Pacific Economic Monitor - July 2010

8/13/2019 Pacific Economic Monitor - July 2010

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Pacific Economic Monitor

The Monitorprovides anupdate of developments inPacific economies andexplores topical policyissues.

July 2010 www.adb.org/pacmonitor

Contents

Highlights 1

The economic setting 3

Economic conditionsPacific Islands 5Papua New Guinea 14

Timor-Leste 15

Economic policy andmanagement 17

Data 28

How to reach us

E-mail

[email protected]

Asian Development Bank

Pacific DepartmentApiaLevel 6 Central Bank of Samoa Bldg.Apia, Samoa

Telephone: +685 34332DiliADBWorld Bank Bldg., Avenida dosDireitos Humanos, Dili, Timor-LesteTelephone: +670 332 4801Honiara

Mud AlleyHoniara, Solomon IslandsTelephone: +677 21444Manila6 ADB Avenue, Mandaluyong City1550 Metro Manila, PhilippinesTelephone: +63 2 632 4444Nuku'alofaFatafehi StreetTonga Development Bank BuildingNukualofa, TongaTelephone: +676 28290

Port MoresbyLevel 13 Deloitte TowerPort Moresby, Papua New GuineaTelephone: +675 321 0400/0408Port VilaLevel 5 Reserve Bank of Vanuatu Bldg.Port Vila, VanuatuTelephone: +678 23610Suva5th Floor, Ra Marama Building91 Gordon Street, Suva, Fiji IslandsTelephone: +679 331 8101SydneyLevel 18, One Margaret StreetSydney, NSW 2000, AustraliaTelephone: +612 8270 9444

Highlights Projected 2010 economic growth in the Pacific islands remains

unchanged at 0.5% overall. An upgrade of projected growth inSolomon Islands, from 2.0% to 3.5%, is offset by downgradesfor the Cook Islands, Kiribati, Nauru, Tonga, and Vanuatu. Thedowngrades reflect weaker than expected tourism growth outsidethe Fiji Islands and slower than expected implementation ofpublic investment programs. Economic growth is still expected toimprove slightly in 2011 to 1.3%.

Stronger than expected growth in Timor-Leste has resulted in anupgrade of projected economic growth in the Pacific region(comprising the Pacific islands, Papua New Guinea, and Timor-Leste) to 4.3% in 2010. Timor-Lestes growth is driven by a large

increase in expected government expenditures.

Inflation projections have been revised upward, reflecting theearlier than expected inflation increases in major tradingpartners. Inflation is now projected to reach 5.0% in the Pacificislands in 2010, and 5.9% in the Pacific region as a whole.

The post-crisis rise in world oil prices is a primary cause ofinflation. Pacific economies are particularly sensitive to high oilprices because they pay more for fuel than other regions. Theconsequences of high fuel prices are highlighted by internationalcomparisons of the general price levels presented in this Monitor.

Using these comparisons, illustrative estimates of per capitaincomes are presented in purchasing power parity terms. They

indicate that real incomes in many Pacific economies have beenbelow much of developing Asia.

The potential for better structural policy to reduce costs andhence prices in the Pacific is explored. The good progress madein telecommunications such as in Palau and Tonga, is illustratedby a regional comparison of telecommunication prices. However,telecommunications prices remain very high in some Pacificisland economies, a problem that could be addressed by betterstructural policy.

Strengthened structural policy also holds considerable potentialfor lowering the price of fuel and electricity. These possibilitiesare explored as well.

The management of rising revenue from mining and petroleum isan important emerging issue for the region. This issue of theMonitor provides an overview of the sovereign wealth fundsproposed for Papua New Guinea (PNG). Recent proposals arewell-aligned with best practice standards, and could optimize thebenefits of mining and petroleum development in PNG. Possibleenhancements to the proposals are discussed, notably the use offunds to address a backlog of infrastructure maintenance and toprovide a catalyst for PNGs publicprivate partnership program.


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HIGHLIGHTS

2

Abbreviations

$ US dollars, unless otherwisestated

ABS Australian Bureau ofStatistics

ADB Asian Development BankADO Asian Development OutlookA$ Australian dollarb budgetCPI consumer price indexe estimatefas free along sidefob free on boardFSM Federated States of

MicronesiaFY fiscal yearGDP gross domestic productIMF International Monetary Fundlhs left hand scaleLNG liquefied natural gasm.a. moving averageNZL New Zealandp projectionPEM Pacific Economic ManagementPNG Papua New Guinearhs right hand scaleRMI Republic of the Marshall IslandsUS United Statesy-o-y year-on-year

Latest Asian Development Bank projections

Real GDP growth

-2 0 2 4 6 8 10 12

Cook Islands

Fiji Islands

Tonga

Nauru

Kiribati

Marshall Islands

FSM

Palau

Samoa

Tuvalu

Solomon Islands

Vanuatu

Papua New Guinea

Timor-Leste

Change in real GDP (%)

-3

0

3

6

9

2007 08 09e 10p 11p

Pacific Region

Pacific Islands

2010

2011

Inflation

0 2 4 6 8 10

Papua New Guinea

Fiji Islands

Solomon Islands

Kiribati

Timor-Leste

VanuatuMarshall Islands

Palau

Cook Islands

FSM

Tuvalu

Nauru

Tonga

Samoa

Change in consumer price i ndex (%, annual average)

0

4

8

12

2007 08 09e 10p 11p

Pacific Region

Pacific Islands

2010

2011

Note: Projections are for fiscal years. Regional averages of gross domestic product (GDP) growthand inflation are computed using weights derived from levels of gross national income in currentUS dollars following the World Bank Atlas method. Averages for the Pacific islands exclude PapuaNew Guinea and Timor-Leste.Source: ADB estimates.

NotesThis Monitoruses year-on-year percentage changes and 3-month movingaverages. The use of year-on-year percentage changes reduces theimpact of seasonality. The use of 3-month moving averages reduces theimpact of volatility in monthly data.

Fiscal years are the end of June for the Cook Islands, Nauru, Samoa, andTonga (e.g., FY2010 is the year ended 30 June 2010); the end ofSeptember in the Marshall Islands, the Federated States of Micronesia(FSM), and Palau; and end of December elsewhere.

2010 Asian Development Bank

All rights reserved. Published 2010.Printed in the Philippines.Publication Stock No:RPS090535

Cataloging-In-Publication DataAsian Development Bank.Pacific Economic Monitor, July 2010.Mandaluyong City, Philippines: AsianDevelopment Bank, 2010.

This edition of the Monitorwas preparedby Emma Ferguson, Vivian Francisco,Joel Hernandez, Milovan Lucich,Dominic Mellor, Adolf Moises Nicolas,Rommel Rabanal, Craig Sugden, RaquelTabanao, and Laisiasa Tora of the PacificDepartment.

The views expressed in this publicationare those of the authors and do notnecessarily reflect the views and policiesof the Asian Development Bank (ADB)or its Board of Governors or thegovernments they represent.

ADB does not guarantee the accuracy ofthe data included in this publication andaccepts no responsibility for anyconsequence of their use.

By making any designation of orreference to a particular territory orgeographic area, or by using the termcountry in this document, ADB doesnot intend to make any judgements asto the legal or other status of anyterritory or area.

ADB encourages printing or copyinginformation exclusively for personal andnoncommercial use with properacknowledgement of ADB. Users arerestricted from reselling, redistributing,or creating derivative works forcommercial purposes without theexpress, written consent of ADB.


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3

THE ECONOMIC SETTING

Developments overseasReal GDP growth

(%, annual)

-3

0

3

6

9

12

2007 08 09e 10p 11p

Australia

NZLUSDeveloping Asia

e=estimate, p=projectionSource: ADB. 2010.Asian Development Outlook 2010.Manila; and IMF. 2010. World Economic Outlook.

Washington D.C. (April and July).

Pacific Islanders in New Zealand(quarterly)

0

50

100

150

Sep08 Dec Mar09 Jun Sep Dec Mar100

5

10

15

20Employed persons ('000, lhs)

Unemployment rate (%, rhs)

Source: Statistics New Zealand.

Inflation(y-o-y % change in CPI; quarterly)

0

2

4

6

Sep07 Mar08 Sep Mar09 Sep Mar10

Australia

NZL

CPI= consumer price index.Sources: ABS and Reserve Bank of New Zealand.

This section draws on ADB. 2010.Asia Development Outlook2010. Manila and latest IMF. 2010. World Economic Outlook,Washington D.C. (April and July).Lead author: PEM Research Team

Global recovery underway, with emerging risks

The world economy is expected to make a solidrecovery from last years contraction and achieve

growth of 4.6% in 2010, according to theInternational Monetary Funds (IMF) WorldEconomic Outlook Update. This projection hinges onachieving an orderly withdrawal of accommodativefiscal and monetary policies to begin bringing downpublic debt to more sustainable levels, and avoidingsovereign debt contagion. Advanced economies areprojected to grow by only 2.6%. Emerging anddeveloping economies are poised to lead therecovery; the latest Asian Development Bank (ADB)projection for growth in developing Asia is 7.5%.

Large budget deficits in developed economies areadding to the risk of sovereign debt defaults in

some European economies. This is contributing touncertainty and volatility in financial markets, andposes a key risk to medium-term growth prospects.

Major stock market indexes have recently retreatedto multi-month lows over uncertainty aboutsovereign debt markets and possible contagioneffects.

