## 2018. Public debt is picking up from a low level. The risks to the economy are on the downside

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### Executive Board Assessment
- Welcomed recent solid growth performance, low inflation and comfortable external reserves.
- Expressed concern that the fiscal position has weakened, depleting buffers and leading to an accumulation of domestic payment arrears; encouraged timely actions to place the fiscal position on a firmer footing.
- Noted long-term development challenges, including natural disasters and climate change, and underscored need to strengthen fiscal discipline and improve quality of public spending.
- Urged tackling domestic arrears, gradually rebuilding cash reserves, and better prioritizing spending; suggested considering an operational fiscal target to guide annual budgets.
- Emphasized balancing borrowing for infrastructure against debt sustainability, absorptive capacity and domestic market development.
- Encouraged sustained fiscal reform efforts and commended the recently launched tax review.
- Called for a Medium-Term Fiscal Strategy to assess tradeoffs between development spending and building buffers, including for disaster risk reduction.
- Recommended enhancing transparency of Constituency Development Funds, strengthening revenue compliance, improving the legal framework, and strengthening the AML/CFT framework.
- Considered the current monetary policy stance and the exchange rate peg broadly appropriate; suggested the central bank can gradually increase the cash reserve requirement to absorb structural excess liquidity and periodically reassess the level of the exchange rate.
- Commended efforts to enhance financial inclusion and strengthen the financial sector; noted need to clear backlog of financial legislation including the Financial Institutions Act, the Credit Unions Act, and National Provident Fund Act.
- Directors underlined the need to diversify the economy, generate new sources of growth and strengthen resilience; emphasized achieving objectives of the National Development Strategy, including significant investment in infrastructure, legislative and policy reforms, and reforms to foster private sector development and improve the business environment.

### Key issues and context
- Large medium-term development challenges: infrastructure needs in energy, transportation, and telecommunications.
- Structural vulnerabilities:
  - Narrow production base reliant on logging.
  - Geographic dispersion, remoteness, capacity constraints.
  - High vulnerability to natural disasters and climate change.
  - Large infrastructure gap and dependence on aid and imports.
- Natural disaster risk statistics:
  - 14 percent probability in any year of a natural disaster affecting more than 5 percent of the population or inflicting damage/loss of more than 3 percent of GDP.
  - Worst observed disaster: more than half of the population affected and damage/loss reached 14 percent of GDP.
- Political fragility: RAMSI withdrew in 2017 after fourteen years; frequent government changes and elections by early 2019.
- IMF engagement: Article IV consultation focused on placing fiscal position on firmer footing and building resilience; staff mission in Honiara during September 19–28, 2017.

### Recent macro developments and indicators (selected)
- Growth and prices (annual percent change unless otherwise indicated):
  - Real GDP: 2013: 3.0; 2014: 2.3; 2015: 2.5; 2016: 3.5; 2017 Est.: 3.2; 2018 Proj.: 3.0; 2019 Proj.: 2.9.
  - CPI (period average): 2013: 5.4; 2014: 5.2; 2015: -0.6; 2016: 0.5; 2017: 1.0; 2018: 1.3; 2019: 2.0.
  - GDP deflator: 2013: 2.3; 2014: 2.5; 2015: 3.1; 2016: 3.6; 2017: 1.6; 2018: 2.7; 2019: 3.2.
  - Nominal GDP (in SI$ millions): 2013: 8,250; 2014: 8,646; 2015: 9,139; 2016: 9,798; 2017: 10,281; 2018: 10,884; 2019: 11,564.
- Central government operations (percent of GDP):
  - Total revenue and grants: 2013: 50.9; 2014: 47.3; 2015: 47.9; 2016: 41.2; 2017: 41.2; 2018: 42.4; 2019: 42.0.
  - Revenue: 2013: 33.5; 2014: 32.8; 2015: 35.1; 2016: 31.7; 2017: 31.7; 2018: 31.5; 2019: 31.4.
  - Grants: 2013: 17.5; 2014: 14.5; 2015: 12.9; 2016: 9.5; 2017: 9.5; 2018: 10.8; 2019: 10.6.
  - Total expenditure: 2013: 46.8; 2014: 45.6; 2015: 48.2; 2016: 44.5; 2017: 45.3; 2018: 48.1; 2019: 45.8.
  - Recurrent expenditure: 2013: 33.8; 2014: 32.6; 2015: 33.7; 2016: 30.4; 2017: 30.4; 2018: 31.0; 2019: 31.0.
  - Development expenditure: 2013: 16.2; 2014: 12.6; 2015: 14.3; 2016: 14.7; 2017: 14.9; 2018: 17.1; 2019: 14.9.
  - Overall balance: 2013: 4.1; 2014: 1.7; 2015: -0.2; 2016: -3.3; 2017: -4.1; 2018: -5.7; 2019: -3.9.
  - Foreign financing (net): 2013: -0.6; 2014: -0.5; 2015: -0.2; 2016: 0.3; 2017: 0.1; 2018: 4.2; 2019: 2.7.
  - Domestic financing (net): 2013: -3.5; 2014: -1.2; 2015: 0.4; 2016: 3.0; 2017: 4.0; 2018: 1.5; 2019: 1.1.
- Central government debt 1/ (percent of GDP):
  - 2013: 15.3; 2014: 12.8; 2015: 10.1; 2016: 7.9; 2017: 10.0; 2018: 14.6; 2019: 16.4.
  - Domestic debt: 2013: 4.2; 2014: 2.9; 2015: 0.5; 2016: 0.4; 2017: 1.8; 2018: 2.7; 2019: 2.5.
  - External debt: 2013: 11.1; 2014: 9.9; 2015: 9.7; 2016: 7.5; 2017: 8.2; 2018: 11.9; 2019: 13.9.
- Macrofinancial indicators (annual percent change, end of year):
  - Credit to private sector: 2013: 15.1; 2014: 16.4; 2015: 16.7; 2016: 12.1; 2017: 8.0; 2018: 8.0; 2019: 7.5.
  - Broad money: 2013: 12.4; 2014: 5.6; 2015: 15.0; 2016: 13.4; 2017: 10.1; 2018: 11.9; 2019: 5.3.
  - Reserve money: 2013: 3.0; 2014: -10.1; 2015: 23.5; 2016: 14.5; 2017: 9.0; 2018: 6.7; 2019: 5.3.
- Balance of payments (US$ millions unless otherwise indicated):
  - Trade balance: 2013: -139.0; 2014: -116.7; 2015: -93.5; 2016: -71.6; 2017: -84.5; 2018: -115.0; 2019: -147.8.
    - (percent of GDP): 2013: -12.3; 2014: -9.9; 2015: -8.1; 2016: -5.8; 2017: -6.6; 2018: -8.3; 2019: -10.1.
  - Current account balance: 2013: -38.5; 2014: -50.1; 2015: -35.2; 2016: -48.7; 2017: -56.1; 2018: -68.5; 2019: -92.9.
    - (percent of GDP): 2013: -3.4; 2014: -4.3; 2015: -3.0; 2016: -3.9; 2017: -4.4; 2018: -5.0; 2019: -6.4.
  - Foreign direct investment (US$ millions): 2013: 50.4; 2014: 20.3; 2015: 27.6; 2016: 36.0; 2017: 58.6; 2018: 34.8; 2019: 52.9.
    - (percent of GDP): 2013: 4.5; 2014: 1.7; 2015: 2.4; 2016: 2.9; 2017: 4.6; 2018: 2.5; 2019: 3.6.
  - Overall balance: 2013: 31.6; 2014: -16.2; 2015: 53.0; 2016: 2.2; 2017: -10.7; 2018: 24.3; 2019: 0.4.
- Gross official reserves (US$ millions, end of period):
  - 2013: 531.2; 2014: 514.3; 2015: 519.6; 2016: 513.6; 2017: 569.0; 2018: 589.9; 2019: 588.3.
  - (in months of next year's imports of GNFS): 2013: 9.3; 2014: 10.0; 2015: 10.0; 2016: 9.5; 2017: 9.7; 2018: 9.2; 2019: 8.7.
- Net official reserves (US$ millions, end of period):
  - 2013: 511.5; 2014: 496.2; 2015: 505.6; 2016: 503.5; 2017: 561.0; 2018: 585.3; 2019: 585.8.
  - (in months of next year's imports of GNFS): 2013: 9.0; 2014: 9.6; 2015: 9.7; 2016: 9.3; 2017: 9.6; 2018: 9.1; 2019: 8.7.
- Memorandum items:
  - Cash balance (in SI$ millions): 2013: 608; 2014: 880; 2015: 694; 2016: 412; 2017: 154; 2018: 87; 2019: -44.
    - in months of recurrent spending: 2013: 3.7; 2014: 5.1; 2015: 3.6; 2016: 2.0; 2017: 0.7; 2018: 0.4; 2019: -0.1.
  - SIG Deposit Account (in SI$ millions): 2013–2019: 140 each year.
  - Broader cash balance (=Cash balance+SIG Deposit Account; in SI$ millions): 2013: 748; 2014: 1,020; 2015: 834; 2016: 552; 2017: 294; 2018: 227; 2019: 96.
    - in months of total spending 4/: 2013: 3.7; 2014: 4.6; 2015: 3.1; 2016: 1.9; 2017: 1.0; 2018: 0.7; 2019: 0.3.

### Outlook, risks, vulnerabilities
- Main vulnerabilities:
  - Fiscal slippage has depleted buffers and increased vulnerability to shocks.
  - Exposure to natural disasters and climate change can materially lower potential growth and public finances.
  - Political fragility and pre-election spending pressures risk further fiscal deterioration.
- External position:
  - Current account deficits projected to widen (see Current account balance series above).
  - International reserves remain above adequacy benchmarks but import cover shows slight decline (gross reserves months: 9.2 in 2018; 8.7 in 2019).
- Debt dynamics:
  - Central government debt expected to rise from 7.9 percent of GDP in 2016 to 16.4 percent in 2019 in projections shown.
- Summary Risk Assessment (selected):
  - Upside: Reopening of Gold Ridge mine and nickel and bauxite projects start up (Likelihood: Medium; Impact: High); Positive spillovers from large infrastructure projects (Medium; High); Lower oil prices (Low; Medium).
  - Downside: Fiscal policy slippage (High; High); Security risk (Low; High); Weaker-than-expected global growth, especially significant China slowdown (Medium; High); Tighter or more volatile global financial conditions (High; Medium); Reduced financial services by correspondent banks (High; Medium); Natural disasters and climate change (High; High).

### Policy recommendations and priorities
- Rebuild fiscal buffers and adopt a clear fiscal anchor to guide annual budgets, maintain fiscal discipline, and provide flexibility to respond to shocks.
- Implement revenue-enhancing and expenditure-prioritization measures:
  - Strengthen tax compliance.
  - Streamline exemptions.
  - Improve transparency and prioritization of spending.
- Strengthen the medium-term fiscal framework to ensure fiscal sustainability and advance public financial management reforms; introduce a Medium-Term Fiscal Strategy.
- Balance borrowing for critical infrastructure against debt sustainability, absorptive capacity and domestic market development.
- Continue implementing the currency basket peg exchange rate regime with annual reviews to align the peg with underlying conditions.
- Consider a gradual increase in the cash reserve requirement to absorb structural excess liquidity while maintaining broadly appropriate monetary stance.
- Complete outstanding financial sector reforms begun under the Fund-supported program, including clearing the backlog of financial legislation (Financial Institutions Act, Credit Unions Act, National Provident Fund Act) and strengthening supervisory and regulatory frameworks.
- Strengthen AML/CFT framework and anti-corruption efforts; enhance transparency of Constituency Development Funds.
- Diversify the economy, generate new sources of growth (tourism, fisheries, agriculture per NDS 2016–35), and foster private sector development and an improved business environment.

