pacific economic monitor - august 2009

8/13/2019 Pacific Economic Monitor - August 2009

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Pacific Economic Monitor

The Pacific EconomicMonitorprovides an updateof developments and policyissues in the Pacificeconomies.

Contents

Highlights 1

A view from neighboringeconomies 3

The state of the Pacific 9

Risks and scenarios 24Economic managementissues 28

Data 32

How to reach us

E-mail

[email protected]

Asian Development BankPacific Department

Dili

ADB-World 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, Tonga

Telephone: +676 28290Port MoresbyLevel 13 Deloitte TowerPort Moresby, Papua New GuineaTelephone: +675 321 0400/0408Suva

5th Floor, Ra Marama Building91 Gordon Street, Suva, Fiji IslandsTelephone: +679 331 8101SydneyLevel 18, One Margaret StreetSydney, NSW 2000, AustraliaTelephone: +612 8270 9444

August 2009 www.adb.org/pacmonitor

Highlights

A view from neighboring economies

The world economy is showing some signs of stabilizing, with therate of economic contraction slowing. However, majorneighboring economiesAustralia, New Zealand, and the UnitedStatesare still projected to contract in 2009. Unemployment

remains high in neighboring economies.

Higher international prices of some key commodities are helpinglift export earnings above expectations in the Pacific. Crude oilprices in particular are benefiting Papua New Guinea (PNG) andTimor-Leste. Falling log prices are, however, dampening the

outlook for Solomon Islands.

The drop in departures from Australia to the Pacific halted in Apriland May 2009. Tourism from Japan, New Zealand, and the US tothe region remains in decline.

The state of the Pacific

Regional economic growth is expected to slow further in 2009than originally forecast, but remains positive at 2.8%. An overallcontraction of 0.4% is expected in 2009 in the Pacific Islandeconomies (i.e., the region excluding PNG and Timor-Leste).

Five Pacific economiesthe Cook Islands, the Fiji Islands, Palau,Samoa, and Tongaare each projected to contract over 2009. No

growth is expected in Solomon Islands.

Inflation is easing across the Pacific, with the exception of the FijiIslands (because of devaluation). The recent rise in crude oilprices will see somewhat higher inflation than originally expected.

Risks and scenarios

The Fiji Islands is beginning to recover its Australian tourists. Thiswill now slow tourism growth in the Cook Islands, Samoa, Tonga,and Vanuatu. Moderate growth is expected in all majordestinations in 2010, with the Fiji Islands expected to achieve thehighest growth.

Weakening government revenue outcomes are being addressed

by cuts in recurrent expenditure that will put pressure on basicservice delivery. Capital spending is rising in some economies aspart of the response to the global crisis.

Economic management issues

The economic and fiscal impacts of the global economic crisisappear to be larger than expected by some economies. There isas strong case for concerted action to stabilize some of theregion's faltering economies. The quality of the fiscal response willbe central to the achievement of a sustainable recovery.


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HIGHLIGHTS

2

A b b r e v i a t i o n s

$ US dollars, unless otherwisenoted

ABS Australian Bureau ofStatistics

ADB Asian Development BankADO Asian Development OutlookA$ Australian dollarCPI consumer price indexf forecastfas free along sidefob free on boardFSM Federated States of

MicronesiaFY fiscal yearGDP gross domestic productIMF International Monetary Fundm.a. moving averageNZ New ZealandPNG Papua New Guinearhs right hand scaleUS United Statesy-o-y year-on-year

Latest Asian Development Bank forecasts for 2009

Real GDP growth

-4 -2 0 2 4 6 8 10

Palau

Fiji

Samoa

Tonga

Cook Islands

Solomon Islands

Marshall Islands

FSM

Kiribati

Nauru

Tuvalu

Vanuatu

PNG

Timor-Leste

Change in real GDP (%)

-2

0

2

4

6

2008 2009f 2010f

Regional

Pacific Islands

Inflation

0 2 4 6 8 10 12

Marshall Islands

Fiji Islands

Solomon Islands

PNG

Kiribati

Cook Islands

Tonga

Samoa

Palau

Vanuatu

Tuvalu

FSM

Nauru

Timor-Leste

Change in consumer price index (%, annual average)

0

4

8

12

2008 2009f 2010f

Regional

Pacific Islands

Note: Forecasts for the Cook Islands, FSM, Marshall Islands, Nauru, Palau, Samoa, andTonga are for their fiscal years (year ended Jun or Sep 2009). Regional averages of GDPgrowth and inflation are computed using weights derived from levels of gross nationalincome in current US dollar following the World Bank Atlas method. Averages for PacificIslands exclude Timor-Leste and PNG.Source: ADB staff estimates.

2009 Asian Development Bank

All rights reserved. Published 2009.Printed in the Philippines.Publication Stock No:RPS090535

Cataloging-In-Publication DataAsian Development Bank.Pacific Economic Monitor, August

2009. Mandaluyong City,Philippines: Asian DevelopmentBank, 2009.

This edition of the Pacific EconomicMonitor was prepared by CecilCaparas, Emma Ferguson, VivianFrancisco, Joel Hernandez, MilovanLucich, Dominic Mellor, AdolfMoises Nicolas, Rommel Rabanal,Craig Sugden, Raquel Tabanao,and Laisiasa Tora of the PacificDepartment.

The views expressed in thispublication are those of theauthors and do not necessarilyreflect the views and policies of the

Asian Development Bank (ADB) orits Board of Governors or thegovernments they represent.

ADB does not guarantee theaccuracy of the data included inthis publication and accepts noresponsibility for any consequenceof their use.

Use of the term "country" does notimply any judgment by the authorsor ADB as to the legal or otherstatus of any territorial entity.

ADB encourages printing orcopying information exclusively forpersonal and noncommercial usewith proper acknowledgement ofADB. Users are restricted fromreselling, redistributing, or creatingderivative works for commercialpurposes without the express,written consent of ADB.

A no te on methodology:This Pacific Economic Monitor uses year-on-year percentage changes and 3-month moving averages. The use of year-on-year percentage changes is toaccount for the high seasonality in the data. The use of 3-month movingaverages is to account for the volatility in monthly data.


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3

AVIEW FROM NEIGHBORING ECONOMIES

Developments overseasSigns of stabilization

The world economy is showing some signs ofstabilizing. Financial stress and the pace of

economic decline are slowing. The provision ofextensive financial and fiscal policy has been centralto this outcome. But despite these early positiveindications, the global economy is expected tocontract in 2009 for the first time since 1950. TheInternational Monetary Fund (IMF) revised forecastfor global output is a decline by 1.4% for 2009.

Both the US and New Zealand economies are still inrecession, and are forecast to remain flat until theDecember quarter before a sluggish climb. Australiais faring better than forecast, avoiding recessionwith a 0.4% expansion in the March quarter, butnonetheless is still expected by the IMF to contract

in 2009.

The Asian Development Banks Asia EconomicMonitor projects that emerging East Asia hasentered the transition from recession to a possibleV-shaped recovery, with growth dropping sharplythis year before returning to 2008 levels next year.

Unemployment remains high

Labor market conditions are still dire in spite of aslower rate of job losses. The US unemploymentrate in June rose to a 26-year high at 9.5%.Australia's unemployment in the same month wasalso at a high 5.8%, while New Zealand's

unemployment rate was 5.0% in the March quarter.Some commodity prices rising again

Commodity prices of some key exports from thePacific have started to trend up. Crude oil priceshave increased by 32% from January to May 2009,while prices of palm oil, coconut oil, and copra havealso risen. Log prices are an exception, falling by11% from January to May. Most commodity pricesare expected to settle on a slow uptrend, reflectinga somewhat improved market sentiment.

Stock markets also up

Major world stock markets posted moderate gains in

recent months; the main Australian index rose by4% while the main New Zealand index is up by 1%year-to-date. The US Dow Jones is down by 10%year-to-date, reflecting continuing uncertaintyabout the health of the US economy.

GDP growth

(%, annual)

-4

-2

0

2

4

6

2007 08 09 10

Aus traliaNew Zealand

United States

World

Source: International Monetary Fund. 2009. World EconomicOutlook, July.

