Vanuatu: 2019 Article IV Consultation—Press Release; Staff Report; and Statement by the Executive Director for Vanuatu
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International Monetary Fund. Asia and Pacific Dept
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Publication Date:
13 Jun 2019
eISBN:
9781498319485
ISBN:
9781498319485
Language:
English
Keywords:
ISCR; CR; authority; Vanuatu; exchange rate; debt; emergency fund; improvement Project; road reconstruction Project; Natural disasters; Tourism; Infrastructure; Anti-money laundering and combating the financing of terrorism (AML/CFT)
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2019 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Vanuatu

Abstract

2019 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Vanuatu

Background

1. Vanuatu is a small island developing state and low-income country. Its income per capita is US$3356, with the economy dominated by tourism, construction, and agriculture. In the aftermath of the GFC (2010–14), real GDP growth averaged 1.8 percent per year. Following 2015’s devastating Cyclone Pam, growth rebounded to almost 4 percent on average, backed by substantial public investment. The recovery phase has seen strong support by development partners through grants, concessional lending, and technical assistance.1

uA01fig01

GDP per Capita, 2017

(In U.S dollars)

Citation: IMF Staff Country Reports 2019, 162; 10.5089/9781498319485.002.A001

Sources: Country authorities; and IMF staff calculations
uA01fig02

Real GDP Growth, 2010–18

(In percent year-on-year)

Citation: IMF Staff Country Reports 2019, 162; 10.5089/9781498319485.002.A001

Sources: Authorities’ and IMF staff estimates.

2. Vanuatu is the world’s most at-risk country for natural disasters, as measured by the UN World Risk Index.2 Cyclone Pam affected more than 70 percent of the population and required extensive development partner support, including US$23.8 million from the IMF’s RCF and RFI. Vanuatu also faced volcanic eruptions on the islands of Ambae and Ambrym in 2018. While Vanuatu has adopted disaster planning, including the National Disaster Management Office (NDMO), funding and staffing shortages remain.

3. The authorities have been improving governance and encouraging growth. Under the Vanuatu Infrastructure Strategic Investment Plan 2015–24, they have been developing urban and rural areas, improving living standards and community services. They have also been improving government services, administration and legal and regulatory frameworks. Development partners have provided vital financial support for infrastructure and technical assistance towards better governance.

Recent Developments, Outlook and Risks

A. Recent Developments

4. Real GDP growth was strong in 2017 at 4.4 percent but slowed to 3.2 percent in 2018. Construction was the main driver, sustained by development-partner-financed infrastructure projects, even with delays in completion. Agriculture was disrupted by a stronger cyclone season, the volcanic eruptions, and weaker prices for its agricultural exports. Tourism receipts grew 4.3 percent, the strongest since Cyclone Pam.

Major Development-Partner-Financed Infrastructure Projects 2013–19

article image
Source: Vanuatu authorities. Notes: All loans are concessional; AUS is Australia, JPN is Japan, NZL is New Zealand, EIF is the Enhanced Integrated Framework GREEN designates a post-cyclone-Pam reconstruction project If no “completed” date is indicated, the project is ongoing as of March, 2019.

5. Windfall revenues led to a strong fiscal position in 2018. The projected 4.8 percent of GDP surplus reverses the 0.9 percent of GDP deficit from 2017. The surplus, resulting from an additional 5.9 billion vatu from the economic citizenship programs (ECPs), 3 was used for unexpected expenses (Ambae disaster relief, and the mandated restoration of public benefit cuts) and early debt repayments (about 3.2 percent of GDP).

6. The 2018 external sector position is assessed to have been stronger compared with fundamentals and desirable policy settings (Annex II). The current account surplus stood at 3.5 percent of GDP, driven by surprisingly strong revenue collection from ECPs and significant growth in remittances from seasonal worker programs in Australia and New Zealand. Staff estimates a current account gap of 6.7 percent of GDP and a REER gap of -18.5 percent compared with fundamentals and desirable policy settings. As ECP inflows moderate, the current account is expected to quickly revert to a deficit, consistent with an external sector assessment as moderately weaker.

B. Outlook

7. After a rebound in 2019, growth is projected to slow going forward. Real GDP growth, after strengthening to 3.4 percent in 2019, is projected to reach 2.9 percent by 2024. Growth should be supported by continued development-partner-financed infrastructure projects. Outcomes for the agriculture sector could initially be weaker than previously expected because of negative impacts from natural disasters and the downward revision to the global outlook passing through to export demand. The increase in agricultural diversification efforts on the part of the authorities is expected to mitigate some of these effects. There is expected to be an increasing shift from public to private investment as delayed private-sector tourism investment commences in 2019.

8. Inflationary pressures are expected to remain low. CPI inflation, peaking at 2.9 percent in 2018, boosted by the 2.5 percentage point VAT increase, is expected to moderate in the medium term to 2.6 percent. Inflationary pressures are strongly linked to import prices. Provided that the Reserve Bank of Vanuatu (RBV) continues to successfully maintain its exchange rate peg, Vanuatu should benefit from the expected low inflation in its main trading partners, Australia and New Zealand. There is expected to be additional temporary downward pressures from a weaker global outlook for commodity prices relevant to Vanuatu, and the government increasing funding for education tuition fees.

9. The current account balance is projected to turn into a deficit of 1.2 percent of GDP in 2019, followed by average deficits of 4.6 percent of GDP from 2020 to 2024. The turnaround in the current account balance stems from lower revenues from the ECPs and higher goods imports reflecting airplane orders by Air Vanuatu as part of the Shared Vision 2030 plan (Box 1). There are projected to be positive offsets – slowing imports of goods from fewer development-partner-financed infrastructure projects and stronger tourism receipts from more cruise ship arrivals at the new international wharfs, the renovated Bauerfield Airport, and increased tourist arrivals from the Shared Vision 2030 plan. Gross international reserves are expected to cover 12.7 months of prospective imports in 2019 and remain strong from external financing through the current and financial accounts, even as external debt repayments begin to exert downward pressure on reserves in the medium term (Annex II).

10. Vanuatu stands to gain from the “PACER plus” free trade agreement with Australia, New Zealand and other Pacific island states. As members start cutting tariffs (assuming to begin in 2022 in the IMF staff forecast), Vanuatu would experience cheaper imports, mildly stimulating consumption. Required tariff cuts are expected to reduce government revenues up to 1 percent of GDP in the long term. “PACER plus” could have additional positive institutional effects, such as technical assistance by Australia and New Zealand for customs modernization.

11. Vanuatu is expected to graduate from LDC status in 2020 (Annex III). This should not have a major impact on the growth trajectory. Where Vanuatu may face challenges is the reduction of preferential market access for trade. The government has ongoing efforts to find alternative means of preferential access through free trade agreements and should continue after graduation.

Shared Vision 20301

The Vanuatu Tourism Office (VTO), Air Vanuatu and the Vanuatu airports authority have elaborated a “shared vision” for tourism in partnership with tourism stakeholders and the government. The main goal is to raise holiday visitors from 87,000 in 2017 to 300,000 in 2030. The main targets are short haul markets such as Australia, New Zealand, and China and new market segments in long haul markets such as Japan, North America and Europe.

Route development is crucial to the plan’s success. Air Vanuatu plans to improve air access from Australia and New Zealand and connections from long haul markets. This includes an expanded fleet of new more cost-effective and smaller aircraft to increase frequency to major destinations and to introduce non-stop flights to smaller cities. The centerpiece will be four 133-seat Airbus A220 airliners, with purchase rights for four more. The VTO is tasked with building demand in existing core markets and developing awareness in new markets ahead of entry by Air Vanuatu with the expectation that market development needs at least two years to show returns. Government support will come from the Ministry of Foreign Affairs (negotiating new bilateral air service agreements), the Ministry of Education (developing airline pilot training programs) and the Ministry of Agriculture (help increase food production for the growing needs of the hospitality sector).

Demand created by tourists and tourism businesses should flow through other sectors like agriculture, semi-skilled labor (handicrafts) and public transportation. This is expected to stimulate GDP growth, create employment, and increase VAT and other tourism-related tax revenues for the government.

The total cost and financing of the plan is uncertain. Growth forecasts in the associated Vanuatu Tourism Marketing Plan 2030 are optimistic with arrivals averaging 10 percent growth per year. Total VTO marketing spending is expected to reach over 1 billion vatu (about 1 percent of GDP) by 2023, although the source of such financing remains unclear. Air Vanuatu is financially overexposed with weak capital and a 1 billion vatu loan has been requested from the VNPF. So far, the government has provided deposits for some airplanes and is at risk at being required to guarantee any debt financing, as Air Vanuatu is a SOE. This could also be the case for any financing provided by the VNPF, itself an SOE, using its depositors’ monies.

1 Prepared by Charlotte Sandoz.

C. Risks

12. The main risk is that of natural disasters, but there are other significant risks (Annex IV). Weaker-than-expected global growth and global trade tensions could lower remittances, development partner funding, export demand and tourism. If correspondent banking relationships retract, remittances would be harder to access. Delays in infrastructure projects because of insufficient external financing or capacity issues from labor and capital could slow growth. On the upside, their benefits could be larger than expected through higher-than-expected productivity gains or stronger tourism growth. Other upside risks include the Shared Vision 2030 plan for tourism growth and the expanded seasonal work programs in Australia and New Zealand for remittances and consumption growth. Continued strong ECP revenues are an upside risk for useful government spending, but a downside risk on the fiscal balance if they come in lower than expected or are used to justify further delays in tax reform.

Vanuatu: Summary Risk Assessment

article image

D. Authorities’ Views on Outlook and Risks

13. The authorities broadly concurred with staff’s assessment on economic developments, outlook and risks. They noted that the completion of the major infrastructure projects by 2019 is expected to strongly support GDP growth. Their GDP growth forecasts were on average slightly higher than that of staff from 2018 to 2020, the difference driven primarily by stronger growth in construction. The authorities also expressed their commitment to foster economic diversification especially in agriculture and tourism. The authorities agreed that foreign reserves would slowly decline over the medium term because of high demand for imports and external debt repayment offsetting inflows of budgeted development partner funds and temporary ECP revenues. The prime risk they saw was the fragility of the tourism industry as it is highly dependent on the economic situation of their trading partners and vulnerable to disruption due to natural disasters.

Aligning Macroeconomic Policies for Growth

14. Macroeconomic policies should foster growth and a stronger fiscal position help build buffers to manage natural disaster risks. Monetary policy should hold the course to maintain Vanuatu’s stable exchange rate and low inflation. Financial policy should focus on reducing non-performing loans (NPLs) and financial inclusion, extending access to credit while being mindful of risks. Fiscal policy should build buffers against natural disasters by completing the tax reform, reducing reliance on ECP revenues, and rationalizing spending. Structural policy should focus on diversification to foster stable growth and resilience. Development partners can back these policies through funding and technical assistance.

