- Christopher Browne
- Published Date:
- August 2006
Samoa consists of nine islands in the South Pacific, the two largest of which are Upolu, where the capital, Apia, is located, and Savai’i, which has a total land area of 2.8 square kilometers. Samoa has a narrowly based economy and, like many of the Pacific island countries, is highly vulnerable to weather-related shocks. It is heavily dependent on private remittances, which are equivalent to about 25 percent of GDP, to finance consumption and on official transfers to finance investment. Expatriates tend to maintain very strong ties with their families, villages, and churches, and this is true even among second-generation migrants. Emigration, which is primarily to Australia, New Zealand, and the United States, has kept the population stable at roughly 180,000 over the past decade. The political system is based on a parliamentary system of democracy and is stable.
Economic Developments since Independence
Inconsistent policies from the mid-1970s to the early 1990s made Samoa one of the weakest performers among the Pacific island economies. In the first decade after independence in 1962, conservative financial policies ensured the preservation of budget balance. However, there were subsequent episodes of macroeconomic imbalances and prolonged periods of stagnation. Expansionary expenditure policies were implemented in an attempt to accelerate growth, but these found little success and resulted in severe balance of payments difficulties and increased inflation.
These developments prompted a major review of economic policy and the introduction of a comprehensive economic reform program in 1996. Since then, Samoa has implemented wide-ranging structural changes, which have been supported by sound macroeconomic policies. In fact, Samoa is the most successful example of reform in the region. The authorities’ biennial Statement of Economic Strategy has provided the overall macroeconomic framework for stability and structural reform, and there are separate strategies that focus on health, education, and rural development. Strong and stable political leadership, close consultation with stakeholders, and extensive efforts to foster a broad consensus for reform have been integral to the program’s success. The major challenge now is for Samoa to press on with the reforms, especially to improve the conditions for private sector development.
Weak Performance during the 1970s, 1980s, and Early 1990s
During the second half of the 1970s, a series of IMF-supported economic adjustment programs were adopted to correct domestic and external imbalances. However, domestic financial policies did not support external adjustment, and the programs generally fell short of their objectives. With a lack of buoyancy in budget revenue and strong growth in expenditure, including wages and salaries, public sector deficits were large and these were financed by the banking system. Monetary policy instruments were unable to constrain demand for imports; balance of payments pressures were fended off only by tight exchange controls. The tala exchange rate was depreciated, on a trade-weighted basis, by 25 percent in 1975 and 19 percent in 1979. This contributed to rising domestic prices for imports, but there was no improvement in competitiveness because the depreciations were not supported by demand management policies.
As a result, other Pacific island economies performed better than Samoa during this period. Most of the newly independent island countries enjoyed sound external positions, which reflected buoyant export markets, plentiful concessional assistance, and cautious demand management policies. Deteriorating terms of trade in the early 1980s caused a pronounced weakening in external current accounts across the region, but most countries made the required external adjustment through a progressive tightening of fiscal, monetary, and wage policies. For Samoa, by contrast, the failure to implement appropriate policies contributed to a sizable fall in relative income, high rates of inflation, and severe external financing problems.
The economic decline was finally reversed during 1983-85 through firm implementation of comprehensive adjustment policies, supported by two IMF Stand-By Arrangements. The central government budget moved from deficit to surplus by 1985. Revenue increased sharply, reflecting both tax policy measures and improved tax collection. Spending was constrained by curbs on the growth of public sector employment, wages, and salaries; postponement of lower-priority projects; and an improved system of expenditure control. A strong recovery in international commodity prices and depreciation of the tala, on a trade-weighted basis, by 18 percent in 1983, strengthened the external position, and there were current account surpluses for the first time in more than 10 years. Sound demand management policies consolidated these gains over the following several years, although the growth rate remained disappointing.
The economy was again thrown off course during the first half of the 1990s by a number of major shocks. These included two cyclones, which devastated infrastructure and coconut and copra production; a blight that destroyed taro, the primary agricultural crop; and a financial crisis at the publicly owned airline. The result was a substantial decline in output and foreign reserves and an increase in public debt to over 90 percent of GDP. Economic recession in Samoa’s major trading partners lowered exports, tourism, and remittances. Cyclone rehabilitation entailed a large increase in public investment, leading to overall government budget deficits in 1992-95.
Economic Transformation during 1996-2005
Samoa embarked on a remarkable economic transformation in the mid-1990s. With sound macroeconomic and strong reform policies, the economy outperformed comparator countries both within and outside the region (Figure 14.1). There was solid growth and low inflation, public finances and international reserve levels improved, and the level of public debt steadily declined.
The fiscal measures included in the program of macroeconomic stabilization and reforms launched in the mid-1990s included steady cuts in expenditures and several tax measures, most notably a 10 percent value-added tax on goods and services (VAGST) and lower tax incentives. After a decade of fiscal prudence, the public debt ratio now stands at roughly 50 percent of GDP, almost all of which is external and is contracted with official creditors on concessional terms, especially to the Asian Development Bank (ADB) and the World Bank’s International Development Association (IDA). Debt service represents only 6 percent of exports of goods and services. However, because Samoa is exposed to various shocks, including natural disasters, the debt position can undergo rapid and large swings, and the government plans to lower the debt ratio further.
