Republic of Nauru: 2019 Article IV Consultation—Press Release; Staff Report; and Statement by the Executive Director for the Republic of Nauru

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

Abstract

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

Context

1. Nauru has a narrow economic base and limited capacity in both the public and private sectors. Nauru is a micro-state with a land area of about 8 square miles and a population of around 12,500 in 2015. Extensive phosphate mining has left most of Nauru’s land unusable. When phosphate revenues peaked in the early 1990s, Nauru briefly became one of the world’s richest nations—the Nauru Phosphate Royalty Trust (NPRT) fund held more than A$1 million per capita. Declining phosphate revenue and weak management of public finances led to economic decline, depletion of the NPRT, and collapse of state-owned enterprises (SOEs), including the Bank of Nauru. In FY2012 the economy was boosted by the establishment of the Australian Regional Processing Center (RPC) for asylum seekers, alongside higher revenue from fishing license fees and a pick-up in residual phosphate mining activity.1 Nauru established a new trust fund in FY2016 aimed at providing long-term fiscal financing (Box 1).

2. The key economic challenge is to develop new sources of economic activity and income. Preparing for and managing the scaling down in RPC activity is a key policy priority. Increased fishing license revenues have provided welcome diversification, but private sector development is hampered by infrastructure and capacity limitations. Nauru is vulnerable to climate change and exhibits worse social indicators than peers (Text Figure 1).

Text Figure 1.
Text Figure 1.

Nauru Social Indicators

Citation: IMF Staff Country Reports 2020, 031; 10.5089/9781513528434.002.A001

3. Governance challenges result in inefficient management of resources and create vulnerabilities to corruption, which weaken growth. Main risks stem from fiscal governance (PFM controls), lack of accountability and monitoring of SOEs, weaknesses in the rule of law (investor protection and contracts), and the AML/CFT framework. Mitigating governance risks will require a long-term effort, with greater transparency in key areas and a robust accountability framework for SOEs.

4. Nauru’s economic policies in FY2018 and FY2019 were partly in line with previous IMF advice (Annex I). Fiscal surpluses have been maintained, and a cash buffer was created in 2018 following the 2017 Article IV recommendations. Progress has been achieved in strengthening revenue administration, and plans are underway to introduce a consumption tax. Fiscal transparency has improved with budget documents now published online. Further efforts are needed to better prioritize expenditures in line with the National Development Strategy and to strengthen public debt management.

Recent Developments, Outlook, and Risks

5. Following a rebound in FY2018, growth has slowed due to reduced activity in phosphate mining and at the RPC. Economic activity rebounded in FY2018 and moderated in FY2019. A higher-than-expected refugee presence in FY2018, alongside strong fishing activity and preparations for hosting of the Pacific Island Forum, contributed to a pick-up in growth to 5.7 percent. However, lower numbers of refugees and asylum seekers have reduced activity in FY2019, and growth is estimated to have slowed to 1.0 percent. Inflation moderated to 0.5 percent in FY2018 mirroring low inflation in Australia but picked up to 3.9 percent in March 2019.

uA01fig01

Nauru: Contribution to Real GDP growth

(Percent, year-on-year change)

Citation: IMF Staff Country Reports 2020, 031; 10.5089/9781513528434.002.A001

Source : Nauru authorities, and IMF staff estimates and projections.

6. The FY2019 fiscal surplus is estimated at 16.1 percent of GDP. The surplus reflects a 12 percent of GDP spike in fishing revenue partly offset by expenditure growth from subsidies and a wage increase related to the new superannuation fund (Box 2). Surpluses have been used to contribute to the Trust Fund, build government deposits, and reduce arrears. In FY2019 government deposits increased to 35.7 percent of GDP, and the Trust Fund to 63.6 percent of GDP (A$105.2 million). Total public debt—including SOE debt—increased to A$138.8 million (86.8 percent of GDP) in 2018 reflecting a new loan from Taiwan Province of China to purchase equipment for secondary phosphate mining.

7. Nauru’s external position in FY2018 is substantially weaker than implied by medium-term fundamentals and desirable policies (Annex 2). The current account balance (CAB) deteriorated in FY2018 due to reduced RPC and phosphate activity. It recorded a deficit of around 4.6 percent of GDP in FY2018 after a surplus of 12.7 percent of GDP in FY2017. The CAB is estimated to have returned to a surplus in FY2019 due to a spike in fishing revenue inflow. The sustainability of the external sector will depend critically on exogenous factors such as RPC activity, fishing license fees and donor support, while REER changes have only a limited impact.

8. The macroeconomic outlook depends on RPC activity, fishing revenues, and completion of infrastructure projects. It is estimated that 300 refugees and asylum seekers will remain in Nauru in FY2020. On this basis growth is expected to moderate further to 0.6 percent in FY2020. Medium-term growth is projected to strengthen to around 2 percent, supported by improved infrastructure and structural reforms. Average inflation is projected to remain low, in line with Australian inflation and stable commodity prices. The current account balance is expected to deteriorate over the medium term with an average deficit of around 5 percent of GDP due to reduced phosphate mining, reduced RPC activity, and normalizing fishing license fees.

