## _cr13169

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### Key facts and context
- Vanuatu: around 80 islands; about 250,000 inhabitants.
- Location: about 1,200 miles northeast of Brisbane and 600 miles west of Fiji.
- Income per capita: around $3,000.
- Credit to the private sector: 70 percent of GDP (highest among Pacific islands).
- Earlier deregulation in telecom and aviation has boosted growth and improved the business climate.

### Recent developments (Staff summary)
- Political
  - October 2012 elections: 17 parties gained representation in parliament.
  - Prime minister elected in October 2012 resigned in March 2013; succeeded by Prime Minister Moana Carcasses Kalosil.
- Real economy and prices
  - Output growth in 2012: estimated around 2¼ percent.
  - Inflation: 0.8 percent y/y in December 2012.
- External sector and reserves
  - Current account deficit: narrowed to 6¼ percent of GDP in 2012 (from over 8 percent of GDP in 2011).
  - Net international reserve (NIR) coverage: rose to 7 months of prospective imports.
  - At end-2012, coverage of NIR of foreign-currency deposits: 96 percent; coverage of NIR of broad money: 29 percent.
- Fiscal
  - Fiscal deficit in 2012: estimated at 1½ percent of GDP (down from 2¼ percent in 2011).
- Financial sector
  - Private sector credit growth slowed to 6.4 percent y/y in January 2013.
  - NPLs: peaked at 9 percent in mid-2012; 8 percent in December 2012.
  - Credit-to-deposit ratio: almost 100 percent.
  - Foreign-currency credit: about one-quarter of total credit.
  - Foreign-currency deposits: fell from over one-half of total deposits in 2008 to one-third in 2012.
  - Authorities stepped up banking supervision; special onsite credit review in late 2011; credit registry began operations in mid-2012.

### Outlook and scenarios (Staff projections)
- Near-term (2013)
  - Output growth forecast: 3¼ percent.
  - Inflation forecast: 1¾ percent y/y.
  - Current account: projected to decline somewhat further; overall balance of payments to remain in surplus.
  - Government budget: targets a small overall surplus with zero net domestic financing and net repayments of external debt; envisages rising revenues and a significant increase in grants.
  - Staff projections (assuming slower revenue growth and less external assistance): imply a modest deficit of 1 percent of GDP.
- Medium-term
  - Donor-supported investment projects (including a new wharf in Port Vila and inter-island shipping investments) scheduled to start, boosting output growth to 4¾ percent by 2015.
  - Growth expected to gradually decline to 3½ percent in the long term.
  - Sustaining higher growth requires mobilizing sufficient external and domestic resources for continued public investment and reviving structural reforms.

### Risks (Box 1 summary)
- Risk tilt: Risks are tilted to the downside.
- Global/external risks
  - Deeper-than-expected slowdown in EMs: Likelihood Medium; Transmission: slowdown in Australia could reduce tourism; Potential impact: Medium.
  - Global oil shock: Likelihood Low; Transmission: higher import prices and fuel inflation; Potential impact: Low/medium.
  - Severe natural disasters (earthquakes or cyclones): Likelihood Low; Transmission: damage to transport, utilities, tourism capital stock; Potential impact: Medium.
- Domestic risks
  - Political instability: Likelihood Medium/high; Transmission: delay in structural reforms and investment projects; Potential impact: Medium.
  - Lower-than-expected implementation: Likelihood Medium; Transmission: lower public investment; Potential impact: Medium.
- Upside domestic risk
  - Decisive push for structural reforms: Likelihood Low; Transmission: boosts private sector and donor confidence raising private and public investment; Potential impact: High (permanent increase in growth potential).

### External sector and reserves
- Exchange rate assessment: level broadly appropriate (see Box 2).
- Exchange rate arrangement: adjustable peg to an undisclosed transactions-weighted basket (de facto “other managed”).
- RBV quotes daily buying and selling rates against USD, AUD, NZD, EUR, GBP, and JPY.
- Rate (USD): VT 91.65 per U.S. dollar as of March 31, 2013.
- Gross international reserves (millions of U.S. dollars): 2008: 115; 2009: 149; 2010: 161; 2011: 174; 2012: 182; 2013 (est.): 198; 2014 (proj.): 221.
- Reserves in months of prospective imports: 2008: 4.9; 2009: 6.1; 2010: 6.2; 2011: 6.9; 2012: 7.0; 2013 (est.): 7.1; 2014 (proj.): 7.4.

### Fiscal position, public debt, and financing of investment
- 2012 fiscal outcome
  - Net lending (+)/borrowing (-): -1.6 percent of GDP.
  - Revenue: 21.7 percent of GDP.
    - Domestic Revenue: 18.7 percent of GDP.
    - Grants: 3.0 percent of GDP.
  - Expenditure: 23.3 percent of GDP.
    - Expense: 21.7 percent of GDP.
    - Net acquisition of non-financial assets: 1.6 percent of GDP.
- Public debt (end-2012): 21.6 percent of GDP (Domestic: 7.7 percent; External: 13.9 percent).
- Debt sustainability
  - Debt sustainability analysis: indicates low risk of debt distress.
  - Contingent liabilities: legal proceedings about 10¾ percent of GDP; loan guarantees 3 percent of GDP.
  - Pipeline of projects (2013–2017): would raise public debt by around 4¼ percentage points by 2017; remain low/manageable under strict public expenditure restraint.
- Box 3 — Financing public investment over the longer term
  - Domestic revenue: 18½ percent of GDP.
  - Maintaining debt-to-GDP ratio broadly constant without tax policy measures would result in public investment declining to below 1 percent of GDP.
  - VAT rate increase from 12.5 percent to 15 percent could yield additional revenue but disproportionately hit poorer segments and likely generate lower revenue than an income tax (some 1–1½ percent of GDP).
  - Introduction of an income tax (wage earners and corporates) could yield between 3 and 4 percent of GDP at modest tax rates; staff estimates suggest revenue of this magnitude would allow sustaining public investment consistent with higher growth and finance a modest increase in current expenditure.

### Revenue mobilization and tax administration
- Authorities strengthening audit in the Department of Customs and Inland Revenue; introducing risk-based auditing.
- Discussions in the Melanesian Spearhead Group (MSG) to amend rules of origin to reduce revenue losses.
- New legislation under discussion to improve customs enforcement and compliance.
- Staff recommended revenue measures and administrative improvements:
  - Hire and train more staff, especially in the large taxpayers office.
  - Establish a VAT tribunal.
  - Prosecute non-payers.
  - Offset revenue losses from new trade agreements through higher excise taxes.
  - Explore streamlining the tax system and reducing exemptions further.
  - Staff recommend introduction of an income tax; prerequisites include significant administrative preparation, hiring and comprehensive training of additional staff and taxpayer education; yields would materialize only in the medium term.
- Authorities’ stance: agree boosting revenue is critical but note administrative and political difficulties with income tax; inclined toward VAT increase, administrative gains, possibly reintroducing a turnover tax, and increases in business licensing fees; requested Fund TA.

### Public investment execution and capacity constraints
- Capital spending has been among the lowest in the Pacific over the past decade.
- Capacity constraints weigh on public investment: VPMU strengthened but planning, coordinating, executing investment projects, and complying with donor requirements remain strained.
- Donor-supported investments completed in 2010–11; new projects only gradually launched despite needs and donor financing availability.

### Financial sector supervision and vulnerabilities
- Onshore financial system: four banks (three foreign-owned branches/subsidiaries) and four insurance companies (two local).
- NPLs: 9 percent peak in mid-2012; 8 percent December 2012.
- Credit financed by drawdown of commercial banks’ net foreign assets (NFA); net foreign assets declined: 2008 40,878; 2009 33,409; 2010 21,876; 2011 20,113; 2012 18,847; Jan. 2013 18,613 (millions of vatu).
- Total broad money (end-period, millions of vatu): 2008 59,873; 2009 60,146; 2010 56,552; 2011 57,287; 2012 56,930; Jan. 2013 56,637.
- Credit to the private sector (percent of GDP, Table 4 memorandum): 53.2 60.3 64.6 68.2 70.3 70.1 (2008–Jan. 2013 series).
- Foreign currency deposits/total deposits (percent): 51.3 48.4 37.2 33.2 33.5 33.5 (2008–Jan. 2013 series).
- Staff recommendations for financial sector
  - Require assigned capital for foreign bank branches (planned).
  - Shift to risk-based supervision.
  - RBV to conduct follow-up onsite review of NPLs; implement prior recommendations and write off existing NPLs more aggressively.
  - Monitor banks’ and system-wide exposure to foreign exchange risk and property market developments; consider regulations to limit foreign currency risks.
  - Consider rules to reflect unhedged foreign currency borrower risk (additional provisioning or higher risk weights).
  - Review liquidity requirements prudentially and strengthen liquidity cushions.
  - Review Vanuatu National Provident Fund (VNPF) operations and clarify mandate to focus on members’ returns and asset safety.

### Monetary and exchange rate policy guidance
- Peg to an undisclosed basket of currencies remains an appropriate anchor.
- Monetary policy objectives: maintain high NIR and contain inflation within RBV’s target range of 0–4 percent.
- RBV lowered rediscount rate from 6 to 5.5 percent in April (signaling).
- RBV should monitor credit developments and tighten policy if required to protect reserves.

