Abstract
This 2013 Article IV Consultation highlights that economic growth in Solomon Islands is slowly rebounding from the slowdown of the first half of 2013, when agriculture, logging, and gold production fell, owing mainly to unfavorable weather developments, lower terms of trade, and one-off factors. Real GDP growth is projected at 2.9 percent for 2013 and 4 percent for 2014. Risks are tilted to the downside, including from lower external demand and grants. Inflation has stabilized at about 6.5 percent and is expected to fall gradually as agricultural prices react to the recovery of production.
The Solomon Islands authorities consider the ECF is valuable to promote continued macroeconomic and financial stability and build momentum for reform, and they remain firmly committed to this three-year program. The program is helping to strengthen the institutional framework to ensure enduring improvements to macroeconomic and public financial management, and to address structural issues that hold back improvements in living standards for Solomon Islanders. The ECF (and predecessor SCF arrangements) have helped strengthen donor support and the ongoing success of the program will help to build confidence with development partners.
The key challenges facing Solomon Islands (and other small Pacific Island states)–small size, remoteness, and a dispersed population; a narrow economic base; and vulnerability to natural disasters and external shocks–cannot be easily overcome. The past six months has, however, seen the significant milestone of the withdrawal of the military component of the Regional Assistance Mission to Solomon Islands (RAMSI), part of the Solomon Islands’ landscape for a decade following the period of civil conflict known as the “ethnic tensions” (1998 to 2003). RAMSI has partnered with Solomon Islands to lay the foundations for stability, security and prosperity. RAMSI’s police presence will be maintained until 2017 and its remaining development work and assistance is transferring to bilateral and multilateral aid programs. The outlook more generally is that donor assistance in the future will be at lower levels than currently.
Progress under the ECF has been steady. All of the June 2013 performance criteria (PCs), indicative targets, and continuous PCs were met. There has been progress with structural reforms. Significantly, the Public Finance Management Act (PFMA) was approved by Parliament ahead of schedule in September. This critical reform provides Solomon Islands with a modern financial and legislative framework that will encourage fiscal responsibility (through a focus on sustainable levels of Government expenditure, revenue and public debt) and promote greater transparency and accountability. This will support the more efficient, effective and ethical use of public resources. Nevertheless, other structural reforms have not progressed as quickly as hoped due to capacity constraints and the attention given to advancing the PFMA. In particular, weakened staff resources in the Attorney-General’s Chambers have delayed legislative reform in respect of the tax changes for mining; the revised National Provident Fund Act; and the new Customs and Excise law. The authorities are actively addressing this constraint with support from the Asian Development Bank to supplement capacity, and are giving priority to ECF program-related legislation.
Economic Developments
The economy faced several adverse shocks in the first half of 2013, including a significant terms of trade deterioration, poor weather conditions affecting agricultural production, and more subdued gold production due to the refurbishment of the Gold Ridge mine. The economy is expected to grow by 2.9 percent this year, down from around 5 percent in 2012, and lift to 4 percent growth in 2014 boosted by recovering agriculture and gold production. Inflation has stabilized in recent months and was 5.5 percent in October (3 month moving average).
As noted by staff, key short-term risks are to the downside: weaker demand from offshore markets; lower commodity prices for Solomon Island exports; higher oil prices; and the risk of lower foreign grant financing. In conjunction with the updated Debt Sustainability Analysis which shows Solomon Islands continues to face a moderate risk of external debt distress owing to possible shocks, these risks highlight the importance of continuing to strengthen economic and fiscal buffers to ward against any shocks.
Fiscal Policy
Government revenues are now projected to be around 0.5 percent of GDP lower than was projected at the time of the first review, reflecting lower growth, reduced revenue from excises on tobacco and alcohol, and weaker revenues from fishing licenses. In light of this, the authorities have requested a small modification of the PC on net credit to the government.
Several challenges have also emerged on the expenditure side, with authorizations for sizeable increases in expenditure in certain areas–most particularly tertiary scholarships.