A. Monetary Policy

15. The RBV has successfully maintained CPI inflation in the target range of 0 to 4 percent. The RBV’s defense of exchange rate peg allows it to import low inflation from Australia and New Zealand (Annex V). It mitigates additional domestic inflationary pressures through bank’s statutory reserve deposit (SRD) requirements and mopping up additional excess liquidity through open market operations. By maintaining a stable exchange rate and rising the SRD requirement to 5.25 percent, along with other measures early in 2018, the RBV quelled inflationary pressures.

uA01fig03

SRD Requirement, Inflation and Credit Growth

(In percent)

Citation: IMF Staff Country Reports 2019, 162; 10.5089/9781498319485.002.A001

Sources: Vanuatu authorities.Note; SRD refers to statutory reserve deposit

Staff’s Views

16. The RBV’s monetary policy stance is appropriate for the short term. Inflation is forecast to remain around 2.6 percent, calling for a continuation of a neutral monetary policy stance. With increased downside risks to the global outlook and therefore import prices, the RBV should maintain its stance, but be ready to loosen if necessary.

17. In the medium term, monetary policy may be hindered by excess liquidity in the banking sector (Annex VI). Banks have registered rapid reserve accumulation since Cyclone Pam and now hold large reserves, split between voluntary reserves as self-insurance, and excess liquidity, which can hinder monetary policy effectiveness. The RBV should investigate the factors behind the large reserves with the large financial institutions. The RBV and government can safeguard the effectiveness of monetary policy by facilitating competition in the banking sector, as highly monopolistic behavior dampens the sensitivity of bank interest rates to monetary policy.

Authorities’ Views

18. The authorities agreed with staff’s view and the monetary policy stance was appropriate. The exchange rate regime has worked well. Foreign reserves were at a comfortable level and inflation was under control. They raised concerns about excess liquidity in the banking system. This was inconsistent with the high lending rates of commercial banks, also a problem as they restrained credit to the private sector and consequently the level of private investment. The authorities recognized this is not a problem unique to Vanuatu and requested if staff could do analysis for the region for the next consultation.

B. Financial Sector Issues

19. Overall, the banking sector has a strong capital and liquidity position.4 The capital adequacy ratio (CAR) was 19.6 percent by 2018Q3, with most banks above the 12 percent minimum. The NPLs to gross loans ratio was at 14.9 percent in 2018Q3 (over half in the personal sector) although the distribution of NPLs among banks was highly uneven. One bank recorded both high NPLs and a low CAR, but both measures were improving over 2018. With consequent increases in provisioning, the banking sector recorded a decline in profit in 2017 but recovered in 2018.

20. The authorities have made good progress on Vanuatu’s AML/CFT legal framework, although implementation has just begun. Staff commends the authorities’ efforts that led to Vanuatu’s removal in 2018 from the FATF’s “grey list” of jurisdictions with strategic AML/CFT deficiencies. This was achieved through extensive legislative work undertaken in conjunction with several development partners.

21. The authorities are carefully considering the use of fintech in the financial sector and aim to better understand the possibilities and risks. Initially, there was little guidance on the use or expected regulation of new digital technologies, which could have increased Vanuatu’s exposure to money laundering and terrorist financing (ML/TF) threats and magnify existing vulnerabilities. Failing to properly regulate virtual asset service providers for AML/CFT would not be in line with the FATF standard. In September, after some firms made claims about Vanuatu’s use and official support of crypto-assets and currencies, the authorities issued a public warning stating that cryptocurrencies were not recognized for payment and ICOs were not allowed and declared a moratorium on fintech initiatives. As a response, the authorities established a Distributed Ledger Technology (DLT) taskforce comprising relevant financial regulators to consider related issues.

uA01fig04

Financial Inclusion in the Pacific

(In percent of population)

Citation: IMF Staff Country Reports 2019, 162; 10.5089/9781498319485.002.A001

Sources: PIRI Demand Side Surveys and Global Findex

Staff’s Views

22. Given elevated NPLs and low profitability, the RBV needs to monitor the banking sector carefully and continue strengthening its supervisory framework. The IMF is assisting on both fronts, with a banking diagnostic assessment in May 2019 and ongoing PFTAC technical assistance. Ensuring that all banks meet the CAR and reduce NPLs should ensure financial stability. Furthermore, it would send the signal that the banking sector remains a responsible partner in its correspondent banking relationships, alongside progress already made on AML/CFT issues.

23. Work on financial inclusion should help further development of the financial sector. The positive effect of financial deepening on growth could be large.5 The authorities, with IMF/PFTAC assistance, have introduced a stronger legal framework for credit unions, which will also prevent cooperatives from operating as poorly-run, unregulated financial institutions. Staff commends the new National Financial Inclusion Strategy 2018–23 (NFIS) and the actions of the National Bank of Vanuatu (NBV). The NFIS provides for financial literacy programs, increased bank account enrollment and use, leveraging technology for inclusive products and services, and financing micro-, small-, and medium-sized enterprises (MSMEs). The NBV is migrating more of its rural base to mobile or electronic banking and using fintech solutions to extend other banking services into remote areas. Financial inclusion measures could stall because of high NPLs in the personal sector. Staff recommends that authorities act based on the recommendations from the IMF-led banking diagnostic assessment.

24. Ongoing improvements to Vanuatu’s AML/CFT regime are needed to strengthen financial sector stability and ease potential pressures on correspondent banking relationships. The AML/CFT legal framework remains largely untested. Enforcement should be complemented by further requests for technical assistance from Vanuatu’s development partners for risk-based financial supervision and capacity building at the Vanuatu Financial Services Commission (VFSC) and Financial Intelligence Unit (FIU). Improvements to the AML/CFT regime may help alleviate pressures on correspondent banking relationships.

25. Strengthening the financial sector’s regulatory and legal frameworks to support fintech use is required. While the RBV has clearly stated restrictive positions on fintech until appropriate regulation is in place, progress on this front is not clear. A well-constructed, clearly delineated framework could harness fintech to make banks more internally efficient, and broaden financial innovation and inclusion, encouraging domestic growth, as well as stimulate its offshore financial sector, provided safeguards are put in place to contribute to the mitigation of ML/TF risks. IMF staff recommends that before expanding into new technologies, products and services the authorities:

  • provide clearer public guidance regarding the DLT taskforce, including a statement of its mandate and interests, supported by timelines for reporting and recommendations, focused on mitigation of associated ML/TF risks and sufficient staffing for regulatory agencies.

  • ensure implementation of the AML/CFT regime and effective oversight of the financial sector

  • consider approaching development partners for assistance.

26. Integrated financial sector policy making though regular meetings of the RBV, VFSC, FIU and MFEM is recommended.6 It would allow for inter-institution sharing of information and knowledge to avoid duplication and inconsistency of policy actions between authorities with limited resources.

Authorities’ Views

27. The authorities fully agreed with the staff’s recommendation about careful monitoring of the banking sector and enhancing financial access. The RBV was closely monitoring individual banks’ financial situation to safeguard financial stability. The RBV welcomed the upcoming banking diagnostic assessment to strengthen the banking sector. With the assistance of the PFTAC, the RBV planned to complete a review of its risk-based supervisory approach for banks by June 2019, followed by insurance and other financial institutions. Given limited financial access for MSMEs and households in rural areas and the outer islands, the authorities continue to implement the NFIS to promote financial inclusion, while keeping in mind credit risks, especially in the personal sector.

28. The authorities highlighted progress in the financial sector. The FIU, VFSC and RBV noted the substantial amount of new AML/CFT legislation that resulted in Vanuatu’s exit from the FATF “grey list.” Work continues on implementation, and the authorities welcomed additional technical assistance in this area to assist them achieve the best results most efficiently with scarce resources. They also continue to look at new issues particularly for fintech and AML/CFT and intend to use the resources made available to them by their development partners.

C. Fiscal Policy

29. The fiscal deficit is expected to be around 4 percent of GDP over the medium-term on current policies, requiring further action on revenue mobilization and expenditure prioritization to maintain debt sustainability. The government customarily runs a surplus of domestic revenues over government-funded expenditures. Expenditures prioritize infrastructure, tourism, education and healthcare, based on the National Sustainable Development Plan 2015 to 2030 (NSDP). Nonetheless, the revenue base is limited, depending on VAT, excise taxes, tariffs and hard-to-predict revenues from the ECPs. There is reliance on development partner grants and concessional lending, which is the source of the deficit.7 The current trajectories are expected to be inconsistent with the 60 percent public-and-publicly-guaranteed (PPG) debt-to-GDP target adopted in 2019.8

30. The debt management framework is being strengthened, and the process needs to be completed. The Ministry of Finance and Economic Management’s (MFEM) updated debt management strategy is almost complete, with strong rules regarding concessionality. Once implemented, the strategy will be complemented by regulations that include a technical committee to make policy recommendations to a debt management committee composed of senior government officials. Some regulations might be embedded in law by amending the Public Finance and Economic Management Act. Consultation with development partners could strengthen the effectiveness of such emendations.

Staff’s Views

31. The success of the debt management strategy is at risk in the medium term without changes in fiscal policy to maintain buffers in the event of potential natural disasters. Public debt rose substantially between 2014 and 2018, from 26.1 percent of GDP to 52.4 percent. While the risk of external debt distress remains moderate according to the joint IDA-IMF Debt Sustainability Analysis (DSA) like last year, it is now attributable to a perceived shift in the speed of accumulation of concessional lending instead of grants, after the November 2018 loan agreement with China. The DSA forecasts the government will breach its 60 percent PPG-debt-to-GDP target in 2025. The government can avoid this by ensuring a sound fiscal path accounting for the role of revenues and spending not just from domestic sources, but also the development partners, which includes better prioritization of proposed projects (often infrastructure). Staff recommends that authorities:

  • Complete the proposed 2017 tax reforms to increase revenues. This includes introducing corporate and personal income taxes and shifting away from less efficient taxes that impede growth (especially those related to trade and government procedures). It broadens the basis for revenues, increasing resilience in the face of shocks, Also, it allows for a more progressive tax system. The VAT is generally a regressive tax, while personal income tax can be calibrated to skew away from low-income earners. A corporate income tax would ease the burden on low-profit-margin firms relative to the current turnover tax.

  • Stabilize expenditures as a share of GDP. Expenditures under the domestically-financed budget are expected to be stable. However, this assumes the authorities follow the suggested path for compensation of employees in the staff’s baseline forecast, where compensation only grows with inflation, and does not repeat the government’s one-off 2018 level adjustment (which was justifiable, as it occurred after a number of years without any nominal wage increases). In terms of the development-partner-financed budget, the focus should be on the prioritizing financing as discussed in the following two bullet points.

