ROLE OF FISCAL POLICY IN RESILIENCE BUILDING: EXPERIENCES OF SMALL ISLAND STATES IN THE PACIFIC REGION

1. ROLE OF FISCAL POLICY IN RESILIENCE BUILDING: EXPERIENCES OF SMALL ISLAND STATES IN THE PACIFIC REGION T.K. Jayaraman University of the South Pacific FIJI ISLANDS

2. INTRODUCTION PACIFIC ISLAND COUNTRIES (PICs): PRONENESS TO NATURAL DISASTERS: GEOGRAPHIC LOCATION HIGH DEGREE OF ECONOMIC OPENNESS DEPENDENCY ON STRATEGIC IMPORTS & NARROW RANGE OF EXPORTS VOLATILITY IN EXPORT EARNINGS CHALLENGES OF INCREASED GLOBALISATION WEAK CAPACITY TO WITHSTAND THE RISKS EXAMPLES OF SUCCESSFUL SMALL STATES: NURTURING ECONOMIC RESILIENCE THRU SOUND MACROECONOMIC MANAGEMENT FISCAL POLICY’S ROLE IN ENSURING MACROECONOMIC STABILITY

3. CURRENT STATUS PICs: UNCERTAIN MACROECONOMIC CONDITIONS HURTING GROWTH & HALTING PROGRESS TOWARDS ACHIEVING MILLENNIUM DEVELOPMENT GOALS AVERAGE ANNUAL GROWTH RATES IN PER CAPITA REAL INCOME DURING 1995-2004 LESS THAN 2%: REQUIRED GROWTH RATE FOR HALVING INCIDENCE OF POVERTY BY 2015 EXTERNAL SHOCKS & DECLINE IN TERMS OF TRADE VOLATILITY IN AID & NATURAL RESOURCE RENT INCOMES: REVENUE FROM FISHING LICENSES

4. CURRENT CONDITIONS Contd… DISCONTINUANCE BY END OF 2007 OF PREFERENTIAL TREATMENT BY EU FOR SUGAR & PRIMARY EXPORTS SLOW PACE IN RESTRUCTURING :IMPROVING FARM PRODUCTIVITY & RAISING FACTORY EFFICIENCY DELAYS HAVE PROVED COSTLY FALLING EXPORT EARNINGS & HIGH IMPORT PENETRATION SHARES WITH LITTLE DIVERSIFICATION INTO ANY MANUFACTURING POSSIBILITIES WIDENING TRADE GAPS

5. POLICYTOOLS NURTURING RESILIENCE THRU MACROECONOMIC STABILITY POLICY TOOLS: EXCHANGE RATE (ER), FISCAL & MONETARY POLICIES FIXED ER REGIMES: MONETARY POLICY LESS EFFECTIVE: NASCENT MONEY & CAPITAL MARKETS: WEAK TRANSMISSION MECHANISMS PICs USING CURRENCIES OF US/AUS/NZ AS LEGAL TENDER: LESS MANOEUVERABILITY:NO CONTROL OVER EXCHANGE RATES DOLLARISATION: GAIN OF FISCAL DISCIPLINE DID NOT MATERIALISE DOLLARISED RMI, FSM & PALAU: COMPACT FUNDS: BUDGET SUPPORT ALL PICs: STAGNANT REVENUES, VOLATILITY IN AID & NATURAL RESOURCE RENT INCOMES WIDENING BUDGET & CURRENT ACCOUNT DEFICITS

