Press Release No. 24/230

IMF Staff Completes 2024 Article IV Mission to Vanuatu

June 20, 2024

• Air Vanuatu’s voluntary liquidation is ongoing and efforts to bring resolution need to be accelerated. The ECP continues to pose risks to fiscal revenue and financial integrity.
• IMF forecasts 2024 GDP growth around 1 percent y/y, and around 1½ percent y/y in 2025, but downside risks remain elevated.
• Fiscal deficit is envisaged to deteriorate in 2024 given low revenue and high spending, including as one-off costs from the liquidation are expected to impact the deficit.
• Keeping a tight rein on non-priority spending and urgently deploying ambitious revenue measures will be key to reduce heightened risks to debt sustainability. Prioritizing support amid the emergency will require reconsidering the design of interim spending measures and increases to public employee compensation and allowances.
• Improving governance and reducing vulnerabilities to corruption need to be prioritized. The Commercial Government Business Enterprises Act needs to be enacted and implemented.
• Effective financial supervision and integrity measures are needed to address ongoing concerns about banking asset quality and governance.

Washington DC:

The voluntary liquidation of Air Vanuatu in May 2024 is a major economic shock with significant spillovers. The decline in tourism will directly impact the services sector through the hospitality industry, transport, retail and wholesale trade, and other activities. Disruptions in air transportation are likely to limit the availability and mobility of labor and cargo networks for infrastructure investment and commerce, and directly impact the industry sector. Some of these effects are likely to be more pronounced outside Efate where flights are still disrupted.

Growth is expected to slow in 2024 to around 1 percent y/y and to around 1½ percent y/y in 2025. There is significant uncertainty regarding the future of the airline. Although temporary price shocks from the airline liquidation are likely, inflation is expected to decelerate more in 2024 and fall to below 4 percent y/y by Q3. The fiscal deficit is likely to deteriorate given reduced revenues and elevated current spending due to the resolution of the airline, modest transfers, and support. Capital expenditure is expected to decline as the Government reprioritizes spending. Alongside the measurable economic shocks, there may be significant social and welfare effects via disrupted access to healthcare, education, and public services.

The balance of risks is tilted to the downside. Major sources of risks stem from severe natural disasters, labor and skill shortages, political instability, weak governance, geopolitical tensions, and trade fragmentation, including slowdown in trading partners.

Managing the emergency will require providing needed targeted support to growth while keeping the fiscal deficit contained to secure sustainability. Stronger revenue mobilization and consolidation efforts to rebuild fiscal buffers is crucial. Economic Citizenship Program (ECP) revenues have declined significantly, and the ongoing EU review of visa-free travel for Vanuatu passport holders may further erode interest in the program. Given the limited revenue sources, Government should aim for better VAT collection, and continue to explore new revenue measures, for example, via income tax and capital gains tax, fisheries licenses, higher VAT rates, and a widening of the tax base. There is an urgent need to keep spending contained, well-targeted and prioritized. Any interim spending measures, such as increases to public employee compensation and allowances, should also be re-evaluated.

Improving governance and reducing vulnerabilities to corruption remain a priority. These include the need for strengthened management and monitoring of state-owned enterprises (SOEs), and enhanced transparency of the contingent liabilities to the government. Rapid approval and implementation of the Commercial Government Business Enterprises Act is needed to enforce the timely release of audited financial statements of SOEs, as well as regular reporting for timely monitoring. Implementing the 2016 Safeguard Assessment recommendations, amending the 2022 Reserve Bank Act, and adopting leading central banking practices would improve the RBV's integrity, autonomy, and governance.

While monetary policy remains appropriately accommodative, fiscal dominance needs to be reduced. The Statutory Reserve Deposit ratio was increased marginally in January 2024 to address large excess liquidity. Monetary policy, including through open market operations, has not been very effective in reducing liquidity, suggesting the urgent need to address fiscal dominance. Concerted efforts should be made to lower it over the medium term.

The financial system appears broadly stable, but the elevated non-performing loans are a concern. The large sovereign-financial sector nexus, reflected in the significant holdings of Government liabilities by SOEs, can amplify financial stability risks. Improving the supervisory function, including increasing loan-loss provisioning for impaired loans, and enhancing capital requirements could encourage banks to accumulate additional buffers. In addition, improving loan recovery and realizing losses on nonperforming assets can help banks strengthen their balance sheet. Greater efforts are also needed to improve the regulatory and supervisory capacity and practices, and reinstate regular on-site inspections.

The authorities need to accelerate efforts to address structural challenges such as labor shortages and skills drain, and climate risks. Development partner-funded investment in quality education and skills development through targeted technical and vocational training should help deliver productivity gains and long-term growth. Policies aimed at promoting a conducive business environment for investment, entrepreneurship and job creation are also needed. Climate investment should be integrated into the medium-term fiscal strategy, with the adequate prioritization of projects given financial and capacity constraints.

The mission would like to thank the authorities for the frank and engaging discussions, and their warm hospitality.