### Fiscal developments and composition (Section 7 highlights)
- Overall deficit widened to 3.3 percent of GDP in 2016 as lower revenues and grants were not matched by expenditure restraint.
- Revenues:
  - Lower goods tax collection and income and profits tax more-than-offset higher-than-expected export duties and fishing license fees.
- Expenditures excluding grants:
  - Fell by 0.3 percentage points but this was less than the decline in grants.
  - Recurrent expenditure remained high.
  - Constituency Development Funds (CDFs) have doubled since 2013 and amounted to 3.3 percent of GDP.
- Grants:
  - Were 3.4 percent of GDP, down reflecting the completion of several donor-assisted projects, a delay in the disbursement of EU budget support, and lower grants in anticipation of RAMSI’s departure.
- Fiscal buffers, cash balances, and arrears:
  - Narrow cash balance fell from 3.6 months of recurrent spending at end-2015 to 2.0 months at end-2016 and further to 1.7 months in July 2017.
  - Domestic arrears were 1.4 percent of GDP in September (year not expressly restated).
  - Unanticipated increases in tertiary scholarship spending and delays in education allowance payments and government employees’ housing rent noted.
- Public and publicly-guaranteed debt rose from 7.9 percent of GDP at end-2016 to 10 percent of GDP in mid-2017.
- Undersea cable financing: government issued a SI$150 million bond to the National Provident Fund (NPF); NPF holds 86.5 percent of the government’s outstanding domestic debt securities (this is 5 percent of NPF’s total assets).
- Monetary conditions:
  - Monetary conditions are accommodative; CBSI maintained an accommodative policy stance.
  - Commercial banks’ structural excess reserves are high; Bokolo bills issuance to mop up excess liquidity is high; CRR is unchanged.
  - Interest spreads around 10 percent and loan-to-deposit ratio of 60 percent indicate weak transmission.
- Financial Soundness Indicators (selected, commercial banks only, end-period series reported):
  - Regulatory Capital to Risk-Weighted Assets: 32.4, 31.6, 31.3, 32.3, 33.0, 32.8.
  - Non-performing Loans to Total Gross Loans: 7.0, 4.7, 4.1, 3.8, 4.2, 5.2.
  - Return on Assets: 4.0, 3.3, 3.4, 3.5, 3.9, 4.3.
  - Liquid Assets to Total Assets: 40.6, 38.0, 33.5, 38.1, 36.0, 37.6.
- FSIs in 2017 Q2: capital adequacy, earnings and profitability, and liquidity were comfortably within historical norms, though NPLs have risen each quarter since end-2016.
- CBSI supervisory concerns: governance (for non-banks) and government payment delays.

### Debt dynamics, DSA and scenarios (selected)
- Historical: Gross public debt fell from 50.3 percent of GDP in 2006 to 7.9 percent of GDP at end-2016.
- Stock and composition (end-2016):
  - External Public and Publicly Guaranteed (PPG) debt: US$89 million = 7.5 percent of GDP.
  - Total public debt: SI$774.8 million = 7.9 percent of GDP.
  - Contingent liabilities from SOEs: SI$121.1 million = 1.2 percent of GDP.
- Recent borrowing:
  - Government tripled annual borrowing limit from SI$300 million in 2016 to SI$900 million in 2017 budget (SI$600 million for TRHDP; SI$300 million for other purposes including undersea cable).
  - March 2017: issued SI$150 million domestic development bonds purchased by NPF; government intends to issue additional SI$150 million by end-2018.
  - Government guarantees early 2017 for TRHDP: US$15.4 million (about SI$122 million).
- TRHDP project cost and financing (US$ millions):
  - Total project cost: US$207.9; GCF 86.0 (70.0 loan / 16.0 grant); WB/IDA 33.6 (24.7 loan / 8.9 grant); ADB 30.0 (18.0 loan / 12.0 grant); IRENA/ADFD 15.0 (15.0 grant); EDCF 31.6 (31.6 loan); Australia 11.7 (11.7 grant). Total financing: 207.9 (159.3 loan / 48.6 grant).
  - Disbursement schedule (loan disbursements in US$ millions): 2018: 57.5; 2019: 28.8; 2020: 36.5; 2021: 36.5 (Total 159.3).
  - Project completion period: 2018–22.
- Baseline macro assumptions (selected):
  - Discount rate for NPV of external debt: 5 percent.
  - Real GDP growth average 2017–22: 2.9 percent; long-term 2023–37: 3.2 percent; natural disasters/climate change lower growth by 0.3 percentage points annually.
  - Inflation (GDP deflator in USD terms) 2017–22 average: 3.2 percent; 2023–37: 4.3 percent.
  - Non-interest current account deficit projected to widen to 5.6 percent of GDP on average over 2017–22; overall current account deficit average 6.1 percent during 2023–37.
- One-off severe natural disaster shock (2018) scenario:
  - Damage equal to 14 percent of GDP.
  - Financing for recovery: grants 4.0 percent of GDP and concessional loans 10.0 percent of GDP.
  - GDP growth deviation: -5.0 percentage points in 2018, +3.0 percentage points in 2019, +2.2 percentage points in 2020; level returns to baseline in 2020.
  - Current account deviation: -3.0 percent in 2018, -4.0 percent in 2019 and 2020.
  - Implication: debt trajectories move upward; repeated large shocks could cause cumulative adverse effects and breach thresholds earlier.
- DSA outcomes (selected projections and sensitivities):
  - Total external PPG debt projected: 7.5 percent of GDP in 2016 → 18.2 percent in 2021 → 30.1 percent of GDP in 2037.
  - Public sector debt (percent of GDP): 2016: 7.9; 2017: 10.0; 2018: 14.6; 2019: 16.4; 2020: 18.6; 2027: 29.6; 2037: 45.3.
  - Under baseline, risk of external debt distress continues to be moderate; PV of public sector debt-to-GDP could exceed authorities’ 30 percent limit in 2028 under current policies; severe shocks can bring forward breaches (e.g., breach of 30 percent in 2023 under the severe natural disaster shock).
  - Sensitivity: a 2 percentage point higher interest rate on new borrowing breaches indicative thresholds; concessional terms are therefore critical.

### Policy adjustment scenario (staff proposal and quantified measures)
- Restoring cash balance objectives:
  - 2018 Budget recommendation: aim for broader cash balance of 1.3 months of spending, building to 2.0 months by 2020.
- Multi-year consolidation: staff sees a gradual cumulative consolidation of 6.0 percent of GDP by 2020 as feasible.
- Revenue measures (near-term and 2017–20 fiscal measures summary):
  - Tax Revenue measures series (percent of GDP): 0.3, 0.85, 0.85, 0.85 (2017–2020).
  - Specifics: align tax reference price for logs to world market prices from 2018 Q1; eliminate ad-hoc tax exemptions; improve compliance and administration.
  - Tackling tax arrears: reducing outstanding cases by 5 percent by June 2018 and outstanding returns by 15 percent could generate up to 0.7 percent of GDP in additional revenues; tax debts amount to 19.6 percent of GDP; 119 of the top 200 taxpayers by turnover have arrears.
- Expenditure measures (percent of GDP): -0.40, -0.90, -0.90, -0.90 (2017–2020).
  - Recurrent spending: -0.10, -0.35, -0.35, -0.35 (contain wage bill growth below nominal GDP growth; reduce scholarships and travel).
  - Development spending: -0.30, -0.55, -0.55, -0.55 (CDF reductions; prioritize/streamline development spending; reduce shipping grants).
- Total savings and cumulative:
  - Total Savings: 0.70, 1.75, 1.75, 1.75 (2017–2020).
  - Cumulative Savings: 0.70, 2.45, 4.20, 5.95 (percent of GDP cumulative).
- Adjustment scenario outcomes (selected, 2017–2020):
  - Overall Balance (percent of GDP) baseline vs reform: baseline: -4.1, -5.7, -3.9, -3.5; reform: -3.4, -3.9, -2.1, -1.7.
  - Cash Balance (in SI$ millions) under adjustment: 164, 293, 369, 551 (2017–2020).
  - Broader Cash Balance (in SI$ millions) under adjustment: 304, 434, 510, 692 (2017–2020).
  - Public Debt (percent of GDP) under adjustment: 10.0, 14.6, 16.4, 18.6 (2017–2020).
  - Real GDP growth series under reform: 3.2, 3.0, 2.9, 2.8 (2017–2020).

### Fiscal anchors: options and tradeoffs (Box 4 summary)
- Rationale: a fiscal anchor could supplement the fiscal framework to guide annual budgets, contain deficits, prevent excessive debt accumulation, create policy space for infrastructure and human capital, and provide a buffer against shocks.
- Current framework elements:
  - Debt Management Strategy limits: public debt-to-GDP ratio limit 30 percent; debt service to domestically sourced revenue ratio limit 10 percent.
  - Public Financial Management Act: government borrowing cannot be used to finance recurrent expenditures.
- Types of simple numerical fiscal targets discussed: Budget balance rules (BBRs), Debt rules (DRs), Expenditure rules (ERs), Revenue rules (RRs) — each with tradeoffs.
- Staff recommended target: 1.5 percent overall fiscal deficit as an operational target to ensure fiscal sustainability while meeting infrastructure demands; alternative options include a non-commodity primary deficit target of 4 percent of GDP or a constraint on total spending.
- Operational considerations: rules should include provisions for shocks and be accompanied by MTFS and contingency reserves.

### Data quality, statistics and capacity
- National Statistics Development Strategy 2016–35 provides a roadmap to address gaps; adequate resources and advisory capacity necessary.
- Authorities agree on need to improve statistics; CBSI notes importance of a national CPI which the National Statistics Office is currently working on.
- National Statistical Office resources lag peers (chart context).
- Staff appraisal: economic activity remained favorable but outlook uncertain; drivers included forestry, higher cash crops and fishing revenues, and stepped-up construction.
- On balance, risks to outlook are on the downside, including fiscal pressures and natural disasters.

### Financial inclusion, fintech and supervisory implications
- National Financial Inclusion Strategy (NFIS1 2011–15) and NFIS2 (2016–20) advanced financial inclusion; NFIS2 target: add 300,000 new users by 2020, half women.
- Mobile banking and agent networks expanded rapidly:
  - Mobile banking agents: 2013: 0; 2014: 10; 2015: 516; 2016: 4,192.
  - Outstanding mobile banking account balance (percent of GDP): 2013: 0; 2014: 1; 2015: 2; 2016: 3.
  - Value of mobile banking transactions (percent of GDP): 2013: 0; 2014: 1; 2015: 2; 2016: 4 (value below 4 percent of GDP in 2016 per source text).
- Policy recommendations:
  - Leverage development partners and other countries’ experience for fintech regulation.
  - Finalize Outsourcing Prudential Guidance and apply Practice Guidance note “Use of cash agents in Solomon Islands”.
  - CBSI should integrate mobile payments risk assessment into regular supervision; monitor agent networks, operational and AML/CFT controls.
  - Maintain financial literacy programs to support usage of mobile financial services.
- Remaining challenges: broadening credit access, ensuring credit growth is widely distributed, and addressing geographic dispersion that impedes bank outreach.

### Authorities’ views and commitments
- Authorities broadly agree with DSA assessment and welcome incorporation of long-term effects of natural disasters and climate change into the baseline.
- Prefer external concessional and grant financing for major projects; intend to increase external and domestic borrowing for TRHDP and undersea cable.
- Noted uncertainty over nominal GDP estimates; National Statistics Office is revising GDP data.
- Authorities emphasize restoring fiscal discipline, rebuilding cash buffers, prioritizing growth-enhancing spending, and progressing key legislation and public financial management reforms.

