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Tuvalu: Staff Report for the 2014 Article IV Consultation

Author(s):
International Monetary Fund. Asia and Pacific Dept
Published Date:
August 2014
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Context

1. Tuvalu is one of the smallest and most isolated countries in the world. With a population of some 11,000 people living on 26 square kilometers, Tuvalu is more than 3,000 kilometers away from its nearest major external market (New Zealand). The country faces tremendous challenges stemming from its remoteness, lack of scale economies, weak institutional capacity, and, above all, climate change and rising sea levels, which threaten the country’s very existence. (Appendix III)

2. Income is relatively high, but the economy is fragile. Fishing revenues and foreign aid, as well as remittances, have significantly raised living standards—absolute poverty is rare, access to primary education is effectively universal, and per capita income is among the highest in the group of small Pacific island countries. Nevertheless, fishing revenues and foreign aid are highly volatile and uncertain (Appendix IV), and could experience a secular decline over the medium to long run, while remittances have not recovered to the level prevailing before the global financial crisis mainly as a result of limited human capacity, pointing to weak competitiveness (Appendix V). The authorities have limited policy space to maneuver—fiscal policy is the only macro policy lever given the use of the Australian dollar as the legal currency; there is little scope for diversifying the small economy that is dominated by inefficient public enterprises; and the lending capacity of banks is constrained by severe asset quality problems. These factors make it all the more important to develop a sound fiscal policy framework, address weaknesses in banks and public enterprises, and foster a favorable business environment for the private sector.

3. Tuvalu holds large assets abroad and also owes substantial debt. The Tuvalu Trust Fund (TTF), originally capitalized by development partners in 1987, aims to provide additional funding for budget support. Holdings are global, but Australian assets are weighted heavily. The TTF is not fully sovereign and cannot be drawn down freely: when its market value exceeds a “maintained value” indexed to Australian CPI, the TTF Board—representing both development partners and Tuvalu government—can decide to transfer the excess to the budget. TTF’s market value dropped markedly during the global financial crisis, but has since recovered steadily to more than $A 140 million (3.5 times of GDP). The Consolidated Investment Fund (CIF) serves as a fiscal buffer and deposit account for development partners’ grants, and can be drawn down freely at the authorities’ discretion. Thanks to large fiscal surpluses achieved in the past two years, CIF has been built up to more than $A 15 million (38 percent of GDP). Meanwhile, Tuvalu’s public debt has reached 41 percent of GDP by end-2013, with external debt—including public enterprise debt on commercial terms—accounting for 35 percent of GDP. The debt is projected to rise sharply to 56.9 percent in 2014 on account of a new loan agreement taken on by a fishing joint venture to finance the expansion of its fishing capacity—the loan could, as usual, be guaranteed by the government.

4. The authorities are cognizant of the challenges and have developed a broad reform agenda. A policy reform matrix (PRM), formulated in consultation with development partners, has been fleshed out in an effort to enhance governance and social development, facilitate private sector growth, and safeguard macroeconomic stability. (Appendix II) Significant progress has been made in the first two phases of the PRM to enhance public financial management, while measures undertaken to rationalize social spending and strengthen public enterprises have witnessed limited success. The authorities are designing the third phase of PRM in close consultation with development partners.

5. Tuvalu has entered into an electoral cycle. The general elections are expected to be held by March 2015.

Background

A. Recent Developments

6. Growth has been weak while inflation picked up moderately. Real GDP growth has been volatile averaging only 1 percent in the past decade. Activity has benefited from increased competition in the retail sector and a recent boom in the fisheries sector, while banking weaknesses constrain the financial support for the private sector, and the poorly managed public enterprises strain government finances and worsen the country’s business climate. Inflation rose to 3 percent by end-2013, largely reflecting a pickup in nonfood inflation. It benefited from lower global food and commodity prices, as well as trade diversification and increased retail competition, but prices rose on account of a weakening Australian dollar.

7. The balance of payments has been supported by large fishing-related receipts and official aid. Owing to the introduction of the Vessel Day Scheme and the establishment of fishing joint ventures with Asian companies, both fishing exports and fishing license fees have more than doubled in just a few years, with each accounting for about half of GDP now.1 Foreign aid, including both budget support and off-budget project financing, has also hovered at around half of GDP. However, remittances, which used to be one of the most important sources of foreign exchange inflows, have shrunk dramatically since the global financial crisis, to 10 percent of GDP compared to the pre-crisis levels of nearly 20 percent. Imports, which closely correlate with fiscal spending, have been generally stable.

8. The budget achieved a substantial surplus for the second consecutive year in 2013. Fishing license fees reached a record high in 2013 because of improved negotiating power under the Vessel Day Scheme and increased revenues under the bilateral treaty with the U.S. government. Tax revenue outperformed the budget target largely as a result of improved compliance following a tax audit of public enterprises and the favorable performance of a fishing joint venture as well as a VAT rate increase. These developments were further reinforced by higher-than-expected foreign grants. Current spending was generally restrained, and on-budget capital spending was small, reflecting the government’s weak implementation capacity. As a whole, the fiscal surplus reached 26.3 percent of GDP.2

9. Vulnerabilities of banks and public enterprises have further aggravated structural weaknesses. In the unsupervised state-owned dual-bank system, asset quality remains poor as half of the loan portfolio is nonperforming, which is caused to a large extent by government-sponsored programs implemented a few years ago and public enterprise borrowing. Although both banks, i.e. the National Bank of Tuvalu (NBT) and Development Bank of Tuvalu (DBT), have restricted their exposure to public enterprises and made substantial provisions, an accurate estimate of capital adequacy is impeded by the lack of a regulatory framework. The DBT—accounting for about10 percent of banking sector assets—has made substantial losses, with its net capital depleted from $A 2.5 million (7.2 percent of GDP) to $A 0.7 million (1.7 percent of GDP) in the past three years. The DBT further experienced a sharp drop in deposits in 2013 as depositors were concerned with its capacity to service obligations. Meanwhile, non-bank public enterprises, with some being insolvent already, accumulated losses of more than 3 percent of GDP in the past few years, leaving this sector’s total capital below 0.5 percent of GDP. (Appendix VI) The immense losses incurred by public enterprises represent deficiencies in governance and the cost of social responsibilities.

10. There is no sign of significant exchange rate misalignment. The real effective exchange rate depreciated over the past year and has returned to its 10-year average on the back of a weakening Australian dollar. However, the economy’s competitiveness remains weak, with remoteness causing high transportation cost and isolation, and the lack of scale increasing transaction cost. The large budget expansion could exert inflationary pressure and cause real exchange rates to appreciate, undermining competitiveness. (Box 1)

B. Outlook and Risks

11. Near-term risks mainly stem from banking sector vulnerabilities, while fiscal sustainability remains a major concern over the medium to long run. Several infrastructure projects financed by grants from development partners (amounting to more than 40 percent of GDP) are expected to come on stream in the next three years, and may boost growth to 2.5 percent, while weak capacity and competitiveness will continue to impede growth over the long run.3 Macroeconomic and financial risks are elevated. In the near term, the impaired balance sheet of the DBT could further weaken its lending capacity, constitute a drag on growth in the private sector, and, more importantly, threaten macro-financial stability and undermine business confidence. Over the medium to long run, maintaining fiscal sustainability remains the most important challenge—the debt sustainability analysis suggests a high risk of debt distress under the baseline; fishing revenues are highly uncertain and face downside risks; and contingent liabilities, mostly associated with state-owned banks and public enterprises, are substantial.

