Mission Concluding Statement 

Kiribati: Staff Concluding Statement of the 2018 Article IV Mission

October 30, 2018

Kiribati has recently enjoyed growth above historical norms, thanks to higher public spending supported by record-high fishing revenues and donor-financed infrastructure investment. There has also been progress on fiscal and structural reforms. The country now has a historic opportunity to leverage these recent gains to ensure inclusive growth in the long run. In order to address this challenge, we encourage the authorities to pursue the following policy priorities:

• Reinforce the fiscal framework to maintain buffers and to meet public spending needs in a sustainable way;
• Create an environment for a dynamic private sector, with continued reform momentum, well-selected infrastructure projects, human capital development, and prudent financial deepening;
• Enhance governance to improve outcomes, reduce vulnerabilities, and catalyze donor support.

Outlook and Risks

1. Kiribati’s economic performance has been strong, and some moderation is expected in the near term. Real GDP growth averaged 5 percent in 2015–17, compared to the average of 1½ percent in 2009–14. The stronger growth reflects in large part higher public spending financed by record-high fishing revenue, and donor-financed infrastructure investment. Inflation remained subdued, in line with low inflation in trading partners and international food prices. External balances have been stable. Growth is estimated to moderate to 2¼ percent in 2018, as fishing volumes normalize. Inflation is expected to remain around 2 percent this year and increase in the medium term to 2½ percent—a pace consistent with major trading partners. The current account surplus is projected to narrow, as fishing license fees decline and imports related to development spending remain high.

2. The strong fishing revenue improved the fiscal position, but also generated pressure to increase public spending. The government’s net financial worth—calculated as the balances of the sovereign wealth fund (Revenue Equalization Reserve Fund, “RERF”) and cash reserves minus public debt—rose to four times the GDP. For the fifth year in a row, the recurrent fiscal balance registered a surplus in 2017, reaching 3½ percent of GDP—and could have been larger but for the offset to the fishing revenue windfall from current spending overruns.

3. Risks to the outlook are substantial and skewed to the downside. The favorable weather conditions underpinning strong fishing catches have lasted unusually long. A cyclical reversal could threaten revenues, with implications for the fiscal balance and the current account. Tighter global financial conditions could adversely affect the economy through the exposure of the RERF. Given Kiribati's high reliance on imported goods, commodity price shocks and exchange rate volatility could have an outsized impact on imports, inflation, and growth. Kiribati remains at high risk of debt distress, given volatile fishing revenue and considerable spending needs.

Policy Priorities

4. Kiribati should leverage its recent gains to ensure inclusive, sustainable growth in the long run. The authorities have undertaken important reforms including SOEs, tax administration, and soundness of public financial institutions. The government has an ambitious 20-year development agenda—the Kiribati Vision 20 (KV20)—initiated in 2016. Public spending needs—driven primarily by the infrastructure gap and climate change adaptation costs—are large. Implementing KV20 and meeting these needs requires further progress in fiscal and structural reforms, as well as securing support from development partners. Priority areas include: the fiscal framework, private sector development, and governance.

Reinforcing the Fiscal Framework

5. The authorities’ fiscal strategy has prudent features, yet the fiscal position is expected to worsen under current policies. The 2018 budget envisaged a modest recurrent fiscal surplus, notwithstanding a sharp increase in the public wage bill offset by a reduction in other recurrent expenditures. However, fishing revenue has again exceeded projections, and a supplementary budget authorizing additional spending has been issued. In the medium run, both recurrent and capital expenditures are projected to decline from their 2016–18 peaks but remain high by historical standards. With conservative assumptions on fishing revenues and grant rollover, the overall deficit is projected to widen to as net financial worth declines from its 2018 peak.

6. The authorities’ commitment to fiscal discipline could usefully be reinforced by:

• Focusing on the controllable portion of the budget by abstracting from volatile, exogenous components of fishing revenue and grants (plus their associated capital spending) to promote expenditure stability and medium-term planning;
• Limiting the increase in the public wage bill and in copra subsidies, and by replacing them with targeted social transfers where necessary;
• Refraining from issuing a supplementary budget in the event of a surge in fishing revenue, and instead keeping the controllable portion of the budget unchanged and only adjusting insofar as permanent wealth increases, while meeting any revenue shortfall by transfers from the cash reserve buffer;
• Adopting a rules-based, transparent mechanism to govern withdrawals from the RERF, that reflects social preferences on intergenerational redistribution and adjusts to structural changes in returns on assets and potential growth;
• Incorporating the toll climate change will take on Kiribati’s finances through an explicit provision for climate change adaptation in the medium-term budget.

Creating an Environment for a Dynamic Private Sector

7. Specific policies to boost the private sector include:

• Further strengthening the commercial mandate of the SOEs and developing a medium-term plan for operationally and financially sustainable delivery of electricity, water, and sanitation services (including through tariff increases where needed);
• Continuing divestment and outsourcing of SOE activities, to help improve efficiency and strengthen public finances;
• Further improvement in connectivity through infrastructure investment in air transportation and shipping services, and building on the donor-funded investment in ICT infrastructure;
• Building human capital by enhancing training opportunities (including through participation in overseas work schemes) and creating employment possibilities through diversification of the economy into infrastructure maintenance, renewable energy, and tourism;
• Facilitating private sector access to credit by improving land registration and dispute resolution, while strengthening financial supervision and risk management in public financial institutions.

Enhancing Governance

8. The mission supports the initiatives launched recently as part a national anti-corruption strategy. The authorities have been in the forefront of the fight against corruption and Kiribati has been declared as an Anti-Corruption Champion for Pacific Island Countries by the UN.

9. Addressing governance deficiencies in budget outcomes and institutions would help improve efficiency, reduce vulnerabilities to corruption, and catalyze donor support. Against the backdrop of an ambitious public investment agenda, it is crucial to strengthen the fiscal framework so that the most beneficial projects are selected, execution is not disrupted by misaligned incentives, fiscal sustainability is ensured, and the best financing terms are obtained. Public investment should be prioritized based on expected economic and social returns. Consideration should be given to making implementation of the PIMA recommendations a prerequisite for approving a surge in public investment projects.

10. Transparency on fisheries management needs to be improved. The annual report published since 2014 is welcome yet lacks crucial information such as how many fishing days are allocated to Kiribati and how these days are sold to domestic and foreign vessels. Further transparency would both facilitate information sharing with stakeholders and boost public trust in the sound management of the country’s key economic resource.

11. Economic governance would also be enhanced by better business regulations. Regulatory practices associated with getting construction permits and registering property should be streamlined. Trade facilitation efforts should primarily focus on information availability (establishing a national customs website) and formalities (simplification and harmonization of documents as well as automation and streamlining of procedures). The regulatory rulemaking process should be made more transparent and consultative.

The mission thanks the authorities for their warm hospitality, cooperation, and open and constructive discussions.