Abstract
Solomon Islands is a small island state, a low-income country that is severely affected by external shocks, including commodity price declines, natural disasters, and climate change.
The ECF program has helped Solomon Islands achieve macroeconomic and financial stability and supported the authorities’ efforts to strengthen core institutions. The Solomon Islands authorities are determined to consolidate these gains, maintaining the important buffers built and continuing the reform agenda. This will ensure continuing improvements in the quality of resource allocation and government spending, and ultimately help achieve stronger, sustainable, more diversified and inclusive growth. This is vital to ensure improved economic opportunities and outcomes for all Solomon Islanders, particularly the 80 percent of the population that live in remote rural areas. To this end the authorities appreciated the constructive engagement and tailored advice of Staff in the ECF Review and Article IV mission. The Article IV Reports focus on building resilience to shocks (particularly natural disasters) and financial inclusion is also timely as these are important priorities, integrally linked to rural development. My authorities look forward to continuing close engagement with the Fund into the future.
The achievements made under the ECF program have been significant, delivering clear benefits to macroeconomic stability. Fiscal and external buffers have increased: net international reserves rose to 9.8 months of imports in December 2015; external public debt has dropped to 9.8 percent of GDP; and the government’s cash reserves for December 2015 were 3.2 months of recurrent spending (SI$694m). Steady growth has been achieved and inflation well contained. The government budget was near-balance in 2015 (-0.3 percent of GDP). Even in periods of stress the economy has proved resilient: during the deadly floods that hit Honiara and Guadalcanal in 2014; the out-of-season Cyclone Raquel in 2015; the ongoing El Niño event, and the sudden closure of the Gold Ridge mining operation in early 2014.
These gains have been underpinned by notable progress in building institutions under the ECF arrangement, a key objective of the program. In particular, the Public Financial Management (PFM) Act and the Central Bank of Solomon Islands (CBSI) Act, subsequent regulatory and implementation steps, and the comprehensive Debt Management Framework (comprising the Debt Management Strategy, SOE borrowing policy, On-lending policy, and Guarantee policy) have helped the authorities strengthen macroeconomic stability and resilience. They provide an important anchor, and the stronger institutional architecture also limits the potential for hard-fought gains to be eroded in the future. Alongside the program, improvements in exchange rate management and monetary operations, supported by useful and targeted TA, have also enhanced macroeconomic management and stability.
Institutional strengthening is inevitably a long-term path in states that are small, low-income, and/or in fragile situations; the Solomon Islands is all three. My authorities are committed to continuing steadfastly along this path. As a small, dispersed, and remote country vulnerable to external shocks and frequent natural disasters, continuing to build resilience is vital. Furthermore, lifting growth is a key challenge. Long-term economic growth averages around 3.5 percent, barely above the rate of population increase. The drift of the population from rural to urban areas and the growing number of unemployed youths also could undermine the recent improvements in social cohesion and security. The authorities are determined to progress critical reform efforts in order to sustain medium to long term macroeconomic stability and growth. This includes giving priority to completing the legislative process to strengthen the financial environment; continuing improvements to public financial management including implementing the new Procurement Rules and Regulations; and Anti Corruption measures, led by the Prime Minister. These are elaborated below.
Performance has been sound in achieving the program’s objectives. All quantitative criteria under the program have been met by a considerable margin; this strong performance continued in December 2015 (outside the monitoring of the program). The only exception was the Indicative Targets on government-funded recurrent spending on health and education, which were narrowly missed owing to stronger procurement requirements by development partners in disbursing ODA in these sectors. Solid progress is continuing to be made across the government’s reform agenda to further build on the key institutional measures already established. Legislative bottlenecks - resulting from continuing capacity constraints in the Attorney General’s Office, and exacerbated by the limited number of parliamentary sittings that generally take place during a year (given the challenges of a small very-dispersed country) – and the complexity of some legislation have seen timeframes extended even while progress continues. The combination of the 5th and 6th reviews, in conjunction with the short extension of the program approved by the Board in December 2015, has been helpful to accommodate progress on reforms and a platform for continued engagement with the Fund.
Economic outlook
Economic growth is solid although the authorities agree that risks are to the downside. The economy is estimated to have grown by 3¼ percent in 2015. Growth is expected to remain around 3 percent in 2016 driven by construction, communication and manufacturing activity as the contribution from logging is expected to soften. The Solomon Islands authorities are nonetheless cautious about the outlook as key trading partners, in particular China, are slowing. While Solomon Islands has yet to see the implications of slowing growth in Asia, it poses a risk to commodity prices and demand. The full extent of the impact of the current El Niño event remains uncertain, in addition to the ever-present risk from natural disasters.
Achieving sustained and inclusive growth is a key objective of the Solomon Islands authorities, as set out in their Economic Development Document (the Medium Term Development Plan 2016 to 2020, circulated separately to the Executive Board in line with the IMF’s new policy on Poverty Reduction Strategy (PRS) documentation). Agribusiness and fisheries offer considerable potential for future growth, as does tourism and mining in the medium-term. Investment in infrastructure will be essential to support rural development as well as private sector development, and to raise productivity across a wider range of sectors. In addition, other complementary measures are needed to improve the business environment including land reform, which is part of the government’s agenda of “fundamental reforms”.