6. Source: Author’s Calculations Asian Development Bank (2006)

7. Source: Author’s Calculations Asian Development Bank (2006)

8. Source: Author’s Calculations Asian Development Bank (2006)

9. STRUCTURAL RIGIDITIES IN BUDGETS PERSISTENT FISCAL DEFICITS: ATTRIBUTED TO STRUCTURAL RIGIDITIES IN THEIR BUDGETS NARROW REVENUE RESOURCE REVENUE: TAXES ON TRADE SUBJECT TO VOLATILITY TAX REVENUES OF PICs AVERAGE 17% TO 25% OF GDP VANUATU: NO DIRECT TAXATION: PURE TAX HAVEN: REVENUE DOMINATED BY INDIRECT TAXES ON CONSUMPTION OF GOODS & SERVICES, EXCISE & VAT OTHERS: DIRECT TAXES, EXCEPT FOR PNG: 10% OF GDP

10. STRUCTURAL RIGIDITIES IN BUDGETS Contd… SHARES OF NONTAX REVENUES IN GDP: LARGER IN KIRIBATI AND TUVALU. THEY RANGED FROM 50% TO 54 %. 2006: FISHING LICENSE FEES ACCOUNTED FOR 87% OF KIRIBATI’S NONTAX REVENUES & 43% OF TOTAL GOVERNMENT REVENUES. RESOURCE RENT INCOME RECEIPTS VARIED FROM YEAR TO YEAR HIGH VOLATILITY IN TOTAL GOVERNMENT REVENUES OF KIRIBATI RMI, FSM & PALAU: RECEIVING COMPACT FUNDS FROM USA GOVERNMENT REVENUES: 69 % of GDP IN RMI & 72 % IN PALAU

11. RIGIDITIES IN GOVT EXPENDITURE EXP RATIOS: KIR 123% OF GDP; FSM 74% & RMI: 84% PICs WITH SMALL POPULATION: UNABLE TO REALISE SCALE ECONOMIES IN PROVISION OF PUBLIC GOODS AND SERVICES. US GENERAL ACCOUNTING OFFICE: COMPACT FUNDS: RMI & FSM FINANCED WAGES & GOVT CONSUMPTION FAILED TO REALISE COMPACT OBJECTIVES: SELF-RELIANCE FIJI: GOVT WAGE BILL: 45 % OF TOTAL EXPENDITURE. OPERATING EXP INCLUSIVE OF WAGES: 80% OF BUDGET HIGH PROPORTION OF RECURRENT EXPENDITURS: DENYING ALLOCATION TO GROWTH ENHANCING CAPITAL PROJECTS

12. TABLE 4: FISCAL VULNERABILITY INDICATORS OF SELECTED COUNTRIES (2001-2005)(in percent of GDP, unless otherwise indicated)

13. TABLE 4: FISCAL VULNERABILITY INDICATORS OF SELECTED COUNTRIES (2001-2005)(in percent of GDP, unless otherwise indicated)

14. TABLE 4: FISCAL VULNERABILITY INDICATORS OF SELECTED COUNTRIES (2001-2005)(in percent of GDP, unless otherwise indicated)

15. TABLE 4: FISCAL VULNERABILITY INDICATORS OF SELECTED COUNTRIES (2001-2005)(in percent of GDP, unless otherwise indicated)

16. TABLE 4: FISCAL VULNERABILITY INDICATORS OF SELECTED COUNTRIES (2001-2005)(in percent of GDP, unless otherwise indicated)

17. TABLE 4: FISCAL VULNERABILITY INDICATORS OF SELECTED COUNTRIES (2001-2005)(in percent of GDP, unless otherwise indicated)

18. TABLE 4: FISCAL VULNERABILITY INDICATORS OF SELECTED COUNTRIES (2001-2005)(in percent of GDP, unless otherwise indicated)

19. TABLE 4: FISCAL VULNERABILITY INDICATORS OF SELECTED COUNTRIES (2001-2005)(in percent of GDP, unless otherwise indicated)

20. TABLE 4: FISCAL VULNERABILITY INDICATORS OF SELECTED COUNTRIES (2001-2005)(in percent of GDP, unless otherwise indicated)

21. TABLE 4: FISCAL VULNERABILITY INDICATORS OF SELECTED COUNTRIES (2001-2005)(in percent of GDP, unless otherwise indicated)

