Vanuatu
Selected Issues and Statistical Appendix
Author: International Monetary Fund
Publication Date:
11 Dec 2002
eISBN:
9781451840537
ISBN:
9781451840537
Language:
English
Keywords:
ISCR; CR; Vanuatu; Vanuatu authorities; bank; enterprise
Download PDF (1.4 MB)

This Selected Issues paper and Statistical Appendix summarizes the factors explaining Vanuatu’s recent growth performance, which has weakened since the mid-1990s. The paper highlights that Vanuatu’s annual rate of growth averaged ¾ percent during 1997–2001, compared with 4¾ percent during 1992–1996. The paper compares Vanuatu’s external competitiveness with several other small island economies in the South Pacific region. The paper describes the development and structure of Vanuatu’s offshore financial center, examines its macroeconomic impact, and highlights some key recent developments. It also provides a preliminary assessment of the prospects for the sector.

Abstract

This Selected Issues paper and Statistical Appendix summarizes the factors explaining Vanuatu’s recent growth performance, which has weakened since the mid-1990s. The paper highlights that Vanuatu’s annual rate of growth averaged ¾ percent during 1997–2001, compared with 4¾ percent during 1992–1996. The paper compares Vanuatu’s external competitiveness with several other small island economies in the South Pacific region. The paper describes the development and structure of Vanuatu’s offshore financial center, examines its macroeconomic impact, and highlights some key recent developments. It also provides a preliminary assessment of the prospects for the sector.

I. Recent Growth Performance

1. This note summarizes factors explaining Vanuatu’s recent growth performance, which has weakened since the mid-1990s. Based on official estimates, the annual rate of growth averaged ¾ percent during 1997–2001, compared with 4¾ percent during 1992–1996 (Figure I.1 and Table I.1.). Population growth has remained steady, at 2¾ percent a year during 1992–2001. On a per capita basis, GDP declined from an estimated $1,200 in 1991 to $1,117 in 2001. A recent poverty analysis found 7 percent of all households (in 1998) still lived on less than one U.S. dollar per day, with three–quarters of these in rural areas.1

Figure I.1.
Figure I.1.

Vanuatu: Real GDP, 1992–2001

(Annual percentage change)

Citation: IMF Staff Country Reports 2002, 266; 10.5089/9781451840537.002.A001

Sources: Vanuatu authorities and staff estimates.
Table I.1.

Vanuatu: Real GDP, 1992–2001

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Sources: Vanuatu authorities; and Fund staff estimates.

2. In 2001, GDP is estimated to have contracted by slightly under 2 percent (Statistical Appendix (SA) Table 1). Agricultural output was affected by two cyclones early in the year, in particular copra and cocoa production, which in volume terms declined by 28 percent and 49 percent, respectively (SA Table 3). On the other hand, the output of kava, a tuberous crop used to produce traditional drink and medicine, nearly doubled. Industrial output, in particular manufacturing, was driven downward by a drop in commercial meat production, because of declining demand in neighboring countries. The decline was partially offset by coconut oil production (for export), which rose sharply as a new processing mill that opened in 2000 reached full capacity. The poor performance in wholesale and retail trade is reflected in low demand for non-oil imports, which rose by only 1 percent in 2001 (in U.S. dollar terms), following a drop by 16 percent in 2000 (SA Table 19).2 Tourism also declined (Figure I.2), owing to the global slowdown and travel concerns, as well as improvements in the security situation in Fiji—a major competitor in this market.

Figure I.2.
Figure I.2.

Vanuatu: Arrivals from Abroad 1/

(in percent of total visitor arrivals, unless otherwise indicated)

Citation: IMF Staff Country Reports 2002, 266; 10.5089/9781451840537.002.A001

Sources: Vanuatu authorities; and Fund staff estimates.1/ Excludes day visitors from cruise ships.

3. The low rate of growth in recent years appears to be related to both trend (namely domestic) and exogenous factors. Growth has been constrained by structural weaknesses, a lack of infrastructure development, and political instability. Vanuatu has experienced ten changes in government over the past decade (including three since late 1999), increasing policy uncertainty, straining budget discipline, and weakening investor confidence. Weather–related shocks have also played a role, most recently in 1999 and 2001, when cyclones severely affected copra production—traditionally the largest export. The Commonwealth Secretariat recently ranked Vanuatu as the most vulnerable country to natural disasters among 111 developing countries. It averaged 2.6 cyclones a year during 1970–1996. In addition, Vanuatu is prone to frequent earthquakes and volcanic eruptions. It is also subject to large terms of trade shocks, which for some exports (namely copra, cocoa, and kava) have been severe in recent years (Figure I.3) The external environment stayed generally strong, on average, across the two periods, although with a considerable weakening in 2001 (Figure I.4).

