Pacific Economic Update: Diminishing Growth amid Global Uncertainty: Ramping up Investment in the Pacific Octob r 2024 Th P cific Economic Upd t provid s n l sis of 11 P cific isl nd countri s (PIC-11): F d r t d St t s of Micron si (FSM), Fiji, Kirib ti, M rsh ll Isl nds, N uru, P l u, S mo , Solomon Isl nds, Ton , Tuv lu, nd V nu tu. 1 Preface and Acknowledgements The Pacific Economic Update (PEU) is a semi-annual publication that informs business leaders, citizens, international partners, and policymakers about economic trends and key development issues in eleven Pacific Island countries (PIC- 11): the Federated States of Micronesia (FSM), Fiji, Kiribati, Marshall Islands, Nauru, Palau, Samoa, Solomon Islands, Tonga, Tuvalu, and Vanuatu. Part One provides an overview of recent economic developments, outlook, and risks. Part Two examines investment trends and offers policy recommendations to revitalize investment strategies, bolster economic resilience, and foster sustainable growth. This edition of the Pacific Economic Update (PEU) was led by Ekaterine Vashakmadze (Senior Economist), Vishesh Agarwal (Economist), and Warunthorn Puthong (Economist). Guidance was provided by Stephen N. Ndegwa (Country Director), Lalita Moorty (Regional Director, EFI), Lars Christian Moller (Practice Manager, MTI), and Ralph Van Doorn (Lead Economist, EFI). Stefano Mocci (Country Manager), Annette Leith, and Omar Lyasse (Resident Representatives) offered additional insights. Part 1 was prepared by Ekaterine Vashakmadze, Vishesh Agarwal, and Warunthorn Puthong, with contributions from a team including Lodewijk Smets, Mehwish Ashraf, and others. Part 2 was prepared by Ekaterine Vashakmadze, Kersten Kevin Stamm, and Dana Vorisek, with contributions from Vishesh Agarwal, Marie Christine Apedo, Nina Doetinchem, Slavena Georgieva, Alvaro Gonzalez, Rafaela Martinho Henriques, Anuja Kar, Christopher Miller, Amina Jarso Mokku, Jiyun Park, Ximing Peng, Rajesh Rohatgi, and Mariano Salto. Communications support was provided by Hamish Wyatt, Vika Waradi, Graeme Litter, and Peter Howe. Bridgette Hogan and Claudia Palic provided overall project support. The team appreciated feedback from Amat Adarov, Ibrahim Saeed Chowdhury, John Nana Darko Francois, Samuel Christopher Hill, Ergys Islamaj, Jeetendra Khadan, Marshall Mills, Ivan Anton Nimac, Francesco Strobbe, and other contributors. The report was edited by Angela Takats, with document design by The Greenhouse Studio. © 2024 The World Bank 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved. 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Contents Preface and Acknowledgments 2 Abbreviations and Acronyms 4 List of Figures 6 List of Tables 7 List of Boxes 7 Executive Summary 8 Part 1. Economic Overview: Short-term Resilience and Persistent Long-term Challenges in the Pacific 12 1.1 How Does the Global Economic Context Affect the PIC-11? 13 1.2 Recent Economic Developments and Near-term Outlook in the PIC-11 17 1.2.1 Growth 17 1.2.2 Inflation 27 1.2.3 Fiscal and Debt Dynamics 30 1.2.4 Monetary Policy and the Financial Sector 35 1.2.5 External Sector 37 1.3 Medium-term Growth: Substantial Output Losses and Slow Income Convergence 40 1.3.1 Stalling Convergence: A Critical Measure of Economic Progress 43 1.4 Risks to Economic Development 44 Part 2. Ramping up Investment to Broaden Horizons 46 2.1 Investment Trends 47 2.2 Barriers to Productive Investment 53 2.2.1 What is Limiting Investment? 53 2.2.2 What is Contributing to Investment Volatility? 58 2.2.3 What is Holding Back Private Investment? 60 2.3 The Way Forward 62 2.3.1 Enable Investment in High-potential Sectors 62 2.3.2 Address Infrastructure Deficiencies 63 2.3.3 Build Resilience Against Disasters 64 2.3.4 Strengthen Fiscal Buffers 64 2.3.5 Establish a Supportive Regulatory and Policy Framework to Attract Private Investment 67 2.3.6 Improve the Availability of Financing and Insurance Products 69 2.3.7 Leverage Global Support 70 References 71 Annexes 75 Annex 1: Growth Forecast Summary (based on fiscal year information) 75 Annex 2: Inflation Forecast Summary (based on fiscal year information) 76 Annex 3: Pacific Fisheries Sector Investment Landscape 77 Annex 4: Pathways for Supporting Small Farmers Through Agro-logistics 79 3 Abbreviations and Acronyms ADB Asian Development Bank AEs Advanced Economies CARICOM Caribbean Community CBRs Correspondent Banking Relationships CBSI Central Bank of Solomon Islands CEM Country Economic Memorandum COVID-19 Coronavirus CPI consumer price index DSA Debt Sustainability Analysis EAP East Asia Pacific ECP Economic Citizenship Program EEZ Exclusive Economic Zones EMDE Emerging Market and Developing Economies EU European Union FAO Food and Agriculture Organization of the United Nations FDI Foreign Direct Investment FFA Forum Fisheries Agency FJD Fijian Dollar FJI Fiji FSM Federated States of Micronesia FY financial year GB gigabyte GDP Gross Domestic Product GNI gross national income HIES Household Income and Expenditure Survey IDA International Development Association IFI international financial institution IMF International Monetary Fund IRENA International Renewable Energy Agency IVAs international visitor arrivals KIR Kiribati LMIC lower-middle-income country MAC Market-Access Countries MPAs marine protected areas MW megawatts NPRT Nauru Phosphate Royalty Trust NRU Nauru OECD Organisation for Economic Co-operation and Development OECS Organization of Eastern Caribbean States PALM Pacific Australia Labour Mobility Scheme PATA Pacific Asia Travel Association PCRAFI Pacific Catastrophe Risk Assessment and Financing Initiative PER Public Expenditure Review PEU Pacific Economic Update 4 PGST Palau Goods and Services Tax PIC-11 Federated States of Micronesia, Fiji, Kiribati, Marshall Islands, Nauru, Palau, Samoa, Solomon Islands, Tonga, Tuvalu, and Vanuatu PIC-9 Kiribati, Marshall Islands, Federated States of Micronesia, Nauru, Palau, Samoa, Tonga, Tuvalu, and Vanuatu PICs Pacific Islands Countries PIFS Pacific Island Forum Secretariat PLW Palau PPA Pacific Power Association PPP Purchasing Power Parity PPP public-private partnership PRDF Pacific Regional Development Framework PREIF Pacific Renewable Energy Investment Facility PRIF Pacific Regional Infrastructure Facility PV photovoltaic RERF Revenue Equalization Reserve Fund RMI Republic of the Marshall Islands RPC Regional Processing Centre SAR Special Administrative Regions of China SIDS Small Island Developing States SMEs Small and Medium-sized Enterprises SOE State-Owned Enterprise SPC The Pacific Community SLB Solomon Islands SPREP Secretariat of the Pacific Regional Environment Programme SWF Sovereign wealth fund TON Tonga TUV Tuvalu UMIC upper-middle-income country UN United Nations UNCTAD United Nations Trade and Development UNDP United Nations Development Programme US United States USAID US Agency for International Development USD United States Dollar VAT Value Added Tax VUT Vanuatu WB World Bank WEO World Economic Outlook WSM Samoa 5 List of Figures Figure 1.1 GDP growth 13 Figure 1.2 Global trade and tourism 14 Figure 1.3 Global commodity prices 15 Figure 1.4 Global inflation 16 Figure 1.5 GDP growth and contributions 17 Figure 1.6 Tourist arrivals in Fiji 18 Figure B.1 Vanuatu real GDP growth, 2024-26 (percent) 20 Figure 1.7 GDP growth and seasonal workers 22 Figure 1.8 GDP growth projections 22 Figure 1.9 Pacific real GDP growth projections 25 Figure 1.10 Poverty outlook and simulations with different growth scenarios, 2019-26 26 Figure 1.11 Consumer price inflation 27 Figure 1.12 Consumer price inflation outlook 29 Figure 1.13 Poverty outlook and simulations with different inflation scenarios 30 Figure 1.14 Fiscal balances (percent of GDP) 31 Figure 1.15 Revenue (percent of GDP) 32 Figure 1.16 General government debt (percent of GDP) 33 Figure 1.17 Wage expenditures and fiscal balance changes 35 Figure 1.18 Central bank policy rates 36 Figure 1.19 Current account balance, 2023 and 2024 (share of GDP) 37 Figure 1.20 PIC-11 current account (share of GDP) 38 Figure 1.21 Current account projections (share of GDP) 39 Figure 1.22 Potential growth and investment growth 40 Figure 1.23 Medium-term GDP growth 41 Figure 1.24 Measures of real output 42 Figure 2.1 Investment growth 47 Figure B.2 Investment growth, GDP growth, and capital-output ratio 49 Figure 2.2 Investment volatility 50 Figure 2.3 Investment and public debt, Fiji 51 Figure 2.4 Public investment and income sources 51 Figure 2.5 Foreign direct investment 52 Figure 2.6 Agriculture, forestry, and fishing sector and marine protected areas 53 Figure 2.7 Fuel imports and share of renewables in electricity capacity and production 56 Figure 2.8 Internet access and cost of internet connectivity 58 Figure 2.9 Average cost and frequency of natural disasters and official reserves 59 6 List of Tables Table 1.1 Growth forecast summary (based on calendar year information) 24 Table 1.2 Inflation forecast summary (based on calendar year information) 28 Table 2.1 Evolution of Debt Sustainability Analysis (DSA) risk ratings 60 Table 2.2 A summary of policy recommendations to boost productive investment 70 List of Boxes Box 1 The economic implications of the liquidation of Air Vanuatu 20 Box 2 Investment growth and GDP growth in the PIC-11 48 Box 3 The energy sector in PICs at a glance 57 Box 4 Successful fiscal management and reform in the PIC-11 66 Box 5 Case study: Telecommunications reform in the Caribbean 68 7 Executive Summary The World Bank’s Pacific Economic Update provides an assessment of the economies of 11 Pacific Island countries (Part 1) and highlights the potential of investment to broaden the economic horizons of the region (Part 2). Uncertain Global Trends and Enduring Challenges In 2024, growth across PIC-11 economies is estimated to have slowed significantly to 3.6 percent, following a robust 5.8 percent expansion in 2023. This slowdown reflects the diminishing impact of the post-pandemic recovery, particularly in Fiji, which accounts for over half of the output of the PIC-11. Fiji’s growth is projected to decelerate to 3.1 percent, down sharply from 8 percent in 2023, as economic activity returns to pre- pandemic levels. Meanwhile, Solomon Islands is expected to see more moderate growth of 2.5 percent, compared to 3 percent in 2023, due to structural challenges limiting the economy’s capacity to sustain higher growth rates. 8 Excluding Fiji and Solomon Islands, which are the two largest economies in the PIC-11, growth in other countries in the region is estimated to have accelerated from 3.8 percent to 4.9 percent. Tourism and remittances-led PICs, which have seen a lag in recovery, experienced a notable surge, with growth estimated at 5.6 percent in 2024, up from 4.6 percent in 2023. This rise reflects robust activity in Palau, Samoa, and Tonga, driven by stronger tourism demand and resilient remittance inflows. Sovereign rent-led economies have experienced modestly accelerated growth of 3 percent in 2024, up from 1.9 percent in 2023. This increase is due to strong non-tax revenue and expansionary fiscal policies, though capacity constraints still limit faster expansion. Inflation across the PIC-11 is estimated to have eased significantly in 2024, with the median rate dropping from 6.8 percent in 2023 to 4 percent. This decline aligns with the global trend of stabilizing commodity prices. In Fiji, inflation is projected to ease to 3.6 percent on average in 2025-26, following a temporary spike to 5.2 percent in 2024, mainly driven by VAT adjustments. Tourism and remittances-led economies, such as Palau, Samoa, and Vanuatu, have experienced the sharpest declines in inflation, reversing their previous surges. Sovereign rent-led economies like Kiribati and FSM are also experiencing reduced inflation. In Kiribati, this decline is attributed to improved supply conditions resulting from better weather patterns. Despite the overall easing of inflation, households in the region continue to face high costs for essential goods, reflecting ongoing economic strain from previous price surges. Over the past two years, several of the PIC-11 have made varying degrees of progress in fiscal consolidation. This has been supported by the gradual phasing out of COVID-19 stimulus measures and improved tax revenue driven by ongoing economic recovery. Additionally, some countries have implemented reforms to mobilize revenue. Due to these fiscal efforts and higher GDP growth, public debt as a share of GDP has decreased in more than two-thirds of the PIC-11. However, progress in restoring fiscal space depleted during the pandemic has been slow, as many countries face rising spending pressures, including demands for higher wages and increased capital investment. Monetary policy in the PIC-11 has been generally accommodative, with central banks keeping interest rates low to support economic recovery. However, its effectiveness in boosting growth has been limited by small financial markets, underdeveloped banking sectors, and a high reliance on external factors. Additionally, fiscal dominance, driven by the high risk of debt destress and limited fiscal space, further constrains the impact of monetary policy. External balances are generally expected to improve, driven by the recovery of tourism and strong remittance flows. Additionally, reduced import costs from lower commodity prices will contribute to this improvement. However, Vanuatu is likely to continue to face widening deficits due to country-specific issues, such as the liquidation of Air Vanuatu. The short-term outlook is subject to several downside risks. A slowdown in major economies, particularly China and the United States, could weaken global demand and incomes, potentially reducing tourism and impacting commodity exports, especially for countries like Solomon Islands. Additionally, climate change and natural disasters pose significant risks, as these events can cause severe economic disruptions and strain fiscal resources. Such external risks could further exacerbate existing economic vulnerabilities and hinder recovery efforts in the PIC-11. The recent rebound has restored output to pre-pandemic levels in most of the PIC-11. However, as the initial recovery boost fades, growth is settling at subdued long-term rates, with some economies falling below pre-pandemic trends. Medium-term growth prospects for the PIC-11 have dropped from 3.2 percent annually in 2000-19 to 2.7 percent in 2020-29, due to reduced investment impact and increased natural disasters and climate change. This subdued growth will impede recovery from the pandemic’s losses. Although poverty is expected to decline, it will remain high compared to similar-income countries, further delaying progress in closing income gaps with advanced economies. 9 Ramping up Investment to Broaden Horizons Investment growth in the PIC-11 has underperformed compared to other emerging markets and developing economies (EMDEs) in recent years and is projected to remain sluggish throughout the 2020s. After experiencing a sharper contraction during the COVID-19 pandemic, investment in the PIC-11 rebounded in subsequent years; however, the recovery from 2021 to 2023 has been weaker on average than in other EMDEs. This sluggish recovery is concerning as the region approaches nearly a decade of stagnation. Projected investment growth in the PIC-11 is expected to be around 1 percent annually from 2020 to 2029—significantly lower than the 4.2 percent average growth achieved from 2000 to 2019—indicating a troubling outlook for the region, barring a rapid and sustained investment boom. High volatility is a defining feature of investment growth in the PIC-11. The longest period of positive aggregate investment growth in the PIC-11 from 2000 to 2024 has been three years, compared to nearly nine years for other EMDEs, excluding China, on average. This difference is partly due to the significant economic impact of natural hazards when they occur. Natural hazards are estimated to cost PICs about 1.5 percent of their GDP annually, and with limited fiscal reserves, many PICs struggle to manage economic shocks. The recovery and rebuilding process locks these countries in a cycle of construction, destruction, and repair, leaving little room for capital accumulation. This lack of sustained investment expansion undermines growth and hampers the achievement of development goals in the region. Several factors hinder investment in the PIC-11, including limited economic integration and infrastructure bottlenecks. The lack of vertical diversification opportunities, driven by outdated incentives that favor low-return sectors like primary agriculture, presents significant challenges for these countries. Despite having extensive ocean territories and some of the largest Exclusive Economic Zones (EEZs) globally, many PICs have yet to capitalize on the blue economy, which encompasses sustainable fishing, aquaculture, and marine biotechnology. The tourism sector faces challenges that are restricting growth and adoptability, limiting its contribution to overall investment and economic growth. Additionally, remote locations, technological gaps, and insufficient information about environmental impacts hinder the sustainable development of the mining sector. Infrastructure challenges related to transportation, port facilities, airport capacities, and unreliable energy and internet connectivity are driving up operational costs and reducing efficiency, further impeding economic integration. Further barriers to investment include unpredictable regulatory environments, issues with state- owned enterprises (SOEs), and limited access to financing. Inconsistent regulatory environments create uncertainty, deferring private investment and increasing the perceived risk for investors. SOEs in PICs also pose significant barriers to investment and economic growth due to their inefficiencies, competition-distorting practices, and fiscal risks. Inadequate access to long-term financing is a critical barrier to public and private investment in the region. High interest rates and underdeveloped domestic financial markets complicate securing funding for large investment projects (IMF 2023a). Without a sustained policy effort to address these challenges, the PIC-11 will likely face lower medium- term growth prospects and more difficulty making progress on per-capita income catch-up. This could fuel outmigration and create a vicious cycle of stagnation. Adopting an integrated approach grounded in the following essential areas could help reverse this trend and foster investment and growth: Enable investment into high-potential sectors: Modernize agricultural practices with a focus on high-value crops, such as organic vanilla and noni juice, while fostering agribusiness development to enhance market opportunities; take an integrated approach by developing the blue economy through marine protected areas, which improve sustainable fisheries management and marine conservation alongside sustainable tourism initiatives; diversify the tourism sector; develop sustainable commodity production and mining, ensuring that these sectors synergize to attract investment and foster inclusive economic growth. 10 Address infrastructure deficiencies: Enhance road infrastructure and connectivity to improve access to markets and boost dynamism in the economy; expand and upgrade port and airport facilities to facilitate trade and attract investment, promoting competitiveness in the global market; prioritize energy and internet access and efficiency, leveraging the strong potential for renewable energy development to support a market-driven economy and sustain growth. Build resilience against disasters: Invest in climate-resilient infrastructure, including coastal protection and enhanced drainage systems to mitigate the impacts of natural hazards; allocate funds to disaster preparedness and early warning systems, ensuring timely responses through improved risk assessments; promote investment in sustainable land use and environmental conservation to reduce vulnerability to disasters and support long-term economic growth. Build fiscal resilience: Strengthen fiscal buffers to manage volatility and respond to external shocks; expand the fiscal space through domestic revenue mobilization and establishment and use of contingency funds; improve fiscal, financial, and investment management, including procurement standards and practices, for more effective budget planning and execution; accumulate fiscal reserves to ensure the continuity of critical public investment during downturns or emergencies. Establish a regulatory and supportive framework to attract and enhance private investment: Establish a robust legal and policy framework for SOEs including regular audits, transparent reporting, effective internal controls, and clear definitions of ownership; improve public-private partnerships (PPPs); reduce red tape and adjust investment incentives to attract private investors to high-potential sectors. Improve the availability of financing and insurance products: Develop long-term, innovative financial instruments to provide stable funding for major private or public investment projects, and to finance post-disaster infrastructure recovery projects and climate-related investment; create insurance products tailored to infrastructure development and disaster risks in PICs. Leverage global support: Secure IFI funding, technical expertise, and risk-sharing mechanisms essential for high-impact projects; ensure funding is timely and aligns with broader developmental goals; engage in collaborative approaches with global and regional partners to facilitate knowledge exchange and enhance investment strategies. 11 PART 1: Economic Overview: Short-term Resilience and Persistent Long-term Challenges in the Pacific 12 1.1 How Does the Global Economic Context Affect the PIC-11? PIC-11 economies are showing notable resilience in 2024, with most on track to exceed pre- pandemic output levels. However, growth is cooling rapidly, aligning with subdued long-term trends. Looking ahead, the Pacific will face a challenging external environment, with sluggish growth in both advanced and emerging economies. These weak external conditions could hinder PIC-11 economies—limiting long-term growth, leaving pandemic-related economic scars largely unhealed, and delaying convergence. 1. In 2024, modest but steady global growth supported the delayed yet sustained recovery of 11 Pacific Island countries (PIC-11) to pre-pandemic output levels.1 Global growth remained at an estimated 2.6 percent in 2024, unchanged from the previous year (Figure 1.1.A). This reflects tepid investment growth amid broadly restrictive monetary policies and moderating consumption growth, partly due to receding savings buffers and diminishing fiscal support. Global growth is projected to edge up to an average of 2.7 percent in 2025-26, as trade growth recovery firms, and broad but measured easing of monetary policy supports activity in both advanced economies and emerging market and developing economies (EMDEs). Figure 1.1 GDP growth A. GDP growth, world, AEs, EMDEs, PIC-11 (percent) B. GDP growth, major PIC-11 trade partners (percent) 10 10 8 8 6 6 4 2 4 0 2 -2 -4 0 -6 -2 -8 -4 -10 2019 2021 2023 2025f -12 2019 2021 2023 2025f China Australia New Zealand USA World AEs EMDEs PIC-11 Source: IMF; World Bank. Note: AEs = Advanced Economies; EMDEs = Emerging Market and Developing Economies. 