## 1vutea2023001 — VANUATU: STAFF REPORT FOR THE 2023 ARTICLE IV CONSULTATION

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### Key issues and overview
- Growth returned with the reopening of borders and resumption of project implementation; real GDP is expected to grow around 3.4 percent in 2023 as tourism and construction resume.
- The Economic Citizenship Program (ECP) is facing significant challenges, reducing revenues and raising governance concerns; the EU agreed in February 2023 to delay converting a partial suspension to a full suspension until August 2024.
- Key structural vulnerabilities: climate change and natural disaster exposure (frequent tropical cyclones, earthquakes, volcanic eruptions), limited infrastructure development capacity, and weak governance including fiscal risks from state-owned enterprises (SOEs).
- The new coalition government (post-October 2022 elections) faces constrained policy buffers after the pandemic and surging commodity prices linked to Russia’s war in Ukraine.

### Fiscal policy: findings and main recommendations
- Findings:
  - Fiscal position deteriorated sharply in 2022: a projected fiscal deficit of 6.6 percent of GDP in 2022, from a surplus of 2.3 percent of GDP in 2021.
  - Decline in ECP revenues weighed heavily on 2022 fiscal outturns.
  - Provisional 2022 revenue outturns only reached 80 percent of the supplementary budget target.
- Recommendations:
  - Adopt a credible medium-term fiscal strategy to rebuild buffers and consolidate.
  - New revenue mobilization policies should include the introduction of corporate or personal income taxes and base broadening.
  - Promptly launch fiscal consolidation efforts and secure at least 2 percent of GDP in savings to meet the fiscal anchor while protecting capital spending.
  - Strengthen monitoring of fiscal risks from SOEs and urgently complete restructuring of Air Vanuatu to reduce contingent liabilities.
  - Expand sizeable cash reserves built in recent years and strengthen fiscal buffers given vulnerability to natural disasters.

### Air Vanuatu: urgent restructuring need
- Restructuring must be completed urgently to reduce fiscal risks.
- Despite recent government financial support, the airline’s operational and financial challenges are worsening, affecting tourism and domestic connectivity.
- Government actions and fiscal exposure:
  - Capital injection of VT 334 million (0.3 percent of GDP) in 2022.
  - Further fiscal transfers, government guarantees, or transfer of some of the airline’s debt (estimated at 6 percent of GDP) to the government may be needed as part of deeper restructuring.
  - Rapid assessment by Australia’s DFAT and IFC analysis are important inputs.
- Recommendation: conduct careful analysis of restructuring options to minimize contingent liabilities and transfers while preserving the airline’s systemic economic role.

### Monetary and exchange rate policy
- Findings:
  - Current monetary policy stance is appropriate given weak private credit growth, subdued core inflation, and a negative output gap.
  - RBV should keep policy on hold to support the fragile recovery but remain data-driven and ready to tighten if there are signs of second round effects such as rapid increases in core inflation.
- Exchange rate:
  - The nominal exchange rate of the vatu is pegged to an undisclosed basket of currencies serving as a key inflation anchor.
  - Recommendation: Maintain two-way flexibility and increase the frequency of reviews of the currency basket.
  - Exchange rate regime detail: 114.44 per U.S. dollar; de facto classification “other managed.”

### Financial sector policies, vulnerabilities, and recommendations
- Findings:
  - Banking system remains profitable, liquid, and adequately capitalized: CAR at 22.5 percent and liquid asset ratio at 58.5 percent as of 2022Q2 (both above regulatory thresholds of 10 percent and 5 percent).
  - Asset quality has deteriorated and non-performing loans (NPLs) remain high relative to peers; households account for the bulk of NPLs while provisioning is low.
- Recommendations:
  - Prioritize reducing elevated NPLs.
  - Strengthen supervisory and resolution frameworks.
  - Increase minimum capital requirements and provisioning for some banks.
  - Introduce a debt-service-to-income (DSTI) ratio to help contain unsustainable household debt formation.
  - Reinforce credit information and improve Vanuatu’s credit bureau.
  - Consider a retail CBDC to facilitate digitalization, conditional on legal, supervisory, and technological readiness.
- Digital finance and access:
  - One in three adults is unbanked; rollout of the digital national payments system (expected 2023) will strengthen payments infrastructure.

### Structural reforms and growth potential
- Recommendations:
  - Implement bold structural reforms to unlock growth potential and diversify the economy, particularly in agriculture.
  - Improve public investment management and capacity to implement large-scale projects.
  - Streamline administrative processes for FDI and implement policies to address labor shortages (including tourism and hospitality training and vocational programs).
  - Design agricultural subsidies to target market failures and subject them to rigorous impact evaluations.
  - Revise reserved occupations and consider labor market impacts of proposed minimum wage hikes (between 36 and 60 percent).

### Governance, AML/CFT, and ECP
- Findings:
  - Significant deficiencies in Vanuatu’s AML/CFT regime and governance frameworks; ECP raises governance and financial integrity risks.
- Recommendations:
  - Better assess ML/TF risks, strengthen the AML/CFT framework in line with international standards (including regulation of virtual asset service providers), and bolster capacity of competent authorities and law enforcement.
  - Address governance risks surrounding the ECP; use the upcoming APG review to demonstrate tangible results.
  - Strengthen public sector governance, particularly central bank and SOE governance and transparency (timely publication of financial statements).

### Recent developments and outlook highlights (selected exact series)
- Real GDP (annual percent change): 2019 = 3.2; 2020 = -5.0; 2021 = 0.6; 2022 = 1.9; 2023 (projection) = 3.5; 2024 = 3.6; 2025 = 3.9; 2026 = 3.1; 2027 = 3.0; 2028 = 2.5.
- Consumer prices (period average): 2019 = 2.7; 2020 = 5.3; 2021 = 2.3; 2022 = 4.6; 2023 = 3.5; 2024 = 3.0; 2025 = 3.1; 2026 = 3.1; 2027 = 3.1; 2028 = 3.1.
- Total revenue (percent of GDP): 2019 = 42.6; 2020 = 41.4; 2021 = 45.7; 2022 = 38.1; 2023 = 40.0; 2024 = 35.7; 2025 = 34.0; 2026 = 33.5; 2027 = 33.2; 2028 = 32.9.
- Net lending (+)/borrowing (–) (percent of GDP): 2019 = 2.8; 2020 = -1.9; 2021 = 2.3; 2022 = -6.6; 2023 = -6.2; 2024 = -7.3; 2025 = -6.9; 2026 = -6.0; 2027 = -6.2; 2028 = -6.1.
- Public and publicly-guaranteed debt (end of period, percent of GDP): 2019 = 45.9; 2020 = 48.9; 2021 = 48.4; 2022 = 46.6; 2023 = 49.2; 2024 = 53.1; 2025 = 56.1; 2026 = 58.5; 2027 = 61.4; 2028 = 64.3.
- Current account (percent of GDP): 2019 = 27.8; 2020 = 7.9; 2021 = 0.8; 2022 = -2.2; 2023 = -3.6; 2024 = -1.2; 2025 = 2.2; 2026 = 2.6; 2027 = 2.3; 2028 = 2.3.
- Travel receipts (percent of GDP): 2019 = 28.8; 2020 = 6.2; 2021 = 0.2; 2022 = 5.1; 2023 = 15.9; 2024 = 18.9; 2025 = 22.9; 2026 = 22.6; 2027 = 22.4; 2028 = 22.2.
- Gross international reserves (in millions of U.S. dollars): 2019 = 511.6; 2020 = 613.6; 2021 = 664.8; 2022 = 706.0; 2023 = 754.5; 2024 = 801.4; 2025 = 871.1; 2026 = 950.5; 2027 = 1,030.2; 2028 = 1,122.7.
- Memorandum: Population (2020) = 301,695; Per Capita GDP (2020) = US$ 3,341; IMF quota = SDR 23.8 million (0.01 percent of total).

### Outlook, tourism, inflation, and output gap
- GDP projected to return to its pre-pandemic level in 2023; growth projected at 3.5 percent y/y in 2023 supported by tourism recovery and higher public infrastructure spending.
- Tourism: expected to recover to about 65 percent of its pre-pandemic level by end-2023; travel receipts projected at 15.9 percent of GDP in 2023.
- Inflation: expected to be 3.8 percent by end-2023 (below 2022 level and RBV’s upper target) and converge to about 3 percent over the medium-term.
- Output gap: GDP level returns to pre-pandemic level in 2023, but output gap expected to close only by 2025 with some scarring.

### Risks and downside scenarios (selected exact outcomes)
- Balance of risks tilted to the downside; uncertainty is high with conjunctural and structural risks (COVID-19 variants, slowdown in trading partners, total loss of ECP revenues, growing NPLs, weak governance, natural disasters).
- Severe Downside Scenario (assumes no ECP revenues from 2023 and no offsetting fiscal measures; additional deficits financed half by non-concessional external debt and half by domestic debt) — selected series (percent of GDP, unless otherwise indicated):
  - ECP revenues (Baseline / Downside Scenario): 7.5 / 7.5 (2022); 4.6 / 0.0 (2024); 4.2 / 0.0 (2027).
  - Fiscal balance: -6.6 / -6.6 (2022); -7.3 / -12.2 (2024); -6.2 / -11.7 (2027).
  - Public debt: 46.6 / 46.6 (2022); 53.1 / 63.5 (2024); 61.4 / 85.0 (2027).
  - Current account: -2.2 / -2.2 (2022); -1.2 / -5.8 (2024); 2.3 / -1.9 (2027).
  - Reserves coverage (months of prospective imports): 10.9 / 10.9 (2022); 11.5 / 9.8 (2024); 12.7 / 9.2 (2027).

### Fiscal strategy: near term and medium term
- Near term:
  - Fiscal policy will remain expansionary; staff estimate fiscal deficit at 6.2 percent of GDP in 2023, increasing in 2024 as externally-financed infrastructure projects accelerate.
  - Unwinding pandemic support and VAT gains from tourism expected to be offset by reduced ECP receipts.
- Medium term:
  - 60 percent of GDP ceiling for public and publicly guaranteed (PPG) debt would be breached by 2027 under current policies.
  - Staff estimate a medium-term strategy generating at least an additional 2 percent of GDP in savings is needed.
  - Strategy elements:
    - Revenue mobilization (update/complete proposed 2017 tax reforms: introduction of corporate and personal income taxes; VAT currently 15 percent).
    - Given VAT regressivity and recent VAT increase, introduce progressive income tax may be more practical; Tax Administration Act provides basic infrastructure.
    - Broadening the tax base by reducing informality (incentives to register for VAT, lower VAT registration threshold, improve audit capacity).
    - Expenditure rationalization (digitalization, staffing rationalization, improve project prioritization).
    - Central agency for social protection and use of national IDs to build social protection database.
    - Contingent spending and revenue policies for adverse shocks.

### Debt sustainability and contingent liabilities
- Risk of debt distress: moderate with limited space to absorb shocks.
- External debt indicators currently below thresholds due to concessional borrowing; contingent liabilities from Air Vanuatu and exposure to natural disasters are key vulnerabilities.
- Severe downside scenario with full loss of ECP revenues leads to significant deterioration and unsustainable paths (public debt could reach 85.0 percent of GDP by 2027 under downside scenario).
- Risks of increased domestic debt issuance: may exceed domestic absorption capacity, crowd out private credit, raise debt service costs; monetary financing risks damaging RBV credibility.

### Policy coordination and priorities
- Capitalize on recovery to adopt and credibly implement a medium-term fiscal strategy that consolidates while protecting productive and climate-critical infrastructure spending.
- Coordinate fiscal and monetary policy to keep inflation under control while supporting growth; RBV should be ready to tighten if warranted.
- Urgently address financial sector vulnerabilities, SOE governance, and ECP-related governance risks to rebuild policy space and enhance resilience.
- Prioritize grants and concessional loans for new infrastructure; continue technical assistance (PFTAC) on revenue administration, PFM, debt management, banking regulation, and statistics.

### Analytical annexes, modeling, and tax policy experiments
- Annex VI (overview): Heterogeneous agents general equilibrium model exercises on income taxes and VAT assessing revenue and welfare trade-offs.
  - First exercise: Introduction of PIT and CIT calibrated to raise 1 percent of GDP; model outcomes include welfare reductions and expected output loss of 2 percent of GDP without transfers.
  - Second exercise: Comparing VAT-only, PIT/CIT-only, and VAT+PIT/CIT to raise tax-to-GDP by 2 percentage points; trade-offs between output loss and welfare/distributional outcomes detailed.
  - Third exercise: Introducing PIT/CIT in an economy with a smaller informal sector reduces output loss by 30 percent for similar revenue increases.
- Key model/tax policy takeaways:
  - Costs of introducing income taxes can be reduced by improving formal sector coverage and VAT efficiency.
  - A progressive income tax with appropriate exemptions can raise revenue and decrease inequality but may distort labor allocations and reduce GDP.
  - VAT C-efficiency improvements and formalization increase revenue capacity with smaller distortions.

### Authorities’ views and commitments
- Authorities concur with assessment of recovery, uncertain outlook, and downside risks.
- Authorities expect GDP growth of 3.6 percent in 2023 and headline inflation above RBV’s upper target of 4 percent in early to mid-2023 but converging toward target by end-2023.
- Authorities recognize ECP proceeds are not stable and should not finance recurrent spending; they do not see scope for new revenue measures, particularly income taxes, favoring growth acceleration and improved tax compliance instead.
- Authorities requested IMF support through a Public Investment Management Assessment (PIMA) and are pursuing solutions for Air Vanuatu with DFAT and IFC input.
- Authorities expressed appreciation for Fund and PFTAC support and requested continuation of capacity-building assistance.

*Italic source attribution: Excerpt from the IMF chapter on Vanuatu (provided content).*

### introduction of corporate or personal income taxes and through base broadening—should

### VANUATU: STAFF REPORT FOR THE 2023 ARTICLE IV CONSULTATION

### Key issues and overview
- Growth returned with the reopening of borders and resumption of project implementation; real GDP is expected to grow around 3.4 percent in 2023 as tourism and construction resume.
- The Economic Citizenship Program (ECP) is facing significant challenges, reducing revenues and raising governance concerns; the EU agreed in February 2023 to delay converting a partial suspension to a full suspension until August 2024.
- Key structural vulnerabilities: climate change and natural disaster exposure (frequent tropical cyclones, earthquakes, volcanic eruptions), limited infrastructure development capacity, and weak governance including fiscal risks from state-owned enterprises (SOEs).
- The new coalition government (post-October 2022 elections) faces constrained policy buffers after the pandemic and surging commodity prices linked to Russia’s war in Ukraine.

### Fiscal policy: findings and main recommendations
Findings
- Fiscal position deteriorated sharply in 2022: a projected fiscal deficit of 6.6 percent of GDP in 2022, from a surplus of 2.3 percent of GDP in 2021.
- Decline in ECP revenues weighed heavily on 2022 fiscal outturns.
- Provisional 2022 revenue outturns only reached 80 percent of the supplementary budget target.

Recommendations
- Adopt a credible medium-term fiscal strategy to rebuild buffers and consolidate.
- New revenue mobilization policies should include the introduction of corporate or personal income taxes and base broadening.
- Promptly launch fiscal consolidation efforts and secure at least 2 percent of GDP in savings to meet the fiscal anchor while protecting capital spending.
- Strengthen monitoring of fiscal risks from SOEs and urgently complete restructuring of Air Vanuatu to reduce contingent liabilities.
- Expand sizeable cash reserves built in recent years and strengthen fiscal buffers given vulnerability to natural disasters.

