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IMF Country Report No. 21/263

REPUBLIC OF PALAU

2021 ARTICLE IV CONSULTATION—PRESS RELEASE; STAFF REPORT; AND STATEMENT BY THE EXECUTIVE DIRECTOR FOR THE REPUBLIC OF PALAU

December 2021

Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. In the context of the 2021 Article IV consultation with Palau, the following documents have been released and are included in this package:

• A Press Release summarizing the views of the Executive Board as expressed during its November 29, 2021 consideration of the staff report that concluded the Article IV consultation with the Republic of Palau.

• The Staff Report prepared by a staff team of the IMF for the Executive Board’s consideration on November 29, 2021, following discussions that ended on October 7,2021, with the officials of the Republic of Palau on economic developments and policies. Based on information available at the time of these discussions, the staff report was completed on November 8, 2021.

• An Informational Annex prepared by the IMF staff.

• A Statement by the Executive Director for the Republic of Palau.

The IMF’s transparency policy allows for the deletion of market-sensitive information and premature disclosure of the authorities’ policy intentions in published staff reports and other documents.

Copies of this report are available to the public from

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PO Box 92780 • Washington, D.C. 20090

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International Monetary Fund

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© 2021 International Monetary Fund

Press Release

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PR21/368

IMF Executive Board Concludes 2021 Article IV Consultation with Palau

FOR IMMEDIATE RELEASE

Washington, DC – December 9, 2021: On November 29, 2021, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation¹ with Palau.

Palau entered the pandemic with some fiscal buffers, including a moderate public debt. While strict health measures and preemptive border closure have helped prevent local community spreads of COVID-19 to date, they have severely impacted the tourism-dependent economy. Real GDP contracted by 9.7 percent in FY2020and is estimated to have further declined by 17.1 percent in FY2021. In contrast to the tourism sector, construction activities were resilient, reflecting progress on large infrastructure projects and strong housing construction. Inflation edged up, driven by a rise in food and energy prices, and the current account widened significantly on the back of a sharp decline in tourism receipts.

The authorities adopted a comprehensive policy response with measures that appropriately aimed at strengthening healthcare and mitigating the economic and social hardship of the pandemic. Despite job losses in the tourism sector, employment support prevented a notable deterioration of overall labor market conditions. The economic fallout of the pandemic and the cost of the fiscal response have led to large fiscal deficits and a rapid increase in public debt. With about 90 percent of the total population fully vaccinated, Palau has started to gradually reopen its borders with some safety measures.

The economic outlook remains challenging. Real GDP is projected rebound by 9.4 percent in FY2022 alongside a gradual recovery in tourist arrivals, which are expected to remain below pre-pandemic levels through FY2023. Inflation is expected to pick up on the back of elevated international fuel prices. The large fiscal and current account deficits are projected to narrow as tourism activities recover. The outlook is subject to high uncertainty, and risks are titled to the downside, including from a protracted pandemic, a domestic outbreak, and natural disasters. Palau’s graduation from the OECD’s list of countries eligible for official development assistance could lead to lower concessional financing, in particular grants.

Executive Board Assessment²

Executive Directors welcomed the authorities’ comprehensive policy response to the pandemic which helped limit its health and economic impacts. They noted that an economic recovery is underway, supported by a high vaccination rate and a gradual resumption of tourism. However, the outlook remains clouded by elevated uncertainty and risks. While support to the economy should remain until the recovery is broadly entrenched, prudent policies are needed over the medium-term to support macroeconomic stability and promote sustainable, greener and inclusive growth.

Directors welcomed the extension of measures to provide targeted fiscal support to still affected households and firms. They agreed that fiscal policy should continue to be the first line of defense in case downside risks materialize.

Directors noted that fiscal risks over the medium-term have increased substantially and underscored the need for fiscal adjustment to rebuild fiscal resilience and preserve debt sustainability. They welcomed the approval of the comprehensive tax reform, which will contribute to fiscal adjustment while improving the efficiency of the tax system. Directors also concurred that additional revenue mobilization and expenditure rationalization efforts are needed to help accommodate higher climate spending, improve the external position, and provide buffers against potentially lower grants and concessional financing.