22. FISCAL VULN. INDICATORS (Contd) OVERALL FISCAL BALANCES: NEGATIVE EXCEPT IN RMI: RECEIVING SUPPORT UNDER COMPACT I & II. AVERAGE NEGATIVE OVERALL BALANCE: (2000-2005) KIRIBATI: 20% OF GDP; VANUATU : 7% & FIJI: 5% OF GDP KIRIBATI: DEFICITS FINANCED BY SUBSTANTIAL DRAWDOWN FROM REVENUE EQUALISATION RESERVES FUND (RERF) IN TUVALU BY SIMILAR RECOURSE TO TUVALU TRUST FUND (TTF) FIJI’S FISCAL DEFICITS: ENTIRELY FINANCED BY DOMESTIC BORROWING UNTIL 2005 2006: FIJI RESORTED TO INTERNATIONAL BOND MKT

23. MONETISATION CENTRAL BANK MONETISATION: NOT UNCOMMON DEFICITS IN PNG, SOLOMONS & VANUATU: DEFICITS FINANCED THROUGH CENTRAL BANK BORROWING PNG’S BUDGET DEFICITS MID 1990S: DUE TO DEFENCE SPENDING ON BOUGAINVILLE, TAX REDUCTIONS, AGRICULTURAL SUBSIDIES, & PERSISTENT EXPENDITURE OVERRUNS: MONETISED BY ITS CENTRAL BANK VANUATU’S UN-SUBSCRIBED BONDS FOR BUYING AIRCRAFT FOR AIR VANUATU WERE PICKED UP BY RESERVE BANK OF VANUATU

24. FINANCING FISCAL DEFICITS DOMESTIC BORROWING & LOANS FROM ADB & WB FIJI: NOT ELIGIBLE FOR BORROWING ON CONCESSIONAL TERMS OTHER PICS: TOOK LOANS FROM ADB & WB GOVERNMENT DEBT IN MOST PICs IS EXTERNAL SAMOA’S GOVERNMENT HIGH AT 50% OF GDP IN 2005, DEBT-SERVICING COSTS: LESS THAN 8% OF XGS FIJI’S FISCAL DEFICITS: 2001-06: DOM BORROWING

25. FINANCING FISCAL DEFICITS Contd… FIJI’S TOTAL GOVERNMENT DEBT IN 2006 WAS 53% OF GDP WITH CONTINGENT LIABILITIES PUBLIC DEBT: CLOSE TO 60% OF GDP FIJI’S EXTERNAL DEBT: LOW AT AROUND 11% OF GDP UNTIL 2006 MINIMAL OVERSEAS BORROWING SEPT 2006: FIJI’S FIRST BOND ISSUE IN INTL BOND MARKET FOR US$ 150 MILLION: LOAN PROCEEDS FOR MEETING 2007 BUDGET DEFICIT REQUIREMENTS

26. TWIN DEFICITS FISCAL DEFICITS: LEAD TO RISE IN AGGREGATE DEMAND SPILLS OVER INTO DEMAND FOR FOREIGN GOODS AND SERVICES BUT FOR SUBSTANTIAL AID INFLOWS AND REMITTANCES, CURRENT ACCOUNT BALANCES IN PICS WOULD HAVE BECOME NEGATIVE & LARGE TABLE 5 PRESENTS BUDGET, TRADE & CA DEFICITS PNG:COMMODITY PRICE BOOMS & HIGH EXPORT EARNINGS IN RECENT YEARS WITH TRADE SURPLUS SOLOMONS: ANOTHER EXCEPTION: PLENTIFUL AID DURING 2001-2004 OTHER 4 MAJOR PICs : SIZEABLE CURRENT ACCOUNT DEFICITS

28. TWIN DEFICITS (contd) CA DEFICITS: FINANCED UNDER FIXED EXCHANGE RATE REGIMES BY A STEADY DRAWDOWN OF THE INTERNATIONAL RESERVES. WEAKENING FIJI’S RESERVES: FROM 6.3 MONTHS OF IMPORT COVER IN 2002 TO 3.2 MONTHS OF IMPORTS COVER IN 2006. PRESSURES ON FIJI DOLLAR: DEVALUATION RUMOURS RESERVE BANK OF FIJI IMPOSED IN DECEMBER 2006 EXCHANGE CONTROLS CREDIT CEILINGS & INCREASES IN INTEREST RATES.

