By Mario F da Costa Pinheiro, an independent policy analyst based in Dili
Timor-Leste is at a critical juncture in its economic development. The Bayu-Undan oil and gas field, whose proceeds have been the backbone of steady income for the Petroleum Fund (PF), ceased production in June 2025. Since production began, the field has contributed over $24 billion to government coffers – enabling successive governments to deliver more services and invest in programs and policies that have been crucial to the country’s progress.
With limited non-oil domestic revenues (approximately 10-15% of GDP) and no sustainable alternative income source in sight, the shutdown in production means that inflows to the PF will be smaller and scarcer.
For context, Timor-Leste has saved all petroleum revenue from the Bayu-Undan field since the early 2000s in a Norway-style sovereign wealth fund. Since 2009, successive governments have invested the fund in international bonds and equity markets. While these investments have occasionally posted losses, they have generally been quite lucrative, yielding an average return of over 4.5%, or between three-quarters of a billion to over a billion dollars annually. That is roughly 40–70% of Timor-Leste’s annual government budget in any given year since 2010.
Revenues from Bayu-Undan have played two vital roles in this financial architecture. First, they served as a cash cow, supplying a steady stream of income for the PF’s market investments and financing most public expenditures. Second, they acted as a buffer against investment losses, continuously replenishing the fund after each withdrawal and ensuring its resilience. The PF has now effectively lost this buffer, leaving both the fund and Timor-Leste in a more precarious financial position.
Nevertheless, the outlook may not be as bleak as feared. While Timor-Leste initially relied heavily on direct petroleum revenues particularly in the first 10 years of the fund’s existence, investment returns have become the PF’s primary source of replenishment since production peaked in 2015 and subsequently declined. This shift marks the country’s transition to a new source of funding for its expenditures and investments.
In other words, returns from PF investments have effectively replaced petroleum revenues as the main income source for the fund, and by extension, the government. This fact has flown under the radar since 2016 and has received little attention in policy and political discourses. It is essential to highlight this shift for several reasons.
First, it makes the outlook of the post-Bayu-Undan production reality just a little less bleak. Since news of the shutdown broke, concerns have grown over a potential fiscal cliff within 5–10 years and its catastrophic consequences. While these fears are legitimate, they may have double-edged consequences in terms of public policymaking. Of particular concern is the risk of distorting public policymaking.
Past projections of the PF’s lifespan appear to have influenced government spending decisions. For instance, several national and international organizations once projected that the fund would be depleted by 2027, based mainly on two assumptions: the commercial life of Bayu-Undan and repeated government withdrawals exceeding the legislated 3% threshold since 2010. Little attention was paid to the growing returns from the PF’s financial investments, even as they began generating significant income.
This earlier projection, however speculative, likely shaped government spending behavior from 2010 onward. Faced with a perceived fiscal countdown, along with the urgent need to rebuild infrastructure such as roads and electricity grids devastated in 1999, and the possible need to minimize future financial constraints related trade-offs, the government embarked on a spending spree including front-loading several large-scale infrastructure projects starting in 2009.
The government could have adopted a more prudent and strategic approach to spending if it had known about the growing importance of the investment returns earlier. It could have opted for a more balanced allocation across sectors, rather than concentrating heavily in one or two sectors such as physical infrastructure. This could have minimized policy trade-offs, reducing the need for sudden, massive investments in historically underfunded sectors now and in the future.
After 15 years of PF investments in bonds and equities, it is hoped that the government has accumulated substantial expertise regarding returns and risk. This input will be crucial to guide the government’s future planning and spending decisions.
So, what is publicly known about PF investments, and can Timor-Leste live off these returns now that oil and gas revenues have ended?
The answer is a definite yes. While this may sound overly optimistic, it is not impossible for Timor-Leste to rely on the fund for another one to two decades. However, this depends on several transformative changes and critical assumptions. A business-as-usual approach to spending will not suffice.
The first necessary change is almost axiomatic: the government must keep withdrawals below both the PF’s average returns and the legal 3% threshold. With average returns around 4.5%, equivalent to 40 – 70% of the annual budget since 2010, this is achievable. A caveat is that positive returns are not always guaranteed every year.
