Republic of Nauru: 2021 Article IV Consultation—Press Release; Staff Report; Informational Annex; and Statement by the Executive Director for Nauru
Author: International Monetary Fund. Asia and Pacific Dept
Publication Date:
07 Feb 2022
eISBN:
9798400200304
Language:
English
Keywords:
government deposit; government priority; government employee; authorities' view; short term government debt; COVID-19; Pacific Islands
Download PDF (2.9 MB)

1. Nauru’s size and location pose challenges for economic growth and development. Nauru is a remote island nation in the Pacific, with a land area of about 21 square kilometers and a population of approximately 12,000 people in 2021. Its size and remoteness constrain potential growth and raise its reliance on food and fuel imports. The revenue base—comprising sales of fishing licenses, residual phosphate mining and, since FY2012, revenues associated with the Australian Regional Processing Center (RPC) for asylum seekers—is narrow and volatile. Due to land degradation from phosphate mining in the 1980s, the population mainly resides along the narrow coastal land, raising vulnerability to climate change. Nauru’s population also has a high incidence of non-communicable disease (NCDs).

Abstract

1. Nauru’s size and location pose challenges for economic growth and development. Nauru is a remote island nation in the Pacific, with a land area of about 21 square kilometers and a population of approximately 12,000 people in 2021. Its size and remoteness constrain potential growth and raise its reliance on food and fuel imports. The revenue base—comprising sales of fishing licenses, residual phosphate mining and, since FY2012, revenues associated with the Australian Regional Processing Center (RPC) for asylum seekers—is narrow and volatile. Due to land degradation from phosphate mining in the 1980s, the population mainly resides along the narrow coastal land, raising vulnerability to climate change. Nauru’s population also has a high incidence of non-communicable disease (NCDs).

Context and Pre-Pandemic Landscape

1. Nauru’s size and location pose challenges for economic growth and development. Nauru is a remote island nation in the Pacific, with a land area of about 21 square kilometers and a population of approximately 12,000 people in 2021. Its size and remoteness constrain potential growth and raise its reliance on food and fuel imports. The revenue base—comprising sales of fishing licenses, residual phosphate mining and, since FY2012, revenues associated with the Australian Regional Processing Center (RPC) for asylum seekers—is narrow and volatile. Due to land degradation from phosphate mining in the 1980s, the population mainly resides along the narrow coastal land, raising vulnerability to climate change. Nauru’s population also has a high incidence of non-communicable disease (NCDs).

2. Nauru’s economy was expanding modestly prior to the COVID-19 pandemic. In the years before the COVID-19 pandemic, real GDP growth slowed to 1.5 percent in 2015–19 from 19.8 percent in 2011–14 owing primarily to reduced phosphate mining. However, infrastructure investment, such as a new climate-resilient port, has supported activity and will improve trade and growth prospects. The establishment of the Nauru Trust Fund in FY2016 and reforms to state-owned enterprises (SOEs) helped strengthen public financial management. Following the resumption of banking services after over a decade in FY2015, Nauru achieved impressive gains in financial inclusion. Nonetheless, the poverty rate in Nauru remains high.

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Nauru: Structural Challenges to Growth

Citation: IMF Staff Country Reports 2022, 028; 10.5089/9798400200304.002.A001

3. Nauru faces formidable challenges in raising long-term growth potential and confronting structural and fiscal risks. The anticipated scaling down of the RPC is expected to weigh on revenues and create job dislocations, underscoring the need to diversify Nauru’s income sources. Efforts to boost potential growth and long-run fiscal sustainability face significant constraints from limited arable land, remoteness, infrastructure capacity limitations, and governance weaknesses. Nauru is vulnerable to climate change as its coastline is endangered by rising sea levels and rising ocean temperatures may affect tuna stocks, which are a vital economic resource. In addition, Nauru has limited financing options, though the country receives significant development partner support.

The Covid-19 Shock: Impact, Policy Response, Outlook, and Risks

4. The authorities’ early and decisive measures successfully contained COVID-19. The initial policy response focused on a total closure of Nauru’s air and sea borders, quarantine protocols, and ensuring reliable delivery of fuel and food. The COVID-19 taskforce prioritized the expansion of intensive care capacity and securing vaccines through bilateral donors and the COVAX facility. As of early-January 2022, there have been no COVID-19 cases on the island, and 96 percent of the eligible adult population is fully vaccinated. A vaccination drive for 12–18-year-olds is expected to commence in 2022, and the taskforce also plans to extend vaccinations to 5–12 years-old in 2022.

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Number of Covid-19 Case

(In percent of population)

Citation: IMF Staff Country Reports 2022, 028; 10.5089/9798400200304.002.A001

Source: CEIC CSSEJHU database.
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Pacific Island Countries: Real GDP Growth, 2021

Citation: IMF Staff Country Reports 2022, 028; 10.5089/9798400200304.002.A001

Sources: Country authorities and IMF staff calculations.

5. The economy continued to expand in FY20 and FY21 owing to the sizeable policy response. Pandemic-related measures to support the economy are estimated at 8.5 and 11 percent of GDP in FY20 and FY21 respectively, including cash support to Nauru Airlines and Nauru Shipping Lines to ensure reliable food and fuel freight; quarantine expenditures; support to the COVID-19 taskforce to secure vaccines and distribute protective personal equipment (PPE); scaling up intensive care facilities; and ex gratia payments to government employees. Notwithstanding a delay in construction projects due to supply chain disruptions, the economy expanded by 0.7 percent in FY20 and 1.5 percent in FY21.

6. An unanticipated extension of the RPC and strong demand for fishing licenses underpinned the fiscal and external balances at the height of the pandemic and enabled generous supportive measures. Despite sizable COVID-19 expenditures and the purchase of a new aircraft, fiscal responsibility ratios were largely satisfied in FY20 and FY21,1 reflecting large fiscal revenues owing to a delay in the scale-down of RPC and windfall revenues from fishing licenses. The moderation in fuel prices in 2020 helped keep inflation low and alleviated pressure on the external accounts, leaving the current account in surplus in FY21. Nauru’s external position in FY21 is assessed to be weaker than consistent with fundamentals and medium-term desirable policy settings (Annex I).

Policy Response to the COVID-19 Shock

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Notes. Covid-19 ex gratia are stimulus payments to government employees.Source: Nauru authorities
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PICs: Fiscal Measures in Response to COVID-19

(In percent of GDP)

Citation: IMF Staff Country Reports 2022, 028; 10.5089/9798400200304.002.A001

7. The resolution of a longstanding sovereign debt default has significantly lowered Nauru’s external debt. The Government of Nauru (GON), as a guarantor, had a longstanding liability on bonds defaulted by the Nauru Phosphate Royalty Trust (NPRT) in the late 1980s with a face value of AUD 83 million. In March 2021, GON reached a substantially discounted settlement on these debt obligations to a U.S.-based hedge fund, Firebird, agreeing to a payment of AUD 4 million in exchange for all their bonds and an indemnity against legal actions on previous court orders or future claims against GON.

