Solomon Islands is a scattered archipelago with a land area of 28,000 square kilometers that stretches across 1,500 kilometers of the South Pacific Ocean. The six main islands, which range up to 200 kilometers in length and 50 kilometers in width, account for 80 percent of the total area. Most of the islands are characterized by precipitous mountain ranges covered with dense tropical forest and intersected by deep and narrow valleys. Rivers are generally narrow and unnavigable, and the coasts are surrounded by extensive coral reefs and lagoons. Rainfall is heavy, and cyclones periodically cause considerable damage to settlements and crops.

Solomon Islands is a scattered archipelago with a land area of 28,000 square kilometers that stretches across 1,500 kilometers of the South Pacific Ocean. The six main islands, which range up to 200 kilometers in length and 50 kilometers in width, account for 80 percent of the total area. Most of the islands are characterized by precipitous mountain ranges covered with dense tropical forest and intersected by deep and narrow valleys. Rivers are generally narrow and unnavigable, and the coasts are surrounded by extensive coral reefs and lagoons. Rainfall is heavy, and cyclones periodically cause considerable damage to settlements and crops.

The population of 300,000 is increasing by more than 3 percent per year, one of the fastest rates in the region. About 93 percent of the residents are Melanesian and most of the remainder are other Pacific islanders. Nearly all live in small and widely dispersed rural settlements along the coasts; the national capital, Honiara, accounts for about 10 percent of the total population and is the only urban center. Since a large proportion of the country is too rugged to support more than a small population, the overall density is relatively low. Although the area suitable for mechanized agriculture is limited, the shortage of arable land is not a serious problem. Village life, the extended family system, and the custom of sharing income among relatives exercise a pervasive influence on economic activity. While there are several large agricultural plantations jointly owned by the Government and foreign investors, 87 percent of land is communally owned. Investment in agriculture is impeded by the land tenure system and unresolved claims over land.

Solomon Islands, which had been a British protectorate since 1893, became independent in 1978. A unicameral legislative assembly is popularly elected every four years. From among its 38 members, a Prime Minister is chosen who, in turn, appoints a Cabinet; the British sovereign is the Head of State. In the absence of strong party allegiances, the governments since independence have been essentially coalitions. Political consensus has been difficult to achieve and sustain, and this has hampered the cohesive and timely implementation of economic policies, including the ability to carry out longer-term planning and project formulation. Moreover, the authorities have begun devolving power to the provinces, a process that is proving to be slow and expensive.

Annual per capita GDP, which was SDR 380 in 1987, has grown more rapidly than in other Pacific island countries over the past two decades, albeit from a low base. Economic performance was highly favorable in the 1970s, when a large and diversified export sector grew with the assistance of considerable private investment. Experience was more in line with the regional norm during the 1980s, when economic policy was primarily focused on adjustment to a less favorable external environment. Although the expansion of the export sector lost momentum, balance of payments financing difficulties were generally avoided.

Economic Structure

Production and Prices

Primary production accounts for about 70 percent of GDP, including large-scale joint ventures with foreign enterprises for export-oriented production of copra, timber, fish, palm oil, and cocoa. Copra is the major source of income for smallholders. Producer prices of copra are set by the Commodity Export Marketing Board to mitigate the effects of fluctuations in export prices on growers’ income and ensure the maintenance of production incentives, as well as the financial viability of the support operations. Industry is based on the processing of primary commodities, including a fish cannery and sawmills, but represents only 5 percent of GDP. Major elements of the services sector are the government administration; marine transportation, which is a vital communications link throughout the country; and the trading sector.

The economy is highly open and prices, which are essentially market determined, are strongly influenced by the cost of imported goods. Wages in the formal sector are determined through collective bargaining, generally on the basis of annual negotiations; disputes are subject to arbitration. Relatively large wage settlements in the public and private sectors reflect the scarcity of skilled labor and effective trade union representation. Wage awards generally have compensated for price increases associated with higher import prices, despite the loss of national income that occurs when the terms of trade deteriorate. There are indications that wage rigidities impeded adjustment and the creation of employment opportunities. Recently, government policy has encouraged agreements that limit general wage increases to a maximum of two thirds of the increase in consumer prices, but some groups have obtained considerably larger increases.