Directors agreed that financial sector reforms should be accelerated to support financial deepening. They highlighted the need to enhance SMEs’ capacity to absorb credit and address the structural determinants of low credit creation. Risk-based supervision should be strengthened, including for non-bank financial institutions, and improving the AML/CFT framework should remain a high priority.

Directors underscored that steadfast implementation of structural reforms should continue to support sustained growth post-pandemic. They welcomed efforts to pursue greater diversification of source markets for tourism. Going forward, Directors saw merit in streamlining processes for foreign investment, improving the business environment, and enhancing human capital to encourage private investment within and outside the tourism sector.

Directors emphasized that strengthening resilience to climate change is essential for Palau’s sustainable development. In this regard, they called for a timely implementation of Palau’s climate change adaptation and mitigation strategy, including by tapping into climate risk financing, to enhance economic resilience.

Directors agreed that pursuing capacity building efforts will enhance macroeconomic management.

^{Table 1.}

Palau: Selected Economic Indicators, 2016/17–2025/26 ^1/

Sources: Palau authorities; and Fund staff estimates and projections.

^1/Fiscal yea rending September 30.

^2/Defined as tax and other revenue less expense.

^3/Includes withdrawals from CTF and Funding for US Federal Programs (Post Office and Meteorological Service)

^4/Includes unspent external bans.

^{Table 1.}

Palau: Selected Economic Indicators, 2016/17–2025/26 ^1/

Nominal GDP for FY2020:	US$258million
Population (2019):	17,457
GDP per capita for FY2020:	US$14,784
Quota:	SDR3.1 million

