Mission Concluding Statement 

Tuvalu: Staff Concluding Statement of the 2021 Article IV Mission

April 26, 2021

Washington, DC: Swift implementation of containment measures, limited spillovers from tourism, and COVID-related fiscal spending financed by buoyant fishing revenues and donor grants have allowed Tuvalu—a fragile Pacific micro-state—avoid a recession in 2020. The economy is expected to expand by 2.5 percent in 2021, supported by fiscal expenditures and resumption of infrastructure projects. But significant challenges remain: Tuvalu is vulnerable to the effects of climate change, its economy is dominated by the public sector, and its revenue base is narrow. Uncertainty around donor commitments complicates fiscal planning. To meet these challenges and support a sustainable recovery, staff has encouraged the authorities to pursue the following policies:

- Maintain COVID-related fiscal measures conditional on the stage of the pandemic, expanding support to vulnerable population and the private sector in case of an outbreak, and working with development partners to procure sufficient vaccines to inoculate the whole population.

- Once the pandemic’s impact fades and the economy fully recovers, implement gradual fiscal consolidation to preserve fiscal buffers while rebuilding government’s net financial worth, using a combination of measures to mobilize domestic revenues and raise the efficiency of public spending through improved public financial management. These buffers will be needed for climate adaptation and infrastructure maintenance needs, and to guard against future shocks, especially natural disasters.

- Develop effective prudential regulation and supervision to promote health of the financial institutions and improve financial intermediation.

- Continue implementation of structural reforms to encourage diversification away from the public sector and improve access to credit.

1. Due to the swift implementation of containment measures, Tuvalu has remained COVID-free as of April 23, 2021. Aware of the significant toll that the pandemic would take on their remote community, Tuvaluan authorities reacted swiftly to the emergence of the COVID-19 pandemic, declaring the State of Emergency and banning all but essential travel. They prepared a response plan (Talaaliki Plan) and swiftly engaged with international donors to obtain emergency funding for health infrastructure, repatriation and medical supply flights, to procure vaccines, and to fund economic stimulus plan.

2. Border closures and containment measures have taken a toll on economic activity in Tuvalu, but government spending helped avoid a recession in 2020. Many infrastructure projects came to a halt as the pandemic prevented travel of international experts and impacted imports of materials. The small hospitality sector was almost entirely shut down due to the lack of tourists and business arrivals, with no domestic demand available to fill the gap. However, a favorable revenue position allowed the authorities to maintain current spending as planned and to extend additional support to the population and businesses through a COVID-19 relief package. As a result, staff estimates that the economy have grown by 1 percent in 2020 compared to 13.9 percent in 2019, with 1.6 percent inflation.

3. Despite elevated COVID-related spending, the 2020 budget is estimated to have closed with a surplus. While final numbers are not yet available, revenues from the sale of fishing licenses—the main source of government revenues—are estimated to have stood at 56 percent of GDP, almost 30 percent higher than budgeted. International donors provided additional AUD6.2 million (or 7.8 percent of GDP) of COVID-related support, although not all has been utilized. Combined with COVID-related underspending on infrastructure projects and travel, these developments allowed Tuvalu to close the 2020 fiscal year with an estimated 4.9 percent of GDP surplus.

4. Under current policies, Tuvalu will face increasing budget deficits. In 2021, staff projects the fiscal balance to shift to a 3.1 percent of GDP deficit, suggesting a worse fiscal outcome than the authorities’ updated forecast of a budget surplus, with staff’s more conservative assumptions on goods and services spending, wage bill, and travel. The expected deficit is driven by a significant increase in current spending, and by higher spending on infrastructure driven by a large outlay on a planned national airline (AUD13 million, or 16 percent of GDP). In addition, there are significant downside risks, including the lack of a timely agreement with donors on reforms underlying budget support poses risks to 2021 grant availability and fiscal outcomes and additional expenditures envisaged under the 2021 supplementary budget unless credible measures are taken to lower spending. In the medium-term, plateauing fishing and internet license revenues, together with elevated current spending, are projected to further widen the general government deficit, and gradually crowd out infrastructure spending. Total public debt remained low, at estimated 9.4 percent of percent of GDP in 2020.

