## 1. External Competiveness and Exchange Rate Assessment

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### Background and recent macroeconomic developments
- Kiribati: 33 islands over 3.5 million square kilometers of ocean; population of about 100,000.
- Poverty and social indicators:
  - Extreme poverty: around 5 percent.
  - Basic needs poverty: around 22 percent; over 24 percent in South Tarawa.
- Key revenue sources and recent developments:
  - RERF balance: declined from 565 percent of GDP in 2006 to 365 percent last year.
  - Fishing license fees: reached a record-high 68 percent of GDP in 2014 (past average about 20 percent).
  - Donor-financed infrastructure projects: reached 45 percent of GDP in 2014.
- Recent performance and near-term outlook:
  - GDP growth: around 4 percent in 2014; projected about 3 percent in 2015.
  - Inflation: remains subdued.
  - Current account: turned positive in 2014 due to high fishing license fees; expected to revert to a deficit in 2015.
  - Fishing license fees: very strong during first four months of 2015, exceeding first four months of 2014.
  - Phoenix Island Protected Area (PIPA) temporarily closed; tuna prices have fallen significantly since the beginning of the year.
  - Recurrent fiscal balance: expected to be positive in 2015 for the third consecutive year.
  - Recurrent expenditures: increased nearly 13 percent in 2014 and a further 5 percent in 2015 (per supplementary budget).
  - One-off transfer to clear debt of one large SOE: around 4 percent of GDP; previously non-transparent support to state-owned power company: around 3½ percent of GDP.
  - VAT rollout: introduced April 2014; tax revenues have yet to pick up.

### External competitiveness and exchange rate (Box 1)
- REER developments and currency arrangement:
  - Real effective exchange rate (REER) depreciated over the last two years and is now below its historical average; mainly reflects weakening of the Australian dollar, which circulates as legal tender in Kiribati.
  - Use of the Australian dollar as official currency remains appropriate: Kiribati needs a strong nominal anchor and lacks institutional capacity to conduct its own monetary policy. Kiribati has accepted obligations under Article VIII of the Fund’s Articles of Agreement.
- Competitiveness constraints:
  - High transportation costs, lack of scale, and remoteness.
  - Precise CGER-like estimates not feasible given data limitations.
  - REER plays limited role in current account developments; current account driven mostly by exogenous factors (fishing license fees, donor flows, global commodity prices).

### Medium-term outlook and fiscal risks
- Fishing license fees outlook and risks:
  - PNA policy changes: US$5,000 minimum fee per vessel day effective in 2012; increased to US$6,000 in 2014 and to US$8,000 in 2015.
  - Staff baseline: annual fishing license fees around 40 percent of GDP on average over 2015–20 (up from average about 24 percent of GDP over past decades), but below outturns averaging more than 50 percent of GDP in 2013–14.
  - Lower fishing license fees: plausible and high-impact downside risk.
- Donor activity: projected to diminish with completion of large infrastructure projects, reducing growth in medium term.
- Climate change and global risks:
  - Climate change and weather-related damages increase downside risks to growth and fiscal balances.
  - Returns on RERF and other financial assets could be affected by protracted slower global growth and low inflation.

### Climate change impacts and fiscal implications (Box 2)
- Physical exposure:
  - Average height above sea level: around 2 meters.
  - Sea level projections (high emission scenario): increase by 24 cm by 2050 and 61 cm by 2100 compared to 1985–2005 average.
- Main impacts: shoreline erosion and land loss, frequent inundation, lower biodiversity, lower agricultural production, water resource and food security issues, increased spread of vector borne diseases.
- Fiscal cost estimates:
  - Coastal protection costs: in the region of 1 percent of GDP per annum.
  - Annual adaptation costs: in the range of ½ to 1½ percent of GDP (medium emissions scenario); as high as 2½ percent of GDP in worst case.
  - Overall climate-related costs: could reach 3½ percent per year, and possibly more in worst case scenarios.
- Implication: More donor funding—including from the new Green Climate Fund—will be required given fiscal constraints.

### Policy findings and fiscal strategy
- Primary policy challenge: manage intergenerational benefits of RERF amid uncertainty about fishing license fees and spending pressures for infrastructure and climate adaptation.
- Fiscal and asset management guidance:
  - Preserve wealth:
    - Sustainable level of drawdown estimated at about 3–4 percent of GDP (wide range reflects uncertainty around projected investment returns and population growth).
    - Staff recommended framing expenditure plans around a conservative fiscal stance: a RERF drawdown averaging about ½ percent of GDP over 2016-2020 to accumulate savings when fishing license fees are strong and limit drawdowns when they disappoint.
  - Expenditure rule:
    - A RERF drawdown of ½ percent of GDP annually would be consistent with recurrent expenditure growth of 1.5 percent per annum over the next 5 years, assuming fishing license fees remain robust.
    - This path would result in a gradual reduction in real per capita spending but leave room for pressing expenditure needs.
    - Capital spending should be primarily grant-financed.
    - With lower fishing revenues—closer to historical average—RERF per capita balances would initially fall but later stabilize under the proposed approach.
  - Stabilization and transparency:
    - Budget transfers and withdrawals should be more transparent, systematic and symmetric around the proposed expenditure path.
    - Save a substantial part of revenues in the RERF when license fees are above average to enable sustainable drawdowns when they fall below average.
    - Maintain a larger cash buffer—equivalent to around two months of budget expenditures (around AUD20 million)—to manage revenue volatility and emergencies.
      - Of the 2014 fiscal surplus of around AUD 50 million, only AUD 10 million was transferred to the RERF to date.
      - Authorities purchased 20 square kilometers of land in Fiji in 2014 for around AUD 9 million drawn down from the RERF.
- Structural reforms: improve business climate and private sector growth given competitiveness constraints from remoteness, high transport costs, and lack of scale.

---

### 2. Managing Volatility of Fishing License Fees and Ensuring Fiscal Sustainability (Box 3)

### RERF performance and recent deterioration
- RERF capitalization: from phosphates until reserves exhausted in 1979; early decades supplemented by fiscal surpluses.
- Expenditure and drawdowns:
  - Current expenditures rose from an average of 48 percent of GDP in 1991–2000 to 58 percent in 2010–14, resulting in large deficits financed by drawdowns; drawdowns stopped only when fishing revenue increased in 2013.
  - Regularizing SOE subsidies and clearing overdrafts kept the deficit high despite containment of regular spending since 2011.
  - Global financial crisis caused significant capital losses to the RERF.
- Per capita RERF value: down to around AUD 5,400 (in 2006 dollars) from around AUD 9,300 in 2000.

### Staff simulations and revenue scenarios
- Two revenue scenarios:
  - Baseline: fishing license fees stay high at AUD 100 Million on average over 2015–35.
  - Lower-revenue: decrease to an average of AUD 63 million, consistent with historical average of around 24 percent of GDP since 1991.
- Simulation findings:
  - Historical spending pace (“historical path” — nominal expenditure growth of 5.5 percent per annum) would be unsustainable, depleting the RERF in about 20 years even under higher fishing revenue scenario.
  - Expenditure growth of 1½ percent per year would ensure sustainability in both revenue scenarios:
    - Under lower revenue scenario: stabilize RERF around AUD 4,000 in real per capita terms by 2035.
    - Under higher revenue scenario: increase RERF real per capita balances to around AUD 6,000 by 2035, saving part of the fishing revenue windfall and improving intergenerational equity.
- Complementary fiscal indicator:
  - Proposed expenditure path consistent with maintaining recurrent non-fish deficit (current fiscal balance excluding fishing revenues) below 35 percent of GDP.

### Recommendations for RERF management and fiscal policy
- Investment and governance:
  - Better articulate and make explicit the saving and stabilization roles of the RERF when formulating the fund’s optimal investment strategy.
  - Improve investment policy and strategic asset allocation to align with long-term objectives and nature of the fund.
  - Ongoing reforms (with World Bank assistance): appointment of new asset manager(s) and reform of the fund investment mandate.
- Fiscal discipline while accommodating new needs:
  - Allow one-off expenditures to be absorbed (2015 budget included one-off expenditures equivalent to around 4 percent of GDP).
  - Assume costs of similar magnitude (climate-change-related spending and maintenance of new capital assets) will become permanent in staff projections.
  - Continue current wage policy (allowing ‘wage drift’ from automatic promotion process, but no additional wage increases).
  - Maintain subsidies to SOEs at current nominal level while exploiting efficiency gains from restructuring (energy sector and copra sector).
  - Provide contingencies for unexpected expenditures within the envelope consistent with recommended path.
  - Continue prudent debt management and avoid non-concessional debt financing of the recurrent budget.