9. Nauru and Australia have signed an agreement for a “hybrid” model of joint management of RPC commercial operations and services for the current financial year. Under the new hybrid model much of the core RPC activity is expected to remain under Australian control. However, Nauru will have responsibility for certain activities with corresponding profit-making opportunities. The authorities are also engaged in negotiations with Australia for increased revenues related to maintaining the RPC, even if activity is to decline. As part of the management arrangements for FY19/20 the authorities received an additional A$21.1 million in the form of a “hosting fee”, which has boosted spending for the year. However, arrangements for hosting fee payments in future years are currently unknown.

10. The fiscal surplus will be maintained in the near term but turn to deficit over the medium term. Over the medium-term staff projects revenue to decline as around 30 percent of revenue is linked to RPC operations and is unsustainable in the long run. At the same time, staff projects expenditure to revert to around the FY2018 level in terms of percent of GDP, meaning that the fiscal surplus declines through the projection period, until turning to deficit in 2024. As it declines, the fiscal surplus will no longer be available to fund Nauru’s committed contributions to the Trust Fund. Staff projections assume that the planned Trust Fund contributions will continue, at first through reductions in the cash balance, and later through payment arrears and increased domestic debt.

11. Risks are skewed to the downside (Annex III, RAM). Downside risks include a faster-than-expected scaling down of RPC activity, and delays in fiscal and structural reforms. Adverse spillovers from global developments are likely to be limited, but weaker-than-expected global growth and volatility in commodity prices could affect fishing revenue. On the upside, positive spillovers from the RPC operations (such as small business development) and higher-than-expected fishing revenue would boost activity and improve fiscal space.

Authorities’ Views

12. The authorities agreed that the near-term outlook for growth and government revenue is highly uncertain but took a more optimistic view of the balance of risks. The authorities agreed that the wind-down of RPC and phosphate activity posed downside risks to revenues and growth but were positive about negotiations with the Australian government on the RPC. They noted that the new “hybrid model” would see a larger Nauruan role in providing services. While agreeing that fishing revenues are potentially volatile, the authorities noted that Nauru has experienced relatively stable demand for its fishing days, as its fish stock has been less sensitive to the impact of shifts in ocean temperatures compared to other Pacific countries. The government is reviewing the plans for secondary phosphate mining given the sharp decrease in phosphate prices.

Ensuring Fiscal Sustainability

Fiscal sustainability is threatened by declining RPC revenues, mandatory Trust Fund contributions, and rising non-priority spending. Spending prioritization is needed to adequately provide for infrastructure, health, education and climate change adaptation. Governance improvements are needed to raise the quality of public services and reduce vulnerabilities to corruption. Debt is unsustainable under current policies, and renewed effort is needed to reconcile and resolve long-standing debt arrears.

13. Fiscal policy is anchored by the government’s commitment to achieve a positive budget balance (text box 1). At a minimum, the budget is expected to run a surplus that is sufficient to meet the mandatory annual Trust Fund contribution of 8–12 percent of domestic revenue. As the Trust Fund is not accessible until 2033, and borrowing capacity is constrained, government deposits effectively represent the country’s fiscal space (and also its stock of foreign exchange reserves). Government deposits include a “cash buffer”, which was recommended by staff for liquidity management purposes.2 Additional buffers to prepare for further RPC scale down may be needed, but it is difficult to determine the size due to uncertainty about the pace and magnitude of the scale down.

14. A fiscal adjustment plan is needed to avoid a breach of the fiscal anchor and ensure debt sustainability (text box 1 and text figure 2). Under the baseline with unchanged policies, the fiscal balance would be insufficient to make the required Trust Fund contributions from FY2021 onward and the public debt-to-GDP ratio would begin rising in FY2024. Staff recommends a multi-year adjustment plan on both revenue and expenditure sides:

  • Reduce expenditure by 5 percent of GDP on average over the medium term, compared to baseline. The FY2021 budget offers an opportunity to begin reorienting spending priorities and reduce current spending through a combination of: constant public employment, maintaining public sector wages and transfers constant in real terms, eliminating unproductive spending (subsidies), and better targeting of social programs.

  • Increase tax revenue by 1 percent of GDP on average over the medium term, compared to baseline. Staff welcomes the authorities continued interest in tax reform, including the introduction of a consumption tax and strengthening revenue administration and compliance.

Text Figure 2.
Text Figure 2.

Fiscal Policy: Authorities’ Baseline and Staff’s Suggested Policy Scenario

Citation: IMF Staff Country Reports 2020, 031; 10.5089/9781513528434.002.A001

Nauru’s Fiscal Framework

Nauru’s fiscal framework comprises three “fiscal responsibility ratios” that guide budget planning, a commitment to Trust Fund contributions, and a target cash buffer.

  • The fiscal responsibility ratios are: The fiscal balance to GDP ratio must not be negative; personnel costs must be less than 30 percent of current expenditure; and tax revenue be maintained within 25 percent of GDP.

  • Nauru’s fiscal surplus to fund the Trust Fund contributions. The Trust Fund MOUs require Nauru to contribute 10–12 percent of domestic revenue to the Trust Fund when domestic revenue is greater than AU$100 million. Nauru’s domestic revenue has exceeded AU$100 million since FY2016 and is expected to remain in this range over the medium term. The Trust Fund Committee has discretion to adjust contributions but the exact conditions that would trigger the flexibility are unclear.

