Kiribati: Staff Concluding Statement of the 2021 Article IV Mission

March 2, 2021

Washington, DC: At the onset of the COVID-19 pandemic, the authorities took preemptive containment measures that successfully limited the risk of a domestic outbreak but also put strains on economic activity. Real GDP is estimated to have declined by 0.5 percent in 2020 with fishing revenues declining by about 16 percent. With restrictions gradually being lifted, an economic recovery is expected in 2021 but the outlook remains uncertain warranting accommodative policies in the near-term. With the aim of supporting a sustainable recovery, we encourage the authorities to pursue the following policy priorities:

• Maintain supportive fiscal measures until the recovery is firmly underway, while ensuring measures are well-targeted and rationalized;
• Mobilize revenues once a durable recovery is underway to strengthen Kiribati’s net financial worth and help finance sustainable development goals (SDGs) and climate related spending priorities;
• Maintain fiscal discipline by formulating a sustainable medium-term fiscal framework and adhering to rules-based withdrawals from the sovereign wealth fund;
• Improve public financial management, particularly in the areas of budget planning as well as strengthening cashflow management and forecasting; and
• Mitigate the long-term consequence of the pandemic by implementing structural reforms to support a dynamic private sector, encourage economic diversification, improve governance, and promote sustainable financial deepening.

THE COVID SHOCK: IMPACT, OUTLOOK AND RISKS

1. The pandemic and containment measures have put strains on economic activity. Prior to the COVID-19 outbreak, Kiribati’s economy performed well with an average annual real GDP growth rate of 4¾ percent in 2015-19, up from about 1½ percent during 2000-14. The stronger growth reflected in part higher public spending financed by record-high fishing revenue – about 75 percent of GDP in 2015-19, up from a 25 percent historical average. The COVID-19 containment measures impacted growth directly through contraction in services including restaurant and hotel services, transportation, and other business activities. Planned large investment projects were delayed because of restrictions on the movement of personnel and materials. Strict containment measures and lower external demand led to a sharp drop in fishing revenues by about 16 percent. As a result, real GDP is estimated to have declined by 0.5 percent in 2020.

2. A recovery is expected in 2021, although growth will remain subdued compared to the pre-COVID environment. The vaccine roll-out is expected in March but it will take time to complete vaccination for the entire population. As a result, restriction on movement will continue and port activity will be reduced, weighing on growth. Nonetheless, a strong fiscal stimulus is expected to support domestic demand resulting in a projected real GDP growth of 1.8 percent in 2021. With the expected vaccine roll-out in most countries, economic activity is projected to reach 2.5 percent in 2022 and converge to slightly below 2 percent over the medium-term. The current account is projected to reach a surplus of about 12 percent in the medium-term with a gradual rise in fishing revenues, but the continued high recurrent expenditure will keep the overall balance in a deficit.

3. Risks to the outlook are substantial and tilted to the downside, with greater uncertainty due to the COVID-19 pandemic. A worsening of the COVID-19 pandemic that prolongs costly containment measures would adversely impact economic activity as the planned resumption of infrastructure projects and activity in the services sector are further delayed. Global financial conditions could also tighten in response to adverse COVID-19 developments and affect the expected return on the Revenue Equalization Reserve Fund (RERF) and the Kiribati Provident Fund (KPF), putting pressure on fiscal resources. A cyclical reversal of the favorable weather conditions could threaten fishing revenues, impacting the fiscal balance and the current account. Climate change would further aggravate these risks.