12. The external account may deteriorate over time. The large inflows of foreign grants would be offset by rising imports as a result of increased budget spending and public investment. With the depletion of the CIF, foreign exchange reserves are projected to decline from 9 months of imports to 5 months over the medium term. The balance of payments is subject to significant risks. Fishing license fees will likely remain buoyant over the medium term, but may decline over the long run because of climate change and overfishing. Remittances by seafarers and seasonal workers might weaken if the risk of protracted slower growth in advanced and emerging economies materializes or China’s economy further slows, affecting growth and job opportunities in the Pacific region. The impact of U.S. tapering is uncertain—the tapering could cause the Australian dollar to further depreciate and improve Tuvalu’s competitiveness, but a disorderly tapering may increase volatility in Australia’s asset markets where the TTF is invested, generating fluctuations in the TTF’s market value and likely transfers to Tuvalu’s budget.

Authorities’ Views

13. The authorities generally agreed with the staff’s views on the economic outlook. They indicated that the weak growth may result from a lack of large projects, and expect growth to pick up in the next few years as several large projects start to be implemented. They also anticipated balance of payments pressure in light of the uncertainty in fishing-related receipts.

Policy Discussions

The key policy agenda is to develop a medium-term fiscal framework that anchors a sustainable fiscal policy; address risks in the banking sector by establishing a regulatory framework; enhance the efficiency of public enterprises, and foster inclusive growth and competitiveness via continued structural reforms.

A. Fiscal Policy and Public Financial Management

14. Despite sound fiscal performance in the past two years, a dramatic expansion of budget spending in 2014 has substantially increased risks to fiscal sustainability. The 2014 budget continues to target a surplus, with a large temporary increase of foreign grants and TTF transfers financing a more than 20 percent expansion of spending, which is mostly one-off increases of current expenditure and includes a 25 percent rise in civil servant salary and a potentially costly revival of the Tuvalu Cooperative Society (TCS), which would supplement the supply of necessities to outer islands by private retailers4. The large salary increase has also induced public enterprises to increase employee wages by the same magnitude, adding to their operational costs.

Expenditure Breakdown

(In millions of Australian dollars unless otherwise specified)

Sources: Tuvalu authorities.

1/ Includes Tuvalu Medical Treatment Scheme, scholarship programs and Special Development Expenditure.

With on-budget foreign grants returning to historical average levels, the budget would move into a deficit from 2015 onwards and fully deplete the fiscal buffers over the medium term unless the spending increase is unwound.

15. Medium-term fiscal risks arise from several sources. First, tax revenue might shrink as the tariff rates that apply to regional trade are cut under the Pacific Island Countries Trade Agreement (PICTA).5 Second, there is a risk that fishing revenue might decline after its recent rapid increase as overfishing and climate change adversely impact fishing resources. Finally, vulnerabilities in banks and public enterprises may pose substantial liabilities to the government—bringing the capital of insolvent non-bank public enterprises to positive would cost at least 4 percent of GDP, while the cost of addressing banking vulnerabilities needs to be assessed under a regulatory framework. The government’ guarantee of public enterprise debt, notably including external loans borrowed by the fishing joint ventures, also constitutes contingent liabilities.

16. To enhance fiscal sustainability, consolidation efforts are needed. Tax administration should be further strengthened, including through legal actions on non-compliance, and a tax policy review would be necessary given the uneven cost-benefit among different taxes. However, given the narrow economic base, the scope for further increases in tax revenue is limited, and most of the fiscal consolidation would more likely be achieved via expenditure control in the near term. To put the fiscal policy on a sustainable footing, the government expenditure should be scaled down from the 2014 budget level at 93 percent of GDP to about 80 percent of GDP in the next three years when the impact of budget spending cut on growth would be offset by the implementation of large infrastructure projects financed by development partners. To achieve this target, spending should be largely frozen—which would bring down its share in GDP to 84 percent within three years—while a few rapidly growing expenditures should be cut back. For example, although rolling back civil servants’ salary increase may be difficult, expenditures on goods and services as well as grants and subsidies—all budgeted to grow by double digits—should be put under tight scrutiny on the back of the newly introduced procurement mechanism and the PRM framework, and be reined in to the extent feasible. Moreover, reviving TCS would require additional financial support, which could cost 10 percent of GDP to clear arrears and regain market share. The authorities should explore more cost effective policies to supply necessities to the outer islands. Additionally, there is considerable room to improve the cost effectiveness of social programs such as the scholarship program and Tuvalu Medical Treatment Scheme (TMTS), which finances overseas treatment of Tuvaluan patients. Last but not least, the government should refrain from providing guarantees for public enterprise borrowing given the already high risk of debt distress.

17. Beyond fiscal consolidation, a new medium-term fiscal framework is needed to ensure fiscal sustainability, address procyclicality and build buffers in view of the daunting challenges facing Tuvalu. Under this framework, the transfers between the budget, the CIF, and the TTF should follow a clear rule anchored by a structural balance target:

  • Targeting a structural balance would reduce expenditure fluctuation as a result of revenue volatility. Given the weak capacity, staff suggests a simple approach to estimate the structural revenue, where fishing license fees are adjusted to reflect their moving average. As fishing license fees have been increasing markedly, targeting a structural balance would imply saving a portion of these fees for the time being. Staff estimates that, with the CIF already built up to a comfortable level, a structural surplus of 0.5-1 percent of GDP is needed to maintain fiscal buffers and bring down the risk of debt distress from high to moderate over the medium and long run.
  • To help achieve the structural balance target, the CIF should be transformed into a fiscal stabilization fund that follows a clear rule of accumulation and withdrawal—temporary windfalls from fishing revenues should be saved in the CIF and it can be drawn down when there is a revenue shortfall.
  • The TTF should serve as a rainy day fund, with the returns on investment saved in a reserve account for use in the event of severe adverse shocks.

Proposed Medium-Term Fiscal Framework

Baseline and Alternative Scenarios

Source: IMF staff estimates and projections.

1/ The alternative scenario assumes a structural surplus of 0.5-1 percent of GDP over the long run.

18. Marked progress has been made in strengthening public financial management. Notably, a central procurement unit has been established, and associated regulations adopted. The authorities also published a budget manual outlining the budget process and policies, strengthened the monitoring of outer island budget operations, and started releasing monthly reports of budget execution, which significantly enhanced transparency and facilitated budget control.

19. Nevertheless, there is scope to further strengthen public financial management to improve transparency and safeguard fiscal resources. The budget process needs to be anchored by a sustainable medium-term fiscal framework that incorporates development objectives. The management of fishing license fees should be streamlined, with a focus to reconcile the treasury receipts and the sale of licenses by the Fisheries Department. Introducing a commitment control system would further improve budget management. Over the medium term, a wage-setting mechanism is necessary to ensure that public sector wage increases are in line with productivity gains in the economy.

Authorities’ Views

20. The authorities shared staffs views on fiscal sustainability risks. They worry about the lack of transparency in the TMTS and its potential overspending, and intend to contain its cost by establishing a comprehensive database and closely following patients’ treatment schedules. They also agreed to carefully estimate the cost of reviving the TCS and consider alternative options as needed. On debt sustainability, they generally concur with staff assessment, but indicate that the contingent liabilities from fishing joint ventures are not a key concern as the joint ventures have a favorable outlook and the probability for the government to assume their debt obligation is small.