*Source: IMF staff report "SOLOMON ISLANDS STAFF REPORT FOR THE 2017 ARTICLE IV CONSULTATION" (cr1857).*

### 2018. Public debt is picking up from a low level. The risks to the economy are on the downside

### 2018. Public debt is picking up from a low level. The risks to the economy are on the downside

### Executive Board Assessment
- Directors welcomed recent solid growth performance, low inflation and comfortable external reserves.
- Concern that the fiscal position has weakened, depleting buffers and leading to an accumulation of domestic payment arrears; encouraged timely actions to place the fiscal position on a firmer footing.
- Noted long-term development challenges, including natural disasters and climate change, and underscored need to strengthen fiscal discipline and improve quality of public spending.
- Urged tackling domestic arrears, gradually rebuilding cash reserves, and better prioritizing spending; suggested considering an operational fiscal target to guide annual budgets.
- Emphasized balancing borrowing for infrastructure against debt sustainability, absorptive capacity and domestic market development.
- Encouraged sustained fiscal reform efforts and commended the recently launched tax review.
- Called for a Medium-Term Fiscal Strategy to assess tradeoffs between development spending and building buffers, including for disaster risk reduction.
- Recommended enhancing transparency of Constituency Development Funds, strengthening revenue compliance, improving the legal framework, and strengthening the AML/CFT framework.
- Considered the current monetary policy stance and the exchange rate peg broadly appropriate; suggested the central bank can gradually increase the cash reserve requirement to absorb structural excess liquidity and periodically reassess the level of the exchange rate.
- Commended efforts to enhance financial inclusion and strengthen the financial sector; noted need to clear backlog of financial legislation including the Financial Institutions Act, the Credit Unions Act, and National Provident Fund Act.

*Directors underlined the need to diversify the economy, generate new sources of growth and strengthen resilience; emphasized achieving objectives of the National Development Strategy, including significant investment in infrastructure, legislative and policy reforms, and reforms to foster private sector development and improve the business environment.*

### Key issues and context
- Solomon Islands faces large medium-term development challenges: infrastructure needs in energy, transportation, and telecommunications.
- Structural vulnerabilities:
  - Narrow production base reliant on logging.
  - Geographic dispersion, remoteness, capacity constraints.
  - High vulnerability to natural disasters and climate change.
  - Large infrastructure gap and dependence on aid and imports.
- Natural disaster risk statistics:
  - 14 percent probability in any year of a natural disaster affecting more than 5 percent of the population or inflicting damage/loss of more than 3 percent of GDP.
  - Worst observed disaster: more than half of the population affected and damage/loss reached 14 percent of GDP.
- Political fragility: RAMSI withdrew in 2017 after fourteen years; frequent government changes and elections by early 2019.
- IMF engagement: Article IV consultation focused on placing fiscal position on firmer footing and building resilience; staff mission in Honiara during September 19–28, 2017.

### Recent macro developments and indicators (selected)
- Growth and prices (annual percent change unless otherwise indicated):
  - Real GDP: 2013: 3.0; 2014: 2.3; 2015: 2.5; 2016: 3.5; 2017 Est.: 3.2; 2018 Proj.: 3.0; 2019 Proj.: 2.9.
  - CPI (period average): 2013: 5.4; 2014: 5.2; 2015: -0.6; 2016: 0.5; 2017: 1.0; 2018: 1.3; 2019: 2.0.
  - GDP deflator: 2013: 2.3; 2014: 2.5; 2015: 3.1; 2016: 3.6; 2017: 1.6; 2018: 2.7; 2019: 3.2.
  - Nominal GDP (in SI$ millions): 2013: 8,250; 2014: 8,646; 2015: 9,139; 2016: 9,798; 2017: 10,281; 2018: 10,884; 2019: 11,564.
- Central government operations (percent of GDP):
  - Total revenue and grants: 2013: 50.9; 2014: 47.3; 2015: 47.9; 2016: 41.2; 2017: 41.2; 2018: 42.4; 2019: 42.0.
  - Revenue: 2013: 33.5; 2014: 32.8; 2015: 35.1; 2016: 31.7; 2017: 31.7; 2018: 31.5; 2019: 31.4.
  - Grants: 2013: 17.5; 2014: 14.5; 2015: 12.9; 2016: 9.5; 2017: 9.5; 2018: 10.8; 2019: 10.6.
  - Total expenditure: 2013: 46.8; 2014: 45.6; 2015: 48.2; 2016: 44.5; 2017: 45.3; 2018: 48.1; 2019: 45.8.
  - Recurrent expenditure: 2013: 33.8; 2014: 32.6; 2015: 33.7; 2016: 30.4; 2017: 30.4; 2018: 31.0; 2019: 31.0.
  - Development expenditure: 2013: 16.2; 2014: 12.6; 2015: 14.3; 2016: 14.7; 2017: 14.9; 2018: 17.1; 2019: 14.9.
  - Unrecorded expenditure 1/: 2013: -3.1; 2014: 0.4; 2015: 0.2; 2016: -0.6; 2017: 0.0; 2018: 0.0; 2019: 0.0.
  - Overall balance: 2013: 4.1; 2014: 1.7; 2015: -0.2; 2016: -3.3; 2017: -4.1; 2018: -5.7; 2019: -3.9.
  - Foreign financing (net): 2013: -0.6; 2014: -0.5; 2015: -0.2; 2016: 0.3; 2017: 0.1; 2018: 4.2; 2019: 2.7.
  - Domestic financing (net): 2013: -3.5; 2014: -1.2; 2015: 0.4; 2016: 3.0; 2017: 4.0; 2018: 1.5; 2019: 1.1.
- Central government debt 1/ (percent of GDP):
  - 2013: 15.3; 2014: 12.8; 2015: 10.1; 2016: 7.9; 2017: 10.0; 2018: 14.6; 2019: 16.4.
  - Domestic debt: 2013: 4.2; 2014: 2.9; 2015: 0.5; 2016: 0.4; 2017: 1.8; 2018: 2.7; 2019: 2.5.
  - External debt: 2013: 11.1; 2014: 9.9; 2015: 9.7; 2016: 7.5; 2017: 8.2; 2018: 11.9; 2019: 13.9.
- Macrofinancial indicators (annual percent change, end of year):
  - Credit to private sector: 2013: 15.1; 2014: 16.4; 2015: 16.7; 2016: 12.1; 2017: 8.0; 2018: 8.0; 2019: 7.5.
  - Broad money: 2013: 12.4; 2014: 5.6; 2015: 15.0; 2016: 13.4; 2017: 10.1; 2018: 11.9; 2019: 5.3.
  - Reserve money: 2013: 3.0; 2014: -10.1; 2015: 23.5; 2016: 14.5; 2017: 9.0; 2018: 6.7; 2019: 5.3.
- Balance of payments (US$ millions unless otherwise indicated):
  - Trade balance: 2013: -139.0; 2014: -116.7; 2015: -93.5; 2016: -71.6; 2017: -84.5; 2018: -115.0; 2019: -147.8.
    - (percent of GDP): 2013: -12.3; 2014: -9.9; 2015: -8.1; 2016: -5.8; 2017: -6.6; 2018: -8.3; 2019: -10.1.
  - Current account balance: 2013: -38.5; 2014: -50.1; 2015: -35.2; 2016: -48.7; 2017: -56.1; 2018: -68.5; 2019: -92.9.
    - (percent of GDP): 2013: -3.4; 2014: -4.3; 2015: -3.0; 2016: -3.9; 2017: -4.4; 2018: -5.0; 2019: -6.4.
  - Foreign direct investment (US$ millions): 2013: 50.4; 2014: 20.3; 2015: 27.6; 2016: 36.0; 2017: 58.6; 2018: 34.8; 2019: 52.9.
    - (percent of GDP): 2013: 4.5; 2014: 1.7; 2015: 2.4; 2016: 2.9; 2017: 4.6; 2018: 2.5; 2019: 3.6.
  - Overall balance: 2013: 31.6; 2014: -16.2; 2015: 53.0; 2016: 2.2; 2017: -10.7; 2018: 24.3; 2019: 0.4.
- Gross official reserves (US$ millions, end of period):
  - 2013: 531.2; 2014: 514.3; 2015: 519.6; 2016: 513.6; 2017: 569.0; 2018: 589.9; 2019: 588.3.
  - (in months of next year's imports of GNFS): 2013: 9.3; 2014: 10.0; 2015: 10.0; 2016: 9.5; 2017: 9.7; 2018: 9.2; 2019: 8.7.
- Net official reserves (US$ millions, end of period):
  - 2013: 511.5; 2014: 496.2; 2015: 505.6; 2016: 503.5; 2017: 561.0; 2018: 585.3; 2019: 585.8.
  - (in months of next year's imports of GNFS): 2013: 9.0; 2014: 9.6; 2015: 9.7; 2016: 9.3; 2017: 9.6; 2018: 9.1; 2019: 8.7.
- Exchange Rate:
  - SI$/US$, end of period: 2013: 7.4; 2014: 7.4; 2015: 8.1; 2016: 7.8; 2017–2019: data not shown in table.
  - Real effective exchange rate (end of period, 2005 = 100): 2013: 135.1; 2014: 144.7; 2015: 154.3; 2016: 153.2.

- Memorandum items:
  - Cash balance (in SI$ millions): 2013: 608; 2014: 880; 2015: 694; 2016: 412; 2017: 154; 2018: 87; 2019: -44.
    - in months of recurrent spending: 2013: 3.7; 2014: 5.1; 2015: 3.6; 2016: 2.0; 2017: 0.7; 2018: 0.4; 2019: -0.1.
  - SIG Deposit Account (in SI$ millions): 2013–2019: 140 each year.
  - Broader cash balance (=Cash balance+SIG Deposit Account; in SI$ millions): 2013: 748; 2014: 1,020; 2015: 834; 2016: 552; 2017: 294; 2018: 227; 2019: 96.
    - in months of total spending 4/: 2013: 3.7; 2014: 4.6; 2015: 3.1; 2016: 1.9; 2017: 1.0; 2018: 0.7; 2019: 0.3.

### Outlook, risks, vulnerabilities
- Main vulnerabilities:
  - Fiscal slippage has depleted buffers and increased vulnerability to shocks.
  - Exposure to natural disasters and climate change can materially lower potential growth and public finances.
  - Political fragility and pre-election spending pressures risk further fiscal deterioration.
- External position:
  - Current account deficits projected to widen (see Current account balance series above).
  - International reserves remain above adequacy benchmarks but import cover shows slight decline (gross reserves months: 9.2 in 2018; 8.7 in 2019).
- Debt dynamics:
  - Central government debt expected to rise from 7.9 percent of GDP in 2016 to 16.4 percent in 2019 in projections shown.

### Policy recommendations and priorities (key policy recommendations from the consultation)
- Rebuild fiscal buffers and adopt a clear fiscal anchor to guide annual budgets, maintain fiscal discipline, and provide flexibility to respond to shocks.
- Implement revenue-enhancing and expenditure-prioritization measures:
  - Strengthen tax compliance.
  - Streamline exemptions.
  - Improve transparency and prioritization of spending.
- Strengthen the medium-term fiscal framework to ensure fiscal sustainability and advance public financial management reforms; introduce a Medium-Term Fiscal Strategy.
- Balance borrowing for critical infrastructure against debt sustainability, absorptive capacity and domestic market development.
- Continue implementing the currency basket peg exchange rate regime with annual reviews to align the peg with underlying conditions.
- Consider a gradual increase in the cash reserve requirement to absorb structural excess liquidity while maintaining broadly appropriate monetary stance.
- Complete outstanding financial sector reforms begun under the Fund-supported program, including clearing the backlog of financial legislation (Financial Institutions Act, Credit Unions Act, National Provident Fund Act) and strengthening supervisory and regulatory frameworks.
- Strengthen AML/CFT framework and anti-corruption efforts; enhance transparency of Constituency Development Funds.
- Diversify the economy, generate new sources of growth (tourism, fisheries, agriculture per NDS 2016–35), and foster private sector development and an improved business environment.

