Kiribati
2013 Article IV Consultation—Staff Report; Informational Annex, Debt Sustainability Analysis, Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Kiribati
Author:
International Monetary Fund. Asia and Pacific Dept
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Publication Date:
06 Jun 2013
eISBN:
9781484338353
Language:
English
Keywords:
ISCR; CR; government; real GDP; debt; RERF balance; RERF drawdown; fishing license; fishing resource; fisheries policy; Kiribati authorities; Agroindustries; Current spending; Public enterprises; Pacific Islands; Australia and New Zealand
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Kiribati is one of the poorest and most remote microstates in the Pacific. It is highly dependent on volatile fishing license fees, remittances, and donor assistance. The challenge is to implement fiscal and structural reforms to help ensure fiscal sustainability, promote private sector development, and increase its resilience to external shocks. Fully using its marine potential beyond fishing license fees will help to improve fiscal revenues and growth opportunities. More generally, private sector development is critical for both increasing growth and reducing fiscal pressures.

Abstract

Kiribati is one of the poorest and most remote microstates in the Pacific. It is highly dependent on volatile fishing license fees, remittances, and donor assistance. The challenge is to implement fiscal and structural reforms to help ensure fiscal sustainability, promote private sector development, and increase its resilience to external shocks. Fully using its marine potential beyond fishing license fees will help to improve fiscal revenues and growth opportunities. More generally, private sector development is critical for both increasing growth and reducing fiscal pressures.

Background

1. Kiribati is one of the poorest and most remote microstates in the Pacific. It is highly dependent on volatile fishing license fees, remittances and donor assistance. Fishing license fees accounted, on average, for 29 percent of GDP and 50 percent of fiscal revenue in 2007–12. Kiribati relies on its sovereign wealth fund—Revenue Equalization Reserve Fund (RERF)—for financing of the fiscal deficit. RERF assets stood at about 3½ times of GDP in 2012.1

2. Fiscal risks and sustainability have worsened in recent years. Since the mid–2000s, revenues have not kept pace with expenditures, leading to increased demands on RERF financing. Tax revenue has declined as a share of GDP largely due to poor compliance and problematic SOEs, while non-tax revenue stagnated. At the same time, expenditures were not contained in line with revenue trends, leading to large and excessive current fiscal deficits and high financing demands on the RERF. Obligations related to underperforming SOEs have exacerbated the problem. As a result, the RERF drawdowns to finance the budget have become unsustainable, putting the RERF on a declining path as a share of GDP and in per capita terms. Besides RERF financing, until recently the government had resorted to expensive commercial borrowing, which had in turn worsened fiscal dynamics further.

3. The Government of Kiribati realized the magnitude of the problems and with the help of donor community has embarked on a broad range of reforms to address its fiscal and structural challenges. In 2012, the government cleared most of the overdraft facilities following the IMF advice and technical assistance (TA), thereby reducing its interest cost. Ongoing reforms cover various areas: public financial management, tax system, SOEs, and the private sector. Successful implementation of these reforms increases the likelihood of higher donor financing, including budget support in the form of grants. Discussions on such financing are ongoing. These reforms are also consistent with the IMF advice provided during the 2011 Article IV consultation and subsequent staff visits.2

4. The IMF has been actively involved in all relevant aspects of the government-led reform program in coordination with the World Bank, AsDB, AusAid and other development partners. The Fund has provided macroeconomic, fiscal, and debt sustainability assessments and projections. IMF experts from headquarters and PFTAC have provided TA in the area of public financial management, management of the RERF and the pension fund (KPF), national accounts, government finance, and external statistics.

Outlook

5. Growth increased to 2.8 percent in 2012, reflecting implementation of donor projects, higher than average fishing license fees and remittances. Airport and sea-port construction projects in particular boosted construction activities. Nevertheless, inflation remained negative on account of lower prices of rice and some other staples. The revenue from fishing licenses was much higher than average, but is expected to decline in the period ahead.

6. The current account deficit widened slightly in 2012 mostly because of an increase in imports, which was partially offset by high fishing license fees. The high level of imports was mostly due to the surge in imports of machinery and equipment associated with donor projects. At the same time, the value of the food imports declined slightly reflecting moderating prices on some main staples in line with world trends. Remittances, which are dominated by transfers from seamen, also dropped, due to the slowdown in the world shipping activity. Income on the RERF was stable, reflecting in particular favorable relative yields on Australian assets.

A01ufig01

International Environment and Kiribati

Citation: IMF Staff Country Reports 2013, 158; 10.5089/9781484338353.002.A001

Sources: Kiribati authorities; and IMF staff estimates.

