Catalog

	Table of Contents
p. 61 of 77 BACK | NEXT Foreword, Acknowledgments, Acronyms and Abbreviations, Definitions 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 Republic of Palau Papua New Guinea Samoa Solomon Islands Democratic Republic of Timor-Leste Tonga Tuvalu Vanuatu III. Promoting competition for long-term development Statistical appendix

Asian Development Outlook 2005 : II. Economic trends and prospects in developing Asia

---

Solomon Islands

Against a background of improving political stability, primary product exports led economic growth of almost 5% in 2004, while inflation fell to single digits, public finances improved further, and financial sector stress declined. However, the short-term outlook is for a growth slowdown followed by an acceleration in 2007.

Macroeconomic assessment of 2004

GDP decelerated slightly to an estimated 4.6% growth in 2004 from 5.3% in 2003. Agriculture, forestry, and fishing (inclusive of subsistence production) was the major source of the expansion, contributing 63% of the aggregate figure. Logging of the natural forests continued (at an unsustainable rate), and fisheries, cocoa, and copra production all grew. The small industry sector was driven by construction, as externally funded infrastructure rehabilitation and development began, while there was no recovery in mining, slow growth in electricity and water, and a modest pickup in manufacturing.

Services contributed 24% of the aggregate growth rate, with the trade subsector in particular responding to increased consumer demand within the context of improved law and order under the ongoing (and largely Australian) Regional Assistance Mission for Solomon Islands. The rise in consumption was fueled by the Government’s payment of arrears to trade creditors and public service employees, and by public servant pay rises. The consequent favorable impact on labor demand was augmented by the ending of a freeze on public service recruitment, but the rapid growth in labor supply, especially in urban areas, and the mismatch between required and available skills remained problematic.

With the population expanding at roughly 3% each year, income per head rose by 1.6% in 2004. However, the average figure conceals considerable inequality of income distribution. According to studies from the early 1990s, urban household incomes were almost four times as high as those in rural areas. More recent research by the Solomon Islands Development Trust (a nongovernment organization) reports the perception of villagers and the urban poor that living standards have not improved since the Regional Assistance Mission arrived in July 2003, though it acknowledges that the restoration of peace is a fundamental achievement. For the 85% of the population living in villages, hardship appears to have increased as cash income generation has been outpaced by rising costs of basic goods and services such as salt, rice, soap, kerosene, school fees, and ship transport.

The fiscal objective of ensuring a recurrent budget balance was achieved in 2004. Domestically sourced revenues rose by 36.2% from the 2003 level to SI$497 million, largely because of better than expected tax compliance, though the granting of goods tax exemptions reduced the potential tax take. Revenues from customs and excise also exceeded original 2004 budget expectations, partly because logging companies accelerated their activities in anticipation of new legislation aimed at reducing the rate of exploitation of natural forests. Strong domestic revenue growth was supplemented by budget support of SI$111.1 million, bringing total revenues to SI$608.1 million. Total recurrent expenditures in 2004 were estimated at SI$559 million, or 1.6 times the 2003 level. Expenditures on goods and services accounted for the bulk of the rise, with spending concentrated as planned in education, health, and law and justice. Debt service expenditures increased almost threefold, while the public service wage bill rose by 14%. In addition to recurrent spending, an estimated SI$300.2 million was available in 2004 for funding development expenditures: 94.3% of this amount was from external cash grants and 5.7% from overseas loans, with a negligible amount funded by the Government. (No details are available on implementation of this development budget.)

The Government continued to address current and future debt obligations in 2004. Total public domestic and external debt was estimated to be about SI$2.1 billion at the end of 2004, down slightly from the level of SI$2.2 billion in late 2003. The public debt consisted of about SI$1.6 billion in “official” public sector debt and SI$0.5 billion in contingent liabilities and guarantees and informal debt obligations (e.g., unpaid superannuation contributions, debts to trade creditors and public enterprises, and payments to the National Provident Fund). The official debt was reduced from the 2003 level as a result of debt servicing, exchange rate stability, and domestic debt restructuring. The Australian Government’s servicing of ADB and World Bank loans ended at midyear and was taken over by the Government. Under the domestic debt restructuring, the three commercial banks and the National Provident Fund agreed to forgive 60% of the Government’s interest arrears on treasury bills and to accept long-term amortizing bonds in their place. These bonds carried much lower annual interest rates and provided for a grace period of 7 years on half of the principal amount, but offered a monthly repayment of interest and principal where none had been forthcoming in recent years. The Government also made a partial payment of trade creditor arrears and unpaid public service pay contributions owed to trade unions, insurance companies, health funds, and the Home Finance Corporation.