Unemployment in key economies

(% of labor force, monthly/quarterly)

0

2

4

6

8

10

Jan08 May Sep Jan09 May

Australia

New Zealand

United States

Sources: Australian Bureau of Statistics (ABS), Reserve Bankof New Zealand, and US Bureau of Labor Statistics.

Commodity prices

(Index: January 2005=100)

0

100

200

300

400

May08 Jul Sep Nov Jan09 Mar May

Crude oil

Logs

Palm oil

Source: IMF International Financial Statistics onlinedatabase.


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4


Tourism and tradeTourist departures remain weak

Following a 5% contraction in the March quarter2009 compared with the March quarter of 2008,

tourism from Australia was up in April and May. Thedurability of this improvement is a key issue for theregional outlook for 2009, but remains highlyuncertain at this stage. The latest forecast byTourism Australia is a 2.9% decline in Australiantourist departures in 2009. Overall, actualAustralian tourist departures for the Pacific were flatfor the first 5 months of the year.

Australian tourism has been skewed towardVanuatu, which has attracted 46% more Australiantourists from January to May of 2009 compared tosame period in 2008. Australian departures for theFiji Islands from June 2008 to May 2009 are still

well down, although the large declines seen in early2009 have now ended.

New Zealand tourism to the Pacific continues todecline. However, the rate of decline is slowing.

Tourist departures from the US to Oceania remainlow. The volume of Japanese tourists bound forAustralia and New Zealand is also weak, and asimilar situation is expected in the major Pacificdestinations

Import story remains mixed

Growth in the overall value of imports (exclusive offuel) by the Pacific has so far held steady.

Growth in the nominal value of non-fuel Australianexports to the Pacific has increased, mainly becauseof rising imports by PNG. Imports by the Fiji Islandsfrom Australia are down for the first 5 months of theyear.

The nominal value of non-fuel imports from NewZealand has leveled off in total. Imports by theCook Islands and Samoa are up over the first 5months of the year. There is, however, a markedslowdown in the level of imports by Tonga.

Motor vehicle imports from Japan remain innegative territory for most Pacific economies. The

general weakness in domestic demand appears toalso be constraining consumption of nonessentialitems. Vehicle imports by the Fiji Islands areslowing and showing signs of stabilizing after sharpincreases in early 2009.

Departures for the Pacific('000 persons, Jan to May totals)

0

40

80

120

160

1999 2001 03 05 07 09

Australia

New Zealand

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

-20

0

20

40


-100

0

100

200

Australia

New Zealand (rhs)

Sources: ABS and New Zealand Ministry of Tourism.

Non-fuel exports to the Pacific(value; y-o-y % change, 3-month m.a.)

-10

0

10

20

Mar08 May Jul Sep Nov Jan09 Mar May

Aus tralia

New Zealand

Sources: ABS and Statistics New Zealand.


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5


Departures from Australia to the Pacific

(monthly)

Fiji Islands

-20

-10

0

10

20

30

Jan

08

Mar May Jul Sep Nov Jan

09

Mar May

-40

-20

0

20

40

60

persons ('000)

y-o-y % change (rhs)

Samoa

-1

0

1

2

3

4

Jan

08


09

Mar May

-25

0

25

50persons ('000)


Tonga

-1

0

1

2

3

4

Jan

08


09

Mar May

-50

0

50

100

150

200

persons ('000)


Vanuatu

-2

0

2

4

6

8

Jan

08


09

Mar May

-20

0

20

40

60

80

persons ('000)


Major destinations

-20

0

20

40

May

93

May

94

May

95

May

96

May

97

May

98

May

99

May

00

May

01

May

02

May

03

May

04

May

05

May

06

May

07

May

08

May

09

-60

0

60

120(persons ('000)


Cook Islands

-1

0

1

2

3

Jan

08


09

Mar May

-80

-20

40

100

160

220persons ('000)


Major destinations

-25

0

25

50

Jan

08

Mar May

08

Jul Sep Nov Jan

09

Mar May

09

persons ('000)

y-o-y % change

Source:ABS.


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6


Departures from New Zealand to the Pacific

(monthly)

Cook Islands

-4

0

4

8

Jan

08


09

Mar May

-20

0

20

40

persons ('000)

y-o-y % change (rhs )

Fiji Islands

-40

-20

0

20

Jan

08


09

Mar May

-40

-20

0

20

persons ('000)


Sam oa

-2

0

2

4

6

Jan

08


09

Mar May

-20

0

20

40

60

persons ('000)


Tonga

-2

0

2

4

6

Jan

08


09

Mar May

-20

0

20

40

60

persons ('000)


Vanuatu

-2

0

2

3

Jan

08


09

Mar May

-60

0

60

120

persons ('000)


Major dest inations

-20

0

20

40

May99 May 00 May01 May02 May03 May04 May05 May06 May07 May08 May09

-60

0

60

120

persons ('000)


Major destinations

-40

-20

0

20

40

Jan

08


09

Mar May

-20

-10

0

10

20

persons ('000)


Source:New Zealand Ministry of Tourism.


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7


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

Fiji Islands

-20

-10

0

10

20


Papua New Guinea

-20

20

60


-100

0

100

200

300


Solomon Islands

Nauru

-80

-40

0

40

80


Kiribati

Vanuatu

Source: ABS.

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)

-50

-25

0

25

50


Cook Islands

Samoa

Tonga

Fro m US

($ million, fas)

-100

0

100

200


FSM

Marshall Islands

Palau

FSM=Federated States of MicronesiaSources: Statistics New Zealand and US Census Bureau.


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8


Motor vehicle imports from Japan

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

Cook Islands

-90

-60

-30

0


Fiji Islands

-75

-50

-25

0

25

50


FSM

-50

0

50

100


Kiribati

-200

-100

0

100

200


Nauru

-200

-100

0

100

200

300


Palau

-80

-40

0

40

80


Papua New Guinea

-80

-40

0

40


Samo a

-200

600

1400

2200


Solomon Islands

-80

-60

-40

-20

0


Timor-Leste

-100

0

100

200

300

400


Vanuatu

-100

0

100

200

300

400


Tonga

-150

0

150

300


Source: Japan e-Stats website.


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10

THE STATE OF THE PACIFIC

Fiji IslandsGDP growth

(%, annual)

-8

-4

0

4

8

2004 05 06 07 08 09f 10f

Sources: Reserve Bank of Fiji andADB staff estimates.

Departures to the Fiji Islands

('000 persons, monthly)

0

10

20

30

Jan08 Apr Jul Oct Jan09 Apr

From Australia

From New Zealand

Sources: ABS and New Zealand Ministry of Tourism.

Cement imports

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

-100

-50

0

50

100

150


From Australia

From Japan

Sources: ABS and Japan e-Stats website.

Key developments

In April, the Reserve Bank of Fiji revised its growth

forecast. The revised projection is for a contractionof 0.3% in 2009. There are significant downsiderisks to this forecast: the weak economies of majortrading partners; rising fuel prices; the significantcontraction in tourism earnings; underlyingstructural constraints that continue to restrictexport growth, particularly for sugar and garments;and slow implementation of major public works.ADB forecasts have been downgraded to reflectthese downside risksthe economy is now forecastto contract by 1.0% in 2009, before a slightrecovery of 0.5% in 2010 helped by an expectedturnaround in tourism.

Economic data presents a mixed picture for the firsthalf of 2009. Compared with the same period in2008, resident departures from Australia showedsigns of leveling off while departures from NewZealand dropped by about 20%. Total new car salesfell by 16% in May. Imports of frozen chicken fromNew Zealand in April 2009 were 35% lower than thesame period in 2008, indicative of rising stress onmany households.

Tax revenue collections fell below budget estimatesin the June quarter of 2009 due to decreasedeconomic activity, a situation likely to prevailthroughout 2009. Total spending over the sameperiod was around $92 million below budgeted

levels, resulting in a modest fiscal surplus of around0.7% of GDP. There is a risk that capital spendingwill be deferred given the weakness in revenue.While this can control the aggregate fiscal position,it will be at the expense of much-needed capital.External debt servicing costs will increasesignificantly as a result of the devaluation of the Fijidollar.