Figure I.3.
Figure I.3.

Vanuatu: Commodity Export Prices 1/

(1996/97 = 100)

Citation: IMF Staff Country Reports 2002, 266; 10.5089/9781451840537.002.A001

Sources: Vanuatu authorities; and Fund staff estimates.1/ Based on U.S. dollar prices per metric ton.
Figure I.4.
Figure I.4.

Real GDP Growth for Vanuatu and Major Trade Partners

(period average)

Citation: IMF Staff Country Reports 2002, 266; 10.5089/9781451840537.002.A001

Sources: National authorities; and Fund staff estimates.

4. New GDP data on an expenditure basis are expected to be published through 2001 by end year, but related indicators point to a drop in investment in recent years (Table I.2), which may explain some of the slowdown in growth. Preliminary estimates (through 1999) show gross fixed capital formation (as a share of GDP) lower on average by 2 percentage points of GDP a year in 1997–1999 than in 1992–1996. In line with this, growth in government capital expenditure and FDI has declined as a share of GDP. Nonetheless, real GDP growth attributable to construction activity outpaced overall real GDP growth during 1997–2001—a reversal from the previous period, but this appears to have been a result of increases in the housing stock rather than productive outlays. Growth in bank credit (in real terms) also slowed considerably during 1997–2001, although both construction and housing activity took up a larger share of outstanding loans.

Table I.2.

Vanuatu: Investment Indicators

(In percent of GDP, unless otherwise indicated)

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Sources: Vanuatu authorities; and Fund staff estimates.

Annual percentage change, in real terms.

Data through 1999 only.

Thousands of square meters of new floor area.

As a share of total bank credit.

5. On a sectoral basis, the slowdown in growth in the second half of the 1990s was most pronounced in services, in particular when tourism–related activity is excluded. Wholesale and retail sales and government services experienced the sharpest declines in growth, reflecting weak primary and secondary sector activity and lower recurrent outlays by government (but primarily in non–social sectors). The overall contributions to growth of agriculture and industry remained very limited. As noted, the agricultural sector has been subject to several major supply shocks in recent years. More generally, growth in primary products, which account for most merchandise exports, has been impeded by the unreliable transport, costly inputs, and market size, which affect external competitiveness.

6. Focusing on agriculture and fisheries, although this sector makes a relatively small direct contribution to GDP, its growth is critical to further poverty reduction. Approximately 80 percent of the labor force remains tied to subsistence activity, and the recent poverty analysis found 90 percent of all poor households were involved in agricultural activity of some kind. In recent years, copra output, a mainstay of rural incomes, has been particularly hard hit. An Asian Development Bank (AsDB) study noted that depressed earnings along with credit inaccessibility had left a number of small farmers without adequate resources to replace drying equipment, resulting in deterioration in copra quality.3 Subsidies for copra farmers provided by the Vanuatu Commodity Marketing Board since mid-2001 are likely unsustainable given world price trends and limited financial resources. However, long lasting solutions to agriculture and fisheries development appear rooted in a greater diversity of products and activities, including agro–processing and commercial fishing, which remain severely underdeveloped. Growth prospects in these and other sectors, including for export, hinge on building skills and attracting investment and, relatedly, addressing competitiveness concerns (see Section II).

II. Regional Comparison of Competitiveness

A. Introduction

1. This note compares Vanuatu’s external competitiveness with several other small island economies in the South Pacific region. Economic growth in Fiji, Samoa, and Tonga, as well as Vanuatu, is constrained by a small domestic market, limiting economies of scale and narrowing the production base.4 As a result and in view of low growth in traditional sectors, a number of Pacific Island countries (PICs) have attempted to develop export sectors to bolster overall growth. However, with the exception of Fiji, merchandise exports remain generally small, although travel receipts arising largely from tourism also provide an important source of foreign exchange, especially in Fiji and Vanuatu. Given the region’s isolation, maintaining well–valued exchange rates, implementing macroeconomic policies conducive to containing production costs, and ensuring an open trade and investment regime are factors that weigh heavily on the region’s competitiveness.

