A. Aggregate Supply and Demand²

The Vanuatu economy has experienced modest growth in recent years, averaging about 3 percent between 1991 and 1995. In 1994, the growth in real GDP slowed to 2.6 percent, as agricultural production was adversely affected by a severe drought and demand was reduced owing to a prolonged civil service strike. In addition, tourism stagnated in the first half of the year although it increased in the second half, in line with the economic recovery of the region.

In 1995, GDP growth picked up to an estimated 3.2 percent, led by a strong performance in the agricultural, tourism and construction sectors (Table 1). The agricultural sector, which accounts for about 23 percent of GDP, grew by 6.4 percent, reflecting increased production in copra and cocoa. Copra--the main agricultural product--continued to increase as trees recovered from the cyclones of 1992. Overall, the service sector--which accounts for some 63 percent of GDP--experienced only 1.4 percent growth in 1995 owing to weak private consumption, although tourism continued to do well with 4.5 percent growth. Industry expanded by 6.4 percent, as a large number of construction approvals from 1994 were carried over into 1995.

On the demand side, private consumption (as a percent of GDP) declined in 1995 compared with the previous year, due to the introduction of a 4 percent turnover tax and increases in the cost of public transportation (Table 3). Government consumption remained mostly unchanged. Meanwhile, gross capital formation rose in line with the high construction activity which was more than covered by the increase in national savings. Reflecting these developments, the deficit on the net exports of goods and services narrowed in 1995.

B. Sectoral Developments

Agricultural production increased by 6.4 percent in 1995, due to higher copra and cocoa output. Aided by favorable weather conditions, copra production increased by approximately 13 percent (Table 5). The procurement price for copra remained at VT 25,000 for the higher quality (hot-air dried) variety and VT 20,000 for the lower quality (smoked) variety; over the past few years, this price differential has induced a shift toward production of the higher quality copra, which now accounts for about 86 percent of total production. Cocoa production recovered in 1995 from the drought stricken poor harvest in the previous year.

Beef production declined in 1995, mainly due to depressed prices in Japan, the largest export market for beef. However, production is expected to rebound as the Melanesian Spearhead Group (MSG) agreement (see section VI.B) has opened the markets of the Solomon Islands and Papua New Guinea to Vanuatu-produced beef. Commercial ventures in hog and poultry production are few: commercial pig production is concentrated on Efate Island and there are two poultry producers in Port Vila. A joint venture between Vanuatu and New Zealand has been established to develop the deep water commercial fishing industry. The production of logs declined in 1995 as a result of the log export ban introduced in 1994; however, exports of log products such as sawn timber and plywood have increased.

The industrial sector in Vanuatu is small and inward-oriented, accounting for only about 13 percent of GDP. Growth in industrial production fell from 7.3 percent in 1994 to 6.4 percent in 1995, due to weak domestic demand in the second half of 1995. The construction sector exhibited a strong performance (although building approvals were down from the previous year) as a large number of construction approvals were carried over from 1994 into 1995. Two major projects that came on stream in 1995 were the construction of the University of the South Pacific Law School and the hydro-dam project in Luganville.

Tourism is a major contributor to the service sector in Vanuatu. Tourism grew by 4.5 percent in 1995, with the number of tourists reaching 31,217, the bulk of them from Australia, New Zealand and New Caledonia (Table 9). The average length of stay of visitors remained at about 9 days. While tourism continued to be buoyant, the growth in domestic trade remained weak in 1995; two branches of a major wholesale company closed, leaving the service sector with an overall growth rate of 1.4 percent in 1995. Transport and communication picked up following the deregulation of the licensing procedures in the taxi and bus market. Looking ahead, the Government is giving special attention to the tourism sector as a potential growth area and has outlined a tourism master plan toward this end.

A. Prices

Inflation slowed from 2.7 percent in 1994 to 1.7 percent in 1995, broadly in line with Vanuatu’s major trading partners (Table 10). Despite an increase in the turnover tax, inflation declined in 1995 due to a significant reduction in import tariffs and a sharp decrease in rents. A housing loan scheme introduced by the National Provident Fund boosted new housing construction activity, which together with the sale of government houses softened the rental market in 1995; vacancy rates in housing for middle and high income groups went up.

