## 1. The Impact of Lower Oil Prices (_cr15102)

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### Context and recent macroeconomic developments
- Political and strategic context
  - New government formed after parliamentary elections on November 19, 2014; Prime Minister Manasseh Sogavare announced the Twenty-Year National Development Strategy 2015–35.
  - Key medium-term challenges: diversify growth away from logging and mobilize revenues to finance investment projects.
- Recent macro developments (2014)
  - Real GDP growth estimated at 1.5 percent in 2014.
  - Current account expected to have deteriorated to about -8.5 percent of GDP in 2014 (from -4.5 percent of GDP in 2013).
  - Net reserves: US$478 million at end-December 2014 (equal to 8.2 months of imports) against a program target of US$450 million; reserves declined from US$550 million at end-June 2014.
  - Inflation slowed to about 4.2 percent in December 2014 from 7.5 percent in May 2014.
  - Main shocks in 2014: closure of Gold Ridge mine and April 2014 flood; non-mineral production and exports benefited from reentry logging, rebound in agriculture and fisheries.

### Baseline outlook, risks and buffers
- Baseline outlook
  - Economic activity expected to increase by 3.3 percent in 2015, led by agriculture, tuna processing, and construction.
  - Reopening of Gold Ridge mine unlikely in near term at prevailing gold prices; negotiations ongoing for transfer of ownership to government.
  - Potential environmental/fiscal risk from tailings dam collapse—tentative fiscal cost estimate up to 2 percent of GDP.
  - Logging growth expected to be modest in 2015 due to a moratorium on new logging licenses.
  - Major infrastructure projects (Tina River Hydro; submarine cable) shifted to late 2015 and beyond.
- Risks to the outlook
  - Downside: decline in aid envelope, weaker emerging market growth, potential global financial market turbulence, natural disasters.
  - Upside: sustained low oil prices could boost growth through windfall for consumers/producers; better prospects for nickel exploitation (starting in late 2015) and nascent bauxite industry.
- Buffers and fiscal space
  - Cash balance at year end: SI$880 million, or 4.4 months of recurrent spending.
  - Preliminary 2015 budget indicates a fiscal deficit of about 2.1 percent of GDP financed with a drawdown of the cash balance, leaving cash balance at 3.4 months of recurrent spending at end-2015.
  - Over the next four years, reform program targets an increase in government spending of SI$20 billion (or 230 percent of 2014 GDP), with three quarters allocated to infrastructure (mainly roads), health, and education.
  - Staff view: fiscal buffers exist but multiple negative shocks could quickly erode them.

### Program performance and financing
- Overall assessment: broadly satisfactory.
- Performance criteria and targets
  - All June 2014 performance criteria (PCs) were met with large margins; all continuous PCs met; most indicative targets for September 2014 met except narrowly missed health and education spending targets for June and September 2014.
- Structural reforms and benchmarks
  - Four structural benchmarks met (Financial Institutions Act drafting instructions approved; amendment of export duty schedule for mining tax regime; publishing mid-year budget review; publishing budget strategy document).
  - Other reform benchmarks delayed or rescheduled due to dissolution of Parliament and election-related capacity constraints.
- IMF financing and review outcome
  - Completion of the fourth review enables the Solomon Islands to draw an amount equivalent to SDR 0.149 million (about US$0.2 million) immediately.
  - Total disbursements under the arrangement to date: SDR 0.743 million (about US$1.02 million).
  - The three-year ECF arrangement approved December 7, 2012, in an amount equivalent to SDR 1.04 million (about US$1.59 million), or 10 percent of the country’s quota.
- Program risks
  - Main risk: political uncertainty related to the new government’s planned spending after general elections; pressures to draw down cash reserves beyond program targets.
  - Combined annual budget support from Australia and New Zealand was substantially lower than projected in 2014: US$25 million versus US$35 million.
  - ADB approved additional US$13 million for transportation sector flood-recovery, alongside US$5 million planned budget support and US$40 million for other infrastructure projects during 2014–16.
  - World Bank Group approved US$10 million of additional financing expected to be disbursed throughout 2015 and 2016.
  - Staff working with World Bank Group on debt implications of a potential hydropower project involving a government guarantee of US$130 million (11 percent of GDP); full updated DSA to be presented at the fifth review scheduled for June 2015.
- Staff recommendation: completion of the fourth review to enable release of the fifth disbursement in the amount of SDR 148,571.

### The impact of lower international oil prices — quantified effects
- Four transmission channels identified:
  - rising real income increasing consumption;
  - lower production costs due to lower energy costs;
  - substantial improvement in the external position;
  - easing of inflation.
- Key quantitative estimates and parameters
  - Fuel imports average 10 percent of GDP, or one quarter of total import bill.
  - Staff analysis suggests that lower imports could strengthen the current account balance by 2 percentage points of GDP.
  - Staff estimated that for every 10 percent drop in oil prices, Solomon Islands GDP rises by 0.3 percentage point.
  - Specific scenario: GDP growth: a reduction of "0.8 percentage point in 2015 relative to the scenario without the oil price drop."
  - Estimated elasticity: "The estimated elasticity between the real oil price and Solomon Islands’ GDP is 0.03."
  - Inflation: "Inflation is expected to moderate by 0.3 percentage point given an estimated weight of energy in the CPI basket of around 7 percent."
  - Pass‑through: measured (June–December 2014) by fuel type (Kerosene, Diesel, Petrol); pass‑through calculated as "the absolute difference in local fuel prices divided by the absolute difference in international prices, in terms of local currency, multiplied by 100."
- Consumption, investment, and electricity costs
  - Reduced energy costs likely have positive effects on consumption and investment, mitigated by incomplete pass-through of international oil prices to domestic retail prices.
  - Solomon Islands relies mainly on oil-based fuel for energy needs and fuel is used for electricity generation.
  - Electricity tariffs: "The impact on consumers will depend on the decline in electricity tariffs, which are the highest among all small states."
- Fiscal first‑round and overall effects
  - First‑round fiscal effect: negative due to lower collection from import duties and goods tax on fuel (which both amounted to around 2¼ percent of GDP in recent years).
  - Overall fiscal outcome: fiscal balance expected to improve slightly mainly because of revenue buoyancy from higher economic activity and some expected increase in fuel imports related to investment.

### Monetary, exchange rate, and financial sector assessment
- Monetary policy stance and indicators
  - Current stance broadly appropriate; staff econometric analysis suggests credit growth of 16 percent (y/y) could add inflation pressures of up to 1 percent in 2015.
  - Credit to the private sector grew strongly in 2014 at 16.3 percent.
  - Average lending rates around 10 percent for most of 2014.
  - CBSI shifted toward an accommodative monetary stance in September 2014 and capped Bokolo bills issuance at SI$710 million.
  - With weak monetary transmission, the exchange rate basket peg is the primary nominal anchor.
- Exchange rate framework and developments
  - CBSI fully implemented the invoice-based basket peg regime and removed the ±1 percent exchange rate band vis-à-vis the U.S. dollar in November.
  - Solomon Islands dollar depreciated 5 percent against the U.S. dollar between October 2014 and March 2015.
  - Buy and sell margins for U.S. dollar and Australian dollar trades were increased to promote foreign exchange market efficiency.
- Financial sector soundness and inclusion
  - Financial system generally sound but intermediation remains limited.
  - Liquidity and capital adequacy ratios are above minimum regulatory requirements; asset quality adequate with low NPLs.
  - Profitability declined in 2014 partly reflecting competition from Pan Oceanic Bank Limited.
  - Westpac announced plans to sell operations; Bank South Pacific (BSP) expected to increase market share.
  - Credit penetration: 18 percent of GDP versus 35 percent in the Pacific small states, 40 percent in African small states, and 70 percent in Caribbean small islands.
  - Interest-rate spreads among the highest in the region.
  - Positive developments: mobile banking introduced over last 18 months; first credit bureau opened in February 2015.
- Staff recommendations on monetary and financial stability
  - Authorities should be ready to tighten monetary policy if credit growth induces demand-driven inflation or a surge in imports; instruments include reserve requirement adjustments and issuing Bokolo bills.
  - Continue developing tools to mop up excess liquidity with IMF technical assistance.
  - Ensure strict prudential standards amid greater competition, monitor mortgage and other credit market segments closely.
  - Continue PFM and financial sector reforms: revised National Provident Fund Act, Credit Union bill, Financial Institutions Act to promote stability and inclusion.
  - Promote mobile banking while ensuring adequate supervision and consumer protection.

