Abstract
2018 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for the Republic of Palau
Palau is a very small island state in the North Pacific with an exceptional marine environment. The government has set aside around 80 percent of the country’s maritime territory – roughly the size of France – as a marine sanctuary. Tourism is the main industry. A spike in tourist numbers in 2015 put significant strain on public infrastructure and raised environmental concerns. In response, the authorities acted to reduce the number of arrivals to levels consistent with their goal of preserving the fragile environment and safeguarding Palau’s reputation as a pristine tourist destination. They are also increasing infrastructure investment to support private sector development.
The decline in tourist arrivals meant the economy contracted by 3.7 percent in 2017. The Palauan authorities agree with staff that growth picked up in 2018 and will strengthen to 2 percent in 2019 and into the medium term. Growth will be supported by public infrastructure projects and the construction of already-approved luxury hotel investments. Palau also recently completed a fiber-optic connectivity project, bringing high-speed broadband to the country. This will create new opportunities for Palauans and aid the delivery of more efficient health and education services.
Palau is vulnerable to natural disasters and external shocks. In the absence of monetary and exchange rate policies, the authorities agree that risk mitigation is limited to fiscal and structural policies. They have been building fiscal buffers and have secured a $15 million facility with the Asian Development Bank that provides a predictable, quick-disbursing source of financing for response, recovery, and reconstruction activities following a natural disaster. Palau is working to diversify its tourism source markets as well as the tourism products it offers, while promoting inclusive growth through tourism product development in rural communities.
Fiscal sustainability
The Palauan authorities are grateful for continued financial assistance from the international community. In particular, the United States provides support through the Compact of Free Association and the recently-approved $123 million in Compact grants will help finance much-needed infrastructure investments. Compact grants are due to expire in 2024 and the authorities are working on a medium-term strategy to ensure fiscal self-sufficiency. Palau has seen a fiscal surplus since 2011 – even in 2017 when the economy slowed. The authorities have saved some of these surpluses in a General Fund Reserve, which currently stands at 5 percent of GDP in 2018. They plan to continue building this into a fully-fledged stabilization fund to help cushion against economic shocks that impact domestic revenues.
Fiscal surpluses have been aided by revenue mobilization measures, including an environmental fee levied on inbound passengers. With technical support from PFTAC, a comprehensive tax reform bill has been prepared and is currently under consideration by the Congress. This proposed Palau Goods and Services Tax (PGST) is a much more efficient tax system that will result in strong revenue growth over the long term.
Potential contingent liability risks from the Civil Service Pension Fund (CSPF) and the SOEs have been acknowledged. An actuarial study will guide the plans to support the CSPF’s long-term sustainability. The authorities also want to make SOEs, particularly the Palau Public Utilities Corporation, self-sustaining. They intend to phase out subsidies when service quality is upgraded, and social protection measures have been developed to support the low-income village residents who are likely to be affected by subsidy removal.
Financial sector stability
The presence of three U.S. FDIC-insured banks is the back-bone of the banking system in Palau, holding 91 percent of loans and 99 percent of deposits in 2017. The government also owns the National Development Bank, which is taking a more active role in providing credit to smaller borrowers in Palau. Banks are well-capitalized and liquid, with a low proportion of non-performing loans. With regards to supervision, the Financial Institutions Commission continues to enhance its capabilities through technical assistance and training from the IMF and US-FDIC and is broadening supervision and regulation to non-bank institutions. The Financial Intelligence Unit is making efforts to improve the AML/CFT regime.
While several cryptocurrency investors have approached Palau, the authorities recognize the risks and uncertainties around cryptocurrencies and do not plan to entertain any proposals. The authorities have asked the IMF and other international institutions to be proactive in their outreach and to raise awareness of the potential risks and benefits of blockchain technology more generally.
Growth and private sector development
Development in Palau will continue to be guided by the Palau Responsible Tourism Policy Framework, which aims to make Palau a high-value tourism destination, targeting high-spending visitors over quantity. This will help safeguard Palau’s unique natural assets and ensure a sustainable and resilient income stream for decades to come. The authorities have engaged with a Japanese company in a PPP to renovate, expand and manage Palau’s international airport. Renewable Energy Investment plans will also help reduce energy costs for businesses and consumers, and assist Palau to meet its Paris Agreement pledge of increasing the share of renewable power to 45 percent by 2025. The authorities and development partners are ensuring that all new infrastructure projects are resilient to natural disasters and climate change.
Palau continues to experience “brain drain”. In response, the President has submitted a bill to the Senate which would gradually raise the minimum wage from $3.50 to $8.50 per hour over the next 10 years. While staff recommends against this policy, the authorities are convinced that it is necessary to attract and retain Palauans and enhance labor force productivity given the more attractive minimum wage levels in neighboring islands.
The Palauan authorities thank the mission Chief and her team for the productive engagement and quality policy discussions, and thank the IMF for the continued support through provision of technical assistance and policy advice.