## _cr0792 - Executive Summary

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### Background
- Macroeconomic conditions have improved: output growth rebounded, private capital inflows increased, and inflation remains low.
- Since December 2004 donor pledges increased sharply, including U.S. Millennium Challenge Account funds that could amount to US$66 million in grant aid (17 percent of 2006 GDP) over the next five years to support infrastructure projects.
- Structural constraints persist: weak private activity environment; rapid population growth; narrow output and export base; low infrastructure spending (especially inter-island travel and communications); weak education system with shortages of skilled workers; almost no emigration and few remittances; high vulnerability to natural disasters; about 80 percent of the labor force employed in subsistence farming in rural areas.
- Persistent political uncertainties and a fragmented party structure have produced fragile coalition governments, impeding structural reform. Current government in place since December 2004; next general election due in July 2008.

### Recent economic developments
- Growth and inflation
  - Growth reached 7 percent in 2005 and an estimated 5½ percent in 2006.
  - Inflation peaked at 3 percent in 2003 and declined to 1½ percent in 2006.
  - National accounts revisions for 2004–05 are large; staff regard direction of revisions as broadly correct and consistent with other indicators.
- Fiscal developments
  - Budget moved from a deficit of 4 percent of GDP in 2002 to a surplus of nearly 2 percent of GDP in 2005.
  - A 20-25 percent increase in civil servants’ wages from July 2006 eroded the fiscal position; expected deficit in 2006 around ½ percent of GDP.
  - Public debt-to-GDP declined to about 30 percent, from nearly 45 percent in 2002.
- External sector
  - Current account deficit remains in the range of 8-10 percent of GDP but has been more than offset by FDI, aid, and private capital inflows.
  - Reserves increased to over 7 months of import cover, above the official target of 4 months.
  - Real exchange rate has appreciated slightly relative to 2002.
- Structural reforms
  - Financial sector reforms: substantial improvements in supervision of domestic banks and the offshore financial sector.
  - Fiscal structural reforms: limited progress; wage bill in 2006 reached over half of total expenditures (around 12½ percent of GDP); numerous VAT and duty exemptions persist.
  - Little progress on reforms to improve the private sector environment.
- Specific concern
  - Law passed in June 2006 allows for a new agriculture development bank; prior experience: a similar bank’s politically-motivated lending and mismanagement led to bankruptcy in 1998 and higher public debt.

### Outlook and risks
- Baseline near-term projection
  - Growth projected to be maintained at about 4-5 percent over the next two-three years, supported by aid and private capital inflows and growing tourism following new flights launched in 2006.
  - Inflation expected to increase modestly but remain subdued.
- Risks
  - Loosening fiscal policy combined with continued capital inflows could put upward pressure on private sector wages and prices, risk overheating, and weaken the external position.
  - Without structural reforms, aid may remain insufficient to deliver sustained medium-term growth; medium-term growth unlikely to exceed Vanuatu’s historical performance of 2-2½ percent, with per capita income growth remaining stagnant.

### Key policy recommendations
- Overarching priorities
  - Maintain macroeconomic stability and avoid inflationary pressures, particularly those arising from the recent civil service wage increase.
  - Accelerate structural reforms to improve private sector environment and enhance effectiveness of aid.
  - Subject proposed agriculture development bank to strict central bank supervision from inception.
- Fiscal policy and public spending
  - Undertake fiscal restructuring while macroeconomic environment is favorable.
  - Improve delivery and efficiency of government services, reduce size of the wage bill, and remove numerous tax exemptions.
  - Restructure loss-making state-owned enterprises, including through privatization where appropriate.
  - Redirect spending toward development-related priorities and strengthen fiscal policy formation framework.
- Labor and wages
  - Monitor and manage demand effects of the 20-25 percent civil service wage increase to prevent excessive inflation and wage-driven overheating.
- Financial sector
  - Consolidate recent reforms and ensure ongoing strong supervision to keep sector sound.
  - Limit risk of mismanagement and loan losses in any new development bank by placing it under strict central bank supervision.
- Exchange rate and monetary considerations
  - Maintain transactions-weighted, basket pegged exchange rate regime as appropriate anchor.
  - Disclose weights of currencies in the basket and outline policy for implementing changes in weights.
  - Closely monitor capital inflows, credit growth, reserve developments, and property prices; consider sterilization only as a short-run option.
  - Use strong bank supervision to limit buildup of nonperforming loans amid rising domestic credit.

### Fiscal restructuring and public service delivery (staff findings and concerns)
- Platform to restructure government budget and improve fiscal policy formulation; priority to reorient expenditures toward development.
- Strong support for establishment of a medium-term expenditure framework.
- Staff finding: public sector wage bill reached 14 percent of GDP in 2007.
- Staff assessment: public sector wages among the highest in the region given similar public employment levels.
- Authorities’ view: geographic spread necessitates larger civil service; recent wage increase justified by differential between civil service and private sector wages.
- Staff concern: large ad hoc wage increases potentially damaging to macroeconomic management; need for rational mechanism for civil service wage increases.
- Risks if unaddressed:
  - Much of the improvement in overall budget position likely to unwind.
  - Wage-heavy expenditure crowds out development spending and could reduce competitiveness by limiting labor supply to private sector and putting pressure on wages in export-oriented sectors including tourism.
  - Risk that registered legal claims on land disputes against the government will materialize.

### 2007 budget structure and implications (staff assessments)
- Authorities project a balanced budget in 2007; staff estimate higher-than-budgeted expenditure needs could produce a deficit of ½ percent of GDP.
- Key elements:
  - Tax revenue expected to increase by 2 percent of GDP, mainly reflecting stronger economic outlook and higher consumer spending after wage increase; budget includes limited measures to improve tax collection and limit VAT and duty exemptions.
  - Import duties: duty rates range from 0 to 55 percent; 2007 budget increases import duties on some items and reduces them on others, possibly increasing duty spreads.
  - Current expenditures to increase by 2½ percent of GDP, almost entirely due to the wage increase; public sector wage bill expected to approach nearly two-thirds of current expenditures.
  - Maintenance spending to rise with donor-related capital spending, particularly associated with the MCA.
  - Capital expenditures budgeted to rise by nearly 4 percent of GDP, largely financed by donor grants, raising sustainability questions if grants decline.

### Millennium Challenge Account (MCA) program specifics
- Vanuatu agreement with MCA: a grant of nearly $66 million over a five-year period (2006-10).
- MCA objectives: benefit poor, rural agricultural areas and spur tourist-related goods and services by reducing transportation costs and improving access to transportation services.
- Eleven projects over eight islands identified.
- Long-run program goals:
  - increase average income per capita by $200,
  - provide market and social service access to rural inhabitants,
  - expand tourism by 15 percent.
- Allocation of MCA funds:
  - 83 percent to engineering and construction,
  - 9 percent to institutional strengthening for sustainability and maintenance,
  - 6 percent for program administration and audits,
  - 2 percent for monitoring and evaluation.
- Project design and timeline:
  - Engineering and construction for all eleven projects tendered to a single external contractor as a design-build contract; contract expected to be finalized in early 2007 with bulk of construction occurring from end-2007 through 2009.
- Local economic impact:
  - Most contracted employees will be living in Vanuatu, boosting local housing and consumer markets.
  - Depending on the external contractor, projects’ local content of labor, goods and services could be as much as 20 percent.
  - Program requires government to budget annually for maintenance of program-related roads and to develop and implement wharf user fees for wharf maintenance.

### State-owned enterprises (SOEs) and private sector competitiveness
- SOE reform a key priority: many SOEs heavily subsidized, depleting budget resources and distorting price-setting.
- Most SOEs operate without adequate oversight or accountability.
- Staff urged quick action to restructure major SOEs, including Air Vanuatu and Vanuatu Commodities Marketing Board.
- Authorities agreed at minimum to establish plans to restructure Air Vanuatu and to require regular financial reports from government business enterprises to the Ministry of Finance.
- Key barriers to private sector development: poor and expensive infrastructure; legal framework shortcomings (particularly land use); political instability and policy uncertainty; high costs of doing business.
- Structural policy recommendations:
  - Improve physical and legal infrastructure.
  - Strengthen regulation of utility monopolies.
  - Establish a secured transactions system for moveable assets as collateral.
  - Put in place a utilities regulatory authority for telecommunications, energy, and other utilities.
  - Reform land tenure system to ensure transparent, fair, and enforced property rights.
  - Restructure loss-making SOEs including through privatization.