Baseline Assumptions of the RPC Scale-Down

  • The RPC will transition to “Enduring Capability on July 1, 2022

  • No new asylees will be added to RK in FY22-FY26.

  • Temporary job dislocations will affect 5 percent of the labor force (one-third of current RPC workers) during the second half of FY22 and the first half of FY23.

  • Remaining current RPC workers will either be retained in the Enduring Capability arrangement, reallocated into other local jobs, or sent abroad for training.

  • Relative to FY21, in FY22 there is a decline of: 10 percent in business profit taxes, non-resident withholding taxes. and reimbursable costs A services fees, and about 75 percent in visa revenues.

  • Relative to FY22. in FY23 there is a decline of: 50 percent in business profit taxes and non-resident withholding taxes, and a decline of 10 percent in reimbursable costs & service fees

  • FY23-FY26 assumes a continuation of the hosting tee and no visa revenues. There is a further 10 percent decline every year in FY24-FY26 in business profit and nonresident withholding taxes, and in reimbursable costs & service fees

Source: Staff assumptions.

8. Nauru’s debt is sustainable under current policies. This is a significant improvement from the Debt Sustainability Analysis conducted during the 2019 Article IV consultations which assessed debt to be unsustainable. The two key factors that contribute to this improvement are the settlement of the Firebird debt and some repayment of domestic debt related to the liquidation of the Bank of Nauru (Annex II).

9. Growth is expected to moderate, and the current account to narrow, in FY22, due to the expected slowdown in RPC activity. Despite ongoing fiscal support, the high COVID-19 vaccination rate, and the resumption of construction activity, real GDP growth is expected to slow from 1.5 percent in FY21 to 0.9 percent in FY22. This largely reflects the staff’s baseline view of the scale-down of the RPC (text box), which is an important source of economic activity on the island, and some supply dislocations and travel restrictions resulting from the Omicron virus variant. Growth is expected to pick up in FY23, aided by the operationalization of the climate-resilient port. The current account surplus is expected to narrow to 3.5 percent of GDP in FY22, reflecting lower RPC-related services exports, some departure of RPC-associated expatriate workers, and the projected increase in fuel prices. Higher global commodity prices and Nauru’s import dependency are expected to raise inflation from 0.9 percent in FY20 to 1.7 percent in FY22. The new SDR allocation of SDR 2.68 million (about USD 4 million or 2.2 percent of GDP) will support foreign exchange reserves.

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Real GOP in Nauru

(Index, 2019=100)

Citation: IMF Staff Country Reports 2022, 028; 10.5089/9798400200304.002.A001

Source: IMF, Word Economic Outlook.
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COVID-19 Vaccinations

(percent of population that is fully vaccinated, as of December 2021)

Citation: IMF Staff Country Reports 2022, 028; 10.5089/9798400200304.002.A001

Sources: Our World in Data Nauru authorities and IMF staff estimates.

10. Risks to the outlook are tilted significantly to the downside. Given limited medical facilities and a high incidence of risk factors such as diabetes, a local COVID-19 outbreak could have adverse health and growth implications. The emergence of the Omicron variant risks worsening supply chain dislocations and maintaining border closures that delay infrastructure projects on the island. The medium-term fiscal outlook remains uncertain pending clarity about RPC-related revenues when the facility moves to a model of “enduring capability” in July 2022.2 As RPC employment is about 15 percent of the local labor force, a significant number of jobs could be at risk if enduring capability results in a near-total shutdown of RPC facilities and a labor reallocation strategy is inadequately implemented. External downside risks include a sharper-than-projected rise in commodity prices. Upside risks include an extension of RPC with no job losses, and spillovers from commercialization of the port project.

Authorities’ Views

11. The authorities broadly concurred with staff’s assessment of recent developments, outlook, and risks. Authorities agreed that the scale-down of the RPC posed downside risks but were optimistic that the new arrangement under enduring capability would potentially retain some current RPC workers for facility maintenance, limiting job losses. Authorities were confident that strong revenues from fishing licenses in FY23 would support the budget as most fishing days have already been sold and Nauru is in negotiations to purchase additional days from other PNA members’ allocations. While agreeing that sales of fishing licenses are in general volatile, the authorities expect lower volatility going forward due to stable partnerships. The authorities expressed concern about the budgetary implications of fuel price escalation due to Nauru’s high dependence on fuel imports for desalination, electricity, and transportation needs. They confirmed their intention to hold the new SDR allocation as reserves.

Harnessing New Sources of Economic Growth and Building Fiscal Self-Reliance in a Post-Pandemic World

A. Strengthening the Post-Pandemic Recovery

12. Despite no COVID-19 outbreak onshore, Nauru must remain vigilant in the post-pandemic recovery. An ongoing priority is a successful rollout of the vaccination drive to newly eligible under-18-year-olds. Authorities should calibrate containment measures to the state of the pandemic while scaling up preparedness, including enhancing medical facilities to meet both long-term needs and a possible public health emergency. The authorities should ensure timely delivery of materials for ongoing infrastructure investment in view of a potential continued tightness of global supply bottlenecks.

13. Fiscal support should remain calibrated to the state of the pandemic, and non-COVID spending should be contained to make room for priority social needs and climate-related expenditures. Given ongoing pandemic-related uncertainties, near-term fiscal support to ensure food and fuel security continues to be appropriate. While support for freight and inventory management was essential during the peak of the pandemic, these subsidies should be scaled back to the levels consistent with the Community Service Obligation (CSO) framework as operations return to pre-pandemic levels.3 Subsidies to Ronphos,4 whose profitability is uncertain and which does not make its financial statements public, should be phased out in line with previous staff advice. The authorities should limit subsidies to SOE services that are consistent with the CSO framework and shift budget allocations away from non-transparent expenditures, such as the housing improvement allocations, toward improving the efficiency of health and education, and retraining of current RPC workers, prioritizing spending in accordance with the social and environmental goals of the National Sustainable Development Strategy (NSDS). Complementing measures to support climate-change resilience, such as investment in the seawalls and solar farms projects, the authorities should cost adaptation plans and integrate these plans into a medium-term budget framework (Annex VI).