7. The economy will continue to expand at rates close to 3 percent in the next two years, supported by donor projects and construction activities. The road project, renovation of the airport, expansion of oil storage terminals, and continuing port renovation will expand local employment and income. Inflation is projected at 2–2.5 percent.

8. The risks in the external environment may affect the outlook (see risk assessment matrix). They include a slowdown in some of the main world economies that could lead to a decline in RERF assets and remittances, and price shocks that would increase value of imports. The main risks in the medium term relate to the adverse growth and fiscal implications in case domestic reforms lack progress.

Policies to Achieve Fiscal Sustainability and Promote Long-Term Growth

Key policy challenges are in reducing structural fiscal imbalances and increasing growth opportunities, in particular for private sector growth. These challenges are interconnected because private sector growth is vital for reducing the fiscal burden.

A. Fiscal Policy

Background

9. Since the mid-2000s, the fiscal position has worsened as revenues stagnated and expenditures were not adjusted to reflect lower revenues. Tax revenues declined because of poor compliance and non-performing SOEs. Non-tax revenue stagnated mainly because fishing license fees and other fees did not keep up with GDP growth and have been on a declining trend in real terms.3 The wage bill constituted about one half of the current expenditure. Subsidies were dominated by those for copra and SOEs. Underperforming SOEs put additional fiscal pressure through their debt which was guaranteed by the government.

10. The worsening fiscal position led to high current deficits financed by unsustainable RERF drawdowns and non-concessional borrowing.4 By 2011–12, the RERF balance, in constant per capita terms, was almost half of its amount in 2000. The government accumulated significant non-concessional debt from its overdraft facility with the commercial bank (ANZ) and from taking on debt guarantees of the SOEs. By mid-2012, the government overdraft with the commercial bank stood at A$22½ million (13½ percent of GDP) and the SOEs’ overdraft (mostly guaranteed by the government) at A$11¾ million (7 percent of GDP).

11. Consistent with the advice of the IMF staff, which was supported by the donor community, the government cleared its overdraft and other non-concessional debt in 2012 using the RERF. The government’s repayment of its overdraft debt of about A$26 million has reduced interest costs by about A$2⅓ million per year.

12. The 2013 budget implies a current fiscal deficit of about 18⅓ percent of GDP, assuming conservative projections for fishing license revenue. The budget factors in an increase of about 6 percent in the wage bill including other employee allowances and a similar level of subsidies compared to the 2012 budget. Assuming about A$5 million of budget support from donors and no commercial borrowing, the financing requirement implies a RERF drawdown of about A$27 million or 15.4 percent of GDP leading to a further decline in the RERF per capita balance.

13. The government has been undertaking a broad range of reforms to reduce fiscal imbalances and improve fiscal planning and execution with the assistance of development partners, including:

  • The government plans to introduce value added and excise taxes in the first half of 2014 and has been preparing the framework and draft legislation for these taxes with the assistance of PFTAC.

  • A revision of the public finance regulation act has been prepared and is ready for official approval. Revised regulations would strengthen procedures for budget execution, reporting and auditing.

  • The parliament passed an SOE bill establishing a strengthened legal framework for governance, financial reporting, and management of SOEs.

  • The government with the help of the AsDB and PFTAC has been upgrading its fiscal information systems to improve accountability and functionality.

  • Work is underway to improve Kiribati’s fisheries policy (with the assistance of Australian TA).

  • The government plans to introduce improvements in RERF management and asset allocations, with the support of technical assistance.

Based on the reform program, the government has been discussing with the World Bank, AusAid, AsDB, and the European Union budget grant support for 2013 and 2014.

Staff Views

14. Restoring fiscal sustainability by stabilizing RERF real value in per capita terms in the longer term would require a challenging fiscal effort (Box 1, Table 5).

Table 1.

Kiribati: Selected Economic Indicators, 2009–14

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Sources: Data provided by the Kiribati authorities; and IMF staff estimates and projections.

Current balance excludes grants and development expenditure.

The Australian dollar circulates as legal tender.

Index, 2005=100.

Table 2.

Kiribati: Summary of Central Government Operations, 2009–18

article image
Sources: Data provided by the Kiribati authorities; and IMF staff estimates and projections.

Includes excises.

Includes subsidies to copra production.

Development expenditure equals grants plus loans for development projects.

Current balance excludes grants and development expenditure (see footnote 3 above)

Overall balance in the table is different from official budget because loans are classified as financing.

Table 3.

