## 1. Logging Developments ## Source details **Canonical URL:** [1. Logging Developments](https://www.imf.org/-/media/files/publications/cr/2018/cr18309.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2018/cr18309.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2018/cr18309.pdf.json) --- ### Context - Solomon Islands restored law and order and public institutions since the Tensions; important reforms include a Public Financial Management Act, a new debt management framework, and a Central Bank Act. IMF-supported programs from 2010–16 were successful, but the fiscal position deteriorated sharply after program end; fiscal cashflow problems emerged (Appendix I). - Structural and geographic constraints: - Economy narrow and concentrated on an over-exploited logging sector. - Located far from international markets; geographically dispersed population. - Highly vulnerable to natural disasters and climate change. - Large infrastructure gap and capacity constraints; political situation remains fluid (Figure 1). - Logging depletion implies new sources of growth are required to meet the Sustainable Development Goals (Appendix II). - Governance challenges: management of logging and emerging mining sectors; lack of transparency in government spending including Constituency Development Funds (CDFs); weak public financial management leading to fiscal slippages. - Vulnerabilities: - Erosion of fiscal buffers reduces room to respond to exogenous shocks. - Ranked the fourth most vulnerable country to natural disasters among the Pacific islands; in any year, there is a 13.5 percent probability of the occurrence of a severe natural disaster. - Political instability episodes: in November 2017 the Prime Minister was replaced following a vote of no confidence; new government coalition faces elections in early 2019. ### Recent Developments - Growth and inflation: - Real growth: 3.5 percent in 2017, supported by logging, higher cash crop yields, fishing revenues, and construction activity. - Headline inflation: 2.4 percent in June 2018. - External sector: - Current account deficit: around 4.2 percent of GDP in 2017. - Reserves: 8.8 months of import cover in June 2018. - Exchange rate: moved closely with the US dollar; greater volatility against the Australian dollar. - Fiscal position deterioration: - Fiscal deficit: 3.8 percent of GDP in 2017 as revenues fell short and spending on tertiary scholarships, shipping grants and CDFs remained high. - Domestic expenditure arrears: 1.3 percent of GDP in 2017. - Government broad cash balance declined to 1.5 months of total spending, below the two-month target. - Public debt increased to 9.4 percent of GDP in 2017 following issuance of domestic bonds to the National Provident Fund (NPF) for infrastructure development. - Monetary and financial sector: - Credit growth slowed to 5 percent year on year by May 2018. - Bank spreads high at 10 percent. - Net non-performing loans (NPLs) almost doubled in 2017 to 11.5 percent of capital and reserves; in 2018 Q1 NPLs moved back down and banks curtailed credit. - Excess liquidity remains high. - Correspondent banking risk: - Withdrawal of correspondent banking from a domestic bank providing services to the logging industry poses potential financial stability risk. - A temporary solution is in place until the end of the year; progress is being made on a permanent solution contingent on strengthened screening and transaction monitoring. - Recurrence would pose a downside risk. ### Outlook, Risks, and Vulnerabilities - Growth and inflation projections: - Growth: around 3.4 percent in 2018; expected to moderate to 2.9 percent in 2019. - Staff projects growth at 2.9 percent on average over 2018–2 3. - Inflation: projected at 3.2 percent in 2018, easing below 3 percent in 2019 and thereafter; expected to remain moderate at 3.2 over the medium term. - Current account: - Likely to widen to 6.4 percent of GDP in 2018 and 8.3 percent of GDP in 2019 with higher imports for infrastructure. - Projected to widen to 7.5 percent of GDP on average over 2018–2 3 due to upcoming infrastructure projects with high import content. - Medium-term considerations: - Positive: Tina hydropower project expected to come on stream by 2022; Gold Ridge Mine could restart in 2020 (upside risk); undersea internet cable could boost longer-run activity. - Negative: fiscal challenges, declining logging activity, and uncertain timing of mining sector expansion. - Fiscal trajectory and debt: - If fiscal situation not addressed, cash reserves would be exhausted in 2021. - 2018 budget aimed for balanced budget (excluding external financing) to maintain cash balance as of December 2017, but a supplementary budget of 2 percent of GDP was enacted; budget includes sharp cut in government-funded development expenditures that appears unattainable. - IMF staff expect deficit to remain high at 3.6 percent of GDP in 2018 with cash balance falling to one month of total spending and new domestic arrears of 0.7 percent of GDP. - On current trajectory, broader cash balance would decline to zero in 2021. - Nominal public debt-to-GDP ratio was raised by 5 percentage points to 35 percent of GDP to promote infrastructure development. - Debt Sustainability Analysis (DSA) indicates risk of external debt distress remains moderate though vulnerability to shocks is high; a one-off natural disaster shock would significantly add to debt and breach the public debt threshold (Appendix IV). - Principal downside risks: - Elections in early 2019 slowing policy reform and delaying fiscal problem resolution. - Large natural disaster impact intensified by depleted fiscal buffers. - Re-emerging difficulties securing correspondent banking links, which would adversely impact logging exports and fiscal position. - Financial feedback loop risk: continued government payment delays could drive NPLs up, creating an adverse loop between fiscal stress and the financial sector. ### Authorities’ Views - Agree with staff’s medium-term growth assessment: expect logging activity to decline with sustainability policies; anticipate donor-supported infrastructure projects (undersea cable and Tina river hydropower), possible reopening of Gold Ridge mine, and bauxite mining to offset decline; fish catch expected to grow. - Aware of risks and the need to strengthen fiscal position; actions being taken to contain the fiscal deficit and to improve forestry industry sustainability. - Seek policies to promote a healthy mining sector and growth in agriculture and tourism. ### Policy Discussion: Priorities for Stability - Overall prescription: fiscal adjustment, tax reform, public financial management strengthening, and new sources of growth to promote sustainable development. Structural reforms, infrastructure investment, and improved governance to support the business environment and generate growth. Prevent governance failures in logging from spreading to mining. Retain correspondent banking relationships to preserve foreign exchange inflows and fiscal revenues. A. Managing the Fiscal Position — Staff’s Assessment and Recommendations - Objective: rebuild the cash balance to around 2 months of total spending by 2021 while clearing arrears; a multi-year plan with cumulative consolidation of 7.3 percent of GDP by 2021. - Immediate actions: - Thorough stocktaking of arrears to clarify true position; claims for 2017 have been paid and contractual commitments for 2018 identified, but not all arrears are confirmed eliminated. - 2019 Budget should aim for a cash balance of 1.2 months of total spending. - Revenue measures: - Continue strengthening revenue administration and compliance; efforts to reduce tax arrears are yielding good results and will help generate a one-off revenue increase. - Implement steps to streamline and adjust tax reference prices for logs to align with world prices to reduce transfer pricing scope; similar efforts needed for bauxite. - Spending measures: - 2019 budget opportunity to streamline spending areas that increased rapidly (e.g., CDFs, tertiary scholarships, shipping grants), clear arrears, and better align spending with the National Development Plan. - Staff urged authorities to lower CDF spending and partially restore critical line-ministry development spending. - Expenditure on the 2023 Pacific Games needs to be limited prudently. - Noted 2019 budget strategy proposes reallocation of development spending but includes a sizeable increase in payroll. - Growth effects: - Revenue and expenditure measures expected to only moderately affect growth; fiscal multipliers likely low as measures aim to improve spending quality and tackle tax debts and efficiency. B. Governance of the Logging and Mining Sectors — Staff’s Assessment - Logging sector recommendations: - Enforce policies and transparency, establish credible forestry management certification, reduce scope for transfer pricing, and promote development of well-managed plantations. - Clamping down on corruption to expand export markets. - Mining sector: - Large deposits of gold, copper, nickel and bauxite identified. - Gold Ridge mine contains an estimated 9 million tons of gold, with extraction expected to last 15 years. - Reaping benefits requires strong regulatory and policy environment; National Mining Policy launched June 2017; staff recommended rejoin and fully implement EITI. - Strengthen capacity in fiscal compliance, auditing, and monitoring market reference pricing. C. Financial Inclusion in Support of Climate Change Adaptation - NFIS objectives: build financial resilience by expanding microinsurance and saving products for informal workers through SINPF. - Benefits: - Insurance (including weather index-based) spreads risks from extreme weather. - Savings support consumption smoothing and agricultural investment. - Access to credit can boost climate-resilient technology investment. - Implementation challenges: - Encourage greater usage of opened accounts and extend mobile payments; CBSI updating guidance on mobile money. - Authorities to drive NFIS given underdeveloped private sector. D. Other Issues and Technical Assistance - IMF TA engagements: tax policy and revenue administration, public financial management, monetary and foreign exchange operations, banking supervision, and statistics. - Authorities interested in TA on a medium-term revenue strategy, anti-corruption bill implementation, and transfer pricing in logging and mining. - Statistics: progress on National Statistics Development Strategy; revisions to national accounts, compilation of a national CPI, first-ever agriculture census and labor force survey. ### STAFF APPRAISAL — Key conclusions and recommended actions - Recent performance and risks: - Economic activity encouraging; logging outperformed expectations; cash crops, fishing, and construction supported growth. - Headline inflation contained, though higher oil prices may push inflation up. - International reserves remain comfortable. - Risks mostly on the downside. - Policy priorities: - Prudent policies essential to safeguard stability. - Generate new sources of growth as logging activity is expected to decline; substantial infrastructure investment required. - Decisive actions to address governance challenges and enforce anti-corruption measures. - Specific reforms: - Manage transition from logging to new growth areas gradually while ensuring macro stability. - Ensure governance problems from logging do not spread to mining. - Structural reforms: legal and regulatory framework, enforcement of contracts, insolvency resolution, access to finance, property registration, tackle customary land-ownership challenges. - Financial sector reforms: - Finalize backlog of financial legislation; address AML/CFT weaknesses; strengthen supervisory effectiveness to aid restoration of correspondent banking relationships. - Continue financial inclusion strategy linked to resilience. - Data improvements: - Channel adequate resources to economic data compilation and dissemination. ### Box 1 — Logging developments and fiscal effects (selected statistics and estimates) - 2017 logging contribution and shares: - accounted for two-thirds of exports of goods and 52 percent of exports of goods and services; - 22 percent of total government revenue; - contributed 1.1 percent points to growth. - Employment: nearly half of the workforce thought to be directly or indirectly associated with the forestry sector. - 2018 log export volumes (proxy for log production): increased by 26 percent year-on-year to 1.309 million cubic meters by June 2018. - Reference price adjustments and foregone revenue: - Between 2016 and 2018 reference prices adjusted by 10–15 percent. - Delayed adjustment resulted in lost tax revenues estimated at about 2.7 percent of GDP in 2016. - Rough estimates show foregone revenues could be as high as 5 percent of GDP for 2017. - Example price/declaration calculations (USD/m3 and totals): - Landed CIF price: 289.5 USD/m3 - freight: 57.9 - insurance: 5.8 (2% of CIF price-estimated) - agent fees: 17.4 (6% CIF price-estimated) - sub total: 208.4 - declared fob: 100.6 (Determined value schedule) - Difference: 107.8 (unaccounted difference between declared and landed) - Log exports to China in 2016: 1,256.0 thousand cubic meters (Comtrade data) - Foregone income: 135.4 US million dollars - Estimated foregone revenue: 33.9 US million dollars - 2.7 foregone revenue as percent of GDP ### Key Statistics and Indicators (selected) - Real growth: 3.5 percent in 2017. - Headline inflation: 2.4 percent in June 2018. - Current account deficit: around 4.2 percent of GDP in 2017. - Reserves: 8.8 months of import cover in June 2018. - Fiscal deficit: 3.8 percent of GDP in 2017. - Domestic expenditure arrears: 1.3 percent of GDP in 2017; new domestic arrears of 0.7 percent of GDP expected in 2018. - Government broad cash balance: 1.5 months of total spending (below two-month target). - Public debt: increased to 9.4 percent of GDP in 2017; nominal public debt-to-GDP ratio raised by 5 percentage points to 35 percent of GDP for infrastructure development. - Credit growth: 5 percent year on year by May 2018. - NPLs: 11.5 percent of capital and reserves in 2017. - Bank spreads: 10 percent. - Probability of a severe natural disaster in any year: 13.5 percent. - Staff consolidation target: cumulative 7.3 percent of GDP by 2021. - 2018 supplementary budget size: 2 percent of GDP. - Staff expected deficit in 2018: 3.6 percent of GDP. - Staff cash balance target for 2019 budget: 1.2 months of total spending. ### Alternative Policy Action Scenario (Adjustment Scenario, selected outcomes) - Fiscal measures (2018–2021, In percent of GDP relative to baseline): - Revenue increases: 0.5 0.8 0.8 0.8 - Expenditure cuts: -0.3 -1.1 -1.5 -1.5 - Total Savings: 0.8 1.9 2.3 2.3 - Cumulative Savings: 0.8 2.7 5.0 7.3 - Adjustment Scenario outcomes vs Baseline (selected): - Overall Balance (In percent of GDP) under Adjustment Scenario: -2.8 -2.1 -1.6 -1.8 (2018–2021) - Cash Balance (in SI$ millions) under Adjustment Scenario: 296 278 472 626; in months of recurrent spending: 1.2 1.1 1.8 2.2 - Broader Cash Balance (in SI$ millions) under Adjustment Scenario: 436 418 612 766; in months of total spending: 1.3 1.2 1.7 2.0 - Public domestic debt, including arrears (In percent of GDP) under Adjustment Scenario: 2.8 2.0 1.9 1.8 - Baseline Scenario outcomes (selected): - Overall Balance (In percent of GDP): -3.6 -3.3 -4.0 -4.1 - Cash Balance (in SI$ millions): 206 122 20 -140; in months of recurrent spending: 0.8 0.5 0.1 -0.5 - Broader Cash Balance (in SI$ millions): 346 262 160 0; in months of total spending: 1.0 0.7 0.4 0.0 ### Appendix V — Economic Impact of the Loss of CBR (selected projections for 2019) - Two scenarios considered: - Full impact scenario: loss of CBR shuts down logging industry exports for one year. - Half impact scenario: milder disruption with logging continuing through informal channels. - Quantitative projections for 2019 (IMF estimates): - Real GDP growth: Proj. (baseline) 2.9; Proj. (Full Impact Scenario) -6.7; Proj. (Half Impact Scenario) -3.1 - Current account balance (percent of GDP): -8.3; -21.7; -16.5 - Gross official reserves (In months of Import): 6.8; 4.6; 5.5 - Revenue (percent of GDP): 32.2; 26.6; 28.1 - Cash balance (SI$ million): 26; 200; 0 - Public debt (percent of GDP): 14.6; 24.5; 21.2 - Note: Scenarios do not take into account expenditure measures or aids to cope with a revenue loss. *Source: IMF staff report text for "1. Logging Developments."* ### 1. Logging Developments ________________________________________________________________________ 16 ### 1. Logging Developments ### Context - Solomon Islands restored law and order and public institutions since the Tensions; important reforms include a Public Financial Management Act, a new debt management framework, and a Central Bank Act. IMF-supported programs from 2010–16 were successful, but the fiscal position deteriorated sharply after program end; fiscal cashflow problems emerged (Appendix I). - Structural and geographic constraints: economy narrow and concentrated on an over-exploited logging sector; located far from international markets; geographically dispersed population; highly vulnerable to natural disasters and climate change; large infrastructure gap and capacity constraints; political situation remains fluid (Figure 1). - Logging depletion implies new sources of growth are required to meet the Sustainable Development Goals (Appendix II). - Governance challenges: management of logging and emerging mining sectors; lack of transparency in government spending including Constituency Development Funds (CDFs); weak public financial management; results in fiscal slippages undermining stability and impeding growth. New government aims to address issues including an anti-corruption strategy (paragraph 45) and a focus on sustainable forestry and mining policy, but mitigating governance risks will require sustained effort with greater transparency and effective policy implementation. - Vulnerabilities noted: - Erosion of fiscal buffers reduces room to respond to exogenous shocks. - Solomon Islands is ranked the fourth most vulnerable country to natural disasters among the Pacific islands. In any year, there is a 13.5 percent probability of the occurrence of a severe natural disaster. - Political instability episodes: in November 2017 the Prime Minister was replaced following a vote of no confidence; new government coalition faces elections in early 2019. ### Recent Developments - Growth and inflation: - Real growth: 3.5 percent in 2017, supported by logging, higher cash crop yields, fishing revenues, and construction activity (Figure 2, Table 1). - Headline inflation: 2.4 percent in June 2018. - External sector: - Current account deficit: around 4.2 percent of GDP in 2017. - Reserves: 8.8 months of import cover in June 2018. - Exchange rate: moved closely with the US dollar; greater volatility against the Australian dollar. - Fiscal position deterioration: - Fiscal deficit: 3.8 percent of GDP in 2017 as revenues fell short and spending on tertiary scholarships, shipping grants and CDFs remained high. - Domestic expenditure arrears: 1.3 percent of GDP in 2017. - Government broad cash balance declined to 1.5 months of total spending, below the two-month target. - Public debt increased to 9.4 percent of GDP in 2017 following issuance of domestic bonds to the National Provident Fund (NPF) for infrastructure development (Figure 3, Table 2). - Monetary and financial sector: - Credit growth slowed to 5 percent year on year by May 2018. - Bank spreads high at 10 percent, indicating need for greater competition. - Net non-performing loans (NPLs) almost doubled in 2017 to 11.5 percent of capital and reserves; in 2018 Q1 NPLs moved back down and banks curtailed credit. - Excess liquidity remains high. - Correspondent banking risk: - Withdrawal of correspondent banking from a domestic bank providing services to the logging industry poses potential financial stability risk. - A temporary solution is in place until the end of the year; progress is being made on a permanent solution contingent on strengthened screening and transaction monitoring. - Recurrence would pose a downside risk. ### Outlook, Risks, and Vulnerabilities - Growth and inflation projections: - Growth: around 3.4 percent in 2018; expected to moderate to 2.9 percent in 2019. - Staff projects growth at 2.9 percent on average over 2018–2 3. - Inflation: projected at 3.2 percent in 2018, easing below 3 percent in 2019 and thereafter; expected to remain moderate at 3.2 over the medium term. - Current account: - Likely to widen to 6.4 percent of GDP in 2018 and 8.3 percent of GDP in 2019 with higher imports for infrastructure. - Projected to widen to 7.5 percent of GDP on average over 2018–2 3 due to upcoming infrastructure projects with high import content. - Medium-term considerations: - Positive: Tina hydropower project expected to come on stream by 2022; Gold Ridge Mine could restart in 2020 (upside risk); undersea internet cable could boost longer-run activity. - Negative: fiscal challenges, declining logging activity, and uncertain timing of mining sector expansion. - Fiscal trajectory and debt: - If fiscal situation not addressed, cash reserves would be exhausted in 2021. - 2018 budget aimed for balanced budget (excluding external financing) to maintain cash balance as of December 2017, but a supplementary budget of 2 percent of GDP was enacted; budget includes sharp cut in government-funded development expenditures that appears unattainable. - IMF staff expect deficit to remain high at 3.6 percent of GDP in 2018 with cash balance falling to one month of total spending and new domestic arrears of 0.7 percent of GDP. - On current trajectory, broader cash balance would decline to zero in 2021. - Nominal public debt-to-GDP ratio was raised by 5 percentage points to 35 percent of GDP to promote infrastructure development. - Debt Sustainability Analysis (DSA) indicates risk of external debt distress remains moderate though vulnerability to shocks is high; a one-off natural disaster shock would significantly add to debt and breach the public debt threshold (Appendix IV). - Principal downside risks: - Elections in early 2019 slowing policy reform and delaying fiscal problem resolution. - Large natural disaster impact intensified by depleted fiscal buffers. - Re-emerging difficulties securing correspondent banking links, which would adversely impact logging exports and fiscal position (Appendix V). - Financial feedback loop risk: continued government payment delays could drive NPLs up, creating an adverse loop between fiscal stress and the financial sector. ### Authorities’ Views - Authorities agree with staff’s medium-term growth assessment: expect logging activity to decline with sustainability policies; anticipate donor-supported infrastructure projects (undersea cable and Tina river hydropower), possible reopening of Gold Ridge mine, and bauxite mining to offset decline; fish catch expected to grow. - Authorities are aware of risks and the need to strengthen fiscal position; actions being taken to contain the fiscal deficit and to improve forestry industry sustainability. They seek policies to promote a healthy mining sector and growth in agriculture and tourism. ### Policy Discussion: Priorities for Stability - Overall prescription: fiscal adjustment, tax reform, public financial management strengthening, and new sources of growth to promote sustainable development. Structural reforms, infrastructure investment, and improved governance to support the business environment and generate growth. Prevent governance failures in logging from spreading to mining. Retain correspondent banking relationships to preserve foreign exchange inflows and fiscal revenues. A. Managing the Fiscal Position — Staff’s Assessment and Recommendations - Objective: rebuild the cash balance to around 2 months of total spending by 2021 while clearing arrears; a multi-year plan with cumulative consolidation of 7.3 percent of GDP by 2021 (Table 6). - Immediate actions: - Thorough stocktaking of arrears to clarify true position; claims for 2017 have been paid and contractual commitments for 2018 identified, but not all arrears are confirmed eliminated. - 2019 Budget should aim for a cash balance of 1.2 months of total spending. - Revenue measures: - Continue strengthening revenue administration and compliance; efforts to reduce tax arrears are yielding good results and will help generate a one-off revenue increase. - Implement steps to streamline and adjust tax reference prices for logs to align with world prices to reduce transfer pricing scope; similar efforts needed for bauxite. - Spending measures: - 2019 budget opportunity to streamline spending areas that increased rapidly (e.g., CDFs, tertiary scholarships, shipping grants), clear arrears, and better align spending with the National Development Plan. - Staff urged authorities to lower CDF spending and partially restore critical line-ministry development spending. - Expenditure on the 2023 Pacific Games needs to be limited prudently. - Noted 2019 budget strategy proposes reallocation of development spending but includes a sizeable increase in payroll. - Growth effects: - Revenue and expenditure measures expected to only moderately affect growth; fiscal multipliers likely low as measures aim to improve spending quality and tackle tax debts and efficiency (the buckets approach indicates low fiscal multipliers given high openness, weak PFM and potential debt risks). ### Key Statistics and Indicators (selected) - Real growth: 3.5 percent in 2017. - Headline inflation: 2.4 percent in June 2018. - Current account deficit: around 4.2 percent of GDP in 2017. - Reserves: 8.8 months of import cover in June 2018. - Fiscal deficit: 3.8 percent of GDP in 2017. - Domestic expenditure arrears: 1.3 percent of GDP in 2017; new domestic arrears of 0.7 percent of GDP expected in 2018. - Government broad cash balance: 1.5 months of total spending (below two-month target). - Public debt: increased to 9.4 percent of GDP in 2017; nominal public debt-to-GDP ratio raised by 5 percentage points to 35 percent of GDP for infrastructure development. - Credit growth: 5 percent year on year by May 2018. - NPLs: 11.5 percent of capital and reserves in 2017. - Bank spreads: 10 percent. - Probability of a severe natural disaster in any year: 13.5 percent. - Staff consolidation target: cumulative 7.3 percent of GDP by 2021. - 2018 supplementary budget size: 2 percent of GDP. - Staff expected deficit in 2018: 3.6 percent of GDP. - Staff cash balance target for 2019 budget: 1.2 months of total spending. *Source: IMF staff report text for "1. Logging Developments."