## 1vutea2024001-print-pdf ## Source details **Canonical URL:** [1vutea2024001-print-pdf](https://www.imf.org/-/media/files/publications/cr/2024/english/1vutea2024001-print-pdf.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2024/english/1vutea2024001-print-pdf.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2024/english/1vutea2024001-print-pdf.pdf.json) --- ### Recent developments: shocks, growth, inflation, and fiscal outcomes - Natural disasters and damages: - Two back-to-back tropical cyclones (Judy and Kevin) in March 2023 with damages estimated at around VT16 billion (estimated at 12 percent of 2023 GDP); agriculture sector particularly impacted. - Category 5 Tropical Cyclone Lola in Q4 2023 with a smaller impact; several earthquakes and volcanic eruptions in 2023 were less damaging. - Air Vanuatu liquidation: - Voluntary liquidation commenced on May 9 (operations halted); airline controlled virtually all domestic connectivity and was a major international carrier. - Administrator considering resumption of domestic-only operations; negotiations ongoing. - Shock disrupted tourism, commerce, and project implementation with potential fiscal, financial, and external sector consequences. - Output, credit and inflation: - Economy likely grew by 2.2 percent y/y in 2023 despite twin cyclones, supported by tourism recovery and government response. - Private sector credit grew by 5.6 percent y/y in 2023; household lending accounted for 54 percent of total loans. - CPI: rose from 3.7 percent y/y in 2022Q2 to 14.4 percent y/y in 2023Q2 (largely driven by food); CPI decelerated to 7 percent y/y in 2023Q4 and to 5.3 percent y/y in 2024Q1. A recalibration of CPI weights in 2023 may have led to higher readings. - Fiscal position and public debt: - Overall balance narrowed to -3.6 percent of GDP in 2023 (from -6.4 percent of GDP in 2022). - Total public and publicly guaranteed debt grew to VT54 billion in 2023 (43 percent of GDP). ### External sector, reserves, and flows - Current account and financing: - Current account deficit narrowed to 2.2 percent of GDP in 2023 (following average deficit of 9.1 percent of GDP in 2021 and 2022), supported by tourism recovery and seasonal-worker income. - 2023 capital and financial flows driven by project-related capital grants and foreign direct investment. - Reserves: - Gross international reserves provided 12 months of import cover in 2023 and were above RBV’s minimum target of 4 months; early estimates indicate a small notional decline in Q1 2024 coinciding with increased foreign currency demand. - Gross international reserves (millions of U.S. dollars): 2023: 644; 2024: 633; 2025: 613; 2026: 622; 2027: 639; 2028: 675; 2029: 705. - Gross international reserves (months of prospective G&S imports): 2023: 12.0; 2024: 10.9; 2025: 9.9; 2026: 9.4; 2027: 8.7; 2028: 8.6; 2029: 8.8. ### Outlook and baseline macroeconomic projections - Air Vanuatu assumptions (staff): - Three international carriers increased frequency/capacity to Efate; pre-liquidation overseas capacity expected to be reinstated by 2024Q3. - Domestic flights assumed to resume slowly and be restored by end-2024; airline tourism value-added to GDP assumed zero in Q2 2024 and to gradually resume through Q4 2024, with full connectivity restored by year-end. - Staff project airline tourism’s contribution to growth for remainder of 2024 will be reduced by 3/4 relative to a no-liquidation baseline; industrial sector GDP contribution assumed reduced by about 1/3 due to project delays. - Growth, inflation, and current account projections (staff estimates and tables): - Real GDP growth projections (multiple presentations in source): staff-projected deceleration to around 1 percent y/y in 2024 and recovery to around 1½ percent in 2025; alternative table shows annual percent change: 2023: 2.2; 2024: 0.9; 2025: 1.5; 2026: 2.1; 2027: 2.5; 2028: 2.0; 2029: 2.0. - Current account deficit projected to widen to around 7½ percent of GDP in 2024 and 6½ percent of GDP in 2025; table shows Current account (percent of GDP): 2023: -2.2; 2024: -7.4; 2025: -6.5; 2026: -4.6; 2027: -4.2; 2028: -4.0; 2029: -4.4. - Inflation estimated to decline to around 3.2 percent y/y by end-2024 and 2.3 percent y/y by end-2025; consumer prices (period average): 2023: 11.2; 2024: 4.2; 2025: 2.8. - Foreign reserves forecast to fall slightly but remain above RBV’s benchmark (4 months of import cover). ### Channels of transmission from Air Vanuatu liquidation - Tourism and services: - Decline affects lodging, restaurants, recreational activities, transport, retail trade, and other activities; air arrivals provide tourists who stay longer (average of 12 nights per person) and spend nearly ten times more than cruise ship tourists (authorities’ estimate). - Domestic connectivity and projects: - Disruption of nearly sole carrier connecting Efate with outer islands affects travel, delays infrastructure projects, and reduces manufacturing and construction activity. - Survey evidence: 92 percent of Vanuatu Chamber of Commerce and Industry respondents affected; 70 percent reporting minimum 30 percent drop in turnover; over half of construction and manufacturing businesses experienced turnover drop >30 percent y/y. - Agriculture, fisheries, and social services: - Air transport disruptions affect availability of high-value exports and logistics; Vanuatu Coconut Copra Exporters reported a 50 percent decline in copra production on Santo and Malekula. - Reduced connectivity may disrupt access to healthcare, education, aid, compress domestic demand, and exacerbate disaster vulnerability. ### Fiscal risks, Economic Citizenship Program (ECP), and near-term fiscal outlook - ECP revenue and fiscal impacts: - Projected ECP revenue has fallen 60 percent below authorities’ 2024 target; ECP revenues estimated to average around 2½ percent of GDP going forward, down from around 14 percent of GDP at its peak in 2020; ECP revenues were around 14 percent of GDP in 2020, declined to 5.4 percent of GDP in 2023. - Staff forecast domestic revenue likely reduced by 6 percentage points of GDP in 2024 (to 20 percent of GDP) from 2023. - Budgetary projection highlights: - Fiscal deficit projected to deteriorate to about 6½ percent of GDP in 2024, with gradual improvement through the medium term. - Central government totals (millions of Vatu): Total revenue 2023: 50,689; 2024: 43,612; 2025: 44,430. Expenditure 2023: 55,309; 2024: 52,633; 2025: 51,934. - Net lending (+)/borrowing (-) (millions of Vatu): 2023: -4,620; 2024: -9,020; 2025: -7,505. - Public and publicly-guaranteed debt (millions of Vatu): 2023: 54,914; 2024: 62,742; 2025: 70,437; 2026: 77,349; 2027: 84,136; 2028: 90,290; 2029: 96,620. ### Debt trajectory, DSA findings, and contingent liabilities - DSA risk assessments: - DSA indicates debt remains sustainable but both external and public debt distress risk indicators are now rated “high” as key indicators breach relevant thresholds under the baseline scenario. - PV of public-debt-to-GDP breaches the 55 threshold between 2033-2034 under baseline; alternate scenario with zero ECP revenues breaches earlier (from 2027 onward). - PV of external debt-to-exports breaches indicative threshold under baseline in 2024 and 2025. - Air Vanuatu contingent liabilities and DSA treatment: - Preliminary contingent-liability estimate related to Air Vanuatu could be around 2 percent of GDP (linked to debt owed to secured creditors); DSA assumes government will honor airline’s secured debt such that secured debt is realized as public debt in 2024. - Projected restructuring costs could total around VT3 bn (2.3 percent of GDP) in 2024; potential recurring annual operating costs if government bears community service obligations. - Public debt composition (end-2023 and DSA tables): - Public and publicly guaranteed (PPG) debt estimated at approximately 43 percent of GDP at end-2023; end-2023 PPG debt in nominal terms around VT54 billion. - External debt comprises over ¾ of total public debt; currency composition of external debt portfolio: 46 percent in Chinese yuan, 21 percent in Japanese yen, 17 percent in US dollars, 13 percent in Euros and 3 percent in British pounds. - Stock of public debt (end-2023, millions of Vatu): Total Stock of Debt: 54065471.0; External Debt: 41383360.5; Domestic Debt: 12682110.5. ### Financial sector stability, vulnerabilities, and stress tests - Banking system metrics: - Total banking system assets: VT171 billion (around 1.5 times GDP); total credit to economy around VT78 billion. - Capital adequacy ratio (2023Q4): 24.1 percent; liquid asset ratio: 46.3 percent (minimum regulatory thresholds: 10 percent and 5 percent). - Non-performing loans (NPLs): 19.8 percent of total loans in 2023Q4 (Table 7 lists 19.6 percent for 2023); system-wide loan loss coverage ratio remains below other Pacific Island countries; impaired loans to households constitute the largest share—“Other loans (including households) comprise 86 percent of total NPLs.” - Return on assets: 2023: 2.0; Return on equity: 2023: 13.9. - Sensitivity analysis (bank-by-bank scenarios): - Mild Downside Scenario assumptions: - Credit Risk: NPLs increase to double the current maximum NPL among banks (increase about 60 percent); provisioning level assumed 40 percent. - Interest Rate Risk: interest rate decreases by 0.65 percentage points. - FX Risk: vatu depreciates by 7 percent. - Mild scenario results: average CAR for banks averages 24.2 percent; none fall below 10 percent regulatory minimum. - Severe Downside Scenario assumptions: - Credit Risk: NPLs increase to three-times the current maximum NPL among banks (increase 87 percent); provisioning level assumed 80 percent. - Interest Rate Risk: interest rates decline by 2.25 percentage points. - FX Risk: vatu depreciates by 16 percent. - Severe scenario results: under credit risk shock CARs decrease by 14.9 percentage points on average; some banks fall below 10 percent regulatory minimum; interest rate shock reduces average CAR by about 5 percentage points; FX shock reduces CAR by about 1.2 percentage points on average. - Supervisory events and policy actions: - A small domestic bank was placed into administration in June 2023; remains without an appointed administrator due to coordination issues. - RBV launched VANKLIA (RTGS) in September 2023. - RBV increased the Statutory Reserve Deposit ratio by 25 basis points in December 2023 and increased RBV notes issuance in October 2023. - Central bank financing to government at VT6 bn (4.5 percent of GDP) has exceeded previous 20 percent limit for lending to the government (amended in 2022 to 40 percent). - RBV not considering temporary forbearance measures; IMF assistance planned via Financial Sector Stability Review (FSSR) in 2024-25 and PFTAC support for prudential guidelines. ### Key downside risks to the outlook - Political instability: three changes of government in second half of 2023; potential project delays and deterrence of investment. - Severe natural disasters and climate change: large economic damages, price volatility, pest outbreaks (e.g., Coconut Rhinoceros Beetle). - China slowdown and geopolitical trade fragmentation: negative spillovers, higher shipping costs, supply-chain disruptions, and domestic inflation pressures. - Labor constraints, governance, and structural deficiencies: labor shortages, strikes, skills drain, and limited implementation capacity. ### Policy recommendations and priorities (selected, as stated in source) - Fiscal policy and revenue mobilization: - Rebuild fiscal buffers via stronger revenue mobilization and urgent fiscal consolidation beginning in 2025 (ambitious consolidation should start as early as possible but no later than 2025). - Explore new revenue measures and improve collection/administration: income taxes (particularly corporate), capital gains taxes on real estate transactions, fisheries licenses, widening the tax base, better targeted or higher VAT rates. - Improve VAT collection and tax administration (including electronic solutions). - Interim spending for Air Vanuatu should be prudently prioritized and accompanied by commensurate cuts in non-priority spending; pause interim increases to public employee compensation and allowances. - Define and adhere to a fiscal anchor (overall deficit and/or primary balance). - Debt management and safeguards: - Reassess MTDS over 2024-27 in light of Air Vanuatu liquidation and ECP collapse; limit contracting new external non-concessional debt; implement strict safeguards for SOE guarantees. - Consider reverting RBV government borrowing cap to previous threshold (20 percent of average government revenue) and repeal 2022 amendments that increased cap and weakened RBV autonomy. - Improve market infrastructure: implement Vanuatu Central Securities Depository System (VCSDS), publish Annual Borrowing Plan and Issuance calendar, operationalize automated securities registry and payment systems. - Monetary and liquidity management: - Reduce fiscal dominance to restore monetary policy effectiveness and stop monetary financing by lowering RBV holdings of government debt over the medium term. - RBV to monitor currency misalignments and review currency basket weights; continue OMOs and liquidity management. - Financial sector and governance: - Strengthen supervisory function, increase loan-loss provisioning, enhance capital requirements, reinstate regular on-site inspections, and improve loan recovery/resolution frameworks. - Enhance AML/CFT effectiveness ahead of APG evaluation in 2026 to mitigate risks to financial integrity and correspondent banking relationships. - Strengthen SOE governance and transparency; expedite Commercial Government Business Enterprises (GBE/CGBE) Act with stronger conflict-of-interest, procurement, and reporting provisions. - Climate, structural, and human capital: - Integrate climate investment needs into a medium-term fiscal strategy, prioritize projects given capacity and debt sustainability constraints. - Scale up access to climate finance, technology, and capacity building; execute updated NDC. - Address labor shortages via skills development, targeted recruitment of seasonal workers, promotion of entrepreneurship and formalization, and reintegration support for returned seasonal workers. ### Data, capacity development, and TA priorities - Data adequacy and limitations: - Staff conclude data have shortcomings but are broadly adequate for surveillance; national accounts and balance of payments typically delayed by 1 to 3 years; CPI quarterly with weight consistency issues. - Security breach of government systems in 2022 led to serious data sourcing issues affecting statistics. - Key gaps: population census, household and corporate data, SOE reporting, labor statistics, donor grant information. - Ongoing and requested TA: - Ongoing TA from STA, ICD, and PFTAC addressing statistics, financial supervision, national accounts, and government finance. - Authorities interested in assistance examining vatu currency basket, revenue administration, and additional financial sector supervision. - Recommended institutional measures: - MOUs/service level agreements between data compilers and source entities; strengthen cybersecurity and resourcing for government data systems. *Source: IMF staff and Vanuatu authorities (excerpts from the supplied IMF country report chapter).