### Revenue-side measures and tax policy
- Tax revenue trends and expectations:
  - Tax revenues: around 19 percent of GDP in two decades leading to 2007; declined since 2008 to about 14 percent of GDP in 2014.
  - VAT: introduced in 2014; implementation successful, revenues in line with expectations.
  - Staff expect tax ratio to gradually increase to 17 percent in the next five years with improved compliance and strengthened SOE efficiency.
- Policy cautions:
  - Proposals to widen exemptions (e.g., exempting essential services from VAT) would undermine tax collection and increase compliance costs.
  - Further exemptions should be avoided; consider phasing out existing exemptions and replacing them with targeted support for low income households and direct transfers.
  - If exemptions are maintained, keep the list short and narrowly defined.

### Authorities’ views and intentions
- Authorities acknowledge volatility of fishing license fees and do not expect 2014 fee levels to persist indefinitely.
- Intentions and commitments:
  - Maintain spending discipline, consider additional transfers to the RERF, maintain a larger cash buffer, and invest part of surpluses in alternative safe financial assets given RERF asset management transition.
  - Recognize trade-off between strengthening RERF and addressing immediate infrastructure and social needs; welcome staff advice to allocate resources to climate-change-related and maintenance expenditures.
  - On VAT: concerned about negative public perception of price impacts but remain committed not to undermine the tax.

---

### 3. Social Outcomes, Fiscal Assessment, and Policy Guidance

### Improving social outcomes
- Key social indicators:
  - Extreme (food) poverty: around 5 percent.
  - Basic needs poverty: around 22 percent; over 24 percent in South Tarawa.
  - Sanitation: about half of households do not have access to toilet facilities.
  - Safe drinking water: available to about 65 percent of households.
  - Education attainment: about 57 percent reached secondary level; about 3 percent reached tertiary level.
- Health and education:
  - Health and education are the two largest budget items.
  - Kiribati among top Pacific Island countries in health expenditures as percent of GDP and ranks twentieth in the world.
  - High shares reflect high fixed costs due to lack of scale; scope for efficiency gains, particularly in personnel management.
- Authorities’ priorities:
  - Education and health will remain highest priorities.
  - Acknowledge possible efficiency gains but note challenges: insufficient resources to maintain capital assets; inadequate hospital supplies.
  - Several infrastructure projects to improve water access and sanitation underway.

### Staff appraisal — macroeconomic and fiscal assessment
- Economic performance:
  - Strong performance buoyed by large donor-financed infrastructure projects.
  - Staff project real GDP growth will remain above 3 percent in 2015; inflation should stay low.
- Fiscal position and risks:
  - Fiscal position improved markedly, but further efforts needed for sustainability.
  - Recent fiscal surpluses mainly driven by record-high fishing license fees, which are volatile.
  - Recent increases in recurrent expenditures partly due to more transparent support to SOEs.
  - Historical pace of spending increase unsustainable long term.
- Expenditure guidance and tax policy:
  - Limit nominal expenditure growth to 1½ per year over the next years.
  - Build budget contingencies for unexpected expenditures consistent with this path.
  - Contain public sector wages and SOE subsidies to create room for pro-growth and climate-related expenditures.
  - Expenditure growth path may be increased over time if fiscal position strengthens and fishing license fees support it.
  - VAT introduction successful; consider phasing out existing exemptions and replacing with targeted support for low income households; if exemptions maintained, keep list short.
- RERF and transparency:
  - Strengthening RERF should remain key policy goal.
  - Progress in RERF financial management reforms.
  - Transfers and withdrawals should be more transparent and symmetric around proposed expenditure path; maintain cash buffer equivalent to around two months of budget expenditures.
  - Major part of 2014 surplus should be transferred to the RERF.
- Private sector and SOE reforms:
  - Progress made to create conditions for private sector growth.
  - Further lower telecommunication and transportation costs, streamline business registration, and facilitate private land use to improve investment climate.
  - Progress on SOE reform to improve efficiency and contain fiscal drain.
  - Encourage further reduction of copra subsidy and speed up energy sector restructuring by increasing efficiency of two energy companies and rationalizing fuel and electricity prices.
- Donor support:
  - Continued support from donors and IFIs required given fiscal constraints.
  - Future donor-supported projects should focus on climate change mitigation and improving basic services: water, electricity, housing, education, and health.

---

### 4. Cross-country Context, Projections, and Key Indicators

### Structural challenges and connectivity
- Per capita income: remains below many other small states.
- Remoteness measured by Liner Shipping Connectivity Index (2005-2014); lower index indicates lower connectivity/higher transportation costs.
- Infrastructure indicators (2013 or latest): Access to electricity, Improved water source, Mobile subscriptions, Internet users — Kiribati compared to PICs and other small states.
- Reliance on donors increases import demand; export base limited.

### Key economic indicators and projections (selected figures and series preserved)
- Nominal GDP (2013): US$181.1 million
- GDP per capita (2013): US$1,676
- Nominal GNI (2013): US$289.8 million
- Population (2013): 108,021
- Main export products: fish and copra
- Quota: SDR 5.6 million
- Real GDP (percent change), 2009–2017: 0.3 -0.9 -0.2 3.4 2.4 3.7 3.1 1.8 2.1
- Real GNI (percent change), 2009–2017: -2.9 1.8 -5.8 14.3 11.5 13.6 -7.7 -3.6 1.9
- Consumer prices (percent change, average), 2009–2017: 9.8 -3.9 1.5 -3.0 -1.5 2.1 1.4 0.3 0.8
- Central government finance (percent of GDP) highlights, 2009–2017:
  - Revenue and grants: 68.4 70.2 59.6 84.2 94.4 128.7 105.4 94.9 95.0
  - Total domestic revenue: 41.2 46.2 35.6 50.3 65.6 84.9 65.5 56.6 57.0
  - Grants: 27.1 23.9 24.1 33.9 28.8 43.8 39.9 38.3 38.0
  - Expenditure and net lending: 79.9 82.4 81.9 80.5 84.9 107.6 106.5 102.2 97.3
  - Current: 52.8 56.1 57.6 47.0 56.5 59.5 59.7 59.3 58.5
  - Wages and salaries: 23.8 26.2 26.3 26.4 27.9 26.8 26.5 26.4 26.1
  - Development: 27.1 26.3 24.3 33.5 28.4 48.1 46.8 42.9 38.7
  - Current balance1/: -11.5 -9.9 -22.0 3.4 9.1 25.4 5.8 -2.8 -1.5
  - Overall balance: -11.5 -12.2 -22.2 3.8 9.5 21.1 -1.1 -7.3 -2.3
- RERF closing balance (in millions of US$), 2009–2017: 51 25 66 58 86 60 65 51 58 0 59 60 62 7 (table shows closing balance in US$ and A$ series).
- Balance of payments (in millions of US$), current account including official transfers, 2009–2017: -8.3 3.1 -24.1 -2.8 25.8 30.4 -8.3 -17.3 -12.5
- External debt (in millions of US$), 2009–2017: 15.9 14.3 14.3 14.3 14.3 14.3 20.8 32.4 40.1

### Central government operations (selected projected series)
- Total revenue and grants (2009–2020 Est./Proj.): 115.4 119.0 103.7 152.8 176.5 257.4 220.5 202.7 208.8 205.2 187.2 190.7
- Revenue (2009–2020): 69.6 78.4 61.9 91.3 122.6 169.7 137.0 120.9 125.3 128.4 131.7 135.1
- Tax revenue (2009–2020): 28.7 28.3 27.3 27.4 27.8 27.6 30.9 32.7 35.4 36.7 38.2 39.6
- Nontax revenue and fishing license fees (2009–2020):
  - Nontax revenue: 40.8 50.1 34.6 64.0 94.8 142.2 106.0 88.1 89.9 91.7 93.5 95.4
  - Fishing license fees: 29.5 41.7 29.1 58.8 88.6 136.8 100.0 82.0 82.0 83.6 85.3 87.0 88.8
- Total expenditure (2009–2020): 134.9 139.7 142.4 146.0 158.8 215.3 222.8 218.4 213.8 209.6 190.1 191.1
- Recurrent fiscal balance (2009–2020): -19.5 -16.8 -38.3 6.1 17.0 50.7 12.8 -5.9 -3.4 -2.2 -0.8 0.5
- Overall balance (2009–2020): -19.5 -20.8 -38.7 6.8 17.7 42.2 -2.4 -15.7 -5.0 -4.3 -2.9 -0.4

### Medium-term projections (selected)
- Real GDP (percentage change), 2007–2020 series: 0.3 -0.9 -0.2 3.4 2.4 3.7 3.1 1.8 2.1 2.1 1.4 1.5
- Inflation (period average), 2007–2020: 9.8 -3.9 1.5 -3.0 -1.5 2.1 1.4 0.3 0.8 1.2 1.7 2.1
- Nominal GDP at market prices (in millions of A$), 2007–2020: 156.3 167.3 168.7 169.6 174.0 181.4 187.0 200.0 209.2 213.7 219.8 227.2 234.3 242.7
- Government finance (percent of GDP) projected totals and components preserved in tables.

