Mission Concluding Statement 

Nauru: Staff Concluding Statement of the 2023 Article IV Mission

September 15, 2023

Washington, DC: An International Monetary Fund (IMF) mission held discussions for the 2023 Article IV consultation for Nauru, during September 1 -14. The mission issued the following statement at the conclusion of the mission:

ECONOMIC CONTEXT, OUTLOOK, AND RISKS

Growth picked up due to strong phosphate mining activities and inflation rose reflecting external factors . The economy expanded by 2.8 percent in fiscal year (FY) 2022 as strong phosphate production and sizable fiscal support to households and State-Owned Enterprises (SOEs) partially offset a weaker transportation sector hit by COVID‑related restrictions and rising fuel prices. Real GDP growth is estimated at 0.6 percent in FY2023 as the Regional Processing Center (RPC) [1] continued to scale down, leading to weaker demand and service-related trade. Average inflation increased to 3.6 percent in FY2022, driven by higher international food and fuel prices. While food and fuel costs receded in FY2023, persistent inflation in Nauru’s trading partners and the reduction of transportation subsidies pushed inflation higher to 6.3 percent.

The fiscal surplus declined but remained sizable. Tax revenue declined as a reduction in RPC-related activities led to lower import duty and non-resident tax withholding. On non‑tax revenue, however, Nauru received higher-than-expected RPC revenues in FY2023 due to an extension of RPC operations at limited capacity. Fishing license fees moderated slightly but remained above pre‑pandemic levels. The fiscal balance excluding the government’s contribution to the Nauru Trust Fund (NTF) was at 8.3 percent of GDP in FY2023.

Nauru’s external position was moderately weaker than the level implied by fundamentals and desirable policies in FY2022. Rising imports, driven by the high transportation costs, led to a current account balance (CAB) of -0.5 percent of GDP in FY2022. The reserve coverage is equivalent to 3.5 months of imports in FY2022, above the reserve adequacy ratio of 2.8 months, but it is expected to decline over the medium term. [2]

Growth is expected to moderate over the medium term. Growth is projected at 1.4 percent in FY2024, as an increase in wholesale and retail trade financed by RPC revenues offsets lower growth in transportation from delay in the completion of the port. Notwithstanding higher RPC revenues this year[3], the planned scale-down of the RPC over the next few years is expected to adversely affect economic activity over the medium term, given the RPC’s importance in generating fiscal revenue and employment. Nevertheless, diversification opportunities from the climate resilient port and the ongoing construction of the fiber-optic cable are expected to provide some offset. Inflation is expected to slow to 5.3 percent in FY2024, consistent with lower global inflation and a tightening of monetary policy in Australia. The CAB is expected to temporarily improve in FY2024 due to inflows associated with the RPC before worsening over the medium term as RPC revenues decline.

The fiscal balance is expected to deteriorate over the medium term . The fiscal surplus excluding the government’s contributions to the Nauru Trust Fund (NTF) is projected to moderate to 6 percent of GDP in FY2024, as higher RPC revenues offset declining tax revenues. Current expenditure is projected to fall with the withdrawal of Covid-related fiscal support but donor-financed capital expenditure is expected to pick up. The weaker-than-warranted fiscal balance poses a significant challenge to ensuring medium-term fiscal sustainability and building fiscal buffers against a sharp decline in RPC-related revenue. Over the medium term, the fiscal balance is expected to deteriorate significantly due to the wind-down of the RPC.

Nauru’s debt is assessed to be sustainable under current policies. Debt is estimated at 20.2 percent of GDP in FY2023. The resolution of Nauru’s external debt to Firebird (a global fund manager) in 2021 and sustained fiscal surpluses in past years significantly reduced Nauru’s debt vulnerability. However, the dependence on volatile non-tax revenues and donor grants underscores the importance of maintaining fiscal discipline to ensure debt sustainability.

Risks to the outlook are tilted to the downside . Uncertainties related to activities of the RPC pose risks to the medium-term economic and fiscal outlook. Continued pressure on financial services could disrupt payment systems, affecting essential economic activities. Delayed fiscal and structural reforms could lead to an overdependence on volatile sources of revenues, jeopardizing fiscal sustainability. Deepening geo-economic fragmentation and an abrupt global slowdown could affect Nauru’s trading partners and donors. Higher commodity prices could put upward pressure on inflation and fiscal spending. Similar to other pacific island countries (PICs), Nauru remains vulnerable to extreme climate events. Upside risks include an unexpected extension of RPC activities and increased demand for fishing licenses.

FISCAL POLICY

Fiscal policy should continue to be anchored by the government’s commitment to fiscal discipline . Nauru’s fiscal framework includes three fiscal responsibility ratios and a supplemental requirement for the government to contribute to the NTF. The authorities broadly complied with the fiscal responsibility ratios during the pandemic. Maintaining sufficient fiscal surplus to finance the government’s contribution to the NTF will be key to achieving its target value of AUD 700 million by 2033.

