Report and Recommendation of the President to the Board of Directors Sri Lanka Project Number: 41180 November 2008 Proposed Asian Development Fund Grant Tuvalu: Improved Financial Management Program CURRENCY EQUIVALENTS (as of 10 November 2008) Currency Unit – Australian dollar (A$) A$1.00 = $0.67 $1.00 = A$1.48 ABBREVIATIONS ADB – Asian Development Bank AusAID – Australian Agency for International Development CIF – Consolidated Investment Fund CPS – country partnership strategy DBT – Development Bank of Tuvalu GDP – gross domestic product MFEP – Ministry of Finance and Economic Planning MTFF – medium-term fiscal framework NAFICOT – National Fishing Corporation of Tuvalu NBT – National Bank of Tuvalu NPL – nonperforming loan NZAID – New Zealand Agency for International Development OIASA – outer islands agency suspense account PBI – performance benchmark indicator PFTAC – Pacific Financial Technical Assistance Centre TA – technical assistance TEC – Tuvalu Electricity Commission TMC – Tuvalu Media Corporation TMTI – Tuvalu Maritime Training Institute TNPF – Tuvalu National Provident Fund TTC – Tuvalu Telecommunications Corporation TTF – Tuvalu Trust Fund TTFAC – Tuvalu Trust Fund Advisory Committee VLH – Vaiaku Lagi Hotel GLOSSARY corporation – Government-owned entity that has been recognized as an independent entity under legislation enterprise – any area of government operations that has businesslike characteristics, inclusive of corporations and units within ministries Falekaupule – local island council Te Kakeega II – National Strategy for Sustainable Development 2005–2015 NOTES (i) The fiscal year (FY) of the Government and its agencies ends on 31 December. (ii) In this report, “$” refers to US dollars unless otherwise stated. Vice-President C. Lawrence Greenwood, Jr., Operations 2 Director General S. Hafeez Rahman, Pacific Department (PARD) Regional Director R. Keith Leonard, Pacific Subregional Office, PARD Team leader E. Ferguson, Country Specialist, PARD Team members T. Gloerfelt-Tarp, Principal Portfolio Management Specialist, PARD L. Nazarbekova, Senior Counsel, Office of the General Counsel C. Png, Counsel, Office of the General Counsel CONTENTS Page GRANT AND PROGRAM SUMMARY i MAP I. THE PROPOSAL 1 II. THE MACROECONOMIC CONTEXT 1 III. THE PUBLIC FINANCE SECTOR 3 A. Sector Description and Performance 3 B. Issues and Opportunities 10 IV. THE PROPOSED PROGRAM 13 A. Impact and Outcome 13 B. Policy Framework and Actions 14 C. Financing Plan 20 D. Implementation Arrangements 21 V. PROGRAM BENEFITS, IMPACTS, AND RISKS 23 A. Benefits and Impacts 23 B. Risks 25 VI. ASSURANCES 27 A. Special Assurances 27 B. Condition to Grant Effectiveness 27 VII. RECOMMENDATION 28 APPENDIXES 1. Design and Monitoring Framework 29 2. Analysis of the National Bank of Tuvalu 32 3. Public Finance Sector Analysis 34 4. Problem and Constraints Analysis 43 5. Technical Assistance 46 6. Development Policy Letter and Policy Matrix 49 7. Description of Ineligible Items 58 8. Development Coordination Matrix 59 9. Summary Poverty Reduction and Social Strategy 62 GRANT AND PROGRAM SUMMARY Recipient Tuvalu Classification Targeting classification: General intervention Sector: Law, economic management, and public policy Subsector: Public finance and expenditure management Themes: Capacity development, sustainable economic growth, private sector development Subthemes: Institutional development, promoting macroeconomic stability, private sector investment Environment Category C. Environmental implications of the proposed policy and Assessment institutional reforms were reviewed, and environmental interventions have been incorporated, as required. Program The Program will provide for the development of a strengthened Description governance framework for the oversight of public enterprises in Tuvalu, improved capacity for oversight on the part of the Government, the capacity to respond positively to such oversight on the part of public corporations, strengthened capacity to manage debt, and a reduction in government debt to the National Bank of Tuvalu (NBT). Rationale Tuvalu’s economy is strongly dependent on external earnings, the level of which is determined by global economic forces. In recent years, external earnings have fallen, placing fiscal pressure on the Government, and highlighting the need to reduce the domestic economy’s reliance on the public sector as the driver of growth and instead create opportunities for private sector development to build insurance against volatility. Impact The intended impact of the Program will be sustained economic growth and fiscal stability as prioritized in Tuvalu’s national plan objectives. Indicators of success will be the Government’s performance benchmark indicators. Outcome The outcome of the Program will be improved government capacity for fiscal planning and management. The policy matrix is structured around three outputs: (i) improved public debt management capacity, (ii) strengthened oversight of public enterprises, and (iii) strengthened management capacity in public enterprises. The outputs are designed to directly address the core of