Major monetary policy changes were made in theMarch quarter of 2009 to maintain financial andexternal stability. The impact of these policychanges, which include the 20% currencydevaluation and reduction of lending rates to

commercial banks, has improved the situationslightly in the short term.

As expected, inflation is rising because of thedevaluation. The year-on-year inflation rate stood at5.0% as of June 2009 and is projected to reach9.5% at the end of 2009 (compared with 6.6% atthe end of 2008), and 13.5% in mid-2010 beforemoderating. The depreciation, the recent surge inoil prices (rising by around 32% from January toMay 2009), and the June minimum wage increaseare key factors behind this projection. Risinginflation could also make the export sector


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11


Fiji IslandsPetroleum imports from Singapore(tonnes; y-o-y % change, 3-month m.a.)

-60

0

60

120


Source: International Enterprise Singapore.

Monetary indicators(monthly)

-10

0

10

20

30

40

May06 Nov May07 Nov May08 Nov May09

Credit growth (y-o-y, %)

Inflation rate (y-o-y, %)

Nominal interest rate (per year, %)

Source: Reserve Bank of Fiji.

Foreign exchange reserves(months of imports, monthly)

0

1

2

3

4

5

Jan07 Jun Nov A pr08 Sep Feb09

Source: Reserve Bank of Fiji.

uncompetitive and undermine the initial gains fromdevaluation.

External accounts remain under pressure as import

payments are outstripping export revenues,widening the trade deficit by 4.3%. Cumulative toApril 2009, imports fell by 6.8%, led by a decline inimports of intermediate goods. But exports fell by21.0%, compared with a 41.0% growth rate in thesame period in 2008. Lower receipts were recordedfor sugar, mineral water, garments, and fish.

Foreign reserves increased to $315 million, althoughtroublingly this remains significantly below thetarget of 45 months of import cover. Liquidity inthe banking system also improved from $51 millionin early 2009 to $73 million, and bank private creditgrowth has increased.

Key issues

Weak external demand will, despite the benefitsfrom the devaluation, continue to put pressure onthe balance of payments and foreign reserves. It iscritical that aggregate demand is moderated so thatimport levels are reduced, given the prevailing lowdemand for exports.

There is a risk that without essential structuralchanges to the key export sectors, the devaluationbenefits may be muted. Foreign reserves willremain a key concern in the absence of an exportupturn.

Fiscal discipline is necessary to tightly controlnonessential expenditures and to reduce operationalcosts so capital works can expand. Theimplementation performance of capital projectsmust be drastically improved to stimulate economicactivity and to support private sector growth.

The net deficit will need to be sharply reduced overthe medium term to return to a sustainable debtlevel of below 40% of GDP. High interest ratesaround 8% for 5-year bonds and 10% for 10-yearbondsand the devaluation have increased thegovernments debt servicing costs. This will havethe adverse effect of constraining critical

development expenditures, at least until thebenefits for the economy and government revenuefrom the devaluation flow through.


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12


Federated States of Micronesia

Kiribati

Import demand was buoyant in early 2009, asimports of machinery and transport equipmentsurged. Food imports, likewise, continue to grow.Large externally funded infrastructure projectsappear to be behind these developments, byproviding a fiscal stimulus that supportsemployment generation and economic activity.

The disbursement of grants provided under theCompact of Free Association agreement is likely toremain the key short-run positive factor for growth.A slowdown in commercial and consumer lending isexpected to continue through the rest of 2009.Tourism revenues and remittances are expected tobe sluggish at best because of the economicslowdown in the US and Asia. Taking these positiveand negative factors into account, only very slighteconomic growth is projected for 2009.

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

-200

0

200

400

600

800

Mar08 May Ju l Sep Nov Jan09 Mar May

Total import

Food

Source: US Census Bureau.

Key developments

The decline in world trade volumes will have anegative impact on seafarer remittances andsuppress household consumption levels. IMFforecasts (World Economic Outlook, July) acontraction in world trade volumes in2009 (-12.2%) before only a slight rebound in 2010(1.0%), which points to a sustained problem forKiribati.

Cement imports rose in April 2009 but the trendlevel is still far below a typical level. This reflectsthe limited scale of ongoing construction. Vehicleimports, which declined significantly in theDecember quarter of 2008, remain negligible. Meatimports continue to decline, suggesting substitutionof cheaper alternativesa sign of stress at thehousehold level.

Key issues

Increased spending on public infrastructure hasbeen discussed as a possible economic stimulus.

However, implementation of any package remainssome way off.

The rally seen in world stock markets will lift themarket value of the Revenue Equalization ReserveFund. But if the target per capita value is to beachieved, drawdowns must be minimized to allowthe rebuilding of capital. By March 2009, the yearlydrawdown has reached A$10 million. A reduction innonproductive public spending is essential.

Cement imports from Australia(tonnes; y-o-y % change, 3-month m.a.)

-250

0

250

500


Source: ABS.

Meat imports from Australia(tonnes; y-o-y % change, 3-month m.a.)

-80

0

80

160


Beef

Chicken

Source: ABS.


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13


Marshall Islands

NauruAustralian imports from Nauru

(% of 2007 GDP, quarterly)

0

5

10

15

20

Jun07 Dec Jun08 Dec Jun09

Note: Mostly consists of phosphate.Source: ABS.

Australian exports to Nauru(A$; y-o-y % change, 3-month m.a.)

-100

0

100

200

300


Source: ABS.

Key developments

After recording sharp increases in the second half of2008, receipts from phosphate exports are down inthe first half of 2009. Australia, Nauru's main buyer,recorded no imports of phosphate during thisperiod. Port damage also restricted exports of smallshipments to Asian countries such as the Republic ofKorea. Lower world demand is now suppressing

phosphate prices.

Australian exports to Nauru have trended up inrecent years. A key factor was the resumption ofphosphate mining, which stimulated aggregatedemand and returned the economy to positivegrowth. Nauru's import demand, however, hasshown signs of slowing in recent months, consistentwith a weakening domestic economy. Reflecting thisslowdown and the weak outlook for phosphate,growth forecasts have been downgraded to 1% for2008/09 and 0% for 2009/10.

In the 2009/10 Budget, Nauru continued the recentpattern of near-balanced budgets. Higher donor

funding is expected, which will help offset anexpected 10% contraction in domestic revenue.

Key issues

Naurus long-term economic future remainsdependent on making good use of phosphateincome, reducing indebtedness, and developing anyviable alternative sources of income.

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

-40

0

40

80


FoodNonfood


2008's fiscal constraints spilled into 2009. Overallspending is flat, and cuts in discretionary spendingwere needed to allow for a small rise in capital

expenditures. A rise in food imports from the USsuggests some improvement in domestic demand.Subdued economic growth of 0.5% is forecast for2009.

Attaining fiscal sustainability is central to themedium-term outlook. Weaknesses in the fiscalposition include stagnant domestic revenuecollections, declining grants, rising operationalexpenditures, and large transfers to unprofitablepublic enterprises.

Budget cuts made to low-priority expenditures are astep in the right direction. These positive actionscan now be usefully extended to a well thought-out

program of fiscal and economic reforms.


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14


Palau

Papua New Guinea

Visitor arrivals

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

-80

-60

-40

-20

0

20

Apr08 Jun Aug Oct Dec Feb09 Apr Jun

Total arrivals

From Taipei,China

Source: Palau Visitors Authority.

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

-10

0

10

20

30

40



Key developments

The slowdown in neighboring economies led to asubstantial decline in tourism activity. Total visitor

arrivals for January to June 2009 were 11.4% belowthe same period in 2008. Tourist numbers fromTaipei,China in particular were down, although therehas been an improvement since May.

Domestic demand has been weak as reflected in flatgrowth of US food imports over the first 5 monthsof 2009. Inflation in the March quarter was down to8.6% after peaking at 16.8% in 2008.

