SOLOMON ISLANDS PUBLIC EXPENDITURE REVIEW FISCAL REFORM AND THE PATH TO DEBT SUSTAINABILITY OCTOBER 2022 STANDARD DISCLAIMER: ACKNOWLEDGEMENT: This volume is a product of the staff of the International The team would like to acknowledge and thank all Bank for Reconstruction and Development / The World those who provided input to this analysis. The lead Bank. The findings, interpretations, and conclusions authors are Lodewijk Smets, Lachlan McDonald, expressed in this paper do not necessarily reflect the Ildrim Valley, Rashad Hasanov, Grzegorz Poniatowski, views of the Executive Directors of The World Bank or Wilfred Lus, Wayne Irava, Michael Mike, Jimmy Kaluae, the governments they represent. The World Bank does Juliana Weingaertner, Jeremie Amoroso, and Roberta not guarantee the accuracy of the data included in this Bassett. Virginia Horscroft, Shohei Nakamura, Yuto work. The boundaries, colors, denominations, and other Kanematsu, Heather Ruberl, Massimo Mastruzzi, and information shown on any map in this work do not imply Fabian Seiderer provided valuable analytical support any judgment on the part of The World Bank concerning and feedback. The team is grateful to the government the legal status of any territory or the endorsement or for their cooperation in providing data and feedback acceptance of such boundaries. and to key development partners in Solomon Islands for their support. Specific thanks goes out to Coswal Nelson (MoFT) who acted as the PER focal point. COPYRIGHT STATEMENT: The team would also like to thank Hassan Zaman, The material in this publication is copyrighted. Lars Moller, Steve Ndegwa, Paul Vallely, David Gould, Copying and/or transmitting portions or all of this and Annette Leith for providing overall guidance as work without permission may be a violation well as the peer reviewers for useful feedback and of applicable law. The International Bank for suggestions. Angela Takats edited the report and Reconstruction and Development/The World Bank Heidi Romano provided graphic design services. encourages dissemination of its work and will normally grant permission to reproduce portions of the work promptly. For permission to photocopy or reprint any Cover photo: Selling food on the water part of this work, please send a request with complete © Neil Nuia/World Bank information to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, USA, telephone 978-750-8400, fax 978-750-4470, www.copyright.com. All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA, fax 202-522-2422, e-mail: pubrights@worldbank.org. 2 LIST OF FIGURES 5 LIST OF TABLES 8 LIST OF BOXES 9 LIST OF ABBREVIATIONS 10 1 EXECUTIVE SUMMARY 12 2 SOLOMON ISLANDS MACRO-FISCAL CONTEXT: A LOOK IN THE REARVIEW MIRROR 18 2.1 Country context 19 2.2 Fiscal trends 25 3 THE NARROW PATH TOWARDS FISCAL SUSTAINABILITY 32 3.1 Macro-fiscal outlook 33 3.2 Fiscal buffers 38 3.3 Fiscal space for resilient development 44 4 GETTING REVENUE REFORMS ON THE ROAD 46 4.1 Introduction 47 4.2 Rationale for tax system reform 48 4.3 The introduction of VAT 50 4.4 Tax administration reforms 58 4.5 Tax revenue from the extractive industry 62 5 MAPPING OUT THE SOLOMON ISLANDS WAGE BILL 68 5.1 Introduction 69 5.2 International benchmarking 71 5.3 Spending trends 73 5.4 Pay analysis 74 5.5 Staffing analysis 77 5.6 Budget planning, control, and credibility 79 5.7 Policy implications 80 3 6 PAVING THE WAY FOR MORE EFFICIENT SPENDING IN HEALTH AND EDUCATION 82 6.1 The health sector 83 6.2 The education sector 95 7 A HIGHWAY TO SUCCESS? ANALYZING SELECTED ISSUES IN PUBLIC INVESTMENT MANAGEMENT 102 7.1 Introduction 103 7.2 Allocative efficiency 105 7.3 Productive efficiency 119 7.4 Policy implications 134 REFERENCES 140 ANNEXES 146 Annex 1: Benchmarking Solomon Islands against its peers 147 Annex 2: Solomon Islands Macro-Fiscal Model 149 Annex 3: VAT and Tax Administration reform – Technical background 151 Decomposition of tax revenue components 151 VAT revenue estimation 151 Microsimulation of distributional impacts of VAT introduction 152 Assumptions for increasing collection efficiency 153 Annex 4: Base salary and allowance schedule Magistrature (2021) 154 Annex 5: Historical macro-fiscal indicators 155 Annex 6: Macro-fiscal framework reform scenario 156 Annex 7: Scenarios for scholarship reform 157 4 LIST OF FIGURES Figure 1: GDP per capita 2020, PPP 20 Figure 2: Human Capital Index (HCI) 20 Figure 3: CPIA public sector management and institutions cluster 20 Figure 4: Solomon Islands sectoral contribution to real GDP 22 Figure 5: Fiscal balance 22 Figure 6: Public debt 22 Figure 7: Public debt composition 22 Figure 8: General government expenditure Solomon Islands 24 Figure 9: General government expenditure (GGE) 2020 24 Figure 10: Public expenditure 24 Figure 11: Budget support expenditure 24 Figure 12: Public expenditure by function 27 Figure 13: Recurrent expenditure 27 Figure 14: General government revenue 28 Figure 15: General government revenue and grants 28 Figure 16: Tax revenue 28 Figure 17: Composition of tax revenue 28 Figure 18: Logging revenue 31 Figure 19: The evolution of public debt under the baseline scenario 35 Figure 20: The evolution of public debt under the reform scenario 38 Figure 21: Reliance on natural resource rents 39 Figure 22: Natural disasters in Pacific Islands (1980–2020) 40 Figure 23: Broad cash balance at year-end (2015–2021) 41 Figure 24: Debt sustainability with restored cash buffers 44 Figure 25: Debt sustainability in the baseline and reform scenario 45 5 Figure 26: Tax Revenue (2019–2020) 48 Figure 27: Taxes on goods and services (2019–2020) 48 Figure 28: Productivity of taxes on goods and services vs. the prevailing rate 49 Figure 29: Household consumption structure in Solomon Islands 55 Figure 30: VAT productivity after implementation in selected countries 55 Figure 31: VAT productivity after implementation in four selected countries, average 55 Figure 32: Impact of introducing an exemption on basic foodstuffs and agricultural goods on real income 56 Figure 33: Revenue growth with and without VAT adoption 57 Figure 34: Revenue growth with and without increased collection efficiency 61 Figure 35: Gross values add of mining and quarrying (2008–2020) 62 Figure 36: Staff by Sector (2017) 70 Figure 37: Wage bill worldwide 70 Figure 38: Wage bill 70 Figure 39: Wage bill in structural peers (2019) 70 Figure 40: Wage bill in small Pacific Island States (2019) 72 Figure 41: Evolution of wage bill 72 Figure 42: Evolution of the nominal wage bill by function 72 Figure 43: Distrbution of staff 75 Figure 44: Evolution of the wage bill by component 75 Figure 45: Allowances by type (2020) 76 Figure 46: Distribution of civil service staff by region and sector (2017) 78 Figure 47: Distribution of vacancies by grade (2022) 78 Figure 48: Budget variance of the wage bill 80 Figure 49: Life expectancy vs. per capita health spending 88 Figure 50: Health financing flows in Solomon Islands 90 Figure 51: Health sector budget 90 Figure 52: Budget execution rates by Ledger (2012–2020) 92 6 Figure 53: Utilities budget and expenditure 2016–2020 93 Figure 54: Source of financing for the Solomon Islands immunization program 94 Figure 55: Number of scholarships awarded (2011–2019) 99 Figure 56: SIG-funded scholarship spending 100 Figure 57: Share of non-payroll recurrent expenditure in the education sector (MEHRD) 100 Figure 58: Access to internet 104 Figure 59: Efficiency of capital spending 104 Figure 60: Public capital expenditure in Solomon Islands 104 Figure 61: Public capital expenditure (Percent of total budget) 106 Figure 62: Public capital expenditure (Percent of GP) 106 Figure 63: Share of total public capital expenditure, largest ministerial allocations 106 Figure 64: Executed public capital expenditure 107 Figure 65: Solomon Islands central government capital budget taxonomy 109 Figure 66: Executed public capital spending 110 Figure 67: 2021 Development Budget 110 Figure 68: Capital and non-capital expenditure 111 Figure 69: Fragmentation of capital expenditure 112 Figure 70: Capital expenditure share of development budget 112 Figure 71: Donor commitments (By sector) 112 Figure 72: Donor commitments (By donor) 112 Figure 73: Funding sources for pipeline projects 114 Figure 74: Public Investment pipeline 115 Figure 75: CDF budget allocations to MPs 116 Figure 76: CDF spending (By type, 2015) 117 Figure 77: A framework for reviewing public investment efficiency 120 Figure 78: PIM diagnostic findings 120 Figure 79: Execution rates (2013–2020) 125 Figure 80: SIG capital execution 125 7 Figure 81: Execution rate scenarios 129 Figure 82: Maintenance spending 131 Figure 83: Maintenance spending (2013–2020) 131 Figure 84: Share of total maintenance 131 Figure 85: Maintenance as percent of capital expenditure 132 Figure 86: Gap between maintenance needs and spending 133 LIST OF TABLES Table 1: Summary of recommendations 17 Table 2: Baseline macro-fiscal indicators 34 Table 3: Fiscal impact of revenue and expenditure measures in reform scenario 37 Table 4: National disaster funds in PICs 43 Table 5: Guide for response to shocks 43 Table 6: VAT systems in selected peer countries 51 Table 7: Scenarios for VAT 53 Table 8: Estimated revenue for alternative tax systems 54 Table 9: Percent of all essential medicines in stock at primary health care facilities 84 Table 10: Proportion of health facilities closed due to understaffing or maintenance 84 Table 11: Medical facilities and medical personnel per capita for provinces (2020) 86 Table 12: Health indicators and the COVID-19 pandemic 86 Table 13: UHC SCI index for selected Pacific countries and structural peers 88 Table 14: Current Health Expenditure (CHE) 91 Table 15: Immunization rates for selected vaccination programs 94 Table 16: Student enrollment data (By sector) 96 8 Table 17: Tertiary enrollment data for Solomon Islands and its structural and aspirational peers 98 Table 18: Per-student expenditure by sector (2018 and 2019) 100 Table 19: Planned infrastructure 114 Table 20: Policy options 135 LIST OF BOXES Box 1: The structure of the SIG budget and data sources used in the PER 26 Box 2: Cyclical and structural components of the fiscal balance 30 Box 3: Redistribution role and efficiency of VAT 53 Box 4: Measures aimed at increasing tax collection efficiency in best performing peer countries 61 Box 5: Governance challenges for the mining sector in Solomon Islands 63 Box 6: Constituency Development Funds – A primer 116 Box 7: Capital expenditure by provincial governments 118 Box 8: The use of multi-criteria analysis in project selection in the SINIIP 123 Box 9: The PIM implications of hosting the 2023 Pacific Games 126 Box 10: Project appraisal thresholds in Ireland 139 9 LIST OF ABBREVIATIONS ADB Asian Development Bank GDP Gross Domestic Product APT Additional Profits Tax GFCF Gross Fixed Capital Formation BETA Budget Expenditure GGE General Government Expenditure Tracking Analysis GVA Gross Value Added CAT-DDO Catastrophe Deferred Drawdown Option HCI Human Capital Index CDF Constituency Development Funds HDI Human Development Index CDP Constituency Development Plan HFPS High-Frequency Phone Survey CI Composite Indicator HIES Household Income and Expenditure Survey CIT Corporate Income Tax HPV Human Papillomavirus CHE Current Health Expenditure HSS Health System Strengthening CPIA Country Policy and Institutional Assessment ICT Information Communication Technology DMF Debt Management Framework IDMC Internal Displacement DP Development Partner Monitoring Centre DSA Debt Sustainability Analysis IFMIS Integrated Financial Management Information System ECE Early Childhood Education IMF International Monetary Fund EEVI Economic and Environmental Vulnerability Index IPC Infection Prevention Control EITI Extractive Industries IRD Inland Revenue Division Transparency Initiative ITA Income Tax Act EPI Expanded Program on Immunization LDC Least Developed Country ESF Education Strategic Framework LTO Large Taxpayers Office ESP Economic Stimulus Program LMIC Low Middle-Income Countries FMIS Financial Management MCA multi-criteria analysis Information System MEHRD Ministry of Education and FOB Free on Board Human Resources Development GAVI Global Alliance for Vaccines MDTP Medium Term Development Plans and Immunization MHMS Ministry of Health and GER Gross Enrolment Rate Medical Services 10 MID Ministry of Infrastructure PRIF Pacific Regional Development Infrastructure Facility MMA Mines and Minerals Act PPP Purchasing Power Parity MMERE Ministry of Mines, Energy & RAMSI Regional Assistance Mission Rural Electrification to Solomon Islands MNPDC Ministry of National Planning RMNCAH Reproductive, Maternal, and Development Coordination Newborn, Child, and Adolescent Health MOFT Ministry of Finance & Treasury ROC Republic of China MRD Ministry of Rural Development RRA Risk and Resilience Assessment MTFS Medium-Term Fiscal Strategy SBD Solomon Islands Dollar MTRS Medium-Term Revenue Strategies SCI Service Coverage Index NER Net Enrolment Rate SDG Sustainable Development Goal NHA National Hosting Authority SI Solomon Islands NHSP National Health Strategic Plan SIDS Small Island Developing States NMP National Minerals Policy SIG Solomon Islands Government NMS National Medical Stores SIIP Solomon Islands Infrastructure NRH National Referral Hospital Program NTF National Transport Fund SIIRD Solomon Islands Inland Revenue Department PATH Program for Appropriate Technology in Health SINIIP Solomon Islands National Infrastructure Investment Plan PAYE Pay As You Earn SLP Sustainable Logging policy PCDF Provincial Capacity Development Fund SOE State Owned Enterprise PCRAFI Pacific Catastrophe Risk UNICEF United Nations Children’s Fund Assessment and Financing Initiative WEO World Economic Outlook PER Public Expenditure Review WHO World Health Organization PICs Pacific Island Counties UHC Universal Health Care PIPIs Pacific Infrastructure VAT Value-Added Tax Performance Indicators PIM Public Investment Management PIT Personal Income Tax PNG Papua New Guinea 11 EXECUTIVE SUMMARY 12 ABSTRACT Context A Public Expenditure Review (PER) is a diagnostic 1. Solomon Islands is a small, remote instrument to analyze public expenditures and archipelago that faces a unique set of revenues, support policy dialogue with government, development challenges, characterized by and inform engagement with other stakeholders. economic geography and state fragility. During November 2021 and July 2022, a PER was A population of 721,000, dispersed across conducted for Solomon Islands, titled ‘Fiscal reform 90 inhabited islands, complicates public and the path to debt sustainability’. The PER examines service delivery and makes the provision of the public finance implications of a large public infrastructure disproportionally costly. A small investment pipeline and declining logging revenues, domestic economy, internal division, and and identifies the importance of reform for fiscal remoteness from large export markets limit sustainability and resilient development. On the private sector development and international revenue side, the PER examines pathways in which trade. Furthermore, natural disasters and the the government’s tax reform agenda and the mining impacts of climate change pose a continuous sector can contribute to income generation and threat to sustainable development. Finally, economic growth. On the recurrent expenditure side, limited state capacity tends to constrain the the PER assesses public sector pay and employment, design and implementation of effective public and identifies options to make spending in health and policies (World Bank, 2017). education more efficient. Finally, the PER investigates 2. The logging industry is a major contributor the risks and opportunities of the large public to the economy, but production needs to investment pipeline and the consequences for decrease in order for the industry to become (fiscal) sustainability. sustainable. In 2019, the production of round logs reached 2.6 million cubic meters, which accounted for 70 percent of goods exports, 7 percent of GDP, and 16 percent of total revenue. However, increased activity has depleted resources and log production needs to be decreased substantially to reach a sustainable level (estimated at 250,000 cubic meters per year). To improve the sustainability of the industry, the government adopted a Logging Sustainability Policy in 2018, aiming to introduce phased reductions in log export volumes. Effective implementation of this policy would result in halving logging activity by 2023. 13 3. A large infrastructure pipeline aims to put New sources of revenue Solomon Islands on a new growth path. A 5. The Solomon Islands Government (SIG) is lack of quality infrastructure is germane to currently reviewing its national tax system as many of the Solomon Islands’ key growth and part of a larger fiscal reform agenda. A first development challenges, including limited key reform is the revision of taxes on goods private sector development and spatial and services and the introduction of a Value- disparities in public service delivery. A large Added Tax (VAT). Second, the SIG is pursuing amount of externally financed investment – major tax administration reforms with the core totaling 74 percent of GDP over a 7-year period objective of increasing collection efficiency – in transport infrastructure, sporting facilities by addressing non-compliance. Third, SIG is for the 2023 Pacific Games, renewable energy, developing a fiscal regime for the extractive telecommunications, water, and health aims sector as new mining projects are in the to address these challenges and decrease the pipeline. Successful implementation of these country’s dependence on the logging industry. reforms will improve the efficiency and equity 4. The developments in the logging industry and of the tax system and help the SIG fill revenue the infrastructure pipeline have substantial gaps left from the decline in logging. implications for fiscal sustainability. With 6. Successful implementation of a Value-Added the expectation of declining logging receipts Tax could lead to large efficiency gains and and increased investment spending, there improve the fairness of the tax system. is a clear need for new sources of revenue. The current system of taxes on goods and The tax reform agenda – including the services – which accounts for 36 percent of introduction of a Value-Added Tax (VAT), a new tax revenue – is highly fragmented, leading tax administration law, and major reforms in to revenue losses and hampering economic the inland revenue division – has the potential growth. As a response, the SIG is planning to to bring in new revenue. The authorities introduce a VAT and is currently developing the also aim to strengthen the fiscal regime and policy framework. The PER analysis shows that governance framework of the mining sector the introduction of a VAT with a standard rate to encourage new mining projects, which of 15 percent would be revenue neutral at the could become an important driver for fiscal moment of introduction, with efficiency gains sustainability and economic growth. Next to in the years to follow. The report also examines boosting revenues, there is a need to improve the distributional consequences of exempting the efficiency of public spending. A review of basic foodstuffs and shows that doing so would the public sector wage bill and a reform of the reduce income inequality. However, for VAT to country’s tertiary scholarship program have be revenue neutral in this scenario, a higher the potential to increase spending efficiency. rate (17 percent) would be required. Finally, a While health expenditures have increased due successful implementation of a VAT requires to the COVID-19 crisis, fully reflecting donor an information campaign, as well as capacity engagements in the budget and implementing building in the tax administration, on potential measures to contain spending could sources of non-compliance (Table 1). contribute to fiscal consolidation. Improving implementation and supporting maintenance 7. Improving collection efficiency could spending of the large public investment increase tax revenue by 11 percent. The program may lead to high economic and fiscal available data suggests that tax non- returns. Without such reforms, however, compliance is substantial in Solomon Islands. maintaining long-term fiscal sustainability may For instance, the total value of tax debt in 2019 become challenging, increasing the risk of was estimated at SI$2.6 billion (23 percent debt distress and delaying the achievement of of GDP). To address this issue, the SIG is important development goals. implementing an ambitious tax administration reform, including the introduction of a Tax Administration Act, the creation of a Large Taxpayers Office (LTO), a system of e-tax, and a strengthened tax audit function. The LTO is already operational and achieved a 20 percent reduction in tax debt within the first months of operation. 14 8. The mining sector has the potential to 10. A comprehensive reform of pay practices contribute to growth and fiscal sustainability, is required to ensure that growth in public but governance challenges need to be sector remuneration remains within the addressed. Despite an abundance of mineral overall confines of fiscal responsibility. The resources, Solomon Islands has failed to Solomon Islands public sector wage bill more develop a sustainable mining sector over the than doubled in the past decade. This is partly past two decades. However, the redevelopment driven by an increase in various allowances, of the Gold Ridge Mine and new mineral which makes the renumeration system discoveries could resuscitate the extractive considerably more complex. Furthermore, sector in Solomon Islands. Gold production limited information is available to make could add 5 percent to Solomon Islands’ GDP, adequate decisions on staffing levels and while nickel mining projects could increase composition. To address these issues, a GDP by 6 percent in the medium term, adding public sector census is needed, as well as a about 1 percent of GDP in yearly revenue. As broad pay and grading exercise. A data-driven such, the mining sector could be a key driver of approach would allow for a review of the total fiscal sustainability. However, for a sustainable compensation package and help ensure that mining sector to flourish, the SIG needs to growth in public sector remuneration remains address important governance challenges, fiscally sustainable (Table 1). including the passing and implementation of a 11. Measures to contain spending pressures new Mining Bill (Table 1). in the health sector and efforts to reflect donor funds in the annual health budget Efficiency gains in public expenditure could increase the efficiency of health 9. With large spending on health and education, expenditures. Due to the COVID-19 a rising wage bill, and a sizeable capital pandemic, health spending increased program, the report examines how efficiency substantially, including external financing from gains in public expenditure could contribute development partners (DPs). These inflows to fiscal sustainability. Combined, spending supported much needed health services on health and education amounts to 44 and had positive impacts on health system percent of the budget. The COVID-19 pandemic strengthening. However, a large share of caused a surge in health expenditures, while DP spending is estimated to be off-budget, the country’s tertiary scholarship program leading to low execution rates of on-budget largely determines spending in the education funds and complicating resource allocation sector. The health and education sectors at the national and sectoral level. Therefore, have been the main drivers of a large increase measures are needed to reflect donor spending in the public sector wage bill. The country’s in the budget and increase the efficiency of large public investment pipeline brings about health expenditures. Measures to keep utility many challenges, including execution and costs and payroll in check, and actions to coordination problems, capacity constraints, improve energy efficiency of public buildings, and unbudgeted maintenance needs. The could further increase the efficiency of health report analyzes these issues, draws out the spending (Table 1). fiscal sustainability implications, and provides recommendations to make public spending more efficient (Table 1). 15 12. Shifting the tertiary scholarship program Implications for fiscal sustainability towards local institutions has the potential and resilient development to make the program more cost-effective. In 14. Not engaging in fiscal consolidation and Solomon Islands, 70 percent of children begin revenue reform would compromise long-term primary school at their expected entrance debt sustainability. While economic conditions age. Due to an erosion of students from are expected to improve in the medium term, the formal education stream, however, the a lack of a fiscal consolidation and a slow tertiary enrolment rate is only 5.6 percent, implementation of the tax reform agenda which is among the lowest in the world. In would lead to fiscal sustainability concerns. contrast, spending on tertiary education The report shows that in such a scenario, far exceeds expenditures at other levels, public debt would surpass the government’s mainly driven by the country’s scholarship debt anchor – 35 percent of GDP – in 2026. program. For instance, in 2019, educating a Furthermore, according to a customized Debt university student was more than 100 times Sustainability Analysis (DSA) conducted for the cost of a primary student. In recent years, this report, the present value (PV) of public SIG spending on the scholarship program debt would breach the threshold in 2030, decreased, from 3.5 percent of GDP in 2017 to putting Solomon Islands at a high risk of debt an estimated 1.7 percent in 2021, and moved distress. A natural disaster shock of similar to local scholarships. A further shift towards scale to the largest historical shock would local scholarships would contribute to fiscal cause a significant deterioration in the debt consolidation and free up resources to build trajectory. In that scenario, the PV of public institutional capacity in the tertiary sector, debt-to-GDP would breach the DSA threshold while at the same time retaining talented by 2025. students in-country. An increased focus on local scholarships must go hand-in-hand with 15. On the other hand, successful reform would strengthening the evidence-base regarding keep public debt in check and generate the value-for-money investments in education, fiscal space needed to rebuild fiscal buffers such as tracer studies or progression reports and contribute to resilient development. (Table 1). The successful implementation of the tax reform agenda, the development and good 13. There is a clear rationale for capital governance of new mineral projects, and deepening in Solomon Islands, but efficiency savings in public spending could implementation challenges and maintenance generate substantial fiscal gains, totaling 7.8 need to be addressed for infrastructure percent of GDP by 2026. The results from a investment to contribute to sustainable customized DSA indicate that, in this reform development. Total investment spending in the scenario, public debt would stabilize at around country averaged 12.3 percent of GDP between 27 percent of GDP by 2031, significantly 2015 and 2020, less than half the share of low below the government’s debt anchor of 35 middle-income countries. As a result, the rate percent. Furthermore, the PV of public debt of investment has been insufficient to replace would stabilize at around 19 percent of GDP, the depreciation of the existing capital stock. keeping the country at a moderate risk of In response, the government is embarking on debt distress. This would allow the country to a large public investment program over the rebuild its cash buffers – to two months of total next seven years, estimated at 74 percent domestic spending – without compromising of GDP, including transport infrastructure, debt sustainability. However, other investments renewable energy, telecommunications, and are needed to achieve resilient and inclusive the water sector. To increase productive development, which requires a concerted efficiency, the government needs to address effort – including fiscal consolidation, financial key implementation bottlenecks – e.g., support from the international community, and improving technical and administrative potential involvement from the private sector. capacity – and reallocate spending to support increasing maintenance needs (by 2025, yearly maintenance needs are estimated at 2.4 percent of GDP) (Table 1). 16 Table 1: Summary of recommendations SECTOR RECOMMENDATION To achieve fiscal sustainability: Fiscal Make progress with the tax reform agenda, i.e., the introduction of VAT and the implementation of tax administration reforms. Mining Develop a sustainable mining sector, including the passage of a new Mining Law and Mining Regulations. Health Consider measures to keep utility costs in check and actions to improve energy efficiency of public buildings. Education Consider a shift from scholarship spending to local institutions. To support resilient development: Fiscal Consider rebuilding cash buffers at a rate of 0.5 percent of GDP per year. Fiscal Develop a suite of fiscal buffers, including risk-transfer mechanisms and a natural disaster fund. Public investment Address implementation bottlenecks by better planning and executing capital projects, including the preparation of within-year cash flow forecasts and capacity building at line ministries. Public investment Develop a dedicated funding scheme to support the country's medium- term maintenance needs (estimated at 2.4 percent of GDP). Public investment Earmark a proportion of CDF spending to reflect national priorities and climate resilience. To improve transparency, accountability, and evidence-based decision making: Health Take measures to reflect donor spending in the health budget. Education Engage in an integrated Education Public Expenditure Review across all levels of the education sector. Education Improve data accessibility and coverage to establish value for money in scholarship investments. Wage bill Engage in a comprehensive review of public sector pay practices. Public investment Strengthen project appraisal by formalizing the appraisal mandate and issuing appraisal guidelines. Public investment Issue budget regulations to clarify the distinction between recurrent and development spending, and to strengthen the integration of the recurrent budget with the development budget. 17 chapter 2 SOLOMON ISLANDS MACRO-FISCAL CONTEXT: A LOOK IN THE REARVIEW MIRROR 18 2.1 COUNTRY CONTEXT 18. Natural disasters pose a continuous threat to sustainable development and are likely 16. Solomon Islands is a low middle-income to worsen with climate change. Due to its country (LMIC) with a low level of human location in the South Pacific tropical cyclone development. The country’s GDP per capita basin and the Pacific Ring of Fire, Solomon (PPP) was US$2,483 in 2020, well below most Islands is regularly buffeted by the effects structural peers and the average of the Pacific of cyclones, heavy rainfall, earthquakes, Island Countries (PICs) (see Figure 1).1 Per volcanoes, and occasional tsunamis. As such, capita income was around one-fifth of the level the country is considered as the second of its aspirational peer in the region, Fiji. Low most at-risk of natural disasters in the world, incomes are also reflected in the country’s low after neighboring Vanuatu. Furthermore, the Human Development Index,2 which ranked 151 economic and humanitarian costs of natural out of 189 countries in 2020. Notwithstanding disasters are expected to escalate with some improvement since the turn of the climate change. The Pacific Catastrophe Risk century, the Human Capital Index (HCI)3 for Assessment and Financing (PCRAFI) estimated Solomon Islands remains in the bottom 20 in 2015 that over the next 50 years Solomon percent of countries worldwide: a child born Islands should expect average annualized today is only expected to achieve 42 percent losses equivalent to 1.6 percent of GDP due to of their full potential (see Figure 2).4 As of climatic events. 2012, the poverty headcount ratio stood at 24.7 percent of the population, measured at US$1.90 a day (2011 PPP). 17. A challenging economic geography plays a key role in shaping these outcomes. The country is the sixth most remote country in the world from large markets, being more 1. For a discussion of the selection of peers used in this PER, remote than the PICs average. Furthermore, see Annex 1. Solomon Islands is highly fragmented across 2. The Human Development Index (HDI) is a summary measure nearly one thousand islands, of which an of average achievement in key dimensions of human development: a long and healthy life, being knowledgeable, estimated 90 are inhabited (World Bank, 2017). and have a decent standard of living. Around 74 percent of the 721,000 population 3. The Human Capital Index (HCI) quantifies the contribution lives in rural areas, mainly in smaller villages, of health and education to the productivity of the next with an estimated 50 percent under the age generation of workers. of 20 years. This makes Solomon Islands less 4. Solomon Islands’ weak performance in literacy and numeracy skills partly explains why the country is lagging behind its densely populated and more rural than PICs peers in terms of the HCI. This, in turn, is related to low as a group. The small and dispersed nature enrolment rates and the poor quality of education. See of the Solomon Islands’ population makes chapter 6. it difficult and expensive for the Solomon 5. These difficulties are reflected in the materially worse outcomes for rural areas in terms of access to incomes, Islands Government (SIG) to provide quality employment, and essential services, and correspondingly public services and infrastructure outside of higher rates of poverty. A Poverty Mapping based on the urban areas. Additionally, the limited extent of 2012/13 HIES data indicates that median per capita income in urban areas was more than double the level of rural areas. connective infrastructure prevents the benefits Poverty rates were estimated to be highest in the extremely of development from being broadly shared.5 remote areas of southern Guadalcanal and eastern parts of Makira. Notably, urban areas are also hubs of poverty and inequality. In contrast, in rural areas, subsistence agriculture helps place a floor under the welfare of rural Solomon Islanders. 19 Figure 1: GDP per capita 2020, PPP (Constant 2017 international $) Aspirational peer Fiji Structural peers Kiribati Solomon Islands Timor-Leste Papua New Guinea Kyrgyz Republic Myanmar Mauritania Lao PDR Pacific island small states Lower middle income 0 2 4 6 8 10 12 Source: WDI Thousands Figure 2: Human Capital Index (HCI) (Scale min=0; max =1) Aspirational peer Fiji Structural peers Mauritania Solomon Islands Papua New Guinea Timor-Leste Lao PDR Myanmar Kiribati Kyrgyz Republic 0,0 0,1 0,2 0,3 0,4 0,5 0,6 0,7 0,8 Source: WDI Figure 3: CPIA public sector management and institutions cluster (Average low=1 to high=6) Timor-Leste Papua New Guinea Solomon Islands Lao PDR Myanmar Kyrgyz Republic Mauritania Kiribati Lower middle income Pacific island small states 0,0 0,5 1,0 1,5 2,0 2,5 3,0 3,5 Source: WDI 20 19. Compounding the disadvantages of 21. Economic performance for much of this economic geography and climate change century has been shaped by post-conflict are limited state capacity and political reconstruction and volatility (Figure 4). A economy dynamics which tend to constrain period of strong and broad-based growth the implementation of effective public occurred between 2003 and 2010, as the policies (World Bank, 2018). The quality of country rebuilt from the Tensions with the public sector management and institutions in support of donors. Between 2010 and 2016, Solomon Islands is lower than most structural the average pace of growth slowed and peers (see Figure 3). In part, this reflects the became more volatile as swings in commodity limited technical capacity of the bureaucracy prices, plus a series of natural disasters (Haque, 2013), though it also reflects the (floods in Honiara in 2014 and Severe Tropical prevailing political economy dynamics that Cyclone Pam in 2015), all influenced domestic elevate interest groups over bureaucratic output. In 2016, the country enjoyed a brief strengthening. The combination of limited state period of above-trend growth (5.6 percent), reach, fragmented localized identities, and the supported by favorable commodity prices, value of resource rents create an incentive for strong international demand for logs, as personalized forms of political leadership to well as favorable weather conditions, which flourish. This is reflected in the shift toward contributed to production gains in logging channeling investment funding through and agriculture, as well as strong growth Constituency Development Funds (CDF) rather in exports.6 Thereafter, however, the pace than ministerial portfolios. Indeed, the style of growth steadily trended down as falling of leadership in which MPs focus on securing commodity prices, and weakening Chinese resources for local constituents rather than demand for logs amid the US-China tariff building state capability, is characteristic of tensions, weighed heavily on log exports. Melanesian countries (Word Bank, 2021). This compounded the adverse effects on the domestic economy from the temporary 20. Interconnected development challenges are slowdown in private and public sector activity the drivers of Solomon Islands’ institutional during the national elections in 2019. and social fragility. These dynamics have contributed to violent events, resulting in damage to property and the loss of lives. The most notable manifestation of this was the period of civil unrest in the late 1990s known as the ‘Tensions’, in which inequities in resource distribution and economic opportunities sparked conflict between provincial ethnic groups. The conflict wrought considerable human and economic destruction, with around 200 people killed and many thousands displaced, plus a severe disruption to economic activity, resulting in real economic output declining by 23 percent from 1999 to 2002. The mobilization of an international peacekeeping force (RAMSI) in 2003 formally brought an end to open hostilities. 6. Logging output peaked in 2016 at around 3.0 million m3 and remained elevated through to 2019. 21 Figure 4: Solomon Islands sectoral contribution to real GDP (Annual percent change) 10 Othe 8 Indu 6 4 Agric 2 Serv 0 -2 -4 -6 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Services Agriculture, Industry Other* GDP growth Fisheries & Forestry * Taxes on Products less subsidies, less imputed bank charges. Source: SINSO 10 GDP Othe 8 Figure 5: Fiscal balance Figure 6: Public debt 6 (Percent of GDP) (Percent of GDP) Serv 4 Indu 260 25 Agri Expenditure 050 20 Revenue -240 -4 15 30 -6 20 10 10 5 0 10 -10 0 Othe 8 2016 2017 2018 2019 2020 2021 2022(f) 2016 2017 2018 2019 2020 2021 2022(f) Indu 6 Revenue Expenditure Fiscal balance 4 Agric Source: World Bank Source: SIG, World Bank 2 Serv 0 60 Figure -2 7: Public debt composition Fiscal balance 50 -4 20 40 -6 Domestic debt 30 16 External Other 11% debt Other T-bonds 20 22% Percent of GDP 12 ADB 10 ADB 30% IDA 0 8 IMF 14% -10 IMF 4 IDA 23% T-bonds 0 2016 2017 2018 2019 2020 2021 External debt Domestic debt Lorem ipsum Lorem ipsum Lorem ipsum Lorem ipsum Lorem ipsum Other Source: World Bank Other ADB 80 80 T-bonds 20 11% 22 Domestic debt 22% IDA 70 70 16 External debt ADB IMF IMF 30% 22. In 2020, the agriculture, forestry, and fishing 24. Civil unrest in November 2021 and sectors accounted for 30 percent of GDP. community transmission of COVID-19 in 2022 Non-logging agriculture predominantly involves have further weakened the macroeconomic family-based production units producing food environment. At the end of November 2021, from nearby horticultural resources on a small widespread looting and rioting took place scale. The oceanic fisheries sector in Solomon in Honiara, causing significant damage and Islands is a key export revenue earner, while destruction estimated at 7 percent of GDP. the coastal fisheries sector is an important The civil unrest also led to the loss of around source for local livelihoods. As a whole, the 1,000 jobs. Compounding the impact of the non-logging agriculture and fisheries sectors riots, Solomon Islands has also been grappling make the largest contribution to economic with widespread community transmission of activity, accounting for 24 percent of real GDP COVID-19 since January 2022.8 To contain the in 2020. In contrast, the commercial logging spread of the virus, the SIG initially imposed sector, which is predominantly foreign-owned severe public health restrictions, though most and export-oriented, is also a major contributor have since been relaxed as more emphasis to the economy. In 2019, timber products, is placed on sustaining economic livelihoods. which include round logs and sawn timber, Social distancing measures are expected accounted for 7 percent of GDP, 16 percent of to have dented output in sectors where total government revenue, 70 percent of the production requires the physical presence of value of all goods exported, and 43 percent workers, such as logging and manufacturing. of total foreign exchange receipts. The dependence on logging has increased over time and is reflected in the growing importance of natural resource rents, which have surged from 5 percent of GDP at the turn of the century to 16.4 percent GDP in 2019. 23. The COVID-19 crisis caused a significant deterioration in economic conditions. While Solomon Islands remained largely COVID- free through 2020 and 2021, the combined effect of the global economic downturn, plus strict preventative measures implemented by the SIG, caused the real GDP to contract by 4.3 percent in 2020. Domestic demand was severely curtailed as the government temporarily scaled down public services to essential services, closed schools, and restricted domestic travel.7 This led to substantial job losses – between 7 percent and 11 percent of the pre-crisis workforce – according to the World Bank’s High-Frequency Phone Survey (HFPS). While some of these jobs were restored, by December 2020, employment remained well below pre- pandemic levels. 7. Among the preventative measures implemented by the government was the suspension of all commercial international flights, temporary ban on entry of non-citizens, and strict mandatory quarantine for all returning passengers. This staunched the flow of tourists and foreign workers, which adversely affected mining operations, as well as major donor-funded construction projects (see Chapter 7). 8. As of May 13, 2022, 25,815 cases of COVID-19 have been detected, with 146 related deaths. With limited testing capacity, the actual number of cases is likely to be substantially higher. As COVID-19 patients are instructed to stay at home, the actual number of COVID-related deaths is also likely to be higher. 23 Figure 8: General government expenditure Solomon Islands (Percent of GDP) 50 40 30 20 10 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022(f) Source: IMF Figure 9: General government expenditure (GGE) 2020 (Percent 50 of nominal GDP and Levels; PPP, constant 2017 international $) 40 120 4500 4000 100 30 3500 80 3000 20 2500 60 2000 10 40 1500 0 1000 20 500 0 0 PIC LMIC Kiribati Timor- Solomon Kyrgyz Papua Myanmar Mauritania Lao PDR Fiji Leste Islands Republic New Guinea GGE % Normal GDP (LHS) GGE per capita ($PPP) (RHS) Lorem ipsum Lorem ipsum Lorem ipsum Source: IMF WEO and World Bank staff estimates 80 Figure 10: Public expenditure 70 Figure 11: Budget support expenditure (By expenditure type; percent of GDP) (By major sector) 60 45 100 Total recurrent Other 40 50 35 80Total capex Health and Me 40 30 Education and 30 60 25 20 20 40 15 10 10 20 0 5 0 0 2013 2014 2015 2016 2017 2018 2019 2020 2016 2017 2018 2019 2020 Total capex Total recurrent Total Education Health and Other expenditures and Human Medical Resources Services Development *Capital expenditure as defined in Chapter 7. Source: SIG Source: SIG; World Bank staff estimates 45 40 24 35 30 2.2 FISCAL TRENDS 2.2.2 Expenditure trends 27. The small size of the Solomon Islands’ 2.2.1 Overall fiscal context economy means that, despite a relatively large fiscal footprint as a share of GDP, the 25. Fiscal deficits have begun to widen as the overall level of public spending is small in per demands for additional spending have met capita terms (Figure 8). General government weakening revenues (Figure 5). Following expenditure (GGE) in 2021 was 42 percent of a broadly balanced budget strategy in the GDP; slightly lower than its peak of 47 percent aftermath of the Tensions, and a period in in 2017. However, with spending demands which budget surpluses were supported by continuing to increase in 2022 and beyond, external grants thereafter, the trend has been this share is expected to continue to rise. It toward deficits. Between 2016 and 2021 the is characteristic of countries that are both SIG has consistently run deficits (except in small, and have a high degree of remoteness 2018 and 2019), averaging 2.8 percent of GDP. and dispersion, to have a large share of public In 2020, the deficit increased to 4.9 percent spending (Horscroft, 2014), which helps to and again to 4.8 percent in 2021. As a result, explain why Solomon Islands has a much larger the steady decline in public debt, as a share share than most structural peers, though not of GDP, that had been underway since at least PIC peers (Figure 9). The level of per capita 2003, ceased. government spending in Solomon Islands, 26. Public debt increased sharply since 2019, (US$837 in 2020 based on the implied PPP reflecting the impact of the COVID-19 crisis conversion rate), however, is well below most and civil unrest. Debt to GDP increased of the level of spending of structural peers, from 8.3 percent in 2019, to an estimated and less than half the average level of LMICs. 14.9 percent in 2021, almost doubling in a Similar to the gap in incomes, the gap in per three-year timespan. External debt accounts capita public spending with structural and for 60 percent of the total debt stock, and the regional peers has widened over time. share of domestic debt has increased in recent 28. On-budget capital expenditure has declined years (see Figure 7). The increase in public debt as a share of total public expenditure since reflects borrowing to finance COVID-19 related 2017, though there is a large share of off- expenditures and the impact of the civil unrest. budget capital expenditure funded by donors. While spending on debt servicing is relatively The SIG budget excludes key spending and low, the current inflationary environment revenue items, which has implications for the may lead to higher debt servicing costs. The analysis in the PER (see Box 1). Focusing on average interest rate on external loans stood that share of spending undertaken by the SIG, at 1 percent in 2021, while the average interest there appears to have been a reprioritization rate on domestic debt was 4.9 percent. away from capital expendiure in recent years, with the capital share declining from 23 percent of total expenditure in 2016 and 2017, to 11 percent in 2020 (Figure 10). Indications are that greater prioritization is being placed on capital spending – particularly SIG-funded investments in infrastructure and works related to the 2023 Pacific Games (see Chapter 7). However, even with this boost to investment, the SIG’s capital share is likely to remain well below its recent peak.9 9. Public spending is not differentiated by location, so analysis of the geographic distriction of expenditure is not possible. 