14. A plan to absorb, relocate, or upskill current RPC employees should be expeditiously formulated. A decommissioning of the RPC could create job dislocations for a significant number of current RPC workers. Finding new employment will be challenging given Nauru’s narrow economic base. Staff encouraged the authorities to implement a plan to limit long-term job dislocations for current RPC employees, including through technical education at universities abroad, which could also help address existing skill shortages in Nauru. Increased participation in regional employment schemes may also present opportunities, as in other Pacific Island nations (Annex V). Over the longer term, increased employment opportunities will become available through development of the port and fisheries.

Authorities’ Views

15. Authorities stressed their strong commitment to supporting jobs and activity, including by reprioritizing expenditures. The authorities highlighted that subsidies allocated to Ronphos in the FY22 budget are at a multi-year low and future allocation will be dependent on a comprehensive cost-benefit assessment of secondary phosphate mining. They noted that under the CSO framework, subsidies to Nauru Utility Corporation (NUC) were likely to be retained due to the rising cost of fuel and GON’s commitment to supply affordable electric power to low-income households. The authorities recognized the urgency of assisting current RPC workers, and noted that plans were underway to absorb some RPC workers into the local police force and provide upskilling to others through training programs in Australia and the University of the South Pacific. Authorities agreed with the importance of prioritizing expenditures towards Nauru’s development needs and highlighted that the FY22 fiscal strategy was anchored in part to achieving the goals of the NSDS and Nauru Integrated Infrastructure Strategic Plans (NIISP).

B. Addressing Fiscal Challenges: Uncertain Revenues

16. Nauru draws a large share of non-tax government revenues from external sources that are volatile and uncertain, undermining fiscal self-reliance.5 Nauru stands out for its dependence on external sources for non-tax revenues, even relative to regional peers. Non-tax revenues are predominantly the RPC hosting fee, whose future magnitude is uncertain, and fishing license revenues that are volatile and vulnerable to adverse effects from climate change.

17. Past tax reforms have supported government revenues. The authorities have reformed the tax code in recent years, including the introduction of the employment and services tax in FY2015 and the business profits tax in FY2017, and improved customs and tax administration. However, customs revenue is a relatively small share of revenues, and a significant share of business profit and employment services taxes are derived from RPC-related activity, which are vulnerable to a decline from the expected scale-down.

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External Source of Revenue

(In percent of GDP)

Citation: IMF Staff Country Reports 2022, 028; 10.5089/9798400200304.002.A001

Sources: Country authorities and IMF staff estimates.

18. Further tax reforms are urgently required to generate more reliable sources of revenue. Given the uncertainty and volatility of Nauru’s external and domestic revenue streams, a renewed effort is needed to reform the tax code, including by identifying new forms of revenues, widening the tax base, improving compliance, and modernizing the tax administration. Drawing on Fund provided technical assistance (TA),6 specific reforms could include:

  • Broadening the personal income tax (PIT) base, which is very narrow due to tax-free thresholds that are excessively high.7

  • Raising domestic excise taxes, particularly on items tied to poor diet and adverse health, such as liquor, cigarettes, sugar products, and carbonated soft drinks that can simultaneously help address the high incidence of NCDs, such as diabetes.

  • Introducing a broad-based consumption tax such as a value-added tax (VAT), with careful attention to its design, including the rate structure and tax base, to ensure that poorer households are not adversely affected.

  • Modernizing tax revenue administration and customs collection by introducing, for example, the infrastructure to digitize business record-keeping and replacing the manual approach which is vulnerable to tax avoidance. The ASYCUDA system is currently planned for implementation, although this will cover digitization of only customs-related transactions.

Staff’s recommendation is to place tax reform in a comprehensive medium-term revenue strategy, with careful attention to the sequence and timing of changes to the tax code. In a context where most Nauruans have not previously paid taxes, the authorities should consider a gradual increase in existing income and excise tax rates before introducing new taxes. Carefully communicating the incidental health benefits of excise taxes on liquor, sugar products and cigarettes can help engender tax compliance. Over the medium term, once the tax administration capacity has developed further, the authorities should introduce a broad-based consumption tax, such as a VAT, to further address revenue concerns.

Authorities’ Views

19. Authorities shared staff’s views on rising fiscal challenges but expressed reservations about undertaking the tax reforms recommended by the mission. Authorities recognized the need for greater revenue mobilization. They informed the mission of the non-ratification of PACER Plus which will limit the need to recoup import duties that would have been lost from ratifying this regional trade agreement. 8 However, authorities emphasized that tax collection is a politically sensitive issue in Nauru and expressed weak appetite for either a comprehensive broadening of the tax base or lowering the tax threshold, and were not in support of excise taxes in general on the grounds that it could raise consumer prices. They noted that the requisite digital infrastructure to support a VAT is prohibitively expensive for Nauru given its size, and the capacity to manage its implementation will take time to build up.

C. Structural Reforms to Further Improve Governance and Public Financial Management

20. Measures that improve governance are critical to achieving Nauru’s medium-term growth and development objectives. Notwithstanding recent improvements to public financial management (PFM), Nauru’s main governance risks stem from weaknesses in fiscal governance due the lack of timely, transparent, and audited financial statements of SOEs, inadequate financial controls from the high usage of cash transactions, lack of transparency in procurement processes, and gaps in the anti-money laundering/combating the financing of terrorism (AML/CFT) framework. These weaknesses result in inefficient management of resources, create vulnerabilities to corruption, and negatively impact growth.

21. Authorities have implemented important reforms in recent years to improve PFM. Following the 2019 Article IV consultations, the authorities implemented the Public Enterprise Act, introduced the CSO framework, and established an SOE monitoring unit, all with a view to improving SOE service delivery (Annex VIII). Authorities have significantly improved transparency with online publication of the budget and updates to the legal and tax frameworks. Authorities have welcomed capacity development and TA from the Fund in improving the collection and recording of macroeconomic data (Annex IX).

22. Annual contributions to the Nauru Trust Fund (NTF) are a strong pillar of the fiscal framework and have helped maintain fiscal discipline. Under Nauru’s fiscal framework, the budget is expected to run a surplus sufficient to meet the mandatory annual contribution to the NTF, whose purpose is to support GON’s post-2033 investments in education, health, environment, and infrastructure. Financial statements indicate that the NTF, whose portfolio is well-diversified, was valued at AUD 217.8 million at end-FY21 and is on track to reach its target of AUD 400 million by 2033 (Annex III).9 As per the MOU, early withdrawals from the NTF or changes to the contribution scale are decided in coordination with development partners. There is currently no discussion to revise the scale or schedule of contributions in light of the anticipated scale-down of RPC as the MOU already offers the flexibility to delay, reduce, or forgo contributions under extenuating circumstances, such as a large negative revenue shock. The FY22 budget has appropriated 10.1 percent of adjusted prior year revenue for the annual contribution to the NTF.

