## _cr12259

## Source details

**Canonical URL:** [_cr12259](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12259.pdf)

## Other formats

- [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12259.pdf.md)
- [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12259.pdf.json)

---

### Background and outlook
- Population: only 11,000; nearly all goods are imported.
- Currency: Australian dollar; no central bank.
- Main foreign exchange sources: earnings of Tuvaluans working abroad (particularly seafarers) and donor assistance.
- Public sector employs around a tenth of the country’s population.
- CIF (Consolidated Investment Fund) used to close deficits.
- Social indicators:
  - Absolute poverty is rare.
  - Access to primary education effectively universal.
  - Millennium Development Goals health targets on track to be reached by 2015.

### Key macroeconomic developments and stocks
- Growth and inflation:
  - Economy grew by 1.1 percent in 2011 after two consecutive years of decline.
  - Inflation: 0.5 percent in 2011.
  - Seafarer employment remains depressed and has dragged on growth.
- Government expenditure and revenue:
  - 2005–2008: government expenditure averaged 80 percent of GDP while grants and revenue averaged 71 percent.
  - By 2010: expenditure rose to 104 percent of GDP; revenue remained at 74 percent.
  - 2011: expenditure fell to 93 percent of GDP, lowering the before-grants budget deficit to A$12.9 million.
- Consolidated Investment Fund (CIF):
  - Fell from 34 to 21 percent of GDP by 2010.
  - Fell to 11 percent of GDP, or A$3.1 million, by end-2011 despite higher donor financing.
- Tuvalu Trust Fund (TTF):
  - End-March 2012 holdings: A$122.9 million (345 percent of GDP).
  - Investment strategy aims at a 4½ percent real return.
  - Historical average returns: 8.4 percent; 2008–2011 returns fell to 0.5 percent.
  - Recovery in early 2012 closed gap to maintained value to only 3.6 percent.
- Joint ventures (JVs) with Asian fishing companies:
  - A$20 million in market-rate debt; Tuvalu’s share could represent a contingent liability of 28 percent of GDP.
- External position:
  - Trade deficit in 2011: 58 percent of GDP.
  - Remitted wages fell from around 30 percent of GDP in 2001–2003 to only 8 percent in 2011.
  - Current account deficit (less errors and omissions) in 2011: 8 percent of GDP; before errors and omissions the deficit was around 29 percent of GDP (authorities believe this overstates the deficit).
  - 2010 current account deficit: 3¾ percent of GDP.
  - Reserves: 6.7 months of import coverage in 2011.

### Policy Reform Matrix (PRM) and government agenda
- PRM origins and structure:
  - Stems from Te Kakeega II (TKII) and serves as disbursement criteria for increased donor program support.
  - Four main PRM areas: Governance; Social development; Education and human resources; Macroeconomic growth and stability.
- Expected effects:
  - Raise growth, improve tax collections, reduce non-priority expenditure, unlock additional budget support.
- PRM fiscal implications (projected/assumed):
  - Keeping the deficit below 10 percent of GDP will return the CIF to a sustainable level.
  - CSOs would be contained below 5 percent of GDP.
  - Without PRM implementation:
    - Revenues would stall at around A$24 million.
    - Recurring grants at around A$4½ million.
    - Additional World Bank financing of around A$1¾ million.
    - Expenditure around A$33 million would force cuts or exhaust the CIF.
  - With PRM implementation:
    - Growth and investment could rise by around ½ - ¾ percent of GDP.
    - Donor commitments from the ADB, Australia, and New Zealand would rise from A$4.5 million to A$9 million.
    - Full implementation would allow higher and more focused public spending, rising to around A$40 million by 2017.

### Fiscal policy — findings, measures, and recommendations
- Recent drivers of spending increases (2009/10): new scholarships, TMTS payments, Outer Islands capital programs.
- Reforms undertaken:
  - TMTS: eliminated free travel for caretakers, reduced housing costs, hired a surgeon in Tuvalu, established a committee of doctors to approve referrals.
  - Government will approve no new scholarships this year; ongoing costs for current recipients remain high.
- Capital expenditure:
  - Budgeted to fall from 13.3 percent of GDP in 2011 to 5.9 percent of GDP in 2012.
- Revenue reforms and VAT:
  - .tv domain licensing revenues to rise under a new regime but depressed by Australian dollar strength.
  - VAT compliance rising in private sector; poor among public enterprises (PEs).
  - VAT rate rise from 4 to 7 percent postponed from 2012 to 2013.
  - PRM target: improve VAT compliance to 75 percent of eligible taxpayers, including all PEs.
  - Government recommended further VAT rate increase to 10 percent in 2015.
- Staff appraisal—key fiscal priorities:
  - Raise VAT rates and raise VAT compliance among PEs (currently none pay VAT).
  - Enforce penalties for noncompliance on direct taxes, including nonfinancial penalties.
  - Continue returning TMTS referrals to a committee of doctors to control costs.
  - Coordinate with donors to ensure scholarships remain sustainable and bring PE subsidies transparently on budget.
  - Tie public wage increases more closely to inflation.
  - Sign new JVs only after verifying that any borrowing does not endanger concessional assistance from donors.

### External sustainability — findings and risks
- Freely usable reserves: CIF and NBT foreign assets (mostly Australian time deposits).
- Reserve peak: 8.6 months of import coverage in 2008.
- Risks identified:
  - Government financing needs have nearly drained the CIF.
  - Sustained low seafarer employment could force NBT to run down holdings as deposits are liquidated.
  - Nominal and real appreciation widened the current account deficit and reduced the local currency value of U.S. dollar‑denominated seafarer wages and government licensing revenue.
  - Volatile Australian dollar affects imports and government revenue.
- Policy guidance:
  - Rebuild buffers to restore resilience.
  - Implement TTF objective-based asset allocation with strong bias toward protecting Tuvalu’s asset holdings (TTF and TNPF) from risky global market conditions.
  - Fiscal consolidation and rising seasonal worker uptake should mitigate risks.

### Public enterprises (PEs), financial sector, and private sector growth
- Private sector objective:
  - TKII goal: private sector to constitute half of GDP by 2015; as of 2010 private sector activity ≈ one quarter of GDP.
- Public enterprises:
  - PEs dominate economy; historically poor management.
  - PEA passed in 2010 requires commercial operation of PEs and removal of civil servants from boards; a unit established to monitor PEs.
  - Implementation slow and mixed; some setbacks (e.g., suspension of independent board of TEC in 2011).
  - When profitable, few PEs pay corporate income tax, none pay VAT, some omit social contribution payments.
  - CSOs should be negotiated and transparently allocated; CSOs were dropped from 2012 budget.
- Financial sector constraints:
  - NBT: around half of assets are nonperforming; about one-third of NBT nonperforming assets are PE lending.
  - DBT: around half of lending portfolio nonperforming but has begun write-offs.
  - Interest rates and lending: deposit rates fixed > four years; lending rates fixed since 2010 by government directive; high spreads have kept lending profitable.
  - NBT monopoly over foreign exchange transaction fees — main income source.
- Recommendations:
  - Improve PE governance and install professional boards (e.g., electric company).
  - Encourage TNPF actuarial viability assessment and legal amendment to promote annuities over lump-sum withdrawals.
  - As DBT and NBT return to health, gradually allow them to set their own rates in competitive areas.

