Kiribati: 2018 Article IV Consultation—Press Release; Staff Report; and Statement by the Executive Director for Kiribati
  • 1 https://isni.org/isni/0000000404811396, International Monetary Fund

2018 Article IV Consultation -Press Release; Staff Report; and Statement by the Executive Director for Kiribati

Abstract

2018 Article IV Consultation -Press Release; Staff Report; and Statement by the Executive Director for Kiribati

Context

1. Kiribati is one of the most remote countries in the world, which creates significant economic challenges. The population of about 112,000 lives on 21 islands, spread over an ocean area of 3.5 million square kilometers. This geography raises the cost of public service delivery, leading to an infrastructure gap. It limits opportunities for private sector development and diversification—economic activity primarily consists of fisheries and copra. Weaknesses in governance, business regulations, and access to credit exacerbate the geographical challenges.

2. Long-run prospects are clouded by climate change. Kiribati’s low-lying atolls are vulnerable to rising sea levels. Storm surge, coastal erosion, and saltwater intrusion further jeopardize the country’s limited resources. Higher ocean surface temperatures will potentially disrupt Kiribati’s largest economic resource—the tuna fishery—through the impact on migration and spawning patterns.

A01ufig1

Kiribati has an Infrastructure Gap

Citation: IMF Staff Country Reports 2019, 026; 10.5089/9781484396131.002.A001

Note: 2015 data except for access to electricity (2014) and mobile cellular subscriptions (2016).Sources: World Bank, World Development Indicators.

Recent Developments, Outlook, and Risks

3. Economic performance has been strong, both relative to Kiribati’s history and to its peers. The economy grew at an average annual pace of 5¼ percent in 2015–17, compared to 1½ percent in 2000–14.1 The stronger growth reflects in large part higher public spending financed by record-high fishing revenue and donor-financed infrastructure investment. Inflation remained subdued, in line with low inflation in trading partners and international food prices but also reflecting one-off domestic factors.2 Credit to the private sector is estimated to have remained broadly stable. Lack of regularly-reported, system-wide data greatly hinders financial sector analysis.

A01ufig2

Recent Economic Performance Exceeded Historical Norms

(change in real GDP, annual average, percent)

Citation: IMF Staff Country Reports 2019, 026; 10.5089/9781484396131.002.A001

Sources: World Bank, World Development Indicators.
A01ufig3

Outstanding Loans have been Broadly Stable

(percent of GDP)

Citation: IMF Staff Country Reports 2019, 026; 10.5089/9781484396131.002.A001

Note: KPF=Kiribati Provident Fund, DBK=Development Bank of Kiribati. 2018 annualized based on latest observation available.Sources: Country authorities; IMF staff estimates.

4. Strong fishing revenue improved the fiscal position, but also generated political pressure to increase public spending. For the fifth year in a row, the recurrent balance registered a surplus in 2017, reaching 12 percent of GDP.3 The recurrent surplus could have been larger but for the offset to the fishing revenue windfall (26 percent of GDP) from current spending overruns (12 percent of GDP was appropriated for the outer islands development program while copra subsidies exceeded projections by 2 percent of GDP). The balance of the sovereign wealth fund (Revenue Equalization Reserve Fund, “RERF”) was 386 percent of GDP at end-2017, cash reserves reached 77 percent, and public debt stood at 23 percent. The government’s net financial worth— calculated as the balances of the RERF and cash reserves minus public debt—rose to 440 percent of GDP.

5. The fishing revenue windfall prompted a reassessment of the cash management strategy. The government has committed to no drawdowns from the RERF at least until a target balance of A$1 billion (about 400 percent of GDP) is reached—the balance stood at A$994 million as of November 2018. Furthermore, cash reserves now are more than four times staff’s recommended buffer (three months of recurrent spending), and about half are in a non-interest-bearing account with the local branch of ANZ. The authorities have recently approved a program to transfer a component of these cash holdings to an interest-bearing account with State Street.

6. External balances have been stable. The current account surplus is estimated at 14 percent of GDP in 2017. The real effective exchange rate (REER) has tracked the weakening of the Australian dollar against the US dollar since early 2018 but remains within historical norms. Staff assesses the underlying external position in 2017 to be broadly in line with the level implied by medium-term fundamentals and desirable policies (Annex I). Given the idiosyncratic features of the Kiribati economy and data quality, the uncertainty around this assessment is substantial.

7. The near-term outlook is expected to feature some moderation of recent trends. Growth is estimated to grow at a slower pace of 2% percent in 2018, as fishing volumes normalize. Inflation is expected to remain around 2 percent this year and increase in the medium term to 2½ percent—a pace consistent with major trading partners. The current account surplus is projected to narrow, as fishing license fees decline, and imports related to development spending remain high.

8. The fiscal position is expected to worsen under current policies.

  • The 2018 budget envisaged a modest recurrent surplus, notwithstanding a sharp increase in the public wage bill (amounting to 6 percent of GDP) offset by a reduction in other recurrent expenditures. However, fishing revenue exceeded projections again—this time by 16 percent of GDP—and additional spending amounting to 9 percent of GDP has been authorized under supplementary budgets. Three-fourths of the additional spending is to cover the initial upfront cost of and down payment for aircraft acquisition as part of Air Kiribati Limited (AKL)’s plans for establishing independent international transportation services (Box 1). With these layouts incorporated in the baseline, the overall balance would register a deficit of 20 percent in 2018 and 23 percent in 2019.