Kiribati: Medium-Term Projections, 2010–18

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Sources: Data provided by the Kiribati authorities; and IMF staff estimates and projections.

Development expenditure equals grants plus loans for development projects.

Current balance excludes grants and development expenditure (see footnote 2 above)

Overall balance in the table is different from official budget because loans are classified as financing.

Table 4.

Kiribati: Balance of Payments, 2009–18

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Sources: Data provided by the Kiribati authorities; and IMF start estimates and projections.

Includes fishing license fees, which would be shown as current transfers under conventional international guidelines.

Including errors and omisions for projections.

Excludes valuation changes.

Comprises the Consolidated Fund, Development Fund, and STABEX Fund.

Table 5.

Kiribati: Summary of Central Government Under Different Scenarios, 2010–30

article image
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Sources: Data provided by the Kiribati authorities; and IMF staff estimates and projections.

Includes subsidies to copra production.

Development expenditure equals grants plus loans for development projects.

Current balance excludes grants and development expenditure (see footnote 2 above).

Kiribati: Restoring Fiscal Sustainability

  • The baseline scenario incorporates the authorities’ current commitments to reform, assumes the introduction of value added and excise taxes (with implementation adjustment), and assumes that current expenditures will grow more slowly than nominal GDP in the medium and longer term. The baseline scenario also incorporates donor budget support in the amount of A$5 million under the reform program in 2013–14. Under this scenario, the current fiscal deficit will be reduced from 18.2 percent of GDP in 2013 to 9⅓ percent of GDP in 2018 and to about 8⅓ percent in the longer run. The RERF drawdown would be reduced from 15.4 percent of GDP to 8⅓ percent of GDP correspondingly. Despite significant narrowing of the current fiscal deficit by about 10 percent of GDP under this scenario, the RERF per capita value does not stabilize and declines by more than 40 percent by 2030 compared to the 2011 level. The debt sustainability analysis points to a high risk of debt distress under this scenario.

  • The stronger reform scenario incorporates additional fiscal measures to stabilize RERF per capita values by 2021–22 at slightly below A$4,000 in constant terms. Such stabilization will be difficult to achieve, requiring a narrowing of current fiscal deficit of more than 15 percent of GDP, distributed broadly between taxes, wages, and other expenditure measures. The scenario also assumes some improvement in fishing license fees revenues through better pricing. The adjustment period is appropriate given the magnitude of fiscal adjustment, capacity constraints and the time needed to implement fiscal and structural reforms. The current fiscal deficit under this scenario will be limited to 2⅔ percent of GDP on average in 2022–30. Stronger reforms would allow Kiribati to finance a greater proportion of development financing needs through grants and reduce the risk of debt distress according to the debt sustainability analysis.

  • The downside policy stagnation scenario, which assumes that the current fiscal deficits will remain at the 2013 level in relation to GDP, leads to a much worse outcome. Under this scenario, not only will the per capita RERF balance fail to stabilize, but RERF assets will eventually be depleted.

A01ufig02

Baseline Scenario: Current Deficit and RERF Balance

Citation: IMF Staff Country Reports 2013, 158; 10.5089/9781484338353.002.A001

Source: IMF staff estimate.
A01ufig03

Stronger Reform Scenario: Current Deficit and RERF Balance

Citation: IMF Staff Country Reports 2013, 158; 10.5089/9781484338353.002.A001

Source: IMF staff estimate.
A01ufig04

Policy Stagnation Scenario: Current Defict and RERF Balance

Citation: IMF Staff Country Reports 2013, 158; 10.5089/9781484338353.002.A001

Source: IMF staff estimate.

15. Staff welcomed the authorities’ commitment to tax reform. Implementation challenges are significant and need to be addressed promptly. The challenges include finalizing modalities of VAT application, and provision of necessary equipment and software.

16. Maintaining sufficient growth of fishing license revenues while abiding by international commitments and managing their volatility is very important. An increase in the minimum price of fishing licenses from US$5,000 to US$6,000 per day for 2014 should strengthen the near-term fishing license revenue outlook. Nevertheless, as the regional Nauru Agreement sets only minimum prices, it may be helpful to consider ways to improve current negotiating processes with the fishing companies by using international expert advice. In the longer run, developing a viable local commercial fishing industry and going beyond fishing license fees is vital for both lifting growth and living standards and reducing fiscal imbalances.