23. Notwithstanding improvements to PFM, further reforms are needed to improve fiscal discipline, the accountability of SOEs, and the transparency and efficiency of spending. These could include:

• Further reforms to improve SOE accountability. While the establishment of the SOE monitoring unit is an important step towards strengthening SOE accountability, authorities should ensure that the unit is well-resourced with adequate staffing of the required technical expertise,10 and that it can exercise the authority to publish the audited financial statements of all SOEs on an annual basis.

• Phasing out subsidies to non-performing or weakly-performing SOEs and diverting them towards infrastructure development and reskilling workers. With the heightened revenue uncertainty from RPC scale-down, authorities should take this opportunity to limit budgetary resources to poorly performing SOEs, redirecting them toward SOEs engaged in critical infrastructure development such as internet connectivity, waste management and worker retraining, particularly in the context of RPC worker reallocation (see paragraph 14).

• Enhancing procurement procedures in line with international standards. Measures should be taken to ensure the transparency of COVID-19 spending and procurement processes, including the publication of procurement contracts, names of awarded companies and their beneficial owners. The procurement of public goods and services in Nauru is governed under the Public Finance Control Act 2013. There is currently no publicly available information on procurement. Authorities are in discussions with the ADB to review their procurement framework with TA expected in 2022.

• Formalizing the fiscal responsibility ratios in a rules-based framework and introducing mechanisms to manage large, unexpected shocks and deviations from those rules. Currently, the fiscal responsibility ratios are annual indicative targets within each budget. Authorities should consider further strengthening the fiscal framework, including by formalizing those ratios with a well-designed fiscal rule. The framework should have well-calibrated rule limits, and provisions of well-designed escape clauses and correction mechanisms to manage large, unexpected shocks and breaches from rule limits. In FY21, the fiscal balance was in deficit according to the authorities’ cash accounting, largely due to the purchase of an aircraft for Nauru Airlines before an EXIM loan from Taiwan POC could be disbursed. Following the FY21 budget deficit, the government should aim for a return to a fiscal surplus in subsequent years to ensure that government deposits are replenished.

• Phasing out cash for tax and other transactions. Many individuals as well as government departments use cash for tax payments and other transactions. Authorities should accelerate a plan to phase out cash for tax collections and business transactions to strengthen financial controls and reduce corruption risks.

The planned PEFA assessment in 2022 by PFTAC is expected to provide a baseline against which to assess future reform progress.

24. The resolution of domestic debt should be expedited, and a new debt management strategy should be adopted. As of December 2021, GON, as a guarantor of BON liabilities, has repaid about one-third of the original BON liability. Authorities should articulate a firm timeline and payout schedule for settling the remaining debt, and transparently communicate how they plan to treat that part of the debt where creditors cannot be identified. Going forward, new debt should be carefully assessed against Nauru’s expected revenue streams and its ability to service the debt.

uA001fig08

Outstanding Domestic Debt from BON Liquidation

Citation: IMF Staff Country Reports 2022, 028; 10.5089/9798400200304.002.A001

Source: Nauru authorities

Authorities’ Views

25. Authorities are committed to further strengthening governance and PFM. Authorities reaffirmed their intention to ensure that the SOE monitoring unit is sufficiently well-resourced to fill long-standing gaps in SOE accountability including in exercising the authority to publish the audited financial statements of all SOEs on an annual basis. They informed the mission of a newly created Project Steering Committee that will meet quarterly and assist the SOE monitoring unit on enforcement and policy decisions. In authorities’ view, procurement is minimal for GON operational requirements and managed adequately by Nauru Post and Eigigu Procurement, while donor-funded projects use donors’ procurement processes. While there is no current plan to phase out cash transactions (due to limited banking services), authorities informed the mission of an EFTPOS terminal in place and active at the Revenue Department, with a rollout planned to Police, Transportation, and other cash collection departments as soon as the equipment becomes available. The authorities were receptive to the suggestion of formalizing the fiscal rules in a rules-based framework .

D. Financial Sector Reforms

26. Improving the perceived jurisdictional risk of Nauru is essential to lowering the cost of international transactions. International transactions can be made in Australian dollars through Bendigo Bank Australia. However, Nauru continues to have limited ability to undertake international transactions in non-AUD currencies, particularly USD. Staff was informed that transactions for Nauruan customers in USD and some other major currencies are not processed by Bendigo’s U.S. correspondent bank, hampering local business, and resulting in significant exchange-rate-induced losses in revenues from the sales of fishing licenses (which are invoiced in USD). Several factors may have contributed to correspondent banking relationship (CBR) pressures in Nauru, including being affected by broader CBR challenges in Pacific island nations, profitability considerations, AML/CFT concerns, and legacy reputational issues (e.g., from an attempt to set up a financial center).

Bendigo Bank Agency

Bendigo Bank Agency is the primary financial service provider in Nauru.1 The Agency opened in Nauru in 2015, pursuant to an agency agreement between Nauru’s Ministry of Finance and Bendigo and Adelaide Bank Limited of Australia. It operates under the Australian AML/CFT regulatory regime and is supervised by AUSTRAC, including for customer due diligence and suspicious transaction reporting. Nauru-based customers of the Agency have reported constraints with respect to their cross-border transactions denominated in US dollars. Such pressures may be attributable to ML/TF risks and profitability concerns. While there have been efforts to address the legacy reputational issues from the country’s past offshore sector (since resolved), existing shortcomings in the AML/CFT framework are still critical factors. The size of the market in Nauru and expected profitability are also contributing to financial services providers’ decisions especially when dealing with very small markets such as Nauru.

1 Authorities noted that Western Union also operates as a low volume money remitter in Nauru, and is under New Zealand’s regulatory and supervisory framework for AML/CFT purposes.

27. Efforts to improve the effectiveness of the AML/CFT framework are ongoing. In view of the 2012 Mutual Evaluation Report and upcoming comprehensive AML/CFT assessment, the authorities are aiming to align the AML/CFT framework with the revised 2012 FATF Recommendations. To address the remaining shortcomings, they are developing a national risk assessment (NRA) and national strategy, preparing amendments to the legal framework, including with TA provided by the Asia Pacific Group (APG) to improve technical compliance, and aim to increase the resources and capacity of the financial intelligence unit with technical assistance from AUSTRAC. The authorities continue to coordinate with the Australian supervisor (AUSTRAC) with respect to AML/CFT compliance by the principal financial service provider in Nauru, Bendigo Bank Agency (Box 1).

