## _cr16336 ## Source details **Canonical URL:** [_cr16336](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16336.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16336.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16336.pdf.json) --- ### Background and context - Vanuatu is a small island developing state and a low-income country recovering from Cyclone Pam; income per capita is about USD3,000, with tourism and agriculture the leading drivers of economic activity. - Real GDP growth averaged below 2 percent per year over the last 5 years (down from above 5 percent in the previous 5 years). - At end-2015: public debt was 25.6 percent of GDP; reserves were 7.1 months of imports; inflation was 2.5 percent; private sector credit was around 70 percent of GDP. - Cyclone Pam struck in March 2015, causing damages estimated at around 60 percent of GDP (Post-Disaster Needs Assessment: physical capital damages around 35 percent of GDP; damages to tourism and transport infrastructure estimated at 11 percent of GDP; production losses in agriculture and tourism equivalent to 10 percent of GDP). - IMF emergency support in June 2015 included a disbursement of about USD11.9 million under the Rapid Credit Facility (RCF, at zero interest rate) and an equal disbursement under the Rapid Financing Instrument (RFI), intended to help cope with immediate balance of payments needs and catalyze donor support. ### Recent economic developments and outlook - Real GDP growth: - 2013: 2 percent (estimated) - 2014: 2.3 percent (estimated) - 2015: cyclone induced an estimated decline in real GDP of 0.8 percent - Projection: 4 percent in 2016 and 4.5 percent in 2017 due to recovery in tourism and agriculture and ramped-up infrastructure projects - Inflation: - Pre-cyclone dipped below 1 percent; rose to 2.5 percent in 2015 due to cyclone-induced shortages and reconstruction. - Projection: remain below 3 percent in 2017. - External sector and reserves: - Current account: widened to 11 percent of GDP in 2015 from an average of 3 percent of GDP in the three years before; projected to widen to around 20 percent of GDP in 2016 and 2017. - Gross international reserves: USD273 million (7.1 months of imports) by end-2015; reserves excluding Pam-related grants and loans about USD215 million (5.6 months of imports). - Projection: gross international reserves 250 (millions of U.S. dollars) in 2016 (projected); reserves (months of prospective G&S imports): 5.8 (2016, projected). - Fiscal position: - 2015 fiscal balance: recorded a surplus of about 7 percent due to cyclone-related grants received but unspent. - Outlook: large deficits (above 10 percent of GDP) in 2016 and 2017 due to reconstruction and clearing past due legal commitments. - 2016 projections: fiscal balance projected to record deficits of about 10 percent of GDP; government expects domestic revenue to increase by 2.3 percent compared to the 2015 budget (19.2 percent of GDP). - Key numerical series (selected): - Nominal GDP (billions of vatu): 70.9 (2011); 72.4 (2012); 75.8 (2013); 79.1 (2014); 80.4 (2015); 85.5 (2016, projected). - Nominal GDP (millions of U.S. dollars): 792 (2011); 782 (2012); 802 (2013); 815 (2014); 738 (2015); 773 (2016, projected). ### Risks to the outlook - Major uncertainties: - Rate of implementation of public infrastructure projects. - Pace of recovery in tourism and agriculture. - External and exchange risks: - Weaker-than-expected growth in emerging and advanced economies could depress commodity prices and tourism. - Persistent appreciation of the vatu against the Australian dollar (despite depreciation against the U.S. dollar) could reduce attractiveness to Australian tourists and lower the real value of Australian aid. - Natural disaster risk: - Probability of a natural disaster in any given year is 65 percent and more than 99 percent in a five-year period. - EM-DAT indicates natural disasters caused annual damages equivalent to 2.4 percent of GDP over 1950-2014. - Staff risk matrix (selected downside risks with Likelihood and Impact): - Weaker-than-expected global growth slowdown — Medium — Medium - Sharp rise in risk premia with flight to safety (US dollar appreciation) — Medium — Medium - Natural disasters and climate change — High — High - Delays in implementation of infrastructure projects — High — High ### Institutional and response lessons (summary) - Institutions and coordination: - Immediate response effective via a cluster system; NDMO coordinates preparedness and recovery; Recovery Committee established in August 2015 but lacked a dedicated technical unit and some procedures were burdensome, delaying implementation. - Immediate response rated: High; Reconstruction activities rated: Low-Medium. - Fiscal buffers and emergency funds: - Emergency Fund allocation: Vt25 million (about USD230,000). - Response Fund can provide up to 1.5 percent of the government’s budget for a fiscal year (about USD2.5 million or 0.3 percent of GDP). - Government spent in total Vt390 million with Pam-related relief and recovery in 2015 (about USD3.6 million or 0.5 percent of GDP); Response Fund insufficient for extreme events. - Response fiscal buffers rated: Low. - Donor financing and catalytic role: - IMF RCF/RFI support about USD23.8 million helped catalyze donor support. - World Bank committed USD50 million; Asian Development Bank USD22 million. - Bilateral: Australia AUD15 million immediate response and AUD35 million for recovery; New Zealand NZD3.5 million immediate response and NZD6 million for recovery; E.U. EUR10.5 million. - About USD72 million in grants received in 2015; disbursements picking up in 2016 but absorption capacity stretched. - Response donor financing rated: High for bilateral commitments and disbursements; Medium for multilateral commitments and disbursements. ### Insurance, social support, and liquidity measures (Box 1 highlights) - Insurance and assistance: - Pacific Catastrophe Risk and Financial Insurance (PCRFI) payout: USD1.9 million; covered less than 1 percent of damages. - Private sector insurance payouts: Vt5.7 billion (about USD52 million); primarily available to large and established businesses and in urban areas. - Social safety nets and VNPF actions: - VNPF allowed 40,000 active members to withdraw up to 20 percent of retirement savings; total withdrawals amounted to Vt1.7 billion (2.1 percent of GDP) for three months following the disaster. - VNPF withdrew Vt2.1 billion in the domestic banking sector to fund members’ needs. - Monetary and liquidity support by RBV: - Policy rate tied to 91-day RBV Note decreased from 5.25 percent to about 1.85 percent. - Reduced Statutory Reserve Deposit (SRD) requirement from 7 to 5 percent; activated additional credit facility for commercial banks; decreased interest rate on RBV’s Secured Advance Facility; included SRD holdings as eligible collateral. - Provided financial assistance relief of Vt40 million to the government and provinces. - Response rating: High. ### Fiscal outcomes, reconstruction spending, and infrastructure program - 2015 fiscal outcomes: - Unexpected surplus of 7.2 percent of GDP due to unspent cyclone-related grants. - Government expenses rose to 23.6 percent of GDP due to immediate relief needs and early election expenses. - Capacity constraints and political uncertainties kept reconstruction spending and public investment low in 2015. - 2016 projections and measures: - Fiscal balance projected to record deficits of about 10 percent of GDP in 2016. - A supplementary budget of 1.6 percent of GDP was passed in July to fulfill part of overdue severance payments to civil servants (2.6 percent of GDP). - Capital expenditure projected to rise sharply starting 2016 on account of ambitious infrastructure scale up. - Long-term domestic bonds issued: 1.4 percent of GDP to close financing gap. - 2016 budget reported major infrastructure projects for a combined value of 57 percent of the country’s 2015 GDP spread over the next 7 years, with bulk construction during 2016-18. - Financing and RBV actions: - Financing sources: grants, external concessional loans, deposits, and domestic issuance. - Two domestic issuances in 2016 raised government debt outstanding held by domestic financial institutions by 18.2 percent from end-2015 level. - RBV purchase: Vt1.1 billion 10 year-maturity bond increased RBV credit to the government to the limit. - Debt service projection: USD18 million by 2020. ### Debt sustainability and recommended emphasis - Debt outlook and risks: - Central government debt projected to rise sharply to 33.5 percent of GDP in 2016 and higher over the medium term. - Updated Debt Sustainability Analysis (DSA) suggests Vanuatu faces a moderate risk of debt distress, up from a low rating in 2013. - Key risks: sizeable infrastructure projects when grants and concessional financing are delayed or insufficient; another extreme weather event would likely raise the risk of debt distress. - Staff recommendations: - Set the debt-to-GDP ratios on a declining path by 2021. - Seek grant financing for the majority of any additional development projects. - Emphasize risk reduction investments and reliance on grant financing. - Reprioritize expenditure and incorporate maintenance costs in recurrent budget. ### Revenue mobilization, tax reform, and GBEs - Tax reform: - Introduction of personal and corporate income tax by 2018 projected to generate additional revenue of about 1 percent of GDP. - A Tax Review Committee, supported by an AusAid-funded resident tax advisor, was formed. - Government Business Enterprises (GBEs): - Government-guaranteed GBE debt amounted to 4.6 percent of GDP at the end of 2015. - Vanuatu has 11 GBEs; only eight are active and regularly producing audited financial accounts; NBV, Air Vanuatu (Operations) Limited, and AVL account for 96 percent of total GBE assets. - Portfolio ROA averaged -0.13 percent and ROE averaged -0.39 percent (2010-2014). - Government transfers to GBEs averaged 2.3 percent of general government expenditure during 2010-2014. - Air Vanuatu contributed 94 percent of GBE losses during 2008 to 2014; estimated unfunded CSOs of Vt176 million in 2013; resulted in a Vt1.4 billion loan and a Vt2.2 billion guarantee from government; 2016 financing package of Vt423 million in two tranches. - Recommended GBE reforms: - Require GBEs to generate profits sufficient to cover their cost of capital. - Put in place