Palau
Recent Economic Developments
Author:
International Monetary Fund
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Publication Date:
04 Jan 2000
eISBN:
9781451831467
Language:
English
Keywords:
ISCR; CR; U.S. dollar; Percent share; dollar; independent auditor; banks in Palau; savings account; operating expenses; development bank; Palau's export
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This paper provides a review of recent economic developments in Palau, covering the first five years of the Compact of Free Association (Compact) with the United States. The paper analyzes the economic growth, prices, wages, and employment. The study assesses the public finances and overall developments, which include revenues and grants, expenditure, local governments, trust funds, and nonfinancial public enterprises. The paper provides a detailed study of the financial and external sectors, current and capital accounts, external debt, and exchange and trade systems.

Abstract

This paper provides a review of recent economic developments in Palau, covering the first five years of the Compact of Free Association (Compact) with the United States. The paper analyzes the economic growth, prices, wages, and employment. The study assesses the public finances and overall developments, which include revenues and grants, expenditure, local governments, trust funds, and nonfinancial public enterprises. The paper provides a detailed study of the financial and external sectors, current and capital accounts, external debt, and exchange and trade systems.

I. Introduction and Summary

1. This paper provides a review of recent economic developments in Palau, covering the first five years of the Compact of Free Association (Compact) with the United States (1994/95-1998/99), as background for the staff report for the 1999 Article IV consultation.

2. Palau, an archipelago in the Western Pacific, has a small population of about 18,000, but a relatively high GDP per capita of over $7,000 (Table 1). Palau faces many development constraints common among Pacific island economies, including a narrow resource base, geographical isolation, a small domestic market, a lack of infrastructure and skilled labor, and vulnerability to external and natural shocks.

Table 1.

Republic of Palau: Selected Social Indicators

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3. The economy, comprising mainly services including a large public sector, grew rapidly in the first years of the Compact, as large Compact grants fueled consumption and investment, and tourist arrivals increased sharply (Table 2). However, the economy entered a period of recession in 1998, as the Asian crisis brought about a marked downturn in tourism. Inflation appears to have been in the single-digit range in recent years, in line with inflation in the major partner countries (United States and Japan).

Table 2.

Republic of Palau: Gross Domestic Product, 1992-98

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Source: Data provided by the Palauan authorities; and Fund staff estimates.

Data for 1992 and 1993 are from the University of Oregon and the U.S. Department of the Interior.

Data for 1994 and 1995 have been estimated using indicators for tourism, trade, and public administration between 1993 and 1996 benchmarks.

Data for 1996 and 1997 have been estimated by a UNDP statistics specialist.

Inflation data are not available for Palau. Nominal GDP is deflated by inflation in the neighboring Marshall Islands as an approximation.

4. Palau depends heavily on grants from the United States to finance otherwise unsustainable fiscal imbalances. With a narrow tax base and high current expenditure (about half GDP in recent years), fundamental adjustments are required to adjust to the scheduled phasing down of U.S. grants during the next ten years (Compact grants are scheduled to end in 2008/09). The urgency of the situation has been increased by a marked deterioration of the fiscal position in 1998/99 (a budget deficit of 12 percent of GDP is expected for this fiscal year).

5. After recording a large balance of payments surplus in 1994/95, reflecting up-front grant disbursements under the Compact, the balance of payments has been in deficit in three of the last four years. Because of Palau’s dependence on imports and its narrow export base, the trade account has experienced large deficits in recent years. However, the external current account (including grants) has continually been in surplus, owing to large tourist receipts, income from investing unspent Compact funds, and grants. The deficits in the overall balance of payments have reflected large capital outflows (recorded as errors and omissions), reflecting the pooling of deposits by large U.S.-based banks at their respective headquarters for investment elsewhere. As a result, Palau’s foreign reserves (approximated by government financial assets, excluding the Trust Fund) have declined to around $65 million in mid-1999 (equivalent to about a year of imports) from about $100 million at end-1994/95 (Table 3).

Table 3.

Republic of Palau: Financial Holdings of the Central Government, 1992/93-1997/98

(In thousands of U.S. dollars; end of period)

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Source: Data provided by the Palauan authorities.

Deposits with all foreign banks, including those in the United States.

Deposits with local banks.

