MACROECONOMIC AND FISCAL ASSESSMENT

Public Sector Financial Management Program (RRP SAM 46384) A. BACKGROUND MACROECONOMIC AND FISCAL ASSESSMENT 1. Samoa is composed of about 10 islands, 4 inhabited, and several uninhabited islets situated in the South Pacific Ocean, about 3 hours flight north of New Zealand. The country has a total land area of just under 3,000 km 2 and an exclusive economic zone of about 129,000 km 2, the smallest in the Pacific. The country used to be located east of the International Date Line, but switched to the other side in December 2011 in order to share the same trading days as its major economic partners. Samoa has a population of almost 200,000 people, 99% of which reside primarily on the country s two main islands: Upolu, which hosts 75% of the total population as well as the capital city of Apia, and Savai i. 2. Samoa s economy is narrowly based, driven primarily by remittances, tourism, industry, agriculture and infrastructure projects funded mainly via aid from development partners. This leaves the economy highly sensitive to exogenous shocks. Further, Samoa s vulnerability to natural disasters remains a constant threat to the development of the economy as a whole. An earthquake and tsunami in 2009 plunged the country into years of reconstruction and rehabilitation, only to be followed by tropical cyclone Evan in 2012. B. ECONOMIC AND FISCAL PERFORMANCE 3. Samoa was one of the Pacific s better performing economies before it was hit by an earthquake and tsunami in FY2009. From FY1999 to FY2008, the economy grew at an average of 4.3% a year (Figure 1). The bulk of this growth was driven by services output, mainly commerce, and transportation and communication, whose share of gross domestic product (GDP) averaged 58.8% during this period. Industrial output, mainly from manufacturing and construction, placed a distant second with an average share of 28.6%. Agriculture and fisheries output had an average share of 13.8%. It must also be noted that contribution of agriculture and fisheries to GDP fell by nearly half, from 19.2% in FY1999 to 10.8% in FY2008. 9.0 Figure 1. Contribution to GDP (in % per annum) 6.0 3.0 0.0 3.0 6.0 FY1999 FY2001 FY03 FY05 FY07 FY09 FY11 Source:Samoa Bureau of Statistics

2 4. In September 2009, an earthquake and tsunami hit Samoa, leaving almost 150 people dead and another 5,300 homeless, and causing significant damage to vital infrastructure. Compounding this was the onset of the global financial and economic crisis. The crisis resulted in the downsizing of a major factory in the country, as well as sharp increases in global fuel and food prices, which accelerated Samoa s inflation to 14.6% in FY2009 from 6.3% in the previous fiscal year. In FY2009, the economy contracted by 5.1%. 5. Subsequently, Samoa has been unable to return to its pre-tsunami growth levels. Real GDP growth averaged only 1.2% during the period FY2010 FY2012. This was fueled by fiscal stimulus spending undertaken in response to the economic shocks of FY2009, as well as posttsunami reconstruction and rehabilitation. Samoa s other traditional sources of growth, overseas remittances and earnings from tourism, averaged shares to GDP of 27.5% and 22.8%, respectively, in FY2010 FY2012, but inflows have been volatile (Figure 2). 30.0 Figure 2. Key sources of income (in % per annum, based on a 3-month moving average) 20.0 10.0 0.0 10.0 20.0 Tourism receipts Remittances 30.0 Jun09 Oct Feb10 Jun Oct Feb11 Jun Oct Feb12 Jun Oct Source: Central Bank of Samoa 6. Over the past few years, Samoa s economy has become more dependent on development partner-financed infrastructure and stimulus as sources of growth. Its principal productive sectors continue to be hampered by structural bottlenecks and the impact of the successive shocks over 2009 to 2012. 7. Stimulus spending helped push the overall fiscal deficit from 4.2% of GDP in FY2009 already well above the government s target of 3.5% to 7.5% of GDP in FY2010. With the decline in revenue collection during this period, the deficit was financed by grants and concessional loans from Australia, the European Union, Japan, New Zealand, and the People s Republic of China, as well as from Asian Development Bank and the World Bank. The winding down of post-tsunami reconstruction and rehabilitation, coupled with slight improvement in revenue collections, reduced the fiscal deficit to 6.4% in FY2011 and 5.6% in FY2012. These are, however, still notably higher than pre-crisis, pre-tsunami, levels. 8. Post-tsunami recovery, as well as progress in reducing the deficit to approach mediumterm fiscal targets, was dealt a serious blow when tropical cyclone Evan hit Samoa in December 2012. It caused total property damage and productivity loss amounting to over $210 million, or

