Vanuatu
2004 Article IV Consultation—Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Vanuatu

This 2004 Article IV Consultation highlights that Vanuatu’s real GDP growth rebounded to 2.4 percent in 2003, and the recovery continued in 2004 with growth of an estimated 3 percent. The improvement was bolstered by a strong supply response to a recovery in export prices and the liberalization of trading in two key exports (cocoa and copra), the discovery of new markets for kava following the ban by several countries in 2002, and higher tourist arrivals with an expansion in airline capacity to Vanuatu. Progress has also been made in strengthening Vanuatu’s financial sector.

Abstract

This 2004 Article IV Consultation highlights that Vanuatu’s real GDP growth rebounded to 2.4 percent in 2003, and the recovery continued in 2004 with growth of an estimated 3 percent. The improvement was bolstered by a strong supply response to a recovery in export prices and the liberalization of trading in two key exports (cocoa and copra), the discovery of new markets for kava following the ban by several countries in 2002, and higher tourist arrivals with an expansion in airline capacity to Vanuatu. Progress has also been made in strengthening Vanuatu’s financial sector.

I. Background

1. Vanuatu achieved positive real growth in 2003–04, after two years of decline.1 Macroeconomic stability was maintained and some progress made in addressing structural weaknesses (Figure 1). However, a weak environment for private activity, including poor infrastructure and political instability, and rapid population growth have compounded the difficulties that come from a narrow output and export base, and contributed to low per capita GDP growth relative to comparator Pacific and Caribbean island countries over the past decade. As a result, the outlook for the faster economic growth needed to lift living standards is not bright without a deepening of reform. Human development indicators are among the lowest of the Pacific island countries. About 40 percent of the population lives below the poverty line and 80 percent of the labor force is employed in subsistence activities in rural areas.

Figure 1.
Figure 1.

Vanuatu: Regional Comparators

(Averages, 2000–2004)

Citation: IMF Staff Country Reports 2005, 124; 10.5089/9781451840568.002.A001

Sources: Vanuatu authorities; and Fund staff estimates.
uA01fig01

Real GDP, 1995–2004

(1995=100)

Citation: IMF Staff Country Reports 2005, 124; 10.5089/9781451840568.002.A001

Sources: Authorities; and staff estimates.

Gross Domestic Product (GDP) Per Capita and Human Development Index (HDI) in Vanuatu and Comparator Countries

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Sources: UN Human Development Report, 2004, and IMF.

Rank out of 177 countries.

Antigua and Barbuda, Dominica, Grenada, St. Kitts and Nevis, St. Lucia, and St. Vincent and the Grenadines.

2. Political instability has hindered implementation of needed reforms during much of 2004 (Box 1). The coalition government which took office in July 2004 was followed by a new period of uncertainty, including a deterioration in relations with the donor community, delays in pending economic and financial legislation, and proposed policies which would reverse previous economic reforms. Following a motion of no confidence in December 2004, a new government under Prime Minister Ham Lini was formed (Finance Minister Carcasses and Governor Tevi have remained in their positions). The initial public statements of the Lini government point to an improved budget outlook, a resumption of financial sector reforms, and strengthened dialogue with donors. At the same time, the comprehensive economic policy of the new government has not yet been announced and its commitment to pursuing needed deep reform is still uncertain.

Political Environment in vanuatu

Background. The current political environment has its roots in the Anglo-French condominium where France and Britain shared control over Vanuatu (then New Hebrides). The two parties dominating politics at independence in 1980, one identified with Anglophone voters and one identified with Francophone voters, have since splintered into more than ten political parties plus independents. With 52 parliamentary seats, elected by universal adult suffrage, no party regularly earns a majority of the vote. The resulting coalition governments survive only for short periods as political unions are created and dissolved with frequency.

Since the early 1990s, there has been a high degree of political instability in Vanuatu.

  • Although not subject to the unrest seen in some of the neighboring Pacific island countries, the political instability distracts from needed action on reforms.

