## _cr04258 — Conclusion of the Article IV Consultation (Selected Findings and Recommendations)

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### Executive summary — economic background and recent turnaround
- Real GDP declined by one-quarter following outbreak of conflict in mid-1999; exports halved and inflation increased to 15 percent.
- Budget deficit rose to over 10 percent of GDP; government defaulted on virtually all domestic and external debt obligations; international reserves (net of external arrears) were fully exhausted.
- Policy performance improved markedly after multinational intervention force (RAMSI) arrival in mid-2003 that restored law and order.
- 2003 outcomes and near-term developments:
  - Budget deficit in 2003 reduced to 1½ percent of GDP.
  - Real GDP estimated to have grown by 5 percent in 2003 (document also cites 5.1 percent in selected indicators).
  - International reserves increased sharply by May 2004 to almost $40 million (net of external arrears); gross official reserves (end-of-period, 2003) 35.9 (millions of U.S. dollars).
  - Inflation fell back to single-digit levels (CPI period average, 2003: 10.1 percent; 2004 Est./Proj.: 5.6).
  - Urban employment reportedly increasing though unemployment remains high.
- 2004 projection: authorities projected a budget surplus (accrual basis) of 4 percent of GDP after first quarterly review; a budget surplus of 4 percent of GDP is projected for 2004 in the Executive Summary.

### Key issues and staff recommendations (summary)
- Main challenge: move beyond stabilization to implement policies for sustained per capita growth in rural and urban areas.
- Fiscal recommendations:
  - Further improve tax administration and resist pressure for tax exemptions.
  - Maintain control over low priority expenditures to fund a sharp increase in social, development, and operations and maintenance outlays.
  - Regularize government debt and arrears within a sustainable medium-term fiscal framework.
  - Use bulk of projected 2004 revenue overperformance to pay down wage-related and other arrears (for 2004 Supplementary Appropriations Bill).
  - Develop and regularly update a comprehensive medium-term fiscal framework including analysis of development project spending and operations and maintenance components.
- Monetary and exchange rate recommendations:
  - Focus on containing inflationary pressures and increasing reserves.
  - Resist upward pressure on the exchange rate arising from large aid flows to build reserves; do not resist downward pressure as imports rise and aid flows diminish.
  - Central bank should be ready to sterilize aid flows and absorb excess liquidity if needed (changes in reserve requirements, direct controls on lending, open market operations).
- Financial sector recommendations:
  - Maintain central bank vigilance on prudential guidelines; resist financing the budget deficit.
  - Strengthen asset quality of the National Provident Fund (NPF) and settle future of Development Bank of Solomon Islands (DBSI).
  - Prioritize implementation of AML/CFT laws and complete establishment of reporting Commission.
- Structural reform priorities:
  - Streamline licensing procedures (including Foreign Investment Board), relax foreign labor permit limits, aid rural production, strengthen enterprise sector, improve governance and financial management.
  - Public enterprise reform, corporatization/privatization, and improved utility services governance recommended; proceeds from privatization to pay down government debt.
  - Rehabilitation and sustainable management of forestry and fisheries; address land ownership issues.

### Medium-term framework: growth, debt, and assumptions
- Growth projections and assumptions:
  - Authorities and staff agreed real GDP growth during 2004–09 could average 4½–5 percent a year (2 percent per capita) provided appropriate policies are implemented.
  - Medium-term scenario: inflation in low single digits; international reserves slowly increase if fiscal and monetary discipline maintained.
  - Growth initially driven by donor-financed public investment, later by rising private investment and exports contingent on regulatory burden reduction and structural reforms.
- Fiscal and debt projections and assumptions:
  - Assuming the budget deficit averages ½ percent of GDP and new foreign borrowing is contained, government debt ratio would decline from 100 percent in 2003 to 65 percent of GDP by 2009.
  - External debt would decline to 42 percent of GDP by 2009; servicing burden would remain sustainable though vulnerable to shocks.
  - Staff scenario assumptions include securitization of arrears on pension contributions for government employees due to NPF (2½ percent of GDP) and repayment of other arrears on wage-deductions in 2004–05 (2½ percent of GDP); balance of domestic arrears (~8 percent of GDP) assumed settled with any revenue overperformance.

### Fiscal policy — 2004 stance and medium-term actions
- 2004 fiscal outcomes and proposals:
  - Authorities projected a budget surplus (accrual basis) of 4 percent of GDP after first quarterly review (higher than 2 percent surplus forecast in 2004 budget).
  - Overperformance mainly from sales tax collections, business registrations, and tax-arrears collection under an amnesty (closed end-2003).
  - Authorities proposed using higher projected surplus to reduce the stock of expenditure arrears; staff supported this.
- Reprioritization and wage bill actions:
  - Cleansed civil service payroll of ghosts; restricted allowances; demobilized around 800 ex-militants from police; initiated New Zealand-funded audit of education sector employment.
  - Savings enabled nominal wage increase of 5 percent for remaining civil servants.
  - Pace of nonwage social and development spending slower than envisaged due to low absorptive capacity; expected to pick up.
- Medium-term fiscal strengthening measures:
  - Prepare medium-term fiscal strategy embedded within explicit macroeconomic and fiscal financing framework.
  - Multi-year revenue mobilization to widen tax base and strengthen administration: focus on business registration, staff training, increased use of audits, PFTAC technical assistance.
  - Staff urged no erosion of future tax base via income-tax exemptions for existing and new foreign or domestic investments.
  - Rationalize expenditures with priorities: basic health and education, inter-island transport, rural infrastructure and extension services, operations and maintenance.

### Monetary policy, exchange rate, and liquidity management
- 2004 monetary objectives (Governor’s statement):
  - Maintain inflation in single-digit levels and increase international reserves to at least five months of nonproject imports.
- Key liquidity risks and tools:
  - Excess reserves in banking system roughly 20 percent of deposits; large government deposits at central bank represent aid flows for investment projects.
  - Central bank would absorb liquidity as needed via changes in reserve requirements, direct lending controls, and open market operations.
  - Ability to conduct open market operations will be enhanced once government debt restructuring plan is implemented.
- Exchange rate stance:
  - Staff supported resisting upward pressure on the exchange rate arising from large aid flows to build reserves.
  - Recommendation: as aid flows diminish and imports rise, downward pressure on exchange rate should not be resisted.
  - Authorities not considering major changes to exchange rate regime (e.g., dollarization) in current environment.
  - Recent liberalizations effective April 2004:
    - Raised indicative minimum approval limit on all outward payments from SI$5,000 to SI$25,000.
    - Raised overnight limit on commercial bank foreign exchange holdings from SI$2 million to SI$3 million.
- Real exchange rate estimates (staff tentative): 20 percent below pre-1999 conflict level and 10 percent below mid-1990s level.