### Fiscal policy guidance and structural reforms
- Fiscal outcomes and composition (2014)
  - Preliminary data: fiscal balance posted a surplus of about 2 percent of GDP in 2014.
  - Detailed estimate: fiscal balance posted a surplus of 1.9 percent of GDP in 2014.
  - Revenues (excluding grants) were higher in 2014 by 1.7 percentage points of GDP than expected; tax performance stronger than anticipated despite a 2.8 percentage point of GDP deterioration relative to 2013 due to the gold mine closure.
  - Grants revised down due to far lower donor disbursements.
  - Payroll bill increased by 13 percent (y/y) in nominal terms.
  - Election-related current spending estimated at 1 percent of GDP; supplementary budget included higher spending equivalent to 0.9 percent of GDP; large end-of-term payment to members of Parliament equal to US$2.7 million (0.2 percent of GDP).
- Staff recommendations on fiscal management
  - Use fiscal space wisely: balance buffers and spending; maintain fiscal buffers to enhance resilience to shocks (including natural disasters).
  - Pace and scale of capital spending should reflect absorptive capacity, revenue envelope, financing availability, and realistic revenue mobilization plans.
  - Improve quality of public spending and accountability (ex-ante spending plans, management rules for constituency funds, procurement rules, reporting) in accordance with the PFM Act; continue steady implementation of the PFM roadmap.
  - If oil prices fall further, authorities should save the higher cyclical revenue—from higher GDP—relative to the budget.
  - Medium-term anchor: non-mineral primary balance of about 2 percent of GDP to manage revenue volatility and promote fiscal sustainability.
  - Continue fiscal structural reforms to support revenue mobilization: tax policy and administration measures to implement mining tax regime (expensing prospecting/development expenditures; penalties for failing to file additional profit tax forms; clarify interagency roles and information sharing; strengthen taxpayer register); review overlapping and regressive consumption taxes.
- Authorities’ stance
  - Favor increasing development spending to boost growth prospects, supported by sectoral and structural reforms.
  - Streamlining public sector allowances to create fiscal space for development spending.
  - Commitment to improving spending quality and pursuing tax reforms with IMF assistance; plan to require line ministries to develop evaluation frameworks for development programs and publish the Final Budget Outcome Report annually.

### Program monitoring, targets and data reporting
- Monitoring framework
  - Implementation monitored through semiannual reviews based on performance criteria, indicative targets, and structural benchmarks.
  - Fifth review expected on or after June 15, 2015; sixth review expected on or after November 15, 2015.
- Selected quantitative targets and reported values (as presented)
  - Net international reserves (NIR) of CBSI (floor, end-of-period stock, in US$ millions):
    - 12/31/2014: 490
    - 3/31/2015 (Act. Status): 551 Met
    - 6/30/2015 (Act. Status): 465 552 Met
    - 9/30/2015 (PC IT PC IT): 450 480 480 480
  - Net domestic assets (NDA) of CBSI (ceiling, end-of-period stock, in SI$ millions):
    - 12/31/2014: -1,576
    - 3/31/2015 (Act. Status): -1,945 Met
    - 6/30/2015 (Act. Status): -1,393 -1,760 Met
    - 9/30/2015 (PC IT PC IT): -1,194 -1,406 -1,247 -1,185
  - Central government overall balance (percent of GDP): 3.8 (2012), 4.4 (2013), 1.9 (2014), -2.1 (2015 Est.), -1.6 (2016 Proj.)
  - Current account balance (percent of GDP): 1.5 (2012), -4.5 (2013), -8.5 (2014), -8.4 (2015 Est.), -12.6 (2016 Proj.)
  - Gross official reserves (US$ millions, end of period): 499.6 (2012), 527.7 (2013), 496.9 (2014), 539.8 (2015 Est.), 530.8 (2016 Proj.)
- Data provision and timelines
  - Weekly, monthly and quarterly reporting obligations specified for monetary, fiscal, external sector and real sector data with defined submission timelines.

### Staff appraisal — conclusions and priority policy advice
- Key conclusions
  - Solomon Islands has strengthened macro-financial performance and institutions; fiscal and reserve buffers have been rebuilt and important reforms (PFM and financial sector reforms) are being implemented.
  - The country is at a critical juncture: rebuilt buffers can be used up rapidly if high planned spending materializes.
- Priority policy advice
  - Strike a balance between building buffers and spending.
  - Strengthen implementation capacity for capital investment to enhance potential growth while maintaining adequate financial buffers to preserve resilience to shocks.
  - Advance structural reforms, in particular land reform and tax reforms, to support medium-term growth and enhance productivity.
  - Use fiscal space cautiously in 2015; align pace of capital spending with absorptive capacity and develop realistic revenue mobilization plans.
  - Continue PFM reforms to improve transparency and accountability of scholarships and constituency funds and strengthen quality of public spending.
  - Monetary policy: be ready to tighten if high credit growth triggers inflationary pressures; use reserve requirement and Bokolo bill issuance to mop up excess liquidity.
  - Financial sector: maintain vigilance, strengthen supervisory and regulatory frameworks, broaden financial inclusion, and progress National Provident Fund Act, Financial Institutions Act, and Credit Union Act.
  - Promote mobile banking while ensuring adequate supervision and consumer protection.

*Source: IMF staff report excerpt — "1. The Impact of Lower Oil Prices" and related chapters and appendices (Solomon Islands, _cr15102).*

### 1. The Impact of Lower Oil Prices ________________________________________________________________ 18

### 1. The Impact of Lower Oil Prices

### The Setting: Context and Outlook
- Political and strategic context
  - New government formed after parliamentary elections on November 19, 2014; Prime Minister Manasseh Sogavare announced an ambitious reform program in January 2015 (Twenty-Year National Development Strategy 2015–35).
  - Key medium-term challenges: diversify growth away from logging and mobilize revenues to finance investment projects.
- Recent macroeconomic developments (2014)
  - Real GDP growth estimated at 1.5 percent in 2014.
  - Current account expected to have deteriorated to about -8.5 percent of GDP in 2014 (from -4.5 percent of GDP in 2013).
  - Net reserves: US$478 million at end-December 2014 (equal to 8.2 months of imports) against a program target of US$450 million; reserves declined from US$550 million at end-June 2014.
  - Inflation slowed to about 4.2 percent in December 2014 from 7.5 percent in May 2014.
  - Main shocks in 2014: closure of Gold Ridge mine and April 2014 flood; non-mineral production and exports benefited from reentry logging, rebound in agriculture and fisheries.
- Baseline outlook and project timing
  - Economic activity expected to increase by 3.3 percent in 2015, led by agriculture, tuna processing, and construction.
  - Reopening of Gold Ridge mine unlikely in near term at prevailing gold prices; negotiations ongoing for transfer of ownership to government.
  - Potential environmental/fiscal risk from tailings dam collapse—tentative fiscal cost estimate up to 2 percent of GDP.
  - Logging growth expected to be modest in 2015 due to a moratorium on new logging licenses.
  - Major infrastructure projects (Tina River Hydro; submarine cable) shifted to late 2015 and beyond.
- Risks to the outlook
  - Downside: decline in aid envelope, weaker emerging market growth, potential global financial market turbulence, natural disasters.
  - Upside: sustained low oil prices could boost growth through windfall for consumers/producers; better prospects for nickel exploitation (starting in late 2015) and nascent bauxite industry.
  - Fiscal response capacity exists but multiple negative shocks could quickly erode buffers.

### Authorities’ Views (as reported)
- Risks considered balanced and mainly external; closure of Gold Ridge mine seen as main near-term factor weakening outlook.
- Twenty-Year National Development Strategy envisages potential medium-term growth of 5 percent, led by fisheries, telecommunications, construction, and eventually tourism.

### Program Performance under the ECF Arrangement
- Overall assessment: broadly satisfactory.
- Reserves and performance criteria
  - All June 2014 performance criteria (PCs) were met with large margins; cash balance PC largely met due to higher cyclical revenues and lower-than-expected spending.
  - All continuous PCs met; all indicative targets for September 2014 were met except narrowly missed health and education spending targets for June and September 2014.
- Structural reforms and benchmarks
  - Four structural benchmarks met: Cabinet approval of drafting instructions for a new Financial Institutions Act; amendment of export duty schedule to implement new mining tax regime; publishing a mid-year budget review; publishing a budget strategy document.
  - Other reform benchmarks delayed or rescheduled due to dissolution of Parliament and election-related capacity constraints.
- Authorities’ view: committed to remaining program benchmarks despite delays and capacity constraints.