25 BOX 1: THE STRUCTURE OF THE SIG BUDGET AND DATA SOURCES USED IN THE PER The SIG budget is divided into two parts: the For the latter analysis, the PER relied on BOOST, recurrent budget and the development budget. a World Bank developed platform that collects Both budgets follow a similar logic, being data on the public expenditure accounts from the organized by a Ministerial Budget Head, and government’s Integrated Financial Management then into high-level projects/programs and a Information System (IFMIS). The original BOOST common set of economic classifications. The dataset for Solomon Islands comprised over recurrent budget divides recurrent expenditure 141,000 observations and covered information on into Domestic Funded Recurrent Expenditure budget expenditure from 2006 to 2021. In cross- (Ledger 2) and Donor Funded Recurrent Budget checking the data, duplicate values were identified and Budget Support (Ledger 3). The development and removed. After this procedure, the final budget (Ledger 4) includes appropriated (i.e., on- dataset contained 135,911 data points. budget) support for new and ongoing development The disaggregated structure of the BOOST projects (Figure B1). Importantly, these budget data set allows for analysis of approved and distinctions do not precisely align with actual executed budget expenditures at the sectoral recurrent and capital expenditure (see Chapter 7). (FUNC1) and sub-sectoral level (FUNC2, FUNC3), Additionally, a substantial amount of public as well as by economic categories (ECON1, spending is not captured in the SIG budget. ECON2, ECON3). In addition, it allows for the Most saliently, a good share of externally funded categorization of expenditures by their financial capital investment is not captured in the budget, source (FIN_SOURCE) and budget type (Recurrent, nor included in the SIG’s financial management Development, Budget Support). information system (this is referred to as the ‘non-approproiated development budget’ – see Chapter 7). A similar situation occurs with revenues, with the FMIS not being able to capture all funding from external sources. The IMF World Figure B1: Public expenditure Economic Outlook (WEO) estimates spending (Executed spending; by budget type) and revenue that is not included in the budget books of the SIG – the most salient of these are $6000 Ledger 4 externally-funded capital projects. The differences between the total expenditure estimates of the $5000 Lefter 3 IMF and the SIG outturns fluctuates between $4000 Ledger 2 9 percent and 27 percent of the IMF estimate $3000 (Figure B1); potentially reflecting the lumpiness of capital investment. Accordingly, in this PER $2000 the IMF’s WEO is the data source for analyzing $1000 aggregate expenditure and revenue. Data provided by the SIG are used for analyzing the composition $0 2013 2014 2015 2016 2017 2018 2019 2020 of spending/revenue – though only up to 2020 given the availability of information on executed Recurrent expenditure Development budget (Ledger 2) (Ledger 4) spending and realized revenue. Budget support IMF WEO (Ledger 3) Source: SIG 26 29. Budget support plays a minor role in public Figure 12: Public expenditure by function expenditure overall, though a significant role (Share of total; COFOG classifications) in funding health and education. Expenditure classified as general budget support (Ledger 100 3) is the share of on-budget ministerial 706 90 appropriations that are externally funded.10 Such spending is subject to the SIG’s financial 80 708 management processes and systems, as well as SIG procurement rules. Budget support 70 has contributed to around 5 percent of total 705 60 SIG executed expenditures over the past five years, though it has been as high as 9 per cent 50 710 in 2013. In 2022, 13 ministries received budget support. Historically, though, most budget 40 704 support has been channeled to essential health 30 and education, and generally earmarked for certain development priorities – in health, 20 703 for instance, being used to finance front-line 10 service delivery responsibilities of provincial 707 divisions, and national disease control 0 programs, plus capex (World Bank 2018b).11 2013 2014 2015 2016 2017 2018 2019 2020 2021 (RB) 2022 (B) Between 2016 and 2020, budget support 709 funded 18 percent of total health expenditure on average, with the proportions relatively 701 703 705 701 unchanged. Over the same timeframe, the 709 704 708 importance of budget support in education has 707 710 706 declined from around 6 percent to around 3 percent. Source: SIG Figure 13: Recurrent expenditure 40 Oth 35 Use 30 25 Com 20 15 10 5 0 2020 2014 2016 2018 2019 2013 2015 2017 Compensation of Use of Goods Other 10. Budget support (Ledger 3 in the SIG Budget) is generally employees and services the only place where externally funded on-budget spending is located. The notable exception is the Constituency Development Fund, which sits in the Development Budget Source: SIG, World Bank staff estimates (Ledger 4) and is funded through a combination of contributions from the SIG and development partners (See Chapter 7). 11. Very little DP recurrent expenditure is on payroll and staff benefits, as DP funding cannot be used to pay for establishment staff and is only used to recruit local contracted staff for temporary support to MHMS. 27 Figure 14: General government revenue (PPP, constant 2017 international $; 2020) 120 4500 4000 100 3500 80 3000 2500 60 2000 40 1500 1000 20 500 0 0 PIC LMIC Kiribati Timor- Solomon Kyrgyz Papua New Myanmar Mauritania Lao PDR Fiji Leste Islands Republic Guinea Revenue % Nominal GDP (LHS) Revenue per capita (RHS) Source: IMF WEO and World Bank staff estimates Figure 15: General government revenue and grants (By revenue type; percent of GDP) 50 O 40 G G 30 G 20 10 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Grants Taxes Other Total Source: IMF Figure 16: Tax revenue Figure 17: Composition of tax revenue (Percent of GDP) (By tax type; percent of total revenue) 100 Myanmar Int. trade Papua New Guinea 80 Goods an Kyrgyz Republic 60 Income a Timor-Leste 40 Fiji Solomon Islands 20 Kiribati 0 0 5 10 15 20 25 30 2013 2014 2015 2016 2017 2018 2019 2020 2021 Lorem ipsum Lorem ipsum Lorem ipsum Income and Goods and Int. trade and profits services transactions 80 28 70 60 30. The SIG spends a large share of its budget 2.2.3 Revenue trends on health and education (Figure 12). Before 32. Similar to expenditures, total revenue the pandemic, the prioritization afforded collection is relatively high as a share of to education and health in the SIG budget nominal GDP. In 2020, total government was already well above peers. However, the revenue stood at 33 percent of nominal GDP, magnitude of spending on these services is not which is higher than most structural peers, commensurately large, on account of the small save for Kiribati and Timor-Leste, which are size of the budget overall. Accordingly, future both highly resource-dependent and have rates increases in education and health spending among the highest in the world (Figure 14). will need to come from some combination of The high revenue shares in these countries growth, improved fiscal capacity (change in suggest that there may be some scope for the total general government spending as a Solomon Islands – also resource-abundant – share of GDP), or efficiency, rather than rising to raise additional resource-related revenues prioritization. (see Chapter 4). In absolute terms, the amount 31. The public sector wage bill is large relative to of revenue collected per capita in Solomon most structural peers. Recurrent expenditure Islands remains relatively small, at US$780 is mostly divided between the purchase of (based on the implied PPP conversion rate), goods and services (47 percent in 2020) and which was lower than all structural peers, the wage bill (37 percent). The wage bills of save for PNG where revenue collection is public sector employees (which includes basic systemically weak, and was 53 percent lower wages and allowances) were equivalent to than the average level of revenues in LMICs. 12.8 percent of real GDP in 2020 – above most Low levels of per capita revenue collection are peers and greater than the average of LMICs. partly explained by a high degree of informality Relative to PICs, however, the wage bill is and a dependence on the resource sector. modest.12 Between 2015 and 2020, the wage 33. Tax and non-tax revenue collection has grown bill has increased by 38 percent, well-outpacing considerably since the Tensions and has growth in GDP (12.3 percent) and recurrent replaced dependence on grant financing. Tax spending (25.0 percent) over the same period. collections are broadly split across taxes on The growth in the wage bill has been powered income (profits and capital gains), taxes on the by an 81 percent increase in spending on consumption of goods and services (including allowances. excise tax), and taxes on international trade transactions (see Figures 16 and 17). Non- tax revenues include fees, property income (including SOE dividends), and fines. In 2002 during the Tensions, total revenue fell to SI$288 million (5.6 percent of GDP) with tax revenue collection only SI$237 million.13 In the wake of the Tensions, external grants played a vital role in lifting government revenues, accounting for nearly three-fifths of revenue growth between 2003 and 2010 (Figure 15). At their peak, grants represented 55 percent of total government revenues. As the extent of external support waned, tax and on-tax revenue collection grew strongly – peaking at 34.8 percent of GDP in 2018, in line with the strengthening economic activity and reforms to improve state capacity to collect revenues (World Bank, 2017). 12. The seven countries included Fiji, Solomon Islands, Samoa, Tonga, Kiribati, and Tuvalu. 13. To put this into context, this represented around US$116 per capita that year. 29 BOX 2: CYCLICAL AND STRUCTURAL COMPONENTS OF THE FISCAL BALANCE As actual budget balances are affected both by As can be seen from Figure B2, cyclical effects cyclical factors and structural measures, it is were most prominent until 2015. The business insightful to decompose the overall balance into cycle effect appears to reduce the fiscal surplus a cyclical and a structural component, which until 2010, while during the 2010–2015 period is presented in Figure B2. To obtain cyclically it was driving the overall balance. Interestingly, adjusted revenue, the output gap was computed, the overall balance during the post-2015 period and revenue elasticity was set at 1. For cyclically was almost entirely driven by discretionary fiscal adjusted expenditure, a zero-expenditure elasticity policy. This period coincided with fiscal expansion, was applied, implying that the business cycle does implying pro-cyclicality of fiscal policy. not generate a response in expenditure levels. The difference between cyclically adjusted revenue and expenditure reflects the cyclical component of fiscal balance. Figure B2: Cyclical and structural components of fiscal balance 0,12 Cyclica 0,10 Structu 0,08 0,06 0,04 0,02 0,00 Cyclica -0,05 Structu -0,10 -0,15 -0,20 -0,25 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 1999 2013 2014 2015 2016 2017 2018 2019 2020 2021 Structural balance Cyclical component 30 Figure 18: Logging revenue (Percent of GDP) 8 7 6 5 4 3 2 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 Source: IMF 34. Since 2018, there has been a sharp drop off 35. Revenues collected from logging have in revenue collections, with total revenue been critical to the government’s fiscal in 2022 expected to fall to its lowest level position but are in decline. Duties on logging since 2010. The combined impacts on revenue exports are the single largest revenue handle, collection – of the economic slowdown, civil accounting for 16 percent of total revenue in unrest, and the pandemic – have been severe. 2018 and 73 percent of taxes on international In addition to weakening economic conditions trade. Additionally, logging operations generate and this narrowing of the tax base, strict social revenue in the form of income taxes and fees, distancing requirements have had adverse which are key to rural economic development.14 impacts on tax administration and taxpayer However, revenues from the logging sector compliance. Between 2018 and 2022, tax declined from 5.4 percent of GDP in 2018 to revenues fell by 23 percent while non-tax less than 3 percent of GDP in 2021. A further revenues fell by 25 per cent. expected decline in logging revenue over the medium term (to 2.3 percent of GDP in 2025) is likely to weigh on fiscal outcomes. As a sign of the fiscal impact of the decline in the sector, the 22 percent drop in log exports in 2020 was matched by an equivalent fall in log duties (SI$141 million), or around one-quarter of total health expenditure in the year. 14. Revenue from logging activities, mainly in the form of export taxes, are an import source of revenue for the central government, which are then notionally redistributed throughout the country via the central budget. Revenue collected from business licenses allocated to logging firms are also an important source of own-source revenue for provinces. 31 chapter 3 THE NARROW PATH TOWARDS FISCAL SUSTAINABILITY 32 36. This chapter analyzes Solomon Islands’ 3.1 MACRO-FISCAL OUTLOOK fiscal sustainability, taking into account the government’s reform agenda, the need 3.1.1 Baseline scenario to rebuild fiscal buffers, and the country’s 37. After three years of decline, economic development gaps. The chapter presents two conditions are expected to improve in the stylized macro-fiscal scenarios. The first is medium term. Economic growth is expected a baseline scenario, with limited reform and to pick up in 2023 – from a low base caused by growth opportunities. The second is a reform three consecutive years of contraction – and scenario that entails the full implementation of average 3 percent over the period 2023–2026 the government’s tax reform agenda, efficiency (see Table 2). Growth is driven by public savings in expenditure, and the development of investment and initiatives related to the 2023 the mining sector. In light of these scenarios, Pacific Games. Large infrastructure projects the chapter examines ways to rebuild fiscal in roads, air transport, telecommunications, buffers and highlights the importance of sporting facilities, and energy are anticipated fiscal consolidation for resilient recovery and to drive growth in the construction sector development. (see Chapter 7). Increased connectivity and transport facilities may crowd-in private investment, potentially in internet-based services and/or tourism. Furthermore, the easing of border restrictions should contribute to the recovery in the industry and services sectors. Logging activity, however, is expected to decline in line with the country’s sustainable logging policy, while the reopening of the Gold Ridge mine is projected to contribute to economic growth in the mining sector. The current account deficit is expected to remain elevated over the medium term, as the recovery in primary exports is more than offset by higher imports for infrastructure projects and civil unrest reconstruction. Foreign reserves are expected to gradually decline but would remain above the recommended reserve adequacy range of seven months of imports. 33 Table 2: Baseline macro-fiscal indicators 2020 2021 2022 2023 2024 2025 2026 Real economy Annual percentage change Real GDP growth -4.3 -0.2 -4 3.2 3.1 3 3 Consumer prices 3.4 4.2 5.2 3.6 3.7 3.6 3.7 (period average) Selected monetary accounts In billion SBD Broad money 4.6 4.6 4.6 4.5 4.4 5.6 6.8 Balance of payments (in In billion SBD percent of GDP) Current account balance -1.6 -12.0 -14.6 -14.5 -12.8 -11.5 -10.5 Gross official foreign reserves 0.7 0.7 0.7 0.6 0.6 0.5 0.5 Public sector finances In percent of GDP Revenues and grants 33.2 30.7 28.1 29.6 30.2 30.9 30.8 o/w grants 8.8 8.5 5.6 6.2 5.8 5.8 5.8 Total expenditure 35.8 34.2 34.8 35.0 35.7 36.0 36.2 Goods and services 19.0 16.9 14.6 13.6 13.6 15.0 16.4 Investment 6.4 7.1 9.2 10.4 10.9 10.2 9.6 Other 10.2 9.8 10.2 10.2 10.3 9.7 9.0 Interest payments 0.3 0.4 0.7 0.8 0.9 1.0 1.1 Overall fiscal balance -2.6 -3.4 -6.7 -5.4 -5.5 -5.1 -5.4 Public debt 13.3 17.0 22.9 26.4 29.5 32.2 35.3 Change in debt 3.6 5.9 3.5 3.1 2.8 3.1 Memorandum items In Billion USD Nominal GDP (billion USD) 1.55 1.61 1.67 1.78 1.90 2.03 2.17 Exchange rate (USD per SBD) 0.12 0.12 0.13 0.13 0.13 0.13 0.13 34 38. Fiscal deficits are expected to remain 39. Due to limited fiscal consolidation, public elevated over the medium term. The fiscal debt is expected to surpass the government’s deficit is projected to decline from 6.7 percent debt anchor and put the country at a high of GDP in 2022 to 5.4 percent of GDP in 2026, risk of debt distress. Public debt is expected averaging 5.4 percent over the period 2023– to exceed the government’s debt anchor – 2026 (see Table 2). Revenues are projected to nominal debt below 35 percent of GDP – in average 30.4 percent of GDP over the period 2026 (see Table 2 and Figure 19). Furthermore, 2023–2026. Trade tax revenues are expected according to a Debt Sustainability Analysis to decline in line with the projected reduction (DSA) conducted for this report, the present in logging activity, but this will be offset by a value (PV) of public debt is expected to breach recovery in income and consumption taxes. the threshold in 2030,16 putting Solomon A moderate impact is expected from ongoing Islands at a high risk of debt distress. Solomon tax reforms.15 The increase in medium-term Islands is one of the countries expected to be public spending, from 35.0 percent of GDP in most affected by climate change. A tailored 2023 to 36.2 percent in 2026, is driven by the natural disaster shock of similar scale to capital budget – with the main spending areas the largest historical shock would cause a being the large infrastructure pipeline, the significant deterioration in the debt trajectory. organization of the 2023 Pacific Games, and In that scenario, the PV of public debt-to-GDP discretionary Rural Constituency Development ratio would breach the threshold of 35 percent Funds – as well as increased interest by 2025. payments. 15. The government is engaging in a large fiscal reform agenda, including the introduction of VAT and reforms in tax administration (see Chapter 4). The baseline scenario assumes that the government partially implements the reforms, resulting in about 1.5 percent of GDP of additional revenue. 16. Solomon Islands’ Composite Indicator (CI) index, calculated based on the October 2021 World Economic Outlook (WEO) and the 2020 Country Policy and Institutional Assessment (CPIA), is 2.651, indicating that the debt-carrying capacity is assessed to be weak. Concurrently, the debt sustainability threshold for the present value of public debt is set at 35 percent of GDP. Figure 19: The evolution of public debt under the baseline scenario (Percent of GDP) 60 50 40 30 20 10 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 DSA - PV of debt-to-GDP Debt-to-GDP ratio DSA - natural disaster shock Threshold Source: Author's 35 40. Furthermore, macro-fiscal risks are tilted 3.1.2 Reform scenario towards the downside. The COVID-19 41. Ongoing tax reforms, the development of pandemic had a severe impact on the economy the mining sector, and efficiency savings and exacerbated pre-existing weaknesses. in expenditures may generate substantial The recent social unrest, the lockdown and fiscal gains. To improve domestic resource mitigation measures during the COVID-19 mobilization, the government is engaging pandemic, and the commodity price shock due in a large fiscal reform agenda, including to the Ukraine war have further deteriorated the introduction of a VAT and reforms in tax socio-economic conditions. There is a risk that administration (see Chapter 4). Compared to domestic payment arrears will accumulate, the baseline scenario, a full implementation impacting negatively on private sector activity of the VAT reforms and increased collection and potentially on the health of the financial efficiency could add 2.1 percent of GDP in system, against a background of increased revenue by 2026 (see Table 3 and Chapter 4). non-performing loans. Under an unfavorable Furthermore, the SIG is developing a fiscal economic environment, the risks of additional regime for the extractive sector with new episodes of civil unrest cannot be ruled out. mining projects in the pipeline (see Chapter 3). This would endanger economic recovery and With a proper legislative framework in place, potentially lead to additional job losses and gold and nickel mining projects could generate the destruction of productive capital. Given 3.3 percent of GDP in additional tax revenue the country’s limited expenditure controls (royalties, export duties, and PIT) and stimulate and governance constraints, the risk exists further increases in GDP and exports (and that recurrent expenditures and discretionary inflation). Furthermore, specific reforms in spending in the development budget may the health sector – i.e., a reduction in utility fail to be contained. Lower than expected costs and a review of the wage bill – may lead revenues would weaken the fiscal position and to efficiency savings in health expenditure create risks of further arrears accumulation. (1 percent of GDP over the period 2023–2026). As a small exporter, Solomon Islands is highly Finally, a continued focus on local scholarships exposed to international price fluctuations would make the tertiary scholarship program and Chinese market demand for logs. As more cost-effective and bring 1.4 percent of mentioned, Solomon Islands is prone to natural GDP in fiscal savings (see Chapters 5 and 6).17 disasters, which could also put stress on the financial sector. Meanwhile, frequent changes in government are likely to persist, which could hamper commitment to improved fiscal management. Relatedly, limited capacity, a stretched civil service, and information failures may complicate public sector governance and increase corruption, including in the organization of the 2023 Pacific Games. Finally, the large infrastructure portfolio may lead to excess demand for certain goods and services, possibly resulting in inflationary pressures. Rising global prices may further add to inflation risk. 17. Nominal expenditure on tertiary scholarships is assumed to remain constant between 2022 and 2026, generating increasing savings totaling 1.4 percent of GDP by 2026. See Chapter 6. 36 Table 3: Fiscal impact of revenue and expenditure measures in reform scenario 2023 2024 2025 2026 2023-2026 Revenue measures – change in revenue (as % of 2022 GDP) Tax efficiency gains 0% 0% 0.70% 1.40% 2.1% Tax gains from the mining sector 0.30% 0.70% 1.10% 1.20% 3.3% Expenditure measures – change in expenditure (as % of 2022 GDP) Health care spending -0.20% -0.20% -0.20% -0.30% -1% Tertiary scholarships -0.10% -0.30% -0.40% -0.60% -1.4% Source: Authors’ own calculations 42. The successful implementation of these The results from a customized DSA indicate reforms would put Solomon Islands on a that, in the reform scenario, public debt different macro-fiscal path and keep public would stabilize at around 27 percent of GDP debt in check. If the abovementioned reforms by 2031, significantly below the government’s are successfully implemented – which is debt anchor of 35 percent. Furthermore, the quite challenging, the fiscal deficit would PV of public debt would stabilize at around average 3.5 percent of GDP over the period 19 percent of GDP, keeping the country at a 2023–2026, significantly lower compared moderate risk of debt distress (see Figure 20).19 to the baseline scenario. Furthermore, the While a natural disaster would significantly implementation of mineral projects would increase public debt, the PV of public debt provide a boost to the economy, with real would remain below the 35 percent of the growth averaging 4 percent of GDP during GDP threshold. 2023–2026. Combined with temporary higher inflation, nominal GDP in the reform scenario is 7.4 percent larger by 2026 compared to the baseline scenario, further contributing to a reduction of the debt-to-GDP ratio.18 18. Both the baseline and the reform scenario were developed in a customized MFMOD model for Solomon Islands. See the appendix for more detail on the model and the macro-fiscal framework of the reform scenario. 19. All debt indicators remain below their relevant thresholds in the baseline scenario, but breaches of the benchmark occur in a number of stress tests (e.g., real growth and commodity price shock). Results are not reported but are available upon request. 37 Figure 20: The evolution of public debt under the reform scenario (Percent of GDP) 40 T D 30 D 20 D 10 0 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 DSA - PV of debt-to-GDP Debt-to-GDP ratio DSA - natural disaster shock Threshold Source: Authors' own calculations 3.2 FISCAL BUFFERS (IMF, 2020). Additionally, broader fiscal buffers can be built-up via risk-transfer instruments, 43. A successful implementation of the such as parametric insurance, catastrophe government’s reform agenda would allow to swaps, or catastrophe bonds. Borrowing can rebuild fiscal buffers. The fiscal space created take the form of contingency credit lines, in the reform scenario would, in principle, with an upfront fee but relatively low interest allow to rebuild cash buffers to recommended rate, or ex-post borrowing in domestic and levels. This section analyzes the principles international financial markets. and rationale for building fiscal buffers in more detail and applies the insights to the Solomon 45. Holding fiscal buffers, however, creates Islands’ context. After a short introduction, an economic cost, with cost-risk tradeoffs this section estimates the fiscal cost of shocks differing for each type of buffer. The primary for Solomon Islands, followed by an overview cost of cash buffers is the cost of carry, which of the country’s fiscal buffers and the different is the opportunity cost in terms of foregone instruments available to rebuild resilience spending. Risk-transfer mechanisms and against unexpected shocks. contingent financing mechanisms potentially reduce this opportunity cost, net of the interest 44. Fiscal buffers serve to deal with unexpected charged, insurance premiums, and/or front- revenue or expenditure shocks. Fiscal buffers end fees. However, such instruments may have refer to the fiscal space governments have to stringent conditions on their use, which limits cover unexpected expenditure increases or their flexibility when compared to cash buffers. revenue decreases without disrupting regular The opportunity cost of holding buffers, budget execution or debt servicing. Buffers can as well as flexibility in use, are important come in many different forms. Cash buffers, considerations for designing a well-developed held in highly liquid treasury accounts, are an suite of fiscal buffers. For Solomon Islands, important way for governments to continue the optimal mix of fiscal buffers should be meeting day-to-day liquidity needs during determined by the SIG’s needs, its exposure to periods of unexpected revenue weakness. They shocks, and the local financing context.20 are often the first line of defense for cushioning against volatility, especially in instances where alternative short-term financing options are limited. Cash buffers also have the advantage of being available for immediate deployment without much restraint. The usefulness of 20. Clarke, D.J., Mahul, O., Poulter, F., and The, T.L. (2017). cash buffers is evident in their widespread Evaluating Sovereign Disaster Risk Finance Strategies: A use in countries across the income spectrum Framework, The Geneva Papers 42, (565–584). 38 Figure 21: Reliance on natural resource rents (Percent of GDP) 40 Timore-Leste (45%) 30 20 10 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 Kyrgyz Republic Lao PDR Mauritania Solomon Islands Kiribati Myanmar Papua New Guinea Source: World Development Indicators 3.2.1 The fiscal cost of shocks 47. The fiscal cost of natural disasters in Solomon Islands is particularly large. In total, 46. Solomon Islands is exposed to a wide range 29 natural disasters have affected Solomon of fiscal shocks due to the structure of its Islands since 1980 (see Figure 22). Disasters economy, its geography, and the country’s cause the destruction of physical and/or social and institutional fragility. Inherent human capital and lead to a loss of output. The revenue volatility stems from the SIG’s production losses created by natural disasters heavy reliance on natural resource rents reduce fiscal revenue, as taxable economic and (unpredictable) development partner activity is wiped out. Governments may also support (see Figure 21). Combined with limited need to provide tax deductions or tax rate cuts expenditure controls, the government often to assist recovery. Furthermore, post-disaster faces urgent liquidity needs, as evidenced recovery involves multiple costs including by the build-up of domestic payment arrears emergency and relief services; reconstruction – estimated at SI$95 million at the end of of public infrastructure and buildings; 2021 – and under-execution of the capital reconstruction of (uninsured) housing; budget (see Chapter 7). Next, due to its expenditures on social, employment, and location in the South Pacific cyclone basin and economic recovery programs; and payments the Pacific Ring of Fire, Solomon Islands is for the liabilities and investment needs of state- regularly buffeted by cyclones, heavy rainfall, owned enterprises. Based on information from earthquakes, volcanoes, and occasional the international disasters database (EM-DAT), tsunamis. The effects of climate change the average nominal value of physical damage will likely exacerbate the impacts of natural caused by natural disasters in Solomon Islands disasters, especially for hydrometeorological amounts to 3–4 percent of GDP. Furthermore, events. Relatedly, the COVID-19 pandemic, econometric analysis conducted for this report a health-related disaster, had major macro- indicates that severe natural disasters reduce fiscal impacts for the country. Finally, Solomon revenue collection in Solomon Islands by 2–3 Islands’ social and institutional fragility has percent of GDP,21 which is in line with other contributed to damaging violent events. estimates from the literature (Lee, et al., 2018). Combined, the fiscal cost of natural disasters is in the range of 5–7 percent of GDP. 21. A severe natural disaster is defined as a disaster with a GDP impact above the 75th percentile in the distribution of damage, for disasters measured over the period 1980–2016. 39 Figure 22: Natural disasters in Pacific Islands (1980–2020) 60 O 50 S 40 F 30 E 20 D 10 0 Fiji Kiribati Marshall Micronesia Palau Samoa Solomon Tonga Tuvalu Vanuatu Islands Islands Drought Earthquake Flood Storm Other Source: EM-DAT; World Bank staff calculations 48. With severe natural disasters expected 3.2.2 Rebuilding fiscal buffers to occur every 7.5 years, Solomon Islands 49. The SIG presently lacks the fiscal buffers needs to build resilience against these, and needed to effectively manage its highly other, shocks. The COVID-19 crisis has led risky environment. The SIG mainly relies to the realization that countries need to on contingency warrants and cash buffers prepare for tail risks, and experience has to deal with unexpected shocks. The value shown the importance of precautionary fiscal of contingency warrants in the 2022 budget buffers. Indeed, many countries have revised was set at SI$20 million (0.01 percent GDP), upwards their cash buffer targets in the wake which is negligible compared to the shocks the of COVID-19 (IMF, 2020). Finally, given the country may face. When faced with unexpected country’s history of fragility, fiscal buffers events, the government could engage in are needed to respond to violent events. budget reallocations and the approval of For instance, the 2021 civil unrest caused supplementary budgets.22 There have been 7 percent of GDP in damages and an estimated attempts by the government to keep two revenue loss of 1.5 percent of GDP. While such months of total spending – i.e., recurrent plus events occur less frequently, they cannot be domestically financed development spending – disregarded given their large-scale impact. in cash accounts, but it has failed to reach that target in the past five years. Furthermore, the SIG relies, to a limited extent, on risk-transfer mechanisms and contingent financing to insure itself against natural and health-related disasters. The small size of the domestic credit market and constraints to borrowing on international markets mean that sufficient ex-post funding to respond to a potential economic shock is unlikely to be secured at a reasonable cost. 22. The substantial time involved in the approval of a supplementary budget, which requires a Supplementary Appropriation Bill, an examination of the Public Accounts Committee, and an approval of Parliament, make it an inefficient instrument when dealing with pressing fiscal needs. 40 Figure 23: Broad cash balance at year-end (2015–2021) 1200 2.75% 2.50% 1000 2.25% 2.00% 800 Millions SBD 1.75% 1.50% 600 1.25% 1.00% 400 0.75% 200 0.50% 0.25% 0 0.00% 2015 2016 2017 2018 2019 2020 2021 Broader cash balance (left axis) Implied 2-month balance (left axis) Broader cash balance (right axis) Note: The figure does not take into account unpaid checks and domestic payment arrears. Source: Authors’ own calculation 50. Recent macro-fiscal shocks have created 51. Due to different nature and severity of fiscal considerable liquidity challenges and shocks, Solomon Islands should rebuild depleted cash reserves. At the beginning of its fiscal resilience using a combination 2022, the total cash balances of the SIG, which of instruments. A diversified portfolio of include a debt servicing account, stood at instruments would allow the country to adapt SI$430 million, which was considerably below its shock response and optimize the cost- its target of two months of total spending (see risk trade-offs it faces. Fiscal tools to rebuild Figure 23).23 The value of cash balances has buffers include the cash balances, contingency been significantly depleted. Between 2015 warrants, budget reallocations, a natural and 2020, the value of the broad cash balance disaster fund, and risk-transfer mechanisms. fell from 2.7 to 1 month of total spending and The remainder of this section will discuss each from 8.1 to 3.4 percent of GDP.24 Furthermore, of these instruments in turn. the SIG accumulated large domestic payment 52. Fiscal buffers in Solomon Islands should arrears, which need to be deducted from the rely, to a large extent, on flexible financing gross cash balances together with unpaid instruments, such as cash buffers. Cash payment orders and unpresented checks. buffers are a crucial element to mitigate liquidity risk for budget execution and provide funding for post-shock responses. As the most liquid asset at the government’s disposal, cash buffers provide immediate financing to counter inherent revenue volatility (stemming from natural resource rents and/or delayed disbursements of external grants). Importantly, 23. The broad cash balance includes SIG deposit accounts, SIG revenue account, SIG debt servicing account, and SIG funded cash buffers are available to be deployed in development project account, deposits held at the CBSI and instances where other mechanisms, such as the commercial banks minus unpaid payment orders and disaster funds or risk-transfer mechanisms, unpresented checks. Source: Ministry of Finance & Treasury. (2022). Brief COVID-19 Impact Update Macroeconomic Impact may not be triggered (e.g., in the event of and Assessment of the Recent Covid-19 Lockdown/Community social unrest). However, the optimal value of Transmission. cash buffers should be determined in context 24. IMF. (2022). 2021 Article IV Consultation—Press Release; of the carrying cost, as well as the availability Staff Report; and Statement by the Executive Director for the Solomon Island, IMF Country Report No. 22/14; IMF. (2020). of other sources of post-shock financing, 2019 Article IV Consultation—Press Release; Staff Report; like insurance and contingency credit lines, And Statement by The Executive Director For The Solomon and debt management and debt refinancing Island, IMF Country Report No. 20/49. considerations.25 25. IMF. (2020). How to Set Up a Cash Buffer: A Practical Guide to Developing and Implementing a Cash Buffer Policy, Fiscal Affairs Department, 20/04. 41 53. A target level of two months of total 56. Limited availability of large emergency domestic spending remains relevant for financing options, and the high cost of ex- the cash balances. The target level of two post borrowing, means that risk-transfer months of total spending – i.e., recurrent mechanisms should also feature in the plus domestically financed development country’s suite of fiscal buffers. Risk- spending – was first proposed by the IMF in transfer mechanisms reduce the budgetary 2009, but remains relevant today.26 Meeting cost of responding to severe disasters and the cash reserve target, however, would imply thus the need to sacrifice development a substantial increase on the current level goals and diverting public funds from other of buffers, which stood at SI$430 million at policy objectives.30 For instance, Solomon the end of 2021. Despite being about the Islands could consider expanding the use of world average, it is well below the two-month contingent credit lines like the World Bank’s threshold. Using 2021 budget estimates, Catastrophe Deferred Drawdown Option or two months of spending is equivalent to 749 the ADB’s Contingent Disaster Financing.31 million (or 5.7 percent of GDP) – implying that Another option involves parametric insurance a SI$319 million rise (74 percent) in the cash instruments, like the products offered by the balances is needed from current levels. Pacific Catastrophe Risk Insurance Company (PCRIC). 54. Next, the government could consider increasing contingency warrants in the 57. A well-developed suite of fiscal buffers would budget. The value of contingency warrants equip the SIG with the fiscal wherewithal in the 2022 budget was set at SI$20 million to effectively manage and respond to (0.01 percent GDP), which is negligible different crises. If a severe natural disaster compared to the shocks the country may hits the country, full and partial risk-transfer face. Although practices regarding the size mechanisms and a dedicated natural disaster and scope of warrants vary, in regions prone fund should provide immediate sources of to disasters, warrants are substantially larger funding. If these means are insufficient, the SIG than in Solomon Islands. As an example, the should also consider supplementary budget contingency warrants in the Philippines’ budget appropriations and the use of available cash amount to 4 percent of total expenditure or balances to provide necessary liquidity. In the roughly 0.8 percent of GDP.27 case of milder natural disasters that do not meet the drawdown triggers of risk-transfer 55. A well-managed natural disaster fund, in the mechanisms, a natural disaster fund can play range of 2–3 percent of GDP, would facilitate a key role. For all other shocks, the response the build-up of fiscal buffers without can be based on the accumulated cash buffers, endangering long-term fiscal sustainability. potentially complemented by supplementary Natural disaster funds can provide a appropriations or budget reallocations (see substantial pool of available resources for Table 5). emergency response – without relying on supplementary budgets, reprioritization of spending, or external grants. Several peer countries in the Pacific have operational disaster funds (see Table 4). National disaster funds are financed from in-budget mechanisms and invested to reduce carrying costs. They 26. The Solomon Islands: 2009 Article IV Consultation—Staff should be transparent; have well-established Report; Staff Statement; Supplement to the Staff Report; rules for drawdowns; and be funded via Public Information Notice; Statement by the Executive standing appropriations. Funds should be Director for the Solomon Islands. IMF Country Report No. 09/309. invested as to maintain a relatively high degree 27. Cevik, S., Huang, G. (2018). How to manage the fiscal of liquidity and minimize pressures on the costs of natural disasters, International Monetary Fund. banking system.28 Interestingly, Solomon 28. Cevik, S., Huang, G. (2018). How to manage the fiscal Islands has experience with a natural disaster costs of natural disasters, International Monetary Fund. fund, the Solomon Islands National Disaster 29. National Disaster Council Act from 1989. Council Fund (SINDCF), which was established 30. IMF. (2018). How to manage the fiscal costs of natural disasters, https://www.elibrary.imf.org/downloadpdf/ in 1989.29 However, misuse of funds has meant journals/061/2018/003/article-A001-en.pdf that the SINDCF has remained dormant since 31. Under its Pacific Disaster Resilience Program, the ADB 2008. extended a US$5 million contingent credit line to Solomon Islands, which disbursed in 2022, following the community transmission of COVID-19. 42 Table 4: National disaster funds in PICs Country Fund Year of establishment Annual appropriation/value of the fund New Zealand Natural 1945 Aimed at NZD 1.75 billion by 2030 (at Disaster Fund maximum in 2010, before the Canterbury (Initially, as the earthquake, the fund amounted to ca. Earthquake and War NZD 6.4 billion (2 percent of GDP) Damage Commission) Tonga National 2008 An annual appropriation up to at least Emergency Fund TOP 5 million (0.5 percent of GDP) Tuvalu Climate Change and 2015 AUD 5 million (6 percent of GDP in 2020) / Disaster Survival Fund no standing appropriation Source: National legislation Table 5: Guide for response to shocks Type of shock Scale/fiscal cost Response/sources of financing Natural disaster Large Main sources: Contingency financing/risk- transfer mechanism, natural disaster fund Other sources: Supplementary budget with expenses covered from available cash balances, inter-year reprioritization Small Natural disaster fund, virement Other shocks with revenue impact All Cash balances Other shocks with All Supplementary budget with expenses covered expenditure impact from available cash balances, virement and inter-year reprioritization Source: Own, based on Cevik, S., Huang, G. (2018). How to manage the fiscal costs of natural disasters. International Monetary Fund 43 Figure 24: Debt sustainability with restored cash buffers (Percent of GDP) 40 T 34 R R 28 22 16 10 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 Reform + buffers - Debt-to-GDP ratio Reform - Debt-to-GDP ratio Threshold Source: Authors' own calculations 58. Given the risky environment, the government 3.3 FISCAL SPACE FOR should start rebuilding fiscal buffers without, RESILIENT DEVELOPMENT however, hampering economic recovery. In light of the estimated fiscal cost of severe 59. There is a clear need to rebuild fiscal buffers, natural disasters, and considering other but also other investments are needed to socio-economic shocks, the build-up of fiscal achieve resilient and inclusive development. buffers should be around 0.5 percent of GDP Given Solomon Islands’ susceptibility to per year.32 Rebuilding the cash accounts to at (climatic) shocks, the previous section has least two months of total domestic spending shown the need to rebuild fiscal buffers. should be an immediate priority given their With a Human Capital Index in the bottom current low level and the fact they provide the 20 percent of countries worldwide, there SIG with the most flexibility. With an annual is also a clear need to invest in health and appropriation of 0.5 percent of GDP between education (see Chapter 6). The COVID-19 2022 and 2027, the cash buffers would reach crisis has shown the need to build sound the two-month target by 2027. The fiscal space social protection systems, which are currently created in the reform scenario would allow for lacking in the country, as to ensure no one such a build-up without compromising debt is left behind. Furthermore, given the large sustainability (see Figure 24). Additionally, the infrastructure deficit, investments in climate- country may consider expanding the use of risk proof infrastructure are required to improve transfer instruments – e.g., contingent credit connectivity and address uneven development. lines like the ADB’s CDFs or the World Bank’s With a large public investment pipeline coming CAT-DDOs – and establish a dedicated and on stream, yearly maintenance needs are well-functioning natural disaster fund. estimated to increase to 2.4 percent of GDP by 2025. To prevent the wasteful ‘build, neglect, rebuild’ paradigm, the SIG may direct the fiscal savings to address maintenance needs (see Chapter 7). These and other investments are needed if Solomon Islands wishes to achieve a green, resilient, and inclusive development (GRID) (World Bank, 2021). 32. This is in line with recommendations in: IMF. (2018). 2017 Article IV Consultation—Press Release; Staff Report; And Statement by the Executive Director for Solomon Islands, IMF Country Report No. 18/57. 44 Figure 25: Debt sustainability in the baseline and reform scenario (Percent of GDP) 40 34 28 22 16 10 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 Baseline - PV of debt-to-GDP Reform - PV of debt-to-GDP Threshold Source: Authors' own calculations 60. To achieve these goals, a concerted 61. Investing in new sources of growth will fiscal effort is needed, including fiscal also be key. Growth will bring additional consolidation and financial support from fiscal revenues, which will help to arrest the the international community. IMF (2022) increase of the fiscal deficit observed during estimates that yearly, 7 percent of GDP in the pandemic. As illustrated in this chapter, additional spending is required for Solomon a higher level of economic development Islands to achieve the SDG goals in health, also contributes to lower debt-to-GDP education, and infrastructure by 2030 in ratios (all other things considered equal). a climate-resilient manner. To meet these World Bank (2017; 2018) suggests that large development spending needs, fiscal the brightest prospects for future growth consolidation is needed through a combination are in better capturing value from specific of revenue mobilization and expenditure natural endowments – fish, minerals, and rationalization. This chapter has shown that tourism – plus unlocking greater productivity selected revenue and expenditure reforms from improved connectivity – domestic ICT could create much-needed fiscal space (while connections and labor mobility. Outside of a business-as-usual scenario would put the mining, however, all gains are either likely to country at a high risk of debt distress (see be only gradual or long term. Accordingly, Figure 25). However, given the sheer size of medium-term growth prospects are likely to the spending needs, sustained concessional depend on mining development, given the financing from the development community country’s abundant natural resources and will also be required.33 Furthermore, private strong international demand, with tourism sector investment and financing could play an holding significant potential over the longer important complementary role. The Tina River term. However, with pronounced uncertainty Hydropower Development Project, developed around the economic outlook – including in as a public–private partnership (PPP), could the mining sector (see Chapter 4), rebuilding provide a valuable benchmark in this respect fiscal buffers and creating fiscal space through (see Chapter 7). consolidation should remain a priority. 