### Debt sustainability (Joint IMF/World Bank DSA) — key findings and scenarios
- Overall assessment:
  - Tuvalu is at high risk of debt distress.
  - Under baseline assumptions debt ratios are broadly stable long run but sensitive to assumptions.
  - Donors should continue assistance in the form of grants.
- Key metrics and projections:
  - Tuvalu’s GDP in 2011: US$36 million.
  - TTF end‑March 2012: A$122.9 million (345 percent of GDP).
  - CIF holds A$6.1 million as of mid‑2012, including A$4.0 million injection from Australia in 2012.
  - Public and publicly guaranteed (PPG) debt stock: A$17.3 million (50 percent of GDP) at end‑2011.
  - External PPG debt: A$14.9 million (36.7 percent of GDP in PV terms) at end‑2011.
  - Tuvalu’s share of JV debts amounts to 28 percent of GDP (contingent liability).
- Macroeconomic assumptions in DSA:
  - Growth estimated to average 1.2 percent throughout scenario.
  - Recurrent grants expected to average 14 percent of GDP over medium and long term.
  - DSA assumes term IDA borrowing of A$1¾ million annually as only new borrowing.
  - Expenditure projected to fall by 13 percent of GDP to around 80 percent of GDP bringing deficit to around A$3½ million (around 10 percent of GDP), then rise modestly to around 85 percent of GDP beginning around 2016.
  - Current account projected to settle at around a 4 percent surplus.
  - TTF nominal returns in scenario: 7 percent.
- Stress scenarios and sensitivities:
  - A one-time 30 percent nominal depreciation raises PV/external debt ratio to 51 percent (from baseline).
  - Historical scenario with persistent weak current account and financing shortages results in PV of public external debt reaching 108 percent of GDP around 2027.
  - Scenario with permanently lower GDP growth pushes PV of public debt to 113 percent of GDP by 2032.
- Selected tabulated indicators preserved exactly as in source (examples):
  - External debt (nominal) / o/w public and publicly guaranteed (PPG): 53.0 49.1 41.7 36.1 35.8 36.1 36.8 38.5 40.7 49.7 63.2.
  - Change in external debt (selected entries): 4.7 -3.9 -7.5 -5.6 -0.3 0.3 0.8 1.7 2.2 2.3 0.2.
  - Identified net debt-creating flows (selected entries): -21.4 -3.8 23.7 8.1 2.9 -2.3 -4.6 -4.7 -4.6 -4.8 -5.2.
  - Real GDP growth (in percent, selected series): -1.7 -2.9 1.1 1.2 4.5 1.2 1.3 1.2 1.2 1.2 1.0 1.2 1.2 1.5 1.3.
  - Government revenues (excluding grants, in percent of GDP) (selected entries): 59.6 52.0 56.2 59.6 59.6 59.6 59.6 56.4 56.4 56.4 56.4 56.4.
  - Nominal GDP (Millions of US dollars) (selected entries): 27.4 31.9 35.8 36.5 36.7 36.8 36.9 37.2 38.1 43.7 59.0.
- Implementation priorities from DSA:
  - Strengthen macro management to reduce GDP volatility.
  - Improve tax compliance and revenue mobilization.
  - Rebuild buffers (CIF) and protect TTF management.
  - Limit exposure to exchange-rate-induced debt deterioration; stress-test against AUD movements.
  - Deepen structural reforms to boost private-sector participation and PE performance.

### Risks and prospects
- Short-term (downside) risks:
  - Minimal exports and slow seafarer employment recovery limit upside growth.
  - Linkages to global growth and imported commodity price shocks.
  - Large asset holdings expose country to financial market shocks.
  - Volatile Australian dollar affects imports and government revenue.
  - Natural disasters such as drought.
  - With weak fiscal buffers and limited levers, additional donor support would likely be the only source to respond to a shock.
- Long-run risks:
  - Decline in internet and telephone licensing revenue as technologies age.
  - Potential depletion of fishing resources without better study and management.
  - Most overseas employment opportunities for unskilled labor; higher-productivity migrants less likely to return.
  - Climate change: sea‑level rise, rising sea temperatures and irregular rainfall threaten fisheries, crops, and habitability.
- Staff and Executive Board policy recommendations and priorities:
  - Rebuild fiscal buffers and accelerate structural reforms.
  - Continue fiscal consolidation within a multi‑year budget framework.
  - Support an increase in VAT next year and stress improving tax compliance.
  - Reduce subsidies and contain non-essential spending without compromising development goals.
  - Ensure TTF’s new investment strategy does not add undue risk.
  - Increase private sector participation and commercialize PEs.
  - Implement policies to improve labor skills and expand seasonal employment overseas.
  - Improve banking sector credit quality and address high non‑performing loans.
  - Improve availability and quality of economic statistics; continue IMF technical assistance.

### Data, surveillance, and capacity building
- Data shortcomings hamper surveillance, especially national accounts and balance of payments.
- PFTAC assistance has improved national accounts compilation since 2009; more staff required.
- CPI: quarterly, timely, weights revised in 2011 based on 2010 Household Income and Expenditure Survey.
- Monetary and financial statistics: not produced nationally because Tuvalu uses Australian dollar and has no central bank; bank balance sheets provided to mission used for monetary data.
- Balance of payments: compiled by visiting PFTAC experts; underlying data have inconsistencies and errors.
- Reporting and participation:
  - Tuvalu is not a General Data Dissemination System participant.
  - No data ROSC available.
  - No data currently reported to STA for publication.
- Staff recommendation: Next Article IV consultation on a 24‑month cycle; further donor support requested for long‑term advisors in public financial management, tax collection, and statistical capacity.

### Exposure to global shocks and market links (summary points)
- Small, open economy; merchant ship work traditionally largest source of foreign exchange.
- Fuel and food constitute about half of total goods imports.
- Growth correlation with Australian GDP: 0. 36; with New Zealand: -0.01.
- IMF analysis finds elasticity of Tuvaluan GDP growth to global growth: 0.5.
- A 2012‑13 Euro Area shock to global growth of 1.5 percent would have a relatively strong but short-lived effect on Tuvalu.
- A 50 percent rise in oil prices would affect Tuvalu similarly to the median Pacific Island country.
- TTF, TNPF, and FTF invest along TTF guidelines, exposing holdings to global market fluctuations.
- TTF disbursement rules tend to make government resources procyclical; discussions to make disbursements more regular and less procyclical are underway.

*Source: TUVALU 2012 ARTICLE IV REPORT — IMF staff report content as provided in _cr12259*

### 1.    Tuvalu’s    Policy    Reform Matrix ________________________________________________________________ 12

### 1.    Tuvalu’s    Policy    Reform Matrix

### Background and outlook
- Population of only 11,000; nearly all goods are imported.
- Currency: Australian dollar; no central bank.
- Main foreign exchange sources: earnings of Tuvaluans working abroad (particularly seafarers) and donor assistance.
- Public sector employs around a tenth of the country’s population.
- CIF (Consolidated Investment Fund) is Tuvalu’s budget support fund used to close deficits.
- Social indicators:
  - Absolute poverty is rare.
  - Access to primary education effectively universal.
  - Millennium Development Goals health targets on track to be reached by 2015.

Key macroeconomic developments and stocks
- Growth:
  - After two consecutive years of decline, economy grew by 1.1 percent in 2011.
  - Recovery led by private retail sector competitiveness and increased education spending.
  - Seafarer employment has not recovered from the financial crisis and has dragged on growth.
- Inflation: 0.5 percent in 2011.
- Government expenditure and revenue:
  - 2005–2008: government expenditure averaged 80 percent of GDP while grants and revenue averaged 71 percent.
  - By 2010: expenditure rose to 104 percent of GDP; revenue remained at 74 percent.
  - 2011: expenditure fell to 93 percent of GDP, lowering the before-grants budget deficit to A$12.9 million.
- CIF:
  - Fell from 34 to 21 percent of GDP by 2010.
  - Despite higher donor financing, CIF fell to 11 percent of GDP, or A$3.1 million, by end-2011.
- Joint ventures (JVs) with Asian fishing companies:
  - A$20 million in market-rate debt; Tuvalu’s share could represent a contingent liability of 28 percent of GDP.
- Trade and current account:
  - Trade deficit in 2011 reached 58 percent of GDP.
  - Remitted wages fell from around 30 percent of GDP in 2001–2003 to only 8 percent in 2011.
  - Current account deficit (less errors and omissions) in 2011: 8 percent of GDP.
  - Before errors and omissions the deficit was around 29 percent of GDP (authorities believe this is an overstatement).
  - 2010 current account deficit was 3¾ percent of GDP.
  - Reserves: 6.7 months of import coverage in 2011.
- Tuvalu Trust Fund (TTF):
  - End-March 2012 holdings: A$122.9 million (345 percent of GDP).
  - Investment strategy: aims at a 4½ percent real return.
  - Historical average returns: 8.4 percent; 2008–2011 returns fell to 0.5 percent.
  - Recovery in early 2012 closed gap to maintained value to only 3.6 percent.
  - Shift from static benchmark-matching to dynamic targeting; portfolio shifted toward low-risk assets.