### AML/CFT and institutional capacity
- APG mutual evaluation 2006: Vanuatu did not pass 11 out of 16 core/key recommendations.
- 2011: placed under “Enhanced Mutual Evaluation Follow-Up”.
- Vanuatu enacted more comprehensive AML/CFT legislation and established a Financial Intelligence Unit (FIU); effective implementation and enforcement remain to be demonstrated.
- FIU: severely understaffed; personnel and financial resources need significant increases; has prepared several cases for prosecution.
- Vanuatu to present detailed AML/CFT progress report to APG membership at July 2013 annual meeting.

### Structural reforms to support sustainable growth (staff recommendations)
- Reform government business enterprises (GBEs)
  - Enhance accountability, strengthen governance, clarify objectives.
  - Introduce new policy framework for GBEs; consider privatization for some GBEs; close entities slated for liquidation.
  - There are 21 GBEs: 5 regulatory entities and 16 fully or partially state-owned enterprises.
- Civil service reform
  - Ensure civil service is well-educated, well-staffed, well-paid while avoiding unproductive employment.
  - Focus scarce resources on investment promotion and business service delivery; consider private sector involvement for some activities.
- Improve the business climate
  - Lower costs of key inputs such as energy and trading; strengthen regulators where natural monopolies exist.
  - Streamline procedures (electronic business registration, one-stop shop).
  - Improve land market: complete land registry data and strengthen dispute resolution mechanisms.
- Develop new markets for tourism: geographic diversification and enhancing value added; requires resources for promotional campaigns and collaboration with external partners.

### Debt sustainability analysis (LIC DSA) — assumptions and outcomes
- Key assumptions
  - GDP growth peaks at 4¾ percent in 2015 as donor-financed investment projects are implemented; long-run growth declines to 3½ percent.
  - GDP deflator in US$ terms: rises gradually to 2¾ percent in the long run.
  - Primary fiscal deficit stabilizes at about ½ percent of GDP (overall deficit about 1½ percent of GDP).
  - Foreign aid projected to increase in next few years then decline; roughly 9 percent of total aid in long run assumed to be concessional loans.
  - Current account deficit projected around 5 percent in the longer run, financed by FDI inflows and capital grants.
- External debt sustainability
  - Total external debt projected to increase to 26¾ percent of GDP by 2016 before declining.
  - PPG external debt projected to increase to 15¼ percent of GDP by 2016 before declining.
  - Present value of PPG external debt, PPG debt service to exports, and PPG debt service to revenue remain well below thresholds under baseline and stress tests.
- Public debt sustainability
  - Public sector debt increases to 26 percent of GDP in 2018, then broadly stabilizes.
  - Stress test: realization of contingent liabilities equal to 10 percent of GDP would result in equivalent increase in debt-to-GDP over the longer term.
  - A growth shock or lower long run growth poses larger risk to public debt sustainability.
- Staff assessment: Vanuatu is at low risk of debt distress; external and public debt levels are low and manageable under baseline.

### DSA selected numeric highlights and projections (preserve original table values)
- Real GDP (annual percent change, Est./Proj. 2011–18): 1.4 2.3 3.3 4.2 4.8 4.5 4.3 4.0.
- Consumer prices (period average, 2011–18): 0.7 1.4 1.4 1.9 2.3 2.8 3.0 3.0.
- Government finances (percent of GDP, 2011–18):
  - Revenue: 22.4 21.7 22.7 23.9 23.6 23.1 22.5 21.9.
  - Expenditure: 24.6 23.3 23.7 26.0 26.6 26.7 24.8 24.0.
  - Net lending (+)/borrowing (-): -2.2 -1.6 -1.0 -2.1 -3.0 -3.6 -2.3 -2.0.
  - Public debt (end of period): 20.9 21.6 21.6 22.5 24.0 25.9 26.4 26.7.
- Balance of payments (percent of GDP, 2011–18):
  - Current account: -8.1 -6.3 -5.9 -6.4 -7.3 -7.5 -6.5 -6.2.
  - Trade balance: -24.6 -25.2 -24.6 -25.3 -25.9 -25.9 -23.8 -23.0.
  - Tourism receipts: 28.7 33.2 32.7 32.5 31.9 31.3 29.7 28.8.
  - Gross international reserves (millions of U.S. dollars): 174 182 198 221 257 290 304 305.
  - Reserves in months of prospective imports: 6.9 7.0 7.1 7.4 8.2 9.5 9.7 9.2.

### Medium-term baseline projections (summary from DSA/Informational Annex)
- Real GDP (annual percent change, 2011–18 series): 1.4 2.3 3.3 4.2 4.8 4.5 4.3 4.0.
- Consumer prices (period average, 2011–18 series): 0.7 1.4 1.4 1.9 2.3 2.8 3.0 3.0.
- Current account (percent of GDP, 2011–18 series): -8.1 -6.3 -5.9 -6.4 -7.3 -7.5 -6.5 -6.2.

### Macro-critical areas and coordination with development partners
- Macro-critical areas identified jointly with World Bank: (i) strengthen medium-term fiscal framework and generate more revenues (including income tax option); (ii) safeguard financial stability by strengthening supervision; (iii) improve basic infrastructure (seaports, airports, urban amenities); (iv) structural reforms to strengthen competition and business service delivery.
- Technical assistance and regional engagement: LEG, MCM, PFTAC, and STA provided TA on AML/CFT, banking supervision, reserve management, tax and fiscal accounts, tax administration and policy, balance of payments, and national accounts.
- Resident Representative office for the Pacific Islands opened September 2010 in Suva, Fiji; Mr. Yongzheng Yang is the Resident Representative.
- PFTAC assistance: upgrading government finance statistics to 2001 GFS Manual; assisting rebasing constant price GDP to 2010 base year and developing a quarterly GDP measure; FMIS assessment in April 2009; macro assistance including financial programming framework and inflation model.

### Article IV timing, IMF relations, and Fund positions (as of March 31, 2013)
- Article IV consultation cycle: 24-month.
- Previous Article IV consultation: March 2–10, 2011; concluded April 22, 2011 (Country Report No. 11/120).
- Quota: 17.00 SDR Million (100.00 percent).
- Fund holdings of currency: 14.51 SDR Million (85.33 percent).
- Reserves tranche position: 2.50 SDR Million (14.68 percent).
- Net cumulative SDR allocations: 16.27 SDR Million (100.00 percent); holdings: 1.52 SDR Million (9.37 percent).
- Projected payments to the Fund (charges/interest): 0.01 (SDR million) in each of 2013, 2014, 2015, 2016, and 2017.

### Statistical and data issues
- Data provision: some shortcomings but broadly adequate for surveillance.
- National accounts: work underway to rebase constant price GDP using 2010 base year; PFTAC assistance to develop quarterly GDP.
- CPI: weights based on 1998 household surveys; cover only Port Vila and Luganville; CPI rebasing underway using 2010 Household Income and Expenditure Survey.
- Government finance statistics: central government coverage only; excludes public enterprises, provincial governments, municipalities, grant bodies, and other extra-budgetary units.
- External sector: recommendations to improve compilation of offshore banking data, coverage/classification of public external debt, and FDI approval forms to identify new investments.
- GDDS participant since April 2004; no data ROSC available.
- Reporting to STA: exchange rate and reserves through October 2012; monthly monetary statistics through August 2012; balance of payments to 2011 (inconsistent); quarterly CPI through Q3 2012; annual trade figures through 2011; annual GFS through 1990 intermittently.

### Executive Board assessment and recommendations (summarized)
- Directors commended prudent macroeconomic and financial policies.
- Exchange rate peg: remains appropriate anchor; monitor monetary conditions and tighten if needed.
- Fiscal: spending needs will put pressure on fiscal position; welcome strengthening tax administration and consideration of new revenue measures; underscore advantages of an income tax for revenue yield and distributional impact.
- Debt management: maintain conservative approach; seek external financing only on concessional terms; phase projects and partner with private sector.
- Financial sector and AML/CFT: further strengthen supervision; consider regulations limiting banks’ net open FX positions; address liquidity and credit risks; speed up AML/CFT implementation and enforcement.

### Key selected statistics (preserve reported series)
- Real GDP: 3.3 (2009), 1.6 (2010), 1.4 (2011), 2.3 (2012), 3.3 (2013), 4.2 (2014).
- Consumer prices (period average): 5.2 (2009), 2.7 (2010), 0.7 (2011), 1.4 (2012), 1.4 (2013), 1.9 (2014).
- Consumer prices (end period): 2.4 (2009), 3.3 (2010), 1.2 (2011), 0.8 (2012), 1.8 (2013), 2.0 (2014).
- Revenue (percent of GDP): 26.0 (2009), 24.6 (2010), 22.4 (2011), 21.7 (2012), 22.7 (2013), 23.9 (2014).
- Net lending (+)/borrowing (-): -0.8 (2009), -2.5 (2010), -2.2 (2011), -1.6 (2012), -1.0 (2013), -2.1 (2014).
- Public debt (end of period): 20.5 (2009), 19.4 (2010), 20.9 (2011), 21.6 (2012), 21.6 (2013), 22.5 (2014).
- Gross international reserves (millions of U.S. dollars): 148.6 (2009), 161.4 (2010), 173.8 (2011), 182.2 (2012), 197.7 (2013), 221.3 (2014).
- Reserves in months of prospective imports: 6.1 (2009), 6.2 (2010), 6.9 (2011), 7.0 (2012), 7.1 (2013), 7.4 (2014).
- Nominal GDP (in millions of U.S. dollars): 610 (2009), 701 (2010), 786 (2011), 787 (2012), 827 (2013), 865 (2014).

