Solomon Islands

Country Report

Solomon Islands

September 2006

The Economist Intelligence Unit 26 Red Lion Square London WC1R 4HQ United Kingdom

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Solomon Islands 1

Contents

Solomon Islands

2 Summary

3 Political structure

4 Economic structure 4 Annual indicators 5 Quarterly indicators

6 Outlook for 2006-07

7 The political scene

9 Economic policy

10 The domestic economy

11 Foreign trade and payments

The region

12 Summary

13 Outlook for 2006-07

14 The political scene

16 Economic policy and the domestic economy

List of figures

6 Solomon Islands: foreign reserves 6 Solomon Islands: foreign trade 8 Solomon Islands: gross domestic product 8 Solomon Islands: consumer price inflation

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Solomon Islands September 2006 Summary

Outlook for 2006-07 Constitutional reform is planned, but the political environment will remain fragmented and unstable. Outlying areas are increasingly dissatisfied with the role of central government, and the role and responsibilities of the Australian- led intervention force will be questioned. Continued economic growth is forecast in 2006-07, helped by the resumption of palm oil production. However, landowner hostility could prejudice the growth of the mining sector, and overlogging will continue to threaten the country!s long-term future.

The political scene The Grand Coalition for Change government survived the sacking of the commerce minister, Francis Billy Hilly, in a crisis linked to the country!s recognition of Taiwan. The government is pushing forward with its legislative agenda, including constitutional change. However, dissatisfaction with the central government remains acute at the local level. Some outlying islands have pushed for secession.

Economic policy The new foreign investment law should simplify procedures for those wishing to invest in the Solomon Islands. The government is looking to adjust economic policy with a view to promoting rural development. One aspect of this may be the commoditisation of customary land. Illegal land occupation in the capital has also caused growing concern. The fiscal position remained strong in the first half of 2006.

The domestic economy Output of most key commodities, including timber, fish, copra and cocoa was down year on year in the first quarter of 2006. The Asian Development Bank and Japan have contributed funds towards the rehabilitation of rural infrastructure in the Solomon Islands, focusing on roads and bridges. Inflation has accelerated, boosted by high global oil prices.

Foreign trade and payments The merchandise trade deficit rose to SI$102.9m (US$13.5m) in the first quarter of 2006, owing to the rising cost of oil imports. However, the current-account deficit was partially reduced by surpluses in services, transfers and the income account. The EU agreed to provide extra assistance to promote rural development.

Editors: Graham Richardson (editor); Gerard Walsh (consulting editor) Editorial closing date: August 17th 2006 All queries: Tel: (44.20) 7576 8000 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

Country Report September 2006 www.eiu.com © The Economist Intelligence Unit Limited 2006 Solomon Islands 3

Political structure

Official name Solomon Islands

Form of state Constitutional monarchy

The executive UK-style cabinet, led by the prime minister, who is chosen from and by parliament

Head of state Queen Elizabeth II, represented by a Solomon Islander governor-general, currently Sir Nathaniel Waena

National legislature Unicameral, 50-member national parliament, elected for a four-year term

Local government The islands are divided into eight provinces and one town council (Honiara)

Legal system English-style system; a series of lower courts leads to the Court of Appeal

National elections Elections were held on April 5th 2006. The next elections are due in 2010

National government Following the April 2006 election a government based around the former government, incorporating the People!s Alliance Party (PAP) and the Association of Independent Members (AIM), was installed, led by former deputy prime minister Snyder Rini of the AIM. However, rioting led to the collapse of the Rini government within the month. A new administration based around the former opposition and led by former prime minister, Manasseh Sogavare, of the Social Credit Party (Socred), was installed in May 2006

Main political parties The PAP; the AIM; Socred; the Rural Advancement Party (RAP); the Lafari Party; the Christian Alliance Party; the Democratic party; the National Party; the Liberal Party; the Labour Party

Prime minister & public service Manasseh Sogavare (Socred) Deputy prime minister Job Duddley Tausinga (RAP)

Key ministers Agriculture & livestock Trevor Olavae Commerce, industries & employment Peter Shannel Communications & aviation Patrick Vahoe Junior Culture & tourism Bently Samuel Education & human resources Derek Sikua Energy & mines Toswel Kaua Finance & treasury Bartholomew Ulufa!alu Fisheries & marine resources Nollen Leni Foreign affairs Patteson Oti Forests, environment & conservation Job Duddley Tausinga Health & medical services Clay Forau Soalaoi Home affairs Bernard Ghiro Infrastructure & development Stanly Festus Sofu Justice & legal affairs Samuel Manetoali Lands & survey Leslie Boseto National reconciliation Sam Iduri Planning & aid co-ordination Gordon Darcy Lilo Police & national security Isaac Inoke Provincial government & constituency development Japhet Waipora Public service Joses Wawari Sanga