29. SIGNS OF MACROECONOMIC INSTABILITY FIJI’S 2006 SITUATION: SIMILAR TO PNG CONDITIONS IN 1990s PNG’S EXPANSIONARY FISCAL POLICIES FOR 4 YEARS PRECEDING 1997 ELECTIONS: TAX REDUCTIONS, AGRICULTURAL EXPORT SUBSIDIES, PERSISTENT EXPENDITURE EXCESSES AND HEAVY TRANSFERS TO UNVIABLE SOEs MASSIVE ANNUAL BUDGET DEFICITS IN A ROW PNG GOVT DEBT: ROSE TO 60% OF GDP IN 1996 FROM 45% IN 1990 BALANCE OF PAYMENT CRISES ENSUED

30. MACROEC INSTABILITY:PNG (contd) 1996: INTL RESERVES FELL TO HALF-MONTH OF IMPORTS SWITCHED ON TO FLOATING EXCHANGE RATES REGIME EXTERNAL STABILITY: ONLY FOR A SHORT PERIOD CONTRACTION IN EXPORTS: DROUGHT IN 1997 & ASIAN FIN. CRISIS ANOTHER CURRENT ACCOUNT CRISIS 1999: BUDGETARY REFORMS BEGAN FOR RESTORING STABILITY MONTHS LEADING UP TO 2002 ELECTIONS: FISCAL EXCESSES BY GOVERNMENT 2002-2004: DETERIORATION OF BUDGET & CURRENT ACCOUNT BALANCES 3 YEARS OF NEGATIVE GROWTH 2005: SENSIBLE POLICIES & MINERAL EXPORT BOOM 2006: INTL. RESERVES: 5 MONTHS IMPORT COVER: RECORD LEVEL

31. SOLOMON ISLANDS CASE SOLOMON IS: 3 DECADES OF FISCAL DEFICITS SINCE 1978 STAGNANT REVENUES: TAX & CUSTOMS EXEMPTIONS RISE IN RECURRENT EXPENDITURES: WAGES & SALARIES: TRANSFERS TO LOCAL GOVTS & WEAK EXPENDITURE CONTROLS. SHORT LIVED RECOVERY ON CURRENT ACCOUNT: 1990-95 LOGGING & LOG EXPORTS: DID NOT LAST LONG 1998: ASIAN FINANCIAL CRISIS 1999: ETHNIC CONFLICT: NEGATIVE GROWTH FOR 3 YEARS FALL IN REVENUES & DECLINE IN EXPORTS 2001: FISCAL DEFICIT: 12% OF GDP

32. SOLOMON ISLANDS CASE (Contd) RESERVES LEVEL IN 2001: 2 MONTHS OF IMPORT COVER 2002: REGIONAL ASSISTANCE MISSION TO SOLOMON ISLANDS DONORS SETTLED DEBT SERVICING OBLIGATIONS TO INTL AGENCIES. IMPROVEMENTS IN FISCAL MANAGEMENT SINCE 2003 STABILISED THE ECONOMY & FISCAL POSITION CONDITIONS : NOT VERY DISSIMILAR TO THE ONES OBSERVED IN CARIBBEAN CONTEXT IN MID 1990S (HILAIRE 2000): EXTERNAL CURRENT ACCOUNTS SLIPPING INTO DEFICITS; FOLLOWED BY THE PLUMMETING OF FOREIGN RESERVES; WITH SPECTRE OF DEFAULT ON FOREIGN LOANS LOOMING; AND EXCHANGE RATES BEING UNDER THREAT.