### Policy Discussions — A. Preserving Fiscal Space and Improving the Quality of Public Spending
- 2014 fiscal outcomes and composition
  - Preliminary data: fiscal balance posted a surplus of about 2 percent of GDP in 2014.
  - Detailed estimate: fiscal balance posted a surplus of 1.9 percent of GDP in 2014.
  - Revenues and grants: revenues (excluding grants) were higher in 2014 by 1.7 percentage points of GDP than expected; tax performance was stronger than anticipated despite a 2.8 percentage point of GDP deterioration relative to 2013 due to the gold mine closure. Grants were revised down due to far lower donor disbursements.
  - Expenditure: development spending lower than planned mainly because of lower grants; payroll bill increased by 13 percent (y/y) in nominal terms.
  - Specific spending items: election-related current spending estimated at 1 percent of GDP; supplementary budget included higher spending equivalent to 0.9 percent of GDP; large end-of-term payment to members of Parliament equal to US$2.7 million (0.2 percent of GDP).
  - Cash balance at year end: SI$880 million, or 4.4 months of recurrent spending.
- 2015 budget indications and medium-term plans
  - Preliminary 2015 discussions point to a fiscal deficit of about 2.1 percent of GDP financed with a drawdown of the cash balance, leaving cash balance at 3.4 months of recurrent spending at end-2015.
  - Over the next four years, reform program targets an increase in government spending of SI$20 billion (or 230 percent of 2014 GDP), with three quarters allocated to infrastructure (mainly roads), health, and education.
  - Authorities committed to prudent debt management.
- Staff recommendations and views
  - Fiscal space should be used wisely: balance buffers and spending; maintain fiscal buffers to enhance resilience to shocks (including natural disasters).
  - Pace and scale of capital spending should reflect absorptive capacity, revenue envelope, financing availability, and realistic revenue mobilization plans.
  - Improve quality of public spending and accountability (ex-ante spending plans, management rules for constituency funds, procurement rules, reporting) in accordance with the PFM Act; continue steady implementation of the PFM roadmap.
  - If oil prices fall further, authorities should save the higher cyclical revenue-from higher GDP-relative to the budget.
  - If external downside risks materialize, fiscal buffers could be used to support the economy.
  - Medium-term anchor: non-mineral primary balance of about 2 percent of GDP to manage revenue volatility and promote fiscal sustainability.
  - Sequence development projects within a medium-term fiscal framework to align resources with spending capacity.
  - Continue fiscal structural reforms to support revenue mobilization: tax policy and administration measures to implement mining tax regime (expensing prospecting/development expenditures; penalties for failing to file additional profit tax forms; clarify interagency roles and information sharing; strengthen taxpayer register); review overlapping and regressive consumption taxes.

### Authorities’ Views on Fiscal Policy
- Authorities favor increasing development spending to boost growth prospects, supported by sectoral and structural reforms.
- Streamlining public sector allowances is part of the agenda to create fiscal space for development spending.
- Commitment to improving quality of spending and pursuing tax reforms with IMF assistance; plan to require line ministries to develop evaluation frameworks for development programs and to publish the Final Budget Outcome Report annually.
- Request for IMF TA to assist with a comprehensive tax review to ensure a fair, simple, and broad-based tax system.

### Policy Discussions — B. Strengthening the Monetary and Exchange Rate Policy Frameworks
- Credit and monetary conditions
  - Credit to the private sector grew strongly in 2014 at 16.3 percent.
  - Credit growth drivers: mortgage financing and investment in the communication sector, contributing 8 percent and 3.5 percent of the total increase, respectively.
  - Increase in credit has not yet put pressure on inflation due to recovered domestic food supply and lower oil prices.
- Central bank actions and instruments
  - In September 2014, CBSI shifted toward an accommodative monetary stance for six months; CBSI capped the stock of Bokolo bills issuance at SI$710 million.
  - Average lending rates around 10 percent for most of 2014 after steady decline in 2013.
  - Persistently high excess reserves and steady credit growth suggest relatively loose monetary conditions.
- Exchange rate framework and developments
  - CBSI fully implemented the invoice-based basket peg regime and removed the ±1 percent exchange rate band vis-à-vis the U.S. dollar in November.
  - Solomon Islands dollar depreciated 5 percent against the U.S. dollar between October 2014 and March 2015, reflecting closer tracking of the basket and depreciation of the Australian dollar against the U.S. dollar.
  - Buy and sell margins for U.S. dollar and Australian dollar trades were increased to promote foreign exchange market efficiency in line with IMF TA recommendations.
- Monetary indicators referenced
  - Holdings of Bokolo bills and bank reserves trends discussed; broad money growth decomposition and interest rate dynamics referenced (figures and tables in source).

*Source: IMF staff report excerpt — "1. The Impact of Lower Oil Prices" (Solomon Islands).*

### 16. The fall in prices of imported goods has eased the monetary policy trade-off but the

### 16. The fall in prices of imported goods has eased the monetary policy trade-off but the

### Monetary policy: assessment and risks
- Current stance of monetary policy is broadly appropriate.
- Staff econometric analysis suggests that credit growth of 16 percent (y/y) could add inflation pressures of up to 1 percent in 2015.
- If credit growth leads to a pickup in demand-driven inflationary pressure or a surge in imports, the authorities should be ready to tighten monetary policy.
- Instruments available to tighten monetary policy include reserve requirement adjustments and issuing Bokolo bills to mop up excess liquidity.
- With the monetary transmission mechanism remaining weak, the exchange rate basket peg is the primary nominal anchor.
- Staff noted the need for the central bank to continue developing tools for mopping up excess liquidity, including through IMF technical assistance.
- Staff welcomed the full implementation of the basket peg of the Solomon Islands dollar, including the removal of the band around the US dollar, which:
  - delivers a more stable effective exchange rate, and
  - minimizes any further erosion of competitiveness for the moderately overvalued currency.

### Authorities’ views on inflation and monetary policy
- The CBSI has no immediate concerns about inflation.
- Despite strong credit growth, inflationary pressures in the near term are weak thanks to lower oil and commodity prices.
- The CBSI noted that the upcoming IMF TA, led by the Monetary and Capital Market Department, will help improve the effectiveness of monetary policy by strengthening the monetary transmission mechanism.
- The authorities emphasized that the basket peg regime continues to be an important tool to anchor inflation and maintain competitiveness.
- They noted that the removal of the band around the US dollar should allow bilateral exchange rates to move freely in order to keep the basket peg stable.

### Preserving financial stability: background findings
- The financial system is generally sound but financial intermediation remains limited.
- Liquidity and capital adequacy ratios are above minimum regulatory requirements; asset quality remains adequate with low NPLs.
- Profitability declined in 2014, partly reflecting increased competitive pressures from the entry of Pan Oceanic Bank Limited.
- Westpac announced plans to sell operations in Solomon Islands, Samoa, Tonga, and Vanuatu to Bank South Pacific (BSP), expected to substantially increase BSP market share in Solomon Islands’ banking sector.
- Despite brisk credit growth, the magnitude of credit in Solomon Islands relative to the economy is much lower than peers:
  - 18 percent of GDP versus 35 percent in the Pacific small states, 40 percent in African small states, and 70 percent in Caribbean small islands (according to the IMF’s Financial Access Survey Database).
- Interest-rate spreads are among the highest in the region, indicating room to improve financial sector efficiency.
- Solomon Islands is one of the most under-banked small states when measured by total deposits relative to GDP and number of bank branches relative to population.
- Structural constraints to financial sector development include:
  - subsistence level of the rural economy,
  - dispersion of the population in remote villages with little or no road access,
  - high costs of establishing bank branches outside main cities,
  - communal land tenure.
- Positive developments:
  - introduction of mobile banking services by commercial banks over the last 18 months has increased access to banking services and improved financial inclusion,
  - the first credit bureau opened in February 2015.
- Authorities continue progress on revised legislation of the National Provident Fund aimed at improving governance and investment framework.