					2016/17	2017/18	2018/19	2019/20	2020/21	2021/22	2022/23	2023/24	2024/25	2025/26
									Est	Proj.
Real sector
	Nominal GDP (million US$)				285.3	284.7	274.2	257.7	216.2	242.7	294.9	305.5	316.7	327.7
	Real GDP growth (percent change)				-3.3	-0.1	-1.9	-9.7	-17.1	9.4	18.3	2.9	2.9	2.7
	GDP deflator (percent change)				-1.1	-0.1	-1.8	4.1	1.2	2.5	2.8	0.7	0.7	0.8
	Consumer prices (percent change; period average)				0.9	2.0	0.6	0.7	1.2	3.0	2.8	0.7	0.7	0.8
	Tourist arrivals (number of visitors)				122,10	115,99	89,726	41,674	3,167	24,708	85,710	89,996	94,496	99,220
	Expenditure per Tourist Arrival (US$)				976	984	1,061	1,257	1,273	1,312	1,361	1,384	1,408	1,432
Public finance					(In percent of GDP)
	Central government
		Revenue			40.3	44.5	44.5	47.4	46.3	41.2	38.0	39.0	38.6	38.9
			Taxes and other revenue		27.2	27.2	27.8	24.0	22.1	20.3	22.9	24.3	24.8	25.4
			Grants		13.1	17.3	16.7	23.4	24.2	21.0	15.1	14.7	13.8	13.6
		Expenditure			35.5	38.2	44.1	58.3	65.8	53.9	41.1	39.4	38.4	37.1
			Expense		32.5	35.9	39.6	52.3	61.3	48.9	36.7	35.3	34.1	32.3
				of which: grants to other government units	5.1	6.5	11.1	14.1	18.3	12.7	7.4	6.6	6.1	6.0
			Net acquisition of non financial assets		3.0	2.3	4.5	6.1	4.5	5.0	4.4	4.2	4.3	4.8
	Current fiscal balance (excluding grants) 2/				-5.3	-8.8	-11.8	-28.3	-39.2	-28.6	-13.8	-11.0	-9.2	-6.9
	Current fiscal balance (including current grants) 3/				5.6	6.6	-1.0	-11.8	-20.1	-12.1	-2.6	0.0	1.6	3.7
	Net lending (+)/borrowing (-)				4.8	6.3	0.4	-10.9	-19.5	-12.6	-3.2	-0.5	0.2	1.9
	General government debt				34.4	37.0	38.6	62.1	85.7	90.3	74.0	71.1	66.7	62.1
					(In millions of U.S.dollars)
	Compact Trust Fund (CTF) balance				219.5	297.5	281.9	275.6	330.3	333.7	337.3	341.1	345.1	349.4
	Government cash anddeposits4/				43.2	42.9	31.0	60.7	27.8	32.2	22.9	21.5	22.3	28.4
		In percent of GDP			15.1	15.1	11.3	23.6	12.9	13.3	7.8	7.0	7.0	8.7
Monetary sector
	Credit to private sector (in percent of GDP)				12.1	12.3	11.6	11.8	..	..	..	..	..	..
	Credit to private sector (percent change)				15.4	1.9	-9.3	-4.8	..	..	..	..	..	..
Balance of payments 3/
	Trade balance				-138.9	-136.5	-142.9	-147.8	-117.0	-128.1	-150.9	-145.5	-153.9	-160.4
		Exports (fob)			14.6	15.5	13.4	6.1	8.7	10.1	13.9	14.1	14.3	14.6
		Imports (f.o.b.)			153.5	151.9	156.4	153.8	125.7	138.2	164.8	159.6	168.3	175.0
	Tourism receipts				113.0	104.8	91.9	50.9	3.9	31.3	112.8	120.5	128.8	137.6
	Current account balance
		Including grants			-55.3	-44.4	-85.3	-124.4	-120.8	-109.6	-68.7	-61.8	-63.0	-61.3
		Excluding grants			-93.4	-94.3	-120.6	-154.9	-152.8	-136.3	-99.0	-92.5	-94.4	-93.5
	International Investment Position				-136.1	-105.0	-176.8	-256.3	-364.2	-438.5	-470.3	-494.4	-520.5	-544.4
		Assets			629.0	715.2	688.9	736.9	721.7	734.6	763.5	801.4	836.1	874.6
		Liabilities			765.1	820.2	865.7	993.2	1,085.9	1,173.0	1,233.7	1,295.8	1,356.5	1,419.0
			Of which: External debt		85.9	91.8	91.4	150.1	183.4	217.9	214.8	210.8	203.2	194.8
					(In percent of GDP)
	Current account balance
		Including grants			-19.4	-15.6	-31.1	-48.3	-55.9	-45.2	-23.3	-20.2	-19.9	-18.7
		Excluding grants			-32.7	-33.1	-44.0	-60.1	-70.7	-56.2	-33.6	-30.3	-29.8	-28.5
	International Investment Position				-47.7	-36.9	-64.5	-99.4	-168.4	-180.7	-159.5	-161.8	-164.3	-166.1
			Of which: External debt		30.1	32.2	33.3	58.2	84.8	89.8	72.8	69.0	64.2	59.4

Sources: Palau authorities; and Fund staff estimates and projections.

^1/Fiscal yea rending September 30.

^2/Defined as tax and other revenue less expense.

^3/Includes withdrawals from CTF and Funding for US Federal Programs (Post Office and Meteorological Service)

^4/Includes unspent external bans.

View Table

^{Table 1.}

Palau: Selected Economic Indicators, 2016/17–2025/26 ^1/

Nominal GDP for FY2020:	US$258million
Population (2019):	17,457
GDP per capita for FY2020:	US$14,784
Quota:	SDR3.1 million

