## _cr09166

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### Executive Summary — Background and Key Policy Issues
- Economic performance remained strong in recent years, driven primarily by tourism, construction activities, and aid inflows.
- Inflation: rose to 5.8 percent in 2008 from 4.1 percent in 2007, reflecting higher international food and fuel prices and rapid private sector credit growth.
- Fiscal: overall fiscal surplus increased to 2.2 percent of GDP in 2008 (small surplus in 2007) on better tax compliance and strong growth.
- Current account: deficit widened in 2008 but largely financed by donor flows; foreign exchange reserves about 5½ months of projected imports of goods.
- Outlook:
  - Growth averaged 6 percent in 2003–08; projected to moderate to 3 percent in 2009 (staff), authorities project 4½ percent or in other statements around 3½ percent.
  - Risks tilted to the downside, notably spillovers from slowdowns in Australia and New Zealand affecting tourism and FDI.
- Policy priorities:
  - Room for counter-cyclical fiscal measures given strong fiscal position and low public debt.
  - Monetary easing possible if deterioration occurs, noting policy rate differential with trading partners.
  - Strengthen financial sector supervision, including oversight of VADB and VNPF.
  - Structural reforms to reduce cost of doing business: infrastructure (road, port, wharf), labor market flexibility, public enterprise management.

### Recent Economic Developments and Outlook
- Growth and sectoral drivers:
  - Real GDP growth: averaged 6 percent in 2003–08; 2008 growth at 6½ percent driven by services (about two-thirds of GDP), tourism, and aid (including MCA disbursements).
  - Agriculture benefited from higher commodity prices in 2008.
- Inflation and prices:
  - Inflation: 5.8 percent (2008); core inflation relatively stable; recent declines in international food and fuel prices expected to reduce inflationary pressures.
- External sector:
  - Exports rose (copra, coconut oil recovery, tourist revenues) but imports of food, fuel, machinery and transport equipment increased.
  - FDI slowed considerably in 2008 as Australia and New Zealand came under strain.
  - Reserves: comfortable at about 5½ months of projected imports of goods.
- Banking and credit:
  - Credit growth accelerated in 2008; private sector credit growth: 43.3 (2008, percent change, 12-month basis).
  - Lending concentrated in construction and consumer finance; credit growth slowed since Q4 2008 due to tighter liquidity and stricter lending standards.
- Structural reforms:
  - Utilities Act passed in 2007; Personal Property Securities Act passed in 2008; telecom liberalization continued.

### Fiscal Consolidation, Public Debt, and Near-Term Stance
- Debt dynamics and consolidation:
  - Debt-to-GDP ratio declined to about 14 percent in 2007 from over 40 percent in 2002.
  - Total public sector debt stock estimated at 18½ percent of GDP in 2008 (from 28 percent of GDP in 2005).
  - Debt ratio inched up in 2008 reflecting disbursements under a new bilateral loan for the “E-government project”.
  - Public debt projections: PV of public debt-to-GDP 14½ percent at end-2008; expected to decline to 10¾ percent in 2013 and around 1 percent by end-2028 under baseline.
- Fiscal outcomes and 2009 stance:
  - Budget surplus for 2008 estimated at 2.3 percent of GDP; total revenues up by 16 percent from 2007.
  - 2009 budget expected broadly balanced by staff; authorities project a fiscal surplus of about 1 percent of GDP in their budget or 0.9 percent in other statements.
  - Table highlights (in percent of GDP): Total revenue and grants: 28.6 (2008), 26.6 (2009); Revenue: 21.8 (2008), 19.9 (2009); Tax: 19.7 (2008), 18.3 (2009); Grants: 6.8 (2008), 6.6 (2009); Total expenditure: 26.4 (2008), 26.6 (2009); Current expenditure: 19.6 (2008), 19.6 (2009); Capital expenditure: 6.7 (2008), 7.0 (2009); Overall balance: 2.2 (2008), 0.0 (2009); Public debt: 18.5 (2008), 17.3 (2009); External: 14.1 (2008), 14.4 (2009).
- Fiscal risks and contingency measures:
  - Large public wage bill: wage bill rose from 10½ percent of GDP (2005) to an estimated 12 percent of GDP (2008); share of public employment similar to other PICs.
  - Tax base narrow; large tax exemptions estimated at an average of 3½ percent of GDP.
  - Possible counter-cyclical options if downturn sharp: allow automatic stabilizers to work; expand social safety net (with donor assistance), including conditional cash transfers; expedite pending road and infrastructure projects; bring forward donor-financed projects.
- Structural fiscal reform recommendations:
  - Reorient expenditure: streamline wage bill (eliminate vacant positions; avoid ad-hoc wage increases), enhance public enterprise monitoring and restructuring, implement Public Expenditure Financial Management (PEFM) Act.
  - Widen tax base: streamline exemptions (tourism, interisland shipping), better integrate VAT and customs duty collection.
- Authorities’ views:
  - PEFM bill submitted to parliament; introduction of Large Tax Payer Unit planned; no further borrowing planned beyond one-off bilateral loan.

### Monetary Policy, Liquidity, and Banking Supervision
- Policy actions and settings:
  - Discount rate: raised by 25 basis points in September 2008, lowered by 25 bps to 6 percent in December 2008.
  - LAR and SRD requirements reduced to 7 percent and 5 percent respectively (from 8 percent and 10 percent).
- Staff assessment:
  - With lending and inflation decelerating, some scope to ease monetary stance if global slowdown impacts economy significantly.
  - Policy rate in Vanuatu remains significantly above those in Australia and New Zealand, providing room to reduce rates if needed.
  - Alternative: lowering SRD to release liquidity directly.
  - Any easing should preserve RBV’s goal of low inflation and a sound banking system.
- Banking system soundness:
  - Banks well capitalized: capital adequacy ratio above 30 percent.
  - NPLs have been declining rapidly (partly due to rapid loan growth); nonperforming loans (share of total loans): 13.3 (2004), 9.5 (2005), 16.4 (2006), 12.5 (2007), 10.6 (2008).
  - Profitability remains high; lending margins declined late in the year due to tight financing.
- New institutions and supervision needs:
  - VADB established with initial capital of vatu 200 million (total capitalization to reach vatu 500 million by 2011).
  - VNPF has begun providing loans to members using provident fund savings as collateral.
  - Staff recommends bringing VADB and VNPF under RBV supervision, ensure adequate staffing and resources for supervision, and operationalize the Financial Intelligence Unit for AML/CFT enforcement.
- Authorities:
  - Plan to bring VADB under central bank supervision; exploring other financial assets as collateral for liquidity provision; committed to AML/CFT implementation and technical assistance.