17. Measures on the expenditure side are necessary, but need to be implemented in a way that supports priority spending on health, education, and infrastructure. Recurrent expenditures on health, education, and infrastructure would need to be maintained. The yearly increase in the public wage bill would need to be contained below nominal GDP growth, in particular taking into account the fact that the public wage bill is relatively high in Kiribati. Copra subsidies currently serve mainly as a livelihood subsidy to support outer islands inhabitants. Without increasing employment opportunities on the islands, it is unlikely that improving the efficiency of this subsidy or replacing it with an alternative scheme would significantly reduce the cost in the near and medium term. SOE subsidies are currently dominated by those for the Public Utilities Board (PUB) and airfares. Given that the PUB has been underperforming and running arrears, a reduction in the PUB subsidy can only be implemented after restoring the PUB performance. The reduction in airfare subsidies is complicated by the need to maintain links with remote islands and limited airline competition. Climate change impact and infrastructure pressures can result in additional costs.

A01ufig05

Wage Expenditure

Citation: IMF Staff Country Reports 2013, 158; 10.5089/9781484338353.002.A001

Sources: Country authorities; and IMF staff calculations.1 Data are as of 2011.

18. The policy of avoiding non-concessional financing of the recurrent deficit should continue. The clearance of overdraft facilities substantially reduced the borrowing costs by more than A$2 million per year. As borrowing costs on commercial debt are substantially higher than the return on RERF investments, borrowing on commercial terms should be avoided under the government’s debt and asset management strategy.

19. Implementation of a sound public financial management framework is critical to restoring fiscal sustainability. Such a framework would ensure the formulation and execution of sustainable budgets over the medium and long term and corresponding RERF drawdowns over the long run. In this context, it is also important to adopt a prudent policy on contracting and guaranteeing debt and to strengthen revenue and expenditure projections. Staff welcomed the authorities’ decision to seek technical assistance in these areas.

Authorities’ Views

20. The authorities were in broad agreement with the mission’s recommendations. They agreed that maintaining fiscal sustainability and preserving the value of the RERF is a priority. They intend to introduce necessary revenue measures and to limit current expenditure, including the wage bill. The authorities also pointed out that they continue to avoid overdraft borrowing for the budgetary needs and have reduced the amount of guarantees to SOEs. At the same time, the authorities noted the potential spending needed to replace vessels, improve infrastructure on the outer islands, and address the negative impact of climate change.

21. The authorities intend to introduce a VAT in the first half 2014. The VAT would initially be levied on the largest businesses with high turnover, which would ease somewhat the implementation process. The authorities hoped that development partners would speed up the delivery of needed equipment and requested technical assistance to study the welfare impact of introducing the VAT.

22. The authorities acknowledged that the high fishing license revenue in 2012 is not sustainable. They recognized the importance of such revenues for the budget and noted that fishing companies are aware of the government’s reliance on fishing license revenues and have use that to bid for the lowest fees. The authorities also contended that since the regional Nauru Agreement sets the minimum price for licenses, most companies bid around this minimum price. They agreed that the development of the local fishing industry beyond license fees is very important for increasing economic growth and improving fiscal outcomes. With regard to the smoothing mechanism for fishing licenses, the authorities noted their preference for conservative projections for fishing license fees in the budget in order to avoid possible shortfalls.

B. State-owned Enterprises Reforms

Background

23. The government has been implementing SOE reforms with the assistance of the AsDB. After a stock-taking in 2012, it has proposed action plans for non-performing SOEs. Private-public partnership (PPP) agreements have been designed to support the continued operation of some SOEs, while others have been identified as candidates for either sale, liquidation or future joint-ventures. These action plans have been implemented for a number of companies.5 The SOE bill that provides an improved governance framework for SOEs was passed at the April 2013 session of parliament. The cabinet has also submitted to parliament legislation to liberalize and increase competition in the telecommunication sector.

24. Some important SOEs continue to underperform. In particular, the PUB has been operating at a loss, consistently accumulating arrears. The company’s largest arrears are owed to the Kiribati Oil Company (KOIL), totaling in excess of A$5 million. The government’s current strategy aims at improving collection and compliance via the installation of new meters and use of prepaid schemes, without raising tariffs.

Staff Views

25. Staff welcomed the SOE reforms undertaken by the government with the assistance of the AsDB. The stocktaking of the SOE performance and restructuring should improve efficiency and reduce costs. The SOE bill will help improve the governance. Measures towards commercialization of SOEs also hold potential. Efforts to expand renewable energy sources are commendable.