The Solomon Islands authorities consider tertiary scholarships are vital to support the country’s future development prospects and to provide opportunities for the youth. Nevertheless, the rapid increase in tertiary scholarship expenditure and emergence of arrears revealed weaknesses. The authorities are determined to ensure spending on tertiary scholarships is responsible, managed within a budget, and applies best practices in public financial management. As such, corrective action is underway with the Ministry of Education and the Ministry of Finance and Treasury working closely to improve the policies and processes related to tertiary scholarships. Revised policies will go to Cabinet for approval by the end of January so that they may come into effect for the coming school year. Recognizing the importance that basic education is not unduly crowded out, the government will also review tertiary policies in coordination with development partners to ensure an appropriate balance of spending between primary and tertiary education.
The government is committed to maintaining fiscal discipline and improving the quality of spending. The authorities have committed to manage total expenditure in 2013, including that authorized in the supplementary budget approved by Parliament in September, within the overall spending envelope approved during the first review of the ECF and thus achieve a balanced budget. The authorities are doing this through reallocating other spending and utilizing under-spends in the first half of 2013 (including in the development budget). The 2014 Budget recently passed by Parliament also targets a balanced cash budget, while protecting spending on primary education and health.
Steps are well advanced to bring greater rigor to the management of Constituency Development Funds. Implementing regulations that will give effect to the Constituency Development Funds Act have been drafted by a bipartisan committee and are being consulted widely. The regulations will introduce requirements on the management, use and reporting of funds to deliver greater accountability and transparency.
A key priority for the coming months will be to bring the new PFMA into effect. The authorities recognize that solid implementation is vital if the new fiscal framework is to truly deliver responsible fiscal management and improved quality of spending over time. A number of new program benchmarks have been established to begin to bring into effect the new requirements under the Act, including new reporting, and updating of the financial instructions.
Strengthening the debt management framework remains a priority. The authorities are committed to a prudent approach to borrowing in line with the Debt Management Strategy. With the completion of the Debt Management Strategy, the Government continues to put in place a comprehensive debt management policy framework over the last 18 months. This includes the endorsement by Cabinet of annual borrowing limits in line with the debt sustainability analysis; completion of the State Owned Enterprises Debt Policy; the incorporation of key aspects of the new Debt Management Strategy into the new Public Financial Management Act 2013; the establishment and excellent running of the Debt Management Advisory Committee; and the recent approval by Cabinet of the Guarantee and On-Lending Policy, ahead of the new ECF benchmark.
Monetary Policy and Financial Sector
The authorities are committed to efforts to further deepen financial markets and strengthen monetary policy instruments. In this context the Central Bank of Solomon Islands (CBSI) will review all its monetary policy instruments and is continuing to deepen the market for Bokolo bills through issuing additional maturities. The CBSI is alert to inflationary risks in the light of stronger credit growth, and stands ready to take action if needed to reduce liquidity.
Access to financial services remains of critical importance. The decision of the banks currently operating in Solomon Islands to no longer provide banking services to logging firms from 2014–reflecting pressure from environmental groups in their home countries–is a concern. Nevertheless, CBSI has responded to this cautiously in order to safeguard financial stability. While two ‘interim’ banking licenses have now been issued (to a Malaysian and a Sri Lankan bank), these entities are not permitted to carry out banking operations until due diligence is complete and a full banking license has been issued.
Strengthening the financial supervisory and regulatory frameworks remains vital and the authorities are continuing work to revise the National Provident Fund legislation; prepare the Credit Unions Act; and to prepare a new Financial Institutions Act.
Structural Reforms
The authorities agree with staff on the need to develop new sources of growth–and thus secure employment opportunities, government revenue and foreign exchange earnings - given the long-term decline of the logging industry. Sectors that have been identified as offering potential are agriculture, tourism, fisheries and mining, with new fisheries and mining investments currently being explored.
Investment in critical infrastructure, particularly energy and transport, will remain vital to secure improved growth prospects. The authorities are currently finalizing a new medium-term development plan that will set out development goals for Solomon Islands and priority actions to achieve these. Furthermore, the authorities are motivated to see the functioning of the National Transport Fund (NTF) improved so that it can better support transport infrastructure development in Solomon Islands.
Conclusion
The Solomon Island authorities would like to thank IMF staff for their constructive engagement and valued technical assistance, including that provided from Headquarters and the Pacific Financial Technical Assistance Centre (PFTAC). This is playing an important role supporting Solomon Islands to strengthen its economic resilience and growth prospects, in order to deliver a higher standard of living for all Solomon Islanders.