Solomon Islands
2007 Article IV Consultation: Staff Report; Staff Supplement; and Public Information Notice on the Executive Board Discussion

This 2007 Article IV Consultation highlights that real GDP growth of Solomon Islands rose to an estimated 6 percent in 2006, driven by fish, palm oil production, and services. However, it is expected to ease to 5½ percent in 2007, as a further escalation in logging will be likely offset by lower growth of fish and traditional crops. With the natural forest expected to be depleted within the next few years, structural reforms are necessary to generate higher sustainable growth, raise living standards, and reduce the economy’s vulnerability to shocks.

Abstract

This 2007 Article IV Consultation highlights that real GDP growth of Solomon Islands rose to an estimated 6 percent in 2006, driven by fish, palm oil production, and services. However, it is expected to ease to 5½ percent in 2007, as a further escalation in logging will be likely offset by lower growth of fish and traditional crops. With the natural forest expected to be depleted within the next few years, structural reforms are necessary to generate higher sustainable growth, raise living standards, and reduce the economy’s vulnerability to shocks.

I. Background

1. The economy has been recovering since the end of the civil conflict, but the Solomon Islands remains the poorest country in the region and relies heavily on logging and aid. Since the intervention of the Regional Assistance Mission to the Solomon Islands (RAMSI) in mid-2003, growth has averaged 6 percent and financial stability has been maintained (Table 1). Nevertheless, with one of the fastest growing populations in the world, per capita income is the lowest in the region. Economic activity continues to rely on the unsustainable exploitation of the country’s forests and large donor assistance. Social indicators are poor, and most MDGs are unlikely to be met (Annex V).

Table 1.

Solomon Islands: Selected Economic Indicators, 2002–07

Nominal GDP (2006): US$336 million

Population (2006): 494,959

GDP per capita (2006): US$678

Quota: SDR 10.4 million

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

Expenditures are presented on an accrual basis.

Includes recurrent budget grant support.

Calculated from above-the-line data.

Includes interest arrears.

Includes arrears.

As of May 30, 2007.

uA01fig01

GDP Growth

(In percent)

Citation: IMF Staff Country Reports 2007, 304; 10.5089/9781451951653.002.A001

uA01fig02

Per Capita GDP in PPP Terms (US$ thousand)

Population growth (percent)

Citation: IMF Staff Country Reports 2007, 304; 10.5089/9781451951653.002.A001

2. After a rocky period following the 2006 elections, relations with donors have improved recently, but the political situation remains fragile. The government survived a no-confidence vote last February and has taken steps to mend relations with donors. Aid flows have been largely unaffected, but tensions remain, and political instability could resurface given shifting political alliances.

3. The government program focuses on rural development, but a comprehensive and well-articulated development and poverty reduction strategy has yet to be elaborated. The government Policy Translation and Implementation Document emphasizes a bottom-up approach to development. At the same time, implementation of some donor-assisted sector strategies in education, health, transport, and agriculture are benefiting from improved capacity of some government departments. To bring order to these separate initiatives, recently there appears to be some renewed interest in reviving a national development strategy, which was shelved late last year contrary to Fund advice, after the change in government.

4. The effectiveness of past surveillance has been mixed. Progress has been made in simplifying foreign investment applications, developing transport infrastructure, reducing tax exemptions, and monitoring aid delivery. Nevertheless, reforms of state-owned enterprises (SOEs), the National Provident Fund (NPF), and the proposed liquidation of the troubled Development Bank of the Solomon Islands (DBSI) have fallen short of expectations. The large civil service wage increases approved last October contradicted Fund advice. The backpedaling on the increase in the reference prices of logs, little follow-up to the Auditor General’s Special Audits, and controversial government appointments have reinforced perceptions of uneven progress on governance.

5. Longer-term challenges are daunting. Based on a new government report, the fast-declining stock of logs is now estimated to run out in 2014, much earlier than previously anticipated. Activity in this sector accounts for 70 percent of exports, 15 percent of domestic government revenue, and 10 percent of GDP. Committed aid flows, currently about 35 percent of GDP, are also expected to decline.

uA01fig03

Estimated Logging Volume

(in million cubic meters)

Citation: IMF Staff Country Reports 2007, 304; 10.5089/9781451951653.002.A001

II. Recent Economic Developments and Outlook

6. Economic growth remained satisfactory in 2006. Real GDP rose an estimated 6 percent: nonlogging growth accelerated to 6 percent, driven by fish, palm oil production, and services (Figure 1). Logging continued broadly at the same level as in 2005, over four times the sustainable rate. The current account deficit widened slightly to 26 percent of GDP, mainly reflecting higher fuel and investment-related imports (Table 2 and Figure 2).1 Continued strong aid inflows and private FDI in the gold mine and the palm oil project kept international reserve cover at adequate levels. Brisk private credit growth persisted, but as credit to government again contracted reflecting an overall budget surplus, monetary growth moderated (Tables 3 and 4, Figures 3 and 4). Due to this and receding oil prices, inflation decelerated to 7½ percent, but remains the highest among the Pacific Island Countries (PICs).

Figure 1.
Figure 1.

Solomon Islands: Production and Price Developments, 1986–2007 1/

Growth continued to be robust and inflation eased in 2006, but per capita income is still two-thirds of its pre-conflict level.

