2018 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for the Solomon Islands
Solomon Islands is a low-income country of around 600,000 people speaking many different languages across hundreds of islands in the Pacific. Its dispersed population, large infrastructure needs, narrow economic base, and exposure to natural disasters and commodity price volatilities pose many development challenges. The authorities are aware of the macroeconomic risks the country faces and appreciate the analysis, advice and technical assistance provided by the Fund.
Robust growth is being driven by the logging and palm oil sectors, supported by the fishing, construction, wholesale and retail, and transport and storage sectors. Inflation remains within the expected range of 2 to 4 percent. The first six months of 2018 saw a current account surplus, but this is expected to reverse over the second half of the year and widen in future years because of capital goods imports from major projects. Foreign reserves are equivalent to 11.8 months of imports and are likely to decline moderately in the future.
The Solomon Island authorities are more optimistic about growth prospects than staff, in part because they assume logging activity will hold up for longer. In addition, reopening of the Gold Ridge Mine and major infrastructure projects will support growth in the next few years. These projects—including the undersea cable and Tina River Hydro Project— will also help lower the cost of doing business and improve productivity over the long term. Diversification is a challenge, but there is scope to promote activity in the non-logging sector. An inter-agency sustainable taskforce has been established to help steer the economy away from its overdependence on logging and initial measures include a reduction in logging licenses and changes to the tax regime. A policy is also being developed to encourage downstream processing of some of the harvested log volumes.
Stabilizing public finances has been a priority of the government since its formation in 2017, and this will be a gradual process over many years. The government’s clearance of most, if not all, of the 2017 arrears has been an important step. To contain the deficit, large spending cuts were made in the 2018 Budget, although many of these cuts reflected underspends across government ministries in prior years due to capacity constraints. Priority infrastructure projects were protected. The authorities welcomed a Fund technical assistance report on strengthening the fundamentals of public financial management. The recent appointment of an Accountant-General, a position unfilled since 2016, will help address issues highlighted in the TA report, including problems with cash management.
The authorities welcomed the debt sustainability analysis that assesses Solomon Islands at moderate risk of debt distress. Noting the large infrastructure financing gaps of the country, the authorities raised the public debt threshold from 30 percent of GDP to 35 percent to allow borrowing for future capital investment needs. The authorities remain committed to ensure future borrowings are affordable and in line with the spirit of the debt management framework. Currently, public debt stands at 11 percent of GDP.
Monetary and financial sector policies
The Central Bank of Solomon Islands has announced it will continue its accommodative monetary policy in view of the low inflation environment, weak credit growth and subdued aggregate demand. There is structural excess liquidity in the banking system but no urgency in mopping this up, as lending remains subdued and poses little threat to inflation.
There is also a cost in issuing more paper in the under-developed domestic market. In fact, the authorities hope commercial banks lend more to businesses to help boost private sector activities and employment. However, they are prepared to take remedial action if credit growth threatens price stability.
Banks are well-capitalized and profitable, in a shallow and under-developed market. High interest rate spreads reflect downward stickiness in commercial banks’ lending rates despite notable improvements in the country’s economic and risk conditions. Pressure to regulate interest rates is growing from businesses and politicians but the authorities are reluctant to intervene. NPLs have improved in 2018 to 5.8 percent of gross loans because of recovery actions by banks. The main bank serving the logging industry is currently without a correspondent banking relationship and is being assisted by the Central Bank through a temporary arrangement with the Federal Reserve Bank that expires at the end of the year. The bank in question is addressing issues identified by a potential correspondent and is on track to have a relationship established in January next year.
Work is continuing under the National Financial Inclusion Strategy 2016–2020. The Solomon Islands National Provident Fund Act has been amended to allow the rollout of the ‘youSave’ scheme that lets informal and self-employed people join the superannuation scheme. Recognizing that basic financial literacy is low throughout the country, the authorities are working to mainstream financial literacy in the school curriculum.
The authorities share many of the governance concerns raised by the mission team and recognize that this is an area where more work needs to be done, drawing on technical assistance from the Fund, amongst others. Legislation has already been passed to promote good governance, despite a difficult political environment. This includes the Anti-Corruption Act, Whistleblowers Act and Ombudsman Act. While development spending was cut back strongly in the 2018 Budget to help the fiscal position, it is worth noting that discretionary funds managed by Members of Parliament—including shipping grants, scholarship grants, church grants and rural constituency development funds—were also cut by 35 percent. The authorities note staff’s recommendations to strengthen public investment management and welcome technical assistance to develop the country’s capacity in this area.