* ### 22. Tax reform is an opportunity to generate revenue more efficiently, fairly and ### 22. Tax reform is an opportunity to generate revenue more efficiently, fairly and ### Tax reform, revenue strategy, and VAT - Clear guidance needed on: policy goals, sequencing and timing for implementation, tax administration modernization, and clientele management (large and small tax payers). - Medium-term revenue strategy recommended to achieve the above. - Plans to introduce a VAT law are at an early stage; important to: - clearly articulate the policy intent for the new VAT and other reforms under consideration; - build consensus with the business community; - ensure adequate funding and capacity in the Inland Revenue and customs. ### Fiscal anchor and targets - Debt limit: 35 percent of GDP. - Staff recommendation: add an operational fiscal target of an overall deficit of 1.5 percent of GDP to supplement the debt limit once the cash balance is restored. ### Constituency Development Funds (CDFs) transparency and management - Publication of the audit report on CDFs by the Office of Auditor General highlighted serious shortcomings. - Report recommendations to improve CDFs: - increase citizen participation in allocation of CDFs; - implement rigorous reporting and third-party oversight of CDF activities; - expand project management capacity. - Finalizing the CDF Act and following Commonwealth Parliamentary Association principles would substantially improve accountability and transparency. ### Fiscal buffer and disaster preparedness - 2018 budget contingency provision: 0.7 percent of total spending (excluding grants) for unforeseen expenditures to cover moderate but frequent natural disasters. - Staff suggestion: consider a larger contingency of up to 3 percent of spending over the medium term. - Authorities’ plan: set up a Pacific Disaster Contingent Savings Facility with assistance from the ADB. ### Donor coordination and climate adaptation costing - More complete collection and reporting of programs conducted directly with ministries by development partners would help identify development expenditure gaps, including in disaster risk reduction and contingency planning. ### Public investment and public financial management (PFM) - PRIF Public Investment Management Diagnostic: Solomon Islands has shortcomings across the project management cycle, including project appraisal and selection. - Immediate PFM priorities: - develop short-term liquidity forecasting; - improve monitoring and bank reconciliation; - curb issuance of warrants. - The public expenditure and financial accountability roadmap is comprehensive; progress requires focus on a core set of actions. ### Authorities’ views on fiscal position and tax reform - Fiscal position deteriorated in past two years due to acceleration of spending; 2018 Budget and supplementary budget aim to stabilize and eliminate domestic arrears. - Better-than-expected revenue collection and revenue mobilization will partly help address the gap; development expenditures were cut. - CDF spending plays a critical role in rural areas; scaling back considered for the 2019 Budget. - Anti-corruption bill recently passed will increase CDF transparency. - Tax reform to be pursued following the 2019 election; authorities welcome IMF technical assistance and agree on the value of a medium-term revenue strategy. - Progress sequence per 2017 Tax Review: prioritize tax administration Act before reviewing consumption taxes, income taxes and other taxes. ### Monetary policy and exchange rate management - Monetary stance: accommodative and broadly appropriate given low inflation, uncertain growth outlook, and moderate credit growth. - Recommendation: modest tightening of domestic reserve requirements to mop up structural excess liquidity. - Reserve management: reinforce framework to help stem CBSI valuation losses and increase CBSI’s ability to issue Bokolo bills. - Exchange rate regime: basket exchange rate peg remains appropriate. - CBSI could review basket composition and parity annually. - Although AUD has significant weight, CBSI manages much more tightly against USD with an estimated 90 percent effective weight. - Allowing greater volatility against USD (and less against AUD) could stabilize the overall basket and reduce food price inflation volatility. - External position: staff assesses external sector moderately weaker than suggested by fundamentals. - Current account deficit was moderately weaker than the norm in 2017 by around 1.5 percent of GDP (or an overvaluation of around 4.5 percent). - Gap likely to widen with higher oil prices, infrastructure spending, and contraction in logging activity. - Fiscal consolidation and structural reforms would help narrow the current account gap over the medium term. - CBSI net assets requirement and position: - CBSI Act requires net assets to be at or above SI$50 million. - Net assets stood at -SI$13 million in March 2017. ### Financial stability, inclusion, and governance - Financial sector characteristics: - Relatively underdeveloped and among the most underbanked of the small states. - High interest rate spreads; chart indicates comparative spreads for Pacific countries. - National Financial Inclusion Strategy: progress on mobile banking; recommended continuation into second phase (account usage and financial literacy). - Legislative priorities to strengthen supervision and widen investment options: - new Financial Institutions Act; - Credit Unions Act; - National Provident Fund Act (NPF Act would widen international portfolio diversification and help lower excess liquidity). - Correspondent banking pressures: - Progress restoring a CBR link for a domestic bank is welcome; the bank expects a new CBR link by December this year. - Recommendations in response to correspondent banking experience: - take quick remedial actions to address governance and risk management gaps in banks; - bolster CBSI supervisory framework, including prudential standards for governance and a “fit and proper” standard; - ensure effectiveness and enforcement of AML/CFT framework; APG AML/CFT mutual evaluation scheduled with onsite in October 2018; - contingency planning if CBR solutions fail (donor financing, temporary relaxation of export repatriation requirement, targeted support to affected communities); - seek additional CBR links in USD and other currencies. - Development Bank (DBSI) plans: - Establishing DBSI would be costly; staff urged exploration of cheaper alternatives to promote SME financing. - If DBSI proceeds, recommended rigorous supervision by CBSI and a strong governance structure with independent board members. ### Growth challenges and structural reform priorities - Logging decline and rapid population growth challenge sustained growth. - Logging currently accounts for more than half of GDP, is the main supplier of foreign exchange and the largest formal-sector employer after government, and a significant provider of government revenues. - Medium-Term Development Plan 2016–35 identifies agriculture, fisheries, forestry, tourism, and mining as possible growth sectors. - Transition to new growth sources unlikely to be smooth; mining likely medium-term. - Investment in agriculture, fisheries and tourism recommended to broaden income sources. - Address infrastructure lags in sanitation, transport, communications, and energy; harness undersea cable potential. - Structural reforms to encourage private sector role: - enforcement of contracts; - procedures for trading across borders; - insolvency resolution; - access to finance; - property registration; - tackle customary land-ownership challenges (long-term leases, land registry). - Anti-corruption momentum: - National Anti-Corruption Strategy and passage of three Acts—Anti-corruption (July 2018), Whistleblower and Ombudsman—are positive steps. - Anti-Corruption Act mandates establishing an independent commission against corruption. - Staff emphasized fiscal transparency, asset declarations, revenue compliance, and a stronger AML/CFT framework. - Civil society can play an important role in implementation. ### Box 1 — Logging developments and fiscal effects (selected statistics and estimates) - 2017 logging contribution and shares: - accounted for two-thirds of exports of goods and 52 percent of exports of goods and services; - 22 percent of total government revenue; - contributed 1.1 percent points to growth. - Employment: nearly half of the workforce thought to be directly or indirectly associated with the forestry sector. - 2018 log export volumes (proxy for log production): increased by 26 percent year-on-year to 1.309 million cubic meters by June 2018. - Reference price adjustments and foregone revenue: - Between 2016 and 2018 reference prices adjusted by 10–15 percent. - Delayed adjustment resulted in lost tax revenues estimated at about 2.7 percent of GDP in 2016. - Rough estimates show foregone revenues could be as high as 5 percent of GDP for 2017. - Example price/declaration calculations (USD/m3 and totals): - Landed CIF price: 289.5 USD/m3 - freight: 57.9 - 20% CIF price-estimated - insurance: 5.8 (2% of CIF price-estimated) - agent fees: 17.4 (6% CIF price-estimated) - sub total: 208.4 - declared fob: 100.6 (Determined value schedule) - Difference: 107.8 (unaccounted difference between declared and landed) - Log exports to China in 2016: 1,256.0 thousand cubic meters (Comtrade data) - Foregone income: 135.4 US million dollars - Estimated foregone revenue: 33.9 US million dollars - 2.7 foregone revenue as percent of GDP *Sources: IMF staff estimates.* ### 46. It is imperative for Solomon Islands to generate new sources of growth over the ### cr18309 - 46. It is imperative for Solomon Islands to generate new sources of growth over the ### Need for new sources of growth and macro policy implications - Reform of the logging sector is long overdue but will be difficult; adopting sustainable practices would result in a sharp contraction in activity, shrinking exports and government revenues. - Bridging the transformation from logging to other activity will require careful policy management and support from the Fund and other development partners. - Fiscal position: - The fiscal position has deteriorated, leaving little room to respond to shocks. - Rebuilding the government cash balance and prioritizing spending would help secure fiscal sustainability and build resilience. - Authorities are encouraged to clear domestic arrears and begin rebuilding the cash balance by boosting revenues and improving compliance, containing spending and realigning priorities consistent with the National Development Strategy. - Once the cash balance is restored, the cash balance and debt limit should be supplemented by an operational fiscal target to guide annual budgets and maintain discipline. - Recommended fiscal and public financial management actions: - Sustain fiscal reform efforts and continue public financial management strengthening. - Present a Medium-Term Fiscal Strategy to assess tradeoffs between development spending and building buffers, including for disaster risk reduction. - Increase transparency of the Constituency Development Funds to gain an accurate picture of development spending. - Pursue tax reform and prepare a medium-term revenue strategy. - Monetary and exchange rate policy: - A modest tightening of monetary settings is called for; a small increase in domestic reserve requirements would help reduce structural excess liquidity. - Improvements to the reserve management framework could strengthen the central bank’s balance sheet and increase ability to issue Bokolo bills to mop up liquidity. - The basket exchange rate peg is appropriate; the CBSI should review the composition of the exchange rate basket and the parity on an annual basis. - Risks to the outlook: - Fiscal pressures could weigh on growth. - Natural disasters are an ever-present risk. - A re-emergence of correspondent banking problems would pose a risk. ### B. Governance of the Logging and Mining Sectors — Staff’s Assessment - Logging sector: - Global concerns about the environmental impact of logging in Solomon Islands are long-standing. - Regulatory enforcement is lax, and the industry is largely controlled by foreign companies. - Past attempts to reduce uncontrolled logging have been unsuccessful. - The CBR withdrawal placed a spotlight on unsustainable logging practices. - The formation of the inter-agency committee to guide policies for a sustainable logging sector is welcome. - For success, critical actions include enforcement of policies and transparency, establishing credible forestry management certification, reducing the scope for