### Air Vanuatu: urgent restructuring need
- The restructuring of Air Vanuatu must be completed urgently to reduce fiscal risks.
- Despite recent government financial support, the airline’s operational and financial challenges are worsening, affecting tourism and domestic connectivity.
- A careful analysis of restructuring options is needed to identify a sustainable solution that minimizes contingent liabilities and transfers from the government while preserving the airline’s systemic economic role.
- A rapid assessment by Australia’s Department of Foreign Affairs and Trade (DFAT) is an important first step.

### Monetary and exchange rate policy
Findings
- Current monetary policy stance is appropriate given weak private credit growth, subdued core inflation, and a negative output gap.
- The Reserve Bank of Vanuatu (RBV) should keep policy on hold to support the fragile recovery but remain data-driven and ready to tighten if there are signs of second round effects such as rapid increases in core inflation.
- The exchange rate should continue to act as a shock absorber.

### Financial sector policies
Findings
- The banking system remains profitable, liquid, and adequately capitalized: CAR at 22.5 percent and liquid asset ratio at 58.5 percent as of 2022Q2 (both well above regulatory thresholds of 10 percent and 5 percent, respectively).
- Asset quality has deteriorated and non-performing loans (NPLs) remain high compared to peers.

Recommendations
- Prioritize reducing elevated NPLs.
- Strengthen the supervisory and resolution framework.
- Increase minimum capital requirements and provisioning for some banks.
- Introduce a debt-service-to-income ratio to help contain the formation of unsustainable household debt.

### Structural reforms and growth potential
Recommendations
- Implement bold structural reforms to unlock growth potential and diversify the economy, particularly in the agricultural sector.
- Improve public investment management to strengthen capacity to implement large-scale projects.
- Streamline administrative processes for FDI and implement policies to address labor shortages.

### Governance, AML/CFT, and ECP
Findings and recommendations
- Significant deficiencies exist in Vanuatu’s AML/CFT regime and governance frameworks.
- Authorities should better assess and understand ML/TF risks, strengthen the AML/CFT framework in line with international standards (including regulation of virtual asset service provider activities), bolster capacity of competent authorities and law enforcement, and address governance risks surrounding the ECP.
- The upcoming APG review is an opportunity to show tangible results.
- Strengthen public sector governance, particularly regarding the central bank and SOEs.

### Recent developments and outlook highlights
- Real GDP: 2019 = 3.2; 2020 = -5.0; 2021 = 0.6; 2022 = 1.9; 2023 (projection) = 3.5; 2024 = 3.6; 2025 = 3.9; 2026 = 3.1; 2027 = 3.0; 2028 = 2.5.
- Consumer prices (period average): 2019 = 2.7; 2020 = 5.3; 2021 = 2.3; 2022 = 4.6; 2023 = 3.5; 2024 = 3.0; 2025 = 3.1; 2026 = 3.1; 2027 = 3.1; 2028 = 3.1.
- Total revenue (percent of GDP): 2019 = 42.6; 2020 = 41.4; 2021 = 45.7; 2022 = 38.1; 2023 = 40.0; 2024 = 35.7; 2025 = 34.0; 2026 = 33.5; 2027 = 33.2; 2028 = 32.9.
- Net lending (+)/borrowing (–) (percent of GDP): 2019 = 2.8; 2020 = -1.9; 2021 = 2.3; 2022 = -6.6; 2023 = -6.2; 2024 = -7.3; 2025 = -6.9; 2026 = -6.0; 2027 = -6.2; 2028 = -6.1.
- Public and publicly-guaranteed debt (end of period, percent of GDP): 2019 = 45.9; 2020 = 48.9; 2021 = 48.4; 2022 = 46.6; 2023 = 49.2; 2024 = 53.1; 2025 = 56.1; 2026 = 58.5; 2027 = 61.4; 2028 = 64.3.
- Current account (percent of GDP): 2019 = 27.8; 2020 = 7.9; 2021 = 0.8; 2022 = -2.2; 2023 = -3.6; 2024 = -1.2; 2025 = 2.2; 2026 = 2.6; 2027 = 2.3; 2028 = 2.3.
- Travel receipts (percent of GDP): 2019 = 28.8; 2020 = 6.2; 2021 = 0.2; 2022 = 5.1; 2023 = 15.9; 2024 = 18.9; 2025 = 22.9; 2026 = 22.6; 2027 = 22.4; 2028 = 22.2.
- Gross international reserves (in millions of U.S. dollars): 2019 = 511.6; 2020 = 613.6; 2021 = 664.8; 2022 = 706.0; 2023 = 754.5; 2024 = 801.4; 2025 = 871.1; 2026 = 950.5; 2027 = 1,030.2; 2028 = 1,122.7.
- Memorandum: Population (2020) = 301,695; Per Capita GDP (2020) = US$ 3,341; IMF quota = SDR 23.8 million (0.01 percent of total).

### Policy coordination and priorities
- Capitalize on the recovery to adopt and credibly implement a medium-term fiscal strategy that consolidates and enacts meaningful reforms while protecting productive and climate-critical infrastructure spending.
- Coordinate fiscal and monetary policy carefully to keep inflation under control while supporting growth; monetary policy should be calibrated to data and the RBV should be ready to tighten if warranted.
- Urgently address financial sector vulnerabilities, SOE governance, and ECP-related governance risks to rebuild policy space and enhance resilience.

*VANUATU: STAFF REPORT FOR THE 2023 ARTICLE IV CONSULTATION (IMF staff report).*

### 10.      The current account deficit widened, but the external sector position remains broadly

### 10.      The current account deficit widened, but the external sector position remains broadly

### Current account and external sector
- The current account balance is expected to move into a deficit of 2.2 percent of GDP in 2022 from a surplus of 0.8 percent of GDP in 2021, largely due to a widening of the trade deficit following rising import prices related to Russia’s war in Ukraine.
- Gross international reserves remain adequate.
- The 2021 SDR allocation is maintained with the Reserve Bank of Vanuatu to boost foreign reserves.

### Outlook and growth projections
- GDP is projected to return to its pre-pandemic level in 2023.
- GDP growth projections:
  - 3.5 percent y/y in 2023, supported by:
    - gradual recovery in tourism,
    - higher public infrastructure spending particularly for construction,
    - ongoing recovery in trading partners.
  - Growth is anticipated to peak in 2025 when tourism fully returns to pre-pandemic level before trending down to its long-term rate of about 3 percent.
- Tourism recovery:
  - Tourism is expected to recover to about 65 percent of its pre-pandemic level at the end of 2023.
- Inflation:
  - Expected to remain high at 3.8 percent by end-2023, below its 2022 level and the RBV’s upper target.
  - Expected to converge to about 3 percent over the medium-term.
- Output gap:
  - GDP level should return to its pre-pandemic level in 2023, but the output gap is expected to only close by 2025 with some scarring from the pandemic.

### Risks and downside scenarios
- Balance of risks is tilted to the downside; uncertainty is high.
- Conjunctural risks include:
  - COVID-19: return of tourism could spread variants and cause new lockdowns; could halt return of foreign experts and delay projects.
  - Slowdown in global outlook among main trading partners could lower tourism and remittances.
  - Total loss of ECP revenues could jeopardize medium-term fiscal and debt sustainability and erode reserve buffers.
- Structural risks include:
  - Growing NPLs affecting banks’ profitability and capital.
  - Weak governance, anti-corruption frameworks, and financial integrity; Air Vanuatu’s financial distress and operational challenges; lack of transparency and supervisory framework for SOEs; AML/CFT concerns.
  - Higher frequency and severity of natural disasters induced by climate change.
- Severe Downside Scenario (assumes no ECP revenues from 2023 and no offsetting fiscal measures; additional deficits financed half by non-concessional external debt and half by domestic debt):
  - Baseline / Downside Scenario (percent of GDP, unless otherwise indicated)
    - ECP revenues: 7.5 / 4.6 / 4.2 (2022 2024 2027) — Baseline; 7.5 / 0.0 / 0.0 (2022 2024 2027) — Downside Scenario
    - Fiscal balance: -6.6 / -7.3 / -6.2 (2022 2024 2027) — Baseline; -6.6 / -12.2 / -11.7 (2022 2024 2027) — Downside Scenario
    - Public debt: 46.6 / 53.1 / 61.4 (2022 2024 2027) — Baseline; 46.6 / 63.5 / 85.0 (2022 2024 2027) — Downside Scenario
    - Current account: -2.2 / -1.2 / 2.3 (2022 2024 2027) — Baseline; -2.2 / -5.8 / -1.9 (2022 2024 2027) — Downside Scenario
    - Reserves coverage (months of prospective imports): 10.9 / 11.5 / 12.7 (2022 2024 2027) — Baseline; 10.9 / 9.8 / 9.2 (2022 2024 2027) — Downside Scenario

### Fiscal policy: near term and medium term
- Near term:
  - Fiscal policy will remain expansionary.
  - Staff estimate fiscal deficit at 6.2 percent of GDP in 2023, and increasing further in 2024 as externally-financed infrastructure projects accelerate.
  - Unwinding pandemic-related support programs will help contain current spending; return of tourism will boost VAT revenues, but reduced ECP receipts will offset revenue gains.
- Need for consolidation and buffer rebuilding:
  - Large projected fiscal deficits and increased current spending require scaling back non-priority domestic spending and improving tax collection during the recovery period.
  - Priorities include:
    - addressing weaknesses in tax administration, especially VAT collection given decline in C-efficiency;
    - reviewing costly transfers to other government units;
    - targeted assistance for households if inflation exceeds expectations, while avoiding costly and regressive untargeted subsidies and public wage increases.
- Medium-term fiscal strategy:
  - 60 percent of GDP ceiling for public and publicly guaranteed (PPG) debt would be breached by 2027 under current policies.
  - A credible medium-term fiscal strategy that secures adequate consolidation to keep debt below the ceiling while protecting growth-critical infrastructure and creating fiscal space for adaptation is needed.
  - Staff estimate that a strategy generating at least an additional 2 percent of GDP in savings as early as possible would adequately meet these aims.
  - Strategy elements:
    - Revenue mobilization policies, including updating and completing the proposed 2017 tax reforms (introduction of corporate and personal income taxes). Staff analysis shows that a 2 percent of GDP increase in revenues can be achieved through combinations of new income taxes or increases in the VAT rate (currently 15 percent), with efficiency and distributional trade-offs.
    - Given the recent VAT increase and regressivity of VAT, introducing a progressive income tax may be more practical; basic infrastructure for income taxes exists through the Tax Administration Act.
    - Broadening the tax base by reducing informality is essential. Possible interventions: incentives for businesses to register for VAT, encourage customers to request invoices, lowering the threshold for VAT registration, and improving audit capacity.
    - Expenditure rationalization: gradually reduce wage bill via digitalization and staffing rationalization; improve public infrastructure management and project prioritization considering absorptive capacity and expected returns.
    - Assign a central agency responsibility for social protection and use newly-issued national IDs to create a database for social protection programs to improve spending efficiency.
    - Contingent spending and revenue policies for adverse shocks, given contingent liabilities, climate change, and natural disaster risks.
- VAT specifics:
  - Current VAT rate is 15 percent (increased from 12.5 percent to 15 percent in 2018).
  - VAT C-efficiency has declined despite no change to the standard VAT rate, suggesting administrative gaps and large informal sector.
  - Current VAT registration threshold: businesses with over VUV 4 billion in total taxable supplies over a 12-month period.

### Debt sustainability and contingent liabilities
- Risk of debt distress remains moderate with limited space to absorb shocks.
- External debt indicators are below thresholds due to concessional borrowing.
- Vulnerabilities:
  - Contingent liabilities from Air Vanuatu.
  - Exposure to natural disasters.
- Severe downside scenario with full loss of ECP revenues leads to significant deterioration in external debt sustainability and unsustainable path.
- Beyond 2027, absent consolidation and limited donor support, reliance on domestic debt and monetary financing would increase, with risks:
  - Domestic debt expansion may exceed absorption capacity of domestic banking system, crowd out private credit, and raise debt service costs.
  - Monetary financing risks damaging RBV’s credibility, triggering fiscal dominance, raising inflation, and eroding international reserves.

### Air Vanuatu and SOE fiscal risks
- Air Vanuatu is in severe financial distress with arrears and staff shortages.
- Government actions and fiscal exposure:
  - Government appointed new leadership and is assessing solutions with support from Australia’s DFAT rapid assessment and IFC analysis.
  - Capital injection of VT 334 million (0.3 percent of GDP) in 2022.
  - Further fiscal transfers, government guarantees, or transfer of some of the airline’s debt (estimated at 6 percent of GDP) to the government may be needed as part of a deeper restructuring.
  - Closer monitoring and timely policy action related to fiscal risks from other SOEs is needed.

### Authorities’ views (summarized)
- Authorities concur with assessment of recovery, uncertain outlook, and downside risks.
- They expect GDP growth of 3.6 percent in 2023 driven by agriculture and construction, and retail trade and accommodation following reopening.
- They expect headline inflation to remain above RBV’s upper target of 4 percent in early to mid-2023 but converge toward the target by end-2023.
- Authorities recognize ECP proceeds are not stable and should not finance recurrent spending; they do not see scope for new revenue measures, particularly income taxes, favoring growth acceleration and improved tax compliance instead.
- Authorities acknowledge scope for improvement in public investment management and requested IMF support through a Public Investment Management Assessment (PIMA).
- Authorities are actively pursuing solutions for Air Vanuatu and plan to use rapid assessment and IFC analysis to develop restructuring plans.

### Monetary and exchange rate policy
- Monetary policy is on hold; RBV kept the statutory reserve deposit (SRD) ratio unchanged to support the economy.
- Credit to the private sector is weak but gradually improving; output gap remains negative.
- Despite accelerating headline inflation in 2022Q2, core inflation remains low.
- RBV should stand ready to tighten monetary policy if:
  - growing import demand leads to sustainably high inflation, or
  - signs of second-round effects such as rapid increases in core inflation emerge.
- Possible tightening tools:
  - increasing the SRD ratio,
  - reducing excess liquidity through open market operations.
- Greater coordination with fiscal policy is needed given Vanuatu’s relatively weak transmission of monetary policy into the real economy.

*International Monetary Fund staff report (excerpt).*

### 23.      The exchange rate should continue to act as a shock absorber. The nominal exchange

### 23.      The exchange rate should continue to act as a shock absorber.

### Exchange rate policy and inflation anchoring
- The nominal exchange rate of the vatu is pegged to an undisclosed basket of currencies corresponding to the bilateral exchange rates of the main trade and tourism partners and serving as a key inflation anchor.
- The basket-peg has allowed for flexibility; the real and nominal effective exchange rates appreciated in 2022, helping cushion the impact of rising import prices.
- Recommendation: Maintain two-way flexibility and monitor for emerging imbalances arising from any currency misalignment (Annex II).
- Recommendation: Increase the frequency of reviews of the currency basket to help the economy cope with shocks.
- Authorities’ view: The authorities consider that the exchange rate regime has served the country well and are currently reviewing the weights of the vatu basket of currencies, including the possibility of adding more currencies.