B. Recent Performance

2. In Vanuatu, a weak external position and declining foreign reserves since the late 1990s have raised competitiveness concerns, as has more generally the recent slowdown in economic growth (see Section I). Exports of goods and nonfactor services (GNFS) increased by an average of only 1½ percent a year (in U.S. dollar terms) during 1997–2001. Merchandise exports peaked in 1997, but have declined each year since, with the exception of 2000, reflecting lower export volumes and falling commodity prices (Figure II.1). Copra, traditionally Vanuatu’s largest commodity export, accounted for nearly all of this reduction, although in 2000 and 2001 the drop was partially offset by coconut oil exports (Figure II.2). Travel receipts, which contribute one–third of total exports of GNFS, have also been down—in 2001, they were roughly three–quarters of the peak in 1998. This occurred despite steady growth in the number of foreign arrivals through 2000 (by an average of 3¼ percent a year in the 1990s), nearly two–thirds of which typically come from Australia.5 Overall, the current account balance registered a very modest deficit (averaging 0.1 percent of GDP during 1997–2001) (SA Table 16). However, with the capital and financial account also in deficit (due in part to a sizeable drop in FDI), gross official reserves declined noticeably, from $43 million (4 months of prospective imports) at end–1996 to $38 million at end–2001 (3 months of imports).

Figure II.1.
Figure II.1.

Vanuatu: Merchandise Exports and Tourism Receipts, 1992–2001 1/

(In millions of U.S. dollars)

Citation: IMF Staff Country Reports 2002, 266; 10.5089/9781451840537.002.A001

1/ Excludes re-exports.
Figure II.2.
Figure II.2.

Vanuatu: Merchandise Exports by Commodity, 1992–2001 1/

(In millions of U.S. dollars)

Citation: IMF Staff Country Reports 2002, 266; 10.5089/9781451840537.002.A001

Sources: Vanuatu authorities; and Fund staff estimates.1/ Excludes re-exports.

3. A brief comparison of the recent economic performance in the four PICs generally reveals similar declines in real GDP and export growth in recent years (Table II.1 and Figure II.3). Merchandise exports as a share of GDP have stagnated (Figure II.4). Travel receipts have also come under pressure, which in part is due to greater inter–regional competition, most notably from Indonesia and Thailand owing to lower effective costs brought on by the Asian financial crisis. While it is beyond the scope of this note to discuss factors that might explain these slowdowns, the relatively poor performance suggests that the inability to improve external competitiveness may be limiting the prospects for achieving sustained growth.

Table II.1.

Recent Macroeconomic Performance

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Sources: National authorities; and Fund staff estimates.

Excludes re-exports.

Based on fiscal year ending June 30.

Figure II.3.
Figure II.3.

Regional Comparison of Real GDP Growth

(period average) 1/

Citation: IMF Staff Country Reports 2002, 266; 10.5089/9781451840537.002.A001

Sources: National authorities; and Fund staff estimates.1/ For Tonga, fiscal year basis ending June 30.
Figure II.4.
Figure II.4.

Exports to GDP, 1991-2001 1/2/

(in percent)

Citation: IMF Staff Country Reports 2002, 266; 10.5089/9781451840537.002.A001

1/ Excludes re-exports.2/ For Tonga, fiscal year basis ending June 30.

4. The export base of each PIC, with the exception of Fiji, has remained concentrated in relatively few agricultural and fishery products (Table II.2). Growth has also tended to concentrate in only a few items—garments in Fiji, fish in Samoa, and kava and coconut oil in Vanuatu. In the case of Vanuatu, five primary products accounted for nearly three–quarters of the total value of merchandise exports in 2001. Each product is susceptible to large terms of trade shocks, which in the case of copra saw a drop in the unit price (in U.S. dollar terms) by 60 percent between 1999 and 2001. Copra exports were also affected by weather–related shocks in 1999 and 2001.

Table II.2.

Export Concentration

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Sources: National authorities; and Fund staff estimates.

Gini-Hirschman coefficient for four largest commodity exports, where 1 is the highest degree of export concentration (i.e., a single commodity export).

Based on fiscal year ending June 30.

