## _cr16292 - 3.5 percent in 2015, supported by record high fishing revenue, donor-financed infrastructure

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### Overview
- Real GDP growth: "3.5 percent in 2015, supported by record high fishing revenue, donor-financed infrastructure projects and reconstruction in the aftermath of cyclone Pam."
- Growth outlook: "projected to moderate somewhat to around 3 percent this year."
- Inflation: "remains subdued owing to low food and commodity prices."

### Recent developments and macro balances
- Growth and inflation (percent changes):
  - Real GDP: 2015 = 3.5 percent; 2016 (proj.) = 3.1 percent; 2017 (proj.) = 2.5 percent; 2018 (proj.) = 2.0 percent.
  - Consumer prices (average): 2015 = 0.6 percent; 2016 (proj.) = 1.5 percent; 2017 (proj.) = 2.0 percent; 2018 (proj.) = 2.5 percent.
- Fiscal outcomes and public debt:
  - "High fishing revenue contributed to a recurrent fiscal balance of almost 50 percent of GDP in 2015."
  - Government recurrent spending increased by "13 percent" (year-on-year).
  - Public debt rose from "less than 10 percent of GDP in 2014 to 23 percent of GDP at the end of 2015" owing to the Bonriki International Airport repair and upgrade project financed by concessional loans.
- External sector:
  - "The current account surplus reached 40 percent of GDP in 2015."
  - Imports were elevated due to donor-financed projects, but fishing revenue and a recovery in seamen remittances more than offset them.
  - Exchange rate: depreciation in real effective terms "to below the historical average."

### Medium-term outlook and risks
- Growth projection: "Growth is projected to weaken further over the medium term with the projected decline in fishing revenue and the completion of large infrastructure projects."
- Balance of payments (current account incl. official transfers, percent of GDP): 2015 = 44.9 percent; 2016 (proj.) = -7.2 percent; 2017 (proj.) = -2.5 percent; 2018 (proj.) = -1.6 percent.
- External debt (percent of GDP): 2015 = 23.1 percent; 2016 (proj.) = 27.0 percent; 2017 (proj.) = 29.4 percent; 2018 (proj.) = 31.9 percent.
- Key vulnerabilities:
  - Climate change: "can have an impact on long-run prospects given the country’s low elevation."
  - Financial market exposure: "Global financial market turmoil may feed into the domestic economy through the exposure to foreign assets of the Revenue Equalization Reserve Fund (RERF) and the Kiribati Provident Fund (KPF)."

### Sovereign wealth fund and fishing revenue
- Role of RERF: "the primary vehicle for intergenerational saving."
- Fishing license dynamics:
  - Fishing license fees reached "nearly 100 percent of GDP (A$220 million)" in 2015.
  - Authorities forecast license revenue to "halve to around A$100 million in 2016", consistent with the historical average of the last seven years.
- RERF closing balance (A$ millions): 2012 = 614; 2013 = 661; 2014 = 679; 2015 = 756; 2016 (proj.) = 866; 2017 (proj.) = 880; 2018 (proj.) = 891.
- RERF per capita (2006 A$): 2012 = 4,872; 2013 = 5,018; 2014 = 4,932; 2015 = 5,305; 2016 (proj.) = 5,869; 2017 (proj.) = 5,727; 2018 (proj.) = 5,553.
- Recent fiscal mechanics: strong 2015 fishing revenue "halted a prolonged period of relying on drawdowns from the RERF to finance the budget deficit."

### Fiscal framework, key recommendations and scenarios
- Fiscal policy priority: "Committing to a balanced structural budget over the medium term in light of the declining fishing revenue."
- Recommended fiscal framework components:
  - (i) commit to a balanced structural budget over the medium term;
  - (ii) strengthen the RERF as an anchor for long run fiscal sustainability by formulating a rule-based withdrawal mechanism;
  - (iii) maintain an appropriately-sized cash reserve buffer to cope with revenue volatility and external shocks.
- Structural-balance implications and adjustment needs:
  - Staff baseline: on current policies, recurrent deficit would widen to around 10 percent of GDP over the medium term, resulting in gradual depletion of the RERF.
  - Targeting a structurally balanced budget based on A$100 million fishing license fees would require fiscal adjustment of around 4½ percentage points of GDP in 2017 rising to 8½ percentage points by 2021 compared to the baseline scenario.
  - Adjustment options: boost revenue collection (e.g., phasing out VAT exemptions), limit recurrent spending growth to under 1.5 percent per year, cap nominal copra subsidies at the 2016 level, set wage increases within current wage policy framework.
  - In the event of temporary fee surges: fiscal surplus should be saved in the RERF; shortfalls relative to the A$100 million baseline could be met by transfers from the reserve buffer.
- RERF rule-based withdrawal guidance:
  - If goal is to preserve real value after reaching a target level, withdrawal rate should be limited to around 1–2 percent of the overall balance, assuming average return rate on the fund of 3–5 percent and long run inflation of 2.5 percent.
  - Withdrawal could be indexed to nominal GDP based on projected long run average growth and targeted return rate.
- Cash reserve buffer:
  - Limit to three months of recurrent expenditure.
  - Sizeable cash reserves from 2014–15 fishing revenue in excess of this amount should be transferred to the RERF ASAP.
  - On 2016 level of current expenditure, this would leave a cash reserves buffer of roughly A$40 million (40 percent of the projected fishing revenue).
  - Drawdowns should be transparent and replenished when revenue exceeds expectations; surplus after replenishment to be transferred to RERF.

### VAT, debt distress and debt dynamics
- VAT and revenue:
  - VAT introduced in 2014 reversed decline in non-fishing revenue since 2008.
  - Reintroduced SOE exemptions in late 2015 estimated to have reduced VAT collection by around 15 percent in 2016.
  - Staff urge phasing out SOE exemptions, further training of tax office staff, greater use of IT systems, and increased taxpayer assistance.
- Debt distress:
  - Kiribati remains at high risk of debt distress despite RERF assets.
  - RERF is not viewed as buffer against debt distress because it serves intergenerational saving.
  - Containing debt distress risk requires fiscal sustainability and securing grants to finance large development needs.
  - Government borrowing through concessional loans should be closely monitored.
- DSA highlights and projections:
  - Overall assessment: Kiribati remains at high risk of debt distress.
  - PV of external debt-to-GDP ratio breaches the indicative threshold (30 percent) by 2026 under the baseline scenario.
  - Under extreme stress tests, indicators breach thresholds earlier (e.g., PV debt-to-GDP/by 2023 and PV debt-to-exports by 2028).
  - Public sector debt projections (selected, percent of GDP): 14.2 (2013), 17.7 (2014), 30.1 (2015), 31.0 (2016), 30.4 (2017), 30.2 (2018), 30.4 (2019), 30.2 (2020), 34.5 (2021), 56.2 (2026), 80.2 (2036).
  - External debt (nominal, percent of GDP): 9.6 (2013), 13.4 (2014), 27.6 (2015), 31.0 (2016), 30.4 (2017), 30.2 (2018), 30.4 (2019), 30.2 (2020), 34.5 (2021), 56.2 (2026), 80.2 (2036).
  - Memorandum: Nominal GDP (US$ millions): 187.7 (2013), 186.3 (2014), 160.4 (2015), 165.7 (2016), 175.6 (2017), 182.5 (2018), 187.7 (2019), 193.5 (2020), 198.2 (2021), 226.9 (2026), 301.9 (2036).

### Climate change and resilience
- Macro-criticality and costs:
  - Climate change and natural disasters are macro critical due to low-elevation coral atolls and limited freshwater.
  - Probability of natural disaster occurrences in Kiribati is less than 10 percent (half the regional average of around 20 percent), but costs tend to be large relative to economy size.
  - 2015 Budget included one-off Cyclone Pam related expenditures equivalent to around 4 percent of GDP.
  - Staff analysis: growth likely to be 0.1 percent lower than historical average of 1.8 percent over the long run due to climate change.
- Budgetary treatment and recommendations:
  - Recommend budget include explicit provision for climate change adaptation costs and that outturns be monitored.
  - Adaptation allocation recommended to amount to around 2 percent of GDP annually over the medium term.
  - Additional room needed for maintenance of newly constructed infrastructure (about 0.5 percent of GDP).
  - Cash reserve buffer enhances ex-ante readiness; RERF can be last-resort backstop.
- Institutional context:
  - Adaptation approach embedded in Kiribati Joint Implementation Plan for Climate Change and Disaster Risk Management 2014–23 (KJIP).
  - 2016-19 Kiribati Development Plan (KDP) identifies climate change as a key priority.
  - Staff recommend tracking spending on climate adaptation to assist in seeking donor funding.