  • Focus on grants and loans with higher concessionality. Larger grants or grant components for concessional financing would help lower the path of the PPG-debt-to-GDP ratio. If the new bilateral financing assumed after 2022 relative to the 2018 DSA were to come from grants rather than concessional lending, the PPG debt target would not be breached, and the PPG-debt-to-GDP ratio would stabilize around 56 percent (figure above).

  • Limit and prioritize loans, especially less concessional lending. Current criteria for accepting loans focus on their intended use and their concessionality, which is commendable, but preventing the breach of the debt target should be a major criterion. The authorities should prioritize which loans to accept on this basis as well as limit the loans made available to state-owned enterprises (SOEs) or made by the Vanuatu National Provident Fund (VNPF, itself an SOE) as this debt would likely be publicly guaranteed and could lead to a target breach.

uA01fig05

Vanuatu: Public Debt Financing Scenarios

(in percent of GDP)

Citation: IMF Staff Country Reports 2019, 162; 10.5089/9781498319485.002.A001

Sources; Vanuatu authorities and IMF staff calculations.

32. An illustrative fiscal reform scenario based on the recommendations above suggests the deficit could be less than 3 percent of GDP (table below). Tax reform could lead to a sustained revenue increase of around 2.5 percent of GDP.9 The extra revenue could help achieve a lower deficit, even allowing for -1.0 percent of GDP lower ECP revenues and permanent funding for natural disaster relief of 0.5 percent of GDP.10 Prioritization of new infrastructure spending to lower concessional borrowing by 10 percent would reduce expenditures around 0.3 percent of GDP. This would stabilize the PPG-debt-to-GDP ratio around 54 percent. Real GDP growth would be somewhat lower for 3 years.

Table. An Illustrative Fiscal Reform Scenario for Vanuatu Starting in 2021

article image
Sources: Vanuatu authorities and IMF staff estimates and projections.

33. The authorities should then aim for a 50 percent PPG debt-to-GDP target. The lower target would provide an additional buffer, of up to 10 percent of GDP, against fiscal risks from natural disasters, as recommended by the 2018 Article IV consultation.

Authorities’ Views

34. The authorities stressed their commitment to a balanced budget outside of the development partners’ operations. Given limited domestic financial resources, development-partner-financed infrastructure projects were needed to meet the country’s large infrastructure needs. Despite prioritizing grants and loans with a high concessional element, these projects, not domestic recurrent spending, have driven the increase in debt since 2014. The authorities recognized that there would be an upward pressure on maintenance costs for infrastructure going forward on the domestically-funded budget, even with some funding by grants. They also recognized that revenue mobilization, including the introduction of personal and corporate income taxes, may be needed in the future, as ECP revenues were not a stable and sustainable source of income.

35. The authorities underscored their strong commitment to make prepayments to contain debt accumulation and meet debt obligations. They plan to run down their solid cash reserves, which had been accumulated from ECP revenues. They were in the final stage of updating the debt management strategy and finalizing their debt on-lending policy and debt management unit procedure manuals. They agreed with the staff recommendations to focus on grants and high concessional loans to fund infrastructure projects. They remain committed to maintain a grant-element target of at least 35 percent on new loans. They stressed that it will be challenging for the government to provide any guarantee in the near future for borrowing by the SOEs.

D. Structural Policies

36. In response to policy initiatives, there has been increased activity in Vanuatu’s largest sectors, agriculture and tourism. The government has introduced modern agricultural methods, worked to restock Vanuatu’s cattle, and promoted export growth including through free trade agreements. They will receive grants from the European Development Fund (EDF-11) for enhancing production and value chains for beef, coconut products, and fruits and vegetables, starting with

a EUR 3 million allocation. Shared Vision 2030 has been launched as a cross-sector integrated plan to develop the country’s air transportation and tourism sectors (Box 1), at a time when Vanuatu’s share in the Pacific’s tourism market is falling.

Staff’s Views

37. The authorities should continue to promote agricultural diversification. They will receive budget and technical support from the EDF-11 grants. Domestic policy should continue its focus on market access and linking small landowners into stronger marketing cooperatives. There are proposed loans like that from the Israeli private-sector Agriculture and Services Technical Center that should contribute to diversification, but they must be examined within the context of debt sustainability and MFEM’s best practices on concessionality of new loans.

38. The diversification strategy should be complemented by further improvements in the business environment. The current simplification of customs procedures at Port Vila is a good example. Similar efforts could be made on regulations for FDI and employment, and bottlenecks when registering property and land titling. These could trigger higher private investment and enhance competition and productivity.

Authorities’ Views

39. The authorities have continued to shift their policies to strengthen economic diversification. They recognized that agriculture and tourism activities were critical for medium-term growth and they have formulated initiatives to improve productivity in both sectors. Policies in agriculture focused on diversifying the production chain by using development partner funds such as the EDF-11 and developing their policy frameworks to allow small landowners to have market power through larger cooperatives. The authorities see the Shared Vision 2030 plan for tourism as needed to accelerate momentum and noted that faster growth would also help minimize any related fiscal burden.

E. Addressing Risks from Natural Disasters

40. The authorities have enhanced Vanuatu’s resilience to natural disasters, while coping with prolonged volcanic activity. They have strengthened the National Disaster Management Office (NDMO), launched the National Policy on Climate Change and Disaster-Induced Displacement. They introduced the Disaster Risk Management Act 2018 (DRMA) bill to replace the Natural Disaster Act 2006, to better involve provincial and municipal participation in the process, facilitate donor-funded disaster assistance and humanitarian aid, and establish a national emergency fund, which has not yet been defined.

Staff’s Views

41. The national emergency fund should be the central element of Vanuatu’s fiscal framework, carefully designed with stable and substantial funding (Annex VII). The authorities should pass the DRMA bill and provide specific guidelines on the proposed national emergency fund in 2019. The fund should be a multi-year fund that would grow over time, absent of any drawdowns, with an investment strategy focused on safe highly-liquid foreign assets. The authorities could approach its development partners to secure an endowment to which it would annually contribute.

42. The national disaster planning framework has improved substantially in recent years, and this process should continue. The framework has relatively strong planning and tools for public use, which are constantly being developed and improved. Additional measures that could bolster the effectiveness of the framework include:

  • Allocating more funds as part of the annual budget prioritization exercise to meet staffing targets and strengthen training at the NDMO.

  • Stronger monitoring and evaluation of the framework’s performance to uncover further issues to address or possibilities for efficiencies in spending.

  • Complementing large domestic buffers with insurance and externally financed instruments, such as contingent credit lines with multilateral partners, and stronger relations with development partners.

  • Updating the Vanuatu National Adaptation Plan for Action 2006, focusing on investing in and maintaining resilient infrastructure, ensuring the plan is consistent with a multi-year fiscal strategy.

Authorities’ Views

43. The authorities underscored the importance of enhancing natural disaster preparedness and investing in resilient infrastructure. They increased the size of contingency provision from 50 million vatu in 2018 to 150 million vatu in 2019 to be able to respond expeditiously to a series of natural disasters. Once the DRMA bill is passed, they intend to consider the design of their natural disaster fund. They were working with the WBG for a development policy grant with a Catastrophe-Deferred Drawdown Option (Cat DDO), a facility that would provide immediate liquidity to the country in the aftermath of a natural disaster. At the same time, they withdrew from a membership of the Pacific Catastrophe Risk Assessment and Financing Initiative (PCRAFI), judging its benefits too limited for the costs to Vanuatu.

Improving Governance and Fostering Growth

44. Vanuatu, being a small lower-income state with limited administrative capacity, is vulnerable to corruption from gaps in governance. These gaps leave parts of the economy either without appropriate supervision, or with excess regulation prone to bribery. This report focuses on removing gaps in the areas of revenue administration, central bank governance and AML/CFT. Other gaps include weak PFM practices and procurement practices; overly complex import procedures; and a lack of prudential standards at the RBV for the financial sector, along with broader governance concerns.

45. Vanuatu could foster growth by improving governance. Vanuatu has been strengthening its institutions through funding and technical assistance from its development partners, including the IMF and PFTAC. Recent IMF/PFTAC technical assistance has successfully focused on financial and AML/CFT legislation, tax administration and audit functions. The current focus should continue to be the major public institutions, so that the authorities can provide effective support to the economy.)

uA01fig06

Vanuatu: Governance 1/ 2/

(Lower scores indicate weaker governance)

Citation: IMF Staff Country Reports 2019, 162; 10.5089/9781498319485.002.A001

Sources: Worldwide Governance Indicators. D. Kaufman (Natural Resources Governance Institute and Brookings Institutions), and A. kraay (World Bank), 2017. Verisk Maplecroft's Corruption Risk Index, 2017. Transparency International Corruption Perceptions Index, 2017.1/ Use of these indicators should be considered carefully, as they are derived from perceptions-based data. Ranges are for a 90 percent confidence interval. Confidence intervals for peer group averages are negligible.1/ Confidence intervals are not available for Verisk .Maplecroft.

Staff’s Views

46. Strengthening the RBV’s governance would help ensure the continuation of effective monetary and financial policies that support growth. Central banks that follow best practice have substantial autonomy, and strong internal controls. The 2016 Safeguards Assessment made several recommendations on these issues.11 There has been progress on the internal audit function, and the overall structure of the RBV. However, greater autonomy for the RBV would help ensure continued policy effectiveness and formally guard against political influence by amending the RBV Act. Staff recommends continued engagement with PFTAC for internal audit functions and the IMF’s Legal Department for the RBV Act.

47. The ability of government to support growth depends on strong processes and good management of government assets. The authorities could build on work already completed for the budgetary process, with PFTAC and UNDP technical assistance. Tax administration will be strengthened once the introduction of a tax identification number (TIN) regime for individuals and firms under the Tax Administration Act is completed. The authorities should complete and pass the Government Business Enterprises Act bill, which will be complemented by the upcoming report by MFEM’s Government Business Enterprise Unit that will discuss the financial position of, and fiscal risks posed by SOEs. Further staffing and training of that unit, possibly with assistance from Vanuatu’s development partners, would support effective monitoring and governance of SOEs going forward. The Machinery of Government Review taskforce has been examining the effectiveness of the government’s structure and its performance, looking for further efficiencies and should continue, but not at the expense of pursuing tax reforms.

Authorities’ Views

48. The authorities highlighted progress in governance. The RBV noted the restructuring of the units within the bank and improvements in its audit function, line with the Safeguards Assessment recommendations. The government should complete this year several legislative efforts that are expected to improve governance. This included completing the new framework for tax administration and governance reform for credit unions and SOEs.

Other Issues

49. Statistical issues. While broadly adequate for surveillance purposes, large revisions, quality and timeliness remain a concern for some data (Informational Annex). Vanuatu has a National Summary Data Page as part of the e-GDDS, with some work still needed (Annex VIII). Staff recommend that the authorities seek further support from PFTAC and STA on the compilation and development of national accounts statistics and improvements to local technical capacity.

