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Asian Development Outlook 2004 : II. Economic Trends and Prospects in Developing Asia
Solomon Islands After the restoration of law and order and fiscal discipline, and following 4 years of contraction, the economy expanded. The medium-term outlook is for faster economic growth, led by exports and externally funded government spending. Economic Assessment After 4 straight years of contraction, GDP rose by an estimated 3.8% in 2003 (Figure 2.33). The law and order situation substantially improved after the arrival, in July 2003, of a multicountry regional assistance mission. This involved the deployment of nearly 3,000 military personnel from five countries, 250 Australian Federal police under New Zealand leadership, and over 70 civilian technical advisors, including a 16-person budget stabilization team occupying line and advisory positions in the Ministry of Finance and National Planning. This team, particularly, was to help restore sound public financial management in a situation where budget execution and planning had broken down and debt management was absent. In the first 3 quarters of 2003, actual public expenditures were 25% higher than budgeted, largely because of a huge expenditure overrun by the Ministry of Police. There were delays in payment of public service wages, and severe shortfalls in nonpayroll expenditures and debt servicing. Despite poor tax compliance, actual revenues were 31% higher than budgeted, so that the budget was in cash surplus for the first 3 quarters. However, it was in substantial overall deficit because of continued growth in arrears. Preliminary estimates indicated that, by 31 August 2003, arrears on official debt had reached SI$479 million (80% of it on domestic debt), and arrears on informal debt-such as debts to trade creditors and to public enterprises-was even higher at SI$593 million. Total official and informal debt, inclusive of arrears, was estimated to be at least SI$2,200 million (US$296.9 million), or almost 140% of GDP. Key actions implemented after the arrival of the budget stabilization team included imposing tight expenditure control, extending a 10% sales tax to bar-trade activities as intended by the existing law, initiating a payroll audit, and preparing a budget plan for the fourth quarter of 2003 that incorporated SI$15.7 million in Australian government budget support. The formulation of a medium-term debt management strategy was initiated, and the reengagement of multilateral financial institutions in the country was facilitated by the Australian Government's settlement of arrears with regard to ADB and World Bank loans and its commitment to servicing those loans until mid-2004. From 9.0% in 2002, inflation dipped to 8.3%, reflecting primarily a drop in domestic food prices, as the restoration of law and order allowed greater supplies of fresh fruit and vegetables through to the Honiara markets. Currency depreciation continued to exert a major influence on prices. With foreign exchange controls still in place, the local currency remained stable against the US dollar but depreciated against major trading partner currencies, most importantly 18.4% against the Australian dollar (the country that supplies about 56% of imports). The financial sector remained under serious strain. Commercial banks and the National Provident Fund continued to be encumbered by government debt, and are awaiting a comprehensive government financial restructuring package. Following several years of poor performance, the Development Bank of Solomon Islands became insolvent in 2003 and it was expected that the central bank would write off its 10% share holding. Broad money rose by 19.4% in the first 3 quarters of 2003, largely reflecting an increase in net foreign assets. A lack of commercially viable projects was reflected in greater excess liquidity in the banking system. The weighted average interest rate on deposits rose from 0.64% in January 2003 to 0.99% in September, while the rate on loans fell from 15.58% to 15.39%. Export growth in 2003 was strong, led by logs and supported by cocoa and fisheries exports. Imports increased in line with the economic recovery, particularly oil, building and construction materials, and plant, vehicles, and machinery. Both the trade and current accounts recorded a surplus and, with the capital account also recording one due to higher official inflows, foreign reserves (exclusive of the Government's external debt arrears) rose to cover almost 3 months of imports. There was no evidence of a revival in FDI, with most long-term foreign investors still regarding Solomon Islands as an unstable environment for investment. Policy Developments The 2004 budget provides for a balanced cash position. Domestic revenues are estimated to be 7.4% higher than the expected outcome for the whole of 2003, as a result of greater compliance with tax and customs laws, closure of unofficial revenue accounts operated by line ministries, and redeployment of staff to revenue-gathering positions. Budget support from Australia and New Zealand amounts to almost one quarter of total revenues (with the latter's support targeted at the education sector). This budget support permits total recurrent expenditures to rise by 41.5% (from the expected outcome for all of 2003) in 2004. Spending is reallocated toward the key service areas of health and education, financial administration, provincial affairs, and law and justice. However, spending 21% of domestic revenues on debt servicing is insufficient to fully service all debts and the current budget makes no explicit allocation for the payment of past arrears. Arrears are addressed as part of the comprehensive debt management plan formulated in the first quarter, for consideration in future budgets. The Government