Vanuatu
2002 Article IV Consultation-Staff Report; Staff Statement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Vanuatu

This 2002 Article IV Consultation highlights that despite frequent shocks and an uncertain policy environment in Vanuatu, macroeconomic stability has been maintained. Real GDP growth was 2½ percent in 2000 owing to an agriculture-led recovery. However, the economy contracted by 2 percent in 2001, owing to the effects of several major cyclones and a global downturn in agriculture and tourism. Inflation remained subdued, increasing from 2½ percent in 2000 to 3¾ percent in 2001. The current account surplus declined from 2 percent of GDP in 2000 to ¾ percent in 2001.

Abstract

This 2002 Article IV Consultation highlights that despite frequent shocks and an uncertain policy environment in Vanuatu, macroeconomic stability has been maintained. Real GDP growth was 2½ percent in 2000 owing to an agriculture-led recovery. However, the economy contracted by 2 percent in 2001, owing to the effects of several major cyclones and a global downturn in agriculture and tourism. Inflation remained subdued, increasing from 2½ percent in 2000 to 3¾ percent in 2001. The current account surplus declined from 2 percent of GDP in 2000 to ¾ percent in 2001.

I. Recent Economic and Political Developments

1. This year’s consultation discussions took place against the backdrop of a continued slump in economic activity. A trend slowdown in real GDP growth since the mid 1990s appears rooted in a persistence of fiscal and structural weaknesses. As a result, Vanuatu has a relatively high cost structure and poor basic infrastructure vis-à-vis the region, which has eroded competitiveness (Box 1). This is compounded by a narrow production base, leaving it more susceptible to economic shocks.1 Like other countries in the region, business activity is hindered by a small population, which limits economies of scale. Formal sector employment remains very limited, with 80 percent of the labor force tied to subsistence activity. As a result, Vanuatu rates low on regional human development indicators.

uA01fig01

Vanuatu: Real GDP, 1992–2001

(Annual percentage change)

Citation: IMF Staff Country Reports 2002, 265; 10.5089/9781451840490.002.A001

Sources: Vanuatu authorities; and staff estimates.

2. In recent years, macroeconomic stability has generally prevailed, but structural reforms have slowed with several recent changes in government. The government’s reform agenda has been guided, in part, by the Comprehensive Reform Program (CRP), which was initiated in 1998 with assistance from the Asian Development Bank (AsDB) and other donors. The CRP provides a framework for raising public sector efficiency; strengthening economic and financial management; and improving parliamentary, judiciary, and legal procedures. Progress was initially good, but waned in 2000 and 2001 owing to a lack of consensus in policy direction. At the same time, poor growth performance continues to highlight the need for further reforms to the state-owned enterprise (SOE) and financial sectors and trade and investment regimes.

3. Despite frequent changes in government, Vanuatu so far has managed to avoid the political and social unrest experienced by other Melanesian countries. A coalition government comprising Vanuatu’s two largest parties—the Vanuaaku Pati (VP) and Union of Moderate Parties (UMP)—came to power in April 2001, after the latter defected from the previous ruling coalition.3 The new coalition strengthened its hold on Parliament in a national election in May 2002. The VP retained the prime minister’s post, despite the UMP’s achievement of a one-seat edge over the VP in the Parliament, which has necessitated considerable power sharing. The government’s most immediate challenge was containing a police insurrection in July 2002. The incident, which involved the temporary detention of several senior government officials, is being resolved in the courts.

uA01fig02

Vanuatu: Contribution to Real GDP Growth, 1997–2001

(in percentage points of contribution to total GDP growth, unless otherwise indicated)

Citation: IMF Staff Country Reports 2002, 265; 10.5089/9781451840490.002.A001

Sources: Vanuatu authorities; and staff estimates.1/ Annual percentage change.

4. Economic activity contracted in 2001, with real GDP falling by 2 percent due to the impact on the agricultural and tourism sectors of several major cyclones and a weak external environment (Table 1). Inflation increased from 2½ percent in 2000 to 3¾ percent in 2001, mainly on account of oil prices (Figure 1). The current account surplus declined from 2 percent of GDP in 2000 to ¾ percent in 2001, reflecting the impact of shocks to copra exports and tourism receipts (Table 2 and Figure 2). With the capital account remaining in deficit, gross official reserves fell slightly to $38 million at end-2001 (3 months of next year’s imports of goods and nonfactor services). Under the adjustable peg exchange rate arrangement, the vatu depreciated by 2¾ percent against the U.S. dollar in 2001, but appreciated by 5¾ percent in the first nine months of 2002.4 Since early 2001, the exchange rate has stayed broadly unchanged in real effective terms.

