## cr18109 — Vanuatu: IMF staff report excerpts (2018)

## Source details

**Canonical URL:** [cr18109 — Vanuatu: IMF staff report excerpts (2018)](https://www.imf.org/-/media/files/publications/cr/2018/cr18109.pdf)

## Other formats

- [Markdown version](/-/media/files/publications/cr/2018/cr18109.pdf.md)
- [Structured JSON version](/-/media/files/publications/cr/2018/cr18109.pdf.json)

---

### BACKGROUND
- Vanuatu is a small island developing state and a low-income country with income per capita about USD 3,000.
- Key drivers of economic activity: tourism and agriculture.
- Growth history:
  - Average real GDP growth 2005–15: 3.4 percent.
  - Average real GDP growth 2010–15: 1.5 percent.
  - Average real GDP growth 2000s earlier five-year period: 5.7 percent (previous 5-year period).
- Population growth: 2.3 percent in 2016.
- Cyclone Pam (March 2015) caused extensive damages; the Fund disbursed about USD 23.8 million under RCF/RFI.
- Government introduced VISIP 2015 (Vanuatu Infrastructure Strategic Investment Plan 2015-2024); reconstruction supported by IDA and ADB started in 2017.

### RECENT DEVELOPMENTS, OUTLOOK, AND RISKS
- 2016 indicators and developments:
  - Real GDP growth: 3.5 percent in 2016 (from 0.2 percent in 2015).
  - Inflation: below 1 percent in 2016 (from 2.5 percent in 2015).
  - Current account deficit: about 4 percent of GDP in 2016 (down from 10.6 percent of GDP in 2015).
  - Foreign reserves: USD 267 million (6.4 months of imports) at end-2016.
  - Fiscal deficit: 6.1 percent of GDP in 2016.
  - Financing: mostly external concessional borrowing, grants, and FDI.
- Staff outlook (estimates):
  - Real GDP growth expected around 4 percent in 2017 and 2018.
  - Inflation estimated: 3.1 percent in 2017; 4.8 percent in 2018 (mainly due to VAT increase from 12.5 to 15 percent).
  - Current account deficit expected around 9 percent of GDP in 2017 and 2018.
  - Fiscal deficit expected around 7 to 8 percent of GDP in 2017 and 2018.
  - Offsetting measures: temporary VAT increase, proceeds from citizenship programs (VDSP and VCP).
- Risk assessment (summary):
  - Overall: High vulnerability; downside risks dominate.
  - Upside risks:
    1. Positive spillovers from large infrastructure projects — Likelihood: Medium; Impact: High.
    2. Lower energy prices — Likelihood: Low; Impact: Medium.
  - Downside risks:
    1. Implementation of infrastructure projects — Likelihood: High; Impact: High.
    2. Natural disasters and climate change — Likelihood: High; Impact: High.
    3. Delays in implementation of tax reform — Likelihood: Medium; Impact: High.
    4. Weaker-than-expected global growth — Likelihood: Medium; Impact: Medium.
    5. Reduced financial services by correspondent banks — Likelihood: High; Impact: Medium.
- Authorities concurred with staff on developments, outlook, and risks; expect modest slowdown after major infrastructure projects complete; concerned about unanticipated effects of graduation from UN LDC status in 2020.

### A DEVELOPMENT STRATEGY TO SUPPORT STRONG AND DURABLE GROWTH
- Policy focus areas:
  - Fostering strong, durable, and disaster-resilient medium-term growth.
  - Preserving fiscal space and safeguarding debt sustainability amid rising development needs.
  - Maintaining prudent monetary policy while pursuing financial inclusion and stability.

A. Fostering growth under natural-disaster risk
- Context and challenges:
  - Per capita GDP growth since 2005: 1.0 percent.
  - Two main causes of low and volatile growth: concentration in tourism; natural disasters.
- Diversification strategies:
  - Diversify within and outside tourism; strengthen tourism–agriculture linkages.
  - Segment tourism marketing (e.g., Espiritu Santo and Port Vila separately).
  - Promote agricultural production (e.g., Vanuatu beef) and agri-tourism.
- Natural disaster preparedness — lessons from Cyclone Pam:
  - Ex-post actions: suspension of VAT and import duties on construction materials; RBV reduced SRD requirement; banks implemented business continuity plans.
  - Ongoing measures: Tropical Cyclone Pam Recovery program continuing in 2018; RBV’s Natural Disaster Reconstruction Credit Facility.
  - Implementation gaps: coordination issues delayed projects (e.g., Bauerfield runway); slower recovery in outer islands.
- Disaster resilience funding and climate finance:
  - Emergency Fund increased from VUV 25 million (2017 budget) to VUV 50 million (2018).
  - Fiscal framework allows swift withdrawal up to 1.5 percent of a year’s total appropriation (around VUV 330 million), later requiring Parliamentary approval.
  - VUV 200 million spent via supplementary budget for Ambae eruption in September 2017 instead of drawing on Emergency Fund.
  - Green Climate Fund grant of USD 18.1 million in February 2018 for Climate Information Services (CIS).

Staff policy recommendations (paragraph 12)
- Promote diversification to boost growth and resilience:
  - Improve ease of doing business (remove bottlenecks in registering property and land titling).
  - Reassess recent leasing reforms for customary land.
  - Prioritize access to employment and financial inclusion, especially in outer islands.
- Strengthen ex-ante disaster preparedness through:
  i) Strengthening risk assessment and planning.
  ii) Building domestic fiscal buffers.
  iii) Securing external buffers.
  iv) Promoting resilient infrastructure and adequate maintenance.
- Present a fiscal risk statement with the budget to identify and disclose fiscal risks, including natural disaster and climate change.
- Medium term: consider a disaster resilience fund to address higher-frequency, lower-intensity events and reduce reliance on the supplementary budget.

Authorities’ views
- Support broad-based economic activity, inclusive tourism-driven growth, and agriculture initiatives.
- Barriers: land leasing system, high cost of capital, non-tariff barriers for agricultural exports, and data gaps.
- Legislation to promote farmers’ associations planned for first session of Parliament in 2018.
- Committed to disaster-resilient frameworks, concessional financing, improved donor coordination, building absorptive capacity, and international assistance when major disasters strike.

### FISCAL OUTLOOK AND PROJECTIONS
- Staff projections envisage a fiscal deficit of 7.5 and 8.0 percent of GDP in 2017 and 2018, respectively.
- Fiscal developments:
  - Tax collection in 2017 stronger than in 2016.
  - Non-tax revenue, including citizenship programs, remains high.
  - Expenditure in 2017 higher than in 2016 due to severance payments and the Pacific Mini Games (December 2017).
  - Fiscal deficit deteriorated from 6.1 percent of GDP in 2016 to 7.5 percent in 2017.
  - Deficit expected to widen to 8.0 percent of GDP in 2018 owing to a 7–8 percent on average increase in the government wage bill, despite VAT increase from 12.5 to 15 percent starting January 1, 2018.
  - Implementation of tax administration and income tax bills in early 2019, plus lower committed capital spending as projects complete, expected to reduce deficit to 4.3 percent in 2019.

### INFRASTRUCTURE PROJECTS AND IMPLEMENTATION RISKS
- Major projects nearing completion in 2018–2019:
  - Luganville International Wharf; Tanna & Malekula Road Rehabilitation & Upgrade Program (China EXIM Bank).
  - Port Vila Lapetasi International Multi-Purpose Wharf Development Project (JICA).
  - Cyclone Pam road and school reconstruction (ADB).
  - Vanuatu Infrastructure Reconstruction and Improvement Project (IDA).
  - Rehabilitation of Bauerfield International Airport and runway repairs for Santo and Tanna (IDA).
- Implementation issues: coordination problems and contractor plan delays that could hurt tourist arrivals.

### PUBLIC DEBT AND DEBT SUSTAINABILITY
- Public and publicly-guaranteed debt: 28.7 percent of GDP in 2014 → 48.8 percent in 2016.
  - Increase due to disbursements for infrastructure and reconstruction; borrowing largely highly concessional.
  - Vanuatu’s public debt at higher end relative to other Pacific Island countries.
- DSA findings:
  - Risk of external debt distress: moderate (consistent with 2016 assessment).
  - Debt service pressure expected to rise over the medium term.

### GOVERNMENT REVENUES AND ECONOMIC CITIZENSHIP PROGRAMS
- Revenues remain low compared to regional peers.
- Authorities aim to introduce corporate and personal income taxes as early as 2019 with IMF HQ, PFTAC and Australia TA.
- Interim measures: VAT rate increase; continued use of economic citizenship programs.
- Economic Citizenship Program details:
  - VDSP contribution: USD 200,000 (single person) to USD 280,000 (family with elderly parents).
  - REO Program requires USD 230,000 investment in real estate-related investments.
  - VDSP application process: 1 to 2 months; citizens of North Korea, Yemen, Syria, Iraq, and Iran excluded.
  - 2017 revenue from programs: around VUV 3.5 billion (around 3.7 percent of GDP), accounting for 16.1 percent of total revenue, excluding grants.
  - October 2017: government reportedly accepted Bitcoin payments for VDSP; Reserve Bank of Vanuatu reversed decision.
- Risks: reputational risks may impact correspondent banking relationships; reliance on these revenues not sustainable.

### PUBLIC FINANCIAL MANAGEMENT AND REFORMS
- Guided PEFA self-assessment (2015) led to a medium-term PFM Reform Roadmap.
- Reforms: improve internal audit, accounting, and reporting capacity.
- PFTAC support areas: public investment management, medium-term budgeting, fiscal risk analysis from GBEs.

Staff fiscal, debt, and anchor recommendations
- Fiscal Adjustment:
  - Support reconstruction/public investment with donor help and mobilize domestic revenues (VAT increase, income tax introduction).
  - Move swiftly after payroll tax introduction in January 2019 to implement remaining personal and corporate taxes.
  - Consider restraining spending if income tax introduction delayed or other revenues do not materialize.
  - After reconstruction/infrastructure scale-up conclude, embark on fiscal adjustment measures:
    - (i) Restrain recurrent spending (public wage bill and severance payments).
    - (ii) Prioritize and carefully select public infrastructure projects considering absorptive capacity and returns.
    - (iii) Continue revenue mobilization, including tax administration enhancements.
- Debt Management:
  - Update the debt management strategy (DMS) annually.
  - Contract external financing as grants or on concessional terms where possible.
- Fiscal Anchor:
  - Consider adopting a medium-term fiscal anchor defined by a fiscal deficit target and debt ceiling.
  - Staff assessment: reasonable medium-term debt ceiling for Vanuatu in the range of 50–60 percent for nominal public and publicly-guaranteed debt-to-GDP ratio.
  - Such a debt ceiling consistent with a fiscal deficit target of 3–4 percent of GDP.

Authorities’ views on fiscal policy
- Agreed on need for fiscal adjustment, management of wage bill and severance payments, and annual DMS updates.
- Concerned a medium-term fiscal anchor may unduly limit infrastructure investment.
- Committed to payroll tax for public servants in early 2019 followed by remaining personal and corporate taxes in mid-2019, and reversing temporary VAT increase.
- Concurred on risks of heavy reliance on Economic Citizenship Program revenues.
- Agreed to seek grant financing where possible and maintain a grant-element target of at least 35 percent on new loans.

