We thank staff for their report and close engagement with the authorities. The IMF has placed the country under intensive surveillance and has worked closely, alongside other donor partners, to provide considerable international support. We thank the IMF for the policy advice and technical assistance provided by the many teams that have visited over the last 24 months.
The islands of Kiribati illustrate the challenges of governance in a remote highly open country dispersed over a large geographic area. Kiribati is a large ocean state consisting of 33 small islands spread over roughly 3.5 million square kilometers of ocean. 70 percent of the 103,000 residents are located on the island of South Tarawa following a gradual migration towards formal employment opportunities. The remaining members of population are spread across the nineteen other inhabitable islands. These islands can be upwards of several thousand kilometers apart. The tension between growing population pressures on South Tarawa verses the economic benefits of agglomeration define Kiribati’s internal economic policy. Development opportunities on many of the outer islands remain limited, but the island of South Tarawa may be approaching its carrying capacity without significant investment in infrastructure.
Most of South Tarawa is less than three meters above sea level, which suggests the country remains exposed to increased weather volatility from climate change or tsunamis. An increase in sea levels may present a potential existential threat over the next hundred years, although recent research highlights that reef islands, such as Kiribati, may undergo a dynamic response as a result of the constant erosion and accumulation of sand (accretion).
Economic growth will strengthen as several major donor funded projects get underway over the next few years. The airport will be resurfaced, the seaport enlarged, and South Tarawa’s only road will be resealed. The actual lasting impact on the domestic economy may remain modest as all materials, specialist machinery, and most of the construction staff will need to be sourced from abroad. GDP growth will strengthen to around 2.8 percent and inflation will become positive rising to 2.5 percent in 2012. Fishing revenues strengthened over 2012, but are expected to remain volatile as the number of day licenses sold depends on migratory tuna stocks, which remain sensitive to climatic conditions and changes in water temperature.
General spending pressures and the decline in fishing revenue through 2011 widened the structural government budget deficit. Tax revenues have fallen alongside an increase in non-compliance. The authorities agree that action will be required to stabilize the budget given the current fiscal balance is forecast to reach 18.2 percent of GDP in the 2013.
Kiribati has significant financial assets amounting to around 340 percent of GDP held in a sovereign wealth fund called the Revenue Equalization Reserve Fund (RERF). These funds were accumulated from phosphate mining at the time of independence in 1971. Current projections suggest the RERF will undergo a gradual depletion without policy change over the next couple of decades. The authorities aim to retain the financial flexibility to handle the uncertainty around the effects of climate change. Thus, Kiribati’s overriding fiscal goal remains to protect the value of the RERF. The staff projections suggest an adjustment in the current deficit of 15 percent will be required to stabilize the RERF over a period of 8-9 years. Our authorities remain committed to prudent macroeconomic policies, but achieving this target could remain difficult. There are limited policy tools to stabilize the economy as government budget contracts and the country continues to face significant infrastructure needs. Our authorities are working on a new macro framework with IMF assistance.
The World Bank and Aus Aid have offered to provide budget support to ease adjustment. Ongoing support remains contingent on future policy action. Donor partners, including the IMF, have agreed a policy reform matrix that identifies key reforms. These reforms have been carefully prioritized to reflect the capacity constraints on the Kiribati Government and will be supported through the provision of extensive technical assistance from a range of sources. Tax reform that includes steps to improve compliance has been highlighted as immediate priorities for reform over the coming two years. Financial reforms, SOE reform, and improved guidance around management of the RERF will also occur. Subsidy reforms are under consideration as the copra purchasing scheme, which provides an important safety net for subsistence populations on the outer islands remains expensive. Our authorities emphasized the vulnerability of populations living on the outer islands and the importance of providing opportunities to slow the flow of migration towards South Tarawa, where the population pressures are most acute. The World Bank has agreed that some sort of transfer system will ultimately be required and are investigating whether subsidies could be provided through a better targeted scheme to lower the cost of the current social safety net. To prevent a further buildup of loans, technical assistance has been requested to provide advice on centralized debt management guidelines to establish policy criteria around any additional borrowing. Departments and SOEs will face new limitations on their ability to independently incur debt or invoke government guarantees through a requirement for formal Cabinet approval.
