Bangladesh Bank

UNITED NATIONS ECONOMIC AND SOCIAL COMMISSION FOR ASIA AND THE PACIFIC Regional High-Level Workshop on Strengthening the Response to the Global Financial Crisis in Asia-Pacific: The Role of Monetary, Fiscal and External Debt Policies 27-30 July 2009 Dhaka, Bangladesh

Session on Monetary, Fiscal Policy and External Debt Management

Fijis Fiscal, Monetary and External Debt Management Policies

By Mr. Peter Wise Permanent Secretary Prime Ministers Office and National Planning Fiji And Mr. Jitendra Singh Chief Manager Economics Reserve Bank of Fiji

July 2009

The views expressed in the paper are those of the author(s) and should not necessarily be considered as reflecting the views or carrying the endorsement of the United Nations. This paper has been issued without formal editing.

COUNTRY PAPER ON REGIONAL WORKSHOP ON STRENGTHENING THE RESPONSE TO THE GLOBAL FINANCIAL CRISIS IN ASIA-PACIFIC THE ROLE OF MONETARY, FISCAL AND EXTERNAL DEBT POLICIES INTRODUCTION The intention of the paper is to provide information on the Fiji economy particularly on how the Government is responding to the global financial and economic crisis. It is part of the contribution for capacity building in sharing experiences to strengthen the response for the Asian and Pacific countries by learning from each other. To fully appreciate Fijis response to the crisis, it is critical to look at the basic political, economic and social reality of the country as a small island developing state. The paper outlines the background information of the country and in particular, the political situation and its vulnerable position to fully appreciate the responses put into place by the Government. POLITICAL LANDSCAPE Since Independence in 1970, Fiji has had stable government until May 1987. The country has experienced political turmoil since 1987 when there were a number of military coups. After the events of 1987, the country had another political crisis in 2000 and another Military takeover in December 2006. This was followed by the abrogation of the constitution by the President of the Republic of Fiji Islands on 10 April 2009. The events of December 2006, followed by the abrogation of the Constitution in April 2009 have made the situation worse, particularly from the international community in terms of good governance and democracy.

BACKGROUND The Fiji Islands are situated north of New Zealand and North West of Australia in the Melanesian group of the South Pacific region. They are relatively small in size with a total land area of 18,272 square kilometres of which only 9.9 percent is arable (United Nations, 1998). Fijis Exclusive Economic Zone (EEZ) has 1,290,000 square kilometres of sea. Fiji Islands was ceded to Great Britain in 1874 and regained independence in 1970. According to the 2007 population census, there were 827,900 people in Fiji (Fiji Islands Bureau of Statistics, 2007). There is no significant increase expected in the population, since the average annual growth rate has been 0.6 percent for the past 11 years. The population comprises two major ethnic groups: indigenous Fijians (57 percent), and Indo-Fijians (38 percent) (Fiji Islands Bureau of Statistics, 2007). The United Nations Human Development Index (HDI) ranks Fiji at 92nd position from a total of 177 countries (United Nations, 2008). The index is calculated using measures of life expectancy, education and standard of living. Life expectancy at birth in Fiji is 68.3 years. The education index for Fiji is now 74.8 percent. Standard of Living in the HDI is measured using Gross Domestic Product (GDP) per capita, which in Fiji Islands is just over $US 3,000. THE ECONOMY The Fiji economy is faced with the following vulnerabilities: - group of small islands spread of a large expanse of sea - isolated from major markets - prone to natural disasters - narrow output base - highly exposed to global conditions - Small market with population of 0.83 million Average Gross Domestic Product (GDP) growth rates in Fiji have been declining in recent years compared to the early years after independence. Since 2000 there have been two years of economic contraction (2000 and 2006) with further contraction forecasted this year. Figure 1: The Economy 1971-2008 (percentages) Indicator Year 1971198719912000 86 90 99 Real GDP Growth 4.12 -0.94 2.76 -1.66 Inflation 3.53 6.56 3.7 3.0 Unemployment 8.9 7.5 6.4 7.6