a clear framework for funding CSOs to avoid unfunded obligations. - Prohibit appointment of civil servants and elected officials to GBE boards. - Resource and empower the GBE Monitoring Unit and appoint a dedicated GBE minister. ### Monetary policy, exchange rate, and reserves - Staff stance and recommendations: - Maintain the peg at its current level. - The accommodative monetary stance and exchange rate peg "remain appropriate" to support economic recovery, and price and financial stability after the cyclone. - Authorities should be ready to adjust the level and composition of the peg "if Vanuatu’s external position worsens significantly." - RBV encouraged to "clarify further its objectives and instruments" to improve the weak transmission mechanism. - Reserve and liquidity metrics: - Gross international reserves covering an estimated 5.8 months of imports of goods and services by end-2016. - Authorities’ committed level: 4 months of imports. - Staff recommendation: Keep foreign reserves at above 4 months of imports. - Exchange rate dynamics: - Vatu per U.S. dollar (period average): 89.5 (2011); 92.6 (2012); 94.5 (2013); 97.1 (2014); 109.0 (2015). - Vatu per U.S. dollar (end of period): 93.6 (2011); 91.7 (2012); 97.3 (2013); 102.7 (2014); 110.5 (2015). - RBV exchange rate: VT 108.72 per U.S. dollar as of August 31, 2016. - The vatu has appreciated against the AUD and depreciated against the USD (both around 20 percent since 2013 in bilateral terms). ### Financial stability and AML/CFT - Financial sector soundness: - Capital adequacy indicators (selected): Regulatory capital to risk-weighted assets: 16.4 (2015); Regulatory Tier 1 capital to risk-weighted assets: 16.2 (2015). - Asset quality: Nonperforming loans to total gross loans: 12.6 (2015); NPLs increased temporarily after the cyclone and started to decrease since Q4 2015. - Liquidity: Liquid assets to total assets: 26.2 (2015). - Profitability: Return on assets: 0.6 (2015); Return on equity: 4.6 (2015). - Credit conditions and access: - Large interest rate spreads and high lending rates have persisted despite RBV’s lowering of the rediscount rate. - Credit to business sector remains limited despite sufficient liquidity. - NBV recorded a 35 percent growth of microfinance lending in 2015. - AML/CFT and cross-border risks: - Vanuatu was included in the FATF gray list in February 2016 after agreeing to an action plan to address AML/CFT deficiencies. - Inclusion in FATF list and takeovers in the banking sector "may pose some difficulties in cross-border payments, trade finance, and remittances." - Staff policy recommendations: - Normalize regulatory requirements gradually for banks and non-bank financial sectors. - Undertake diagnostic assessment of banks’ financial situation. - Seek PFTAC assistance to review the current credit union act and draft amendments for effective supervision. - Accelerate implementation of the AML/CFT action plan and align legal framework with international standards. ### Inclusive growth, diversification, and social protection - Employment and inclusion: - Agriculture accounts for about 70 percent of the labor force. - World Bank study notes poverty is widespread; eliminating absolute poverty and achieving shared prosperity requires higher growth, employment and financial services, and a resilient social safety net. - Labor mobility and remittances: - Labor mobility agreements with Australia and New Zealand important; seasonal workers increased living standards and remittances. - Financial inclusion: - Financial development index has surpassed the PICs average since 2004. - Number of ATMs per 100,000 adults (2014): Vanuatu ranks high relative to many PICs. - Commercial bank loan accounts per 100,000 adults (2014): Vanuatu is among the highest in the sample. - Constraints: many SMEs still face stringent collateral requirements. - Structural recommendations: - Prioritize preparing vulnerable populations for recurring climatic events and incorporate efforts into the medium-term development strategy. - Continue expanding private access to finance and secure soundness of non-bank financial institutions. - Support quality upgrading in agriculture and leverage donor initiatives. ### Appendix I and VIII — Risk Assessment Matrix and Exchange Rate Issues (highlights) - RAM global risks include: Significant growth slowdown in China — High/Medium; Reduced financial services by global/regional banks — High (impact: Medium). - RAM domestic risks: Natural disasters and climate change — High/High; Delays in infrastructure implementation — High (likelihood) / High/Medium (impact). - REER and sectoral findings: - Staff EBA-lite assessment: real overvaluation ranging from 6.7 to 7.9 percent. - Tourism-based REER shows largest price competitiveness loss since 2014; Australia accounts for about 59 percent of tourist arrivals (2005-2015). - Agriculture exports to Australia: 18 percent (2010-2015); other Asian countries accounted for 56 percent. - Alternative REER specifications considered: baseline, tourism-based, agriculture-based, commodity-based. - Policy implications: - Maintain the vatu peg to a basket of currencies. - Monitor vulnerabilities to AUD appreciation; promote tourism diversification. - Seek grant or highly concessional financing and rebuild fiscal buffers; introduce income and corporate taxes as part of revenue mobilization. ### Staff’s selected policy recommendations (verbatim where numeric) - Slowing down debt accumulation: - Set the debt-to-GDP ratios on a declining path by 2021. - Seek grant financing for the majority of any additional development projects. - Exercising fiscal discipline: - Reprioritize expenditure and seek synergies between pre-planned infrastructure projects and reconstruction activities. - Incorporate cost of maintenance in the recurrent budget to minimize public infrastructure depreciation. - Tax reform and capacity: - Implement the tax reform in a timely and orderly manner; collaboration with the Fund’s tax policy and administration experts recommended. - GBE reform: - Adoption of the GBE law welcomed to improve fiscal discipline, accountability, and financial viability. ### Authorities’ views and actions - Authorities concur with staff assessment but expect stronger GDP growth over the medium term and plan steadfast implementation of major infrastructure projects. - Authorities committed to simplify and improve the Recovery Plan established in August 2015. - Fiscal measures: - Operation and maintenance budget increased by Vt200 million in 2016 (0.25 percent of GDP). - An Infrastructure Maintenance Fund is being set up with an expected budget of Vt1 billion by 2020 (about 1 percent of GDP). - Tax and structural reforms: - Authorities committed to comprehensive tax reforms starting with introduction of income tax by early 2018. - Authorities requested Fund technical assistance on policy, legislation, and implementation guidance. - Monetary and financial system: - RBV stands ready to adjust policy and to tighten should inflationary pressures emerge. - Authorities proceeding with AML regulations and expect steady implementation of the action plan. ### Staff appraisal and concluding judgments - Recovery and growth: - Reconstruction efforts are beginning to yield positive results; "a full recovery from Cyclone Pam is within reach." - Growth expected to rebound in 2016 due to recovery in tourism and agriculture, and construction from public infrastructure projects. - Main downside risk: "the rate of implementation of public infrastructure projects." - Disaster resilience priorities: - Build domestic fiscal buffers and secure reliable external financial support. - Promote resilient infrastructure and maintenance. - Establish a simple but actionable contingency plan. - Fiscal and debt strategy: - Continue a cautious borrowing strategy to avoid worsening debt dynamics. - Rebuild fiscal buffers over the medium term by strengthening public finance management, reprioritizing spending, and mobilizing new revenue resources, including income taxes. - Recommendation on Article IV: - It is recommended that the next Article IV Consultation takes place on the standard 12-month cycle. *Source: IMF staff report, "Lessons from Cyclone Pam."* ### 1. Lessons from Cyclone Pam ______________________________________________________________________9 ### 1. Lessons from Cyclone Pam ### Background and context - Vanuatu is a small island developing state and a low-income country recovering from Cyclone Pam; income per capita is about USD3,000, with tourism and agriculture the leading drivers of economic activity. - Real GDP growth averaged below 2 percent per year over the last 5 years (down from above 5 percent in the previous 5 years). - At end-2015: public debt was 25.6 percent of GDP; reserves were 7.1 months of imports; inflation was 2.5 percent; private sector credit was around 70 percent of GDP. - Cyclone Pam struck in March 2015, causing damages estimated at around 60 percent of GDP (Post-Disaster Needs Assessment: physical capital damages around 35 percent of GDP; damages to tourism and transport infrastructure estimated at 11 percent of GDP; production losses in agriculture and tourism equivalent to 10 percent of GDP). - IMF emergency support in June 2015 included a disbursement of about USD11.9 million under the Rapid Credit Facility (RCF, at zero interest rate) and an equal disbursement under the Rapid Financing Instrument (RFI), intended to help cope with immediate balance of payments needs and catalyze donor support. ### Recent economic developments and outlook - Real GDP growth: estimated 2 percent in 2013, 2.3 percent in 2014; cyclone induced an estimated decline in real GDP of 0.8 percent in 2015. - Inflation: dipped below 1 percent pre-cyclone; rose to 2.5 percent in 2015 due to cyclone-induced shortages and reconstruction. - Current account: widened to 11 percent of GDP in 2015 from an average of 3 percent of GDP in the three years before; financed by grants, borrowing, and FDI. - Foreign reserves: USD273 million (7.1 months of imports) by end-2015; reserves excluding Pam-related grants and loans about USD215 million (5.6 months of imports). - Fiscal balance: recorded a surplus of about 7 percent in 2015 due to cyclone-related grants received but unspent during the fiscal year. - Outlook: recovery in tourism and agriculture plus ramped-up infrastructure projects expected to propel