2019 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for the Solomon Islands
The Solomon Islands is a low-income country of around 650,000 people, speaking over 120 languages, across some 900 islands in the South Pacific. The Solomon Islands has a total land area of about 28,400 square kilometers spread over 1.34 million square kilometers of ocean – an area larger than France, Germany and Poland combined. Its dispersed population, large infrastructure needs, narrow economic base, and exposure to natural disasters and commodity price volatilities pose many development challenges. The authorities are aware of the macroeconomic risks the country faces and appreciate the analysis, advice and technical assistance provided by the Fund.
The authorities note that preliminary data suggest that economic growth has slowed further than staff’s expected 2.7 percent in 2019 owing to weak performances from commodities combined with subdued domestic demand. The forestry sector declined as a result of weak demand for logs from China. Uncertainties emanating from the national elections in April and the newly elected government’s decision to switch ties from the Taiwan Province of China to China eroded business confidence and weakened domestic demand. Over the medium term, staff estimate growth to average around 2.7 percent with growth expected to be supported by infrastructure spending and mining activity that is expected to commence in late 2020. Inflation remains within the target range of 2 to 4 percent. Foreign reserves are equivalent to 8.1 months of imports.
The authorities agreed with the overall economic assessment. They are aware that the economy may be transitioning away from the logging sector with consequential effects on export earnings, employment, government revenue and overall demand. Diversification is a challenge for the authorities and more granular advice from staff on how to adjust would be welcome. An inter-agency committee has been established to develop a logging sustainability policy to be implemented in 2020. The mining sector has been identified as one of the main potential growth drivers over the medium term and the authorities collaborated with one of the development partners to improve the legislative framework. The expected reopening of the Gold Ridge Mine and major infrastructure projects will support growth in the next few years. These projects – including the undersea cable and the Tina River Hydro Project – will also help to improve business conditions and improve productivity in the long term.
Budget pressures resurfaced in 2019. Revenue underperformance, of around 5 percent in the first six months, reflected broad-based declines across major revenue categories most notably log export duties, import duties and corporate income tax.
Stabilizing public finances remains a priority for the government, but the general election in early 2019 interrupted progress on fiscal consolidation. The authorities are maintaining their efforts to strengthen tax compliance, to progress tax reform – including indirect tax reform, and to tighten expenditure controls and procurement processes at the Ministry of Finance and Treasury.
The authorities are committed to the current debt management framework which has been in place since 2012. Given the country’s large infrastructure needs, the authorities are working closely with development partners, including China, to address these needs. On the preparation for the 2023 Pacific Games, the authorities are negotiating grant financing from bilateral development partners for the investments required, but are prepared to borrow if necessary, within the bounds of the debt management framework.
Monetary and financial sector policies
The Central Bank of Solomon Islands will continue an accommodative monetary policy stance in view of the low inflation environment, the weak growth outlook and slowing credit growth. The authorities consider that the basket exchange rate peg remains an appropriate nominal anchor for Solomon Islands.
There remains structural excess liquidity in the banking system, reflecting limited demand for credit. The authorities acknowledge the staff advice around the options to reduce structural excess liquidity over time, including facilitating further offshore investment by the National Provident Fund. But with contained credit growth and low inflation, the authorities prefer a more gradual approach to avoid putting any unnecessary pressure on domestic banks.
The banking sector remains well-capitalized and profitable, in a shallow and underdeveloped market. Interest rates on lending remain exceptionally high, as do ATM fees, and the authorities are working with the banks (both foreign and local) to understand the drivers. A correspondent banking relationship has been established between the one local bank and its overseas counterpart for a period of three years from January 2019, which has reduced financial stability risks.
Given the temporary nature of the correspondent banking arrangement, the Central Bank is urging the local bank to ensure bank processes comply with the overseas bank requirements and for the local bank to provide regular updates to the supervision department. Additionally, the authorities are continuing to encourage the local bank to establish alternative correspondent banking relationships in non-USD currencies.
The authorities are continuing to implement a number of measures to foster financial inclusion. The next financial inclusion strategy plan from 2020 will shift focus to green finance to build climate change resilience and the authorities remain committed to mainstreaming financial literacy in the school curriculum.
Natural disaster resilience
Solomon Islands faces many natural disasters, including tropical cyclones, drought, earthquake, tsunami and flood. Disasters could occur with higher frequency and severity owing to climate change and global warming. In any year, there is a one in seven chance that the Solomon Islands will face a severe natural disaster.
The National Development Strategy released in January 2015 envisages higher investment in climate and natural disaster proof infrastructure. But the weak fiscal position hampers the ability for the authorities to prepare for a major natural disaster.
As a country that is highly vulnerable to climate change and exposed to shocks from high frequency of natural disasters, the authorities are pleased that the Debt Sustainability Analysis continues to take account of these factors. They acknowledge the importance of rebuilding fiscal buffers to respond to natural disasters and to undertake infrastructure investments to increase resilience.
The authorities highly value the capacity development and technical assistance provided by the Fund. In this regard, they very much welcome the addition of Annex 1 to the staff report, which highlights priority areas for technical assistance.
The authorities welcome continuing technical assistance on public financial management, cash flow management, and assistance to develop a medium-term revenue strategy, which should boost revenue collections from both tax and non-tax categories.
Given the weak monetary policy transmission channels, the authorities have also sought additional technical assistance for the development of a monetary policy framework while expressing an interest in follow-up technical assistance on reserve and exchange rate management and/or transfer pricing in the mining sector.
While the authorities highly value the assistance provided by the Fund, they encourage further efforts to coordinate technical assistance across development partners given capacity constraints. They are interested in knowing whether Annex 1 could be expanded to capture assistance provided by other partners such as the World Bank or OECD. The authorities consider that technical assistance at the operational level would also be very valuable as it would greatly enhance knowledge transfer and enhance the authorities’ capacity to implement recommendations.
The authorities thank the Fund for their advice and ongoing technical assistance and look forward to further constructive engagement in the future.