Enhancing Resilience to Shocks and Fostering Inclusive Growth in the Pacific Islands by Min Zhu, Deputy Managing Director, International Monetary Fund
March 22, 2012By Min Zhu, Deputy Managing Director, International Monetary Fund
Pacific Islands Conference co-hosted by the IMF and the Government of Samoa
Apia, Samoa, March 23, 2012
As prepared for delivery
Good morning. I am delighted to be here in Samoa today to launch this first IMF conference in the region in many years. While much attention is currently concentrated on Europe, I welcome this opportunity to refocus the IMF’s attention on the challenges faced by small states. This conference is a great opportunity to exchange views on how the Pacific island countries are navigating the current global economic environment, and how regional policymakers can increase their countries’ resilience to shocks and promote growth. In this regard, the roles of the private sector and of development partners are, of course, also critical.
I would like to express my sincere gratitude to the government of Samoa for co-hosting this event and for its generous hospitality. I would also like to thank all the authorities of the Pacific island countries gathered here together with your main development partners and representatives of the private sector, as well as senior management of the international financial institutions. Finally, I am grateful to our keynote speaker, Professor Peter Montiel, a leading expert on the topics we will be discussing for sharing his thoughts on how the region’s economies can promote growth amid a period of great global uncertainty.
The global outlook
It is appropriate to begin with an overview of the global outlook. As you know, global prospects are improving compared with just a few months ago. Thanks to strong policy measures in Europe, we see signs that the global economy is stabilizing. Markets have calmed and recent data show uptick in economic activities, especially in the U.S.
But, we are not out of the woods yet. There are still major risks and vulnerabilities that policymakers need to address. The financial system is still highly fragile, public and private debt are still too high, and unemployment is still a major economic and social problem. On top of this, the fuel price hike could become a major threat to the global recovery.
The regional landscape
Let me now turn to Asia. Asia—especially emerging Asia—and Australia have been more resilient than other regions during the recent global financial crisis. The reasons for this hold important lessons for the rest of the world. Asia entered the 2008-09 crisis in a healthy position because it had emerged stronger from its own crisis in the late 1990s thanks to the implementation of a critical mass of structural reforms. These reforms were especially focused on the corporate and banking sectors. Firms had drastically reduced their leverage; debt-equity ratios fell by two-thirds. Banks strengthened their capital buffers and reduced their reliance on foreign debt. The ratio of short-term foreign debt to official reserves, a key indicator of external vulnerability, was cut by one third or more in Korea and in other ASEAN+3 economies.
Prudent fiscal and monetary policies also created more policy room to respond to negative spillovers from the global economy. As a result of greater policy space and credibility, Asian economies could afford to take bolder actions during the global financial crisis: they implemented large policy stimulus and reduced policy rates by about twice as much than in other parts of the world. This was essential for the region’s speedy recovery and it also helped support global activity.
Australia has been remarkably resilient to the global turmoil in 2008-09, recording the strongest growth of any other advanced economy. Australia’s resilience is the result of robust demand for commodities; strong linkages with emerging Asia—especially China; a flexible exchange rate; a healthy banking sector; and large policy space created by credible fiscal and monetary policies in the years preceding the crisis. As we will see in the course of this conference, the resilience of Australia has also helped the Pacific islands to navigate the crisis.
So one key lesson is that countries’ first insurance against shocks is to build policy space and buffers and implement structural reforms during good times.
Against this backdrop, what is the outlook for Asia?
Growth in Asia is expected to gain momentum in 2012. Although activity slowed markedly across the region in the last quarter of 2011, owing to weakening external demand, domestic demand has remained strong. This strength has been supported by low unemployment, high capacity utilization, and robust credit growth. Recent leading indicators point to a pickup in activity, a rise in inflation expectations, and, most important, a resumption of vigorous capital inflows into emerging Asia. Average growth for the Asia and Pacific region as a whole in 2012 is projected to be only marginally lower than last year—at about 6 percent—before rising to about 6½ percent in 2013.