### Exchange Rate, Competitiveness, and External Indicators
- Exchange rate policy and competitiveness:
  - REER broadly in line with fundamentals; vatu largely stable in real effective terms since early 2000s.
  - Current basket regime considered appropriate by staff and authorities; nominal effective exchange rate stability anchors inflation expectations.
- External figures and indicators (selected exact values):
  - Nominal GDP (2007): US$507 million
  - GDP per capita (2007): US$2,218
  - FDI (2007): US$33 million
  - Public debt (2007): 20 percent of GDP
  - Foreign public debt (2007): 70 percent of total public debt
  - Gross official reserves (millions of U.S. dollars): 62.1 (2004), 67.6 (2005), 105.1 (2006), 119.6 (2007), 115.2 (2008), 135.3 (2009)
  - Reserves (months of imports): 5.8 (2004), 5.4 (2005), 7.8 (2006), 7.1 (2007), 4.8 (2008), 6.3 (2009)
  - Current account balance (millions of U.S. dollars): -16.5 (2004), -27.5 (2005), -17.1 (2006), -30.0 (2007), -42.3 (2008), -33.4 (2009)
  - Current account (percent of GDP): -5.0 (2004), -7.4 (2005), -4.1 (2006), -5.9 (2007), -7.4 (2008), -6.0 (2009)
  - Vatu per U.S. dollar (period average): 111.9 (2004), 109.2 (2005), 110.5 (2006), 102.4 (2007), 101.3 (2008)

### Debt Sustainability (Appendix I) — Baseline and Stress Tests
- Baseline assumptions:
  - Real GDP growth: about 4½ percent on average over the medium term.
  - Inflation: about 3 percent.
  - Overall fiscal balance: modest surplus; baseline projects average surplus of ¼ percent of GDP over the medium term.
  - Baseline assumes no additional external borrowing other than the new bilateral loan contracted in 2008 (about US$27 million at 2 percent interest, 5-year grace, 20-year maturity).
  - Reserve cover projected to remain around six months of projected imports by 2014.
- Key debt indicators and projections:
  - External debt: 15¾ percent of GDP in FY2008.
  - PV of external debt: 10½ percent of GDP in 2008; expected to fall to 9¼ percent by FY2013 and decline further.
  - PV of public sector debt: 14.5 percent (end-2008); expected to decline to 10¾ percent in 2013; projected to fall to around 1 percent by end-2028.
- Sensitivity analysis:
  - External debt sensitive to exchange rate shocks: one-time 30 percent nominal depreciation raises NPV of debt-to-GDP to 18 percent in 2009–10 before declining.
  - Growth shock (assumed contraction by 11½ percent in two years) can have lasting medium-term effects.
  - None of the stress tests cause breaches in indicative thresholds under baseline assumptions.
- Staff policy implications:
  - Debt sustainability manageable under baseline, but vulnerabilities exist to exchange rate and growth shocks.
  - Recommendation: continue reducing external debt and improve coordination with donors to align aid with development objectives.

### Structural Bottlenecks, Reforms, and Capacity Building
- Main constraints:
  - Infrastructure bottlenecks: poor road network, lack of interisland shipping, inadequate wharf storage, port congestion.
  - Labor market: new Employment Act passed but not implemented; initial severance pay provisions would raise severance pay fourfold and could raise labor costs significantly.
- Staff recommendations:
  - Continue reforms to reduce business costs: improve ports to lower trade-related costs, balance worker protections with employer constraints in Employment Act, improve public enterprise management, and pursue privatization where appropriate (Air Vanuatu under consideration).
  - Improve statistical capacity: rebase GDP (from 1983 base to 2006 underway), improve CPI weights, expand national accounts and balance of payments data, and enhance compilation frequency.
- Authorities’ actions:
  - Efate Ring Road (MCA financed) underway, due early 2011; working with donors to upgrade wharfs and extend roads; seeking donor assistance for interisland shipping; planning privatization and management improvements for public enterprises.
  - Employment Act under review with planned stakeholder consultations.

### Data Adequacy and Technical Assistance Needs
- Data issues:
  - Expenditure-based GDP estimates not yet available; constant price GDP uses 1983 base; CPI weights from 1998 household surveys covering only Port Vila and Luganville.
  - Government operations exclude public enterprises and provincial governments; budget operations recorded on cash plus invoice basis.
  - Trade data: imports via post office not captured; capital account data needs improvement; errors and omissions large.
- Data dissemination:
  - Participant in GDDS since April 2004; no data ROSC available.
  - Selected data frequency and latest observations provided (examples): Exchange Rates: Mar. 2009 (D); International Reserve Assets: Dec. 2008 (M); Consumer Price Index: Dec. 2008 (Q); GDP/GNP: 2008 (A).
- Technical assistance:
  - Authorities requested assistance to improve national accounts and balance of payments; Fund staff and PFTAC to continue support.

### AsDB CPS and Borrowing Context
- CPS 2010–14 potential focus areas: Inter-Island Shipping Service Reforms; Continued Private Sector Development support; Urbanization of Port Vila; Promoting Energy Efficiency and Renewable Energy; Improving efficiency and effectiveness of infrastructure and service delivery.
- AsDB loan allocation for 2009–10: $11.7 million.
- Future lending to be based on debt sustainability analysis and may include loan buy-downs, co-financing partnerships, and complement grants in transport and infrastructure.
- Past debt reduction may have increased government willingness to consider borrowing in 2009; innovative financing approaches contemplated.

*Source: IMF staff report – Executive Summary, _cr09166.*

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

### Executive Summary

### Background
- Economic performance has remained strong over the past several years, driven primarily by tourism, construction activities, and aid inflows. Inflation picked up last year, reflecting the lagged impact of higher international food and fuel prices and an acceleration in bank credit to the private sector during the first three quarters. Fiscal balance improved on better tax compliance and continued strong growth. The current account deficit widened last year, but was largely financed by donor flows.
- Vanuatu has so far been largely shielded from the impact of the global slowdowns, but the slowdown in Australia and New Zealand are likely to have spillover effects. Vanuatu’s close links with these two countries, mainly through tourism and foreign direct investment, have contributed significantly to its remarkable growth performance in recent years. But they have also heightened Vanuatu’s vulnerability to the projected downturn in these two countries, and there are some indications that growth is slowing.
- There has been some progress in structural reforms, but more remains to be done. Fiscal structural reforms should be further advanced to reorient expenditure and widen the tax base, while policies to support private sector development are also needed.

### Key Policy Issues
- Vanuatu is well placed to take counter-cyclical measures should growth slow more than expected. Given the strong fiscal position, the authorities have room to use temporary fiscal stimulus measures in addition to expediting pipeline infrastructure projects. While close monitoring of banks is necessary given the rapid growth in private sector credit last year, the wide differential in policy rates between Vanuatu and its major trading partner countries suggests there is some scope for monetary easing if things deteriorate more than expected.
- Financial sector supervision could be further improved. In addition to improvements in the oversight of commercial banks, supervision of the newly established Vanuatu Agricultural Development Bank (VADB) and the Vanuatu National Provident Fund (VNPF) should be enhanced.
- Structural reforms that reduce the cost of doing business are critical to ensure sustained growth. In particular, improvements in infrastructure, including road transport, port and wharf facilities, and enhanced flexibility of the labor market are needed.

### I. Introduction
- After a period of relative political instability, the political situation has stabilized. With no party commanding a majority, a coalition government, headed by Edward Natapai, took office on September 22. After defeating several opposition-led no-confidence votes, the political situation has stabilized and the government is moving ahead on policymaking. The 2009 budget was also finally passed in March. With support from donors, a number of initiatives, including improving transparency of government operations, are underway.
- The 2009 Article IV consultation focused on the spillovers from the global slowdown in Vanuatu and measures to reduce its adverse impact on the economy. In particular, while Vanuatu’s close links with Australia and New Zealand (through tourism and foreign direct investment (FDI)) have been the major sources of growth so far, they have heightened Vanuatu’s vulnerability to the projected downturn in these two countries. In addition, growth could be affected further if concerns about the global slowdown were to drive domestic banks to cut back lending. On the positive side, the decline in food and fuel prices should help reduce inflationary pressures, providing room to ease monetary policy.