### Staff appraisal — consolidated policy guidance
- Maintain cautious macroeconomic policies and conservative debt financing.
- Monetary policy: geared toward maintaining high international reserves and low inflation; tighten if reserves decline or inflationary pressures emerge.
- Strengthen supervision: introduce regulations limiting net open foreign exchange positions; monitor liquidity and credit risks; shift to risk-based supervision.
- Revenue measures: new revenue measures are needed to fund infrastructure and social services while keeping debt low; staff recommend introduction of an income tax as the option expected to yield sufficient resources and improve after-tax income distribution; preparatory work needed soon.
- Use higher revenues to strengthen, not broaden, the state: prioritize public investments, maintenance of public capital stock, and a well-educated, well-paid, and well-staffed civil service while concentrating state activities where impact is highest.
- Carefully assess financing options for large infrastructure projects; consider phasing investments and private sector involvement; prefer grants and additional domestic revenue where possible.

*Source: INTRODUCTION and subsequent sections — IMF staff report excerpt (_cr13169)._

### INTRODUCTION __________________________________________________________________________________  3

### INTRODUCTION

### Key facts and context
- Vanuatu is a small island economy in the Pacific, consisting of around 80 islands, and has about 250,000 inhabitants.
- Situated about 1,200 miles northeast of Brisbane and 600 miles west of Fiji.
- Vanuatu’s income per capita is around $3,000.
- The government is relatively small; credit to the private sector is 70 percent of GDP (the highest among Pacific islands).
- Earlier deregulation in telecom and aviation has boosted growth and improved the business climate.

### Recent developments (Staff summary)
- Political:
  - October 2012 elections: 17 parties gained representation in parliament.
  - Prime minister elected in October 2012 resigned in March 2013 and was succeeded by Prime Minister Moana Carcasses Kalosil.
- Real economy and prices:
  - Output growth in 2012 is estimated to have accelerated to around 2¼ percent, driven by a strong recovery in tourism.
  - Inflation: 0.8 percent y/y in December (2012).
- External sector and reserves:
  - Current account deficit narrowed to 6¼ percent of GDP in 2012 (from over 8 percent of GDP in 2011).
  - Net international reserve (NIR) coverage rose to 7 months of prospective imports.
- Fiscal:
  - Fiscal deficit estimated at 1½ percent of GDP in 2012, down from 2¼ percent in 2011.
- Financial sector:
  - Private sector credit growth slowed to 6.4 percent y/y in January 2013.
  - Authorities stepped up supervision of the banking system.
  - Revenue-to-GDP ratio remains low compared to other Pacific islands; administrative improvements made to raise revenue.
  - Authorities considering tax policy measures to create additional fiscal space in the medium term.

### Outlook and scenarios (Staff projections)
- Near-term (2013):
  - Output growth forecast to rise to 3¼ percent driven by continued tourism growth and some private sector investment projects.
  - Inflation expected to pick up to 1¾ percent y/y.
  - Current account projected to decline somewhat further; overall balance of payments to remain in surplus.
  - Government budget targets a small overall surplus with zero net domestic financing and net repayments of external debt; envisages rising revenues and a significant increase in grants.
  - Staff projections (assuming slower revenue growth and less external assistance) imply a modest deficit of 1 percent of GDP.
- Medium-term:
  - Donor-supported investment projects (including a new wharf in Port Vila and inter-island shipping investments) are scheduled to start, boosting output growth to 4¾ percent by 2015.
  - Growth expected to gradually decline to 3½ percent in the long term.
  - Sustaining higher growth requires mobilizing sufficient external and domestic resources for continued public investment and reviving structural reforms.

### Risks (Box 1 summary)
- Risk tilt: Risks are tilted to the downside.
- Global/external risks:
  - Deeper-than-expected slowdown in EMs: Likelihood Medium; Transmission: slowdown in Australia could reduce tourism; Potential impact: Medium (growth slowdown, cushioned by continued aid flows).
  - Global oil shock: Likelihood Low; Transmission: higher import prices and fuel inflation; Potential impact: Low/medium (large reserves can absorb BOP shock, and inflation is low).
  - Severe natural disasters (earthquakes or cyclones): Likelihood Low; Transmission: damage to transport, utilities, tourism capital stock; Potential impact: Medium (relatively low capital intensity).
- Domestic risks:
  - Political instability: Likelihood Medium/high; Transmission: delay in structural reforms and investment projects; Potential impact: Medium (lower growth).
  - Lower-than-expected implementation: Likelihood Medium; Transmission: lower public investment; Potential impact: Medium (lower growth).
- Upside domestic risk:
  - Decisive push for structural reforms: Likelihood Low; Transmission: boosts private sector and donor confidence raising private and public investment; Potential impact: High (permanent increase in growth potential).

### Securing stability — major assessments and policy guidance
- External sector and reserves:
  - Current account deficits remain sizable but are comfortably financed by foreign direct investment inflows and capital grants.
  - At end-2012, coverage of NIR of foreign-currency deposits stood at 96 percent, and at 29 percent of broad money.
  - The level of the exchange rate is broadly appropriate (see Box 2: Exchange Rate Assessment).
- Public finances:
  - Debt sustainability analysis indicates low risk of debt distress.
  - At end-2012, total public and public external debt remained low at 21½ and 14 percent of GDP, respectively.
  - Projected pipeline of loans would increase public debt by 2017 but remain low and manageable under strict public expenditure restraint.
  - Significant contingent liabilities: legal proceedings about 10¾ percent of GDP and loan guarantees 3 percent of GDP.
- Financial system vulnerabilities and recent trends:
  - Onshore financial system: four banks (three foreign-owned branches/subsidiaries) and four insurance companies (two local).
  - NPLs peaked at 9 percent of total loans in mid-2012; NPL ratio was 8 percent in December (2012).
  - Credit-to-deposit ratio has reached almost 100 percent, creating liquidity risks.
  - Foreign-currency credit is about one-quarter of total credit; foreign-currency deposits fell from over one-half of total deposits in 2008 to one-third in 2012.
  - Lending financed by a drawdown of commercial banks’ net foreign assets (NFA); resumed repatriation of foreign-currency deposits would constrain FX lending.
  - Property market weakness and potential exposure of banks to credit risks if property downturn expands.
  - RBV actions: special onsite credit review in late 2011; increased reporting frequency; credit registry began operations in mid-2012.
- Monetary and exchange rate policy guidance:
  - The peg to an undisclosed basket of currencies remains an appropriate anchor.
  - Monetary policy objectives: maintain high NIR and contain inflation within RBV’s target range of 0–4 percent.
  - RBV lowered the rediscount rate from 6 to 5.5 percent in April (signaling).
  - Authorities should monitor credit developments to avoid buildup of risks as growth picks up.
- Fiscal policy guidance:
  - Maintain cautious borrowing policies to protect fiscal cushions given significant fiscal contingencies.
  - Carefully assess financing of new projects (e.g., airport system upgrading) for tax productivity and debt sustainability.
  - Evaluate risks of alternative financing models (e.g., public-private partnerships); consider phasing large projects.
  - Prefer grants and additional domestic revenue where possible.
- Financial sector policy recommendations:
  - Require assigned capital for foreign bank branches (planned).
  - Shift to risk-based supervision to address systemic risks.
  - RBV should conduct a follow-up onsite review of NPLs to implement prior recommendations and write off existing NPLs more aggressively.
  - RBV should monitor banks’ and system-wide exposure to foreign exchange risk and property market developments; consider regulations to limit foreign currency risks.
  - Consider regulations to reflect unhedged foreign currency borrower risk in bank balance sheets (additional provisioning or higher risk weights).
  - Review liquidity requirements from a prudential viewpoint and strengthen liquidity cushions due to high credit-to-deposit ratio.
  - Review Vanuatu National Provident Fund (VNPF) operations and clarify its mandate to focus on members’ returns and asset safety.

*Source: INTRODUCTION (IMF staff report).*

### 17.      The authorities broadly concurred with the staff’s views. They stressed their

### _cr13169 - 17.      The authorities broadly concurred with the staff’s views. They stressed their

### Authorities’ broad stance and immediate priorities
- Authorities concurred with staff views and stressed commitment to continue prudent fiscal policies to maintain fiscal buffers, including in the light of fiscal contingencies.
- Infrastructure investment—particularly in the airport system—is viewed as critical for future growth, but authorities are conscious of risks involved in debt financing such projects and are considering options including private sector involvement.
- The exchange rate regime is considered a key anchor for maintaining stability and authorities are determined to maintain it.
- Authorities consider there is room for higher credit growth to support economic activity.
- Authorities emphasized a conservative approach to financial sector supervision, citing revocation of several licenses of offshore banks, and requested further technical assistance (TA) to help improve supervision along staff-suggested lines.

### Growth outlook and background
- Growth is expected to rise in 2013–15 on the back of a recovery in tourism and investment, but a broader foundation is required for sustainable long-term growth.
- Low investment poses risks to future growth; upgrading the main airport is critical to expand tourism and tap the Asian market.
- Investments to deliver public services to remote islands are needed.
- Government revenues are low compared with other Pacific islands, even as a significant share of recurrent spending—the wage bill—is comparable.