28. Measures aimed toward addressing identified risks and concerns should contribute to alleviating CBR pressures. A robustly implemented AML/CFT framework should contribute to addressing correspondent banking relationship (CBR) pressures and mitigate reputational risks. Legislative improvements to the AML/CFT framework and development of the NRA should be swiftly put in place, followed by measures to mitigate the identified risks. Once technical compliance has improved through legislative drafting, implementation should follow and effectiveness should be significantly enhanced, notably in relation to ensuring AML/CFT compliance, analysis and dissemination of financial intelligence, and enforcement. Of importance is an environment that facilitates appropriate implementation of customer due diligence and timely suspicious transaction reporting by the financial sector. Given the unique circumstances of Nauru, the authorities are also encouraged to engage with external partners and stakeholders in pursuit of regional solutions (e.g., collective payment solutions, digital identities, regional know-your-customer utilities) which have the potential to leverage economies of scale and for accessing CBRs as a collective market.

Authorities’ Views

29. Authorities highlighted their strong commitment and ongoing efforts to a robust AML/CFT framework. They noted that efforts to comply with the AML/CFT legal framework and its effectiveness were ongoing especially in view of Nauru’s upcoming AML/CFT assessment of the 2012 FATF 40 Recommendations. The authorities’ view is that CBR pressures are largely driven by legacy reputational issues from the country’s past failed attempt to operate as an international financial center, and the profitability considerations that impact financial services providers’ decisions, and that these continue to constrain access to international banking services. They recognize the importance of the upcoming AML/CFT assessment in addressing CBR pressures. Authorities also noted broader challenges in facilitating foreign currency transactions, and welcome engaging with external partners and stakeholders in developing regional solutions. Perceptions about compliance with international standards are a major source of concern for the authorities.

E. Reforms Needed for More Sustainable, Inclusive and Green Growth

30. New sources of economic growth and revenues are vital for Nauru’s long-term development and growth potential. In line with the National Sustainable Development Strategy of 2019–30 (Annex IV), which highlights economic diversification as a key national development priority for Nauru, the below are potential long term growth areas that can generate additional government revenues and create more local employment:

  • Niche tourism: While tourism is likely to remain limited in Nauru, a small increase in visitor arrivals could help to support demand for local businesses and handicrafts. Authorities could also consider niche markets, such as astro-tourism.11 Connectivity is available through Nauru Airlines, with regular flights to Australia and neighboring islands. In staff’s view, efforts to increase visitors should focus on infrastructure improvements that would also benefit the local population (such as waste management).

  • Domestic fisheries. Significant prospects lie in developing the fisheries sector, such as domestic fish processing facilities. Nauru’s exclusive economic zone (EEZ) is one of the most favorable in the region for tuna purse seine fishing. The completion of the new port and related infrastructure, including refrigerated storage and container ships, can also help Nauru capitalize more on its EEZ (Annex V).

  • Greater participation in regional labor mobility schemes. Nauru is part of Australia’s Seasonal Worker Program (SWP) and Pacific Labor Scheme (PLS), but its remittances revenues to date are negligible. Such schemes have assumed greater importance with the jobs that are at risk with the anticipated scaling down of RPC. Remittances can be a valuable source of income and employment for Nauru, potentially raising the demand for financial services and developing the financial sector.

31. To develop new sources of growth, measures to lower structural barriers should be taken in the short-term. The authorities should take steps to improve the business environment and encourage private investment in Nauru. Authorities should redouble efforts for new donor commitments to address key infrastructure gaps such as access to clean water and an upgrade of dwelling facilities. The business environment should be improved, including by strengthening investor and property rights, lowering business visa fees, and streamlining new business registration procedures (Annex V). Issues pertaining to land tenure are complex, and the Lands Act requires the consent of at least 75 percent of landowners to gain access to land. Over time, a legal and regulatory framework that improves access to land will be needed to attract private sector investment in Nauru.

32. Addressing governance weaknesses would enhance long-term growth potential. In light of Nauru’s size, usual third-party indicators are unreliable measures of corruption and rule of law issues. There is, however, an indication of potential governance weaknesses affecting PFM and the protection of property and contractual rights. The authorities are encouraged to implement transparency and accountability measures to further prevent risks of corruption in these areas.

33. Improving the quality of education and health in accordance with the SDG goals will need targeted investment.

  • Education. Despite significant investments in the provision of free education for school-aged children, challenges persist in improving school attendance, literacy, and completion rates. Authorities should strive to improve the efficiency of education expenditures by investing into understanding the underlying causes of poor educational outcomes.

  • Health. The pandemic has brought the low life expectancy and high incidence of NCDs (a risk factor for COVID-19) in Nauru to the fore. NCDs, tied to poor diet and other lifestyle habits, weigh significantly on the budget (prescriptions and overseas referrals). Health expenditures should focus on preventative measures, including through health education, primary medical services and the promotion of physical activity and better nutrition.

34. A greener future requires Nauru to have a well-planned climate finance strategy. Nauru is among countries most severely exposed to the negative effects of climate change, affected by droughts and scarce freshwater, coastal erosion, storm surges, flooding, and ocean acidification (Annex VI). To complement existing measures, additional steps authorities can take to accelerate its climate strategy include costing adaptation plans at the sectoral level and integrating these into the budget and medium-term framework; and securing new donor support for green financing by continuing to contribute to green and climate-proof projects.

Authorities’ Views

35. The authorities were in strong agreement that economic diversification is important for Nauru’s long-term development and higher growth potential. They agreed that developing fisheries sector and expanding the usage of the port would help support potential growth and fiscal self-reliance. The authorities were of the view that tourism might have limited potential in niche markets. They noted that, given the new state-of-the-art hospital facilities on the island, there could be a reduction in the cost of overseas medical support for Nauru citizens, but cautioned that imported labor may be required to meet the needs of such an endeavor. Authorities agreed on the importance of improving the efficiency of investment in education but noted that retaining university-trained students in Nauru was difficult due to the greater opportunities in neighboring countries. Authorities are committed to developing a climate finance strategy and highlighted that the FY22 budget has made provisions to support the new climate change unit. The authorities emphasized the costs associated with the economic diversification given the small population, high fixed costs, and capacity constraints.

Statistics and Capacity Development

36. Capacity Development. Capacity development is an ongoing challenge for Nauru. The national statistics office is understaffed with weak capacity to collect and process data. Capacity supplementation from PFTAC and TA has been needed for compilation of real sector and government finance statistics (GFS), and from CDOT for external sector statistics (Annex IX). Virtual delivery of TA has helped maintain engagement. The mission informed authorities that the Fund is committed to assisting with setting up a sustainable compilation program for macroeconomic accounts.

37. Statistics. Data are lacking or outdated in several areas which significantly hamper surveillance. Core macroeconomic accounts, such as national accounts, balance of payments and international investment positions are produced only during TA missions. The population census undertaken in November 2021 will provide important demographic data. Staff appreciated the authorities’ assistance during the mission in reducing discrepancies in GFS and errors and omissions in the balance of payments. Staff encourages the authorities to leverage development partner assistance to continue improving the quality and availability of statistics. An external sector statistics remote TA mission was conducted in parallel with the 2021 Article IV consultation.