A weaker turnout in the tourism industry, lowerinfrastructure spending (from recent highs), anddelays in planned private investment in tourismfacilities are expected to result in economiccontraction in 2009 and 2010. The outlook for 2009would, however, improve much if the recent pickupin tourism continues.

Key issues

The extension to September 2010 of US financialassistance through the Compact of Free Associationwill provide temporary budget relief. Nevertheless,the need remains to reduce low-priority publicspending to stabilize the fiscal position and lessendrawdowns on the diminished trust fund assets.

Investor confidence is likely to remain underminedby uncertainty about the new financialarrangements with the US, on top of the impact of

the global crisis. This suggests the investmentoutlook will remain subdued.

Key imports(y-o-y % change, annualized)

-5

0

5

10

2003 04 05 06 07 08

estimate

09f

-60

0

60

120

GDP growth (%, annual)

Motor vehicles (number, rhs)Petrol (tonnes, rhs)

Note: Motor vehicles from Japan; petroleum from Australia.Sources: ABS; Japan e-Stats website; PNG Department ofTreasury; and ADB staff estimates.

Key developments

The growth outlook has improved slightly as exportearnings benefit from a recovery in internationalcommodity prices. The kina price of PNG exportsrose by 20.0% during the June quarter of 2009.

Growth for 2009 has been revised upward from4.0% to 4.5%, and the 2010 forecast from 3.5% to3.9%.

However, there remains much uncertainty in theoutlook for PNG. This is mainly because of globaluncertainty and the prospect of commodity pricesremaining volatile.

Despite the recovery in commodity prices, year-to-date export earnings through the end of June 2009are estimated to be around 33% lower than in thecorresponding period of 2008. Lower export income


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16


Papua New GuineaCentral Government balances

(% of GDP, quarterly)

-4

-2

0

2

4

Jun07 Sep Dec Mar 08 Jun Sep Dec Mar09 Jun

estimate

0

4

8

12

16

Overall balance

Mineral revenue (rhs)

Sources: PNG Ministry of Treasury and ADB estimates.

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

-20

0

20

40

60

Jun05 Jun06 Jun07 Jun08 Jun09

estimate

Real lending rate

Private credit growth

Sources: Bank of PNG and ADB staff estimates.

Exchange rate and reserves

(quarterly)

0

4

8

12

16

20

Mar05 Mar06 Mar07 Mar08 May09

0.0

0.1

0.2

0.3

0.4

0.5

Months of non-mineral import coverUS$/Kina (rhs)

Source: Bank of PNG.

Although the Bank of PNG will be in a position toloosen monetary policy to support domestic demandas supply-side inflationary pressures ease, there areunlikely to be any major changes. This is mainlybecause concerns remain over the possibleinflationary impact of the government'sexpansionary fiscal policy.

The current account balance is expected to moveinto negative territory during 2009 as exportearnings decline, while momentum in theconstruction sector and strong government demandmaintain import demand. However, a recent pickupin export volumes has helped the kina to appreciateagainst all major trading partner currencies. Thekina appreciated by 8% against the US dollarbetween April and June 2009.

The Bank of PNG intervened in the foreign exchangemarket by buying foreign currency to prevent thekina from appreciating too rapidly, and in theprocess has replenished some of the internationalreserves lost through heavy trading in the secondhalf of 2008. As of 31 May 2009, internationalreserves were $2.2 billion (or about 14 months ofnon-mineral import cover).

Key issues

Despite the recent pickup in commodity prices,there remain downside risks to government revenueforecasts. Fiscal pressures are expected to build asthe Government comes under pressure to quickly

implement its additional priority spending programs.

Given public sector capacity constraints, fiscaldiscipline is important to ensure that trust fundsavings are not drawn down too rapidly.Accumulated mineral windfalls are best safeguardedand directed toward a steady upgrading ofinfrastructure and basic service delivery, as outlinedin the Government's medium-term developmentstrategy.


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17


SamoaKey developments

A weakening in growth was inevitable following theend of the mini-boom in construction, but the

economy was unexpectedly pushed into recessionby the loss of jobs at Yazakis large manufacturingoperation, a decline in remittances, weakeningtourism, and the erosion of purchasing power byhigh inflation. GDP in the September quarter of2008 was 8.0% below the same period of theprevious year, the December quarter was down7.3% over the previous year, and the March quarterof 2009 was down 4.3%.

The real value of remittances has been rising on ayear-on-year basis since March. This could be anearly sign of an approaching economic turnaround.However, it could instead reflect an increase in

payments for new vehicles in preparation for theSeptember switch to driving on the left hand side ofthe road (vehicle imports are up substantially thisyear). If so, remittances may decline later in theyear.

Tourism has improved this year. Samoa hasbenefited from problems in the Fiji Islands and theongoing stimulus provided by the restructuring ofthe national airline and development of majorhotels. These factors, combined with the filming ofthe Survivor television series now underway, areexpected to result in overall growth in tourism in2009.

However, the growth in tourism is unlikely to offsetnegative effects elsewhere. A number of jobs arebeing lost due to the closure of a major cannery inAmerican Samoa. This is adding to jobs lost in thelocal economy. The level of commercial banklending to the private sector has hardly changedsince late 2008, indicating a pause in privateinvestment. Data on imports of key commoditiesare consistent with a leveling off in activity.

Inflation had eased to 9.2% year-on-year as of June2009, half of last years peak. International reserveshave risen to 5.1 months of imports, above theofficial target of 4.0 months.

Key issues

2008/09 will record a large economic contraction.This is, however, expected to be the bottom of thedownturn, primarily because of a large fiscalexpansion provided for in the 2009/10 Budget.Some of the fiscal expansion is for projects that usefew local products or services and offer little help tothe economy, but othersnotably expanded roadworkshave the potential to boost the economy.

Remittances

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

20

25

30

35

Jul07 Oct Jan08 Apr Jul Oct Jan09 Apr

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

30

May07 Sep Jan08 May Sep Jan09 May

Visitor arivals(persons)

Tourism receipts(Tm, real)

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

Key imports

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

-90

-60

-30

0

30

60

Mar08 May Jul Sep Nov Jan09 Mar

Food from US ($)

Petroleum fromSingapore ( tonnes)

Sources: International Enterprise Singapore and US CensusBureau.


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18


Solomon IslandsLogging volumes

(m3; y-o-y % change, 3-month m.a.)

-50

0

50

100

Aug07 Nov Feb08 May Aug Nov Feb09 May

Source: Central Bank of Solomon Islands.

Production of key commodities

(Index: March 2006 =100)

0

200

400

600

800

Mar06 Sep Mar07 Sep Mar08 Sep Mar09

Fish

Copra

Palm Oil

Cocoa

Source: ADB. 2009. Draft Solomon Islands Economic Report.

Building activity(quarterly)

0

200

400

600

Dec06 Jun07 Dec Jun08 Dec Jun09

0

20

40

60

80Cementimports

(tonnes)

Buildingpermits('000, rhs)

Note: Building permits are lagged by 3 quarters.Sources: ABS and Honiara City Council.

Key developments

Solomon Islands is one of the Pacific economiesmost affected by the global economic crisis. Exports

are dominated by logs, fish, palm oil, and copra,and in total declined by 11% in the March quarter of2009 in value terms compared to the same quarterin 2008. Logging volumes fell by 31% in the Marchquarter and registered a 22% fall in the Junequarter; they are on track to decline from 1.5million m3 in 2008 to 1.1 million m3 in 2009, a fallof almost 30%.

As a result of the weaker-than-expected exportperformance, growth forecasts for Solomon Islandshave been downgraded to 0% in 2009 and 2.6% in2010. Growth is expected to remain modest in theout-years as the medium-term decline in logging

stocks is increasingly felt.

Imports of cement, petroleum, and chicken have allstarted to drop, in line with a slowing economy. Thedecline in cement imports matches (with a lag) thedecline in building permits issued.

A positive recent development has been thestabilization and improvement in the foreignreserves position. Import cover as of July is inexcess of 3.0 months after having fallen to as lowas 2.5 months earlier in the year. This has beenpartly due to some one-off factors such as receipt ofsubstantial aid disbursements. The effects of theincreased aid flows will wane as these funds are

spent. Foreign reserves may again come underpressure in the second half of the year and into2010.