### Financial sector strengthening and risks
- Commendable strengthening of financial sector supervision; additional steps needed.
- Banking supervision largely compliant with Basel Core Principles; need for staff training to address supervisory skill gaps.
- Banking system: two Australian-owned commercial banks and one domestically-owned bank; generally sound and profitable but experienced recent increase in nonperforming loan ratio due to a few large loans; remaining loans adequately provisioned.
- Offshore financial center supervision dramatically improved: offshore banks reduced from some 100 in early 1990s to 7 by end-2006.
- Insurance supervision: regulatory framework in place but lack of skilled staff; staff encouraged timely transfer of insurance supervision to the Reserve Bank of Vanuatu.
- AML/CFT and Financial Intelligence Unit:
  - AML/CFT legislation in place, but awareness of obligations needs increasing.
  - Staff urged steps to bring Financial Intelligence Unit to full operational capacity and reexamine its institutional setting to increase effectiveness.
- Vanuatu Agriculture Development Bank (VADB) risks:
  - Under current law VADB would not be subject to central bank supervision but required to provide information to the Ministry of Finance.
  - Authorities agreed Ministry of Finance lacks capacity to supervise such a bank and noted previous development bank experience did not end well.
  - Agreed VADB should be required from inception to operate under central bank supervision.
  - Authorities recognized need for a board including independent members skilled in commercial banking to prevent political interference.

### Staff appraisal: outlook, risks, and policy priorities
- Near-term outlook: Vanuatu positioned to capitalize on favorable developments to maintain strong growth over the next several years; output growth rebounded, private capital inflows increased, macroeconomic conditions sound, and donor pledges increased.
- Medium-term risks and priorities:
  - Aid flows alone cannot maintain performance without addressing structural weaknesses hindering private sector development.
  - Recent civil service wage increases could add to demand and accelerate inflation.
  - Given basket exchange rate peg, monetary policy role is limited; central bank should monitor credit growth to prevent demand pressures and increases in nonperforming loans. Strong bank supervision is important.
  - Fiscal restructuring should focus on improving delivery and efficiency of government services, reducing wage bill, removing tax exemptions, and restructuring loss-making SOEs including via privatization.
  - Transactions-weighted, basket pegged exchange rate regime appropriate for Vanuatu’s stage of development; resolving structural problems is key to improving competitiveness.
  - Proposed agriculture development bank should be placed under strict central bank supervision from inception to prevent mismanagement and loan losses experienced by previous development bank.

### Key statistics and historical context (selected)
- Public sector wage bill: 14 percent of GDP in 2007.
- Lost revenue in 2006 due to tax and duty exemptions: over 3½ percent of GDP.
- Staff-estimated possible 2007 budget deficit: ½ percent of GDP.
- Tax revenue expected to increase by 2 percent of GDP.
- Duty rates range from 0 to 55 percent.
- Current expenditures to increase by 2½ percent of GDP.
- Public sector wage bill expected to approach nearly two-thirds of current expenditures.
- Capital expenditures budgeted to rise by nearly 4 percent of GDP (largely financed by donor grants).
- MCA grant: nearly $66 million over a five-year period (2006-10).
- MCA allocation: 83 percent engineering and construction; 9 percent institutional strengthening; 6 percent program administration and audits; 2 percent monitoring and evaluation.
- MCA local content could be as much as 20 percent.
- MCA long-run goal: expand tourism by 15 percent.
- Staff estimate to stabilize debt-to-GDP: fiscal deficit of less than 1½ percent of GDP.
- Historical growth: real GDP growth averaged only 2 percent in the past decade.
- GDP per capita: $1,557 in 2004.
- Ease of doing business rank: 58th out of 175 in 2006.

### Statistical capacity, surveillance, and Article IV timing
- Improving domestic capacity to compile statistics is necessary to strengthen monitoring and policy analysis.
- Fund staff, including through PFTAC, will continue to assist in this area.
- Recommended that next Article IV consultation take place on the 24-month cycle; authorities welcomed a proposed interim staff visit during 2007.

### Medium-term outlook scenarios (Appendix I)
- Baseline scenario — policy assumptions:
  - Medium-term real GDP growth assumed to fall to historic levels of about 2½ percent as MCA grant money fades and structural constraints persist.
  - Revenues rise in line with GDP; expenditures increase with maintenance and development needs, worsening budget deficit over time.
- Baseline scenario — outcomes (2006–2016; averages 2013–16):
  - Public debt (percent of GDP): 30.6, 27.9, 26.6, 25.7, 25.2, 24.9, 24.6, 24.1
  - Fiscal balance (percent of GDP): -0.5, -0.5, -0.5, -0.6, -0.7, -0.8, -0.9, -1.0
  - Current account (percent of GDP): -8.0, -13.2, -13.7, -10.1, -8.6, -8.0, -7.3, -6.1
  - Gross official reserves (months of imports): 7.2, 7.1, 7.4, 7.9, 7.7, 7.2, 6.6, 5.5
  - Summary: Under baseline the current account deficit is sustainable (driven by donor-related imports); public debt declines gradually from 30 percent to 24 percent of GDP over ten years.
- Comprehensive reform scenario — policy assumptions:
  - Structural reforms implemented expeditiously; real annual GDP growth maintained at 4 percent over medium term; revenues rise faster than GDP; efficiency gains reduce overall expenditures and keep budget near balance.
- Comprehensive reform scenario — outcomes (2006–2016; averages 2013–16):
  - Public debt (percent of GDP): 30.6, 27.9, 26.5, 25.3, 24.0, 22.7, 21.4, 18.3
  - Fiscal balance (percent of GDP): -0.5, -0.5, -0.5, -0.4, -0.3, -0.2, -0.1, 0.0
  - Current account (percent of GDP): -8.0, -13.2, -13.7, -9.0, -7.6, -7.1, -6.5, -5.3
  - Export growth (goods and nonfactor services, percent): 9.7, 5.0, 4.3, 6.9, 6.9, 7.4, 7.5, 7.6
  - Gross official reserves (months of imports): 7.2, 7.1, 7.4, 8.2, 8.2, 8.0, 7.8, 7.3
  - Comparative outcomes:
    - Export growth increases by 4 percent relative to baseline.
    - Reserves increase by 2 months of import cover relative to baseline.
    - Public debt declines more rapidly to 18 percent of GDP by medium term.
- Policy implication summary:
  - Maintaining or strengthening fiscal policy critical to debt sustainability under either scenario.
  - Accelerating structural reforms can sustain higher real GDP growth (assumed 4 percent), improve external competitiveness and export performance, improve reserve adequacy, and reduce public debt more rapidly.

*Source: IMF staff report — Executive Summary and informational annexes (content unit: _cr0792).*

### Executive Summary ......................................................................................................

### _cr0792 - Executive Summary ......................................................................................................

### Background
- Macroeconomic conditions have improved over the last several years: output growth has rebounded, private capital inflows have increased, and inflation remains low.
- Since the formation of the present government in December 2004, donor pledges have increased sharply, including U.S. Millennium Challenge Account funds that could amount to US$66 million in grant aid (17 percent of 2006 GDP) over the next five years to support infrastructure projects.
- Structural constraints persist: a weak environment for private activity, rapid population growth, a narrow output and export base, low infrastructure spending (especially inter-island travel and communications), a weak education system with shortages of skilled workers, almost no emigration and few remittances, high vulnerability to natural disasters, and about 80 percent of the labor force employed in subsistence farming in rural areas.
- Persistent political uncertainties and a fragmented party structure have produced fragile coalition governments, impeding structural reform. The current government led by Prime Minister Lini has been in place since December 2004; the next general election is due in July 2008.

### Economic Developments
- Recent growth and inflation
  - Growth reached 7 percent in 2005 and an estimated 5½ percent in 2006.
  - Inflation peaked at 3 percent in 2003 and declined to 1½ percent in 2006.
  - Note: national accounts revisions for 2004–05 are large; staff regard the direction of the revisions as broadly correct and consistent with other indicators.
- Fiscal developments
  - Budget moved from a deficit of 4 percent of GDP in 2002 to a surplus of nearly 2 percent of GDP in 2005.
  - A 20-25 percent increase in civil servants’ wages from July 2006 (first in some ten years) eroded the fiscal position, with an expected deficit in 2006 of around ½ percent of GDP.
  - Public debt-to-GDP declined to about 30 percent, from nearly 45 percent in 2002.
- External sector
  - The current account deficit remains in the range of 8-10 percent of GDP but has been more than offset by FDI, aid, and private capital inflows.
  - Reserves have increased to over 7 months of import cover, above the official target of 4 months.
  - The real exchange rate has appreciated slightly relative to 2002.
- Structural reforms
  - Financial sector reforms have been impressive, with substantial improvements in supervision of domestic banks and the offshore financial sector.
  - Fiscal structural reforms have not advanced: the wage bill in 2006 reached over half of total expenditures (at around 12½ percent of GDP), and numerous VAT and duty exemptions persist.
  - Little progress on reforms to improve the private sector environment.
- Specific concern
  - A law passed in June 2006 allows for a new agriculture development bank; staff note prior experience where a similar bank’s politically-motivated lending and mismanagement led to bankruptcy in 1998 and higher public debt.