The 4 percent turnover tax on wholesalers and retailers introduced in January 1995 contributed to inflation as many businesses took the opportunity to raise their prices well in excess of the tax and the taxes had a cascading effect on prices--the prices of some goods, such as clothing and footwear, rose by more than 10 percent. However, the pressure that resulted from the turnover tax was mitigated by reductions in import duties on essential foodstuffs in April 1995--imported goods account for about one-half of Vanuatu’s CPI basket. The impact on inflation of the minimum wage increases introduced in 1995 was not very significant since the unskilled wage levels for the public sector and the urban private sector were already above the new minimum level (see below).

B. Wages and Employment

Minimum wages were increased in 1995 to a unified level of VT 16,000 for urban and rural workers alike, in line with recommendations made earlier by the Minimum Wage Board. Prior to that, the minimum wage was VT 13,200 in urban areas and VT 11,400 in rural areas. These changes do not appear to have had a significant impact on wages and employment overall since average salaries are around VT 120,000 for skilled labor and VT 26,000 for unskilled labor in the public sector, and around VT 200,000 for skilled labor and VT 34,000 for unskilled labor in the private sector.³ However, the increase in minimum wages is likely to have had an adverse impact on rural small businesses.

The economically active population is estimated at some 80,000 or 50 percent of ni-Vanuatu population, the bulk of whom are engaged in subsistence agriculture. The formal economy is dominated by services, including government, tourism and an offshore finance center. There has been a slow but steady growth in employment in the formal sector, the total number of paid employees registered with the Vanuatu National Provident Fund (VNPF) at the end of 1995 was about 34,000 compared with some 28,000 in 1993, and the number of employers grew from some 2,700 to 3,400 over the same period (Table 16).

A. Fiscal Developments

The fiscal situation improved in 1995, with the overall budget deficit declining to an estimated 1 ½ percent of GDP from about 3 percent of GDP in 1994 mainly due to lower capital expenditure (Chart 2). At the same time, extra revenues from several one-off receipts were used to finance supplementary expenditures of some VT 600 million over the original budget (Table 11).

VANUATU: Fiscal Indicators, 1991-95

(In percent of GDP)

Citation: IMF Staff Country Reports 1996, 075; 10.5089/9781451840469.002.A001

Source: Data provided by the Vanuatu authorities.1/ Development expenditure plus net lending.

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VANUATU: Fiscal Indicators, 1991-95

(In percent of GDP)

Citation: IMF Staff Country Reports 1996, 075; 10.5089/9781451840469.002.A001

Source: Data provided by the Vanuatu authorities.1/ Development expenditure plus net lending.

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VANUATU: Fiscal Indicators, 1991-95

(In percent of GDP)

Citation: IMF Staff Country Reports 1996, 075; 10.5089/9781451840469.002.A001

Source: Data provided by the Vanuatu authorities.1/ Development expenditure plus net lending.

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Two major offsetting tax developments in 1995 were the introduction of a 4 percent turnover tax on wholesalers and retailers in January ⁵ and substantial import duty reductions in April. The new turnover tax yielded an estimated VT 303 million, boosting total tax revenues by over 1 percent of GDP. (The revenue from this tax was not incorporated into the 1995 budget.) However, this was offset by a drop in tariff revenue of almost VT 400 million relative to the budget. Import duty rates were slashed for a wide range of items, including: foodstuffs such as dairy products,⁶ sugar, salt, yeasts, and tea (from 30-45 percent to 20 percent), chemicals (from 17-25 percent to 10 percent), metals (from 12-25 percent to 10-20 percent), and machinery (from 25 percent to 10 percent.) Duty rates were eliminated completely for items such as cereals and flour (previously taxed at 15-25 percent), and coal and petroleum products (previously taxed at 17 percent).⁷

Nontax revenues benefitted from several one-off receipts, including VT 200 million from the Government’s sale of its 20 percent share in Banque d’Hawaii and VT 50 million from the sale of government houses, as well as higher-than-anticipated Reserve Bank profits. The flow of foreign aid continued in 1995, with cash grants, aid in kind, and foreign technical assistance amounting to about VT 3½ billion, over 13 percent of GDP.