33. IMF (2022) estimates that without fiscal reform, 4.4 percent of GDP in additional grants are needed every year to achieve the SDG targets. In a reform scenario with a front-loaded fiscal adjustment, the SDG spending goals could be met with an additional 1.5 percent of GDP in grants. Given the current geopolitical environment in the region, Solomon Islands may well see increased aid flows going forward. 45 chapter 4 GETTING REVENUE REFORMS ON THE ROAD 46 62. This chapter examines the revenue 4.1 INTRODUCTION generating potential of the mining sector and the government’s tax reform agenda. 63. The SIG is currently reviewing its national With logging revenues on the decline and an tax system as part of a larger fiscal reform uncertain economic outlook, the previous agenda. First, is a revision of taxes on goods chapter has shown there is a clear need and services and the potential introduction for new sources of revenue. This chapter of VAT. Second, the SIG is pursuing major discusses how the government’s tax reform tax administration reforms with the core agenda – with the introduction of VAT, and objective of increasing collection by addressing reforms to tax administration and the mining non-compliance. This includes: (i) the sector – can contribute to fiscal sustainability implementation of Medium-Term Revenue and economic growth. The chapter also Strategies (MTRS), (ii) a change in the highlights the risks and challenges ahead. functional structure of the Solomon Islands Inland Revenue Department (SIIRD) and the implementation of the Large Taxpayers Office (LTO), (iii) the introduction of e-tax, (iv) a strengthening of the audit function, and (v) an improvement of tax debt and return management. Third, the SIG is developing a fiscal regime for the extractive sector as new mining projects are in the pipeline. All reforms are at an advanced stage of implementation. Successful implementation of these reforms will improve the efficiency and equity of the tax system and help the SIG fill revenue gaps left from the decline in logging. The reforms will also allow the country to build fiscal buffers and create the fiscal space for more effective spending. 47 Figure 26: Tax Revenue (2019–2020) 64. This chapter provides an additional (SBD million) analysis of the SIG’s tax reform agenda. Following a description of the tax system and its challenges, which provide a rationale 3000 for reform, three substantive topics are Other tax and customs revenue addressed. First, this chapter considers a 2500 range on Taxes goods and of scenarios services for the introduction of a 2000 broad-based consumption tax, examining in detail the revenue and distributional 1500 characteristics of different configurations 1000 of VAT. Second, it quantifies the revenue impact of improving collection efficiency via 500 administration reforms. And third, it briefly analyzes the fiscal regime of the mining sector. 0 2020 2021 Taxes on goods and Other tax and customs services revenue 4.2 RATIONALE FOR TAX SYSTEM REFORM Source: World Bank staff calculations based on data from MoFT 65. Presently, the system of taxes on goods and services is highly fragmented. Multiple indirect taxes are charged on goods and services: (i) Goods Tax, (ii) Sales Tax, (iii) excise duty, (iv) accommodation levy, and (v) stamp duty. Each of the taxes and levies in this framework has its own legislation Figure 27: Taxes on goods and services and obligations. There is also fragmentation (2019–2020) in terms of the tax bases and applicable rules. Goods Tax is charged on all goods; Excise triggered either on the sale by a domestic manufacturer or wholesaler to a retailer, or on Stamp duty the importation. The rate applicable to locally manufactured goods is 10 percent, whereas Accommodation levy the rate of 15 percent is charged on the implied wholesale price value of imported goods. Sales Tax The most notable exemptions from Goods Tax include rice, pharmaceuticals, medical Goods Tax (on import) products, and government purchases. Services are outside of the scope of Goods Tax. Goods Tax (domestic) Twenty-two groups of selected services and goods fall under the parallel regime of Sales Tax. Most of these categories are taxed ad Goods Tax (domestic) Accommodation levy valorem at 10 percent, whereas certain groups Goods Tax (on import) Stamp duty of products and services attract various Sales Tax Excise ‘specific’ rates. Accommodation services and transfer of real estate are not covered by Source: World Bank staff calculations based on data from MoFT Sales Tax provisions. The former is subject to Graph sizes a 10 percent accommodation levy, the latter 1 coloum: 70mm x 42 – to a stamp duty with the rate varying from 2 coloumns: 155 X 42 0 to 4 percent depending on the value of the transaction. Excise in Solomon Islands is levied c2 2020 2021 only on tobacco and alcoholic beverages. 130 x 42 if text on lef Petroleum products and vehicles are not subject to excises but are taxed in other ways (import duties and license fees respectively). 48 66. Taxes on goods and services are a crucial Figure 28: Productivity of taxes on goods and source of the SIG’s revenue, accounting for services vs. the prevailing rate (Percent of GDP) 35.6 percent of the overall tax and customs revenue in 2020 (Figure 26). Goods Tax accounted for two-thirds of revenue from taxes 20 Ma on goods and services and with 38 percent collected on imported goods (Figure 27). WSM The revenue contribution of excise was also 15 VUT substantial – with 60 percent of total excise TON revenue coming from taxing tobacco products, FJI whereas the other taxes on goods and services 10 accounted for a relatively minor share of the SLB revenue (around 10 percent of the revenue from taxes on goods and services). PNG 5 67. The productivity of taxes on goods and 0.08 0.10 0.12 0.14 0.16 Main rate services in Solomon Islands is low and lower than regional peers. In 2019, the ratio Source: World Bank staff Calculations based on UNU WIDER and of revenue from taxes on goods and services IMF data in 2019 or most recent year available to net household final consumption fell Note: Countries with blue labels operate VAT whereas labels in below 10 percent. In other words, assuming aqua stand for a turnover/sales tax in place. theoretical full compliance, a consumption tax The yellow line is a fitted linear curve/trend for six countries included in the analysis. with a uniform rate of 10 percent on all final consumption categories would bring higher revenue than the application of cascading and overlapping Goods and Sales taxes, excise, and other levies on goods and services. Revenue from these taxes in Solomon Islands is also significantly below the trend of tax revenue and prevailing statutory rate observed in the region (Figure 28).34 In other words, the productivity of taxes on goods and services is lower than the statutory rates would imply. If Solomon Islands reached a level of productivity of taxes on goods and services on par with the observed average in the region, revenue would Lorem ipsum Lorem ips increase by 4 percent of GDP without changes to the rates’ structure. Productivity of sales and goods taxes in Solomon Islands is lower 80 than the productivity of VAT operated by its peers, despite higher statutory rates and the 70 ability to deduct input tax in VAT 60 credit systems.35 50 68. Productivity of income taxes in Solomon 34. Solomon Islands applies two major rates to taxable goods 40 Islands, in contrast, is high compared to and services, 10 percent – which is the major rate for sales other countries in the region. Revenue from tax and domestically produced goods, and 15 percent – which 30 is the rate on imported goods. taxes on income, profits, and capital gains 35. 20 Higher overall burden tends to impede efficiency of amounted to 7.8 percent of GDP, which was collections whereas the cascading effect of turnover taxes higher than in peer countries: Fiji (6 percent of 10 increases its effective burden compared to VAT. Samoa, GDP), Papua New Guinea (7 percent), Samoa Tonga, and Vanuatu are operating a VAT with the standard 0 of 15 percent, whereas Fiji applies a 9 percent rate on rate (5.9 percent), and Tonga (4.7 percent),36 the vast majority of goods. Due to unavailability of household despite comparable rates to other PICs.37 The final consumption for some of the countries, GDP is used as a PIT rates in Solomon Islands vary from 0 to proxy of tax base. 36. Sample included all countries in the region with available 40 percent depending on yearly income. The data. Source: UNU-WIDER. CIT rate for companies established in Solomon 37. CIT rates in Fiji, PNG, Samoa, and Tonga vary from 10 to 30 Islands is 25 percent, whereas the rate on percent for resident companies and from 20 to 48 percent for income of foreign companies is 35 percent. non-resident companies. Top marginal PIT rate ranges from 20 to 42 percent. 49 69. Non-compliance and the narrow tax base are 71. The inefficiencies and incentives created likely the major cause of foregone revenue by the unwieldy tax system can hamper from taxes on goods and services. In 2015, economic growth. As there is no credit there were only 90 active Goods Tax registrants system for input tax in place, multiple taxes and 96 percent of collections came from create cascading effects with businesses’ manufacturers/wholesalers with a turnover intermediate use often taxed more than once of more than SI$10 million. This indicates in the value-added chain.39 By imposing a that most smaller manufacturers do not pay high burden on business inputs, the system taxes and remain in the underground/informal discourages specialization and puts exporters economy. Taxes are naturally not charged at a disadvantage compared to countries on certain transactions: own production of with fully refundable input VAT for exports. agricultural and other goods, non-monetary Furthermore, any manufacturing that requires transactions, or goods and services that are imported inputs is at a disadvantage, which very difficult to tax (e.g., imputed and actual could result in higher imports of final goods and rents) or remain untaxed due to social reasons less imports of intermediate goods if cascading (e.g., basic food items, pharmaceuticals, and taxes make it too expensive to produce these education). The ratio of Sales Tax revenue to goods domestically. The costs related to input household consumption of services was only tax, as well as fragmented and overlapping tax around 5 percent in 2017; suggesting that the bases of different taxes on goods and services, provision of only around half of services was make the system unfair and discouraging for taxed, with the other half untaxed due to non- the private sector and foreign investment. compliance or because they fell outside of the tax base.38 A contributing factor is likely to be the outdated and incomplete list of services 4.3 THE INTRODUCTION OF VAT covered by the Sales Tax, which excludes various communication, household, and 72. Many of the problems related to the entertainment services. tax system in Solomon Islands could be minimized by the introduction of a single 70. Compliance costs borne by businesses broad-based goods and services tax with are likely to be elevated by very high a credit system for input tax. Value-added fragmentation of the tax system. Parallel tax (VAT), by its design, reduces distortions tax systems with separate legislations, to competition compared to turnover taxes different tax rules, overlapping tax bases, and such as a Goods Tax or Sales Tax. The ability to obligations create unnecessary inefficiencies deduct input tax creates incentives to register. and increase costs of collection incurred by the It makes the system fairer, as the tax burden tax administration. Sales Tax, accommodation on final goods and services depends on the levy, and stamp duty account for around 10 use of intermediate inputs. It also can promote percent of revenue from taxes on goods and exports by removing hidden tax burdens on services and could be well incorporated by a exported goods. If well designed, VAT could single consumption tax with a broad tax base. broaden the tax base which, together with increased collection efficiency, could lead to significant increases in tax revenue. 38. Own calculations based on Solomon Island National Statistical Office. Although the tax is also charged at purchases of services by economic operators (i.e., for intermediate use), the ‘effective rate’ on services is calculated with respect to household final consumption, which makes ‘50 percent’ a conservative estimate. 39. As an example, business services provided to a manufacturer will be taxed at a 10 percent Sales Tax as well as at their value added when the produced goods are sold to a retailer. 50 73. VAT is operated by most of the Solomon In addition, the scope of exemptions in Islands’ regional peers, including Fiji, Kiribati, particular countries contain agricultural PNG, Samoa, Tonga, Tuvalu, and Vanuatu. products and production inputs, transport The VAT systems implemented by other services, electricity, and water supply (Table countries in the region share many similarities. 6). To reduce the burden on small operators, The systems are relatively simple with a there are VAT registration thresholds single statutory rate and some concessions in place varying from the equivalent of granted in the form of exemptions with and US$34–70 thousand.40 Such thresholds without the right to deduct input tax. The are high compared to VAT systems in high- concessions have a rather limited scope and income countries, but they reflect elevated are restricted mostly to financial services, compliance and enforcements costs. education, and medical services. These groups of services are mostly exempt with no right to deduct, which reduces compliance costs for taxpayers but leaves the burden of hidden input VAT in the value-added chain. 40. Situation in 2021. Table 6: VAT systems in selected peer countries Fiji Kiribati PNG Samoa Tonga Vanuatu Year of 1992 2014 1999 1994 2005 1998 introduction Standard rate 9% (reduced 12.5% 10% 15% 15% 15% from 15% in (increased 2016) from 12.5% in 1998) VAT FJD 100,000 AUD 100,000 PGK 250,000 WST 130,000 TOP 100,000 VUV registration (approx. USD (approx. USD (approx. USD (approx. USD (approx. USD 4,000,000 threshold 45,000) 70,000) 70,000) 50,000) 40,000) (approx. USD 34,000) Main Financial Financial Financial Financial Financial Financial exemptions services, services, services, services, services, health services, without educational pharmaceuticals, educational bus and taxi care services, educational the right to services, health care services, services, pharmaceuticals, services deduct gambling, services, educational domestic bus and taxi sugar cane educational services, water services, services medical transport, educational services, selected services, public road telecom selected telecom transport, services services, newspapers, selected gambling agricultural goods and inputs to production Specific Medical Educational Electricity, water exemptions supplies, services, supply with the right supplies to electricity, to deduct religious, water supply charitable or educational institutions Source: National legislation 51 74. In addition to regional experience, there is 76. In the scenarios, financial, educational, and a large body of practice in designing VAT health care services are exempt from VAT. systems. These practices include: (i) setting Collecting VAT on these services is difficult and a broad tax base including all monetary may go against social goals.43 Extending the transactions for newly produced goods, (ii) scope of exemptions above the basic catalogue introducing exemptions with the right to deduct – e.g., for redistributive objectives – would granted to export, international transport, and decrease the tax base and lead to a potentially purchases of diplomats, (iii) introduction of higher VAT rate on non-exempt goods and exemptions without the right to deduct granted services. Furthermore, a separate treatment for education, financial, and medical services, for different goods and services creates and (iv) setting the VAT registration threshold additional compliance costs for businesses exemption for small companies, for which the and the tax administration, also creating a cost of VAT collection, both for taxpayers and risk of tax avoidance and evasion.44 Income administration, would be high compared to taxes are therefore better suited for meeting potential receipts.41 redistribution objectives (see discussion on the redistribution role of VAT in Box 3). 4.3.1 Scenario analysis for VAT introduction 77. Decreasing the tax burden on basic 4.3.1.1 Assumptions foodstuffs may have positive distributional impacts.45 The share of expenditure on basic 75. Scenario analysis for VAT introduction foodstuffs in Solomon Islands was over 50 in Solomon Islands takes into account percent for the poorest households (first best international practices and regional income decile) and below 20 percent for experiences (Table 7). Three of the four last income decile (see Figure 29). Although scenarios considered, including the baseline, purchases of such goods will remain partially include a statutory standard rate of 15 untaxed, the purchases in shops and imported percent – the rate used by Samoa, Tonga, products would be taxed at 15 percent. and Vanuatu. Such a rate is expected to be To analyze how VAT may affect the poor, revenue neutral after replacing other taxes two alternative scenarios were reviewed. and duties on goods and services (Goods Tax, Alternative #1 assumed that the exemption Sales Tax, accommodation levy, and stamp with the right to deduct is implemented, i.e., duty) in the moment of VAT introduction. As an taxpayers could reduce their liability by the alternative (Alternative #3), the revenue impact value of tax paid on intermediate goods and of the standard rate set at 10 percent was services purchased. Alternative #2 assumed tested, which is the current rate of Sales Tax that basic agricultural goods and foodstuffs in Solomon Islands and the VAT rate applied were subject to the exemption without the right by PNG. The envisaged registration threshold to deduct (see Table 2). in all the scenarios is in the range of values observed in the region, between SI$400,000 and SI$600,000. Such a threshold excludes small business, for which compliance with VAT obligations would be disproportionately large, 41. For the discussion on rationale for concessions see Keen, but maintains a broad base that would shrink, M. (2013). The Anatomy of the VAT, IMF Working Paper, if the threshold is higher.42 WP/13/111. 42. The VAT registration threshold should be set appropriately high as not to increase the compliance burden on the smallest companies. At the same time, the system should be broad and enable the inclusion of a maximum number of taxpayers. A threshold between SI$400,000 and SI$600,000 meets these criteria. The analysis of revenue impacts of different thresholds was not possible due to the unavailability of firm-level fiscal data. 43. Specific health care and education services – such as tertiary education – are not exempt in many modern VAT systems, as such exemptions may be regressive. However, the granularity of expenditure data did not allow for the simulation of models with such services subject to VAT. 44. Abramovsky, L., Phillips, D., Warwick, R. (2017). Redistribution, efficiency and the design of VAT: a review of the theory and literature, IFS Briefing Note BN212. 45. This category includes bread and cereals (CP0111), fruits (CP0116), and vegetables (CP0117). 52 Table 7: Scenarios for VAT Baseline Alternative #1 Alternative #2 Alternative #3 Standard rate 15 percent Revenue neutral Revenue neutral 10 percent compared to compared to 15 percent 15 percent VAT registration Average in the Average in the Average in the Average in the threshold region – between region – between region – between region – between SBD 400k and 600k SBD 400k and 600k SBD 400k and 600k SBD 400k and 600k Main exemptions Financial, Financial, Financial, Financial, without the right educational, and educational, and educational, and educational, and to deduct input medical services medical services medical services, medical services tax agricultural goods, and basic foodstuffs Specific Basic agricultural exemptions with goods and the right to deduct foodstuffs input tax Source: Own elaboration BOX 3: REDISTRIBUTION ROLE AND EFFICIENCY OF VAT The simplest VAT systems with the broadest tax The response to this question varies substantially base impose a uniform rate on domestic use of across countries. In the EU, for which comparable all goods and services excluding or exempting information is available, the revenue losses from the elements that are difficult to be taxed either applying preferential treatment, the so-called because they are not offered at market prices Actionable Policy Gap, ranges from 3 percent (public services), because it is difficult to define (Denmark) to over 31 percent (Luxembourg) of, so- the tax base (financial and insurance services), or called, notional ideal revenue. The average revenue because it is cumbersome to define the place of loss was about 16 percent of the theoretical supply (international transport). revenue with most EU Member States applying preferential treatment to foodstuffs and a broad In practice, many tax systems make exemptions range of services. and apply lower VAT rates to a much broader list of categories of goods and services mostly Compared to the EU and other high-income because of income redistribution objectives. economies, the application of preferential Many countries apply preferential treatment to treatment to goods and services is relatively foodstuffs and other necessities. As such, the narrow in the VAT systems in PICs (see Table 2). VAT burden on poorer households, which spend In low and middle-income countries, introduction relatively larger portions of their income on such of a flat VAT rate system, which is efficient and goods, is reduced by more than the burden on less costly for taxpayers and administration, richer households. However, since not only poor could be crucial for raising the revenues that allow households consume necessities, targeting real for the development of more efficient income income by consumed product categories cannot redistribution measures. In addition, VAT rate be fully accurate. This poses a question whether differentiation creates distortions as it affects VAT should be used as an instrument for income household consumption. Different treatment of redistribution or whether there are better-suited similar services is also a source of tax avoidance tools for this. and evasion due to misalignment of applicable rates. 53 4.3.1.2 Results 79. The adoption of a VAT system with a 10 percent standard rate (Alternative #3) 78. A VAT system with a 15 percent standard would lead to a significant decrease in rate is estimated to be revenue neutral revenue. The drop in revenue is estimated at the moment of its introduction.46 If the at about one-third of the current revenue efficiency of tax collection remained at the from tax and levies on goods and services. current level, the revenue from VAT on imports In the scenario of a decreased average tax would be in line with the revenue collected burden, positive impacts on economic activity currently by customs at the 15 percent rate and compliance should be expected. Yet any of Goods Tax. The revenue collected from potential increase in collection efficiency and domestically produced goods would also growth of tax base in the longer-term would not remain broadly unchanged. Although the VAT be sufficient to fully compensate for foregone rate would be higher than the rates currently revenue from lower effective rates (see the in place and the tax base would be broader, Appendix for tax revenue decomposition), the ability to deduct input tax would reduce which would create substantial fiscal losses. the tax burden compared to the turnover taxes currently in place. Assuming the 2019 tax base, the revenue from VAT would amount to SI$767 million, which is nearly the same as the revenue collected from the Goods Tax, Sales Tax, stamp duty, and accommodation levy 46. See Annex 3 for assumption and methodology (see Table 8). used in the simulation. Table 8: Estimated revenue for alternative tax systems (Simulation for 2019) 2019 revenue VAT scenario: VAT scenario: VAT scenario: VAT scenario: from replaced Baseline Alternative #1 Alternative #2 Alternative #3 taxes on goods (17% SR, (16% SR, (10% SR) and service foodstuffs foodstuffs exempt with exempt with no the right to right to deduct) deduct) Goods Tax (customs) 353 - - - Goods Tax (domestic) 313 - - - Sales Tax 76 - - - Stamp duty 15 - - - Accommodation levy 9 - - - VAT - customs - 353 348 328 235 Domestic VAT - 414 414 440 276 Total revenue 766 767 762 768 511 Source: Own elaboration based on various data sources, see Annex 3 54 Figure 29: Household consumption structure in Solomon Islands (By income decile) .10 .8 .6 .4 .2 0 D1 D2 D3 D3 D5 D6 D7 D8 D9 D10 Basic foodstuffs Medical services Education Other Source: World Bank staff calculations based on HIES (2012) Figure 30: VAT productivity after implementation in selected countries (Percent of GDP) 8% 7% 6% 5% 4% 3% 2% 1% t t+1 t+2 t+3 t+4 Antigua and Barbuda Bahamas Guyana Kiribati Source: World Bank staff calculations based on UNU-WIDER 10 Other 8 Education Figure 31: VAT productivity after implementation in four selected countries, average (Percentage point y-o-y change) 6 Medical services Basic foodstu s 2.0 4 1.5 2 1,0 0 D1 D2 D3 D3 D5 D6 D7 D8 D9 D10 0,5 0.0 -0.5 t+1 t+2 t+3 t+4 Mean change y-o-y Source: World Bank staff calculations based on UNU-WIDER 55 Figure 32: Impact of introducing an exemption on basic foodstuffs and agricultural goods on real income (Percent of pre-VAT income) 3.0 2.5 2.0 1.5 1.0 0.5 0 -0.5 -1.0 -1.5 -2.0 -2.5 D1 D2 D3 D4 D5 D6 D7 D8 D9 D10 Exemption with the right to deduct Exemption with no right to deduct Source: World Bank staff calculations based on HIES (2012/13) and other data sources, see Annex 3 Ot Se Ind 80. The efficiency gains from the adoption of 81. To maintain the level of revenue and achieve VAT are expected to gradually increase tax progressive redistribution, the standard rate Ag receipts. The availability of more efficient would need to be set at 16 or 17 percent, tax instruments does not only have positive depending on the right to deduct. Such higher growth implications but also increases tax-to- rates would compensate for the revenue lost GDP ratios. The empirical literature suggests from the importation and domestic sales of that countries that adopt VAT perform better basic foodstuffs by registered VAT-payers. A in terms of revenue collection than countries statutory standard rate of 16 or 17 percent rate that operate simple turnover taxes, due to would be higher compared to regional peers. incentives provided by the credit system Furthermore, imposing such a high rate would under the VAT regime.47 Evidence from four strengthen the incentives not to comply. That comparator countries that have introduced is, businesses selling standard-rated goods VAT – Antigua and Barbuda, Bahamas, Guyana, and services would be tempted to move their and Kiribati – corroborates this finding (see activity to the informal economy. Due to the Figure 30). Figure 31 indicates that the largest relatively larger share of domestic production increase in VAT productivity was observed in of foodstuffs, it would also decrease the share the year after VAT introduction. of revenue collected by customs and it would put additional strain on inland revenue services (see Table 3). 47. Ebrill, L. P., Keen, M., & Perry, V. J. (2001). The Modern VAT, USA: International Monetary Fund. 56 Figure 33: Revenue growth with and without VAT adoption (2020=100%) 160% 150% 140% 130% 120% 110% 100% 90% 80% 2020 2021 2022 2023 2024 2025 2026 VAT adoption Baseline scenario Source: World Bank staff calculations 50 40 30 82. 20 The distributional consequences of 4.3.2 Policy implications exempting basic foodstuffs would be positive 83. In conclusion, the introduction of VAT could 10 but relatively modest. The after-tax Gini bring large efficiency gains, increase fairness coefficient,48 currently estimated at 42.4, of the tax system, and provide a stimulus 0 would fall to 41.7 in the case of exemptions to growth for Solomon Islands. To maximize with the right to deduct, and to 41.9 percent these gains and secure sufficient revenue, the in the case of exemptions without the right to system should be simple and have a broad tax deduct. The introduction of the exemption with base. The system with a 15 percent standard the right to deduct input tax would increase rate, basic concessions introduced for health the real income of the lowest income decile Lorem ipsum care, Lorem and financial education,Lorem ipsum ipsum services, and an by around 2.5 percent. At the same time, the average VAT registration threshold would be income of the richest households would fall revenue neutral at the moment of introduction. by 2 percent compared to the flat VAT rates 80 Compared to the system of fragmented system. In the case of exemption without consumption taxes currently in place, VAT 70right to deduct, the impact would be 20 the implementation could bring substantial percent milder, as hidden VAT would appear in 60 revenue gains through increasing efficiency the value-added chains of agriculture and food of VAT collection and positive impacts from 50 manufacturing, likely leading to price increases. growth in the tax base. If a VAT is implemented The 40 modest impact on income inequality in 2024, modelling suggests a 5-percentage statistics suggests that imposing breaks in the 30 point gain in overall tax revenue by 2026 consumption tax system may be relatively less (see Figure 33). efficient 20 in fighting income inequalities than the income tax system. 10 0 48. Gini coefficient is a measure of income inequality that takes values from 0 to 100. The lower the Gini coefficient, the more equal the income distribution is. 57 84. While exempting foodstuffs would have 4.4 TAX ADMINISTRATION REFORMS modest impacts on income inequality, it reduces the efficiency of the tax system. 86. Revenue foregone due to non-compliance is Furthermore, to ensure sufficient revenue, the likely to be substantial in Solomon Islands. introduction of exemptions on basic foodstuffs Although precise estimates of compliance and would require setting a higher standard rate, tax policy gaps are unavailable, several partial which may incentivize non-compliance and and indirect indicators suggest that non-filing create an increased burden on the revenue of returns and non-payment of liabilities are administration. If the government prefers the an important source of foregone revenue. For VAT to have a distributional role, it is advisable instance, the total value of tax debt in 2019 to take a gradual approach and implement is estimated at SI$2.6 billion,50 equivalent to any additional exemptions after the basic 90 percent of tax revenue. Furthermore, the system is fully operational and teething issues actual level of non-compliance is likely to be are resolved. Alternatively, the government higher than the observed level of tax debt. could introduce a fiscal package that has 87. The stock of accumulated tax debt, on-time spending measures targeted at the poor (e.g., filing rates, and audit assessments also an adaptive social protection system), which confirm significant problems with non- would also help with building popular support compliance of large taxpayers. In 2019, after for the VAT. clearing tax arrears and penalties, the stock of 85. Achieving efficiency gains from the tax debt of the largest companies amounted adoption of VAT requires critical capacity to SI$168 million. Following the introduction building and ways to mitigate VAT fraud and of the Large Taxpayers Office (LTO), tax debt challenges related to refund managment. dropped by nearly 50 percent in 12 months.51 The adoption of VAT requires amending Tax audit assessments generated SI$135 many rules and regulations, which could lead million in tax recovery – 7.2 percent of total to administrative bottlenecks and delays. tax revenue in 2017, with the average audit Relatedly, the introduction of VAT may create yielding SI$1.5 million in tax debt.52 These opportunities for tax credit fraud – e.g., fake developments signal considerable potential for invoices and overstated deductions – that revenue increase and provide a strong rationale could substantially reduce VAT’s potential to for tax administration reform. raise revenue and increase the fairness of the tax system. Lack of critical audit functions and limited capacity at SIIRD may lead to delayed refunds and a breakdown of trust in the tax system. This, in turn, could create an excessive burden (on exporters) and trigger increased tax evasion. To address these issues, capacity building and resources are needed for invoice verification, among other actions. It will also be important to precede the introduction of VAT with an information campaign, including on the potential sources of non-compliance.49 If not, there is a substantial risk of foregone revenue after VAT adoption. 49. Important to note that the Asian Development Bank will provide wide-ranging technical assistance – including an expert in VAT systems and business processes – to support the implementation of the country’s tax reform agenda. 50. IMF. (2020). Solomon Islands: Strengthening Tax Debt and Return Management, IMF Technical Report. 51. IMF. (2020). Solomon Islands: Reviewing Implementing of the Large Taxpayer Office, IMF Technical Report. 52. IMF. (2018). Solomon Islands: Reviewing Tax Administration Reforms, IMF Technical Report. 58 88. Improving collection efficiency is therefore • The implementation of a medium- a priority for the SIG. Collection efficiency term revenue strategy (MTRS) will is the proportion of the tax liability that is facilitate gradual improvement of tax actually collected, relative to the amount that compliance over the next 4–6 years. could be collected based on the tax base and The MTRS aims to provide a roadmap and statutory tax rules.53 The main component of management framework for reforming the collection efficiency is tax compliance, both functioning of the tax system as a whole, voluntary and forced by the risk of potential and improvement of tax compliance, in sanctions. Generally, governments have three particular. As one of the interdependent broad strategies for building compliance: components in the reform agenda, the (i) strengthening the prevention role of MTRS will set a revenue mobilization target enforcement, (ii) facilitating tax compliance which should encompass revenue gains by reducing its cost, and (iii) building trust from increasing tax compliance. It will to encourage more voluntary compliance. facilitate monitoring revenue targets and Increases in tax collection efficiency can also support the implementation of measures to arise from areas outside of compliance, such increase tax compliance. as direct enforcement of tax payments in the • The creation of a Large Taxpayers Office form of audits and tax debt recovery. (LTO) is aimed at enforcing compliance 89. The first impacts of the SIG’s tax of large taxpayers. Given the country’s administration reforms are already evident, unique characteristics, there is a need for but further increases in domestic resource taxpayer segmentation and ringfencing of mobilization are expected if the following entities with a large turnover (exceeding reforms are implemented in full: SI$50 million). As few as 50 taxpayers in Solomon Islands contribute around two- • The new legal framework for the fifths of total tax revenues and 10 percent tax system is provided by the Tax of taxpayers bring in around four-fifths. Administration Bill, which has been These large taxpayers differ from others, presented in Parliament. The TAB clarifies not only by the volume of transactions powers, functions, and duties of the Inland but also due to their involvement in Revenue Division, the Commissioner of international transactions, unique sectoral Inland Revenue, and tax officers. It outlines characteristics (such as in the financial the general obligations of taxpayers, tax and mining sectors), their complicated representatives, and tax agents. It includes organizational structures, and their ability several elements aimed at decreasing to implement tax avoidance strategies. The compliance costs and facilitating specific objectives of the LTO are to monitor enforcement of tax payments. Among the payment of taxes and take action in these, it provides the right to object to tax case returns are not submitted or taxes decisions and appeal to the High Court and remain unpaid. The LTO is also tasked with the Court of Appeal. It also regulates the conducting audits of high risk cases. powers for recovering tax and prosecuting • Within the first months, the LTO has offences, and the types of penalties for already achieved impressive results, non-compliance, including late payment including an 8-percentage point interest. The Bill also lays down the improvement in on-time filing and a procedures related to the implementation 20 percent reduction in tax debt. The of e-tax and electronic issuance of tax LTO has already commenced its basic assessments. operations, but further roll-out plans were delayed by the COVID-19 pandemic. The extent to which further compliance and revenue gains are achieved will depend on management, staffing, and other activities including the strengthening of tax audit functions, modernization of IT systems, and organizational reforms by SIIRD. 53. Collection efficiency is closely related to tax productivity which is defined as the ratio of tax revenue over the theoretical tax base. (See Annex 3 for more detail). 59 • The introduction of an e-tax system, 92. In addition, more effective audit procedures which is already available for SIIRD and collection of outstanding tax debt customers, could increase voluntary could further boost the growth of tax compliance. SIIRD customers can already revenue. An increase in the number of audit lodge returns and summaries for ‘pay as procedures and efficiency of audits could you earn’ (PAYE), Goods Tax and Sales Tax; bring an additional SI$55 million in revenue. make payments for these taxes; check If the SIIRD is also successful in reducing account balances for all tax types; make outstanding debt of taxpayers, revenue would enquiries with the Inland Revenue Division further increase. Assuming all SIIRD goals are (IRD); and track progress of responses. The met,57 total tax revenue between 2022 and implementation of the e-tax is a first step in 2026 would increase by over 11 percentage further digital reporting requirements and points over the period 2022–2026, compared data matching (as implemented in Fiji and to a counterfactual scenario that assumes no Tonga, see Box 4). increase in collection efficiency (see Figure 34). • SIIRD is in the process of strengthening 93. Importantly, if realized, growth in tax its tax audit function. In addition to revenues would be faster than the expected improving the audit function, to ensure growth in the economy. This boost to revenue that the declared and assessed taxes are would provide the foundations for the SIG collected without delay, SIIRD has set an to cover revenue gaps left by the decline objective of improving tax debt and return in logging activities, while also potentially management.54 facilitating the accumulation of necessary fiscal 90. These reforms aim to improve collection buffers and decreasing risks for debt distress. efficiency through different means. Increased However, experience from other countries capacity of audit procedures aims to reduce indicates substantial inertia in reducing incentives for non-compliance, whereas the non-compliance due to political economy e-tax is expected to decrease compliance considerations and interest group politics. costs of taxpayers and facilitate paying taxes. It will therefore be key to improve voluntary In turn, more efficient administration is likely compliance by easing the administrative to improve the perception of fairness and tax burden, enhancing risk-management, and trust by taxpayers. creating effective information campaigns. 91. If the reforms are fully implemented, analysis suggests that tax collection could increase by more than 11 percent compared to a counterfactual scenario, with no changes in collection efficiency (see Figure 34).55 This corresponds with an improvement in compliance of 2 percent per annum, which is realistic given the widespread prevalence of non-compliance. The revenue-to-liability ratio would rise by more than 10 percent between 2022 and 2026 compared to a no-reform scenario.56 Next to increased willingness to pay taxes, SIG’s cashflow is expected to improve due to increased timeliness of declarations and payments. Furthermore, if the share of on-time payments of tax liabilities by large business would increase from 85 to 54. IMF. (2020). Solomon Islands: Strengthening Tax Debt and Return Management, IMF Technical Papers. 95 percent, revenue would jump once by over 55. See the Annex 3 for more detail on the data and method used 4 percent, relative to baseline. for arriving at these estimates. 56. As implied by the results obtained by Akitoby, B., Honda, J., Miyamoto, H., Primus, K., Sy, M., & Keen, M. (2019). Case Studies in Tax Revenue Mobilization in Low-Income Countries, IMF Working Papers, 104, collection efficiency in selected LICs increased by over 10 percent in 5-years’ time during episode of implementing important reforms. 57. See: SIIRD. (2021). Solomon Islands Inland Revenue Department Large Taxpayer Compliance Improvement Strategy. 60 BOX 4: MEASURES AIMED AT INCREASING TAX COLLECTION EFFICIENCY IN BEST PERFORMING PEER COUNTRIES Fiji Tonga High productivity of VAT and other taxes in Fiji Similarly, to Fiji, the performance of Tonga’s is the result of the country’s efforts to increase tax administration has been quite impressive.58 tax compliance. Among other measures, Good practices include third-party data matching, the government implemented a real-time supported by dedicated field activities and the data collection and retention system for VAT use of withholding systems that facilitate tax purposes. Furthermore, a digital invoice regime collection. Tonga also aims to improve voluntary was gradually introduced from 2016 with the tax compliance, among other means, by objective of providing automatic, real-time, and increasing transparency and accountability. encrypted reporting of all taxable (both B2B and B2C) transactions. The minimum increase in revenue after full enrollment of the system was estimated at FJD 185 million (8.6 percent of overall tax revenue) in FY 2019-20. In addition to the introduction of digitization in recent years, Fiji implemented a medium-term revenue recovery 58. See: Sapere Research Group. (2014). Evaluation of taxation reform in the Pacific; and IMF. (2021). strategy, strengthened the tax audit function, and Tonga TADAT Performance Assessment Report, implemented a skills development program. IMF Technical Reports. Figure 34: Revenue growth with and without increased collection efficiency 180% 170% 160% 150% 140% 130% 120% 110% 100% 90% 80% 2020 2021 2022 2023 2024 2025 2026 Efficiency improvement Baseline scenario Source: World Bank staff calculations 61 4.5 TAX REVENUE FROM THE 95. Since 2016, the mining sector has had a minimal contribution to GDP and exports. EXTRACTIVE INDUSTRY Mining was limited to bauxite deposits on 4.5.1 Context and challenges Rennell. Next to bauxite mining, artisanal gold mining takes place in some locations. Since 94. Despite an abundance of mineral resources, 2016, mining activity contributed less than Solomon Islands has failed to develop 0.5 percent of GVA. According to the National sustainable production of mineral resources Statistics Office of the Solomon Islands, in over the past two decades. The challenges in 2019 and 2020, overall GVA of the mining and developing stable mineral production are partly quarrying sector amounted to SI$28 million related to Gold Ridge Mine in Guadalcanal. and SI$23 million, respectively. However, Due to repeated social tensions, economic according to CBSI, mineral exports – mostly challenges, and unsuccessful negotiations bauxite – amounted to SI$162 million in 2019, between the government and landowners, corresponding to 4.6 percent of total exports the mine has ceased its production a number of goods and services. of times since the beginning of exploration in 1996. During the most recent production 96. As bauxite mining has been exempt from period, between 2011 and 2013, the mine export duties, the production of minerals on generated some 1.5–2 tons of gold annually Rennell generated royalties, income taxes, and contributed to 95 percent of the export of and tenement fees. Total payments made precious and base metals. At the peak of its by the mine in the form of taxes and fees operation in 2011, the quarrying and mining was SI$131 million in 2020. The total value sector contributed to 5.8 percent of Gross of royalties in 2020 was ca. SI$35 million, Value Added (GVA) in Solomon Islands (see whereas the value of tenement fees was ca. Figure 35). SI$1 million. The total direct contribution to overall government tax revenue was ca. 5 percent. Figure 35: Gross value added of mining and quarrying (2008–2020) (SBD million; percent of GVA) 600 12% % of 500 10% 400 8% 300 6% 200 4% 100 2% 0 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 % of GDP, right axis SBD million, left axis Source: World Bank staff calculations based CBSI 12% 10% 8% 6% 62 4% 2% BOX 5: GOVERNANCE CHALLENGES FOR THE MINING SECTOR IN SOLOMON ISLANDS Weak property rights in general and, especially, The Minerals Board is comprised of senior friction between rights to explore for and mine government ministry officials and provincial minerals and customary use of land and natural government representatives and is not presently resources: This has generated problems in required to include participation of civil society or managing relations between the government and other groups. Too many regulatory matters have miners with landowners, communities, and women ended up in dispute, including legal challenges (who are often excluded from local and national against board decisions, or generated grievances level decision making), generating disputes over for which formal channels for redress have proven land access, use of renewable natural resources, inadequate. community benefit sharing and local development. Challenges have also been faced in safeguarding Adherence by mining operators to good corporate the national interest to secure a fair share social responsibility practices has been inadequate of revenues from mining and generate wider and associated with these deficiencies have been economic benefits from mining, such as jobs social problems. and local supply chain development: Since Low levels of regulatory capacity at central each mining project involves ad hoc negotiation and provincial levels across a range of core of key terms and conditions and low capacity regulatory functions, including licensing, for implementation exists, concerns persist monitoring compliance, providing technical that asymmetries in access to information and and geodata services, revenue collection, and negotiating skills disadvantage the government management of the environment and land: The and that royalties, taxes, and other economic mining sector regulator operates on a meagre benefits are being waived or avoided. An example budget and has had difficulty attracting and is waivers of export duty and challenges faced retaining qualified staff as well as providing itself in collecting royalties from companies mining with facilities and equipment commensurate bauxite, for which the relevant valuation basis is with its functions. It is widely perceived to lack not yet settled. Other examples are of a heavy capacity to monitor mineral exploration and mining reliance by some mining companies on expatriate operations and assure compliance to an adequate labor, even in jobs for which local people have standard. Its ability to provide geodata services requisite skills. – including safe storage and management of Mining has been associated with environmental data, interpretation and mapping, and promoting harm: Environmental challenges derive from the exploration – is quite limited. Poor coordination fragile ecology and vulnerability to natural and among regulatory institutions, especially on man-made disasters, coupled with low quality matters of revenue, the environment, and land – operating practices employed by many of the owing to insufficient harmonization of laws and companies that have secured mineral rights. administrative arrangements – has sometimes Heavy rainfall has raised repeated concerns that undermined effective action by the subnational the tailings dam at Gold Ridge Mine would overflow and national government. or burst, exposing downstream communities High levels of discretion in decision making to potential contamination. Seismic events can are relied upon with relatively few checks also increase the risk of tailings dam failures. and balances in place and limited scope for Extreme weather, including cyclones, increases officials and leaders to be held to account: The the likelihood of catastrophic incidents, when conduct of the Minerals Board, which is vested coupled with poor performance by operators and with authority to grant and cancel rights, and regulators, such as the bauxite and oil spills from issue penalties, has faced criticism, with some mining vessels in Rennell and Bellona Province. stakeholders considering it as too opaque and arbitrary in the use of the discretionary powers given to it in the mining legislation. 