Nauru: Fiscal Sustainability Reform Program

Public sector management / Public administration

1. The proposed Fiscal Sustainability Reform Program is the latest in a series of program grants and technical assistance (TA) operations of the Asian Development Bank (ADB) and other development partners designed to support the Government of Nauru's efforts to achieve fiscal sustainability. The main feature of the program is the establishment of the Nauru Intergenerational Trust Fund (NTF). This will be complemented by reforms to improve public financial management (PFM) and efficient delivery of power and water services.

2. Development context. Nauru is very small and geographically remote. It has a total land area of 21 square kilometers and a population of approximately 10,000. Small size, remoteness, and limited resources mean the scope for private sector development is significantly constrained. This in turn places limits on the country's ability to finance basic government operations and service delivery while the public sector itself also faces diseconomies of scale and a thin domestic pool of skilled labor.

3. Overview of the economy. The public sector dominates the economy. The civil service and state owned enterprises (SOEs), particularly the Nauru Utilities Corporation (NUC), accounted for 82% of total employment in 2010. The state budget is reliant on a limited set of volatile revenue sources including fishing license fees, phosphate mining, customs duties, and, more recently, revenues associated with the reopened Australian Regional Processing Centre (RPC) for asylum seekers. The Australian dollar is used as legal tender. This supports price stability but removes monetary policy as a tool for economic management.

4. Recent economic and fiscal performance. Nauru experienced a resurgence in economic growth following the reopening of the RPC in 2012. This, together with windfall fishing license revenue and high levels of development assistance, led to average growth of about 8% between FY2012 and FY2014, and a 288% increase in domestic revenues in FY2015 compared with FY2012. ADB's estimates for growth in FY2015 and FY2016 are 6.8% and 5.4%, respectively, as the effects of the above positive shocks tapers off. The FY2016 national budget targets a surplus of $100,604 (or 0.1% of GDP) predicated on expenditure restraint as revenue stabilizes around current levels. Public debt has fallen significantly in recent years and, together with arrears and liabilities, is around $19.4 million (or 31.8% of GDP) . Nonetheless Nauru faces large downside risks which could undo much of this progress, with significant uncertainty existing around the future of the RPC and the sustainability of fisheries revenue.

5. Government reform efforts. A _stable, trustworthy, fiscally responsible government_ is the central long-term goal of Nauru's National Sustainable Development Strategy (NSDS), 2005 2025. Under this strategy, the government has delivered fiscal surpluses, reduced government debt, introduced finance sector reforms, started to restructure poorly performing SOEs, and implemented vital PFM reforms. The government acknowledges the importance of continuing these reforms, particularly those related to improving PFM quality and utilities service delivery. Furthermore, establishment of a Nauru Intergenerational Trust Fund (NTF) will be a critical next step in accelerating these efforts.

6. PFM reform. In 2011, the government adopted a PFM Action Plan, based on its 2010 Public Expenditure and Financial Accountability (PEFA) assessment, to guide its reform efforts. Steady progress is being made. For example: (i) an automated financial management information system, Technology One, has been installed; (ii) the public procurement law has been revised and major procurement operations have been outsourced; and (iii) expenditure is now more closely linked to the NSDS through Annual Operating Plans. However, many challenges remain that could potentially undermine the fiscal position. For example, effective expenditure controls need to be implemented, the efficiency and fairness of the revenue system needs to be improved, as does the allocation of public resources through the budget process.

7. Utilities reform. The supply of electricity and water is provided by NUC. Poor asset management and antiquated infrastructure has led to frequent power outages, a situation that has been exacerbated by the large increase in electricity demand since the resumption of the RPC. In addition, subsidies provided to NUC in the form of fuel for power generation has been a significant drain on the annual budget. Although this arrangement has ended, it was replaced with a provision of up to $5.5 million as a direct subsidy to NUC. Planned power sector tariff reform should reduce the fiscal burden of these subsidies.

8. Ensuring future service delivery. The government has been trying to set up the NTF since 2009 when a prospectus was forwarded to potential donors. Parliament passed the Nauru Trust Fund Act 2012 to authorize its establishment. The NTF will help ensure that donor funds and windfall revenues are better managed and provide a future source of stable budget financing. The government has demonstrated its commitment by setting aside $14.6 million during FY2015 FY2016 as its contribution to the NTF. ADB's experience with trust funds in the region show that they help _sterilize_ a portion of these funds to avoid the resource curse that could result in spending and inflationary spirals that are nonproductive and non-wealth-producing, and avoid capacity and other constraints such as strains on infrastructure, some of which are now emerging in Nauru. Furthermore, trust funds should be established (i) when there are unanticipated excess resources available for which there are no immediate or urgent uses; (ii) when a critical long-term resource shortage is forecast and there are no foreseeable cheaper or more efficient means of financing available; and (iii) as a hedge against economic volatility. The NTF meets these criteria.

9. Program modality. ADB proposes a stand-alone policy-based operation that will require that all policy actions are accomplished in advance of grant effectiveness. The program fully supports implementation of key policies agreed with the government and is supported by all major development partners including the Government of Australia. The program is being developed in the context of a programmatic policy discussion with key partners and is based on the NSDS. Lessons from ADB's experience in Nauru and in the Pacific include (i) limiting reform to a small number of major actions; (ii) using a single tranche within a programmatic, multiyear, framework for policy dialogue and TA; and (iii) combining TA with policy-based operations to undertake complex, politically sensitive reforms.

The project is aligned with Nauru's National Sustainable Development Strategy, 2005 2025 objectives:

1. A stable, trustworthy, fiscally responsible government.

2. Provision of enhanced social, infrastructure, and utilities services.

3. Development of an economy based on multiple sources of revenue.

3. Improved funding mechanism for future service delivery

2. Efficient service delivery by the National Utility Corporation (NUC)

1. Improved public financial management