State Owned Enterprise Reform
Kiribati’s SOEs were originally set up to provide basic services, but as the private sector develops, there may be options to reexamine the line between public and private provision. Several SOEs have been privatized, although a range of structural factors complicate increased private sector engagement. The import trading company was sold and tenders are open for the sale of the state owned hotel. The Government is examining other asset sales and has submitted a Bill opening the telecommunications industry to competition. The incumbent SOE in the sector is being commercialized. Other SOEs with a social mandate will be more difficult to privatize. These entities provide essential services and are often unlikely to prove commercially viable. For example, internal shipping services remain essential to provide food and basic supplies to the population on the outer islands. It remains questionable as to whether the private sector could operate a commercially viable shipping service to the outer islands that have populations of less than a thousand people and can be up to several thousand kilometers away.
Financial surprises and a lack of profitability can be traced back to three main factors involving: mixed social and commercial objectives; an inability to gain economies of scale; and a lack of management expertise. Our authorities are working with the ADB on a comprehensive review of the SOEs aimed at improving financial transparency through improved management or sale. An SOE Bill has been passed this April establishing a strengthened legal framework covering independence, governance, financial reporting, and the management of SOEs. Arrears on inter-SOE debt and loans to the commercial bank are being catalogued and are expected to be cleared, including those between the Public Utilities Board and Kiribati Oil. The Ministry of Finance is also increasing its supervision and oversight to gain an early warning of potential financial distress.
Private Sector Growth
Growth in the private sector will be important to reduce the social cost of fiscal adjustment given high unemployment and relatively low annual income. The rapid population growth in South Tarawa has created a growing private sector, although most businesses remain small, informal, and largely family run. Improved urban planning given rising population density and clarity around lack of formal land title could encourage investment. Our Kiribati authorities are finalizing a National Private Sector Development Strategy to examine ways to address these issues.
The authorities have worked for many years to encourage local participation in the fishing industry – the nation’s primary economic resource. A range of joint ventures, employment agreements have been trialed in an attempt to overcome a chronic lack of capital. The Government hopes to complete a National Fishing Strategy in 2014 to encourage development through, among other things, improvements to the process of approval and management of joint ventures. Kiribati has received international direct investment in a new fish processing plant, which offers a promising opportunity for Kiribati to earn more from its fishery resource. The factory will provide employment and exposure to international management practice. The authorities are in negotiations with Fiji to open the air route to competition. In the mean time, fish can be shipped frozen once a month by boat, although frozen fish sell for less global markets.
Labor mobility and foreign policy
Given high underemployment or unemployment, Kiribati sees global integration as its primary avenue towards economic development and the Government has placed a large emphasis on providing the population with the education and skills necessary to capitalize on employment opportunities abroad. Kiribati has sent seafarers abroad for nearly fifty years and will be encouraging international contractors to take on and train local workers. The local technical institute has supported this trend through work to align training schemes with Australian educational standards. This should allow local tradesmen to migrate to meet skill shortages in Australia. New Zealand and Australia also attract seasonal workers from around the Pacific, which will add to remittance flows.
Shocks to growth increasingly come from abroad and many of Kiribati’s key challenges, including those associated with fisheries or climate change, increasingly rely on international cooperation. President Tong has become a global advocate for action against climate change and Kiribati remains a party to the Nauru fishing agreement. The experience in the fishing industry is illustrative of the need small nations have for more regional and international cooperation. The Nauru Agreement’s floor on the sale of day fishing licenses remains an important regional initiative as small Pacific states have historically struggled to negotiate on an individual basis. The floor has remained fairly binding as vessel owners arbitrage given they can easily choose to fish in neighboring waters. The minimum price set by the Parities to the Nauru Agreement will increase by 20 percent in 2014.