### EXTERNAL POSITION, RESERVES, AND EXCHANGE RATE POLICY
- Basket peg regime working well; external position broadly consistent with medium-term fundamentals and desirable policies.
- Staff assessment: external position broadly in line with external current account benchmark (current account gap of -1.9 to 1.8 percent of GDP and REER gap of -4.7 to 5.0 percent).
- International reserves:
  - Reserves covered an estimated 6.4 months of imports of goods and services by end-2016.
  - Above authorities’ commitment (4 months) and adequacy benchmarks (3.9–5.2 months).
  - Reserves expected to remain comfortable over next several years; downside risks if infrastructure imports exceed projections.
- External Sector Assessment highlights:
  - Adequate reserves estimated in range 3.9 to 5.2 months; actual noted as 6.9 months in one assessment.
  - Staff expects reserve cover to fall to around 5.4 months by 2023.
  - Current account deficit likely to persist at 7–9 percent of GDP over the medium term.
  - REER mild appreciation trend since 2014; nominal depreciation vs AUD and appreciation vs USD since 2016.
  - EBA-Lite and external sustainability approaches indicate external position broadly consistent with fundamentals; REER gaps reported (CA approach REER gap -4.7 percent; external sustainability REER gap range 1.3 to 5.0 percent).

### MONETARY POLICY, INFLATION, AND RESERVES MANAGEMENT
- Excess liquidity in banking system associated with building inflation pressure.
- Monetary transmission weak; lending rates around 10 percent.
- Inflation:
  - Above 3 percent (y/y) in 2017Q2 and 2017Q3, driven by food, transport, and education.
  - Projected to pick up to 4.8 percent in 2018 due to VAT increase from 12.5 percent to 15 percent.
- Credit growth:
  - Subdued after cyclone (2015Q3–2016 average: 1.8 percent); recovered to pre-cyclone level (2012–14 average: 6.2 percent) in 2017.
- Staff recommendations:
  - Maintain the peg at current level; be ready to adjust if external position worsens.
  - Maintain international reserves above 5 months of imports.
  - Tighten monetary policy via gradual increase of reserve requirements; normalize policy rate mainly for signaling.
- Authorities agreed with gradual increase of reserve requirements and cautious tightening.

### FINANCIAL INCLUSION AND STABILITY
- Access to financial services limited:
  - 37 percent of adults have a bank account — 45 percent including insurance, microfinance, credit union, or mobile money.
  - Comparators: Fiji 60 percent; Tonga 41 percent; Samoa 39 percent; Solomon Islands 26 percent.
- Financial sector structure:
  - Three foreign commercial banks, one domestic bank (National Bank of Vanuatu), micro credit unions, and VNPF.
  - Small domestic market, large informal sector, stringent collateral requirements; high interest-rate spreads.
- Consequences:
  - Low financial access for households and SMEs; business start-ups rely on informal financing.
- Financial soundness and risks:
  - NPLs increased: 2016Q4: 11.2 percent → 2017Q3: 17.5 percent.
  - Banks’ conservative provisioning and unfavorable business conditions contributed to rising NPLs.
  - VNPF withdrawals after Cyclone Pam: VUV 1,721 million.
- AML/CFT progress:
  - Since FATF grey listing in 2016, Vanuatu enacted key laws and completed offshore sector and terrorist financing risk assessment.
  - Repealed secrecy provisions under International Companies Act for beneficial ownership access.
  - FATF listing led to increased CBR pressures; banks found replacement CBRs and reassessed high-risk customers.
  - Staff encourages accelerated AML/CFT action plan implementation to exit FATF monitoring by summer 2018.

Staff policy recommendations (financial sector)
- Financial inclusion:
  - Prioritize increasing private access to financial services; focus on SMEs and rural/outer island households.
  - Support authorities’ “financial sector architecture” initiative.
- Financial stability:
  - RBV ready to secure stability by gradually normalizing regulatory requirements for banking and non-banking sectors.
  - Increase SRD and LAR to contain excess liquidity while maintaining sufficient liquid assets.
  - Monitor individual banks’ liquidity closely.
  - Strengthen banking supervision to ensure accurate loan quality assessment and sufficient loss provisions.
- AML/CFT:
  - Accelerate implementation of AML/CFT action plan to exit FATF monitoring by summer 2018.

Authorities’ views
- Agreed with prioritizing financial access, gradually increasing LAR, and addressing remaining AML/CFT issues.
- Expect financial sector architecture review to promote access for SMEs and rural households.
- Emphasized close monitoring of uneven liquidity distribution; cautioned that monetary tightening may constrain some banks.
- Noted completion of required AML/CFT legislation and ongoing implementation; stressed need for international support to exit FATF monitoring.

### STATISTICS, INSTITUTIONAL, AND SAFEGUARDS ISSUES
- RBV safeguards assessment (2016) recommended:
  - Amend RBV Act to strengthen autonomy.
  - Establish Audit Committee.
  - Formulate recapitalization strategy.
  - Set up internal audit function.
- Capacity constraints have hindered progress despite TA.
- Data broadly adequate for surveillance but concerns on quality and timeliness; staff encouraged PFTAC support on national accounts.
- Graduation from LDC scheduled for 2020; implies loss of LDC-specific treatment and potential loss of access to LDC-specific instruments.

### STAFF APPRAISAL (summary)
- Reconstruction from Cyclone Pam near completion; full recovery in sight.
- Real GDP growth expected around 4 percent in 2017 and 2018.
- Main risks: implementation rate of infrastructure projects and major natural disasters.
- Structural priorities: diversify beyond tourism into agriculture; improve ease of doing business; increase employment access and financial inclusion; internalize disaster risks and boost ex-ante resilience.
- Fiscal policy: follow public debt acceleration after Cyclone Pam with well-anchored medium-term fiscal adjustment post-reconstruction, including managing recurrent spending, prioritizing infrastructure, mobilizing domestic revenue, and considering a fiscal anchor.
- Monetary policy: excess liquidity and inflation pressures call for gradual reserve requirement increases; maintain peg.
- Reiteration: prioritize financial access for SMEs and rural households; RBV should act to secure financial stability and implement AML/CFT framework to mitigate CBR pressures.

### KEY STATISTICS AND SELECTED MACRO SERIES (exact figures as reported)
- Population (2016): 274,775
- Per capita GDP (2016): $2,923
- IMF quota: SDR 23.8 million (0.01 percent of total)
- Literacy rate (2012): 83.4 percent
- Main products and exports: Coconut oil, copra, kava, beef
- Key export markets: New Zealand, Australia, Japan

Selected macro series (2013–2018 rows as reported)
- Real GDP: 2.0 2.3 0.2 3.5 4.2 3.8
- Consumer prices (period average): 1.5 0.8 2.5 0.8 3.1 4.8
- Consumer prices (end period): 1.5 1.1 1.5 2.1 3.8 4.6
- Total revenue (% of GDP): 21.4 23.5 21.9 30.8 31.5 31.6
- Expenditure (% of GDP): 21.7 28.5 41.5 36.9 38.9 39.5
- Net lending (+)/borrowing (-) (% of GDP): -0.2 -5.0 -9.6 -6.1 -7.5 -8.0
- Public and publicly-guaranteed debt (end of period, % of GDP): 23.1 28.7 42.4 48.8 51.0 53.7
- Gross international reserves (end-2016): equivalent to 6.3 months of imports
- Gross international reserves (US$ millions, 2013–2023 baseline): 179 184 269 267 368 361 350 344 332 319 307
- Current account balance (% of GDP, 2013–2018): -3.3 -0.3 -10.6 -4.1 -9.0 -9.2

Selected monetary and financial indicators (2013–2018)
- Total broad money (millions of vatu): 53,772 58,391 65,061 71,969 77,399 80,444
- Net foreign assets (millions of vatu): 16,272 13,908 23,867 34,976 39,029 38,785
- Credit to private sector (% of GDP): 68.7 71.7 69.5 66.8 69.1 66.2
- Bank regulatory capital to RWA (2012–2017Q3): 20.5 18.1 17.6 16.4 19.3 17.1
- Nonperforming loans to total gross loans (2012–2017Q3): 8.1 13.5 11.1 12.6 11.2 17.5
- Return on equity (2012–2017Q3): 4.3 3.1 3.0 4.6 4.2 8.0

Balance of payments (current account, US$ millions, 2013–2017): -26 -2 -82 -32 -78

Fund obligations and outstanding Fund credit (in millions of SDRs, 2017–2027; exact series)
- Principal (2017–2027): 0.0 2.1 4.3 3.0 1.7 1.7 1.7 1.7 0.9 0.0 0.0
- Charges and interest (2017–2027): 0.1 0.1 0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
- Total obligations (2017–2027): 0.1 2.2 4.3 3.0 1.7 1.7 1.7 1.7 0.9 0.0 0.0
- Outstanding Fund credit (2017–2027): 17.0 14.9 10.6 7.7 6.0 4.3 2.6 0.9 0.0 0.0 0.0
- Outstanding Fund credit (% of quota, 2017–2027): 100.0 87.5 62.5 45.0 35.0 25.0 15.0 5.0 0.0 0.0 0.0

### RISK ASSESSMENT: POSITIVE SPILLOVERS FROM INFRASTRUCTURE PROJECTS
- Potential positive spillovers from international wharfs and inter-island shipping facilities from 2018 onwards.
- RAM probability labels preserved where provided; examples:
  - Positive spillovers: Low / Medium — Upside (as presented in RAM).
  - Other entries preserved: Lower energy prices: High / High — Downside; Implementation delays: High / High; Natural disasters and climate change: Medium / High; Delays in tax reform: Medium / High; Weaker global growth: Medium / High; Reduced correspondent banking services: High (global risk).

RAM-specific policy suggestions (as listed)
- Public investment guided by careful project selection and implementation.
- Stimulate private sector investment by improving business environment and credit provision.
- Build ex-ante resilience to natural disasters (adaptation, spatial planning, fiscal buffers).
- Maintain donor financial support and seek climate financing opportunities.
- Seek IMF TA on tax reform implementation to secure revenue and fairness.
- Improve VAT compliance efficiency; continue Compliance Improvement Strategy.
- Ensure transparency and strengthen banking regulation/supervision.
- Continue strengthening AML/CFT framework and tax transparency via TA.

### APPENDIX III — EXPORT DIVERSIFICATION HIGHLIGHTS
- Goods exports to GDP: 6.8 percent over 2011–15.
- Commodity concentration:
  - HS 2-digit: primary products dominate.
  - Fish, crustaceans, molluscs share rose to 70 percent or more after 2000 and persisted.
  - Other exports together 7 percent over 2011–15.
- Market diversification for fish exports:
  - 2000–2010: around 95 percent of fish exports by value to Japan and Thailand.
  - 2011–15: emergence of Vietnam, China and Korea (together 8 percent).
  - Mexico, Ecuador, Singapore, Hong Kong SAR combined 2.5 percent over same period.
- Beef export opportunity:
  - 2013–15: beef exported to Japan (55 percent), Solomon Islands (40 percent), New Zealand (5 percent).
- Services and tourism:
  - Strengthen linkages with agriculture to increase domestic value-added.
  - Niche tourism (eco-tourism) and agri-tourism recommended.

