Tuvalu: Improved Financial Management Program

Progress Report on Tranche Release

Program Number: 41180 Grant Number: 0139 July 2011

This consultant’s report does not necessarily reflect the views of ADB or the government concerned. [For PPTAs: Also, all of the views expressed herein may not be incorporated into the proposed project’s design.]

CURRENCY EQUIVALENTS as of 4 July 2011

Currency Unit – Australian Dollar (A$) A$1.00 = $1.0770 $1.00 = A$0.9285

ABBREVIATIONS

ADB – Asian Development Bank CSO – community service obligation DBT – Development Bank of Tuvalu MFED – Ministry of Finance and Economic Development MFEP – Ministry of Finance and Economic Planning MTFF – medium-term budget framework NBT – National Bank of Tuvalu PFM – public financial management PFTAC – Pacific Financial Technical Assistance Centre TA – technical assistance TTFAC – Tuvalu Trust Fund Advisory Committee

NOTE

In this report, "$" refers to US dollars unless otherwise stated.

Vice President B. Lohani, Vice-President-in-Charge, Operations 2 Director General R. Wihtol, Pacific Department (PARD) Director A. Ruthenberg, Pacific Subregional Office (SPSO), PARD

Team leader M. Lototele, Senior Economics Officer, PARD Team members A. Pala, Associate Project Analyst, PARD C. Png, Counsel, Office of the General Counsel E. Veve, Senior Country Specialist, PARD

In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS Page

I. INTRODUCTION 1 II. DEVELOPMENTS IN FISCAL AND FINANCIAL REFORMS 1 III. STATUS OF SECOND TRANCHE RELEASE POLICY CONDITIONS 2 A. Summary of Compliance with Policy Conditions 2 B. Progress on Second Tranche Release Conditions 2 IV. MAINTENANCE OF TRANCHE 1 CONDITIONS AND COVENANTS 8 V. CONCLUSION 8 VI. THE PRESIDENT’S DECISION 9

APPENDIXES 1. Status of Compliance with Second Tranche Release Conditions 10 2. Continued Compliance with First Tranche Conditions 13

I. INTRODUCTION

1. In 2008, the Board of Directors of the Asian Development Bank (ADB) approved a grant of $3.24 million from ADB’s special funds resources to Tuvalu for the Improved Financial Management Program, to be disbursed in two tranches of $1.24 million and $2.00 million. 1 The program aims to (i) strengthen the governance framework for the oversight of public enterprises in Tuvalu; (ii) improve (a) capacity for oversight on the part of the Government of Tuvalu, and (b) the capacity to respond positively to such oversight on the part of the public corporations; (iii) strengthen capacity to manage debt; and (iv) reduce government debt to the National Bank of Tuvalu (NBT). The grant agreement was signed on 3 February 2009 and the grant was declared effective on 14 May 2009, following an extension of the date for grant effectiveness. 2 The first tranche of $1.24 million was disbursed to the government on 8 June 2009 following satisfaction of first tranche conditions and upon grant effectiveness.

2. To support the capacity development necessary for the success of the program, standalone technical assistance (TA)—Capacity Development for Public Financial Management—was approved. 3 The TA assists capacity development through the development and implementation of high-level policy and legislation, and formal and informal training and mentoring of individuals with an emphasis on on-the-job learning.

3. This progress report provides the details of achievements that support compliance with the conditions for the release of the second and final tranche of $2.00 million.

II. DEVELOPMENTS IN FISCAL AND FINANCIAL REFORMS

4. Fiscal and financial management reforms in Tuvalu have produced mixed results. In the late 1990’s, as part of the reform process to improve public financial management (PFM), the government moved from line-item to output-based budgeting. The intent was to better link policy and expenditures, and to strengthen the performance orientation in the civil service. The government introduced the 2000 national budget as the first comprehensive output budget. However, output-based budgeting quickly returned to an iterative process with an output list being grafted onto the traditional line-item budget. 4 The move to output budgeting failed, at least in part, due to the lack of ownership by the ministries of the outputs they had been tasked to produce. For the 2004 budget, the government reintroduced line-item budgeting.

