Solomon Islands: Fourth Review Under the Extended Credit Facility Arrangement
Author: International Monetary Fund. Asia and Pacific Dept
Publication Date:
15 Apr 2015
eISBN:
9781475548129
Language:
English
Keywords:
ISCR; CR; ECF arrangement; government; vulnerabilities to shock; SDR; Solomon Islands government; country authorities; U.S. dollar; government pressure; basket peg regime; development plan; Commercial banks
Download PDF (3.2 MB)

KEY ISSUES Recent Developments and Outlook. Solomon Islands held its parliamentary elections on November 19, 2014 and elected a new government led by Prime Minister Manasseh Sogavare, representing the Democratic Coalition for Change. The country’s Gold Ridge mine, its only gold mine, remains closed and the chances of it re-opening are limited given current gold prices. At the same time, the logging industry is being adversely affected by the depletion of forestry resources. As a result, the near-term outlook has worsened. While lower oil prices constitute a windfall to consumers and producers, diversifying sources of growth and boosting the competitiveness of the economy are key to strengthening medium-term growth prospects. The risks to the outlook are to the downside. Program Performance. Performance under the Extended Credit Facility (ECF) arrangement has been broadly satisfactory. Performance criteria for end-June 2014 were met by large margins. Indicative targets (ITs) for end September 2014 were also met, except for those on health and education spending, which were both narrowly missed in June and September 2014. Despite delays, the authorities have made progress in implementing the structural reform agenda. Policy Recommendations ? In the medium term, recalibrate ambitious spending plans in line with implementation capacity, revenue envelope, financing availability, and the need to preserve fiscal buffers for resilience against shocks given the serious setback in mining prospects linked to the closure of the only gold mine. ? Strengthen the quality of public spending and fiscal management by advancing Public Financial Management (PFM) reform, including improving the transparency and accountability in the use of constituency funds. ? Maintain the current monetary stance but stand ready to tighten policy if credit growth and inflationary pressures surge. ? Strengthen financial regulation and supervision, including supervision of the National Provident Fund, and improve private sector access to credit.

Abstract

KEY ISSUES Recent Developments and Outlook. Solomon Islands held its parliamentary elections on November 19, 2014 and elected a new government led by Prime Minister Manasseh Sogavare, representing the Democratic Coalition for Change. The country’s Gold Ridge mine, its only gold mine, remains closed and the chances of it re-opening are limited given current gold prices. At the same time, the logging industry is being adversely affected by the depletion of forestry resources. As a result, the near-term outlook has worsened. While lower oil prices constitute a windfall to consumers and producers, diversifying sources of growth and boosting the competitiveness of the economy are key to strengthening medium-term growth prospects. The risks to the outlook are to the downside. Program Performance. Performance under the Extended Credit Facility (ECF) arrangement has been broadly satisfactory. Performance criteria for end-June 2014 were met by large margins. Indicative targets (ITs) for end September 2014 were also met, except for those on health and education spending, which were both narrowly missed in June and September 2014. Despite delays, the authorities have made progress in implementing the structural reform agenda. Policy Recommendations ? In the medium term, recalibrate ambitious spending plans in line with implementation capacity, revenue envelope, financing availability, and the need to preserve fiscal buffers for resilience against shocks given the serious setback in mining prospects linked to the closure of the only gold mine. ? Strengthen the quality of public spending and fiscal management by advancing Public Financial Management (PFM) reform, including improving the transparency and accountability in the use of constituency funds. ? Maintain the current monetary stance but stand ready to tighten policy if credit growth and inflationary pressures surge. ? Strengthen financial regulation and supervision, including supervision of the National Provident Fund, and improve private sector access to credit.

The Setting: Context and Outlook

1. The new government. Solomon Islands held its parliamentary elections on November 19, 2014. The new Prime Minister, Manasseh Sogavare, representing the Democratic Coalition for Change, announced the new government’s reform program in January 2015—an ambitious policy agenda (MEFP paragraph 6) which includes both land and sector reforms, aimed at boosting GDP growth by fighting corruption and enhancing business confidence to attract FDI, supported by large public investment over the medium term. The new government is also developing a Twenty-Year National Development Strategy (2015–35). Diversifying the sources of growth away from logging and mobilizing revenues to finance investment projects will remain key challenges going forward.

