Mission Concluding Statement 

IMF Staff Visit, July 26 to August 2, 2011

The mission would like to express its sincere gratitude to our hosts in the Tuvaluan government for their hospitality, their time, and many constructive and open discussions.

Tuvalu’s recovery from the global financial crisis is slow, though inflation also remains subdued. With the government’s cash balances weak and likely to run out during 2011, gaining control over spending this year and holding the line in 2012, as well as continuing momentum with revenue reforms, will be crucial to securing donor support and moving the economy toward a more sustainable framework. Creating space for more private sector growth will require discipline in public enterprise management, retooling the financial sector to support private sector growth, and creating a transparent and level playing field across the economy.

Economic Developments

The slowdown in economic growth that began with the global financial crisis has not yet run its course in Tuvalu. GDP fell by 0.5 percent in 2010, and we expect growth of only 1.0 percent in 2011. On the other hand, thanks to cheaper clothing and land transportation, inflation was -0.6 percent in the year to the second quarter, preserving the purchasing power of Tuvaluans and the competitiveness of wages relative to other countries. The recovery in Australian financial markets and improved global economic conditions have led to higher remittances and investment income for Tuvalu’s substantial offshore funds, with gross national disposable income, a better measure of the country’s purchasing power than GDP, recovering to pre-crisis levels.

Tuvalu’s economy remains highly vulnerable to external factors. Tuvalu remains dependent on global demand, particularly for seafarers, where competitiveness is falling. Rising food prices have had an effect on the balance of payments, while higher oil prices have affected the government accounts. And with donor support in 2010 of of GDP, improving the coordination and predictability of donor flows will be crucial to ensuring medium-term fiscal sustainability and implementing Te Kakeega II.

Policy Discussions

Fiscal Policy

Tuvalu’s fiscal situation is precarious. With the CIF likely to be emptied this year, the financing outlook is highly uncertain, and 2012 will be at least as challenging. While revenue reforms are beginning to bear fruit, getting through the next eighteen months will require measurable and clear progress on controlling expenditure.

Visible improvements to revenue administration this year bode well. The increased follow-up of delinquent taxpayers, as well as questioning of incomplete tax returns is an important sign that public financial management is improving. Ensuring that large public enterprises (PEs), particularly TEC and TTC, fall under the TCT net and pass on withholdings for income tax is crucial, as is ensuring that all profitable PEs fall under the corporate income tax net. As the stock of delinquent accounts begins to decline and compliance in Funafuti rises, revenue capacity can be diverted to bring the Outer Islands (OI) under the presumptive tax and TCT net to further broaden the government’s revenue base.

There may also be scope for improving nontax revenues. The depreciation of the U.S. dollar (USD) relative to the Australian dollar (AUD) is a reminder that when Tuvalu negotiates licensing contracts, whether for .tv revenue or for fishing licenses, government revenue falls. With industrial-scale fishing enterprises that have access to sophisticated insurance products, there is no reason for contracts to be negotiated in USD. While not all licensing contracts can be negotiated in AUD, for example the US fishing license, contracts should be written in AUD to the extent possible, even though this may cost Tuvalu revenue in the short term¹.

Important opportunities to contain spending have already been missed this year. Given uncertainty about the 2011 financing outlook voiced last year by donors and in the IMF Article IV report - not to mention the fact that prices have, on average, fallen since the last wage increase in January 2009 - it is unfortunate that civil servants’ wages were increased mid-year. The large special development expenditure (SDE) appropriations, such as for OI projects, made in the budget are also of concern. The abolition of the physicians’ referral council for the TMTS, which reduced professional oversight over medical referrals, and the large number of scholarships approved for 2011 have greatly added to donors’ concerns that scarce recurrent resources are being diverted to schemes of marginal benefit to Tuvaluans, while opportunities to utilize Tuvalu’s domestic capacity for medical services, and retooling the education system to prepare Tuvaluans for an increasingly competitive labor market, are not being taken.

With the CIF likely to run dry in 2011, and few sources of external finance on the horizon, consolidating spending cannot wait until 2012. For example, with the TMTS by far the most sensitive program for donors, it is highly commendable that there have been efforts to reduce per-patient costs through scheduling follow-up consultations in Funafuti rather than Suva, reducing the duration of stays, and ensuring that caretakers are sent only when necessary. Terminating the scholarships of three students who began studies this year but failed their coursework also sends a signal about consolidation. But without a broader commitment to postpone nonessential spending and cut costs in areas where spending has increased dramatically, the situation in 2012 will be even more difficult.