### Financial sector, public financial institutions, and reforms
- Financial sector structure:
  - One commercial bank (ANZ joint venture with Government), Development Bank of Kiribati (DBK), Kiribati Provident Fund (KPF), Kiribati Insurance Corporation, and small credit unions.
- KPF key facts (Box 5):
  - Latest crediting rate for 2015: 7.5 percent.
  - Interest on KPF members’ accounts in 2015: AUD 9.5 million.
  - Total investment assets increased by AUD 3 million in 2015.
  - Widening deficit in 2015 nearly A$18 million, roughly 15 percent of KPF’s total investments.
  - Average annual increase in investment assets: 3 percent (past ten years); roughly 5 percent (past five years, excluding nearly 20 percent loss in 2008).
  - KPF minimum floor for crediting rate: 4 percent.
  - Nearly 90 percent of KPF investments are in diversified overseas portfolio under external management.
- KPF recommendations:
  - Introduce rules-based crediting policy linking interest on member balances to fund’s investment returns.
  - Guide crediting rates by multi-year average investment returns (e.g., 3-year average) to reduce volatility.
  - Consider lowering minimum floor below 4 percent and introduce a maximum cap.
  - Review investment strategy toward fully passive and more conservative allocation; consider reducing management fees.
  - Monitor KPF exposure to domestic economy, particularly small loans scheme.
- DBK and asset quality:
  - Doubtful loans roughly 23 percent of total loan stock (A$2.6 million) at end-2015.
  - Recommendation to review provisioning practices and carefully assess commercialization into deposit-taking given risk monitoring capacity and limited reserves.
- Financial deepening and supervision:
  - Credit expansion exposes institutions to high and correlated credit risks.
  - Remove structural impediments to credit: improve financial education, land access procedures, dispute resolution, loan recovery.
  - Strengthen risk monitoring and address weaknesses in public financial institutions' balance sheets.

### SOE reforms, CSOs, infrastructure and human capital
- SOE reforms and CSO issues:
  - SOE Act adopted in 2013; operational SOEs reduced from twenty-five to sixteen by 2016; government plans to reduce SOEs to twelve over next five years.
  - Seven SOEs lodged CSO claims totaling $7 million for 2014; government allocated $4.5 million in 2014 budget but by October 2015 only $0.9 million had been paid.
  - Budget recognized subsidy to SOEs of A$5 million.
  - Recommendations: strengthen commercial mandate, consolidate ownership responsibility under single minister, continue divestment and outsourcing, improve CSO compliance and compensation mechanisms.
- Infrastructure and private sector:
  - Development Plan priorities: invest in human capital, expand connectivity, build climate resilience, strengthen public sector reforms.
  - Recommend investment in air transportation and shipping, feasibility analyses, development partner support, streamline business licensing, improve land registration.
- Human capital:
  - New education strategic plan focuses on teacher quality, curriculum refinement, infrastructure.
  - Emphasis on vocational and technical training to exploit fishing industry opportunities and overseas seasonal work schemes.

### Risks to the outlook (Annex I) — selected
- Main risk channels and likelihoods:
  - Tighter and more volatile global financial conditions — Likelihood: Medium. Transmission: RERF exposure to foreign assets, lower returns requiring stronger fiscal stance.
  - Weaker-than-expected global growth — Likelihood: Medium/High. Transmission: lower demand for fish and shipping, negative impact on RERF assets.
  - Dislocation in capital and labor flows — Likelihood: Medium. Transmission: reduced correspondent banking services, higher remittance costs.
  - Domestic risks: Risks to fishing license fees — Likelihood: Medium. Natural disasters and climate change — near-term probability of disaster less than 10 percent.
- Policy responses: maintain cash buffer, seek cost-effective insurance, establish contingent financing with development partners, fiscal adjustment and structural reforms where needed.

### External engagement, ADB support, and statistical issues
- ADB and TA:
  - TA amounting to US$37.3 million provided for 46 projects.
  - AsDB loan: South Tarawa Sanitation Improvement Sector project (approved October 2011).
  - AsDB TA grant: US$0.8 million for SOE reform (approved October 2013).
  - South Tarawa Sanitation project will increase sanitation access from 64 percent to 80 percent by 2019; additional financing $610,000 approved in 2014.
  - Road Rehabilitation Project rehabilitated 32.5 km main roads and about 8 km feeder roads; additional financing of $8.4 million in 2015 and 2016.
  - ADB policy grant of $3m to Kiribati in 2014 focused on fiscal sustainability and public sector reform.
- Statistical and data adequacy:
  - Data provision has shortcomings but broadly adequate for surveillance; Balance of Payments and Government Finance Statistics need improvement.
  - National accounts: improvements with PTFAC assistance; GDP data revisions for 2012–14; further capacity building needed for expenditure-based GDP.
  - Price statistics: monthly retail price index (2006=100) based on South Tarawa survey; no national index, no producer/wholesale/trade price indices.
  - Government finance statistics: GFS mission in June 2014; gap remains on donor-financed project funds.
  - Balance of payments: compiled quarterly in BPM6 format; quality improving marginally.
  - Kiribati participant in GDDS since 04; no data ROSC available; no data reported to STA for Yearbook publications.

### Authorities’ views, commitments and administrative note
- Authorities broadly shared staff’s assessment, noted fishing revenue volatility, and supported modest increases in public spending for subsidies, education, and health.
- Authorities committed to:
  - preserving net value of RERF by efficient management;
  - avoiding non-concessional external borrowing;
  - pursuing SOE reforms;
  - mapping and following a prudent fiscal path.
- Recent actions:
  - AUD$70 million moved into the RERF from strong fishing returns.
  - Modest increases in education and health spending.
  - Commitment to increase maintenance spending.
  - Establishment of Taxpayer Services Division to improve VAT compliance.
  - Intend to maintain a buffer of around 3 months of recurrent spending and consider rules-based RERF withdrawal mechanism.
- Administrative recommendation: next Article IV consultation on the standard 12-month cycle.

*Source: IMF staff report for the 2016 Article IV consultation for Kiribati (content unit _cr16292).*

### 3.5 percent in 2015, supported by record high fishing revenue, donor financed infrastructure

### _cr16292 - 3.5 percent in 2015, supported by record high fishing revenue, donor financed infrastructure

### Overview
- Real GDP growth: "3.5 percent in 2015, supported by record high fishing revenue, donor-financed infrastructure projects and reconstruction in the aftermath of cyclone Pam."
- Growth outlook: "projected to moderate somewhat to around 3 percent this year."
- Inflation: "remains subdued owing to low food and commodity prices."

### Recent developments and macro balances
- Growth and inflation:
  - Real GDP (percent change): 2015 = 3.5 percent; 2016 (proj.) = 3.1 percent; 2017 (proj.) = 2.5 percent; 2018 (proj.) = 2.0 percent.
  - Consumer prices (percent change, average): 2015 = 0.6 percent; 2016 (proj.) = 1.5 percent; 2017 (proj.) = 2.0 percent; 2018 (proj.) = 2.5 percent.
- Fiscal outcomes and public debt:
  - "High fishing revenue contributed to a recurrent fiscal balance of almost 50 percent of GDP in 2015."
  - Government recurrent spending increased by "13 percent" (year-on-year).
  - Public debt rose from "less than 10 percent of GDP in 2014 to 23 percent of GDP at the end of 2015" owing to the Bonriki International Airport repair and upgrade project financed by concessional loans.
- External sector:
  - "The current account surplus reached 40 percent of GDP in 2015."
  - With donor-financed projects, imports were elevated but fishing revenue and a recovery in seamen remittances more than offset them.
  - Exchange rate: depreciation in real effective terms "to below the historical average."