3 around 30% of GDP. The hardest hit sectors were tourism and agriculture, both of which suffered damage of about $28 million. Cyclone Evan also caused extensive damage to essential infrastructure, and schools and housing. As a result, in January 2013, the government introduced a supplementary budget increasing expenditures by 0.8% of GDP to support immediate post-cyclone recovery spending. It has also announced plans to undertake further rehabilitation spending equivalent to 2.4% of GDP. C. OUTLOOK AND RISKS 9. The GDP growth forecast for Samoa in FY2013 has been downgraded to 0.9% (from a pre-cyclone estimate of 2.5%) due to cyclone Evan s impact on the domestic economy. ADB expects post-cyclone reconstruction and rehabilitation to boost growth to 2.0% in FY2014, a more conservative estimate than the 3.1% projected by the International Monetary Fund (IMF) (Table 1), which will continue to stimulate the economy over the next 2 to 3 years. However, its impact is expected to dissipate over time as projects are completed and as the outlook for Samoa s major economic partners remains subdued. The long-term growth forecast is 2.5% per annum, lower than the 4.3% average growth realized prior to FY2009. Table 1: Economic and Fiscal Outlook, FY2009 FY2016 Item FY2009 FY2010 FY2011 FY2012 FY2013 e FY2014 f FY2015 f FY2016 f Real GDP (% change) (5.1) 0.4 2.0 1.2 0.9 3.1 2.6 2.5 Inflation (% change) 10.0 (0.3) 2.9 5.5 4.5 (2.0) 4.0 4.0 Current expenditure (% of GDP). 25.2 24.0 24.8 29.4 31.8 31.0 29.5 29.4 Of which personnel costs a 36.9 25.0 30.0 38.8 37.6 32.5 38.9 38.3 Development expenditure (% of GDP) 12.8 18.9 18.0 13.7 15.7 20.0 18.8 17.2 Overall fiscal balance (% of GDP) (4.2) (7.5) (6.4) (5.6) (6.9) (8.2) (6.9) (3.5) Total public debt (% of GDP) 44.4 49.5 50.1 55.5 61.8 66.8 70.6 70.9 ( ) = negative, e = estimate, f = forecast, FY = fiscal year, GDP = gross domestic product. a Personnel costs as a percentage of current expenditure include wages and salaries of all ministries and public beneficiary bodies, previously reflected as part of grants to state-owned enterprises prior to FY2012. Source: International Monetary Fund. 2003. Samoa: Staff Report. Washington, DC. 10. Posing a significant downside risk to this outlook is the continued sluggish growth in the economy s principal sectors. This situation is not likely to improve if the global economic environment worsens: for instance, the ongoing contraction in Australia s automotive sector does not bode well for the automotive parts manufacturing industry in Samoa. Remittance inflows may also take a hit due to the lukewarm growth outlook for New Zealand, the main source country, and Australia. 11. Similar to the aftermath of the shocks in FY2009, responding to the impact of the cyclone will require fiscal expansion and likely result in more public borrowing. Preliminary IMF estimates show that Samoa will require total financing of $166.9 million (equivalent to 25.3% of GDP) over the period FY2013 FY2015. The major portion of this amount (or 24.5% of GDP) will be used to fund post-cyclone reconstruction and rehabilitation. These financing requirements would be partly met by adjustments in government expenditures (estimated to provide some fiscal breathing room equivalent to 7.5% of GDP during the period), grants and concessional