Staff Appraisal

50. Four years after Cyclone Pam struck Vanuatu causing extensive damages, reconstruction is near completion with full recovery in sight. The authorities are now more focused on implementing their broader development plans that were slowed by the rebuilding process, which will require fiscal discipline and some further reforms to maintain debt sustainability. The authorities should continue their constructive engagement with their development partners for technical assistance, capacity development, and concessional and grant-based funding. By doing so, the authorities can continue to press ahead with reforming and strengthening the governance of its institutions and removing vulnerabilities to corruption.

51. The outlook is relatively stable and should be underpinned by continued efforts at economic diversification. Real GDP growth is set to average 3.3 percent from 2018 to 2020, but is expected to be 2.9 percent by 2024, underpinned by diversification in agriculture and tourism. Current agricultural diversification efforts are positive, but the authorities also need to consider domestically-funded agricultural policies beyond reliance on development partner funding. The new integrated air travel and tourism plan Shared Vision 2030 is expected to drive tourism growth. Risks associated with new debt arising from airplane purchases by Air Vanuatu and optimistic air-travel tourist arrival assumptions make the projected gains increasingly uncertain after 2021. The government must carefully consider the degree of its financial involvement, which also extends to SOEs such as the VNPF, so that the government maintains its debt sustainability, and help maximize the success of the plan, even without full implementation in later years. The diversification strategy should be complemented by improvements in the business environment to trigger private investment and enhance competition and productivity.

52. The monetary policy stance is appropriate. Inflation is expected to stay near the middle of the 0–4 percent target band, as the exchange rate basket peg administered by the RBV remains broadly stable allowing for low inflation from imported goods. Given the downside risks to growth and inflation, RBV should stand ready to ease as needed.

53. There are downward pressures on the external sector. The current strength of the external position is temporary, driven by strong revenues from the economic citizenship programs. Going forward, it is expected there will be a current account deficit averaging 4.0 percent of GDP. This can be mitigated by a stronger fiscal position, discussed below.

54. Building on the recent improvements in the fiscal policy framework, further efforts are needed to safeguard debt sustainability over the medium term. Domestic revenues and government-funded expenditures are projected to be in balance or surplus. Given the strong pipeline of development projects with associated concessional lending, the overall fiscal deficit is expected to be around 4 percent of GDP through 2024, leading to debt exceeding the public-and-publicly-guaranteed-debt-to-GDP target of 60 percent of GDP as of 2025. The government should engage in further fiscal reform, including introducing corporate and personal income taxes while removing inefficient taxes as outlined in the 2017 Vanuatu Revenue Review, reducing reliance on ECP revenues, and prioritizing the reduction of future borrowing for infrastructure. This should reduce the pressure on public debt, contribute to an external position consistent with fundamentals, and allow for a lower public-and-publicly-guaranteed-debt-to-GDP target of 50 percent.

55. The financial sector is broadly stable but should be carefully monitored because of excess liquidity and vulnerabilities to ML/TF. Most banks are performing well, but some still face some uncertainties over NPLs, capital adequacy. Excess liquidity in the system may be reducing monetary policy effectiveness, but the extent of the excess is unclear. An IMF-led banking sector diagnostic assessment in May 2019 should provide clarification and suggest some possible solutions. Together with ongoing progress in strengthening the AML/CFT framework, this should help maintain correspondent banking relationships and allow for continued progress on financial inclusion. Staff commends the activity of the RBV and the broader financial sector in pursuing the authorities’ National Financial Inclusion Strategy 2018–2023, which is expected to provide clear gains for financial inclusion. The financial sector’s regulatory and legal frameworks should be carefully examined and strengthened to account for increasing fintech use. This would be complemented by the authorities clarifying the mandate and responsibilities of the Distributed Ledger Technology (DLT) taskforce and publicly providing relevant information.

56. The national disaster planning framework has improved substantially in recent years, and further strengthening should focus on meeting future funding demands. The proposed Disaster Risk Management Act 2018 establishes a national emergency fund. Staff recommends that the fund not just legally enshrine the current year-by-year framework for disaster relief but be used as an opportunity to be establish a multi-year, self-replenishing fund with consistent government funding, possibly with an initial endowment from Vanuatu’s development partners. There should also be continued efforts to increase insurance and externally financed instruments.

57. Vanuatu, being a small lower-income state with limited administrative capacity, is vulnerable to corruption from gaps in governance. The authorities should focus on strengthening the RBV’s autonomy, in line with recommendations from the IMF’s 2016 Safeguards Assessment; and strengthening fiscal governance by completing the Tax Administration Act (also a precondition for tax reform) and the Government Business Enterprises Act (which also strengthens SOE governance).

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

Figure 1.
Figure 1.

Vanuatu: Reconstruction is Drawing to a Close but Growth Could be Stronger

Citation: IMF Staff Country Reports 2019, 162; 10.5089/9781498319485.002.A001

Figure 2.
Figure 2.

Vanuatu: Development Projects Exert Pressure on External Balances While Stimulating Growth

Citation: IMF Staff Country Reports 2019, 162; 10.5089/9781498319485.002.A001

Figure 3.
Figure 3.

Vanuatu: Public Finance Needs More Reform While Monetary Policy is Supportive

Citation: IMF Staff Country Reports 2019, 162; 10.5089/9781498319485.002.A001

Figure 4.
Figure 4.

Vanuatu: Financial Sector is in Recovery, while Financial Inclusion is Increasing

Citation: IMF Staff Country Reports 2019, 162; 10.5089/9781498319485.002.A001

Table 1.

Vanuatu: Selected Economic and Financial Indicators, 2014–21

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Sources: Vanuatu authorities; and IMF staff estimates and projections.

Does not include consumption of fixed capital (depreciation)

Weighted average rate of interest for total bank deposits and loans.

The vatu is officially pegged to an undisclosed basket of currencies.

Table 2.

Vanuatu: Central Government Budgetary Operations, 2014–241/

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Fiscal year corresponds to the calendar year.

Does not include consumption of fixed capital (depreciation).

Gross operating balance is used instead of net as there is no data on consumption of fixed capital (depreciation).

Defined as domestic revenue minus government-funded expense and acquisition of nonfinancial assets.

Sources: Vanuatu authorities; and IMF staff estimates and projections.
Table 3.

Vanuatu: Reconciling the Domestic Budget with the IMF Presentation, 2014–241/

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Fiscal year corresponds to the calendar year.

Table 4.

Vanuatu: Monetary Survey, 2014–21

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Source: Vanuatu authorities, and IMF staff estimates and projections.
Table 5.

Vanuatu: Balance of Payments, 2014–24

(In percent of GDP, unless otherwise stated)

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Sources: Vanuatu authorities; and IMF staff estimates and projections.
Table 6.

Vanuatu: Medium-Term Baseline Scenario, 2014–24

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Sources: Vanuatu authorities and IMF staff estimates and projections.

Does not include consumption of fixed capital (depreciation)

Table 7.

Vanuatu: Banks’ Financial Soundness Indicators, 2012–18Q3

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Source: Reserve Bank of Vanuatu.
Table 8.

Vanuatu: SDGs Identified in the National Sustainable Development Plan 2016 to 2030 (Vanuatu 2030)

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Staff compilation.

Table 9.

Vanuatu: Indicators of Capacity to Repay the Fund, 2019–28

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Source: IMF staff estimates and projections.

Total debt service includes IMF repurchases and repayments.

Annex I. Authorities’ Responses to Fund Policy Advice

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Annex II. External Sector Assessment1

In 2018, the external sector position was stronger compared with fundamentals and desirable policy settings. The policy gaps, on net, help improve the external sector position. The external position is driven largely by windfall revenues from the economic citizenship programs, without which the external sector position would have been judged as moderately weaker.

External Balance Assessment2

1. The external balance assessment is based on the revised EBA-lite current account (CA) approach.3 Preliminary data for 2018 indicate a large current account surplus compared to previous years and is the focus of this assessment.

2. The revised EBA-lite methodology using the current account approach estimates an adjusted current account gap of 6.7 percent of GDP in 2018. This is the gap between the current account norm and the cyclically-adjusted current account surplus. The cyclically-adjusted surplus, in turn, is the actual surplus adjusted to reflect cyclical factors and the fact that a significant share of imports is financed by capital grants, which are insensitive to changes in exchange rates. This approach implies that in 2018 the real effective exchange rate was undervalued as the REER gap is -18.5 percent.

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Source: IMF staff estimates. Note: All numbers are percentage points of GDP, except for the elasticity and the REER gap, which are expressed in percent.

3. The policy gap reinforces the adjusted current account gap. The regression-based model results rely on the private credit growth, the change in official reserves, the share of the overseas population as a proxy of remittance inflows, a control for the health expenditure to GDP ratio and a dummy variable for natural disasters. These all affect intertemporal decisions for savings and investment and the level of the current account deficit. The policy gap positively contributes to the current account surplus and it is driven by Vanuatu’s absence of capital controls.

4. The external position would have been moderately weaker compared with fundamentals and desirable policy settings without the extraordinary revenue windfall from the economic citizenship programs (ECPs) in 2018. The government received around US$9 million (about 10 percent of GDP) from the ECPs, almost 4 times higher than estimated in the 2018 budget. Otherwise, the current account could have fallen to an estimated deficit between 5–6 percent of GDP and a current account gap around -2.5 percent of GDP.

5. Vanuatu’s external sector position is likely to shift over the medium term. The current account deficit is expected to stabilize around 5 percent of GDP after 2020 as strong revenues from the ECPs are expected to be temporary. The deficit is forecast to be driven by high import demand from public and private infrastructure projects, financed by sustained inflows from remittances, tourism activities, development partners’ grants and concessional loans. As there is no major expected change in the policy variables, the external position is expected to be moderately weaker compared with fundamentals and desirable policy settings over the medium term.

Foreign Exchange Reserves

6. Vanuatu’s gross official reserves stood at US$502 million (around 12 months of imports) in 2018, reflecting grants and FDI for infrastructure projects. Official reserves grew in 2018 and remained at comfortable levels because of the windfall inflows from the ECPs. They will continue to be strong from external financing even as external debt repayments begin to exert downward pressure in the medium term.

Reserve Adequacy

7. A cost-benefit analysis on the level of reserves held suggest an optimal level between 4.1 to 5.5 months of imports. When measured against Vanuatu’s vulnerability to external shocks, the adequate level of reserves is estimated to lie in the range of 4.1 to 5.5 months of imports, depending on the probability of a large shock event, based on the sample average of countries (50 percent) and Vanuatu’s high vulnerability to natural disasters (75 percent). The staff’s estimate for reserve adequacy is somewhat higher than the RBV’s objective to maintain enough official reserves to cover at least 4 months of imports. Even if the current need to finance construction-related imports for infrastructure projects and loan repayments exert downward pressure on official reserves, inflows from remittances, tourism, FDI and capital grants are expected to remain strong over the medium term.

uA01fig07

Official Foreign Exchange Reserves

(In millions of US dollars)

Citation: IMF Staff Country Reports 2019, 162; 10.5089/9781498319485.002.A001

Sources: Authorities data; and IMF staff calculations and projections.