200105 2.45 2.82 8.2

200608 -1.0 5.0 8.6

2009-11 (f) 1.1 2.0 to 3.0

There are numerous challenges, in addition to the global financial and economic crisis, for the Fiji economy. Sustainable solutions have to be found for our causes of political instability, the difficulties faced by the sugar industry need to be resolved and our

manufacturing sector needs to develop efficiencies to compete in the global environment. Visitor arrivals on a month-on-month basis are lower than last 2 years levels. There is expectation that some improvement will be expected in the upcoming months which include the peak tourism months. Our sugar industry is declining as a result of declining EU price preferences. Efforts are being made with the limited resources to reduce production costs in the industry to make it globally competitive. Foreign reserves position deteriorated significantly as a result of rising food and energy prices and declining demand for Fiji exports requiring a devaluation of the Fiji dollar. This has resulted in some reduction in imports but as a result of depressed global demand, exports do not show any signs of recovery yet. FISCAL POLICY Generally, the fiscal policy of the country has been expansionary over time due to limited contribution by private sector in the growth and development process. Although successive Governments have tried to encourage private sector participation, there are reservations due to lack of confidence in view of political instability and lack of confidence. In considering the approach in the formulation of policies, the Government normally takes a consultative framework. Given the developmental status in the country, a significant portion of government expenditure is directed towards basic infrastructure development vis a vis roads, shipping, health, education and utilities. Contingencies usually arise during the course of the year as a result of our vulnerability to natural disasters such as cyclones, floods and droughts. Such incidents require economic revitalisation policies to be implemented to ensure adequate food supply for the population and visitors received. Total tax revenue collected up to 30th June 2009 was $570.1m representing a shortfall of $30m (0.1%) from the forecast for the 2009 Budget. It is expected that there would be a shortfall of some $103m compared to budgeted tax collection of $1,331m. This shortfall comprises lower revenue collections (by $52m) and higher VAT refunds ($51m). Government revenue collection is below budgeted levels due to declining exports which have fallen in the first four months of this Figure2:GovernmentDebtPosition20012008 year over the same period last year. 3500 54% Similarly, imports also fell by 7 percent in 3000 52% the first four months of this year. 2500 50% P Between 2001 and 2006 government debt as a percent of GDP rose by 4.6 percentage points with nominal value increase of $1.21 billion. This represents
s n 2000 o i l l i M 1500 $ F 1000 500 0 2001 2002 2003 2004 2005 2006 2007 2008 TotalDebt DebttoGDPPercent 48% 46% 44% 42% 40% D G f o t n e c r e P

an annual increase in debt stock by $200 million. Debt as a percentage of GDP declined over 2007-2008. Further borrowings are intended in 2009 and beyond to complete the governments intended infrastructure development program. Government borrowings will only be targeted at investment projects so that developments are able to contribute to sustained economic growth upon completion. The full implication of the global crisis is yet to be realised by Fiji, therefore it is expected that revenue collections will be further affected later this year and early next year as the effects unfold. MONETARY POLICY The major thrust of monetary policy in Fiji are directing towards achieving low inflation and an adequate level of foreign reserves. Fiji has a fixed exchange rate, pegged to a basket of 5 major trading partner currencies. Protecting Fijis Balance of Payments therefore remains a priority for the central bank amidst the developments in the global environment. As a result of high level of consumption activity in the country the RBF started raising interest rates from 2004 to curb domestic demand. Given there was little reaction on the commercial bank interest rates and credit, further rate hikes were imposed. This weak link to commercial bank interest rates was a reflection of the high level of liquidity with the commercial banks. Hence, in 2006, the Statutory Reserve Deposit (SRD) ratio was increased from 5 percent to 7 percent this improved the responsiveness of the commercial bank interest rate to the changes in the RBF official interest rate. Credit eased somewhat, but the slowdown in credit growth was more pronounced after the imposition of the credit ceiling. The political events of late 2006 forced the RBF to implement a credit ceiling on private sector lending, and in the process, abandon the interest rate targeting framework. Consequently, the Bank suspended the flotation of RBF Notes. This was a deliberate measure to allow liquidity to build up and ease the upward pressure on interest rates. The outcome of a review of monetary policy in April 2008 suggested that the credit ceiling remain in place, but certain exchange control policies which were tightened, were relaxed a little. However, provisions are made for commercial banks to exceed their ceiling and lend to priority sectors. Looking at outcomes in 2007, the credit ceiling had its desired effects the annual growth rate of total lending by commercial banks slowed to around 2 percent in December 2007 from 21 percent in December 2006. Importantly, lending for consumption purposes slowed to 0.04 percent from 11 percent in the same review period. Mirroring these credit developments, merchandise imports had fallen. Foreign reserves reached F$958.7 million at the end of 2007. On exchange control policies, local borrowing guidelines for non-resident companies and individuals were relaxed given the need to raise investment to support long term economic growth. Exchange control guidelines were also amended in line with Governments introduction of a category for permanent resident status for former Fiji residents. These changes were aimed at encouraging former Fiji residents to return and