Central Bank governor Rick Hou

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Economic structure

Annual indicators 2001a 2002a 2003a 2004a 2005b GDP at current prices (SI$ m)c 1,436 1,528 1,588 1,775b 1,990 Real GDP growth (av; %)d -9.0 -2.4 5.6 5.5 4.7 Consumer price inflation (av; %)c 7.7 9.3 10.0 7.1 7.4 Population ('000)c 476 490 508 521 n/a Exports fob (US$ m)c 47 58 74 97 102 Imports cif (US$ m)c 82 65 67 72 144 Current-account balance (US$ m)c -33 -4 27 67 n/a Reserves excl gold (US$ m)e 19.34 18.25 37.20 80.58 93.51 Total external debt (US$ m)c 134 152 161 160 n/a Debt-service ratio, paid (%)c 5.1 7.8 6.4 6.4 n/a Exchange rate (av; SI$:US$)e 5.278 6.749 7.506 7.485 7.530a a Actual. b Economist Intelligence Unit estimates. c Asian Development Bank. d Central Bank of the Solomon Islands. e IMF, International Financial Statistics.

Origins of gross domestic product 2002a % of total Agriculture 47.7 Mining n/a Manufacturing 4.1 Electricity, gas & water 1.8 Construction 2.3 Trade 10.4 Transport, communications & finance 10.1

Principal exports fob 2005a SI$ m Principal imports cif 2005a SI$ m Timber 517.0 Machinery & transport equipment 386.0 Fish & fish products 67.1 Mineral fuels 324.6 Cocoa 56.8 Food & live animals 291.0 Copra 16.6 Basic manufactures 169.9

Main destinations of exports fob 2004b % of total Main origins of imports cif 2004b % of total China 28.2 Australia 25.3 South Korea 15.7 Singapore 23.8 Thailand 15.7 New Zealand 5.3 Japan 9.7 India 4.8 Philippines 5.1 Japan 3.9 Vietnam 3.1 US 1.9 a Central Bank of the Solomon Islands. b Asian Development Bank

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Quarterly indicators 2004 2005 2006 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr Financial indicators Exchange rate SI$:US$ (av) 7.472 7.478 7.499 7.503 7.514 7.529 7.574 7.594 Exchange rate SI$:US$ (end-period) 7.463 7.502 7.508 7.51 7.513 7.559 7.576 7.593 Deposit rate (av; %) 1.00 0.92 0.75 0.92 1.00 1.00 1.00 1.00 Lending rate (av; %) 16.08 16.08 16.08 16.08 16.08 16.08 16.08 16.08 Treasury bill rate (av; %) 6.00 6.00 6.00 6.00 5.03 3.57 3.52 3.38 M1 (end-period; SI$ m) 356.95 397.90 374.35 401.86 433.09 486.92 540.67 551.34 M1 (% change, year on year) 28.2 36.5 12.9 24.9 21.3 22.4 44.4 37.2 M2 (end-period; SI$ m) 560.33 643.26 624.63 653.09 697.69 782.14 866.69 871.09 M2 (% change, year on year) 23.3 32.9 17.5 26.1 24.5 21.6 38.8 33.4 Foreign trade (SI$ m) Exports foba 181.97 238.28 171.01 160.15 194.97 190.10 226.41 203.16 Imports fob -134.00 -154.78 -214.40 -255.33 -245.00 -288.20 -294.91 -306.04 Trade balance 47.97 83.50 -43.39 -95.18 -50.03 -98.10 -68.50 -102.88 Foreign reserves (US$ m) Reserves excl gold (end-period) 58.9 71.6 80.6 79.0 86.3 93.5 95.4 94.7 a Includes re-exports. Sources: IMF, International Financial Statistics.

Solomon Islands: foreign reserves Solomon Islands: foreign trade (US$ m; end-period) (SI$ m)

100 Exports (a) Imports Trade balance 300 90

80 200

70 100

60 0 50

-100 40

30 -200

20 -300 10 -400 0 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 2004 05 06 2004 05 06 (a) Includes re-exports. Source: IMF, International Financial Statistics. Source: IMF, International Financial Statistics.