Unemployment is tapering off, but remains high

The New Zealand unemployment rate fell sharply to6.0% in the March quarter 2010, down from 7.1%in the December quarter 2009. However,unemployment among Pacific islanders in New

Zealand remains more than twice the average, at13.3%.

The Australian unemployment rate edged slightlylower in the June quarter 2010, but remained at amoderately high 5.1%

The United States (US) unemployment rate eased to9.5% in June 2010, down slightly from Januarylevels. US manufacturing overtime hours, a leadingindicator for labor demand, fell slightly to 2.9 hoursin June 2010.

Inflation rising overseas

Inflation is starting to increase again, lifted by rising

world oil and commodity prices. The Reserve Bankof Australia raised its benchmark interest rate to4.5% in May 2010its sixth interest rate hike sinceOctober 2009to curb inflationary pressures.Australias inflation rate reached 2.9% in the Marchquarter 2010.

The Reserve Bank of New Zealand raised its interestrate to 2.75% in June to counter rising inflation, thefirst increase in 3 years.

Inflation is also trending upward in Indonesia,Singapore, and much of developing Asia.


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4

THE ECONOMIC SETTING

A view from neighboring economiesRising commodity prices to help exporters

Latest IMF projections are for a 22% rebound ininternational commodity prices in 2010, to befollowed by a slight 2% rise in 2011. Crude oil pricesare projected to rise by 30% in 2010 and 4% in2011.

Pacific demand for imports recovering

Non-fuel exports from Australia to the Pacific havepicked up following a brief decline from late 2009through early 2010. Demand from Papua NewGuinea remains strong, while Australian exports tothe Fiji Islands are showing early signs of recoveryfrom a prolonged downturn.

The Pacific's non-fuel imports from New Zealand,which were weak through most of the second half of

2009, have also improved over early 2010. WhileNew Zealand exports to the Cook Islands andSamoa are improving, exports to Tonga declinedfrom January to May 2010.

The latest motor vehicle import data from Japan alsoshow a strong upward trend for most Pacificeconomies. Only Nauru and Timor-Leste exhibitweak demand for imported vehicles from Japan.

Rising tourism to the Pacific, focused on the FijiIslands

Australian tourism to the Pacific posted stronggrowth over the first 5 months of 2010. Departures

from Australia to the Pacific were up by about 27%from January to May compared with the samemonths in 2009. The Fiji Islands recorded thesharpest rise, 49%, as it wins back Australiantourists. Visitors to the Cook Islands also increasedby about 27% over this period. However, asexpected, Australian tourism to Samoa, Tonga, andVanuatu has declined as the Fiji Islands continues toregain its previous market share.

Building on a slight improvement in late 2009,departures from New Zealand to the Pacific alsoincreased by about 9% in the first 5 months of2010. Growth was driven by a 22% (year-on-year)

rise in tourism to the Fiji Islands over January toMay 2010. The number of New Zealand tourists alsoincreased in Tonga and Vanuatu. It remained aboutthe same in the Cook Islands and Samoa relative tothe same period last year.

Japanese tourism to Oceania and to the NorthernPacific is showing some improvement afterpersistent decline over the past 2 years. US tourismto Oceania has also sustained year-on-year growthsince the second half of 2009, reflecting the overallincrease in American outbound travel.

Non-fuel exports to the Pacific(value; y-o-y % change, monthly)

-20

-10

0

10

20

Nov Feb09 May Aug Nov Feb10 May

Australia

NZL

Sources: ABS and Statistics New Zealand.

Departures for the Pacific

(persons; January to May totals)

0

50

100

150

2000 02 04 06 08 10

Australia

NZL

(persons; y-o-y % change, monthly)

-20

0

20

40

60

Nov Feb 09 May Aug Nov Feb10 May

Australia

NZL

Sources: ABS and New Zealand Ministry of Tourism.

Lead author: PEM Research Team


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5

ECONOMIC CONDITIONS

Cook IslandsVisitor arrivals

(persons; y-o-y % change, 3-month m.a.)

-20

-10

0

10

20

May08 Sep Jan09 May Sep Jan10 May

Australia and NZL

Northern Hemisphere

Source: Cook Islands Statistics Office.

Key indicators(y-o-y % change, quarterly)

-5

0

5

10

15

Mar07 Sep Mar08 Sep Mar09 Sep Mar10

-10

0

10

20

30

40Inflation rate

Credit growth (rhs)

Source: Cook Islands Statistics Office.

Real GDP growth

(% change, annual)

-4

0

4

8

12

2001 02 03 04 05 06 07 08 09e 10p 11p 12p 13p

e=estimate, p=projectionNote: Actual growth for 20012008, estimate for 2009, and

forecast for 20092013.

Source: Cook Islands Statistics Office and Ministry ofFinance and Economic Management.

Recent developments

Tourism has been low since November 2009, as theboost from last years special events dissipated and

unemployment woes and the weak recovery inconsumer spending elsewhere weighed down tourismarrivals. Tourist arrivals were down 4.4% for Januaryto May 2010 compared with the same period in2009. The bright point has been tourism fromAustralia, which grew 7% over the same 5-monthperiod.

Cyclone Pat caused an estimated NZ$15 milliondamage to public and private buildings andinfrastructure on the island of Aitutaki, the secondmost visited location in the Cook Islands.

Consumer prices were unchanged during the Marchquarter (year-on-year). The significant discounting in

airfares and decline in electricity prices offset priceincreases in other items, including fuel.

Domestic demand remains subdued. Lending activitypoints to continued weak investment prospects.

Outlook The GDP growth projection for 2010 is lowered to

0.5% from 1.0%, as the development partner-financed infrastructure activities have not yeteventuated. These were expected to boost economicgrowth through the creation of domestic employmentand local purchasing.

Air New Zealands announcement of a capacity

increase in the Rarotonga

Los Angeles route over thepeak season, and the July commencement of thegovernment-subsidized SydneyRarotonga route,should boost tourist numbers in the second half of2010. However, discounting in the tourism sectormay undermine the growth in earnings.

Looking further ahead, concerns over the level ofpublic debt (though still well under the Cook Islandsown ceiling of 35% of GDP) are pressing thegovernment to achieve a fiscal surplus in FY2011.This will require budget cuts that will reduce growthgenerated through public spending.

Prices are likely to remain stable over the rest of the

year as the domestic demand tracks a slow recovery.ADB projects 3.5% inflation in 2010. Delayed effectsfrom rising oil prices and higher prices from NewZealand, a major trading partner, are likely to showin domestic inflation in early 2011.

Key issues

Government growth projections to FY2013 do not riseabove 1.6%. This weak outlook highlights theimperative for sound infrastructure investments tomove the Cook Islands through the currentbottleneck in growth and to step up to a higher plane.Lead author: Emma Ferguson


6/32

6

ECONOMIC CONDITIONS

Fiji IslandsResident departures to Fiji Islands

(000 persons; monthly)

0

10

20

30


From Australia

From NZL

Source: ABS and New Zealand Ministry of Tourism.

Monetary indicators

(y-o-y % change, monthly)

-20

-10

0

10

20


Inflation

Broad money

Credit growth

Source: Reserve Bank of Fiji.

Foreign reserves

(months of import cover, quarterly)

0

1

2

3

4

Jun07 Dec Jun08 Dec Jun09 Dec Jun10

Source: Reserve Bank of Fiji.

Recent developments and outlook

The economy contracted by 2.2% in 2009, less thaninitially estimated. ADB still expects the economy to

contract by 0.5% in 2010 on the back of delayed landtenure and sugar industry reforms, sluggish privatecredit growth, and the adverse impacts of risinginflation.

Inflation soared in the first 5 months of 2010 due tothe removal of some price controls, higher fuel prices,and increased liquidity in the banking system. TheReserve Bank of Fiji raised the reserve requirement, asign of monetary tightening ahead. This isinopportune, as private sector credit is declining.

A revised 2010 budget was released in late June. Therevisions accommodate the expenditure demandsfollowing the cyclones of early 2010 and ongoing

termite infestation. The revisions were conservative,with no major shifts in policy direction. Tourism andagriculture are seen as drivers of economic growth,and import substitution and export promotion remainfront and center for government. The outlook for themacroeconomic framework remains optimistic and thedeficit target remains at 3.5% of GDP.

The official 2010 growth forecast of 1.8% dependsheavily on increases in sugar earnings and tourism.The Fiji Sugar Corporation reports cane production isdown from 2009, and there have been some initialdelays in sugarcane crushing with the extensive millupgrades, to improve mill operations. While in the

first 4 months of 2010 tourist numbers were up22.7% over 2009 (which was far below average dueto the impact of severe flooding), this is not expectedto be maintained. Heavy discounting remains inplace, reducing the economic benefits of increasedarrivals.

Key issues

The Fiji Islands faces a large external financing gap inthe near term. The $150 million sovereign bondmatures in late 2011, and revenues from export,tourism, and workers remittances remain weak.

The revised budget does not provide the degree of

fiscal consolidation that conditions suggest may berequired, and underlying fiscal risk remains. Actionson the revenue side are particularly weak, and it isnot clear if those actions will provide for an overallgain. Any further unanticipated expenditures, or arevenue slowdown, would place the achievement ofthe planned deficit in doubt.

Target expenditure savings rely on continued non-filling of vacant government positions and across-the-board operational cuts. Both have negativeimplications for the governments already stretchedcapacity to provide services.