21. The authorities agreed with the staffs proposal on introducing a medium-term fiscal framework. They share the concern about revenue volatility, and support the suggestion to have the fiscal policy anchored by a structural balance and make the TTF a rainy day fund, with its investment returns saved in a reserve account for large adverse shocks.

22. The authorities are committed to further enhancing public financial management. They are developing the IT system to better reconcile fishing license fees between the Treasury and Fisheries Department. They will also aim to further improve public financial management when implementing the third phase of PRM.

B. Financial Stability

23. Given substantial vulnerabilities in the banking sector, there is an urgent need to establish a framework of banking supervision and resolution. The NBT’s financial risk appears under control given the sound profitability as indicated by a return on assets of around 3 percent and comfortable capital equivalent to 24 percent of total assets, although these need to be verified under a prudent regulatory framework. The rapid deterioration of the DBT’s financial position points to a looming solvency issue. This would imply spillover risks across the banking system, which may be limited by the DBT’s small market share and relatively simple financial linkages, and perhaps more importantly, result in large government liabilities: the budget would need to allocate resources to repay the bank’s borrowing guaranteed by the government (1.4 percent of GDP). Moreover, fresh capital may eventually need to be injected into the banking system should an assessment based on prudent standards suggest—given the underdeveloped private sector and its limited financial capacity as well as the unsuccessful experience of privatizing public enterprises, introducing private capital could be challenging, and resorting to budget resources would still be likely. Going forward, the priority is to implement a banking supervisory and regulatory framework—in particular, a Bank Commission needs to be established and supervisors employed as soon as feasible with due regard to controlling administrative costs. Given Tuvalu’s limited capacity and the need for arm’s-length supervision, development partners’ support for this initiative will be crucial.6 The financial condition of the banking sector and its implications for the economy, e.g. the cost of a possible recapitalization, should be assessed urgently on the basis of prudential standards, and a banking resolution framework needs to be set up.

Authorities’ Views

24. The authorities are cognizant of the need to strengthen the banking sector. They are considering establishing the Bank Commission as stipulated by the law, and agreed with staff’s views on the need to strengthen the banking sector, albeit with more focus on expanding banking services.

C. Public Enterprise Reform

25. Progress has been made in enhancing the governance of public enterprises, but they remain broadly inefficient. Staff welcomes the improved financial reporting, enforcement of the Public Enterprise Act, and progress made in merging and privatization efforts. Nonetheless, given their responsibilities to implement social policies, the poorly managed public enterprises are far from operating on a commercial basis and are mostly making losses despite receiving large government subsidies. The situation of the Tuvalu Electricity Corporation (TEC) is particularly worrisome as fuel grants by development partners are to be phased out by end-2014, which would add to fiscal burdens in subsidizing this corporation and make Tuvalu increasingly susceptible to fluctuating oil prices in the global market. A recent review conducted by a third party suggests that tariff adjustments may be inevitable to make the TEC financially viable.

26. A reform plan is needed to put public enterprises on a sustainable footing. The reform package should aim to enhance the enterprises’ commercial orientation and financial soundness. In particular, there is a need to clearly define and cost their social responsibilities, which, together with strengthened accounting and auditing practices, would enhance their transparency and accountability. With respect to the TEC, electricity tariff rates should be reviewed periodically and allowed to adjust to appropriately reflect operational cost and fuel price movements, and government social policies should be directed at protecting the most affected poor.

Authorities’ Views

27. The authorities are committed to advancing public enterprise reform with assistance by development partners. They are working with the Asian Development Bank on public enterprise reform through privatization and merging, and are seeking additional technical assistance in reviewing the operation of the Telecommunication Corporation.

D. Promoting Inclusive Growth

28. The reform momentum should continue with a focus on promoting macroeconomic stability and growth. The completion of the PRM I and II is commendable. Continued reform via the initiation of PRM III is important and should focus on strengthening the fiscal framework and addressing structural weaknesses, notably in the banking and public enterprise sectors. Rebalancing resources toward basic and vocational education, improving gender equality in accessing training opportunities, and enhancing infrastructure would help deliver better development outcomes and strengthen competitiveness. Greater efforts are also needed to foster domestic job market and explore employment opportunities for the labor force abroad, including through the seasonal worker scheme in other countries of the Pacific region.

Authorities’ views

29. The authorities are committed to continued reforms. Building upon the achievements made under the first two phases of PRM, the authorities are working closely with development partners on the design of PRM III, which may be launched in a few months and will continue to focus on fiscal sustainability and public financial management as well as structural issues to foster private sector development.

E. Other Issues

30. Article XIV/VIII. At the time of joining the Fund in 2010, Tuvalu availed itself of the transitory provisions of Article XIV, Section 2. While the exchange control regulations are quite restrictive and prescribe approval requirements from the NBT or the Finance Minister for most payments or transfers, staff’s understanding is that in practice, no approval is required and payments and transfers for current international transactions are administered liberally. Staff continues to conduct a comprehensive review of the exchange system to assess jurisdictional implications. Staff has recommended that the regulations be updated in line with current practice so that Tuvalu can accept the obligations of Article VIII, Sections 2, 3, and 4, although the authorities have indicated that they have no current plans to do so.

31. Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT). Tuvalu is currently strengthening its anti-money laundering framework, based on the 2006 AML/CFT law and benefitting from technical assistance. Tuvalu became an observer to the Asia/Pacific Group on Money Laundering (APG) in 2014.

32. Capacity building in government statistics remains a daunting task. Progress is being made in a few areas such as budget execution reporting and balance of payments statistics. However, the statistical office is understaffed, and weaknesses in national accounts statistics impede economic analysis. Going forward, there is an urgent need to increase resources allocated to statistical work and to strengthen training and technical assistance provided by development partners including PFTAC.

Staff Appraisal

33. Tuvalu has made significant strides in implementing reform policies. Tax administration, particularly the compliance of public enterprises, and public financial management have been strengthened. Progress has also been made in enhancing the monitoring and auditing of public enterprises and removing civil servants from Board positions. Nevertheless, important challenges remain.

34. Now is the time to build on the favorable budget outcome of the last two years to further enhance fiscal sustainability. With the buildup of fiscal buffers, the budget is in a strong position to reinforce fiscal soundness. Fiscal consolidation, particularly unwinding the 2014 budget expansion, is crucial to put the budget on a sustainable footing. Introducing a medium-term fiscal framework that targets a structural surplus would profoundly strengthen Tuvalu’s capacity to manage revenue volatility, and creating more savings in the TTF would build resilience against adverse shocks.

35. There is considerable room to rationalize social spending. It will be prudent to institutionalize the referral committee and closely scrutinize the medical expenses under the TMTS. Staff also encourages the authorities to explore alternative health plans with burden sharing by individuals, for example negotiating health insurance for its citizens, which can be purchased using citizens’ savings at the Tuvalu National Provident Fund. For the scholarship program, targeting the total number of students studying abroad instead of new students would make the resource allocation more predictable and facilitate budget management.

36. There is an urgent need to address the heightened banking risks. The increasing losses and liquidity pressure experienced by the DBT may lead to a solvency problem. The authorities need to develop a contingency plan for the bank’s possible failure, most importantly a resolution framework and an estimate of associated fiscal costs. Meanwhile, measures need to be undertaken to contain losses incurred by the bank. A complete review of the banking system should be conducted, and a regulatory framework should be established as soon as feasible.

