Solomon Islands: Fourth Review Under the Extended Credit Facility Arrangement
Author:
International Monetary Fund. Asia and Pacific Dept
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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
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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.

25. Staff discussed plans to develop a new Poverty Reduction Strategy Paper (PRSP). The government is planning to release a Medium-Term Development Plan (2015–19) over the next few weeks, building on the national development strategy to achieve more inclusive growth for social cohesion and to ensure a sustainable growth path. This will act as the basis for a PRSP preparation status report, ahead of the next ECF review.

Staff Appraisal

26. Solomon Islands has made enormous strides in strengthening its macro-financial performance and its institutions over the last few years. Fiscal and reserve buffers have been rebuilt, and important reforms, notably PFM and financial sector reforms, are being implemented.

27. The country is now at a critical juncture. While policy and financial buffers have been rebuilt over the last few years, they can be used up rapidly if the high level of planned spending in the medium-term policy agenda were to materialize. While the country has large development needs, a balance should be struck between building buffers and spending. Going forward, the new government should capitalize on past achievements in macroeconomic management. This will require strengthening its implementation capacity for undertaking capital investment in order to enhance potential growth while maintaining an adequate level of financial buffers to preserve resilience to shocks. Such an approach would be consistent with the weaker economic outlook also driven by less clear sources of growth in the pipeline. To this end, the structural reforms envisaged by the authorities, in particular land reform and tax reforms, are key to support growth in the medium term and enhance productivity across a wide range of sectors.

28. Fiscal space should be used wisely in 2015, given Solomon Islands’ vulnerabilities to shocks and the uncertain growth outlook. While buffers could be partly used to finance much needed capital projects, the pace of spending should also be consistent with absorptive capacity to avoid waste, and realistic plans for revenue mobilization should be developed. Advancing PFM reforms, including by improving the transparency and accountability of scholarships and constituency funds will be paramount to strengthening the quality of public spending and continuing to attract donor support.

29. Monetary policy is broadly appropriate, but the authorities should be ready to tighten if high credit growth triggers inflationary pressures. In this event, the CBSI should use all the instruments at its disposal, including the reserve requirement and Bokolo bill issuance, to mop up excess liquidity.

30. The authorities are to be commended for fully implementing the basket peg—an appropriate exchange rate regime for Solomon Islands. The CBSI has removed the exchange rate band around the US dollar since November 2014 to allow the bilateral exchange rates to move freely in order to keep the peg stable. It has also increased the buy-sell margin in foreign exchange trading to allow greater flexibility in exchange rate management.

31. The financial sector is sound but continued vigilance concerning potential sources of vulnerability is important, along with further efforts to strengthen the supervisory and regulatory frameworks and broaden financial inclusion. Closer and improved monitoring of the underlying trends in the main segments of the credit market, including mortgage financing, will be critical. The forthcoming new National Provident Fund Act and the new Financial Institutions Act and Credit Union Act should help promote financial sector stability. In addition, ongoing initiatives to promote mobile banking while ensuring adequate supervision and consumer protection will go a long way toward promoting financial inclusion. Solomon Islands has made remarkable progress in financial inclusion over the last year, compared to other small states in the Pacific, and this is to be encouraged.

32. Based on Solomon Islands’ program performance, staff recommends completion of the fourth review under the ECF-supported program. The completion of the fourth review will enable the release of the fifth disbursement in the amount of SDR 148,571. Staff also supports the authorities’ request for the modification of the structural conditionality (MEFP, Table 2) and for setting the end-June 2015 performance criteria.

Solomon Islands: The Impact of Lower Oil Prices 1/

The recent global oil price slump is expected to boost Solomon Islands’ economy through four main channels: rising real income will increase consumption; production costs will fall due to lower costs of energy; the external position will improve substantially; and inflation will ease.

A01ufig8

Solomon Islands: GDP Growth Differential Under Lower Oil Price Forecasts1

(Percent difference)

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

Source: IMF staff estimates.1 Illustrates the deviation from growth forecasts that were based on the IMF’s oil price forecasts in September 2014. Scenario 1 shows the difference in estimated GDP growth using revised IMF oil price forecasts as of November 2014, while Scenario 2 reflects an additional 15 percent oil price drop.

Solomon Islands is an oil importer and fuel imports average 10 percent of GDP, or one quarter of total import bill. Staff analysis suggests that lower imports could strengthen the current account balance by 2 percentage points of GDP. Staff estimated that for every 10 percent drop in oil prices, Solomon Islands GDP rises by 0.3 percentage point.2 This implies an increase in Solomon Islands output by 0.8 percentage point in 2015 relative to the scenario without the oil price drop. Inflation is expected to moderate by 0.3 percentage point given an estimated weight of energy in the CPI basket of around 7 percent.

A01ufig9

Small States: Industrial Electricity Tariffs, 2013

(In U.S. cents per KWh)

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

1 Average.Sources: Country authorities; International Renewable Energy Agency; and IMF staff estimates.

Reduced energy costs are likely to have a positive effect on consumption and investment although this would be mitigated by incomplete pass-through of international oil prices to domestic retail prices. The cost of energy will decrease as Solomon Islands relies mainly on oil-based fuel for its energy needs and fuel is used for electricity generation. The impact on consumers will depend on the decline in electricity tariffs, which are the highest among all small states.

A01ufig10

Solomon Islands: Pass-through of International Fuel Prices to Domestic Retail Prices (June-December 2014)1

(In percent)

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

Sources: CBSI; Bloomberg, L.P.; and IMF staff calculations1 Pass-through is calculated as the absolute difference in local fuel prices divided by the absolute difference in international prices, in terms of local currency, multiplied by 100.