### Monetary developments and central bank stance
- Finding: Gradual credit growth is supporting the recovery amid rising price pressures and subdued core inflation.
- Finding: Excess reserves could hinder monetary policy transmission while the exchange rate is acting as a shock absorber.
- RBV policy stance:
  - Plans to keep policy on hold, given low underlying inflation and weak credit growth.
  - Policy rates kept unchanged through the pandemic; recent increases in headline inflation viewed as mostly imported.
  - Monetary policy will remain supportive while credit to the private sector remains weak.
  - RBV will conduct open market operations to mop up excess liquidity from banks.
  - The central bank did not introduce measures since the previous Article IV consultation that may give rise to exchange rate restrictions.

### Financial sector policies, vulnerabilities, and recommendations
- Finding: The banking system remains profitable and liquid; moratoria on loan repayments and easing of prudential requirements expired in September 2022. On-site inspections expected to resume in 2023.
- Finding: National Bank of Vanuatu re-established correspondent banking relationships (CBRs) allowing foreign currency intermediation (particularly USD clearing) at a relatively high cost compared to competitor banks.
- Non-Performing Loans (NPLs):
  - Households account for the bulk of NPLs while the level of provisioning is low.
  - High NPLs, particularly for households and the National Bank of Vanuatu, remain a concern.
  - Impaired loans could further increase as forbearance measures expire; some banks extended relief measures to support affected customers.
- Recommendations to strengthen resilience:
  - Strengthen the supervisory framework and resolution frameworks, including through restructuring programs.
  - Increase loan-loss provisioning and encourage accumulation of reserves in anticipation of potential loan losses.
  - Increase the minimum capital requirement to encourage banks to accumulate additional buffers (e.g., via retained earnings).
  - Introduce a DSTI ratio (debt-service-to-income ratio) to contain formation of unsustainable household debt.
  - Reinforce credit information by improving Vanuatu’s credit bureau.
- Digital finance:
  - Finding: One in three adults is unbanked due to remoteness and dispersion across Vanuatu’s 83 islands.
  - Recommendation: Establishing a retail CBDC could facilitate digitalization of financial services for rural and unbanked populations, conditional on appropriate legal, supervisory, regulatory frameworks, and technological infrastructure.
  - The upcoming launch of the digital national payments system for real time and more efficient payments will strengthen technological infrastructure.
- Authorities’ view: RBV assesses the banking system as profitable and liquid but agrees high NPLs, cyber-related risks, and de-risking of CBRs are key challenges. RBV is developing a new prudential guideline in line with Basel III expected to be issued in 2023 to strengthen capital, improve asset classifications, align provisions with IFRS 9, improve NPL monitoring, introduce a debt service to income ratio, and increase loan-loss provisioning.

### Structural policies for diversification, governance, and public investment
- Economic diversification and infrastructure:
  - October 2022 ratification of the Pacific Agreement on Closer Economic Relations Plus will facilitate greater investment.
  - Continued efforts toward agricultural development, including copra subsidies and a pilot mechanization subsidy program.
  - Recommendation: Design agricultural subsidies to target well-identified market failures and subject them to regular rigorous impact evaluations.
  - Recommendation: Reduce administrative barriers and streamline application and registration processes to attract additional FDI; review the Foreign Investment Act to consider the country’s needs for greater partnerships with foreign investors while balancing preference for ni-Vanuatu representation in key sectors.
  - Infrastructure projects improving connectivity (electricity, internet, waste management) are essential to expand key sectors such as tourism.
- Governance and financial integrity priorities:
  - Strengthen AML/CFT and financial integrity: progress made (ultimate beneficial ownership database, increased FIU independence) but ongoing deficiencies remain, particularly given ECP risks.
  - The Mutual Evaluation by the Asia-Pacific Group on Money Laundering (next APG Review, 4th mutual evaluation) is underway and will be completed by 2025; authorities should showcase tangible improvements.
  - ECP reforms: New government committed to addressing governance issues around the ECP flagged by the EU and secured an 18-month extension (from February 2023 to August 2024) of the partial visa waiver suspension to enact reforms aiming to ensure compliance with security and due diligence procedures.
  - RBV governance: Progress on implementing the 2016 Safeguards Assessment has been slow; authorities plan to repeal some 2022 amendments to the RBV Act that deteriorated autonomy, but two provisions (board seating allowance and increased government borrowing threshold) remain problematic and should be repealed.
  - SOE governance: Establish supervisory frameworks and enhance transparency, including timely publication of financial statements.
  - Public investment management: Centralize major projects under a single unit (e.g., Vanuatu Project Management Unit) from inception to completion; consider a Public Investment Management Assessment (PIMA).
  - Public financial management: Authorities finalizing a PFM Improvement Program for 2023–2026, a successor to 2017–2021 PFM Reform Roadmap.
  - Audits of COVID-related spending: External audit of first phase of Economic Stimulus Program has started; planned audits for second and third phases may be infeasible due to data loss from November 2022 ransomware cyber-attack.

### Climate resilience and labor market policies
- Climate resilience:
  - Vanuatu’s revised and enhanced Nationally Determined Contribution (NDC), issued in August 2022, details mitigation and adaptation needs over the next decade.
  - The total cost is estimated at over 120 percent of 2022 GDP and is beyond previously budgeted amounts.
  - Recommendation: Integrate financing plans for adaptation into a medium-term fiscal strategy; prioritize projects to maximize efficiency given capacity constraints and debt sustainability risks.
- Labor market and skills shortages:
  - Finding: Reopening of borders led to shortages of skilled labor in sectors like tourism as parts of the workforce participate in international labor mobility programs; Vanuatu has the largest participation of seasonal workers to Australia and New Zealand even prior to the pandemic.
  - Increased participation in seasonal worker programs has created a labor drain in major sectors and poses risks to growth despite higher remittances.
  - Recommendation: Improve labor market conditions, develop local skills via apprenticeship and vocational training, increase tourism and hospitality training, and improve female labor participation.
  - Policy consideration: Authorities are considering a significant hike to minimum wages (between 36 and 60 percent); this could lead to second-round inflation effects and push more unskilled labor into the informal sector.
  - Recommendation: Revise the list of reserved occupations under the Employment Act to identify opportunities to defray domestic labor market impacts.

### Capacity development and data needs
- The Fund is supporting Vanuatu authorities through technical assistance projects on balance of payments data, financial supervision, and public financial management.
- Data issues:
  - While data provision is broadly adequate for surveillance, statistical issues on the real and external sectors require further assistance.
  - Specific concerns include potential measurement errors and methodological shortcomings in the consumer price index as it relates to the magnitude of price increases (see Informational Annex).
- Authorities requested capacity building on macro-forecasting, public investment management, national payment system, reserve management, and stress testing.

*Source: IMF staff report text on Vanuatu (excerpts).*

### 37.      The authorities expressed their appreciation for the support received from the Fund

### 1vutea2023001 - 37.      The authorities expressed their appreciation for the support received from the Fund

### Authorities' request and commitments
- The authorities expressed their appreciation for the support received from the Fund and PFTAC and requested that this support be continued.
- The authorities reiterated their commitment to push ahead with reforms supported by capacity building, especially strengthening AML/CFT due diligence, financial sector supervision, and statistics.

### Staff appraisal — macroeconomic context and outlook
- The new government faces daunting challenges that require bold reforms due to:
  - The pandemic, increase in global commodity prices, and lower revenues from the ECP reducing macroeconomic policy buffers.
  - Prospects for the return of tourism are at risk due to the operational and financial challenges faced by the national airline, and labor shortages.
  - Vulnerability to natural disasters increases uncertainty and reduces policy space.
- Growth expectations for 2023:
  - Stronger GDP growth is expected in 2023 supported by public infrastructure spending and resumption in tourism.
  - Drivers of growth in 2023 include an expansionary fiscal policy geared toward more capital spending, gradual recovery in tourism, higher agriculture production on the back of government support, ongoing recovery in trading partners, and resilient remittances.

### Risks to the outlook
- Short-term to near-term risks:
  - (i) the spread of Covid-19 variants following the reopening of borders delaying the implementation of major infrastructure projects;
  - (ii) a slowdown in main trading partners’ growth negatively weighing on tourism and remittances; and
  - (iii) additional losses in ECP revenue that could derail medium-term fiscal sustainability.
- Structural risks:
  - (i) increasing NPLs and their effects on banks’ financial performance and lending capacity;
  - (ii) weak governance and anti-corruption framework; and
  - (iii) extreme vulnerability to climate change.
- Overall characterization: Risks to the outlook are tilted to the downside.

### Fiscal strategy and debt sustainability
- A credible medium-term fiscal strategy that secures adequate consolidation is essential for preserving debt sustainability.
- Given the projected decline in ECP revenues, Vanuatu’s ambitious infrastructure agenda must be accompanied by tax revenue mobilization and expenditure rationalization efforts to reduce the already high deficits and keep debt below 60 percent of GDP over the next decade.
- Policy recommendations:
  - Increasing tax revenues—including through the introduction of corporate or personal income taxes and through base broadening—should be at the core of any fiscal strategy.
  - Promptly launching fiscal consolidation efforts and securing two percent of GDP in savings would help meet the fiscal anchor while protecting capital spending.
  - Fiscal buffers should be strengthened given Vanuatu’s vulnerability to natural disasters, including through expanding the sizeable cash reserves built in recent years.

### Air Vanuatu restructuring
- The restructuring of Air Vanuatu must be completed urgently in order to reduce fiscal risks.
- Key points:
  - Despite financial support from the government in recent years, the national airline’s operational and financial challenges are worsening, with implications for tourism and domestic connectivity.
  - The rapid assessment by Australia’s DFAT is an important first step.
  - A careful analysis of restructuring options is needed to identify a sustainable solution that minimizes contingent liabilities and transfers from the government while preserving the airline’s systemic economic role.

### Monetary policy assessment
- The current monetary policy stance is appropriate.
- Rationale:
  - Weak private credit growth, subdued core inflation, and negative output gap call for keeping monetary policy on hold to support the fragile recovery.
  - Monetary policy should remain data-driven, and the RBV should stand ready to tighten if there are signs of second round effects such as rapid increases in core inflation.

### Financial sector measures
- Financial sector policies should focus on tackling elevated non-performing loans.
- Observations and recommendations:
  - The financial system appears sound overall, but high NPLs are a concern.
  - Need to strengthen the supervisory and resolution framework, increase the minimum capital requirements, and provisioning for some banks.
  - Introducing a debt-service-to-income ratio can help contain the formation of unsustainable debt.

### Structural reforms to unlock growth potential
- Bold structural reforms are needed to unlock growth potential.
- Recommended priorities:
  - Continue to promote economic diversification particularly in the agricultural sector.
  - Improve the public investment management process to strengthen capacity to implement large-scale projects.
  - Prioritize streamlining administrative processes for FDI and implement policies that may help address labor shortages.

### Strengthening AML/CFT and governance
- Strengthening AML/CFT and improving governance remain essential.
- Specific actions called for:
  - Address significant deficiencies in Vanuatu’s AML/CFT regime, including by better assessing and understanding ML/TF risks faced by the jurisdiction.
  - Strengthen the AML/CFT framework to be in line with international standards (including to regulate virtual asset service provider activities).
  - Bolster the capacity of competent authorities and law enforcement.
  - Reduce governance risks related to the ECP; the upcoming APG review offers an opportunity to show tangible results.
  - Strengthen governance in the public sector particularly with respect to the central bank and state-owned enterprises.

*Source: 1vutea2023001 - 37.*

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

### 47.      It is recommended that the next Article IV Consultation takes place on the standard 12-month cycle.

### Real sector developments
- "The pandemic caused the first GDP contraction in decades..."
- "... and services, via the loss of tourism, led the growth decline."
- "Apart from tourism, manufacturing also contracted."
- "Economic indicators are now recovering."
- GDP growth (Real GDP, annual percent change): 2019: 3.2; 2020: -5.0; 2021: 0.6; 2022: 1.9; 2023: 3.5; 2024: 3.6; 2025: 3.9; 2026: 3.1; 2027: 3.0; 2028: 2.5
- "Headline inflation is accelerating, led by food."
- Consumer prices (period average): 2019: 2.7; 2020: 5.3; 2021: 2.3; 2022: 4.6; 2023: 3.5; 2024: 3.0; 2025: 3.1; 2026: 3.1; 2027: 3.1; 2028: 3.1
- Consumer prices (end period): 2019: 3.5; 2020: 6.6; 2021: 0.7; 2022: 4.9; 2023: 3.9; 2024: 3.1; 2025: 3.1; 2026: 3.1; 2027: 3.1; 2028: 3.1
- Sectoral notes: "Agriculture," "Manufacturing," "Construction," "Others," "Accommodation," "Other services." Notes: "Others includes Mining & Quarrying, and Electricity & Water Supply."

### External sector developments
- "The current account balance went into deficit in 2022 due to rising import prices."
- "Capital grants remained strong, and FDI is recovering."
- "Exports, mainly agricultural products, are slowly recovering."
- "Tourism was particularly affected by the pandemic."
- "The real effective exchange rate appreciated in 2022 due to nominal exchange rate appreciation."
- "Reserves, supported by remittances and donors’ funds, remain adequate."
- Current account (in percent of GDP): 2019: 27.8; 2020: 7.8; 2021: 7.9; 2022: 0.8; 2023: -2.2; 2024: -3.6; 2025: -1.2; 2026: 2.2; 2027: 2.6; 2028: 2.3
- Trade balance (in percent of GDP): 2019: -24.0; 2020: -22.8; 2021: -24.9; 2022: -27.0; 2023: -32.2; 2024: -30.0; 2025: -29.0; 2026: -27.9; 2027: -27.6; 2028: -27.6
- Travel receipts (in percent of GDP): 2019: 28.8; 2020: 6.2; 2021: 0.2; 2022: 5.1; 2023: 15.9; 2024: 18.9; 2025: 22.9; 2026: 22.9; 2027: 22.6; 2028: 22.4
- Gross international reserves (in millions of U.S. dollars): 2019: 420.6; 2020: 511.6; 2021: 613.6; 2022: 664.8; 2023: 706.0; 2024: 754.5; 2025: 801.4; 2026: 871.1; 2027: 950.5; 2028: 1,030.2
- Gross international reserves (in months of prospective G&S imports): 2019: 9.4; 2020: 11.5; 2021: 13.6; 2022: 13.1; 2023: 10.9; 2024: 11.5; 2025: 11.5; 2026: 12.0; 2027: 12.4; 2028: 12.7