37. Given the dominance of public enterprises, their financial viability is crucial to the health of banks and fiscal sustainability. The Public Enterprise Reform and Management Unit (PERMU), which is supposed to play a critical role in developing a reform package, should be well staffed. At the current conjuncture, priority should be given to clearly defining public enterprises’ social responsibilities and enhancing their transparency and accountability via strengthened accounting and auditing practices.

38. Prudent macroeconomic policies and continued structural reforms are essential to enhancing competitiveness and building resilience. Although there is no sign of significant overvaluation, Tuvalu’s competitiveness remains weak, as indicated by the falling remittances from seafarers. In this context, government spending and wage increase should be restrained to reduce inflationary pressure and real exchange rate appreciation. Over a longer horizon, providing sound education and vocational training opportunities, for example, by upgrading training programs at the Tuvalu Maritime Training Institute and allowing access by women, is key to improving employment and competitiveness. The implementation of the PRM has begun to bear fruit, and reforms in the next phase should continue to aim at containing fiscal risks, addressing structural weaknesses in banks and public enterprises, and enhancing the business environment for the private sector.

39. Data shortcomings, particularly in the national accounts, hamper surveillance. Additional resources need to be allocated to the statistical work necessary for surveillance and policymaking.

40. Staff recommends that the next Article IV consultation take place on a 24-month cycle.

Box 1.Tuvalu: External Sector and Exchange Rate Assessment1

Tuvalus real effective exchange rate (REER) has returned to its historical level. The REER has depreciated by about 8 percent since its recent peak in early 2013. The real depreciation was mainly driven by the weakening of the Australia dollar, the legal currency in Tuvalu. Historically, Tuvalu’s REER has moved closely with that of Australia, but has been less appreciated since the global crisis.

International Comparison: Real Effective Exchange Rate

(Index, 2005 = 100)

Sources: IMF, INS; IMF, APD-CORE; and IMF staff calculations.

There is no sign of significant exchange rate misalignment, but loose policies could increase the risk of overvaluation over the medium term. Benefiting from lower global food and commodity prices, as well as increased trade diversification and retail competition, inflation in Tuvalu has been below trading partners’ inflation. However, the expected sizable increase in public sector wages would boost domestic demand, widen the trade deficit, and exert upward pressure on inflation and real exchange rate appreciation.

Reserves appear sufficient, but would decline in the medium term.2 The significant increase in the CIF as a result of fiscal surplus in 2012 and 2013 is estimated to push reserves up to around nine months of imports. In the medium term, however, the fiscal balance is expected to move into a widening deficit on the back of stagnated fishing license fees and a loose control on expenditure, which will cause the CIF to be fully depleted by 2020 and a rise of imports. As a consequence, import cover will decline to five months. Although the reserve cover appears sufficient by traditional cover, an estimate based on risk metrics suggests it should be kept at above seven months of imports.

Tuvalu: International Reserves

(In millions of Australian dollars unless otherwise specified)

Source: Tuvalu authorities.

1/ Ratio of international reserves to next year’s imports of goods and services, in months.

Tuvalus competitiveness remains weak. Remoteness causes high transportation costs and isolation, and the lack of scale increases transaction cost. Moreover, insufficient human capital impedes Tuvaluans to explore overseas job opportunities, with declining remittances pointing to structural weaknesses. In this connection, improving the business climate and taking an innovative approach to exploring growth opportunities, including strengthening education and training, are particularly important in the long run.

1 Prepared by Sung Eun Jung.2 Reserves are defined as the sum of CIF and liquid foreign assets held by the National Bank of Tuvalu.

Figure 1.Tuvalu: The Setting in a Cross-Country Context

Sources: IMF, WEO; IMF, APD-LISC; and IMF staff estimates.

Figure 2.Tuvalu: Economic Developments

Sources: Tuvalu authorities; TTFAC reports; NBT; DBT; and IMF staff estimates.

Figure 3.Tuvalu: Fiscal Developments

Sources: Tuvalu authorities; TTFAC reports; World Bank; and IMF staff estimates.

Table 1.Tuvalu: Selected Social and Economic Indicators, 2010–2015 1/
Population (2013): 10,753Poverty rate (2010): 26.3 percent
Per capita GDP (2013 est.): US$3,554Life expectancy (2012): 65 years
Main export: FishPrimary school enrollment (2006): 100 percent
Key export markets: Fiji, Australia, JapanSecondary school enrollment (2001): 79.5 percent
201020112012201320142015
Est.Proj.
(Percent change)
Real sector
Real GDP growth−2.78.50.21.32.22.5
Consumer price inflation (period average)−1.90.51.42.03.33.1
(In percent of GDP)
Government finance
Revenue and grants71.969.084.3107.5116.087.6
Revenue55.547.856.682.964.665.6
of which: Tax revenue16.516.915.019.015.118.0
Fishing license fees20.614.921.845.433.832.8
Grants 2/16.421.227.824.651.422.1
Total expenditure95.777.975.081.1100.292.1
Current expenditure92.576.175.081.0100.191.9
of which: Wages and salaries33.831.331.932.238.036.2
Capital expenditure and net lending3.21.80.00.20.20.2
Overall balance−23.8−8.99.326.315.8−4.4
Extra budgetary grants 3/31.821.229.325.225.731.4
Tuvalu Trust Fund (stock, $A million)108119131141146145
Consolidated Investment Fund (stock, $A million)7.23.24.514.520.618.2
(Percent change, unless otherwise indicated)
Money and credit
Deposits−8.38.69.729.39.5
Credit0.915.1−11.4−7.70.8
Lending interest rate (in percent) 4/10.610.610.610.610.6
(In millions of Australian dollars, unless otherwise indicated)
Balance of payments
Current account balance−4.1−13.99.810.511.5−16.3
(In percent of GDP)−11.9−36.525.326.427.7−37.2
of which:
Exports of goods10.910.219.920.521.121.9
ow/ Fish10.49.419.520.120.721.4
Imports of goods−17.3−17.6−16.7−19.1−22.3−35.8
Fishing license fees7.25.78.418.014.114.3
Current transfers (net)15.214.320.318.023.115.7
ow/Remittances4.34.43.73.84.04.1
Capital and financial account balance10.012.30.81.20.513.4
of which: .TV domain license fees2.01.93.74.44.14.1
Capital transfers (net)7.512.34.75.15.89.1
Gross official reserves 5/26.624.127.536.548.545.6
(In months of next year’s imports)6.16.66.67.87.97.9
(In percent of GDP, unless otherwise indicated)
Debt indicators
Gross public debt55.645.343.041.156.948.6
External50.640.736.435.352.044.6
Domestic5.14.66.75.84.94.1
Exchange rates
Australian dollars per U.S. dollar (period average)1.11.01.01.0
Nominal effective exchange rate (2005=100)111.2119.1122.7123.7
Real effective exchange rate (2005=100)108.3111.0112.4110.6
Nominal GDP (In millions of Australian dollars)34.738.138.539.741.743.8
Sources: Tuvalu authorities; PFTAC; SPC; ADB; World Bank; and IMF staff estimates and projections.

Tuvalu uses the Australian dollar as its currency. It has no central bank.

Includes transfer from the Tuvalu Trust Fund to the Consolidated Investment Fund.

Estimated by staff based on balance of payments and fiscal data.

Average of personal, business, overdraft, and housing loans.

Defined as the sum of foreign assets of the National Bank of Tuvalu, the Consolidated Investment Fund, and SDR holdings.

Sources: Tuvalu authorities; PFTAC; SPC; ADB; World Bank; and IMF staff estimates and projections.

Tuvalu uses the Australian dollar as its currency. It has no central bank.