### Staff’s views and recommendations on financial stability
- Continued vigilance over drivers of credit growth is important, accompanied by ongoing financial sector reform and efforts to improve financial inclusion.
- Authorities should ensure strict prudential standards are adhered to, especially given greater competition in subsectors such as mortgage financing with the entry of a new bank.
- Staff welcomed progress in strengthening supervisory and regulatory frameworks and called for continued efforts to fulfill program commitments, specifically:
  - revised National Provident Fund Act (program benchmark, proposed for September 2015),
  - Credit Union bill (program benchmarks, proposed for September 2015) to improve supervision of nonbanking institutions and promote financial inclusion.
- Mobile banking introduction is encouraged as a way to circumvent physical barriers to financial access.
- Efforts on financial inclusion are particularly welcome given lower competition for financial services in small states can hamper inclusion.

### Authorities’ views on financial sector access and initiatives
- CBSI agreed that financial sector access is paramount to support inclusive growth and stressed initiatives to promote financial inclusion.
- Plans include strengthening regulation of mobile banking services and developing new prudential guidelines for consumer protection.
- Authorities will collect more data to measure effectiveness of mobile banking in promoting financial inclusion.
- CBSI will promote more financing for small- and medium-sized enterprises to widen financial access.
- Developments from Westpac’s planned exit will be closely monitored to ensure competitiveness.
- Opening of the credit bureau is highly valued and expected to make access to credit more affordable by reducing transaction costs and creating credit history.

### Program discussion and other issues
- Fourth review under the ECF arrangement and program conditionality through September 2015 were discussed (PCs, indicative targets, structural benchmarks).
- The NIR indicative target and PC for March, June, and September 2015 were raised to US$480 million (7.5 months of imports) to reflect stabilization and gradual rebound in reserves expected in 2015.
- Given broadly satisfactory program performance, staff supports re-phasing and modifying the structural agenda owing to recent elections and change in government, and adding a new benchmark on implementation of the Constituency Development Funds Act (program benchmark, July 2015).
- Authorities proposed modifying a structural benchmark to enable members of Parliament to request public release of the complete 2012 Constituency Development Funds audit reports for their individual constituencies.
- Main risk to the ECF arrangement: political uncertainty related to the new government’s planned spending after general elections; pressures to draw down cash reserves beyond program targets have increased.
- Combined annual budget support from Australia and New Zealand was substantially lower than projected in 2014:
  - US$25 million versus US$35 million.
- Combined support is projected to rebound to US$35 million in 2015, though Australia’s recent announcement of ODA cuts suggests additional reductions could be made.
- EU may provide budget support for 2015–20 of about $US3.5 million a year, contingent on PFM reform progress.
- ADB approved additional US$13 million for transportation sector flood-recovery, alongside US$5 million planned budget support and US$40 million for other infrastructure projects during 2014–16.
- World Bank Group approved US$10 million of additional financing expected to be disbursed throughout 2015 and 2016.
- Staff is working with World Bank Group on debt implications of potential hydropower project involving a government guarantee of US$130 million (11 percent of GDP); a full updated DSA, including assessment of medium-term debt implication of the proposed hydropower project, will be presented at the fifth review scheduled for June 2015.
- Solomon Islands has adequate capacity to repay the Fund and the ECF-supported program remains fully financed.

### Staff appraisal: key conclusions and recommendations
- Solomon Islands has made enormous strides in strengthening macro-financial performance and institutions; fiscal and reserve buffers have been rebuilt and important reforms (PFM and financial sector reforms) are being implemented.
- The country is at a critical juncture: rebuilt buffers can be used up rapidly if high planned spending materializes.
- Policy guidance:
  - Strike a balance between building buffers and spending;
  - Strengthen implementation capacity for capital investment to enhance potential growth while maintaining adequate financial buffers to preserve resilience to shocks;
  - Structural reforms, in particular land reform and tax reforms, are key to support medium-term growth and enhance productivity.
- Fiscal space should be used wisely in 2015 given vulnerabilities to shocks and uncertain growth outlook:
  - Buffers could be partly used to finance capital projects, but pace of spending should align with absorptive capacity to avoid waste;
  - Develop realistic plans for revenue mobilization;
  - Advance PFM reforms, including improving transparency and accountability of scholarships and constituency funds, to strengthen quality of public spending and continue attracting donor support.
- Monetary policy is broadly appropriate, but authorities should be ready to tighten if high credit growth triggers inflationary pressures; CBSI should use all instruments, including reserve requirement and Bokolo bill issuance, to mop up excess liquidity.
- Authorities are commended for fully implementing the basket peg; CBSI removed the exchange rate band around the US dollar since November 2014 and increased the buy-sell margin in foreign exchange trading to allow greater flexibility.
- Financial sector is sound but requires continued vigilance over potential vulnerabilities and further efforts to strengthen supervisory and regulatory frameworks and broaden financial inclusion.
- Close monitoring of trends in main credit market segments, including mortgage financing, is critical.
- New National Provident Fund Act, Financial Institutions Act, and Credit Union Act should promote financial sector stability.
- Initiatives to promote mobile banking while ensuring adequate supervision and consumer protection are important for financial inclusion.
- Staff recommends completion of the fourth review under the ECF-supported program to enable release of the fifth disbursement in the amount of SDR 148,571.
- Staff supports the authorities’ request for modification of structural conditionality and for setting end-June 2015 performance criteria.

### Box 1. Solomon Islands: The Impact of Lower Oil Prices
- The global oil price slump is expected to boost Solomon Islands’ economy through four channels:
  - rising real income increasing consumption;
  - lower production costs due to lower energy costs;
  - substantial improvement in the external position;
  - easing of inflation.
- Solomon Islands is an oil importer and fuel imports average 10 percent of GDP, or one quarter of total import bill.
- Staff analysis suggests that lower imports could strengthen the current account balance by 2 percentage points of GDP.
- Staff estimated that for every 10 percent drop in oil prices, Solomon Islands GDP rises by 0.3 percentage point.

*Source: IMF staff report excerpt (chapter 16) provided in the supplied content.*

### 0.8 percentage point in 2015 relative to the scenario

### _cr15102 - 0.8 percentage point in 2015 relative to the scenario

### Impact of lower international oil prices on growth and inflation
- GDP growth: a reduction of "0.8 percentage point in 2015 relative to the scenario without the oil price drop."
- Estimated elasticity: "The estimated elasticity between the real oil price and Solomon Islands’ GDP is 0.03."
- Inflation: "Inflation is expected to moderate by 0.3 percentage point given an estimated weight of energy in the CPI basket of around 7 percent."
- Pass‑through: pass‑through of international fuel prices to domestic retail prices measured (June–December 2014) by fuel type (Kerosene, Diesel, Petrol); pass‑through is calculated as "the absolute difference in local fuel prices divided by the absolute difference in international prices, in terms of local currency, multiplied by 100."

### Effects on consumption, investment, and electricity costs
- Consumption and investment: "Reduced energy costs are likely to have a positive effect on consumption and investment although this would be mitigated by incomplete pass-through of international oil prices to domestic retail prices."
- Energy reliance: "Solomon Islands relies mainly on oil-based fuel for its energy needs and fuel is used for electricity generation."
- Electricity tariffs: "The impact on consumers will depend on the decline in electricity tariffs, which are the highest among all small states."

### Fiscal and budgetary effects
- First‑round fiscal effect: "The first round effect of lower oil price on the budget would be negative due to lower collection from import duties and goods tax on fuel (which both amounted to around 2¼ percent of GDP in recent years)."
- Overall fiscal outcome: "Nonetheless, the fiscal balance is expected to improve slightly mainly because of revenue buoyancy from higher economic activity and some expected increase in fuel imports related to investment."

### Broader macroeconomic context and vulnerabilities (selected indicators from source)
- Reserves and fiscal space: "In Solomon Islands, reserves remain at comfortable levels... and fiscal space has increased."
- Need for buffers and disaster vulnerability: "But Solomon Islands needs to continue to rebuild policy buffers... given its vulnerability to natural disasters."
- Revenue volatility and fiscal policy: "Managing revenue volatility is essential... to avoid procyclical fiscal policy."
- Electricity tariffs (industrial, 2013): comparative indicator shows Solomon Islands among high industrial electricity tariff countries (chart context).
- Banking and monetary snapshots (selected indicators):
  - Per capita GDP (2014): "US$1,931 (estimate)"
  - Population (2014): "562,000"
  - Real GDP growth (2015 Est.): "4.7" (2012), "3.0" (2013), "1.5" (2014), "3.3" (2015 Est.), "3.0" (2016 Proj.) — preserved as in source tables.
  - CPI (period average): "5.9" (2012), "5.4" (2013), "5.1" (2014), "3.8" (2015 Est.), "3.4" (2016 Proj.)
  - Nominal GDP (in SI$ millions): "7,540" (2012), "7,738" (2013), "8,542" (2014), "9,164" (2015), "9,951" (2016)
  - Central government overall balance (percent of GDP): "3.8" (2012), "4.4" (2013), "1.9" (2014), "-2.1" (2015 Est.), "-1.6" (2016 Proj.)
  - Current account balance (percent of GDP): "1.5" (2012), "-4.5" (2013), "-8.5" (2014), "-8.4" (2015 Est.), "-12.6" (2016 Proj.)
  - Gross official reserves (in US$ millions, end of period): "499.6" (2012), "527.7" (2013), "496.9" (2014), "539.8" (2015 Est.), "530.8" (2016 Proj.)