### Revenue mobilization and tax administration efforts
- Authorities are strengthening audit in the Department of Customs and Inland Revenue, including introducing risk-based auditing.
- Discussions in the Melanesian Spearhead Group (MSG) aim to amend rules of origin to reduce revenue losses from the MSG free trade agreement.
- New legislation is being discussed in parliament to improve customs enforcement and compliance.
- The government is exploring tax policy measures.

Staff views and recommended revenue measures
- Vanuatu’s cautious external borrowing and low debt level provide an important buffer; to preserve this, efforts to widen fiscal space for infrastructure and public services should come primarily from raising additional domestic revenue.
- Further administrative measures that could produce gains:
  - Hire and train more staff, especially in the large taxpayers office.
  - Establish a VAT tribunal.
  - Prosecute non-payers.
  - Offset revenue losses from new trade agreements through higher excise taxes.
  - Explore opportunities for streamlining the tax system and reducing exemptions further.
- Staff recommend introduction of an income tax; noted prerequisites:
  - Significant administrative preparation, including hiring and comprehensive training of additional staff and taxpayer education.
  - An early decision would produce higher revenue yields only in the medium term.
- To alleviate business impact, structural reforms to lower costs of doing business should be implemented simultaneously.

### Box 3 — Financing public investment over the longer term (key points)
- Capital spending in Vanuatu has been among the lowest of the Pacific islands over the past decade.
- Pipeline of projects scheduled for implementation during 2013–2017 would raise public debt by around 4¼ percentage points by 2017.
- Maintaining the debt-to-GDP ratio broadly constant over the long term without tax policy measures would result in public investment declining to below 1 percent of GDP.
- Vanuatu’s domestic revenue is 18½ percent of GDP.
- Options for domestic revenue mobilization:
  - Strengthening compliance should result in continued VAT collection improvements, but further scope is relatively narrow.
  - Raising the VAT rate from the current 12.5 percent to 15 percent could yield additional revenue relatively quickly, but would disproportionately hit poorer segments and would likely generate lower revenue than an income tax (some 1–1½ percent of GDP).
  - Introduction of an income tax, levied on both wage earners and corporates, could yield between 3 and 4 percent of GDP at modest tax rates and bring greater equity to the tax system; staff estimates suggest revenue of this magnitude would allow sustaining public investment consistent with higher growth and finance a modest increase in current expenditure.

### Capacity constraints and public investment execution
- Capacity constraints weigh on public investment; donor-supported investments completed in 2010–11, but new projects have only gradually been launched despite needs and donor financing availability.
- VPMU has been strengthened, but strain on planning, coordinating, executing investment projects, and complying with donor requirements is significant.

### Structural reforms to support sustainable growth (staff recommendations)
- Reform government business enterprises (GBEs):
  - Enhance accountability, strengthen governance, clarify objectives.
  - Introduce a new policy framework for GBEs; consider privatization for some GBEs; close entities slated for liquidation.
  - Note: there are 21 GBEs, of which 5 are regulatory entities and 16 fully or partially state-owned enterprises.
- Civil service reform:
  - Ensure civil service is well-educated, well-staffed, well-paid while avoiding unproductive employment.
  - Focus scarce resources on key areas, including investment promotion and business service delivery.
  - Consider involving private sector associations in some activities.
- Improve the business climate:
  - Lower costs of key inputs such as energy and trading; strengthen regulators where natural monopolies exist.
  - Streamline procedures and reduce time required through measures such as electronic business registration and one-stop shop support.
  - Improve the land market by completing data in the land registry and strengthening dispute resolution mechanisms.
- Develop new markets for tourism (geographic diversification and enhancing value added), requiring additional resources for sustained promotional campaigns and collaboration with external partners and investors.

### Authorities’ perspectives on reforms and taxation
- Authorities agree boosting revenue is critical to preserve low debt and reduce donor reliance, but highlight administrative and political difficulties of introducing an income tax and concerns that consumers would bear the burden and that an income tax could impact the business environment.
- Authorities seem inclined toward a combination of a VAT increase, administrative efficiency gains, possibly reintroducing a turnover tax, and increases in business licensing fees, while exploring all options and requesting Fund TA.
- Authorities concur on need to enhance business climate and GBE reform but note considerable political challenges; plan to strengthen the Public Service Commission, promote the Chamber of Commerce as the single interlocutor for business, increase capacity of the public prosecutor’s office, and maintain some reservation of activities (including in tourism) for majority-local ownership.

### AML/CFT and Financial Sector supervision
- APG mutual evaluation in 2006 assessed Vanuatu as not passing 11 out of 16 core/key recommendations.
- In 2011 Vanuatu was placed under “Enhanced Mutual Evaluation Follow-Up” and subject to close APG monitoring.
- Since then Vanuatu enacted more comprehensive AML/CFT legislation and established a Financial Intelligence Unit (FIU), but effective implementation and enforcement still need demonstration.
- FIU personnel and financial resources need significant increases; FIU, though severely understaffed, has prepared several cases for prosecution.
- A detailed report by Vanuatu on AML/CFT progress will be analyzed and discussed by the APG membership at its annual meeting in July 2013.

### Staff appraisal — macro, fiscal, and financial policy guidance
- Continue cautious macroeconomic policies and conservative approach to debt financing.
- Monetary policy should remain geared toward maintaining high international reserves and low inflation; RBV should monitor monetary conditions as growth picks up and tighten policies if needed.
- Strengthen supervision further by introducing regulations limiting net open foreign exchange positions; monitor liquidity and credit risks.
- New revenue measures are needed to maintain low debt while funding infrastructure, maintenance and social services. Staff recommend introduction of an income tax as the option expected to yield sufficient resources and improve after-tax income distribution; a decision is needed soon given extensive preparatory requirements.
- Higher revenues should be used to strengthen, not broaden, the state: prioritize public investments, maintenance of public capital stock, and a well-educated, well-paid, and well-staffed civil service while concentrating state activities where impact is highest.
- Reforms to increase civil service effectiveness, enhance competition in key sectors, and improve land accessibility will lower business costs and help offset pass-through of higher taxes.
- Assess financing options for large infrastructure projects carefully (e.g., airport upgrade). Consider phasing investments and involving the private sector while carefully assessing risks to public finances.

*Italic: Source — _cr13169 (IMF staff report excerpt).*

### 34.      It is recommended that the next Article IV consultation be held on the 24-month cycle.

### 34. It is recommended that the next Article IV consultation be held on the 24-month cycle.

### Article IV timing and Fund relations
- Vanuatu is on a 24-month Article IV consultation cycle.
- The previous Article IV consultation took place during March 2–10, 2011, and was concluded on April 22, 2011 (Country Report No. 11/120).
- As of March 31, 2013:
  - Quota: 17.00 SDR Million (100.00 percent).
  - Fund holdings of currency: 14.51 SDR Million (85.33 percent).
  - Reserves tranche position: 2.50 SDR Million (14.68 percent).
  - Net cumulative SDR allocations: 16.27 SDR Million (100.00 percent); holdings: 1.52 SDR Million (9.37 percent).
- Projected payments to the Fund (charges/interest): 0.01 (SDR million) in each of 2013, 2014, 2015, 2016, and 2017.

### Exchange arrangements and reserve management
- Since 1988, Vanuatu has maintained an adjustable peg exchange rate arrangement.
- The vatu is linked to a transactions weighted (trade and tourism receipts) basket of currencies; weights and composition are not publicly disclosed and are adjusted periodically.
- The de facto classification is “other managed,” because composite weights are not disclosed.
- The Reserve Bank of Vanuatu (RBV) quotes daily buying and selling rates against the U.S., Australian, and New Zealand dollars; the euro; the U.K. pound; and the Japanese yen.
- The rate in terms of the U.S. dollar as of March 31, 2013 was VT 91.65 per U.S. dollar.
- Gross international reserves (selected series):
  - 2008: 115 (millions of U.S. dollars)
  - 2009: 149
  - 2010: 161
  - 2011: 174
  - 2012: 182
  - 2013 (est.): 198
  - 2014 (proj.): 221
- Reserves in months of prospective imports (selected series):
  - 2008: 4.9
  - 2009: 6.1
  - 2010: 6.2
  - 2011: 6.9
  - 2012: 7.0
  - 2013 (est.): 7.1
  - 2014 (proj.): 7.4