5. In 2006, ADB—together with the Government of Australia, the Pacific Islands Forum Secretariat and the Pacific Financial Technical Assistance Centre (PFTAC)—assisted Tuvalu to modernize its taxation systems and legislation. 5 The TA helped revise and implement the Tuvalu customs and income tax legislation, and put in place and implement new consumption tax legislation. The modernized customs and consumption tax legislation provided legal backing for Tuvalu to join regional and international free trade agreements. The TA also trained staff on

1 ADB. 2008. Report and Recommendation of the President on the proposed Asian Development Fund grant to Tuvalu for the Improved Financial Management Program. Manila (Grant 0139-TUV approved on 16 December 2008 for $3.24 million). 2 The date was originally 4 May 2009. 3 ADB. 2008. Technical Assistance to Tuvalu for Capacity Development for Public Financial Management. Manila (approved 3 November for $857,750, with Government of Australia cofinancing of $57,750). The TA, while related to the program, was processed separately to allow the diagnostic analysis of the capacity of the Ministry of Finance and Economic Planning (MFEP) to be undertaken promptly to provide ADB and other development partners with a better understanding of where capacity gaps are and how to better address these. 4 ADB. 2002. Tuvalu: 2002 Economic and Public Sector Review. Manila. 5 ADB. 2006. Capacity Building for Taxation Reform. Manila (TA4902-TUV approved on 18 December 2006 for $300,000).

the use of the revenue monitoring system in the Internal Revenue Department and the modified PC Trade system (software used by Customs) in the Customs Department.

6. In 2008, the Government of Australia assisted the government to implement a medium- term fiscal framework to provide forward-looking macro resource allocation. The use of the medium-term fiscal framework helped the government forecast the medium-term impacts of policy decisions on its financial position. Currently, the Government of Australia is also working with the government on medium-term expenditure frameworks for health and education.

7. ADB has built on these areas of assistance through the program and standalone TA (para. 2) to help the government improve the efficiency and effectiveness of its public enterprises and improve debt management. Under the program, policies were put in place to strengthen oversight of and management capacity in public enterprises.

8. The government’s continued commitment to strengthened PFM is shown by their support for the ongoing public expenditure and financial accountability assessment, which is scheduled to be completed in June 2011. A PFM roadmap will then be formulated that will guide the government in prioritizing future PFM development in Tuvalu for support by development partners.

III. STATUS OF SECOND TRANCHE RELEASE CONDITIONS

A. Summary of Compliance with Policy Conditions

9. The second tranche has seven conditions in three output areas: (i) improving public debt management, (ii) strengthening oversight of public enterprise, and (iii) strengthening management capacity in public enterprises. While putting in place policies to improve public debt management and strengthen oversight of public enterprises has progressed well, legislative reforms—especially on the adoption and implementation of a legal framework for the licensing, ongoing supervision and regulation of banking institutions—delayed the government’s compliance with all the second tranche release conditions. As a result, the second tranche could not be released in November 2009 as originally envisaged. The closing date was extended from 30 September 2010 to 30 June 2011. 6 The government has since provided compliance documentation for all seven second tranche release conditions (Appendix 1). Based on the documentation provided, the government has complied with six second tranche release conditions and substantially complied with one second tranche release condition.

B. Progress on Second Tranche Release Conditions

1. Output 1 : Improved Public Debt Management Capacity

10. The conditions under this output area seek to support the development and implementation of a debt risk management and mitigation policy and strategy. The intent is to support the government’s move to a more sustainable debt level and to ensure that financial risks are at prudent levels.

11. Policy Condition 2.1 (complied with). Cabinet to approve the debt risk management and mitigation policy and strategy, which shall include: (i) processes and responsibilities for the

6 The first extension was approved on 23 September 2010 for six months, a second extension for a further three months was approved on 25 March 2011, and the third extension approved on 22 June 2011 for an additional three months.

analysis and approval of the proposed new guarantees and debt; (ii) processes for prioritizing and scheduling debt repayment including debt which is currently not being repaid; and (iii) a schedule of timely and standardized reporting on government’s debt portfolio.