  • A “cash buffer” of at least 2 months of non-RPC recurrent spending should be held in government deposits. Total government deposits currently exceed 2 months of non-RPC spending, but the deposit account that was established as the “cash buffer account” (a fixed term account) is about 0.9 months of non-RPC spending.

The main fiscal anchor is the need for fiscal surpluses to be sufficiently large to fund Trust Fund contributions. The cash buffer requirement also adds to the magnitude of the surplus.

If the fiscal adjustment cannot be fully implemented then Trust Fund contributions may need to be reduced, at the cost of lower Trust Fund revenues in future.

15. With the cash buffer target of two months of non-RPC current spending yet to be reached, staff recommends the following steps to safeguard the cash buffer:

  • Provide guidance on use and replenishment of the cash buffer within the fiscal framework. The cash buffer should ease day-to-day cash management and provide the flexibility to respond to shocks.

  • Establish a cash management unit (CMU) and a cash management committee (CMC). The CMU would prepare cash flow forecasts for the CMC to smooth the payments profile in line with cash availability and ensure the cash balance target is maintained. The CMU would regularly update the CMC on plans and adjust as required.

16. The authorities have reformed the tax system over recent years. An employment and services tax was introduced in 2014 (FY2015), followed by a business profits tax in 2016 (FY2017) and improvements in customs and tax administration. The tax reforms have increased tax revenues, but not to a level sufficient to offset the projected decline in RPC revenue. The bulk of domestic taxes are levied on and paid by expatriate workers.

Text Table 1.

Nauru: Central Government Operations, Baseline and Reform Scenario, FY2015–24

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

Under the baseline scenario, current policies would deplete government deposits by FY2023 and require borrowing of around 2.1 months of non-RPC spending in FY2024. With the expected yield from measures, the borrowing is avoided and the government deposit target of 2 months of non-RPC current spending achieved.

17. Further tax reform is an opportunity to generate revenue more efficiently. Increased domestic tax revenue will be needed to offset lost customs revenue from Nauru’s ratification of the Pacific Agreement on Closer Economic Relations Plus (PACER Plus) and loss of revenue from a scaling down in RPC activity.3 The focus on introducing a consumption tax in the near term is appropriate, but for the reform to yield expected results it requires careful design (including choice of tax base and rate structure), sequencing and timing of implementation, as well as modernization of the tax administration. Staff recommends setting tax reform in a comprehensive medium-term revenue strategy to coordinate broad based reforms. The IMF is available to provide advice through PFTAC. As most Nauru citizens do not have experience of paying tax, policy changes will require careful communication to engender taxpayer compliance.

18. Improved public financial management (PFM) is needed to improve fiscal discipline and the quality of spending, based on the PFM roadmap. The authorities are working to address the issues identified during the 2016 PEFA assessment, following their PFM roadmap. Good progress has been made towards improvement in transparency, with the online availability of budget statements (see also paragraph 32). Staff encourages continued focus on PFM reform, given weaknesses remaining to be addressed. Staff recommends:

  • Limiting the use of supplementary budgets. Supplementary budgets have been used excessively, with six issued in FY2018/19 and three so far in FY2019/20to increase spending of windfall revenues in non-priority areas. Staff encourages the authorities to set aside windfall revenues for appropriation in the normal budget cycle rather than through a supplementary budget process. Windfall revenues should be used to boost resources for carefully planned investment spending.

  • Continuing efforts to reconcile government accounts. Continued work is needed to reduce the large discrepancies between recorded revenues and expenditures, and government financing data.

  • Phasing out the use of cash for tax and other payments. While large taxpayers make online tax payments, many smaller tax payers still pay in cash, and government departments are often handling cash. The handling of cash should be phased out to strengthen financial controls, improve accountability, and reduce corruption vulnerabilities.

19. Implementation of the new Public Enterprises Act is a high priority. Poorly performing SOEs absorb large amounts of scarce capital on which they provide low returns and divert government resources from other critical investments.4 Performance improvement in the National Utilities Corporation (NUC) demonstrates the benefits of successful SOE reform. Staff welcomes the new Public Enterprises Act (2019), which provides for the establishment of an SOE monitoring committee and requires quarterly financial reporting. The next step will be to implement the Act and ensure that SOEs meet the Act’s requirements, particularly regarding submission and publication of audited financial statements, given long-standing gaps in financial reporting.

20. Staff emphasizes sound public debt management, including reconciling and resolving old debts, to ensure debt sustainability and improve Nauru’s access to credit markets (Annex IV, DSA). A reasonable resolution of the yen-denominated bonds would remove a large share of total government debt. Reconciliation work to identify amounts owed by SOEs, including outstanding royalty payments to landowners by the Nauru Phosphate Trust Fund and RONPHOS, should be expedited to resolve these debts. Staff assesses public debt as unsustainable under current policies.

Authorities’ Views

21. The authorities are committed to maintaining fiscal and debt sustainability. They agreed on the need to adjust spending if RPC revenues were to fall in line with the staff’s baseline projection. They noted that tax reform should not push up consumer prices and would seek to preserve government revenue at current levels. Any new taxes should be easy to implement and monitor and would preferably be imposed at the border. The authorities have commenced modernization of taxpayer records and data and welcomed PFTAC assistance in this area. They agreed with staff’s recommended target cash buffer and intended to press ahead with public enterprise reform and establish the SOE monitoring unit, in accordance with the new Public Enterprise Act.