the Asian Development Bank’s (ADB) country partnership strategy, which focuses on effective fiscal management. The salient features of the policy matrix include (i) passing of taxation reform legislation; (ii) endorsement of a public enterprise strategic policy; (iii) development of a public corporations act and its tabling in Parliament; (iv) repayment of the outer islands agency suspense account held with NBT; (v) endorsement of a debt risk management and mitigation policy and strategy; (vi) analysis of private sector growth potential; (vii) adoption of a legal framework for the licensing and ongoing supervision and regulation of banking institutions; and (viii) NBT board-approved policies for the timely collection of past due loans and advances of credit; and for measuring, monitoring, and maintaining adequate liquidity by NBT. ii Financing Plan ADB will support the Program by providing a grant of $3.24 million from ADB’s Special Funds resources. Tuvalu is classified as country with high risk of debt distress and is therefore eligible to receive 100% grant assistance. The grant will be provided in two tranches. The first tranche of $1.24 million will be available upon satisfaction of the first tranche conditions and grant effectiveness, estimated at around December 2008. The second tranche of $2 million will be available upon satisfaction of the second tranche conditions, estimated at around November 2009. Counterpart Counterpart funds generated from the grant will be applied to the Funds repayment of the Government’s estimated A$3,795,610 overdraft in the outer islands agency suspense account with NBT, with any remaining funds to be directed toward other outstanding debt to NBT. Program Period The Program is from 1 November 2008 to 31 March 2010. Policy, legislative, organizational, and operational changes agreed upon with the Government and set out in the policy matrix are to be put in place from 1 November 2008 to 30 November 2009. Executing Agency Ministry of Finance and Economic Planning (MFEP) Implementation MFEP will coordinate policy, legal, and regulatory actions and ensure that Arrangements the reforms as agreed to by the Government and ADB are duly carried out on time. A program steering committee, chaired by the secretary of MFEP and including representatives of the Office of the Attorney General and MFEP’s budget and public enterprise oversight areas, will be established to monitor and coordinate the Program and support technical assistance from ADB and other agencies. Program Benefits The Program is anticipated to provide benefits to society in terms of fiscal and Beneficiaries stability, improvement in enterprise performance, and business and public confidence. Risks and Risks are the continued political will required to implement a robust policy Assumptions framework for enterprise performance improvement and support for needed institutional structures, and the ongoing availability of appropriate technical capacity. The Government’s adoption of the performance benchmark indicators is seen as a statement of political will to initiate change in financial management, and the financial incentive provided by Australia and New Zealand to achieve these targets will also support continued political will and allow for retention of capacity. Procurement The proceeds of the program grant will be disbursed against a broad range of imports, subject to a negative list. 150 o 00'E 170 o 00'W 177 o 00'E I N o r t h P a c i f i c O c e a n n t o e o 20 00'N r 20 00'N n a t i o n PACIFIC REGION TUVALU Philippine MARSHALL ISLANDS a l Sea D a t IMPROVED FINANCIAL e l i n e MANAGEMENT PROGRAM REPUBLIC OF PALAU FEDERATED STATES OF MICRONESIA 0o 0o NAURU KIRIBATI Lakena Matagi PAPUA INDONESIA NEW GUINEA NANUMEA SOLOMON ISLANDS TUVALU SAMOA o NORTHERN ISLANDS COOK 6 00'S o C o r a l S e a VANUATU ISLANDS 6 00'S REPUBLIC TONGA o OF THE o NIUTAO 20 00'S FIJI 20 00'S ISLANDS NANUMAGA A U S T R A L I A S o u t h P a c i f i c O c e a n 150 o 00'E 170 o 00'W 179 o 00'E S O U T H P A C I F I C O C E A N NUI Fenuatapu VAITUPU N CENTRAL ISLANDS NUKUFETAU 0 20 40 60 80 Fuunaota Fale Lafaga Kilometers Motulalo National Capital Airstrip Fualefeke Tegako FOGAFALE Road Fuafatu FUNAFUTI Reef/Atoll Funafala International Boundary Boundaries are not necessarily authoritative. o 177 00'E NUKULAELAE Tumuiloto Fagaua Niuoku 179 o 00'E Fualefeke SOUTHERN ISLANDS Mulitefala Amatuku Tepuka Tegako o o Fualopa 10 00'S 10 00'S o 8 o 30'S 8 30'S Fuafatu L a g o o n FOGAFALE FUNAFUTI Vasafua Fatato Papaelise NIULAKITA Fuakea Funamanu Falefatu Tefala Mateika FUNAFUTI ATOLL Lua Motu Tuamotu Funafala Tegasu Avalau Telele Motuloa 179 o 00'E 179 o 00'E 08-4658 HR I. THE PROPOSAL 1. I submit for your approval the following report and recommendation on a proposed grant to Tuvalu for the Improved Financial Management Program. The design and monitoring framework is in Appendix 1. II. THE MACROECONOMIC CONTEXT 2. Tuvalu is small and isolated. It has a land area of only 26 square kilometers (km2) covering nine coral atolls and reef islands spread across more than 900,000 km2 of the Pacific Ocean.