### Fiscal and monetary sector developments
- "Fiscal deficits will remain elevated as infrastructure projects accelerate and ECP revenues decline further."
- "In the medium-term, external infrastructure financing will moderate once excess from pandemic delays is absorbed."
- "Public debt will increase rapidly absent fiscal consolidation, reaching 60 percent of GDP by 2027."
- "The RBV maintained the SRD at 5 percent to support the recovery."
- "Money supply has increased, driven by foreign inflows."
- "Net foreign assets of commercial banks are stable, through increasing asset positions."
- Government finance (in percent of GDP) — selected series:
  - Total revenue: 2019: 42.6; 2020: 41.4; 2021: 45.7; 2022: 38.1; 2023: 40.0; 2024: 35.7; 2025: 34.0; 2026: 33.5; 2027: 33.2; 2028: 32.9
  - Expenditure: 2019: 39.8; 2020: 43.4; 2021: 43.4; 2022: 44.7; 2023: 46.1; 2024: 42.9; 2025: 41.0; 2026: 39.5; 2027: 39.3; 2028: 39.0
  - Net lending (+)/borrowing (-): 2019: 2.8; 2020: -1.9; 2021: 2.3; 2022: -6.6; 2023: -6.2; 2024: -7.3; 2025: -6.9; 2026: -6.0; 2027: -6.2; 2028: -6.1
  - Public and publicly-guaranteed debt (end of period): 2019: 45.9; 2020: 48.9; 2021: 48.4; 2022: 46.6; 2023: 49.2; 2024: 53.1; 2025: 56.1; 2026: 58.5; 2027: 61.4; 2028: 64.3
- Central government budgetary operations (in millions of vatu), selected entries:
  - Total revenue: 2020: 45,807; 2021: 43,471; 2022: 48,652; 2023: 43,260; 2024: 48,829; 2025: 46,563; 2026: 47,569; 2027: 49,683; 2028: 52,232; 2029: 54,785 (table spans 2020–2028)
  - Domestic revenue: 2020: 33,254; 2021: 31,399; 2022: 31,718; 2023: 28,561; 2024: 31,360; 2025: 32,918; 2026: 35,054; 2027: 36,733; 2028: 38,919; 2029: 41,063
  - Grants from development partners: 2020: 12,552; 2021: 12,072; 2022: 16,934; 2023: 14,699; 2024: 17,469; 2025: 13,645; 2026: 12,514; 2027: 12,950; 2028: 13,313; 2029: 13,722
  - Expenditure: 2020: 42,786; 2021: 45,514; 2022: 46,175; 2023: 50,763; 2024: 56,358; 2025: 56,032; 2026: 57,250; 2027: 58,623; 2028: 61,968; 2029: 64,870

### Financial sector developments
- "Private credit growth is recovering...  ... boosting bank profitability..."
- "... but bank asset quality has deteriorated."
- "The banking system is liquid."
- "Financial access of households is moderately high compared to its Pacific peers..."
- "... and access to bank loans for households and SMEs are stable."
- Monetary survey (end of period, in millions of vatu):
  - Net foreign assets: 2019: 67,017; 2020: 78,328; 2021: 84,941; 2022: 92,321; 2023 (E): 100,671; 2024 (E): 115,953
  - Total broad money (M2): 2019: 92,282; 2020: 97,154; 2021: 110,947; 2022: 121,018; 2023 (E): 129,952; 2024 (E): 147,738
  - Narrow money: 2019: 62,949; 2020: 67,668; 2021: 76,326; 2022: 89,282; 2023 (E): 101,047; 2024 (E): 126,970
  - Credit to private sector as percent of GDP: 2019: 57.7; 2020: 60.0; 2021: 59.4; 2022: 55.9; 2023 (E): 52.9; 2024 (E): 50.3
  - Net foreign assets of banks (in millions of U.S. dollars): 2019: 103.3; 2020: 119.4; 2021: 127.7; 2022: 147.9; 2023 (E): 172.1; 2024 (E): 258.4

### Selected economic indicators and balance of payments
- Population (2020): 301,695
- Per Capita GDP (2020): US$ 3,341
- IMF quota: SDR 23.8 million (0.01 percent of total)
- Literacy rate (2018): 87.5 percent
- Main products and exports: Kava, coconut oil, copra, cocoa, beef
- Key export markets: New Caledonia, Australia, New Zealand
- Balance of payments (memoranda):
  - Nominal GDP (in millions of U.S. dollars): 2019: 929; 2020: 930; 2021: 1,008; 2022: 942; 2023: 1,001; 2024: 1,064; 2025: 1,137; 2026: 1,217; 2027: 1,293; 2028: 1,372
  - Travel receipts and remittances detailed in Table 1 (see figures above for percent-of-GDP values)

### Medium-term baseline scenario (2019–2028)
- Output and prices (annual percent change) — repeats headline projections:
  - Real GDP: 2019: 3.2; 2020: -5.0; 2021: 0.6; 2022: 1.9; 2023: 3.5; 2024: 3.6; 2025: 3.9; 2026: 3.1; 2027: 3.0; 2028: 2.5
  - Consumer prices (period average): 2019: 2.7; 2020: 5.3; 2021: 2.3; 2022: 4.6; 2023: 3.5; 2024: 3.0; 2025: 3.1; 2026: 3.1; 2027: 3.1; 2028: 3.1
- Public and publicly-guaranteed debt (end of period): 2019: 45.9; 2020: 48.9; 2021: 48.4; 2022: 46.6; 2023: 49.2; 2024: 53.1; 2025: 56.1; 2026: 58.5; 2027: 61.4; 2028: 64.3
- Balance of payments and reserves summarized above under External sector developments

### Banks’ financial soundness indicators (2017–2022, Q1)
- Capital adequacy:
  - Regulatory capital to risk-weighted assets: 2017: 18.0; 2018: 20.1; 2019: 19.2; 2020: 20.0; 2021: 24.1; 2022: 23.3
  - Regulatory Tier 1 capital to risk-weighted assets: 2017: 15.6; 2018: 16.3; 2019: 17.9; 2020: 18.9; 2021: 21.5; 2022: 22.7
- Asset quality:
  - Nonperforming loans net of provisions to capital: 2017: 57.1; 2018: 52.2; 2019: 42.5; 2020: 57.5; 2021: 48.9; 2022: 46.7
  - Nonperforming loans to total gross loans: 2017: 15.6; 2018: 16.0; 2019: 14.4; 2020: 19.0; 2021: 17.7; 2022: 16.3
- Earnings and profitability:
  - Return on assets: 2017: 0.5; 2018: 1.5; 2019: 0.1; 2020: -0.1; 2021: 1.0; 2022: 0.9
  - Return on equity: 2017: 3.8; 2018: 13.0; 2019: 0.9; 2020: -0.6; 2021: 7.3; 2022: 6.5
- Liquidity:
  - Liquid assets to total assets (liquid asset ratio): 2017: 35.5; 2018: 45.2; 2019: 43.6; 2020: 44.0; 2021: 46.0; 2022: 47.6
- Source: Reserve Bank of Vanuatu.
- Note: "There are seasonal effects explaining the quarterly trend in the return on assets and return on equity as banks pay some non-interest expenses and overhead costs towards year end. Provisioning expenses also tend to be higher by year end."

### Integration matrix of surveillance issues and capacity building
- Fiscal Sector:
  - Public financial management: Past 2022 ✓✓✓✓    ✓; Planned/Ongoing entries indicated
  - Expenditure framework: ✓
  - Revenue framework: ✓✓✓
- Macro-financial Issues:
  - Financial Supervision and Regulation: ✓✓✓✓    ✓
  - Financial Market Development: ✓    ✓
  - Correspondent Banking Partnerships: ✓✓
- Macro-structural Issues:
  - Infrastructure: ✓    ✓    ✓    ✓
  - Private sector development: ✓    ✓
  - Governance issues: ✓    ✓
  - Natural disaster management: ✓    ✓
  - Financial inclusion: ✓    ✓
- Statistics:
  - Data enhancement: ✓✓✓
- Footnote: 1/ IMF Fiscal year.

*Source: Vanuatu authorities; and IMF staff estimates and projections.*

### References

### References

### Selected citations
- Kpodar Kangni, Montford Mlachila, Saad Quayyum, Vigninou Gammadigbe (2021), ‘’Defying the Odds: Remittances During the COVID-19 Pandemic’’, IMF Working Paper No 21/186.
- Sy Mouhamadou, Andrew Beaumont, Enakshi Das, Georg Eysselein, David Kloeden, and Katrina R Williams, 2022. “Funding the Future: Tax Revenue Mobilization in the Pacific Island Countries.” IMF Departmental Paper No 2022/015.

---

### Annex I. Authorities’ Actions to Previous Fund Policy Advice

### Fiscal Policy — findings and actions
- Recommendation: Formulate a medium-term fiscal strategy; complete the proposed 2017 tax reforms that include the introduction of a personal and corporate income taxes; and stabilize expenditures as a share of GDP.
  - Action: The authorities did not formulate a medium-term fiscal strategy, and did not adopt the 2017 tax reforms and have not introduced an income tax.
  - Action: The authorities established a national revenue governance committee to oversee the government’s efforts in expanding its revenue base, but it has not yet been staffed.
- Recommendation: Properly manage fiscal risks by minimizing the contingent the contingent liabilities of Air Vanuatu; establish effective supervision and transparency of SOEs and limit and prioritize their external borrowing.
  - Action: There has been no progress on SOEs governance reform since the last Article IV consultation; the unit overseeing SOEs at the MFEM (GBE Unit) has been reactivated and is working on collecting data on SOE debt and finances.
  - Action: Air Vanuatu continues to be a drag on the budget and its restructuring has been delayed.

### Monetary Policy — findings and actions
- Recommendation: The RBV should maintain an accommodative macroeconomic and financial policies in the near term to support the recovery.
  - Action: The RBV has kept unchanged the policy and statutory reserve deposit (SRD) rates to support the economy.
  - Action: The authorities are also gradually withdrawing the financial support measures given the ongoing recovery.

### Financial Sector Policy — findings and actions
- Recommendation: Closely monitor the banking sector and establish crisis management frameworks.
  - Action: The authorities stated that they are closely monitoring the banking system to safeguard financial stability and are eager to establish crisis management and resolution frameworks in the future.
- Recommendation: Strengthen legal frameworks and institutional capacities on AML/CFT.
  - Action: Legislative frameworks have been developed and amended, including to the AML/CFT Act with regard to its governance and structure resulting in re-establishing the Financial Intelligence Unit as an independent institution.
- Recommendation: Strengthen the RBV’s autonomy and governance.
  - Action: 2016 Safeguards Assessment recommendations are still incomplete.

### Structural Policy — findings and actions
- Recommendation: Diversify the economy to foster stable growth and resilience.
  - Action: The authorities have ratified the Pacific Agreement on Closer Economic Relations (PACER) Plus in October 2022.
  - Action: Economic Development Zone (EDZ) legislation is in progress and the Vanuatu Electronic Single Window (WESW) project, aiming to reduce the cost and time of trading, was completed.

### Natural Disasters and Climate Change — findings and actions
- Recommendation: Integrate financing plans, consistent with a medium-term fiscal strategy, for the adaptation plan and disaster response in a more efficient and effective manner.
  - Action: The authorities published a revised NDC, including estimated costs of needed adaptation and mitigation efforts.
  - Action: The authorities have not integrated climate investment needs or disaster response into medium term fiscal planning.

---

### Annex II. External Sector Assessment

### Overall assessment
- Statement: The external sector position for 2022 is broadly in line with the level implied by fundamentals and desirable policy settings.
- Note: The ESA is preliminary and subject to uncertainty due to limited data availability for year 2022.

### Current account and contributors
- 2022 CA estimated at a deficit of 2.2 percent of GDP (from a surplus of 0.8 percent of GDP in 2021).
- Imports rose to 34.1 percent of GDP in 2022 (from about 31.2 percent of GDP on average over 2017–21), driven by rising import prices, particularly for commodities.
- Drivers of 2022 CA deterioration: higher import bills, declining receipts from the Economic Citizenship Program (ECP), and delayed grants.
- Larger-than-expected remittances from seasonal workers and increased donor support helped prevent a worse CA in 2021.

### EBA-lite model results (2022)
- CA-Actual: -2.2 (in percent of GDP)
- Cyclical contributions (from model): (-)0.5
- COVID-19 adjustors: (-) 2/2.0
- Additional temporary/statistical factors: (-) 3/-1.0
- Natural disasters and conflicts: (-) -0.5
- Adjusted CA: -3.2
- CA Norm (from model): -3.8
- Adjustments to the norm: (-)0.0
- Adjusted CA Norm: -3.8
- CA Gap: 0.6
  - o/w Relative policy gap: 2.6
- Elasticity: -0.3
- REER Gap (in percent): -2.2
- Footnotes:
  - 1/ Based on the EBA-lite 3.0 methodology
  - 2/ Additional cyclical adjustment to account for the temporary impact of the pandemic on tourism (4.6 percent of GDP), grants (-2.25 percent of GDP), and remittances from seasonal workers (-0.33 percent of GDP).
  - 3/ Adjustment to the revenue windfall from the ECP (-1.0 percent of GDP).
  - 4/ Cyclically adjusted, including multilateral consistency adjustments.

### Exchange rate and competitiveness
- Exchange rate: The vatu is linked to a transaction-weighted (trade and tourism receipts) basket of currencies with weights adjusted periodically.
- REER appreciated in 2022, mainly due to the appreciating nominal exchange rate.
- CA gap model implies a small REER undervaluation of 2.2 percent (applying an estimated elasticity of the trade balance with respect to changes in the REER of 0.3), suggesting the currency is not misaligned.
- Policy note: Medium-term fiscal consolidation and greater efforts to boost productivity and address competitiveness recommended to keep currency in line with fundamentals.

### Capital and financial accounts
- Flows mainly driven by donor project-related capital grants and FDI in 2022.
- Net errors and omissions: -10.1 percent of GDP in 2021.

### International reserves and adequacy
- Gross official reserves: USD 706 million in 2022, equivalent to 10.9 months of imports.
- Reserve adequacy estimated range: 4.4 to 5.6 months of imports (based on sample average of countries (50 percent) and Vanuatu’s high vulnerability to natural disasters (75 percent)).
- RBV objective: maintain enough official reserves to cover at least four months of imports.
- Assessment: Reserve coverage expected to remain adequate to finance imports and loan repayments despite moderating ECP revenues.
- Example risk: Cyclone Pam in 2015 destroyed between 70 and 80 percent of GDP and led to large reconstruction and imports needs.

---

### Annex III. Risk Assessment Matrix

### High-level risks, likelihood, expected impact, and policy recommendations (selected entries)
- Medium likelihood — Local COVID-19 outbreaks.
  - Expected impact: Medium. Spread of new variants could lead to a total new lockdown, inducing a drop in tax revenue collections and hindering the recovery.
  - Recommendation: Continue to observe global health guidelines.
- Medium likelihood — Delays in major infrastructure projects.
  - Expected impact: Medium. Delays could negatively affect GDP growth and jeopardize the fragile recovery.
  - Recommendation: Continue building internal capacity; plan with technical and financial partners; consider diversifying the tourism sector into related businesses.
- Medium likelihood — Abrupt global slowdown or recession.
  - Expected impact: Medium. Slowdown in main trading partners Australia and New Zealand could affect Vanuatu via tourism and remittances.
  - Recommendation: New stimulus package would be needed to support the economy.
- High likelihood — Potential further drop in ECP revenues.
  - Expected impact: High. ECP revenue accounted for 33 percent of total revenue (including grants) in 2020; further drop might jeopardize medium-term fiscal sustainability.
  - Recommendation: Formulate a medium-term fiscal consolidation plan; strengthen AML/CFT controls and ECP due diligence; improve tax revenue mobilization by introducing income tax and strengthening tax administration; rationalize some spending such as wages and salaries.
- High likelihood — Rising non-performing loans (NPLs).
  - Expected impact: Medium. Banks could deleverage and tighten credit conditions; structurally high household NPL ratios could hinder financial inclusion.
  - Recommendation: Guide banks to accumulate further general provisioning early; establish crisis management and resolution frameworks.
- High likelihood — Weak governance of SOEs.
  - Expected impact: High. Weak SOE governance could induce large fiscal costs and deter FDI.
  - Recommendation: Establish the governance structure of the SOEs.
- High likelihood — Weak financial integrity and financial sector oversight.
  - Expected impact: High. AML/CFT weaknesses and EU blacklisting related to tax transparency could lead to loss of correspondent banking relationships and weak FDI.
  - Recommendation: Strengthen the AML/CFT regime; make the tax bill consistent with international standards of tax transparency; implement the 2016 recommendations of the Safeguards Assessment.
- Medium likelihood — Natural disasters related to climate change.
  - Expected impact: High. More frequent natural disasters could severely damage infrastructure and reduce medium-term growth.
  - Recommendation: Build climate-resilient infrastructure; integrate financing plans consistent with the medium-term fiscal strategy for adaptation and disaster response.