real GDP growth to 4 percent in 2016 and 4.5 percent in 2017. - Inflation projection: remain below 3 percent in 2017. - Current account projection: projected to widen to around 20 percent of GDP in 2016 and 2017 due to cyclone-related spending and import-heavy infrastructure projects. - Fiscal projection: large deficits (above 10 percent of GDP) in 2016 and 2017 due to reconstruction and clearing past due legal commitments. ### Risks to the outlook - Major uncertainties: - Rate of implementation of public infrastructure projects. - Pace of recovery in tourism and agriculture. - External and exchange risks: - Weaker-than-expected growth in emerging and advanced economies could depress commodity prices and tourism. - Persistent appreciation of the vatu against the Australian dollar (despite depreciation against the U.S. dollar) could reduce attractiveness to Australian tourists and lower the real value of Australian aid. - Natural disaster risk: - Probability of a natural disaster in any given year is 65 percent and more than 99 percent in a five-year period. - EM-DAT indicates natural disasters caused annual damages equivalent to 2.4 percent of GDP over 1950-2014. - Cyclone Pam affected more than 188,000 inhabitants; in most affected southern islands (about 30,000 inhabitants) schools and health centers remain in temporary facilities. - Staff risk matrix (sources: Staff assessment): - Downside risks listed with Likelihood and Impact: - 1. Weaker-than-expected global growth slowdown — Medium — Medium - 2. Sharp rise in risk premia with flight to safety (US dollar appreciation) — Medium — Medium - 3. Natural disasters and climate change — High — High - 4. Delays in implementation of infrastructure projects — High — High ### Institutional and response lessons (Box 1 summary) - Institutions: - Immediate response was effective via a cluster system; National Disaster Management Office (NDMO) coordinates preparedness and recovery; Recovery Committee established in August 2015 to coordinate reconstruction but lacked a dedicated technical unit and some procedures were burdensome, delaying implementation. - Immediate response rated: High; Reconstruction activities rated: Low-Medium. - Fiscal buffers: - Emergency Fund allocation: Vt25 million (about USD230,000). - Response Fund can provide up to 1.5 percent of the government’s budget for a fiscal year (about USD2.5 million or 0.3 percent of GDP). - Government spent in total Vt390 million with Pam-related relief and recovery in 2015 (about USD3.6 million or 0.5 percent of GDP); Response Fund insufficient for extreme events. - Response fiscal buffers rated: Low. - Donor financing: - IMF RCF/RFI support about USD23.8 million (first disbursed among IFIs) helped catalyze donor support. - World Bank committed USD50 million; Asian Development Bank USD22 million. - Bilateral: Australia AUD15 million immediate response and AUD35 million for recovery; New Zealand NZD3.5 million immediate response and NZD6 million for recovery; E.U. EUR10.5 million. - About USD72 million in grants received in 2015; disbursements picking up in 2016 but absorption capacity stretched. - Response donor financing rated: High for bilateral commitments and disbursements; Medium for multilateral commitments and disbursements. ### Staff’s policy recommendations to strengthen disaster resilience - Strengthening risk assessment and planning: - Improve the disaster-response plan by making it simpler and more agile. - Establish a stronger monitoring and evaluation framework. - Better understand sources of vulnerability and potential costs of extreme weather events. - Building domestic fiscal buffers: - Incorporate disaster costs into national budget planning. - Make the Response Fund a more proactive instrument rather than reactive. - Introduction of a corporate and personal income tax is an opportunity to build an additional buffer. - Securing external buffers: - Complement domestic buffers with externally financed instruments, such as contingent credit lines with multilateral partners. - Continue and enhance strong engagement with key donors. - Promoting resilient infrastructure and adequate maintenance: - Invest in adaptation (e.g., seawalls, breakwater reefs, relocating key infrastructure, disaster mapping) despite higher costs due to positive spillovers. - Ensure maintenance of critical infrastructure is adequately funded and included in a medium-term expenditure framework (e.g., stable allocations for the Infrastructure Maintenance Fund, including donor support). ### Authorities’ views and actions - Authorities concur with staff assessment but expect stronger GDP growth over the medium term, citing stable recent political environment and expected steadfast implementation of major infrastructure projects. - Authorities noted early response delays were in part due to development partners’ process requirements and coordination challenges among donors and civil society; they commit to simplify and improve the Recovery Plan established in August 2015. - On fiscal buffers, authorities acknowledge enhancing domestic buffers is a priority but challenging given competing development needs and reliance on external support. - Infrastructure maintenance measures: - Operation and maintenance budget increased by Vt200 million in 2016 (0.25 percent of GDP). - An Infrastructure Maintenance Fund is being set up with an expected budget of Vt1 billion by 2020 (about 1 percent of GDP). *Source: IMF staff report, "Lessons from Cyclone Pam."* ### Box 1. Vanuatu: Lessons from Cyclone Pam ### Box 1. Vanuatu: Lessons from Cyclone Pam ### Insurance and Immediate Financial Assistance - Pacific Catastrophe Risk and Financial Insurance (PCRFI) payout: USD1.9 million; covered less than 1 percent of damages. - Private sector insurance payouts: Vt5.7 billion (about USD52 million); primarily available to large and established businesses and in urban areas. - Risk noted: insurance premia may rise in the future. ### Social Safety Nets and Household Support - Temporary tax and fee measures: - Suspended VAT and import duties on construction materials for two months after the cyclone. - Deferred payments of vehicle registration fees and VAT payments to the next quarter. - Subsidies for agricultural seedlings to affected households. - Vanuatu National Provident Fund (VNPF) actions: - Allowed 40,000 active members to withdraw up to 20 percent of retirement savings. - Total withdrawals amounted to Vt1.7 billion (2.1 percent of GDP) for three months following the disaster. - VNPF withdrew Vt2.1 billion in the domestic banking sector to fund members’ needs, with limited financial impact on its books. - Reach limitation: most VNPF members are located in the three major (less affected) islands, while the most considerable damages were in the southern islands. ### Monetary Policy Response and Liquidity Support - Reserve and policy actions by the Reserve Bank of Vanuatu (RBV): - Tied policy rate to the 91-day RBV Note (variable) rate, implying a decrease from 5.25 percent to about 1.85 percent. - Reduced the Statutory Reserve Deposit (SRD) requirement from 7 to 5 percent. - Activated an additional credit facility for commercial banks. - Decreased interest rate on the RBV’s Secured Advance Facility. - Included SRD holdings as eligible collateral. - Provided financial assistance relief of Vt40 million to the government and provinces. - Response rating in the source: High. ### Banking Sector Continuity and Credit Measures - Business continuity plans implemented to ensure cash availability when banks and ATMs were down. - Largest food and petrol retailers were visited twice daily to facilitate cash holdings and deposits. - Loan relief and lending actions: - Immediate waiver on retail customers’ loan repayments for 2 to 3 months. - Delayed loan repayments for 6 to 12 months to some corporate customers pending insurance payout. - Provided additional lending to commence repair work. - Impact on arrears and NPLs: not significant; some banks wrote off several NPLs. - Response rating in the source: High. ### Communications, Energy, and Early Warning Systems - Early warning messages sent through radio and mobile phones, helping reach communities prior to the cyclone. - Telecommunication restoration timeline: - Electricity reestablished for hospitals and major services after 3 days. - 95 percent of service restored after 4 weeks in Efate island. - 95 percent of service restored after 8 weeks in Tanna island. - Damages to electricity assumed by the government; limited pass-through to consumers due to regulated monthly-updated electricity prices. - Fuel price change: price of fuel dropped Vt10 per liter on all products a month after the cyclone. - Response rating in the source: Medium. --- ### Fiscal Outcomes and Reconstruction Spending (2015–2016) - 2015 government budget: - Unexpected surplus of 7.2 percent of GDP due to unspent cyclone-related grants. - Government expenses rose to 23.6 percent of GDP due to immediate relief needs and early election expenses. - Domestic revenue stable; duties’ collection improved thanks to increased imports. - Capacity constraints and political uncertainties kept reconstruction spending and public investment low in 2015. - 2016 projections: - Fiscal balance projected to record deficits of about 10 percent of GDP due to large cyclone-related current and capital spending, and overdue severance payments. - Government expects domestic revenue to increase by 2.3 percent compared to the 2015 budget (19.2 percent of GDP), supported by receipts from the Citizenship Program and Vanuatu Economic Rehabilitation Program. - A supplementary budget of 1.6 percent of GDP was passed in July to fulfill part of overdue severance payments to civil servants (2.6 percent of GDP). - Capital expenditure projected to rise sharply starting this year on account of ambitious infrastructure scale up. - Long-term domestic bonds issued: 1.4 percent of GDP to close financing gap. ### Infrastructure Program and Financing - 2016 budget reported major infrastructure projects for a combined value of 57 percent of the country’s 2015 GDP spread over the next 7 years, with bulk construction during 2016-18. - Financing sources: grants, external concessional loans, deposits, and domestic issuance. - Two domestic issuances in 2016 raised government debt outstanding held by domestic financial institutions by 18.2 percent from