Refer only to Compact Section 211(f) Trust Fund, excluding the Civil Service Pension Trust and Social Security Retirement Fund.

6. The banking system in Palau is generally in a good financial position, but has played a relatively limited role in promoting economic development. The banks are not burdened by significant amounts of nonperforming loans (except the National Development Bank of Palau), but this largely reflects the fact that the U.S.-based banks, which account for about 80 percent of deposits, place around two-thirds of their deposits at their headquarters abroad, while a large share of the local loans they do make is in the form of well-secured consumer loans rather than business loans. Increasing loan activity by these banks depends in particular on the clarification of land ownership and lease rights, as uncertainty in this area is preventing an effective use of land and leases as loan collateral. At the same time, there are currently no banking regulations covering locally chartered banks in Palau, which presents a potential systemic risk.

II. Output and Prices

A. Output

7. Real GDP grew by 10-15 percent per annum during 1994/95-1995/96, reflecting the impact of large Compact grants on consumption and investment, and a sharp rise in tourist activity. The sectors that experienced the fastest rates of growth were: wholesale and retail trade, and transportation, to handle increasing volumes of imports; hotels and restaurants, to accommodate the growing numbers of tourists;1 and construction, reflecting a five-fold increase in government spending on infrastructure during 1994/95-1995/96 (Table 2).

8. However, real GDP growth stalled in 1996/97 and subsequently turned negative in 1997/98, owing to the impact of the Asian crisis on tourism and the phasing down of U.S. grants under the Compact. Real GDP is now expected to decline by about 5 percent in 1998/99, after falling by a similar amount in 1997/98. Tourists from the region were discouraged by the downturn in their economies, as well as the considerable appreciation of the U.S. dollar against their currencies (the U.S. dollar is legal tender in Palau). As a result, the hotels and restaurants, and trade sectors contracted sharply in 1996/97-1997/98. With the phasedown of grants, the government kept a tighter hold on current expenditure and cutback on capital spending, which dampened growth in the construction and public sectors in the last few years.

9. The greatest potential for future growth clearly lies in tourism. Tourist activity in Palau currently is limited to scuba diving and snorkeling, but there is potential to also provide facilities for golfing, hiking, and biking, particularly with the development of Babeldaob, the largest island. The construction of a ring road around Babeldaob, which is scheduled to begin in late 1999, should greatly improve access. Fisheries, a traditionally important sector consisting primarily of commercial fishing in Palau’s exclusive economic zone, is likely to continue to decline owing to oceanographic changes (this sector has also been adversely affected by falling prices of high-grade tuna and reduced demand owing to the Asian crisis). Agriculture (mostly subsistence) accounts for only 2 percent of GDP, and manufacturing is small, consisting mainly of a small number of establishments involved in bakeries, garments, building materials, furniture, and handicrafts.

B. Prices, Wages, and Employment

10. Inflation in Palau, based on anecdotal evidence, has been in the single-digit range in recent years, in line with inflation in neighboring Guam and Saipan, and its major trading partners (Japan and the United States).2 In addition to the U.S. dollar providing an anchor for prices, there are indications that the current economic slowdown has had a dampening effect on wages: the average gross wage for the economy (as reported by the social security administration) increased by 6.3 percent in 1997 and 0.5 percent in 1998, while the average gross government wage rose by 7.7 percent in 1997 and fell by 1 percent in 1998.

11. Employment has been growing steadily over the last five years reflecting mainly the steady inflow of workers mostly from the Philippines (the native Palauan population has grown only very slowly in recent years).3 Many Palauans tend to work in the public sector, where wages on average have been about double the wages in the private sector, while the non-Palauans tend to work in tourism-related service sectors. The public sector remains the largest employer, accounting for about one-third of total employment in recent years (Table 4).

Table 4.

Republic of Palau: Employed Persons by Industry, 1990 and 1995

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Sources: Office of Planning and Statistics, 1994 Statistical Yearbook; 1995 Census of Population and Housing.

Includes business, repair, personal, entertainment and recreation, health, education, and social services.

III. Public Finances

A. Overall Developments

12. The public sector is made up of the national government, 16 state governments, and nonfinancial public enterprises. The national government conducts budgetary operations through four main funds: (1) the general fund; (2) the special fund; (3) the capital project fund; and (4) the debt-service fund. Transfers are made between these funds, mainly from the general fund to other funds within the national government, but from the general fund to the state governments’ funds as well. There is, however, very limited or no authority for the use of foreign grants earmarked for capital projects to finance current expenditures.