intends to use revenues in excess of budget estimates to deal with its arrears and debt obligations, while acknowledging that medium-term fiscal tightening will be required to meet them fully. To improve accountability throughout government, the Auditor General's Office is to be strengthened. Increased public expenditures in 2004 should improve service delivery, but care will be needed to ensure that budgetary supplementation is used to support a transition to fiscal self-reliance and sustainability, and that higher spending does not create dependence on donor funding for recurrent as well as development spending. Australian budget support is provided for 2004 only, while New Zealand's support is scheduled to end sometime in 2006. The 2004 development budget is huge in the context of recent fiscal history, almost matching the planned level of recurrent expenditures (SI$480 million), and focusing mostly on general government and security, and human resources and community development. The recurrent and development budgets together constitute a heavy demand on the country's limited administrative and technical capacity. The Ministry of Finance has developed a medium-term fiscal framework to assist in a durable rebuilding of public finances. A key issue is the public service payroll, which accounts for 52% of estimated domestic revenues in 2004, and which the Government accepts as too high. The payroll audit begun in late 2003 and a planned downsizing of the police force will likely generate savings, but funding for implementation of a redundancy and retirement program needs to be secured. In November 2003, the Government finalized its National Economic Recovery, Reform and Development Plan, 2003-2006, which sets out an ambitious program of action in several strategic areas, including public sector reform. The sector has not delivered adequate services because of a failure by central and provincial administrations to perform core government functions, and because of poor SOE performance in the electricity, water, transport, and telecommunications sectors. A prerequisite for successful reform is genuine government ownership at the highest political level. Given the need to restore and improve administrative capacity, reform of public services will need to be planned carefully, and not carried out simply as downsizing. Similarly, reform of SOEs will need to consider various options for improving performance, including better management, corporatization, and privatization within an appropriate regulatory framework. Improving the performance of the public sector generally will be central to generating higher living standards, especially in rural areas. A plan to create a federal system of government under a new constitution is expected to be introduced by July 2004. However, while moves toward decentralization are an understandable response to the widely held view that the national Government has failed and that resources have been shared very inequitably between the capital and the rest of the country, the benefits and costs of decentralization need to be assessed carefully prior to legislative change, in full recognition that the Government is already facing the major challenge of restoring public financial management and central public administration, with limited managerial capacity. Outlook for 2004-2005 Economic growth of 4-5% is forecast for 2004-2005, on the premise that the vastly improved law and order situation will be maintained, further progress in public financial management will be made, and investor confidence will gradually return. Log, fisheries, and cocoa exports to a stronger international economy will be the main drivers of growth, with an additional stimulus coming from external grant-funded development expenditures and from the substantial budget supplementation provided by Australia and New Zealand. It is unclear whether palm oil and minerals exports will show a significant recovery in the medium term, given investors' uncertainty over the medium- to long-term policy environment. The absence of such a recovery will make it difficult to achieve the target of creating 1,000 new jobs in the private sector in 2005. Inflation is projected to moderate slightly to 6-7% in a context of rising domestic food supplies and a cautious monetary policy stance. Imports will rise as economic growth accelerates, but export expansion and increased official transfers are expected to more than offset this, allowing for some easing of foreign exchange rationing. On the assumption that the projections made in the 2004 budget are realized, the public debt will fall relative to GDP. The extent to which domestic investor confidence, in particular, returns will depend crucially on the provisions to be made for payment of trade creditor arrears under the Government's forthcoming comprehensive debt management plan.
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Forestry production was on track to reach near-record levels, providing crucial foreign exchange earnings and tax revenues, but involving logging at rates that, if continued, will eliminate the remaining virgin forest before 2015. Fisheries, cocoa, and copra production all grew rapidly. Rehabilitation and resumption of palm oil production, previously a major export activity, is required, and recently some investor interest was seen. Gold mining operations remain suspended, and manufacturing suffered a setback in October with the closure of a food-processing operation. Construction activity in the capital visibly picked up, and the trade and hotels and restaurants subsectors grew. This patchwork of expansion and contraction, alongside a labor force increase of about 3.6%, meant that aggregate growth had limited impact on unemployment.
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