end-2015 level. - RBV purchase: Vt1.1 billion 10 year-maturity bond increased RBV credit to the government to the limit. - Debt service projection: USD18 million by 2020. ### Debt Sustainability and Risks - Debt outlook: - Central government debt projected to rise sharply to 33.5 percent of GDP in 2016 and higher over the medium term. - Updated Debt Sustainability Analysis (DSA) suggests Vanuatu faces a moderate risk of debt distress, up from a low rating in 2013. - Key risks: - Sizeable infrastructure projects pose threats to debt and fiscal sustainability when grants and concessional financing are delayed or insufficient. - Another extreme weather event in the medium term would likely raise the risk of debt distress. - Repeated large-scale borrowing to rebuild from disasters is noted as not a viable long-term strategy. - Recommended emphasis: risk reduction investments and reliance on grant financing. ### Revenue Mobilization and Tax Reform - Revenue context: - Government revenues low by regional standards. - Vanuatu does not have a personal or corporate income tax. - Tax reform initiative: - Introduction of personal and corporate income tax by 2018 projected to generate additional revenue of about 1 percent of GDP. - A Tax Review Committee, supported by an AusAid-funded resident tax advisor, was formed and is expected to start consultations soon. ### Government Business Enterprises (GBEs) - Concerns: - GBEs operate under unclear regulatory framework, raising transparency and effectiveness concerns. - Government-guaranteed GBE debt amounted to 4.6 percent of GDP at the end of 2015. - Actions: Authorities working with ADB to assess GBE financial situation and improve governance. - Staff view: GBE law submission to Parliament would help improve fiscal discipline, accountability, and financial viability of GBEs. --- ### Staff’s Policy Recommendations (selected and verbatim where numeric) - Slowing down debt accumulation: - Set the debt-to-GDP ratios on a declining path by 2021. - Seek grant financing for the majority of any additional development projects. - Need for a concerted effort with the private sector and international financial institutions to ensure public investment program yields expected returns and that financing at concessional terms—in particular through grants—is available. - Exercising fiscal discipline: - Reprioritize expenditure and seek synergies between pre-planned infrastructure projects and reconstruction activities. - Incorporate cost of maintenance in the recurrent budget to minimize public infrastructure depreciation. - Implementing the tax reform in a timely and orderly manner: - Close collaboration with the Fund’s tax policy and administration experts recommended. - Reforming GBEs: - Adoption of the GBE law welcomed to improve fiscal discipline, accountability, and financial viability. ### Authorities’ Views (summarized statements and commitments) - Authorities recognize infrastructure “big push” may pressure debt sustainability and intend to seek concessional financing—particularly grants. - Authorities concurred with mission’s recommendations for further fiscal discipline and agreed to prioritize prudent fiscal policy to ensure ample fiscal space and macroeconomic stability. - Authorities committed to comprehensive tax reforms starting with introduction of income tax by early 2018, emphasizing effectiveness and social fairness. - Authorities requested Fund technical assistance on policy, legislation, and implementation guidance. --- ### Monetary Policy, Reserves, and Exchange Rate Assessment - Monetary policy stance: - Accommodative monetary policy remains appropriate to support recovery and financial stability. - RBV actions after cyclone: lowered policy rate tied to 91-day bill rate, reduced reserve ratio, activated credit facilities. - Monetary policy transmission mechanism remains obscure due to unclear objectives, inconsistent use of instruments, and shallow financial markets. - Credit provision: - Credit to business sector remains limited despite sufficient liquidity; reasons include uncertainty around business prospects and stringent collateral requirements. - Foreign exchange reserves: - Gross international reserves covering an estimated 5.8 months of imports of goods and services by end-2016. - Authorities’ committed level: 4 months of imports. - Considerable foreign exchange reserves expected to remain over next several years; reserves will be needed by 2020 to provide foreign currency for government’s debt repayment obligations. - Downside risk: materialized imports during infrastructure scaling up can be larger than projected. - Staff recommendation on reserves: - Keep foreign reserves at above 4 months of imports to provide a necessary buffer. ### External Balance and Exchange Rate (Box 2 key findings) - REER and competitiveness: - Real exchange rate remains broadly in line with fundamentals despite mild real appreciation after Cyclone Pam. - Dissonant bilateral nominal fluctuations: vatu appreciated against AUD and depreciated against USD (both around 20 percent since 2013), much of which materialized over the last 12 months. - Potential sectoral effects: tourism (Australia accounts for about 55 percent of tourist arrivals and the majority of foreign aid) could be adversely affected by appreciation against AUD. - Current account and financing: - Current account imbalances likely to persist (well above 10 percent of GDP over the medium term) given reconstruction needs, high import-content of infrastructure projects, and piecemeal tourism recovery. - External deficit financed predominantly by external grants, concessional borrowing, and FDI expected to remain high in the medium term. - Competitiveness and business environment: - Vanuatu ranked 94 (of 189) in the WB’s Ease of Doing Business index. - Key bottlenecks: time and cost of starting a business; cost of dealing with construction permits; enforcing contracts; land titling. - Structural reforms recommended to remove bottlenecks and stimulate investment, especially for expanding production of beef and other agricultural products. - Staff EBA-lite assessment: - Real overvaluation ranging from 6.7 to 7.9 percent, indicating the real exchange rate may be somewhat stronger than level consistent with external current account benchmark (around 8 percent of GDP). - Baseline scenario: overall no strong indication of misalignment. *Prepared by Ricardo Marto (RES) — Box 1. Vanuatu: Lessons from Cyclone Pam* ### 30. Staff recommends maintaining the peg at its current level. Despite a mild real ### 30. Staff recommends maintaining the peg at its current level. ### Monetary policy and exchange rate - Staff recommendation: maintain the peg at its current level. - Rationale: Despite a mild real appreciation in the aftermath of Cyclone Pam, the peg to an undisclosed basket of currencies "continues to serve Vanuatu well in promoting stability and confidence." - Conditional guidance: Authorities should be ready to adjust the level and composition of the peg "if Vanuatu’s external position worsens significantly." - Staff view in appraisal: - The accommodative monetary stance and exchange rate peg "remain appropriate" to support economic recovery, and price and financial stability after the cyclone. - Vigilance is required to tame inflation pressures if they emerge and to ensure consistency between monetary policy, the exchange rate, and reserve cover goals. - The real effective exchange rate "remains broadly in line with fundamentals and the peg should be maintained at its current level." - Policy tool development: RBV encouraged to "clarify further its objectives and instruments" to improve the weak transmission mechanism. ### Authorities’ views on monetary policy and external position - Authorities concurred with staff on the monetary policy transmission mechanism and the need to develop policy tools. - Constraints noted: "capacity constraints and shallow financial markets" restrict monetary policy options. - Authorities’ stance: - Agree to maintain accommodative monetary policy, but "stand ready to tighten should inflationary pressures emerge." - Agree with staff’s external balance assessment and on "the need to maintain sufficient reserves to face future commitments." - Intend to maintain the current peg and "consult with the IMF on any changes." - Will reassess the peg level if "deemed necessary by new developments in the economy" to ensure external stability over the medium term. ### Securing financial stability and improving the financial system — Findings - Post-cyclone recovery: - Financial sector "has recovered well from the adverse impact of the cyclone, but vigilance is still needed." - Since last quarter of 2015, financial soundness of banks has been improving: "rise of capital and liquid asset ratios" and "decline of the ratio of non-performing loans (NPLs)." - Longer-term trend: "the longer-term financial soundness of banks has been on a deteriorating trend since 2010." - Recent RBV measures: - RBV lowered the Statutory Reserve Deposit (SRD) requirement and the Liquid Asset Requirement (LAR) to alleviate potential liquidity pressures on banks. - Non-bank sector: "remains, on the other hand, small and not sufficiently supervised." - Credit and lending: - Growth of corporate lending "has declined during the post-cyclone recovery period even though liquidity has been plentiful." - Large interest rate spreads and high lending rates have persisted despite RBV’s lowering of the rediscount rate. - Payments and cross-border issues: - AML/CFT: Vanuatu was included in the FATF gray list in February 2016 after agreeing to an action plan to address AML/CFT deficiencies. - Implications: Inclusion in FATF list and the selloff of Westpac to PNG’s Bank South Pacific in July 2016 "may pose some difficulties in cross-border payments, trade finance, and remittances." - Remittance costs: "The cost of transferring funds to Vanuatu has been trending up since 2014 and is substantially higher than in other PICs." ### Securing financial stability — Staff’s policy recommendations - Normalize regulatory requirements gradually for banks and non-bank financial sectors. - Undertake a diagnostic assessment of banks’ financial situation to prepare for risks from potential tightening of reserve and liquid asset requirements. - Seek PFTAC assistance to: - Review the current credit union act. - Draft amendments to