2. Recent developments. The closure of Gold Ridge mine and the flood of April 2014 weakened economic activity. Nonetheless, non-mineral production and exports have surprised on the upside thanks to reentry logging and a rebound in agricultural output and fisheries. As a result, real GDP growth is now estimated at 1.5 percent in 2014 (Tables 1–2). While, the current account is expected to have deteriorated to about -8.5 percent of GDP in 2014 (from -4.5 percent of GDP in 2013), performance has been better than initially anticipated (EBS/14/65) notwithstanding the effects of the mine closure, flood, and slowdown in official transfers in the run-up to the elections. This is due largely to the reduced trade deficit, including delays in import-intensive reconstruction. Net reserves were at US$478 million at end-December 2014 (equal to 8.2 months of imports) against a program target of US$450 million. They declined from US$550 million at end-June 2014 owing to a widening trade deficit, significantly lower-than-expected donor support and some large one-off capital outflows, including some debt repayment. Inflation slowed to about 4.2 percent in December 2014 from 7.5 percent in May because of lower commodity prices and post-flood food-supply recovery.

Table 1.

Solomon Islands: Selected Economic Indicators, 2012–16

Per capita GDP (2014): US$1,931 (estimate)

Population (2014): 562,000

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

Includes disbursements under the IMF-supported programs.

Includes SDR allocations made by the IMF to Solomon Islands in 2009 and actual and prospective disbursements under the IMF-supported programs.

Table 2.

Solomon Islands: Medium-Term Baseline Scenario, 2012–20

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Sources: Data provided by Solomon Islands authorities; and IMF staff estimates and projections.

Defined as nonmineral revenue (excludes grants) minus government-funded recurrent and development spending excluding interest payments.

Defined as nonlogging and nonmineral revenue (excludes grants) minus government-funded recurrent and development spending excluding interest payments.

Includes disbursements under the IMF-supported programs.

Includes SDR allocations made by the IMF to Solomon Islands in 2009 and actual and prospective disbursements under the IMF-supported programs.

Solomon Islands: Macroeconomic Indicators

(In percent of GDP, unless indicated otherwise)

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FDI numbers have been revised down as a result of changes to ensure the correct treatment of net losses under reinvested earnings, in line with the sixth edition of the Balance of Payments and International Investment Position Manual (BPM6).

Evalueted at program exchange rate.

Source: IMF staff estimates and projections.
A01ufig1

Solomon Islands: Real GDP Growth and Commodity Production

(Year-on-year percent change)

Citation: IMF Staff Country Reports 2015, 102; 10.5089/9781475548129.002.A001

Sources: Country authorities; and IMF staff calculations.

3. Baseline scenario. The economic activity is expected to increase by 3.3 percent in 2015, led by agriculture, tuna processing, and construction, but uncertainty regarding sustainable sources of growth remains. First, prospects for a near-term re-opening of the gold mine are dim with the current price of gold not facilitating the re-opening of the mine or finding a buyer willing to absorb the high sunk costs. Negotiations with the mining company to transfer ownership to the Solomon Islands’ government are underway. Concerns are rising that heavy rain could cause the mine’s tailings dam to collapse, incurring environmental damage and fiscal costs—tentatively estimated at up to 2 percent of GDP. Second, despite the strong performance in 2014, growth in the logging sector is expected to be modest this year, particularly given the government’s recently announced moratorium on new logging licenses aimed at improving environmental sustainability and tackling illegal activity. And finally, the timing of major infrastructure projects which were earlier expected to support growth in 2014–15 has been shifted to late 2015 and beyond. These projects include the Tina River Hydro and the submarine cable projects.

4. Risks to the outlook are to the downside. The aid envelope may decline more than previously envisaged posing additional challenges to Solomon Islands in meeting development objectives. The main risks are tied to weaker growth in a number of emerging markets, as well as potential negative spillovers from emerging Asia in the event of global financial market turbulence which could worsen Solomon Islands’ growth prospects. On the upside, consumers’ and producers’ windfall from sustained low oil prices could raise growth more than anticipated, given the country’s dependence on oil imports. Additional upside risks include better prospects for exploiting nickel deposits (starting in late 2015) and a nascent bauxite industry. The new government’s development plan includes major projects to spur rural development and boost growth potential. But their impact on medium-term growth will hinge on a critical mass of structural reforms (including land reform). If a downside scenario were to materialize Solomon Islands still has the fiscal space to respond. However, a series of negative shocks, including from natural disasters could quickly erode the policy buffers that the country has re-built since 2010 owing to its strong macroeconomic performance under IMF-supported programs. Solomon Islands remains a fragile state because of its vulnerability to external shocks, its history of civil unrest, and its weak institutional capacity.