33. WAY OUT: FISCAL ADJUSTMENT PROGRAM BROADER DEFINITION: FISCAL ADJUSTMENT WOULD MEAN CHANGE IN FISCAL STANCE EITHER TIGHTENING OR LOOSENING TERM FISCAL CONSOLIDATION HAS A DIRECT CONNOTATION REDUCING GOVT.DEFICIT & DEBT ACCUMULATION FISCAL ADJUSTMENT FACILITATES EXTL ADJUSTMENT

34. EXPERIENCES IN INDUSTRIAL COUNTRIES GENUINE FEARS : IMPACT OF FISCAL ADJUSTMENT IN SHORT-RUN: POTENTIAL TO TRIGGER A RECESSION INVESTIGATIONS OF SUSTAINED CONSOLIDATION EXPERIENCES IN INDUSTRIAL COUNTRIES (McDERMOTT AND WESTCOTTT 1996A): LOSS FROM SLOWDOWN IN THE SHORT-RUN IS OFFSET BY GAINS IN THE LONG RUN. NON-KEYNESIAN EC. LITERATURE: SUSTAINED FISCAL ADJUSTMENT IN TERMS OF BUDGET & DEBT REDUCTION WOULD RESULT IN LOWER INTEREST RATES EXCHANGE RATE DEPRECIATION GIVE RISE TO “POSITIVE EXPECTATIONAL EFFECTS” THAT WOULD SWAMP UNDESIRABLE EFFECTS OF FISCAL CONTRACTION

35. ARGUMENT IN FAVOUR OF REDUCED SPENDING SMALLER BUDGET REDUCES THE PERCEIVED RISK THAT A GOVERNMENT MIGHT DEPRECIATE ITS DEBT THRU HIGH INFLATION IN THE FUTURE (PAYING OFF DEBT WITH CHEAPER MONEY) REDUCTION IN THE PERCEIVED RISK LEADS TO FALL IN INTEREST RATES REDUCTION IN DEFAULT RISK PREMIUM INTEREST RATES BUDGET REDUCTION IMPROVES IMAGE OF GOVERNMENT SOLVENCY

36. REDUCED SPENDING (contd) COMPRESSION OF EXPENDITURE BY REDUCING SALARIES & WAGES WILL HAVE AN IMPACT ON PRIVATE SALARIES WOULD RAISE PROFITABILITY & COMPETITIVENESS, THUS STIMULATING INVESTMENT & EXPORTS BUDGET REDUCTION: SIGNALS TO HOUSEHOLD & BUSINESSES: FUTURE TAX BURDENS WOULD BE LOWERED, AS DEBT FINANCING BY GOVERNMENT WOULD DECLINE HOUSEHOLDS WOULD THEN INCREASE CONSUMPTION & BUSINESS WOULD INCREASE INVESTMENT SPENDING EVENTUAL OUTCOME: AN INCREASE IN OUTPUT

37. FISCAL CONSOLIDATION MEASURES INCLUDE EFFECTIVE EXPENDITURE CONTROL & MONITORING EFFICIENT REVENUE SYSTEM MEASURES FOR RESPONDING TO CHANGING NON-TAX REVENUE RECEIPTS & VOLATILE AID INFLOWS RE-DIRECTING SAVINGS INTO CAPITAL PROJECTS BY REDUCING RECURRENT EXPENDITURES CAREFUL DEBT-MANAGEMENT MAINTAINING COMPETITIVE REAL EXCHANGE RATE : EXTERNAL DEBT SERVICING DOES NOT POSE PROBLEMS IN THE LONG RUN.