  • In the medium run, both recurrent and capital expenditures are projected to decline from their 2016-18 peaks but remain high by historical standards at 69 percent and 38 percent of GDP, respectively. With conservative assumptions on fishing revenues and grant rollover, the overall deficit is projected to be around 11 percent of GDP by 2025, causing net financial worth to decline from its 2018 peak. Staff’s DSA indicates that Kiribati remains at high risk of debt distress. While the large size of the RERF relative to external debt limits immediate risks, the RERF could be significantly depleted over the longer run in downside scenarios to fishing revenue (see Box 2 in 2017 Article IV Staff Report). The RERF would also be subject to withdrawals if current spending policies are maintained and reliance on grants is eventually reduced (as staff’s baseline conservatively assumes).

Improvement in the Fiscal Position Unlikely to last Under Current Spending Plans

(percent of GDP unless otherwise noted)

article image

Revenue plus budget grants minus current expenditure.

Revenue and grants minus total expenditure.

Revenue excluding grants and fishing revenue minus current expenditure.

Balances of RERF, custodial, and cash accounts minus public debt.

Custodial and cash accounts.

9. Risks to the outlook are substantial and skewed to the downside (Annex II). The favorable weather conditions underpinning strong fishing catches have lasted unusually long. A cyclical reversal could threaten revenues, with implications for the fiscal balance and the current account. Tighter global financial conditions could adversely affect the economy through the exposure of the RERF. Given Kiribati’s high reliance on imported goods, commodity price shocks and exchange rate volatility could have an outsized impact on imports, inflation, and growth.

Authorities’ Views

10. The authorities broadly shared staff’s assessment of the economic outlook. They agreed that a growth moderation is to be expected and that the volatility of fishing revenue poses a significant risk. Any fluctuations in fishing revenue—either negative or positive—would have a significant impact on the fiscal position and the current account. Regarding external risks, they noted that they anticipate the RERF balance to reduce somewhat in reflection of the global equity market correction in late 2018. They also noted that, despite strong growth in recent years, large gaps in meeting basic needs remain.

Policy Discussions

11. Kiribati should leverage its recent gains to ensure inclusive, sustainable growth in the long run. The government has an ambitious 20-year development agenda—the Kiribati Vision 20 (KV20)—initiated in 2016. Public spending needs—driven primarily by the infrastructure gap and climate adaptation costs—are large. Implementing KV20 and meeting these needs requires further progress in fiscal and structural reforms, as well as securing support from development partners.

12. Priority should be given to three action areas: reinforcing the fiscal framework, creating an environment for a dynamic private sector, and enhancing governance.

A01ufig4

Domestic Recurrent Balance Worsened in Recent Years and the Deficit Projected to Remain Wide in the Baseline

(percent of GDP)

Citation: IMF Staff Country Reports 2019, 026; 10.5089/9781484396131.002.A001

Sources: IMF staff estimates.1/ Domestic recurrent balance is the overall balance minus fishing revenue and grants plus capital expenditures.
A01ufig5

Modest Current-spending-based Consolidation would Maintain the Net Financial Worth at a Safer Level

(in percent of GDP)

Citation: IMF Staff Country Reports 2019, 026; 10.5089/9781484396131.002.A001

Note: Domestic recurrent balance on left-hand-side axis, net financial worth on the right-hand-side axis.Sources: IMF staff calculations.
A01ufig6

Savings in an Illustrative Adjustment Scenario could be used to Prop up the RERF

(in percent of GDP, except for RERF real per capita in thousands of A$ in RHS)

Citation: IMF Staff Country Reports 2019, 026; 10.5089/9781484396131.002.A001

Note: Lighter columns show values in the adjustment scenario. NFW: net financial worth = RERF + cash reserves - public debt. RERF real pc: RERF balance per capita in 2006 A$.Sources: IMF staff calculations.

A. Reinforcing the Fiscal Framework

13. The authorities’ commitment to fiscal discipline should be reinforced by using the domestic recurrent balance as an operational target.

  • Focusing on the controllable portion of the budget by abstracting from volatile, exogenous components (fishing revenue and grants, plus their associated capital spending) would promote expenditure stability and medium-term planning. Indeed, the deterioration in 2016 and 2017 in this measure of the fiscal stance underscores the potentially unsustainable increase in subsidies and wages.

  • Instead, spending should be consistent with a “safe” level of net financial worth. Under an illustrative scenario where the government reduces the domestic recurrent deficit by ½ percent of GDP each year until 2028, the deficit would stabilize around 44 percent of GDP compared to 49 percent in the baseline.

  • Net financial worth would be maintained at 321 percent of GDP in 2030, providing an additional buffer over the 291 percent forecast in the baseline. That would be sufficient to roughly cover one year of climate change adaptation costs (estimated to gradually increase and reach 12 percent of GDP by 20404) and a sharp decline in fishing revenue (21 percent of GDP, corresponding to one standard deviation in the 2012–17 period), while keeping the RERF balance as a percent of GDP constant.

14. Strengthening the fiscal framework would help contain spending pressures. In the event of a surge in fishing revenue, the authorities should avoid issuing a supplementary budget, with the windfall being allocated only after evaluating alternatives in a comprehensive framework and considering medium-term sustainability. The objective should be to keep the controllable portion of the budget unchanged and only adjust insofar as permanent wealth increases. Short-run revenue shortfalls could be met by transfers from the cash reserve buffer. Withdrawals from the RERF should be governed by a rules-based, transparent mechanism that reflects social preferences on intergenerational redistribution and adjusts to structural changes in returns on assets and potential growth (see Annex III in the 2017 Article IV Staff Report).