13. The budget recorded a surplus of about $100 million (100 percent of GDP) in 1994/95, reflecting very large upfront grant disbursements under the Compact ($143 million)4 (Tables 5 and 6). While grants fell sharply in the following year, as scheduled, to about $35 million, current and capital spending accelerated with the greater availability of funds, giving rise to a budget deficit of 8 percent of GDP. The budget returned to a surplus in 1996/97-1997/98, but mainly because of one-time revenue gains (unusually high earnings on investments in U.S. stocks in 1996/97 and a large legal settlement pertaining to the collapse of a bridge in 1997/98). In 1998/99, the fiscal position is expected to worsen sharply, reflecting in addition weak tax revenues stemming from the recession, a scheduled step-down in Compact grants, and an acceleration of current spending.

Table 5.

Republic of Palau: National Government Budgetary Operations, 1992/93-1998/99

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Sources: Reports on the Audit of Financial Statements for fiscal years 1992/93-1997/98 (data for 1998/99 are preliminary); and data provided by the Palauan authorities. Fiscal year runs from October to September.

Includes mainly grants from U.S. Department of Interior (DOI) and other U.S. agencies. These grants are used to support both current and capital expenditures.

Includes subsidies and transfers for current operations.

Excluding trust fund.

Includes local trust funds and investment income.

Calculated using simple quarterly interpolation.

Table 5a.

Republic of Palau: Summary of Tax Structure, 1998/99

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Table 6.

Republic of Palau: U.S. Grants, 1994/95-2002/03

(In thousands of U.S. dollars)

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Sources: Independent Auditor’s Report on Financial Statements; and data provided by the Palauan authorities.

Other U.S. assistance is received based on the proposals submitted to each grantor agency. Based on the Compact agreement, various programs were to phase out beginning fiscal year 1996. Scheduled phasing out is 25 percent reduction of grant authorization for each fiscal year. However, there are available old and new programs for which the Republic of Palau is eligible.

B. Revenue and Grants

14. Reflecting a narrow base and problems in administration, tax revenue has remained relatively low in relation to GDP (Table 5). Tax revenue comes mainly from a 4 percent gross receipts tax on business (after allowable deductions for wages and salaries paid to workers), income tax on wages and salaries, the import tax, and tourism-related taxes (mainly hotel occupancy and airport taxes).5 Tax revenue has remained low despite a number of changes in recent years: (1) starting in 1995/96, the government reduced the share of wages paid to noncitizen workers deductible for gross receipts tax purposes from 100 percent to 50 percent; (2) “sin taxes” on imports of cigarettes and tobacco products, and on liquors and other beverages were raised in 1996 and again in 1998; (3) exemptions from taxes for commercial imports were eliminated in 1994, while the exemptions for personal imports were removed in 1998, leaving only government imports still exempt from taxes; and (4) the airport tax has been raised in stages to $20 per head from $5 for citizens and $10 for noncitizens prior to the Compact.

15. Since 1994/95, nontax revenue has been dominated by earnings from the investment of unspent Compact grants. Excluding income from the Compact Trust Fund (which is essentially escrowed for future use and is therefore treated separately from normal budget operations), investment income has fluctuated within a range of $5-8 million a year consistent with the strong performance of the U.S. stock market.6 Fees and charges have also been a major source of nontax revenue, while fishing rights fees have been declining with the fishing industry. In 1997/98, nontax revenue was boosted by a $13 million legal settlement pertaining to the collapse of the Koror-Babeldaob bridge.

16. However, grants remain the largest source of government receipts. U.S. grants account for almost all foreign aid and are mainly provided under the Compact or by the U.S. Department of Interior (Table 6). However, both Compact and non-Compact U.S. grants are scheduled to be phased out over time. Grants under the Compact, after a peak of $126 million (excluding the Trust Fund) in 1994/95, will be phased down from above $20 million per annum during 1995/96-1997/98 to around $14-15 million a year during 1998/99-2008/09. There are no commitments for grants under the Compact beyond 2008/09.