Includes transfer from the Tuvalu Trust Fund to the Consolidated Investment Fund.

Estimated by staff based on balance of payments and fiscal data.

Average of personal, business, overdraft, and housing loans.

Defined as the sum of foreign assets of the National Bank of Tuvalu, the Consolidated Investment Fund, and SDR holdings.

Table 2.Tuvalu: Illustrative Medium-Term Baseline Scenario, 2010–2019
2010201120122013201420152016201720182019
Est.Projections
(Percent change)
Growth and inflation
Real GDP growth−2.78.50.21.32.22.52.51.92.01.9
CPI inflation (period average)−1.90.51.42.03.33.13.02.92.82.8
(In percent of GDP)
Fiscal accounts
Total revenue and grants71.969.084.3107.5116.087.682.476.374.072.2
Revenue55.547.856.682.964.665.659.959.057.356.0
Grants16.421.227.824.651.422.122.517.316.816.3
Total expenditure and net lending95.777.975.081.1100.292.187.984.080.277.4
Overall balance (including grants)−23.8−8.99.326.315.8−4.4−5.5−7.8−6.1−5.1
(In millions of Australian dollars, unless otherwise indicated)
Balance of payments
Current account−4.1−13.99.810.511.5−16.3−10.5−8.9−4.6−5.6
(In percent of GDP)−11.9−36.525.326.427.7−37.2−23.0−18.7−9.2−10.9
of which:
Exports10.910.219.920.521.121.922.623.424.325.1
(In percent of GDP)31.526.751.751.750.750.049.349.048.848.7
Imports−17.3−17.6−16.7−19.1−22.3−35.8−28.5−27.1−25.9−26.3
(In percent of GDP)49.946.343.348.253.481.862.156.752.151.1
Capital and financial account10.012.30.81.20.513.46.02.90.20.5
of which: Capital transfers7.512.34.75.15.89.111.38.66.16.4
.TV domain license fees2.12.43.74.44.14.14.14.24.24.2
Memorandum items
Gross external public debt (percent of GDP)50.640.736.435.352.044.637.932.125.520.3
External debt service ratio 1/7.819.411.211.612.813.212.510.711.79.4
Gross official reserves (millions of U.S. dollars)26.624.127.536.548.545.641.035.030.625.5
(In months of next year’s imports)6.16.66.67.87.97.97.57.05.94.8
Tuvalu Trust Fund (stock, $A million)108.0118.7130.6140.6146.4145.5149.1152.8156.6160.6
Consolidated Investment Fund (stock, $A million)7.23.24.514.520.618.215.211.17.64.5
Sources: Data provided by the Tuvalu authorities and IMF staff estimates and projections.

In percent of exports of goods and services.

Sources: Data provided by the Tuvalu authorities and IMF staff estimates and projections.

In percent of exports of goods and services.

Table 3.Tuvalu: Summary Operations of the General Government, 2010–15 (GFS 1986)
20142015
2010201120122013BudgetProj.Proj.
(In millions of Australian dollars)
Total revenue and grants24.926.332.542.752.048.338.4
Revenue19.318.221.832.931.026.928.7
Tax revenue5.76.45.87.57.96.37.9
Personal income tax2.02.12.21.51.81.61.6
Corporate income tax1.21.61.03.02.81.51.6
Consumption & sales tax0.10.10.61.21.21.31.9
Excise and others0.80.80.80.70.80.70.8
Import duty1.71.91.21.11.31.22.0
Nontax revenue13.611.816.025.423.120.620.8
of which: Fishing license fees7.25.78.418.014.014.114.3
Interest and dividends1.91.50.90.20.71.31.3
.TV license fees2.01.93.74.44.14.14.1
Grants 1/5.78.110.79.821.021.49.7
Total expenditure and net lending33.229.728.932.238.741.840.3
Current expenditure32.129.028.932.138.741.740.2
of which: Wages and salaries11.711.912.312.815.915.915.9
TMTS2.22.12.32.62.32.83.0
Scholarship programs1.81.82.32.32.3
Capital expenditure and net lending1.10.70.00.10.00.10.1
Capital expenditure1.10.70.00.10.00.10.1
Net lending0.00.00.00.00.00.00.0
Overall balance (incl. grants)−8.3−3.43.610.513.26.6−1.9
Overall balance (excl. grants)−13.9−11.5−7.10.7−7.8−14.8−11.6
Structural balance 2/−9.4−2.33.82.63.5−4.6
Financing8.33.4−3.6−10.5−13.2−6.61.9
Foreign (net)−0.8−0.2−0.1−0.4−0.4−0.4−0.4
Domestic (net)−0.10.00.00.00.00.00.0
CIF (net, -=increase)9.23.6−3.5−10.0−12.8−6.12.4
(In percent of GDP)
Total revenue and grants71.969.084.3107.5124.7116.087.6
Revenue55.547.856.682.974.364.665.6
Tax revenue16.516.915.019.018.915.118.0
Nontax revenue39.130.941.563.955.349.547.6
of which: Fishing license fees20.614.921.845.433.633.832.8
Interest and dividends5.44.02.30.51.73.23.0
.TV license fees5.84.99.611.09.79.79.3
Grants 1/16.421.227.824.650.451.422.1
Total expenditure and net lending95.777.975.081.193.0100.292.1
Current expenditure92.576.175.081.092.9100.191.9
of which: Wages and salaries33.831.331.932.238.038.036.2
TMTS6.45.66.16.55.56.86.9
Scholarship programs4.74.55.65.65.3
Capital expenditure and net lending3.21.80.00.20.10.20.2
Capital expenditure3.21.80.00.20.10.20.2
Net lending0.00.00.00.00.00.00.0
Overall balance (incl. grants)−23.8−8.99.326.331.715.8−4.4
Overall balance (excl. grants)−40.2−30.1−18.41.8−18.7−35.6−26.5
Structural balance 2/−27.1−6.19.86.48.3−10.5
Financing23.88.9−9.3−26.3−31.6−15.84.4
Foreign (net)−2.4−0.5−0.1−1.0−1.0−1.0−0.9
Domestic (net)−0.3−0.10.0−0.10.0−0.1−0.1
CIF (net, -=increase)26.49.4−9.2−25.3−30.7−14.75.5
Memorandum items:
Extra budgetary grants 3/31.821.229.325.225.731.4
Public debt (in percent of GDP)55.645.343.041.156.948.6
Stock of CIF ($A million)7.23.24.514.520.620.618.2
Nominal GDP ($A million)34.738.138.539.741.741.743.8
Sources: Tuvalu authorities; and IMF staff estimates and projections.

Includes transfer from the Tuvalu Trust Fund to the Consolidated Investment Fund.

Defined as the overall balance minus deviation from a normal level of fishing license fees, calculated on the basis of backward and forward averages.

Estimated by staff based on balance of payments and fiscal data.

Sources: Tuvalu authorities; and IMF staff estimates and projections.

Includes transfer from the Tuvalu Trust Fund to the Consolidated Investment Fund.

Defined as the overall balance minus deviation from a normal level of fishing license fees, calculated on the basis of backward and forward averages.

Estimated by staff based on balance of payments and fiscal data.