8. The latter estimate, however, likely underpredicts the actual optimal level of reserves needed and should be considered a minimum benchmark. Since Vanuatu is at the upper tail of the distribution of shocks because of a high likelihood of the occurrence of natural disasters, the cross-country comparators may underestimate of Vanutau’s reserve needs. For instance, Cyclone Pam in 2015 destroyed between 70 and 80 percent of GDP, corresponding approximately to the total amount of reserves in 2018 or the estimated optimal level of reserves if the probability of a large shock event was 100 percent. In this context,Vanuatu needs extra buffers to cover its external needs for reconstruction and losses in domestic production in the event of natural disasters. This pressures on reserve needs would be less in the presence of the national emergency fund discused in Annex VII.

Annex III. Graduation from the Least Developed Country (LDC) Category1

1. Vanuatu was included in the category of the least developed countries (LDCs) in 1985, five years after its independence. The LDC category was established by the United Nations’ General Assembly in 1971 for developing countries, which were characterized by a low level of income and structural impediments to sustainable development and require special measures to deal with those problems. The LDC category allows the country to access certain international support measures, such as access to concessional finance and preferential market access. As of 2018, 47 countries were included in the category. Five countries have graduated – Botswana, Cabo Verde, Equatorial Guinea, Maldives and Samoa. The graduation of LDCs is based on meeting any two of three criteria in two consecutive triennial reviews: 1) GNI per capita of US$1,230 or above; 2) a Human Asset Index rating of 66 or above; and 3) an Economic Vulnerability Index rating of 32 or above.

2. Vanuatu is scheduled to graduate from the LDC category in December 2020. At the 2015 triennial review, it was decided that the country would graduate from the LDC category in December 2017. However, in December 2015, the United Nations decided to extend the preparatory period before graduation by three years until December 2020 because of the economic disruption caused by Cyclone Pam in March 2015. At the 2018 triennial review, Vanuatu still met all three criteria.

Vanuatu: LDC Criteria Indicators

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Source: Monitoring of Graduated and Graduating Countries from the LDC Category: Vanuatu

3. The impact of graduation on bilateral and multilateral cooperation is likely to be limited. Bilateral development partners generally consider not only the LDC category, but other factors including historical and cultural ties, diplomatic relations, and their own national policies, to determine grant allocation. Australia and New Zealand have recently embarked upon programs of enhanced engagement with the Pacific small states. China has also strengthened its economic ties with Vanuatu under the Belt and Road Initiatives. International institutions, such as the IMF, the WBG, and the ADB, do not use the LDC category itself as a determinant, while the IDA uses GNI per capita to determine eligibility for their funds. Vanuatu’s GNI per capita in 2018 is US$3,014, higher than the established threshold of US$1,145 in 2019, but the Small Island Economies Exception will allow the country to continue to have access to IDA resources at concessional terms, despite graduation.2 Recently, both IDA and ADB have scaled up their financing to the Pacific island states.

4. There might be some impact of graduation on preferential market access. The graduation might affect the duty-free quota-free market access, which some developed countries grant to Vanuatu under their Generalized System of Preferences (GSP) schemes, leading to higher tariffs on the country’s main exports such as fish, coffee, beef, kava, copra and cocoa. However, Vanuatu can continue to access to benefits of the UN’s Enhanced Integrated Framework (EIF) automatically for three years after graduation, which should aid a smooth transition.3

5. Even after the graduation, Vanuatu can access markets in Australia and New Zealand for most products on a preferential basis. This currently the case under the South Pacific Regional Trade and Economic Cooperation Agreement (SPARTECA). This one-way agreement will be replaced by the Pacific Agreement on Closer Economic Relations (PACER Plus), a reciprocal arrangement, which maintains this market access but obliges the Pacific island signatories to reduce import tariffs over time.4 The PACER Plus includes a delayed tariff reduction schedule for LDCs. While tariffs in non-LDCs must fall to zero by 25 years after the calendar year of the date of entry into force of PACER Plus, tariff reductions in LDCs begin in the 11th calendar year. PACER Plus states that in the event of graduation, the first year for tariff reductions will be the calendar year following the date of a country’s LDC graduation – potentially 2021 in the case of Vanuatu if PACER Plus were to enter into force by 2020. In that case, most tariffs would have to reach zero by 2031 and tariffs on all goods would have to be removed by 2046.

6. Vanuatu can learn from the experience of Samoa. Samoa successfully graduated from the LDC status in January 2014. Samoa has been receiving support for a smooth transition from its trading partners and development partners. For example, the EU provided a transition period for the its duty-free, quota-free “Everything, but Arms’ arrangement until 1 January 2019, after which normal tariffs will apply.5 China granted a three-year transition period from duty-free treatment. The EIF provided support for trade facilitation and implementation of institutional reforms for the trade, commerce and manufacturing sectors.

7. The government has been participating in the graduation process, but more remains to be done. The government established the National LDC Coordinating Committee to prepare for the smooth transition strategy in 2017, but limited progress has been made. The government is encouraged to start bilateral discussions with its main trading partners.

Annex IV. Risk Assessment Matrix1

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The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Nonmutually exclusive risks may interact and materialize jointly. “Short term” and “medium term” are meant to indicate that the risk could materialize within 1 year and 3 years, respectively.

Annex V. An Update on Exchange Rate Issues: Competitors and Sectors1

1. This annex updates previous analysis on exchange rates for Vanuatu and its Pacific island small state competitors in international markets. Vanuatu continues to exhibit relatively stable effective exchange rates in comparison to other Pacific island small states, and across different sector-based weighting schemes for its real effective exchange rates (REERs). Nonetheless, that stability may be somewhat disadvantageous for tourism, and to a lesser extent, agriculture, two of its largest sectors not related to development partner activity (such as construction, the largest sector).

2. Notable exchange rate fluctuations with main trading partners’ currencies is not exclusive to Vanuatu. Most Pacific island small states, whom compete against one another in the tourism industry, have experienced some degree of depreciation of their currency against the U.S. dollar, and appreciated against that of Australia (except Tuvalu and Vanuatu). For Vanuatu’s tourist sector, the Australian dollar is a better indicator than the U.S. dollar – Australia accounts for roughly 54 percent of tourist arrivals after Cyclone Pam. The Vanuatu vatu has slightly depreciated in both nominal and real terms against the Australian dollar unlike the other currencies, so Vanuatu is more competitive for Australians looking to go abroad and may be a more favored destination. Tourist arrivals have also been responding positively to other factors since Cyclone Pam such as the renovation of Bauerfield International Airport and the general improvement in tourist-related infrastructure in Port Vila and Luganville.

uA01fig08

Exchange Rates with U.S. and Australian Dollars

(Percentage change between 2018H2 and 2016H2)

Citation: IMF Staff Country Reports 2019, 162; 10.5089/9781498319485.002.A001

Sources: National Authorities and IMF staff calculationsNote 1: An increase indicates an appreciationNote 2: Dark color indicates a real bilateral exchange rate; light color indicates a nominal bilateral exchange rate

More generally, if the effective exchange rates are compared across Pacific island small states, Vanuatu’s REER seems to be broadly stable over time (shown in black). Most of the others, except Tuvalu, are appreciating relative to Vanuatu, leaving Vanuatu more competitive against its peers in broader markets, making their exports more attractive to most of its trading partners. The REER is also more relevant for the agricultural sector, as agricultural exports are dispersed across many countries – Australia accounts for only 18 percent (over the 2010–2015 period) with over half covered by other Asian and Pacific economies (Philippines, Malaysia, Japan, New Caledonia, Fiji, and Papua New Guinea). The behavior of Vanuatu’s REER relative to other Pacific islands can work in favor of its agricultural sector.

uA01fig09

Nominal Effective Exchange Rates

(Index, 2010=100)

Citation: IMF Staff Country Reports 2019, 162; 10.5089/9781498319485.002.A001

Sources: National authorities and IMF staff calculations.Note: An increase indicates an appreciation
uA01fig10

Real Effective Exchange Rates

(Index, 2010=100)

Citation: IMF Staff Country Reports 2019, 162; 10.5089/9781498319485.002.A001

Sources: National authorities and IMF staff calculations.Note: An increase indicates an appreciation.

3. A sectoral decomposition of the REER can help illustrate the competitiveness challenges faced by certain sectors.2 To assess price competitiveness in a specific sector, weights of the REER can reflect sectoral measures (such as trade flows or other quantity measures), while inflation can be expressed in terms of a subset of its components. With data availability as a constraint, we compute alternative specifications of the REER assuming weights are implied by tourist arrivals (2016–18) and agriculture exports (2005–15). Within Vanuatu’s economy, the tourism sector has faced a price competitiveness loss since 2014, while agriculture producers were less affected by exchange rate fluctuations than what the baseline REER suggests into mid-2017, after which point the agricultural sector more or less tracks the baseline REER.

uA01fig11

Vanuatu Real Effective Exchange Rates

(Index, 2010=100)

Citation: IMF Staff Country Reports 2019, 162; 10.5089/9781498319485.002.A001

Annex VI. Excess Liquidity and the Effectiveness of Monetary Policy in Vanuatu1

1. Vanuatu has rapidly accumulated liquid reserves in the recent years. It likely reflects the easing of monetary policy and subdued economic conditions starting with the GFC around 2009 (RBV 2017). In 2018, strong revenue inflows from the economic citizenship programs (ECPs) have bring up additional liquidity in the banking system as open market operation were insufficient to sterilize them. The large increase in the RBV balance sheet might reveal a liquidity overhang that has weakened the monetary policy transmission mechanism. Even if inflationary pressures seem well contained and liquidity well managed in the short term, excess liquidity remains a long-standing problem in Vanuatu.

2. This annex aims to examine the issues around excess liquidity in Vanuatu. The first section defines concepts around the purposes of reserves held in the banking sector and about liquidity. The second section looks at the measurement of reserves and liquidity, just not in Vanuatu, but in a boarder set of Pacific island states as well. The third section links liquidity issues with monetary policy, both in general and in Vanuatu. The fourth section explores the specific example of Fiji. This motivates the final section’s policy choices and recommendations for Vanuatu.

Defining Excess Liquidity and Associated Concepts

3. When discussing Pacific island states, excess liquidity is considered below as a subset of another concept, that of free reserves. Free reserves are the presence of more liquid reserves than are required to meet central bank obligations and lending. Many Pacific island states have issues with large amount of free reserves, as is the case with Vanuatu.