26. While the government has made impressive progress in reforming SOEs, a number of important issues still need to be tackled. Staff recommended evaluating the effectiveness and magnitude of increased revenue collections by the PUB, with due consideration for additional revenue measures if needed. Improving the framework for the government’s debt and guarantee policy would help keep guarantees within acceptable limits and reduce the fiscal risks to the government.

Authorities’ Views

27. The authorities stressed that they will continue with the process of reforming SOEs. They pointed out that the PUB finances can be substantially improved with higher revenue collection, without raising tariffs. They also intend to introduce an improved debt and guarantee framework.

28. The government recognizes that certain SOE services may not be taken up by private sector players, given economy of scale considerations. The authorities opted to continue to manage the Kiribati Shipping Services Limited (KSSL), instead of completely contracting services out to the private sector. Larger boats are needed for shipping to the outer islands, costs for which only the public sector is able to bear at this stage.

C. Increasing Private Sector Growth Opportunities

Background

29. Kiribati’s private sector is small, in part due to the country’s limited production base, remoteness, and high transport costs. Major private sector activities include fisheries, tourism, retail trade and copra, with the exports base largely limited to fisheries and copra. Tourism activity is dominated by game fishing at Kiritimati Island. The agricultural sector mainly consists of subsidized copra production and subsistence agriculture. In addition, to improve food security, the government has encouraged the growing of longer-term crops including breadfruit and big taro.

30. The current domestic fishing industry is small and fishing license fees account for most of the revenues from fishing resources. The recently opened joint venture processing plant employs modern technology and has created employment and income opportunities. However, local fishermen still remain ill-equipped to meet a steadily rising demand for fish. In addition, the limited numbers of international flights to Kiribati have resulted in high charges for higher-priced fresh fish exports.

31. A significant part of Kiribati’s national income is in the form of worker remittances from abroad. The country’s Marine Training Center (MTC) prepares seamen mostly for work on foreign freight lines while the Fisheries Training Center (FTC) focuses on training for work on fishing vessels. Seamen remittances were on average 5 percent of GDP in 2005–12, while the number of seamen on board averaged over 8,000 from 2005–11.

Staff Views

32. Given the limited potential for agricultural and manufacturing development, the improved management and development of Kiribati’s marine resource—particularly fisheries—provide the greatest potential for increased growth in the island economy. Currently Kiribati receives only a small share of the value of fish caught in its waters. The authorities should aim to increase the value added from fishing resources by expanding the local fishing industry in addition to relying on fishing license fees (Box 2).

Kiribati: Utilizing Fishing Resources

Kiribati has some of the most productive tuna fishing grounds in the region. It accounts for, on average, over 20 percent of the value of total catch in national waters in the Pacific island countries during 2000–11.

Fishing license revenues are a key income source for Kiribati. Over the last decade, fishing license revenues average 45 percent of current fiscal revenues, the highest among regional peers. Fishing license revenues have been volatile, varying from 18 percent to 34½ percent of GDP during the past 10 years. Volatility reflected the El Nino cycle, which affects fish movement, and to some extent changes in the exchange rate of the Australian dollar, the official currency, against U.S. dollar which is the invoice currency of the vast majority of the license fees.

While fiscally important, fishing license revenues account for less than 10 percent of the value of fish catch in Kiribati waters, indicating the untapped potential of Kiribati’s fishing resources (Figure). In fact the value of fish catch in Kiribati waters exceeds the total Kiribati GDP more than twice, and exceeds value added in the domestic fishing industry plus fishing license fees by more than nine times (Figure).

To utilize this untapped potential, Kiribati could promote investment, job creation and export generation in its fishing industry beyond securing license revenues. Consider Iceland, another country with abundant marine resource, as a comparison. Iceland has a much developed fishing industry that brings higher return per value of the catch. Simple calculation shows that the value of by-product from fishing processing in Iceland is on average six times higher than the fishing license fees Kiribati receives from each metric ton of fish catch (Figure). To increase proceeds from fishing resources, Kiribati should encourage private sector investment in onshore marine processing. Some progress has been made in recent years. Kiribati Fish Ltd., a joint venture for marine processing with Chinese and Fijian fishing companies, has become operational at end-2012. It processes sashimi for the Japanese and US markets, and creates job opportunities for locals. To ensure a viable domestic fishing industry, improving infrastructure and business climate, and removing obstacles for doing business are essential.