38. EFFECTIVE EXPENDITURE CONTROL SINCE REVENUE MOBILIZATION IS CONSTRAINED BY RIGIDITIES, FOCUS ON EFFECTIVE EXPENDITURE ADJUSTMENTS REDUCE THE WAGE BILL OVERCOME RELUCTANCE TO DOWNSIZE CIVIL SERVICE, WITH GHOST-EMPLOYEES ON ITS ROLL & HIGH RATE OF ABSENTEEISM. BUDGETARY EXERCISES: UNREALISTIC FORWARD ESTIMATES: EITHER UNDER ESTIMATES FOR O & M OF EXISTING ASSETS OR OVER ESTIMATES FOR NEW CAPITAL PROJECTS PICs ARE “LITTERED LITERALLY WITH BUDGET PREPARATION MANUALS” (HUGHES 2003) LACK OF SUSTAINED CAPACITY BUILDING EFFORTS, OFTEN ADVERSELY AFFECTED BY LARGE TURN OVER OF KEY PERSONNEL

39. EFFECTIVE EXPENDITURE CONTROL Contd… 2001-04: PNG’S FISCAL CONSOLIDATION: CONTINUOUS FOR 4 YEARS RESULTS : 3 YEARS IN A ROW: POSITIVE FISCAL BALANCE, MEETING ALL DOMESTIC & EXTERNAL INTEREST PAYMENT OBLIGATIONS. IN 2006: REDUCING NUMBER OF DEPARTMENTS WAS POSTPONED TO A LATER DATE AFTER THE 2007 GENERAL ELECTIONS SHORTLIVED CONSOLIDATION EPISODES IN OTHER PICs FIJI: PERIODICAL TIGHTENING OF PUBLIC EXPENDITURES: EFFECTS OF COUPS: CUTS IN WAGE & SALARY BILL TIGHTENING PROVED UNPOPULAR, REVERSED AFTER SOME TIME DISRUPTED FISCAL ADJUSTMENT EFFORTS BOUND TO FAIL WITHOUT ANY LASTING IMPACTS [(GUPTA ET AL. (2004)].

40. EFFICIENCY IN REVENUE MOBILIZATION NEED OVERHAULING SIMPLIFICATION OF THE TAX SYSTEM REVIEW OF TAX INCENTIVES IN ALREADY FLOURISHING ACTIVITIES, LIKE TOURISM FOREIGN INVESTORS ARE INFLUENCED BY OTHER FACTORS TAX FACTORS ARE FAR FROM THE MAIN CONCERN IN DECIDING WHERE TO PLACE THEIR FUNDS ( DANIEL ET AL. 2006)

41. EFFICIENCY IN REVENUE MOBILIZATION (contd) MINISTERIAL DISCRETIONARY AD HOC EXEMPTIONS FROM CUSTOM & IMPORT DUTIES, TAX HOLIDAYS BE DISCONTINUED SUSPECTED CASES OF CORRUPTION THEY UNDERMINE INTEGRITY AND REVENUE POTENTIAL PICs: HEAVILY DEPENDENT ON IMPORT AND EXPORT DUTIES REVENUE IMPLICATIONS OF FREE TRADE BY 2010 REFORMS FOR ADDRESSING LIKELY FALL IN TAX REVENUES.

42. EFFICIENCY IN REVENUE MOBILIZATION Contd… RECOMMENDED: (I) CONVERSION OF SELECTED IMPORT DUTIES TO EXCISE TAXES, WHICH ARE WTO INCOMPATIBLE (II) BROADENING TAX SYSTEM BY INTRODUCING CONSUMPTION BASED TAXES, SUCH AS VALUE-ADDED TAXES (VAT) HALF THE COUNTRIES IN THE REGION HAVE INTRODUCED VAT IMF STUDY: VAT ADMINISTRATION COULD BE IMPROVED BY FASTER PROCESSING OF REBATES, IMPROVED COMPLIANCE AT PORTS (WHERE MOST REVENUE IS COLLECTED) & CAPACITY FOR CONDUCTING AUDITS. VANUATU: NEED FOR DIRECT TAXATION:DECLINING IMP of OFC. REDUCE REGRESSIVITY OF INDIRECT TAXES INCREASE IN REVENUE MOBILISATION CONTRIBUTES TO STRENGTHEN FISCAL CONSOLIDATION EFFORTS (GUPTA 2004)