Inflation in 2004 was estimated at virtually half its previous year’s level, at 6.5%; the inflation rate for domestically produced food slowed as a result of the supply of fresh fruit and vegetables to the Honiara market continuing to improve, and of the relative stability of the exchange rate, which ensured that low inflation in the major source countries for imports flowed through to the domestic economy. The Solomon Islands dollar depreciated by just 4% against a strengthening Australian dollar in 2004 and by 1% against the Japanese yen, while remaining steady against the US dollar. Broad money supply expanded by 21.2% in 2004, with an increase in net foreign assets more than offsetting a decline in net domestic assets that resulted from a fall in net credit to government (Figure 2.32). Credit to the private sector rose by 8.6%, mainly in telecommunications, distribution, and professional services. The commercial banks’ weighted average interest rate margin edged down from 13.71% to 13.69%, but was still high by regional standards, indicating limited competition in the banking sector.

Strong export growth in the first half of 2004 and a rise in official transfers lifted foreign reserves to US$57.8 million by June, enough to cover 5.6 months of imports of goods and services. This balance-of-payments improvement was maintained in the second half of the year, with foreign reserves reaching US$73.2 million in December, equivalent to about 7 months of import cover.

Macroeconomic policy developments

The 2005 recurrent budget estimates a deficit of SI$80 million to be funded out of cash balances accumulated in 2003-2004. Total revenues are forecast to fall by 3% from the 2004 level to SI$590 million. Budget support from bilateral agencies will drop to 36% of the 2004 amount because of the cessation of Australian budget assistance, and the remaining New Zealand aid (SI$40 million) will be earmarked for education. However, domestically sourced revenues are estimated to rise by 10.7% on the basis that increased revenues from the goods tax, import duties, and ministerial fees and charges will more than offset falls in company and withholding tax and log export duties. Achievement of this outcome assumes nominal economic growth of 10.5% and effective elimination of the tax exemptions that reduced the 2004 revenues from the goods tax. However, such a growth assumption may be optimistic and the removal of tax exemptions requires legislative reform in a situation where legal capacity is stretched.

Total recurrent expenditures are projected to rise by 19.9% from the 2004 level, with the public service wage bill and expenditures on goods and services surging by 31.3% and 21.9%, respectively. These figures reflect the Government’s commitment to continuing its program of rebuilding public administration and service delivery. In particular, it is making a strategic reallocation of resources toward improving service delivery in the health and education sectors; revitalizing the productive sectors; supporting law and justice and good governance; and promoting the country internationally (as a destination primarily for tourism, but also for FDI). The budget also has an increased provision for debt servicing that includes amounts for payment of arrears, but the provision is still insufficient to cover all debt service obligations. The Government has stated its intention to pursue debt negotiations with bilateral lenders and domestic trade creditors in 2005, to further reduce its debt burden. The 2005 development budget estimates a high, probably unrealistic level of project expenditures of SI$585.6 million; over 97% of this spending is funded externally, mostly through grants, and is allocated to the key strategic areas of the National Economic Recovery, Reform and Development Plan, 2003-2006.

The July 2004 restructuring of the Government’s domestic debt reduced stress in the financial sector and increased the capacity of the Central Bank of Solomon Islands (CBSI) to use open-market operations as a policy instrument, though it still had the capacity to use reserve requirements and impose credit limits. The strong foreign reserves position permitted CBSI to remove exchange rate controls on current account transactions; the central bank also continued to address the problems of key nonbank financial institutions under its supervision. In addition, CBSI prepared a report on the financial condition of the National Provident Fund, and took over as provisional manager the bankrupt Development Bank of Solomon Islands, initiating a process of liquidation. Finally, it initiated supervision of the insurance industry. However, while the legal framework for dealing with antimoney laundering was established in 2002, the institutional framework for effective implementation is still to be created, and antiterrorism legislation remains in draft form.