1. The PIC-11 refers the Federated States of Micronesia (FSM), Fiji, Kiribati, Marshall Islands, Nauru, Palau, Samoa, Solomon Islands, Tonga, Tuvalu, and Vanuatu. 13 2. A subdued outlook and slow growth among major trade partners present challenges for the PIC-11. After robust growth of 2.5 percent in both 2023 and 2024, growth in the United States is projected to moderate to 1.8 percent in 2025 and 2026 (Figure 1.1.B). In China, the structural slowdown is expected to deepen, with growth decelerating from 4.8 percent in 2024 to an average of 4.1 percent in 2025-26, weighed down by slowing productivity, reduced investment, and mounting public and private debt. Although growth in Australia and New Zealand is projected to accelerate to around 2.2 percent on average in 2025-26 after several years of economic weakness, it will still fall short of pre-pandemic levels. 3. The delayed global recovery in trade and tourism is now supporting the PIC-11’s gradual rebound. After stagnating in 2023, global trade is estimated to have increased by 2.5 percent in 2024 and is projected to grow further to 3.4 percent in both 2025-26 (Figure 1.2.A). Commercial services trade was lifted by recovering international travel and a surge in digitally delivered services, with a rebound in services trade supporting activity in the PIC-11. In the first quarter of 2024, the number of international arrivals worldwide reached 97 percent of 2019 levels. Figure 1.2 Global trade and tourism A. Global trade growth (percent) B. International tourist arrivals, 2024H1 compared to 2019 (percent difference) 5 30 2000 - 19 average 4 15 3 0 2 Global -15 1 0 -30 2023e 2024e 2025f MENA Europe SSA LAC EAP Source: Haver Analytics; World Bank. Note: A. e = estimate; f = forecast. Trade in goods and services is measured as the average of export and import volumes. B. EAP = East Asia and Pacific; LAC = Latin America and the Caribbean; MENA = Middle East and North Africa; SSA = Sub- Saharan Africa. 4. Despite the global recovery in tourism and travel, the rebound has been uneven and impacted by lingering scarring effects. As of the first half of 2024, countries in the Asia-Pacific region are still experiencing an 18 percent shortfall compared to pre-pandemic levels (Figure 1.2.B).2 Among the PIC-11, this has particularly affected recovery in Palau, which is heavily reliant on travelers from Asia. The pandemic’s economic impact on tourism-dependent communities in the PIC-11 has been substantial. The outlook for tourism in the Asia-Pacific region through 2025 appears promising, with strong growth anticipated. 5. Global commodity prices, which significantly contribute to inflation in the Pacific region, are stabilizing after a sharp decline that helped reduce global inflation last year (Figure 1.3.A). Between mid-2022 and mid-2023, global commodity prices plummeted by nearly 40 percent. This helped to drive most of the roughly 2-percentage-point reduction in global inflation between 2022 and 2023 (World Bank 2024a). The decline in global commodity prices and global inflation led to a broad-based decrease in inflation across the PIC-11 from mid-2022 to mid-2023. 2. Following severe disruptions during the COVID-19 pandemic, the MENA region experienced the most robust tourism recovery. Dubai, Egypt, Qatar, Saudi Arabia, Turkey, and United Arab Emirates are leading this resurgence, driven by strategic investments and targeted marketing, favorable visa policies, and a strong aviation sector. 14 Figure 1.3 Global commodity prices B. Commodity prices and global growth in 2024- A. Commodity price indexes (Index, 100 = 2022) 25, deviation from 2015-19 averages (percent, percentage points) 170 60 0.6 40 0.4 140 20 0.2 110 0 0 -20 -0.2 80 -40 -0.4 Energy -60 -0.6 50 Agriculture Commodity Copper Gold (RHS) Oil prices Global growth Metals & Minerals 20 Jan-19 Nov-20 Sep-22 Jul-24 Source: World Bank. Note: A. Monthly data in U.S. dollar terms, last observation in July 2024. B. Deviation of the 2024-25 average global growth, nominal commodity index, oil, copper, and gold prices from 2015-2019 averages. GDP growth forecast from the Global Economic Prospects (June 2024) (World Bank 2024a). 6. Since mid-2023, however, the World Bank’s index of commodity prices has remained largely unchanged for most of 2024. Going forward, global commodity prices are projected to decline by approximately 4 percent in 2025 and remain broadly stable in 2026, assuming no further escalation in geopolitical tensions. Despite the recent declines, commodity prices are projected to remain significantly higher over the next few years compared to the average levels seen in the five years prior to COVID-19 (Figure 1.3.B). Elevated commodity prices continue to impact both producers and consumers across the PIC-11. This is evident in the high prices of imported goods and materials necessary for production and consumption, due to the region's limited local production capabilities. 7. Headline inflation is expected to move closer to 2018-19 average levels in both advanced economies and EMDEs over the next 12 months. This will likely narrow the gap between current inflation and 2018-19 averages among the major PIC-11 trade partners (Figure 1.4.A and Figure 1.4. B). After easing to an estimated 3.5 percent in 2024, global inflation is projected to further decline to 2.9 percent in 2025 and 2.8 percent in 2026, which is broadly consistent with average country inflation targets. In most of East Asia, inflation is near central bank targets, surpassing the achievements seen in other regions. Global financial conditions have eased, on balance, since last year, primarily reflecting declines in risk premia. While central banks across major advanced economies have begun lowering policy interest rates, the pace of easing is expected to be gradual. EMDE sovereign risk spreads have declined, but they remain elevated among economies with weak credit ratings. 15 Figure 1.4 Global inflation B. Consumer price inflation difference from 2018-19 A. Consumer price inflation (percent) average (percentage points) 12 6 10 5 4 8 3 6 2 1 4 0 2 -1 -2 0 Australia New United China 2018 2020 2022 2024 2026 Zealand States World AEs EMDEs EAP 2022 2023 2024 2025 2026 Source: IMF; World Bank. Note: AEs = Advanced Economies; EMDEs = Emerging Market and Developing Economies. 16 1.2 Recent Economic Developments and Near-term Outlook in the PIC-11 Economic progress in the PIC-11 remained steady in 2024, with growth slightly exceeding expectations. However, post-pandemic economic drivers are cooling rapidly, leading to a sharp slowdown. By 2025, many PIC-11 economies are expected to return to long-term growth rates, but significant post-pandemic economic scarring will persist. Despite easing inflation, recent cumulative price increases will continue to affect households. 1.2.1 Growth Recent developments 8. Growth in the PIC-11 slowed to an estimated 3.6 percent in 2024, down from 5.8 percent in 2023 (Figure 1.5.A). About half of the PIC-11, including the two largest economies, Fiji and Solomon Islands, are estimated to have experienced slower growth in 2024 compared to 2023. This slowdown is attributed to the diminishing effects of the post-pandemic rebound and the tightening of fiscal and monetary policies in some countries. In the PIC-11, excluding Fiji, growth accelerated from 3.6 percent in 2023 to an estimated 4.1 percent in 2024, driven primarily by the robust performance of tourism and remittances-led economies. Figure 1.5 GDP growth and contributions A. GDP growth, the PIC-11, Fiji, and the B. Contribution to PIC-11 GDP growth (percentage PIC-11 excluding Fiji (percent change) point) 25 15 20 15 10 10 5 5 0 0 -5 -5 -10 -10 -15 -20 -15 2019 2020 2021 2022 2023 2024e 2019 2020 2021 2022 2023 2024e PIC-11 excl. Fiji Fiji PIC-11 PIC-11 Fiji PIC-11 excl. Fiji Source: Haver Analytics; World Bank. Note: e = estimate; p = projection. All data in the report is presented on a calendar year basis for consistency and comparability. For countries with a fiscal year different to the calendar year period, data in a calendar year basis are computed based on the fiscal year’s estimates. The data presented, corresponding to fiscal years, is explicitly indicated as such. 17 9. The overall growth in the PIC-11 for 2024 was 0.1 percentage points stronger than earlier projections and several notable revisions have emerged. Growth in Palau is estimated to be around 3 percentage points weaker than initially expected due to ongoing delays in resuming direct flights from Asia. In Vanuatu, the liquidation of Air Vanuatu has negatively affected economic performance, leading to an almost 2-percentage point downgrade in growth compared to the March projection. Conversely, there have been positive revisions, such as stronger-than-expected recovery in public investment in Tuvalu and higher tourist activity in Samoa, both of which have provided a strong boost to growth. 10. Growth in Fiji is estimated to decline further to 3.1 percent in 2024, slightly below its long-term economic trend. This follows a gradual slowdown from its peak of 20 percent in 2022 to 8 percent in 2023. As a result, Fiji’s contribution to PIC-11 growth decreased from over 80 percent in 2023 to about 50 percent in 2024 (Figure 1.5.B). By May 2024, total tourist arrivals had exceeded 2019 levels by 10 percent (Figure 1.6.A), with visitors from Australia (45.8 percent of total visitors) and New Zealand (21.1 percent) surpassing pre-pandemic levels by about 26 percent and 23.5 percent, respectively, compensating for weaker arrivals from China (Figure 1.6.B). While consumption activity has been robust—supported by higher tourist demand, personal remittances, and improved disposable incomes—investment activity remains weak with a slow uptake in new projects. Figure 1.6 Tourist arrivals in Fiji A. Monthly arrivals (thousands) B. Arrivals by country, January-May 2024 (thousands) 150 200 150 100 Total (% of 2019) 100 50 50 0 0 Oct Apr Jul Mar Jun Jan Aug Nov May Sep Dec Feb Australia NZ US China Other 2020 2021 2022 2023 2024 Share of 2019 Number of visitors Source: Haver Analytics; World Bank. Source: IMF; World Bank. 11. Growth in Solomon Islands—the second largest economy among the PIC-11—slowed to an estimated 2.5 percent in 2024, down from a peak of 3 percent in 2023. Economic activity was previously supported by preparations for national elections, the organization of the Pacific Games, and substantial investments in the energy and transport sectors (including airport upgrades). Additionally, heightened mining activity, particularly at the Gold Ridge mine, had bolstered the construction and services sectors. However, these factors have not been sufficient to sustain higher growth rates and offset a structural decline in logging, leading to a slowdown in Solomon Islands’ economy (World Bank 2024b). 18 12. Tourism and remittances-led countries continued their economic recovery into the second year, with broad-based growth acceleration (Figure 1.7.A).3 This group, including Palau, Samoa, Tonga, and Vanuatu, saw growth rise to an estimated 5.6 percent in 2024, up from 4.6 percent in 2023, significantly above their long-term average. Samoa led the recovery, with growth accelerating to 10.9 percent in 2024, building on a strong rebound of 10.2 percent in 2023, fueled by substantial inflows of Australian and New Zealand tourists and increased remittances. Palau’s growth rebounded to an estimated 9.1 percent in 2024 after a prolonged contraction due to slow tourism recovery in Asia and delays in international flights. Tonga saw a modest growth acceleration to an estimated 1.9 percent in 2024, supported by increased visitor arrivals and ongoing reconstruction efforts, although growth was limited by the destruction of hotel infrastructure from the Hunga Tonga volcano explosion in 2022. Conversely, Vanuatu experienced a slowdown, with growth dropping to an estimated 0.9 percent in 2024 from 2.2 percent in 2023, primarily due to the impact of Air Vanuatu’s liquidation in May, which severely affected the tourism sector (Box 1). 3. The March 2024 edition of the Pacific Economic Update provides a detailed classification of the PIC-11 based on their economic foundations. Fiji and Solomon Islands are placed in separate categories due to their larger populations and economies. The remaining nine countries (PIC- 9) are divided into two sub-groups. The first includes Palau, Samoa, Tonga, and Vanuatu, where tourism and remittances contribute about 41 percent of GDP. The second sub-group includes FSM, Kiribati, Marshall Islands, Nauru, and Tuvalu—sovereign rent-led economies, where fishing and other non-tax revenues make up 30 percent of GDP, while tourism and remittances contribute only about 14 percent. Sovereign rent-led countries also rely significantly on external grants, which make up over 35 percent of GDP. All countries in this group, except for FSM, are either full atoll or predominantly atoll (coral reef) islands. Unlike the tourism-driven nations, these countries use either the U.S. or Australian dollars. During the COVID-19 pandemic, the two groups experienced different economic impacts, with tourism-led economies suffering more severely due to border closures (World Bank 2024c). 19 Box 1. The economic implications of the liquidation of Air Vanuatu Air Vanuatu went into liquidation on May 9, 2024, due to financial difficulties that were exacerbated by maintenance issues, labor shortages, rising costs, and extreme weather disruptions. This resulted in the cancellation of all flights, stranding thousands of passengers. Qantas Airways and other airlines assisted stranded passengers with alternative travel arrangements. Efforts are underway to resume operations after necessary safety and maintenance checks, but no restart date has been set. Several options are being considered, including the resumption of domestic-only operations. The liquidation of Air Vanuatu is expected to significantly decrease economic activity. The airline was a major carrier of international tourists into the country and the only provider of domestic connectivity. This connectivity shock is anticipated to have a substantial effect on growth for 2024 and beyond due to the lag in restoring tourism confidence and expanding capacity. Disruptions in air travel are likely to affect labor mobility and infrastructure development, alongside indirect effects on other industrial sectors. Overall, growth is expected to decelerate in 2024 to 0.9 percent (down from an expected 2.6 percent prior to the liquidation) and continue to lag previous forecasts until 2027 (Figure B.1). The decline in tourism activity will result in widening current and fiscal deficits, and an increase in public debt. The current account deficit is expected to widen substantially from 2.2 percent of GDP in 2023 to 7.4 percent of GDP in 2024 as travel receipts decline. The economic shock will reduce domestic revenue by 6 percentage points of GDP in 2024 compared to 2023, while expenditures remain elevated due to the restructuring costs of the airline. This is expected to result in a large fiscal deficit of 6.7 percent of GDP in 2024, with significant structural deficits over the next few years. To finance these deficits, public debt is expected to increase substantially from 42.6 percent of GDP in 2023 to over 55 percent of GDP by 2027. The recent Joint World Bank/IMF Debt Sustainability Analysis rates Vanuatu’s debt as sustainable but places the country at high risk of both external and public debt distress. Figure B.1 Vanuatu real GDP growth, 2024-26 (percent) 5 4 3 2 1 0 2024e 2025f 2026f Current forecast March 2024 forecast Note: e = estimate; f = forecast. 20 Critical reforms are needed to reduce fiscal risks, strengthen revenue mobilization, and enhance consolidation efforts. Air Vanuatu’s liquidation highlights the risks associated with opaque SOE administration. Strengthening governance practices to increase transparency and accountability in SOEs is essential to mitigate future fiscal risks. To increase revenues, new measures are required to widen the tax base, such as the introduction of income taxes, fishing licensing fees, and higher VAT rates. A careful re-evaluation of expenditures is necessary to reduce non-priority spending, including pausing interim spending measures like increases in public employee compensation and allowances (IMF 2024). 13. Countries that send labor abroad, like Fiji, Samoa, Vanuatu, and Tonga, have continued to benefit from robust remittance inflows.4 In Tonga, remittances totaled about 38 percent of GDP (around US$222 million) in the year leading up to April 2024. In Samoa, remittances are estimated to account for approximately 30 percent of GDP in 2024, while in Vanuatu, they are expected to represent 15 percent of GDP. These countries have benefited from expanded seasonal worker programs in Australia and New Zealand. Compared to pre-COVID levels, the number of workers under the Pacific Australia Labour Mobility (PALM) scheme has increased more than fourfold, reaching over 32,000 workers, or about 3 percent of the labor force across the PIC-11. As of May 2024, Samoa, Tonga, and Vanuatu together accounted for about 81 percent of PALM workers, representing about 14 percent of the labor force in Tonga, 9 percent in Samoa, and 6 percent in Vanuatu (Figure 1.7.B). 14. Aggregate growth in sovereign rent-led countries also accelerated, though more modestly. Growth in this group, which includes FSM, Kiribati, Marshall Islands, Nauru, and Tuvalu, increased from 1.9 percent in 2023 to 3.0 percent in 2024, above their long-term average. Some countries have benefitted from U.S. Compact funds, while others have been experiencing gains due to looser fiscal policies. In the Marshall Islands, real GDP is estimated to have grown by 3.3 percent in 2024, compared to 2.1 percent in 2023. This growth was driven by improvements in the fisheries sector, increased construction activity supported by U.S. Compact transfers, and preparations for the 2024 Micronesian Games. In the FSM, growth rebounded from near stagnation in 2022 to approximately 1 percent in 2024, driven by an increase in public wages and the resumption of infrastructure projects partly benefitting from U.S. Compact funds. In Kiribati, growth accelerated from 4.2 percent in 2023 to an estimated 5.8 percent in 2024. This increase, exceeding the trend, is attributed to a nearly 40 percent rise in public sector wages before the election. Nauru’s growth rebounded to an estimated 1.8 percent in 2024, as Australia’s Regional Processing Center (RPC) returned to operational capacity after temporarily winding down in 2023. Tuvalu’s GDP growth moderated from 3.9 percent in 2023 to an estimated 3.5 percent in 2024. This reduction reflects the diminishing benefits of the December 2022 border reopening, including the resumption of infrastructure projects. 4. Over one-third of the nationals from these countries reside in OECD member states (World Bank 2017). 21 Figure 1.7 GDP growth and seasonal workers A. GDP growth (percent) B. Seasonal workers (percent, thousand) 8 6 4 16 10 2 12 8 0 6 8 -2 4 4 2 -4 - - -6 Kiribati Fiji SLB Nauru Vanuatu Tuvalu Samoa Tonga -8 2019 2020 2021 2022 2023 2024e Tourism and remittances-led PICs Sovereign rent-led PICs Number of PALM workers (RHS) Share of labor force Source: Haver Analytics; IMF; World Bank. Note: e = estimate. Near-term outlook 15. GDP growth in the PIC-11 is forecast to slow further to 3.4 percent in 2025, but it will remain above the historical average for these countries (Figure 1.8.A; Table 1.1). Domestic demand in PIC-11 is expected to remain strong as fiscal consolidation is anticipated to proceed more gradually than initially anticipated (Figure 1.8.B). These forecasts assume that policy uncertainty in Vanuatu will moderate; that the magnitude of any natural disasters is within a typical range; and that no new financial or debt crises develop. Figure 1.8 GDP growth projections A. GDP forecast, PIC-11 (percent) B. GDP growth forecast, Fiji C. GDP growth forecast, Solomon (percent) Islands (percent) 10 20 5 15 4 5 10 3 5 2 0 1 0 0 -5 -1 -5 -10 -2 -15 -3 -10 -20 -4 2026f 2025f 2020 2023 2024e 2022 2019 2021 2022 2023 2024e 2019 2021 2020 2025f 2026f 2026f 2025f 2020 2023 2024e 2022 2019 2021 Source: World Bank staff estimates. Note: e = estimate; f = forecast. Red lines denote 2010-19 average growth. 22 16. The unchanged average growth projection for the PIC-11 in 2025 masks several noteworthy revisions to individual country forecasts. The growth forecast for Vanuatu for 2025 has been downgraded by over two percentage points due to the impact of Air Vanuatu’s collapse, which significantly affected tourism and the fiscal outlooks. This downgrade is partially offset by a 1.6 percentage point forecast upgrade for both Samoa and Palau. The upgrade for Samoa reflects stronger-than expected tourism activity, while Palau’s upgrade is due to a delayed recovery in international flights from Asia. Additionally, growth forecasts for Kiribati and the Marshall Islands have been revised significantly upward. In Kiribati, this adjustment reflects the lasting impact of a surge in public wages, while in the Marshall Islands, it accounts for increased U.S. Compact-related capital spending. 17. GDP growth in both Fiji and Solomon Islands is expected to see a slight uptick in 2025. In Fiji, growth is projected to reach 3.3 percent, aligning with the long-term trend, supported by a gradual rise in tourism capacity and policies aimed at addressing investment bottlenecks. In contrast, Solomon Islands’ growth is projected to increase to 2.9 percent in 2025 but will remain below the long-term trend due to persistent structural constraints. Despite ongoing recovery efforts, these constraints continue to limit Solomon Islands’ economic potential (Figure 1.8.C). 18. Growth in tourism and remittances-led countries is projected to remain significantly above the trend in 2025 (Figure 1.9.A). In Samoa, sustained growth in the tourism sector and strong remittances inflows are expected to bolster the broader economy. However, momentum is expected to gradually slow as the recovery surpasses its peak. Palau is expected to record a strong 11.2 percent growth in 2025. This reflects a bounce- back following delayed post-COVID tourism recovery and a resumption of direct airline routes from Asia. Remittances inflows into the region in 2025 are expected to remain significantly above pre-pandemic levels, bolstered by expanded migration schemes that now include semi-skilled sectors alongside horticulture. 