### Financial sector soundness, supervisory actions, and institutions
- Financial system composition and assessment:
  - Components: CBSI; three commercial banks (one domestically owned); NPF; DBSI; small nonbank financial institutions.
  - Commercial banks reported financially sound despite difficult environment; NPF asset quality severely impaired; DBSI illiquid and likely insolvent.
- CBSI position and supervision:
  - CBSI balance sheet: net liability of SI$28 million in 2003 versus net assets of SI$102 million in 1998, driven by full provisioning against government debt in default.
  - Prudential framework under 1998 Financial Institutions Act; mandate extended to NPF and DBSI in August 2002; insurance sector supervision to fall under CBSI in mid-2004.
- Commercial banks performance (assets = 32 percent of GDP):
  - Average risk-weighted capital ratio: 28 percent in 2003.
  - NPLs: SI$6 million (3 percent of total loans) before 1999 tensions; SI$20 million (11 percent) in 2002; SI$16 million (8 percent) in 2003.
  - Return on average assets: 5 percent in 2003 versus 3 percent in 1999.
  - Noninterest income share of total operating income: 65 percent in 2003 versus 43 percent in 1998.
  - Liquid asset reserves: 28 percent of total deposit liabilities in 2003 versus 14 percent in 1998; prudential requirement 7.5 percent.
- National Provident Fund (NPF):
  - Assets equal two-thirds of banking sector assets.
  - Asset composition: Government securities 25 percent; Loans 17 percent to government entities and 14 percent to members; Shares in public enterprises 18 percent; remainder property and cash deposits.
  - Problems: Large portion nonperforming due to government debt default, lending to provincial governments, housing loans; operating surpluses declined; government arrears on contributions worsened liquidity.
  - Ongoing actions: Implementing CBSI audit recommendations; reviewing investment guidelines with World Bank technical assistance.
- Development Bank of Solomon Islands (DBSI):
  - Assets (net of provisions) account for 7 percent of banking sector assets.
  - Illiquidity: liquidity ratio 2.6 percent versus 7.5 percent required.
  - Provisions for bad debt: 38 percent of total loans (noted as understated).
  - Deposit liabilities: SI$20 million in default.
  - Borrowing obligations: SI$28.5 million in default, of which SI$24 million is due to foreign creditors.
  - Conclusion: DBSI likely insolvent; in June 2004 High Court assigned CBSI as provisional manager; staff suggested operations of DBSI be wound up.
- AML/CFT framework and priority:
  - Framework comprises Money Laundering and Proceeds of Crime Act (2002); Mutual Assistance in Criminal Matters Act (2002); Financial Institutions Act (1998).
  - Banks and cash dealers required to report suspicious transactions exceeding SI$15,000 to a Commission (Commission not yet established).
  - Implementation of AML/CFT laws should be undertaken as a priority.

### Structural reforms, trade, and private sector development
- Structural reform priorities:
  - Streamline licensing procedures, especially Foreign Investment Board.
  - Relax foreign labor permit limits.
  - Encourage small-scale production and inter-island distribution of export crops (vanilla, teak, seaweed).
  - Prepare strategy for sustainable forestry and fisheries; address land ownership issues.
  - Public enterprise reform: publish annual reports, improve regulatory environment, capital investments, strengthen governance, rationalize workforce.
  - Reinvigorate corporatization/privatization program; use proceeds to pay down government debt.
- Trade policy and tariffs:
  - Tariff bands reduced since 1998 from five bands (5–70 percent) to three bands (5–20 percent).
  - Weighted average tariff now stands at 11 percent.
  - No significant nontariff barriers.
  - Several export taxes exist; log export tax is the only large revenue earner and should be reviewed as tax administration is strengthened.
  - PICTA (signed 2003): Solomon Islands committed to eliminate tariffs for trade in goods between members by 2016 at the latest.
  - Ratified PACER in July 2003.
  - Rated three under the Fund’s 10-point trade restrictiveness index.

### Governance, transparency, and statistics
- Governance initiatives:
  - Donor assistance to strengthen Auditor General and Ombudsman; addressing budgetary and Cabinet procedures.
  - Intention to establish Solomon Islands Leadership Integrity Commission using external technical assistance.
- Statistical system rehabilitation:
  - NSO ceased compiling national accounts since 1994 and price data until very recently; only partial estimates by CBSI available.
  - PFTAC preparing plan to rehabilitate NSO and improve data quality and timeliness; World Bank undertaking capacity building initiative.
  - Key statistical recommendations: appointment of a chief statistician, externally funded long-term adviser, urgent business survey and household income and expenditure survey, consider Population Census.
  - Priority to liaise with NPF for employment statistics, increase response rate on BOP surveys, resume use of Customs data for import estimation.
- PFTAC capacity-building activities:
  - 1999: Solomon Islands sent 19 officials to seminars and workshops; PFTAC organized 9 attachments.
  - PFTAC assistance across PEM, tax administration, financial sector supervision, and economic and financial statistics; recovery plan devised February 2004 including long-term adviser and training attachments.

### External and domestic debt, arrears, and fiscal decentralization
- Debt rescheduling and servicing targets:
  - Authorities committed to finalize rescheduling agreement with domestic creditors (commercial banks, NPF, central bank) in next few months.
  - Rescheduling terms guided by intention to ensure total external and domestic debt servicing not exceed 15 percent of projected domestic revenue.
  - Authorities intend thereafter to discuss with commercial and some bilateral creditors plans to reduce external debt levels and servicing costs.
- Composition of external debt: World Bank and Asian Development Bank 57 percent; Taiwan Province of China 16 percent; two commercial creditors 10 percent.
- Stock of expenditure arrears: bulk due to utility companies, wage-deduction arrears to pension, credit, and trade unions, and to trade creditors; will be paid down as circumstances permit once legitimacy verified.
- Federal structure and decentralization:
  - Authorities plan to establish a federal structure including significant budget decentralization to decrease inter-island tensions.
  - Proceed only cautiously; national budget should first be stabilized.
  - Ministry of Finance should maintain expenditure monitoring system of provincial revenue and expenditure before implementation.
  - Provinces should not be allowed to run budget deficits.

### Medium-term outlook, stress tests, and risks
- Baseline medium-term outlook (2004–09):
  - Annual growth rate averages almost 5 percent during 2004–09.
  - Export/GDP share envisaged to increase by 3 percent of GDP; share of private investment to increase by 2½ percent of GDP.
  - Current account deficit peaks in 2005 and falls back to 2 percent of GDP by 2009.
  - Inflation contained at about 3 percent a year.
  - Real exchange rate assumed broadly unchanged.
  - Fiscal stance: deficit around ½ percent of GDP a year; government debt ratio declining from 100 percent of GDP to 65 percent of GDP by 2009.
  - Revenue: increase in revenue share of 1½ percent of GDP between 2004 and 2009 via strengthened tax administration and widened tax base.
  - External debt: level declines to 42 percent of GDP by 2009 under net repayments averaging 1 percent of GDP a year.
- Stress tests and risk findings:
  - Tests used one-standard-deviation shocks lasting two years and other specified shocks (combination shock, 30 percent nominal depreciation).
  - Temporary shocks to growth or exchange rate have large but manageable impact on external debt; combined shock most extreme with NPV of external debt-to-GDP rising to 64 percent by 2009 versus baseline projection of 27 percent (staff simulation results).
  - Debt-service sensitivity: one-standard-deviation shock in export growth could raise external debt-servicing ratio from ~6 percent currently to 15 percent in 2008 before easing.
  - Policy implication: cautious fiscal and macroeconomic policies essential to preserve flexibility to respond to adverse shocks.