transfer pricing, and promoting development of well-managed plantations. - Clamping down on corruption would enable Solomon Islands to expand its export markets. - Mining sector: - Mining is likely to become an increasingly important source of growth over the medium term. - Large deposits of gold, copper, nickel and bauxite have been identified across the country. - Rehabilitation of the Gold Ridge mine is the most promising immediate prospect followed by nickel and bauxite. - The Gold Ridge mine contains an estimated 9 million tons of gold, with extraction expected to last 15 years. - Despite strong interest and intense prospecting, communities and government agencies have little experience working with the mining sector. - Institutional and fiscal framework for mining: - Reaping benefits from the mining sector would require a strong regulatory and policy environment. - The National Mining Policy (NMP) was launched in June 2017 and work has begun on legislation, regulatory and oversight capacity. - Gaps to be addressed include agency coordination, adjustments to tax administration, information collection and audit procedures. - Staff recommended that the authorities rejoin and fully implement EITI, with the supporting legislation placed on a fast-track. - A new mining fiscal regime was adopted in July 2014; the fiscal regime is described as fundamentally sound and competitive. - Non-tax factors likely to inhibit foreign investment include lack of skilled labor, regulations, high costs of doing business, and skepticism towards mining operations from landowners and citizens. - To effectively implement the regime, capacity should be strengthened in the areas of fiscal compliance, auditing, and monitoring market reference pricing. - Authorities’ views on mining: - The mining regime needs to be transparent, predictable and even-handed for industry to be viable. - Work is underway to operationalize the Mining Policy through new regulations and reform of existing legislation. - Most outstanding tax policy and administrative issues raised by previous Fund TA had been addressed to ensure an attractive tax environment while safeguarding government revenues. - Assistance to address transfer pricing is required. ### C. Financial Inclusion in Support of Climate Change Adaptation - Strategy and objectives: - The National Financial Inclusion Strategy (NFIS) includes an objective to build financial resilience in households and communities by expanding the formal sector for microinsurance and saving products for informal workers through the National Provident Fund (SINPF). - Promoting access to insurance, savings, and credit can help those who are vulnerable to the effects of climate change. - Benefits of financial products: - Insurance services spread out risks and reduce losses caused by extreme weather events. - Use of weather index-based insurance can help insulate farmers from losses due to weather shocks. - Research shows that subsidized insurance can encourage larger investment (but costs would need to be contained). - Savings help consumption smoothing in the event of natural disasters and boost agricultural investment. - Access to credit can boost climate-resilient technology investment, particularly in the agricultural sector. - Authorities’ views and implementation challenges: - A key challenge for the second phase is to encourage greater usage of opened accounts and extend usage of mobile payments. - The CBSI is updating the guidance note on mobile money. - Authorities are keen to learn from global developments and innovations in financial inclusion. - Generating a positive feedback loop between financial inclusion and climate change adaptation is important. - Given an underdeveloped private sector, the authorities continue to play a pivotal role in driving financial inclusion through the NFIS to cope with climate-related disasters. ### D. Other Issues and Technical Assistance - IMF technical assistance engagements: - The IMF is engaged in assistance on tax policy and revenue administration, public financial management, monetary and foreign exchange operations, banking supervision, and statistics. - Authorities expressed interest in TA on a medium-term revenue strategy, supporting implementation of the anti-corruption bill and advice on transfer pricing in the logging and mining sectors. - Statistics and capacity: - Staff welcome progress on the National Statistics Development Strategy. - Substantial improvements underway include revisions to national accounts, the compilation of a national CPI and the first ever agriculture census and labor force survey. - Adequate resources should be channeled to the statistics office, especially important for the oncoming census. ### STAFF APPRAISAL — Key conclusions and recommended actions - Recent economic performance and risks: - Economic activity has been encouraging: logging outperformed expectations; cash crops, fishing revenues, and construction activity supported growth. - Headline inflation is contained, although higher oil prices are likely to push inflation up in the second half of the year. - International reserves remain comfortable. - Risks to the outlook are mostly on the downside. - Policy priorities: - Prudent policies are essential to safeguard stability. - Generate new sources of growth as logging activity is expected to decline; achieving this will entail substantial infrastructure investment. - Decisive actions needed to address long standing governance challenges, together with strong enforcement of anti-corruption measures. - Specific reform areas: - Manage the transition from logging to new growth areas gradually in line with capacity while ensuring macro stability. - Ensure governance problems which afflicted the logging sector do not spread to the mining sector. - Structural reforms to support sustained growth: legal and regulatory framework for the business environment, enforcement of contracts, exploring options for small business finance. - Tackle challenges posed by customary land-ownership to support development and financial deepening. - Financial sector reforms: - Prioritize finalizing the backlog of financial legislation to provide the basis for the CBSI to strengthen its supervisory framework. - Address AML/CFT framework weaknesses and supervisory effectiveness to aid restoration of correspondent banking relationships. - Continue the financial inclusion strategy and efforts to link it to resilience building. - Data improvements: - Channel adequate resources to compilation and dissemination of economic data to further improve the quality of macroeconomic data. *Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18309.pdf* ### 66. It is proposed that the next Article IV consultation take place on the standard ### It is proposed that the next Article IV consultation take place on the standard 12-month cycle. ### Cross-Country Context - Solomon Islands is noted as “one of the poorest small states” with multiple structural challenges including “vulnerability to natural disasters,” “geographical dispersion,” “high infrastructure gaps,” “low sanitation access,” and “high broadband prices.” - GDP per Capita, 2017 (In U.S. dollars): chart places Solomon Islands below many Pacific peers (exact chart values shown visually). - Pacific Island Countries: Average Number of Natural Disasters per Year (1980-2016): charted index from 0 to 1 for countries with Solomon Islands among the higher-risk group (visual). - Geographical Dispersion: Average Sea Distance Between Two Inhabitants of the Same Country (In kilometers): charted values with Solomon Islands among the largest distances (visual). - Access to Electricity (In percent of population): Solomon Islands shown below many peers (visual). - Internet Users (Per 100 people): Solomon Islands substantially below many peers (visual). - Sanitation Access, 2015 (In percent of population with access): visual comparison shows Solomon Islands below the “Pacific Small States Average” and “Other Small States Average.” - Fixed Broadband Prices (In percent of GNI per capita): Solomon Islands shown among high-priced broadband group (visual). ### Macroeconomic Developments and Outlook - Growth: “Growth in 2017 was stronger than anticipated, driven by logging, agriculture and fisheries.” - Inflation: “Inflation is relatively contained” but “is likely to rise with higher commodity prices.” - Current account: “The current account deficit remained unchanged, due to large repatriation of income.” - Exports and imports: “Logging exports are increasing again in 2018” and “Imports of fuel are increasing.” - Sectoral contributions to real growth: visual chart for 2009–2019 shows notable positive contributions from Forestry and logging, Agriculture and fisheries, and volatility from Mining and quarrying (visual). - Contribution to CPI inflation: chart separates domestic and imported components; visual range from -7 to 8 percentage points across 2013–2018 (visual). - World food and fuel price indices vs. CPI: charted together showing CPI alongside world food/fuel indices (visual). - Current Account Balance (In percent of GDP): charted with projections to 2019 (visual). - Total Exports and Imports (In percent of GDP): charts show exports and imports trends with projections through 2019 (visual). ### Fiscal Indicators and Risks - Characterization: “Solomon Islands’ high fiscal revenue volatility... leads to a procyclical fiscal policy due to a lack of fiscal anchor and weak PFM.” - Fiscal buffer: “The government’s fiscal buffer has shrunk as the fiscal position continues to deteriorate... and as public debt rises from a low level to finance large infrastructure projects.” - Revenue and expenditure trends: “Revenue collection is improving slightly... but expenditures are elevated.” - Volatility of tax revenue (Standard deviation of tax revenue to GDP ratio, 2005-2017): Solomon Islands shown among higher volatility peers (visual). - Fiscal impulse and terms of trade, 2005-17: chart shows fiscal impulse frequently procyclical relative to terms of trade changes (visual). - Fiscal Balance and Financing (In percent of GDP): Net external and net domestic financing and overall balance charted for 2010–2019 with projections (visual). - Public External Debt (percent of GDP) and Debt Service (percent of government revenue and exports of GNFS): chart shows rising public external debt and debt service projected through 2019 (visual). - Government Revenue and Expenditure (In percent of GDP): charts show total revenue, grants, development expenditure, and recurrent expenditure with projections through 2019 (visual). ### Money and Credit Developments - Reserves: “Reserves remain adequate.” Net International Reserves (In millions of US$) charted Jun-11 to Jun-18; values shown visually (peak and troughs). - Interest rates: “While lending rates remain high” — Lending and Deposit Rates charted Oct-11 to Jun-18; lending rate plotted in the 10 percent per annum range (visual). - Broad money: “Broad money growth is moderate in line with nominal GDP growth” — Broad Money (Year-on-year percent change) charted (visual). - Credit growth: “Credit growth decelerated through to the early part of the year.” - Bank excess reserves: “Bank excess reserves are still high” — Liquid Asset Ratio and Bank Reserves charted (visual). - Net Credit to Central Government: “Credit to the central government has stabilized after the bond issuance in 2017” — Net Credit to Central Government (In millions of SI$) charted with negative and positive swings (visual). ### Financial Access and Inclusion - Trend: “Financial deepening has been increasing but more needs to be done” and “credit to the private sector has been rising.” - Comparative levels: “Solomon Islands lags low income peers” on several metrics (visual series). - Geographical constraint: “Geographical dispersion is a major impediment for commercial banking expansion,” leading to “relatively low access to commercial banks.” - Mobile banking: “Growth in mobile banking could leapfrog conventional banking in financial access.” - Indicators (visual time series comparisons): - Domestic Bank Deposits to GDP (In percent): Solomon Islands compared to Caribbean Small States, Small States, PICs, LICs (visual). - Private Credit to GDP (In percent): Solomon Islands compared to peers (visual). - Private Credit to Deposits (In percent): time series visual. - Number of Branches, Commercial Banks (Per 100,000 adults): Solomon Islands values shown visually, low relative to peers. - Accounts, Commercial Banks (Per 1,000 adults): visual comparisons. - Number of Mobile Money Transactions (Per 1,000 adults), 2015–2016: Solomon Islands rising but below some peer groups (visual). ### Constituency Development Fund (CDF) - Spending trends: “CDF spending has increased over the past ten years.” SIG Budget Allocation For CDF chart (1993–2018) shows increases in $SBD millions and percent of GDP (visual). - Budget allocation per constituency: chart shows sharp rise in per-constituency allocations (In $SBD millions). - CDF actuals (2010–2017) and funding composition: Grant vs SIG shown (visual). - Funds received per