## Box 1.  Solomon Islands: Reducing Pro-cyclical Bias in Fiscal Policy

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### I. Backdrop and outlook
- Macroeconomic recovery and program context
  - IMF-supported programs over the last two and a half years helped restore and strengthen macro and financial stability and trigger donor support.
- Growth and inflation
  - Real GDP growth: rebounded from the 2009 recession to achieve 8 percent in 2010 and nearly 11 percent in 2011; growth expected to slow to 5½ percent in 2012.
  - Drivers: mining (gold production in the first half of 2012 surpassed total output for all of 2011 by 50 percent) and services; logging contribution declined.
  - Inflation: surged to 11 percent (year-on-year) in October 2011; slowed to an annual rate of 4.3 percent in September 2012; projected to average about 5 percent in 2012 and reach 6¼ percent at yearend 2012, then fall to 4 percent over the medium term.
- External position and reserves
  - Export growth slowed to just 1 percent in September (three-month moving average, year-on-year), down from 14 percent average in Q2 2012.
  - Current account: shifted into a small surplus for late-2011/early-2012 from a deficit of 30 percent of GDP in 2010; more recent data point to a deterioration to a deficit of about 1½ percent of GDP, financed by FDI and capital transfers.
  - Gross international reserves: US$497 million as of September (about eight months of 2013 imports), up from US$412 million at end-2011 (7.4 months of next year’s imports) and from less than US$100 million in mid-2009.
  - Reserves leveled off in September relative to August because of weak export demand from Asia.
- Outlook and risks
  - Baseline: GDP growth projected to slow to 4 percent over the near and medium term; gold output and services remain main drivers; logging production declining over the medium term.
  - Infrastructure and events: rehabilitation of main roads in Honiara for the Festival of Pacific Arts and planned infrastructure investment should underpin growth.
  - Main near-term external risk: deeper and more protracted slowdown in global and regional economy, sharply reducing commodity and forestry exports; gold production and prices could mitigate declines.
- Downside scenario (staff analysis)
  - Assumes intensification of the euro area crisis lowering global growth by almost 2 percentage points in 2013 and 2014 relative to the WEO.
  - Impacts: contraction of FDI (projected at 25 percent lower relative to the baseline), lower demand for logging, deterioration in terms of trade, exports and FDI falling, rapid depletion of foreign reserves, prompting need for increased access of the ECF arrangement.
  - Scenario table excerpts (2012–2014; IMF staff estimates and projections):
    - Real GDP growth (in percent): Baseline 5.5; 2013 4.0; 2014 2.0; Downside 3.8; 2014 2.0.
    - Current account balance (in percent of GDP): -5.8; -10.6; -19.3; -8.7; -21.9.
    - Logging exports (in percent of GDP): 17.6; 15.9; 11.7; 13.9; 8.4.
    - Mining exports (in percent of GDP): 13.9; 15.5; 12.6; 14.8; 10.7.
    - Financing (in millions of U.S. dollars): -91.3; -28.0; 91.7; -30.8; 123.5.
    - Change in gross reserves (- = increase): -91.5; -28.4; 85.4; -29.6; 118.8.
    - IMF 1/: 0.2; 0.4; 6.3; -1.2; 4.7.
    - Gross official reserves (in millions of U.S. dollars): 503.8; 532.2; 384.0; 561.8; 265.2.
    - In months of next year's imports: 7.9; 8.6; 5.7; 8.7; 3.5.
    - Overall fiscal balance (in percent of GDP): -0.6; 1.2; -2.3; 0.9; -3.7.
  - Note: Baseline envisages disbursements under the low-access ECF in 2013–2014; downside reflects disbursements under ECF with augmented access.
- Authorities’ view
  - Authorities concurred with staff on the outlook and balance of risks; considered downside risks mainly external.

### II. Program performance
- Arrangement and targets
  - One-year SCF arrangement approved December 6, 2011.
  - Quantitative targets for net credit to the government (NCG), net international reserves (NIR), net domestic assets (NDA) of the central bank, and the cash balance for end-June 2012 were met with comfortable margins.
  - Cash balance reached SI$391 million—exceeding program target of SI$342 million.
  - Government consolidated account at the central bank: SI$140 million at end-June, in line with commitments.
  - End-September indicative targets met comfortably, although cash balance target missed by about SI$35 million.
- Structural benchmarks and reforms
  - Cabinet approved amendments to the Central Bank Act (end-March 2012 benchmark) and drafting instructions for the National Provident Fund Act (end-June 2012 benchmark).
  - Draft legislation and discussion papers of the new Public Finance Act finalized, published, and presented in a public workshop (end-September 2012 benchmark).
  - Tax reforms delayed due to resource constraints and need for wider stakeholder consultation.
- Authorities’ view
  - Authorities stressed importance of the SCF arrangement in preserving macro and financial stability and catalyzing donor support; noted deeper institutional weaknesses remain.

### III. Policy discussions — Rebuilding policy buffers and fostering broad-based growth
A. Fiscal policy — Background
- Fiscal weakening in 2012 driven by higher spending.
  - Structural-balance analysis suggests 2011 improvement overstated when using overall balance due to logging revenue cycle.
  - Through September 2012: revenues increased by 1 percentage point of GDP relative to same period in 2011, but recurrent and development spending increased by 4 percentage points of GDP.
  - Spending rise components: one-off Pacific Arts Festival (~2½ percent of GDP), investment in tertiary education abroad, increased constituency funds.
  - Constituency funds: increased to 4 percent of GDP in 2012 from 2 percent in 2010–11.
  - Cash balance fell to SI$337 million in September from SI$391 million in June.
  - Supplementary budget submitted in September envisages a deficit of about 3 percent of GDP.
- 2013 budget
  - To be unveiled end-November 2012; discussions suggest fiscal consolidation relative to 2012 planned despite increase in nominal basic public wages.

B. Fiscal policy — Staff views and recommendations
- Overarching objective
  - Continue building fiscal buffers in the near term while fostering inclusive growth over the medium term; re-establish fiscal discipline via a more conservative 2013 budget.
- Key staff recommendations
  - Preserve the cash balance
    - Maintain cash balance as fiscal anchor; staff recommended substantial tightening in last two months of 2012 to keep cash balance just above two months of recurrent spending.
    - Recommend slower implementation of supplementary budget spending.
    - For 2013: adopt more realistic revenue projections and contain spending (including constituency funds) to reach a cash balance target equivalent to two and a half months of recurrent spending.
  - Contain public expenditure and improve quality of spending
    - Contain expenditure for remainder of 2012 and in 2013; support planned nominal wage increases but streamline allowances and benefits including overtime.
    - Concerned about doubling of constituency funds in 2012 and lack of accountability; welcomed internal audits coordinated by Auditor General; stressed ex ante and ex post project evaluation.
    - Align pace of development spending with absorptive capacity.
    - Introduced indicative target for spending on health and education (no less than 32 percent of government-funded recurrent spending); end-June and September targets met.
    - Emphasized balance between tertiary and primary education spending given large increase in scholarships abroad.
  - Strengthen domestic revenue mobilization
    - Critical to undertake tax reform in mining sector given strong mining prospects; new mining legislation will allow government to receive a fair share of revenue.
    - Delays in cabinet approval of tax amendments; authorities plan cabinet approval of draft amendments by end-December.
    - Draft customs and excise bill with ADB and AusAID assistance; aim to release draft for public consultation by end-December 2012.
  - Enhance public financial management
    - New charts of accounts to be introduced in 2013 budget.
    - Submit draft Public Finance Act to cabinet by mid-November; Act to incorporate fiscal responsibility provisions and strengthen PFM and budget transparency.
  - Strengthen fiscal framework over medium term
    - Adopt multi-year budget framework; present forward estimates of revenue and recurrent expenditure in 2013 budget; forward estimates of development spending to be released by end-2013 for 2014 budget.
    - Staff view: cash balance appropriate fiscal anchor now; once multi-year framework complete, consider targeting the non-commodity fiscal balance rather than the cash balance to mitigate pro-cyclicality from volatile commodity revenues.
  - Enhance debt management capacity
    - New Debt Management Strategy (DMS) provides framework for future borrowing plans.
    - Resuming concessional borrowing important for investments (e.g., Tina River Power project; undersea fiber optic cable) but must be prudent.
    - Joint IMF-World Bank DSA: risk of debt distress remains moderate assuming borrowing plans of about 1½ percent of GDP annually.
    - Cautioned against increases in contingent liabilities associated with SOE debt; urged identification of outstanding SOE debt and caution in contracting borrowing on behalf of SOEs.
    - Emphasized capacity building in debt management, guidelines and procedures to strengthen project appraisal and evaluation.

### Authorities’ views (on policy discussions)
- Authorities concurred with staff on the outlook and balance of risks; considered the SCF arrangement instrumental in preserving macro and financial stability and in catalyzing donor support.
- Authorities recognized the need to address deeper institutional weaknesses over an extended period.

### Box 1 — Summary of findings and recommendations (reducing pro-cyclical bias)
- Main fiscal challenges: volatility of fiscal revenue and intergenerational equity in distribution of earnings from natural resources.
- Resource-related revenues account for 18 percent of total revenue, excluding grants.
- Logging stocks expected to be exhausted by the end of this decade.
- Exports of gold could decrease national wealth unless there is compensating accumulation of assets, physical or financial.
- Over the medium term, targeting a non-commodity balance could help address fiscal risks posed by volatile, unpredictable, and exhaustible commodity revenue.
- Examples cited: cyclically-adjusted structural balance rule as in Chile; non-commodity balance target rule as in Norway.
- Empirical observation: commodity exporters with a fiscal target responsive to commodity prices do not exhibit a pro-cyclical fiscal policy bias; real government expenditure has remained broadly stable as a share of GDP over the business cycle in those cases.
- Policy tools suggested:
  - Aim for a relatively smooth path of spending to avoid abrupt adjustments when resource revenues decline.
  - Establish “stabilization” funds to smooth government expenditure.
  - Establish “saving” funds to convert resource wealth into financial wealth.
- Staff analysis: adjusting for transitory or one-off fluctuations in commodity revenues (from logging and gold) provides a more accurate measurement of the underlying fiscal position than using the headline balance.

### Monetary and exchange rate policies — Background and staff views
- Monetary policy broadly appropriate; inflation pressures have eased.
- Reserve and liquidity developments
  - CBSI began mopping up excess liquidity in early 2011 via Bokolo bills; outstanding stock nearly doubled from SI$240 million in July to SI$404 million in October.
  - Net international reserves (NIR) reached US$478 million at end-September 2012.
  - Private credit growth moderated from 6½ percent during the first half of 2012 to 2 percent (year-on-year) in August.
- Exchange rate regime change
  - October move from a de facto peg to the U.S. dollar to a basket peg using weights of main currencies of external payments.
- Staff recommendations
  - Monetary stance appropriate but be prepared to tighten if domestic inflation pressures re-emerge.
  - Central bank should stand ready to tighten if risks of second-round effects from higher oil prices become high.
  - If downward risks materialize, manage the exchange rate flexibly to provide a buffer against external shocks.
  - CBSI draft bill (end-March 2012 benchmark) endorsed by cabinet in early July will strengthen operational autonomy and transparency of the central bank.