4. Free reserves have two common causes, both relevant for Vanuatu. Many small states, especially in the Pacific, are dependent on remittances from nationals working abroad and transfers from international development partners. The flows from export receipts, FDI and grants are then converted into local currency. When the central bank converts foreign currency inflows into domestic currency, this registers as increase in its official reserves in foreign currencies on the asset side of its balance sheet, and a rise in the deposits of commercial banks in local currency on the liability side. Therefore, the expansion of central bank’s balance sheet mechanically creates a high level of liquidity in the banking system.

uA01fig12

Inflows in Foreign Currencies and Domestic Money Supply

Citation: IMF Staff Country Reports 2019, 162; 10.5089/9781498319485.002.A001

Source: IMF staff.

5. The central bank may offset some of the free reserves held by banks through a statutory reserve deposit (SRD) requirement. The total amount of commercial banks’ reserves at the central bank gives the overall level of liquidity in the banking system. The central bank can require commercial banks to hold a defined share of their liabilities for monetary policy purposes in their central bank accounts. This freezes at least some portion of commercial banks’ free reserves and reduces liquidity in the banking system (Keister and McAndrews 2009). This is a common practice in many Pacific island states, including Vanuatu.

6. Free reserves can be further decomposed into two categories. There are: (i) voluntary reserves held by commercial banks for precautionary motives (self-insurance), (ii) excess liquidity because of the lack of other liquid and investment opportunities consistent with a bank’s risk appetite. The level of voluntary reserves depends on banks’ risk appetite and the ease of liquidating non-reserve assets. From the point of view of monetary policy, a rise of voluntary reserves is not an issue, unlike excess liquidity in the banking system (Darvas and Pichler 2018).

Measuring Free Reserves and Excess Liquidity in the Small States of the Pacific

7. Liquidity has significantly risen in the small states of the Pacific since the GFC. Since 2008, Fiji, Papua New Guinea, Tonga and Vanuatu have been holding reserves significantly above their national regulatory requirements, with high proportions of assets in liquid form.

8. Vanuatu had the highest loan-to-deposit ratio in the region on average between 2009 and 2016.2 During that period, its loan-to-deposit ratio rose from 73 percent to 107 percent. In many Pacific island states, foreign-owned banks usually provide a limited amount of loans to domestic private sector as there are few projects with low risk. In the case of Vanuatu, the situation is different. The domestic-owned bank (National Bank of Vanuatu, NBV) provides loans to a large set of clients and promotes financial inclusion, which helps explain the high level of Vanuatu’s loan-to-deposit ratio. More data would be useful to assess the distribution of liquidity among domestic banks and determine if banks behave differently according to ownership.

uA01fig13

Loan-to-DeposJt Ratio for Selected Pacific Islands

(In percent)

Citation: IMF Staff Country Reports 2019, 162; 10.5089/9781498319485.002.A001

Sources: Central bank prudential data

9. Given the high number of nonperforming loans in Vanuatu, it should be expected that banks would hold higher-than-normal ratios of liquid assets for self-insurance. Before Cyclone Pam, nonperforming loans rose from 7.3 percent to 12.6 percent of total gross loans, while the share of liquid assets to total assets in domestic banks followed the same trend and grew from 16.5 percent to 26.2 percent. Poorly-implemented financial inclusion leading to lower ability to repay loans (that is lower asset quality) could explain the growth of NPLs before Cyclone Pam, but further data would be needed to assess the impact.

10. After Cyclone Pam, the accumulation of free reserves in the Vanuatu banking system accelerated, while commercial banks’ vulnerabilities worsened. Free reserves in form of liquid assets owned by commercial banks represented 15 percent of total assets in 2015 and built up to 29 percent by 2017, roughly stabilizing afterwards. At the same time, credit to the private sector declined from 72 percent of GDP in 2014 to 60 percent of GDP in 2018Q2 and nonperforming loans reached 17.9 percent of total gross loans in 2018Q2. In addition, the share of nonperforming loans net of provisions to capital sharply declined from 70 percent in 2015 to 36.5 percent in 2016 but moved up to 55.0 percent by 2018Q2. Given that the last ratio demonstrates the capacity of domestic banks to withstand losses from nonperforming loans, banks were highly vulnerable in 2015 after the cyclone, recovered in 2016, but backslid afterwards.

uA01fig14

Domestic Banks Liquidity in Vanuatu

(In percent, Base 1 = 2009)

Citation: IMF Staff Country Reports 2019, 162; 10.5089/9781498319485.002.A001

Sources: Vanuatu Authorities

11. In 2018, an extraordinary revenue windfall from the ECPs brought extra liquidity into the banking system and increased money supply. The government received around US$90 million as revenue inflows from ECPs in U.S. dollars in 2018. Government converted them into domestic currency using a deposit account in a commercial bank. This raised the money supply and liquidity in the banking system as open market operations were not enough to fully sterilize the extra liquidity.

How Excess Liquidity and Reserves Interact with Monetary Policy Transmission

12. The main monetary policy transmission channel depends on how liquidity affects interest rates. An increase in liquidity should lead to a decline in interest rates across maturities and activities, stimulating demand for loans, which can then be easily met by banks. In presence of excess liquidity, passthrough to interest rates can be weakened. For instance, if the central bank attempts a contractionary monetary policy, it will cause banks to reduce their free reserves, but it will be only effective if the contractionary action reduces commercial banks’ free reserves below the level of voluntary ones (Saxegaard 2006).

13. Interest rate pass-through in the Pacific island states is likely to be further limited because of monopolistic behavior of banks and credit market frictions. Limited competition in the banking sector implies that individual banks can charge higher markups due to market power and this generates incomplete pass-through. Moreover, interest rates can be sticky if adjustment costs of changing lending rates are high for the banks (i.e. printing new promoting materials or investment in information technology systems) or if the elasticity of loan demand is low (i.e. customers are less likely to leave a bank in response to a better loan offer from elsewhere because of high switching costs). Finally, asymmetric information and relationship banking between a bank and its borrowers can reinforce the previous mechanisms, leading to high lending rates and credit rationing.

14. An increase in domestic lending does not absorb excess liquidity, unlike open market operations. Changes in volumes or interest rates are more relevant than the level of free reserves to determine if the monetary policy transmission mechanism is effective. The level of free reserves in the banking system is only determined by the balance sheet of the central bank. If a bank buys an asset from another domestic bank or makes a loan, the reserves will return to the central bank balance sheet through another commercial bank’s account. To reduce excess liquidity in the domestic banking system, the central bank can use sterilized intervention to reduce the monetary base (bank reserves and currency). For instance, a sale of foreign currency on the open market would result in a reduction of the central bank’s net foreign assets and a contraction of the monetary base (Dominguez 2009).

Monetary Policy and Foreign Exchange Reserves in Vanuatu

15. The RBV faces issues from excess liquidity, but its monetary policy framework may help lessen its importance. The RBV manages a pegged exchange rate for reserve stability, in addition to price stability, achieved with a CPI inflation target range of 0–4 percent. The RBV has been able to maintain the inflation rate within the target range over a long time period because a main driver of inflation is import prices, which dominate much of the CPI basket. Import prices, in turn, are determined by their trading partners (in particular Australia and New Zealand) who main low inflation rates themselves, and benefit from the stable exchange rate. Their monetary policy instruments – primarily an SRD requirement and open market operations – are most useful in targeting domestic inflationary pressures. This motivated the RBV’s increase in the SRD requirement from 5 to 5.25 percent and the use of open market operations in 2018.

16. After the Cyclone Pam in 2015, a large share of foreign exchange inflows was not sterilized by the central bank because of a voluntary increase in the RBV capital base and the high costs of sterilization. From January 2013 to end-2014, the vatu depreciated by 13 percent against the U.S. dollar while appreciating by 11 percent against the Australian dollar. The value of international reserves in U.S. dollars increased considerably less than would have been expected from overall surplus in the balance of payment, indicating valuation losses because of U.S. dollar appreciation. This trend is somewhat obscured by large errors and omissions in the balance of payments. After the large revaluation, the RBV had to strengthen its capital base to cushion the effects of such shocks and build up reserves (IMF 2015). In addition, sterilizing large capital inflows is costly for a small central bank as the RBV. Open market operations to reduce the domestic component of the monetary base would offset the reserve inflows and ease the threat of inflation, but the operations for smaller authorities such as the Vanuatu government and the RBV are difficult to execute without incurring substantial fiscal costs (Lee 1997).

Monetary Policy in Another Pacific Island State: The Case of Fiji

17. The Reserve Bank of Fiji (RBF) does not actively manage foreign reserves, as its monetary policy is akin to a currency board system. The RBF has a pegged exchange rate and its last devaluation was in 2009. Since GFC, the RBF has not carried out any open-market operations or changes in its reserve requirements for commercial banks.

18. Instead, when FX reserves are too high, the RBF allows the national pension fund to invest abroad. The pension fund always has an interest to invest abroad, but its access to foreign exchange reserves is capped by the RBF through two channels. First, the RBF governor sits on the board of the pension fund and has direct power over the pension fund’s decisions. Secondly, the RBF has capital controls on both inflows and outflows. The pension fund must request the RBF’s permission prior to transferring large amounts of foreign currency out of the country. Otherwise, the RBF’s primary objective is to manage foreign exchange reserves through the capital controls on residents’ overseas investment.

19. Liquidity does not appear to be excessive and monetary policy transmission is effective in Fiji. During 2009–17, the loan-to-deposit ratio was high, stabilizing around 84 percent. Commercial banks in Fiji hold most of their nonlending assets as reserves and have adequate liquidity levels to manage short-term liabilities and shocks (Gottschalk 2016). Moreover, the influence of the RBF’s policy rate on lending rates was significant between 2010 and 2014, confirming the effectiveness of monetary transmission despite a thin interbank market and limited capital mobility (IMF 2018).

uA01fig15

Policy and Lending Rates in Fiji

(In percent)

Citation: IMF Staff Country Reports 2019, 162; 10.5089/9781498319485.002.A001

Source; Reserve Bank of Fiji

Policy Recommendations to Manage Excess Liquidity and Reserves

20. The banking system in Vanuatu has large free reserves but a significant portion are being held for precautionary motives, which makes it difficult to properly assess the potential impacts on monetary policy transmission. More disaggregated data on commercial banks’ reserves would be useful to identify the share of excess liquidity in free reserves. To the extent that excess liquidity is an issue, there are policy measures that can be taken.

21. To improve effectiveness of monetary policy in presence of excess liquidity, the RBV could tighten its monetary policy stance through a gradual increase of banks’ SRD requirement over the medium term. While the SRD requirement was increased to 5.25 percent in April 2018, relative to historic norms there is still room for further increases to normalize monetary policy. For example, the SRD requirement was at 8 percent before the GFC. This would be necessary only if the central bank decided to raise interest rates because of strong domestic inflationary pressures, which are not currently present in the economy.