Table 1.

Vanuatu: Selected Economic and Financial Indicators, 1998–2003

Nominal GDP (2001): US$220 million

Population (2001) 196,900

GDP per capita (2001): US$1,117

Quota: SDR 17.0 million

article image
Sources: Vanuatu authorities; and Fund staff estimates and projections.

Official estimate of performance in the first half of 2002, unless otherwise indicated.

Change in percent of beginning of period broad money.

August 2002.

Weighted average rate of interest.

Unweighted rate of interest on one-month bank deposits.

As of end-August 2002.

Imports of goods (for domestic consumption) and nonfactor services.

Medium- and long-term public debt only.

In percent of exports of goods and nonfactor services.

As of September 30, 2002.

Figure 1.
Figure 1.

Vanuatu: Selected Economic Indicators, 1997-2002

Citation: IMF Staff Country Reports 2002, 265; 10.5089/9781451840490.002.A001

Sources: Vanuatu authorities, and Fund staff estimates.1/ Measured with respect to a weighted average lending rate on bank and the four-quarter average inflation rate.2/ Available to August 2002 and based on a transactions-weighted basket of currencies.
Table 2.

Vanuatu: Balance of Payments, 2000–2007 1/

(In millions of U.S. dollars, unless otherwise indicated)

article image
Source: Vanuatu authorities; and Fund staff estimates and projections.

Data for 2000 and 2001 are converted from vatu to U.S. dollars using annual average exchange rate.

In 2001, the outstanding balance on a loan from China for construction of the University of the South Pacific Law School was forgiven.

Figure 2.
Figure 2.

Vanuatu: External Sector Developments, 1996-2002

Citation: IMF Staff Country Reports 2002, 265; 10.5089/9781451840490.002.A001

Sources: Vanuatu authorities, and Fund staff estimates.

5. The fiscal situation improved in 2001, but the adjustment came mostly from a reduction in capital expenditure as a result of the completion of several large transport projects.5 The overall budget deficit (excluding net lending) declined from 7¼ percent of GDP in 2000 to 3¾ percent in 2001 (Table 3). Despite this, problems persisted with tax compliance and expenditure prioritization, which impeded effective budget execution in both 2000 and 2001. Revenue shortfalls stemmed from problems with VAT arrears and customs compliance and also reflected the economic slowdown. Expenditure priorities were skewed toward the wage bill, which continued to account for more than one-half of total recurrent expenditure, despite some expected savings under the CRP (Box 2). Education and health outlays grew slightly as a share of total spending, but service delivery to the outer islands and rural areas continued to lag due to resource shortfalls and capacity constraints. Starting in mid-2001, the government instructed the Vanuatu Commodity Marketing Board (VCMB) to pay subsidies to copra farmers.6 The cash-strapped VCMB, in turn, relied on direct advances from the Reserve Bank of Vanuatu (RBV) to make these payments, as none were budgeted. For the year ending June 2002, the total cost of subsidy payments made by the VCMB was estimated at VT 350 million (1 percent of GDP).

Table 3.

Vanuatu: Central Government Fiscal Operations, 1998–2002

(In millions of vatu)

article image
article image
Sources: Vanuatu authorities; and Fund staff estimates and projections.

Net of tax rebate for import duties.

Cash grants only.

Excludes transfers to the Development Fund.

For 2001 estimate and 2002 projection, includes capital transfers to the Vanuatu National Provident Fund of VT 325 million and to the Asset Management Unit of VT 288 million, respectively.

Includes statistical discrepancy.

uA01fig03

Vanuatu: Recent Fiscal Developments, 1996–2002

(In percent of GDP)

Citation: IMF Staff Country Reports 2002, 265; 10.5089/9781451840490.002.A001

Sources: Vanuatu authorities; and staff estimates.
uA01fig04

Vanuatu: Composition of Government Expenditure, 1996–2002

(In percent of GDP)

Citation: IMF Staff Country Reports 2002, 265; 10.5089/9781451840490.002.A001

Sources: Vanuatu authorities; and staff estimates.