### Policy Reform Matrix (PRM) and government agenda
- PRM stems from Te Kakeega II (TKII) and serves as disbursement criteria for increased donor program support.
- Four main PRM areas:
  - Governance
  - Social development
  - Education and human resources
  - Macroeconomic growth and stability
- Expected effects of PRM implementation:
  - Raise growth, improve tax collections, reduce non-priority expenditure, unlock additional budget support.

### Risks and prospects
- Short-term risks (downside):
  - Minimal exports and slow seafarer employment recovery limit upside growth.
  - Linkages to global growth trends and imported commodity price shocks.
  - Large asset holdings expose the country to financial market shocks.
  - Volatile Australian dollar affects imports and government revenue.
  - Natural disasters such as drought.
  - With weak fiscal buffers and limited levers, additional donor support would likely be the only source to respond to a shock.
- Long-run risks:
  - Decline in internet and telephone licensing revenue as technologies age.
  - Potential depletion of fishing resources without better study and management.
  - Most overseas employment opportunities for unskilled labor; higher-productivity migrants less likely to return.
  - Climate change: Tuvalu is the world’s second lowest-lying country; rising sea temperatures and irregular rainfall cited as reasons for declining income from fish and crops; higher sea levels could render much of the country uninhabitable.
- Authorities’ view: Authorities share mission views, note PRM’s dual role in near-term macro management and long-term support for health, education, and private sector growth.

### Policy discussions — Macroeconomic stability
- Fiscal policy is the sole macroeconomic instrument to buffer external shocks.
- Real exchange rate has appreciated, largely due to a strong Australian dollar, which may discourage labor migration.

A. Fiscal policy — findings and measures
- 2009/10 spending increases largely on:
  - New scholarships for Tuvaluans studying abroad.
  - Payments under Tuvalu Medical Treatment Scheme (TMTS).
  - Outer Islands capital programs.
- Reforms undertaken:
  - TMTS: eliminated free travel for caretakers, reduced housing costs, hired a surgeon in Tuvalu, established a committee of doctors to approve referrals.
  - Government will approve no new scholarships this year; ongoing costs for current recipients remain high.
- Capital expenditure:
  - Budgeted to fall from 13.3 percent of GDP in 2011 to 5.9 percent of GDP in 2012.
- Revenue reforms:
  - .tv domain licensing revenues to rise under a new regime, but Australian dollar strength depresses proceeds.
  - VAT compliance rising among private companies but poor among public enterprises (PEs).
  - VAT rate rise from 4 to 7 percent postponed from 2012 to 2013.
  - PRM target: improve VAT compliance to 75 percent of eligible taxpayers, including all PEs.
  - Government recommended further VAT rate increase to 10 percent in 2015.
- TTF strategy: new objective-based investment strategy intended to allow more flexibility in achieving target returns with less volatility; additional oversight planned.
- Authorities’ view: Government committed to improving fiscal outlook; notes reforms are ambitious and that donors have helped offset declines in government support.

B. External sustainability — findings and risks
- Freely usable foreign reserves consist of CIF and NBT foreign assets (mostly Australian time deposits).
- Reserve peak: 8.6 months of import coverage in 2008.
- Risks:
  - Government financing needs have nearly drained the CIF.
  - Sustained low seafarer employment could force NBT to run down holdings as deposits are liquidated.
  - Nominal and real appreciation widened the current account deficit and reduced domestic currency value of U.S. dollar-denominated seafarer wages and government licensing revenue.
- Authorities’ view: Concerned about strong Australian dollar; view that TTF’s new investment strategy, fiscal consolidation, and rising seasonal worker uptake should help mitigate risks; return of wages denominated in Australian dollars for some workers noted.

### Creating conditions for private sector growth
- TKII goal: private sector to constitute half of GDP by 2015.
- As of 2010: private sector activity accounted for around a quarter of GDP.
- Preconditions for stronger private growth:
  - Sustainable macroeconomic and fiscal framework.
  - Address drags on growth, including financial sector limitations and PE reforms.
- Public enterprises:
  - PEs dominate the economy; historical poor management.
  - VAT introduction increases stakes for weak tax compliance.
  - Government runs Tuvalu National Provident Fund (TNPF); workers can borrow up to a third of total holdings before maturity; rising delinquencies on these small loans.
  - Most retirees take lump-sum withdrawals, reducing TNPF’s effectiveness for retirement savings.
- Financial sector constraints:
  - NBT: around half of assets are nonperforming; about one-third of NBT nonperforming assets are PE lending; largest share related to a rental housing-construction scheme financed by NBT.
  - Interest rates set by fiat; deposit rates fixed for more than four years; lending rates fixed since 2010 cut by government directive.
  - High spreads have kept lending profitable.
  - NBT monopoly over foreign exchange transaction fees — main source of income.
  - DBT: smaller lender to small businesses; around half of lending portfolio nonperforming but DBT has begun to write off nonperforming loans.
  - Both banks have tightened lending standards.
- Authorities’ view: Government committed to PE reform, acknowledges mixed progress, notes improved collections and compensation practices, and emphasizes financial system inclusiveness.

### Other issues
- Article XIV/VIII:
  - At joining the Fund, Tuvalu availed itself of transitory provisions of Article XIV, Section 2.
  - Exchange control regulations prescribe approval requirements but in practice current international transactions administered liberally.
  - Staff recommended updating regulations to accept obligations of Article VIII, Sections 2, 3 and 4.
  - Spreads charged on NBT wire transactions differ by currency; practice may lack commercial basis and could constitute a multiple currency practice.
- AML/CFT:
  - AML/CFT law drafted with Australia and approved in 2006.
  - Tuvalu should consider applying for membership in a FATF-style regional body.
- Capacity building:
  - PFTAC assistance has grown statistics office capacity; further donor support necessary.
  - Authorities willing to move fiscal data to GFS 2001 format; initial mission visited in early May.
  - Revenue administration benefitted from PFTAC-funded long-term consultant in Funafuti.
  - PFTAC to support development of a reform plan for public financial management.
- Authorities’ view: Open to eliminating payment restrictions on current transactions and to participate in Asia/Pacific Group on Money Laundering (APG); request further donor support for long-term advisors in public financial management, tax collection, and statistical capacity.

### Staff appraisal — key recommendations and priorities
- Build on measures to bring the budget under control: TMTS cost reductions and approval of no new scholarships are commendable.
- Fiscal position improvements due to: steps taken, improved private sector tax compliance, and a large one-off Australian grant.
- Budget support next year will be tied to implementing the PRM.
- Key policy priorities:
  - Raise VAT rates and, crucially, raise VAT compliance among PEs (currently none pay VAT).
  - Enforce penalties for noncompliance on direct taxes, including nonfinancial penalties.
  - Continue returning TMTS referrals to a committee of doctors to control costs.
  - Coordinate with donors to ensure scholarships remain sustainable and bring PE subsidies transparently on budget.
  - Tie public wage increases more closely to inflation.
  - Sign new JVs only after verifying that any borrowing does not endanger concessional assistance from donors.