### Financial sector stability — status, risks, and supervisory agenda
- Banks sound and profitable but challenges persist.
  - CAR at more than 25 percent at the end of September—well above required minimum of 15 percent.
  - NPLs declined from 6.8 percent in June to 5½ percent in September.
  - Liquid asset ratio exceeded 60 percent at the end of September.
  - Return-on-asset ratio: 3½ percent in September.
  - Return-on-equity ratio: 19½ percent in September.
- Core Financial Soundness Indicators (selected series, 2009–2012)
  - Regulated capital to risk-weighted assets: 22.1, 22.7, 24.6, 28.5, 22.0, 25.1.
  - Tier 1 capital to risk-weighted assets: 15.7, 22.7, 24.6, 28.5, 22.0, 25.1.
  - Nonperforming loans, net of provisions to capital: 9.3, 15.0, 6.7, 6.0, 9.1, 7.1.
  - Nonperforming loans to total gross loans: 3.8, 7.9, 5.9, 5.9, 6.8, 5.4.
  - Return on average assets: 6.0, 4.9, 3.2, 2.8, 3.4, 3.5.
  - Return on average equity: 31.6, 26.3, 16.8, 14.7, 18.3, 19.4.
  - Net interest income to gross income: 52.6, 43.9, 45.7, 48.3, 45.0, 45.2.
  - Noninterest expenses to gross income: 37.5, 41.4, 48.2, 51.8, 46.7, 47.8.
  - Liquid assets to total assets: 33.4, 47.7, 56.0, 57.4, 59.9, 61.6.
  - Liquid assets to short-term liabilities: 67.4, 72.8, 85.9, 85.9, 84.2, 84.4.
- Staff recommendations and actions
  - Strengthen supervisory and regulatory framework; planned amendments to Financial Institution Act; IMF TA requested to revise the Act.
  - CBSI to strengthen supervisory capacity for on-site examinations and off-site monitoring and enforce corrective actions.
- Authorities’ concerns
  - High spread between lending and deposit rates and limited access to credit for private sector; plan to request TA to identify causes.

### Program discussions, successor arrangement, objectives, and conditionality
- Authorities committed to program quantitative targets and made progress on structural benchmarks.
- Staff and authorities agreed a three-year low-access ECF—equivalent to 10 percent of quota or SDR 1.04 million—is appropriate.
- Rationale for ECF
  - Need more time to tackle institutional weaknesses and capacity-building needs after 2½ years under SCF.
  - ECF will anchor fiscal plans, strengthen fiscal discipline, push structural reform agenda, and build institutions.
  - Protracted balance of payments problem and vulnerability to external shocks argue for ECF support.
- Monitoring and conditionality
  - ECF to be monitored through semi-annual reviews, quantitative targets, and structural benchmarks.
- Program objectives include
  - Support completion of politically difficult tax reforms, broaden tax base, enhance transparency of tax collection, and secure fair share from mining.
  - Push PFM reforms to promote fiscal transparency and institutional capacity.
  - Support private sector development by promoting financial inclusion and addressing access to financial services, especially rural areas.

### Financing outlook from development partners (as presented)
- Disbursements from most development partners depend on satisfactory program implementation.
- Expected large donor financing
  - Australia and New Zealand — about US$50 million in budget support for health and education in 2012 and US$40 million in 2013.
  - Asian Development Bank — more than US$38 million projected during 2013–16 for transport and ICT; of this US$38 million, US$18 million—US$7½ million in grants and US$10½ million in loans—is expected in 2013–14 for the undersea fiber optic cable.
  - World Bank — US$2 million in budget support approved in April 2012, and additional US$2 million Development Policy Grant in the pipeline for 2013.
  - European Union — US$1½ million disbursed in 2012 and a further US$1¾ million expected in 2013.

### Main risks to the ECF-supported program and capacity constraints
- Main risks
  - Political uncertainty and possible instability weakening program ownership.
  - Resource constraints in implementing structural benchmarks.
  - Inability to submit timely data for program monitoring.
- Capacity issues
  - Limited institutional capacity since phased withdrawal of RAMSI technical advisors.
- Mitigating factors
  - Success of previous and current programs indicates strong bipartisan program ownership.
  - Fund technical assistance effective in implementing current program.
  - Authorities committed to completing Safeguards Assessment update by first review under ECF.

*Source: IMF staff report content, "Box 1.  Solomon Islands: Reducing Pro-cyclical Bias in Fiscal Policy."*

### Box 1.  Solomon Islands: Reducing Pro-cyclical Bias in Fiscal Policy  ..................................10

### Box 1.  Solomon Islands: Reducing Pro-cyclical Bias in Fiscal Policy

### I. Backdrop and outlook
- Macroeconomic recovery and program context
  - IMF-supported programs over the last two and a half years helped restore and strengthen macro and financial stability and trigger donor support.
- Growth and inflation
  - Real GDP growth: rebounded from the 2009 recession to achieve 8 percent in 2010 and nearly 11 percent in 2011; growth expected to slow to 5½ percent in 2012 (Table 1).
  - Contribution to growth: driven by mining (gold production in the first half of 2012 surpassed total output for all of 2011 by 50 percent) and services; logging contribution declined relative to previous years.
  - Leading indicators suggest growth momentum weakened in the second half of 2012.
  - Inflation: surged to 11 percent (year-on-year) in October 2011; slowed to an annual rate of 4.3 percent in September 2012; projected to average about 5 percent in 2012 and reach 6¼ percent at yearend 2012, then fall to 4 percent over the medium term.
- External position and reserves
  - Export growth slowed to just 1 percent in September (three-month moving average, year-on-year), down from 14 percent average in Q2 2012.
  - Current account: shifted into a small surplus for late-2011/early-2012 from a deficit of 30 percent of GDP in 2010; more recent data point to a deterioration to a deficit of about 1½ percent of GDP, financed by FDI and capital transfers.
  - Gross international reserves: US$497 million as of September (about eight months of 2013 imports), up from US$412 million at end-2011 (7.4 months of next year’s imports) and from less than US$100 million in mid-2009 (Table 2).
  - Reserves leveled off in September relative to August because of weak export demand from Asia.
- Outlook and risks
  - Baseline projection: GDP growth projected to slow to 4 percent over the near and medium term; gold output and services remain main drivers; logging production declining over the medium term.
  - Infrastructure and events: rehabilitation of main roads in Honiara for the Festival of Pacific Arts and planned infrastructure investment should underpin growth.
  - Main near-term external risk: deeper and more protracted slowdown in global and regional economy, sharply reducing commodity and forestry exports; gold production and prices could mitigate declines.
- Downside scenario (staff analysis)
  - Assumes intensification of the euro area crisis lowering global growth by almost 2 percentage points in 2013 and 2014 relative to the WEO.
  - Impacts on Solomon Islands: contraction of FDI (projected at 25 percent lower relative to the baseline), lower demand for logging, deterioration in terms of trade, exports and FDI falling, rapid depletion of foreign reserves, prompting need for increased access of the ECF arrangement.
  - Scenario table excerpts (2012–2014; IMF staff estimates and projections):
    - Real GDP growth (in percent): Baseline 5.5; 2013 4.0; 2014 2.0; Downside 3.8; 2014 2.0 (table shows multiple columns—preserve as in source).
    - Current account balance (in percent of GDP): -5.8; -10.6; -19.3; -8.7; -21.9 (table format in source).
    - Logging exports (in percent of GDP): 17.6; 15.9; 11.7; 13.9; 8.4.
    - Mining exports (in percent of GDP): 13.9; 15.5; 12.6; 14.8; 10.7.
    - Financing (in millions of U.S. dollars): -91.3; -28.0; 91.7; -30.8; 123.5.
    - Change in gross reserves (- = increase): -91.5; -28.4; 85.4; -29.6; 118.8.
    - IMF 1/: 0.2; 0.4; 6.3; -1.2; 4.7.
    - Gross official reserves (in millions of U.S. dollars): 503.8; 532.2; 384.0; 561.8; 265.2.
    - in months of next year's imports: 7.9; 8.6; 5.7; 8.7; 3.5.
    - Overall fiscal balance (in percent of GDP): -0.6; 1.2; -2.3; 0.9; -3.7.
  - Note: In 2013 and 2014, the baseline envisages disbursements under the low-access ECF arrangement, while the downward scenario reflects disbursements under the ECF arrangement with augmented access.
- Authorities’ view
  - Authorities concurred with staff on the outlook and balance of risks; considered downside risks mainly external and were concerned about potential global deterioration.

### II. Program performance
- Arrangement and targets
  - One-year SCF arrangement approved December 6, 2011, replacing an expired SCF arrangement.
  - Quantitative targets for net credit to the government (NCG), net international reserves (NIR), net domestic assets (NDA) of the central bank, and the cash balance for end-June 2012 were met with comfortable margins (Table 1, MEFP).
  - Cash balance reached SI$391 million—exceeding program target of SI$342 million.
  - Government consolidated account at the central bank: SI$140 million at end-June, in line with program commitments.
  - End-September indicative targets met comfortably, although cash balance target missed by about SI$35 million.
- Structural benchmarks and reforms
  - Progress with some delays: cabinet approved amendments to the Central Bank Act (end-March 2012 benchmark) and drafting instructions for the National Provident Fund Act (end-June 2012 benchmark).
  - Draft legislation and discussion papers of the new Public Finance Act finalized, published on the treasury website, and presented in a public workshop (end-September 2012 benchmark).
  - Tax reforms delayed due to resource constraints and need for wider stakeholder consultation to build consensus and ownership.
- Authorities’ view
  - Authorities stressed importance of the SCF arrangement in preserving macro and financial stability and catalyzing donor support; noted program helped build stakeholder consensus but deeper institutional weaknesses remain.

### III. Policy discussions — Rebuilding policy buffers and fostering broad-based growth
A. Fiscal policy — Background
- Fiscal weakening in 2012 driven by higher spending (Table 3).
  - Structural-balance analysis suggests 2011 improvement overstated when using overall balance due to logging revenue cycle.
  - Through September 2012: revenues increased by 1 percentage point of GDP relative to same period in 2011, but recurrent and development spending increased by 4 percentage points of GDP relative to year-earlier period.
  - Spending rise components: one-off Pacific Arts Festival (~2½ percent of GDP), investment in tertiary education abroad, increased government-funded development spending allocated as “constituency funds.”
  - Constituency funds: increased to 4 percent of GDP in 2012 from 2 percent in 2010–11.
  - Cash balance fell to SI$337 million in September from SI$391 million in June.
  - Supplementary budget submitted in September envisages a deficit of about 3 percent of GDP.
- Fiscal trends and composition (figures summarized)
  - Fiscal balance, overall and structural: charts in source show revenue excluding grants, development expenditure (government funded), recurrent expenditure, development expenditure (loan funded), overall balance, noncommodity balance, and adjustments for logging revenue cycle.
  - Revenue composition: mining tax, logging tax, nonmining nonlogging tax, other revenue (in percent of GDP).
  - Expenditure composition: recurrent (grant funded), recurrent (government funded), development (grant funded), development (loan funded), development (government funded) (in percent of GDP).
- 2013 budget
  - To be unveiled end-November 2012; discussions with authorities suggest fiscal consolidation relative to 2012 is planned despite an increase in nominal basic public wages.

