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Countries and Regions Country Partnership Strategies Document
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Country Strategy and Program Update 2005-2006: Solomon Islands
II. Current Development Trends and IssuesA. Recent Political and Social Developments2. Solomon Islands is emerging from several years of ethnic tension that resulted in the overthrow of the elected government in June 2000 and a subsequent armed conflict. The political and security situation has improved significantly since the arrival in July 2003 of the Regional Assistance Mission to Solomon Islands (RAMSI), which enjoys strong public support. However, the process of building sustainable peace and security and resuscitating the economy will take time and depend on continued Government efforts, supported by RAMSI and the aid community. Rehabilitation will also depend on progress in tackling important governance issues, public sector reforms, and economic reforms, including state-owned enterprise (SOE) reform. 3. Solomon Islands is one of the least developed among ADB's Pacific developing member countries (PDMCs). Measured by the most recent United Nations Human Development Index (HDI) and Human Poverty Index (HPI), Solomon Islands ranks below all but one PDMC. The country is unlikely to meet the Millennium Development Goals (MDGs) by 2015. Poverty has worsened with the near-collapse of the economy, primary school enrollments are very low, gender disparities remain high, and environmental indicators are generally poor. Progress on infant and child health indicators has been slight but maternal health indicators have worsened. 4. Although data are insufficient to update either the HDI or the MDG indicators, social conditions have almost certainly worsened over the period of ethnic tension and conflict, and disparities between Honiara and the provinces are wide. Successive governments have not succeeded in providing adequate social infrastructure and services, especially in rural areas; nor in facilitating income-generating opportunities. Job opportunities are in short supply, with little formal employment outside Honiara. The situation is exacerbated by conflict, displacement, law and order problems, an ongoing financial crisis and a contracting economy, rising unemployment, and high population growth. Funding for essential social services has substantially diminished and the Government is often unable to pay teachers, health workers, and public servants, causing a standstill in the provision of social services. The population growth rate of 2.8% is among the highest in the world, which combined with slow economic growth exacerbates poverty and greatly increases the challenge of meeting development goals. 5. Heavily supported by external assistance, the Government is now seeking to redress these significant problems. Reliable access to domestic and international markets for rural produce will be a key strategy to restart rural economies, reduce the demand for migration to the capital in search of employment, reduce conflict between groups competing for limited opportunities, and address the challenge of restoring basic social services in rural areas. B. Economic Assessment and Outlook1. Recent Performance and Outlook 6. After 4 years of contraction, real GDP increased (from a very low base) by an estimated 3.8% in 2003 and 5.8% in 2004, and is forecast to grow by 4-5% in 2005 in expectation of continued law and order, further progress in public financial management, and a gradual return of investor confidence. Forestry (which has reached an unsustainable level), fisheries, cocoa and copra production are all growing rapidly and will be the main drivers of growth. Gold mining and oil palm operations remain suspended, and are not expected to resume exports in the near term, given the uncertainty over the long-term policy environment in these sectors. Growth prospects would improve considerably if constraints were eased in the areas of secure land tenure, employers' rights to employ labor of their choice, and interisland transport. 7. Several years of fiscal mismanagement were turned around with the arrival in August 2003 of the RAMSI budget stabilization team, which imposed tight expenditure control, initiated a payroll audit, increased revenue growth, improved tax compliance, and formulated a medium-term debt management strategy. The 2004 budget now provides for a balanced cash position. Budget support from Australia and New Zealand represents a major fiscal stimulus at almost one-quarter of total revenue, and permits total recurrent expenditure to rise by 41.5% from the 2003 level. The 2004 development budget is huge in the context of recent fiscal history, almost matching the planned level of recurrent expenditure (SI$480 million). Public expenditure has been reallocated to the key service areas of health and education, financial administration, provincial affairs, and law and justice. Care will be needed to ensure that external supplements support a transition to fiscal sustainability and do not create dependence on aid agencies for recurrent and development funding. 