Inflation peaked at 23.5% in September 2008 on ayear-on-year basis. After surging once again to16.5% in the March quarter of 2009 due to floodingin Guadalcanal, inflation had fallen back to 9.3% inJune as fuel and food prices eased and demandweakened.

Inflation forecasts have been revised down to 8.3%for 2009 and 6.9% for 2010 as the economy slows.But inflation remains at risk of reaccelerating,particularly if the Government resorts to central

bank financing.

Growth in domestic credit has fallen sharply overthe past year as the central bank has moved toreduce excess liquidity in the banking system.

The fiscal situation has come under particularpressure. Logging revenues are in sharp decline,and other tax collections, such as consumptiontaxes, are affected by the slowing economy andlower prices, particularly for oil. Actual revenue forthe first quarter of 2009 of around SI$316 million


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20


Timor-LesteReal GDP growth

(Non-oil, excluding UN; % annual change)

-8

0

8

16

2005 06 07 08

estimate

09f

UN = United NationsSource: Asian Development Outlook database.

Merchandise imports from Australia(3-month m.a.)

0

2

4

6


A$ million

US$ million

Sources: ABS and Reserve Bank of Australia.

Inflation(y-o-y % change in CPI, monthly)

-5

0

5

10

15

Jun07 Oct Feb08 Jun Oct Feb09 Jun

Timor-Leste

Indonesia

CPI = consumer price indexSources: Timor-Leste National Statistics Directorate andBank Indonesia.

Key developments

The IMF has upgraded growth estimates for 2008from 10% to about 13%. The large rise in

government spending, a good year for theagriculture sector, and peace and stabilityunderpinned the economy. Higher governmentwages and large cash transfers (e.g., to the elderly,veterans, and internally displaced persons) providedimportant economic stimulus.

The Petroleum Fund grew by $553.0 million in theMarch quarter, lifting savings to around $4.8 billion.This is roughly 11 times the non-oil GDP.

The high growth rate is reflected in rising trends inimports from Australia and vehicles from Japan.Bank lending remains stable, with past over-lendingand the associated high rate of non-performing

loans continuing to weigh down the financial sector.

Rising government spending is expected to keepgrowth high over 2009 and into the medium term.But some easing in growth is expected as the rateof increase in spending is now slowing.

Inflation has also declined as the retreat ininternational commodity prices fed through theeconomy and as the US dollar appreciated. Inflationwas 1.3% on a year-on-year basis by the Junequarter after averaging 7.6% in 2008. A relativelyhigh inflation rate in the main source of consumerimports (Indonesia), combined with high demand inTimor-Leste, is expected to produce a positive

inflation rate of around 1.5% in 2009.

Key issues

The key challenge for economic policy remains theconversion of the large savings in the PetroleumFund into broad-based development, while ensuringthe fund remains viable for future generations.Recent success in achieving peace and stabilityneeds to extend to high-return capital investmentsand recurrent programs. Here the priority is to meetthe basic needs of the agriculture sector, whichmost of the population will remain dependent on forsome decades.

Improved agricultural extension services, access tomarkets, and investment in human capital (viaeducation and health programs) are normally thefirst steps to agriculture-led development. Some ofthe shortcuts now being used in the developmentprocess, such as government intervention in thebuying and selling of produce, are unlikely to matchthe returns from these solid building blocks ofgrowth.


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21


TongaMotor vehicles

(number, monthly)

0

100

200

300

400

Mar05 Mar06 Mar07 Mar08 Mar09

New registrations of motor vehicles

Motor vehicle imports from Japan and NZ

(3 month m.a.)

Sources: Japan e-Stats website, National Reserve Bank ofTonga, and Statistics New Zealand.

Private remittances(pa'anga million; 3-month m.a.)

-20

-10

0

10

20

May07 May08 May09-30

-15

0

15

30real Pa'anga million


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

Private sector credit(y-o-y % change, monthly)

-20

0

20

40

60


To households

To business

Source: National Reserve Bank of Tonga.

Key developments

The Government expects the economy to grow by1.7% in 2009/10. A key downside risk to this

forecast is the potential for delays inimplementation of the reconstruction work financedby China Eximbank. A more conservative estimateof domestic content of the work reduces itspotential contribution to economic activity, furtherdampening the growth outlook.

Remittances, the major source of foreign exchangereceipts, are down by about 13% as of May 2009 ona year-on-year basis and continue to trend down.Credit growth has also slowed to almost nil aslending remains constrained, with commercial bankstightening credit policies after a rapid increase inbad loans.

The recession in New Zealand and the US andsoftening demand for seasonal workers in Australia(some companies employing such workers havereportedly gone into liquidation) suggest thatgrowth is indeed more likely to be lower than theofficial projection.

Inflation rose by 1.9% in May 2009 due to higherfood and transport prices, and may peak around5.0% in early 2010 before abating. If oil prices stayat recent levels, inflation may exceed earlierprojections and reach about 3.1% in 2010. Thereserves position improved over the first half of2009 to 4.7 months of import cover, slightly above

the 4.0 month target level. However, rapid changesin prices of key imports such as fuel couldundermine these recent gains.

Revenues and grants received at the end of theMarch quarter were around 20% under budget.Total expenditures are also below budget, resultingin a fiscal surplus of 8.9 million pa'anga at the endof May 2009. The surplus appears to reflect tightspending control, particularly for non-staffexpenditures such as operations and maintenance.Cuts to such items, however, have the potential toadversely impact service delivery.

Key issues

The Government's response to the likely impacts ofthe global economic crisis has been limited topolicies that have not contributed to underlyingeconomic performance (e.g., wage increases andtighter expenditure controls on essential services).The economy remains highly vulnerable to externalconditions, notably via remittances. Efforts todiversify the export sector and to implementstructural reform remain critical.


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22


Tuvalu

Vanuatu

Imports from Australia

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

-120

-60

0

60

120


Chicken

Flour

Source: ABS.

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

-20

0

20

40

Jan08 Mar May Jul Sep Nov Jan09 Mar

Source: Vanuatu Statistics Office.

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

-40

-20

0

20

40

60

Mar07 Sep Mar08 Sep Mar09

Total imports

Australian exportsto Vanuatu

Sources: ABS and Vanuatu Statistics Office.

Key developments

Growth forecasts for Vanuatu have been revised upto 4.0% for 2009, reflecting strength in tourism andsigns of improvement in domestic demand.

Tourism in Vanuatu has continued its strong growth

momentum in the first half of 2009. In the first 5months of 2009, the number of cruise ship visitorsrose by 58% and airline visitors rose 18%(compared with the same period of 2008). Tourismfrom Australia has been particularly strong, with airdepartures for Vanuatu increasing by 40% in thesame period.

A key issue for the remainder of 2009 is thepotential effect on Vanuatu of a recovery in tourismin the Fiji Islands. Growth in tourist arrivals toVanuatu is expected to slow in the second half of2009 followed by a further slowdown in 2010 as theFiji Islands recovers from the recent floods and winsback tourists.

The more recent data shows signs of a pickup inimport growth in the June quarter, with Australianexports to Vanuatu recovering in this period.

Similarly, while both motor vehicle registrations andJapanese car exports slowed in late 2008 and early2009, the more recent Japanese export data showssome increases.

The pace of credit growth remains a concern, withcredit increasing by over three times the forecasted

Key developments

Expected growth in 2009 and 2010 is subdued at1%, due to low foreign earnings. Imports from

Australia declined in May 2009, suggesting waningdemand as real incomes decline. Although foodprices have fallen from the peaks seen at the end of2008, prices of key commodities remained higherthan at the end of 2007 (e.g., the price of rice inthe March 2009 quarter was two-thirds higher thanin the December quarter 2007.

Key issues

The lower market value of the Tuvalu Trust Fund,lower seafarer remittances, and a drop in domesticemployment following completion of the wharfreconstruction will reduce government revenue.There is little potential to quickly correct the fiscal

imbalances caused by higher governmentexpenditure. However, addressing inefficient publicexpenditures, such as medical treatment andscholarships, could free funds for other priorityareas.