6. Monetary policy has been generally restrained. Broad money grew by 6 percent in 2000 and 2001, fueled by foreign currency deposits (FCDs) arising from a relatively strong current account (Table 4 and Figure 3). In view of the slowdown in the economy in 2001, the repo rate was reduced at mid-year (by 50 basis points), which contributed to a rebound in private sector credit growth (to 6½ percent in 2001).7 Domestic liquidity conditions were allowed to further ease in the first half of 2002, reflecting a switch from foreign currency to local currency deposits as a result of reduced market tension following the election and an appreciation of the vatu vis-à-vis the U.S. dollar (given its depreciation against other currencies in the basket). However, bank interest rate spreads continued to widen, reflecting the high operating costs, prospective credit risk, and uncertain policy environment.

Table 4.

Vanuatu: Monetary Survey, 1999–2002

article image
Sources: Vanuatu authorities; and Fund staff estimates and projections.

Reserve Bank of Vanuatu and small Treasury foreign exchange operations.

Figure 3.
Figure 3.

Vanuatu: Monetary and Financial Indicators, 1998-2002 1/

Citation: IMF Staff Country Reports 2002, 265; 10.5089/9781451840490.002.A001

Sources: Vanuatu authorities; and Fund staff estimates1/ Data for 2002 Q3 as of end August.

II. Outlook and Risks

7. Performance so far this year suggests that real GDP growth will be slightly negative in 2002 (by about ¼ percent). A moderate rise in agricultural output, led by copra production (up 21 percent in the first half of 2002), is expected to be offset by slumps in tourism and construction activity. Tourist arrivals were down 14 percent in the first half of the year, affected in part by a strong recovery in Fiji—the major competitor in the region. Inflation is expected to stay below 3 percent (at 2 percent for the year ending June 2002), in view of prudent monetary management and despite a further increase in oil prices. A current account deficit of 2½ percent of GDP is projected, with a further softening in tourism receipts, but reserves should be unchanged at $38 million by year-end (3 months of imports) on account of a slowing of capital outflows. External vulnerability appears to remain moderately low at this juncture, despite the weaknesses in economic performance in recent years, given a relatively small external debt and cautious monetary stance (Table 5).

Table 5.

Vanuatu: Vulnerability Indicators, 1998–2002

(In percent of GDP, unless otherwise indicated)

article image
Sources: Vanuatu authorities; and Fund staff estimates and projections.

Central government only.

Imports of goods (for domestic consumption) and nonfactor services.

Foreign currency exposure is defined as foreign currency liabilities as a percentage of foreign currency assets.

Medium- and long-term public debt only.

For 2001, includes debt forgiveness.

8. Over the medium term, sustained growth depends on tackling fiscal and structural weaknesses in order to improve external competitiveness and expand productive opportunities (Box 3). Fiscal policy should be geared to providing adequate resources to meet key social and infrastructure needs, while maintaining prudent debt levels. In the structural areas, the focus remains on ensuring a well-supervised onshore and offshore financial sector, an open trade system, a transparent legal and regulatory framework, and a more limited government role in commercial activity. These policies would be expected to reduce high operating costs, build business confidence, and stimulate private investment, as necessary for sustained growth. Without these improvements, growth prospects would dim considerably, raising the risk of macroeconomic instability and social unrest, given rapid population increases and limited employment opportunities.

III. Policy Discussions

9. In view of recent growth performance, policy discussions focused on fiscal and structural issues, as did the 2000 Article IV consultation. The authorities and staff noted some progress had been made in addressing policy challenges highlighted during the last consultation (as summarized in Box 4), but agreed more progress was needed to lay a better foundation for sustained economic growth and a viable external position. The appropriateness of exchange rate policy was also discussed extensively, in view of concerns about competitiveness. In addition, financial sector policy featured prominently, including the risks posed by offshore financial center (OFC) activity.