The first round effect of lower oil price on the budget would be negative due to lower collection from import duties and goods tax on fuel (which both amounted to around 2¼ percent of GDP in recent years). Nonetheless, the fiscal balance is expected to improve slightly mainly because of revenue buoyancy from higher economic activity and some expected increase in fuel imports related to investment.

A01ufig11

APD Small States: Oil Imports, 2012–13

(In percent of GDP)

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

1 Average.Sources: Country authorities; IMF, WEO; and IMF staff estimates.
1 Prepared by Fazurin Jamaludin and Leni Hunter. 2 A vector autoregression was estimated with Solomon Islands’ real GDP, real oil prices, real logging prices, and Australian real GDP. The estimated elasticity between the real oil price and Solomon Islands’ GDP is 0.03.
Figure 1.

Solomon Islands: Economic Indicators Relative to Other Small States

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

1/ Excludes grants.2/ Excludes advanced economies.Sources: Country authorities; Alliance Development Works, World Risk Report 2013; and IMF staff estimates and projections.
Figure 2.
Figure 2.

Solomon Islands: Macroeconomic Developments and Outlook

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

1/ In 2007, includes debt forgiveness.2/ Includes privatization receipts.Sources: Country authorities; and IMF staff estimates and projections.

Appendix 1. Letter of Intent

Ref: RF/457/5/5

March 20, 2015

Madame Christine Lagarde

Managing Director

International Monetary Fund

Washington, DC 20431

Dear Madame Lagarde:

As a small state comprising hundreds of islands located in the South Pacific, Solomon Islands faces several challenges. Smallness and dispersion make public service delivery in the most remote islands extremely difficult. More than eighty percent of our population lives in rural areas without access to electricity. Capacity constraints are also an issue. The severe flood that hit Honiara in April 2014 has also reminded us of how vulnerable our country is to natural disasters. This in conjunction with the closure of the Gold Ridge Mine, which will have a much larger ongoing impact on the economy and Government revenue, displays how critical it is to build resilience to shocks given our narrow production base.

We are convinced that our country also has great potential and that appropriate policies will help overcome some of these challenges and achieve higher economic growth. That is why the Government is placing its policy emphasis on two key development fronts. The first relates to sectoral reform and the second relates to fundamental reform. Central to the sectoral reform agenda is an emphasis on the productive and economic and finance sectors. The second emphasis is to pursue and execute fundamental reform programmes. This is a critical segment of the Government’s policies. The collective goal of the fundamental reform programmes is to create confidence in our economy by creating an enabling environment for economic development goals to be achieved, as well as for our people to benefit optimally from the fruits of economic growth. There are two central themes emphasized in these programmes.

The first relates to the pursuit of good governance while the second relates to the evasive goal of opening up our customary lands for economic development and for landowners to fully benefit from the exploit of their tribal lands.

On these endeavors, this government looks forward to continuing the constructive engagement with the IMF under the current three-year Extended Credit Facility (ECF) arrangement to help the country anchor economic policies and ensure macroeconomic stability.

We are very determined to implement our reform agenda, aimed at promoting growth and improve the composition of public spending. The attached Memorandum of Economic and Financial Policies (MEFP) describes the Government’s reform policies for 2015. We believe these policies will strengthen our macroeconomic framework and public institutions. To assist with the development of this agenda, the expertise of the IMF is sought to examine the current tax system in place in Solomon Islands and to assist us to develop tax reform proposals that will promote economic growth.

To ensure strong implementation, the program will continue to be monitored through quantitative performance criteria, indicative targets, and structural benchmarks. In terms of recent program performance, all end-June 2014 performance criteria (PCs) have been achieved and by a considerable margin in some instances (MEFP Table 1). We have also made progress in implementing the structural benchmarks (MEFP Table 2). Therefore, we request the completion of the fourth review under the ECF, the modification of the structural conditionality, and propose setting the end-June 2015 performance criteria.

We intend to maintain a close two-way policy dialogue with the IMF, and we stand ready to take additional measures, as appropriate, to ensure the achievement of the Government’s objectives under the ECF arrangement. We will consult with the Fund in advance of adopting these measures, or on any revisions to the policies laid out in the MEFP, in accordance with the Fund’s policy on such consultation. Furthermore, we will provide the Fund with any appropriate information it may request on policy implementation, as necessary, to achieve the program objectives. We also authorize the publication of this Letter of Intent, the related attachments, and the related IMF staff report.

Sincerely yours,

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Attachments:

  • - Memorandum of Economic and Financial Policies and Technical

  • - Memorandum of Understanding

Attachment I. Memorandum of Economic and Financial Policies

Recent Developments, Outlook, and Program Performance

1. The economy is still recovering from the closure of the Gold Ridge mine. The only gold mine, Gold Ridge, ceased production and prospects for its near-term reopening are weak. Economic activity in 2014 was not as weak as previously expected as the impact of the April floods in Honiara and Guadalcanal proved relatively short-lived and limited. Agriculture has rebounded and logging, despite secular decline in forestry, has surprised on the upside because of re-entry logging. GDP growth estimates for 2014 are still uncertain—between zero and 1½ percent.

2. Nonetheless, policy space has been maintained and important reforms achieved. Gross international reserves stood at around US$500 million at end-November 2014, sufficient to cover 10 months of imports of goods and services. Public financial management (PFM) reforms have continued together with financial sector reforms.