Authorities’ Views

38. Authorities expressed their appreciation for the Fund’s continued capacity development support and noted that progress in compiling macroeconomic statistics remains a government priority. The authorities welcomed the planned capacity development support in FY22 and expressed interest in continuing TA to support the collection and processing of macroeconomic data.

Staff Appraisal

39. Strong and timely containment measures successfully prevented a local COVID-19 outbreak, and extending vaccinations to all eligible individuals is an ongoing priority. Despite a high adult vaccination rate of 96 percent, authorities should ensure a successful and timely rollout of the vaccination drive to newly eligible 12–18-year-olds.

40. Growth is expected to moderate in FY22 due to the anticipated scale-down in RPC activities. After expanding in FY20 and FY21, at respectively 0.7 percent and 1.5 percent, growth is projected to slow to 0.9 percent in FY22 due to the expected scale-down of the RPC, which is an important source of jobs and activity. Nauru’s external position in FY21 is assessed to be weaker than the level consistent with fundamentals and desirable policy settings. The current account is expected to narrow to a surplus of 3.5 percent of GDP in FY22, owing to lower RPC-related services exports and a projected increase in fuel prices. Nauru’s debt is sustainable under current policies.

41. Risks to the outlook are tilted significantly to the downside. A local COVID-19 outbreak could have severe growth implications due to the high prevalence of NCDs and limited medical facilities. The medium-term fiscal outlook is uncertain pending clarity about the magnitude of RPC-related revenues when the RPC is scaled down to a model of enduring capability, which also risks significant job dislocations. Due to its high dependence on fuel imports, Nauru is vulnerable to a sharper-than-projected escalation in commodity prices. A more protracted global recovery, including from supply chain dislocations due the Omicron virus variant, could slow activity on the island.

42. Fiscal support over the near term should be calibrated to the state of the pandemic. Near-term support to ensure food and fuel security due to ongoing pandemic-related uncertainty continues to be appropriate. Subsidies to SOEs for freight and inventory dislocations initiated during the pandemic should be scaled back to levels consistent the CSO framework as operations return to normal levels. To make room for more fiscal support to health, education and climate mitigation, spending should be shifted away from weakly-performing SOEs and non-transparent budget allocations. A comprehensive plan to absorb, relocate, or upskill current RPC workers must be formulated to limit local long-term job dislocations when the facility moves to a model of enduring capability.

43. Post-pandemic fiscal policy should focus on generating more reliable sources of revenues and implementing reforms to strengthen governance and PFM. Formulating a medium-term revenue strategy, sequenced to widen the tax base and gradually raise excise taxes before introducing a consumption tax, are important steps towards fiscal self-reliance. Adequately resourcing the SOE monitoring unit, enhancing procurement policies to international standards, formalizing the fiscal responsibility ratios in a rules-based framework, and articulating a new debt strategy are needed to improve fiscal governance and advance PFM.

44. Authorities should continue efforts to strengthen the effectiveness of the AML/CFT framework and pursue regional solutions for access to CBRs. Improvements to the AML/CFT framework and its implementation should be expedited in view of Nauru’s upcoming FATF assessment, including the adoption of a risk-based approach to implementation based on a national risk assessment. Staff recommends that authorities continue to engage with external partners and stakeholders and undertake efforts in pursuit of regional solutions and approaches for access to CBRs as a collective market.

45. Structural reforms are needed to diversify Nauru’s income sources and transition the economy toward an inclusive, and green growth model. Diversifying the economy to obtain new sources of growth will require near-term policies to accelerate investment in human capital, improve the business environment, and address infrastructure gaps in internet connectivity, water and waste management and dwelling facilities. Strengthening investor rights, access to land, and streamlining new business registration procedures will help attract private investment. To strengthen resilience to climate change, authorities should cost adaptation plans at the sectoral level in a medium-term framework and continue to pursue donor support for green financing.

46. Nauru’s data shortcomings are significant and present a hindrance to surveillance. Nauru’s statistical capacity remains weak, and data suffer from shortcomings that prevent timely analysis and hamper surveillance. Addressing resource constraints is an imperative to developing a self-sustained compilation program for macroeconomic statistics. A remote external sector statistics mission conducted in parallel with the Article IV consultation exposed limitations of the virtual format, including due to connectivity challenges. Staff encourages the authorities to leverage development partner assistance to continue improving the quality and availability of statistics.

47. It is recommended that the Article IV Consultation continue to take place on the 24-month cycle.

Figure 1.
Figure 1.

Nauru: Recent Developments

Citation: IMF Staff Country Reports 2022, 028; 10.5089/9798400200304.002.A001

Figure 2.
Figure 2.

Nauru: Recent Fiscal Developments

Citation: IMF Staff Country Reports 2022, 028; 10.5089/9798400200304.002.A001

Figure 3.
Figure 3.

Nauru: Constraints to Raising Growth Potential

Citation: IMF Staff Country Reports 2022, 028; 10.5089/9798400200304.002.A001

Table 1.

Nauru: Selected Economic Indicators, FY2017–22 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.

In FY2021 grants include debt forgiveness for Yen Bonds.

Stock of government deposits is under review by authorities and may be updated.

Including the defaulted Yen bonds (until 2021 when the debt was settled), and use of Special Drawing Rights (SDR).

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

External debt service over the projection period is through bilateral grants.

Table 2.

Nauru: Illustrative Medium-Term Baseline Scenario, FY2017–26 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.

Fiscal year runs from July 1 to June 30.

Including the defaulted Yen bonds (until 2021 when the debt was settled), and use of Special Drawing Rights (SDR).

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

Table 3.

Nauru: Balance of Payments, FY2017–26 1/

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

The fiscal year ends in June.

Including the defaulted Yen bonds, until 2021 when the debt was settled and total SDR allocation

Table 4.

Nauru: Central Government Operations, FY2017–26 1/

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

The fiscal year ends in June.

In 2021, the government settled the defaulted Yen Bond debt of $41.6 million for $4million. Debt forgiveness of $37.6 million was recorded as revenues under grants in FY2021.

Change in government deposits reflects Nauru contribution to the Trust Fund. Stock/changes of government deposits are under review by the authorities and may be updated.

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.

For purposes of debt sustainability, external debt includes only the difference between SDR cumulative allocation and SDR holdings.

Includes the defaulted Yen bond until it was settled in 2021, use of SDRs, and the government’s liability to Bank of Nauru’s liquidation.

