Washington, DC: On December 1, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation[1]with Palau.
Palau has emerged from the pandemic with significant output loss, high external debt, and inflation. After contracting by 2.0 percent in FY2022, economic activity is estimated to have stalled, growing by 0.8 percent in FY2023. Declining construction activity due to delays in the implementation of new infrastructure projects, is estimated to have offset a modest increase in tourism. Since fully lifting border restrictions in July 2022, the recovery in the tourism sector has been slow, reflecting lack of flights, tighter travel restrictions in Palau's source markets in East Asia, and the appreciation of the US dollar. After expanding to support the economy during the pandemic, fiscal policy has been significantly tightened towards its pre‑pandemic balanced position.
Inflation has increased to historical highs—13 percent during FY2022 and FY2023—on the back of higher import prices for food and fuel due to Russia's war in Ukraine and global supply chain disruptions, the introduction of the Palau Goods and Services Tax (PGST), and one‑off utility tariff adjustments. Inflation is projected to moderate to 5.9 percent in FY2024, as the impact of one‑off price increases subsides.
While still subject to approval in the U.S. Congress, the renewal of the COFA Agreement (CRA‑23) on May 22, 2023, under better financial terms, improves Palau's macroeconomic prospects. A gradual rebound in tourism and construction activity are expected to support the recovery, with growth projected at 12.4 percent in FY2024. Uncertainty around the outlook is elevated, reflecting the timing of approval of the CRA-23, strength of tourism recovery, international commodity price volatility, and natural disasters, with risks tilted to the downside.
Executive Board Assessment[2]
Executive Directors welcomed the improving economic outlook following significant scaring from the pandemic and commended the authorities for their decisive fiscal reform efforts over the past two years. Recognizing that the uncertainty around the outlook is elevated, Directors encouraged the authorities to maintain their prudent policies and reform momentum to secure a sustainable economic recovery while addressing long-term growth bottlenecks and preparing for climate shocks. Directors emphasized the importance of continued engagement with development partners and the Fund, including in the area of technical assistance.
Directors welcomed the signing of a Compact Review Agreement (CRA) with the United States, under better financial terms, which would significantly enhance fiscal resources and present an opportunity to pay down debt while boosting priority social, infrastructure, and climate adaptation spending. Noting the high uncertainties, including on the timing of US Congress approval of the CRA, they welcomed the authorities' commitment to prudent fiscal and debt policies, supported by the Fiscal Responsibility Act and Debt Management Act, and the recent comprehensive tax reforms to enhance revenue mobilization. They encouraged further improvements in the efficiency of public spending, including more targeted social spending.
Directors underscored the importance of maintaining the reform momentum notably in the areas of civil service pensions, public sector employment, and wage bill management. They welcomed the authorities' plans to improve public financial management and encouraged the authorities to seek IMF capacity building in these areas.
Directors recommended enhancing financial sector resilience by further monitoring asset quality as pandemic support measures expire and strengthening financial sector supervision in the National Development Bank. Improving the payment system, and addressing structural impediments, including by establishing a credit bureau, would also be important.
Noting the benefits to financial inclusion, Directors called for a cautious approach to Fintech initiatives. They underscored the need to first close existing gaps in the regulatory and governance frameworks, and strengthen the country's AML/CFT framework, before exposing the financial system to new risks.
Directors underscored the importance of reforms to enhance the value added of tourism and encourage private and foreign direct investments. Integrating climate change adaptation and mitigation in the development policy is paramount given the criticality of climate risks for Palau.
It is expected that the next Article IV Consultation with Palau will be held on the 24-month cycle.
Table 1. Palau: Selected Economic Indicators
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[1]Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.
[2]At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summings up can be found here:http://www.IMF.org/external/np/sec/misc/qualifiers.htm.