C. Expenditure

17. Current expenditure has remained high, though it has declined from well above 50 percent of GDP in 1994/95 to around 45 percent of GDP in the last few years. About 90 percent of total current spending has been accounted for by wages and salaries (fueling the growth of public sector employment and supporting relatively high public sector wages), and purchases of goods and services (Tables 5 and 7). Subsidies to public enterprises, after reaching nearly $8 million in 1995/96, have declined sharply to an estimated $1.4 million in 1998/99, as large subsidies provided to the Public Utilities Corporation (PUC) were eliminated in 1998/99.7

Table 7.

Republic of Palau: National Government Expenditure by Budget Category, 1992/93-1997/98

(In thousands of U.S. dollars)

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Sources: Reports on the Audit of Financial Statements for fiscal years 1992/93-1997/98 (1997/98 data are preliminary); and data provided by the Palauan authorities.

Includes subsidies and other transfers for current operations.

18. Capital expenditure, which focuses on the physical infrastructure, has fallen to about 8 percent of GDP in the last two years from some 14 percent of GDP in 1995/96-1996/97. Non-Compact capital expenditures have declined from about $6 million in 1994/95-1995/96 to less than $2 million in 1997/98, as existing pre-Compact projects near completion. Capital expenditure using Compact grants earmarked for capital improvement8 rose sharply from less than $3 million in 1994/95 to $10 million in 1995/96 and $13 million the following year, as many of the projects held back pending the signing of the Compact came on stream. After the initial spurt, however, capital spending has slowed considerably ($7.6 million in 1997/98).

D. Local Governments

19. The main sources of local government revenue are national government grants, fishing rights fees, and other local fees and charges, such as motor vehicle registration fees and payments for business and import licenses. Local government expenditures typically cover local wages and salaries, municipal and civic services, and small-scale capital expenditures (Table 8), The authorities indicated that local governments were under strict instructions to keep spending within available resources, that is, local revenues plus grants from the national government.

Table 8.

Republic of Palau: Operating Accounts of the State Governments, 1992/93-1995/96

(In thousands of U.S. dollars)

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Source: Data provided by the Palauan authorities.

E. Trust Funds

20. There are three trust funds administered by the government: the Compact Trust Fund, the Social Security Fund, and the Civil Service Pension Fund. Two disbursements were made under the Compact for investment in the Compact Section 211(f) Trust Fund ($66 million in 1994/95 and $4 million in 1996/97), the future proceeds of which can be used only after the annual Compact grants end in 2008/09 (see Annex II of the staff report for more details). The government has been investing these funds in a U.S. securities portfolio managed by U.S. investment managers. The market value of the Compact Trust Fund holdings amounted to $141 million at end-May 1999, about 13 percent higher than envisaged under the Compact at this time (Table 9).

Table 9.

Republic of Palau: Financial Position of the Compact Section 211(f) Trust Fund, 1994/95-1998/99

(In thousands of U.S. dollars)

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Sources: Independent Auditor’s Report on Financial Statement; and data provided by the Palauan authorities.

Covers operations of the Compact Section 211(f) Trust Fund, starting in 1994/95.

21. Palau’s social security system is self-financing by law (the government only provides employers’ contributions), and provides retirement, disability, and death benefits to qualified individuals and their surviving families. All employees of the public and private sectors are covered under the system. Presently, there are over 29,400 active and inactive members of the system, with approximately 1,300 members and surviving spouses and children receiving social security benefits. With a sizable balance in the Social Security Fund ($23 million at end-1997/98), and revenues still much larger than expenditures (Table 10), the social security system will be able to continue to meet its current obligations for some time, although, based on the latest actuarial valuation, the system is underfunded by $19 million.

Table 10.

Republic of Palau: Financial Position of the Social Security Fund, 1992/93-1997/98

(In thousands of U.S. dollars)

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Sources: Annual Audit Reports; and data provided by the Palauan authorities.

Total benefit payout includes retirements, survivors, disability, and lump-sum payments.

Including administrative and investment management expenses and fees.

22. The Civil Service Pension Fund provides retirement, disability, death, security, and other benefits to civil servants, and their spouses and dependents. The government has made a number of contributions to the Pension Fund recently (Table 11). Total revenues have exceeded expenditures, and the total Pension Fund balance at end-1997/98 amounted to $22.4 million. The government recently changed the mandatory retirement age from 60 years to 30 years’ service (effective July 1, 1999). While the Pension Fund is able to meet its current payments, it is estimated to be underfunded (on an actuarial basis) by $23 million.