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24

RISKS AND SCENARIOS

Government budgetsTax revenues(% to GDP)

10

20

30

40

1998 2000 02 04 06 08 10

0

100

200

300PNG

Timor-Leste (rhs)

10

20

30

40

1998 2000 02 04 06 08 10

Cook Islands

Samoa

Vanuatu

0

10

20

30

40

1998 2000 02 04 06 08 10

Fiji IslandsSolomon IslandsTonga

Notes: Tax revenues include direct and indirect taxes. 2009are best estimates in most cases but use budget projectionsin some. 2010 data are budget projections. Fiscal years varyamong countries.Sources: Various Pacific countries statistics offices andbudget documents.

Key risks

Government revenue is weakening in most Pacificcountries as their economies slow and incomes

from external investments decline. Somegovernments have already anticipated lowercollections and factored weakening revenue intotheir latest budgets. For example, PNG has factoredin a 20% decline in tax revenues in 2009, primarilyfrom lower mining and oil revenues. Timor-Lestealso expects much lower oil revenue. The CookIslands and Samoa have recognized that their taxrevenue is likely to be flat at best because of theglobal economic crisis. Some others appear to beoverly optimistic, with revenue projectionsassuming a more robust economic performancethan the data are pointing to.

Countries that maintain an optimistic outlook runthe risk of high revenue shortfalls. This, in turn,

can lead to last minute spending adjustments. Inthe Pacific (as elsewhere), it is typical for poorrevenue outcomes to be met by cuts to capitalexpenditures and maintenance. Across-the-boardspending cuts on goods and services are also oftenused. Such cuts are normally a crude response thatdamages basic service delivery, particularly if madeat the last minute.

To date, only the Marshall Islands and Samoa havereported efforts to prioritize expenditures to reducethe impact of spending cuts.

Some countries (e.g., the Cook Islands, PNG,Samoa, and Timor-Leste) are expanding capitalworks in order to provide a fiscal stimulus.Increased spending on good capital projects can besensible provided it is affordable.

Others are potentially aggravating their fiscal andeconomic problems by increasing public sector payrates and allowances (e.g., in Tonga and inSolomon Islands for Parliament members).

Preferred scenario

A sound response to the economic downturn is toanchor the budget in realistic revenue programs

and to prioritize expenditures. This will reduce therisk of disrupting the delivery of basic services bymaking damaging cuts to essential expenditures.

It is also important to steer the budget towardgood capital projects, particularly those with highlocal content. Providing a short-term stimulus andbuilding the economy's productive capacity willreduce the risk of prolonged economic downturn.


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25

RISKS AND SCENARIOS

Key government expenditure aggregates

(% of GDP)

Cook Islands

0

10

20

30

1998 2000 02 04 06 08 10

0

5

10

15

20

`

Fiji Islands

0

10

20

30

1998 2000 02 04 06 08 10

0

5

10

15

Papua New Guinea

0

10

20

30

1998 2000 02 04 06 08 10

0

5

10

15

Timor-Leste

0

40

80

120

2000 02 04 06 08 10

0

5

10

15

Samoa

0

10

20

30

1998 2000 02 04 06 08 10

0

5

10

Solomon Islands

0

10

20

30

40

1998 2000 02 04 06 08 10

0

5

10

Tonga

0

10

20

30

40

1998 2000 02 04 06 08 10

0

10

20

30

Vanuatu

0

10

20

30

1998 2000 02 04 06 08 10

0

5

10

15

Notes: 2009 are best estimates in most cases but use budget projections in some. 2010 data are budget projections. Fiscal years vary amongcountries.Sources: Various Pacific countries statistics office and budget documents.


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26

RISKS AND SCENARIOS

TourismAustralian tourist departures


-40

0

40

80

Jan06 Jul Jan07 Jul Jan08 Jul Jan09

Fiji Islands

Vanuatu

Source: ABS.

-40

0

40

80

Jan06 Jul Jan07 Jul Jan08 Jul Jan09

Fiji Islands

Cook Islands, Samoa,

and Tonga

Source: ABS.

Forecasts for Australian departures


-50

-25

0

25

50

75

100

Dec07 Jun Dec08 Jun Dec09 Jun Dec10

Fiji Islands

Other majordestinations

'Alternate' scenario

Note: Other major destinations are the Cook Islands,Samoa, Tonga, and Vanuatu. Values to the right of thebroken line are projections.Sources: ABS and ADB staff estimates.

Key risks

Tourism activity has been highly variable across thePacific this year. While the latest data show that

tourist arrivals in the Fiji Islands are down by 19%so far this year, they are up by 19% for Vanuatu,9% for Samoa, 6% for Tonga, and 5% for the CookIslands.

There is a substitution effect evident betweendestinations for Australian tourism. Notably,problems in the Fiji Islands (e.g., floods in Januaryand political uncertainty) spurred an increase intourist arrivals to other Pacific economies this year.

A well-established substitution effect is evidentbetween the Fiji Islands and Vanuatu. This reflectstheir shared market within Australia. For example,Australian departures to the Fiji Islands fell in 2007

because of the December 2006 coup and itsaftereffects, while departures to Vanuatu roserapidly. When the Fiji Islands recovered its touristsin 2008, the growth in Australian departures forVanuatu slowed and ultimately contracted. Thesubstitution effect between the two destinations hasbeen even more pronounced this year.

Destination-switching between the Fiji Islands, onone hand, and the Cook Islands, Samoa, andTonga, on the other, is a more recent development.It has been apparent this year, but the effect wasweak in 2007. This appears to represent a structuralbreak from the previous periods. It is likely driven

by the introduction of low cost air travel alternativesthat have opened up Pacific destinations to a widermarket.

This substitution effect is not evident for NewZealand tourism to the Pacific. Tourist arrivals areall trending down for the first 5 months of the yearfor the Cook Islands, the Fiji Islands, Samoa,Tonga, and Vanuatu.

The substitution effect has important implicationsfor the outlook in the tourism-based economies.This is studied by conducting scenario analyses.

Scenarios

A simple scenario was prepared that uses year-to-date numbers as an estimate of the growth intourist arrivals for all of 2009. That is, the latestoutcome on a year-to-date basis is assumed toapply for the whole year. Tourist arrivals are thenassumed to increase in 2010 in all destinations by6%. The 6% figure is the latest Tourism Australiaforecast for Australian outbound tourism.

An alternate scenario assumes that the patternsevident in 20072008 will be replicated in 20092010. That is, for both Australia and New Zealand


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27

RISKS AND SCENARIOS

Tourismdepartures, the monthly pattern for 2009 isassumed to match the monthly pattern in 2007, andthe monthly pattern for 2010 is assumed to match

the monthly pattern in 2008. In this way, thealternate scenario incorporates the substitutionbetween destinations evident in the behavior ofAustralian tourists. Projections made under thisscenario do follow the actual outcomes so far in2009.

A complicated scenario was also constructedbased on a model that assumes that tourism in adestination expands due to exogenous factors (e.g.,growth in international travel, global economicgrowth) and endogenous factors (e.g., country-specific conditions such as peace and politicalstability and aggressive marketing campaigns to

lure tourists). Both cyclical patterns and structuraltrends are recognized in the model. The modelassumes that tourism arrivals will grow by 6%during 2010 after falling by 2% on an annualizedbasis over the second half of 2009. These resultsare similar to the alternate scenario, and for thisreason are not reported.

Using the two scenarios, the change in tourismreceipts as a percentage of GDP was also estimated.

Under the simple scenario, the Fiji Islands bears amajor contraction in 2009 while other destinationsgain. All are projected to be better off in 2010,benefiting equally from an assumed improvement in

international tourism. The alternative scenario presents a very different

story. Under this scenario, the Fiji Islands doesmuch better in the second half of 2009 than in thefirst half. In total, there is little change over theyear. This relatively better outcome is at theexpense of other destinations. The Fiji Islands isprojected to be a big winner in 2010 as tourismarrivals fully recover. Again, this is in part at theexpense of other destinations.