23 Table 1.1 Growth forecast summary (based on calendar year information) Percentage point difference (Real GDP growth at market prices in percent, unless otherwise indicated) from March 2024 projection 2020 2021 2022 2023 2024e 2025f 2026f 2024 2025 PIC-11 -10.8 -2.3 9.9 5.8 3.6 3.4 3.0 0.1 0.1 Fiji -17.0 -4.9 20.0 8.0 3.1 3.3 3.2 -0.5 0.0 Solomon Islands -3.4 2.6 2.3 3.0 2.5 2.9 2.9 -0.3 -0.2 Tourism and -5.8 -2.6 0.2 4.6 5.6 4.0 3.0 1.6 -0.1 remittances-led PICs Palau -5.1 -11.6 -3.7 0.2 9.1 11.2 5.2 -3.2 1.6 Samoa -10.1 -2.3 0.0 10.2 10.9 5.3 3.5 6.6 1.6 Tonga 0.5 0.0 -0.6 1.0 1.9 2.1 2.2 -0.4 0.2 Vanuatu -5.0 -1.6 1.9 2.2 0.9 1.5 2.1 -1.7 -2.4 Sovereign rent-led -0.5 3.2 1.4 1.9 3.0 2.9 2.5 0.3 1.1 PICs Kiribati -0.6 8.5 3.9 4.2 5.8 4.1 3.3 0.2 2.1 RMI 0.2 0.1 -0.2 2.1 3.3 3.9 3.4 0.6 2.0 FSM -0.5 1.8 -0.3 -0.1 0.9 1.6 1.3 -0.4 0.1 Nauru 0.0 4.5 5.8 1.7 1.8 2.0 1.9 0.5 0.1 Tuvalu -4.3 1.8 0.7 3.9 3.5 3.0 2.5 1.7 0.6 Memo item PIC-11 excluding -4.1 0.0 1.1 3.6 4.1 3.5 2.9 0.7 0.2 Fiji PIC-11 excluding -4.5 -1.0 0.5 3.8 4.9 3.7 2.8 Fiji and Solomon Islands Source: World Bank. Note: e = estimate; f = forecast. RMI = Republic of the Marshall Islands; FSM = Federated States of Micronesia. Data and projections are based on the calendar year. For fiscal year information, see Annex 1. World Bank forecasts are frequently updated based on new information and changing global circumstances. Consequently, projections presented here may differ from those in other Bank documents, even if basic assessments of countries’ prospects do not significantly differ at any given time. 24 19. Aggregate growth of sovereign rent-led countries is projected to remain broadly unchanged, at 2.9 percent in 2025, slightly above the long-term average (Figure 1.9.B). However, growth trends will vary significantly across these countries. U.S. Compact countries are expected to experience accelerated growth, with the Marshall Islands and FSM benefiting from U.S. Compact disbursements.5 Specifically, the Marshall Islands is projected to see growth rise to 3.9 percent, while the FSM is expected to grow by 1.6 percent. Nauru is projected to experience a modest uptick in growth in 2025, though this outlook remains highly uncertain. The growth is driven by RPC resource rent revenues and new budget support, both of which are volatile. In contrast, other sovereign rent-led countries will face a slowdown. Kiribati’s growth is anticipated to slow to 4.1 percent as the impact of recent public wage increases diminishes. Tuvalu is also expected to experience reduced growth, projected at 3 percent, as the benefits from the post-COVID rebound wane. Figure 1.9 Pacific real GDP growth projections workers A. Tourism and remittances-led countries (percent) B. Sovereign rent-led countries (percent) 6 4 4 3 2 2 0 1 -2 0 -4 -1 -6 -8 -2 2019 2021 2023 2025f 2019 2021 2023 2025f Source: World Bank staff estimates. Note: e = estimate; f = forecast. Red lines denote 2010-19 average growth. 20. Supported by ongoing economic growth, poverty rates are expected to decline in most of the PIC-11, with the notable exception of Vanuatu (Figure 1.10). To assess the impact of potential risks, simulations were conducted under various economic growth shock scenarios, including growth rates 10 percent, 25 percent, and 50 percent lower than projected, to evaluate their effect on poverty rates. 21. In Fiji, steady economic growth is expected to reduce the poverty rate—measured using the upper- middle-income poverty line (US$6.85 per capita in 2017 PPP)—from 50.7 percent in 2024 to 48.3 percent in 2026. This reduction is projected to be resilient even under scenarios of 10 or 25 percent slower economic growth. Tonga, Kiribati, and the Marshall Islands are also likely to see poverty reductions by 2026, though these gains could slow significantly if economic growth underperforms by 25 percent or more. In contrast, Vanuatu is likely to experience rising poverty levels due to sluggish economic growth, which is not expected to keep pace with population increases. 5. The Compact of Free Association (COFA) agreements approved by the United States on March 9, 2024, will deliver a total of US$6.5 billion in assistance to the three North Pacific countries over the next 20 years starting in FY24. FSM will receive US$3.3 billion, RMI US$2.3 billion and Palau $889 million. 25 Figure 1.10 Poverty outlook and simulations with different growth scenarios, 2019-26 A. Fiji (UMIC poverty line) 70 69.6 Poverty Rate (%) 66.3 60 58.3 50 52.8 50.7 48.5 46.6 40 2020 2021 2022 2023 2024 2025 2026 Scenario: Decrease in GDP pc growth by 10% Scenario: Decrease in GDP pc growth by 25% Scenario: Decrease in GDP pc growth by 50% $6.85 PL (Baseline) B. Tonga (UMIC poverty line) C. Vanuatu (LMIC poverty line) Tonga Vanuatu 22 55 21 21.6 21.5 21.6 50 20.8 Poverty Rate (%) Poverty Rate (%) 20 48.5 45 47.5 19 46.1 19.2 43.8 44.4 18 40 42.4 17.9 39.7 17 35 16 16.7 15 30 2020 2021 2022 2023 2024 2025 2026 2020 2021 2022 2023 2024 2025 2026 Scenario: Decrease in GDP pc growth by 10% Scenario: Decrease in GDP pc growth by 25% Scenario: Decrease in GDP pc growth by 10% Scenario: Decrease in GDP pc growth by 25% Scenario: Decrease in GDP pc growth by 50% $3.65 PL (Baseline) Scenario: Decrease in GDP pc growth by 50% $6.85 PL (Baseline) D. Kiribati (LMIC poverty line) E. Marshall Islands (UMIC poverty line) RMI Kiribati 22 34 20 32 20.8 32.1 Poverty Rate (%) 31.8 31.4 Poverty Rate (%) 18 30 31.3 30.1 16 28 16.5 27.7 14 14.7 26 13.8 25.9 12 24 12.2 10 22 10.8 10.2 8 20 2020 2021 2022 2023 2024 2025 2026 2020 2021 2022 2023 2024 2025 2026 Scenario: Decrease in GDP pc growth by 10% Scenario: Decrease in GDP pc growth by 25% Scenario: Decrease in GDP pc growth by 10% Scenario: Decrease in GDP pc growth by 25% Scenario: Decrease in GDP pc growth by 50% $6.85 PL (Baseline) Scenario: Decrease in GDP pc growth by 50% $3.65 PL (Baseline) Source: World Bank; Poverty and Equity Global Practice. Note: A. The poverty line for lower-middle-income countries (Vanuatu and Kiribati) is US$3.65 in 2017 PPP; the poverty line for upper-middle-income countries (Fiji, Tonga, and Marshall Islands) is US$6.85 in 2017 PPP. Calculations based on EEAPOV harmonization using the most recent household income and expenditure survey (HIES) data for each country. Actual data: 2019. Nowcast: 2020-2023. Forecasts are from 2024 to 2026. Projections use a neutral distribution (2019) with a pass- through rate of 1 based on GDP per capita in constant LCU. The estimates do not capture general equilibrium or substitution and behavioral effects. Additional analyses would be necessary to investigate the potential factors that could help cushion the impact of declining economic growth on the most vulnerable individuals and households. 26 1.2.1 Inflation Recent developments 22. In 2024, inflation decreased across most of the PIC-11, with the median rate falling from 6.8 percent in 2023 to an estimated 4 percent (Figure 1.11.B). This broad-based reduction aligns with the global trend of falling inflation and reflects the region’s heavy reliance on imported commodities. The easing of inflation has helped alleviate cost-of-living pressures for households throughout the region. Despite this, the cumulative price increases from recent years will continue to affect households in 2025. Figure 1.11 Consumer price inflation A. PIC-11 (percent) B. World, EMDEs, SIDS, East Asia, PIC-11 (percent) 14 9 12 10 8 6 6 4 3 2 0 FJI SLB VUT WSM TON PLW KIR NRU RMI TUV FSM 0 Tourism & Sovereign rent-led remittances-led 2020 2021 2022 2023 2024e World PIC-11 EMDE East Asia 2024e 2024 average 2023 Source: IMF; World Bank. Source: IMF; World Bank. Note: e = estimate. Red lines denote median growth for each group. Note: World and EMDE exclude EAP countries. 23. The decline in inflation was widespread among the PIC-11, except for Fiji and Nauru. In Fiji, inflation rose to an estimated 5.2 percent, up from 2.3 percent in 2023, driven by the merger of the 9 percent VAT with the 15 percent rate and increasing import costs and tariffs (Figure 1.12). Despite these pressures, the Reserve Bank of Fiji kept its monetary policy accommodative, maintaining interest rates at 0.25 percent as of June 2024, reportedly due to the transitional nature of this increase. In contrast, inflation in Solomon Islands fell from 4.7 percent in 2023 to an estimated 3.7 percent in 2024, continuing its downward trend from a 2022 spike due to higher import prices. By May 2024, inflation had decreased to 3.6 percent from 4.4 percent in April, driven by lower fuel prices. This decline enabled the Central Bank of Solomon Islands to maintain its accommodative monetary stance. 24. In 2024, tourism and remittances-led countries experienced significant relief from inflation. The median inflation rate fell markedly to an estimated 3.6 percent in 2024, down from 9.3 percent in 2023. Palau and Vanuatu saw the most substantial decreases. In Palau, inflation dropped from 10.8 percent in 2023 to 3.1 percent in 2024, driven by falling global commodity prices and the waning impact of new consumption taxes and utility price hikes from the previous year. In Vanuatu, inflation eased to an estimated 4.2 percent in 2024 from 11.2 percent in 2023, following a period of persistent food price increases and adjustments to CPI weights. Samoa also saw a significant reduction, with inflation falling to an estimated 3.6 percent in 2024 from 7.9 percent in 2023, allowing the Central Bank of Samoa to maintain its accommodative monetary policy stance. In Tonga, inflation decreased to an estimated 3.5 percent in 2024, below the central bank's target rate of 5 percent. 27 25. Inflation also moderated in sovereign rent-led countries in 2024. The median inflation rate for this subgroup decreased to 4.3 percent in 2024, down from 6.8 percent in 2023. Kiribati experienced the largest drop, with inflation falling from 9.3 percent in 2023 to 4.5 percent in 2024. The 2023 increase was driven by a severe drought that impacted the agricultural sector, leading to supply shortages and high freight costs.6 Inflation also eased in Tuvalu, FSM, and RMI, as global commodity prices continued to decline throughout 2024. In Nauru, inflation increased slightly from 4 percent in 2023 to 4.5 percent in 2024, although it remained at relatively moderate levels. Near-term outlook 26. Inflation is anticipated to further ease in the PIC-11 in 2025 and 2026 (Table 1.2). In line with global trends and falling global commodity prices, the median inflation rate is expected to decrease to 3.2 percent by 2026. This trend is expected to be consistent across the Pacific, with inflation in Fiji and Solomon Islands also projected to hover around 3.3–3.4 percent in 2026. However, volatility in global commodity prices due to geopolitical tensions poses an upside risk to this outlook. Table 1.2 Inflation forecast summary (based on calendar year information) 2021 2022 2023 2024e 2025f 2026f PIC-11 median 2 5.5 6.8 4 3.2 3 Fiji 0.2 4.3 2.3 5.2 3.8 3.4 Solomon Islands -0.1 5.5 4.7 3.7 3.3 3.3 Tourism and remittances-led PICs median 2.7 11 9.3 3.6 2.9 2.6 Vanuatu 2.3 6.7 11.2 4.2 2.8 2.1 Samoa 3.1 11 7.9 3.6 3 3 Tonga 5.6 10.9 6.4 3.5 3.2 3 Palau -0.5 13.2 10.8 3.1 2.2 2.2 Sovereign rent-led PICs median 2 5 6.8 4.3 3.4 3.2 Kiribati 2.1 5.3 9.3 4.5 3 2.5 Nauru 2 2.6 4 4.5 4 3.5 Marshall Islands 1.1 3.2 6.8 4.3 3.5 3.5 Tuvalu 6.7 12.1 7.2 3.9 3.4 3.2 Micronesia 1.8 5 6.2 4 3 2.5 Source: Haver Analytics; World Bank. Note: e = estimate; f = forecast. Data and projections are based on the calendar year. For fiscal year information, see Annex 2. World Bank forecasts are frequently updated based on new information and changing global circumstances. Consequently, projections presented here may differ from those in other Bank documents, even if basic assessments of countries’ prospects do not significantly differ at any given time. 6 Elevated air temperatures are associated with more frequent food-related illnesses, the emergence of diseases and pests, reduced crop yields, and stress on livestock, ultimately leading to decreased agricultural productivity. 28 27. Inflation is expected to ease broadly, affecting both tourism and remittances-led countries as well as sovereign rent-led countries. For tourism and remittances-led countries, median inflation is forecast to drop below 3 percent by 2025 and dip further to 2.6 percent by 2026. By then, Palau and Vanuatu could see inflation rates around 2 percent, driven by global commodity trends and easing supply constraints. Samoa and Tonga will also see a continued decline in inflation, with rates falling closer to the Central Bank targets in both countries. In sovereign rent-led countries, inflation is projected to moderate to 3.4 percent on average in 2025, sliding to 3.2 percent by 2026. Kiribati and the FSM are likely to see inflation fall below 3 percent, with the rest of the subgroup staying under 4 percent. Figure 1.12 Consumer price inflation outlook A. PIC-11 plus groups (percent) B. Tourism and remittances-led and sovereign rent-led countries (percent) 8 12 10 6 8 4 6 PIC-11 4 2 Fiji Solomon Islands 2 PIC-excl Fiji 0 0 2021 2022 2023 2024e 2025f 2026f 2021 2022 2023 2024e 2025f 2026f Sovereign rent-led PICs Tourism and remittances-led PICs Source: IMF; World Bank. Note: e = estimate; f = forecast. Lines show medians of country groups. 28. Despite this easing of inflation, the cumulative price increases from recent years will continue to affect households in 2025. The lingering high prices of essential goods and services, such as food, housing, and healthcare, will place a persistent financial strain on families. This sustained burden makes it challenging for households to fully recover from the real income losses they have experienced. Many families will find it difficult to rebuild their savings, meet daily expenses, and invest in future opportunities, thereby prolonging the economic hardship brought about by past inflationary pressures. For example, simulation analysis conducted for this report indicates that a 5 percent increase in inflation is projected to slow poverty reduction in the PIC-11 by 2 to 4 percentage points (Figure 1.13). 29 Figure 1.13 Poverty outlook and simulations with different inflation scenarios A. Upper-middle-income countries B. Lower-middle-income countries Increase in Food 65 Increase in Food 40 Inflation by 5% and Inflation by 5% and 36.4 Non-Food Inflation by 56.1 Non-Food Inflation 5% 55 by 5% 35 Increase in Food Poverty Rate (%) 34.9 Inflation by 0% and 52.5 Increase in Food Non-Food Inflation by 30 Inflation by 0% and 5% Poverty Rate (%) 45 Non-Food Inflation Increase in Food by 5% 25 Inflation by 5% and 32.9 21.8 Non-Food Inflation by 35 Increase in Food 0% Inflation by 5% and 20 $3.65 PL (Baseline) 31.5 Non-Food Inflation 22.7 19.5 25 by 0% 15 $6.85 PL (Baseline) KIR VUT 21.5 15 FJI RMI TON Source: World Bank; Poverty and Equity Global Practice. Note: The poverty impacts were calculated by re-estimating household consumption expenditures using the most recent harmonized data from household income and expenditure surveys (HIES). The estimates assume different scenarios of an increase in food and non-food inflation. The estimates do not capture general equilibrium or substitution and behavioral effects. Additional analyses would be necessary to investigate the potential factors that could help cushion the impact of increasing inflation on the most vulnerable individuals and households 1.2.3 Fiscal and Debt Dynamics Recent developments 29. Fiscal positions among the PIC-11 varied due to differences in economic conditions, fiscal policies, and structural factors (Figure 1.14). Despite this divergence, many countries continued to face fiscal challenges characterized increased spending pressures, and highly volatile non-tax revenues. Over the past two years, several of the PIC-11 have made varying degrees of progress in fiscal consolidation, supported by the gradual phasing out of COVID-19 stimulus measures and improving tax revenue driven by ongoing economic recovery. Additionally, some countries have implemented reforms to mobilize revenue. Due to these fiscal efforts and a continued economic recovery, public debt as a share of GDP has decreased in more than two-thirds of the PIC-11. However, overall progress has been slow. 30 Figure 1.14 Fiscal balances (percent of GDP) A. Fiscal balance in Fiji, Solomon Islands, and tourism B. Fiscal balance in sovereign rent-led PIC-11 and remittances-led PIC-11 15 35 10 20 5 0 5 -5 -10 -10 -15 -25 Fiji SLB Tonga Vanuatu Palau Samoa RMI FSM Tuvalu Kiribati Nauru Sovereign rent-led Tourism and remittances-led 2022 2024 Pre-Pandemic (FY2018-19) 2022 2024 Pre-Pandemic (FY2018-19) Source: IMF Article IV (2023 and 2024); World Bank staff calculation. Note: Data for FSM is based on the latest published IMF Article IV reports. Data for 2023 are estimates. 30. In Fiji, the fiscal deficit has narrowed since 2022. The improvement reflected progress across multiple dimensions, including tax reforms such as realigning the corporate tax rate to 20 percent, implementing stricter controls on public wages, and reducing operating subsidies and capital expenditures. Tax revenue is estimated to have increased in FY24, driven by revenue-enhancing measures including higher rates for value-added tax (VAT), corporate income tax, airport departure tax, water resource tax, and various other duties and excises. 31. Over the past two years, the fiscal positions strengthened in three remittances-led PICs. Both Tonga and Samoa achieved a substantial fiscal surplus in 2024, driven by robust revenue collections and sizable grants.7 In Palau, higher tax revenues were partly due to early gains from tax reform; the Palau Goods and Services Tax (PGST), introduced in January 2023, generated approximately 6.5 percent of GDP in its first year. In contrast, Vanuatu faced a significant decline in domestic revenue following the May 2024 liquidation of Air Vanuatu, resulting in a projected fiscal deficit of 6.7 percent of GDP for 2024. 32. In sovereign rent-led countries, fiscal surpluses have eroded due to lower non-tax revenue and increased spending allocations. In Nauru, phosphate deposits are heavily depleted, and fishing revenues have declined. In FY23, income from RPC-related activities constituted 64 percent of fiscal revenue, or 90 percent of GDP, down from 93 percent of GDP in FY22 (Figure 1.15.A).8,9 The fiscal surplus in Tuvalu and FSM deteriorated due to a decline in highly volatile revenues, such as fishing license fees, along with a significant rise in public wages and salaries (Figure 1.15.B). In RMI, a small surplus declined to a balanced budget as the withdrawal of COVID-related spending coincided with the normalization of donors’ grant revenues. In Kiribati, the fiscal deficit temporarily narrowed in FY23, thanks to favorable fishing activities associated with the El Niño effect which caused warmer-than-normal water temperatures on the eastern side of the Western Central Pacific area (IMF 2023d). However, recurrent spending, particularly on public wages, social protection, grants, and the copra subsidy, remained substantial resulting in a resurgence of fiscal budget deficit in FY24. 7. In January 2023, Samoa raised excise taxes on unhealthy foods, with an expected full-year impact of 0.2–0.3 percent of GDP (IMF 2023b) 8. IMF 2023c. 9. As of June 30, 2023, the Nauru Regional Processing Center (RPC), which was initially slated to go on standby, remains active due to recent arrivals of asylum seekers. 31 Figure 1.15 Revenue (percent of GDP) A. Composition of revenue source in 2023 B. Volatility of non-tax revenue 180 100 25 130 80 20 60 15 80 40 10 20 5 30 0 0 -20 Kiribati Tonga Vanuatu Nauru SLB Palau Samoa Tuvalu Fiji Timor Leste RMI FSM Fiji RMI SLB Kiribati FSM Nauru Palau Tuvalu Tonga Samoa Vanuatu Tourism and Sovereign rent- Tourism and Sovereign rent-led remittances- led remittances- led led Non-tax revenue Standard deviation of revenue (RHS) Grants Sovereign rent Tax revenue Other non-tax revenue Source: IMF Article IV (2023 and 2024); World Bank staff calculation. Note: Data for FSM is based on the latest published IMF Article IV reports. Data for 2023 are estimates. A. Based on the PIC9 PER definition. Sovereign rent includes Fishing license fees (Nauru, Tuvalu, Kiribati, FSM, Marshall Islands), Economic Citizenship Program (Vanuatu), .TV domain (Tuvalu), and RPC revenue (Nauru). B. Based on FY23 estimates. 33. In 2024, public debt levels are estimated to have declined across the PIC-11, with the exceptions of Nauru, Solomon Islands, Palau, and Vanuatu (Figure 1.16.A). In Fiji, public debt declined to 80.6 percent in 2023, down from a peak of 92.8 percent in 2021, reflecting fiscal consolidation efforts. However, it remained 30 percentage points above pre-COVID levels. During the pandemic, Fiji’s public debt surged by over 40 percentage points due to extensive domestic and external borrowing, with external debt making up 55 percent of the increase. This rise was driven by fiscal stimulus measures aimed at protecting vulnerable households and businesses from the effects of COVID-19 and the twin cyclones. In Solomon Islands, public debt rose to 21.7 percent of GDP in 2024 reflecting persistent fiscal deficits. 32 Figure 1.16 General government debt (percent of GDP) A. Public debt B. Development of public debt 90.0 100 80.0 70.0 80 60.0 50.0 60 40.0 30.0 20.0 40 10.0 0.0 20 Fiji Kiribati RMI SLB Nauru FSM Palau Tuvalu Vanuatu Samoa Tonga 0 2020 2023 2026f 2022 2025f 2018 2019 2021 2024e Tourism and Sovereign rent-led remittances-led Fiji SLB Palau Domestic External Total, 2023 Total, 2024 Samoa Tonga Vanuatu C. Sovereign wealth funds 500 400 300 200 100 0 Kiribati Tuvalu Nauru 2021 Latest Source: IMF; World Bank. Note: Data as of: Nauru: Mar 2024; Tuvalu: 2023; Kiribati: 30 Jun 2024. 34. Public debt performance has been mixed among the tourism and remittances-led PIC-11. Samoa has seen a significant decline in public debt, dropping from 43.6 percent of GDP in 2022 to 33.4 percent in 2023, thanks to a large fiscal surplus, ongoing debt repayments, and a sharp increase in nominal GDP. Palau’s public debt continued to rise through 2024 due to the uptake of highly concessional loans but is projected to decline sharply thereafter. The outlook for Vanuatu’s public debt, which increased by an estimated 4.1 percentage points in 2024, has deteriorated, and is projected to remain challenging in the medium-term (Box 1). 