Nauru: Staff Concluding Statement of the 2023 Article IV Mission
IMF News, September 15, 2023
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- Published: September 15, 2023
Economic context, outlook, and risks
- Key recent outcomes
- Real GDP growth: 2.8 percent in fiscal year (FY) 2022 driven by strong phosphate production and sizable fiscal support to households and State-Owned Enterprises (SOEs).
- Real GDP growth estimated at 0.6 percent in FY2023 as the Regional Processing Center (RPC) continued to scale down, leading to weaker demand and service-related trade.
- Average inflation: 3.6 percent in FY2022, driven by higher international food and fuel prices.
- Inflation increased to 6.3 percent in FY2023 due to persistent inflation in trading partners and reduction of transportation subsidies.
- Current account balance (CAB): -0.5 percent of GDP in FY2022, with rising imports driven by high transportation costs.
- Reserve coverage: 3.5 months of imports in FY2022, above the reserve adequacy ratio of 2.8 months, but expected to decline over the medium term.
- Projections and medium-term outlook
- Growth projected at 1.4 percent in FY2024 as increased wholesale and retail trade financed by RPC revenues offsets lower transportation growth from delays in port completion.
- Inflation expected to slow to 5.3 percent in FY2024, consistent with lower global inflation and tighter monetary policy in Australia.
- CAB expected to temporarily improve in FY2024 due to RPC inflows before worsening over the medium term as RPC revenues decline.
- The planned scale-down of the RPC over the next few years is expected to adversely affect economic activity and fiscal revenue; diversification from a climate resilient port and a fiber-optic cable construction are expected to partly offset.
- Risks to the outlook (tilted to the downside)
- Uncertainties related to RPC activities.
- Continued pressure on financial services that could disrupt payment systems.
- Delayed fiscal and structural reforms increasing dependence on volatile revenues.
- Deepening geo-economic fragmentation and an abrupt global slowdown affecting trading partners and donors.
- Higher commodity prices raising inflation and fiscal spending.
- Vulnerability to extreme climate events similar to other pacific island countries (PICs).
- Upside risks include an unexpected extension of RPC activities and increased demand for fishing licenses.
Fiscal policy
- Current fiscal position and outlook
- Fiscal surplus excluding government’s contribution to the Nauru Trust Fund (NTF): 8.3 percent of GDP in FY2023.
- Fiscal surplus excluding contributions to the NTF projected to moderate to 6 percent of GDP in FY2024 as higher RPC revenues offset declining tax revenues.
- Debt estimated at 20.2 percent of GDP in FY2023; assessed to be sustainable under current policies.
- Nauru Trust Fund (NTF) target: AUD 700 million by 2033; maintaining sufficient fiscal surplus to finance government contributions will be key.
- Staff recommendations on revenue mobilization
- Short-term: (i) remove discretionary exemptions in import duties and ultimately replace import duties with excise duties; (ii) improve the progressivity of the personal income tax and reduce exemptions in the corporate income tax.
- Medium-term: implement revenue administration measures such as revenue risk management, audits, and regular review of excise rates.
- Long-term: consider introducing a value added tax.
- Expenditure priorities and public financial management (PFM)
- Prioritize spending that promotes growth, resilience, and inclusion; improve efficiency of current spending through enhanced PFM.
- Formalize fiscal responsibility ratios in a rules-based framework; improve health and education spending efficiency; implement more targeted and progressive subsidies.
- Review SOE subsidies and grants to increase efficiency; adopt digital technologies to expand remote access to education and healthcare.
- Implement key recommendations from the 2022 Public Expenditure and Financial Accountability Assessment, including: (i) a single supplementary budget linked to a mid-year review; (ii) enhancing budget submission quality and frequency of publishing budget information; (iii) enhancing public asset management; (iv) improving internal and external audit.
- Continue engaging PFTAC in technical assistance on revenue mobilization and PFM.
Financial sector policies
- AML/CFT and regulatory progress
- Beneficial Ownership Act passed in 2017.
- New Anti‑Money Laundering and Targeted Financial Sanctions Act passed in June 2023 with APG support.
- APG mutual evaluation ongoing: on-site visit scheduled for October 2023; adoption of the report scheduled for July 2024.
- The newly passed AML law is expected to improve mutual evaluation outcomes; a positive outcome would be beneficial as the report will be published online by APG and FATF after adoption.
- Staff support and recommendations
- Continue improving the AML/CFT framework, including implementing recommended actions expected from the mutual evaluation.
- Support provision of financial sector services by regional financial institutions effectively regulated and supervised by their home jurisdiction, backed by strong bilateral cooperation between Nauruan authorities and overseas counterparts.
- Address infrastructure gaps constraining digital payments, for example through the planned undersea fiber-optic cable project.
- Specific legal provisions
- Nauru’s Anti-Money Laundering and Targeted Financial Sanctions Act 2023 includes provisions enabling certain exemptions from Nauru’s AML/CFT framework for financial institutions adequately regulated and supervised in another country, or where there is low risk of financial crime; cooperation continues between AUSTRAC and the Nauru Financial Intelligence Unit (NFIU).
Structural reforms
- Human capital and social outcomes
- Around 35 percent of the population is of school age; 55 percent of the population is under 25.
- School enrollment rate and teacher-to-student ratio are lower than the world average; attendance rates in primary and secondary schools are low.
- Recommendation: prioritize education spending to improve enrollment and attendance rates and increase the teacher-to-student ratio.
- Climate adaptation, mitigation, and infrastructure
- Progress: construction of a climate resilient port and solar farms; Nauru is reviewing and updating its National Adaptation Plan including sectoral detail.
- Recommendation: prepare detailed costing of priority projects and integrate costing into the budget and medium-term framework, including provisions to support the new climate change unit.
- Economic diversification and connectivity
- Completion of the new port and related infrastructure could create new growth and employment opportunities, support domestic containerization, potential fish processing, and act as a regional transportation hub.
- Investments in refrigerated storage facilities could support containerization and eventual fish processing and generate additional government revenues.
- Increased participation in regional labor mobility schemes could increase remittances to partially offset RPC employment losses.
- Universal digital connectivity could improve labor force participation, access to education and healthcare, strengthen social protection, and support long-term growth potential.
- A legal and regulatory framework that improves access to land will be needed over time to attract private sector investment.
- Governance and anti-corruption
- Recent PFM improvements: clearer fiscal strategy, better debt management, improved timeliness of in-year budget reports, increased transparency of budget information, and better internal controls for non-salary expenditures.
- Recommendation: continue strengthening fiscal governance (PFM controls) and the rule of law (investor protection and contracts) to improve resource management efficiency, reduce vulnerabilities to corruption, and support growth.
Closing and IMF engagement
- Staff assessment highlights
- Nauru’s external position was moderately weaker than implied by fundamentals and desirable policies in FY2022.
- Debt vulnerability reduced by resolution of external debt to Firebird in 2021 and sustained past fiscal surpluses, but reliance on volatile non-tax revenues and donor grants remains a vulnerability.
- IMF support
- The IMF stands ready to support the authorities to implement reforms through policy advice and continued capacity development engagement.
- Acknowledgement
- Staff thanks the authorities for their hospitality and collaboration.
Staff Concluding Statement of the 2023 Article IV Mission, September 15, 2023