Peter Kammerer – East Timor remains among the world's poorest and least developed nations on the second anniversary of independence, but observers are not as gloomy about its future as might be expected.

As celebrations began last night, analysts suggested that prospects for the country's 800,000 people were finally lifting. Although much work needed to be done by the government to build infrastructure, create jobs and prevent corruption, conditions were improving, they said.

Their assessment appeared to be backed by a World Bank report released yesterday showing East Timor's economy, which contracted by 2 per cent last year, would grow by 1 per cent this year. International donors meeting in Dili said the government had cut the deficit and enacted laws to stimulate development.

The United Nations also gave a vote of confidence yesterday by handing over command of policing to a 3,000-strong East Timorese force, although an international contingent will remain as support for at least a year.

President Xanana Gusmao also acknowledged that many challenges remained, four years after the former Portuguese colony fought a bloody struggle for freedom from Indonesian occupation. Independence was finally won on May 20, 2002.

"Timor-Leste will continue to face many new challenges; in security, in development and in our struggle against poverty," Mr Gusmao observed. "All these cannot be overcome without ensuring stability."

A UN report last month indicated problems including "disturbing reports" of corrupt practices, criminal activities and negligent use of firearms.

Worsening the troubles are allegations that Prime Minister Mari Alkatiri took US$2.5 million in bribes from the oil and gas company ConocoPhillips in return for investment in the rich Timor Sea fields. He has denied the claims.

Oxford University researcher Peter Carey believes such problems are outweighed by the progress the government has made in the past two years. "East Timor started from zero minus 10," he said from Manatutu, the town most devastated by Indonesian-backed militias following an independence vote in 1999.

Dr Carey cited rampant poverty, disease and unemployment, especially among young people, as being among the biggest difficulties for the government.

The World Bank's report put the jobless rate at 20 per cent, although some estimates have put the combined unemployment and underemployment rates at 50 per cent.

Australian National University expert on East Timor George Quinn said the government was hampered by having a small budget and revenues moSuara Timur Lorosaey reliant on international donors.

Income from oil and gas reserves in the Timor Sea, seen as the nation's lifeblood for development, were being held up by a territorial dispute with Australia.

Without more revenue from oil, East Timor faced a "very difficult road", he believed. Nonetheless, there were signs of improvement. "At least it's getting back to where it was in the latter years of the Indonesian administration."