Some progress was made in 2004 in implementing the structural reforms needed to promote both good governance and sustained, broad-based private sector-led economic growth. However, much more of the same is needed since few of the elements for successful private sector-led growth are in place yet: a large residual of uncertainty from the civil tensions of 2000 to mid-2003 remains; public service delivery is generally poor; property rights and the legal system are weak; the financial sector is not functioning effectively; physical infrastructure is underdeveloped; the quality and reliability of water, electricity, and communications services are poor; and the costs of establishing, running, and closing a business are high by regional standards.

The cabinet has committed itself to reform, but this commitment must be translated into effective, innovative actions supported by coordinated donor assistance. In 2004, an Economic Reform Unit was established within the Ministry of Finance, National Reform and Planning, in order to facilitate the design and implementation of economic reforms. The process of simplifying the legislation and procedures governing foreign investment began, but this has to be finalized and implemented. A tax and customs reform strategy has been presented by the Pacific Financial Technical Assistance Center in response to a government request and needs to be acted upon. Improving utilities services requires a medium-term process of public enterprise reform that has barely begun. To round off, the long-delayed new forest legislation needs to be passed and implemented. This will be a litmus test of the Government’s real commitment to good governance in this key sector of the economy.

Some sector-specific signs of a restoration of foreign investor confidence appeared in late 2004, with the signing of a memorandum of understanding between the Government and a Papua New Guinea-based palm oil company on the reconstruction of a palm oil operation on Guadalcanal, and a reported increase in foreign interest in minerals exploration. However, the key Gold Ridge gold mine remained closed, and there was no evidence of a general improvement in foreign investor confidence.

Outlook for 2005-2007 and medium-term trends

In the context of a slowdown in global economic and trade growth, economic activity in 2005-2007 will largely be determined by the balance between two opposing factors. On the one hand, short- and medium-term growth will be reduced to the extent that new and entirely appropriate forest legislation--aimed at reducing logging rates to sustainable levels--is introduced and implemented. On the other hand, private investment and economic growth will be stimulated if the following three conditions are met: gains from improved law and order and public finances are consolidated, structural reforms are designed and implemented promptly, and major economic activities disrupted by the ethnic tensions of 2000-2003 are restarted. With regard to the last point, a major boost to the economy can be expected by 2007 if the rehabilitation of the Guadalcanal palm oil operation proceeds as planned. A start to palm oil production on Malaita could add to this stimulus, as could the revitalization of the Gold Ridge gold mine. Aid-funded physical infrastructure projects are expected to drive the construction sector, while manufacturing production is likely to do no more than nudge up until palm oil processing gets under way in 2007. Modest growth in the services sector will be fueled by the Government’s increased recurrent spending and by external grant-funded development expenditures.

The official budget forecast is for growth of 4.5% in 2005, but this seems either to discount the impact of declining log production or to assume that the new forest legislation will be ineffective. Aggregate growth rates of about 3% for 2005 and 2006 appear more realistic if logging is curtailed substantially, with a possible acceleration toward 6% in 2007 as palm oil production recommences. In the absence of such an acceleration, income growth will barely keep pace with that of the population, and so living standards will stagnate.

With a reduction in bilateral budget support and the need to spend on the essential revitalization of public administration and service delivery, pressure on the recurrent budget will intensify in 2005 if the official growth forecast indeed turns out to be too high or if efforts to reduce tax exemptions fall short (or both). However, this pressure will be met with a government commitment to aggregate fiscal discipline and to the continued implementation of the public debt management strategy, which will lead to a reduction in the ratio of public debt to GDP.

Inflation is projected to moderate slightly to about 5%, on the assumptions that monetary policy will control any inflationary pressures arising from excess liquidity in the banking system, and that the exchange rate will remain relatively stable.

Back Samoa	Next Democratic Republic of Timor-Leste