POST-PANDEMIC RESELIENCY: POLICIES TO BUILD BACK BETTER

A. Recovering from the Pandemic: Immediate Policy Measures

4. Supportive fiscal measures should remain in place until the recovery is firmly underway, but measures should be targeted and rationalized. The government approved an economic relief package of AUD$13.5 million in 2020 (about 5 percent of estimated 2020 GDP), which includes unemployment income support, support for both private firms and state-owned enterprises, and financial aid for cargo deliveries. About 60 percent of the relief package has been implemented as (i) cross checks are being conducted on the applicants for the unemployment income support (no disbursement has been made); and (ii) private firms have yet to receive funds from the Development Bank of Kiribati (state-owned bank) through the on-lending scheme at reduced interest rates. This has helped cushion the economic impact of the pandemic in 2020. A separate COVID-19 economic relief package in 2021 is not envisioned, but the fiscal deficit is expected to widen partly due to increases in the wage bill, unemployment support scheme, land rent (government leasing), and senior citizen’s benefits. While fiscal measures need to continue focusing on economic recovery in 2021, policy efforts should be retargeted depending on the severity of damage in the affected sectors. Measures can include:

• evaluating the results of the recent payroll audit to recalibrate the wage bill appropriately and redirecting available resources to targeted social transfers in response to the pandemic;
• properly identifying those eligible for unemployment benefits to limit the increase in expenditure; and
• putting in place pandemic-related spending safeguards including public access to procurement contracts, availability of beneficial ownership information for awarded entities, and publication of an ex-post audit report of emergency spending.

B. Nurturing the Recovery: Reinforcing the Fiscal Framework

5. Fiscal consolidation will be necessary to reduce fiscal risks once the recovery is underway. Kiribati’s recurrent spending is mainly financed by volatile fishing revenues and budget grants, with project grants used for development financing and no regular access to debt financing. Volatile revenue and dependence on donor grants underscore the importance of maintaining fiscal discipline and adequate cash buffers. Under staff’s baseline scenario, however, the deficit is projected to remain high in 2022 (about 17 percent of GDP), given the recurrent spending introduced in 2021, and plans to double the copra subsidy in 2022 (to AUD$32 million). Assuming that the recovery is underway in 2022, the authorities should consider a cut in domestic recurrent spending to reverse the fall in the net financial worth of Kiribati and raise it towards pre-COVID levels. This could be achieved by keeping the copra subsidy at the current level and by unwinding unemployment benefits conditional on a sustained pace of recovery.

6. Fiscal discipline could be further reinforced by:

• adhering to the rule-based withdrawal policy approved by the Cabinet in 2020 to preserve the value of the RERF for future generations;
• formulating a sustainable medium-term fiscal framework to promote recurrent expenditure stability while also ensuring that (i) RERF withdrawals only finance development expenditure, in line with the withdrawal rule; and (ii) development expenditure itself is determined in the context of multi-year plans with clearly identified financing; and
• making explicit provisions in the budget for climate change adaptation for a greener post-COVID recovery.

7. The pandemic has brought the importance of generating greater revenue mobilization to the forefront. Building on the success of the last tax reforms implemented in 2014, the authorities can implement medium-term reforms to put revenues on a more sustainable footing by:

• protecting the tax base by eliminating discretionary exemptions including on state-owned enterprises (SOEs);
• revising the dividend policy to ensure that the SOEs comply with the dividend payment obligations to the government;
• increasing the progressivity of personal income tax, streaming the corporate income tax, and simplifying the tax regime for small businesses;
• increasing the excise tax on tobacco and fuel which also help the environment and help fund climate adaptation costs;
• reviewing the tax policy to align Kiribati’s tax rates to international levels to incentivize private sector investment;
• formulating the deep seabed mining fiscal regime with a focus on aligning tax rates with regional peers to generate a more stable source of revenue; and
• leveraging Kiribati’s participation in the Parties to the Nauru Agreement (PNA) to broaden the vessel day scheme to maximize fishing revenue potential.

8. Improving public financial management is also necessary to make public spending more effective to boost the post-COVID recovery. As implementing all measures for a sound PFM system takes time, the authorities can prioritize the following near-term reforms:

• developing credible budgets by improving fishing revenue projections, ensuring both recurrent and development expenditure ceilings are binding, and avoiding supplementary budgets;
• executing in-year controls over expenditure and revenue by introducing a quarterly commitment system for non-salary payments, and ensuring all fishing revenue is deposited into a central government account; and
• executing central controls over cash balances by consolidating government bank accounts and establishing a cash management planning committee that could lead to higher investment returns through efficient and effective cash management practices.