### Banking sector (outstanding loans, 2007–2014)
- DBK total loans (2007–2014): 8.9 9.1 9.4 9.1 9.0 8.7 8.9 8.9
- ANZ total loans (2007–2014): 32.9 49.9 48.9 36.3 40.0 31.4 38.0 33.2
- Total Loans (in millions of A$), 2007–2014: 41.8 59.0 58.3 45.4 49.0 40.2 46.9 54.1

### Balance of payments details (selected)
- Current account balance (in millions), 2009–2020 Est./Proj.: -10.6 3.3 -23.3 -2.8 26.6 33.7 -10.6 -22.3 -16.2 -11.8 -2.5 -1.4
- Current account (in percent of GDP), 2009–2020: -6.3 2.0 -13.4 -1.5 14.2 16.8 -5.1 -10.4 -7.4 -5.2 -1.0 -0.6
- Trade balance (in percent of GDP), 2009–2020: -43.4 -40.7 -41.7 -47.4 -45.0 -50.7 -50.2 -47.9 -45.0 -42.2 -36.6 -35.7
- Fishing license fees (percent of GDP): 21.0 24.8 16.8 32.2 47.6 68.4 47.8 38.4 38.1 37.5 37.1 36.6
- Investment income (percent of GDP): 15.9 17.1 16.5 15.3 13.6 8.8 10.1 10.6 10.8 10.8 11.0 11.1
- Remittances (percent of GDP): 7.6 7.0 6.5 6.4 6.7 6.6 6.8 7.0 7.0 7.0 7.0 7.0

---

### 5. Risk Assessment, Infrastructure, Data, and Debt Sustainability

### Risk Assessment Matrix — key risks and likelihoods
- Risks to fishing license fees:
  - Likelihood: Medium
  - Potential Impact: High
  - Description: Failure to enforce Nauru Agreement or weather changes could sharply drop fishing license fees from 2012-2014 levels; would expose fiscal pressures and jeopardize fiscal sustainability.
- Global financial risks:
  - Likelihood: Medium
  - Potential Impact: Medium
  - Description: Financial imbalances amid low interest rates; exposure to Australian assets makes RERF vulnerable to downside risks in that country.
- Protracted slowdown in advanced and emerging economies:
  - Likelihood: Medium (emerging markets); High (advanced economies)
  - Potential Impact: Medium
  - Description: Weak demand and low inflation could reduce global returns, negatively affecting RERF assets and fishing license fees/remittances.
- Risks to energy prices:
  - Likelihood: Medium
  - Potential Impact: Medium
  - Description: Persistently low prices could be favorable (reduce import value).
- Sharp slowdown in China:
  - Likelihood: Low
  - Potential Impact: Medium
  - Description: Lower Asian growth could affect fishing license fees and shipping.

### Project infrastructure and ADB support
- Road improvements in South Tarawa: 32.5 kilometers of main roads and about 8 kilometers of feeder roads.
- Cofinanced by Government of Australia, World Bank, and Pacific Regional Infrastructure Facility.
- ADB provided first policy grant of $3m to Kiribati in 2014.
- ADB approvals (2008–14) — loans, grants, and TA counts and amounts preserved in the source.

### Statistical issues and data adequacy (as of June 5, 2015)
- Data broadly adequate for surveillance but shortcomings, especially in Balance of Payments.
- National accounts: improvements with PTFAC assistance; work ongoing on expenditure-based GDP estimates.
- Price statistics: monthly retail price index (1996=100) for South Tarawa; no national index; no producer/wholesale/trade price indices.
- Government finance statistics: GFS mission June 2014; coverage extended but gap remains on donor-financed project funds.
- Monetary statistics: balance sheets of financial institutions available with lags; consolidated financial sector balance sheet not available.
- Balance of payments: participating in JSA project; three ESS missions in 2014; data compiled quarterly in BPM6; quality improving marginally but constrained by capacity and source-data quality.
- Reporting timestamps and frequencies for key indicators preserved in source.

### Debt Sustainability Analysis (DSA) — key messages
- DSA conclusion: Kiribati remains at high risk of debt distress.
- Context and assumptions:
  - Baseline growth: economy expected to grow about 3.1 percent in 2015 and average 1.8 percent a year through 2020; longer-term average 1.7 percent.
  - Inflation: projected to return to about 2 percent per year in longer term.
  - Fishing license fees: peaked at 68 percent of GDP in 2014; projected to decline from peak to a level consistent with average fish price and catch volumes and remain at that level in real terms.
  - Fiscal balance: surplus in 2013–14; projected small deficit of about one percent in 2015 and widen in medium/long term.
  - Recurrent expenditure growth: assumed 1½ percent per year until 2020, increasing to around 3½ percent per year long-term.
  - Climate-change-related recurrent spending and new infrastructure maintenance costs: together equivalent to around 4 percent of GDP included in expenditure envelope.
  - Development expenditures: about 47 percent of GDP in 2015; decline to around 23 percent of GDP in 2020; return to historical average of about 30 percent in long-term; financed by grants and loans with increasing share of loans after 2020.
- Results and vulnerabilities:
  - PV of external debt-to-GDP ratio threshold (30 percent) projected to increase from about 10 percent of GDP in 2015 and breach threshold around 2028 for the remainder of projection period.
  - PV of debt-to-exports ratio breaches threshold around 2035.
  - Long-run increase in external nominal debt driven by continued high imports as percent of GDP and low growth potential.
  - Stress tests: PV debt-to-export and PV debt-to-GDP thresholds breached under extreme stress test scenario.
  - PV of total public debt projected to increase from about 14 percent of GDP in 2015 and breach indicative threshold by 2032, driven mainly by external borrowings.
  - Extreme stress scenario: PV of debt-to-GDP breaches threshold by 2022 and exceeds 65 percent by 2033.
- Policy implications:
  - Continue reliance on grants to support large development needs to contain debt distress risk.
  - Implement fiscal and structural reforms to promote sustainability and growth.
  - Improve debt management: formal approval process for external borrowing and loan guarantees, clearance of costly overdraft debt, elimination of non-concessional borrowing.

---

### 6. Conclusion — Policy Recommendations and Key Numerical Highlights

### Debt sustainability and fiscal strategy
- RERF resources should be treated like an endowment fund to ensure sustainable financing for recurrent expenditures and cushion against lower fishing license fees or higher climate costs.
- Baseline projections assume:
  - Authorities save recent windfalls from fishing license fees.
  - A conservative fiscal stance is maintained.
  - Development budget largely relies on grants, except already committed loans.
- Policy recommendations:
  - Save record recent windfalls from fishing license fees into RERF.
  - Treat RERF as an endowment fund to protect recurrent spending and build a cushion for shocks.
  - Maintain a conservative fiscal stance.
  - Further implement structural reforms to make SOEs more competitive and limit SOE subsidy costs.
  - Finance development expenditures largely from external grants.
  - Limit even concessional loan financing; avoid non-concessional external borrowing.
- Authorities' response:
  - Broad agreement with assessment.
  - Commit to continue avoiding non-concessional external borrowing, pursue SOE reform, and follow a prudent fiscal path.