Lead author: Emma Ferguson


7/32

7

ECONOMIC CONDITIONS

Kiribati

Nauru

Growth expectations in 2010 have been lowered to0.5% from 0.8%. Remittances continue to decline,and demand for copra from major consumers, such

as the Peoples Republic of China and India, is lowerthan expected. The 2010 inflation forecast is likewiserevised down to 5.4% from 5.9% due to the weakdomestic demand.

Looking further ahead, the projected recovery in theworld production of copra substitutes, such assoybean oil, has tempered expectations of highercopra prices. Despite the recovery in global trade, thenumber of i-Kiribati seafarers is expected to decline,which will further undermine remittance flows.

Returns from offshore investments held in theRevenue Equalization Reserve Fund (RERF), whichunderwrites recurrent expenditure, are likely to fall

this year as international capital markets consolidate.

The government has adopted measures to reduce thebudget deficit, lessening the pressure on the RERF.This will improve revenue compliance measures andreduce overall expenditure in the 2010 budget (byA$2 million over 2009). While these actions arefiscally sound, they are also dampening economicactivity.

Lead authors: Emma Ferguson and Laiassa Tora.

Real GDP growth and inflation

(%, annual)

-3

0

3

6

9

12

05 06 07 08 09e 10p 11p

GDP growth rate

Inflation rate

e=estimate, p=projectionSource: Kiribati National Statistics Office.

Real GDP growth(%, annual)

-30

-20

-10

0

10

FY2005 FY06 FY07 FY08 FY09e FY10p FY11p

%

e=estimate, FY=fiscal year, p=projectionSource: ADB estimates.

Lead author: Milovan Lucich

GDP projections for FY2010 have been downgraded to0%, as damage to the port mooring buoys has stillnot been fully repaired. This, together with morerecent damage to the cantilevers, has severelyrestricted phosphate exports.

Nauru recently received A$10 million in aid fromRussia following the decision to recognize therepublics of Abkhazia and South Ossetia. This moneywill largely be used to repair the mooring facilities.Together with an ongoing recovery in phosphatedemand, this should support a return to positivegrowth in 2011.

The recent performance of the Nauruan economy has

highlighted the poor state of the country's economicinfrastructure assets and the effect this has ongrowth prospects. Obsolete and worn-out equipmentis only one of the problems; many individual serviceproviders within infrastructure subsectors areperforming poorly. Performance contracts and othertypical accountability measures (such as governancearrangements to measure actual to agreed outcomes)cannot be used in Nauru because the policy and legalframework within which state-owned enterprises(SOEs) operate either does not exist (as in the caseof the utilities authority) or lacks sufficientrequirements for monitoring and evaluation.

Lead author: Laisiasa Tora


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8

ECONOMIC CONDITIONS

Northern Pacific StatesFederated States of Micronesia

Imports from the US remain low, pointing tocontinuing low domestic demand.

Nevertheless, the economy is expected to grow

modestly in 2010, by 0.5%. Development partner-funded infrastructure activities will provideadditional employment, boost domestic demand,and increase government revenue. Risks to thegrowth forecast are on the downside, mainlybecause of uncertain capacity to implementinfrastructure projects on schedule. Key hurdles totimely implementation include a lack of skilledlaborers, materials, and equipment.

Marshall Islands

GDP growth projections for 2010 remain unchangedat 0.5%. The ongoing weakness in domestic

demand is evident in low import demand.

The government is continuing a broad-based publicsector reform program. Efforts are guided by therecommendations of the ComprehensiveAdjustment Program Advisory Group, whichidentified expenditure rationalizations that couldachieve annual savings of $4.0 to $10.5 millionwithin 3 years, and the Tax and Revenue Reformand Modernization Commission, whichrecommended replacing an array of existing taxeswith a modern tax regime that offers higherrevenue potential. Actions under the MarshallEnergy Company Comprehensive Recovery Program

are also leading the reinvigoration of the state-owned enterprise.

The reforms are critical to addressing impedimentsto private sector-led economic growth arising fromweaknesses in the revenue and public expendituresystems.

Palau

The turnaround in tourism has firmed in recentmonths. Arrivals from Japan, Palaus primarymarket, were up by 28% in May 2010 on a year-on-year basis. This builds on the sustained growth inthe number of tourists from Taipei,China evidentsince the September quarter of 2009. Total visitor

arrivals are up by almost 6% during January to May2010 relative to the same period last year.

Consumption spending is showing some early signsof improvement. The steep decline in the value offood imports from the US appears to have ended.

Nevertheless, low growth of only 0.5% is projectedfor 2010 as fiscal adjustments (e.g., 10% cut inspending, streamlining of the public service) beginin an effort to stabilize government finances overthe longer term. Inflation is expected to accelerateto about 5.0% in 2010.

FSM imports from the US

($; y-o-y % change, 3-month m.a.)

-50

0

50

100

150

200


-200

0

200

400

600

800Food

Total imports (rhs)

FSM=Federated States of MicronesiaSource: ADB estimates.

RMI imports from the US($; y-o-y % change, 3-month m.a.)

-25

0

25

50

75

100


-300

0

300

600

900

1200

1500Food

Nonfood (rhs)

RMI=Republic of the Marshall IslandsSource: International Monetary Fund.

Palau visitor arrivals

(persons; y-o-y % change, monthly)

-40

-20

0

20

40

Nov08 Feb09 May Aug Nov Feb10 May

Total arrivals

From Japan

Source: Palau Visitors Authority.

Lead authors: Rommel Rabanal and Raquel Tabanao


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9

ECONOMIC CONDITIONS

SamoaRecent developments and outlook

The economy grew 0.7% in the December quarter of2009 after 5 consecutive quarters of negative growth.

Growth is picking up in manufacturing after severalquarters of marked contractions, while other sectors(fisheries, public administration, finance, andtransportation) posted solid growth throughout theyear. Post-tsunami reconstruction is progressing onschedule. ADBs outlook remains at 0.5% growth for2010.

The government plans to maintain an expansionarypolicy in FY2011 through the continuation of tsunami-related reconstruction and increased spending ineducation, health, and agriculture. The budget deficitis set to reach 9.4% in FY2011 from 7.6% in FY2010,the financing of which will require further borrowing.

Deflation returned with a 0.1% year-on-year declinein the consumer price index (CPI) in April. However,inflationary pressures are expected over 2010 as theeffects of higher fuel prices and the higher inflation inNew Zealand feed through the economy. ADB expectsinflation to be just 1.0% in 2010.

Visitor arrivals for the first 4 months of 2010 weredown 4.5% year-on-year. Tourism receipts have beenbelow the previous years levels in every month butone since September 2009. Nonetheless, real tourismreceipts are being helped by firm prices. Departuresfrom New Zealand to Samoa was flat in January toMay, while Australian tourist number declined by

5.6%. Real private remittances have trended downward

year-on-year since January. It appears thatremittances, like travel of friends and relatives, werebrought forward in late 2009 to assist familymembers affected by the tsunami. Weak labormarkets in source economies are likely to sustainthese trends in both remittances and tourism.

Key issues

The post-tsunami increases in grants, remittancesand visitor arrivals appear to have ended. Relativelystrong results for these indicators in Decemberquarter of 2009 were followed by weak performancein March quarter of 2010, which points to slow growthin 2010.

The FY2011 budget strategy statement acknowledgesthat fiscal consolidation may not be achievable untilafter FY2013 due to ongoing post-tsunamireconstruction. The macroeconomic framework showspublic debt peaking at 52% of GDP in FY2013 (in netpresent value terms). The government has not yetreleased the details of how the deficit will becontained and debt returned to below the thresholdtarget of 40% of GDP.Lead author: Emma Ferguson

Real GDP and manufacturing growth(y-o-y % change, quarterly)

-8

-4

0

4

8

12

2007Q1 Q3 2008Q1 Q3 2009Q1 Q3

-40

-20

0

20

40GDP growth (lhs)

Manufacturing (rhs)

Source: Samoa Department of Statistics

Remittances(tala million, 3-month m.a.)

-40

-20

0

20

40

60

Mar08 Jul Nov Mar09 Jul Nov Mar10

Nominal terms Real terms

Note: Real values derived using consumer price index.Source: Central Bank of Samoa.

Tourism

(y-o-y % change, 3-month m.a.)

-20

-10

0

10

20

Oct Jan09 Apr Jul Oct Jan10 Apr

Visitor arrivals (persons)

Tourism receipts (real)

Note: Real values derived using tourism price index.Source: Central Bank of Samoa.


10/32

10

ECONOMIC CONDITIONS

Solomon IslandsRecent developments

The GDP growth projection for 2010 has been revisedup to 3.5%, reflecting a stronger than expected

recovery in commodities. Logging, cocoa, fish, andpalm oil all experienced higher production andexports in the first 5 months of 2010, assisted bymodest increases in world market prices for most ofthese commodities.

The current recovery has not been evenly spreadacross all sectors. A recent ADB businessexpectations survey showed that 61% of businessessurveyed in June reported flat or declining salescompared with the same quarter the previous year.However, 56% of businesses expect sales to improveover the next 3 months.

Reflecting the uneven nature of the recovery,

government finances continue to be strained.Revenue collections were short of budget up to theend of May. The cumulative revenue shortfall to theend of May was around SI$26.3 million. However,there has been substantial underspending, mainly indevelopment expenditures. Payrolls, however, havebeen around 10% over budgeted levels. The totaldeficit at end May was SI$25.2 million.