  • At the same time, increasing political fractionalization further complicates progress on reforms, due to the need to accommodate a growing number of political constituencies.

  • The private sector regularly lists political instability among its major concerns inhibiting investment.

2004 was a year of particularly intense political uncertainty.

  • Following increasing parliamentary discord in the early part of the year, in May then Prime Minister Natapei called an election to avoid a possible no-confidence vote. None of the major parties won a majority in the early July elections (the largest number of seats held by any party was 10), and after a long period of negotiations, a fragile coalition government was formed at end-July under Prime Minister Vohor. Almost immediately negotiations resumed among the parties along with talk of a new no-confidence vote. In September a no-confidence motion was put before Parliament but defeated by the Vohor government.

  • At the same time, relations between the Vohor government and donors were deteriorating, particularly following the expulsion of Australian law enforcement advisors in August together with public statements questioning the role of all foreign advisors. The government also disregarded court decisions and planned an expansion in the number of ministries to accommodate the diverse factions in the coalition. Donors expressed concern over developments, and Australia, a major donor, warned of reductions in its aid program.

  • Prime Minister Vohor’s controversial attempts to grant diplomatic recognition to Taiwan Province of China led to his coalition’s defeat by a no-confidence motion in December 2004. Prime Minister Ham Lini formed a new government, which maintains Mr. Moana Carcasses as Minister for Finance and Economic Management. Relations with donors have since improved, as seen in the subsequent visit to Port Vila by Australian Prime Minister Downing.

3. Some progress has been made in beginning to address issues identified at the last Article IV consultation, despite the unstable political environment. Executive Directors emphasized the need to ensure lasting fiscal consolidation, strengthen the regulation and supervision of offshore banks, and implement structural reforms. Since then, fiscal balances have improved with strengthened tax revenue, including the introduction of the recommended excise tax on alcohol and tobacco, and new expenditure controls. However, spending is still not well prioritized and capital expenditure is sharply lower, despite development needs. The financial supervision of offshore banks has been significantly improved. Additional reform, such as restructuring public enterprises and improving infrastructure, remains crucial for establishing the sound private sector environment needed to raise economic growth over the medium term. During the November discussions, the authorities noted that they found missions’ views during Article IV consultations useful, and welcomed the initiation of interim-year staff visits.

II. Recent Economic Developments

4. The Vanuatu economy recovered in 2003–04 following two years of decline (Table 1 and Figures 24). Real GDP growth rebounded to 2.4 percent in 2003 and the recovery continued in 2004 with growth of an estimated 3 percent, notwithstanding the crop damage caused by Cyclone Ivy early in the year.2 The improvement was bolstered by a strong supply response to a recovery in export prices and the liberalization of trading in two key exports (cocoa and copra), the discovery of new markets for kava following the ban by several EU countries in 2002, and higher tourist arrivals with an expansion in airline capacity to Vanuatu (Figure 5).3 4

Table 1.

Vanuatu: Selected Economic and Financial Indicators, 2000-05

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

Weighted average rate of interest for total bank deposits and loans.

Significant improvements in data compilation from 2002 onward account for a break in the series through 2001.

Imports values are on c.i.f. basis.

Medium- and long-term public debt only.

In percent of exports of goods and services.

Figure 2.
Figure 2.

Vanuatu: Selected Economic Indicators, 1998-2004

Citation: IMF Staff Country Reports 2005, 124; 10.5089/9781451840568.002.A001

Sources: Vanuatu authorities, and Fund staf estimates.1/ Measured with respect to a weighted average lending rate on bank loans and the four-quarter average inflation rate.
Figure 3.
Figure 3.

Vanuatu: External Sector Developments, 1998-2004

Citation: IMF Staff Country Reports 2005, 124; 10.5089/9781451840568.002.A001

Sources: Vanuatu authorities, and Fund staff estimates.
Figure 4.
Figure 4.