### Medium-term outlook and risks
- Growth projection: "Growth is projected to weaken further over the medium term with the projected decline in fishing revenue and the completion of large infrastructure projects."
- Key vulnerabilities:
  - Climate change: "can have an impact on long-run prospects given the country’s low elevation."
  - Financial market exposure: "Global financial market turmoil may feed into the domestic economy through the exposure to foreign assets of the Revenue Equalization Reserve Fund (RERF) and the Kiribati Provident Fund (KPF)."
- Balance of payments projection:
  - Current account including official transfers (in percent of GDP): 2015 = 44.9 percent; 2016 (proj.) = -7.2 percent; 2017 (proj.) = -2.5 percent; 2018 (proj.) = -1.6 percent.
- External debt (in percent of GDP): 2015 = 23.1 percent; 2016 (proj.) = 27.0 percent; 2017 (proj.) = 29.4 percent; 2018 (proj.) = 31.9 percent.

### Sovereign wealth fund and fishing revenue
- Role of RERF: "the primary vehicle for intergenerational saving."
- Recent dynamics:
  - Fishing license fees reached "nearly 100 percent of GDP (A$220 million)" in 2015.
  - Authorities forecast license revenue to "halve to around A$100 million in 2016", consistent with the historical average of the last seven years.
  - RERF closing balance (in millions of Australian dollars): 2012 = 614; 2013 = 661; 2014 = 679; 2015 = 756; 2016 (proj.) = 866; 2017 (proj.) = 880; 2018 (proj.) = 891.
  - RERF per capita value (in 2006 Australian dollars): 2012 = 4,872; 2013 = 5,018; 2014 = 4,932; 2015 = 5,305; 2016 (proj.) = 5,869; 2017 (proj.) = 5,727; 2018 (proj.) = 5,553.
- Recent fiscal mechanics: strong 2015 fishing revenue "halted a prolonged period of relying on drawdowns from the RERF to finance the budget deficit."

### Fiscal and policy recommendations (Key policy recommendations and Executive Board Assessment)
- Fiscal policy:
  - "Committing to a balanced structural budget over the medium term in light of the declining fishing revenue."
  - "Strengthening the role of the sovereign wealth fund as an anchor for long run fiscal sustainability."
  - "Maintaining an appropriately-sized cash reserve buffer to cope with revenue volatility and external shocks."
  - "Further enhancing tax collection and public financial management to facilitate the needed growth-friendly fiscal adjustment."
- RERF governance:
  - "Encouraged the authorities to formulate a target-level and a rule-based withdrawal mechanism for the RERF, which would enhance its role as an endowment fund for both current and future generations."
- Climate change and resilience:
  - "Explicitly recognizing climate change adaptation costs and infrastructure maintenance needs in the budget would help ensure adequate provision of resources, including from development partners."
  - "Continued efforts are needed to enhance resilience to climate change and mitigate its negative impact on long run growth."
- Structural reforms and private sector development:
  - "Further strengthening of the SOEs’ commercial mandate, continued investment in business climate and infrastructure and enhancing human capital to better harness Kiribati’s marine resources."
  - Improve infrastructure including air transportation and shipping services; streamline business licensing processes; improve land registration.
- Financial sector and public financial institutions:
  - "Enhance financial deepening and address deficiencies in financial supervision."
  - "Steps to facilitate private sector access to credit while safeguarding the long-run sustainability of public financial institutions."
  - "Strengthened risk monitoring, addressing deficiencies in financial supervision and better aligning operations with their institutional roles."

### Key statistics (selected)
- Nominal GDP (In millions of US dollars): 2012 = 188.1; 2013 = 187.7; 2014 = 186.3; 2015 = 165.7; 2016 (proj.) = 175.6; 2017 (proj.) = 182.5; 2018 (proj.) = 187.7.
- Nominal GDP (2014): "US$186.1 million"; GDP per capita (2013): "US$1,656".
- Nominal GNI (2014): "US$371.8 million"; Population (2013): "109,366".
- Central government finance (percent of GDP), 2015:
  - Revenue and grants = 165.4
  - Total domestic revenue = 116.4
  - Grants = 49.0
  - Expenditure and net lending = 119.9
  - Current = 64.0
  - Development = 55.9
  - Current balance (excludes grants and development expenditure) = 52.4
  - Overall balance = 45.5
- External debt (in millions of US dollars): 2015 = 35.7; 2016 (proj.) = 45.3; 2017 (proj.) = 51.6; 2018 (proj.) = 58.1.
- Seamen's remittances (In millions of USD): historical series shown, with a recovery noted in 2015.

*Source: IMF staff report for the 2016 Article IV consultation for Kiribati.*

### 9.      Risks to the outlook are on the downside (Annex I). Changing climate cycle could

### _cr16292 - 9.      Risks to the outlook are on the downside (Annex I). Changing climate cycle could

### Risks to the outlook
- Changing climate cycle could increase uncertainty for fishing revenue over the medium term, as the VDS has not been tested in a low revenue environment for Kiribati since its implementation.
- Global financial market turmoil can feed into the domestic economy through the exposure to foreign assets of the RERF and the Kiribati Provident Fund (KPF), the country’s two main savings vehicles.
- Given Kiribati’s high reliance on imported goods, commodity price shocks and volatility in the Australian dollar could swing imports in ways hard to accommodate.
- Without a central bank, fiscal policy is the only macroeconomic policy lever and buffer against such shocks.

### Authorities’ views (on risks and spending priorities)
- Authorities broadly shared staff’s assessment of Kiribati’s economic outlook and noted that fishing revenue could be highly volatile with risks on both sides.
- They considered it appropriate to aim for a modest increase in public spending on subsidies, education, and health for long run economic and social returns.
- They noted the recent increase in copra subsidies was important to support more inclusive growth, including by providing income opportunities in the outer islands, and could help reduce health care costs due to overcrowding on Tarawa.
- They acknowledged Kiribati’s vulnerability to natural disasters and climate change related shocks and were mindful of the need to maintain buffers against such shocks.
- Authorities welcomed staff’s recommendation for a rule-based withdrawal mechanism for the RERF and expressed intent to transfer current cash reserves in excess of three months of recurrent spending to the RERF.

### External competitiveness and exchange rate assessment (Box 1)
- Kiribati’s real effective exchange rate (REER) continued to depreciate for much of 2015 and remains below its historical average after stabilizing since the beginning of the year.
- The REER has closely tracked changes in the Australian dollar circulating as the legal tender.
- The real exchange rate has limited effect on Kiribati’s current account developments because receipts are dominated by fishing license fees, donor flows and RERF investment returns, all largely driven by exogenous factors.
- Kiribati is heavily reliant on imported goods and sensitive to swings in global commodity prices.
- An assessment based on EBA-lite methodologies would not be meaningful nor feasible due to data limitations.
- Beyond exogenous factors, competitiveness hinges on boosting private sector development and addressing structural impediments: lack of scale, high transportation costs, infrastructure deficits, and lagging Ease of Doing Business rankings.
- The use of the Australian dollar as the legal tender remains appropriate and provides a strong nominal anchor given close trade and financial linkages with Australia.
- Kiribati has accepted the obligations under Article VIII of the IMF’s Articles of Agreement and maintains an exchange system free of restrictions on payments and transfers for current international transactions.

### Enhancing sustainability and resilience — Overview
- Prudent management of public resources remains the key policy priority.
- Authorities have strengthened the fiscal position and reformed RERF governance to better align investment strategy with long-term objectives.
- Conditions underlying strong fishing activity have started to wane, requiring budget decisions within a medium term fiscal framework with prudent assessment of spending goals, revenue projections and wealth management targets.
- Given the expected decline in fishing revenue and susceptibility to climate change related shocks, the framework should embed adequate fiscal buffers and likely imply saving much of the fishing revenue windfall.
- Further strengthening the RERF would support the fund’s capacity to provide sustainable future income for intergenerational equity.