Key issues

Solomon Islands initiated a wide-ranging policyprogram to counter the effects of the global economiccrisis and to reduce its dependency on logging andforeign aid. Development partners are actively

supporting the program, including through theprovision of targeted budget support. In March 2010,ADB approved a 2-year Economic Recovery SupportProgram. This supports government efforts toimprove economic and fiscal management. A $5million grant is provided with the program, with asecond grant scheduled for release in early 2011.Australia and New Zealand provided an additional$4.5 million in budget support in early 2010, and theEuropean Commission may provide $15 million beforethe end of 2010. The IMF also approved a standbyarrangement in June 2010.

National elections will be held in early August 2010.

The new government will face significant challengesas economic prospects remain uncertain due to themedium-term decline in logging. It will be importantfor the incoming government to develop andimplement programs and policies that continue toplace the economy on a sustainable growth path.Priorities include improving infrastructure, such asthrough contracting out of maintenance andrehabilitation and the use of publicprivatepartnerships; opening the telecommunicationsindustry to competition; reforming SOEs; simplifyingthe licensing and tax systems; and improving accessto land.

Production of key commodities

(% change, May 2010 year-to-date)

20% 0% 20% 40%

Logs

Fish

Copra

PalmOil

Cocoa

Source: Central Bank of Solomon Islands; ADB estimate.

ADB Solomon Islands BusinessExpectations Survey (June 2010)

Were sales over the last 3 months up on

last year?

0%

10%

20%

30%

40%

50%

60%

70%

No Yes Other

Do you expect sales to improve over

the next 3 months?

0%

10%

20%

30%

40%

50%

60%

No Yes Other

Sources: ADB Business Expectations Survey.



11/32

11

ECONOMIC CONDITIONS

TongaPrivate sector credit


-30

-15

0

15

30


Private sector credit

To households

To business

Source: National Reserve Bank of Tonga.

Remittances and tourism receipts

(paanga; y-o-y % change, 3-month m.a.)

-40

0

40

80


Real tourism receipts (rhs)

Real remittance

Sources: National Reserve Bank of Tonga and Tonga Ministryof Finance and National Planning.

Inflation and domestic credit


-10

-5

0

5

10

15


Inflation

Money supply

Imported inflation

Source: National Reserve Bank of Tonga.


Key developments

ADB projects the economy to contract by 0.4% in

2010, down from earlier expectations for a slightexpansion. The expected contraction is due todelays in public infrastructure spending, andconcomitant weakness in remittances, tourismreceipts, and domestic demand.

Continued high unemployment in major sourcemarkets such as the US means that remittanceflows to Tonga will continue to decline. Recordedremittances in the 12 months to May 2010 were still12% below the same period last year.

Tourist arrivals fell by 8.5% in March quarter 2010compared with the same period in 2009.Consequently, earnings from tourism fell by 14% in

May on a year-on-year basis, following a decline of11% the previous month.

Private sector credit continues to contract, asconsolidation in the banking sector was followed bymore stringent lending conditions in the latter halfof 2009. Commercial banks are expected tomaintain this stance over the next 6 to 12 months.The contraction in credit to businesses has beensharper and deeper compared with that ofhouseholds due to the excessive credit growth thatoccurred over most of 2008.

Inflation has been rising since November 2009,reaching 4.6% in April, mainly due to higher oil

prices. Inflation is expected to average about 3.5%in 2010 as oil prices stabilize later in the year.

Key issues

Significant reductions in public debt are needed torelieve pressure on a worsening fiscal position. Keydebt sustainability indicators such as the ratio ofnet present value of external debt to GDP, and thedebt-to-exports ratio, indicate that Tongas debtlevels have exceeded target thresholds (by 11%and 26%, respectively). The government intends toreduce the debt by prioritizing the achievement ofprimary surpluses in FY2012 and FY2013.

Efforts to strengthen public financial management

are even more critical given the limited fiscal spaceenvisaged over the medium term as governmentimplements its fiscal consolidation program.Moreover, momentum must be sustained onreforms in SOEs, the business regulatoryenvironment, and strategic economic management(encompassing planning and budgeting) for benefitsto eventuate.


12/32

12

ECONOMIC CONDITIONS

Tuvalu

VanuatuVisitor arrivals

(persons; y-o-y % change, 3-month m.a.)

-10

0

10

20

30

May Sep Jan09 May Sep Jan10 May

Source: Vanuatu National Statistics Office.

Recent developments

There was a reversal in total tourist arrivals inJanuary to May 2010. After growing by 10.8% in2009, the number of monthly visitors contracted on

the average by 6.0% as arrivals from Australiaslowed.

Weak domestic demand is evident in slower growth intotal import demand and a sustained decline inprivate sector credit growth. Imports from Australiacontracted by 5.9% in the March quarter. The size ofmonthly contractions has declined, however,indicating the potential for stabilization in comingmonths.

Sluggish growth in private sector credit continuedfrom 2009 to May 2010. Value-added tax receiptshave also declined, with January and February figuresbelow their 2009 levels.

Recent developments and outlook

Economic growth projection for 2010 remains at1.6% as the expected flow-on effects of the increase

in government expenditure

ostensibly to generateshort-term growthare dampened by the inflationaryimpacts of rising oil prices. Inflation is expected torise to 3.5% in 2010.

Distributions from the Tuvalu Trust Fund to thegovernment, which fund about 15% of the recurrentbudget, are unlikely in 2010. In the second half of2009, the market value of the Tuvalu Trust Fundincreased by around 4.4% but remained below themaintained value (a condition for distributions).

Remittances from seafarers have been declining forsome years. The recent economic slowdownexacerbated this trend in 2009. The underlying

problem of weakening demand from shippingagencies remains.

The 2010 budget, including supplementaryappropriations, projects a deficit of A$10.8 millionbased on a 14.1% expenditure increase (A$4.4million), accompanied by a 13% revenue decrease(A$3.8 million). Further deficits of A$6.4 million areprojected for 2011 and A$7.0 million for 2012.

Key issue

Without expenditure cuts or other remedial action,the governments cash and Consolidated InvestmentFund reserves will likely be exhausted in 2011. It is

critical that the government adopt a prudent fiscalstance and improve the quality of its decision makingto achieve macroeconomic and fiscal stability over themedium term.

The lead author of the section is

Budget balance

(% of GDP, annual)

-40

-30

-20

-10

0

09e 10p 11p 12p

e=estimate, p=projectionSource: Tuvalu Trust Fund Advisory Committee, 2010 FirstHalf Report, May 2010.

Imports from Australia(tons; y-o-y % change, 3-month m.a.)

-200

-100

0

100

200

300

400

May08 Sep Jan09 May Sep Jan10 May

Chicken

Flour

Source: ABS.



13/32

13

ECONOMIC CONDITIONS

Vanuatu Inflation stabilized at 2.8% during the March

quarter.

Outlook

Tourisms contribution to growth is expected todecline in 2010 due to vigorous marketing andheavy discounting by the Fiji Islands and the CookIslands. This may require Vanuatu to offercompeting discounts.

The projected 2010 GDP growth has been reviseddown to 4.0% from 4.6%, primarily because of theweaker than expected performance in tourism,which contributes approximately 20% of economicoutput.

Inflation is likely to exceed both the government'starget maximum of 4.0% and the 2009 rate of

4.5%. The projected inflation rate for 2010remains at 5.0%. Key upside risks to inflationinclude the recent imposition of excise taxes ondrinks and tobacco and imported inflation due toincreasing international commodity prices.

Key issues

While Vanuatu's recent growth has beenimpressive, further reforms are required to sustainmedium-term growth. In particular, there is astrong need to improve the performance andaccountability of SOEs so that they operateefficiently and allow room for the private sector.

SOEs absorb large amounts of scarce capital on

which they provide very low returns, divertgovernment resources from vital socialinvestments in health and education, and drive upthe costs of doing business where they are thesole service providers. While poor financialreporting practices make it difficult to accuratelyestimate the extent of the fiscal strain representedby SOEs, a recent audit of one of the larger SOEsrevealed that its accumulated losses totaled $20million. Moreover, recent court rulings haveaffirmed that under the 2006 Public Finance andEconomic Management Act, the government canbe considered a guarantor of the debts of SOEs.

Vanuatu has 20 SOEs, 14 of which are engaged incommercial activities (6 perform variousnoncommercial functions for government). Of the14, the central government is the majority ownerof 9 and a minority shareholder in the remainder.Only 4 of the 14 commercial SOEs have reportedproducing commercially acceptable returns in thepast 5 years.

Key indicators

(%, quarterly)

0

2

4

6

8


0

10

20

30

40

50

Inflation rate

Credit growth

Sources: Vanuatu National Statistics Office and Reserve Bank

of Vanuatu.

Imports(value; y-o-y % change, quarterly)

-40

-20

0

20

40

60


Total imports

Imports fromAustralia

Sources: ABS and Reserve Bank of Vanuatu.

Value-added tax revenue

(million vatu, quarterly)

0

400

800

1200

1600

Q 1 '0 8 Q2 Q 3 Q 4 Q 1 '0 9 Q2 Q3 Q 4 Q 1 '1 0

Source: Reserve Bank of Vanuatu.



14/32

ECONOMIC CONDITIONS

14

Papua New GuineaAgricultural and mineral exports

(index: Dec 2003=100, quarterly)

0

100

200

300

400

Jun

04

Dec

04

Jun

05

Dec

05

Jun

06

Dec

06

Jun

07

Dec

07

Jun

08

Dec

08

Jun

09

Dec

09

Jun

10

Volume (agriculture and log)

Price (agriculture and log)

Volume (mining and oil)

Price (mining and oil)

Source: Bank of PNG; ADB estimates.