### Recent macroeconomic and financial developments (highlights)
- Output and prices (selected annual changes):
  - Real GDP: 2012 estimate 2.3 percent; 2013 estimate 3.3 percent; 2014 projection 4.2 percent (Table 1: Real GDP 6.5 3.3 1.6 1.4 2.3 3.3 4.2 across 2008–14).
  - Consumer prices (period average): 2012 1.4 percent; 2013 1.4 percent; 2014 projection 1.9 percent.
  - Consumer prices (end period): 2012 0.8 percent; 2013 1.8 percent; 2014 projection 2.0 percent.
- Fiscal position (percent of GDP, Table 1 / Table 3):
  - Revenue (2008–14 series): 27.0 26.0 24.6 22.4 21.7 22.7 23.9 (Est./Proj. 2008–14).
  - Domestic Revenue (2008–14 series): 20.5 18.9 18.1 18.3 18.7 18.4 18.5.
  - Grants (2008–14 series): 6.4 7.1 6.5 4.1 3.0 4.3 5.3.
  - Expenditure (2008–14 series): 27.0 26.8 27.1 24.6 23.3 24.3 26.0.
  - Net lending (+)/borrowing (-) (2008–14 series): 0.0 -0.8 -2.5 -2.2 -1.6 -1.0 -2.1.
  - Public debt (end of period, percent of GDP): 20.6 20.5 19.4 20.9 21.6 20.2 21.6 22.5 (Table 3 memorandum).
- External sector (Table 2):
  - Current account balance (in millions of U.S. dollars, selected series): -48 -37 -38 -63 -50 -49 -55 (2008–14).
  - Current account balance (percent of GDP): -7.9 -6.1 -5.4 -8.1 -6.3 -5.9 -6.4 (2008–14).
  - Trade balance (in millions of U.S. dollars, 2008–14): -201 -181 -192 -193 -198 -203 -218.
  - Tourism receipts (in percent of GDP, Table 1): 2008 28.1; 2009 30.6; 2010 30.9; 2011 28.7; 2012 33.2; 2013 32.7; 2014 proj. 32.5.
  - Gross international reserves (in millions of U.S. dollars): see reserve series above.
- Monetary and credit (selected highlights, Table 4):
  - Net foreign assets (end-period, millions of vatu): 2008 40,878; 2009 33,409; 2010 21,876; 2011 20,113; 2012 18,847; Jan. 2013 18,613.
  - Total broad money (end-period, millions of vatu): 2008 59,873; 2009 60,146; 2010 56,552; 2011 57,287; 2012 56,930; Jan. 2013 56,637.
  - Credit to the private sector (in percent of GDP, Table 4 memorandum): 53.2 60.3 64.6 68.2 70.3 70.1 (2008–Jan. 2013 series).
  - Foreign currency deposits/total deposits (percent): 51.3 48.4 37.2 33.2 33.5 33.5 (2008–Jan. 2013 series).
  - Net foreign assets (annual percent change): 9.0 -18.3 -34.5 -8.1 -6.3 -9.9 (2008–Jan. 2013 series).
- Vulnerability indicators (Table 6, selected):
  - Public debt (percent of GDP): 20.6 20.5 19.4 20.9 21.6 (2008–12).
  - Broad money (percent change, 12-month basis): 13.2 0.5 -6.0 1.3 -0.6 (2008–12).
  - Nonperforming loans (share of total loans): 9.9 7.3 4.9 8.1 8.1 (2008–12).
  - Regulatory capital to risk-weighted assets: 36.0 33.7 30.6 21.3 20.5 (2008–12).
  - Total external debt (percent of GDP): 16.4 16.7 14.5 14.8 13.9 (2008–12).
  - Gross official reserves (millions of U.S. dollars): 115.3 148.6 161.4 173.8 182.2 (2008–12).
  - Exchange rate (vatu per U.S. dollar, end of period): 112.6 97.9 93.2 93.6 91.7 (2008–12).

### Medium-term baseline projections (summary)
- Real GDP (annual percent change, 2011–18 series): 1.4 2.3 3.3 4.2 4.8 4.5 4.3 4.0 (Est./Proj. 2011–18, Table 5).
- Consumer prices (period average, 2011–18 series): 0.7 1.4 1.4 1.9 2.3 2.8 3.0 3.0.
- Government finances (percent of GDP, 2011–18 series):
  - Revenue: 22.4 21.7 22.7 23.9 23.6 23.1 22.5 21.9.
  - Expenditure: 24.6 23.3 23.7 26.0 26.6 26.7 24.8 24.0.
  - Net lending (+)/borrowing (-): -2.2 -1.6 -1.0 -2.1 -3.0 -3.6 -2.3 -2.0.
  - Public debt (end of period): 20.9 21.6 21.6 22.5 24.0 25.9 26.4 26.7.
- Balance of payments (percent of GDP, 2011–18 series):
  - Current account: -8.1 -6.3 -5.9 -6.4 -7.3 -7.5 -6.5 -6.2.
  - Trade balance: -24.6 -25.2 -24.6 -25.3 -25.9 -25.9 -23.8 -23.0.
  - Tourism receipts: 28.7 33.2 32.7 32.5 31.9 31.3 29.7 28.8.
  - Gross international reserves (millions of U.S. dollars): 174 182 198 221 257 290 304 305.
  - Reserves in months of prospective imports: 6.9 7.0 7.1 7.4 8.2 9.5 9.7 9.2.

### Technical assistance and regional engagement
- Technical assistance has been provided by LEG, MCM, PFTAC, and STA on anti-money laundering, banking supervision and regulation, reserve management, tax and fiscal accounts, tax administration and policy, balance of payments, and national accounts.
- The resident representative office for the Pacific Islands, including Vanuatu, was opened in September 2010 in Suva, Fiji. Mr. Yongzheng Yang is the Resident Representative.
- PFTAC engagement (selected):
  - Assisted with upgrading government finance statistics to the 2001 GFS Manual (2010–2011) and ongoing support via a regional GFS project managed by STA.
  - Helped finalize and publish GDP by expenditure approach and is assisting with rebasing constant price GDP to a 2010 base year; future plans include developing a quarterly GDP measure.
  - Provided an FMIS assessment in April 2009 and macroeconomic assistance including a financial programming framework and an empirical-based inflation model integrated into that framework.

*Prepared by the Asia and Pacific Department (Informational Annex for the 2013 Article IV Consultation).*

### 1.      A representative of the World Bank accompanied the IMF Article IV team on their visit

### _cr13169 - 1.      A representative of the World Bank accompanied the IMF Article IV team on their visit

### Mission, coordination, and timeline
- A representative of the World Bank accompanied the IMF Article IV team on their visit to Vanuatu on April 2–10, 2013 and participated in discussions with the team and the Government of Vanuatu.
- The Bank and Fund country teams exchanged views on key macroeconomic prospects, fiscal policy priorities, and fiscal sustainability, and agreed to coordinate the two teams’ work over the period April 2013 to March 2014.

### Agreed main macroeconomic issues and policy priorities
- Near- and medium-term growth outlook, appropriate fiscal and monetary policies over the near term, maintaining a sound fiscal course over the medium term, and addressing structural issues to sustain economic growth over the longer term.
- More specifically:
  - Near-term growth outlook
    - Key determinants of growth: Continued growth in the tourism sector of the economy and the role played by donor-financed construction activities.
  - Fiscal policy
    - Appropriate fiscal stance in 2013 and 2014.
    - Revenue mobilization to support improvements in key service delivery areas such as health and education and to enhance growth prospects, including via the introduction of an income tax in the medium term and near-term policies such as increased compliance and enforcement, and a continued reduction in exemptions.
  - Monetary policy
    - Effectiveness of monetary policy in managing economic activity.
  - Financial policy
    - The implications of declining net foreign assets for bank soundness.
    - Continuing efforts to strengthen financial supervision and regulation.
  - Structural issues
    - Improving basic infrastructure including transport, electricity, telecommunications and urban amenities.
    - Strengthening the investment climate, including through enhanced competition.
    - Improving investor services, including through a one-stop shop.
    - Improving education and health services.

### Macro-critical areas identified
- The teams identified four macro-critical areas central to a sound macro-financial framework and sustained growth:
  - (i) Continue efforts to strengthen the medium-term fiscal framework and explore options to generate more revenues to counter the decline in collections due to trade liberalization and to mobilize more funds to finance social and physical infrastructure, including through the introduction of income taxation;
  - (ii) Continue efforts to safeguard financial stability by further strengthening financial supervision and regulation;
  - (iii) Improve basic infrastructure such as seaports, airports and urban amenities to support reduced costs and increased economic activity;
  - (iv) Structural reforms to strengthen competition and improve business service delivery to bolster the underlying growth potential of the economy.

### Requests for information and collaboration between teams
- Fund team requests:
  - To be kept informed of progress in various projects and analytical work undertaken by the Bank in order to use resources efficiently and avoid work overlaps.
- Bank team requests:
  - The Fund to make available to the Bank its latest macroeconomic assessment and macroeconomic data from time to time as inputs to the Bank’s lending and non-lending operations.

### Division of tasks and disagreements
- No disagreements among the two teams emerged on the key issues, challenges, or on the division of tasks to tackle these.
- Further details on collaboration, as necessary, will be agreed at the technical level as work progresses.

### Bank and Fund planned activities in macro-critical structural reform areas (April 2013–March 2014) — summary of planned products and expected delivery
- Bank Work Program (status)
  - Support to Department of Energy, Mines and Mineral Resources to extend electricity connections to lower income households — Ongoing
  - Support to regulatory reform in telecoms — Ongoing
  - Support to Government in identifying appropriate level and mix of financing in the health sector — Ongoing
  - Institutional strengthening to support labor migration schemes — Ongoing
- Fund Work Program (products and expected delivery dates)
  - Surveillance (Article IV consultation concluded), including a joint debt sustainability analysis — June 2013
  - Technical assistance: strengthening supervision (PFTAC) — December 2013
  - Technical assistance: revenue options (PFTAC) — December 2013

### Relations with the Asian Development Bank (As of April 19, 2013)
- Operational Strategy
  - AsDB Country Partnership Strategy for 2010–2014 aligned with the government’s poverty reduction strategy; focus areas: (i) transport; (ii) urban development—focus on Port Vila; and (iii) energy—energy efficiency, rural electrification, and renewable energy.
  - Support to improve enabling environment for private sector through legal and regulatory updates, better access to finance, and SOE reform.
  - Envisioned support from 2013 to 2014 of about $10.56 million in loans from the Asian Development Fund as well as $300,000 per annum in technical assistance (TA) grant support.
  - Cofinancing opportunities will be pursued with other development partners.

