Vanuatu: Staff Report for the 2019 Article IV Consultation—Debt Sustainability Analysis
Author: International Monetary Fund. Asia and Pacific Dept
Publication Date:
13 Jun 2019
eISBN:
9781498319485
Language:
English
Keywords:
ISCR; CR; authority; Vanuatu; exchange rate; debt; sustainability analysis; debt sustainability; dynamics equation; creating flow; debt carrying capacity; Natural disasters; Debt sustainability analysis; Public and publicly-guaranteed external debt; Pacific Islands; debt indicator
Download PDF (492.7 KB)

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

Public Debt Coverage

1. The coverage of public sector debt for this debt sustainability analysis is central government debt, central government-guaranteed debt, and central bank debt, which has been borrowed on behalf of the government. 2 Because of data limitations, non-guaranteed SOE debt and private external debt are not included in the analysis.3 Given the limited capacity to borrow both externally and domestically by Vanuatu’s state and local governments, SOEs and its private sector, data deficiencies do not affect the overall assessment.

Coverage of Public Sector Debt

article image

Background on Debt

2. After Cyclone Pam struck Vanuatu in 2015, public sector debt has increased sharply to 52.4 percent of GDP in 2018 from 26.1 percent in 2014. This was mainly caused by new disbursement for infrastructure development supported by bilateral partners, including the Japan International Cooperation Agency (JICA) and the Export-Import Bank of China (China EXIM Bank). In addition to the IMF’s disbursement of USD 23.8 million in June 2015, the IDA and ADB have provided loans and grants to support the reconstruction and improvement of roads and schools. As of end-2018, the share of bilateral and multilateral creditors amounted to 51.7 and 31.2 percent of total public debt, respectively. Of public domestic debt, central government bonds were largely held by public corporations (primarily the Vanuatu National Provident Fund, VNPF), followed by the Reserve Bank of Vanuatu (RBV) and commercial banks. There are also government-guaranteed debts for state-owned enterprises (SOEs), such as Air Vanuatu prior to 2019.4

Stock of Public Debt (External and Domestic) at End-2018

article image
Source: Vanuatu authorities and IMF staff estimates.

3. Windfall revenues from the economic citizenship programs (ECPs) have enabled the authorities to embark on a debt reduction program.5 They paid off domestic and external debt in the amount of VUV 1.8 billion and VUV 1.5 billion, respectively, in 2018. External loan repayments included VUV 1.0 billion to China, VUV 0.4 billion to the ADB, and VUV 60 million to the IDA.

4. Following the end of the Tanna and Malekula Road Rehabilitation and Upgrade Program (Phase I), the authorities signed a Phase II loan agreement, amounting to VUV 5.7 billion, with China in November 2018. As the Phase II project was effectively an extension of the Phase I project, the financing terms and grant element were the same.6 The grant element was 29.2 percent, lower than the authorities’ commitment of a 35 percent grant component, which was first introduced in 2015 under its Debt Management Strategy (2015–17), one year after the Phase I project was signed. The authorities intend to retain their 35 percent grant component target as they update the debt management strategy.

Background on Macroeconomic Forecasts

5. Similar to the last DSA, the baseline scenario, which is consistent with the macroeconomic framework, incorporates the effects of natural disasters and climate change over the longer-term. The years 2019–24 are assumed to be free from newly-occurring major, costly disasters to simplify the policy discussion of the near-term outlook – standard practice in DSAs for other Pacific island small states with a similar risk profile. However, from 2025 onwards, the baseline incorporates the average long-term effects of natural disasters and climate change. Based on staff’s research on the impact of natural disasters, real GDP growth is lowered by 0.5 percentage points annually, the current account deficit is raised by 1.3 percentage points of GDP and the fiscal deficit is increased by 0.35 percentage points of GDP relative to disaster-free projections.7 The projected changes in 2025 for these three variables are smaller than the effects listed above. This is because real GDP growth is projected to rise in 2025 (in the absence of newly-occurring natural disasters), as the negative effect of recent natural disasters such as the Ambae and Ambryn volcanic eruptions and Cyclone Oma wanes. Similarly, the assumed increase in the fiscal and current account deficits from 2025 onwards (due to incorporation of the average effect of natural disasters and climate change) is masked somewhat by a coincident decline in the projected acquisition of non-financial assets. The discount rate used to calculate the net present value of external debt remains at 5 percent. The main assumptions are:

  • Real GDP growth is projected at 2.8 percent on average during 2019–29, which is lower than growth rates in the past three years, during which public investment has boomed and reconstruction efforts have been ongoing after Cyclone Pam. It is also lower than the 10-year average of 3.1 percent in the previous DSA, better reflecting the authorities’ longstanding views.

  • Inflation (measured by the GDP price deflator) is projected to average 2.2 percent (in U.S. dollar terms, the relevant measure for external debt), and 2.5 percent (in domestic currency term, the relevant measure for public debt) during 2019–29 both similar to their historical averages.

