Public Information Notice No. 04/102

Public Information Notice: IMF Concludes 2004 Article IV Consultation with Fiji

September 14, 2004

On August, 23, 2004, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Fiji.¹

Background

Fiji's economic growth in recent years has been high by historical standards. In 2004, real GDP growth of 4¾ percent is projected, which will bring average growth in 2002-04 to 4½ percent. While partly a recovery from the coup in May 2000, the recent growth performance is still well above Fiji's average growth in the 1990s of 3.2 percent. Domestic demand has been the main factor driving growth, as retail sales rose by an estimated 13 percent in 2003 on top of 17 percent growth in 2002, and construction activity increased by 38 percent in 2002-03. Rising tourist arrivals, up 14 percent in 2002 and 8 percent in 2003, also contributed, but sugar production resumed its decline in 2003.

Domestic demand was stimulated by the largest fiscal deficits in any three year period since Fiji's independence in 1970. In 2001-02, the budget deficit widened to an average of 7 percent of GDP as the government sought to stimulate the recovery from the 2000 coup. The government aimed to reduce the deficit to 5½ percent of GDP in 2003, and it increased the rate of VAT from 10 percent to 12.5 percent in January that year. Even with strong revenues, the deficit out-turn was 5¾ percent of GDP, partly due to a supplementary budget for the cost of damages from Cyclone Ami. The large fiscal deficits in 2001-2003 lifted central government debt to almost 50 percent of GDP in 2003, from 37 percent of GDP in 1999.

An accommodative monetary policy facilitated renewed bank lending in 2003. The Reserve Bank of Fiji (RBF) maintained its target interest rate at 1¼ percent for most of the period since the 2000 coup as credit was stagnant. Lending to the construction and manufacturing sectors, and also to households, revived in 2003, with private sector credit growing by 17 percent year on year. Nonetheless, inflation has been relatively stable in recent years—excluding the effects of the VAT increase in 2003—as the exchange rate peg continued to ensure that inflation remained broadly in line with Fiji's trading partners. In June 2004, CPI inflation was 2.7 percent y/y.

The external position has weakened in recent years. The external current account deficit (excluding aircraft leases) widened to an estimated 7½ percent of GDP in 2003, from 3½ percent in 2001-02. A 35 percent rise in imports (excluding aircraft leases) contributed to the situation, while rising inflows of travel earnings were offset by higher services imports. As a result, official reserves were 3¼ months of imports in June 2004, from an average of 4 months in 2000-02.

Domestic demand appears to remain strong in 2004, as government revenues have exceeded projections by 6½ percent in the first five months. Tourist arrivals are on course to again rise strongly in 2004, partly due to falling airfares. The 2004 budget aims to reduce the budget deficit to 4 percent of GDP, but the public sector unions demand a Cost of Living Adjustment of 5 to 6 percent, which could lead to an overrun of the budget target. In May 2004, the RBF increased the target interest rate by 50 basis points to 1.75 percent, and it announced that further interest rate increases may be needed.

Executive Board Assessment

Executive Directors welcomed the strong economic growth in Fiji since 2002, supported by political stability, and led by consumer spending and rising tourist arrivals. Directors particularly welcomed indicators that private investment is beginning to rise. Notwithstanding the upturn in domestic demand, inflation has remained low, and the level of international reserves adequate. However, Directors expressed concern about the increase in public debt and the deterioration in the external position due to rising imports. In the period ahead, the authorities should give priority to tightening fiscal policy to contain the public debt and ensure medium-term fiscal sustainability, and to implementing structural reforms with a view to lowering costs for business, improving private sector employment prospects, and reinforcing the authorities' goal of sustaining strong economic growth. The authorities should also prepare for the social and economic challenges presented by the ending of trade concessions for the sugar and garment sectors. The appropriate sequencing of these policies will be essential to ensure their effectiveness in a context of social and political stability.

Directors emphasized that timely fiscal consolidation will be crucial for strengthening Fiji's capacity to cope with future shocks. In this regard, the deficit target in the 2004 budget is a step in the right direction, and Directors urged the authorities to adopt corrective measures if expenditure overruns threaten it. Directors supported the government's medium-term goal of bringing down the public debt to 40 percent of GDP. Most Directors urged the authorities to make a front-loaded effort to carry fiscal consolidation forward more rapidly. Some Directors, however, agreed with the authorities that a more gradual pace of adjustment was reasonable, in order to cushion the contractionary impact of the ending of trade concessions and avoid a "hard landing."

Directors emphasized the importance of ensuring that adequate resources are available for essential infrastructure investments and maintenance expenditures. In this vein, the focus of fiscal consolidation should be on reductions in current spending and increases in revenues in the medium term. Directors called attention to the large share of the wage bill in the budget. They considered that the recent civil service reforms and the introduction of the performance management system should provide an opportunity to contain public sector salary increases and improve efficiency. Directors supported a further strengthening of tax administration, especially by introducing a single taxpayer identification number for each taxpayer, and by establishing a large taxpayer unit. They recommended that tax concessions be rationalized, particularly those granted on a discretionary basis. Directors urged the timely implementation of financial management reform plans to help secure the success of the fiscal consolidation and civil service reform efforts.

Directors supported the decision to tighten monetary policy in May 2004 through an increase in interest rates. Given the strength of domestic demand, the recovery in bank lending, and the deterioration in the external position, further interest rate increases may be warranted. Directors nonetheless considered that fiscal policy must carry the main burden of macroeconomic policy adjustment, so that a crowding out of private investment can be avoided.

Directors considered that the financial sector in Fiji is relatively sound. They welcomed Fiji's decision to participate in the Financial Sector Assessment Program in 2005-06. Directors endorsed the expansion of financial supervision to cover the Fiji National Provident Fund, and they welcomed the progress Fiji is making in implementing measures to combat money laundering and the financing of terrorism. Directors supported the authorities' intention to assess carefully the Fiji Development Bank's request for a commercial banking license.

Directors agreed that the peg of the exchange rate to a basket of currencies has served Fiji well. Directors encouraged the authorities to make appropriate adjustments in macroeconomic policies on a timely basis in order to support the peg. If made necessary by developments in trade or the current account, an adjustment in the peg should not be ruled out after careful consideration of benefits and costs and adequate preparation.

Directors noted that Fiji's garments exports may fall sharply due to the expiry of quotas in the U.S. market at the end of 2004, and that sugar exports could also drop substantially with the expiry of the EU sugar protocol after 2007. To cushion the adverse employment and poverty impact of a contraction of these sectors, as well as of the civil service reforms, structural reforms to facilitate private sector growth and job formation will be essential. Directors considered that measures are needed to improve the flexibility of the labor market. Directors supported a deepening of public enterprise reforms, through strict commercialization and possible privatization. Improved management of public enterprises would help reduce the costs of utilities, and support the development of infrastructure, thereby promoting private investment and increasing the resilience of the economy. Directors also supported the authorities' efforts to diversify the agricultural sector and reform the sugar sector. They recommended that the authorities implement measures to encourage the planting of alternative crops on lands where sugar cane will no longer be viable. They noted that early agreement on the maximum allowable return on leased land would remove an uncertainty about land tenure and reinforce the prospects for investment in agriculture.

Directors noted that exchange controls are being gradually liberalized, but Fiji still maintains a restriction on certain current account transactions. Directors recommended that the authorities set a clear timetable for eliminating the remaining restriction on current payments.