Wages and salaries continued to constitute the largest share of expenditure--55 percent of current expenditure, excluding technical assistance payments-and remained the foremost area of concern. Ironically, public sector employment increased following the civil service strike of 1994--although some 600 striking workers were dismissed or terminated, a larger number was hired to replace them. The share of transfers and subsidies also increased, from 12 percent of total current expenditure in 1994 to 14 percent in 1995. As required by the Decentralization Act of 1994, 5 percent of central government revenue (totaling VT 256 million) was transferred to the six provincial governments in the form of administration and equipment grants. This represented a substantial increase over the annual VT 30-50 million previously allocated to the 11 local councils, especially in view of the fact that there were no corresponding transfers of expenditure.

In functional terms, the largest expenditure allocations were to the education sector (almost 20 percent of total current expenditure) and general public services (over 32 percent of total current expenditures), the latter bong where most of the two supplementary budgetary appropriations were spent. As for development expenditures, major projects in 1995 included the construction of the University of the South Pacific Law School in Port Vila, funded by an interest-free loan from the Chinese Government, the hydro-dam project in Luganville, and a primary schools rehabilitation program. The upgrading of the airports, originally scheduled to begin in 1995, however, was delayed to 1996.

B. The 1996 Budget

The annual budget framework in Vanuatu involves only a recurrent budget and does not encompass a development budget. The authorities, as in the past, adopted a balanced recurrent budget for 1996. The overall fiscal deficit however is estimated to widen to about 2 percent of GDP in 1996 owing to an increase in development expenditures related to an upgrading of the airports.

The budget (recurrent) calls for VT 6.8 billion in expenditures, a 14½ percent increase over the previous budget (but only about 4½ percent more than actual spending in 1995).⁸ It highlights expenditure on infrastructure maintenance, funded by savings from the public sector wage bill and increases in selected import tariffs. A major effort is being made to keep the public sector wage bill under control in 1996, following the overspending in 1995. The latest budget calls for a 10 percent cut in expenditure on wages and salaries relative to the budgeted 1995 level (excluding the supplementary appropriations), implying no increase in the wage bill compared with the outturn in 1995. This is to be achieved through a rationalization of the civil service to reduce the large number of daily-rated workers taken on in the aftermath of the strike, combined with an across-the-board wage and hiring freeze.

The projected savings from the wage bill are targeted to be spent mainly on much-needed repair and maintenance of the country’s existing infrastructure. Hence the Department of Public Works has received a much larger allocation than in previous years (about 75 percent above the 1995 budget). The education and health sectors have also been given increased allocations of 7 percent each over the 1995 budget. By contrast, the provincial governments will receive slightly less than the statutory 5 percent of total revenues as the 1995 revenues were especially high, artificially boosted by several one-off receipts.

On the revenue side, the 1996 budget incorporates three main measures: an increase in the duty rate imposed on selected goods, such as tobacco products (from VT 2,074-9,074 per kilogram to VT 2,264-9,321 per kilogram), motor fuels (from VT 15-30 per liter to VT 30-35 per liter), and biscuits (from 20 percent to 65 percent); an increase in the service tax on most items from 5 percent to 7 percent (or 9 percent in the case of motor vehicles, and 10 percent for rice and wheat); and an increase in the gaming duty from 10 percent to 15 percent. Aside from the rate increases, improved collection measures are also expected to contribute to higher customs revenues in 1996.

