Economic growth rests on successful elections
The International Monetary Fund (IMF) has concluded its Article IV Consultation Mission with Fiji. It concluded that after a period of sluggish growth economic activity is picking up and the near-term outlook is broadly favourable.
The Fund does note that much rests on successful elections in 2014 and states that “Under a scenario of successful elections in 2014, both domestic and foreign investment is expected to pick up significantly as political uncertainty is reduced. However, the economy urgently needs to boost investor confidence and expand its capacity to accommodate increased private sector investment”.
The full press release as published on the IMF website is as follows:
“Republic of Fiji—Concluding Statement of the 2013 Article IV Consultation Mission
August 19, 2013
This document summarizes the preliminary findings of the 2013 Article IV consultation mission, which took place in Nadi, Lautoka and Suva during August 1—15, 2013. 1 The mission met with the Prime Minister and Minster for Finance, Attorney General and Minister for Public Enterprises, Industry and Trade, Governor of the Reserve Bank of Fiji, and Permanent Secretary of Finance; other officials from the government, the Reserve Bank of Fiji (RBF), and key state-owned enterprises; and representatives from the private sector, academia, development partners, and civil society.
After a period of sluggish growth, economic activity has picked up. Growth in 2012 increased to 2¼ percent supported by income tax cuts, low interest rates, rising investment and the one-time pay-outs under the Fiji National Provident Fund (FNPF) reform in 2012, which offset the negative impact of the severe floods and Cyclone Evan on the agriculture and tourist sectors. Inflation declined as imported commodity and food prices moderated and inflationary pressures are subdued. On the fiscal side, the debt-to-GDP ratio continued to decline in 2012 with a lower-than-budgeted deficit of 1 percent of GDP. The financial sector is stable and international reserves have stabilized at 5-months of imports.
The near-term outlook is broadly favourable. Economic growth is set to increase to around 3 percent in 2013. The latest available consumption indicators suggest accelerating momentum in the first half of 2013 as consumers have increased consumption using the boost to disposable income and through increased borrowing. These effects are likely to taper off somewhat in the latter part of 2013. As a result of this above-potential growth, the slack in the economy is estimated to narrow. In 2014, growth is projected to moderate to 2¼ percent, in line with estimated potential.
Risks to the outlook stem both from domestic and external factors. Domestic risks stem largely from the complex political situation as Fiji prepares for elections in 2014, and delays in further implementation of structural reforms. On the external side, regional tourism spending may be adversely affected by the economic slowdown in Australia and the appreciation of the Fiji dollar against the Australia and New Zealand currencies. Moreover, Fiji continues to be susceptible to natural disasters, requiring the maintenance of macroeconomic policy buffers.
In the event that risks to the Fijian economy materialize, allowing the automatic stabilizers to operate would be the first line of defense. If the downturn persists, there is scope for limited fiscal stimulus. Monetary policy will be of limited effectiveness given that policy rates are near the zero-lower bound and the weak transmission mechanism. On the upside, a successful implementation of democratic elections in 2014 could trigger a surge in foreign investment and development aid. To take advantage of the benefits of increased foreign direct investment, it is urgent to accelerate the implementation of structural reforms to alleviate supply side constraints and boost the absorptive capacity in the economy so as to avoid bidding up asset prices and wages of skilled workers in short supply.
B. Policies to Raise Potential Growth and Reduce Vulnerability to Shocks
The macroeconomic situation has improved and the current configuration of macroeconomic policies is broadly appropriate. However, there is no time for complacency. Fiji can do better. The current environment is a rare window of opportunity to address deep-seated structural issues and lay the foundation for higher and broad-based growth that is inclusive and sustainable.
Fiji is a richly endowed economy but growth has remained slow over the past decades owing to political instability, susceptibility to external shocks, and slow progress on structural reform. The authorities have accelerated reforms in recent years, but the key policy challenge remains to raise the potential growth rate and increase resilience to shocks. Unemployment, at nearly 9 percent, remains stubbornly high with the youth and underemployment even higher. Emigration pressures continue, especially among the higher skilled. The need for faster and deeper structural reform is urgent to boost investor confidence, reduce the economy’s supply bottlenecks and raise the absorptive capacity in order to take full advantage of a potential increase in foreign and domestic investment following the planned elections in 2014.
Monetary and financial policies
In view of low inflation and downside risks to the growth outlook, the accommodative monetary policy stance is appropriate, but the monetary transmission mechanism remains weak. Despite RBF’s policy easing, real lending rates remain high and margins in the banking sector are sizable. There are signs that the policy easing is slowly leading to lower lending rates and credit growth has picked up. New entrants to the banking sector have encouraged competition and it could potentially improve the transmission of monetary policy.
The recent pickup in credit growth—albeit from low levels—warrants close monitoring. The strong growth in loans for consumption purposes and vehicle imports likely reflects a one-time consumption increase due to the permanent tax cuts that has led to higher disposable income, as well as aggressive marketing by banks. Real estate lending is also brisk and real estate prices, particularly of free-hold land, have increased, although the picture is clouded by the lack of comprehensive house price data. The RBF is urged to monitor sectoral developments closely, including enhanced data collection and surveillance of sectors with rapid credit growth. In case of rekindled and broad-based inflationary pressures, the RBF should use open market operations more aggressively to reduce excess liquidity and, if necessary, tighten policy rates.