---

### Annex IV. Post-COVID-19 Inflation Dynamics in Vanuatu

### Summary of inflation dynamics
- Headline inflation: Elevated for most of 2020 and 2021 primarily due to escalating food prices.
- Import dependence: Food related and fuel imports accounted for 40 percent of the annual import bill in 2021.
- Underlying inflation (authorities’ definition): excludes volatile food and fuel items and remained low while headline inflation rose.

### Causes and recent trends
- Inflation driven by cost-push factors (supply side constraints) rather than demand-pull.
  - Domestic demand remained weak as the economy recovered from TC Harold and the pandemic.
  - Fiscal spending increases did not create inflationary pressures partly because of slow implementation of major public infrastructure projects.
- TC Harold (made landfall in April 2020) had a devastating impact on domestic agriculture food supply; shock lasted until 2021Q1.
- Recent assessment limitations:
  - November 2022 ransomware cyber-attack severely disrupted core IT infrastructure of many government agencies, affecting statistical data collection and dissemination.
  - Delayed CPI data are likely to continue showing significant price increases.
  - Possible measurement errors and methodological shortcomings in the CPI.

### Persistence and sectoral pass-through
- Global shipping costs rose seven-fold during the pandemic and had persistent inflationary impact in remote and small island states.
- Sectoral passthrough to consumer prices:
  - Food prices: accelerated to an average yearly growth of 7.7 percent from 3.1 percent pre pandemic.
  - Drinks and tobacco: rose from 0.9 percent over the 2016–2019 period to 2.6 percent.
  - Transport prices: account for more than 6 percent of headline inflation and have worsened since end 2020.
- Notable timing: Domestic prices for transport and drinks and tobacco began rising steeply about a year into the pandemic, suggesting gradual passthrough of increased shipping costs to consumer prices.

*Source: IMF staff compilation from the provided content.*

### 4.      Certain country specific factors have helped contain the inflationary impact of rising

### 4.      Certain country specific factors have helped contain the inflationary impact of rising

### Exchange rate dynamics and inflation passthrough
- Vanuatu’s fixed exchange rate system has helped cushion the impact of higher import prices on domestic prices.
- Bai et.al (2016) found that for Pacific Island countries like Vanuatu:
  - depreciation of the domestic currency against the Australian dollar puts pressure on headline inflation;
  - appreciation in the nominal effective exchange rate is associated with an equal decline in inflation.
- From 2019 to 2021, the nominal effective exchange rate has broadly appreciated, as the vatu largely strengthened against the Australian and US dollars.
- According to the authorities, since 2019:
  - around 57 percent of imports were denominated in US dollars;
  - 16 percent were in Australian dollars.
- In 2021, imports from Australia accounted for 22 percent of total imports in Vanuatu.
- Exchange rate hedges (such as forwards) may have helped contain domestic inflationary pressures by delaying the transmission of higher import prices to domestic prices.
- Renewable energy production in some parts of the country (energy production in Luganville is largely hydro based) has helped contain the passthrough of rising global fuel prices to domestic energy prices.
- Housing & utilities within the CPI basket is based on Port Vila and Luganville.

### Near-term inflation outlook and drivers
- The war in Ukraine is affecting Vanuatu mainly through higher imported prices for food and fuel, and agricultural supply side constraints have led to shortages of key commodities like flour.
- Ongoing pandemic-related supply chain disruptions and the Russia’s war in Ukraine are likely to raise shipping costs even further.
- Headline inflation is expected to surge to 4.9 percent in 2022 with both food and nonfood inflation expected to rise above 4 percent.
- Inflation is expected to decline over the medium term within the RBV’s target range of 0–4 percent, as supply side disruptions from the pandemic and the war in Ukraine are expected to subside.
- Risks to the inflation outlook remain on the upside.

### Monetary, fiscal, and macroprudential policy guidance
- The RBV’s on hold monetary policy stance remains appropriate given the subdued economic conditions and weak private sector credit growth.
- Once aggregate demand strengthens, the central bank will need to review the stance of monetary policy to avoid unnecessary pressure on inflation.
- Appropriate tightening of monetary policy may be warranted if growing import demand contributes to headline inflation rising beyond the RBV’s target.
- Policymakers should:
  - balance the need to contain inflationary pressures with supporting the ongoing post-pandemic economic recovery;
  - calibrate monetary policy with exchange rate and fiscal policies;
  - ensure the fiscal-monetary-FX policy mix is coherent and appropriately tailored to contain macro stability risks and secure policy buffers.
- Authorities should avoid a premature tightening of financial conditions and may need to tackle pockets of vulnerabilities that pose inflationary risks by appropriately tightening macroprudential tools where possible.
- To the extent possible and where relevant, targeted fiscal support for vulnerable groups may be considered to reduce potential inequalities arising from higher food and fuel prices.

*Source: 1vutea2023001 - 4.      Certain country specific factors have helped contain the inflationary impact of rising (IMF PDF content provided).*

### 16.      Accordingly, there is a need to increase the level of tourism and hospitality training

### 1vutea2023001 - 16.      Accordingly, there is a need to increase the level of tourism and hospitality training

### Tourism workforce and skills; gender considerations
- 72 percent of tourism businesses found it either hard or very hard to recruit Ni-Vanuatu workers with the required skills (Vanuatu Department of Tourism, 2020).
- Expansion of the Australian seasonal worker program into tourism and hospitality, and increased duration, has intensified under-supply of workers with required skills.
- A majority of seasonal workers from Vanuatu are male; absorbing more women into the tourism sector could help limit the impact of brain drain and alleviate labor shortages in the sector.

### Infrastructure constraints impeding recovery and expansion of tourism
- Electricity
  - Electricity in Vanuatu is largely solar driven; grid electricity is only accessible in main urban centers such as Port Vila and Luganville.
  - Only 61.9 percent of the population had access to electricity in 2018; urban access 93.7 percent versus rural access 51.1 percent (IMF, 2021).
  - Energy costs in Vanuatu are higher than most PICs and other tourism-based small states; electricity is a key input to the cost of running accommodation businesses.
- Internet
  - Internet access in Vanuatu is 26 percent of the population compared with 82 percent in New Caledonia and 50 percent in Fiji (IMF, 2021).
  - The monthly cost of broadband is about USD 160 (2020-21).
  - Cyber resilience is a concern, highlighted by the 2022 ransomware attack against government digital infrastructure.
- Waste management and sewage
  - Further improvement needed in waste management and sewage systems, particularly downtown, harbor areas, and upscale resort and vacation home developments.
  - A ban on swimming in Port Vila harbor was imposed in 2018 due to unsafe bacteria levels; ban was partially lifted in April 2021, but continued monitoring and management are required.

### Health system and tourism demand
- Health preparedness and medical capacity could influence tourists’ destination choices post-COVID.
- Vanuatu’s health system suffers from a lack of facilities and qualified staff, especially midwives, doctors, and specialists (World Vision).
- Patients with serious conditions are typically flown to Australia, New Zealand, or New Caledonia for treatment.
- Improving medical facilities could attract more tourists and support development of hospitality services for elderly visitors, noting that pensioners from Australia and New Zealand are projected to increase.

### Business environment, governance, and investment
- High costs to start a business and bottlenecks on registering property and land titling remain.
- Judicial effectiveness is relatively low, leading to weak enforcement of contracts (IMF, 2021).
- Improvements in these areas would reduce costs of running tourism businesses and attract private and foreign investment.

### Annex VI: Toward a New Revenue Strategy for Vanuatu — The Role of Income Taxes (overview)
- Stagnant tax revenues, increasing reliance on non-tax revenues (Economic Citizenship Program, ECP), and growing development needs motivate a new medium-term revenue strategy.
- The annex analyzes income taxes via three exercises using a heterogeneous agents general equilibrium model calibrated to Vanuatu:
  1. Introduction of a personal income tax without changing VAT rates.
  2. Alternative combinations of VAT and income taxes to increase the tax-to-GDP ratio by 2 percentage points.
  3. Introduction of income taxes in an economy with a smaller informal sector.
- Model features and calibration:
  - Population distribution: 78 percent rural, 22 percent urban (2020 Population and Housing census).
  - Consumption Gini coefficients: rural 0.319; urban 0.269; whole economy 0.323.
  - Average monthly income in urban areas is 1.8 times larger than in rural areas.
  - Large share of rural households engage in subsistence agriculture; commercial agriculture underdeveloped.
  - Formal-informal split for urban activities: 30 percent formal, 70 percent informal (VNSO estimates).
  - Government has access to VAT on agricultural goods and urban formal sector; a personal income tax (PIT) on formal labor income; and a corporate income tax (CIT) on urban formal firms and rural exporters.
  - Baseline VAT rate set to match average 2015–2019 revenue-to-GDP ratio from tax revenue on goods and services.

### First exercise: Introduction of PIT and CIT (calibrated to raise revenue)
- Design:
  - Taxes calibrated to raise 1 percent of GDP in additional revenue and account for about 10 percent of tax revenue.
  - Flat rate applied to all workers (rural and urban) and all formal firms.
  - To proxy minimum income exemption and alleviate distributional effects, ~25 percent of additional revenues are redistributed as transfers to both urban and rural areas.
- Modeled outcomes and trade-offs:
  - Without compensation, introduction of income taxes leads to a welfare reduction: households would prefer to permanently reduce baseline consumption by 1 percent rather than face the income tax.
  - Expected output loss of 2 percent of GDP, driven by reductions in consumption and investment across sectors; labor supply distortion from income taxes reduces output and contracts informal and rural production.
  - Transfers reduce welfare loss but do not materially change output loss because higher-productivity individuals remain most affected.
- Distributional effects:
  - Income taxes without transfers decrease inequality in rural areas and marginally improve inequality in urban areas (improvement in rural inequality arises from taxing exporting firms).
  - Welfare decomposition (IMF staff calculations, Figure 5 / Table excerpt):
    - PIT/CIT — Welfare Total: -1.0; Rural: -1.2; Urban: -1.0
    - PIT/CIT — Aggregate: -1.0; Rural: -1.4; Urban: -1.3
    - PIT/CIT — Distributional: 0.0; Rural: 0.2; Urban: 0.3
    - PIT/CIT + Transfers — Welfare Total: 0.1; Rural: -1.1; Urban: -0.2
    - PIT/CIT + Transfers — Aggregate: -0.1; Rural: -1.3; Urban: -1.0
    - PIT/CIT + Transfers — Distributional: 0.2; Rural: 0.2; Urban: 0.8
- Takeaway:
  - A well-designed, progressive income tax can raise revenue and decrease inequality by taxing high-earners and exempting lower-income earners, but it distorts labor market allocations and reduces GDP, potentially disincentivizing formal sector work.

### Second exercise: Comparing configurations to raise tax-to-GDP by 2 percentage points
- Alternatives assessed:
  - VAT only.
  - PIT/CIT only.
  - Combination of VAT and PIT/CIT.
- Key trade-offs:
  - VAT-only achieves lowest output loss but highest welfare cost (decreases aggregate demand most and redistributes spending toward formal goods, widening urban-rural gaps).
  - PIT/CIT-only produces highest output cost due to labor market distortions but lowest welfare cost because it has larger distributional effects and less redistribution across urban/rural aggregate demand.
  - VAT+PIT/CIT yields intermediate outcomes.
- Takeaway:
  - The same 2 percentage point increase in revenue-to-GDP can be achieved through different mixes; choice depends on government priorities between efficiency (output) and distributional (welfare) concerns.

### Third exercise: Introducing PIT/CIT in an economy with a smaller informal sector
- Setup:
  - Economies with smaller informal sectors have automatically higher VAT collections and a broader VAT base; VAT rate lowered to keep initial steady-state tax-to-GDP ratio equal to baseline.
- Results:
  - Welfare cost of PIT/CIT introduction remains similar to baseline.
  - Output loss is reduced by 30 percent for a similar increase in revenue.
  - Income taxes improve consumption distribution more in the urban area in the smaller-informal-sector economy.
- Takeaway:
  - More efficient VAT collection (smaller informal sector) lowers the output costs of introducing income taxes while maintaining similar distributional benefits.

*Prepared from IMF staff analysis contained in the supplied content.*

### 15.      The takeaway from this exercise is that the costs of introducing income taxes

### 15. The takeaway from this exercise is that the costs of introducing income taxes

### Major findings: taxes, informal sector, and VAT efficiency
- The costs of introducing income taxes can be vastly reduced by first improving the coverage of the formal sector and second by boosting the efficiency of VAT collection.
- By reducing the prominence of the informal sector:
  - the same revenue-to-GDP collection can be achieved more efficiently,
  - VAT and income taxes have a broader base and create smaller distortions.
- The tax-to-GDP ratio could be increased by up to 2 percentage points of GDP with different combinations of direct and indirect taxes; using a combination of both types of instruments achieves a balance between efficiency and well-being costs.
- There is scope for introducing a personal income tax:
  - it would not increase inequality if the minimum exemption were appropriately set,
  - it has a cost in terms of growth by introducing an additional distortion.
- Increasing formal sector coverage has the potential of increasing tax revenues without introducing additional distortions and without worsening distributional outcomes.
- For a related discussion on the potential of improving VAT C-efficiency for Vanuatu (Figure 8), see Sy and others (2022).

### Welfare and VAT C-efficiency (selected model outputs)
- PIT/CIT, smaller informal sector — Welfare (Rural / Urban / Whole):
  - Total: -1.5 -1.1 -1.3
  - Aggregate: -1.5 -1.8 -1.7
  - Distributional: 0.0 0.7 0.4
- Note: VAT C-efficiency conveys the additional percentage of potential VAT a country can collect. Data pertains to 2020. (Source: Sy and others (2022) as cited in the chapter.)