### Key macro and fiscal indicators (selected figures)
- Nominal GDP (2003): US$226 million
- Population (2003): 455,000 est.
- GDP per capita (2003): US$496
- Quota: SDR 10.4 million
- Central government debt (percent of GDP, 2003): 100.2
- External debt (end-of-period, 2003): 159.7 (millions of U.S. dollars)
- Gross official reserves (end-of-period, 2003): 35.9 (millions of U.S. dollars); in months of next year's imports of GNFS: 4.5
- Exports, f.o.b. (2003): 74.2 (millions of U.S. dollars)
- Imports, c.i.f. (2003): -85.2 (millions of U.S. dollars)
- Current account (2003): 3.2 (millions of U.S. dollars); (Percent of GDP) 1.4
- Inflation (CPI period average, 2003): 10.1 percent
- Broad money (annual change, 2003): 26.0 percent
- Credit to private sector (annual change, 2003): 26.1 percent

### Selected historical and 2004 indicator highlights (2000–04)
- Real GDP growth: 2000: -14.3; 2001: -9.0; 2002: -1.6; 2003: 5.1; 2004 (Est./Proj.): 4.2
- CPI (period average): 2000: 6.9; 2001: 7.6; 2002: 9.4; 2003: 10.1; 2004 (Est./Proj.): 5.6
- Central government operations (percent of GDP): Total revenue 2003: 39.8; 2004: 48.1. Grants 2003: 18.3; 2004: 24.6. Total expenditure (accrual basis) 2003: 39.6; 2004: 44.1. Recurrent balance 2003: 1.5; 2004: 4.0. Overall balance 2003: -1.4; 2004: 4.0.
- Stock of expenditure arrears (percent of GDP; end-of-period): 2000: 4.7; 2001: 8.5; 2002: 11.5; 2003: 14.4; 2004: 8.1.
- Central government debt (percent of GDP): 2000: 65.4; 2001: 82.2; 2002: 96.2; 2003: 100.2; 2004: 92.5.
- Gross official reserves (millions of U.S. dollars; end-of-period): 2000: 31.3; 2001: 18.5; 2002: 17.5; 2003: 35.9; 2004: 52.1. In months of next year's imports of GNFS: 2000: 3.1; 2001: 2.8; 2002: 2.1; 2003: 3.6; 2004: 4.5.
- Exchange rate (SI$/US$, end-of-period): 2000: 5.10; 2001: 5.56; 2002: 7.46; 2003: 7.49.

### Staff appraisal and recommended follow-up
- Assessment: marked turnaround since early 2003 with growth accelerating and inflation falling to single digits; situation remains fragile.
- Key policy priorities:
  - Strengthen budget finances to sustain programmed increases in social and development outlays while placing high government debt ratio on a downward path.
  - Maintain price stability amid resumption of economic activity and large donor flows.
  - Deep structural reforms to boost private sector investment, employment, and foreign exchange earnings.
  - Accelerate civil service reform, rationalize workforce, increase skills capacity while reducing nonpriority costs; any general wage increase only in context of realized savings elsewhere.
  - Improve economic statistics framework; full support recommended for NSO rehabilitation and statistical capacity building.
- Institutional recommendation: next Article IV consultation with Solomon Islands be held on the standard 12-month cycle.

*Source: _cr04258 — IMF staff report and PIN No. 04/89: Conclusions of the 2004 Article IV consultation with the Solomon Islands.*

### conclusion of the last Article IV consultation in January 2003. Since that time, the

### _cr04258 - conclusion of the last Article IV consultation in January 2003. Since that time, the

### Executive Summary — Economic background
- Real GDP declined by one-quarter following the outbreak of conflict in mid-1999.
- Exports halved and inflation increased to 15 percent.
- The budget deficit increased to over 10 percent of GDP; the government defaulted on virtually all domestic and external debt obligations; international reserves (net of the external arrears) were fully exhausted.
- Policy performance improved markedly after the arrival of a multinational intervention force in mid-2003 that restored law and order.
- The budget deficit in 2003 was reduced to 1½ percent of GDP reflecting increased domestic revenue collections and expenditure restraint; large donor grants funded development and other expenditures.
- A budget surplus of 4 percent of GDP is projected for 2004.
- Real GDP is estimated to have grown by 5 percent in 2003.
- International reserves increased sharply by May 2004 to almost $40 million (net of external arrears).
- Inflation fell back to single-digit levels.

### Key issues and staff recommendations (Executive Summary)
- Main challenge: move beyond stabilization to implement policies for sustained per capita growth in rural and urban areas.
- Fiscal recommendations:
  - Further improve tax administration and resist pressure for tax exemptions.
  - Maintain control over low priority expenditures to fund a sharp increase in social, development, and operations and maintenance outlays.
  - Regularize government debt and arrears within a sustainable medium-term fiscal framework.
- Monetary and exchange rate recommendations:
  - Focus on containing inflationary pressures and increasing reserves.
  - Resist upward pressure on the exchange rate arising from large aid flows to build reserves.
  - Central bank should be ready to sterilize aid flows and absorb excess liquidity if needed.
- Structural reform priorities:
  - Streamline licensing procedures, aid rural production, strengthen the enterprise sector, and improve governance.

### Recent developments (summary of findings)
- Long-run trends:
  - Early 1990s: real GDP growth averaged 8 percent a year, driven largely by logging; budget deficit increased due to tax exemptions and rising civil service wage bill.
  - 1996: government defaulted on domestic debt obligations; per capita income declined.
  - 1997–98: log prices and export volumes declined after the Asian crisis.
- Mid-1999 conflict effects:
  - Much basic infrastructure destroyed; real GDP declined by one-quarter; exports halved.
  - Budget deficit increased to over 10 percent of GDP due to import duty exemptions and large payments to militants (employed under a peace agreement).
  - Donor support largely withdrawn; by end-2002 international reserves (net of external arrears) virtually exhausted despite a 30 percent depreciation of the exchange rate.
- Policy response and stabilization:
  - RAMSI intervention (July 2003) restored law and order; Australia and New Zealand placed nationals in key positions; donors committed sizable grants in November 2003.
  - Australia paid arrears owed to the World Bank and Asian Development Bank.
- Fiscal stabilization in 2003:
  - Budget deficit fell to 1½ percent of GDP from 10 percent in 2002.
  - Factors: strengthened tax collections (amnesty on penalties), termination of payments to ex-militants, greater scrutiny over the wage bill, tighter expenditure controls, large general budget grants.
  - Government committed to preventing new nondebt expenditure arrears from October 2003.
- Economic activity:
  - Real GDP grew by an estimated 5 percent in 2003, helped by fish, copra, and cocoa production.
  - Renewed investor interest in natural resource projects; private sector credit growth increased though overall credit growth remained low due to high government deposits at the central bank.
- Other indicators by May 2004:
  - International reserves increased to almost $40 million (net of external arrears).
  - Inflation fell to single-digit levels as food supply increased and nominal effective exchange rate stabilized.
  - Urban employment reportedly increasing though unemployment remains high.

