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p. 54 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

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Tuvalu

GDP growth slowed in 2002, reflecting a significant reduction in government expenditures from the levels of 2001. It was sustained by the finalization of public infrastructure projects and a strong housing market. Major policy issues include adjustment to lower levels of government revenues and spending, and the need for improved budgetary processes and public sector management. The medium-term outlook is for modest growth.

Macroeconomic Assessment

Economic growth decelerated to about 2.0% in 2002, following several years of 3-4% expansion. The slowdown came in the wake of severely reduced government spending. Receiving little stimulus from the state sector, the country's production suffered in many sectors. The construction and retail sectors recorded marginal growth, with the primary sector faring slightly better.

Total government expenditures in 2002 were less than half the original estimate, as a result of lower special development spending, capital expenditures, and transfers. Special development spending was only A$3.8 million, against an original estimate of about A$11 million. The wage bill was some 8% lower than the original estimate. Maintenance expenditures were also only about half the original estimate, while spending on goods and services was also significantly reduced. The policy of increasing rents for government housing to close to their true economic value, introduced in February 2002, contributed to the restraining of economic activity.

This contraction of government expenditures can be understood in the context of the country's experience. In 2000, Tuvalu benefited from a huge windfall revenue from a leasing arrangement with the manager of Tuvalu's Internet domain address (".tv"). The windfall supported a dramatic rise in government spending that year, while still generating a large budget surplus (equal to 32.2% of GDP). Big spending continued in 2001 but the expected further windfall gain for that year did not materialize, giving rise to the country's first overall deficit (equal to 42.8% of GDP). In 2002, a substantial one-off boost to revenues came as a result of the sale of DotTV Corporation for A$20 million, but spending was curtailed in an effort to prevent a replication of the deficit of the preceding year. The combination of expanded revenues and a significant reduction in overall government expenditures led to a very large budget surplus of around 85% of GDP (Figure 2.34). Unfortunately, it also slowed economic growth.

Inflation rose slightly to 2.6%, largely reflecting developments in trading partner countries. Foreign trade statistics for Tuvalu are unavailable. It is a fact, however, that the country's nonmerchandise account is dominated by seafarers' remittances, estimated at about 20% of GDP a year. Another source of income is the Tuvalu Trust Fund (TTF). With the recent weakness in world equity markets, the market value of the TTF on 30 September 2002 was 10% less than the maintained value. Consequently, there was no distribution of earnings in 2002 and none is expected in 2003. In addition, the balance on the Consolidated Investment Fund (CIF) a buffer account that takes government surpluses and is normally used to finance deficits was half the minimum target balance.

The financial sector is dominated by the government-owned National Bank of Tuvalu, which continued to be highly profitable, reflecting its monopoly position. Real interest rates for deposits were slightly negative in 2001 and near zero in 2002. The spread between deposit and lending rates was maintained at around 8%, comparable to spreads in other small Pacific island economies.

The Australian dollar continues to serve as the domestic currency, so that fiscal policy effectively constitutes macroeconomic policy as a whole. Although it has been adversely affected by the impact of the downturn in world equity markets on the TTF investments, the Government's fiscal position has been boosted by the DotTV revenues and provides funds sufficient to cover some 5 years of imports.

A new Government came to power in mid-2002 and presented its first budget in November. This Government will continue to focus on human resources development, economic infrastructure, financial management, public sector reform, and private sector development. In addition, it allocated further funding to the Falekaupule Trust Fund to match extra contributions made by some outer islands.

Policy Developments

One of the main development issues is the devolution of administrative responsibilities to communities on the outer islands and the improvement of infrastructure and services for them. Toward these ends, the Falekaupule Trust Fund was established in June 1999 as a key component of an Island Development Program with around A$16 million provided by the Government, an ADB loan, and the island communities themselves. The Fund's first distribution was made in June 2001 to finance development projects and maintain community assets. A policy of devolution and infrastructure development for the outer islands has been promoted since then.