4 loans from development partners (10.0% of GDP), and insurance payments (1.5% of GDP). However, a financing gap equivalent to 6.3% of GDP remains (Table 2). Table 2. Sources of financing for post-cyclone reconstruction and rehabilitation (in % of GDP, cumulative for FY2013-FY2015) Item Share Additional direct costs for reconstruction and rehabilitation 24.5 Expected decline in revenues 0.8 a. Total financing requirements 25.3 Grants and loans from development partners 10.0 Expenditure adjustments by government 7.5 Insurance payments 1.5 b. Total expected financing 19.0 Financing gap (a-b) 6.3 Source: ADB estimates based on IMF. 2013. Samoa: Request for Disbursement Under the Rapid Credit Facility - Debt Sustainability Analysis. Washington. 12. Borrowing anew to bridge this financing gap will derail recent progress in fiscal consolidation. In addition, the financial obligations arising from added public debt could limit the government s fiscal flexibility and therefore its responsiveness to future economic shocks. 13. Additional loans from development partners to help fund post-cyclone recovery is expected to push the public debt burden, already elevated due to post-tsunami borrowing, to over 70% of GDP by FY2015, well above the government s 40% threshold. This has led the IMF and World Bank, in their joint debt sustainability analysis for 2013, to classify Samoa as being at high risk of debt distress. The country is particularly exposed to exchange rate risk, given its increasing foreign currency-denominated debt. D. POLICY ISSUES 14. Samoa is faced with the need to mitigate the impact of cyclone Evan in the short term, and implement the reforms necessary for sound public finances and sustainable, private sectordriven growth in the longer term. A key challenge is to accomplish these goals without adding to the debt overhang and disrupting the delivery of critical social services. 15. The government believes it will achieve its target of reducing public debt to 40% of GDP through a fiscal consolidation program, which will reduce the deficit to 1.5% of GDP by FY2018. With debt repayments expected to increase in the future, the government must therefore prioritize its expenditures to ensure that these deliver the best value for money and development outcomes. Embedded in this is the need to incorporate climate change considerations into the design of public infrastructure, so that these can better withstand any future natural disasters. 16. Preliminary World Bank assessments suggest that the Samoan government has done well in terms of managing its expenditures and prioritizing key sectors. On average, the public wage bill accounted for only 39% of the government s current expenditures in FY2006 FY2012, quite low relative to comparable economies. Further, the growth of the wage bill during this period is more attributable to increased hiring than to higher wages and the inclusion of public beneficiary bodies from FY2012, which were previously reflected as part of grants to stateowned enterprises (SOEs). Spending on goods and services likewise increased during the

5 period, but this was partly due to price pressures resulting from higher oil prices in the global market. 17. Capital expenditures increased significantly over FY2009 to FY2013 due to post-tsunami reconstruction, but on average, resources have been evenly allocated among the infrastructure, social, and administration and justice sectors since FY2006. Continued public investment in the social and infrastructure sectors will be key to improving the quality and broadening the reach of public services, as well as supporting overall economic growth and development. 18. As of 31 December 2012, total public debt was 61% of GDP, comprising 96% external debt and 4% domestic debt. As most of Samoa s public debt is concessional, its debt service (2.5% of GDP) is low relative to projected foreign reserves and government revenue. 1 Moreover, much of Samoa s debt is long term with 61% owed to multilateral agencies and 39% to bilateral partners. 2 The objective of the government s Medium Term Debt Strategy is to minimize the cost of debt consistent with government tolerance for financial risks. The government plans to achieve this objective by (i) restricting the level of public debt to less than 50% of GDP; (ii) ensuring that loans contracted are highly concessional, with a grant element of at least 35%; (iii) effectively managing SOEs guarantees; (iv) prudently managing the public debt portfolio; and (v) putting in place a credible fiscal consolidation plan and strengthening debt management. 19. The continued pursuit of structural reforms will also help reduce the fiscal deficit and debt burden, and facilitate recovery and growth. Samoa has made notable progress in SOE reforms and improvements to the business environment, but these remain key areas that would benefit from further policy action. More follow through is needed in privatization and corporate governance in order to improve SOEs financial performance and generate additional revenues, as well as reduce the amount of required subsidies and free up more government resources for other development initiatives. Further, based on the results of recent World Bank Doing Business surveys, Samoa would do well to improve private sector access to credit, as well as contract enforcement and credit risk management. 20. Monetary policy tools can complement fiscal reforms in ushering the economy towards recovery. Domestic food prices spiked immediately after cyclone Evan, but they stabilized quickly and there are currently no other sources of inflationary pressure. Nevertheless, the Central Bank of Samoa, the country s monetary authority, may wish to monitor the financial sector to ensure appropriate levels of liquidity, as well as the government s financing requirements in close cooperation with the Ministry of Finance. 1 Although debt service burden remains relatively low, the recent reduction of the Commercial Interest Reference Rate to 3% from 4% has led to a significant drop in the grant element of Samoa s debt stock and increased the present value of future debt repayments. 2 Samoa s external debt composition: ADB 32%, PRC 32%, World Bank 26%, Japan 7%, Others (OPEC/EIB/IFAD) 3%.