					2016/17	2017/18	2018/19	2019/20	2020/21	2021/22	2022/23	2023/24	2024/25	2025/26
									Est	Proj.
Real sector
	Nominal GDP (million US$)				285.3	284.7	274.2	257.7	216.2	242.7	294.9	305.5	316.7	327.7
	Real GDP growth (percent change)				-3.3	-0.1	-1.9	-9.7	-17.1	9.4	18.3	2.9	2.9	2.7
	GDP deflator (percent change)				-1.1	-0.1	-1.8	4.1	1.2	2.5	2.8	0.7	0.7	0.8
	Consumer prices (percent change; period average)				0.9	2.0	0.6	0.7	1.2	3.0	2.8	0.7	0.7	0.8
	Tourist arrivals (number of visitors)				122,10	115,99	89,726	41,674	3,167	24,708	85,710	89,996	94,496	99,220
	Expenditure per Tourist Arrival (US$)				976	984	1,061	1,257	1,273	1,312	1,361	1,384	1,408	1,432
Public finance					(In percent of GDP)
	Central government
		Revenue			40.3	44.5	44.5	47.4	46.3	41.2	38.0	39.0	38.6	38.9
			Taxes and other revenue		27.2	27.2	27.8	24.0	22.1	20.3	22.9	24.3	24.8	25.4
			Grants		13.1	17.3	16.7	23.4	24.2	21.0	15.1	14.7	13.8	13.6
		Expenditure			35.5	38.2	44.1	58.3	65.8	53.9	41.1	39.4	38.4	37.1
			Expense		32.5	35.9	39.6	52.3	61.3	48.9	36.7	35.3	34.1	32.3
				of which: grants to other government units	5.1	6.5	11.1	14.1	18.3	12.7	7.4	6.6	6.1	6.0
			Net acquisition of non financial assets		3.0	2.3	4.5	6.1	4.5	5.0	4.4	4.2	4.3	4.8
	Current fiscal balance (excluding grants) 2/				-5.3	-8.8	-11.8	-28.3	-39.2	-28.6	-13.8	-11.0	-9.2	-6.9
	Current fiscal balance (including current grants) 3/				5.6	6.6	-1.0	-11.8	-20.1	-12.1	-2.6	0.0	1.6	3.7
	Net lending (+)/borrowing (-)				4.8	6.3	0.4	-10.9	-19.5	-12.6	-3.2	-0.5	0.2	1.9
	General government debt				34.4	37.0	38.6	62.1	85.7	90.3	74.0	71.1	66.7	62.1
					(In millions of U.S.dollars)
	Compact Trust Fund (CTF) balance				219.5	297.5	281.9	275.6	330.3	333.7	337.3	341.1	345.1	349.4
	Government cash anddeposits4/				43.2	42.9	31.0	60.7	27.8	32.2	22.9	21.5	22.3	28.4
		In percent of GDP			15.1	15.1	11.3	23.6	12.9	13.3	7.8	7.0	7.0	8.7
Monetary sector
	Credit to private sector (in percent of GDP)				12.1	12.3	11.6	11.8	..	..	..	..	..	..
	Credit to private sector (percent change)				15.4	1.9	-9.3	-4.8	..	..	..	..	..	..
Balance of payments 3/
	Trade balance				-138.9	-136.5	-142.9	-147.8	-117.0	-128.1	-150.9	-145.5	-153.9	-160.4
		Exports (fob)			14.6	15.5	13.4	6.1	8.7	10.1	13.9	14.1	14.3	14.6
		Imports (f.o.b.)			153.5	151.9	156.4	153.8	125.7	138.2	164.8	159.6	168.3	175.0
	Tourism receipts				113.0	104.8	91.9	50.9	3.9	31.3	112.8	120.5	128.8	137.6
	Current account balance
		Including grants			-55.3	-44.4	-85.3	-124.4	-120.8	-109.6	-68.7	-61.8	-63.0	-61.3
		Excluding grants			-93.4	-94.3	-120.6	-154.9	-152.8	-136.3	-99.0	-92.5	-94.4	-93.5
	International Investment Position				-136.1	-105.0	-176.8	-256.3	-364.2	-438.5	-470.3	-494.4	-520.5	-544.4
		Assets			629.0	715.2	688.9	736.9	721.7	734.6	763.5	801.4	836.1	874.6
		Liabilities			765.1	820.2	865.7	993.2	1,085.9	1,173.0	1,233.7	1,295.8	1,356.5	1,419.0
			Of which: External debt		85.9	91.8	91.4	150.1	183.4	217.9	214.8	210.8	203.2	194.8
					(In percent of GDP)
	Current account balance
		Including grants			-19.4	-15.6	-31.1	-48.3	-55.9	-45.2	-23.3	-20.2	-19.9	-18.7
		Excluding grants			-32.7	-33.1	-44.0	-60.1	-70.7	-56.2	-33.6	-30.3	-29.8	-28.5
	International Investment Position				-47.7	-36.9	-64.5	-99.4	-168.4	-180.7	-159.5	-161.8	-164.3	-166.1
			Of which: External debt		30.1	32.2	33.3	58.2	84.8	89.8	72.8	69.0	64.2	59.4

Sources: Palau authorities; and Fund staff estimates and projections.

