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Inflation in Vanuatu to pick up to 4.8% in 2018: IMF

Inflation in Vanuatu to pick up to 4.8% in 2018: IMF

An International Monetary Fund (IMF) mission led by Chris Papageorgiou visited Port Vila during January 29–February 8, 2018 to hold discussions on the 2018 Article IV consultation.

“Vanuatu is poised to fully recover from the extensive damages caused by Cyclone Pam in 2015, with several large infrastructure projects near completion and growth bouncing back. A recovery in tourism and agriculture combined with further ramping-up of infrastructure projects is expected to continue to propel real GDP growth to around 4 percent in 2017 and 2018”, Mr. Papageorgiou stated.

Inflation is estimated to pick up to 3.1 percent in 2017 driven by domestic demand, and rise further to 4.8 percent in 2018 mainly due to the VAT increase before gradually reverting to modest levels in the medium term. The current account deficit is expected to widen to above 10 percent of GDP in 2017 and 2018, due to the high import content of infrastructure projects.

“The downside risks to this favorable outlook stem mainly from uncertainty in the rate of implementation of the public infrastructure projects. The delayed implementation of revenue mobilization measures, such as the introduction of the income tax, could put a strain on fiscal accounts. On the external front, while the withdrawal of correspondent banking and the negative impact of weaker-than-expected global growth have so far been limited, they pose non-negligible risks. The danger of natural disasters is ever-present,” Papageorgiou added.

“Looking further ahead, economic growth in Vanuatu needs to be stronger and more stable. In this regard, resilience to natural disasters should be at the core of any development strategy for the country to ensure sustainable and inclusive growth. It is in this context that diversification of economic activity is required. Tourism sector needs to be strategically segmented across locations, and efforts to diversify the economy into the agricultural sector need to be intensified. To facilitate diversification, supporting the private sector by improving the ease of doing business and reaching out to small businesses in need for credit is necessary.

“The public and publicly-guaranteed debt increased sharply since 2014 mainly due to disbursements for reconstruction and infrastructure projects, though the new external borrowing was highly concessional. The fiscal deficit is expected to remain high at around 7 to 8 percent of GDP in 2017 and 2018, again reflecting elevated spending on reconstruction and infrastructure.

“Once the reconstruction and infrastructure scaling up are over, the authorities should consider embarking on fiscal adjustment measures to address the rising debt and to rebuild fiscal buffers. An appropriate medium-term fiscal anchor, with fiscal target and debt ceiling in place, is required to facilitate this consolidation. External financing should continue to be contracted as much as possible in the form of grants, or on concessional terms.

“Given recent signs of excess liquidity along with building up of inflation pressure, the Reserve Bank of Vanuatu should be ready to tighten its monetary policy stance through the gradual increase of reserve requirements. The basket peg regime is working well in Vanuatu, and the real effective exchange rate (REER) remains broadly in line with fundamentals and desirable policies. Vanuatu’s comfortable foreign exchange reserves should be maintained at above 5 months of imports to provide foreign currency for government’s debt repayment obligations.

“Although the overall credit-to-GDP ratio is relatively high, credit is not evenly distributed between large firms and small and medium-sized enterprises (SMEs) or between urban areas and rural areas. Increasing private access to financial services for SMEs and households in rural areas and outer islands should remain a priority.”

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