pursuing through initiatives such as Special Zones of Social Market Economy (ZEESM). The ZEESM in Oecusse — a special administrative region of Timor-Leste — is a billion-dollar megaproject intended to incubate basic manufacturing growth through links with Indonesian supply chains. It includes a new international airport and the country’s largest bridge, echoing the same “build it and they will come” mentality as Tasi Mane.

Closer economic ties with Indonesia may seem an obvious path, but formidable political hurdles exist.

In this vein, Fidelis Magalhães, a senior Timorese government minister from 2018-23, has called for a free trade zone (FTZ) with Indonesia,

which would help Timor-Leste benefit from recently announced plans for manufacturing growth in East Nusa Tenggara,

the Indonesian province with which Timor-Leste shares a land border. In addition, the newly operational Tibar Bay Port — 12 kilometres from Dili — gives Timor-Leste a competitive advantage as it aims to integrate itself into regional logistics networks.

It remains to be seen how viable the Oecusse ZEESM and FTZs with Indonesia will be. In 2019, Michael Rose, who has conducted extensive research in Oecusse, wrote that the ZEESM’s development had been a “mixed bag”,

and in 2020, Fredrik Sjöholm argued that “there is a real risk that Tasi Mane and the Oecusse industrial cluster will turn out to be white elephants”.

Closer economic ties with Indonesia may seem an obvious path, but formidable political hurdles exist. The author raised this prospect with a Timorese government official, who immediately pointed to apprehensions about economic dependence on Indonesia and how it might enable de facto control over Timor-Leste. Current data gives a level of credence to this viewpoint. In 2021, nearly 40 per cent of Timor-Leste’s imports came from Indonesia, and more than 73 per cent of its exports went to Indonesia.

The Timorese official noted regional integration as one way the country protects itself from over-reliance on any one external power,

reflecting the long-standing emphasis placed on multilateralism by Timorese decision-makers.

While not the focus of this paper, Timor-Leste must develop a workforce that can compete within the region. To do so, it needs to vastly improve its health and education systems. Malnutrition is prevalent, and issues such as stunting disadvantage many Timorese from infancy. Schools are not teaching students the skills they need to succeed, leaving a workforce that is not ready to fill technically skilled let alone basic jobs.

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