Table 11.

Republic of Palau: Financial Position of the Civil Service Pension Fund, 1992/93-1997/98

(In thousands of U.S. dollars)

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Sources: Independent Auditor’s Report on Financial Statements; and data provided by the Palauan authorities.

Including lump-sum benefits, refunds, and disability benefits.

Including investment management expenses and fees.

F. Nonfinancial Public Enterprises

23. Four nonfinancial public enterprises have received budgetary subsidies in recent years: PUC, PVA, the Belau National Museum, and the Palau Housing Authority (see Annex VI of the membership paper, EB/CMXRepublic of Palau/97/1 (7/25/97), for a description of the institutional and operational aspects of these enterprises and other public entities). In the absence of large subsidies, the PUC made substantial losses in 1996/97-1997/98 and is expected to make further losses in 1998/99 (Table 12). Subsidies to PVA have increased considerably in recent years, reflecting the government’s strong intention to promote tourism in Palau. The Palau Housing Authority receives a small subsidy annually to provide low-cost housing for Palauan families (Table 13). It recorded small surpluses in the latest three years for which data are available (1994/95-1996/97). The Palau National Communication Corporation has not received subsidies in recent years, but made a loss in 1997/98 for the first time since the early 1990s, as the Asian crisis adversely affected tourism and thus significantly reduced the volume of international phone calls (Table 14).

Table 12.

Republic of Palau: Operating Accounts of the Palau Public Utilities Corporation, 1994/95-1997/98

(In thousands of U. S. dollars)

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Sources: Independent Auditor’s Report on Financial Statements; and data provided by the Palauan authorities.
Table 13.

Republic of Palau: Operating Accounts of the Palau Housing Authority, 1992/93-1996/97

(In thousands of U. S. dollars)

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Sources: Independent Auditor’s Report on Financial Statements; and data provided by the Palauan authorities.
Table 14.

Republic of Palau: Operating Accounts of the Palau National Communications Corporation, 1992/93-1997/98

(In thousands of U. S. dollars)

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Sources: Independent Auditors Report on Financial Statements; and data provided by the Palauan authorities.

Not related to the normal operation of the corporation and includes adjustments to the fund balance.

Table 15.

Republic of Palau: Structure of Interest Rates, May 1997-May 1999 Bank of Hawaii

(In percent per annum)

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Source: Data provided by the Palauan authorities.

Commercial loan rates follow the highest New York Prime plus 4 percent.

Table 16.

Republic of Palau: Structure of Interest Rates, May 1997-May 1999 Bank of Guam-Palau Branch

(In percent per anuum)

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Source: Data provided by the Palauan authorities.

IV. Money and Banking

24. Palau uses the U.S. dollar as legal tender and has no central bank. Palau’s financial sector consists of eight commercial banks and one development bank, the National Development Bank of Palau (NDBP). The largest three commercial banks (Bank of Hawaii, Bank of Guam, and Guam Savings and Loans) are U.S.-based and account for more than 80 percent of total deposits. The other five are smaller locally chartered banks (Bank of Palau, Pacific Savings Bank, Bank of Micronesia, Palau Construction Bank, and Melekeok Government Bank). In states other than the capital of Koror, there are some very small credit unions serving local banking needs.

25. A monetary survey is not available in Palau, as the banks do not provide balance sheet data to the authorities. However, the three largest U.S.-based banks had deposits in total of about $85 million as of mid-1999, of which only about $30 million were loaned out in Palau. Most of the remainder is pooled in their respective headquarters for investment elsewhere. Clearly, significant amounts of financial capital (private and government savings) are being exported from Palau via the banking system. About one-half of the domestic loans are small consumer loans, typically serviced by withholding from borrowers depositing their salaries in these banks. The consumer loans are thereby well secured and the banks reported minimal defaults on these loans. However, the banks tend to be waiy of expanding their business lending operations, as they view this type of lending to carry considerable credit risk in Palau, especially for business startups. While there are ceilings on interest rates on loans in Palau,9 the banks view as a more serious problem the fact that foreigners (and foreign-owned banks) cannot own land under Palauan law and that there is a great deal of uncertainty about rights to land leases, which makes it very difficult to use land or leases as loan collateral.