Authorities’ Views

5. The authorities considered the risks to the outlook to be balanced and mainly external. They see the closure of the Gold Ridge mine as the main cause of the deterioration in the near-term economic outlook. According to the new Twenty-Year National Development Strategy, potential growth could reach 5 percent in the medium term, led by the fisheries, telecommunications, and construction sectors—and eventually in the long term by tourism.

Program Performance

6. Program performance under the ECF arrangement has been broadly satisfactory.

  • Reserve buffers are at a comfortable level. All performance criteria (PCs) for June 2014 were met with large margins (MEFP Table 1). In particular, the PC on the cash balance was largely met owing to higher cyclical revenues and lower-than-expected spending, including current spending. All continuous PCs were also met. All indicative targets for September 2014 were met, but the ones on health and education spending for June and September 2014 were narrowly missed owing to stronger procurement requirements by development partners in disbursing ODA.

  • Progress has been made in implementing the structural agenda. Four structural benchmarks were met: obtaining the Cabinet’s approval of drafting instructions for a new Financial Institutions Act; amending the export duty schedule to complete the implementation of the new mining tax regime in line with the IMF’s recommendations; and two important Public Financial Management (PFM) reforms—publishing a mid-year budget review and a budget strategy document. These last two benchmarks are expected to increase budget transparency and improve budget planning and execution. But despite the political commitment, reform implementation related to other benchmarks (MEFP Table 2) has slowed with the dissolution of Parliament in September, ahead of the election.

Authorities’ Views

7. The authorities noted that the four recently-met benchmarks have improved the mining tax regime and PFM and have laid the foundation for improved financial system legislation. They remain committed to achieving the remaining program benchmarks, notwithstanding unanticipated delays and capacity constraints that have led to repeated rescheduling of test dates.

Policy Discussions

A. Preserving Fiscal Space and Improving the Quality of Public Spending

Background

8. The fiscal position in 2014 was much stronger than targeted in the program (Table 3), but fiscal risks have increased going forward, with mining operations unlikely to resume in 2015 and the expected reduction of donors’ support. According to preliminary data and estimates, in 2014, the fiscal balance posted a surplus of about 2 percent of GDP.

Table 3.

Solomon Islands: Summary of Fiscal Accounts, 2012–16

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

Includes spending financed by recurrent grants.

Includes changes in the stock of unpaid payment orders and unpresented checks (+ = reduction) and the statistical discrepancy.

Defined as the sum of government deposits in the cash balance accounts minus unpaid payment orders and unpresented checks.

Nonmineral revenue (excludes grants) minus government-funded spending excluding interest payments.

Defined as nonmineral nonlogging revenue (excludes grants) minus government-funded spending excluding interest payments.

Defined as nonmineral nonlogging revenue (excludes grants) minus government-funded recurrent spending excluding interest payments.

  • Revenues and grants. Owing to higher-than-expected activity, tax performance in 2014—despite having deteriorated relative to 2013 by 2.8 percentage points of GDP because of the gold mine closure—has been stronger than anticipated (EBS/14/65). Trade taxes were particularly buoyant owing to strong logging exports. Nontax revenues, mainly fishing license fees, also surprised on the upside, as in other small states in the Pacific, owing to the higher minimum fee for fishing per vessel day under the Nauru agreement. As a result, revenues (excluding grants) were higher in 2014—by 1.7 percentage points of GDP—than expected. But grant estimates have been revised down, reflecting far lower disbursements by donors, which may partly reflect earlier political uncertainty.

  • Expenditure. Mostly because of lower grants, development spending was less than planned, which led to a downward revision of estimates for 2014. With regard to recurrent expenditure, the payroll bill increased by 13 percent (y/y) in nominal terms, in line with the 2014 budget. While the government’s public sector remuneration review, intended to address payroll fiscal risks, is still ongoing due to the administrative slowdown ahead of the elections, the authorities remain committed to it (MEFP paragraph 14). Election-related current spending is estimated at 1 percent of GDP. Other recurrent spending was lower than targeted, notwithstanding the supplementary budget in September 2014 which included higher spending (equivalent to 0.9 percent of GDP) to fund election costs, additional flood-related spending, and a large end-of-term payment to members of Parliament, equal to US$2.7 million (0.2 percent of GDP).