### II. Recent Economic Development and Outlook
#### A. Economic Backdrop
- Vanuatu has so far been largely sheltered from the impact of the global financial turmoil. Coming out of a decade of stagnant growth, Vanuatu has grown at an average rate of 6 percent in 2003–08, outperforming most of the other Pacific Island countries (PICs), while maintaining a relatively low inflation rate and an improving fiscal balance.
- A booming tourist sector helped to keep economic activity buoyant. Growth remained strong in 2008 at 6½ percent, driven primarily by the service sector (which accounts for about two-thirds of GDP) and aid inflows, including increased disbursements from the Millennium Challenge Account (MCA). The agricultural sector also pitched in last year on the back of higher commodity prices.
- Boxed findings on recent success:
  - Progresses in transportation and communication sector: policy changes, foreign carriers, and telecom liberalization (second license; Digicel entry).
  - Fiscal resource management: Introduction of VAT, capacity building in the tax office, increased transparency, strengthened regulatory framework for state-owned utility, consideration of Air Vanuatu privatization.
  - Sound monetary and financial policy: RBV capacity and transparency improvements, exchange rate arrangement containing inflationary pressures, banking sector follows international prudential standards, AML/CFT framework assessed in 2007.
  - Political stability: improvement after prior frequent government changes.
  - Continued reform efforts are essential to prevent return to lower growth.
- Inflation accelerated to 5.8 percent in 2008 from 4.1 percent in 2007. The increase was driven largely by the pass-through of higher international food and fuel prices, with the depreciation in the Australian dollar since August and rapid private sector credit growth also being contributory factors. More recently, food and fuel prices have started to decline, and with core inflation remaining relatively stable, the second round effects appear to be limited and manageable.
- The current account deficit widened but was largely financed by aid flows. The current account deteriorated in 2008 as rising exports, driven primarily by the recovery in copra and coconut oil exports and tourist revenues, were more than offset by increased imports of food and fuel, and machinery and transport equipment (the latter due to infrastructure projects under the MCA). An uptick in aid inflows, mainly disbursements from the MCA, helped finance the large import bill. On the other hand, FDI slowed considerably in 2008 as Australia and New Zealand, the largest sources of FDI, came under increasing strain from the financial crisis. Foreign exchange reserves remain comfortable at about 5½ months of projected imports of goods.
- Overall, fiscal performance continued to improve. The overall fiscal surplus increased to 2.2 percent of GDP in 2008, following a small surplus in 2007. Improved VAT and trade taxes, reflecting an improvement in tax compliance, more than offset the additional (election-related) spending on goods and services. Development expenditure also picked up as the long-awaited donor financing from the MCA began to feed into capital projects.
- Credit growth accelerated in 2008. Bank lending increased significantly last year, in part reflecting the entry of a fourth foreign-owned commercial bank. Most bank loans went to the construction and consumer finance sectors. However, tighter liquidity conditions in the domestic money market combined with stricter lending standards have resulted in a slow down in credit growth since the fourth quarter of 2008.
- There has been some progress on structural reforms. A new Utilities Act aimed at strengthening the regulatory framework was passed in 2007. The Personal Property Securities Act, which broadens the range of assets that can be used as collateral and strengthens the rights of secured creditors, was passed in 2008. In addition, the telecommunications sector has been opened up to foreign competition.

#### B. Outlook and Risks
- The global slowdown is likely to affect Vanuatu more than some of the other PICs, given its heavy dependence on tourism.
- Growth is projected to moderate to 3 percent in 2009. Indications (based on banking sector data) are that real estate activity, which has attracted capital inflows from Australia and New Zealand, has begun to slow. While tourist arrivals remain strong (airlines and hotel operators suggested confirmed bookings through May remain strong; frequency of cruise ships has also increased this year so far), spending by tourists has declined. However, MCA disbursements, which picked up last year after several delays, are expected to remain strong and combined with other aid inflows should help alleviate some of the negative impact on growth. In addition, the recent easing in monetary policy and a more accommodative fiscal stance for the 2009 budget would help cushion the impact on growth. Inflation will likely fall, reflecting lower international food and fuel prices. The current account deficit is expected to narrow and foreign exchange reserves to improve, reflecting lower imports due to the decline in commodity prices.
- Risks to the outlook are tilted to the downside. Should the global slowdown be more protracted than expected, including in Australia and New Zealand, this would further exacerbate the negative impact on tourism and FDI. Furthermore, with three of the four commercial banks being subsidiaries of foreign banks, banks could come under increasing pressure from their parent companies to tighten lending standards and add to the slowdown in growth.
- The authorities agreed that growth will moderate in 2009, but only modestly. The authorities project growth in 2009 at 4½ percent, somewhat higher than staff’s projections. While there was no fundamental difference in views, the authorities believe that the impact from the global slowdown is likely to be smaller given the dominance of subsistence farming and continued strong tourist arrivals based on Vanuatu’s geographic advantage. Also, Australians concerned about future income are likely to curb their travel budgets and instead of far away vacations may come to Vanuatu. That said, the authorities concurred with the staff’s views that overall the risks to the economic outlook are tilted to the downside given developments in the global economy.

### III. Policy Discussions
- Policy discussions focused on how Vanuatu could mitigate the effects of the global slowdown, especially if tourism were to nosedive. Staff recommended that while fiscal policy should be primarily used to counter the effects of a downturn, the relatively high policy rate in Vanuatu provides scope to use monetary policy (though constrained by the exchange rate system) by lowering the policy rate to those prevailing in trading partner countries, notably Australia and New Zealand. However, it will be critical to ensure that any policy easing is supportive of growth without creating inflationary pressures. In addition, the mission stressed that continued structural reforms remain critical to place the economy on a higher trajectory of long-term sustainable growth.

#### A. Macroeconomic Policies — Fiscal Policy (Background)
- Fiscal performance has improved substantially.
  - The budget surplus for 2008 is estimated at 2.3 percent of GDP. Reflecting improved tax compliance (partly due to additional staffing in the tax office) and continued strong growth, total revenues, especially from VAT and trade taxes, were up by 16 percent from 2007. Expenditures were higher than in the budget, although the strong revenue performance resulted in a sizable fiscal surplus. Furthermore, expenditure remains skewed toward nonproductive spending, with all revenue collections going toward meeting recurrent expenditure. The wage bill continued to constitute about half of recurrent expenditure, and allocations for emergency spending were, in part, used to finance election-related spending.
  - The 2009 budget is expected to be broadly balanced. In light of the projected slowdown in economic activity, the mission’s revenue projections are somewhat lower than in the authorities’ budget (which envisages fiscal surplus of about 1 percent of GDP). Keeping recurrent expenditure similar to the authorities’ projections, staff projects the fiscal balance to be broadly balanced.