Given that outlook, the Fund welcomes the government’s commitment to a stronger consolidation in 2012. Forgoing a civil service wage increase in 2012 is an important step, but will only control rather than reduce expenditure. The commitment to reduce expenditure on scholarships is therefore important: bringing the number of students back down to between 30 and 40, ending companion allowances, eliminating extensions beyond three years, terminating the scholarships of students who fail their courses, and enforcing upper age limits for scholarship recipients will improve spending quality and reduce the deficit.

Additional measures will also be necessary. While TMTS costs can be reduced through lowering per-patient costs, real savings will have to come from better use of Tuvalu’s medical resources and reducing the number of patients going to Suva. Subsidies to TEC, which could total more than 5 percent of GDP this year, should be reduced, and the board of TEC allowed to raise electricity rates to make up the difference². SDE should be minimized, particularly in areas such as OI projects where other sources, such as the FTF or donor funds, can be utilized, and temporarily reducing travel expenditure for government officials can also have an impact.

These measures taken together would reduce the 2012 fiscal gap to a level that could likely be filled via donor support. By our estimates, these measures would reduce the deficit to A$2.7 million. Without the CIF, this will be a challenge to close, but we would expect that a fiscal effort culminating in such a large reduction from 2011 to 2012 would mobilize additional donor budget support over the course of the year.

Statistics

Statistical quality continues to improve, and the Fund hopes to continue our collaboration. Fiscal and CPI statistics are produced in a timely and efficient manner. The CSD’s work with PFTAC has led to a noticeable improvement in the ease of use for both national accounts and balance of payments statistics since the Article IV mission. As experience rises within the CSD, and possibly with additional donor support, more timely dissemination of statistics would be useful.

Private Sector Development

Attaining the MDGs for Tuvalu will require creating the conditions for private sector growth. The Public Enterprises Act (PEA) is an important first step, but there are areas where progress still needs to be made. Moving the financial system to a firmer footing will be necessary to allocate capital more effectively and generate employment. Finally, in some areas, government involvement in the private sector is excessive and opaque.

The commitment to the PEA is commendable but must be sustained. Ensuring boards are fully professionalized by end-2011 is key. Going forward, CSOs should be negotiated based on transparent and simple formulas, such as a straightforward calculation of the cost premium for OI telecommunications or electrical services, to avoid them becoming a mechanism for public sector subsidy for profitable lines of business. Remaining arrears, for withholding and consumption tax but also for Provident Fund contributions, should be cleared as soon as possible.

Moving the NBT to a more market-based footing is essential. In the short run, a fully professional NBT board should move to modernize credit grading and step up collections and enforcement, as the DBT and TNPF have done, as well as write off uncollectible private sector loans. The fact that a bank with a near-monopoly in many areas of lending nevertheless earns more money from foreign exchange transactions suggests that other institutions should be allowed into this business to increase competition. Finally, improving banking supervision to ensure that the quality of the credit portfolio does not deteriorate again in the future will also be important, though given limits on capacity, we recognize this will be difficult.

Continued support for the Tuvalu Cooperative Society (TCS) hurts one of Tuvalu’s most vibrant economic sectors. Allowing TCS to run tax arrears and secure bank overdrafts, while popular, damages the environment for private sector development in Tuvalu by reducing profit opportunities for more efficient retailers. With other companies now initiating OI operations, the government should move to ensure a level playing field in retail by supporting freight costs, rather than favoring a particular enterprise.

Joint ventures should be taken on in a more transparent manner. Tuvalu’s fishing joint ventures (JVs) remain murky and must be clarified before the World Bank and IMF can accurately assess Tuvalu’s debt sustainability. For example, if NAFICOT is decorporatized, then its debts count as the government’s. If NAFICOT is not decorporatized, then its revenues are its own and must be used to service this debt, with the government benefitting only after debt service. More broadly, Tuvalu’s fisheries are a valuable resource that should be managed in a sustainable long-run fashion. We strongly encourage the authorities to seek out donor expertise in how best to allocate fishing rights in Tuvalu’s EEZ.

The mission proposes to schedule Tuvalu’s next Article IV Consultation in mid-2012.