A. Fiscal Policy

10. The staff noted recent improvements in the fiscal situation, but cautioned that a stronger revenue effort and expenditure prioritization were required, in order to address critical spending needs while maintaining a sustainable debt situation. An overall budget deficit of 1¾ percent of GDP was initially targeted in 2002, but it is now projected to be 1 percent of GDP largely on account of delays in implementing externally-financed capital projects.8 Despite the continued economic slump, revenue shortfalls are expected to moderate as a result of higher specific duties on select imports and increased business licensing fees. Some improvements have also been made in VAT and customs administration through the introduction of automated systems aimed at strengthening tax audit and compliance procedures and recording tax arrears. Notwithstanding lower capital spending, expenditure is expected to be close to budget. However, spending priorities have remained skewed towards unproductive outlays, putting a squeeze on operations and maintenance and other critical needs. In particular, unbudgeted savings achieved on the wage bill, in part through controls over new hires (Box 2), are largely being offset by spending associated with salary arrears and the national election. In addition, supplementary budget support has been provided to the Asset Management Unit (AMU) (paragraph 18). In view of this, a tight cash situation persists in 2002, with the government still using a system of monthly warrants to control spending units.9 Moreover, it has continued to resort to advances from the RBV to fill a financing gap.

11. Some further actions to safeguard the fiscal position in 2002 were discussed. In the revenue area, despite expected shortfalls, the authorities did not favor new tax measures in 2002 on account of the weak economy. However, the staff recommended that excises on alcohol and tobacco products originally proposed in the 2002 budget be approved without further delay. On the expenditure side, the authorities agreed with staff on the need for strict limits on supplemental appropriations to avoid further compressing nonwage spending and incurring domestic payment arrears. The staff encouraged the use of treasury bill auctions rather than central bank advances to meet financing needs, in order to protect inflation performance and improve fiscal discipline. However, the authorities were reluctant, citing the need first to strengthen debt management. The authorities and staff did concur that copra subsidies should be rolled back in order to contain fiscal risks and avoid market distortions, but no official decision has been taken yet. In this regard, the staff urged an unwinding of the advances to the VCMB and a limitation on future support to farmers to that which was well targeted, small in scope, and fully budgeted, as well as a restriction of the VCMB to at most promotional activities.

12. The staff also noted that additional actions were needed in the context of the 2003 budget to promote lasting fiscal consolidation. To this end, the staff welcomed the cautious approach being taken by the authorities in formulating budget deficit targets in 2003, including a current budget balance. On the revenue side, in addition to new excises, further increases in specific duties on select imports are being considered. The staff cautioned against excessive reliance on trade taxes in view of future trade commitments (paragraph 19), which would require collapsing the number of tariff bands and lowering rates over the medium term. To safeguard revenue, the staff also urged limits on tax exemptions, including those that serve as implicit subsidies for SOEs, by strictly specifying their availability and use in the Foreign Investment Act and other relevant laws. In the expenditure area, the authorities acknowledged the need for further cuts in the wage bill in relation to GDP, given comparatively low spending on operations and maintenance and in social areas, and indicated that plans were being formulated to consolidate some ministerial tasks. The staff noted that higher capital spending was also appropriate in context of a well-designed public investment program and with donor coordination.

B. Monetary and Exchange Rate Policy

13. A cautious monetary stance remains a priority, to safeguard inflation performance and support the external position. The authorities and staff agreed that strict limits were needed on RBV advances for the remainder of 2002, as supported by fiscal restraint, to contain any further relaxation of domestic liquidity conditions. However, even with a seasonal pick up in domestic demand, broad money growth in 2002 will be very modest, with private sector credit expected to expand by 4 percent.

14. The staff stressed the need to monitor exchange rate movements closely, owing to poor export performance and steady reserve losses since the late 1990s, which signal low external competitiveness. In consideration of this, the staff acknowledged that given the structure of Vanuatu’s economy, most notably the large share of imports to GDP (68 percent in 2001), a depreciation might have a limited initial impact on relative prices. At the same time, it could prove unavoidable in the absence of a concerted effort to raise productivity, foremost being through the maintenance of a sound fiscal stance and acceleration of structural reforms. The authorities recognized the need to address Vanuatu’s competitive disadvantage vis-à-vis the region, but were cautious in their support for a more flexible exchange rate management.

15. The staff also encouraged a deepening of the interbank market and greater transparency about the exchange rate peg in order to improve reserves management. In the past, the RBV relied on copra export proceeds from the VCMB to build up reserves, but low world prices and domestic copra sales have dried up this source of foreign exchange.10 At the same time, banks still look to the RBV to meet some foreign exchange needs, in particular for large importers.11 The staff encouraged the RBV to (i) widen its trading band (currently 0.3 percent around the RBV’s daily announced mid rate) to give it more latitude in entering the interbank market and acquiring foreign exchange, and (ii) allow greater transparency about the nature of the exchange rate peg to reduce uncertainty about policy direction, including through public disclosure of the current composition and weights of the currency basket. The authorities indicated they would consider widening the band, but were reluctant to disclose details of the basket for fear of encouraging destabilizing speculation on exchange rate movements.