63 97. The mining sector in Solomon Islands is 99. The fiscal mining regime is administered by associated with resource management several agencies. IRD administers payments and sustainability concerns. The mining of of CIT and APT. The Ministry of Finance and bauxite uses low-cost extraction methods, Treasury (MoFT) monitors documentation mining near-surface pockets of the resource. on export tonnages, grades, and the Free This has attracted investors using relatively on Board (FOB) value of shipments. It unsophisticated methods, with little concern also oversees export duties and royalties. for the environment. In addition, artisanal The Ministry of Mines, Energy and Rural mining has remained in the informal economy Electrification (MMERE) conducts mining and is thus barely regulated. Political economy feasibility studies and mining work programs. It concerns and limited regulatory capacity also registers prospecting and mining licenses have put further strain on the sustainable and is responsible for administering royalty management of the mining sector (see Box 5). collections.59 100. Royalties are collected ad valorem, at 4.5.2 Mining fiscal regime the rate negotiated with mine operators. 98. The fiscal regime for extractive mining in Royalties are collected on the gross value of Solomon Islands consists mainly of royalties, the metals produced and transferred to the export duties, profit-based taxes, and mining Mining Royalty Special Fund for redistribution tenement fees. The regime is entrenched to national and sub-national governments, as primarily in three acts: the Solomon Islands well as landowners – as specified in project Mines and Minerals Act (MMA, 1990), the agreements. Under the Gold Ridge Mining Income Tax Act (ITA), and the Customs and Agreement of 1996, the operating company Excise Act. The MMA provides the legal paid 1.5 percent of the gross value of gold framework for mining in Solomon Islands, and silver produced. Eighty percent of this including royalties and tenement fees. It contribution was transferred to 16 groups also prescribes appropriate procedures for with registered interest on the leased area. granting licenses, permits or leases, and for Twenty percent of the value went to the the establishment of a Minerals Board, tasked Guadalcanal Province Royalty Special Fund. with regulating and monitoring the mining Both payments were subject to a withholding sector. The ITA regulates Corporate Income Tax tax of 7.5 percent, collected by the national (CIT) and Additional Profits Tax (APT), applied government. Minerals exported by holders of to positive net revenue and cash flows of Mining Leases and Gold Dealer’s Licenses are mining companies, respectively. The Customs subject to export duty with exemptions granted and Excise Act specifies export duties paid to nickel and bauxite.60 Gold and silver are on mineral resources. The Minerals Policy taxed at 15 percent of the actual value. 2017 aims to create inclusive mineral sector governance arrangements that provide for efficient, transparent, affordable, and culturally appropriate decision making processes at all steps of the mining lifecycle. Implementation of the Minerals Policy 2017 requires that tax, cost, and physical audits of mining companies be conducted systematically in a risk-based manner. The revenue collecting agencies need to coordinate with other agencies and departments to collect and manage all relevant data (on prices, production, and sales) for audit purposes. Provisions regarding transfer pricing require file documentation that demonstrates compliance with transfer pricing rules including arms-length pricing. There are, however, no regular audits of domestic and international related party transfer pricing transactions, nor of compliance with thin capitalization rules. 59. IMF. (2019). Solomon Islands Mining Industry: Export Prices and Profit Shifting Risks, Technical Report. 60. Source: https://www.customs.gov.sb/portal/services/tariff/ headings-detail.jsf 64 101. Income of mine operators is subject to 4.5.3 Mining developments and policy implications CIT and APT if the project generates an 103. Redevelopment of the Gold Ridge Mine and internal rate of return of 25 percent. CIT new mineral discoveries could resuscitate is calculated based on net income with an mineral production in Solomon Islands. unlimited carry-forward of tax losses and China Railway, China’s largest SOE, was 100 percent capital allowance for exploration contracted by the current rights holder and development costs. The rate applicable to to revive production in Gold Ridge. The resident taxpayers is 30 percent, whereas non- committed investment includes the necessary resident taxpayers are taxed at 35 percent. infrastructure – power and port facilities, The base for APT, applied at 30 percent, is roads, rail, and bridges – to restart the net cash flows. This means that the tax base mine’s operations. The project consists of excludes depreciation but accounts for capital two phases, open-pit mining and stripping, replacement expenditure and paid CIT. To and an underground development. The mine avoid CIT and APT profit shifting, any goods is expected to restart its production in 2024 and services sold to affiliated companies and reach a processing scale of 2.5 million should be valued at “the price prevailing in tons of ore, which is about the capacity of normal arms-length transactions on the open the mine during its production peak period market.”61 In the region, Papua New Guinea in the past. Furthermore, recent exploration applies an APT of 30 percent (in addition suggests sizeable untapped high-grade mineral to CIT) for mining companies with rates of resources – gold, nickel, and bauxite – at return above 15 percent, while Indonesia is several locations, including ore reserves in the currently considering imposing an export tax Vulolo ward of Central Guadalcanal containing on low content nickel products to encourage an estimated 200,000 ounces of gold. While downstream investments. feasibility studies are underway for nickel 102. The SIG is currently introducing a series projects, bauxite mining is unlikely to develop. of legislative reforms within the confines Nickel deposits are estimated at over 200 Mt of the National Minerals Policy (NMP) that of ore reserves, including a tenement of 159 will impact the fiscal regime. The goal of the Mt containing an estimated 1.1 percent of NMP is to improve the regulatory framework to nickel and 0.07 percent cobalt. In addition, ensure sustainable development of the mining smaller deposits of nickel with a potential for sector. Within this objective, the NMP aims to exploration have been found in Jajevo and increase balance and transparency in sharing Kolosori on Santa Isabel. On the other hand, benefits between stakeholders, national limited public support exists for bauxite mining, budgets, local budgets, and those individuals that generally relies on low-cost extraction who are directly affected by the mining methods with negative environmental impacts. projects. Under the amendments proposed For instance, in 2019 the Environmental within the NMP, the benefits from royalties Advisory Committee overturned a mining will be distributed in fixed proportions instead license for the production of bauxite in of being negotiated for each mining project. Vaghena, after environmental concerns Half of the royalties’ value will be transferred were raised. to the national government, 10 percent will be transferred to the budget of the province in which the tenement area is located, whereas the remaining 40 percent will be paid to the owners of the land comprising the tenement area. If the owner of the land is the holder of a mining tenement, no royalties are to be distributed to the owners of the land. The amount that would otherwise be transferred to the owners is instead to be distributed in a 96 to 4 ratio between the national and provincial budget. 61. IMF. (2019). Solomon Islands Mining Industry: Export Prices and Profit Shifting Risks, Technical Report. 65 104. Sizeable economic and fiscal returns are 105. For a sustainable mining sector to flourish, possible if all prospective gold and nickel however, the SIG needs to address important mining projects reach full capacity in the governance challenges, including the medium term. Increased mineral production is passing of a new Mining Bill. The Mines and primarily driven by nickel. The feasibility studies Minerals Act of 1990 inherited many of the submitted to MMERE show the potential for features of prevailing legislation from the a production of about 70 thousand tons of colonial period. Although amended from time nickel. New mining projects are expected to to time, it became increasingly apparent that increase their production capacity gradually the Act was incompatible with the needs of as of 2023 and reach full capacity in 2025. the sector and the protection of the interests Gold production is assumed to increase by of a range of stakeholders. A review of the an additional US$12 million year in 2026. This Act was launched in 2018, steered by an production is expected to increase gradually Inter-Ministerial Taskforce chaired by the from 2024. Additional production and exports Permanent Secretary of the MMERE. Based of minerals will generate additional tax revenue on consultations with several stakeholders, in the form of royalties on nickel, royalties and including the mining industry and local NGOs, a export duty on gold, and revenue from PIT is new Mining Bill is being prepared and expected assumed in the medium term. None of the new to be adopted in 2022 or 2023. Once enacted, projects will generate a positive rate of return it will be important to fully implement the Act, by 2026, thus no additional revenue form CIT is further develop the regulatory framework, assumed. Gold production could add 5 percent and build capacity in the MMERE so that the to the Solomon Islands’ GDP, whereas revenue legislation can be enforced. The new Mining from royalties and export duties could reach Bill will help implement the Minerals Policy around 0.8 percent of GDP. The nickel mining 2017 which advocates for the role of local projects could increase GDP by 6 percent in communities by requiring mining companies the medium term. In addition, the government to commit to progressive employment and revenue from royalties from nickel could training opportunities for local people and to reach 0.15 percent of GDP. From the moment publicly report on and address grievances on mining projects would generate positive rates these commitments. The new Bill will also allow of return, substantial revenue gains can be opportunities for Provincial Governments and expected from CIT, APT, and income tax (it is Communities to negotiate employment matters believed that new mining projects could add as part of their respective development over 1,000 direct jobs). agreements, ensuring that both men and women have opportunities to be involved. The new Mining Law and Regulations will enable Community Mining Licenses (CML) to be issued to local communities to pursue small alluvial and non-alluvial mining operations.62 The new Mining Bill allows for a negotiation framework between government and landowners to ensure the payment of direct benefits and implementation of social and environmental safeguard measures. 62. It is estimated that over 1,000 people are engaged in alluvial mining, mainly of gold. 66 67 chapter 5 MAPPING OUT THE SOLOMON ISLANDS WAGE BILL 68 106. As a key driver of public spending, this 108. Managing the public sector wage bill is a chapter examines developments in the fine balancing act. Making decisions about Solomon Islands public wage bill. The pay and employment requires policy makers to Solomon Islands wage bill represents 10.9 make complex trade-offs between competing percent of GDP and more than 40 percent objectives. On the one hand, compensation of domestic revenue, significantly above the arrangements should attract and retain global average. Furthermore, the nominal capable staff to deliver on government wage bill has more than doubled over the past commitments. On the other, they should decade, outpacing inflation and GDP growth. remain fiscally sustainable and not distort the If the current trends continue, spending on the overall labor market. wage bill may become unaffordable and fiscal 109. At the same time, the government needs to policy unsustainable. This chapter assesses decide on the right balance between labor, several dimensions of public sector pay and capital, and other expenditures needed for employment, and provides a roadmap for delivering its core functions. This, in turn, further analysis. will depend on the government’s priorities, as well as its choice of service delivery model. For example, delivering functions such as public 5.1 INTRODUCTION education tend to be more labor intensive, requiring many hours of work but relatively 107. The civil service plays a critical role little capital compared to, say, building public within (and outside) government. They are infrastructure. How public goods and services responsible for implementing the decisions of are delivered also matters for the size of Cabinet, delivering public services, enforcing the wage bill because some governments legislation, and providing advice on matters may prefer to deliver services by employing considered by government. In 2017, the central their own staff, while others would rather government employed 17,485 civil service commission services by engaging private and staff including teachers, police officers, and non-government sectors. This has implications health workers. As shown in Figure 36, the for the size of the wage bill as workers may education sector was the largest employer, appear under other types of expenditure, accounting for nearly 60 percent of the public depending on the service delivery model. service workforce during that year, including 8,586 teachers.86 Furthermore, the public 110. Managing the Solomon Islands wage bill is sector also represents a large share of paid becoming increasingly challenging, both employment and, as such, has substantial from a fiscal and service delivery point of impacts on the competitiveness of the entire view. First, the wage bill has been growing labor market. At the same time, the wage bill is since 2011, reaching 11.6 percent of GDP in a major expenditure item, accounting for about 2020. Second, declining revenues are putting 26.4 percent of total government expenditure stresses on state finances. If the wage bill is in 2020. Therefore, even small changes in maintained at current levels and the decline in compensation or employment levels can have revenue is sustained over a long period, it may large impacts on the fiscal balance. require sharp adjustments in other spending items to ensure fiscal sustainability. Third, even if the revenue recovers to pre-pandemic levels, spending pressures will continue to mount as 63. In addition, there are likely to be additional jobs in provincial a growing population places more demand on governments for which information is not readily available. frontline workers. 69 Figure 36: Staff by Sector (2017) 12000 10000 Number of employees 8000 6000 4000 2000 0 Education Health Justice Other Police Force Source: Authors’ calculations based on SIG Ministry of Public Service Figure 37: Wage bill worldwide Figure 38: Wage bill (Percent of GDP 2019) (Percent of domestic revenue 2019) 30 30 Wage bill (% of domestic revenue) 24 24 Wage bill (% of GDP) Solomon Islands 18 18 Solomon Islands 12 12 6 6 0 0 103 104 105 103 104 105 Log of GDP per capita (USD), 2019 Lorem ipsum Log Lorem of GDP per capita ipsum (USD), Lorem 2019 ipsum Source: World Bank’s World Development Indicators Source: World Bank’s World Development Indicators 80 70 60 Figure 50 39: Wage bill in structural peers (2019) 40 70% 30 60% 50% 20 40% 10 0 30% 20% 10% Lorem ipsum Lorem ipsum Lorem ipsum 0% SLB PNG MRT TLS KIR LAO KGZ MMR 80 bill as a % of GDP Wage Wage bill as a % of domestic revenue 80 70 70 Source: Source: Authors’ calculations based on SIG Ministry of Public Service 60 60 50 50 70 40 40 111. Moreover, the institutional framework Technical analysis of pay and employment governing public pay and employment issues can inform policy choices, but suffers from structural weaknesses. The ultimately the size of the wage bill is a political remuneration framework is complex and decision that involves complex tradeoffs fragmented, making it difficult for the central between affordability, the reach and scope of government to plan and control the wage government, as well as the quality of public bill. Schemes of Service, which set terms services. and conditions of employment for specific occupational groups (including several types of allowances), complicate wage bill 5.2 INTERNATIONAL BENCHMARKING management. A lack of transparency around total remuneration levels also makes it difficult 114. The Solomon Islands wage bill is high to assess whether pay is adequate. when compared to the global average. An international comparison of the costs of civil 112. To deliver sustainable wage bill adjustments, services shows that prior to the COVID-19 while protecting public services, a data- pandemic, the 2019 wage bill in Solomon driven approach is needed. A data-driven Islands – at 10.9 percent of GDP – was above approach can help decision makers understand the international average of 9 percent of GDP the tradeoffs involved in managing the wage (see Figure 37). In terms of the wage bill as a bill and assess the policy choices available share of domestic revenue, Solomon Islands to them. For example, if the government (41 percent) was significantly above the global decides to adjust the size of the public average (see Figure 38). sector wage bill as the primary tool to control expenditure, granular workforce data can be 115. However, global benchmarking does not used to evaluate policy options (e.g., selected consider the unique set of challenges recruitment freezes, targeted reductions arising from Solomon Island’s economic in employment, changes in remuneration geography and state fragility. The geographic for selected groups of employees) that are characteristics that put upward pressure affordable and minimize the impact on core on the wage bill include small size, widely public services. Data on employment and dispersed populations, and long distances remuneration is also critical to controlling to major markets. There are also additional the wage bill from a whole-of-government costs associated with providing civil services perspective. Without a full picture of how many in fragile and conflict-affected settings, people are on the government payroll, how which must account for potential conflict and much they earn and how their remuneration breakdown of law and order. In addition, there is adjusted, it is difficult to provide policy are challenges arising from the limited state makers and fiscal planners with the projections capacity to deliver core services to its citizens. needed to manage state finances in a fiscally When compared to structural peers, the wage sustainable manner. bill as a share of GDP is not exceptionally large. However, compensation for employees is large 113. This chapter assesses several dimensions as a share of domestic revenue (see Figure 39). of public sector pay and employment. It highlights data gaps and identifies reforms needed to improve the management of the wage bill. The analysis applies the approach outlined in the Assessment Framework for Public Sector Employment and Compensation (World Bank, 2021). The first part discusses several high-level fiscal aggregates that can be used to examine the size of the wage bill. The following sections focus on the composition and distribution of employment as well as wage levels. Important to note that there are no simple formulas for calculating the ‘right’ size of the wage bill. 71 Figure 40: Wage bill in small Pacific Island States (2019) 70% 60% 50% 40% 30% 20% 10% 0% FJI KIR MHL FSM PLW WSM SLB TON TUV VUT Wage bill as a % of GDP Wage bill as a % of domestic revenue Source: Authors’ calculations based on SIG Ministry of Public Service Figure 41A: Evolution of wage bill Figure 41B: Evolution of wage bill Wage Bill Trend as a share of GPD Wage Bill Trend as a share of the Domestic Revenue 12% 50% 11% 40% 10% 30% 9% 20% 8% 10% 2011 2013 2015 2017 2019 2011 2013 2015 2017 2019 Lorem ipsum Lorem ipsum Lorem ipsum Source: Source: Authors’ calculations based on Source: Source: Authors’ calculations based on SIG Ministry of Public Service SIG Ministry of Public Service 80 70 60 Figure 42: Evolution of the nominal wage bill by function 50 1500 40 30 1200 20 900 Million SBD 10 600 0 300 0 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 701 General public services 705 Lorem ipsum protection Environmental Lorem ipsum 708 Lorem Recreation, culture ipsum Lorem and religion ipsum Lorem ipsum 703 Public order and safety 706 Housing and community amenities 709 Education 704 Economic affairs 707 Health 710 Social protection 80 80 Source: Source: Authors’ calculations based on SIG Ministry of Public Service 70 70 72 60 60 116. Compared to regional peers,64 Solomon 5.3 SPENDING TRENDS Islands public sector wage bill, as a share of GDP and domestic revenue, is not 117. While not necessarily excessive, managing exceptionally large (see Figure 40). Solomon the wage bill has become increasingly Islands shares several features with other challenging. The wage bill has been growing small PICs that push up the cost of the wage in both real and nominal terms since 2011. bill. First, PICs have small populations, ranging Nominal expenditure on the wage bill has from 11,655 in Tuvalu to 889,995 in Fiji in more than doubled between 2011 and 2020, 2019. Smallness means that cost advantages increasing from SI$626 million to SI$1.36 billion that governments obtain thanks to scale over the period, which is well above the of operations are harder to achieve. This is inflation rate. In real terms, the wage bill because running a government and core public grew by around 70 percent.65 Moreover, the institutions needs minimum levels of staffing, wage bill as a percentage of GDP has been regardless of a country’s size. Second, PICs increasing steadily, reaching 11.6 percent of have widely dispersed populations, scattered GDP in 2020 (see Figure 41). This means that over many islands. This further limits their the nominal wage bill has been growing faster ability to take advantage of economies of than GDP. Recently, this is mostly due to GDP scale, creating additional staffing needs. For growth slowing down in 2019 and then falling example, the population in many outer islands in 2020. Relatedly, the wage bill also increased may be too small for a school to use teachers as a share of domestic revenue, more sharply and classrooms efficiently. Moreover, their in recent years as revenues eroded due to remoteness from major markets puts upward the COVID-19 pandemic. Important to note, pressure on the costs of tradeable goods. To however, that as a share of total expenditure, the extent that these goods are an input to spending on the wage bill has declined slightly government activity, it can lead to more labor- over the period 2011–2020, falling from intensive government services. 27.2 percent in 2011 to around 26.4 percent in 2020. 118. The overall growth in the wage bill has been driven by the education and health sectors. In the education sector, the nominal wage bill increased from SI$250 million in 2011 to SI$604 million in 2020, an increase of 141 percent (see Figure 42). While the education sector is an important driver of the wage bill increase, key indicators, however, point to a staff deficit. For instance, despite additional recruitment, the pupil–teacher ratio in primary schools increased from 19.1 in 2012 to 25.4 in 2018. Moreover, demand for teachers is set to grow as the population of school-aged children increases over the next decade. In the health sector, the wage bill increased from SI$127 million in 2011 to SI$293 million in 2020, a 131 percent increase (see Figure 42). With 2.2 health workers per 1,000 inhabitants in 2018, Solomon Islands is very close to the World Health Organization norm of 2.3 health workers. 64. Moreover, when measured against other fragile and conflict- affected states, the Solomon Islands wage bill also does not stand out. 65. The lack of a time series on employee numbers prevents us from concluding whether the increase in the wage bill has been mainly driven by rising salaries or an increase in the number of staff (or a combination of both). However, anecdotal evidence suggests that it is the latter rather than the former mechanism driving wage bill growth. 73 119. Nominal GDP has not been growing fast 5.4 PAY ANALYSIS enough to sustain the wage bill at a level that accounts for population growth. 122. Salaries are set according to a unified salary According to the provisional count of the 2019 structure approved by the government, but National Population and Housing Census, allowances tend to vary. Solomon Islands the population has grown by 30.8 percent uses a common grade structure for the civil over the period 2009–2019. The growth in service. Overall, salary grades range from population has been particularly pronounced Level 1 to Level 13 plus five Super Scales (see in Guadalcanal and Honiara, which have seen Figure 43). Moreover, there are 5 to 20 steps increases of 45.4 percent and 78 percent, in each grade. The highest earner in the civil respectively.66 This creates more demand for service unified pay scale earns 9.5 times the frontline workers, including teachers, nurses, salary of the lowest earner, not suggestive and doctors, as the demand for these services of an excessively compressed pay scale. is heavily influenced by demographics. On a per Moreover, the distribution of staff between capita basis, the nominal wage bill has been salary levels does not point to an excessively growing faster than GDP per capita, which top-heavy administration. As shown in Figure peaked in 2018. If GDP per capita and domestic 43, the intermediary levels 5 and 6 accounted revenue continue to fall, and spending on all for most of the staff in 2017. In addition to the other categories remains the same, spending base salary, allowances are a key component on the wage bill may become unaffordable. of civil service compensation. In contrast to That is, if the government aims to provide the salaries and wages, which are monitored by the same level of services for a population that is Ministry of Public Services, allowances tend to growing faster than GDP, it will need to spend vary across occupations and are managed at more on the wage bill, even as a share of GDP the ministry level. They can be specified either (everything else considered equal). in General Orders, Schemes of Services, or Special Policies and Procedures.67 120. To address pressures from a rising wage bill, the SIG announced containment measures. 123. Salary scales are not regularly reviewed. In the 2021 budget, the SIG reprioritized The last time salaries were adjusted was in spending by placing public servants on half 2019. A regular review to account for changes pay; reducing the size of the public service in the cost of living, productivity growth, through redundancies; freezing public sector and economic conditions could help ensure recruitment outside the productive and that growth in public sector remuneration resource sectors and essential services; remains within the overall confines of fiscal reducing public servants’ annual leave; and responsibility over the medium term. To be lowering the retirement age for some of the effective in controlling the wage bill, however, civil service. a review of the unified salary structure would need to consider non-wage remuneration. This 121. These steps helped the government respond is not workable in the current context as there to the fiscal crisis in the short term but is no central authority for approving changes in are not sustainable in the medium term. If total remuneration. maintained, they could have a severe impact on service delivery, affecting long-term growth and development outcomes. A prolonged hiring freeze could result in unintended skills gaps and reduced workforce motivation (as overworked employees stretch to cover multiple positions), with adverse consequences for the government’s performance. Moreover, policy settings could worsen a potential staffing shortage. For example, for specialist 66. According to the Provisional Census, the population of functions that need long investments in skills Honiara and Guadalcanal was adjusted for an undercount of and education, requiring employees to retire 8.3 percent in 2009. early decreases the talent pool. On the other 67. The current remuneration framework for the public service is hand, salary freezes can lead to an increase complex and scattered across several legislative instruments including the Public Service Act and Public Service in non-transparent allowances as a back-door Commission Regulations, and non-legislative mechanisms means to increase wages. Over time, the short- including the General Orders, Scheme of Service for term measures should be replaced with more professional bodies, Circular Memoranda and Government HR Policy and Procedures. sustainable reforms. 74 Figure 43: Distrbution of staff (By grades, sector and gender) (2017) 5000 5000 Police Force M 4000 Other 4000 F Number of employees Justice Millions of SBD 3000 3000 Health 2000 2000 Education 1000 Rank 1000 0 0 Level 1 Level 2 Level 3 Level 4 Level 5 Level 6 Level 7 Level 8 Level 9 Level 10 Level 11 Level 12 Level 13 Level SS1 Level SS2 Level SS3 Level SS4 Level SS5 Level 1 Level 2 Level 3 Level 4 Level 5 Level 6 Level 7 Level 8 Level 10 Level 11 Level 12 Level SS1 Level SS2 Level SS3 Level SS4 Level SS5 Other Other Level 9 Level 13 Education Justice Police Force Female Male Health Other Source: SIG Ministry of Public Service Figure 44: Evolution of the wage bill by component 1500 1200 Million SBD 900 600 Lorem ipsum Lorem ipsum Lorem ipsum Lorem ipsum Lor 300 0 80 80 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 70 70 Wages and Salaries Allowances Social Contributions (N.P.F.) 60 60 50 Source: SIG Ministry of Finance and Treasury 50 40 40 30 30 20 20 10 10 0 0 Lorem ipsum Lorem ipsum Lorem ipsum 75 80 Figure 45: Allowances by type (2020) Elected Members Housing - Various Allowance Allownces - Elected Members Housing Allowance Special Duty Allowance - Public Servants Public Allowances Overtime Allowance - Public Servants MP’s Allowances Clothing Allowance Various Allowances Domestic Equipment Allowance Members Allowances Representational Allowances Touring/Sitting Allowance Staff Welfare Touring/Sitting Allowance Various Allowances Sta Welfare Public Allowances Elected Members - Various Allownces Representational Allowances Members Allowances Source: SIG Ministry of Finance and Treasury Domestic Equipment Allowance Graph Clothing Allowance 1 colo 2 colo 124. Allowances account for a high share of the 125. The distribution and level of allowances MP's Allowances c2 total wage bill and make the remuneration vary across sectors. In the health sector, system considerably more complex. In allowances account for the largest part of the 130 x 2018, there were more than 90 distinct types remuneration Overtime package. Allowance In part, - Public this reflects the Servants of allowances within the Solomon Islands additional duties taken on by health workers, public sector, accounting for an increasing in line with the policy priority of safeguarding share of the wage bill. For instance, in 2020, Special Duty Allowance the population - Public from the Servants COVID-19 pandemic. allowances comprised 29 percent of the Furthermore, the allowance rate can vary wage bill, up from 25 percent in 2011 (see greatly by sector, creating equity issues. Figure 44).68 A few allowances account for Housing Allowance groups have successfully Some occupational a substantial proportion of spending. For negotiated higher rates for specific allowances example, housing allowances represent a through their respective Scheme of Services Housing Allowance - Elected Members substantial part of allowances in the education or General Orders, reflecting their greater sector while the Special Duty Allowance is the bargaining power. For example, the Special key allowance within the Health and Public Duty Allowance, paid to staff who regularly Order and Safety sectors. Together, these two perform work outside normal working hours, allowances represented nearly 36 percent of varies by Scheme of Service. Pay inequity the allowances paid in 2020 (see Figure 44). can be justified if there is a high demand for some jobs from the private sector. In this case, higher wages may be needed to ensure that these workers remain in government service. However, any pay differential would be reflected in the base pay rather than through less transparent allowances. 68. While further study is needed, it may be the case that allowances are increasingly used to top up salaries to achieve satisfactory pay. See the Annex 4 for how allowances compare to base salary for the Magistrature. 76 126. There are major gaps in the information 5.5 STAFFING ANALYSIS needed to make informed decisions about pay levels. The Ministry of Public Service 128. In 2017, 17,485 people were employed in the collects individual information on pay grades, public sector, which is unevenly distributed but it does not have visibility over the total across provinces. The education sector had remuneration package because allowances the highest headcount, employing 10,236 are managed at the ministry level. This makes people, followed by the health sector, which it difficult to plan and control the wage bill employed 1,944 workers. The single largest from a whole-of-government perspective. It category of civil servants is teachers, of which also makes it difficult to assess whether pay is there were 8,586 in 2017 (MEHRD, 2018). The adequate, in relation to people doing the same distribution of staff across provinces is uneven, job – as well as in relation to people who take with 5,952 public servants concentrated on greater responsibilities. in Honiara.69 As Figure 46 shows, there is considerable variation in the per capita 127. Compensation benchmarking would make allocation of government employees across it easier to assess the adequacy of pay in provinces. The Western Province receives the relation to other jobs within and outside lowest relative allocation of civil service staff the public sector. Comparing public sector with 0.8 staff per 100 population, while the remuneration with their equivalents in the Temotu Province has three public employees private and non-government sectors can help per 100 population.70 governments set wages more efficiently. Since no salary or compensation benchmarking has 129. By employing a large number of women, been conducted, it is difficult to assess the the public sector provides opportunities adequacy of base pay for different sectors. And for female empowerment. In 2017, women without looking at the appropriateness of base represented nearly 43 percent of the public pay, we cannot conclude that allowances make sector workforce. In the health sector, they overall remuneration inadequate. In this case, accounted for 54 percent of workers. Yet within using allowances to complement salaries may the civil service, women are still poorly paid be the second best solution for what is in fact a compared to men. The difference is particularly low wage problem. pronounced at the higher ranks of the public service, with men outnumbering women by nearly 7.5 times at the Super Scale level (26 women versus 194 men). However, putting this into perspective would require a comparison with the private sector, as opportunities for advancement in the civil service – however limited – could still exceed the opportunities available in the private sector. 69. This includes staff working for the Honiara City Council but excludes church workers and workers at the National Referral Hospital. The large staff contingent is not necessarily a problem because Honiara, as the national capital, serves a different purpose compared to other regions. For example, the National Referral Hospital provides complex clinical care and acts as the referral hospital for patients across all provinces. Moreover, by concentrating public administration functions in Honiara the government is able to benefit from economies of agglomeration. For example, public servants are able to network and learn from each other. Agglomeration also results in a larger and deeper labor pool which allows workers to better match their skills to the needs of the government. 70. Note that some caution is required as the analysis does not include church workers and other community health workers. 77 Figure 46: Distribution of civil service staff by region and sector (2017) 3.0 2.5 Share of population 2.0 1.5 1.0 0.5 0.0 CENTRA CHOISE GUADAL ISABEL MAKULA MALAIT RENBEL TEMOTU WESTRN Education worker as a share of population Other worker as a share of population Health worker as a share of population Police Force as a share of population Justice worker as a share of population Source: SIG Ministry of Public Service and World Bank staff calculations Figure 47: Distribution of vacancies by grade (2022) 400 350 Number of vacancies 300 250 200 150 100 Lorem ipsum Lorem ipsum Lorem ipsum 50 0 80 Level 2 Level 3 Level 4 Level 5 Level 6 Level 7 Level 8 Other Level 9 Level 10 Level 11 Level 12 Level 13 Level SS1 Level SS2 Level SS3 Level SS4 Level SS5 70 60 Source: SIG Ministry of Public Service and World Bank staff calculations 50 40 30 20 10 0 Lorem ipsum Lorem ipsum Lorem ipsum Lorem ipsumLorem ipsum Lorem ipsum 78 80 80 130. There are large job vacancies in the public 5.6 BUDGET PLANNING, CONTROL, sector, suggestive of a skills deficit. Public AND CREDIBILITY employment should ensure that there is an adequate skills mix to deliver on the functions 132. Under current circumstances, planning the of government. In 2022, there were 1,341 wage bill is extremely difficult. Uncertainty vacancies in the public sector, mostly in the regarding the duration of the COVID-19 crisis, middle-band levels (see Figure 47). Vacancies and what the ‘new normal’ may look like, were recorded across all grades apart from makes wage bill planning a complicated matter. the entry level, with some positions staying Apart from the pandemic, however, there unfilled for up to 144 months. Notably, there are some structural issues that could limit were 548 vacancies in the health sector the government’s ability to plan the wage bill in 2022, a significant increase from 2020, effectively. Barring the teaching service, the when 259 vacancies were recorded. A high structure of the civil service is defined in the vacancy rate may indicate a shortage of skills, Establishment, a list of authorized positions possibly resulting from low wages compared by ministry. Under current arrangements, to alternative employment opportunities. line ministries that would like to create new Further analysis, however, would be needed to positions need to secure the approval of determine the drivers of these vacancies and the Public Service Commission. However, the impact on service delivery. the extent to which the Establishment is used as a key control mechanism is unclear. 131. There are major gaps in the information Furthermore, it is not clear whether line needed to make informed decisions about ministries can use the budgetary space created staffing levels and composition. For example, by vacancies to fund other expenditures. job evaluation is a tool commonly used to assess the relative work value of jobs in an 133. Consistent deviations in wage bill spending organization. In Solomon Islands, there has suggest difficulties in budget credibility been no systematic process of measuring and control. Figure 48 illustrates that in and agreeing on the time and staffing levels most years there is a budget shortfall, needed to complete the tasks required of any which occurs if actual wage costs come in particular position. This would involve clarifying higher than predicted. Consistent under- what each position is expected to achieve, budgeting suggests inefficiencies in the including deliverables and accountability for budget formulation process, which can performance. There are two types of equity to lead to allocative inefficiencies. Moreover, be considered: horizontal equity – where you a 2011 Ombudsman investigation found get paid the same as other people doing the deficiencies in human resources and payroll same job; and vertical equity – where you get systems for teachers, with a high number of greater compensation as you take on more complaints about payment and non-payment responsibilities. This information can then be of salaries, allowances, delayed promotions used to set up classification grades, which and appointments, and unexplained demotions in turn, can be used to decide levels of pay. and suspensions, pointing to deeper issues in Moreover, functional reviews can be useful in human resource management. assessing whether staffing levels are aligned to government priorities. 71. Often, the binding constraint with public sector staffing is not so much its size as its composition. For example, a department could potentially have an excess of unskilled staff while at the same time facing shortages of technical and professional staff. This skills mismatch would contribute to inefficiencies in public service delivery. 79 Figure 48: Budget variance of the wage bill 100% 80% 60% 40% 20% 0% -20% -40% -60% -80% -100% 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 701 General public services 707 Health 703 Public order and safety 708 Recreation, culture and religion 704 Economic affairs 709 Education 705 Environmental protection 710 Social protection 706 Housing and community amenities Source: SIG Ministry of Finance and Treasury 5.7 POLICY IMPLICATIONS 135. Better targeting could achieve greater returns for citizens from spending, but data 134. Looking forward, improvements in workforce is needed to inform decisions. One way of productivity will be needed. Managing the improving workforce productivity is by focusing wage bill is challenging because a growing on the distribution of public employment, and population is creating more demand for public whether the right people, in terms of skills and services, while at the same time revenues to capabilities, are placed in the right positions fund these services are declining – as is GDP to meet the needs of the government and its per capita, relative to the wage bill. Thus, citizens. However, deploying public servants keeping the wage bill on a sustainable path will to activities and locations where they are require better use of existing resources. That needed most requires better data on employee is, improving public sector efficiency is key to distribution, skill levels, job sizes, and total addressing these challenges and achieving compensation. It also requires greater clarity better outcomes. on policy priorities so that resources can be directed to higher-value areas. In doing so, it is important that the government considers the range of activities to be conducted in each location, the standards of service, to whom services should be provided, the outputs and outcomes expected, and how much these activities will cost. Making these decisions will often involve complex trade-offs between equity, efficiency, and fiscal goals. 