ensure effective supervision of credit unions and promote their role in financial inclusion. - Accelerate implementation of the AML/CFT action plan and align legal framework with international standards (examples cited: secrecy obligations, bearer shares and share warrants, transparency of beneficial ownership information of offshore companies and trusts). - Leverage support from Papua New Guinea and Australia, and other partners, to exit FATF monitoring. ### Authorities’ views on financial stability and AML/CFT - Authorities emphasized RBV’s prompt policy response after the cyclone "significantly enhanced overall bank liquidity." - They acknowledged the need for caution when tightening reserve and liquid asset requirements. - Authorities are proceeding with AML regulations and expect steady implementation of the action plan "in line with international standards." - They are engaging with FATF, the Asia-Pacific Group, and other development partners for technical and legal support, and are committed to enhancing the overall effectiveness of the AML/CFT regime. ### Ensuring inclusive growth through diversification and quality upgrading — Findings - Poverty and inclusion: - World Bank study notes poverty is widespread in most Pacific islands; eliminating absolute poverty and achieving shared prosperity in Vanuatu requires: "higher growth, employment and financial services, and a resilient social safety net against external shocks." - SDG links highlighted: Goal 1 (End poverty) and Goal 2 (End hunger/food security), with target excerpts for resilience and sustainable food production by 2030. - Employment and labor mobility: - Improving access to employment and basic social services is a priority, especially in outer islands. - Labor mobility agreements with Australia, New Zealand, or the United States are important; expanding agreements is critical to address unemployment. - Seasonal workers in Australia and New Zealand have increased and raised living standards and remittances; skills and marketing of workers could be improved with training policies. - Financial inclusion and SME credit: - National Bank of Vanuatu (NBV) provided notable outreach: "NBV recorded a 35 percent growth of microfinance lending in 2015" after introducing Rural Land and Seasonal Labour Loans. - Financial literacy program helped open bank accounts in rural areas. - Credit unions complement banking services, but many SMEs still face stringent collateral requirements limiting credit access. - Diversification and quality upgrading: - Improvements in connectivity (submarine cable), planned transport investments, and lower fuel prices are attracting more and higher quality tourism. - Agrotourism and increased agricultural production, including beef, can diversify domestic activities and provide buffers against external shocks. - Ease of doing business: - Vanuatu ranks 94 (of 189) in the World Bank’s Ease of Doing Business index. - There is room to improve starting a business, registering property, and land titling. - Recent reforms to the leasing regime for customary land caused unexpected delays in land registration due to inefficient procedures intended to improve transparency. ### Inclusive growth — Staff’s policy recommendations - Poverty alleviation: - Prioritize preparing vulnerable populations for recurring climatic events and incorporate these efforts into the new medium-term development strategy. - Financial inclusion: - Continue expanding private access to finance as financial deepening is strongly linked to growth. - Secure the soundness of non-bank financial institutions, important for financial inclusion in outer islands. - Quality upgrading: - Support authorities’ efforts to improve quality upgrading in the agricultural sector, which "accounts for about 70 percent of the labor force." - Leverage new donor initiatives to expand agricultural opportunities. ### Authorities’ views on inclusive growth and reforms - Authorities agreed on the importance of financial inclusion and intend to continue promoting access to financial services in rural areas. - Concurred with staff recommendations on poverty reduction, diversification, and quality upgrading. - Intend to introduce structural competitiveness measures to reduce the cost of doing business and promote economic activities in outer islands with a focus on agricultural production supported by development partners. - Agreed to improve the business environment by removing key bottlenecks and focusing on complementary structural competitiveness measures to stimulate private investment. ### Other issues and institutional matters - Engagement with donors: - Staff discussed donor engagement on grants and loans for reconstruction and infrastructure. - Emphasis on making grant financing available to maintain debt sustainability and support SDGs, especially poverty elimination and climate change goals. - Safeguard assessment: - First-time RBV safeguards assessment identified weaknesses in governance, autonomy, transparency, and audit mechanisms. - RBV has a recognized accounting framework and an external audit but these could be strengthened. - The central bank "requires recapitalization." - Authorities plan to seek IMF technical assistance to draft amendments to the RBV Act and formulate a recapitalization plan. - Statistical issues: - Data are "broadly adequate for surveillance purposes" but quality and timeliness remain a concern for some series. - Staff encouraged authorities to seek further PFTAC support on national accounts compilation, analysis, and dissemination. ### Staff appraisal — Key judgments and risks - Recovery and growth: - Reconstruction efforts are beginning to yield positive results; "a full recovery from Cyclone Pam is within reach." - Growth is expected to rebound in 2016 due to recovery in tourism and agriculture, and construction from public infrastructure projects. - Main downside risk: "the rate of implementation of public infrastructure projects." - Disaster resilience: - Vanuatu needs to improve resilience to natural disasters through: (i) building domestic fiscal buffers and securing reliable external financial support; (ii) promoting resilient infrastructure and maintenance; and (iii) establishing a simple but actionable contingency plan. - Fiscal and debt risks: - Major infrastructure projects pose "sizeable threats to debt and fiscal sustainability." - With public debt rising fast, fiscal discipline and revenue mobilization are essential. - Authorities commended for launching a comprehensive tax reform initiative to raise revenue and reduce fiscal pressure. - Financial sector and AML/CFT: - Financial sector recovery noted but challenges remain. - RBV must act to secure financial stability by gradually normalizing regulatory requirements for banks and non-bank financial institutions. - Staff welcomes AML/CFT initiatives and encourages drawing on international technical assistance. - Monetary policy and peg: - The accommodative stance and peg are appropriate to support recovery and stability. - The peg should be maintained at its current level given the real effective exchange rate is "broadly in line with fundamentals." - Inclusive growth priorities: - "Higher growth, job availability, and resilience to external shocks" are key to reduce poverty and share prosperity. - Authorities should promote private sector investment, advance land reforms, and enhance quality upgrading in tourism and agriculture. - Improving access to employment and financial inclusion remains a priority, especially for outer islands. *Source: IMF staff report excerpts.* ### 57. It is recommended that the next Article IV Consultation takes place on the standard ### _cr16336 - 57. It is recommended that the next Article IV Consultation takes place on the standard 12-month cycle. ### Macroeconomic outlook and recent developments - Growth: - Real GDP: 1.2 (2011); 1.8 (2012); 2.0 (2013); 2.3 (2014); -0.8 (2015); 4.0 (2016, projected). - Growth slowed since 2010 and turned negative in 2015 due to Cyclone Pam; growth is projected to rebound driven by infrastructure projects, reconstruction activities, and government consumption growth. - Inflation: - Consumer prices (period average): 0.9 (2011); 1.3 (2012); 1.5 (2013); 0.8 (2014); 2.5 (2015); 2.2 (2016, projected). - Consumer prices (end period): 1.2 (2011); 0.8 (2012); 1.5 (2013); 1.1 (2014); 1.5 (2015); 2.5 (2016, projected). - Inflation picked up right after the cyclone and moderated since the second half of 2015. - Labor and demand: - Formal employment picked up after the cyclone and returned to pre-cyclone trend in the first quarter of 2016. - Indicators of private demand declined after the cyclone and rebounded since Q4 2015. ### External sector - Current account and trade: - Current account (in percent of GDP): -8.1 (2011); -6.5 (2012); -3.3 (2013); -0.3 (2014); -11.1 (2015); -16.6 (2016, projected). - Trade balance (in percent of GDP): -24.4 (2011); -25.4 (2012); -27.8 (2013); -24.2 (2014); -36.5 (2015); -32.4 (2016, projected). - Exports of goods (in percent of GDP): 8.5 (2011); 7.0 (2012); 5.6 (2013); 7.7 (2014); 5.3 (2015); 7.8 (2016, projected). - Imports of goods (in percent of GDP): -32.9 (2011); -32.4 (2012); -33.4 (2013); -31.9 (2014); -41.7 (2015); -40.2 (2016, projected). - Current account balance is expected to drop sharply in 2016 due to higher imports. - Tourism and exports: - Tourism receipts (in percent of GDP): 28.1 (2011); 30.9 (2012); 35.9 (2013); 31.6 (2014); 23.7 (2015); 25.5 (2016, projected). - Tourist arrivals declined right after the cyclone but recovered since the second half of 2015. - Export growth was negative in 2015 due to cyclone damage and started to rebound in 2016. - Capital flows and reserves: - Capital and financial account (in percent of GDP): 14.7 (2011); 6.1 (2012); 7.2 (2013); 6.1 (2014); 21.3 (2015); 13.6 (2016, projected). - FDI and other investment will only cover part of the current account deficit. - Gross international reserves (in millions of U.S. dollars): 175 (2011); 184 (2012); 179 (2013); 184 (2014); 273 (2015); 250 (2016, projected). - Gross international reserves (in months of prospective G&S imports): 5.3 (2011); 5.4 (2012); 5.4 (2013); 4.5 (2014); 7.1 (end-2015); 5.8 (2016, projected). - Reserves rose to comfortable levels while public debt increased significantly in 2015. - Exchange rates: - Vatu per U.S. dollar (period average): 89.5 (2011); 92.6 (2012); 94.5 (2013); 97.1 (2014); 109.0 (2015). - Vatu per U.S. dollar (end of period): 93.6 (2011); 91.7 (2012); 97.3 (2013); 102.7 (2014); 110.5 (2015). - The nominal exchange rate has been appreciating against the Australian dollar but weakening against the U.S. dollar. - The vatu is officially pegged to an undisclosed basket of currencies. ### Fiscal policy, public debt and projections - Fiscal balances and composition: - Total revenue (in percent of GDP): 22.3 (2011); 21.8 (2012); 21.4 (2013); 23.5 (2014); 32.1 (2015); 29.1 (2016, projected). - Taxes (in percent of GDP): 16.4 (2011); 16.5 (2012); 17.2 (2013); 17.4 (2014); 16.7 (2015); 18.0 (2016, projected). - Grants (in percent of GDP): 4.2 (2011); 3.0 (2012); 2.2 (2013); 4.1 (2014); 11.2 (2015); 7.7 (2016, projected). - Expenditure (in percent of GDP): 24.4 (2011); 23.4 (2012); 21.7 (2013); 22.7 (2014); 24.9 (2015); 39.7 (2016, projected). - Expense (in percent of GDP): 21.9 (2011); 21.8 (2012); 20.7 (2013); 21.8 (2014); 23.6 (2015); 32.0 (2016, projected). - Net acquisition of nonfinancial assets (in percent of GDP): 2.7 (2011); 1.6 (2012); 1.0 (2013); 0.9 (2014); 1.3 (2015); 7.7 (2016, projected). - Fiscal balances improved in recent years, but reconstruction and new investment needs will likely lead to high fiscal deficits. - Fiscal outcomes and debt: - Net lending (+)/borrowing (-) (in percent of GDP): -2.1 (2011); -1.6 (2012); -0.2 (2013); 0.8 (2014); 7.2 (2015); -10.6 (2016, projected). - Central government debt (end of period, in percent of GDP): 20.7 (2011); 21.7 (2012); 20.6 (2013); 19.3 (2014); 25.6 (2015); 33.5 (2016, projected). - Public and publicly-guaranteed debt (in percent of GDP): 23.7 (2011); 24.6 (2012); 23.3 (2013); 23.9 (2014); 33.4 (2015); 38.6 (2016, projected). - Projections indicate debt will rise further in the medium term under the baseline scenario (central government debt: 44.8 in 2017; 52.2 in 2018). - Debt service and primary balance: - Interest payment (in percent of GDP): 0.6 (2011); 0.6 (2012); 0.7 (2013); 0.7 (2014); 0.9 (2015); 0.9 (2016, projected). - Primary balance (in percent of GDP): -1.7 (2011); -1.0 (2012); 0.5 (2013); 1.5 (2014); 8.0 (2015); -9.7 (2016, projected). ### Monetary sector and liquidity - Money and credit: - Broad money (M2) annual change: 1.3 (2011); -0.6 (2012); -5.5 (2013); 8.6 (2014); 11.4 (2015); 0.2 (2016, projected). - Net foreign assets (annual change): -8.5 (2011); -6.3 (2012); -14.8 (2013); -14.5 (2014); 71.6 (2015); -19.3 (2016, projected). - Net foreign assets rose sharply in 2015, linked to central bank positions; net foreign assets of commercial banks were negative since mid-2014 until turning positive in May 2016. - Reserve money (annual percentage change): 6.5 (2011); 9.4 (2012); 18.0 (2013); 9.9 (2014); 20.4 (2015); -11.4 (2016, projected). - Interest rates and credit: - Deposit rate (vatu deposits, end period): 2.8 (2011); 2.2 (2012); 1.9 (2013); 2.6 (2014); 2.3 (2015). - Lending rate (vatu loans, end period): 10.3 (2011); 9.4 (2012); 10.5 (2013); 10.3 (2014); 10.0 (2015). - Large interest rate spreads have persisted and transmission from policy rate to commercial banks’ interest rates appears limited. - Domestic credit (annual percentage change): 10.9 (2011); 5.7 (2012); 2.7 (2013); 9.4 (2014); -7.6 (2015); 9.0 (2016, projected). - Credit to private sector (annual percentage change): 8.8 (2011); 6.9 (2012); 2.0 (2013); 9.0 (2014); 1.8 (2015); 6.7 (2016, projected). ### Financial sector soundness and access - Banks and stability: - Capital adequacy: - Regulatory capital to risk-weighted assets: 30.6 (2010); 21.3 (2011); 20.5 (2012); 18.1 (2013); 17.6 (2014); 16.4 (2015). - Regulatory Tier 1 capital to risk-weighted assets: 29.5 (2010); 18.7 (2011); 18.3 (2012); 15.9 (2013); 16.7 (2014); 16.2 (2015). - Asset quality: - Nonperforming loans to total gross loans: 4.9 (2010); 8.1 (2011); 8.1 (2012); 13.5 (2013); 11.1 (2014); 12.6 (2015). - NPLs increased temporarily after the cyclone and started to decrease since Q4 2015. - Profitability: - Return on assets: 0.8 (2010); 0.6 (2011); 0.6 (2012); 0.4 (2013); 0.4 (2014); 0.6 (2015). - Return on equity: 6.2 (2010); 4.7 (2011); 4.3 (2012); 3.1 (2013); 3.0 (2014); 4.6 (2015). - Liquidity: - Liquid assets to total assets: 16.5 (2010); 18.2 (2011); 18.8 (2012); 26.1 (2013); 23.8 (2014); 26.2 (2015). - Despite a high loan-to-deposit ratio, overall bank liquidity remained ample; liquidity has become more evenly distributed across banks. - Capital ratios have been on a declining trend but remain above the required level. - Credit conditions: - Private credit growth declined sharply from the second half of 2015 in tandem with a large drop in credit to the business sector. - Overall credit growth: (monthly/quarterly series) shows declines in 2015 and modest recovery in 2016. - Financial access and inclusion: - Financial development index has surpassed the PICs average since 2004. - Number of ATMs per 100,000 adults (2014): Vanuatu ranks high relative to many PICs (chart shown). - Commercial bank loan accounts per 100,000 adults (2014): Vanuatu is among the highest in the sample. - However, financial access by the business sector is constrained, with a high share of loans requiring collateral and a higher share of firms identifying access to finance as a major constraint. ### Key numerical indicators (selected) - Nominal GDP: - In billions of vatu: 70.9 (2011); 72.4 (2012); 75.8 (2013); 79.1 (2014); 80.4 (2015); 85.5 (2016, projected). - In millions of U.S. dollars: 792 (2011); 782 (2012); 802 (2013); 815 (2014); 738 (2015); 773 (2016, projected). - Balance of payments (2015/2016): - Current account: -82 (millions of U.S. dollars, 2015 estimate); -129 (2016 proj). - Gross international reserves (millions of U.S. dollars): 273 (end-2015); 250 (2016, projected). - IMF obligations and capacity to repay: - Outstanding Fund credit (in millions of SDRs): 17.0 (2016); projected 14.9 (2018); 10.6 (2019); 7.7 (2020); 6.0 (2021). - Total obligations based on existing and prospective credit (in millions of SDRs): 0.1 (2016); 0.1 (2017); 2.2 (2018); 4.3 (2019); 3.0 (2020). ### Policy-relevant findings and implications - Reconstruction and large new public investment needs following Cyclone Pam are expected to: - Raise fiscal deficits sharply (net lending/borrowing: -10.6 percent of GDP in 2016 projected). - Drive up public debt (central government debt projected at 33.5 percent of GDP in 2016, rising further in the medium term under the baseline). - External financing: - FDI and other investment will only cover part of widening current account deficits; reserves remain comfortable but the current account is projected to deteriorate in 2016. - Monetary and financial stability: - Large interest rate spreads and limited monetary transmission suggest challenges for monetary policy effectiveness. - Bank liquidity is ample but capital ratios have declined; NPLs increased after the cyclone but started declining in Q4 2015. - Financial inclusion: - Household access to financial services (ATMs, loan accounts) is relatively high compared to PIC peers, but business access is constrained by collateral requirements. - Scheduling: - It is recommended that the next Article IV Consultation takes place on the standard 12-month cycle. *Source: Vanuatu — IMF staff estimates, projections, and analyses (figures, tables, and text as provided).* ### Appendix I. Vanuatu: Risk Assessment Matrix ### Appendix I. Vanuatu: Risk Assessment Matrix ### Global risks - Risks and likelihoods (as presented): - Weaker-than-expected global growth slowdown — Low/Medium - Significant growth slowdown in China — High/Medium - Structurally weak growth in key advanced/emerging economies — Medium - Sharp rise in risk premia with flight to safety — Medium (impact: Medium) - Reduced financial services by global/regional banks (“withdrawal of corresponding banking relationships”) — High (impact: Medium) - Key potential impacts: - A decline in exports and tourism receipts would worsen the current account balance, reduce fiscal revenue, and weaken the reserves buffer. - A large U.S. dollar appreciation against the Australian dollar will result in the vatu’s sizable appreciation against the Australian dollar, potentially creating problems given Australia is Vanuatu’s largest trading partner, tourist source, and grant provider. - Inclusion in the FATF list may pose difficulties in cross-border payments, trade finance, and remittances; closure of MTOs could increase the cost of remittances. - Policies to minimize impact: - Facilitate diversification by introduction of new activities and expansion into new markets. - Accelerate infrastructure investment to stimulate domestic demand in the short-term and improve competitiveness in the long-term. - Continue implementation of the basket currency peg; consider some intervention to basket currencies and weights in the medium term if underlying fundamentals worsen. - Strengthen reserve management in line with IMF TA. - Ensure transparency and improve banking regulation and supervision to mitigate the risk of loss of correspondent banking relationships. - Strengthen the AML/CFT framework in line with the international standard through TA from stakeholders (e.g., IMF, World Bank, and Australian government). ### Domestic risks - Risks and likelihoods (as presented): - Natural disasters and climate change — High/High (likelihood/impact) - Delays in implementation of infrastructure projects — High (likelihood) / High/Medium (impact) - Earlier-than-desired implementation of tax reform — Medium (likelihood) / High/Medium (impact) - Key potential impacts: - Natural disasters: damages to agriculture and infrastructure can reduce fiscal space and have significant impacts on potential growth; climate change likely to increase intensity and frequency of disasters, alter weather and precipitation patterns, and raise sea levels. - Delays in infrastructure projects: adverse effects on short- and medium-term growth. - Premature tax reform (introduction of income tax and corporate tax without proper preparation): could cause contractions in household consumption and business investment. - Policies to minimize impact: - Natural disasters and climate change: - Build greater ex-ante resilience by enhancing adaptation measures (better infrastructure, territorial planning, and fiscal buffers). - Improve disaster response planning with more swift coping mechanisms. - Seek global/regional climate financing opportunities. - Delays in infrastructure projects: - Promote public investment by prioritizing project selection and implementation. - Stimulate private sector investment by improving the business environment and facilitating credit provision. - Tax reform implementation: - Seek TA from the IMF on implementation of tax reforms to secure expected revenue return and fairness of the tax system. ### RAM methodology note (staff assessment of relative likelihood) - The RAM shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). - Relative likelihood labels are staff’s subjective assessments: “low” indicates a probability below 10 percent, “medium” indicates a probability between 10 and 30 percent, and “high” indicates a probability between 30 and 50 percent. - The RAM reflects staff views as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly. *Italic: Appendix I. Vanuatu: Risk Assessment Matrix — IMF staff compilation as presented in the source document.