*TUVALU 2012 ARTICLE IV REPORT*

### 26. Going forward, expenditure should be reoriented toward supporting social goals and

### _cr12259 - 26. Going forward, expenditure should be reoriented toward supporting social goals and

### Expenditure reorientation and social goals
- PRM focus: primary education and streamlining health expenditure.
- Recommendations to improve labor outcomes:
  - More support for training, particularly for women and in nontraditional areas.
  - Determine priority areas for scholarships to improve Tuvalu’s ability to send productive workers abroad.
  - Take more advantage of seasonal labor schemes in Australia and New Zealand.
- Capital expenditure guidance:
  - Cuts to capital expenditure should not postpone needed infrastructure improvements.
  - Outer Islands projects should be clearly prioritized and financed by the FTF’s unspent balances rather than relatively scarce government resources.

### External position, buffers, and asset management
- Currency regime: Given labor, donor and trade flows, the use of the Australian dollar remains appropriate.
- Buffer rebuilding: Buffers should be rebuilt to restore resilience.
- Fiscal and labor adjustments to improve external sustainability:
  - Smaller budget deficits will allow the government’s assets to be rebuilt.
  - Better training and more opportunities for Tuvaluan workers in New Zealand and increasingly in Australia will help cushion the blow of declining seafarer demand.
- Fund management:
  - Implement the new objective-based asset allocation of the TTF with a strong bias toward protecting Tuvalu’s asset holdings, both of the TTF and the TNPF, from risky conditions in global financial markets.

### Policy Reform Matrix (PRM) — objectives and fiscal implications
- PRM aims to strengthen the policy framework and coordinate budget support with donor assistance.
- Overriding goal: Fiscal sustainability.
- Fiscal rules and targets:
  - Keeping the deficit below 10 percent of GDP will return the CIF to a sustainable level.
  - Community Service Obligations (CSOs) would be contained below 5 percent of GDP.
- Key measures:
  - Tie wages more closely to inflation.
  - Reduce travel costs and nonpriority transfers and subsidies.
  - Priority health and education spending would rise.
  - Higher VAT rates and better enforcement.
- Without PRM implementation:
  - Revenues would stall at around A$24 million.
  - Recurring grants at around A$4½ million.
  - Additional World Bank financing of around A$1¾ million.
  - Expenditure expected at around A$33 million would force cuts or exhaust the CIF.
- With PRM implementation:
  - A better business climate and additional capital spending could raise growth by around ½ - ¾ percent of GDP.
  - Donor commitments from the ADB, Australia, and New Zealand would rise from A$4.5 million to A$9 million.
  - Full implementation would allow higher and more focused public spending, rising to around A$40 million by 2017.

### Public enterprise (PE) reform and fiscal flows
- Addressing tax arrears and poor customer payment culture is especially challenging in small countries.
- Improved accounting procedures should help determine net positions of unpaid government supplier payments to PEs and PE tax arrears.
- Long-run priority: Ensure both parties make all payments on time and transparently.
- Commercialization outcomes:
  - Effort to commercialize PE operations is paying off with improved risk management at the NBT and higher utilities collections.
  - Over time, increased flow of dividends to the government will ease fiscal pressures and free capital for lending.

### Financial sector progress and recommendations
- Recent progress:
  - Improved focus on credit quality and financial position of the DBT and NBT.
  - The DBT has begun to clean its balance sheets by writing down uncollectible loans.
  - NBT should begin similar write-downs as risk monitoring capabilities improve.
- TNPF recommendations:
  - Seek actuarial viability assessment.
  - Amend the law to encourage retirees to take annuities rather than lump-sum withdrawals.
- Banking market structure and rates:
  - As DBT and NBT return to health, they should gradually be allowed to set their own rates, at least in areas where they are effectively in competition (e.g., lending to businesses).
- PE governance:
  - Install a new and fully professional board at the electric company to ensure company independence and signal seriousness about improved PE management.

### Government intervention and market signals
- Recommendation: Reduce government intervention in the economy as DBT and NBT return to health.
- Allow greater autonomy in rate setting for banks where competition exists.

### Data, surveillance, and Article IV cycle
- Data shortcomings hinder surveillance, particularly in the national accounts and balance of payments.
- Additional resources needed to compile data necessary for surveillance and to support policymaking.
- Staff recommendation: Next Article IV consultation take place on a 24-month cycle.

### Exposure to global shocks (Box 2 summary)
- Economic characteristics:
  - Small, open economy; merchant ship work is traditionally the largest source of foreign exchange.
  - Nearly everything, including skilled services, is imported; fuel and food constitute about half of total goods imports.
- Pass-through and correlations:
  - Growth linked to Australian GDP (correlation of 0. 36) but not with New Zealand (-0.01).
  - IMF analytical work finds elasticity of Tuvaluan GDP growth to global growth of 0.5.
  - A 2012-13 shock to global growth of 1.5 percent emanating from the Euro Area would have a relatively strong but short-lived effect on Tuvalu.
  - A 50 percent rise in oil prices would affect Tuvalu similarly to the median Pacific Island country.
  - Correlation of domestic energy prices with global fuel prices is 0.36, reduced by government subsidies for inter-island freight.
- Policy trade-offs:
  - Price controls on staple foods dampen global food price shocks but drag on private retailers and the budget.

### Links to global financial markets (Box 3 summary)
- Major funds and exposures:
  - TTF (Tuvalu Trust Fund): jointly controlled with Australia and New Zealand; by far the largest foreign asset holding.
  - TNPF: invests social contributions from slightly more than half the country’s population.
  - FTF (Falekaupule Trust Fund): pool to finance investment projects in the Outer Islands.
  - All three funds are invested along TTF guidelines, exposing government, local governments, and retirement holdings to global market fluctuations.
- Procyclicality and disbursements:
  - TTF disburses only when market value of assets exceeds a long-run index, which tends to make government resources rise when market returns are high.
  - Authorities have sometimes recapitalized the TTF with unspent CIF funds even when times are good.
  - Discussions underway to make TTF disbursements more regular and reduce procyclicality.
- Banking exposures:
  - NBT is deposit-financed with stable funding costs and infrequent deposit rate changes.
  - DBT is partly capitalized by EIB credit lines, exposing it to exchange rate and funding cost risk.
  - NBT invests surplus cash in Australian time deposits; interest on these deposits now exceed half of GDP and are linked to Australian business cycles, raising the opportunity cost of NBT lending and increasing the bank’s profits and government dividends when the economy does well.

*Source: TUVALU 2012 ARTICLE IV REPORT, INTERNATIONAL MONETARY FUND*

### Box 4. Public Enterprises in Tuvalu

### Box 4. Public Enterprises in Tuvalu

### Financial and operational weaknesses of PEs
- Most public enterprises (PEs) are financially weak.
- Major impediments: low tariff structures, arrears on payments by the government, and structural inefficiencies, many aggravated by Tuvalu’s small size.
- Limited availability of experienced managers and boards chaired by civil servants hinder the prospects of PEs to operate on a commercial basis.
- PE losses strain government finances, lead to overdrafts at the NBT, and worsen the country’s business climate.

### Reform efforts and legal framework
- An ambitious reform plan was launched in 2008.
- A Public Enterprise Act (PEA) was passed in 2010 establishing a unit tasked with monitoring and managing the performance of all PEs.
- The act requires operation of PEs on a commercial basis and removal of civil servants from boards.
- The act aims to regularize government financial relations with PEs, which are undermined by disagreement over the net size of tax arrears and unpaid government bills.
- The government is obliged to compensate PEs on-budget for necessary but uneconomical services, such as provision of electricity and banking services to the Outer Islands, through allocations for Community Service Obligations (CSOs), which amounts are negotiated with the PEs.