### A. Strengthening the fiscal framework — findings and staff recommendations
- Fiscal framework components recommended:
  - (i) committing to a balanced structural budget over the medium term;
  - (ii) strengthening the RERF as an anchor for long run fiscal sustainability by formulating a rule-based withdrawal mechanism; and
  - (iii) maintaining an appropriately-sized cash reserve buffer to cope with revenue volatility and external shocks.
- Committing to a balanced structural budget over the medium term:
  - Steps are needed to ensure fiscal sustainability in the face of a projected moderation of annual fishing license fees to the A$100 million range over the medium term.
  - On current policies, staff’s baseline projections envisage a widening of the recurrent deficit to around 10 percent of GDP over the medium term, resulting in a gradual depletion of the RERF.
  - Targeting a structurally balanced budget over the medium term, based on assumed fishing license fees of A$100 million, would require fiscal adjustment of around 4½ percentage points of GDP in 2017 rising to 8½ percentage points by 2021 compared to the baseline scenario.
  - Adjustment options include boosting revenue collection (e.g., phasing out VAT exemptions to restore tax revenue collection to the 2015 level) and limiting recurrent spending growth to under 1.5 percent per year.
  - Staff advise to cap nominal spending on copra subsidies at the 2016 level and refrain from any increase in subsidies and grants beyond the 2016 budget commitment.
  - Wage increases should be set within the current wage policy framework which allows for a “wage drift” from the automatic promotion process without additional increases in salaries.
  - In the event of a temporary surge in fees, the resulting fiscal surplus should be saved in the RERF; any shortfall relative to the A$100 million baseline could be met by transfers from the reserve buffer.
  - As additional information on license fee trends accumulates, the A$100 million baseline can be gradually adjusted while preserving a structural balance.
- Formulating a target-level for the RERF and a rule-based withdrawal mechanism:
  - After strengthening the RERF, the structural balance target could be adjusted over the longer term to allow moderate annual financing from the RERF in a rule-based and transparent manner.
  - The sustainable level of drawdown depends on the government’s wealth management target.
  - If the goal is to preserve the real value of the fund after reaching a certain level, the withdrawal rate should be limited to around 1–2 percent of the overall balance, assuming an average return rate on the fund of 3–5 percent and a long run inflation rate of 2.5 percent.
  - The withdrawal could also be indexed to nominal GDP based on projected long run average growth rate and targeted return rate of the fund.
  - Drawdowns could be gradually adjusted to preserve the real value of the fund in the event of shortfalls in investment returns.
  - Maintaining the real value of the fund over the long run would be consistent with authorities’ policy to ensure equitable distribution of RERF income between generations while protecting capital growth.
- Limiting the complementary cash reserve buffer:
  - Limit to three months of recurrent expenditure.
  - The sizeable cash reserves from the 2014–15 fishing license revenue in excess of this amount should be transferred to the RERF as soon as possible.
  - On the basis of the 2016 level of current expenditure, this would leave a cash reserves buffer of roughly A$40 million (40 percent of the projected fishing revenue).
  - Policy of drawdowns from the cash buffer should be transparent and ensure replenishment when revenue exceeds expectations; any fiscal surplus after replenishing the cash reserve buffer should be transferred to the RERF.

### A. Strengthening the fiscal framework — VAT and debt distress
- VAT implementation:
  - VAT introduced in 2014 was key to reverse decline in non-fishing revenue since 2008.
  - Implementation broadly successful in diversifying the revenue base; 2014–15 outcomes were in line with expectations and improved record keeping and tax compliance.
  - Reintroduced SOE exemptions in late 2015 were estimated to have reduced VAT collection by around 15 percent in 2016.
  - Staff urge phasing out SOE exemptions, further training of tax office staff, greater utilization of improved IT systems, and increased emphasis on taxpayer assistance.
- Debt distress:
  - Kiribati remains at high risk of debt distress despite RERF assets.
  - The RERF is not viewed as a buffer against debt distress risk because it serves as a vehicle for intergenerational saving.
  - Containing debt distress risk requires ensuring fiscal sustainability and securing grants to finance large development needs.
  - Government borrowing through concessional loans should be closely monitored.

### Box 2 findings: Fishing revenue and the impact on the RERF (key projections)
- Historical context:
  - RERF initially capitalized by phosphate mining royalties until deposits exhausted in 1979; growth since via investment returns and modest drawdowns.
  - Acceleration in drawdowns since the turn of the millennium and periods of negative investment returns significantly eroded the fund’s capital base until recently.
- Staff simulations:
  - Baseline scenario: projected decline in fishing revenue to around A$100 million leading to a widening deficit financed by RERF drawdowns; RERF nominal balance will decline gradually to below A$800 million dollars by 2030.
  - Balanced structural budget scenario: RERF balance will reach A$1 billion by 2021 thanks to accumulation of investment returns.
  - If authorities set the target to preserve the real value of the fund at the A$1 billion level, this would allow a 1.5 percent annual withdrawal equivalent to 5.5 percent of GDP in 2021.
  - Low revenue scenario: if fishing revenue declines to A$60 million (average level since 2001), the current pace of spending would be unsustainable, leading to depletion of the RERF in about 15 years.
- Per capita considerations:
  - Preservation of the RERF’s real value would still imply some erosion in its value in per capita terms.
  - At the current low-yield environment, a real per capita target would limit drawdowns given projected long-run annual population growth of 1.5–2 percent.

### B. Enhancing resilience to climate change — findings and staff recommendations
- Climate risk and macro-criticality:
  - Climate change and natural disasters are macro critical for Kiribati due to low elevation coral atolls and limited fresh water supply, making it vulnerable to sea level rise.
  - Although probability of natural disaster occurrences in Kiribati is less than 10 percent (half the regional average of around 20 percent), the cost tends to be large relative to the size of the economy: the 2015 Budget included one-off expenditures—mainly for Cyclone Pam related damages—equivalent to around 4 percent of GDP.
  - Staff’s analysis suggests growth is likely to be 0.1 percent lower than the historical average of 1.8 percent over the long run due to climate change.
- Budgetary treatment of adaptation:
  - Staff recommend the budget include an explicit provision for climate change adaptation costs and that outturns be monitored.
  - The allocation would cover coastal protection, damage repairing, and soil desalinization, and should amount to around 2 percent of GDP annually over the medium term.
  - Additional room within the budget envelope is needed to accommodate maintenance costs of newly constructed infrastructure (about 0.5 percent of GDP).
  - The cash reserve buffer can enhance ex-ante readiness to respond to natural disasters, backstopped by the RERF as a last-resort measure.
- Institutional and planning frameworks:
  - Authorities’ adaptation approach is embedded in the Kiribati Joint Implementation Plan for Climate Change and Disaster Risk Management 2014–23 (KJIP).
  - The 2016-19 Kiribati Development Plan (KDP) identifies climate change as a key priority, in line with the United Nations 2030 Agenda for Sustainable Development.
  - Staff recommend tracking spending on climate change adaptation to ensure adequate provision of resources and to assist in seeking donor funding for climate change projects.

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

### 19.      The authorities were open to identifying climate change adaption cost in the budget,

### The authorities were open to identifying climate change adaption cost in the budget

### Climate change adaptation and budgetary implications
- Authorities noted current adaptation projects, largely financed by development partners, were probably already at or above 2 percent of GDP.
- Authorities agreed budget plans need to consider infrastructure maintenance cost.
- Authorities highlighted challenges in catalyzing external climate change financing sources, including capacity constraints to meeting the access requirements.

### Growth impact of climate change (Box 3)
- AsDB (2013) estimated climate change is likely to cost the Pacific 0.5–2.5 percent of GDP by 2050.
- Staff estimate that Kiribati’s average growth rate is likely to be 0.1 percent lower than the historical average of 1.8 percent due to climate change impacts on agriculture, fishing and tourism.
- Historical/contextual facts:
  - Primary sector output share declined from one third in the 1990s to around 25 percent.
  - Seawater intrusion from storm surges and high tides increases soil salinity and affects potable water and mining and quarrying activity.
- Mechanisms of impact:
  - Adverse effects concentrated in agriculture, fisheries, tourism, and related industries (real estate, wholesale and retail trade).
  - Stronger aggregate demand can place upward pressure on output, partially offsetting negative spillovers.