### Model calibration and fit — key parameter values and targets (selected)
- Exogenously calibrated parameters:
  - Depreciation rate: 0.06
  - Labor share in food production: 0.46
  - Labor share in informal sector production: 0.67
  - Capital share in formal sector production: 0.33
  - Persistence of urban income shocks: 0.95
  - Persistence of rural income shocks: 0.95
  - Urban population share: 0.22
  - Rural population share: 0.70
  - Rural population, exporter: 0.08
- Endogenously calibrated parameters and model fit (selected):
  - Informal goods preference: 1.2812 — Informal goods share in consumption Target: 42.5% ; Model: 42.2%
  - Formal goods preference: 1.2764 — Formal goods share in consumption Target: 32.3% ; Model: 32.4%
  - Rural income shock variance: 0.3525 — Rural consumption Gini index Target: 0.3190 ; Model: 0.3187
  - Urban income shock variance: 0.3425 — Urban consumption Gini index Target: 0.2690 ; Model: 0.2695
  - Value added tax: 0.30 — Tax revenue as share of GDP Target: 13.0% ; Model: 13.0%
  - Profit tax: 0 — Corporate tax share in tax revenue Target: 0% ; Model: 0%
  - Income tax: 0 — Income tax share in tax revenue Target: 0% ; Model: 0%
  - Agricultural productivity: 0.5469 — Agricultural share in GDP Target: 19.8% ; Model: 19.1%
  - Manufacturing productivity: 39.2390 — Formal sector share in GDP Target: 46.9% ; Model: 43.2%
  - Exporting productivity: 1.25 — Exporting agricultural share in GDP Target: 6.0% ; Model: 6.0%

### Sector correspondence and GDP shares (selected items)
- Agriculture: 19.8% of GDP
  - Crop production, animal production, forestry and fishing: 19.8%
- Formal non-agriculture: 46.9% of GDP (breakdowns include)
  - Manufacturing: 2.7%
  - Electricity and water supply: 2.3%
  - Information and communication: 7.4%
  - Finance and insurance: 7.8%
  - Government services: 12.5%
  - Retail trade (30% allocated to formal): 4.1%
  - Wholesale trade (30% allocated to formal): 1.5%
  - Real estate (30% allocated to formal): 2.6%
  - Other services and smaller line items as listed in the model correspondence
- Informal non-agriculture: 33.3% of GDP (breakdowns include)
  - Retail trade (70% informal): 9.7%
  - Real estate (70% informal): 6.1%
  - Wholesale trade (70% informal): 3.6%
  - Construction (70% informal): 4.1%
  - Transport (70% informal): 3.1%
  - Accommodation and food services (70% informal): 3.4%
  - Other services and smaller line items as listed in the model correspondence

### Annex VII: Digital money landscape — key points for Vanuatu
- Financial inclusion and payments context:
  - 32 percent of adults remain unbanked and excluded from the formal financial sector because of Vanuatu’s remote and geographically dispersed islands.
  - Correspondent banking relationship (CBR) issues (de-risking) and high transaction costs and slow processing times are key drivers for better digital payments solutions.
- CBDC considerations:
  - Two types of CBDCs: wholesale CBDCs (inter-bank settlements) and retail CBDCs (domestic use).
  - Retail CBDCs could benefit Vanuatu by reducing financial inclusion issues, but must be weighed against implementation risks, resource burden, and costs.
  - Offline functionality is an important consideration for Vanuatu; retail CBDCs like China’s e-CNY demonstrate offline capability.
- Local readiness and policy steps:
  - Vanuatu currently lacks the technical capacity and infrastructure to test and adopt a CBDC; there are no immediate plans to adopt a CBDC.
  - Digital national payments system progress: expected to go live in 2023 (a go-live decision is planned for June).
  - The National Payment System Act enacted in 2021 strengthens regulation of digital money activities.
  - The Financial Dealers Licensing (FDL) Act amendment in 2021 allows certain crypto asset investments, but no companies have been licensed under the amendment; crypto assets are not regarded as legal tender in Vanuatu.
  - Domestic commercial banks are not allowed to exchange crypto currencies for legal tender; progress on the Virtual Asset Providers Bill has been slow.
- Macroeconomic and regulatory implications of CBDCs:
  - For a highly open economy with a fixed exchange rate regime, CBDCs may put pressure on foreign reserves and could override potential improvements in monetary policy effectiveness because maintaining the exchange rate peg would take precedence.
  - Central bank credibility, cybersecurity, privacy, consumer protection, and risks of bank disintermediation are policy considerations.
  - CBDCs could potentially raise additional risks to financial integrity where existing risks are not effectively mitigated.

### Annex VIII: De-risking and de-banking — key issues for Vanuatu
- Current situation and trends:
  - The Pacific Island Countries continue to face loss of correspondent banking relations (CBRs); Vanuatu shows one of the highest losses of CBR transactions in the region.
  - In 2021, the National Bank of Vanuatu (NBV) lost its US dollar CBR with National Australia Bank.
  - The Vanuatu banking system comprises: (i) two domestic banks and three foreign banks in the onshore market; and (ii) nine foreign banks in the Offshore Financial Center, OFC (RBV 2022). It is unclear how the OFC is affected by the CBR problems.
  - The predominance of foreign-owned banks in Vanuatu provides resilience, but this cannot be taken for granted.
  - Vanuatu’s Economic Citizenship Program (ECP) has been associated with reputational and financial integrity concerns; Vanuatu is on the EU list of non-cooperative tax jurisdictions for specified reasons.
- Main drivers of de-banking:
  - Business opportunities in the PICs are generally less attractive: low GDP per capita growth, sectoral idiosyncrasies (land tenure, lack of rule of law, political uncertainty) reduce appeal for international bank investment.
  - High costs of banking in the PICs, notably compliance costs related to AML/CFT due diligence, tax reporting and information sharing (OECD, US, EU standards), and handling numerous small MTOs.
  - International banks face pressure from their own correspondent banks to limit exposure to perceived risky local banks and MTOs.

*Italic source attribution: Excerpt from the IMF chapter on Vanuatu (provided content).*

### 6.      The costs of compliance violations or breaches can be high. This can be in

### 1vutea2023001 - 6.      The costs of compliance violations or breaches can be high. This can be in

### Consequences of compliance breaches and de-banking
- Compliance violations and breaches impose:
  - Financial penalties hitting the balance sheet.
  - Associated reputational costs.
  - High operational costs of banking in the PICs, especially salaries and staff training amidst low capacity and high staff turnover.
- Foreign banks’ roles and importance:
  - Brought technology infrastructure such as ATMs, staffing, and capital.
  - Facilitate cross-border payments and currency exchange vital for trade flows, foreign direct investment, and inward remittances by PIC migrant and seasonal workers.
  - These factors drive growth and support foreign exchange reserve accumulation.
- Remittance dependence (country comparisons preserved exactly as presented):
  - Vanuatu: remittances amount to about 15 percent of GDP.
  - Tonga: remittances amount to 27 percent of GDP.
  - Samoa: remittances amount to 21 percent of GDP.
- Risks from de-banking:
  - Could hinder or severely limit international flows and remittances, further marginalizing PIC economies and accentuating economic vulnerability.
  - For the financial system, de-banking would:
    - (i) further increase the costs of banking services, which are already high by international standards with very high spreads, reducing remittance flows and raising trade costs;
    - (ii) lead to an undue concentration on a few players that adds to market and systemic risks;
    - (iii) perhaps force PIC banks and customers toward more risky channels including more marginal institutions and/or informal and unregulated payment networks that could facilitate money laundering with a reversion to cash flows.
  - Impediments on trade could restrict efforts to build climate-proofed infrastructure that are import intensive and rely on foreign donor flows.

### Broad mitigation strategies (overview)
- A multi-pronged, sustained approach is necessary; no single immediate "magic bullet."
- Regional implementation is preferable; the region’s "2050 Strategy for the Blue Pacific Continent" (endorsed by the region’s leaders ministers in mid-2022) is identified as an ideal vehicle for comprehensive, consistent reforms.

### Market solutions
- Priority: improve incentive structure for international banks to operate in the region by creating profitable business opportunities.
  - Requires improvements in the business climate, acceleration of on-going structural reforms, and supportive policies.
  - Such reforms will take time and depend on a healthy and growing economy for durable impact.
- New intermediary relationships emerging in Vanuatu:
  - USD CBR business channeled through a new intermediary, Choice Mauritius (expertise in similar issues in Africa).
  - Another USD CBR provider: Western Union, whose main agent is Vanuatu Post.
  - Increasing CBR providers would increase competition and lower costs.

### Non-market (public sector) solutions
- Rationale: CBRs are necessary financial infrastructure with public-good characteristics; absence creates negative externalities suggesting a role for public intervention.
- Potential public-sector actions:
  - Subsidies:
    - On welfare economics grounds, governments could provide subsidies to allow CBR and other cross-border transactions to be conducted.
    - Subsidies could be direct cash payouts, capital endowments, or tax rebates.
    - Must be carefully designed to avoid moral hazard and governance issues; require coordination among banks, source country authorities, PICs, and IFIs; potential need for burden sharing.
  - Host country central banks acting as conduits for CBRs:
    - Could maintain a single account with overseas banks while intermediating CBRs.
    - Would place considerable financial, operational, and reputational risks on central banks and require due diligence capacity.
    - Anecdotal reports: several regional central banks attempted this but faced problems establishing accounts with overseas banks at the branch level; would likely require commitment by overseas banks at the HQ level and support by source central banks.
  - Source country central banks facilitating payment corridors:
    - Could facilitate payments through local banks or central banks, especially for low-risk transactions (e.g., documented overseas workers) by pre-validating and approving remitters and recipients.
    - Example: Tonga’s cashless remittance service developed by the IFC and Tonga Development Bank in collaboration with the Reserve Bank of Australia (RBA) and Reserve Bank of New Zealand (RBNZ) — a potential template for the region including Vanuatu.
  - Further development of initiatives:
    - The RBNZ’s 2019 Pacific Remittance Project aimed to enhance remittance flows; the project is exploring initiatives including information gathering, policy/legislative changes, and operational improvements.

### Operational and technical improvements
- Necessary reforms include proper implementation of AML/CFT and tax frameworks; weaknesses have presented risks.
- AML/CFT specific actions:
  - Implement international standards: improve AML/CFT preventive measures by reporting entities, establish an FIU, and increase supervisory capacities.
  - Applies to regional respondent banks and money transmitters (MTs), given perceptions of higher risk.
  - Development partners continue to provide technical assistance.
  - Guidance from AUSTRAC: correspondent banks should not apply blanket de-risking and should be selective; risks in remittance transfers are considered low.
  - Vanuatu: officially removed from the FATF “Grey List” in June 2018 after progress on key technical deficiencies from the 2015 Mutual Evaluation Report (effectiveness not examined at that stage; further reviews will take place in 2023).
- International financial center (IFC) tax and transparency issues:
  - Several PICs, including Samoa and Vanuatu, have IFCs with very liberal disclosure/reporting requirements; opacity led to EU listing as non-cooperative tax jurisdictions.
  - Strengthening national frameworks and moving off the EU list would send a strong signal and address concerns.
  - Vanuatu should continue negotiating with the EU on next steps including a review by the Global Forum on Tax Transparency and greater information sharing.
  - Vanuatu still undertakes the ECP that is now paid in a variety of currencies; more transparency would help.

### Technological changes and digital innovations
- Digital innovations (if appropriately designed and managed) could address inclusion and access issues from de-banking, cross-border CBR problems, and economies of scale constraints.
- Relevant innovations:
  - Rise of e-money as a means of payment and store of value fully backed by fiat currency.
  - Central bank digital currencies and/or private sector stablecoins using blockchain technology.
  - Interest exists across the region; Vanuatu has made recent legal reforms regarding cryptoassets and digital trading in the OFC.
- Potential benefits:
  - E-money can provide greater convenience, lower transaction costs, and network effects.
  - Reduced reliance on bank branches; only mobile phones, adequate internet, and agents needed to convert digital to fiat currency and vice versa.
  - Tokenized e-money on blockchain could simplify cross-border transfers, making them faster, more transparent, and cheaper.
- Preconditions and required reforms:
  - Enhancements to the AML/CFT regime are necessary as innovations may introduce new risks or exacerbate existing ones.
  - Legal and regulatory changes required to permit such instruments, including amendments to central bank and banking laws.
  - Payments infrastructure upgrades needed.
  - Close coordination between PIC central banks and source-country counterparts (Australia, New Zealand, US) on common platforms, especially for remittances.
  - IFIs and development partners can support capacity development (e.g., ADB-supported e-KYC program).
  - These measures will take time and must be designed to avoid path dependency and adverse outcomes if implemented incorrectly.
- Wider risks and safeguards:
  - Digital approaches could encourage dollarization, carrying risks to monetary policy and financial stability:
    - Digital foreign-currency denominated balances could lower barriers to increased foreign currency use in PICs.
    - If advanced economies introduce digital currencies ahead of PICs, first-mover advantages could lead to a permanent increase in dollarization that is difficult to reverse.
  - Need to develop consumer protection, financial literacy, and other safeguards.
  - Emphasizes need for regional cooperation between PICs and advanced economies and the importance of sound macroeconomic frameworks to limit dollarization risks.

### Key policy recommendations and actions (summarized)
- Pursue a multi-pronged and sustained regional strategy (e.g., via the 2050 Strategy for the Blue Pacific Continent).
- Improve business climate and structural reforms to incentivize international banks’ participation.
- Explore market-based solutions and new intermediaries to expand CBR providers and competition.
- Consider carefully designed public interventions where justified (subsidies, central bank intermediation, source-country central bank facilitation).
- Strengthen AML/CFT frameworks, establish FIUs, and increase supervisory capacity; utilize technical assistance from development partners.
- Move toward greater tax transparency and stronger IFC regulation to address non-cooperative jurisdiction concerns.
- Invest in payments infrastructure, legal/regulatory reforms, and coordination for digital innovations (e-money, CBDCs, stablecoins) while managing associated risks (dollarization, consumer protection).
- Coordinate regionally and with source-country central banks (Australia, New Zealand, US) and IFIs for effective implementation.

*Source: VANUATU STAFF REPORT FOR THE 2023 ARTICLE IV CONSULTATION—INFORMATIONAL ANNEX (Asia and Pacific Department), sections on consequences, mitigation strategies, market and non-market solutions, operational/technical improvements, and technological changes.*

### 114.44 per U.S. dollar. The de facto classification is “other managed,” as the composite weights are

### 1vutea2023001 - 114.44 per U.S. dollar. The de facto classification is “other managed,” as the composite weights are

### Exchange rate regime and Article VIII status
- Exchange rate: 114.44 per U.S. dollar.
- De facto exchange system classification: “other managed,” as the composite weights are not disclosed and cannot be confirmed.
- Article VIII obligations: Vanuatu has accepted the obligations of Article VIII, Sections 2, 3, and 4, and maintains an exchange system that is free of restrictions on making of payments and transfers for current international transactions and multiple currency practices.

### Article IV consultation and OFC/safeguards assessments
- Article IV consultation cycle: 12–month consultation cycle.
- Previous Article IV mission: June 28 – July 22, 2021; consultation concluded on August 31, 2021 (Country Report No. 21/208).
- OFC Module II Assessment: most recent assessment conducted by MFD concluded in May 2006.
- Safeguards assessment (RBV):
  - First safeguards assessment completed in October 2016 in connection with emergency financing received in 2015.
  - Findings: RBV has a recognized accounting framework and publishes annual financial statements (albeit with some delay); weaknesses in governance arrangements, autonomy, transparency, and audit mechanisms.
  - 2016 recommendations included:
    - Draft amendments to the Reserve Bank of Vanuatu Act to align with leading practices for central banks.
    - Establish an Audit Committee.
    - Outsource internal audit services to an independent international audit firm.
    - Formulate a recapitalization plan.
  - Subsequent actions: RBV received technical assistance on recapitalization framework and appointed a Chief Risk Officer.
  - Remaining risks and developments:
    - Absence of an audit committee and an internal audit function continue to present risks to RBV’s control environment.
    - Plans to draft RBV Act amendments in line with 2016 recommendations have not materialized.
    - Parliament enacted amendments to the RBV Act in June 2022 that further deteriorate RBV’s autonomy and governance arrangements.
    - Authorities committed to repeal the 2022 amendments to the RBV Act in 2023.