While Asia remains exposed to external shocks, the risks are balanced
While many Asian economies have increased their resilience, they are still exposed to external shocks, including through trade and financial channels. A sharp fall in exports to advanced economies and a reversal of foreign capital flows would severely affect activity in Asia, both directly and through knock-on effects on domestic demand.
On the upside, further stabilization of global economic and financial conditions could boost growth and add to inflationary pressures in the region. That is because macroeconomic policy stances have remained generally accommodative.
What role for policies?
Asia has the policy scope to respond to an abrupt change in the global economic outlook. Also, the most robust insurance against the risk of external shocks for emerging Asia remains stronger domestic sources of growth achieved through rebalancing. In China, this would require a sustained rebalancing away from investment and exports toward consumption. In India, it requires measures to improve the investment climate and liberalize trade to maximize gains from the country’s ongoing demographic transition. And among the ASEAN economies, public investment in infrastructure could help crowd-in private investment, thereby promoting more broad-based growth.
Australia has more policy flexibility than almost any other advanced economy with one of the highest policy rates and among the lowest public net debt-to-GDP ratios. The free-floating exchange rate provides an important buffer to external shocks.
Let me turn now to the Pacific islands.
The Pacific islands are heterogeneous but all face challenges
These islands are quite heterogeneous. Some rely on tourism (Fiji, Samoa, Palau and Vanuatu), some on remittances (Kiribati, Samoa, Tonga, and Tuvalu). Some rely on commodities (Papua New Guinea, Solomon Islands, and Timor Leste), and some on fishing license fees (Kiribati, Marshall Islands, Micronesia and Tuvalu) to support incomes.
And they face specific challenges because of their small size. To be sure, some of these challenges are common to other small states. These include narrow production and export bases, limited economies of scale, a lack of diversification and high fixed costs of government given the small size of the population. But most are also vulnerable states that depend heavily on aid to finance their internal and external imbalances.
Climate change and geographical remoteness also pose challenges:
Climate change is a huge issue for the atoll islands (Kiribati, Tuvalu, and the Marshall Islands). It also has important implications for non-atoll islands—such as the Solomon Islands and Samoa—where increasing sea levels have already begun to affect rural incomes. The fiscal costs of climate change are enormous and cannot be internalized by small countries.
Transportation costs are far greater when hundreds of islands are scattered across vast stretches of ocean. Their remoteness presents an additional constraint.
They do, however, have large potential going forward…
Further private-sector development in the tourism industry—including niche and eco tourism—could boost potential growth. The same holds true for further developing the most extensive marine-resource endowment in the world.
Proximity to the resilient Australian economy and emerging Asia should also help to meet some of the challenges. But policy needs to respond too.
What are the main policy challenges?
A key challenge is how to boost potential growth in the Pacific island countries, which has been weak over the last decade. The commodity importers seem to be stuck on a low-growth path. In the 10 years preceding the 2008–09 global financial crisis, Pacific islands’ growth averaged just 2 percent a year—a much lower rate than the Asian low-income countries (where growth was 6 percent), the Eastern Caribbean Currency Union countries (where growth was 4 percent) and small states (where growth was 4½ percent), which are similar comparators.
Another challenge is to broaden the base of growth and to ensure that growth is more inclusive. We know that diversified economies are likely to be less vulnerable to shocks and better able to support sustained, broad-based growth. We also know that inclusive growth—growth that creates jobs for more people, and shares the benefits more widely—matters for long-run stability. Although growth among the commodity exporters has been fast lately, one key policy issue is to ensure that the benefits of commodity wealth spread to the rest of the economy—in the form of jobs created in the non-commodity sector. For example, in Solomon Islands, the government is passing a tax regime to raise the government’s mineral revenue while planned reforms of the mining legislation will improve the investment climate and attract more foreign direct investment (FDI). Improving access to credit for the private sector is also a way to make growth more inclusive. This will be discussed more during the conference.
Volatility is a source of vulnerability. The Pacific islands remain vulnerable to commodity price volatility and terms of trade shocks, given the severe impact of high food prices on poverty, and high transportation costs. Our analysis suggests that commodity price shocks are particularly relevant for the Pacific islands. Countries that rely on fishing license fees as a key source of their income face additional earnings volatility that complicates macroeconomic management. Thus, managing volatility will continue to remain an issue for many years to come—not just for the Pacific island countries, but for the global economy.