C. Financial Sector Policy

16. The authorities have taken steps to strengthen the regulatory and supervisory regime for domestic banks. The OFC Module II Assessment conducted by the Fund’s Monetary and Exchange Affairs Department in May 2002 found the RBV’s supervisory regime for domestic banks to be mostly compliant with the Basel Core Principles (BCP). In keeping with this assessment, the overall financial health of the domestic banking sector, dominated by three commercial banks, is viewed as generally sound. To address deficiencies identified in the OFC assessment, customer due diligence guidelines were approved in July 2002, and the Financial Institutions Act is being amended to improve oversight of banks’ anti-money laundering systems and controls and introduce a more rigorous “fit and proper” regime.

17. The staff noted that decisive actions were needed to strengthen the supervisory regime for offshore banks, which the Fund’s OFC assessment found to be mostly noncompliant with the BCP. Otherwise, domestic banks would continue to be exposed to reputational harm inflicted by the prevalence of “shell” institutions (Box 5). The authorities shared this concern in weighing the potential gains from a sounder financial system against the losses from a smaller offshore sector, which at present makes a very limited contribution to macroeconomic activity and government revenue.12 In addition, the global focus on combating money laundering and terrorist financing since 2001 had given further impetus to strengthening OFC oversight. In view of this, a new law is being finalized, so as to bring the regulatory and supervisory framework for offshore banks in line with domestic banks and under the control of the RBV. This law is also expected to clarify financial regulators’ on-site supervisory powers against existing secrecy provisions, which have constrained effective oversight. Consistent with these moves, steps are being considered to achieve the removal of OECD designation of Vanuatu as an uncooperative tax haven, which occurred in April 2002.

18. The authorities have completed the financial and operational restructurings of the state-owned National Bank of Vanuatu (NBV) and Vanuatu National Provident Fund (VNPF), but acknowledged that the AMU set up to handle nonperforming loans (NPLs) transferred from the NBV and VNPF had underperformed. In view of low NPL recoveries, government budget support was provided to the AMU in April 2002 to repay the NBV, effectively recapitalizing the bank.13 Prospects for future recoveries remain low, owing to the poor quality and depressed value of the assets transferred to the AMU. The staff recommended that the government formulate a clear and timebound strategy for quickly resolving bad loans by selling foreclosed properties and writing off NPLs with no prospect for recovery to limit fiscal risks.14

D. Other Issues

19. Progress in other structural areas has been slow since the last consultation, limiting long-term growth prospects.

  • On SOE reform, the process of privatizing and commercializing SOEs as envisaged in the original CRP framework is yet to be completed. Since 2000, the government has sold or liquidated ten small and medium-sized SOEs (namely in fishery and livestock activity and wholesale and retail trade). In addition, its remaining shares in the electricity company were divested in early 2002. However, no action has been taken on Air Vanuatu, which was to be partially privatized in 2001.15 This and additional privatizations originally envisaged in 2002 (most notably NBV and Telecom Vanuatu) are being delayed until the authorities complete a review of their divestment strategy, which is expected by year-end. In particular, the authorities cited the need to find ways to counter an expected fall in government revenue from further divestment. As most of the 20 wholly or partially-owned SOEs are loss-making, the staff urged a more aggressive approach to downsizing the public sector, noting a loss in government revenue could be offset by limits on tax exemptions extended to new owners.

  • On trade reform, WTO accession stalled just prior to completion in late 2001 because of requests for wider sector openings and lower binding rates—mainly from the United States.16 The authorities cited the need to build internal political support to reconcile these differences, which the staff encouraged be done quickly to build on the progress so far. The authorities are also pursuing commitments under the Melanesian Spearhead Group (MSG) trade agreement17 and seeking ratification of the Pacific Island Countries Trade Agreement (PICTA), which the staff welcomed. The MSG is seen as a stepping stone to the PICTA, under which the maximum tariff rate with the 13 other Pacific Island Forum countries is expected to fall from the current 30 percent to 25 percent by January 2004 and gradually to zero by 2012.