Fiscal performance and policies
Solomon Islands recorded a fiscal deficit of 0.3 percent of GDP in 2015, maintaining solid cash buffers whilst also repaying all its domestic debt early. The budget outturn was markedly better than the budgeted deficit of 5.5 percent of GDP, reflecting a slower pace of spending early in the year and careful expenditure management, and better than expected revenues. The outturn also incorporated the early repayment of SI$100m (approx 1.1 percent of GDP) of domestic debt, further building buffers. This good performance was retained even as the government was able to lift the implementation rate of development spending relative to previous years (whereas in previous years the cash balance has been bolstered by the inability of the government to implement its spending plans).
The Solomon Islands authorities are committed to preserving fiscal discipline and maintaining a strong cash reserve following the completion of the ECF arrangement. Solomon Islands’ vulnerability to natural disasters underlines the importance of maintaining meaningful buffers, as does the more challenging external environment currently prevailing. While the 2016 Budget projects a similar deficit to that projected in 2015, the Solomon Islands authorities are committed to carefully manage the budget in order to preserve the gains made under the ECF. In particular, my authorities appreciated the opportunity to discuss with Staff what tools could be useful to help them manage their fiscal affairs following the expiry of the ECF. The authorities will target the cash balance to not fall below two months of total expenditure. To give effect to this, the authorities will put in place quarterly fiscal targets, and look to align expenditure flows with revenue collection. Additional TA is being sought by the authorities from the Fund to strengthen the management of consolidated funds, including cash balances. In addition the authorities will review overall progress in spending as well as the spending mix at the Mid-Year Update to ensure it is in line with the Solomon Islands’ development priorities and fiscal objectives. The authorities will take a cautious approach to resuming concessional borrowing and have set an Annual Borrowing Limit of SI$300 million for 2016, consistent with the debt sustainability threshold under their Debt Management Framework (of a face value of debt to GDP of 25 percent).
Mobilising domestic revenue in an efficient way remains important for the authorities to deliver their development objectives. The new Customs and Excise Bill – a long (400 pages) and complex piece of legislation including amendments to other revenue Acts -will help to protect government revenue and promote accountability and transparency in decision making. It has been approved by Cabinet for vetting by the Attorney General’s Chambers, and is expected to be presented to Parliament later in the year.
Solomon Islands will continue to strengthen budget management and presentation, and would value continued discussions on appropriate medium-term fiscal anchors. My authorities see merit in enhancing the presentation of the budget and are open to ideas on how this could be progressed. My authorities also look forward to continued discussions with staff on their recommendation to use a non-commodity primary balance target as a medium- to long-term fiscal anchor. It will be important to understand the merits and implications of different options, noting that an anchor must be economically meaningful as well as easily understood to be most useful from a political management perspective.
The authorities are strongly committed to continue to strengthen public financial management practices, with further measures in train. The new Procurement Rules and Regulations are well-advanced and will come into effect by 1 July 2016, entrenching discipline to procurement processes. This will help enhance the improvements being made in the quality of resource allocation decisions as a result of the PFM Act. In addition Cabinet has recently approved the development of a Capital Structure policy for SOEs over the medium term with the objective of improving the performance, governance and oversight of SOEs by promoting efficient investment decisions.
Considerable resource has been put into strengthening the systems for planning, procurement and reporting of Constituency Development Funds. The Ministry of Rural Development is significantly scaling up its staffing; each constituency office is now well-resourced (including an accountant) and the Ministry is strengthening its central capacity to analyze constituency development plans and ensure consistency in reporting. A new project database system will further enhance this. A significant amount of information is now being produced as every constituency has an annual development plan and they report progress quarterly. The PFM Act has provided more governance to the implementation of CDFs, which are now abiding by procurement processes and will be covered by the new Procurement Rules and Regulations. My authorities welcome the suggestions Staff have made as to how the information produced could be presented in an accessible way – such as in the development budget by constituency – to further increase awareness of what is being delivered through the CDFs (e.g. Staff’s analysis that the amount of spending on capital projects under the CDFs is projected to increase in 2016). The completed audit reports on CDFs are expected to be submitted to Parliament at the sitting in the middle of the year, upon which they will be publicly available.
Control of tertiary education spending is being enhanced. The Solomon Islands authorities are keen to ensure that the capacity of Solomon Islands at tertiary level increases over time, but recognize it is important to consider what is the most effective way to do this and also ensure that Solomon Islands has the vocational and trade skills that it needs. A clear process is being used to determine the allocation of new scholarships and to ensure the continued performance of scholars abroad. Nonetheless there are continuing demand pressures as more students meet the academic achievement threshold than scholarships available. Work is well underway on a new Education Bill (expected before Parliament later this year) and reviewing tertiary education policies. The results are expected to enhance clarity and responsibility for tertiary spending, separate from primary and secondary education spending.