Cumulative trust fund spending(million kina, quarterly)

0

500

1000

1500

2000

2500

Q1 Q2 Q3 Q4

2008 2009

Source: PNG Ministry of Treasury.

Inflation

(year-average % change, quarterly)

0

3

6

9

12

Jun08 Dec Jun09 Dec Jun10 Dec10p Jun11p Dec11p

p=projectionSource: Bank of PNG; ADB estimates.

Recent developments

The joint Treasury and Bank of PNG SovereignWealth Fund Working Group, established in March2010 was scheduled to submit a report to theNational Executive Council at the end of June 2010.The report outlined suggestions on how best toimplement the sovereign wealth fund proposed bythe government. (Key policy issues are explored onpages 2527).

PNG merchandise exports have recovered. The USdollar value of exports increased by 1% over the 12months to June 2010, after falling by 24% during2009. The weighted kina export price rebounded by38% over the 12 months to June 2010 (9% for thenon-mineral sector and 41% for the mineralsector).

However, in real terms, government revenues weredown by 18% in the 12 months to March 2010.Taxes on income and profits remain subdued,particularly in the mineral sector. However, realpublic expenditures increased by about 2% over thesame period, supported by K2.4 billion trust funddrawdowns over 2009 (equivalent to 11% of GDP).

Despite rising government expenditure, annualinflation trended down to 5.6% on a year-averagebasis to June 2010.

In July 2010, the Bank of PNG reconfirmed itscommitment to a policy indicator rate of 7% for the

seventh consecutive month.Outlook

ADBs growth projections for PNG remainunchanged at 5.5% in 2010 and 7.7% in 2011. Asanticipated in theAsian Development Outlook 2010,there were delays in the construction phase of theliquefied natural gas (LNG) project due to landaccess and compensation issues and a shortage ofskilled labor. These delays are shifting the growthcontribution of the project into 2011.

Inflation is anticipated to remain relatively high at7.1% in 2010 and 7.7% in 2011. Price pressure isbeing generated from high levels of private sectoractivity as well as the delayed impact of rapid trustfund expenditures by the public sector in 2009.

Domestic risks to the 2010 projections remainslightly on the upside. GDP could be slightly higherthan forecast if landowner compensation disputesrelated to the LNG project can be resolved quickly,and if project developers are able to secure thenecessary equipment, material, and skilled laborinputs to ramp up plant construction. This may,however, be at the expense of growth in the non-mineral sector.Lead author: Dominic Mellor


15/32

ECONOMIC CONDITIONS

15

Timor-LesteReal GDP growth

(%, annual)

0

5

10

15

2007 08 09e 10p 11p

e=estimate, p=projectionSources: Timor-Leste Ministry of Finance, National Directorate

of Macroeconomics, and National Directorate of Statistics.

Own-funded government expenditure

($ million, quarterly)

0

100

200

300

Mar07 Mar08 Mar09 Mar10

Sources: Timor-Leste Ministry of Finance, National Directorateof Statistics. Quarterly Statistical Indicators. various quarters.

Own-funded government expenditure

(by category; $ million, annual)

0

100

200

300

Wages andsalaries

Goods andservices

Transfers Capital

08

09

10b

b=budget,e=estimate, p=projectionNote: Own-funded government expenditure shownSources: Timor-Leste Ministry of Finance,General Budget ofState, various years.

Recent developments

Official estimates of economic growth for 2009 havebeen upgraded from 6%8% to 12.2%. The upgradeis driven by a higher than expected level of own-funded government expenditure. Improvedagricultural performance, a result of the spread ofhigher yield seeds and increased use of key inputssuch as fertilizer and tractors, has also acceleratedgrowth.

Only 45% of the own-funded portion of the 2009budget had been recorded as spent at the end of theSeptember quarter 2009. The low rate of budgetexecution underpinned official preliminary estimatesof decline in own-funded expenditure in 2009. A9.5% decline, from $553 million in 2008 to $501million, was expected in 2009. There was, however,

a surge in expenditure in December quarter 2009.About 89% of the own-funded portion of the 2009budget was ultimately spent, and own-fundedexpenditure rose by 9.3% to $604 million in 2009.

Most of the additional expenditure was on capitalexpenditure and wages and salaries. Recordedcapital expenditure surged in December quarter2009 as contractors took advantage of the dryseason, as quickly implemented small-scale projectswere undertaken and earlier expenditurecommitments were brought into the accounts.

Consistent with the high rate of economic expansion,imports of merchandise goods were up considerably

in 2009. The total value of merchandise imports roseby 9.9%. Excluding petroleum and cereal, which fellin price over the year, the value of imports rose by26.4% in 2009. Capital goods imports increased by36.6% in 2009 as construction activity andequipment purchases surged. Imports have begun topick up after slowing during 2009. In the first 5months of 2010, the value of non-petroleum andcereal imports was 8.8% above that of the sameperiod in 2009.

Merchandise exports, mainly coffee, remain low. Thetrade deficit to non-petroleum GDP reached nearly45% over 2009.

The rate of money supply growth has eased. Afteralmost doubling in 2008, broad money grew by39.6% over 2009. It then rose by 5.0% over the first5 months of 2010. Commercial bank lending to theprivate sector remains flat, reflecting thegovernment-oriented nature of construction andother investment activity. Nonperforming loans haveincreased and by mid-2010 accounted for 45% ofloans to the private sector (provisioning for baddebts exceeds the level of nonperforming loans).

Inflation is on the rise. After ending 2009 at 1.6%,inflation had reached 6.6% by June on a year-on-year basis.


16/32

16

ECONOMIC CONDITIONS

Timor-LesteNon-petroleum imports

($ million, 3-month m.a.)

0

10

20

30

40

Sep Jan09 May Sep Jan10 May

Other goods

Cereals

Capital goods

Sources: Timor-Leste Ministry of Finance, National Directorateof Statistics, Trade Accounts, various quarters.

Projected Petroleum Fund balance($ billion, annual)

0

2

4

6

2008 09 10

2006-07 Budget

2008 Budget

2009 Budget

2010 Budget (rev)

rev=revisedSources: Timor-Leste Ministry of Finance, General Budget ofState, various years.

Expenditure and funding

($ million, annual)

0

500

1,000

08 09e 10b

Own-funded expenditure

Petroleum Fund withdrawal

b=budget, e=estimateSources: Timor-Leste Ministry of Finance,General Budget ofState, various years.

Outlook

Economic growth is projected to remain high in2010, driven by continued increases in government

own-funded expenditure and improved agricultureproduction. Private construction, transport andcommunications, and whole sale and retail trade allexpanded. Under the original 2010 budget, therewould have been only a small increase in own-fundedgovernment expenditure. However, a supplementarybudget approved in June substantially increasedexpenditure plans. Expenditure is now budgeted torise by an additional 38.7% in 2010. Much of theadditional expenditure will be in transfers (such as toveterans) and for small-scale capital works, whichwill flow quickly into the local economy and keepaggregate demand high.

Inflation is expected to average 5% for the year,

close to the inflation rate in Indonesia, Timor-Lestesmajor trading partner.

Key issues

Savings in the Petroleum Fund continue to exceedprojections, a result of higher than expectedpetroleum prices. The fund was worth $5.9 billion atthe end of April 2010, and is projected to reach $6.4billion by the end of the year. This compares with the2008 budgets projection of a $4.9 billion balance atthe end of 2010, and the 2009 budgets projectionfor that balance to be $5.7 billion.

The savings are accumulating faster than expecteddespite withdrawals that substantially exceed theestimated sustainable income. The estimatedsustainable income (now 3% of the net present valueof petroleum revenue) is that level of withdrawal thatcan be sustained indefinitely. Withdrawals exceededthe estimated sustainable income for the first time in2009. While the 2010 budget originally keptexpenditure within the estimated sustainable income,$502 million, the withdrawal is now budgeted toexceed it by $309 million (some of this is held asgovernment cash reserves).

Key issues for budget management are (i) whetherthe higher levels of expenditure are fiscally

sustainable, and (ii) whether implementationcapacity has advanced quickly enough to spend theadditional budget effectively and in a transparentand accountable manner.

In July, Timor-Leste became only the third nation tocomply with the Extractive Industries TransparencyInitiative. This international initiative aims tostrengthen governance by improving transparencyand accountability in the extractives sector.Compliance provides international recognition thatTimor-Leste is accurately and fully disclosing thegovernment revenue it receives from petroleum.

Lead author: Craig Sugden


17/32

ECONOMIC POLICY AND MANAGEMENT

17

Incomewho scores highest?Purchasing power parity

Average incomes in the Pacific, measured by percapita gross national income, compare favorably

to those in developing Asia. Many Pacific islandnations report a higher per capita gross incomethan much of developing Asia. But the comparisonis potentially misleading. This is because itignores the disadvantage that arises from thePacifics very high cost structure and the resultinghigh price levels. A similar argument can be madewhen comparing incomes within the Pacific.Comparisons within the Pacific will be mostmeaningful if they factor in the consequences ofdifferent cost structures and price levels.

More meaningful comparisons are made whenundertaken in purchasing power parity terms. A

dollar equivalent (i.e., $1 worth of local currency)in one country can have a very differentpurchasing power to a dollar equivalent held inanother country. Specifically, a dollar equivalentheld in a lower income country will normally buymore goods and services than a dollar equivalentheld in a higher income country. This is becauseprices in a lower-income economy are normallylower than prices in higher-income economies.

