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IMF Executive Board Concludes 2018 Article IV Consultation with the Republic of Palau

Author(s):
International Monetary Fund. Asia and Pacific Dept
Published Date:
February 2019
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On February 1, 2019, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Palau.1

Palau’s economic activity slowed significantly in FY2016 and FY2017. GDP contracted by 3.7 percent in FY2017, due to tourist arrivals dropping sharply by 17 percent. Construction activities also remained subdued because of lower capital grants and a delay in the construction of a new luxury hotel. Inflation turned positive at 0.9 percent in FY2017 as fuel and food prices rose. The current account deficit increased substantially to 17.9 percent of GDP in FY2017, due to the downturn in tourism. The fiscal position improved over the past years owing to concerted efforts at fiscal consolidation. The overall fiscal surplus (including grants and capital) rose to 4.8 percent of GDP in FY2017, with capital expenditure compressed at a low level due to low capital grant receipts. Public debt remains moderate and sustainable.

Growth is projected to recover moderately to 0.4 percent in FY2018 and increase to 2 percent in FY2019 with a recovery in construction activities and tourism. Inflation is projected to rise by 2.8 percent in FY2018, as commodity prices increase. The current account deficit is projected to come down to around 13 percent of GDP with a recovery of the tourism sector and the completion of major infrastructure projects. The fiscal position is projected to improve in the near-term as the overall fiscal balance is boosted temporarily after the disbursement of the Compact capital grants. Risks to the economic outlook are tilted to the downside. Economic downturn due to lower than expected tourism arrivals would worsen the fiscal position and the external sector. A shortfall of non-Compact capital grants would lead to lower infrastructure investment and lower economic growth. Palau remains vulnerable to natural disasters and climate change as in other Pacific Island economies. Other risks include weaker than expected global growth, including in the U.S. and China and a sharp tightening of global financial conditions and further US dollar appreciation. These risks could adversely affect the economy through lower tourism receipts.

Executive Board Assessment2

Executive Directors agreed with the thrust of the staff appraisal. They welcomed signs of a gradual recovery of economic activity in tourism and construction. However, Directors noted that Palau continues to face medium-term challenges arising from the expiration of the Compact grants in FY2024, revenue volatility stemming from limited economic diversification, and vulnerabilities to climate change and natural disasters. They emphasized that continued sound macroeconomic policies will be important to ensure long-term fiscal sustainability, safeguard financial stability, reduce vulnerabilities to external shocks, and promote sustainable and resilient growth.

Directors welcomed the authorities’ plan to develop a medium-term fiscal framework to accommodate high revenue volatility and to manage fiscal risks. They noted that the framework should employ a net worth approach, which provides the desired path for the current fiscal balance consistent with medium-term fiscal objectives. Directors recommended the need for additional fiscal adjustment over the medium term to ensure sustained increases in public investment for resilient growth. They underscored that adjustment should rely on a revenue-enhancing tax reform, complemented by a strengthening of public financial management, including in public investment. Directors welcomed the authorities’ plan to implement a comprehensive tax reform, including the introduction of the VAT. They also encouraged continued efforts to lower subsidies to state-owned enterprises.

Directors welcomed the efforts to implement a comprehensive tourism strategy to support sustainable and resilient economic growth. They noted that greater geographical diversification of source countries could enhance the resilience of the sector and the economy. Directors also encouraged the authorities to improve the investment climate and foster the development of the private sector by adopting a streamlined foreign investment regime and addressing infrastructure bottlenecks. They encouraged the authorities to tackle the brain drain from youth emigration.

Directors noted that the banking system remains sound but lends too little domestically. They advised the authorities to relax the interest rate ceiling for commercial loans to better reflect riskiness and help small companies prepare business plans and financial statements. Directors welcomed the plans to broaden financial supervision to nonbank financial institutions to preserve financial stability. They recommended a cautious approach to cryptocurrencies, given the associated financial risks. In this regard, Directors encouraged steps to address the deficiencies in the AML/CFT framework.