### Selected projects and sectoral notes
- Tina River Hydropower Development Project (TRHDP):
  - Solomon Islands’ first large energy project to reduce electricity costs and reliance on diesel imports; potential to more than cut in half annual greenhouse gas emissions.
  - Supported by development partners including the Green Climate Fund (GCF).
  - Project completion period: 2018–22.
  - Financing scheme (In millions of US dollar): Total 207.9; GCF loan 86.0, grant 70.0, total 16.0; WB/IDA 33.6 loan, 24.7 grant, 8.9 concessional; ADB 30.0 loan, 18.0 grant, 12.0 concessional; IRENA/ADFD 15.0 loan, 15.0 grant; EDCF 31.6 loan, 31.6 grant; Australia 11.7 loan, 11.7 grant. (Tabulated in source.)

*Italicized source: IMF staff report "SOLOMON ISLANDS STAFF REPORT FOR THE 2017 ARTICLE IV CONSULTATION" (January 4, 2018).*

### 7.      Fiscal discipline has slipped and the setting is challenging. The deficit widened to 3.3

### 7.      Fiscal discipline has slipped and the setting is challenging. The deficit widened to 3.3 

### Fiscal developments and composition
- Overall deficit widened to 3.3 percent of GDP in 2016 as lower revenues and grants were not matched by expenditure restraint.
- Revenues:
  - Lower goods tax collection and income and profits tax more-than-offset higher-than-expected export duties and fishing license fees.
- Expenditures excluding grants:
  - Fell by 0.3 percentage points but this was less than the decline in grants.
  - Recurrent expenditure remained high.
  - Constituency Development Funds (CDFs) have doubled since 2013 and amounted to 3.3 percent of GDP.
- Grants:
  - Were 3.4 percent of GDP, down reflecting the completion of several donor-assisted projects, a delay in the disbursement of EU budget support, and lower grants in anticipation of RAMSI’s departure.

### Fiscal buffers, cash balances, and arrears
- Narrow cash balance:
  - Fell from 3.6 months of recurrent spending at end-2015 to 2.0 months at end-2016 and further to 1.7 months in July 2017.
  - Definition: narrow cash balance equals the sum of government deposits held at the CBSI and the commercial banks minus unpaid payment orders and unpresented checks.
- Broader cash balance:
  - Also declined (broader cash balance = narrow cash balance plus reserves in the government consolidated deposit account (SI$140mn) as a proportion of total spending, with a floor of 2 months per the 2016 AIV recommendation).
- Domestic arrears and payment delays:
  - Domestic arrears were 1.4 percent of GDP in September (year not expressly restated).
  - Unanticipated increase in tertiary scholarship spending.
  - Delays in education allowance payments and government employees’ housing rent.
  - Hiring freeze for nurses and doctors announced in August.

### Public debt and financing of infrastructure
- Public and publicly-guaranteed debt:
  - Rose from 7.9 percent of GDP at end-2016 to 10 percent of GDP in mid-2017.
- Undersea fiber-optic cable financing:
  - Development partners pulled out; government issued a SI$150 million bond to the National Provident Fund (NPF) to finance the project.
  - Loan guarantees also increased.
- NPF exposure:
  - With the SI$150 million bond issue, the NPF holds 86.5 percent of the government’s outstanding domestic debt securities.
  - This is just 5 percent of the NPF’s total assets.

### Monetary conditions, credit, and financial soundness
- Monetary stance and transmission:
  - Monetary conditions are accommodative; CBSI maintained an accommodative policy stance.
  - Commercial banks’ structural excess reserves are high due to accumulation of export receipts and unsterilized inflows of donor financing.
  - Bokolo bills issuance to mop up excess liquidity is high; CRR is unchanged.
  - Interest rates are below their long-term average.
  - High spreads of around 10 percent and a low loan to deposit ratio of 60 percent suggest the transmission mechanism is weak.
- Credit growth:
  - Averaged 15.5 percent throughout 2013–16; decelerated to around 10 percent (2017).
  - Housing loans had been a major contributor; banks reinscribed exposure to households.
  - In 2017 lending channeled to the retail sector, supported by higher royalty payments from logging activity.
- Financial Soundness Indicators (2013–2017, commercial banks only, end-period):
  - Regulatory Capital to Risk-Weighted Assets: 32.4, 31.6, 31.3, 32.3, 33.0, 32.8 (years/quarters as in table).
  - Non-performing Loans Net of Provisions to Capital: 12.0, 8.1, 7.3, 6.6, 7.4, 10.0.
  - Non-performing Loans to Total Gross Loans: 7.0, 4.7, 4.1, 3.8, 4.2, 5.2.
  - Return on Assets: 4.0, 3.3, 3.4, 3.5, 3.9, 4.3.
  - Return on Equity: 23.3, 20.0, 20.1, 22.7, 23.3, 25.7.
  - Interest Margin to Gross Income: 54.3, 56.7, 54.7, 56.3, 56.9, 55.2.
  - Non-interest Expenses to Gross Income: 52.8, 51.6, 51.9, 47.1, 45.9, 43.7.
  - Liquid Assets to Total Assets (Liquid Asset Ratio): 40.6, 38.0, 33.5, 38.1, 36.0, 37.6.
  - Liquid Assets to Short Term Liabilities: 56.5, 51.7, 46.2, 53.3, 50.3, 55.1.
- FSIs in 2017 Q2:
  - Capital adequacy, earnings and profitability, and liquidity were comfortably within historical norms, though NPLs have risen each quarter since end-2016.
- CBSI Financial Stability Report supervisory concerns:
  - Governance (for non-banks) and government payment delays.

### Outlook, risks, and vulnerabilities
- Growth projections:
  - Growth projected at 3.2 percent in 2017 and 3.0 percent in 2018.
  - Real GDP growth averages 2.9 percent over 2017–22 in staff baseline.
  - Long-run growth without disasters gradually rises to 3.5 percent but is scaled down by 0.3pps a year in the projections to 3.2 percent to account for natural disasters.
- Inflation:
  - Remains low in 2017 and 2018 and rises over the medium term to 4.0 percent.
- Current account:
  - Deficit widens to 5–6 percent of GDP over 2017–22 as infrastructure projects have a high import content.
- Fiscal projections:
  - Staff projects a deficit of 4.1 percent of GDP in “this year” (context: projections section).
  - Broader cash balance falling to one month of total spending by the end of 2017.
  - Deficit widens to 5.7 percent of GDP in 2018 as infrastructure projects progress, then narrows to around 3 percent of GDP over the medium term.
- Public debt outlook:
  - Authorities tripled annual borrowing limit to SI$900 million in the 2017 Budget, and raised the public debt-to-GDP ratio limit to 30 percent.
  - DSA indicates risk of debt distress is moderate; nominal public debt-to-GDP ratio could exceed the 30 percent limit in 2028.
- Risks (Summary Risk Assessment):
  - Upside: Reopening of Gold Ridge mine and nickel and bauxite projects start up (Likelihood: Medium; Impact: High); Positive spillovers from large infrastructure projects (Medium; High); Lower oil prices (Low; Medium).
  - Downside: Fiscal policy slippage (High; High); Security risk (Low; High); Weaker-than-expected global growth, especially significant China slowdown (Medium; High); Tighter or more volatile global financial conditions (High; Medium); Reduced financial services by correspondent banks (High; Medium); Natural disasters and climate change (High; High).
- Fiscal deterioration amplifies downside risks:
  - Fast-shrinking fiscal cushion leaves Solomon Islands ill-prepared to deal with shocks.
  - Fiscal strains could trigger unrest through non-payment of salaries and transfers or indirectly via mounting arrears affecting suppliers.
- Fiscal-financial linkages:
  - Previous delays in government rental payments led to jumps in NPLs due to banks’ exposure to housing loans and landlords’ mortgage defaults when rental payments delayed.
  - A protracted delay would dent bank balance sheets.

### Authorities’ views
- Authorities are more optimistic about growth prospects:
  - Gold Ridge mine could restart production soon; mining activities would add to growth.
  - Investment in the undersea cable would improve connectivity and infrastructure investment would yield returns.
  - 2016 was a peak year for logging; high volumes continued in 2017 but industry expected to gradually decline with uncertain trajectory.

### Policy discussion and recommended actions
- Overall strategy:
  - Fiscal adjustment, tax reform and public financial management strengthening together with structural reforms and financial deepening would improve outcomes.
  - Better fiscal management would widen policymakers’ options and boost efficiency of government spending.
- A. Restoring Fiscal Buffers — Staff’s assessment and policy action scenario:
  - Objectives:
    - (i) Stem domestic arrears and rebuild the cash balance.
    - (ii) Place fiscal policy on a sustainably firmer footing.
  - Rebuilding the cash balance:
    - 2017 steps: revising down overly optimistic revenue projections and asking line ministries to contain spending for the final months of the year.
    - 2018 Budget recommendation: aim for the broader cash balance of 1.3 months of spending gradually building to 2.0 months by 2020.
  - Multi-year consolidation:
    - Staff sees a gradual cumulative consolidation of 6.0 percent of GDP by 2020 as feasible.
  - Revenue measures:
    - Tax review ongoing but will take time.
    - Near-term suggestions: align tax reference price for logs to world market prices from 2018 Q1 and eliminate ad-hoc tax exemptions.
    - Improve compliance and revenue administration.
    - Tackling tax arrears could boost revenues—reducing outstanding cases by 5 percent by June 2018 and outstanding returns by 15 percent could generate up to 0.7 percent of GDP in additional revenues.
    - Note: Tax debts amount to 19.6 percent of GDP. 119 of the top 200 taxpayers by turnover have arrears.
  - Expenditure measures:
    - Restrain expenditures on tertiary scholarships, CDFs, and shipping grants.
    - 2018 Budget opportunity to realign spending to NDS goals and preserve critical social services.
    - Use of department ceilings for annual expenditure is welcome.
    - Scale back discretionary recurrent expenditures—travel and allowances.
    - Reign in CDF spending and increase transparency; publish 2015 and 2016 annual reports of CDFs and in 2018 Budget publish a supplement describing for each CDF: planning process, use of funds, development achievements, and future plans.
    - Spending allocations for 2018/19 should include room to eliminate domestic arrears.
  - Growth impact:
    - These measures should not adversely affect growth; fiscal multipliers likely low as measures aim to improve quality of spending.
    - Tackling tax debt would improve equity; addressing domestic arrears would instill confidence and reduce delays in capital spending.
  - Budget realism:
    - Adopt more realistic revenue projections to help establish the budget as a fiscal planning tool.
  - Transparency of CDFs:
    - Publish CDF reports and supplement as detailed above (CDF community audit report noted only 14 out of 1000 interviewed in 39 constituencies were aware and had basic knowledge of the CDF fund).
- Medium-Term Fiscal Policy Goals:
  - Increase external concessional borrowing and domestic borrowing space, set borrowing strategy within a medium-term fiscal framework with prioritized expenditures, and pace borrowing consistent with debt sustainability, absorptive capacity and domestic market development.
  - Choice of fiscal anchor:
    - Once cash balance restored, the cash balance and debt limit could be supplemented by an operational fiscal target.
    - A small deficit of 1.5 percent of GDP would contain debt levels and provide some space to close the infrastructure gap.
    - Flexibility important with provisions for natural disasters.
  - Contingency reserve:
    - Include a specific contingency reserve line in the budget of up to one month of nondiscretionary recurrent spending; consider setting up a natural disaster fund once buffers rebuilt.
  - Donor coordination and costing climate change adaptation:
    - Improve collection and reporting of commitments and expenditures for donor programs and NGOs to identify gaps in climate change and disaster risk mitigation.
    - Reestablish regular donor coordination meetings with government.
  - Medium-Term Fiscal Strategy (MTFS):
    - Present MTFS analysis including expected fiscal costs from natural disasters and climate change adaptation to help tradeoff assessment and mobilize external financing.
  - Public financial management strengthening:
    - Continue reforms and fill critical vacancies (Accountant General position vacant since 2016).
    - IMF technical assistance to support cash-flow management and forecasting, monitoring and bank reconciliation, revenue forecasting, and handling tax debts.
    - Public expenditure assessment roadmap provides comprehensive reform set—identify quick wins.

