Ministry of Finance and World

Bank

Public Expenditure Review of Infrastructure

(March 2015)

Background and Drafting

2

• MoF decided Terms of Reference for report and employed World Bank to assist with drafting

• MoF has led every step of process including drafting, reviewing and presenting

• Process has followed the new deal principle of government ownership

• This has resulted in a higher quality, more practical and useful report than the World Bank normally writes

• The report proves that Government ownership works and results in a better quality product

Report and Presentation Structure

3

• Trends in infrastructure spending

• Impact on economic growth and fiscal sustainability

1: Macro-fiscal

• Explanation and review of investment management cycle

• Planning, budgeting, procurement etc

2: Investment Management

• Detailed review of electricity, irrigation and road sectors

3: Sectors

4

Part 1: Macro-fiscal Chapter

Infrastructure Spending has Sharply Increased

5

0%

10%

20%

30%

40%

50%

60%

$0

$200

$400

$600

$800

$1,000

$1,200

Budgeted Infrastructure Spending

Actual Infrastructure Spending

Actual Infrastructure Spending % of Total Spending

To One of the Highest Levels in the World

6

0

10

20

30

40

50

60

70

80

Pu

blic

Inve

stm

ent

as a

% o

f N

on-

pet

role

um

GD

P

Past Spending (2008 to 2013) was Heavily Concentrated on Electricity, Roads and Bridges and District

Development

7

896

254

169

265

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

in $ Million

All Other

District Development

Roads and Bridges

Electricity

Electricity Generation has Increased Compared to Our Peers

8

TL 2013

TL 2008 -

200

400

600

800

1,000

- 1,000 2,000 3,000 4,000 5,000

Wat

ts in

stal

led

/gen

erat

ed p

er

cap

ita

GDP per capita (2011 US$)

9

There Has Also Been An Increase in the Percentage of Households Receiving Electricity

22%

53%

0%

10%

20%

30%

40%

50%

60%

2007 2013

Rec

eivi

ng

Ele

ctri

city

Roads (at least until 2012) Had Not Improved

10

0

20

40

60

80

100

120

2010 2011 2012

% o

f R

oad

s

Fast Two Wheel Drive Slow Two Wheel Drive

Two Wheel Drive with Vehicle Damage Slow 4 Wheel Drive

High Recurrent Costs and Possible Under Budgeting Electricity

11

$0

$50

$100

$150

$200

$250

$300

$350

$400

$450

$500

Actual 2008

Actual 2009

Actual 2010

Actual 2011

Actual 2012

Actual 2013

Budget 2014

Forecast 2015

Forecast 2016

Forecast 2017

Forecast 2018

$ M

illio

n

Operations and Maintenance: Fuel for Generators

Operations and Maintenance: Hera and Betano

Operations and Maintenance: Other

Infrastructure Spending

Economic Growth

12

•Government expenditure sharply increased from 2008 to 2012 • Led to economic growth concentrated in the Government administration and construction sectors •Is taking money out of the petroleum fund (by definition not part of non-petroleum GDP) and increasing Government spending (by definition part of non-petroleum GDP) really creating economic value? •In the long term infrastructure spending increases economic growth when it results in roads, electricity and other outputs which firms use to increase production •This has not yet occurred in Timor-Leste, with manufacturing and agriculture growing slowly between 2008 and 2012 •Unsurprising as there are normally lags between spending, the completion of construction and the availability of the new infrastructure •In addition, there are already indications that some energy intensive industries, such as brewing and cement making, are considering moving to Timor-Leste

Frontloading. But at What Amount?

13

Excess withdrawals

Construct Infrastructure

Economic Growth

Higher revenue and lower spending

Back to the ESI

ESI is Conservative. But not Being Conservative does not Change Things that Much Because Most Oil has

Already Been Mined.

14

Sustainable income with

reference case for oil price and

production

Frontloading Can Work

15

$0

$200

$400

$600

$800

$1,000

$1,200

$1,400

$1,600

$1,800

$2,000

2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030

ESI Loans Domestic Revenue Total Expenditure Total Sustainable Revenue

Gap shows excess withdrawals

But Only with Difficult Choices

16

2015

Short Term

2016 to 2018

Medium Term

2019 to 2030

Long Term

Fiscal Envelope with ESI 1.3 1.3 1.5

Fiscal Envelope with FSIIPR 1.3 1.4 1.8

• Total expenditure can only grow very slowly over time • Most of increase in recurrent will be on new operation and maintenance spending • Other recurrent expenditure will be falling in real terms per capita •Domestic revenue has to increase to 15% of non-oil GDP in medium term • Infrastructure fund spending would need to be restricted to less than $370 million a year (this is lower than outer year spending in the 2014 budget)

17

Part 2: Overview of the Investment

Management Cycle

Where are the Bottlenecks? (Under Spending by Cause in 2012 for Infrastructure Fund)

18

$23 $26

$135

$6

$211

$59

$0

$50

$100

$150

$200

$250

Over budgeted or activity paid under

different budget

Design or feasibility study has been

delayed

Procurement of major construction component of the project has been

delayed

Payment Processing

Constraints/Delays

Construction and therefore payment

has proceeded more slowly than

envisaged

Other or not explained

Mill

ion

19

Investment Management Cycle Strengths and Weaknesses

• Timor-Leste has exceeded expectations and its peers in terms of the development of its public investment management system

• Strong preparation of project briefs (MPS and Line Ministries), project appraisals (MPS) and budget preparation process (MPS and DNO)

• Areas of weakness:

– Projects being included in budget despite appraisals showing that they have low rates of economic return (e.g. MPS review of irrigation projects)

– Poor design studies from line ministries being shared with MPS and ADN late in the process and delaying procurement

– Little or no consideration of maintenance costs or activities when selecting projects