### Outlook and Risks
- Baseline near-term projection
  - Growth is projected to be maintained at about 4-5 percent over the next two-three years, supported by aid and private capital inflows and growing tourism following new flights launched in 2006.
  - Inflation is expected to increase modestly but remain subdued.
- Risks
  - A loosening of fiscal policy combined with continued capital inflows could put upward pressure on private sector wages and prices, risk overheating, and weaken the external position.
  - Without structural reforms to improve the private sector environment, aid may remain insufficient to deliver sustained medium-term growth. In that case, medium-term growth is unlikely to exceed Vanuatu’s historical performance of 2-2½ percent, with per capita income growth remaining stagnant.

### Policies to Improve Growth Prospects — Key Recommendations
- Overarching priorities
  - Maintain macroeconomic stability and avoid inflationary pressures, particularly those that might arise from the recent civil service wage increase.
  - Accelerate structural reforms to improve the private sector environment and enhance the effectiveness of aid.
  - Subject the proposed agriculture development bank to strict central bank supervision from inception.
- Fiscal policy and public spending
  - Undertake long overdue fiscal restructuring while the macroeconomic environment is favorable.
  - Focus reforms on improving the delivery and efficiency of government services, reducing the size of the wage bill, and removing numerous tax exemptions.
  - Restructure loss-making state-owned enterprises, including through privatization where appropriate.
  - Redirect spending toward development-related priorities and strengthen the framework for fiscal policy formation.
- Labor and wages
  - Monitor and manage the demand effects of the 20-25 percent civil service wage increase to prevent an excessive pick-up in inflation and wage-driven overheating.
- Financial sector
  - Consolidate recent financial sector reforms and ensure ongoing strong supervision to keep the sector sound.
  - Limit the risk of mismanagement and loan losses in any new development bank by placing it under strict central bank supervision.
- Exchange rate and monetary considerations
  - Maintain the transactions-weighted, basket pegged exchange rate regime as an appropriate anchor given the small open economy, narrow export base, generally sound fiscal stance, and limited institutional capacity for independent monetary policy.
  - Disclose the weights of currencies in the basket and outline the policy for implementing changes in weights.
  - Closely monitor capital inflows, credit growth, reserve developments, and property prices; consider sterilization only as a short-run option given potential costs and limits.
  - Use strong bank supervision to limit buildup of nonperforming loans in a context of rising domestic credit.

### Staff Appraisal — Main Conclusions
- The present economic situation provides an opportune time to begin fiscal restructuring and to press ahead with reforms that improve private sector competitiveness.
- Continued sound macroeconomic policies and political stability could sustain positive near-term outcomes, but transformational medium-term gains require decisive structural reforms to make aid more effective and to facilitate private sector–led growth.

*Source: IMF staff report — Executive Summary (content unit: _cr0792 - Executive Summary).*

### 15.      The staff team emphasized that the current economic situation provided an

### _cr0792 - 15.      The staff team emphasized that the current economic situation provided an

### Fiscal restructuring and public service delivery
- Current situation provides an opportune platform to restructure the government budget and improve fiscal policy formulation.
- Priority: improve efficiency of government service delivery and reorient the structure of expenditures toward development.
- Strong support for establishment of a medium-term expenditure framework.
- Staff finding: public sector wage bill reached 14 percent of GDP in 2007.
- Staff assessment: with levels of public employment similar to that in other countries, public sector wages are among the highest in the region.
- Authorities’ view: Vanuatu’s large geographic spread necessitates a larger civil service than in many other Pacific island countries; recent wage increase justified by differential between civil service and private sector wages.
- Staff concern: large ad hoc increases in wages are potentially damaging to macroeconomic management; need to develop a more rational mechanism for civil service wage increases going forward.
- Risk if issues not addressed:
  - Much of the improvement in the overall budget position to date is likely to unwind.
  - Expenditure heavily directed toward the wage bill crowds out development-related spending and could reduce competitiveness by limiting labor supply to the private sector, putting pressure on wages in export-oriented sectors including tourism.
  - Risk that some outstanding registered legal claims on land disputes against the government will materialize.

### Revenue structure and tax policy
- Considerable scope for improving structure of revenues and widening the tax base.
- Staff observations:
  - Tax rates are high, variable, and with numerous exemptions.
  - Need for further improvements in tax administration.
  - Encouraged streamlining of VAT and duty collections to increase budget revenue considerably.
- Authorities’ action: 2007 budget includes for the first time an estimate of revenue lost to tax and duty exemptions.
  - According to this estimate, the lost revenue in 2006 was over 3½ percent of GDP.

### Structure and implications of the 2007 budget
- Authorities project a balanced budget in 2007; staff estimate higher-than-budgeted expenditure needs could produce a deficit of ½ percent of GDP.
- Key budget elements and staff assessments:
  - Tax revenue is expected to increase by 2 percent of GDP. Increased revenue mainly reflects strong economic outlook and expected increase in tax receipts associated with higher consumer spending following the civil service wage increase; budget includes some limited measures to improve tax collection and limit VAT and duty exemptions.
  - Import duties: some duties adjusted to increase revenue slightly; duty rates range from 0 to 55 percent. Prior to the 2007 budget, number of duty rates had been sharply reduced; the 2007 budget increases import duties on some items and reduces them on others, with possible result that duty spreads may increase.
  - Current expenditures are to increase by 2½ percent of GDP, almost entirely accounted for by the wage increase; public sector wage bill expected to approach nearly two-thirds of current expenditures.
  - Maintenance spending will rise in line with increase in donor-related capital spending, particularly associated with the MCA.
  - Capital expenditures related to development needs are budgeted to rise by nearly 4 percent of GDP, although this increase is more than financed by donor grants, raising questions about sustainability if grants decline.

### Millennium Challenge Account (MCA) program (Box 1)
- Vanuatu agreement with MCA: a grant of nearly $66 million over a five-year period (2006-10).
- MCA objectives: benefit poor, rural agricultural areas and spur tourist-related goods and services by reducing transportation costs and improving access to transportation services.
- Eleven projects over eight islands identified.
- Long-run program goals include:
  - increasing average income per capita by $200,
  - providing market and social service access to rural inhabitants,
  - expanding tourism by 15 percent.
- Allocation of MCA funds:
  - 83 percent to engineering and construction,
  - 9 percent to institutional strengthening for sustainability and maintenance,
  - 6 percent for program administration and audits,
  - 2 percent for monitoring and evaluation.
- Project design and timeline:
  - Engineering and construction for all eleven projects tendered to a single external contractor as a design-build contract; contract expected to be finalized in early 2007 with bulk of construction occurring from end-2007 through 2009.
- Local economic impact:
  - Most contracted employees will be living in Vanuatu, boosting local housing and consumer markets.
  - Depending on the external contractor, projects’ local content of labor, goods and services could be as much as 20 percent.
  - Program requires government to budget annually funds for maintenance of program-related roads and to develop and implement wharf user fees for wharf maintenance.

### State-owned enterprise (SOE) reform
- SOE reform is a key priority: many SOEs are heavily subsidized, depleting budget resources and distorting price-setting that would encourage private sector development.
- Most SOEs operate without adequate oversight or accountability.
- Staff underscored need to take quick action to restructure:
  - Air Vanuatu (national airline),
  - Vanuatu Commodities Marketing Board,
  two of the largest recipients of budget subsidies.
- Authorities recognize problems but note SOE restructuring is particularly difficult in current political environment; agreed at minimum to establish plans to restructure Air Vanuatu as soon as feasible.
- Staff support for government initiative to require all government business enterprises to provide regular financial reports to the Ministry of Finance to improve accountability and performance.