  • Cash and fiscal balances. In 2014, the fiscal balance posted a surplus of 1.9 percent of GDP. This surplus reflected an under-execution of both current and development spending, especially in the last quarter of 2014. With disbursement of large donor support taking place in December 2014, spending decisions have been postponed to early 2015. As a result, the cash balance at year end was much larger than targeted at SI$880 million, or 4.4 months of recurrent spending.

  • The 2015 fiscal budget and beyond. The 2015 budget has yet to be unveiled. Preliminary discussions with the authorities point to a fiscal deficit of about 2.1 percent of GDP financed with a drawdown of the cash balance—which would still remain healthy at 3.4 months of recurrent spending at end-2015. The deficit reflects the combined effect of lower expected revenue (including from logging, fuel, and gold) and higher planned spending—the latter from a very low base in 2014—and also political economy pressure to spend during the first year after the elections. Over the next four years, the reform program targets a massive increase in government spending of SI$20 billion (or 230 percent of 2014 GDP), partly financed by drawing down cash reserves. Three quarters of this spending is allocated to infrastructure (mainly roads), health, and education. While the annual borrowing limit for 2015 has not been announced yet, the authorities remain committed to prudent debt management (MEFP paragraph 16).

Staff’s Views

9. Given the large development needs (including infrastructure, health, and education), fiscal space should be used wisely in the 2015 budget in light of Solomon Islands’ vulnerabilities and the uncertain outlook. To this end a balance should be struck between building buffers and spending. Maintaining fiscal buffers is essential to enhance resilience to shocks—including natural disasters. While an increase in spending for capital investment to upgrade infrastructure (including water and sanitation) and enhance health and education outcomes is welcomed, the pace and scale of spending needs to be consistent over the medium term with the country’s absorptive capacity, the revenue envelope, availability of financing, and reflect realistic plans for revenue mobilization. Improving the quality of public spending and using the cash balance wisely are paramount given the uncertainty about growth (including mining) prospects. This includes improving accountability in the use of constituency funds by continuing to develop ex-ante spending plans, rules for managing fund accounts and for procuring goods, and reporting on the use of funds, in accordance with the PFM Act. Also in this context, steady implementation of the PFM roadmap is important. With external assistance expected to fall in the medium term, sound PFM is likely to remain crucial, also to win further donor support. If oil prices fall further, the authorities should save the higher cyclical revenue-from higher GDP-relative to the budget. If external downside risks materialize, the authorities could use some of the fiscal buffers to support the economy. Over the medium term, anchoring fiscal plans to the non-mineral primary balance of about 2 percent of GDP could help manage revenue volatility and promote fiscal sustainability. Realistic spending plans should also be pursued by better sequencing development projects within a medium-term fiscal framework to carefully align resources with spending capacity.

10. Other fiscal structural reforms should continue to support revenue mobilization. In addition to PFM reforms, tax reforms are a priority for improving the business environment. Recent TA by the IMF Fiscal Affairs department has identified tax policy and administration measures needed to implement the mining tax regime. Some of the administrative reforms should also benefit overall tax administration. These measures relate to the expensing of prospecting and development expenditures, imposition of penalties for failing to file additional profit tax forms, clarifying the roles of government agencies (and interagency information sharing), and strengthening the taxpayer register. The incidence of overlapping and regressive consumption taxes merits review, given their potential to curtail business opportunities.

Authorities’ Views

11. The authorities stressed the need to increase development spending to boost economic growth prospects, supported by sectoral and structural reforms (MEFP paragraph 6). They see spending on development as paramount given the country’s needs and the size of the fiscal buffers accumulated. Streamlining public sector allowances is also part of the government’s agenda to create more fiscal space for development spending (MEFP paragraph 7).

12. The authorities also emphasized their commitment to improving the quality of spending and pursuing tax reforms with the assistance of the IMF. They stressed the critical role that the PFM system plays in improving the quality of public spending (MEFP paragraph 13). The authorities are taking steps to continue improving budget planning and execution and increasing budget transparency. Line ministries will be required to develop and monitor an evaluation framework to assess and measure the implementation of development programs. They plan to publish the Final Budget Outcome Report on an annual basis, following the first report in 2014. On constituency funds, they stressed their role in providing public service delivery and government support to rural areas in a highly dispersed geographical landscape. The authorities requested TA (see Letter of Intent) to assist with a comprehensive tax review to ensure a fair, simple, and broad-based tax system, which encourages economic growth by supporting local businesses and attracting foreign investors.