### Implementation progress and setbacks
- The process has been slow and success has been mixed.
- Beyond the NBT and TEC, prospects for profitability are poor without improved management.
- When profitable, few PEs pay corporate income tax, none pay VAT, and some do not make social contribution payments for employees.
- In 2011, the independent board of TEC was suspended following a billing dispute, reversing one of the PEA’s main successes.
- CSOs were dropped from the 2012 budget.

### Positive steps under consideration or undertaken
- TTC and TEC tariffs were reviewed in 2010.
- The government is considering privatization of the Vaiaku Lagi Hotel.
- Government departments responsible for public works such as roads and ports are being considered for corporatization.

*Source: _cr12259 - Box 4. Public Enterprises in Tuvalu*

### APPENDIX I. TUVALU – EXCHANGE RATE ASSESSMENT

### APPENDIX I. TUVALU – EXCHANGE RATE ASSESSMENT

### REER developments and trend
- Tuvalu’s real effective exchange rate (REER) is high relative to historical levels.
- After sustained increases during the 2000s, the REER dipped in 2008, but has now recovered strongly.
- The upward trend is pronounced over time, though short-term factors accelerated appreciation in the runup to the global financial crisis and afterward.
- Cyclical factors have now dissipated, but the REER has continued to appreciate since the crisis.
- Figure note: REER decomposition shows trend and cyclical components (1/ Based on Hodrick-Prescott Filter).

### Drivers of appreciation
- The main reason for the appreciation is the strengthening Australian dollar, not rising wages in Tuvalu.
- Tuvaluan inflation has been below trading partner inflation since mid-2009, mitigating nominal Australian dollar strength.
- Contributing one-off factors to low measured domestic inflation:
  - A shift toward cheaper Asian import sourcing.
  - A recent increase in domestic retail competition.
- Public employees—who constitute slightly less than a tenth of the population—generally receive annual real salary increases of around 1½ percent, adding to domestic demand.

### Effects on external position and adjustment mechanisms
- Real appreciation has likely affected Tuvalu’s external position.
- With a minimal tradables sector and capital markets, external adjustment occurs through labor mobility:
  - Higher domestic wages reduce emigration and raise imports.
  - Lower wages raise emigration and remittances.
- Since 2002, the ratio of imports to remittances has risen, implying less emigration.
- Reserves coverage remains below pre-crisis levels.
- Figure notes:
  - Ratio of International Reserves to Next Year Imports of Goods and Services (months).
  - Ratio of Imports to Transfers (1/ Ratio of imports of goods to private transfers and remitted compensation).

### Risks to sustainability and data limitations
- Continued real appreciation could challenge external sustainability.
- Tuvalu does not publish sufficient data for CGER analysis.
- Tuvalu’s terms of trade have not improved to the extent Australia’s have, and nominal appreciation has expanded imports.
- Damage has so far been contained, but continued appreciation could lead to falling public and private asset balances, and concerns about sustainability.

*Source: APPENDIX I. TUVALU – EXCHANGE RATE ASSESSMENT (2012) — IMF staff report content as provided.*

### ANNEX V. TUVALU: STATISTICAL ISSUES

### ANNEX V. TUVALU: STATISTICAL ISSUES

### I. Assessment of Data Adequacy for Surveillance
- General: Data have shortcomings that hamper surveillance. Shortcomings are most serious in the national accounts and balance of payments. The Pacific Financial Technical Assistance Centre (PFTAC) has provided technical assistance to the Central Statistics Division (CSD) of the Ministry of Finance to help start compiling those statistics for surveillance and the authorities’ own policy analysis and formulation. The CSD will require additional staff to improve data provisioning.
- National accounts:
  - With PFTAC assistance since 2009, the compilation methodology for the national accounts was improved.
  - Attention needs to be paid to improving source data for national accounts.
- Price statistics:
  - The consumer price index (CPI) is the only price index compiled in Tuvalu.
  - The CSD produces a quarterly CPI, which is timely and of reasonable quality.
  - The CPI weights were revised in 2011, based on the 2010 Household Income and Expenditure Survey.
- Government finance statistics:
  - The MOF compiles the central government data for budget analysis and control.
  - Classifications of some accounts, particularly on capital spending, need to be improved to be in line with international standards.
- Monetary and financial statistics:
  - Tuvalu uses the Australian dollar as its legal tender and does not have a central bank.
  - Monetary and financial statistics are currently not produced in Tuvalu.
  - The National Bank of Tuvalu and the Development Bank of Tuvalu provided the Article IV mission with their balance sheets and income statements, which were used to produce the monetary data on the two banks.
- Balance of payments:
  - Balance of payments statistics have been compiled by visiting PFTAC experts.
  - PFTAC is assisting the authorities in developing a balance of payments compilation system to enable CSD staff to compile the balance of payments data.
  - Many of the underlying data have inconsistencies and errors, resulting in poor quality of the balance of payments statistics.
  - The CSD needs better trained staff to produce quality balance of payments statistics.

### II. Data Standards and Quality
- Tuvalu is not a General Data Dissemination System participant.
- No data ROSC are available.

### III. Reporting to STA
- No data are currently reported to STA for publication.

### Tuvalu: Table of Common Indicators Required for Surveillance (as of June 13, 2012) — key data status
- Exchange rates:
  - Date of Latest Observation: 6/13/12
  - Date Received: 6/13/12
  - Frequency of Data: D
  - Frequency of Reporting: NA
  - Frequency of Publication: NA
- International reserve assets and reserve liabilities of the monetary authorities:
  - Date of Latest Observation: 04/2012
  - Date Received: 05/2012
  - Frequency of Data: M
  - Frequency of Reporting: I
  - Frequency of Publication: NA
- Consolidated balance sheet of the banking system:
  - Date of Latest Observation: 04/2012
  - Date Received: 05/2012
  - Frequency of Data: M
  - Frequency of Reporting: I
  - Frequency of Publication: NA
- Interest rates:
  - Date of Latest Observation: 04/2012
  - Date Received: 05/2012
  - Frequency of Data: M
  - Frequency of Reporting: I
  - Frequency of Publication: NA
- Consumer price index:
  - Date of Latest Observation: 04/2012
  - Date Received: 05/2012
  - Frequency of Data: Q
  - Frequency of Reporting: Q
  - Frequency of Publication: Q
- Central government revenue, expenditure, balance and composition of financing:
  - Date of Latest Observation: 04/2012
  - Date Received: 05/2012
  - Frequency of Data: A
  - Frequency of Reporting: A
  - Frequency of Publication: A
- Stocks of central government and central government-guaranteed debt:
  - Date of Latest Observation: 12/2011
  - Date Received: 05/2012
  - Frequency of Data: A
  - Frequency of Reporting: A
  - Frequency of Publication: A
- External current account balance; Exports and imports of goods and services; GDP/GNP; Gross external debt; International investment position:
  - Latest observation dates and reception dates are generally 12/2011 and 05/2012 with annual frequency for most indicators; publication frequency varies and is often NA.

