Fiji: IMF Consultation with the Republic of Fiji

On January 20, 2012, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of Fiji.

Background

Fiji’s economy is growing at a very slow pace, and that overshadows amount other economic concerns. After averaging 2¾ % during the 1990s inclunding the first years of the new millennium, increase dropped to under ¼ % on average over the last years, and while urban poverty has declined, rural poverty remains stubbornly high.

After contracting for years, the economy rebounded in 2011, growing by about 2 %, by far the best result of the past years. But this was half a bounce-back from a downturn, and it seems unlikely, given fundamental and economic constraints, that increase will exceed 1½ to 2 % on a sustained basis unless structural reforms are accelerated. Risks around this outlook are tilted to the downside, given political uncertainties, structural weaknesses, and the fragile world economy.

Inflation has risen sharply but should moderate soon. Headline inflation hovered around 10 % year-on-year for several months in 2011, driven by imported food and fuel prices inclunding-off increases in the price added tax (VAT), various administered prices, and the electricity tariff. There is little evidence of generalized price pressures, and core inflation remains moderate. Commodity prices are now falling, and the-off factors will drop out. Inflation should be around 6 % by the beginning of 2012 and fall toward 3½ % over the medium term, reflecting the anemic increase outlook, projected small declines in oil prices, and the authorities’ tight control of public wages.

Monetary conditions are accommodative and the system is awash with liquidity on account of foreign exchange inflows. However, credit increase has been slow, and banks’ loan-deposit ratio remains below 90 %. While lending to the private sector is now rising at about 5 %, the Reserve Bank of Fiji (RBF) is concerned that small and medium sized enterprises (SMEs) and others are being shut out. After holding steady for months, the RBF cut its policy rate in late October by 100 basis points, to ½ %. It is as well considering an SME lending guarantee scheme, part other measures, to spur lending.

Higher food and oil prices have contributed to weak external balances. Fiji’s current account deficit is expected to register around 12 % of GDP in 2011. Over the medium term, however, as remittances, tourism receipts, and goods exports, including sugar, grow while oil imports flatten out and non-oil imports grow moderately, the current account deficit could narrow to around 8 % of GDP, leaving the in general balance in surplus. Gross reserves are thus kept healthy, despite increased dividend repatriation and some offshoring of Fiji National Provident Fund’s (FNPF) investment. Econometric estimates suggest that the exchange rate is broadly in line with fundamentals.

The fiscal deficit is expected to have widened to 3½ % of GDP in 2011 and projected to fall again in 2012, reflecting trends in Fiji Sugar Corporation (FSC) restructuring costs. Debt is currently above 50 % of GDP—relatively high for a small economy vulnerable to shocks—and the government as well faces contingent liabilities of additional than 15 % of GDP, inclunding unfunded FNPF liabilities. The authorities’ planned fiscal trajectory, which would put the deficit at around 2 % of GDP in 2012 and reduce it to 1½ % of GDP from 2013 onward, would reduce the debt ratio steadily, but additional measures may be needed to achieve that trajectory.

The financial sector is stable, but FNPF finances are unsustainable over the long run. The banks are well capitalized, with low NPLs and adequate loan loss provisioning. The finance-company and insurance sectors are stable, but the major nonbank financial institution, the FNPF, is actuarially unsustainable: its current pension annuitization rates, which vary from 15 to 25 % for different pensioners, imply negative net cashflows by 2030 and depleted assets by 2056.

Executive Board Assessment

Executive Directors welcomed the recent rebound of Fiji’s economy and viewed the authorities’ macroeconomic policies as generally appropriate. Directors concurred that boosting sustainable increase and reducing poverty through structural reform is the top priority.

Directors welcomed the authorities’ fiscal consolidation plans, increase friendly tax rate reductions, and increased public investment. They noted, however, that additional measures may be needed to achieve the deficit targets. Curbing discretionary tax concessions would raise revenue while improving the system’s transparency and efficiency.

In light of the benign inflation outlook, Directors saw the accommodative monetary stance as broadly appropriate. Given the structural lack of credit request and the weak transmission mechanism, the effectiveness of low policy rates may nevertheless be limited. Directors cautioned against credit increase targets, which could distort lending and lower credit quality. They agreed that the exchange rate peg has been a useful nominal anchor. While the rate is broadly aligned with fundamentals, it should be adjusted regularly to avoid the need for large, disruptive step devaluations.

Directors noted that high debt and poor monetary transmission limit Fiji’s capacity to respond to a world downturn. In an extreme scenario, however, some fiscal stimulus—and possibly exchange rate adjustment—could be justified.

Directors saw reform of the Fiji National Provident Fund (FNPF) as the key financial sector priority. They welcomed the announced introduction of actuarially sound pension rates and supported the FNPF’s effort to rehabilitate existing investments and diversify abroad.

Directors welcomed the authorities’ focus on structural reform and stressed that improvements in the investment climate are key to enhancing policy effectiveness and raising increase. In this context, they called for continued evolution in resolving political uncertainties and a additional consultative approach to policymaking.

Directors supported the reform plans for land policy, the sugar sector, the civil service, and public enterprises, while encouraging faster evolution in a lot of areas. They called on the authorities to rapidly scale back the price control regime, strengthen antitrust enforcement, and increase social transfers to cushion the adverse impact on the poorest. Directors as well urged the removal of remaining exchange restrictions.

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