Timor-Leste Compact - Constraints Analysis

MCC’s evidence-based approach to its investments begins with a mutual understanding of a country’s main growth challenges. During the first phase of the compact or threshold program development process, MCC and the selected partner country, jointly conduct a constraints-to-growth analysis (CA). This analysis identifies the constraints to private investment and entrepreneurship that are most binding to economic growth in the country. The results of this analysis enable the country, together with MCC, to select activities most likely to contribute to sustainable, poverty-reducing growth.

The Constraints Analysis Report for the Timor-Leste Compact highlights the following  binding constraints to economic growth:

1. Public Financial Management: Low sustainability and effectiveness of fiscal expenditures – The sustainability of government expenditures funded through the Petroleum Fund is in doubt. If the fund were to be exhausted, the resulting fiscal contraction would have significant consequences. Both the efficiency and targeting of government expenditures can be improved to better promote private investment and grow a tax base that can begin to displace excess withdrawals.
2. Dutch Disease: An uncompetitive real exchange rate – The rapid growth of consumption enabled by oil resources has inflated the prices of non-tradeable goods in Timor Leste including land and labor. As a result, it is difficult for sectors like manufacturing and tourism to compete against lower cost international producers.
3. Business Enabling Environment: Weak institutions for supporting market transactions – Timor Leste has not yet put into place the policies and institutions needed to support a market economy. The country lacks the legal framework and judicial institutions necessary to support contracts and their enforcement. The lack of these institutions creates inefficiencies in transactions across multiple markets but especially affects transactions in land and financial markets.
4. Human Capital: Poor nutritional outcomes and lack of high skilled workers – Early childhood health and nutrition is inadequate and reflected in high rates of stunting. The low availability of tertiary education in the workforce has led to relatively large premiums for higher skilled workers and firms disproportionately bringing in skills from abroad.