^1/Fiscal yea rending September 30.

^2/Defined as tax and other revenue less expense.

^3/Includes withdrawals from CTF and Funding for US Federal Programs (Post Office and Meteorological Service)

^4/Includes unspent external bans.

Title page

REPUBLIC OF PALAU

STAFF REPORT FOR THE 2021 ARTICLE IV CONSULTATION

November 8, 2021

KEY ISSUES

Context. The COVID-19 pandemic and related containment measures have severely impacted the economy. Border closure and the suspension of commercial flights curtailed tourist arrivals. Real GDP contracted by 9.7 percent in FY2020, notwithstanding policy support. The economic contraction is estimated to have deepened in FY2021, and a gradual recovery is expected in FY2022 as tourism activities resume. While Palau’s public debt remains sustainable, the economic fallout of the pandemic and the cost of the fiscal response have led to a sharp deterioration of the fiscal position and a rapid increase in public debt. The high share of concessional loans from multilateral creditors in Palau’s external debt is an important risk mitigating factor. Palau is vulnerable to climate change and natural disasters.

Policies. Economic policies should focus on supporting the recovery, rebuilding fiscal resilience, and supporting sustainable growth post pandemic. The main policy recommendations include:

• In the near-term, extend policy support until the recovery is firmly entrenched, while improving the efficiency of COVID-related spending.

• In the medium-term, rebuild fiscal resilience through a gradual fiscal consolidation once the recovery is firmly underway and reform the public sector to contain rising fiscal risks. In addition to lowering public debt, fiscal consolidation would help improve the external position, accommodate higher spending to address climate change, and provide some buffers against potentially lower grants and concessional financing due to Palau’s graduation from the OECD’s list of countries eligible for official development assistance.

• Accelerate structural and financial sector reforms to help lift medium-term growth and promote a more resilient economy post pandemic, including through investment in climate resilient infrastructure and diversification within and outside the tourism sector.

Approved By

Thomas F. Helbling (APD) and Stefania Fabrizio (SPR)

Contents

• CONTEXT AND PRE-COVID-19 LANDSCAPE

• RECENT DEVELOPMENTS: A SEVERE IMPACT OF THE PANDEMIC CUSHIONED BY POLICY SUPPORT

• OUTLOOK: A DIFFICULT AND UNCERTAIN RECOVERY

• POLICIES TO UNDERPIN A SUSTAINABLE RECOVERY

• A Near-Term Fiscal Policy Response to the Pandemic

• B. Rebuilding Fiscal Resilience over the Medium-Term

• C. Financial Sector Policies to Support Credit and Preserve Stability

• BEYOND THE PANDEMIC: A MORE RESILIENT AND GREENER ECONOMY

• A Strengthening Economic Structure and Addressing Climate Change

• B. Other Issues

• STAFF APPRAISAL

• BOX

• 1. Medium-Term Fiscal Adjustment Scenario

• FIGURES

• 1. Real Sector Developments

• 2. Tourism Sector Developments

• 3. External Sector Developments

• 4. Fiscal Sector Developments

• TABLES

• 1. Selected Economic Indicators, 2016/17–2025/26

• 2. Balance of Payments, 2016/17–2025/26

• 3. National Government Operations, 2016/17–2025/26

• 4. Assets and Liabilities of Deposit Money Banks, 2013/14–2019/20

• 5. Banks’ Financial Soundness Indicators, 2016–2021Q1

• APPENDICES

• I. Palau’s Climate Change Challenges

• II. Covid-19 Developments

• III. Policy Responses to the Covid-19 Pandemic

• IV. External Sector Assessment

• V. Risk Assessment Matrix

• VI. Debt Sustainability Analysis

• VII. The COVID-19 Pandemic and Public Debt

• VIM. Tax Reforms

• IX. Financial Sector Reforms

• X. Rethinking Palau’s Growth Model