C. Competitiveness Indicators

5. The most readily available indicator of external competitiveness is the real effective exchange rate (REER). A comparison of REER developments in the four PICs since the early 1990s suggests that Vanuatu has experienced some loss in competitiveness in relation to the region (Figure II.5). Focusing on the “slow growth” period (i.e., since end–1996), Vanuatu’s REER has appreciated by nearly 10 percent. During the same period, the REER of Fiji depreciated by 15 percent, largely reflecting a 20 percent devaluation of the Fiji dollar against a basket of currencies in January 1998. Tonga’s REER depreciated by 10 percent, while Samoa’s REER appreciated by a modest 2 percent.6 The steady real effective appreciation of the vatu since late 1996 has come at a time when Vanuatu has undertaken some structural reform and trade liberalization. However, weak overall economic performance during 1997–2001 compared with 1992–1996 and recent signs of deterioration in the current account would tend to counter the view that reform has brought a shift in the equilibrium exchange rate.

Figure II.5.
Figure II.5.

Real Effective Exchange Rates, January 1992-August 2002

(2000=100)

Citation: IMF Staff Country Reports 2002, 266; 10.5089/9781451840537.002.A001

Sources: IMF, information Notice System, and Fund staff estimates.

6. Factors that possibly explain Vanuatu’s low competitiveness vis-à-vis the region include a relatively high cost structure, lack of infrastructure development, and restrictive trade and investment regime. Cross–country data on average wage levels and unit labor cost (ULC) are not readily available.7 However, non–wage costs also appear to be higher in Vanuatu compared with the three other PICs, when looking at utility and transport related charges. Electricity and telecommunication costs are much higher in Vanuatu compared with the other PICs (Table II.3), partly due to greater geographical dispersion of its population, which affects transmission and distribution charges. In Vanuatu, each service is provided by a local monopoly (partially government–owned in the case of telecommunications), which is largely unregulated. Fuel costs in Vanuatu, including and excluding taxes, are also among the highest in the region. The retail price of gasoline (including VAT and customs duties) in Vanuatu in mid-2002 was approximately US$0.75 per liter, or about 40 percent higher than the comparable price in Fiji and Tonga and 75 percent higher than in Samoa (only New Caledonia exceeded Vanuatu in the South Pacific region)8. The lack of an adequate road network and port facilities also contributes to high overall transport costs, as does the lack of competition among shipping lines because of low volumes (Table II.4). The AsDB also estimates that air transport is on average 60 percent higher than in neighboring countries.9

Table II.3.

Electricity and Telecommunications Indicators 1/

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Sources: National telecommunications providers; South Pacific Forum Secretariat; International Telecommunication Union, World Telecommunication Development Report 2002; World Bank, World Development Indicators.

For 2001, unless otherwise indicated. All regional data for 2000.

As of September 2002.

Table II.4.

Transport Infrastructure Indicators 1/

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Sources: World Bank, World Development Indicators, 2002.

For 2000, or latest period available.

Land mass only.

By carriers designated by the U.S. Department of Transportation as major and national air carriers.

7. Other cost–related factors include the degree of taxation and the level of real interest rates, on which Vanuatu’s performance vis-à-vis the region is mixed. On taxation, the ratio of tax revenue to GDP is about the same across the four PICs (Table II.5). However, unlike the other countries, Vanuatu has no corporate (or personal) income tax. As a result, the tax take is geared more towards VAT and customs duties. Tax exemptions are reported to be widely used, especially for state-owned enterprises and large (including foreign–owned) businesses. Under such circumstances, the tax burden falls disproportionately on small and medium–scale enterprises, which are considered an important engine of growth. On real interest rates, both real lending rates and interest rate spreads were the highest in Vanuatu in 2001, in part reflecting high operating costs, as well as prospective credit risk and policy uncertainty in the current low growth environment (Table II.6).

Table II.5.

Government Revenue and Expenditure

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Sources: Vanuatu authorities; and IFS and Fund staff estimates.

Excludes net lending.

For fiscal year ending June 30.

Table II.6.

Interest Rate Spreads

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Sources: Vanuatu authorities; and IFS and Fund staff estimates.

Period average.

8. The level of productive outlays by the government is relatively low in Vanuatu compared with Samoa, but in line with Fiji. In Vanuatu, government capital expenditure averaged 5.7 percent of GDP during 1997–2001, down from 6.8 percent of GDP during 1992–1996. At the same time, the government wage bill also declined by about 1 percentage point of GDP, but in 2001 still accounted for nearly one–half of total government spending.