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Outlook for 2006-07

Constitutional reform is The government survived its first major internal crisis in August, when a

planned dispute over the Solomon Islands! allegiance to Taiwan prompted the sacking of the minister for commerce, Francis Billy Hilly. However, the prime minister, Manasseh Sogavare, faces a large number of internal challenges. Consultation on a new constitution will take place over the remainder of 2006, with the aim of having a new document ready for 2007. The government is also attempting to pass a Political Integrity Bill, designed to improve political stability by reducing the ability of members of parliament (MPs) to switch parties. But these documents cannot solve a number of underlying problems, most importantly the level of dissatisfaction in many parts of the Solomon Islands with the central government. Despite recent increases in external assistance, the central government is still unable to deliver on a number of development promises, and this is fuelling dissent and talk of secession among the outer islands. The continued presence of the Australian-led Regional Assistance Mission to the Solomon Islands (RAMSI) will be crucial to future security. The Australian government will doubtless want to further reduce the size of RAMSI, but a substantial troop deployment is likely to remain for some years. One problem is that popular dissatisfaction with the local government could spill over into dissatisfaction with RAMSI itself. At some point, the mission may need to redefine its role, but it is likely resist the current government!s desire to exert more influence over RAMSI!s policy agenda, and to indigenise RAMSI!s hierarchy and appointments. As long as RAMSI is in place, substantial aid funding is likely to continue from Australia, the EU, New Zealand, Japan, Taiwan and other donors.

Continued growth is forecast After four years of contraction, the economy is estimated to have expanded by 4.7% in 2005, amid strong growth in agricultural and logging output. The economy will continue to recover in 2006-07, the Solomon Islands (unexpectedly) being one of the best performing Pacific island economies. At the urging of RAMSI advisers, during the forecast period the government will seek to address the structural problems that have impeded growth. An important new investment law, making foreign investment easier, has already been implemented. Inflation, as measured by the Honiara retail price index, is on the rise again, averaging 7.2% in 2005, and reaching a year-on-year rate of 9.1% in May 2006, mainly because of high oil prices. The rate of inflation for local products was a much lower 6.2% year on year in May, which bodes well for the future. Long-term growth prospects should be boosted by the resumption of a key commodity, palm oil, as the rehabilitation and expansion of plantations on the Guadalcanal Plain progresses. Prospectors are showing increasing interest in exploration for copper and gold. Production of copra and, particularly, cocoa has been recovering and the island!s fish catch may increase in 2006 following several poor years as new boats are launched. However, landowner hostility could frustrate the planned reopening of mines, and overlogging poses a serious threat both to the environment and to the timber industry!s long-term

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future"there has been a recent warning from the governor of the Central Bank of the Solomon Islands, Rick Hou, that all forests could be cut down within six years if logging continues at its current rate.

Solomon Islands: Solomon Islands: gross domestic product consumer price inflation (% change, year on year) (av; %)

Solomon Islands Asia excl Japan Solomon Islands Asia excl Japan 8.0 12.0

10.0 4.0 8.0 0.0 6.0 -4.0 4.0

-8.0 2.0

-12.0 0.0 02 03 04 05 02 03 04 05 2001 2001

The political scene

Taiwan relationship once The Grand Coalition for Change (GCC) government led by the prime minister,

again proves controversial Manasseh Sogavare of the Social Credit (Socred) party, appeared to survive its first internal crisis in August 2006, which followed the sacking of the minister for commerce, Francis Billy Hilly. Mr Billy Hilly was fired for refusing to renounce an agreement signed between his National Party and the Chinese Communist Party (CCP) in 2005. However, two other National Party ministers who had faced a similar threat, Toswell Kaua (mines and energy) and Gordon Darcy (planning and aid co-ordination), eventually backed Mr Sogavare in the dispute, and the party remained a member of the ruling coalition. Had the National Party left the coalition, it is possible that the government could have been forced into a minority in parliament, although given the fluid nature of party allegiance in the Solomon Islands the government might have been able to persuade some of the party!s legislators to remain in the government. All other members of the GCC, which includes the National Party, Solomon Islands Democratic Party, Solomon Islands Rural Advancement Party, Liberal Party and Socred, reaffirmed their support for the government in the wake of the crisis. The dispute was centred on the controversial issue of the Solomon Islands! diplomatic recognition of Taiwan rather than mainland China. The Solomon Islands receive millions of dollars in aid from Taiwan every year, but critics have suggested that in the past much of the money has been misused. This problem was one of a number of factors that aggravated the violence that followed the general election in April 2006. Mr Sogavare had initially stated in May that the country could face a significant change in foreign policy under his government"a comment that was taken to suggest that he was considering changing recognition to China. However, shortly afterwards he confirmed that the government!s policy towards Taiwan would not be altered. In August the

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prime minister travelled to Taiwan on a five-day visit to confirm that ties with the island remained strong.

