Mission Concluding Statement 

Kiribati – 2013 Article IV Consultation Concluding Statement of the IMF Mission

April 9, 2013

This statement contains the mission’s preliminary views and policy recommendations following discussions with the Kiribati authorities, development partners and the private sector. The discussions focused on policies to ensure fiscal sustainability and improve public financial management, reduce Kiribati’s vulnerability to external shocks; and promote private sector growth.

1. Kiribati has started an ambitious reform program supported by the donor community. Steady implementation of the reforms will be key to improve fiscal prospects, promote private sector development, and increase resilience to external shocks. Climate change and pressures on infrastructure raise additional challenges.

Outlook

2. Growth increased to 2¾ percent in 2012, driven by donor projects, higher than average fishing license fees, and remittances. Inflation remained low. Revenue from fishing licenses was much higher than average, but is expected to revert to long term average in the next few years. Going forward, growth is expected to increase further to 3 percent as donor-financed road and airport projects are expected to boost construction. Inflation also is expected to increase somewhat to 2½ percent.

Fiscal Policy

Key policy challenges in the fiscal area include reducing fiscal imbalances and setting up mechanisms for public financial management that would enable the authorities to formulate and execute a sustainable fiscal framework over the long run. On the structural front, SOE reforms and improving the prospects for private business growth should continue to be in focus to reduce fiscal burden.

3. Fiscal policy faces the challenge of reducing structural fiscal imbalances. Since the mid-2000s, the fiscal position has worsened as revenues stagnated and expenditures were not adjusted to reflect lower revenues. This led to high current deficits¹ financed by unsustainable RERF drawdowns and non-concessional borrowing. By 2011–12, the RERF balance, in constant per capita terms, was almost half of its amount in 2000. The government’s decision to clear the overdraft facility and other non-concessional borrowing significantly reduced borrowing costs. Nevertheless, fiscal imbalances remain large, with the current deficit in 2013 estimated to exceed 18 percent of GDP.

4. We commend the government for embarking on a broad range of reforms to reduce fiscal imbalances and improve fiscal planning and execution. These reforms are supported by the developing partner community and cover several areas. The government plans to introduce value added and excise taxes at the beginning of 2014 and has prepared a public finance regulation act to strengthen procedures for budget execution, reporting, and auditing, and has been upgrading the relevant information systems. Significant work has been done to reform non-performing SOEs and the cabinet has submitted to parliament an SOE bill to strengthen SOE governance and financial reporting. Work is underway to improve Kiribati’s fisheries policy. The government plans to introduce improvements in the management and asset allocation of the RERF with the support of technical assistance. Based on the reform program, the government has been actively engaged with the World Bank, AusAid, and AsDB to secure budgetary grant support for 2013 and 2014.

5. We welcome the authorities’ commitment to introduce the VAT. The government is planning to introduce VAT at the beginning of 2014 – an ambitious task. Implementation challenges are significant and need to be addressed promptly, in particular with regard to provision of necessary equipment and software to customs for collection of import VAT. The donor community could speed up efforts to deliver and install such equipment.

6. Further analysis is needed to evaluate the impact of VAT on prices. While VAT would replace and indeed exceed custom duty for some staples, such as flour and rice, there are other elements, such as price controls and levies and charges that need to be taken into account.

7. The copra subsidy scheme could be made more efficient. The efficiency can be increased by streamlining arrangements between Kiribati Copra Mill Ltd. (KCML) and Kiribati Copra Cutter Society (KCCS) to avoid duplication of activities, and by more effective monitoring. As this is more a livelihood subsidy than a production subsidy, other options for providing assistance to the islands should include alternative forms of subsidies and transfers. We welcome the government’s work in this area with the assistance of the World Bank.

8. Maintaining sufficient growth of fishing license revenues while abiding by international commitments and managing their volatility is very important. Many factors outside of Kiribati’s control combine to underpin the volatility of fishing license revenues. These include seasonal weather patterns that affect tuna stocks, annual sale of fishing licenses, and, to some extent, exchange rate movements associated with the US dollar. Hence the strong spike in fishing revenue in 2012 reflects one off factors that cannot be sustained into the medium term. At the same time, an agreement between Parties to the Nauru Agreement (PNA) member-countries to increase the minimum price of fishing licenses from US$5,000 to US$6,000 per day for 2014, improves the near-term fishing revenue outlook.

9. Restoring fiscal sustainability by stabilizing the per capita value of the RERF in real terms would require significant fiscal efforts and additional reforms to boost revenues and/or reduce expenditures. This can be illustrated by considering the following scenarios:

• The baseline scenario assumes the introduction of value added and excise taxes, growth of current expenditures and wages in line with inflation in the medium term and below nominal GDP growth in the longer term, Under this scenario, the current fiscal deficit will be reduced from above 18 percent of GDP in 2013 to about 7 ¾ percent of GDP in the longer term. Despite significant fiscal adjustment under this scenario, the RERF per capita value does not stabilize and declines by more than 30 percent by 2030 compared to the 2011 level.
• An illustrative stronger reform scenario incorporating additional fiscal measures achieves stabilization of the RERF per capita value by 2021–22 at the level of about A$3,900 in constant terms. Such stabilization requires additional fiscal adjustments compared to the baseline scenario because the current deficit will need to be reduced to about 2½ percent of GDP on average in 2022-30. The adjustment would be distributed broadly between taxes, wages, and other expenditure measures. The scenario also assumes some improvement in fishing license fees revenues through better pricing. The adjustment period is appropriate given the magnitude of fiscal adjustment, capacity constraints and the time needed to implement fiscal and structural reforms.