Purchasing power parities can be thought of asconversion factors that ensure a commonpurchasing power over a given set of goods andservices (see the special chapter on Comparing

Poverty Across Countries: The Role of PurchasingPower Parities in the ADB publication KeyIndicators 2008.)

Methodology

The International Comparison Program led by theWorld Bank, provides the key source ofpurchasing power parity adjustment factors. Themost recent estimates from the program are for2005, which fortunately included the Fiji Islands,This was the first time a Pacific Island economywas included in the program.

The purchasing power parity index for the Fiji

Islands was estimated at 208 when expressedrelative to Asia (i.e., the average index for Asia is100). That is, $2.08 in the Fiji Islands was foundto have the same purchasing power, on average,as $1 in Asia. When expressed relative to the US(i.e., the average index for the US is 100), the FijiIslands index was 85. This means the Fiji Islandsis a lower-cost economy than the US. Thiscompares with a typical index for Asianeconomies of around 50 when expressed relativeto the US.

It is possible use to the index for the Fiji Islandsas a benchmark for preparing estimates of thepurchasing power parity index for other Pacific

economies. This is done by using detailed priceinformation from the consumer price index.Specifically, prices in a typical year arecompared (in the levels) for a selection of goodsthat are in the consumer price index basket forthe Fiji Islands and another Pacific Islandeconomy. This comparison is used to estimatethe aggregate difference in price levels betweenthe two economies.

Such estimates can only be consideredillustrative. The comparison is undertaken for asample of goods, and this sample varies acrosscountries. Ideally the estimates would be basedon comparisons of goods that are the sameacross countries. A further limitation is that thegoods being compared may not be strictlycomparable (e.g., because of differences inquality).

Results

Illustrative purchasing power indexes wereprepared for the Cook Islands, the MarshallIslands, Palau, Solomon Islands, Tonga, andTuvalu. Each had a higher index than the FijiIslands.

Thus most Pacific island economies are found tobe higher price economies than the US. Most arefound to have a price level comparable to orabove Australia and New Zealand, that areslightly higher price economies than the US. Themuch higher cost structures in the Pacificcompared to Asia stand out from theinternational comparisons.

Of this group, the Cook Islands was found to bethe highest-cost economy, with an index of 150expressed relative to the US. Tuvalus index wasestimated at 135, and the remaining countriesbetween 100 and 110.

The purchasing power parity index is used to

prepare adjusted estimates of per capita grossnational income. When income levels areexpressed in purchasing power parity terms,lower-income countries will normally appearbetter off relative to higher-income countries (incontrast to measuring incomes in standardterms). The opposite applies to the Pacific islandcountries, which are high-cost economies.Importantly, the data suggest real incomes inthe Pacific are, on average, below that of mostof developing Asia.

Lead authors: Raquel Tabanao and Craig Sudgen


18/32


19/32

19


Tackling fuel prices

The Pacifics high cost structure and resultanthigh prices impair the regions internationalcompetitiveness. Lowering the cost structure

through productivity improvements would raisepurchasing power, thereby lifting real incomes.It would also help expand exports and makelocal production more competitive againstimports. Lower costs would assist theproduction of agricultural commodities andother goods, and help expand tourism andother services.

But can the regions high cost structure bereduced? If so, how, and what are the prioritiesfor action? Understanding the answers to thesequestions can help in formulating the policiesneeded to make the region more competitive.

The Pacifics remoteness from major marketsand its small, dispersed communities areobvious causes of high costs. These factorscontribute to high transport costs and meanthat production often takes place at the upperend of cost curves.

The importance of transport costs is readilyevident from a comparison of fuel prices.Economies with a relatively high purchasingpower parity index also tend to have relativelyhigh fuel costs, and vice versa. The CookIslands, for example, has both the highestpurchasing power parity index and the highestfuel prices, while the Fiji Islands has the lowestindex and low fuel prices. High fuel prices addto an economys cost structure, both directlythrough use in vehicles, boats, and ships, andindirectly through the transport servicesembedded in other goods. In most economies,the penalty of remoteness and smallness iscompounded by special taxes and levies onfuel.

The penalty of high fuel prices can also be seenin electricity prices. Fuel accounts for more than50% to 70% of operating costs for the diesel-dependent utilities in the region. Across thePacific, electricity prices tend to be higherwhere the price of fuel is higher. For example,the Cook Islands has the highest fuel prices andamong the highest electricity prices.

But the correlation is not perfect, as the linkbetween fuel and electricity prices is notcomplete. One reason is the presence ofsubsidies. In 2009, operating costs for the smallto mid-sized diesel-dependent utilities wereprobably in the range of 25 to 40 cents per

kilowatt-hour. However, some governments wereproviding large electricity subsidies, which keptprices below operating costs. Kiribati, the

Federated States of Micronesia, the MarshallIslands, Nauru, Timor-Leste, and Tuvalu have beenamong the largest subsidizing countries, in somecases helped by development partner funding forfuel. Elsewhere, the presence of private orcommercialized operators (such as in the FijiIslands, PNG, Samoa, Tonga, and Vanuatu) tend tokeep prices closer to total costs (i.e., operatingplus capital costs).

A second reason is the advantage of hydropower.For example, the Fiji Islands and PNG benefit fromlower prices than other countries because of boththeir size (they can better take advantage ofeconomies of scale) and the high share ofelectricity supplied from hydropower (accountingfor 60%65% of generated power). Samoa also

benefits from having around half of its electricitygenerated from hydropower.

While subsidies reduce electricity prices, they donot offer savings in fuel coststhey simply shift

fuel costs from users to taxpayers. Taking intoaccount transport, electricity, and other needs, theratio of fuel imports to GDP ranges up to almost30%. Additional fuel costs are also embedded inthe cost of transporting merchandise imports andpeople to and from the region. High fuel costs thushave an extensive reach in the Pacific economies.

The high fuel costs in the Pacific can be traced tothe long freight routes, multiple interislandhandling, and suboptimally small shipment sizes.But high fuel and electricity prices are not all aboutsmallness and dispersed populations.

A 2006 World Bank study highlighted that countrieswith open market international tendering processesand price regulation, such as Samoa and SolomonIslands, have lower fuel prices than those withoutprice regulation and closed market monopolysuppliers, such as Kiribati and Vanuatu (WorldBank. 2006. The Pacific Infrastructure ChallengeA

review of the obstacles and opportunities forimproving performance in the Pacific Islands.Washington D.C.) Samoas experience is widelycited. It has the lowest fuel costs in the region,helped by a competitive allocation of the rights touse a government-owned fuel farm.

Finding ways to tackle fuel prices, as Samoa has,falls under the umbrella of structural policy.Enhancing competition in fuel supply is one way to


20/32

20


Petrol prices (US$ per liter, 2009) Diesel prices (US$ per liter, 2009)

PPP and the fuel price Fuel imports to GDP ratio (%, latest year)

0.0 0.5 1.0 1.5 2.0

COO

FIJ

PAL

PNG

RMI

SAM

SOL

TIM

TON

TUV

VAN

PPP Index(US=1.0)

Pre-tax petrolprice in 2009($/liter)

0.0 0.5 1.0 1.5 2.0

AUS

NZL

VAN

TUV

TON

TIM

SOL

SAM

RMI

PNG

PAL

FIJ

COO

Without taxesand duties

Taxes andduties

0.0 0.5 1.0 1.5 2.0

AUS

NZL

VAN

TON

SAM

PNG

PAL

FIJ

Without taxesand duties

Taxes andduties

0 10 20 30 40

COO

FIJ

FSM

KIR

NAU

PAL

PNG

RMI

SAM

SOL

TIM

TON

TUV

VAN

AUS=Australia, COO=Cook Islands, FIJ=Fiji Islands, GDP=gross domestic product, NZL=New Zealand, PAL=Palau, PNG=Papua New Guinea,PPP=purchasing power parity, RMI=Republic of the Marshall Islands, SAM=Samoa, SOL=Solomon Islands, TIM=Timor-Leste, TON=Tonga,TUV=Tuvalu, VAN=VanuatuNote: The countries used various commodity classifications such as the Standard International Trade Classification (SITC), Broad Economic Categories(BEC) 1, and Harmonized Commodity Description and Coding System (HS) 2. Due to unavailability of more disaggregated data, resulting fuel importsshare could be understated or overstated as it includes other non-fuel products such as minerals and lubricants.Source: ADB estimates based on fuel prices from statistical agencies and various reports of government agencies, reserve banks, and newspapers;data from the Pacific Forum Islands Secretariat. 2007. Pacific Fuel Price Monitor. May; and World Bank. 2005. Global Purchasing Power Parities andReal Expenditures. Washington D.C.