B. Strengthening the Monetary and Exchange Rate Policy Frameworks

Background

13. Credit to the private sector continued to grow strongly in 2014 at 16.3 percent (Table 4). Credit growth has been driven mainly by mortgage financing and investment in the communication sector, each factor contributing 8 percent and 3.5 percent of the total increase, respectively. This increase has not yet put pressure on inflation as the domestic food supply has recovered from the flood and the lower oil prices are curbing domestic prices.

Table 4.

Solomon Islands: Summary Accounts of the Banking System, 2012–15 1/

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Sources: Data provided by the Central Bank of Solomon Islands; and IMF staff estimates and projections.

Based on the new program exchange rate of SI$7.331 per US$.

Includes claims of the CBSI on other (nonbank) financial corporations.

Weighted average of different maturities, period average.

14. In September 2014, in light of uncertain growth prospects, the CBSI announced a shift toward an accommodative monetary stance over the following six-month period. In particular, the CBSI capped the stock of its Bokolo bills issuance at SI$710 million. While average lending rates have hovered at around 10 percent for most of 2014, after a steady decline throughout 2013, persistently high excess reserves held by commercial banks and steady credit growth suggest that monetary conditions have remained relatively loose.

15. The CBSI has fully implemented the invoice-based basket peg regime. In November, the CBSI also removed the ±1 percent exchange rate band vis-à-vis the U.S. dollar. The recent depreciation of the Solomon Islands dollar against the U.S. dollar (5 percent between October 2014 and March 2015) reflects the closer tracking of the value of the basket, particularly the significant depreciation of the Australian dollar against the U.S. dollar. In line with IMF TA recommendations, the buy and sell margins for U.S. dollar and Australian dollar trades were also increased to promote foreign exchange market efficiency.

A01ufig2

Solomon Islands: Monetary Developments

(Contribution to broad money growth, in percent)

Citation: IMF Staff Country Reports 2015, 102; 10.5089/9781475548129.002.A001

1/ Year-on-year percent change.Source: Central Bank of Solomon Islands.
A01ufig3

Solomon Islands: Holdings of Bokolo Bills

(In millions of Solomon Islands dollars)

Citation: IMF Staff Country Reports 2015, 102; 10.5089/9781475548129.002.A001

Source: Central Bank of Solomon Islands.
A01ufig4

Solomon Islands: Interest Rates and Bank Reserves

Citation: IMF Staff Country Reports 2015, 102; 10.5089/9781475548129.002.A001

1/ Weighted average rate of commercial banks.Source: Central Bank of Solomon Islands.
A01ufig5

Solomon Islands: Nominal Exchange Rate

(Solomon Islands dollars per foreign currency unit)

Citation: IMF Staff Country Reports 2015, 102; 10.5089/9781475548129.002.A001

Sources: Central Bank of Solomon Islands; Bloomberg; and IMF staff estimates.

Staff’s Views

16. The fall in prices of imported goods has eased the monetary policy trade-off but the authorities should remain vigilant. While the current stance of monetary policy is broadly appropriate, the authorities should be ready to tighten if credit growth leads to a pickup in demand-driven inflationary pressure or a surge in imports. Staff econometric analysis1 suggests that credit growth of 16 percent (y/y) could add inflation pressures of up to 1 percent in 2015. If credit growth does lead to a pickup in demand-driven inflationary pressure, the authorities should be ready to use all the instruments at its disposal (reserve requirement and issuing Bokolo bills) to tighten monetary policy. With the monetary transmission mechanism remaining weak, the exchange rate basket peg is the primary nominal anchor. In this context, staff noted the need for the central bank to continue developing its tools for mopping up excess liquidity, including through IMF technical assistance. Staff also strongly welcomed the full implementation of the basket peg of the Solomon Islands dollar, including the removal of the band around the US dollar, which delivers a more stable effective exchange rate and minimizes any further erosion of competitiveness for the moderately overvalued currency.