  • In the areas of private sector development and FDI, the authorities recognized that prospects depended on swift and effective actions to reduce administrative constraints, including streamlining land procurement and business licensing procedures. They also noted concerns about the effect of Vanuatu’s cost structure on new business development, citing plans to establish a body to regulate utility prices, which are high by regional standards. The staff cautioned against the use of direct price controls on general commodities, in light of the reactivation of the Price Control Board in 2001, which at this stage is only monitoring price developments.

20. The authorities have made a number of improvements recently in statistical methods and reporting, which should assist in policy formulation and monitoring (Annex V). In two of the weaker statistical areas—national income accounts and the balance of payments—work is ongoing to improve accuracy and coverage with donor technical assistance. Surveillance is expected to be enhanced by the authorities’ commitment to provide regular and timely updates of key economic and financial data. The staff also encouraged Vanuatu’s timely participation in the Fund’s General Data Dissemination System (GDDS).

IV. Staff Appraisal

21. Vanuatu faces a number of challenges to address recent poor growth performance and a weakened external situation. To its credit, macroeconomic stability has been maintained and external vulnerability is still manageable, despite frequent shocks and an uncertain policy environment. However, growth continues to trend downward, which points to the need to bolster external competitiveness and, in turn, expand productive opportunities. Medium-term prospects hinge on further actions on the fiscal and structural front. Given the low and declining level of per capita income, decisive steps are needed to deepen the reform agenda. Otherwise, Vanuatu risks further eroded competitiveness and diminished growth prospects, which could act to undermine macroeconomic stability and increase political and social tensions as a result of limited employment opportunities and rising urban drift.

22. The overall fiscal situation has improved, but substantial additional actions are needed to achieve lasting fiscal consolidation. A sound fiscal policy requires a further strengthening of VAT and customs administration and improvements to expenditure control and debt management. To this end, most immediately, passage of the excise act by end 2002 is essential for revenue performance. The government wage bill must also be reduced as a share of GDP to ensure sufficient resources for key social and infrastructure needs. Government subsidies should be limited, as their recent use points to wider problems arising from a lack of export diversification and narrowness of the production base, which require far reaching solutions. Close coordination is needed with donors on a public investment program that promotes more broad-based growth with continued caution in incurring new public debt.

23. Monetary conditions eased in the first half of 2002, but a cautious stance is expected for the year as a whole and beyond. This will require close monitoring of the current situation by the RBV to ensure domestic liquidity conditions are consistent with the inflation prospects and the external position. In line with this, the use of central bank advances to finance the budget should be strictly limited, as it also carries the risk of undermining fiscal discipline. Additionally, steps should be taken to restrict outside interference in central bank operations to ensure sound monetary management.

24. The external position warrants close attention to exchange rate policy and reserves management. While the adjustable peg exchange rate arrangement is broadly appropriate, the weakening of the external position remains a source of concern. Sound macroeconomic policies and additional structural reforms would be expected to strengthen overall competitiveness and the external position. However, in the event of a further deterioration, exchange rate adjustment may be necessary. As an immediate step to maintaining reserve levels, measures to deepen the interbank foreign exchange market should be adopted, including by publicly disclosing the nature of the currency basket.

25. Progress has been made in strengthening the regulation and supervision of the onshore banks, but more stringent oversight of the offshore banks is needed to safeguard the domestic system. Passage of legislation aligning the onshore and offshore supervisory regimes will serve as an important first step. There is little justification for not acting quickly and decisively in this area, when weighing the OFC’s limited overall economic contribution to the domestic economy against its potential reputational harm. However, the RBV will need adequate resources and support for proper enforcement, including technical assistance.

26. Further steps have been taken to strengthen the NBV and VNPF, but close supervision is necessary to ensure continued sound finances in order to minimize fiscal risk. Consistent with this, a more aggressive approach should be taken by the AMU on NPL recoveries, given delays so far and limited budget resources.

27. In other structural areas, additional reforms are needed in view of recent growth performance and the high cost structure. SOE reform should continue without further delay, given the SOEs’ poor performance and small budget contribution and the government’s limited management capacity. Trade commitments need to be implemented in a timely way, including WTO accession, to improve market access and reduce costly barriers, and with a view to attracting FDI. Private investment could also benefit from a more transparent legal and regulatory framework. However, with a narrow tax base and low tax take, tax exemptions to investors should be limited in scope and applied uniformly.

28. Statistical reporting and coverage in Vanuatu have improved in recent years, and further changes are being made to allow more effective surveillance. Participation in the GDDS would provide a useful foundation for setting out future commitments in statistical areas.