B. Fiscal policy — Staff views and recommendations
- Overarching objective
  - Continue building fiscal buffers in the near term to save for rainy days, while fostering inclusive growth over the medium term; re-establish fiscal discipline via a more conservative 2013 budget.
- Key staff recommendations (as communicated to authorities)
  - Preserve the cash balance
    - Cash balance as fiscal anchor helped strengthen the fiscal position and credibility.
    - Staff strongly recommended substantial tightening of fiscal stance during last two months of 2012 to maintain cash balance at just above two months of recurrent spending.
    - Recommended slower implementation of supplementary budget spending.
    - For 2013 budget: adopt more realistic revenue projections relative to 2012 budget and contain spending (including constituency funds) to reach a cash balance target equivalent to two and a half months of recurrent spending.
  - Contain public expenditure and improve quality of spending
    - Urged containment of expenditure for remainder of 2012 and in 2013.
    - Supported planned nominal wage increases in 2013 (given basic wages have declined in real terms over last twenty years) but recommended streamlining public-sector allowances and benefits—including overtime—since their share within wage bill has increased at expense of basic salaries.
    - Raised concerns about doubling of constituency funds in 2012 and lack of accountability; welcomed upcoming internal audits coordinated by Auditor General; stressed importance of ex ante evaluation of projects as well as ex post.
    - Advised aligning pace of development spending with absorptive capacity to avoid waste.
    - Noted positive steps: introduction of an indicative target for spending on health and education (no less than 32 percent of government-funded recurrent spending) and establishment of mechanism to track government-funded spending on health and education; end-June and September indicative targets on health and education were met comfortably.
    - Emphasized balance between tertiary and primary education spending given large increase in scholarships abroad.
  - Strengthen domestic revenue mobilization
    - Critical to undertake tax reform in mining sector given strong mining prospects.
    - New mining legislation will allow government to receive a fair share of revenue from mining.
    - Delays in cabinet approval of tax amendments related to new resource taxation regime (end-September 2012 benchmark); authorities plan to seek cabinet approval of draft amendments to relevant tax legislation by end-December (end-December benchmark).
    - New comprehensive draft bill on customs and excise being drafted with ADB assistance and co-financed by AusAID (end-October 2012 benchmark); given resource constraints, authorities aim for cabinet approval to release draft bill for public consultation by end-December 2012 (end-December 2012 benchmark).
  - Enhance public financial management
    - New charts of accounts to be introduced in 2013 budget to enhance transparency and accountability.
    - Authorities aim to submit draft Public Finance Act to cabinet by mid-November (mid-November 2012 benchmark); new Act will incorporate fiscal responsibility provisions and strengthen PFM and budget transparency.
  - Strengthen fiscal framework over medium term
    - Efforts to adopt multi-year budget framework under way to enhance fiscal discipline and align fiscal plans with national development strategy.
    - Forward estimates of revenue and recurrent expenditure to be presented in 2013 budget; forward estimates of development spending to be released by end-2013 for 2014 budget.
    - Staff view: cash balance remains appropriate fiscal anchor now; once multi-year budget framework is complete, authorities should consider targeting the non-commodity fiscal balance rather than the cash balance to mitigate pro-cyclicality from volatile commodity revenues and ensure sustainable use of exhaustible resources as mining taxes grow (Box 1 referenced).
  - Enhance debt management capacity
    - New Debt Management Strategy (DMS) provides appropriate framework for anchoring future borrowing plans.
    - Resuming concessional borrowing important to finance investments (e.g., Tina River Power project; undersea fiber optic internet cable project) but borrowing must be prudent to preserve external stability.
    - Joint IMF-World Bank debt sustainability analysis: risk of debt distress remains moderate assuming borrowing plans of about 1½ percent of GDP annually over medium and long term.
    - Cautioned against increases in contingent liabilities associated with SOE debt; praised guidelines for SOE borrowing; urged identification of outstanding SOE debt and extreme caution contracting borrowing on behalf of SOEs.
    - Emphasized capacity building in debt management, establishing guidelines and procedures to strengthen project appraisal and evaluation.

### Authorities’ views (on policy discussions)
- Authorities concurred with staff on the outlook and balance of risks; considered the SCF arrangement instrumental in preserving macro and financial stability and in catalyzing donor support.
- Authorities recognized the need to address deeper institutional weaknesses over an extended period.

*Source: IMF staff report content, "Box 1.  Solomon Islands: Reducing Pro-cyclical Bias in Fiscal Policy."*

### 13. The authorities remain committed to preserving the cash balance while providing

### _cr12333 - 13. The authorities remain committed to preserving the cash balance while providing

### Fiscal stance and 2013 budget
- Authorities remain committed to preserving the cash balance while providing adequate resources for spending critical to promoting higher and more inclusive growth.
- Agreed that the 2013 budget will need to be tighter than in 2012 to ensure fiscal sustainability.
- Emphasized that realistic fiscal revenues projections are essential for calibrating the expenditure envelope.
- Political pressure to spend will continue to build given large development needs; constituency funds are unlikely to return to their 2010–11 levels given the importance of public sector delivery in rural areas.
- Accountability system under development is viewed as necessary to avoid waste and enhance transparency in the use of public funds.
- Multi-year budget framework is expected to help contain spending pressure by better sequencing implementation of development projects.
- Authorities indicated that investing in infrastructure remains a key priority.

### Box 1 — Solomon Islands: Reducing Pro-Cyclical Bias in Fiscal Policy (summary of findings and recommendations)
- Main fiscal challenges: volatility of fiscal revenue and intergenerational equity in distribution of earnings from natural resources.
- Resource-related revenues account for 18 percent of total revenue, excluding grants.
- Logging stocks expected to be exhausted by the end of this decade.
- Exports of gold could decrease national wealth unless there is compensating accumulation of assets, physical or financial.
- Over the medium term, targeting a non-commodity balance could help address fiscal risks posed by volatile, unpredictable, and exhaustible commodity revenue.
- Examples cited: cyclically-adjusted structural balance rule as in Chile; non-commodity balance target rule as in Norway.
- Empirical observation: commodity exporters with a fiscal target responsive to commodity prices do not exhibit a pro-cyclical fiscal policy bias; real government expenditure has remained broadly stable as a share of GDP over the business cycle in those cases.
- Policy tools suggested:
  - Aim for a relatively smooth path of spending to avoid abrupt adjustments when resource revenues decline.
  - Establish “stabilization” funds to smooth government expenditure.
  - Establish “saving” funds to convert resource wealth into financial wealth.
- Staff analysis: adjusting for transitory or one-off fluctuations in commodity revenues (from logging and gold) provides a more accurate measurement of the underlying fiscal position than using the headline balance.

### Monetary and exchange rate policies — Background and staff views
- Monetary policy has been broadly appropriate and inflation pressures have eased.
- During 2010–11, rapid buildup of foreign exchange reserves led to fast growth in reserve money (Table 5).
- CBSI began mopping up excess liquidity in early 2011 via short-term Bokolo bills; outstanding stock nearly doubled from SI$240 million in July to SI$404 million in October.
- Net international reserves (NIR) reached US$478 million at the end of September 2012, fueled by donor inflows and FDI.
- Private credit growth moderated from 6½ percent during the first half of 2012 (boosted by the Pacific Arts Festival) to 2 percent (year-on-year) in August.
- Structural impediments to lending (e.g., problems in using land as collateral) constrain credit growth; growth in mining and forestry activities continued to be financed offshore through FDI.
- Authorities modified exchange rate regime in October: moved from a de facto peg to the U.S. dollar (in effect since 2002) to a basket peg using weights of main currencies of external payments—consistent with IMF technical assistance recommendations.
- Staff recommendations:
  - Monetary policy stance is appropriate, but be prepared to tighten if domestic inflation pressures re-emerge.
  - Inflation expected to pick up slightly toward end of the year reflecting pass-through of temporary higher international food and fuel prices.
  - Central bank should stand ready to tighten monetary policy if risks of second-round effects from higher oil prices become high or domestic price pressures re-emerge.
  - If downward risks materialize, manage the exchange rate flexibly to provide a buffer against external shocks.
- CBSI draft bill (end-March 2012 benchmark) endorsed by cabinet in early July will strengthen operational autonomy and transparency of the central bank, improving effectiveness of monetary transmission.

### Financial sector stability — status, risks, and supervisory agenda
- Banks are sound and profitable but challenges persist.
- Capitalization and asset quality:
  - Capital-to-risk-weighted-asset ratio (CAR) at more than 25 percent at the end of September—well above required minimum of 15 percent.
  - Nonperforming loans (NPLs) declined from 6.8 percent in June to 5½ percent in September.
- Liquidity and profitability:
  - Liquid asset ratio exceeded 60 percent at the end of September.
  - Return-on-asset ratio: 3½ percent in September.
  - Return-on-equity ratio: 19½ percent in September.
- Earnings composition and market structure:
  - Non-interest income, mainly from foreign exchange activities and other charges and fees, is a key source of bank profitability due to subdued credit growth.
  - Interest rate spread between deposit and lending rates is above the Pacific Islands average; private sector complaints about high charges and fees constitute a constraint to private sector development.
- Core Financial Soundness Indicators (selected series as presented):
  - Regulated capital to risk-weighted assets: 22.1, 22.7, 24.6, 28.5, 22.0, 25.1 (years shown across 2009–2012).
  - Tier 1 capital to risk-weighted assets: 15.7, 22.7, 24.6, 28.5, 22.0, 25.1.
  - Nonperforming loans, net of provisions to capital: 9.3, 15.0, 6.7, 6.0, 9.1, 7.1.
  - Nonperforming loans to total gross loans: 3.8, 7.9, 5.9, 5.9, 6.8, 5.4.
  - Return on average assets: 6.0, 4.9, 3.2, 2.8, 3.4, 3.5.
  - Return on average equity: 31.6, 26.3, 16.8, 14.7, 18.3, 19.4.
  - Net interest income to gross income: 52.6, 43.9, 45.7, 48.3, 45.0, 45.2.
  - Noninterest expenses to gross income: 37.5, 41.4, 48.2, 51.8, 46.7, 47.8.
  - Liquid assets to total assets (liquid asset ratio): 33.4, 47.7, 56.0, 57.4, 59.9, 61.6.
  - Liquid assets to short-term liabilities: 67.4, 72.8, 85.9, 85.9, 84.2, 84.4.
- Staff recommendations and actions:
  - Continue strengthening financial-sector supervisory and regulatory framework in line with program commitments.
  - Drafting instructions for the NPF Act endorsed by cabinet in July (end-June 2012 benchmark); planned amendments to the Financial Institution Act expected to strengthen regulatory framework.
  - Authorities have requested IMF technical assistance to revise the Financial Institution Act; assistance to be delivered early next year.
  - CBSI needs to continue strengthening supervisory capacity for on-site examinations and off-site monitoring and to enforce corrective actions when needed.
- Authorities’ concerns and planned follow-up:
  - Authorities expressed particular concern over high spread between lending and deposit rates and limited access to credit for the private sector.
  - They plan to request technical assistance to understand causes of high spreads and limited access.

### Program discussions, successor arrangement, objectives, and conditionality
- Authorities have remained committed to complying with program quantitative targets and have made meaningful progress in implementing structural benchmarks.
- Staff and authorities agreed that a three-year low-access Extended Credit Facility (ECF) arrangement—equivalent to 10 percent of quota or SDR 1.04 million—is the most appropriate modality of engagement.
- Rationale for ECF:
  - Need more time to tackle institutional weaknesses and capacity-building needs after 2½ years under the SCF-supported program.
  - ECF will help anchor fiscal plans, strengthen fiscal discipline, push structural reform agenda, and build institutions.
  - Presence of protracted balance of payments problem due to persistently high aid dependency argues for support under an ECF arrangement.
  - ECF viewed as critical given vulnerability to external shocks from an undiversified export base, strong dependence on aid, and frequent natural disasters.
- Monitoring and conditionality:
  - ECF-supported program described in the MEFP to be monitored through semi-annual reviews (Tables 6 and 7), quantitative targets (Table 1, MEFP), and structural benchmarks (Table 2, MEFP).
- Program objectives include:
  - Support completion of politically difficult tax reforms to broaden the tax base, enhance transparency of tax collection, and allow government to receive a fair share of revenue from the mining sector.
  - Push public financial management reforms to promote fiscal transparency and strengthen institutional capacity.
  - Support private sector development by promoting financial inclusion and addressing weaknesses in access to financial services, especially in rural areas—measures to include financial literacy training and financial education in schools.
- Alignment:
  - Authorities’ macroeconomic and reform program in the MEFP is aligned with the development strategy (matrix) under the Core Economic Working Group (CEWG)—a government-donor partnership.