Balance of Payments

The foreign trade account is in approximate balance. Exports are equivalent to about 55 percent of GDP on average, the highest ratio among Pacific island countries, and are about the same magnitude as imports. Unprocessed primary products still represent a high proportion of exports. Among the main categories of imports, food and beverages represent only 20 percent of the total, reflecting plentiful local food supplies. The share of finished consumer goods is also relatively modest. By contrast, machinery and transport equipment, financed mainly with external aid, account for one third of the total, and petroleum products for about one fourth. The direction of the country’s trade has shifted since independence away from the traditional links with the United Kingdom and Australia and toward Japan and other Asian regional markets.

There is a net deficit on services and transfers. The deficit on services is equivalent to about 25 percent of GDP. Services receipts are modest; tourist potential, in particular, remains to be exploited. Payments for services include freight, which represents about one fifth of the cost of imports; charter payments associated with the fishing industry; and dividends to foreign partners in joint ventures. Private transfers are small; inward remittances are limited primarily to church donations. Most concessional aid is received in the form of grants, which are equivalent to about 15 percent of GDP. Since the mid-1970s, aid dependence on the United Kingdom has been reduced and major donors now include Australia, Japan, New Zealand, and the European Community. In 1986 and 1987, Solomon Islands received substantial disbursements of grants from the Community, averaging about 8 percent of GDP, in connection with a shortfall in commodity export earnings.

The overall balance of payments normally registers a surplus. External commercial loans are mainly limited to private sector borrowing for export-oriented agricultural projects and a line of credit that the Government may draw on to ensure that gross reserves remain adequate. Although external debt is over 70 percent of GDP, it contains a large concessional element in the form of loans from multilateral financial institutions and the debt service ratio remains below 10 percent of current receipts. Gross official international reserves are normally equivalent to 5–6 months of imports of goods. The exchange rate is determined in relation to a basket of the currencies of Solomon Islands’ four main trading partners and managed flexibly with adjustments geared primarily to underlying trends in export profitability. The Central Bank is authorized to change the rate by up to 2 percent per month with respect to the basket; larger variations need government approval.

Public Sector

The public sector consists of the central government, 8 provincial governments, and 17 public enterprises. There are no consolidated public sector accounts. Provincial activities, including public works, education, health, and economic services, are financed mainly through transfers from the central government, reflecting the commitment to the constitutional mandate for devolution. The tax on wages and salaries, business license fees, rents from public housing, and charges for public services are the main provincial sources of revenue, which finance about one third of local current expenditure. The public enterprises provide basic social and economic services, including electricity generation, telecommunication services, port services, and housing. Their investment programs are financed primarily from budgetary transfers.

The central government budget is prepared on a calendar year basis. The revenue estimates tend to be based on conservative assumptions about the outlook for the domestic economy and external transactions. Current expenditure projections in recent years have made only modest allowance for wage and other cost increases. Expenditure overruns and programs adopted outside the regular budget cycle have sometimes required the submission of supplementary budgets. On the other hand, appropriations in the capital budget have usually been in excess of the amounts actually utilized. Noncash development grants, which are excluded from the budget, are difficult to monitor.

Domestic budgetary revenue was equivalent to about 23 percent of GDP during 1981–87. The main sources of revenue are import and export duties, which account for more than half of the total, and income taxes on corporations and individuals. Indirect taxes are small, and nontax revenue is limited to property income, central bank profits, and fees and charges. External cash grants recorded in the budget averaged about 5 percent of GDP. Cash budgetary support from the United Kingdom, which financed about half of current expenditure in the 1970s, was terminated in 1980 in accordance with the agreement negotiated at independence. Grant receipts were sharply higher in 1986–87 owing to the large inflow of STABEX funds.

Total budgetary expenditure was equivalent to about 35 percent of GDP during 1981–87, with current expenditure of about 25 percent of GDP. Development expenditure, which averaged about 10 percent of GDP while fluctuating considerably from year to year, was directed toward the improvement of infrastructure, the exploitation of natural resources, and the expansion of education and health services. External loans, chiefly on concessional terms, financed about three fourths of the overall budget deficits, which averaged 7 percent of GDP. Nonbank domestic sources met most of the remaining financing needs.