Table 4.Tuvalu: Summary Operations of the General Government, 2010–15 (GFS 2001)
20142015
2010201120122013BudgetProj.Proj.
(In millions of Australian dollars)
Total revenue and grants24.926.332.542.752.048.338.4
Revenue19.318.221.832.931.026.928.7
Tax revenue5.76.45.87.57.96.37.9
Nontax revenue13.611.816.025.423.120.620.8
of which: Fishing license fees7.25.78.418.014.014.114.3
Interest and dividends1.91.50.90.20.71.31.3
.TV license fees2.01.93.74.44.14.14.1
Grants 1/5.78.110.79.821.021.49.7
Expenditure33.229.728.932.238.741.840.3
Expense32.129.028.932.138.741.740.2
Wages and salaries11.711.912.312.815.915.915.9
Purchase of goods and services8.07.57.78.59.811.69.2
Transfers 1/5.24.56.37.98.39.610.7
Interest payments0.30.30.10.10.10.10.2
Other expense6.84.72.53.04.54.54.2
Net acquisition of nonfinancial assets1.10.70.00.10.00.10.1
Gross operating balance−7.1−2.73.610.513.36.6−1.9
Net lending / borrowing (overall balance)−8.3−3.43.610.513.26.6−1.9
Net financial transactions8.33.4−3.6−10.5−13.2−6.61.9
Net acquisition of financial assets9.23.6−3.5−10.0−12.8−6.12.4
Domestic0.00.00.00.00.00.00.0
Foreign9.23.6−3.5−10.0−12.8−6.12.4
Net incurrence of liabilities−0.9−0.2−0.1−0.4−0.4−0.5−0.5
Domestic−0.10.00.00.00.00.00.0
Foreign−0.8−0.2−0.1−0.4−0.4−0.4−0.4
(In percent of GDP)
Total revenue and grants71.969.084.3107.5124.7116.087.6
Revenue55.547.856.682.974.364.665.6
Tax revenue16.516.915.019.018.915.118.0
Nontax revenue39.130.941.563.955.349.547.6
of which: Fishing license fees20.614.921.845.433.633.832.8
Interest and dividends5.44.02.30.51.73.23.0
.TV license fees5.84.99.611.09.79.79.3
Grants 1/16.421.227.824.650.451.422.1
Expenditure95.777.975.081.193.0100.292.1
Expense92.576.175.081.092.9100.191.9
Wages and salaries33.831.331.932.238.038.036.2
Purchase of goods and services23.219.820.121.323.627.921.0
Transfers 1/15.011.716.319.920.023.024.5
Interest payments0.80.80.30.20.30.30.5
Other expense19.712.56.47.410.910.99.7
Net acquisition of nonfinancial assets3.21.80.00.20.10.20.2
Gross operating balance−20.6−7.19.426.531.815.9−4.3
Net lending / borrowing (overall balance)−23.8−8.99.326.331.715.8−4.4
Net financial transactions23.88.9−9.3−26.3−31.6−15.84.4
Net acquisition of financial assets26.49.4−9.2−25.3−30.7−14.75.5
Domestic0.00.00.00.00.00.00.0
Foreign26.49.4−9.2−25.3−30.7−14.75.5
Net incurrence of liabilities−2.7−0.5−0.2−1.1−1.0−1.1−1.0
Domestic−0.3−0.10.0−0.10.0−0.1−0.1
Foreign−2.4−0.5−0.1−1.0−1.0−1.0−0.9
Memorandum items:
Extra budgetary grants 2/31.821.229.325.225.731.4
Public debt (in percent of GDP)55.645.343.041.156.948.6
Stock of CIF ($A million)7.23.24.514.520.620.618.2
Nominal GDP ($A million)34.738.138.539.741.741.743.8
Sources: Tuvalu authorities; PFTAC; and IMF staff estimates and projections.

Includes medical treatment scheme and scholarships, as well as Community Service Obligations (CSO).

Estimated by staff based on balance of payments and fiscal data.

Sources: Tuvalu authorities; PFTAC; and IMF staff estimates and projections.

Includes medical treatment scheme and scholarships, as well as Community Service Obligations (CSO).

Estimated by staff based on balance of payments and fiscal data.

Table 5.Tuvalu: Balance of Payments, 2010–19
2010201120122013201420152016201720182019
Est.Projections
(In millions of Australian dollars, unless otherwise indicated)
Current account balance−4.1−13.99.810.511.5−16.3−10.5−8.9−4.6−5.6
Trade−6.4−7.43.21.4−1.1−13.9−5.9−3.7−1.6−1.2
Exports, f.o.b.10.910.219.920.521.121.922.623.424.325.1
of which: Fish10.49.419.520.120.721.422.122.923.724.5
Imports, f.o.b.−17.3−17.6−16.7−19.1−22.3−35.8−28.5−27.1−25.9−26.3
Services−24.0−30.2−23.1−26.6−29.5−32.8−35.2−33.6−28.6−30.3
Credit4.44.24.34.44.64.95.15.35.55.7
Debit−28.4−34.4−27.4−31.0−34.1−37.7−40.3−38.9−34.1−36.0
Net income11.09.49.417.619.014.714.414.314.314.3
Credit12.710.612.422.424.020.019.920.120.320.5
Debit−1.7−1.2−3.1−4.8−5.0−5.3−5.5−5.8−6.0−6.2
Net transfers15.214.320.318.023.115.716.214.011.411.7
Credit17.416.722.420.425.518.218.916.814.314.7
Debit−2.2−2.4−2.2−2.3−2.4−2.6−2.7−2.8−2.9−3.0
Capital and financial account10.012.30.81.20.513.46.02.90.20.5
Capital account9.614.78.49.59.813.215.412.810.310.6
of which: Capital tranfers7.512.34.75.15.89.111.38.66.16.4
.TV domain license fees2.01.93.74.44.14.14.14.24.24.2
Financial account0.4−2.3−7.6−8.3−9.30.2−9.5−9.9−10.1−10.1
Direct investment (net)0.6−0.11.60.70.70.80.80.90.90.9
Portfolio investment (net)−1.90.0−1.4−1.4−1.5−1.6−1.6−1.7−1.8−1.8
Other (net) 2/1.7−2.3−7.9−7.6−8.61.0−8.7−9.0−9.2−9.2
Errors and omissions−9.1−0.1−8.7−2.70.00.00.00.00.00.0
Overall balance−3.3−1.71.99.012.0−2.9−4.6−6.0−4.4−5.1
Financing
Change in official reserves (-=increase in reserves)3.31.7−1.9−9.0−12.02.94.66.04.45.1
Memorandum items:
Current account balance (percent of GDP)−11.9−36.525.326.427.7−37.2−23.0−18.7−9.2−10.9
excluding official grants (percent of GDP)−58.8−77.5−30.7−22.1−30.9−76.1−61.3−51.1−35.2−36.6
Gross official reserves 1/26.624.127.536.548.545.641.035.030.625.5
(in months of imports of goods and services)6.16.66.67.87.97.97.57.05.94.8
Sources: Tuvalu authorities; PFTAC; and IMF staff estimates and projections.

Defined as the sum of liquid assets of the National Bank of Tuvalu, the Consolidated Investment Fund, and SDR holdings.

Includes financial transactions related to the joint venture company, Tuvalu Tuna FH Co.

Sources: Tuvalu authorities; PFTAC; and IMF staff estimates and projections.

Defined as the sum of liquid assets of the National Bank of Tuvalu, the Consolidated Investment Fund, and SDR holdings.

Includes financial transactions related to the joint venture company, Tuvalu Tuna FH Co.