Staff recommends revenue mobilization to generate more sustainable sources of revenue . Policy actions would include: (i) removing discretionary exemptions in import duties and ultimately replacing import duties with excise duties; and (ii) improving the progressivity of the personal income tax and reducing exemptions in the corporate income tax in the short term. In the mediumterm, the authorities should implement further revenue administration measures, such as revenue risk management, audits, and regular review of excise rates. Over the longterm, the authorities could consider introducing a value added tax—a good sustainable source of revenue.

Expenditure policies should prioritize spending that promotes growth, resilience, and inclusion . This requires improving the efficiency of current spending through enhanced public financial management (PFM) such as formalizing the fiscal responsibility ratios in a rules-based framework, [4] improving health and education spending efficiency and more targeted and progressive subsidies. Staff proposes a careful review of SOE subsidies and grants to increase efficiency of government spending, and the adoption of digital technologies to promote remote access to education and healthcare services abroad. Staff encourages the authorities to implement key recommendations from the 2022 Public Expenditure and Financial Accountability Assessment, including: (i) improving the efficiency of public spending with a single supplementary budget linked to a mid-year review; (ii) enhancing the quality of the budget submission and the frequency of publishing budget related information; (iii) enhancing public asset management; and (iv) improving internal and external audit. The authorities are encouraged to continue engaging PFTAC in technical assistance on revenue mobilization and PFM.

FINANCIAL SECTOR POLICIES

Efforts to improve the AML/CFT legal framework are ongoing and are crucial . Nauru passed the Beneficial Ownership Act in 2017, and subsequently a new Anti‑Money Laundering and Targeted Financial Sanctions Act in June 2023, with support from the Asia Pacific Group on Money Laundering (APG). The APG’s mutual evaluation for Nauru is ongoing, with the on-site visit scheduled for October 2023. The adoption of the report by the APG is scheduled for July 2024. The newly passed AML law should improve the outcomes of the mutual evaluation; a positive outcome would be beneficial for Nauru as the mutual evaluation report will be published online by APG and FATF after adoption.

Staff supports ongoing measures to improve Nauru’s access to formal financial services and recommends further actions . The authorities are encouraged to continue to improve the AML/CFT framework, including the recommended actions that are expected from the mutual evaluation. Staff supports the provision of financial sector services by regional financial institutions that are effectively regulated and supervised by their home jurisdiction, backed by strong bilateral cooperation between the Nauruan authorities and their overseas counterparts. [5] Infrastructure gaps that constrain the use of digital payments would also need to be properly addressed, for example, through the planned undersea fiber-optic cable project.

STRUCTUAL REFORMS

Staff recommends measures to improve Nauru’s human capital to achieve the SDGs . Around 35 percent of the population in Nauru is of school age, with 55 percent of the population under 25, but the school enrollment rate and the teacher-to-student ratio are lower than the world average. Furthermore, attendance rates in primary and secondary schools are low. Education spending should prioritize improving enrollment and attendance rates and increasing the teacher-to-student ratio.

Accelerating climate adaptation and mitigation could further enhance Nauru’s resilience to climate change . Nauru has made further progress in climate adaptation and mitigation through the ongoing construction of a climate resilient port and solar farms, but long-term climate-related challenges remain significant. Nauru is undergoing a review and update to further refine and develop its National Adaptation Plan, including at the sectoral level. A detail costing of priority projects would be critical in allowing a more strategic pursuit of climate finance. The costing should be integrated into the budget and medium-term framework, including provisions to support the new climate change unit.

Structural reforms to diversify the economy are crucial for Nauru’s long-term development . The completion of the new port and related infrastructure could help bring new sources of growth and employment opportunities. For example, investing in refrigerated storage facilities could help develop domestic containerization (and potentially fish processing in due course) and generate additional government revenues. The new port could support the transit of container ships, potentially as a regional transportation hub. Increased participation in regional labor mobility schemes could help increase remittances, partly offsetting the employment losses from the RPC wind-down. Universal digital connectivity could improve labor force participation, enhance access to education and healthcare, strengthen social protection, and support Nauru’s long-term growth potential. A legal and regulatory framework that improves access to land is needed over time to attract private sector investment.

Measures to address governance and corruption vulnerabilities are critical to achieving Nauru’s medium-term growth and development objectives. Recent PFM improvements include a clearer fiscal strategy and better debt management, improved timeliness of in-year budget reports, further transparency of budget information, and better internal controls for non-salary expenditures. However, the authorities should continue to strengthen fiscal governance (PFM controls), and the rule of law (investor protection and contracts). Addressing these governance weaknesses could improve efficiency in resource management, reduce vulnerabilities to corruption, and support growth.

Staff thanks the authorities for their hospitality and collaboration. The IMF stands ready to support the authorities to implement reforms through policy advice and continued capacity development engagement.