9. The degree of openness of the trade and investment regime is difficult to compare across countries, but Vanuatu has shown signs of improvement. Changes in Fiji, Samoa, and Vanuatu have been guided, in part, by comprehensive reform programs in recent years. In Vanuatu’s case, tariff rates were brought down with the introduction of a VAT in 1998, but the number of bands and dispersion of rates is still larger than in the three other PICs. The prevailing import tariff rates in Fiji are 0–27 percent, Samoa 0–20 percent, Tonga 0–25 percent, and Vanuatu 0–55 percent. For Vanuatu, this also excludes effective rates from specific import duties and ad valorem rates on selected luxury items, which are considerably higher. Vanuatu nearly completed WTO accession in late 2001, but its bid stalled owing to domestic concerns about requests for wider sector openings and lower binding rates (Fiji joined the WTO in 1996, but Samoa and Tonga, like Vanuatu, only have observer status). Vanuatu, as well as Fiji, Samoa, Tonga and ten other countries, is also a party to the Pacific Islands Countries Trade Agreement (PICTA) finalized in 2001, which aims to set up an FTA among member states by 2014. To date, Fiji, Samoa, and Tonga, as well as the Cook Islands, have ratified the PICTA, which will begin to come into force with two additional signatories.10 With respect to foreign investment, some attempts have been made in Vanuatu to streamline approvals, following the establishment Foreign Investment Board (now Foreign Investment Authority) in 1998. However, these approvals still require the agreement of ministries charged with oversight of certain sectors of the economy, which tends to lengthen the process. In addition, new investors must contend with obtaining land user rights,11 completing environment assessments, and negotiating tax exemptions.

D. Conclusion

10. The above discussion suggests that Vanuatu’s degree of competitiveness is low when compared to other countries in the region. While PICs tend to have relatively low populations and narrow production bases, Vanuatu appears to have a particularly high cost structure. In order to improve competitiveness, effective steps need to be taken to lower and contain costs. This includes the maintenance of macroeconomic stability through sound fiscal and monetary management and adequate exchange rate flexibility. On the fiscal front, in particular, a broadening of the tax base and containment of tax exemptions are important, so as to reduce the burden on individual taxpayers. Refocusing spending towards capital expenditure is needed to upgrade and expand basic infrastructure, especially in outer island areas, but this will require further containment of unproductive outlays, including the wage bill. Trade reforms need to concentrate on lowering effective duties and reducing discretionary exemptions, as well as putting WTO accession back on track and meeting other bilateral and multilateral trade commitments. The investment regime could also benefit from a more transparent and streamlined regulatory framework, to contain startup and operating costs.

III. Developments in the Offshore Sector

A. Introduction

1. Vanuatu’s offshore sector has been a long–standing feature of its economy. Originally seen as a potential boon to financial sector development and economic growth, Vanuatu’s offshore financial center (OFC) has stagnated in recent years. Increased global scrutiny of the nature and source of international financial flows has raised the profile of OFC–related issues, with the Vanuatu authorities currently considering significant changes to the legal and regulatory framework governing the OFC. This note describes the development and structure of Vanuatu’s OFC, examines its macroeconomic impact, and highlights some key recent developments. In addition, it provides a preliminary assessment of the prospects for the sector.

B. Background

2. Vanuatu’s offshore sector was created in 1971, the first among the Pacific Island countries. At the time, Vanuatu was being administered jointly by France and the United Kingdom, and the development of an offshore financial centre was seen as a potential source of growth for a geographically–isolated and largely undiversified economy. A separate regulatory regime was adopted for the offshore sector with the enactment of the Banking Act in 1970. The act allowed the establishment of “exempt institutions” largely free from oversight and taxation, but prohibited from transacting with Vanuatu residents. The size and range of services offered by the OFC continued to expand following Vanuatu’s independence in 1980, with minimal changes to the legal and regulatory framework.

3. At end-2001, the offshore sector comprised 38 banks, 15 insurance companies, and 10 trust companies.12 In addition, about 4,300 international companies are registered in Vanuatu, as well as a small number of firms providing legal and accounting services.13 As a whole, Vanuatu’s OFC is relatively small (for example, in 2000 the Cayman Islands’ OFC consisted of 450 banks, 500 insurance companies, and nearly 50,000 international companies).