A01ufig06

Kiribati: Fishing License Revenues and Value of Fish Catch

(US dollars per metric tonnes)

Citation: IMF Staff Country Reports 2013, 158; 10.5089/9781484338353.002.A001

Sources: Pacific Islands Forum Fisheries Agency; and IMF staff estimates.
A01ufig07

Kiribati: Value of Fish Catch and GDP

(Ratio)

Citation: IMF Staff Country Reports 2013, 158; 10.5089/9781484338353.002.A001

Sources: Pacific Islands Forum Fisheries Agency; and IMF staff estimates.
A01ufig08

Iceland: Value of By-products from Fishing Processing

(US dollars per metric tonnes)

Citation: IMF Staff Country Reports 2013, 158; 10.5089/9781484338353.002.A001

Sources: Pacific Islands Forum Fisheries Agency; and IMF staff estimates.

33. Current and planned improvements to infrastructure should strengthen general economic activity and opportunities for tourism. There is a potential for tourism outside of Tarawa, particularly in Kiritimati Island, and the Phoenix and Line islands.

34. Removing obstacles for doing business and improving the business climate is essential for private business growth (Box 3). Kiribati ranks low compared to its Pacific islands peers in a number of doing business indicators - including time to get electricity and construction permits, and access to land and credit. Nevertheless, there is scope for the government to shorten and standardize the business applications process, and reduce red tape.

Authorities’ Views

35. The authorities agreed that increasing private sector participation in the economy and promoting its robust growth is critical for improving Kiribati’s long-term growth prospects. In particular, they indicated that the development of a robust the local fishing industry is key to fully utilizing Kiribati’s abundant marine resources.

36. Working and studying abroad is essential given limited local employment opportunities. High airfare costs associated with a single major airline carrier has put Kiribati’s workers, in particular seamen and seasonal workers, and students abroad, at a disadvantage. The authorities also hoped that the foreign quotas for Kiribati’s students and workers will be increased in the near term.

Kiribati: Supporting Private Sector Growth

Streamlining business and investment approval processes and reducing business costs are important for attracting and securing both foreign and domestic investment. Cumbersome procedures and high establishment costs, amongst other factors, place Kiribati in low ranking among regional neighbors for starting a business. The government is currently finalizing its National Private Sector Development Strategy that would facilitate the introduction of a ‘one-stop shop’ concept for investment approvals.

Accessing land, together with obtaining licenses, is one of the biggest impediments to starting a business in the business survey. Enforcing contracts appears to be quite a lengthy process in Kiribati and improvements to enforcement of property rights and speedier settlement of court settlement procedures, in particular for those relating to land, should help strengthen the business legal environment in Kiribati and promote increased private sector activity.

Private sector access to credit remains limited and is complicated by unclear land titles and cumbersome access procedures that restrict the use of land as collateral. This is evident in Kiribati’s poor access to credit ranking. New entrants to the business sector, usually lacking proper business records are disadvantaged in accessing credit. Increasing credit access for viable business would require addressing these concerns.

Table: Doing Business Rankings 1/

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Source: World Bank, Doing Business 2013.

FJI=Fiji, FSM = Federated States of Micronesia, KIR=Kiribati, RMI= Republic of Marshall Islands, PNG = Papua New Guinea, SAM-Samoa, TON=Tonga.

Economies are ranked from 1-185, with a high ranking (lesser number) reflective of a more conducive environment

D. Financial Sector

Background

37. Formal financial intermediation and access to credit for the private sector is limited. Unclear land titles and cumbersome access procedures restrict the use of land as collateral, underpinning weak collateral recovery and the underdeveloped nature of secured lending. Unsecured consumer and house lending by the single commercial bank (ANZ) is very limited and constrained by problems with obtaining collateral and recovery in case of default. That said, there has been a rise in household credit (from very low levels) since 2011. For the Development Bank of Kiribati (DBK), the majority of its loans are collateralized by salary deductions and pension contributions. Nevertheless, the DBK has accumulated a significant amount of non-performing loans in excess of 22 percent. There is also a sizeable informal sector whose access to formal credit remains restricted. The lack of competition in Kiribati’s financial sector contributes to relatively expensive cost of finance.

A01ufig09

Interest Rate Spread of Commercial Banks1/

(In percent)

Citation: IMF Staff Country Reports 2013, 158; 10.5089/9781484338353.002.A001

Sources: Country authorities; IMF, International Financial Statistics; and IMF staff estimates.1/ 2011 or lastest available.

38. The KPF runs a small loans scheme (SLS) collateralized by member’s pension balance. The expanded scheme currently stands at A$10 million and charges 8.5 percent annual interest rate, which is determined by the KPF board.6 Early indications are that the KPF SLS has contributed to private sector lending. Regarding the balance sheet, the KPF has accumulated the deficit of more than A$ 20 million as members’ balances exceed the value of the KPF investments, in part because of high rates paid to the KPF members.