8. The current and capital accounts have been in surplus as a result of a rise in official inflows, so foreign reserves (exclusive of external debt arrears) continue to improve. Inflation fell from 15.4% in 2002 to 10% in 2003, and is projected to be in the 4-6% range in 2004-2005. Imports will increase as economic growth accelerates, but export growth and increased official transfers are expected to more than offset them, possibly allowing some easing of foreign exchange rationing as foreign reserves are rebuilt. The Solomon Islands dollar was stable against the United States dollar in 2003, but depreciated 18.4% against the Australian dollar, the currency of the country supplying about 56% of Solomon Islands' imports. 9. Reducing the public debt burden will be a long and arduous task. The Government's total debt is around SI$2.2 billion or about 139% of GDP. An external debt of SI$1.211 billion accounts for 72% of the formal debt, with 30% owed to ADB. However, the allocation of 22% of total revenue to debt servicing is insufficient to fully service all debts and the budget makes no allocation for the payment of past arrears. A comprehensive government financial restructuring initiative that is under way involves negotiations over debt forgiveness, debt rescheduling, and lower interest rates. Given the unsustainability of the debt situation, the Government has decided not to consider additional external loans in the short to medium term. 2. Policy and Governance Developments 10. National Economic Recovery, Reform, and Development Plan 2003-2006. NERRDP was finalized in November 2003 through a consultative process and represents an important attempt to introduce order to policy, planning, and public expenditure. It sets out a program in five strategic areas: (i) normalizing law and order and security; (ii) strengthening democracy, human rights and good governance; (iii) restoring fiscal stability and reforming the public sector; (iv) revitalizing the productive sector and rebuilding supporting infrastructure; and (v) restoring basic social services and fostering social development. NERRDP is ambitious in scope and will be difficult to implement fully within its medium-term timeframe. A key test of effectiveness will be the extent to which it drives the annual externally funded development budget. The Government is yet to prepare an action plan for its implementation. 11. Governance. During consultations for the formulation of NERRDP, respondents frequently expressed concern over corruption, misuse of public funds, discretionary tax and duty exemptions, non-adherence to existing rules and procedures, and political appointments to the civil service. Corruption is widely acknowledged to be pervasive and ingrained. Its removal will require top-level political commitment and a long-term process of strengthening key governance institutions, reforming the public service, and educating the public. Freedom of the media is guaranteed by the Solomon Islands constitution, and has generally been exercised. However, a recent review of the Ombudsman's Office, the Leadership Code Commission, and the Auditor General's Office concluded that those offices were under resourced and ineffective. Governance institutions will receive increased funding in 2004 to improve accountability throughout the government, but institutional strengthening is also required. 12. A new constitution and federal system of government is being considered for introduction in 2004. The desire for decentralization appears to be a response to the perceptions that the national Government has failed in effectively fulfilling its core functions, and that resources have not been equitably shared by the capital and the rest of the country. However, the benefits, costs, and implementation challenges of decentralization need to be assessed carefully. The country faces major challenges in restoring public administration due to limited managerial capacity and substantial differences in the capacity of the nine provinces to take on new state government functions of policy development, planning, financial and operational management, regulation, and supervision under a federal system. The creation of state governments may simply increase the financial burden of government without improving in public service delivery and accountability. 13. Public Sector Reform and Capacity Building. The public sector has not delivered adequate services because both national and sub-national levels have failed to effectively fulfill the core government functions of revenue administration, public expenditure management, public administration, and regulation of SOEs. Improving the performance of central and provincial administrations and public utilities will be fundamental to higher living standards, especially in rural areas. A key issue for the durable rebuilding of public finances is the size of the public service, which claims 52% of estimated domestic revenue in 2004. Considerable reform and capacity building are needed for national and provincial governments to fulfill their functions effectively. These efforts should not be confined to human resource development, but should include development of systems for effective planning and management, including action plans, coordination mechanisms, and rational links to the recurrent and development budgets. To restore administrative capacity, public service reform must be planned carefully, and not be a simple downsizing exercise. While in some cases it might be appropriate to create new functions, in other areas outsourcing may be the best solution. Funding is needed to implement a redundancy and retirement program, combined with more comprehensive reforms. 