- Christopher Browne
- Published Date:
- August 2006
The Republic of Kiribati consists of 33 islands straddling the equator.
All the islands are coral atolls, with the exception of Banaba, which is of limestone origin and once had rich phosphate deposits, although these were exhausted in 1979, just at the time of independence. Whereas Kiribati’s total land mass is very small, the exclusive economic zone (EEZ) that surrounds the islands is 3.5 million square kilometers, far larger than that of any other country in the region.
Kiribati gained independence from the United Kingdom in 1979, and its constitution provides for a government that combines parliamentary and presidential systems. The unicameral House of Assembly has 40 members elected for four years by universal adult suffrage, plus one ex officio member (the attorney general) and one member representing a community of Banabans who settled in Rabi, Fiji after the phosphate mine closed. The president is head of both the state and the government, is elected nationally, and selects his or her ministers from among the members of parliament.
Kiribati’s population has increased rapidly, from 58,000 in 1980 to an estimated 90,000 in 2004. One-third of the population resides in South Tarawa, the capital and seat of government, and several of the outer islands are uninhabited. The population is young and the workforce is growing rapidly. This is especially true in the capital because of migration from the outer islands. Emigration is limited, except that around 2 percent of the workforce participates in an internationally recognized seamen certification program that provides temporary work opportunities abroad in international shipping.
Figure 9.1.Kiribati: GDP Growth
Source: Kiribati authorities.
The country is one of the smallest and least developed economies in the world. Its per capita GDP has remained stagnant since independence, and its total output is only about $70 million. Kiribati has very few natural endowments. The islands have shallow topsoil and low water absorption capacity, which allows the cultivation of very few crops. The main agricultural product is copra. As noted, the phosphate deposits on Banaba are exhausted; they had previously accounted for roughly 80 percent of export earnings and 50 percent of government revenue. There are vast marine resources, but these have brought only limited benefits, primarily from license fees paid by foreign fishing vessels.
Economic Profile since Independence
From independence until the mid-1990s, there was little growth, no manufacturing activity, and wide fluctuations in GDP, which reflected the economy’s dependence on copra and on the fish catch (Figure 9.1). In some years, partly because of weather conditions, strong growth in one product compensated for a decline in the other. In other years, when the cycles were synchronized, there were large booms or busts. Overall, there was little progress in achieving sustainable growth during this period.
Figure 9.2.Kiribati: Copra Production
Source: Kiribati authorities.
The government took a number of steps to boost copra production, with only limited success (Figure 9.2). Periodic subsidies to copra producers were financed by two funds, one that was replenished during good harvest periods and another supported by grants from the EU. In addition, the government distributed improved planting materials and provided extension services to spur replanting in an effort to lower the average age of the coconut trees and increase farms’ productivity. However, the replanting targets were repeatedly scaled down because of growers’ reluctance to forgo current income in order to invest in new trees. Shipping continues to be costly and cumbersome because of the lack of deepwater ports and infrequent service to foreign markets.
The domestic fish catch, the other mainstay of the economy, has also been highly volatile. There is a small fleet for deep-sea tuna fishing, and private households largely engage in subsistence fishing. The fluctuations in the fish catch reflect not only the weather conditions but also the condition of the fishing fleet. Poor maintenance leads to breakdowns of the fishing vessels. These problems have been compounded by the continual financial difficulties facing the state-owned fishing company, which have hampered the timely maintenance and repair of vessels, and by the limited access to export markets in the absence of storage facilities and regular commercial air transport links.
Tourism has been constrained by the country’s remoteness, poor flight services, and the lack of knowledge about Kiribati in the major markets of Japan and the United States. There remains great potential for specialty tourism, such as birding, diving, and sport fishing. In fact, bird-watchers began to visit Christmas Island in the early 1990s, when reliable weekly service was established to and from Honolulu, three hours’ flight away, but the air connections did not prove profitable for the national airline. As a signal to the private sector to take the lead in developing the tourist trade, the government offered for sale the main hotel on Christmas Island and later the hotel in South Tarawa, but neither has yet been privatized.