80 136. A comprehensive reform of pay practices 3. Conduct a broad pay and grading is needed to address the complexities, exercise. The goal of this exercise is to inefficiencies, and excessive use of assess whether pay is proper for the size of allowances in Solomon Islands’ system the job. This would include a compensation of salary setting.72 In the medium term, benchmarking survey to collect information this could restore transparency and the on remuneration packages as well as a government’s ability to contain the wage bill, job evaluation, i.e., an assessment of while ensuring that public sector salaries are the responsibilities associated with the adequate to attract and keep skilled staff. position. The sizing of jobs, in turn, requires The reform would include a Review of the a good grasp on what the government Schemes of Service – including associated priorities are, and if people are aligned to allowances – with the goal of creating a these priorities. As part of the exercise, simpler pay structure and incorporating a decision should be made on which allowances and other payments into base pay. allowances should move into base pay. The government could also consider adopting 4. A review of the Schemes of Service. a job-based public service system, where This should be conducted once the public servants are compensated, according government has the vital information to the content of the job they perform, rather needed to make decisions. The review than based on their education qualifications should include associated allowances or other considerations. This is a long- term – with a view to create a simpler pay project that involves updating the Public structure and incorporate allowances Service Act and subordinary instruments. and other payments into base pay. 137. Specifically, to improve wage bill 5. A regular review of the total management, the government could compensation package. This consider taking the following five steps: would help ensure that growth in public sector remuneration remains 1. Conduct a public sector census and within the overall confines of fiscal reconcile personnel management responsibility over the medium term. records with those of the payroll sector census. This would provide greater clarity on how many people are employed by the government and how much they are paid. A lack of comprehensive and easy to access data on staffing numbers (e.g., teaching service, provincial health workers) makes it difficult to understand the drivers of the wage bill and draw conclusions about the appropriateness of the composition and distribution of employment. Moreover, a lack of visibility of employee’s total remuneration makes it difficult to predict and control the wage bill. 2. Conduct functional reviews of ministries. This could help to assess whether the number and type of roles are directly related to the service delivery priorities of the government, including the appropriateness of the 72. The decision to reform public sector pay and employment has allocation of staff (in different sectors/ already been made. In October 2017, the Cabinet approved grades) between the capital, provincial the implementation of the SIG-Public Service Transformation Strategy (PSTS) 2017-2021. The Strategy outlines an headquarters, and rural areas. ambitious reform agenda and includes several initiatives that seek to improve the way in which the public sector wage bill is managed, including a benchmarking study, a government- wide Pay and Grading reform, and an amendment of the Public Service Act and subsidiary legislation. The government also announced a review of the Public Service Unified Pay Structure. The planned income tax reforms provide a complementary opportunity to make concurrently make progress with wage bill reforms. 81 chapter 6 PAVING THE WAY FOR MORE EFFICIENT SPENDING IN HEALTH AND EDUCATION 82 138. This chapter analyzes selected issues in 6.1 THE HEALTH SECTOR health and education spending through the lens of fiscal sustainability. With about 44 6.1.1 Overview and challenges percent of the budget spent on health and 139. The Ministry of Health and Medical Services education, this chapter examines ways to make (MHMS) is the main health care provider in public expenditures more efficient and the the country. The health system in Solomon potential of these sectors to contribute to fiscal Islands is similar to other Pacific Island consolidation. It first provides a brief overview countries where the government is largely and discusses the main challenges in health seen as responsible for ensuring the provision and education. Afterwards, specific topics of health care services to the population. are analyzed that have important implications The MHMS is the government’s central for fiscal sustainability. For the health sector, administrator in the health system, and it budget execution, cost pressures related to functions as budget holder, regulator, and payroll and utility costs, and the country’s provider of almost all health services at both immunization program are examined. The the national and provincial levels. The officer in education sector analysis focuses specifically charge is the Permanent Secretary for Health on the Solomon Islands tertiary scholarship who reports to the Minister for Health. The program, as it makes up a large share of MHMS National Health Strategic Plan (NHSP) government spending (peaking at 3.5 percent 2016–2020 provides the overall strategic of GDP in 2017). direction for the MHMS. The key objective of the strategy is to contribute to the wellbeing of all Solomon Islanders in order to achieve a healthy, happy, and productive society. It aims to ensure that the 24 targets under the Sustainable Development Goal (SDG) 3 and Universal Health Care (UHC) are achieved. The guiding principle of UHC is to ensure integrated quality care that is accessible to all without financial hardship.73 73. A review conducted in 2020 of the key result areas in the strategy found that many gaps remain to be addressed. Several recommendations were made in the review, and these will feed into informing the development of the new NHSP. Work on the development of the new NHSP is expected to be completed in 2022 and subsequently launched. The new NHSP will have a timeframe of 10 years and will also include a national monitoring and evaluation framework to monitor and measure implementation of the policy. 83 Table 9: Percent of all essential medicines in stock at primary health care facilities Province 2016 2017 2018 2019 Central Island 83 70 45 40 Choiseul 83 84 27 43 Guadalcanal 80 78 34 23 Honiara 94 71 52 43 Isabel n/a 84 41 9 Makira 79 69 34 21 Malaita 87 75 50 27 Renbel 76 78 38 17 Temotu 85 75 36 6 Western 78 83 21 17 Solomon Islands 83 72 38 24 Source: MHMS HIS Report 2020 Table 10: Proportion of health facilities closed due to understaffing or maintenance Province 2017 2019 2020 2021 Jan Sep Jan Sep Jan Sep Jan Sep Guadalcanal 21 7 25 14 30 14 30 9 Western 29 23 26 8 18 5 20 7 Malaita 21 16 13 10 21 12 23 10 Temotu 18 6 24 12 6 6 17 17 Central 35 27 40 20 32 5 32 9 Choiseul 35 4 23 19 31 19 8 8 Isabel 46 14 34 16 32 18 39 16 Makira 22 7 32 22 32 12 17 7 Honiara 5 0 5 5 14 14 32 9 Renbel 33 0 33 33 33 0 0 0 Solomon Islands 26 13 24 14 24 11 24 10 Source: MHMS Health Information System 3rd quarterly report (2017–2021) 84 140. There are six levels of health care services 143. Service provision at the National Referral offered by the Solomon Islands health Hospital is also fraught with difficulties. system. There are 207 Nurse Aid Posts, 112 Due to the COVID-19 pandemic, in-patient Rural Health Clinics, 34 Area Health Centers, overcrowding has become a problem. The nine Provincial Hospitals, and one National bed occupancy rate at the NRH increased Referral Hospital (NRH). The NRH and National from 88.6 percent in the first quarter of 2019 Public Health Programs offer health services to 137 percent in the first quarter of 2021. nationwide. The NRH is the end facility for the Relatedly, the NRH was built in 1955, but the patient referral pathway within the domestic infrastructure has not kept up with the pace health system. If the NRH cannot provide the of the growing population and the increasing treatment needed by the patient, the patient burden of disease. There is, therefore, a may be considered as a candidate for the clear need for maintenance, renovation, and overseas medical referral scheme. These public upgrading works. Finally, governance is an health programs strengthen preventative and issue, as illustrated by the fact that the NHR primary health care and help improve health was without a confirmed CEO for about two coverage and access across the country years before the position was filled in early by building a strong partnership with rural 2021. communities and villages. Provincial health 144. Geographic inequities exist in the services, under the command of a provincial distribution of health care staff, complicating health director, are delivered through a range the provision of universal health care. In of provincial health facilities (e.g., hospitals, 2020, medical staff in Solomon Islands totaled area health centers, nurse aid posts). 1,339 individuals. On aggregate, this results 141. The provision of health care services in in 1.86 medical staff per 1000 population (see rural locations and outer islands remains Table 11) which is fairly close to the World challenging. Challenges include geographical Health Organization (WHO) norm of 2.3 isolation, limited (or no) health workforce, medical staff per 1000 pax. However, this does absence of health information, lack of access not take into account Solomon Islands’ unique to essential medicines, difficulty in accessing geography, with 74 percent of the population financing, and limited accountability. For living in rural areas, scattered over many small example, drug stockouts are a common islands. Consequently, the country’s dispersion challenge, and Table 1 indicates that the makes achieving universal access to adequate situation has deteriorated over the period health care complicated. For instance, out of 2016–2019. For instance, in 2019 none of the the 97 doctors, 65 are located at the NRH, primary health care facilities in the provinces while the remaining 32 are thinly distributed had more than 50 percent of all essential across the country. Forty-two percent (391) of medicines available. all nurses are stationed at NRH, with the other 58 percent (677) shared across all other health 142. Despite the large number of rural health facilities in the country. clinics and nurse aid posts, many of these are under-staffed and/or under maintenance. Furthermore, these health facilities are not necessarily situated in a location that is based on population density or disease burden. While most of the population lives in rural areas – 74 percent according to the 2019 Census, health resources and medical staff are heavily concentrated in the capital, Honiara. In the rural provincial areas, some health facilities are not operating at full capacity. Table 10 shows that several health facilities across the provinces are closed due to unavailability of staff or maintenance and repair.74 74. The MHMS is working on a master plan for carrying out renovation and maintenance works across health facilities in the provinces. 85 Table 11: Medical facilities and medical personnel per capita for provinces (2020) Province Medical Staff* Medical staff per Medical Medical facility 1000 persons Facilities** per 1000 persons Guadalcanal 93 0.60 46 0.30 Western province 141 1.50 64 0.68 Malaita 172 0.99 59 0.34 Temotu 60 2.71 18 0.81 Central Island 30 0.99 26 0.86 Choiseul 51 1.67 26 0.85 Isabel 63 2.07 37 1.22 Makira 75 1.44 36 0.69 Honiara City 132 1.01 16 0.12 Renbel 19 4.64 3 0.73 NRH (National Referral Hospital) 503 - 1 - Solomon Island 1339 1.86 331 0.46 *Medical workers here include doctors, nurses, dentists, and pharmacists. **Medical facilities include hospitals, area health centers, rural health centers, nurse aid posts. Source: HR department, MHMS, authors’ calculations Table 12: Health indicators and the COVID-19 pandemic Indicator 2019 Q3 2020 Q3 2021 Q3 Children immunized against PCV (%) 96 88.9 86.7 Women completing 4 or more ANC visits (%) 65.9 66.1 63.7 Percent of NCD patients with diabetes 29.3 30.5 31.9 (confirmed or suspected) Number of confirmed malaria cases 58,824 51,600 61,636 Outreach and people-focused activities 5,641 4,389 3,479 Source: Health core indicator report, MHMS 86 145. Next to disrupting lives and livelihoods, 147. Efficiency gains in health spending are the COVID-19 pandemic also affected the paramount if the country wishes to make balance between the provision of health progress on health-related SDGs and UHC. care services and mitigating the spread With real GDP per capita in 2027 predicted of the virus.75 Since the outbreak of the to be lower than 2019 levels, the Solomon COVID-19 pandemic in March 2020, Solomon Islands’ economy is not expected to get back Islands recorded 18,174 positive cases and to its pre-COVID-19 level in the next five years 146 deaths (situation at May 25 2022).76 (World Bank, 2022). Relatedly, government Furthermore, the crisis also affected the finances are projected to follow a similar delivery of health care services, resulting in trend while the Solomon Islands population is reduced child immunization rates, increased expected to expand. As a result, the country’s infant mortality, and rising cases of malaria per capita spending capacity is expected to and TB (see Table 14). Preparedness and drop in the medium-term. However, if Solomon response efforts towards the pandemic Islands wishes to sustain efforts towards required additional resources and attention, the achievement of health-related SDGs and and so health workers, health facilities, and UHC, it will likely have to increase the share some health services were re-purposed to of government spending on health. This is a address pandemic impacts. However, this has challenging task, given the current economic been detrimental to the provision of routine situation and constrained fiscal position. More health care, which was further impacted by than ever, maximizing the use of available lockdowns, curfews, and the civil unrest of resources and efficiency gains in health November 2021. spending is becoming paramount. 146. Given the above constraints, it has been difficult for Solomon Islands to make progress in achieving UHC. The UHC service coverage index (SCI) measures progress towards UHC and is based on 14 indicators related to service coverage, infectious diseases, noncommunicable diseases, and service capacity and access. Solomon Islands made a one-point improvement on its overall score for the UHC SCI, increasing from 49 in 2017 to 50 in 2019. The score remains below the SCI average of 58 for lower middle-income countries and mainly reflects challenges in the areas of reproductive, maternal, newborn and child health, as well as service capacity and access. However, Solomon Islands scores broadly in the same range compared to other Pacific Island countries, as shown in Table 13. While some structural peers perform better than Solomon Islands (e.g., Kyrgyz Republic), 75. However, the crisis also had positive impacts on health the country outperforms others (e.g., Papua system strengthening. To respond to the COVID-19 crisis, New Guinea). The country underperforms both the government and development partners expanded on preventative indicators but does slightly the focus on the country’s health sector. While increased health resources were largely driven by COVID-19 needs, better than others in the region on treatment they also contributed to strengthening the overall indicators. health system of the country, especially in improving hospital ICU and isolation units, disease surveillance, laboratory capacity, supply chain management, and infection prevention and control policies and procedures. In the past two years, much of the assistance from bilateral partners has been towards strengthening the preparedness and response efforts towards COVID-19, and the MHMS has been a key recipient of this support. The preparedness and response efforts have also strengthened the Solomon Islands’ health system’s ability to respond to a future crisis. 76. With limited testing capacity, and with COVID-19 patients instructed to stay at home, the actual number of COVID- related deaths is likely to be higher. 87 Table 13: UHC SCI index for selected Pacific countries and structural peers Ccountry 2015 -2019 2019 Level Tonga 55 56 Medium Kiribati 50 51 Medium Vanuatu 50 52 Medium Samoa 53 53 Medium Fiji 59 61 Medium Solomon Islands 49 50 Medium Lao 48 50 Medium Mauritania 38 40 Medium PNG 33 36 Low Kyrgyz Republic 70 70 High Timo-Leste 53 51 Medium Myanmar - 61 Medium Source: World Health Organization (WHO) GHO Figure 49: Life expectancy vs. per capita health spending 85 80 Samoa Life expectancy, 2018 (years) 75 Solomon Is. Tonga RMI 70 Kiribati Fiji Micronesia 65 60 55 50 15 40 100 250 600 1,500 4,000 10,000 Current health expenditure per capita, 2018 (US$) Note: Markers in aqua are Caribbean Island economies. Source: WHO, World Bank 88 148. Despite the above challenges, Solomon 6.1.2 Health budget and expenditures Islands performs relatively well in terms 149. The health system in Solomon Islands is of health outcomes. Life expectancy in the largely finance through the Solomon Islands country is 72.8 years, higher than the life Government (SIG) domestic revenue and expectancy in Fiji (67.3 years), Kiribati (68.1), DPs external funding. Figure 50 shows the PNG (64.2), and Tonga (70.8). Furthermore, flow of financing resources within the MHMS. the country’s life expectancy is higher than The bulk of financing for MHMS comes from what one would expect, based on its per capita MOFT through Ledger 276 (recurrent domestic health spending (see Figure 1).77 Both infant budget), Ledger 376 (DP on system budget), and adult mortality rates are lower compared and Ledger 476 (capital budget for large to Fiji, Kiribati, and PNG – and structural infrastructure type investments). The DP peers including Laos, Myanmar, and Timor- off-system funds (Ledger 476NA), including Leste. However, Solomon Islands compares financing from Australia’s Department of poorly with respect to maternal mortality, Foreign Affairs and Trade (DFAT), the Vaccine coming in (significantly) higher than a number Alliance (GAVI), the Global Fund and the of Pacific peer countries at 104 deaths per World Bank, provide substantial financing 100,000 live births in 2017. For example, the and in-kind support to the MHMS. These off- maternal mortality rate in Fiji is only 34 deaths system funds are processed outside of the SIG per 100,000 live births. Kiribati also performs budget and the MHMS financial management better with a maternal mortality rate of 92. information system. While MHMS has made Relatedly, early childbearing is much higher in some efforts to collect financing information Solomon Islands (15 percent of women aged on 476NA expenditures in recent years,78 20–24 gave birth before 18) compared to peer this process has somewhat diminished since countries (Kyrgyzstan 2.8 percent; Fiji 3.7 the onset of the COVID-19 pandemic. This is percent). Access to appropriately equipped partly due to MHMS staffing shortages due to and staffed birthing facilities, as well as the reprioritization of staff to pandemic response geographical dispersion of communities in rural efforts, low priority and emphasis placed on areas and outer islands are among key drivers off-system funding, and in some cases due to for this result. poor reporting compliance by DPs to MHMS off-system data requests. In addition, there is some health expenditure that is funded from private organizations and household out-of- pocket payments (OOP).79 However, these are minimal given the small private sector in the country (which is largely concentrated in the capital). The National Health Programs include the National Referral Hospital (NRH) and the National Medical Stores (NMS), which are two of the most important cost pressures for the MHMS. Funding is also required for health services and health facilities located across the nine provinces. 77. Several factors influence life expectancy beyond health spending, so this statement should be interpreted with caution. 78. In 2018, DP expenditures under L476NA were estimated at SI$70 million, close to 15 percent of on-budget spending. 79. Ascertaining the true contribution of OOP financing is challenging given the lack of data and measurement. 89 Figure 50: Health financing flows in Solomon Islands Solomon Inlands Ministry of Finance Development Government and Treasury Partners Ledgers 276, 376, 476 DP off-system funds Ministry of Health and Medical Services (MHMS) Provincial Health National Health Services Programs Ad-hoc funds and donations including OOP Source: Authors’ own development Figure 51: Health sector budget Panel A: Health sector budget as a share Panel B: Health sector budget by expenditure type of the total budget (SBD million) 18% 700 Developmen 16% 600 14% Developmen 500 12% SIG Recurrent 10% 400 8% 300 6% 200 4% 100 2% 0% 0 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 SIG Recurrent Development Partner Budget Development Budget Source: Budget Expenditure Tracking Analysis (BETA) from the Pacific Health Advisory Services and Analytics 90 150. The SIG has consistently prioritized health 151. Budget execution is high for the SIG in its annual budgets. Panel A in Figure 51 Recurrent Budget (276), but low for the DP shows that health funding has averaged 14 Recurrent (376) and Development Budget percent of total government expenditures over (476) (see Figure 52). Ledger 276 is used the period 2016–2021. This is broadly in line mainly for human resource costs (payroll) and with the average of the country’s structural other charges, which are largely operational peers (see Figure 50). In 2019, current health expenditures such as fuel, utilities, and travel. expenditure amounted to 5 percent of GDP, Ledger 376 (DP on-system funds) is mainly for again broadly in line with structural peers. supporting the implementation of public health In the past five years, health budgets and programs. The execution rate of Ledger 376 spending have increased annually despite tends to be low for public health programs due continued fiscal pressures. The MHMS total to low absorptive capacity, poor planning, and SIG Recurrent Budget (276) and Development issues related to delays in DP disbursements. Partner (DP) Recurrent Budget (376) has Furthermore, DPs tend to disburse off-budget increased in both nominal terms and as a funds for public health programs first, before share of the SIG domestic budget (see Figure turning to on-budget financing, which is 51). The COVID-19 pandemic has further led another reason for the low execution rate to increased investments in health, both from of Ledger 376. Weaknesses in upstream SIG reprioritization of budgets as well as an public investment management processes outpouring of funding and aid-in-kind from and lengthy procurement have contributed DPs. With the pandemic slowly waning and to the low execution rate in the development reduced fiscal space, further increases in the budget (see Chapter 7). Low execution of the health budget are unlikely. 476-development budget is due to a budget allocation for a multi-year infrastructure project in one budget cycle. Table 14: Current Health Expenditure (CHE) (As percent of General Government Expenditure (GGE)) Countries Indicators 2012 2013 2014 2015 2016 2017 2018 2019 Mauritania CHE as % of GGE 12 14 15 14 15 16 18 19 Kyrgyzstan CHE as % of GGE 21 21 19 19 16 17 15 14 Myanmar CHE as % of GGE 13 14 18 23 22 24 23 23 Kiribati CHE as % of GGE 9 11 9 8 8 10 9 9 Lao People's CHE as % of GGE 8 10 9 10 11 12 11 13 Democratic Republic Papua New Guinea CHE as % of GGE 8 7 7 6 8 9 8 6 Solomon Islands CHE as % of GGE 11 12 13 11 11 10 10 14 Source: The WHO Global Health Expenditure Database (https://apps.who.int/nha/database) 91 Figure 52: Budget execution rates by Ledger (2012–2020) 120% 100% 80% 60% 40% 20% 0% 2015 2016 2017 2018 2019 2020 2021 SIG recurrent Development Partner Budget Development Source: Budget Expenditure Tracking Analysis (BETA) from the Pacific Health Advisory Services and Analytics 152. Payroll costs are increasingly becoming 153. Utility costs (phone, power, and water) a cost pressure for the MHMS. Ledger continue to be an area of concern for the 276 is used to fund payroll and for other MHMS. Over the years, attempts have been charges. Payroll expenses are a mix of wages, made to reduce utility costs, but in the years allowances, and superannuation expenses and 2019 and 2020 utility costs have been rising have increased from 33 percent of recurrent again (see Figure 53). This has resulted in expenditures in 2012 to 45 percent in 2021. outstanding utility bills and domestic payment As a corollary, the share of funds available to arrears, which are expected to be cleared finance operation costs – including grants, in the 2022 budget. Contributing factors utilities, freight and shipping, training, etc. to the payment arrears are poor planning – are reduced. As analyzed in Chapter 6, and budgeting, a reallocation of the health allowances have increased at a much faster budget for the COVID-19 response, as well pace than salaries and wages. A review by as a crowding-out of the operational budget MHMS into the administration of employee due to rising payroll costs. The COVID-19 allowances uncovered significant evidence crisis may partly explain the rising utility of both under and overpaying of employees costs in the 2020 budget. That is, high (MHMS Annual Report, 2017). As a response, telephone expenses resulted from phone the payroll and salaries budget was adjusted in lines being made widely available to health 2018 based on annual expenditure amounts. staff, resulting in increased use. The MHMS is currently assessing all ministry phone lines and restricting both usage and access. Furthermore, the Ministry is also looking into electricity consumption and exploring ways in which they can reduce future costs. 92 Figure 53: Utilities budget and expenditure (2016–2020) 18 18 18 16 16 16 14 14 14 12 12 12 Millions SBD 10 10 10 8 8 8 6 6 6 4 4 4 2 2 2 0 0 0 2016 2017 2018 2019 2020 2016 2017 2018 2019 2020 2016 2017 2018 2019 2020 Water Water Telephone Telephone Electricity Electricity budget expenditure budget expenditure budget expenditure T_expenses W_expenditure E_expend Source: Budget Expenditure Tracking Analysis (BETA) from the Pacific Health Advisory Services and T_budget Analytics W_Budget E_budget 18 16 14 12 6.1.3 The Expanded Program on Immunization (EPI) 155. The cost of routine immunization in the 10 154. The EPI Unit manages and coordinates country is largely funded by GAVI, but GAVI 8 financing is slated to cease at the end of routine immunization and the introduction of 6 2023. During 2017–2020, GAVI financing new vaccines across the country with support accounted for 72.5 percent of the direct 4 from the Vaccine Alliance (GAVI). The unit immunization costs on average, while payroll 2 is located within the National Reproductive, costs were funded by the SIG (see Figure 54). In 0 Maternal, Newborn, Child, and Adolescent 2020, the contribution from GAVI represented Health (RMNCAH) division of the MHMS. The SI$5.1 million. While domestic funding for programs and activities of the EPI unit are immunization has slowly increased since 2017, supported by GAVI and include vaccinations for more resources are needed to fully sustain the Polio (IPV), Measles Rubella (MR), Pentavalent, immunization program. Given that GAVI funding Pneumococcal, Human Papillomavirus (HPV), is expected to cease at the end of 2023,80 and Rotavirus. Furthermore, GAVI also supports the MHMS will need to carefully manage the Health System Strengthening (HSS) efforts transition to domestic financing to ensure that which include the provision of funds through new and routine immunization services are the WHO, UNICEF, Program for Appropriate adequately financed with minimal disruption to Technology in Health (PATH), and technical the delivery of health services. assistance to the EPI Unit. 80. Eligibility to receive GAVI funding is based on a country’s per capita GNI. Countries with a GNI per capita of less than US$1,630 over the past three years are eligible for GAVI support. Once countries cross this threshold, they enter an accelerated transition phase. As Solomon Islands’ GNI per capita exceeds the GAVI threshold, GAVI financing was supposed to cease at the end of 2022. However, GAVI agreed to freeze country eligibility for one year, leaving the country in the accelerated transition phase until the end of 2023. 93 Table 15: Immunization rates for selected vaccination programs Indicator 2019 2020 2021 Children immunized against measles MR1 (%) 84.3 79.3 71.8 Children immunized against PCV (%) 96 88.9 86.7 Children immunized against Polio (%) 95.2 88.3 85.0 Children immunized against PENTA (%) 95.9 90.2 87.0 Figure 54: Source of financing for the Solomon Islands immunization program 12 10 Millions SBD 8 6 40 2 0 2017 2018 2019 2020 SIG GAVI Other sources Source: Costing the Expanded Program on Immunization (EPI) in Solomon Islands 2017–2020 report 156. Due to the COVID-19 pandemic, however, Furthermore, the Solomon Islands health routine child immunization coverage rates Sector Wide Approach Partnership agreement have decreased. The impact of COVID-19, (SWAP), which expired in 2020, may need to including an increased focus on COVID-19 be reviewed and reinstated. This partnership vaccination, has resulted in reduced governed a shared commitment of DPs and immunization coverage of routine vaccines (see the MHMS to principles of cooperation, Table 15). An important driver for this decline transparency, accountability, and good was the reallocation of the MHMS EPI team governance. One of the shared objectives of away from routine immunization to COVID-19 the SWAP was to work with the MHMS on vaccination. Resumption of these immunization developing, implementing, and monitoring services is critical to reduce the risk of possible Annual Operational Plans that better link disease outbreaks. budgets, activities, and results. With respect to the MHMS, program managers and directors 6.1.4 Policy implications need more time to develop actionable and well- defined annual operational plans and budgets. 157. With low budget execution resulting in slow implementation of health programs, 158. Relatedly, with a significant share of DP measures should be identified to address financing off-budget, measures could be deficiencies in the MHMS annual budget. taken to reflect DP spending in the annual As the low budget execution is largely due to health budget. Activities that are planned from Ledger 376, DP funding should be harmonized all sources, both the government budget and with the SIG PFM systems to help ensure that DP funds, are reflected in the annual budget. It funding is available when needed for execution. also provides the legal basis for the executive This includes a review of the different donor to implement its development vision. There is, funding payment modalities. therefore, a need to ensure that DP funding is included in the budget. 94 Furthermore, the inclusion of DP funds on- 6.2 THE EDUCATION SECTOR budget provides a more complete picture of the resources allocated at the country and 6.2.1 Overview and challenges the sectoral level (Piatti et al, 2021). As a first step, both the government and the DPs can 160. The education system in Solomon Islands take action to reflect DP spending in the annual is guided by a 15-year strategic framework, budget (in Ledger 476NA). For the DPs, this published by the Ministry of Education and involves the provision of a total budget ceiling, Human Resources Development (MEHRD). including the activities to be financed. These Education in Solomon Islands consists of activities need to be reflected in the annual two years of early childhood education (ECE) budget. Next, a reform roadmap could be (ages 3–4), six years of primary education developed to align the DP engagement in the (ages 5–11), and seven years of secondary health sector more fully with country systems, education (12–18). The sector is guided by including budget execution and financial the Education Strategic Framework (ESF) reporting, as well as the use of national audit 2016–2030, which has established four and procurement systems. This requires strategic goals: (i) increasing access while an analysis of the various DP protocols, the also improving the quality of education, (ii) incentives driving DP and recipient country strengthening policies, plans, management, behavior, and an examination of Solomon and systems, (iii) emphasizing equity, inclusion, Islands’ PFM systems. Over time, this could and gender equality, and (iv) introducing result in higher execution rates for the DP lifelong learning. The National Education Action budget, among other benefits. Plan (NEAP) 2016–2020 complemented the current framework in providing direct activities 159. Given the need for fiscal consolidation, the targeting the strategic goals of both the government could consider measures to preceding (2007–2015) ESF and the current contain spending pressures in the health one. NEAP 2016–2020 core considerations sector and take action to improve the included: providing universal access to effectiveness of health service delivery. quality basic and secondary education for all GAVI funding is expected to end in 2023, while children by 2030, and improving access to at the same time payroll expenditures and early childhood education, care, as well as utility costs have increased. Furthermore, technical and vocational education and training the implementation of a large infrastructure opportunities. pipeline and declining logging revenues may put the financing envelope of the health sector 161. Government spending on education is under pressure. The authorities could take high, but it has not translated to increased measures to keep utility costs in check, and education outcomes. Government also engage in a deep review of the sector’s expenditures on education are approximately wage bill (cfr. Chapter 5). The government 10.1 percent of GDP, markedly higher than could consider taking measures to improve the OECD average of 3.4 percent and the energy efficiency. Combined with a review in global average of 4.7 percent. The high level pay and grading, climate proofing public health of spending partly reflects structural factors, buildings could generate 1 percent of GDP in including a high proportion of school-aged fiscal savings in the health sector. Furthermore, children in the population, as well as a high action is needed to improve service delivery cost of providing education services in in both rural locations and at the National the outer islands, but also disproportional Referral Hospital. This includes the upgrading spending on specific programs. The of health facilities and ensuring that essential expenditures, however, are not currently medicines are in stock. Finally, the government resulting in similar gains, especially in upper should take a proactive approach to cover secondary and tertiary education. This has left the GAVI funding shortfall, especially as the country with a skills gap that jeopardizes immunization rates have decreased in the past long-term development. For instance, few years. according to the World Bank’s Human Capital Index, a child born in Solomon Islands today will only be 42 percent as productive when they grow up compared to what they would have been if they enjoyed complete education and full health. 95 This is lower than the average for East Asia, 164. Enrolment at the secondary school level, the Pacific, and lower middle-income countries. formally regulated via a secondary school Furthermore, results of the harmonized test entrance exam, shows a further erosion of scores suggest that students from Solomon students from the formal education stream. Islands are outperformed by many of their This is reflected in high dropout rates among Pacific peers. secondary school students. In 2016, the survival rate to Year 6 was 65 percent, which 162. Education in Solomon Islands is free but declined to 49 percent by 2019. Furthermore, non-compulsory, which has resulted in low the survival rate drops even more at the later enrolment rates. Approximately 70 percent of stages of education. For example, in 2019 children begin primary school at their expected the dropout rate in Year 12 stood at over 85 entrance age. Gross enrolment rates, however, percent. In addition, there is a notable gender show over-age and repetition enrollees, which gap in secondary school, with boys’ gross bring the primary school rates to over 100 enrolment rate around 32 percent and girls’ percent (see Table 16). Enrolment at secondary around 27 percent. school shows a further erosion of students from the formal education stream. Tertiary 165. More information is needed to understand education serves only an estimated 1.8 percent the quality of education and learning of students in the post-secondary age cohort, outcomes. To begin with, more assessment resulting in a dearth of highly skilled workers in or examination data to document students’ the population. Access to education has, even learning outcomes at key stages of the with the introduction of fee-free primary and education cycle is needed. One source of such early secondary education in 2009, remained data is a regional assessment called the Pacific significantly below the stated goals of the Islands Literacy and Numeracy Assessment Solomon Island Ministry of Education and (PILNA) 2018, which measures students’ skills Human Resource Development (MEHRD). in Year 4 and Year 6. The data from PILNA 2018 shows that 30 percent of Year 6 students 163. Late enrolment and low participation at the in Solomon Islands were unable to read at early stages affects the education system the expected grade level. A more recent further downstream. Enrolment in ECE is assessment of students’ reading, writing, and limited due to a lack of ECE centers within numeracy skills was carried out in November walking distance. Furthermore, an observed 2021 (PILNA 2021), with a regional report of the gap between the Gross Enrolment Rate (GER) results launched in September 2022. This data and Net Enrolment Rate (NER) suggests that – alongside the questionnaires administered many children enter ECE centers overaged. to students, teachers, and school heads – Late enrolment and low overall participation provides invaluable insights into the quality in the early years of education contributes to of education provided, and the underlying overage enrolments throughout the rest of determinates. But, thus far, the data has not the system, as evidenced by a high GER at the been made public. primary school level. Table 16: Student enrollment data (By sector) Sector Enrollment (No.) Enrollment (%) Gross enrollment Net enrollment ratio (%) ratio (%) Primary 130,140 70% 104.3% (2019) 67.5% (2018) Upper Secondary 54,012 30% 28.7% (2012) N/A Tertiary 3,977 1.8% N/A N/A Total 224,031 Source: MEHRD, Annual Report 2019; epdc.org 2018; World Bank; UNESCO 96 Analyzing this data would provide invaluable 168. Tertiary enrollment has doubled in less than insights into what students can and cannot a decade but remains among the lowest in do by Year 4 and Year 6, and what are the world. Data from MEHRD indicates 3,977 some of the proximate causes of potential students were enrolled at tertiary institutions problems observed. For instance, how in 2019, accounting for less than 2 percent of important is the absence of textbooks? students across all levels of education. This Data from a 2022 World Bank High signifies a doubling of enrollments in almost Frequency Phone Survey indicates that only a decade, as 1,720 students were enrolled in 43 percent of children attending school tertiary education in 2012. Even still, tertiary have a complete set of textbooks at their enrollment rates in Solomon Islands are disposal. Furthermore, the education system among the lowest in the world, and also much is faced with a large share of unqualified or lower than most of the country’s structural underqualified teachers, even though the and aspirational peers (see Table 17). Several situation has improved in recent years. factors explain the country’s low participation in higher education, including high drop-out 166. Along with limited access, the quality of rates and low survival rates at the secondary education remains a significant challenge. level, lower perceived value of education, This is partially driven by a lack of proper as well as the limited supply and geographic teaching materials and low textbook-to- concentration of tertiary education providers. pupil ratios. For instance, data from a 2022 World Bank High Frequency Phone Survey 169. Solomon Islands students interested in indicates that only 43 percent of children pursuing tertiary education may apply for attending school have a complete set of scholarship funding from the government. textbooks at their disposal. Furthermore, the There are five categories of scholarships education system is faced with a large share available to applicants: (i) pre-service, (ii) of unqualified or underqualified teachers, in-service public sector, (iii) in-service private even though the situation has improved in sector, (iv) in-service teaching sector, and (v) recent years. The number of certified teachers skills development. In the first category, there increased from 58 percent to 81 percent are three subcategories: (i) school-based in primary, and from 73 to 84 percent in scholarships which require exceptional grades, secondary school, over the period 2011–2019. (ii) constituency scholarships where Members This development suggests that the amount of of Parliament endorse four applicants who time a student spends with qualified teaching meet merit-based selection criteria, and (iii) staff has improved over the past decade, scholarships for self-funded students who contributing to improved learning outcomes. have financed at least one year of tertiary education and obtained a minimum GPA of 6.2.2 Tertiary education and the 3.5. Scholarships allow students to pursue scholarship program tertiary education at both local institutions and at universities abroad. The Solomon 167. In Solomon Islands, tertiary education Islands Tertiary Education and Skills Authority is provided by two main institutions. The (SITESA) is responsible for managing the Solomon Islands National University (SINU) scholarship program. was founded in 2013 and absorbed the schools and colleges of the Solomon Islands College of Higher Education (SICHE). The second institution is the University of the South Pacific Solomon Islands (USP-SI). Located in Honiara, SINU and USP-SI cater to the majority of the 3,977 students (2019) who are enrolled in tertiary programs. According to the NEAP, the main strategic focus for tertiary education is on the establishment of a comprehensive, integrated system of tertiary education which provides quality education and relevant skills for employment, decent jobs, and entrepreneurship. 97 Table 17: Tertiary enrollment data for Solomon Islands and its structural and aspirational peers Country Tertiary enrollment rate (gross %) South Sudan (ranked last) 1% Papua New Guinea 2% Solomon Islands 6% Mauritania 6% Lao PDR 13% Timor-Leste 18% Myanmar 19% Kyrgyz Republic 46% Fiji 53% Source: World Development Indicators; most recent value 170. Due to key policy decisions, the number of 171. Spending on the scholarship program awarded scholarships has been fluctuating remains high but has declined since 2017. widely over the past decade. The number Over the past six years, scholarship spending of scholarships averaged 184 over the peaked in 2017, amounting to 3.5 percent of period 2011–2013. In 2013, however, a policy GDP (SI$406 million). Scholarship expenditures decision was made to award scholarships to made up about 11 percent of overall recurrent all students enrolled at the newly established spending that year, costing more than the Solomon Islands National University (SINU). entire policing budget. Since then, scholarship This led to a rapid increase in the number spending has declined, reaching an estimated of awarded scholarships, with scholarships 1.7 percent of GDP in 2021 (SI$226 million) rising to 1,792 in 2014 and, further to 2,283 in (see Figure 56). The SINU policy reversal was 2017. As discussed in more detail below, the a contributing factor, but also the COVID-19 rapid growth in awarded scholarships meant pandemic played an important role in the rapid growth in public spending. By 2017, the decline. That is, at the onset of the COVID-19 unsustainable nature of this growth made it pandemic, the government chose not to clear that a policy change was needed. With offer new scholarships overseas but instead the passage of the Solomon Islands Tertiary focused on funding scholarships for programs and Skills Authority Act in 2017, these new at the two main local institutions, SINU and regulatory procedures came into effect. As USP-SI. However, the SIG continued to fund expected, the number of scholarships dropped scholarship recipients studying overseas substantially, from 2,283 in 2017 to 898 in that were stranded in their host countries 2018 and 968 in 2019 (see Figure 55). for much of the pandemic’s duration. Over the period 2016–2020, the SIG spent on average 1.7 percent of GDP (SI$221 million) on overseas scholarships and 0.6 percent of GDP (SI$82 million) on local scholarships.81 81. These figures exclude MP scholarship awards, training awards, and scholarships managed by the Ministry of Provincial Government and Institutional Strengthening. The figures also exclude donor-funded scholarships, which were estimated at SI$40 million in 2018. 98 Figure 55: Number of scholarships awarded (2011–2019) 2500 2000 1500 1000 500 0 2011 2012 2013 2014 2015 2016 2017 2018 2019 Source: Ministry of Education and Human Resource Development. 2020. Annual Report 2019 172. As a result of the scholarship program, 174. Recently, steps have been taken to make the spending in the education sector is heavily scholarship program more cost-effective. skewed to tertiary education. The country First, until recently, public employees who spends around 3 percent of its GDP on received a scholarship did not forgo their public tertiary education, significantly higher than sector pay, retaining a full salary while pursuing its structural peers. For instance, spending their studies. In the latest budget, however, the on tertiary education as a share of GDP is salary of public servants on a scholarship has roughly sevenfold that of Mauritania and been reduced to 50 percent for the duration almost 10 times that of Myanmar. Relatedly, of the study. Second, for the 2022 budget, non-payroll spending on tertiary education was the SIG continued shifting the scholarship more than the amount spent on all other levels program towards local institutions. The of education combined. The large spending recurrent budget for domestic scholarships on tertiary education is mainly driven by the – excluding MP scholarship awards – has scholarship program, which comprises more increased by 47 percent compared to revised than 90 percent of the tertiary education budget estimates for 2021, while the budget budget (see Figure 57). for overseas scholarship awards declined by 42 percent. Finally, the scholarship program 173. Relatedly, per-student expenditure in the has become more merit-based, arguably tertiary sector far exceeds spending at resulting in higher returns. For instance, other levels, again mainly driven by the in 2017, only 18 percent of the awarded scholarship program. In 2019, educating a scholarships were merit-based. By 2020, university student was 45 times the cost of however, the share of merit-based scholarships educating a secondary school student and increased to 90 percent, a fivefold jump more than 100 times the cost of a primary compared to 2017 (MEHRD, 2020). student (see Table 18). These findings are similar to the results of a previous World Bank analysis conducted in 2012.82 Again, the stark differences are largely driven by the scholarship program. As fewer than 2 percent of students across the education system are 82. The 2012 World Bank analysis noted significant equity enrolled in tertiary education, these choices concerns regarding tertiary scholarships. The analysis noted that improving scholarship support and supervision systems raise equity and allocative efficiency concerns. would lead to better economic and employment outcomes. To achieve education goals, the study recommended rebalancing public expenditure away from tertiary scholarships and towards basic, secondary, and second-chance education. 