Vanuatu: Monetary and Financial Indicators, 1999-2004

Citation: IMF Staff Country Reports 2005, 124; 10.5089/9781451840568.002.A001

Sources: Vanuatu authorities, and Fund staf estimates.
Figure 5.
Figure 5.

Tourism and Growth, 1990-2004

Citation: IMF Staff Country Reports 2005, 124; 10.5089/9781451840568.002.A001

Sources: Vanuatu authorities and Fund staff estimates.

5. Fiscal consolidation continued over the past two years (Table 2). Although in large part reflecting sharply reduced development expenditure, new controls on current spending and improved tax collection also contributed to the outcome. However, the wage bill remained high, while service delivery to the outer islands continued to be poor. Following the completion of large development projects, capital outlays fell to an average 1.6 percent of GDP in 2003–04 from an average 4.5 percent of GDP in 1999–2002, despite continued pressing development needs. Reflecting the government’s cautious approach to incurring new public debt, total public debt, including external debt, fell below 40 percent of GDP.5

Table 2.

Vanuatu: Central Government Fiscal Operations, 2000-05 1/

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Sources: Vanuatu authorities; and Fund staff estimates.

Data for 2005 are preliminary, as the budget has yet to be finalized.

Net of tax concessions for VAT, excise, and import duties, except for those for Unelco.

Cash grants only.

Excludes transfers to the Development Fund.

4/ Based on the current government policy. The scenario assumes deficit is financed through domestic market borrowings instead of additiona5/ Assumes no increase in number of Ministers and salary for Parliamentarians.
uA01fig02

Vanuatu: Fiscal Balance, 1998-2004

(In percent of GDP)

Citation: IMF Staff Country Reports 2005, 124; 10.5089/9781451840568.002.A001

Sources: Vanuatu authorities; and staff estimates.
uA01fig03

Vanuatu: Composition of Government Expenditure, 1998-2004

(In percent of GDP)

Citation: IMF Staff Country Reports 2005, 124; 10.5089/9781451840568.002.A001

Sources: Vanuatu authorities; and staff estimates.
uA01fig04

Government Debt

(In percent of GDP)

Citation: IMF Staff Country Reports 2005, 124; 10.5089/9781451840568.002.A001

6. Against the background of a basketpeg exchange rate regime, inflation has remained subdued at just under 3 percent in 2004.6 The mid-year appreciation of the Vatu against the Australian dollar offset price pressures from cyclone-related agricultural shortages. Broad money growth picked up in 2004, as deposits with the banking sector rose and the net foreign assets position of commercial banks strengthened (Table 3). Commercial banks’ liquidity positions improved in 2004, allowing for lower lending rates, which resulted in a slight narrowing of the interest rate spread.

Table 3.

Vanuatu: Monetary Survey, 2002-05

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

Reserve Bank of Vanuatu, and foreign exchange held by the Treasury.

7. The external current account deficit narrowed in 2004 with the stronger performance in tourism and exports (Table 4). In real effective terms, the vatu remained broadly stable over the past five years, while official reserves have recovered since 2002.

Table 4.

Vanuatu: Balance of Payments, 2000-05 1/

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

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

Significant improvements in data compilation from 2002 onward account for a break in the series through 2001.

Imports values are on c.i.f. basis.

uA01fig05

Exchange Rates, Jan 1998 - Oct 2004

(June 2000=100)

Citation: IMF Staff Country Reports 2005, 124; 10.5089/9781451840568.002.A001

uA01fig06

Gross Official Reserves

Citation: IMF Staff Country Reports 2005, 124; 10.5089/9781451840568.002.A001

8. The outlook is for a softening of the macroeconomic environment in 2005. Real GDP growth is expected to taper off closer to trend as global commodity prices for many of Vanuatu’s exports again ease, notwithstanding the expected full year impact on tourism of the increased airline capacity. Inflation is likely to edge higher with the delayed impact of higher world oil prices. The current account deficit should widen slightly, as a boost in imports related to tourism investment offset an increase in tourism revenue. Official foreign reserve levels should remain roughly unchanged in U.S. dollars. Based on early reports of the revised 2005 budget expected to be submitted for Parliamentary consideration in February, the fiscal accounts should be near balance, as higher current spending, including an increase in parliamentarians’ salaries and higher spending on education, are accompanied by additional donor funding.