Financial Sector

The banking system comprises the Central Bank of Solomon Islands, which was established in 1983, and four commercial banks. The Central Bank succeeded the Solomon Islands Monetary Authority (SIMA), which had been created in 1976 as an initial step in establishing a national monetary policy. The SIMA enjoyed most central banking powers, including the sole right of currency issue, control and supervision of banks and other financial institutions, and management of the government accounts and foreign exchange reserves. The policy instruments available to the monetary authority to influence credit developments included reserve and liquidity requirements, limits on its own lending to commercial banks, and the ability to influence the switching of the deposits of various public institutions from the commercial banks. The Solomon Islands dollar was introduced in October 1977 to replace the Australian currency, which had traditionally circulated as domestic currency and was withdrawn during a one-year conversion period. The four commercial banks, which are all branches or subsidiaries of foreign banks, are the principal institutions for mobilizing financial savings. In order to encourage the spread of banking facilities to the rural population and to promote domestic lending, the Government in 1980 acquired a 49 percent share holding in one of the existing banks.

There are three other financial institutions. The National Provident Fund, which was created in 1976, mobilizes compulsory savings and provides social security benefits for all persons in paid employment. Rates of contribution are 5 percent of earnings for employees and 7.5 percent of earnings for employers; most of its surpluses are invested in government securities. The Government Shareholding Agency, which was established in 1977, acquires equity in major commercial undertakings, including plantations, fishing, sea and air transport, and hotels, using resources that come primarily from the budget. The agency was converted into the Investment Corporation of the Solomon Islands in 1988, with broader powers to borrow in domestic and external capital markets. The Development Bank, which opened in 1978, promotes economic development and concentrates its lending in rural areas, processing, and industrial activities.

Developments in the 1970s

Economic performance in the 1970s was impressive. Real GDP increased by 7–8 percent annually, reflecting the expansion of export production and high public and private investment. Growth was achieved with reasonable price stability. At the beginning of the decade, timber emerged as an important export, and fishing was transformed from a subsistence occupation to a major commercial activity following the establishment of a joint venture between a Japanese company and the Government. During the second half of the decade, the palm oil industry was established as another joint venture and grew rapidly. Large-scale rice production was also undertaken with the assistance of foreign capital and technology in order to replace imports. However, the venture was eventually abandoned owing to insufficient profitability.

The strong expansion of exports and sustained nonmonetary capital inflows, mostly on account of foreign direct investment, permitted vigorous growth in imports, and also contributed to persistent overall balance of payments surpluses. The foreign trade balance improved and the larger net deficit on services, reflecting rising freight and dividends, was more than offset by higher official grants. The external current account recorded surpluses averaging 6 percent of GDP during 1976–79. Gross official reserves rose steadily, which was welcomed by the authorities as a contributory factor to postindependence confidence and as a safeguard against the economy’s vulnerability to fluctuations in export earnings and external aid. Reflecting the strength of the external position and hoping to mitigate the effects of rising import costs on domestic prices, the Government appreciated the exchange rate by 5 percent against the Australian dollar in early 1979, breaking the fixed parity that had existed since the introduction of domestic currency.

The central government budget remained in approximate balance during the latter part of the decade. Revenue from export and import duties was buoyant because of the expansion of international trade, and income tax receipts also rose sharply. Prior to independence, the United Kingdom helped to finance a substantial rise in current expenditure, including the high administrative costs associated with the country’s political evolution. After independence, external grants grew strongly, as a wide range of donors helped to finance an expansion of public investment. Solomon Islands emphasized the need to ease the development constraints arising from the difficult terrain, seeking to improve roads and interisland shipping and communications. The Government also played a key role in inducing and coordinating major investments in the private sector, especially through equity participation.