### IMF program, financing, and outlook notes (selected)
- Program financing and reviews: table of reviews and disbursements under the Extended Credit Facility shows multiple review completion dates and cumulative "Total 10.0 1,040,000" (in percent of quota and SDRs respectively) as recorded.
- Balance of payments projections (selected): Current account balance (US$ millions): "-47.2" (2014 Est.), "-98.2" (2015 Est.), "-101.3" (2016 Proj.), "-165.6" (2017 Proj.)
- External reserves and adequacy: "Net international reserves (in US$ million) 508 478 524 519 528 533 537" (selected series as presented).

*Prepared by Fazurin Jamaludin and Leni Hunter; content extracted from the provided IMF chapter text.*

### Appendix 1. Letter of Intent

### Appendix 1. Letter of Intent

### Recent developments, outlook, and program performance
- The Gold Ridge mine, the only gold mine, ceased production; prospects for near-term reopening are weak.
- Impact of April 2014 floods in Honiara and Guadalcanal was relatively short-lived and limited; agriculture has rebounded and logging benefited from re-entry logging.
- GDP growth estimates for 2014 are still uncertain—between zero and 1½ percent.
- Gross international reserves stood at around US$500 million at end-November 2014, sufficient to cover 10 months of imports of goods and services.
- June 2014 and September 2014 performance criteria (PCs) under the ECF were met with comfortable margins; indicative targets and continuous PCs were met except for indicative targets on government-funded recurrent spending on health and education, which were narrowly missed.
- Four structural benchmarks since the last review were met, including:
  - Draft instructions of a new financial institution Act (end-June 2014 benchmark) approved by Cabinet.
  - Preparation and publication of the 2014 budget strategy document and the mid-year budget review (end-August 2014 benchmarks).
  - New mining tax regime (end-July 2014 benchmark).
- Progress on other benchmarks (Credit Union Act, National Provident Fund (NPF) Act, tertiary education, customs and excise laws, audits related to constituency development funds (CDFs)) expected to be completed in or by the second half of this year.
- Delays in some reforms reflect capacity constraints in the Attorney General’s Chambers and a slowdown in Cabinet activity ahead of the November 2014 general elections.

### Fiscal policy — objectives and measures
- Policy objective: preserve a sustainable fiscal position while providing resources for capital spending; the 2015 budget will target a budgetary position that will not involve any borrowing to fund operating expenditures.
- Recurrent spending containment measures: limit public sector allowance and benefits and the non-capital component of the development budget, while still allowing spending on capital projects.
- Spending priorities: health, education, and infrastructure.
- Commitment: maintain spending on education and health at no less than 32 percent of Government-funded recurrent spending.
- Transparency and planning:
  - Produce and publish a medium-term development plan to prioritize spending.
  - Publish the Final Budget Outcome annually and continue publishing the mid-year budget update every July.
  - Starting with the 2015 budget, include tables in recurrent and development budgets showing spending on new or improved physical infrastructure, other direct capital expenditures, capital grants, and other non-capital development.
- Constituency development funds (CDFs): adopt regulations to ensure planning, consultation, effective spending, accountability and transparent reporting; CDF expenditure is subject to the Public Financial Management Act, 2013 and audits by the Office of the Auditor General.
- Request to modify structural benchmark for publication of the CDF audit: allow the Auditor General to release individual audits of members of Parliament’s CDFs at their request rather than wait for all audits.
- PFM Reform Roadmap (2014–17) priorities:
  - Publishing the budget at the same time as it is tabled in Parliament.
  - Cabinet requirement for the Ministry of Finance and Treasury to comment on all Cabinet papers with financial implications before submission to Cabinet.
  - Implement revised regulations and financial instructions for disciplined financial management of special funds, targeted balances and expenditure controls consistent with the PFM Act.
- Additional public spending reforms:
  - Public sector remuneration review to streamline and consolidate existing remuneration benefits.
  - Development of a Line Ministry Expenditure Analysis (LMEA) to map expenditure trends with core outputs and service delivery outcomes.
- Tertiary education scholarships:
  - Significant progress in bringing the budget under control in 2014; further measures planned in 2015.
  - New Cabinet paper on revamp of scholarship policies (end-September 2014 benchmark) to be prepared and submitted to Cabinet; modification sought to change test date to end-April 2015.
  - Review of tertiary education policies (end-March 2015 benchmark) in coordination with development partners.
- Debt management:
  - Borrowing conducted under the Debt Management Framework (Debt Management Strategy, PFM Act, SOE Borrowing Policy).
  - Annual Borrowing Limit for 2014 was set at SI$250 million; 2015 limit to be announced in the Budget.
  - Borrowing limit guided by Debt Management Unit’s debt sustainability analysis consistent with a debt limit equivalent to 25 percent of GDP.
  - Current borrowing proposals include the submarine internet cable project and the Tina River Hydropower Project.

### Revenue and tax administration
- Commitment to comprehensive tax reform to simplify the tax system, support business and attract foreign investors; IMF assistance welcomed for a full review of the overall tax system.
- Specific tax reform aims:
  - Review incidence of overlapping and cascading regressive consumption taxes.
  - Strengthen the taxpayer register to improve tax administration and compliance.
  - Amend the Sales Tax Act to eliminate loopholes.

### Monetary, exchange rate, and financial sector policies
- Monetary policy: with inflation on a downward trend due to lower world oil prices, the Central Bank of Solomon Islands (CBSI) shifted to an easing bias in September 2014 by capping Bokolo bills issuance.
- Exchange rate policy: implementation of the basket peg regime with slight depreciation against the U.S. dollar and significant appreciation against some other key currencies, including the Australian dollar; removal of the exchange rate band and increase in the buy-sell margin in foreign exchange trading to allow greater flexibility.
- CBSI actions and vigilance:
  - Awaiting follow-up IMF TA in March to strengthen monetary transmission mechanism.
  - CBSI stands ready to review monetary stance toward less accommodative bias should inflationary pressure arise.
  - Vigilant against strong credit growth on mortgage and consumption loans.
- Financial sector development and supervision:
  - New bank began operations in July 2014, increasing the total number of banks and financial access.
  - Mobile banking services introduced since end-2013, boosting financial inclusion.
  - CBSI consulting with ADB on regulation of mobile banking services and developing new prudential guidelines for consumer protection.
  - Draft Financial Institutions Bill in public consultation; revised draft legislation expected to be sent to Cabinet by September 2015.
  - Working with ADB on drafting instructions for revised NPF Act; Attorney General Chambers to draft NPF legislation update by end-September 2015 (modification sought in test date).
  - Draft Credit Union Act (end-December 2014 benchmark) expected to be submitted to Cabinet by end-September 2015 (modification sought in test date).

### Competitiveness and inclusive growth
- Priority: raise productivity growth and enhance private sector development.
- Land reform is a top government priority to support investment and private sector activity.
- Medium-term development plan will provide basis for a Poverty Reduction Strategy status report to be produced for the fifth review of the ECF arrangement.
- A hardship and vulnerability assessment will complement the Poverty Reduction Strategy status report, with support from the World Bank Group.

### Program monitoring
- The program will continue to be monitored through quantitative performance criteria, indicative targets, and structural benchmarks.
- The government requests completion of the fourth review under the ECF, modification of structural conditionality, and setting of end-June 2015 performance criteria.
- The government will consult with the Fund in advance of adopting additional measures or revisions to policies in the MEFP and provide the Fund with appropriate information on policy implementation.
- The government authorizes publication of the Letter of Intent, related attachments, and the related IMF staff report.