### Financing outlook from development partners (as presented)
- Disbursements from most development partners depend on satisfactory implementation of the IMF-supported program.
- Expected large donor financing:
  - Australia and New Zealand — about US$50 million in budget support for health and education in 2012 and US$40 million in 2013.
  - Asian Development Bank — more than US$38 million projected during 2013–16 to finance infrastructure projects in transport and information and communication technology, in the form of both budget support and concessionary loans.
    - Of this US$38 million, US$18 million—US$7½ million in grants and US$10½ million in loans—is expected to be disbursed in 2013–14 to finance the undersea fiber optic cable.
    - About US$5 million in budget support is being negotiated for 2013 under the Economic and Financial Reform Program.
  - World Bank — US$2 million in budget support approved in April 2012, and an additional US$2 million Development Policy Grant is in the pipeline for 2013.
  - European Union — US$1½ million disbursed in budget support in 2012 and a further US$1¾ million expected to be disbursed in 2013.

### Main risks to the ECF-supported program and capacity constraints
- Main risks:
  - Political uncertainty and possible political instability that could weaken program ownership.
  - Resource constraints in implementing structural benchmarks.
  - Inability to submit timely data for program monitoring.
- Capacity issues:
  - Limited institutional capacity remains a challenge and has increased since phased withdrawal of the Regional Assistance Mission to Solomon Islands (RAMSI), including technical advisors.
  - RAMSI technical assistance started in 2003 as a partnership between the government of Solomon Islands and 15 countries of the Pacific; RAMSI focuses on security, justice, law, and economic growth.
- Mitigating factors:
  - Success of previous and current programs provides indication that program ownership in Solomon Islands is strong and bipartisan.
  - Fund technical assistance has been effective in helping authorities implement the current program.
  - Authorities committed to completing the Safeguards Assessment update by the time of the first review under the successor ECF arrangement; CBSI will provide necessary information for the update and staff has begun initiating the update safeguards assessment.

### Other issues and commitments
- Authorities will submit a revised National Development Strategy (relative to version launched in September 2011) at the time of the second review of the prospective ECF arrangement, together with sector strategies developed by the ministry of planning and key development partners.
- CBSI draft bill (end-March 2012 benchmark) endorsed by cabinet in early July expected to strengthen operational autonomy and transparency of the central bank.

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

### 28. The macroeconomic situation has improved over the last two years and growth,

### 28. The macroeconomic situation has improved over the last two years and growth,

### Macroeconomic overview and growth drivers
- The macroeconomic situation has improved over the last two years and growth, although moderating, remains relatively strong.
- The economy has benefited from the implementation of the government’s economic reform program supported by the SCF arrangement, owing to strong political commitment to rebuilding policy buffers and sound macroeconomic management.
- Logging stocks—historically the main engine of growth—are expected to be exhausted during this decade.
- Since this year, the mineral sector has become the main driver of growth together with the service sector; several reforms are needed to ensure the country as a whole benefits from its mineral wealth.

### Fiscal position and recommendations
- Fiscal discipline needs to be strengthened in the 2013 budget, given the still relatively positive growth outlook.
- The deterioration of the cash balance in September is a concern which needs to be addressed.
- Maintaining the cash balance at about two and a half months of recurrent spending will provide a more comfortable buffer for rainy days, should the global and regional outlook deteriorate further.
- Building these fiscal buffers will help enhance resilience to shocks and ensure debt sustainability.
- Given the expected decline in logging revenue over the medium term, public spending in 2013 should be kept at a more sustainable level than in 2012.
- The pace of development spending should be aligned more closely with the absorptive capacity of the economy, in light of capacity constraints and to avoid waste.
- A mechanism should be set up to make spending under constituency funds accountable to enhance transparency in the use of public resources.
- Improving the composition of public spending will foster inclusive growth.

### Public financial management reforms
- Commended efforts: reforming the public financial management system and developing the medium-term fiscal framework.
- Key steps to promote public transparency and enhance credibility of fiscal policy and of the budget process:
  - Introduction of the new charts of account in the 2013 budget presentation.
  - Forward estimates of revenues and current expenditure (end-December 2012 benchmark).
  - Publication of the discussion papers on the draft legislation of the PFM.
- The multi-year budget framework will help build consensus on the appropriate sequencing of development projects.

### Structural reforms to foster inclusive growth
- Reform agenda includes:
  - Reforming mining legislation to broaden the tax base.
  - Implementing a new resource taxation regime to promote fiscal transparency.
  - Enhancing the efficiency of tax collection.
- The authorities have undertaken significant reforms in these areas and their efforts should continue.

### Debt management and external borrowing
- The debt management strategy developed by the authorities is important for resuming external borrowing while safeguarding external stability.
- Resuming concessional borrowing is critical for obtaining resources to finance much-needed investments, but prudent borrowing is paramount to maintain debt sustainability and minimize external and fiscal risks.
- A conservative borrowing limit should be introduced to keep debt distress at a moderate level.
- Capacity building in debt management is essential, including establishing guidelines and procedures to strengthen project appraisal and evaluation.

### Monetary policy, exchange rate, and financial sector
- Monetary and exchange rate policies are appropriate.
- If growth remains strong and domestic inflation pressures re-emerge, monetary policy should be tightened.
- The recent move toward a currency basket, away from a de facto peg with the U.S. dollar, should help buffer external shocks in the future, should downside risks materialize.
- The financial system is sound, but the supervisory and regulatory frameworks need strengthening.
- Drafting instructions for the NPF Act endorsed by the cabinet in July, together with planned amendments to the Financial Institution Act, should help strengthen the regulatory framework.
- Initiatives to increase access to financial services, especially in rural areas, are welcome and important for supporting private sector development.

*Source: _cr12333 - 28. The macroeconomic situation has improved over the last two years and growth,*

### 37. Based on Solomon Islands’ program performance, staff recommends the

### _cr12333 - 37. Based on Solomon Islands’ program performance, staff recommends the

### Recommendation for Fund Support
- Staff recommends the completion of the second and last review under the SCF-supported program.
- Staff recommends approval of the authorities’ request for a successor arrangement in the form of a three-year low-access Extended Credit Facility (SDR 1.04 million).
- The current SCF will expire on December 5.
- Because a member cannot have two arrangements effective at the same time under the PRGT Instrument, a proposed decision approving the ECF arrangement (as set in this Staff Report) will be circulated to the Board for adoption on a lapse-of-time basis, for effectiveness after the current SCF arrangement expires.

### Program Performance and Policy Priorities
- The authorities’ reform program going forward will:
  - help secure the progress achieved with respect to macro stability under the two consecutive SCF arrangements,
  - provide fiscal discipline, and
  - help the authorities implement their ambitious reform agenda.

### Macroeconomic developments and outlook
- Growth drivers and outlook:
  - The economic recovery has been driven by booming resource sectors, especially logging and gold mining.
  - Logging is expected to decline over the medium term.
  - Export volume has been strong driven by log and mineral exports, although log exports started to decline in 2012 due to weaker export demand and overexploitation.
  - Export developments (2006–14) and projections show significant contributions from Fishing, Logging, Mining, and Other exports.
- Inflation and prices:
  - Inflation has been moderating in the third quarter because of lower domestic pressure and slow pass-through from world food and oil prices.
  - Contribution to CPI Inflation, Sep. 2007–12: series shown for Domestic component, Imported component, CPI inflation, World food price, World fuel price.
- External sector and reserves:
  - The current account balance improved in 2011, supported by record-high logging and palm oil exports, and recommencement of gold exports but the commodity-led export boom seems to be subsiding.
  - Reserve buffers have been rebuilt, thanks to donor grants and FDI.
  - Reserve Change Decomposition (2006–14) includes contributions from Trade of goods and services; Income and transfers, excl. exceptional financing; Capital and financial account; Exceptional financing; Change in gross official reserves.
- Key indicators (selected exact values from tables and text):
  - Per capita GDP (2011): US$1,578 (estimate)
  - Population (2011): 552,000
  - Poverty rate (2006): 23 percent
  - Main products and exports: logs and gold
  - Main export markets: emerging Asia

### Fiscal developments and projections
- Recent fiscal outcomes:
  - The fiscal position has weakened in 2012, causing a decline in the cash balance.
  - Central government operations (percent of GDP) for 2009–13 (selected rows, exact values preserved):
    - Total revenue and grants: 55.2, 62.6, 60.2, 57.0, 57.3, 54.4
    - Revenue: 30.5, 32.0, 33.1, 32.5, 32.7, 31.5
    - Grants: 24.7, 30.6, 27.1, 24.5, 24.5, 23.0
    - Total expenditure: 53.4, 56.4, 51.2, 56.2, 57.9, 53.2
    - Recurrent expenditure: 28.6, 28.2, 25.6, 28.0, 31.0, 26.7
    - Development expenditure: 25.6, 27.9, 25.5, 28.2, 26.9, 26.5
    - Overall balance: 1.8, 6.2, 9.0, 0.9, -0.6, 1.2
  - Table 3 (Summary of Fiscal Accounts, 2010–13) provides detailed SI$ million levels and percent of GDP metrics for 2010–13 (total revenue and grants, tax revenue, grants, expenditure categories, financing breakdowns, gross cash balance, targets).
- Medium-term fiscal outlook (Table 4, 2009–17 baseline):
  - Real GDP (percent change): -4.7, 7.8, 10.7, 7.4, 5.5, 4.0, 3.8, 3.7, 3.6 (2009–17 series)
  - Gross official reserves (end of period) 2009–17: 146.0, 265.8, 412.3, 503.8, 532.2, 561.8, 588.7, 609.0, 636.3 (in US$ millions)
  - Current account balance (in US$ millions and percent of GDP) 2009–17: -128.2 (-21.4%), -210.1 (-30.8%), -52.2 (-6.0%), -58.3 (-5.8%), -116.2 (-10.6%), -101.9 (-8.7%), -117.2 (-9.6%), -126.7 (-9.8%), -131.8 (-9.8%)

### Monetary and banking sector developments
- Reserve and money growth:
  - Rapid increase in reserve position has contributed to strong money growth.
  - Broad money (M3) and components (2006–12, and projections) are documented in Table 5 and related charts.
- Credit and lending:
  - Private sector credit growth remains sluggish even with lower lending rates and ample liquidity of the banking sector.
  - Credit to private sector (annual percentage change, selected years): -4.7, 4.7, 7.2, 5.0, 3.3, 8.3, 8.2, 6.7, 6.5 (series from Table 5)
- Interest rates and liquidity:
  - Interest rates (percent per annum), latest available for 2012: deposit rate 0.7 (where shown); lending rate 11.4 (where shown) — weighted average of commercial banks.
  - Deposit and credit growth (Sep. 2007–12) and loan-to-deposit ratio series are presented (exact series in Table 5).
- Exchange rate:
  - The real effective exchange rate appreciated by 2 percent since October 2010.
  - Nominal and Effective Exchange Rates, Sep. 2006–12 series are provided (index, 2005 = 100).