12. Cabinet approved the debt risk management and mitigation policy on 20 October 2009. 7 Under the new policy, the Planning and Budget Department within the Ministry of Finance and Economic Development (MFED)—formerly known as the Ministry of Finance and Economic Planning (MFEP)—is to analyze the impacts of any new guarantee or debt and report the results to the Minister of Finance. The analysis should assess the economic and social impact of such debt on job creation in the capital (Funafuti) and the outer islands, poverty alleviation in the outer islands, gender equity impacts, and impacts on health and education expenditure. The procedures for processing new debts in the debt risk management and mitigation policy are yet to be tested, as the government has not considered any new borrowing or guarantees.

13. The policy also requires the Treasury Department, together with the Planning and Budget Department, to provide quarterly reports on the debt level to Cabinet, while the Tuvalu Trust Fund Advisory Committee (TTFAC) is to report on the debt level through its annual report to Parliament. To date, there is no confirmation that the Planning and Budget Department and Treasury Department are providing quarterly reports on the debt level to cabinet as specified in the debt risk management and mitigation policy. In their report covering the first half of 2010, the TTFAC reported that total government debt was A$17.59 million. The TTFAC was also concerned that there was no central debt record kept at MFED, other than the analysis provided by the TTFAC.

14. The government, in Te Kakeega II—National Strategy for Sustainable Development, 2005–2015, 8 set a ceiling for government total debt liability, both domestic and external, of 60% of GDP.9 By the end of 2010, total government gross external debt was estimated to be about 39% of GDP. Further, the domestic debt had a negative impact on the performance of the NBT, which is the only domestic source of government debt financing, but which has not been earning a commercial return from this lending. The 2010 debt sustainability analysis carried out by the World Bank and the International Monetary Fund confirmed that Tuvalu is at high risk of debt distress. 10 Reducing the overall level of debt is a national priority.

15. Condition 2.2 (complied with). Part of the outer islands agency suspense account overdraft is repaid using counterpart funds generated from the proceeds of the first tranche ($1.24 million).

16. The Government of Tuvalu paid the National Bank of Tuvalu A$1,489,736 on 12 June 2009 as a partial repayment of the outer islands agency suspense account overdraft using the entire proceeds from the first tranche. The remaining value of this overdraft is A$2,053,000 as of December 2010.

7 Prior to this, the government lacked a consistent and coordinated debt risk management and mitigation policy. The risks associated with the lack of such a policy became apparent when the government agreed to guarantee Air Fiji debts in 2003 without carrying out due diligence on the debts. This resulted in government having to pay A$2.1 million to settle Air Fiji’s debts in 2009. 8This consultant’s report does not necessarily reflect the views of ADB or the government concerned. [For Government of Tuvalu. 2005. Te kakeega II—National Strategy for Sustainable Development 2005–2015. Funafuti. 9PPTAs: As part Also, of its all commitment of the views to fiscalexpressed restraint, herein the government may not be adopted incorporated a set of into five theperformance proposed benchmark project’s design.]indicators that were jointly developed by the government, ADB, Australian Agency for International Development and the New Zealand aid program. One of these relates to debt levels and restates the government’s commitment to not breaching the 60% of GDP ceiling. 10 IMF/World Bank. 2011. Joint IMF/World Bank Debt Sustainability Analysis: Tuvalu. Washington.

2. Output 2 : Strengthened oversight of public enterprises

17. This set of conditions seeks to support the development and implementation of the public enterprise governance reform policy and the Public Enterprise Act. The intent is to help strengthen oversight of public enterprises, raising efficiency and effectiveness.

18. Condition 2.3 (complied with). Cabinet to approve the public enterprise governance reform strategic policy which shall include (i) service delivery priorities and requirements; (ii) identification of strategic assets and position on ownership of each enterprise; (iii) a process for review of the social and sustainability implications of changes in ownership of government assets; and (iv) identification of small government business-like activities for possible transfer to the private sector.

19. Cabinet approved the public enterprise governance reform strategic policy in October 2009. This was an important step as it clarifies (i) what the government needs to own and the logic for this, (ii) how the government can improve the performance of the public enterprises it wishes to own, and (iii) options and priorities for divestment or private sector participation. The public enterprise governance reform strategic policy clearly stated that public enterprises must be strengthened and run as commercial businesses.