*Source: IMF staff report – Executive Summary (cr09166).*

### 7.      Fiscal consolidation has helped to

### _cr09166 - 7.      Fiscal consolidation has helped to

### Fiscal consolidation and public debt
- Authorities’ fiscal consolidation and no new borrowing for several years led to a decline in the debt-to-GDP ratio to about 14 percent in 2007 from over 40 percent in 2002.
- The debt ratio inched up in 2008 reflecting disbursements under a newly contracted bilateral loan to finance the “E-government project” to computerize fiscal operations and enhance expenditure tracking and transparency.
- The debt ratio remains low, gradually declining over the medium term, and debt burden indicators remain below the indicative thresholds (see Appendix I on debt analysis).
- Charts referenced (preserve labels): Domestic and External Debt (In percent of GDP) and Budget Developments (In percent of GDP) with series including Overall balance (LHS), Revenue (excl. grants, RHS), Current expenditure (RHS); sources: Vanuatu authorities; and IMF staff estimates.

### Domestic and external debt composition and recent borrowing
- New bilateral loan in 2008 for the “E-government project” caused a small uptick in the debt ratio.
- Staff recommendation: Maintain external debt at a low level, especially given donors’ willingness to provide aid.
- Recommendation: Improve capacity to implement aid-related programs and align donor assistance with government development objectives to reduce need to borrow.

### Structural problems hindering fiscal management
- Large public wage bill:
  - Vanuatu’s wage bill (in percent of total expenditure) is the highest among PICs.
  - The share of public employment in total employment is broadly the same as in other PICs.
  - The wage bill ratio increased from 10½ percent of GDP in 2005 to an estimated 12 percent of GDP in 2008.
- Inefficient public enterprises:
  - There are 24 public enterprises in Vanuatu, the majority receiving financial assistance from time to time.
  - Some (e.g., Air Vanuatu) support tourism; privatization (under consideration for Air Vanuatu) and/or better management could reduce the budget burden.
- Narrow tax base:
  - Vanuatu has a relatively low tax revenue/GDP ratio among PICs.
  - Large tax exemptions exist (especially on interisland shipping and tourism), estimated at average of 3½ percent of GDP.

### Near-term fiscal stance and contingency options
- Staff view: Recent fiscal performance and the more accommodative fiscal stance under the 2009 budget are welcomed; authorities are on firmer ground to use counter-cyclical fiscal policy given prior consolidation.
- The 2009 budget is overall accommodative (although there are no explicit stimulative measures); the fiscal balance is expected to remain in surplus over the medium term as activity and tax revenues recover.
- Caution: Authorities should avoid expansion in areas where retrenching spending is difficult (e.g., a general increase in the public wage bill) so as not to jeopardize medium-term fiscal sustainability.
- In the event of a sharper-than-expected downturn, possible fiscal stimulus measures include:
  - Allowing the automatic stabilizers to work; budget could accommodate a decline in other taxes, notably customs and property taxes.
  - Expanding the social safety net (with donor assistance), including conditional cash transfers targeted to those who lose their jobs.
    - The 2006 Household Income and Expenditure Survey suggests urban areas are more susceptible to the global slowdown with more than 30 percent of the urban population being wage earners; the majority of the rural population appears engaged in subsistence agriculture.
  - Expediting implementation of pending projects in road construction, including in the outer islands.
  - Bringing forward new projects (principally financed by additional donor funding).

### Long-term fiscal “structural” reforms recommended
- Reorienting expenditure:
  - More than half of the recurrent budget is spent on the wage bill, crowding out expenditure that could improve productive capacity.
  - Most development expenditure is currently financed by aid inflows.
  - Measures to restructure expenditures include:
    - Streamlining the wage bill by eliminating vacant positions, and avoiding ad-hoc increases in wages.
    - Enhancing monitoring and accountability of public enterprises to improve efficiency, and restructuring those that continue to make losses and require government subsidies.
    - Improving the budget framework to establish transparency and accountability, including through passage and implementation of the Public Expenditure Financial Management (PEFM) Act.
- Widening the tax base:
  - Streamline large tax exemptions, especially in the tourism sector, and rationalize exemptions in interisland shipping.
  - Further rationalize tax administration by better integrating VAT and customs duty collection.

### Authorities’ perspectives on fiscal management
- 2009 budget:
  - Authorities agreed that the revenue target may be challenging but believed it could be achieved through enhanced efficiency, including introduction of a Large Tax Payer Unit this year.
- Policy response to a larger-than-expected slowdown:
  - Authorities indicated initiation of contingent plans, including possibly asking donors to expedite projects and streamlining bureaucracy to expedite pipeline projects.
- Structural issues:
  - Authorities noted Vanuatu’s dispersed landscape requires a larger civil service, especially in education, but agreed there is scope to streamline expenditures and have started to reduce vacant positions.
  - PEFM bill has been submitted to parliament to enhance budget monitoring and transparency.
- External debt:
  - Newly contracted loan was a one-off event to provide cheap financing for improving efficiency and transparency; authorities have no further plans to borrow and remain committed to reducing debt levels.

### Monetary policy stance and banking liquidity
- Background:
  - Following a monetary tightening in September, the Reserve Bank of Vanuatu (RBV) eased in December as interbank liquidity tightened.
  - Discount rate raised by 25 basis points in September, then lowered by 25 bps to 6 percent in December.
  - Liquid Asset Requirement (LAR) and Statutory Reserve Deposit (SRD) requirement reduced to 7 percent and 5 percent respectively (from 8 percent and 10 percent).
- Rationale: Liquidity shortage caused largely because lending had accelerated while deposit growth remained modest.
- Staff views:
  - With lending and inflation decelerating recently, and assuming credit growth continues to moderate, there is some scope to ease the monetary stance if the global slowdown significantly impacts the economy.
  - Concerns:
    - It is too early to assess impact of last year’s credit expansion on bank balance sheets.
    - Most loans concentrated in construction and consumer finance; a slowdown could have significant negative consequences for bank balance sheets.
  - Policy options:
    - Policy rate in Vanuatu remains significantly above those in Australia and New Zealand, providing room to reduce rates if growth slows more than expected.
    - Alternatively, lowering the SRD could release additional liquidity more directly than a change in the policy rate.
  - Any easing should ensure RBV’s goal of low inflation and a sound banking system are not jeopardized.
- Authorities’ views:
  - Agreed with need to monitor bank balance sheets closely.
  - If inflation fails to decline to the 3–4 percent range and the economy is resilient, they may tighten SRD/LAR requirements.
  - If growth slows substantially, a more accommodative stance may be warranted.
  - Exploring other financial assets, besides RBV notes, that can be used as collateral for liquidity provision.

### Exchange rate, competitiveness, and reserves
- Staff analysis:
  - Vanuatu’s REER is broadly in line with economic fundamentals.
  - Fluctuations in major currencies have broadly offset each other; the vatu has been largely stable in real effective terms since early 2000s.
  - Trade deficit has risen recently, but exports of goods and services were strong and helped finance a large import bill driven by higher international prices of food and fuel.
  - Foreign exchange reserves remain strong.
- Policy view:
  - Current exchange rate policy remains appropriate; relative stability of the nominal effective exchange rate anchors inflation expectations.
  - Structural bottlenecks and international commodity prices better explain the modest widening in the current account deficit than external price competitiveness.
  - Current account deficit, mainly reflecting FDI and donor-financed imports, expected to remain large over the medium term.
- Authorities’ view:
  - Continue to believe the current basket regime is appropriate.
  - Agree that eliminating structural bottlenecks is key to increasing competitiveness.