22. Higher SRD requirements would mop up excess liquidity but could also shrink voluntary reserves in some banks and increase financial stability risks. An increase of the SRD requirement has a symmetric impact on all banks, but it may cause some banks to reduce their free reserves below the level of voluntary ones and lead to upward pressure on interest rates. As banks with higher NPL ratios tend to hold a larger share of liquidity for precautionary reasons, the liquidity position may also worsen for those banks and financial instability risks may arise. Prior to any changes of SRD requirement, a banking diagnostic with the assistance from their development partners would help to analyze excess liquidity and NPLs among individual banks to avoid unintended consequences of recalibrating the SRD requirement to reduce excess liquidity.

23. Considering the example of Fiji discussed above, the authorities could also encourage the VNPF to invest abroad. In 2018, the VNPF invested 1.3 percent of its portfolio abroad, while the required benchmark in the VNPF’s policy guidelines has been 15 percent. Greater portfolio diversification would help with diversifying risk, and potentially improve portfolio performance in the longer term. The added benefit would be to contribute to the reduction of excess liquidity.

24. To reduce lending rates of commercial banks and reinforce monetary policy passthrough over the long term, the authorities should improve the functioning of the banking sector. To foster competition, the authorities should continue to promote financial inclusion and the use of new technologies. Investing in infrastructure to improve access to fintech, and information and computer technology in general, should help to overcome the asymmetric information problem and reduce switching and adjustment costs. Screening costs for banks are an important concern in the Pacific as the necessary instruments such as credit histories and credit scores are less available

References

  • Darvas, Zsolt and David Pichler, 2018, “Excess Liquidity and Bank Lending Risks in the Euro Area,” Policy Contribution Issue 16, Bruegel.

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  • Dominguez, Kathryn, 2009, “Sterilization,” Kenneth Reinert and Ramkishen Rajan (eds.), The Princeton Encyclopedia of the World Economy, Princeton: Princeton University Press, 1035–1038.

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  • Gottschalk, Jan, 2016, “The Role of Excess Liquidity and Interest Rate Pass-Through for The Monetary Transmission Mechanism in the Pacific,” Hoe Ee Khor, Roger Kronenberg, and Patrizia Tumbarello (eds.), Resilience and Growth in the Small States of the Pacific, Washington D.C.: International Monetary Fund.

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  • International Monetary Fund (IMF), 2015, Vanuatu: 2015 Article IV Consultation, IMF Country Report No. 15/149.

  • International Monetary Fund (IMF), 2018, Fiji: 2018 Article IV Consultation, IMF Country Report No. 19/57.

  • Keister, Todd and James McAndrews, 2009, “Why Are Banks Holding So Many Excess Reserves?” Current Issues in Economics and Finance, 15(8), New York: Federal Reserve Bank of New York.

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  • Lee, Jang-Yung, 1997, “Sterilizing Capital Inflows,” Economic Issues, Washington D.C.: International Monetary Fund.

  • Reserve Bank of Vanuatu (RBV), 2017, Quarterly Economic Review, December 2017, Port Vila: Reserve Bank of Vanuatu.

  • Saxegaard, Magnus, 2006, “Excess Liquidity and Effectiveness of Monetary Policy: Evidence from Sub-Saharan Africa,” IMF Working Paper 06/115, International Monetary Fund.

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Annex VII. The Fiscal Framework in the Event of Emergencies and its Application 1

Current Practice

1. Vanuatu’s fiscal framework allows for swift disbursements to meet immediate needs in the aftermath of national emergencies, including natural disasters. The Public Finance and Economic Management Act allows the authorities to swiftly draw down up to 1.5 percent of a given year’s total appropriation (around 330 million vatu or 0.3 percent of GDP in the 2018 budget), with the prior approval of the Council of Ministers (COM), to either alleviate a state of emergency or a financial emergency. The withdrawal does not require passage in Parliament, but it must be later appropriated by Parliament.

2. In practice, the annual budget sets aside contingency provisions for emergency purposes, given Vanuatu’s high vulnerability to natural disaster risks. The allocation has increased from 25 million vatu in the 2017 budget to 150 million vatu (about 0.6 percent of government-funded expenditure) in 2019.

3. The government used swift disbursement to cope with volcanic eruptions on Ambae and Ambrym islands. A state of emergency was declared on Ambae after the September 2017 eruption and the COM quickly endorsed a 200 million vatu fund (about 0.2 percent of GDP), which was appropriated along with the 2018 budget that December. COM added 40 million vatu in March 2018 to address the devastating impacts from volcanic ash and 200 million vatu in August 2018 upon the compulsory evacuation of Ambae’s population of 10,000. The June 2018 supplementary budget included a further 362 million vatu for disasters. Following December 2018’s volcanic eruption on Ambrym island, the COM put aside up to 100 million vatu from the Ambae recovery fund, adding another 50 million vatu in January 2019. In 2018, the government appropriated a further 532 million vatu for emergency relief from Tropical Cyclone (TC) Hola and again from the Ambae volcanic eruption.

4. The VNPF, as directed by the government, provided financial assistance to its affected members on Ambae. It released about 90 million vatu from their retirement accounts (up to 20 percent) to help rebuild accommodations and livelihoods. Relative to Cyclone-Pam-related withdrawals, the amount is relatively small (1.7 billion vatu), limiting the impact on the VNPF’s liquidity.

5. Development partners have provided financial support and humanitarian assistance in both cases. Some support came through NGOs such as the Red Cross and Oxfam, helping with essential relief, water, sanitation, and education services for the evacuees.

Looking Forward – The Proposed National Emergency Fund

6. To prepare for impacts from prolonged volcano activity, or another large natural disaster like Cyclone Pam, the authorities should consider establishing a multi-year contingency fund. The authorities’ intention to establish an emergency fund under the Disaster Risk Management Act 2018 bill (DRMA) is a welcome step. The authorities (specifically, the Department of Finance within the Ministry of Finance and Economic Management, MFEM) will prescribe a guideline for the use of funds, including procedures for the urgent request of funds and types of emergencies or disasters for which the funds could be utilized. However, those guidelines are not part of the act, and have yet to be defined.

7. The first key issue is the source of funding for the national emergency fund, which can come from a variety of sources. The fund should consist of the government’s contribution and any contribution or donation by other sources – initial gifts from development partners would be desirable. On the part of Vanuatu’s government, the revenue windfall from ECPs could fund it, but this would not be a stable source of funding. Another possibility would be a repeated, permanent government contribution to such a fund. In the current fiscal environment, if the government were to continue with its program to increase revenue mobilization, it could earmark some of the new taxes raised as a substantial contribution, perhaps 0.5 percent of GDP or higher.

8. Second, a strong governance structure is needed to promote transparency and avoid the misuse of the fund. In this regard, IMF staff (Cevik and Huang 2018) provides the following recommendations for establishing and operating a well-designed framework, all highly relevant of Vanuatu:

  • The fund should be consolidated with budget information to allow for a proper assessment of the overall fiscal situation. At a minimum, the fund balance should appear in financial statements, and drawdowns from the fund should appear in budget execution reports.

  • The fund should generally apply best PFM practices to promote transparency. Specifically, it should have clear rules governing the use of resources, follow normal government accounting standards, prepare and publish audited financial statements, and define its governance rules.

  • Drawdowns should be authorized only above a minimum level of fiscal cost, as use of the fund should be limited to responding to disasters with large fiscal impacts.

  • The size of the fund should be based on a calibration of the fiscal impact of natural disasters. Too much cash accumulated in a fund might tempt policymakers to use it for other purposes.

  • The fund’s financial investment strategy should aim to maintain a relatively high degree of liquidity, given the potential urgency of disaster relief expenditure. The fund should invest in liquid foreign assets because of the high likelihood of post-disaster stress in domestic financial markets.

9. The current intentions for the fund are not yet clearly articulated. The Vanuatu government, in the DRMA bill, establishes the fund, but without stating any details, leaving it to future guidelines. Staff recommends that the purpose of the fund, in line with best practice, should be for large disasters, and should consider providing more than just immediate assistance. Such a fund could finance, for example, disasters such as the Ambae island volcanic eruption, which required both a large-scale evacuation and financial support to victims to both establish them in their new locations and until more permanent solutions could be formulated. For Vanuatu, this suggests the need for a large fund, with suggestions for quantification below.

10. Establishing the size of the fund can be calibrated from prior experiences in Vanuatu and elsewhere, and analytical work from other international organizations. This provides two approaches. Prior country experiences are best for understanding the amount required for immediate relief. Analytical work provides a fuller view on longer-term demands on the fund.

11. Immediate relief costs are best indicated by experiences in Vanuatu, and preparatory measures in other Pacific island states. After Vanuatu was hit by Cyclone Pam in 2015, the government used its own resources, amounting to 401.6 million vatu (about 0.5 percent of GDP), for the relief and recovery efforts. In 2017 and 2018, the government appropriated 200 million vatu (about 0.2 percent of GDP) and 532 million (about 0.5 percent of GDP), respectively, for emergency relief for Ambae volcano and TC Hola. A cross-country experience shows that Fiji has a National Disaster Relief and Rehabilitation Fund, whose size is US$1.9 million (0.04 percent of GDP) as of March 2019, while Marshall Islands had US$1.5 million (0.8 percent of GDP) of a Disaster Assistance Emergency Fund as of June 2013.

12. If the fund has a more ambitious intent to also contribute to longer-term support or perhaps even starting reconstruction, its size would need to be much larger. PCRAFI (2015) estimates that Vanuatu will incur average annual long-term annual losses of US$48 million because of cyclones and earthquakes. Public sector assets have no insurance coverage, and the insurance market overall is small, with yearly premiums totaling only US$13.5 million (about 2 percent of GDP) in 2012. In 2015, there was a 50 percent probability of a disaster with losses of over US$330 million, and a 10 percent probability of one greater than US$540 million. TC Pam fit this definition, yet the risk remains.

13. The intention to establish a national emergency fund is a welcome development. However, it will require a clear purpose for either immediate relief or perhaps some contributions to reconstruction, and strong funding with strong rules to govern those funds – something not yet established under the proposed DRMA bill. Having a fund of sufficient size would also reduce potential pressures on Vanuatu’s external position when addressing natural disasters, particularly large ones.

References

  • Cevik, Serhan, and Guohua Huang, 2018, “How to Manage the Fiscal Costs of Natural Disasters,” How To Notes, 2018/03 (Washington: Fiscal Affairs Department, International Monetary Fund).