RERF Balances would Stabilize Under an Illustrative Adjustment Scenario 1/

(percent of GDP unless otherwise noted)

article image

For illustrative purposes only. Assumes accumulation (in RERF and cash reserve accounts) of savings, which could instead be used to pay down debt.

Revenue excluding grants and fishing revenue minus current expenditure.

Balances of RERF, custodial, and cash accounts minus public debt.

Custodial and cash accounts.

15. The fiscal framework should more fully consider the toll climate change will take on Kiribati’s finances. The medium-term budget should include an explicit provision for climate change adaptation, up to 2 percent of GDP annually to cover the recurrent costs (including infrastructure damage repair). Longer-run plans should provide for further increase to reach 6 percent of GDP (the remaining half of annual costs (¶13) is assumed to be financed by development partners5). To ensure fiscal room for climate change adaptation, it is crucial to limit increases in public wages and copra subsidies—including by replacing them with targeted social transfers where necessary. Financing from multilateral platforms, such as the Green Climate Fund and the Adaptation Fund, should be pursued actively. In this context, the establishment of the Climate Finance Division—whose mission is to coordinate climate-change-related expenditures funded through the budget or by donors—is a welcome step forward. Adequate staff resources should be allocated to this division.

16. The medium-term fiscal planning challenge is compounded by the reliance on highly volatile fishing revenue, underscoring the usefulness of the domestic recurrent balance as an operational target. The current practice has been to err on the conservative side and forecast fishing revenue to remain constant in nominal terms roughly at its 2014 level.6 The authorities should explore ways to improve fishing revenue projections, including through PFTAC-assisted information sharing with other countries in the region.

17. The cash management strategy should be formalized and better coordinated with the investment strategy. Foregone interest on large cash reserves does not fit well with prudent public financial management (PFM) objectives. A lower level of cash reserves in the non-interest-bearing account would maximize returns to public assets while still ensuring healthy functioning of the banking system. For the former, the government could take the governance mechanism for the RERF as a guide and establish a cash management committee that sets clear benchmarks in coordination with the investment unit at the Ministry of Finance. For the latter, the authorities should monitor and take all risk factors (credit, liquidity, and market) into account when assessing the financial stability implications of their cash management strategy—which requires capacity development.

Authorities’ Views

18. There was broad agreement on the need to maintain a prudent fiscal position. The strategy laid out for the 2019 budget aims to ensure that top priorities are met in a sustainable way. The strategy makes three pledges: balanced budget, no withdrawal from the RERF, and no new debt. These pledges, taken together with conservative projections on fishing license fees, imply that expenditures would need to be kept within the country’s means. While the authorities noted that the domestic recurrent balance could serve as a useful analytical tool, they saw a balanced overall budget target as easier to communicate. They recognized that it is desirable to limit the need for supplementary budgets and to commit to meeting shortfalls with cash reserve buffers without recourse to the RERF. To this end, the government is working on setting a new strategy for the RERF, likely featuring a commitment to preserve the real value of the fund and to limit withdrawals for projects that benefit both current and future generations.

B. Creating an Environment for a Dynamic Private Sector

19. A more dynamic private sector would help achieve the goal of inclusive prosperity. Specific policies to boost the private sector include:

  • Further strengthening the commercial mandate of the SOEs and developing a medium-term plan for operationally and financially sustainable delivery of electricity, water, and sanitation services;

  • Continuing divestment and outsourcing of SOE activities, to help improve efficiency and strengthen public finances;

  • Further improvement in connectivity through infrastructure investment in air transportation and shipping services;

  • Building human capital by enhancing training opportunities and creating employment possibilities through improved natural resource utilization and diversification of the economy;

  • Facilitating private sector access to credit by improving land registration and dispute resolution, while strengthening financial supervision of public financial institutions.

20. The SOE reform momentum should continue. The reform started slowly but accelerated in 2017. The authorities made progress in consolidating and downsizing the copra-linked SOEs and completed the sale of the telecom SOE. An overall strategy for setting the SOEs on a more commercial and sustainable footing should be articulated. This should include recalibration of tariffs in water and sanitation services (also considering the environmental impact of water usage), while protecting the most vulnerable. Formal guidelines on dividends and retention of earnings for self-funding capital expenditures should be established. Efforts to improve the timeliness and quality of SOE financial reporting should continue, including those to transform the audited statements into a database and maintain that database for ongoing monitoring and analyses. Past staff advice to phase out SOE exemptions from the VAT should be implemented without further delay to level the playing field.

21. The outer islands development program should be better designed. The 2017 supplementary budget allocated 13 percent of GDP to develop the periphery’s infrastructure without mention of specific projects. Some of the funds have been allocated to improvement of air transportation infrastructure, yet disbursement of funds has been delayed due to capacity constraints and logistical challenges. Also last year, the doubling of the copra subsidy further distorted incentives: virgin coconut oil (which Kiribati could export competitively without a subsidy) is now not as remunerative for households as copra. Current export prices and projected yields paint a picture where the distortion of incentives is leading to overharvesting and potentially threatening the sustainability of this important natural resource. The authorities should consider alternatives to the copra subsidy scheme in providing support to outer-island residents (for example, recalibrating other social transfer programs).