* ### 1. Real Sector Developments ____________________________________________________________________ 21 ### 1. Real Sector Developments ### Recent developments: growth shocks and inflation - Natural disasters in 2023: - Two back-to-back tropical cyclones in March 2023 (Judy and Kevin) with damages estimated at around VT16 billion (estimated at 12 percent of 2023 GDP); agriculture sector particularly impacted. - Category 5 Tropical Cyclone Lola in Q4 2023 with a smaller impact; several earthquakes and volcanic eruptions in 2023 were less damaging. - Air Vanuatu liquidation: - On May 9, the Vanuatu government placed Air Vanuatu under voluntary liquidation and all operations halted. - The airline controlled virtually all domestic air connectivity within the archipelago and was a major international carrier into Vanuatu. - Negotiations ongoing; administrator considering options including resumption of domestic-only operations. - Shock has disrupted tourism, commerce, and delayed project implementation with potential fiscal, financial, and external sector consequences. - GDP and sector performance: - The economy likely grew by 2.2 percent y/y in 2023 despite the twin cyclones, supported by a sharp tourism recovery, government emergency response, and recovery programs. - Private sector credit grew by 5.6 percent y/y in 2023, driven by household lending (household lending accounted for 54 percent of total loans). - Inflation: - Inflation rose from 3.7 percent y/y in 2022Q2 to 14.4 percent y/y in 2023Q2 (largely driven by food prices). - CPI decelerated to 7 percent y/y in 2023Q4 and to 5.3 percent y/y in 2024Q1. - A recalibration of CPI weights in 2023 may have led to higher inflation readings. - Fiscal position and public debt: - Overall balance narrowed to -3.6 percent of GDP in 2023, from -6.4 percent of GDP in 2022. - Total public and publicly guaranteed debt grew to VT54 billion in 2023 (43 percent of GDP). - Financial sector metrics: - As of 2023Q4, capital adequacy ratio = 24.1 percent; liquid asset ratio = 46.3 percent (minimum regulatory thresholds: 10 percent and 5 percent). - Non-performing loans (NPLs) = 19.8 percent of total loans in 2023Q4 (up from around 16 percent in late 2021); system-wide loan loss coverage ratio remains below other Pacific Island countries. - The Reserve Bank of Vanuatu (RBV) launched VANKLIA (RTGS) in September 2023. ### External sector and reserves - Current account: - Current account deficit narrowed to 2.2 percent of GDP in 2023, following an average deficit of 9.1 percent of GDP in 2021 and 2022. - Narrowing supported by tourism recovery and income from seasonal workers. - Capital and financial accounts: - 2023 flows driven by project-related capital grants and foreign direct investment. - Reserves: - Gross international reserves remained adequate with 12 months of import cover in 2023 and above RBV’s minimum target of 4 months of imports; early estimates indicate a small notional decline in Q1 2024 coinciding with increased foreign currency demand. ### Outlook and baseline assumptions - Air Vanuatu assumptions for staff forecasts: - Three international carriers have increased frequency or capacity servicing Efate; more airlines may commence operations in near term. - By 2024Q3, foreign airlines are expected to have reinstated overseas flight capacity to pre-liquidation levels. - Domestic flights assumed to resume slowly and be restored by end-2024. - Staff project the airline tourism’s contribution to growth for remainder of 2024 will be reduced by ¾ relative to a no-liquidation baseline; airline tourism value-added to GDP assumed to be zero in Q2 2024 and gradually resume through Q4 2024, with full domestic and international connectivity restored by year-end. - Forecast assumes about ⅓ reduction in the GDP contribution from the industrial sector due to delays in project implementation. - Growth and current account projections (staff estimates): - Real GDP growth projected to decelerate to around 1 percent y/y in 2024 and recover to around 1½ percent in 2025. - Current account deficit projected to widen to around 7½ percent of GDP in 2024 and 6½ percent of GDP in 2025. - Foreign reserves forecast to fall slightly but remain above RBV’s benchmark (4 months of import cover). - Inflation estimated to decline to around 3.2 percent y/y by end-2024 and 2.3 percent y/y by end-2025 (inside RBV’s target). ### Channels of transmission from Air Vanuatu liquidation - Direct and indirect effects on output: - Tourism: decline will affect hospitality (lodging, restaurants, recreational activities), transport (tour operators and general transportation), retail trade, and other activities. Air arrivals provide tourists who stay longer (average of 12 nights per person) and spend nearly ten times more than cruise ship tourists (authorities’ estimate). - Domestic connectivity: Air Vanuatu was nearly the only carrier connecting Efate to the rest of the country; disruptions affect travel to outer islands. - Industry and construction: disruptions to labor and cargo mobility will delay infrastructure projects and reduce activity in manufacturing and construction; a Vanuatu Chamber of Commerce and Industry survey shows 92 percent of respondents affected and 70 percent reporting a minimum of 30 percent drop in turnover; over half of construction and manufacturing businesses experienced a turnover drop of more than 30 percent y/y. - Agriculture and fisheries: likely less impacted overall, though air transport disruptions affect availability of high-value exports; copra production faces additional structural pressures (Vanuatu Coconut Copra Exporters reported a 50 percent decline in copra production on Santo and Malekula). - Social and public services: reduced connectivity may disrupt access to healthcare, education, aid, and other public services, compressing domestic demand and exacerbating disaster vulnerability. ### Fiscal risks and Economic Citizenship Program (ECP) - ECP revenue: - Projected revenue has fallen 60 percent below the authorities’ 2024 target, partly due to reactivation of a cheaper citizenship-by-investment program. - ECP raises financial integrity concerns ahead of the 2026 FATF/APG Mutual Evaluation; EU announced permanent removal of visa-free travel for Vanuatu citizens from February 2025. - Fiscal implications: - Limited revenue sources and elevated spending related to Air Vanuatu’s liquidation expected to worsen the deficit and reduce fiscal space. - Capital spending likely to decline as authorities reprioritize expenditures, potentially depressing growth and affecting potential output in medium to long term. ### Key downside risks to the outlook - Political instability: three changes of government in the second half of 2023; potential delays in project implementation, deterrence of investment, and disruptions to donor programs. - Severe natural disasters and climate change: could cause large economic damages and price volatility; may exacerbate invasive pests affecting crop production and food supply/inflation. - China slowdown: weaker activity in China could have negative spillovers through trade partners. - Geopolitical tensions and trade fragmentation: increased shipping costs and trade disruptions could strain supply chains and fuel domestic inflation. - Labor constraints and governance/structural deficiencies: labor shortages, strikes, skills drain, and limited capacity integrated into baseline but could materialize more severely. *Source: IMF staff and Vanuatu authorities (from "1. Real Sector Developments").* ### 12. The authorities agreed with staff on the uncertain outlook and significant downside ### 12. The authorities agreed with staff on the uncertain outlook and significant downside ### Outlook and economic impacts - The Macroeconomic Committee (MEC) will downgrade GDP growth (from their April MEC round projection of 4 percent y/y for 2024). - Authorities expect the effects of Air Vanuatu’s liquidation to be contained within the accommodation and transport sectors, with larger effects on tourism-related and other service sectors, including retail. - Authorities are more optimistic than staff for 2025, expecting that resuming air connectivity will catalyze more robust economic growth. - Headline inflation is expected to fall below the RBV’s upper end of the target of 4 percent later in 2024. - Vanuatu Coconut Copra Exporters (VCCE) report a 50 percent decline in copra production (Vanuatu Budget Book 2024) on Santo and Malekula islands, attributed to labor shortages, lower prices, reduced income opportunities, adverse weather patterns and the Coconut Rhinoceros Beetle pest. - Private sector survey (December 2023) identifies political and Air Vanuatu instability as one of the main risks for future investments in the hospitality sector. ### Fiscal policy: immediate effects of Air Vanuatu liquidation - The voluntary liquidation of Air Vanuatu is expected to significantly affect the already precarious fiscal position and likely result in a significant deterioration of fiscal revenue. - Weaker tourism and services activity will directly reduce VAT revenue, excise duty receipts, and associated fees (even assuming that all air travel, including domestic is fully restored by end-2024). - Delayed implementation of industrial projects and investment will reduce foregone VAT and import fees; general commercial slowdown will further depress revenue. - Spillovers will require urgent and targeted government support to the tourism sector (possible subsidies and fee exemptions) that could create spending pressures. - Restructuring costs and possible revival costs for domestic operations are likely to significantly impact expenses in 2024 and possibly later years. - Development partners have expressed willingness to increase assistance via direct budget support, concessional loans and reprioritization of other grants that will likely fund some needed spending. ### Staff fiscal forecasts and key figures - Staff forecast: domestic revenue likely reduced by 6 percentage points of GDP in 2024 (to 20 percent of GDP) from 2023. - ECP revenues are estimated to average around 2½ percent of GDP going forward, down from around 14 percent of GDP at its peak in 2020. - Budget support grants from all development partners forecast to remain at relatively high levels in 2024-25, while project grants expected to gradually ease. - Expenditures expected to remain elevated in 2024 to reflect airline restructuring costs, modest social transfers and support to the economy. - Capital expenditure likely to decline from 2025 due to longstanding delays and capacity constraints in project execution. - Fiscal deficit projected to deteriorate to about 6½ percent of GDP in 2024, with a path of gradual improvement through the medium term. ### Debt trajectory and risks - Vanuatu’s debt trajectory has worsened since the previous Debt Sustainability Analysis (DSA). - DSA indicates debt remains sustainable but both external and public debt distress risk indicators are now rated ‘high’ as key indicators breach relevant thresholds under the baseline scenario. - Baseline assumptions contributing to breaches: - (a) increase in external debt as government absorbs some of Air Vanuatu’s liabilities; - (b) increased fiscal deficits—albeit on a gradual declining trend—attributed to sharp decline in ECP revenues and recurring expenses linked to sustaining the airline’s domestic operations; - (c) larger fiscal deficits over the medium term financed primarily with external debt and expensive domestic borrowing; - (d) weaker service exports attributed to the airline liquidation. - Domestic debt issuance expected to increase, testing absorption capacity of government bonds by the domestic financial sector and potentially crowding out private sector credit. - Government borrowing from domestic banks could exacerbate sovereign-bank nexus; central bank financing could increase if risks materialize. - Urgent corrective measures are critical to prevent rapid deterioration of fiscal metrics threatening debt sustainability. ### Revenue policy options and administration - Major driver of persistent fiscal deficits is a structural weakness in revenue. - Government should explore new revenue measures and improve collection/administration of existing fees, levies, and taxes. - Potential revenue sources include: - income taxes (particularly on the corporate sector), - capital gains taxes on real estate transactions, - fisheries licenses, - widening the tax base, - better targeted or higher VAT rates. - IMF past suggestion: a 2 percent of GDP increase in revenue was achievable through a combination of new income taxes and VAT rates that would improve efficiency, reduce inequality and achieve better distributional outcomes than VAT rate increases alone. - VAT collection is relatively low; options to improve VAT include reforms to reduce informality, improve compliance, boost VAT collection, and streamline VAT refunds and credits. - Better tax administration (including electronic solutions) can help jumpstart collections. ### Expenditure policy and fiscal consolidation - Reducing expenses rapidly to align with the new revenue outlook is a high priority. - Government spending is not significantly out of place compared to peers, but spending remains elevated and there is scope to rationalize expenditures, especially given growth in public sector size in recent years. - Interim spending measures related to Air Vanuatu should be based on prudent prioritization and accompanied by commensurate cuts in non-priority spending. - Interim measures such as increases to public employee compensation and allowances (especially those pertaining to the Government Remuneration Tribunal) should be paused. - Careful reprioritization of investment spending recommended; envisaged budget spending on airport upgrades and related infrastructure could be partially or fully suspended