IMF Executive Board Concludes 2016 Article IV Consultation with the Republic of Palau

October 19, 2016

The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation ¹ with the Republic of Palau on September 9, 2016.

Palau’s economy has performed well in recent years. The economy grew strongly in FY2015 (ending September 30, 2015) at 9.4 percent, with tourist arrivals and construction activity expanding by 35 percent. However, the rapid rise in tourism activity strained infrastructure and was tilted towards low budget tourists, which led the authorities to limit the number of charter flights in FY2016. Inflation declined to 2.2 percent in FY2015 in line with falling commodity prices, and the external position improved due to lower commodity prices and higher tourism receipts. The fiscal position strengthened because of spending restraint and strong revenue growth, with the current fiscal deficit (current expenditure less domestic revenue) falling from 11 percent of GDP in FY2014 to 5.5 percent in FY2015. Public debt remains moderate and sustainable.

The outlook for Palau is also favorable. Economic growth is expected to slow temporarily to zero in FY2016 as tourist arrivals decline, but to rebound to 5 percent in FY2017 as tourism activity recovers with the entry of new hotels and construction picks up. Inflation is projected to remain low at 2 percent as commodity prices stabilize. The current account deficit is expected to rise due to larger infrastructure related imports, and the fiscal position is projected to improve further on continued spending restraint. 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, further U.S. dollar appreciation, and natural disasters could hurt tourism activity. Higher commodity prices could make food and fuel imports costlier. Failure to implement a strategy for sustainable tourism development could reduce growth in the medium term. Palau will have to rely on fiscal and structural policies should risks materialize.

Executive Board Assessment²

The Executive Directors welcomed Palau’s robust economic growth and improved fiscal and external positions, underpinned by a strong tourism industry and significant expansion in construction activity. Directors noted that, while the outlook is favorable, the economy is subject to downside risks arising from the exposure to natural disasters and climate change, and from its heavy reliance on tourism and grants. They emphasized the importance of continued sound macroeconomic policies and structural reforms to ensure fiscal sustainability, preserve financial stability, and boost potential growth.

Directors welcomed the measures taken to strengthen the fiscal position. They underscored, however, that additional efforts will be needed over the medium term to ensure fiscal self‑sufficiency when the Compact grants expire. Fiscal adjustment should build on the progress made on revenue and expenditure measures, including by replacing the gross revenue tax with a value added tax, and by reorienting infrastructure investment to support the tourism industry and enhance the resilience to natural disasters and climate change. Directors highlighted the importance of strengthening the fiscal framework by targeting a public sector net worth position as the fiscal anchor, while using the current fiscal balance as an operational target. In addition, they emphasized that improving public financial management and strengthening the civil service pension system would help contain fiscal risks and ensure debt sustainability.

Directors noted that the banking system remains sound and well supervised and welcomed the steps being taken to preserve financial stability and facilitate domestic credit expansion. Directors encouraged continued efforts to relax the ceiling on credit rates and to broaden the Financial Institutions Commission oversight to include non‑bank financial institutions.

Directors emphasized that economic diversification and improving the business climate are key to reducing Palau’s vulnerabilities and boosting potential growth. Priority should be given to developing a comprehensive strategy to ensure sustainable tourism development, supported by adequate infrastructure investment. Directors also encouraged the authorities to improve the regulatory environment and to strengthen the coordination among the national and state governments.

1. Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.

2. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.

Palau: Selected Economic Indicators, 2009/10–2016/17 1/
Nominal GDP for FY2015: US$287 million Population (2015): 17,885 GDP per capita for FY2015: US$16,070 Quota: SDR 3.1 million
	2013/14	2014/15	2015/16	2016/17	2017/18	2018/19	2019/20	2019/21
		Est.	Proj. 2/
Real sector
Nominal GDP (million US$) 3/	250.9	287.4	296.0	318.6	341.2	362.0	380.3	395.7
Real GDP growth (percent change)	4.2	9.4	0.0	5.0	5.0	4.0	3.0	2.0
GDP deflator (percent change)	5.2	4.7	3.0	2.5	2.0	2.0	2.0	2.0
Consumer prices (percent change; period average)	4.0	2.2	2.0	2.0	2.0	2.0	2.0	2.0
Tourist arrivals (number of visitors)	125,674	168,767	148,515	158,911	166,857	173,531	178,737	184,099
Public finance 3/	(In percent of GDP)
Central government
Revenue	43.3	40.6	39.6	41.8	40.8	40.3	39.8	39.4
Taxes and other revenue	24.4	25.4	24.8	25.5	26.1	26.0	25.9	25.8
Grants	18.9	15.3	14.8	16.3	14.8	14.3	13.9	13.6
Expenditure	39.8	35.6	41.6	42.7	39.6	36.7	36.5	36.0
Expense	35.4	30.9	30.3	30.2	30.1	30.0	29.9	29.9
Net acquisition of nonfinancial assets	4.4	4.7	11.3	12.5	9.5	6.7	6.5	6.1
Current fiscal balance (excluding grants) 4/	-11.0	-5.5	-5.5	-4.7	-4.0	-4.0	-4.0	-4.0
Net lending (+)/borrowing (–)	3.5	5.0	-2.0	-0.9	1.2	3.5	3.3	3.4
	(In millions of U.S. dollars)
Compact Trust Fund (CTF) balance	199.2	183.9	188.9	194.2	201.8	208.9	215.9	222.8
Government cash and deposits 5/	9.6	23.4	30.6	39.1	44.7	52.8	63.0	72.8
In percent of GDP	3.8	8.1	10.4	12.3	13.1	14.6	16.6	18.4
Balance of payments 3/
Trade balance	-158.2	-142.4	-148.4	-164.8	-176.1	-177.0	-180.8	-184.6
Exports (f.o.b.)	19.1	14.5	11.9	14.6	16.1	17.7	18.7	19.6
Imports (f.o.b.)	177.3	156.8	160.3	179.4	192.2	194.7	199.5	204.2
Tourism receipts	129.3	150.4	139.0	153.2	163.2	172.3	180.1	188.3
Current account balance
Including grants	-29.5	-1.5	-15.6	-22.4	-28.3	-22.8	-21.1	-19.3
Excluding grants	-74.4	-42.3	-56.1	-62.2	-66.3	-60.6	-58.3	-55.8
International Investment Position	245.4	272.1	272.1	280.3	295.2	318.4	345.4	372.9
Assets	467.1	511.0	539.4	569.7	599.8	632.2	667.1	702.0
Liabilities	221.7	239.0	267.3	289.3	304.6	313.8	321.7	329.1
Of which: External debt	70.6	64.2	77.4	90.0	92.6	88.9	83.7	77.9
	(In percent of GDP)
Current account balance
Including grants	-11.8	-0.5	-5.3	-7.0	-8.3	-6.3	-5.6	-4.9
Excluding grants	-29.7	-14.7	-19.0	-19.5	-19.4	-16.7	-15.3	-14.1
International Investment Position	97.8	94.7	91.9	88.0	86.5	88.0	90.8	94.3
Of which: External debt	28.1	22.4	26.1	28.2	27.1	24.6	22.0	19.7
Sources: Palau authorities; and Fund staff estimates and projections.
1/ Fiscal year ending September 30.
2/ Staff projections.
3/ Incorporates the authorities' revised estimates of GDP and balance of payments, and the audited government financial statements.
4/ Defined as tax and other revenue less expense.
5/ Includes unspent external loans.

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IMF Executive Board Concludes 2016 Article IV Consultation with the Republic of Palau

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