22. Opportunities for better utilizing natural resources and diversifying the economy should be explored actively. The conservation measures undertaken by Kiribati and its neighbors under the Parties to the Nauru Agreement (PNA) to promote sustainable fisheries have benefits but also carry costs. Further, there is a premium on information sharing and cooperation when it comes to combating illegal fishing that can hurt all countries in the region. An equitable regional distribution of the benefits and costs and compliance with international rules and regulations are needed to preserve the spirit of the PNA (Box 2). Transforming the economy to foster growth in the services sector (particularly in infrastructure maintenance, renewable energy, and tourism) could open up diversification opportunities and increase resilience (Box 3). Enhancing training opportunities, including through participation in overseas work schemes, would complement the employment possibilities generated through better natural resource utilization and diversification.

23. Financial deepening needs to be implemented in a sustainable way. Facilitating private sector access to credit would be best achieved by improving land access procedures and dispute resolution mechanisms (to enhance property rights and enable lending against collateral). Building on the donor-funded investment in ICT infrastructure, mobile connectivity and mobile banking should be promoted more, as experience in the region has demonstrated their job-creation and financial-deepening benefits. Potential to develop credit unions, which tend to be better at understanding the information needed for lending to small borrowers, could also be explored. In line with the PFTAC recommendation, a comprehensive regulatory and supervisory framework that provides the necessary legal powers to authorize and supervise banks with a complete suite of prudential standards is needed.7 Against this background, improving financial sector statistics (for example, compiling a consolidated banking system balance sheet) is a priority. The authorities should strengthen the institutional capacity to report these statistics in a timely manner to enable effective surveillance and policy formulation.

24. Supervision of public financial institutions should be strengthened. The Development Bank of Kiribati (DBK) and the Kiribati Provident Fund (KPF—a national compulsory savings scheme) play an important role for access to finance. Steps should be taken to ensure that the DBK remains adequately capitalized, including a full assessment of its current capital buffers against the legacy nonperforming loans. Further, its risk monitoring and liquidity management ability should be improved. Progress has been made to enhance the long-run sustainability of the KPF by closing the accumulated deficit from 24 percent of total net assets to 4 percent. However, its investment strategy continues to feature relatively ambitious promised returns and active fund managers. A more prudent, passive strategy would not only reduce management costs but also mitigate the fiscal risk posed to the government. More generally, consideration should be given to explicitly task the investment unit at the Ministry of Finance to oversee the RERF, the KPF, and the cash reserves with a unified lens and to devise a comprehensive strategy to manage the country’s public financial assets.

A01ufig7

Improvement in KPF Balance and Asset Growth Leveled off

Citation: IMF Staff Country Reports 2019, 026; 10.5089/9781484396131.002.A001

Source: Country authorities; and IMF staff calculations.

Authorities’ Views

25. The authorities recognized many of the points raised by staff as areas where continued action is planned, but pointed out that capacity and political constraints sometimes slow progress. There is no specific timeline to phase out the VAT exemption for the SOEs, yet there is recognition that it is important to level the playing field. In certain areas, the cost of public service delivery is so high that it is not realistic to imagine that the SOE subsidies would be fully phased out. The copra subsidy has served an important objective to ensure that households in the outer islands are able to meet basic needs (and reduce incentives for migration to Tarawa, given overcrowding problems) and, more recently, share the wealth from fishing revenue. While there are many issues with the program (misaligned incentives, overharvesting, fraud), it is politically difficult to discuss alternatives. Financial sector development is important, and a regulatory and supervisory framework would help foster competition—a priority for the authorities. While they agreed that credit unions could play some role with household credit and small business loans, these institutions would not be able to fulfill the other, payment-related services that commercial banks can provide.

C. Enhancing Governance

26. Several initiatives have been launched recently as part of a national anticorruption strategy. Kiribati ratified the UN Convention against Corruption in 2013. A regional summit on anti-corruption is planned to be held in Kiribati in June 2019. Recent initiatives to prevent corruption focus on:

  • Implementation of measures recommended by staff and the donors to strengthen PFM;

  • Fostering the integrity and independence of institutions whose mandate is to promote good governance and eliminate corruption (including through development of an anti-corruption code of conduct and its integration with the Public Service Act);

  • Strengthening strategic partnerships and institutionalizing anti-corruption and good governance principles in the public service and education systems (including through establishment of an anti-corruption committee with an oversight role to be executed in cooperation with the appropriate agencies and in engagement with civil society).

27. Addressing governance deficiencies in budget outcomes and institutions would help improve efficiency, reduce vulnerabilities to corruption, and catalyze donor support. Past consultations, TA missions, and the authorities’ self-assessment have consistently noted the main areas of weakness as spending and revenue outcomes, procurement, fiscal transparency, and PFM controls. Against the backdrop of an ambitious public investment agenda, it is crucial to strengthen the fiscal framework so that the most beneficial projects are selected, execution is not disrupted by misaligned incentives, fiscal sustainability is ensured, and the best financing terms are obtained.

A01ufig8

Authorities’ Self-assesment Points to Weakness in all PFM Pillars, and Particularly External Scrutiny and Transparency

(Grade, 11 highest and 0 lowest)

Citation: IMF Staff Country Reports 2019, 026; 10.5089/9781484396131.002.A001

Sources: PEFA Self Assessment, 2017; IMF staff calculations.