The complicated scenario of the model produces aprojection (not shown) between the simple and thealternate scenarios. Such a middle view is probably

the most realistic.

One important implication of the scenario analysesis that it is premature to assume an early tourism-led economic recovery in the Cook Islands, Samoa,and Tonga, and a continuation of Vanuatu's recentvery high growth rates. The flip side is that there issome prospect of economic support from tourism forthe Fiji Islands in the second half of 2009 andduring 2010.

Visitor arrivals

(y-o-y % change)

-10

0

10

20

COO FIJ SAM TON VAN

'09 Simple '10 Simpl e

-20

-10

0

10

20

COO FIJ SAM TON VAN

'09 Alternate

'10 Alternate

-20

-10

0

10

20

COO FIJ SAM TON VAN

'09 Simple

'10 Simple

Tourism receipts

(y-o-y change as % of GDP)

-6

-3

0

3

6

COO FIJ SAM TON VAN

'09 Simple

'10 Simple

-6

-3

0

3

6

COO FIJ SAM TON VAN

'09 Alternate

'10 Alternate

COO=Cook Islands, FIJ=Fiji Islands, GDP=gross domesticproduct, SAM=Samoa, TON=Tonga, VAN=VanuatuNote: Scenarios assume a 1% increase in arrivals leads to a1% increase in receipts and vice versa.Source: ADB staff estimates.


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28

ECONOMIC MANAGEMENT ISSUES

40thPacific Islands ForumSTEERING A NEW COURSE

Remarks byPresident Haruhiko KurodaAsian Development Bank

At the 40th Pacific Islands ForumCairns, Australia5 August 2009

I. INTRODUCTION

Excellencies, distinguished guests:

It is a great privilege for me to join you here today. I would like to thank Prime Minister Rudd for hiswarm hospitality and the Pacific Islands Forum for giving me this opportunity to share myperspectives with you.

II. THE GLOBAL STORM

As we meet, the global economy is starting to show some signs of stabilizing. The pace of economic

contraction is slowing and the optimist in all of us would like to think that the worst of the economiccrisis may be over. We must be cautious, however, since this may not signal the beginning of asustained recovery. It is important to note that the key drivers of recoverythe US, Japan, andEuropean economieshave yet to bottom out.

The crisis has hit our region quite hard. In Asia, most economies have seen their worst performancesince the 1997/1998 Asian financial crisis. An open and outward approach to economic policyunderpinned Asia's economic transformation. But this year, it has been the export-intensiveeconomies that have faced the most pressure as external sales tumbled.

The outlook for Asia is now more encouraging. Many indicators show that most economies in Asiahave bottomed out. Indeed, it is possible that Asia can lead the recovery of the global economy if thistrend continues.

III. TURBULENCE IN THE PACIFIC

In the Pacific, the global crisis has markedly slowed growth or caused economic contraction. Weakerrevenues are constraining the ability of governments to finance much-needed basic services.Declining incomes, falling remittances, and high inflation threaten the quality of life in the Pacific.Low-wage female employees in tourism and the manufacturing sector are at particularly high risk aslabor markets worsen.

Much of the burden of a policy response to the global economic crisis will fall on fiscal policy. Anincrease in government expenditure, where fiscally sustainable, may be needed in the worst-hiteconomies. However, this must be supported by structural reforms to help economies sustaineconomic recovery over the medium term, and be combined with policies to protect the mostvulnerable.

However, even with the best response now, the lagged effects of that action mean recovery could stillbe some way off.

IV. PLOTTING A NEW COURSEI would now like to share some perspectives that I believe are particularly relevant to managing thesechallenges.

In times of economic stress, it may be tempting to put on hold efforts to correct the structuralweaknesses that constrain economies. Yet times like these can instead provide us with our greatestopportunities.

Asia's experience following the 1997/1998 financial crisis provides useful insights. Asia learnedimportant lessons from the crisis, and pursued deep-seated financial reforms to help build theresilience of the financial sector. This resilience has softened the impact of the current globaleconomic crisis.


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29


40thPacific Islands ForumAnd the efforts towards regional cooperation and economic integration were at the heart of therebuilding of the Asian financial sector following the Asian financial crisis. Efforts to improve regionalcooperation and economic integration in other sectors have also helped protect Asia during theglobal financial crisis this time.

The third point is the importance of quick and decisive action in the face of serious economic stress.The early action taken this year by many countries to safeguard financial systems, to adjust themonetary policy stance, and to pump-prime budgets demonstrate this point. These early actions arehelping the global economy stabilize and, for some economies, to begin the transition to recovery.

V. ADB'S RESPONSE TO THE REGION'S CHALLENGES

The recent tripling of ADB's capital base and the replenishment of concessional Asian DevelopmentFund (ADF) last year gave us much-needed resources to support prompt responses to the globalfinancial crisis and address longer term development needs in Asia and the Pacific.

In the Pacific, ADF resources have been increased to $203 million over 2009 and 2010, from $130million during the 20072008 period. Extra resources from ADF and other sources are helping ADBprovide quick-disbursing budget support to the economies worst hit by the global economic crisis.Programs will help stabilize economies and facilitate the reforms that will aid recovery. Country-led

responses are being supported by strengthened country dialogue and high-level technical assistanceunderpinned by enhanced monitoring and analytical work.

Extra resources are also helping ADB address other threats to the region. Most notably, we areactive in addressing climate change, a threat that is contributing to the Pacific being one of the moreeconomically and environmentally fragile regions of the world.

Earlier this year, ADB prepared the Climate Change Implementation Plan (CCIP) for the Pacific toidentify climate change issues and options in the Pacific DMCs. CCIP identified adaptation as apriority area for the Pacific countries. We are already making good progress in helping the DMCcountries integrate adaptation measures in the national development plans and climate proofinginfrastructure. We are also working with them in further integration with disaster preparedness andresponse.

As part of our mitigation effort, ADB has set an ambitious target of doubling clean energy

investments such as renewable energy and energy efficiency to $2 billion per year starting in 2013.This will be of great relevance to the Pacific DMCs in terms of their contribution to climate changemitigation, but more importantly in addressingtheir energy security issue as renewable energy andenergy efficiency investments would help ease Pacific DMCs' dependence on expensive importedfossil fuel.

I am also pleased to note the progress made by the Pacific DMCs and major development partners toestablish in 2008 the Pacific Regional Infrastructure Facility. Last year, ADB conducted high levelconsultations with all major development partners, and with the Pacific Forum Island Secretariat andthe Secretariat of the Pacific Communities. We will continue to work on these regional cooperationefforts to further strengthen coordination with development partners.

In these and other ways we are working closely with our development partners to strengthen ourcollective ability to assist the Pacific DMCs.

VI. CONCLUSIONThis Pacific Leaders Meeting provides a very timely opportunity to discuss these important issues andtake early action to hasten the achievement of their development goals.Addressing the complexand, in many respects, unique challenges facing the region will require changes to howgovernments, the private sector, and communities contribute to development. As you know fromyour own experience, visionary leadership that shapes practices and cultures to meet the aspirationsof communities for a better future, is vital.

And, we, ADB, have been working closely with other development partners to provide harmonizedassistance to the Pacific region. We stand ready to redouble our efforts to help address the impact ofthe global economic crisis, and the broad range of challenges facing the region.

Once again, I thank the Forum for the opportunity to address you today.


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30


Interest rate marginsInterest rate margins

Interest margins reflect a variety ofdeterminants. Stable growth and low inflation

tend to boost credit growth and banking sectorprofitability and hence interest rate margins (forexample, see the 2009 IMF working paper, TheDeterminants of Commercial Bank Profitability inSub-Saharan Africa). Conversely, economicdownturns lead to credit contractions that arelikely to exert downward pressure on lendingrates. This may in turn narrow interest ratemargins (i.e., banks may become less profitableas economies weaken).

In a competitive banking sector environment,interest rate margins can be expected to adjustto prevailing economic conditions. But this may

not be the case if a banking sector is highlyconcentrated (i.e., a small number of bankshave most of the market share) or there aresignificant barriers to entry (such that theindustry is non-contestable). Under theseconditions, interest margins may not narrow ascredit growth shrinks during economicdownturns.