### Debt sustainability and medium-term fiscal strategy
- Authorities and staff agree medium-term fiscal strategy should focus on maintaining Vanuatu’s debt sustainability.
- Budget is overly reliant on donor grants.
- Staff estimate: a fiscal deficit of less than 1½ percent of GDP would be sufficient to stabilize the debt-to-GDP ratio at its current level under the baseline scenario.
- A strong fiscal position would reduce reliance on grants and create a cushion against lower revenue or unforeseen expenditure needs (e.g., natural disasters).
- Note: Vanuatu is now eligible for graduation from LDC status, which could impact future aid and trade preferences over the medium term and reinforces need to increase competitiveness and reduce reliance on donor grants.

### Promoting private sector growth and competitiveness
- Key barriers to private sector development:
  - Poor and expensive infrastructure,
  - Shortcomings in legal framework, particularly for land use,
  - Political instability and policy uncertainty from short-lived coalition governments,
  - High costs of doing business.
- Structural policy recommendations:
  - Improve physical and legal infrastructure,
  - Strengthen regulation of utility monopolies,
  - Establish a secured transactions system for use of moveable assets as collateral,
  - Put in place a utilities regulatory authority for telecommunications, energy, and other utilities,
  - Reform land tenure system to ensure transparent, fair and enforced property rights,
  - Restructure loss-making SOEs including through privatization.
- Recent trade and tariff context:
  - Vanuatu expanded regional trade links beginning in 2004; intends to participate in prospective Economic Partnership Agreement with the EU.
  - Prior to the 2007 budget, Vanuatu had sharply reduced the number of tariff rates, though average rate remains high by regional standards.
  - Authorities have taken steps to liberalize exports of copra, cocoa, and kava by reducing role of Vanuatu Commodities Marketing Board, but steps can be easily reversed, creating uncertainty.

### Financial sector strengthening
- Commendation for substantial strengthening of financial sector supervision; additional steps needed.
- Banking supervision:
  - Domestic bank supervision largely compliant with Basel Core Principles.
  - Need for staff training to address lack of supervisory skills.
  - Banking system comprises two Australian-owned commercial banks and one domestically-owned bank; generally sound and profitable but recent increase in nonperforming loan ratio due to a few large loans; some loans resolved through collateral sales and remaining loans are adequately provisioned for.
- Offshore financial center supervision:
  - Dramatic improvement since 2002; elimination of licenses for shell banks reduced offshore banks from some 100 in early 1990s to 7 by end-2006.
- Insurance supervision:
  - Regulatory framework in place but lack of skilled staff; staff encouraged timely transfer of insurance supervision to the Reserve Bank of Vanuatu.
- AML/CFT and Financial Intelligence Unit:
  - AML/CFT legislation in place, but awareness of legislative obligations needs increasing.
  - Staff urged steps to bring the Financial Intelligence Unit to full operational capacity and to reexamine its institutional setting to increase effectiveness.
- Vanuatu Agriculture Development Bank (VADB) risks:
  - Legislation intends VADB to facilitate development in agriculture and related sectors; bank may issue bonds and borrow money but not take deposits.
  - Under current law VADB would not be subject to central bank supervision but required to provide information to the Ministry of Finance.
  - Authorities agreed Ministry of Finance lacks capacity to supervise such a bank and noted previous development bank experience did not end well.
  - Agreed VADB should be required from inception to operate under central bank supervision.
  - Authorities recognized need for a board including independent members skilled in commercial banking to prevent political interference in lending decisions.

### Staff appraisal: outlook, risks, and policy priorities
- Near-term outlook:
  - Vanuatu positioned to capitalize on favorable developments to maintain strong economic growth over next several years.
  - Output growth has rebounded, private capital inflows have increased, near-term growth prospects are good.
  - Macroeconomic conditions are sound and improved donor relations led to significant increase in donor pledges.
- Medium-term risks and priorities:
  - Aid flows alone cannot maintain performance without addressing structural weaknesses hindering private sector development.
  - Risk that recent civil service wage increases could add to strong demand and lead to more pronounced pickup in inflation.
  - Given basket exchange rate peg, monetary policy role is limited; central bank should monitor closely to prevent credit growth from adding to demand pressures and increasing nonperforming loans. Strong bank supervision important.
  - Fiscal restructuring should focus on improving delivery and efficiency of government services, reducing size of the wage bill, removing numerous tax exemptions, and restructuring loss-making SOEs including via privatization.
  - Transactions-weighted, basket pegged exchange rate regime is appropriate for Vanuatu’s stage of development; resolving structural problems is key to improving competitiveness.
  - Financial sector reforms are commendable; the proposed agriculture development bank should be placed under strict central bank supervision from inception to prevent mismanagement and loan losses experienced by the previous development bank.

### Key statistics and historical context cited
- Public sector wage bill: 14 percent of GDP in 2007.
- Lost revenue in 2006 due to tax and duty exemptions: over 3½ percent of GDP.
- Staff-estimated possible 2007 budget deficit: ½ percent of GDP.
- Tax revenue expected to increase by 2 percent of GDP.
- Duty rates range from 0 to 55 percent.
- Current expenditures to increase by 2½ percent of GDP.
- Public sector wage bill expected to approach nearly two-thirds of current expenditures.
- Capital expenditures budgeted to rise by nearly 4 percent of GDP (largely financed by donor grants).
- MCA grant: nearly $66 million over a five-year period (2006-10).
- MCA allocation: 83 percent engineering and construction; 9 percent institutional strengthening; 6 percent program administration and audits; 2 percent monitoring and evaluation.
- MCA local content could be as much as 20 percent.
- MCA long-run goal: expand tourism by 15 percent.
- Staff estimate to stabilize debt-to-GDP: fiscal deficit of less than 1½ percent of GDP.
- Historical growth: real GDP growth averaged only 2 percent in the past decade.
- GDP per capita: $1,557 in 2004.
- Ease of doing business rank: 58th out of 175 in 2006.

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

### 31.      Improving domestic capacity to compile statistics is necessary to strengthen

### _cr0792 - 31.      Improving domestic capacity to compile statistics is necessary to strengthen

### Statistical capacity and Fund assistance
- "Improving domestic capacity to compile statistics is necessary to strengthen monitoring and policy analysis."
- "Fund staff, including through PFTAC, will continue to assist in this area."

### Article IV consultation timing
- "It is recommended that the next Article IV consultation take place on the 24-month cycle."
- "The authorities welcomed a proposed interim staff visit during 2007."

### Regional comparators (Averages, 2004–06) — Figure 1: Vanuatu: Regional Comparators
- Real GDP growth (annual percent change) comparisons include: Marshall Islands, Fiji, Papua New Guinea, Samoa, Palau, Vanuatu, Solomon Islands, Micronesia, Kiribati, Tonga (chart scale -2 to 16).
- CPI inflation (annual percent change) comparisons include: Fiji, Micronesia, Marshall Islands, Palau, Samoa, Tonga, Solomon Islands, Kiribati, Vanuatu, Papua New Guinea (chart scale -2 to 16).
- Central government balances (In percent of GDP) comparisons include: Fiji, Marshall Islands, Samoa, Papua New Guinea, Kiribati, Palau, Micronesia, Tonga, Vanuatu, Solomon Islands (chart scale -28 to 12).
- Central government expenditure (In percent of GDP) comparisons include: Papua New Guinea, Samoa, Solomon Islands, Palau, Micronesia, Marshall Islands, Kiribati, Vanuatu, Fiji, Tonga (chart scale 0 to 180).
- Gross foreign reserves (In months of imports) comparisons include: Fiji, Micronesia, Tonga, Samoa, Solomon Islands, Vanuatu, Papua New Guinea, Kiribati, Palau, Marshall Islands (chart scale 0 to 10).
- External debt (In percent of GDP) comparisons include: Vanuatu, Micronesia, Tonga, Papua New Guinea, Samoa, Solomon Islands, Marshall Islands, Fiji, Kiribati, Palau (chart scale 0 to 100).

### Selected economic indicators, 2002–06 — Figure 2
- Inflation (12-month percentage change): CPI, Food and foodstuffs, Non-food (quarterly series from Q1 02 to Q3 06; chart range -4 to 8).
- Interest rates (Percent per annum, end of period): Nominal and Real 1/ (quarterly series Q1 02 to Q3 06; chart range 6 to 18).
- Exchange rates: Vatu per U.S. dollar (left scale) and Real effective exchange rate (2002=100, right scale) (quarterly series Q1 02 to Q3 06; Vatu chart approximately 90–150, REER 85–115).