- Lending trends / ADF grants / portfolio status
  - Since joining AsDB in 1981, 11 loans provided for a total amount of $67.07 million and 60 TA projects for $21.82 million.
  - More than 50 percent of the loans were for infrastructure rehabilitation and more than 40 percent of the TAs were for institutional support and capacity building.
  - ADB resumed lending operations with two projects approved in late 2011: Vanuatu Interisland Shipping Project ($26.82 million), cofinanced by the New Zealand Government; and Port Vila Urban Development Project ($39.16 million), cofinanced by the Australian Government.
  - Four ongoing TA projects amounting to $3.96 million: TA7288-VAN; TA7345-VAN; TA7588-VAN; and TA8285-VAN.

- Private sector development focus areas
  - Improving the business regulatory environment: drafting a new Companies Act, Insolvency Act, and Trustee Act; advisory support for implementation and electronic companies’ registry.
  - Expanding access to financial services: support for National Bank of Vanuatu rural outreach program; diagnostic for Reserve Bank of Vanuatu and Vanuatu Financial Services Commission on microfinance regulation; support to improve outreach in rural areas.
  - State-Owned Enterprise Program: SOE reform supported through Japan Fund for Poverty Reduction; support to improve governance, transparency, and efficiency of SOEs, including possible closure or divestiture.

- Key projects and financing
  - Interisland Shipping Support Project outcomes targeted by 2014: better access to markets and social services in outer islands; stronger safety regulations and compliance; better shipping infrastructure.
    - Financing: AsDB loan $10.82 million, New Zealand government parallel grant $12.60 million, Vanuatu government $3.40 million. Implementation started in the beginning of 2013.
  - Port Vila Urban Development Project
    - AsDB concessionary loan of $5.0 million equivalent and administering a corresponding grant of $31.0 million equivalent from the Australian government.
    - Focus: urban planning, integrated storm water drainage and sanitation master plan, institutional strengthening and capacity development, provision of high priority drainage and sanitation infrastructure.
  - Energy Sector Initiatives
    - Overall access to energy estimated at 33 percent; power generation heavily dependent on diesel resulting in high power tariffs.
    - RETA-7329 Promotion of Renewable Energy in the Pacific concluded hydropower is the least cost expansion option.
    - $11 million Energy Access Project (EAP), proposed for 2014, to support increased energy access in provincial centers via expansion of distribution grids and development of low-cost renewable energy generation from hydropower; includes pilot grid-connected solar project in Luganville and regional TA on energy efficiency.

- Regional cooperation initiatives
  - Continued regional support for renewable energy and energy efficiency, climate change, coastal and marine resources management, private sector development, civil aviation management, and information and communications technology.
  - Pacific Alliance for Sustainability (Global Environment Facility funded) to build climate change adaptation capacity.
  - Regional TA for Statistical Capacity Building in the Asia and Pacific Region will continue.
  - AsDB support for Vanuatu’s participation in regional forums and collaboration with the Pacific Islands Forum.

- AsDB–World Bank joint Development Coordination Office
  - Opened in June 2010 in Port Vila to strengthen assistance, aid coordination, and aid effectiveness.

### Statistical issues (As of April 30, 2013)
- Overall assessment
  - Data provision has some shortcomings, but is broadly adequate for surveillance.
  - National accounts and external sector statistics need further improvement; coverage of government finance statistics could be expanded.

- National accounts
  - Improvements in methodology and additional data sources exist, but accuracy of recently-released, experimental expenditure-based GDP estimates could be further improved.
  - Data are compiled only on an annual basis.
  - Work underway on rebasing constant price GDP estimates using 2010 as the new base year; PFTAC providing technical assistance for rebasing, improvement of experimental expenditure-based GDP, and development of quarterly GDP estimates.

- Price statistics
  - CPI weights based on 1998 household surveys and cover only Port Vila and Luganville.
  - Work on rebasing the CPI is underway using data from the 2010 Household Income and Expenditure Survey.

- Government finance statistics
  - Budget classification broadly consistent with the 2001 GFSM.
  - Government operations data compiled for central government but exclude public enterprises, provincial governments, the two municipalities, grant bodies, and other central government extra-budgetary units.
  - Operations of the budget recorded on a cash plus invoice basis.

- Monetary statistics
  - Reserve Bank of Vanuatu reports monthly monetary data, including accounts of monetary authorities, commercial banks, and interest rates in its monthly bulletin posted on its website.
  - RBV publishes a quarterly report with wider coverage including fiscal transactions and financial soundness indicators.

- External sector statistics
  - External sector statistics mission (March 2013) key recommendations:
    - (1) Review and improve compilation of offshore banking data in the balance of payments and international investment position using information from the Financial Institutions Supervision Department;
    - (2) Improve coverage and classification of the public external debt;
    - (3) Propose to the Vanuatu Investment Promotion Authority improvements to the different application forms for foreign direct investment approvals to allow identification of new investments in Vanuatu.

- Data standards and reporting
  - Participant in the General Data Dissemination System (GDDS) since April 2004.
  - No data ROSC is available.
  - Reporting to STA: Exchange rate and reserves data reported only through October 2012. Monthly monetary statistics reported through August 2012. Annual balance of payments published through 2011 but inconsistent with data provided to the mission. Quarterly consumer price data available through Q3 2012. Annual trade figures available only through 2011. Annual GFS data through 1990 reported intermittently in the 2001 GFS format. No sub-annual fiscal data reported for publication in the IFS.

### Debt sustainability assessment — key background facts and indicators
- Vanuatu remains at a low risk of debt distress based on the Low-Income Country Debt Sustainability Assessment (LIC DSA).
- Public debt profile and recent developments:
  - In 2012, public debt rose slightly to 21.6 percent of GDP.
  - A fiscal deficit of 1.6 percent of GDP was domestically financed.
  - Total external debt declined to 25.5 percent of GDP, mainly reflecting lower private external debt and net repayments of public and publicly guaranteed (PPG) external debt, which declined to slightly below 14 percent of GDP.
  - Publicly guaranteed domestic debt (not included in the DSA baseline) amounts to 3 percent of GDP.
  - Contingent liabilities arising from potential court-imposed damages in lawsuits amount to 10¾ percent of GDP.
  - No other known contingent liabilities.
- Conclusion in the DSA
  - Vanuatu’s overall public debt level is low and should remain manageable, provided fiscal deficits remain small.
  - Under the baseline scenario, all external debt sustainability indicators are projected to remain well below their applicable thresholds.
  - Public debt is also projected to remain low, consistent with the authorities’ conservative borrowing policies.
  - Contingent liabilities arising from lawsuits (all domestic) pose a moderate risk.

*Prepared by the staffs of the International Monetary Fund and the International Development Association (excerpt).*

### 2.      The analysis is based on the standard LIC DSA framework. The key assumptions

### 2.      The analysis is based on the standard LIC DSA framework. The key assumptions

### Key Assumptions (Box 1)
- GDP growth is projected to recover to a peak of 4¾ percent in 2015 as new largely donor-financed investment projects are implemented. This is, however, well below previous investment-driven growth spurts. In the long run, growth is assumed to gradually decline to 3½ percent, below the average of the past 10 years.
- The GDP deflator in US$ terms is projected to rise gradually to 2¾ percent in the long run, in line with an inflation rate within the Reserve Bank of Vanuatu’s target band.
- The primary fiscal deficit is assumed to stabilize at about ½ percent of GDP (and the overall deficit at about 1½ percent of GDP), slightly lower than the average of the past five years and consistent with the authorities’ conservative borrowing policies and a stabilization of the public debt-to-GDP ratio. Critically, maintaining the modest deficits envisaged in the baseline scenario would compress public investment in the absence of domestic revenue measures.
- Foreign aid is projected to increase significantly in the next few years, before declining gradually as a percentage of GDP. Roughly 9 percent of total aid in the long run is assumed to be concessional loans, higher than the historical average but lower than in 2013–18 when a large, highly concessional loan is being disbursed.
- The current account deficit is projected around 5 percent in the longer run and assumed to be financed by foreign direct investment inflows and capital grants, reflecting the structure of the economy. Tourism, the main earner of foreign exchange, has significant upside potential.

### Historical and Projection Table (selected figures)
- Real GDP (percent change): Historical 4.2; 2013-18 3.6; 2019-33 4.3; Avg. (10 yrs) 3.7; 2010-15 4.0; 2016-30 (table heading alignment retained from source)
- GNFS exports (US$ terms; percent change): Historical 3.6; 2013-18 7.0; 2019-33 12.7; Avg. (10 yrs) 7.3; 2010-15 7.3
- Non-interest current account balance (percent of GDP): Historical -6.4; 2013-18 -5.0; 2019-33 -6.4; Avg. (10 yrs) -5.4; 2010-15 -4.7
- GDP deflator in US$ terms (percent change): Historical 1.2; 2013-18 2.8; 2019-33 6.3; Avg. (10 yrs) 5.7; 2010-15 3.0
- Primary balance (percent of GDP): Historical -1.4; 2013-18 -0.6; 2019-33 0.2; Avg. (10 yrs) -0.4; 2010-15 0.0

### External Debt Sustainability
- Under the baseline scenario, Vanuatu’s external debt remains sustainable.
- Total external debt is projected to increase to 26¾ percent of GDP by 2016 before declining again to levels similar to those at end-2012.
- PPG external debt is projected to increase to 15¼ percent of GDP by 2016 before declining again to levels similar to those at end-2012.
- Other key indicators of sustainability—the present value of PPG external debt, the ratio of PPG debt service to exports, and the ratio of PPG debt service to revenue—all remain well below the indicative thresholds.
- Stress tests indicate no breaching of the applicable thresholds for PPG external debt.
- Risk note: If the authorities were to increase their external borrowing significantly beyond the amounts assumed in the baseline scenario, for example to finance large infrastructure projects with uncertain tax productivity, external debt levels could quickly rise, particularly if the terms of this borrowing were to be less favorable than the baseline borrowing mix.