province vs average income per capita: chart shows funds received per province are not tied to average income per capita (visual). - Spending comparison: “CDF spending is substantially higher than provincial allocations.” (visual) - Distribution: “CDFs are not based on the average income per capita in each province but on the number of MPs.” - Average tenure for MPs has risen over time; “Average Term of Parliament Members (One term is 4 years)” charted (visual). ### Selected Economic Indicators (Table 1, 2014–23) - Per capita GDP (2014): US$1,931 - Quota: SDR 20.8 million - Population (2014): 562,000 - Main products and exports: logs - Poverty rate (2006): 23 percent - Main export markets: Emerging Asia - Real GDP (annual series 2014–2023): 2.3 2.5 3.5 3.5 3.4 2.9 2.8 2.7 2.7 2.8 - CPI (period average) 2014–2023: 5.2 -0.6 0.5 0.5 2.7 2.6 2.9 3.2 3.8 4.2 - CPI (end of period) 2014–2023: 4.2 3.5 -2.2 2.1 3.2 3.3 3.6 3.7 4.0 4.4 - GDP deflator 2014–2023: 2.5 3.1 3.6 2.7 4.2 3.4 3.5 4.1 3.9 4.6 - Nominal GDP (in SI$ millions) 2014–2023: 8,646 9,139 9,798 10,420 11,228 11,946 12,705 13,578 14,492 15,574 - Central government operations (selected lines in percent of GDP, 2014–2023): Total revenue and grants and Total expenditure series are presented in table form (visual numeric series). - Overall balance (percent of GDP) 2014–2023: 2.1 0.0 -3.9 -3.8 -3.6 -3.3 -4.0 -4.1 -4.1 -4.4 (annual table) - Gross official reserves (in US$ millions, end of period) 2014–2023: 514.3 519.6 513.6 571.0 536.5 502.3 468.9 460.6 449.5 461.7 - Net official reserves (in US$ millions, end of period) 2014–2023: 496.2 505.6 503.5 561.0 530.1 497.9 464.8 456.9 446.0 458.5 - Exchange rate (SI$/US$, end of period): 7.4 8.1 8.2 7.9 (series shown to 2017; later periods visually blank) ### Summary of Fiscal Accounts (Tables 2a and 2b) - Table 2a (in millions of Solomon Islands Dollars) provides detailed yearly flows and stocks (2019–2023 Act./Proj./Budgets). Selected entries: - Total revenue and grants (2019 Act.): 4,089; (2023 Proj.): 6,508 - Total revenue (2019 Act.): 2,835; (2023 Proj.): 4,894 - Grants (2019 Act.): 1,255; (2023 Proj.): 1,614 - Total expenditure (2019 Act.): 3,908; (2023 Proj.): 7,188 - Of which: excluding grant-funded expenditure (2019 Act.): 2,653; (2023 Proj.): 5,574 - Development expenditure (2019 Act.): 1089; (2023 Proj.): 2,239 - Of which: CDFs (2019 Act.): 178; (2023 Proj.): 486 - Current balance (2019 Act.): 750; series through projections included. - Overall balance (2019 Act.): 181; series through projections included. - Public domestic debt, including arrears (2019 Act. memo): 173 (in SI$ millions) with projected increases shown in memorandum rows. - Table 2b (in percent of GDP) shows: - Total revenue and grants (2019 Act.): 47.3 percent of GDP; (2023 Proj.): 41.8 percent of GDP - Total expenditure (2019 Act.): 45.2 percent of GDP; (2023 Proj.): 46.2 percent of GDP - Overall balance (2019 Act.): 2.1 percent of GDP; projected to deteriorate to -4.4 percent of GDP by 2023 - Public domestic debt, including arrears (memo): rises from 2.0 percent (2014) to 5.0 percent (2023) of GDP (table values). ### Balance of Payments (Table 3, 2014–23) - Current account balance (US$ millions): -50.1 -35.2 -48.7 -54.2 -91.7 -125.5 -141.4 -127.8 -134.5 -133.9 (2014–2023 series) - Trade balance for goods (US$ millions): -4.9 -17.2 12.8 6.4 -15.2 -51.8 -65.6 -73.5 -84.3 -83.5 - Exports (US$ millions): 455.2 420.3 432.1 462.0 507.7 537.0 562.5 567.3 577.3 632.5 - Imports (US$ millions): -460.1 -437.5 -419.4 -455.6 -522.9 -588.8 -628.1 -640.8 -661.6 -716.0 - Trade balance for services (US$ millions): -111.8 -76.3 -84.4 -81.9 -99.4 -105.9 -109.4 -121.9 -129.7 -137.9 - Income balance (US$ millions): -35.7 -24.2 -41.6 -34.0 -46.8 -48.6 -55.3 -34.9 -34.6 -44.8 - Current transfers balance (US$ millions): 102.3 82.4 64.5 55.3 69.6 80.8 89.0 102.4 114.1 132.3 - Capital and financial account balance (US$ millions): 62.3 88.6 93.4 63.3 80.8 113.4 128.3 139.8 143.7 146.4 - Direct investment balance (US$ millions): 20.3 27.6 36.0 25.8 31.1 49.1 54.1 54.1 59.3 59.4 - Overall balance (US$ millions): -16.2 53.0 2.2 59.9 -30.9 -32.1 -33.1 -8.0 -10.8 12.5 - Net international reserves (in US$ million): 496 506 503 561 530 498 465 457 446 459 (memo) - Gross official foreign reserves (in US$ million): 514 520 514 571 537 502 469 461 449 462 (memo) - Gross external public debt (percent of GDP): 9.9 9.7 7.5 7.6 9.3 11.6 14.3 16.6 18.2 19.7 (memo) ### Banking System Summary (Table 4) - Central Bank of Solomon Islands (end-of-period, selected lines, in SI$ millions): - Net international reserves (NIR): 3,651 (2014) rising to 4,411 (2019) then projected 3,368 (2023) (table series) - Reserve money: 1,832 (2014), 3,302 (2019), 4,633 (2023) (table series) - Other Depository Corporations (selected): - Claims on the private sector: 1,697 (2014) rising to 3,153 (2023) (table series) - Reserves and vault cash: 1,248 (2014) rising to 3,378 (2023) (table series) - Deposits: 3,051 (2014) rising to 5,555 (2023) (table series) - Depository corporations survey: - Broad money (M3): 3,635 (2014) rising to 6,811 (2023) - Credit to the private sector (annual percent change): 16.4 16.7 12.1 8.0 6.0 5.5 5.0 4.0 4.0 3.5 - Loan-to-deposit ratio (in percent): 55.6 56.4 55.7 61.7 60.8 59.8 59.1 59.4 58.8 56.8 - Interest rates (period averages): deposit and lending rates listed in table (lending rate ~10.5–10.9 percent in earlier years shown). ### Indicators of Capacity to Repay the Fund (Table 5) - Fund obligations based on existing credit (in SDR millions, selected years): - Principal outstanding: 2.4 (2018); progressively falling to 0.00 by later projected years (table series). - Charges and interest: 0.08 (2018), 0.09 (2019), then 0.09 each year in projection rows. - Total in millions of SDRs and US$ provided with percent of gross international reserves, percent of exports of goods and services, percent of debt service, percent of GDP, and percent of quota — all shown in table form (visual numeric series). - Outstanding Fund credit (in millions of SDRs): 2.4 (2018) falling to 0.00 in later projections. - Memorandum items: - Exports of goods and services (in US$ millions): 645 682 714 727 745 808 947 956 (table series) - Gross international reserves (in US$ millions): 537 502 469 461 449 462 475 480 (table series) - Debt service (in US$ millions): 9.3 8.8 5.5 8.1 8.8 9.1 10.9 13.0 15.0 16.7 (table series) - Quota (in SDR millions): 20.8 constant across years. ### Alternative Policy Action Scenario (Table 6) - Fiscal Measures (2018–2021, In percent of GDP relative to the baseline): - Revenue increases: 0.5 0.8 0.8 0.8 (total revenue gains per year) - Tax Revenue: 0.5 0.8 0.8 0.8 - Income and profits: 0.1 0.1 0.1 0.1 (measures: reducing tax exemptions; improving administration and compliance; reducing stock of tax arrears; strengthening timeframe for prosecution) - International trade and transactions: 0.1 0.1 0.1 0.1 (measure: tax reference price for logs aligned with world market prices) - Expenditure cuts: -0.3 -1.1 -1.5 -1.5 - Recurrent spending: 0.0 -0.5 -0.5 -0.5 - Compensation of employees: 0.0 -0.2 -0.2 -0.2 (measure: containing wage bill growth below nominal GDP growth) - Other recurrent spending: 0.0 -0.3 -0.3 -0.3 (measures: reduce scholarships and other low-priority spending such as travel) - Development spending: -0.3 -0.6 -0.9 -0.9 - CDFs: -0.2 -0.4 -0.7 -0.7 (measures: reducing CDFs; publish a supplement on CDFs planning; use of funds in 2019 Budget) - Other development spending: -0.1 -0.2 -0.2 -0.2 (measure: prioritizing and streamlining development spending; reducing shipping grants) - Total Savings: 0.8 1.9 2.3 2.3 - Cumulative Savings: 0.8 2.7 5.0 7.3 - Adjustment Scenario outcomes vs Baseline (selected): - Overall Balance (In percent of GDP) under Adjustment Scenario: -2.8 -2.1 -1.6 -1.8 (2018–2021) - Cash Balance (in SI$ millions) under Adjustment Scenario: 296 278 472 626; in months of recurrent spending: 1.2 1.1 1.8 2.2 - Broader Cash Balance (in SI$ millions) under Adjustment Scenario: 436 418 612 766; in months of total spending: 1.3 1.2 1.7 2.0 - Public domestic debt, including arrears (in SI$ millions) under Adjustment Scenario: 318 238 238 238 - Public domestic debt, including arrears (In percent of GDP) under Adjustment Scenario: 2.8 2.0 1.9 1.8 - Baseline Scenario outcomes (selected): - Overall Balance (In percent of GDP): -3.6 -3.3 -4.0 -4.1 - Cash Balance (in SI$ millions): 206 122 20 -140; in months of recurrent spending: 0.8 0.5 0.1 -0.5 - Broader Cash Balance (in SI$ millions): 346 262 160 0; in months of total spending: 1.0 0.7 0.4 0.0 - Public domestic debt, including arrears (in SI$ millions): 318 318 318 318 - Public domestic debt, including arrears (In percent of GDP): 2.8 2.7 2.5 2.3 - Note: “In the adjustment scenario, arrears are cleared by the end of December 2019.” Additional measure: “Reducing stock of tax arrears 0.3 0.6 0.6 0.6” (table row). *Source: IMF staff estimates and projections, tables and figures as presented in the chapter.* ### Appendix I. Authorities’ Response to Fund Policy Advice ### Appendix I. Authorities’ Response to Fund Policy Advice ### Fiscal Policy - Rebuild fiscal buffer and stem domestic arrears - The government’s broad cash balance fell from the equivalent of 1.9 months of total spending at end-2016 to 1.5 months at end-2017, below the two-month target. - Domestic arrears as of end-2017 was cleared by March 2018. - The 2018 supplementary budget tries to address the identified arrears that built up in the early month of 2018 but staff believes pressures will reemerge. - Increase fiscal openness, transparency and planning - The 2018 budget documents were published on the website. - The 2017 Final Budget Outcome was published in line with the Public Financial Management Act 2013. - The tax review was launched. - Broaden the tax base and increase revenue transparency - A new Customs and Excise bill (previously an ECF benchmark) was approved by Cabinet in February 2016. There is not yet a firm timeline for presenting the bill to Parliament. - The tax review was launched in September 2017 to reform the current tax system and focuses on modernizing tax administration and considering whether to make the current system work better or to introduce a value-added tax (VAT). - Promote transparency and accountability of public funds - In April 2018, the audit report on the Constituency Development Funds (CDFs) by the Office of Auditor General was published with recommendations to increase citizen participation, implement rigorous reporting and third-party oversight, and expand project management capacity. - Strengthen public debt management - In September 2016, the debt management framework was revised and strengthened with new guidelines on direct borrowing, on-lending and guarantees. - The government has recently increased a limit for the public debt-to-GDP ratio by five percentage points to 35 percent. - The annual borrowing limit in the 2018 budget is SI$462 million. ### Monetary and Financial Sector Policy - Strengthen supervisory and regulatory framework for the financial system - Cabinet approved drafting instructions for a new Financial Institutions Act and started the process to draft a Credit Unions bill as part of ECF benchmarks; as of July 2018, the bills had not been submitted to Parliament. - Improve long-term viability of the NPF and reduce financial risks - Since the Cabinet approval in July 2012 of drafting instructions to revise the NPF Act, no further progress has been made towards passing a new NPF Act (previously an ECF structural benchmark). - Strengthen the monetary transmission mechanism - In March 2015, in line with IMF TA recommendations, the CBSI announced plans including a potential change in the cash reserve requirement (CRR) ratio and introducing a forex swap facility; CBSI has remained cautious in raising the CRR ratio. - Increase access to financial services and ensure inclusive growth - The National Financial Inclusion Taskforce released the National Financial Inclusion Strategy 2016–20 (NFIS 2). - Exchange rate policy and external policy buffer - The invoice-based basket peg regime has been fully implemented and the operational band was removed in November 2014. The basket peg has been applied in line with IMF TA recommendations and exchange rate and basket peg information are published daily on the CBSI website. ### Structural Reforms - Infrastructure and growth diversification - Progress slow due to closure of the gold mine and legal disputes over nickel mining rights. - Financing for the Tina River Hydropower Project has been secured, but delays in signing a power purchase agreement are affecting progress. The project is expected to reduce the cost of electricity. - Legislative reforms in taxation, the mineral and logging sectors, and measures to curb corruption are expected to improve the business environment. - Resilience to natural disasters - The National Development Strategy 2016-35 (released January 2015) envisages higher investment in climate—and natural disaster—proof infrastructure. - Depleting fiscal buffers are reducing Solomon Islands’ preparedness for a major natural disaster. --- ### Appendix II. SDGs Identified in the 2016–35 National Development Strategy (NDS) - Key development objectives identified by the NDS and corresponding SDGs (staff compilation) - Sustained and inclusive economic growth - Role of the IMF: Assistance in public investment management; TA on domestic revenue mobilization; TA on financial stability to support financial deepening and inclusion. - Poverty alleviation - Role of the IMF: Surveillance and policy advice on macro-economic policies. - Access to quality social services - Role of the IMF: Coordination with the World Bank Group and development partners; Emphasis prioritization of expenditure in line with NDS. - Resilient and environmental sustainable development - Role of the IMF: Provide analytical and policy framework on how to incorporate the cost of natural disasters and climate change into the macroframework; Capacity development. - Stable and effective governance and public order - Role of the IMF: TA on PFM with a focus on improved medium-term revenue and expenditure forecasting; stronger integration of planning and budgeting within a medium-term framework; Focus on governance of logging and mining sectors. - Selected SDG links listed in the source include: 1 NoPoverty; 2 ZeroHunger; 3 Good Health and Well Being; 4 Quality Education; 5 GenderEquality; 6 Clean Water; 7 Affordable and Clean Energy; 8 Inclusive Economic Growth & Decent Work; 9 Resilient Infrastructure & Innovation; 10 Reduced Inequality; 11 Sustainable Cities & Communities; 12 Responsible Consumption; 13 Climate Action; 14 Sustainable Use of Oceans; 15 Protect Forests & Ecosystem; 16 Peace, Justice, and Strong Institution; 17 Partnerships for the Goals. --- ### Appendix III. Risk Assessment Matrix (RAM) — Selected Risks, Likelihoods, Impacts, and Policy Responses - Risk classification notes - “Low” indicates probability below 10 percent, “medium” between 10 and 30 percent, and “high” between 30 and 50 percent. - “Short term” = within 1 year; “medium term” = within 3 years. - Upside risk: Take advantage of upside surprises to lock in an improvement in fiscal buffers and ensure new sources of growth are taxed properly. - 1. Reopening of Gold Ridge mine and beginning of the nickel and bauxite projects - Likelihood: Medium - Impact/Time Horizon: High / ST, MT - Note: Production would contribute to export growth and revenue increase. - 2. Positive spillovers from large infrastructure projects - Likelihood: Medium / High - Impact/Time Horizon: High / ST, MT - Policy: Consider ways to use some gains to invest in resilient infrastructure. Completion of undersea cable projects by end of 2019 will substantially improve connectivity. - Downside risks and recommended policy responses - 1. Fiscal policy slippage - Likelihood: High - Impact/Time Horizon: High / ST, MT - Policy: Put in place a plan to eliminate domestic arrears; consider measures to contain discretionary spending; contain spending on CDFs, tertiary scholarships and shipping grants. - 2. Security risk (general election expected early 2019) - Likelihood: Low - Impact/Time Horizon: High / ST - Policy: Ensure adequate financing and strengthen RSIPF with continued support from Australia and New Zealand; continue anti-corruption strategy. - 3. Weaker-than-expected global growth (including spillovers from China) - Likelihood: Low / Medium - Impact/Time Horizon: High / ST, MT - Policy: Use policy buffers including international reserves to cushion impact; seek additional concessional financing; diversify sources of growth over time. - 4. Sharp tightening of global financial conditions (US dollar strengthening) - Likelihood: High - Impact/Time Horizon: Medium / ST - Policy: Continue effective implementation of the basket currency peg in line with IMF TA; strengthen reserve management via Fund TA; regularly review and realign the basket exchange rate peg. - 5. Reduced financial services by correspondent banks (de-risking) - Likelihood: Medium/High - Impact/Time Horizon: High / ST - Policy: Reduce environmental concerns in logging; address governance gaps in the bank; complete establishment of a replacement CBR; set prudential standards for governance, fit and proper; strengthen AML/CFT framework; develop contingency plans. - Context: Solomon Islands’ sole domestic bank Pan Oceanic Bank (POB) lost its last correspondent banking relationship (CBR) for US dollars; a temporary solution is in place with progress expected on establishing a new link before end of 2018. - 6. Natural disasters and climate change - Likelihood: High - Impact/Time Horizon: High / ST, MT - Policy: Build fiscal buffers against a natural disaster shock; use available space post-shock to ease fiscal stance and provide social safety net, and plan how to adjust back; invest in resilient infrastructure. --- ### Appendix IV. PPG External Debt under Alternative Scenarios (2018–28) - The public DSA allows for domestic financing to cover additional financing needs generated by shocks under stress tests. Default terms of marginal debt are based on baseline 10-year projections. - Selected labels and figures from charts (as provided in source): - Public debt benchmark; Baseline; Most extreme shock 1/; Historical scenario; Natural Disaster shock; Default; User defined. - Charts in source display PV of Debt-to-Revenue Ratio, Debt Service-to-Revenue Ratio, PV of Debt-to-GDP Ratio over 2018–2028 under baseline and most extreme shock (most extreme shock is Growth). --- ### Appendix V. Economic Impact of the Loss of CBR - Context - The domestic bank serving most of the logging industry lost its correspondent banking relationship for U.S. dollars and is seeking a replacement. - Three foreign banks in Solomon Islands are unlikely to take up CBR for logging firms due to governance and environmental concerns. - CBSI provided a temporary arrangement until the end of the year and progress has been made on a permanent solution once strengthened screening and transaction monitoring is in place. - Key points - Logging is the major export and an important source of rural income; loss of US dollar export proceeds could have significant adverse impact. - International reserves are comfortable, but fiscal position is vulnerable and buffers almost depleted. - The key driver of CBR loss is weak governance in the logging sector; without substantial governance and transparency improvements, solutions are limited. - Two scenarios analyzed (staff considered): - Full impact scenario: The loss of CBR shuts down logging industry exports for one year. - Half impact scenario: A milder scenario which assumes logging continues through different informal channels. - Impact on growth and external sector (summary of IMF staff estimates) - Impact on Growth - Cumulative decline of about 9.6 percent in growth during 2019 to a negative 6.7 percent due to a sharp (80 percent) drop in logging output under the Full impact scenario. - Growth would decline to a negative 3.1 percent under the Half impact scenario. - The disruption under the full impact scenario is substantial but less than the GDP contraction of 15 percent in the aftermath of the Asian Financial Crisis and the Tensions. - External Sector - Export of logs is only permitted upon issuance of a Specific Authority to Export and proceeds are to be repatriated within one month. - Without the ability to repatriate, exports could cease, resulting in a substantial widening of the current account deficit under both scenarios. - Quantitative projections for 2019 (IMF estimates) - Real GDP growth: Proj. (baseline) 2.9; Proj. (Full Impact Scenario) -6.7; Proj. (Half Impact Scenario) -3.1 - Current account balance (percent of GDP): -8.3; -21.7; -16.5 - Gross official reserves (In months of Import): 6.8; 4.6; 5.5 - Revenue 1/ (percent of GDP): 32.2; 26.6; 28.1 - Cash balance (SI$ million): 26; 200; 0 - Public debt (percent of GDP): 14.6; 24.5; 21.2 - Note: 1/ The scenarios do not take into account expenditure measures or aids to cope with a revenue loss. --- ### Appendix VI. Public Investment Management Assessment (PIMA) — Findings and Recommendations - Overview - The PIMA evaluates infrastructure governance across planning, allocation, and implementation stages using 15 institutional features. Staff used a PRIF Public Investment Management Diagnostic to construct the equivalent PIMA for Solomon Islands. - (i) Planning — Key findings - Fiscal Principles or Rules - Public debt threshold is 30 percent of GDP; given a current low level of debt, the threshold is not binding. - Cash balance target is two months of total spending, but it has been missed for the past two years. - No protection for capital spending; significant cut in government-funded development in 2018. - National & Sectoral Plans - MTDP in line with NDS is published and includes broad cost estimates; only transport, health, and education have sectoral plans. - Coordination between Entities - Limited coordination between central and provincial/local governments; CDFs are main sources of local funding. - Project Appraisal - Projects are not systematically subject to cost benefit analyses; no standard methodology or central support for project appraisal. - MDPAC appraisal does not include feasibility assessments but includes screening for NDS alignment. - Alternative Infrastructure Financing - A PPP arrangement was signed in July 2017 with SICCI, but there is no published PPP policy framework. Government does not systematically review public corporations’ investment plans. - (ii) Allocation — Key findings - Multiyear Budgeting - MTDP includes projections of total capital spending over five years, but no multiyear ceilings on capital expenditure by ministry, sector, or program. - Budget Comprehensiveness & Unity - Most capital projects included in budget documentation, but public corporations’ projects are not shown. - Budgeting for Investment - Under the PFM Act, MOFT may approve virements within an agency’s budget but must table them in Parliament. - Maintenance Funding - Development budget includes maintenance costs, but no standard methodology for routine maintenance needs; public assets are not adequately maintained. - Project Selection - Government does not publish criteria or a required process for project selection nor maintain a pipeline of appraised investment projects. - (iii) Implementation — Key findings - Procurement - Most projects tendered competitively through MOF website; annual tender award report includes winning bidders and amount but not standard analysis. - Availability of Funding - Cash-flow forecasts are not prepared; financing of project outlays subject to cash rationing. - Portfolio Management & Oversight - Annual project costs and physical progress are monitored for major projects; ex-post reviews of major projects were conducted in April 2017. - Management of Project Implementation - Senior officers assigned to manage major projects and implementation plans submitted for approval; no standardized rules for project adjustments; major capital projects not subject to ex-post external audit. - Monitoring of Public Assets - MID developed an asset inventory managed and updated periodically; no evidence of asset registry at line ministries except MID. - Government financial accounts do not include the value of non-financial assets; depreciation of fixed assets is not recorded in operating statement. - Recommendations (first steps) - Given limited availability of funds, identify high priority projects aligned with NDS objectives that have large growth impact. - Strengthen project appraisal by conducting feasibility studies. - Enhance project selection by publishing or adhering to standard criteria to minimize political influence. *Sources: Country authorities, and staff estimates; IMF staff assessments as presented in the appended material.