### APPENDIX IV — PUBLIC INVESTMENT, DSA, AND NATURAL DISASTERS
- Infrastructure gaps: lag peers in electricity access; internet users per 100 people below PIC average; high broadband cost.
- VISIP 2015 launched August 2015.
- Cyclone Pam (March 2015): damages/losses about 60 percent of GDP; affected >70 percent of population; damages to tourism and transport expected at 11 percent of GDP.
- Fiscal financing scenarios modeled for reconstruction:
  1. Tax-financed reconstruction (increase consumption taxes):
     - Consumption tax from 12.5 percent to close to 23 percent short term and about 14 percent medium term.
     - Private consumption and private investment adversely affected by 20 percent and 40 percent, respectively, relative to pre-Pam.
  2. External borrowing:
     - Public debt would exceed 90 percent of GDP in the medium term.
  3. External grants:
     - Preserves debt sustainability and macro stability.
- Resilience-building options modeled:
  - Option (i) Invest in resilient infrastructure: spend 3 percent of GDP per year in adaptation in five years prior to Pam (donor-funded in model); public debt reaches <60 percent of GDP medium term (vs 100 percent in tax-financed scenario).
  - Option (ii) Build fiscal buffers: half of 3 percent GDP to adaptation and half saved in contingency fund reaching ~8 percent of GDP at disaster time; allows reconstruction without short-term borrowing but GDP more affected than full adaptation case.
- Policy implications:
  - Contract external disbursements on concessional terms or as grants.
  - Prioritize spending toward resilient infrastructure and maintenance.
  - Rebuild fiscal buffers via reprioritization and revenue mobilization; consider contingency fund or other self-insurance mechanisms.

### APPENDIX V — REVENUE MODERNIZATION AND REFORMS
- Revenue Review launched March 2016: objectives to improve efficiency, effectiveness, and fairness.
- VAT provides almost 40 percent of total revenues excluding grants.
- Revenue Review Project Team (RRPT) composition and Governance Committee described.
- Tax reform proposal elements:
  - Abolish costly fees and charges.
  - Bring forward PACER Plus reductions in import duties over five years.
  - Introduce income tax for individuals (with tax-free threshold) and companies.
- MOVE (Model Of the Vanuatu Economy) developed by RBV and MFEM with VNSO and DCIR; supported by PFTAC.
- PFTAC/IMF assistance: risk-based compliance, new functional operating model, drafting laws, VAT and Rent Tax Act reviews, new corporate strategy, IT synchronization.
- Compliance Improvement Strategy delivering results: increased audits and reduced outstanding returns; increased voluntary compliance.

### DEBT DEVELOPMENTS SINCE CYCLONE PAM (selected exact figures)
- External PPG debt: 16.3 percent of GDP in 2014 → 30.5 percent in 2015 → 37.6 percent in 2016.
- IMF quick disbursement: USD 23.8 million in June 2015.
- DMS 2015–2017 objectives included keeping PV of public external debt below 40 percent of GDP and targeting grant element ≥35 percent.
- Stock of public debt (end-2016):
  - External PPG debt: US$290 million (37.6 percent of GDP).
  - Total public debt: 42,593 million Vatu; 377 million US dollars; 48.8 percent of GDP.
  - External: 32,810 million Vatu; 290 million US dollars; 77.0 percent of total debt; 37.6 percent of GDP.
    - Multilateral: 9,411 million Vatu; 83 million US dollars; 22.1 percent of total debt; 10.8 percent of GDP.
      - ADB: 5,952 million Vatu; 53 million US dollars; 14.0 percent of total debt; 6.8 percent of GDP.
      - IDA: 875 million Vatu; 8 million US dollars; 2.1 percent of total debt; 1.0 percent of GDP.
      - IMF: 2,584 million Vatu; 23 million US dollars; 6.1 percent of total debt; 3.0 percent of GDP.
    - Bilateral: 23,399 million Vatu; 207 million US dollars; 54.9 percent of total debt; 26.8 percent of GDP.
      - China EXIM Bank: 15,124 million Vatu; 134 million US dollars; 35.5 percent of total debt; 17.3 percent of GDP.
      - JICA: 8,192 million Vatu; 72 million US dollars; 19.2 percent of total debt; 9.4 percent of GDP.
      - Others: 83 million Vatu; 10 million US dollars; 0.2 percent of total debt; 0.1 percent of GDP.
  - Domestic: 9,784 million Vatu; 87 million US dollars; 23.0 percent of total debt; 11.2 percent of GDP.
    - Government bonds: 7,377 million Vatu; 65 million US dollars; 17.3 percent of total debt; 8.5 percent of GDP.
    - Publicly guaranteed debt: 2,407 million Vatu; 21 million US dollars; 5.7 percent of total debt; 2.8 percent of GDP.
- Loans largely concessional: interest rates 0-2 percent, maturities 20-40 years.

### DSA—ASSUMPTIONS, SCENARIOS, AND FINDINGS (selected exact values)
- Baseline macro assumptions:
  - GDP growth: 2017: 4.2 percent; 2018: 3.8 percent; Medium term (2017–2022) average: 3.4 percent; Long term (2023–2037) average: 3.0 percent (after netting out 0.5 percentage point disaster/climate impact).
  - Inflation (GDP deflator): 2017: 3.1 percent; 2018: 4.8 percent; Long run average: 3.3 percent.
  - Non-interest current account deficit: long term average expected to narrow to 4.4 percent of GDP; after 2023 natural disasters/climate change projected to widen deficit by 0.7 percentage points annually.
  - FDI inflows: medium term average about 3.9 percent; longer term average 2.8 percent.
  - Primary balance (% of GDP): 2017: -6.5 percent; 2018: -6.9 percent; medium term (2017–2022) average: -3.8 percent; long term: -1.8 percent; natural disasters/climate change effects: deteriorate fiscal balance by 0.3 percent of GDP annually.
  - New external borrowing projected to average 3.9 percent of GDP over the longer term; grants expected to decline to 5.5 percent of GDP.
- Customized extreme disaster scenario:
  - Another extreme natural disaster in 2020 assumed to increase debt-to-GDP by 14 percentage points in that year.
- DSA findings:
  - Baseline: external debt remains sustainable; PV of external PPG debt indicators below thresholds.
  - Nominal external PPG debt peaks in 2020 at 44.3 percent of GDP (from 37.6 percent in 2016).
  - Debt service ratios low because debt is highly concessional; debt service pressure rises medium term.
  - Stress tests: one breach in most extreme shock (one-time depreciation) with PV debt-to-GDP breaching 40 percent threshold; moderate risk of external debt distress.
  - Policy implication: contract external borrowing on concessional terms/grants.

Public debt projections (selected)
- Nominal public debt trajectory:
  - 2016: 48.8 percent of GDP
  - 2019: expected 53.9 percent of GDP
  - 2037: expected 50.8 percent of GDP
- Debt service-to-revenue ratio: expected to rise from 9.9 percent in 2017 to 13.5 percent in 2037.
- Staff recommends vigilance on borrowing pace and selection of investments.

Authorities’ response
- Authorities broadly concurred with DSA assessment.
- Intend to maintain grant-element target of at least 35 percent and seek grant financing; recognize need to rebuild fiscal buffers via revenue mobilization (introducing personal and corporate income taxes).
- Acknowledge debt-servicing for key projects commences in 2019 and the need for prudent debt management.

### POLICY RECOMMENDATIONS AND IDENTIFIED ACTIONS (summary)
- Invest gains in resilient infrastructure.
- TA on PFM to increase fiscal resilience, transparency, and accountability.
- TA on financial supervision to support financial deepening and inclusion.
- Analytical/policy framework to incorporate cost of natural disasters and climate change.
- Coordinate with World Bank Group and development partners.
- Surveillance and policy advice on macroeconomic policies.
- TA on tax administration reform and domestic revenue mobilization.
- Capacity development.

*Source: cr18109 — IMF staff report (excerpts).*

### 2018. The staff team comprised Chris Papageorgiou (head), Dongyeol

### VANUATU

### BACKGROUND
- Vanuatu is a small island developing state and a low-income country with income per capita about USD 3,000.
- Key drivers of economic activity: tourism and agriculture.
- Growth history:
  - Average real GDP growth 2005–15: 3.4 percent.
  - Average real GDP growth 2010–15: 1.5 percent.
  - Average real GDP growth 2000s earlier five-year period: 5.7 percent (previous 5-year period).
- Population growth: 2.3 percent in 2016.
- Cyclone Pam (March 2015) caused extensive damages. The Fund disbursed about USD 23.8 million under RCF/RFI to help cope with balance-of-payments needs and catalyze donor support.
- Government introduced the Vanuatu Infrastructure Strategic Investment Plan 2015-2024 (VISIP 2015) to scale up urban and rural infrastructure; reconstruction supported by IDA and ADB started in 2017.

### RECENT DEVELOPMENTS, OUTLOOK, AND RISKS
Findings and indicators
- 2016 developments:
  - Real GDP growth rebounded to 3.5 percent in 2016 from 0.2 percent in 2015.
  - Inflation dipped below 1 percent in 2016 from 2.5 percent in 2015.
  - Current account deficit: about 4 percent of GDP in 2016 (down from 10.6 percent of GDP in 2015).
  - Foreign reserves: USD 267 million (6.4 months of imports) at end-2016.
  - Fiscal deficit: 6.1 percent of GDP in 2016, mainly due to reconstruction and infrastructure spending.
  - Financing: deficit mostly financed by external concessional borrowing, grants, and FDI.
- Outlook (staff estimates):
  - Real GDP growth expected around 4 percent in 2017 and 2018.
  - Inflation estimated to pick up to 3.1 percent in 2017 and rise to 4.8 percent in 2018, mainly due to a temporary VAT increase from 12.5 to 15 percent.
  - Current account deficit expected to widen to around 9 percent of GDP in 2017 and 2018 because of high import content of infrastructure projects.
  - Fiscal deficit expected to remain high at around 7 to 8 percent of GDP in 2017 and 2018, reflecting reconstruction and infrastructure expenditure.
  - Offsetting measures: temporary VAT increase, proceeds from citizenship programs (Vanuatu Development Support Program (VDSP) and Vanuatu Contribution Program (VCP)).
Risk assessment (summary)
- Overall: High vulnerability; risks to the downside dominate.
- Upside risks:
  1. Positive spillovers from large infrastructure projects — Likelihood: Medium; Impact: High.
  2. Lower energy prices — Likelihood: Low; Impact: Medium.
- Downside risks:
  1. Implementation of infrastructure projects — Likelihood: High; Impact: High.
  2. Natural disasters and climate change — Likelihood: High; Impact: High.
  3. Delays in implementation of tax reform — Likelihood: Medium; Impact: High.
  4. Weaker-than-expected global growth — Likelihood: Medium; Impact: Medium.
  5. Reduced financial services by correspondent banks (globally) — Likelihood: High; Impact: Medium.
Authorities' views
- Authorities concurred with staff on developments, outlook, and risks.
- Expect modest slowdown after completion of major infrastructure projects.
- Concerned about unanticipated effects of graduation from UN LDC status in 2020.

### A DEVELOPMENT STRATEGY TO SUPPORT STRONG AND DURABLE GROWTH
Policy focus areas
- Fostering strong, durable, and disaster-resilient medium-term growth.
- Preserving fiscal space and safeguarding debt sustainability amid rising development needs.
- Maintaining prudent monetary policy while pursuing financial inclusion and stability.