Until 1995, fiscal policy was consistently prudent, designed to promote the development of infrastructure without incurring deficits. Budgetary spending was restrained in order to reduce public services to a level sustainable in the post-phosphate era. Specifically, current expenditure was reduced from close to 70 percent of GDP at the time of independence to 50-55 percent in the mid-1980s, particularly through the compression of real wages of government employees, and was maintained there until the mid-1990s. Capital expenditure was primarily limited to projects financed by external assistance, particularly in the areas of transportation, fresh water, sewage, shipping, and telecommunications. As a result, there was either an overall surplus or a small deficit almost every year until the mid-1990s.
This prudent fiscal management, by successive governments, helped Kiribati persistently increase the value of its Revenue Equalization Reserve Fund (RERF), which was a stock of external assets built up in anticipation of the exhaustion of phosphate resources, primarily using royalties on phosphate exports (Box 9.1). Following the exhaustion of the phosphate deposits, government revenue declined by about half. On independence, the value of the RERF was equivalent to several years of imports of goods and services. It grew consistently because the authorities drew down only earned interest and dividends, while the principal increased in value as a result of buoyant international capital markets.
Kiribati’s balance of payments was sound through the 1980s and early 1990s because of these prudent fiscal policies. Although exports represented only a small fraction of total imports, the current account remained in surplus reflecting the cautious domestic policies and the resultant increase in investment income. In addition, there were several important sources of foreign exchange, namely, fishing royalties from foreign vessels that were licensed to fish in the EEZ, private transfers from workers abroad, and external aid. As a result, external reserves rose in most years and remained at comfortable levels.
Box 9.1.Kiribati: The Revenue Equalization Reserve Fund
The Revenue Equalization Reserve Fund (RERF) was established in 1956 to hold royalties from phosphate mining in trust, anticipating the depletion of the deposits. The buildup of these savings occurred despite the lack of any explicit rule to safeguard the value of the RERF. Fiscal policy is not subject to any explicit rules, and there is no dedicated legislation governing the RERF. The 1979 Public Finance Act, Kiribati’s budget law, set out general principles to guide government investments, but there is no requirement governing the size of drawdowns to finance current expenditure, and the government does not need parliamentary approval to increase drawdowns above budgeted levels. However, in 1996 parliament agreed in principle to hold the RERF’s expected real per capita value constant for future generations. The use of the Australian dollar as domestic currency and the absence of a domestic debt market preclude other sources of domestic financing.
Prudent fiscal management by successive governments helped increase the value of the RERF until 1995. In the second half of the 1990s, the strong performance of the global equity market helped further boost its value. Between 1997 and 2000, average drawdowns were limited to 5.6 percent of GDP per annum, resulting in a 55 percent real increase in the value of the assets per citizen.
Starting in 2001, budget expenditure began to rise more quickly than revenues, and the growing deficit required a large drawdown. In 2001, expenditures rose sharply and budget financing from the RERF rose to 13½ percentage points of GDP despite near-record levels of revenues. During 2001-03, the correction in the stock markets caused the rate of return to turn sharply negative. In 2004, the drawdown to finance the deficit reached 24½ percent of GDP, although the increase in world stock prices still led to an overall increase in the size of the fund. Subsequently, because of persistent drawdowns and negative average rates of returns, the real per capita value of the fund has declined.
Revenue Equalization Reserve Fund
Source: Kiribati authorities.
If current policies continue, the RERF could be depleted. Further drawdowns will be needed if growth continues to stagnate, population growth continues at current levels, the return on investments matches the long-term yield on Australian government bonds, and inflation converges to the Australian level of 2½ percent. Without corrective action, simulation exercises suggest that the RERF could be halved in 13 years and depleted in 24 years.