### Stress tests and scenario methodology (selected)
- Most extreme stress test: the test that yields the highest ratio on or before 2025.
- Representative shocks used in sensitivity analysis:
  - Real GDP growth at historical average minus one standard deviation.
  - Primary balance shocks.
  - One-time 30 percent real depreciation in 2016.
  - 10 percent of GDP increase in other debt-creating flows in 2016.
- Debt indicators highlighted: PV of debt-to-GDP ratio; PV of debt-to-exports ratio; PV of debt-to-revenue ratio; Debt service-to-revenue ratio; Debt service-to-exports ratio.
- Staff tables and figures present multi-year projections through 2035 and sensitivity outcomes used to classify and quantify debt distress risks.

*Source: IMF staff report — _cr15207*

### 1. External Competiveness and Exchange Rate Assessment _______________________________________ 6

### 1. External Competiveness and Exchange Rate Assessment _______________________________________ 6

### Background and recent macroeconomic developments
- Kiribati comprises 33 islands spread over 3.5 million square kilometers of ocean and a population of about 100,000.
- Extreme poverty is low, at around 5 percent, but 22 percent of the population lives below the basic needs poverty line.
- Key revenue sources: sovereign wealth fund (RERF), fishing license fees, and donors’ aids.
  - RERF balance declined from 565 percent of GDP in 2006 to 365 percent last year.
  - Fishing license fees reached a record-high 68 percent of GDP in 2014 (compared to the past average of about 20 percent).
  - Donor-financed infrastructure projects reached 45 percent of GDP in 2014.
- Recent performance and near-term outlook:
  - GDP growth was around 4 percent in 2014.
  - Growth is projected at about 3 percent in 2015.
  - Inflation remains subdued.
  - The current account turned positive in 2014 due to high fishing license fees, but is expected to revert to a deficit in 2015.
  - Fishing license fees were very strong during the first four months of 2015, exceeding their level during the first four months of 2014.
  - The Phoenix Island Protected Area (PIPA) has been temporarily closed; tuna prices have fallen significantly since the beginning of the year.
  - Recurrent fiscal balance expected to be positive in 2015 for the third consecutive year.
  - Recurrent expenditures increased by nearly 13 percent in 2014 and a further 5 percent in 2015 (per supplementary budget).
  - A one-off transfer to clear the debt of one large SOE was worth around 4 percent of GDP; previously non-transparent support to the state-owned power company was equivalent to around 3½ percent of GDP.
  - Tax revenues have yet to pick up despite the rollout of the VAT in April 2014.

### External competitiveness and exchange rate (Box 1)
- The real effective exchange rate (REER) depreciated over the last two years and is now below its historical average; this mainly reflects the weakening of the Australian dollar, which circulates as legal tender in Kiribati.
- Competitiveness remains hampered by high transportation costs, lack of scale and remoteness.
- Precise CGER-like estimates are not feasible given data limitations; the REER plays a limited role in current account developments, which are mostly driven by exogenous factors (fishing license fees and donor flows, and global commodity prices).
- The use of the Australian dollar as the official currency remains appropriate: Kiribati needs a strong nominal anchor and lacks institutional capacity to conduct its own monetary policy. The Australian dollar circulates as legal tender and Kiribati has accepted obligations under Article VIII of the Fund’s Articles of Agreement.

### Medium-term outlook and fiscal risks
- Fishing license fees are expected to stay higher than their historical level but fall from their 2014 peak.
  - PNA policy changes: US$5,000 minimum fee per vessel day effective in 2012, increased to US$6,000 in 2014 and to US$8,000 in 2015.
  - Staff baseline projects annual fishing license fees around 40 percent of GDP on average over 2015–20 (up from an average of about 24 percent of GDP over past decades), but below outturns averaging more than 50 percent of GDP in 2013–14.
  - Lower fishing license fees represent a plausible and high-impact downside risk.
- Donors’ activity is projected to diminish with completion of large infrastructure projects, reducing growth in the medium term.
- Climate change and weather-related damages increase downside risks to growth and fiscal balances.
- Returns on RERF and other financial assets could be affected by global risks (protracted slower global growth and low inflation could compress equity returns and bond yields).

### Climate change impacts and fiscal implications (Box 2)
- Kiribati’s average height above sea level is only around 2 meters.
- Climate model simulations estimate sea level could increase by 24 cm by 2050 and 61 cm by 2100 compared to the 1985–2005 average (high emission scenario).
- Main impacts: permanent erosion of shoreline and loss of land, frequent inundation, lower biodiversity, lower agricultural production, water resource and food security issues, increased spread of vector borne diseases.
- Fiscal cost estimates:
  - Coastal protection costs alone are estimated to be in the region of 1 percent of GDP per annum.
  - Annual adaptation costs could be in the range of ½ to 1½ percent of GDP (medium emissions scenario) and as high as 2½ percent of GDP in the worst case scenario.
  - Overall, climate change related costs could reach 3½ percent per year, and possibly more in worst case scenarios.
- Implication: Given fiscal constraints, more donor funding—including from the new Green Climate Fund—will be required.

### Policy findings, scenarios, and recommendations to restore sustainability and resilience
- Primary policy challenge: manage intergenerational benefits of the large sovereign wealth fund (RERF) amid uncertainty about future fishing license fees and spending pressures for infrastructure and climate adaptation.
- Fiscal and asset management guidance:
  - Preserve wealth:
    - Sustainable level of drawdown is estimated at about 3–4 percent of GDP (wide range reflects uncertainty around projected investment returns and population growth).
    - Staff recommended framing expenditure plans around a conservative fiscal stance: a RERF drawdown averaging about ½ percent of GDP over 2016-2020. This would help accumulate savings when fishing license fees are strong and limit drawdowns when they disappoint.
  - Expenditure rule:
    - A RERF drawdown of ½ percent of GDP annually would be consistent with recurrent expenditure growth of 1.5 percent per annum over the next 5 years, assuming fishing license fees remain robust.
    - This path would result in a gradual reduction in real per capita spending but leave room for pressing expenditure needs.
    - Capital spending should be primarily grant-financed.
    - With lower fishing revenues—closer to the historical average—RERF per capita balances would initially fall but later stabilize under the proposed approach.
  - Stabilization and transparency:
    - Budget transfers and withdrawals should be more transparent, systematic and symmetric around the proposed expenditure path.
    - Save a substantial part of revenues in the RERF when license fees are above average to enable sustainable drawdowns when they fall below average.
    - Maintain a larger cash buffer—equivalent to around two months of budget expenditures (around AUD20 million)—to manage revenue volatility and emergencies.
      - Of the 2014 fiscal surplus of around AUD 50 million, only AUD 10 million was transferred to the RERF to date.
      - Authorities purchased 20 square kilometers of land in Fiji in 2014 for around AUD 9 million drawn down from the RERF.
- Staff also highlighted the need for structural reforms to improve the business climate and support private sector growth, given competitiveness constraints from remoteness, high transport costs, and lack of scale.

*Source: IMF staff report — 1. External Competiveness and Exchange Rate Assessment*

### Box 3. Managing Volatility of Fishing License Fees and Ensuring Fiscal Sustainability

### Box 3. Managing Volatility of Fishing License Fees and Ensuring Fiscal Sustainability

### RERF performance and recent deterioration
- The RERF was capitalized with revenues from phosphates until reserves were exhausted in 1979 and, in the early decades, with fiscal surpluses.
- Sharp increase in current expenditures from an average of 48 percent of GDP in 1991–2000 to 58 percent in 2010–14 resulted in large deficits financed by drawdowns from the RERF; drawdowns stopped only when fishing revenue increased in 2013.
- Regularizing SOE subsidies and clearing overdrafts kept the deficit high despite containment of regular spending since 2011.
- The global financial crisis caused significant capital losses to the RERF.
- Current per capita value of the RERF is down to around AUD 5,400 (in 2006 dollars) from around AUD 9,300 in 2000.

### Staff simulations and scenarios for fishing license fee revenues
- Two revenue scenarios analyzed:
  - Baseline: fishing license fees stay high at AUD 100 Million on average over 2015–35.
  - Lower-revenue: decrease to an average of AUD 63 million, consistent with the historical average of around 24 percent of GDP since 1991.
- Simulation findings:
  - Historical pace of spending (“historical path” — nominal expenditure growth of 5.5 percent per annum) would be unsustainable, leading to depletion of the RERF in about 20 years, even under the higher fishing revenue scenario.
  - Expenditure growth of 1½ percent per year would ensure sustainability in both revenue scenarios:
    - Under the lower revenue scenario, it would stabilize the RERF around AUD 4,000 in real per capita terms by 2035.
    - Under the higher revenue scenario, it would increase RERF real per capita balances to around AUD 6,000 by 2035, effectively saving part of the fishing revenue windfall and improving intergenerational equity.
- Complementary fiscal indicator:
  - The proposed expenditure path would be consistent with maintaining the recurrent non-fish deficit (i.e., current fiscal balance excluding fishing revenues) at below 35 percent of GDP.