4. Little information is available on the activities of offshore entities. All offshore entities are required to register with and pay annual registration fees to the Vanuatu Financial Sector Commission (VFSC), a quasi–public agency currently charged with oversight of the OFC. However, there is no requirement for offshore entities to maintain a physical presence in Vanuatu, nor to prepare annual reports of their financial transactions or operational plans. The 1986 Companies Act includes strong secrecy provisions that limit the ability of government agencies (including the courts) to acquire or share information on the operations of offshore entities. Offshore entities are not subject to income, withholding, and capital gains taxes, and Vanuatu does not maintain tax treaties with other countries. Most offshore banks appear to operate as in–house treasuries for foreign conglomerates and wealthy individuals. Trust companies are seen to facilitate the creation of asset holding companies, while international companies on the corporate registry likely undertake more complicated financial operations.

5. The size of the offshore financial sector has stagnated in recent years (Table III.1). The number of offshore banks has fallen sharply from 88 in the mid-1990s (and over 100 at the peak) to 34 in mid-2002, while the number of insurance companies has increased modestly over the same period. In contrast, the number of international companies registered with the VFSC has more than tripled since 1995, following the enactment of the International Companies Act in 1993, which created a separate registration procedure for non–financial companies.14 There is no reliable information on the amount of assets controlled by offshore entities. However, unofficial estimates indicate that offshore banks had over $2 billion in deposits at end–2001. This compares with total domestic bank deposits of $230 million.

Table III.1.

Vanuatu: Number of Offshore Sector Entities, 1980–2002

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Sources: Vanuatu Financial Services Commission; and Fund staff estimates.

Prior to the International Companies Act of 1993, all offshore companies were registered as exempt companies. Starting 1993, only financial sector offshore companies are required to register as exempt companies.

Incorporated as domestic companies, but providing offshore services.

6. The activities of offshore entities are largely unsupervised. The Module II OFC Assessment conducted by the Fund’s Monetary and Exchange Affairs Department in May 2002 determined that the VFSC failed to comply with most of the Basel Core Principles in regulating and supervising the OFC. In addition to its limited resources, the tight secrecy provisions of the Companies Act inhibit the VFSC from conducting effective oversight. However, under the Financial Transactions Reporting Act (FTRA) adopted in September 2000, offshore entities are required to report suspicious transactions to the Financial Intelligence Unit (FIU) in the State Law Office, but to date very few incidents have been reported. In contrast, the domestic banks, which also must comply with the act, have reported some suspicious transactions, but the ability of the FIU and others to investigate typically requires cooperation with foreign officials given the lack of a physical presence of potential offenders in Vanuatu.

7. Vanuatu has a mixed record on compliance with international initiatives to improve the oversight of offshore entities. Following the adoption of the FTRA, the Financial Action Task Force (FATF) determined that Vanuatu should not be included on its list of noncooperative countries with respect to money laundering. Separately, as part of its campaign against harmful tax practices, in 2000 the OECD included Vanuatu among a list of 35 jurisdictions which it deemed to be tax havens. In April 2002, the OECD designated Vanuatu, along with six other jurisdictions, as an uncooperative tax haven, given its failure to commit to improve the transparency of tax enforcement and to allow the effective exchange of information.

C. Macroeconomic Impact

8. The offshore sector makes a very limited contribution to the Vanuatu economy. Most of the offshore banks are “shell” operations, with only three offshore banks maintaining offices in Vanuatu, and most international companies have no connection to Vanuatu beyond the appointment of a local agent. Consequently, the contribution of the OFC to domestic demand is marginal (Table III.2). In particular:

  • The OFC is a relatively small source of employment for ni–Vanuatu residents. Official labor statistics consider employment in the financial sector as a whole, with no breakdown between onshore and offshore entities. However, the offshore sector is believed to employ at most 200 ni–Vanuatu (or 1½ percent of formal sector employment), including at domestically–incorporated entities that serve the OFC (e.g., trust companies, accounting firms, and insurance companies). In comparison, the three largest domestic banks employ almost 300 ni–Vanuatu.

  • OFC activity does lead to some increased turnover for domestic banks. Domestic banks mostly process flows through nonresident offshore accounts maintained by international companies. Otherwise, the domestic banks provide limited financial services to offshore account holders. As a result, the share of their staff devoted exclusively to the OFC is believed to be small. In addition, the domestic banks do not intermediate these accounts, owing to the nature and volatility of the deposits. For the most part, foreign currency deposits are placed with the parent bank, with the domestic bank earning a modest margin for this activity.