  • The non-interest current account deficit is projected to rise to 3.8 percent of GDP on average over 2019–29, relative to the historical average of 2.7 percent. This reflects the high import content for key infrastructure projects. It is lower than last year’s assumption of 6.6 percent because of higher expected ECP revenues and remittances.

  • Foreign direct investment inflows are expected to average 3.3 percent of GDP over 2019–29, lower than the historical average of 5.1 percent, which included the post-Cyclone-Pam investment boom.

  • The primary deficit is expected to be 3.1 percent of GDP on average over 2019–2029, more negative than the historical average of 1.1 percent and last year’s assumption of 2.5 percent. This reflects higher infrastructure spending going forward than the previous DSA, and a more accurate accounting of maintenance costs for infrastructure. Staff does not take into account the possible introduction of income taxes.

  • External borrowing and grants will continue to be strong. Borrowing is driven in the short term by the disbursements for the new USD 51 million project supported by China, that should take place from 2019 to 2021. From 2022 onwards, staff assumes a slightly lower disbursement as a percent of GDP from bilateral development partners. The level of new annual external borrowing is expected to average around 5.0 percent of GDP, higher than last year’s assumption of 4.2 percent of GDP, reflecting the new loan from China and the authorities’ increased willingness to borrow externally to promote infrastructure development. Grant and lending flows from multilateral development partners are expected to increase over the medium term because of the scaling-up of IDA and ADB financing.8 However, grants are expected to decline over the longer term, as the country’s economy grows.

  • The government-guaranteed debts as of end-2018 will continue for the projection period. Staff assumed that the government would not provide any guarantees for any new borrowing by SOEs, including Air Vanuatu.

6. The realism tool highlights that assumptions on the primary balance are conservative (Figure 4). The three-year adjustment in the primary deficit between 2018 and 2021 is at 8.9 percent of GDP. The deteriorating fiscal position is based on a conservative assumption for the proceeds from the ECPs and stronger infrastructure spending. The assumption on real growth in 2019 and 2020 is lower than possible growth paths which are calculated by the model based on a one-year fiscal adjustment. Two charts on public and private investment rates and their contributions to real GDP growth are not available because of a lack of data. Staff will try to estimate the capital stock if relevant information becomes available.

Figure 1.
Figure 1.

Vanuatu: Indicators of Public and Publicly Guaranteed External Debt under Alternative Scenarios, 2019–29 1/

Citation: IMF Staff Country Reports 2019, 162; 10.5089/9781498319485.002.A003

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in or before 2029. Stress tests with one-off breaches are also presented (if any), while these one-off breaches are deemed away for mechanical signals. When a stress test with a one-off breach happens to be the most exterme shock even after disregarding the one-off breach, only that stress test (with a one-off breach) would be presented.2/ The magnitude of shocks used for the commodity price shock stress test are based on the commodity prices outlook prepared by the IMF research department.
Figure 2.
Figure 2.

Vanuatu: Indicators of Public Debt Under Alternative Scenarios, 2019–29 1/

Citation: IMF Staff Country Reports 2019, 162; 10.5089/9781498319485.002.A003

* Note: The public DSA allows for domestic financing to cover the additional financing needs generated by the shocks under the stress tests in the public DSA. Default terms of marginal debt are based on baseline 10-year projections.Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio in or before 2029. The stress test with a one-off breach is also presented (if any), while the one-off breach is deemed away for mechanical signals. When a stress test with a one-off breach happens to be the most exterme shock even after disregarding the one-off breach, only that stress test (with a one-off breach) would be presented.
Figure 3.
Figure 3.

Vanuatu: Drivers of Debt Dynamics – Baseline Scenario

Citation: IMF Staff Country Reports 2019, 162; 10.5089/9781498319485.002.A003

1/ Difference between anticipated and actual contributions on debt ratios.2/Distribution across LICs for which LIC DSAs were produced.3/Given the relatively low private external debt for average low-income countries, a ppt change in PPG external debt should be largely explained by the drivers of the external debt dynamics equation.
Figure 4.
Figure 4.

Vanuatu: Realism Tools

Citation: IMF Staff Country Reports 2019, 162; 10.5089/9781498319485.002.A003

Vanuatu: Baseline Macroeconomic Assumption

(In percent of GDP, unless otherwise stated)

article image
Source: IMF staff projections.

Country Classification

7. The country’s debt-carrying capacity as applied in the 2019 DSA is medium. The Composite Indicator (CI) index for Vanuatu, which has been calculated based on the April 2019 WEO (but with updated data on remittances) and the 2017 CPIA, is 2.94, indicating that the county’s debt-carrying capacity would be medium in the revised LIC-DSF framework.

Calculation of the CI Index

article image
Source: IMF staff calculations.