Financial Sector

22. Efforts in financial sector reforms are commendable but challenges remain (Box 3). The Bendigo Bank Agency (the “agency”), the sole financial institution and provider of financial services in Nauru, has helped in reestablishing trust in the financial sector, contributing to improvements in financial inclusion and payment services. The agency recently opened its first US correspondent bank account and is seeking to open correspondent bank accounts in other major currencies. Efforts to improve financial literacy should continue.

23. Availability of formal credit products is needed to support private sector growth. Staff encourages the authorities to work towards developing new credit legislation, to pave the way for micro-finance loans and potentially other forms of credit such as working capital.

Economic Diversification, Inclusive Growth

24. Significant opportunity exists to diversify the economy and create jobs through private sector development. Steps are needed to streamline business registration requirements, reduce high business visa fees, develop a credit act, and pave the way for the reintroduction of an insurance product. Legislation that reduces incentives for non-citizens to invest should be reviewed and amended if necessary. SOE reform should involve the opening of non-performing SOEs to private sector management or ownership. Over time, overcoming barriers to land use will require solutions that benefit all parties. Staff encourages the authorities to work with the private sector through regularized dialogue to identify measures that can be implemented in the near term to improve the business environment.

25. The business environment will benefit from efforts to improve infrastructure, including the port and undersea cable. Reforms at the Nauru Utility Corporation have improved water and electricity provision, and steady progress is being made on the new port development. A new undersea cable is expected to be in place by 2020/2021, with assistance and funding from development partners. Internet connectivity is especially important given Nauru’s remote location and reliance on internet access for financial services provided by the Bendigo Agency. The cable will significantly improve business conditions and opportunities and is expected to also improve the efficiency of public sector service delivery.

26. Land rehabilitation has been limited to date but is needed for long term development. Loss of arable land has increased reliance on imported food, reinforcing a dietary switch to imported food products that has been linked to an increased rate of NCDs. The Nauru Rehabilitation Corporation has rehabilitated 5 hectares of land and has started work on a further 6 hectares to clear land for solar panels. Plans are underway to rehabilitate more land for agriculture.

27. Nauru faces severe health challenges but is taking steps towards improving health outcomes. Nauru has one of the lowest life expectancies in the world due to the high incidence of NCDs. Given limited medical services on the island, many patients suffering from NCDs need overseas medical referrals, weighing heavily on the health budget. Nauru is focusing on primary healthcare improvement, with assistance from development partners, including the digitalization of patient records. Preventative measures have included campaigns to encourage physical activity and improve nutrition through cultivation of household gardens. Staff encourages the authorities to ensure that maintenance issues with hospital buildings are addressed as needed to ensure an appropriate standard for patient care. Health spending should continue to focus on preventive measures, with careful monitoring and evaluation of health-related spending.

28. Renewed effort is needed to improve the quality of education and clearly identify and address underlying causes of low attendance. Nauru provides compulsory free education, including for early childhood education. Despite this, enrolment rates and attendance have been low. Literacy rates urgently need to be updated, but 2010 data signaled a very low literacy rate of 25 percent for Year 7 pupils (11 years of age).5 In an attempt to improve participation, Nauru implemented a school lunch program and daily payments for school attendance, but problems have persisted. Key areas of concern have included high student-teacher ratios, language barriers faced by students with limited English language skills, and deficiencies in teacher qualifications.6

29. Plans to continue secondary phosphate mining must be carefully evaluated. An in-principle decision to mine secondary phosphate was made in 2019, and mining equipment has been purchased by RONPHOS. Despite this, staff believes that further mining is economically inefficient given the significant costs attached to secondary phosphate mining in an environment of decreasing phosphate prices, as world supply has increased.

Authorities’ Views

30. The authorities expressed broad agreement on the need to improve the business environment to mobilize private investment and diversify the economy. They were keen to remove impediments to doing business and planned to engage the private sector to address concerns. The authorities saw scope for diversification by investing in agriculture to contribute to growth and improve nutrition, but this will require accelerating land rehabilitation. They noted that the new sea port and undersea cable have the potential to support growth and provide new growth opportunities.

Governance

31. Governance challenges are significant and are exacerbated by limited public sector capacity. The main governance risks stem from weaknesses in fiscal governance (PFM controls, as discussed in paragraph 18), lack of accountability and monitoring of SOEs, gaps in business legislation (as discussed in paragraph 24), and the AML/CFT framework. These weaknesses result in inefficient management of resources, create vulnerabilities to corruption, and reduce growth. Mitigating governance risks requires improving transparency in key areas and putting in place a robust accountability framework for SOEs. Staff welcomes the “largely compliant” rating from the recent OECD peer review on transparency and exchange of information for tax purposes.

32. Staff welcomes the online publication of fiscal documents. Next steps in the effort to increase fiscal transparency could include publication of the public sector’s assets and liabilities and more timely release of audited financial statements. Continued effort is needed to improve the quality of fiscal data and extend the data coverage from core government to SOEs. The mission encourages a strong focus on enhancing procurement practices and greater transparency on funds disbursed at the district level to ensure access for all citizens to these funds.