III. Policy Discussions

A. Overview

9. The discussions focused on the policy priorities needed to raise Vanuatu’s economic growth rate sustainably above that of its population growth rate.7 The consultation took place in November during the last month of the previous government’s tenure. Some of the concerns raised during the discussions have now been eased, including the previous government’s plans to expand the size of government and to possibly reverse gains made in financial sector supervision. However, the main themes of the consultation discussion—namely the need to broaden the economic base to strengthen resiliency to external and natural shocks—remain valid. The mission’s recommendations included the following key components:

(i) Continuing the responsible fiscal and monetary policies followed in recent years;

(ii) Reorienting government spending toward more productive capital outlays through both revenue and expenditure measures, while maintaining needed social spending;

(iii) Further strengthening of the financial sector to improve availability and lower costs of domestic credit, and

(iv) Structural reforms to improve the environment for private sector activity.

B. Outlook and Risks

10. Growth prospects over the medium term are not bright without a stronger policy commitment for deeper reform (Table 5, Figure 6, and Box 2). On the current trajectory, without an active reform effort that addresses weak infrastructure and other sources of high business costs, real GDP growth could fall below even the current moderate level of 2.5–3.0 percent. Pressures to raise current spending would likely continue to be difficult to resist, leading to a return to fiscal deficits. In contrast, with a stronger reform effort (Table 7) than that currently contemplated, growth could rise to allow an improvement in per capita GDP over the medium term. Vanuatu has growth potential, especially in agriculture and tourism. By reorienting fiscal spending to well-targeted social and infrastructure needs, introducing further financial sector reform, and creating an investmentfriendly environment, growth prospects could improve considerably, along with an improved external balance, further accumulation of foreign reserves, and a gradual reduction in public debt. Areas for increased infrastructure spending include roads, electricity, water, and transportation both in the main and outer islands.

Table 5.

Vanuatu: Medium-Term Non-Adjustment Scenario, 2002-10

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Sources: Vanuatu authorities; and IMF staff estimates and projections.

Including official transfers.

Imports values are on c.i.f. basis.

Net of tax rebate for import duties.

Cash grants only.

Excludes transfers to the Development Fund.

Medium- and long-term public debt only.

Figure 6.
Figure 6.

Vanuatu: Medium-Term Macroeconomic Outlook, 2003–10

Citation: IMF Staff Country Reports 2005, 124; 10.5089/9781451840568.002.A001

Source: Vanuatu authorities; and Fund staff estimates and projections.
Table 6.

Vanuatu: Vulnerability Indicators, 2000–05

(In percent of GDP; unless otherwise indicated)

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Sources: Vanuatu authorities; and Fund staff estimates.

Change in percent of beginning of period broad money.

Through end-September 2004.

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

Imports values are on c.i.f. basis.

Medium- and long-term public debt only.

Table 7.

Vanuatu: Medium-Term Reform Scenario, 2002-10

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Sources: Vanuatu authorities; and IMF staff estimates and projections.

Including official transfers.

Imports values are on c.i.f. basis.

Net of tax rebate for import duties.

Cash grants only.

Excludes transfers to the Development Fund.

Medium- and long-term public debt only.

11. Given its narrow base, the economy will remain vulnerable over the medium term. Its resilience will depend on the strength of implementation of structural reforms, while the downside risks pointing to a less favorable outlook are sizeable (Table 8). The recent history underscores the importance of political stability and the preservation of good relations with major donors, particularly given the need to fu