33 35. In sovereign rent-led countries, debt has remained relatively stable, ranging between 5 percent and 21 percent of GDP. However, Sovereign wealth funds (SWFs) have been significantly eroded due to higher budget outlays, volatile investment returns, and volatile non-tax revenues (Figure 1.16.C; World Bank 2024c). Kiribati, which has the largest SWF among the PIC-11 both in absolute terms and relative to GDP, has financed its persistent large fiscal deficit through cash reserves and withdrawals from the Revenue Equalization Reserve Fund (RERF). This resulted in a significant reduction of its SWF reserves by more than 100 percentage points, from 456 percent of GDP in July 2021 to 340 percent as of June 2024. Near-term outlook 36. In the near-term, fiscal consolidation is expected to continue in Fiji and accelerate in Solomon Islands. In Fiji, the consolidation path remains intact, despite a temporary increase in expenditures in FY24 due to higher wages for civil servants. In FY25, the fiscal deficit is projected to gradually narrow due to increased tax collections. With ongoing fiscal consolidation efforts, public debt—currently the highest in the region—is projected to stabilize (Figure 1.16.B). In Solomon Islands, the fiscal deficit is projected to narrow in the near- term, reaching 2.8 percent of GDP by 2026. This reduction is expected due to a decline in recurrent expenditure and the normalization of capital spending after the pandemic and election preparations. 37. In tourism and remittances-led countries like Samoa, Tonga, and Vanuatu, the fiscal positions are expected to weaken with the normalization of grant revenues and increases in capital expenditures. Among Pacific peers, Vanuatu is expected to experience the largest deterioration in its fiscal deficit. This is attributed to declining revenue from the Economic Citizenship Program (ECP) and increased spending, including modest transfers, support, and one-off costs from the liquidation of Air Vanuatu, all of which are anticipated to adversely impact the deficit. In Samoa and Tonga, modest fiscal deficits are projected as increased capital expenditures, and a normalization of grants are expected to outweigh the strong domestic revenue collections. By contrast, in Palau, modest fiscal surpluses are expected from FY25 onwards due to an increase in tourism receipts and the full implementation of the tax reform bill. 38. In sovereign rent and grant-led countries, fiscal balances are also projected to deteriorate in 2025. While donor grants are expected to normalize over the medium-term, Kiribati faces an uncertain revenue outlook due to its reliance on weather sensitive fishing license revenues. Additionally, Kiribati is anticipated to record the largest fiscal deficit as a share of GDP in the region in 2024, driven by increased public sector wages despite already high wage expenditures (Figure 1.17.A). 34 Figure 1.17 Wage expenditures and fiscal balance changes (percent of GDP) A. Expenditures on wage and salary B. Change in fiscal balances three years after major events 40 1.5 30 1.0 Pacific average = 19 0.5 20 0.0 10 -0.5 -1.0 0 -1.5 Fiji Kiribati RMI SLB Nauru FSM Palau Tuvalu Vanuatu Samoa Tonga -2.0 Natural disasters Global recessions Tourism and Sovereign rent-led Pacific small states Small states EMDEs excl. small states remittances-led Source: IMF; World Bank. Note: B. Difference in average fiscal balance as a percent of GDP in small states three years after global recessions and a natural disaster resulting in damages of almost 2 percent of GDP compared to year preceding the shock. Based on a sample of up to 34 small states, with four Pacific states for natural disaster impact assessment and nine Pacific states for global recessions impact, and 111 other EMDEs. 1.2.4 Monetary Policy and the Financial Sector Recent developments 39. Since mid-2020, Fiji has kept its policy rate unchanged, maintaining an accommodative stance despite recent price pressures from tax adjustments. In contrast, Solomon Islands has implemented tighter monetary policies since mid-2022 in response to rising inflation. In its March 2024 update, the Central Bank of Solomon Islands (CBSI) continued its previous monetary stance to stabilize inflation within the desired range while supporting growth. 35 Figure 1.18 Central bank policy rates (basis points) 1.0 4.0 0.8 3.0 0.6 2.0 0.4 1.0 0.2 0.0 0.0 2019Q1 2020Q4 2022Q3 2024Q2 Fiji Samoa Vanuatu (RHS) Solomon Islands Tonga Source: Country authorities. Note: For Solomon Islands, the policy rate is based on 28-day Bokolo Bills of CBSI. 40. Central banks in tourism and remittances-led countries with their own currencies (Samoa, Tonga, Vanuatu) continue to maintain accommodative monetary policy. In Vanuatu, although the central bank increased the Statutory Reserve Deposit ratio by 25 basis points in December 2023, monetary policy is still broadly accommodative. In Samoa, the central bank intends to increase its interest rate, which has been near zero since 2008, back to its neutral rate. In Tonga, interest rates continue to be at zero and the Statutory Reserve Deposit ratio at 15 percent (Figure 1.18). 41. Although policy rates in selected PIC-11 are low, monetary policy transmission remains weak. This is largely due to small financial markets, underdeveloped banking sectors, and high reliance on external factors. Additionally, fiscal dominance in these countries renders monetary policy, in particular open market operations, ineffective in reducing liquidity. These challenges limit the effectiveness of traditional monetary tools in influencing domestic economic conditions. Additionally, fiscal dominance, driven by high risk of debt distress and limited fiscal space, further constrains the impact of monetary policy. Near-term outlook 42. Monetary policy is expected to remain stable in the near term, with no major changes anticipated in Fiji, Samoa, Tonga, Vanuatu, and Solomon Islands. Given the expectation of dissipating transitory price pressures and subdued inflation, the central bank in Fiji is anticipated to maintain its accommodative monetary policy throughout 2025. In Solomon Islands, monetary policy is expected to remain stable to ensure that inflation stabilizes within the desired range while also supporting growth. In Samoa, falling inflation is expected to allow the central bank to maintain an accommodative monetary policy while excess liquidity is likely to be absorbed through open market operations. Similarly, in Vanuatu, open market operations are expected to be used to control liquidity and help ease inflation while continuing to aid the economic recovery. In Tonga, the central bank is expected to keep interest rates at zero as inflation is expected to remain below its reference rate. However, the central bank continues to retain flexibility to respond to large shocks. 36 1.2.5 External Sector Recent developments 43. Current account deficits have narrowed substantially in 2024 in both Fiji and Solomon Islands (Figure 1.19). In Fiji, the current account deficit was reduced by half from 15.3 percent of GDP in 2023 to an estimated 7 percent of GDP in 2024—driven by a significant increase in tourism flows. This reduced deficit has helped maintain a robust level of foreign reserves, covering over five months of imports as of March 2024. In Solomon Islands, the current account deficit also narrowed from 15 percent of GDP in 2023 to 12.7 percent in 2024, primarily due to a reduction in the import bill. However, the deficit in Solomon Islands remains significantly above the pre-pandemic average of 4.6 percent, recorded between 2015 and 2019. Figure 1.19 Current account balance, 2023 and 2024 (share of GDP) 10 5 0 -5 -10 -15 -20 Fiji Solomon Islands PIC-11 PIC-11 excl Fiji Tourism and Sovereign rent-led remittances-led PICs PICs Source: World Bank staff estimates. 44. Tourism-led and remittances-led countries exhibit contrasting trends in current account deficits, influenced by country-specific factors. Palau saw an improvement in its large current account deficit, returning to pre-pandemic levels in 2024, primarily due to a delayed recovery in tourism. In contrast, Vanuatu experienced a widening of its current account deficit from 2.1 percent of GDP in 2023 to 7.4 percent of GDP in 2024, driven by a significant decrease in travel receipts following the liquidation of Air Vanuatu. In Tonga, the deficit remained broadly unchanged at around 12 percent of GDP in 2024 due to increased imports for reconstruction spending. Samoa experienced a reduction of its current account surplus in 2024, also largely due to accelerated reconstruction efforts (Figure 1.20). 37 Figure 1.20 PIC-11 current account (share of GDP) 30 20 10 0 -10 -20 -30 -40 -50 Marshall Islands Solomon Islands Kiribati Micronesia Vanuatu Nauru Samoa Tuvalu Palau Fiji Tonga Tourism and remittances-led PICs Sovereign rent-led PICs 2024 2023 2015-19 Source: IMF World Economic Outlook, April 2024; World Bank staff estimates. 38 Figure 1.21 Current account projections (share of GDP) 20 10 0 -10 -20 -30 -40 Fiji Nauru Vanuatu Tonga Micronesia Solomon Islands Samoa Palau Marshall Islands Kiribati Tuvalu Tourism and Sovereign rent-led remittances-led PICs PICs 2024 2025-26 Source: World Bank staff estimates. 47. All tourism and remittances-led countries are expected to see improvements in their current account deficits in 2025-26. In Palau, the gradual resumption of flights and additional planned routes from key markets such as China; Hong Kong SAR, China; Republic of Korea; Macao SAR, China; and Singapore are expected to boost tourism arrivals, helping to improve the current account. In Samoa and Tonga, normalizing economic activity, coupled with strong remittance inflows, is likely to support stable external balances. This positive trend is anticipated to help maintain adequate foreign reserves. In Vanuatu, a recovery in tourism, driven by increased flights from additional carriers and the resolution of Air Vanuatu's issues, is expected to further narrow the current account deficit in the medium-term. 48. Current account balances are expected to remain stable over 2025-26 in sovereign rent-led countries. In Kiribati and the Marshall Islands, large current account surpluses are anticipated to be maintained due to robust fishing license revenues. A small current account surplus is also expected to be maintained in FSM due to development grants and taxes paid by foreign firms. Meanwhile, a modest current account deficit is expected in Tuvalu due to its large import bill. 39 1.3 Medium-term Growth: Substantial Output Losses and Slow Income Convergence Despite a commendable recent rebound, medium-term growth projections for the region remain mixed, with many of the PIC-11 facing subdued expectations. Although output has returned to pre-pandemic levels in most countries, a sluggish medium-term outlook in the PIC-11 suggests that these countries will not make significant progress toward income convergence with advanced economies. Poverty is expected to decline in many PICs, but it will remain persistently high compared to other countries with similar per capita income levels, highlighting a significant challenge in addressing inequality and improving living standards. 49. In the medium term, the PIC-11 will grapple with persistent structural challenges, marked by the scarring effects of the COVID-19 pandemic and a convergence toward low potential growth. The medium-term growth prospects for the PIC-11 have declined from 3.1 percent per year in 2000-19 to 2.7 percent in 2000- 29 (Figure 1.22.A). This can be attributed to the diminishing impact of underlying growth drivers since 2000, particularly in investment, and the escalating frequency and severity of natural disasters and climate change. Investment growth in the Pacific Islands is projected to slow from an average 3.1 percent annually during 2000- 19 to around 1 percent annually from 2020-29 (Figure 1.22.B). Figure 1.22 Potential growth and investment growth (percent) A. Potential growth, baseline scenario B. Investment growth, baseline scenario 6 4.5 5 4.0 3.5 4 3.0 2.5 3 2.0 2 1.5 1.0 1 0.5 0 0.0 EMDE EAP excl. PIC-11 2010-19 2020-29 2010-19 2020-29 China PIC-11 PIC-11 excl. Fiji 2010-19 2020-29 Source: IMF; Kose and Ohnsorge 2024; World Bank. Source: IMF; World Bank. Note: EMDE = emerging market and developing Note: Growth rates for 2024-29 are projections. economies. For EMDE and EAP excl. China, the figure panel shows GDP-weighted averages of production function-based potential growth estimates for 53 EMDEs and four EAP countries. Data for 2024-30 are forecasts. For PIC-11, the panel shows unweighted averages of the five-year ahead growth projection from the World Economic Outlook (Kose and Ohnsorge 2024). 40 50. Growth in Fiji and Solomon Islands is expected to average 3.2 percent and 2.9 percent, respectively in 2026-28 (Figure 1.23). The projected growth in Fiji is just 0.1 percentage points below the long-term average. This reflects expectations of continued economic resilience and the relatively modest lingering effects of the COVID-19 pandemic, thanks to a swift and robust post-pandemic recovery. In contrast, the projected medium- term growth rate in Solomon Islands is about 1.2 percentage points lower than its pre-pandemic decade average, reflecting a sharp slowdown in investment growth. In Solomon Islands, the projected investment growth rate has halved compared to the pre-pandemic decade average, directly impacting income growth and economic potential. Figure 1.23 Medium-term GDP growth (percent) B. Tourism and remittances-led A. PIC-11 groups countries and sovereign rent-led countries 5 3.0 4 2.5 3 2.0 2 1.5 1 1.0 0 0.5 PIC-11 Fiji SLB PIC-11 0.0 excl. Fiji Tourism and Sovereign rent-led and SLB remittances-led PICs PICs 2010-19 2020-25 2026-28 2010-19 2020-25 2026-28 Source: IMF; World Bank. Source: IMF; World Bank. Note: For PIC-11, panel shows weighted average expected Note: Panel shows weighted average expected growth rate from the World Economic Outlook. growth rate from the World Economic Outlook. 51. The medium-term growth projections for tourism and remittances-led countries are slightly stronger than their long-term growth rate (Figure 1.23.B). However, this optimistic projection is tempered by significant permanent output losses. Although the anticipated growth rate is modestly higher, it remains inadequate to fully recover the substantial losses incurred during the pandemic. This is especially true for countries like Samoa, Vanuatu, and Palau, where the economic impact of the pandemic has been particularly severe, and recovery remains challenging. Reflecting the significant impacts of COVID-19 and deteriorating medium-term growth prospects, output losses relative to pre-pandemic trends are estimated to be substantial. These losses have only been partially recovered, with gaps expected to remain in double digits as a percentage of the pre-pandemic trend in 2024-25 (Figure 1.24). 41 Figure 1.24 Measures of real output B. Pre-pandemic output trend vs. A. Output relative to pre-pandemic C. Cumulative output losses, actual and projected, PIC-11 level (Index, 2019 = 100) 2020-2029 (% of 2019 GDP) (billion 2015 constant UD$) 15 0 125 14 -5 115 13 -10 105 12 -15 11 95 10 -20 85 9 -25 75 8 -30 2028 2026 2020 2023 2025 2024 2022 2027 2019 2021 7 PIC-11 Fiji SLB PIC-11 2010 2016 2022 2028 excl. Fiji PIC-11 Fiji Output Trend SLB PIC-11 excl. Fiji and SLB Source: World Bank. Source: World Bank. Source: IMF WEO April 2018; World Note: Index: 2019 = 100. Bank staff estimates. Note: Cumulative output loss refers to the total sum of output losses from 2024 to 2029, assuming the region had not experienced the COVID-19 shock and had maintained trend growth. 52. The aggregate medium-term growth projections for sovereign rent-led countries are lower than their historical long-term growth rates, though there are significant cross-country variations. Among sovereign rent-led countries, medium-term growth projections broadly align with the pre-pandemic decade averages in FSM, Kiribati, and the Marshall Islands. This reflects the expected positive impact from the renewed US Compact agreement, which will be a critical factor for FSM and the Marshall Islands, as it will determine the level of economic assistance committed to these countries. This extension has the potential to create significant fiscal space, offering an opportunity to enhance public investment initiatives. For Nauru and Tuvalu, growth is projected to average 2 percent during the same period, which is approximately half the average growth rate of the decade preceding the pandemic. Tuvalu’s medium-term outlook, which will affect migration, remittances, and development, will be influenced by the 2023 Australia-Tuvalu Falepili Union Treaty. 42 1.3.1 Stalling Convergence: A Critical Measure of Economic Progress 53. The progress of the PIC-11 in narrowing the income gap with advanced economies has significantly stalled, with projections indicating that this trend is likely to continue. The per capita income of the PIC- 11, which once approached 25 percent of the average advanced-economy level, is now projected to stagnate at around 20–22 percent by 2030. This slowdown threatens to widen the already substantial income disparity between the PIC-11 and wealthier nations, raising critical concerns about the long-term economic stability of the region. 54. The average annual GDP growth rate for the PIC-11 was above 3.0 percent in the 2010s. However, this rate is projected to decline to approximately 2.7 percent in the medium term, falling behind the growth rates of many EMDEs. Income convergence is a crucial indicator of economic development, reflecting how quickly developing economies are catching up with wealthier nations in terms of per capita income. For the PIC-11, closing this income gap is vital, not only for economic growth but also for improving living standards, reducing poverty, and building resilience against external shocks. 55. Slow convergence can be attributed to a range of challenges (see Section 2.2)—and the consequences of this stalling convergence are profound. Slower income growth relative to advanced economies will make poverty reduction efforts less effective, potentially exacerbating income inequality within the PIC-11. This could lead to increased social instability and deteriorating living standards, fuel outmigration, and create a vicious cycle of stagnation. A widening income gap can make the PIC-11 less attractive to foreign investors, who often prioritize economies with robust growth potential. Without sufficient investment, these countries may struggle to build the infrastructure and human capital necessary for sustainable development. The economic resilience of the PIC-11 is closely linked to their ability to close the income gap with advanced economies. Without convergence, these countries remain more susceptible to external shocks, such as commodity price fluctuations, global financial crises, and the impacts of climate change. 43 1.4 Risks to Economic Development The primary risk to the outlook for the PIC-11 is prolonged economic stagnation. Persistent weak income growth could lead to deeper reversals in progress, exacerbating existing vulnerabilities. The PIC-11 are particularly susceptible to natural disasters linked to climate change. Weaker-than- expected global growth, geopolitical tensions, fragmentation of trade and investment networks, or prolonged tighter global financial conditions could further deteriorate their prospects. 56. The PIC-11 face numerous external risks, including: • Falling global growth: Weaker long-term global growth could further compound risks for the PIC-11. Global potential growth is projected to fall to a three-decade low of 2.2 percent over the remainder of the 2020s, driven by an aging labor force, slower investment, and weakening productivity. This slowdown can reduce demand for exports from the PIC-11, lower remittance inflows, and decrease tourism revenues— all critical sources of income for these economies. • Geopolitical tensions: Escalating geopolitical tensions, especially in the Middle East and from Russia’s invasion of Ukraine, could disrupt oil supplies and spike food and fuel prices in the PIC-11, especially given their reliance on imported fuel. Increased geopolitical tensions could also lead to currency depreciations, disruptions to international shipping, higher inflation, and rising external debt servicing costs. The volatility in global markets can lead to financial instability, making it more challenging for these countries to secure affordable financing for development projects. • Slowdown in major economies: A sharper-than-expected slowdown in major economies, particularly China and the United States, could severely affect the PIC-11 directly, as well as indirectly through other major trading partners. Slower growth in major economies could weaken global demand and incomes, potentially reducing tourism in the PIC-11. Commodity exporters within the PIC-11, especially Solomon Islands, may also experience decreased demand, particularly given China’s significant role as an importer of various commodities. Reduced global demand can lead to significant revenue losses, affecting trade balances and fiscal stability. This slowdown can also impact foreign direct investment flows, as investors reassess risks and returns in a more uncertain global economic environment. • Tighter global financial conditions: Abrupt tightening of global financial conditions could challenge the PIC-11, especially those with twin fiscal and current account deficits, leading to higher inflation, and increased costs of servicing foreign-currency debt. Higher borrowing costs can constrain government budgets, limiting their ability to invest in essential infrastructure and social programs. This can exacerbate existing economic vulnerabilities and slow down recovery efforts. • Fragmentation of trade and investment networks: Increasing fragmentation could complicate the outlook for the PIC-11, which are often less integrated into global value chains but have concentrated export sectors. Fragmentation can lead to reduced market access, higher transaction costs, and increased volatility in trade flows. This can make it more difficult for these countries to achieve economies of scale and benefit from global trade and investment opportunities, further marginalizing them in the global economy. 44 • Increased outmigration: Outmigration poses significant risks to economic growth in Pacific Island countries by depleting the local labor force, particularly among skilled workers. As people seek better employment opportunities abroad, the loss of human capital can reduce productivity and slow economic development. While remittances from emigrants provide some financial relief, they are often insufficient to offset the long-term impact of reduced labor capacity. 57. Climate change-related disasters pose a significant risk for the PIC-11. The cost of natural disasters, when they do occur, has been around 60 percent of GDP in Vanuatu and 29 percent in Tonga, highlighting their significant impact on livelihoods (World Bank 2024d). Pacific atoll nations—Kiribati, RMI, and Tuvalu—also face considerable risk from climate variability and sea-level rise. An analysis of global recessions and natural disasters since 2000 shows that both types of events can lead to a persistent weakening of fiscal balances and increased debt, relative to GDP, in small states (Figure 1.17.B; World Bank 2024a). For example, large natural disasters are typically associated with a 0.7 percentage point deterioration of the fiscal balance in the year of the shock, with the negative effects persisting over the following two years. 