contingent on whether domestic air traffic resumes. - Initiate early fiscal consolidation: ambitious fiscal consolidation should start as early as possible but no later than 2025 and be sustained decisively over the medium term. - Gradual consolidation under the baseline is insufficient to reduce high debt sustainability risks; bringing the primary balance under control is critical. - Defining and adhering to a fiscal anchor (overall deficit and/or primary balance) is critical for debt sustainability. - Adherence to principles of responsible public financial management in the PFEM Act recommended, including reliable forecasting, compliance with fiscal rules, and greater accountability. ### Authorities’ fiscal views - Authorities agreed on the need to secure medium term fiscal sustainability. - They attribute decline of ECP revenue to payment-clearance delays related to AML/CFT checks and re-activation of an older, lower-cost program. - Considering a revamp to the ECP to allow the government to keep a higher share of fees currently allocated to third-party agents. - Evaluating introduction of a capital gains tax; acknowledged staff recommendation for income tax but cited political considerations. - Acknowledge urgent need for expenditure rationalization and concurred with staff on fiscal slippages due to discretionary spending (wages, allowances, travel, vehicles). - Keen to pursue a “reset budget” in 2025 around fiscal consolidation. ### Monetary policy, liquidity, and exchange rate - Monetary policy remains broadly accommodative; RBV increased the Statutory Reserve Deposit ratio by 25 basis points in December 2023. - RBV carries out open market operations (OMOs) to reduce excess liquidity and elevated inflation; in October 2023 RBV increased the volume of new RBV notes issued from VT100 million to VT200 million. - Central bank financing to the Government is increasing and at VT6 bn (4.5 percent of GDP) it has exceeded the previous 20 percent limit for lending to the government (amended in 2022 to 40 percent). - Fiscal dominance is rendering OMOs ineffective in reducing liquidity. - Near-term priority: effective liquidity management and better coordination with debt policy. - Fiscal consolidation is an opportunity for RBV to reduce exposure and holdings of government debt and stop monetary financing. - Recommendation: repeal the 2022 Reserve Bank Act amendments that increased the government borrowing cap and weakened RBV autonomy. - Exchange rate: nominal exchange rate of the vatu pegged to an undisclosed basket of currencies; REER has appreciated considerably since late 2021 and helped cushion rising import prices. - Current account model-derived REER gap implies an undervaluation of 8.4 percent, but assessment carries significant uncertainty. - Liquidation of Air Vanuatu could lead to protracted reduction in exports and reserves, limiting foreign exchange availability and heightening exchange rate pressures. - RBV has comfortable reserve buffers to manage short-term shocks though there were indications of a small nominal drop in early 2024. - Recommendation: RBV should monitor currency misalignments and continue to review the currency basket weights. ### Authorities’ monetary views and governance - RBV likely to continue tightening monetary policy given ongoing high excess liquidity. - Authorities acknowledge central bank financing to government poses significant risks but contend alternative domestic financing options are limited. - They intend to repeal most of the 2022 Reserve Bank Act, but did not commit to reduce the government borrowing cap. - Authorities view exchange rate as cushioning passthrough of import prices to inflation but see signs of possible overvaluation. - A review of currency basket weights is likely to continue with possible externally sourced technical assistance. - Resolving RBV governance issues remains a priority; pace of implementation of 2016 Safeguard Assessment recommendations remains slow and a definitive timeline is missing. - Urgent legislative action and resolution of outstanding governance issues at RBV are crucial to strengthen integrity and autonomy. - A National Risk Assessment is ongoing to address AML/CFT related issues. ### Financial sector stability and vulnerabilities - Financial sector appears broadly stable but enhancing safeguards against financial vulnerabilities is essential. - Staff sensitivity analysis indicates elevated NPLs are the most significant vulnerability; a severe downside scenario could lead to an average decline of 14.9 percentage points in the capital adequacy ratio, pushing certain banks below the regulatory minimum of 10 percent. - Large sovereign-financial sector nexus, reflected in significant holdings of government liabilities by state-owned entities, can amplify financial stability risks. - Air Vanuatu’s liquidation could increase macro-financial stability risks given its significant impact on tourism and economic activity. - RBV is not considering temporary forbearance measures at this time. - Negative real credit growth in 2023 evidences banks' limited ability to lend, with most credit growth occurring through loan refinancing rather than new lending. - Recommended focus: strengthen supervisory and resolution frameworks and incentivize improved loan recovery and workouts; RBV working on new prudential guideline in line with Basel III and has requested assistance from PFTAC. *Source: IMF staff report text (chapter 12).* ### 25. Greater supervisory scrutiny is needed. A small domestic bank was placed into ### 1vutea2024001-print-pdf - 25. Greater supervisory scrutiny is needed. A small domestic bank was placed into ### Financial supervision, banking stability, and safeguards - Findings - A small domestic bank was placed into administration in June 2023 to preserve its operations and protect depositors. - The bank remains without an appointed administrator due to inadequate coordination between supervisors, and its funding is precarious with consequences for the supervisor. - The event underscores the need for an upgrade in regulatory, supervisory, and monitoring practices, reinstating regular on-site inspections, and boosting RBV’s capacity. - The financial sector appears broadly stable, but non-performing loans (NPLs) are high. - The large sovereign-financial sector nexus, reflected in the significant holdings of Government liabilities by state-owned entities, can amplify financial stability risks. - NPL shock increases NPLs by 87% , three times the current maximun NPL among banks. - Interest rate shock is a decline in the policy rate of 2.23 pp, which was the actual fall in interest rates following COVID. - ER depreciation shock depreciates the VATU by 16 % which corresponds to the largest depreciation of the currency over the past two decades. - Level of provisioning needed is assumed to be 80%. - Policy recommendations and actions - IMF will assist with an upcoming Financial Sector Stability Review (FSSR) in 2024-25 that will recommend and augment relevant technical assistance. - Improve the supervisory function, including increasing loan-loss provisioning for impaired loans, and enhancing capital requirements to encourage banks to accumulate additional buffers. - Improve loan recovery (including through improved legal processes) and realize losses on nonperforming assets to help banks strengthen their balance sheet. - Reinstate regular on-site inspections and strengthen regulatory and supervisory capacity and practices. - Authorities’ intended enhancements to the credit reporting bureau can yield better lending decisions and lower future NPLs. - Improve effective liquidity management and better coordination with debt policy; fiscal consolidation offers an opportunity for RBV to reduce its exposure and lower its holdings of government debt to stop monetary financing. ### Financial integrity, correspondent banking, and AML/CFT - Findings - Risks to financial integrity posed by the ECP are highlighted by the decision to revoke visa free travel by UK in August 2023 and Ireland in March 2024. - The European Union is expected to permanently reinstate visa requirements in February 2025. - Ongoing pressure on correspondent banking relationships (CBRs) and risks from cryptoasset activity highlight the need for more effective financial integrity measures. - While there has been progress toward strengthening Vanuatu’s AML/CFT framework in recent years, there are ongoing deficiencies. - Vanuatu’s AML/CFT framework and its effectiveness are due to be assessed in 2026 by the Asia Pacific Group on Money Laundering (APG). - Policy recommendations - Enhance the effectiveness of the AML/CFT regime ahead of the APG evaluation to mitigate risks to financial integrity. - Improve governance and transparency within the banking sector and SOEs to help improve CBRs and address AML/CFT concerns. ### Structural policies: SOEs, governance, and anti-corruption - Findings - Air Vanuatu’s liquidation highlights the risks associated with the opacity of SOE operations in Vanuatu; voluntary liquidation occurred in May 2024. - Enhancing anti-corruption frameworks and the transparency and oversight of SOEs is crucial to reduce corruption vulnerabilities and fiscal risks. - Rapid approval and implementation of the Commercial Government Business Enterprises (GBE) Act is needed to enforce regular reporting to the Government for higher-frequency monitoring and to give greater oversight and autonomy to the GBE Unit with greater accountability to the Minister of Finance. - The current draft GBE Act lacks important transparency and integrity best practices, including stricter conflict of interest measures, prohibition on political spending, procurement regulations, and timely release of audited financial statements. - Policy recommendations - Strengthen SOE performance, monitoring and evaluations, and greater transparency of contingent liabilities to the Government. - Improve corporate governance practices for state-owned enterprises and strengthen anti-corruption frameworks. ### Climate risks and adaptation - Findings - Urgent and decisive actions are needed to tackle growing risks from climate change. - Vanuatu is already experiencing the severe impact of various climate disasters and is expected to worsen. - IMF staff analysis estimates costs of three different adaptation strategies against sea level rise in Vanuatu (see Selected Issues Paper). - Preliminary results show that sea-level rise costs around 0.8 percent of GDP annually without planned adaptation. - Complete protection of coastal areas can reduce average losses by approximately 50 percent, but it is expensive, with an estimated annual average cost of around 5.3 percent of GDP. - Planned retreat from areas at risk of inundation is estimated to cost 0.16 percent of GDP annually on average. - Policy recommendations - Enhance capacity and climate literacy through community education and awareness, strengthen coastal defenses, and develop resilient infrastructure by adhering to climate-proofed building codes, environmental impact assessments and regulations. - Scale up access to climate finance, technology, technical support, and capacity building; improve governance and institutional structures and effective laws and policies. - Integrate climate investment needs or disaster response into a medium-term fiscal strategy and prioritize projects to maximize efficiency given capacity constraints and debt sustainability risks. - Execute the updated Nationally Determined Contribution which outlines priority areas for mitigation, adaptation and loss & damages over the next decade. ### Labor market, migration, and human capital - Findings - Labor shortages and skills drain from high emigration remain structural issues that can impede private sector growth. - To fill labor gaps, employers have used Emergency Employment allowing at least 1,500 foreign workers into the country to work for a year; only 172 visas have been issued as of January 2024. - In June 2023, the minimum wage was increased (by 36 percent to VT300 per hour). - A few firms reported slightly reduced working hours and staff numbers in response to the minimum wage increase. - Female labor force participation rates and overall labor force participation show room for improvement (charts summarized in source). - Policy recommendations - Accelerate efforts to enhance benefits of labor mobility, improve the business environment and domestic labor market conditions. - Raise the skill level of the ni-Vanuatu workforce through continued investment in education, provision of scholarships and targeted technical and vocational training. - Target recruitment of seasonal workers to areas where skills development is needed and towards women in rural and the informal sector and unemployed youths. - Promote entrepreneurship and the formalization of the informal sector; reintegration programs should help returned seasonal workers establish entrepreneurial activities. ### Fiscal outlook, revenue mobilization, and debt sustainability - Findings and projections - Real GDP growth is expected to decelerate markedly in 2024 due to the loss of air connectivity and related spillovers. - The fiscal deficit is envisaged to deteriorate in 2024 given reduced revenues and elevated current spending related to the one-off estimated resolution costs and contingent liabilities of the airline. - Capital expenditure is likely to decline as the Government reprioritizes spending due to limited fiscal space. - The balance of risks is tilted to the downside, including a protracted or failed resolution of Air Vanuatu, large fiscal costs from the liquidation, labor disruptions, political instability, weak governance and corruption, and external risks such as geopolitical tensions and trade fragmentation. - Policy recommendations - Stronger revenue mobilization and consolidation efforts to rebuild fiscal buffers are crucial. - Given limited revenue sources, Government should aim for better VAT collection, and continue to explore new revenue measures, for example, via income tax and capital gains tax, fisheries licenses, higher VAT rates, and a widening of the tax base. - Spending prioritization and reallocation will be needed; commensurate cuts in non-priority spending should occur and interim spending measures such as increases to public employee compensation and allowances should be paused. - Ambitious fiscal consolidation should initiate in 2025—and be sustained decisively over the medium term to address heightened risks to debt sustainability. - Define a fiscal anchor clearly linked to securing debt sustainability (the overall