43. RESPONDING TO VOLATILITY IN NON-TAX REVENUE RECEIPTS & AID REVENUES FROM FISHING LICENSES: BE DEPOSITED IN TRUST FUNDS IN KIRIBATI & IN TUVALU PRESENTLY A MULTIYEAR CONTRACT IS NEGOTIATED WITH FISHING NATIONS THAT INVOLVE A FIXED YEARLY PAYMENT OVER THE TERM OF THE CONTRACT THERE IS AN ASYMMETRY OF INFORMATION INVOLVED ABOUT THE LIKELY CATCH AND THE LIKELY PRICE THE COUNTRY OWNER OF OFFSHORE FISHING FIRMS SHOULD BE ASKED TO BID AGAINST EACH OTHER THROUGH AN AUCTION FORCE THEM TO BE “TRUTHFUL” ABOUT THEIR LIKELY CATCH. IN EXCHANGE FOR A FIVE YEAR FISHING CONTRACT, FIRMS SHOULD BE ASKED TO BID A FIVE YEARLY STREAM OF PAYMENTS, WHICH WOULD ENSURE MAXIMUM ACCESS FEES AS THE PRESENT LICENSE FEES ARE WELL BELOW THE “TRUE RESOURCE RENT” (DUNCAN AND TEMU 1997).

44. RESPONDING TO VOLATILITY IN NON-TAX REVENUE RECEIPTS & AID Contd… TO SAFEGUARD TRUST FUNDS: LIMIT ANNUAL DRAWDOWNS FOR KEEPING PER CAPITA REAL VALUE OF ASSETS KIRIBATI’S PARLIAMENT HAS LAID DOWN VALUE OF RERF BE KEPT CONSTANT THERE WAS NO REQUIREMENT OF PRIOR APPROVAL OF THE PARLIAMENT TO EXCESS DRAWDOWNS. KIRIBATI: CONSIDER APPROPRIATE LEGISLATIVE AMENDMENTS IN PUBLIC FINANCE MGMT ACT

45. RE-DIRECTING MONEYS INTO CAPACITY BUILDING INVESTMENTS REDUCTION IN WAGE BILL, SUBSIDIES & TRANSFERS: SUBSTANTIAL ANNUAL SAVINGS REDIRECTING FUNDS SO SAVED FROM RECURRENT EXPENDITURES INTO CAPITAL OUTLAYS IS POSITIVELY RELATED TO PERSISTENCE OF FISCAL ADJUSTMENT (GUPTA ET AL. 2004) SAMOA’S EXPERIENCES RELEVANT: CIVIL SERVICE REFORMS 2001-2003: N0.OF MINISTRIES REDUCED:28 TO 13

46. RE-DIRECTING MONEYS INTO CAPACITY BUILDING INVESTMENTS Contd… REDUCTIONS IN STAFF: NATURAL ATTRITION & FREEZING VACANCIES WAGE BILL OF SAMOA IS WELL BELOW THAT OF PICs FISCAL CONSOLIDATION ENABLED SAMOA TO REDIRECT MORE FUNDS FOR INVESTMENT PROJECTS LONGER PERIOD FISCAL CONSOLIDATION HAD LASTING IMPACTS COMPOSITION OF PUBLIC EXPENDITURE: DIFFERENT FROM PICs 2006: BUDGET DEFICIT OF 0.4% OF GDP