A. Fostering growth under natural-disaster risk
Context and challenges
- Growth has been unstable and insufficiently strong; per capita GDP growth since 2005 stands at 1.0 percent.
- Two main causes of low and volatile growth:
  1. Concentration in tourism.
  2. Ever-present danger of natural disasters.
Diversification strategies
- Diversify within and outside tourism and strengthen tourism–agriculture linkages (Appendix III).
- Segment tourism marketing (e.g., Espiritu Santo and Port Vila separately) to reduce concentration risks.
- Promote agricultural production (e.g., Vanuatu beef) and agri-tourism to enhance domestic value addition and inclusive growth.
Natural disaster preparedness — lessons from Cyclone Pam (Appendix IV)
- Positive ex-post actions after Cyclone Pam included:
  - Suspension of VAT and import duties on construction materials for household reconstruction.
  - RBV reduced Statutory Reserve Deposit (SRD) requirement to alleviate liquidity constraints.
  - Banks implemented business continuity plans to ensure currency availability.
- Ongoing measures:
  - Tropical Cyclone Pam Recovery program continuing in 2018.
  - RBV’s Natural Disaster Reconstruction Credit Facility provides funds to businesses.
- Implementation gaps:
  - Coordination issues delayed projects (e.g., runway upgrade at Bauerfield International Airport).
  - Slower recovery pace in outer islands.
Disaster resilience funding and climate finance
- Emergency Fund increased from VUV 25 million (2017 budget) to VUV 50 million (2018).
- Fiscal framework allows swift withdrawal up to 1.5 percent of a year’s total appropriation (around VUV 330 million), later requiring Parliamentary approval.
- VUV 200 million spent via supplementary budget for Ambae Island volcano eruption in September 2017, rather than drawing on Emergency Fund.
- PCRFI mechanism (World Bank) modified post-Pam but payouts remain small relative to rapid response needs.
- Green Climate Fund grant of USD 18.1 million in February 2018 targeted to expand Climate Information Services (CIS) across tourism, agriculture, infrastructure, water management and fisheries.

Staff policy recommendations (paragraph 12)
- Promote diversification to boost growth and increase resilience to natural disasters:
  - Development strategy:
    - Improve ease of doing business to support private sector (remove bottlenecks in registering property and land titling).
    - Reassess recent reforms to the leasing regime for customary land that create further inefficiencies.
    - Prioritize access to employment and financial inclusion, especially in outer islands.
  - Natural disasters — strengthen ex-ante preparedness through:
    i) Strengthening risk assessment and planning.
    ii) Building domestic fiscal buffers.
    iii) Securing external buffers.
    iv) Promoting resilient infrastructure and adequate maintenance.
    - Present a fiscal risk statement with the budget to identify and disclose fiscal risks, including natural disaster and climate change.
    - In the medium term, consider setting up a disaster resilience fund to address higher-frequency and lower-intensity events and reduce reliance on the supplementary budget.
Authorities' views on development strategy
- Authorities recognize the need for broad-based economic activity and more inclusive tourism-driven growth.
- Acknowledge agriculture as macro-critical; initiatives include combining agriculture education with financial inclusion.
- Barriers to scaling up production: land leasing system, high cost of capital, non-tariff barriers for agricultural exports, and data gaps.
- Legislation to promote farmers’ associations planned for the first session of Parliament in 2018.
- Authorities committed to disaster-resilient frameworks, concessional financing, improved coordination with donors, building absorptive capacity, and human capital development; they emphasized need for international financial assistance when major disasters strike.

*IMF staff report: cr18109 (2018) — mission led by Chris Papageorgiou*

### 15. Staff projections envisage a fiscal deficit of 7.5 and 8.0 percent of GDP in 2017 and

### cr18109 - 15. Staff projections envisage a fiscal deficit of 7.5 and 8.0 percent of GDP in 2017 and

### Fiscal outlook and projections
- Staff projections envisage a fiscal deficit of 7.5 and 8.0 percent of GDP in 2017 and 2018, respectively.
- Fiscal developments:
  - Tax collection in 2017 stronger than in 2016, underpinned by the economic recovery.
  - Non-tax revenue, including from citizenship programs, remains high.
  - Expenditure in 2017 higher than in 2016, mainly due to severance payments and the Pacific Mini Games held in Port Vila in December 2017.
  - Fiscal deficit deteriorated from 6.1 percent of GDP in 2016 to 7.5 percent in 2017.
  - Deficit expected to widen to 8.0 percent of GDP in 2018 owing to an increase (7–8 percent on average) in the government wage bill, despite the VAT rate increase from 12.5 to 15 percent starting January 1, 2018.
  - Implementation of tax administration and income tax bills in early 2019, combined with lower committed capital spending as large infrastructure projects complete, is expected to reduce the deficit to 4.3 percent in 2019.

### Infrastructure projects and implementation risks
- Several infrastructure projects started in 2015 and accelerated in 2016–2017 are nearing completion in 2018 and 2019, including:
  - Luganville International Wharf and Tanna & Malekula Road Rehabilitation & Upgrade Program (financed by China EXIM Bank).
  - Port Vila Lapetasi International Multi-Purpose Wharf Development Project (financed by JICA).
  - Cyclone Pam road and school reconstruction projects (supported by the ADB).
  - Vanuatu Infrastructure Reconstruction and Improvement Project (supported by IDA).
  - Rehabilitation of Bauerfield International Airport and runway repairs for Santo and Tanna airports (supported by IDA).
- Implementation issues:
  - Persistent coordination issues related to contractors’ implementation plans have resulted in major delays that could hurt tourist arrivals.

### Public debt and debt sustainability
- Public and publicly-guaranteed debt increased sharply from 28.7 percent of GDP in 2014 to 48.8 percent in 2016.
  - Increase mainly due to disbursements for infrastructure and reconstruction activities; new external borrowing was highly concessional.
  - Vanuatu’s public debt is now at the higher end compared to other Pacific Island countries.
- Updated Debt Sustainability Analysis (DSA) suggests:
  - Risk of external debt distress remains moderate (consistent with the 2016 assessment).
  - Debt service pressure expected to rise over the medium term.

### Government revenues and economic citizenship programs
- Government revenues remain low compared to regional peers.
- Authorities aim to introduce corporate and personal income taxes as early as 2019 with technical assistance from IMF HQ, PFTAC and Australia.
- In the interim, measures include:
  - VAT rate increase.
  - Continued use of economic citizenship programs for additional revenue.
- Economic Citizenship Program (key figures and features):
  - VDSP contribution ranges from USD 200,000 for a single person application to USD 280,000 for a family with elderly parents.
  - REO Program requires applicants to invest USD 230,000 in real estate related investments.
  - Application process for VDSP takes between 1 to 2 months; citizens of North Korea, Yemen, Syria, Iraq, and Iran are not allowed to apply.
  - 2017 revenue from the programs estimated at around VUV 3.5 billion (around 3.7 percent of GDP), accounting for 16.1 percent of total revenue, excluding grants.
  - In October 2017, the government reportedly accepted Bitcoin payments for VDSP, but the Reserve Bank of Vanuatu reversed the decision.
- Risks:
  - Economic citizenship programs may lead to reputational risks, potentially adversely impacting correspondent banking relationships (CBRs).
  - Reliance on these program revenues is not deemed to be a sustainable source of income.

### Public financial management and reforms
- Authorities have started reviewing the policy framework on non-tax revenues.
- Based on a guided PEFA self-assessment in 2015, a medium-term PFM Reform Roadmap was formulated.
- Reforms include improving capacity for internal audit, accounting and reporting.
- PFTAC support and further technical assistance areas include public investment management, medium-term budgeting, and analysis of fiscal risks from Government Business Enterprises (GBEs).

### Staff policy recommendations (fiscal, debt, and anchor)
- Fiscal Adjustment:
  - Support reconstruction and public investment with donor help and mobilization of domestic revenues (including VAT increase and introduction of income tax).
  - Move swiftly after introduction of payroll tax for public servants in January 2019 to implement remaining personal and corporate taxes to avoid further uncertainty.
  - Consider restraining spending if income tax introduction is delayed or other revenues (e.g., economic citizenship program) do not materialize.
  - As reconstruction and infrastructure scale-up conclude, embark on fiscal adjustment to address rising debt and rebuild fiscal buffers. Measures should include:
    - (i) Restraining recurrent spending, including effective and sustainable management of the public wage bill and severance payments.
    - (ii) Prioritization and careful selection of public infrastructure projects with consideration of absorptive capacity and expected returns.
    - (iii) Continued revenue mobilization, including through enhancements in tax administration.
- Debt Management:
  - Update the debt management strategy (DMS) on an annual basis.
  - Contract external financing as grants or on concessional terms where possible.
- Fiscal Anchor:
  - Consider adopting a medium-term fiscal anchor defined in terms of a fiscal deficit target and debt ceiling, as current fiscal objectives do not provide adequate guidance.
  - Staff assessment suggests a reasonable medium-term debt ceiling for Vanuatu would be in the range of 50–60 percent for the nominal public and publicly-guaranteed debt-to-GDP ratio.
  - The debt ceiling would be consistent with a fiscal deficit target of 3–4 percent of GDP.

### Authorities’ views on fiscal policy
- Authorities agreed on the need for fiscal adjustment, effective management of the public wage bill and severance payments, and updating the DMS annually.
- Authorities recognized the importance of a medium-term fiscal anchor but expressed concerns it may unduly limit required infrastructure investment.
- Authorities reiterated commitment to introducing payroll tax for public servants in early 2019 followed by remaining personal and corporate taxes in mid-2019, and reversing the temporary VAT increase.
- Authorities concurred on the risks of heavy reliance on revenue from the Economic Citizenship Program.
- Authorities agreed to seek grant financing as much as possible and maintain a grant-element target of at least 35 percent on new loans.

### External position, reserves, and exchange rate policy
- Basket peg regime:
  - The basket peg regime is working well; external position remains broadly consistent with medium-term fundamentals and desirable policies.
  - Staff assessment: external position broadly in line with the level consistent with the external current account benchmark (a current account gap of -1.9 to 1.8 percent of GDP and REER gap of -4.7 to 5.0 percent).
- International reserves:
  - Reserves covered an estimated 6.4 months of imports of goods and services by end-2016.
  - This is above the authorities’ commitment (4 months of imports) and reserve adequacy benchmarks (3.9–5.2 months of imports).
  - Level of reserves expected to remain comfortable over the next several years, though downside risks to import coverage exist if actual infrastructure imports exceed projections.
- External Sector Assessment (Box 2) highlights:
  - Adequate reserves estimated in the range of 3.9 to 5.2 months of imports; actual level noted as 6.9 months in one assessment.
  - Staff expects reserve cover to fall to around 5.4 months by 2023.
  - Current account deficit likely to persist at 7–9 percent of GDP over the medium term.
  - REER has shown a mild appreciation trend since 2014, with nominal depreciation against AUD and appreciation against USD since 2016.
  - EBA-Lite and external sustainability approaches indicate the external position broadly consistent with fundamentals, with REER gaps reported (e.g., CA approach REER gap -4.7 percent; external sustainability REER gap range 1.3 to 5.0 percent).