The Government is pursuing a strong anti-corruption agenda as an utmost priority. An Anti-Corruption Bill is expected shortly that will give effect to the UN Convention Against Corruption, prohibiting corruption in the public and private sectors and establishing mechanisms for the investigation, prosecution and punishment of corruption offences. It will establish the Solomon Islands Independent Commission Against Corruption (SIICAC). Complementary legislation will also be introduced in the form of a Whistle Blower Bill and a revised and enhanced Ombudsman Bill.
Staff’s analysis on resilience to natural disasters is very timely as this is a high priority. The Solomon Islands authorities are placing an increased emphasis on disaster risk preparedness and mitigation as immediate priorities, as set out in their EDD. They are exploring different mechanisms to build buffers within a multi-pillar approach. Domestically they are setting up a contingency fund for natural disasters, and looking to strengthen the work of the National Transport Fund. They are also considering regional mechanisms, including a proposed Melanesian Fund that would provide short-term liquidity support. They will examine a future phase of the Pacific Catastrophic Risk Insurance scheme, although earlier pilots failed to meet expectations and Solomon Islands withdrew when it did not receive any payout following the 2014 floods. Enhancing debt management capacity is also critically important when subject to frequent natural disasters, and my authorities will look over time to better integrate this into the DSA.
Monetary, exchange rate and financial policy
Monetary policy remains accommodative but the authorities are watchful for any signs of inflationary pressures. In the first half of 2015 Solomon Islands experienced deflation, which warranted supportive monetary policy and expansionary fiscal policy. There was a return to low inflation in the second half of 2015. The authorities have maintained current monetary policy settings but are alert to any building of inflationary pressures. The authorities are conscious that monetary policy effectiveness is hampered by excess liquidity and appreciate Staff’s views on tools that might help better manage this. The authorities do not view the cash reserve requirement ratio as a viable tool at the current conjuncture, and are receiving technical assistance from the Reserve Bank of Australia on how to conduct liquidity swaps.
The basket exchange rate regime is operating well. Innovations to remove the operational 1 percent band and to increase the buy-sell margin in foreign exchange trading have enhanced exchange rate management. Bilateral exchange rates have shown greater flexibility while the currency basket remains more stable. Bilateral exchange rates are now published daily. The authorities are considering whether to include the renminbi in the currency basket. My authorities are open to a periodic review of the appropriate level of the peg but are conscious that without fundamentally addressing some of the supply side constraints in the economy (such as the business climate and land reform), the competitiveness benefits from devaluation may be shortlived. The authorities are interested in continuing discussions on how to achieve a sustainable lift in competitiveness.
The Central Bank of Solomon Islands (CBSI) is continuing work to implement the final recommendations from the helpful Safeguards assessment. Further upgrades to the legislative framework to ensure a stable and efficient financial sector are well advanced. My authorities are committed to bringing these to completion as a priority, as they are key planks in their efforts to strengthen financial stability and inclusion. In particular:
The Credit Unions Act will help promote financial sector stability and development. In February Cabinet endorsed the detailed policy paper and instructed the Attorney General’s Chambers to draft the legislation. A model Credit Union Bill has been prepared, which should substantially reduce the time needed to finalize the Bill.
The revised National Provident Fund (NPF) Act will strengthen the NPF’s governance structure and investment framework. Cabinet approval is being sought for the Attorney General’s Chambers to proceed with drafting.
The Financial Institutions Act will modernize and strengthen supervision of the financial sector. The CBSI has developed new financial instructions, issued new Prudential Guidelines, and endorsed a Fitness and Propriety Regulation, in anticipation of the new Act.
My authorities welcome Staff’s innovative and timely analysis on financial inclusion, key to the government’s rural development objectives and to empowering women. The CBSI has been proactive in promoting financial inclusion and the Governor chairs the National Financial Inclusion Taskforce (NFIT) including government, financial institutions, communication providers, and donors. NFIT recently endorsed the next medium-term National Financial Inclusion Strategy (NFIS2), which sets out clear goals and a coordinated approach to broaden and deepen financial inclusion in Solomon Islands. Solomon Islands is a leader in mobile banking services among Pacific small states, and one of the Taskforce’s four working groups is focused on digital finance. The authorities are mindful that it is important to balance financial inclusion with financial stability.
In conclusion, the ECF program has helped strengthen the institutional environment to achieve and safeguard continued macroeconomic stability. Solomon Islands is committed to continuing to advance their reform agenda, including completing remaining legislative processes and continuing to strengthen public financial management. My authorities view these as integral to their objective to build a robust and diversified economy that delivers benefits for all, particularly those in the rural areas. Even when capacity constraints and political management may slow the pace of progress, the direction of effort and commitment is clear and the authorities are continuing to move forward.
The IMF remains an important partner for Solomon Islands. My authorities would like to thank Staff for their untiring commitment and support through the ECF. They look forward to continued close engagement with the Fund following the expiry of the program, including through technical assistance aligned with key priorities. The move to a 12 month Article IV cycle is welcome and will help foster this.