28. A key policy challenge is to meet public investment needs in the absence of comprehensive identification of the upcoming infrastructure priorities and financing needs. Public investment should be prioritized based on expected economic and social returns. Consideration should be given to making implementation of the PIMA recommendations—which focus on procurement, project selection, and maintenance—a prerequisite for approving a surge in public investment projects. A case in point is the planned expansion of AKL operations, which could bring important benefits by improving connectivity but pose significant fiscal risks (Box 1).

A01ufig9

Kiribati Scores Low on Project Selection, Procurement, Maintenance of Public Investment, and Monitoring of Assets

Citation: IMF Staff Country Reports 2019, 026; 10.5089/9781484396131.002.A001

29. Transparency on fisheries management needs to be improved. The authorities have published an annual report for the purpose of monitoring fishing license fees since 2014. Yet, the report lacks crucial information such as how many fishing days are allocated to Kiribati and how these days are sold to domestic and foreign vessels. The report would greatly benefit from including detailed information, both to facilitate information sharing with stakeholders that can use such information to improve the accuracy of their forecasts and to boost public trust in the sound management of the country’s key economic resource.

30. Economic governance would also be enhanced by better business regulations. Regulatory practices associated with getting construction permits and registering property should be streamlined. Trade facilitation efforts should primarily focus on information availability (establishing a national customs website) and formalities (simplification and harmonization of documents as well as automation and streamlining of procedures). The regulatory rulemaking process should be made more transparent and consultative.

31. Filling in data and information gaps would allow for a more comprehensive assessment and help track progress. For example, survey-based fiscal transparency indicators are not available. More generally, data provision—while broadly adequate for surveillance—has shortcomings that impair policymaking. The authorities should strengthen the institutional capacity to report accurate and timely statistics.

A01ufig10

Similar to Infrastructure and Credit Gaps, Regulations for Registration and Permits make doing Business Difficult

(Percentile of rank, higher is better)

Citation: IMF Staff Country Reports 2019, 026; 10.5089/9781484396131.002.A001

Note: There is uncertainty around point estimates.Sources: World Bank, Doing Business (2018).
A01ufig11

Lack of Information Availability and Complexity of Formalities Hinder Trade Facilitation

(Farthest from center = best performance that can be achieved)

Citation: IMF Staff Country Reports 2019, 026; 10.5089/9781484396131.002.A001

Source: OECD TradeFaciliation Indicators.

Authorities’ Views

32. The authorities agreed that improving the PFM framework and enhancing business regulations would help boost economic performance. They noted that the PIMA has not been disseminated widely or discussed internally yet, but acknowledged that staff’s summary of the findings resonate with their self-assessment. A procurement unit has been established recently and the authorities are seeking TA to implement additional reforms in this area. They concurred that business regulations can be improved and transparency on fisheries is important. They appreciated the recognition that Kiribati takes anti-corruption efforts seriously. On data gaps, the authorities underlined that they are already stretched in their capacity to develop the main macroeconomic indicators and would appreciate assistance from international institutions and donors in compiling the needed statistics as well as better coordination across international agencies to reduce the burden on their limited resources from duplication of data requests.

Staff Appraisal

33. Kiribati has made considerable economic progress in the last few years and the near-term outlook remains favorable. Growth has exceeded historical norms, thanks to higher public spending supported by record-high fishing revenues and donor-financed infrastructure investment. Fiscal and structural reforms, most notably in SOEs, have advanced. The government’s net financial worth rose to four times the GDP.

34. Risks to the outlook are substantial and skewed to the downside. A cyclical reversal of favorable weather conditions could threaten fishing revenue, with implications for the fiscal balance and the current account. Tighter global financial conditions could adversely affect the economy through the exposure of the RERF. Commodity price shocks and exchange rate volatility could have an outsized impact on imports, inflation, and growth. Kiribati remains at high risk of debt distress, given volatile fishing revenue and considerable spending needs.

35. The country has a historic opportunity to leverage its recent gains to ensure inclusive growth in the long run. Implementing KV20 and meeting the significant public investment needs in a sustainable way requires further progress in fiscal and structural reforms, as well as securing support from development partners.

36. Policies should:

  • Reinforce the fiscal framework to maintain buffers and to meet public spending needs in a sustainable way;

  • Create an environment for a dynamic private sector, with continued reform momentum, well-selected infrastructure projects, human capital development, and prudent financial deepening;

  • Enhance governance to improve outcomes, reduce vulnerabilities, and catalyze donor support.

37. The authorities’ commitment to fiscal discipline could usefully be reinforced by:

  • Focusing on the controllable portion of the budget to promote expenditure stability and medium-term planning;

  • Limiting the increase in the public wage bill and in copra subsidies, and by replacing them with targeted social transfers where necessary;

  • Avoiding a supplementary budget in the event of a surge in fishing revenue, and instead evaluating projects in a comprehensive medium-term framework and adjusting the controllable portion of the budget insofar as permanent wealth increases, while meeting any revenue shortfall by transfers from the cash reserve buffer;

  • Adopting a rules-based, transparent mechanism to govern withdrawals from the RERF, that reflects social preferences on intergenerational redistribution and adjusts to structural changes in returns on assets and potential growth;

  • Incorporating the toll climate change will take on Kiribati’s finances through an explicit provision for climate change adaptation in the medium-term budget.