### Monetary policy, inflation, and reserves management
- Excess liquidity in the banking system associated with building inflation pressure over the past year.
- Monetary transmission weak; high lending rates around 10 percent have continued post-cyclone.
- Inflation developments:
  - Inflation stood above 3 percent (year-on-year) in the second and third quarter of 2017, driven by food, transport, and education price increases.
  - Inflation projected to pick up to 4.8 percent in 2018 due to a VAT increase by 2.5 percent (from 12.5 percent to 15 percent).
- Credit growth:
  - Subdued credit growth after the cyclone (2015Q3–2016 average: 1.8 percent) recovered to pre-cyclone level (2012–14 average: 6.2 percent) in 2017.
- Staff recommendations for monetary and reserve policy:
  - Maintain the peg at its current level; be ready to adjust level and composition if external position worsens significantly.
  - Maintain international reserves at above 5 months of imports to provide foreign currency for government debt repayment and buffer against shocks.
  - Tighten monetary policy stance through a gradual increase of reserve requirements; normalizing policy rate (rediscount rate) could be used mainly for signaling.
- Authorities’ views:
  - Agreed with tightening via gradual increase of reserve requirements and cautioned that such tightening must be carried out cautiously.
  - Acknowledged accommodative policy after Cyclone Pam supported recovery and financial stability and concurred with exchange rate and reserve-level assessments.

### Financial inclusion and stability
- Access to financial services limited for households and SMEs.
- Financial sector characteristics:
  - Three foreign commercial banks, one domestic bank (National Bank of Vanuatu), micro credit unions, and Vanuatu National Pension Fund (VNPF).
  - Small domestic market, significant informal sector, stringent collateral requirements; high interest rate spreads.
- Consequences:
  - Low financial access for households and SMEs.
  - Credit provisions remained limited during post-cyclone recovery; recent pickup due to improved business prospects and infrastructure scaling-up.

*International Monetary Fund staff report excerpt.*

### 28. There exists ample room to support financial inclusion. Despite the growing role of

### cr18109 - 28. There exists ample room to support financial inclusion. Despite the growing role of

### Financial inclusion: current gaps and data
- Only 37 percent of adults have a bank account—45 percent including those with an insurance policy or a microfinance, credit union, or a mobile money account.
- Comparative access rates cited: Fiji (60 percent), Tonga (41 percent), Samoa (39 percent), Solomon Islands (26 percent).
- Business start-ups mainly rely on informal financing services (Micro, Small & Medium Enterprise Survey, 2016).
- The non-bank financial sector remains small and not sufficiently supervised.
- The authorities have initiated a “financial sector architecture” review, supported by ADB experts, to address financial inclusion, especially for SMEs and households in rural areas and outer islands.

### Financial sector soundness and risks
- Banking sector has maintained adequate capital and liquidity positions, but vigilance is needed.
- Non-performing loans (NPLs) increased significantly in 2017: 2016Q4: 11.2 percent → 2017Q3: 17.5 percent.
- Contributing factors to rising recorded NPLs include banks’ conservative balance sheet management (e.g., proactive recognition of impaired assets) and unfavorable business conditions (e.g., delays in airport runway rehabilitation).
- VNPF maintained sufficient liquidity despite significant withdrawals after Cyclone Pam (VUV 1,721 million).
- Excess liquidity in the banking system and a buildup of inflation pressure over the past year motivate monetary tightening (see Staff appraisal).

### AML/CFT progress and implications
- Since inclusion in the FATF gray list in 2016, Vanuatu enacted several key laws and completed the offshore sector and terrorist financing risk assessment.
- Secrecy provisions under the International Companies Act were repealed to allow key law enforcement agencies enhanced access to basic and beneficial ownership information.
- Efforts continuing on AML/CFT supervision: licensing, fit and proper requirements, off-site and on-site supervision, sanctions.
- Mechanisms for international cooperation and exchange of information have been widened.
- The FATF listing led to increased correspondent banking relationship (CBR) pressures for some banks; impact has not reached a critical level as banks have found replacement CBRs and re-assessed high-risk customers.
- Staff encourages accelerated implementation of AML/CFT action plan to exit FATF monitoring by summer 2018.

### Staff’s policy recommendations (summary)
- Financial inclusion
  - Continue prioritizing increasing private access to financial services.
  - Focus on addressing difficulties faced in obtaining credit by SMEs and households in rural areas and outer islands.
  - Support the authorities’ “financial sector architecture” initiative.
- Financial stability
  - RBV should be ready to take actions to secure financial stability by gradually normalizing regulatory requirements for both banking and non-banking financial sectors.
  - The rise of SRD and LAR would be complementary in securing financial stability by containing excess liquidity while maintaining sufficient liquid assets.
  - Authorities should closely monitor individual banks’ liquidity situations.
  - Strengthen banking supervision frameworks to ensure more accurate assessment of loan quality, secure sufficient loss provisions, and foster sound risk management practices.
- AML/CFT
  - Accelerate implementation of the AML/CFT action plan to exit FATF monitoring by summer 2018.

### Authorities’ views
- Authorities agreed with prioritizing financial access, gradually increasing LAR, and addressing remaining AML/CFT issues.
- They expect the financial sector architecture review to promote access to financial services for SMEs and households in rural areas and outer islands.
- Emphasized the importance of closely monitoring individual banks’ financial situations given uneven liquidity distribution among banks; monetary tightening may cause liquidity constraints for some banks.
- Noted completion of required legislations on AML/CFT issues and ongoing implementation of the action plan.
- Stressed the importance of continued support by international institutions to succeed in exiting the FATF monitoring list by Summer 2018.

### Other institutional and statistical issues
- Safeguards assessment of the RBV (2016) identified areas needing significant strengthening:
  - Amendments to the RBV Act to strengthen the bank’s autonomy.
  - Establishment of an Audit Committee.
  - Formulation of an effective recapitalization strategy.
  - Setting up an internal audit function.
- Capacity constraints have hindered progress on key safeguards recommendations despite technical assistance.
- Statistical issues: data broadly adequate for surveillance but concerns remain about quality and timeliness. Staff encouraged seeking further support from PFTAC on national accounts statistics and improving local technical capacity.
- Graduation from Least Developed Countries (LDC): Vanuatu was included in the LDC list in 1985 and is scheduled for graduation in 2020. Graduation implies loss of LDC-specific differential treatment in WTO commitments and potential loss of access to LDC-specific instruments of development cooperation; UN emphasizes the need for a smooth transition mechanism.

### Staff appraisal: reconstruction, growth, and policy stance
- Reconstruction from Cyclone Pam is near completion and full recovery is in sight.
- Projection: real GDP growth expected to be around 4 percent in 2017 and 2018.
- Main risks: rate of implementation of public infrastructure projects and the risk of major natural disasters.
- Structural priorities:
  - Diversify economic activity beyond tourism into agriculture and strategically segment tourism across locations.
  - Improve ease of doing business to support private sector and diversification.
  - Increase access to employment opportunities and financial inclusion, including in outer islands.
  - Internalize risks from natural disasters and boost ex-ante resilience (resilient infrastructure, improved coordination with development partners).
- Fiscal policy: public debt acceleration after Cyclone Pam should be followed by well-anchored medium-term fiscal adjustment once reconstruction ends. Recommended measures include:
  - Effective management of recurrent spending.
  - Prioritization and careful selection of infrastructure projects.
  - Mobilization of domestic revenue.
  - Consideration of a medium-term fiscal anchor defined by a fiscal deficit target and debt ceiling.
- Monetary policy: excess liquidity and inflation pressures call for monetary tightening. The RBV should tighten policy through a gradual increase of reserve requirements. The peg to an undisclosed basket of currencies continues to serve Vanuatu well in promoting stability and confidence. The external position remains broadly consistent with medium-term fundamentals and desirable policies.
- Reiteration: increasing access to financial services should be a priority, with a focus on SMEs and households in rural areas and outer islands; RBV should stand ready to act to secure financial stability and ensure effective implementation of AML/CFT framework to mitigate CBR pressures.

*Source: cr18109 — IMF staff report (excerpts).*

### 42. It is recommended that the next Article IV Consultation takes place on the standard

### cr18109 - 42. It is recommended that the next Article IV Consultation takes place on the standard

### Recent developments and prospects
- After the adverse impact of Cyclone Pam in 2015, growth is estimated to have rebounded in 2016 and 2017.
- Growth is estimated to continue to be strong, driven by infrastructure projects and reconstruction activities.
- Recovery is driven by investment growth and service sector recovery.
- Inflation has been risen above 3 percent since the second quarter of 2017.
- Since 2016, formal employment has also returned to the increasing trend seen before the cyclone.
- Indicators of private demand are also recovering.

### External sector developments and prospects
- Current account deficit is estimated to increase in 2017 due to higher imports.
- FDI and other investment is expected to fund only a part of the current account deficit.
- Export growth is recovering at a slow pace.
- Tourist arrivals are recovering mainly driven by the recovery in airline visitors.
- Since the second half of 2015, the nominal exchange rate has been mildly appreciating against the U.S. dollar but moderately weakening against the Australian dollar.
- Reserves are being maintained at a comfortable level while public debt has increased significantly since 2015.

### Public finance and monetary developments
- Fiscal balance has deteriorated in recent years.
- High fiscal deficits will likely continue until 2018 due to reconstruction and new investment needs.
- Deterioration in fiscal balance has driven up public and publicly-guaranteed debt.
- Large interest rate spreads have persisted, and transmission from policy rate to commercial banks’ interest rates appears limited.
- Money supply is stabilizing since the second half of 2015 in tandem with decreasing net foreign assets of the central bank.
- Net foreign asset of commercial banks turned positive in May 2016 and continued to increase afterwards.

### Financial sector developments and financial inclusion
- Private credit growth recovered in 2017, driven by a large increase in credit to both corporate and household sectors.
- Bank profitability has improved in 2017 due to an improvement in earnings.
- Nonperforming loans (NPLs) also increased driven by an increase in substandard and doubtful assets.
- Despite the high loan-to-deposit ratio, overall bank liquidity has increased significantly in 2017.
- Financial access: number of ATMs and bank loan accounts per 100,000 adults indicate moderately high access compared to other PIC peers.