Table 6.Tuvalu: Assets and Liabilities of the Banking Sector, 2007–13
2007200820092010201120122013
Est.
(In millions of Australian dollars)
Assets38.446.041.441.142.844.351.3
Cash1.11.11.51.21.62.31.7
Deposits10.212.813.814.916.718.020.0
Loans and advances 1/23.727.019.820.720.819.518.1
of which: Government loans4.93.61.72.10.30.30.0
Claims on other banks0.62.21.11.61.01.88.6
Fixed assets0.50.50.50.40.40.40.4
Other assets2.12.44.72.42.32.42.4
Liabilities25.431.024.821.723.525.733.0
Deposits21.424.122.320.422.224.331.5
of which: Government deposits4.33.42.63.93.33.79.3
Demand deposits7.19.77.97.67.610.218.3
Securities0.10.10.3
Liabilities to other banks 2/1.42.31.00.70.60.50.5
Other liabilities2.64.61.60.60.60.70.8
Capital13.015.016.619.419.218.618.2
of which: Paid-up capital3.43.74.04.64.74.74.7
Retained earnings2.33.13.95.75.14.54.4
Provision for credit impairment7.38.28.69.19.59.49.1
Sources: National Bank of Tuvalu; and Development Bank of Tuvalu.

Gross loans and advances.

Development Bank of Tuvalu’s loans from the European Investment Bank.

Sources: National Bank of Tuvalu; and Development Bank of Tuvalu.

Gross loans and advances.

Development Bank of Tuvalu’s loans from the European Investment Bank.

Appendix I. Tuvalu: Risk Assessment Matrix 1/
Sources of RisksLikelihoodPotential ImpactRecommendation
Surges in global financial market volatilityH.High. Elevated market volatilities will feed through to the market value of TTF that is primarily invested in Australia, making TTF’s transfers to the budget more uncertain.• Make TTF a rainy day fund, save most if not all investment returns, and smooth TTF transfers to the budget by targeting a longer-horizon benchmark.
Protracted period of slower growth in advanced and emerging economiesH.Medium. Slower growth and reduced demand in the Pacific region would cause remittances by seafarers and seasonal workers to fall. But meanwhile, a weakening Australian dollar would help improve Tuvalu’s competitiveness.• Develop human capital to improve competitiveness

• Foster domestic business climate to improve employment

• Take an innovative approach to explore foreign employment opportunities
Growth slowdown in ChinaM.Medium. Slower growth and reduced demand in the Pacific region would cause remittances by seafarers and seasonal workers to fall. But meanwhile, a weakening Australian dollar would help improve Tuvalu’s competitiveness• Develop human capital to improve competitiveness

• Foster domestic business climate to improve employment

• Take an innovative approach to explore foreign employment opportunities
Climate changeM-H.High. The occurrence of extreme weather conditions could cause fluctuation in fishing revenues and large economic loss, while tuna stock tends to relocate and decline on variability of the ocean’s conditions over the long run.• Strengthen fiscal buffers (see above)

• Build adaptive capacity to increase resilience, with assistance by development partners
Weak fiscal policy and lower foreign aidM-H.High. Fiscal buffers could be fully depleted, making the economy highly vulnerable to adverse shocks.• Establish a transparent fiscal framework that addresses pro-cyclicality and saves for rainy days

• Conduct fiscal consolidation and build fiscal buffers

• Closely engage with development partners to mobilize foreign aid.
Poor governance of public enterprises and banksH.High. The weaknesses in public enterprises and banks pose challenges to growth and stability.• Adopt public enterprise reforms to enhance transparency and accountability
Elevated banking risks/Insolvency of DBTH.High. Large NPLs impede lending, and pose substantial contingent liabilities to the budget. A possible insolvency of the DBT could cause spillover risks to the banking system and large fiscal cost.• Establish a regulatory framework for banks

• Assess fiscal cost of bank restructuring based on prudential standards

• Develop a bank resolution framework
Appendix II. Tuvalu—Policy Reform Matrix—Policies and Progress of Implementation
PoliciesObjectivesImplementation as of 2014Q2
Produce annual reports for the Education and Health programs, and reduce cost of the overseas medical treatment schemeImprove transparency and accountability of social programs, and contain their costsA few reports have been produced, but others remain to be completed and the regularity of reporting remains to be improved. Some measures, albeit insufficient, have been introduced to reduce the cost of the overseas medical treatment scheme.
Conduct annual reporting and auditing for public enterprisesStrengthen governance and transparency of public enterprisesAll public enterprises except the National Fishing Corporation of Tuvalu have been audited in 2012. The 2013 audit is in progress.
Remove public servants from Public Enterprise BoardsReduce government intervention in Public EnterprisesThe government requested voluntary resignation of public servants from Board positions, and all public servant Board members have now resigned.
Develop a budget manualEnhance public financial managementThe manual was drafted with the assistance of external advisors, and has been approved by the Cabinet. The Ministry of Finance and Economic Development is organizing training sessions for budget staff.
Increase VAT compliance to 75% of registered entities, including 100% of Public EnterprisesStrengthen tax administrationThis has been achieved.
Conduct tax audit training and undertake at least 2 audits of large taxpayersStrengthen tax administrationThe external tax advisor has conducted intensive tax audit training for IRD staff. So far IRD has made more than two audits of large taxpayers
Increase VAT rate to 7% in 2013Increase tax revenue and move toward common practices of other countriesThe Regulation validating a 7% VAT rate has been passed and implemented.
Appendix III. Tuvalu—Climate Change—The Economic Impact on Pacific Islands Economies1

Climate change poses substantial challenges to small island economies in the Pacific.2 Estimates suggest that sea levels in the Pacific could rise by as much as 1.2 meters to 1.7 meters before 2100, which would lead to significant declines in land area. Moreover, El Niño and La Niña events could also increase by over 40 percent in the Pacific, leading to a rise in the frequency and intensity of extreme weather events. This will particularly threaten the existence of Pacific island countries, where a concentration of population, socioeconomic activities, and major infrastructure along the low-lying coastal areas make them highly vulnerable to rising sea levels and extreme weather events.3 In this context, Tuvalu, one of the lowest countries in the world with the highest point only 4.6 meters above sea level, is particularly susceptible.

Area of Land Devoted to Agriculture, 2011

(Percentage of total area)

Estimates suggest climate change could inflict losses to the Pacific region amounting to 2.2 to 3.5 percent of GDP per year. Given a 2-4 C° temperature increase, projected economic losses amount to US$1 billion in damages to water resources.4 Agriculture could account for one-third to one-half of total economic losses caused by climate change. These effects would be acutely felt in Tuvalu where more than 60 percent of the total land area is devoted to agricultural production. Fisheries will also be affected by more acidic oceans and degraded fish habitats, which will lower the yields of some species and cause the location of fish resources to shift.

Estimates of Sea-Level Rise By 2100 Relative to 2010

(In meters)

Building capacity against climate change would entail substantial investment. Currently, the Pacific island countries are far from being resilient to climate change, and substantial investments are needed to enhance the capacity to offset the impact of climate change. Building adaptive capacity such as climate-proofing critical infrastructure, enhancing existing early-warning systems for coastal inundation, and developing plans in coastal management—including coral-reef conservation and protection—are necessary to address a wide range of uncertain climate outcomes. The funding cost could average from 1.5 to 2.5 percent of GDP per year.

Appendix IV. Tuvalu—Pacific Islands—Are Fishing Resources Renewable?1

The Pacific islands region is the home to some of the last healthy tuna populations in the world. The Western and Central Pacific Ocean (WCPO) contains the world’s largest stock of tuna and accounts for more than half of the global tuna catch. The value of tuna catch in this region has almost doubled since 2010, reaching around US$2.8 billion.