### External sector financing and Fund arrangements
- Reviews and disbursements under the current Standby Credit Facility (SCF):
  - December 6, 2011: 171,733,333 (Approved Fund arrangement)
  - June 25, 2012: 171,733,333 (Completion of the first review and observance of end-December 2011 performance criteria)
  - November 15, 2012: 171,733,334 (Completion of the second review and observance of end-June 2012 performance criteria)
  - Total under SCF: 505,200,000 (in SDR)
  - Note: There has been no drawings under the current SCF, which was precautionary in nature.
- Successor Extended Credit Facility (ECF) schedule (amounts and review-linked disbursements):
  - December 7, 2012: 1.4 percent of quota, 148,571 (Approved Fund arrangement)
  - June 15, 2013: 1.4 percent of quota, 148,571 (Completion of the first review and observance of end-December 2012 performance criteria)
  - November 15, 2013: 1.4 percent of quota, 148,571 (Completion of the second review and observance of end-June 2013 performance criteria)
  - June 15, 2014: 1.4 percent of quota, 148,571 (Completion of the third review and observance of end-December 2013 performance criteria)
  - November 15, 2014: 1.4 percent of quota, 148,571 (Completion of the fourth review and observance of end-June 2014 performance criteria)
  - June 15, 2015: 1.4 percent of quota, 148,571 (Completion of the fifth review and observance of end-December 2014 performance criteria)
  - November 15, 2015: 1.4 percent of quota, 148,574 (Completion of the sixth review and observance of end-June 2015 performance criteria)
  - Total under ECF: 101,040,000 (in SDR)
  - Note: The ECF drawings are expected to be completed.
- Indicators of capacity to repay the Fund (Table 7, 2011–22, selected exact values):
  - Outstanding Fund credit (in millions of SDRs, 2011–22): 12.5, 12.6, 12.9, 12.2, 10.4, 7.6, 4.9, 2.4, 0.9, 0.7, 0.5, 0.3
  - Outstanding Fund credit (in millions of US$): 19.3, 19.1, 19.5, 18.4, 15.7, 11.5, 7.3, 3.6, 1.3, 1.1, 0.8, 0.5
  - Total obligations based on existing and prospective credit (in millions of SDRs, selected years): 0.0, 0.0, 0.0, 1.1, 2.1, 2.8, 2.8, 2.5, 1.5, 0.2, 0.2, 0.2
  - Fund obligations in percent of quota and other ratios are reported for 2011–22 in Table 7.

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

### APPENDIX I–LETTER OF INTENT

### APPENDIX I–LETTER OF INTENT

### Recent developments and outlook
- Implementation of IMF-supported programs since June 2010 has preserved macroeconomic and financial stability and catalyzed donor support.
- GDP:
  - Contracted by 5 percent in 2009.
  - Rebounded to 6¾ percent in 2010.
  - Exceeded 10 percent in 2011.
  - Growth slowing to around 5 percent in 2012.
  - Growth expected to moderate to almost 4 percent in the medium term.
- External buffers and reserves:
  - Gross international reserves increased to US$ 496 million (about ten months of this year’s imports of goods and services) as of September 2012, relative to US$412 million at end-2011.
  - Net international reserves stood at US$454 million at end-June 2012.
  - Reserves levelled off in September compared to August.
- Inflation:
  - Eased to 4.7 percent (year-on-year) in August 2012.
  - Headline inflation likely to be in the 4-6 percent range over the medium term.
- Sectoral drivers and risks:
  - 2012 growth driven by mining and services; logging contributed less than in previous years but surprised on the upside in 2012.
  - Economy remains heavily dependent on aid to finance the structural trade deficit.
  - Key external downside risks include weaker growth in emerging Asia, worsening terms of trade, reduced demand for logging (especially from China), and lower foreign direct investment.
  - Logging production uncertainty could result in higher medium-term GDP growth if activity exceeds expectations.

### Program status and request
- SCF performance:
  - Program under the Standby Credit Facility (SCF) is broadly on track.
  - End-June 2012 quantitative targets met with comfortable margins.
  - Missed the September indicative target on the cash balance by SI$35 million due to revenue shortfalls and higher recurrent spending (Festival of Pacific Arts, tertiary education).
  - Development spending higher in 2012 (4 percent of GDP) compared to 2010 and 2011 (2 percent of GDP), largely via the Rural Constituency Development Livelihoods Fund (RCDL).
  - Most structural benchmarks implemented; capacity constraints slowed some benchmarks’ pace.
- IMF requests:
  - Request completion of the second and final review under the SCF arrangement (arrangement approved December 2011).
  - Not requesting release of the outstanding disbursement of SDR5.2 million under the SCF, given its precautionary nature.
  - Request a successor low-access three-year Extended Credit Facility (ECF) equivalent to 10 percent of quota (SDR 1.04 million or about US$1.6 million).
  - Request release of the first disbursement equivalent to SDR 0.149 million upon Executive Board approval of the ECF.
  - If external downside risks materialize and large balance of payments needs arise, the Government would request an augmentation of access under the ECF.
  - Monitoring: quantitative performance criteria and indicative targets, structural benchmarks, and semi-annual reviews (MEFP Tables 1 and 2).
  - Review schedule: first review on or after June 15, 2013; second review on or after November 15, 2013.

### Program objectives and commitments
- Overarching objectives:
  - Strengthen fiscal framework and policy buffers.
  - Preserve external stability and debt sustainability.
  - Maintain stable monetary conditions.
  - Strengthen the financial sector.
  - Implement medium-term structural reform agenda and tackle institutional weaknesses.
  - Promote strong, sustainable, and inclusive growth beyond the commodity sector to help reduce poverty.
- MEFP:
  - Memorandum of Economic and Financial Policies (MEFP) for 2013–15 attached to the letter.
  - Government affirms MEFP policies are adequate to achieve program objectives and will take further measures if appropriate.
  - Government will consult the Fund on policy revisions and provide requested information on policy implementation.
  - Government authorizes publication of the Letter of Intent and attached MEFP.

### Fiscal policies (detailed commitments)
- Fiscal anchor and strategy:
  - Cash balance will remain the fiscal anchor and be preserved according to quantitative targets and performance criteria in Table 1.
  - Tighter fiscal policy going forward relative to 2012; strengthening fiscal position in the 2013 Budget.
  - Any commodity revenue windfalls or under-spending of the development budget will be saved for future development spending or to increase fiscal buffers.
- Expenditure and wages:
  - Contain public expenditure and enhance quality of public spending in line with expected slower revenue growth.
  - Plan a prudent increase in basic public sector wages in 2013; size to be determined in the 2013 Budget process.
  - Consolidate allowances and benefits into the remuneration base, control overtime and other allowances, and increase transparency of remuneration levels.
  - Commit to a comprehensive payroll reform to attract and retain qualified staff and improve payroll composition.
  - Maintain spending on education and health at no less than 32 percent of Government-funded recurrent spending; continue to track government-funded spending on education and health.
  - Balance financing tertiary education abroad with investing in primary education given low basic education enrolment by regional standards.
- Constituency funds and accountability:
  - Contain use of constituency funds and enhance accountability; internal audits underway.
  - Office of the Auditor General (OAG) assessment expected to advise on standardizing procedures for ex ante evaluation and prioritization of development projects.
  - Introduce an accountability system where OAG reports to Cabinet and Parliament on actual spending and project achievements.
- Budget presentation and multi-year framework:
  - Improved 2012 Budget presentation to include output line items (end-September 2012 benchmark) ahead of schedule.
  - New chart of accounts implemented in 2012 to better capture Government expenditure according to natural account codes.
  - Continue seeking development partner assistance to strengthen procurement, financial management information systems, and internal audit processes.
  - Implement a multi-year budget framework with forward estimates of revenues and current expenditure included in the 2013 recurrent Budget (end-December 2012 benchmark); complete inclusion of forward estimates for the 2014 Development Budget next year.
- Public Finance Act (PFA) reform:
  - Continue reforming the Public Finance Act to incorporate fiscal responsibility, public funds management, and public debt management.
  - Drafted four discussion papers posted on the Ministry of Finance and Treasury website and presented in a public workshop (end-September 2012 benchmark).
  - Aim to submit draft legislation on the PFA to Cabinet by mid-November (mid-November 2012 benchmark).
  - Submit draft PFA to Parliament by end-October 2013 (end-October 2013 benchmark).
  - Revise Financial Instructions and accompanying manuals during 2013; PFA to take effect January 1, 2014. Training to embed reforms.
- Revenue mobilization and tax reform:
  - Strengthen compliance and streamline exemptions; draft comprehensive Customs and Excise bill being prepared with Asian Development Bank and AusAID support (end-October 2012 benchmark).
  - Plan Cabinet approval to release draft Customs and Excise Act for public consultation, including exemptions and draft amendments to revenue acts, by end-December 2012 (end-December 2012 benchmark); submit to Parliament by November 2013 (end-November 2013 benchmark).
  - Considering further tax reforms to strengthen and broaden the narrow tax base.
- Resource taxation and mining regime:
  - Implement a new mining taxation regime with draft amendments to income tax, customs and excise, and goods tax legislation:
    - Originally set for end-September 2012 (end-September 2012 benchmark), revised to mid-December 2012 (end-December 2012 benchmark), and to Parliament by November 2013 (end-November 2013 benchmark).
  - Wider stakeholder consultation undertaken (consultation meeting in July 2012).
  - Until the new tax regime is in place, refrain from approving new mining leases.
  - Adopt measures to enhance mining tax administration to ensure government receives its share of mining revenue.
  - Continue to apply the full market price for log exports with an automatic quarterly adjustment (policy in place since January 2012) to support revenue mobilization efforts.
- Borrowing and debt management:
  - Exercise caution in resuming concessional borrowing to preserve domestic and external stability while financing investment projects (Submarine Cable System Project and Tina River Power Project).
  - Internet submarine connection expected to be fully operational by the middle of 2014.
  - Debt Management Strategy (DMS) endorsed in May 2012 by Cabinet, building on IMF-World Bank Debt Sustainability Analysis; DMS incorporated in the Honiara Club Agreement (HCA) review (end-April 2012 benchmark).
  - Set a yearly borrowing limit in the 2013 Budget covering domestic, external and SOE borrowing and guarantees; limit to be revised yearly based on debt outlook and investment needs, maintaining a conservative approach.
  - Next steps: develop instructions for SOE borrowing (end-March 2013 benchmark) and include in DMS; identify outstanding SOE debt; develop on-lending policy framework; design framework to estimate cost of guarantees.

### Monetary, exchange rate, and financial sector policies
- Policy focus areas (as stated in program objectives):
  - Improve monetary operations.
  - Maintain a strong foreign exchange position.
  - Contain financial risks and strengthen the financial sector.
  - Promote financial inclusion to enhance private sector access to financial services, especially in rural areas.

_Letter of Intent from the Government of Solomon Islands to the Managing Director, IMF, November 13, 2012 (APPENDIX I and Attachment I: Memorandum of Economic and Financial Policies)._

### 8.      Monetary and exchange rate policies will continue to be geared to maintaining

### 8.      Monetary and exchange rate policies will continue to be geared to maintaining

### Monetary and exchange rate policy stance and actions
- Objective: maintain price and external stability.
- Measures taken:
  - Issuance of short-term Bokolo bills to contain inflationary pressures.
  - Modified exchange rate regime in October: move from a de facto peg to the U.S. dollar (in place since 2002) toward a basket peg using as weights the currency denominations of the largest shares of external payments.
  - Drafted a new CBSI Act to reinforce the effectiveness of the CBSI in conducting monetary policy and supervisory activities.
- Rationale and expected effects:
  - The basket peg is intended to provide more flexibility to maintain external stability and absorb external shocks.
  - Monetary transmission mechanism has improved over the last couple of years, but remains weak.
  - Ongoing monitoring: will closely monitor credit, liquidity and real sector developments and scale up issuance of Bokolo bills if needed.
- Timetable and status for CBSI Act:
  - Cabinet approved the draft in July (end-March 2012 benchmark).
  - Plan: ready to submit the final Act to Parliament by December 2012 (end-December 2012 benchmark).