47. DEBT-MANAGEMENT DOMESTIC BORROWING FOR FINANCING FISCAL DEFICITS LARGE SCALE IN FIJI & PNG FIJI: GOVERNMENT DEBT: INCLUDING CONTINGENT LIABILITIES CLOSE TO 60% OF GDP DUE TO EXPANSIONARY POLICIES OF 2001-2006 PNG‘S GOVT DEBT LEVEL DECREASED OVER 4-YEAR PERIOD:73% OF GDP IN 2002 TO 51% IN 2005; & 42% IN 2006. EXTERNAL DEBT LEVEL ALSO DECREASED: 21% OF GDP IN 2006 REDUCTIONS IN DEBT LEVELS: DUE TO FISCAL CONSOLIDATION EFFORTS SINCE 2001

48. EXTERNAL DEBT PICs OTHER THAN FIJI: ELIGIBLE FOR BORROWING FROM INTERNATIONAL FUNDING AGENCIES ON CONCESSIONAL TERMS PICs UTILIZED THE OPPORTUNITY IN THE PAST TO BORROW FROM ADB AND THE WORLD BANK FOR SEVERAL CAPITAL PROJECTS. PICs HAVE TO EARMARK BUDGETARY SAVINGS FOR DEBT SERVICING BURDEN. EXTERNAL DEBT SERVICING NEEDS TO ENSURE ADEQUATE PROVISION FOR FOREIGN EXCHANGE. CASES OF DEFAULTS IN THE 1990S: SOLOMON ISLANDS RMI FAILED IN 2006 TO MEET DEBT SERVICE REQIREMENTS ESTIMATES OF DEBT SUSTAINABILITY IN RMI: NET PRESENT VALUE OF EXTERNAL DEBT TO GDP RATIO IS 80% & DEBT SERVICE AS PROPORTION OF EXPORTS AT 78%. AN ADB STUDY ON RMI (2007): EVEN IF NO NEW EXTERNAL DEBT WERE INCURRED, DEBT SERVICE WOULD INCREASE OVER THE NEXT FIVE YEARS.

49. EXTERNAL DEBT (contd) SAMOA’S EXT DEBT WAS IN EXCESS OF 100% OF GDP IN MID 1990S FISCAL CONSOLIDATION: 1999-2003: REDUCTION IN DEBT STOCK 2006: 36% OF GDP IMF 2005 DEBT SUSTAINABILITY STUDY: ISOLATED SHOCKS WILL NOT SERIOUSLY AFFECT THE DEBT RATIO COMBINATION OF SHOCKS: VOLATILITY IN AID & REMITTANCES & HIKES IN OIL PRICE MIGHT RAISE DEBT LEVEL (ADB 2007). VANUATU: PARLIAMENT DEFINED THE “PRUDENT LEVEL” OF EXTERNAL DEBT/GDP RATIO AT 40% & DEBT SERVICE/DOMESTIC REVENUE RATIO AT 8% OF GDP OTHERS CONSIDER ADOPTING SIMILAR RESTRICTIVE LEGISLATION?

50. MAINTENANCE OF COMPETITIVE REAL EXCHANGE RATE EXTERNAL DEBT-SERVICING: GROWTH IN EXPORTS IS CRITICAL FISCAL DEFICITS RESULT IN INFLATIONARY PRESSURES WILL RAISE REAL EXCHANGE RATES RENDERING EXPORTS & TOURISM LESS COMPETITIVE AVOID SUBSTANTIAL AMOUNTS OF OFFICIAL TRANSFERS BEING DIVERTED TO FINANCING HIGHER WAGE BILL & RECURRENT EXPENDITURES, EITHER BUDGETED OR UNBUDGETED. INSTANCES OF ADDITIONAL, HIGHER ADJUSTMENTS IN SALARIES: COST OF LIVING ADJUSTMENTS (COLA) & GOVT CONSUMPTION OF LOCAL GOODS AND SERVICES SO CALLED “DUTCH DISEASE” EFFECT: PUSHING REAL EXCHANGE RATE: ADVERSE IMPACT ON EXPORTS