*Source: IMF staff report content as provided in the supplied document.*

### Box 4. Fiscal Anchors: Options and Tradeoffs

### Box 4. Fiscal Anchors: Options and Tradeoffs

### Rationale for a fiscal anchor
- A fiscal anchor could usefully supplement the fiscal framework to guide the annual budget cycle.
- A fiscal anchor would guide the annual budget discussion, help contain fiscal deficits and prevent excessive public debt accumulation, create policy space for spending on infrastructure and human capital, and provide a buffer to cushion against shocks.
- Current framework elements:
  - The Debt Management Strategy (DMS) stipulates a limit for the public debt-to-GDP ratio and debt service to domestically sourced revenue ratio set respectively at 30 percent and 10 percent.
  - Under the Public Financial Management Act government borrowing cannot be used to finance recurrent expenditures.
- These targets are not binding and have not been sufficient to maintain fiscal discipline:
  - Public debt is substantially lower than the debt limit.
  - The restriction on borrowing is ineffective as the main growth area is on development expenditures—but many of these, e.g. CDFs, include recurrent spending.

### Types of simple numerical fiscal targets (classification and tradeoffs)
- Countries choose one or a combination of fiscal rules based on their characteristics. Four types are described:

1) Budget balance rules (BBRs)
- Set a specific target in overall balance, structural or cyclically adjusted balance, and balance “over the cycle”.
- Provide clear operational targets with direct links to debt sustainability, but may not address the procyclicality of fiscal policy.
- All balances except the overall balance take into account economic shocks which requires the estimation of adjustments through the output gap.
- These rules are difficult to communicate and monitor.
- The golden rule (GR), which targets the overall balance net of capital expenditures to safeguard public investment spending, is less linked to debt sustainability.

2) Debt rules (DRs)
- Are directly linked to the debt target and are easy to communicate and monitor.
- Do not provide sufficient guidance for fiscal policy, especially when debt is well below its ceiling.

3) Expenditure rules (ERs)
- Are relatively easy to communicate and monitor.
- Do not have a direct link to debt sustainability, as ERs do not cover revenues.
- Can provide an operational tool to trigger the required fiscal consolidation when ERs are accompanied by BBRs or DRs.

4) Revenue rules (RRs)
- Can improve tax policy and administration.
- Setting targets can be challenging as revenues are affected by the business cycle.
- Are not directly connected to debt sustainability, as RRs do not cover spending.

### Staff’s analysis and recommended targets
- Staff’s analysis suggests that the 1.5 percent overall fiscal deficit target would ensure fiscal sustainability and meet high infrastructure demands.
- Advantages of a target for the overall balance:
  - Has the advantage of being simple and comprehensive.
  - Would help maintain a buffer to cope with shocks.
  - Would need specific provision for adjustment in the face of a shock (including how policies would be brought back afterwards).
- Other options mentioned:
  - A non-commodity primary deficit target of 4 percent of GDP.
  - A constraint on total spending.

*Prepared by Hidetaka Nishizawa.*

### 38.      Efforts to improve data quality are welcome.

### cr1857 - 38.      Efforts to improve data quality are welcome.

### Data quality and statistical capacity
- The National Statistics Development Strategy 2016–35 has a roadmap to address pressing gaps.
- Adequate resources and advisory capacity are necessary to sustain progress.
- The authorities agree on the need to continue to improve statistics.
- The CBSI notes the importance of a national CPI which the National Statistics Office is currently working on.
- National Statistical Office resources lag peers (chart shows recurrent spending on National Statistical Offices in Solomon Islands dollar per capita compared with Papua New Guinea, Vanuatu, Samoa).

### Staff appraisal — economic outlook
- Economic activity has remained favorable but the outlook is uncertain.
- Drivers of stronger-than-expected activity include:
  - forestry sector,
  - higher cash crops and fishing revenues,
  - stepped-up construction.
- The current account deficit widened moderately in 2016, but international reserve levels remain comfortable and inflation is contained.
- On balance, risks to the outlook are on the downside, including fiscal pressures and natural disasters.

### Development challenges and strategy
- Solomon Islands faces long-term development challenges and needs to generate new sources of growth.
- The authorities’ National Development Strategy (NDS) identifies priority sectors for development, specifies development objectives and aligns them to corresponding Sustainable Development Goals.
- Achieving NDS objectives will require additional efforts, including significant infrastructure investment, legislative and policy reforms.

### Fiscal policy: risks and recommendations
- Decisive actions are needed to strengthen fiscal discipline and improve the quality of public spending.
- Fiscal buffers have substantially eroded and payment arrears are on the rise.
- Timely actions are needed to place the fiscal position on a firmer footing.
- Recommendations:
  - Stem domestic arrears and begin rebuilding the cash balance by boosting revenues and containing spending.
  - Once the cash balance is restored, supplement the cash balance and debt limit with an operational fiscal target to guide annual budgets and maintain discipline.
  - Keep the pace of borrowing for critical infrastructure aligned with debt sustainability, absorptive capacity and domestic market development.
  - Sustain fiscal reform efforts by combining public financial management reforms with disaster risk mitigation to raise public investment returns and reduce fiscal and growth volatility.
  - 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.
  - Strengthen revenue compliance, improve the legal framework, and enhance the AML/CFT framework to contribute to anti-corruption efforts.
  - The recently launched tax review is a commendable step.

### External sector and monetary policy
- The basket peg is working well and the monetary stance is broadly appropriate.
- Staff assess the external sector position as moderately weaker than suggested by medium-term fundamentals.
- The basket peg is an appropriate exchange rate regime for Solomon Islands, but the parity of the peg should be reviewed annually and, if necessary, adjusted to keep the exchange rate in line with changes in underlying conditions.
- Consider a gradual increase in the cash reserve requirement to absorb structural excess liquidity.

### Financial sector legislation and inclusion
- High priority should be given to clearing the backlog of financial legislation, including:
  - the new Financial Institutions Act,
  - the Credit Unions Act,
  - the National Provident Fund Act.
- These acts fill important gaps in prudential standards and would provide the basis for the CBSI to strengthen its supervisory framework.
- Efforts to promote financial inclusion are commendable and are working well.

### Structural reform priorities
- Structural reforms should aim to foster private-sector development by:
  - improving enforcement of contracts,
  - improving access to finance,
  - improving property registration.
- Ensuring strong compliance with regulations is particularly important to promote sustainable development.
- Solutions to challenges posed by communal land-ownership will be important but there are no quick fixes.

*Source: cr1857 - 38.      Efforts to improve data quality are welcome.*

### 48.      It is proposed that the next Article IV consultation take place on the standard

### 48.      It is proposed that the next Article IV consultation take place on the standard 

### Cross-country context
- Solomon Islands described as "one of the poorest small states" with challenges including "vulnerability to natural disasters", "geographical dispersion", "high infrastructure gaps", and "perception of lack of political stability".
- Pacific Island Countries: Average Number of Natural Disasters per Year (1980-2016) — chart context (no numeric summary beyond figure axis shown).
- Access to Electricity (percent of population) — Solomon Islands compared with peers (chart context).
- Internet Users (Per 100 people) — Solomon Islands compared with peers (chart context).
- Political Stability and Absence of Violence/Terrorism: Percentile Rank 2015 — Solomon Islands percentile shown among peers (chart context).
- GDP per Capita, 2016 (In U.S. dollars) — Solomon Islands shown among peers (chart context).
- Geographical Dispersion: Average Sea Distance Between Two Inhabitants of the Same Country (In kilometers) — chart context.
- Doing Business 2017 Overall Rank — Solomon Islands ranked as "Less Favorable Business Environment" relative to small states (chart context).

### Macroeconomic developments and outlook
- Growth drivers: "Growth in 2016 was driven by stronger-than-expected logging activity and construction."
- Inflation and prices:
  - CPI (period average) series (Table 1): 5.4, 5.2, -0.6, 0.5, 1.0, 1.2, 2.0, 2.7, 3.0, 4.0 (corresponding to years 2014–2022 as presented).
  - GDP deflator (Table 1): 2.3, 2.5, 3.1, 3.6, 1.6, 2.7, 3.2, 3.5, 3.8, 3.9 (2014–2022).
- Real GDP growth (Table 1): 3.0, 2.3, 2.5, 3.5, 3.2, 3.0, 2.9, 2.8, 2.8, 2.8 (2014–2022).
- Balance of payments:
  - Current account balance (in percent of GDP, Table 1): -3.4, -4.3, -3.0, -3.9, -4.4, -5.0, -6.4, -6.8, -5.9, -6.2 (2014–2022).
  - Gross official reserves (US$ millions, end of period, Table 1): 531.2, 514.3, 519.6, 513.6, 500.1, 520.0, 517.4, 519.1, 540.1, 556.8 (2014–2022).
  - Net official reserves (US$ millions, end of period, Table 1): 511.5, 496.2, 505.6, 503.5, 492.8, 516.2, 515.7, 517.6, 538.9, 556.0 (2014–2022).
- Exports and imports (Figure 2 & Table 5): logs continue to support exports; imports contained by lower fuel prices (chart context). Table 5 shows exports and imports levels and trade balances across 2014–22 (see published tables for full series).

### Fiscal developments and risks
- Fiscal volatility: "Solomon Islands’ high fiscal revenue volatility... leads to an often procyclical fiscal policy" (chart context; volatility measured as standard deviation of detrended tax revenue-to-GDP ratio; 1990-2016).
- Fiscal position (selected figures from Table 1):
  - Total revenue and grants (percent of GDP, Table 2b): 47.3, 47.9, 40.3, 41.2, 44.1, 41.2, 41.2, 42.9, 42.4, 41.6 (2014–2022 entries shown across years).
  - Total expenditure (percent of GDP, Table 2b): 45.6, 48.2, 45.6, 44.5, 45.3, 48.6, 45.3, 49.4, 48.1, 45.8 (selected years as presented).
  - Overall balance (percent of GDP, Table 2b): 1.7, -0.2, -5.3, -3.3, -1.2, -7.4, -4.1, -6.5, -5.7, -3.9 (2014–2022 sequence as presented).
  - Central government debt (percent of GDP, Table 1): 15.3, 12.8, 10.1, 7.9, 10.0, 14.6, 16.4, 18.6, 20.4, 21.9 (2014–2022).
- Revenue composition (Table 2a):
  - Grants (in SI$ millions, Table 2a): 1,255, 1,175, 930, 930, 980, 980, 980, 1,177, 1,177, 1,221 (selected year sequence).
  - Tax revenue (in SI$ millions, Table 2a): 2,487, 2,621, 2,710, 2,578, 2,945, 2,700, 2,692, 2,870, 2,838, 3,001 (selected series).
- Expenditure composition (Table 2a):
  - Recurrent expenditure (in SI$ millions, Table 2a): 2,819, 3,076, 2,976, 2,983, 3,135, 3,391, 3,121, 3,417, 3,374, 3,582 (selected series).
  - Development expenditure (in SI$ millions, Table 2a): 1,089, 1,306, 1,497, 1,437, 1,523, 1,607, 1,534, 1,962, 1,857, 1,718 (selected series).
- Fiscal risks: "The government’s fiscal buffer has shrunk... and as public debt increases to finance large infrastructure projects."

