Press Release No. 21/225

IMF Staff Concludes 2021 Article IV Mission to Vanuatu

July 23, 2021

• The COVID-19 pandemic and major natural disasters hit the Vanuatu economy severely in 2020. Due to the authorities’ decisive measures, Vanuatu has had no domestic transmission of COVID-19, but the border closure brought tourism to a virtual stop.
• The economy is projected to return to positive growth in 2021. However, risks to the outlook are substantial and tilted to the downside.
• Given heightened uncertainty, macroeconomic and financial policies should remain accommodative in the near term to support the recovery. However, short-term accommodation and support should be embedded in a medium-term framework to anchor sustained and inclusive growth while ensuring fiscal and debt sustainability.

“The COVID-19 pandemic and major natural disasters hit the Vanuatu economy severely in 2020. Due to the authorities’ decisive measures, Vanuatu has had no domestic transmission of COVID-19. However, the border closure dealt a heavy blow to tourism. Infrastructure projects have also been delayed. In addition, Tropical Cyclone Harold and a volcanic eruption in Tanna Island caused extensive damage the first half of 2020. Notwithstanding the authorities’ policy responses, the reduction in travel receipts led to severe economic contraction. Strong receipts of the Economic Citizenship Programs (ECP) and donor support have helped mitigate the impact of the pandemic on fiscal and external balances.

“After a severe contraction in 2020, real GDP growth is expected to rise to 1.2 percent in 2021. Agricultural production and remittance income from seasonal workers will help to support a return to positive growth in 2021. Growth will also be supported by construction activity, despite delays which will push several large infrastructure projects into 2022. Tourism related sectors are expected to contract further in 2021 due to the extended border closure and are expected to start a gradual recovery beginning in 2022.

“Risks to the outlook are substantial and tilted to the downside. A worsening of the pandemic requiring longer border closure would adversely impact economic activity. ECP revenues could fall sharply amid growing concerns on AML/CFT risks to ECP under the recent loss of the key correspondent banking relationship. Further deterioration of banks’ asset quality could erode the soundness of Vanuatu’s financial system. Lack of transparency and effective supervision framework for state enterprises could negatively affect the business environment and fiscal management. Issues concerning AML/CFT and EU blacklisting related to tax transparency could accelerate de-risking by foreign firms and impede foreign direct investment (FDI). An ever-present downside risk relates to further natural disasters.

“Given heightened uncertainty, macroeconomic and financial policies should remain accommodative in the near term to support the recovery, while securing sufficient buffers for near- and medium-term risks. However, short-term accommodation and support should be embedded in a medium-term framework to anchor sustained and inclusive growth while ensuring fiscal and debt sustainability.

“On fiscal policy, continued fiscal support over the near term is necessary. It is critical to ensure that support is well targeted at the most vulnerable and that public expenditure and investment management is strengthened. The medium-term fiscal trajectory remains uncertain, and Vanuatu’s fiscal space is limited. Near-term support needs to be embedded in a credible medium-term fiscal strategy that brings about a gradual fiscal adjustment once recovery is firmly entrenched. While the initiation of fiscal adjustment should remain state-contingent, a credible forward-looking fiscal strategy should be put in place. Further fiscal consolidation would allow the authorities to reduce the reliance on ECP revenues and to use the revenues for resilient infrastructure. In the medium-term, Vanuatu’s development needs and vulnerabilities to climate change would require a scaling up of infrastructure spending.

“Regarding monetary policy, the RBV should maintain the current accommodative stance until the recovery is entrenched and continue to closely monitor and periodically reassess the policy stance —particularly in the event of unexpected shocks.

“The RBV should carefully monitor the banking sector and continue to strengthen supervisory frameworks. It is important to establish crisis management and resolution frameworks and to improve the collateral asset recovery environment for liquidation of NPLs. The RBV should encourage banks to accumulate further provisioning and to restructure the debt of temporarily illiquid but otherwise solvent borrowers. Digitalization could advance financial inclusion, but there are challenges ahead.

“Regarding macro-structural and governance issues, economic diversification and development of quality infrastructure is essential for sustained and inclusive growth and resilience to shocks. Smooth ratification of PACER Plus and improving the regulatory framework could promote vital foreign investment. Further enhancing climate resilience is necessary. Staff recommends integrating financing plans, consistent with a medium-term fiscal strategy, for the adaptation plan and disaster response to support resilience-building in a more efficient and effective manner. Improving governance, reducing vulnerabilities to corruption, and bolstering Vanuatu’s risk profile is essential. It is critical to urgently establish stronger management and transparency of the GBEs—particularly with respect to Air Vanuatu. The authorities should establish supervisory frameworks for GBEs and enhance their transparency as soon as possible. The authorities should strengthen further legal frameworks and institutional capacities on AML/CFT (especially ECP due diligence), tax transparency, central bank autonomy and governance.