Figure 14.1.Samoa: Real GDP per Capita
Source: IMF, World Economic Outlook database.
The fiscal measures taken in the mid-1990s and strong growth through 2001 helped contain the overall deficit below 2 percent of GDP (Figure 14.2). However, growth started to slow after 2002, and the government took several measures to limit the impact on the budget, notably on the revenue side. The VAGST rate was increased to 12.5 percent, and excise taxes were raised on a range of products, including alcoholic beverages, petroleum products, and tobacco products. As a result, the overall deficit has been brought down to less than 1 percent of GDP.
The level of revenue to GDP has been increasing (Figure 14.3). Total revenue, excluding grants, is at 22½ percent, very close to the average for other tourism-based island economies. Although revenue from import duties has declined continuously over the past few years, this has been more than offset by the VAGST and excise taxes, which now represent one-third and one-sixth of tax revenues, respectively. Indirect taxation, largely dependent on consumption, represents the bulk of tax revenues. As a result, the sensitivity of revenues to GDP downturns has diminished.
Figure 14.2.Samoa: Evolution of Samoa’s Budget Deficit
Sources: Samoa authorities and IMF staff calculations.
While the level of fiscal expenditures is broadly in line with other Pacific island countries, its composition differs. Samoa spends a larger share of its budget on capital expenditure and public investment projects, which are largely financed by foreign donors. In contrast, spending on the public sector wage bill is below that of comparator countries in the region. At the same time, Samoa does not have a well-developed social safety net. There has been steady progress in reforming the civil service. The restructuring exercise undertaken in 2003 reduced the number of government ministries from 28 to 13, plus four Constitutional Agencies. There have been 12 Institutional Strengthening Projects focused on improving the efficiency and effectiveness of government operations. There was a large downsizing of the Ministry of Public Works in 2001, with subsequent reductions in staffing levels relying primarily on natural attrition and a general freeze on funding for vacant posts.
Figure 14.3.Samoa: Total Revenue and Tax Revenues
Sources: Samoa authorities and IMF staff calculations.
The Public Service Commission is leading a review of all existing ministries, with a view to refocusing them on their core functions. Implementation of the legislative framework underpinning financial management reforms is not yet complete. The Public Financial Management Act of 2001 did not officially come into force until 2003. After that, the subordinate regulations and finance instructions underpinning the act took considerable time to prepare. In addition, the Companies Act of 2001, which was designed to strengthen the operations of state-owned enterprises and make them more commercially oriented, was delayed by the need to incorporate bankruptcy and litigation provisions.
Weaknesses in fiscal transparency were highlighted by the Financial Management Improvement Project 2003-08 Implementation Plan, which emphasizes the need for improved budget documentation and more timely fiscal reporting. These proposals will be implemented on a phased basis, beginning with a financial management information system. Next will be development of a more timely and comprehensive budget formulation process, including medium-term budget forecast estimates and, later, better monthly and quarterly financial reporting.
Efforts are being made to strengthen the governance and accountability of state-owned enterprises, in line with the Public Bodies Act, which provides the policy framework. A first step was to establish a monitoring unit and to launch institution-strengthening projects in Samoa Telecommunications, the Electric Power Corporation, and the Samoa Water Authority. All enterprises are now required to submit annual corporate plans to the Ministry of Finance. Divestment of minority shareholdings in Computer Services Limited, National Pacific Insurance, and Samoa Breweries is under way, and the Agricultural Store, Samoa Shipping Services, and Samoa Broadcasting Corporation are to be privatized.
The state-owned Polynesian Airlines has been a persistent burden to the budget. During the second half of the 1990s, the government cut much-needed spending on education and health to keep the airline operating. Subsidies averaged 3 percent of GDP annually during 2001-04. In addition, the government took over the airline’s debt and provided guarantees for bank debt and aircraft leases. Polynesian Airlines was restructured as a joint venture with an Australian partner in 2005 and is expected to become profitable in coming years.
Monetary and Exchange Rate Management
Before the 1996 structural reforms, direct controls on interest rates and credit had inhibited financial sector competition and monetary policy implementation in Samoa. The controls resulted in artificially low deposit interest rates, which contracted savings, and rigid loan rates, which precluded risk-based credit pricing. Combined with volatile inflation, this caused wide fluctuations in real deposit and lending rates, constraining the level and efficiency of financial sector activity. In addition, supervision was weak, with only limited supervisory capacity at the central bank and no effective supervision of nonbank financial institutions.