Until recently, the country had a reputation for disciplined fiscal policy. A distinction is made between core and noncore revenues and expenditures. Surpluses in excess of the CIF buffer have been placed in the TTF, providing a sustainable fund to finance core expenditures. However, strong receipts from fishing license fees for several consecutive years and windfall revenues from the DotTV agreements in 2000 and 2001 raised public expectations for increased government spending. This led to a flouting of the ceiling on core expenditures for 3 years in a row and the creation of accountability and management problems associated with the budget, including improper use of advances.

The budget is formulated in a single-year framework which, together with the core/noncore distinction, leads to a number of adverse economic efficiency effects. The identification of expenditures as "core" creates a sense that they are essential. This has the effect of "protecting" most recurrent spending, which is classified as core. In addition, there is no integration between special development expenditures, extrabudgetary expenditures, and recurrent costs. In the 2002 budget, around 40% of special development expenditures were of a recurrent nature that could not be stopped without reducing government services.

A 3-year rolling public sector investment program is presented with the annual budget but it has no clear integration with the budget and has no policy strategy to guide its implementation. Recognizing this weakness, the Government intends to hold a national summit this year as part of the preparation for a medium-term economic development strategy.

Budget reform has been an important component of the public sector reform program since the mid-1990s. Performance-oriented "output" budgeting was introduced in 2000 and since then has guided budget preparation. However, reports consistent with effective output budgeting are yet to be prepared. There have also been long delays in complying with legislated reporting requirements. Audited government financial statements for 1997-1999 were prepared by a private auditing firm on behalf of the Auditor General and only submitted to Parliament in November 2002.

The 2003 budget announced that a new multiyear budget framework and improvements in the budget process will be introduced. However, consideration needs to be given to developing a more meaningful, usable, and effective performance-oriented framework and to ensuring that the framework matches institutional capacity. The 2003 budget has been formulated in recognition that there will be no windfall revenues and no distribution from the TTF in 2003.

The main civil service capacity issues are how to strengthen local capacity on the outer islands within existing budget constraints and to improve the capacity to develop and provide policy advice to the Ministry of Finance and Economic Planning and to the Cabinet. The civil service has been subject to considerable disruption in recent years with several changes of government and increased use of in-service scholarships. Poor record keeping is also a long-standing weakness in public administration. Various recommendations to improve accountability in the civil service and for public enterprises were endorsed by the Cabinet in 1999. However, apart from the drafting of a new Audit Act there has been very limited follow-up action.

Like budget reform, public enterprise reform has been under way since the mid-1990s. However, there is still a need to develop an effective governance framework to help improve financial accountability and operational performance. There have been clear failures to comply with legislation that requires timely annual reports and financial accounts. The 2003 budget announced that no operating subsidies will be paid to SOEs until they have signed operating agreements with the Government, and technical assistance will be sought to develop improved governance arrangements.

Tax and tariff reforms are issues for Tuvalu as it is a signatory to PICTA. Under this, all tariffs have to be gradually removed by 2016. The impact on revenues would also be intensified once tariffs on products from Australia and New Zealand are reduced under the framework Pacific Agreement on Closer Economic Relations. Import duties are currently around 14% of total non-grant, non-windfall revenues, so that the eventual removal of tariffs will create a need for new revenue sources. It should, though, not be too difficult to extend the existing sales tax and make use of selective excises on luxury products to replace import duties.

Outlook for 2003-2004

Growth in 2003 is projected to remain at about 2%, with inflation increasing to 3.0%. Revenues will be significantly lower in the medium term but expenditures will be higher. Restraint will be focused on capital and special development expenditures. An overall deficit of 6.5% of GDP is projected and will be financed from the CIF. The budget assumes a significant increase in grants and fishing license fees. However, with the CIF balance at half its recommended minimum target in late 2002 and a further drawdown anticipated in 2003, and the prospect of zero distribution from the TTF in 2003 and 2004, the Government's cash position will need careful management if it is to help ensure macroeconomic stability. The economy will continue to receive strong support from seafarers' remittances.

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