After independence, monetary policy was guided primarily by the concern to prevent monetary conditions from restraining growth, while preserving financial stability. The external surplus was the principal factor allowing annual additions to the domestic money stock. This source injected considerable liquidity, particularly during the second half of the decade. The Government took few steps to use instruments of credit control that could moderate this expansionary influence; reserve requirements were not introduced when the central monetary authority acquired the foreign assets of the commercial banks in 1978. The local currency received by the banks in return for these funds added greatly to their liquidity. However, in view of the Government’s small financing needs and limited private sector demand, the authorities considered it unlikely that external pressures would emerge if bank lending decisions were allowed to determine the pace of domestic credit expansion.

Developments in the 1980s

Solomon Islands achieved only modest output growth during 1980–87, despite the continued development of marine and forestry resources and a rising investment rate. Less favorable world economic conditions had a greater impact on Solomon Islands than other Pacific island countries, because of the size of its export sector and the damage to tree crops caused by a severe cyclone in 1986. The rate of real GDP growth averaged only about 2 percent during 1980–87, and real national income fell after adjustment for the decline in the terms of trade. In response to the deterioration in the balance of payments, the Government adjusted financial and structural policies to mobilize public sector resources, contain private sector credit demand, limit imports, and increase the profitability of the export sector. The programs were supported by two stand-by arrangements with the Fund in the early 1980s. Financial stability was restored in 1983–84. Although subsequent shocks, including low export prices and the cyclone, hampered efforts to strengthen economic growth, an upsurge in external grants provided temporary relief to the balance of payments and the budget in 1986–87.

External Imbalances During 1980–83

During 1980–81, the terms of trade declined sharply and the external current account deficit reached 18 percent of GDP. Export prices of copra, timber, and palm oil fell dramatically, and the increase in petroleum prices further worsened the trade balance. The deficit on services rose because of higher freight payments, and external grants fell following the agreed-upon reduction in British financial assistance after independence. In addition, uncertainty about economic growth and external stability triggered a surge in private capital outflows. External borrowing and a drawdown in official reserves financed the overall balance of payments deficit.

Central government finances deteriorated because of adverse external developments, including lower grants, and strong public pressure for increased expenditure, which followed the transfer of functions from the colonial to national authorities. The overall budget deficit widened to 7 percent of GDP in 1981. To accommodate the borrowing needs of the Government, initial issues were made of five-year development bonds and treasury bills that were taken up by the commercial banks and the National Provident Fund. Following a pronounced growth in domestic credit, reserve requirements were imposed on commercial banks for the first time in 1981 at 5 percent of deposit liabilities.

The Government felt that additional measures were needed to strengthen the external position. An economic program was developed in 1981 that aimed at expanding exports, restraining less essential imports, mobilizing public sector domestic resources, and sustaining investment in order to restore growth with external stability. The measures included action to increase government revenue, including a 20 percent rise in non-oil import duties; efforts to contain current expenditure, including wages and salaries; the use of external commercial borrowing to expand investment; and a currency depreciation of 6 percent.

The circumstances and adjustments that were necessary to secure the required improvement in the external accounts and to restore public confidence in the economy were not forthcoming. A modest recovery in export production failed to offset the decline in export prices. The value of the Solomon Islands dollar did not depreciate because of the rise in domestic inflation. Strong growth in current expenditure reflected pressures for an increased range of services after independence and increased wages. Despite substantial cuts in public investment that were made in order to limit the budget deficit, government credit from the domestic banking system rose rapidly.

In the face of a continued fall in the terms of trade, the value of the Solomon Islands dollar was depreciated further by 10 percent on a trade-weighted basis in mid-1982. To strengthen the fiscal position, the Government increased import duties and improved tax administration. While capital outflows were halted and the overall balance of payments reverted to surplus, the external current account recorded a deficit of 7 percent of GDP in 1982. The fiscal position did not improve because lower economic activity held down revenue, and inadequate expenditure controls thwarted attempts to contain current spending. The overall budget deficit was held at 7 percent of GDP only because of limited investment capacity, despite the plentiful availability of external concessional assistance.

Although the fiscal and external positions were weak, Solomon Islands redirected policies in early 1983 to promote economic recovery through private investment in the export sector, supported by increased public expenditure on infrastructure. It introduced measures for public resource mobilization and current expenditure restraint, and raised bank deposit rates to encourage private savings. The Government introduced a liquid assets requirement of 15 percent of deposit liabilities to replace the 5 percent reserve requirement. The value of the Solomon Islands dollar was further depreciated on a trade-weighted basis to help shift resources toward the traded goods sector.