99 Figure 56: SIG-funded scholarship spending (As a percent of GDP) 4.0 3.5 3.0 2.5 2.0 1.5 2016 2017 2018 2019 2020 2021 (estimate) Source: BOOST data, IMF Figure 57: Share of non-payroll recurrent expenditure in the education sector (MEHRD) 100 80 60 40 20 0 2016-2018 2019-2021 Other Primary Secondary Tertiary Scholarships Note: Figure excludes scholarships linked to the Ministry of Provincial Government and Institutional Strengthening totaling SI$31.4 million during the six-year period. Figure also excludes scholarships linked to donor support, which is estimated at SI$40 million in 2018. Churches also provide education services, which are not included in the analysis. Source: BOOST data Table 18: Per-student expenditure by sector (2018 and 2019) 2018 2019 Sector Expenditure Student Unit Cost Expenditure Student Unit Cost (SBD) enrollment (SBD) (SBD) enrollment (SBD) mn mn ECE 16.3 30,340 538 19.4 16,067 1,210 Primary 90.3 133,604 676 115.6 130,140 888 Secondary 105.5 73,837 1,428 110.6 54,012 2,047 Tertiary 409.0 3,502 116,791 371.3 3,977 93,372 Total 621.1 241,283 617.0 204,196 Note: Expenditure data excludes payroll amounts. TVET unit costs are excluded due to many students enrolling part-time. Source: MEHRD Annual Reports for 2018 and 2019 100 6.2.3 Policy implications 177. Salary benefits for public servants receiving tertiary scholarships should be phased 175. There is need to better understand whether out. There is notable inefficiency in financing primary students are sufficiently mastering a scholarship scheme that allows public the literacy and numeracy skills which are sector workers to continue receiving 50 required for further study at the secondary percent of their salary from employment while and tertiary level. Data to allow such simultaneously receiving the financial benefits understanding was collected in November of a publicly funded scholarship. Such double 2021 as part of a regional assessment primary benefiting from public expenditures limits the students’ numeracy and literacy skills. As a reach of public spending in expanding access first important step, the government could through financial aid. The policy should be make this data available, thereby allowing revised to ensure financial support during researchers and development partners the studies, regardless of employment status, but ability to help the government analyze the data. also guarantee a re-entry into the public sector In addition, the government could consider after completing tertiary education studies. commissioning analytical work to look more closely at teachers’ content knowledge and 178. Evidence-based decision making, regarding teaching practices. Evidence from elsewhere the value for money in scholarship in the region suggests big challenges related investments, needs to be strengthened. to both (Yarrow et al, 2020; Molina et al, 2019). MEHRD was a relatively early adopter of an And remedying potential problems related to education management information system teachers having poor content knowledge and/ (SIEMIS) in 2004. This system, however, is or ineffective teaching practices would be no longer fit for purpose, and a new open- aided by having better information about the source system, designed in conjunction with magnitude and exact nature of such problems. UNESCO, has been piloted in recent years. Other sector-specific platforms are used. 176. Given the low enrolment rates throughout For instance, the Scholarships Information the education sector, there is a need for Management System (SIMS) supports the reform, including in the scholarship program. mission of the tertiary education agency – the The current scholarship-focused funding Solomon Islands Tertiary Education and Skills model for tertiary education does not support Authority (SITESA). While the SIMS is now enhanced investments in national institutions. operational, data accessibility and reliability A further shift towards local scholarships remain insufficient without a longitudinal would free up resources to build institutional time series. Furthermore, mechanisms such capacity at SINU and USP-SI, while at the as labor market surveys, tracer studies, same time retaining – and expanding – the and progression reports would allow for a number of talented students in-country. more granular understanding of the impact Furthermore, a reallocation of scholarship scholarship grants have on those benefiting savings to other education sub-sectors needs from them. Such tools are essential for to be investigated, as student progression assessing the effect of public spending on the diminishes greatly from primary to secondary achievement of national development goals, and through tertiary education.83 Improving as well as employability and earnings. The SIG quality throughout the education pipeline is is already taking some important steps in this imperative to building a population with the direction, with the development of a Tertiary variety of relevant skills to suit the labor market Education Monitoring, Evaluation and Learning and the competitive global economy. With a Plan, the development of an alumni tracking new financing model for tertiary education and reintegration system, and an alignment of – focused on national systems, strategic the SIMS to the SITESA business warehouse. development, and quality – and a related rationalization of scholarship spending, funds should be dedicated to expanding teacher training and related quality investments. As a necessary but non-sufficient condition for improving education outcomes, further study is required, including an integrated Education PER across all levels of the education sector. 83. See Annex 7 for a number of scenarios on scholarship reform and reallocation. 101 chapter 7 A HIGHWAY TO SUCCESS? ANALYZING SELECTED ISSUES IN PUBLIC INVESTMENT MANAGEMENT 102 179. This chapter examines the risks and 181. Substantial capital deepening is therefore opportunities of the large public investment required to promote growth and mitigate pipeline. A large public investment program, the risks of uneven development. There worth 74 percent of 2021 GDP, is expected to is an extremely large pipeline of externally be implemented over the period 2022–2029. funded investment, worth around SI$7.5 The chapter highlights the development billion, scheduled to be undertaken in the benefits the capital program could bring, but next six years. Much of this, however, is due also notes that challenges in budget execution to be completed prior to the Pacific Games may lead to underinvestment and subdued in late 2023. This substantial investment growth. Furthermore, the chapter stresses the (equivalent to three-quarters of real GDP importance of addressing maintenance needs in 2021) has the potential to address key for (fiscal) sustainability. essential infrastructure deficits and should provide a welcome short-term fiscal stimulus to somewhat offset the decline in logging and the devastating macro-fiscal impacts of 7.1 INTRODUCTION the pandemic, the civil unrest, and the war in 180. Inadequate investment is germane to Ukraine – as well as potentially longer-term many of the Solomon Islands’ growth fiscal multipliers (Vagliasindi and Gorgulu, and development challenges. Chronic 2021).84 However, the pipeline also raises underinvestment materializes in a number of considerable challenges. Most obviously, such ways, including the small and declining level a large schedule of planned work occurring in of the capital stock plus severe shortages of a short timeframe will be a stern test of the essential infrastructure, with rates of access absorptive capacity of the already-stretched generally among the lowest of structural SIG’s public investment management (PIM) and regional peers (see Figure 58) and to system, as well as of local implementation countries at a similar level of development. capability. That it is also set against a backdrop The infrastructure deficit inhibits the country’s of the pandemic and recent civil unrest, growth potential, limits human capital which is placing even further demands on the formation, and contributes to the uneven construction and rebuilding of infrastructure, spatial pattern of economic development and is likely to create further implementation access to essential services across urban/rural challenges. Furthermore, large amounts of lines. The inherent risks of natural disasters, such capital expenditure are not captured by already high in Solomon Islands, yet likely to the budget. worsen with climate change, present a further challenge by hastening the degradation and destruction of assets. 84. Vagliasindi and Gorgulu. (2021). Note that while public investment can carry a longer-term fiscal multiplier in excess of one, institutional factors play a crucial role in determining the size of the public investment multiplier, in particular the country’s absorptive capacity, and the selection of high- quality projects. 103 Figure 58: Access to internet Aspirational peer Fiji Structural Papua New Guinea peers Solomon Islands Timor-Leste Lao PDR Myanmar Kiribati Mauritania Kyrgyz Republic Pacific island small states Lower middle income 0 10 20 30 40 50 60 70 80 Source: WDI Figure 59: Efficiency of capital spending Input Output Outcome Capital spending funded by Economic growth, improved Public infrastructure government and donors access to services Allocative efficiency Productive efficiency Source: Authors; adapted from World Bank (2017a); Myanmar Public Expenditure Review 2017: Fiscal Space for Economic Growth Figure 60: Public capital expenditure in Solomon Islands 30% 800 27% 24% 700 Dotted: 21% 2021 Budget 18% SBD Millions 600 15% 12% 500 9% 6% 400 3% 0% 300 2013 2014 2015 2016 2017 2018 2019 2020 2021 2013 2014 2015 2016 2017 2018 2019 2020 2021 Capital/recurrent Capital/total Total public capex Note: Capex = capital expenditure. Source: MoTF and WB staff estimates 104 182. Sound public investment management 7.2 ALLOCATIVE EFFICIENCY (PIM) systems and processes that can deliver quality, effective, and sustainable 184. Budget data show that despite the acute investments are integral to realizing investment needs, the SIG has decreased the potential growth and development the prioritization of public capital dividends of these and future investments. expenditure during the recent period of The PIM system is key to ensuring that the fiscal consolidation (Figure 60).87 Total capital investments of the SIG and external public capital expenditure executed through partners are aligned with the greatest needs the SIG budget has demonstrated a pro- (allocative efficiency) and also for ensuring that cyclical trend. Between 2014 and 2017, as the projects are effectively coordinated and can total fiscal envelope was expanding, public be delivered on time and on budget without capital expenditure increased strongly, rising sacrificing quality to deliver their purported from SI$442 million to SI$916 million and benefits (productive efficiency). In highly rising a share of total public spending from capital constrained contexts, such as Solomon 15.6 percent to around a peak of 23.6 percent Islands, misdirected and wasteful investments in 2016. However, as total spending began have dire consequences: locking up precious to decline from 2018, total public capital limited implementation capacity for long expenditure declined at a much faster rate, periods and leading to poor-quality outcomes declining by 49 percent over the three years to for citizens.85 Additionally, the sustainability 2020, to SI$463 million and contracting to just and resilience of investments loom large over 11.2 percent of spending. Budget estimates for both allocative and productive efficiency – 2021 indicate that while the capital share will particularly in the face of the Solomon Islands’ rise to 17 percent, it will remain well short of inherent vulnerability, natural hazards, and a its recent peak as a share of total spending. changing climate. This puts Solomon Islands behind its peers (Figure 61 and Figure 62). 183. This analysis aims to strengthen the SIG’s capability to manage public investment as well as strengthen the climate resilience of public investments. Recommendations are based on a holistic assessment of the current investment landscape, as well as recent diagnostic work.86 The analysis is divided into four sections: Section 1 is a short introduction; Section two focuses on the allocative efficiency of total capital expenditure and growth linkages, noting the challenges of analyzing the highly fragmented system of spending that spans across the whole SIG budget and development partner contributions; Section three examines productive efficiency through the lens of a stylized framework of a well- functioning PIM system, with a specific focus on the divergence in PIM practices across different types of financing and the challenges of project implementation; Section four concludes with a suite of recommendations. 85. Moreover, with such a slew of investment needs across the country and caps on external borrowing, ineffective selection and implementation of investment projects also has a high opportunity cost. 85. This includes PRIF, 2018 and Lee. et al, 2018. Article IV Consultations. 87. Total public capital expenditure combines all executed spending in the SIG budget with the economic classification “Capex” “capital expenditure” and “Land Acquisition” in the description (as per ECON4 code in BOOST database). This includes capital expenditure included in the recurrent budget (funded by the SIG and via budget support) as well as the development budget. 105 Figure 61: Public capital expenditure (Percent of total budget) (Cross-country comparison) 70 70 50 Myanm MyanmaMy 60 60 40 Kyrgyz Kyrgyz Re Ky 50 50 Lao La Lao 40 40 30 Kiribat KiribatiKir 30 30 20 Timor- Timor-LeTim 20 20 10 Maurit Mauritan Ma 10 10 PNGPN PNG 0 0 0 2016 2016 2017 2017 2018 2018 2019 2019 2020 2020 2016 2017 2018 2019 2020 Solom Solomon So Solomon İslands Mauritania Kiribati Kyrgyz Republic PNG Timor-Leste Lao Myanmar Source: MoTF, WEO; WB staff estimates 50 Figure 62: Public capital expenditure (Percent of GDP) (Cross-country 40 comparison) 70 70 10 10 30 Myanmar Myanmar 9 9 60 60 8 8 Kyrgyz Kyrgyz Rep Republ 20 50 50 7 7 LaoLao 40 40 6 6 10 5 5 Kiribati Kiribati 30 30 4 4 0 Timor-Leste Timor-Leste 20 20 3 3 2 2 Mauritania Mauritania 10 10 1 1 PNG PNG 0 0 0 0 2016 2016 2017 2017 2018 2018 2019 2019 2020 2020 2016 2016 2017 2017 2018 2018 2019 2019 2020 2020 Solomon Solomon İslan İs Solomon İslands Mauritania Lorem ipsum Lorem ipsum Kiribati Lorem ipsum Kyrgyz Republic PNG Timor-Leste Lao Myanmar Myanmar Myanmar Source: MoTF, WEO; WB Kyrgyzstaff Kyrgyz estimates Republic Republic 80 70 LaoLao 60 Share Figure 63: of total public capital expenditure, largest ministerial allocations Kiribati Kiribati 50 Timor-Leste Timor-Leste 60 40 Mauritania Mauritania Ru 50 30 PNG PNG Inf 40 20 Solomon Solomon İslands İslands Ed Dotted: 30 10 2021 Budget Pro 20 0 He 10 O 0 2013 2014 2015 2016 2017 2018 2019 2020 2021(B) Office of the Prime Minister & Cabinet Provincial Gov’t & Institutional Infrastructure Development Health & Medical Services Strengthening Rural Development Education & Human Resource Development Source: MoTF and WB staff estimates 106 Figure 64: Executed public capital expenditure (By economic classification; SBD millions) 500 400 SBD Millions 300 200 100 0 2013 2014 2015 2016 2017 2018 2019 2020 Machinery and equipment Buildings (residential and Transport infrastructure Land non-residential) Source: MoTF and WB staff estimates 50 40 30 20 10 185. 0 Within the SIG budget, there has been a 186. In contrast, there has been a distinct shift substantial shift in the composition of capital toward executing the Rural Development expenditure, with a marked decline in the Budget Head and Constituency Development Ministry of Infrastructure Development and funding (Figure 64).88 In 2014, capital spending on transport, despite the clear expenditure by the infrastructure development transport infrastructure needs (Figure Lorem ipsum 63). andipsum Lorem Lorem ipsum rural development ministerial heads The level of executed capital spending by was equivalent in scale (both accounting for the Ministry of Infrastructure Development around 20 percent of total capital expenditure), 80 declined by 83 percent between its peak in whereas by 2020 rural development spending 2017 (US$257 million) to 2020 (US$43 million); was more than five times as large. The 70 also shrinking as a share of total capital Rural Development Head mainly reflects the 60 spending from 28 percent to 9 percent over deployment of Constituency Development that50time. The decline in the infrastructure Funds (CDF) to individual Members of development head since 2017 coincides with Parliament, which have been difficult to track the 40 pronounced fall in the amount of spending through the PFM system. Demonstrating this, transport infrastructure (roads and bridges on 30 the rise in Rural Development spending has plus structures, airfields, and wharves), which coincided with the prominence of the obscure 20 fell by 79 percent over the same timeframe. economic classification ‘Other Equipment’, 10 same time, development partners have At the which rose from 27 percent of capital substantially increased the amount spent expenditure in 2016 to 48 percent in 2020. 0 on infrastructure development; raising the possibility that the SIG is leaving large-scale infrastructure spending to donors. 88. The notable exception is 2019, in which Rural Development Head in general nearly halved. 107 187. Investments in health have also increased 7.2.1 The fragmentation of capital investment strongly in recent years, helping to arrest a 189. A comprehensive evaluation of the allocative general decline in prioritization. Health capital efficiency of public investment in Solomon expenditure fell noticeably as a share of total Islands is undermined by the budget process capital expenditure between 2013 and 2017, that produces a fragmented and incomplete declining from 5 percent to 1 percent. However, picture of capital expenditure. The total strong increases in allocations in the years government budget is divided into two parts: immediately thereafter lifted its share to a peak the development budget and the recurrent of 9 percent in 2019. Budget estimates for 2021 budget. Both budgets follow a similar logic, indicate that this share will continue to rise, being organized by a Ministerial Budget Head, underpinned by the demands of the pandemic and then into high-level projects/programs and response, to 11 percent. If realized, this would a common set of economic classifications. be the first time since at least 2013 that health The development budget (Ledger 4) includes investment exceeded education investment.89 appropriated (i.e., on-budget) support for In contrast to health, education-related capital new and ongoing development projects. The expenditure has been on a steady downward recurrent budget divides recurrent expenditure trajectory since 2015, halving as a share of into Domestic Funded Recurrent Expenditure total public capital expenditure over that (Ledger 2) and Donor-Funded General Budget time, to 7 percent in 2020. In the 2021 budget, Support (Ledger 3).92 The rest of this section education investment is expected to receive a focuses on three issues that arise from this boost, though its share of total expenditure is budgetary fragmentation that confound likely to remain broadly unchanged. assessments of the allocative efficiency of 188. Amid the general decline in prioritization of capital expenditure: (i) inconsistencies in capital expenditure in 2020, infrastructure accounting for capital expenditure across investment was a clear priority of the budget components, (ii) significant public SI$306 million Economic Stimulus Program investments being undertaken outside of (ESP). The focus of the stimulus investment the budget, and (iii) lack of transparency and program is to bring forward previously oversight over activities under the CDF. unfunded rural transport infrastructure These issues are summarized in Figure 65. rehabilitation projects that were included in the National Transport Plan, (2017–2036) (SIG 2020a).90 These included two provincial wharves (in Makira and Malaita) and airports (in New Georgia and Choiesul) that serve as agricultural hubs, as well as key bridges in Malaita. The entirety of the ESP was categorized as recurrent spending in the SIG budget (notwithstanding the infrastructure component; exacerbating fragmentation) under the Ministry of Finance and Treasury.91 By the end of 2020, SI$204 million of the ESP had been spent, though only 48 percent of the funding for infrastructure initiatives (SI$41.3 million) had been spent, with the residual amount included in the 2021 budget. 89. Around half of the budgeted health investment in 2021 derives from external budget support (Budget Head 376). 90. Government of Solomon Islands. (2020). Economic Stimulus Package to Address the Impacts of the COVID-19 Pandemic. Honiara. 91. The infrastructure initiatives in the ESP are not included in the estimations of public capex. Recategorizing this spending as capital expenditure would lift the share by 1 percent in 2020 (from 11.2 percent to 12.2 percent). Including the 2021 budgeted amounts (SI$48 million) would also lift the estimated capital expenditure share by 1.0 percentage points, to 18.1 percent. 92. Budget support refers to aid that is earmarked at the sectoral level as opposed to general budget support that is unearmarked aid allocated to the treasury. 108 Figure 65: Solomon Islands central government capital budget taxonomy CENTRAL GOVERNMENT BUDGET Capital investment projects not captured Recurrent budget Development budget in government budget SIG recurrent DP recurrent SIG appropriated Non-appropriated (2934) (623) (940) DP projects 2. Off-budget (0) investments Rec. Capex Rec. Capex Rec. Capex (2890) (44) (541) (82) (294) (646) In 2019 SBD m 3,483 committed SBD m 1,846 disbursed 3. Poor oversight DP budget support - SIG and on-budget support of CDF (342) - includes PRC support for CDF 1. Inconsistancies in accounting for capital expenditure. No consolidated perspective * 2021 budget figures in SBD mil. in paranthesis Note: A small amount in the off-budget investment estimates is captured within the SIG budget, including the PRC funding of the CDF but would, nonetheless, represent a very small share of the overall external financing. Exchange rate used for conversion of external financing USD: SBD of 0.1246. SIG = Solomon Islands Government, DP = development partner, CDF = constituency development fund, PRC = People’s Republic of China, Rec. = recurrent, Capex = capital expenditure. Source: Authors using SIG budget. Off-budget data from Lowy Institute 7.2.1.1 Inconsistencies in accounting If realized, the total development budget for capital expenditure envelope in 2021 would be SI$940 million, accounting for 21 percent of total spending94 190. Most capital spending is located in the – a substantial jump in spending from the development budget, which has fluctuated SI$514.1 million spent in 2020.95 Particularly in importance in recent years. Nearly noteworthy has been the continuing nine-tenths of all public capital expenditure trend toward the use of CDFs in the Rural between 2015 and 2020 has been included Development Head (2019: SI$172 million; in the development budget (though the share 2021: SI$342 million) plus a significant jump dipped to around 80 percent in both 2013 in the allocation to the Office of the Prime and 2019) (Figure 66). The historical profile Minister and Cabinet (2019: SI$44 million; of public capital spending has thus largely 2021: SI$201 million) which is responsible reflected changes to the development budget. for overseeing the preparations for the 2023 After peaking in 2017 at SI$1,100.3 million Pacific Games. Together, these two ministries (27 percent of total spending) the development have increased their share of the development budget shrank by 36 percent in the three budget from 37 percent in 2019 to 56 percent years to 2020, to be only 12 percent of total in 2021 (Figure 67). spending. However, it is the stated aim of the SIG to reprioritize development spending in the 2021 and 2022 budgets, and better calibrate it 93. This includes the self-described ‘resource’ and ‘productive’ toward what is considered to be the country’s sectors, which are a sum of selected ministry heads. main drivers of growth.93 94. Of which US$90 million is on-budget support provided by the PRC to support Constituency Development. 95. In 2022 the Development budget is expected to shrink somewhat, to SI$870.9 million (19 percent of total expenditure). 109 Figure 66: Executed public capital spending Figure 67: 2021 Development Budget (By budget type; SBD millions) (Percent share of total) 1200 Ledger 3 1000 Ledger 2 Other 800 Ledger 4 Provincial Gov't and Institutional Streng 600 Grand Total Education and Human Resources 400 Total Development Budget 200 Health and Medical Services 0 Infrastructure Development 2013 2014 2015 2016 2017 2018 2019 2020 O ce of PM&C Ledger 4 Total Development Budget Rural Development Education and Human Ledger 2 Grand Total Office of PM&C Resources Rural Development Provincial Gov’t and Ledger 3 Infrastructure Development Institutional Strengthening Health and Medical 1200 Services Other 1000 MoTF and WB staff estimates Source: Source: MoTF and WB staff estimates 800 600 400 191. Importantly, the development budget does 192. In addition, the recurrent budget also 200 not equate to on-budget capital expenditure, includes a non-trivial share of planned capital with capital spending fragmented across expenditure. This is particularly the case for 0 the budget. While the development budget the externally funded general budget support includes stand-alone investment projects, component of recurrent spending (Ledger such as planned infrastructure investments of 3). In the 2021 budget, capital expenditure the SIG plus the SIG co-financing obligations accounted for 26 percent of the total – a share on donor-funded development projects; much higher than the average between 2013 a good share of spending is on recurrent Lorem ipsum and Lorem 2020 (around ipsum 15 ipsum Lorem percent).98 SIG-funded development programs.96 Arguably, these recurrent spending also includes capital should be reassigned to the recurrent budget.97 expenditure, albeit generally only between Consequently, 80 the development budget is not 1 and 2 percent of total spending. However, strictly a capital budget and instead appears to the relatively large size of the recurrent budget 70used by the SIG as a ‘project-based’ budget, Lorem ipsum Lorem ipsu be means that on average between 7–8 percent of which 60 includes all related spending (capital and total public capital expenditure is designated recurrent) on key projects. Only 69 percent of as SIG recurrent spending. 50 all spending in the 2021 development budget 80 40 classified as capital spending, with the was rest recurrent in nature (Figure 68); the share 70 30 has been fluctuating between 40 percent and 60 70 percent 20 since 2013. 96. Mainly goods and services, but also compensation 10 50 of employees, and grants and subsidies. 97. The SIG acknowledge this, noting that “[t]here are several 0 40 development programmes that were ongoing for more than ten (10) years now. Most of the programmes were recurrent 30 in nature hence should shift to recurrent budget in order to allow the development budget to be more focus on capital investment projects that really drives economic growth of this 20 country.” (SIG 2020b, Final Budget Outcome Report, p27). 98. 10 With the appropriated development budget entirely funded by the SIG, there appears to be little option but to place externally funded on-budget support for capex through the 0 recurrent budget. This may explain the jump in the capex share in 2021. 110 Figure 68: Capital and non-capital expenditure (2021 budget; by budget type) SIG Recurrent (Ledger 1) Budget Support Recurrent (Ledger 3) Development Budget (Ledger 4) Capex 1.5% Capex 13.1% Capex 68.7% Non-capex Non-capex Non-capex Non-capex 98.5% Non-capex 86.9% Non-capex 31.3% Capex Capex Capex Source: MoTF and WB staff estimates 193. Nearly all large ministries fragment capital expenditure across different budgets (Figure 69). Ministries in the productive and resources sector, which are more likely to be involved in development-related infrastructure projects, are generally reported in the development budget. While the ministries in the foundational and other sectors, which tend to be more administrative in nature, include almost all capital expenditure in the recurrent budget.99 This reflects the broad division between the budgets whereby smaller machinery and equipment are located in the recurrent budget, while the development is left for larger infrastructure spending. There are, however, Lorem ipsum Lorem ipsum Lorem ipsum some notable exceptions within each sector. This mainly reflects the outsized influence of externally funded capital expenditure, 99. In the social sector, where there is a greater heterogeneity 80 channeled as budget support in the health, of ministries, the broad distinction between infrastructure education, and fisheries ministries, as well being allocated to the development budget and 70 as the strong bias of the Rural Development administrative-related capital expenditure allocated to the recurrent budget holds. An example is the Ministry of 60 Ministry toward the development budget. 100 Provincial Government and Institutional Strengthening, which includes small-scale infrastructure development and 50 relies almost entirely on the development budget, while the ministries of Home Affairs and Women, Youth and Children’s 40 Affairs rely almost exclusively on the recurrent budget. 100. Capital expenditure reported as external budget support 30 in the recurrent budget accounted for a material share of total on-budget capital expenditure in education, health, and fisheries sectors in 2020: 43 percent in of total capital 20 spending in education in 2020, 33 percent in health and 61 percent for fisheries. For health and education, these 10 proportions increased further in the 2021 budget: health (52%), education (40%). 0 111 Figure 69: Fragmentation of capital expenditure (By sector and ministry; average 2018–2020) Other Sector R Rest of Foundational Sector Office of PM&C B Rest of Social Sector D Health Education Rest of Resources Sector Rural Development Rest of Productive Sector Fisheries & Marine Resources 0 20 40 60 80 100 Development budget share Budget support share Recurrent budget share Source: SIG; WB staff estimates Figure 70: Capital expenditure share of development budget (By ministry; average 2017–2021) Rural Dev. Av Education Av Inst. Strengthening Infra Dev. Health All other ministries Office of PM&C 0 20 40 60 80 100 Average 17-19 Average 20-21 Source: SIG; WB staff estimates Figure 71: Donor commitments (By sector) Figure 72: Donor commitments (By donor) (USD millions) (Percent of total) 500 100 Other Other 400 80 Government & Civil Society World Bank Health United States 300 60 Rural Dev. Water & Sanitation Aver United Arab Em 200 Education 40 Transport Aver New Zealand Prov Gov't & 100 20 Energy China Inst. Strengthening Infra Dev. Communication Australia 0 0 2015 2016 2017 2018 2019 2019 ADB Health Communication Health ADB United Arab Emirates All other ministries Energy Government & Civil Society Australia United States Transport Office of PM&C Other China World Bank Water & Sanitation 0 20 40 New Zealand 60 Other 80 100 Source: Lowy Institute https://pacificaidmap.lowyinstitute.org/ 112 194. The capital expenditure share within the 196. Commitments reported by donors indicate development budget also varies between that the size of investment that is undertaken ministries (Figure 70). At one end of outside of the budget is likely to be quite the spectrum are the rural development, large. According to data from the Lowy education, and provincial government Institute, in 2019 total donor commitments ministries, in which all, or nearly all, of the to Solomon Islands amounted to at least development budget allocations are capital US$434 million (of which US$235 million was expenditure. A majority of the infrastructure spent). With externally funded budget support development allocation is also capital of approximately US$25 million in 2019, expenditure. At the other end of the spectrum, and the development budget reflecting SIG the Office of Prime Minster and Cabinet appropriations, this implies that potentially typically had very little capital expenditure in around 90 percent of total donor spending was its development budget allocation, averaging off-budget.103 Sectoral allocations vary from only 4 percent between 2017 and 2019. year-to-year, though support tends to favor However, with the large influx of Pacific Games priority development areas (communications, funding in 2020 and 2021, this share has risen energy, transport, water and sanitation dramatically, to 39 percent. Health also has (Figure 71). had its development budget reoriented toward 197. The large size and scope of investment needs capital expenditure since the pandemic, with in Solomon Islands mean that donors will the share rising from 43 percent across 2017 continue to play an important role in capital and 2019 to 91 percent across 2020 and expenditure for the foreseeable future (PRIF 2021.101 2018). Donors are expected to fund, wholly or in part, a large pipeline of public infrastructure 7.2.1.2 Off-budget investments and work, worth approximately SI$7.5 billion the investment pipeline (equivalent to 74 percent of real GDP in 2021) 195. Additional fragmentation occurs because a over the period 2022–2029. Much of the work large amount of externally funded investment is concentrated in a small number of large sits apart from the government’s planning, development-related projects that have been budgeting, and monitoring systems. Solomon identified as priority projects in the Solomon Islands relies heavily on external support Islands National Infrastructure Investment Plan for the design, funding, and implementation (SINIIP) and are aligned with the Sustainable of most large projects. Much of this sits Development Goals, with some capital off-budget. Provision is made in the Chart expenditure associated with the COVID-19 of Accounts for externally financed project emergency response. Additionally, the pipeline spending to be included in the development includes a substantial amount of investment budget (via the ‘non-appropriated’ development associated with the 2023 Pacific Games (see budget). However, this value is persistently Table 19). reported as zero, as individual line ministries, the Ministry of National Planning and Development Coordination (MNPDC), and MoFT are all unable to gather the requited information in a timely and reportable manner. The implication is that the SIG effectively has little central financial oversight over donor- funded acquisitions, which are implemented outside the SIG PFM system, nor the true level 101. Before the sharp increase in the development budget in of capital investment flowing through 2020 associated with the Pacific Games, the Office of Prime Minister and Cabinet had a similar budgetary composition the economy in any given year.102 of capital expenditure as the rest of the fundamental sector. 102. The IMF attempts to incorporate these projects in estimates of government spending, using information on the Balance of Payments and consultations with donors. However, difficulties matching disbursements and spending (both of which can be delayed) means these estimates are not always precise. 103. This share declines to 82 percent if one included the budget support provided by the Republic of China (ROC) and the People’s Republic of China (PRC) for the CDF. Though it is not clear if these allocations would been included in the Lowy Institute’s data. 113 Table 19: Planned infrastructure Project Total Cost (SBD; Timeframe Estimated cost % of 2021 real millions) 2022-2029 GDP Solomon Water Capital Works 745 2020–2027 700 6.9 Tina River Hydro 1,891 2021–2025 1,855 18.2 Ports and Roads Program 1,371 2022–2029 1,333 13.1 Kukum Highway Phase II 256 2021–2023 192 1.9 International Airport Terminal 348 2021–2023 261 2.6 Solomon Islands Roads and 419 2022–2024 419 4.1 Aviation Project (SIRAP) SIRAP II 723 2024-2029 723 7.1 Regional Airport and runways 140 2021–2023 105 1.0 Pacific Games Construction 2,500 2020–2023 1,875 18.4 COVID-19 Emergency Response 78 2022-2023 78 0.8 TOTAL 8,470 7,540 74.1 Source: World Bank staff estimates based on publicly available project information Figure 73: Funding sources for pipeline projects (Selected projects;* share of total project cost) SIG Grant Debt Debt 54% Grant 35% SIG 11% *Includes: Solomon Water Capital Works; Tina River Hydro; Ports and Roads Program; Solomon Islands Roads and Aviation Project (SIRAP); and COVID-19 response. Source: World Bank staff estimates based on publicly available project information 114 Figure 74: Public Investment pipeline* (SBD millions) 3500 25% 3000 20% 2500 15% SBD Millions 2000 1500 10% 1000 5% 500 0 0% 2021 2022 2023 2024 2025 2021 budgeted capex (unchanged budget assumption) Pipeline % GDP Pipeline ex Pacific Games Pacific Games Construction *Calculated, where possible, using project implementation information and procurement plans. When such information is not available, an assumption that 25 percent of the total project cost will be spent in half of the project, with the remaining 75 percent spent in the second half. Commencement dates are based on information from project documentation or the public domain. Calculated using total project cost, so does not differentiate between externally funded and SIG funded components. * Excludes SIG co-financing of donor-funded development projects and Pacific Games, to avoid double counting. Presumes no change in SIG public expenditure from 2021. Source: World Bank staff estimates based on publicly available project information; SIG; IMF 198. Many of the pipeline projects are funded 199. The pipeline represents a massive bulge in using grants and concessionary loans, with investment-related economic activity that some also requiring counterpart funding from will shape the macroeconomic outlook in the the SIG. Among the projects for which data are coming years and could set Solomon Islands publicly available (which include a combination on a new growth and development trajectory. of energy, sanitation, and transport projects, Using a spending profile based on available plus the COVID-19 response worth around project plans, plus some assumptions, the 58 percent of the pipeline), 54 percent of peak in the pipeline investment activity total financing is concessional debt (Figure associated with the current pipeline will likely 73). Grant funding accounts for a further 35 occur over 2022 and 2023 – presuming no percent of funding, with the SIG counterpart significant implementation delays – reflecting contributing the remainder. Collectively, this the overlay of multiple projects in the near debt represents around 25 percent of 2021 term, the fixed deadline of the Pacific Games GDP. It is likely that much of the SI$2.5 billion (November 19th, 2023), and a host of games- Pacific Games infrastructure is also being related transport infrastructure. In these funded by grants. years, the level of investment could account for more than 20 percent of forecast real GDP each year. The Pacific Games alone accounts for nearly one-third of all projected investment activity between 2021 and 2023. With such a large amount of work occurring simultaneously, the real welfare benefits will be contingent on effective prioritization and enhancing implementation capacity. 115 Figure 75: CDF budget allocations to MPs (Nominal SBD millions and percent of GDP) (2000–2022) 400 4.0% 350 3.5% 300 3.0% 250 2.5% 200 2.0% 150 1.5% 100 1.0% 50 0.5% 0 0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 SBD m Percent of GDP (RHS) Source: MEF, Fraenkel, J 2011, CDF Community Consultation and Assessment Workshop 2018, UNDEF; WB staff estimates BOX 6: CONSTITUENCY DEVELOPMENT FUNDS – A PRIMER Constituency Development Funds (CDFs) are The shortcomings have also been noted allocations of public funds provided to MPs elsewhere. In April 2018, the audit report on across 50 constituencies in the country to be the CDFs by the Office of Auditor General spent at their discretion. The Constituency recommended increasing citizen participation Development Fund Act 2013 simply describes in the allocation of CDFs, implementing rigorous CDFs as ‘funds allocated to Constituencies’. reporting and third-party oversight of CDF Broadly speaking, CDFs are considered to activities, and expanding project management be any funds which are channeled through a capacity. constituency-based account. These may appear Consequently, CDFs bypass the existing under the budget headings of ministries. administrative structure (central and provincial The CDF Act was passed in 2013 with draft governments) for service delivery and utilize the regulations being prepared but not finalized. political structure (electoral constituencies) for The CDF has been operating without enforcing the disbursement of funds and service delivery measures stipulated in the Act. For example, outputs. This forces the two delivery mechanisms the CDF Act provides a schedule for funding (administrative and political) to be competitors applications requiring funding applications and results in additional layers of service delivery to include details of project outcomes, the to a small country already burdened by capacity way it will achieve them, project activities constraints. with a timeline, budget details on how the project will be managed, and the number of direct and indirect beneficiaries. The act also stipulates that the basis for disbursement should be a Constituency Development Source: Authors and World Bank. (2014). Solomon Plan (CDP), which is not systematically Islands: Towards Better Investment in Rural Communities. developed across the constituencies. Washington, DC: World Bank Group 116 7.2.1.3 Constituency Development Funds Figure 76: CDF spending (By type, 2015) 200. The large and growing use of Constituency Development Funds (CDF) adds another layer of budgetary fragmentation, due to Administration its opaque nature and the role of donor funding. By international standards, the CDF WASH (water & sanitation mechanism in Solomon Islands is unique in terms of its scope and the share of budgetary Transportation resources104 and is less regulated than similar funds established in other developing countries Rural electri cation (Batley, 2015).105 There are also inherent issues regarding transparency; as well as their role in Basic infrastructure weakening the state’s accountability to local communities (see Box 6). Nonetheless, CDFs Housing scheme have become an increasingly important fixture General assistance Rural electrification of development spending, particularly under Income generation Transportation Housing scheme Income generation WASH (water & sanitation) the current government, rising in importance Basic infrastructure Administration as a share of public spending and the economy General assistance more generally (Figure 75).106 The increase Source: Development Finance Assistance (Strawson et al, 2018.). reflects both increased prioritization of SIG Ministry of Rural Development 2015 annual report, Appendix B resources – SIG funding for CDFs more than tripled between 2019 and 2021 – plus donor support (in particular the People’s Republic of China, which has provided substantial direct budgetary support for the CDF), channeled through the appropriated budget.107 201. Comprehensive analysis of CDFs is made difficult by persisting gaps in how these funds are managed. There is little information as to how CDF resources are used. Lack of data contributes to a poor understanding of how CDFs are managed by MPs and their staff (from selection to day-to-day management), and how effective and sustainable the expenditure is. One of the challenges is rooted in the way CDF expenditure is reported with funds recorded as spent at the time of the transfer to MPs not Lorem ipsum at the point of execution, thus obscuring the targeting of funds. However, it is understood that a sizable share of CDF resources is used for local infrastructure. 80 202. Limited evidence that does exist suggests 70 that a majority of resources are oriented toward spending on housing (Figure 76). For 60 the latest publicly available information on CDF 104. Solomon Islands and PNG have the highest CDF spends 50 as a share of overall government spending in a sample of spending, in 2015, there was some variation in selected developing countries (Howes et al. 2014, p. 129). the pattern of spending across constituencies. 40 105. https://dpa.bellschool.anu.edu.au/sites/default/files/ However, housing projects were consistently publications/attachments/2016-07/ib2015.67_batley.pdf reported as a large share of spending, making 30 106. CDF spending accounts for all of the Rural Development up over 40 percent of the funds spent, while Head in the development budget. 20 only 4 percent was spent on water and 107. In 2019, actual CDF spending was funded through a sanitation despite it being a priority and a key combination of contributions from the SIG (76 million), PRC 10 (84 million), and the ROC (50 million). However, by 2021, infrastructure gap. after bilateral relations with the ROC had been severed, all 0 external support was provided by the PRC (which increased its commitment to 90 million in 2021). These figures refer to actual spending, which is higher than allocated budget amounts presented in Figure 75. 