### External sector developments, 2000–06 — Figure 3
- Export and tourism receipts (In millions of U.S. dollars) components: Agriculture 1/ (beef, cocoa, coconut oil, copra, kava, and timber), Other, Tourism (time series 2000–2006, scale 0 to 120).
- External debt (In millions of U.S. dollars, right scale) and External debt (In percent of GDP, left scale) (2000–2006; debt series 15–35; percent of GDP 40–100).
- External debt and debt service (In percent of exports of goods and nonfactor services): External debt (left scale) and Debt service (right scale) (2000–2006; percent scales 15–90 and 0.0–4.0).
- External trade and current account (In millions of U.S. dollars): Imports (incl. non-factor services), Current account balance, Exports (incl. non-factor services) (2000–2006; scale -50 to 250).

### Monetary and financial indicators, 2002–06 — Figure 4
- Monetary aggregates (Year-on-year percent change): Broad money, Credit to the economy (quarterly series Q1 02 to Q3 06; range -20 to 30).
- Contribution to broad money growth (Year-on-year percent change): Broad money, Net foreign assets of the banking system, Net domestic assets (quarterly series Q1 02 to Q3 06; range -20 to 30).
- Vatu deposit and lending rates (In percent per annum): Vatu lending rate, Vatu deposit rate (quarterly series Q1 02 to Q3 06; range 0 to 20).

### Key summary statistics and projections — Table 1: Vanuatu: Selected Economic and Financial Indicators, 2002–07
- Nominal GDP (2005): US$368 million
- Main exports: Tourism, kava, beef
- GDP per capita (2005): US$1,692
- FDI (2005): US$12.6 million
- Public debt (2005): 32.2 percent of GDP
- Foreign public debt (2005): 61.1 percent of total public debt
- Output and prices (annual percentage change, 2002–2007 Est./Proj.):
  - Real GDP: -7.4, 3.2, 5.5, 6.8, 5.5, 5.0
  - Nominal GDP: -6.4, 7.0, 7.8, 9.0, 7.2, 7.6
  - Consumer prices (period average): 2.0, 3.0, 1.4, 1.2, 1.6, 2.5
- Government finance (in percent of GDP, 2002–2007 Est./Proj.):
  - Total revenue and grants: 21.5, 19.8, 21.5, 21.7, 22.5, 28.8
  - Revenue: 19.1, 18.5, 19.1, 19.8, 20.3, 22.2
    - Tax: 17.0, 16.8, 17.1, 17.7, 17.8, 19.8
    - Nontax: 2.1, 1.8, 1.9, 2.1, 2.5, 2.4
  - Grants 1/: 2.3, 1.3, 2.5, 1.9, 2.3, 6.6
  - Total expenditure: 25.6, 21.3, 20.2, 19.8, 23.1, 29.3
    - Current expenditure 2/: 21.7, 20.0, 18.6, 18.0, 20.3, 22.7
    - Capital expenditure: 3.9, 1.4, 1.6, 1.8, 2.8, 6.6
  - Overall balance: -4.2, -1.5, 1.3, 1.9, -0.5, -0.5
- Money and credit (annual percentage change):
  - Broad money (M2): -1.7, -0.8, 9.8, 11.6, 11.1,...
  - Net foreign assets: -6.0, -0.3, 11.7, 6.9, 12.2,...
  - Domestic credit: 12.0, 5.3, 7.9, 8.7, 13.0,...
    - Credit to private sector: 7.9, 9.8, 9.8, 16.3, 11.5,...
- Interest rates (in percent, end of period) 3/:
  - Deposit rate (vatu deposits): 2.1, 2.2, 2.4, 2.3, 1.9,...
  - Lending rate (vatu loans): 11.6, 11.7, 11.6, 11.4, 10.9,...
- Balance of payments (2002–2007 Est./Proj., in millions of U.S. dollars and percent of GDP):
  - Current account (in millions of U.S. dollars): -22.2, -30.0, -23.9, -36.8, -30.9, -55.7
    - (in percent of GDP): -9.7, -10.7, -7.3, -10.0, -8.0, -13.2
  - Tourism exports (in millions of U.S. dollars): 44.1, 52.0, 67.4, 76.1, 88.7, 93.5
  - Merchandise exports, f.o.b. (in millions of U.S. dollars): 20.1, 26.6, 38.1, 38.1, 38.9, 40.5
  - Merchandise imports, f.o.b. (in millions of U.S. dollars): 74.6, 86.8, 106.8, 124.7, 140.3, 170.9
  - Gross official reserves (end of period) in millions of U.S. dollars: 36.4, 44.3, 62.1, 67.6, 99.1, 118.9
    - In months of corresponding imports of goods 4/: 5.0, 5.2, 6.0, 5.6, 7.2, 7.1
    - In months of prospective imports of goods 4/: 4.3, 4.3, 5.1, 4.9, 5.9, 6.8
  - External debt (in percent of GDP) 5/: 28.8, 26.6, 24.2, 19.7, 18.5, 16.6
  - External debt service 6/: 1.4, 1.5, 1.7, 3.3, 1.6, 1.7
- Exchange rates (period average):
  - Exchange rate regime: pegged to an undisclosed basket of currencies
  - Vatu per U.S. dollar (period average): 139.2, 122.2, 111.8, 109.2, 111.2,...
  - Real effective exchange rate (average, 2000=100): 106.5, 111.5, 113.6, 114.5,......

### Central government fiscal operations, 2002–07 — Table 2 (In percent of GDP)
- Revenue and expenditure series (2002–2007 Budget/Proj. extracts):
  - Total revenue and grants: 21.5, 19.8, 21.5, 21.7, 20.1, 22.5, 29.3, 28.8
  - Tax 1/: 17.0, 16.8, 17.1, 17.7, 16.9, 17.8, 20.3, 19.8
    - Taxes on properties: 0.2, 0.2, 0.3, 0.4, 0.3, 0.5, 1.2, 1.0
    - Goods and services: 10.5, 10.7, 10.8, 11.3, 10.7, 11.5, 11.8, 11.8
    - International trade: 6.4, 5.9, 6.0, 6.0, 5.9, 5.7, 7.3, 7.0
  - Grants 2/: 2.3, 1.1, 2.3, 1.8, 1.1, 2.3, 6.6, 6.6
  - Total expenditure: 25.6, 21.3, 20.2, 19.8, 20.2, 23.1, 29.3, 29.3
  - Current expenditure: 21.7, 20.0, 18.6, 18.0, 18.2, 20.3, 22.7, 22.7
    - Wages and salaries 3/: 12.3, 11.9, 11.1, 10.5, 10.8, 12.5, 14.2, 14.2
    - Purchases of goods and services: 5.2, 3.8, 3.6, 3.7, 3.7, 3.5, 4.8, 4.8
    - Interest payments: 1.0, 1.0, 1.0, 0.9, 0.9, 0.7, 0.8, 0.8
    - Transfers: 2.4, 2.4, 2.3, 2.2, 2.2, 3.0, 2.4, 2.4
  - Capital expenditure: 3.9, 1.4, 1.6, 1.8, 2.0, 2.8, 6.6, 6.6
  - Overall balance: -4.2, -1.5, 1.3, 1.9, -0.1, -0.5, 0.0, -0.5
- Financing and public debt:
  - Public debt: 44.4, 43.0, 38.5, 32.2, 30.2, 30.6, 28.0, 27.3
  - Domestic (in millions of vatu): 15.6, 16.4, 14.3, 12.5, 11.7, 12.1, 11.5, 10.7
  - External (in millions of vatu) 4/: 28.8, 26.6, 24.2, 19.7, 18.5, 18.5, 16.6, 16.6
  - Debt service-to-revenue: 6.9, 7.3, 7.7, 10.9, 7.6, 6.2, 6.1, 5.9
  - Nominal GDP growth (annual percent change): -6.4, 7.0, 7.8, 9.0, 7.2, 7.2, 7.6, 7.6
  - Real GDP growth (annual percent change): -7.4, 3.2, 5.5, 6.8, 5.5, 5.5, 5.0, 5.0