26. The NDBP10 provided a solution to this problem to some extent as it would guarantee 90 percent of business loans for a fee (the NDBP would take possession of the land in case of default). However, the NDBP has been unable to provide such guarantees in the last couple of years, as its own balance sheets had deteriorated significantly. Some 30 percent of the NDBP’s loan portfolio is currently nonperforming, owing partly to poor loan assessment skills, but also to a lack of accountability for the management of the bank. Consequently, the NDBP has been in a consolidation mode for the past couple of years in an attempt to solidify its balance sheet prior to resuming its lending and guaranteeing operations (Tables 17-19).

Table 17.

Republic of Palau: Operating Accounts of the National Development Bank of Palau, 1992/93-1997/98

(In thousands of U. S. dollars)

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Sources: Independent Auditor’s Report on Financial Statements; and data provided by the Palauan authorities.
Table 18.

Republic of Palau: Assets and Liabilities of the National Development Bank of Palau, 1992/93-1997/98

(In thousands of U.S. dollars; end of period)

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Sources: Independent Auditor’s Report on Financial Statement; and data provided by the Palauan authorities.

Includes other receivables, inventory, and prepaid expenses.

Includes accrued expenses.

Includes contributed capital and retained earnings.

Table 19.

Republic of Palau: Credit Allocation by the National Development Bank of Palau, 1992-98

(In thousands of U.S. dollars)

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Source: Data provided by the Palauan authorities.

27. Although banks in Palau are licensed by the Attorney General’s Office, there are currently no banking regulations in Palau. The deposits of Palau branches of U.S.-based banks are insured by the FDIC and these banks are required to follow U.S. banking regulations. The local banks tend to follow some of these regulations in order to have a corresponding relationship with a U.S. bank, but banking regulations have yet to be formulated. There are presently no serious concerns about the health of the banks (except the NDBP, which cannot by law accept deposits), as nonperforming loans are small, reflecting banks’ preference for consumer loans.

V. External Sector

A. Current Account

28. The current account deficit excluding grants narrowed from 15 percent of GDP in 1994/95-1995/96 to 6 percent of GDP in 1996/97, reflecting strong growth of tourism earnings and a spike in investment earnings in 1996/97 (Table 20). However, the deficit has subsequently widened to around 10 percent of GDP in the last two years, owing to the adverse impact of the Asian crisis on tourism earnings and a return of investment earnings to more normal levels, although the deterioration has been partly offset by lower trade deficits reflecting the import compression. The current account including grants has been further exacerbated by the step-down in Compact grants in 1998/99 by the equivalent of 4½ percent of GDP.

Table 20.

Republic of Palau: Balance of Payments, 1992/93-1997/98

(In thousands of U.S. dollars)

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

Includes government and tax-exempt imports.

Estimated on the basis of official data on the number of visitors to Palau, and data on average length of stay and average daily spending.

Estimated to have amounted to 25 percent of the f.o.b. value of Imports.

Contribution to international and regional organizations.

Grants received for capital improvements.

Principal payment on external debt

Reflects the changes in the financial holdings of the government excluding Compact Section 211(f) Trust Fund.

Merchandise trade

29. Palau’s exports, consisting almost exclusively of fish (sashimi-grade tuna headed for Japan), have fallen in recent years; total exports amounted to 9 percent of GDP in the last two years, compared with 12 percent of GDP in 1995/96. The decline in fish exports reflected an overall decline in fish catch, a weakening in export prices from 1996 onward, and lower levels of demand following the onset of the Asian crisis. In addition, the fishing industry has been hampered by limited air freight capacity, due to infrequent commercial and charter flights out of Palau.11 Other exports consist mostly of garments and handicraft.

30. Imports rose rapidly during 1994/95-1996/97, reflecting growing consumption and investment fueled by U.S. grants and rising demand from the tourism industry, although its size relative to GDP remained relatively constant at somewhat above 50 percent of GDP. However, imports have since declined with the recession. Imports consisted primarily of fuel, food and beverages, machinery and equipment, and miscellaneous manufactured articles (Table 21). The United States (including Guam) was by far the largest source of imports, followed by Japan and Singapore (Table 22).

Table 21.

Republic of Palau: Imports by Product Category, 1994-97 1/

(In thousands of U.S. dollars; f.o.b.)