– Limited ex-post evaluation of infrastructure projects

20

Part 3: Key Issues from the Electricity, Irrigation and Roads

Sectors

Increased Generation has Led to a Large Yearly Subsidy

21

•In 2012 EDTL generated 237 million KWH electricity. This cost $100.7 million • It revenue was $14.9 million so there was a subsidy of $85.8 million. • This subsidy could be reduced in at least three main ways reducing theft, implementing a new tariff structure and reducing the costs • Reducing theft if EDTL completed the installation of 70,000 pre-paid metres, brought all consumers into its database and stopped all theft then there would be a net saving of $21.7 million •So while metering can reduce the subsidy, unless we reform the tariff structure there is still going to be a significant subsidy

100.7

14.9

85.8

$0

$20

$40

$60

$80

$100

$120

EDTL Costs

EDTL Revenue

Subsidy

$ M

illio

n

Reducing the Subsidy Through Implementing a New Tariff Structure

• The tariff structure for residential users: – Up to 20 KWH per month $0.05 – Above 20 KWH per month $0.12

• This is not progressive enough. Somebody using 21 KWH a month is likely quite poor (only using say four fluorescent lights), but is paying the same tariff as somebody using 2,000 KWH per month who is running an air conditioner all day and is likely fairly rich

• 281 biggest customers consumed more than 16% of electricity* but paid same as all but the smallest consumers

• New tariff structures with high use customers paying more should be considered

22

One Potential New Tariff Structure

23

Tariff

category

Tariff

cents per kilowatt-

hour

% of

customers

Up to 50 kilowatt hours/month 5 21

51 - 1,000 kilowatt hours/month 12 77

1,001-2,000 kilowatt hours/month 15 1.4

2,001-5,000 kilowatt hours/month 30 0.3

Over 5,000 kilowatt hours/month 42 0.2

•The tariff structure below is more progressive •It would lead to additional revenue of $2 million • At low levels of consumption it is more generous

Electricity Subsidy Conclusion

24

• Government has successfully increased generation and access to electricity

• This has led to a large subsidy. However significantly reducing the subsidy is possible by:

– Increasing metering and reducing theft

– Increasing the tariff for households who use a lot of electricity (likely richer households)

– Considering ways to reduce the cost of producing electricity

Ministry of Agriculture has Spent and Plans to Spend Quite a Lot on Large Weir Based Irrigation

Schemes (2013 prices)

25

0

20,000

40,000

60,000

80,000

100,000

120,000 2

00

3

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

20

14

20

15

20

16

20

17

20

18

20

19

20

20

S m

illio

n

<--Planned Expend. ($592 million)-->

<---Past Expenditure ($82 million)--->

But to Date this Spending has Not Led to High Economic Rates of Return Or Increased Overall Production

26

Laclo Bebui Maliana I

Economic Internal Rate of Return Negative Negative Negative

Benefit to Cost Ratio 0.18 0.32 0.31

Average 98,500

Average 89,500

0

50,000

100,000

150,000

200,000

2005 2006 2007 2008 2009 2010 2011 2012 2013 Av

Mt

Rice

Maize

Why Haven’t Irrigation Schemes Been Successful

27

• The negative returns on these completed schemes can be explained by the high associated construction costs and their limited impact on rice production levels

• The costs of the schemes are high compared to other countries at $10,000 per hectare.

• The schemes benefit a limited number of farmers and have a limited impact on production because: – There is a lack of financial incentives for farmers to produce

more rice (due to subsidized rice and other sources of income)

– The Ministry of Agriculture does not provide an appropriate package of software. More specifically: • Extension workers are poorly trained • Supply of seed, fertilizer and other chemicals is poor • Limited and/or unreliable market and price for rice

• Going forward spending on large scale weir based irrigation should be decreased, spending on software should be increased and tube well irrigation should be considered

Not all Road Construction/Rehabilitation Outlined in the SDP is Necessary to Become an

Upper-middle Income Country

28

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

Timor-Leste Current

Timor-Leste 6 Priority Roads Rehabilitated

Timor-Leste All Roads

Rehabilitated

Timor-Leste All Roads

Rehabilitated and Ring Road

Built

Low Income Countries

Lower Middle Income

Countries

Upper Middle Income

Countries

High Income Countries

Ro

ad D

en

sity

29

Average Cost Per KM

$0

$200,000

$400,000

$600,000

$800,000

$1,000,000

$1,200,000

Existing alignment and return to a maintainable

standard

Simple repair and rehabilitation of existing roads to

3.5 metres

Improve alignment where

needed and improve drainage

Rehabilitate to 4.5 metres

Expand to 6 metres and

realign when needed

Expansion to 6 metre width and

upgrade alignment

Expand to 7 metres with major slope adjustment

As Unit Costs Increase Benefit to Costs Ratio Declines

30

0

1

2

3

4

5

6

$150 $250 $350 $450 $550 $600 $700 $800

Be

nef

it/C

ost

Rat

io

Average Unit Cost of Reconstruction

B/C Ratio

Key Recommendations

31

1. Expenditure should be constrained to $1.3 billion a year at most in the short and medium term

2. Budget for operation and maintenance spending for roads and agriculture should be increased. More priority should be given to maintaining and less to constructing

3. Establish a “project bank” of pre-qualified projects with design studies, cost benefit analysis and high economic rates of return. CAFI should choose from bank based on priority and fiscal envelope

4. For all infrastructure projects, line ministries should submit detailed plan and costing of expected operation and maintenance activities. This should be considered when deciding whether to approve new infrastructure spending

5. Ministry of agriculture should maintain existing irrigation schemes and increase farmer support services and market development programs and consider tube-well irrigation

6. Installation of 70,000 additional pre-paid metres should be urgently undertaken and then changes in tariff structure considered