### Policy discussions — Medium-Term Framework
- Objective: use high donor assistance to support macroeconomic stability, private-sector-led growth, and improved social indicators.
- Authorities completed the National Economic Recovery, Reform, and Development Plan and established three task forces (law and order, economic reform, infrastructure and government services).
- Donor assistance uncertainties:
  - General purpose budget grants from Australia and New Zealand scheduled to end in 2004 and 2006 respectively (some extension possible).
  - European Union committed development grants amounting to $100 million; disbursement period uncertain.
  - Asian Development Bank mission to restart a $10 million lending program suspended in 2002; disbursements might start by end-2004.
  - World Bank providing grants to strengthen capacity; no lending plans at the time.
- Growth projections and assumptions:
  - Authorities and staff agreed real GDP growth during 2004–09 could average 4½–5 percent a year (2 percent per capita) provided appropriate policies are implemented.
  - Medium-term scenario: inflation in low single digits; international reserves slowly increase if fiscal and monetary discipline maintained.
  - Growth initially driven by donor-financed public investment, later by rising private investment and exports contingent on regulatory burden reduction and structural reforms.
  - Current account deficit as share of GDP would gradually decline as exports increase and project-related imports fall back.
  - Assuming the budget deficit averages ½ percent of GDP and new foreign borrowing is contained, government debt ratio would decline from 100 percent in 2003 to 65 percent of GDP by 2009.
  - External debt would decline to 42 percent of GDP; servicing burden would remain sustainable though vulnerable to shocks.

### Fiscal policy — findings and recommendations
- 2004 fiscal stance:
  - Authorities projected a budget surplus (accrual basis) of 4 percent of GDP after the first quarterly review, higher than the 2 percent surplus forecast in the 2004 budget.
  - Overperformance mainly from sales tax collections, business registrations, and tax-arrears collection under an amnesty (closed end-2003).
  - Authorities proposed using higher projected surplus to reduce the stock of expenditure arrears; staff supported this.
- Reprioritization progress in 2004:
  - Cleansed civil service payroll of ghosts, restricted allowances, demobilized around 800 ex-militants from the police force, initiated a New Zealand-funded audit of education sector employment.
  - Savings enabled a nominal wage increase of 5 percent for remaining civil servants.
  - Pace of nonwage social and development spending slower than envisaged due to low absorptive capacity; expected to pick up.
- Medium-term fiscal strengthening measures (authorities’ approach):
  - Prepare a medium-term fiscal strategy; staff suggested embedding it within an explicit macroeconomic and fiscal financing framework.
  - Multi-year revenue mobilization to widen the tax base and strengthen administration: focus on business registration, staff training, increased use of audits, utilizing technical assistance from PFTAC.
  - Staff urged that the future tax base not be eroded through income-tax exemptions for existing and new foreign or domestic investments.
  - Further rationalize expenditures over time with priorities on basic health and education, inter-island transport, rural infrastructure and extension services, and operations and maintenance outlays.
  - Monitor actual level of development spending to keep focus on medium-term priorities.

### Monetary, exchange rate, and financial sector (high-level points from document)
- Monetary policy focus:
  - Contain inflationary pressures and increase reserves.
  - Resist upward exchange rate pressure from large aid flows to build reserves.
  - Central bank readiness to sterilize aid flows and absorb excess liquidity to keep inflation in check.
- Financial sector supervision:
  - Directors at the January 24, 2003 Article IV consultation advised close supervision of the financial sector; central bank should resist financing the budget deficit and continue downward adjustments to the exchange rate where appropriate (as conditions permit).

### Structural reforms and other issues
- Structural reform priorities reiterated:
  - Streamline licensing procedures.
  - Aid rural production and strengthen the enterprise sector.
  - Improve governance and financial management.
- Medium-term agenda aims to lift per capita income through rehabilitation of the economy (especially rural areas) and strengthened governance and financial management.

*IMF staff report: Conclusion of the last Article IV consultation (January 24, 2003) — selected conclusions and policy recommendations from the IMF staff mission as presented in the report.*

### 14.      Resources will also be required to regularize and reduce external and domestic

### _cr04258 - 14.      Resources will also be required to regularize and reduce external and domestic

### External and domestic debt, and arrears
- Authorities committed to finalize a rescheduling agreement with domestic creditors (mainly the commercial banks, the National Provident Fund, and the central bank) in the next few months.
- Rescheduling terms guided by the intention to ensure that total external and domestic debt servicing not exceed 15 percent of projected domestic revenue.
- Authorities intend thereafter to discuss with commercial and some bilateral creditors plans to reduce external debt levels and servicing costs.
- Stock of expenditure arrears (bulk due to utility companies, for wage-deductions due to pension, credit, and trade unions, and to trade creditors) will be paid down as circumstances permit once legitimacy is verified.
- Composition of external debt: World Bank and Asian Development Bank 57 percent, Taiwan Province of China 16 percent, two commercial creditors 10 percent.
- Authorities have been in contact with external creditors in arrears to inform them of intent to discuss an agreed repayment arrangement.

### Federal structure and fiscal decentralization
- Authorities plan to establish a federal structure including significant budget decentralization to decrease inter-island tensions.
- Proceed only cautiously; national budget should first be stabilized.
- Ministry of Finance should maintain an expenditure monitoring system of provincial revenue and expenditure before implementation.
- Provinces should not be allowed to run budget deficits.

### Monetary policy, exchange rate, and liquidity management
- Main 2004 objectives from Governor’s monetary statement: maintain inflation in single-digit levels and increase international reserves to at least five months of nonproject imports.
- Risks to objectives: high level of excess reserves in the banking system (roughly 20 percent of deposits) and large government deposits at the central bank representing aid flows for investment projects.
- Authorities did not expect a sharp increase in private sector lending or a sudden drawdown in government deposits; central bank would absorb liquidity if needed using:
  - changes in reserve requirements,
  - direct controls on lending,
  - open market operations.
- Ability to conduct open market operations will be enhanced once government debt restructuring plan is implemented.
- Staff supported resisting upward pressure on the exchange rate arising from large aid flows to build reserves.
- Recommendation: as aid flows diminish and imports rise with recovery, downward pressure on the exchange rate should not be resisted.
- Authorities not considering major changes to the exchange rate regime (e.g., dollarization) in current environment.
- Recent liberalization: elimination of remaining restrictions on current transactions; effective April 2004 changes included:
  - raised indicative minimum approval limit on all outward payments from SI$5,000 to SI$25,000 (approval for transactions above this limit necessary only to check bona fide nature),
  - raised overnight limit on commercial bank foreign exchange holdings from SI$2 million to SI$3 million.
- Staff view: current exchange rate broadly competitive; recent export volumes determined more by domestic supply constraints than demand.
- Real exchange rate estimates: 20 percent below pre-1999 conflict level and 10 percent below mid-1990s level (staff REER estimates tentative given absence since mid-2000 of comprehensive price data).

### Financial sector stability and reforms
- Central bank vigilant to ensure commercial banks comply with prudential guidelines; bank profitability improved since law and order restored.
- Central bank widened supervisory powers in mid-2002 and acted to address difficulties in major nonfinancial institutions.
- Poor asset quality of National Provident Fund being gradually addressed following on-site inspection in late-2003 with World Bank technical assistance.
- High Court approved central bank request to assume management of the small and insolvent Development Bank of Solomon Islands (DBSI); staff suggested operations of DBSI be wound up.
- Implementation of AML/CFT laws should be undertaken as a priority.
- AML framework comprises three laws requiring banks and cash dealers to report suspicious transactions exceeding SI$15,000 to a Commission (Commission not yet established):
  - Money Laundering and Proceeds of Crime Act (2002),
  - Mutual Assistance in Criminal Matters Act (2002),
  - Financial Institutions Act (1998).
- Authorities completed MFD AML/CFT questionnaire and seek PFTAC assistance to review and assist implementation.