58. One of the key financial sector risks in the Pacific is the decline of correspondent banking relationships (CBRs). Ongoing withdrawal of CBRs is impeding access to the global financial system and, within affected countries, undermining financial inclusion and resilience, including for seasonal laborers reliant on the ability to send and receive remittances. For businesses, withdrawal of CBRs has adverse consequences for access to cost effective financial services needed for trade, investment, and commercial transactions. 59. Heightened policy uncertainty could undermine growth and impede development. Uncertainty regarding fiscal policy and monetary policy, has been shown to effect economic output, consumption, investment, and prices in both advanced and emerging economies. One standard deviation government spending uncertainty shock would decrease real GDP by a cumulative 1 percentage point and marginally increase inflation after two years. One standard deviation real interest rate uncertainty shock would lower real GDP by a cumulative 1.3 percentage points after two years but raise inflation by 0.5 percentage point (World Bank 2023a). Uncertainty regarding policy direction can also create a hesitant investment climate, where businesses delay or cancel planned projects due to unclear regulatory environments and potential policy reversals. This can stifle innovation, reduce job creation, and slow economic diversification efforts. 60. Growth in the PIC-11 is expected to stagnate at a lower rate without sustained international support and comprehensive, holistic reform efforts. A major risk under a low-growth scenario is accelerated migration, which could further reduce their already limited potential output. This labor outflow risks creating a vicious cycle, worsening economic divergence, and increasing reliance on external support, thereby intensifying challenges to achieving sustainable growth. Part 2 discusses the investment landscape in the PIC-11, policies to accelerate investment growth, and how to make investment more productive in order to boost potential growth and reverse economic stagnation. 45 PART 2 Ramping up Investment to Broaden Horizons Although output has returned to pre-pandemic levels in most countries, the PIC-11 are likely to endure permanent and significant output losses. To jumpstart growth, policymakers will need to pursue strategies to generate sustained investment. Fostering investment in high-potential sectors, managing economic volatility, and enhancing investment efficiency will all be important components of a well-designed plan. By tackling key barriers and leveraging global support, the PIC-11 can create a robust investment environment that drives sustainable economic development. 46 2.1 Investment Trends Investment growth in the PIC-11 is expected to be far lower in the 2020s than in previous decades. Moreover, investment growth has long been highly volatile and subject to frequent contractions. Addressing the structural constraints and inefficiencies that contribute to high investment volatility is critical for enhancing economic resilience and achieving development goals in the PIC-11. 61. Investment growth in the PIC-11 is projected to decelerate sharply in the 2020s (Figure 2.1.A).10 From an average of 2.0 percent annually during 2000-09, investment growth accelerated to 4.2 percent in 2010-19. However, it is projected to slow to around 1 percent annually from 2020-29. Excluding Fiji, which accounts for nearly half of the region’s total investment, the slowdown is even more pronounced. Investment growth in the PIC-11 excluding Fiji, averaged 4.1 percent annually in 2010-19, down from 4.7 percent in 2000-09, and is expected to stagnate at just 0.04 percent per year this decade. 62. Investment growth in the PIC-11 has underperformed compared to other EMDEs in recent years. During the COVID-19 pandemic in 2020, the PIC-11 experienced a sharp contraction in investment, averaging around 12.6 percent, while investment in other EMDEs excluding China contracted by 8.4 percent. Although investment growth in the PIC-11 rebounded in subsequent years, the recovery between 2021 and 2023 was, on average, weaker than in other EMDEs (Figure 2.1.B). This underperformance occurred despite a broad-based slowdown in investment growth across EMDEs excluding China, which has been evident since 2010. Investment growth fell from 9 percent in 2010 to 1 percent in 2019, and subsequently contracted in 70 percent of EMDEs in 2020. The recovery of investment has been slower than the recovery following the global financial crisis (World Bank 2023b). Figure 2.1 Investment growth A. Investment growth, by decade (percent) B. Investment growth, 2020-23 (percent) 5 15 4 10 5 3 0 2 -5 1 -10 0 -15 2020 2020 2020 2023 2023 2023 2022 2022 2022 2021 2021 2021 2000-09 2010-19 2020-29 2000-09 2010-19 2020-29 PIC-11 EMDEs excl. IDA PIC-11 PIC-11 excl. Fiji China and IDA Source: Haver Analytics; IMF; World Bank. Source: Haver Analytics; IMF; World Bank. Note: Growth rates for 2024-29 are projections. Note: The panel shows the investment-weighted average Red lines denote 2010-19 average growth. growth rate of investment for the respective groups. Red lines denote 2000-19 average growth. 63. Investment-to-GDP ratios in the PIC-11 are not lagging ratios in other EMDEs (Box 2). Since 2010, investment-to-GDP ratios in the PIC-11 have averaged 23 percent. This aligns broadly with the average ratios observed in EMDEs and small states, though it remains lower compared to those in rapidly growing Asian economies. In Palau, Samoa, and Vanuatu, the ratio is substantially higher, at more than 30 percent. In the largest economies, Fiji and Solomon Islands, investment-to-GDP is lower than the PIC-11 average, however, at less than 20 percent. 10. Unless otherwise stated, investment refers to total (private and public) gross fixed capital formation. 47 Box2. Investment growth and GDP growth in the PIC-11 Between 2000 and 2019, investment growth in PIC-11 economies averaged 3.1 percent per annum. Notably, some island economies registered considerably higher growth rates in investment during this period. For instance, the Marshall Islands experienced average annual investment growth of approximately 19 percent, Solomon Islands nearly 13 percent, and Vanuatu around 8 percent. Nevertheless, while increasing investment is essential for economic growth, it must translate into productive capital accumulation and be utilized efficiently to drive sustainable growth (World Bank 2024d). Despite these high investment growth rates, GDP growth remained modest. Over the same timeframe, the Marshall Islands recorded an average annual GDP growth of 2 percent, Solomon Islands 2.4 percent, and Vanuatu 2.1 percent. In comparison, EMDEs (excluding IDA countries) have averaged 3.9 percent annual investment growth since 2010, alongside 3.2 percent GDP growth. The correlation between investment growth and GDP growth in PIC-11 economies is markedly lower than in other EMDEs (Figure B.2.A). Historically, investment has been more closely associated with GDP growth when it has been sustained over time and supported by macroeconomic stability, robust institutions, and elevated levels of human capital (Stamm and Yu 2024; Bakker et al. 2024). The incremental capital-output ratio (ICOR) provides a complementary perspective on investment efficiency within the PIC-11. On average since 2010, for EMDEs excluding China and IDA countries, approximately seven dollars of investment have been required to generate one additional dollar of GDP. For IDA countries, the ratio improves to six dollars per additional dollar of GDP. Among the PIC-11, only Fiji and Solomon Islands exhibit similar efficiency levels, with ICORs of six and seven, respectively (Figure B.2.B). In contrast, other island economies display significantly higher ICORs, with Samoa reaching a ratio of 47 due to prolonged periods of high investment coupled with minimal GDP growth. Investment contributes to economic growth through augmenting the productive capital stock (Kose and Ohnsorge 2024). The weak correlation between investment growth and GDP growth in PIC-11 economies is likely due to disaster exposure. A critical factor in fully understanding this weak correlation is the availability and quality of data. Comprehensive data on public and private investment, particularly granular information on investment types and capital stock, are essential for analyzing the specific challenges facing the PIC-11. Improved data availability would enable more refined assessments of investment efficiency and facilitate more targeted policy recommendations. Investment outcomes can be measured through various lenses, including the quantity of resulting capital stock, indicators of capital quality, and estimates of capital utilization (Kapsoli, Mogues, and Verdier 2023). Disaggregating public and private investment is also essential, as public investment has been shown to be less efficient in many developing economies (Herrera and Ouedraogo 2018). The lack of capital stock data in the PIC-11 could be addressed by employing proxy indicators that correlate strongly with capital stock (Warner 2024). 48 Figure B.2 Investment growth, GDP growth, and capital-output ratio A. Correlation between investment B. Incremental capital-output ratio in the growth and GDP growth PIC-11 10 12 60 Incremental capital output ratio 10 8 8 40 6 GDP growth 6 4 4 20 2 2 0 0 0 KIR SLB RMI FJI WSM (RHS) (RHS) (RHS) (RHS) PLW VUT TON 0 10 20 30 PIC-11 EMDEs IDA Investment growth IDA EMDEs excl. CHN and IDA Source: International Monetary Fund; Haver Economics; World Bank. Note: FIJ = Fiji; FSM = Micronesia; KIR = Kiribati; RMI = Marshall Islands; NRU = Nauru; PLW = Palau; SLB = Solomon Islands; TON = Tonga; TUV = Tuvalu; VUT = Vanuatu; WSM = Samoa. A. Panel shows the average investment growth rate and GDP growth rate for EMDEs, IDA countries, and eight Pacific Islands from 2000-19. Countries with negative investment growth are not shown. B. Bars show the average incremental capital-output ratio for the Pacific Islands since 2010 until the latest available year. Lines show the ICOR for the respective groups. 64. One defining feature of investment in the PIC-11 is high volatility; the region has long experienced pronounced fluctuations in investment growth (Figure 2.2.A). The longest period of positive aggregate investment growth in the PIC-11 from 2000 to 2024 has been three years, compared to nearly eight years for other EMDEs on average. Among the PIC-11, Vanuatu has faced the most frequent declines between 2010 and 2024, with ten years of negative investment growth. The Marshall Islands and Palau have experienced eight years of negative growth. Moreover, the magnitude of investment contractions tends to be large (Figure 2.2.B). On average across eight PIC-11 countries, nearly three-quarters of contractions were more than 5 percent, and half were more than 10 percent. 49 Figure 2.2 Investment volatility A. Investment growth (percent) B. Number of investment contractions, 2010-24 Percent Count 40 12 30 10 20 8 10 6 0 -10 4 -20 2 2000 2008 2006 2004 2002 2020 2022 2010 2018 2016 2014 2012 -30 0 FJI KIR RMI PLW SLB TON VUT WSM PIC-11 IDA EMDEs excl. CHN and IDA Number of contractions exceeding 10% Number of contractions Number of contractions exceeding 5% Source: International Monetary Fund; Haver Economics; World Bank. Note: FIJ = Fiji; RMI = Marshall Islands; PLW = Palau; SLB = Solomon Islands; TON = Tonga; TUV = Tuvalu; VUT = Vanuatu; WSM = Samoa. A. Lines show the investment-weighted average growth rate of investment for the respective groups. PIC-11 sample includes Fiji, Solomon Islands, Palau, Samoa, Tonga, Vanuatu, Kiribati, Marshall Islands. B. Bars count the number of annual investment contractions at the indicated thresholds. 65. While detailed investment data by public and private sectors is limited, indirect estimates reveal significant contrasts across the PIC-11. From 2000 to 2019, private investment in Fiji accounted for about 70 percent of total investment, while public investment increased from 30 percent of total investment between 2000 and 2013 to nearly 50 percent by 2019 (Figure 2.3.A). Although private investment growth had already slowed before the pandemic, it was offset by a rise in public investment, often financed through borrowing, leading to a sharp increase in public debt, especially since 2020 (Figure 2.3.B). Before the recent sharp increase, public investment in Fiji averaged less than 4 percent of GDP between 2005 and 2012. By 2019, it had risen to 8 percent of GDP. In comparison, public investment in EMDEs averaged 6 percent of GDP from 2010 to 2022, despite similar overall investment levels relative to GDP, which have been around 20 percent (World Bank 2024d). 50 Figure 2.3 Investment and public debt, Fiji A. Public and private investment (percent of GDP) B. Investment and public debt (percent of GDP) 70 12 25 60 10 20 50 8 15 40 6 30 10 4 20 10 2 5 0 0 0 1998 2009 2020 2000-09 2010-19 Public debt Private investment Public investment (RHS) Private investment Public investment Source: Haver Analytics; IMF; World Bank. Note: B. Average 2019-23. Red line shows PIC-11 median investment. 66. In sovereign rent-led PIC-11 economies, where the public sector drives growth, investment is dominated by public flows (Figure 2.4.A). This dominance reflects their economic reliance on rents, including foreign aid, resource extraction, licensing fees, and lease agreements. These dependencies arise from limited opportunities for income generation, compounded by greater remoteness, smaller size, and more pronounced geographic dispersion compared to other PIC-11 economies (Figure 2.4.B). Indirect estimates suggest that the private sector plays a more significant role in tourism and remittances-led economies, although detailed data is lacking. Figure 2.4 Public investment and income sources A. Public investment (percent of GDP) B. Income sources (percent of GDP) 40 120 30 80 20 40 10 0 Fiji Solomon Isl. RMI Nauru FSM Tonga Vanuatu Palau Samoa Tuvalu Kiribati 0 FSM SLB Vanuatu Tonga Nauru Palau Samoa Kiribati Tuvalu Fiji RMI Tourism & Tourism and Sovereign rent-led Sovereign rent-led remittances-led remittances-led Tourism & Remittances Sovereign rents Grants Source: Haver Analytics; IMF; World Bank. Note: A. Average 2019-23. Red line shows PIC-11 median investment. B. 2009-19 averages for most countries or average data for the available years when some datapoints are missing; Sovereign rents includes fishing revenue and other non-tax revenue. 51 67. Foreign direct investment (FDI) trends in the PIC-11 reveal a varied landscape. Significant investments are concentrated in Fiji, Solomon Islands, and two tourism and remittances-led countries, Palau and Vanuatu (Figures 2.5.A). Sovereign rent-led countries generally experience limited FDI inflows due to geographic isolation and smaller market sizes (Figure 2.5.B). Overall, FDI inflows have been influenced by global economic conditions and sector-specific opportunities. Recently, only Palau has seen a notable increase in FDI, similar to the trend observed in the Maldives. In contrast, FDI has declined in most other PIC-11 countries, including Fiji and Solomon Islands, and has diminished further in smaller PIC-11 nations from already low levels. Figure 2.5 Foreign direct investment A. Foreign direct investment, Fiji, Solomon B. Foreign direct investment, tourism and Islands, and Maldives (percent of GDP) remittances-led and sovereign rent-led PICs (percent of GDP) 14 20 12 15 10 10 8 6 5 4 0 Kiribati RMI Palau Samoa Tonga Vanuatu 2 0 Fiji SLB Maldives Tourism and remittances-led Sovereign 2000-09 2010-19 2020-22 rent-led 2000-09 2010-19 2020-22 Source: Haver Analytics; World Bank. Note: Net inflows. 52 2.2 Barriers to Productive Investment The PIC-11 face significant barriers to productive investment, including distorted incentives that lead to resource misallocation and high infrastructure costs. They also contend with substantial volatility from environmental vulnerabilities and weak fiscal buffers. Additionally, barriers to private investment arise from insufficient coordination and a lack of resources. This section explores these critical barriers and outlines the necessary actions to support productive and sustained investment growth in the PIC-11. 2.2.1 What is Limiting Investment? Underinvestment in high-potential sectors 68. The agricultural sector represents a substantial portion of output in some of the PIC-11 but is often focused on low-return products. In the PIC-11, agriculture accounts for about 16 percent of GDP and employs a significant portion of the population. In contrast, it makes up only 3 percent of GDP in small states excluding Pacific islands small states (Figure 2.6.A). The highest shares are in Solomon Islands, at over 30 percent, and Vanuatu, at around 20 percent. Fiji, the region’s largest economy, has agriculture contributing about 10 percent to its GDP. In many PICs, though, agricultural production is largely subsistence farming and low-value export crops. In Kiribati, for example, output is highly dependent on heavily subsidized copra production (World Bank 2023c).11 Lack of vertical integration in agriculture, in part due to insecure land tenure, limits investment opportunities and increases vulnerability to global economic shocks and climate change. Limited technological innovation creates significant gaps between actual and potential agricultural productivity. Figure 2.6 Agriculture, forestry, and fishing sector and marine protected areas A. Agriculture, forestry, and fishing value B. Marine protected areas (percent of territorial added (percent of GDP) waters) 92.7 35 30 20 25 20 15 15 10 10 5 5 0 0 remittances Fiji SLB rent-led Sovereign states Kiribati Small Samoa Palau SLB Tonga Fiji Tourism -led and World Small states PIC-11 Source: Haver Analytics; World Bank. Note: Orange lines show average for small states excluding Pacific island small states. 11. The copra subsidy has also narrowed the economic base, increased exposure to natural disasters, and crowded out other crops that could improve nutrition. 53 69. Despite their extensive ocean territories—encompassing some of the world’s largest exclusive economic zones (EEZs)—many PICs have yet to fully capitalize on the blue economy. Among the PIC- 11, only Kiribati and Palau have committed significant portions of their territorial waters to marine protected areas (MPAs). Palau leads with one of the largest marine sanctuaries in the world, covering over 92 percent of its territorial waters (Figure 2.6.B). In contrast, most other PIC-11 countries are still in the early stages of establishing MPAs. This is below the global average of 11.5 percent and the 6 percent average for small states (excluding Pacific islands). 70. The potential of the blue economy—sustainable fishing, aquaculture, marine biotechnology, and other ocean-based industries—is vast. It offers avenues for economic diversification, sustainable development, and poverty alleviation. Traditional fishing practices dominate many PICs, with limited development of high- value sectors like aquaculture and marine biotechnology. The management of marine resources suffers in many countries from inadequate regulatory frameworks and enforcement capabilities, leading to overfishing and environmental degradation. Moreover, the development of the blue economy is constrained by inadequate infrastructure, limited technological expertise, and restricted access to global markets—factors that are crucial for scaling up these industries (see Annex 3). 71. The tourism sector in the PIC-11 struggles to attract investment due to a dated system of incentives and regulations that restrict growth and adaptability. This outdated framework includes rigid licensing requirements, limited tax incentives, and inadequate support for sustainable tourism initiatives, discouraging both local and foreign investment. Consequently, the sector fails to evolve in response to contemporary market demands, such as eco-tourism and digital marketing strategies. Tourism activity is heavily concentrated in specific geographical areas, with over 80 percent of Samoa's tourism centered around Apia and nearby beaches (Samoa Bureau of Statistics 2023). Similarly, in Vanuatu, tourism is largely focused on Port Vila and Efate, leaving rural and remote areas with minimal tourism income. This concentration not only restricts the distribution of economic benefits but also increases vulnerability to external shocks; for example, tourist arrivals in Port Vila declined by 40 percent following Cyclone Pam in 2015. Moreover, climate change and environmental degradation further limit investment opportunities. In Solomon Islands, rising sea levels erode beaches and contaminate freshwater aquifers, while coral bleaching in Fiji and Palau threatens popular diving and snorkeling attractions. These challenges underscore the need for a more flexible regulatory environment that can attract investment and enhance the resilience of the tourism sector in the PIC-11. 72. Remote locations, technological gaps, and a lack of information about environmental impacts are hindering the sustainable development of the mining sector. There is potential for PICs to develop deep-sea mining but miscalculating the impacts or proceeding with development before the impacts are well understood could generate significant, potentially irreversible damage to the blue economy. Remote locations and the high costs of developing essential infrastructure significantly impact the mining sector’s ability to operate efficiently. These limitations raise transportation and construction costs, thereby affecting competitiveness and investment attractiveness (World Bank 2021a). Additionally, the PIC-11 often lack access to modern technology and skilled labor necessary for implementing sustainable mining practices (IMF 2019a). Infrastructure deficiencies 73. Poor infrastructure increases operational costs for businesses, reduces the efficiency of trade and logistics, and holds back investment. The PIC-11 are affected by challenges linked to transportation, port facilities, and airport capacities, which hinder economic diversification, limit tourism potential, and impede overall regional development. Underinvestment in critical infrastructure—such as transport, energy, and telecommunications—has led to high operational costs. These deficiencies, which influence various aspects of economic activity and exacerbate existing vulnerabilities, are particularly detrimental to private investment which relies on efficient infrastructure to reduce costs and ensure smooth business operations. 