deficit and/or the primary balance are possible options) and adhere to it. - Adhere to principles of responsible public financial management such as reliable and realistic forecasting, compliance with the PFEM Act and greater accountability across government public finances, including auditing. ### Capacity development, data, and technical assistance - Findings - Technical assistance needs remain critical across many areas. - Earlier and ongoing TA administered on financial supervision and regulation, national accounts statistics, and government finance have been positive in boosting capacity. - The Data Adequacy Assessment (DAA) reveals that data provided to the Fund have some shortcomings that somewhat hamper surveillance; issues affect national accounts, balance of payments, fiscal accounts and statistics. - Ongoing TA programs from STA, ICD, and PFTAC are addressing some of these issues. - Requests and interests - Authorities have expressed interest in assistance with examining the vatu basket of currencies, revenue administration, and additional financial sector supervision. ### Staff appraisal: key judgments and risks - Summary judgments - The voluntary liquidation of Air Vanuatu in May 2024 is a major shock with significant growth spillovers affecting tourism, services, labor mobility, cargo networks, domestic demand, and net exports. - Multiple carriers have increased, or will increase, air travel capacity on some routes, partially mitigating the disruption, but disruptions will likely persist in 2024. - The external position in 2023 was moderately stronger than the level implied by fundamentals and desirable policies, but anticipated declines in exports (tourism) and foreign receipts (ECP) in 2024 necessitate improving exports, enhancing productivity and rebuilding fiscal buffers. - Recommended priorities - Rebuild fiscal buffers via stronger revenue mobilization and urgent fiscal consolidation beginning in 2025. - Improve governance and reduce vulnerabilities to corruption, strengthen SOE oversight, and enhance financial integrity measures to support correspondent banking relationships and address crypto asset risks. - Reduce fiscal dominance to restore monetary policy effectiveness and stop monetary financing by lowering RBV holdings of government debt over the medium term. - Accelerate efforts to address structural challenges such as labor shortages and skills drain, and integrate climate investment needs into the medium-term fiscal strategy. *Source: IMF country report content provided in the supplied PDF excerpt.* ### 43. It is recommended that the next Article IV Consultation takes place on the standard ### It is recommended that the next Article IV Consultation takes place on the standard 12-month cycle. ### Real sector developments - Vanuatu recovered from the pandemic GDP contraction before Air Vanuatu liquidation, mostly through a large impulse in services and a recovery in the tourism sector, although tourism will slow down significantly in 2024. - Inflation spiked through 2023 driven by external shocks, but recently started to decelerate. - Economic indicators are stagnant, and labor shortages due to increased participation in seasonal worker programs could pose challenges to sustained economic growth. - Key projections and indicators (annual percent change): - Real GDP: 2023: 2.2; 2024: 0.9; 2025: 1.5; 2026: 2.1; 2027: 2.5; 2028: 2.0; 2029: 2.0. - Consumer prices (period average): 2023: 11.2; 2024: 4.2; 2025: 2.8; 2026: 2.1; 2027: 2.0; 2028: 2.0; 2029: 2.0. - Consumer prices (end period): 2023: 7.0; 2024: 3.2; 2025: 2.3; 2026: 2.0; 2027: 2.0; 2028: 2.0; 2029: 2.0. - Tourist arrivals by key source markets are recovering versus 2019 (2019=100), with Australia, New Zealand, New Caledonia, and other countries contributing; total arrivals ratio to 2019 shown in figure (sources: Vanuatu Bureau of Statistics; IMF staff estimates). ### External sector developments - The current account deficit narrowed in 2023 supported by tourism receipts, grants, and remittances; capital transfers and FDI fell in 2023. - Exports fell sharply due to the twin cyclones in early 2023 affecting agricultural production. - Tourism is recovering since borders reopened but will stall given the liquidation of Air Vanuatu. - The real effective exchange rate appreciated in 2023 due to nominal exchange rate appreciation; reserves are expected to remain adequate driven by gradual recovery of tourism receipts and remittances. - Key balance of payments figures (in percent of GDP): - Current account: 2023: -2.2; 2024: -7.4; 2025: -6.5; 2026: -4.6; 2027: -4.2; 2028: -4.0; 2029: -4.4. - Trade balance: 2023: -31.4; 2024: -25.9; 2025: -28.2; 2026: -29.3; 2027: -30.3; 2028: -33.2; 2029: -34.3. - Travel receipts: 2023: 14.2; 2024: 3.5; 2025: 5.8; 2026: 11.1; 2027: 14.6; 2028: 18.2; 2029: 19.6. - Gross remittances (percent of GDP): 2023: 13.5; 2024: 14.8; 2025: 15.4; 2026: 15.2; 2027: 14.8; 2028: 14.5; 2029: 14.2. - Gross international reserves (millions of U.S. dollars): 2023: 644; 2024: 633; 2025: 613; 2026: 622; 2027: 639; 2028: 675; 2029: 705. - Gross international reserves (in months of prospective G&S imports): 2023: 12.0; 2024: 10.9; 2025: 9.9; 2026: 9.4; 2027: 8.7; 2028: 8.6; 2029: 8.8. ### Fiscal and monetary sector developments - The fiscal deficit is expected to remain large on the back of strong capex spending and lower grants. - Public debt levels are expected to climb, posing risks to debt sustainability. - The Reserve Bank of Vanuatu (RBV) increased the statutory reserve deposit (SRD) to control inflation. - Money supply has fallen and foreign inflows are also decreasing; net foreign assets of commercial banks are stable through increasing asset positions. - Key fiscal and public debt figures: - Net lending (+)/borrowing (-) (percent of GDP): 2023: -3.6; 2024: -6.7; 2025: -5.4; 2026: -4.2; 2027: -4.0; 2028: -3.4; 2029: -3.4. - Public and publicly-guaranteed debt (end of period, percent of GDP): 2023: 42.6; 2024: 46.7; 2025: 50.5; 2026: 53.3; 2027: 55.4; 2028: 57.1; 2029: 58.7. - Domestic debt (percent of GDP): 2023: 9.7; 2024: 10.5; 2025: 11.8; 2026: 13.4; 2027: 15.0; 2028: 16.0; 2029: 15.1. - External debt (percent of GDP): 2023: 33.0; 2024: 36.3; 2025: 38.8; 2026: 39.9; 2027: 40.4; 2028: 41.1; 2029: 43.7. - Fiscal aggregates (percent of GDP): - Total revenue: 2023: 39.3; 2024: 32.5; 2025: 31.9; 2026: 30.4; 2027: 29.2; 2028: 29.8; 2029: 29.6. - Expenditure: 2023: 42.9; 2024: 39.2; 2025: 37.3; 2026: 34.7; 2027: 33.2; 2028: 33.2; 2029: 32.9. - Grants from development partners (percent of GDP): 2023: 13.2; 2024: 12.5; 2025: 11.4; 2026: 9.3; 2027: 7.4; 2028: 8.0; 2029: 7.8. - Monetary aggregates and banking flows: - Broad money (M2) annual % change: 2023: -0.8; 2024: 3.7; 2025: 8.0; 2026: 10.5; 2027: 9.6; 2028: 9.3; 2029: 5.8. - Net foreign assets (annual % change): 2023: 0.8; 2024: 2.3; 2025: 7.4; 2026: 10.4; 2027: 9.0; 2028: 9.5; 2029: 7.4. - Reserve money (in millions of vatu): 2023: 56,892; 2024: 56,203; 2025: 54,675. ### Financial sector developments - Private credit growth is decelerating, especially to households. - The banking sector remains profitable, overall liquid with respect to funding, and adequately capitalized. - Bank asset quality has further deteriorated and NPLs remain high. - Financial access of households is moderately high compared to peers. - Selected financial soundness indicators: - Private credit growth (year-on-year percentage change): 2023M3 to 2024M3 show deceleration; specific series: total credit to private sector, corporate credit, household credit (figures shown in chart; source: Vanuatu authorities). - Bank profitability (quarterly): Return on equity and Return on assets series shown; overall positive in recent quarters. - Loan-to-deposit ratio and excess reserves to deposits shown as measures of liquidity. - Capital adequacy ratio (percent, 2023Q4): Vanuatu (2023Q4) compared to peers shown in chart. - Nonperforming loans to total gross loans (percent): 2023: 19.6 (Table 7). - Regulatory capital to risk-weighted assets: 2023: 24.1 (Table 7). - Return on assets: 2023: 2.0; Return on equity: 2023: 13.9 (Table 7). ### Selected economic indicators and vulnerabilities - Demographics and baseline: - Population (2021): 312,039. - Per Capita GDP (2021): US$ 2,952. - 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. - Table 1 highlights: - Nominal GDP (in millions of U.S. dollars): 2023: 1,123; 2024: 1,169; 2025: 1,214; 2026: 1,265; 2027: 1,323; 2028: 1,377; 2029: 1,433. - Balance of payments – overall balance (percent of GDP): 2023: 0.5; 2024: -0.9; 2025: -1.6; 2026: 0.7; 2027: 1.3; 2028: 2.6; 2029: 2.1. - External debt service (percent of GNFS exports): 2023: 26.7; 2024: 13.0; 2025: 10.7; 2026: 11.4; 2027: 9.9; 2028: 8.5; 2029: 7.3. ### Central government budgetary operations (high-level) - Central government totals (in millions of Vatu, Table 2): - Total revenue: 2023: 50,689; 2024: 43,612; 2025: 44,430; 2026: 44,193; 2027: 44,343; 2028: 47,062; 2029: 48,630. - Domestic revenue: 2023: 33,703; 2024: 26,858; 2025: 28,528. - Economic citizenship program revenue (component of other revenue): 2023: 7,004; 2024: 3,936; 2025: 3,530; 2026: 3,665. - Grants from development partners (including infrastructure and budget support): 2023: 16,986; 2024: 16,755; 2025: 15,901; infrastructure grants 2023: 9,330; 2024: 6,813. - Expenditure: 2023: 55,309; 2024: 52,633; 2025: 51,934. - Acquisition of nonfinancial assets: 2023: 7,579; 2024: 3,526; 2025: 3,485. - Net lending (+)/borrowing (-) (millions of Vatu): 2023: -4,620; 2024: -9,020; 2025: -7,505. - Public and publicly-guaranteed debt (millions of Vatu): 2023: 54,914; 2024: 62,742; 2025: 70,437; 2026: 77,349; 2027: 84,136; 2028: 90,290; 2029: 96,620. - Notes: - For 2024 and beyond, in-kind aid includes estimated expenses related to restructuring costs for Air Vanuatu and resuming domestic operations. - Gross operating balance is used instead of net due to lack of data on depreciation. ### Monetary survey (high-level) - Monetary aggregates (end of period, millions of vatu, Table 4): - Net foreign assets: 2023: 88,167; 2024: 90,192; 2025: 96,880. - Net domestic assets: 2023: 28,048; 2024: 30,302; 2025: 33,235. - Total broad money (M2): 2023: 116,215; 2024: 120,494; 2025: 136,572. - Narrow money: 2023: 73,920; 2024: 81,692; 2025: 98,831. - Credit to private sector (in percent of GDP): 2023: 55.2; 2024: 53.5; 2025: 47.9. - Net foreign assets of banks (in millions of U.S. dollars): 2023: 149.4; 2024: 177.9; 2025: 255.9. - Reserve money (in millions of vatu): 2023: 56,892; 2024: 56,203; 2025: 54,675. ### Balance of payments (selected items) - Current account balance (percent of GDP): 2023: -2.2; 2024: -7.4; 2025: -6.5; 2026: -4.6; 2027: -4.2; 2028: -4.0; 2029: -4.4. - Financial account and capital account dynamics: - Capital and financial accounts (percent of GDP): 2023: 4.6; 2024: 6.4; 2025: 4.9; 2026: 5.3; 2027: 5.4; 2028: 6.7; 2029: 6.5. - Foreign direct investment (percent of GDP): 2023: 0.4; 2024: 3.4; 2025: 3.6; 2026: 3.8; 2027: 3.8; 2028: 3.7; 2029: 3.5. - Memorandum items: - Nominal GDP (in millions of U.S. dollars): 2023: 1,123; 2024: 1,169; 2025: 1,214; 2026: 1,265; 2027: 1,323; 2028: 1,377; 2029: 1,433. - Exchange rate (vatu per U.S. dollar, period average): 2023: 114.8. ### Medium-term baseline scenario and financial soundness - Medium-term baseline reiterates projections noted above for output, prices, fiscal balances, public debt, and balance of payments (see sections above). - Bank financial soundness indicators (2017–23, Table 7 highlights): - Regulatory capital to risk-weighted assets: 2023: 24.1. - Nonperforming loans to total gross loans: 2023: 19.6. - Return on assets: 2023: 2.0. - Return on equity: 2023: 13.9. - Liquid assets to total assets (liquid asset ratio): 2023: 46.3. ### Capacity development and technical assistance activities - IMF and development partners engagement across areas (Table 8): - Fiscal sector: public financial management, expenditure framework, revenue framework, debt management (past and planned/ongoing activities). - Macro-financial issues: financial supervision and regulation, financial market development, correspondent banking partnerships. - Macroeconomic framework: macroeconomic framework and macroeconomic programming. - Macro-structural issues: infrastructure, private sector development, governance issues, poverty/gender/inequality, climate change, natural disaster management, financial inclusion. - Statistics: data enhancement activities (past and planned/ongoing). - Partners listed in table include IMF, Asian Development, World Bank (activities indicated as past or planned/ongoing). *Source: Vanuatu — IMF staff estimates and projections as presented in the content unit.