29. It is proposed that the next Article IV consultation with Vanuatu take place on the current 24-month cycle.

Vanuatu—Regional Comparison of Competitiveness

Vanuatu’s competitiveness vis-à-vis other countries in the region is relatively low, when considering a broad range of indicators (see table below). In real effective terms, Vanuatu’s exchange rate has stayed largely unchanged since the mid 1990s. This contrasts with Fiji—the South Pacific region’s largest overall economy and tourism market, which has experienced a real effective depreciation equivalent to 15 percent.

Real GDP growth in Vanuatu since the mid 1990s has also been lower than in neighboring countries. The selected issues paper for this consultation contains background notes on recent growth performance and regional competitiveness, suggesting that despite similar structures of and shocks faced by the region’s economies, low growth in Vanuatu can be partly attributed to competitive disadvantages.

uA01fig05

Real Effective Exchange Rate, January 1995-August 2002 (2000=100)

Citation: IMF Staff Country Reports 2002, 265; 10.5089/9781451840490.002.A001

Sources: Information Notice System, and staff estimates.
uA01fig06

Real GDP, 1995-2001

(1995 = 100)

Citation: IMF Staff Country Reports 2002, 265; 10.5089/9781451840490.002.A001

Sources: Vanuatu authorities, and staff

Other Competitiveness Indicators 1/

article image
Sources: National authorities and telecommunications providers; World Bank, World Development Indicators, 2002; International Telecommunication Union, World Telecommunication Development Report 2002; IFS and Fund staff estimates.

For 2001, unless otherwise indicated.

For 2000.

As of September 2002.

Excludes effective rates from specific import duties and ad valorem rates on selected luxury items.

Vanuatu—Fiscal Management and the Comprehensive Reform Program

Since the last consultation, the government has taken some further steps to improve fiscal management in the context of its Comprehensive Reform Program (CRP). At the time, the CRP was entering its final (i.e., third) phase, which among its major remaining tasks looked to put into practice the principles of sound fiscal management laid out in legal and administrative measures taken in the earlier phases. The centerpiece of these actions was the Public Financial and Expenditure Management (PFEM) Act of 1998. It, along with several other acts, requires the government to take steps to strengthen budget preparation and monitoring and fiscal reporting and information systems. To improve budget transparency, the PFEM Act also necessitates the government prepare and implement a program-based budget. In addition, the act stipulates a prudent debt management.

In the area of budget preparation and fiscal reporting, some positive steps have been taken. The government has published an annual fiscal strategy report since 1999, which reviews recent economic performance and sets out main budget objectives in the forthcoming year. Included in this is a budget policy statement, summarizing prospective policy initiatives. In keeping with the PFEM Act, the government also prepares a monthly budget report and half yearly financial and economic update for budget monitoring and control purposes, but these reports are not published. Budget estimates still tend to overinflate wage requirements, based on the use of unapproved plans by certain line ministries to expand administrative structures. As a result, operational expenditure tends to go underbudgeted. Budget execution could also improve by ensuring fiscal reports are used to provide timely feedback to ministerial departments (i.e., the spending units). A financial management information system was also introduced in mid 2002 to improve program budgeting and expenditure tracking.

Budget implementation still remains a problem owing to a tight cash situation, which has led the government to use a system of monthly warrants based on the cash plans of spending units. In addition, problems with cash management have forced the government to rely on central bank advances (limited to VT 400 million and repayable up to six months). While this has allowed the government to address temporarily the problems faced by revenue shortfalls, at times it restricts proper budget execution, owing to a lack of certainty about prospective budget releases and the lumpiness of certain budget outlays (the problem is mainly in operational expenditures of line ministries, as wages are managed centrally and capital expenditure is mostly tied to external financing). In 2002, the situation has improved, in part due to better revenue planning.

Despite steps taken under the CRP to contain the number of government personnel and reduce the government wage bill as a share of total spending, limited additional progress has been made. In the first two phases of the CRP, the number of ministries was cut from 34 to 9 (but subsequently raised to 13), and the size of the civil service was reduced by 7 percent. However, the number of government departments stayed relatively constant, and there is still some substantial overlap in tasks. In addition, the wage bill has remained generally unchanged as a share of GDP and risen as a share of total recurrent expenditure. As of end-2000, there were approximately 4,500 public workers (30 percent of formal sector employment). Concerns also remain over the hiring of advisory and contractual (i.e., temporary) personnel. To address the latter, the Ministry of Finance and Economic Management implemented system of financial visas in 2002, under which it must authorize all new hires.