54 74. The poor condition of major roads in PICs limits the ability to transport goods and people efficiently, leading to increased transportation costs and delays. In Fiji, for example, despite the relatively well-developed tourism sector, road and transportation networks are inadequate, particularly in rural and remote areas. The poor condition of rural roads limits access to key tourist destinations, thereby reducing the potential for further investment in the tourism industry. Major roads in several PICs—for example, key roads on the main island of Pohnpei in FSM—are frequently impassable during heavy rains due to poor construction and maintenance. This situation discourages potential investors and complicates local business operations (World Bank 2023d). In Vanuatu, the road network is fragmented, with limited connectivity between rural areas and major economic hubs. This lack of reliable transportation infrastructure impedes the movement of agricultural products from rural farms to urban markets and reduces the potential for investment in machinery and equipment. 75. Ports in the PIC-11 are outdated and unable to handle an increasing volume of cargo—limiting trade and economic activity. For instance, in Fiji, the Port of Suva, which handles most the country’s cargo, has been operating beyond its design capacity. The port's congestion and inefficiencies in cargo handling is leading to delays, increased shipping costs, and logistical challenges, which can deter foreign investment and trade (World Bank 2023e). Ports in Solomon Islands (Honiara) and Vanuatu (in particular Luganville and Tanna) struggle with limited capacity and outdated infrastructure, leading to increased transaction costs and delays for businesses reliant on imports and exports. These delays have been a significant deterrent to investment in tourism and trade. 76. Airports are vital for tourism and international connectivity, yet many PICs face limitations in airport infrastructure that constrain their ability to attract tourists and facilitate international trade. For example, in Samoa, the Faleolo International Airport is constrained by its limited capacity, handling only about 1.2 million passengers annually, while tourism arrivals have been increasing steadily.12 The airport's inability to accommodate more flights and passengers restricts the growth of the tourism sector and limits the potential for increased visitor numbers (Samoa Airport Authority 2023). In Palau, the Roman Tmetuchl International Airport faces similar issues, with facilities that are outdated and unable to handle the increasing number of international flights. This limitation affects the country's ability to capitalize on tourism opportunities and expand its international connectivity. As a result, the tourism industry experiences bottlenecks, reducing the attractiveness of Palau as a destination and limiting its economic benefits from tourism. 77. Energy-related infrastructure challenges are a significant barrier to private investment, with businesses often citing unreliable power supply as a major constraint to their operations (Box 3). In Samoa, the country's energy infrastructure is particularly problematic, with electricity costs among the highest in the world, averaging US$0.40 per kilowatt-hour. The high cost, coupled with frequent power outages—estimated at 12– 15 per year—makes it difficult for businesses to operate efficiently. In Solomon Islands, inadequate energy infrastructure has been a major impediment to investment, particularly in rural areas where access to electricity is limited. Approximately 85 percent of the population lacks access to reliable electricity, making it difficult for businesses to operate efficiently outside of the capital, Honiara. The Solomon Islands Electricity Authority estimates that it would require an investment of approximately US$100 million to expand the country’s energy infrastructure to meet growing demand. This lack of reliable energy supply has deterred investment in sectors such as agriculture and manufacturing, which are vital to the country’s economic diversification efforts. 78. Reliance on imported fossil fuels for electricity generation remains high. This is particularly evident in Palau and the Marshall Islands, where fuel imports account for 13 percent and 12 percent of GDP, respectively (Figure 2.7.A). Renewable energy development is uneven across the PIC-11. Despite significant potential for renewable energy development from abundant solar, wind, and ocean resources, renewables accounted for only 10 percent of the energy mix in Tonga and 15 percent in Tuvalu as of 2022 (Figure 2.7.B; IRENA 2023). The limited progress of small Pacific countries in capitalizing on the potential of the energy transition has constrained investment growth, as the high cost and unreliability of traditional energy sources continue to deter businesses. 12. Despite Faleolo International Airport’s capacity constraints, factors like efficient operations, seasonal demand, future planning, and alternative entry points enable a steady increase in tourism without surpassing capacity limits. 55 Figure 2.7 Fuel imports and share of renewables in electricity capacity and production A. Fuel imports, 2017-18 (percent of GDP) B. Share of renewables in electricity capacity and production, 2022 (percent) 14 60 12 10 40 8 6 4 20 2 0 0 Fiji RMI Fiji SLB FSM Kiribati SLB Nauru Palau FSM Tuvalu Nauru Tonga Palau Samoa Tuvalu Vanuatu Tonga Samoa Kiribati Vanuatu Tourism and Sovereign rent- Tourism and Sovereign rent- remittances-led led remittances-led led Capacity Production Source: ADB (2021a). Note: Orange lines show average for PIC-11. 56 Box 3. The energy sector in PICs at a glance Total installed electricity capacity in the PICs reached about 757 MW in 2022, of which 59 percent was generated from fossil fuels and 41 percent from renewables (IRENA 2024). Fiji has the largest installed capacity, with 396 MW in 2022. Some smaller countries, including Kiribati and Tuvalu have installed capacities below 10 MW. The share of renewables in power production grew by 54 percent, between 2010 and 2022. Eighty percent is generated from hydropower, 12 percent from solid biofuels, 6 percent from solar PV (photovoltaic),13 and 1.4 percent from onshore wind. Despite rising electricity generation, PICs continue to face issues with reliability and affordability of supply. As of 2022, about 89 percent of the population in the PIC-11 had access to electricity, leaving about 300,000 individuals unserved (World Bank 2024a). The high cost of electricity, largely due to dependence on imported fossil fuels, poses a major challenge, especially for low-income households and small businesses. Since 2010, per capita electricity consumption has increased in most PICs. Exceptions include Kiribati and Vanuatu, which have experienced a plateau, possibly due to their small economies or slow economic growth, and Solomon Islands, where consumption has decreased, possibly resulting from demand-side and energy efficiency strategies driven by the high electricity prices. A significant investment gap in the power sector hinders PICs from achieving sustainable development and decarbonization targets. Although most PICs have set ambitious targets for renewable energy projects, the pace of implementation has been slower than anticipated. To bridge the gap in the power sector, an estimated US$870 million in annual investment is necessary across the PICs, including PNG, by 2030. Current funding sources, comprising public sector funds, private investments, and donor contributions, are expected to meet only 27 percent of these investment needs, resulting in an annual shortfall of about US$630 million (World Bank 2022c). PICs have access to several international funding mechanisms designed to support energy sector development, with a focus on clean energy and climate resilience. Bilateral and multilateral donors have been providing financing to PIC governments for renewable energy development, decarbonization, energy access, smart grid, capacity building and, to a lesser extent, resilience efforts. Notably, the Asian Development Bank (ADB) and US Agency for International Development (USAID) function as a key financier for energy projects in PICs. The World Bank has also substantially boosted its funding for the energy sector, focusing on in-depth studies, business development, just-in-time advisory, and capacity building programs for client countries. Several regional initiatives are working to focused on address collective challenges and promote regional integration in energy projects. The Pacific Community (formerly, South Pacific Community or SPC) and the Pacific Power Association (PPA) mobilize regional financing, bringing together domestic stakeholders and development partners. The SPC manages a regional energy program and serves as the leading coordinating agency on energy issues at the ministerial level. The PPA provides support to power utilities across the region. Along with them, the Pacific Regional Infrastructure Facility (PRIF) approved US$0.5 million to support technical assistance activities in the energy sector. The Pacific Renewable Energy Investment Facility (PREIF) has recently enhanced its coordination of investments from the ADB and development partners by approving approximately US$700 million to finance numerous small-value renewable energy projects (ADB 2021b). 13. This technology converts sunlight directly into electricity using solar panels. 57 79. Digital infrastructure remains underdeveloped across most of the Pacific. Internet access is uneven. About 70 percent of the population uses the internet in the median PIC-11 as of 2022. This is an improvement from five years before but still lower than in other small states (Figure 2.8.A.). The PIC-11 face connectivity challenges at both point of entry and within their borders. Several countries (Kiribati, Nauru, and Tuvalu) are not yet connected to submarine fiber-optic cables, leaving them vulnerable to disruptions in satellite service. Upgrading intra-country networks is complicated by geographic obstacles and insufficient electrification. 4G mobile phone networks, which are widely used for internet access, cover only 40 percent of the population in the median PIC-11. This is half the coverage in other small states and developing countries. Bandwidth is generally poor, with internet download speeds in the bottom 30th percentile of all developing countries. The cost of broadband service has fallen sharply in Pacific Island economies since the mid-2010s. However, both mobile and fixed broadband services remain more expensive compared to other small states and developing countries. Fixed broadband service costs about 11 percent of monthly gross national income (GNI) per capita, more than five times the recommended benchmark of 2 percent (Figure 2.8.B). Figure 2.8 Internet access and cost of internet connectivity A. Individuals using the B. Cost of internet connectivity (percent internet (percent) of monthly GNI per capita) 15 100 80 10 60 40 5 20 0 0 2017 2022 2017 2022 Fiji Kiribati SLB Nauru FSM Tuvalu Vanuatu Samoa Tonga Data-only mobile Fixed-broadband broadband basket Internet basket Tourism and Sovereign rent-led remittances-led PIC-11 Developing economies PIC-11 excl. Fiji Target Source: International Telecommunication Union; World Bank. Note: A. Data are for 2021. The yellow line shows average for small states, which excludes PIC-11. B. The price baskets are for 2 GB of data usage per month for mobile broadband and 5 GB for fixed broadband. The target cost is 2 percent of monthly GNI per capita. Bars show medians in each country group. 2.2.2 What is Contributing to Investment Volatility? 80. PICs are highly susceptible to natural disasters yet lack the infrastructure to manage these events effectively. Natural disasters, some of which are exacerbated by climate change, are estimated to cost PICs approximately 1.5 percent of their GDP annually (Figure 1.5.A; World Bank 2022b). The fiscal cost of severe natural disasters is typically much higher, at 14–21 percent of GDP over three years (IMF 2022a). Vanuatu, for example, experienced significant development setbacks due to Cyclone Pam in 2015, which forced the diversion of funds from planned infrastructure projects to immediate recovery efforts, such as rebuilding schools and housing (World Bank 2016). Similarly, Cyclone Winston in 2016 caused damage to Fiji, equivalent to about 20 percent of the country’s GDP—resulting in funds intended for infrastructure development being redirected to emergency relief and reconstruction. This clearly demonstrates how recurrent natural disasters undermine investment stability and economic growth (ADB 2017a). 58 81. Limited fiscal and external reserves in some PICs exacerbate investment volatility, undermining the ability to manage economic shocks (Figure 2.9.B). After Cyclone Gita in 2018, Tonga faced significant financial strain due to depleted reserves and high reconstruction costs. Tonga’s fiscal reserves were well below the recommended levels, impeding the country’s ability to respond to economic shocks and invest in long-term projects (IMF 2020a). Palau faces similar challenges, with its fiscal reserves insufficient to absorb external shocks or invest in infrastructure. Figure 2.9 Average cost and frequency of natural disasters and official reserves A. Average cost and frequency of natural disasters B. Official reserve assets (percent of GDP) 30 16 400 350 12 20 300 8 250 10 200 4 150 100 0 0 50 Fiji Palau* RMI Tuvalu* FSM Kiribati* SLB Tonga Vanuatu Samoa 0 Kiribati Fiji RMI Nauru Vanuatu SLB FSM Palau Samoa Tonga Tourism and Sovereign rent-led remittances-led Average damage cost per year of event (% of GDP) Tourism and Sovereign rent-led Number of events between 2011 and 2022, RHS remittances-led Source: EM-DAT (database); World Bank. Source: IMF; World Bank. Note: Frequency is total number of natural disasters Note: Latest data as of 2023 for Nauru, Palau, and between 2011 and 2022. Average cost of natural Solomon Islands; 2021 for Tonga; FSM does not have disasters per year as percent of GDP. cost is not official reserve; and 2022 for the rest. available for Palau, Kiribati, Tuvalu, and Nauru. Natural disasters include droughts, storms, floods, extreme temperatures, earthquakes, volcanic activity, and wildfires. Sample period is 2011-22. 82. Limited fiscal space and insufficient human capital hinder the effectiveness of public investment in the PIC-11. When governments have sufficient fiscal space and manageable debt levels, they can foster private sector confidence by avoiding distortionary taxes and inflationary financing, which support growth and private investment (IMF 2020b). Conversely, high debt levels and limited fiscal space can create economic uncertainty and reduce private sector confidence, impeding investment and growth (World Bank 2021b). The Debt Sustainability Analysis (DSA) conducted by the World Bank and IMF indicates that many PIC-11 are at high risk of debt distress, underscoring the need to address how constrained fiscal space affects the effectiveness of public investment and its ability to drive economic development (Table 2.1; Pacific Islands Forum 2022). At the same time, lack of public investment management capacity in PICs contributes to high volatility of public investment. 59 Table 2.1 Evolution of Debt Sustainability Analysis (DSA) risk ratings LIC-DSA 2015 2016 2017 2018 2019 2020 2021 2022 2023 Kiribati H H H H H H H H H Marshall H H H H H H H H H Islands Micronesia H H H H H H H H M Samoa M M H H H H H H H Tonga M M M H H H H H H Tuvalu H H H H H H H H H Vanuatu M M M M M M M M H Solomon M M M M M M M M M Islands MAC-DSA 2015 2016 2017 2018 2019 2020 2021 2022 2023 Fiji S S S S S S S S S Palau S S S S S S S S S Nauru n/a n/a n/a n/a n/a U S S S Source: IMF; World Bank. Note: Colors indicate: Green – Low risk of debt distress; Orange – Medium risk; Red – High risk. Fiji, Palau, and Nauru are assessed using the MAC-DSA, including S-Sustainable; U-Unsustainable. 83. In most PICs, external grants and non-tax revenues are vital for financing public investment, creating significant fiscal space and bolstering investment initiatives (Part 1; World Bank 2023f). However, the predictability of these sources is problematic. The volatility of external grants often results in unpredictable revenue streams, which can hinder effective fiscal planning and investment stability (World Bank 2023g; Pacific Islands Forum Secretariat 2024). While these revenues provide crucial support for public investment, their inconsistency poses challenges for long-term financial stability and planning in the PIC-11 (IMF 2022b). PIC-11 economies are often influenced more by a ‘natural disaster cycle’ and an ‘aid cycle’ rather than by traditional business cycles (World Bank 2023g). This cycle includes financing for recovery from natural disasters and donor-funded infrastructure projects. Since such external funding is often unpredictable and constitutes a significant portion of revenue for public investment, better predictability can reduce investment volatility and enhance the effectiveness of public investment initiatives. 2.2.3 What is Holding Back Private Investment? 84. Inconsistent and sometimes unpredictable regulatory environments deter investment by creating uncertainty and increasing the perceived risk for investors. In Micronesia, for example, frequent changes in land ownership laws and regulations have created uncertainty for investors in the tourism sector, leading to delays and cancellations of several projects over the past decade. Regulatory uncertainty in Micronesia has contributed to an estimated 20 percent decline in foreign direct investment (FDI) in the tourism sector since 2010 (PIFS 2023). Land tenure and property rights are significant challenges in many PICs, where complex and ambiguous land ownership can delay investment projects. For example, in Solomon Islands, land disputes and unclear property rights have been known to delay infrastructure projects by several years, affecting overall investment attractiveness (World Bank 2024b). At the same time, many of the PIC-11 lack effective incentives to attract private sector investment. Countries like Vanuatu and Palau face challenges due to insufficient tax incentives and support mechanisms. 60 85. State-owned enterprises (SOEs) in PICs pose significant barriers to investment and economic growth due to their inefficiencies, competition-distorting practices, and fiscal risks. Many PICs rely heavily on SOEs, which often account for over 40 percent of GDP and employ between 30 percent and 75 percent of the formal sector workforce (ADB 2023a). The large presence of SOEs can create a challenging environment for private investment. In Fiji, SOEs involved in telecommunications, manufacturing, and fish processing are stifling competition by reinforcing the dominance of established firms and raising entry barriers for new players (World Bank forthcoming). This inefficiency burdens government finances and limits opportunities for private sector growth. In Kiribati and Tonga, SOEs benefit from tax exemptions that create an uneven playing field (World Bank 2023h). The recent bankruptcy and liquidation of Air Vanuatu highlights how SOEs can strain public resources and hinder investment. 86. Inadequate access to long-term financing is a critical barrier to public and private investment in the PIC- 11. High interest rates and underdeveloped domestic financial markets complicate securing funding for large projects that would boost investment in these countries (IMF 2023a). The decline in correspondent banking relationships has compounded these challenges. The dearth of financing options in the PIC-11 and the limited availability of insurance products increases the perceived risk of investing, particularly in infrastructure and tourism, which require substantial upfront capital. In Tuvalu, limited access to insurance is estimated to have led to a 15 percent reduction in agricultural investment over the past decade, as farmers face difficulties mitigating the risks associated with climate-related events (World Bank 2023i). Even Fiji, the most developed of the PIC- 11, grapples with challenges related to long-term financing. Only about 25 percent of businesses in Fiji have access to long-term financing, compared to a global average of 60 percent (World Bank 2022c). Additionally, the absence of a well-developed insurance market in Fiji further constrains risk management, particularly in sectors like tourism, which are susceptible to natural disasters. Improving access to long-term financing and insurance could potentially boost Fiji’s GDP by an additional 2–3 percent annually (World Bank 2023j). 87. Given the significant role of remittances in PICs, these transfers are crucial in stimulating private investment and overall economic activity (IMF 2022c). Remittances account for up to 25 percent of GDP in some PICs, such as Tonga and Samoa (World Bank 2023k).This substantial flow of funds provides households with additional income that can be invested in entrepreneurial ventures and local businesses, thereby enhancing private sector growth. For example, in Samoa, remittances have been linked to a 10 percent increase in local business investments (IMF 2022c). However, investing remittances in the Pacific faces several constraints including high transaction costs, de-risking and withdrawal of correspondent banking relationships, economic volatility, and poor investment climates. Remittances are often used for immediate consumption rather than investment, limiting their developmental impact (World Bank 2006). Economic challenges like those posed by the COVID-19 pandemic and the shift to informal remittance channels further complicate the effective use of these funds (World Bank 2020a). 61 2.3 The Way Forward Boosting productive investment and capturing the related development gains in the PIC-11 will require a multifaceted policy approach for attracting investment into high-potential activities, correcting infrastructure deficiencies, improving resilience against disasters, building fiscal and external buffers, establishing a regulatory and policy environment attractive to private investors, and increasing the availability of financing. Global support for these efforts will be crucial. This section explores key priorities and recommendations to create rapid and sustained investment growth. 2.3.1 Enable Investment in High-potential Sectors 88. Expanding agricultural diversification and agro-processing opportunities is crucial for moving away from subsistence farming and low-value crops. Governments can modernize agricultural practices by investing in research, extension services, and capacity building – as well as encouraging diversification of crops. The Cook Islands, for example, focused on high-value niche agricultural markets, like organic vanilla, boosting export revenues and job creation (FAO 2023). Similarly, Saint Lucia and Dominica are shifting their agricultural production towards agro-processing, transforming tropical fruits into high-value export products (World Bank 2022a). Creating a conducive policy and regulatory environment in this sector will attract private investment, while agribusiness partnerships can enhance productivity and competitiveness among small- scale producers. For example, international support in Solomon Islands has led to the establishment of new agribusiness partnerships, creating jobs and benefiting rural communities. 