Constitutional reform is on the The government has confirmed that it hopes to have completed a new

agenda constitution for the country by January 2007. Consultation with provincial authorities and international experts will be carried out over the rest of 2006. Although it is unclear what changes will be made in the new draft, it seems likely that it will put increased emphasis on the role of local communities. The administration is also pushing ahead with the passage of a Political Integrity Bill. This would restrict the right of members of parliament (MPs) to change parties between elections, potentially improving the level of political stability in the Solomon Islands. Some MPs have also suggested that the state should provide financial and legal assistance to political parties. The reforms are part of the government!s policy framework document, which consists of two components. The first deals with priority issues that in addition to constitutional change include economic, fiscal and monetary measures, foreign policy, public-service reform, indigenisation and the establishment of a commission to look into the post-election riots of 2006, and the ethnic violence and lawlessness of 1998-2003. The second relates to strategic themes, such as developing the system of law and order, building an environment for economic growth, and developing accountable and transparent government.

The outer islands talk of In July 2006 community leaders in Ontong Java stated that they would present

secession a petition to the government calling for independence for the Malaita Outer Islands. Given that the islands have a population of just 3,000, and that their MP, Patrick Vahoe, is a member of the cabinet, it seems unlikely that the threat will be realised. Nevertheless, the push for secession highlights the high level of dissatisfaction with the central government in many parts of the Solomon Islands outside of the capital, Honiara. Concerns over the government!s failures at the local level also featured in a report published by Oxfam Australia, a non- government organisation, in July. This noted specific issues such as a lack of water and sanitation, poor roads and communication links, inadequately trained teachers and the lack of easily accessible and affordable medical treatment. Support for the central government is unlikely to have been boosted by a recent decision to raise MPs! salaries, in many cases roughly doubling their incomes. The opposition leader, Fred Fono, described the move, along with the acquisition of 46 new cars for ministers and senior civil servants, as an extravagance that would reduce the administration!s ability to implement its rural development strategy. However, government officials declared that Mr Fono had not raised objections to the salary rises in his position as a member of the Parliamentary Entitlements Commission that had awarded the pay increases.

RAMSI comes under pressure Oxfam has also suggested that the gulf between community expectations and politicians! ability to deliver development could be undermining public support for the Australian-led Regional Assistance Mission for the Solomon Islands (RAMSI). RAMSI has made extremely positive contributions towards restoring

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basic security in the country, but the task of rebuilding the islands! institutional capacity may prove more challenging. Oxfam!s report calls for a more consultative approach involving local communities outside Honiara. However, RAMSI is also facing pressure from the government to allow the Honiara-based parliament to have a greater say over policy, particularly regarding economic matters. Realigning relations with RAMSI, through a review of the Facilitation Act that governs RAMSI!s operations, was one of the priority issues highlighted by Mr Sogavare in his policy framework document.

Economic policy

A new investment law comes The World Bank was among those who welcomed the launch of a new Foreign

into force Investment Act that came into operation in June 2006. The Act sees the creation of a one-stop-shop system for investment approvals using an electronic register, which should reduce the processing time for new investment applications from around three months to just five days. Under the new legislation the complexity of the registration procedure should also be reduced"previously the application form for investors was 14-pages long, compared with two pages for the new form. The number of sectors closed to foreign investors has been reduced from over 80 to 13, largely in small-scale agricultural and service sectors targeting the domestic market. The government hopes that the new system will also prove more transparent. Francis Billy Hilly, the commerce minister at the time new law was launched, declared that the reform was just part of the government!s economic agenda. He noted that the administration was also working on an overhaul of the tax system, designed to simplify it, and aimed to streamline business regulations and policies in order to improve the operations of the state-owned Solomon Islands Electricity Authority (SIEA), Solomon Islands Water Authority (SIWA) and Solomon Airlines. In July the minister for planning, Gordon Darcy Lilo, added that the government would review the exclusivity and legality of the 15- year monopoly licence awarded to Solomon Telekom in 2003. He suggested that the current arrangement could breach the rules of the World Trade Organisation, of which the Solomon Islands is a member.

Land law reform is a priority As part of its rural development strategy, the government is pushing for a reform of existing land laws, so as to make customary land bankable and transferable. The prime minister, Manasseh Sogavare, regards improving access to the financial sector for indigenous residents of rural areas as a key policy goal for his government, and allowing the collateralisation of customary land would be a step towards this goal. The vast majority of land in the Solomon Islands is owned by local islanders under customary tenure. While customary land can be disposed of under the Land and Titles Act, regulations governing such land are often controversial and unclear. Previous government attempts to clarify the status of customary land, for example through registration, have been hampered by the years of ethnic conflict and the contested nature of many claims.

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A separate facet of the issues involving land that face the government is the problem of illegal land occupation. A survey by the Ministry of Lands and Survey this year found that around 17,000 of the 50,000 inhabitants of the capital, Honiara, were unauthorised residents squatting on government and customary land. The number of squatters in Honiara is said to be rising at a rate of around 26% a year. The problem has been exacerbated by the country!s population growth of 2.8% a year, the fastest rate in the Pacific region, which has increased the demand for living space. Many residents in the illegal settlements are unemployed, contributing to social and political instability.