20. The government determined it should continue to own three public enterprises because of their strategic significance and social importance—the Tuvalu Electricity Corporation, the Tuvalu Media Corporation and the Tuvalu Maritime Training Institute. While the Tuvalu Electricity Corporation is a monopoly power supplier, Tuvalu is considered unable to support more than one power supplier due to economies of scale. The Tuvalu Media Corporation has been decorporatized and is a department under the office of the Prime Minister. The seafaring industry is an important source of remittances to the Tuvalu economy. To maintain the international standing of Tuvaluan seafarers, the Tuvalu Maritime Training Institute must remain on the International Maritime Organization’s “white list”. Maintaining the standards of the Tuvalu Maritime Training Institute with respect to training and infrastructure has required ongoing government investment.

21. In adopting this policy, the government stated their support for private sector participation in the Tuvalu Telecom Corporation (infrastructure only), Vaiaku Lagi Hotel, NBT, the Development Bank of Tuvalu (DBT) and the Philatelic Bureau. The policy also identified embedded businesses that could be considered for private sector participation, including stevedoring, the government internet service provider, the post office, travel agent and some public works activities (e.g., housing maintenance, furniture manufacture, mechanical workshop, and joinery and plumbing works). The policy directed scoping studies be undertaken on identified public enterprises and embedded businesses to determine the potential for private sector participation and any social and economic implications.

22. To date, the government has undertaken the recommended scoping studies on the potential for private sector participation in three public enterprises: (i) a merged bank comprising NBT and DBT; (ii) the Philatelic Bureau, after merging with the post office and the travel office; and (iii) the Vaiaku Lagi Hotel. Scoping studies were also undertaken on some of the embedded businesses in the Public Works Department to identify potential candidates for private sector participation. The analyses have been conducted and are being considered by the government.

23. Condition 2.4 (substantially complied with). Cabinet to submit to Parliament a draft public corporations act, which shall include (i) roles of the board of directors and management of a public corporation, and procedures and criteria for their appointment and dismissal; (ii)

requirements for periodic disclosure of information and filing of audited accounts; (iii) a procedure for decorporatization; (iv) the roles of relevant ministers and auditor general; and (v) a provision for the introduction of performance contracts for management.

24. The Public Enterprise (Performance and Accountability) Act 2009, which was enacted by Parliament on 28 May 2010 and entered into force on 1 December 2010, specifies both the requirements of and government responsibilities in relation to public enterprises. Prior to enactment of the Public Enterprise Act, each public enterprise was governed by its own individual act of incorporation. The Public Enterprise Act requires that a Public Enterprise Reform and Monitoring Unit be created to (i) monitor the performance of all public enterprises on behalf of the shareholding ministers, and (ii) advise these ministers with respect to the government’s investment in public enterprises. This provides for a coordinated approach to monitoring public enterprise performance. The act also specifies the procedures for selecting and dismissing directors from boards.

25. The overall aim of the Public Enterprise Act is to ensure that all public enterprises conduct their operations in as close to a commercial manner as possible, thereby reducing the government’s ability to influence business decisions. The act removes government representatives from boards and seeks to reduce expectations of government financial support. Public enterprises are required to register as limited liability companies under the Companies Act 1991, reflecting the expectations in terms of commercial operations. This provides further clarity in processes for decorporatizing public enterprises, bringing public enterprises under the scope of the Tuvalu Companies (Winding Up) Act 2008, revised edition.

26. Under the Public Enterprise Act, the auditor general, at the request of the shareholding minister or the secretary of finance, can carry out a performance audit on any public enterprise. In carrying out this task, the auditor general has been empowered to enter the premises and take copies of required documents. For transparency purpose, the act also requires public enterprises to submit annual corporate plans, and financial statements and accounts. MFED has also linked the payment of community service obligations (CSOs) to the submission of these reports.

27. Clear steps have been taken to put the act into effect. The Public Enterprise Reform and Monitoring Unit was established within MFED in October 2009 and staff trained on their expected roles under the act. Since December 2010, all of the government’s representatives on public enterprise boards have resigned and selection of new boards of directors has begun. Various steering committees have been formed to identify potential board directors from those who have applied. It is expected that new directors will be in place around mid-2011. To build capacity, training has been conducted with potential candidates on the role and expectation of directors under the act and in understanding financial reports. One of the achievements of this act is the legislating of CSOs. For the first time in 2011, CSOs for qualified public enterprises are reflected in the national budget. An allocation of A$277,200 has been included in the approved 2011 national budget to pay for CSOs.

