Abstract
Kiribati is a small and fragile state vulnerable to climate change. Record high fishing revenue in recent years has boosted growth, improved the current account, and strengthened the balance of the sovereign wealth fund, the primary vehicle for intergenerational saving. However, fishing revenue has declined in the early months of 2016 and is projected to remain at more modest levels over the medium term. Building fiscal buffers to enhance resilience and continued support from development partners are essential to mitigate downside risks to growth.
We thank the staff for their report, the high quality of engagement – both in terms of the thoughtful analysis as well as the open attitude of the team in their dialogue with our authorities. We welcome the past and continuing assistance of the IMF, other international financial institutions and Kiribati’s development partners. The new Government largely agrees with the staff’s analysis and would like to highlight a number of points.
Context
Kiribati consists of 33 small islands spread over a vast area of the Pacific Ocean; there is about 4,500km between the eastern and western zones. High transaction costs between the outer islands and South Tarawa, due to isolation and infrastructure needs, affect development. Growth to a large extent depends on the fortunes of the fishing industry. Half the population is located in and around the capital, South Tarawa. The vast majority of Kiribati is only a few metres above sea level, and having a relatively limited supply of fresh drinking water, the country is highly vulnerable to climate change as well as both El Niño and La Niña events. In facing these challenges, Kiribati has a good record of stable democracy and orderly transitions between governments, social cohesion, good relations with donors and prudent economic management. Building on recent reforms, the new Government is also committed to taking a prudent approach to economic management.
Economic Outlook
The authorities agree with staff that the underlying drivers of economic growth are moderating and risks are generally to the downside. At the same time, upside risks are present, including growth flowing from continued construction activity at the airport, water and sanitation projects, and an upgrade to the causeway running between the two most heavily populated islands. The authorities agree that inflation is expected to remain low.
Fiscal Policy
The authorities welcome the IMF’s analysis of the fiscal position, and will carefully consider the IMF’s advice in putting together the medium-term fiscal framework. The new Government intends to maintain a balanced budget over the medium term. It will consider carefully the recommendations to target structural balances, so fluctuations are treated symmetrically. Some flexibility in the framework is appropriate in order to respond to large variations in fishing license revenue. The Government also intends to carefully manage Kiribati’s balance sheet. It intends only to draw on the Revenue Equalization Reserve Fund (RERF) as a last resort and not for recurrent spending.
The Government has recently announced a number of fiscal measures that will both improve social inclusion as well as reduce costs in the longer-term. In particular, early evidence suggests that people are migrating back to the outer islands in response to the increase in copra prices; this is helping to reduce both economic and social issues in South Tarawa. The Government has also recently committed to reviewing some expenditures, including SOEs and public financial management, and is considering civil service reforms including outsourcing. The Government has also provided a modest increase in spending on education and health to address critical social needs. Furthermore, the 2016 Budget Speech noted that the Government will seek to increase maintenance spending in the coming years to a level proportionate with the needs of the nation so as to reduce long-run repair costs. It should be noted that last year’s increase in public sector wage costs was driven by a one-off change in the mechanism by which home leave payments were provided.
The Government is undertaking a number of actions to improve revenues. Most importantly, the authorities are working to improve compliance with the new VAT system. In particular, the newly established Taxpayer Services Division will work on improving the collection rate as well as the timeliness of collections. The Government recognizes the revenue implications of exempting SOEs from the VAT. At the same time, these exemptions are important in keeping costs down for outer islanders (especially as the exemptions primarily relate to household necessities). The Government is considering introducing new measures to widen the tax base.
The authorities carefully consider potential climate change mitigation and adaption costs and are examining the feasibility of explicitly recognizing these costs in the budget. This information can already be obtained from the budget and identifying it more explicitly would help underline the need for assistance. Kiribati has also been at the forefront of efforts to highlight the need to address climate change on a global level. It will continue to seek assistance from the international community in adjusting to climate change.
SWF and Cash Reserves
The Revenue Equalization Reserve Fund (RERF), Kiribati’s sovereign wealth fund, has significant financial assets and will be managed prudently for both current and future generations. Protecting the capital value of the RERF is a key priority of the Government and the authorities are developing a framework for achieving this. The Government will consider a rules-based withdrawal mechanism using the IMF’s research as an input. Since the finalisation of the staff report, the Government has moved AUD$70 million into the RERF arising from strong recent returns from fishing. The authorities agree with staff’s proposals to maintain a buffer of around 3 months of recurrent spending.
Structural Reforms
The authorities remain firmly committed to their reform efforts and welcome staff’s acknowledgement of the progress made in recent years. This has made good use of the technical assistance provided by the Asian Development Bank and the World Bank since 2009. Beyond the significant reduction in the number of SOEs, there has been a marked change in the strategic direction of the remaining SOEs towards a more commercial focus. The Government is currently undertaking the second stage of these reforms. This has two main elements. First, major decisions affecting SOEs will now be joint decisions between the portfolio minister and the Minister of Finance, rather than just the portfolio minister. Second, a number of additional SOEs are in the process of being privatized. Each of these are at a separate stage but the direction of travel is clear. The new government looks forward to the negotiations with the corporatized SOEs on the appropriate size of any community service obligation (CSO) payments now that the budget is out of the way. In progressing this, it will be important for these entities to improve their competitiveness - especially given that many are now in monopoly positions.
The Government will carefully assess proposals to promote air transportation and shipping services. This will help ensure that any expansions are sustainable and the best use of resources when considered in a holistic manner. Given the complexity of such decisions, the authorities will also ensure that they seek a number of different perspectives, including expertise from international financial institutions and development partners.
The authorities agree on the need to address issues with the Development Bank of Kiribati (DBK) and the Kiribati Provident Fund (KPF) and note that this is under active consideration. Policy initiatives in these areas will aim to strengthen the resilience of these institutions while, at the same time, continuing to improve the population’s access to finance. The latter is especially important as financial development in Kiribati significantly lags behind that in similar countries. Any expansion of the DBK into commercial banking will only be done after careful analysis. Likewise, the authorities intend to approach PFTAC for technical assistance on KPF investment policies and operations, noting that ‘crediting rates’ provided to KPF members have fallen over time and are subject to periodic review.
Private Sector Development
The authorities recognize that encouraging growth in the private sector is vital. To facilitate this, the Government finalized a Private Sector Development Strategy in 2015. This strategy focused on creating an enabling environment for the private sector as well as generating business opportunities for small-, micro-, and medium-enterprises. This, in turn, is supported through actions ranging from improving infrastructure and the availability of capital to updating business registration processes. These tasks remain important today and, as such, the authorities plan to review progress and update this strategy where gaps are found. On land registration, this is a long running challenge for both Kiribati and other Pacific countries given the customary land system.
Longer term, improved educational outcomes are a key plank of the new Government’s plan to help private sector growth. The new strategic plan for the education sector – itself coming out of the recently released 2016-19 Development Plan – will allow students to better capitalize on employment opportunities both domestically and overseas, through improving both the quality of teaching and infrastructure. This has been developed with considerable input from Kiribati’s development partners and intensive business community involvement to help ensure that students are best suited to workforce. Beyond this, the authorities are working with Australia and New Zealand to increase both temporary and permanent opportunities for i-Kiribati workers.