Pacific Economic Update B ck on Tr ck? Th Imp r tiv of Inv stin in Educ tion M rch 2024 The Pacific Economic Update provides analysis of 11 Pacific island countries (PIC-11): Federated States of Micronesia (FSM), Fiji, Kiribati, Marshall Islands, Nauru, Palau, Samoa, Solomon Islands, Tonga, Tuvalu, and Vanuatu. 1 Contents Executive summary 4 Preface and acknowledgements 7 Acronyms 8 List of figures 10 List of tables 10 List of boxes 10 Part 1: Economic overview: Slow global recovery and enduring challenges in the Pacific 11 1.1 Global and regional context 12 1.2 Recent economic developments 16 1.2.1 Growth 16 1.2.2 Inflation 22 1.2.3 Fiscal and debt dynamics 25 1.2.4 Monetary policy and the financial sector 27 1.2.5 External sector 28 1.3 Pacific economic outlook 30 1.3.1 Growth outlook 30 1.3.2 Medium-term growth prospects 35 1.3.3 Inflation 36 1.3.4 External sector 38 1.3.5 Risks 39 1.3.6 Policy considerations 41 Part 2: Investing in people: The Pacific’s most valuable asset 52 2.1 The region’s basic learning deficit 53 2.2 Better teaching is needed to improve student learning 55 2.2.1 Some education systems are struggling to attract enough teachers 56 2.2.2 Many teachers are not using effective teaching practices and a key unknown is whether 56 teachers master the content they are teaching 2.2.3 Teacher behavior often does not support learning 59 2.2.4 More than half of teachers expected to be employed in 2035 have already been recruited, so 59 focusing on existing teachers is critical 2.3 The way forward 61 2.3.1 Mechanisms to make teaching more attractive and selective 61 2.3.2 The right training and tools can enhance teaching capacity 62 2.3.3 Incentives can motivate greater teacher effort 65 2.3.4 Teachers cannot do it on their own 66 2.3.5 Aligned efforts across a range of stakeholders is needed 66 Annex 67 Annex 1: Grouping analysis of the PIC-11 67 Annex 2: Non-monetary dimensions of poverty 69 References 70 3 Executive summary In 2023, growth in the Pacific islands (PIC-11) decelerated but remained robust at 5.5 percent—about two and a half times the long-term average.1 This followed an historically high growth rate of 9.1 percent in 2022 during the first year of post-pandemic recovery, led by Fiji.2 Moderating growth in the PIC-11 in 2023 reflects tempered—albeit resilient—growth in Fiji, which accounts for more than half of the group’s output. Fiji’s output surpassed pre-pandemic levels in 2023 despite a notable deceleration, with growth rates halving from 20 percent in 2022 to eight percent in 2023. Fiji made an impressive rebound after severe contractions in 2020 and 2021. Rising tourism, household consumption, and remittances bolstered growth. As the economy recovered, fiscal policy shifted towards revenue-based fiscal consolidation to reduce the high level of debt accumulated during the pandemic. The PIC-11, excluding Fiji, experienced a noteworthy rebound of 2.7 percent growth in 2023, after a 0.5 percent output contraction in 2022. The bounce-back was bolstered by the gradual pickup in tourism and robust inflows of remittances and grants. The strengthening in activity was widespread, with growth picking up in eight out of ten PIC-11 economies (excluding Fiji). In 2023, only Nauru and Vanuatu experienced a deceleration in growth, due in part to the downsizing of the Regional Processing Center (RPC) in Nauru and the impact of the twin cyclones that struck Vanuatu in March 2023. Growth in Solomon Islands, the second-largest economy in PIC-11, rebounded to 1.9 percent in 2023 after a 4.1 percent contraction in 2022. The upturn was fueled by hosting the Pacific Games and substantial investments in the energy and transport sectors. Nevertheless, growth fell short of expectations, primarily due to a reduction in government spending. For the first time since the pandemic, growth in the tourism and remittances-led countries surpassed growth in the sovereign rent-led countries.3 In the former group, growth rebounded sharply to 3.4 percent in 2023 after a significant cumulative output contraction in 2020-21 and subdued growth in 2022. In contrast, sovereign rent-led countries, which experienced a relatively mild contraction in 2020, saw moderate growth acceleration to 2.3 percent in 2023. Debt dynamics in the PIC-11 improved in 2023, driven by a trend toward fiscal consolidation and a resurgence in economic growth. Public debt as a share of GDP decreased in eight of the PIC-11 economies, driven by economic recovery and enhanced government revenues. However, public debt-to-GDP ratios increased slightly in Solomon Islands and Vanuatu, due to continued fiscal policy support amid remaining negative output gaps, and in Nauru, reflecting slower growth. By the end of 2023, regional output nearly reached pre-pandemic levels, falling just under one percent short. Fiji led the recovery with an early reopening, swiftly rebounding from a severe contraction. Excluding Fiji, PIC-11 output remained about four percent below its pre-pandemic level. Solomon Islands experienced persistent negative output gaps due to a 4.1 percent contraction in 2022 amid political turmoil. “PIC-11” is defined as a group of 11 Pacific island countries: Federated States of Micronesia (FSM), Fiji, Kiribati, Marshall Islands, 1 Nauru, Palau, Samoa, Solomon Islands, Tonga, Tuvalu, and Vanuatu. 