Economic Context

Kiribati consists of 33 small islands in the mid-Pacific Ocean, mainly coral atolls with a distance of 4,500km between the eastern and western economic zones comparable with the distance between the east and west coast of Australia and the United States. 56 percent of the population of approximately 110,000 are located on the islands of South Tarawa and Betio with high patterns of migration from outer islands. The remaining 44 percent of the population are spread across 22 other inhabitable islands. High transaction costs between the outer islands and South Tarawa due to isolation and poor infrastructure affects the development of the productive sectors on the outer islands.

Most of South Tarawa is less than three meters above sea level which means that the country is highly vulnerable to climate change. Latest meteorological reports suggest the tropical Pacific Ocean has warmed steadily in recent months, with large warm anomalies in the ocean sub-surface and increasingly warm sea surface temperatures. These trends suggest that there is a 70 percent likelihood that an El Nino-Southern Oscillation (ENSO) event will occur in July this year. The implications for Kiribati are that it will be subjected to abnormally higher levels of rainfall with potential flooding.

Economic Outlook

Economic growth has strengthened and will likely remain strong due to major infrastructure projects commencing over the next few years. A roads rehabilitation project, the airport terminal renovation and a water and sanitation rehabilitation project are several major donor funded projects to get underway over the next few years. The actual lasting impact on the domestic economy may remain modest as all materials, specialist machinery, and most of the construction staff will need to be sourced from abroad. GDP growth will strengthen to around 3.0 percent and inflation will become positive rising to 2.5 percent in 2014 with the introduction of the VAT in April 2014. Fishing revenues strengthened in 2012 and 2013, but are expected to remain volatile as the number of day licenses sold depends on migratory tuna stocks, which remain sensitive to climatic conditions and changes in water temperature. The complete abolition of commercial fishing in the Phoenix Islands Protected area at the end of 2014 will provide some protection to fish stocks which are threatened by higher catches but will also lead to a decline in fishing revenue in 2015.

Fiscal Policy

Company tax revenues fell in 2012 alongside an increase in noncompliance. However, a small increase in company taxes of 4.6 percent occurred in 2013. Fisheries revenue rose to a record 89.8 million AUD and as a result, the current fiscal balance is forecast to reach 19.4 percent of GDP in 2013. The Revenue Equalization Reserve Fund (RERF), Kiribati’s sovereign wealth fund, has significant financial assets amounting to around 370 percent of GDP in 2013. These funds were accumulated from phosphate mining at the time of independence in 1979. Current projections suggest the RERF will undergo a gradual depletion without policy change over the next couple of decades. Thus, Kiribati’s overriding fiscal goal remains to protect the value of the RERF. The staff projections suggest that the withdrawals from the RERF should be limited to less than 12 million AUD annually to stabilize the RERF over a period of 8-9 years. Our authorities remain committed to prudent macroeconomic policies, but achieving this target will be difficult.

The introduction of the VAT and excise taxes will put Kiribati on a more equal footing with the tax structures of other Pacific nations and ensures that Kiribati complies with the provisions of the trade agreement PACER Plus which promotes free trade in the Pacific region. The introduction of the VAT along with excise tax and the abolition of customs duty will see overall taxation levels declining in 2014 (mainly due to lags in the collection of VAT) but in 2015 taxation revenue is expected to significantly rise. The World Bank has provided budget support of 5.8 million AUD in 2014 and the Asian Development Bank has offered 3 million USD in budget support to ease adjustment. Other donors have also displayed some interest in the provision of budget support in 2014 and 2015.

Ongoing support remains contingent on future policy action. Donor partners, including the IMF, have agreed on a policy reform matrix that identified key reforms. These reforms have been carefully prioritized to reflect the capacity constraints on the Kiribati Government and were supported through the provision of extensive technical assistance from a range of sources. The programmatic series of Kiribati Economic Reform Operations supports three key elements, including increasing revenues; improving the management of public assets and liabilities; and expanding private sector opportunities. Tax reform that includes steps to improve compliance has been an integral part of the reform. Financial reforms, SOE reform, and improved guidance around management of the RERF have also occurred. Subsidy reforms are under consideration to the copra purchasing scheme. This subsidy provides an important safety net for subsistence populations on the outer islands but remains expensive with 7 percent of total expenditure being outlaid in 2013. However, the Government of Kiribati believes that income generating schemes such as the copra price subsidy go a long way towards stemming the drift of population from the outer islands to South Tarawa where population pressures are intense. The World Bank has provided assistance to improve the efficiency of the copra price subsidy through recommendations such as the merger of the two main organisations involved. Technical assistance has been provided on centralized debt management guidelines to establish policy criteria around any additional borrowing which the government has agreed to. Departments and SOEs now face new limitations on their ability to independently incur debt or invoke government guarantees through a requirement for formal Cabinet approval.