*Appendix 1. Letter of Intent.*

### 21.      Implementation of the program will continue to be monitored through semiannual

### _cr15102 - 21.      Implementation of the program will continue to be monitored through semiannual

### Program monitoring and review schedule
- Implementation monitored through semiannual reviews based on performance criteria, indicative targets, and structural benchmarks.
- Indicative target for end-March 2015, performance criteria for end-June 2015, and indicative targets for end-September 2015 set as per Table 1 and structural benchmarks as per Table 2.
- The fifth review under the ECF arrangement is expected to take place on or after June 15, 2015.
- The sixth review under the ECF arrangement, assessing end-June 2015 performance criteria, is expected to take place on or after November 15, 2015 on the basis of the performance criteria and structural benchmarks indicated in Tables 1 and 2, and further detailed in the TMU.

### Quantitative performance criteria and indicative targets (Table 1 — selected items and reported values)
- Performance criteria and indicative targets are presented for the dates: 12/31/2014, 3/31/2015, 6/30/2015, 9/30/2015.
- Net international reserves (NIR) of the Central Bank of Solomon Islands (CBSI) (floor, end-of-period stock, in millions of U.S. dollars (US$)) 2/:
  - 12/31/2014: 490
  - 3/31/2015 (PC with adjusters/EBS/14/65): 490
  - 3/31/2015 (Act. Status): 551 Met
  - 6/30/2015 (IT/EBS/14/65 with adjusters): 470
  - 6/30/2015 (Act. Status): 465 552 Met
  - 9/30/2015 (PC IT PC IT): 450 480 480 480
- Net domestic assets (NDA) of the CBSI (ceiling, end-of-period stock, in millions of Solomon Islands dollars (SI$)) 3/:
  - 12/31/2014: -1,576
  - 3/31/2015 (PC/EBS/14/65 with adjusters): -1,579
  - 3/31/2015 (Act. Status): -1,945 Met
  - 6/30/2015 (IT/EBS/14/65 with adjusters): -1,431
  - 6/30/2015 (Act. Status): -1,393 -1,760 Met
  - 9/30/2015 (PC IT PC IT): -1,194 -1,406 -1,247 -1,185
- Net credit to central government (NCG) (ceiling, cumulative change from the beginning of the year, in millions of SI$) 4/:
  - 12/31/2014: 99 -107 Met
  - 3/31/2015: 3775 -126 Met
  - 6/30/2015: 40 -10 -35 -20
- New nonconcessional external debt maturing in more than one year, contracted or guaranteed by the public sector (ceiling, end-of-period stock since the beginning of the program, in millions of US$) 5/:
  - 12/31/2014: 0 0 0 Met
  - 3/31/2015: 0 0 0 Met
  - 6/30/2015 / 9/30/2015: 0 0
- New nonconcessional external debt maturing in one year or less, contracted or guaranteed by the public sector (ceiling, end-of-period stock since the beginning of the program, in millions of US$) 5/:
  - 12/31/2014: 0 0 0 Met
  - 3/31/2015: 0 0 0 Met
  - 6/30/2015 / 9/30/2015: 0 0
- Accumulation of new external payment arrears by the public sector (ceiling, end-of-period stock since the beginning of the program, in millions of SI$) 5/:
  - 12/31/2014: 0 0 0 Met
  - 3/31/2015: 0 0 0 Met
  - 6/30/2015 / 9/30/2015: 0 0
- Central government program cash balance (floor, end-of-period stock, in millions of SI$) 4/:
  - 12/31/2014: 520 520 624 Met
  - 3/31/2015: 420 382 657 Met
  - 6/30/2015 (Act.Status): 374 560 545 535
- Indicative targets (cumulative) — selected reported values:
  - 12/31/2014: 345 ... 267 Not met
  - 3/31/2015: 520 ... 479 Not met
  - 6/30/2015: 710 161 348 542
- Memorandum items (selected):
  - The threshold of indicative target on health and education (actual 32 percent of government funded recurrent spending)
  - Budget support from bilateral and multilateral donors other than IMF (cumulative change from the beginning of the year, in millions of US$), program level: 29 30 ... 37 32 ... 48 25 10 11
  - Outstanding stock of Solomon Islands government (SIG) treasury bills, excluding restructured government bonds (end-of-period stock, in millions of SI$), program level: 40 40 ... 40 40 ... 40 40 40 40
  - Balance of SIG Consolidated Deposits Account, millions of SI$ 7/: 140 140 ... 140 140 ... 140 140 140 140
- Government funded recurrent spending on health and education (cumulative from the beginning of the year, in millions of SI$) 6/: reported as part of Table 1.

### Structural benchmarks (Table 2 — actions, criticality, dates, status)
- Obtain Cabinet's approval of drafting instructions of a new Financial Institutions Act.
  - Macroeconomic criticality: To promote financial sector stability and development.
  - Date: June 30, 2014.
  - Status: Met.
- Amend the Export Duty Schedule (by Ministerial Order) to complete the implementation of the new mining tax regime in line with IMF TA recommendations.
  - Macroeconomic criticality: To broaden the tax base and increase revenue transparency.
  - Date: July 31, 2014.
  - Status: Met.
- Produce and publish a mid-year Budget review.
  - Macroeconomic criticality: To promote transparency on economic and fiscal developments.
  - Date: August 31, 2014.
  - Status: Met.
- Produce and publish a Budget strategy document.
  - Macroeconomic criticality: To facilitate planning and fiscal strategy.
  - Date: August 31, 2014.
  - Status: Met.
- Review the policies on tertiary education and ensure an adequate balance of spending between primary and tertiary education.
  - Macroeconomic criticality: To promote the transparency and accountability in the use of public funds.
  - Date: March 31, 2015.
- Revised test dates and proposed new benchmark: Obtain Cabinet approval of revamped policies for tertiary scholarships as specified in TMU.
  - Macroeconomic criticality: To promote the transparency and accountability in the use of public funds.
  - Date (revised): April 30, 2015.
  - Status: A Cabinet paper has been drafted and submitted to Cabinet for its deliberation. Reset from 30 September 2014.
- Release to public the results of the audits conducted by the office of the Auditor General on spending of constituency funds by the 50 constituencies, and project achievements in 2012.
  - Macroeconomic criticality: To promote the transparency and accountability in the use of public funds.
  - Date: June 30, 2015.
  - Status: A draft working copy on each constituency was delivered to each of the relevant Members of Parliament on 5 September 2014 for comments due 10 October 2014. The compiled draft report is now expected to be presented to the Ministry of Rural Development for comment by late January 2015. The authorities aim to get the final report to the Office of the Speaker by late February 2015. Reset from 30 September 2014.
- Issue (by Ministerial Order) implementing regulations on the implementation of the Constituency Development Funds Act, in accordance with the PFM Act.
  - Macroeconomic criticality: To promote the transparency and accountability in the use of public funds.
  - Date: July 30, 2015.
  - Status: New program benchmark.
- Submit to Parliament the revised NPF Act that strengthens its governance structure and investment framework.
  - Macroeconomic criticality: To improve the long-term financial viability of the NPF and reduce financial risks.
  - Date: September 30, 2015.
  - Status: A set of detailed drafting instructions has been received and the Ministry of Finance and Treasury is preparing a minute to send to the Attorney General's Chambers to review the drafting instructions and being preparing the Bill. The Attorney General's Chambers will prepare and vet the final NPF legislation before it goes to Cabinet and Parliament. Reset from 30 June 2014.
- Submit to Parliament the new Customs and Excise bill, including the clauses related to exemptions and the draft amendments to other revenue acts (income tax, stamp duties, goods and sales tax acts).
  - Macroeconomic criticality: To promote fiscal transparency and enhance the efficiency of revenue collections.
  - Date: September 30, 2015.
  - Status: ADB is providing technical assistance and the authorities expect to receive the final draft of the Bill from ADB in April. Reset from 30 June 2014.
- Submit to Cabinet the draft Credit Unions bill.
  - Macroeconomic criticality: To promote financial sector stability and development.
  - Date: September 30, 2015.
  - Status: A policy paper on recommendations for reform was endorsed by Cabinet in February 2014. Consultations were completed in July 2014. Discussion of outstanding recommendations, and the consultation report have been finalized. ADB has finalized the Policy Framework for review and circulated for comments from the Review Committee. Reset from December 31, 2014.