Fiscal figures are strong, so far In August the Ministry of Finance reported that the budget for the year to June was SI$45.4m (US$6m) in surplus, well above a forecast deficit of SI$86m. Revenue inflows had exceeded budgeted rates by SI$30.2m, boosted by strong collection of fishing licence fees, increased duties on the export of logs and higher personal and company tax payments. Public expenditure was SI$101.2m below budgeted levels. However, officials cautioned that the pattern of budgeted flows and that of actual flows were likely to be different, making it hard to assess the full-year fiscal position from half-year figures.

The domestic economy

Logging output is subdued Output of logs in the first quarter of 2006 was low, with log export volumes (a proxy for the industry!s output) down by 52,000 cu meters year on year to 228,100 cu meters. Given concerns surrounding over-logging, the slowdown in the sector is not unwelcome. The governor of the Central Bank of the Solomon Islands (CBSI), Rick Hou, noted in July 2006 that at current rates of logging the country!s forests would last just six more years. This could have disastrous implications for long-term economic stability, as logging exports account for roughly two-thirds of total exports. The government is drawing up a revised Forestry Act that will aim to encourage sustainable forest management, with a focus on replanting and local processing of timber. However, fears remain that the influence of the timber lobby may stymie significant change. Output of other key products in the first three months of 2006 was also lower than in the same period of 2005. Copra production fell by 27.7% year on year to 5,065 tonnes, against a background of weak international prices for copra. Cocoa production was down by 7%, compared with the first quarter of last year at 555 tonnes, and the fish catch for January-March was 3.3% lower than in the same period of 2005, at 5,976 tonnes.

The ADB and Japan provide The Asian Development Bank (ADB) announced a US$16.2m package for the

support for infrastructure Solomon Islands in August 2006, which will help to support the rehabilitation of the country!s rural road network. Currently, the road network is under- developed, and fails to reach 77% of the population. Only around one-fifth of the country!s roads are in good repair, with the rest impassable in light vehicles. The ADB!s move followed the announcement earlier in the same month that three bridges along the eastern feeder road in Guadalcanal would be upgraded with assistance from the Japanese government. Japan has also agreed to provide aid worth SI$51m (US$6.7m) to launch the second phase of a

programme upgrading the distribution and transmission systems of the Solomon Islands Electricity Authority (SIEA). Improving rural infrastructure is a key element of the government!s campaign to re-emphasise rural development, particularly in outlying provinces.

The inflation rate stays high The three-month moving average inflation rate dropped to 9.1% in May 2006, from 9.2% in April, but nevertheless remained significantly higher than the 8.5% recorded in the last quarter of 2005. Rising costs in the capital, Honiara, notably for food, and the impact of higher global fuel prices on transportation costs have been two of the main factors driving prices higher.

Foreign trade and payments

The trade deficit remains The Solomon Islands recorded a merchandise trade deficit of SI$102.9m

substantial (US$13.5m) in the first quarter of 2006, according to the Central Bank of the Solomon Islands (CBSI), up by around 8% compared with the year-earlier period. Exports were up by 27%, reaching SI$203.2m, whereas imports rose by 20% to SI$306m. Rising global energy prices have driven up the country!s oil import bill; oil now accounts for around 30% of imports. Exports, which are dominated by timber, have grown rapidly on the back of strong demand from emerging markets such as China. The large trade deficit was partially offset by net surpluses in other parts of the current account. The services account posted a surplus of SI$7.9m in January- March 2006, the income account a surplus of SI$6.9m and the transfer account a surplus of SI$26.6m. Gross external reserves stood at SI$748.7m in May 2006 according to the CBSI, up by 15.8% year on year. In dollar terms gross external reserves stood at US$98.5m, up by 14.4% year on year.

EU funds aim to promote In May 2006 the government and the EU signed an agreement that should

development release extra money for development in the Solomon Islands. The funding will be channelled through two EU programmes, Stabex 98, which targets transport, agriculture, forestry and rural development, and Stabex 99, which deals with the education sector. As a result of the deal the amount available for spending will rise from SI$315m to SI$420m, according to Solomon Islands government sources.

The region September 2006 Summary

Outlook for 2006-07 The political situation will remain fragile in many countries in the region. Fiji!s multi-party cabinet could experience increased friction with the military, and New Caledonia!s government will have to deal with large-scale environmental protests. Tonga must manage a difficult transition to democracy, and the Solomon Islands administration will need to deal with the aftermath of years of violence. Samoa!s government must face up to some difficult social issues, whereas Vanuatu!s will struggle simply to keep functioning. Continued Chinese interest in the region suggests that it may have a new agenda. Increased inflows of aid could create problems, both in relation to more allegations of corruption and to increased internal tensions through uneven distribution of aid. Increased aid could also lead to an unfortunate loosening of already poor controls over government spending. Merchandise export growth is likely to remain disappointing this year and next, although some relief is likely to be provided through increased services receipts from tourism. Despite this, GDP growth in 2006 could be better than some governments predict.