### SOE reforms, community service obligations (CSOs), and fiscal risks
- Progress noted: adoption of the SOE Act in 2013, reduction of operational SOEs from twenty-five to sixteen by 2016, merger in copra sector, privatization of the telecom company; government plans to reduce SOEs to twelve over the next five years.
- CSO funding and performance issues:
  - Seven SOEs lodged CSO claims totaling $7 million for the 2014 financial year.
  - Government allocated $4.5 million in the 2014 budget to fund CSOs, but by October 2015 only $0.9 million had been paid.
  - Budget recognized the subsidy to SOEs of A$5 million, which can fall short of full CSO costs based on previous years’ experience.
  - Rising commodity prices may widen the financing gap for SOEs to breakeven.
- Policy recommendations:
  - Strengthen the commercial mandate of SOEs and consolidate SOE ownership responsibility under a single minister for operational and financial management.
  - Continue divestment and outsourcing of SOE activities to the private sector to improve efficiency and strengthen public finances.
  - Improve compliance and adequate compensation mechanisms for CSOs, including regular learning events and briefings for officials.

### Infrastructure, human capital, and private sector development
- Policy priorities in the Kiribati Development Plan (2016–19): invest in human capital, expand connectivity infrastructure, build climate change resilience, and strengthen public sector reforms.
- Infrastructure and business climate:
  - Continued investment in transportation (air and shipping) could support tourism and private sector development in fishing and agriculture; thorough feasibility analyses and development partner support are important.
  - Streamlining business licensing and improving land registration are recommended to improve business climate.
- Human capital:
  - New strategic plan for education focuses on improving quality of teaching, refining curriculum, and improving infrastructure.
  - Vocational and technical training emphasized to exploit growth potential in the fishing industry and other domestic sectors.
  - International labor mobility and overseas seasonal work schemes present opportunities; improving workforce skills and institutional frameworks could increase participation.

### Financial sector and public financial institutions
- Financial sector structure:
  - One commercial bank (joint venture between ANZ and the Government of Kiribati) and two public financial institutions: Development Bank of Kiribati (DBK) and Kiribati Provident Fund (KPF). Others include the Kiribati Insurance Corporation and a few small credit unions.
- Credit expansion and risks:
  - Private sector credit has continued to expand, supported by public financial institutions.
  - Credit expansion exposes institutions to relatively high and correlated credit risks given borrowers’ susceptibility to common shocks and weak supervisory frameworks.
  - Regional withdrawal of correspondent banking relations has had limited impact so far, though compliance costs may have increased.
- Financial deepening constraints and recommendations:
  - Remove structural impediments to credit: improve financial education, land access procedures, dispute resolution, and loan recovery processes.
  - Strengthen risk monitoring and address weaknesses in public financial institutions’ balance sheets.

### Kiribati Provident Fund (KPF): funding deficit and reform options (Box 5)
- Key numerical facts:
  - Latest crediting rate for 2015 set at 7.5 percent.
  - Interest on KPF members’ accounts amounted to AUD 9.5 million in 2015.
  - Total investment assets increased by AUD 3 million in 2015.
  - Widening deficit in 2015 to nearly A$18 million, roughly 15 percent of KPF’s total investments.
  - Average annual increase in the fund’s investment assets over past ten years was only 3 percent (roughly 5 percent over the past five years, excluding the nearly 20 percent loss incurred in 2008).
  - KPF’s minimum floor for crediting rate is 4 percent.
  - Vast majority (nearly 90 percent) of KPF’s investments are in diversified overseas portfolio and under external management.
- Drivers and implications:
  - Persistence of the deficit reflects crediting rates set substantially above sustainable rate of return.
  - Increasing member contributions would be ineffective on a cash-balance basis because they increase liabilities by the same amount.
  - Recapitalization by government could eliminate the deficit but would leave the fund vulnerable without additional measures.
- Policy recommendations:
  - Introduce a rules-based crediting policy linking interest rates on member balances to the fund’s investment returns.
  - Guide crediting rates by multi-year average investment returns (e.g., over a 3-year period) to reduce volatility.
  - Consider lowering the minimum floor below 4 percent and introducing a maximum cap to allow replenishment in high-return years.
  - Review KPF’s investment strategy toward a fully passive and potentially more conservative asset allocation; consider reducing management fees via a fully passive mandate.
  - Closely monitor KPF’s exposure to the domestic economy, particularly through the small loans scheme.

### Development Bank of Kiribati (DBK) and asset quality
- DBK concerns:
  - Persistently high share of doubtful loans standing at roughly 23 percent of total loan stock (A$2.6 million) at the end of 2015.
  - Recommendation to review provisioning practices to ensure they reflect expected recovery rates.
  - Commercialization into deposit taking should be carefully weighed against current risk monitoring capacity, limited reserves, and the need to develop regulatory and supervisory frameworks.

*Source: IMF staff report content provided in the source PDF.*

### 31.      The authorities saw the need to address the issues of the public financial institutions

### _cr16292 - 31.      The authorities saw the need to address the issues of the public financial institutions

### Authorities' assessment of public financial institutions
- Noted need to address issues of the public financial institutions, including:
  - DBK’s financial situation.
  - Sustainability gap of the KPF.
- Observed that most household borrowings were backed by their provident fund savings and therefore did not constitute a systemic risk to financial stability.
- Stressed the importance of further enhancing financial deepening especially for the outer islanders.

### Staff appraisal — recent performance and outlook
- Recent economic performance described as strong due to record high fishing revenue that:
  - Boosted growth.
  - Improved the fiscal position.
  - Strengthened the current account.
- Growth projection: "projected to moderate somewhat to around 3 percent this year."
- Inflation projection: "projected to remain subdued owing to low food and commodity prices."
- Risks: "Risks to the economic outlook are largely related to external factors and on the downside."

### Fiscal policy priorities and RERF guidance
- Key policy priority: "Prudent management of public resources," especially given the projected decline in fishing revenue.
- Budget framing recommendations:
  - Take budget decisions in the context of a medium term fiscal framework.
  - Consider achieving a balanced structural budget in the medium term.
  - Strengthen the RERF as an anchor for long run fiscal sustainability.
  - Maintain a cash reserve buffer to deal with revenue volatility and external shocks.
- After strengthening RERF balances, consider formulating a rule-based mechanism for RERF withdrawal to:
  - Preserve the RERF as an endowment fund that can provide the population with a permanent and stable stream of income.
  - Align government spending plans to this mechanism.

### Budget priorities: climate, infrastructure, and external support
- Budget provision needs to explicitly recognize climate change adaption costs.
- Additional room within the budget envelope is needed to accommodate infrastructure maintenance.
- Given fiscal constraint and high risks of debt distress, Kiribati needs continued support from development partners.

### State-owned enterprise (SOE) reforms
- Maintaining momentum of SOE reforms is important to support private sector growth.
- Recommendations for SOEs:
  - Further strengthen the commercial mandate of the SOEs.
  - Consolidate SOE ownership responsibility under a single minister responsible for both operational goals and financial management.
  - Continue divestment and outsourcing of SOE activities to the private sector to improve efficiency and strengthen public finances.

### Private sector development and human capital
- Further improvement needed in infrastructure, business climate and human capital to support private sector development and employment, including:
  - Promoting air transportation and shipping services.
  - Streamlining business licensing process.
  - Improving land registration.
  - Building human capital through vocational and technical training to harness marine resources.
  - Further development of tourism and routine infrastructure maintenance to offer employment possibilities.

### Financial deepening and public financial institutions' sustainability
- Financial deepening should be implemented in a more sustainable way.
- Long-term sustainability of public financial institutions requires:
  - Strengthened risk monitoring.
  - Addressing deficiencies in financial supervision.
- Specific cautions and guidance:
  - Plans to expand DBK activities into deposit taking should be carefully assessed against DBK’s track record in recovering nonperforming loans and its capacity to assume increased liability risk.
  - Crediting rates for KPF member balances should be more closely guided by its investment returns to address the financing deficit.

### Administrative recommendation
- It is recommended that the next Article IV consultation take place "on the standard 12-month cycle."