5. The economy is expected to rebound in 2021. The vaccine rollout has started in April, but securing enough vaccines to inoculate the entire population will take time. As a result, partial border reopening is expected at the end of 2021 at the earliest. Nonetheless, higher current spending and gradual resumption of infrastructure projects is expected to raise growth to 2.5 percent in 2021. Growth is expected to increase to 3.5 percent by 2022, factoring in full resumption of travel, continued high public spending, and further implementation of infrastructure projects. Inflation is expected to gradually increase to 2.0 percent in 2021 and 2.5 percent in 2022.

6. Risks to the outlook are high and tilted to the downside. Prolonged containment measures would delay resumption of infrastructure projects and hamper the already-limited private sector activity. Government revenues could fall short given significant revenue risks—including from: delays in agreeing on reform priorities with donors; changes in weather patterns which could shift tuna stocks and negatively affect fishing revenues; or an unforeseen drop in returns from the Tuvalu Trust Fund given uncertain global financial conditions. Continued lack of effective financial supervision of banks and weak SOE balance sheets create contingent risks to the government and impede credit intermediation. A loss of the current correspondent banking relationship would endanger Tuvalu’s ability to process international payments. Finally, Tuvalu is heavily exposed to the effects of climate change and natural disasters.

Recovering from the Pandemic

7. The COVID responses should remain conditional on the stage of the pandemic.

• In 2020, the authorities approved an economic relief package of AUD23.3 million (30 percent of GDP), which included expenditures on medical equipment and vaccines, quarantine facilities, and support to the population and the private sector. In addition, island communities were allowed to use their development grants (AUD4 million total, or 5 percent of GDP) for COVID-related support to local populations, and residents were granted partial access to their retirement savings. Around a third of the planned amount of the relief package was implemented, with the underspending explained by the suspension of the universal cash payments after the first two months with no infections and the lower than expected demand for repatriation flights, which reduced quarantine expenditures. Difficulty in procuring medical equipment and supplies explained most of the underspending on health. The 2021 budget includes AUD1.1 million (or 1.3 percent of GDP) appropriations for COVID-related spending (repatriation flights and quarantine facilities and payments to frontline workers).
• Going forward, the fiscal response should continue to be dependent on the developments of the pandemic. Any additional fiscal support in case of an outbreak would best be focused on the vulnerable population and the private sector. The authorities should continue working with development partners to seek flexibility in the use of the remaining grants, including to secure additional vaccine doses and medical equipment needed for inoculations, and to maintain buffers given the uncertainty surrounding virus developments. All COVID-related spending should be conducted in line with the procurement rules, with details published on the website of the Ministry of Finance, to improve transparency and accountability. In this context, the planned audit of the COVID expenditures is a welcome development.

Securing Resources for Sustainable Growth

8. Once the economy fully recovers, gradual fiscal consolidation will be necessary to secure fiscal sustainability and reduce fiscal risks. Given the volatility and the largely exogenous nature of fishing revenues and grants as well as capital expenditures, the domestic current fiscal balance—defined as current revenues excluding grants and fishing license fees less current expenditures—would provide an appropriate anchor. Targeting a domestic current deficit of around 40 percent of GDP through a combination of expenditure restraint and revenue mobilization would reduce the risk of a rapid adjustment if shocks occur. It would also help secure fiscal buffers through the Consolidated Investment Fund and the Tuvalu Survival Fund and protect government’s net financial worth over the medium-term, offsetting a potential decline in fishing revenues or natural disaster costs. Additional fiscal space would also help ensure sufficient resources to achieve the government’s development goals, including on infrastructure investment and maintenance, and to finance climate adaptation needs.

9. A combination of measures to increase spending efficiency and mobilize domestic revenues would help achieve fiscal consolidation.