117 BOX 7: CAPITAL EXPENDITURE BY PROVINCIAL GOVERNMENTS Provincial governments play a modest role It is now maintained and fully funded by the in managing public investments, particularly government, with the formula, funds management, when compared to CDF. Their biggest vehicle in performance assessment, incentives, and penalty managing capital expenditure is the Provincial arrangements institutionalized as a government Capacity Development Fund (PCDF). PCDF is a system. performance-based grant that gives provincial Access to funds and their distribution is rules- governments resources to manage public based with clear minimum access conditions for all investments with incentives for improved funds. Compliance with the minimum conditions governance. It is a meaningful example of over a triggers 30 percent of the PCDF funds – the basic decade-long reform effort to break the observed component – within which 40 percent of funds vicious circle of low capacity and performance, are divided equally between the provinces and limited mandatory responsibilities, and limited 60 percent are divided based on population. The resources of provincial governments. Established remaining 70 percent of PCDF funds – in addition under the Provincial Government Strengthening to the minimum conditions – are distributed based Programme (PGSP), it was initiated in 2006 by the on each province’s performance score (across Ministry of Provincial Government and Institutional pre-determined performance measures) relative Strengthening (MPGIS), and commenced to the average score of all provinces to ensure operation in the 2008/09 provincial fiscal year. they face the same proportional incentives. PCDF was initially funded by donors, with accompanying technical assistance. Figure B7a: PCDF spending Figure B7b: PCDF spending (SBD millions and percent of capital (By sector) expenditure) 60 10% Disbursement in SBD millions ( LHS) 9% 50 % of total capital expenditure (RHS) Environment/convervation, wast 8% 7% 40 6% Women, youth, culture & social 30 5% 4% 20 Rural & urban electri cation 3% 2% 10 Local economic development 1% 0 0% 2012/2013 2016/2017 2019/2020 Agriculture, sheries & forestry Roads, infrastructure & works Disbursement in SBD % of total capital Administrative Buildings Local economic millions (LHS) expenditure (RHS) Education development Water supply & sanitation Health Rural & urban electrification Water supply & sanitation Women, youth, Health culture & social Roads, infrastructure & works Environment/ conservation, waste Education Agriculture, fisheries management & DRM & forestry Administrative Buildings Source: MPGIS and WB Staff estimates Source: MPGIS and WB Staff estimates 118 203. Budget documents do not demonstrate that 7.3 PRODUCTIVE EFFICIENCY CDF spending is in line with the National Development Strategy and infrastructure 205. The likelihood of planned capital expenditure plans. There is currently no mechanism to being adequately targeted and delivered monitor the extent to which CDF spending on time and on-budget is shaped, to a large promotes social development and climate extent, by the SIG’s Public Investment (disaster) risk resilience. Project and capital Management (PIM) systems and processes. investments risk misalignment with sector The Pacific Regional Infrastructure Facility needs and failure through poor investment (PRIF) conducted a review in 2018 of the in high profile but standalone buildings. Solomon Islands’ PIM systems and processes Specifically, there is a risk of common failures using a stylized framework of a well-functioning that arise from fragmentation, such as the public investment system (Raijaram et al. construction of medical clinics or school 2014) (see Figure 77). The results showed buildings without ensuring that the buildings considerable systemic weaknesses in the SIG’s meet usage standards set by the relevant PIM performance. All key functions were found ministries, or that there are enough staff and to be well short of best practice, with upstream supplies available for each building. This could functions such as appraisal, selection, and result in classrooms without teachers, and allocation of funding performing particularly aid posts not supplied with drugs, reducing poorly (see Figure 78). The budgetary the value for money and use of investments to fragmentation that blurs the analysis of communities. As a result, CDF contributes to allocative efficiency echoes in PIM processes. allocative inefficiencies, posing a significant While there are similarities in PIM weaknesses, challenge owing to the sheer size of the funds processes that underpin certain functions as a share of the budget. differ across SIG on-budget development spending, donor-funded projects, and CDF. 204. The CDF is by far the largest mechanism for These result in a lack of central financial subnational public funding and investment oversight, leading to a likely misalignment but mostly operates independently of investment spending with development from the provincial administrations. In needs undermining the quality, efficiency, addition to the CDF, the Provincial Capacity and effectiveness of investments (PRIF, Development Fund (PCDF) provides another 2018).108 This section drills down to examine key subnational funding mechanism the interaction of the planning and budgeting designed to respond to the priorities of process and the PIM system, to identify local communities. It is significantly smaller root causes for some of these observed in size than CDF but presents the largest weaknesses, and to provide the analytical source of finance for capital expenditure foundations for remedies. by Provincial Governments (see Box 7). The two funds operate largely independently of each other with no structures to ensure collaboration resulting in little coordination between the two funding mechanisms. 108. PRIF. (2018). Solomon Islands Public Investment Management Diagnostic. PRIF Coordination Office. Sydney Australia. Available from: https://theprif.org/media/61 119 Figure 77: A framework for reviewing public investment efficiency Consistency in Authority to screen Maintain asset Evaluation to project preparation and reject projects register, operate improve guidance and maintain asset 1 2 3 4 5 6 7 8 INDEPENDENT REVIEW IMPLEMENTATION ADJUSTMENT EVALUATION OPERATION APPRAISAL SELECTION GUIDANCE Link to development Key to credible An effective budget and procurement process strategy selection to support implementation and operation Source: PRIF, 2018 Figure 78: PIM diagnostic findings 1. Financial rules and guidance 3,0 2,5 8. Evaluation 2,0 2. Project appraisal 1,5 1,0 0,5 7. Operation and 3. Review of appraisal asset management 6. Project 4. Project selection and adjustments allocation of funds - budgeting 5. Project implementation Best practice SIG current practices Source: PRIF, 2018 120 206. The rest of the section reviews the PIM 209. One of the key challenges is the lack of a through the lens of productive efficiency. Medium-Term Fiscal Strategy (MTFS) to Out of the identified issues, the near-term feed into the planning framework. Fiscal priorities for addressing the PIM challenge policy is guided by the PFM Act of 2013. The focus on subjecting strategic guidance to the government Debt Management Framework reality of a fiscal constraint, strengthening (DMF) sets a public debt threshold of 35 prioritization, appraisal, and increasing focus percent of GDP. As of the end of 2020, this on maintenance to reduce resource waste. was not binding, with public debt at around 13 percent of GDP.110 The DMF and the PFM 7.3.1 Planning, strategic guidance, and selection Act require the government to set an Annual Borrowing Limit as part of its budget process, 207. Strategic and sector-level guidance for placing a limit on how much new government investment is provided in multiple medium- borrowing can be undertaken annually based to-long term plans and strategy documents. on the MTFS.111 There is, however, no evidence At the highest level, the National Development of MTFS publications since 2014. This limits Strategy (2016–2036) sets out the SIG’s opportunities to: design an operational deficit strategic vision, mission, and objectives for target that assesses spending needs; create growth and development. Five-year rolling strategies to raise long-term economic growth; Medium Term Development Plans (MTDP) address climate vulnerabilities; and assess translate these strategies and priorities trade-offs, for example, between development into implementable policies, programs, spending and building buffers. There are no and projects; listing the specific projects to fiscal rules to protect capital spending, as is be funded from the development budget, evidenced by sharp declines in capital spending sometimes accompanied by broad multi- between 2017 and 2019. year cost estimates (the latest plan is for the period 2021–2025). Some individual sectors 210. Effective appraisal of proposed projects is (Transport, Health, Education) also have plans severely constrained by a range of structural but only transport has project proposals and and institutional limitations, which creates costings. The Ministry of Mines, Energy and space for ad hoc and politicized decision Rural Electrification has no national energy making. The Ministry of National Planning sector plan. The Solomon Islands National and Development Coordination (MNPDC) Infrastructure Investment Plan 2013–2023 coordinates and oversees development budget (SINIIP) combines holistic and sectoral plans formulation and execution. Although the to develop and prioritize a list of projects. MNPDC has adopted a pre-screening process to try and control the development budget plan, 208. Strategic and sector investment plans are it is not strictly enforced. The Cabinet may still weakly integrated with the project selection approve projects that were previously rejected and budgeting processes. On the face of it, by MPDAC. The gatekeeping function of the the SIG’s planning framework provides a strong MNPDC is weakened by a number of factors: basis for ensuring that the SIG’s resources are • A lack of formal mandate for appraisal. allocated efficiently and effectively to maximize There is no formal or legal mandate in place welfare gains. However, as is typical of national for ministries and agencies to appraise development planning elsewhere (Chimhowu, their projects, submit project appraisals Hulme, and Munro, 2019)109 planning is weakly to MNPDC, or require appraisal approval integrated with core budgeting functions in to be a condition for funding. As a result, Solomon Islands. Projects are proposed by appraisal is a voluntary function with only ministries and other stakeholders without the Ministry of Infrastructure Development being properly costed and/or with little appraising its projects. regard to the available resource envelope (fiscal space) that is forecast to be available 109. Chimhowu, A, Hulme, D., and Munro, L. (2019). “The ‘New’ over the medium-term planning horizon. national development planning and global development Accordingly, the planning process results in an goals: Processes and partnerships.” World Development Volume 120, 2019, Pages 76-89, https://doi.org/10.1016/j. unrealistic wish list of projects being proposed, worlddev.2019.03.013 unencumbered by the reality of fiscal 110. IMF. (2021). Article IV Consultations; SIG Financial Policy constraints. Implicit in these lists is that gaps Objectives and Strategies. will be picked up by development partners. 111. The Annual Borrowing Limit for 2020 was US$300 million. Public debt includes obligations such as direct borrowing by the government, by SOEs, on lending arrangements and guarantees provided by the government. 121 • A lack of clarity on selection criteria. 212. There is some evidence of the MCA There are no published guidelines or framework being internalized in SIG methodologies to assist MPDAC staff in decision making processes – particularly appraising projects. What transpires is not in infrastructure – though there are still a rigorous assessment of project feasibility key gaps. PRIF (2018) noted that the MCA but instead an inconsistent qualitative was useful as an objective screen – and screening of proposals. Ministries submit indeed, development partners have generally project proposals to MNPDC which has drawn from the aforementioned shortlist, established templates for project appraisal. selecting the project pipeline discussed in The scope does not systematically include the previous section – though they will have all the potential costs and benefits – their own separate selection processes as externalities, environmental risks – nor well. Additionally, the process has helped the beneficiary consultation and feedback. Ministry of National Planning and Development The coverage does not include government Coordination (MNPDC) recently update its appraisal of DP-funded projects. MNPDC list of high-priority infrastructure investments staff are not trained for conducting a cost– that are not yet being funded by donors, which benefit analysis. cover both economic and social infrastructure. • A lack of information on medium-term However, a large share of the development resource constraints. A corollary of the budget, and capital investment more generally, disconnect between planning and medium- is not subject to a systematic screening and term resource availability is that MPDAC selection process. also has no medium-term budget ceiling 213. Notably, projects funded under the CDF upon which base screening and selection. mechanism – which account for upward • Neglected maintenance functions. There of one-third of all SIG-funded public is no standard methodology for evaluating investments – do not follow a systematic whether proposed projects adequately nor standardized appraisal or selection provision for routine maintenance. process. The CDF Act of 2013 describes the Accordingly, maintenance is a chronically need for Constituency Development Plans underfunded function. as the basis for identifying funding priorities in each constituency. However, in practice, 211. The SINIIP provides a nominal framework for these plans do not appear to be a meaningful project selection in infrastructure. Initially, a guide nor are consistently prepared for all long list of 90 proposed infrastructure projects constituencies. Similar to other on-budget over the ten years to 2023 was identified in funds, the appraisal function is curtailed the SINIIP, based on the development goals by a lack of a formal legal mandate for of the NDS plus a consultative process appraisal, lack of adequate safeguards, and involving a wide range of stakeholders.112 likely limited capacity. As a result, projects This longlist was whittled down to 19 high- are not systematically nor comprehensively priority projects based on a fit-for-purpose appraised, leading to limited transparency multi-criteria analysis (MCA) that links to in the selection and use of CDF funds. the objectives of the NDS yet does not rely too heavily on data, which is an enduring limitation (see Box 8). Specifically, priority projects were reviewed for their susceptibility to climate change and the investments needed to strengthen climate resilience. 112. For instance, the NDS targets that by 2035, at least 40 percent of Solomon Islanders in rural areas should have access to essential services as a direct result of rehabilitation, and building of new roads, bridges and wharves. 122 BOX 8: THE USE OF MULTI-CRITERIA ANALYSIS IN PROJECT SELECTION IN THE SINIIP To help identify a list of priority infrastructure Reflecting data limitations, 13 of the 14 criteria are projects, the SINIIP uses a multi-criteria analysis qualitative, with only one (the number of people (MCA) framework. This involves evaluating served by a project) being quantitative. Each each project across 14 criteria that embody the criterion is assigned a score out of five based on seven strategic priorities of the NDS (including whether the project in question would contribute poverty and livelihoods, access to essential (or not) to the objectives. The prioritization services, growth promotion, suitability for the framework, and its results after being applied to local context, connectivity and coordination with the longlist, were extensively workshopped with existing infrastructure, and the capability and stakeholders. In all, the long list of 90 projects was affordability of effective operations management turned into a high priority list of 19, with a ‘next and maintenance) and the contribution to climate best’ 10 also identified. Some projects that scored resilience. Additional judgments were made highly on technical criteria, were downgraded from regarding implementation feasibility, project the priority list due to pessimistic assessments of readiness, and funding availability. project readiness. Priority projects deemed to be located in highly vulnerable areas and/or where The aim of the prioritization framework was to performance is dependent on changes in climate identify the highest priority projects that would were additionally screened through a climate make the greatest contribution to delivering the change and disaster lens. NDS objectives. NDS objectives SINIIP criteria 1. Poverty Will the scheme provide affordable transport, energy, water supply and sanitation infrastructure to support socio-economic development and income generation? What is the total population served by the scheme? 2. Vulnerable Will the scheme specifically support the household and income generation activities of people women, reducing the burden for basic tasks, whilst improving women’s and children’s health and nutrition? 3. Health and Will the scheme assist in improving access to and delivery of healthcare and education? education 4. Economic Is the scheme likely to support identified areas of investment and growth, providing growth infrastructure to unlock key elements of these projects? Will the scheme help to remove barriers to trade, by removing infrastructure constraints such as transport, communications and reliable power supplies? Does the scheme have the potential to support expansion of the tourism industry? 5. Infrastructure Does the scheme utilize or connect well with existing infrastructure? Does the scheme use appropriate technology for Solomon Islands? Are the ongoing maintenance and operational costs of the scheme affordable either through scheme generated revenues or SIG support? 6. Environment Can the scheme improve Solomon Islands’ resilience to the effects of climate change and natural hazards? Will the scheme improve the environment or enable actions to protect the environment, reduce pollution and damage to the environment, or improve sustainability? Is the scheme robust against the effects of climate change and natural hazards? 7. Capacity Does the scheme promoter have the capacity to manage the implementation of the scheme, to budget and program, and is there a clear and approved sector strategy? Source: SIG (2013) 123 214. The potential impacts of climate change also This could be partially explained by procurement tend not to be systematically considered challenges in implementation, which may require during appraisal and selection processes a different process for donor funds which is not for government-funded projects. Although assessed in this report. The health sector had the MCA does explicitly account for climate a particularly low capital spending execution change, it is likely that such impacts are not rate, with an average execution rate of just systematically evaluated for government- 49 percent, and just 35 percent of externally funded projects in the development budget. funded capital being spent. Spending is also While externally funded projects may include typically backloaded to the end of the fiscal year. climate screening, these do not contribute Between 2014 and 2020, spending in the last to the government’s capacity to mainstream quarter typically accounts for nearly 40 percent climate screening and this contributes to of overall spending for the year (Figure 80). fragmentation that impacts medium-term Only about one-third of spending typically took planning for maintenance. In the absence of a place in the first half of the year. This suggests robust medium-term fiscal strategy and lack of persistent issues in getting projects off the systematic appraisal processes that cover SIG- ground in the earlier stages of the budget year. related investments and CDF, there are limited 217. Implementation of public investment is opportunities for SIG to strategically budget likely hampered by weaknesses in upstream for and strengthen infrastructure resilience to PIM processes. In addition to the structural climate events. Recent estimates show that the challenges associated with difficult economic additional cost of climate-proofing investments geography and state fragility (see Chapter 2), in energy, road infrastructure, water, and weaknesses in implementation stem from sanitation amounts to 4.9 percent of GDP in inefficiencies that flow from poor project 2030 (IMF, 2022).113 selection and appraisal. This is compounded 215. These shortcomings in upstream PIM by issues relating to the availability of funding. functions undermine the effective The lack of a medium-term resource envelope prioritization of capital spending and has its implications on prioritization as well potentially lead to allocative inefficiencies. as implementation, facilitating a disconnect This, in turn, leads to common problems between the resource needs of multi-year of strategic misalignment with planning projects and annual allocations. This extends documents, and the lack of consideration of to the within-year availability of cash. Cash alternative project designs for achieving the flow forecasts are not prepared regularly, and project’s objective more effectively. Ultimately, project financing is becoming subject to cash weaknesses in these upstream functions rationing. Without clear commitment ceilings, (selection and appraisal) lead to downstream ministries are unable to commit expenditure to inefficiencies characterized by implementation capital projects in advance and are unable to delays. That the selection and implementation plan on the basis of reliable cash-flow forecasts. of Pacific Games infrastructure is being Recurrent obligations take priority, followed managed through a separate governance by favored or political projects. These lead process from ordinary public investment, to project implementation delays. Cash flow potentially presents a set of unique additional challenges are reflective of the broader cash risks (see Box 9). management challenges in Solomon Islands that extend beyond capital spending. For example, 7.3.2 Implementation in 2021 the Treasury had over SI$200 million of payments that it struggled to pay due to limited 216. The difficulties the SIG has in implementing cash flow. These payments related to provincial capital expenditure are evident in the low health funding, provincial administration and execution rates and the typical pattern of salary grants, education grants, parliamentary investment spending throughout the year. entitlements, as well as allowances and Ministry Across the whole SIG budget, between 2013 of Rural Development (MRD) constituency and 2020, capital expenditure was underspent payments.114 by an average of 19 percent relative to revised budget estimates; underspending was reported each year. Externally funded capital items in 113. IMF Country Report No. 22/15 (2022). the recurrent budget (budget support) were 114. https://theislandsun.com.sb/govts-cash-flow-problem- continues/ the most problematic, with barely half of all https://www.sibconline.com.sb/cash-flow-problem-is-only- budgeted spending actually executed. temporary-says-mckinnie/ 124 Figure 79: Execution rates (2013–2020) (Period average; budget type; relative to revised budget) 0% -9% -15% -17% -10% -19% -22% -20% -29% -30% -40% -54% -50% -60% -66% -70% -80% Budget support Development Recurrent Total Capex Maintenance Source: SIG Figure 80: SIG capital execution (Percent of annual expenditure by quarter; average 2014–2020) 45% 40% 35% 38% 30% 25% 29% 20% 24% 15% 10% 5% 9% 0% Q1 Q2 Q3 Q4 Source: CBSI; Data on quarterly execution includes government expenditure on non-financial assets as an approximation of the spending profile within the year 125 BOX 9: THE PIM IMPLICATIONS OF HOSTING THE 2023 PACIFIC GAMES Preparations for the 2023 Pacific Games are being The parallel PIM process for the Games also potentially managed by a National Hosting Authority (NHA) raises issues around the adequacy of climate resilience under the aegis of the Office of Prime Minister and and maintenance – contributing to the prevailing ‘build, Cabinet. The NHA is responsible for coordinating, neglect, rebuild’ paradigm. It is not clear if any of the arranging, and facilitating all 2023 Games funding agreements with external partners for the Pacific preparation. Importantly, the NHA is also responsible Games include funding for maintenance. However, the for overseeing the domestically funded component substantial increase in on-budget Pacific Games-related of Pacific Games-related infrastructure. The SIG is capital expenditure (via the Prime Minister and Cabinet potentially responsible for up to one-quarter of the Head) has not yet been commensurately met with investment pipeline. Accordingly, there has been a increases in maintenance expenditure. Consequently, the sudden and pronounced surge in capital spending ratio of maintenance to capital expenditure has fallen to allocated to the Office of Prime Minister and Cabinet near-zero within the Office of Prime Minister and Cabinet. envelope in the SIG budget – requiring officials in The experiences of other host cities of large-scale that agency to manage spending levels that are many events such as the Pacific Games suggest that orders of magnitude larger than they are used to ineffective investment management leads to wasted (Figure B9). resources and large ongoing fiscal burdens on In addition to concerns about the absorptive capacity taxpayers. A myriad of examples exist of Olympic within the NHA, the fact that the management of stadia sitting abandoned and in various states of Games-related investment stands alone potentially disrepair, due to a combination of factors including further fragments PIM in Solomon Islands. The poor integration with existing infrastructure, minimal NHA is working with donors and other contributors mixed-use applications, and lack of maintenance in funding components of the preparations. Sub- funding. Moreover, mega-events such as the Olympics committees have been formed to look after specific have the highest average cost overrun of any type areas of the Games’ preparation. This includes of mega-project, with overruns found in all Olympic coordination with the People’s Republic of China Games, without exception (Flyvbjerg, et al. 2016).116 as the major funder, and Chinese firms, which are They leave host countries with large debts and ongoing heavily involved in construction (Fiji Times, 2021).115 liabilities for maintaining specialized facilities that have However, the amount of complementary transport little positive economic or social benefit after the Games. and urban renewal projects underway means that While the Pacific Games are on a much smaller scale, effective coordination is key. Anecdotal evidence the importance of longer-term planning and effective from stakeholders suggests that coordination failures implementation nonetheless continue to resonate. between projects during implementation have While there is little data on the Pacific Games, there already delayed construction and wasted resources. are indications that in previous host cities, such as Port Moresby (2015) and Apia (2019), they resulted in wasteful spending, unmaintained facilities, and large debt burdens.117 Figure B9: Capital Spending: Office of Prime Minister and Cabinet (SBD millions) 80 70 60 115. Fiji Times. (2021). Chinese company to construct 2023 50 Pacific Games Stadium. 25 March 2021. Online article. 40 Available from: https://www.fijitimes.com/chinese- company-to-construct-2023-pacific-games-stadium/ 30 116. Flyvbjerg, B., Stewart, A., and Budzier, A. (2016). The Oxford 20 Olympics Study 2016: Cost and Cost Overrun at the Games 10 (July 1, 2016). Said Business School WP 2016-20. Available at SSRN: https://ssrn.com/abstract=2804554 0 or http://dx.doi.org/10.2139/ssrn.2804554. 2013 2014 2015 2016 2017 2018 2019 2020 2021 (RB) 117. The 2015 Games, held in Port Moresby, for instance, were marred by substantial cost blow outs as well as delays Source: MPGIS and WB Staff estimates in payments from the government and work on other infrastructure investment projects. 126 Parallels exist in the Pacific, most notably, Korman Cyclone Pam caused further damage to its Stadium in Port Vila, Vanuatu, which is an archetype already weakened state in 2015 and the stadium of the ‘build, neglect, rebuild’ model. Originally built was subsequently condemned and demolished. by a consortium of French and Tahitian construction In 2017, the stadium complex was completely companies for Port Vila to host the 4th Mini South Pacific rebuilt – this time by a Chinese construction Games in 1993, Korman Stadium included a grandstand company using Chinese development assistance running track and an indoor multi-purpose facility funding – for the 10th Pacific Mini Games in used for basketball and other indoor sports. However, 2017. The total project cost was estimated to be systematic neglect of maintenance led to the rapid around Vt3 billion (US$26 million). Responsibility deterioration of the complex and in fewer than 15 years for maintaining the stadium was transferred the stadium was rendered inoperable and dangerous – to Vanuatu officials beginning in 2019, with well short of the expected lifespan of a stadium. the construction company providing technical assistance on how to maintain the complex. Abandoned Olympic Stadia Aquatic center Rio De Janeiro (2016 Olympics) Softball stadium Athens (2004 Olympics) Source: Getty images Source: Getty images ‘Build, neglect, rebuild’ in the Pacific – Korman Stadium in Port Vila Photo: Maximilian Laackman Photo: RFA 127 218. The SIG’s own monitoring framework 220. These challenges have been made worse by indicates that the challenges of efficiently the effects of the pandemic, riots, and the and effectively implementing the war in Ukraine. Even in the absence of any Development Budget have been growing. further difficulties, effectively implementing According to the MNPDC Development Budget the pipeline would be a tall order for Solomon Implementation Report, of the 78 development Islands. However, the operating environment programs in 2019 a large share is rated red has substantially deteriorated. The needs of (‘off track’) as having major management the pandemic are creating new infrastructure issues, while few are rated as having minor demands in the form of health infrastructure issues. Implementation performance is uneven to test and treat patients. In addition, the need across ministries, owing to gaps in capacity to rebuild property destroyed in the recent at implementing ministries. For example, civil unrest in late 2021 will add to demands the Ministry of Infrastructure Development and may also divert scarce construction (MID) possesses a high degree of technical resources away from development and health knowledge that could be expanded to other projects. Travel restrictions associated with the ministries and agencies; through targeted pandemic have already shaped implementation capacity building or possibly outsourcing some – leading to delays in the construction of project oversight to MID. Japanese-funded road and aviation projects due to the inability of the necessary technical 219. Against this backdrop, the large volume of labor to enter the country (Island Sun, work in the pipeline presents further inherent 2021).118 The spike in global inflation due to the implementation challenges that may hamper pandemic-related restrictions in international productive efficiency. Already weak technical supply chains and the war in Ukraine also and administrative capacity will be severely threaten to blow out project budgets. stretched. With so much complementary work scheduled to occur simultaneously in the next 221. The large size of the pipeline means that few years, across different contractors and escalating implementation challenges could managing agencies, there will be a premium have a substantial impact on economic on effective coordination to appropriately activity (Figure 81). The potential impact sequence, coordinate, and integrate of the abovementioned implementation investments. As a corollary, officials within challenges on the project pipeline can be ministries will also be required to oversee assessed by comparing the level of investment building activities to ensure that environmental in different scenarios when execution rates and social regulations are maintained and deteriorate relative to baseline. The baseline building quality is up to scratch. Moreover, in this instance is the historical execution rate that there will be such a high simultaneous for total public capital expenditure (minus demand for construction materials may create 19 percent) and is applied only to non-Pacific shortages and chokepoints in supply chains, Games spending. Given the political priority of which place upward pressure on prices and the Games’ infrastructure being completed by increase construction costs, with implications deadline, it is presumed that this component for the whole construction sector. Machinery of the pipeline will be completed on time. and equipment will need to be imported, as Four implementation scenarios are modeled. will most construction materials, though some Across 2022 and 2023, the impact of these materials (such as aggregate, cement, and implementation challenges could be around steel) may be sourced locally depending on 0.2 percent of GDP in the case of the small availability and costs. Moreover, there is a risk impact, and up to 7 percent of GDP in the case that demand for skills will overwhelm supply of the severe impact. and place upward pressure on wages and tenders. 118. Island Sun. (2021). Delays in Kukum Highway project. October 28, 2021. Online article. Available from: https://theislandsun.com.sb/delays-in-kukum-highway- project/ 128 Figure 81: Execution rate scenarios (Lost investment relative to baseline; expressed as a percent of GDP) 0% -1% -2% -3% -4% -5% -6% -7% -8% 2022 2023 Small Medum Severe Very severe Small implementation impact: An additional 5 percent deterioration in the under-execution of non-Pacific Games spending. Medium implementation impact: An additional 30 percent deterioration in the under-execution of non-Pacific Games spending. Severe implementation impact: A doubling in the under-execution of non-Pacific Games spending. Very severe implementation impact: The severe implementation impact also spreads to Pacific Games spending Source: SIG; World Bank staff calculations. 222. Local contracting may offer an opportunity At present, some projects appear to be for circumventing some procurement proceeding with local labor; albeit for low- bottlenecks, with some attendant positive skilled roles.120 With travel barriers still in place developmental spillovers, but could add and project schedules slipping, it may become to costs. The SIG has made it a medium- increasingly necessary to increase local to-long term priority in its ESP for donor- content across some of the non-specialized funded projects to use more labor-intensive aspects of the project pipeline. methods to stimulate local employment, plus increasingly source local materials. Solomon Islands has a long history of labor-based approaches in development projects, albeit in menial road maintenance activities, that involve private sector contracts with local communities, with several benefits.119 For larger construction projects across the Pacific, however, there is an inherent bias toward 119. These have proven to be cost-effective and a sustainable international firms, sometimes in partnerships approach to road and bridge road maintenance as well as with local contractors (Lawther, Phelps, and an important avenue for local development multipliers, Hamilton, 2021). This reflects both demand- including an increase in household incomes from agricultural production and provision of labor and the side barriers, including the focus on the least inclusion of women in the workforce (PRIF 2014). cost from funding agencies, an aversion to risk, 120. JICA-funded road and aviation projects, for instance are and the administrative burdens of managing using a Japanese contractor and are employing local multiple smaller contracts. On the supply side, labour. The Bank’s SIRAP assessed that there was sufficient interest and competition from local firms for road and the local market for implementation is thin, bridge construction works carried out on Malaita. Local and even when prospective contractors have workers, consultants, contractors, and sub-contractors are the requisite expertise, they may lack specific being engaged in the construction process of some of the big infrastructure projects for the 2023 Games including the financial and technical abilities to effectively National Stadium and Games Village, though it is not clear bid for infrastructure projects. whether this represents a large or small share of overall work. 129 223. Donors are also providing critical 7.3.3 Maintenance institutional support, aimed at helping to 225. Maintenance is an essential, but chronically ensure that the pipeline is delivered and under-funded, downstream PIM function managed in a manner that benefits the in Solomon Islands. Maintenance is critical Solomon Islands economy and people. to ensuring available public infrastructure is Embodied in the ADB and World Bank productively utilized to contribute to economic projects is funding to support improvements growth and ensure uninterrupted access in transport infrastructure maintenance to services. It is an essential component of practices – this includes multi-year funding PIM, with estimates that PICs operations and and contracting mechanisms for output- maintenance over the life cycle of public assets based post-construction maintenance (rather can be more than four times the capital costs than input-based maintenance). In addition, (PRIF, 2021). Moreover, periodic preventative Australia’s new 10-year US$250 million maintenance is cost-saving – in roads, for Solomon Islands Infrastructure Program (SIIP) instance, having a benefit-to-cost ratio of will aim to improve the quality and accessibility around 5:1 in terms of reconstruction costs of economic infrastructure to contribute avoided from extending useful life. At a macro to broad-based, inclusive, and sustainable level, total public maintenance spending in economic growth in Solomon Islands. Focus Solomon Islands fell well short of international areas will include: supporting infrastructure benchmarks; in 2019, representing around policy development, and building national 0.8 percent of an assumed replacement value regulatory and enforcement capability. of the public capital stock – well short of the 224. Public–private partnerships (PPPs) could ‘gold standard’ maintenance spending rate of play a larger role in the implementation and between 2–5 percent of capital costs.121 private sector investment of infrastructure, 226. The priority given to maintenance spending however, the modality remains very limited in has declined in recent years (Figure 82). Solomon Islands. The Tina River Hydropower Between 2013 and 2019 maintenance spending Development Project is the country’s first fluctuated around an average of 4 percent of large-scale infrastructure project developed total recurrent spending.122 However, in 2020 as a PPP. It provides a valuable benchmark there was a pronounced fall in maintenance for PPP projects and experience as it relates spending, which contracted to SI$70 million, to the government’s capacity and cross- down from around SI$145 million in the ministerial collaboration, including possibly previous year – possibly a consequence of for the management of the existing pipeline the pandemic, accompanied by contractions of projects. However, caution is warranted, to the maintenance spending to create fiscal with examples of PPP power projects in 2012 space. This caused the maintenance share being cancelled. The institutional framework is of the recurrent spending envelope to more nascent, and PPPs are yet to be codified into than halve, to 1.9 percent. The new lowering of law. Beyond the scope of the report, some PPP prioritization appears to have been maintained guidelines are believed to be in the process of in the 2021 budget. being developed and could be explored further. 121. This calculation is known as the ‘Replacement Asset Value = Annual Maintenance Expenditure/Gross Replacement Cost’. The estimated replacement value of the public capital stock is based on estimates of the total capital stock, with an assumed rate of public ownership of 70 percent, based on the data from structural peers. Notably, the SINIIP (p6) estimates maintenance costs of the priority project pipeline as being 2 percent of capital costs. 122. This is calculated as total recurrent spending – which is the sum of recurrent spending components from the SIG recurrent, budget support recurrent and development budgets. 130 227. Most maintenance expenditure is funded by the SIG, though, like capital expenditure, is fragmented across the budget, which obscures effective oversight. Responsibility for planning, prioritizing, funding, and implementing maintenance is generally the responsibility of the SIG; even for externally funded projects (sometimes after a nominal grace period). Most maintenance spending is split across the recurrent and development budgets, with budget support only funding a small share (Figure 83).123 Furthermore, 123. Maintenance pending under the aegis of the National SIG’s accounting principles do not enable it Transport Fund (NTF), which includes earmarked funding to extract key infrastructure maintenance for maintaining roads and bridges largely funded by development partners, is reported in the appropriated performance indicators from annual budgets development budget. and the consolidated whole-of-government 124. Accrual-based accounting principles allow countries to accounts (though major SOEs in each PIC apply account for long-term fixed assets (infrastructure) in their accrual accounting standards).124 Statement of Financial Positions. Figure 82: Maintenance spending (Levels and shares) 160 8% 140 7% 120 6% SBD Millions 100 5% 80 4% 60 3% 40 2% 20 1% 0 0% 2013 2014 2015 2016 2017 2018 2019 2020 2013 2014 2015 2016 2017 2018 2019 2020 2021 (B) Total maintenance Maintenance/recurrent Figure 83: Maintenance spending (2013–2020) Figure 84: Share of total maintenance (By budget type) (Largest ministerial allocations) 40 Dotted: Infra 35 2021 Budget Recurrent Com 30 25 Fina Development 20 Hea Budget Support 15 Educ 10 O c 5 0 2013 2014 2015 2016 2017 2018 2019 2020 2021 Lorem ipsum Lorem ipsum Lorem ipsum Budget Support Development Recurrent Office of the Prime Minister Finance & Treasury & Cabinet Communication & Aviation Education & Human Infrastructure Development 80 Resource Development Health & Medical Services 70 131 60 50 Figure 85: Maintenance as percent of capital expenditure (Major ministries) 10 1,2 1,0 8 0,8 6 0,6 4 0,4 2 0,2 0 0,0 2013 2014 2015 2016 2017 2018 2019 2020 2013 2014 2015 2016 2017 2018 2019 2020 2021 (B) Infrastructure Development Rural Development Health & Medical Services Office of the Prime Minister & Cabinet Education & Human Resource Development Communication & Aviation Communication & Aviation Health & Medical Services Office of the Prime Minister & Cabinet Infrastructure Development 228. Infrastructure development and 229. SIG’s maintenance needs far exceed its communication ministries have spent the fiscal space and will only likely grow as the most on maintenance (Figure 84). These two new pipeline of work is completed. To lift ministries accounted for just under half of maintenance spending to the lower bound all maintenance spending between 2013 and of the ‘gold standard’ RAV (i.e., 2 percent 2019. However, in line with the decline in the of the capital stock) implies an increase in importance of infrastructure development to maintenance spending to SI$350 million based execute capital expenditure, the Ministry’s on 2019 estimates of the capital stock (Figure share of maintenance expenditure has 86). That would require an increase in 2019 declined. The Communication and Aviation levels of 240 percent and an increase on 2020 Ministry has consistently had larger levels of 494 percent. Critically, maintenance maintenance as a share of capital expenditure obligations are only likely to increase in line than other ministries (Figure 85): with the pipeline of investment – indeed, using assumed maintenance spend of 2 percent of • Similar to the capital expenditure, in recent the capital costs, the maintenance obligations years budget support for maintenance has associated with the projected investment generally been directed to the health and over the period 2021–2025 are estimated to education sectors; collectively accounting be SI$190 million (average US$38 million per for 82 percent of all maintenance budget year) – placing even further pressure on the support between 2018 and 2020 (34 recurrent budget. percent of all health maintenance and 29 percent of all education maintenance). • There appears to be a substantial and systematic underspend on maintenance in key sectoral priorities. Despite the significant shift toward executing capital expenditure through the CDF, there is next-to-no maintenance spending allocated under the Rural Development Budget Head (save for one year in 2014). Additionally, there was very little maintenance spending budgeted for education in 2021, with no maintenance budget support or development budget – contrary to previous years. 132 Figure 86: Gap between maintenance needs and spending (SBD millions per year) 2019 146 204 2020 71 279 Estimated current 350 maintenance needs Estimated maintenance 388 needs by 2025 0 50 100 150 200 250 300 350 400 SBD m. per year Annual maintenance gap in SBD m. Source: SIG; World Bank staff calculations 230. The costs of strengthening climate 231. The overwhelming demands of maintenance resilience and effective maintenance are and climate change adaptation will require only likely to increase further and become the ongoing support of external partners prohibitively high for Solomon Islands. and alternative sources of funding. Even The costs of constructing and maintaining with substantial increases in PIM efficiencies adaptation infrastructure are typically higher and fiscal space, SIG is not likely to be able than conventional infrastructure on a per to adequately maintain its infrastructure unit basis – due to more expensive material, without external financing. This is particularly higher levels of skills involved, and frequency relevant to development partners financing of maintenance. In just one example of the a significant share of public investments in magnitude of such costs, modelling for Pacific Solomon Islands, whose investments may Possible (World Bank, 2017b) indicates that underperform due to inadequate maintenance, the marginal cost of protecting infrastructure possibly requiring further financing to repair in Solomon Islands against changes in rainfall or rebuild the asset. Spending to strengthen and temperature due to climate change by the climate and natural disaster resilience 2050 – i.e., to maintain the same quality of of infrastructure, in particular, is likely to be infrastructure services as in the absence of highly net beneficial – with clear benefits for climate change – could possibly account for fiscal indicators, investment, and growth (IMF, up to 9 percent of public expenditures. Roads 2018).125 alone are expected to account for more than 90 percent of the average costs of adaptation. 