contribute to the economy. The gradual recovery in the economy also witnessed the relaxation of selected exchange controls. Delegated approval limits were raised for prepayment of imports, credit and debit card payments, travel, and other various payments. As a result of rising oil and food prices, the 2008 average inflation was 7.7 percent. Since monetary policy was already tight and domestically generated price pressures were minimal, no further monetary policy actions were necessary. To mitigate the impact of high inflation outcomes, the RBF relaxed parts of its Forward Foreign Exchange Cover Facility. Commercial banks could enter into forward foreign exchange contracts with local importers of rice, wheat, flour, edible oils and milk/milk powder to hedge against future price increases. This measure, alongside the fiscal measures put in place (removal of duty on certain items and the increase in the tax threshold) were aimed at assisting the public during the high inflation episode. Credit growth picked up pace and was recorded at 11.6 percent in December 2008. Foreign reserves at the end of 2008 fell to around F$558.7 million. EXTERNAL DEBT POSITION In 2007, Governments debt level stood at 50.0 percent of GDP. This was later reduced to 48.0 percent in 2008 through tight financial restraint. The rule of thumb is that debt levels above 40 percent are unsustainable, particularly for economies that have a narrow production base, as in the case of Fiji. In terms of debt stock, while majority of Government debt is held in domestic currency, the present monetary conditions have led to increases in interest costs. Recent devaluation of the Fiji dollar has increased service costs for external debt. Total Government debt stood at $2.887 billion at the end of 2008 registering an increase of 6 percent from the preceding year. The major factors attributed to the increase were the net increase in domestic bond issuance and the impact of exchange rate movement on the value of our US$150.0 million Global Bonds. Figure 3: TOTAL OUTSTANDING( $Million ) 2005 Domestic Debt External Debt Total Debt 2,258.4 GOVERNMENT 2006 2,446,4 2007 2,337.8 DEBT 2008 2,410.9

164.1 2,422.5

416.7 2,863.1

397.0 2,734.8

475.9 2,887.2

Source: Ministry of Finance Domestic debt is comprised mostly of bonds and t-bills. Approximately 97.0 percent of domestic debt outstanding is bonds that are issued in the domestic capital market.

Governments external borrowings ($475.9m) comprise loans obtained from our multilateral and bilateral lenders and also from the 1st ever global bond issuance made in 2006 to JP Morgan ($250m). To date, governments largest multi-lateral Figure 4:External Debt to GDP Ratio lender, the Asian Development Bank (%) (ADB), holds approximately $140.3 10.0 8.0 million of outstanding debt, whereas 6.0 the Japan Bank for International 4.0 Cooperation (JBIC), our largest bilateral 2.0 0.0 lender holds $37.7 million of it.
2004 2005 2006 2007

Governments external debt outstanding has increased significantly (19.9%) over the Dec-07 quarter and also over the Sep-08 quarter (12.4%). The increase was mainly due to the appreciation of the three (3) major servicing currencies against the Fiji dollar over the period, an increase equivalent to 8.0% of the GDP as a result of our currency devaluation. Figure 5 depicts the exchange rates movement of the Fiji dollar against its three major currencies of repayment for the past 6 years. As can be seen, there has been a steady growth of the Euro and the US dollar against the Fiji dollar. The Fiji dollar has depreciated significantly in value over the same period last year and also over the Sep-08 quarter.
Figure 5: Exchange Rate for FJD against EUR, USD,and JPY, as at Dec 2008. 3.00 80.00 2.50 60.00 2.00 ($) 1.50 40.00 1.00 20.00 0.50 0.00 0.00 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08
Euro US JPY