* ### Annex I. Authorities’ Actions to Previous Fund Policy Advice ### Annex I. Authorities’ Actions to Previous Fund Policy Advice ### Fiscal Policy - Fund 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. - Fiscal strategy should contain new revenue mobilization policies, including a well-designed income tax, and an expenditure rationalization agenda, while protecting productive and climate-critical infrastructure spending. - Properly manage fiscal risks by minimizing the contingent liabilities of Air Vanuatu; establish effective supervision and transparency of SOEs and limit and prioritize their external borrowing. - Authorities’ actions and status: - The authorities have not formulated a medium-term fiscal strategy or adopted the 2017 tax reforms (including the introduction of an income tax). - The authorities established a national revenue governance committee to oversee efforts in expanding its revenue base, but continue to have capacity/staffing issues. - The government introduced a PFM Improvement Roadmap in May 2023, though progress on implementation remains unclear. - On Air Vanuatu: The bill on commercial government business enterprises (CGBE), that will enable the timely preparation and publication of CGBE financial statements, has met with delays and is yet to be tabled in Parliament. ### Monetary Policy - Fund recommendation: - The RBV should remain data-driven and stand ready to act if there are signs of persistent excess liquidity that leads to rapid credit growth. - Authorities’ actions and status: - The RBV has increased the statutory reserve deposit (SRD) 0.25 pp to address inflationary pressures. - The RBV has carried out OMOs to mop up excess liquidity in the system. - The authorities should stay vigilant of liquidity developments. ### Financial Sector Policy - Fund recommendations: - Closely monitor the banking sector and establish crisis management frameworks. - Strengthen legal frameworks and institutional capacities on AML/CFT. - Strengthen the RBV’s autonomy and governance to help ensure the continuation of effective monetary and financial policies. - Authorities’ actions and status: - The authorities stated that they are closely monitoring the banking system to safeguard financial stability. They requested assistance to the Pacific Financial Technical Assistance Center (PFTAC) to implement changes and develop/review their current prudential standards. - Legislative frameworks have been developed and amended, notably resulting in re-establishing the Financial Intelligence Unit as an independent institution. - Implementation of 2016 Safeguards Assessment recommendations are still incomplete. - There is a pressing need to repeal the 2022 Reserve Bank Act amendments that allow the government to increase its borrowing from the central bank (from 20% to 40%), to reduce monetary financing and improve the bank's independence. ### Structural Policy - Fund recommendations: - Diversify the economy to foster stable growth and resilience. - Enact reforms to address governance and corruption weaknesses, including the governance of SOEs, the AML/CFT framework, the ECP, tax transparency, and central bank governance and autonomy. - Authorities’ actions and status: - The authorities have ratified the Pacific Agreement on Closer Economic Relations (PACER) Plus in October 2022. The PACER Plus Implementation Unit is working with relevant authorities to implement its trade and development needs. - In January 2023, the Vanuatu Electronic Single Window project, aiming to reduce the cost and time of trading was completed. - The Economic Development Zone (EDZ) legislation is in progress and yet to be approved in Parliament. ### Natural Disasters and Climate Change - Fund 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. - Authorities’ actions and status: - The authorities have not integrated climate investment needs or disaster response into medium term fiscal planning. - The authorities amended the Disaster Risk Management Act (2024). - The authorities published a revised NDC, including estimated costs of needed adaptation, mitigation and loss and damage efforts. *Annex I. Authorities’ Actions to Previous Fund Policy Advice — source: provided content* ### 2. Vanuatu is already experiencing the severe impact of climate change and is expected ### 1vutea2024001 — Vanuatu: climate impacts, adaptation needs, and financial-sector sensitivity ### Climate impacts and recent disasters - Vanuatu “is already experiencing the severe impact of climate change and is expected to worsen.” - Category 5 Tropical Cyclone Harold (early 2020) affected 43 percent of the population with loss and damages estimated at over 60 percent of GDP (Vanuatu Government, 2022). - Tropical Cyclone Pam (2015) affected an estimated 188,000 people (more than half of the population) and displaced more than 65,000 people (Vanuatu National Disaster Management Office, 2018). - Volcanic activity on Ambae Island (2018) led to the displacement of around 11,700 people (McDonnell, 2021). - An estimated 75 percent of households are engaged in subsistence agriculture; natural disasters, pests, and diseases destroy livestock and crops, imperiling agricultural production and food and water security. - Climate-related health risks include increased incidence of food and water-borne diseases and heat-related illness. - Sea-surface warming, ocean acidification and tropical storms degrade ocean resources, harming marine life and livelihoods that depend on natural resources. ### Long-term climate risks, relocation, and cultural impacts - Sea-level rise combined with tectonic activity and storm surges threaten low-lying coastal communities and may require permanent relocation. - A portion of Efate (where Port Vila is located) is slowly sinking due to seismic activity, which “worsens the real rate of sea level rise.” - “6 villages on 4 of Vanuatu’s islands have been relocated inland due to rising sea levels” while other at-risk settlements have been identified for future relocation (Sengupta, 2023). - Climate-induced relocation plus increasing urbanization could lead to rising informal settlements, overcrowding, socio-economic tensions, and strain on natural and financial resources. - Climate relocation threatens the survival of Vanuatu’s unique cultural knowledge and connection to ancestral land. ### Nationally Determined Contribution (NDC) and financing needs - Vanuatu updated and enhanced its NDC in 2022 with the country’s highest commitments on adaptation, mitigation and loss and damage over the next decade. - The enhanced NDC contains 20 mitigation, 116 adaptation, and 12 loss and damage commitments linked to the National Sustainable Development Plan, Sustainable Development Goals, and sectoral action plans. - The NDC requires significant financing estimated at 108 percent of 2023 GDP, beyond any reasonable domestic investment capacity. - The total estimated NDC financing composition: adaptation (64% of GDP), mitigation (28% of GDP) and loss & damages (16% of GDP). - Achievement of NDC targets is conditional upon international support in the form of increased access to funding, capacity development and technology transfer. ### Selected current environmental and adaptation projects (project costs and timelines preserved) - Climate Information Services for Resilient Development in Vanuatu (Van-KIRAP): Supports climate information services for agriculture, fishery, infrastructure, water sectors and communities. Timeline: 2016-2024. Total Project Cost: US$12.5 million (1.1% of GDP). - Enhancing Adaptation and Community Resilience by Improving Water Security in Vanuatu: Create safe, climate-resilient, and sustainable water utilization and improve water security in local communities. Timeline: 2022-2028. Total Project Cost: US$32.7 million (2.9% of GDP). - Vanuatu Coastal Adaptation Project Phase 2 (VCAP2): Focus on supporting environmental resource protection and biodiversity. Timeline: 2022-2028. Total Project Cost: US$26.6 million (2.4% of GDP). ($23m funded by the Green Climate Fund and $3.6m co-financing.) - Vanuatu Climate Change Resilience Project (VCRRP): Seeks to increase community access to climate information and early warning systems, enhance food, water security, and build climate resilient livelihoods. Timeline: 2022-2028. Total Project Cost: US$28.3 million (2.5% of GDP). ($23.3m funded by the Green Climate Fund and $5m co-financing; funded by the Global Environment Facility and the Least Developed Country Fund; $26.2m funded by the Green Climate Fund and $6.5m co-financed from the Vanuatu and Australia Governments and Save the Children.) ### Gaps, constraints, and enablers for adaptation - Current adaptation efforts and resources “falls short of the enormous adaptation needs.” - Constraints include financial, institutional, and human resource limitations, and lack of effective governance and financial management systems. - Feasible and effective adaptation actions today may become less effective given increasing climate hazards (IPCC, 2023). - Required elements to address shortcomings: strong and inclusive stakeholder collaboration and coordination (government, civil society, business, development agencies, donors); strengthening institutional capacity, frameworks, laws, and policies; scaling up access to climate finance, technology, and international support; and effective governance for accountable and transparent decision-making. - Integration of indigenous knowledge and cultural values with scientific knowledge is highlighted as beneficial; a Traditional Knowledge Climate and Weather Indicator Booklet was compiled in 2023 documenting traditional weather and climate indicators in Vanuatu. ### Financial sector: key features and vulnerabilities - Total banking system assets: VT171 billion, equivalent to around 1.5 times the size of the economy. There are five banks in the sector, including a large state-owned bank and three subsidiaries of foreign banks. (The smaller domestic bank, Wanfuteng Bank, went into administration by the Reserve Bank in June 2023.) - Total credit to the economy from the banking sector: around VT78 billion. Largest borrower sectors: household (54 percent), tourism (10 percent), professional (10 percent), and wholesale and retail (10 percent). - Average return on assets (ROA) for the sector: around 2 percent, with a range between 1–3 percent for some banks (2023 provisional data); net income has been weak or negative at other banks. - As of 2023Q4, average capital adequacy ratio (CAR) for the banking system: around 24.1 percent, with wide dispersion (14–42 percent) among banks. (Minimum regulatory CAR reference: 10 percent; 10 percent minimum used for assessment context.) - Non-performing loan (NPL) industry average: around 19.4 percent (noted earlier as “around 19 percent” elsewhere); NPLs have been high since at least 2016—the highest among regional peers. - Loan loss provisioning appears relatively low for some banks; some lenders may hold optimistic assumptions about asset quality in NPL portfolios. - Impaired loans to households comprise the largest portion of NPLs: “Other loans (including households) comprise 86 percent of total NPLs,” construction 4 percent and trade 3.9 percent are next largest contributors. - Vanuatu’s banking system has around 35 percent of its loans in FX, on average; the bank with the largest FX exposure has FX loans at around 50 percent of total loans. ### Banking-system sensitivity analysis: scenarios, assumptions, and results - Method: bank-by-bank sensitivity analysis with two downside scenarios (Mild Downside Scenario; Severe Downside Scenario). - Mild Downside Scenario assumptions: - Credit Risk: NPLs increase to double the current maximum NPL among banks (equivalent to an increase of about 60 percent). Level of provisioning needed assumed to be 40 percent for NPLs. - Interest Rate Risk: Interest rate decreases by 0.65 percentage points (mirroring the RBV's rate cut in response to the COVID-19 pandemic). - FX Risk: The vatu depreciates by 7 percent against the US dollar (corresponds to the average depreciation of the vatu over the past two decades, excluding the pandemic period). - Severe Downside Scenario assumptions: - Credit Risk: NPLs increase to three-times the current maximum NPL among banks (corresponds to an increase of 87 percent in NPLs). Level of provisioning needed assumed to be 80 percent for NPLs. - Interest Rate Risk: Interest rates decline by 2.25 percentage points (corresponds to the actual fall in interest rates following the pandemic). Note: the historical average adjustment of 4.75 percentage points would produce a negative policy rate, so the rate cut was adjusted to set the policy rate at 0. - FX Risk: The vatu depreciates by 16 percent (largest depreciation of the currency over the past two decades, excluding the pandemic period). - Mild scenario results: average CAR for banks averages 24.2 percent. For domestic banks, CAR declines by 9.8 percentage points after an NPL shock, by 1.4 percentage points under the interest rate shock and increases by 0.03 percentage points under an FX shock. Given high current capitalization, none of the banks falls below the minimum regulatory CAR under the mild scenario. - Severe scenario results and vulnerabilities: - Under the credit risk shock: CARs decrease by 14.9 percentage points on average for the banks; for some banks CAR falls below the minimum regulatory requirement of 10 percent. Foreign banks appear more vulnerable to an increase in their NPLs. - Under the interest rate shock: policy rate cuts of 225 basis points (2.25 percentage points) induce a decrease in the average CAR of about 5 percentage points relative to the baseline, with heterogeneity across banks. - Under the FX shock (16 percent depreciation): CAR for the banks decreases on average by 1.2 percentage point, mostly on the back of rising NPLs on FX loans. Such a depreciation benefits banks with a positive net open position and negatively affects banks with a negative net open position. *Source: IMF staff report chapter text from 1vutea2024001-print-pdf.* ### 4. Vanuatu is susceptible to many shocks. Figure 1 presents the outcomes of local projection ### 4. Vanuatu is susceptible to many shocks. ### Impact on GDP growth - Climate shocks - Output declines by approximately 3 percentage points the year of the shock and peaks at 4 percentage points one-year post-shock. - Regional/global uncertainty - A one standard deviation increase in the Asia-Pacific uncertainty index leads to a GDP decrease of about 4 percentage points over three years. - One standard deviation increase in the index corresponds to a level increase of about 46 percent. For context: - In 2019-20, the index increased by around 61 percent. - In 2022 early, it increased by 55 percent. - Trade partner growth - A 1 percent drop in trade partner growth lowers Vanuatu's GDP growth by 2 percentage points, with the effect peaking after two years. - Trade restrictions (geoeconomic fragmentation) - An increase in trade barriers in Vanuatu’s top five trade partners shows a GDP reduction in Vanuatu of 3 percentage points, on average, within a year of the shock. - Inflationary shock (example) - A substantial shock, such as Australia in 2023Q2 with CPI increases of above 6 percentage points year on year, could lead to a sharp decline of Vanuatu’s output about 10 percentage points. - Persistence - These shocks can persistently influence Vanuatu's growth patterns for up to 5 years after occurrence. ### Impact on CPI (inflation) - Uncertainty - Asia-Pacific uncertainty increases Vanuatu inflation by approximately 1 percentage point two years following the shock. - Imported inflation transmission - A 1 percent increase in trade partners' inflation results in nearly a 2-percentage point rise in Vanuatu’s inflation. - Substantial inflation spikes in trade partners can amplify this effect to around 15 percentage points 2 years post-shock. - Persistence - The inflationary impact from trade partners is persistent, continuing to escalate up to five years after the initial shock. - Policy implication noted in source - Findings underscore the need for the central bank to closely monitor these shocks and proactively manage monetary policy to mitigate their long-term effects. ### Impact on investment - Climate shocks - Two years after a climate shock, investment falls by 10 percentage points of GDP. - Uncertainty - Uncertainty negatively affects investment growth over the medium term; the impact is delayed but