### Financial sector soundness and supervision
- Background:
  - Despite rapid credit growth, the banking system remains sound.
  - Banks are well capitalized with the capital adequacy ratio above 30 percent.
  - Nonperforming loans (NPLs) have been declining rapidly (partly reflecting rapid growth in total loans).
  - Profitability remains high, though tight financing conditions late in the year led to a decline in lending margins.
  - Banking Soundness Indicators chart referenced with CARNPL ratio to total loans and ROE series; source: Vanuatu authorities.
- New institutions and developments:
  - Vanuatu Agricultural Development Bank (VADB) established last year with initial capital of vatu 200 million from the budget (total capitalization to reach vatu 500 million by 2011) to provide loans to farmers.
  - VNPF has started providing loans to members using provident fund savings as collateral.
- Staff recommendations for supervision:
  - Enhance financial sector supervision given rapid credit growth and the global environment.
  - Vigilance over risks from possible slowdown, especially exposure to personal and construction-related loans.
  - Bring both VADB and VNPF under RBV supervision.
  - Ensure adequate staffing and resources for supervision, particularly with decision to move insurance supervision from the Financial Service Commission to RBV.
  - Make the Financial Intelligence Unit fully operational to enforce AML/CFT provisions.
- Authorities’ view:
  - Agree on importance of enhanced supervision and are monitoring increases in personal-consumption loans.
  - Plan to bring VADB under central bank supervision.
  - Committed to implementing AML/CFT regulations and seeking technical assistance for staff training.

### Policies to support sustainable growth and structural bottlenecks
- Background constraints:
  - Infrastructure bottlenecks: poor road network, lack of interisland shipping, lack of storage facilities at wharfs, congestion at ports raise cost of doing business.
  - Labor market cost: A new Employment Act (passed by parliament but not yet implemented) would raise the severance pay scale fourfold, potentially raising labor costs significantly and causing business community concern.
- Staff view:
  - Continued structural reforms needed to reduce business costs.
  - Improving infrastructure to lower trade-related costs at ports would raise growth potential.
  - Strike a balance between workers’ rights and employer constraints in the Employment Act to improve worker pay and safeguard employment while maintaining attractiveness for business.
- Authorities’ actions:
  - Discussions with a donor to upgrade wharf facilities.
  - Efate Ring Road (financed by MCA) underway and due to be completed by early 2011; seeking donor assistance to extend roads and develop interisland shipping.
  - Plans for privatizing Air Vanuatu are underway; government identifying other enterprises for possible privatization.
  - Employment Act under review; government plans stakeholder consultations before implementation.

### Staff appraisal and near-term growth outlook
- Recent performance:
  - Vanuatu has shown remarkable growth driven by tourism and construction; real GDP averaged 6 percent in the last five years.
- Near-term risk:
  - Not immune to the global slowdown; construction-related FDI and tourist spending show some signs of slowing.
- 2009 growth projection:
  - Growth in 2009 is expected to be at 3 percent, with risks tilted to the downside.

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

### 27.      Vanuatu is well positioned to respond with counter-cyclical fiscal measures,

### Vanuatu is well positioned to respond with counter-cyclical fiscal measures

### Fiscal stance and policy options
- The 2009 budget aims for a more modest surplus than last year and in this sense is more accommodative.
- Given the strong fiscal position and low public debt, the authorities have room to use temporary fiscal stimulus measures (e.g., targeted conditional cash transfers) to cushion the impact on the economy.
- Expediting pipeline infrastructure projects will also help.
- Table highlights (selected fiscal figures, in percent of GDP):
  - Total revenue and grants: 28.6 (2008), 26.6 (2009)
  - Revenue: 21.8 (2008), 19.9 (2009)
  - Tax: 19.7 (2008), 18.3 (2009)
  - Grants: 6.8 (2008), 6.6 (2009)
  - Total expenditure: 26.4 (2008), 26.6 (2009)
  - Current expenditure: 19.6 (2008), 19.6 (2009)
  - Capital expenditure: 6.7 (2008), 7.0 (2009)
  - Overall balance: 2.2 (2008), 0.0 (2009)
  - Public debt: 18.5 (2008), 17.3 (2009)
  - External 4/: 14.1 (2008), 14.4 (2009)

### Monetary policy and inflation outlook
- A cautious easing of the monetary stance may be warranted if the slow down turns out to be more serious than anticipated.
- Domestic price pressures have been coming down, although with a lag compared to most other regions.
- Provided inflation continues to decline and bank balance sheets remain strong, the monetary stance could be further relaxed to support growth.
- Consumer prices (period average): 4.8 (2008), 4.3 (2009)
- Consumer prices (end period): 5.8 (2008), 3.5 (2009)
- Interest rates (end of period, deposit and lending): deposit rate data series includes 2.6 (2008); lending rate series includes 10.0 (2008).

### Financial sector supervision and banking system soundness
- Further improvements in bank supervision are advisable.
- In particular, closer monitoring of bank balance sheets, including RBV supervision of VADB, will help early detection of any signs of deterioration in loan quality and help the authorities to take timely action to ensure a continued sound banking system.
- Financial indicators:
  - Nonperforming loans (as share of total loans): 13.3 (2004), 9.5 (2005), 16.4 (2006), 12.5 (2007), 10.6 (2008)
  - Broad money (percent change, 12-month basis): 9.8 (2004), 11.6 (2005), 7.0 (2006), 16.1 (2007), 13.2 (2008)
  - Private sector credit (percent change, 12-month basis): 9.6 (2004), 16.3 (2005), 9.7 (2006), 12.3 (2007), 43.3 (2008)
  - Share of foreign currency deposits in total deposits (percent): 62.6 (2004), 59.8 (2005), 55.5 (2006), 54.9 (2007), 54.0 (2008)

### External sector and exchange rate
- The current exchange rate regime remains appropriate.
- The exchange rate appears to be broadly in line with economic fundamentals.
- With a sound reserve position supported by tourism and capital inflows, there appears to be little sign of exchange rate misalignment.
- Key external figures:
  - Nominal GDP (2007): US$507 million
  - GDP per capita (2007): US$2,218
  - FDI (2007): US$33 million
  - Public debt (2007): 20 percent of GDP
  - Foreign public debt (2007): 70 percent of total public debt
  - Gross official reserves (end of period, in millions of U.S. dollars): 62.1 (2004), 67.6 (2005), 105.1 (2006), 119.6 (2007), 115.2 (2008), 135.3 (2009)
  - Reserves (in months of corresponding imports of goods): 5.8 (2004), 5.4 (2005), 7.8 (2006), 7.1 (2007), 4.8 (2008), 6.3 (2009)
  - Current account balance (in millions of U.S. dollars): -16.5 (2004), -27.5 (2005), -17.1 (2006), -30.0 (2007), -42.3 (2008), -33.4 (2009)
  - Current account (in percent of GDP): -5.0 (2004), -7.4 (2005), -4.1 (2006), -5.9 (2007), -7.4 (2008), -6.0 (2009)
  - Exchange rate regime: officially pegged to an undisclosed basket of currencies
  - Vatu per U.S. dollar (period average): 111.9 (2004), 109.2 (2005), 110.5 (2006), 102.4 (2007), 101.3 (2008)

### Structural reforms and capacity building
- Further structural reforms are necessary to sustain a high growth path.
- Priority areas: improving road and port infrastructure, improving management and efficiency at public enterprises, and ensuring a flexible labor market.
- Improving capacity to compile statistics is necessary.
  - Authorities identified several areas for technical assistance, especially to improve national accounts and balance of payments data.
  - Fund staff, including through PFTAC, will continue to provide assistance in these areas.