On development expenditures, given the emphasis on tourism as a potential high-growth sector, airport upgrading has become a high priority. Three airport projects are planned (to begin in 1996): the replacement of the Lenakel strip at Tanna airport; the resurfacing of the runway at Pekoa airport on Santo to accommodate the landing of Boeing 737 aircraft; and the upgrading of facilities at Bauerfield airport in Port Vila to handle Boeing 767 traffic. As far as possible, commercial borrowing will be eschewed: the Tanna project, estimated at VT 380 million, will be financed by a grant from the Caisse Française de Développement; the Santo project, estimated at A$7 million, will be financed through a combination of French and Australian grants and concessionary loans; and the Port Vila project, estimated at VT 750 million, will be financed by a concessionary loan from the European Investment Bank.

C. The Vanuatu Commodities Marketing Board (VCMB)

Despite high international copra prices of more than US$400 per ton and domestic procurement prices that have remained unchanged since 1992 (at VT 20,000 per ton for the smoked variety and VT 25,000 per ton for the hot-air dried variety), the VCMB’s operating balance remained negative, although its gross operating deficit decreased from VT 143.7 million in 1994 to VT 21.8 million in 1995 (Table 15). No government subsidies were paid to the VCMB in 1995. A government loan of VT 133.8 million drawn from a partial release of funds from the 1988-91 Stabex allocation reduced the net overall operating deficit to VT 9.9 million in 1994. The remaining VT 40 million Stabex funds left in the 1988-91 allocation have been frozen pending the results of an audit into the VCMB’s financial operations. The audit is long overdue as the VCMB’s inability to break even under the current favorable conditions signals the need for a careful study of its operational costs.

A. Money and Credit

Developments in broad money are heavily influenced by changes in foreign currency deposits, which account for about two thirds of total broad money. Broad money expanded by 3 1/2 percent in 1994, and more sharply, by 11 percent in 1995, mainly owing to large increase in foreign currency deposits (Chart 3 and Table 18). The latter declined by 4 percent in 1994, but increased by 18 percent in 1995, reflecting substantial private capital inflows and a shift back into foreign currency deposits from vatu deposits. ¹⁰ Vatu broad money increased by 17 percent in 1994, and only by 1 1/2 percent in 1995; abstracting from the shifts between foreign currency and vatu deposits in the last two years, vatu broad money increased at an annualized rate of about 9 percent during 1994-1995, roughly similar to the increase in 1993.

VANUATU: Monetary Indicators, 1991-95

Monetary Developments

(Percent change)

Citation: IMF Staff Country Reports 1996, 075; 10.5089/9781451840469.002.A001

Source: Data provided by the Vanuatu authorities.

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VANUATU: Monetary Indicators, 1991-95

Monetary Developments

(Percent change)

Citation: IMF Staff Country Reports 1996, 075; 10.5089/9781451840469.002.A001

Source: Data provided by the Vanuatu authorities.

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VANUATU: Monetary Indicators, 1991-95

Monetary Developments

(Percent change)

Citation: IMF Staff Country Reports 1996, 075; 10.5089/9781451840469.002.A001

Source: Data provided by the Vanuatu authorities.

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Changes in broad money were largely reflected in changes in net foreign assets held by the banking system. Net foreign assets of commercial banks rose by 16 percent in 1995, reflecting the substantial increase in foreign currency deposits. Practically all foreign currency deposits taken by commercial banks were placed abroad, and the foreign exchange positions of the banks were broadly in balance (Table 20); commercial banks take a small margin by offering lower interest rates on foreign currency deposits in view of Vanuatu’s advantage as a tax haven. Thus, the availability of domestic credit to the private sector was largely determined by the demand for vatu broad money and the fiscal position.

Net credit to the Government by the banking system rose by VT 295 million in 1994 and VT 368 million in 1995; the Government continued to draw down its deposits with the banking system to finance the overall fiscal deficit. Credit to the private sector rose by 7 1/2 percent in 1994 and 6 1/2 percent in 1995, broadly in line with nominal GDP growth during these years. Of this, credit to the construction sector increased substantially owing to buoyant construction activities, and credit for vehicles rose sharply, reflecting the liberalization of the licensing procedures for the taxi and bus market.