significant. - Trade partner economic conditions - Adverse economic conditions in partners can suppress investment growth up to 5 percentage points of GDP. - Structural context - A significant portion of investment in Vanuatu occurs through donors and loans; uncertainty can erode investor confidence and weaken financial capabilities of investment partners. ### Fiscal context and risks (Annex VII material) - Recent fiscal developments - Fiscal deficits have widened in recent years following the pandemic, multiple tropical cyclones, and ambitious infrastructure plans. - Increased discretionary spending occurred alongside sharp structural declines in revenues from the Economic Citizenship Program (ECP). - Following the Air Vanuatu voluntary liquidation in May 2024, the government assumed liabilities including paying down arrears to lessors, compensating airline staff made redundant and absorbing entitlement costs. - Public debt and composition (exact figures) - Public and publicly guaranteed (PPG) debt stood at an estimated VT55 billion (43 percent of GDP) as of end-2023. - External debt (33 percent of GDP) comprising three-fourths of total debt. - Public debt reached a high of around 50 percent of GDP in 2021 but has edged lower in the past two years as the government made early repayments to external creditors. - Fiscal balance and revenues - Current expenditures have grown sharply since 2018, with increased spending primarily funded through ECP revenues between 2018-2022. - Little growth in tax revenue combined with a sharp decline in ECP revenues makes current expenditures look unsustainable. - Fiscal rules and institutions - The Public Economic and Financial Management Act (PFEM) stipulates that “total overall expenditures of the State in each financial year should be less than its total overall receipts in the same financial year.” - The PFEM Act allows for temporary deviations accompanied by reasons and a strategy/timeline to return to the principle; however, implementation and interpretation appear subjective and inconsistent. - Authorities appear to interpret the rule as applying to “recurrent items” and “over the medium-term,” despite PFEM Act language referring to “total overall expenditures” and “in the same financial year.” - There is no formal enforcement of the fiscal rule, limited monitoring of budget implementation outside government, and scant evidence of auditing. - The debt rule in the MTDS is a political commitment and not enshrined in law. - Key Medium-Term Debt Management Targets (2023-2026) — current and target values - Domestic debt ATM (years): Current 6.7 — Target Above 10 years - Debt refixing in one year (%): Current 8.7 — Target Below 6 percent - FX debt as a percentage of total debt: Current 79.4 — Target Below 70 percent - Total debt as a percentage of Nominal GDP: Current 43.8 — Target Below 60 percent - External Debt as a percentage of Nominal GDP: Current 36.5 — Target Below 40 percent - Domestic Debt as a Percentage of Nominal GDP: Current 7.3 — Target Below 20 percent - Fiscal outlook risk - The government has run deficits in three of the past five years and is likely to realize a large deficit in 2024 and subsequent years given the impact of Air Vanuatu’s liquidation and the structural decline in ECP revenues. ### Policy recommendations and priorities (as stated in source) - Reduce or diversify external dependence. - Refine monetary policy frameworks to manage inflationary pressures effectively. - Improve institutional quality to develop robust investment programs that support sustained economic growth. - Improve the ability to monitor and react to economic indicators swiftly. - Implement a robust investment program to enhance resilience and sustain economic development despite shocks. - Re-establish a fiscal anchor and improve enforcement of the fiscal rule to secure medium-term fiscal sustainability. - Strengthen public financial management (PFM) capacity, especially: - Budget planning and monitoring. - Expenditure management. - Accountability. - Formulate more realistic macroeconomic projections with clear assessment of downside risks and tie Medium-Term Fiscal Frameworks (MTFFs) closely to the annual budget process. *Source: IMF staff calculations and content from the provided IMF chapter.* ### Annex VIII. Data Issues ### Annex VIII. Data Issues ### 1. Data adequacy assessment for surveillance - Overall staff conclusion: "The data provided to the Fund is adequate for surveillance." / "The data provided to the Fund has some shortcomings but is broadly adequate for surveillance." / "The data provided to the Fund has some shortcomings that somewhat hamper surveillance." / "The data provided to the Fund has serious shortcomings that significantly hamper surveillance." (these qualitative statements appear in the source classification scheme). - Median Rating heatmap entries (sectoral descriptors as provided): BBCCBCC - Coverage heatmap entries (sectoral descriptors as provided): BBCBB / BBCB / BB - Consistency heatmap entries (sectoral descriptors as provided): CC / C - Frequency and Timeliness heatmap entries (sectoral descriptors as provided): DBCCA / A / B / C / D - Granularity (Data Adequacy Assessment Rating / Questionnaire Results): - Data Adequacy Assessment Rating: C - Questionnaire Results / Detailed Questionnaire Results: Assessment (as reported) - Key staff findings and constraints: - National accounts and balance of payments data are typically delayed at most by 1 to 3 years. - National accounts: production-side GDP estimates are solid; expenditure-side official estimates could be improved due to large statistical discrepancies. - Prices: CPI frequency is quarterly; broadly adequate for surveillance but shows consistency issues, specifically with CPI weights. "Recent revisions to the CPI weights may help resolve consistency issues." - Balance of payments data are typically subject to large revisions. - Fiscal data: published at higher frequency, but certain elements such as ECP revenues, donor grants, SOE data, bilateral debt, etc. are not comprehensively and consistently reported. - A security breach of government systems in 2022 led to serious data sourcing issues that impacted a range of statistics and external statistics in particular. - Multiple data series gaps: population census, households, corporates, infrastructure projects, SOEs, labor-related statistics. - Use of non-official estimates: "The country team has needed to replace official data with its own estimates at places to ensure consistency across sectors and accounts." For some series (e.g., donor grant information, credit from MDBs) information is sometimes obtained from alternate sources to cross-check or replace official information. ### 2. Data standards initiatives and corrective actions - Vanuatu participates in the Enhanced General Data Dissemination System (e-GDDS) and publishes data on its National Summary Data Page since April 2019. - Corrective actions and capacity development priorities: - Ongoing TA programs by STA/ICD/PFTAC are addressing some issues. - Staffing, systems and funding for the statistics function are key issues, similar constraints across the PIC region. - Suggested institutional measures: memoranda of understanding and service level agreements between primary data compilers and source entities (relevant for DoFT/MEMF, GFS, and RBV). - Resourcing for cybersecurity across government recommended to avoid disruptions like the 2022 security breach. - Authorities implemented new software for calculating CPI and the use of scale; working to improve GDP official estimates from the expenditure side and developing methods to calculate GDP from the revenue side. ### 3. Rationale for staff assessment (selected excerpts) - Timing and quality: - National accounts and BOP: "typically delayed at most by 1 to 3 years." - CPI frequency: "quarterly, which is broadly adequate for surveillance, but the data shows some consistency issues, more specifically, with the CPI weights." - Fiscal data: availability at higher frequency but with incomplete reporting for ECP revenues, donor grants, SOE data, bilateral debt. - Data shocks and impacts: - 2022 government systems security breach affected data reconstruction and external statistics, leading to delays and possible consistency issues for 2022. ### 4. IMF staff use of and deviations from official data - The country team has replaced official data with staff estimates in places to ensure cross-sectoral consistency. - Alternate sources are used to cross-check or replace official information for certain series (e.g., donor grants, MDB credit). ### 5. Selected institutional and operational metadata (as reported) - Vanuatu participates in e-GDDS (National Summary Data Page since April 2019). - Staff note: "The data provided to the Fund has some shortcomings but is broadly adequate for surveillance." ### 6. Key statistics and operational figures (as presented) - Exchange rate: - "The rate in terms of the U.S. dollar as of June 30, 2024 was VT 118.83 per U.S. dollar." - Article IV and institutional timing: - Vanuatu is on a 12–month consultation cycle. - Previous Article IV mission: January 11 – January 25, 2023; consultation concluded March 20, 2023 (Country Report No. 23/115). - IMF financial positions (selected figures reported as of June 30, 2024): - Quota: "23.80" SDR Million; "100.00" Percent Quota - Fund holdings of currency: "19.61" SDR Million; "82.38" Percent Quota - Reserves tranche position: "4.20" SDR Million; "17.63" Percent Quota - Net cumulative allocations (SDR Department): "39.08" SDR Million; "100.00" Percent Quota - Holdings (SDR Department): "18.72" SDR Million; "47.90" Percent Quota - Outstanding Purchases and Loans: - RCF Loans: "1.70" SDR Million; "7.14" Percent Quota - Latest financial arrangements (outstanding/approved): - RCF: Date of Commitment Jun 05, 2015; Date Approved Jun 15, 2015; Amount Approved (SDR Million) 8.50; Amount Drawn (SDR Million) 8.50 - RFI: Date of Commitment Jun 05, 2015; Date Approved Jun 08, 2015; Amount Approved (SDR Million) 8.50; Amount Drawn (SDR Million) 8.50 - Projected Payments to the Fund (SDR Million; forthcoming): - Principal: 2024 0.85; 2025 0.85 - Charges/Interest: 2024 0.41; 2025 0.82; 2026 0.82; 2027 0.82; 2028 0.82 - Total: 2024 1.26; 2025 1.67; 2026 0.82; 2027 0.82; 2028 0.82 ### 7. Debt sustainability and public debt data issues (selected findings and figures) - Risk ratings from DSA: - "Risk of external debt distress: High" - "Overall risk of debt distress: High" - "Granularity in the risk rating: Sustainable" - "Application of judgement: No" - Key DSA findings: - Liquidation of Air Vanuatu (voluntary liquidation) increased uncertainty around outlook and fiscal outcomes; immediate impact on tourism and growth; longer-term fiscal implications likely protracted with higher public debt. - Sharp reduction in revenues from the Economic Citizenship Program (ECP) expected to create a structural fiscal deficit into the medium term. - Under baseline, PV of public-debt-to-GDP breaches threshold level of 55 percent from 2033 onwards (a year later than previous DSA). - Under alternate scenario with zero ECP revenues, PV of public-debt-to-GDP breaches threshold from 2027 onward. - PV of external debt-to-exports breaches indicative threshold under baseline scenario in 2024 and 2025. - PV of external debt-to-GDP breaches threshold level of 40 in later years (2033-34) under envisaged increase in external debt. - Public debt is deemed sustainable given breaches are marginal and in later years; sustainability hinges on Air Vanuatu restructuring success, access to highly concessional external loans, and assumption of gradually declining deficit. - Composite Indicator (CI) for Vanuatu: "3.05" (based on April 2024 WEO and 2022 World Bank CPIA); debt carrying capacity assessed as medium. - Public debt coverage and contingent liabilities: - Public sector debt coverage changed after Air Vanuatu liquidation on May 10, 2024; debt stock covers central government, central government guaranteed debt and central bank debt borrowed on behalf of the government. - Due to likely government takeover of Air Vanuatu liabilities, significant portion of Air Vanuatu debt now accounted for within public debt. - Non-guaranteed SOE debt and private external debt are not included in the DSA due to data limitations; contingent liability scenario for SOEs considered. - Total debt of non-financial SOEs is estimated at around "1.6 percent of GDP"; contingent liability test uses default value of "2 percent of GDP" for SOEs. - Contingent liabilities from financial markets set at default value of "5 percent of GDP". - Public and publicly guaranteed (PPG) debt levels and composition (end-2023): - "Public and publicly guaranteed (PPG) debt is estimated at approximately 43 percent of GDP at end-2023." - End-2023 PPG debt stock in nominal terms: "around VT54 billion" (compared to VT53 billion in 2022). - External debt comprises "over ¾ of total public debt". - Bilateral lender debt: "44 percent of total debt". - Multilateral creditors: "33 percent of total debt". - Export-Import Bank of China: "31 percent of total debt" (largest single creditor). - Japan International Cooperation Agency (JICA): "11 percent of total". - World Bank (IDA): "21 percent". - Asian Development Bank (ADB): "12 percent". - Currency composition of external debt portfolio: "46 percent in Chinese yuan, 21 percent in Japanese yen, 17 percent in US dollars, 13 percent in Euros and 3 percent in British pounds." - Domestic debt comprises "around 23.5 percent of total debt", primarily domestic bonds held by domestic banks and the Vanuatu National Provident Fund (VNPF). - Stock of public debt (external and domestic) at end-2023 (as provided): - Total Stock of Debt: "54065471.0" In Millions of Vatu; "100.0" As % of total debt - External Debt: "41383360.5" In Millions of Vatu; "76.5" As % of total debt - Multilateral: "17827155.3" In Millions of Vatu; "33.0" As % of total debt - Asian Development Bank: "649756.6" In Millions of Vatu; "12.0" As % of total debt - International Development Association (World Bank): "1127098.2" In Millions of Vatu; "20.8" As % of total debt - Multilateral Government Guarantees: "600.5" In Millions of Vatu; "0.1" As % of total debt - Bilateral: "23556205.2" In Millions of Vatu; "43.6" As % of total debt - EXIM Bank of China: "16718145.6" In Millions of Vatu; "30.9" As % of total debt - Japan International Cooperation Agency: "599352.2" In Millions of Vatu; "11.1" As % of total debt - Bilateral Government Guarantees: "8457.4" In Millions of Vatu; "1.6" As % of total debt - Domestic Debt: "12682110.5" In Millions of Vatu; "23.5" As % of total debt - Domestic Government Bonds: "11736102.2" In Millions of Vatu; "21.7" As % of total debt - Domestic Government Guarantees: "9468.2" In Millions of Vatu; "1.7" As % of total debt ### 8. Data limitations and staff recommendations (implied priorities) - Expand coverage and timeliness of: population census series, household and corporate statistics, SOE financial reporting, infrastructure project data, labor statistics. - Improve fiscal reporting for ECP revenues, donor grants, SOE data, bilateral debt; broaden GFS coverage from budgetary central government to general government and SOEs (PFTAC support ongoing). - Strengthen cybersecurity and resourcing for government data systems to prevent future data sourcing disruptions. - Continue TA engagement (STA/ICD/PFTAC) and consider MOUs/service level agreements between data compilers and source entities to improve data flows and consistency. - Enhance methods to reconcile GDP expenditure and revenue side estimates and continue improvements in CPI methodology and CPI weights. *Source: Annex VIII. Data Issues, 1vutea2024001-print-pdf — Vanuatu staff report excerpts (as provided).