14. Economic Reforms. NERRDP acknowledges that the private sector environment must be enhanced by improving the institutional infrastructure and revising outdated and incomplete legal and regulatory frameworks. To ensure sustainable peace and ethnic harmony, it will also be crucial to address the inequitable distribution of resources, create opportunities for income generation, and provide basic infrastructure and services. Adequate solutions to the fundamental issue of customary land ownership should be driven by the Government, but may require external resources in support. An Economic Reform Unit (ERU) will be established in the Ministry of Finance, National Reform, and Planning (MFNRP) to oversee, coordinate, and implement private sector regulatory reforms; infrastructure service provision policy and regulation; SOE reform; financial sector reforms; provincial economic development; statistical collection service reforms; and specific sectoral policy reforms to promote new investments in potential growth areas. ADB will actively support ERU operations in cooperation with other external sources, especially in the areas of infrastructure policy and regulation, legal and regulatory business environment, and SOE reforms. 15. State-Owned Enterprises. Solomon Islands has 17 SOEs covering statutory authorities; air transport services; telecommunications; resource-based enterprises in forestry, fishing, and agricultural production; and service providers in ship repair, printing, tourism promotion, and export marketing. While these SOEs have provided much-needed services, they have also created numerous problems for the economy, because of (i) crowding out of the private sector, (ii) higher cost of inputs to private enterprises, (iii) inconsistent and unreliable service delivery and quality, (iv) ineffective politically appointed boards, and (v) inappropriate mixing of regulatory and commercial functions causing mismanagement and poor governance. Reform of the SOEs will need to consider various options for improving performance, including better management, corporatization, and privatization within an appropriate regulatory framework. The privatization process envisaged under the 1998 Public Sector Reform needs to be revived; however, care needs to be taken that privatization does not lead to a simple replacement of public sector monopolies with unregulated private sector monopolies. C. Implications for the Country Strategy and Program16. At the request of the Government, ADB will not give new loans to Solomon Islands until public finances stabilize. Progress will be assessed based on the Government's ability to service all existing obligations and on the stability of the recurrent budget. 17. Reflecting a post-crisis focus, external funds are heavily weighted toward law and order, peace building, and restoration of basic social and administrative services. Transport, energy, and communications infrastructure receive less than 10% of external funding in the development budget, yet are essential inputs to create access to social services and markets for rural economic production. Support for the business environment receives only 0.1%, but must be increased if the private sector is to generate economic growth. 18. Pro-poor economic growth is an element common to several of the key strategic areas of NERRDP. An enabling physical and institutional environment for private businesses, comprising effective institutions, sound infrastructure, and service delivery, is critical. Reform and private sector participation in the SOE sector are high priority areas, in which ADB has a history of support to Solomon Islands, as well as comparative strengths to implement. 19. Since reform of land tenure issues is being addressed by two external agencies, ADB will monitor emerging needs for potential TA in future planning cycles but will not propose assistance during this planning period. Similarly with the significant development agenda in the social sectors, other aid agencies are implementing substantial programs with significant external resources allocated to education and to health, nutrition, and social protection, and there are no apparent gaps. ADB will therefore not propose direct assistance in the social sectors, but will support improved access. 20. The combination of a high level of external support, weak government capacity, and ADB's relatively limited resources in the absence of a lending program suggests that a highly focused ADB technical assistance program will be appropriate. It should aim for long-term capacity building while at the same time delivering rapid impact and reform outcomes. To address the Government's priorities, and to complement the extensive activities of development partners in other sectors (as shown in Table A2.6), ADB will focus on transportation infrastructure and services and strengthening the enabling environment for the private sector. By supporting rural economic growth and access to health and education, ADB's program will make a positive contribution to moving Solomon Islands closer to the MDG on poverty.
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