38. Specific policies to boost the private sector include:

  • Further strengthening the commercial mandate of the SOEs and developing a medium-term plan for sustainable delivery of electricity, water, and sanitation services;

  • Continuing divestment and outsourcing of SOE activities, to help improve efficiency and strengthen public finances;

  • Further improvement in connectivity through infrastructure investment in air transportation and shipping services, and building on the donor-funded investment in ICT infrastructure;

  • Building human capital by enhancing training opportunities and creating employment possibilities through improved natural resource utilization and diversification of the economy into infrastructure maintenance, renewable energy, and tourism;

  • Facilitating private sector access to credit by improving land registration and dispute resolution, while strengthening financial supervision and risk management in public financial institutions.

39. Staff supports the authorities’ anti-corruption initiatives and calls for further action to improve governance by:

  • Prioritizing public investment projects based on expected socio-economic returns, and making implementation of the PIMA recommendations a prerequisite for approving a surge in spending;

  • Improving transparency in the fisheries report through coverage of crucial information such as fishing day allocations;

  • Streamlining regulatory practices, improving trade information availability, and making the regulatory rulemaking process more transparent and consultative.

40. It is recommended that the next Article IV consultation takes place on the standard 12-month cycle.

Air Connectivity: Risky Business

Air connectivity can be one of the keys to unlocking a country’s economic potential. It can boost business development by enabling access to a wider marketplace. It can also spur tourism, vital to many countries with narrow production bases. In countries where there are few viable alternatives to air travel (for example, islands), air connectivity is even more important for growth.

Kiribati’s air connectivity is very limited. AKL is an SOE and its current operations are primarily domestic, notwithstanding service to Honiara in partnership with Solomon Airways and short-haul international service to Tuvalu. Fiji Airways operates flights to Tarawa and Kiritimati.

AKL plans to expand its operations, in line with the government’s strategy to reap benefits of improved air connectivity. In 2017, a Dash 8 aircraft was purchased by the government for the Gilberts and Tuvalu route, costing roughly 3 percent of GDP. In October 2018, Cabinet approved the purchase of two brand-new Embraer E190-E2 jets for delivery in December 2019 and March 2020. These will operate flights to and from Brisbane, Fiji, and Kiritimati. The funds for the down payment (8½ percent of GDP) have been appropriated in supplementary budgets. Capex funding over 2019–20 is likely to reach 20 percent of GDP per year.

Currently, AKL is not profitable. Despite subsidies, AKL has been incurring losses (amounting to A$3 million over 2014–17). It reported positive equity of A$10.5 million at end-2017, but only through aircraft provided by the government being accounted as equity.

Operating losses may grow. The new routes involve an established competitor (Fiji Airways), and the E190-E2 model is a high-value aircraft that may have low utilization in the proposed routes. AKL will need to obtain the approvals necessary for operating the proposed routes. Timely completion of this depends not only on AKL’s management capabilities but also on domestic aviation regulators’ capacity to establish and enforce rules in line with international standards (for example, on safety and maintenance).

Close monitoring of AKL will be essential as the fiscal risk is very substantial. The government has committed to provide the necessary support for AKL to establish its own international operations. Staff estimates annual fiscal costs to be around 1 percent of GDP, if none of the downside risks materialize. There is great uncertainty surrounding this estimate.

Fisheries Management: Risks and Actions

Fisheries are Kiribati’s main natural resource and economic driver. Historically, fishing revenue was low and highly volatile, but the implementation of the Vessel Day Scheme (VDS) under the Parties to Nauru Agreement (PNA) in 2012—which sets a maximum number of annual fishing vessel days and a minimum benchmark daily price per vessel—allowed Kiribati to more effectively tap its fisheries. Fishing revenue has been outperforming anc now provides about three-quarters of total domestic fiscal revenue. In 2014 alone, Kiribati waters supplied one quarter of the global tuna catch.

High concentration of revenue poses significant risks. Fish stocks can fluctuate wildly, due to weather patterns and water temperatures. This inherent volatility renders projecting catch volumes difficult and hinders efforts to develop a robust medium-term fiscal strategy. Another challenge in developing a sound revenue strategy is the tuna price, which is driven by supply and demand forces in a globally competitive market. Moreover, because of overfishing and illegal activity, fishing operators can face diminishing marginal catches, despite favorable weather and water conditions.

VDS agreements can be unstable.

  • Since not all risk is pooled, nations with narrow-based economies—such as Kiribati—are still exposed to the sudden large fluctuations from El Nino. This could create incentives to re-negotiate, but reaching consensus among PNA members to change the benchmarks may be difficult since some members tend to benefit from the very weather events from which the other members suffer. Kiribati’s VDS has never been tested in low-yield years, which could pose a challenge when the El Nino conditions reverse.

  • Enforcement of sustainable fishing practices benefit all in the long run, but costs can sometimes be distributed unevenly, or there may be incentives to deviate from the collaborative equilibrium if short-run rewards—in the form of temporarily higher catch volumes—for doing so are high.

  • Climate change is projected to lead to a general shift of tuna biomass eastward until 2050—initially benefiting Kiribati—followed by a marked decline between 2050 and 2100. Such shifts may also put pressures on VDS agreements.

A01ufig12

Fishing Revenue has Skyrocketed Under the VDS

Citation: IMF Staff Country Reports 2019, 026; 10.5089/9781484396131.002.A001

Sources: Country authorities; IMF staff calculations.