  • The OFC’s contribution to government revenue is very limited. The main source of revenue comes from company registration fees, including an incorporation fee of $ 150 in the first year, and an annual registration fee of $300 thereafter. Bank license fees currently are $5,000 a year. All fees are paid directly to the VFSC, which uses them to fund its operations (including marketing and promotion activities), with the net amount transferred to the government budget. In 2001, the VFSC collected about $0.8 million, with most of this transferred to the budget (equivalent to 1% percent of total government revenue). Revenue from the offshore sector has averaged under 2 percent of government revenue (excluding grants) since 1995. The loss of this revenue source could likely be offset through improvements in tax compliance and customs administration and stricter control over discretionary tax exemptions.

Table III.2.

Vanuatu: Economic Impact of Offshore Financial Center

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Sources: Reserve Bank of Vanuatu and Vanuatu Financial Services Commission; and Fund staff estimates.

Employment at trust companies and at accounting and legal firms. The latter provide services to both onshore and offshore companies.

Based on 2000 Labour Market Survey and assuming employment growth in line with real GDP growth in 1999 and 2001.

9. In the current global environment, the presence of the OFC has created additional burdens for domestic banks. Given the heightened concern of OFC’s possible facilitation of money laundering and terrorist financing activity, transactions with banks that have direct financial dealings with offshore entities have come under close international scrutiny, especially since the events of September 2001. In Vanuatu’s case, foreign banks have been seeking more assurances that domestic banks can verify the bona fides of the clients on whose behalf they are transacting. In particular, following the enactment of the U.S. Patriot Act in October 2001, banks in the United States face a greater burden in determining that their correspondent banking relationships are appropriate. As a result, the settlement of some external transactions processed through Vanuatu banks have been delayed and, in a number of cases, denied. Given its small and concentrated domestic banking system, the Vanuatu economy is particularly vulnerable to a disruption in the external operations of any of its three large commercial banks.

10. On balance, the reputational impact from the OFC sector appears to be negative. Some industry representatives maintain that the presence of an OFC promotes foreign investment and tourism. These potential positive benefits should be weighed against the negative impact of the OFC. Most importantly, without assurances that transactions are isolated from the OFC, there is a risk that foreign counterparties could decide to suspend their relationships with Vanuatu banks. Such a move would disrupt the normal banking and trade activities of Vanuatu companies. Separately, the OECD may decide to impose sanctions in line with its assessment that Vanuatu is an uncooperative tax haven. Such sanctions could include a withholding tax on the transfer of funds to Vanuatu, leading to a possible further disruption of external transactions.

D. Recent Developments

11. Recent steps have been taken to strengthen oversight of the OFC. Initial efforts have focused on tightening the framework for domestic banks’ transactions with offshore entities. The Reserve Bank of Vanuatu (RBV), which is responsible for the supervision of domestic banks, issued a “know your customer” guideline in mid-2002. By requiring domestic banks to verify the true nature of their transactions, the guidelines are expected to lead to requests for greater disclosure of offshore client activities. In connection with this, the RBV has also begun on–site inspections of the anti–money laundering procedures in place at domestic banks.

12. More fundamental changes to the regulatory and supervisory framework of the OFC are under consideration. While the supervisory regime for the domestic financial system was updated in 1999 with the adoption of Financial Institutions Act and is now largely compliant with Basel Core Principles, the offshore banking sector continues to be governed by the Banking Act of 1970. A new draft international banking act governing offshore banks is under final consideration which, if adopted, would improve the oversight of offshore banks. Among its provisions, the new act would unify the supervision of onshore and offshore banks under the RBV, applying similar requirements (with respect to capital adequacy, information disclosure, fit–and–proper evaluations of bank owners, etc.). The act would also require all offshore banks to maintain a physical presence in Vanuatu. In addition, by bringing the guidelines for information sharing and reporting in line with those prevailing for the domestic banking system, the act would relax some of the strict secrecy provisions of the existing setup.