### Public Debt Sustainability
- Under the baseline scenario, public sector debt increases to 26 percent of GDP in 2018, and then broadly stabilizes at that level.
- This contrasts somewhat with the external DSA, where PPG external debt falls back to 2012 levels, due to amortization of old debt and a sharp slowdown in new external borrowing from 2017.
- Stress tests suggest that a realization of contingent liabilities equal to 10 percent of GDP, would result an equivalent increase in the debt-to-GDP ratio over the longer term.
- A growth shock or lower long run growth poses a bigger risk to public debt sustainability over the longer term.
- Risk note: Should the government debt-finance large infrastructure projects, public debt levels would rise commensurately.

### Staff Assessment
- Vanuatu is at a low risk of debt distress; external and public debt levels are low.
- While they are projected to rise in the next few years, they remain manageable, and all indicators of vulnerability remain well below the applicable thresholds, even under stress tests.

*Prepared jointly with the World Bank in accordance with the Debt Sustainability Framework for low-income countries; debt data provided by the Vanuatu authorities (May 16, 2013).*

### 8.      However, to contain public and external debt at prudent levels, the authorities will

### 8.      However, to contain public and external debt at prudent levels, the authorities will

### Overview and context
- To contain public and external debt at prudent levels, the authorities will need to continue the cautious borrowing strategy of the past.
- Combined with significant spending needs for infrastructure investment and maintenance, as well as in social sectors, this requires that domestic revenues be increased significantly.

### Debt indicators and projections (selected figures and ratios)
- Public sector debt (percent of GDP): 19.4 (2010); 20.9 (2011); 21.6 (2012); 25.4 (2018); 26.0 (2015); 25.5 (2016); 26.6 (2019-33 average).
- Of which: foreign-currency denominated (percent of GDP): 14.5 (2010); 14.8 (2011); 13.9 (2012); 15.3 (2018); 14.0 (2019-33 average).
- Change in public sector debt: -1.2 (2010); 1.5 (2011); 0.7 (2012); 0.0 (2019-33 average).
- Identified debt-creating flows (percent of GDP): 0.9 (2010); 1.6 (2011); 0.6 (2012); 0.0 (2019-33 average).
- Primary deficit (percent of GDP): 2.0 (2010); 1.7 (2011); 1.0 (2012); 1.4 (2019-33 average).
- Revenue and grants (percent of GDP): 24.6 (2010); 22.4 (2011); 21.6 (2012); 22.5 (2019-33 average).
- Of which: grants (percent of GDP): 6.5 (2010); 4.1 (2011); 3.0 (2012); 2.4 (2019-33 average).
- Primary (noninterest) expenditure (percent of GDP): 26.6 (2010); 24.0 (2011); 22.6 (2012); 23.0 (2019-33 average).
- Automatic debt dynamics (percent of GDP): -1.1 (2010); 0.0 (2011); -0.4 (2012); -0.5 (2019-33 average).
- Contribution from average real interest rate (percent of GDP): 0.2 (2010); 0.2 (2011); 0.3 (2012); 0.5 (2019-33 average).
- Contribution from real GDP growth (percent of GDP): -0.3 (2010); -0.3 (2011); -0.5 (2012); -0.9 (2019-33 average).
- Residual, including asset changes (percent of GDP): -2.0 (2010); -0.1 (2012); -0.1 (2019-33 average).
- Gross financing need (percent of GDP): 3.5 (2010); 3.1 (2011); 2.6 (2012); 3.0 (2019-33 average).
- PV of public sector debt-to-revenue and grants ratio (percent): 101.2 (historical value shown); 108.7 (2019-33 average).
- Debt service-to-revenue and grants ratio (percent): 6.2 (2010); 6.4 (2011); 7.6 (2012); 11.4 (2019-33 average).
- Debt service-to-revenue ratio (percent): 8.4 (2010); 7.8 (2011); 8.8 (2012); 12.8 (2019-33 average).
- Primary deficit that stabilizes the debt-to-GDP ratio (percent of GDP): 3.2 (2010); 0.2 (2011); 0.2 (2012); 0.4 (2019-33 average).

### Key macroeconomic and fiscal assumptions (selected)
- Real GDP growth (in percent): 1.6 (2010); 1.4 (2011); 2.3 (2012); 4.2 (2013); 4.7 (2016); 4.3 (2019-33 average).
- Average nominal interest rate on forex debt (in percent): 1.3 (2010); 1.6 (2011); 1.4 (2012); 1.6 (2019-33 average).
- Average real interest rate on domestic debt (in percent): 5.1 (2010); 5.4 (2011); 6.2 (2012); 4.6 (2019-33 average).
- Inflation rate (GDP deflator, in percent): 2.6 (2010); 2.1 (2011); 1.4 (2012); 3.0 (2019-33 average).
- Grant element of new external borrowing (in percent): 35.4 (one historical/projection row); 28.6; 38.1; 39.4; 40.3; 40.9; 37.1; 21.5; 21.5 (values appear across projection rows).

### External debt and DSA highlights (selected)
- External debt (nominal, percent of GDP): 33.2 (2010); 28.3 (2011); 25.5 (2012); 25.5 (2019-33 average).
- Of which: public and publicly guaranteed (PPG) external debt (percent of GDP): 14.5 (2010); 14.8 (2011); 13.9 (2012); 14.0 (2019-33 average).
- Change in external debt (percent of GDP): 2.2 (2010); -5.0 (2011); -2.7 (2012); 0.0 (2019-33 average).
- Identified net debt-creating flows (percent of GDP): -4.3 (2010); -2.9 (2011); 1.6 (2012); 1.2 (2019-33 average).
- Non-interest current account deficit (percent of GDP): 4.7 (2010); 7.4 (2011); 5.8 (2012); 5.0 (2019-33 average).
- Exports (percent of GDP): 46.6 (2010); 44.9 (2011); 47.5 (2012); 45.6 (2019-33 average).
- Imports (percent of GDP): 52.4 (2010); 51.6 (2011); 50.8 (2012); 49.2 (2019-33 average).
- Net FDI (negative = inflow, percent of GDP): -5.7 (2010); -7.3 (2011); -4.7 (2012); -3.1 (2019-33 average).
- PV of external debt (percent of GDP): 25.8 (historical/projection entries); 23.4 (2019-33 average).
- PV of PPG external debt (percent of GDP): 14.2 (historical/projection entries); 11.8 (2019-33 average).
- PV of PPG external debt (in percent of exports): 29.8 (historical/projection entries); 25.9 (2019-33 average).
- Debt service-to-exports ratio (percent): 4.8 (2010); 4.2 (2011); 3.6 (2012); 3.6 (2019-33 average).
- PPG debt service-to-exports ratio (percent): 1.4 (2010); 1.4 (2011); 1.4 (2012); 1.4 (2019-33 average).
- Total gross financing need (Millions of U.S. dollars): 8.9 (2010); 16.0 (2011); 22.0 (2012); 88.7 (2019-33 average).
- Government revenues (excluding grants, percent of GDP): 18.1 (2010); 18.3 (2011); 18.6 (2012); 19.5 (2019-33 average).
- Grant-equivalent financing (in percent of GDP): 4.4; 5.5; 6.1; 5.8; 4.2; 3.3; 2.7; 3.0 (values shown across projection rows).

### Stress tests and sensitivity analysis (selected outcomes)
- Figure 2 summary: most extreme stress test in various panels corresponds to One-time depreciation shock, Terms shock, or combinations as specified per panel (figure captions).
- Table 2: PV of Debt-to-GDP Ratio projections under scenarios:
  - Baseline series (selected): 22 (2013); 23 (2014); 23 (2015); 24 (2016); 24 (2017); 24 (2018); 24 (2023); 24 (2033).
  - Alternative scenario A3 (Permanently lower GDP growth): values rise to 29 (2018); 41 (2033) in that row.
- Table 2: PV of Debt-to-Revenue Ratio (baseline vs scenarios, selected):
  - Baseline: 96 (2013); 94 (2014); 97 (2015); 102 (2016); 105 (2017); 109 (2018); 106 (2023); 109 (2033).
  - A3 (Permanently lower GDP growth): 105 (2015); 110 (2016); 117 (2018); 180 (2033).
- Table 2: Debt Service-to-Revenue Ratio (baseline vs scenarios, selected):
  - Baseline: 10 (2013); 10 (2014); 10 (2015); 11 (2016); 11 (2017); 11 (2018); 11 (2023); 11 (2033).
  - A3 (Permanently lower GDP growth): 11 (2015); 11 (2016); 15 (2018); 21 (2033).
- Table 4 (external debt sensitivity, selected):
  - PV of debt-to-GDP ratio baseline: 13 (2013); 12 (2014); 13 (2015); 14 (2016); 13 (2017); 12 (2018); 11 (2023); 12 (2033).
  - PV of debt-to-exports ratio baseline: 28 (2013); 26 (2014); 27 (2015); 30 (2016); 30 (2017); 28 (2018); 26 (2023); 26 (2033).
  - PV of debt-to-revenue ratio baseline: 71 (2013); 66 (2014); 68 (2015); 72 (2016); 69 (2017); 64 (2018); 59 (2023); 59 (2033).
  - Stress scenario B6 (One-time 30 percent nominal depreciation relative to the baseline in 2014) increases select ratios (examples shown in table rows, e.g., PV of debt-to-GDP up to 18 in 2014 for that scenario).