### Balance of payments, 2002–07 — Table 3 (In millions of U.S. dollars, unless otherwise indicated)
- Current account balance (2002–2007 Est.): -22.2, -30.0, -23.9, -36.8, -30.9, -55.7
  - Trade balance: -54.5, -60.2, -68.7, -86.6, -101.4, -130.4
  - Services balance: 33.1, 38.1, 49.0, 55.9, 67.4, 71.1
    - Receipts: 83.6, 98.7, 114.6, 129.5, 145.0, 152.6
      - travel: 44.1, 52.0, 67.4, 76.1, 88.7, 93.5
    - Payments: -50.4, -60.5, -65.5, -73.6, -77.6, -81.5
  - Income: -11.5, -15.2, -18.7, -25.9, -29.9, -31.4
    - Receipts: 22.4, 24.2, 27.2, 27.8, 29.1, 30.6
    - Payments: -33.9, -39.4, -45.8, -53.7, -59.0, -62.0
  - Current transfers (net): 10.7, 7.3, 14.4, 19.9, 33.0, 35.0
    - Official current transfers (net): 15.9, 14.8, 20.6, 19.8, 28.0, 30.0
    - Private current transfers (net): -5.2, -7.5, -6.3, 0.1, 5.0, 5.0
- Capital and financial account: 26.1, 35.1, 50.8, 35.9, 62.4, 75.5
  - Capital account: -1.9, -3.9, -2.1, 0.9, 1.6, 27.3
    - Official capital transfers (net): 6.4, 5.6, 7.2, 10.2, 10.9, 36.6
    - Private capital transfers (net): -8.3, -9.5, -9.4, -9.4, -9.4, -9.4
  - Financial account: 28.0, 39.0, 52.9, 35.1, 60.8, 48.3
    - Foreign direct investment: 13.6, 17.3, 19.2, 12.6, 40.0, 30.0
    - Portfolio investment: -0.3, 2.0, 0.9, -1.4, 0.5, 0.5
    - Government (disbursements/amortizations): 1.5, 0.0, 0.0, 0.0, 2.4, 0.0 (disbursements); -0.8, -0.9, -1.5, -4.8, -2.1, -2.2 (amortizations)
    - Other investment: 14.0, 20.5, 34.4, 28.6, 20.0, 20.0
- Net errors and omissions: -5.1, 2.8, -9.1, 11.1, 0.0, 0.0
- Overall balance: -1.2, 7.9, 17.7, 10.3, 31.5, 19.8
- Gross official reserves (millions of U.S. dollars): 36.4, 44.3, 62.1, 67.6, 99.1, 118.9
  - In months of corresponding imports of goods 1/: 5.0, 5.2, 6.0, 5.6, 7.2, 7.1
  - In months of prospective imports of goods 4/: 4.3, 4.3, 5.1, 4.9, 5.9, 6.8
- Current account balance (in percent of GDP): -9.7, -10.7, -7.3, -10.0, -8.0, -13.2
- Exchange rate (vatu per U.S. dollar, period average): 139.2, 122.2, 111.8, 109.2, 111.2,...

### Balance of payments, 2006–11 projections — Table 4 (In millions of U.S. dollars)
- Current account balance (2006–2011): -30.9, -55.7, -62.0, -48.3, -43.2, -42.4
- Trade balance (2006–2011): -101.4, -130.4, -137.8, -125.2, -121.5, -122.2
- Merchandise exports (f.o.b.) (2006–2011): 38.9, 40.5, 42.9, 45.5, 48.2, 51.1
- Merchandise imports (f.o.b.) (2006–2011): -140.3, -170.9, -180.6, -170.6, -169.7, -173.2
  - of which: imports of capital goods (donor-related projects): -33.0, -36.2, -15.1, -9.5, -9.0
- Services balance (2006–2011): 67.4, 71.1, 73.7, 76.5, 79.7, 83.0
  - Receipts (2006–2011): 145.0, 152.6, 158.5, 164.2, 169.6, 175.2
    - travel (2006–2011): 88.7, 93.5, 97.0, 100.6, 104.4, 108.3
  - Payments (2006–2011): -77.6, -81.5, -84.8, -87.8, -89.9, -92.2
- Income (2006–2011): -29.9, -31.4, -33.0, -34.6, -36.4, -38.2
  - Receipts: 29.1, 30.6, 32.1, 33.7, 35.4, 37.2
  - Payments: -59.0, -62.0, -65.1, -68.4, -71.8, -75.4
- Current transfers (net): 33.0 (2006) and constant 35.0 (2007–2011)
  - Official current transfers (net): 28.0 (2006) and 30.0 (2007–2011)
  - Private current transfers (net): 5.0 (2006–2011)
- Capital and financial account (2006–2011): 62.4, 75.5, 73.7, 49.9, 38.6, 36.1
  - Financial account (2006–2011): 60.8, 48.3, 42.9, 42.5, 37.5, 35.5
    - Foreign direct investment: 40.0, 30.0, 25.0, 25.0, 20.0, 18.0
    - Portfolio investment: 0.5 (each year)
    - Government: 0.3, -2.2, -2.6, -3.1, -3.1, -3.1
    - Other investment: 20.0 (each year)
- Net errors and omissions: 0.00 (2006–2011)
- Overall balance (2006–2011): 31.5, 19.8, 11.6, 1.6, -4.6, -6.3
- Financing and reserves:
  - Change in net official reserves of the RBV (-, increase): -31.5, -19.8, -11.6, -1.6, 4.6, 6.3
  - Gross official reserves (in millions of U.S. dollars): 99.1, 118.9, 130.5, 132.1, 127.5, 121.2
  - In months of corresponding imports of goods 1/: 7.2, 7.1, 7.4, 7.9, 7.7, 7.2
- Current account balance (in percent of GDP, 2006–2011): -8.0, -13.2, -13.7, -10.1, -8.6, -8.0

### Financial sector and vulnerability indicators — Table 5: Vanuatu: Vulnerability Indicators, 2002–07
- Public debt: 44.4, 43.0, 38.5, 32.2, 30.2, 30.6, 27.3
- Broad money (percent change, 12-month basis) 1/: -1.7, -0.8, 9.8, 11.6, 11.1,...
- Private sector credit (percent change, 12-month basis) 1/: 7.9, 9.8, 9.8, 16.3, 11.5,...
- Nonperforming loans (as share of total loans) 2/: 3.9, 8.4, 13.3, 19.5, 16.4,...
- Share of deposits in broad money (percent): 94.5, 93.9, 93.5, 93.7, 93.3, 92.0
- Share of foreign currency deposits in total deposits (percent): 66.8, 64.5, 62.6, 59.8, 55.4, 50.2
- External indicators:
  - Exports of goods (annual percentage change, in U.S. dollars): 0.7, 32.5, 43.4, 0.0, 2.0, 4.0
  - Imports of goods (annual percentage change, in U.S. dollars): -4.5, 16.4, 23.1, 16.7, 12.5, 21.8
  - Current account balance (excl. official transfers): -16.6, -16.0, -13.5, -15.4, -15.2, -20.3
  - Capital and financial account balance: 11.3, 12.5, 15.4, 9.8, 16.1, 17.9
  - Inward foreign direct investment: 5.9, 6.2, 5.8, 3.4, 10.3, 7.1
  - Gross official reserves (in millions of U.S. dollars): 36.4, 44.3, 62.1, 67.6, 99.1, 118.9
    - (in months of corresponding imports of goods) 3/: 5.0, 5.2, 6.0, 5.6, 7.2, 7.1
    - (in months of prospective imports of goods and services) 4.3, 4.3, 5.1, 4.9, 5.9, 6.8
    - (in percent of broad money): 13.9, 14.3, 17.3, 17.8, 22.3, 25.6
- Foreign liabilities and assets (through end-September/ August 2006 where noted):
  - Foreign liabilities of Reserve Bank of Vanuatu (in millions of U.S. dollars) 2/: 1.9, 1.9, 1.9, 2.2, 2.0,...
  - Foreign currency exposure of Reserve Bank of Vanuatu 4/ 5/: 5.8, 4.9, 3.4, 3.5, 2.3,...
  - Foreign assets of commercial banks (in millions of U.S. dollars) 2/: 215.7, 243.4, 263.4, 260.7, 287.8,...
  - Foreign liabilities of commercial banks (in millions of U.S. dollars) 2/: 65.2, 65.0, 64.8, 63.6, 85.4,...
  - Foreign currency exposure of commercial banks 2/ 4/: 30.2, 26.7, 24.6, 24.4, 29.7,...
- Total external debt (in percent of GDP) 6/: 28.8, 26.6, 24.2, 19.7, 18.5, 16.6
  - (in percent of exports of goods and nonfactor services): 66.8, 65.0, 54.9, 42.1, 40.6, 36.3
  - External debt-service (in percent of exports of goods and nonfactor services): 1.4, 1.5, 1.7, 3.3, 1.6, 1.7
- Exchange rate (vatu per U.S. dollar, end of period): 133.2, 111.8, 106.5, 112.3, 106.5,...