### Structural reforms, private sector, and trade
- Structural reform critical to lift private sector activity and employment; focus on gold and mining, palm oil production, tourism, local manufacturing.
- Private sector requests: streamline licensing procedures (especially Foreign Investment Board), relax limit on foreign labor permits.
- Encourage small-scale production and inter-island distribution of export crops such as vanilla, teak, and seaweed to increase rural employment and income.
- Authorities preparing strategy for sustainable development and management of forestry and fisheries; policy to address land ownership issues.
- World Bank and Asian Development Bank providing technical assistance, including World Bank’s FIAS.
- Public enterprise reform needed to reestablish reliable supply and improve quality of utility services; measures include publishing annual reports, improving regulatory environment, capital investments, strengthening governance, rationalizing workforce.
- Reinvigoration of enterprise corporatization and privatization program recommended; proceeds should be used to pay down government debt.
- Trade policy:
  - Tariff bands reduced since 1998 from five bands (5–70 percent) to three bands (5–20 percent).
  - Weighted average tariff now stands at 11 percent.
  - No significant nontariff barriers.
  - Several export taxes exist; log export tax is the only large revenue earner and should be reviewed as tax administration is strengthened.
  - In PICTA (signed 2003), Solomon Islands committed to eliminate tariffs for trade in goods between members by 2016 at the latest.
  - Ratified PACER in July 2003.
  - Rated three under the Fund’s 10-point trade restrictiveness index (rating could improve once detailed tariff schedule information received).

### Governance, transparency, and statistics
- Initiatives underway to strengthen governance and transparency and reduce corruption: donor assistance to strengthen Auditor General and Ombudsman, addressing budgetary and Cabinet procedures.
- Intention to establish Solomon Islands Leadership Integrity Commission using external technical assistance.
- National Statistical Office (NSO) ceased compiling real and nominal national accounts estimates in 1994 and, until very recently, price data in 2000; only partial estimates by central bank available.
- PFTAC preparing plan to rehabilitate NSO and improve data quality and timeliness; World Bank undertaking capacity building initiative.
- Authorities agreed progress on statistical rehabilitation is a priority.

### Staff appraisal: assessment and policy recommendations
- Recent performance: marked turnaround since early 2003 with growth accelerating and inflation falling to single digits; situation remains fragile.
- Main challenges: move beyond stabilization to policies reducing medium-term risks and underpin sustained per capita growth.
- Key recommendations:
  - Strengthen budget finances to sustain programmed increases in social and development outlays while placing high government debt ratio on a downward path.
  - Maintain price stability amid resumption of economic activity and large donor flows.
  - Deep structural reforms to boost private sector investment, employment, and foreign exchange earnings.
  - For 2004 Supplementary Appropriations Bill: use bulk of projected revenue overperformance to pay down wage-related and other arrears.
  - Expenditure reprioritization: accelerate civil service reform, rationalize civil service, increase skills capacity while reducing nonpriority costs, maintain control over salary increases; any general wage increase only in context of realized savings elsewhere.
  - Reallocate spending toward basic health and education, rural infrastructure and extension services, and operations and maintenance.
  - Develop and regularly update a comprehensive medium-term fiscal framework including analysis of development project spending and operations and maintenance components.
  - Revenue mobilization: widen tax base, strengthen tax and customs administration, review export taxes, do not grant new income-tax exemptions for foreign or domestic investments, consider abolishing existing tax and customs exemptions.
  - Decentralization: not ready to implement federal Constitution with decentralization until national budget stabilized and expenditure monitoring system for provincial revenue and expenditure established; safeguards needed to prevent undue weakening of national budget.
  - Monetary policy: maintain 2004 objectives of containing inflationary pressures and increasing international reserves; continue to resist upward exchange rate pressure to build reserves; do not resist downward pressure as imports rise and aid flows diminish.
  - Financial sector: maintain central bank vigilance on prudential guidelines; continue efforts to strengthen asset quality of NPF and settle future of DBSI; prioritize AML/CFT implementation.
  - Structural reform priorities reiterated (Foreign Investment Board, foreign labor permits, licensing, forestry and fisheries sustainability, public enterprise reform, trade liberalization, governance and transparency).
  - Improve economic statistics framework; full support recommended for NSO rehabilitation and statistical capacity building.
- Recommendation: next Article IV consultation with Solomon Islands be held on the standard 12-month cycle.

*Source: _cr04258 - 14.      Resources will also be required to regularize and reduce external and domestic*

### Box 2. Solomon Islands: Impediments to Growth and Poverty Reduction

### Box 2. Solomon Islands: Impediments to Growth and Poverty Reduction

### Overview
- Real per capita GDP of the Solomon Islands was 7 percent lower in 1999 than at independence in 1978.
- The civil conflict during 1999–2003 reduced real per capita GDP by another one-quarter.
- Solomon Islands lags behind most other Pacific Island countries in terms of social indicators.
- Malaria is rampant, with the highest rate of infection in the world outside of sub-Saharan Africa.
- More than a third of the rural population lacks access to safe water.
- Major obstacles to higher sustained economic growth include limited infrastructure, remote geographical location, lack of well-defined property rights, and inadequate education and health services.

### Agriculture
- More than 80 percent of the population live in the rural areas and engage in subsistence or semi-subsistence agriculture.
- Transport in and between the islands is inadequate, making it challenging for smallholders to take produce to market.
- Small producers lack financial services and technical assistance; cash crops such as vanilla have not been grown despite regional success.
- Large-scale plantations are restrained by difficulty in acquiring land, most of which is communally owned and lacks titles.

### Forestry
- Timber extraction accounts for two-thirds of the value of merchandise exports.
- Current level of extraction is estimated to be two to three times above the sustainable level.
- Main issues: better governance of the sector and encouraging sustainable forestry practices.
- Foreign operators often exploit uncertainty in land ownership by compensating an individual rather than the collective body of owners.

### Fishing
- The Solomon Islands has large fish resources; artisanal fishing is widespread for subsistence and local sales.
- Small producers cannot access larger markets due to poor inter-island transportation; most fish consumed in Honiara is of the canned and frozen variety.
- Two major companies export most of their catch, although the cost of transport to the main export markets in Asia is high.
- Private companies are disadvantaged by a tax concession enjoyed by the largest firm, which is owned by the government.

### Mining
- There are rich gold and nickel resources in the Solomon Islands, which are not currently exploited.
- The Gold Ridge mine was closed at the height of conflict in 2000, and its infrastructure and assets have been severely damaged.
- Main risk for mining operations is the uncertain legal status of land: mining companies cannot buy land, and profit-share arrangements with landowners are often challenged by other claimants.

### Tourism
- The Solomon Islands has natural and cultural attractions: pristine coral reefs, rich marine life, and a large number of World War II wrecks offering world-class diving and snorkeling.
- Existing tourism facilities are insufficient and concentrated in Honiara, eschewing natural attractions of outlying areas.
- Although security warnings have been lifted, disease risks and costly air travel discourage tourists.

### Manufacturing and Employment
- Manufacturing is limited, mainly processing agricultural commodities such as coconut and palm oil and fish processing.
- Little foreign direct investment and domestic enterprise development has been hindered by the security situation and lack of entrepreneurial experience.
- Urban areas, particularly Honiara, have grown rapidly, but formal sector employment opportunities have remained limited.
- Even before the outbreak of the conflict in 1999, only one in three men aged 20–24 was estimated to be engaged in paid employment; for women, the ratio was less than one in six.