### Recommendation for surveillance cycle
- It is recommended that the next Article IV consultation with Vanuatu takes place on a 24-month cycle.

### Selected macroeconomic projections and indicators (2004–09, as presented)
- Real GDP (annual percentage change): 5.5 (2004), 6.5 (2005), 6.5 (2006), 7.4 (2007), 6.8 (2008), 6.6 (2009), 3.0 (2009 projection in Table 5 context elsewhere)
- Nominal GDP (annual percentage change): 7.8 (2004), 9.6 (2005), 13.8 (2006), 13.8 (2007), 11.7 (2008), 7.4 (2009)
- Consumer prices (period average): 1.4 (2004), 1.2 (2005), 2.0 (2006), 3.9 (2007), 4.8 (2008), 4.3 (2009)
- Tourism receipts (in millions of U.S. dollars): 74.8 (2004), 85.6 (2005), 92.4 (2006), 118.0 (2007), 160.9 (2008), 139.5 (2009)
- Merchandise exports, f.o.b. (in millions of U.S. dollars): 38.1 (2004), 38.1 (2005), 37.7 (2006), 29.7 (2007), 41.7 (2008), 37.1 (2009)
- Merchandise imports, f.o.b. (in millions of U.S. dollars): 106.7 (2004), 124.7 (2005), 134.4 (2006), 167.9 (2007), 239.1 (2008), 216.0 (2009)
- External debt (in percent of GDP, medium- and long-term public debt only): 24.2 (2004), 19.8 (2005), 16.7 (2006), 14.1 (2007), 14.1 (2008), 14.4 (2009)

*Source: IMF staff report (Vanuatu), as provided in the content unit.*

### APPENDIX I. VANUATU: PUBLIC AND EXTERNAL DEBT SUSTAINABILITY

### APPENDIX I. VANUATU: PUBLIC AND EXTERNAL DEBT SUSTAINABILITY

### I. Introduction and Baseline
- Total public sector debt stock estimated to have declined to 18½ percent of GDP in 2008 from 28 percent of GDP in 2005.
- Ratio of external debt to GDP fell from over 30 percent in 2000 to 13¾ percent in 2007, and rose to 15¾ percent in 2008 due to a new bilateral loan.
- Baseline scenario assumptions (see Box I.1):
  - Real GDP growth: about 4½ percent on average over the medium term.
  - Inflation: about 3 percent.
  - Overall fiscal balance: modest surplus; baseline projects an average surplus of ¼ percent of GDP over the medium term.
  - Baseline assumes no additional external borrowing other than the new bilateral loan contracted in 2008 (a bilateral loan of about US$27 million at 2 percent interest, with a 5-year grace period and 20-year maturity).
  - Aid inflows assumed to remain stable; FDI related to tourism and real estate expected to increase significantly.
  - Real effective exchange rate assumed constant; reserve cover projected to remain around six months of projected imports by 2014.
- Data limitation: public debt sustainability analysis limited to central government debt data (state enterprise and provincial government debt data not available).

### II. External Debt Sustainability — Key Findings and Projections
- External debt: 15¾ percent of GDP in FY2008, down from over 20 percent in FY2005.
- NPV of external debt:
  - Projected at 10½ percent of GDP in 2008 (below the indicative threshold based on the CPIA rating which assumes Vanuatu to be a weak reformer).
  - Expected to fall to 9¼ percent by FY2013 and decline further in the medium term.
- NPV of debt-to-exports and revenue ratios: increase somewhat in 2009–10, then decline thereafter.
- Debt service indicators: PPG debt service in percent of exports and revenue remain well below their respective indicative thresholds under the baseline.
- Sensitivity and stress tests:
  - External debt sustainability sensitive to an exchange rate shock.
  - Bound test 6 (one-time 30 percent nominal depreciation of the exchange rate) raises NPV of debt-to-GDP ratio to 18 percent in 2009–10, then declines gradually.
  - Historical-average-growth scenario leads to a fall in the NPV of debt-to-GDP ratio.
  - None of the stress tests cause breaches in the indicative thresholds.

### III. Public Debt Sustainability — Key Findings and Projections
- Public sector debt declined from over 40 percent of GDP in 2002 to 18½ percent of GDP in 2008.
- NPV of public debt-to-GDP:
  - 14½ percent at end-2008.
  - Expected to decline to 10¾ percent in 2013.
  - Projected to fall to around 1 percent by end-2028.
- Public debt composition and vulnerability:
  - Dominance of external debt in total public debt makes public debt sensitive to exchange rate changes.
  - A one-time 30 percent real depreciation in 2009 would raise the NPV of public debt-to-GDP by 6 percent age points in 2009, then fall gradually thereafter.
- Growth shock impact:
  - A sizable growth shock in 2009–10 (economy assumed to contract by 11½ percent in two years compared to the baseline) will likely have a lasting effect over the medium term.
- Comparative scenarios:
  - Baseline scenario more favorable than the historical one, reflecting recent fiscal consolidation success and commitment to continue.

### IV. Staff Assessment and Policy Implications
- Overall judgment:
  - Assuming continued steady progress in reducing public debt, public debt sustainability should be manageable.
  - The country faces a low level of debt distress under the baseline.
- Vulnerabilities and risks:
  - Debt remains somewhat vulnerable to a major exchange rate shock.
  - Changes in GDP growth materially affect debt dynamics.
  - Tourism-driven growth and balance of payments imply exposure to external environment shocks, especially the global environment at the time.
- Policy recommendations:
  - Authorities should remain committed to bringing down external debt further to reduce vulnerabilities.
  - Improved coordination with donors to align donor plans with authorities’ development objectives can help mobilize and use aid inflows more effectively.

### V. Selected Quantitative Indicators (as presented)
- External and public debt ratios and dynamics (selected exact figures from tables and text):
  - External debt (nominal): 15.7 (FY2008, percent of GDP).
  - PV of external debt: 10.5 (2008, percent of GDP).
  - PV of PPG external debt-to-exports: 22.8–30.8 (period variation shown in tables).
  - PV of public sector debt: 14.5 (end-2008, percent of GDP).
  - Share foreign-currency denominated (public sector): 15.7 (2008, percent of GDP) and 10.0 (PV of foreign-currency denominated public debt, 2008).
  - Debt service-to-exports ratio (PPG): 1.9 (2008) rising to 2.9 (2012) then declining; PPG debt service-to-revenue ratio: 3.9 (2008) rising to 6.1 (2012) then declining (table values preserved).
  - Non-interest current account deficit series and other flow components are reported in table form (examples): Non-interest current account deficit 3.3 (2008, percent of GDP); Exports 46.0 (2008, percent of GDP); Imports 58.4 (2008, percent of GDP); Net FDI (negative = inflow) -6.7 (2008, percent of GDP).
  - Key macro assumptions (selected): Real GDP growth by year series (examples): 2.3 (2008), 5.0 (2009), 6.6 (2010), baseline medium-term average 4.5 (repeated in projections); GDP deflator changes and effective interest rates reported in tables.