### Technical Memorandum of Understanding (TMU) — definitions and key adjustments
- Monitoring instruments: quantitative performance criteria, indicative targets, structural benchmarks, and reviews.
- Performance criteria for end-June 2015 and indicative targets for end-September 2015 established with respect to:
  - Floors on the level of net international reserves (NIR) of the CBSI.
  - Ceilings on the level of net domestic assets (NDA) of the CBSI.
  - Ceilings on the level of net credit to the central government (NCG).
  - Floors on the central government cash balance.
  - An indicative target (cumulative) for spending on health and education at no less than 32 percent of government-funded recurrent spending.
- Continuous performance criteria established for:
  - Ceilings on contracting and guaranteeing by the public sector of new medium- and long-term nonconcessional external debt.
  - Ceilings on contracting and guaranteeing by the public sector of new short-term nonconcessional external debt.
  - Ceilings on accumulation of new external payment arrears by the public sector.
- Institutional definitions:
  - Central government: all units of budgetary central government and extra budgetary funds.
  - Depository corporations (DCs): CBSI and other depository corporations (ODCs). ODCs include commercial banks, the Credit Corporation of Solomon Islands, and credit unions.
  - Financial corporations: DCs and other financial corporations (OFCs). OFCs: National Provident Fund (NPF), Development Bank of Solomon Islands, Investment Corporation of Solomon Islands.
- Reserve money: currency issued by the CBSI (excluding CBSI holdings of currency) and all transferable deposits held at the CBSI.
- Net international reserves (NIR):
  - A floor applies to NIR; the floor will be adjusted upward (downward) by the amount of budget support from bilateral and multilateral donors (excluding the IMF) in excess (short) of the programmed level.
  - NIR = gross international reserves (GIR) less international reserve liabilities. For monitoring, foreign assets and liabilities of the CBSI are reported in U.S. dollars and valued at the program exchange rates specified in Table 1.
  - GIR defined as the 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 held with an investment-grade institution; the reserve position of the Solomon Islands in the IMF; holdings of SDRs; monetary gold.
  - Excluded from GIR: foreign currency deposits of ODCs and OFCs held at the CBSI; any foreign currency claims on residents, capital subscriptions in international institutions, and foreign currency assets in nonconvertible currencies; GIR encumbered or pledged.
  - International reserve liabilities: all outstanding liabilities of the Solomon Islands to the IMF, excluding IMF SDR allocations; foreign currency liabilities in convertible currencies to nonresidents with original maturity up to and including one year.
- Net domestic assets (NDA):
  - A ceiling applies to NDA; the ceiling 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 = reserve money less the sum of NIR and other NFA of the CBSI. Revisions to historical reserve money due to accounting treatment changes will be notified to the Fund and used to adjust monetary aggregates.
  - Other NFA includes foreign assets and liabilities not included in NIR as specified.
- Net credit to the central government (NCG):
  - A ceiling applies to NCG measured cumulatively from the beginning of the year; the ceiling will be adjusted upward by the amount of budget support from bilateral and multilateral donors (excluding the IMF) short of the programmed level.
  - NCG defined as the sum of net claims of: (i) the CBSI, (ii) commercial banks and other ODCs, (iii) OFCs, (iv) insurance companies, (v) government treasury bills held by the general public.
- Central government program cash balance:
  - A floor applies to the program cash balance; the floor will be adjusted downward by budget support short of the programmed level and 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 will be adjusted upward by the difference between SI$140 million (program level) in the SIG Consolidated Deposits Account and its actual balance, should the actual balance be lower than SI$140 million.
  - Program cash balance defined as gross cash balance minus unpaid payment orders and unpresented checks.
  - Gross cash balance defined as sum of government deposits in specified CBSI, Australia New Zealand Bank, Bank of South Pacific accounts and donor-funded budget support accounts under government control.
- External debt:
  - Ceiling applies to contracting and guaranteeing by the public sector of new nonconcessional borrowing with original maturities of more than one year; applies to debt and commitments contracted or guaranteed for which value has not yet been received, including private debt with official guarantees.
  - Definition and exclusions for program purposes align with Fund guidelines and specified exemptions (use of Fund resources; World Bank and ADB lending; certain refinancing/restructuring; concessional debts; specified SI$-denominated securities held by nonresidents).
  - Guarantee of a debt includes explicit legal obligations of central government, CBSI, nonfinancial public enterprises, or other official entities to service debt in the event of nonpayment by the main obligor.
  - Concessional debt: grant element of at least 35 percent, where grant element = (NPV of debt difference from nominal) / nominal value; discount rate used = five percent.
- Program exchange rates (Rates as of September 30, 2013) — TMU Table 1 (Solomon Islands (Program) Exchange Rates for the ECF Arrangement):
  - Australian dollar: 6.8310.932 (Currency: Solomon Islands Dollar per currency unit; U.S. Dollar per currency unit)
  - British pound: 11.8201.612
  - Euro: 9.9011.350
  - Japanese yen 1/: 13.35297.890
  - New Zealand dollar: 6.0680.827
  - SDR: 11.2361.533
  - Singapore dollar: 5.8380.796
  - U.S. dollar: 7.3311.000
  - 1/ Currency unit per Solomon Islands dollar and U.S. dollar.

*Source: IMF staff report text for Solomon Islands ECF program (excerpt provided).*

### 24. A ceiling applies to the contracting and guaranteeing by the public sector of new

### 24. A ceiling applies to the contracting and guaranteeing by the public sector of new

### Ceiling on short-term nonconcessional borrowing
- 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.
- 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.

### Definition of debt for program purposes
- 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).

### Exclusions from the ceiling
- 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.

### VI. External Payment Arrears — Performance criterion
- 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.

### VII. Tertiary Education — Policy strengthening elements to be approved by Cabinet
- Approval will be sought from Cabinet to strengthen the policy of the granting of tertiary scholarships, which will contain at least the following elements:
  - Commitment controls:
    - The Ministry of Finance will certify the availability of budget allocation before any new award letters can be granted, in order to ensure that the budget ceilings are abided by and no new arrears are incurred.
    - Commitment information will be entered into the Ministry of Finance’s Financial Management Information System to record commitments made for each individual scholarship awardee.
    - The Ministry of Education will ensure that the documentation relating to identification and eligibility, expected length of studies, as well as due dates for tuition and stipend payments is provided to the Ministry of Finance in a timely manner.
  - Queuing system:
    - If there are more candidates for scholarships than resources available in a fiscal year, a queuing policy for eligible applicants based on the timing of their application will be established.
  - Arrears:
    - All arrears will be cleared and no new arrears allowed.
  - Documentation:
    - In consultation with the Ministry of Finance, the Ministry of Education will establish the standards for eligibility documentation and documentation retention for each application.
    - The required and retained documentation should include at least the application form, high school transcript, receipt for the payment of the application fee, copy of Ministry award letter, signed declaration letter, transcripts of results in each semester from tertiary institutions and qualifications attained by the scholarship holders.
  - Monitoring and dissemination:
    - The Ministry of Education will produce regular reports on total number of applicants for scholarships, number granted scholarships, current number of students classified by gender and educational institutions, and number of terminations or fails in the last 12 months.
    - The Ministry of Education will publish the guidelines for obtaining scholarships and publish their periodic reports.
  - Tuition and Fee Rates:
    - The Ministry of Education will sign a memoranda of understanding the USP and other tertiary institutions, including to establish the basis of the financial commitment of the Solomon Islands Government.
  - Allowances:
    - The Ministry of Education, in consultation with the Ministry of Finance, will recommend an allowances policy with specific allowance amounts that vary for students depending on the institutions where they study, the course that they are undertaking, employment status, travel requirements, whether studies are full-time or part-time, the length of the program in which they are enrolled and the number of years they have received the grant.

### VIII. Data Provision — Reporting obligations and timelines
- The data listed below will be provided for monitoring performance under the program based on data templates agreed with Fund staff.
- Reporting responsibilities are indicated in parentheses under each section.
- Submission timelines:
  - Weekly data: requested for submission to Fund staff by the end of the following week.
  - Monthly and quarterly data: 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.

- A. Monetary Data (CBSI)
  - On a weekly basis:
    - 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.
  - On a monthly basis:
    - 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.

- B. Fiscal Data (Ministry of Finance and Treasury (MoFT))
  - On a monthly basis:
    - 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 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.

- C. External Sector Data (CBSI and MoFT)
  - On a quarterly basis:
    - 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.
  - On a quarterly basis:
    - Balance of payment data, including detailed components of current accounts and capital and financial accounts.

