Public debt and contingent liabilities are equivalent to 74 percent of GDP and limit the fiscal space Fiji should reserve to respond to frequent shocks. Volatile commodity prices, increasing reliance on tourism, risk of natural disasters and some uncertainty about external financing represent significant vulnerabilities. Investor interest is likely to remain subdued in the presence of exchange and price controls and continued political uncertainty.

The current monetary policy stance is appropriate. High excess liquidity in the banking system reflects the weak economic environment and exchange restrictions. Monetary policy should be gradually tightened if core inflation rises or a return of confidence leads to strong credit growth. Restrictions on the repatriation of profits and dividends should be relaxed to build investor confidence.

The 2011 budget deficit falls short of the effort needed to bring public debt below 50 percent of GDP in the medium term. The authorities are to be commended for the bold revenue measures in the 2011 budget. If these are complemented by ambitious civil service and public enterprise reform Fiji will move towards fiscal sustainability.

Public enterprise and FNPF reform will bolster fiscal sustainability. The fiscal risk of supporting public enterprises has been made clear by FSC. The government should move quickly to finalize the FSC restructuring plan and the company should be divested within the next three years. FNPF reforms should be completed in 2011.

Fiji should adopt a more flexible exchange rate regime to help absorb shocks and protect reserves. An appropriate first step would be to move to an exchange rate band of ±2–3 percent around the current rate. This should be supported by strong fiscal adjustment, prudent monetary policy, and continued interest rate flexibility. The independence of the RBF should be strengthened and changes to the RBF Act recommended in the recent safeguards assessment should be implemented.

Recent RBF action to strengthen bank supervision is welcome but further steps toward risk-based supervision are needed. Stress tests should be conducted and reviewed with banks more frequently and the RBF should make greater use of credit-analysis data available from large banks.

Structural reforms are necessary to spur growth and would help protect macroeconomic stability. Well-designed land reform and the removal of price controls should support investment and the diversification of economic activity. Civil service reform and adjusting tariffs for public services will help contain contingent liabilities and should increase efficiency. The social impact of redundancies and higher tariffs can be addressed through retraining programs and additional targeted social assistance. Fiji should seek support from development partners, including technical and expert advice, to help design and implement these important structural reforms, which are critical to improving the overall business environment.

Background

Economic growth in Fiji has been negative or low for four years. This is in part due to the weak domestic investment climate that results from delays in structural reforms, an increase in exchange restrictions and price controls, the decline of the sugar industry, and political uncertainty. Fiji’s economy contracted by 3 percent in 2009 and marginal growth is estimated for 2010. The 2010 improvement is based on tourism rebounding on the strength of regional economies and the ongoing competitive gain secured through the April 2009 devaluation. Exports and investment driven by resource extraction are showing positive signs, though growth in these areas is from a small base. Growth is projected at 1 to 2 percent over the medium term in the absence of structural reforms and other measures to improve the investment climate. Inflation is projected to fall to 3 percent over the medium term in the weak growth environment. Without fiscal consolidation and stronger growth public debt will remain high and Fiji will not have the fiscal space it needs to respond to shocks.

Foreign exchange reserves have improved steadily following the April 2009 devaluation and stood at just over 4 months of imports at end 2010. Reserves have, however, been supported by exchange restrictions. The real effective exchange rate has remained stable. After rising through mid-2010, inflation—inclusive of two electricity tariff increases—moderated to 4.0 percent (year on year) by late 2010 due to sluggish demand and steady international commodity prices. Price controls imposed on many food products since 2009 have likely contributed to low inflation.

The fiscal deficit is estimated to have fallen to 3.6 percent of GDP in 2010 from 3.9 percent of GDP in 2009. This reduction resulted from a public hiring freeze (other than for some key areas), lower-than-budgeted capital spending, and stronger-than-projected VAT receipts. The losses and mismanagement of the Fiji Sugar Corporation (FSC) have led to pressures on the budget. The deficit was financed mostly by the Fiji National Provident Fund (FNPF) as commercial banks remained near their sovereign lending limits. Central government debt at end-2010 is estimated at close to 56 percent of GDP. Contingent fiscal liabilities are estimated at 17.6 percent of GDP at end 2010 and include guarantees on bonds issued by Fiji Development Bank. On November 26, 2010, the authorities announced a 2011 budget with a deficit of 3.5 percent of GDP.

The Reserve Bank of Fiji (RBF) relaxed interest controls in the beginning of 2010 by removing ceilings on bank lending rates (though banks still must justify deposit-lending rate spreads greater than 4 percent). In response, average deposit and lending rates rose marginally. The government re-established variable rate auctions for government securities in May 2010. Government borrowing costs have risen as banks and the FNPF can now better price risk. Banks report limited lending opportunities due to the weak investment climate, and credit growth has been modest. Banks’ excess liquidity has increased to 12 percent of deposits in recent months, much of it attributable to the lack of lending and investment opportunities for banks and exchange restrictions preventing or delaying outflows.

On the structural front, the government is drawing up a detailed plan to revive the FSC and the sugar industry. A land bank has been established to increase security of land leases as part of an overall effort to encourage investment and job creation. Significant progress has been made in state-owned enterprises (SOE) reforms, including adjustments to electricity tariffs to increase cost recovery and the establishment of a water authority. A functional review of public service positions is under way, as is the adoption of a performance-based remuneration system. However, wide-spread price controls have continued and, in some cases, they have intensified in recent months.