Trade and financial integration have benefited the Pacific island countries, but they have also brought some challenges because shocks are transmitted faster. Spillovers from the regional and global economy have increased over the last twenty years. And we will be able to examine this issue more in depth during the next session.
This brings me to another topic of the conference: building greater resilience to external shocks. What is the best way? The first priority is to rebuild macroeconomic buffers. It is like build up “self insurance” during the good times. When growth is solid and external conditions are still favorable, it makes sense to rein in deficits and shore up reserves. In this way a country could build policy space and a cushion for the bad times—especially to protect the most vulnerable. Of course, Pacific islands must be able to count on continued support from development partners when shocks hit. The second priority is to strengthen social safety nets, so that in times of crisis support can reach the most vulnerable quickly and efficiently. There is also a need to increase spending on critical infrastructure, health and education to increase potential growth. Implementing growth oriented structural reforms would help boost investor confidence. Higher potential growth is a recipe for sustained growth and stronger long-term resilience.
Policies will need to adjust as needed and become more flexible and credible. But sometime this entails a trade-off. The best way to reconcile this trade-off is by strengthening the macroeconomic framework and developing multi-year budget frameworks. Also needed are simple fiscal rules that take into account the business cycle, especially the commodity cycle that is so important for the Pacific islands. These measures could help governments better prioritize spending and support the economy during downturns.
How can the IMF help meet these challenges?
This is a broad and extremely challenging agenda. It is up to the Pacific island countries to set the course and the priorities.
As for the IMF, a deeper dialogue—with the IMF listening even more carefully to the needs of our Pacific island members—will help us serve them even more effectively. That’s why we are here today. I am personally committed to this deeper, more fruitful dialogue with the Pacific islands and other small states.
The IMF supports the Pacific islands through our bilateral country engagement, including surveillance, programs like in the case of Solomon Islands and technical assistance (TA).
To strengthen our engagement with the Pacific islands, we have established since September 2010 a regional resident representative office for Pacific island countries based in Suva to better serve our members. This brings our policy advice closer to the countries on a more regular and timely basis. We have also established a new Pacific islands unit at the IMF that oversees the work of Pacific islands, increases synergies across country teams and increases awareness within the IMF of the main policy issues the Pacific islands are facing.
And of course we have our toolkit of IMF facilities to help the countries when they face balance of payments problems. The IMF can work with members that have external financing needs to provide loans to bridge temporary financing gaps. We also work with members borrowing to design adjustment programs to help eliminate the problems leading to the balance of payments problems. IMF lending is provided on terms related to the Treasury bill rates of major industrial countries and subsided or zero-interest rate financing is available for lower-income Pacific island members.
Technical assistance and capacity building is a key part of our job. The Pacific Financial Technical Assistance Centre (PFTAC) is a vital component of the IMF’s assistance to the region. PFTAC has been providing technical assistance and training to Pacific Island countries for almost 20 years and we are proud that it has helped your countries achieve great improvements in economic management. PFTAC was the first IMF Regional Technical Assistance Centre and its success in the Pacific led to the model being replicated by the IMF across the world. We now have eight different centers covering more than 100 countries and are looking to expand yet further. PFTAC is also expanding the support it makes available to the region and will soon have a team of seven advisors based in Suva. We are grateful for the increasingly generous financial support provided by Australia, the European Union, Korea, and New Zealand.
I also would like to stress that we have increased synergies with other international institutions, the World Bank—our twin institution—and the ADB. I want to thank the vice presidents for being here today to ensure the coherence of our support for Pacific islands and maximize its effectiveness. The staff of our institutions has worked together very closely on the Pacific islands; and the WB and ADB colleagues join regularly IMF missions in this part of the world.
I would like to reiterate that I am here to listen to your views and to learn more about your countries. The reason for this conference is to serve better our member countries. Thank you for your attention. I wish you stimulating and fruitful discussions.