Maximizing the returns from Kiribati’s fisheries in a sustainable way is a top priority. A first step could be private-sector or SOE-led expansion of the current fishing fleet to bolster near-shore and off-shore fishing by allocating vessels to the outer islands. The viability of alternative fishing activities—such as transshipment, aquaculture, and fish farming—could also be explored. The government could survey the development of transshipment and processing facilities in the periphery, such as a transshipment hub in Kiritimati that would leverage the island’s location and encourage private sector engagement. In the same vein, further synergies linked to the islands’ location or resources, such as the excess supply of salt found on Kiritimati, could be explored in collaboration with KFL (a joint venture of the government with a Chinese and Fijian company).

Domestically-oriented efforts should be accompanied with those on the international front. Implementation of the Fisheries Amendment Act of 2017—which defines illegal, unreported, and unregulated (IUU) fishing and raises the penalty for serious offenses—should proceed swiftly. This would avoid being labeled a non-cooperating country in the global fight against IUU fishing and losing access to international markets in the short run. It would also improve the viability of Kiribati’s fisheries in the longer run. The authorities could also invest in negotiating a side-payment system to complement the VDS for broader risk sharing or in enforcing a quota system on volumes of fish caught as an additional mechanism for sustainability.

Economic Diversification: Possible Directions

Kiribati’s export structure is one of the most concentrated in the world. In the latest available data from UN COMTRADE, fish and coconut products make up almost the entirety of Kiribati’s exports.1 In terms of destination, Thailand alone accounted for 70 percent of exports. The degree of concentration in Kiribati’s goods exports has also been higher than its peers.

Incorporating diversification objectives to the overall development strategy could provide substantial benefits. Export diversification can guard against sharp terms-of-trade shocks and, hence, cushion against excessive growth volatility. This is especially important in economies characterized by a high level of trade openness—such as Kiribati.

New product lines, or quality upgrades, and new trade partners would create opportunities for a more diversified export base. The quality of fish exports is low (with an average index value of 0.52 from 1990 to 2010, down from 0.67 in the 1970s and 1980s).2 Investing in sustainable fishing methods and in state-of-the-art processing facilities could help improve quality.

A01ufig14

Concentration of Goods Exports

(Herfindahl-Hirschman index at the SITC 3-digit level, 3-year moving average)

Citation: IMF Staff Country Reports 2019, 026; 10.5089/9781484396131.002.A001

Sources: UNCTAD; IMF staff calculations.

Expanding the product lines into higher-value-added categories would complement this upgradation efforts. An underappreciated area of strength could be copra and other coconut products such as coconut oil, which score relatively high in the quality index (0.98 and 0.87, respectively). Further leveraging Kiribati’s comparative edge on this front could involve launching a quality-focused marketing campaign. European and Latin American markets could also be explored further.

On the services side, tourism can be developed to secure a robust share in emerging niche markets. Offering activities closely linked to the atolls’ natural and cultural history could be the key to attracting highend travelers seeking unique experiences. KV20 takes steps in this direction, through investment in eco-tourism, training opportunities for service providers in the hospitality sector with a focus on high-end travelers, and improved infrastructure and connectivity. Further options could involve targeted campaigns for the Phoenix Islands Protected Area (PIPA) and facilities to enable sports fishing and other water activities.

Renewable energy could be another niche to explore. Heavy reliance on imported fossil fuels is not only costly but also exposes the country to abrupt changes in external factors. Innovative technologies that can leverage Kiribati’s natural resources to meet its energy needs would support growth and help increase resilience. For instance, ocean thermal energy conversion (OTEC) plants could generate power and supply cold ocean water for use in refrigeration or aquaculture as well as desalinated water for drinking. The authorities, in cooperation with the Korea Research Institute of Ships and Ocean Engineering, plan to deploy a plant in 2019-21. This will be one of the first grid-connected OTEC systems in the world, creating a potential to export to the onshore power grids.

1 There is a large discrepancy between the exports data reported by Kiribati and the mirror data reported by its trading partners. This is because the methods used by countries somewhat differ on treatment of fish catch. In this case the data we use includes fishing license fees for reconciliation with partner country data. This captures commodity flow and the source of external revenues for Kiribati better.2 Based on the export quality index developed by the IMF for 4-digit products “Fish, fresh, chilled or frozen” and “Fish, salted, dried or smoked”. An index value of 1 corresponds to the 90th percentile of all exporters of a given commodity. The database is available for download at https://www.imf.org/external/np/res/dfidimf/diversification.htm.
Figure 1.
Figure 1.

Cross-Country Setting: Economic Fundamentals

Citation: IMF Staff Country Reports 2019, 026; 10.5089/9781484396131.002.A001

Figure 2.
Figure 2.

Cross-Country Setting: Structural Indicators

Citation: IMF Staff Country Reports 2019, 026; 10.5089/9781484396131.002.A001

Figure 3.
Figure 3.

Recent Developments

Citation: IMF Staff Country Reports 2019, 026; 10.5089/9781484396131.002.A001

Table 1.

Kiribati: Selected Economic Indicators, 2013–19

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Sources: Data provided by the Kiribati authorities; and Fund staff estimates and projections.

Domestic recurrent balance excludes fishing revenue, grants, and capital expenditure.

Overall balance in the table is different from official budget because loans are classified as financing.

Cash reserve buffer includes the government’s custodial account and cash account.

Table 2.

Kiribati: Medium-Term Projections, 2015–23

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Sources: Data provided by the Kiribati authorities; and Fund staff estimates and projections.