### Financial supervisory and inclusion reforms
- Objectives: strengthen financial supervisory and regulatory frameworks; improve access to credit and financial services, especially rural areas.
- National Provident Fund (NPF) reform:
  - Drafting instructions for the NPF Act endorsed by Cabinet in July (end-June 2012 benchmark).
  - Expected effects: strengthen NPF governance and investment framework, reduce political influence on investment decisions, maximize returns to members.
  - Plan: ready to submit the revised NPF Act to Parliament by October 2013 (end-October 2013 benchmark).
  - Request: IMF technical assistance in strengthening on-site supervision of the NPF and insurance companies and in formulating prudential regulations and reports for the NPF.
- Financial Institution Act and banking supervision:
  - Planned amendments to the Financial Institution Act to strengthen regulatory framework.
  - An IMF TA mission will arrive shortly to assist in reviewing the Financial Institution Act to reflect international best practices.
  - Request additional IMF TA on banking supervision to capitalize on recent assistance from PFTAC and continue capacity building in financial markets supervision.
- Financial inclusion and literacy:
  - Advance work on financial inclusion, including financial literacy training and financial education in schools.
  - Plan: present work developed by the financial inclusion taskforce in a public workshop by March 2013 (end-March 2013 benchmark).
- Structural benchmarks and dates (selected):
  - Workshop organized by the National Financial Inclusion taskforce: March 31, 2013.

### Other structural reforms to support private sector and governance
- Policy orientation: continuous improvement of business climate; align conditionality under successor arrangement with the development strategy (economic and financial reform matrix) from the Core Economic Working Group (CEWG).
- Plans:
  - Submit to the IMF a revised National Development Strategy at the time of the second review of the prospective ECF, together with sector strategies from the Ministry of Planning and Aid Coordination (MDPAC) and key development partners to serve as the Poverty Reduction Strategy Paper.

### Safeguards and statistics
- Safeguards assessment:
  - Commitment: complete the Safeguards Assessment update by the time of the first review under the successor ECF arrangement.
  - CBSI will provide Fund staff with necessary information for the update.
- Statistics and data quality:
  - Progress made in strengthening national accounts, fiscal and monetary statistics for program purposes, but delays in timely release of national accounts and fiscal data.
  - Delays partly attributable to implementation of the Household Income and Expenditure Survey (HIES) 2012/13.
  - HIES will provide data for updating CPI weights, and provide estimates for GDP, poverty and MDG indicators.
  - Two key positions within the Ministry of Finance recently filled to help timely data provision for IMF program monitoring.
  - Plan to devote more resources to the National Statistics Office by hiring additional permanent staff if resources become available.
  - CBSI requests a follow-up TA to support the ongoing Monetary and Financial Statistics Project.

### Quantitative performance criteria, indicative targets, and program monitoring (selected figures and definitions)
- Monitoring instruments: quantitative performance criteria (PC), indicative targets (IT), structural benchmarks, and reviews.
- Key quantitative targets and performance criteria (values shown in tables as end-period stocks or cumulative changes):
  - Net international reserves (NIR) of the CBSI (floor, end-of-period stock, in millions of U.S. dollars (US$)) — sample values in monitoring table:
    - 341, 390, 346, 423, 421, 424, 454, 428, 428, 473, 470, 475, 480, 485
  - Net domestic asset (NDA) of the CBSI (ceiling, end-of-period stock, in millions of Solomon Islands dollars (SI$)) — sample values:
    - -737, -1,118, -835, -1,290, -1,253, -1272, -1,309, -1,256, -1258, -1,425, -1,173, -1,122, -1,120, -1,102
  - Net credit to central government (NCG) (ceiling, cumulative change from the beginning of the year, in millions of SI$) — sample values:
    - -27, -561, 62, -149, -28, -28, -266, -26, -26, -250, 95, 6, -33, -60
  - New nonconcessional external debt maturing in more than one year contracted or guaranteed by the public sector (ceiling, end-of-period stock since beginning of program, in millions of US$): 00   00   000 0  0  0 0 0  0  0
  - New nonconcessional external debt maturing in one year or less (ceiling): 00   00   000 0  0  0 0 0  0  0
  - Accumulation of new external payment arrears by the public sector (ceiling, end-of-period stock since beginning of the program, in millions of SI$): 00   00   000 0  0  0 0 0  0  0
  - Central government program cash balance (floor, end-of-period stock, in million of SI$) — sample values:
    - 254, 522, 232, 402, 342, 321, 391, 392, 372, 337, 425, 440, 4, 20, 383
- Indicative target (cumulative):
  - Government funded recurrent spending on health and education: sample values include 273, 294, 409, 418, 611, 147, 294, 441.
  - Indicative target: spending on health and education at no less than 32 percent of government-funded recurrent spending.
- Memorandum items and program-level figures (selected):
  - Budget support from bilateral and multilateral donors other than IMF (cumulative change from beginning of year, in millions of US$), program level — sample values include 46, 9, 38, 40.6, 47, 61, 11, 26, 44.
  - Outstanding stock of Solomon Islands government (SIG) treasury bills, excluding restructured government bonds (end-of-period stock, in millions of SI$), program level — sample values include 38, 40, 60, 39, 60, 40, 40, 40, 40, 40.
  - Balance of SIG Consolidated Deposits Account, millions of SI$ — sample values: 60, 140, 140, 140, 140, 140, 140.
- Definitions and valuation rules:
  - Program exchange rate for valuation of foreign currency-denominated accounts: SI$7.36 per U.S. dollar, as of end-June 2012.
  - NIR calculation: gross international reserves (GIR) less international reserve liabilities.
  - GIR defined as sum of:
    - Foreign currency assets in convertible currencies held abroad and as vault cash under direct and effective control of the CBSI and readily available for intervention and of investment grade or held with an investment-grade institution.
    - The reserve position of the Solomon Islands in the IMF.
    - Holdings of SDRs.
    - Monetary gold.
  - Exclusions from GIR: foreign currency deposits of ODCs and OFCs held at the CBSI; any foreign currency claims on residents; capital subscriptions in international institutions; foreign currency assets in nonconvertible currencies; and GIR that are encumbered or pledged.
- Adjustors specified in the Technical Memorandum of Understanding (TMU):
  - Floor on NIR will be adjusted upward (downward) by amount of budget support from bilateral and multilateral donors (excluding the IMF) in excess (short) of program level.
  - Ceilings on NDA will be adjusted downward (upward) by amount of budget support from bilateral and multilateral donors (excluding the IMF) in excess (short) of program level.
  - Floor on central government program cash balance will be adjusted downward and ceiling on NCG will be adjusted upward by the stock amount of budget support short of the program level; program cash balance floor adjusted upward (downward) by stock of government treasury bills excluding restructured government bonds in excess (short) of program level; program cash balance floor adjusted upward by balance in the SIG Consolidated Deposits Account short of program level (applies to end-June PC and end-September IT).
- Institutional definitions:
  - Central government includes all units of budgetary central government and extra budgetary funds.
  - Depository corporations (DCs) include the CBSI and other depository corporations (ODCs). ODCs include commercial banks, the Credit Corporation of Solomon Islands, and credit unions.
  - Other financial corporations (OFCs) include the National Provident Fund (NPF), the Development Bank of Solomon Islands, and the Investment Corporation of Solomon Islands.

_Italic line: Source: IMF staff and Solomon Islands authorities, as presented in the provided chapter content._

### 11.      International reserve liabilities of the CBSI are defined as the sum of:

### _cr12333 - 11.      International reserve liabilities of the CBSI are defined as the sum of:

### International reserve liabilities of the CBSI
- Defined as the sum of:
  - All outstanding liabilities of the Solomon Islands to the IMF, excluding IMF SDR allocations; and
  - Foreign currency liabilities in convertible currencies to nonresidents with an original maturity of up to and including one year.

### Net Domestic Assets (NDA) of the CBSI
- A ceiling applies to the level of NDA of the CBSI.
- The ceiling on NDA will be adjusted downward (upward) by the amount of budget support from bilateral and multilateral donors (excluding the IMF) in excess (short) of the programmed level.
- NDA of the CBSI will be calculated as the difference between reserve money and the sum of NIR of the CBSI and other NFA of the CBSI.
- Any revisions to the historical stock of reserve money based on changes to the accounting treatment of the profit/loss account of the CBSI will be notified to the Fund immediately and used to adjust monetary aggregates by an equivalent amount, as deemed appropriate.
- Other NFA of the CBSI includes:
  - Foreign assets related to holdings of foreign currency deposits, and securities not included in NIR of the CBSI, and loans, shares, financial derivatives, or accounts receivable with nonresidents; and other foreign assets that are not included in NIR of the CBSI, as defined in Section III. B; and
  - Foreign liabilities related to IMF SDR allocations; deposits, securities, loans, financial derivatives, and other accounts payable with nonresidents; and other foreign liabilities that are not included in NIR of the CBSI, as defined in Section III. B.

### Net Credit to the Central Government (NCG)
- A ceiling applies to the NCG measured cumulatively from the beginning of the year.
- The ceiling on NCG will be adjusted upward by the amount of budget support from bilateral and multilateral donors (excluding the IMF) short of the programmed level.
- NCG is defined as the sum of net claims of:
  - (i) the CBSI,
  - (ii) commercial banks and other ODCs,
  - (iii) OFCs,
  - (iv) insurance companies,
  - (v) and government treasury bills held by the general public.

### Fiscal Aggregates — Cash Balance of the Central Government
- A floor applies to the program cash balance of the central government.
- The floor on the program cash balance will be adjusted downward by the amount of budget support from bilateral and multilateral donors (excluding the IMF) in short of the programmed level.
- The floor on the program cash balance will also be adjusted upward (downward) by the stock of government treasury bills, excluding restructured government bonds, in excess (short) of the program level of SI$40 million.
- The floor on the program cash balance will be adjusted upward by the difference between SI$140 million (hereafter known as program level) in the SIG Consolidated Deposits Account and its actual balance, should the actual balance in the SIG Consolidated Deposits Account be lower than SI$140 million.
- The program cash balance of the central government is defined as the gross cash balance minus the total amount of unpaid payment orders and unpresented checks.
- The gross cash balance is defined as the sum of government deposits, which are not in any way encumbered or pledged as collateral or used as a guarantee against government incurred liabilities, in the following accounts:
  - In CBSI: Solomon Islands Government (SIG) Revenue Account, SIG Funded Development Account, SIG Debt Servicing Account;
  - In Australia New Zealand Bank: SIG Creditors Account; Payroll Imprest Account, and Airport Service Fees Account;
  - In Bank of South Pacific: Provincial Revenue Holding Account, SIG Inland Revenue Account, Sub Treasury Gizo Account, and Sub Treasury Auki Account; and
  - Donor funded budget support accounts that are created by and under control of the government.

### External Debt — Medium- and Long-Term External Debt
- A ceiling applies to the contracting and guaranteeing by the public sector of new nonconcessional borrowing with nonresidents with original maturities of more than one year.
- The ceiling applies to debt and commitments contracted or guaranteed for which value has not yet been received; it applies to private debt for which official guarantees have been extended and which, therefore, constitutes a contingent liability of the public sector.
- The public sector comprises the central government, the CBSI, nonfinancial public enterprises (i.e., enterprises in which the government owns more than 50 percent of the shares), and other official entities.
- The definition of debt for the purposes of the program is set out in Point 9 of the Guidelines on Performance Criteria with Respect to External Debt in Fund Arrangement Executive Board Decision No. 6230-(79/140), as revised on August 31, 2009 (see Annex I).
- Excluded from the ceiling are:
  - (i) the use of Fund resources;
  - (ii) lending from the World Bank and the Asian Development Bank;
  - (iii) debts incurred to restructure, refinance, or prepay existing debts, to the extent that such debt is incurred on more favorable terms than the existing debt and up to the amount of the actually restructured/refinanced/prepaid debt;
  - (iv) concessional debts;
  - (v) any SI$-denominated treasury bill and bond holdings and Bokolo bonds held by nonresidents.
- For program purposes, the guarantee of a debt arises from any explicit legal obligation of the central government, the CBSI, nonfinancial public enterprises, or other official entities on behalf of the central government or the CBSI to service debt in the event of nonpayment by the main obligor (involving payments in cash or in kind).
- For program purposes, a debt is concessional if it includes a grant element of at least 35 percent, calculated as follows:
  - The grant element of a debt is the difference between the net present value (NPV) of debt and its nominal value, expressed as a percentage of the nominal value of the debt.
  - The NPV of debt at the time of its contracting is calculated by discounting the future stream of payments of debt service due on this debt.
  - The discount rates used for this purpose are the currency specific commercial interest reference rates (CIRRs), published by the Organization for Economic Cooperation Development (OECD).
  - For debt with a maturity of at least 15 years, the 10-year-average CIRR will be used to calculate the NPV of debt and, hence, its grant element.
  - For debt with a maturity of less than 15 years, the 6-month average CIRR will be used.
  - To both the 10-year and 6-month averages, the same margins for differing repayment periods as those used by the OECD would continue to be added:
    - 0.75 percent for repayment periods of less than 15 years,
    - 1 percent for 15 to 19 years,
    - 1.15 percent for 20 to 29 years, and
    - 1.25 percent for 30 years or more.