State Owned Enterprise Reform

Kiribati’s SOEs were originally set up to provide commercial services so as to meet public policy objectives. However, governance, sustainability and accountability have been long standing issues in the management of SOEs in Kiribati. Several SOEs have been privatized, with plans for more in the future, opening the potential for increased private sector engagement. The import trading company was sold and the first PPP has been developed between the Government and the owners of the former state owned hotel, the Otintaai Hotel. The Government is examining other asset sales and in 2013 approved a Bill opening the telecommunications industry to competition. The Government has sought expressions of interest in operating the national telecommunications company. For other SOEs with a social mandate, the concentration will be on providing effective subsidies and ensuring their commercial viability. Shipping is one area that the Government has focused its attention on, with a view to encouraging private sector involvement. Our authorities are working with the ADB on a comprehensive review of the SOEs, aimed at improving financial transparency through improved management or sale. An SOE Bill was passed in May 2013 establishing a strengthened legal framework covering independence, governance, financial reporting, and the management of SOEs. The emphasis has been on improving the commercial performance of the SOEs. Arrears on inter-SOE debt and debt to Government Ministries as well as loans to the commercial bank have been catalogued and are being cleared, including those between the Public Utilities Board and Kiribati Oil. The Ministry of Finance has also increased its supervision and oversight to carefully monitor debt management.

Private Sector Growth

Growth in the private sector will be important to reduce the social cost of fiscal adjustment, given high unemployment and relatively low annual income. The rapid population growth in South Tarawa has created a growing private sector, although most businesses remain small, informal, and largely family run. Improved urban planning, given rising population density and clarity around lack of formal land title, could encourage investment. Kiribati authorities have finalised a National Private Sector Development Strategy to progress private sector initiatives.

The authorities have worked for many years to encourage local participation in the fishing industry – the nation’s primary economic resource. A range of joint ventures and, employment agreements have been trialled in an attempt to overcome a chronic lack of capital. The Government completed a National Fishing Policy in 2013 to strengthen the sustainable management of fisheries resources and maximize license revenue income. Kiribati has received international direct investment in a new fish processing plant, which offers a promising opportunity for Kiribati to earn more from its fishery resource. The factory will provide employment and exposure to international management practice. The authorities are in negotiations with Fiji to open the air route to competition. Lack of a second airline to Kiribati from Fiji inhibits the growth of important fishing exports due to the limited capacity of the airline.

Labor Mobility and Foreign Policy

With official unemployment rates of over 30 percent, Kiribati sees global integration as its primary avenue towards economic development. The Government has placed a large emphasis on providing the population with the education and skills necessary to capitalize on employment opportunities abroad with a greater emphasis on technical qualifications that are internationally recognised. For instance, the Marine Training Centre in Kiribati is an internationally recognised institution which has provided qualifications for I-Kiribati seafarers to be sent abroad for nearly fifty years. The local technical institute is also supporting this trend to align training schemes with Australian educational standards. This should allow local tradesmen to migrate to meet skill shortages in Australia and New Zealand. New Zealand and Australia also attract seasonal workers from Kiribati, which adds to remittance flows. The Government is attempting to improve basic skills such as financial literacy to boost the numbers of seasonal workers abroad.

Growth to a large extent in Kiribati depends on the fortunes of the fishing industry which accounted for 70 percent of revenue in 2013. The ENSO event expected in July will also mean better conditions for fishing as fish stocks normally rise with ENSO in Kiribati. However, the fishing industry is highly volatile and therefore highly unpredictable with fiscal revenues from fishing in Kiribati fluctuating from 29 million AUD in 2011 to 90 million AUD in 2014. World events such as the Global Financial Crisis also add to the challenges with a sudden downturn for employment of seafarers and commensurate effects on remittances one end result. The world price of rice, a staple commodity, also affects the inflation rate. Exchange rate variations also have an impact on revenue. The Australian dollar is the currency in Kiribati and revenue from fishing contracts, normally written in US dollars, will fluctuate with movements in the Australian dollar. Kiribati is one of the Parties to the Nauru Agreement (PNA) which implements measures to maintain sustainable tuna fisheries and minimise the impact on bycatch species. Regional agreements such as these assist in the management and the revenue streams for the industry.