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 Solomon Islands authorities remain committed to the continuing engagement of the ECF program, which is helping to promote macroeconomic and financial stability and support the authorities’ reform efforts. Solomon Islands faces enormous challenges. A small and remote country, it has a predominantly rural population dispersed over many islands, and has a narrow economic base. Solomon Islands is vulnerable to natural disasters and external shocks. The peaceful election and transition to a new government in late-2014 is an important achievement, indicating greater stability a decade after the end of the period of civil conflict known as the “ethnic tensions” (1998 to 2003). The IMF program is making an important contribution towards strengthening the institutional framework to lift macroeconomic and public financial management, and to address structural impediments to stronger inclusive growth and a more prosperous future. The ECF also plays a confidence-building role with development partners and other stakeholders.
Solomon Islands has continued to make steadfast progress in program implementation. All of the quantitative targets under the 4th Review have been met except for the Indicative Targets on health and education spending, which were narrowly missed due to more robust procurement requirements by donors that slowed expenditure. Four of the structural benchmarks were completed. The 2014 Mid-Year Budget Review and the 2015 Budget Strategy were both produced for the first time, notable steps in implementing the 2013 Public Financial Management Act. In addition, preparation for the implementation of the mining tax regime was completed with amendments to the export duty schedule; and Cabinet approved drafting instructions for a new Financial Institutions Act. Progress has been made on the remaining benchmarks, despite the interruptions to government business and limited sitting of Parliament inevitably associated with a general election, and domestic capacity constraints. Capacity constraints within the Attorney-General’s Chambers have delayed timeframes on structural benchmarks involving legislation but they continue to be progressed. The authorities appreciate the flexibility of the IMF to adjust test dates in recognition of these capacity challenges.
The new Government’s Priorities
The authorities are confident the country’s natural resources and resilient population can be translated into new growth and income opportunities for all Solomon Islanders. The new Government, elected in November 2014, has an ambitious policy agenda to lift medium-term growth. The Government’s Policy Programme outlines a long-term strategy to facilitate good governance and encourage broad-based economic development, with a target of at least 5 percent growth per annum. The government will progress reforms on two fronts:
Fundamental reforms will pursue good governance and land reform to create confidence and support an enabling environment for economic development. Fighting corruption is an important element of the governance agenda and an area that has not previously received much attention. The Government intends to develop a National Anti-Corruption Strategy, enact anticorruption legislation, and establish an Independent Commission against Corruption.
Sectoral reforms are a set of sector-specific initiatives to facilitate entrepreneurship, SME development, further commercial development of natural resources, connectivity through transport and telecommunications, and to efficiently and effectively deliver social services. Improving the quality of expenditure remains a continuing priority for the authorities, complemented by the addition of tax policy reform to the agenda. Solomon Islands has requested IMF assistance to review the current tax system, which includes overlapping and cascading sales taxes, and developing reform proposals that will be more supportive of business.
Economic Outlook
The authorities’ current projections are generally in line with Staff’s forecasts. At the time the Board considered the 3rd Review of the Solomon Islands ECF, the capital Honiara and surrounding Guadalcanal had just been hit by severe floods. The impact of the 2014 floods proved more limited than initially feared, and economic growth for 2014 is believed to have been stronger than anticipated at the 3rd Review (estimates range between zero and 1.5 percent growth). Nonetheless, the ongoing closure of the Gold Ridge goldmine on Guadalcanal is a substantial drag on the economic and fiscal outlook. Before it closed the mine produced approximately 20 percent of Solomon Islands net exports and was a significant employer and contributor to government revenue (approximately 6 percent of government revenue in 2013). The mine is not expected to reopen in the foreseeable future. Growth in 2015 is expected to be modest and new sources of growth are needed to boost medium-term prospects and strengthen resilience.
Fiscal Policy
The Solomon Islands Government achieved a surplus in 2014 of about 1.9 percent of GDP on preliminary estimates. This outcome was better than expected at the time of the flood as revenues were supported by strong logging exports and fishing license fees, and development expenditure outturns were lower than planned. The cash balance was further buoyed by a disbursement of donor support in December 2014 to fund expenditure in 2015. This lifted the cash balance to 4.4 months of recurrent spending.
The authorities recognize that prudent fiscal management is a necessary part of their economic management strategy. The 2015 Budget was presented late last week. It reflects a balance between sustaining a prudent approach over the medium-term whilst delivering additional expenditure in the short-term in support of the country’s priorities and capital needs and to advance the Government’s Policy Programme. The Government has budgeted for a fiscal deficit of SI$462m (approx 5 percent of GDP) in 2015 to meet immediate needs, funded by drawing down some of the cash balance. While total expenditure is budgeted to increase by 10 percent in 2015, this is entirely driven by an increase in the development budget to reflect the Government’s policy priorities (recurrent expenditure in the budget is flat). The increased development spending is focused on strengthening infrastructure and rural development to ensure the 85 percent of the population in rural areas benefit from improvements to their standard of living. The budget includes notable increases in expenditure on health and basic education, and full-funding for the establishment of the Independent Commission Against Corruption. Capacity constraints will moderate the reality of the pace of fiscal expansion. The Government remains committed to keeping a sustainable and affordable level of debt.
