Countries and Regions

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p. 2 of 5 BACK | NEXT I. Country Strategy II. Current Development Trends and Issues III. Implementation of the Country Strategy and Program IV. Portfolio Management Issues V. Country Performance and Lending Levels

Country Strategy and Program Update 2004-2006: Vanuatu

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II. Current Development Trends and Issues

A. Recent Political and Social Developments

3. Following the May 2002 election, a coalition government of the Vanuaaku Pati and the Union of Moderate Parties is governing the country. The coalition has lasted though with some periods of turbulence. In 2002, for example, there was an armed standoff in the center of Port Vila between the Vanuatu Police Force and the Vanuatu Mobile Force over a dispute in appointing a new Police Commissioner. Political instability and inconsistency in policy and leadership direction continue to undermine the framework of public service reforms and private sector initiatives introduced under the comprehensive reform program (CRP), thereby eroding public and investor confidence.

4. There are four branches of government: Parliament, a Council of Ministers to lead the executive, a public service to advise on and implement policy, and a State Law Office, police, and judiciary to enforce the rule of law. There are 52 seats in Parliament covering 17 constituencies throughout Vanuatu. Some of these institutions of government have had difficulty in fulfilling effectively the roles specified under the Constitution. Under the CRP, the process of renewal and rebuilding of the institutions of government is ongoing. Past and present projects, many of them supported by ADB, have helped (i) improve the executive by creating the Council of Ministers, supported by a Development Committee of Officials, to consider policy issues; (ii) enact a Government Act and and a Public Service Act clearly defining roles for ministers and civil servants; (iii) strengthen the public service, State Law Office, judiciary, and police; (iv) improve fiscal management through better forecasting and revenue administration; (v) enhance dialogue between the Government, civil society, and the business community; and (vi) strengthen Parliament by enhancing the capacity of committees to review bills, budgetary documents, accounts and performance reports. However, since the CRP rightsizing, there has been a substantial increase in the size of the civil service, eliminating some of the financial gains achieved under the CRP. Although performance agreements are being put in place for senior civil servants, the overall performance of the civil service remains weak.

5. The role of custom and of traditional rights in the modern state significant. In rural areas, people recognize both modern leaders and custom chiefs, and their roles are relatively well defined, with chiefs responsible for local issues and modern leaders for national issues. In urban areas, however, the custom systems tend to break down, leading to potential social conflict. Migrants to urban centers such as Port Vila and Luganville normally do not have land rights, often causing them to live in unsatisfactory conditions as "unofficial" tenants unable to secure power, water, and transport services. As a result, squatter communities are increasing. Land tribunals are being developed under legislation passed in 2002 and have the potential to help significantly in resolving land disputes. Strata title legislation also passed in 2002 will help make business investments easier, at least in urban centers. Crime is increasing as joblessness becomes more severe. The police remain ineffective in protecting the general public, and the courts are overloaded. A free press has helped keep the public informed and continues to be essential to good governance. An ADB governance report prepared for Vanuatu has been completed and, subject to the Government's request, a workshop to discuss the findings will be arranged.

6. The geographic isolation and remoteness of the islands and the lack of job creation contribute to poverty. The wide income disparities between urban and rural areas are related in part to low agricultural productivity and poor outer island infrastructure facilities and services. Less than 500 jobs are created each year in the formal sector, while over 2,000 school-leavers seek employment. Vanuatu ranks among the lowest in ADB's Pacific developing member countries (PDMCs) for adult literacy (75%) and net secondary enrollment (23%). The low rate of secondary enrollment and high levels of adult illiteracy are substantial obstacles to efforts to modernize and develop. While the infant mortality rate improved between 1979 and 2000 (from 94 to 30 deaths per 1,000 births), it remains high compared to other PDMCs (Appendix 2, Table A2.1). Education for All is being advocated as the priority program in this regard and female enrollment ratios are increasing. Gender balance is being addressed by the public service with one female director-general appointed and several females holding director-level positions.

B. Economic Assessment and Outlook

7. Real GDP declined further by 2.8% in 2002, following a fall of 2.1% in 2001, reflecting the effects on agriculture and tourism of several major cyclones, weak demand, increased competition from other island countries, and supply constraints including high cost and unreliable air and sea transport (Appendix 2, Table A2.2). Agriculture as a whole grew modestly, due to an expansion of the cocoa and root crop sectors, but the forestry sector contracted further by 11.6% following a larger decline in 2001. The construction and manufacturing sectors fell by 1.4% and 13.1% in 2002, respectively, leading to an overall industry decline of 5.9%. The services sector contracted by 3.9%. Tourist arrivals fell further by 6.5%, reflecting Vanuatu's high costs, the withdrawal of Air Vanuatu's direct services to Melbourne, and the more active marketing of the Fiji Islands. Several large hotels are experiencing occupancy rates of only 35%.