Kiribati’s use of the Australian dollar as its domestic currency has helped to underpin economic stability. The country did not establish a central monetary authority and imposed no exchange controls. Inflation, on average, has reflected price changes in major trade partners, in particular Australia. In 1984, the Bank of Kiribati commenced operations as the only bank, with government majority ownership, taking over the functions provided since 1970 by a branch of an Australian bank. The Bank of Kiribati invested most of its assets abroad because of the negligible use of credit by the public sector and the management’s perception that there was a shortage of viable lending opportunities in the domestic private sector. Interest rates on most types of deposits were generally comparable with those prevailing in Australia.
In 1995, in a major break with past conservatism, the government shifted to a more activist and unsustainable fiscal policy. Current expenditure increased substantially as large wage increases and the creation of two government ministries raised the wage bill, while subsidies and transfers also increased sharply (Figure 9.3). By 1996, the budget had moved to a deficit of 35 percent of GDP, requiring large drawdowns from the RERF.
Figure 9.3.Kiribati: Current Expenditures
Source: Kiribati authorities.
Reflecting the expansionary government spending, GDP growth temporarily picked up and the current account went into deficit. Construction activity and government services increased, and the higher civil service wage bill increased household disposable income and consumption. Agriculture, domestic fishing, and manufacturing activities, on the other hand, remained stagnant or weakened. Imports of goods and services remained strong, even though there was a fall in exports and service receipts (in particular, fishing license fees), and the current account deteriorated from a surplus of around 15 percent of GDP in the early 1990s to a deficit of 27 percent of GDP in 1996.
There was a temporary closing of the large budget and current account gaps in 1997-98 because of a large increase in revenue from licenses for tuna fishing in the EEZ. A strong El Niño weather pattern boosted the catch in Kiribati waters, and fishing license revenue jumped to almost 60 percent of GDP (Box 9.2). The budget balance improved to a surplus of 24 percent of GDP, and there was no need for drawdowns from the RERF. Even though current expenditure remained very high at more than 65 percent of GDP, the external current account surplus surged to 39 percent of GDP in 1998, in part because remittances from seamen grew rapidly.
Large budget and current account deficits subsequently reemerged, however, as public expenditure increased further and revenue from fishing licenses retreated to more usual levels. Current government expenditure rose consistently from 66 percent of GDP in 1998 to 84 percent of GDP in 2004, because personnel costs surged following increases in both public sector wages and the size of the workforce; higher subsidies to public enterprises, including large outlays for the lease of a commercial aircraft; and higher expenditure on locally purchased services. Development expenditure also increased sharply and exceeded the increase in external grants. The fiscal position deteriorated further to a record 41 percent of GDP in 2004 when expenditure cuts, mostly in development spending, proved insufficient to offset the continuing decline in revenue. Reflecting these developments, the current account deficit deteriorated to 16 percent of GDP.
The government began to draw heavily from the RERF as its fiscal situation deteriorated. In 2001, budget financing rose sharply to 13 percent of GDP. By 2004, drawdowns doubled to 25 percentage points of GDP. The persistent drawdowns and negative average rate of return over the 2001-04 period resulted in a marked decline in the real per capita value of the RERF. This was despite a 1996 decision by the parliament to keep constant for future generations the RERF’s expected real per capita value. However, the 1979 Public Finance Act set only general principles to guide investment, and the government therefore did not need parliamentary approval to increase drawdowns above budgeted levels.
Economic growth came to a halt during 2000-04. Despite increases in government services and in construction related to development expenditure, growth was constrained by poor agricultural performance, especially a sharp decline in copra production after 1999, and by lack of improvements in the fishing fleet and support services. Various infrastructure problems also emerged periodically, notwithstanding increased spending in this area financed by external grants, especially for power generation, transportation, and telecommunications. Job creation in the formal sector remained limited. An increasing share of the labor force found employment in the subsistence, informal, or household sectors.