28. Subcondition (v) required that the act include a provision for the introduction of performance contracts for the management of public enterprises. Performance contracts were intended to be used as a tool to motivate and reward management for achievement of agreed This consultant’s report does not necessarily reflect the views of ADB or the government concerned. [For performancePPTAs: Also, alltargets. of the Howeverviews expressed such aherein provision may notwas be notincorporated included into in thethe proposedact, due project’s to the gdesign.]overnment ’s concerns about the resultant cost to the government as owner of the public enterprises, and public enterprise management concerns that they may not be fairly compensated under such contracts. Corporate planning was used as an alternative mechanism

6 to achieve the same outcome. The Public Enterprise Act makes each public enterprise board responsible for the submission of an annual corporate plan within a stated time frame to the secretary of finance; Cabinet is the final arbiter of the approval of the corporate plan, and has the ability to remove one or more directors if they fail to submit a plan. The act also states that the corporate plan must be complied with, and directors can be dismissed by the Cabinet if the plan is not complied with. Direct responsibility is thereby placed on each board to ensure public enterprise management meets the performance targets set out in the relevant corporate plan, which is a stronger governance mechanism than the use of management performance contracts.

29. Based on the above, government is judged to have substantially complied with this condition.

3. Output 3 : Strengthened management capacity in public enterprises

30. This set of conditions seek to support the development and implementation of (i) NBT’s debt collection and liquidity policy; and (ii) a legal framework for the licensing, on-going supervision and regulation of banking institutions.

31. Condition 2.5 (complied with). The National Bank of Tuvalu (NBT) to have adopted written and board-approved policies, as proposed in the PFTAC report of July 2008, for (i) the timely collection of past due loans and advances of credit; and (ii) measuring, monitoring and maintaining adequate liquidity.

32. The NBT board of directors approved an asset and liability management (liquidity) policy and a loan grading policy on 15 December 2010; both policies are in line with PFTAC’s report of July 2008. The government and NBT worked closely with PFTAC (which is the competent authority in this area) to develop liquidity and loan grading policies.

33. The new loan grading policy now reflects international best practices allowing for the timely collection of past due loans. Instead of waiting for 180 days to react to poorly performing loans, the new policy allows management to identify such loans in as little as 30 days. The new policy also ensures that NBT has adequate provision for non-performing loans so as to better reflect non-performing loans, earnings and capital. Government loans will now be subject to the new collection procedures. Furthermore, the 2009 Public Enterprise (Performance and Accountability) Act required that all government suspense accounts be converted to term loans by NBT and interest charged appropriately. The NBT will replace their current outdated computerized lending system so as to conform with the new loan grading policy.

34. The asset and liability management policy sets out the procedures for determining NBT’s liquidity position to ensure that it can meet its client demands, both on Funafuti and the outer islands. Prior to this, NBT did not have a liquidity policy. While it has maintained adequate liquidity to date, a written policy better guides the identification, management and maintenance of adequate liquidity. An asset and liability management committee was formed in early 2011 to manage the bank’s assets and liabilities. 11 Under the policy, the asset and liability management committee is required to meet at least monthly.

11 The asset and liability management committee is made up of the general manager, manager of finance and international business, manager of lending, and chief operations supervisor.

35. Condition 2.6 (complied). The Parliament to adopt a legal framework for the licensing and on-going supervision and regulation of banking institutions, which shall provide for implementation and adherence to the Basel core principles for effective banking supervision.

36. Tuvalu has two banks (NBT and DBT), but had no legal framework to guide issuing of banking licenses, and supervision and regulation of banking institutions in Tuvalu. Such a legal framework provides assurance to potential investors that requirements and standards are uniformly applied and adhered to by all banks.

37. The use of the Basel core principles as the benchmark for this legal framework presented a challenge in ensuring an arrangement practical for a small administration. ADB and the government worked closely with PFTAC on this policy condition. In August 2010, Parliament adopted the Banking Act 2010, but PFTAC identified issues in the act that needed to be amended in order to comply fully with the Basel principles. Instead of tabling the amendments, government repealed the Banking Act 2010 and retabled it at the April 2011 parliamentary session as the Banking Commission Bill, incorporating the amendments recommended by PFTAC.