### Technical assistance and resident representation
- Technical assistance provided mainly through PFTAC in:
  - Revenue administration
  - Public financial management
  - Debt management
  - Banking regulation and financial sector supervision
  - Statistics (GDP, external sector statistics, government finance statistics)
- Resident Representative office for the Pacific Islands (including Vanuatu) opened September 2010 in Suva, Fiji.
- Current Resident Representative: Mr. Neil Saker.

### Relations with other international financial institutions (IFIs)
- Relations highlighted with:
  - World Bank Group
  - Asian Development Bank
  - Pacific Financial Technical Assistance Center (PFTAC)

### Statistical issues — data adequacy and dissemination
- Overall assessment: Data provision has shortcomings but is broadly adequate for surveillance.
- National accounts:
  - Improvements made in methodology and additional data sources, but accuracy of expenditure-based GDP estimates could be further improved.
  - Data compiled only on an annual basis.
  - Plans to rebase GDP and develop a new quarterly measure to at least 2022 have been delayed.
  - PFTAC providing technical assistance and refocusing on core capacity development for FY2024.
- Price statistics:
  - Quarterly CPI covers Port Vila and Luganville.
  - Dissemination irregular; most recent release: 2nd quarter of 2022.
  - CPI weights based on 2010 household surveys.
  - Rebasing CPI deprioritized due to delays in the Household Income and Expenditure Survey.
- Government finance statistics (GFS):
  - Budget classification broadly consistent with budgetary central government under GFSM 2014.
  - Some budget item classifications still to be reviewed in line with GFSM 2014; IMF provided technical support.
  - Lack of a dedicated GFS compiler slows progress.
  - Central government debt and government guarantees compiled quarterly.
  - Recommendation: start reporting data to the joint IMF and World Bank QPSDS database.
  - Need to expand coverage to consolidated general government and wider public sector debt.
  - Discrepancies exist across DoFT, VNSO, and RBV fiscal data that need reconciliation.
- Monetary statistics:
  - Compiled broadly in line with the Monetary and Financial Statistics Manual.
  - RBV reports monthly monetary data using Standardized Report Forms (SRFs) published in International Financial Statistics.
  - SRFs have not been updated since March 2022.
  - RBV reports indicators to Financial Access Survey, including mobile and internet banking, gender-disaggregated data, and SDG Target 8.10 indicators.
- Financial sector surveillance:
  - RBV reports Financial Soundness Indicators (FSIs) quarterly, including 13 core and 6 encouraged indicators for deposit takers.
  - FSI data and metadata published in IMF’s FSI data portal.
  - FSI data not updated since 2018Q1.
- External sector statistics:
  - RBV releases quarterly BOP and IIP data in Quarterly Economic Review and working to disseminate in BPM6 format.
  - Dissemination lags could be shortened; frequent large-scale revisions have occurred.
  - Coverage could be improved (e.g., positions of other financial corporations).

### Data dissemination and metadata
- Since April 2019, Vanuatu has implemented e-GDDS recommendations by publishing essential data through a National Summary Data Page (NSDP).
- No data ROSC available.

### Table of Common Indicators (as of February 2023) — selected entries (Date of Latest Observation / Date Received / Frequency of Data / Frequency of Reporting / Frequency of Publication)
- Exchange Rates: 04/2022 / 06/2022 / M / M / M
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities: 03/2022 / 06/2022 / M / M / M
- Reserve/Base Money: 03/2022 / 06/2022 / M / M / M
- Broad Money: 03/2022 / 06/2022 / M / M / M
- Central Bank Balance Sheet: 03/2022 / 06/2022 / M / M / M
- Consolidated Balance Sheet of the Banking System: 03/2022 / 06/2022 / M / M / M
- Interest Rates: 09/2021 / 11/2021 / M / M / M
- Consumer Price Index: 06/2022 / 06/2022 / Q / Q / Q
- Central Government (Revenue, Expenditure, Balance and Composition of Financing): 12/2022 / 02/2023 / M / M / M
- Stocks of Central Government and Central Government-Guaranteed Debt: 2022 / 01/2023 / M / M / M
- External Current Account Balance: 9/2022 / 9/2022 / Q / Q / Q
- Exports and Imports of Goods and Services: 9/2022 / 9/2022 / Q / Q / Q
- GDP/GNP: 2020 / 9/2022 / A / A / A
- Gross External Debt: 12/2022 / 01/2023 / Q / Q / Q
- International Investment Position: 03/2022 / 10/2022 / Q / Q / Q

### Debt Sustainability Analysis (DSA) — summary findings and implications
- DSA conclusion (2023): Risk of debt distress for Vanuatu remains moderate for both external and overall public debt; rating unchanged from 2021 DSA.
- Granularity in risk rating: Limited space to absorb shocks.
- External debt stock and liquidity indicators: Remain below benchmark levels in the baseline scenario given concessional borrowing, but stock indicators are vulnerable to natural disasters and macroeconomic shocks.
- Severe downside scenario: Full loss of Economic Citizenship Program (ECP) revenues would likely cause three external debt indicators to breach their benchmarks.
- Public debt trajectory and implications:
  - Public debt stock and public debt service costs forecast to grow over the long term.
  - Increasing reliance on domestic borrowing necessitates development of domestic debt markets.
  - Recommendation: rebuild fiscal space and enhance resilience against shocks.
  - Policy advice: formulate a medium-term fiscal strategy with robust revenue mobilization and expenditure rationalization; continue seeking grants and concessional loans for new infrastructure financing.
- Composite indicator: 2.99, based on October 2022 WEO and 2021 World Bank CPIA, indicating a medium debt carrying capacity.

### Public debt coverage for the DSA
- Coverage included in DSA:
  - Central government debt
  - Central government guaranteed debt
  - Central bank debt borrowed on behalf of the government
- Exclusions and data gaps:
  - Air Vanuatu debt not included due to lack of data; staff plans to work with authorities and Australia’s DFAT and the IFC to address missing information.
  - Other elements of general government, other non-guaranteed SOE debt, and private external debt also not included due to data limitations.
  - PFTAC providing technical assistance to expand GFS coverage from budgetary central government to general government and SOEs.
- DSA uses residency-based definition of external debt.

### Contingent liabilities and SOE fiscal risks
- Combined contingent liabilities stress test: contingent liability risks mostly from Air Vanuatu and other SOEs.
- Air Vanuatu-specific risks and history:
  - Large cost overruns and an overambitious investment plan (order of six Airbus aircraft) resulted in losses.
  - Government took temporary control of Air Vanuatu in March 2021 to restructure the enterprise; restructuring ongoing.
  - Airbus contract revised to reduce number of aircraft and associated liabilities, but airline remains in severe financial distress.
  - Ongoing restructuring entails fiscal risks:
    - Forgiveness of VUV 2.1 billion (1.8 percent of GDP) in loans owed to the government by Air Vanuatu.
    - Transfer of the remainder of the airline’s VUV 5.8 billion (5.1 percent of GDP) in debt, including Airbus contract costs, to the government as part of restructuring.
- Total debt of other non-financial SOEs estimated at VUV 2.1 billion (1.8 percent of GDP) based on most recent data.
- To capture risks, shock magnitude of SOE debt adjusted from default value of 2 percent to 8.7 percent of GDP.
- Contingent liabilities from financial markets set at default value of 5 percent of GDP (average cost to government of a financial crisis in a low-income country).

### Key debt stock figures (end-2022)
- Total public debt: 53,009 Vatu mnUSD mn% of total debt 462100 (table formatting preserved from source).
- External: 41,490 (361) 78
  - Multilateral: 17,212 (150) 32
    - ADB: 5,748 (50) 11
    - IDA: 10,815 (94) 20
    - IMF: 649 (6) 1
  - Bilateral: 23,360 (204) 44
    - China EXIM Bank: 15,724 (137) 30
    - JICA: 7,636 (67) 14
    - Others: 000
  - Publicly guaranteed debt (external): 918 (82)
- Domestic: 11,518 (100) 22
  - Government bonds: 10,508 (92) 20
  - RBV: 3,319 (29) 6
  - VNPF: 4,600 (40) 9
  - Commercial banks & other: 2,590 (23) 5
  - Publicly guaranteed domestic debt: 1,010 (92)
- Source: Vanuatu authorities and IMF staff estimates.

### Background on public debt dynamics and policy-relevant projections
- PPG debt at end-2022: 46.6 percent of GDP; stabilized in recent years.
- Historical context:
  - PPG debt more than doubled between 2014 and 2016 (from 21.6 to 45 percent of GDP) due to reconstruction after Tropical Cyclone Pam and infrastructure development support.
  - Key lenders over that period: China Eximbank, JICA, ADB, IDA, IMF.
  - After 2016, PPG stabilized around 45-48 percent of GDP.
- Economic Citizenship Program (ECP) role:
  - ECP revenues and donor grants financed initial policy responses to COVID-19 and natural disasters in 2020 and 2021.
  - ECP revenues enabled Vanuatu to not opt into the Debt Service Suspension Initiative.
  - ECP structure (since 2017): Vanuatu Development Support Program (VDSP) and Vanuatu Contribution Program (VCP) offering honorary citizenship for a one-time contribution; application costs range from USD 135,000 for a single applicant (government’s share USD 80,000) to USD 185,000 for a family of four (government’s share USD 130,000).
- Creditor composition: External debt accounts for 78 percent of total PPG debt as of end-2022; China Eximbank accounts for 30 percent of total PPG debt.
- Early repayments:
  - 2021: authorities prepaid VUV 2 billion (1.6 percent of GDP), primarily on less concessional loans from China Eximbank.
  - 2022: early repayments continued with VUV 687 million (0.5 percent of GDP) paid in advance on a concessional JICA loan.
- Domestic debt market characteristics:
  - Shallow and underdeveloped; excessive dependence on a few investors (VNPF, RBV, commercial banks including NBV).
  - Government-guaranteed SOE debt accounts for 1.9 percent of total PPG debt.
  - Without significant revenue mobilization, elevated fiscal deficits will require increasing domestic issuance over the long term (especially after 2027), putting pressure on markets.
  - Projection: domestic debt projected to rise from 10 percent of GDP in 2022 to 15 percent of GDP by 2030, and then to surge to 40 percent of GDP by 2043.
  - Recent bond issuances oversubscribed, signaling some scope to expand domestic issuance; however, rapid expansion would likely imply large-scale monetary financing with significant repercussions.

### Policy recommendations and priorities from staff analysis
- Rebuild fiscal space and enhance resilience against shocks.
- Formulate a medium-term fiscal strategy with:
  - Robust revenue mobilization measures.
  - Expenditure rationalization measures.
- Prioritize grants and concessional loans when financing new infrastructure.
- Develop domestic debt markets to manage projected increases in domestic financing needs and reduce concentration risks.
- Continue technical assistance (e.g., PFTAC) to:
  - Improve national accounts, CPI rebasing and dissemination, and GFS coverage and compilation.
  - Reconcile fiscal data across DoFT, VNSO, and RBV.
  - Update SRFs and FSI reporting and reduce data lags for external sector statistics.
- Address RBV governance weaknesses: reestablish audit functions and align RBV Act with safeguards recommendations (authorities committed to repeal 2022 RBV Act amendments in 2023).

*Source: IMF staff report and joint Bank-Fund Debt Sustainability Analysis for Vanuatu (extracts as provided).*

### 6.      A new Debt Management Strategy (DMS) which preserves the prudent approach of

### 6.      A new Debt Management Strategy (DMS) which preserves the prudent approach of 

### New DMS: design and policy recommendations
- The previous DMS expired at end-2022; authorities have been preparing a new DMS and received Fund TA support but have not yet finalized the strategy.
- The new DMS should:
  - Continue to require all new external borrowing be concessional (with a 35 percent grant element).
  - Continue to encourage the development of domestic debt markets.
  - Limit prepayments of external debt given the deterioration in medium-term fiscal prospects and Vanuatu’s high exposure to risks, and instead focus on strengthening cash buffers if revenues exceed expectations.
  - Be aligned with a new medium-term fiscal strategy and be based on realistic fiscal assumptions.
- Under the Sustainable Development Finance Policy (SDFP), Vanuatu satisfactorily implemented the FY21 and FY22 Performance and Policy Actions (PPAs) to improve fiscal sustainability and reduce debt vulnerabilities.
- As an FY23 PPA, the country committed to adhere to a zero non-concessional borrowing ceiling, in line with domestic legal requirements.

### Background on macroeconomic forecasts and baseline assumptions
- 2022 outcomes and near-term:
  - Growth in 2022 is projected at 1.9 percent.
  - Fiscal deficit for 2022 is estimated at 6.6 percent of GDP (preliminary data), a change from a surplus of 2.3 percent of GDP in 2021.
  - Current account estimated to have turned to a deficit of 2.2 percent of GDP in 2022, from a surplus of 0.8 percent of GDP in 2021.
- Main baseline assumptions (selected):
  - Real GDP growth over 2023–3  3 is projected to average 2.9 percent. Average growth during the recovery period (2023–2  5) is projected at 3.7 percent.
  - Inflation (GDP deflator) is projected to average 3.0 percent (in U.S. dollar terms) and 3.1 percent (in domestic currency terms) over 2023–3  3.
  - The non-interest current account is projected to average a surplus of 1.5 percent of GDP over 2023–3  3 (historical average surplus 3.2 percent).
  - Foreign direct investment inflows expected to average 3.7 percent of GDP over 2023–3  3 (historical average 4.2 percent).
  - The primary deficit is expected to average 4.9 percent of GDP over 2023–3  3 (historical average surplus 0.1 percent of GDP).
  - All new external borrowing is assumed to be at concessional terms, consistent with Vanuatu’s debt management strategy (including new loans from China and other bilateral partners, which are all expected to contain a grant element of 35 percent).
  - Grants are expected to average 9.0 percent of GDP over 2023–33 (down from 10.6 percent of GDP over the last decade).
  - Government-guaranteed debt is forecast to remain stable at 2022 levels for the entire projection period; staff assumes no government guarantees for new SOE borrowing in the baseline.
  - From 2027 onwards, baseline macroframework incorporates long-term effects of natural disasters and climate change: real GDP growth lowered by 0.5 percentage points annually, current account deficit raised by 1.3 percentage points of GDP, and fiscal deficit increased by 0.35 percentage points of GDP relative to disaster-free projections.
- Noted data/forecast caveats:
  - Realism tools do not flag substantial risks around the forecast; realism of projections for public and private investment rates could not be assessed due to data availability constraints.