In spite of a drawdown of government deposits held with the RBV, reserve money declined by 6 1/2 percent in 1994 owing to a decline in the net foreign assets of the RBV (Table 17). In 1995, however, reserve money increased by 30 percent owing to an increase in net foreign assets and a continued drawdown of government deposits to finance the fiscal deficit.

B. Interest Rates

Interest rates in Vanuatu are market-determined. Although the RBV issued guidelines on bank lending rates in the mid-1980s, these guidelines have not been enforced in recent years. Interest rates on foreign currency deposits adjust to international rates, but vatu deposits rates have been generally sticky and slow to adjust to changes in international rates, notwithstanding the openness of the economy to capital flows. Residents are free to hold deposits in any currency; however, a minimum amount of US$5,000 is required to maintain foreign currency accounts. The demand for foreign currency deposits has been influenced by interest rate differentials and developments in exchange rates, as well as the domestic political situation.

Lending rates offered by commercial banks ranged between 8 and 17 percent in 1994 and between 10 1/2 and 17 percent in 1995. The weighted average lending rate has been relatively stable, fluctuating between 13 1/2 and 14 1/2 percent during 1991-95;¹¹ it showed a declining trend during 1995. The spread between domestic deposit and lending rates has fluctuated between 8 and 10 percentage points in recent years. It declined somewhat over the last two years, but it remained high at 8 1/2 percentage points at the end of 1995, reflecting the perceived riskiness of projects, high administrative costs, and high excess balances held by the banks. Although the spread is high by international standards, it is similar to the spreads observed in the neighboring Pacific Island economies.

A. Balance of Payments¹²

In 1995, the current account deficit narrowed to 4.1 percent of GDP, from 5.6 percent in 1994, reflecting a rise in export earnings and the steady growth in tourism receipts. After a substantial increase in 1994, exports continued to increase by 11 percent in U.S. dollar terms in 1995, mainly owing to substantial increases in copra export prices and volumes (Table 25). Squash exports also increased in unit value and volume terms in 1995. Exports of beef; which is now the second important export commodity, stagnated in 1995 owing to increased competition in the Japanese market from other countries such as Australia, the United States, and New Zealand.¹³ Timber exports, which had declined sharply in 1990 as a result of the ban on exports of uncut logs, rebounded beginning 1992 following the granting of exemptions from the export ban. However, after the reintroduction of the export ban in June 1994, log exports declined. The decline in the export of uncut logs has been partly offset by the increase in the exports of sawn wood and wood products. After increasing by 16 percent in 1994, imports for domestic consumption continued to increase by 8 percent in U.S. dollar terms in 1995, reflecting buoyant construction activities and continued steady growth in tourism. In particular, the growth of mineral fuel and basic manufactures imports was strong (Table 26).

The share of exports to the European Union increased to 37 percent in 1995 from 32 percent in 1994, reflecting an increase in copra exports. This share however has declined significantly in recent years, from about 50 percent in 1991, due to the diversification of agricultural products and export markets (Table 27). Japan, Vanuatu’s second largest market, has been the primary destination for exports of beef and squash. Australia continued to dominate the import market, accounting for 37 percent in 1994 and 1995. New Zealand, Japan, France, and Fiji together accounted for a similar share.

Vanuatu’s foreign exchange receipts are dominated by services, in particular tourism receipts and interest income, and official transfers. On the payments side of the services account, investment income of foreign companies, freight and insurance, and the value of expatriate services are major items. In 1995, the services account surplus increased, reflecting higher tourism receipts and interest income (Table 28). After declining in 1992 and 1993, official grants, including capital in cash and in kind and technical assistance, continued to increase in 1994 and 1995 (Table 29).

The long-term capital account surplus increased from US$27 million in 1993 to about US$32 million in 1994 and 1995. These increases largely reflected an increase in direct investment, mostly in the form of reinvested earnings. In 1995, there was a sharp increase in private capital inflows, which was matched by a big jump in the foreign assets of commercial banks. The overall balance of payments recorded a surplus of US$4.9 million in 1995, and gross official reserves increased to US$48.3 million (7 1/2 months of imports).