*Source: IMF staff appraisal and associated tables and figures from the provided content unit.*

### Annex I. Risk Assessment Matrix 1/

### Annex I. Risk Assessment Matrix

### Global risks
- Tighter and more volatile global financial conditions
  - Likelihood: Medium
  - Transmission channels: Investors withdraw from specific risk asset classes as they reassess underlying economic and financial risks in large economies, or respond to unanticipated Fed tightening, and increase in U.S. term premia, with poor market liquidity amplifying volatility.
  - Potential impact and policy response:
    - The RERF invests in foreign financial assets mostly in the Australian market. This exposure constitutes a significant channel through which global financial market turmoil can feed into the domestic economy.
    - A lower return on investments and smaller RERF balance would require a stronger medium-term fiscal stance commensurate with smaller steady-state RERF drawdowns.
- Weaker-than-expected global growth
  - Likelihood: Medium/High
  - Transmission channels: Significant slowdown in EMs/frontier economies (Medium) and structurally weak growth in key advanced and emerging economies (Medium/High). The spillover impact could be larger-than-expected, and would reverberate largely through the trade channel as well as through contagion to global financial markets.
  - Potential impact and policy response:
    - Fishing license fees and seamen’s remittances could be negatively affected if demand for fish and shipping declines due to weaker than expected global growth.
    - A decline in global returns and valuations would have a negative impact on RERF assets.
    - In addition to fiscal adjustment to preserve the RERF (see above), structural reforms should be accelerated to underpin competitiveness.
- Dislocation in capital and labor flows
  - Likelihood: Medium
  - Transmission channels: Reduced financial services by global/regional banks (“de-risking”).
  - Potential impact and policy response:
    - The withdrawal of correspondent banking relations has been associated with higher transaction cost for remittances in small island countries in the Pacific.
    - In the short run, fiscal deficits from lower fishing fees can be financed through RERF drawdowns. If license fees decline on a sustained basis, steps should be taken to strengthen the budget through additional revenues and expenditure savings.

### Domestic risks
- Risks to fishing license fees
  - Likelihood: Medium
  - Transmission channels: Fishing license fees decline more than projected due to changing weather conditions.
  - Potential impact and policy response:
    - This would lead to higher fiscal deficits. A sustained decline in fishing revenue may jeopardize long run fiscal sustainability.
    - Steps to strengthen banking oversight will help maintain international banking linkages.
- Natural disasters and increased uncertainty due to climate change
  - Likelihood and probability note: While long-term sea level rise is predictable, the near-term probability of a natural disaster is less than 10 percent for Kiribati.
  - Transmission channels and impact:
    - Historical experience suggests that natural disasters can cause large loss and damages to production and potential growth.
  - Potential impact and policy response:
    - Contingency plans for natural disasters should include maintaining a strong cash buffer, seeking cost-effective insurance, and establishing contingent financing plans with development partners.

### Risk assessment methodology and interpretation
- The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (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.
- “Short term” and “medium term” are meant to indicate that the risk could materialize within 1 year and 3 years, respectively.

*Source: Annex I. Risk Assessment Matrix, KIRIBATI — STAFF REPORT FOR THE 2016 ARTICLE IV CONSULTATION — INFORMATIONAL ANNEX.*

### 1974. In addition, TA amounting to US$37.3 million has been provided for 46 projects. The latest

### STAFF REPORT FOR THE 2016 ARTICLE IV CONSULTATION—DEBT SUSTAINABILITY ANALYSIS

### ADB Engagement, Loans, Grants, and Technical Assistance
- TA amounting to US$37.3 million has been provided for 46 projects.
- AsDB loan to Kiribati: South Tarawa Sanitation Improvement Sector project, approved in October 2011.
- AsDB TA grant: US$0.8 million for enhancing economic competitiveness through state-owned enterprise (SOE) reform, approved in October 2013.
- ADB objectives in line with Kiribati Development Plan 2016-19:
  - Strengthen governance.
  - Improve infrastructure.
  - Maintain a stable macroeconomic framework.
  - Improve access to basic services.
  - Strengthen climate change adaptation.
  - Reduce poverty.
- SOE focus: improving corporate governance arrangements and commercial focus; technical assistance to improve economic management and public sector reform has helped improve SOE performance.
- South Tarawa Sanitation Improvement Sector Project:
  - Improved sanitation and hygiene practices in South Tarawa.
  - Will increase access to sanitation from 64 percent to 80 percent by 2019.
  - Additional financing of $610,000 approved in 2014.
- Road Rehabilitation Project (approved December 2010):
  - Rehabilitated 32.5 kilometers of main roads and about 8 kilometers of feeder roads on South Tarawa.
  - Additional financing of $8.4 million in 2015 and 2016 to complete rehabilitation and allow upgrade of the road network on Betio.
  - Cofinanced by the Government of Australia, the World Bank and the Pacific Regional Infrastructure Facility.
- ADB policy grant of $3m to Kiribati in 2014:
  - Focused on increasing fiscal sustainability by improving public expenditure quality, revenue performance, management of public assets and liabilities, and the business environment.
- ADB strategic engagement in the medium term:
  - Focus on major transformative infrastructure investments with scope to mobilize significant co-financing.
  - Given improvement in Kiribati’s fiscal situation, limited policy financing to further build buffers and demonstrate confidence in the government’s reform agenda.

### Loan, Grant and TA Approvals (2009–16)
- Loan Approvals:
  - 2009 Number 0 Amount (US$m) 0
  - 2010 Number 1 Amount (US$m) 12
  - 2012 Number 1 Amount (US$m) 7.56
  - 2013 Number 0 Amount (US$m) 0
  - 2014 Number 0 Amount (US$m) 0
  - 2015 Number 0 Amount (US$m) 0
  - 2016 Number 0 Amount (US$m) 0
- Grant Approvals:
  - 2009 Number 0 Amount (US$m) 0
  - 2010 Number 0 Amount (US$m) 0
  - 2012 Number 0 Amount (US$m) 0
  - 2013 Number 0 Amount (US$m) 0
  - 2014 Number 2 Amount (US$m) 3.6
  - 2015 Number 1 Amount (US$m) 2.4
  - 2016 Number 1 Amount (US$m) 6
- TA Approvals:
  - 2009 Number 2 Amount (US$m) 0.8
  - 2010 Number 2 Amount (US$m) 0.85
  - 2012 Number 1 Amount (US$m) 0.2
  - 2013 Number 2 Amount (US$m) 0.8
  - 2014 Number 1 Amount (US$m) 1
  - 2015 Number 0 Amount (US$m) 0.22
  - 2016 Number 0 Amount (US$m) 0

### Statistical Issues and Data Adequacy for Surveillance (As of July 11, 2016)
- General: Data provision has some shortcomings, but is broadly adequate for surveillance. Balance of Payments and Government Finance Statistics could be further improved.
- National Accounts:
  - With PTFAC assistance, GDP estimates have improved.
  - One TA mission in 2015 to improve the national data accounting system, with updates and revisions to GDP data for 2012–14.
  - Further capacity building needed, particularly for expenditure-based GDP estimates.
  - Presently, only current and constant 2006 prices GDP data is compiled using the Value-Added approach.
- Price statistics:
  - Monthly retail price index (2006=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 Chart of Accounts and extend coverage to donor-financed projects.
  - Complete review of government units, statutory extra budgetary units, and SOEs completed; gap remains regarding donor-financed project funds.
  - PEFA review tentatively scheduled for early 2017.
- Monetary statistics:
  - Balance sheets of all financial institutions are available with lags, but consolidated balance sheet of the financial sector is not available.
  - Data on interest rates are reported with a long lag.
- Balance of payments:
  - Kiribati part of Pacific Region module of JSA project on Improvement of External Sector Statistics.
  - Three ESS missions in 2014.
  - Data compiled quarterly in BPM6 format.
  - Quality improving only marginally due to capacity constraints and quality of source data; shortcomings in trade data adjustments, recording of investment income, direct investment and foreign aid data.
- Data Standards and Quality:
  - Kiribati has been a participant in the General Data Dissemination System (GDDS) since 04.
  - No data ROSC are available.
  - No data currently reported to STA for publication in the Government Finance Statistics Yearbook, the Balance of Payments Statistics Yearbook or in the IFS.