Financial sector liberalization and the introduction of indirect monetary policy instruments were a major part of the 1996 structural reform program. All credit ceilings and interest rate controls were removed in 1998. Auctions of central bank bills began and became the primary monetary policy instrument. In addition, the liquid asset requirement was reduced and eventually abolished in 1999. These changes had a positive impact on financial institutions and markets. Credit to the private sector grew more rapidly, and banks’ profitability improved. Programs were launched to strengthen the central bank’s capacity to undertake prudential supervision, including for nonbank financial institutions and insurance companies. These liberalization measures facilitated faster real GDP growth during 1999-2003. Credit growth, in combination with sales of central bank bills, substantially reduced excess liquidity in the banking system. The Central Bank of Samoa then eased monetary policy in order to support economic activity following the 2004 cyclone.
Monetary policy is conducted in the context of a pegged exchange rate arrangement supported by capital controls, with the tala linked to a basket of currencies based on transaction-weighted trade, remittances, and tourism receipts. This regime has served well as a nominal anchor. The central bank periodically makes adjustments in the value of the tala within a plus or minus 2 percent band in order to strike a balance between maintaining external competitiveness and preserving the exchange rate peg’s role as an anchor for inflation.
Regional indicators, despite some recent appreciation, do not signal an overvaluation of the tala nor do they suggest any loss of competitiveness within the region. External current account surpluses were recorded during 1998-2004, and official reserves were adequate. Export growth has stalled over the last few years, but this was due not to a lack of competitiveness and/or movements in prices and costs out of line with Samoa’s major trading partners, but rather to the effects of unfavorable weather on fishing, which remains the largest export industry. There are plans to build more efficient landing and docking facilities to assist the fishing industry, and there are efforts to shift toward new export crops, although improvements in the agricultural sector are likely to be gradual. New Zealand recently entered an agreement to enhance Samoa’s market access for higher-value-added goods, including organic crops and processed food, and to help diversify the export base. The Samoa Tourism Development plan seeks to strengthen this sector, which is seen as a promising engine for growth and is underdeveloped compared to some Pacific islands. Tourism will get a boost if the recent Polynesian Airlines merger is successful in lowering the high airfares. Remittances are expected to remain substantial.
The Financial Sector
The financial sector remains sound, and progress has been made in strengthening the supervisory framework, as noted. The four commercial banks, two of which are subsidiaries of major Australian banks, have a joint market share of over 75 percent of total banking system assets, are adequately capitalized, and are in compliance with the 15 percent capital adequacy requirement. The central bank’s current practice is to conduct examinations through external auditors and extensive off-site monitoring, along the lines of the New Zealand model, and this is effective. Information is shared among the central bank, the external auditors, and the foreign banks, whose parent institutions maintain strong internal controls on their subsidiaries, and this reduces the need for an extensive on-site monitoring.
Samoa continues to make progress in tightening the regulatory requirements for offshore banks and strengthening the framework for anti-money laundering and combating the financing of terrorism (AML/CFT). The international banking bill approved by parliament in 2005 requires all offshore banks to establish a physical presence in Samoa and established an International Financial Authority as the supervisory agency for the offshore banks. An AML/CFT bill also was passed in 2005.
The authorities are reviewing the role and investment guidelines of the National Provident Fund (NPF) and are strengthening its supervisory framework. Its assets are now skewed in favor of short-term loans to members and to various public sector projects, and these borrowers can access about 50 percent of their outstanding balances, using their balances as collateral, because of the lack of long-term investment opportunities in the private sector. Thus, the government in 2005 gave the NPF the authority to invest abroad about 1½ percent of GDP or about 7 percent of its total assets.
The public sector still dominates the economy, accounting for about 40 percent of both GDP and total employment. The goal is to reduce this share and enhance the contribution of the private sector to stimulate growth. The policy framework focuses on incorporation for state enterprises of strategic public interest, including power, ports, and water, and privatization for state enterprises in nonstrategic sectors. The Public Bodies Act stipulates that all enterprises be run on strict commercial principles. There are plans to inject more competition into the telecommunications sector, supported by an appropriate regulatory framework.
The reform program has helped improve the business and investment climate, but there are constraints on private sector activity that need to be addressed. Poor infrastructure is a concern, although public investment has been increased for road construction, telecommunications, and port development. Approval procedures for new businesses (domestic or foreign-owned) remain lengthy, and a one-stop shop is to be established to alleviate these bottlenecks. Addressing such structural weaknesses is critical not only to stimulate domestic employment and growth but also to invigorate and diversify the export base.
Land reform is important for private sector development. Most of the sites suitable for commercial development are on communal land, but the constitution bars the sale of communal land for commercial purposes. The challenge is to build an institutional and legal framework capable of sustaining an efficient lease market, while safeguarding the interests of the local community and protecting investors.
Trade has been liberalized, and there has been progress toward accession to the World Trade Organization. Since 1998, the maximum tariff rate has been reduced from 60 percent to 20 percent, the tariff schedule has been simplified to four rates, and rates of 35-42 percent have been reduced in several steps to 8 percent. Samoa is a founding member of PICTA, which aims to eliminate all intraregional tariffs by 2011. Samoa is also a participant in the negotiations currently under way for new access to the EU market through reciprocal Economic Partnership Agreements, which are expected to take effect in 2008.