Catalog

	Table of Contents
p. 58 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

---

Republic of Palau

Economic growth accelerated slightly in 2004 as a result of strong tourism expansion. However, the economy remains heavily dependent on US assistance and the Government needs to curb public expenditures. This is a key element of a general reorientation toward encouraging private sector-led development, which is essential to sustainable economic growth in the post-Compact era starting in 2009.

Macroeconomic assessment of 2004

Palau became independent on 1 October 1994 in free association with the US, and joined ADB on 29 December 2003 as the 63rd member. Historically, Palau was a part of the UN Trust Territory of the Pacific under US administration. A Compact of Free Association--an economic, political, and strategic treaty between Palau and the US--was approved in 1986 but was not ratified until 1993. Under this Compact, which covers the 15-year period FY1994-FY2009, Palau conducts its own domestic and foreign affairs, while the US retains control of defense and security matters (for which it has exclusive access to Palau’s waterways); pays for health services; and provides about $600 million in economic development assistance, including grants for direct budget support (of around $13 million annually) and disbursements for the creation of a Compact Trust Fund (CTF). Palau consequently has enjoyed one of the highest living standards in the Pacific, though this has largely been generated by an aid-dependent public sector.

Based on the limited data available, Palau’s GDP increased by 2.0% in 2004, compared with contraction of 0.1% in 2003 and 4.7% in 2002. The growth was attributable to the continued revival of tourism following the downturn induced by the 1997—98 Asian financial crisis. In FY2003 (ended 30 September), visitor spending almost reached the precrisis level, and in FY2004 visitor arrivals grew to a record of nearly 80,000. This tourism growth boosted the retail trade sector, which continued to benefit also from expansion in public sector activity. The relatively small agriculture sector generated some subsistence income, but its development has been hampered by lack of infrastructure, while revenues from fishing license fees remained at the fairly low level of recent years. Tuna harvesting by fishing fleets from Japan; US; PRC; and Taipei,China failed to produce the catch levels characteristic of the late 1980s.

With GDP and population growing at almost the same rate in 2004, per capita income grew slightly but remains at 6% below the 2000 level. Moreover, income disparities have reportedly widened in the last 5 years. According to census figures, the share of the non-Palauan resident population increased from 16.8% in 1990 to 25.6% in 1995 before reaching 30.1% in 2000. The 1990-2000 increase accounts for four fifths of the increase in the country’s total population.

Government expenditures increased to 66.3% of GDP in FY2004 from 57.5% in FY2003, and revenue collection was poor. The overall budget deficit was estimated at 9.9% of GDP and was again financed by drawdowns from the CTF. The balance of the CTF had already dropped from a peak of $162 million at end-FY2000 to $136 million at end-FY2003.

The high level of consumption relative to domestic production was reflected in a large trade deficit equivalent to almost two thirds of GDP: merchandise exports were estimated at $11.9 million in 2004, compared with merchandise imports of $108.8 million. The current account deficit increased from $5.3 million in FY2003 to $22.5 million in FY2004. Use of the US dollar as the currency precludes an independent monetary policy and means that inflation tends to track that in the US, which has been low over the last 3 years.

Macroeconomic policy developments

Fiscal deficits in most recent years have been the highest among Pacific island economies and have been a major drain on the CTF, which has also been adversely affected by trends in international equity markets. FY2005 marks the 11th year of the Compact and Palau will receive $12.8 million in direct assistance during the year, but Compact grant disbursements are expected to decline over the remainder of the Compact period. There is therefore an urgent need to formulate and implement a medium-term fiscal strategy that ensures long-term fiscal sustainability. This strategy must involve a reprioritization of a reduced level of government expenditures and augmentation of the CTF as a source of sustained revenues. The policy challenge is substantial, given that the Government provides utilities, communications, and health services in addition to the usual public services, making it the single largest service provider and employer in the country. It is critical that the Government improve its management of service provision, including the adoption of innovative financing options and mutually beneficial partnerships with the private sector.

Additionally, the Government will need to promote private sector-led development that generates greater benefits to the domestic economy. At present, it relies heavily on grant-funded public sector construction activities that have limited multiplier effects on total output: many construction workers are temporary foreign workers, largely from the Philippines (61% of foreign workers) and the PRC, who remit their salaries to their home countries. Economic activities with greater output and employment multiplier effects need to be promoted through structural reforms, including the creation of a leaner, results-oriented civil service, tax and tariff reform, and public enterprise reform. The costs of doing business in Palau are generally high by international standards, as is the case in other Pacific island countries, and are especially high for closing a business. Bringing these costs down is an essential component of an improved enabling environment for the private sector.

Outlook for 2005-2007 and medium-term trends

In the medium term, growth is forecast to be about 2% and to occur in a low-inflation environment, with a large trade deficit offset by inflows on the services, income, and transfers accounts. This growth will be driven in part by tourism, with economic recovery in Japan and continued economic growth in the PRC ensuring that tourist arrivals and spending exceed the 2004 level. Public sector infrastructure projects will be the other driver of growth, as two major construction projects will be completed in 2005 to early 2006.

The larger project is the construction of a 53- mile two-lane highway on the island of Babeldaob, which will be the second longest after a highway in Guam in the Micronesian region. Included as a special economic development project in the Compact financial package from the US, this project is known as the Compact Road. Substantial delays have occurred due to problems with the technical implementation design and bad weather, but completion is expected by mid-2005. This will make tourist attractions and many commercial facilities more accessible, strengthening the foundations for future private sector growth.

The second major project is the construction of the new national capital complex at Melekeok, again on Babeldaob. The project is funded by a $23 million concessional loan from Taipei,China and will be completed in early 2006 when the Government will move about half of the administration from the highly populated and urbanized center of Koror on Babeldaob, which will retain health and policy development among other functions. The development of a new, modern capital symbolizes Palau’s emergence as an independent state, but this has significant implications for the budget. It is estimated that the recurrent cost of the new facilities will add $2 million a year to government spending.

A third project that will contribute to growth is the establishment of a central market in Babeldaob, which is intended to support agricultural development by improving marketing facilities. A feasibility study by the Bureau of Agriculture with the Food and Agriculture Organization of the United Nations included an investigation of central market systems in several Pacific countries and concluded that, once completed, the central market will have a capacity to handle an annual output of some 420 tons of fruits, vegetables, and root crops, and 160 tons of fish. Construction is scheduled to start in April 2005.

Over the medium to long term, the Government faces the twin economic challenges of managing the fiscal adjustment to a decline in sector grants and encouraging broad-based private sector development in a small domestic economy. At present, there is an overdependence on aid and tourism and a consequent uncertainty about sustained growth prospects in the post-Compact period.

Back Nauru	Next Papua New Guinea