Authorities’ Views

17. The CBSI has no immediate concerns about inflation. Despite strong credit growth, inflationary pressures in the near term are weak thanks to lower oil and commodity prices. The CBSI noted that the upcoming IMF TA, led by the Monetary and Capital Market Department will help improve the effectiveness of monetary policy by strengthening the monetary transmission mechanism.

18. The authorities emphasized that the basket peg regime continues to be an important tool to anchor inflation and maintain competitiveness. In particular, they noted that the removal of the band around the US dollar should allow bilateral exchange rates to move freely in order to keep the basket peg stable.

C. Preserving Financial Stability

Background

19. The financial system is generally sound but financial intermediation remains limited.

  • Liquidity and capital adequacy ratios are above minimum regulatory requirements. Asset quality remains adequate, with low NPLs. Profitability, however, declined in 2014, partly reflecting increased competitive pressures generated by the entry of Pan Oceanic Bank Limited (Solomon Islands’ fourth bank), founded by a group of Sri Lanka-based investors. The bank was set up to provide banking services to the logging industry after the withdrawal of foreign-owned banks from the logging business. In late January 2015 Westpac, an Australian bank, announced its plans to sell its operations in Solomon Islands, Samoa, Tonga, and Vanuatu to Papua New Guinea-based Bank South Pacific (BSP). This is expected to lead to a substantial increase in BSP market share in Solomon Islands’ banking sector. Despite brisk credit growth, the magnitude of credit in Solomon Islands relative to the economy is much lower than peers (18 percent of GDP versus 35 percent in the Pacific small states, 40 percent in African small states, and 70 percent in Caribbean small islands, according to the IMF’s Financial Access Survey Database). Interest-rate spreads are also among the highest in the region, suggesting much room for improving financial sector efficiency. Solomon Islands continues to be one of the most under-banked small states in the world, when measured by the size of total deposits relative to GDP and the number of bank branches relative to the population. Long-standing structural issues—including the subsistence level of the rural economy, the dispersion of the population in remote villages with little or no road access, high costs of establishing bank branches outside the main cities, and communal land tenure—continue to constrain financial sector development. On the upside, the introduction of mobile banking services—based on the mobile telephone network—by commercial banks over the last 18 months has increased access to banking services among underserved segments of the population. It has also improved financial inclusion, which fosters inclusive growth. The first credit bureau was opened in February 2015—another important step to increase access to credit. Despite delays, the authorities continue to make progress in preparing the revised legislation of the National Provident Fund—Solomon Islands’ largest pool of financial savings—which is aimed at improving the governance and investment framework.

Solomon Islands: Core Financial Soundness Indicators, 2012-14 1/

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Sources: Central Bank of Solomon Islands; and IMF staff estimates.

Commercial banks only, at end-period.

Staff’s Views

20. Staff underlined the importance of continued vigilance over the drivers of credit growth, accompanied by ongoing financial sector reform and sustained efforts to improve financial inclusion. Staff encouraged the authorities to ensure that strict prudential standards are adhered to, particularly given the greater competition for market share in certain subsectors of the credit market—particularly mortgage financing—with the entry of the new bank. Staff welcomed the progress made in strengthening the financial sector’s supervisory and regulatory framework and called for continued efforts to fulfill program commitments, specifically relative to a revised National Provident Fund Act (program benchmark, proposed for September 2015). The Credit Union bill (program benchmarks, proposed for September 2015) will also help improve supervision of nonbanking institutions and promote financial inclusion. The introduction of mobile banking is welcome as a way to circumvent physical barriers to financial access. Efforts on financial inclusion are particularly welcome at this conjunction as lower competition for the provision of financial services in small states can hamper financial inclusion by limiting the supply of credit.2 Better access to financial services is important for fostering inclusive growth. But adequate regulation and supervision are also needed to ensure financial stability.

Authorities’ Views

21. The CBSI agreed that financial sector access is paramount to support inclusive growth and stressed several initiatives being undertaken, including efforts to promote financial inclusion. Going forward, the CBSI will be strengthening the regulation of mobile banking services and developing new prudential guidelines to ensure adequate consumer protection. The authorities will also collect more data to measure the effectiveness of mobile banking initiatives in promoting financial inclusion. In addition, the CBSI emphasized promoting more financing for small- and medium-sized enterprises as part of its efforts to widen financial access. Developments in the wake of Westpac’s planned exit from Solomon Islands will be closely monitored with a view to ensuring that the domestic banking sector remains competitive. The authorities highly value the opening of the credit bureau, which should make access to credit more affordable by reducing the banks and other financial institutions transaction costs and due diligence and by creating credit history for borrowers.

