Countries and Regions

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Country Strategy and Program Update 2002-2004: Vanuatu

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I. Development Situation

A. Recent Political and Social Developments

3. The coalition Government¹ gives priority to development of agriculture and infrastructure, the rule of law, independence of the civil service, a level playing field for business, and financial discipline.

4. The ongoing reform has substantially raised society's awareness of social development needs, and expectations of better social welfare. However, the quality of social services remains extremely poor in the outer islands, where 80 percent of the population lives. Of the economically active population, only 25 percent work for pay or profit, 67 percent are subsistence farmers, and the rest have no work. In 1989-1999, the urban population grew by as much as 4.2 percent annually, while the rural population grew by 2.6 percent. Only about 30 percent rural boys and girls age 16 and below attended school, compared with 58 percent of those in urban areas. Only 7 percent of rural households have electric lighting compared with 61 percent of urban households.

B. Economic Assessment and Outlook

5. The economy recovered slightly in 2000 with estimated growth of 2.8 percent, which was, however, considerably lower than the projected 4 percent. Substantial growth in tourism and construction was offset by a fall in copra production and higher oil import prices.

6. The overall budget deficit in 2000 stood at about 8 percent of gross domestic product (GDP), while the recurrent budget deficit kept within 2 percent of GDP. The higher-than-expected deficit reflected the rollover of major development projects that were not completed but were budgeted in 1999. Revenues were below target, leading to tight controls on recurrent expenditure. Due to a narrow revenue base without income taxes, total annual revenue remained at around 26 percent of GDP, severely constraining spending. A revenue initiative was proposed in 2000 but Parliament turned it down, straining the 2001 budget even more.² The overall budget deficit is targeted at no more than 2 percent of GDP over the next 2-3 years with annual surpluses in the recurrent budget and with financing of the overall deficit through external concessional funding. However, 2001 revenues were overoptimistically budgeted based on the aborted revenue initiatives and the newly introduced, but unrealistic, Internet gaming. The Government relies heavily on overdraft facilities of the Reserve Bank. If the revenue base is not broadened and tax laws are not enforced, the fiscal situation will continue to deteriorate, undermining economic stability.

7. The most important monetary initiative in 2000 was the reintroduction of foreign exchange guidelines on 23 February, when foreign reserves fell to less than five months of import cover.

8. The economy was expected to grow modestly at 3 percent in 2001 and 2002, aided mainly by the recovery of agriculture and the continuous success of tourism. However, policies must be reformed if the country is to achieve the forecast growth rate. Private sector investment in mainstay sectors remains low. The current account was expected to record a modest deficit in 2001 followed by a small surplus in 2002. However, the first half of 2001 saw fewer tourists and low copra prices, and cyclones disrupted the local food supply, resulting in higher food prices and food imports (Appendix 1).

C. Implications for the Country Strategy and Program

9. A country strategy and program (CSP) needs to be developed to support reform efforts. The TA program is needed to continuously support the reform process until it becomes sustainable and improves economic and fiscal management. The lending program will be adjusted according to the Government's priorities, which are broadly in line with the ADB strategy of reducing poverty and social and economic disparities.

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