3. The near- and medium-term outlook is uncertain as new sources of growth are needed given the cessation of operations of the Gold Ridge mine. With the expected decline in forestry sector in the medium term, growth will need to be supported by increased broader-based activities and productivity across a wide range of sectors, including tuna processing and eventually tourism. But these will require large investment in infrastructure and sanitation. Growth prospects in the near term will be influenced by how quickly future mining projects such as nickel and bauxite come on stream. Investment in the undersea cable and Tina River Hydropower project that are in the pipeline are still under negotiation, but will also help support private sector development in the medium term. Sustained lower oil prices could boost Solomon Islands’ economy and lower inflation. However, the expected decline in aid from Australia and other development partners over the medium term may imply lower reserve buffers going forward.

4. On the ECF program, the June 2014 and September 2014 PCs were met with comfortable margins. The indicative targets and all continuous PCs were also met, with the exception of the indicative targets on government-funded recurrent spending on health and education, which were narrowly missed.

5. We have also made progress on the structural reform agenda reflected in the structural benchmarks. We have met four structural benchmarks since the last review. Draft instructions of a new financial institution Act (end-June 2014 benchmark) were approved by Cabinet. The benchmarks on preparing and publishing the 2014 budget strategy document and the mid-year budget review (end-August 2014 benchmarks)—key from a public finance management perspective to improve budget planning and execution—were also met together with the benchmark related to the new mining tax regime (end-July 2014 benchmark). Progress has been made on other benchmarks related to the review of the Credit Union Act, National Provident Fund (NPF) Act, tertiary education, customs and excise laws, and audits related to the constituency development funds (CDFs). These benchmarks are expected to be completed in or by the second half of this year. These reforms have taken longer than expected, reflecting partly capacity constraints in the Attorney General’s Chambers as well as a slowdown in Cabinet’s activity ahead of the general elections in November 2014.

Program Policies

6. The new government’s economic policies are aimed at lifting economic activity by enhancing competitiveness and enabling private sector-led growth. To meet these objectives, we will need to implement growth-oriented structural reforms to crowd-in the private sector and attract FDI. This will comprise: land and sectoral reforms, including tax reforms. These actions will help restore investor confidence and ensure a lower-cost business environment to diversify sources of growth.

A. Fiscal Policy

7. We remain committed to preserving a sustainable fiscal position while providing resources for much-needed capital spending. Despite lower growth and revenues related to the closure of the Gold Ridge mine, and higher spending due to the election, the overall fiscal position was broadly kept intact. Maintaining a prudent fiscal stance in 2015 will remain a top priority given fiscal risks have increased with the uncertainty surrounding mining sector and growth prospects in 2015 onwards. In the 2015 budget, we will therefore target a budgetary position that will not involve any borrowing to fund operating expenditures. This will be done cautiously to ensure a balance between providing for high value development needs while ensuring that sufficient funds are maintained for cash flow purposes. It will occur by containing recurrent spending, especially public sector allowance and benefits as well as the non-capital component of the development budget. The strategy will still allow for spending on capital projects.

8. Given the large development needs, we will prioritize spending toward key sectors such as health, education, and infrastructure. To achieve this fiscal strategy, we will produce and publish a medium-term development plan to better prioritize spending. We are committed to maintain spending on education and health at no less than 32 percent of Government-funded recurrent spending to improve human development.

9. A comprehensive tax reform is needed to simplify the tax system, support business and attract foreign investors. Thus, we would welcome a full review of the overall tax system with assistance from the IMF. For example, the incidence of overlapping and cascading regressive consumption taxes should be reviewed given their potential to hamper business opportunities. We will also strengthen the tax payer register to improve tax administration and compliance, and further bolster revenue mobilization by amending the Sales Tax Act to eliminate loopholes.

10. We will continue to improve budget planning and increase budget transparency. To this end we will publish on a yearly basis the Final Budget Outcome—a report that we firstly released in April 2014 as a benchmark under the ECF arrangement with the IMF. We will also continue publishing the mid-year budget update every July. In addition, beginning with the 2015 budget, both the recurrent and development budget will include tables showing spending on new or improved physical infrastructure, other direct capital expenditures, capital grants, and other non-capital development.

11. Given the importance of rural development to the Government’s agenda, constituency development funds (CDFs) will form an important part of providing Government support to rural areas. Like any other form of Government spending, CDFs need to be well managed and provide value for money. While recognising that all constituencies are different, the Government is committed to the adoption of sensible regulations that will help ensure good planning, consultation, effective spending, accountability and transparent reporting in relation to CDFs. CDF expenditure is already subject to all of the requirements of the Public Financial Management Act, 2013. CDF’s expenditure is also subject to audits from the Office of the Auditor General.

12. Despite delays we remain committed to publication of the CDF audit conducted by the office of the Auditor General. An audit of the 2012 constituency funds was delayed by the retirement of the former auditor general, but was completed in December 2013. In order to facilitate publication of audit reports, we request that the structural benchmark for publication of the audit be modified to provide that the Auditor General can release the individual audits of members of Parliament’s CDFs at their request, instead of waiting for the all audits to become available in order to publish them.

13. We are fully aware that a strong PFM system is critical to improve the quality of public spending, particularly as donor assistance is expected to decline over the medium term. The first PFM Reform Roadmap (2014–17) has been developed to implement the new PFM Act and the Government is fully committed to its implementation. The main priorities are:

  • Publishing the budget at the same time as it is tabled in Parliament;

  • Introducing a Cabinet requirement for the Ministry of Finance and Treasury and to comment on all Cabinet papers with financial implications before being submitted to Cabinet;

  • Putting into effect revised regulations and financial instructions consistent with international standards for disciplined financial management of special funds, targeted balances and expenditure controls consistent with the PFM Act.