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21


Electricity tariffs (US cents, 2010) 1st tier residential electricity tariffs

Residential electricity tariffs(US cents, 2010 prices) Commercial electricity tariffs (US cents, 2010 prices)

0 20 40 60 80

COO

FIJ

FSM

KIR

RMI

NAU

PAL

PNG

SAM

SOL

TIM

TON

TUV

VAN

1997

2006

2010

0 20 40 60 80

COO

FIJ

FSM

KIR

RMI

NAU

PAL

PNG

SAM

SOL

TIM

TON

TUV

VAN

1997

2006

2010

0 10 20 30 40 50 60

COO

FIJ

FSM

KIR

RMI

NAU

PAL

PNG

SAM

SOL

TIM

TON

TUV

VAN

AUS

NZL

Residential(2nd tier,where applied)

Commercial

(US cents, 2010)

0 10 20 30 40 50

FIJ

FSM

NAUPAL

PNG

RMI

SAM

TUV

VAN

Maximum usage (kWh/month)

0 100 200 300 400 500

FIJ

FSM

NAU

PAL

PNG

RMI

SAM

TUV

VAN

AUS=Australia, COO=Cook Islands, FIJ=Fiji Islands, FSM=Federated States of Micronesia, KIR=Kiribati, kWh=kilowatt hour, RMI=Republic of theMarshall Islands, NAU=Nauru, NZL=New Zealand, PAL=Palau, PNG=Papua New Guinea, SAM=Samoa, SOL=Solomon Islands, TIM=Timor-Leste,TON=Tonga, TUV=Tuvalu, VAN=VanuatuNote: 1st tier refers to a situation where there is a lower tariff at lower usage levels. It is often called a lifeline tariff.Sources: ADB estimates based on Kolone Vaai & Associates. 1998. Electric Power Corporation Tariff Study; World Bank. 2006. The Pacific InfrastructureChallenge; Official communications and various reports of power utilities; Independent Pricing and Regulatory Tribunal, downloaded 26 July2010:http://www.ipart.nsw.gov.au/documents/EA_Residential_and_business_price_list_2009.pdf:Ministry of Economic Development, downloaded 28 July 2010:http://www.med.govt.nz/ upload/72610/ QSDEPMay2010%20updated.pdf


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22


Tackling fuel prices

lower fuel costs. The bulk fuel procurement initiative,developed under the auspices of the Pacific IslandsForum secretariat, is another option for lowering fuel

costs. This structural policy initiative aims to lowerfuel costs through improved coordination inpurchasing, better procurement practices, and risksharing.

Structural policy extends to exploring policy actionsthat will make electricity utilities work better.Inefficiency in the regions electricity utilities is onereason for the high fuel prices that add to theregions high cost structure. Improving the efficiencyof utilities is one approach to tackling the costdisadvantage faced by the region and lifting realincomes.

Insights on the potential extent of inefficiency areprovided by a comparison of indicators for a sampleof Pacific electricity utilities. In the sample, laborproductivity, measured by output per employee,tends to be higher, and operating costs lower, forlarger utilities (those generating higher amounts ofelectricity). This pattern is consistent with therealization of economies of scale in production.

The indicators also establish that some utilities areable to achieve equivalent or higher laborproductivity than some larger utilities. This suggestssome of the larger utilities have significant potentialto increase their labor productivity. Considerable

differences are evident in labor productivity ofutilities of similar size, again suggesting someutilities are less efficient than others.

In addition, some smaller utilities are able to achievea unit operating cost similar to the largest utilities inthe sample. This suggests the larger utility couldprobably reduce its operating cost through betterpractices.

These observations point to marked differences inefficiency between utilities and the likelihood thatbetter policy can lift performance.

The Marshalls Energy Company provides a guide tothe sort of structural reforms that can lift utilityefficiency. Guided by the Marshalls Energy CompanyComprehensive Recovery Plan, corporate governancehas been improved through reconstitution of theboard, procurement and financial managementpractices are being improved, tariffs have beenrealigned to reflect costs, system loss is beingreduced, billings are being improved through theadoption of prepaid metering and better collectionpractices, and the utilitys generators and othermajor equipment are being overhauled.

Indicators for Pacific electricity utilities(2009, sample of Pacific utilities)

0

10

20

30

40

50

60

0 200 400 600 800

MWh per employee

Operating

costperkWh(cents)

0

10

20

30

40

50

60

0 50 100

MWh generated (index)

Op

eratingcostperkWh(cents)

0

200

400

600

800

1000

0 5 10 15 20 25kWh generated (index)

MWhperemployee

kWh= kilowatt-hours, MWh=megawatt-hoursSource: ADB estimates based on communication with electricityutilities and utility reports and websites.

Lead authors: PEM Research Team and Craig Sugden


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Changing the rulestelecommunicationsThe telecommunication industry provides the regionsmost graphic example of the benefits of soundstructural policy. In telecommunications, changing the

rules in favor of competition and performance hasmade users much better off while also helping ensurethat suppliers are financially sustainable.

Performance in the industry is dominated by thequality of structural policy. Industry structure, which islargely determined by whether government policyallows new players, is a key determinant ofperformance. More open industries are associated withlower tariffs and charges, and better service qualityand coverage. Quality economic regulation that seeksto lower charges and raise service standards is alsoimportant to ensure better industry performance.

Actions to aggressively take advantage of newtechnology and fast-track the spread of mobile andwireless telecommunications have helped overcomethe limits of landline services. In particular, low-costaccess to mobile phones allows users to avoid the highfixed cost of landline services, providing many peopleaccess to telecommunications for the first time. Tongaled the way in this regard, but similar structuralreforms have now spread through almost the entireregion.

The wide range of services and pricing structuresacross providers complicates comparisons oftelecommunications prices. To overcome this, atelecommunications price index is computed based ona basket of services likely to be used by a typicalhousehold. The basket includes the monthlysubscription fee for a landline connection and the costof a representative bundle of local and internationalcalls from landline and mobile phones. The lowest-pricecountry, Tonga, has an index of 1, with prices in othereconomies expressed relative to Tonga.

Kiribati is found to be the highest-price country, withthe bundle of services 4 times that of Tonga. This canbe traced back to the presence of a single governmentprovider. The high prices in the Cook Islands andTimor-Leste can also be traced back to the presence ofone operator. In this case, the operator is privatelyrun, but economic regulation is inefficient and hastolerated damaging monopolistic practices. Bothcountries are considering structural reform of theirindustries.

The countries with lower prices, such as Tonga andPalau, are characterized by competition. Oneinteresting observation is that the presence of agovernment provider has not necessarily been a barrierto lower prices. But this appears to be the case onlywhen the government player operates on anindependent, commercial basis. Lead authors: PEM Research Team and Craig Sugden

Landline subscription fee

($, monthly)

0 10 20 30

COO

FIJ

KIR

RMI

FSM

PAL

PNG

SAM

TIM

TON

VAN

Residential

Commercial/industrial

Price of a bundle of residential services(index: Tonga=1.0)

0 1 2 3 4 5 6

COO

FIJ

KIR

RMI

FSM

PAL

PNG

SAM

TIM

TON

VAN

COO=Cook Islands, FIJ=Fiji Islands, FSM=Federated States ofMicronesia, KIR=Kiribati, RMI=Republic of Marshall Islands,PAL=Palau, PNG=Papua New Guinea, SAM=Samoa, TIM=Timor-Leste, TON=Tonga, VAN=Vanuatu.Source: ADB estimates based on communication withtelecommunication providers and provider reports and websites.


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Telecommunication charges ($, 2009 or 2010)COO FIJ KIR RMI FSM PAL PNG SAM TIM TON VAN AUS NZ

Landline services

Residential

Installation fee 53 41 56 35 24 20 4 20 40 30 83 172 38

Monthly subscription fee 7 5 6 12 8 12 3 8 10 3 14 20 46Local call rate (per minute)

a0.01 0.08 0.02 0.00 0.00 0.00 0.02 0.02 0.11 0.03 0.23 0.18 0.00

Commercial/ industrial

Installation fee 53 41 56 35 24 20 18 20 40 30 83 100 35

Monthly subscription fee 13 7 11 30 16 24 3 12 10 6 14 29 33

Local call rate (per minute)a

0.01 0.00 0.04 0.00 0.00 0.00 0.02 0.13 0.03 0.23 0.12 0.03

Mobile call rates (per minute)

Mobile to landline 0.51 0.19 0.40 0.10 0.10 0.21 0.52 0.21 0.27 0.09 0.21 0.72 0.38

Mobile to mobile 0.51 0.18 0.24 0.10 0.10 0.21 0.45 0.17 0.23 0.10 0.21 0.72 0.38

International call rate (per minute)c

Average across all destinations 1.75 0.57 2.80 1.25 1.71 1.04 1.06 0.56 0.87 0.61 0.89 1.95 0.74

Average for AUS, NZL and US 1.23 0.27 3.27 1.25 1.08 0.35 0.90 0.52 0.59 0.35 0.42

= not available, AUS=Australia, COO=Cook Islands, FIJ=Fiji Islands, FSM=Federated States of Micronesia, KIR=Kiribati, NZL=New Zealand, RMI=Republicthe Marshall Islands, PAL=Palau, PNG=Papua New Guinea, SAM=Samoa, TIM=Timor-Leste, TON=Tonga, VAN=Vanuatu, US=United Statesa For a local call of 3 minutes, averaged across providers, excluding special offers.b Average of prepaid and postpaid rates during peak hours, averaged across providers, excluding special offers.c Average rate from a landline and mobile call during peak hours including tax, averaged across providers, excluding special offers.Sources: ADB estimates based on communication with telecommunication providers and provider reports and web sites.

Industry players

Privately owned Government owned

High tariffs KIR Telecom Services Kiribati Limited

Digicel Limited

Telecom Vanuatu Limited

COO Telecom Cook Islands (majority)

Bemobile Limited

Telikom PNG

TIM Timor Telecom

Digicel Limited

Vodafone Fiji Limited

RMI National Telecommunications Authority

SAM Digicel Limited Samoatel Limited

FSM FSM Telecommunications Corporation

Low tariffs TON Digicel Limited Tonga Communications Corporation

and charges PAL Palau Mobile Corporation Palau National Communications Corp.