Tuvalu: Selected Social and Economic Indicators, 2007–2012 I. Social and Demographic Indicators   GDP (2010):   Poverty rate (2010)     24.8 U.S. dollars (millions) 31.5 Life expectancy at birth (years, 2008) 64.0 Per capita 2,778 Total fertility rate (births per woman, 2008) 3.2     Infant mortality rate (per 1,000 live births, 2008) 30 Population:   Births attended by skilled personnel (percent, 2007) 98 Total (thousands, 2010) 11.3 Adult literacy rate (2002)   99.0 Urban population (percent of total, 2009) 49.0 Unemployment rate (2004)   16.3 II. Economic Indicators 1/       2007 2008 2009 2010 2011 2012             Proj. Proj.       (Percent change) Real sector                 Real GDP growth   5.5 7.6 -1.7 -0.5 1.0 1.4   Consumer prices (period average)   2.3 10.4 -0.1 -1.9 0.5 2.6     (In percent of GDP) Government finance 2/                 Revenue and grants   69.2 75.2 93.3 74.0 85.2 83.5    Current Revenue   51.2 57.4 61.6 54.5 51.8 50.9    Grants   18.0 19.9 31.6 19.5 33.5 32.5   Expenditure and net lending   80.0 78.9 96.5 112.0 107.9 91.1    Current expenditure   70.3 70.6 80.3 92.8 91.7 80.6    Capital Expenditure and net lending   9.7 8.3 16.1 19.1 16.2 10.5   Overall balance   -10.8 -1.5 -3.2 -38.0 -22.7 -7.6                   Tuvalu Trust Fund   321.5 267.5 273.1 287.4 234.8 …   Consolidated Investment Fund   39.4 35.5 45.7 20.5 0.0 …     (Percent change, unless otherwise indicated) Money and credit                 Deposits 3/   -10.5 21.7 -9.5 6.2 … …   Credit to non-government 3/   4.0 14.0 -9.6 0.8 … …   Lending interest rate 4/   10.5 10.5 10.5 9.5 … …     (In millions of Australian dollars, unless otherwise indicated) Balance of payments                 Current account balance   0.1 -10.9 5.0 -5.3 -5.9 -6.3    (In percent of GDP)   0.4 -31.4 14.9 -15.5 -16.9 -17.5    Trade balance   -11.2 -18.3 -16.0 -18.6 -18.9 -19.5     Exports   0.5 0.6 0.6 0.5 0.6 0.6     Imports   11.7 19.0 16.6 19.1 19.5 20.0    Services balance   -23.5 -26.9 -21.8 -22.4 -23.0 -23.6    Income balance   25.3 24.1 27.3 21.3 21.3 22.1    Current transfers (net)   9.5 10.3 15.5 14.3 14.7 14.6   Gross official reserves 5/   20.3 30.7 30.3 25.6 27.0 25.6    (In months of imports of goods and services) 7.8 10.3 10.0 8.2 8.5 8.0   Debt indicators                  Total government debt (including guarantees) 19.7 21.7 15.6 15.1 19.1 19.1     (In percent of GDP)   61.2 62.5 46.7 44.3 54.9 53.4    Of which: External   13.6 16.8 12.3 10.8 9.9 9.4     (In percent of GDP)   42.3 48.4 36.7 31.6 28.4 26.2    External debt service   0.5 0.6 0.8 1.6 0.8 0.5     (In percent of exports of goods and services) 16.1 17.2 22.8 39.4 17.9 29.6   Exchange rates                   Australian dollars per U.S. dollar                    Period average 6/   1.2 1.2 1.3 1.1 1.0 …      End-period 6/   1.1 1.5 1.1 1.0 0.9 …     Nominal effective exchange rate (2005=100) 6/ 104.4 102.5 98.1 111.6 79.2 …     Real effective exchange rate (2005=100) 6/ 105.2 103.5 100.7 115.2 81.7 …   Nominal GDP   32.2 34.6 33.5 34.2 34.8 35.8   Gross National Disposable Income 7/   67.0 69.0 76.3 69.8 … …     Sources: Tuvalu authorities, PFTAC, Asian Development Bank, UNDP, CIA World Factbook, and IMF staff estimates. 1/ Tuvalu uses the Australian dollar as its currency. It has no central bank operations. 2/ Data for 2011 are Tuvalu authorities and staff estimates. 3/ Data for 2010 are provisional estimates. 4/ Rates for personal and business loans. 5/ Defined as sum of foreign assets of the National Bank of Tuvalu, the Consolidated Investment Fund, and SDR holdings. Excludes the Tuvalu Trust Fund. 6/ Data for 2011 are as of end-June. 7/ Gross domestic product plus net compensation of employees, investment income, and current transfers. 1 If all contracts are negotiated in AUD, there is no risk that currency fluctuations will hurt government revenue, but there is no gain when the USD rises. Alternatively, if all contracts are negotiated in USD, then Tuvalu stands to gain when the USD strengthens, but can lose when it falls. The fact that fishing contracts with the United States cannot be negotiated in AUD presents a solution: if other contracts are negotiated in AUD, then there is some gain when the USD strengthens (on the U.S. contract) but the losses when it weakens are reduced. 2 Encouraging TEC to invest in solar energy - an area of intense donor interest - would reduce the need for TEC subsidies and strengthen Tuvalu’s moral position in global climate change discussions.