2008 (P)

Over the Dec-07 quarter, the Fiji dollar weakened against the Euro (4.7%), the Japanese yen (22.8%) and the US dollar (15.2%), and over the last quarter, the Fiji dollar weakens against the Euro (5.8%), the Japanese yen (19.4%) and the US dollar (6.9%). The Fiji dollar was further devalued on 15 April 2009. The impact of this low Fiji dollar value would be greatly felt while servicing the external loans, hence measures such as allocating funds to governments sinking fund account will be crucial to safeguard in this regard. Figure 6 HA (Loan Guarantee) 118.8 State Guarantees and Contingent 52.56 ties Liabili Section B: 2006 International Subscriptions (ADB,IBRD,IDA) 52.56 Total Contingent Liabilities ($m) Ministry of Finance 3,036.7 Source: Of which the major components includes: Section A: 2,984.1 FNPF (Members Funds) 2,347.16 FEA (Loan Guarantee) 165.6 FDB (Loan Guarantee) 271.57 106.5 51.71 2007 51.71 3,326.4 3,274.7 2,481.08 156.17 415.17 90.21 58.32 2008(P) 58.32 3,262.7 3,204.4 2,622.50 235.8 279.37 In contr ast to

real Government debt, which rose significantly, total contingent liabilities are still considered high by Fijis standard. Governments contingent liabilities outstanding stood at $3,262.7 million at the end of 2008, or approximately 58.0 percent of GDP. This was mainly due to more loans being guaranteed by the Government for majority of the public entities that it owns. IMPLICATIONS FROM THE GLOBAL ECONOMIC CRISIS The financial sector in Fiji is relatively insulated from the global financial crisis as credit institutions and banks have little or no direct exposure to the global financing market. Although mortgagee sales are conducted on a regular basis, the non-performing loans as a ratio of total loans are only 6 percent. Funds for domestic credit are raised from domestic deposits. Effects of the global financial crisis on Fiji, although indirect are significant. Most of Fijis trading partner economies are expected to contract in 2009 and as a result there is expectation that demand for our exports and tourism will be adversely affected. Inward remittances are also expected to decline as foreign employment opportunities for Fiji citizens disappear. Foreign Direct Investment (FDI) in Fiji is also expected to decline as key growth industries decline or remain stagnant. Reduced economic activity and trade will result in lower revenue for Government. This has already been observed in lower revenue collections for the first half of the year. This will require government to exercise prudent financial management. There is likelihood of lower aid spending by our development partners FISCAL POLICY RESPONSE Fiscal policy has largely been expansionary given our development status while debt levels have been increasing. Our ability on fiscal expansion has been severely constrained by expansionary policies of past that have resulted in a significant real and contingent debt stock. Fiscal expansion may result in the crowding out of private investment, which is already low, if financed from the domestic market. Liquidity in the domestic market has been relatively low recently but have been boosted to some extent by monetary policy measures. Other possible problems with fiscal stimulus include the time lag between the implementation of the policy and detectable effects in the economy. It also has inflationary effects as a result of increased demand. In theory, fiscal stimulus does not cause inflation when it uses resources that would have otherwise been idle. For instance, if a fiscal stimulus employs a worker who otherwise would have been unemployed, there is no inflationary effect; however, if the stimulus employs a worker who otherwise would have had a job, the stimulus is increasing demand while labor supply remains fixed, leading to inflation. Given that unemployment levels have exceeded 8.6 percent, it is unlikely that any such stimulus will lead to demand driven inflation.

Government Expenditure
Fiji has adopted a modest expansionary stance targeted at stimulating investment. The target of the government is largely to change the operating/capital expenditure mix. This target, particularly on infrastructure, is expected to result in higher levels of economic activity in the medium term. To achieve this, civil service reforms have been implemented to eliminate inflation based cost of living adjustment payouts, reduce worker numbers in the civil service by controlling appointments and retiring workers at age 55. There has been fiscal expansion through infrastructure spending where it is intended that budgeted construction and rehabilitation works will be completed before the end of the year. Government is mindful not to reduce worker numbers such that it adversely affects the capital expenditure program. Fiscal spending on capital formation, particularly in infrastructure, is expected to lay the platform for investments by the private sector and improve access to markets and services for rural dwellers.