38. Parliament approved the Banking Commission Act 2011 during the April 2011 session. This was judged by PFTAC to be in line with Basel principles. In addition, in a letter signed by the minister of Finance and Economic Development on 8 February 2011, the government assured ADB of their commitment to (i) fill the position of the banking supervisor three months after the commencement of the act, and (ii) put in place an independent supervisory board. To ensure the independence of the banking supervisor (which is difficult to ensure in small countries such as Tuvalu, where everyone is related in some way), the government will seek advice from an independent expert on the shortlist of candidates. These commitments go beyond the requirement of this condition and demonstrate a clear intent to implement the act.

39. Condition 2.7 (complied). MFEP to prepare a detailed report on private sector potential, which shall reflect the results of community consultation. The report shall cover: (i) private sector capacity to undertake small-scale management contracts; (ii) additional upstream and downstream business potential as a result of management contracts, as well as untapped business potential from existing business; (iii) identification of new business niches; (iv) assessment of business support requirement including business and accounting services, and (v) assessment of outer islands business opportunities.

40. The private sector in Tuvalu is very small. Formal businesses account for about 15% of market production, while the total private sector is estimated to account for 30% of GDP, once informal and subsistence activities are included. 12 There are around 97 private businesses registered with the Tuvalu National Provident Fund.

41. The government, supported by ADB, carried out the required analysis in October 2009. The analysis focused on: (i) private sector capacity to undertake small-scale management contracts; (ii) additional upstream and downstream business potential as a result of management contracts, as well as untapped business potential from existing business; (iii) identification of potential new business niches; and (iv) assessment of outer islands business opportunities.This consultant’s report does not necessarily reflect the views of ADB or the government concerned. [For PPTAs: Also, all of the views expressed herein may not be incorporated into the proposed project’s design.]

12 ADB. 2007. Tuvalu 2006 Economic Report. From Plan to Action. Manila.

42. The government consulted the different communities on Funafuti, including members of the two major private sector associations—the Tuvalu Chamber of Commerce and the Private Sector Organization of Tuvalu (all private sector businesses are affiliated with at least one of these organizations)—in finalizing the report. The government approved the report on 8 February 2011.

43. The assessment concluded that:

(i) giving management contracts to the private sector without complementary policies to strengthen the private sector is likely to result in outcomes that are below expectations. Carefully designed policies can be adopted that will produce the desired outcomes over time. One option is to contract out embedded government businesses to the staff members that presently operate these businesses.

(ii) Additional upstream and downstream business potential and new business niches have been identified, but these are not easily transformed into actual operations and may not be financially viable because of the economy’s small size.

(iii) The opportunities for private sector operations in the outer islands are very limited. Outer island businesses continue to raise the issue of the high cost of transportation of goods from the capital to the outer islands with the government. The lack of available credit is also problematic. The Falekaupule business development credit scheme, established in 1997, has evolved into community loan schemes with unsustainably low repayment rates, while women’s credit schemes are reported to have run short of funding.

44. The study noted that staff who have specialist skills (e.g., accounting) and are currently employed by the government can be provided with incentives to take part in the privatization of government businesses. This will contribute to the reduction of the government’s wages and salaries. It will provide the new entities with experienced staff who, with the appropriate incentive structure, should respond positively to working under a framework based on private sector financial disciplines.

IV. MAINTENANCE OF TRANCHE 1 CONDITIONS AND COVENANTS

45. The first tranche release conditions comprised five policy actions in all areas of the program. Policy action 1.1—Parliament to pass taxation reform legislation (an income tax act amendment, a customs act amendment, and a consumption tax bill)—was maintained with all legislation remaining in force. The remaining four policy actions in tranche 1 are built upon and reinforced by related policy actions in tranche 2. In these cases achievement of tranche 2 actions demonstrates maintenance of tranche 1 policy actions (see Appendix 2).

V. CONCLUSION

46. It has been a challenge for Tuvalu to put in place the policy conditions required for the release of the second tranche. The changing of permanent secretaries in MFED, and the September 2010 election and subsequent changes in the government also presented challenges to program continuity. Some of the conditions—such as the requirement to have in place a legal framework for the supervision and monitoring of banking activities that is compatible with the Basel Principles of Banking and Supervision, or the use of performance contracts for managers of public enterprises—proved challenging, and may be too ambitious for a small administration such as Tuvalu’s. Nonetheless, the government has demonstrated its

commitment to the program by implementing the policy actions set out in the program, and in some cases finding strong alternative arrangements or committing to undertake actions beyond the second tranche release requirements.

