Abstract
Vanuatu has a comparatively favorable economy and cautious macroeconomic policies that have helped maintain stability and confidence. Financial sector policies also have been appropriately cautious. The economy must maintain low debt in the longer term, but as funding is needed for infrastructure, maintenance, and social services, new revenue measures have to be identified. This revenue could help strengthen the state while maintaining growth potential, especially in the tourism and agricultural sectors. The financing options for new large infrastructure projects have to be assessed.
The Vanuatu authorities thank staff for the constructive policy dialogue and useful advice provided during the Article IV Consultation. The favorable 2013 economic assessment is a welcoming sign that the country is maturing further and heading in the right direction. Nonetheless, the authorities recognize that they face numerous challenges, including in infrastructure and tax reform, and, in this regard, reaffirm their full commitment to the economic growth agenda.
Economic Developments, Outlooks and Risks
Vanuatu is a highly open, small island economy in the Pacific, and remains significantly exposed to external uncertainties. The delay in the global economic recovery has put a strain on the economy over the past few years. The economy began to recover in 2012, with the tourism sector picking up strongly. Inflation is low at 0.8 percent and the current account deficit has narrowed to 6¼ percent of GDP, from 8 percent in 2011. Growth for 2013 is projected to continue, supported by a pickup in manufacturing and construction.
Downside risks to the growth forecast include: further delay in the global recovery, unexpected rise in global fuel prices, and a change of preference from tourism originating from Australia and New Zealand. At the domestic level, the frequent changes in the political arena present challenges to reform efforts. However, the new government, headed by Prime Minister Moana Carcasses Kalosil, is committed to ensuring political stability in order to promote economic growth and structural reform.
Fiscal Management
Fiscal management is sound and the authorities are committed to maintaining this position. Authorities intend to maintain debt at low levels, although they recognize that this will be a significant challenge, given projected infrastructure financing needs. Authorities agree with the Staff assessment that the government budget needs to be strengthened to support the financing of public capital investment projects. In this regard, the government will continue to work closely with the development partners and to seek external financing support on concessional terms only.
The fiscal revenue base must be strengthened over the longer term. The authorities are pleased to advise that discussions with the line ministries on the planned new revenue initiatives have started and the government is putting together the recommendations. While some recommendations can be implemented right away, such as increasing the VAT rates, others like the income tax proposal will require comprehensive analysis to be carried out first. As noted in the staff report, authorities are open to considering all tax options, and would welcome Fund assistance to this end.
Tax administration will be further strengthened by the recruitment of suitable personnel, appropriate training and improving enforcement capacity. On the expenditure side, the authorities will continue to improve expenditure management and strengthen the oversight of audit controls. The authorities recently amended the Public Finance and Economic Management Act to improve the control and disbursement of funds. The government’s plan to address the financial health of state owned enterprises (SOEs) through the restructuring of these entities and liquidation of those that are no longer profitable will ease the pressure on the government budget.
Monetary Policy and Exchange Rate
The monetary policy framework of the Reserve Bank of Vanuatu (RBV) continued to be effective in achieving the monetary policy targets over the past two years. The peg to a basket of currencies has served the country well in providing stability and guiding expectations. While inflation is currently low, inflationary pressure is expected to increase over the coming years with the implementation of government projects and the expected increase in domestic demand. The RBV stands ready to tighten monetary policy and to take appropriate steps to protect net international reserves above the four months import cover threshold as demand for import rises in the near term.
Financial Sector
The financial sector is sound and domestic banks are well capitalized. However, growth of non-performing loans (NPLs) resulting from weak economic environment is a concern. The RBV has responded proactively, by conducting onsite reviews of NPLs, increasing their monitoring and instructing banks to adhere to prudent credit lending standards. The RBV strongly advised banks to ensure they had adequate provisioning to cover potential losses. As a result, specific provisions for the banking industry as a whole, increased by 159 percent from August 2011 to December 2012.
On the high credit to deposit ratio, the RBV is closely monitoring the situation, particularly in relation to the Vanuatu National Provident Fund’s recent withdrawal of its significant deposits from the banking system to fund its huge investments. More broadly, while the industry’s liquidity level is high, the distribution among individual banks is uneven. To this end, the RBV will continue to review the prudential liquidity requirements of commercial banks and ensure that banks continue to adhere to best liquidity management practices.
