IMF Executive Board Concludes 2007 Article IV Consultation with the Solomon IslandsPublic Information Notice (PIN) No. 07/110
September 7, 2007
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2007 Article IV Consultation with Solomon Islands is also available.
On July 16, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Solomon Islands.1
The economy has been recovering since the end of the civil conflict and the intervention of the Regional Assistance Mission to the Solomon Islands (RAMSI) in mid-2003, but the country remains poor and relies heavily on logging and aid. Over the last four years, economic growth has averaged 6 percent—although logging is occurring at an unsustainable rate—and financial stability has been maintained. Large amounts of donor assistance and the restart of two large projects (gold mine and palm oil plantation) have helped sustain economic activity.
Real GDP growth rose to an estimated 6 percent in 2006, driven by fish, palm oil production, and services, but is expected to ease to 5½ percent in 2007, as a further escalation in logging—now running at around five-times the sustainable rate—will be likely offset by lower growth of fish and traditional crops. The April 2007 tsunami is not expected to have a significant impact on growth. The current account deficit, which widened slightly to 26 percent of GDP in 2006, mainly reflecting higher fuel and investment-related imports, is expected to increase to 40 percent of GDP in 2007 due to imports related to the refurbishment of the gold mine (17 percent). Nevertheless, continued strong aid flows and foreign direct investment are expected to keep reserves adequate.
A sizeable overall budget surplus in 2006 helped slow overall monetary growth, as the resulting contraction in credit to government partly offset continued strong growth in banking sector credit to the private sector. This moderation in monetary growth, combined with receding oil prices, helped inflation decelerate to 7½ percent from 8½ percent at end-2005. In 2007, despite a higher revenue effort, the overall budget surplus is projected to decline to ½ percent of GDP, reflecting sharply higher spending on wages and goods and services. Thus, while private sector credit growth is expected to moderate and oil prices stabilize, inflation is projected to ease only slightly, to 7 percent by end-year.
With the natural forest expected to be depleted within the next few years, structural reforms are necessary to generate higher sustainable growth, raise living standards, and reduce the economy's vulnerability to shocks. However, progress in this area has been mixed. Import duties were lowered; statutory and discretionary tax exemptions were reduced; reference prices of logs were raised for the first time since 2003; work permit and immigration procedures were streamlined; and, with the help of donors, sectoral strategies are being implemented in health, education, transport, and agriculture. The road network is improving. Against this, little progress has been made in easing other critical constraints to higher sustainable growth; namely, in restructuring the utilities, which continue to provide unreliable and costly services and threaten the budget, and in strengthening governance, which continues to be adversely affected by opaque rules, the perception that government exercises excessive discretion, and uncertain land tenure arrangements.
Executive Board Assessment
Executive Directors welcomed the Solomon Islands' favorable near-term growth prospects, and the authorities' success in maintaining macroeconomic stability since the end of the civil tensions, and the support of the Regional Assistance Mission to the Solomon Islands. Directors supported the authorities' intention to adopt a medium-term national development strategy, which once implemented, could help them better cope with the significant challenges ahead. These include improving the outlook for employment, poverty reduction, and growth, against the backdrop of rapid depletion of the natural forests due to intensive logging. In that connection, Directors encouraged the authorities to implement their planned structural reforms to generate alternative sources of growth in the context of a poverty reduction strategy framework.
Directors commended the recent strengthening of the revenue effort, especially in reducing tax exemptions and improving tax administration and collection in the Inland Revenue Division, and the simplification of the import duty structure. They encouraged the authorities to save most of this year's expected revenue overperformance. They looked forward to the introduction of an automatic adjustment mechanism for the reference prices of logs used in calculating export duties, and to further progress on a comprehensive tax reform. Directors welcomed proposals to strengthen the budget process and called for efforts to rein in current expenditure in order to make room for higher spending on high-priority maintenance and infrastructure investments. This should include tighter payroll controls, linking future civil service wage increases to productivity improvements, and strengthening public financial management.
Looking ahead, Directors encouraged the authorities to adopt a medium-term fiscal framework to help anchor fiscal policy in the face of impending revenue pressures, assist with the prioritization of spending, and support the attainment of debt sustainability. They recommended that the authorities refrain from new borrowing until the sustainability of public debt is well secured.
Directors supported the central bank's commitment to restrain inflation and its readiness to tighten reserve requirements if inflation accelerates. They considered that the introduction of a standing deposit facility would help absorb some of the excess liquidity and increase the central bank's control over monetary aggregates. Looking ahead, Directors recommended that the authorities develop a more forward-looking and proactive approach to monetary policy, and supported Fund assistance to develop inflation forecasting capability. Directors agreed that the banking system appears generally sound, but the continued growth in bank credit calls for intensified supervision and tightened loan classification.
Directors observed that although the current account deficit is fully financed by aid inflows and foreign direct investment, close monitoring is called for in view of the large swings in the deficit. Export competitiveness appears adequate, but Directors cautioned that a large minimum wage increase—in excess of productivity increases—could weaken labor-intensive exports and rekindle inflation. Directors supported the current exchange rate policy of stabilizing the exchange rate against the U.S. dollar, in the light of strong inflows and adequate competitiveness. However, Directors recommended that the exchange rate be allowed to adjust downward, if needed, in response to market pressures.
Directors considered that the restructuring of state-owned enterprises, liquidation of the Development Bank of Solomon Islands, and durable strengthening of the National Provident Fund will be critical to minimize future contingent liabilities and improve public sector governance. They encouraged the authorities to implement without further delay the management contracts for the electricity and water utilities, which should lower costs and improve service delivery. Continued efforts to improve basic infrastructure should lead to a better return on investments over the medium term. Directors welcomed recent improvements in the investment and business environment, and looked forward to further progress, including the promotion of further governance enhancements.
Directors welcomed recent improvements in the statistical database, and recommended continued efforts to address weaknesses that complicate the effectiveness of surveillance and policymaking.