33. Nauru is making good progress on its AML/CFT framework. In preparation for the 2022 mutual evaluation, the Financial Investigations Unit (FIU) is undertaking a review of Nauru’s AML/CFT legislation and is working on an information-sharing MOU with Austrac. Amendments to the Corporations Act, the Business Licenses Act, the Beneficial Ownership Act, the new Trusts Act (October 2018), the Partnership Act, and the Business Names Registration Act (December 2018) will improve transparency and accountability and strengthen investor protection and contract rights.

Authorities’ Views

34. The authorities are committed to implementing PFM reforms and are working hard to prepare for the next mutual evaluation. They reiterated their strong commitment to PFM improvements, including necessary improvements to SOE transparency and accountability. The authorities are steadily moving forward with efforts to strengthen the AML/CFT framework, which has involved removing the offshore financial center.

Climate Change Resilience

35. Nauru is actively engaged with development partners on mitigation and adaptation measures. The new port is expected to reduce Nauru’s carbon footprint by as much as 30 percent, by reducing the waiting time (and hence fuel consumption) for ships to use the current mooring system. Work is underway with assistance from development partners on solar power generation capacity that will generate as much as 50 percent of Nauru’s electricity needs. The government is also moving to cleaner fuels for its vehicles.

36. Staff encourages steps towards integrating climate change plans into economic and development policies. Staff encourages the authorities to cost adaptation plans and integrate them into the budget and medium-term framework, ensure new infrastructure is climate proof, seek donor funds for green projects, and broaden development partner relationships to access funds for agriculture and food security. Transparent budget management would facilitate the mobilization of climate change financing and technical assistance from donors.

Statistics and Capacity Development

37. Gaps in statistics pose a significant challenge for policy development and surveillance. Nauru’s Statistics Office remains very small and is currently limited to producing the CPI, with reliance on TA experts to compile national accounts. Data is lacking or outdated in several areas, with shortcomings that significantly hamper surveillance. Staff welcomes plans to implement a household survey, and a business survey, which will provide valuable information for policymaking. In addition, the planed update of the last census, from 2011, will provide important population data. These efforts will need adequate resourcing to be successfully implemented. Staff encourages the authorities to take full advantage of development partner assistance to continue improving the quality and availability of statistics.

38. Capacity development efforts in statistics, revenue, and PFM are well aligned with the National Sustainable Development Strategy (NSDS) and surveillance priorities. Continued progress in these areas would help to achieve the NSDS goals, including fiscally responsible government, enhanced public service provision, and broadening the revenue base of the economy. While the current capacity supplementation is helpful, scope exists for a gradual reduction of supplementation over time. Staff encourages the authorities to continue to develop domestic capacity with assistance from development partners, underpinned by strong ownership and commitment.

Staff Appraisal

39. Nauru’s key economic challenge is to develop new sources of economic activity and income. The economy is in transition, given reduced RPC and phosphate activity. Growth exceeded expectations in 2018, but has been modest in 2019. Preparing for and managing the scaling down in RPC activity is a policy priority. Increased fishing license revenues have provided welcome diversification, but private sector development is hampered by infrastructure and capacity limitations. Staff encourages efforts to re-engage and revitalize private sector development in order to provide for future growth.

40. The authorities need to confront the rising fiscal risks. Revenue is likely to decline significantly over the medium term as around 30 percent of the receipts of the budget are linked to RPC operations. A fiscal adjustment plan is needed to avoid breaching the fiscal anchor, meet the mandatory Trust Fund contributions, and avoid further debt accumulation. Staff recommends maintaining a cash buffer target of two months of non-RPC current spending, to ease day-to-day cash management and provide the flexibility to respond to shocks. The authorities should also redouble efforts to seek a reasonable resolution of the defaulted yen-denominated bonds, which would help put the public debt back on a sustainable path.

41. Fiscal reforms should focus on strengthening revenues and PFM to increase fiscal discipline and lift the quality of spending. A medium-term revenue strategy could provide a governance structure to coordinate tax reforms, engage stakeholders, and foster cooperation among development partners. On public financial management, stronger monitoring and accountability of SOEs is needed to improve performance and reduce reliance on budget transfers. Equally important is strengthening public debt management. Staff encourages the authorities to limit the use of supplementary budgets and set aside windfall revenues for appropriation in the normal budget cycle rather than through a supplementary budget process, to boost resources for carefully planned investment spending.

42. Staff assess Nauru’s external position in FY2018 as substantially weaker than implied by medium-term fundamentals and desirable policies. In the absence of monetary and exchange rate policies, Nauru relies on fiscal policy and structural reforms to ensure external sustainability. Maintaining prudent fiscal policy over the medium term would help build-up fiscal buffers and preserve the external balance whereas improving infrastructure would provide some impetus to diversify the export base.

43. Structural reforms will promote inclusive growth, provide opportunity for economic diversification, and mitigate governance and corruption risks. SOE reform should continue to strengthen governance, transparency, and accountability and reduce reliance on budget financing. The return of banking services in Nauru through Bendingo Bank agency has improved financial inclusion. Efforts to strengthen the AML/CFT framework and enhance financial literacy should continue to promote confidence and financial stability. Renewed effort is needed to improve quality of education and health outcomes, including by combating NCDs. Steps should be taken to improve the ease of doing business. The new seaport and undersea cable have the potential to support growth and provide new growth opportunities.