Domestic recurrent balance excludes fishing revenue, grants, and capital expenditure.

Balances of RERF and cash reserves minus public debt.

In this table, it is assumed that Kiribati will continue to benefit from its grants-only status. This assumption is consistent with MDB’s grant decision rules given the DSA rating and even assuming the realization of such grants and their impact on the DSA. On the other hand, in the LIC-DSA, for World Bank (IDA) and other MDBs, regular credit terms on all lending is assumed for all years in the projection period for which grant finance has not already been committed. This is because the DSA serves to test a country’s capacity to take on WB and ADB financing on credit terms.

Table 3a.

Kiribati: Summary of Government Operations, 2015–23

(in millions of Australian dollars)

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Sources: Data provided by the Kiribati authorities; and staff estimates and projections.

Projections for the current expenditure for 2017 included the supplementary budget.

Development expenditure equals grants plus loans for development projects.

Domestic recurrent balance excludes fishing revenue, grants, and capital expenditure.

Overall balance in the table is different from official budget because loans are classified as financing.

The custodial account is government’s fund managed by State Street.

The cash account is the government’s deposit account at ANZ.

Balances of RERF, custodial, and cash accounts minus public debt.

Cash reserve buffer includes the custodial account and the cash account.

In this table, it is assumed that Kiribati will continue to benefit from its grants-only status. This assumption is consistent with MDB’s grant decision rules given the DSA rating and even assuming the realization of such grants and their impact on the DSA. On the other hand, in LIC- DSA, for World Bank (IDA) and other MDBs, regular credit terms on all lending is assumed for all years in the projection period for which grant finance has not already been committed. This is because the DSA serves to test a country’s capacity to take on WB and ADB financing on credit terms.

Table 3b.

Kiribati: Summary of Government Operations, 2015–23

(in percent of GDP)

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Sources: Data provided by the Kiribati authorities; and staff estimates and projections.

Projections for the current expenditure for 2017 included the supplementary budget.

Development expenditure equals grants plus loans for development projects.

Domestic recurrent balance excludes fishing revenue, grants, and capital expenditure.

Overall balance in the table is different from official budget because loans are classified as financing.

The custodial account is government’s fund managed by State Street.

The cash account is the government’s deposit account at ANZ.

Balances of RERF, custodial, and cash accounts minus public debt.

Cash reserve buffer includes the custodial account and the cash account.

In this table, it is assumed that Kiribati will continue to benefit from its grants-only status. This assumption is consistent with MDB’s grant decision rules given the DSA rating and even assuming the realization of such grants and their impact on the DSA. On the other hand, in LIC- DSA, for World Bank (IDA) and other MDBs, regular credit terms on all lending is assumed for all years in the projection period for which grant finance has not already been committed. This is because the DSA serves to test a country’s capacity to take on WB and ADB financing on credit terms.

Table 4.

Kiribati: Balance of Payments, 2015–23

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Sources: Data provided by the Kiribati authorities; and Fund staff estimates and projections.

Includes fishing license fees, which would be shown as current transfers under conventional international guidelines.

Appendix I. External Sector Assessment

Kiribati’s external sector developments are driven by exogenous, volatile factors. Current account inflows are dominated by fishing license fees, RERF investment income, seafarers’ remittances, and donor contributions. The outflows largely relate to infrastructure investment, financed by project grants and loans. Volatile flows, data limitations, and other characteristics make standard approaches for external sector assessment (such as the EBA current account and real effective exchange rate models) less suitable or unfeasible.

Notwithstanding the caveats, staff assesses the underlying external position in 2017 to be broadly in line with the level implied by medium-term fundamentals and desirable policies.

  • The real effective exchange rate (REER) has been stable within the bands implied by historical averages. That said, given the narrow export base, the real exchange rate has limited impact on the current account.

  • The EBA external sustainability (ES) approach suggests that the projected medium-term current account balance is in line with the level that would stabilize the net international investment position (NIIP) as a share of GDP at its estimated 2017 level.

  • Taking all of these factors into account and giving the most weight to the ES approach, staff assesses the underlying external position to be broadly in line with the level implied by medium-term fundamentals and desirable policies. However, there is substantial uncertainty around this assessment, given the idiosyncratic features of the Kiribati economy and data quality.

A01ufig15

Real Effective Exchange Rate

(Index, 2010 = 100)

Citation: IMF Staff Country Reports 2019, 026; 10.5089/9781484396131.002.A001

Sources: IMF International Financial Statistics; staff calculations.
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Removing the long-standing structural impediments would help improve competitiveness and ensure external sustainability. While the large size of the RERF relative to external debt limits immediate risks, the RERF could be significantly depleted over the longer run in downside scenarios to fishing revenue. Closing the infrastructure gap and addressing governance weaknesses would expand the country’s export capacity while increasing efficiency. In this context, securing donor grants for development spending is critical and borrowing through concessional loans should be closely monitored.

The use of Australian dollar as the legal tender remains appropriate. It provides a strong nominal anchor given close trade and financial linkages with Australia (a high share of RERF assets is invested in Australian markets) and limited capacity to run an independent monetary institution.

Appendix II. Risk Assessment Matrix1/

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Appendix III. Main Recommendations of the 2017 Article IV Consultation

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Appendix IV. SDG and Strategic Surveillance Matrix

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Source: Kiribati Development Plan 2016-19; and Kiribati Voluntary National Review and Kiribati Development Plan Mid-Term Review July 2018.