Authorities concur with the staff assessment that individual banks’ systematic exposure to foreign exchange risk should be monitored carefully. Notably, the trend increase in demand for foreign-currency credit, against declining foreign-currency deposits, is of concern. At this stage, the RBV has drafted, but not yet implemented, a guideline on managing foreign currency risk. The guideline will also address the risk of exposure to unhedged foreign currency lending to ensure that it is reflected in the banks’ balance sheet.
AML/CFT Issues
As an offshore center, Vanuatu’s reputation has come under intense scrutiny over the years. However, Vanuatu is committed to complying with the international standards on anti-money laundering practice. Vanuatu has enacted more comprehensive AML/CFT legislations and has established the Financial Intelligence Unit (FIU) to oversee this function. The authorities agree, however, that effective enforcement of the legislation is an area of weakness and they will put more focus on this. More financial support will be provided to the FIU and the authorities will continue to recruit and upgrade the HR capacity of the Unit through its participation in domestic and international trainings.
Structural Reform
The government continues to pursue structural reform steadfastly in its efforts to improve government services to make basic services more affordable and reliable to the general public. The 2008 reform in the telecommunication sector brought greater competition with the entry of Digicel, bringing the total telecommunication service providers to two. The government also launched in 2012 its e-government network allowing it to run its own network, improving its services throughout the country. The government is also giving its full support behind a private-led joint venture project to deploy Vanuatu’s first international submarine cable system linking Vanuatu to Fiji. This new set up, planned for completion this year, will deliver faster, more efficient and cost effective internet connectivity, replacing the current unstable satellite telecommunication set up.
On the energy sector, concerted effort has been made to increase power supply, improve reliability, and reduce the high costs of electricity. The government has opened up the energy sector and licensed a new electricity company, Vanuatu Utilities and Infrastructure, which operates in the second town, in the northern part of the country. The main power provider, Unelco Vanuatu Ltd., has also diversified its energy source to include coconut oil and wind energy. The government is also in the process of finalizing the setup of a geothermal plant venture with a reputable international energy company, Kuth Energy, on the northern side of the island of Efate. The project, once in operation, is expected to reduce the high cost of electricity in Port Vila (the capital) and reduce the high dependency on diesel based electricity generation.
The drop in the country’s 2013 doing business ranking from 62 to 80 is unfortunate. The authorities are determined to improve the ranking by reducing the time it takes to start a new business and the time taken to obtain a construction permit. Authorities also see merit in eliminating redundant procedures to reduce start-up and compliance costs.
The government is committed to reforming Government Business Enterprises (GBEs) to achieve the combined goals of improved public service delivery, reduced fiscal transfers to the GBE sector and private sector development. A policy paper on reforming GBEs is currently being finalized for submission to the Council of Ministers. The GBE policy will form the basis of a new SOE legislation. While there are no current plans for privatizing any GBEs over the medium term, any restructuring and privatization of GBEs can only occur after the new SOE legislation is in place.
The future driver of growth will mainly come from the tourism sector. To reduce the heavy reliance on the Australia and New Zealand markets, the authorities are also looking to expand into the Asian market. Last year, the authorities conducted a number of big promotions in the Asian region and they intend to increase this further. The outcome of last year’s promotion is already showing positive results. Given that the infrastructure capacity of the country is insufficient to support tourism targeted growth, the implementation of the donor funded projects to improve Port Vila’s urban infrastructure, main wharf and shipping is a welcomed development. Short-term growth will be driven by the implementation of donor funded public infrastructure projects that have already been approved. To avoid delays and to smooth out the impact of donor funded large capital projects, the authorities will strengthen the role and capacity of the Vanuatu Project Management Unit. Over the longer term, the government is focused on soliciting financial support to fund the expansion of the country’s main airports to accommodate larger aircrafts and increased capacity.
For the agriculture and fishery industries, the authorities will continue to exploit the comparative advantage of these industries and will more critically address the barriers to labor and investment. Plans are also under way to open up a government fishery processing plant (built with the assistance from China some years ago) on Efate in June this year. This processing plant will help facilitate private sector activities, increase the value-added in the production process, and provide local employment. Job opportunities have also increased with the opening up of the unskilled labor mobility scheme with the New Zealand Government in 2006 under the Recognized Seasonal Employee scheme. A similar scheme has just been established with Australia, although the scale is still small.