*Source: IMF staff projections and simulations, APPENDIX I. VANUATU: PUBLIC AND EXTERNAL DEBT SUSTAINABILITY.*

### 2009. AsDB’s future CPS will be broader than the current private sector development focus,

### _cr09166 - 2009. AsDB’s future CPS will be broader than the current private sector development focus,

### AsDB CPS directions and lending framework
- CPS 2010–14 potential focus areas:
  - (i) Inter-Island Shipping Service Reforms
  - (ii) Continued support in Private Sector Development
  - (iii) Urbanization of Port Vila
  - (iv) Promoting Energy Efficiency and Access to Renewable Energy
  - (v) Improving the efficiency and effectiveness of infrastructure and service delivery
- AsDB loan allocation for 2009–10: $11.7 million
- Any future lending operations:
  - will be based on a thorough debt sustainability analysis
  - will consider innovative approaches such as loan buy-down mechanisms and the use of co-financing partnerships to reducing financing costs
  - will emphasize flexibility to respond to reform opportunities and complement grant resources of other agencies, especially in transport and infrastructure

### Debt and borrowing context
- Progress in debt reduction in recent years may have increased the government's willingness to consider returning to borrowing in 2009.
- Consideration of innovative financing: loan buy-down mechanisms; co-financing partnerships.

### Assessment of data adequacy and statistical issues (As of March 25, 2009)
- General: Data provision has some shortcomings, but are broadly adequate for surveillance. Data on national accounts, government finance and external sector statistics need further improvement.
- National accounts:
  - Expenditure-based GDP estimates are not yet available.
  - Data are compiled only on an annual basis.
  - Constant price GDP estimates still use 1983 as the base year; work to rebase to 2006 is underway.
- Price statistics:
  - CPI weights are based on 1998 household surveys, and only cover Port Vila and Luganville.
  - CPI basket does not reflect recent structural changes (e.g., telecommunication prices and related utilities).
- Government finance statistics:
  - Budget classification broadly consistent with the 1986 GFSM.
  - Government operations data include all central government agencies but exclude public enterprises and operations of provincial governments and the two municipalities.
  - Budget operations recorded on a cash plus invoice basis.
- Monetary statistics:
  - Reserve Bank of Vanuatu (RBV) reports monthly monetary data, including accounts of monetary authorities, commercial banks, and interest rates in its monthly bulletin.
  - RBV publishes a quarterly report covering wider financial data including fiscal transactions and financial soundness indicators (e.g., amount of non-performing loans and earnings).
- External sector statistics:
  - Quarterly and annual balance of payments data compiled according to The Balance of Payment Manual, Fifth Edition.
  - Trade data compiled from customs declaration forms collected at Port Vila and Santo; imports by air captured; imports through the post office not captured.
  - Capital account data needs further improvements; errors and omissions remain quite large.
- Data standards and reporting:
  - Participant in the General Data Dissemination System (GDDS) since April 2004.
  - No data ROSC is available.
  - Annual GFS data through 1999 reported for GFS Yearbook (1986 GFS format). No sub-annual fiscal data reported for publication in IFS since 2001.

### Selected data availability (As of March 25, 2009) — frequencies and latest observations
- Exchange Rates: Date of Latest Observation Mar. 2009; Date Received Mar. 2009; 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 Dec. 2008; Date Received Feb. 2009; Frequency M M M
- Reserve/Base Money: Dec. 2008; Feb. 2009; M M M
- Broad Money: Dec. 2008; Feb. 2009; M M M
- Central Bank Balance Sheet: Dec. 2008; Feb. 2009; M M M
- Consolidated Balance Sheet of the Banking System: Dec. 2008; Feb. 2009; M M M
- Interest Rates: Dec. 2008; Feb. 2009; M M M
- Consumer Price Index: Dec. 2008; Feb. 2009; Q Q Q
- Revenue, Expenditure, Balance and Composition of Financing – General Government: NA NA NA NA NA
- Revenue, Expenditure, Balance and Composition of Financing – Central Government: Sep. 2008; Dec. 2008; Q Q Q
- Stocks of Central Government and Central Government-Guaranteed Debt: Sep. 2008; Feb. 2009; A A A
- External Current Account Balance: Dec. 2008; Feb. 2009; Q Q Q
- Exports and Imports of Goods and Services: Dec. 2007; Feb. 2009; Q Q Q
- GDP/GNP: 2008; Feb. 2009; A I I
- Gross External Debt: Dec. 2008; Feb. 2009; A A A
- International Investment Position: Dec. 2008; Feb. 2009; Q Q Q

### IMF Article IV consultation — Background and macro developments (Public Information Notice No. 09/67, May 21, 2009)
- Growth performance:
  - Growth averaged 6 percent in 2003–08.
  - Growth in 2008 estimated at 6.6 percent.
- Inflation:
  - Inflation accelerated to 5.8 percent in 2008 from 4.1 percent in 2007 (mainly due to higher international food and fuel prices).
  - Core inflation remained relatively stable.
- Current account and reserves:
  - Current account deficit widened in 2008 reflecting higher imports of food, fuel, and aid-related capital imports.
  - An uptick in aid inflows helped finance the larger import bill.
  - Foreign exchange reserves remain comfortable at about 5½ months of projected imports of goods.
- Fiscal performance:
  - Overall fiscal surplus increased to 2.2 percent of GDP in 2008 from a slight surplus in 2007.
  - Higher-than-projected spending on goods and services offset by improved VAT collections and trade taxes.
  - Development expenditure picked up as donor financing from the Millennium Challenge Account (MCA) began to feed into capital projects.
  - Public debt-to-GDP ratio estimated to have declined to 18½ percent of GDP in 2008 from over 40 percent in 2002.
- Financial sector and credit:
  - Credit growth accelerated in 2008, partly reflecting the entry of a fourth foreign-owned commercial bank.
  - Most bank loans went to construction and consumer finance sectors.
  - Tightening of liquidity and stricter lending standards led to a slowdown in credit growth in the fourth quarter.
  - Banks remain well capitalized and nonperforming loans remain low.
- Structural reforms:
  - Utilities Act passed in 2007 to strengthen the regulatory framework.
  - Personal Property Securities Act passed in 2008 to broaden collateral and strengthen secured creditors’ rights.
  - Telecommunications sector further liberalized and opened to foreign competition.

### Executive Board assessment and policy advice
- Directors welcomed robust economic performance and noted limited initial impact from the global slowdown; adverse effects likely via tourism and FDI channels.
- Fiscal policy:
  - Directors supported the option for additional fiscal stimulus in the event of a sharper-than-expected slowdown, including by expediting pending projects and strengthening the social safety net.
  - Emphasized the importance of well coordinated donor support.
  - Emphasized prioritization of spending to promote growth while keeping expenditure pressures manageable.
  - Stressed monitoring of the large public sector wage bill and loss-making public enterprises.
  - Recommended improvements in tax administration and widening the tax base to finance development expenditure as foreign aid tapers.
- Monetary policy:
  - Agreed central bank could cautiously ease the monetary stance if slowdown is deeper and longer than expected.
  - Saw room for further monetary easing given wide interest-rate differentials with major central banks.
  - Warned authorities to be mindful of rapid credit expansion given inflation experience.
- Financial sector and supervision:
  - Emphasized strengthening banking supervision to preserve a stable pro-growth environment; supervisors should be vigilant against possible worsening of bank balance sheets.
  - Welcomed plan to expand central bank supervision to the Vanuatu Agricultural Development Bank.
  - Saw need to implement AML/CFT regulations expeditiously.
- Exchange rate:
  - Directors acknowledged current exchange rate regime remains appropriate; exchange rate broadly in line with fundamentals and provides an inflation anchor.
- Structural reforms to sustain growth:
  - Emphasized priority reforms related to improving road and port infrastructure, strengthening management and efficiency at public enterprises, and ensuring flexible labor markets.
- Statistics:
  - Welcomed authorities’ intention to improve statistical capacity; improvements will enhance transparency and aid policy decision-making.