*Source: _cr04258 - Box 2. Solomon Islands: Impediments to Growth and Poverty Reduction_*

### Box 3. Solomon Islands: Financial Sector Soundness and Supervision

### Box 3. Solomon Islands: Financial Sector Soundness and Supervision

### Financial system overview
- Components: Central Bank of Solomon Islands (CBSI); three commercial banks (one domestically owned); National Provident Fund (NPF); Development Bank of Solomon Islands (DBSI); and small nonbank financial institutions (credit unions, insurance companies, housing schemes).
- Overall assessment: Commercial banks reported financially sound despite difficult environment and government debt defaults; NPF asset quality severely impaired; DBSI illiquid and likely insolvent.

### Central Bank soundness and supervision
- CBSI balance sheet: net liability of SI$28 million in 2003 versus net assets of SI$102 million in 1998, driven by full provisioning against holding of government debt (all in default).
- Outlook: CBSI financial position expected to strengthen once government debt-rescheduling discussions are completed.
- Supervision framework:
  - Prudential regulator under 1998 Financial Institutions Act; mandate extended to cover NPF and DBSI in August 2002; insurance sector supervision to fall under CBSI in mid-2004.
  - Prudential standards generally in accordance with Basle Core Principle; enforcement via off-site and on-site inspections; NPF and DBSI covered for first time in 2003.
  - Pending issue: majority ownership status of National Bank of Solomon Islands (NBSI) by three local trust funds—trusts do not meet “fit and proper” guideline.
  - Regulatory actions: CBSI took legal actions against a pyramid scheme in 2003.

### Commercial banks performance (assets = 32 percent of GDP)
- Capital adequacy:
  - Average risk-weighted capital ratio: 28 percent in 2003.
  - All three banks well above 10 percent prudential requirement; requirement may be raised to 15 percent as of mid-2004.
- Asset quality:
  - NPLs: SI$6 million (3 percent of total loans) before 1999 tensions; SI$20 million (11 percent) in 2002; SI$16 million (8 percent) in 2003.
- Earnings and profitability:
  - Return on average assets: 5 percent in 2003 versus 3 percent in 1999.
  - Noninterest income share of total operating income: 65 percent in 2003 versus 43 percent in 1998.
- Liquidity:
  - Liquid asset reserves: 28 percent of total deposit liabilities in 2003 versus 14 percent in 1998; prudential requirement 7.5 percent.

### National Provident Fund (NPF)
- Role: Compulsory saving scheme for retirement.
- Size: Assets equal two-thirds of banking sector assets.
- Asset composition:
  - Government securities: 25 percent
  - Loans: 17 percent to government entities and 14 percent to members
  - Shares in public enterprises: 18 percent
  - Remainder: property and cash deposits
- Problems: Large portion of portfolio nonperforming due to government debt default, lending to provincial governments (under government guarantee), and housing loans; operating surpluses declined over four years due to civil conflict and heavy withdrawals; government arrears on contributions worsened liquidity.
- Ongoing actions: Implementing CBSI audit recommendations; reviewing investment guidelines with World Bank technical assistance.

### Development Bank of Solomon Islands (DBSI)
- Ownership: Government-owned development lender.
- Size: Assets (net of provisions) account for 7 percent of banking sector assets.
- Financial position:
  - Illiquidity: liquidity ratio 2.6 percent versus 7.5 percent required for commercial banks.
  - Provisions for bad debt: 38 percent of total loans (noted as understated).
  - Deposit liabilities: SI$20 million in default.
  - Borrowing obligations: SI$28.5 million in default, of which SI$24 million is due to foreign creditors.
  - Conclusion: DBSI has likely become insolvent.
- Resolution: In June 2004 the High Court assigned the CBSI as provisional manager for DBSI (under 1998 Financial Act provisions).

### Key macro and fiscal indicators (selected figures from source)
- Nominal GDP (2003): US$226 million
- Population (2003): 455,000 est.
- GDP per capita (2003): US$496
- Quota: SDR 10.4 million
- Central government debt (percent of GDP, 2003): 100.2
- External debt (end-of-period, 2003): 159.7 (millions of U.S. dollars)
- Gross official reserves (end-of-period, 2003): 35.9 (millions of U.S. dollars); in months of next year's imports of GNFS: 4.5
- Exports, f.o.b. (2003): 74.2 (millions of U.S. dollars)
- Imports, c.i.f. (2003): -85.2 (millions of U.S. dollars)
- Current account (2003): 3.2 (millions of U.S. dollars); (Percent of GDP) 1.4
- Inflation (CPI period average, 2003): 10.1 percent
- Broad money (annual change, 2003): 26.0 percent
- Credit to private sector (annual change, 2003): 26.1 percent

### Medium-term outlook and risks (summary)
- Baseline scenario:
  - Annual growth rate averages almost 5 percent during 2004–09, driven initially by donor-financed public investment and later by private investment and exports.
  - Export/GDP share envisaged to increase by 3 percent of GDP; share of private investment to increase by 2½ percent of GDP.
  - Current account deficit peaks in 2005 and falls back to 2 percent of GDP by 2009.
  - Inflation contained at about 3 percent a year.
  - Real exchange rate assumed broadly unchanged.
  - Fiscal stance: deficit around ½ percent of GDP a year; government debt ratio declining from 100 percent of GDP to 65 percent of GDP by 2009.
  - Revenue: increase in revenue share of 1½ percent of GDP between 2004 and 2009 via strengthened tax administration and widened tax base.
  - External debt: level declines to 42 percent of GDP by 2009 under net repayments averaging 1 percent of GDP a year.
- Assumptions noted in staff scenario:
  - Securitization of arrears on pension contributions for government employees due to NPF (2½ percent of GDP) and repayment of other arrears on wage-deductions in 2004–05 (2½ percent of GDP); balance of domestic arrears (~8 percent of GDP) assumed settled with any revenue overperformance.
- Stress tests and risks:
  - Tests used one-standard-deviation shocks lasting two years to growth, export value growth, U.S. dollar GDP deflator, nondebt creating flows; one-half standard deviation combined shock; 30 percent nominal exchange rate depreciation.
  - Findings: Temporary shocks to growth or exchange rate have large but manageable impact on external debt; combined shock most extreme with NPV of external debt-to-GDP rising to 64 percent by 2009 versus baseline projection of 27 percent.
  - Debt-service sensitivity: one-standard-deviation shock in export growth could raise external debt-servicing ratio from ~6 percent currently to 15 percent in 2008 before easing.
  - Policy implication: Cautious fiscal and macroeconomic policies are essential to preserve flexibility to respond to adverse shocks.

*Sources: Data provided by the Ministry of Finance; Central Bank of Solomon Islands; and Fund staff estimates and projections.*

### Appendix Table 1. Solomon Islands: Medium-Term Adjustment Scenario, 2002–09

### Appendix Table 1. Solomon Islands: Medium-Term Adjustment Scenario, 2002–09

### Table structure (columns)
- Columns correspond to: Average, 2003, 2004, 2005, 2006, 2007, 2008, 2009, 2004–09 (as presented in the source).