The management and reporting of Constituency Development Funds (CDF) is being improved. The Public Financial Management (PFM) Act 2013 is being applied to CDFs, for example with respect to procurement processes, and parts of the 2013 CDF Act are being applied ahead of the implementing regulations being gazetted. The authorities, under the Prime Minister’s leadership, are determined that CDF expenditures are best able to support the development of a vibrant rural economy, and are focused on strengthening the implementation of the PFM Act 2013 and will review the CDF Act 2013 for implementation. In addition, the authorities remain committed to the publication of the results of already-conducted audits on spending of constituency funds and project achievements.
Continuing the efforts to strengthen policies and controls around tertiary scholarships following the 2013 overrun in expenditure, new tertiary scholarships policies have been approved by Cabinet. Cabinet also approved that the 2015 scholarship selection process follows the Ministry of Education and Human Resource Development (MEHRD) processes with the number of scholarships specified to enable value for money, transparency and accountability. Approval was also granted for MEHRD to implement a scholarship tracking database (recently developed scholarship information management system) to record and analyze the base data on current scholarships in the system. Furthermore, the authorities are committed to ensuring a better balance between investing in primary and secondary education, and financing tertiary education. With respect to the Customs and Excise Bill (a structural benchmark) a final draft has now been received.
Strengthening Public Financial Management remains a key priority. The authorities will continue to implement the PFM Act approved in September 2013. Building on the new suite of documents published last year, the 2015 Budget will introduce greater information on capital spending in both the recurrent and development budgets. The Government is firmly committed to implementing the PFM Reform Roadmap 2014-2017, developed with assistance from the Pacific Financial Technical Assistance Centre (PFTAC). In addition, a public sector remuneration review is underway to consider options for streamlining and consolidating the existing remuneration benefits. The authorities continue to take a cautious approach to debt management, using concessional borrowing only for productive priority investments. Solomon Islands’ debt is currently around 11 percent of GDP, and the Annual Borrowing Limit set in the 2015 budget (SI$300m) is in line with the Debt Management Framework (DMF). The DMF ensures that Government borrowing and/or guarantees is used for investing in productive capacity, funding priority core infrastructure and development initiatives and projects that are high priorities in the National Development Strategy.
Monetary Policy and Financial Sector
Monetary and exchange rate policies have supported economic activity during 2014 and remain appropriate. Inflation initially spiked after the April 2014 floods but has since eased, to 4.8 percent in the year to December and 1.6 percent in the year to February 2015. The inflation outlook remains sanguine. The Central Bank of Solomon Islands (CBSI) stands ready to review its monetary policy stance should inflationary pressure arise, and is closely monitoring strong credit growth (from a low base) on mortgage and consumption loans.
The Central Bank of Solomon Islands (CBSI) has now fully implemented the exchange rate’s basket-peg regime. This is an important tool to anchor inflation and allow greater flexibility in the exchange rate management, thus helping maintain competitiveness. A subsequent IMF TA Mission has just concluded, providing the opportunity for follow-up on the operation of the basket-peg regime, and helpful input on strengthening the monetary transmission mechanism (such as tools to manage excess liquidity).
Strengthening financial regulation and supervision remains a focus to preserve financial stability and foster financial sector development and financial inclusion. The introduction of a new bank (Pan-Oceanic Bank) into the market in mid-2014 has enhanced financial access and competition. The authorities are mindful to ensure that lending standards are not undermined in this environment. Banks currently have ample liquidity and remain profitable. The introduction of mobile banking since late 2013 is also a meaningful boost to financial inclusion efforts, increasing access to financial services for the underserved rural population. The first credit bureau opened in February 2015. The authorities are working with the Asian Development Bank on strengthening the regulation of mobile banking services and developing prudential guidelines to ensure adequate consumer protection. Progressing the National Provident Fund, Financial Institutions and Credit Union Acts (structural benchmarks) remain priorities in order to further enhance financial sector stability and promote financial inclusion and access to credit. Policy proposals and legislative drafting are at various stages of development with the Financial Institutions the most advanced, with a draft Bill currently out for public consultation.
Conclusion
The authorities are keenly focused on supporting medium-term growth and enabling private sector development in Solomon Islands. The ECF program plays an important role in helping to strengthen the institutional framework and improve the quality of expenditure and tax policy, and in boosting confidence. The Government values continued engagement through the ECF program, which is an important element in the authorities’ ambitious reform agenda. To deliver this agenda the Government is seeking a balance between higher development spending to boost economic growth prospects and meet development needs, whilst maintaining prudent fiscal management and sufficient buffers over time.
Finally, the Solomon Islands authorities would like to thank Staff for the quality of their engagement, collaborative approach and readiness to engage with the new Government on its objectives. Technical assistance provided by PFTAC and HQ departments continues to be invaluable to the Solomon Islands authorities’ efforts to strengthen macroeconomic management and lift economic performance.