* ### Appendix VII. External Sector Assessment ### Appendix VII. External Sector Assessment ### Summary assessment - Overall, the external position in FY17 was moderately weaker than that suggested by fundamentals and desirable policies. - The current account (CA) deficit is weaker than norm and is expected to remain so given expectations that investments will continue to be strong. - The real exchange rate (REER) is moderately stronger than warranted. - Reserve coverage continues to be adequate but is expected to decline over the medium term. - Policy mix should aim to boost both private and public investment necessary to increase competitiveness and diversification. ### EBA Lite analysis and CA metrics - The EBA Lite analysis suggests the external sector position is moderately weaker than that consistent with medium-term fundamentals and desirable policy settings. - Key CA model metrics: - CA-Actual-4.1% - Cyclical Contributions (from model)-0.1% - additional temporary/statistical factors 0 - Cyclically adjusted CA-4.0% - CA-Norm-5.1% - additional adjustments to the norm 3% - Cyclically adjusted CA Norm-2.4% - CA-Gap-1.5% - o/w Policy gap 0.2% - Elasticity -0.34 - REER Gap 4.5% - Specific findings: - The cyclically adjusted CA deficit of 4.0 percent of GDP in 2017 was weaker than the adjusted CA norm by 1.5 percent of GDP suggesting an exchange rate overvaluation of 4.5 percent of GDP. - The CA-norm was adjusted by 2.0 percent of GDP to account for a dwindling in aid flows post-RAMSI. - Over the longer term, the CA is expected to remain in deficit on the expectation that investments will continue as suggested by the strong import demand for capital goods. ### External sustainability and net IIP - Based on data provided by the authorities, net IIP was -0.3 percent of GDP in 2017, higher than the position reported in the 2017 Article IV assessment (variations arise from revision in financial liabilities). - External Sustainability (ES) approach results: - Show an overvaluation of 6–10 percent indicating that some REER depreciation would be necessary to sustain the IIP position or narrow the negative net international investment position over the medium term. ### Scenarios (CA norm, Underlying CA, CA gap, REER gap) - Scenario 1: Stabilizing net IIP at -0.3% of GDP - CA norm: -3.6 - Underlying CA: -5.9 - CA gap: -2.3 - REER gap: 6.7 - Scenario 2: Stabilizing net IIP at 5.0% of GDP - CA norm: -3.3 - Underlying CA: -5.9 - CA gap: -2.6 - REER gap: 7.6 - Scenario 3: Reaching net IIP at 5.0% of GDP in 2022 - CA norm: -2.4 - Underlying CA: -5.9 - CA gap: -3.5 - REER gap: 10.2 ### Real exchange rate and competitiveness - After a period of sustained appreciation (2014–16), the real exchange depreciated in 2017, consistent with limited flexibility against the US dollar in the basket peg. - Recent trends point to a greater weighting of the US$ in the basket than that prescribed by the formula (despite moderate adjustments to the balance of weights after 2015 revisions). - With the recent pickup in inflation and the appreciation in the US$, the REER is on an upward trajectory again at a time when the terms of trade is deteriorating. - The economy benefits from a high level of FX reserves and foreign aid, but a loss of competitiveness over the medium term could slow growth. - Recommendation: In addition to exchange rate flexibility, competitiveness needs to be strengthened by structural and fiscal policies to ensure external balance in the medium term. ### Reserve adequacy - Net international reserves are currently comfortable and in line with reserve adequacy benchmarks. - Applying the staff’s reserve adequacy framework for credit-constrained economies and a resource-rich, fragile, small economy, the adequate level of reserves for Solomon Islands is estimated in the range of 3.9–7.7 months of imports. - Current level: 9.5 months import cover. - Staff projection: reserve cover expected to fall back to around 7.7 months by 2022, equal to the most stringent benchmark. - Note: While adequate at current levels, reserves may decline as the government takes measures for sustainable logging in the forestry sector. *Source: Appendix VII. External Sector Assessment, cr18309* ### 5. To make further progress the authorities could also consider the following: ### 5. To make further progress the authorities could also consider the following: ### Policy recommendations and actions - Consider how financial service providers and government can best leverage the improved connectivity from the undersea cable. Competition among the telecom and internet industries may help bring down costs and improve services. - Continue to promote new financial technology, such as mobile banking and payments, which help expand financial services, especially in rural areas, as well as facilitate transactions for climate change mitigation and resilience. - Encourage the private sectors to provide services and products such as weather-index insurance. - Continue to invest in climate-resilient infrastructure and agriculture. The Tina river hydropower development project, supported by development partners, including Green Climate Funds (GCFs), aims to reduce electricity costs and reliance on diesel imports. - Consider enabling limited drawdown from SINPF in event of a disaster in return for a higher mandatory contribution but reduce security to banks. - Rebuild fiscal buffers and the contingency fund, complementing the ADB Pacific Disaster Contingent Saving Facility. Once buffers are rebuilt, consideration could be given to a strictly limited facility that offers concessional finance for investment that promotes climate change adaptation. ### Context, rationale, and relevant fiscal/debt considerations - Public debt dynamics and financing plans: - Public debt increased to 9.4 percent of GDP in 2017 from 7.9 percent in 2016. - The pick-up in debt is due mainly to the SI$150 million issuance of a domestic development bond in 2017 and disbursements from multilateral creditors. - The government set an annual borrowing limit at SI$462 million in the 2018 budget to finance key infrastructure projects, including the Tina River hydropower development project (TRHDP). - The government plans to borrow SI$30 million during 2018 from the SOEs to resolve domestic arrears. - Debt composition and exposures: - Public and Publicly Guaranteed (PPG) external debt stood at US$100 million (7.6 percent of GDP) as of end-2017. - The International Development Association (IDA) and the Asian Development Bank (ADB) account for 29 percent and 36 percent of total public debt respectively. - There were no explicit contingent liabilities—public debt guaranteed by the government—in 2017, but the government will provide a guarantee for the ADB’s forthcoming US$15.4 million loan to fund the new University of the South Pacific campus in Solomon Islands. - Private sector external debt amounted to 0.8 percent of GDP in 2017. - Public domestic debt stood at SI$193 million (1.9 percent of GDP) at end-2017. - Implicit contingent liabilities—mainly non-guaranteed borrowing by state-owned enterprises (SOEs)—were SI$121 million (1.2 percent of GDP) at end-2017. - Debt management framework and targets: - The debt management strategy sets a limit for the public debt-to-GDP ratio at 35 percent in nominal terms, with debt service to domestically-sourced revenue ratio set at 10 percent. - Debt sustainability assessment highlights: - Risk of external debt distress: Moderate. - Overall risk of debt distress: Moderate. - All external debt indicators remain below the relevant indicative thresholds under the baseline scenario, which incorporates the average long-term effects of natural disasters on growth, the fiscal balance, and the current account balance. - An export shock would cause a prolonged breach of the threshold for the PV of PPG external debt-to-GDP ratio. - The nominal debt-to-GDP ratio would breach the authorities’ target of 35 percent in 2028 under baseline projections. - A tailored natural disaster shock, using a scale similar to the largest shock in Solomon Islands’ history, causes a significant deterioration in debt sustainability in the aftermath of the event. - To rebuild fiscal buffers and enhance resilience against shocks, including natural disaster shocks, both stronger revenue mobilization measures and expenditure rationalization are needed. - Staff note fiscal cashflow problems are acute, with rising domestic expenditure arrears and a very low cash balance. The sharp cut in development spending for 2018 looks difficult to fully achieve given a significant infrastructure investment gap; pressure on domestic expenditure arrears is expected to reemerge later in the year. - Baseline scenario assumptions related to disasters and climate change: - The baseline incorporates the average long-term effects of natural disasters and climate change by lowering GDP growth by 0.3 percentage points (pps) annually, raising the current account deficit by 0.5 pps and increasing the fiscal deficit by (text continues in source). *Prepared by the staff of the International Monetary Fund and the International Development Association, October 4, 2018.* ### 0.2 pps vis -à-vis disaster-free projections to reflect the country’s historical experience. These are consistent ### cr18309 - 0.2 pps vis -à-vis disaster-free projections to reflect the country’s historical experience. These are consistent ### Baseline macroeconomic assumptions - Real GDP growth is projected at 2.9 percent on average during 2018–28. - Upside: higher capital spending on key infrastructure projects, including TRHDP and the undersea cable project. - Downside: (ii) continued fiscal problems that would negatively affect private sector activity; and (iii) a decline in logging activity, which might be offset over the medium term by an expected rise in mining activity. - Inflation (measured by GDP deflator in USD terms) is projected to average 4.2 percent during 2018–28, higher than last year’s projection due mainly to a recovery in oil prices. - Non-interest current account deficit is projected to rise to 7.2 percent of GDP on average over 2018–28, reflecting high import content for key infrastructure projects and lower exports due to a long-term decline in logging activities. - FDI inflows are expected to increase on average to about 3.1 percent of GDP over 2018–28, slightly lower than last year’s projection due to worsening business sentiment caused by the government’s cash-flow problems. - Logging output is expected to be slightly lower in the next couple of years and then to start declining on average by 1.1 percent a year from 2023. - Mining production assumptions: - Gold production is assumed to resume in 2023, peak from 2024 to 2027, and then decrease gradually. - Other mining activity (nickel and bauxite) is expected to come fully onstream in the long run and implicitly add a small impetus to long-term growth rates. - External borrowing and grants: - New disbursements for projects in the pipeline, including TRHDP, are expected to take place in the next five years (2018–22). - From 2023 onwards, the level of new annual external borrowing is expected to be around 3 percent of GDP. - Grant and lending flows from multilateral development partners are expected to increase over the medium term due to the scale-up of IDA and ADB financing, partly offset by lower financing from other development partners. - Grants and the grant element of new borrowing are expected to decline over the medium term. - Fiscal outlook: - The ten-year forward-looking average of the primary deficit is expected to remain high at 3.5 percent of GDP, reflecting the recent worsening of the fiscal position that has resulted in a buildup in domestic arrears. - By 2021, when the cash balance is positive, the deficit will be financed by cash reserves. Once depleted, the government is expected to seek domestic borrowing from SOEs. - The accumulation of new domestic arrears is included in public debt during the projection period. - Discount rate used to calculate the net present value of external debt remains at 5 percent. ### Key statistics (as presented) - This excludes domestic arrears of SI$138 million at end-2017, which were cleared by March 2018. - Stock of public debt (external and domestic at end-2019) - Solomon Islands: Baseline Macroeconomic Assumptions (In percent of GDP, unless otherwise states) - In million of SI dollars - In million of US dollars - As a share of total debt - In percent of GDP - Table entries (preserved as in source): - Total public debt 980125100%9.4 - External78710080%7.6 - Multilateral 7038972%6.8 - IDA 2883729%2.8 - ADB3494436%3.4 - IMF5375%0.5 - IFAD1321%0.1 - Bilateral84119%0.8 - EXIM Bank (Taiwan province of China)76108%0.7 - EU811%0.1 - Domestic19324 20%1.9 - Government domestic bonds15019 15%1.4 - Treasury Bills 3854%0.4 - Others 511%0.0 - Selected projection comparisons and averages (preserved format): - 2018 DSA / 2017 DSA / 2018-28 ave. / 2017-27 ave. - Real GDP growth 2.93.0 - GDP deflator in US dollar terms (change in percent)4.23.7 - Non-interest current account deficit7.25.8 - Net FDI (negative = inflow )-3.1-3.6 - Primary deficit3.53.4 ### Debt sustainability analysis — External - Baseline: - All external PPG debt indicators remain below policy relevant thresholds for the next ten years. - PV of debt-to-GDP ratio expected to increase from 5.3 percent in 2017 to 15.4 percent in 2028, due mainly to new disbursements for key infrastructure projects, including TRHDP. - Main driver of debt dynamics during the projection period is the current account deficit. - Even under the 20-year forecast horizon used previously, there would be no breach for all debt indicators in the baseline scenario. - Standardized stress tests: - The export shock has the largest negative impact on the debt trajectory, causing a breach of the threshold for the PV of debt-to-GDP ratio. - Other shocks — real GDP growth, primary balance, and a one-time 30 percent depreciation — do not lead to a breach of the debt threshold. - Tailored natural disaster shock: - Based on EM-DAT, largest damage from natural disasters (over 1980–2016) at 14 percent of GDP. - DSA assumes a one-off shock of 14 pp of GDP to the debt-GDP ratio in 2019 and a reduction of real GDP growth and exports by 2.5 and 7.0 pps respectively. - Multiple severe natural disasters are possible; staff’s work shows probability around 13.5 percent of a disaster