44. Transparent budget management would catalyze climate change financing and technical assistance from donors. Nauru’s mitigation and adaption efforts are commendable, including the new seaport which will reduce Nauru’s carbon footprint. However, to strengthen resilience to climate change, the authorities need to fully cost adaptation plans and integrate them into the budget and medium-term framework, ensure new infrastructure is climate proof, and seek donor funds for green projects.

45. Nauru’s statistical capacity remains weak, and data suffers from shortcomings that prevent timely analysis and hamper surveillance. Technical assistance will continue to play an important role in strengthening economic statistics.

46. It is recommended that the next Article IV consultation take place on the 24-month cycle.

Trust Fund

Nauru’s intergenerational Trust Fund has been operational for three years. The Trust Fund was established with development partner support to save windfall revenue over the medium term that, through earnings on accumulated funds, will generate revenue over the long term. The Trust Fund is perpetual, and the charter does not provide for withdrawals during the build-up period of 2016–33, unless the Trust Fund Committee determines otherwise.

Australia, Taiwan Province of China, the Asian Development Bank, and the Government of Nauru (GoN) have committed to contribute to the Fund. New Zealand recently became the Trust Fund’s newest contributor and will continue its association with the Fund through additional contributions and as a future representative on the Fund’s Committee.

The Trust Fund reached A$84.4 million (60 percent of GDP) in FY2018, from a starting value of around A$34 million (25 percent of GDP) in FY2016. Nauru contributed A$14.8 million to the Trust Fund in FY2016 and made a total contribution of A$47.1 million as of 30 June 2018. Since the Trust Fund was established, Australia has contributed A$12.1 million, Taiwan Province of China A$10.6 million, and New Zealand A$1.9 million.

Nauru’s Trust Fund has reached major milestones. Nauru has joined the International Forum of Sovereign Wealth Funds and has completed a self-assessment of the Trust Fund in line with the Santiago Principles. In addition, the Trust Fund has transitioned to Stage 2 of the investment strategy, broadening its portfolio to include more illiquid assets. In FY2019, the Trust Fund made initial investments into illiquid asset classes, including property and private equity.

uA01fig03

Trust Fund Contributions (2016)

Citation: IMF Staff Country Reports 2020, 031; 10.5089/9781513528434.002.A001

Sources: Nauru authorities, and IMF staff estimates
uA01fig04

Trust Fund Contributions (2018)

Citation: IMF Staff Country Reports 2020, 031; 10.5089/9781513528434.002.A001

Sources: Nauru authorities, and IMF staff estimates.

Nauru’s Superannuation Fund

In July 2018 the Government introduced Nauru Super, a defined-contribution superannuation scheme. The Nauru Super Scheme is governed by a Board of Trustees and managed by a New Zealand-based fund manager, Superlife. Payments from Nauru Super will be additional to existing pension payments for individuals over 60 years old. The scheme was originally made available only to Nauruan government employees, including those of SOEs. However, from January 1, 2019, the scheme was expanded to citizens residing in Nauru and government officials posted overseas, and all employers of one or more Nauruan staff. This scheme is not applicable to contract or expatriate employees.

Enrollment in Nauru Super is compulsory, and both employers and employees are required to contribute 5 percent of salaries to the fund. To encourage acceptance of the scheme, the government initially raised salaries by 5 percent, so there would be no change to take-home pay. Employees can make additional contributions to the fund on a voluntary basis at any time, but these will not be matched by the employer. Access to the funds will only be granted at the retirement age of 55 years or more. Currently, the scheme does not include options for life insurance cover or other insurance programs, but these can be evaluated and added at a later stage.

Nauru’s Financial Sector

The Bendigo Bank Agency (the “agency”) is the sole financial institution and provider of financial services. The agency is a special project under the Ministry of Finance and Bendigo and Adelaide Bank Limited of Australia (Bendigo Bank). When it opened in 2015, it was the first bank operation in Nauru in over a decade. As part of Bendigo Bank, the agency falls under Australian bank supervision, and customers hold Australian bank accounts. It is the only Australian agent bank operating outside Australia. The agency recently opened its first U.S. correspondent bank account and is continuing efforts to open correspondent bank accounts in other major currencies. Nauru citizens have access to deposit accounts, ATMs, and internet banking through the agency, but there are currently no available credit or insurance products.

The agency has contributed to improvements in financial inclusion and payment services. The agency has 11,200 accounts, representing close to full account penetration among adults. The agency has installed 11 ATMs, processing up to 36,000 transactions per month. About 9,000 ATM cards have been issued – roughly the same as the number of smart phones in Nauru. Although the economy remains heavily cash-based, greater use is being made of online transaction facilities. For example, most large taxpayers make online tax payments. The agency is starting to install Point of Sale (POS) terminals, which are in strong demand. To help improve financial literacy, the agency is offering deposit accounts to students and is working with development partners on the potential introduction of financial education in schools.

The agency operates in accordance with Australian financial regulation, but it continues to face challenges in transferring funds internationally. The agency adheres to the Australian-standard AML/CFT requirements, and the parent bank in Australia carries out regular internal audits. For example, it implements transaction monitoring by Bendigo’s financial crimes department, which is in regular contact with Nauru’s Financial Intelligence Unit. Nonetheless, the agency continues to face restrictions imposed by correspondent banks that prevent transferring funds internationally.

Figure 1.
Figure 1.