The political scene Fiji!s multi-party cabinet has so far worked reasonably well, and some ground rules on its operation are due to be agreed on in September. The Samoan prime minister, Tuila!epa Sa!ilele Malielegaoi, has dropped law suits against opposition leaders. The Solomon Islands government survived its first major internal crisis in August, but talk of outer islands seceding has continued. In New Caledonia, protests against new mining developments have been used to vent public dissatisfaction with other issues. In Tonga, the death of a leading royal reformer is unlikely to derail the move towards democratic government, and could indeed precipitate change. In Vanuatu, the prime minister, Ham Lini, has made some bold policy statements, but continues to struggle with the day-to-day business of government.

Economic policy and the A number of policy reforms have been implemented across the region. Samoa domestic economy is to increase its rate of value-added tax, Tonga is reducing the size of its civil service, the Solomon Islands has introduced a new investment law, and New Caledonia says its will put a greater focus on inflation control. But major problems with economic policy remain, highlighted by recent disappointing merchandise trade performances, and the distinctly shaky state of public finances in many countries. Trade problems will take some time to fix. Tourism growth, thanks to budget airlines, has provided some relief. Inflation rates are currently low, but demand management remains a problem in many countries. Editors: Graham Richardson (editor); Gerard Walsh (consulting editor) Editorial closing date: August 18th 2006 All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

Outlook for 2006-07

The political situation will The political situation will remain fragile in most countries in the region. The remain fragile multi-party cabinet in Fiji has survived well so far, but could be vulnerable to renewed tensions between the government and the military. New Caledonia!s politics will be complicated not just by disputes over the future relationship with France, but also by escalating rows over the environmental impact of planned mining projects. Tonga will continue to suffer from political growing pains, as the monarchy slowly metamorphoses into democratic government. Samoa!s autocratic regime will find it difficult to deal with worsening social problems and criminality. The Solomon Islands government must deal with the aftermath of years of violence, and Vanuatu!s leaders will continue to struggle to hold together an artificially created country, beset by ethnic divides. Many of these political problems have deep roots, and can often be traced back to colonial decisions on national boundaries, or other errors. But blaming the past cannot conceal a general lack of current progress. Hopes of "good governance" seem as remote as ever for a large number of countries in the region, and although Fiji!s cabinet currently shows one way forward, most governments in the region remain beset by ethnic wrangling, and are frequently paralysed by incompetence or corruption. The regional political situation appears to be in a state of transition. Until recently, there were great hopes that increased regional political co-operation" as manifest through the Pacific Plan, approved at the October 2005 summit meeting of the Pacific Islands Forum (PIF, the main regional political body) in Papua New Guinea"could solve the region!s woes. Debate on how to implement many aspects of the Pacific Plan continues, but any mood of optimism has been replaced by cynicism, as individual countries struggle to get to grips with their own political or economic problems.

China may have a new agenda China has responded to this lack of unity by sharply increasing its presence in the region in recent months, with the visit of the its premier, Wen Jiabao, to the Pacific Islands Forum in April followed up by the visit of the Chinese foreign minister, Li Zhaoxing, to a number of regional capitals in late July and early August. China has long been interested in the region, and in recent decades this interest has been focused on ensuring that more countries do not extend diplomatic recognition to Taiwan. The recent Chinese trips have been accompanied by a number of funding initiatives, but their high-profile nature suggests that Chinese diplomacy may now be following other objectives. If China is seeking to counterbalance the role of Australia in the region, it may have picked an opportune time to do so. With its extensive foreign military commitments elsewhere, Australia may be distracted, and must anyway not relish the prospect of being sucked into another Pacific Island contretemps, as it was with the Solomon Islands. New Zealand, whose resources are even more limited, will continue to play quite a canny game, focusing on improving trade links, while still playing a supporting role to Australian security interests.

Increased aid could create Increased inflows of aid, be they from China, Australia, New Zealand, Japan or difficulties elsewhere, may cause as many problems as they solve. Most national institutions remain incapable of handling these large amounts of money, and some aid will be siphoned off, at central government, local government or contractor level. It will be interesting to see how much China gets involved with the disbursement of its aid at a local level. Accusations of corruption will continue to dog political leaders in the region, and an uneven distribution of the benefits of aid within countries could exacerbate internal tensions.