14. We are also undertaking additional reforms which will complement PFM reforms in improving quality of public spending. We are undertaking a public sector remuneration review to consider options for streamlining and consolidating the existing remuneration benefits. In addition, we are developing a Line Ministry Expenditure Analysis (LMEA). This analysis provides a measure of efficiency of public spending by mapping trends in expenditure in key line ministries with core outputs and service delivery outcomes.

15. While investing in education is key to sustain long-term growth in Solomon Islands, we will sustain our efforts to strike a better balance between financing tertiary education and investing in primary and secondary education. Significant progress has been made in bringing the budget for tertiary education scholarships under control in 2014 and we will continue to do so in 2015. A new Cabinet paper on the revamp of the policies for these scholarships—details of which are specified in the TMU—will be prepared. Once the paper is completed, we plan to submit it to Cabinet for approval (currently an end-September 2014 benchmark) and we seek a modification of the test date to end-April 2015. In coordination with development partners, we will also review tertiary education policies (an end-March 2015 benchmark), including the selection criteria, budget allocation, and accountability and transparency of the use of funds. A “think tank” group is scheduled to meet in March before the new structure is implemented.

16. We have adopted a conservative approach to debt management while tapping resources to finance much-needed investment. We continue to undertake borrowing in accordance with our established Debt Management Framework, which consists of the Debt Management Strategy as well as the PFM Act and SOE Borrowing Policy. The Annual Borrowing Limit for 2014 was set at SI$250 million, and while the 2015 limit on new borrowing has not yet been finalized, it will be announced in the Budget. The borrowing limit will be set in line with the debt framework and based on the Debt Management Unit’s debt sustainability analysis which is consistent with a debt limit equivalent to 25 percent of GDP. Current borrowing proposals include the submarine internet cable project and the Tina River Hydropower Project. Given the high costs of electricity generation in Solomon Islands and current limitations in connectivity, these projects will improve strongly the business environment and foster private sector development.

17. These policies will help underpin our drive to safeguard the management and use of public funds. The fiscal policies outlined here are essential in underpinning this Government’s fight against corruption, including: the development of a comprehensive National Anti-Corruption Strategy; the enactment of anticorruption legislation; and the establishment of an Independent Commission against Corruption.

B. Monetary, Exchange Rate, and Financial Sector Policies

18. Monetary and exchange rate policies have been supportive of economic activity since the flood and the uncertain economic prospects also surrounding the mining sector. With inflation on a downward trend thanks to lower world oil prices, the Central Bank of Solomon Islands (CBSI) shifted monetary policy to an easing bias in September 2014. This has been achieved by fixing a cap on the size of its Bokolo bills issuance. The exchange rate policy, through the implementation of the basket peg regime has also seen a slight depreciation against the U.S. dollar but a significant appreciation against some other key currencies, including the Australian dollar. We have removed the exchange rate band and increased the buy-sell margin in foreign exchange trading to allow greater flexibility in the exchange rate management. We look forward to a follow-up IMF TA in March to help us strengthen the monetary transmission mechanism. Should inflationary pressure arise, the CBSI stands ready to review its monetary policy stance in favor of less accommodative bias to ensure domestic price stability. We will also remain vigilant of strong credit growth on mortgage and consumption loans.

19. We continue to strengthen financial regulation and supervision to preserve financial stability and to foster the financial sector development as an enabler of economic growth. With the start of operations of a new bank in July 2014, the total number of banks in Solomon Islands has increased allowing greater financial access. The introduction of mobile banking services since the end of 2013 has further boosted our efforts to make financial system more inclusive. The CBSI has begun consultations with the Asian Development Bank (ADB) on strengthening the regulation of mobile banking services and will be developing new prudential guidelines to ensure adequate consumer protection. The draft of a new Financial Institutions Bill is currently at the public consultation stage. Revised draft legislation is expected to be sent to Cabinet for approval by September 2015. We continue to work with the ADB on drafting instructions for a revised National Provident Fund (NPF) Act, which will provide a basis for the Attorney General Chambers to draft the NPF legislation update by end-September 2015 and we accordingly seek a modification in the test date for this benchmark. A draft Credit Union Act (an end-December 2014 benchmark) is expected to be submitted to Cabinet by end-September 2015 and we also seek a modification in the test date for this benchmark.

Competiveness and Inclusive Growth

20. Raising productivity growth and enhance private sector development is high on the Government’s reform agenda. Land reform is one of this Government’s top priorities. The forthcoming medium-term development plan will provide the basis for the preparation status report of the Poverty Reduction Strategy, which we will produce for the fifth review of the ECF arrangement. This report will be complemented by a hardship and vulnerability assessment, with the support of the World Bank Group.

C. Program Monitoring

21. Implementation of the program will continue to be monitored through semiannual reviews based on performance criteria, indicative targets and structural benchmarks. Indicative target for end-March 2015, performance criteria for end-June 2015, and indicative targets for end- September 2015 are set as per Table 1 and structural benchmarks are set as per Table 2. The program performance will be assessed in the course of the reviews. The fifth review under the ECF arrangement is expected to take place on or after June 15, 2015. The sixth review under the ECF arrangement, assessing end-June 2015 performance criteria, is expected to take place on or after November 15, 2015 on the basis of the performance criteria and structural benchmarks indicated in Tables 1 and 2, and further detailed in the TMU.

MEFP Table 1.

Solomon Islands: Quantitative Performance Criteria (PC) and Indicative Targets (IT)

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Evaluated at the program exchange rate.