### External Debt — Short-Term External Debt
- A ceiling applies to the contracting and guaranteeing by the public sector of new nonconcessional borrowing with nonresidents with original maturities of up to and including one year.
- The ceiling applies to debt and commitments contracted or guaranteed for which value has not yet been received; it applies to private debt for which official guarantees have been extended and which, therefore, constitute a contingent liability of the public sector.
- The public sector comprises the central government, the CBSI, nonfinancial public enterprises (i.e., enterprises in which the government owns more than 50 percent of the shares), and other official entities.
- For program purposes, the definition of debt is set out in Point 9 of the Guidelines on Performance Criteria with Respect to External Debt in Fund Arrangement approved by the Executive Board Decision No. 6230-(79/140), as revised on August 31, 2009 (see Annex I).
- Excluded from the ceiling are:
  - (i) debts classified as international reserve liabilities of the CBSI;
  - (ii) debts incurred to restructure, refinance, or prepay existing debts, to the extent that such debt is incurred on more favorable terms than the existing debt and up to the amount of the actually restructured/refinanced/prepaid debt;
  - (iii) SI$-denominated treasury bills and bonds and CBSI and Bokolo bills held by nonresidents;
  - (iv) concessional debts; and
  - (v) normal import financing. A financing arrangement for imports is considered to be “normal” when the credit is self-liquidating.

### External Payment Arrears
- A continuous performance criterion applies to the non-accumulation of external payments arrears by the public sector, comprising the central government, the CBSI, nonfinancial public enterprises, and other official entities.
- External payments arrears consist of external debt-service obligations (principal and interest) that have not been paid at the time they are due, as specified in the contractual agreement, subject to any applicable grace period.

### Data Provision — Reporting Requirements and Timelines
- The data listed will be provided for monitoring performance under the program based on data templates agreed with Fund staff.
- Weekly data are requested for submission to Fund staff by the end of the following week.
- Monthly and quarterly data are requested for submission within six weeks of the end of the observation period.
- The authorities have committed to using the best available data, so that any subsequent data revisions will not lead to a breach of quantitative performance criteria or benchmarks. All revisions to data will be promptly reported to Fund staff.

- Monetary Data (CBSI)
  - Weekly:
    - Daily exchange rates, both buying and selling rates, of the Solomon Islands dollar against the U.S. dollar, including the official, interbank, and parallel market exchange rates;
    - Stock of NIR and sales and purchases by the CBSI in the foreign exchange markets;
    - Stock of reserve money and its components; and
    - Treasury bill auction reports.
  - Monthly:
    - Financial corporations’ survey, including the balance sheet of CBSI, the consolidated balance sheet of ODCs, and the consolidated balance sheet of OFCs;
    - Liquid asset ratios and/or reserves requirement of the commercial banks;
    - Interest rates, including average interbank rate, bank deposit rates, and bank lending rates;
    - A detailed breakdown of NCG from the CBSI, commercial banks and other ODCs, and OFCs;
    - Foreign exchange cash-flow of the CBSI, including donor disbursements; and
    - Balances of each central government account specified in Section IV. A., as recorded or collected by the CBSI.

- Fiscal Data (Ministry of Finance and Treasury (MoFT))
  - Monthly:
    - Consolidated accounts of the central government, including detailed data on:
      - Revenue, including tax and nontax revenues, and recurrent and development grants included in the consolidated budget;
      - Recurrent expenditure, including payroll, goods and services, and other recurrent outlays, including those funded by donor support;
      - Other recurrent charges of the Ministry of Education and Ministry of Health, separating spending funded by donor support;
      - Debt service payments, classified into amortization and interest payments on (i) domestic debt, (i) external debt, (iii) domestic arrears, and (iv) external arrears; and
      - Development expenditure funded by (i) central government of the Solomon Islands, and (ii) foreign grants and loans included in the consolidated budget.
    - Detailed financing components of central government’s accounts, classified into foreign and domestic sources:
      - Foreign financing includes (i) disbursement and amortization of project and program loans, and (ii) changes in external debt arrears, classified into principal and interest arrears.
      - Domestic financing includes (i) borrowing from and repayment to the CBSI, commercial banks and other ODCs, and OFCs; (ii) changes in deposits at the CBSI, commercial banks and other ODCs, and OFCs; and (iii) privatization receipts and changes in domestic debt arrears, classified into principal and interest arrears.
    - Stock of domestic debt, including the outstanding balance of government securities, treasury bills, cash advances, and other debt instruments.
    - Balances of each central government account specified in Section IV. A., as recorded by the MoFT.
    - Stock of unpaid government payment orders and unpresented checks.

- External Sector Data (CBSI and MoFT)
  - Quarterly:
    - New external debt obligations contracted and/or guaranteed by the government of the Solomon Islands, CBSI, and other official entities, including details on the amounts, terms, and conditions of each obligation.
    - Stock of outstanding external debt at end-month and disbursement, amortization, and interest payments for short-term external obligations contracted or guaranteed by the government or the CBSI by creditor in original currency and U.S. dollars.
    - Stock of external debt at end-month and disbursement, amortization, and interest payments for medium- and long-term external obligations contracted or guaranteed by the government or the CBSI by creditor in original currency and U.S. dollars.
    - Stock of arrears on the external debt contracted or guaranteed by the government or the CBSI by creditor in original currency and in U.S. dollars at end-month.
    - Balance of payment data, including detailed components of current accounts and capital and financial accounts.

- Real Sector Data (MoFT, National Statistical Office)
  - Monthly:
    - The monthly consumer price index and a detailed breakdown by major categories of goods and services included in the consumer basket.

### Annex I — Guidelines on Performance Criteria with Respect to Foreign Debt (excerpt)
- Definition of “debt” (Point 9):
  - A current, i.e., not contingent, liability, created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and which requires the obligor to make one or more payments in the form of assets (including currency) or services, at some future point(s) in time; these payments will discharge the principal and/or interest liabilities incurred under the contract.
  - Primary forms of debt include:
    - (i) loans, including deposits, bonds, debentures, commercial loans and buyers’ credits, and temporary exchanges of assets equivalent to fully collateralized loans (repurchase agreements and official swap arrangements);
    - (ii) suppliers’ credits, where the supplier permits the obligor to defer payments until sometime after delivery; and
    - (iii) leases, where the debt is the present value (at the inception of the lease) of all lease payments expected to be made during the period of the agreement excluding payments that cover operation, repair or maintenance.
  - Under this definition, arrears, penalties, and judicially awarded damages arising from failure to make payment under a contractual obligation that constitutes debt are debt.

*International Monetary Fund — excerpted program documentation and related guidelines contained in the supplied content.*

### 4.      The cabinet endorsed the Debt Management Strategy (DMS) in May, providing

### _cr12333 - 4.      The cabinet endorsed the Debt Management Strategy (DMS) in May, providing

### Debt management framework and recent developments
- The cabinet endorsed the Debt Management Strategy (DMS) in May, providing a framework to anchor borrowing plans going forward.
- The HCA was amended in July to allow external borrowing to resume.
- Under the DMS, the government will set a yearly borrowing limit once the results of the DSA exercise prepared by the Debt Unit at the Ministry of Finance and Treasury (MOFT) become available.
- The debt limit will be part of the budgetary process and will cover external borrowing by the government and all forms of SOE borrowing and guarantees (both domestic and external).
- For 2012, the limit was set at SI$150 million (2 percent of GDP). So far in 2012, only one SOE (Solomon Airlines) contracted domestic debt of SI$32 million. No additional borrowing is expected until the end of this year.
- The government is expected to resume access to external concessional financing in 2013.

### DSA assumptions and projections (summary)
- The assumptions and results behind the current DSA are broadly in line with the 2011 DSA, with some revisions:
  - Medium-term GDP growth reduced from an average of 5.1 percent to 4 percent.
  - Long-term GDP growth reduced from 3.6 percent to 3 percent.
  - Logging production: medium-term decline of 7 percent each year (relative to 20 percent decline each year in 2011 DSA).
  - Gold production: forecast to be some 20 percent lower than in 2011 DSA.
  - Aid flows lowered by 1 percent in medium and long term.
  - FDI inflows lowered by 2 percent.
  - Primary surplus revised down by 1 percent for the medium term; long-term deficit improved by 0.8 percentage point.
  - More conservative borrowing path envisaged: 1½ percent of GDP annually over the next five years (versus 2½ percent of GDP annually in the 2011 DSA).
- Result: debt rating remains unchanged.

### Box 1 — Macroeconomic assumptions under the baseline scenario
- GDP growth:
  - 8 percent in 2010; nearly 11 percent in 2011.
  - Expected to slow to 5½ percent in 2012.
  - Projected to moderate to 4 percent over the near and medium term.
  - Over the longer term, growth expected to fall to 3 percent.
  - Population projected to grow by 2.2 percent annually over the medium to long term.
- Logging and mining:
  - Log production expected to decline by about 7 percent each year until 2018, then remain stable.
  - Gold output projected at 80,000 ounces in 2012 and 95,000 ounces during 2013–20; will gradually wind down by 2023.
- Aid flows and FDI:
  - Aid flows peaked in 2010 at 25 percent of GDP; expected to average about 20 percent over the medium term and decline to about 12 percent by 2031.
  - FDI projected to decrease from 35 percent of GDP in 2010 to about 8 percent over the medium term and stabilize at about 5 percent over the longer term.
- External borrowing:
  - New loan disbursements expected to begin in 2013, with AsDB disbursements of US$4.2 million in 2013 and US$7.3 million in 2014 to finance the undersea fiber optic cable.
  - Private sector expected to borrow an additional US$13 million in 2013 from the Private Sector Operations Department of the AsDB to finance the cable.
  - Concessional borrowing projected to average about 1½ percent of GDP annually over the next five years and about 2½ percent over the longer term.
- Fiscal outlook:
  - Primary balance expected to generate a surplus averaging about 1 percent of GDP over the medium term.
  - Over the longer term, the primary balance expected to shift into a deficit of about ½ percent of GDP.
  - Revenue (excluding grants) forecast at about 30 percent of GDP over the longer term.
- Current account:
  - Non-interest current account deficit projected to be about 5 percent of GDP in 2012, widening to about 9 percent in the next two years and likely to stay at this level over the medium and long term.