### Recommendations for RERF management and fiscal policy
- Better articulate and make explicit the saving and stabilization roles of the RERF when formulating the fund’s optimal investment strategy.
- Improve investment policy and strategic asset allocation to align with long-term objectives and nature of the fund.
- Ongoing reforms (with World Bank assistance) are being implemented, including appointment of new asset manager(s) and reform of the fund investment mandate.
- Maintain fiscal discipline while accommodating new spending needs by:
  - Allowing for one-off expenditures to be absorbed (2015 budget included one-off expenditures equivalent to around 4 percent of GDP).
  - Assuming costs of similar magnitude (covering climate-change-related spending and maintenance of new capital assets) will become permanent in staff projections.
  - Continuing current wage policy (allowing for a ‘wage drift’ from automatic promotion process, but no additional wage increases).
  - Maintaining subsidies to SOEs at the current nominal level while exploiting efficiency gains from restructuring (energy sector and copra sector).
  - Providing contingencies for unexpected expenditures within the envelope consistent with the recommended path.
  - Continuing prudent debt management and a policy of avoiding non-concessional debt financing of the recurrent budget.

### Revenue-side measures and tax policy
- Tax revenue developments:
  - Tax revenues were around 19 percent of GDP in the two decades leading to 2007, started declining in 2008, and had dropped to about 14 percent of GDP in 2014.
  - The VAT was introduced in 2014 and implementation has been successful, with revenues in line with expectations.
  - Staff expect the tax ratio to gradually increase to 17 percent in the next five years with improved compliance and strengthened SOE efficiency.
- Policy cautions:
  - Recent policy proposals to widen exemptions (e.g., exempting essential services from VAT) would undermine tax collection and increase tax administration and compliance costs for businesses.
  - Further exemptions should be avoided; consideration should be given to phasing out existing exemptions and replacing them with targeted support for low income households and direct transfer payments.
  - If exemptions are maintained, the list should be short and narrowly defined.

### Authorities’ views and policy intentions
- Authorities acknowledge volatility of fishing license fees and do not expect 2014 fee levels to persist indefinitely.
- Spending in 2014 and 2015 budgets remained contained despite increases due to more transparent budgeting, one-off spending, and natural disasters.
- Authorities intend to maintain spending discipline, consider additional transfers to the RERF, maintain a larger cash buffer, and invest part of surpluses in alternative safe financial assets given the transition in RERF asset management.
- Authorities recognize the trade-off between strengthening the RERF and addressing immediate infrastructure and social needs, welcoming staff advice to allocate resources to climate-change-related and maintenance expenditures.
- On VAT, authorities were concerned about negative public perception of price impacts that led to proposals to exempt essential services, but they remain committed not to undermine the tax.

*Source: IMF staff Box 3 text as provided.*

### 24.      The authorities agreed that some of these plans were risky and noted that Cabinet approval

### _cr15207 - 24.      The authorities agreed that some of these plans were risky and noted that Cabinet approval

### Improving Social Outcomes
- Extreme (food) poverty is low in Kiribati (around 5 percent), but basic needs poverty is relatively widespread: the share of population with income below the cost of acquiring enough food for adequate nutrition and other essentials such as clothing and shelter is around 22 percent, with over 24 percent in the main urban center of South Tarawa.
- About half of all households do not have access to toilet facilities.
- Access to safe drinking water is available to about 65 percent of households.
- Health and education outcomes face challenges:
  - Rising population density, particularly in South Tarawa, increases risks of communicable diseases.
  - Non-communicable diseases (diabetes in particular) represent a significant challenge.
  - Education attainment: about 57 percent of the population reached the secondary level, but only about 3 percent the tertiary level.6
- Health and education already represent the two largest items in the budget.
- Kiribati is among the top Pacific Island countries in terms of health expenditures as a percent of GDP and ranks twentieth in the world.7
- The relatively high share of health and education expenditures as a percent of GDP and as a share of the budget reflects high fixed costs due to lack of scale and suggests scope for efficiency gains, particularly in personnel management.

### Authorities’ Views
- Education and health will continue to be the highest priorities going forward.
- Authorities acknowledge possible efficiency gains but emphasize remaining challenges in the health and education sectors, notably:
  - Insufficient resources to maintain capital assets.
  - Inadequate supplies in hospitals.
- Several infrastructure projects are being implemented to improve water access and sanitation.

### Staff Appraisal — Macroeconomic and Fiscal Assessment
- Economic performance:
  - Economic performance has been strong, buoyed by large donor-financed infrastructure projects.
  - Staff projects real GDP growth will remain above 3 percent in 2015, while inflation should stay low.
- Fiscal position:
  - The fiscal position has improved markedly, but further efforts are needed to ensure sustainability.
  - Substantial fiscal surpluses in recent years were mainly driven by record-high fishing license fees which can be volatile.
  - Recent increases in recurrent expenditures are partly explained by more transparent support to SOEs.
  - The historical pace of increase in spending is unsustainable over the long term.
- Expenditure guidance:
  - Nominal expenditure growth should be limited to 1½ per year over the next years.
  - Budget contingencies should be built in for unexpected expenditures consistent with this expenditure path.
  - Public sector wages and SOEs’ subsidies should be contained to create room for pro-growth and climate change-related expenditures.
  - Expenditure growth path may be increased over time when the fiscal position has strengthened and become more sustainable, depending on the fishing license fees outturn.
- Tax policy:
  - The introduction of the VAT has overall been successful and revenues are in line with expectations.
  - Consideration should be given to phase out existing exemptions and replace them with targeted support of low income households.
  - If exemptions are to be maintained, the list should be short and narrowly defined.
- Sovereign Wealth / Stabilization Fund (RERF):
  - Strengthening the RERF should remain a key policy goal.
  - Important progress has been made in reforming RERF financial management.
  - Transfers and withdrawals should be more transparent and symmetric around the proposed expenditure path: subject to maintaining a cash buffer equivalent to around two months of budget expenditures, a substantial part of the current above-average surpluses should be saved to allow for sustainable drawdowns when they fall below the average.
  - Accordingly, the major part of the 2014 surplus should be transferred to the RERF.
- Private sector and SOE reforms:
  - Progress has been made in creating conditions for private sector growth.
  - Further lowering telecommunication and transportation costs, streamlining business registration processes, and facilitating the private usage of land will be critical to improve the investment climate and lift growth prospects.
  - There has been progress on implementing the reform of SOEs to improve their efficiency and contain the drain on public finances.
  - Authorities are encouraged to further reduce the copra subsidy and speed up the restructuring of the energy sector through further increasing the efficiency of the two energy companies and rationalizing the structure of both fuel and electricity prices.
- Donor support:
  - Given fiscal constraints, Kiribati will need continued support from donors and IFIs.
  - Future donor-supported projects should focus on climate change mitigation measures, and improving the provision of basic services such as water, electricity, housing, education, and health.

*Source: _cr15207 - 24.      The authorities agreed that some of these plans were risky and noted that Cabinet approval*

### 37.      It is recommended that the next Article IV consultation takes place on the standard 12-

### _cr15207 - 37.      It is recommended that the next Article IV consultation takes place on the standard 12-

### Cross-country context and structural challenges
- Kiribati’s per capita income remains below that of many other small states.
- One key challenge: remoteness as measured by connectivity/transportation costs (Liner Shipping Connectivity Index, 2005-2014; note: smaller number indicates lower connectivity/high transportation costs; countries with maximum connectivity=100).
- Infrastructure indicators, 2013 (or latest data available): Access to electricity (% of population), Improved water source (% of population with access), Mobile cellular subscriptions (per 100 people), Internet users (per 100 people) — Kiribati compared to PICs (Median) and Others small states (Median).
- Kiribati is heavily reliant on donors’ support to finance its development, increasing import demand; the export base remains very limited.
- The public sector dominates the economy, but key infrastructure are still lagging.
- Sources: IMF LIC data and staff estimates.