* ### Appendix V. Benchmarking Government Business Enterprise ### Appendix V. Benchmarking Government Business Enterprise Performance in Vanuatu ### Overview and portfolio structure - GBEs (commercial government business enterprises) account for about 8 percent of the total stock of fixed capital in Vanuatu. - Number and activity: - Vanuatu has 11 GBEs; only eight are active and regularly producing audited financial accounts. - The three largest—National Bank of Vanuatu (NBV), Air Vanuatu (Operations) Limited, and Airports Vanuatu Limited (AVL)—accounted for 96 percent of total GBE assets. - Sector composition: - The portfolio is relatively concentrated in non-infrastructure, commercially-oriented activities, notably financial services (including NBV and Vanuatu Agriculture Development Bank (VADB)). - Vanuatu Post Limited is included in the analysis but had no 2014 accounts; its 2013 statements remain unaudited. Vanuatu Post Limited accounted for 8% of total GBE assets in 2013 and recorded positive profits from 2008 to 2013. ### Comparative financial performance (2010–2014) - Period of analysis: 2010-2014. - Profitability and efficiency: - Portfolio Return on Assets (ROA) averaged -0.13 percent. - Portfolio Return on Equity (ROE) averaged -0.39 percent. - These figures represent the second worst performance in the comparator group. - Comparator reference: Solomon Islands averaged ROA of 6.7 percent and ROE of 10.0 percent. - Asset utilization measures indicate Vanuatu’s GBE portfolio is among the weaker performers in the region. - Productivity implication: - GBEs add only 0.24 percent to Vanuatu’s GDP for every 1 percent share of the total fixed capital stock they hold. ### Fiscal cost and Community Service Obligations (CSOs) - Government transfers: - Government transfers to GBEs averaged 2.3 percent of general government expenditure during 2010-2014. - This is the third highest among the comparator group. - Role of unfunded CSOs: - Unfunded CSOs are a significant burden, reducing profitability and undermining management incentives. - Air Vanuatu: - Contributed 94 percent of GBE losses during 2008 to 2014. - Estimated unfunded CSOs of Vt176 million in 2013 alone. - Resulted in a Vt1.4 billion loan and a Vt2.2 billion guarantee from government. - In 2016 the government is providing another financing package for Air Vanuatu, to be disbursed in two tranches valued at a total of Vt423 million. - NBV: - Financial performance declining in recent years in part due to unfunded CSOs for rural outreach, estimated to cost about $1.7 million in 2014. - Cross-country variation: - Some comparator countries realize negative government transfers to GBEs (i.e., dividends), highlighting scope for fiscal improvement. ### Reform experience, implementation, and policy recommendations - Policy history and implementation status: - Vanuatu adopted a broad-based GBE reform policy in October 2013; implementation has been weak. - An GBE Monitoring Unit has been formally established but remains under-resourced. - A GBE minister is yet to be appointed; sector ministers continue to be responsible for GBEs in their portfolios. - In 2011 parliament passed a bill to liquidate the Vanuatu Commodities Marketing Board, but no action has been taken. - An GBE Bill based on the 2013 policy has been prepared and was planned to be submitted to government during 2016. - Lessons from the region: - Countries undertaking substantive reforms (e.g., Solomon Islands and Tonga) are seeing improvements in financial performance and apparent rises in GBE productivity. - Political will must be sustained over time for reforms to deliver results. - Recommended reform priorities (implicit in the analysis and policy documents): - Require GBEs to generate profits sufficient to cover their cost of capital. - Put in place a clear framework for funding CSOs to avoid unfunded obligations that undermine profitability. - Prohibit the appointment of civil servants and elected officials to GBE boards to strengthen governance and accountability. - Resource and empower the GBE Monitoring Unit and appoint a dedicated GBE minister to centralize oversight and reform implementation. *Prepared by Roland Rajah (Asian Development Bank); based on Finding Balance: Benchmarking the Performance of State-Owned Enterprises in Island Countries (ADB, forthcoming).* ### Appendix VIII. Exchange Rate Issues: Competitors and Sectors ### Appendix VIII. Exchange Rate Issues: Competitors and Sectors ### Exchange rate dynamics with competitors - Diverging exchange rate fluctuations with main trading partners’ currencies is not exclusive to Vanuatu; most other Pacific Island Countries (PICs) also experienced some appreciation of their currency against the AUD and some depreciation against the USD. - Despite cyclical volatility and as opposed to some neighbors, Vanuatu’s REER seems to be broadly consistent across time. - The RBV quotes daily buying and selling rates for the vatu against the U.S., Australian, and New Zealand dollars; the euro; the U.K. pound; and the Japanese yen. The rate in terms of the U.S. dollar as of August 31, 2016 was VT 108.72 per U.S. dollar. - De facto classification: “other managed,” as the composite weights are not disclosed and cannot be confirmed. - Note on signs: In the provided exchange rate charts, a positive number indicates a depreciation; in the nominal and real effective exchange rate charts, an increase indicates an appreciation. ### Sectoral impacts and competitiveness - Sectoral effects depend on the predominant foreign currency used in each sector; some sectors may experience price competitiveness loss. - Tourism: - Australia accounts for about 59 percent of tourist arrivals (over the 2005-2015 period) and the majority of foreign aid. - The vatu’s appreciation against the AUD could adversely affect the tourism sector and the value of aid flows. - So far, the price elasticity of demand for tourism suggests a low sensitivity to nominal fluctuations with tourist arrivals steadily bouncing back after the airport’s runway repairs and the reopening of hotels and resorts. - Sectoral REER decomposition shows the tourism sector has faced the largest price competitiveness loss since 2014. - Agriculture: - Agricultural exports are spread across Australia (18 percent, over the 2010-2015 period) and several other Asian countries (Philippines, Malaysia, Japan, New Caledonia, Fiji, and Papua New Guinea accounted for an additional 56 percent). - Agriculture producers were less concerned by exchange rate fluctuations than what the baseline REER suggests; they may be more insulated against recent nominal fluctuations. - Imports and commodity exposure: - High import content of production and consumption implies import prices matter; a commodity-based REER suggests recent nominal fluctuations have not affected producers and consumers alike with no major price competitiveness loss. ### REER measurement and decomposition - The REER is a function of a weighted average of indexed nominal bilateral exchange rates and inflation differentials. - Baseline REER assumptions: - Inflation differentials are based on consumer price indices. - Weights in Vanuatu’s effective exchange rates are based on the 2004-2006 trade flows. - With limited data availability, alternative REER specifications were computed assuming weights implied by: - tourism receipts (tourism-based REER), - agriculture exports (agriculture-based REER), - commodity (oil and agriculture) imports (commodity-based REER). - Findings from alternative REER specifications: - Tourism-based REER: largest price competitiveness loss since 2014. - Agriculture-based REER: less competitiveness loss than baseline. - Commodity-based REER: suggests no major price competitiveness loss for producers and consumers. ### Policy implications and recommendations - Maintain the vatu peg to a basket of currencies: the vatu peg has served Vanuatu well and should be maintained, given the importance of exchange rate stability for maintaining confidence. - Address vulnerabilities to AUD appreciation: - Because Australia constitutes about 59 percent of tourist arrivals, monitor and, where appropriate, promote tourism diversification (including newer long-haul markets) to reduce concentration risk. - Fiscal and external policy coordination: - Seek external financing on grant or highly concessional credit terms for necessary development and reconstruction spending. - Rebuild fiscal buffers over the medium term, including by taking steps to increase domestic revenues through the introduction of income and corporate taxes (as discussed elsewhere in the staff report). - Formulate an infrastructure investment plan in line with national priorities, ensuring discipline and allocative efficiency in public expenditure. - Sectoral policies: - Complement scaling-up of infrastructure with reforms to enhance the business environment, promote tourism, and improve resilience, consistency and quality of agricultural output. - Continue to monitor import price effects given the high import content of production and consumption. ### Key quantitative notes and indicators (as presented) - Australia accounts for about 59 percent of tourist arrivals (over the 2005-2015 period). - Agricultural exports to Australia: 18 percent (over the 2010-2015 period); other Asian countries accounted for an additional 56 percent. - RBV exchange