OREANDA-NEWS.  An International Monetary Fund (IMF) staff team led by Jaime Guajardo visited Koror from May 18?31, 2016, to conduct the 2016 Article IV Consultation discussions. The team exchanged views on recent developments, economic outlook, and economic policies with officials in the government and other public institutions. It also met with representatives of the private sector and parliament. At the conclusion of the visit, Mr. Guajardo issued the following statement:

“Palau’s economy has performed well in recent years. Real GDP grew by 9.4 percent in FY2015 (ending September 30) led by robust tourism and construction activity. The external position improved due to the fall in commodity prices and stronger tourism receipts, with inflation falling to 2.2 percent. The fiscal position strengthened due to spending restraint and strong growth, with the current fiscal deficit (domestic revenue less current expenditure) declining by 6 percent of GDP to 5 percent.

“Economic growth is expected at zero in FY2016 as tourist arrivals decline because of the limits in charter flights. Growth is projected to pick up to 5 percent in FY2017 as tourism activity recovers and robust construction activity continues. Inflation would remain low as commodity prices stabilize, and the current account deficit would rise due to larger infrastructure related imports. The fiscal position should improve further due to the increase in the airport departure and visa fees, with government expenditure remaining contained.

“Palau’s positive outlook is subject to substantial risks due to its reliance on tourism, grants, and commodity imports. A slowdown in key trading partners, U.S. dollar appreciation, and natural disasters could hurt tourism activity. Higher commodity price could make food and fuel imports costlier. Failure to adopt a comprehensive tourism strategy could reduce growth in the medium term. Palau will need to rely on fiscal and structural policies if any of these risks materializes.

“Against this background, the key policy challenge is to enhance resilience and lift potential growth in the medium term. The mission’s recommendations focus on four priority areas: (i) securing fiscal sustainability; (ii) adopting a comprehensive tourism strategy; (iii) improving infrastructure quality; and (iv) ensuring financial stability.

“Notwithstanding the recent improvements in the fiscal position, continued fiscal adjustment is needed to create space for public investment and to ensure adequate buffers are in place. An increase public investment is key for the development of the tourism industry and to make infrastructure more resilient to natural disasters and climate change. Fiscal buffers also need to be built up for future contingencies. The mission recommends reducing the current fiscal deficit from the current 5 percent of GDP to 1 percent of GDP by FY2022, which is feasible given the track of expenditure restraint and the planned increase in the airport departure and visa fees. This adjustment would not only secure fiscal self-sufficiency when the Compact grants expire in FY2024 but also allow increasing public investment and building buffers.

“Further fiscal adjustment should comprise of both revenue and expenditure measures. On the revenue side, the mission supports the government’s plan to replace the gross revenue tax with a value added tax, and the efforts to improve tax compliance. On the expenditure side, spending should be prioritized and subsidies should be reduced. The Civil Service Pension Fund needs to be reformed to ensure its sustainability, while state owned enterprises need to operate at full cost recovery by raising tariffs and lowering operational costs. Strengthening public financial management remains key to support fiscal adjustment and contain fiscal risks.

“There is an urgent need to develop and implement a comprehensive tourism strategy. The rapid rise in tourist arrivals in FY2015 was tilted toward mass package low budget tourists, which strained infrastructure and led to an increase in the number of foreign-owned low-quality hotel establishments. This goes against Palau’s goal of positioning itself as a high- end tourism destination and is a threat to the pristine environment. This strategy should include coherent policies in domestic and foreign investments, infrastructure priorities, employment, and land use and zoning. The regulatory environment also needs to be strengthened to enhance scrutiny and enforcement of regulations. Better coordination among the national and state governments is necessary to ensure effective implementation of the authorities’ long-term vision.

‘Palau needs to improve its infrastructure to support sustainable development and to make it more resilient to natural disasters and climate change. Natural disasters pose a significant risk to the economy. Priorities include limiting developments in areas at risk of tropical storms and rising sea levels, and improving the water system. Staff welcomes the authorities’ plans to upgrade the water pipeline system in Koror and to broaden the sources of water to prevent shortages in the future.

“Palau’s banks remain sound, with low nonperforming loans, high liquidity, and healthy returns. The Financial Institution Commission (FIC) has improved examinations and data collection, and the Financial Intelligence Unit (FIU) has enhanced anti-money laundering investigations. But banks continue to lend little domestically despite the rapid rise in deposits, investing most of their assets abroad. In order to mobilize domestic credit, the mission recommends relaxing the interest rate ceiling for loans to the business sector to better reflect riskiness, and helping small and medium size enterprises (SMEs) prepare business plans. The National Development Bank of Palau (NDBP) can also help fill the financing gap for SMEs, especially in agriculture. Staff welcomes the authorities plan to put the NDBP under FIC supervision, subject to the same regulations of commercial banks, while allowing it to take deposits and expand its lending activities. Staff also stresses the need for continued monitoring of foreign flows into the banking system and recommends increasing the resources for the FIU.

“The mission is grateful to the authorities for their hospitality and representatives of the government and the private sector for the open and constructive dialogue. The IMF’s Executive Board is tentatively scheduled to discuss the Staff Report in early September.”