The adjustors are specified in the Technical Memorandum of Understanding (TMU) and include: the floor on NIR will be adjusted upward (downward) by the amount of budget support from bilateral and multilateral donors (excluding IMF) in excess (short) of the

The adjustors are specified in the TMU and include: the ceilings on NDA will be adjusted downward (upward) by the amount of budget support from bilateral and multilateral donors (excluding the IMF) in excess (short) of the program level. Following the recommendations of the IMF Safeguards Assessment, the program targets starting from end-December 2010 incorporate the recommended changes in the measurement of reserve money.

The adjustors are specified in the TMU and include: the floor on the central government program cash balance will be adjusted downward and the ceiling on NCG will be adjusted upward by the stock amount of budget support from bilateral and multilateral donors (excluding the IMF) short of the program level; the floor on the program cash balance will be adjusted upward (downward) by the stock of the government treasury bills, excluding restructured government bonds, in excess (short) of the program level; the floor on the program cash balance will be adjusted upward by

These performance criteria are aplicable on a continuous basis.

An indicative target for spending on health and education at no less than 32 percent of government-funded recurrent spending.

The SIG Consolidated Deposits Account functions like a contingency fund for the government and transfers to and from this account can affect the program cash balance. Negative deviations from the projected balance in this account will therefore be used to adjust the program cash balance targets upward.

MEFP Table 2.

Solomon Islands: Structural Benchmarks

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Attachment II. Technical Memorandum of Understanding

1. The program will be monitored through quantitative performance criteria, indicative targets, structural benchmarks, and reviews. This memorandum sets out the definitions for quantitative performance criteria and indicative targets under which performance under the program will be assessed. Monitoring procedures and reporting requirements are also specified.

I. Quantitative Performance Criteria and Indicative Targets

2. Performance criteria for end-June 2015 and indicative targets for end-September 2015 have been established with respect to:

  • Floors on the level of net international reserves (NIR) of the Central Bank of Solomon Islands (CBSI);

  • Ceilings on the level of net domestic assets (NDA) of the CBSI;

  • Ceilings on the level of net credit to the central government (NCG); and

  • Floors on the central government cash balance.

  • An indicative target (cumulative) for spending on health and education at no less than 32 percent of government-funded recurrent spending.

3. Performance criteria applicable on a continuous basis have been established with respect to:

  • Ceilings on the contracting and guaranteeing by the public sector of new medium- and long-term nonconcessional external debt;

  • Ceilings on the contracting and guaranteeing by the public sector of new short-term nonconcessional external debt; and

  • Ceilings on accumulation of new external payment arrears by the public sector.

II. Institutional Definitions

4. The central government includes all units of budgetary central government and extra budgetary funds.

5. Depository corporations (DCs) include the CBSI and other depository corporations (ODCs). ODCs include commercial banks, the Credit Corporation of Solomon Islands, and credit unions. Financial corporations include DCs and other financial corporations (OFCs). OFCs are the National Provident Fund (NPF), the Development Bank of Solomon Islands, and the Investment Corporation of Solomon Islands.

III. Monetary Aggregates
A. Reserve Money

6. Reserve money consists of currency issued by the CBSI (excluding CBSI holdings of currency) and all transferable deposits held at the CBSI.

B. Net International Reserves of the CBSI

7. A floor applies to the level of NIR of the CBSI. The floor on NIR will be adjusted upward (downward) by the amount of budget support from bilateral and multilateral donors (excluding the IMF) in excess (short) of the programmed level.

8. NIR will be calculated as gross international reserves (GIR) less international reserve liabilities. For NIR program monitoring purposes, the stock of foreign assets and foreign liabilities of the CBSI will be reported in U.S. dollars and be valued at the program exchange rates, as specified in Table 1.

TMU Table 1.

Solomon Islands: Program Exchange Rates

Solomon Islands (Program) Exchange Rates for the ECF Arrangement (Rates as of September 30, 2013)

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Currency unit per Solomon Islands dollar and U.S. dollar.

9. GIR of the CBSI are defined as the sum of:

  • Foreign currency assets in convertible currencies held abroad and as vault cash that are under the direct and effective control of the CBSI and readily available for intervention in the foreign exchange market or the direct financing of balance of payments imbalances and are of investment grade or held with an investment-grade institution.

  • The reserve position of the Solomon Islands in the IMF;

  • Holding of SDRs; and

  • Monetary gold.

10. Excluded from the definition of GIR are:

  • Foreign currency deposits of ODCs and OFCs held at the CBSI;

  • Any foreign currency claims on residents, capital subscriptions in international institutions, and foreign currency assets in nonconvertible currencies, and;

  • GIR that are in any way encumbered or pledged, including, but not limited to, reserve assets used as collateral or guarantee for third-party external liabilities.

11. International reserve liabilities of the CBSI are defined as the sum of:

  • All outstanding liabilities of the Solomon Islands to the IMF, excluding IMF SDR allocations; and

  • Foreign currency liabilities in convertible currencies to nonresidents with an original maturity of up to and including one year.

C. Net Domestic Assets of the CBSI

12. A ceiling applies to the level of NDA of the CBSI. The ceiling on NDA will be adjusted downward (upward) by the amount of budget support from bilateral and multilateral donors (excluding the IMF) in excess (short) of the programmed level.

13. NDA of the CBSI will be calculated as the difference between reserve money and the sum of NIR of the CBSI and other NFA of the CBSI. Any revisions to the historical stock of reserve money based on changes to the accounting treatment of the profit/loss account of the CBSI will be notified to the Fund immediately and used to adjust monetary aggregates by an equivalent amount, as deemed appropriate. Other NFA of the CBSI includes:

  • Foreign assets related to holdings of foreign currency deposits, and securities not included in NIR of the CBSI, and loans, shares, financial derivatives, or accounts receivable with nonresidents; and other foreign assets that are not included in NIR of the CBSI, as defined in Section III. B; and

  • Foreign liabilities related to IMF SDR allocations; deposits, securities, loans, financial derivatives, and other accounts payable with nonresidents; and other foreign liabilities that are not included in NIR of the CBSI, as defined in Section III. B.