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Source: Data provided by the Palauan authorities.

On a calendar-year basis.

Table 22.

Republic of Palau: Imports by Origin, 1996-97 1/

(In thousands of U.S. dollars; f.o.b.)

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Source: Data provided by the Palauan authorities.

On a calendar-year basis.

Services, income, and transfers

31. Services account receipts are mostly made up of earnings from tourism, which more than doubled to over $60 million (47 percent of GDP) between 1993/94 and 1996/97. This reflected a doubling of tourists to 66,000, mostly accounted for by increases in visitors from Taiwan, Province of China (Table 23). However, tourists proved to be highly sensitive to the Asian crisis and their numbers fell both because of the relative appreciation of the U.S. dollar and because of declining incomes.12

Table 23.

Republic of Palau: Tourism and Business Arrivals, 1993-99 1/

(In number of arrivals, by country of citizenship, except as otherwise indicated)

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Source: Data provided by the Palauan authorities.

Includes returning residents, fishermen, crews, students, transits, and dependents.

Percentage change in arrivals is calculated in relation to the first quarter of 1998.

32. Service account payments comprise mostly freight and insurance costs, estimated at about 25 percent of the f.o.b. value of imports. The relatively high figure reflects Palau’s remote location and reliance on air transportation, and is in line with estimates for the neighboring island economies.

33. Sizable income has been generated from the investment of Compact grants (excluding the Trust Fund), and the Social Security and Civil Service Pension Funds. Investment income hit a peak of $18 million (14 percent of GDP) in 1996/97, but has since declined to around $7 million in the last couple of years, partly reflecting the drawdown of government financial assets.

34. Both inflows and outflows of private transfers (remittances) have increased steadily in recent years. Remittances by Palauans working abroad (mostly in Guam, Saipan, and Hawaii) rose to over $1 million in the last few years, while outward remittances (mainly by Filipino workers in Palau) have also risen to more than $7 million, reflecting a significant rise in the number of foreign workers.

35. Official current grants peaked at $85 million in 1994/95, reflecting frontloaded Compact disbursements, then dropped to around $30 million a year during 1995/96-1997/98, and subsequently to $22 million in 1998/99. Fishing rights fees, collected mainly from distant water fishing vessels from Japan, have remained relatively unchanged at around $1 million in recent years.

B. Capital Account and External Debt

36. Data on capital account transactions are scarce, partly owing to a lack of commercial banking statistics. Official capital grants, earmarked for infrastructural investment, rose sharply to $62 million in the first Compact year (1994/95), but has since dropped off to $2-3 million a year more recently. There has, however, been an increase in capital grants from Japan for utilities improvement and fisheries development, albeit from a low level.

37. Palau has modest external debt of about $5 million as of mid-1999, arising from the financing of a power plant. The original debt of $60 million incurred for the power plant was renegotiated in 1994 to an interest-free debt of $20 million, with a stream of repayments of around $4 million a year for five years starting in 1995. The debt is expected to be fully repaid in 1999/2000 (Table 24).

Table 24.

Republic of Palau: National Government Debt and Debt Service, 1992/93-1999/2000

(In thousands of U.S. dollars)

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Sources: Independent Auditor’s Report on Financial Statements; and data provided by the Palauan authorities.

Total external debt outstanding (related to the construction of IPSECO power plant), including payments arrears.

In June 1993, an agreement was reached with the guarantor banks for the settlement of the outstanding IPSECO debt, by which there would be debt relief and only $20 million would be paid to the guarantor banks over the period 1994/95-1999/2000 without any interest payment.

38. There are no official data on foreign direct investment, but a number of private investments (mainly in hotels, fisheries, and a garment factory) have been financed in recent years through joint ventures with foreign private capital.

39. Large negative errors and omissions suggest that there has been significant outflows of private capital in recent years (Table 20), reflecting the pooling of resources by banks noted earlier. A sharp decline in errors and omissions in 1997/98 likely reflects that many banks faced increased deposit withdrawals in the summer of 1998, as many businesses and consumers were squeezed for cash as the Asian crisis intensified.