### Key statistics and projections (selected exact figures from source)
- Population (2016): 274,775
- Per capita GDP (2016): $2,923
- IMF quota: SDR 23.8 million (0.01 percent of total)
- Literacy rate (2012): 83.4 percent
- Main products and exports: Coconut oil, copra, kava, beef
- Key export markets: New Zealand, Australia, Japan

Selected macro series (as reported)
- Real GDP row (2013–2018): 2.0 2.3 0.2 3.54.2 3.8
- Consumer prices (period average) row (2013–2018): 1.50.82.50.83.14.8
- Consumer prices (end period) row (2013–2018): 1.51.11.52.13.84.6
- Total revenue (in percent of GDP, 2013–2018): 21.423.531.930.831.531.6
- Expenditure (in percent of GDP, 2013–2018): 21.728.541.536.938.939.5
- Net lending (+)/borrowing (-) (in percent of GDP, 2013–2018): -0.2-5.0-9.6-6.1-7.5-8.0
- Public and publicly-guaranteed debt (end of period, in percent of GDP, 2013–2018): 23.128.742.448.851.053.7
- Gross international reserves (end-2016, equivalent to 6.3 months of imports)
- Gross international reserves (in millions of U.S. dollars, 2013–2023 baseline projection): 179184269267368361350344332319307
- Current account balance (in percent of GDP, 2013–2018): -3.3-0.3-10.6-4.1-9.0-9.2

Selected monetary and financial indicators
- Total broad money (end of period, in millions of vatu, 2013–2018): 53,77258,39165,06171,96977,39980,444
- Net foreign assets (end of period, in millions of vatu, 2013–2018): 16,27213,90823,86734,97639,02938,785
- Credit to private sector (in percent of GDP, 2013–2018): 68.771.769.566.869.166.2
- Bank regulatory capital to risk-weighted assets (2012–2017Q3): 20.518.117.616.419.317.1
- Nonperforming loans to total gross loans (2012–2017Q3): 8.113.511.112.611.217.5
- Return on equity (2012–2017Q3): 4.33.13.04.64.28.0

Balance of payments (selected rows, in millions of U.S. dollars)
- Current account balance (2013–2017): -26 -2 -82 -32 -78
- Trade balance (2013–2017): -223 -197 -269 -264 -320
- Exports of goods (f.o.b., 2013–2017): 45 63 39 50 52 60 66 73
- Imports of goods (f.o.b., 2013–2017): -268 -260 -308 -314 -373 -324
- Services receipts (2013–2017): 331 307 283 330 347 337

Fund obligations and outstanding Fund credit (Table 8, exact presentation)
- Principal (in millions of SDRs, 2017–2027): 0.0 2.1 4.3 3.0 1.7 1.7 1.7 1.7 0.9 0.0 0.0
- Charges and interest (in millions of SDRs, 2017–2027): 0.1 0.1 0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
- Total obligations based on existing and prospective credit (in millions of SDRs, 2017–2027): 0.1 2.2 4.3 3.0 1.7 1.7 1.7 1.7 0.9 0.0 0.0
- Outstanding Fund credit (in millions of SDRs, 2017–2027): 17.0 14.9 10.6 7.7 6.0 4.3 2.6 0.9 0.0 0.0 0.0
- Outstanding Fund credit (in percent of quota, 2017–2027): 100.0 87.5 62.5 45.0 35.0 25.0 15.0 5.0 0.0 0.0 0.0

### Policy recommendations and identified actions
- Consider ways to use some of the gains to invest in resilient infrastructure.
- TA on PFM with a particular focus on increased fiscal resilience, transparency and accountability.
- TA on financial supervision to support financial deepening and inclusion.
- Provide analytical and policy framework on how to incorporate the cost of natural disasters and climate change.
- Coordination with the World Bank Group and development partners.
- Surveillance and policy advice on macro-economic policies.
- TA on tax administration reform and domestic revenue mobilization.
- Capacity development.

*Source: IMF staff estimates, projections, and Vanuatu authorities as presented in the supplied document.*

### 1. Positive spillovers from large infrastructure projects

### 1. Positive spillovers from large infrastructure projects

### Risk Assessment: major identified risks and potential positive spillovers
- Implementation of major infrastructure projects (including building of international wharfs and inter-island shipping facilities) could have positive spillovers to the economy from 2018 onwards.
- Low / Medium likelihood assessment for positive spillovers (as presented in the RAM).
- Other RAM entries (probability labels preserved):
  - Lower energy prices: High / High — Downside
  - Implementation delays of infrastructure projects: High / High
  - Natural disasters and climate change: Medium / High
  - Delays in implementation of tax reform: Medium / High
  - Weaker-than-expected global growth (notably China slowdown) and spillovers: Medium / High
  - Reduced financial services by correspondent banks: Global risk of loss of correspondent banking relationships is high; inclusion in FATF grey list may pose difficulties and closure of money transfer operators could increase remittance costs.

### RAM-specific policy suggestions (as listed)
- Take advantage of favorable conditions to push ahead with the medium-term development and diversification strategies.
- Public investment should be guided by careful project selection and implementation.
- Stimulate private sector investment by improving business environment and facilitating credit provision.
- Build greater ex-ante resilience to natural disasters by enhancing adaptation measures (with better infrastructure, spatial planning, and fiscal buffers).
- Maintain financial support from development partners and seek global/regional climate financing opportunities.
- Seek TA from the IMF on the implementation of tax reforms to secure the expected revenue return and achieve fairness in the tax system.
- Continue improving the implementation of Compliance Improvement Strategy to raise the efficiency of VAT collections.
- Accelerate infrastructure investment to stimulate domestic demand in the short-term and improve competitiveness in the long-term.
- Facilitate diversification by introduction of new activities and expansion into new markets.
- Ensure transparency and improve banking regulation and supervision to mitigate the risk.
- Continue to strengthen the AML/CFT framework and tax transparency in line with the international standard through TA from various stakeholders (e.g., IMF, World Bank, and Australian government).

---

### Implementation delays and natural disaster vulnerabilities (findings)
- Vanuatu faces many natural disasters: tropical cyclones, earthquakes, floods, and volcanic activity; climate change likely to increase intensity/frequency, alter weather/precipitation patterns, and raise sea levels.
- Delays in implementation of major infrastructure projects could have negative spillovers to the economy.
- The inclusion in the FATF grey list and global loss of correspondent banking relationships could complicate cross-border payments, trade finance, and remittances.

---

### Appendix II — Authorities’ Response to Past Fund Policy Advice

### Fiscal Policy: actions and outcomes
- Debt accumulation slowed from 2015 to 2016.
  - Public debt rose by 13.7 percent in 2015 due to sizable disbursements for infrastructure projects, decelerating to 6.4 percent in 2016.
- Fiscal deficit remains high due to increase in expenditure related to reconstruction and infrastructure projects, though they were largely financed by highly concessional external borrowing.
- Tax reform actions:
  - The government increased the VAT rate from 12.5 to 15 percent in January 2018.
  - Committed to introducing income tax and implementing the revised tax administration bill from January 2019.

### Monetary Policy: actions and outcomes
- The authorities maintained an accommodative policy stance to support economic recovery and financial stability after the cyclone; monetary policy transmission remains weak.
- Reserve management:
  - Foreign exchange reserves have remained above 5 months of imports throughout 2016 and 2017.
  - Maintain foreign reserves at above 4 months of imports as policy guidance.
  - RBV improved its reserve management system significantly benefiting from IMF TA on reserve management in 2015 and 2017.

### Financial Sector Policy: actions and outcomes
- RBV maintained accommodative regulatory requirements to alleviate liquidity pressures and support post-cyclone recovery.
- RBV is reviewing overall financial sector architecture to address financial inclusion.
- AML/CFT:
  - Authorities allocated significant resources to policy reformulation, legislative drafting, and completion of offshore sector and terrorist financing risk assessment.
  - Accelerating implementation of AML/CFT action plan and aligning legal framework with international standards.
- Financial inclusion:
  - RBV hosted a symposium on financial inclusion and intends to set up the National Financial Inclusion Strategy.

### Exchange Rate Policy
- Maintain the exchange rate basket peg at the current level; be ready to review/adjust if the external position worsens significantly.
- The basket peg regime has been working well; the REER remains broadly in line with fundamentals and desirable policies.

### Structural Policies and Disaster Preparedness
- Reform Government Business Enterprises (GBEs): authorities plan to submit the GBE law to Parliament in March 2018 to improve GBE governance, accountability, and performance.
- Enhance preparedness to natural disaster risk by strengthening risk assessment and planning, building domestic fiscal buffers, securing external buffers, and promoting resilient infrastructure and adequate maintenance.
  - Noted successful ex-post responses to Cyclone Pam but need for strengthened ex-ante preparedness including a simpler and more effective response action plan.
- Improve quality upgrading in the agriculture sector: authorities committed to passing legislation aimed at tapping agricultural resources and promoting agri-tourism.

---

### Appendix III — Export Diversification: findings and opportunities

### Key statistics and findings (trade and export structure)
- Vanuatu’s goods exports as a ratio to GDP stood at 6.8 percent over 2011–15.
- Commodity concentration:
  - At HS 2-digit, primary products dominate.
  - After 2000, share of “fish, crustaceans, molluscs” in total goods exports rose to 70 percent or more and persisted over time.
  - Other exports together accounted for 7 percent share over 2011–15 and included “cocoa and preparations”, “animal, vegetable fats”, and “meat, edible meat”.
- Concentration Index (UNCTAD Herfindahl-Hirschman Index at SITC 3-digit level) indicates Vanuatu’s degree of concentration higher than peers for most of the period, though it began to reduce after 2013.
- Market diversification for fish exports:
  - From 2000 to 2010, around 95 percent of Vanuatu’s fish exports by value were sent to Japan and Thailand.
  - Over 2011–15, emergence of Vietnam, China and Korea which together accounted for 8 percent of Vanuatu’s fish exports.
  - Markets in Mexico, Ecuador, Singapore, Hong Kong SAR had a combined share of 2.5 percent over the same period and could be tapped further.
- Quality index for Vanuatu’s fish exports: index value of 0.6 over 1998 to 2010 (value 1 reflects the 90th percentile among all exporters of that commodity).
- Beef export opportunity:
  - Over 2013–15, Vanuatu exported beef to Japan (55 percent), Solomon Islands (40 percent), and New Zealand (5 percent).
  - Over 2006–10 additional destinations (Australia, New Caledonia, Tonga, Fiji, Kiribati) accounted for 16 percent share.

### Services and tourism
- Tourism can be made more inclusive by strengthening linkages with agriculture and promoting agri-tourism.
- FAO study: developing domestic supply chains in agriculture can increase domestic value-added from the tourism sector by reducing dependence on food imports.
- Suggested diversification into other services and widening financial services spread, especially in outer islands, to facilitate shared prosperity.
- Niche tourism options (e.g., eco-tourism) suggested as sustainable strategies.

---

### Appendix IV — Public Investment, Debt Sustainability, and Natural Disasters

### Infrastructure need and debt trajectory
- Infrastructure gaps: Vanuatu lags peers in access to infrastructure, especially electricity; number of internet users per 100 people lower than average in other small Pacific Islands countries; cost of broadband higher than developing country average.
- Government launched Vanuatu Infrastructure Strategic Investment Plan 2015–2024 (VISIP 2015) in August 2015.
- Public and publicly guaranteed debt increased from 28.7 percent of GDP in 2014 to 48.8 percent in 2016, driven by accelerated infrastructure borrowing from external bilateral and multilateral partners.

### Natural disaster impact (Cyclone Pam)
- Vanuatu is ranked first in UN World Risk Index as most at risk of natural disasters.
- Cyclone Pam (March 2015), a category five cyclone, inflicted damages and losses of about 60 percent of GDP and affected more than 70 percent of the population.
- Damages to tourism and transport infrastructure were expected to be at 11 percent of GDP.
- International community (IDA, ADB) supported reconstruction with loans and grants.

### Fiscal financing scenarios for reconstruction (model results summary)
Three scenarios modeled for financing the fiscal gap from reconstruction:
1. Tax-financed reconstruction (increase in consumption taxes):
   - Government would have to raise the consumption tax rate from 12.5 percent to close to 23 percent in the short term and to about 14 percent over the medium term.
   - Private consumption and private investment would be adversely affected by 20 percent and 40 percent, respectively, relative to pre-Pam level.
2. External borrowing:
   - Public debt would exceed 90 percent of GDP in the medium term.
3. External grants (exogenous, large inflow of grants):
   - Preserves both debt sustainability and macroeconomic stability.
   - External grants often come with substantial technical assistance and stricter procurement/institutional rules.

