Public Information Notice No. 01/96

Public Information Notice: IMF Concludes 2001 Article IV Consultation with Kiribati

September 21, 2001

On June 25, 2001, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Kiribati.¹

Background

Real GDP growth slid in 1999-2000, and real per capita income declined. Growth averaged ¼ percent per annum, well below the population growth of 2 percent. This outturn partly stemmed from adverse external shocks (for example, the onset of La Niña, which affected fishing; and a drought and lower world copra prices, both of which hurt the copra sector). Inflation remained subdued in 1999-2000, owing to the weakening of economic activity and the easing of supply problems.

The fiscal position weakened significantly in 1999-2000. Total revenue and grants dropped by 34 percentage points of GDP, owing to a fall in fishing license fees and external grants. Development expenditure declined in line with lower external assistance, but current expenditure rose slightly in both years because of increased support to public enterprises and copra producers, and higher spending on goods and services. The overall budget balance swung from a surplus of 19 percent of GDP in 1998 to a deficit of 7 percent of GDP in 2000. The government financed the deficits by drawing down deposits in the Consolidated, Development, and STABEX Funds.

The external position also deteriorated. The current account deficit (excluding official grants) increased, owing to a larger trade deficit and lower fishing license fees. The trade deficit worsened, due to weaker exports of fish and copra, coupled with increased imports occasioned by major construction projects. The overall surplus halved from $A 33 million in 1998 to $A 17 million in 2000.

Despite the external and fiscal deterioration, official international reserves remain comfortable. Kiribati's reserves, which are mainly held in the Revenue Equalization Reserve Fund (RERF), amounted to $A 677 million at end-2000 (equivalent to seven years of imports or nine times GDP). Notwithstanding the fiscal deterioration, the government contributed $A 5 million to the RERF in 1999 and has made no drawdowns since 1997. Public external debt remained low, and was on highly concessional terms.²

The depreciation of the Australian dollar--Kiribati's legal tender--since mid-1997 has improved external competitiveness. The real effective exchange rate (REER) in 2000 was 13 percent below the average for 1994-97. However, the major items in the balance of payments (fishing license fees, external grants, and investment income) are not sensitive to changes in price competitiveness.

The National Development Strategy for 2001-03, which was considered by the National Assembly in November 2000, focuses on the need to reduce the role of the public sector while encouraging private sector-driven growth. However, progress in implementing reform has been slow. Meanwhile, the government is set to expand its role in the economy through several new ventures, including an expansion of the operations of Air Kiribati and the state-owned fishing company; the setting-up of a copra mill; and the extension of telecom services to the outer islands.

Near-Term Outlook

The near-term outlook is continued slow growth, low inflation, and a deterioration in the fiscal and external positions. Real GDP growth is projected to average 2 percent in
2001-02. The continuation of unfavorable fishing conditions is expected to be offset by increased government spending. With fishing activity projected to remain below the high levels of 1997-98, the current account is projected to worsen. Meanwhile, the budget deficit is expected to increase further, reflecting lower fishing fees and external grants, higher domestically financed development expenditure, and increased support to public enterprises and copra cutters.

Executive Board Assessment

Executive Directors commended Kiribati's record of macroeconomic stability and its success in maintaining a substantial cushion of external reserves to counter shocks and safeguard the welfare of future generations. At the same time, Directors observed that unfavorable external conditions, fiscal slippages, and the lack of structural reforms since the end of 1998 have led to a weakening in the country's external and fiscal positions, which needs to be reversed. They considered that the main policy challenge was to achieve a sustained increase in the growth rate. However, Directors recognized that geographical remoteness and a narrow resource base pose significant challenges in this regard, and that the preservation of social cohesion must be a central concern in policymaking.

Against this backdrop, Directors welcomed the adoption in November 2000 of the National Development Strategy for 2001-03 to encourage private sector activity, human resource development, and economic diversification.

Noting the prospective widening in the fiscal deficit in 2001, Directors regarded fiscal retrenchment as an urgent priority. They noted that fishing license fees and external grants are projected to decline in the medium term. Directors considered that, in order to maintain fiscal balance and preserve external assets, the authorities should curb spending, especially on wages, subsidies--including to copra producers--and lending to state-owned enterprises. They should also redirect outlays to education, health, and environmental protection. On the revenue side, Directors considered that the authorities should broaden the tax base. They welcomed the authorities' ongoing efforts to increase the accountability and transparency of fiscal management.

Directors commended the authorities' prudent management of the Revenue Equalization Reserve Fund (RERF), and urged them to continue to use the resources judiciously to ensure the RERF's long-term viability, and to frame their macroeconomic policies accordingly.

Directors emphasized that public enterprise reform and rationalization of the civil service are key to successful structural reform. Public enterprise reform should include improving management, promoting joint ventures, and privatizing enterprises to the extent possible. Civil service reform would help contain budget spending. They recognized the authorities' concern, however, to avoid undue hardship on personnel released from the public sector, primarily by ensuring the expansion of private sector activity, including through the provision of support for new commercial enterprises.

Noting that foreign direct investment is low, Directors recommended streamlining and making more transparent the relevant procedures, as well as reducing other barriers to investment. They welcomed the passage of new land legislation, which clarified land ownership rules in South Tarawa and promoted secure land transactions. Directors also urged the authorities to explore innovative solutions to ease the restrictions on foreign ownership of land in order to facilitate investment and credit growth. They particularly encouraged the authorities to explore ways to develop tourism and fishing.

Directors noted that they use of the Australian dollar as legal tender has served Kiribati well by providing a framework for macroeconomic discipline, low inflation, and a liberal exchange regime.

Directors noted that surveillance of Kiribati has been hampered by weak data and irregular reporting. They urged the authorities to provide more resources to the National Statistical Office and to supply a set of core data to the Fund on a regular basis.

It is expected that the next Article IV consultation with Kiribati will be held on the 24-month cycle.