Kiribati: Outstanding Banking Loans, 2007–12

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Source: Data provided by the Kiribati authorities.

Staff’s Views

39. Strengthening institutional arrangements with regard to access to land would help boost financial intermediation. The authorities are encouraged to enact the relevant laws and procedures that will facilitate collateral recovery, improve and enhance secured borrowing. Increasing access to credit for viable private sector projects is important. Introducing microfinance schemes and improving financial literacy may be promising as some start-up business lack proper financial records that disqualify them for formal bank loans.

40. At the same time, lending standards and risk management need to be maintained and strengthened in those institutions with high share of non-performing loans. Such frameworks need to be implemented in the absence of a separate financial supervisory authority.

41. Restoring an operating surplus at the KPF will be important to ensure the sustainability of the pension fund’s operations. While rebuilding the financial position of the pension fund may take some time, in the immediate future, the KPF is advised to avoid setting rates of return on members’ balances in excess of returns on its investments.

Authorities’ Views

42. There was general agreement about the impediments to increased financial intermediation, particularly for the private sector. While increased competition may be harder to introduce in the short term given high establishment costs, the authorities recognize that better management of current lending practices are important for ensuring the stability of the financial sector. In that vein, officials were interested in technical assistance in risk management and improved asset allocation.

E. External Competiveness and Exchange Rate Assessment

43. The Australian dollar circulates as legal tender. Kiribati has accepted the obligations of Article VIII, Sections 2, 3, and 4 and maintains an exchange system free of restrictions on payments and transfers for current international transactions.

44. Reflecting the strength of Australian dollar, the real effective exchange rate (REER) is well above its long run average despite depreciating by 8 percent over the last two years. CGER-like analysis of exchange rate valuation is currently neither feasible nor meaningful for Kiribati given the data limitations. That said, the strength of the REER in recent years points to exchange rate overvaluation, given that, unlike Australia, Kiribati is not a commodity exporter.

A01ufig10

Kiribati: Real Effective Exchange Rate

(Index, 2005 = 100)

Citation: IMF Staff Country Reports 2013, 158; 10.5089/9781484338353.002.A001

Sources: INS and IMF staff calculations.

45. The use of the Australian dollar as the official currency remains appropriate. It has provided a strong nominal anchor, given Kiribati’s close linkages with Australia and in light of its limited capacity to conduct its own monetary policy. The reforms aimed at boosting private sector growth discussed above will be crucial to improving and maintaining competitiveness following the strengthening of the REER. The current account deficit in relation to GDP is largely driven over the medium term by fiscal policy. Consistent with this, the projected fiscal consolidation in the coming years will also be important to help narrow the trade deficit.

Staff Appraisal

46. Kiribati’s challenge is to implement fiscal and structural reforms to help ensure fiscal sustainability, promote private sector development, and increase its resilience to external shocks. These reforms, in combination with the large developments projects financed by foreign partners, will help support favorable medium-term growth prospects. Steady implementation will be the key.

47. Restoring fiscal sustainability and stabilizing per capita RERF balances will require significant fiscal effort in the medium and longer term. Strong revenue measures are necessary while adjustments on the expenditure side would need to accommodate the need to maintain adequate health and education systems, communication lines, and adapt to climate change. The authorities are urged to press ahead with plans to adopt a VAT, which is urgently needed to increase revenues. Sound public financial management is essential. Steps are needed to improve fiscal projections. Consistent with adoption of a prudent borrowing and debt guarantee policy, Kiribati should avoid commercial borrowing to finance its budget.

48. Making subsidies more efficient would help reduce risks to the budget and align incentives. Over the medium term, subsidies should be streamlined and subject to better targeting. These reforms will need to recognize the impact that subsidies are having in the short term to support infrastructures and communications, as well as the importance of copra subsidy in supporting the livelihood of outer islands inhabitants.

49. SOE reforms have helped resolve a number of problem enterprises and reduced fiscal exposure. These reforms should continue. However, underperformance of some important SOEs remains a significant concern. In particular, the Public Utility Company needs to increase revenues and clear arrears. The current strategy of raising payment compliance to achieve this goal needs to be reviewed periodically.

50. Maintaining sufficient growth of fishing license revenues while abiding by international commitments and managing their volatility is very important. Many factors outside of Kiribati’s control combine to influence the volatility of fishing license revenues. Nevertheless it would be beneficial to explore the possibilities of improving license pricing mechanisms using international best practices and experience.