### Social indicators — Table 6: Vanuatu: Social Indicators (selected)
- Population:
  - Total population (millions): 0.221
  - Growth rate (percent annual): 2.60
  - Urban population (percent of population): 24.0
  - Total fertility rate (births per woman): 4.0
  - GNI per capita (in U.S. dollars): 1,579
- Public expenditure (percent of GDP):
  - Health: 3.1
  - Education: 10.3
- Gross primary enrollment (percent of school age population): 118
  - Male: 120
  - Female: 116
- Immunization rate (percent 12-23 months):
  - Measles: 48
  - Diptheria/Pertussis/Tetanus (DPT): 49
- Life expectancy at birth (years):
  - Total: 69
  - Male: 67
  - Female: 71
- Mortality (per thousand live births):
  - Infant: 32
  - Under 5: 40

*Sources: Vanuatu authorities; and Fund staff estimates and projections.*

### APPENDIX I. VANUATU—MEDIUM-TERM OUTLOOK

### APPENDIX I. VANUATU—MEDIUM-TERM OUTLOOK

### Baseline scenario — policy assumptions
- After rising initially, medium-term real GDP growth is assumed to fall to historic levels of about 2½ percent, reflecting poor and expensive infrastructure, as well as shortcomings in the legal framework, particularly for land use.
- Revenues rise in line with GDP.
- Expenditures increase in line with increasing needs for spending on maintenance and development-related investment, resulting in a worsening over time in the budget deficit.
- Flows from traditional bilateral donors and the MCA grant raise GDP in the short term; as the MCA grant money fades, growth declines to its historical trend.

### Baseline scenario — outcomes and key statistics (2006–2016; averages 2013–16)
- Public debt (in percent of GDP): 30.6, 27.9, 26.6, 25.7, 25.2, 24.9, 24.6, 24.1
- Fiscal balance (in percent of GDP): -0.5, -0.5, -0.5, -0.6, -0.7, -0.8, -0.9, -1.0
- Current account (in percent of GDP): -8.0, -13.2, -13.7, -10.1, -8.6, -8.0, -7.3, -6.1
- Export growth of goods and nonfactor services (percent): 9.7, 5.0, 4.3, 4.1, 3.9, 3.9, 3.9, 3.9
- Import growth of goods and nonfactor services (percent): 9.9, 15.8, 5.2, -2.6, 0.5, 2.2, 1.8, 2.4
- Gross official reserves (in months of imports): 7.2, 7.1, 7.4, 7.9, 7.7, 7.2, 6.6, 5.5

- Summary finding: Under the baseline, the current account deficit is sustainable (driven by donor-related imports). Public debt declines gradually from 30 percent of GDP to 24 percent of GDP over a ten year period.

### Comprehensive reform scenario — policy assumptions
- Structural reforms are implemented expeditiously to reduce barriers to private sector development and enhance external competitiveness.
- Real annual GDP growth is assumed to be maintained at 4 percent over the medium term.
- With widening of the tax base, revenues rise faster than GDP.
- Improvements in the efficiency of public sector services allow increasing needs for maintenance and development-related investment to be accommodated with lower overall expenditures than in the baseline, keeping the budget near balance over the medium term.

### Comprehensive reform scenario — outcomes and key statistics (2006–2016; averages 2013–16)
- Public debt (in percent of GDP): 30.6, 27.9, 26.5, 25.3, 24.0, 22.7, 21.4, 18.3
- Fiscal balance (in percent of GDP): -0.5, -0.5, -0.5, -0.4, -0.3, -0.2, -0.1, 0.0
- Current account (in percent of GDP): -8.0, -13.2, -13.7, -9.0, -7.6, -7.1, -6.5, -5.3
- Export growth of goods and nonfactor services (percent): 9.7, 5.0, 4.3, 6.9, 6.9, 7.4, 7.5, 7.6
- Import growth of goods and nonfactor services (percent): 9.9, 15.8, 5.2, -2.5, 3.6, 5.5, 5.6, 6.1
- Gross official reserves (in months of imports): 7.2, 7.1, 7.4, 8.2, 8.2, 8.0, 7.8, 7.3

- Additional outcomes and comparative findings:
  - Structural reforms combined with Vanuatu’s relatively open trade regime improve external competitiveness and produce a strong export-driven economy, particularly for tourism.
  - Relative to the baseline scenario, export growth increases by 4 percent.
  - Reserves increase by 2 months of import cover (relative to baseline scenario).
  - Public debt declines more rapidly, from 30 percent of GDP to 18 percent of GDP.
  - Real GDP per capita and total government debt trajectories are illustrated in the source (Baseline versus High growth), showing higher real GDP per capita and lower total government debt under the reform (High growth) scenario.

### Policy implications (derived from scenario comparisons)
- Maintaining or strengthening fiscal policy is critical to debt sustainability under either scenario.
- Accelerating structural reforms to reduce barriers to private sector development and to widen the tax base can:
  - Sustain higher real GDP growth (assumed 4 percent).
  - Improve external competitiveness and export performance (export growth up by 4 percent relative to baseline).
  - Improve reserve adequacy (reserves up by 2 months of import cover relative to baseline).
  - Reduce public debt more rapidly (to 18 percent of GDP by the medium term under reform).

*Prepared by the Asia and Pacific Department; Staff Report for the 2006 Article IV Consultation—Informational Annexes.*

### ANNEX V. VANUATU: TABLE OF COMMON INDICATORS REQUIRED FOR SURVEILLANCE

### ANNEX V. VANUATU: TABLE OF COMMON INDICATORS REQUIRED FOR SURVEILLANCE (As of January 31, 2007)

### Data availability and dissemination (table of indicators and frequencies)
- Exchange Rates — Date of latest observation: Jan.2007; Date received: Jan.2007; Frequency of data: D; Frequency of reporting: D; Frequency of publication: M
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities — Date of latest observation: Nov.2006; Date received: Jan.2006; Frequency of data: M; Frequency of reporting: M; Frequency of publication: M
- Reserve/Base Money — Date of latest observation: Nov.2006; Date received: Jan.2007; Frequency of data: M; Frequency of reporting: M; Frequency of publication: M
- Broad Money — Date of latest observation: Nov.2006; Date received: Jan.2007; Frequency of data: M; Frequency of reporting: M; Frequency of publication: M
- Central Bank Balance Sheet — Date of latest observation: Nov.2006; Date received: Jan.2007; Frequency of data: M; Frequency of reporting: M; Frequency of publication: M
- Consolidated Balance Sheet of the Banking System — Date of latest observation: Nov.2006; Date received: Jan.2007; Frequency of data: M; Frequency of reporting: M; Frequency of publication: M
- Interest Rates — Date of latest observation: Nov.2006; Date received: Jan.2007; Frequency of data: M; Frequency of reporting: M; Frequency of publication: M
- Consumer Price Index — Date of latest observation: Jun.2006; Date received: Nov.2006; Frequency of data: Q; Frequency of reporting: Q; Frequency of publication: Q
- Revenue, Expenditure, Balance and Composition of Financing — General Government — NA; NA; NA; NA; NA
- Revenue, Expenditure, Balance and Composition of Financing — Central Government — Date of latest observation: Nov.2006; Date received: Nov.2006; Frequency of data: Q; Frequency of reporting: Q; Frequency of publication: Q
- Stocks of Central Government and Central Government - Guaranteed Debt — Date of latest observation: Nov.2006; Date received: Nov.2006; Frequency of data: A; Frequency of reporting: A; Frequency of publication: A
- External Current Account Balance — Date of latest observation: Sept.2006; Date received: Nov.2006; Frequency of data: Q; Frequency of reporting: Q; Frequency of publication: Q
- Exports and Imports of Goods and Services — Date of latest observation: Sept.2006; Date received: Nov.2006; Frequency of data: Q; Frequency of reporting: Q; Frequency of publication: Q
- GDP/GNP — Date of latest observation: Nov.2006; Date received: Nov.2006; Frequency of data: A; Frequency of reporting: I; Frequency of publication: I
- Gross External Debt — Date of latest observation: Nov.2006; Date received: Nov.2006; Frequency of data: A; Frequency of reporting: A; Frequency of publication: A

Notes from table:
- 1 Includes reserve assets pledged or otherwise encumbered as well as net derivative positions.
- 2 Both market-based and officially-determined, including discount rates, money market rates, rates on treasury bills, notes and bonds.
- 3 Foreign, domestic bank, and domestic nonbank financing.
- 4 The general government consists of the central government (budgetary funds, extra budgetary funds, and social security funds) and state and local governments.
- 5 Does not include currency and maturity composition. For central government only.
- 6 Daily (D), Weekly (W), Monthly (M), Quarterly (Q), Annually (A); Irregular (I); Not Available (NA).