Export Recovery in Late 1983 and 1984

External economic conditions turned strongly and unexpectedly in favor of Solomon Islands after mid-1983. International prices of copra and palm oil began to rise because of shortfalls in other producing countries, and warm ocean temperatures led to an increase in the fish catch. With expansionary financial policies, imports rose considerably and the current account deficit was 9 percent of GDP in 1983. However, the Government achieved the objectives of reduced inflation and renewed real economic growth. In this situation, the further rise in the overall budget deficit to 8 percent of GDP was permitted, although its financing required considerable recourse to the domestic banking system.

The balance of payments strengthened as a result of the one-third improvement in the terms of trade during 1984, mainly because of the continued rise in export prices. With higher export volume, the trade balance became positive. Despite an increased deficit on services owing to higher profit remittances, the external current account recorded a surplus of 3 percent of GDP. The stronger external position enabled commercial debt to be reduced, while official international reserves increased. The depreciation of the Solomon Islands dollar was discontinued.

The overall budget deficit fell markedly to 3 percent of GDP in 1984, principally because of cutbacks in current expenditure. Monetary policy continued to be guided by the traditional aim of avoiding constraints on real growth. Consequently, little attempt was made to offset the strong monetary growth that emanated from the higher export earnings. Although government borrowing was small, private sector demand led to rapid domestic credit expansion. Given the acceleration in the rate of inflation, the Government adopted a more restrictive monetary stance from late 1984. To tighten commercial bank liquidity, the copra board was required to transfer resources from the commercial banks to the Central Bank and a rise in the liquid assets ratio to 25 percent of deposit liabilities was announced. However, while nominal bank interest rates increased during the year, most deposit rates and some lending rates became negative in real terms.

Domestic Financial Strains in 1985–87

The rate of growth of real GDP slowed in 1985 and became negative in 1986 mainly as a result of adverse developments in the export sector. In 1985, export prices fell steeply, with the increase in world supply of vegetable oils contributing to a one-third decline in the terms of trade. Imports remained high because of strong domestic demand. The external current account deficit rose to 12 percent of GDP, and the overall balance of payments moved into deficit. In mid-1986, a cyclone caused heavy loss of life and extensive damage to export crops of copra, palm oil, and cocoa, as well as to economic and social infrastructure. Imports declined, despite the boost from reconstruction needs, because of lower incomes and reduced petroleum prices. Additional aid was received, including the early disbursements of large compensatory grants for export shortfalls from the European Community. The external current account deficit was reduced to 9 percent of GDP, and the overall balance of payments reverted to surplus.

Real GDP and exports fell again in 1987 because of the continued depressive effect of the cyclone and temporary factors that curtailed fish and timber exports. Following the earlier downturn in export prices, exchange rate flexibility had been reintroduced. The depreciation of the Solomon Islands dollar on a trade-weighted basis, by about 30 percent in real effective terms between mid-1985 and end-1987, helped to contain the deterioration in the external position and mitigate the impact on export profitability of low commodity prices. The continued high level of grants, including additional receipts from the European Community equivalent to almost one fifth of exports of goods and services, cushioned the balance of payments. The external current account deficit was reduced to 3 percent of GDP and, with external commercial borrowing to help finance investment, the overall balance of payments remained in surplus.

Despite the rise in external grants, fiscal imbalances increased during 1985–87. The overall budget deficit widened to 9 percent of GDP in 1985, when there was a pronounced rise in current expenditure, because of wage increases, transfers to local government to promote decentralization, and subsidies to public enterprises. The deficit remained high in 1986. Although revenue increased as a result of higher rates of import duties, the fall in export incomes depressed collections of income tax. The Government provided relief to the fishing industry in the form of lower export taxes and reduced rates of import duties on imported fuel and other materials. Capital expenditure rose by three fourths as a result of spending on fishing vessels, road building, airport expansion, and cyclone reconstruction. The budget deficit increased again to 12 percent of GDP in 1987, despite considerable revenue growth and a further rise in external grants. Wage payments and transfers to public enterprises exceeded budget estimates. Capital expenditure, partly financed from abroad, continued to surge largely because of investments in fishing vessels and a cannery.