### Country classification and stress-testing framework
- Debt carrying capacity:
  - Vanuatu’s debt carrying capacity is assessed as medium.
  - Composite index (CI) of 2.99 based on October 2022 WEO data.
- Applicable external debt burden thresholds for medium carrying capacity:
  - PV of debt in % of exports = 180
  - PV of total public debt in percent of GDP = 55
  - Debt service in % of exports = 15
  - Debt service in % of revenue = 18
- Tailored stress tests:
  - Combined contingent liability stress test (described earlier in text).
  - Tailored natural disaster shock: one-off shock of 10 percentage points to the debt-to-GDP ratio in 2023; real GDP growth and exports lowered by 4 and 10 percentage points respectively in the year of the shock.

### External debt sustainability (key findings)
- Baseline trajectory:
  - PV of PPG external debt-to-GDP ratio expected to increase from 22.6 percent in 2023 to 32.5 percent in 2033 due to new loan disbursements for infrastructure.
  - PV of debt-to-exports and debt service-to-exports ratios drop slightly in the near term before increasing and stabilizing in the medium-term.
  - Two liquidity indicators remain well below their thresholds over the medium and long term, reflecting the concessional nature of external debt.
- Stress test outcomes:
  - Combined macroeconomic and export shocks have the largest impact on external debt dynamics, causing breaches of PV of debt-to-GDP and PV of debt-to-exports thresholds from 2025 onwards.
  - Tailored natural disaster shock would push PV of debt-to-GDP above its threshold starting in 2032.
  - No shocks cause a breach of liquidity indicators in most scenarios, indicating external debt service capacity remains relatively strong given concessional financing.
- Severe downside scenario (complete loss of ECP revenues from 2024 onward):
  - Assumes three quarters of lost ECP revenues replaced by non-concessional external financing and one quarter by local debt issuance.
  - Results: PV of debt-to-GDP breaches threshold in 2027; PV of debt-to-exports breaches in 2032; debt service-to-revenue breaches in 2033.
  - Highlights need for a robust medium-term fiscal strategy to reduce reliance on ECP and identify alternative revenue sources.

### Public sector debt sustainability (key findings)
- Baseline trajectory:
  - PPG debt-to-GDP ratio expected to rise from 46.6 percent in 2022 to 75.1 percent of GDP in 2032, breaching the authorities’ fiscal anchor (to keep PPG debt-to-GDP below 60 percent) in 2027.
  - PV of PPG debt-to-GDP does not breach the 55 percent benchmark under the baseline but is projected to reach 52.9 by 2033.
  - PV of debt-to-revenue ratio and debt service-to-revenue ratio are projected to rise; debt service-to-revenue projected to rise steeply due to rising interest costs from domestic debt and declining ECP revenues.
- Stress test outcomes:
  - Growth shock has the largest impact on public debt dynamics, causing breach of PV of PPG debt-to-GDP benchmark from 2028 onward (assumes negative growth in 2024 and 2025).
  - Full loss of ECP revenue scenario causes PV of PPG debt-to-GDP ratio to breach 55 percent threshold in 2028.

### Risk rating and policy implications
- Risk of external debt distress: assessed as moderate under the baseline.
- Under broad-based macroeconomic shocks, debt could increase substantially, indicating the need to:
  - Build additional buffers and create fiscal space.
  - Aim for a close-to-even external financing mix between grants and loans.
  - Continue to restrict external borrowing to concessional terms (greater than 35 percent grant element) to preserve a low debt service burden.
  - Strengthen supervision and oversight of SOEs and enhance resilience against natural disasters.

*Source: Vanuatu authorities, and IMF staff estimates (extracted from the provided content).*

### 21.      The overall risk of debt distress is moderate. Even though the 55 percent benchmark for

### 21. The overall risk of debt distress is moderate. Even though the 55 percent benchmark for the PV of PPG debt-to -GDP would not be breached under the baseline scenario, public debt and debt service costs are on a steep upward path.

### Risk assessment and classification
- Overall risk of debt distress: moderate.
- Granularity assessment: indicates Vanuatu has limited space to absorb shocks (Figure 5).
- For the PV debt/GDP and PV debt/exports thresholds, x is 20 percent and y is 40 percent. For debt service/Exports and debt service/revenue thresholds, x is 12 percent and y is 35 percent.
- The most extreme stress test is the test that yields the highest ratio in or before 2033; the one-off breach logic is applied as described in the notes to the figures.

### Baseline projections and fiscal anchor
- Under current policies, authorities’ fiscal anchor aimed at keeping PPG debt under 60 percent of GDP will be breached in 2027.
- The authorities’ strategy and vulnerabilities noted:
  - Increased reliance on domestic issuance will raise interest costs over the long term.
  - Accelerated development of domestic debt markets and a credible medium-term fiscal strategy securing adequate consolidation via revenue mobilization and expenditure rationalization measures are critical to preserve public debt sustainability, respect fiscal anchors, and protect growth-critical infrastructure spending.
  - Diversifying external financing sources by seeking concessional financing from new development partners could help avoid reliance on more costly domestic issuance and contain total debt service costs.
- The Debt Management Office has been working on establishing contacts with various development and agricultural funds in order to attract new sources of financing.

### Stress tests, downside scenarios, and vulnerabilities
- Under the severe downside scenario of a total loss of ECP revenues, as well as under a shock to growth, the PV of PPG debt-to-GDP ratio would breach its benchmark.
- Tailored stress tests and shocks described in figures and tables include:
  - No ECP revenues scenario (presented as an alternative scenario and in public DSA stress testing).
  - Natural disaster shocks.
  - Combination shocks (noted as “Most extreme shock: Combination” in the figures).
  - Bound tests (B1–B6) and tailored tests (C1–C4) results are reported in Table 3 for 2023–2033 for indicators such as PV of debt-to-GDP, PV of debt-to-exports, and debt service ratios.

### Key projections and indicators (selected exact figures from the DSA tables)
- PV of PPG external debt-to-GDP ratio (Table 1, baseline projections): 20.8, 22.6, 24.0, 25.2, 26.3, 27.2, 28.0, 28.9, 29.8, 30.7, 31.6, 32.5, 36.5
- PV of PPG external debt-to-exports ratio (Table 1, baseline projections): 136.3, 86.5, 83.0, 76.4, 80.6, 83.8, 86.8, 89.9, 93.0, 96.1, 99.3, 102.3, 148.0
- PPG debt service-to-exports ratio (Table 1, selected years): 19.2, 42.2, 13.9, 5.4, 4.8, 3.9, 3.8, 4.9, 4.8, 4.7, 4.6, 4.7, 4.8
- PPG debt service-to-revenue ratio (Table 1, selected years): 10.1, 13.0, 8.4, 5.5, 5.5, 5.1, 6.0, 6.4, 6.3, 6.2, 6.0, 6.1, 6.2
- Gross external financing need (Million of U.S. dollars, Table 1, selected years): -79.5, -16.7, -1.2, 9.9, -17.8, -63.4, -73.5, -68.4, -71.3, -69.9, -68.7, -64.3, -65.2
- Nominal GDP (Million of US dollars, Table 1): 1,008, 942, 1,001, 1,064, 1,137, 1,217, 1,293, 1,372, 1,449, 1,530, 1,616, 1,707, 1,802, 1,903, 3,331
- Public sector debt (Table 2, baseline historical/projections): 48.9, 48.4, 46.6, 49.2, 53.1, 56.1, 58.5, 61.4, 64.3, 66.9, 69.6, 72.4, 75.1, 77.8, 98.8, 40.9, 64.0
- PV of public debt-to-GDP ratio (Table 2, baseline projections): 31.1, 31.4, 33.3, 34.8, 36.5, 38.8, 41.2, 43.3, 45.6, 48.0, 50.4, 52.9, 75.3
- Debt service-to-revenue and grants ratio (Table 2, baseline projections, selected values): 11.5, 11.5, 9.4, 7.3, 8.1, 9.0, 11.6, 13.2, 18.0, 21.6, 23.2, 25.1, 25.7, 27.4, 51.8
- Real GDP growth (key macro assumption, Table 1 and Table 2): -5.0, 0.6, 1.9, 3.5, 3.6, 3.9, 3.1, 3.0, 2.5, 2.5, 2.5, 2.5, 2.5, 2.5, 3.4, 1.9, 2.9
- Government revenues (excluding grants, percent of GDP, Table 1): 29.9, 29.8, 25.1, 25.7, 25.2, 25.1, 24.7, 24.7, 24.7, 24.7, 24.7, 24.7, 24.7, 24.4, 25.5, 24.9
- Aid flows (Million of US dollars, Table 1): 116.0, 149.9, 129.5, 213.7, 187.5, 178.9, 166.0, 169.1, 173.8, 182.4, 191.0, 199.6, 208.7, 218.8, 265.6
- Grant element of new public sector borrowing (in percent, Table 1): 53.1, 54.2, 54.0, 48.7, 47.8, 48.1, 48.1, 48.2, 48.1, 48.1, 48.1, 48.1, 49.7
- Effective interest rate (percent, Table 1): 1.4, 1.1, 1.1, 1.1, 1.1, 1.1, 1.1, 1.1, 1.1, 1.1, 1.1, 1.2, 1.2
- Average real interest rate on domestic debt (percent, Table 2): 3.2, 5.5, 1.3, 2.4, 3.8, 3.7, 3.8, 3.7, 3.8, 3.7, 4.0, 4.1, 4.3, 4.4, 4.1, 3.3, 3.8

### Policy recommendations and priorities (as stated)
- Accelerate development of domestic debt markets.
- Formulate and implement a credible medium-term fiscal strategy to secure adequate consolidation via:
  - Revenue mobilization measures.
  - Expenditure rationalization measures.
- Preserve public debt sustainability and respect fiscal anchors while protecting growth-critical infrastructure spending.
- Diversify external financing sources by seeking concessional financing from new development partners to reduce reliance on costly domestic issuance and contain total debt service costs.

*Source: IMF staff estimates and projections as presented in the DSA material for Vanuatu.*

### 2. Primary balance55445555555

### 2. Primary balance55445555555

### Sensitivity analysis — key projection series (selected)
- Baseline (series): 3133353739414346485053
- A. Alternative Scenarios
  - A1. Key variables at their historical averages in 2023-2033 2/: 3129292828292929303030
  - A2. Alternative Scenario: [Loss of ECP revenue]: 3138434955616773788490
- B. Bound Tests
  - B1. Real GDP growth: 3137455055616671768186
  - B2. Primary balance: 3137414244474951535557
  - B3. Exports: 3138485052545658606264
  - B4. Other flows 3/: 3141495052545658616365
  - B5. Depreciation: 3137363636373738383940
  - B6. Combination of B1-B5: 3135383841434648515356
- C. Tailored Tests
  - C1. Combined contingent liabilities: 3143444547495153555760
  - C2. Natural disaster: 3143444649525457606366
  - C3. Commodity price: n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.
  - C4. Market Financing: n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.

### PV of debt-to-GDP and related benchmark projections (selected series 2023–2033)
- PV of debt-to-GDP ratio, Baseline (2023–2033): 79 93 102 109 117 125 132 139 147 155 163
- A1. Key variables at their historical averages in 2023-2033 2/: 79 81 84 84 84 86 87 88 90 91 90
- A2. Alternative Scenario: [Loss of ECP revenue]: 7 9 15 19 22 30 37 41 45 47 51
- B. Bound Tests (selected)
  - B1. Real GDP growth: 79 102 127 143 160 177 192 207 223 238 254
  - B2. Primary balance: 79 103 120 127 134 142 148 154 162 169 177
  - B3. Exports: 79 106 141 148 155 163 169 176 184 191 198
  - B4. Other flows 3/: 79 114 143 150 158 165 171 178 186 193 200
  - B5. Depreciation: 79 107 107 109 111 113 115 117 120 123 126
  - B6. Combination of B1-B5: 79 99 110 113 122 131 138 146 154 163 171
- C. Tailored Tests (selected)
  - C1. Combined contingent liabilities: 79 121 128 135 143 150 155 162 169 176 184
  - C2. Natural disaster: 79 118 128 137 147 156 164 173 182 192 201

### Other ratio projections (selected)
- Baseline (series): 7 8 9 12 13 18 22 23 25 26 27
- A1. Key variables at their historical averages in 2023-2033 2/: 7 8 4 11 13 16 20 23 25 26 27
- A2. Alternative Scenario: [Loss of ECP revenue]: 7 9 15 19 22 30 37 41 45 47 51
- B. Bound Tests (selected)
  - B1. Real GDP growth: 7 9 12 17 20 26 32 35 38 39 42
  - B2. Primary balance: 7 8 13 17 15 20 25 26 27 27 29
  - B3. Exports: 7 8 9 12 14 19 22 24 26 26 29
  - B4. Other flows 3/: 7 8 9 13 14 19 22 24 26 26 29
  - B5. Depreciation: 7 8 10 11 14 18 21 23 25 25 27
  - B6. Combination of B1-B5: 7 8 9 12 14 19 23 25 27 27 29
- C. Tailored Tests (selected)
  - C1. Combined contingent liabilities: 7 8 20 15 15 23 27 26 27 27 29
  - C2. Natural disaster: 7 8 18 16 16 24 28 28 30 30 32
  - C3/C4: n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.n.a.

### Natural disasters and economic assessment (narrative)
- Event timing and immediate situation:
  - Two category 4 tropical cyclones: TC Judy on March 1 and TC Kevin on March 3.
  - A 6.5 magnitude earthquake recorded on March 3 near the largest island, Santo.
  - Government declared a six-month state of emergency.
  - Status as of March 8, 2023: no casualties reported so far; thousands affected, many evacuated to shelters; widespread damage to property and infrastructure including roads, public buildings, schools, and hospitals; power outages, water supply disruptions, fuel shortages and communication network failures continue.
  - Tanna and Erromango islands appear particularly affected.
- Expected economic effects:
  - Natural disasters likely to add significant pressure to government spending, inflation, and external balances.
  - Immediate expenditure required for disaster aftermath and additional spending likely for recovery and reconstruction in coming months.
  - Tourism may be temporarily disrupted with negative implications for growth and fiscal revenues.
  - Additional spending, temporary supply shortages, and slow resupply likely to add to inflation.
  - Higher imports, disruption in tourism, and lower agricultural exports expected to weaken external balances relative to staff’s baseline projection.
  - Reconstruction efforts may lead to delays in other planned large-scale projects, setting back growth prospects.
  - Staff do not yet have adequate information to revise their forecast, but lower growth could potentially weaken the overall assessment of debt vulnerabilities over the long term (although there is space to absorb spending in the immediate term).
- Buffers and risks:
  - Authorities have comfortable buffers with reserves exceeding the ARA metric at 6 months of imports.
  - These buffers are exposed to pressures as discussed in paragraph 5 of the External Sector Assessment Annex II of the accompanying staff report.
  - A deep and protracted impact on growth from the two tropical cyclones could add to external sector pressures.

### International response and policy engagement
- Immediate international assistance and logistics:
  - United Nations, Australia, New Zealand, France, and others providing essential humanitarian relief supplies.
  - Australia and New Zealand providing logistical support on the ground with rapid damage assessment.
  - Development partners extended immediate aid.
  - World Bank expected to provide emergency assistance, including through the Catastrophe Deferred Drawdown Option (Cat DDO).
- Fund engagement and options offered:
  - IMF staff in contact with Vanuatu authorities and have offered to discuss potential avenues of support, including the drawdown of the SDR allocation and possible access to the Fund’s emergency financing facilities.

*Sources: Country authorities; and staff estimates and projections.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2023/english/1vutea2023001.pdf_