Government Revenue and Taxation

In addition to expanding the capital expenditure budget, various other measures have been undertaken to alleviate the impact of the global crisis on the people, particularly the vulnerable poor. Income tax threshold has been increased to $15,000, a more than $5,000 increase and Value Added Tax (VAT) and Import VAT have been removed from basic food items. The above measures and declining trade and economic activity is expected to result in reduced revenue for Government, measures to reduce the cost of its operations have to be implemented. Reduction in government consumption, as a result of declining revenues, will result in a further contraction of the Fiji economy. The boost is expected to be provided through increased capital expenditure.

Food Security
Another focus of fiscal policy is targeted at food security. A lot of resources, particularly in agriculture are being refocused to target food production. Food is a significant component of our imports and our import capacity is reduced as a result of our monetary policy to devalue. Furthermore increased foreign debt service obligations further reduce our capacity to import. Given that the poor spend a greater proportion of their income on food, they will be affected more. There is additional emphasis on improving agricultural production to improve food security and reduce the cost of food, particularly for the poor. Monetary Policy Response to the Global Financial Crisis Although the impact of the global financial crisis translated into reduced remittances in 2007, the Fiji economy started feeling the fuller impact of the slowing world economy from the second half of 2008. This came in the form of reduced remittances, export

earnings and lower visitor arrivals. In 2009, the impact was more pronounced this was direct reflection of the several rounds of downgrade to world economic growth projections. The falling world oil and food prices post July 2008 was a relief, as it meant lower payments on these commodities. While foreign exchange income fell, due to lacklustre performance of exports and flattening tourism earnings, Fijis total import bill remained substantially high, almost 3 times the size of exports. Fortunately, the reduction in international oil prices mitigated the impact on foreign reserves. As a result, Fijis current account deficit widened, forcing a reduction in foreign reserves. The de-leveraging process in the international foreign exchange markets also resulted in a sharp appreciation of the Fiji dollar against certain trading partner currencies (namely the Australian and New Zealand dollars 1 , which had significantly depreciated against the US dollar). While the ideal stance for monetary policy in an environment of weakening growth would have been to relax monetary policy, Fijis fixed exchange rate and the worsening Balance of Payments made it difficult to do this. Policy decisions continued to be dominated by the objective of keeping foreign reserves at an adequate level to protect the exchange rate peg. In response to the weakening BoP situation, in April 2009, the RBF made several major monetary policy changes. The policy measures were in line with the Banks ongoing efforts to maintain financial and external stability, and to move the economy forward sustainably. On 14 April, the RBF announced a tightening of exchange controls. Major changes included suspension of certain foreign exchange transactions; increased requirement for Reserve Bank approval for certain payments; and reduction of delegated limits for all transactions. Subsequent to this, the Deputy Governor of the RBF was appointed the new Governor, effective 15 April 2009. The 20 percent devaluation of the Fiji dollar was a key proactive policy response to safeguard Fijis competitiveness and to protect Fijis foreign reserves in light of the negative impact of the global financial crisis. As a result, the foreign reserves which had been falling rapidly (to F$440 million), improved to around F$700 million2 (by 17 July 2009) and have been steadily increasing since. Liquidity in the banking system has also improved. It rose strongly to around F$190 million from very low levels ($15m) early in the year. The improved liquidity situation is expected to ease credit conditions both in terms of lending rates and availability of bank credit. Following the devaluation, prices have increased as expected. Prices rose by 2.3 percent in June on an annual basis due to higher prices for food, durable household goods and transport. During the coming months, prices are forecast to rise further and then start moderating towards the end of next year. For 2009, the year-end inflation is expected at between 9-10 percent.
1 2

Australia and New Zealand account for around 50 percent of Fijis exports and tourism. 1 Fiji dollar = USD 0.4851 (as at 20 July 2009)