### External debt sustainability findings
- External DSA indicates Solomon Islands faces a moderate risk of debt distress.
- Under the baseline scenario:
  - Total external debt projected to decline to about 22 percent of GDP in 2012, and further next year.
  - Further declines in 2013–15 expected due to scheduled repayments more than offsetting new external borrowing.
  - External debt projected to gradually increase starting in 2016, reaching just over 30 percent of GDP over the longer term.
  - PPG external debt projected to fall to 13 percent in 2012 and to rise moderately to about 26 percent of GDP over the longer term.
  - PV of PPG external debt, PPG debt service-to-exports, and PPG debt service-to-revenue ratios remain well below indicative thresholds.
- Sensitivity analysis and stress tests:
  - A shock to net non-debt-creating flows (lower share of net current transfers and net FDI of GDP in 2013–14 at one standard deviation less than the historical average) would keep the PV of PPG external-debt-to-GDP ratio above the threshold for 19 years before it begins to decline; PV of PPG external debt to exports would also breach the threshold around the scheduled closure of the Gold Ridge mine.
  - A permanent shock to financing terms (interest rate 2 percentage points higher during 2012–32 than baseline) would keep the PV of PPG external-debt-to-export ratio above the threshold starting from 2032.
  - A shock to nominal export growth no longer causes a breach of thresholds (historical 10-year average growth of exports 24.5 percent; standard deviation 22.3 percent; implying a growth rate of 2 percent in 2013–14 under the stress test).

### Public debt sustainability findings
- Public debt includes PPG external debt plus central government contingent liabilities of 1½ percent of GDP (of which 1 percent of GDP represents guaranteed loans for SOEs as of end-2011).
- Under the baseline scenario:
  - PV of total public debt projected to decline further to about 12 percent of GDP over the medium term.
  - Over the longer term, projected to increase to about 22 percent of GDP, driven by external borrowing after completion of the HCA review.
- Vulnerabilities:
  - Under the most extreme stress test—permanently lower real GDP growth—the PV of debt reaches about 30 percent of GDP by 2022 and surges to more than 70 percent of GDP by 2032.

### Policy implications and recommendations
- Maintain public and external debt at sustainable levels through actions on multiple fronts:
  - Continue efforts to rebuild fiscal buffers and create fiscal space, especially given external uncertainties.
  - Accelerate structural reforms (examples: a new resource tax regime and new mining legislation) to maximize spillovers from commodity sectors to non-commodity sectors, boost investor confidence, and promote sustainable growth.
  - Strengthen and deepen ongoing reforms in budget formulation and execution, with greater attention to the medium-term fiscal consequences of current policy choices to improve fiscal discipline and the quality of spending.
  - Exercise caution in contracting new borrowing, especially by SOEs.

* _cr12333 - 4.      The cabinet endorsed the Debt Management Strategy (DMS) in May, providing*

### 12.      The authorities have broadly agreed with this assessment. They are fully

### 12.      The authorities have broadly agreed with this assessment. They are fully

### Fiscal framework and public financial management reforms
- Authorities committed to strengthening the fiscal framework by continuing to reform the Public Finance Act (PFA) and implementing a multi-year budget framework.
- Policy measures to increase resource capture and predictability:
  - Implement a new resource taxation regime to ensure that the government receives its fair share of mining revenue.
  - Reform mining legislation to provide a predictable investment regime to attract foreign investment.
- Public spending and fiscal buffers:
  - Near-term fiscal priority: safeguard accumulated cash balances while improving the efficiency, transparency, and composition of public spending.
  - Authorities plan to raise public sector wages in the 2013 budget to reduce the decline in the real wage; a review of the remuneration structure is planned.
  - Minimum levels have been set on education and health spending.
- Revenue collection and tax administration:
  - Improvements in revenue collection have been made, with a strong focus on reducing tax exemptions and work on the new Customs and Excise Tax Act.
  - Authorities agree revenue forecasts must be appropriately conservative given external uncertainties.

### Debt management, SOE borrowing, and contingent liabilities
- Strengthening debt management capacity:
  - Develop instructions for SOE borrowing and include SOEs in the Debt Management Strategy (DMS).
  - Identify outstanding debt of SOEs.
  - Develop an on-lending policy framework.
  - Design a framework to estimate the cost of guarantees.
- New debt management strategy:
  - Incorporated into the Honiara Club Agreement and includes an annual borrowing limit.
  - Facilitates measured resumption of external borrowing to finance key infrastructure projects (Submarine Cable System Project; Tina River Power Project).
  - Will guide SOE borrowing; a description of application to SOE borrowing will be released.
- Debt sustainability assessment (summary indicators and risks):
  - The economy continues to face a moderate risk of debt distress.
  - Primary deficit that stabilizes the debt-to-GDP ratio examples: -0.7, -1.3, -3.0 (years/data points as reported in the DSA tables).
  - PV of public sector debt examples shown in projections: 19.7, 16.2, 13.6, 12.1, 11.5, 11.5, 12.1, 15.1, 21.7 (selected projection entries).

### External debt indicators and stress-test scenarios (selected figures from DSA tables)
- External debt (nominal) time-series entries (selected): 32.4; 31.9; 25.1; 21.7; 21.3; 20.0; 19.7; 19.9; 20.5; 23.3; 30.2.
- Public and publicly guaranteed (PPG) external debt (selected): 23.2; 19.8; 15.2; 12.9; 11.7; 11.0; 11.2; 11.9; 13.0; 17.7; 26.5.
- PV of PPG external debt (selected projection entries): 12.7; 10.9; 9.9; 9.2; 9.2; 9.5; 10.1; 13.4; 20.3.
- PV of PPG external debt as percent of government revenues (selected): 38.3; 33.2; 31.4; 29.8; 28.4; 30.2; 32.5; 47.9; 77.4.
- Debt service-to-exports ratio (in percent) (selected): 5.9; 4.7; 2.5; 2.6; 2.7; 3.4; 3.7; 3.7; 3.5; 2.7; 3.7.
- Debt service-to-revenue ratio (in percent) (selected): 6.9; 6.3; 4.3; 6.1; 5.1; 4.8; 4.0; 3.7; 3.1; 1.9; 3.0.
- Stress-test notes:
  - “The most extreme stress test is the test that yields the highest ratio in 2022. In all figures, it corresponds to a non-debt flows shock.”
  - Alternative and bound-test scenarios are presented, including A1 (variables at historical averages), A2 (new public sector loans on less favorable terms), and bound tests B1–B6 (real GDP growth shock, export value shock, US dollar GDP deflator shock, net non-debt creating flows shock, combined shocks, and one-time 30 percent nominal depreciation).

### Macroeconomic assumptions and projections (selected key assumptions and projections)
- Real GDP growth (in percent) time-series and projections (selected): -4.7; 7.8; 10.7; 5.6; 5.5; 5.5; 4.0; 3.8; 3.7; 3.6; 3.6; 4.0; 2.0; 3.1; 3.0.
- GDP deflator in US dollar terms (change in percent) (selected): 3.2; 5.8; 15.1; 3.3; 8.2; 10.2; 4.5; 2.4; 1.2; 1.4; 1.3; 3.5; 4.0; 1.8; 3.5.
- Effective interest rate (percent) (selected): 2.3; 2.3; 2.6; 2.3; 0.5; 2.6; 2.7; 2.8; 2.9; 2.8; 2.7; 2.7; 2.1; 1.6; 1.9.
- Growth of exports of G&S (US dollar terms, in percent) (selected): -12.9; 40.6; 68.5; 24.5; 22.3; 8.1; 3.8; 1.7; 0.8; 1.1; 3.1; 3.1; -3.7; 5.1; 3.0.
- Growth of imports of G&S (US dollar terms, in percent) (selected): -15.8; 59.2; 10.3; 22.0; 30.8; 10.5; 14.0; -2.4; 4.6; 6.2; 6.2; 6.5; 2.5; 6.0; 4.5.
- Government revenues (excluding grants, in percent of GDP): 30.5; 32.0; 33.1; 32.7; 31.5; 30.8; 32.2; 31.5; 31.2; 27.9; 26.2; 27.6.
- Aid flows (in Billions of US dollars) (selected): 0.3; 0.3; 0.4; 0.2; 0.3; 0.3; 0.3; 0.3; 0.3; 0.3; 0.4.
  - Of which: Grants (selected): 0.1; 0.2; 0.2; 0.2; 0.3; 0.3; 0.3; 0.3; 0.3; 0.3; 0.4.
- Grant-equivalent financing (in percent of GDP) (selected projection entries): 24.5; 23.1; 22.5; 21.8; 21.1; 20.3; 16.7; 11.4; 15.1.
- Nominal GDP (Billions of US dollars) (selected): 0.6; 0.7; 0.9; 1.0; 1.1; 1.2; 1.2; 1.3; 1.4; 1.9; 3.6.
- Nominal dollar GDP growth (selected): -1.7; 14.1; 27.4; 16.2; 8.8; 6.3; 4.9; 5.0; 5.0; 7.7; 6.0; 4.9; 6.7.

### IMF program actions, approvals, and key statements
- Standby Credit Facility (SCF) completion:
  - On November 28, 2012 the IMF Executive Board completed the second and final review under the SCF arrangement.
  - Mr. Min Zhu (Deputy Managing Director and Acting Chair) highlighted: restored macroeconomic and financial stability, remaining vulnerabilities (lack of diversification, strong dependence on aid, frequent natural disasters), priorities to bolster resilience, strengthen institutional capacity, and pursue inclusive growth.
  - Recommended policy priorities: enhance efficiency of tax collection via new resource taxation regime, implement public financial management reforms, promote access to financial services (especially rural), preserve debt sustainability while financing investment, target the non-commodity budget balance, and tighten monetary policy if domestic inflation pressures re-emerge.
  - Monetary policy and exchange rate: shift to a currency basket regime for exchange rate management to help buffer external shocks.
  - Financial sector: banking system remains profitable and adequately capitalized; central bank should continue to strengthen supervision and regulation and promote access to financial services.
- Extended Credit Facility (ECF) approval and disbursement:
  - IMF Executive Board approved on December 7, 2012 a three-year arrangement under the Extended Credit Facility (ECF) for Solomon Islands in an amount equivalent to SDR 1.04 million (about US$ 1.59 million), or 10 percent of the country’s quota.
  - Immediate disbursement enabled: SDR 0.149 million (US$ 0.228 million).
  - The ECF is intended to tackle deep institutional and structural issues, catalyze donor support, and support vulnerabilities associated with an undiversified export base, dependence on aid, and frequent natural disasters.
  - ECF financing terms: financing under the ECF carries a zero interest rate, with a grace period of 5½ years, and a final maturity of 10 years (as described in the ECF facts note summarized in the press release text).
- Program performance and structural benchmarks:
  - Most structural benchmarks were met under the second SCF; remaining benchmarks are being progressed.
  - New PFA and multi-year budgeting: expected to strengthen fiscal framework but benefits depend on implementation of legislative requirements.
  - The authorities met most performance criteria for end-June 2012; the cash balance indicative target was missed in September due to optimistic revenue expectations, higher development spending on constituency funds, higher tertiary education expenditure, and one-off Festival of Pacific Arts spending.
  - Capacity constraints have limited execution of development spending; authorities increased allocations to constituency funds (higher disbursement rate) and called for audits of twenty of fifty constituency funds.

### Financial sector, monetary policy, and structural reforms
- Financial sector stability:
  - Banks are stable, profitable, and well capitalized; credit growth remains weak due to limited lending opportunities.
  - Authorities concerned about high spread between deposit and lending rates and welcome technical assistance.
- Legislative and supervisory reforms:
  - Legislative reforms underway: new CBSI Act, National Provident Fund Act, and Financial Institution Act.
  - Central bank has replaced the de facto peg to the US dollar with a basket peg with weights based on largest shares of external payments.
  - Central bank prepared to tighten monetary policy if domestic inflation pressures re-emerge.
- Financial inclusion:
  - Central bank promoting financial inclusion, including expansion of mobile phone banking; access in remote regions remains limited.

*Sources: Country authorities; and staff estimates and projections; Press Release No. 12/464; Press Release No. 12/479.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12333.pdf_