2 In 2022, Fiji saw an early economic rebound owing to its swift reopening, contrasting with the rest of the Pacific Islands, which encountered COVID-19 outbreaks later, leading to a delayed recovery in 2023. 3 Box and Annex 1 present the grouping of the PIC-11. Fiji and Solomon Islands are classified into distinct groups. Nine other countries (PIC-9) are categorized into the tourism and remittances-led countries of Palau, Samoa, Tonga, and Vanuatu, and the sovereign rent-led countries of FSM, Kiribati, Marshall Islands, Nauru, and Tuvalu. 4 Economic output in tourism and remittances-led countries continues to trail nearly five percent below pre- pandemic levels. This reflects a combination of severe initial COVID shocks, due to high exposure to tourism and travel, and some country-specific factors. Samoa faced additional challenges with a concurrent measles outbreak, while Tonga and Vanuatu have grappled with compounded difficulties arising from natural disasters, resulting in significant setbacks. Palau’s slower recovery is attributed to the delayed resurgence of tourism in Asia and the prolonged suspension of international flights. In contrast, sovereign rent-led countries swiftly rebounded, standing about four percent above their pre-pandemic level, on average. However, growth within this group diverged, with FSM and Marshall Islands grappling with a sluggish recovery amid low growth potential. Growth in the PIC-11 is anticipated to slow in 2024 and 2025 as the temporary boost from the pandemic recovery fades and fiscal policies continue to tighten. Projected growth of 3.5 percent in 2024 and 3.3 percent in 2025 would be the highest since 2017, excluding the bounce-back of 2022 and 2023, reflecting a continued economic recovery. By 2025, growth in Fiji is expected to converge to its long-term average. The rest of the group, whose recovery has been lagging, is expected to see a modest acceleration of growth, from 2.7 percent in 2023 to 3.4 percent on average in 2024 and 2025. Output in the PIC-11 as a whole is expected to surpass its 2019 level by 2024. Nevertheless, it is still expected to lag approximately seven percent below the pre-pandemic trend. Despite the recent improvement in growth, the PIC-11 still faces formidable development challenges (Gould and Wai-Poi 2023). Medium-term growth fell from 3.2 percent per year in 2000-11 to 2.7 percent in 2012-19. This can be attributed to the diminishing impact of underlying growth drivers since 2000, particularly investment, and the escalating frequency and impact of natural disasters and climate change. Without fundamental reforms and continued international support, growth is expected to plateau at this lower rate amid a subdued investment outlook. More than half of PIC-11 countries, including 80 percent of sovereign rent-led countries, are projected to experience slower per capita growth than advanced economies, resulting in a widening income gap. There are substantial uncertainties concerning the PIC-11’s growth prospects. Short-term risks to the outlook for the PIC-11 have become more balanced since the Pacific Economic Update in August 2023, with easing commodity prices and inflation. However, the region continues to face downside risks from adverse global economic growth, trade, and tourism developments. These risks may be triggered by an escalation of geopolitical tensions, leading to increased commodity prices, inflation, and pressure on current accounts and fiscal deficits. Moreover, the persistent threat of natural disasters and extreme weather events continues to present significant risks. A decline in growth will have significant and varied implications for poverty in the Pacific. Fiji and Tonga are expected to make progress in poverty reduction. Fiji is projected to return to pre-COVID levels of poverty by 2024, even with a slower-than-projected economic recovery. Vanuatu may grapple with sustained high poverty rates, worsening with a slower economic recovery amid persistent output gaps. Kiribati’s poverty is anticipated to decrease gradually, but 25 percent slower growth could impede progress in poverty reduction. The Marshall Islands are projected to revert to pre-COVID poverty levels by 2026. Non-monetary