Catalog

	Table of Contents
p. 51 of 68 BACK | NEXT I. Developing Asia and the World II. Economic Trends and Prospects in Developing Asia East Asia Southeast Asia South Asia Central Asia The Pacific Cook Islands Fiji Islands Kiribati Republic of the Marshall Islands Federated States of Micronesia Nauru Papua New Guinea Samoa Solomon Islands Democratic Republic of Timor-Leste Tonga Tuvalu Vanuatu III. Competitiveness in Developing Asia Statistical Appendix

Asian Development Outlook 2003 : II. Economic Trends and Prospects in Developing Asia

---

Solomon Islands

The country is still suffering from the after-effects of the ethnic tension that erupted in mid-2000. The fiscal situation is desperate, and quality of life has plummeted. Restoring the rule of law and achieving macroeconomic stability are the priorities to be tackled for the economy to recover and grow at a sustained rate.

Macroeconomic Assessment

Economic crisis continued to characterize the economy in 2002. GDP declined for the fourth year in a row, although the contraction of 4.0% was much lower than in 2000 and 2001. The economy has contracted by about 26% since 1998. With annual population growth of around 3%, GDP per capita in US dollar terms fell by about half over this period. The recent economic weakness reflects the damage to infrastructure, government functions, and private sector activity caused by the political crisis and violence associated with the coup in mid-2000. Disruption and economic weakness continued after a truce due to the Government's inability to initiate a rehabilitation and reconstruction program, prudently manage its finances, adopt a credible reform program, or restore law and order. The new Government that came to power, following generally peaceful elections in December 2001, has taken some steps to restore public security and stabilize the macroeconomy, but these have been grossly inadequate. The economy remains highly vulnerable to political developments and associated militant activity, social dissatisfaction, fiscal weakness, and problems of a general lack of confidence. The tax base has collapsed and business sentiment is weak.

Logging remains the main economic activity generating foreign exchange and tax revenue, though at a high cost to the environment. Log production, which contributed around 18% of GDP in 2001, was relatively weak in the first half of 2002 but strengthened in the second half with the harvesting of the Government's Alu plantation in Western Province. In the first 9 months of 2002, log production was 1.6% lower than in the same period in 2001. Cocoa production was around 28% higher than a year earlier, reflecting a rise in export prices and an improvement in the law and order situation in some parts of Guadalcanal. The fish catch was 14.2% higher than in the same period in 2001. Fishing exports have resumed with Solomon Taiyo (the only producer for export markets) operating at about 40% of capacity and supported by tax incentives. The financial difficulties faced by the Commodities Export Marketing Authority and Russell Island Plantation Limited have impacted adversely on copra production, which provides cash income for around 85% of the population. Copra growers experienced packaging, transport, and marketing problems, as well as weak prices, in 2002. Resumption of gold mining and of palm oil production is unlikely for at least 12 and 24 months, respectively. Most other sectors remained depressed.

Inflation was 9.0% in 2002, only slightly higher than in 2001. The modest rise, despite significant currency depreciation, reflects weak domestic demand.

Exports increased by 7.7% in 2002 but were still only about one third of their 1999 level. On the other hand, imports declined by 26.5%, the seventh consecutive annual decline, reflecting the general weakness in the economy. As a result, the trade deficit declined substantially and the overall current account recorded a small surplus of 3.0% of GDP. The overall balance of payments recorded a tiny surplus but gross official reserves remained at a level sufficient to cover only 1.5 months of imports of goods and services. By end-October 2002, the currency had depreciated over 12 months by 29.5% against the US dollar. In real effective terms and for 2002 as a whole, depreciation was about 19%.

The fiscal situation remains the most serious concern to macroeconomic stability (Figure 2.31). The overall deficit for 2002 was around 12.2% of GDP. Government arrears built up substantially, to around 19% of GDP at end-2002. In 2002, the public sector payroll was often up to three pay periods in arrears. Central government debt surged to about 110% of GDP in 2002, with external debt standing at 79% of GDP. The Government has generally been unable to meet its external or domestic debt service commitments for the past 2 years.

Restructured government bonds accounted for 27% of the total assets of the nation's commercial banks in mid-2002. The Government defaulted on its restructuring agreement with government bondholders, who included commercial banks, in 2001 and negotiations for a further agreement broke down in early 2002. Unilateral payments by the Government of interest of 3% resumed only in September 2002. As a result, the banks are faced with the prospect of being unable to recover the book value of the bonds or market interest on them.

The financial sector was under extreme stress in 2002, mainly due to the Government's inability to meet debt service commitments. The central bank had to confront a substantial negative equity position following a write-off of government loans in 2002. The Development Bank of the Solomon Islands also continued to face capitalization problems. However, the situation at the National Provident Fund has improved somewhat with the Government resuming payment of its contributions in May 2002. It too has been significantly affected by the loss of income on restructured government bonds. The foreign partner in the National Bank of the Solomon Islands withdrew in 2002, underlining the seriousness of the country's banking situation.

