Brad Howarth – The newest nation is struggling to its feet, but little will happen without foreign investment.

East Timor is one of Australia's nearest neighbors, but economically the two countries could hardly be further apart. Four hundred years of Portuguese colonialism, followed by 24 years of oppression under Indonesian rule, during which an estimated 200,000 people died, has left the fledgling country the poorest in South-East Asia and among the 10 poorest in the world. It has the basic infrastructure, health care, and education standards of a Third World country. The nation's future depends on royalties from the rich natural resources, valued at more than $US30 billion, that lie off East Timor's south coast, and its ability to attract foreign investment from countries such as Australia. But this investment is far from certain.

The East Timorese paid a terrible price for choosing independence from Indonesia in August 1999. Pro-Indonesia militia groups killed hundreds of people and destroyed more than 70% of the country's public buildings.

On May 20, 2002, the country celebrated its independence. Now the task of rebuilding the nation of 950,000 rests with an alliance of the United Nations, the World Bank, foreign donors, non-government organisations, and a domestic Government seriously short of experience.

East Timor's Foreign Minister, Jose Ramos-Horta, a Nobel Peace Prize winner, says the country's predicament is rooted in history. "We are only independent for two years, starting from literally ground zero, from destruction and profound trauma caused by 25 years of war and humiliation of the people. Neither Portugal nor Indonesia cared much in preparing the country for independence, because neither ever contemplated that Timor should be independent. So there were similarities in the two countries' approach – that is, to make the people here illiterate and dependent on them."

Rebuilding began in 1999 with the assistance of the UN Transitional Administration in East Timor (Untaet), which was superseded in May 2002 by the UN Mission of Support in East Timor (Unmiset). This mission was to be phased out by May 20, 2004, but has been extended by another year.

Since independence, the East Timorese Government has begun a substantial program of economic and physical reconstruction, based on a 20-year national development plan. Its vision includes halving or eliminating poverty within 20 years, while improving literacy. The Government is spending 30% of its national budget of less than $US80 million on health and education. Domestic revenue contributes only half of the national budget; the rest is supplied by donor countries under the stewardship of the World Bank. Many non-government agencies also are running assistance and development programs. The country needs all the assistance it can get; an estimated 35% of children are underweight and half the women and young children suffer from iron-deficiency anaemia. East Timor is among the countries with the highest rates of leprosy and polio. World Vision is operating emergency food relief programs in six regions to alleviate the effects of recent droughts, and Habitat for Humanity has micro-loan schemes to assist people in reconstructing the estimated 85% of houses destroyed.

East Timor's long-term success will depend on how effectively it exploits its natural resources and attracts foreign investors from countries such as Australia. Its main resources include oil and gas fields in the Timor Sea, fisheries, a strong local coffee industry, and its tourism potential.

But nothing will happen without foreign investment.

An immediate concern for the local economy is the phasing out of Unmiset and withdrawal of high-spending international workers. East Timor's Prime Minister, Mari Alkatiri, is confident the economy can ride out the changes; it has confounded predictions of negative growth for the past two years.

According to the World Bank, East Timor's gross domestic product increased by 5% for the year ended June 30, 2002, but decreased by 2% in the following year. A further 2% decline is expected for the year to June 30, 2004. But Alkatiri believes that strengthening small businesses and improving agricultural productivity will mean that, at worst, the country will report zero growth in gross domestic product. He says the economy has already survived the reduction of Unmiset numbers from 7000 in 2000, to 2500 today, without serious disruption.

The East Timor country chief for the World Bank, Elisabeth Huybens, says the scaling down of Unmiset will be felt most in the service industry, such as hotels and restaurants, which are mainly in the capital, Dili. There will also be an effect on wages, which the UN presence has inflated to above-average levels for the region. However, Huybens agrees with Alkatiri that the economy is more robust than most economists believe. "The number of trucks lining up at the port is getting bigger, not smaller," she says.

"That has nothing to do with the UN presence. There is also a lot of private construction going on that has little to do with the UN presence."

Of greater concern to Alkatiri are delays in revenue from the Bayu-Undan oil and gas field, caused by technical difficulties. He says: "It means that we still need assistance from development partners – our donors – for some three to four more years."

So far, the country has accepted no loans from the World Bank. Alkatiri says the Government did not want to borrow its way into an unmanageable situation. However, it is now working with the World Bank on a feasibility study for future borrowings.

Security concerns

The state of the economy is a concern for foreign investors, but security is more pressing. The peace since the arrival of UN troops was shattered by riots in December 2002. Much of the violence was directed against Alkatiri, and resulted in the destruction of property belonging to him and his family. (Alkatiri has since been mired in bribery allegations, accused by the United States resources company Oceanic of accepting up to $US2.5 million in exchange for granting development rights to a rival US company, ConocoPhillips. Alkatiri has denied the allegations.) The rioters, reportedly pro-Indonesia militia, also attacked Australian-owned businesses, including the Hello Mister Supermarket, Chubb Security and Harvey World Travel. The UN Security Council recently extended the peacekeeping mission to May 2005. Up to 150 soldiers will remain in East Timor, with 150 police and 400 advisers and support personnel.

Another headache for foreign companies is the state of East Timor's legal system. The country's company law was passed only in March, and its investment law is being finalised now. Insurance and bankruptcy laws are still being developed. Laws relating to property title have only recently been enacted.

Huybens says this may worsen any economic problems arising from the reduction in the UN presence. "Given that the legislative framework is not really ready, given that the land and property legislation is not ready yet either, it is hard to see how the leaving of the UN would be [offset] by considerable foreign investment.

"That being said, the Government is very focused on getting it all together. It's a country with a lot of challenges, but a lot of opportunities as well, and I am quite positive about this country and the commitment needed to make it work."