D. Net Credit to the Central Government

14. A ceiling applies to the NCG measured cumulatively from the beginning of the year. The ceiling on NCG will be adjusted upward by the amount of budget support from bilateral and multilateral donors (excluding the IMF) short of the programmed level.

15. NCG is defined as the sum of net claims of: (i) the CBSI, (ii) commercial banks and other ODCs, (iii) OFCs, (iv) insurance companies, (v) and government treasury bills held by the general public.

IV. Fiscal Aggregates
A. Cash Balance of the Central Government

16. A floor applies to the program cash balance of the central government. The floor on the program cash balance will be adjusted downward by the amount of budget support from bilateral and multilateral donors (excluding the IMF) in short of the programmed level. The floor on the program cash balance will also be adjusted upward (downward) by the stock of government treasury bills, excluding restructured government bonds, in excess (short) of the program level of SI$40 million. The floor on the program cash balance will be adjusted upward by the difference between SI$140 million (hereafter known as program level) in the SIG Consolidated Deposits Account and its actual balance, should the actual balance in the SIG Consolidated Deposits Account be lower than SI$140 million.

17. The program cash balance of the central government is defined as the gross cash balance minus the total amount of unpaid payment orders and unpresented checks.

18. The gross cash balance is defined as the sum of government deposits, which are not in any way encumbered or pledged as collateral or used as a guarantee against government incurred liabilities, in the following accounts:

  • In CBSI: Solomon Islands Government (SIG) Revenue Account, SIG Funded Development Account, SIG Debt Servicing Account;

  • In Australia New Zealand Bank: SIG Creditors Account; Payroll Imprest Account, and Airport Service Fees Account;

  • In Bank of South Pacific: Provincial Revenue Holding Account, SIG Inland Revenue Account, Sub Treasury Gizo Account, and Sub Treasury Auki Account; and

  • Donor funded budget support accounts that are created by and under control of the government.

V. External Debt
A. Medium- and Long-Term External Debt

19. A ceiling applies to the contracting and guaranteeing by the public sector of new nonconcessional borrowing with nonresidents with original maturities of more than one year. The ceiling applies to debt and commitments contracted or guaranteed for which value has not yet been received. This applies to private debt for which official guarantees have been extended and which, therefore, constitutes a contingent liability of the public sector. The public sector comprises the central government, the CBSI, nonfinancial public enterprises (i.e., enterprises in which the government owns more than 50 percent of the shares), and other official entities.

20. The definition of debt, for the purposes of the program, is set out in Point 9 of the Guidelines on Performance Criteria with Respect to External Debt in Fund Arrangement Executive Board Decision No. 6230-(79/140), as revised on August 31, 2009 (see Annex I).

21. Excluded from the ceiling are (i) the use of Fund resources; (ii) lending from the World Bank and the Asian Development Bank; (iii) debts incurred to restructure, refinance, or prepay existing debts, to the extent that such debt is incurred on more favorable terms than the existing debt and up to the amount of the actually restructured/refinanced/prepaid debt; (iv) concessional debts; (v) any SI$-denominated treasury bill and bond holdings and Bokolo bonds held by nonresidents.

22. For program purposes, the guarantee of a debt arises from any explicit legal obligation of the central government, the CBSI, nonfinancial public enterprises, or other official entities on behalf of the central government or the CBSI to service debt in the event of nonpayment by the main obligor (involving payments in cash or in kind).

23. For program purposes, a debt is concessional if it includes a grant element of at least 35 percent, calculated as follows: the grant element of a debt is the difference between the net present value (NPV) of debt and its nominal value, expressed as a percentage of the nominal value of the debt. The NPV of debt at the time of its contracting is calculated by discounting the future stream of payments of debt service due on this debt. The discount rate used for this purpose is five percent.

B. Short-Term External Debt

24. A ceiling applies to the contracting and guaranteeing by the public sector of new nonconcessional borrowing with nonresidents with original maturities of up to and including one year. The ceiling applies to debt and commitments contracted or guaranteed for which value has not yet been received. This applies to private debt for which official guarantees have been extended and which, therefore, constitute a contingent liability of the public sector. The public sector comprises the central government, the CBSI, nonfinancial public enterprises (i.e., enterprises in which the government owns more than 50 percent of the shares), and other official entities.

25. For program purposes, the definition of debt is set out in Point 9 of the Guidelines on Performance Criteria with Respect to External Debt in Fund Arrangement approved by the Executive Board Decision No. 6230-(79/140), as revised on August 31, 2009 (see Annex I).

26. Excluded from the ceiling are (i) debts classified as international reserve liabilities of the CBSI; (ii) debts incurred to restructure, refinance, or prepay existing debts, to the extent that such debt is incurred on more favorable terms than the existing debt and up to the amount of the actually restructured/refinanced/prepaid debt; (iii) SI$-denominated treasury bills and bonds and CBSI and Bokolo bills held by nonresidents; (iv) concessional debts; and (v) normal import financing. A financing arrangement for imports is considered to be “normal” when the credit is self-liquidating.

VI. External Payment Arrears

27. A continuous performance criterion applies to the non-accumulation of external payments arrears by the public sector, comprising the central government, the CBSI, nonfinancial public enterprises, and other official entities. External payments arrears consist of external debt-service obligations (principal and interest) that have not been paid at the time they are due, as specified in the contractual agreement, subject to any applicable grace period.