A01ufig6

Small States: Spreads Between Lending and Deposit Rates

(In percent)

Citation: IMF Staff Country Reports 2015, 102; 10.5089/9781475548129.002.A001

Source: Country authorities; and IMF staff calculations.
A01ufig7

Small States: Commercial Bank Branches per 100,000 Adults

(Number of branches)

Citation: IMF Staff Country Reports 2015, 102; 10.5089/9781475548129.002.A001

Sources: World Bank Group; and IMF staff calculations.

D. Program Discussion and Other Issues

22. Discussions focused on the fourth review under the ECF arrangement and on setting program conditionality through September 2015 (PCs, indicative targets, and structural benchmarks). The NIR indicative target and PC for March, June, and September 2015 were raised to US$480 million (7.5 months of imports) to reflect the stabilization and gradual rebound in reserves that is expected in 2015. Given broadly satisfactory program performance, staff supports the authorities’ proposal to re-phase and modify the structural agenda pursuant to a revised implementation path, owing to the recent elections and the change in government, and to add a new benchmark on the implementation of the Constituency Development Funds Act (program benchmark, July 2015). In addition, given the delay in releasing the complete 2012 Constituency Development Funds (CDFs) audit, the authorities propose modifying the structural benchmark to enable members of Parliament to request the public release of the audit reports for their individual constituencies. This should encourage transparency and best practice and enhance accountability in the use of the constituency funds.

23. The main risk to the ECF arrangement remains the political uncertainty related to the new government’s planned spending in the year after the general elections. Since the new government’s agenda includes highly ambitious spending plans, government pressures to draw down cash reserves beyond program targets have increased. Nonetheless, partnership with the IMF remains strong as indicated in the attached LOI and MEFP.

24. As in the past, staff will continue to collaborate closely with Solomon Islands’ other development partners, including through the Core Economic Working Group. The IMF-supported program continues to play a catalytic role in disbursements of donor assistance. Combined annual budget support from Australia and New Zealand was substantially lower than projected in 2014 (US$25 million versus US$35 million). This partly reflected a reduction in the run-up to the elections, but also the earlier reallocation of financing to meet immediate post-flood recovery needs and the non-disbursement of performance-linked aid for education. While combined support is currently projected to rebound to US$35 million in 2015, Australia’s recent announcement of ODA cuts suggests that additional reductions could be made. The EU may provide budget support for 2015–20 of about $US3.5 million a year, but this may depend on Solomon Islands’ progress on PFM reforms. In response to the floods, the Asian Development Bank (ADB) has approved an additional US$13 million for a transportation sector flood-recovery project, alongside US$5 million of planned budget support and US$40 million for other infrastructure projects during 2014–16. And the World Bank Group recently approved US$10 million of additional financing in the form of budget support, project grants, and loans. This sum is expected to be disbursed throughout 2015 and 2016. Staff is continuing to work with the World Bank Group on the debt implications of the potential hydropower project (which has been delayed), which would involve a government guarantee of US$130 million (11 percent of GDP).3 A full updated DSA, including an assessment of the medium-term debt implication of the proposed hydropower project, will be presented at the fifth review of the ECF arrangement scheduled for June 2015. Solomon Islands has adequate capacity to repay the Fund (Table 7) and the ECF-supported program remains fully financed.

Table 5.

Solomon Islands: Balance of Payments, 2013–19 1/

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

Incorporates the authorities’ revision of historical data, including a new formula for f.o.b/c.i.f conversion, new estimates of reinvested earnings and donor grants, and reclassification of current and capital transfers.

FDI numbers have been revised down as a result of changes to ensure the correct treatment of net losses under reinvested earnings, in line with BPM6 practice.

Includes actual and prospective disbursements under the IMF-supported arrangement.

Table 6.

Solomon Islands: Reviews and Disbursements Under the Extended Credit Facility

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Source: IMF.

For reviews that have already been completed, the date refers to the actual Board date when the review was completed.

Table 7.

Solomon Islands: Indicators of Capacity to Repay the Fund, 2014–25

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Source: IMF staff estimates and projections.

Prospective credit includes the 7.1 percent of quota (SDR 0.74 million) available under the Extended Credit Facility.

Total public debt service, including IMF repayments.