Annex I. External Sector Assessment

1. Overall Assessment. The external position of Nauru in FY21 is assessed to be weaker than the level consistent with fundamentals and desirable policies. However, this assessment is subject to high uncertainty owing to significant data gaps, the high dependence of current account (CA) determination on exogenous and volatile factors, and available indicators pointing in different directions. As EBA-Lite estimates of the CA gap and real effective exchange rate (REER) gap are unavailable due to data shortcomings, the assessment is largely factual.

2. Context. Nauru’s competitiveness is hampered by its remoteness and scale which limits its export base and is associated with high transport costs, its large infrastructure gaps, and capacity limitations. It is vulnerable to swings in global commodity prices due to its heavy reliance on imported goods. Mitigating factors are the large share of imports from Australia and the use of the Australian dollar as legal tender. The CA is driven by factors exogenous to the domestic economic cycle including the sales of fishing licenses, RPC activities, grants, and donor-funded infrastructure projects.

3. Current Account. Nauru’s historical CA has been driven by large and offsetting movements in the trade and income balance. The FY21 CA is estimated at 4.1 percent of GDP. The surplus results from a primary income surplus of 66 percent of GDP, a nearly offsetting goods and services trade deficit of 65 percent of GDP and small a secondary income surplus of 3 percent of GDP. The magnitudes and diverging signs of the trade and primary income balance suggest that the CA as a whole may be less reliable as an indicator of competitiveness than its components.

4. Trade Balance. Historically, Nauru’s trade balance has been determined largely by phosphate exports and fuel imports, with a services surplus from RPC activity largely tied to expatriate workers on the island. With rapidly declining phosphate production, the trade balance has shifted to steadily rising deficits since FY14. In FY21, the trade deficit of 65 percent of GDP is primarily a result of large fuel imports (43 percent of GDP) and a pandemic-induced decline of travel into Nauru which has kept the services balance in deficit. However, the trade balance is expected to shift to a smaller deficit over the medium term as fuel imports subside as the port project and solar farms become operational.

5. Primary Income Balance. Large surpluses in the primary income balance have financed the trade deficit. The primary income balance is driven by the sale of fishing licenses and RPC related flows, including the RPC hosting fee since FY20. In FY21, the primary income surplus is estimated at 66 percent of GDP. In our baseline, it only modestly narrows as the RPC moves into enduring capability. Large revenues from fishing activity do not necessarily represent underlying competitiveness, as fishing activity in the region is regulated by the eight member nations of the Parties to the Nauru Agreement (PNA), including Nauru. The PNA annually set the price of fishing licenses and total fishing days through the Vessel Day Scheme (VDS) in their combined exclusive economic zones (EEZ) (which accounts for approximately 30 percent of the world’s raw canning material), giving significant pricing power in the region to the PNA.

uA001fig09

Primary Income Balance

(In percent of GDP)

Citation: IMF Staff Country Reports 2022, 028; 10.5089/9798400200304.002.A001

Sources: Nauru authorities, IMF staff calculation.

6. External Sustainability. Following the resolution of a longstanding external debt default in March 2021, external assets (including the Trust Fund) amount to 319 percent of GDP and external liabilities to 63 percent of GDP, implying a FY21 net lending position to the rest of the world of 255 percent of GDP. Under staff’s baseline assumptions the CA deficit is projected to narrow over the medium-term to a small deficit in FY26 owing to the anticipated closure of RPC, the departure of expatriate workers, still high dependency on fuel imports, and a decline in phosphate exports. Under the forecasted evolution of growth and rates of returns on the stocks of foreign assets and liabilities, the external position is sustainable under the baseline.

uA001fig10

International Investment Position

(In percent of GDP)

Citation: IMF Staff Country Reports 2022, 028; 10.5089/9798400200304.002.A001

Sources: Nauru authorities, IMF staff calculation.

7. REER. Fluctuations in the REER largely mirror movements in the Australian dollar, which is the legal tender in Nauru. Movements in the REER have little impact on competitiveness because trade is predominantly in Australian dollars.

8. Desirable Policies. Adherence to the fiscal responsibility ratios, setting aside windfall revenues to build cash buffers, and robust implementation of the Public Enterprise Act to minimize SOE reliance on subsidies will help support the external balance, particularly if the enduring capability model of RPC results in lower revenues. As residual phosphate reserves approach depletion, economic diversification such as by expanding the usage of the new port facilities and growing a tourism sector could raise the trade balance. Improvements in competitiveness will need structural policy measures that promote the growth of a private business sector, improve the efficiency of SOEs, and increase investment in human capital development.

9. Currency. The use of the Australian dollar as legal tender remains appropriate in view of Nauru’s small size and its close economic linkages with the Australian economy. In the absence of a monetary authority, the Australian dollar provides a nominal anchor.

Annex II. Debt Sustainability Analysis

Staff assesses debt as sustainable under current policies.1 This is a significant improvement from Nauru’s 2019 Debt Sustainability Analysis, which found debt unsustainable. Two key factors contributed to this improvement: 1) the settlement in March 2021 of the long-defaulted external debt (yen bonds); and 2) reductions in domestic debt inherited from the liquidated Bank of Nauru. A continuation of sound fiscal and public debt policies, which is expected in the baseline, will help maintain public debt sustainability.

1. Total public debt is estimated at 27.1 percent of GDP (A$48.3 million) in FY21 and is primarily denominated in domestic currency. External public debt (5.2 percent of GDP or A$9.3 million) is now composed of a Taiwan POC EXIM bank loan (A$5.2 million) which is being paid off through grants from Taiwan POC, informal debt (estimated at A$2.9 million), which includes membership arrears to international institutions, and debt related to the use of Special Drawing Rights (A$1.3 million), which Nauru is using for its reserve position at the Fund.2 Domestic debt consists entirely of the liability that the Government of Nauru undertook as the guarantor of the Bank of Nauru, which went into liquidation in 2006. This liability was quantified in the Deloitte 2014 Report submitted to the District Court and was then estimated at A$62.7 million. At end-FY21, domestic public debt was estimated at 23.4 percent of GDP (A$39.0 million), and is owed to individuals, Nauru Phosphate Royalties Trust (NPRT) and other clubs and businesses. Nauru has not had access to international financial markets in recent years.3

2. In March 2021, the Government of Nauru reached a settlement with a U.S.-based hedge fund, Firebird, lowering Nauru’s external debt by about 83 percent, according to Fund estimates. The Government of Nauru (GON), as a guarantor, had a longstanding liability on bonds defaulted by the Nauru Phosphate Royalty Trust. NPRT served as a sovereign wealth fund for GON in the 1980s, issuing in 1988–89 two series of yen-denominated bonds with a face value of A$83 million, before it went bankrupt. Firebird acquired some of the defaulted bonds at a discount in 2009. Several court cases were subsequently filed seeking repayment, and while rulings were in favor of GON, GON’s liability remained. In FY20, this debt was estimated at A$41.6 million (23.3 percent of GDP). Negotiations on a settlement started in 2015 and agreement was reached in March 2021. Under the terms of the final settlement, Firebird was paid A$4 million in exchange for all their bonds and an indemnity against legal actions on previous court orders or future claims against GON. Due to passage of time, any potential remaining obligation related to the Yen bond are now considered expired.