125. IMF. (2018). Public Investment in the Face of Natural Disasters: a Model Application to Solomon Islands. Solomon Islands: Selected Issues. International Monetary Fund. Asia and Pacific Dept Available from: https://www. elibrary.imf.org/view/journals/002/2018/073/article-A002- en.xml 133 232. The National Transport Fund (NTF) is • Control weaknesses in the SIG accounting partially filling the gap in maintenance needs. system that prevented the preparation Held out to be a good example of maintenance of Financial Statements compliant with funding (PRIF, 2021), NTF was established in international standards, and thus not 2009 under the MID, and accompanied by the meeting the minimum accountability NTF Act, to serve as a special revenue fund standards of some donors to finance the development and maintenance • Inefficiencies in procedures for the review of transport assets. Between 2011 and 2016, of documents, Bid Opening, and contract about 87 percent of its funds (SI$313 million) administration. For example, the absence were allocated to maintenance projects, of a functioning contract administration resulting in the length of all roads under unit resulted in delayed payments to regular maintenance increasing from 20 contractors for NTF-funded contracts percent in 2011 to 42 percent in 2016 (World • NTF board decision making and investment Bank, 2021).126 In its original objective, it was prioritization are not supported by effective meant to become the sole source of funding evidence and data on asset performance by SIG and Donor Partners for the sector-wide levels approach to transport in Solomon Islands. The effect was to insulate transport infrastructure • Climate and disaster vulnerability level maintenance and construction from general of assets is not a parameter used for budget pressures and intervention by the investment prioritization. There is also executive; NTF allocations could not be no mechanism for funding or planning reallocated back to the general budget and any resilience improvements during expenditures were aligned with the NTP and maintenance and operations activities. overseen by a board that included a donor representative (World Bank, 2017). The funding of the NTF board helped to ensure there was 7.4 POLICY IMPLICATIONS an element of control and planning that had not 234. This section proposes options for the existed before. authorities to consider to strengthen PIM 233. The experience with NFT serves as a systems. It focuses on areas identified as valuable platform for SIG and development priorities. Primarily, these are strategic partners to frame efforts in addressing the guidance, appraisal, and maintenance. maintenance challenge in Solomon Islands. Addressing these challenges is potentially a The approved NTF budget expired in 2021. In complex reform that would require close and promoting and facilitating its continuation, careful coordination between donors and the lessons learned could play a meaningful SIG. Critically, progress will depend on the role in improving the fund and establishing increased capacity in specific functional areas, similar funds in other sectors. The overall highlighting the importance of complementing perception of NTF, as captured by an early capital investments with technical assistance review of the NTF (ADB, 2014)127, was that it in identified areas. was not performing as SIG and its development partners expected; nor as required by law. 7.4.1 Strategic guidance Some of the raised concerns and areas for improvement include: 235. Stronger integration of strategic guidance and budgeting can help place policies • The absence of a fully functional Secretariat within a defined fiscal space and resource as intended by the regulations. Specifically, envelopes. This is foundational to allowing the limited performance of the Secretariat policymakers to move from ambition to action. against the responsibilities set out in clause It is common for countries to struggle in finding 9 (3) of the regulations and the weakness efficient mechanisms for linking medium- of reporting systems which contributed to and long-term infrastructure plans within a ineffective delivery sustainable fiscal framework. 126. World Bank. (2021). “Resilient Transport in Small Island Developing States: Resilient Road Asset Management System Diagnosis and Transition Plan”. 127. Solomon Islands Government, Asian Development Bank and Department of Foreign Affairs and Trade, Government of Australia, 2014, “Joint Review of the Solomon Islands National Transport Fund”. 134 Table 20: Policy options Issue Options Short term Medium term Capital spending is not easily Issue budget regulations to Integrate the development and identifiable owing to accounting clarify the distinction between recurrent budget and have one practices and fragmentation the definition of recurrent and unified budget estimate. across budget types and development spending. Include external financing. recurrent costs of projects in the recurrent budget for the life of the projects. Strengthen integration of the Strengthen reporting of donor recurrent budget with the assistance by inclusion in the development budget through non-appropriated budget. regulation and by supporting joint budget consultations between MOFT and MNPDC. Project proposals and Determine and publish the Present a medium-term fiscal development plans include indicative funding envelope of the strategy (MTFS) rooted in estimation of multi- development budget and CDF. medium-term fiscal estimates annual project costs for to help (a) design an operational Strengthen MDTP regulations implementation, operation, and deficit target that assesses to articulate medium-term maintenance but do not cover spending needs and (b) assess expenditure needs and alignment the whole budget and are not tradeoffs between development of donors’ assistance. reflected in top-down medium- spending and building buffers, term fiscal planning. including assessment of fiscal impacts of climate risks. CDF operating to date without Finalize regulations to enforce Earmark (or incentivize) a supporting regulations, strong the legal requirement for proportion of CDF to reflect planning, project selection and constituency development national priorities (NDS), transparency on the use of plans. Regulations to include maintenance spending, and funds. standardized guidelines for climate resilience. development plans and annual funding applications. Introduce regulation to strengthen coordination across committees that govern the spending of the PCDF and CDF. This could be enshrined in CDF regulations to embed the provincial role in the development of constituency development plans. Lack of project prioritization and Formalize the mandate for the Tailor the roll-out of more appraisal causing downstream central appraisal function through complex technical guidelines to implementation problems. amendments to the PFM Act or scarce administrative resources, through regulations. focusing first on large projects, and progressively enforcing Strengthen the MNPDC project technical appraisals for lower appraisal template and introduce value projects. appraisal guidelines for capital projects. Align guidelines to the existing MCA. 135 Issue Options Short term Medium term Cash flow forecasts are not Establish a process for an Account for uneven prepared regularly and project efficient cash management implementation performance. financing is subject to cash system and develop guidance to Authorities could seek to rationing resulting in delays produce cash forecasts (within match the allocation of LMs) prior to the issuance of development expenditure to Accounting Warrants. This the implementation capacity of could include a cash plan to ministries and agencies. guide budget execution, that incorporates actual monthly cash flows and updated forecasts. Underinvestment in Increase maintenance spending. Consider NFT-like funding maintenance; expenditure Revamp the NFT to pool mechanisms in other key levels may run into diminishing donor and SIG resources for infrastructure sectors. economic returns maintenance in the transport sector. 236. Seeking clarity and precision in the 237. Moving towards multi-year funding budgeting framework could help address envelopes for capital projects could help budgetary fragmentation and difficulties address a key constraint to effective project in identifying capital expenditure. The implementation. Funding constraints to government could issue budget regulations to implement projects can lead to delays and clarify the distinction between the definition of expose the project to additional cost increases recurrent and development spending. This will (e.g., inflation). Addressing the challenge would require an assessment of what is presently in require a clear roadmap and a complex reform the Development Budget and what should and process. The following steps could be explored should not be in it. These should also aim to to strengthen the medium-term guidance and strengthen integration of the recurrent budget planning: with the development budget, which can be • Develop regulations to support the MTDP complemented by joint budget consultations and its implementation (PFM Act S45 between MOFT and MNPDC, including close (2)). Include estimates of medium-term liaisons of counterpart sectoral officers expenditure needs in MTDP for large to coordinate recurrent and development capital projects, ongoing or forthcoming. budgets. Closer technical coordination could It should also be aimed at strengthening facilitate the determination of the development the alignment of donor assistance with the budget resources early in the budget cycle to MTDP and improving the flow of information allow more time for prioritization to be done from development partners to help with effectively with line ministries. Regulations multi-year budgeting. Donors could look to should also aim to include recurrent costs of fill the gap between the available funding projects in the recurrent budget for the life of and needs on the list of projects. Yearly the projects. These costs can be identified in updates to MTDP should carry forward the current development budget templates. unfunded projects in any given year. Ultimately, the regulations could seek the presentation of an integrated development and recurrent budget under unified budget estimates. 136 • In the short term, MoFT could consider 238. Addressing this data gap could help improve issuing aggregate spending ceilings for the the allocative efficiency of capital. Sector- development budget and CDF as part of its wise data on the geographic distribution of SIG existing budget documentation128 for the capital spending was not available for analysis. three forthcoming years on a rolling basis. This limits the understanding of the geographic Currently, each ministry provides three- allocation of spending, and the extent to which year estimates, although none are included spending is aligned with infrastructure gaps, or for the CDF, and are not consistently connectivity needs. This is compounded by the aggregated to form top-down, medium-term lack of visibility of CDF spending. Compilation fiscal guidance (unlike revenue projections of this data could be led by MOTF, and that are aggregated and reported with ultimately incorporated into the regular budget forward estimates). reporting. • Over the medium term, MoFT could 239. Strengthen strategic planning for CDF consider building on the contents of the and finalize the regulations that govern Financial Policy Objectives and Strategies its operations to help align spending with to present a medium-term fiscal strategy infrastructure priorities. The CDF plays a (MTFS) to (i) design an operational critical role in investment management, taking deficit target that assesses spending one-third of the development budget and as needs and (ii) assess tradeoffs between the largest source of subnational funding. It development spending and building buffers. functionally serves as the main mechanism This could also include articulation and for public investment in a large number of fiscal implications of climate risks. The constituencies. Lack of transparency around MTFS could, in turn, serve as basis for CDF obscures the effectiveness of targeting. expenditure needs and indicative costing There is an opportunity through the regulations under the MTDP, thus linking macro-fiscal to enhance the alignment of spending with objectives with fiscal priorities as defined the NDS and other planning documents, by under the NDS. improving planning standards and earmarking • Over the medium term, develop a certain proportion of spending for priority mechanisms for creating multi-year issues. The authorities could build on the commitments for capital projects. This CDF Act by finalizing the regulations to bring could be accompanied by development basic standards and more effectively align partner engagement guidelines, changes CDF with investment priorities. The following in the annual budget law, or an overarching suggestions could be considered to strengthen PFM Act, allowing for multi-year these regulations: commitment budgets to be appropriated for • Finalize regulations to enforce measures selected large capital projects. Currently, stipulated in the CDF Act. Enforce the the appropriation documents include requirement to develop constituency columns for two forthcoming years but are development plans (CDPs). The CDF Act always left blank. requires that funding applications include • Strengthen alignment and reporting of details of the intended project outcomes, donor assistance. Specifically, budget a list of activities, a timeline, and details documents should gradually include donor of the budget. In the short-term this could spending in the non-appropriated section be supported by standardizing guidelines of the budget, which is currently left for CDPs and for applications for annual blank. Furthermore, seek to align donor funding, complemented by training for assistance to the MTDP through donor constituency development officers and policies, SIG strategies, and possibly budget elevation of good practice examples regulations. This linkage is weak as donors from constituencies within the country. engage directly with line ministries rather Development partners could work with than linking into the MTDP. the Ministry of Rural Development and constituency development committees to encourage CDPs and proposed guidelines to focus on objectives under the NDS, and possibly the MTDP. 128. For example, the Financial Policy Objectives and Strategies. 137 • Development of CDPs and alignment The appraisal guidelines could be aligned with priorities could be strengthened with the multi-criteria analysis (MCA) which by earmarking a percentage of CDF on underpins the government’s infrastructure prioritized sectors or types of expenditure, investment plan. However, the approach for example, maintenance and climate lacks theoretical or conceptual resilience. underpinnings for investment appraisal • Over the medium term, regulations could and may result in having to rely on decision be strengthened to improve coordination makers having a high degree of discretion in with sector and subnational funding. driving the analysis. Greater coordination between the CDF, • The MCA can be complemented by LMs, and other subnational funding cost-effectiveness analysis, which is mechanisms could strengthen allocative commonly used when conducting a cost- efficiency, reduce duplication, and improve benefit analysis or quantifying the benefits the responsiveness of funds to constituency is difficult (Kaplan, 2014). The benefit needs. For example, authorities could of cost-effectiveness analysis is it is promote cross-representation between simpler methodology. Implementing these the ward development committees, guidelines would require comprehensive provincial authorities, and the constituency training. development committees that manage CDF • Tailor guidelines to scarce administrative spending. resources. It would be impractical to expect the government to adopt a rigorous 7.4.2 Strengthening project appraisal appraisal process across all project and prioritization processes proposals. The guidelines should recognize 240. Strengthening appraisal processes can that appraisal has to be proportionate help minimize the risks of making mistakes to scale and complexity, with different in terms of project selection and design. methodologies for different types (size Effective appraisals support decision making and complexity) of projects to avoid the for the optimization of project design and excessive administrative burden. See Box impact. The process is critical in selecting 10, for an example of a global experience. projects that yield the highest social and The example is an illustration of how economic returns, and helping to avoid guidelines could help prioritize scarce making costly mistakes. Poor project selection administrative resources and capacity to can result in over-programming of projects large projects while still providing objective or wasteful ‘white elephant’ projects with guidance to lower-value and less complex limited social and economic value (Rajaram projects. et al., 2010). Mistakes in project selection and design can also lead to high costs during 7.4.3 Implementation and maintenance implementation, resulting in wasting resources 241. The authorities could look to ease through project delays and poor maintenance. implementation bottlenecks by better The following actions could be considered to planning. Underspending of the development improve project appraisal: budget and project execution can be hampered • Formalize the mandate for central by cash rationing and uneven capacity across appraisal. MNPDC is nominally in charge LMs. Without commitment ceilings, ministries of appraisals but the process is not are unable to commit expenditure to capital structured, with process decisions not projects in advance and are unable to plan always binding. Solomon Islands could on the basis of reliable cash-flow forecasts. benefit from strengthening appraisal With limited cash, recurrent expenditure regulations to mandate agencies to submit takes priority, with the remaining balance, if appraisal reports for review by MNPDC. available, repositioned to capital and political projects. This leads to significant delays in • Strengthen the MNPDC project appraisal project implementation. The following options template and introduce guidelines. New could be considered: project proposal forms could be developed to provide relevant project information alongside guidelines for appraisal, economic analysis, and other relevant analytics. 138 • Prepare and regularly update within-year Against the backdrop of a sizable investment cash-flow forecasts to provide ministries pipeline, preventative maintenance could and agencies with commitment ceilings in provide a better financial return than investing a timely manner. This can help anticipate in new infrastructure in some sectors. Despite bottlenecks and inform the efforts by SIG increased allocations to capital spending, and DPs to reduce the underspending of the maintenance has not kept pace. development budget earlier in the budget 243. Donors should support SIG to leverage cycle. Authorities could develop guidance to dedicated funding schemes for maintenance. produce cash forecasts (within LMs) prior Prioritizing maintenance spending can help to the issuance of Accounting Warrants. address both the persisting maintenance gap This could be supplemented with inter- in Solomon Islands and the underperformance ministerial cash management committees of externally funded investments due to and pilot use of quarterly procurement inadequate maintenance. Lessons from (and/or commitment) plans within selected the experience with the NTF should be ministries to strengthen cash planning. incorporated in the next iteration of the fund. • Account for uneven implementation This includes strengthening a fully functional performance. Looking beyond a given Secretariat, reporting, and control weaknesses budget year, authorities could seek to in SIG accounting system. The next iteration match the allocation of development of the NFT could also include provisions for expenditure to the implementation capacity prioritization of spending based on climate of ministries and agencies. Allocations and the disaster vulnerability level of assets. and cash-rationing could prioritize high Donors could consider establishing similar implementation performance to reduce funds in other infrastructure sectors. The underspending while seeking to address efforts to pool SIG and DP resources to fund gaps in capacity elsewhere. maintenance could be extended beyond 242. Reallocate spending to support maintenance. transport into other critical infrastructure The sector and public goods allocation sectors. Critically, the establishment of of capital and maintenance spending maintenance funds for public assets should be necessitate a review, as current expenditure accompanied by capacity-building programs levels and patterns may run into diminishing to plan, prioritize, and deliver the capital economic returns. Inadequate infrastructure maintenance programs, support of fully maintenance leads to premature deterioration functional Secretariats, and reporting systems. of infrastructure, which impacts the quality of the investment, the environment, as well as the safety of the population. BOX 10: PROJECT APPRAISAL THRESHOLDS IN IRELAND The appraisal methodology used in Ireland Wherever possible, cost–benefit analysis is depends on the type, scale, and complexity of the used. In cases where this may not be possible project. For project proposals below €10 million or desirable, cost-effectiveness or multi-criteria (US$11 million), approving authorities engage analysis may be used. with sponsoring agencies to assess whether an Cost–benefit analysis is used for all projects more economic appraisal is required and what type of than €100 million (US$111 million) (Department of economic appraisal is appropriate. Public Expenditure and Reform, 2019). For all other project proposals, approving authorities and sponsoring agencies engage on the Source: Schwartz, G., Fouad, et al., Well Spent. choice of the appropriate appraisal methodology, (International Monetary Fund, 2020) in line with sectoral guidance. 139 REFERENCES 140 ABC. (2020). “Full benefits of cheaper and faster Burns, A., Campagne, B.P.M., Jooste, C., Stephan, internet to Solomon Islands and PNG still to come”. D.A., and Bui, T.T. (2019). The World Bank Macro-Fiscal Australian Broadcasting Corporation. Pacific Beat Model Technical Description. 8965. 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World Bank, Washington, D.C. https://openknowledge. worldbank.org/handle/10986/29881 144 145 ANNEXES 146 ANNEX 1: BENCHMARKING SOLOMON As a result of this screening process, the following countries were selected as structural peers for ISLANDS AGAINST ITS PEERS Solomon Islands: • PNG In this study, the Solomon Islands’ performance • Mauritania on different aspects is benchmarked to structural • Timor-Leste peers, relevant aggregates, and aspirational peers. Specifically, structural peers have been selected • Kiribati based on the geographic, economic, demographic, • Lao PDR and institutional characteristics of the country, • Kyrgyz Republic drawing on the following criteria: • Myanmar • Categorized as a lower-middle-income group with GNI per capita in 2019 between US$1,036 and Additionally, all countries are broadly similar in terms US$4,045 of their CPIA Cluster D score for 2020 (range: 3.3-2.6, with Sols = 2.7), indicating a comparable quality of • Categorized as commodity exporters (defined as public sector governance. a developing economy for which gross exports of commodities constitute at least 35 percent of total In addition, Solomon Islands is benchmarked exports and net exports of commodities constitute against relevant aggregates, including: at least 5 percent of exports-plus-imports on • East Asia and Pacific average, based on the available data for 1960–2014) • Lower-middle-income countries • Countries with a rural population above • PICs 50 percent of the total population Neighboring Fiji is included as an aspirational peer. • Value added by the agricultural sector Fiji has some similar characteristics to Solomon is above 10 percent of GDP Islands, being a small, remote archipelagic state • Countries with a population density of in the Pacific and also extremely vulnerable to fewer than 50 people per square kilometer climate-linked disasters, albeit with a slightly larger • Landlocked and large countries were excluded. population. Fiji, however, has some notable socio- economic differences. It has a larger urban population and is more reliant on higher-value-added services. Accordingly, GNI in Solomon Islands is only around one-third of that of Fiji (as per Atlas method, current USD), with the level of GNI in 2020 in Solomon Islands equivalent to Fiji’s level around the turn of the century. 147 Figure A.1: General flow of funds in MFMOD Domestic wages and rents Private investing financing Factor Markets Households Dir taxes Lending interest Trnsfr- Private consumption Factor demand Trnsfr-interest Indir taxes Intermediate input Gov cons and inv Government demand Private Capital Account Lending interest Trnsfr- Activities Lending FDI Domestic Commodity Rest of the Markets Imports Domestic demand World Exports Foreign wages and rents Private investing Source: MFMod training material Figure A.2: Key identities in MFMOD: GDP Accounting PRODUCTION: EXPENDITURE: INCOME: YV - GDP (factor) Y - GDP (market) YI - GDP (factor) A - Agriculture C - Consumption WB - Wage Bill IN - Industry G - Government GOS - Gross operating surplus S - Services I - Investment X - Exports M - Imports D - Discrepancy SD - Change in inventories Y = YV + Taxes - subsidies on production = YI + Taxes - subsidies on production Source: MFMod training material 148 ANNEX 2: SOLOMON ISLANDS Demand side equations MACRO-FISCAL MODEL Demand side expenditure is split into the normal categories using data provided by the Central bank Model Dynamics of the Solomon Islands. This method takes the expenditure shares in 2016 and projects them forward MFMod is a structural econometric model that onto aggregate GDP data thereafter. reproduces the flow of funds across the whole economy by mapping out the main identities of Sectoral detail in the model (production side) the national accounts, balance of payments, labor markets and financial sectors (see Figure A.1). As mentioned, an important modeling consideration Macrostructural models make a concerted effort to is the mapping of demand and supply components estimate the economic and behavioral determinants to value-added. Ideally one would model the factor of economic variables. These structural relationships input choices in each sector. Doing this requires are developed to be both consistent with economic data on labor, capital, rental rates and wages on a theory (in the long run) and the observed dynamics sectoral level. Unfortunately, time series data for of the economy in the short-term (Burns et al. 2019). these variables are typically not available for most As a result, the speed of adjustment of each country countries. Many macrostructural models neglect this specific model to its economically-determined long- part of the model by either omitting the value-added term equilibrium129 depends mainly on the actual block entirely or by writing this block as reduced historical behavior of the economy. forms, with an identity determining the level of each sector. In MFMod, the modeling of GDP comprises three standard measurements. GDP from the The standard MFMod models the economy/the (i) expenditure side, (ii) production side and (iii) GDP from the production side into three sectors: income side (see Burns et al. 2019 for more details; agriculture, industry and services. Figure A.2). Capital stock and Potential GDP Capital stock is constructed using available data and some assumptions. Table A1: Assumptions Wage share 0.7 Risk premium 0.1 Depreciation rate 0.05 129. The overall time-variant equilibrium growth path of the economy is determined by potential output, which is calculated using the production-function methodology as a function of total factor productivity, the level of capital and labor (which are functions of assumptions on capital investment, population growth rates, labor participation). 149 Our production function gives output Y is a function Fiscal Detail of labour supply N and the capital stock K. The model contains the following fiscal policy channels: • Impact of VAT on private consumption prices We use a standard definition130 for the Cost of Capital: • Impact of excise duties on private consumption prices • Impact of import taxes on in import prices where the cost of capital (CoC) is a function of the risk premium riskt, the depreciation rate δ, expected • Impact of export taxes on exports prices inflation E(π_t ) (I use the smoothed GDP deflator due Although direct taxes are incorporated into the model, to a lack of data availability) and the cash rate rb t. they are not split into personal and corporate income taxes, and do not affect the dynamics of household consumption or private investment. Then the capital stock is equal to the capital share (1 – wage share) of GDP, divided by the cost of capital. This is a simple inversion of the marginal product of capital from our production function: This gives us an estimate of the equilibrium capital stock, since we need to assume that the cost of capital is equal to the rental rate of capital (i.e., the marginal product). An estimate of the capital stock allows us to estimate Total Factor Productivity: Which we smooth using a HP filter. We can then construct potential GDP using these estimates: Potential GDP is the supply potential of the economy and anchors the real side of the model. It determines how much output can be produced when all of the resources in the economy are fully employed (given existing distortions, technology and preferences). The output gap is then the difference between potential and actual output: 130. See for eg: http://www.econ2.jhu.edu/people/ccarroll/ public/lecturenotes/Investment/HallJorgenson.pdf 150 ANNEX 3: VAT AND TAX ADMINISTRATION REFORM – TECHNICAL BACKGROUND Decomposition of tax revenue components Tax revenue can be decomposed into three multiplicative (and inter-linked) components: (i) net tax base in nominal terms, (ii) effective rate, and (iii) collection efficiency. Their relation laid out in the equation below: VAT revenue estimation To estimate VAT revenue, we use a broad set of data sources including Sales and Goods Tax revenue, customs data on imports, and national accounts’ household final consumption broken into main product categories. Due to the unavailability of supply and use tables for Solomon Islands, to estimate the liability accrued at the intermediate level we use relevant coefficients from the supply and use table of PNG and assume that production technologies are similar in both countries. Importantly, the information from national accounts allows to proxy the theoretical tax base. To estimate the actual tax base, we use revenue figures and calculate the efficiency of current tax collection, i.e., fraction of tax base that brings tax revenue. To estimate VAT liability, before correcting it for collection inefficiency, we model tax rules and align them with the theoretical base. The formula for VAT revenue consists of two main blocks – the liability on household final consumption and hidden VAT paid at the intermediate level in industries that could not deduct their input VAT (intermediate consumption and GFCF liability): This is where: i denotes groups of products and services j denotes sectors of economic activities Ratei are the effective rates for respective groups of products and services HHC Valuei is household final consumption (denoted in net terms) IC Valuei,j is the value of IC (denoted in net terms) GFCF Valuei,j is the value of GFCF (denoted in net terms) Prorataj is the percentage of output in a given sector that is exempt from VAT efficency_coefficent is the ratio of revenue to the value of the liability estimated for the current system and value of the tax base 151 Household consumption liability The estimation is based on the methodology The core component of VTTL is the household presented by Decoster et al. (2014) but relatively consumption liability, which is a product of the simpler due to relatively low differentiation of rate effective VAT rates and household consumption in different VAT introduction scenarios.131 In the values of each of the groups of products and first step of the analysis, household expenditure activities. Households’ consumption values, was grouped into 16 main categories including basic similar to other components of the use tables, foodstuffs and agricultural goods. The group consists are recorded in purchaser’s prices, thus of bread and cereals (CP0111), fruits (CP0116), and they require correction for the included VAT vegetables (CP0117). component. Moreover, the calculation requires In the second step, we combined the information adjustment for non-taxable consumption, in gathered in the revenue impacts analysis to estimate particular self-supply, and imputed rents. the implicit rates paid on various categories of consumption in 2019 and in counterfactual VAT Intermediate consumption and GFCF liability introduction scenarios. The estimated implicit The liability from intermediate consumption rates estimated account for the complex tax policy is computed for each industry as a product of structure today of main taxes on goods and services. intermediate use of each of the inputs, times the They are also corrected for the inefficiency of tax average VAT rate for these groups of inputs, times collection, resulting in non-payment of taxes on a industry average proportion of non-deductible VAT in large fraction of tax base. the intermediate consumption. The latter, the non- In the next step, we model the expenditure on deductibility pro-rata coefficient, is estimated using basic foodstuffs by estimating the ‘Engel’ curve. the breakdown of sectoral production to narrow The estimated Engel curve describes how share of categories of goods and services. Importantly, as expenditure on basic foodstuffs is determined by intermediate consumption is reported in purchaser’s household total real income proxied by expenditure prices, it includes non-deductible VAT that needs to on goods and services net of taxes and controlling be excluded from the use tables to reflect the net tax for households’ headcount. As suggested by the base. Similar to intermediate consumption liability, theory, the share of expenditure on basic foodstuffs is non-deductible investment is estimated as a product inversely proportional to household income with the of tax rates, pro-rata coefficient and tax base, i.e., fastest decline in the share observed for lower income industry’s GFCF. The core components of this liability households. Total income and household headcount component include an estimate of the housing and proved to explain well the variation of the expenditure public investment. across income groups as shown be the proximity of the observed share and fitted trend in Figure A1. In Microsimulation of distributional impacts the last step of the analysis, we simulate how change of VAT introduction in implicit rates under different scenarios affects real income measured in the net value of purchased The Household Income and Expenditure Survey products and services. This impact is then translated (HIES) 2012/13, which is the source of data for to changes in household consumption structure. As estimating the impact of exemptions granted to a result, we are able to model the direct impact of foodstuffs on households’ real income, contains changes in rates on overall tax burden and indirect the information on ca. 4,500 households and their impact of tax burden on consumption structure. expenditure structure. The expenditure lines of every households contain granular information on the classification of goods and services by COICOP codes. The survey contains also other households’ characteristics that could be helpful in explaining households’ consumption behavior. 131. Decoster, A., Ochmann, R., Spiritus, K. (2014). Integrating VAT into EUROMOD. Documentation and results for Belgium, EUROMOD Working Papers EM12/14, EUROMOD at the Institute for Social and Economic Research. 152 Assumptions for increasing collection efficiency Figure A3: Actual and fitted Engel curves basic foodstuff and agricultural goods To estimate the revenue gains from increased tax (Share of total expenditure) compliance, we relied on the government’s tax reform implementation strategy.132 Assumptions were made regarding: (i) the increase in voluntary compliance of 6 large taxpayers, (ii) the increase in the number and 5 effectiveness of audits, (iii) the increase in on-time filing and payment for large taxpayers together with 4 increased collection of tax debt, and (iv) the collection of outstanding tax debt of large taxpayers. Most of 3 the reform efforts are expected to materialize for 2 large taxpayers and taxes on goods and services, income tax, PAYE and withholding tax. Currently, 1 this accounts for 42 percent of total tax revenue. No improvements to other taxes and other types of 0 0 100000 200000 300000 400000 taxpayers were assumed. Observed Fitted The baseline scenario assumes that voluntary Fitted trend - observed Fitted trend - forcast values compliance will grow at a steady rate of 2 values percent per year to reduced administrative Source: World Bank staff calculations. burden, increased advisory visits, compliance campaigns, and improved audit functions. Voluntary compliance encompasses increased self-assessments, a decrease of underreporting of registered companies, and new registrations. In the reform scenario, the number of audits is expected to increase, along with their effectiveness, i.e., the strike rate and the average value of the assessment (but remain considerably below 100 percent). Improvement in tax debt and return management will lead to the reduction of tax debt. It is assumed that the level of tax debt from large taxpayers would reduce from SI$136 million to SI$125 million, at a faster pace due to better return management. Over the medium term, 95 percent of taxpayers would use e-tax, contributing to efficiency gains.   132. See SIIRD. (2021). Solomon Islands Inland Revenue Department Large Taxpayer Compliance Improvement Strategy. 153 ANNEX 4: BASE SALARY AND ALLOWANCE SCHEDULE MAGISTRATURE (2021) Reg Item Chief Deputy Principle First Second Magistrate Chief Magistrate Class Class Magistrate Magistrate Magistrate 5 Forthnightly Salary $6.300 $5.494 $4.931 3.616 $3.415 7 Monthly Housing allowance $12.000 $9.000 $7.000 $6.000 $6.000 9 Monthly utilities allowance $3.000 $2.500 $2.000 $1.500 $1.500 10 Monthly Fuel allowance $2.500 - - - - 10 Monthly veichle allowance Vehicle $3.000 $2.500 $2.000 $2.000 provided by Government 13 Daily travel allowance- USD$300 USD$200 USD$200 USD$150 USD$150 outside Solomon Islands 14 Daily travel allowance- $300 $200 $200 $200 $200 within Solomon Islands 15 Annual Clothing allowance $10.000 $7.500 $6.000 $5.000 $5.000 19 Annual Education Grant $10.000 $7.500 $6.000 $5.000 $5.000 20 Daily Higher $100 $100 $100 $100 $100 duties allowance 21 Appointment grant $10.000 $8.000 $7.000 $5.000 $5.000 21A Annual entertainment $10.000 - - - - allowance 21C Mobile handset $5.000 $3.000 $3.000 $2.500 $2.500 21C Monthly communication $1.000 $800 $600 $500 $500 allowance 21E End of Service grant $150.000 $100.000 $75.000 $50.000 $50.000 154 ANNEX 5: HISTORICAL MACRO-FISCAL INDICATORS 2013 2014 2015 2016 2017 2018 2019 2020 In millions of Solomon Islands dollars Revenue 4203 4089 4381 4226 4592 5058 4207 4218 Tax revenue 2411 2487 2622 2578 2954 3275 2872 2643 Income and profits 868 863 991 947 1028 1090 1049 1008 Goods and services 903 907 855 833 878 1095 937 924 Int. trade and 640 717 776 798 1048 1090 886 711 transactions Grants 1440 1255 1175 1118 1058 1243 816 1115 Other revenue 352 348 584 530 580 540 519 460 Total Expenditure 3862 3908 4382 4682 4930 4950 4320 4526 Total expenditure, 3038 3173 3674 3820 4053 3922 3872 4135 excluding grants Total capex 477 442 694 901 916 629 461 463 Total recurrent 2561 2731 2980 2918 3137 3292 3411 3672 Compensation 767 819 984 1058 1135 1189 1276 1360 of Employees Use of Goods 1238 1342 1229 1510 1690 1753 1745 1733 and Services Debt & Interests 21 77 172 62 37 58 44 45 Grants & Subsidies 515 453 563 252 235 225 280 252 Social Benefits 21 40 33 36 30 53 44 55 In percent of GDP Overall balance 3.7 1.9 -0.0001 -4.6 -3.2 1 -1 -2.9 Primary balance 3.9 2.8 1.8 -3.9 -2.9 1.5 -0.6 -2.5 Nominal GDP (in 9227 9324 9456 10012 10547 10963 11095 10616 millions of Solomon Islands dollars) Source: IMF 155 ANNEX 6: MACRO-FISCAL FRAMEWORK REFORM SCENARIO 2020 2021 2022 2023 2024 2025 2026 Annual percentage change Real economy Real GDP growth -4.3 -0.2 -4 4.5 4.6 4.1 2.5 Consumer prices (period 3.4 4.2 5.2 4.2 4.8 5.6 5.8 average) In billion SBD Selected monetary accounts Broad money 4.6 4.6 4.6 4.5 4.3 5.4 6.4 In billion SBD (unless otherwise noted) Balance of payments (in percent of GDP) Current account balance -1.62 -11.96 -14.57 -13.00 -8.67 -3.57 1.35 (in % of GDP) Gross official foreign reserves 0.7 0.7 0.7 0.6 0.6 0.5 0.5 In percent of GDP Public sector finances Revenues 33.2 30.7 28.1 29.5 29.9 30.5 30.5 o/w grants 8.8 8.5 5.6 6.1 5.6 5.5 5.4 Total expenditure 35.8 34.2 34.8 34.2 34.1 33.4 32.9 Goods and services 19.0 16.9 14.6 13.1 12.7 13.7 14.7 Investment 6.4 7.1 9.2 10.3 10.5 9.6 8.9 Other 10.2 9.8 10.2 10.1 10.0 9.2 8.4 Interest payments 0.3 0.4 0.7 0.7 0.8 0.8 0.8 Overall fiscal balance -2.6 -3.4 -6.7 -4.7 -4.2 -2.8 -2.4 Gross debt 13.3 17.0 22.9 25.3 26.7 26.8 27.0 Change in debt 3.6 5.9 2.4 1.4 0.2 0.2 Memorandum items Nominal GDP (billion USD) 1.55 1.61 1.67 1.81 1.98 2.16 2.33 Exchange rate (USD per SBD) 0.12 0.12 0.13 0.13 0.12 0.12 0.12 156 ANNEX 7: SCENARIOS FOR Scenario 1: SCHOLARSHIP REFORM Reduce overseas scholarship spending by 25 percent; reallocate cost savings equally Scholarship expenditure at the tertiary level is largely between primary/secondary education and driven by financing students’ enrolment in overseas tertiary education programs. In 2020, overseas awards accounted for almost three-fifths of SIG scholarship spending. Reducing expenditures on overseas scholarships is Further, overseas scholarships are the most likely to benefit significantly more students, if cost expensive category of scholarships funded by the savings are reallocated to pre-tertiary education and SIG but this category benefits relatively few Solomon also toward improving funding for Solomon Islands’ Islanders (considering several factors such as the cost universities. Reducing expenditure on overseas structures of local and international HEIs as well as scholarships by 25 percent could save SI$50 million differences in the cost of delivery for STEM programs). (2020) assuming no policy changes across other scholarship categories are implemented (Table A2a). Reallocating half of the cost savings generated (by reducing spending on overseas scholarships) toward primary and secondary education would increase spending at these levels by 17 percent (SI$170 million excluding payroll). At the tertiary level, the aforementioned cost savings would double spending. Table A2a: Scenario 1. Reducing overseas scholarship spending by 25 percent and reallocate cost savings to primary/secondary education and the tertiary sector SBD Overseas Scholarships Expenditure 199,682,653 25% reduction 49,920,663 Total 149,761,990 Reallocating overseas scholarship savings Primary and Secondary Education Expenditure 145,354,579 add 50% of overseas scholarships savings 24,960,332 Total 170,314,911 Tertiary Expenditure (excl. scholarships) 23,379,703 add 50% of overseas scholarships savings 24,960,332 Total 48,340,034 Source: WB calculations based on BOOST database 157 Scenario 2: Reduce overseas scholarship spending by 25 percent; reallocate all cost savings to tertiary education Reallocating SI$50 million in cost savings exclusively to universities would almost triple tertiary spending (excluding payroll and scholarship expenditures) (Table A2b). Table A2b: Scenario 2. Reduce overseas scholarship expenditure by 25 percent and reallocate cost savings to tertiary education SBD Overseas Scholarships Expenditure 199,682,653 25% reduction 49,920,663 Total 149,761,990 Reallocating overseas scholarship savings Tertiary expenditure (excl. scholarships) 23,379,703 add 100% of overseas scholarships savings 49,920,663 Total 73,300,366 Source: WB calculations based on BOOST database 158 Scenario 3: Reduce overseas scholarship spending by 30 percent; reallocate cost savings equally between primary/secondary education and tertiary education Reducing overseas scholarship spending by 30 percent could generate SI$60 million in cost savings (Table A2c). Reallocating half of the cost savings generated (by reducing spending on overseas scholarships) toward primary and secondary education would increase spending for these sectors by one-fifth (to SI$175 million excluding payroll). At the tertiary level, the increase in tertiary spending through increased support to universities (due to cost savings generated by reduced overseas scholarships) would be SI$53 million. This amount represents a 128 percent increase in tertiary expenditure, mainly to the benefit of the Solomon Islands’ universities. Table A2c: Scenario 3. Reduce overseas scholarship expenditure by 30 percent SBD Overseas Scholarships Expenditure 199,682,653 30% reduction 59,904,796 Total 139,777,857 Reallocating overseas scholarship savings Primary and Secondary Education Expenditure 145,354,579 add 50% of overseas scholarships savings 29,952,398 Total 175,306,977 Tertiary Expenditure (excl. scholarships) 23,379,703 add 50% of overseas scholarships savings 29,952,398 Total 53,332,101 Source: WB calculations based on BOOST database 159 Scenario 4: It is worth noting that a large share of students fail to progress to secondary education in the Solomon Reduce overseas scholarship spending by Islands. In 2020, however, the MEHRD removed 30 percent; reallocate all cost savings to the Year 6 External Examination (SISEE), resulting tertiary education in all Year 6 students being allowed to progress to Reallocating SI$60 million in cost savings exclusively Year 7. Year 6 is the final year of primary education, to universities increases tertiary spending to while Year 7 is the first year of the junior secondary SI$83 million overall (excluding payroll and level. The SISEE was cited as a major contributor scholarship expenditures) (Table A2d). to student push out. As such, secondary spending may increase, irrespective of the above scenarios, due to this structural barrier to student access being removed. More students are expected to transition from Year 6 to Year 7. Table A2d: Scenario 4. Reduce overseas scholarship exp. by 30 percent SBD Overseas Scholarships Expenditure 199,682,653 30% reduction 59,904,796 Total 139,777,857 Reallocating overseas scholarship savings Tertiary Expenditure (excl. scholarships) 23,379,703 add 100% of overseas scholarships savings 59,904,796 Total 83,284,499 Source: WB calculations based on BOOST database 160 161