The financial sector is generally well regulated. The banking sector is well capitalized and most banks have low NPLs. While the RBF has improved supervision, there is scope for further progress in improving stress testing and scenario analysis. Good progress has been made on the 2006 Financial Sector Assessment Program (FSAP) recommendations but in view of the time elapsed since the last FSAP; the authorities are encouraged to consider requesting an update.
Initiatives to broaden financial access are welcome. The RBF has recently introduced a small- and medium-sized enterprise loan guarantee scheme, established sector lending ratios for banks, and encouraged micro-finance operations. However, the international experience with sectoral lending targets is mixed and can lead to a misallocation of resources. In the context of providing increased financial access, particularly to the agricultural sector and small & medium enterprises, the Fiji Development Bank should focus on its core mandate to expand access to financial services but the lending criteria should be implemented transparently and with clear budgetary support.
The fiscal policy stance in the 2013 budget is appropriate. Fiji’s fiscal policy continues to balance the need to strengthen the fiscal position against the need to increase public investment to enhance the growth potential. The increase in public investment, especially upgrading the inadequate infrastructure, is appropriate to support growth, if administered effectively. The cabinet-endorsed plan to keep the fiscal deficits small (2 percent of GDP in 2014; 1.5 percent in 2015; and 1 percent in 2016) implies primary surpluses, a declining debt ratio, and limited roll-over risk since most of the public debt is domestic.
Tax revenues have been boosted by increased consumption, but may prove less buoyant in the period ahead. The reduction in income tax rates has resulted in sharply lower direct tax revenue in 2012 and thus far in 2013. This decline has so far been largely offset by buoyant VAT collection, including contributions driven by one-off factors such as increased VAT arrears collection efforts and the temporary consumption boost. Based on revenue and expenditure developments in the first half of 2013, the deficit target of 2.8 percent of GDP in 2013 appears to be on track to be comfortably met. Looking ahead, revenue buoyancy in 2014 may prove somewhat lower as the effect of one-off factors that have contributed to higher revenues tapers off. In such a case, imposition of intrusive ad hoc taxes and administrative fees to meet deficit targets should be avoided because such measures would damage business confidence. On the expenditure side, expenditure restraint should be focused on non-interest recurrent spending rather than capital spending.
Recent direct tax cuts are growth friendly, but need to be accompanied by base-broadening measures. Base-broadening measures are needed as abundant use of income-tax holidays and tax incentives have hollowed out the direct tax revenue base and discretionary tax concessions should be curbed. To better assess the cost and benefit of sector-specific incentives, the authorities are encouraged to enhance the cost-benefit analysis and reporting of the incentives. Further reducing the scope for discretionary concessions would make the system more transparent and create fiscal space for well-targeted investment incentives. The corporate income tax rate has been lowered significantly to 20 percent over the past few years and should not be lowered further.
Public debt has declined and is broadly sustainable. Public debt stood at just above 50 percent of GDP in 2012, down from 54.7 percent in 2010. In addition, contingent liabilities, largely on account of state-owned enterprises, remain in excess of 15 percent of GDP. The preliminary debt sustainability analysis indicates that public debt is sustainable, but points to some caution on external financing. Fiji’s external debt remains low from a regional perspective, but it has increased rapidly recently, largely reflecting the US-dollar denominated sovereign bond issued in 2011, and increased reliance on bilateral loans from non-traditional sources for infrastructure financing. The financing terms of these loans are long-term and the interest rates appear lower compared with market rates, but the total cost of the project (including specified suppliers and other captive costs) should be evaluated.
Debt management strategies should be geared to preserving policy options. The US$250 million sovereign bond issued in 2011 matures in 2016. To maintain policy buffers and reduce the risk of being forced to roll over the bond in potentially difficult external market conditions, debt management may consider taking advantage of relatively favorable domestic financing conditions to gradually build up balances in the sinking fund (currently amounting to around US$128 million).
The FNPF reform in 2012 is commendable but some risks remain. The reform has enhanced the actuarial sustainability of the pension fund and reduced the medium-term contingent liabilities of the government. The introduction of periodic updating of actuarial assumptions every three years should fortify sustainability. The current lump-sum payout policy has resulted in only 5 percent electing more gradual payments. Despite the positive actuarial impact of the pension reform, the risk remains of an increase in government social spending in the longer term, as the lump sum payment is unlikely to support an adequate level of income over the remaining lifespan of the retirees. However, any fiscal impact would likely only materialize in the longer term. In the meantime, the authorities are encouraged to plan ahead and continue using international expertise to review the pension system.
In the medium term, structural reform to boost growth is key to create fiscal space for capital investment spending, lowering the public debt and increasing resilience to shocks. Fiji’s susceptibility to natural disasters and narrow export base suggest the need to continue building fiscal buffers to respond to adverse developments.