Although Vanuatu’s external public debt has increased over recent years, its external debt indicators have remained favorable. External debt increased from US$39.5 million in 1994 to US$43.9 million in 1995 (Table 31). The debt-GDP ratio was 18.6 percent in 1995, compared with 17.8 percent in 1994. However, most of external financing was concessional loans from the Asian Development Bank, the International Development Association, and bilateral donors. Therefore, the debt-service ratio remained very low (less than 1 percent) in recent years; in 1995 it amounted to 0.6 percent of exports of goods and nonfactor services.

B. Exchange and Trade System

The vatu has been pegged to an undisclosed basket of currencies since February 1988. The rate in terms of the U.S. dollar was VT 113.74 as of December 31, 1995. The weights assigned to the currencies in the basket have not been revised since 1988. Within the framework of a fixed exchange rate regime, the nominal and real effective exchange rates of the vatu have remained relatively stable in recent years (Chart 4). The nominal and real effective exchange rates of the vatu depreciated somewhat during 1995 reversing the appreciation that had taken place in the year before.

VANUATU: Exchange Rate Indices, 1991-95

(1988 = 100)

Citation: IMF Staff Country Reports 1996, 075; 10.5089/9781451840469.002.A001

Sources: Data provided by the Vanuatu authorities, IMF, Information Notice System; and IMF, International Financial Statistics.

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VANUATU: Exchange Rate Indices, 1991-95

(1988 = 100)

Citation: IMF Staff Country Reports 1996, 075; 10.5089/9781451840469.002.A001

Sources: Data provided by the Vanuatu authorities, IMF, Information Notice System; and IMF, International Financial Statistics.

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VANUATU: Exchange Rate Indices, 1991-95

(1988 = 100)

Citation: IMF Staff Country Reports 1996, 075; 10.5089/9781451840469.002.A001

Sources: Data provided by the Vanuatu authorities, IMF, Information Notice System; and IMF, International Financial Statistics.

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Vanuatu has accepted the obligations of Article VIII, Sections 2, 3, and 4 and maintains an exchange system free of restrictions on current and capital transactions. Import duties on a wide range of foodstuffs and essential items, as well as on alcohol and tobacco were reduced in 1995. The tariff cuts were substantial, ranging from 2 to 35 percent. Most exports are subject to export duties, which are currently 3 percent.

To promote regional trade and cooperation, the Melanesian Spearhead Group (MSG) --consisting of Papua New Guinea, Solomon Islands, and Vanuatu--entered into a trade agreement effective September 1994. The goods for duty-free trade under the agreement were beef from Vanuatu, canned tuna from Solomon Islands, and tea from Papua New Guinea. Toward the end of 1995, the following changes were made to the Agreement: (1) all goods listed for duty-free trade was allowed to originate from any of the MSG countries; and (2) the original list of products for duty-free trade was expanded to include the following items--coffee, yogurt, cheese and curd, wooden furniture, kava, jam, fruit jellies, portland cement, matches, fiberglass boats, toilet paper, iron or steel nails, and plastic shopping bags.

In May 1995, the Government of Vanuatu submitted a formal application to accede to the World Trade Organization (WTO) and a Working Party was established by the WTO to oversee Vanuatu’s membership process. The authorities are currently responding to clarifications sought by the Working Party on the memorandum on the foreign trade regime submitted by the Government in August 1995. Given that fiscal revenues in Vanuatu depend heavily on import duties and levies, the accession to the WTO could have a significant impact on future government revenues depending on Vanuatu’s efforts to restructure its tax system. In view of Vanuatu’s status as a less developed country, it has at least ten years to modify its current level of import duties to be consistent with the WTO rules. With respect to trade, Vanuatu’s main export commodities face very small or zero tariffs, and exports are not likely to be directly affected by the accession to the WTO. However, Vanuatu would need to strengthen its competitiveness and adjust to the more open global trade environment.