Exports will disappoint Increased aid will also only paper over economic problems, not resolve them. Although some countries may see higher GDP growth this year, as aid and a reviving tourism sector push up construction and other sectors, the underlying economic situation of most countries will remain uncertain. The essential problem for most countries will remain that while their merchandise export growth is poor, economic growth is rapidly increasing their demand for consumer and investment goods. Export problems with certain commodities (such as coconut products) this year have served only to highlight a secular trend towards increased merchandise trade deficits, something that can only be partially offset by increasing services receipts from tourism. Increased transfers (private or through aid) are needed to make up the gap, if increased borrowing or payments crises are to be avoided. These can not be guaranteed, and are likely to have strings attached"making a nonsense of Pacific Islands states! long- held wish for economic self-determination. Increased aid could also allow a further loosening of control over public finances, already poorly monitored in many countries. Public spending is likely to increase sharply in Samoa this year, and Vanuatu!s public finances are already creaky. Returning recurrent spending to more normal levels could prove difficult.

Growth could prove better Recent official growth forecasts have varied widely across the region, although

than expected most tend to be on the low side. For example, Fiji!s Reserve Bank currently forecasts GDP growth of 2.7% in 2006, and the Tongan government is predicting an expansion of just 0.9%, owing to that country!s civil-service restructuring. Growth may turn out to be better than expected, however, thanks to a sustained revival in tourism, expectations of further aid inflows, and continued (if unsustainable) consumer confidence across the region. But growth and confidence could take a tumble in 2007 if simmering problems in many countries! public finances finally come to a head.

The political scene

Post-elections stresses continue A number of countries in the region are still coming to terms with the results of elections held earlier this year. Fiji!s general election was held in May, without the predicted unrest, and the incumbent Soqosoqo Duavata ni Lewenivanua (SDL) won a narrow victory, winning 36 of the 71 seats in the House of Representatives. Fiji!s prime minister, Laisenia Qarase, then surprised many by

creating a multiracial cabinet, with nine members of the Indian-based Fijian Labour Party (FLP) being sworn into office at the end of May. This cabinet has functioned reasonably well, despite being overly large (it contains 24 full ministers and 12 junior ministers). The country!s three major political parties have pledged themselves to establish ground rules for the cabinet!s operations by September, and there have been few major rifts so far within the body (one of these, predictably, surrounded the government!s affirmative action programme for native Fijians). However, tensions lurk beneath the surface: the FJP looks unstable, with major divisions in its leadership, and the military could yet try to reassert itself, particularly if it is threatened by spending cuts. The government in Samoa has trod fairly carefully since its unexpectedly easy victory in its general election in March. The ruling Human Rights Protection Party (HRPP) co-opted a few notionally "independent" members of parliament (MPs) with indecent haste and there was criticism about other aspects of the election. But the prime minister and leader of the HRPP, Tuila!epa Sa!ilele Malielegaoi, has subsequently dropped legal suits against opposition leaders, and a more subtle approach towards dissent is likely. The Samoan government needs to focus on getting to grips with a range of social issues, including increased drug abuse and juvenile crime. Violence remains closer to the surface in the Solomon Islands: here, the result of elections in March led to violent clashes, the intervention of Australian and New Zealand security forces, and a replacement government, composed of parties in opposition to the previous government and led by Manasseh Sogovare of the Social Credit Party (Socred). This government survived its first major internal crisis in August, centred on the government!s diplomatic recognition of Taiwan, and Mr Sogavare has grand plans for constitutional change. But the outer islands are again talking of secession, and the exact role of the Australian-led intervention force is being questioned. Major political issues remain unresolved elsewhere in the region. In New Caledonia, protests against massive new mining developments have intensified, and these have been used to vent public dissatisfaction about a number of other issues (for example, the increased cost of living). France has continued to urge its overseas territory to integrate itself better with its Pacific Islands neighbours, but independence is still a long way off. In Tonga, the slow march towards democracy continues. The Princess Regent, Pilolevu Tuita, has spoken of the inevitability of political reform, and the death of a leading royal reformer, Prince Tu!ipelehake, could intensify pressures for change. The death of the elderly King Taufa!ahau Tupou IV, who is presumed to be very ill, would be a likely catalyst. The government in Vanuatu staggers on, with the prime minister, Ham Lini, forced into yet another change in policy over kava exports. Mr Lini has seen off a number of threatened no-confidence votes, and has made some increasingly bold policy statements, but fulfilling these will prove difficult.