10. The key to restoring fiscal sustainability lies in the implementation of a sound public financial management framework. In this context, it is important to adopt a prudent debt policy that limits budget borrowing and granting of guarantees, strengthens saving of revenue windfalls, and prevents exceptional spending allocations. The mission continues to recommend avoidance of expensive commercial borrowing to finance budget needs. Technical assistance to develop and implement such a policy framework may be needed.

Financial Sector

11. Efforts in financial sector development need to focus on improving access to credit for viable private business projects. The limited scope of the financial sector and difficulties with getting collateral lead to relatively high lending rates. At the same time, risk management procedures need to be observed.

12. Returning the Kiribati Provident Fund’s (KPF) financial position to positive territory is important to ensure the sustainability of the pension fund’s operations. While rebuilding the financial position of the pension fund may take some time, in the immediate future, the KPF is advised to avoid setting rates of return on members’s balances in excess of return on investments.

Structural Reforms and Private Sector Development

13. The poor performance of SOEs has created a drag on the budget and the economy. By May 2012, SOEs had accumulated some A$11 million of overdraft debt to ANZ, in addition to debts to the government and the KPF. Given the high interest rate on the ANZ debt, the government has repaid most of the SOEs’ overdraft balances, but unless the government takes measures to improve the performance of these enterprises, additional costs are likely to emerge. There are also arrears between SOEs, with the biggest being the Public Utilities Board’s (PUB) debt, in excess of A$5 million, to the Kiribati Oil Company (KOIL).

14. We welcome the government’s SOE reforms undertaken with the assistance of the AsDB. In particular, the stocktaking of performance and financial positions of all SOEs and design of restructuring modalities with proposed action plan for each enterprise was a milestone. Action has been already taken with regard to a number of SOEs, including the shipyard, the wholesale and retail trading, and the public broadcast companies. In addition, an SOE bill, if passed by parliament, will help improve the governance of SOEs.

15. Measures towards the commercialization of SOEs are also promising. The cabinet submitted to parliament legislation to liberalize and increase competition in the telecommunication sector. It has also issued a privatization tender for the Otintaai hotel.

16. While the government has made impressive progress in reforming SOEs, a number of important issues still need to be tackled. In particular, the Public Utilities Board (PUB) currently operates at a loss, resulting in unsustainable arrears to Kiribati Oil Company (KOIL). The mission is encouraged that the government is actively working on a plan to increase collection rates and improve the PUB’s performance. We recommend evaluating the effectiveness and magnitude of increased revenue collections once the plan is put in place. Government efforts to expand renewable energy sources that would reduce the need for diesel fuel are also commendable.

17. Private sector development is critical for both lifting growth and reducing fiscal pressures. Improving the management and development of Kiribati’s marine resources—particularly fisheries, developing the tourism industry, and expanding opportunities for studying and working abroad provide the greatest economic potential. In addition, removing obstacles for doing business is of utmost importance.

18. The mission is encouraged by some recent entrepreneurial efforts. The fish processing joint venture employs modern technology and provides employment opportunities. Nevertheless, there is a need to ensure consistent local supply of fish and improve infrastructure in order to ensure a viable domestic fishing industry

19. Current and planned improvements to infrastructure should strengthen general economic activity and opportunities for Kiribati tourism. There is potential for tourism outside of Tarawa, particularly in the Phoenix and Line islands. Christmas Island provides opportunities for fishing tourism, while the Phoenix Island world-heritage marine protected area is a unique attraction for eco-tourists. In this regard, improvements to the road and airport infrastructure and much-needed investment in inter-island travel would be key to promoting and eventually meeting tourism demand.

20. Removing obstacles for doing business and improving the business climate is essential for private business growth. Kiribati ranks low compared to its Pacific islands peers in a number of doing business indicators including time to get electricity and construction permits, and access to credit. Getting access to land for collateral is also a major obstacle. Some of the difficulties are related to local traditions - for example land transactions normally involve multiple family members. Nevertheless, there is scope for the government to shorten the business applications process and reduce red tape. The mission suggested looking into ways to simplify and standardize business applications procedures.

The IMF team thanks the authorities for constructive discussions and warm hospitality.

¹ For the purpose of this statement, current fiscal deficit is defined as the deficit that excludes development expenditures financed by donors and corresponding development grants on the revenue side. It is a better indicator of the fiscal stance and financing demands on Kiribati government than the overall deficit. The current deficit in this definition also corresponds to the concept that the government uses for its budget.