### Baseline and Alternative Scenarios (first panel)
- Baseline
  - 48, 44, 41, 37, 33, 30, 27, 35
- A. Alternative Scenarios
  - A1. Key variables at their historical averages in 2005–09 1/
    - 48, 44, 44, 45, 46, 48, 49, 46
  - A2. New public sector loans on less favorable terms in 2005–09 2/
    - 48, 44, 41, 37, 34, 31, 28, 36
- B. Bound Tests
  - B1. Real GDP growth at historical average minus one standard deviation in 2005–06
    - 48, 44, 46, 47, 42, 38, 34, 42
  - B2. Export value growth at historical average minus one standard deviation in 2005–06 3/
    - 48, 44, 47, 55, 51, 47, 43, 48
  - B3. U.S. dollar GDP deflator at historical average minus one standard deviation in 2005–06
    - 48, 44, 46, 48, 43, 39, 35, 42
  - B4. Net non-debt creating flows at historical average minus one standard deviation in 2005–06 4/
    - 48, 44, 48, 49, 45, 41, 38, 44
  - B5. Combination of B1–B4 using one-half standard deviation shocks
    - 48, 44, 59, 80, 74, 69, 64, 65
  - B6. One-time 30 percent nominal depreciation relative to the baseline in 2005 5/
    - 48, 44, 57, 52, 47, 43, 38, 47

### Baseline and Alternative Scenarios (second panel)
- Baseline
  - 113, 102, 94, 84, 74, 66, 59, 80
- A. Alternative Scenarios
  - A1. Key variables at their historical averages in 2005–09 1/
    - 113, 102, 102, 102, 102, 105, 108, 103
  - A2. New public sector loans on less favorable terms in 2005–09 2/
    - 113, 102, 94, 85, 75, 68, 61, 81
- B. Bound Tests
  - B1. Real GDP growth at historical average minus one standard deviation in 2005–06
    - 113, 102, 94, 84, 74, 66, 59, 80
  - B2. Export value growth at historical average minus one standard deviation in 2005–06 3/
    - 113, 102, 154, 255, 229, 210, 193, 190
  - B3. U.S. dollar GDP deflator at historical average minus one standard deviation in 2005–06
    - 113, 102, 94, 84, 74, 66, 59, 80
  - B4. Net non-debt creating flows at historical average minus one standard deviation in 2005–06 4/
    - 113, 102, 110, 111, 99, 90, 82, 99
  - B5. Combination of B1–B4 using one-half standard deviation shocks
    - 113, 102, 143, 205, 184, 169, 156, 160
  - B6. One-time 30 percent nominal depreciation relative to the baseline in 2005 5/
    - 113, 102, 94, 84, 74, 66, 59, 80

### Baseline and Alternative Scenarios (third panel — source contains formatting/artifact entries)
- Baseline
  - 96   76675
6
- A. Alternative Scenarios
  - A1. Key variables at their historical averages in 2005–09 1/
    - 9, 6, 7, 7, 7, 10, 8, 8
  - A2. New public sector loans on less favorable terms in 2005–09 2/
    - 9, 6, 76675
6
- B. Bound Tests
  - B1. Real GDP growth at historical average minus one standard deviation in 2005–06
    - 9, 6, 76675
6
  - B2. Export value growth at historical average minus one standard deviation in 2005–06 3/
    - 9, 6, 10, 13, 13, 15, 12, 11
  - B3. U.S. dollar GDP deflator at historical average minus one standard deviation in 2005–06
    - 9, 6, 76675
6
  - B4. Net non-debt creating flows at historical average minus one standard deviation in 2005–06 4/
    - 9, 6, 76675
6
  - B5. Combination of B1–B4 using one-half standard deviation shocks
    - 9, 6, 8, 10, 10, 12, 9, 9
  - B6. One-time 30 percent nominal depreciation relative to the baseline in 2005 5/
    - 9, 6, 76675
6

### Memorandum item
- Grant element assumed on residual financing (i.e., financing required above baseline) 6/
  - ..., ..., 48, 48, 48, 48, 48, 48

### Footnotes (as presented in the source)
- 1/ Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.
- 2/ Assumes that the interest rate on new borrowing is 2 percentage points higher than in the baseline, while grace and maturity periods are the same as in the baseline.
- 3/ Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assuming an offsetting adjustment in import levels).
- 4/ Includes official and private transfers and FDI.
- 5/ Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.
- 6/ Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

*Source: Fund staff projections and simulations.*

### 1999. The Solomon Islands sent 19 officials to seminars and workshops, and PFTAC organized 9 attachments

### _cr04258 - 1999. The Solomon Islands sent 19 officials to seminars and workshops, and PFTAC organized 9 attachments

### PFTAC assistance and capacity building
- 1999: The Solomon Islands sent 19 officials to seminars and workshops, and PFTAC organized 9 attachments (including for the manager of CBSI’s Financial Institutions Department to a seminar in Washington).
- Contact person: Luc Leruth, Project Coordinator.
- The Pacific Financial Technical Assistance Centre (PFTAC) in Suva, Fiji is a regional technical assistance institution operated by the IMF with financial support of the Asian Development Bank, Australia, Japan, and New Zealand. Member countries include Solomon Islands among others.

### Public financial management (PEM)
- PFTAC participated in two PEM missions in 1998, one with AusAID, and one with UNDP, to explore the scope for sustainable improvements in financial management.
- An advisor was a member of the August 2002 IMF mission and reviewed the PEM system.
- Priority actions identified:
  - Rehabilitation of public financial management.
  - Strengthening expenditure and commitment controls.
  - Tightening treasury and cash management operations.
  - Improving the budget and accounting system.
- Status: Indications are that the situation has considerably improved in recent months.

### Tax administration and policy
- Prior to February 1999, PFTAC provided input to administration improvement projects proposed by AusAID and NZAID.
- Following an Inland Revenue administration review, two four-week consultancies for strengthening the audit area were organized in May and November 1998.
- 2003: Discussions at PFTAC Headquarters on a decentralization strategy revealed that the tax system is in need of reform.
- March and May 2004: A tax and customs administration mission took place with the involvement of a customs expert, partly to determine future PFTAC involvement.

### Financial sector regulation and supervision
- Late 2002: PFTAC participated in an on-site review of the domestically owned commercial bank.
- Technical assistance in:
  - Bank ownership issues.
  - Quality of bank holdings of government bonds.
  - Supervision of the National Provident Fund.
  - Assistance provided to CBSI staff at PFTAC Headquarters.
- PFTAC funded:
  - Attachment of a CBSI bank examiner to the Reserve Bank of Fiji.
  - Participation of CBSI staff in regional supervision workshops.

### Economic and financial statistics
- January 2003 mission: National Statistics Office (NSO) was barely functional, having suffered severe losses of resources and records in previous years.
- PFTAC recommended temporary transfer of staff producing the CPI to the CBSI.
- Following stabilization, NSO partially re-equipped; the CPI is again being produced in the NSO and a business survey for national accounts is planned for mid-2004.
- February 2004 PFTAC mission devised a recovery plan including:
  - Provision of a long-term adviser.
  - Training attachments.
  - Future technical assistance.
- GDDS mission (February 2004) conclusions and recommendations:
  - Rebuilding the statistical system requires extensive TA over at least two years and external funding.
  - Appointment of a chief statistician and an externally funded long-term adviser.
  - Urgent need for a business survey and a household income and expenditure survey to provide a new base for national accounts and CPI and enable an assessment of poverty levels.
  - Priority statistical issues: liaise with National Provident Fund for employment and other statistics; increase response rate on BOP surveys; reduce dependence on Foreign Exchange Transaction records for BOP purposes; resume use of Customs data for import estimation; consider a Population Census due to significant recent population movements making the 1999 Census results unreliable.