8. Inflation moderated at 2.0% in 2002, down from 3.7% in 2001. Exports grew by 1.1% in 2002 following a significant decline of 24.1% in 2001. Imports declined by 0.4% following growth of 0.9% in 2001. Consequently, the trade deficit decreased slightly to 24.2% of GDP. With the capital account in deficit due in part to a sizable drop in foreign direct investment, gross official reserves declined noticeably to $34.9 million (4.7 months of imports) at the end of 2002. There is the potential for further decline unless tourism and exports are expanded.

9. The Government's fiscal situation improved slightly in 2002, with an overall deficit of 1.5% of GDP. The improvement was mainly due to expenditure restraints, in particular to the impact of financial controls on personnel costs, and to better revenue planning. However, a tight cash situation persisted throughout 2002 with the Government using a system of monthly warrants to control spending and the continuing use of advances from the Reserve Bank of Vanuatu to fill a financing gap. Payments for goods and services, subsidies, and capital spending were lower than in 2001. Revenue was also lower than originally estimated, reflecting the impact of weaker than expected economic growth. Such conditions are continuing in 2003.

10. Public debt declined slightly from 38% to 37% of GDP in 2002. The funding of substantial losses at the Vanuatu National Provident Fund (VNPF), the National Bank of Vanuatu (NBV), Vanair (the domestic airline), Air Vanuatu (the international airline) as well as the Vanuatu Commodity Marketing Board contributed to a significant buildup of domestic debt in the period 1997 to 2002. Such debt, which is held by the Reserve Bank, commercial banks, and VNPF, is now reaching the absorptive limits of the economy. ²

11. The Government is concerned about recent and continuing increases in debt service requirements³ relative to domestic revenue. Total debt-servicing costs increased significantly from 2.6% at end-1998 to 6.1% at end-2002, and are expected by the end of 2004 to have risen to 7.7%, slightly below the target limit of 8.0%. Given the tight fiscal situation, the Government has decided to avoid any large increases in the level of debt, especially short-term debt, and to keep loan funding of projects to a bare minimum by seeking grant funding wherever possible.

12. ADB has helped prepare an action plan to improve fiscal management and it is being extended by a study of revenue sources under way with support from the Government of New Zealand. The plan and study indicate that there are opportunities to rationalize the import tax structure, improve land taxation, and introduce more consistency in tax and administration. Fiscal management needs to emphasize more realistic forecasting, better control and greater compliance. An enhanced revenue system with a broader tax base is needed in the long-term future, but a consensus has not emerged about its desirability in light of its economic impacts.

C.Implications for the Country Strategy and Program

13. The conditions and trends described above indicate that Vanuatu should aim over the medium-term (3-5-year) future to increase its rate of economic development to a level moderately in excess of the rate of population growth. Expansion of tourism is possible and even likely, provided that reasonably priced air transport services are expanded. Growth of agricultural production, particularly of beef and organic crops, is also likely provided that sea and air freight services are available. On the other hand, maintenance of social order will remain problematic. Although the courts, the State Law Office, and the police are being strengthened, it will be years before they are able to effectively keep up with their caseloads. Land management is being improved, but disputes due to lack of clarity of ownership and the difficulty of acquiring land for economic investment due to complex ownership patterns will continue. It will continue to be difficult to retain qualified professionals in the civil service, and to effectively manage the economy without them. There will be strong pressures for increased expenditure, for the infrastructure to support the productive sectors, and for the education and health services needed by a rapidly growing and young population. However, growth in revenues will be substantially constrained until the tax base is broadened.

14. For these reasons, ADB's assistance should focus on the underlying constraints on development. Transfer of knowledge will be as important as transfer of capital. It should help in:

1. development of a government and bureaucracy operating in a transparent, accountable, and fully accessible manner, with decisions on economic matters taken after public deliberation of the issues;
2. creation of an enabling environment for private sector development, including reducing costs, encouraging competition, creating a secure framework for transactions, and expanding business development finance; and
3. reduction in poverty, through improvements in governance and economic growth, as well as provision of services for the poor, particularly to address the problems of the outer islands.

15. Furthermore, it has been agreed that the Government may request ADB assistance primarily as grant-funded technical assistance (TA). Loan assistance will be used only sparingly, and only where sustainability is strongly indicated.

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