Still, important lessons can be drawn. First, despite volatility, PF investments have yielded positive results overall. Since 2010, the fund has recorded losses only twice, with one major loss (over $2 billion) – a success rate of 87% across a 15-year period. Moreover, Timor-Leste’s PF prioritizes capital preservation and has avoided high-risk investment portfolio like stocks. This should help minimize losses and preserve the fund’s long-term effectiveness.
That said, it would be misleading to assume the same performance will repeat over the next 15 years. Nevertheless, recognizing risk patterns and an acute awareness of global macroeconomic trends can and should inform government long-term planning, investment, and spending.
Second, our economic circumstances have changed now that revenues from oil and gas have ended. This should drive the imperative for change in the way the government conducts its affairs to avoid getting locked in a fiscal straitjacket that can lead to a resource squeeze on public service provision. The government must respond to this new fiscal context and the pressures that come with it. It needs to transition into a new mode of governance.
Government agencies need to start imposing severe fiscal discipline in the services they provide. They must seek to, where possible, broaden the revenue base, reduce recurrent expenditure, cut slacks, de-scaling activities and downsize if appropriate. The government has grown exponentially in the last 15 years. Its recurrent expenditure alone has been consistently high, averaging between 60 to 70% of the budget. It must strive for doing more with less and finding improved ways of doing business.
In essence, it must be creative and innovative with sourcing and financing options to chart pathways to fiscal sustainability. It must begin to reassess its core role and responsibilities and explore options for the most cost-effective service delivery system.
It also appears that the legal 3% threshold withdrawal rate doesn’t seem to have the desired effect as a behavioral incentive. It has become largely a symbol of fiscal discipline with no real effect in nudging or pushing for innovation in program financing and governance. The government’s propensity to withdraw from the PF beyond the legal limit remains a lingering issue. Containing this predisposition is a key element to that goal and unfortunately, the current fiscal rule is not that effective.
Perhaps, it is time to reform the PF withdrawal rules – introducing additional criteria for fund withdrawal. For instance, in addition to the 3% threshold, the fund can only be withdrawn for specific or designated spending category. Tying the use of the PF to essential spending categories such as subsidies for senior citizens and people with disabilities (PWDs), pensions for retired workers and war veterans, funding for education and health care could be a starting point for this proposed criterion. This should compel the government to think innovatively, find ways to finance programs not funded through the PF, and support extending the PF’s lifespan at least until a sustainable source of income is secured.
Third, charting pathways to fiscal sustainability through fiscal control alone is just one piece of the puzzle. A more sustainable means to achieve that goal is through creating an enabling environment for the non-oil economy to grow and thrive. To this end, the government needs to invest more in agriculture and tourism to grow industries in these sectors.
The urgency to diversify the economy cannot be overstated. There has been massive historical underinvestment in these areas and the imperatives for increased investment are significant. Greater budget allocations to productive sectors like agriculture, fisheries, livestock and forestry, and tourism from now and into the next 5 years will be crucial to kickstart industries in these sectors and promote private-sector led growth. It doesn’t have be a sudden surge in investment. It can increase incrementally to allow these sectors to absorb these increases in gradually, and continue the upward trend until industries in these sectors are fully developed.
Politically, national convergence on key policies is urgently needed. To unlock the country’s true potential with minimal risk, political parties must reconcile their differences and build a consensus on strategic policies and goals for the next 5 to 10 years. The current “government vs opposition” dynamic is a luxury the nation can no longer afford, and is a direct disservice to long-term progress.
Adopting unified national strategies to alleviate poverty, combat corruption and spur private sector-led growth initiatives is essential. This cooperation would eliminate wasteful duplication, streamline service delivery, and yield massive long-term benefits.
In closing, the end of Bayu-Undan’s revenues has fundamentally changed Timor-Leste’s economic reality, sparking legitimate fears of a fiscal crisis that threatens public service provision and distort public policymaking. Yet, collapse is not inevitable. With disciplined management and strategic reforms, the PF itself possesses the strength to sustain the nation for years to come or until a more sustainable economic foundation is secured. This viability, however, hinges entirely on the government’s commitment to transformative changes and disciplined fiscal governance.
Mario F da Costa Pinheiro is an independent policy analyst based in Dili. He has a Master in Public Policy, specializing in Public Finance and Social Policy from Crawford School of Public Policy, The Australian National University.
TATOLI