• Disciplining expenditures. Policies to restrain current spending include: (i) a review of the public sector wage bill and establishing clear criteria linking wage increases to performance, fiscal revenues, and inflation; (ii) lowering spending on the Tuvalu Medical Treatment Scheme (by improving preventive programs for non-communicable diseases and developing early care, systematically tracking expenditures by beneficiary and expense type, and rationalizing travel of family members); (iii) rationalizing spending on overseas scholarships (by developing a comprehensive strategy across ministries to ensure that obtained degrees align with Tuvalu’s needs and reviewing scholarship award criteria, systematically monitoring outcomes of the scholarship programs—including completion rates, repatriation to Tuvalu, job placement—and tracking costs, providing incentives to complete studies on time and with honors, enforcing mandatory service periods for returning students, and enforcing loan repayment agreements); (iv) reviewing SOE subsidies; (v) improving cost effectiveness and control of the government’s travel budget; and (vi) conducting a detailed analysis of the commercial viability of the new airline, making budgetary provisions for the associated investment and maintenance costs over the medium-term, and establishing legal framework governing the airline.
• Mobilizing revenues. This could be achieved through: (i) eliminating tax exemptions, including those for projects financed by development partners; (ii) improving tax compliance, especially among the corporates, by ensuring sufficient staff resources and training to improve tax arrears management and enable a conduct of audits; (iii) improving taxpayer services; and (iv) strengthening revenue administration by implementing effective risk management practices. Given the potential impact of the ratification of the PACER Plus trade agreement on Tuvalu’s revenues, a comprehensive review of the taxation system should be considered. Diversification of Tuvalu’s economy would also help raise revenues.

10. Improving public financial management is necessary to raise the efficiency of public spending. This could be achieved through:

• Improving the budget preparation process by developing high-quality projections of grants, tax revenues, and current and infrastructure spending, and ensuring that the classification and presentation of budgets and fiscal reports follows the GFSM2014 format. Full implementation of the new Financial Management Information System should help improve processes. Supplementary budgets should be avoided.
• Re-instituting in-year revenue and spending controls by resuming compilation and publication of quarterly budget outcomes, standardizing fiscal accounts classification, and reporting data based on the 2014 Government Finance Statistics Manual. The resumption of annual audits of government accounts is welcome, and should continue in a timely manner.
• Improving the procurement process to ensure better transparency and control of awarded contracts, including by publishing annual reports by the Central Procurement Unit that include a list of successful/unsuccessful bidders for public contracts and their beneficial owners, an amount of each awarded contract, contract type, types of goods/services provided; and undertaking periodic internal audits of public procurement.
• Developing a medium-term infrastructure maintenance plan based on the 2017 asset register to ensure sufficient funds for maintenance/replacement of public assets, with a clear delineation between routine (operating) maintenance and capital maintenance (overhaul) in accordance with GFSM2014 classifications. The maintenance plan should be linked to the budget processes, and annual appropriations should account for high depreciation of domestic infrastructure due to climate events.

11. Given limited fiscal space, the authorities’ plans to mobilize international resources for building resilience to climate change are welcome. After a lengthy process, in 2019 Tuvalu became the second national entity in the Pacific region to be accredited with the Adaptation Fund, giving the country more control over the management of its climate finance, as well as project development and implementation. This step should facilitate accreditation with other climate financing facilities such as the Green Climate Fund. However, there is an urgent need to increase capacity in order to navigate the complex landscape of climate finance and ensure the continuity of multi-sector and multi-year projects. The establishment of a Climate Finance Unit under the Planning, Budget and Aid Coordination Department would help. In addition, the authorities should continue their efforts to explore multilateral risk sharing mechanisms such as the Pacific Island Insurance Facility (PIFIC).