Real and External Sector Developments

Citation: IMF Staff Country Reports 2020, 031; 10.5089/9781513528434.002.A001

Figure 2.
Figure 2.

Fiscal Sector Developments

Citation: IMF Staff Country Reports 2020, 031; 10.5089/9781513528434.002.A001

Figure 3.
Figure 3.

Medium-Term Fiscal Outlook

Citation: IMF Staff Country Reports 2020, 031; 10.5089/9781513528434.002.A001

Figure 4.
Figure 4.

Recent Economic Developments in the Regional Context

Citation: IMF Staff Country Reports 2020, 031; 10.5089/9781513528434.002.A001

Table 1.

Nauru: Selected Social and Economic Indicators, FY2015–21 1/

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

Nauru uses the Australian dollar as the legal tender, and the fiscal year ends in June.

The social indicators are taken from United Nations Development Program and Secretariat of the Pacific Community.

Including the defaulted Yen bonds.

Including the estimated government liability related to Bank of Nauru’s liquidation.

Table 2.

Nauru: Illustrative Medium-Term Baseline Scenario, FY2015–24 1/

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

Nauru uses the Australian dollar as the legal tender, and the fiscal year ends in June.

Including the defaulted Yen bonds.

Including government liability related to Bank of Nauru’s liquidation.

Table 3.

Nauru: Balance of Payments, FY2015–24 1/

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

The fiscal year ends in June.

Including the defaulted Yen bonds.

Table 4.

Nauru: Central Government Operations, FY2015–24 1/

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

The fiscal year ends in June.

Excluding reimbursement for RPC expenses.

Includes only revenue and expense items directly related to RPC.

Non-RPC revenue plus current grants or budget support minus non-RPC expenses.

In FY2024, the stock of government deposit would have been -2.1 months of non-RPC current spending in the absence of the government borrowing A$24.9 million to finance the cash shortfall.

Including the defaulted Yen bond and the government’s liability to Bank of Nauru’s liquidation.

Annex I. Authorities’ Response to Fund Policy Advice

article image

Annex II. External Sector Assessment1

Assessment: Staff assess Nauru’s external position in FY2018 as substantially weaker than medium-term fundamentals and desirable policies. However, the uncertainty around this assessment is high, given that the analysis is hampered by data limitations and the high volatility of external inflows.

Approach to assessment: Nauru’s current account developments are mostly driven by exogenous factors: RPC operations, fishing license fees, operational capacity of the seaport, and donor inflows. Given the volatility of some of these factors and data limitations, it is difficult to assess Nauru’s external sector under EBA-Lite methodologies. The assessment is mostly factual, and only the EBA-Lite current account methodology is applied with some assumptions.

Goods and services balance: Nauru’s historical trade balance has been influenced primarily by phosphate exports. Given the dwindling phosphate production and continued dependence on imports, the goods and services deficit worsened to 53 percent of GDP (7 percent of GDP increase) in FY2018 compared to FY2017. Estimates indicate a further decline in phosphate exports in FY2019, resulting in a widening of the goods and services deficit. The deficit is expected to average around 54 percent of GDP over the medium term, amidst uncertainties surrounding secondary phosphate mining.

Other flows: The trade deficit has been financed by large surpluses in the income account. In FY2018, the income account balance declined to 48.7 percent of GDP (10 percentage points of GDP decline), driven by a drop in RPC revenues. In FY2019, the decline in RPC revenues is estimated to have been offset by a 12 percent of GDP increase in fishing revenue resulting in a spike in the income account balance to 64 percent of GDP. Nonetheless, this is expected to drop to an average of 50 percent of GDP over the medium term given the expected scaling down of RPC operations and normalizing fishing revenues.

Current account: The current account recorded a deficit of 4.6 percent of GDP in FY2018, which is weaker than fundamentals based on the EBA-Lite current account model. The cyclically adjusted current account deficit of 3.7 percent of GDP is assessed against a cyclically adjusted current account balance norm of 7.1 percent of GDP, resulting in a current account gap of -10.8 percent of GDP. Nonetheless, the current account balance is estimated to have turned around in FY2019 to a surplus of 5 percent of GDP.

REER: Nauru’s main current transactions are not significantly affected by REER fluctuations, including phosphate exports and RPC operations. Moreover, import dependence is high. As a result, the REER plays a limited role in achieving external balance. The EBA-Lite REER model could not be used for the assessment given data limitations. Although Nauru’s NEER appreciated in FY2018 in line with the appreciation of the Australian dollar against the US, the REER depreciated in line with the moderation in inflation.

External sustainability: In the absence of monetary and exchange rate policies, Nauru relies on fiscal policy and structural reforms to ensure external sustainability. Nauru’s recent strong fiscal performance with a corresponding build-up in government deposits has supported external sustainability. While the trust fund accumulation (contributing to large positive IIP) also promotes external sustainability, it cannot be drawn from until FY2033. Under staff’s baseline scenario, the current account is expected to remain in a deficit of about 4 percent of GDP on average over the medium term due to collapsing phosphate exports, declining RPC income and normalizing fishing revenue. In addition, the worsening fiscal position poses a risk to external sustainability. A fiscal adjustment would provide some cushion to Nauru’s external sustainability (the current account deficit improves to about 3.6 percent of GDP on average in the medium term in the adjustment scenario); although not enough to offset the pressures from slowing RPC operations and a halt in phosphate production. Nauru’s competitiveness is constrained by several factors: a limited exports base, infrastructure bottlenecks, remoteness, and high transport costs. The country is also vulnerable to global commodity prices due to its heavy reliance on imported goods. The EBA-lite external sustainability approach could not be used due to data limitations.

