Mission Concluding Statement 

Staff Visit to Tuvalu, August 28 to September 4, 2013, Concluding Statement of the IMF Mission

September 10, 2013

The mission would like to express its sincere gratitude to the Tuvaluan authorities for their hospitality, and constructive and open discussions.

Tuvalu continues to recover gradually from the effects of the global financial crisis, but the near-term risks are tilted to the downside. Real GDP growth is projected to pick up to just above 1 percent in 2013, and inflation is currently low but could rise to 2¾ percent by this year end due to the recent Australian dollar depreciation and rising oil prices. Remittances remain weak, while a transfer (AU$2-5 million) from the Tuvalu Trust Fund (TTF) is likely at end-2013 or early 2014. Looking ahead, a weakening Australian economy, driven by a slowdown in China, could result in further weak demand for Tuvaluan seafarer and seasonal employment abroad, reducing remittances, and might adversely affect transfers from TTF that invests heavily in Australian assets. Financial risks associated with the SOE and banking sectors remain elevated

The authorities deserve credit for the renewed commitment to reform as illustrated by the newly designed Reform Roadmap and planned launch of phase III of the Policy Reform Matrix (PRM). To be fully effective, the Reform Roadmap and the PRM need to be mutually complementary, with achieving fiscal sustainability at the core of economic policies.

Fiscal policy and public finance management (PFM)

The authorities’ commitment to fiscal consolidation is commendable, but stronger efforts are needed. Fiscal expenditures are being reined in, with a focus on the reform of the medical scheme and scholarship program. An ongoing tax audit of SOEs has identified substantial amounts of tax arrears of AU$1 million (16 percent of tax revenue). On PFM, staff welcomes the steps undertaken to strengthen budget monitoring and introduce a more stringent spending approval process. However, the depletion of fiscal buffers, i.e. the Consolidated Investment Fund (CIF), envisaged over the medium term need to be reversed to ensure fiscal sustainability:

• Sufficient fiscal buffers are needed to withstand temporary revenue shortfalls. Considering historical volatility, the CIF should be kept above AU$5½ million.
• Revenue collection should be enhanced on the back of a functioning legal framework. The current administration suffers from pervasive non-compliance, notably among SOEs. The authorities are encouraged to strengthen the legal framework and follow up non-compliance with penalties, including legal actions. Additionally, staff endorses the proposal to restructure the National Fisheries Corporation and to devote staff specifically on fishery revenue.
• Subsidies should be scaled down. Subsidies, including community service obligations (CSO), are budgeted to grow by 69 percent in 2013, which is clearly excessive. Staff suggests the authorities terminate unnecessary transfers and refocus CSO to protect the poor via well-targeted social programs. CSOs to SOEs should be phased out gradually.
• Staff supports the authorities’ initiative to optimize medical resources. Spending under the Tuvalu Medical Treatment Scheme, which finances patients treated abroad, exceeded the budget by more than 40 percent in 2012. Staff supports proposals to re-establish a medical referral committee with transparent criteria for overseas medical treatment, as the need to embed this in legislation. To complement such reforms, secondary treatment in Tuvalu should be enhanced with adequate funding.
• Staff supports the authorities’ emphasis on building up human capacity through education, but suggests further improving the cost effectiveness. It may be appropriate to lengthen bonding requirements associated with the overseas scholarship program so as to retain graduates for longer, and base the budgeting on the number of study positions abroad rather than the number of new approvals to better reflect the cost.

Public debt management should be strengthened to safeguard debt sustainability. Government’s guarantee of SOE loans, at 5½ percent of GDP, could significantly increase public liability in case these loans turn nonperforming. At a minimum, no new government guarantees should be provided, and the existing government guarantees should be gradually phased out. The ceiling on the government’s bank overdraft, currently at AU$2 million, should be formalized and reduced to below 5 percent of previous year’s revenue.

TTF transfers should be smoothed with a focus to reduce macroeconomic pro-cyclicality. Under the current mechanism, a transfer from TTF, which heavily invests in Australian assets, takes place when TTF’s portfolio value exceeds the “maintained value” indexed to Australia’s inflation. Thus, the transfer largely depends on Australia’s economic performance. Since the global financial crisis, there has been no TTF transfer. In this context, smoothing the transfer and reducing its pro-cyclicality would help enhance budget performance and reduce uncertainty. One option could be to set up a saving account under the TTF and determine transfers based on a longer horizon benchmark.

SOE and financial sector reform

The mission recommended the authorities to develop a complete reform strategy for the loss making SOE sector. The Public Enterprise Reform Management Unit should play an active role in pushing forward SOE reforms. Improving accounting and auditing procedures would help sort out SOEs’ financial position, and the priority should be given to cleaning up the balance sheets, i.e. arrears and long-standing debts, and making SOEs relinquished of social responsibilities and operate on a commercial basis, including installing a professional Board. Specifically, for the Tuvalu Electricity Company, the tariff structure, which was designed on the basis of 2007 oil prices, should be reviewed. The initiative to refloat the Tuvalu Corporative Society, which used to deal with retail business but incurred substantial loss given private competition, should be treated cautiously to prevent renewed fiscal and banking sector risks.

Introducing a banking regulatory and supervisory framework is essential to enhancing financial soundness and reducing risks to taxpayers. The financial sector is unregulated, and harbors substantial risks as illustrated by substantial nonperforming loans that weaken banks’ lending capacity. Additionally, the Provident Fund engages in lending collateralized with contributions, creating additional financial risks. Bringing the financial sector under oversight would be crucial to address financial vulnerabilities, and writing off bad loans under appropriate regulation would enhance lending capacity.

Other issues

Statistics and data reporting, particularly national account and balance of payments statistics, are very weak and could impede economic assessment. Staff suggests that the authorities increase statistical staffing and actively seek technical assistance from the Fund and PFTAC, with a priority on banking supervision, national account statistics, and PFM reforms.