The lackluster economic performance after 1995 stems from a number of structural policy weaknesses. These include a large public sector that drew the country’s scarcest resource—skilled labor—away from other productive activities and crowded out the private sector, an inefficient tax system, an unclear system of land titles, price controls, government subsidies, limited competition in the financial sector, and complicated procedures for foreign direct investment. Other, non-policy-related factors also continued to constrain growth, such as Kiribati’s remoteness from international markets and the wide dispersion of its population.
Box 9.2.Kiribati: Fishing License Fees
Kiribati has a very large exclusive economic zone (EEZ), covering over 3 million square kilometers of tuna-rich waters. Given the country’s very limited fishing capacity, revenue comes mainly from fishing license fees paid by foreigners, including from Korea and Taiwan Province of China. Fees are negotiated under bilateral agreements with all countries except the United States. In general, the license fees are around 5 percent of the value of the catch, but are sometimes negotiated together with grant aid and may thus be lower. The multilateral agreement with the United States covers the fishing waters of Kiribati and 15 other nations. Most of the fees are paid at the end of the year based on where the fish were actually caught.
Exogenous factors influence the amount of fishing license fees received in a year. Since 1990, there has been strong growth in revenues, but also substantial volatility. For example, revenues increased from $A 4 million in 1990 to a record of $A 47 million in 2001. However, the volumes caught depend on climatic conditions. In general, favorable El Niño weather patterns produce larger catches. International prices also determine the value of the catch and thus revenue levels, which also contributes to the volatility of fees.
To safeguard revenues and the environment over the long run, attention must be given to changes in fish stocks. In the near term, overfishing is not a major issue, because the bulk of the catch is skipjack tuna, which has not shown signs of declining stocks. However, the more highly priced yellowfin and bigeye tuna stocks have been declining, and this may eventually lead to reduced revenue. Regional cooperation is essential to safeguard the sustainability of stocks.
Over the medium term, there may be scope for Kiribati to develop its own capacity based around private commercial fishing businesses because the value of fish caught could generate substantial profits. Experiments with staterun fishing enterprises, in Kiribati as in other Pacific island countries, have resulted in substantial losses. However, more than 1,000 Kiribati citizens work aboard foreign fishing boats and have substantial experience in the industry. The government could seek to attract investment in onshore processing, including by foreign enterprises with market access.
Future Policy Challenges
Absent a change in policies, growth will likely remain sluggish and the fiscal position unsustainable. With the population growing at close to 2 percent per year, in the absence of stronger growth, per capita GDP will fall even further and unemployment will rise. Moreover, budget deficits are likely to increase, because a large share of total revenue is nontax revenue and grants and because expenditure pressures will rise with a growing population. Such deficits would require continued drawdowns from the RERF, putting the fund’s value on a declining trend and eventually exhausting it.
Fiscal adjustment is needed to restore long-run macroeconomic stability. Budgetary efforts should be geared toward stabilizing the real per capita value of the RERF for future generations, which has been the stated policy since the fund’s inception. The amount of fiscal consolidation required is sizable and will likely take several years of adjustment. In the near term, most of the adjustment must come from the expenditure side, because tax revenue is constrained by the limited growth in economic activity. The difficult measures that need to be taken include reducing the size of the wage bill, better targeting copra and seaweed subsidies, and strictly limiting development spending to the amount of donor grants. In parallel, it is necessary to lay the groundwork for a modern, efficient tax system. Establishing a medium-term fiscal framework would allow the government to track revenue trends over time and to identify periods of above-average revenues, which can be saved.
Structural reforms will be critical to generating growth. The government should give priority to reforms mentioned in the recent National Development Strategy, including streamlining public sector activities and increasing their efficiency, and creating an enabling environment for private sector growth and employment. In particular, commercial enterprises that are not monopolies should be privatized, where possible, to avoid crowding out private firms. Regulatory and financial oversight of noncommercial public enterprises should be enhanced with a view to increasing their efficiency.