### Macroeconomic prospects and drivers (Figure 2)
- Growth supported by donor-financed large infrastructure projects.
- Inflation remains moderate, driven by subdued food prices.
- Fishing license fees have boosted revenues in the last three years and are expected to remain higher than in the past, albeit lower than their 2014 peak.
- Expenditures have increased since 2009 but are expected to gradually decline in percent of GDP.
- The current account tends to be driven by fiscal developments.
- Inflation (In percent, year-on-year): historical series shown 2002–2020; global food prices in local currency (RHS) plotted alongside.
- Growth and Development Expenditures (In percent, year-on-year; in millions of Australian dollars): series plotted 2002–2020.
- Fishing License Fees and Their Changes (In millions of Australian dollars): series 1996–2020 with components Other factors, Exchange rate effect, Fishing licenses.
- Revenue composition (2005–2020 series): Tax, Fees and charges, Fishing licences.
- Current Expenditure components (2005–2020 series): Wages and salaries, Subsidies to SOEs, Other current expenditure.
- Drivers of the Current Account Balance plotted: Current account balance + capital grants (in percent of GDP), Overall fiscal balance (in percent of GDP), Change in REER (in percent, y/y).
- Sources: Kiribati authorities and IMF staff estimates.

### Human development, health and education (Figure 3)
- Secondary gross enrollment rate (2012 or latest available) plotted against public expenditure on education (In percent of GDP; 2005-12) and (In percent of government expenditure; 2005-12).
- Life Expectancy (In years; 2012) plotted against public health expenditure (In percent of GDP; 2005-12) and (In percent of government expenditure; 2005-12).
- Mortality rate under 5-years (per 1,000 live births; 2012) plotted against public health expenditure (In percent of GDP; 2005-12) and (In percent of government expenditure; 2005-12).
- Comparators shown: APD small states, Other small states, Small states (median), Nonsmall states¹ (median).
- Sources: World Bank, WDI; board paper “Macroeconomic Developments and Selected Issues in Small Developing States” and IMF staff estimates.

### Key economic indicators (Table 1: Selected Economic Indicators, 2009–17)
- Nominal GDP (2013): US$181.1 million
- GDP per capita (2013): US$1,676
- Nominal GNI (2013): US$289.8 million
- Population (2013): 108,021
- Main export products: fish and copra
- Quota: SDR 5.6 million
- Real GDP (percent change), 2009–2017: 0.3 -0.9 -0.2 3.4 2.4 3.7 3.1 1.8 2.1
- Real GNI (percent change), 2009–2017: -2.9 1.8 -5.8 14.3 11.5 13.6 -7.7 -3.6 1.9
- Consumer prices (percent change, average), 2009–2017: 9.8 -3.9 1.5 -3.0 -1.5 2.1 1.4 0.3 0.8
- Central government finance (percent of GDP) series 2009–2017 (select):
  - Revenue and grants: 68.4 70.2 59.6 84.2 94.4 128.7 105.4 94.9 95.0
  - Total domestic revenue: 41.2 46.2 35.6 50.3 65.6 84.9 65.5 56.6 57.0
  - Grants: 27.1 23.9 24.1 33.9 28.8 43.8 39.9 38.3 38.0
  - Expenditure and net lending: 79.9 82.4 81.9 80.5 84.9 107.6 106.5 102.2 97.3
  - Current: 52.8 56.1 57.6 47.0 56.5 59.5 59.7 59.3 58.5
  - Wages and salaries: 23.8 26.2 26.3 26.4 27.9 26.8 26.5 26.4 26.1
  - Development: 27.1 26.3 24.3 33.5 28.4 48.1 46.8 42.9 38.7
  - Current balance 1/: -11.5 -9.9 -22.0 3.4 9.1 25.4 5.8 -2.8 -1.5
  - Overall balance: -11.5 -12.2 -22.2 3.8 9.5 21.1 -1.1 -7.3 -2.3
- Financing and RERF (Revenue Equalization and Reserve Fund) flows: financing series and RERF contributions shown (see table).
- RERF closing balance (in millions of US$), 2009–2017: 51 25 66 58 86 60 65 51 58 0 59 60 62 7 (table shows closing balance in US$ and A$ series; preserve table values as presented).
- Balance of payments (in millions of US$), current account including official transfers, 2009–2017: -8.3 3.1 -24.1 -2.8 25.8 30.4 -8.3 -17.3 -12.5
- External debt (in millions of US$), 2009–2017: 15.9 14.3 14.3 14.3 14.3 14.3 20.8 32.4 40.1
- Memorandum: Nominal GDP (in millions of Australian dollars) and US dollars series included.

Notes
- Sources: Data provided by the Kiribati authorities; and Fund staff estimates and projections.
- Footnotes: 1/ Current balance excludes grants and development expenditure. 2/ Balances assume A$25 Million from the 2014 surplus are transferred to the RERF. 3/ The Australian dollar circulates as legal tender. 4/ Index, 2005=100. Proj.

### Central government operations (Table 2: Summary of Central Government Operations, 2009–20)
- Total revenue and grants (2009–2020 Est./Proj.): 115.4 119.0 103.7 152.8 176.5 257.4 220.5 202.7 208.8 205.2 187.2 190.7
- Revenue (2009–2020): 69.6 78.4 61.9 91.3 122.6 169.7 137.0 120.9 125.3 128.4 131.7 135.1
- Tax revenue (2009–2020): 28.7 28.3 27.3 27.4 27.8 27.6 30.9 32.7 35.4 36.7 38.2 39.6
- Personal income tax series (2009–2020): 6.2 6.1 6.1 7.2 7.1 7.0 7.4 7.5 7.7 8.0 8.2 8.5
- Company tax series: 7.0 7.3 5.7 4.7 4.6 4.7 5.5 5.9 6.4 7.0 7.6 8.2
- Nontax revenue and fishing license fees (2009–2020): Nontax revenue: 40.8 50.1 34.6 64.0 94.8 142.2 106.0 88.1 89.9 91.7 93.5 95.4; Fishing license fees: 29.5 41.7 29.1 58.8 88.6 136.8 100.0 82.0 82.0 83.6 85.3 87.0 88.8
- External grants (2009–2020): 45.8 40.6 41.9 61.5 53.9 87.7 83.5 81.9 83.5 76.8 55.4 55.7
- Total expenditure (2009–2020): 134.9 139.7 142.4 146.0 158.8 215.3 222.8 218.4 213.8 209.6 190.1 191.1
- Current expenditure (2009–2020): 89.1 95.2 100.2 85.2 105.6 119.0 124.9 126.7 128.6 130.6 132.5 134.5
  - Wages and salaries (2009–2020): 40.2 44.4 45.8 47.9 52.1 53.7 55.3 56.4 57.4 58.5 59.6 60.7
  - Subsidies to public enterprises (2009–2020): 5.8 6.3 8.5 6.8 9.8 11.2 14.1 14.1 14.1 14.1 14.1 14.1
- Development expenditure (2009–2020): 45.8 44.5 42.2 60.8 53.2 96.3 98.0 91.7 85.1 79.0 57.5 56.6
- Recurrent fiscal balance 4/ (2009–2020): -19.5 -16.8 -38.3 6.1 17.0 50.7 12.8 -5.9 -3.4 -2.2 -0.8 0.5
- Overall balance 5/ (2009–2020): -19.5 -20.8 -38.7 6.8 17.7 42.2 -2.4 -15.7 -5.0 -4.3 -2.9 -0.4
- Financing, RERF, project loans, commercial borrowing and memorandum items are presented in detail in the table.
- Notes: 1/ Expenditure path based on staff recommended "active policies" scenario. 2/ Includes subsidies to copra production. 3/ Development expenditure equals grants plus loans for development projects. 4/ Current balance excludes grants and development expenditure. 5/ Overall balance in the table is different from official budget because loans are classified as financing.