Securing Long-Term Growth Through structural reforms

12. Structural reforms to promote private sector development, improve access to finance, and enhance SOE efficiency would help raise employment and growth. Tuvalu’s private sector is limited to fishing and agriculture, while tourism activity remains small due to poor connectivity, infrastructure, and amenities. Support to micro-enterprises in areas like registering businesses, training in bookkeeping, business operations and management, licensing, taxation, and customs requirements would help promote private sector growth. Policies to diversify growth base include: (i) support small-scale production of goods for local consumption, as a first step toward exports diversification; (ii) continued support for subsistence agriculture to reduce dependence on foreign food sources, increase food security and promote healthy eating habits; (iii) development of the tourism sector through niche markets, such as facilitating visits of small cruise ships for eco-tourism; (iv) development of vocational training and labor mobility plans, in particular in construction, fisheries, healthcare, to improve skillset of Tuvalu’s workforce. Developing a national strategy for financial literacy and education would promote financial inclusion by helping citizens make prudent financial decisions and unlocking economic opportunities.

13. Implementation of the cross-cutting objectives of the Te Kete development plan would help promote resilient and green growth. “Peaceful, resilient and prosperous” Tuvalu is to be achieved though digital development, improved governance, and climate change mitigation actions, in the context of prudent fiscal policy and a resilient private sector. To make the plan succeed, the identified actions need to be measurable and time-bound. To that end, the Te Kete plan could be linked to the achievement of the Sustainable Development Goals, given that both have the same time horizon (2030). Operational plans for line ministries, currently under development, should help establish measurable goals and define monitoring strategy. These plans should also be clearly linked to the annual budget process. Developing data collection processes to track progress will be key.

14. Significant progress has been achieved in improving performance of state-owned enterprises (SOEs). Recent reforms include clarification of the legal status of SOEs, regulation of the appointments of directors, preparing corporate plans (though not by all SOEs), and improving financial reporting. Steps are also being taken to introduce performance-based management and improve governance through the establishment of an informal directors’ institute. However, further reforms are required on several fronts:

• Finalize SOE reforms to improve performance. SOE performance remains weak, with non-financial SOEs repeatedly reporting losses. Corporate plans should be completed for all SOEs in a timely manner. Implementation of tiered electricity tariffs is a step in the right direction to improve financial outcomes of the Tuvalu Electricity Company. Over time, the structure of electricity tariffs should be reviewed to ensure that revenues are at cost recovery levels and linked to oil prices. Pre-payment options for electricity consumers should be introduced (e.g., meters, pre-payment lump sums), as well as competitive bidding for fuel suppliers. Implementation of the solar energy program should improve supply and bring down electricity prices. The remaining joint-venture operating under the NAFICOT should be closely monitored given past history of losses of the joint ventures. Timeliness of corporate reporting and audits of financial statements should be enforced, including to improve tax payments.
• Clarify relationship of SOEs with the public sector. A rules-based system of allocating Community Service Obligations should be adopted, to compensate SOEs for losses incurred from prices set below cost recovery levels. The CSO amounts should be decreased over time, and prices brought to cost recovery levels. Government’s outstanding payment obligations towards SOEs should be resolved, and SOEs should be mandated to repay their tax arrears.

15. Given the significance of cross-border payments for Tuvalu, securing a new correspondent banking relationship (CBR) for the National Bank of Tuvalu (NBT) remains a priority. The NBT—the only financial institution able to conduct international transactions—is currently exposed to the loss of its CBR with Australian banks. Loss of CBR would hamper the authorities’ ability to receive fishing license payments and donor grants and disrupt international commerce and the flow of remittances. It would also limit NBT’s FX trading profits, its largest source of income. Close cooperation with the Asia-Pacific Group on Anti-Money Laundering and with the Fiji Financial Intelligence Unit will help identify reforms needed to strengthen the NBT’s Know Your Customer due diligence and upgrade the AML/CFT processes.