* ### 5. Domestic debt continues to grow and the government’s issuance forecast in 2024-25 ### 5. Domestic debt continues to grow and the government’s issuance forecast in 2024-25 ### Composition of domestic government debt and near-term risks - Domestic debt is primarily held by four domestic entities: the Reserve Bank of Vanuatu (RBV), the VNPF, the state-owned National Bank of Vanuatu (NBV), and PNG-based BSP bank. - As of 2023Q3: - VNPF and RBV held a combined 69 percent of domestic government debt. - NBV held 20 percent. - BSP held 8 percent. - The government’s issuance forecasts for 2024 suggest that nearly VT5 billion in government bonds could potentially come to the market, the largest annual issuance to-date. - Domestic debt is projected to rise from 10 percent of GDP in 2023 to around 15 percent of GDP by 2030, and to 20 percent of GDP by 2040. - Given the shallow domestic debt market, absorbing the bulk of the issuance in the near-term could be difficult for domestic creditors and may test the boundaries of borrowing from the RBV. - RBV’s holdings of government debt already exceed the threshold of 20 percent of the government’s annual revenues. - Increased domestic issuance could add to growing reliance on monetary financing. ### Medium-term debt management strategy (MTDS) and maturities - The government developed a MTDS for 2023-26 with the objective of minimizing long-term costs and supporting the functioning of the domestic government debt market; scope includes central government debt and guarantees to SOEs. - Average maturities: - External debt portfolio average maturity: 10.1 years. - Domestic portfolio average maturity: 6.7 years. - Debt redemption profile: - Around 8-10 percent of total external debt is maturing in each of the next four years. - Between 5-10 percent of total domestic debt is expected to mature in each of the next four years. - Authorities have set internal monitoring thresholds in the MTDS of 60 percent of GDP for Total Debt and 40 percent of GDP for External debt, but there is currently no enforcement procedure to prevent breaching these thresholds. - Legislative history and threshold considerations: - The original RBV Act stipulated a limit on government bond holdings to 20 percent of average government revenue; an amendment in 2021-2022 raised this threshold to 40 percent. - The government is considering reverting to the previous threshold, in line with IMF recommendations. ### Issuance process improvements and governance actions - Planned and ongoing initiatives to improve issuance and market functioning: - Implement the Vanuatu Central Securities Depository System (VCSDS) to improve the government bond issuance process. - Develop an Investor Relations strategy including the development and publication of an Annual Borrowing Plan and Issuance calendar. - RBV’s introduction of a fully automated registry for dematerialized securities and an upcoming automated payment system to improve transparency and efficiency. - Recommendation/action flagged: - In light of the Air Vanuatu liquidation, the government needs to urgently reassess its MTDS over 2024-27 and evaluate the likelihood and safeguards pertaining to breaching internal debt limits. ### Macroeconomic background and medium-term forecast drivers - Growth and shocks: - Real GDP growth likely: 2.2 percent y/y in 2023. - Baseline projection: real GDP growth decelerates to 0.9 percent in 2024 and recovers to around 1.5 percent in 2025 under rapid positive outcomes for airline services resumption. - Natural disasters in 2023 (three cyclones) significantly impeded recovery, especially in agriculture. - Inflation: - CPI moved from 3.7 percent y/y in 2022Q2 to 14.4 percent y/y in 2023Q2; CPI fell to 7 percent y/y in 2023Q4. - Staff estimate inflation to decline to around 3.2 percent y/y by end-2024 and 2.3 percent y/y by end-2025. - Average inflation over 2024–2034 is predicted to be 2.1 percent (compared to the previous projection of 3.3 percent). - Fiscal context and revenue risks: - The government ran deficits over the past two years driven by increased discretionary spending; Budget 2024 included New Policy Proposals (NPPs) with increased project execution of around VT17.5 billion (14 percent of GDP) in NPPs targeted at infrastructure and capital improvements. - The authorities passed a Supplementary Budget in May 2024 including large spending items on allowances and legal expenses. - Economic Citizenship Program (ECP) revenues: - ECP revenues were around 14 percent of GDP in 2020, declined to 5.4 percent of GDP in 2023. - The baseline assumes ECP revenues will continue to decline, averaging around 2.5 percent of GDP in the medium-term. - The collapse in ECP revenues and Air Vanuatu liquidation will almost certainly derail 2024 Budget plans and likely leave a structural deficit into the medium term. - External sector and financing: - Exports of goods and services projected to drop to 16.1 percent of GDP in 2024 and recover to 18.5 percent in 2025 (compared to 26.8 percent and 32.6 percent respectively in the previous DSA). - Average current account deficit estimated to be 4.7 percent of GDP over 2024–34 (previous DSA showed a marginal surplus of 0.5 percent). - Foreign direct investment inflows expected to average 3.6 percent of GDP over 2024–29. ### Implications of Air Vanuatu’s liquidation (summary of DSA box) - Air Vanuatu entered voluntary liquidation in May 2024 with significant consequences for tourism, infrastructure project execution, and labor availability for investments. - DSA assumptions and estimates: - Preliminary estimate of contingent liabilities related to Air Vanuatu could be around 2 percent of GDP (linked to debt owed to secured creditors); the DSA assumes the government will honor the airline’s secured debt and that secured debt will be realized as part of public debt in 2024. - Projected costs to restructure the airline could total around VT3 bn (2.3 percent of GDP) in 2024, with potential recurring annual operating costs if the airline continues to operate and government bears community service obligations. - To finance liquidation-related costs, the DSA assumes the government will raise concessional external debt and rely on grant financing from multilateral and bilateral creditors in the near term. - The airline shock drives a downward revision in growth projections: growth over 2024-29 projected to average 1.8 percent (1.0 percentage point lower than June 2023 DSA); growth 2024-2034 revised to an average of 1.9 percent (from 2.7 earlier). - The current account deficit expected to widen sharply to around 7½ percent in 2024, marginally recovering to around 6½ percent in 2025. - Fiscal and debt implications emphasize higher near-term borrowing needs and contingent liabilities to be managed carefully. ### Key policy recommendations and actions implied in the text - Reassess the MTDS over 2024-27 urgently in light of Air Vanuatu liquidation and ECP revenue collapse. - Evaluate likelihood and safeguards for breaching internal debt limits and reconsider the RBV holding threshold (consider reverting to previous 20 percent of average government revenue in line with IMF recommendations). - Improve market infrastructure and transparency: implement VCSDS, publish an Annual Borrowing Plan and Issuance calendar, operationalize RBV automated registry and automated payment system. - Prioritize fiscal consolidation and expenditure rationalization to address structural deficit risks driven by lost ECP revenues and liquidation-related expenses. - Seek concessional external financing and grant support to finance liquidation costs and mitigate reliance on domestic monetary financing. *Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1vutea2024001-print-pdf.pdf* ### Box 1. Implications of Air Vanuatu’s Liquidation for the DSA (Concluded) ### Box 1. Implications of Air Vanuatu’s Liquidation for the DSA (Concluded) ### Fiscal impact and baseline projection - Restructuring and continuing operations of the airline are projected to increase current expenditure in 2024 and create a recurring expense into the medium term. - Fiscal deficit path under assumptions: - Fiscal deficit widens to around 6.7 percent of GDP in 2024, before easing to 5.4 percent in 2025. - Overall deficit is expected to average around 4.0 percent of GDP between 2024–2034. - Expected downsizing of Air Vanuatu’s international operations would likely lead to scaling back capital expenditure plans related to airport infrastructure and reduce associated positive externalities. - Decline and persistent weakness in ECP revenues, combined with a slowdown in grants, is expected to create deficits into the medium-term. ### Scenario stress tests and contingent liability settings - Staff conducted: - A contingent liability test for SOEs. - A tailored natural disaster shock (LIC-DSF standard natural disaster shock: one-off shock of 10 percentage points in the debt-to-GDP ratio in the second year of the projection period, i.e., 2025). - Default parameter adjustments: - Assumed reduction of real GDP and export growth by 4 and 10 percentage points respectively for the natural disaster adjustment. - Continued use of the default decrease in GDP of 5 percent from financial market turbulence. - Combined contingent liability shock default values used for analysis: - Other elements of the general government not captured in 1.: 0.0 percent of GDP (default 1.0 percent of GDP). - SoE's debt (guaranteed and not guaranteed by the government) 1/: Used for the analysis = 2.0 percent of GDP (Default = 1/2 percent of GDP). - PPP: 35 percent of PPP stock = 0.0. - Financial market (the default value of 5 percent of GDP is the minimum value): 5.0 percent of GDP. - Total (2+3+4+5) (in percent of GDP): 7.0. - Note on 1/: "The default shock of 2% of GDP will be triggered for countries whose government-guaranteed debt is not fully captured under the country's public debt definition (1.). If it is already included in the government debt (1.) and risks associated with SoE's debt not guaranteed by the government is assessed to be negligible, a country team may reduce this to 0%." ### External debt sustainability (A. External Debt Sustainability Analysis) - Baseline breaches: - The PV of external debt-to-GDP ratio breaches the threshold of 40 between 2032-2034. - The PV of external debt-to-exports ratio breaches the threshold in 2024 and 2025, reflecting the sharp drop in exports expected from the fallout of Air Vanuatu’s voluntary liquidation. - External-debt-service-to-exports and external-debt-service-to-revenue ratios remain within their respective thresholds; these ratios decline until 2030 and increase thereafter based on debt repayment schedule assumptions. - Stress test results: - Export shock: largest impact; causes breaches in PV of external debt-to-GDP, PV of external debt-to-exports, and debt service-to-exports ratios at various periods. - Contingent liabilities (excluding Air Vanuatu): PV of external debt-to-GDP and PV of external debt-to-exports breach thresholds; PV of debt-to-GDP breaches between 2029-2034; PV of external debt-to-exports breaches 180 percent in 2024 and 2025. - Natural disaster scenario: PV of debt-to-GDP breaches threshold from 2025 onwards; PV of external debt-to-exports breaches 180 between 2024-2026. - Alternate scenario (zero ECP revenues): - Assumption: three quarters of lost ECP revenues are replaced by non-concessional external financing, remaining quarter by local debt issuance. - PV of external debt-to-GDP ratio would breach the threshold starting 2026 and through the remainder of the forecast horizon. - PV of external debt-to-exports ratio breaches 180 percent between 2024-2027 and again between 2030-2034. - Policy implication: need to diversify revenue sources, consider broadening tax base, and introduce income tax. ### Public sector debt sustainability (B. Public Sector Debt Sustainability Analysis) - Baseline: - PV of public-debt-to-GDP ratio breaches the 55 threshold between 2033-2034. - This breach is a year later than in the June 2023 DSA. - Stress tests: - Growth, exports and primary balance shocks: PV of debt-to-GDP ratio breaches 55 starting in 2026 and remains above threshold for remainder of forecast horizon; other public debt indicators (PV of debt to revenue and PV of debt service-to-revenue) remain within thresholds. - Natural disaster: threshold breached in 2025 and remains above thereafter. - Contingent liabilities (excluding Air Vanuatu) and zero ECP revenues: PV of debt-to-GDP ratio breaches threshold starting in 2027 and remains above threshold for remainder of forecast horizon; other public debt indicators remain within thresholds. - Implication: urgent need to rebuild fiscal buffers and ensure effective revenue and expenditure management. ### Policy recommendations and fiscal measures - Revenue-side recommendations: - Diversify revenue sources and broaden the tax base. - Consider introducing a tax on personal income. - Let cyclone-related VAT exemptions expire and remove exemption measures on VAT. - Consider a capital gains tax (being evaluated by authorities in response to structural decline in ECP revenue). - Expenditure-side recommendations: - Avoid continued fiscal slippage, especially discretionary spending on wages, allowances, travel, and vehicles. - Adopt strong fiscal consolidation measures and pursue a "reset budget" in 2025 around fiscal consolidation. - Enhance