In September 2002, the weighted average interest rate on commercial bank deposits was 0.6% while the weighted average lending rate on commercial bank loans was 15.6%. This implied an interest rate spread of 15%, and with inflation of around 9%, this represented a very large negative real interest rate. The money supply rose by 5.0%, after a contraction of 13.3% in 2001. The increase occurred toward the end of the year, with shrinkage a feature of the first half of the year. Following a sharp overall reduction in credit in 2001, domestic credit rose in 2002 by about 34.2%, with credit to the Government and private sector growing by 48.2% and 9.3%, respectively. Growth of credit to the private sector, albeit small, provides some sign that economic recovery may be under way.

Policy Developments

The budget for 2002, approved in April, provided for a sharp reduction in the overall fiscal deficit to 3% of GDP, to be achieved by cutting the public wage bill by 30% and only undertaking development spending when that was financed by concessional donor financing. However, public sector employment increased during the year, largely as a result of the recruitment of special constables, higher salaries and allowances for police and high-level officials, and a general lack of progress in achieving payroll reductions. Claims for compensation payments and extraordinary allowances continued to contribute to a compensation and rent-seeking culture in 2002.

Total revenues and grants were only 25.0% of GDP in 2002, compared with 44.4% in 1999, i.e., prior to the crisis. In contrast, total expenditures amounted to 37.2% of GDP, leading to a deficit of 12.2% of GDP for the year. The deficit was the outcome of problems on both sides of the budget. The recurrent budget target for wages and salaries for 2002 was exceeded by 42%. At the same time, external grants were well below their precrisis levels in 2002, although revenue targets of the government for 2002 were largely met through measures such as the revocation of duty and tax remissions, increases in import and excise duties on luxury goods, and improved tax administration. Although the management of government accounts improved, this was not enough to turn the budget around.

The 2003 budget proposed recurrent expenditures of SI$259 million with matching revenues. The budget proposed achieving a large reduction in the government wage and salary bill on the assumption that over 1,000 civil service redundancies would be made with redundancy payments financed by donors. However, in the event, donors appeared reluctant to commit. To improve expenditure management, the budget announced that all capital purchases would be subject to the discipline of the Central Tender Board. It also asserted that unauthorized spending by ministries and officers would not be paid. Compared with a large outstanding debt of above SI$2 billion, the budget proposed a modest effort by providing SI$39 million for debt repayments. The budget also proposed a significant amount for development; this, however, assumed donor support.

The ethnic tension in mid-2000 led to the suspension of a donor-sponsored economic reform program that was providing an important source of external financing. The disruption to civil order and government functions and the lack of agreement over an appropriate reform program meant that this program remained suspended in 2001-2002, adding to the Government's financing problems. In late December 2002, the Minister of Finance resigned. This development is likely to place the fiscal strategy at great risk in 2003.

The absence of corrective government action on the fiscal position can be expected to result in further deterioration in the financial sector, and continuing downward pressure on international reserves and the exchange rate. It will also lead to increasing discontent within the civil service and rising arrears in the business community as well as place further pressure on the financial stability of government entities.

Although progress has been made in improving personal security, there are reports of growing organized crime and continuing militant threats. Restoring the rule of law and achieving macroeconomic stability are the major priorities that need to be addressed if economic recovery is to be seen and sustained. The pursuit of various structural reforms such as tax reform, public enterprise reform, and measures to streamline investment and business regulations, although important over the longer term, is unlikely to yield success until these short-term priorities are effectively tackled.

Outlook for 2003-2004

Lack of data constrains a credible analysis of future trends. A modest economic recovery of 2-3% is forecast for 2003 assuming reasonable progress in achieving fiscal stability. Continued growth of exports of timber, fish, copra, and cocoa are projected to be the mainstay of economic activity in 2003. Inflation is projected to moderate slightly to 8% as the supply position improves. The external current account is forecast to record a small surplus, but this also assumes substantial official transfers. Gross official reserves are forecast to remain at critically low levels. It will require strong political will and a remarkable turnaround in fiscal management to meet the projections made in the 2003 budget. However, central government external and domestic debt is forecast to decline slightly relative to GDP.

After contraction of overall economic activity of some 26% over the past 5 years, the complete loss of gold and palm oil exports, and a reduction in overall exports by about two thirds, it is unlikely that continued significant contraction will occur. However, the risks to growth are clearly on the downside given the precarious fiscal situation and the recent record of the Government, political instability, and the uncertain outcomes for public security. The more likely upshot is that the economy continues to experience a fiscal crisis in 2003 with the flow-on effects tending to offset gains made from growth of exports. Although there is obviously considerable uncertainty about the outlook for 2004, it is likely that the current weakness will continue.

Over the medium and longer term, the authorities will need to secure fiscal surpluses for a long period until arrears have been paid off and debt has reached more sustainable levels. Economic growth is unlikely without significant financial assistance from donors to restore infrastructure and recapitalize the financial sector.

Back Samoa	Next Democratic Republic of Timor-Leste