VII. Tertiary Education

28. Approval will be sought from Cabinet to strengthen the policy of the granting of tertiary scholarships, which will contain at least the following elements:

  • Commitment controls. The Ministry of Finance will certify the availability of budget allocation before any new award letters can be granted, in order to ensure that the budget ceilings are abided by and no new arrears are incurred. Commitment information will be entered into the Ministry of Finance’s Financial Management Information System to record commitments made for each individual scholarship awardee. The Ministry of Education will ensure that the documentation relating to identification and eligibility, expected length of studies, as well as due dates for tuition and stipend payments is provided to the Ministry of Finance in a timely manner.

  • Queuing system. If there are more candidates for scholarships than resources available in a fiscal year, a queuing policy for eligible applicants based on the timing of their application will be established.

  • Arrears. All arrears will be cleared and no new arrears allowed.

  • Documentation. In consultation with the Ministry of Finance, the Ministry of Education will establish the standards for eligibility documentation and documentation retention for each application. The required and retained documentation should include at least the application form, high school transcript, receipt for the payment of the application fee, copy of Ministry award letter, signed declaration letter, transcripts of results in each semester from tertiary institutions and qualifications attained by the scholarship holders.

  • Monitoring and dissemination. The Ministry of Education will produce regular reports on total number of applicants for scholarships, number granted scholarships, current number of students classified by gender and educational institutions, and number of terminations or fails in the last 12 months. The Ministry of Education will publish the guidelines for obtaining scholarships and publish their periodic reports.

  • Tuition and Fee Rates. The Ministry of Education will sign a memoranda of understanding the USP and other tertiary institutions, including to establish the basis of the financial commitment of the Solomon Islands Government.

  • Allowances. The Ministry of Education, in consultation with the Ministry of Finance, will recommend an allowances policy with specific allowance amounts that vary for students depending on the institutions where they study, the course that they are undertaking, employment status, travel requirements, whether studies are full-time or part-time, the length of the program in which they are enrolled and the number of years they have received the grant.

VIII. Data Provision

29. The data listed below will be provided for monitoring performance under the program based on data templates agreed with Fund staff. Under each section, reporting responsibilities are indicated in parentheses. Weekly data are requested for submission to Fund staff by the end of the following week. Monthly and quarterly data are requested for submission within six weeks of the end of the observation period. The authorities have committed to using the best available data, so that any subsequent data revisions will not lead to a breach of quantitative performance criteria or benchmarks. All revisions to data will be promptly reported to Fund staff.

A. Monetary Data (CBSI)

On a weekly basis:

  • Daily exchange rates, both buying and selling rates, of the Solomon Islands dollar against the U.S. dollar, including the official, interbank, and parallel market exchange rates;

  • Stock of NIR and sales and purchases by the CBSI in the foreign exchange markets;

  • Stock of reserve money and its components; and

  • Treasury bill auction reports.

  • On a monthly basis:

  • Financial corporations’ survey, including the balance sheet of CBSI, the consolidated balance sheet of ODCs, and the consolidated balance sheet of OFCs;

  • Liquid asset ratios and/or reserves requirement of the commercial banks;

  • Interest rates, including average interbank rate, bank deposit rates, and bank lending rates;

  • A detailed breakdown of NCG from the CBSI, commercial banks and other ODCs, and OFCs;

  • Foreign exchange cash-flow of the CBSI, including donor disbursements; and

  • Balances of each central government account specified in Section IV. A., as recorded or collected by the CBSI.

B. Fiscal Data (Ministry of Finance and Treasury (MoFT)

On a monthly basis:

  • Consolidated accounts of the central government, including detailed data on:

  • Revenue, including tax and nontax revenues, and recurrent and development grants included in the consolidated budget;

  • Recurrent expenditure, including payroll, goods and services, and other recurrent outlays, including those funded by donor support;

  • Other recurrent charges of the Ministry of Education and Ministry of Health, separating spending funded by donor support;

  • Debt service payments, classified into amortization and interest payments on (i) domestic debt, (i) external debt, (iii) domestic arrears, and (iv) external arrears; and

  • Development expenditure funded by (i) central government of Solomon Islands, and (ii) foreign grants and loans included in the consolidated budget.

  • Detailed financing components of central government’s accounts, classified into foreign and domestic sources.

  • Foreign financing includes (i) disbursement and amortization of project and program loans, and (ii) changes in external debt arrears, classified into principal and interest arrears.

  • Domestic financing includes (i) borrowing from and repayment to the CBSI, commercial banks and other ODCs, and OFCs; (ii) changes in deposits at the CBSI, commercial banks and other ODCs, and OFCs; and (iii) privatization receipts and changes in domestic debt arrears, classified into principal and interest arrears.

  • Stock of domestic debt, including the outstanding balance of government securities, treasury bills, cash advances, and other debt instruments.

  • Balances of each central government account specified in Section IV. A., as recorded by the MoFT.

  • Stock of unpaid government payment orders and unpresented checks.

C. External Sector Data (CBSI and MoFT)

On a quarterly basis:

  • New external debt obligations contracted and/or guaranteed by the government of the Solomon Islands, CBSI, and other official entities, including details on the amounts, terms, and conditions of each obligation.

  • Stock of outstanding external debt at end-month and disbursement, amortization, and interest payments for short-term external obligations contracted or guaranteed by the government or the CBSI by creditor in original currency and U.S. dollars.

  • Stock of external debt at end-month and disbursement, amortization, and interest payments for medium- and long-term external obligations contracted or guaranteed by the government or the CBSI by creditor in original currency and U.S. dollars.

  • Stock of arrears on the external debt contracted or guaranteed by the government or the CBSI by creditor in original currency and in U.S. dollars at end-month.