C. Mitigating Long-term Consequences of the Pandemic through Structural Reforms

9. Economic diversification through a more dynamic private sector would help weather future shocks. The production and export structures in Kiribati are highly concentrated, mainly relying on fisheries and copra. Kiribati’s economy could benefit from new product lines and quality upgrades including by:

• upgrading fishing exports through investing in sustainable fishing methods and in state-of-the-art processing facilities;
• upgrading copra-based products such as coconut oil could also be a source of high-quality exports;
• enhancing complementary fishing activities—such as transshipment, aquaculture, fish farming, and processing facilities—particularly in the periphery;
• investing in renewable energy such as building the ocean thermal energy conversion plants to generate power and supply cold ocean water for use in refrigeration; and
• exploring the potential to excavate Kiribati’s manganese and copper resources through deep sea mining while ensuring environmental safety.

10. Diversification will only be possible by improving the business environment and developing human capital. Improvement in connectivity through better air transportation and shipping services could boost business by enabling access to a wider marketplace. Completion of the submarine fiber-optic cables linking Kiribati to the global submarine cable network will also help improve the environment for conducting business. Building human capital by enhancing training opportunities (including through further participation in overseas work schemes) will not only promote diversification but also create employment opportunities.

11. Development of the private sector will also require adequate sources of financing for productive investment. Access to credit would be best enhanced by improving land access procedures and dispute resolution mechanisms, to enhance property rights and enable lending against collateral. Mobile connectivity and mobile banking should be promoted, for their job-creation and financial-deepening benefits. Such financial deepening should be accompanied by formulating a regulatory and supervisory framework that provides the necessary legal powers to authorize and supervise all financial institutions with a complete suite of prudential and AML/CFT standards. The authorities’ plan to formulate two separate acts in the financial sector is a welcome step – the banking act for commercial banks is expected to allow the entry of more commercial banks into Kiribati to foster competition, while a broader financial sector act aims to cover all other financial institutions (Development Bank of Kiribati, KPF, and Kiribati Insurance Corporation).

12. An overall strategy for setting SOEs on a more commercial and sustainable footing will strengthen public finances. Further strengthening the commercial mandate of the SOEs and developing a medium-term plan for a financially sustainable delivery of utilities (including through tariff increases where needed) and for air transportation will improve efficiency. Continued effort is needed to strengthen SOE governance and oversight, including building of capacity in the SOE monitoring unit, and more recent publication of SOEs’ audited financial statements. Phasing out SOE exemptions of the VAT and reducing subsidies will also help level the playing field with the private sector.

13. Overall improvement in governance would boost public trust. Addressing governance deficiencies in budget outcomes and institutions would help improve efficiency and reduce vulnerabilities to corruption. Against the backdrop of an ambitious agenda, it is crucial to strengthen the governance of public investment so that the most beneficial projects are selected, execution is not disrupted, fiscal sustainability is ensured, and the best financing terms are obtained. In this context, staff welcomes the adoption of the Public Procurement Act 2020 which should improve efficiency and consistency of procurement processes in accordance with the internationally recognized procurement policies and procedures. Transparency on fisheries management could be improved through timely publication of the fisheries report that provides critical information on the allocation of fishing days.

14. Continued efforts to build statistical capacity and enhance interagency collaboration will facilitate evidence-based policy making. The COVID-19 pandemic has increased the need for granular, relevant, and reliable data in a timely manner. Moving forward, the authorities need to make further investment in human capital and technology, promote comprehensive inter-agency collaboration, and enhance information sharing to produce timely and high-quality statistics. These efforts will help promote sound policy management through better monitoring of the economy and adjusting the development strategy, if needed.

15. Kiribati is addressing economic challenges caused by the pandemic and strives to make progress in implementing economic reforms for greater resilience. The government is highly engaged with the IMF and other development partners, and the IMF stands ready to continue to support the government’s reform efforts through policy advice and capacity development.

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The mission thanks the authorities for their warm hospitality, cooperation, and open and constructive discussions.