### Authorities’ statement and outlook (statement by Christopher Y. Legg and Yuong Ha, May 11, 2009)
- Growth outlook:
  - Authorities expect growth of around 3½ percent in 2009; staff estimate 3 percent.
  - Factors in favor: close links to Australian and New Zealand economies, substitution effects in tourism (short-haul), increased airline capacity, trend increase in cruise liner visits, international marketing strategies, potential redirection of tourists from competitor markets, and domestic construction pipeline.
  - Authorities preparing contingency fiscal measures with donors if growth weaker-than-expected.
- Fiscal policy:
  - 2009 budget projects a reduction in the fiscal surplus, providing a counter-cyclical stance.
  - Authorities expect a surplus of 0.9 percent of GDP; staff estimate a balanced budget.
  - Authorities view revenue target for 2009 as ambitious but achievable given recent track record and planned enhancements to tax administration.

### Selected economic and financial indicators, 2004–09 (Vanuatu: Selected Economic and Financial Indicators, 2004–09)
- Output and prices (annual percentage change)
  - Real GDP 5.56.57.4 6.8 6.63.0
  - Consumer prices (period average) 1.41.22.0 3.9 4.84.3
- Government finance (in percent of GDP) 1/
  - Total revenue and grants 2/ 21.521.721.8 23.1 28.626.6
  - Total expenditure 2/ 20.719.721.3 22.9 26.426.6
    - Current expenditure 18.617.919.0 20.2 19.619.6
    - Capital expenditure 2/ 2.01.82.2 2.7 6.77.0
  - Overall balance 0.92.00.5 0.3 2.20.0
- Money and credit (annual percentage change)
  - Broad money (M2)  9.811.67.0 16.1 13.2...
  - Net foreign assets  11.76.910.5 15.0 9.0...
  - Domestic credit 7.98.77.2 10.6 36.7...
- Balance of payments
  - Current account (in millions of U.S. dollars) -16.5-27.5-17.1 -30.0 -42.3-33.4
  - (In percent of GDP) -5.0-7.4-4.1 -5.9 -7.4-6.0
  - Of which: tourism exports (in millions of U.S. dollars) 92.4 118.0 160.9139.5
  - Merchandise exports, f.o.b. (in millions of U.S. dollars) 38.138.137.7 29.7 41.737.1
    - (Annual percentage change) 43.30.1-1.1 -21.3 40.7-11.2
  - Merchandise imports, f.o.b. (in millions of U.S. dollars) 106.7124.7134.4 167.9 239.1216.0
    - (Annual percentage change) 22.916.97.7 25.0 42.4-9.7
- Gross official reserves (end of period)
  - In millions of U.S. dollars 62.167.6105.1 119.6 115.2135.3
  - In months of corresponding imports of goods 3/ 5.85.47.8 7.1 4.86.3
- Public debt
  - Total debt (in percent of GDP) 33.728.123.4 19.8 18.517.3
  - External debt (in percent of GDP) 4/ 24.219.816.7 14.1 14.114.4
  - External debt service 5/ 1.63.11.4 1.3 1.32.4

*IMF staff report; Public Information Notice No. 09/67, May 21, 2009.*

### introduction of the Large Tax Payer unit.

### _cr09166 - introduction of the Large Tax Payer unit.

### Fiscal stance and budget framework
- The fiscal consolidation that has occurred in recent years leaves the authorities well placed to cope with the economic slowdown.
- Authorities are preparing contingency measures, consistent with staff’s advice to better prioritise spending and expedite infrastructure projects in consultation with donors, in the event of a sharper-than-expected downturn.
- If revenues prove stronger than staff’s estimates, this would provide greater fiscal space to adopt additional and well-targeted measures.
- The Public Expenditure Financial Management Act was passed in the recent session of Parliament.
- Authorities are aware of the need to contain the public wage bill but stress limits given:
  - the need to provide essential public services to a population that is dispersed across over 80 islands, and
  - a population predominantly engaged in subsistence agriculture.

### Monetary policy
- The Reserve Bank of Vanuatu (RBV) eased monetary policy in late 2008, with core inflation remaining relatively stable.
- Headline inflation is expected to fall back into the RBV’s 0-4 percent target by the end of 2009, suggesting potential scope for further monetary easing.
- Any further easing would require careful assessment of:
  - the impact of last year’s exceptionally-strong credit growth, and
  - the adverse impact of the global economic slowdown on the domestic economy.
- Authorities are considering measures to enhance the monetary policy operational framework, including improving the efficiency of indirect policy instruments and minimising recourse to direct/prudential instruments for liquidity management purposes.
- Authorities agree with staff’s exchange rate assessment: maintaining stability in the nominal exchange rate has proven an effective nominal anchor.
- Addressing infrastructure bottlenecks is identified as key to improving the economy’s competitiveness over the medium term.

### Financial sector soundness and supervision
- Staff’s finding that the banking system is well-capitalised and sound is welcomed by the authorities.
- Maintaining banking system stability is a key priority.
- The RBV will closely monitor bank balance sheets for signs of deteriorating asset quality following the recent strong increase in credit growth.
- Authorities are continuing efforts to improve supervision, including:
  - moving oversight of the insurance sector to the RBV, and
  - plans to place the Vanuatu Agricultural Development Bank (VADB) under the RBV’s supervision.
- Authorities are well aware of the need to minimise the potential risk that the VADB poses to the budget.

### Structural reforms, infrastructure, and public enterprises
- Authorities agree that further structural reforms are needed to improve long-term growth prospects.
- Ongoing and planned infrastructure initiatives:
  - work with donors to upgrade wharf facilities,
  - the MCA-financed Ring Road on Efate island is currently underway.
- Increases in construction costs over recent years mean MCA disbursements will not fully fund all original round-island road programme projects; authorities are seeking donor assistance to cover remaining funding gaps.
- Authorities are working closely with donors to better align aid flows with key development objectives, particularly in healthcare and education.
- Major donor partners have pledged to maintain or increase their development assistance for the next few years.
- Authorities have prepared plans to privatise Air Vanuatu and are engaged in finding suitable investors.
- Authorities acknowledge that management of public enterprises, in general, needs to be improved given the drain on budget resources.

### Labor market legislation
- In relation to the new Employment Act, authorities have acknowledged concerns of the business community.
- Authorities signaled there are likely to be significant modifications to the initial severance pay provisions to ensure an appropriate balance between labour costs and providing an adequate safety net for workers.

*Source: _cr09166 - introduction of the Large Tax Payer unit.*

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