8. The relevant indicative thresholds for the medium category are: 40 percent for the PV of debt-to-GDP ratio,180 percent for the PV of the debt-to-exports ratio, 15 percent for the debt service-to-exports ratio, and 18 percent for the debt service-to-revenue ratio. These thresholds are applicable to public and publicly guaranteed (PPG) external debt. The benchmark for the PV of total public sector debt under medium debt carrying capacity is 55 percent of GDP.

PPG External Debt Thresholds and Total Public Debt Benchmarks

article image

Determination of Scenario Stress Tests

9. Given Vanuatu’s vulnerability to natural disasters, staff conducted a tailored stress test for a natural disaster shock. Vanuatu, which is defined as a small developing natural-disaster-prone state in the IMF (2016) policy paper on small states, is automatically subject to the LIC-DSF standard natural disaster shock. This is a one-off shock of 10 percentage points to the debt-to-GDP ratio in the second year of the projection period (2020 in this case). Staff adjusted the default parameters by assuming a reduction of real GDP and export growth by 4 and 10 percentage points respectively. 9 For combined contingent liability shock, staff adjusted the levels for the increase in public debt from SOEs from 2 percent to 4 percent of GDP to reflect the government’s financial support to Air Vanuatu in 2019.10 Staff continued using the default decrease in GDP of 5 percent from financial market turbulence. For Vanuatu, the default 5 percent of GDP value of the contingent liability can be interpreted as including a capital injection to an undercapitalized domestic bank.

Combined Contingent Liability Shock

article image

The default shock of 2% of GDP will be triggered for countries whose government-guaranteed debt is not fully captured under the country’s public debt definition (1.). If it is already included in the government debt (1.) and risks associated with SoE’s debt not guaranteed by the government is assessed to be negligible, a country team may reduce this to 0%.

Debt Sustainability

A. External Debt Sustainability Analysis

10. All external PPG debt indicators remain below the policy-relevant thresholds for the projection period under the baseline scenario (Figure 1 and Table 1). These thresholds include the present value (PV) of the external-debt-to-GDP ratio, the PV of the external-debt-to-exports ratio, the external-debt-service-to-exports ratio, and the external-debt-service-to-revenue ratio. The PV of external-debt-to GDP ratio is expected to increase continuously from 27.0 percent in 2018 to 35.6 percent in 2029 mainly because of new disbursements for key infrastructure projects. As Figure 3 shows, the main driver of debt dynamics during the projection period is the current account deficit.

Table 1.

Vanuatu: External Debt Sustainability Framework, Baseline Scenario, 2016–39

(In percent of GDP, unless otherwise indicated)

article image
Sources: Country authorities; and staff estimates and projections.

Includes both public and private sector external debt.

Derived as [r – g – ρ(1 +g) + εα(1 + r)]/(1 +g+ρ+gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, ρ = growth rate of GDP deflator in U.S. dollar terms, ε = nominal appreciation of the local currency, and α = share of local currency-denominated external debt in total external debt.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate changes.

Current-year interest payments divided by previous period debt stock.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).

Assumes that PVof private sector debt is equivalent to its face value.

Historical averages are generally derived over the past 10 years, subject to data availability, whereas projections averages are over the first year of projection and the next 10 years.

11. The stress tests indicate that a tailored natural disaster shock has the largest impact on debt trajectory, causing a breach of the external-debt-to-GDP threshold from 2024 onwards. This suggests the need for rebuilding fiscal buffers to enhance resilience against natural disasters. Other tests, including shocks to exports, other flows and the nominal exchange rate (depreciation), would also lead to breaches in the thresholds (Table 3). The export shock, which was the largest impact under the 2018 DSA, still is the fourth largest impact, which continues to suggest the need for expanding the export base through economic diversification.

Table 2.

Vanuatu: Public Sector Debt Sustainability Framework, Baseline Scenario, 2016–39

(In percent of GDP, unless otherwise indicated)

article image
Sources: Country authorities; and staff estimates and projections.

Coverage of debt: The central government, central bank, government-guaranteed debt. Definition of external debt is Residency-based.

The underlying PV of external debt-to-GDP ratio under the public DSA differs from the external DSA with the size of differences depending on exchange rates projections.

Debt service is defined as the sum of interest and amortization of medium and long-term, and short-term debt.

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period and other debt creating/reducing flows.

Defined as a primary deficit minus a change in the public debt-to-GDP ratio ((-): a primary surplus), which would stabilizes the debt ratio only in the year in question.

Historical averages are generally derived over the past 10 years, subject to data availability, whereas projections averages are over the first year of projection and the next 10 years.

Table 3.

Vanuatu: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2019–29

(In percent)

article image
Sources: Country authorities; and staff estimates and projections.

A bold value indicates a breach of the threshold.

Variables include real GDP growth, GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

Includes official and private transfers and FDI.