Citation: IMF Staff Country Reports 2007, 304; 10.5089/9781451951653.002.A001

Sources: Data provided by the authorities, WEO and IFS databases; and Fund staff estimates.1/ 2006 GDP is an estimate.
uA01fig04

Inflation in PICs

(In percent)

Citation: IMF Staff Country Reports 2007, 304; 10.5089/9781451951653.002.A001

7. Growth is expected to be about 5½ percent in 2007, mostly reflecting a further escalation in logging. Logging has accelerated by over 50 percent year-on-year in January-April 2007 and shows no signs of abating given strong international demand, especially from China. However, nonlogging growth is expected to slow to 3½ percent, as fish and traditional crops are contracting, while palm oil will contribute about 1 percentage point to overall growth.2 Despite much higher logging exports, the current account deficit is expected to widen to 40 percent of GDP due to imports related to the gold mine (17 percent of GDP). Nevertheless, continued strong aid flows and FDI are expected to keep reserve cover adequate (Table 5). Inflation is projected to ease to 7 percent.

8. Absent an acceleration of key reforms, even the modest per capita income growth recently achieved is unlikely to be sustained over the medium term. In the baseline scenario, which assumes RAMSI and donor support, an unchanged pace of reforms, and no new major projects, growth is projected to decline to 1½ percent by 2010 and average 3 percent in 2007–12 (nonlogging at about 3¾ percent), compared to population growth rate of almost 3 percent (Table 6). Although aid inflows—most of which are channeled outside the budget—are projected to fall by half, the effect on growth is likely to be limited because the decline will affect mostly technical assistance (representing over 60 percent of total) as capacity improves. Logging is projected to remain broadly at the current rate until 2009 and decline sharply thereafter. With project-related imports falling sharply once the rehabilitation of the gold mine is completed, the start of gold exports from 2008 and the planned expansion of palm oil production should help narrow the current account deficit considerably over the medium term, notwithstanding the decline of logging and diminishing aid flows. The reserve import cover is expected to fall, but remain above three months (Table 7).

Table 2.

Solomon Islands: Balance of Payments, 2002–07 1/

(In millions of U.S. dollars)

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

Import figures from 2002 onwards are now based on customs data and net investment flow projects of the government from 2005 are based on more accurate estimates of aid flows from the authorities.

Figure 2.
Figure 2.

Solomon Islands: External Sector Developments, 1997–2006 1/

The large current account deficit continued to be more than offset by strong aid inflows.

Citation: IMF Staff Country Reports 2007, 304; 10.5089/9781451951653.002.A001

Sources: Data provided by the authorities, WEO and IFS databases; and Fund staff estimates.1/ Prior to 2002, import figures reflect foreign exchange transactions data. From 2002 onwards, import figures are based on customs data. From 2005 onwards, aid flows are based on more accurate estimates from the authorities.
Table 3.

Solomon Islands: Central Government Operations, 2002–07

(In percent of GDP)

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

Development grants and grant-financed development spending are currently administered by donors, and hence are not under the direct control of the government. They exclude police and military spending, but include noncash grants. Data on aid flows are now being captured more accurately, and they indicate much higher levels than previously estimated.

On an accrual basis.

Recurrent costs of projects and from taking over recurrent costs currently funded by donor grants.

Includes transfers for realized contingent liabilities in 2005, 2006, and 2007.

Domestic revenue and recurrent grant budget support minus recurrent expenditure.

Domestic revenue minus noninterest recurrent expenditure and domestically-financed development spending.

Includes interest arrears.

Table 4.

Solomon Islands: Summary Accounts of the Banking System, 2002-7

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Sources: Data provided by the Central Bank of Solomon Islands; and Fund staff estimates.
Figure 3.
Figure 3.

Solomon Islands: Fiscal Developments, 1999–2006 1/

(In percent of GDP)

Citation: IMF Staff Country Reports 2007, 304; 10.5089/9781451951653.002.A001

Sources: Data provided by the authorities and Fund staff estimates.1/ 2006 data are partly estimated by Fund staff.
Figure 4.
Figure 4.

Solomon Islands: Monetary Sector Developments, 1999–2007

Growth in private sector credit remained high, while the banking sector’s claims on government fell and excess liquidity declined slightly. The sector remains generally sound but loan risk exposure is rising.

Citation: IMF Staff Country Reports 2007, 304; 10.5089/9781451951653.002.A001

Sources: Data provided by the authorities and Fund staff estimates.
Table 5.

Solomon Islands: Indicators of External Vulnerability, 2002–07

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

Net foreign assets of commercial banks.

Includes arrears.

2007 column reflects data as of end-May.

Table 6.

Solomon Islands: Medium-Term Baseline Scenario, 2005-12

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

Estimated by staff as currently only limited data exist. Development grants and grant-financed development spending are currently adminisered by donors, and hence are not under the direct control of the government. They exclude police and military spending, but include TA.

Expenditures are presented on an accrual basis.

Includes recurrent budget grant support.

Domestic revenue minus noninterest recurrent expenditure and domestically-financed development spending.

Calculated from above-the-line data.

Includes interest arrears.

2007 column reflects data for end-May 2007.

Table 7.

Solomon Islands: Medium-Term Baseline Scenario–Balance of Payments, 2005–12 1/

(In millions of U.S. dollars)

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

Import figures from 2002 onwards are now based on customs data and net investment flow projects of the government from 2005 are based on more accurate estimates of aid flows from the authorities.