Asian
Development Outlook 2004 : II. Economic
Trends and Prospects in Developing Asia
Source: http://www.adb.org/Documents/Books/ADO/2004/van.asp
The economy
emerged from recession to record moderate, agriculture-led growth in 2003. The
budget deficit was reduced through expenditure cuts. The Government anticipates
a slight acceleration over the medium term, but this will require increased
smallholder production in agriculture and more tourist arrivals.
Economic Assessment
After 2 successive years of contraction, GDP posted
growth of an estimated 1.6% in 2003, below the annual population increase rate
of 2.6% (Figure 2.37). 
The growth was led by an 8.7% rise
in the agriculture, fishing, and forestry sector. Boosted by strong world
commodity prices, cocoa, copra, and cattle production surged. The industry
sector contracted by 1.1% as manufacturing, electricity, and commercial
construction all fell.
The services sector was
virtually stagnant, with the trade subsector
recording just 1.0% growth, government services stationary, and the transport
and communications, and hotels and restaurants subsectors
both contracting.
Total tourist arrivals in the
first 3 quarters of 2003 were 1.2% down on the same period in 2002, largely
because of relatively low numbers in the first half of the year. Tourism picked
up in the third quarter as a result of supplementary flights from
The economic recovery
contributed to a limited reversal in the downward trend in formal sector
employment that was seen in 2001 and 2002. However, employment growth fell well
short of the 10% rate required to absorb the 3,500 school leavers entering the
workforce in 2003. With limited emigration possibilities, the majority of these
new entrants to the labor market had to seek work in the subsistence or urban
informal sectors.
The 2003 fiscal target of a
budget surplus of 0.4% of GDP was based on a 7.7% rise in revenues and grants
and a 7.8% drop in total expenditures and net lending, relative to the actual
levels in 2002. On the basis of actual outcomes in the first three quarters of
2003, the deficit target will not be met. Revenues and grants were 4.0% lower
than the corresponding figure for 2002, largely because of a shortfall in
grants and import duties. Total expenditure and net lending was 12.2% down on
the corresponding figure for 2002 as a result of tighter expenditure control on
both wages and nonsalary outlays. The overall budget
deficit for 2003 is estimated to be about 1.0% of GDP, with domestic financing
in the form of central bank advances. Nonetheless, this outcome represents an
improvement from a deficit of 3.2% of GDP in 2002. In 2003, the Government's
external debt was estimated at 28.2% of GDP, and its domestic debt at 11.0% of
GDP. Debt servicing costs were equivalent to approximately 7% of domestic
revenues and 4% of recurrent expenditures.
The inflation rate accelerated
from 2.0% in 2002 to 3.0% in 2003, because of the one-off impact of increased
duties on imported food; increased alcohol and tobacco excise duties; higher
education and health fees; and because the domestic currency, the vatu,
depreciated significantly against the Australian and
Official balance-of-payments
projections presented in the 2004 budget suggested that the current account
deficit would decline to 0.3% of GDP in 2003. These projections are likely to
prove overoptimistic. In the first 3 quarters of 2003, merchandise export
growth was strong enough to lead to a slight narrowing of the trade deficit,
but the foreign reserves level in October had fallen to $37 million, some Vt200
million short of the projected figure, and sufficient to cover just over 4
months of imports. The overall balance-of-payments was on track to record a
small deficit in 2003.
Policy Developments
An amendment to the
Debits Tax Act of December 2002 effectively increased the tax levied on bank
accounts without addressing community concerns that it was an antipoor tax. The Vanuatu National Provident Fund Amendment
Act reduced the rate of contributions from 12% to 8% of salaries, reduced the
percentage of funds potentially invested overseas from 50% to 15%, and
increased the power of the Minister of Finance over the fund, including
approval of the appointment of the general manager. This last development
constituted a significant reversal of policy initiatives introduced under the
5-year-old, long-term Comprehensive Reform Program, aimed at improving
corporate governance in the public enterprise sector. Political interference in
the operations of public enterprises continued. The public enterprise sector
remained a drain on the public purse, and privatization of several larger
enterprises was delayed.
At the same time, trade reform
was pursued with the passage of the Pacific Islands Countries Free Trade
Agreement Act and the Pacific Agreement on Closer Economic Relations Act, which
paved the way for a resurrection of efforts to join WTO, but also raised the
issue of future loss of government revenues from import duties. Legislation was
finalized to align the regulatory and supervisory framework for offshore banks
with that for domestic banks, and to bring that framework under the control of
the Reserve Bank. As a result,
In September 2003, the
Government outlined a Prioritized Action Agenda intended to more effectively
link the Comprehensive Reform Program with the Government's medium-term
investment program and annual budget. The agenda identifies three key
objectives: (i) macroeconomic stability; (ii)
achieving faster, sustainable economic growth; and (iii) improving public
service delivery, especially in rural areas. Successful implementation of the
last two strategies has proven difficult. Economic growth is constrained by low
private investment, with foreign investors continuing to be concerned about
political instability, an uncertain policy environment, and the economy's high
cost structure (including transaction costs of obtaining investment approvals
and business licenses).
The 2004 budget aims at
further fiscal consolidation. On the assumption that growth will pick up to
about 2% and inflation will moderate slightly, an overall budget surplus of
0.4% of GDP is targeted for 2004. Other than the removal of the debit tax on
bank account withdrawals below Vt5,000, no revenue
initiatives are envisaged, and reaching the estimated revenue level will
require a considerable improvement in revenue collection. Recurrent
expenditures are to be reduced from the 2003 budget level through cuts in
expenditure on wages, nonsalary goods and services,
and transfers to government bodies, with education and health receiving reduced
budget allocations. The share of wages in total recurrent expenditures is still
high at 58.3%. No change is envisaged in capital expenditures, funded mostly by
external grants. Given a substantial negative external financing, a small
domestic financing requirement is to be met from government cash balances.
Outlook for 2004-2005
The 2004 budget forecasts
GDP growth to accelerate to 2.1% in 2004 and to 2.6% in 2005. The agriculture
sector is expected to be the driving force behind this, with the industry and
services sectors playing increasingly supportive roles. For agriculture to
perform as expected, weather conditions and world commodity prices will need to
remain favorable, and smallholder cattle and cocoa production will need to be
further encouraged. World commodity prices are likely to be strong, but
tropical cyclone Ivy hit
Given the population growth
rate, the projected growth would imply a decline in per capita income in the
medium term, increased unemployment and underemployment, and little alleviation
of hardship in rural areas, where 51% of the population live below the poverty
line of $1 per day. The private investment necessary for faster growth in
income and employment is unlikely to be forthcoming, unless the factors
deterring foreign investors can be addressed effectively.
The Government forecasts
budget surpluses of 0.4% in 2004 and 2005, on the assumption that the recurrent
and capital expenditure cuts planned for 2004 can be locked in. Assuming a
slight deceleration of inflation to the 2.0-2.5% range, there would be a
decline in real spending and little growth in real revenue. The wage bill is
forecast to rise at 2.0% annually in nominal terms but to decline only
marginally as a share of total recurrent spending. This will leave limited room
for improving the strategic allocation of public resources.
The current account of the
balance of payments is expected to continue to be characterized by trade
deficits, a surplus on the services account, and inflows of foreign aid, with
the net result being small current account deficits. The Government forecasts a
rising surplus on the capital account in 2004 and 2005 and an increase in
foreign reserves to over 5 months of import cover. However, these forecasts
rest on expectations of a rise in foreign investment, which is unlikely to be
forthcoming. Official external debt is forecast to drop to 24.9% of GDP in 2005.