### Resilience-building options and quantified outcomes
- Option (i) Investing in Resilient Infrastructure:
  - Government decides to spend 3 percent of GDP per year in adaptation infrastructure in the five years prior to Cyclone Pam — expenditures entirely funded by donors in the modeled case.
  - Investing in adaptation would have reduced damages to public and private infrastructure and attenuated fiscal and debt sustainability concerns.
  - Investing in adaptation helps reduce the risks of debt distress, with public debt reaching less than 60 percent of GDP over the medium term (as opposed to 100 percent of GDP in the tax-financed scenario).
- Option (ii) Building Fiscal Buffers:
  - Government allocates annually half of the 3 percent of GDP to adaptation investments and the other half saved in a contingency fund reaching about 8 percent of GDP at the time of the disaster.
  - Availability of financial resources allows reconstruction without additional short-term borrowing.
  - Building fiscal buffers allows lower debt-to-GDP levels compared with only investing in resilient infrastructure over the medium term, though GDP is more affected in this case than with full adaptation investments because infrastructure is less resilient.

### Policy Implications (explicitly listed)
- Given the high level of public debt, external disbursements should be contracted as much as possible on concessional terms or in the form of grants to keep the debt burden contained.
- The government should consider prioritizing public spending towards developing resilient infrastructure and/or better support the maintenance of existing infrastructure.
- Given Vanuatu’s vulnerability to natural disasters, the government should rebuild fiscal buffers over the medium term through reprioritizing spending and mobilizing new revenue resources. This self-insurance mechanism would allow the government to respond swiftly to relatively frequent but small size (in damages) natural disasters by establishing a contingency fund or any other financial mechanism.

*Source: IMF staff report — cr18109 (chapter: Positive spillovers from large infrastructure projects and related appendices).*

### Appendix V. Revenue Modernization and Reforms in Vanuatu

### Appendix V. Revenue Modernization and Reforms in Vanuatu

### Objectives and Context
- Review launched March 2016: "Revenue Modernization and Reform—Building an Effective Tax System/Regime".
- Further objectives: improve the efficiency, effectiveness and fairness of revenue collections and modernize the tax administration.
- Current revenue structure: Value-Added Tax (VAT) provides almost 40 percent of total revenues excluding grants.
- Existing fees and charges: a range of fees and charges are levied that are costly to collect and comply with.

### Institutional arrangements and reform development
- Revenue Review Project Team (RRPT) composition:
  - Project leader: Director of Finance and Treasury.
  - Members: Department of Finance and Treasury, the Prime Minister’s Office, the Department of Customs and Inland Revenue, the Vanuatu Chamber of Commerce, the State Law Office and the Law Commission.
- Governance: tax reform proposal report and recommendations were presented to the Governance Committee in late May-June 2017.
  - Governance Committee chaired by the Honorable Minister of Finance and Economic Management and comprises Directors General of MFEM, Prime Minister’s Office, Ministry of Trade, Tourism, Commerce, Industry and Ni-Vanuatu Business, Ministry of Infrastructure and Public Works Utilities, Attorney General, Parliamentary Secretary and the Parliamentary Committee.

### Tax reform proposal (key elements)
- The proposal included:
  - Abolishing fees and charges that are costly to collect and comply with, to reduce the cost of doing business in Vanuatu.
  - Bringing forward the PACER Plus reductions in import duties over five years, to lower the cost of living as well as the cost of capital, and to support investment and economic growth.
  - Introducing an income tax for individuals (with a tax-free threshold) and companies, to shift the tax burden to higher income earners.

### Analytical and forecasting tools
- Model Of the Vanuatu Economy (MOVE):
  - Purpose: empirical analysis using a macroeconomic and fiscal framework to support methodology to enhance revenue forecasts and evaluate tax reform impacts.
  - Developed by: Reserve Bank of Vanuatu, the Ministry of Finance and Economic Management (MFEM) with inputs from the Vanuatu Statistics Office (VNSO) and the Department of Customs and Inland Revenue (DCIR).
  - Supported by: IMF’s Pacific Financial Technical Assistance Centre (PFTAC).

### PFTAC technical assistance and administrative improvements
- Administrative improvements requested and supported included:
  - Developing a risk-based approach to compliance management.
  - Detailed plans and guidance to facilitate the transition to a new functional operating model in line with the Government’s tax reform agenda.
  - Setting up a Reforms and Modernization Project Team, with appropriate reporting lines and overall governance arrangements to ensure that high-quality objectives are achieved.
  - Hands-on assistance in setting up new core tax and support functions—the new functional business model was successfully introduced on 11th July 2017 with the Inland Revenue Division, and creating management/staff awareness of new ways of work and administrative benefits from the functional approach.
  - Guidance on absorbing an Income Tax into the new functional model, its impact across core tax functions and necessary alignment to DCIR IT systems.
- Additional PFTAC/IMF support:
  - Facilitated drafting of new Laws, Tax Administration Act and Regulations.
  - Reviews of the Value-Added Tax Act and Rent Tax Act.
  - Development of a new corporate strategy (5 years).
  - Synchronizing the roll-out of modernized IT systems.

### Compliance Improvement Strategy: evidence of impact
- Recent analysis indicates the Compliance Improvement Strategy is delivering results.
- Features of progress:
  - Compliance Risk Management approach in its second year.
  - Increases in the number of audits and reductions in the number of outstanding tax returns.
  - Greater public awareness of tax obligations and increased levels of voluntary compliance.
- Figure notes:
  - Real GDP growth is forecast at 5%.
  - Change in VAT Collections (In million vatu).
  - Notes: 2017 GDP is estimated from data to July and past VAT collection trends. VAT collections are those reported in the Government Finance Statistics (i.e. they net out VAT paid by government).
  - Source: PFTAC using the Model Of the Vanuatu Economy (MOVE).

### Linkages to broader fiscal and debt policy (Debt Sustainability Analysis highlights)
- External risk of debt distress: remains moderate.
- Trend: External PPG debt to GDP began to rise in 2014, increasing sharply through end-2016. An upward trend is anticipated to continue over the next few years due to planned public infrastructure projects and reconstruction activities.
- Conditions and caveats:
  - The increase in indebtedness is expected to be manageable provided the financing terms are concessional and the surge in financing needs is temporary.
  - High vulnerability to natural disaster shocks and increased debt service burdens in the medium term imply authorities should be vigilant about rapid debt accumulation.
- Recommended policy actions (from the DSA summary):
  - Take into account the country’s absorptive capacity when considering the pace and scale of new borrowing.
  - Ensure borrowing continues to be on concessional terms to reduce the debt burden.
  - Consider updating the debt management strategy annually.
  - Stand ready to reprioritize spending.
  - Seek ways to increase revenues (including by introducing an income tax) to rebuild fiscal buffers against shocks, including natural disaster shocks.

*Source: Appendix V. Revenue Modernization and Reforms in Vanuatu, Staff Report for the 2018 Article IV Consultation.*

### 1.      Vanuatu’s external public debt has risen sharply since 2015 when Cyclone Pam hit the

### cr18109 - 1.      Vanuatu’s external public debt has risen sharply since 2015 when Cyclone Pam hit the

### Debt developments since Cyclone Pam
- External public and publicly guaranteed (PPG) debt increased from 16.3 percent of GDP in 2014 to 30.5 percent in 2015 and then to 37.6 percent in 2016.
- Main drivers: disbursements for infrastructure projects from bilateral creditors that kickstarted construction in 2015 and accelerated in 2016.
- The IMF’s quick RCF/RFI disbursement of USD 23.8 million in June 2015 catalyzed international support for recovery.
- IDA and ADB provided loans and grants; Vanuatu has received loans from bilateral and multilateral donors for development and reconstruction.

### Debt Management Strategy (DMS)
- Government prepared its first DMS 2015–2017 in August 2015.
- Overall objective: minimize the cost of public debt, consistent with government’s tolerance for financial risk of the existing public debt portfolio.
- Specific targets for 2015–2017 include:
  - Maintain the present value (PV) of public external debt below 40 percent of GDP.
  - Minimize cost by contracting external loans with a grant element of at least 35 percent.
- The government will update the strategy in 2018.

### Stock of public debt (end-2016) — key figures
- External PPG debt: US$290 million (37.6 percent of GDP).
- Total public debt: 42,593 million Vatu; 377 million US dollars; 48.8 percent of GDP.
- Breakdown (end-2016):
  - External: 32,810 million Vatu; 290 million US dollars; 77.0 percent of total debt; 37.6 percent of GDP.
    - Multilateral: 9,411 million Vatu; 83 million US dollars; 22.1 percent of total debt; 10.8 percent of GDP.
      - ADB: 5,952 million Vatu; 53 million US dollars; 14.0 percent of total debt; 6.8 percent of GDP.
      - IDA: 875 million Vatu; 8 million US dollars; 2.1 percent of total debt; 1.0 percent of GDP.
      - IMF: 2,584 million Vatu; 23 million US dollars; 6.1 percent of total debt; 3.0 percent of GDP.
    - Bilateral: 23,399 million Vatu; 207 million US dollars; 54.9 percent of total debt; 26.8 percent of GDP.
      - China EXIM Bank: 15,124 million Vatu; 134 million US dollars; 35.5 percent of total debt; 17.3 percent of GDP.
      - JICA: 8,192 million Vatu; 72 million US dollars; 19.2 percent of total debt; 9.4 percent of GDP.
      - Others: 83 million Vatu; 10 million US dollars; 0.2 percent of total debt; 0.1 percent of GDP.
  - Domestic: 9,784 million Vatu; 87 million US dollars; 23.0 percent of total debt; 11.2 percent of GDP.
    - Government bonds: 7,377 million Vatu; 65 million US dollars; 17.3 percent of total debt; 8.5 percent of GDP.
    - Publicly guaranteed debt: 2,407 million Vatu; 21 million US dollars; 5.7 percent of total debt; 2.8 percent of GDP.
- Loans largely concessional: interest rates 0-2 percent, maturities 20-40 years; relatively high grant element and low debt service burden.
- Due to data limitations, external liabilities of commercial banks used as proxy for private external debt.

*Source: Vanuatu authorities and IMF staff estimates.*

### Public domestic debt and guarantees
- Public domestic debt (central government bonds) stood at VUV 7.4 billion as of end-2016 (about USD 65.2 million, or 8.5 percent of GDP).
- Bonds largely held by public corporations (primarily Vanuatu National Provident Fund), followed by the Reserve Bank of Vanuatu and commercial banks.
- Government provides guarantees for Government Business Enterprises (GBEs) such as Air Vanuatu.
- Publicly guaranteed debt estimated near VUV 2.4 billion (about USD 21.3 million, or 2.8 percent of GDP).

### Methodology and baseline macroeconomic assumptions (DSA)
- DSA incorporates long-term effects of natural disasters and climate change from 2023 onwards.
- Baseline assumes no disaster from 2017 to 2022; from 2023 effects are incorporated by spreading the impact of a large natural disaster over 2023–2037 (15 years).
- Discount rate for net PV of external debt: 5 percent.