VI. THE PRESIDENT’S DECISION

47. In view of the progress made in the implementation of the Improved Financial Management Program, as evidenced by the compliance with six second tranche release conditions and substantial compliance with one second tranche release condition, the President is satisfied with the overall implementation of the Improved Financial Management Program, and that the necessary conditions for the release of the second tranche of the Improved Financial Management Program have now been fulfilled. In accordance with the established procedure, the President will authorize the release of the second tranche in the amount of $2,000,000. The authorization shall be effective not less than 10 working days after the date of circulation of this progress report to ADB’s Board of Directors.

Haruhiko Kuroda President

15 July 2011

Appendix 1 STATUS OF COMPLIANCE WITH SECOND TRANCHE RELEASE CONDITIONS

Progress and submitted material Output Second tranche action evidence Output 1: Improved Public Debt 2.1 Cabinet to approve the Debt Risk Management And Complied with. Management Capacity Mitigation Policy and Strategy, which shall include: (i) processes and responsibilities for the analysis and (i) Tuvalu Debt Risk Management and approval of proposed new guarantees and debt; Mitigation Policy, dated March 2010. (ii) processes for prioritizing and scheduling debt repayment including debt which is currently not being repaid; and (ii) Cabinet minutes dated 20 October 2009 (iii) a schedule of timely and standardized reporting on to verify endorsement of the Tuvalu Debt Government’s debt portfolio. Risk and Mitigation Policy.

The original debt policy only made reference to the Tuvalu Public Finance Ordinance. The policy was later revised with the Tuvalu Public Finance Ordinance as Appendix 1. The minister of finance in his letter dated 21 June 2011 confirmed that the March 2010 version of the debt policy is the final version.

2.2 Part of the outer islands agency suspense account Complied with. overdraft is repaid using the counterpart funds generated from the proceeds of the first tranche ($1.24 million). (i) National Bank of Tuvalu’s letter dated 28 September 2009 confirming the transfer of A$1,489,736 on 12 June 2009 to the government outer island (Vaitupu) account.

Output 2: Strengthened 2.3 Cabinet to approve the Public Enterprise Governance Complied with. Oversight of Public Enterprises Reform Strategic Policy, which shall include: (i) service delivery priorities and requirements; (i) Tuvalu Public Enterprise Policy, dated (ii) identification of strategic assets and position on ownership October 2009. of each enterprise; (iii) a process for review of the social and sustainability (ii) Cabinet minutes dated 20 October 2009 implications of changes in ownership of government assets; to verify endorsement of the public and enterprise policy. (iv) identification of small government business-like activities for possible transfer to the private sector.

Progress and submitted material Output Second tranche action evidence 2.4 Cabinet to submit to Parliament a draft Public Substantially complied with. Corporations Act, which shall include (i) roles of the board of directors and management of a public (i) Public Enterprise (Performance and corporation, and procedures and criteria for their appointment Accountability) Act passed on 28 May 2010 and dismissal; with letter from the clerk to Parliament dated (ii) requirements for periodic disclosure of information and 7 April 2010 to confirm that Parliament has filing of audited accounts; approved the act. (iii) a procedure for decorporatization; (iv) the roles of relevant ministers and the auditor general; and (v) a provision for the introduction of performance contracts for management.

Output 3: Strengthened 2.5 The National Bank of Tuvalu to have adopted written and Complied with. Management Capacity in Public board-approved policies, as proposed in PFTAC report of July Enterprises 2008, for (i) National Bank of Tuvalu’s Asset and (i) the timely collection of past due loans and advances of Liability Management Policy, June 2010. credit; and (ii) measuring, monitoring and maintaining adequate liquidity. (ii) National Bank of Tuvalu Loan Grading, Provisioning and Non Accrual of Interest Policy, June 2010.

