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Asian Development Outlook 2001 : II. Economic Trends and Prospects in Developing Asia

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Vanuatu

The economy recovered in 2000 with 2.8 percent growth in real GDP, led by tourism and construction. Growth is likely to continue at about this level in the medium term. However, fiscal discipline and implementation of reforms remain critical for the economy’s future prospects.

Recent Trends and Prospects

Following a contraction of 3.0 percent in 1999, the economy recovered in 2000 with estimated growth of 2.8 percent, led by tourism and construction. Sustained marketing campaigns in Australia by the National Tourism Office and political instability in neighboring countries boosted the number of visitors to Vanuatu. Major construction projects included the Efate ring road, the expansion of the main airports on Efate and Santo, rehabilitation works from cyclone Dani, and an urban infrastructure project. The agriculture sector continued to experience weakness.

Copra and beef exports weakened but kava exports strengthened significantly in 2000; imports stayed at around the previous year’s level. Despite a trade deficit, a small surplus on the current account is estimated in 2000, compared with a deficit in 1999. However, a sizable deficit of at least 4 percent of GDP is estimated on the capital account in 2000, largely due to outflows from commercial banks. At the end of 2000, foreign reserves were estimated at 5.4 months of import cover, compared with 5.9 months at the end of 1999.

The budgeted deficit in 2000 was 3 percent of GDP, but as a result of the rollover of development projects from 1999’s budget, it reached around 8 percent. Controls on recurrent expenditure were very tight during the year and helped contain further expenditure growth. Total tax revenue for 2000 was only slightly below the levels forecast in the budget, though value-added tax collection was in line with forecasts.

External debt service amounted to only 1.3 percent of exports of goods and services and 5.7 percent of domestic revenue in 2000. At the end of the third quarter of 2000, domestic credit and net foreign assets were at similar levels to those at the end of 1999. The most noticeable monetary development in 2000 was a decline in private sector credit of 8 percent by the end of the third quarter and a substantial rise in net credit to the Government. At the end of the third quarter, domestic borrowing to finance the deficit was much larger than expected, mainly reflecting delays in concessionary financing and a buildup of government commitments to aid projects.

The main monetary initiative in 2000 was the reintroduction of foreign exchange guidelines on 23 February 2000, when foreign reserves fell to less than five months of import cover. In anticipation both of modest growth and stable inflation, and an acceptable level of official reserves, the Reserve Bank indicated in its October 2000 monetary policy statement that there was no immediate requirement to adjust the monetary policy stance.

The vatu is pegged to a basket of major trading partner currencies. During the first nine months of 2000, it appreciated by 7.4 percent against the Australian dollar and by 4.6 percent against the euro, but depreciated by about 10 percent against the US dollar and by about 4 percent against the yen. This may have impacted adversely on the competitiveness of exports, especially to Europe. Inflation has remained moderate in recent years; interest rate spreads widened to an average of 9.7 percent for the first three quarters of 2000. Given the dependence of Vanuatu on imports from Australia and the exchange rate arrangements between the vatu and the Australian dollar, price movements in Vanuatu are closely aligned to those in Australia.

The economy is projected to grow at modest rates of 3–3.5 percent a year in 2001 and 2002, helped mainly by a recovery in agriculture and continued success of tourism. Over this period, the trade account is forecast to improve as exports recover. The current account is projected to record a modest deficit in 2001 followed by a small surplus in 2002. Private capital outflows are expected to be considerably lower in these two years, and anticipated aid transfers should help rebuild reserves. The overall budget deficit is targeted to be no more than 2 percent of GDP over the next two or three years, with annual surpluses in the recurrent budget and external concessionary funds financing the overall deficit.

For the 2001 budget, the Government proposes several new revenue initiatives, along with a higher revenue projection. In 2001, expenditure is projected to decline as a proportion of GDP, and a modest budget deficit of 1 percent of GDP is forecast. Debt-service costs are projected to rise to 6.5 percent by 2002 as repayments of recently acquired external debt begin. Provided the vatu remains stable, inflation is expected to be around 2 percent in 2001 and 2002.

Issues in Economic Management

Policy initiatives in the 2001 budget focused on three objectives: stable government, private sector development, and social equity and sustainability. Relevant measures include balancing the recurrent budget; implementing the next phase of the Government’s Comprehensive Reform Program (CRP), which emphasizes outer island development; and establishing impact monitoring systems for these reforms. Effective implementation of reforms remains critical to maintaining the forecast rate of growth.

The interest rate structure in Vanuatu is characterized by very wide spreads between average lending and deposit rates (see Figure 2.29). Interest rate spreads widened from an average of 8.3 percent in 1996 to 10.4 percent in the third quarter of 2000, to give an average of 9.7 percent in the first three quarters of 2000. Furthermore, certain lending practices greatly widen the effective spread. For example, borrowers are commonly required to borrow twice as much as they need and put half their loan on deposit. The high margins and practices like these reflect weak competition in the banking sector and lack of access to overseas funds (because of recent capital controls).

Policy and Development Issues

The CRP was first formulated and implemented in 1998, and is subject to a process of continual reformulation. It is supported by a loan from the Asian Development Bank and focuses on promoting economic growth through a strategy oriented on the private sector. This strategy entails comprehensive governance reforms, various nondistortionary measures to improve the economic environment for private sector activity, and a range of social and other reforms to improve economic and social conditions at the village level. Both public expenditure management and the utilization of external assistance are expected to improve as a result of the CRP. The Government now needs to integrate it into the budget process and the macroeconomic framework.

Regional and outer island development has been a long-standing and challenging objective for governments in Vanuatu. Outside the major towns of Port Vila and Luganville, infrastructure is poor and government services rarely available. The proposed Outer Island Infrastructure Development Program, an important component of the CRP, is designed to tackle these weaknesses. The Program is near the implementation stage and 14 projects have been identified on road, marine, storage, and airstrip infrastructure. Four of these projects are already being funded. Important features of the Program are (i) the emphasis on components to ensure sustainability and (ii) the integration with planning initiatives in the regions and outer islands to ensure support there.

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