89. The blue economy presents vast economic potential for the PIC-11. Key strategies include establishing marine protected areas for sustainable fisheries and investing in high-value aquaculture species and processing facilities (Annex 3). The Maldives’ aquaculture sector, which focuses on products like tuna and sea cucumbers, has increased export revenues and enhanced resilience to economic and environmental shocks (UNCTAD 2022). PICs are also well-positioned to lead in marine biotechnology, with potential applications ranging from pharmaceuticals to biofuels. However, this requires investment in research and development infrastructure to sustainably harness marine biodiversity. 90. Boosting tourism can drive more economic activity and job creation in PICs (Coste et al. 2023). Diversifying the tourism sector involves developing lesser-known regions and integrating local communities into the value chain. Linking tourism with agriculture, for example, by including locally produced food in the tourism experience, can spread benefits more evenly. Public-private collaborations, such as joint training programs, can build a skilled workforce tailored to the industry’s needs. Environmental conservation measures, like coral reef protection and sustainable tourism certifications, are also vital for the sector’s long-term viability. 91. Sustainable commodity production and mining require integrating environmental, community, economic, and regulatory considerations. Implementing resource-efficient technologies, engaging local communities, and ensuring transparent revenue management are key strategies (International Council on Mining and Metals 2020; World Bank 2018; United Nations Environment Programme 2016). Supporting sustainable policies and investing in green technologies are crucial for reducing the sector’s ecological impact, balancing economic benefits with environmental stewardship and social responsibility (ICMM 2014). 62 92. Foreign investment is vital for accelerating diversification efforts in these sectors. Attracting foreign investment can boost agricultural productivity through advanced technology and innovative practices like precision farming. It also provides access to global markets – increasing profitability and stimulating further investment. Foreign Direct Investment (FDI) can support agro-logistics systems, reducing post-harvest losses and improving supply chain efficiency. Additionally, foreign investment in marine biotechnology can help develop high-value applications, contributing to economic diversification while promoting sustainable marine resource management. For tourism, FDI can assist in developing new tourist destinations, spreading economic benefits more broadly and reducing risks associated with geographical concentration. 2.3.2 Address Infrastructure Deficiencies 93. Investment gaps in the PIC-11 are substantial, particularly in infrastructure (ADB 2017b; World Bank 2020b), making it essential to invest in the modernization of road infrastructure and improving connectivity between rural and urban areas. Routine maintenance, as well as adoption of advanced technologies for traffic management and road monitoring, are vital in avoiding road-related deficiencies. In Saint Lucia, strategic road upgrades are expected to result in reduced maintenance costs and improved road reliability, underscoring the economic benefits of infrastructure investment. This model illustrates how targeted investments can yield significant returns and improve investment conditions (UNOPS 2020). Bermuda’s implementation of ‘smart’ transportation technologies is expected to result in significant improvements in traffic flow and reductions in travel times, providing a replicable model for PICs to optimize their transportation infrastructure and implement technological upgrades. Among the PIC-11, a targeted investment in Vanuatu’s road network is estimated to have significantly reduced transportation costs and boosted economic activity (World Bank 2023f). 94. Expanding and modernizing port and airport facilities—using a regional approach where appropriate— should be a priority. With ports in several of the PIC-11 unable to handle demand and generating delays in distributing goods, it is imperative that port capacity be expanded, and that processing be streamlined, including through the implementation of advanced management systems. Airports, as well, must be expanded to support private sector development and reduce delays. The benefits of upgrading ports and airports can be significant. The modernization of port infrastructure in Mauritius, a small state, has significantly enhanced operational efficiency and reduced cargo handling times (World Bank 2005). An investment in modernizing the Port of Honiara in Solomon Islands could increase the cargo traveling through the country and reduce shipping delays (World Bank 2023f). Regional cooperation can enhance improvements to ports and airports. The Pacific Regional Infrastructure Facility (PRIF), for example, has facilitated joint port development initiatives, enhancing logistics and trade efficiency across the region (PRIF 2023). The Caribbean Community’s (CARICOM) regional aviation strategy has successfully enhanced connectivity and reduced travel costs within the Caribbean, offering a model for PICs to learn from. 95. Using existing proven hydro power, solar, and wind technologies, PICs should take advantage of the excellent potential for renewable energy development. Local PIC economies are well suited to the deployment of modular generation technologies, microgrids, and smart grids. To support this, it is essential to enhance local capabilities through coordinated training and knowledge transfer. Additionally, regional Pacific meetings should be used to align strategies and approaches. A comprehensive energy transition plan could include incentives for private sector investment in renewable energy projects, leveraging international climate financing sources and development banks for funding, and investing in training and infrastructure to support the adoption and maintenance of renewable technologies in PICs. New technologies, such as wave and tidal energy or geothermal power, must be further investigated to assess their suitability for the Pacific context. 96. The experience of reducing dependence on fossil fuels in small states such as Mauritius and Barbados 63 offer lessons for the PIC-11. Mauritius, with its goal to achieve a 60 percent renewable energy target by 2030, has implemented comprehensive energy policies and attracted substantial international investment (IRENA 2023). Similarly, Barbados has invested heavily in solar and wind energy, positioning itself as a leader in the Caribbean’s energy transition. Barbados’s energy efficiency programs led to a 15 percent reduction in energy consumption and a 10 percent decrease in electricity costs for businesses, illustrating how efficiency improvements can support economic development. Among PICs, Fiji has set ambitious renewable energy targets—aiming for 100 percent renewable energy by 2036—and has made notable progress, with over 60 percent of its electricity currently generated from hydropower and other renewable sources (Fiji Ministry of Economy 2017). 2.3.3 Build Resilience Against Disasters 97. Building resilience against disasters is crucial for reducing investment volatility in the PIC-11. Due to their small size, climate-related and natural disasters in the PIC-11 can severely disrupt activity in all economic sectors and cause significant fluctuations in investment flows. By strengthening resilience, the PIC- 11 can mitigate the impact of adverse events and, due to disruptions from disasters being less severe, support domestic conditions that attract long-term investment. Building infrastructure capable of withstanding extreme weather events is crucial for protecting economic assets. 98. Key priorities for the PIC-11 include sea walls and flood barriers, which are essential for mitigating the effects of rising sea levels and storm surges in coastal areas, and drainage systems to prevent flooding. The benefits of resilient infrastructure are already evident in several PICs. In Tuvalu, for example, the Funafuti Coastal Protection Project, which includes sea walls and enhanced mangrove coverage, has significantly reduced vulnerability to coastal erosion and flooding and helped prevent further damage during Cyclone Tino in 2020. In Samoa, recent upgrades to urban drainage systems in Apia have improved the city’s ability to handle heavy rainfall and prevent flooding. In Fiji, Nausori Airport has incorporated flood-resistant designs and elevated construction to endure cyclones and flooding. This approach was influenced by Cyclone Winston in 2016, which inflicted approximately US$825 million in damages (Fiji Government 2022). The PIC- 11 will also need to prioritize the implementation of comprehensive disaster management strategies and the enhancement of early warning systems. 2.3.4 Strengthen Fiscal Buffers 99. Public investment can potentially crowd in private investment but this depends on several factors. Public investment is more effective in stimulating private sector growth when there is adequate fiscal space, strong investor confidence, and a solid track record in public investment management (IMF 2018; OECD 2020a; World Bank 2021c). Without these conditions, public investment may fail to catalyze private investment and could hinder efforts to translate overall investment into substantial economic growth. This highlights the need to critically assess public investment strategies, ensuring they are well-targeted and efficiently managed to contribute effectively to long-term development goals. 100. Enhancing fiscal management practices is vital for maintaining fiscal stability and optimizing resource use. Effective fiscal policies involve maintaining balanced budgets, controlling public debt, and ensuring efficient use of resources. Effective financial management includes improving transparency, strengthening budgetary controls, and adopting best practices in public expenditure management. Several countries have implemented such reforms (Box 4). The PIC-11 would also benefit from adopting international standards and best practices of fiscal transparency and accountability, which can enhance fiscal risk management and sustain investment flows (IMF 2022a). 64 101. PICs should expand their fiscal space, including through the use of contingency funds. Limited fiscal space entrenches economic vulnerability, limiting investment potential. The risk of debt distress in several PICs highlights the connection between having financial flexibility (fiscal space) and the effectiveness of public investment. When governments have sufficient fiscal space, they can invest more effectively in public projects and maintain an adequate buffer for economic stability. This can boost private sector confidence and encourage private investment (Adarov 2024; Adarov, Clements, and Jalles forthcoming). Additionally, a fiscally healthy government is less likely to resort to distortionary taxation or inflationary financing to manage its debt, which could negatively impact the private sector. Contingency funds are crucial for managing unforeseen economic challenges and natural disasters. These funds enable countries to respond quickly to emergencies without disrupting essential services or investments. 102. In sovereign rent-led countries, effectively managed sovereign wealth funds (SWFs), could stabilize fiscal spending. FSM, Kiribati, Marshall Islands, Palau, and Tuvalu have established SWFs (World Bank 2024c). These funds have the potential to stabilize fiscal expenditure by acting as a buffer between volatile revenues and the budget. However, they must be managed effectively, which requires transparent and professional governance, as set out in the International Forum for Sovereign Wealth Funds’ 24 Santiago Principles. The funds also must be integrated into a comprehensive medium-term budgeting framework. Many PIC SWFs have withdrawal rules that limit how much can be spent in any year, though the rules vary in strength. PIC SWFs should adopt the Santiago Principles – and institutionalize deposit, withdrawal, and asset allocation rules – as well as ensure SWF withdrawals are invested in human and physical capital like healthcare and climate adaptation. 65 Box 4. Successful fiscal management and reform in the PIC-11 Palau’s successful increase in external reserves through diversified revenue sources and prudent financial management has helped maintain economic stability and attract investment despite global uncertainties (World Bank 2023h). Increasing reserves can reduce the need for emergency borrowing, which often comes at higher interest rates. For example, building a reserve equivalent to 5 percent of GDP can mitigate the need for high-cost loans during economic crises, potentially saving up to 3 percent annually on borrowing costs. Additionally, well-capitalized reserves enhance investor confidence and credit ratings, facilitating access to lower-cost financing (World Bank 2023h). Tonga’s disaster contingency fund has allowed the country to minimize economic disruption related to frequent cyclones. Establishing contingency funds can significantly reduce the economic impact of disasters. The cost of setting up a contingency fund is typically outweighed by the savings on emergency response and recovery costs. A contingency fund equivalent to 1 percent of GDP can save 3–5 percent in disaster recovery costs compared to relying on high-interest emergency loans. It is crucial that these funds be used effectively and efficiently (Tonga Ministry of Finance 2022). Fiji has implemented comprehensive financial management reforms, including upgrading public financial management systems and increasing transparency in budget execution. These reforms have led to better fiscal discipline and more effective use of public funds. Improved financial management can result in significant cost savings through more efficient use of public funds and can ensure that funds are allocated to high-impact projects. Transparency and better budgetary controls can save governments up to 10 percent of their annual expenditure by preventing mismanagement and ensuring more effective project implementation (Fiji Government 2023a). In Samoa, fiscal management reforms, including the establishment of a contingency fund and increasing external reserves, has helped the country maintain investment stability and respond swiftly to emergencies without relying entirely on emergency loans, including during Cyclone Gita in 2018 (Samoa Ministry of Finance 2022a). 66 2.3.5 Establish a Supportive Regulatory and Policy Framework to Attract Private Investment 103. The establishment of a robust legal and policy framework for SOEs would be advantageous to PICs. A robust SOE governance framework can improve SOE performance and reduce fiscal risks. This includes regular audits, transparent reporting, effective internal controls, and clear definitions of SOE ownership, governance structures, and dividend policies (IMF 2022d; World Bank 2023h). In addition, performance targets and regular monitoring of SOEs can improve efficiency and service delivery, ensuring that SOEs operate effectively and contribute positively to the economy (World Bank 2023h). SOE reforms can yield substantial benefits. A macroeconomic impact assessment found that improving SOE management and reducing fiscal risks can lead to a 1–2 increase in GDP growth over five years due to enhanced investment and efficiency gains (World Bank 2024a). Additionally, better SOE performance can reduce government fiscal transfers by up to 20 percent, freeing resources for other critical areas (World Bank 2023h). Countries such as New Zealand and Singapore have implemented effective SOE governance frameworks that could serve as models for PICs (OECD 2022). It may be beneficial to limit state ownership to sectors where it is crucial to maintain public control, such as infrastructure or essential services, while encouraging private sector involvement in other areas. This approach helps balance public and private sector contributions to the economy (OECD 2022a). 104. Effective public-private partnerships (PPPs) are instrumental in leveraging private sector expertise and capital. When PPPs are well executed, they support investment and growth. At the same time, PPPs allow for public oversight in essential sectors. For example, Fiji’s efforts to develop PPPs in infrastructure projects have shown promise in enhancing infrastructure development, improving service delivery, and reducing fiscal burdens (Fiji Government 2023a). The collaboration between the Fijian government and private investors in upgrading the Nausori Airport terminal is a notable example (Fiji Government 2022). 105. There is a need to improve the efficiency of private firms’ interactions with public agencies. Reducing red tape and creating a more investor-friendly environment can improve firms’ willingness to invest in PICs. In Tonga, for example, a reform introduced in 2021 cut the average project approval time from 18 months to 12 months. The reform significantly improved the efficiency of project initiation and execution, resulting in a 30 percent increase in private sector investment in infrastructure projects over two years (OECD 2024). In Fiji, the implementation of a digital procurement platform led to a remarkable 40 percent reduction in procurement processing times (Fiji Government 2023b). This efficiency boost has accelerated project approvals and improved contractor satisfaction. For instance, the timeline for completion of the upgrade to Nausori Airport was reduced through the more efficient procurement process. The success of Fiji’s e-procurement system underscores the importance of adopting modern technologies to enhance regulatory efficiency. 106. Adjusting investment incentives and other preferential treatment would help attract private investors to high-potential sectors. Countries such as Fiji, Samoa, and Tonga could benefit from implementing incentives to spur investment in sectors like renewable energy and tourism. Providing tax incentives for renewable energy projects could encourage private sector participation, leading to increased investments in sustainable energy solutions. Eliminating or reducing tax exemptions for SOEs can level the playing field for private sector firms (Box 5). This change promotes fair competition and encourages investment. Outside of the Pacific, Jamaica’s reform of SOE tax policies has improved market competitiveness and attracted private investment (IMF 2022d). Additionally, co-financing arrangements can help share the financial burden of large- scale projects, making them more attractive to private investors. 67 Box 5. Telecommunications reform in the Caribbean The Eastern Caribbean Telecommunications Authority (ECTA) provides insights on the potential benefits of cross-country regulatory reform in small states. In 1998, five Eastern Caribbean countries signed an agreement establishing a common regulatory framework for their telecommunications services. The same five countries signed a treaty in 2000 creating the world’s first regional telecommunications regulatory authority, the Eastern Caribbean Telecommunications Authority (ECTEL). ECTEL’S objectives were to promote: • Market liberalisation, competition, and open entry • Harmonised policies and regulatory regimes • Delivery of the widest possible access to telecommunications • Fair pricing and the use of cost-based pricing methodologies • Fair competition by discouraging the exercise of market power • The introduction of advanced technologies and a wider range of services • Increased penetration and the overall development of telecommunications. By the end of 2004, nearly 40 licenses had been issued to new entrants for fixed line, mobile, and internet services. Mobile penetration reached an estimated 63 percent by the first quarter of 2004, up from only 2.3 percent in 2000, with similar growth in fixed line and internet services. Competition has delivered new services and technologies and reduced prices. Businesses have had increased access to information technologies to improve output and reduce costs. The liberalization has not only benefited consumers but also created jobs and increased investment in member states. 68 2.3.6 Improve the Availability of Financing and Insurance Products 107. Long-term, and in some cases innovative, financial instruments are needed to provide stable funding for major private or public investment projects, and to finance post-disaster infrastructure recovery projects and climate- and sustainability-related investment. In 2018, Seychelles, a small state, launched the world’s first sovereign blue bond, raising US$15 million to fund marine conservation and sustainable fisheries.14 This initiative has protected 30 percent of its ocean territory, boosted sustainable fisheries management, and supported local communities (World Bank 2023l). Among the PIC-11, Samoa has taken significant steps to improve access to long-term financing and insurance tailored to infrastructure projects. These measures have helped manage financial risks more effectively and supported the completion of critical projects (Samoa Ministry of Finance 2022b). 108. There is a need to create insurance products tailored to infrastructure development and disaster risks in PICs. Specialized insurance can reduce risk exposure and enhance the attractiveness of investments in vulnerable regions. Samoa provides a practical example of collaborating with international insurers to design policies specifically for infrastructure projects and natural disasters. The country has developed insurance solutions covering risks such as cyclones and flooding, offering policies in infrastructure repair costs. Region- wide insurance pools, such as the Pacific Catastrophe Risk Assessment and Financing Initiative (PCRAFI), offer access to advanced risk assessment tools and financing options. 109. PICs would benefit from more predictable external funding from donors. To enhance the predictability of external funding in the PIC-11, several strategies can be employed. Establishing multi-year donor commitments can provide stability and improve financial planning, as emphasized by the Pacific Regional Development Framework (PRDF) (World Bank 2021d). Enhanced transparency and coordination among donors, exemplified by the Pacific Islands Forum’s Joint Donor Matrix, are also crucial (OECD 2020b). Strengthening local institutional capacity for fund management and reporting ensures effective utilization and adherence to donor requirements (IMF 2019b). Additionally, adopting performance-based funding mechanisms linked to specific outcomes can improve accountability and predictability (Global Partnership for Effective Development Cooperation 2022). Implementing these practices can help stabilize and optimize external funding in the PIC-11. For countries with low levels of external reserves, building this financial cushion will also help policy makers manage unexpected expenses and stabilize their economies during downturns. 