### Medium-term projections (Table 3: Medium-Term Projections, 2009–20)
- Real GDP (percentage change), 2007–2020 series: 0.3 -0.9 -0.2 3.4 2.4 3.7 3.1 1.8 2.1 2.1 1.4 1.5
- Inflation (period average), 2007–2020 series: 9.8 -3.9 1.5 -3.0 -1.5 2.1 1.4 0.3 0.8 1.2 1.7 2.1
- Nominal GDP at market prices (in millions of A$), 2007–2020: 156.3 167.3 168.7 169.6 174.0 181.4 187.0 200.0 209.2 213.7 219.8 227.2 234.3 242.7 (table series).
- Government finance (percent of GDP) projected totals:
  - Total revenue and grants: 66.1 64.8 68.4 70.2 59.6 84.2 94.4 128.7 105.4 94.9 95.0 90.3 79.9 78.6
  - Revenue: 39.3 40.2 41.2 46.2 35.6 50.3 65.6 84.9 65.5 56.6 57.0 56.2 55.6
  - External grants: 26.7 24.6 27.1 23.9 24.1 33.9 28.8 43.8 39.9 38.3 38.0 33.8 23.7 22.9
  - Total expenditure and net lending: 81.7 83.6 79.9 82.4 81.9 82.4 91.9 92.6 84.9 107.6 106.5 102.2 97.3 92.2
  - Current expenditure: 54.9 59.0 52.8 56.1 57.6 55.9 56.5 59.5 59.7 59.3 58.5 57.5 56.6 55.4
  - Wages and salaries (percent of GDP): 26.5 26.9 23.8 26.2 26.3 26.4 27.9 26.8 26.5 26.4 26.1 25.7 25.4 25.0
  - Development expenditure: 26.7 24.6 24.6 27.1 26.3 24.3 33.5 28.4 48.1 46.8 42.9 38.7 34.8 24.6 23.3
- Current balance and overall balance projections shown: Current balance -11.5 -9.9 -22.0 -8.8 9.1 25.4 5.8 -2.8 -1.5 -1.0 -0.3 0.2; Overall balance -15.6 -18.8 -11.5 -12.2 -22.2 -8.4 9.5 21.1 -1.1 -7.3 -2.3 -1.9 -1.2 -0.2
- RERF balance (end of period; in millions of A$) series provided.
- Balance of payments: Current account balance (in percent of GDP) series: -3.4 -4.1 -6.3 2.0 -13.4 -1.5 14.2 16.8 -5.1 -10.4 -7.4 -5.2 -1.0 -0.6
- Trade balance (in percent of GDP) series: -43.4 -40.7 -41.7 -47.4 -45.0 -50.7 -50.2 -47.9 -45.0 -42.2 -36.6 -35.7
- Sources: Data provided by the Kiribati authorities; and Fund staff estimates and projections.

### Banking sector (Table 4: Outstanding Banking Loans, 2007–14)
- DBK total loans (2007–2014): 8.9 9.1 9.4 9.1 9.0 8.7 8.9 8.9
- ANZ total loans (2007–2014): 32.9 49.9 48.9 36.3 40.0 31.4 38.0 33.2
- KPF small loan scheme: KPF data estimated; KPF loans series include 2.0 7.0 12.0 (years shown).
- Total Loans (in millions of A$), 2007–2014: 41.8 59.0 58.3 45.4 49.0 40.2 46.9 54.1
- Household and sectoral loan breakdowns and percent of GDP series provided in table.
- Source: Kiribati authorities and IMF staff calculations.

### Annex 1. Risk Assessment Matrix

### Annex 1. Risk Assessment Matrix

### Summary of identified risks
- Risks to fishing license fees
  - Likelihood: Medium
  - Potential Impact: High
  - Description: Inability to durably enforce the Nauru Agreement or weather pattern changes lead to a sharp drop in revenues fishing license fees from their 2012-2014 level.
  - Macroeconomic implication: This would expose fiscal pressures and lead to high fiscal deficits that would jeopardize fiscal sustainability.

- Global financial risks
  - Likelihood: Medium
  - Potential Impact: Medium
  - Description: Financial imbalances from protracted period of low interest rates remain high: excess leverage, especially for corporates; asset price bubbles.
  - Specific scenarios noted:
    - Sovereign stress in the Euro area re-emerges due to policy uncertainty, faltering reforms, and political and social upheaval, particularly in Greece.
    - In Japan: Abenomics falters, resulting in an eventual return of depressed domestic demand and deflation and leading to bond market stress (medium-term).
  - Exposure: Exposure to Australian assets makes the RERF vulnerable to the materialization of downside risks related to this country, among which the risks related to a booming property market.
  - Macroeconomic implication: Declining growth prospects could impinge on global asset valuations and negatively affect the value of the RERF assets.

- Protracted slowdown in key advanced and emerging economies
  - Likelihood: Medium (emerging markets); High (advanced economies)
  - Potential Impact: Medium
  - Description:
    - Euro area and Japan: Weak demand and persistently low inflation from a failure to fully address crisis legacies and appropriately calibrate macro policies.
    - Emerging markets: Maturing of the cycle, misallocation of investment, and incomplete structural reforms leading to prolonged slower growth.
  - Macroeconomic implication: A decline in global returns and valuations would have a negative impact on RERF assets. Also, fishing license fees and seamen’s remittances could be negatively affected if global demand for fish and shipping grows at a slower pace of growth.

- Risks to energy prices
  - Likelihood: Medium
  - Potential Impact: Medium
  - Description: Persistently low prices triggered by supply factors reversing only gradually, and weaker demand.
  - Macroeconomic implication: Decline in commodity prices would be favorable to Kiribati since it would reduce the value of imports.

- Sharp growth slowdown and financial risks in China
  - Likelihood: Low
  - Potential Impact: Medium
  - Description: Growth falls significantly below target in 2015-2016, possibly due to a severe housing downturn or a shock in the shadow banking sector, and absent offsetting stimulus.
  - Macroeconomic implication: Fishing license fees may be affected by a resulting lower growth in the Asia Pacific region and disruption of shipping.

### Key definitions and caveats
- The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (that is, which is the scenario most likely to materialize in the view of IMF staff).
- The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability  below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent).
- The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.

*Source: Annex 1. Risk Assessment Matrix*

### 32.5 kilometers of main roads and about 8 kilometers of feeder roads. Cofinanced by the

### 32.5 kilometers of main roads and about 8 kilometers of feeder roads. Cofinanced by the

### Project infrastructure and ADB support
- 32.5 kilometers of main roads and about 8 kilometers of feeder roads to be improved in South Tarawa.
- Cofinanced by the Government of Australia, the World Bank and the Pacific Regional Infrastructure Facility.
- ADB provided its first policy grant of $3m to Kiribati in 2014.

### ADB approvals (2008–14)
- Loan Approvals:
  - Number: 2008: 0; 2009: 0; 2010: 1; 2012: 1; 2013: 0; 2014: 0
  - Amount (US$m): 2008: 0; 2009: 0; 2010: 12; 2012: 7.56; 2013: 0; 2014: 0
- Grant Approvals:
  - Number: 2008: 0; 2009: 0; 2010: 0; 2012: 0; 2013: 0; 2014: 1
  - Amount (US$m): 2008: 0; 2009: 0; 2010: 0; 2012: 0; 2013: 0; 2014: 3
- TA Approvals:
  - Number: 2008: 1; 2009: 2; 2010: 2; 2012: 1; 2013: 2; 2014: 0
  - Amount (US$m): 2008: 0.8; 2009: 0.85; 2010: 0.2; 2012: 0.8; 2013: 1; 2014: 0

### Statistical issues and data adequacy (as of June 5, 2015)
- General: Data provision has some shortcomings, but is broadly adequate for surveillance. Balance of Payments data are the most affected area.
- National Accounts:
  - GDP estimates improved with PTFAC assistance.
  - Three TA missions in 2014 to improve national account data and produce revised estimates.
  - Estimates limited to GDP at current and constant 06 prices, using the production approach.
  - Expenditure-based GDP estimates: work ongoing; further capacity building needed.
- Price statistics:
  - Monthly retail price index (1996=100) produced with a short lag (about a month), based on a survey in South Tarawa (a national index is not available).
  - No producer, wholesale, or trade price indices.
- Government finance statistics:
  - GFS mission in June 2014 to integrate GFS requirements into the Chart of Accounts and extend coverage to donor-financed projects.
  - A complete review of government units, statutory extra budgetary units, and SOEs was completed, but a gap remains regarding donor-financed project funds.
- Monetary statistics:
  - Balance sheets of all financial institutions (Bank of Kiribati, Development Bank of Kiribati, Kiribati Provident Fund, and Kiribati Insurance Corporation) are available with lags.
  - Consolidated balance sheet of the financial sector is not available.
  - Data on interest rates are reported with a long lag.
- Balance of payments:
  - Kiribati participates in the Pacific Region module of the JSA project on Improvement of External Sector Statistics (ESS).
  - Three ESS missions were undertaken during 2014.
  - Data are compiled quarterly in the BPM6 format.
  - Quality improving marginally but constrained by capacity and source-data quality; shortcomings in trade-data adjustments, recording of investment income, direct investment and foreign aid data.

