The Solomon Island’s programs with the IMF have been seen by the authorities and other development partners as providing critical support to Solomon Islands’ macro-economic reform efforts. The 3-year program under the ECF is assisting the authorities to address deep institutional and structural issues that are central to broader efforts to improve living standards and alleviate poverty, and is highly complementary to the work of other development partners.
The authorities remain strongly committed to the program, and have welcomed the constructive engagement with the Fund mission teams. As noted by staff, performance criteria have been met with large margins, with the exception of the brief delay in meeting the performance criteria on the cash balance target. The authorities continued to make progress on structural benchmarks, albeit with some delays. However, achievements such as the new Central Bank of Solomon Islands (CBSI) Act are the result of the persistent effort under severe capacity constraints. Lack of institutional capacity has been a key cause of delay in the structural benchmark on the mining tax regime, but with strong prioritization the authorities hope to increase resources in this area, and will not agree to any new licenses until the new mining tax regime is in place.
Solomon Islands shares many challenges common to other small Pacific Island states, including vulnerability to external shocks due to a narrow export base, aid dependence, and frequent natural disasters. The authorities welcomed staff’s judgment that tail risks arising from advanced economies have diminished, though agreed that these remain considerable. Exposure to natural disasters was again demonstrated by the tsunami that in February this year claimed the lives of ten people on Santa Cruz island, and injured fifteen others. Damage to housing, water systems and other infrastructure have affected the lives of 4,509 people, or 37 percent of the Santa Cruz population. Although recovery progress has been good, limited resource is available to address the extensive damage. In addition to these issues, the need to build on and maintain relative stability in the years following the period of civil conflict known as the “tensions” that occurred from 1998 to 2003, has remained a primary concern. Improved stability has enabled the Regional Assistance Mission to Solomon Islands (RAMSI) to undertake a transition, with the military component of RAMSI to withdraw from July 2013, while a RAMSI police presence is maintained until 2017. RAMSI’s remaining aid development work will transfer to bilateral and multilateral aid programs.
Growth and Development
While the economy rebounded in 2011, growth conditions slowed in 2012 reflecting stabilization in logging and mining activity, as well as weaker commodity prices. The reopening of the Goldridge mine, after ten years of closure, provided a significant boost to growth that appears to have stabilized. Likewise, growth in logging export volumes stabilized in 2012, despite remaining at very high levels. With logging having comprised nearly 20 percent of GDP in 2011, the anticipated decline in the industry will weigh on future growth. At the same time, rural farm incomes have been affected price volatility and lower production for agricultural commodities such as copra, cocoa, and palm oil. More positively, upside risks to growth and employment exist from the development of proposals for new fish canning operations. In addition, and as noted at the time of the last review, significant investments have been proposed in nickel mining, pending clarity on the mining tax and land access regimes.
Growth continues to be held back by poor infrastructure. Lack of a reliable and affordable power supply continues to pose challenges to private sector investment and improved living standards. Although electricity supply in Honiara could be greatly improved through the Tina River Hydro project in Guadalcanal (which would be Solomon Islands’ first hydro power scheme) the project has been subject to lengthy delays. Unfortunately, the submarine fiber optic cable project has run into some difficulties, due to higher project costs associated with the original proposal which have increased risks. Given the potential to boost economic development opportunities and education in rural areas, significant Government effort has been expended on project development. The authorities and the Solomons Oceanic Cable Company are examining all options, and the ADB is working with the authorities to resolve the issues.
The authorities agree that improvements in public financial management will assist with achieving development goals. The move to a multi-year budgeting framework will assist the authorities’ communication and sequencing of development spending goals over the medium term. These goals are set out in the authorities’ National Development Strategy (NDS), with the high-level goals including: increasing social and economic opportunities; securing sustainable growth; and maintaining stability and peace. A revised version of the NDS will serve as the basis for the PRSP at the time of the second review, along with sector strategies from the Ministry of Development Planning and Aid Coordination and key development partners.
While the strong fiscal performance in 2012 represented efforts to maintain fiscal buffers, development under-spending has been cause for concern. The authorities are still aiming to achieve a balanced budget in 2013, although they acknowledge the factors underlying staff’s projection of a 1.2 percent deficit. Reaching a balanced budget will be tough in the 2013 fiscal year, due in part to spending pressures, as well as concerted efforts to improve cross-department coordination and address chronic development budgetary underspending. Spending pressures include additional spending on domestic and overseas university student scholarships, as well as increases to public sector wages, following a long period of significant real public sector wage decline. There has also been strong demand for Rural Constituency Development Funds (‘Constituency funds’). While the role of Constituency funds in rural development can help to bring about broad-based inclusive growth, governance structures around the funds have been a concern. In this regard, regulatory guidelines for Constituency funds will be of primary importance, and as noted in the MEFP, these will be in accordance with the new Public Financial Management Act.
Declines in Government debt over the last few years allowed the Honiara Club Agreement (HCA) to be revised in 2012. As discussed at the time of the previous review, Cabinet has endorsed a new Debt Management Strategy (DMS). The DMS allows the Government to undertake prudent concessional borrowing, with the Government to set a yearly borrowing limit as part of the annual budget, based on a debt sustainability assessment. The debt limit covers external borrowing by the Government and all forms of SOE borrowing and guarantees (both domestic and external). The Government approved its first loan under the revised HCA late in 2012, for ADB financing of the planned submarine fiber optic cable, discussed above.
New borrowing guidelines for State Owned Enterprises were recently endorsed by Cabinet. In endorsing the guidelines, Cabinet agreed to amend the DMS to allow commercial borrowing by SOEs under certain circumstances. The new SOE Borrowing Policy intends to provide a balance between allowing SOEs to operate as a profitable and efficient business, with managing total debt levels. Safeguards have been put in place to ensure that SOE borrowing is fit for purpose and does not pose unacceptable risks to Government. SOE borrowing will count towards the Government’s annual limit on new borrowing.
Despite the recent uptick in credit growth, bank-intermediated credit has generally been weak, with the banks relying on non-interest income as noted by staff. However, the year to March 2013 saw an increase in lending from several sources, including a large loan taken by Solomon Airlines. In recognition of the important role played by credit unions in providing credit and financial services, particularly outside of Honiara, the authorities are working on a new Credit Unions Act with assistance from the ADB, to promote the performance of the sector. The authorities also continue to work towards structural benchmarks for the National Provident Fund Act and the Financial Institutions Act.
The Central Bank of Solomon Islands continues its work towards improving financial inclusion, which has been made part of the central bank’s mandate in the new Act. The authorities have ambitious goals to increase access to financial services in the relatively near term, and are also focusing on financial education, both of which will support inclusive growth. With low financial literacy, the central bank has recently highlighted the need to address customer empowerment and protection, and is investigating potential demand for a micro-insurance industry. The banks have undertaken increased investment towards branchless and mobile phone banking, and steps have been taken to facilitate access to financial services, particularly in rural areas. For example, these have included methods to assist with customer identification and verification, and the introduction of “pay as you go” accounts by commercial banks, where customers do not pay monthly account keeping fees, but pay only when they transact.