### Financial sector and monetary conditions
- Reserves: "Reserves remain adequate." Net International Reserves in US$ millions (Table 4 / Table 1): examples — Net international reserves 3,651, 4,077, 4,127, 3,875, 4,033, 4,012, 4,016, 4,166, 4,274 across central bank series (in SI$ millions).
- Interest rates: Lending and deposit rates shown in figures; lending rates "are below historical highs and are within PIC norms" (chart context). Table 4 shows a lending rate series (example: lending rate 10.9, 10.5, 10.1 for years shown).
- Money and credit:
  - Credit to private sector (Table 1): 15.1, 16.4, 16.7, 12.1, 8.0, 8.0, 7.5, 7.3, 7.0, 7.0 (2014–2022).
  - Broad money (Table 1): 12.4, 5.4, 15.0, 13.4, 10.4, 11.9, 5.3, 4.5, 4.6, 4.0 (2014–2022).
  - Reserve money (Table 1): 3.0, -10.1, 23.5, 14.5, 9.0, 6.7, 5.3, 4.5, 4.4, 4.0 (2014–2022).
- Banking system balance-sheet (Table 4): Broad money (M3) levels — 3,635; 4,181; 4,743; 5,088; 5,324; 5,234; 5,063; 4,884; 4,659 (across years shown).

### Financial access and inclusion
- Trends and gaps:
  - Domestic bank deposits to GDP (chart context): Solomon Islands increased but lags peers.
  - Private credit to GDP (chart context): upward trend from a low base; Solomon Islands generally lags peers.
  - Accounts at commercial banks per 1,000 adults (FinStats 2017): Solomon Islands figures shown in chart context (per 1,000 adults).
  - Number of mobile money transactions (per 1,000 adults): Solomon Islands shows growth (chart context).
  - Number of branches, commercial banks (per 100,000 adults) — Solomon Islands low relative to peers (chart context).
- Impediment: "Geographical dispersion presents a major impediment for commercial banks’ ability to reach customers" and "growth in mobile banking could leapfrog conventional banking in providing financial access."

### Selected economic indicators and debt capacity
- Per capita GDP (2014): US$1,931.
- Quota: SDR 20.8 million.
- Population (2014): 562,000.
- Poverty rate (2006): 23 percent.
- Main products and exports: logs; main export markets: Emerging Asia.
- Fund obligations and outstanding credit (Table: Indicators of Capacity to Repay the Fund):
  - Fund obligations based on existing credit (in millions of SDRs) — principal sequence: 2.77, 2.46, 1.46, 0.13, 0.19, 0.21, 0.16, 0.13, 0.07, 0.03 for 2017–2026.
  - Outstanding Fund credit (in millions of SDRs): 4.85, 2.40, 0.94, 0.80, 0.61, 0.40, 0.24, 0.10, 0.03, 0.00 (2017–2026).
  - Memorandum items: Exports of goods and services (in US$ millions) — 564, 589, 620, 649, 660, 674, 732, 860, 866, 905 (2017–2026); Gross international reserves (in US$ millions) — 520, 542, 561, 594, 615, 659, 681, 702, 720, 734 (2017–2026).

### Alternative policy action and reform scenario (Tables 7–8 summary)
- Fiscal measures proposed (2017–20, percent of GDP where indicated):
  - Revenue measures total: 0.3, 0.85, 0.85, 0.85 (2017–2020).
    - Tax Revenue: 0.3, 0.85, 0.85, 0.85.
    - Income and profits: 0.05, 0.10, 0.10, 0.10 with measures including reducing tax exemptions and improving administration and compliance; reduce outstanding tax arrears by 5 percent by end June 2018; reduce outstanding returns on hand by 15 percent by end June 2018; strengthen timeframe for prosecution by December 2017.
    - International trade and transactions: 0.05, 0.05, 0.05, 0.05 with a measure that "Tax reference price for logs should be in line with world market prices".
  - Expenditure savings total: -0.40, -0.90, -0.90, -0.90.
    - Recurrent spending: -0.10, -0.35, -0.35, -0.35 (including containing wage bill growth below nominal GDP growth and reducing scholarships and travel).
    - Development spending: -0.30, -0.55, -0.55, -0.55 (including CDF reductions and prioritizing/streamlining development spending, reducing shipping grants).
  - Total Savings: 0.70, 1.75, 1.75, 1.75; Cumulative Savings: 0.70, 2.45, 4.20, 5.95 (percent of GDP cumulative as presented).
- Adjustment scenario outcomes (Table 8):
  - Overall Balance (In percent of GDP): baseline vs reform — baseline: -4.1, -5.7, -3.9, -3.5; reform/adjustment: -3.4, -3.9, -2.1, -1.7 (2017–2020).
  - Cash Balance (in SI$ millions) under adjustment: 164, 293, 369, 551 (2017–2020).
  - Broader Cash Balance (in SI$ millions) under adjustment: 304, 434, 510, 692 (2017–2020).
  - Public Debt (In percent of GDP) under adjustment: 10.0, 14.6, 16.4, 18.6 (2017–2020) — same as baseline in the table for these years.
  - Real GDP growth and CPI implications under reform vs baseline shown in Table 8 (small differences, see table series: Real GDP growth 3.2, 3.0, 2.9, 2.8 across scenarios).

*Source: IMF staff estimates and projections as presented in the Solomon Islands country chapter.*

### Appendix I. Solomon Islands: SDGs Identified in the 2016–35

### Appendix I. Solomon Islands: SDGs Identified in the 2016–35 National Development Strategy (NDS)

### Key development objectives identified by the NDS and corresponding SDGs
- Sustained and inclusive economic growth
  - Corresponding SDGs: 8, 9, 10
  - Role of the IMF:
    - Analytical work on public investment
    - TA on domestic revenue mobilization
    - TA on financial stability to support financial deepening and inclusion
- Poverty alleviation
  - Corresponding SDG: 1
  - Role of the IMF:
    - Surveillance and policy advice on macro-economic policies
- Access to quality social services
  - Corresponding SDGs: 3, 4, 5
  - Role of the IMF:
    - Coordination with the World Bank Group and development partners
- Resilient and environmental sustainable development
  - Corresponding SDGs: 6, 7, 11, 12, 13, 14, 15
  - Role of the IMF:
    - Provide analytical and policy framework on how to incorporate the cost of natural disasters and climate change
- Capacity development
  - (No specific SDGs listed separately in the table)
- Stable and effective governance and public order
  - Corresponding SDG: 16
  - Role of the IMF:
    - TA on PFM with a particular focus on improved medium-term revenue and expenditure forecasting; stronger integration of planning and budgeting within a medium-term framework
- Partnerships for the Goals
  - Corresponding SDG: 17

### SDG list as presented in the NDS
- 1 No Poverty
- 2 Zero Hunger
- 3 Good Health and Well Being
- 4 Quality Education
- 5 Gender Equality
- 6 Clean Water & Sanitation
- 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

*Source: Staff compilation from Appendix I. Solomon Islands: SDGs Identified in the 2016–35 National Development Strategy (NDS).*

### 5.      A clear policy direction has been critical. With the launch of National Financial Inclusion

### 5.      A clear policy direction has been critical. With the launch of National Financial Inclusion

### Policy direction and institutional coordination
- National Financial Inclusion Strategy 2011–15 (NFIS1)—spearheaded by the CBSI—made Solomon Islands a pioneer among Pacific island countries in charting a roadmap for financial inclusion and was the first country in the world to integrate targets for women in its national financial inclusion strategy.
- NFIS1 led to the formation of the National Financial Inclusion Taskforce (NFIT), comprising representatives of the central bank, the government, commercial banks, the private sector and NGOs, to facilitate coordination and collaboration on financial inclusion among key stakeholders.

### Fintech and mobile banking as strategic priorities
- NFIS1 explicitly identified increasing financial digital services as one of three areas of focus in fostering financial inclusion.
- Solomon Islands has identified fintech as a key component of its national financial inclusion strategy, given the physical barriers to access.
- NFIS2 further includes amplifying “the reach and quality of digital financial services” as one of its six strategic objectives.
- Increased competition after entry of a second mobile network operator in 2010 spurred greater investment in telecommunications infrastructure, enabling wider adoption of mobile banking.
- As at end-2014, around half of the population had access to mobile phones.
- Mobile banking was launched towards the end of 2013 and has grown since then.
- To facilitate adoption, the CBSI started licensing mobile banking agents: as at end-2015, Solomon Islands had one of the highest ratios of active mobile banking agents relative to its population in the Pacific.

### Outcomes, usage, and transaction trends
- During 2011-16, financial access points rose significantly in number, driven by brisk expansion of an EFTPOS-supported branchless banking network as well as mobile banking services.
- Financial access points in Solomon Islands excluding ATMs and bank branches increased by over 300 percent during this period.
- As of 2015, an estimated 40 percent of adults with a banking account had access to mobile banking.
- In 2015, Solomon Islanders conducted at least seven times more mobile banking transactions on average than their Pacific island and small states counterparts.
- Transaction balances and value were below 4 percent of GDP in 2016, but both have trended upwards.
- Falling numbers of EFTPOS terminals and merchants suggest a shift in customers’ preferences towards mobile banking.
- A 2015 demand-side financial inclusion survey shows that apart from checking account transactions and topping up mobile phone credit, the top three uses of mobile banking involved sending or receiving money domestically, with almost one-fifth of mobile banking customers doing so.
- Mobile banking accounted for 5 percent of domestic remittances in 2015, with significant growth potential.

### Key statistics and financial access points (Table 1 data)
- Commercial bank branches: 2011: 13; 2012: 13; 2013: 12; 2014: 14; 2015: 14; 2016: 15
- ATMs: 2011: 38; 2012: 38; 2013: 38; 2014: 39; 2015: 41; 2016: 42
- EFTPOS terminals: 2011: 175; 2012: 224; 2013: 306; 2014: 346; 2015: 400; 2016: 310
- EFTPOS merchants: 2011: n.a.; 2012: n.a.; 2013: 7; 2014: 23; 2015: 253; 2016: 256
- Mobile banking agents: 2011: n.a.; 2012: n.a.; 2013: 0; 2014: 10; 2015: 516; 2016: 4192
- Outstanding mobile banking account balance (In percent of GDP): 2013: 0; 2014: 1; 2015: 2; 2016: 3 (chart axis shows 0–3 but source text: balances and value were below 4 percent of GDP in 2016)
- Value of mobile banking transactions (In percent of GDP): 2013: 0; 2014: 1; 2015: 2; 2016: 4 (chart axis displays growth; source text: value below 4 percent of GDP in 2016)

### NFIS2 targets, indicators, and strategic objectives
- NFIS2 (National Financial Inclusion Strategy 2016–20) aims to add 300,000 new users of formal and semi-formal financial services by 2020, of which half is targeted to be women.
- NFIS2 identifies five key indicators and six strategic objectives.
- Five targets to be achieved by 2020 (Area — Current status — Target):
  - Overall access — 90 percent of the population live within 8 hours of nearest financial access point — 90 percent of the population live within 60 minutes of nearest financial access point
  - Overall use — 33.8 percent of adults have active formal/semiformal financial accounts — 70 percent of adults have active formal/semiformal financial accounts
  - Formal credit — 3.8 percent of adults have active formal/semiformal credit accounts — 10 percent of adults have active formal/semiformal credit accounts
  - Financial literacy (Savings club) — 5.3 percent of adults are members of saving clubs — 10 percent of adults are members of savings club
- Six strategic objectives under NFIS2:
  - (i) digital financial services
  - (ii) micro, small and medium enterprises
  - (iii) inclusion of marginalized groups
  - (iv) rural households’ financial resilience
  - (v) consumer protection
  - (vi) stakeholder coordination and leveraging data
- NFIS2 spells out roles for ministries, non-profits, banks, nonbanks, nonfinancial private sector players, and development partners.
- Continued monitoring of activity in savings clubs, and usage of savings and insurance services, as well as attendance of financial literacy programs.