FIJ Telecomm Fiji Limited

and chargesVAN

PNG Digicel Limited

COO=Cook Islands, FIJ=Fiji Islands, FSM=Federated States of Micronesia, KIR=Kiribati, RMI=Republic of the Marshall Islands, PAL=Palau, PNG=PapuaNew Guinea, SAM=Samoa, TIM=Timor-Leste, TON=Tonga, VAN=VanuatuSources: ADB estimates based on communication with telecommunication providers and provider reports and web sites.


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Sovereign wealth management in PNGIn 2009, though, fiscal discipline weakened.Payments from trust funds equaled 10.8% ofGDP, constituting 81% of total trust fund

expenditures since 2005. These drawdowns werefar above a limit set in the Medium-Term FiscalStrategy. They were presented as an economicstimulus, but this did not appear necessary giventhat the economy was already achieving solidgrowth. Moreover, the channeling of spendingoutside the national budget meant it was notintegrated into the macroeconomic framework.

The national government channels a significantamount of trust fund monies through localadministrations, which have limited capacity toimplement development projects. It is unlikelythat all spending went as planned on development

priority projects, given the rapid pace ofdrawdowns and lack of transparency in thespending.

Public revenue from the LNG project will providePNG with another chance to increase productiveeconomic capacity and raise living standards. Thistime, development objectives are more likely beachieved and macroeconomic stability maintainedif the rules of the medium-term fiscal strategy arefollowed strictly, monetary and fiscal policy areclosely coordinated, and a sovereign wealth fundis established and then integrated into the policyframework.

In light of this challenge, the governmentestablished a joint Department of Treasury andBank of PNG Sovereign Wealth Fund WorkingGroup in March 2010. The working group wasresponsible for reviewing past experience andsuggesting suitable sovereign wealth fundoptions. After seeking feedback from domesticand international stakeholders, the WorkingGroup was scheduled to report back to theNational Executive Council at the end of June2010.

Onshore or offshore

There has been much public debate aboutwhether the sovereign wealth fund should be keptonshore or offshore. There are politicaldimensions to this important policy issue. TheWorking Group recommends an offshore fund asit will assist in achieving macroeconomicstabilization. There is, however, a widespreadalternative view that the fund should be keptonshore and invested directly in rural areas wheremany Papua New Guineans face considerablehardship. Further, some argue that thegovernment should bring revenues onshore in alocal currency fund, as this will reduce the cost ofliving and increase purchasing power.

The $15 billion Exxon Mobil led liquefied naturalgas (LNG) project is fueling expectations of aneconomic and social transformation in Papua

New Guinea (PNG). The project looks likely toeclipse the now closed Panguna mine inBougainville to become the largest in thecountrys history. If petroleum prices stay high,as expected, output value could reach $150billion over its 30-year life and provide as muchas $30 billion in revenue for the government andlandowners. Additional LNG projects are in thepipeline. The potential adverse macroeconomicimplications of these large resource projects willneed to be managed skillfully. Only then will thebenefits of the project be equitably sharedamong PNGs 6.5 million citizens and futuregenerations.

This is not the first time that PNG has had theopportunity to grow from its resource wealth.The Panguna mine led to a surge in economicactivity and government revenue in the 1970sand 1980s. Landowner unrest linked to concernsover the distribution of benefits contributed to itsabrupt closure in 1989. This initiated a chain ofevents that culminated in economic and fiscalcrisis despite extensive international support.Other major mining projects and thecommencement of petroleum productionsubsequently refueled the economy. But the1990s became known as the lost decade

because PNG did not translate high levels ofmining and petroleum revenue into improvedliving standards.

The government had set up a Mineral RevenueStabilization Fund in 1974 to help manage thevolatility in mining revenue. However,weaknesses in the design and operation of thefund, including a lack of transparency andaccountability, meant the fund failed to generatethe anticipated benefits.

The government learned from that experience,and has better managed the windfall revenues

earned from the recent commodity boom. Aseries of important reforms over the past 10years, notably in the early 2000s, have beencritical to improving economic management. TheBank of PNG became more independent, whilethe Medium-Term Fiscal Strategy and FiscalResponsibility Act provided a robust frameworkfor prudent fiscal management. Disciplined fiscalpolicies enabled the government to accumulatewindfall revenue, which it saved in trust fundsearmarked for development purposes and publicdebt repayment.


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Sovereign wealth management in PNGAbsorptive capacity constraints

The Sovereign Wealth Fund Working Grouprecommended that drawdowns be calibrated

subject to capacity constraints within thedomestic economy. This makes good sense.Capacity constraints within both the private andpublic sectors need to be considered. If publicexpenditure exceeds the absorptive capacity ofthe PNG economy, then increased spendingnow will create inflationary pressures. Thiswould particularly hurt small and medium-sizedenterprises by increasing both the cost ofproduction and the cost of living for Papua NewGuineans. It would also reduce value-for-moneyon public investments. This has been evident inthe civil works sector during the recentcommodity boom.

As well as calibrating the rate of drawdown tocapacity, the government could also carefullytarget public expenditure by investing in sectorsand regions of the economy with sparecapacity. For example, in the current climatethe government could target unskilled labor-intensive public works in regions that are notdirectly benefiting from the LNG project.

Other sovereign wealth fund designelements

A whole-of-government consensus is emerging

on many of the other design elementsrecommended by the Sovereign Wealth FundWorking Group. Notably, it is generally agreedthat sovereign wealth funds should be fullyintegrated with the budget and fiscalframework, and that funds should be subject tobest practice governance standards, drawing onthe wealth of international experience, tailoredto the PNG country context.

Public financial management

It is important to stress that while a well-designed sovereign wealth fund can support a

sound fiscal framework, it should not divertattention and scarce resources from the need toundertake key fiscal reforms. There arepressing fiscal management issues that need tobe addressed if the sovereign wealth fund is tobe effective. These primarily relate to theefficiency and equity of public expenditure. As asaving mechanism, recent trust fund experiencewas relatively successful; however, expendituremanagement proved more challenging.Expenditure-side public financial managementshortcomings need to be addressed if futureepisodes of fiscal blowouts are to be avoided.

It is important to distinguish between where thegovernment saves and where it eventuallyinvests the nations resource wealth. Maintainingan offshore sovereign wealth fund means thatresource revenues are only temporarily heldoverseas but eventually they will be invested inPNG.

It makes sense to save funds until publicexpenditures achieve value-for-money and thereturn from public investment is maximized. It isnot possible to spend all resource revenues whenthey accrue because of capacity constraints inboth the private and public sectors. This wasevident in the recent experience where rapiddrawdowns from trust fund accounts in 2009exceeded the capacity to use funds well.

The effective interest rate currently earned ontrust funds kept at commercial banks is -4.5%(1% deposit interest is earned from commercialbanks, while the central bank absorbs thisliquidity by paying the commercial banks 5.5%through the issuance of central bank bills).

The value of trust funds accumulated during therecent commodity boom was K4.3 billion.Foregone 4.5% interest income on these savingsis equivalent to K194 million per year. To put thisin perspective, this money could have financedthe annual maintenance of all national highways.

Another issue is whether or not to try mitigatingthe impact of large foreign currency inflow or toallow the kina to appreciate. While a higher kinavalue would help keep the domestic cost ofimports down, it would however also reduce theincentive for cash crop production. Prices ofPNGs main cash crops are set in US dollars onthe international market. A higher kina willreduce the kina income of producers. Cash cropsare an important source of income at the nationaland household levels, while renewable resourcesectors are an important source of income forrural villages, which account for 87% of thepopulation. Depreciations in the kina since it wasfloated in 1994 have led to increased localproduction and an improved capacity for majorurban centers to feed themselves. The weakerkina has increased the price of imports, which inturn has increased the demand for what becamerelatively cheaper locally grown food. This helpedspur local production. Lower prices on domesticstaple goods have helped to contain inflation andthe cost of living by counteracting importedinflation. Reversing these beneficial changes byallowing the kina to appreciate would be costlyfor the large majority of the population.


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DATA

28

Non-fuelmerchandise exports from Australia(A$; y-o-y % change, 3-month m.a.)

Fiji Islands

-60

-40

-20

0

20


Papua New Guinea

-20

0

20

40


-100

0

100

200

300


Solomon Islands

Nauru

-60

-30

0

30

60


Vanuatu

Kiribati

A$=Australian dollars

Source: Australian Bureau of Statistics.

Non-fuel merchandise exports from New Zealand and the United States(y-o-y % change, 3-month m.a.)

From New Zealand

(NZ$ million, fob)

-25

0

25

50


Cook Islands

Samoa

Tonga

From US

($ million, fas)

-150

0

150

300


FSM

RMI

Palau

FSM=Federated States of Micronesia, fas=free alongside, fob=free on board, m.a.=moving average, NZ=NewZealand, RMI=Republic of the Marshall Islands, US=United StatesNote: The Cook IslandsFiji Islands shipping route was lost during 2009 and into 2010, with only the New Zealand route remaining.Sources: Statistics New Zealand and US Census Bureau.


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DATA

Motor vehicle imports from Japan(number; y-o-y % change, 3-month m.a.)

Cook Islands

-100

-50

0

50

100


Federated

Documents

Pacific Economic Monitor - July 2010