Overfishing constitutes a key challenge to tuna population. The stock of tuna is at a historical low and may not be renewable under intense pressure from international fishing fleets. Since the 1960s, the global catch has increased from 20,000 tons per year to 4 million tons per year, and the tuna population plummeted. Studies estimate that the population of one key species, the Pacific bluefin, has dropped by 96 percent in recent decades because of overfishing, and the catch of bigeye tuna, another popular species in the market, needs to be reduced by at least 32 percent from the 2006-09 levels to ensure long-term sustainability.2,3

Value of Tuna Catch

(In millions of US dollars)

Source: Secretariat of the Pacific Community.

Climate change is expected to reduce the suitability of tuna spawning and forage habitats. In the long run, rising ocean temperatures will reduce primary and secondary production in the sea, which, together with weakening currents and nutrient transport, will reduce the population of tuna. In the short run, concentration areas of tuna tend to move—countries in the central Pacific, such as Kiribati and Tuvalu, experience higher catches during El Niño years, while countries in the western Pacific, such as Papua New Guinea and Solomon Islands enjoy higher catches during La Niña years. These movements will cause year-to-year fluctuations in the tuna catch by individual countries.

Restricting overfishing is a challenging task. The Vessel Day Scheme has vastly boosted fishing revenues in recent years, but its impact on fish resources has been unclear. Although the Pacific island countries attempt to preserve tuna resources by setting limits on the number of vessel days, the number of registered fishing vessels has continued to rise, and fishing technologies have become increasingly efficient and perhaps potentially harmful—the most popular fishing method in the region called purse seine fishing has caused a significant rise of juvenile catches.

Appendix V. Tuvalu—Seafarers’ Employment and Remittances in Kiribati and Tuvalu1

Seafaring provides an important source of employment and remittances for Kiribati and Tuvalu, but both employment and remittances associated with this traditional activity have exhibited clear downward trends in recent years. While remaining sizable, employment fell sharply during the global financial crisis. As of October 2013, there were about 1,008 Kiribati and 112 Tuvalu seafarers on board, compared to 1,452 and 361 respectively in 2006. Over the period, seafarer remittances fell by about 4 percent of GDP for Kiribati and 9 percent of GDP for Tuvalu. In 2012, remittances stood at 5.8 percent of GDP in Kiribati and 10 percent of GDP in Tuvalu. The depreciation of the U.S. dollar over the past few years has also had a negative impact on the Australian dollar value of seafarer remittances.

The recovery in world trade from the global financial crisis did not produce a corresponding recovery in seafarer employment for a number of structural reasons. The shipping industry serving global trade continues to suffer from low profitability and overcapacity, and increasing automation of ship operations has reduced the demand for seafarers. At the same time, seafarers from Kiribati and Tuvalu have become less competitive compared with those from South and Southeast Asian countries as transportation costs for Kiribati and Tuvalu seafarers traveling to their destinations have become relatively high.

Insufficient training in some cases impedes seafarer employment. While the Kiribati Marine Training Center is considered one of the best vocational training institutes in the region, training programs provided by the Tuvalu Maritime Training Institute are generally for traditional merchant vessels and have become inadequate for ships equipped with modern technologies. Moreover, while the close connection with the German merchant ships has traditionally provided an important source of employment and income, this concentration has increasingly aggravated external shocks to Kiribati and Tuvalu seafarers’ employment and remittances.

Seafarers Remittances: Kiribati and Tuvalu

Appendix VI. Tuvalu—Public Enterprises in Tuvalu1

The financial performance of public enterprises remains weak. The audited accounts for 2012 show that most public enterprises reported financial losses and revealed significant vulnerabilities in their financial position.2 The impediments to public enterprise operations remain the same as those identified in the 2012 Article IV staff report, namely persistent inefficiencies in management practices, weak tariff structures, arrears on payments by the government, and limited scope to gain from economies of scale. As such, losses made by these enterprises—at more than 3 percent of GDP in the past few years—entail substantial potential liabilities of the government.

An ambitious reform plan was enacted under the 2010 Public Enterprise Act (PEA), but progress has been slow in most areas. While progress was made in removing civil servants from Board positions, progress in other areas has been limited. Under the Act, the Public Enterprise Reform Monitoring Unit (PERMU) was established to monitor enterprises’ compliance with the legislation, but the unit is effectively not in operation as the Director and supporting positions are presently vacant. Additionally, while the government compensates public enterprises’ social services—for instance the provision of electricity and banking services to the outer islands—through allocations of Community Service Obligations (CSOs), the amounts are determined on the basis of negotiations between the recipients and the government rather than a clear defining and costing of social responsibilities assumed by public enterprises.

Certain public enterprises will face additional financial pressures. The recent wage increase for civil servants has induced public enterprises to raise salaries for their employees by a similar margin, adding to operational costs. The Tuvalu Electricity Corporation faces substantial challenges as fuel grants from Japan are to be phased out by end-2014—the corporation would make more losses and be more susceptible to global oil price movements.3

Public EnterprisesYearAssets (Percent of GDP)Solvency (Profit/Liabilites in Percent)
National Bank of Tuvalu (NBT)2012804
Development Bank of Tuvalu (DBT)20126-55
Tuvalu Telecommunications Corporations (TTC)20126-9
Vaiaku Lagi Hotel (VHL)20120-28
Tuvalu Electricity Corporation (TEC)2012158
Tuvalu Maritime Training Institue (TMTI)201117-2
Tuvalu Philatelic Bureau20100-35
National Fishhing Company of Tuvalu (NAFICOT)N.A.N.A.N.A.
1

The Tuvaluan government holds around 50 percent of the joint venture’s shares.

2

Extrabudgetary spending supported by project financing from development partners have been around 25 percent of GDP.

3

The spending on these large projects would be extrabudgetary.

4

Tuvalu Cooperative Society (TCS) is owned by Tuvaluan people and used to be the main wholesaler and retailer. With increasing competition from private retailers, the TCS was forced to terminate most of its operations after incurring large losses. The TCS currently holds arrears of $A 2.5 million against external suppliers and domestic banks.

5

Under PICTA, tariff rates for the trade among Pacific island countries will be cut to zero by 2015, and this rate cut would be deferred to 2017 for the least developed countries including Tuvalu.

6

The mission suggested that the authorities contact the Pacific Financial Technical Assistance Centre (PFTAC) for technical assistance as soon as feasible.

1

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.

1

Prepared by Inderjit Sian.

2

The Economics of Climate Change in the Pacific, 2013, Asian Development Bank, http://www.adb.org/publications/economics-climate-change-pacific.

3

Climate Change – Small Island Developing States, 2005, UNFCC.

4

Climate Change Impacts—Pacific Islands”, the Global Mechanism and IFAD

1

Prepared by Sung Eun Jung.

2

Harvey, Fiona (January 2013), “Overfishing causes Pacific bluefin tuna numbers to drop 96%”. The Guardian (London: GMG). ISSN 0261-3077. OCLC 60623878.

3

Policy Brief 14/2012, Secretariat of the Pacific Community http://www.spc.int/coastfish/en/publications/brochures/policy-briefs.html

1

Prepared by Xuefei Bai, Sergei Dodzin, and Jiangyan Yu.

1

Prepared by Inderjit Sian.

2

The 2013 audited accounts are not available yet.

3

It is estimated that tariff rates at the electricity company need to rise by around 50% for it to be profitable.

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