Exchange Rate Policy and External Balance
The competitive boost from the April 2009 devaluation has been largely eroded by creeping real exchange rate appreciation, driven by partner-country inflation differentials. The real exchange rate is now slightly higher than the level consistent with medium-term macroeconomic fundamentals.
The current stable macroeconomic environment provides a good opportunity to lay the foundation for a more flexible exchange rate regime. The exchange rate policy should be subject to periodic review and adjustments made if needed, in order to prevent creeping overvaluation. More flexible arrangements, including a wider trading band, could also be considered.
Further relaxation of capital account restrictions could be considered. By standard reserve metrics, the current level of international reserves is adequate although Fiji’s narrow export base and susceptibility to shocks would suggest the need for a relatively higher reserve target in the range of 5 months of retained imports. Capital transactions are still allowed only if the Fiji Revenue and Customs Authority (FRCA) issue a tax clearance, and such issuance is sometimes delayed. In order to ensure sustainability over the longer term, relaxation of capital controls should be accompanied by a continued strengthening of the AML/CFT regime.
Fiji is at cross-roads. The current environment is a rare window of opportunity to make a clear break with the slow growth of past decades and lay the foundation for a transition to a higher growth trajectory. This will require accelerated progress in implementing structural reform. While significant reform has been put in train over the past three years—e.g. sugarcane sector, civil service, land utilization, pension system, infrastructure improvements—a slowing down in the reform momentum now will likely stall potential growth at around 2 percent. Under a scenario of successful elections in 2014, both domestic and foreign investment is expected to pick up significantly as political uncertainty is reduced. However, the economy urgently needs to boost investor confidence and expand its capacity to accommodate increased private sector investment. In this context, relaxation of price controls, increased efficiency of land use, improved predictability and streamlining of government regulation and implementation, continued focus on infrastructure upgrades and better aligned incentives for expanding electricity production, among others, would reduce the economy’s supply bottlenecks in order to utilize productively the increase in private sector investment plans necessary to raise potential growth without fuelling price increases.
Price controls should be scaled back significantly. There may be a case for regulating a few basic commodities for the benefit of the poor, given that oligopolistic behavior is not uncommon in small economies and that it is difficult to prosecute anti-competitive practices. However, the current micromanagement of price controls distorts price signals, creates uncertainty, is costly to administer, gives vendors incentives to reduce product quality and/or supply, and reduces incentives for investment. With inflationary pressures currently low, the price controls should be scaled back to enhance competition, transparency, cost-efficiency, and predictability.
Government policy consultation and predictability should be improved. There is scope to improve communication between the government and stakeholders. The authorities are encouraged to ensure broad involvement of the private sector in the key policy decision making process. Any perceived abruptness of policy decisions may create policy uncertainty deferring long term investment decisions. Moreover, improved intra-government communication and improvement in the capacity of the middle-level management can speed up the approval process and improve the business climate. The line ministries should be discouraged from collecting fees and fines from small-to-medium sized employers (SMEs). Instead they should be encouraged to provide assistance to improve the SME’s operations and their viability, and stimulate employment generation. We encourage more participation of talents with diverse expertise, including private sector experience, in government boards, commissions and other decision making positions.
Continued sector-specific structural reforms are needed to improve the investment climate and broaden the export base. A reliable energy supply is essential to meet the increasing demands of the economy and crucial to improve the investment environment. In this context, a national energy policy that provides clear incentives for energy producers to significantly increase supply, especially in renewable energy sources like solar, is needed. The government has made good plans for reforming the sugar-cane sector, including using the by-products of sugar production for ethanol and electricity generation. However, the issue of unstable land lease, aging workers, lack of larger-scale mechanization, and obsolete and poorly maintained facilities are long-term challenges. With EU preferential purchase agreements expiring, it is imperative to continue reform efforts to ensure the industry remains competitive. Increased efficiency in utilization of land is also a key factor in facilitating investment. The recent establishment of the Land Bank is welcome, but further progress is needed in laws, policy and implementation to provide the predictable and stable supply of land on long term leasing for long-term investment.
Improved data quality is urgently needed for informed policy making. The mission urges the authorities to accelerate and expand efforts to increase data coverage and quality, particularly in the areas of balance of payments and national accounts, including GDP by expenditure, through strengthening the capacity of the Fiji Bureau of Statistics. Increased statistics provision to the public is also encouraged.
Over the longer-term, the key to raising potential growth is raising total factor productivity, which is estimated to have contracted during the period 1990-2012. Under a successful reform scenario of a drastically improved business investment climate, private sector investment can be stimulated to reverse the decline in total factor productivity, and labor as well as capital inputs can be boosted. Under this scenario, potential growth can be raised from the current 2-3 percent to about 4- 5 percent by 2020. Unemployment can be reduced through increased economic opportunities domestically, the debt-to-GDP ratio would stabilize at around 45 percent of GDP, and longer-term inflationary pressures can be mitigated through improvements in productivity. For this to materialize there is no time to lose to accelerate the structural reforms in earnest. We believe Fiji can do it.”