110. Addressing the constraints that hinder the flow of remittances to investment in PICs requires a multi-faceted approach. Firstly, reducing the costs associated with remittance transfers is crucial, as high transaction fees can deter the effective use of remittances for investment purposes. Efforts to lower these costs can include negotiating better terms with remittance service providers and fostering competition in the remittance market. Secondly, enhancing financial stability within PICs is essential to create a conducive environment for remittances to be directed toward productive investments. This involves strengthening financial institutions, improving financial infrastructure, and implementing sound fiscal and monetary policies (IMF 2021). Lastly, creating a more favorable investment environment by improving regulatory frameworks, providing incentives for investment, and ensuring political and economic stability can significantly boost the effective deployment of remittances into productive sectors (ADB 2022). Coordinated efforts in these areas will help to unlock the full potential of remittances as a source of investment capital in the Pacific region. 14. A sovereign blue bond is issued by a government to fund projects that protect and manage ocean and water resources. It supports initiatives like marine conservation and sustainable fisheries. For instance, the Seychelles issued one of the first blue bonds in 2018 to finance marine protection efforts. 69 2.3.7 Leverage Global Support • Access Funding and Technical Assistance: Securing IFI funding, technical expertise, and risk-sharing mechanisms is essential for high-impact projects. • Ensure Timely and Aligned Funding: Ensuring that funding is timely and aligns with broader developmental goals is critical. International support for climate-resilient and sustainable development projects can help the PIC- 11 build a more robust investment environment. For example, funding for infrastructure projects that integrate climate resilience can enhance long-term stability and economic growth. • Embrace Collaborative Approaches: Engaging in collaborative approaches with global and regional partners can facilitate knowledge exchange and enhance investment strategies. Joint ventures and partnerships can leverage global expertise and resources, leading to more effective investment outcomes. By collaborating with neighboring countries and regional organizations, PICs can benefit from shared resources and risk management strategies. Strengthening regional cooperation through initiatives like PCRAFI can improve the effectiveness of disaster risk management and support investment stability across the region. Table 2.2 A summary of policy recommendations to boost productive investment INTEGRATION15 RESILIENCE EFFICIENCY Enable Address Build resilience Build fiscal Establish a Improve investment in infrastructure against disasters buffers framework to availability high-potential deficiencies attract private of financing sectors investment and insurance products • Expand support • Upgrade, • Invest in • Expand fiscal • Establish a • Improve access for agricultural modernize, climate-resilient space, including robust legal to long-term research, and routinely infrastructure, through and policy financing extension, and maintain roads, including coastal domestic framework for agribusiness ports, and protection revenue SOEs • Create training airports and drainage mobilization insurance systems and the use of • Promote products tailored • Develop the • Strengthen contingency public-private to infrastructure blue economy regional • Enhance funds partnerships and disaster cooperation disaster (PPPs) risks • Diversify the related to ports preparedness • Improve fiscal tourism sector and airports and early management • Adjust warning systems investment • Develop • Invest in • Improve incentives to sustainable renewable planning and attract private commodity energy and implementation investors to production and improve the high-potential mining resilience ccumulate • A sectors of energy fiscal reserves infrastructure LEVERAGE GLOBAL SUPPORT • Ensure comprehensive external financing, technical assistance, and knowledge aligned with development goals 15. 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Washington, DC: World Bank. 74 Annexes Annex 1: Growth Forecast Summary (based on fiscal year information) Percentage point (Real GDP growth at market prices in percent, unless otherwise indicated) difference from March 2024 projection 2020 2021 2022 2023 2024e 2025f 2026f 2024 2025 PIC-11 -1.2 11.2 5.5 2.8 3.1 3.0 3.0 -0.4 -0.3 Fiji -4.9 20.0 8.0 3.1 3.3 3.2 3.2 -0.3 -0.1 Solomon Islands 2.6 2.3 3.0 2.5 2.9 2.9 2.9 0.1 -0.2 Tourism and remittances- -4.3 0.0 2.1 6.2 4.0 2.8 2.1 0.0 -1.3 led PICs Palau -13.2 0.0 0.3 12.0 11.0 3.5 2.0 -1.3 -6.1 Samoa -7.1 -5.3 8.0 10.5 5.5 3.5 2.3 1.2 -0.2 Tonga -1.3 0.0 2.0 1.8 2.4 2.0 1.6 0.1 0.1 Vanuatu -1.6 1.9 2.2 0.9 1.5 2.1 2.5 -1.1 -1.8 Sovereign rent-led PICs 3.0 0.7 3.0 3.4 3.0 2.5 2.2 0.3 0.7 Kiribati 8.5 3.9 4.2 5.8 4.1 3.3 2.5 -1.5 1.3 RMI 1.1 -0.6 3.0 3.4 4.0 3.2 2.4 1.3 1.3 FSM 3.0 -1.4 0.4 1.1 1.7 1.1 0.8 0.4 -0.4 Nauru 7.2 2.8 0.6 1.8 2.0 1.9 2.0 0.7 0.0 Tuvalu 1.8 0.7 3.9 3.5 3.0 2.5 2.2 1.2 0.1 Source: World Bank. Note: e = estimate; f = forecast. 75 Annex 2: Inflation Forecast Summary (based on fiscal year information) 2021 2022 2023 2024e 2025f 2026f PIC-11 median 1.8 5.5 6.8 4 3.2 3 Fiji 0.2 4.3 2.3 5.2 3.8 3.4 Solomon Islands -0.1 5.5 4.7 3.7 3.3 3.3 Tourism and remittances-led 0.9 9.9 11 3.6 2.9 2.6 PICs median Vanuatu 2.3 6.7 11.2 4.2 2.8 2.1 Samoa -3 8.8 12 3.6 3 3 Tonga 5.6 10.9 6.4 3.5 3.2 3 Palau -0.5 13.2 10.8 3.1 2.2 2.2 Sovereign rent-led PICs 2 5 6.8 4.3 3.4 3.2 median Kiribati 2.1 5.3 9.3 4.5 3 2.5 Nauru 2 2.6 4 4.5 4 3.5 Marshall Islands 1.1 3.2 6.8 4.3 3.5 3.5 Tuvalu 6.7 12.1 7.2 3.9 3.4 3.2 Micronesia 1.8 5 6.2 4 3 2.5 Source: Haver Analytics; World Bank. Note: e = estimate; f = forecast. 76 Annex 3: Pacific Fisheries Sector Investment Landscape There is often a lack of appreciation for the fishing sector's importance to PICs economies, food security, and nutrition. PIC fishing output is estimated around US$1.4 billion or around 2–4 percent of their combined GDPs, and up to 15 percent in FSM and Kiribati. This contribution increases significantly if post-harvest and ancillary activities are included e.g., seven-fold in RMI and double in PNG. Tuna fisheries are a key contributor to public revenues for PICs (around US$450 million for FFA countries in 2019). Only limited amounts of government revenue generated by fisheries is re-invested into the government departments responsible for fisheries management. What is the current investment landscape in the Pacific fisheries sector? Development Partners The Pacific fisheries sector is a crucial component of the regional economy, with significant investments from several development partners, including the World Bank. Investments are aimed at improving fishery management practices to support sustainable use of marine resources, improving the value chain and supporting the development of domestic industries, developing cold chain logistics, enhancing port facilities, and ensuring effective monitoring, control, and surveillance (MCS) to combat illegal, unreported, and unregulated (IUU) fishing. The World Bank Group, through the Pacific Islands Regional Oceanscape Program: Second Phase for Economic Resilience (PROPER) supports strengthening of sustainable oceanic and coastal fisheries management in the Federated States of Micronesia (FSM), the Republic of the Marshall Islands (RMI), Solomon Islands, Tuvalu, the Forum Fisheries Agency (FFA), Samoa, Tonga, and Kiribati. The program aims to improve fisheries management, climate change adaptation, and economic resilience. The World Bank also supports analytics on fisheries, ecosystems, the blue economy, and pollution/waste through the Pacific Ocean Advisory Program (POAP). Other international development partners include the European Union (EU), Japan International Cooperation Agency (JICA), New Zealand, Australia, the Food and Agriculture Organization (FAO), United States Agency for International Development (USAID) and the Asian Development Bank (ADB). Private Sector The Western and Central Pacific Fisheries Commission (WCPFC) manages highly migratory fish stocks like tuna (including skipjack, yellowfin, bigeye, and albacore) in the Western and Central Pacific Ocean (WCPO) which are fished by domestic and international fleets. Many Pacific Island countries have their own domestic fishing fleets. In addition, Distant Water Fishing Nations (DWFNs), countries that operate large fishing fleets far from their own national waters, including China, the European Union, Japan, Republic of Korea, and the United States also operate in the region. Papua New Guinea, RMI, and Solomon Islands host tuna processing companies predominantly owned by offshore companies based in Italy, the Philippines, the Republic of Korea, Singapore, and others. Many of these companies are at least partially government owned. These facilities process tuna caught in national waters and the broader Western and Central Pacific Ocean (WCPO), contributing to national economies through job creation, export earnings, and value-added production. What are the investment needs within the fisheries sector? • Market Access: There is a need for investments to improve access to international markets, including meeting the stringent requirements of global markets, such as traceability and certification through the establishment of competent authorities.16 16. A competent authority is a body established for sanitary and phytosanitary compliance purposes to meet requirements for European Union (EU) market access. 77 • Value Chain Investments: Enhancing the fisheries value chain through investments in processing facilities, cold storage, and transportation infrastructure including developing the capacity to process catches locally, which adds value and creates jobs. • Domesticizing the Industry: Investment is needed to strengthen local industries and increase local ownership and participation in the sector’s value chain (harvesting, landing, transhipment, processing, services) and reducing dependency on foreign fleets. • Management and Sustainability: Continuous investment in capacity building for fisheries management are vital to maintaining the sustainability of fish stocks. This includes improving data collection, scientific research, and the implementation of sustainable fishing practices. What are the major opportunities for investment in the fisheries sector? • Global Funding Opportunities: International Development Association (IDA) funds, multi-donor trust funds such as PROBlue and the Energy Sector Management Assistance Program (ESMAP) and other global initiatives through the Global Environment Facility (GEF) and Climate Investment Fund (CIF) offer substantial investment opportunities. These funds can be leveraged to improve the enabling environment, including competent authorities, cold chain, ports, and MCS, making the sector more attractive for private investment. • Regional Funding Initiatives: The Forum Fisheries Agency (FFA) and the Pacific Community (SPC) offer technical assistance in the form of policy development, legislative reform, training and capacity development, and fisheries MCS at the regional and national level for member states. FFA support oceanic/offshore fisheries management, whereas SPC supports coastal fisheries management. • Private Sector Investments: With the right public investments in the enabling environment, there is potential for increased private sector involvement. Investments in cold chain logistics, port infrastructure, and MCS are particularly critical in attracting private investment. • Local Funding Opportunities: For inshore fisheries, funding opportunities are more limited and generally come from NGOs supporting community-based fisheries management. There is a need for more substantial local and regional funding to support these efforts. What are the key policy recommendations that would benefit the fisheries sector? • Strengthened Enabling Environment: Continued public investments are needed to improve the enabling environment, including competent authorities, infrastructure, and enforcement capabilities, with a view to enhancing the investment climate and ensuring the long-term sustainability and profitability of the Pacific fisheries sector. • Differentiated Policy Approaches: Policymakers should recognize the different needs of offshore and inshore fisheries, tailoring policies to address often distinct policy objectives between offshore and inshore fisheries as well as specific challenges in either sub-sector. • Capacity Building: Investments in building local capacity for fisheries management, including in monitoring of fish stocks and ecosystem health, MCS to combat IUU fishing and scientific research, are critical to the sector's sustainability. • Promoting Local Industry: Encouraging the domestication of the industry through supportive policies and investments can lead to greater economic returns and job creation within the region. 78 Annex 4: Pathways for Supporting Small Farmers Through Agro-logistics Introduction Agro-logistics is a crucial component of the food system that offers a triple benefit: enhancing food security; reducing environmental pressures; and boosting incomes for farmers, agribusinesses, and households. This system encompasses the infrastructure, equipment, services, and information networks that facilitate the journey of agricultural products from farms to consumers, both domestically and globally. A well-functioning agro-logistics system can lead to sustainable, resilient, and inclusive development outcomes, such as healthier diets, reduced carbon and water footprints, climate resilience, high-quality employment opportunities, and increased market access and profitability for family farmers. For instance, studies show that improving cold chain logistics can reduce food waste by up to 30 percent, while efficient transportation networks can lower greenhouse gas emissions by 20 percent. The Role of Agro-Logistics in Agriculture Agro-logistics involves a series of interconnected activities, including harvesting, transportation, storage, processing, and distribution. Each stage is crucial for ensuring that agricultural products reach consumers in optimal condition. Effective agro-logistics systems can enhance the efficiency of these processes, leading to several benefits: • Maintenance of Product Quality: Ensuring that products maintain their quality from farm to market—with proper handling, storage, and transportation—can significantly reduce post-harvest losses. For example, using refrigerated trucks and cold storage facilities can prevent the spoilage of perishable goods like fruits, vegetables, and dairy products. This is particularly important for high-value crops and export commodities, where quality standards are stringent. • Timely Delivery: Ensuring the timely delivery of agricultural products is essential for meeting market demands and reducing the risk of spoilage. Efficient logistics systems can help farmers and producers respond quickly to market opportunities. • Cost Efficiency: Streamlined logistics processes can reduce transportation and storage costs, making agricultural products more competitive in both domestic and international markets. Bottlenecks for Incentivizing Agro-logistics Support in PICs Agro-logistics systems in PICs have been historically performing poorly, compounding a situation of low agricultural productivity, stifled innovation, limited financial inclusion, and high climate vulnerability. Overall, the region has lagged the world regarding logistics efficiency—with poor roads, weak border infrastructure and management, and underperforming phytosanitary inspection systems—imposing additional costs and hampering food-system productivity and competitiveness. In Solomon Islands, domestic agricultural marketing pathways are crucial for supplying fresh produce and livestock products to the fast-growing urban and peri-urban populations. However, limited market infrastructure and inadequate transport and storage equipment result in substantial losses in both quality and quantity of produce, for instance, fresh vegetables and fruits often spoil before reaching urban markets. 79 Fiji faces fewer agro-logistics challenges compared to Solomon Islands. The country has a much better road network, reasonable inter-island shipping, and good international shipping and air services. Approximately 80 percent of the population resides on the main island of Viti Levu, which simplifies logistics operations. Several large urban areas in Fiji are well-supplied with domestic fresh produce. However, the market infrastructure is often overloaded, and cold-storage facilities are inadequate. This can lead to spoilage and reduced quality of fresh produce, impacting both local consumption and export potential. Strict biosecurity regulations govern the export of fresh produce and root crops, necessitating specialized heat treatment, fumigation, and storage facilities. These regulations ensure that exported goods meet the required standards, but they also add complexity and cost to the logistics process. The domestic food markets in Samoa function well, but local foods are expensive relative to imports. This is also true for Solomon Islands and Fiji, where local produce struggles to compete with imported food items. This has significant implications for food and nutrition security, as reliance on imported foods can lead to dietary imbalances and reduced consumption of locally grown, nutritious foods. The domestic marketing of meat in Samoa is largely informal, with a shortage of efficient and hygienic slaughter facilities. This can impact the quality and safety of meat products available to consumers. Overall while the benefits of agro-logistics are clear, several challenges must be addressed to fully realize its potential: Infrastructure development: Developing countries often face significant infrastructure challenges, including 1. inadequate roads, ports, and storage facilities. Addressing these issues requires substantial investments and coordinated efforts from both the public and private sectors. Technology adoption: The adoption of advanced technologies, such as GPS tracking, automated warehousing, 2. and blockchain for supply chain transparency, can enhance agro-logistics systems. However, the high cost of these technologies and the need for technical expertise can be barriers to adoption. Policy and regulation: Effective policies and regulations are essential for supporting agro-logistics development. 3. Governments can play a crucial role by providing incentives for infrastructure investments, ensuring regulatory compliance, and facilitating public-private partnerships. Capacity building: Building the capacity of farmers, producers, and logistics providers is essential for improving 4. agro-logistics systems. Training programs and knowledge-sharing initiatives can help stakeholders adopt best practices and leverage new technologies. 80 What can PICs do to Promote Agro-logistics Systems? Facilities/Services Commodities Countries • Fresh produce harvesting, processing, transportation, and storage facilities to supply domestic urban markets. Fruit, vegetables, All coconuts, flowers etc. • Urban fresh produce markets providing clean and safe places to market local produce with appropriate waste management. • Efficient and hygienic livestock slaughter and cold storage facilities. Cattle, pigs, chickens All Solomon • Facilities for fermenting, drying and storage—on farm and at Dry commodities: cocoa, Islands and traders’ warehouses. coffee, copra, kava etc. Fiji Solomon • Oil extraction, processing and storage equipment. Crude and virgin Islands and • Coconut oil refining equipment. coconut oil Samoa • Export licenced packhouse facilities for fresh and frozen fruit and Fiji and vegetables. Food safety (HACCP) accredited. Samoa Fruit, vegetables, root crops • Biosecurity treatment facilities for a range of export products— Fiji and washing, packaging, heat treatment, fumigation. Samoa • Equipment for sawn timber production—milling, finishing and kiln Solomon Sawn timber drying. Islands Conclusion Strategic investments in the value chain can effectively implement this agenda and support enabling policies in PICs.17 Agro-logistics plays a pivotal role in agricultural competitiveness by affecting market access, export potential, supply chain integration, and responsiveness to market trends. Investments in infrastructure, technology, policy support, and capacity building are crucial for developing efficient agro-logistics systems. Addressing these challenges and capitalizing on opportunities can significantly enhance the competitiveness of the agricultural sectors in these countries, improve food security, and stimulate economic growth. For example, improving cold chain logistics in Fiji could reduce post-harvest losses by up to 30 percent, while advanced supply chain technologies in Papua New Guinea could increase export revenues by 20 percent. By focusing on these areas, the PIC-11 can achieve substantial economic and social benefits. 17. World Bank Initiatives in PICs supporting agro-logistics: • Solomon Islands: The Agricultural and Rural Transformation Project (ARTP) is financing some investments in agro-logistics including pig breeding facilities and fresh produce markets. A previous Bank-supported initiative, the Rural Development Project Phase II (RDP II) provided substantial support for the development of agro-logistics under its agribusiness partnerships component. • Samoa: The Samoa Agriculture and Fisheries Productivity and Marketing Project (SAFPROM) has a matching grant component for supporting agribusiness partnerships that may include investments in agro-logistics. SAFPROM is also financing the construction of an export packhouse and a cattle slaughtering facility. 81 To be included on an email distribution list for the Pacific Economic Updates and related pub- lications, please contact Bridgette Hogan: bhogan1@worldbank.org or Claudia Palic: cpalic@ worldbank.org. For questions and comments relating to this publication, please contact Ekaterine Vashakmadze: evashakmadze@worldbank.org, Vishesh Agarwal vagarwal3@worldbank.org, or Warunthorn Puthong: wputhong@worldbank.org. For information about the World Bank Group and its activities in the Pacific, please visit: www.worldbank.org/en/country/pacificislands Cover photo: © World Bank. Cover design: The Greenhouse Studio. 83 84