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  • Pacific Catastrophe Risk Assessment and Financing Initiative (PCRAFI), 2015, “Vanuatu: Disaster Risk Financing and Insurance,” Country Note, 2015/02, (Washington: World Bank.)

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Annex VIII. Implementation of the Enhanced General Data Dissemination System (e-GDDS) 1

Vanuatu published at the end of April 2019 key macroeconomic data in a new National Summary Data Page (NSDP) under the enhanced General Data Dissemination System (e-GDDS) to support surveillance and improve data transparency. This will represent a major structural reform in statistical developments and help create strong synergies between data dissemination and surveillance.

1. A renewed data initiative. The e-GDDS was established in May 2015 resulting from introduction of new features to the General Data Dissemination System. The e-GDDS refocuses on data dissemination to support transparency, encourage statistical development, and help create strong synergies between data dissemination and surveillance. It is designed to assist participants in improving data transparency and governance through release of key macroeconomic and financial data in a standardized format and disciplined manner. Implementation of the e-GDDS would lead to structural change in countries’ statistical system. Staff analysis has shown that data transparency reforms reduce borrowing costs and enhance resilience of the economy (Choi and Hashimoto, 2017).

2. A focus on dissemination of data for surveillance. The e-GDDS recommends dissemination of 15 data categories that are considered essential for the analysis and monitoring of macroeconomic and financial conditions. These data categories are aligned with those as listed in the Table of Common Indictors Required for Surveillance (TCIRS). Such alignment facilitates to integrate and leverage both e-GDDS and data provision for TCIRS and create synergies given the central role of TCIRS in surveillance activities.

3. An impetus given to data dissemination as part of the e-GDDS framework. An STA mission visited Vanuatu in August 2018 to support the authorities in preparing to publish key macroeconomic data via NSDP. The authorities committed to publish all core e-GDDS data categories except for general government operations and stock market. Currently there is only one level of government in Vanuatu—fully covered by the central government—and no stock market exists in the country. The authorities have also opted to disseminate two supplementary datasets— labor market indicators and financial soundness indicators. Other additional datasets for publication to support surveillance work include tourism statistics, government bonds outstanding, and financial access survey. The implementation of NSDP has accelerated the authorities’ ongoing efforts to enhance data dissemination via improved data coverage and user accessibility. It has also helped to identify data gaps and thus high priority areas for targeted technical assistance. As a result, data for the Balance of Payments (BOP) and the International Investment Position (IIP) will be included in the NSDP at a later stage, so that the authorities may benefit from an STA technical assistance mission in May 2019 to help further improve BOP and IIP data.

4. NSDP’s features and benefits. The NSDP is a national “data portal” that assembles links for e-GDDS recommended data categories and supplementary datasets for a country. The links provide access to time series in formats readable by humans and computers. These data are usually compiled by multiple agencies, but their dissemination and regular updating are coordinated by one designated agency.

uA01fig16

Inputs and Outputs for the National Summary Data Page

Citation: IMF Staff Country Reports 2019, 162; 10.5089/9781498319485.002.A001

Source: IMF Statistics Department.

The NSDP benefits data users with (i) browse data via link to online datasets that can be easily viewed in time series format or as graphics; (ii) download data in SDMX, a format used for machine-to-machine data sharing; and (iii) access to metadata, which describes a country’s practice for data compilation and dissemination. The NSDP also benefits (i) data reporters by reducing reporting burden via posting data in one data portal in a standardized format that can be accessed by different agencies; (ii) data managers by allowing them to control data updating processes; and (iii) international/regional organizations and other institutional data users by making processing easier due to data dissemination in machine readable format.
1

The main development partners are Australia, China, New Zealand, the Asian Development Bank (ADB), the IMF, Japan International Cooperation Agency (JICA), the United Nations Development Program (UNDP), and the World Bank Group (WBG).

2

UN World Risk Index measures exposure to natural hazards and the capacity to cope with and adapt to these events.

3

The currently active economic citizenship programs (ECPs) include the Vanuatu Development Support Program (VDSP) and Vanuatu Contribution Program (VCP), outlined in Box 1 of Vanuatu: 2018 Article IV Consultation, IMF Country Report No. 18/109.

4

The sector comprises five major banks and a large financing company – three established foreign-owned banks (Bank of the South Pacific from Papua New Guinea, ANZ from Australia, and Bred Bank from France), a new foreign-owned bank that will be active only in Vanuatu (Wanfuteng Bank, with owners from Hong Kong SAR), a domestic bank that is majority-government-owned, the National Bank of Vanuatu (NBV), and Credit Corporation Vanuatu Limited, which primarily finances work and personal vehicles. There are also five credit unions (including one for teachers and one for the police force), plus some cooperatives have financial functions, which should shrink over time as the new credit union law, once passed, will force such cooperatives to reestablish as credit unions, shut down, or substantially reduce in size, while facing improved regulatory oversight.

5

See Sahay and others, 2015, “Rethinking Financial Deepening: Stability and Growth in Emerging Markets,” IMF SDN/15/08.

6

Several countries have adopted this approach, Australia’s Council of Financial Regulators being one example. The Council of Financial Regulators comprises the central bank, the prudential regulation authority, the securities commission and the treasury. It meets regularly and publishes minutes of its meetings, discussing a variety of financial sector issues, including prudential policy and regulatory matters.

7

Table 3 outlines the sources of the difference between the government’s favorable domestic net lending versus its debt-expanding overall net borrowing over history and the forecast horizon.

8

See Annex I for more background on the authorities’ new PPG debt-to-GDP target.

9

These figures are consistent with the work of the Revenue Committee of the government, published as the 2017 Vanuatu Revenue Review. Staff have examined this issue before in “Appendix V. Revenue Modernization and Reforms in Vanuatu” in Vanuatu: 2018 Article IV Consultation, IMF Country Report No. 18/109 and “Appendix IV. Revenue Modernization in Vanuatu: Building an Effective Tax System” in Vanuatu: 2016 Article IV Consultation, IMF Country Report No. 16/336.

10

For more on the suggested form of the fund for natural disaster relief as a national emergency fund, see Section E, “Addressing Risks from Natural Disasters.”

11

For more on the 2016 Safeguards Assessment, please refer to the Informational Annex.

1

Prepared by Charlotte Sandoz (APD).

2

See Methodological Note on EBA-lite (mimeo). The revised EBA-lite for Vanuatu cannot be calculated using the REER model due to data limitations. Revised EBA-lite does not capture fully the characteristics of small states, hence there is significant uncertainty around the estimates.

3

As the net international investment position (NIIP) improved in 2018 and debt sustainability is not a concern for the external sustainability in the medium term, the bottom-line assessment only draws from the CA approach. The external sustainability approach, particularly because of the role of rapidly increasing revenues, gives a REER measurement opposite to, and unreconcilable with, the CA approach.

1

Prepared by Hidetaka Nishizawa (APD).

2

In 1985, the World Bank’s Board approved the Small Island Economies Exception in recognition of small islands’ special characteristics (of size, remoteness, etc.). Currently, 15 middle-income small island states have access to IDA under the Exception, including Vanuatu. Small country loan terms are 40 years of maturity, a 10-year grace period, and an interest rate of 0.75 percent.

3

The EIF is a multi-donor program which supports LDCs to increase their participation in the international trading system by strengthening trade institutions and building capacity and country ownership needed to roll-out coordinated trade and development assistance.

4

PACER Plus is a comprehensive free trade agreement covering goods, services and investment. PACER Plus opened for signatures in June 2017, and has been signed by Australia, New Zealand and 9 Pacific island states (Cook Islands, Kiribati, Nauru, Niue, Samoa, Solomon Islands, Tonga, Tuvalu, and Vanuatu). Australia and New Zealand have ratified it, but other signatories are working towards ratification. The PACER Plus will come into force 60 days after being ratified by an eighth signatory.

5

Samoa completed its accession to the EU’s comprehensive Economic Partnership Agreement for Pacific Countries, joining Fiji and Papua New Guinea. The agreement is intended for all Pacific island states. Solomon Islands and Tonga have moved towards negotiating accession agreements.

1

Prepared by Dirk Muir (APD) based on “Appendix VIII. Exchange Rate Issues: Competitors and Sectors” in Vanuatu: 2016 Article IV Consultation, IMF Country Report No. 16/336 by Ricardo Marto (RES).

2

The REER is a function of a weighted average of indexed nominal bilateral exchange rates and inflation differentials. There are several measures of aggregate price fluctuations, such as the consumer price index, wholesale or producer price index, GDP deflator, or unit labor costs, and weights can be underpinned by trade flows in goods or goods and services. For the baseline scenario, inflation differentials are based on consumer price indices and weights in Vanuatu’s effective exchange rates are based on 2013 trade flows – common practice in the IMF’s Information Notice System when calculating any country’s effective exchange rates.

1

Prepared by Charlotte Sandoz (APD).

2

Because of lack of available data, not all countries can be compared after 2013.

1

Prepared by Hidetaka Nishizawa (APD)

1

Prepared by Xiuzhen Chao (STA)

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Cover IMF Staff Country Reports
Vanuatu: 2019 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Vanuatu
Author:
International Monetary Fund. Asia and Pacific Dept
Volume/Issue:
Volume 2019: Issue 162
Publisher:
International Monetary Fund
ISBN:
9781498319485
ISSN:
1934-7685
Pages:
87
DOI:
https://doi.org/10.5089/9781498319485.002

GDP per Capita, 2017

(In U.S dollars)

Real GDP Growth, 2010–18

(In percent year-on-year)

SRD Requirement, Inflation and Credit Growth

(In percent)

Financial Inclusion in the Pacific

(In percent of population)

Vanuatu: Public Debt Financing Scenarios

(in percent of GDP)

Vanuatu: Governance 1/ 2/

(Lower scores indicate weaker governance)
Figure 1.

Vanuatu: Reconstruction is Drawing to a Close but Growth Could be Stronger
Figure 2.

Vanuatu: Development Projects Exert Pressure on External Balances While Stimulating Growth
Figure 3.

Vanuatu: Public Finance Needs More Reform While Monetary Policy is Supportive
Figure 4.

Vanuatu: Financial Sector is in Recovery, while Financial Inclusion is Increasing

Official Foreign Exchange Reserves

(In millions of US dollars)

Exchange Rates with U.S. and Australian Dollars

(Percentage change between 2018H2 and 2016H2)

Nominal Effective Exchange Rates

(Index, 2010=100)

Real Effective Exchange Rates

(Index, 2010=100)

Vanuatu Real Effective Exchange Rates

(Index, 2010=100)

Inflows in Foreign Currencies and Domestic Money Supply

Loan-to-DeposJt Ratio for Selected Pacific Islands

(In percent)

Domestic Banks Liquidity in Vanuatu

(In percent, Base 1 = 2009)

Policy and Lending Rates in Fiji

(In percent)

Inputs and Outputs for the National Summary Data Page