### Debt Sustainability Analysis — key findings and projections
- Joint IMF/World Bank DSA conclusion:
  - Tuvalu is at high risk of debt distress.
  - Under baseline assumptions debt ratios are broadly stable in the long run, but are sensitive to changes in underlying assumptions.
  - Ensuring debt risks remain contained while the country’s development needs are addressed will require donors to continue to provide assistance only in the form of grants.
- Background:
  - This is the first Joint IMF/World Bank DSA for Tuvalu. Tuvalu joined the Bank and Fund in 2010.
  - The analysis is based on data available to Bank and Fund staff as of June 2012.
  - Tuvalu’s GDP in 2011 was only US$36 million.
  - The Tuvalu Trust Fund (TTF) by end-March 2012 had grown to 345 percent of GDP (A$122.9 million).
  - As of mid-2012, the TTF remains around 3.6 percent below its maintained value, and the Consolidated Investment Fund (CIF) holds A$6.1 million, including a A$4.0 million injection from Australia in 2012.
  - Tuvalu’s public and publicly guaranteed (PPG) debt stock was A$17.3 million (50 percent of GDP) at end-2011. External PPG debt was A$14.9 million (36.7 percent of GDP in PV terms) at end-2011.
  - Loans contracted at market rates by joint ventures (JVs) signed in 2008 and 2010 constitute a possible substantial contingent liability; Tuvalu’s share of the JV debts amounts to 28 percent of GDP.
- Macroeconomic framework and assumptions:
  - Growth is estimated to average 1.2 percent throughout the scenario.
  - Fiscal assumptions:
    - Recurrent grants are expected to average 14 percent of GDP over the medium and long term.
    - The DSA assumes term IDA borrowing of A$1¾ million annually as the only new stream of borrowing.
  - Expenditure path:
    - Expenditure is projected to fall by 13 percent of GDP to around 80 percent of GDP in the next few years, bringing the deficit to around A$3½ million (around 10 percent of GDP).
    - Beginning around 2016, expenditure will rise modestly to around 85 percent of GDP.
  - Current account:
    - Projected to settle at around a 4 percent surplus, slightly above its eleven-year average of 2 percent.
  - TTF nominal returns in the scenario: 7 percent.
- External debt analysis:
  - External debt breaches stock thresholds under the baseline scenario.
  - The PV of public sector external debt closes the simulation at 36 percent of GDP under baseline assumptions.
  - A one-time 30 percent nominal depreciation raises this PV/GDP ratio to 51 percent.
  - Under a historical scenario with persistent weak current account and financing shortages, stock ratios rise throughout the simulation period, with the PV of public external debt reaching 108 percent of GDP around 2027.
- Public debt analysis:
  - Public debt ratios are relatively stable under the baseline as concessional lending comes online.
  - Under the baseline the PV of public debt in 2032 reaches only 38 percent of GDP.
  - A scenario with permanently lower GDP growth pushes the PV of public debt to 113 percent of GDP by 2032.
  - Debt service indicators are less affected in some scenarios because all long-run debt is on IDA terms.
- Risks to the baseline:
  - Downside risks predominate: a slowdown in global growth, a sudden financing stop, weak tax revenue performance, a decline in fishing or telecommunications licensing proceeds, or continued low demand for seafarers.
  - Debt burden is particularly sensitive to growth and exchange rate assumptions.

*Source: ANNEX V. TUVALU: STATISTICAL ISSUES (as of June 13, 2012) and accompanying 2012 Article IV Report—Debt Sustainability Analysis.*

### 15. The authorities have presented to donors a Policy Reform Matrix (PRM) which aims,

### Policy Reform Matrix (PRM) — presentation and aims

### PRM objectives and intended role
- The authorities have presented to donors a Policy Reform Matrix (PRM) which aims, inter alia, at strengthening macroeconomic management.
- The PRM is intended to be a reform roadmap as well as a streamlined list of potential triggers for budget support disbursements by donors.
- Its main targets in the areas of macroeconomic management are:
  - better tax compliance,
  - reorientation of expenditure toward priority areas in health and education,
  - improving the business environment to strengthen growth.

### Macroeconomic effects under full implementation
- IMF staff estimates that full implementation would raise growth and investment in Tuvalu modestly, while allowing for some expansion of spending as the fiscal envelope is widened by better tax collection and additional donor support.
- Overall, the deficit is contained below 15 percent of GDP.
- The current account surplus stabilizes at around 6 percent of GDP.
- Significantly, neither under the baseline nor under the alternative scenario is there any borrowing beyond new IDA disbursements, as there are no additional prospective lenders.

### Fiscal space and financing
- Expansion of spending is possible as the fiscal envelope is widened by better tax collection and additional donor support.
- No additional prospective lenders are assumed beyond new IDA disbursements.

---

### Debt dynamics and sustainability

### Debt dynamics under the reform scenario
- Debt dynamics under the reform scenario are somewhat more benign.
- Faster GDP growth would bring the ratio of the PV of external public debt to GDP below sustainability thresholds and keep it on a gradual downward trend; the relationship with exports is similar.
- Debt service ratios display similar dynamics to the baseline, but levels are lower.
- Public debt, which remained almost stable under the baseline, displays a gradual downward trend under the reform scenario.

### Conclusions on sustainability
- Tuvalu’s weak capacity to service debt means renewed loan disbursements are unlikely to lead to a sustainable outcome.
- Even when the only new disbursements are those provided by the development partners on IDA terms, indicators of public and publicly guaranteed external debt stocks remain well above indicative thresholds, indicating high levels of debt distress.
- Tuvalu’s revenue base (including licensing income) is relatively high, but its small export base and GDP mean that even small disbursements result in a long-term reduction in sustainability.
- While stock indicators do not rise strongly under the baseline scenario, Tuvalu’s current fiscal situation is unsustainable, and maintaining its current level of debt service is unlikely to improve it even as it is able later in the simulation period to take advantage of its external asset holdings.
- Implementation of the PRM would bring debt sustainability somewhat closer.
- While debt ratios remain fragile even under the PRM scenario, a stronger fiscal position and modestly faster GDP growth would make the current debt position more sustainable, and improve debt dynamics.

*TUVALU 2012 ARTICLE IV REPORT—DEBT SUSTAINABILITY ANALYSIS*

### 19. Moreover, the most damaging risks – a slowdown in GDP and a nominal depreciation–

### _cr12259 - 19. Moreover, the most damaging risks – a slowdown in GDP and a nominal depreciation–

### Major risks and vulnerabilities
- “The most damaging risks – a slowdown in GDP and a nominal depreciation– are not low-probability events.”
- GDP growth in Tuvalu is “highly volatile and may not return to historical levels without a significant effort to improve macroeconomic management, the business climate and human capital.”
- A return of the Australian dollar to levels seen only eight years ago “would cause a dangerous increase in Tuvalu’s debt ratios.”
- Specific channels of vulnerability:
  - Falling numbers of Tuvaluan seafarers and corresponding drop in remittances hurt household incomes.
  - Strong Australian dollar increases imports and can negate revenue gains from licensing and joint ventures.
  - A rapid weakening of the Australian dollar would raise prices of imported goods quickly, hurting households.
  - Exposure to global financial environment: reversal in Tuvalu Trust Fund (TTF) performance could deprive government support.

### Executive Board assessment — policy recommendations and priorities
- Re-build fiscal buffers and accelerate structural reforms to boost medium-term growth prospects.
- Continue fiscal consolidation within a multi-year budget framework.
  - Supported an increase in the value-added tax next year.
  - Stress importance of improving tax compliance.
  - Reduce subsidies and contain non-essential spending without compromising development goals.
- Ensure the new investment strategy of the Tuvalu Trust Fund does not add undue risk.
- Adopt and implement the Policy Reform Matrix focused on governance, social programs, and macroeconomic stability.
- Increase private sector participation and accelerate reforms to operate public enterprises on commercial terms.
- Implement policies to improve labor skills and expand seasonal employment overseas.
- Improve banking sector credit quality; address high level of non-performing loans.
- Improve the availability and quality of economic statistics; continue IMF technical assistance.