In such an environment, there is a risk thateconomic recovery would be made moredifficult; interest rates would remain too highand monetary transmissions that aim tostimulate credit growth would be muted.

Margins in the Pacific Interest rate margins are generally higher in the

Pacific than in other regions. There are manyfactors that could account for this. For example,it could be a result of above-average countryrisk (e.g., political or macroeconomic risks) andother sources of high transaction costs. Anotherpossible contributing factor to higher interestmargins is the relatively high reserverequirements imposed by regulatory authorities,which compel banks to seek higher returns onnon-reserve assets to offset the opportunity costof holding low or non-interest-bearing reserves.

High interest rate margins could also be a resultof limited competition in the region's bankingsector. In the Pacific there are only a smallnumber of commercial banks. There are also fewalternative non-bank credit sources, and onlytwo shallow stock markets exist in Suva andPort Moresby, which do not yet allow forsecondary trading. Weak competition may allowbanks to maintain high margins (see text box).

Interest margins in the Fiji Islands, Samoa, andTonga have been steady for some time and areyet to adjust downward despite economic

downturn. In contrast, the growing non-bankfinancial sector in PNG, composed of pensionfunds and other finance companies, appears

to be contributing to a steady decline ininterest rate margins there. The new entrantsappear to be deepening the financial sectorand increasing competition.

However, before concluding that there mustbe a problem with a lack of competition inthe Pacific's banking sector, it is important tonote that interest rate margins are also yetto narrow noticeably in some other nearbyand Asian economies. The Pacific is not alonein seeing steady interest rate margins despitethe current economic contraction.

A more effective way to assess if Pacific

banks are overly profitable would be toconduct a benchmark test of their rates ofreturn.

Market Power in the Fiji Islands' Finance Industry

In 1998, in response to public concern about theactivities of the Fiji Islands banking industry, theMinister of Finance established a Committee of Inquiryinto Financial Services. The committee found there wasinsufficient competition in the financial sector: itconcluded that the banking industry was an oligopoly(that is, controlled by a small number of players)dominated by two major foreign banks, ANZ andWestpac.

Oligopolies tend to form cartels as a basis formanipulating a market. The committee did not establishthe existence of a formal cartel among the banks; it didfind evidence of "price leadership" and other behaviorpatterns whereby the banks tend to replicate eachother's practices. There was no evidence that the banksare aggressively competing for the available market,which suggests that they are not functioning as in acompetitive market.

The lack of effective competition was found to result inhigh bank profits, high user charges, excessive interestrate margins, and poor service standards. The fourmajor banks earned a return on equity of 12.6 to 16.0on their global operations in 1997. But in the Fiji

Islands, the return on equity ranged from 26.0 to 28.0in the same year. Poor service standards were evident indeclining rural services, long queues at the major banks,excessive waiting times for services, and the indifferentattitude of staff to customer concerns. The committeeconcluded that the low level and poor quality of serviceswas becoming the accepted norm in the industry and

that there was apparent apathy and complacency bymanagement about the situation.

Source: Fiji Islands Ministry of Finance. 1999. Report of theCommittee of Inquiry into Financial Services. ParliamentaryPaper 19. Suva: Parliament of theFiji Islands.


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31


Interest rate margins

(Lending rates less deposit rates, monthly, %)

0

3

6

9

12

Mar05 Sep Mar06 Sep Mar07 Sep Mar08 Sep Mar09

Fiji Islands Samoa

0

5

10

15

Mar99 Mar01 Mar03 Mar05 Mar07 Mar09

Papua New Guinea

0

3

5

8

10

Mar03 Mar04 Mar05 Mar06 Mar07 Mar08 Mar09

Tonga Vanuatu

0

5

10

15

20

Jan02 Jan03 Jan04 Jan05 Jan06 Jan07 Jan08 Jan09

Solomon Islands Timor-Leste

0

3

6

9


Australia New Zealand

0

2

4

6

8


Philippines Thailand

0

3

6

9


Malaysia Singapore

0

3

6

9


China

Notes: Interest rate margins are based on weighted average lending and deposit rates, where available. Other margins are based on the followingrates: Malaysia (average lending rate and fixed 3-month deposit rates); New Zealand (base lending rate and deposit rate); Singapore (minimumlending rate and 3-month time deposit rate); Timor-Leste (loans + 6-month LIBOR, and savings deposit rate); and Tonga (prime lending rate andsavings deposit rate).Sources: Banking and Payments Authority of Timor-Leste, Bank of Papua New Guinea, Central Bank of Samoa, Central Bank of Solomon Islands, IMF'sInternational Financial Statistics online database, National Reserve Bank of Tonga Reserve Bank of Fiji, and Reserve Bank of Vanuatu.


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DATA

Latest Pacific Economic UpdatesGDP

GrowthInflation

Credit

Growtha

Trade

Balance

Import

Cover

Fiscal

Balance

(%, 2009f) (%, y-o-y) (%) (% of GDP) (months) (% of GDP)

Cook Islands 0.1 11.2 5.5 70.2 - 8.1(Jun-Q 2009) (Mar-Q 2009) (2008) (FY2009f)

Fiji Islands 1.0 2.3 10.2 43.1 2.7 3.0(Jun 2009) (Apr 2009) (2008) (Feb 2009) (2009f)

FSM 0.5 5.0 - - - 3.0(2008) (FY2009f)

Kiribati 1.0 11.0 - - - 13.0(2008) (2008)

Marshall Islands 0.5 5.6 - 37.9 - -(Mar-Q 2009) (2008)

Naurub 1.0 2.5 - - - 0.4(Mar-Q 2009) (FY2009f)

Palau 3.0 8.6 - - - 4.8(Mar-Q 2009) (2008)

PNG 4.5 6.7 25.7 32.5 9.7 3.3(Jun-Q 2009) (May 2009) (2008) (Mar 2009) (FY2009f)

Samoac 0.8 12.9 6.1 39.4 5.1 5.5(May 2009) (May 2009) (2008) (May 2009) (FY2009f)

Solomon Islands 0.0 19.1 4.0 28.1 3.2 3.7(Mar 2009) (May 2009) (2008) (May 2009) (2009f)

Timor-Lestec 8.0 3.1 5.2 - - 90.1(Jun 2009) (Jun 2009) (2009f)

Tonga 0.4 1.4 2.4 56.8 4.6 1.0(Apr 2009) (Apr 2009) (2008) (May 2009) (FY2009f)

Tuvalu 1.0 5.3 - - - 5.4(2008) (2008)

Vanuatu 4.0 5.8 35.3 43.3 5.2 6.3(Dec-Q 2008) (May 2009) (2008) (Mar 2009) (2008)

aCredit growth refers to growth in total loans and advances to the private sector.bThe Australian CPI is the proxy for measuring Nauru's inflation.cCredit growth includes loans and advances by commercial banks to both public and private sectors.Notes: Period of latest data shown in brackets; import cover for PNG is months of non-mining and oil imports.Sources: ADB. 2009.Asian Development Outlook 2009 Update. Manila (For publication); and statistical releases ofthe regions central banks, finance ministries and treasuries, and statistical bureaus.

Key data sources:

Data used in the Pacific Economic Monitorare available in the ADB PacMonitor database, available inspreadsheet form at www.adb.org/pacmonitor

About the Asian Development Bank

ADB's vision is an Asia and Pacific region free of poverty. Its mission is to help its developing member countriessubstantially reduce poverty and improve the quality of life of their people. Despite the regions many successes, itremains home to two thirds of the worlds poor: 1.8 billion people who live on less than $2 a day, with 903 millionstruggling on less than $1.25 a day. ADB is committed to reducing poverty through inclusive economic growth,environmentally sustainable growth, and regional integration.

Based in Manila, ADB is owned by 67 members, including 48 from the region. Its main instruments for helping itsdeveloping member countries are policy dialogue, loans, equity investments, guarantees, grants, and technicalassistance.

Asian Development Bank6 ADB Avenue, Mandaluyong City1550 Metro Manila, Philippineswww.adb.org

pacific economic monitor - august 2009

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