public investment management and governance given sizeable medium-term capex proposals. - Bolster capacity to effectively oversee infrastructure projects. - Debt management safeguards: - Implement strict safeguards against contracting new external non-concessional debt. - Limit any future guarantees to SOEs to safeguard debt sustainability. - Ensure prudent approach to managing potential liquidation of the national carrier. ### Risk rating and vulnerabilities - External debt distress risk: - Vanuatu’s risk of external debt distress has deteriorated to high, from moderate in the previous DSA. - External debt-to-exports ratio breaches thresholds under baseline in later years; stress tests show multiple breaches across external debt ratios under combined shocks. - External debt-to-GDP expected to overshoot authorities’ own ceiling of 40 in 2027. - Sensitivity to export-related shocks highlights need to broaden export base and build external buffers. - Overall public debt: - Vanuatu’s overall risk of debt distress remains high, but public debt trajectory is considered sustainable conditional on: - Success of Air Vanuatu restructuring to restore commercial viability for domestic operations. - Government’s sustained ability to access highly concessional external loans. - Public-debt-to-GDP ratio would breach authorities’ ceiling of 60 percent by 2030 under current projections. - Given breaches are marginal and in later years, both external and public debt are deemed sustainable, but with increased uncertainty especially in outer forecast years. ### Authorities' views - Air Vanuatu: - Authorities prefer sustaining domestic operations, possibly via a joint venture and some form of government support (including subsidies for community service obligations). - If revived with government support, new airline could be operated by external management with government as minority or majority stakeholder. - Government is not likely to assume liabilities of the existing airline, but is open to capital injections in a new entity. - Fiscal policy and revenue measures: - Authorities attribute ECP revenue decline to AML/CFT-related delays and re-activation of a cheaper program; considering a revamp to retain a higher proportion of fees. - Evaluating introduction of a capital gains tax; acknowledge staff recommendation for an income tax but cite political considerations. - Agree on urgent need for expenditure rationalization and a "reset budget" in 2025. - Acknowledge repeated delays in passing the GBE Act and aim to pass it this year to strengthen SOE management and monitoring. *Source: Box 1. Implications of Air Vanuatu’s Liquidation for the DSA (Concluded).* ### 26. Given the sharp decline in ECP revenues and the higher costs pertaining to Air Vanuatu ### 1vutea2024001-print-pdf - 26. Given the sharp decline in ECP revenues and the higher costs pertaining to Air Vanuatu ### Fiscal financing and policy stance - Authorities indicate the need to raise VT5 billion from domestic bond markets in 2024, the highest annual domestic issuance on record. - This domestic issuance will likely involve significant purchases by the RBV, whose holdings of government debt already exceed 20 percent of average government revenues. - The authorities do not expect to take on any additional concessional external debt in 2024 but remain open to discussing this option with development partners if the need arises. - Development partners have come forward to provide additional budget support loans and grants in 2024, but project grants are expected to recede from last year’s levels. - Authorities acknowledge that urgent fiscal consolidation would be essential to secure medium term debt sustainability. ### Key figures from the External Debt Sustainability Framework (Baseline Scenario, 2021–44) - External debt (nominal) 1/: 40.735.233.036.338.839.940.441.143.745.246.547.147.747.743.034.643.1 - Change in external debt: 0.3-5.5-2.23.32.51.10.60.72.51.61.30.60.60.0-0.7 - Identified net debt-creating flows: 5.36.8-0.93.72.40.1-0.6-0.40.1-0.4-0.30.30.60.31.7-2.30.5 - Non-interest current account deficit: 5.511.91.87.06.14.13.63.53.83.23.33.73.93.54.02.34.2 - PV of PPG external debt-to-GDP ratio (memorandum): ......33.435.136.436.836.937.238.439.239.840.140.340.134.1 - PV of PPG external debt-to-exports ratio (memorandum): ......123.0217.6196.7154.2134.8119.6118.3119.0118.5116.7115.1112.581.9 - Gross external financing need (Million of U.S. dollars): 45.5135.557.564.656.334.428.528.732.623.328.744.052.951.7119.7 - Key macro assumptions (selection): - Real GDP growth (in percent): -1.61.92.20.91.52.12.52.02.02.02.02.02.02.02.01.81.9 - Effective interest rate (percent) 4/: 1.11.11.21.21.31.41.41.41.41.41.31.31.31.31.41.31.3 - Nominal GDP (Million of US dollars): 921 1,039 1,123 1,169 1,214 1,265 1,323 1,377 1,433 1,492 1,553 1,616 1,682 1,751 2,612 ### Key figures from the Public Sector Debt Sustainability Framework (Baseline Scenario, 2021–44) - Public sector debt 1/: 49.545.342.646.750.453.055.056.658.159.560.861.963.164.275.843.257.2 - of which: external debt: 40.735.233.036.338.839.940.441.143.745.246.547.147.747.743.034.643.1 - of which: local-currency denominated: 9.610.511.613.114.615.514.514.314.314.915.416.532.8 - Change in public sector debt: 0.6-4.2-2.74.23.72.62.01.61.51.41.31.21.11.11.3 - Identified debt-creating flows: -0.21.7-0.35.43.82.21.61.21.11.00.90.90.80.81.2-0.91.8 - Primary deficit: -3.35.82.65.74.23.02.61.81.71.71.61.61.51.50.90.22.4 - Revenue and grants: 46.836.739.332.531.930.429.229.829.629.629.629.629.629.629.6 - PV of public debt-to-GDP ratio (sustainability indicator): ......43.045.648.049.951.552.752.953.554.154.955.756.666.8 - Debt service-to-revenue and grants ratio 3/: 11.59.413.19.411.310.711.912.119.610.714.313.915.717.727.7 - Gross financing need 4/: 2.09.37.78.87.86.26.05.57.54.85.85.76.26.79.1 ### Stress tests and scenarios (high-level) - Table 3 highlights alternative scenarios and stress tests for public and PPG external debt indicators for 2024–34. - Alternative Scenario: [Loss of ECP revenues] (A2) shows elevated indicator series: 35 39 41 44 46 49 52 55 57 58 60 (table entries under A2). - Bound and tailored tests produce a range of indicator outcomes (selected labels from Table 3): A1. Key variables at their historical averages in 2024-2034; B1. Real GDP growth; B2. Primary balance; B3. Exports; B4. Other flows; B5. Depreciation; B6. Combination of B1-B5; C1. Combined contingent liabilities; C2. Natural disaster. - Notes on stress-test assumptions: - All additional financing needs generated by shocks under the stress tests are assumed covered by PPG external MLT debt in the external DSA. - Default terms of marginal debt are based on baseline 10-year projections. - The most extreme stress test is the test that yields the highest ratio in or before 2034; one-off breaches are handled as described in the figures' notes. *Source: Country authorities; and staff estimates and projections.* ### 2. Primary balance12121098656677 ### 2. Primary balance ### Sensitivity analysis and debt dynamics (high-level findings) - Table 4: Sensitivity Analysis for Key Indicators of Public Debt 2024–34 presents baseline and scenario paths for multiple debt indicators and stress tests (projections 1/). - Baseline PV of debt-to-GDP ratio (2024–34): 46 48 50 51 53 53 53 54 55 56 57 - Alternative Scenario A1 (Key variables at their historical averages in 2024-2034 2/): 46 44 44 43 43 41 40 39 38 37 37 - Alternative Scenario A2 (Loss of ECP revenue): 46 50 55 59 62 65 68 71 74 77 81 - Total public debt benchmark: 55 55 55 55 55 55 55 55 55 55 55 - Baseline projections for selected rows (illustrative excerpts): - Baseline (row with larger values): 140 151 164 176 177 179 181 183 186 188 192 - A1: 140 140 146 151 147 143 139 136 134 132 130 - A2 (Loss of ECP revenue) excerpt: 9 12 12 14 14 23 14 19 20 24 26 - Bound tests (selected): - B1 Real GDP growth (PV of debt-to-GDP row): 46 51 58 61 64 66 68 71 73 75 78 - B2 Primary balance (same row): 46 51 56 58 59 60 61 62 63 - B3 Exports: 46 52 62 64 65 66 66 67 68 69 - B5 Depreciation: 46 56 56 55 54 53 52 51 50 50 - B6 Combination of B1-B5: 46 49 52 51 53 53 54 55 55 56 - Tailored tests (selected): - C1 Combined contingent liabilities: 46 53 55 56 58 58 58 59 60 60 61 - C2 Natural disaster: 46 57 60 62 65 66 68 69 70 72 - Debt service and ratios tables include repeated numeric series (e.g., Baseline 9 11 11 12 12 20 11 14 14 16 18) across projections. - Figure 3: Drivers of Debt Dynamics – Baseline Scenario highlights contributions from Price and exchange rate, Real GDP growth, Nominal interest rate, Current account + FDI, and Residual; also shows historical and projected changes across 2019–2034. ### Macroeconomic outlook and shocks - Population and geography: "population of just over 300,000" across "an archipelago of 80 islands". - Natural hazard exposure: located on the active ‘Ring of Fire’; "extremely vulnerable to earthquakes, volcanoes, and cyclones." - Air Vanuatu shock: - Authorities ceased all operations and commenced liquidation in May (year implicit in text). - Immediate disruption to airline employees, service providers, residents, and foreign travelers. - Alternative international airline capacity restored; domestic restoration work ongoing. - Discussions with the liquidator and outcome of bidding process expected to be concluded by early September. - Authorities’ revised growth forecasts: - GDP growth for 2024 downgraded to "2.8 percent". - GDP growth for 2025 downgraded to "3.8 percent". - ECP (Economic Citizenship Program) revenue: - ECP previously accounted for "as much as 14 percent of GDP". - Staff stress tests include an Alternative Scenario: "[Loss of ECP revenue]". ### Fiscal position, risks, and policy responses - Materialized fiscal shocks: - Financial and economic exposure to the airline. - Disproportionate reliance on ECP revenue. - Fiscal impacts of Air Vanuatu liquidation: - Sharp drop in tourism-related revenue (primarily the Value Added Tax). - Contingent liabilities associated with Air Vanuatu as a large and complex SOE. - Government actions already taken: paying benefits and entitlements of laid off staff; diverting part of the capital budget to repay some of the airline’s debts. - Anticipated further expenses related to liquidator and creditor processes and potential recapitalization for domestic flight services. - Possible ongoing subsidies for domestic routes to meet Community Service Obligations. - Authorities’ immediate fiscal measures and plans: - Hiring additional revenue collection compliance officers in the Department of Customs and Inland Revenue. - Procuring a new VAT monitoring system to be implemented with local businesses. - Considering fiscal rules and elements of a medium-term debt strategy including a deficit cap, limiting government debt held by the Reserve Bank of Vanuatu, and a stronger process for approving new policy proposals. - Authorities’ stance: - "agree with staff’s debt sustainability assessment and the associated risks" and "the need to undertake urgent and credible fiscal consolidation." - Acknowledge capacity constraints to support partner-funded infrastructure and climate adaptation. ### Monetary, reserves, and financial sector - Inflation: - Expected to "return to the RBV’s target band by the end of the year" partly due to lower aggregate demand following the airline liquidation and improved supply conditions. - Reserve Bank actions: - RBV has adjusted interest rates, tightened open market operations, raised the capital adequacy ratio to pre-pandemic levels, and increased the statutory reserve deposit on commercial banks. - RBV assesses liquidity remains excessive and "expects a need for further action." - Foreign exchange reserves: - Reserves are "estimated to cover just under 7 months of imports at the end of 2024, down from an estimated 8 months at the beginning of the year." - Exchange rate: - Authorities "agree with staff’s assessment that the exchange rate is likely overvalued" and are seeking technical assistance to review the currency basket. - Financial sector risks and reforms: - Financial sector judged "currently stable, but that risks are weighted to the downside." - Interlinkages among government, SOEs, the RBV, and major banks amplify risks. - Nonperforming loans remain high; issues include insufficient supervision and onerous resolution mechanisms. - Authorities have requested a Financial Sector Stability Review (FSSR) to be conducted through 2025 and an Asia-Pacific Group Mutual Evaluation of the AML/CFT framework in 2026. ### Structural vulnerabilities and reform priorities - Recent shocks and vulnerabilities: - Major cyber-attack in 2022-23 that caused loss of access to most government data and records. - Labor drain due to seasonal work programs in Australia and New Zealand. - Delays to capital projects and political instability (three changes of government in 2023). - Priority reforms and governance actions: - Strengthen SOE governance and reporting; pass the Commercial Government Business Enterprises (CGBE) Act to strengthen management and monitoring of SOEs. - Implement overdue recommendations from the Fund’s 2016 Safeguards Assessment with a credible timeline and milestones. - Amend the RBV’s governing Act to improve governance and independence. - Seek technical assistance and external financial and technical advice for restructuring airline arrangements and improving SOE oversight. - Climate vulnerability and financing: - Vanuatu is "highly vulnerable to the accumulating impacts of climate change" with limited domestic capacity for adaptation. - Vanuatu has started gaining accreditation for Green Climate Fund grants. - Large financing gap and capacity gap to meet climate goals; heavy reliance on grants and concessional lending. ### Authorities’ perspectives and commitments - Authorities "broadly agree with staff’s assessment of the outlook and with the thrust of staff’s recommendations." - Authorities are more optimistic than staff regarding the ongoing magnitude of the recent shock beyond 2024. - Commitment highlights: - Progressing structural governance reforms (CGBE Act, Safeguards Assessment follow-up). - Requesting FSSR and engaging with Fund staff on technical assistance. - Considering fiscal rules and strengthening medium-term debt strategy. - Working with partners for a satisfactory resolution to Air Vanuatu and to restore domestic flights without repeating past governance failures. *Sources: Country authorities; and staff estimates and projections.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1vutea2024001-print-pdf.pdf_