### Data standards, reporting, and indicator availability
- Kiribati has been a participant in the General Data Dissemination System (GDDS) since 04.
- No data ROSC are available.
- No data are currently reported to STA for publication in the Government Finance Statistics Yearbook, the Balance of Payments Statistics Yearbook or in the IFS.
- Selected reporting timestamps (as presented):
  - Exchange Rates: Date of latest observation 6/4/2015; Date received 6/4/2015; Frequency: D; Frequency of Reporting/Publication: D
  - Interest Rates: Date of latest observation 3/31/15; Date received 5/7/15; Frequency: A; Frequency of Reporting/Publication: A / I
  - Consumer Price Index: Date of latest observation 3/15; Date received 4/15; Frequency: M; Frequency of Reporting/Publication: Q / Q
  - Revenue, Expenditure, Balance and Composition of Financing - General Government: Date of latest observation 2014; Date received 2/2015; Frequency: A; Frequency of Reporting/Publication: A / I
  - GDP/GNP: Date of latest observation 2013; Date received 2/2015; Frequency: A; Frequency of Reporting/Publication: A / I
  - External Current Account Balance: Date of latest observation 2012; Date received 07/2014; Frequency: A; Frequency of Reporting/Publication: A / I

### Debt Sustainability Analysis (DSA) — key messages
- DSA conclusion: Kiribati remains at high risk of debt distress.
- Drivers and context:
  - Kiribati: 33 islands spread over 3.5 million square kilometers of ocean, population of about 100,000.
  - Limited export base; largely dependent on fishing license fees and donor support; exports limited to fishing, copra, and tourism.
  - RERF (Revenue Equalization Reserve Fund) established in 1956 from phosphate mining proceeds; phosphate deposits exhausted in 1979.
  - Climate change costs uncertain but estimated equivalent to around 3½ percent of GDP per year.
- Baseline scenario assumptions:
  - GDP growth and inflation:
    - Economy expected to grow at about 3.1 percent in 2015 and moderate to an average of 1.8 percent a year in the medium term through 2020.
    - In the longer term, growth is assumed to average 1.7 percent.
    - Inflation projected to return to an average of about 2 percent per year in the longer term.
  - Fishing license fees:
    - Peaked at 68 percent of GDP in 2014.
    - Projected to decline from their peak to the level consistent with average fish price and catch volumes, remain at this level in real terms.
  - Fiscal balance:
    - Overall fiscal balance improved to a surplus in 2013–14; projected to return to a small deficit of about one percent in 2015 and widen in the medium and longer term.
    - Recurrent expenditure growth: assumed at 1½ percent per year until 2020, increasing to an average growth of around 3½ percent per year in the long-term.
    - Climate-change-related recurrent spending and new infrastructure maintenance costs—together equivalent to around 4 percent of GDP—are included in the expenditure envelope.
  - Development expenditures:
    - Estimated at about 47 percent of GDP in 2015; expected to decline to around 23 percent of GDP in 2020.
    - Projected to return to a historical average of about 30 percent of GDP in the long-term.
    - Development expenditures assumed to be financed by a combination of loans and grants, with an increasing share of loans after 2020.
  - Current account:
    - After surpluses in 2013-14, expected to return to a deficit in 2015; medium and long term deficits expected to widen due to imports for capital projects financed by grants and loans.
- Results and vulnerabilities:
  - External debt sustainability:
    - PV of external debt-to-GDP ratio threshold (30 percent) projected to increase from about 10 percent of GDP in 2015 and breach the threshold around 2028 for the remainder of the projection period.
    - PV of the debt-to-exports ratio also breaches the threshold around 2035.
    - Long-run increase in external nominal debt driven by continued high imports as a percent of GDP and low growth potential.
  - Stress tests:
    - PV debt-to-export and PV debt-to-GDP thresholds breached under the extreme stress test scenario.
  - Public debt:
    - PV of total public debt projected to increase from about 14 percent of GDP in 2015 and breaches the indicative threshold by 2032, driven mainly by external borrowings.
    - Large residuals for 2013-14 reflect asset increases related to high windfall fishing revenues (cash and purchase of land in Fiji).
  - Extreme scenarios:
    - Under the most extreme stress test scenario the PV of debt-to-GDP breaches the threshold by 2022 and exceeds 65 percent by 2033.
    - Scenario fixing the primary balance at the 2015 level is not representative given windfall fishing revenues in 2014–15.
- Policy implications highlighted:
  - Continuation of grants to support large development needs is required to contain the risk of debt distress.
  - Implementation of fiscal and further structural reforms to promote fiscal sustainability and growth is necessary.
  - Debt management improvements noted: adoption of a formal approval process for external borrowing and loan guarantees, clearance of costly overdraft debt, elimination of non-concessional borrowing.

*Prepared by the Staff of the International Monetary Fund and the World Bank, July 9, 2015.*

### CONCLUSION

### _cr15207 - CONCLUSION

### Debt sustainability assessment
- The debt sustainability analysis indicates that Kiribati’s scope for external borrowing, even on concessional terms, remains limited.
- The risk of high debt distress remains despite the availability of RERF resources.
- RERF resources should be treated like an endowment fund to ensure sustainable financing for recurrent expenditures and to provide a cushion in case of lower revenues from fishing license fees or higher climate-change-related costs.
- Baseline projections in the staff report assume:
  - The authorities save recent windfalls from fishing license fees.
  - A conservative fiscal stance is maintained.
  - Development budget largely relies on grants, with the exception of already committed loans.

### Policy recommendations and fiscal strategy
- Save the record recent windfalls from fishing license fees into RERF.
- Treat RERF as an endowment fund to protect recurrent spending and build a cushion for shocks (e.g., lower fishing license revenues, higher climate-related costs).
- Maintain a conservative fiscal stance.
- Further implement structural reforms to make SOEs more competitive and limit the cost of SOE subsidies.
- Finance development expenditures largely from external grants.
- Limit even concessional loan financing; avoid non-concessional external borrowing.

### Authorities' response
- The authorities broadly agree with the assessment.
- They expressed commitment to:
  - Continue avoiding non-concessional external borrowing.
  - Pursue the SOE reform agenda.
  - Follow a prudent fiscal path.

### Stress tests and scenarios (as summarized in figures and tables)
- Figure notes:
  - The most extreme stress test is the test that yields the highest ratio on or before 2025.
  - In figure panels b–e the most extreme shock corresponds to a Terms shock; in figure f it corresponds to a One-time depreciation shock.
- Stress-test guidance:
  - Development budget reliance on grants (except already committed loans) under the baseline.
  - Combination and bound tests shown in the staff material include shocks such as:
    - Real GDP growth at historical average minus one standard deviation.
    - Primary balance shocks.
    - One-time 30 percent real depreciation in 2016.
    - 10 percent of GDP increase in other debt-creating flows in 2016.
  - Most extreme single shocks identified include Terms shocks and One-time depreciation shocks (panel-specific).

### Key numerical highlights from the staff framework and projections (selected)
- The staff report baseline and stress-test tables and figures present multi-year projections through 2035 and show:
  - The staff emphasizes limited borrowing space "even on concessional terms."
  - Explicit baseline assumption: development budget largely relies on grants, with the exception of already committed loans.
  - Stress-test methodology: the "most extreme stress test" is defined as the test that yields the highest ratio on or before 2025.
  - Figure captions identify debt indicators including:
    - PV of debt-to-GDP ratio.
    - PV of debt-to-exports ratio.
    - PV of debt-to-revenue ratio.
    - Debt service-to-revenue ratio.
    - Debt service-to-exports ratio.
  - Tables show detailed historical and projected series and sensitivity outcomes used to classify and quantify debt distress risks (see staff tables and figures for full numeric panels).

*Source: CONCLUSION, _cr15207*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2015/_cr15207.pdf_