### Debt sustainability findings and projections (selected figures preserved exactly as in source)
- External debt (nominal) / o/w public and publicly guaranteed (PPG): 53.0 49.1 41.7 36.1 35.8 36.1 36.8 38.5 40.7 49.7 63.2 (tabulated series).
- Change in external debt (selected entries): 4.7 -3.9 -7.5 -5.6 -0.3 0.3 0.8 1.7 2.2 2.3 0.2.
- Identified net debt-creating flows (selected entries): -21.4 -3.8 23.7 8.1 2.9 -2.3 -4.6 -4.7 -4.6 -4.8 -5.2.
- Non-interest current account deficit (selected entries): -29.4 2.7 27.7 -14.8 18.7 7.2 2.2 -2.9 -5.1 -5.0 -4.9 -4.6 -4.7 -4.7.
- Net current transfers (negative = inflow) (selected entries): -57.1 -53.9 -56.0 -45.1 8.0 -32.6 -31.7 -33.7 -35.6 -35.6 -35.6 -35.6 -35.6 -35.6.
- Endogenous debt dynamics (selected entries): 8.0 -6.5 -4.0 0.8 0.7 0.6 0.4 0.3 0.2 -0.1 -0.4.
  - Contribution from nominal interest rate (selected entries): 2.0 1.0 1.4 1.3 1.2 1.0 0.9 0.7 0.6 0.4 0.5.
  - Contribution from real GDP growth (selected entries): 0.9 1.3 -0.5 -0.5 -0.5 -0.4 -0.4 -0.4 -0.4 -0.5 -0.9.
  - Contribution from price and exchange rate changes (note): “5.0 -8.8 -4.9 ........................” (table signal of high volatility of the AUD).
- PV of external debt (selected entries): ......36.7 31.4 29.1 27.4 25.9 25.2 25.4 26.8 35.6.
  - In percent of exports (selected entries): ......316.9 269.6 249.8 235.2 223.0 216.9 218.7 230.8 306.4.
  - In percent of government revenues (selected entries): ......65.3 52.6 48.8 45.9 43.5 44.8 45.1 47.6 63.2.
- Debt service-to-exports ratio (in percent) (selected entries): -15.2 79.9 75.7 49.9 45.3 40.1 39.2 33.7 22.7 11.3 14.3.
- Total gross financing need (Millions of U.S. dollars) (selected entries): -8.5 3.9 13.1 4.8 2.7 0.7 -0.2 -0.4 -0.8 -1.5 -1.8.
- Non-interest current account deficit that stabilizes debt ratio (selected entries): -34.1 6.5 35.2 12.9 2.5 -3.2 -5.9 -6.6 -7.1 -7.0 -4.9.
- Key macroeconomic assumptions (selected series):
  - Real GDP growth (in percent): -1.7 -2.9 1.1 1.2 4.5 1.2 1.3 1.2 1.2 1.2 1.0 1.2 1.2 1.5 1.3.
  - GDP deflator in US dollar terms (change in percent): -9.4 19.9 11.1 9.6 9.7 0.5 -0.7 -0.9 -0.8 -0.6 1.5 -0.1 1.7 1.7 1.7.
  - Effective interest rate (percent): 3.7 2.1 3.2 2.6 0.8 3.2 3.2 2.8 2.4 2.0 1.6 2.6 0.9 0.8 0.9.
  - Growth of exports of G&S (US dollar terms, in percent): -16.8 30.8 8.8 13.7 16.4 2.1 0.6 0.3 0.4 0.6 2.5 1.1 2.9 3.2 3.0.
  - Growth of imports of G&S (US dollar terms, in percent): -21.7 27.1 29.2 10.3 25.1 -18.6 -4.2 -2.2 0.2 0.6 2.5 -3.6 2.9 3.2 3.0.
- Grant element of new public sector borrowing (in percent): 52.3 repeated for projection years.
- Government revenues (excluding grants, in percent of GDP) (selected entries): 59.6 52.0 56.2 59.6 59.6 59.6 59.6 56.4 56.4 56.4 56.4 56.4.
- Aid flows (Millions of US dollars) (selected entries): 8.4 7.0 13.7 8.9 6.0 5.9 6.0 6.1 6.1 6.9 12.0.
  - o/w Grants (selected entries): 8.4 7.0 13.7 8.9 4.5 4.4 4.3 4.1 4.1 4.9 10.0.
  - o/w Concessional loans (selected entries): 0.0 0.0 0.0 0.0 1.5 1.5 1.7 2.0 2.0 2.0 2.0.
- Grant-equivalent financing (in percent of GDP) (selected entries): .........24.5 14.4 14.1 14.1 13.9 13.6 13.6 18.7 16.3.
- Memorandum items:
  - Nominal GDP (Millions of US dollars) (selected entries): 27.4 31.9 35.8 36.5 36.7 36.8 36.9 37.2 38.1 43.7 59.0.
  - Nominal dollar GDP growth (selected entries): -11.0 16.4 12.3 1.8 0.6 0.3 0.4 0.6 2.5 1.0 2.9 3.2 3.0.
  - PV of PPG external debt (in Millions of US dollars) (selected entries): 12.9 11.3 10.5 10.0 9.5 9.4 9.7 11.7 21.0.
  - Gross workers' remittances (Millions of US dollars) (selected entries): 4.1 3.1 3.4 4.0 4.1 4.1 4.2 4.2 4.3 4.9 6.7.
  - PV of PPG external debt (in percent of GDP + remittances) (selected entries): ......33.5 28.2 26.1 24.6 23.3 22.7 22.8 24.1 32.0.
  - PV of PPG external debt (in percent of exports + remittances) (selected entries): ......173.6 138.2 127.6 119.7 113.1 110.0 110.8 117.0 155.3.
  - Debt service of PPG external debt (in percent of exports + remittances) (selected entries): ......41.5 25.6 23.6 20.4 19.9 17.1 11.5 5.7 7.3.

### Baseline macro and fiscal outcomes (selected summary indicators)
- Real GDP growth (percent): 7.6 (2008), -1.7 (2009), -2.9 (2010), 1.1 (2011), 1.2 (2012 Proj.), 1.3 (2013 Proj.).
- Consumer prices (period average): 10.4 (2008), -0.3 (2009), -1.9 (2010), 0.5 (2011), 2.6 (2012 Proj.), 2.7 (2013 Proj.).
- Revenue (In percent of GDP): 72.4 (2008), 90.2 (2009), 74.0 (2010), 94.5 (2011), 84.1 (2012 Proj.), 71.9 (2013 Proj.).
  - of which Taxes (percent of GDP): 16.8 16.2 16.2 18.9 19.3 19.3.
  - of which Grants (percent of GDP): 17.1 30.6 22.1 38.2 24.5 12.3.
- Total Expenditure (percent of GDP): 75.9 93.3 104.1 93.3 79.8 82.0.
- Net Lending/Borrowing (percent of GDP): -0.7 -3.1 -30.0 1.1 4.2 -10.1.
- Tuvalu Trust Fund (TTF) (index or level series in table): 262.8 275.8 310.0 331.7 354.7 364.0 (selected entries).
- Consolidated Investment Fund (CIF) (selected entries): 34.1 44.2 20.8 9.0 11.2 5.6.
- Current account balance (In percent of GDP): -13.2 27.8 -3.8 -29.2 -8.5 -3.3 (selected entries reflect table formatting).
- Trade balance (In percent of GDP): -18.3 -16.0 -18.6 -19.5 -18.0 -16.5.
- Gross official reserves (months of imports) (selected entries): 30.0 29.9 26.0 23.9 23.1 23.8.
- Gross external public debt (In percent of GDP): 48.3 53.0 49.1 41.7 36.1 35.8.
- Debt service (In percent of exports of goods and services): 21.4 15.4 11.2 10.7 14.5 15.1.
- Exchange rate (Australian dollars per U.S. dollar, period average) (selected entries): 1.2 1.3 1.1 1.0 0.9 0.9.
  - End-period: 1.5 1.1 1.0 1.0 0.9 0.9.