### Baseline Macroeconomic Assumptions and Outlook
- GDP and population:
  - Economic growth expected at 3.1 percent in 2016, decelerating to 2.0 percent in the medium term, and moderating to 1.7 percent over the long run.
  - Population growth projected to decline from 2 percent to below 1.5 percent over the long run.
- Prices and inflation:
  - Inflation projected at 1.5 percent in 2016, increasing to 2.5 percent in the long term.
- Fishing revenue:
  - Fishing license receipts grew at an average rate of 65 percent during 2012–15.
  - In 2015, fishing revenue was around 97 percent of GDP.
  - Expected to decline to around 45 percent of GDP in 2016.
  - Fishing revenue assumed to normalize at around A$100 million in the medium to long term.
- Fiscal position:
  - Overall balance stood at 23.5 and 40.1 percent of GDP, respectively in 2014 and 2015.
  - Fiscal position expected to deteriorate in the near term due to projected fall in fishing revenue.
  - RERF drawdown expected to provide 70–80 percent of government’s financing needs.
  - RERF returns expected at 3.0–5.0 percent in the longer term.
- External grants:
  - Projected to decline from 58 percent of GDP in 2016 to around 30 percent of GDP over the medium term, and to stabilize at around 20 percent of GDP in the long run.
- Recurrent and development expenditure:
  - Operating expenditure projected to grow at 9 percent in 2016, and at average rate of 3.6 percent until 2020.
  - Operating expenditure related to climate change contingencies and new infrastructure maintenance assumed at around 2–3 percent of GDP.
  - Development expenditure: estimated at 45 percent of GDP in 2015; assumed to increase to 67 of GDP in 2016, average around 37 percent of GDP in the medium term, and stabilize at around 25 percent of GDP in the long run.
  - Grant element of new borrowing anticipated at 50 percent in the medium to long term.
- External balance:
  - Current account surplus widened post 2013 but will weaken considerably in 2016–17 following projected slowdown in fisheries.
  - Medium-term improvements expected from higher RERF returns and modest increase in fishing license fees; imports to fall as donor-financed infrastructure projects complete.

### Debt Profile and Key Indicators
- Historical debt composition:
  - On average 94 percent of overall debt was foreign currency denominated, equivalent to 22 percent of GDP in 2015.
  - Domestic debt averaged around 3.5 percent of GDP.
  - Government cleared domestic debt by end-2015 with the sale of the state telecom company.
  - DSA does not include potential SOE liabilities related to Community Service Obligations (CSO).
- Kiribati: Stock of Debt ($, million) — selected figures shown in source table:
  - External debt: 2012 13.9; 2013 16.7; 2014 22.9; 2015 35.3
  - Percent of GDP (external debt): 2012 7.4; 2013 8.9; 2014 12.3; 2015 22.0
  - Multilateral: 2012 13.9; 2013 16.7; 2014 19.8; 2015 26.5
  - Percent of GDP (multilateral): 2012 7.4; 2013 8.9; 2014 10.6; 2015 16.5
  - Bilateral: 2012 0.0; 2013 0.0; 2014 3.1; 2015 8.7
  - Percent of GDP (bilateral): 2012 0.00; 2013 0.01; 2014 1.65; 2015 5.4
  - Domestic debt: 2012 6.5; 2013 8.0; 2014 7.3; 2015 3.8
  - Percent of GDP (domestic): 2012 3.4; 2013 4.2; 2014 3.9; 2015 2.4
- Key macroeconomic and fiscal assumptions (comparison 2015 DSA vs 2016 DSA):
  - Real GDP growth (in percent): 2015 DSA 2.0; 2016 DSA 2.1
  - Average nominal interest rate on forex debt (in percent): 2015 DSA 1.4; 2016 DSA 1.2
  - Average real interest rate on domestic debt (in percent): 2015 DSA 11.7; 2016 DSA 11.4
  - Inflation rate (GDP deflator, in percent): 2015 DSA 1.2; 2016 DSA 1.6
  - Growth of real primary spending (deflated by GDP deflator, in percent): 2015 DSA -3.2; 2016 DSA 2.0
  - Grant element of new external borrowing (in percent): 2015 DSA 37.6; 2016 DSA 44.2

### DSA Results and Risks
- Overall assessment: Kiribati remains at high risk of debt distress.
- External debt dynamics:
  - PV of external debt-to-GDP ratio breaches the indicative threshold (30 percent) by 2026 under the baseline scenario.
  - PV of external-debt-to-exports ratio breaches the threshold (100 percent) after 2036 under the baseline scenario.
  - Trend driven by high imports as percent of GDP and dependence on external financing for development investment.
- Extreme shocks:
  - Under extreme stress test scenario, PV of debt-to-GDP and PV of debt-to-exports ratios breach their thresholds by 2023 and 2028, respectively.
  - Public sector debt projected to be unsustainable under the extreme shock scenario:
    - PV of public-sector-debt-to-GDP ratio breaches the threshold by 2017 and will likely double in the following decade.
    - Attributed to higher projected borrowings and financing needs of the government.
- Public sector debt downside risks remain elevated.
- Current fiscal surpluses are driven largely by windfall fishing license revenues.

### Conclusions and Policy Recommendations
- Risks of debt distress remain high; limited scope for external borrowing.
- Immediate to medium term priorities:
  - Revenue management: tax administration and compliance related to VAT.
  - Recurrent expenditure restraints.
  - Financing of capital expenditure by increasing grant element.
  - Progressing with structural reforms.
- Windfall revenue from fishing license fees should be invested in RERF to build long term sustainability and for intergenerational equity.
- Significant scope to support fiscal stance and climate adaptation through additional finance from global climate funds, but this may require:
  - Investment in readiness programs specific to climate financing modalities.
  - Development of project proposals and management capacity.

*Prepared by the Staff of the International Monetary Fund and the World Bank, August 23, 2016.*

### 6. The authorities broadly agreed with this assessment. They expressed strong commitment

### _cr16292 - 6. The authorities broadly agreed with this assessment. They expressed strong commitment

### Assessment and authorities' commitments
- Authorities expressed strong commitment to:
  - preserving the net value of RERF by efficient management;
  - avoiding non-concessional external borrowing;
  - strongly pursuing state-owned-enterprise (SOE) reforms;
  - mapping and following a prudent fiscal path.
- Authorities welcome IMF analysis and assistance and broadly agree with staff that underlying drivers of economic growth are moderating with risks generally to the downside, while noting upside risks from continued construction activity (airport, water and sanitation, causeway upgrade).
- Inflation is expected to remain low (authorities agree with staff).

### Fiscal policy stance and measures
- The new Government intends to maintain a balanced budget over the medium term and will consider targeting structural balances, treating fluctuations symmetrically.
- Flexibility in the fiscal framework is appropriate to respond to large variations in fishing license revenue.
- The Government intends only to draw on the Revenue Equalization Reserve Fund (RERF) as a last resort and not for recurrent spending.
- Recent fiscal actions:
  - AUD$70 million moved into the RERF arising from strong recent returns from fishing.
  - Modest increase in spending on education and health.
  - Commitment to increase maintenance spending in coming years.
  - One-off increase in public sector wage costs last year driven by a change in home leave payment mechanism.
- Revenue measures:
  - Improve compliance with the new VAT system via a newly established Taxpayer Services Division to improve collection rate and timeliness.
  - Recognize revenue implications of exempting SOEs from VAT; exemptions primarily relate to household necessities and help outer islanders.
  - Considering measures to widen the tax base.
- Climate change:
  - Authorities are carefully considering climate change mitigation and adaptation costs and examining feasibility of explicitly recognizing these costs in the budget.
  - Authorities will continue to seek international assistance for climate change adjustment.

### Sovereign Wealth Fund (RERF) and cash buffers
- RERF has significant financial assets and will be managed prudently for current and future generations; protecting the capital value of the RERF is a key priority.
- Authorities are developing a framework for achieving this, will consider a rules-based withdrawal mechanism using IMF research as an input.
- Authorities agree with staff proposals to maintain a buffer of around 3 months of recurrent spending.