### Projections and growth drivers for fintech
- Mobile broadband penetration in the Pacific island countries is expected to rise to 42 percent by 2020 (2014: 17 percent).
- In Solomon Islands, smartphone adoption is projected to rise to 57 percent (2014: 24 percent).
- The 2015 demand-side survey shows more than two-thirds of domestic remittances occurred in cash, transmitted physically by relatives or acquaintances, implying greater use of mobile phone-based remittances.
- Fintech use will grow with introduction of mobile money products—including savings products—and will extend beyond financial access-specific initiatives (example: pilot on-line taxation system under the Pacific Financial Inclusion Programme).

### Policy recommendations and implementation guidance
- Solomon Islands should leverage development partners’ expertise and other countries’ experience in further development of fintech.
- With envisaged involvement of nonbanks, including mobile network operators, other IMF members’ experience in choosing a workable regulatory approach could be instructive.
- Spread of financial literacy programs is crucial to maintain momentum in the rate of usage of mobile financial services.

### Remaining challenges
- Broadening credit access and maintaining usage remain challenges.
- Credit growth has been brisk from a low base, with commercial banks’ loans to the private sector hitting double digits in the last five years.
- Most credit growth has been driven by strong credit growth to households, but this has not been matched by the number of loan accounts per head, suggesting borrowing has been concentrated to a relatively small portion of the population.
- Maintaining momentum in usage of mobile financial services will depend on spreading the financial literacy program.

*International Monetary Fund — Solomon Islands country report excerpt (NFIS1 and NFIS2 discussion).*

### 15.      As mobile payments develop, the CBSI will need to extend the scope of its supervision.

### 15.      As mobile payments develop, the CBSI will need to extend the scope of its supervision.

### Current supervisory tools
- The CBSI has developed a Practice Guidance note “Use of cash agents in Solomon Islands” which addresses the matters banks should focus on in selecting, assessing and contracting with the agents they use to deliver mobile payment services.
- The Outsourcing Prudential Guidance is currently in draft form; once finalized, it should be referenced in relation to the provision of mobile payments and the interaction between banks and its agents.

### Observed developments and challenges
- Mobile payments are accelerating in growth.
- Bank lending to households has not moved in tandem with credit access per capita.
- Maintaining the level of usage of mobile banking will be a key challenge going forward.
- The IMF staff note references “The Mobile Economy: Pacific Islands 2015”, GSM Association, 2015.
- The CBSI should begin integrating assessment of mobile payments risk into regular supervision processes as growth accelerates.

### Policy recommendations and supervisory actions
- Finalize the Outsourcing Prudential Guidance and explicitly reference it for mobile payments arrangements and bank–agent interactions.
- Ensure banks apply the Practice Guidance note “Use of cash agents in Solomon Islands” in selecting, assessing, and contracting agents used to deliver mobile payment services.
- Start assessing the risk of mobile payments to financial institutions and management of those risks as part of regular supervision processes.
- Monitor the relationship between increased mobile payment access and bank lending to households, given that lending has not kept pace with credit access per capita.
- Design supervisory workplans to address the challenge of maintaining mobile banking usage going forward, including oversight of agent networks and operational/AML/CFT controls.

*Source: IMF staff report excerpt (cr1857).*

### 1.       Good progress has been made over the past decade in building fiscal buffers and reducing

### cr1857 - 1.       Good progress has been made over the past decade in building fiscal buffers and reducing

### Debt developments and historical context
- Gross public debt fell from 50.3 percent of GDP in 2006 to 7.9 percent of GDP at end-2016.
- The 2005 Honiara Club Agreement restructured around 10 percent of the stock of external public debt and imposed a moratorium on debt servicing and new external borrowing.
- A new debt management framework introduced in 2012 enabled the resumption of concessional external borrowing; the framework was revised in September 2016 with strengthened guidelines on direct borrowing, on-lending, and guarantees.
- The debt management strategy stipulates limits:
  - public debt-to-GDP ratio limit: 30 percent
  - debt service to domestically sourced revenue ratio limit: 10 percent
- Guidelines require the government to aim for its risk of debt distress to be no more than moderate, as defined by the Debt Sustainability Analysis (DSA).

### Stock and composition of debt (end-2016)
- External Public and Publicly Guaranteed (PPG) debt: US$89 million (7.5 percent of GDP).
- Private sector external debt: 0.8 percent of GDP.
- Total external debt: 98.7 million US dollars (100% of total external debt) = 8.2 percent of GDP.
  - of which: Public and Publicly Guaranteed (PPG): 89.3 million (91% of total external debt) = 7.5 percent of GDP.
  - of which: Private: 9.4 million (9% of total external debt) = 0.8 percent of GDP.
- Total public debt: SI$774.8 million (100% of total public debt) = 7.9 percent of GDP.
  - of which: external: SI$732.2 million = 95% of total public debt = 7.5 percent of GDP.
  - of which: domestic: SI$42.6 million = 5% of total public debt = 0.4 percent of GDP.
- Contingent liabilities from SOEs: SI$121.1 million = 1.2 percent of GDP.
- Public domestic debt at end-2016: SI$42.6 million (0.4 percent of GDP), mostly Treasury bills.
- Government bonds stock SI$99.5 million was repaid in December 2015 ahead of schedule.

### Creditor breakdown and official financing
- Multilateral creditors account for the bulk of loans: IDA and ADB account for 37.0 percent and 36.9 percent of total external PPG debt respectively.
- Bilateral creditors (Taiwan Province of China and EU) account for 13.1 percent of the total.
- Australia and New Zealand provide over two-thirds of total Official Development Assistance to Solomon Islands.

### Recent fiscal trends and new borrowing (2016–2018)
- Fiscal performance has deteriorated recently and borrowing is on an upward trajectory.
- The government tripled its annual borrowing limit from SI$300 million in the 2016 budget to SI$900 million in the 2017 budget:
  - SI$600 million set aside for the Tina River Hydropower Development Project (TRHDP).
  - SI$300 million earmarked for other purposes, including the undersea cable project.
- In March 2017, the government issued domestic development bonds worth SI$150 million purchased by the Solomon Islands National Provident Fund, increasing public debt to about 9.4 percent of GDP.
- Government intends to issue additional bonds amounting to SI$150 million by end-2018.
- Government guarantees provided in early 2017 for the TRHDP: US$15.4 million (about SI$122 million).
- Disbursements for the TRHDP expected to begin in 2018.

### Tina River Hydropower Development Project (TRHDP) — project summary and financing
- Purpose: Solomon Islands’ first large-scale energy project to reduce electricity costs, reduce reliance on diesel imports, diversify generation toward hydro/solar, and potentially cut by more than half annual greenhouse gas emissions.
- Project components and estimated costs (in US$):
  - hydropower facility: US$185.6 million
  - access road: US$25 million
  - transmission line: US$22.8 million
  - technical assistance: US$7.0 million
- Total project cost: US$207.9 million with financing split:
  - Loan/Grant shares (in millions of US dollar): GCF 86.0 (70.0 loan / 16.0 grant), WB/IDA 33.6 (24.7 loan / 8.9 grant), ADB 30.0 (18.0 loan / 12.0 grant), IRENA/ADFD 15.0 (15.0 grant), EDCF 31.6 (31.6 loan), Australia 11.7 (11.7 grant). Total financing: 207.9 (159.3 loan / 48.6 grant).
- Disbursement schedule (in millions of US dollar):
  - Total disbursements: 2018: 57.5; 2019: 28.8; 2020: 36.5; 2021: 36.5 (Total 159.3).
- Project completion period: 2018–22.

### Baseline macroeconomic assumptions (2017–37)
- Discount rate for NPV of external debt: 5 percent.
- Real GDP growth:
  - Projected average 2017–22: 2.9 percent (reflecting higher infrastructure spending, public financial management problems, slightly declining logging).
  - Long-term 2023–37: 3.2 percent (positive spillovers from infrastructure and increase in mining activity offset forestry decline).
  - Includes average effect of natural disasters and climate change lowering growth by 0.3 percentage points annually (without natural disasters growth would be around 3.5 percent).
- Inflation (GDP deflator in USD terms):
  - 2017–22 average: 3.2 percent
  - 2023–37: 4.3 percent
  - Historical average cited: 5.7 percent
- Non-interest current account deficit:
  - Projected to widen to 5.6 percent of GDP on average over 2017–22.
  - Overall current account deficit expected to increase to 6.1 percent of GDP on average during 2023–37 (natural disasters/climate change adds 0.4 percentage points).
- FDI inflows:
  - Expected about 3.6 percent of GDP on average over 2017–22.
  - Expected around 3.4 percent of GDP over 2023–37.
- Logging and mining assumptions:
  - Logging output slightly lower next couple years, then decline on average by 1.1 percent a year from 2023.
  - Gold Ridge Mine reopening delayed until 2023 in baseline; peak at 62,000 ounces per annum from 2024 to 2027; cumulative output assumed 445,000 ounces over 10 years.
  - Other mining (nickel and bauxite) expected to come onstream in the long run (implicitly in long-term growth).
- External borrowing and grants:
  - Disbursements for pipeline projects supported by IDA and ADB expected in 2017–21.
  - From 2022 onwards, new external borrowing projected to average 3.1 percent of GDP (same level as 2017–21).
  - Grant element of new borrowing declines to about 38 percent by 2037.
- Revenues excluding grants fall to around 29.5 percent of GDP over the long term compared to around 31 percent of GDP in the previous DSA.
- Fiscal outlook:
  - Primary deficit: 3.2 percent of GDP in 2016 → 4.0 percent in 2017 → 5.5 percent in 2018 (due to undersea cable and TRHDP spending).
  - Primary deficit expected to average 3.7 percent of GDP during 2023–37.
  - From 2023 onwards, natural disasters and climate change widen the deficit by 0.2 percentage points annually.
  - Deficit financing: both domestic and external borrowing.

### Customized scenario: One-off severe natural disaster shock (2018)
- Shock assumptions:
  - A natural disaster with damage equal to 14 percent of GDP (largest historical damage 1980–2016 per EM-DAT).
  - Financing for recovery/reconstruction: grants 4.0 percent of GDP and concessional loans 10.0 percent of GDP (total financing 14.0 percent of GDP).
  - GDP growth deviation from baseline: -5.0 percentage points in 2018, +3.0 percentage points in 2019, +2.2 percentage points in 2020; level of GDP returns to baseline in 2020.
  - Current account balance deviation: -3.0 percent in 2018, -4.0 percent in 2019 and 2020.
- Impacts:
  - Adds to external borrowing and adjusts GDP growth and current account.
  - Debt trajectories move upward; indicators deteriorate though remain below thresholds given current low external debt.
  - Repeated large shocks (probability of >3 percent of GDP damage affecting >5 percent of population likely every seven years) could have cumulative adverse effects on debt sustainability if causing prolonged low growth.

### Debt sustainability analysis — external and public sector
- External debt:
  - Under baseline, PV of external PPG debt indicators remain below policy-relevant thresholds.
  - Total external PPG debt projected: 7.5 percent of GDP in 2016 → 18.2 percent in 2021 (mainly TRHDP disbursements) → 30.1 percent of GDP in 2037.
  - Sensitivity: a rise in interest rates on new borrowing by 2 percentage points relative to baseline breaches indicative thresholds (PV of debt-to-GDP and PV of debt-to-exports), making concessional terms critical.
  - Severe natural disaster shock raises debt trajectories; indicators still below thresholds given low starting point but risk rises with multiple shocks.
- Public sector debt:
  - PV of public sector debt-to-GDP remains below threshold under baseline but rises from 7.9 percent and breaches authorities’ threshold of 30 percent in 2028 under current policies.
  - Breach driven by high disbursement schedule and continued expansionary fiscal policy.
  - Sensitivity: severe shock to real GDP growth causes PV debt-to-GDP to breach 38 percent of GDP benchmark by 2026 (note elsewhere states by 2030 under a shock to real GDP growth—both emphasize vulnerability to growth shocks).
  - Severe natural disaster shock would cause public debt-to-GDP to breach 30 percent in 2023 (five years earlier than baseline).