Policies: Maintaining prudent fiscal policy over the medium term would help build-up fiscal buffers and preserve the external balance. Also, resolving long-standing arrears associated with the yen bond remains key to maintaining external debt sustainability and improving Nauru’s reputation in external credit markets. Prudent management of the loan from Taiwan POC taken on behalf of the Nauru Phosphate Corporation (Ronphos) to fund the purchase of equipment for secondary phosphate mining is critical. Future borrowings on behalf of SOEs should be discouraged to minimize risks to external debt sustainability. Improvements in the seaport and power infrastructure may provide some impetus for improvements in the export base. But these efforts would need to be complemented by (i) state-owned enterprise reform, which is critical to improving competitiveness, (ii) promotion of private sector development, and (iii) policies to safeguard fiscal sustainability.

The use of the Australian dollar as the legal tender remains appropriate. It provides a nominal anchor. In view of the close linkages with Australia, limited institutional capacity, and a small economic size, the costs of running an independent monetary institution are likely to be significantly higher than the benefits.

Annex III. Risk Assessment Matrix 1/

article image

/ 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 IV. Debt Sustainability Analysis1

Staff assess debt as unsustainable under current policies. Sound fiscal and public debt management policies and policies to generate and diversify economic activity would help ensure debt sustainability and improve Nauru’s access to credit markets.

1. Total public debt is estimated at 86.8 percent of GDP (A$138.8 million) in FY2018 and is mostly denominated in local currency. External public debt is estimated at A$49 million (30.6 percent of GDP) comprising mostly of the defaulted yen bonds (A$38.2 million), loans from the EXIM bank (A$3.9 million), and miscellaneous debt that includes overdue membership obligations to international organizations (A$6.8 million).2 Domestic public debt is estimated at A$69.9 million (43.7% of GDP), made up of long-standing arrears from the Bank of Nauru liquidation and from the Nauru Phosphate Corporation (RONPHOS).3 The total debt stock includes an estimate for SOE debt, of which a significant portion is for financing secondary phosphate mining and also includes legacy debt relating to the Nauru Phosphate Royalty Trust (totaling A$21 million).

2. Public debt remains very high and is assessed as unsustainable under existing policies. Under the baseline scenario, the public debt-to-GDP ratio is expected to decline temporarily as the government runs down deposits. Once these deposits are depleted, public debt is projected to begin rising sharply from already high levels. Given this and the government’s existing arrears, debt is considered unsustainable under current policies. Although Nauru has accumulated a large amount of assets in the Trust Fund (around 64 percent of GDP), these cannot be withdrawn or used as a buffer to mitigate the high level of debt.4 The level of debt is vulnerable to the RPC scaling down, lower than expected fishing revenues, and increased commodity prices.

3. The standardized alternative scenarios show improving debt dynamics. Debt would fall to a more sustainable level of 38.9 percent of GDP by 2024 if real GDP growth, the primary balance, and real interest rates are set to their ten-year historical average. If the primary balance is set at the projected 2019 level for the entire projection period, public debt would fall but still hover at around 60 percent of GDP by 2024. However, attaining the improved dynamics is highly unlikely over the medium term as the key macro indicators in the alternative scenarios reflect a period of unusually strong economic activity with phosphate mining and exports at a peak.

4. Sound fiscal and public debt management policies to generate and diversify economic activity would help promote debt sustainability. Maintaining prudent fiscal policies and diversifying sources of revenue will remain critical in promoting fiscal and debt sustainability. Debt falls to 66.4 percent of GDP in 2024 under a proposed fiscal adjustment scenario. Under this scenario, staff proposes reducing expenditure by 5 percent of GDP and increasing revenue by 1 percent of GDP on average over the medium term, compared to baseline. These measures would yield a reduction of about $25 million in borrowing in 2024 compared to the baseline. The public debt path would nonetheless remain vulnerable to large shocks, especially to GDP growth, as shown in the stress tests.

5. Reducing long-standing arrears and improving accounts transparency remains critical in building credibility and expanding access to international credit markets. A significant amount of Nauru’s debt is in the form of old debt or arrears. Ongoing negotiation with the yen bond holders and consolidation of the liabilities associated with the Bank of Nauru should be expedited to resolve these debts. Identifying amounts owed by SOEs, including outstanding royalty payments to landowners by the Nauru Phosphate Trust Fund and RONPHOS, is critical for a full consolidation of debt obligations and to adequately budget for repayments.

Authorities Views’

6. The authorities broadly agreed with the staff’s assessment on debt. They expressed their commitment to a prudent fiscal policy stance. The authorities acknowledge that continuing on the same trajectory could prove harmful to the economy and have agreed to take steps to reign in the debt levels, especially with respect to increasing debt taken on by SOEs. The authorities also highlighted the role of financial support from bilateral and multilateral donors in meeting infrastructure needs.

Table 1.

Nauru: External Debt Sustainability Framework 2014–2024

(In percent of GDP, unless otherwise indicated)

article image

Derived as [r – g – r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.