### Policy implications and recommendations (as stated in the text)
- Continue the cautious borrowing strategy of the past to contain public and external debt at prudent levels.
- Increase domestic revenues significantly to finance infrastructure investment and maintenance, and spending in social sectors, while maintaining prudent debt levels.

*Source: IMF staff estimates, projections, and tables from the Vanuatu DSA content unit.*

### 0.8 percent year on year in December 2012. The balance of payments remains sound.

### _cr13169 - 0.8 percent year on year in December 2012. The balance of payments remains sound.

### Overview
- Real GDP growth and inflation
  - Real GDP: 2.3 percent in 2012.
  - Inflation (period average): 1.4 percent in 2012.
  - Inflation (end period): 0.8 percent year on year in December 2012.
- Balance of payments and reserves
  - Current account deficit narrowed to 6¼ percent of GDP in 2012.
  - Official reserves rose to $182 million in 2012.
  - Reserve coverage of prospective imports rose to 7 months.

### External sector and capital flows
- Current account and trade
  - Current account: -6.3 percent of GDP in 2012 (from -8.1 percent in 2011).
  - Trade balance: -25.2 percent of GDP in 2012.
  - Exports of goods: 7.0 percent of GDP in 2012.
  - Imports of goods: -32.2 percent of GDP in 2012.
  - Tourism receipts: 33.2 percent of GDP in 2012.
- Capital and financial account
  - Capital and financial account: 6.8 percent of GDP in 2012.
  - Foreign direct investment: 4.7 percent of GDP in 2012.
- Reserves and coverage
  - Gross international reserves: $182.2 million in 2012.
  - Reserves in months of prospective imports of goods: 7.0 months in 2012.
- Assessment
  - The overall balance of payments is projected to remain in surplus in 2013.
  - The current account in 2013 is projected at -5.9 percent of GDP.

### Fiscal position and public debt
- 2012 fiscal outcome and composition
  - Fiscal deficit (net lending (+)/borrowing (-)): -1.6 percent of GDP in 2012.
  - Revenue: 21.7 percent of GDP in 2012.
    - Domestic Revenue: 18.7 percent of GDP in 2012.
    - Grants: 3.0 percent of GDP in 2012.
  - Expenditure: 23.3 percent of GDP in 2012.
    - Expense: 21.7 percent of GDP in 2012.
    - Net acquisition of non-financial assets: 1.6 percent of GDP in 2012.
- Public debt
  - Public debt (end of period): 21.6 percent of GDP in 2012.
    - Domestic: 7.7 percent of GDP in 2012.
    - External: 13.9 percent of GDP in 2012.
- Policy stance and actions
  - Authorities targeted zero net domestic financing and net repayments of external debt in the 2013 budget.
  - Authorities undertaking administrative improvements to raise additional revenue; considering VAT rate increases and an income tax proposal (requiring comprehensive analysis).
  - Authorities intend to seek external financing only on concessional terms and to phase public projects and partner with the private sector to alleviate financing pressures.
  - Recent amendment to the Public Finance and Economic Management Act to improve control and disbursement of funds.
  - Plans to restructure and liquidate unprofitable state owned enterprises (SOEs); new SOE legislation and a GBE policy paper are being finalized.

### Monetary policy and financial sector
- Monetary policy framework
  - The vatu is officially pegged to an undisclosed basket of currencies.
  - The exchange rate peg has served Vanuatu well and remains an appropriate anchor for monetary policy.
  - Reserve Bank of Vanuatu (RBV) stands ready to tighten monetary policy to protect net international reserves above the four months import cover threshold as demand for imports rises.
- Financial soundness
  - Banks remain well capitalized despite a rise in nonperforming loans.
  - Specific provisions for the banking industry increased by 159 percent from August 2011 to December 2012.
  - Concerns noted over:
    - Growth of nonperforming loans (NPLs).
    - Trend increase in demand for foreign-currency credit against declining foreign-currency deposits.
    - High credit to deposit ratio and uneven liquidity distribution among banks (linked to Vanuatu National Provident Fund withdrawals).
  - RBV measures and proposals:
    - Stepped up supervision, onsite reviews of NPLs, increased monitoring, and instructions to adhere to prudent credit lending standards.
    - Drafted, but not yet implemented, a guideline on managing foreign currency risk, including unhedged foreign currency lending.
    - Will continue to review prudential liquidity requirements.
  - AML/CFT:
    - Vanuatu enacted more comprehensive AML/CFT legislation and established a Financial Intelligence Unit (FIU).
    - Authorities acknowledge weaknesses in enforcement and plan to provide more financial support and HR capacity building for the FIU.

### Growth outlook and risks
- Projections
  - 2013: Output growth forecast to rise to 3¼ percent.
  - Inflation in 2013 expected to pick up moderately to 1¾ percent year on year.
  - Medium-term: Donor-supported investment projects scheduled to boost output growth to 4¾ percent by 2015.
- Drivers
  - Continued growth in tourism and private sector investment projects.
  - Short-term boost from donor-funded public infrastructure projects (Port Vila urban infrastructure, main wharf, shipping).
  - Longer-term potential from tourism expansion (including targeting Asian markets), agriculture, and fisheries; planned government fishery processing plant on Efate.
- Risks
  - External downside risks:
    - Further delay in the global recovery.
    - Unexpected rise in global fuel prices.
    - Weaker-than-anticipated regional activity adversely affecting tourism.
  - Domestic risks:
    - Limited administrative and implementation capacity that could affect execution of planned projects.
    - Frequent political changes that can challenge reform efforts.
  - Upside potential:
    - A decisive push for further structural reforms could boost confidence and private sector investment.

### Executive Board assessment and recommendations
- Commendations and general guidance
  - Directors commended the authorities’ prudent macroeconomic and financial policies that fostered macroeconomic stability and resilience to shocks.
  - Directors concurred that the exchange rate peg remains an appropriate anchor and encouraged close monitoring of monetary conditions with tightening if needed.
- Fiscal policy
  - Directors agreed that spending needs, particularly in infrastructure and social services, will put pressure on the fiscal position.
  - Welcomed authorities’ plans to strengthen tax administration and consideration of new revenue measures.
  - Underscored advantages of an income tax among options for revenue yield and distributional impact.
  - Emphasized accelerating reform of government business enterprises to improve governance and reduce fiscal risks.
- Debt management
  - Noted public and external debt remain low.
  - Encouraged maintaining a conservative approach to debt management and seeking external financing only on concessional terms.
  - Suggested appropriately phasing public projects and partnering with the private sector to alleviate prospective financing pressures.
- Financial sector and AML/CFT
  - Saw merit in further strengthening supervision and introducing regulation to limit banks’ open foreign exchange positions.
  - Liquidity and credit risks warrant close attention.
  - Welcomed steps on AML/CFT framework but encouraged speeding up implementation and enforcement.

### Key statistics (selected)
- Real GDP: 3.3 (2009), 1.6 (2010), 1.4 (2011), 2.3 (2012), 3.3 (2013), 4.2 (2014).
- Consumer prices (period average): 5.2 (2009), 2.7 (2010), 0.7 (2011), 1.4 (2012), 1.4 (2013), 1.9 (2014).
- Consumer prices (end period): 2.4 (2009), 3.3 (2010), 1.2 (2011), 0.8 (2012), 1.8 (2013), 2.0 (2014).
- Revenue (percent of GDP): 26.0 (2009), 24.6 (2010), 22.4 (2011), 21.7 (2012), 22.7 (2013), 23.9 (2014).
- Net lending (+)/borrowing (-): -0.8 (2009), -2.5 (2010), -2.2 (2011), -1.6 (2012), -1.0 (2013), -2.1 (2014).
- Public debt (end of period): 20.5 (2009), 19.4 (2010), 20.9 (2011), 21.6 (2012), 21.6 (2013), 22.5 (2014).
- Gross international reserves (in millions of U.S. dollars): 148.6 (2009), 161.4 (2010), 173.8 (2011), 182.2 (2012), 197.7 (2013), 221.3 (2014).
- Reserves in months of prospective imports: 6.1 (2009), 6.2 (2010), 6.9 (2011), 7.0 (2012), 7.1 (2013), 7.4 (2014).
- Nominal GDP (in millions of U.S. dollars): 610 (2009), 701 (2010), 786 (2011), 787 (2012), 827 (2013), 865 (2014).

*IMF staff report for the 2013 Article IV Consultation with Vanuatu.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2013/_cr13169.pdf_