  • On a quarterly basis:

  • Balance of payment data, including detailed components of current accounts and capital and financial accounts.

D. Real Sector Data (MoFT, National Statistical Office)

On a monthly basis:

  • The monthly consumer price index and a detailed breakdown by major categories of goods and services included in the consumer basket.

Annex I. Guidelines on Performance Criteria with Respect to Foreign Debt

Excerpt from Executive Board Decision No. 6230-(79/140), as revised on August 31, 2009

  • 1. (a) For the purpose of this guideline, the term “debt” will be understood to mean a current, i.e., not contingent, liability, created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and which requires the obligor to make one or more payments in the form of assets (including currency) or services, at some future point(s) in time; these payments will discharge the principal and/or interest liabilities incurred under the contract. Debts can take a number of forms, the primary ones being as follows:

    • (i) loans, i.e., advances of money to the obligor by the lender made on the basis of an undertaking that the obligor will repay the funds in the future (including deposits, bonds, debentures, commercial loans and buyers’ credits) and temporary exchanges of assets that are equivalent to fully collateralized loans under which the obligor is required to repay the funds, and usually pay interest, by repurchasing the collateral from the buyer in the future (such as repurchase agreements and official swap arrangements);

    • (ii) suppliers’ credits, i.e., contracts where the supplier permits the obligor to defer payments until sometime after the date on which the goods are delivered or services are provided; and

    • (iii) leases, i.e., arrangements under which property is provided which the lessee has the right to use for one or more specified period(s) of time that are usually shorter than the total expected service life of the property, while the lessor retains the title to the property. For the purpose of the guideline, the debt is the present value (at the inception of the lease) of all lease payments expected to be made during the period of the agreement excluding those payments that cover the operation, repair or maintenance of the property.

  • (b) Under the definition of debt set out in point 9 (a) above, arrears, penalties, and judicially awarded damages arising from the failure to make payment under a contractual obligation that constitutes debt are debt. Failure to make payment on an obligation that is not considered debt under this definition (e.g., payment on delivery) will not give rise to debt.
1

Based on a vector autoregression (VAR) model estimated in Bai, Tumbarello, and Wu, “The Drivers of Inflation in the Pacific Island Countries,” forthcoming, IMF working paper.

2

Financial Inclusion in Small States in “Macroeconomic Developments and Selected Issues in Small Developing States,” FO/DIS/15/40.

3

The delay has been partly caused by the lengthy process of acquiring land for the project. The Hydro power plant was initially planned for completion by end-2015. Winning bidders for the projects are now expected to be announced in mid–2015. The project is estimated to require 18 months to complete.

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Cover IMF Staff Country Reports
Solomon Islands: Fourth Review Under the Extended Credit Facility Arrangement
Author:
International Monetary Fund. Asia and Pacific Dept
Volume/Issue:
Volume 2015: Issue 102
Publisher:
International Monetary Fund
ISBN:
9781475548129
ISSN:
1934-7685
Pages:
51
DOI:
https://doi.org/10.5089/9781475548129.002
  • View in gallery

    Solomon Islands: Real GDP Growth and Commodity Production

    (Year-on-year percent change)

  • View in gallery

    Solomon Islands: Monetary Developments

    (Contribution to broad money growth, in percent)

  • View in gallery

    Solomon Islands: Holdings of Bokolo Bills

    (In millions of Solomon Islands dollars)

  • View in gallery

    Solomon Islands: Interest Rates and Bank Reserves

  • View in gallery

    Solomon Islands: Nominal Exchange Rate

    (Solomon Islands dollars per foreign currency unit)

  • View in gallery

    Small States: Spreads Between Lending and Deposit Rates

    (In percent)

  • View in gallery

    Small States: Commercial Bank Branches per 100,000 Adults

    (Number of branches)

  • View in gallery

    Solomon Islands: GDP Growth Differential Under Lower Oil Price Forecasts1

    (Percent difference)

  • View in gallery

    Small States: Industrial Electricity Tariffs, 2013

    (In U.S. cents per KWh)

  • View in gallery

    Solomon Islands: Pass-through of International Fuel Prices to Domestic Retail Prices (June-December 2014)1

    (In percent)

  • View in gallery

    APD Small States: Oil Imports, 2012–13

    (In percent of GDP)

  • Figure 1.
    View in gallery
    Figure 1.

    Solomon Islands: Economic Indicators Relative to Other Small States

  • Figure 2.
    View in gallery
    Figure 2.

    Solomon Islands: Macroeconomic Developments and Outlook

Solomon Islands: Real GDP Growth and Commodity Production

(Year-on-year percent change)

Solomon Islands: Monetary Developments

(Contribution to broad money growth, in percent)

Solomon Islands: Holdings of Bokolo Bills

(In millions of Solomon Islands dollars)

Solomon Islands: Interest Rates and Bank Reserves

Solomon Islands: Nominal Exchange Rate

(Solomon Islands dollars per foreign currency unit)

Small States: Spreads Between Lending and Deposit Rates

(In percent)

Small States: Commercial Bank Branches per 100,000 Adults

(Number of branches)

Solomon Islands: GDP Growth Differential Under Lower Oil Price Forecasts1

(Percent difference)

Small States: Industrial Electricity Tariffs, 2013

(In U.S. cents per KWh)

Solomon Islands: Pass-through of International Fuel Prices to Domestic Retail Prices (June-December 2014)1

(In percent)

APD Small States: Oil Imports, 2012–13

(In percent of GDP)
Figure 1.

Solomon Islands: Economic Indicators Relative to Other Small States
Figure 2.

Solomon Islands: Macroeconomic Developments and Outlook