Solomon Islands: Staff Report for the 2013 Article IV consultation and Second Review Under the Extended Credit Facility Arrangement and Request for Modification of Performance Criterion

KEY ISSUESContext: Solomon Islands has achieved considerable gains in development andmacroeconomic stability in recent years. However, the country is at an importantjuncture—with both security and development assistance being scaled down by donors,it needs to become more self-reliant. In addition, new drivers of growth are needed asthe depletion of logging stocks in the coming years will adversely affect growth, exports,and public finances. Spending pressures and lower growth give rise to fiscal risks.Outlook and risks: Growth is recovering gradually after slowing in the first half of 2013because of unfavorable external conditions and various supply shocks, while the externalsector is weakening, in part owing to adverse terms-of-trade developments. Risks aretilted to the downside and include lower export prices, an oil price shock, and a steeperthan-expected withdrawal of foreign aid. Legislative elections scheduled for 2014introduce uncertainty over the pace of reform.Program: Program performance has been broadly satisfactory. All performance criteria(PCs) for June 2013 and indicative targets (ITs) for June 2013 and September 2013, aswell as continuous PCs, were met. In addition, a critical reform—the Public FinanceManagement Act (PFMA)—has been approved by Parliament. However, some structuralbenchmarks scheduled for 2013 were missed because of capacity constraints. Theauthorities are requesting a modification of the PC on net credit to the government forend-December 2013 and a re-setting of four program benchmarks.Key policy recommendations:Protect policy buffers and fiscal discipline by keeping overall expenditure, includingfrom the supplementary budget, within the original spending envelope.Strengthen the quality of public spending by improving the transparency andaccountability of programs, including scholarships and constituency funds.Strengthen fiscal management by implementing the new PFMA.Maintain the monetary policy stance, but stand ready to tighten policy if needed.Follow the basket peg more closely, including by widening the operational band andre-centering it periodically.Improve capacity to execute macro-critical reform agenda.Advance structural reforms to create a more conducive environment for privatesector growth. A sound infrastructure investment program within a comprehensivegrowth and poverty reduction strategy would serve the country well.