China commits more funds As noted above, China!s foreign minister, Li Zhaoxing, visited a number of Pacific island countries at the end of July and early August. China remains keen to ratchet up the pressure on those countries that currently recognise Taiwan

(Tuvalu, Kiribati, Palau, the Solomon Islands, Nauru, Palau and the Marshall Islands) to switch allegiance, but the scale of the largesse being dished out suggests that there is another policy agenda. The visits are already having a number of perhaps unintended side-effects, notably the undermining of the status of the Pacific Islands Forum (PIF, the main political organisation in the region), which includes the Taiwan-supporters as well as the China-supporters among its membership. China!s aid contributions, although high profile, are likely to have less impact on development than those from the more established aid donors. Japan has recently decided to increase aid substantially, and Australia and New Zealand continue to work on more complex economic agreements (New Zealand recently unveiled a deal with Vanuatu, for example). The US is also emerging as an important player, with the arrival of significant Millennium Challenge Compact (MCC) funds in Vanuatu.

Economic policy and the domestic economy

Some policy reforms are The immediate policy problems for most Pacific island countries are how to implemented deal with worsening merchandise trade deficits and distinctly shaky public finances. As ever, the temptation is to ignore the complexities of fixing immediate problems and set out grand visions for future improvements. Thus, Fiji has recently announced a five-year government plan to run from 2007 until 2011, and will convene a national economic development conference in September; Vanuatu has unveiled plans for preparing the 2007 budget, and for rejuvenating its agricultural sector. But there has been progress on some issues elsewhere. Samoa is to increase the rate of its controversial value-added tax (VAT) later this year, civil-service redundancies have gone ahead in Tonga, New Caledonia is putting a greater focus on inflation control, and the Solomon Islands has implemented a new investment law.

Trade-related problems may Trade-related problems may take longer to fix, however. High international oil

take time to fix prices have jacked up import bills, and hopes of local substitutes (eg coconut biofuels) remain distant"although one benefit has been that high oil prices have helped to push up the price of palm oil. At the same time, exports of many agricultural products have faltered, either due to long-term underinvestment in agriculture, or changes in trade regimes. The most obvious being the long-running saga over the control of Vanuatu!s kava trade, but changes in EU regulations regarding Fiji!s sugar exports are likely to have a much more profound effect. It remains a concern that several years of high international commodity prices have not elicited much of a rebound in the region!s agricultural sectors, although they have led to increased mining investment, and not just in New Caledonia. One worry is that if Pacific island states become disillusioned about the benefits of international trade, they will simply decide to opt out. At the end of July, Tonga!s prime minister, Fred Sevele, reluctantly bowed to popular pressure and decided to defer his country!s accession to the World Trade Organisation (WTO). As Mr Sevele observed, the problem is that future admission to the WTO may be on much tougher terms.

The longer-term problem of climate change remains in the background. Initiatives will presumably need to be co-ordinated by the PIF, which has much broader development aims. The PIF is now gearing up to deal with its Pacific Plan, which prescribes a wide range of avenues for regional co- operation, with the aim of accelerating economic development and achieving common political objectives. The secretariat of the PIF will establish a small office of officials who will have the task of liaising with the region!s other economic development agencies for the execution of an initial 22 projects over the first three years of the plan!s ten-year time-frame. If global warming does result in significant long-term raising of water levels, many Pacific Islands will be unable to do much to prevent this: attention will then focus on how their populations can be re-housed elsewhere: Australia!s attitude towards immigration will be important here.

Tou ri sm ha s h elp ed GD P Growth in some countries may currently be quite strong, thanks to the impact growth of aid flows on public spending and the revival of tourism. This revival of tourism owes more to external factors than to government strategy: the catalyst has been the appearance of budget airlines such as Virgin Blue and Pacific Blue, which provide a cheaper and (in the short term) more dependable link than the national carriers with major tourism sources, notably Australia. The rapid increase of cheap air travel within Asia will also have spill-over benefits, as will China!s increasingly relaxed attitude towards outward tourism. Hotel construction has responded rapidly to increased inflows of tourists.

Demand management is still a Sustained GDP growth this year looks likely to be accompanied by relatively problem low rates of consumer price inflation; inflation rates in many countries in the region are currently much lower than a year ago, largely reflecting more stable prices for agricultural goods, although they could start to pick up again. But demand-management problems will persist owing to increased public spending. Fiji tightened monetary policy in May, and Reserve Bank of Fiji!s governor, Savenaca Narube, has inferred more recently that further interest rate rises are possible. The problem in Fiji, as elsewhere in the region, is that overly strong credit growth is boosting imports, while exports and imports remain depressed. As noted before, Pacific island countries may be suffering from a form of "moral hazard": they know that other countries will bail them out, if necessary. The costs to Australia of any of these countries going bankrupt"in terms of political instability, or labour migration"would be far higher than simply handing over more money to keep the economy going. This reassurance unfortunately provides a further incentive to go easy on reform to the detriment of the countries! long-term growth prospects.