51. Fully utilizing marine potential beyond fishing license fees will be important to improve fiscal revenues and growth opportunities. Kiribati’s small share of the value of the fish catch in its waters points to the potential to further develop this sector to expand the tax base, widen local employment opportunities, and enhance overall growth potential.

52. More generally private sector development is critical for both lifting growth and reducing fiscal pressures. Improving the management and development of Kiribati’s marine resources, developing the tourism industry, and expanding opportunities for studying and working abroad provide the greatest economic potential. Removing obstacles for doing business is of utmost importance.

53. It is proposed that Kiribati be moved to the 12 month Article IV cycle in light of continuing fiscal and structural challenges and vulnerabilities.

Figure 1.
Figure 1.

Kiribati: The Setting in a Cross-Country Context

Citation: IMF Staff Country Reports 2013, 158; 10.5089/9781484338353.002.A001

Sources: Kiribati authorities; World Bank, World Development Indicators; and IMF staff estimates.
Figure 2.
Figure 2.

Kiribati: Fiscal Dynamics

Citation: IMF Staff Country Reports 2013, 158; 10.5089/9781484338353.002.A001

Sources: Kiribati authorities; and IMF staff estimates.

Appendix I: Risk Assessment Matrix 1/

article image

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (that is, which is the scenario most likely to materialize in the view of IMF staff). The relative likelihood of risks listed is the staff’s subjective assessment of the risks surrounding this baseline. The RAM reflects staff’s views on the source of risks and overall level of concerns as of the time of preparation of this document.
1

The Revenue Equalization Reserve Fund (RERF) is a sovereign wealth fund established in 1956 and capitalized using phosphate mining proceeds before phosphate deposits were exhausted in 1979. It is one of the main sources of fiscal income and budget financing for Kiribati.

2

After the 2011 Article IV consultation, there were two staff visits in January and June 2012. The main recommendations of the consultation and the staff visits included: the call for fiscal consolidation to ensure fiscal sustainability and to preserve the value of the RERF; acceleration of the structural reform agenda, including reform of the SOEs; and implementing measures to promote private sector development through simplification of business procedures and improving access to land. The staff visits focused in particular on addressing growing fiscal imbalances following adverse fiscal outturns. To address such imbalances, the staff called for strengthening tax administration, expanding the tax base by introducing broad base value added tax (VAT), restraining current expenditure, and eliminating the need for non-concessional borrowing. The June 2012 staff visit proposed clearing government outstanding commercial debt and embarking on a strong reform program supported by development partners, which would help attract donor budget support.

3

While fishing license fees were significantly higher in 2012 due to one off factors, such an outcome cannot be sustained in the long run.

4

For the purpose of this report, the current fiscal deficit is defined as the deficit that excludes development expenditures financed by donors and corresponding development grants on the revenue side. It is a better indicator of the fiscal position and financing demands on Kiribati government than the overall deficit. The current deficit in this definition also corresponds to the concept that the government uses for its budget.

5

The Kiribati Supply Company Limited was successfully sold at the end of 2011, while the wholesale and retail company Bobotin Kiribati Limited was approved for sale late last year. A privatization tender has been issued for the Otintaai hotel. Betio Shipyards Limited is a likely candidate for PPP or joint ventures.

6

A member may borrow up to 35 percent of accrued balances for a maximum two years.

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Cover IMF Staff Country Reports
Kiribati: 2013 Article IV Consultation—Staff Report; Informational Annex, Debt Sustainability Analysis, Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Kiribati
Author:
International Monetary Fund. Asia and Pacific Dept
Volume/Issue:
Volume 2013: Issue 158
Publisher:
International Monetary Fund
ISBN:
9781484338353
ISSN:
1934-7685
Pages:
55
DOI:
https://doi.org/10.5089/9781484338353.002

International Environment and Kiribati

Baseline Scenario: Current Deficit and RERF Balance

Stronger Reform Scenario: Current Deficit and RERF Balance

Policy Stagnation Scenario: Current Defict and RERF Balance

Wage Expenditure

Kiribati: Fishing License Revenues and Value of Fish Catch

(US dollars per metric tonnes)

Kiribati: Value of Fish Catch and GDP

(Ratio)

Iceland: Value of By-products from Fishing Processing

(US dollars per metric tonnes)

Interest Rate Spread of Commercial Banks1/

(In percent)

Kiribati: Real Effective Exchange Rate

(Index, 2005 = 100)
Figure 1.

Kiribati: The Setting in a Cross-Country Context
Figure 2.

Kiribati: Fiscal Dynamics