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p. 53 of 69 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 Papua New Guinea Samoa Solomon Islands Democratic Republic of Timor-Leste Tonga Tuvalu Vanuatu III. Foreign Direct Investments in Developing Asia

Asian Development Outlook 2004 : II. Economic Trends and Prospects in Developing Asia

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Nauru

With phosphate reserves nearly exhausted, and the situation exacerbated by prolonged economic and financial mismanagement, a complete collapse of the economy has only been averted by financial assistance from Australia. Urgent measures to improve governance and restructure government finances are now critical.

Economic Assessment

Any economic analysis for Nauru relies heavily on qualitative information and has to be interpreted cautiously as recent data are not available. In 2003, the financial and economic situation continued to deteriorate, as the main natural resources, phosphate reserves, have become nearly exhausted. At the current level, revenues from phosphate production do not cover operating costs, and royalty and dividend payments have been delayed. Phosphate exports were at a virtual standstill in most of 2003 following strikes, sabotage, and other disruptions in production and shipping.

With the decline in phosphate revenues, borrowings against trust fund assets administered by the Nauru Phosphate Royalties Trust (NPRT) have represented the Government's main revenue source. The total value of NPRT assets has declined from an estimated A$1.3 billion in 1990/91 to an estimated A$300 million today, and stems from poor investment decisions and other bad management. The remaining NPRT assets are now almost fully, and relatively expensively, mortgaged.

The size of the budget deficit for the last 3 fiscal years is unknown. FY2003 (ended 30 June 2003) provided for a deficit of A$15.2 million, though the actual budget deficit is expected to have been much higher. In FY2004, expenditures are estimated at A$40 million and revenues at A$18 million.

The Nauru Phosphate Company (NPC) and other SOEs are under pressure to retain high staffing levels despite declining output, but are unable to meet salary expenses. With the Government and NPC no longer able to absorb the increasing number of young job market entrants, youth unemployment has risen to an estimated 35%, impacting severely on standards of living.

Nauru uses the Australian dollar as its currency, thus inflation tends to follow Australia's (2.8% in 2003).

There are no reliable commercial banking services in Nauru. The Bank of Nauru, the country's main bank, is illiquid and insolvent by international standards and is operating only on a very limited basis. Public entities continue to use the bank and the Government issues the bank's checks to fund its budget deficits and royalty payments to landowners.

The country is plagued by frequent fuel, power, and water shortages while the cost of living has increased. Air Nauru, the only airline servicing the country, faced repeated interruptions in 2003, due both to a shortage of funds for lease and maintenance payments and to fuel supply disruptions. Education and health services have deteriorated and suffer from a chronic shortage of skilled staff. Greater numbers of Nauruans have therefore resorted to subsistence farming and fishing.

A complete collapse of the economy has been averted by the continuing support of external sources, particularly Australia's humanitarian and development assistance linked to Nauru's agreement to host asylum-seekers. Australia's assistance has been essential in maintaining water and power supplies as well as education services. Health is receiving substantial support from both Australia and the International Organization for Migration in return for services in refugee camps. In February 2004, the governments of Australia and Nauru signed a new memorandum of understanding providing for A$22.5 million in assistance for the period July 2003-June 2005.

Policy Developments

A new Government was elected in May 2003. It committed to return to the fiscal and financial reform program initiated in 1998. Recommended priorities for reform include (i) addressing the structural budget deficit through expenditure reduction, improvements in revenue collection, and new revenue measures; (ii) restructuring the trust funds; (iii) overhauling arrangements for the management of public finance and public enterprises; (iv) reassessing arrangements for the provision of air services by Air Nauru; and (v) reestablishing commercial banking services.

The Government was overturned in August 2003 and the momentum for reform reversed. Nevertheless, a National Economic Forum was held in October 2003. The consultations that preceded the forum demonstrated general support among the population for increasing government transparency and accountability, widespread acceptance of reductions in government spending, and increases in revenue-raising efforts, provided that the Government adopted improved governance standards. The new Government expressed commitment to consider the recommendations of the forum.

Nauru remains on the OECD's list of Non-Cooperative Countries and Territories of the Financial Action Task Force (FATF) on Money Laundering. Sanctions have been imposed since December 2001 and have hurt the economy. To comply with the FATF recommendations, the Government revoked all banking licenses issued by the Bank of Nauru, enacted legislation eliminating its offshore shell banks, and passed an antimoney-laundering act and new banking legislation. However, additional steps will be necessary before countermeasures are removed. In late 2003, Nauru was, though, removed from the OECD List of Uncooperative Tax Havens following a commitment to improve transparency and establish effective exchange of information on tax matters with OECD countries.

Outlook for 2004-2005

The medium-term outlook is very bleak, particularly in light of the Government's lack of commitment to confront the drastic structural changes essential for reversing the economic decline and bringing back political stability.

The promised assistance package from Australia relieves some of the most immediate pressures. The package also includes provisions for Australian personnel serving in line positions, including an Australian Secretary of Finance, with a clear mandate to address key economic and financial reforms. Agreed tasks also include auditing and assessing the remaining assets of the trust funds and beginning a restructuring of these assets.

Measures to reduce the structural budget deficit are needed. With the steep decline in the value of the NPRT, few options remain for the Government to fund future budget deficits. The failure to reduce expenditures-particularly the public sector wage bill-and to address revenue shortages through taxation and cost recovery remains a particular concern.

Currently the revenue base is very narrow. Some phosphate reserves are left and production could increase to break-even level for several more years, but significant dividends are unlikely. There is an urgent need to restructure the investment portfolio away from its current reliance on property investment, and to maximize income from the remaining trust funds. Few opportunities exist to develop agriculture and service industries targeting the local market, or to expand revenues from licensing of foreign fishing vessels. Improvements in the efficiency of provision of public utilities, including telecommunications, power, and water, as well as stronger mechanisms for cost recovery, are crucial for reducing the dependency on emergency Australian aid.

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