Baseline macro assumptions (selected, as presented)
- GDP growth:
  - 2017: 4.2 percent
  - 2018: 3.8 percent
  - Medium term (2017–2022) average: 3.4 percent
  - Long term (2023-2037) average: 3.0 percent after netting out 0.5 percentage point as impact of natural disasters and climate change
- Inflation (GDP deflator):
  - 2017: 3.1 percent
  - 2018: 4.8 percent
  - Long run average: 3.3 percent
- Non-interest current account deficit:
  - 2017 and 2018: expected to remain high due to elevated imports for reconstruction and projects
  - Long term average expected to narrow to 4.4 percent of GDP
  - After 2023, natural disasters and climate change projected to widen the deficit by 0.7 percentage points annually
- FDI inflows:
  - Medium term average: about 3.9 percent
  - Longer term average: 2.8 percent
- Primary balance (percent of GDP):
  - 2017: negative at 6.5 percent
  - 2018: negative at 6.9 percent
  - Medium term average (2017–2022): primary deficit expected to be 3.8 percent
  - Long term: 1.8 percent
  - Natural disasters and climate change effects: deteriorate fiscal balance by 0.3 percent of GDP annually
- External borrowing and grants:
  - New external borrowing projected to average 3.9 percent of GDP over the longer term
  - Grants expected to gradually decline to 5.5 percent of GDP

### Customized scenario: another major natural disaster event
- Shock calibrated to Cyclone Pam experience:
  - Cyclone Pam reduced real GDP growth by roughly 5 percentage points and increased external borrowing—external debt increased by about 14 percent of GDP in 2015.
- Customized scenario assumes another extreme natural disaster hits in 2020, increasing debt-to-GDP ratio by 14 percentage points in that year.
- Severe natural disasters occurring several times in twenty years could have large cumulative effects on debt sustainability.

### External debt sustainability findings and risks
- Baseline: external debt remains sustainable; PV of external PPG debt indicators remain below thresholds over projection period.
- Nominal external PPG debt peaks in 2020 at 44.3 percent of GDP (from 37.6 percent in 2016) due to disbursements for infrastructure and reconstruction.
- Public external debt service ratios are relatively low because debt is highly concessional.
- Stress tests:
  - One threshold for public external debt is breached in the most extreme shock scenario (one-time depreciation shock): PV of debt-to-GDP ratio breaches 40 percent threshold, indicating moderate risk of external debt distress.
  - The breach is ‘borderline’ as it falls within ±5 percent band around threshold under traditional DSA; probability approach (incorporates country-specific CPIA and growth) indicates a more substantial breach, reinforcing moderate risk.
  - Shock to financing terms—a rise in interest rates on new borrowing by 2 percentage points compared to baseline—is an important risk to sustainability.
- Policy implication: external borrowing should be contracted on concessional terms as much as possible.

### Public debt sustainability findings
- PV of public sector debt as percent of GDP remains below benchmark under baseline.
- Nominal public debt (external plus domestic) trajectory:
  - 2016: 48.8 percent of GDP
  - 2019: expected to increase to 53.9 percent of GDP
  - 2037: expected to decline to 50.8 percent of GDP
- Debt service-to-revenue ratio expected to rise from 9.9 percent in 2017 to 13.5 percent in 2037.
- Standard stress tests show one breach of public benchmark:
  - PV of debt-to-GDP breaches 58 percent threshold significantly in scenario where primary balance is held fixed at 2017 level (6.5 percent of GDP).
  - Context: 2017 deficit driven by Cyclone Pam reconstruction and infrastructure spending financed externally; scenario suggests need for prudent selection of future public investments in line with debt-carrying and implementation capacity.

### Policy recommendations and conclusions
- Updated DSA suggests Vanuatu’s risk of external debt distress is moderate.
- Key recommended policies:
  - Contract external disbursements on concessional terms or as grants to keep debt burden contained.
  - Authorities should consider updating the debt management strategy annually given recent sharp debt accumulation and increased medium-term debt service burden.
  - Rebuild fiscal buffers over the medium term by strengthening public finance management, reprioritizing spending, and mobilizing new revenue resources.
  - Be vigilant about rapid debt accumulation given vulnerability to natural disasters; exercise prudent selection of public investments consistent with debt-carrying capacity.

*Source: Vanuatu authorities and IMF staff estimates.*

### 15.      The authorities broadly concurred with the assessment of the debt sustainability analysis.

### 15. The authorities broadly concurred with the assessment of the debt sustainability analysis

### Authorities' assessment and policy intentions
- The authorities broadly concurred with the debt sustainability analysis.
- Given high infrastructure needs, the authorities underscored the need for financial support from bilateral and multilateral donors for new projects.
- The authorities intended to maintain a grant-element target of at least 35 percent under the upcoming debt management strategy, and seek grant financing as much as possible to reduce debt burden.
- With debt-servicing for key projects commencing in 2019, the authorities recognized the importance of rebuilding fiscal buffers over the medium term through revenue mobilization efforts, especially the introduction of personal and corporate income taxes.
- Debt-servicing for key projects commencing in 2019.

### Debt vulnerabilities, stress tests, and scenarios (summary of DSA findings)
- Stress tests considered multiple shocks; the "most extreme stress test" is defined as the test that yields the highest ratio on or before 2027.
  - In the external-debt figures, the most extreme shocks include One-time depreciation shock and Terms shock (specified per panel).
- Scenarios and sensitivity analyses examined:
  - Baseline and historical scenarios.
  - Alternative scenarios including key variables at historical averages and new public sector loans on less favorable terms.
  - Bound tests including: real GDP growth at historical average minus one standard deviation; export value growth shock; US dollar GDP deflator shock; net non-debt creating flows shock; combination shocks; and a one-time 30 percent nominal depreciation relative to the baseline.
- Memorandum and sensitivity assumptions include:
  - Grant element assumed on residual financing (i.e., financing required above baseline) 6/47.

### Selected key indicators and macro-fiscal context (from the DSA tables)
- External debt (nominal) — sample values across periods (in percent of GDP): 31.1, 46.1, 53.2, 56.7, 59.6, 60.1, 60.2, 59.6, 58.9, 55.8, 55.4.
- Of which: public and publicly guaranteed (PPG) — sample values (in percent of GDP): 16.3, 30.5, 37.6, 40.4, 43.7, 44.2, 44.3, 43.8, 43.2, 40.4, 40.5.
- Change in external debt (in percent of GDP): 8.4, 15.0, 7.0, 3.6, 2.8, 60.5, 0.1, -0.6, -0.7, -0.5, 0.3.
- Identified net debt-creating flows (in percent of GDP): -1.8, 8.5, -4.2, 3.2, 3.2, 72.7, 2.3, 2.3, 2.2, 1.4, 1.4.
- Non-interest current account deficit (in percent of GDP): -0.3, 9.7, 3.3, 5.8, 3.3, 8.1, 8.2, 7.7, 7.0, 6.8, 6.7.
- Exports (in percent of GDP): 45.4, 41.6, 47.6, 45.9, 41.5, 40.4, 40.4, 40.0, 39.9, 40.1, 43.6.
- Imports (in percent of GDP): 49.2, 62.9, 58.3, 58.0, 53.3, 51.5, 50.5, 49.7, 49.3, 47.8, 50.2.
- Net FDI (negative = inflow, in percent of GDP): -1.7, -3.8, -6.9, -5.7, 2.4, -3.8, -3.9, -4.0, -4.0, -3.8, -3.8.
- Endogenous debt dynamics contribution (in percent of GDP): 0.2, 2.5, -0.6, -1.1, -1.1, -1.0, -0.8, -0.8, -0.7, -0.7, -0.8.
- PV of external debt (in percent of GDP) — sample values: 42.4, 44.2, 45.4, 45.3, 45.1, 44.5, 43.9, 41.0, 40.0.
- PV of PPG external debt (in percent of GDP) — sample values: 26.8, 27.9, 29.5, 29.4, 29.3, 28.8, 28.2, 25.6, 25.1.
- PV of PPG external debt (in percent of government revenues) — sample values: 119.1, 120.4, 125.9, 120.0, 118.6, 116.9, 114.9, 104.4, 102.6.
- Debt service-to-exports ratio (in percent): 7.4, 8.8, 7.3, 8.0, 9.5, 11.0, 10.3, 10.7, 10.8, 10.3, 8.7.
- PPG debt service-to-exports ratio (in percent): 2.1, 2.6, 2.1, 2.3, 3.3, 4.6, 4.0, 4.4, 4.4, 4.2, 3.3.
- PPG debt service-to-revenue ratio (in percent): 4.9, 5.5, 4.5, 4.6, 5.8, 7.6, 6.6, 7.1, 7.2, 6.8, 5.8.
- Total gross financing need (Millions of U.S. dollars): 10.7, 74.2, -0.9, 69.5, 78.8, 82.9, 78.4, 85.0, 89.0, 105.0, 185.6.
- Non-interest current account deficit that stabilizes debt ratio (in percent of GDP): -8.8, -5.3, -3.8, 4.5, 5.4, 7.2, 6.9, 7.4, 7.4, 5.7, 3.9.

### Key macroeconomic assumptions (selected)
- Real GDP growth (in percent): 2.3, 0.2, 3.5, 2.7, 1.9, 4.2, 3.8, 3.5, 3.0, 3.0, 3.0.
- GDP deflator in US dollar terms (change in percent): -0.6, -5.2, -0.3, 3.6, 7.4, 4.6, 6.0, 3.4, 3.3, 3.3, 3.3.
- Effective interest rate (percent) 5/: 2.7, 2.7, 1.8, 2.2, 0.4, 1.9, 1.8, 1.7, 1.6, 1.7, 1.7, 1.6, 1.5, 1.6.
- Growth of exports of G&S (US dollar terms, in percent): -1.6, -13.0, 18.1, 8.2, 11.6, 5.1, -0.6, 4.3, 6.3, 5.4, 6.0, 4.4, 8.5, 6.6, 7.1.
- Growth of imports of G&S (US dollar terms, in percent): -1.9, 21.4, -4.4, 9.1, 15.5, 8.3, 1.1, 3.3, 4.5, 4.7, 5.6, 4.6, 5.8, 7.1, 6.5.
- Grant element of new public sector borrowing (in percent) — selected series: 47.8, 46.7, 49.7, 51.2, 51.6, 51.8, 49.8, 49.8, 45.2, 48.4.
- Government revenues (excluding grants, in percent of GDP): 19.4, 20.1, 22.5, 23.1, 23.4, 24.5, 24.7, 24.6, 24.5, 24.5, 24.5.
- Aid flows (Millions of US dollars): 74.3, 212.1, 140.1, 122.2, 146.4, 129.9, 128.8, 128.0, 133.0, 179.3, 351.1.
  - of which: Grants (Millions of US dollars): 33.8, 91.1, 66.2, 72.6, 78.3, 82.2, 86.1, 89.1, 93.6, 124.5, 232.0.
  - of which: Concessional loans (Millions of US dollars): 40.6, 121.0, 73.9, 49.7, 68.1, 47.7, 42.7, 38.9, 39.4, 54.8, 119.1.
- Grant-equivalent financing (in percent of GDP) — selected series: 12.2, 11.6, 10.4, 9.9, 9.4, 9.2, 9.0, 9.1, 9.1.
- Grant-equivalent financing (in percent of external financing) — selected series: 74.3, 74.8, 81.5, 83.8, 85.3, 85.7, 84.7, 81.4, 83.7.

### Policy implications emphasized by the authorities
- Continue to target high grant element in new borrowing to reduce debt burden (target at least 35 percent; practice and projections show much higher grant elements in many years).
- Seek bilateral and multilateral donor support for financing infrastructure needs.
- Rebuild fiscal buffers over the medium term through revenue mobilization, notably by introducing personal and corporate income taxes.
- Monitor debt-service pressures as project repayments begin (noting key debt-servicing commencing in 2019) and maintain prudent debt management to avoid adverse outcomes under stress scenarios.

*Source: IMF staff and country authorities (Vanuatu DSA excerpts).*

---


_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18109.pdf_