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

*Source: IMF staff report (Solomon Islands).*

### Annex I. Guidelines on Performance Criteria with Respect to Foreign Debt

### Annex I. Guidelines on Performance Criteria with Respect to Foreign Debt

### Definition of "debt" and scope
- Debt is 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, requiring 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 discharge the principal and/or interest liabilities incurred under the contract.
- Primary forms of debt:
  - (i) Loans: advances of money to the obligor by the lender made on the basis of an undertaking that the obligor will repay the funds in the future (including deposits, bonds, debentures, commercial loans and buyers’ credits) and temporary exchanges of assets that are equivalent to fully collateralized loans under which the obligor is required to repay the funds, and usually pay interest, by repurchasing the collateral from the buyer in the future (such as repurchase agreements and official swap arrangements).
  - (ii) Suppliers’ credits: contracts where the supplier permits the obligor to defer payments until sometime after the date on which the goods are delivered or services are provided.
  - (iii) Leases: arrangements under which property is provided which the lessee has the right to use for one or more specified period(s) of time that are usually shorter than the total expected service life of the property, while the lessor retains the title to the property. For the purpose of the guideline, 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 those payments that cover the operation, repair or maintenance of the property.
- Under this definition, arrears, penalties, and judicially awarded damages arising from the failure to make payment under a contractual obligation that constitutes debt are debt. Failure to make payment on an obligation that is not considered debt under this definition (e.g., payment on delivery) will not give rise to debt.

### IMF Press Release: Completion of Fourth Review under the Extended Credit Facility (ECF) — Solomon Islands (April 13, 2015)
- Review outcome and disbursement:
  - Completion of the fourth review enables the Solomon Islands to draw an amount equivalent to SDR 0.149 million (about US$0.2 million) immediately.
  - This brings total disbursements under the arrangement to an amount equivalent to SDR 0.743 million (about US$1.02 million).
  - The three-year ECF arrangement was approved December 7, 2012, in an amount equivalent to SDR 1.04 million (about US$1.59 million), or 10 percent of the country’s quota.
- Executive remarks (Mr. Min Zhu, Deputy Managing Director and Acting Chair):
  - Fiscal and reserve buffers have been rebuilt; important reforms in public financial management (PFM) and financial sector reforms are being implemented.
  - Sources of growth are unclear due to setback in mining prospects and depletion of forest resources.
  - Fiscal space should be used wisely in 2015 given vulnerabilities to shocks and uncertain growth outlook.
  - Authorities should sustain PFM reforms, including improving transparency and accountability of scholarships and constituency funds and strengthening quality of public spending.
  - Current monetary policy stance is appropriate as inflationary pressures have remained subdued; central bank should be ready to tighten if inflationary pressures emerge.
  - The basket peg is an appropriate exchange rate regime; removal of the band around the U.S. dollar should help deliver a more stable effective exchange rate and minimize erosion of competitiveness.
  - Financial soundness indicators are adequate; forthcoming National Provident Fund Act and Credit Union Act should enhance financial sector stability.
  - Ongoing initiatives to promote mobile banking while ensuring supervision and consumer protection will promote financial inclusion.

### Authorities' statement and program implementation (Vicki Plater, Alternate Executive Director for Solomon Islands)
- Country context and program role:
  - Solomon Islands: small, remote, predominantly rural population dispersed over many islands, narrow economic base, vulnerable to natural disasters and external shocks.
  - The ECF program supports macroeconomic and financial stability, reform efforts, and plays a confidence-building role with development partners.
- Program implementation status:
  - All quantitative targets under the 4th Review met except Indicative Targets on health and education spending (narrowly missed due to more robust procurement requirements by donors).
  - Four structural benchmarks completed.
  - 2014 Mid-Year Budget Review and 2015 Budget Strategy produced for the first time, implementing aspects of the 2013 Public Financial Management Act.
  - Preparation for mining tax regime implementation completed with amendments to the export duty schedule; Cabinet approved drafting instructions for a new Financial Institutions Act.
  - Capacity constraints in Attorney-General’s Chambers have delayed legislative benchmarks but progress continues; IMF flexibility in adjusting test dates appreciated.

### New Government priorities and reform agenda
- Government target: at least 5 percent growth per annum (Policy Programme).
- Two reform fronts:
  - Fundamental reforms: pursue good governance and land reform; develop a National Anti-Corruption Strategy, enact anticorruption legislation, and establish an Independent Commission against Corruption.
  - Sectoral reforms: facilitate entrepreneurship, SME development, commercial development of natural resources, connectivity (transport and telecommunications), and effective delivery of social services. Improve quality of expenditure and undertake tax policy reform (Solomon Islands requested IMF assistance to review the current tax system, which includes overlapping and cascading sales taxes).
- Emphasis on better quality of expenditure, transparency, and value for money in scholarships and CDFs.

### Economic outlook and key macroeconomic indicators
- Growth and shocks:
  - 2014 growth estimates range between zero and 1.5 percent.
  - Closure of the Gold Ridge goldmine on Guadalcanal is a substantial drag: before closure the mine produced approximately 20 percent of Solomon Islands net exports and contributed approximately 6 percent of government revenue in 2013; the mine is not expected to reopen in the foreseeable future.
  - Growth in 2015 expected to be modest; new sources of growth needed for medium-term prospects and resilience.
- Fiscal outcomes and budgetary plans:
  - Government achieved a surplus in 2014 of about 1.9 percent of GDP (preliminary estimates).
  - Cash balance lifted to 4.4 months of recurrent spending following donor disbursement in December 2014.
  - 2015 Budget:
    - Budgeted fiscal deficit of SI$462m (approx 5 percent of GDP) in 2015, funded by drawing down some of the cash balance.
    - Total expenditure budgeted to increase by 10 percent in 2015, driven entirely by an increase in the development budget; recurrent expenditure in the budget is flat.
    - Increased development spending focused on infrastructure and rural development to benefit the 85 percent of the population in rural areas.
    - Budget includes notable increases in expenditure on health and basic education, and full-funding for establishment of the Independent Commission Against Corruption.
  - Debt and borrowing:
    - Solomon Islands’ debt is currently around 11 percent of GDP.
    - Annual Borrowing Limit set in the 2015 budget: SI$300m, in line with the Debt Management Framework (DMF).
    - DMF ensures government borrowing and/or guarantees are used for investing in productive capacity, priority core infrastructure and development initiatives/projects aligned with the National Development Strategy.

### Monetary policy and financial sector developments
- Inflation and monetary stance:
  - Inflation: 4.8 percent in the year to December and 1.6 percent in the year to February 2015 (initial spike after April 2014 floods has since eased).
  - CBSI stands ready to review monetary policy stance should inflationary pressure arise; closely monitoring strong credit growth (from a low base) on mortgage and consumption loans.
- Exchange rate regime and technical assistance:
  - CBSI fully implemented the exchange rate’s basket-peg regime.
  - IMF TA Mission recently concluded to follow up on basket-peg operation and strengthening monetary transmission (tools to manage excess liquidity).
- Financial sector stability and inclusion:
  - Strengthening regulation and supervision remains a focus.
  - New bank (Pan-Oceanic Bank) entered market in mid-2014, enhancing access and competition; authorities mindful of lending standards.
  - Banks have ample liquidity and remain profitable.
  - Mobile banking introduced since late 2013, boosting financial inclusion for underserved rural population.
  - First credit bureau opened in February 2015.
  - Authorities working with Asian Development Bank on regulation of mobile banking services and developing prudential guidelines for consumer protection.
  - Priority structural benchmarks: progressing the National Provident Fund, Financial Institutions and Credit Union Acts; Financial Institutions Act is most advanced with a draft Bill out for public consultation.

### Policy implications and recommendations (as reflected in the source)
- Sustain PFM reforms: improve transparency and accountability of scholarships and constituency funds; strengthen the quality of public spending.
- Use fiscal space cautiously in 2015 given vulnerabilities to shocks and uncertain growth outlook.
- Continue to prioritize concessional borrowing only for productive priority investments consistent with the DMF.
- Strengthen financial supervision and regulation, progress legislative reforms (National Provident Fund, Financial Institutions, Credit Union Acts), and ensure consumer protection in mobile banking expansion.
- Pursue anti-corruption reforms: develop National Anti-Corruption Strategy, enact anticorruption legislation, and establish an Independent Commission against Corruption.
- Seek IMF assistance on tax policy reform to address overlapping and cascading sales taxes.

*Source: _cr15102 - Annex I. Guidelines on Performance Criteria with Respect to Foreign Debt (excerpt) and Press Release No. 13/168, April 13, 2015, IMF.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15102.pdf_