The Government is also creating a new agency that will act as "one-stop shop" for foreign investors. This is expected to be open by mid-year, to streamline the process of interacting with East Timor's bureaucracy.

Fledgling legal system

Equally important as the legal framework is the need for the judicial system to function properly. In the past, the judiciary has been accused of favoring locals over foreigners. Ramos-Horta himself has been critical of the judiciary, but says the problems stem from judges who are inexperienced and overworked.

The ANZ Banking Group experienced this problem in December 2002, when its Dili branch manager, Kirk McNamara, was charged with theft. At the time, McNamara was living in a house owned by Bader Alkatiri, brother of the Prime Minister. The house had been renovated by the ANZ, but was looted and burnt in the December 2002 riots, and there was a dispute over who was responsible for the cost of its restoration. McNamara was subsequently charged with stealing window frames and doors from the house, but was acquitted.

The ANZ's managing director for the Pacific region, Rob Lyon, says the legal wrangling continues. "That's one of the issues that make it difficult to do business there: the lack of a legal framework under which we can operate. And it's not only in cases like this, where there is confusion about legal obligations and rights. There is no land tenure that you can build a banking situation on. We couldn't take a mortgage over a property."

The ANZ opened its Dili branch in early 2001 after urging from the UN, based on its success in operating banks in other Third World countries in the Asia-Pacific region. The company spent $3 million upfront, simultaneously implementing automatic teller machines and an electronic payments network. Lyon says the branch performed well early, thanks to the strong international presence, but business has declined in line with the withdrawal of foreigners. He hopes business will improve as resources money starts to flow in. So far, ANZ has spent more than $5 million on the branch, and Lyon expects a profit within the next 12 months.

ANZ is one of three banks operating in East Timor. It is aiming at business customers, but Lyon says the East Timorese population lacks business acumen; Australians or Chinese run many of the businesses. "There are not a lot of businesses that they [East Timorese] run themselves," Lyon says.

"[Before independence] a lot of the commerce was done by Indonesians, and when they walked out there wasn't a lot left behind. There's not a thriving private sector; that is what East Timor has still got to develop."

Another problem for Lyon is East Timor's 1% tax on revenue. "That makes it that much harder to get ahead ... They need to gain an understanding of what business expects. There's a fair bit of naivety about why people would go there."

Retail experiment

Retailer Harvey Norman chose not to continue with its East Timor experiment. Executive chairman Gerry Harvey closed the Dili store in December last year, after three years of losses. "It went all right to start with, and then it became obvious there was just no future in being there," Harvey says. Harvey Norman also had an interesting encounter with East Timor's legal system, after the store manager (a former employee from Darwin) allegedly stole between $200,000 and $300,000. Harvey says legal loopholes mean the perpetrator has not been charged in either East Timor or Australia.

Should the Government get its legal system in place, various opportunities will open for foreign investors. Ramos-Horta says East Timor's designation as a Least Developed Nation allows it to export, tariff-free, to Australia, New Zealand and the European Union, providing investors with open markets for goods produced in East Timor.

Agriculture, resources development and tourism are the three sectors the Government is concentrating on for foreign investment. Coffee is proving to be the most lucrative export commodity, with exports of about 6000 tonnes representing most of the country's $US7 million in exports in 2003.

There are no estimates for 2004. Lack of industrialisation is working in the country's favor, as the absence of modern pesticides and fertilisers allows it to market its coffee as 100% organic. The coffee industry is one of East Timor's biggest employers, with 6000 people involved. Its clients include the international cafe chain Starbucks. Ramos-Horta says there are similar opportunities with other crops.

But Timor's oil and gas resources will bring the greatest benefit, delivering an expected $US100 million a year to the Government for 20 years. But production has already been delayed, and further complications may arise from opposing claims by Australia, East Timor and Indonesia regarding seabed territory and subsequent ownership of oil and gas fields [see panel, page 51]. Even when the oil starts flowing, there are few precedents of countries using money from resources to raise the living standards of its people. Alkatiri says his Govern-ment is following the Norwegian model, where the money is kept in trust to produce an ongoing income for the country.

Natural resources may bring money to East Timor, but they are unlikely to directly create many jobs. With unemployment at 20% or higher in urban areas, developing East Timor's fledgling tourism industry has become very important. Alkatiri says the Government is hoping to attract low-volume, high-value tourists in a way that will set the country apart from other popular destinations such as Bali and Phuket.

Local tourism operators say East Timor offers some of the world's best diving experiences, unspoilt beaches and scenic mountain terrain. The coastal waters are unpolluted, and the coral reefs are among the most pristine in the world.

Ann Turner, co-owner of the Dili dive expedition operator The FreeFlow, says this is being recognised in the international diving community. "We're not looking at thousands of dive tourists in one year yet, but we are getting up to the hundreds, which from zero is pretty fast growth," Turner says.

The FreeFlow employs five local staff, and Turner says that although the Government has been supportive, dealing with local bureaucracy can be tedious. "They've only been independent for two years, and they don't always get it right. But there is definitely a feeling from the Timorese Government that businesses such as ours are welcome to invest here.

They understand that tourism ... can play a very important role in the Timorese economy, not the least in employment for the youth."

The FreeFlow has joined the handful of East Timorese tour operators to form a tourism association, to cross-promote services and work together at trade shows to raise awareness of East Timor's tourism products.

The Melbourne adventure travel company Intrepid Travel ran three tours to East Timor in 2003, and is planning another five this year. However, spokesperson Heidi Skjonnemand says East Timor is unlikely to rival the popularity of Thailand or Bali.

"In East Timor they don't yet have a real tourism infrastructure," Skjonnemand says. "It is also still relatively expensive in comparison to other parts of South-East Asia."