### Statistical system and data coverage
- The Solomon Islands’ economic database is poor; the only institution providing regular data in the last two years is the Central Bank of the Solomon Islands (CBSI).
- NSO staff were relocated to the CBSI due to inadequate resources and lack of security in the Ministry of Finance; NSO is recovering and gradually re-taking over data collection and publication.
- The CBSI publishes data in Monthly Review, Quarterly Review, and Annual Report. There is a Solomon Islands country page in IFS, but delays often occur.
- Real sector: NSO has not produced national accounts data since 1994; CBSI produced annual estimates building primarily on commodity export data. NSO reclaimed CPI production for Honiara from CBSI in August 2003.
- Money and banking statistics: Compiled by CBSI monthly and provided to the IMF with a two to four week lag.
- Public finance: Ministry of Finance started disseminating monthly press releases on budget realizations in August 2003. CBSI published revenue and expenditure during the conflict but reliability is in doubt. Provincial government finance data are not available.
- External sector: Partial quarterly BOP data estimated by CBSI on basis of cash foreign exchange transactions reported through banking system and available with a three-month lag; data deficient in detail and coverage without supplementary surveys.

### Public Information Notice (PIN) No. 04/89 — Key background and outlook (August 12, 2004)
- IMF Article IV consultation concluded July 16, 2004.
- Background on crisis impact:
  - After mid-1999 inter-island conflict: real GDP declined by one-quarter, exports halved, inflation increased to 15 percent, budget deficit rose, government defaulted on virtually all domestic and external debt obligations, and international reserves (net of external arrears) were fully exhausted.
- Stabilization since RAMSI arrival mid-2003:
  - Budget deficit fell from 10 percent in 2002 to 1½ percent in 2003.
  - Drivers: strengthened tax collections aided by an amnesty on penalties; termination of payments to ex-militants; greater scrutiny over the wage bill; tightening of expenditure controls; substantial grant support from Australia and New Zealand.
  - 2004 projection: authorities project the 2004 budget will be in surplus.
- Economic activity:
  - Real GDP grew by an estimated 5 percent in 2003, driven by fish, copra, and cocoa production.
  - Private sector credit growth increased as lending interest rates declined, but overall credit growth remained low due to increased government deposits at the central bank from aid flows and recurrent budget surplus.
  - International reserves increased sharply; inflation fell to single digits.
- Medium-term projection (assumptions stated):
  - If appropriate macroeconomic and structural policies implemented, real GDP growth during 2004–09 could average 4½–5 percent a year (around 2 percent per capita).
  - Inflation would remain in low single digits.
  - International reserves would slowly increase, assuming fiscal and monetary discipline is maintained.
  - Current account deficit as a share of GDP would gradually decline as exports increase and project-related imports fall back.
  - Assuming the budget deficit averages around ½ percent of GDP, the government debt ratio would decline from 100 percent of GDP in 2003 to 65 percent of GDP by 2009.

### Executive Board assessment and policy priorities
- Directors welcomed the marked improvement since RAMSI arrival but noted fragility due to destroyed infrastructure, deteriorated social indicators, high unemployment, and large government debt.
- Key challenges and recommended policies:
  - Strengthen budget finances with tight control over expenditures.
  - Maintain price stability.
  - Implement deep structural reforms to promote private sector employment and exports.
  - Reallocate spending toward basic health and education, rural infrastructure and agricultural advisory services, and operations and maintenance.
  - Contain civil service expenditure and boost revenue collections through improvements in tax and customs administration.
  - Resist pressures for new income-tax exemptions for foreign and domestic investment and activity.
  - Defer decentralizing a large part of the budget to provinces until central government finances are on a secure foundation and an effective monitoring system for provincial revenues and expenditures is in place.
- Monetary and financial sector guidance:
  - Endorsed central bank objectives of containing inflationary pressures and increasing international reserves.
  - Continue policy of countering upward pressure on the exchange rate.
  - Monitor banks closely as economic recovery gathers pace; strengthen asset quality of the pension fund; settle the future of the development bank.
  - Prioritize implementation of laws against money laundering and the financing of terrorism.
- Structural reforms emphasized:
  - Boost rural production, improve inter-island distribution, sustainably manage fisheries and forestry.
  - Streamline regulation and licensing for investment.
  - Consider corporatization and privatization of public enterprises.
  - Strengthen institutions, governance, transparency, and reduce corruption.
- Directors fully supported the National Economic Recovery, Reform, and Development Plan and stressed that success depends on sustained policy implementation and improved economic data, including rehabilitation of the National Statistical Office.

### Selected economic developments and indicators (summary highlights from 2000–04 data)
- Real GDP growth:
  - 2000: -14.3
  - 2001: -9.0
  - 2002: -1.6
  - 2003: 5.1
  - 2004 (Est./Proj.): 4.2
- CPI (period average):
  - 2000: 6.9
  - 2001: 7.6
  - 2002: 9.4
  - 2003: 10.1
  - 2004 (Est./Proj.): 5.6
- Central government operations (percent of GDP), 2003 and 2004 notable figures:
  - Total revenue 2003: 39.8; 2004: 48.1
  - Grants 2003: 18.3; 2004: 24.6
  - Total expenditure (accrual basis) 2003: 39.6; 2004: 44.1
  - Recurrent balance 2003: 1.5; 2004: 4.0
  - Overall balance 2003: -1.4; 2004: 4.0
- Stock of expenditure arrears (percent of GDP; end-of-period):
  - 2000: 4.7
  - 2001: 8.5
  - 2002: 11.5
  - 2003: 14.4
  - 2004: 8.1
- Central government debt (percent of GDP):
  - 2000: 65.4
  - 2001: 82.2
  - 2002: 96.2
  - 2003: 100.2
  - 2004: 92.5
- Monetary and credit (percentage change; end-of-period):
  - Net foreign assets 2000: -39.8; 2001: -31.8; 2002: 30.2; 2003: 106.4; 2004: 49.7
  - Broad money 2000: 0.5; 2001: -13.2; 2002: 4.0; 2003: 26.0; 2004: 15.2
- Balance of payments (millions of U.S. dollars):
  - Exports, f.o.b. 2000: 65.1; 2001: 47.1; 2002: 58.2; 2003: 74.2; 2004: 83.0
  - Imports, c.i.f. 2000: -98.1; 2001: -90.6; 2002: -62.3; 2003: -85.2; 2004: -102.0
  - Current account (millions): 2000: -31.7; 2001: -35.1; 2002: -15.7; 2003: 3.2; 2004: -1.4
  - Current account (percent of GDP): 2000: -10.6; 2001: -12.8; 2002: -6.9; 2003: 1.4; 2004: -0.6
- Gross official reserves (millions of U.S. dollars; end-of-period):
  - 2000: 31.3; 2001: 18.5; 2002: 17.5; 2003: 35.9; 2004: 52.1
  - In months of next year's imports of GNFS: 2000: 3.1; 2001: 2.8; 2002: 2.1; 2003: 3.6; 2004: 4.5
- Exchange rate (SI$/US$, end-of-period): 2000: 5.10; 2001: 5.56; 2002: 7.46; 2003: 7.49

*Document: IMF staff report content and Public Information Notice (PIN) No. 04/89, conclusions of the 2004 Article IV consultation with the Solomon Islands.*

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