C. Exchange and Trade System

40. The currency of Palau is the U.S. dollar. The authorities do not transact in foreign exchange. Most commercial banks handle foreign exchange transactions and buy and sell foreign currencies on the basis of rates quoted in the international markets. There are no taxes or subsidies imposed on the purchase or sale of foreign exchange. The Republic of Palau accepted the obligations of Article VIII, Sections 2, 3, and 4 on December 16, 1997.

41. Imports are not subject to any licensing requirements, but importers must obtain a business license to engage in importing activities. Specific and ad valorem taxes are levied under the Customs Rules and Regulations. Specific duties are levied on cigarettes, alcoholic products, and other beverages. Ad valorem duties are assessed on other products (using f.o.b. values) ranging from 3 percent (most products) to 150 percent (tobacco products other than cigarettes).

42. There are no surrender requirements for export proceeds. Exports are not subject to licensing requirements, except with regard to the export of fish. There are no taxes or quantitative restrictions on exports, except that, under the Fish Export Tax Law, as amended, a tax is levied on the export of any species of tuna and any species of billfish at the rate of $0.25 per kilogram.

43. There are no restrictions on the payments for or receipts from invisibles.

44. Foreign investors are required to submit applications to the Foreign Investment Board and obtain an approval certificate to engage in business or to acquire an ownership interest in a business in Palau. Some business activities are reserved exclusively for Palauan citizens or business enterprises wholly owned by Palauan citizens; these include wholesale or retail trade in goods, land transportation, and some tourism and travel activities. There are no special financial incentives offered to foreign investors, except those available under certain provisions of the Compact (for example, duty-free access to the U.S. markets for some products). Foreign ownership of real estate is prohibited, but foreigners can obtain long-term leases extending up to 50 years. There are no restrictions on the repatriation of profit or capital.

1

Tourists from Taiwan, Province of China increased sharply, with the opening of a chartered flight in 1995. At the same time, the average expenditure per tourist is estimated to have increased from $882 in 1994 to $937 in 1997.

2

Consumer price data are not compiled in Palau, The government is currently in the process of gathering price data with UNDP assistance, and a consumer price index is expected to be available in 2000. There are also no reliable time-series data on wages, except for the census survey carried out every five years (the last one was in 1995).

3

Based on 1995 census data, about 40 percent of the total employed were born outside Palau, of which about two-thirds were from the Philippines.

4

The total amount included $17 million of non-Compact grants, mostly from the United States, but excluded a disbursement of $66 million into the Compact Trust Fund in 1994/95.

5

There are no taxes on investment income. See Table 5a for a summary of Palau’s tax system.

6

In 1996/97, a further $3 million was raised from the government selling its holdings in Continental Micronesia.

7

In 1995/96, PUC accounted for $7 million of the $7.9 million of total subsidies to public enterprises, with the Palau Visitors’ Authority (PVA) accounting for another $0.7 million (reflecting the government’s efforts to promote tourism in Palau). In 1998/99, no subsidies were budgeted for PUC, and most of the $1.4 million of subsidies to public enterprises is estimated to be received by the PVA.

8

Under Section 212(b) of the Compact, $52 million (including inflation adjustment) was disbursed in 1994/95 for infrastructural projects.

9

18 percent per annum for loans under $15,000 (mainly consumer loans); and the U.S. prime rate plus 4 percentage pointsfor loans greater than $15,000 (see Tables 15 and 16 for selected actual interest rates).

10

The NDBP receives the bulk of its resources from government transfers and U.S. grants. Its main objective is to provide low-cost capital for projects with development potential in the private sector.

11

The fishing fleet based in Palau has been halved in the last five years to less than 150 vessels in 1998.

12

Weighted by shares in tourist arrivals, Palau’s nominal effective exchange rate appreciated by 21 percent during June 1997-June 1998, though about half of this appreciation has since been reversed. The Taiwanese dollar depreciated by about 20 percent against the U.S. dollar during June 1997-June 1998 and by 14 percent during June 1997-May 1999. With inflation in Palau likely to be in line with the low inflation in the major partner countries, the appreciation in the real effective exchange rate is probably in a similar range.

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Cover IMF Staff Country Reports
Palau: Recent Economic Developments
Author:
International Monetary Fund
Volume/Issue:
Volume 1999: Issue 147
Publisher:
International Monetary Fund
ISBN:
9781451831467
ISSN:
1934-7685
Pages:
41
DOI:
https://doi.org/10.5089/9781451831467.002