Table 1.Palau: Selected Economic Indicators 1/
Nominal GDP for FY2017:US$290 million
Population (2015):17,661
GDP per capita for FY2015:US$17,139
Quota:SDR 3.1 million
2012/132013/142014/152015/162016/172017/182018/192019/20
Est.Proj.
Real sector
Nominal GDP (million US$)225.3245.7293.1304.0289.8296.5309.5323.6
Real GDP growth (percent change)-1.73.010.40.5-3.70.42.02.5
GDP deflator (percent change)6.85.88.13.2-1.01.92.42.0
Consumer prices (percent change; period average)3.44.10.9-1.00.92.82.42.0
Tourist arrivals (number of visitors)110,823125,674168,764146,629122,050115,964118,283121,240
Expenditure per Tourist Arrival (US$)1,0061,0168759371,0031,0741,1521,236
Public finance(In percent of GDP)
Central government
Revenue40.843.439.241.039.840.049.341.2
Taxes and other revenue22.224.224.324.826.628.028.128.1
Grants18.619.214.916.213.112.021.213.0
Expenditure40.139.834.337.534.935.840.539.3
Expense35.835.329.732.032.034.033.933.8
of which: grants to other government units5.04.85.15.85.06.96.96.8
Net acquisition of nonfinancial assets4.34.54.65.52.91.86.65.5
Current fiscal balance (excluding grants) 2/-13.5-11.1-5.4-7.2-5.4-6.0-5.8-5.7
Current fiscal balance (including current grants) 3/-0.32.54.72.75.64.65.53.4
Net lending (+)/borrowing (–)0.73.64.93.54.84.38.81.8
(In millions of U.S. dollars)
Compact Trust Fund (CTF) balance189.6199.2183.9196.8219.8226.5293.9294.8
Government cash and deposits 4/6.29.623.428.632.749.983.693.2
In percent of GDP2.83.98.09.411.316.827.028.8
Monetary sector
Credit to private sector (in percent of GDP)12.412.09.89.811.912.012.2
Credit to private sector (percent change)8.95.9-2.53.615.42.96.6
Balance of payments 3/
Trade balance-129.9-155.1-138.3-136.3-143.7-147.9-156.2-158.7
Exports (f.o.b.)11.812.511.611.39.811.112.612.7
Imports (f.o.b.)141.7167.6149.9147.6153.5159.0168.8171.4
Tourism receipts105.7121.3138.9129.6115.8114.2124.4137.7
Current account balance
Including grants-25.5-33.9-19.2-31.9-51.9-51.4-49.7-51.2
Excluding grants-67.6-79.0-59.9-74.1-94.0-93.7-95.0-89.8
International Investment Position216.5243.2267.3311.3339.7346.6424.4413.8
Assets424.9467.1510.1579.5618.6651.0760.5780.4
Liabilities208.4223.9242.7268.1278.8304.3336.1366.6
Of which: External debt65.070.664.480.085.991.3101.1107.6
(In percent of GDP)
Current account balance
Including grants-11.3-13.8-6.5-10.5-17.9-17.3-16.0-15.8
Excluding grants-30.0-32.1-20.4-24.4-32.4-31.6-30.7-27.8
International Investment Position96.199.091.2102.4117.2116.9137.1127.9
Of which: External debt28.928.722.026.329.630.832.733.2
Sources: Palau authorities; and Fund staff estimates and projections.

Fiscal year ending September 30.

Defined as tax and other revenue less expense.

Includes withdrawls from CTF and Funding for US Federal Programs (Post Office and Meteorological Service)

Includes unspent external loans.

Sources: Palau authorities; and Fund staff estimates and projections.

Fiscal year ending September 30.

Defined as tax and other revenue less expense.

Includes withdrawls from CTF and Funding for US Federal Programs (Post Office and Meteorological Service)

Includes unspent external loans.

1

Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.

2

At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country’s authorities. An explanation of any qualifiers used in summing up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.

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