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p. 50 of 81 BACK | NEXT I. Developing Asia and the World II. Economic Trends and Prospects in Developing Asia East Asia Southeast Asia South Asia Central Asian Republics The Pacific Cook Islands East Timor Fiji Islands Kiribati Marshall Islands Federated States of Micronesia Nauru Papua New Guinea Samoa Solomon Islands Tonga Tuvalu Vanuatu III. Preferential Trade Agreements in Asia and the Pacific

Asian Development Outlook 2002 : II. Economic Trends and Prospects in Developing Asia

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Solomon Islands

The economy is still suffering from the aftereffects of recent ethnic tension. Weak management of the economy and subdued private sector activity have led to a sharp deterioration in government finances and pose a serious threat to the trade and current account balances. The Government needs to quickly adopt sound and credible socioeconomic policies.

Macroeconomic Assessment

After the Townsville Peace Accord in October 2000, the Solomon Islands had an opportunity to recover from the adverse effects of ethnic unrest. However, poor economic management and delays in starting the reconstruction process kept the economy depressed in 2001. GDP is estimated to have declined by about 5% following a much sharper decline of 14% in 2000. Thus the economy’s output level declined by almost one fifth in two years, along with a larger decline in per capita income. The contraction in 2001 was broad based.

The Peace Accord led to substantial compensation payments. Faced with very tight budget constraints, the Government secured a $25 million concessional loan, $15 million of which were disbursed during 2001, helping maintain consumer spending. Domestic demand was also supported by a government payroll increase of around 30% from the 2001 level. Inflation declined marginally to about 8% in 2001, despite subdued economic activity and a decline in the money supply.

The Government’s fiscal position deteriorated greatly in 2001, resulting in a deficit of about 8% of GDP. This was caused mainly by the rise in the number of government employees, the adverse impact on general revenue collections of a weaker economy, and import duty and tax remissions. By the end of 2001, payments to public servants, transfers to provincial governments for education and health, and payments to utilities were all delayed. Repairs to infrastructure damaged during the ethnic tension could not be started. No employee contributions were made to the Solomon Islands National Provident Fund (NPF) for the year. In addition, the Government defaulted on international debts and domestic debts held by local commercial banks and the NPF.

The Government exceeded the statutory limit on borrowing from the central bank. According to an official report, total government debt reached 115% of GDP in December 2001. Further, most key public enterprises also faced cash-flow problems, which were reflected in the delivery of services.

In line with declining economic activity, broad money supply and credit to the private sector contracted by about 12.5% and 21.5%, respectively, in 2001. However, a large level of excess liquidity built up in the banking system—three times the minimum liquid asset ratio set by the central bank at the end of September—while the demand for loans remained low due to weak business confidence.

Major export-oriented business related to fisheries, copra, cocoa, palm oil, and gold remained closed in 2001. Timber exports increased for the first three quarters of 2001, before stalling after exporters and the Government disagreed over log valuations. These supply disruptions, together with generally weaker world prices, led to a substantial fall in exports during the year (Figure 2.35), which was a major factor behind the decline in GDP. Imports, on the other hand, declined only marginally due to the compensation payments under the Peace Accord, the government payroll, and the import duty and tax concessions. Consequently, the trade deficit widened considerably in 2001. Gross external reserves at end-2001 were sufficient to cover only about one month of imports.

In recent years, the Solomon Islands adopted an exchange rate policy that was relatively inflexible, with some controls on capital movements. In mid-2000, further exchange controls were put in place to prevent capital outflows in the wake of lower deposit rates and concerns about capital flight following the ethnic conflict. By the end of 2001, the central bank decided on a more flexible exchange rate regime.

Policy Developments

A new Government was elected in December 2001, and faces the challenge of rebuilding an economy that is almost devastated. Further, the incomplete collection of weapons and insecure law and order conditions are serious concerns. Compensation has also been a major burden on government finances since last year. One of the first initiatives of the new Government was a decision on the cessation of the duty and tax remissions. However, sustainable fiscal consolidation will require further large cuts to the government payroll, strict controls on other expenditure items, and, possibly, the introduction of new revenue measures. There are indications that the Government will consider measures along these lines in the new budget.

It is important that the infrastructure is quickly restored. Special efforts are needed to restore business in the main export-oriented areas. Such initiatives, along with firm commitments to wide-ranging reforms, are likely to generate a more positive and critically needed response from the global donor community.

The finance sector is under great strain due to increased nonperforming assets. Maintenance of stable and efficient financial intermediation will remain crucial during the reconstruction period for sustainable economic development. The financial position of the NPF is also of particular concern as it has a bearing on financial market instability. It already faces large arrears, mainly from the Government, and almost its entire investment portfolio is held domestically.

Outlook for 2002-2003

The formal sector of the economy faces major challenges due to damaged plant and equipment, financial difficulties, and the high cost of rehabilitation. Insurance will be very difficult to obtain for any future venture, particularly in mining, and this will create an added hurdle to investors seeking to restart closed operations. However, some encouraging recent economic developments should be noted, notably in the recommencement of fresh fish exports and sales of tinned fish.

Any forecast for the medium term is severely constrained by the lack of adequate economic data, as the country’s statistical capacity was greatly damaged during the ethnic conflict. However, based on the assumption of substantial positive measures by the Government, an official report expects the contraction in the economy to halt by the end of 2002. Accordingly, GDP is projected to decline by 5% in 2002 and to stagnate in 2003 before growth begins. These projections are realistically achievable given that the economy’s base is already very low.

Inflation is unlikely to change significantly in the medium term since domestic demand is expected to be restrained along with the fiscal deficit, and the supply position is likely to improve. Officials project the current account deficit to decline further to SI$85 million in 2002 before turning into a surplus of SI$40 million in 2003. The overall balance of payments is expected to show a surplus of SI$70 million and SI$192 million, respectively, in 2002 and 2003. The major risks to these projections stem from the possible continuity of weak fiscal management, and from sagging business confidence because of the security conditions.

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