16. Development of effective prudential regulation and supervision would help promote health of financial institutions in Tuvalu. The Banking Commission Act of 2011 established the Banking Commission, with the Permanent Secretary of the Ministry of Finance tasked as the Commissioner and the prudential supervision authority given to the Public Enterprise Reporting and Monitoring Unit (PERMU). It is critical that the supervisory framework covers both the banks and the Tuvalu National Provident Fund (TNPF), given its role in extending credit to the economy. Improving capacity in PERMU to ensure conduct of periodic financial analysis of banks to assess their financial soundness and identify their vulnerabilities would be a welcome first step. Banks’ quarterly prudential reports should be simplified and the submission process to the banking commission streamlined, to facilitate timely analysis. Further close cooperation with technical assistance partners to upgrade staff skills should continue.

17. Going forward, Tuvaluan businesses and citizens would benefit from better access to credit. Financial intermediation could be improved through:

• Upgrading the credit assessment capacity of banks. A centralized credit registry system that collects updated customer information from various sources, including income, tax payments, TNPF contributions, obligations, pledged assets, and credit history would be a good first step. All three lending institutions should report and have access to the registry (ideally in a digital form) and use the information to assess repayment capacity of borrowers when making credit decisions.
• Risk-based loan pricing and adjustment of loan rates in accordance with the economic cycle. Loan rates have remained unchanged for more than a decade despite changes in macroeconomic conditions and varying borrower-specific risks. Risk-based pricing could facilitate more efficient allocation of credit and account for customers’ capacity to repay, especially for business borrowers.
• Introduction of a collateral framework and resolution regime for non-performing loans to boost the ability of the existing financial institutions to expand credit to individuals and businesses. Reviewing the existing Memorandum of Understanding between banks to establish clear rules governing collateral seniority and recourse rules between financial institutions, especially with respect to funds in the TNPF, and codifying it to ensure enforcement, would be a welcome first step. Given that the MoU includes rules related to the debt service-to-income (DSTI) ratio, such codification would also allow the supervisory authority to periodically review its adequacy. The authorities should also review the rule that bars banks from accessing TNPF balances of members with defaulted obligations until these members retire, as it exposes banks to liquidity risks. A bankruptcy legislation for households and firms should be developed to facilitate recovery of non-performing loans in a reasonable timeframe, supplemented by customer rights protection.
• Continuing efforts to modernize the financial system by providing online banking services. The Development Bank of Tuvalu is currently pursuing a three-stage digitalization plan, which will allow clients to view their balance online (by end April 2021), facilitate online applications (by end July 2021) and enable online money transfer (by 2022). NBT is exploring options to upgrade its system to provide online banking services, and offer ATM, debit and credit card services. The government has allocated A$1 million to support these initiatives.

18. The authorities’ plans to adopt digital technologies are welcome, and their prospects for success will be enhanced by selecting private partners with strong implementation track record and avoiding technology or vendor lock-ins. Devising a comprehensive fintech development strategy to enhance financial depth, inclusion, and efficiency would be a welcome first step. The care should be taken to select private partner who has a proven record of implementing such projects in countries with similar constraints and is able to upgrade and maintain systems over time. Such selection should be based on a careful cost-benefit analysis to ensure the investment cost, including the ongoing cost of maintenance and technical support, is justified by expected benefits given the limited size of Tuvalu’s market. Moreover, it is critical that the technological architecture chosen will be open, promote innovation, and avoid technology or vendor lock-in.

19. Continued efforts towards enhancing statistical capacity will help improve the authorities’ decision-making and ensure that policies respond to changing economic circumstances in a timely manner. Strengthening institutional capacity through timely hiring of essential statistical personnel, ensuring their training, and succession planning given frequent turnover is needed. Continued close cooperation with PFTAC and other agencies providing technical assistance will be essential in this regard.

20. Tuvalu’s government continues to be closely engaged with the IMF and other development partners. The IMF stands ready to continue to support the government’s reform programs through policy advice and capacity development.

***

The IMF team is grateful to the government of Tuvalu for their warm welcome, cooperation, and open and candid discussions in a virtual environment.