rate: VT 108.72 per U.S. dollar as of August 31, 2016. - Baseline REER index reference: 2010 = 100 (charts and series use this indexing). - REER weighting for baseline: based on 2004-2006 trade flows. - Alternative REER specifications considered: baseline, tourism-based, agriculture-based, commodity-based. - Chart period comparisons and indices referenced include: - Percentage change between 2012Q4-2013Q1 and 2015Q4-2016Q1 for bilateral exchange measures. - Nominal and Real Effective Exchange Rates series spanning 2003M1–2016M1 and 2003Q1–2016Q1 in index form. *Source: _cr16336 - Appendix VIII. Exchange Rate Issues: Competitors and Sectors* ### CONCLUSION ### CONCLUSION ### Debt sustainability assessment - Vanuatu’s risk of debt distress remains "moderate". - Debt rating was elevated from “low risk” in 2013 to “moderate risk” as a result of the 2015 cyclone and planned infrastructure spending. - In the baseline scenario, external and public debt levels are projected to rise steeply over the next few years and peak at substantially higher levels before starting to decline. - Given Vanuatu’s vulnerability to natural disasters, additional extreme weather events are likely to have large adverse cumulative effects on the country’s fiscal position and debt sustainability (as indicated by the alternative shock scenario). ### Key projections and stress-test findings - Baseline trajectory: external and public debt rise sharply in the near term, peak, then decline (see alternative shock scenario for downside). - Alternative shock scenario: demonstrates large adverse cumulative fiscal and debt effects from extreme weather events. - Stress-test implications: reinforce the importance of grant financing for post-disaster reconstruction and of pursuing risk-reduction investments and efficient public investment. ### Policy recommendations and fiscal strategy - Continue a cautious borrowing strategy to avoid worsening debt dynamics. - Rebuild fiscal buffers over the medium term by: - Strengthening public finance management. - Reprioritizing spending to create room for priority social and developmental expenditures. - Mobilizing new revenue resources, including with the introduction of income taxes within a comprehensive tax reform. - For disaster resilience and post-disaster needs: - Seek grant financing with bilateral and multilateral partners for post-disaster reconstruction. - Pursue risk reduction investments. - Ensure public investment is efficient. ### Authorities’ views - The authorities broadly concurred with the debt sustainability assessment. - They noted the ambitious development plan and reform agenda may add pressure on debt sustainability and agreed on the importance of rebuilding fiscal buffers over the medium term. - The authorities conveyed their intention of seeking grant financing for new projects and expected the comprehensive tax reform to yield additional revenues. *Source: CONCLUSION (IMF staff report).* ### introduction of both household and corporate income taxation – and efforts to address ### _cr16336 - introduction of both household and corporate income taxation – and efforts to address ### Recent Developments and the Outlook - Economic activity is continuing to strengthen following Cyclone Pam. - Reconstruction activities are progressing and services have picked up as tourists return. - The economy has gained further impetus from a number of infrastructure projects, many of which had been on hold. - There are signs that business optimism and investment are lifting, including in response to political stability, the new Government’s decisive actions to implement reforms, and confidence in the legal system. - Authorities agree with staff’s outlook and assessment of the risks, while noting a number of important upside risks. - Successful implementation of the Government’s infrastructure plans would directly boost economic activity and could catalyze further private sector activity; however, this will depend on successful and timely implementation. ### Fiscal Policy - The authorities’ infrastructure-focused fiscal policy will be implemented within Vanuatu’s absorptive capacity. - Prior to Cyclone Pam, a number of transport projects had been delayed or downsized to minimize sequencing problems. - Authorities are working closely with development partners to: - ensure stimulus remains appropriately timed; - improve project planning and implementation capabilities; - maximize gains from public investment. - The Government is seeking to modernize the taxation system by introducing personal income and corporate tax arrangements and modernizing the system’s operation. - Expected benefits of tax reform: - strengthen Government finances; - improve public financial management; - strengthen Vanuatu’s ability to deal with external shocks. - The government plans to support the poor by appropriately calibrating the personal income tax’s tax-free threshold. - Reforms will also: - make the business environment more attractive through reducing a number of minor fees and charges; - strengthen businesses through reducing import duties. - Authorities are undertaking public consultations on the new system and request IMF assistance in implementation. - Efforts underway to improve public financial management include: - reducing the need for supplementary budgets; - better accounting for maintenance costs; - reducing overall costs associated with government machinery; - addressing the long-standing backlog of severance payments. - Economic effects of resolving severance backlog: - will improve public financial management; - will address uncertainty that has caused pension-eligible staff to delay retirements in nursing, police and teaching; - these delays had curtailed hiring of new staff and led to closure of the nursing teaching college for two years given the lack of new positions. - Authorities remain committed to putting the public debt-to-GDP ratio on a declining path over the medium term. - Authorities emphasize seeking grant financing for new infrastructure projects, careful planning and sequencing, rebuilding buffers in the medium term, and maximizing grant funding. ### Monetary Policy - The Reserve Bank of Vanuatu’s actions have continued to help Vanuatu achieve both low and stable inflation and a stable peg over the past year. - The RBV stands ready to adjust policy as appropriate, noting changing developments in economic activity. - Staff analysis indicates the exchange rate is in line with fundamentals and that the pegged exchange rate has provided a useful nominal anchor. ### Financial System - The banking system is well capitalized and very liquid. - The decline in non-performing loans is a welcome development, particularly after Cyclone Pam interrupted businesses’ and households’ incomes. - Authorities are considering ways to improve access to credit, building on: - establishment of a national Financial Inclusion Task Force in 2013; - establishment of a separate Financial Inclusion Unit at the RBV in 2016; - financial literacy programs by the RBV and commercial banks. - Specific measures under consideration: - pursue, with the Ministry of Education, formalizing a financial education curriculum in schools; - conduct a diagnostic assessment of banks’ financial situations. - The RBV completed a financial inclusion demand side survey in 2016 which identified gaps in the financial inclusion agenda given needs, access/barriers and usage of financial services and products. - The RBV Board of Directors has proposed amendments to legislation to strengthen aspects of regulation around AML/CFT. - The RBV is working with PFTAC on improving prudential policies for credit unions that fall within the RBV’s legal minimum threshold and assisting in drafting a new Credit Union Act to improve supervision of this sector. - Efforts to improve Vanuatu’s AML/CFT framework: - national committee established within the PM’s Office; - RBV developing a new risk-based manual on AML/CFT; - RBV assessing international banks’ AML documents to assess their risk tolerances; - new requirements around registering money changers; - Financial Intelligence Unit revising its guidelines; - changes to automatic exchange of information; - a number of amendments have been drafted and will be discussed in Parliament towards the end of 2016 or early 2017. - International engagement and assistance: - assistance from FATF’s Asia-Pacific Group; - recent work with the World Bank and the Australian Government. - Policy objective: rectify deficiencies identified in the mutual evaluation report, improve effectiveness at combating money laundering and terrorist financing, and be removed from the FATF public statement. ### Structural Reforms - Authorities are working closely with ADB to improve the operation of Government Business Enterprises (GBEs). - Public Accounts Committee re-established; newly appointed members starting a review of one GBE providing stevedoring services. - Legislation on GBEs to improve corporate governance will be tabled in Parliament in November 2016; this legislation will, amongst other things, liquidate four of the remaining GBEs. - The office of the Auditor General has completed audits and reports of the operations of GBEs in 2015. - ADB and World Bank are working with Air Vanuatu in reviewing its domestic and international routes; the airline is expected to make a small profit this year. - Authorities emphasize development strategy attention to poverty and inclusion. - Infrastructure focus is intended to: - improve accessibility; - reduce business costs; - facilitate quality upgrading and diversification; - attract more and higher quality tourism. - Complementary measures include working with smaller farmers to improve food security and livelihoods. - The Council of Ministers is scheduled to endorse completion of the trade agreement under the Pacific Agreement on Closer Economic Relations (Pacer-Plus) with other Pacific Island countries, Australia and New Zealand by December 2016; trade negotiations with the EU will quickly follow. - Authorities remain committed to improving the business environment and stimulating private investment by removing key bottlenecks and supporting reforms to improve structural competitiveness. *Source: _cr16336 - introduction of both household and corporate income taxation – and efforts to address* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2016/_cr16336.pdf_