### Scenario and sensitivity analysis — stress tests (high-level outcomes)
- Alternative scenarios and bound tests show wide dispersion in debt indicators under shocks:
  - PV of debt-to-GDP ratio and PV of debt-to-exports ratio rise substantially under various shocks (tables and figures report numerous scenario-specific series).
  - B6: “One-time 30 percent nominal depreciation relative to the baseline in 2013” produces large increases in PV and debt-service indicators (table entries such as 314139373636 and corresponding projected impacts).
- The most extreme stress test in several figures corresponds to a Terms shock; one-time depreciation shocks are also among the most extreme for certain indicators.

### Implementation priorities implied by the analysis
- Strengthen macroeconomic management to reduce GDP volatility.
- Improve tax compliance and revenue mobilization to reduce reliance on grants and volatile receipts.
- Rebuild buffers (CIF) and protect prudent management of the Tuvalu Trust Fund.
- Limit exposure to exchange-rate-induced debt deterioration by stress-testing strategy against AUD movements.
- Deepen structural reforms to boost private-sector participation, improve public enterprise performance, and enhance labor skill development and seasonal employment opportunities.

*Source: 2012 Article IV Report — Debt Sustainability Analysis, Tuvalu; IMF staff report, Executive Board assessment, and tables and figures contained therein.*

### 1. Macroeconomic conditions

### 1. Macroeconomic conditions

### Transmission and immediate impacts
- The global financial crisis spilled over into Tuvalu as slower economic activity and trade in goods translated into less demand for Tuvaluan seafarers.
- The associated slowdown in remittances and economic activity resulted in a worsening fiscal position which is now being addressed by the austerity actions of the incumbent authorities.
- Financial contagion manifested itself through the adverse impact on the principal and income from the sovereign wealth fund and is forcing the authorities to forego much needed investment in human capital and social projects.
- Exchange rate appreciation has allowed inflation to remain low and steady but has also eroded the local currency value of US dollar denominated receipts from the sale of fishing rights and remittances.
- There is little capacity for Tuvalu to build policy buffers to absorb future economic shocks given the extremity of its economic situation on a number of measures.
- In the foreseeable future the country is likely to remain almost completely reliant on support from the international community and its major donors for funds to respond to either real (including environmental), or financial shocks.

### 2. Monetary and exchange rate policy

### Arrangement and constraints
- Tuvalu uses the Australian dollar as legal tender and has no central bank.
- As a result, it has no independent monetary policy flexibility, no exchange rate flexibility separate from the Australian dollar, and domestic interest rates are set based on social and development objectives by the only two banks that operate in Tuvalu. Both of these banks are government-owned.
- Scope to absorb external shocks or decouple from developments in Australia are therefore limited on the monetary side.

### Effects of Australian developments
- Australia’s terms of trade rose to 140 year highs, leading to significant exchange rate appreciation.
- While imports have become significantly cheaper, the local currency value of US dollar-denominated remittances from seafarers and proceeds from fishing licenses is commensurately lower.
- The recent strength in the exchange rate has helped keep inflation low but this positive influence could reverse quickly if the outlook for commodity prices were to deteriorate substantially.
- The fall in the price of imports has translated into a widening of the current account deficit and the associated depletion of foreign currency assets.

### Policy judgment
- Despite disadvantages, the use of the Australian dollar remains the most appropriate exchange rate arrangement given extremely small scale across all aspects, prohibitive cost of establishing a modern banking system, financial markets, a central bank, or an independent currency.
- Dollarization is assessed as the least-cost option given Australia’s role in the region, its leading role as a donor, and the lack of viable alternatives.

### 3. Fiscal policy

### Reliance on fiscal instruments and fund status
- Macroeconomic management and the absorption of shocks therefore largely rely on fiscal policy.
- In 1988, donors capitalized an investment fund from which the income in excess of a stable real principal is used to supplement donor assistance to fund persistent budget deficits.
- Following a number of years of below-average returns and larger than usual deficits, these resources (over and above the principal) are almost exhausted.

### Policy priorities and constraints
- An important policy therefore involves broadening the tax base and improving compliance in order to finance spending on social projects.
- The progress made to consolidate in the most recent budget has been difficult and unpopular but clearly highlights the authorities’ commitment to setting the fiscal stance on a more sustainable footing.
- Budget support from Australia has also helped to alleviate the pressure.
- The high risk of debt distress is a particular concern considering the multifaceted vulnerabilities confronted by the country.
- Grants are the only viable form of financing projects at the current juncture, as even joint ventures with foreign private sector firms in fishing could quickly become unsustainable if financed at commercial loan rates.

### 4. Structural policies

### Development strategy and trade-offs
- The government has an explicitly formulated development strategy to address governance, social development, education, human resources, macroeconomic growth and stability, natural resources and infrastructure.
- The plan is a useful tool for coordinating prioritization of projects and engaging effectively with donors.
- Example trade-off: recent elimination of government-funded scholarships to address short-term budget pressures, at the longer-term cost to human capital development.

### Public sector footprint and reform scope
- The government’s involvement in the economy is extensive and the private sector remains small, accounting for only around ¼ of economic activity.
- Reform of public enterprises is recognized by authorities as an area where efficiency gains would be beneficial.
- Sound governance and professional, independent management of enterprises such as the electricity provider could limit leakage from the public balance sheet and reduce the need for cuts in important spending on social projects.
- Prospects for full commercialization of these enterprises are limited because almost all major service providers fulfill key social functions and are part of the policy mechanisms through which the government manages economic outcomes.

### Diversification of external income sources
- Diversifying sources of income for Tuvaluans working abroad is an important policy to absorb adverse shocks.
- Income from Tuvaluan seafarers on international vessels and proceeds from the maritime zone are major sources; the local currency value of US dollar‑denominated seafarer income has been negatively impacted by exchange rate appreciation and the slowdown in international shipping.
- Workers are increasingly taking seasonal harvesting work opportunities in New Zealand, and more recently Australia, helping to offset part of the decline in remittances from seafarers and expected to expand further.

### 5. Other issues

### Capacity constraints and statistics
- Capacity problems are a major issue across almost all aspects of the economy in a microstate such as Tuvalu.
- There is a need to improve the quality of statistics to better inform policy making.
- The authorities have ambitions to expand the statistics department by 30 percent (or one more person) to deliver better quality data, but the funds and skills are lacking.
- Currently, a single person compiles both the National Accounts and the Balance of Payments, while the other two people in the department compile the remaining statistics and deal with administration.
- PFTAC and the large donor countries have been important in assisting capacity building, but there is scope for further development.

### Public service delivery and fiscal containment
- The government faces major constraints in terms of economies of scale in provision of public goods and services across a very small population and limited tax base.
- Basic health services are provided domestically; most more complicated procedures are carried out in Fiji.
- Measures to contain costs include closer scrutiny of patient referrals abroad, reconsideration of patient accommodation while abroad, more restrictive entitlement for relatives to accompany patients, and patients bearing part of the costs incurred.
- These changes contribute to budget sustainability but also underscore complications of interpreting income per capita in an extremely small state.

### Income per capita and welfare interpretation
- Tuvalu’s income per capita is reported as US$4,760 because the total income numerator (from fishing licenses, remittances, and donor-provided wealth fund) is shared across a very small population denominator.
- Despite a relatively high income per capita, total income is small and it can be prohibitively expensive for the government to provide adequate health services domestically.
- Example: the return airfare from Funafuti to Suva alone is almost ¼ of the average Tuvaluan’s annual income.
- Assessment of welfare based on income per capita alone can be misleading, especially in countries where vulnerabilities are relatively pronounced.

*Source: _cr12259 - 1. Macroeconomic conditions*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12259.pdf_