### Structural reforms and SOEs
- Progress noted in SOE reform since 2009 with assistance from ADB and World Bank.
- Recent reforms:
  - Significant reduction in number of SOEs.
  - Remaining SOEs shifted toward a more commercial focus.
  - Second stage reforms: (i) major SOE decisions will be joint between portfolio minister and Minister of Finance; (ii) additional SOEs are in the process of being privatized (each at separate stages).
- Government will negotiate with corporatized SOEs on community service obligation (CSO) payments and expects these entities to improve competitiveness, especially monopolies.
- Government will carefully assess proposals to promote air transportation and shipping services and will seek multiple perspectives including international financial institutions and development partners.
- Development Bank of Kiribati (DBK) and Kiribati Provident Fund (KPF):
  - Authorities agree on need to address issues with DBK and KPF; policy initiatives aim to strengthen resilience while improving access to finance.
  - Any expansion of DBK into commercial banking will follow careful analysis.
  - Authorities intend to approach PFTAC for technical assistance on KPF investment policies and operations; noting 'crediting rates' to KPF members have fallen over time and are subject to periodic review.

### Private sector development and human capital
- Government finalized a Private Sector Development Strategy in 2015 to create an enabling environment and generate opportunities for small-, micro-, and medium-enterprises.
- Actions include improving infrastructure, availability of capital, and updating business registration processes; plan to review and update strategy where gaps are found.
- Land registration remains a long-running challenge due to customary land system.
- Education: new strategic plan for the education sector (from 2016-19 Development Plan) aims to improve quality of teaching and infrastructure to better prepare students for domestic and overseas employment.
- Authorities working with Australia and New Zealand to increase temporary and permanent opportunities for i-Kiribati workers.

### Debt sustainability and key numeric indicators (selected, preserved exactly as presented)
- Public sector debt (actual/projections, in percent of GDP): 14.2 (2013), 17.7 (2014), 30.1 (2015), 31.0 (2016), 30.4 (2017), 30.2 (2018), 30.4 (2019), 30.2 (2020), 34.5 (2021), 56.2 (2026), 80.2 (2036).
- Of which: foreign-currency denominated: 9.6 (2013), 13.4 (2014), 27.6 (2015), 31.0 (2016), 30.4 (2017), 30.2 (2018), 30.4 (2019), 30.2 (2020), 34.5 (2021), 56.2 (2026), 80.2 (2036).
- Change in public sector debt: 3.4 (2013), 3.5 (2014), 12.3 (2015), 1.0 (2016), -0.6 (2017), -0.3 (2018), 0.2 (2019), -0.2 (2020), 4.3 (2021), 3.8 (2026), 1.5 (2036).
- Identified debt-creating flows (selected): Other (RERF) 24.3 (2013), -4.1 (2014), 23.5 (2015), 39.4 (2016), -6.6 (2017), -7.3 (2018), -10.0 (2019), -10.4 (2020), -11.3 (2021), -14.0 (2026), -21.6 (2036).
- Primary deficit (in percent of GDP): -10.9 (2013), -42.9 (2014), -56.1 (2015), -2.5 (2016), 26.3 (2017), -27.0 (2018), 1.3 (2019), 7.1 (2020), 13.5 (2021), 13.8 (2026), 14.7 (2036).
- Revenue and grants (in percent of GDP): 96.2 (2013), 137.1 (2014), 160.0 (2015), 124.8 (2016), 94.0 (2017), 93.5 (2018), 89.6 (2019), 89.2 (2020), 88.8 (2021), 77.5 (2026), 74.3 (2036).
- Grants (in percent of GDP): 31.8 (2013), 51.2 (2014), 43.6 (2015), 61.8 (2016), 35.8 (2017), 36.2 (2018), 32.7 (2019), 32.7 (2020), 32.7 (2021), 22.4 (2026), 22.4 (2036).
- PV of public sector debt (in percent of GDP): 9.3 (2016), 15.5 (2017), 15.6 (2018), 15.7 (2019), 16.0 (2020), 16.5 (2021), 16.7 (2026), 18.7 (2036), 30.0 (2036) — note table presents a series culminating in 44.3 and 80.2 elsewhere.
- Debt service-to-revenue ratio (in percent): 1.4 (2013), 0.9 (2014), 0.8 (2015), 0.8 (2016), 0.9 (2017), 0.9 (2018), 0.9 (2019), 1.1 (2020), 1.2 (2021), 2.9 (2026), 5.0 (2036).
- Key macro assumptions (selected):
  - Real GDP growth (in percent): 5.8 (2013), 2.4 (2014), 3.5 (2015), 1.5 (2016), 2.8 (2017), 3.1 (2018), 2.5 (2019), 2.0 (2020), 1.5 (2021), 1.7 (2026), 1.7 (2036).
  - Average nominal interest rate on forex debt (in percent): 1.0 (2013), 0.9 (2014), 1.2 (2015), 1.0 (2016), 0.4 (2017), 1.1 (2018), 1.0 (2019), 1.0 (2020), 1.0 (2021), 1.5 (2026), 1.5 (2036).
  - Inflation rate (GDP deflator, in percent): 0.9 (2013), 4.0 (2014), -0.2 (2015), 2.4 (2016), 2.8 (2017), 1.5 (2018), 2.0 (2019), 2.0 (2020), 1.3 (2021), 1.4 (2026), 1.2 (2036).
- External debt (nominal, percent of GDP): 9.6 (2013), 13.4 (2014), 27.6 (2015), 31.0 (2016), 30.4 (2017), 30.2 (2018), 30.4 (2019), 30.2 (2020), 34.5 (2021), 56.2 (2026), 80.2 (2036).
- PV of external debt (in percent of GDP): ...5.0 13.1 15.6 15.7 16.0 16.5 16.7 18.7 30.0 44.3 (as presented in tables).
- Grant-equivalent financing (in percent of GDP, selected): ......48.8 64.2 36.2 36.7 33.3 33.1 35.7 25.7 25.1 26.1 (table entries preserved as presented).
- Memorandum: Nominal GDP (Millions of U.S. dollars): 187.7 (2013), 186.3 (2014), 160.4 (2015), 165.7 (2016), 175.6 (2017), 182.5 (2018), 187.7 (2019), 193.5 (2020), 198.2 (2021), 226.9 (2026), 301.9 (2036).
- Aid flows (Millions of US dollars): 59.6 (2013), 95.4 (2014), 90.1 (2015), 112.1 (2016), 64.5 (2017), 68.1 (2018), 63.8 (2019), 64.8 (2020), 75.4 (2021), 64.9 (2026), 83.6 (2036).
- Grant element assumed on residual financing (Memorandum item): 47 (2016), 45 (2017), 43 (2018), 41 (2019), 39 (2020), 37 (2021), 29 (2026), 17 (2036).

### Stress tests and sensitivity analysis (high-level outcomes preserved)
- Figures and tables present multiple stress and alternative scenarios for 2016–36 including:
  - Baseline, Historical scenario, Most extreme shock (identified per panel), and Combination scenarios.
  - Specific bound tests include: real GDP growth shocks, primary balance shocks, one-time 30 percent real depreciation, 10 percent of GDP increase in other debt-creating flows, and combinations of shocks.
- Selected scenario outcomes (PV of Debt-to-GDP Ratio, PV of Debt-to-Revenue Ratio, Debt Service-to-Revenue Ratio — sample rows preserved from Table xx and Table 4):
  - Baseline PV of Debt-to-GDP Ratio: 16 (2016), 16 (2017), 16 (2018), 17 (2019), 17 (2020), 19 (2021), 30 (2026), 44 (2036).
  - A1. Real GDP growth and primary balance at historical averages: 29 (2016), 27 (2017), 22 (2018), 15 (2019), 7 (2020), 0 (2021), -39 (2026), -167 (2036).
  - A2. Primary balance unchanged from 2016: 16 (2016), 1 (2017), -16 (2018), -36 (2019), -57 (2020), -77 (2021), -183 (2026), -429 (2036).
  - B4. One-time 30 percent real depreciation in 2017: 20 (2016), 20 (2017), 20 (2018), 20 (2019), 21 (2020), 21 (2021), 27 (2026), 36 (2036).
  - Similar detailed scenario tables presented for PV of Debt-to-Revenue Ratio and Debt Service-to-Revenue Ratio with the numeric values preserved in the source tables.

### Authorities' formal statement (September 7, 2016)
- Statement by Barry Sterland, Executive Director for Kiribati and Chris Stewart, Advisor.
- Authorities thank IMF staff for report and engagement, welcome assistance of IMF, other IFIs and development partners, and largely agree with staff analysis while highlighting points above.

*Source: IMF staff report and authorities' statement as presented in the supplied content.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16292.pdf_