each year of magnitude more than 7.1 percent damage-to-GDP ratio or 7.5 percent population affected-to-total population ratio — translating into one shock every seven years. - Multiple disasters would produce larger cumulative effects on debt sustainability through damaging long-term growth and increasing borrowing for reconstruction. ### Debt sustainability analysis — Public sector - Baseline: - PV of public debt-to-GDP ratio does not breach the 35 percent benchmark. - Nominal public debt-to-GDP ratio would rise from 9.4 percent and breaches the authorities’ threshold of 35 percent in nominal terms in 2028. - Breach primarily driven by a primary deficit caused by continued expansionary fiscal policy. - Sensitivity analysis: - Largest shock leading to highest debt/GDP figures in 2028 is to real GDP growth. - Under that shock, PV of debt-to-GDP ratio would reach 56 percent of GDP in 2028. - Tailored natural disaster shock: - Results in a sharper deterioration in debt sustainability; PV of public debt-to-GDP ratio would breach its threshold of 35 percent in 2026. - Combined contingent liability shock: - Adjustments to default SOE debt shock to reflect implicit contingent liabilities of 1.2 percent of GDP (reducing default 2 percent shock); default value of 5 percent used for financial markets. - Combined contingent liability shock moves PV of public debt-to-GDP ratio upward by 2.5-4.2 percentage points from the baseline. ### Scenario and stress test design details - LIC-DSF standard natural disaster shock (default): One-off shock of 10 percentage points to debt-GDP ratio in the second year of the projection period (2019 for this case); Real GDP growth and exports lowered by 1.5 and 3.5 percentage points in the year of the shock. - Tailored natural disaster shock (solomon islands specific): One-off shock of 14 percentage points of GDP to debt-GDP ratio in 2019; real GDP growth lowered by 2.5 percentage points; exports lowered by 7.0 percentage points. - Combined contingent liability shock components (as presented): - Other elements of the general government not captured in 1.: 0 percent of GDP 0.0 - SoE's debt (guaranteed and not guaranteed by the government) 1/2 percent of GDP 1.2 (To reflect the size of implicit contingent liabilities) - PPP 35 percent of PPP stock 0.0 - Financial market (the default value of 6 percent of GDP is the minimum value) 5 percent of GDP 5.0 - Total (2+3+4+6) (in percent of GDP) 6.2 ### Country classification and debt-carrying capacity - First Composite Indicator (CI) index calculated based on April 2018 WEO is 2.72, indicating medium debt-carrying capacity in the revised LIC-DSF framework; change in classification requires second appraisal (two consecutive signals). - DSA is based on weak category ratings pending confirmation. - Relevant indicative thresholds for the weak category: - PV of debt-to-GDP ratio: 30 percent - PV of debt-to-exports ratio: 140 percent - Debt service-to-exports ratio: 10 percent - Debt service-to-revenue ratio: 14 percent - Benchmark for PV of total public debt under weak capacity: 35 percent - CI components and scoring (preserved formatting from source): - Components Coefficients (A) 10-year average values (B) CI Score components (A*B) = (C) Contribution of components - CPIA 0.385 2.967 1.144 2% - Real growth rate (in percent) 2.71 9 2.885 0.083% - Import coverage of reserves (in percent) 4.05 257.963 2.3586% - Import coverage of reserves^2 (in percent) -3.99 33.597 -1.34 -49% - Remittances (in percent) 2.02 20.000 0.000 0.000% - World economic growth (in percent) 13.52 03.660 0.4918% - CI Score 2.72 100% - CI rating Medium - Debt carrying capacity (CI classification) GDP Exports Revenue Weak 30 140 10 14 Medium 40 180 15 18 Strong 55 240 21 23 - PV of PPG external debt in percent of PV of PPG external debt in percent of PV of total public debt in percent of GDP 35 ### Risk rating and vulnerabilities - Overall risk of external debt distress remains moderate under the new LIC-DSF framework. - Key vulnerabilities and implications: - Export shock would breach the PV of external debt-to-GDP threshold — underlines need to broaden export base as logging exports are expected to decline. - Debt service indicators remain well below thresholds under baseline and stress tests; maximizing concessional loans would help contain the debt burden. - Substantial space to absorb shocks given current low level of external debt, but deterioration in fiscal position requires placing policies on a firmer footing to enable higher-debt take-up. - Difficulty in rapidly scaling up without hitting absorptive capacity constraints. - Recent expansionary fiscal policy and buildup of domestic arrears elevate overall risk to moderate. - Urgent need for fiscal adjustment and measures to boost potential growth in the long run. - Importance of rebuilding fiscal buffers against external shocks and prioritizing investment projects that build resilience to natural disasters. ### Policy implications and recommendations (implied by analysis) - Rebuild fiscal buffers through fiscal consolidation to address the buildup of domestic arrears and the high ten-year average primary deficit of 3.5 percent of GDP. - Prioritize investment projects that build resilience to natural disasters and reduce vulnerability to large reconstruction financing needs. - Broaden the export base to mitigate risks from an export shock, given long-term decline in logging exports. - Maximize concessional financing to keep debt burden contained while financing necessary infrastructure. - Strengthen measures to support medium-term growth to reduce vulnerability to growth shocks that could push PV of debt-to-GDP to 56 percent by 2028 under adverse scenarios. - Monitor and limit contingent liabilities from SOEs and financial market exposures, and rebuild buffers to address potential contingent liability shocks that raise PV of public debt by 2.5-4.2 percentage points. *Source: Solomon Islands authorities and IMF staff estimates.* ### 21. The authorities broadly agree with the assessment of debt sustainability analysis under the ### 21. The authorities broadly agree with the assessment of debt sustainability analysis under the ### Authorities' assessment and stance on debt sustainability - The authorities broadly agree with the assessment of debt sustainability analysis under the new framework and support the tailored natural disaster stress test. - They increased their nominal debt threshold from 30 percent to 35 percent of GDP recently to address large infrastructure needs, including for the Tina River hydropower project. - Though the current debt level is relatively low, they continue to seek concessional loans or external grants to keep the debt burden subdued. - The authorities recognize the risks that large borrowing in the context of events (e.g., the 2023 Pacific Games) would pose and are aware that such borrowing would adversely affect debt sustainability. ### Borrowing, arrears, and domestic financing plans - The authorities intend to maintain around SI$40 million for the T-bill market. - They plan to seek borrowing from SOEs so as to clear all domestic arrears by end-2018. - They emphasized a firm intention to clear all domestic arrears by the end of the year which was being achieved through the sharp cut back in development spending. - They noted they are mindful of implicit contingent liability mainly from non-guaranteed SOE debt. - In line with the public financial management act, they can require all SOEs to acquire consent from the Minister of Finance to undertake direct borrowing. ### Key debt and macroeconomic indicators (selected, as reported) - Current public debt stands at 11 percent of GDP. - Nominal external debt (selected years, in percent of GDP): 2015: 10.6; 2016: 8.2; 2017: 8.4; 2018: 10.2; 2019: 12.6; 2020: 15.3; 2021: 17.7; 2022: 19.4; 2023: 20.9; 2028: 26.9; 2038: 30.3; later projection: 19.9; 20.0 (table values preserved as presented). - Public sector debt (selected years, in percent of GDP): 2015: 10.1; 2016: 7.9; 2017: 9.4; 2018: 12.1; 2019: 14.6; 2020: 17.6; 2021: 20.6; 2022: 23.4; 2023: 26.1; 2028: 35.5; 2038: 43.2; later projection: 19.0; 25.0. - PV of PPG external debt-to-GDP ratio (selected): 2018: 5.3; 2019: 6.0; 2020: 7.1; 2021: 8.6; 2022: 9.9; 2023: 10.7; 2024: 11.7; 2025: 15.4; 2028: 19.6. - PV of PPG external debt-to-exports ratio (selected): 2018: 11.7; 2019: 13.3; 2020: 15.7; 2021: 19.4; 2022: 23.3; 2023: 26.4; 2024: 28.4; 2025: 39.5; 2028: 74.8. - PPG debt service-to-exports ratio (selected): 2018: 1.5; 2019: 1.8; 2020: 1.7; 2021: 1.4; 2022: 1.3; 2023: 0.8; 2028: 5.3. - Gross external financing need (Million of U.S. dollars, selected): 2018: 31.0; 2019: 30.9; 2020: 37.9; 2021: 69.3; 2022: 84.1; 2023: 91.1; 2024: 73.9; 2025: 80.5; 2028: 77.3; 2038: 140.8; later: 283.3. ### Key macroeconomic assumptions (selected) - Real GDP growth (in percent): 2015: 2.5; 2016: 3.5; 2017: 3.5; 2018: 3.4; 2019: 2.9; 2020: 2.8; 2021: 2.7; 2022: 2.7; 2023: 2.8; 2028: 3.1; 2038: 3.2. - GDP deflator in US dollar terms (change in percent): 2015: -3.8; 2016: 3.0; 2017: 1.5; 2018: 6.2; 2019: 3.1; 2020: 3.5; 2021: 4.1; 2022: 3.9; 2023: 4.6; 2028: 4.0; 2038: 4.5. - Effective interest rate (percent): 2015: 1.6; 2016: 1.3; 2017: 1.5; 2018: 1.5; 2019: 1.5; 2020: 1.5; 2021: 1.5; 2022: 1.4; 2023: 1.4; 2028: 1.5; later: 1.7. - Nominal GDP (Million of US dollars, selected): 2015: 1,158; 2016: 1,235; 2017: 1,298; 2018: 1,424; 2019: 1,511; 2020: 1,607; 2021: 1,718; 2022: 1,833; 2023: 1,970; 2028: 2,802; 2038: 5,836. - Aid flows (Million of US dollars, selected): 2015: 258.7; 2016: 230.3; 2017: 231.9; 2018: 180.1; 2019: 202.1; 2020: 210.4; 2021: 219.5; 2022: 230.2; 2023: 241.0; 2028: 332.2; 2038: 615.6. ### Stress tests, tailored natural disaster test, and thresholds - The tailored natural disaster stress test is supported by the authorities. - The most extreme stress test is the test that yields the highest ratio in or before 2028; one-off breaches are considered and may be disregarded for mechanical signals as specified. - Public debt benchmark was raised to 35 percent of GDP by the authorities. - Tailored tests reported include: Combined contingent liabilities; Natural disaster (e.g., C2: Natural disaster results shown in sensitivity tables); Commodity price and Market Financing tests are reported as "n.a." where not applicable. ### Fiscal policy and public financial management - Stabilizing public finances has been a government priority since 2017; clearance of most, if not all, 2017 arrears has been an important step. - Large spending cuts were made in the 2018 Budget to contain the deficit; priority infrastructure projects were protected. - Recent appointment of an Accountant-General (position unfilled since 2016) is expected to help address issues including cash management. - Revenue and grants (in percent of GDP, selected): 2015: 47.9; 2016: 43.1; 2017: 42.7; 2018: 43.3; 2019: 43.2; 2020: 42.7; 2021: 42.2; 2022: 42.0; 2023: 41.8; 2028: 39.5. - Primary (noninterest) expenditure (in percent of GDP, selected): 2015: 47.5; 2016: 47.0; 2017: 46.4; 2018: 46.7; 2019: 46.3; 2020: 46.4; 2021: 46.0; 2022: 45.8; 2023: 45.7; 2028: 44.2. ### Monetary and financial sector policies - The Central Bank of Solomon Islands will continue accommodative monetary policy given low inflation, weak credit growth, and subdued aggregate demand. - Foreign reserves are equivalent to 11.8 months of imports and are likely to decline moderately in the future. - Structural excess liquidity exists in the banking system; no urgency to mop up given subdued lending. - NPLs improved in 2018 to 5.8 percent of gross loans. - The main bank serving the logging industry lacks a correspondent banking relationship; a temporary arrangement with the Federal Reserve Bank expires at the end of the year, with expectation of a relationship established in January next year. - Financial inclusion and provident fund reform: National Financial Inclusion Strategy 2016-2020 continues; amendments to the Solomon Islands National Provident Fund Act allow rollout of the ‘youSave’ scheme. ### Governance, diversification, and development priorities - Authorities recognize governance concerns raised by the mission and welcome technical assistance. - Legislation passed includes the Anti-Corruption Act, Whistleblowers Act, and Ombudsman Act. - Development spending was cut back strongly in the 2018 Budget; discretionary funds managed by Members of Parliament were cut by 35 percent. - Diversification challenges noted; inter-agency sustainable taskforce established with initial measures including reduction in logging licenses, tax regime changes, and policy to encourage downstream processing of harvested log volumes. - Authorities are more optimistic than staff about growth, partly due to assumptions about logging, and expect reopening of the Gold Ridge Mine and major infrastructure projects (undersea cable, Tina River Hydro Project) to support growth and productivity. *Source: Country authorities; and staff estimates and projections, as presented in the provided material.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2018/cr18309.pdf_