### Policy adjustment scenario and recommended priorities
- Rebuilding cash balance is the first priority for fiscal consolidation and smoother cash management.
- Policy adjustment scenario shows debt levels similar in early years but lower over longer term as cash buffers are rebuilt.
- Recommendations and policy implications:
  - Contract external borrowing on concessional terms as much as possible to contain debt burden.
  - Tighten fiscal policy and strengthen public financial management.
  - Boost long-term economic growth.
  - Recalibrate fiscal policy to rebuild a fiscal buffer (likely requiring stronger revenue mobilization and expenditure rationalization).
  - Be cautious on expenditures; prioritize investment projects that build resilience to natural disasters and projects that boost potential growth, broaden the export base, or reduce reliance on imports.

### Conclusion: Overall assessment of debt distress risk
- The current DSA suggests the Solomon Islands’ risk of external debt distress continues to be moderate under the baseline.
- Analysis highlights vulnerability of debt sustainability to external financing terms, fiscal and growth shocks, and natural disasters.
- Aid flows and FDI contribute importantly to supporting debt sustainability.
- To keep the debt burden contained, external borrowing should be contracted on concessional terms as much as possible, and fiscal consolidation and public financial management reforms are necessary to rebuild buffers.

*Source: cr1857 — IMF staff estimates.*

### 19.      The authorities broadly agree with the assessment of debt sustainability analysis and

### 19.      The authorities broadly agree with the assessment of debt sustainability analysis and

### Agreement on DSA and incorporation of shocks
- Authorities "broadly agree with the assessment of debt sustainability analysis and welcome the incorporation of the average long-term effects of natural disasters and climate change into the baseline."
- Authorities noted appreciation that "this is the first time that such a shock scenario has been incorporated into staff projections" and found it useful for assessing potential impacts on economic growth and debt dynamics.
- The analysis "reinforces the importance of having strong fiscal buffers" and of undertaking investments in climate proof infrastructure.

### Borrowing plans, preferences, and debt stance
- Medium-term intent: increase both external borrowing (mainly for the Tina River hydropower project) and domestic borrowing for large infrastructure projects (especially for the undersea/submarine cable project).
- Financing preferences: seek "external concessional and preferably grant finance for the bulk of external assistance" given vulnerability to changes in financing terms.
- Current debt level noted: "Debt as a percent of GDP remains low at around 10 percent of GDP in 2017."

### Nominal GDP data uncertainty
- Authorities "noted the uncertainty over the quality of nominal GDP data and the different estimates of the Ministry of Finance and IMF staff."
- IMF staff response: "the differences in nominal GDP estimates were not large enough to impact on the risk rating."
- National Statistics Office: working on "revising and strengthening the GDP data" and "the new data will be published early next year."

### DSA baseline indicators and key statistics (selected, as reported)
- External debt (nominal) in percent of GDP: 2014: 12.0; 2015: 10.6; 2016: 8.2; 2017: 9.0; 2018: 12.8; 2019: 14.9; 2020: 17.3; 2021: 19.3; 2022: 21.1; 2023: 22.6; 2024: 24.1; 2025: 25.5; 2026: 26.9; 2027: 28.0; 2037: 32.1.
- PV of external debt (percent of GDP): reported series includes 6.6, 6.7, 7.7, 8.4, 9.4, 10.3, 11.4, 12.5, 13.6, 14.7, 15.9, 17.0, 21.6.
- PV of PPG external debt (percent of GDP): reported series includes 5.8, 5.8, 6.8, 7.4, 8.3, 9.2, 10.2, 11.2, 12.2, 13.3, 14.4, 15.5, 19.7.
- PV of PPG external debt (in percent of exports): series includes 12.9, 13.1, 15.9, 17.5, 20.0, 23.0, 26.7, 29.1, 29.1, 33.7, 41.5, 73.3 (selected values shown in table).
- Debt service-to-exports ratio (in percent): 2014–2027 series includes 16.5, 4.9, 3.6, 2.0, 1.8, 1.6, 1.3, 1.3, 1.3, 1.2, 1.3, 1.4, 1.4, 5.6.
- PPG debt service-to-revenue ratio (in percent) series includes 2.3, 2.0, 2.6, 2.5, 2.2, 1.9, 1.5, 1.5, 1.5, 1.5, 1.5, 1.6, 1.5, 4.8.
- Total gross financing need (Millions of U.S. dollars): series includes 117.4, 31.0, 30.9, 6.8, 43.3, 48.6, 52.9, 40.7, 51.8, 52.0, 59.7, 67.8, 78.8, 87.4, 203.9 (selected years reported).

### Key macroeconomic baseline assumptions (selected)
- Real GDP growth (in percent) series: 2.3, 2.5, 3.5, 4.5, 4.6, 3.2, 3.0, 2.9, 2.8, 2.8, 2.8, 2.9, 2.9, 3.0, 3.0, 3.1, 3.3, 3.3, 3.2.
- GDP deflator in US dollar terms (change in percent) series includes 1.6, -3.8, 3.0, 5.7, 6.7, 0.2, 4.6, 3.2, 3.5, 3.8, 3.9, 3.2, 4.5, 4.1, 4.3, 4.0, 4.5, 4.5, 4.3.
- Effective interest rate (percent) 5/ series includes 2.7, 1.6, 1.3, 2.4, 0.6, 1.7, 1.8, 1.4, 1.3, 1.2, 1.2, 1.4, 1.2, 1.3, 1.3, 1.3, 1.4, 1.7, 1.5.
- Grant element of new public sector borrowing (in percent) reported in projection years includes 50.7, 62.8, 60.5, 56.9, 56.9, 48.0, 56.0, 39.5, 38.4 (selected projection years).
- Government revenues (excluding grants, in percent of GDP) series includes 32.8, 35.1, 31.7, 31.7, 31.5, 31.4, 31.2, 31.0, 30.9, 30.7, 30.7, 30.7, 30.6, 30.4, 29.5 (selected years).

### Sensitivity analysis and stress tests (selected outcomes)
- Table 2 and Table 3 present alternative scenarios and bound tests for PV of debt-to-GDP, PV of debt-to-exports, and PV of debt-to-revenue ratios for 2017–37 under scenarios including:
  - A1: Key variables at their historical averages in 2017-2037.
  - A2: New public sector loans on less favorable terms in 2017-2037 (assumes interest rate on new borrowing is 2 percentage points higher than baseline).
  - B1–B6: Bound tests including real GDP growth shock (historical average minus one standard deviation), export value shock, US dollar GDP deflator shock, net non-debt creating flows shock, combinations of shocks, and a one-time 30 percent nominal depreciation in 2018.
- Examples of scenario outcomes (selected):
  - PV of debt-to-GDP ratio baseline: 6, 7, 7, 8, 9, 10, 15, 20 (selected snapshot values across projection horizon).
  - PV of debt-to-exports ratio under A2 reaches values such as 26, 97 (selected entries reflect large increases under less favorable financing).
  - Bound test B6 (one-time 30 percent nominal depreciation in 2018) produces pronounced increases in several ratios in 2018–2019.

### Public sector debt baseline and projections (selected)
- Public sector debt (percent of GDP): 2014: 12.8; 2015: 10.1; 2016: 7.9; 2017: 10.0; 2018: 14.6; 2019: 16.4; 2020: 18.6; 2021: 20.4; 2022: 21.9; 2027: 29.6; 2037: 45.3.
- PV of public sector debt (percent of GDP) series includes 6.2, 7.6, 9.5, 9.9, 10.7, 11.4, 12.2, 18.6, 34.7 (selected projection values).
- PV of public sector debt-to-revenue and grants ratio (in percent): series includes 15.1, 18.6, 22.4, 23.6, 25.7, 27.5, 29.8, 45.9, 89.1 (selected values).
- Gross financing need 2/ series reported includes -0.2, 2.7, 4.5, 5.2, 6.7, 4.7, 4.2, 3.8, 3.6, 4.3, 6.6.

### Authorities' economic outlook and growth expectations
- Authorities and staff: "Authorities broadly agree with staff’s assessment of economic activity."
- Growth in 2017: "around 3.2 percent" (driven by log exports, fishing revenues and construction).
- Authorities' expectation for 2018-2020: "average growth of around 4 percent" assuming major projects materialize (Gold Ridge mining development, submarine fiber optic cable, World Bank supported Tina River Hydro project).
- Authorities view major projects as upside risks per staff; they factor projects into their baseline because of confidence they will come to fruition.

### Fiscal policy priorities and actions
- Key priorities: "restore fiscal discipline including by rebuilding cash buffers, while facilitating much needed investment in infrastructure."
- 2017 fiscal position: "deteriorated due to increased expenditure in a number of areas and an over-optimistic outlook for revenue collections."
- 2018 Budget aims: "curb recurrent expenditure in administrative areas, while protecting social spending and prioritizing growth enhancing spending."
- Cash management: "prioritizing cash payments including all payroll obligations" and working on a strategy to deal with government arrears.
- Revenue mobilization measures: tightening compliance and improving tax administration with PFTAC support, centralization of debt collection, modernization of tax payment and lodgment (introducing an online platform), seminars for businesses, appointment of an audit advisor to examine tax avoidance.
- Considering further tax reforms including "introduction of a consumption-based tax and seeking to eliminate ad-hoc exemptions."
- Re-established "Core Economic Working Group" with bilateral partners and donors to support reform priorities and restore fiscal buffers, strengthen public financial management, and progress key legislation (Anti-corruption Bill, Constitutional Amendment Bill and Credit Union Bill).

### Infrastructure, climate resilience, and social indicators
- Key public investment projects: Honiara Road improvement, new wharves under the National Transport Fund, submarine cable project, Tina Hydro dam project (expected to provide "more than 200 jobs during construction" and "will greatly reduce carbon emissions").
- Access statistics noted: "less than half of the population have access to electricity" and "59 percent of households have to travel to access clean water."
- Investments aim to be climate resilient and aligned with the National Development Strategy and Sustainable Development goals.
- Energy sector: Solomon Islands Electricity Authority, with development partners, has started building mini hybrid power stations in the provinces.

### Monetary policy stance
- Authorities "view the current monetary policy stance as appropriate."
- Exchange rate regime: "basket peg exchange rate regime" viewed as working well.
- IMF advice: increase the cash reserve requirement given high liquidity; authorities prefer a gradual approach because of contained credit growth and low inflation.
- Liquidity absorption expectations: issuance of Bokolo bills and financing of new infrastructure projects expected to "slowly soak up excess liquidity."

### Financial inclusion and sector developments
- National Financial Inclusion Taskforce (NFIT) established four working groups in 2017 focusing on:
  - increase financial literacy and financial education;
  - pilot voluntary savings products for the informal sector with the Solomon Islands National Provident Fund;
  - open digital payment channels with the Inland Revenue Department;
  - pilot digitization of the agricultural value chain including payments to coconut farmers and workers.
- Consumer protection measures: two prudential guidelines introduced to protect financial sector consumers from predatory practices.
- Central Bank will "continue to monitor the growth of this sector and will introduce appropriate regulation and legislation when the market matures."
- Phase two of the strategy: "encourage greater usage of newly opened accounts."

### Technical assistance and donor engagement
- Authorities acknowledged value of Fund advice and technical assistance and "look forward to further constructive engagement in future."
- Thanks to development partners and the mission team for candid and constructive discussions.

*Source: Statement by Ms. Barron, Ms. Preston, and Mr. Kikiolo; IMF staff tables and figures as presented in the provided content.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2018/cr1857.pdf_