The government has also set limits on borrowing in its recent budget statements, but not directly on domestic debt. Currently, the ceiling on the total stock of external public debt stands at 40 percent of GDP and on annual public debt service payments (defined as domestic and foreign interest payments and external amortization payments) at 8 percent of government revenue. Based on 2001 budget estimates, external public debt was 31 percent of GDP at end-2001 and public debt service payments (excluding debt forgiveness) were 5 percent of revenue that year.

Vanuatu—Medium-Term Outlook and Risks

Under an illustrative reform scenario and assuming no major shocks, real GDP growth in Vanuatu is envisaged to pick up to about 3 percent a year during 2003-07, rising to 4 percent by 2007 (Table 6). This would be based on an increase in productivity growth and investment activity resulting from the reforms. However, with population growth of 2½ percent a year, per capita GDP (in U.S. dollar terms) in 2007 would only be at the same level as in the mid-1990s. Inflation would be expected to stay in the range of 3-4 percent a year, reflecting prudent monetary management and declining oil prices over the medium term. Fiscal policy would be geared to maintaining low single-digit budget deficits and refocusing spending on key social and infrastructure needs, including in outer island and rural areas, in support of growth. In the event, government debt would remain sustainable, peaking at 40 percent of GDP in 2002, and slowly declining to 35 percent of GDP by 2007.

Higher sustained growth would be underpinned by an improved external position.

  • The current account deficit would be expected to narrow to around 1 percent of GDP by 2005. The effects on external demand of productivity gains from structural reforms would be expected to more than offset a pick up in domestic demand, including from some impact of trade liberalization on imports.

  • Official inflows would rise gradually in line with improved fiscal management, but external debt would remain at manageable levels, especially given the move to grant financing among donors. FDI inflows would also be expected to pick up in response to a more favorable investment climate, in particular in the tourism-related sectors, and also possibly in agro-processing, fisheries and livestock, and light manufacturing.

  • Under these circumstances, the improved external position would allow an increase in the gross reserve cover to 3½ months of prospective imports by 2007.

The main downside risks to this scenario would arise from a lack of progress in addressing key fiscal and structural challenges. Steady implementation of a reform agenda would likely require maintenance of a stable political situation. Under a low case scenario, GDP growth would stay in the very low single digits, with the high cost structure (including real interest rates) persisting, and public spending staying oriented towards low priority outlays. The current account deficit would widen to 3-4 percent of GDP due to continued weaknesses in external demand. Official and FDI inflows would also be considerably lower. In this case, the reserve cover would continue decrease to 2 months of imports by 2007. Public external debt would stay manageable, but domestic debt would likely rise owing to a lack of revenue buoyancy and spending discipline. Pressure would weigh heavily on the exchange rate to adjust for external imbalances.

uA01fig07

Per Capita GDP

(In U.S. dollars)

Citation: IMF Staff Country Reports 2002, 265; 10.5089/9781451840490.002.A001

uA01fig08

Exports of Goods and Nonfactor Services

(In millions of U.S. dollars)

Citation: IMF Staff Country Reports 2002, 265; 10.5089/9781451840490.002.A001

uA01fig09

Current Account Deficit

(In percent of GDP)

Citation: IMF Staff Country Reports 2002, 265; 10.5089/9781451840490.002.A001

uA01fig10

Gross Official Reserves

(In months of prospective imports)

Citation: IMF Staff Country Reports 2002, 265; 10.5089/9781451840490.002.A001

Table 6.

Vanuatu: Medium-Term Scenario, 2000–2007 1/

article image
Sources: Vanuatu authorities; and Fund staff estimates and projections.

This medium-term outlook represents a reform scenario, as discussed in Box 3.

Including official transfers.

Medium- and long-term public debt only.

In percent of exports of goods and nonfactor services.

For 2001, includes debt forgiveness.

Vanuatu—Policy Challenges and Responses

The staff noted several major policy challenges during the 2000 Article IV consultation, which are summarized in the table below. Also described are (i) the authorities’ policy actions since 2000, and (ii) the staff’s assessment of remaining challenges in each area made during the 2002 Article IV consultation.

article image