The main aim of monetary policy was to reduce the pressure on domestic prices and the underlying balance of payments, while providing adequate credit for development. With the large decline in net foreign assets, the rate of growth of broad money was small in 1985. However, the growth of domestic credit was high because of the Government’s financing needs and private sector demand. In 1986, the availability of external finance enabled the Government to repay domestic bank borrowing and limit the increase in domestic credit; the rate of growth of broad money remained moderate. In 1987, the growth of broad money accelerated because of the rise in net foreign assets stemming from the grant inflows. While the Government continued to repay the banking system, private sector credit demand strengthened. In view of the acceleration in inflation, the liquidity ratio was increased to 27.5 percent of deposit liabilities and the Central Bank closed the facility through which banks had automatic access to central bank funding. Tighter monetary conditions were designed to help strengthen the balance of payments, when external grants declined from the unusually high levels of 1986–87.

Table 1.

Solomon Islands: Gross Domestic Product by Sectoral Origin, 1980–87

(In millions of Solomon Island dollars at 1984 prices)

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Sources: Data provided by the Solomon Islands authorities; and Fund staff estimates.
Table 2.

Solomon Islands: Output of Main Commodities, 1975–87

(In thousands of metric tons)

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Source: Data provided by the Solomon Islands authorities.

In thousands of cubic meters.

Table 3.

Solomon Islands: Consumer Price Index, 1980–87

(Annual average percentage change)

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Source: Data provided by the Solomon Islands authorities.

Honiara retail price index, fourth quarter 1984 = 100. Data for 1980–84 are based on the index, fourth quarter 1977 = 100.

Table 4.

Solomon Islands: Central Government Budget, 1975–87

(In millions of Solomon Islands dollars)

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Sources: Data provided by the Solomon Islands authorities; and Fund staff estimates.
Table 5.

Solomon Islands: Central Government Revenue, 1980–87

(In millions of Solomon Islands dollars)

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Source: Data provided by the Solomon Islands authorities.

Including stamp duties.

Including receipts from the levy on log exports earmarked for reforestation.

Including surpluses of departmental enterprises and financial public enterprises.

Table 6.

Solomon Islands: Central Government Expenditure by Economic Classification, 1980–87

(In millions of Solomon Islands dollars)

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Source: Data provided by the Solomon Islands authorities.
Table 7.

Solomon Islands: Monetary Survey, 1980–87

(In millions of Solomon Islands dollars; end of period)

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Source: Data provided by the Solomon Islands authorities.

Including nonfinancial public enterprises.

Table 8.

Solomon Islands: Interest Rate Structure, 1980–87

(In percent per annum; end of period)

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Source: Data provided by the Solomon Islands authorities.
Table 9.

Solomon Islands: Balance of Payments, 1975–87

(In millions of SDRs)

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Sources: Data provided by the Solomon Islands authorities; and Fund staff estimates.
Table 10.

Solomon Islands: Exports by Commodity; 1975–87

(Value in millions of SDRs, volume in thousands of metric tons, unit value in SDRs per metric ton)

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Source: Data provided by the Solomon Islands authorities.

In thousands of cubic meters.

In SDRs per cubic meters.

Table 11.

Solomon Islands: Imports by Commodity Group, 1975–87

(In millions of SDRs)

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Source: Data provided by the Solomon Islands authorities.
Table 12.

Solomon Islands: External Debt and Debt Service, 1980–87

(In millions of SDRs)

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Sources: Data provided by the Solomon Islands authorities; and Fund staff estimates.

Excluding repayments associated with a conversion of private debt to equity (SDR 2.7 million).

Table 13.

Solomon Islands: International Reserves, 1980–87

(In millions of SDRs; end of period)

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Source: Data provided by the Solomon Islands authorities.

Comprises only deposits with the Crown Agents.

Excludes nonresident deposits and capital account of head offices abroad.