Policy changes on the weighted average lending rate of commercial banks and other licensed financial institutions, and interest rate spread of banks, were also announced. Commercial banks are expected to bring their weighted average lending rate to December 2008 level by the end of July 2009. In addition, they have been directed to reduce their interest rate spreads to 4 percent by the end of 2009. These are in an effort to stabilise interest rates and assist in the growth process. These changes are expected to translate to a stable and more conducive borrowing environment for Fijis businesses and the people and offer depositors more reasonable returns on savings. Some downward movement in the lending rates are already being seen but the full impact of the recent policies on interest rates are still to be seen. The Reserve Bank also setup a Financial Systems Development and Compliance (FSDC) Group at the Bank and has plans to setup specialised microfinance service centres for commercial banks. With the commercial banks assurance to stringently apply specified lending guidelines on high priority sectors, the Reserve Bank will closely monitor developments in lending particularly for investment-related projects, export-oriented activities, local businesses and small and medium sized enterprises. The plan now is to link tourism sector domestic borrowings to local value added content and environmental protection is expected to encourage the development of local industries, and at the same time to ensure that our fragile environment is protected in line with national environment policies. Closer policy co-ordination between the Government and the Reserve Bank is critical to ensure that both fiscal and monetary policies are aligned to meet the economic management challenges. The recent policy measures announced by the Bank, including exchange controls, are an attempt to stabilise Fijis external position. This is being complemented by Government maintaining a tight rein on expenditures through fiscal discipline. Reducing operational costs and the prioritisation of expenditure is essential in this regard. March quarter exports fell by 12 percent with lower earnings particularly from mineral water and garments exports. Lower demand for our exports due to the global fall off in demand, and lower remittance receipts will continue to pose risks to our foreign earnings. In this regard there is a need to reduce the level of our imports through various measures and change in sourcing for cheaper imports. Furthermore, government policies to lessen our dependence on oil imports, such as diversification into non-fossil energy, will reduce outflows and help sustain our balance of payments. It is equally important to shift reliance away from imported products to domestic goods, so as to reduce the import bill further. External Debt Management Government will continue to depend on domestic borrowing for financing its budget deficit. This will mitigate the risks of high interest rate and exchange rate associated with the global financial crisis.

External borrowing will only be considered for capital and infrastructure projects with an economic rate of return of more than 12 percent. Arrangement for external borrowing will be channelled through bilateral and multilateral arrangements, taking advantage of the diplomatic relations Fiji has enjoyed over the year with its bilateral partners. These bilateral arrangements are likely to bring about favourable loan terms and conditions compared with commercial contract that is likely to trigger high interest rates as a result of financial crisis. Government will endeavour to reduce the Net Deficit in the medium term to maintain sustainable debt level with more resources freed up to drive economic activity in the key sectors of the economy. Given that Fiji currency was devalued as a result of the global crisis the external debt servicing for existing portfolio changed as follows: Particulars Debt Servicing before 20% Devaluation Debt Servicing after 20% Devaluation Increase in Debt Servicing Conclusions Fiji is faced with one of the toughest times in its economic history which challenges faced on many front. The global crisis comes at a wrong time and is continuously evolving, therefore our policy responses have to be re-visited frequently and responses should have room for manoeuvre in future if circumstances change. Fiji already has a reasonably high debt stock which requires prudent financial management and reduces the ability to undertake significant fiscal expansion in response to economic decline. Fijis fiscal efforts in response to the global crisis are to consolidate operating expenditure and expand capital expenditure, particularly infrastructure development. Room for further fiscal responses, should conditions deteriorate in future, is being maintained. In moving forward, it is clear that the unfolding global crisis and recession has negatively impacted the Fiji economy, like the rest of the world. The anticipated slow economic recovery currently envisaged for the world economy and weak prospects for the domestic economy continue to pose downside risks on various fronts. Since the crisis has been financial in nature most of our responses to date have been through monetary policies, the most significant of which was the 20 percent devaluation of our currency. It is acknowledged that the poor are the most vulnerable to the crisis, therefore policies have generally been targeted to assist the poor through minimum wage implementation, funding boost for social welfare, removal of VAT from basic food items, subsidies for public transport and increasing the income tax threshold. 2009 2010 2011 2012 2013 2014 2015 38.4 37.3 304.9 24.3 20.2 20.6 20.8 42.6 4.2 37.4 0.1 365.9 35.0 61.0 10.7 35.0 14.8 42.8 22.2 52.0 31.2

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