(iii) Special board meeting minutes, 15 December 2010, approving NBT’s Asset and Liability Management Policy and Loan Grading, Provisioning & Non Accrual of Interest Policy

2.6 The Parliament to adopt a legal framework for the Complied with. licensing and on-going supervision and regulation of banking institutions, which shall provide for implementation and (i) Banking Commission Act 2011 (which adherence to the Basel core principles for effective banking repealed the Banking Act 2010) passed by supervision. Parliament in April 2011.

This consultant’s report does not necessarily reflect the views of ADB or the government concerned. [For Appendix PPTAs: Also, all of the views expressed herein may not be incorporated into the proposed project’s(ii) Commitment Letter from Government of design.] Tuvalu, signed by Hon. Lotoala Metia,

minister of finance and economic 1

development on 8 February 2011.

(iii) Correspondence from Mr. Matt Davies, 11

Progress and submitted material Output Second tranche action Appendix 1 evidence coordinator, Pacific Financial Technical Assistance Centre, dated 17 June 2011

confirming the act passed in 2011 was compliant with the Basel requirements.

2.7 MFEP to prepare a detailed report on private sector Complied with. potential, which shall reflect the results of community consultation. The report shall cover: (i) Letter of approval from Government of (i) private sector capacity to undertake small-scale Tuvalu signed by Hon. Lotoala Metia, management contracts; minister of Finance and Economic (ii) additional upstream and downstream business potential as Development on 8 February 2011. a result of management contracts, as well as untapped business potential from existing businesses, (ii) Analysis of Private Sector Growth (iii) identification of new business niches; Potential in Tuvalu, dated November 2010. (iv) assessment of business support requirements including business and accounting services; and (v) assessment of outer islands business opportunities.

ADB = Asian Development Bank, MFED = Ministry of Finance and Economic Development, MFEP=Ministry of Finance and Economic Planning (former name of MFED), NBT = National Bank of Tuvalu, PFTAC = Pacific Financial and Technical Advisory Centre, TTFAC = Tuvalu Trust Fund Advisory Committee. Source: Asian Development Bank.

Appendix 2 13 CONTINUED COMPLIANCE WITH FIRST TRANCHE CONDITIONS Appendix 1 Tranche1 condition Status 1.1 Parliament to pass taxation reform legislation (an Parliament enacted the Income Tax Act income tax act amendment, a customs act amendment and the Tuvalu Consumption

amendment, and a consumption tax bill) Tax Act on 24 November 2008 and the Customs Act amendment on 2 December 2008. These acts came into force on 1 July 2009 and remain in place. 1.2 Cabinet to approve the development of a Debt Risk Continue compliance confirmed by Management and Mitigation Policy and Strategy, completion of tranche 2 action 2.1. (paras. which shall include: 11–14) (i) the processes and responsibilities for the analysis and approval of proposed new guarantees and debt; (ii) processes for prioritizing and scheduling debt repayment including debt which is currently not being repaid; and (iii) a schedule of timely and standardized reporting on Government’s debt portfolio.

1.3 Cabinet to approve the preparation of a public Continue compliance confirmed by enterprise governance reform strategic policy, which completion of tranche 2 action 2.3. (paras. shall include 18- 22) (i) Government’s service delivery priorities and requirements; (ii) identification of strategic assets and position on ownership of each enterprise; (iii) a process for review of the social and sustainability implications of changes in ownership of government assets; and (iv) identification of small government business- like activities for possible transfer to the private sector.

1.4 Cabinet to approve the preparation of a public Continue compliance confirmed by corporations act, which shall include completion of tranche 2 action 2.4. (paras. (i) the roles of the board of directors and 23–29) management of a public corporation, and procedures and criteria for their appointment and dismissal; (ii) the requirement for periodic disclosure of information and filing of audited accounts; (iii) a procedure for decorporatization; (iv) the roles of the relevant ministers and the auditor general; and (v) a provision for the introduction of performance contracts for management.

1.5 MFEP to undertake a short assessment of private Assessment completed under tranche 1 sector business potential based on the analysis of and built upon by action 2.7 (paras. 39–44). sector lending and loan repayments trends, collation of informal information through sources such as the chamber of commerce, as well as identification of successful small businesses and a brief analysis of why they are successful. MFEP=Ministry of Finance and Economic Planning now known as Ministry of Finance and Economic Development (MFED) Source: Asian Development Bank