### Recent economic developments and near-term outlook (Public Information Notice, March 2, 2007)
- Growth and inflation
  - Growth reached 7 percent in 2005 and an estimated 5½ percent in 2006.
  - Inflation peaked at 3 percent in 2003 and declined to 1½ percent in 2006.
- External sector and reserves
  - Reserves increased to over 7 months of imports.
  - The overall external balance benefited from rising foreign direct investment, aid, and private capital inflows.
- Fiscal performance
  - Budget moved from a deficit of 4 percent of GDP in 2002 to a surplus of nearly 2 percent of GDP in 2005.
  - Increase in civil servants’ wages from July 2006 led to an expected deficit in 2006 of around ½ percent of GDP.
  - Public debt-to-GDP ratio declined to about 30 percent from nearly 45 percent in 2002.
- Near-term prospects (staff view)
  - If good macroeconomic policies continue and political stability is maintained, growth should be maintained at about 4-5 percent over the next two-three years.
  - Inflation is expected to increase modestly but remain subdued.
  - Risks: loosening fiscal policy and increased capital inflows could put upward pressure on private sector wages and prices.
- Medium-term prospects
  - Depend on pace of structural reforms; progress limited outside the financial sector.
  - Financial sector reforms have been impressive; fiscal structural reforms have not advanced.
  - Constraints: high wage bill crowding out development-related spending; numerous VAT and duty exemptions not streamlined; substantial barriers to private sector development persist.
  - Without stronger reform efforts, medium-term growth could revert to historical performance and per capita income growth remain stagnant.

### Executive Board assessment and policy recommendations
- Commendations and general advice
  - Directors commended the authorities for maintaining sound macroeconomic policies and progress in financial sector supervision.
  - Directors encouraged authorities to use increased donor support to reduce deep-seated barriers to development.
- Structural reforms and private sector
  - Directors urged acceleration of policies to reduce impediments to private sector development, including poor and expensive infrastructure and legal framework shortcomings.
  - Improving external competitiveness and promoting private sector activity were emphasized.
- Fiscal policy and public sector management
  - Directors stressed the need for long overdue fiscal restructuring.
  - Recommended reforms: improve delivery and efficiency of government services; restructure the civil service and reduce the associated wage bill; remove numerous tax exemptions and enhance tax administration.
  - Loss-making state-owned enterprises should be restructured, including through privatization.
- Monetary and financial sector policy
  - Directors noted the transactions-weighted, basket pegged exchange rate regime is appropriate for Vanuatu’s stage of development.
  - Urged central bank to monitor credit growth to prevent demand pressures and increases in nonperforming loans despite exchange rate peg limits on monetary policy.
  - Strong bank supervision was emphasized.
  - Additional steps needed: place proposed agriculture development bank under strict central bank supervision from inception; promote commercial bank awareness of responsibilities under AML/CFT legislation.
- Statistics
  - Directors underscored need to improve domestic capacity to compile statistics for timely monitoring and policy analysis and encouraged intensifying efforts in this area.

### Selected economic and financial indicators, 2002–07 (highlights from table)
- Output and prices (annual percentage change)
  - Real GDP: 2002: -7.4; 2003: 3.2; 2004: 5.5; 2005: 6.8; 2006: 5.5; 2007: 5.0 (Proj.)
  - Consumer prices (period average): 2002: 2.0; 2003: 3.0; 2004: 1.4; 2005: 1.2; 2006: 1.6; 2007: 2.5 (Proj.)
- Government finance (in percent of GDP)
  - Total revenue and grants 1/: 2002: 21.5; 2003: 19.8; 2004: 21.5; 2005: 21.7; 2006: 22.5; 2007: 28.8 (Proj.)
  - Total expenditure 3/: 2002: 25.6; 2003: 21.3; 2004: 20.2; 2005: 19.8; 2006: 23.1; 2007: 29.3 (Proj.)
    - Current expenditure: 2002: 21.7; 2003: 20.0; 2004: 18.6; 2005: 18.0; 2006: 20.3; 2007: 22.7 (Proj.)
    - Capital expenditure: 2002: 3.9; 2003: 1.4; 2004: 1.6; 2005: 1.8; 2006: 2.8; 2007: 6.6 (Proj.)
  - Overall balance: 2002: -4.2; 2003: -1.5; 2004: 1.3; 2005: 1.9; 2006: -0.5; 2007: -0.5 (Proj.)
- Money and credit (annual percentage change)
  - Broad money (M2): 2002: -1.7; 2003: -0.8; 2004: 9.8; 2005: 11.6; 2006: 11.1; 2007: ...
  - Net foreign assets: 2002: -6.0; 2003: -0.3; 2004: 11.7; 2005: 6.9; 2006: 12.2; 2007: ...
  - Domestic credit: 2002: 12.0; 2003: 5.3; 2004: 7.9; 2005: 8.7; 2006: 13.0; 2007: ...
- Balance of payments
  - Current account (in millions of U.S. dollars): 2002: -22.2; 2003: -30.0; 2004: -23.9; 2005: -36.8; 2006: -30.9; 2007: -55.7 (Proj.)
  - Current account (in percent of GDP): 2002: -9.7; 2003: -10.7; 2004: -7.3; 2005: -10.0; 2006: -8.0; 2007: -13.2 (Proj.)
  - Tourism exports (in millions of U.S. dollars): 2002: 44.1; 2003: 52.0; 2004: 67.4; 2005: 76.1; 2006: 88.7; 2007: 93.5 (Proj.)
  - Merchandise exports, f.o.b. (in millions of U.S. dollars): 2002: 20.1; 2003: 26.6; 2004: 38.1; 2005: 38.1; 2006: 38.9; 2007: 40.5 (Proj.)
    - Merchandise exports annual percentage change: 2002: 0.7; 2003: 32.5; 2004: 43.4; 2005: 0.0; 2006: 2.0; 2007: 4.0 (Proj.)
  - Merchandise imports, f.o.b. (in millions of U.S. dollars): 2002: 74.6; 2003: 86.8; 2004: 106.8; 2005: 124.7; 2006: 140.3; 2007: 170.9 (Proj.)
    - Merchandise imports annual percentage change: 2002: -4.5; 2003: 16.4; 2004: 23.1; 2005: 16.7; 2006: 12.5; 2007: 21.8 (Proj.)
- Gross official reserves (end of period)
  - In millions of U.S. dollars: 2002: 36.4; 2003: 44.3; 2004: 62.1; 2005: 67.6; 2006: 99.1; 2007: 118.9 (Proj.)
  - In months of corresponding imports of goods 4/: 2002: 5.0; 2003: 5.2; 2004: 6.0; 2005: 5.6; 2006: 7.2; 2007: 7.1 (Proj.)
- Public debt
  - Total debt (in percent of GDP): 2002: 44.4; 2003: 43.0; 2004: 38.5; 2005: 32.2; 2006: 30.6; 2007: 27.3 (Proj.)
  - External debt (in percent of GDP) 5/: 2002: 28.8; 2003: 26.6; 2004: 24.2; 2005: 19.7; 2006: 18.5; 2007: 16.6 (Proj.)
  - External debt service 6/ (in percent of exports of goods and nonfactor services): 2002: 1.4; 2003: 1.5; 2004: 1.7; 2005: 3.3; 2006: 1.6; 2007: 1.7 (Proj.)

Notes accompanying indicators:
- Sources: Vanuatu authorities, and IMF staff estimates and projections.
- 1/ Figures in 2006 and 2007 are staff projections.
- 2/ Includes Millennium Challenge Account (MCA) project grant which was launched in 2006.
- 3/ Assumes 20–25 percent civil service wage increase beginning July 2006.
- 4/ Imports values are on c.i.f. basis.
- 5/ Medium- and long-term public debt only.
- 6/ In percent of exports of goods and nonfactor services.

*IMF — ANNEX V. VANUATU: TABLE OF COMMON INDICATORS REQUIRED FOR SURVEILLANCE (As of January 31, 2007).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2007/_cr0792.pdf_