3. GON has been paying off the Bank of Nauru (BON) debt in recent years, whenever fiscal space permits, including during FY21. In FY22, GON is planning further significant reductions in domestic debt, with a budgeted A$12 million repayment to NPRT, and A$2.4 million repayment to individual bank book holders. GON is also undertaking a BON Debt Reconciliation Project, with support from the Asian Development Bank (ADB), to identify all remaining known creditors and outstanding balance amounts. GON expects that the recognized outstanding amounts will decrease after the debt reconciliation exercise. For example, preliminary estimates suggest that A$5.9 million (3 percent of GDP) is owed to individuals who can no longer be identified and whose current Bendigo bank accounts are unknown.

4. With the settlement of the Yen bonds and steady decline in domestic debt, Nauru’s public debt is now assessed as sustainable under existing policies. In Nauru’s last debt sustainability assessment (DSA) in the 2019 Article IV, public debt was estimated at 86.8 percent of GDP (A$138.8 million). Public debt can be regarded as sustainable when the primary balance needed to at least stabilize debt under both the baseline and realistic shock scenarios is economically and politically feasible. This condition is expected to be satisfied under current policies in Nauru. Nauru’s main external debt (EXIM loan) is small and paid off through grants from Taiwan POC. Nauru’s domestic debt is still relatively large, but it is being gradually paid off and there is no rollover risk. Moreover, with Nauru’s consistently contributing about 10 percent of annual revenues to the Nauru Trust Fund (Annex III) since 2015, it has started to build a track record of responsible fiscal stewardship.

5. Nauru’s public debt remains sustainable under alternative scenarios in the Debt Sustainability Analysis. Nauru’s public debt has the following characteristics: i) relatively low share of debt held by non-residents (19 percent); ii) low share of foreign currency denominated debt (13 percent);4 iii) no short-term debt; iv) low external financing requirement (-4 percent); and v) no known remaining contingent liabilities, as SOEs cannot access international financial markets. Given the current debt level and debt characteristics, Nauru would normally not require an in-depth assessment under the DSA guidelines for high-income countries. However, as Nauru’s debt was previously assessed as unsustainable, Nauru was treated as a high-scrutiny case in this DSA. Under additional stress tests and alternative scenarios debt mostly remained sustainable.

6. In FY22 Nauru plans to obtain a new EXIM loan equivalent to A$17.2 million to cover the cost of a much-needed aircraft, with a possible additional loan for a second aircraft purchase. The EXIM loans are paid off directly through grants from Taiwan POC, but are classified as 12-year loans, denominated in USD, with grant support reviewed every three years. Continued grant support for loan repayment is expected thanks to a strong bilateral relationship with Taiwan POC. The planned EXIM loan in FY22, along with the budgeted repayments of domestic debt, are expected to rebalance the amount of debt held by non-residents, and debt denominated in foreign currency. However, it is not expected to change the debt sustainability assessment under current policies, given the grant nature of the EXIM loan arrangement.

7. Nauru faces substantial downside risks to revenue and GDP growth which, in the absence of prudent fiscal policy, has the potential to endanger future debt sustainability. The Regional Processing Center (RPC) is a major source of revenue and activity in Nauru through hosting fees, service fees and tax revenues from related activity on the island. If RPC revenues decline substantially, expenditures would have to be reduced accordingly in order to meet the fiscal responsibility ratios. A significant reduction in revenues and expenditures is anticipated in the baseline, in anticipation of RPC closure, and GON is still projected to meet its Nauru Trust Fund payments without running fiscal deficits. Fishing licenses are a second important source of revenue, and their projections in the baseline are conservative, based on performance in recent years. In the baseline, low positive GDP real growth is expected, and is sufficient to maintain debt sustainability. However, a large GDP contraction could negatively impact debt dynamics.

8. To maintain debt sustainability continued sound fiscal and public debt management policies are needed, as well as policies to generate and diversify economic activity. Starting with the FY22 budget, the authorities are transparently reporting details of their domestic and external debt. They are also working towards strengthening their debt management and monitoring arrangements, including management of fiscal risks, with assistance from the ADB. In terms of economic activity, the authorities are both developing contingent plans for RPC scale-down or closure, and at the same time negotiating the terms of an RPC “enduring capability”, for its continued presence on the island. In addition, the authorities should use the climate-resilient port, expected to be completed in 2022, to generate commercial activity and bring in new sources of revenue. Other options for diversification are discussed in Annex V. Given s till significant levels of domestic debt, Nauru should carefully consider the possibility of taking on new debt and only do it when the expected growth benefits significantly outweigh the (potential) burden of future debt repayments.

Authorities’ Views

9. The authorities agreed with the staff’s analysis and assessment that Nauru’s debt is sustainable. Authorities underscored their commitment to responsible debt management and noted the actions they have taken toward reining in debt levels since FY20, including resolving the long-standing external debt to Firebird in March 2021, the ongoing BON liquidation payments to individuals and the NPRT, and resolving accounts payable arrears for Eigigu Holdings. Authorities stressed that repayment and servicing of the planned EXIM loan to upgrade the Nauru Airlines fleet would be met by committed budget support from Taiwan POC.

Figure 1.
Figure 1.

Nauru: Public Sector Debt Sustainability Analysis (DSA) – Baseline Scenario

(In percent of GDP unless otherwise indicated)

Citation: IMF Staff Country Reports 2022, 028; 10.5089/9798400200304.002.A001

Source: IMF staff.1/ Public sector is defined as central government and includes public guarantees, defined as Arrears.2/ Based on available data.3/ Long-term bond spread over German bonds.4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.5/ Derived as [(r – π(1+g) – g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).6/ The real interest rate contribution is derived from the numerator in footnote 5 as r – π (1+g) and the real growth contribution as -g.7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1+r).8/ Includes changes in the stock of guarantees, asset changes, and interest revenues (if any). For projections, includes exchange rate changes during the projection period.9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.
Figure 2.
Figure 2.

Nauru: Public DSA – Composition of Public Debt and Alternative Scenarios

Citation: IMF Staff Country Reports 2022, 028; 10.5089/9798400200304.002.A001

Source: IMF staff.
Figure 3.
Figure 3.<