13. The adoption of these measures will likely result in a further contraction of the OFC. Most offshore banks would be expected to cease operations in Vanuatu given increased direct supervision and the requirement to maintain a physical presence. The number of international companies may also shrink, as their transactions with onshore and offshore banks come under tighter scrutiny. In the short run, these entities would likely migrate to jurisdictions that maintain weaker supervision of their OFC. However, many countries with offshore sectors are in the process of strengthening their oversight of offshore entities (including through participation in multilateral initiatives). The role of the VFSC would also need to be reconsidered. Although responsibility for bank supervision would shift to the RBV under the new international banking act, oversight of nonbank financial companies (including insurance and trust companies) would remain with the VFSC. Also, the VFSC could increase its role in overseeing the activities of international companies, as well as maintaining the official register of domestic and offshore companies.

E. Conclusion

14. Vanuatu’s offshore sector is at a critical juncture. With the increased global focus on combating money laundering and improving the oversight of financial flows more generally, it will be difficult for the OFC to operate in its current form. Domestic banks are likely to continue to face internal and external pressure to limit their transactions with offshore banks, in light of the demands for greater transparency in their financial dealings. In view of this and the limited contribution of the OFC to economic activity, the overall impact of moves to tighten the supervisory regime is expected to be positive. On the one hand, the short–term impact is likely to result in some loss in financial sector employment and government revenue, but any further spillover would be expected to be limited. On the other hand, the reputational harm of the OFC would be expected to ease. Combined with the benefits of strengthened bank supervision, such reforms to the OFC sector should improve the overall soundness of Vanuatu’s financial system.

Table 1.

Vanuatu: Gross Domestic Product by Type of Economic Activity in Constant 1993 Prices, 1996–2001

(In millions of vatu, unless otherwise indicated)

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Sources: National Statistics Office and Reserve Bank of Vanuatu; and Fund staff estimates.
Table 2.

Vanuatu: Gross Domestic Product by Type of Economic Activity in Current Prices, 1996–2001

(In millions of vatu, unless otherwise indicated)

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Sources: National Statistics Office and Reserve Bank of Vanuatu; and Fund staff estimates.
Table 3.

Vanuatu: Agricultural Production, 1996–2001

(In metric tons, unless otherwise indicated)

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Sources: Reserve Bank of Vanuatu, Vanuatu Commodities Marketing Board, and Ministry of Agriculture.

Kava exported for pharmaceutical purposes is dried; kava sold for the local beverage market is fresh (green).

Total volume slaughtered in Port Vila and Lunganville abattoirs.

Port Vila abattoir only.

Includes transport allowance.

Table 4.

Vanuatu: Energy Production and Consumption, 1996–2001

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Sources: Energy Unit, Ministry of Lands, Energy, and Geology and Mines; and Union Electrique du Vanuatu, Annual Technical Report (various issues).

Annual production by Union Electrique du Vanuatu in Port Vila and Luganville.

The conversion factor is one kiloliter = 6.29 barrels of oil except for LPG, which is one ton LPG (butane) = 10.90 barrels of oil equivalent.

Excludes jet fuel for re-export.

Table 5.

Vanuatu: Tourism Activity, 1996–2001

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Source: National Statistics Office.

Includes visitor arrivals from no stated country.

Table 6.

Vanuatu: Consumer Price Index (CPI), 1997–2002Q2

(Annual percentage change, unless otherwise indicated) 1/

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Sources: National Statistics Office and Reserve Bank of Vanuatu.

Period average, unless otherwise indicated.

The weights are derived from the 1985 Household and Expenditure Survey and have been revalued in terms of the 1990Q1 prices.

End of period.

Table 7.

Vanuatu: Central Government Fiscal Operations, 1997–2001

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Sources: Vanuatu authorities; and Fund staff estimates.

Net of tax rebate for import duties paid by Union Electrique du Vanuatu (UNELCO).

Cash grants only.

Excludes transfers to the Development Fund.

Table 8.

Vanuatu: Central Government Revenue, 1997–2001

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Sources: Vanuatu authorities; and Fund staff estimates.

Business, cocoa, liquor, and vehicle licenses; fishing licenses and agreement fees; arms and prospecting licenses, and air traffic rights.

Hotel/restaurant sales tax.

Gaming, lotteries, and video tax; rent tax; and cheque levy.

Gross income of water suppliers and post and telecommunications providers.

Police and immigration fees, primary education fees, hospital fees, fines and forfeits, and other miscellaneous fees and sales.

Includes port and marine revenue, other property income, and miscellaneous customs revenue.