constraints, such as restricted access to services and education, significantly contribute to shaping poverty outcomes in these countries. Pacific island countries grapple with the dual challenge of subdued growth and slowed poverty reduction. To reverse this trend, boosting economic growth through increased investment is crucial for achieving development goals. Without additional policy measures and international assistance, however, these economies are expected to experience tepid investment growth in the coming decade. Policy shifts enhancing macroeconomic stability and implementing structural reforms, combined with well-functioning institutions, have proven effective. A favorable external environment plays a pivotal role in facilitating these positive outcomes. The trajectory of accelerated and sustainable growth in Pacific island countries depends on a workforce that is well educated and equipped with enhanced skills and capabilities. There is compelling evidence that a more educated workforce can substantially contribute to accelerated and sustainable growth through heightened employability, increased economic mobility, and enhanced resilience to shocks. 5 Boosting education and skills is essential for long-term growth and poverty reduction in the Pacific island countries. More education and improved skills will help people prepare for more productive jobs (either domestically or internationally), innovate, and be more resilient. For many people living in poverty, education is their most valuable asset. However, many adults in the PIC-11 have not completed high school, limiting their chances to secure better paying jobs. Providing people with a better education starts by ensuring that every child can read with comprehension by the end of primary school. Pacific island countries have made great strides in increasing access to basic education, but the quality of education varies widely. Merely attending school is insufficient; children must be learning in school. In nine out of 11 PICs, more than half of 10-year-olds are unable to read and understand age-appropriate texts, a phenomenon known as “learning poverty”. High learning-poverty rates mean that many people will not have the necessary foundation needed to ensure that their region can adapt and innovate. While multiple factors influence learning, once a child enters school, teachers have the largest impact. High-quality teaching is essential to improving foundational learning and students’ skills. However, many Pacific island countries continue to face significant teaching challenges. Classroom observations reveal that two-thirds or more of teachers employ weak teaching methods, and survey data suggest that teacher absenteeism is high, with a detrimental impact on student learning. A robust body of evidence guides policymakers in improving teaching quality and ensuring that all young children acquire strong foundational skills. This report outlines a three-pronged program of action based on this evidence: attracting and recruiting effective teachers, enhancing existing teachers’ capacity, and motivating greater teacher effort. Recognizing that 54 percent of teachers expected to teach in 2035 are already recruited, the report emphasizes a special focus on enhancing the capacity of existing teachers. It provides examples of rigorously evaluated interventions, such as structured pedagogy and access to pre-recorded lectures by highly rated teachers. Implementing these recommendations will aid regional countries in accelerating learning, allowing children and societies to achieve their aspirations. 6 Preface and acknowledgements This Pacific Economic Update is part of an ongoing series intended to inform a broad audience of citizens, policy makers, business leaders, and international donors on economic trends and key development issues for Pacific island countries. Part one presents a detailed overview of the Pacific islands’ economic outlook, risks, and policy recommendations. Part two provides a special focus on enhancing the foundations of education in the Pacific. This edition of the Pacific Economic Update was led by Ekaterine Vashakmadze (Senior Economist and Team Leader), Reshika Singh (Senior Economist), Ruth Nikijuluw (Economist), and Lars M. Sondergaard (Lead Economist) under the guidance of David Gould (Lead Economist and Program Leader), Stephen N. Ndegwa (Country Director), Lalita Moorty (Regional Director, EFI), Lars Christian Moller (Practice Manager, MTI), Cristian Aedo (Practice Manager, Education), and Thomas Walker (Lead Economist and Program Leader). Stefano Mocci (Country Manager), Annette Leith (Resident Representative), and Degi Young (Resident Representative) provided valuable insights. The economic section was prepared by Ekaterine Vashakmadze, Reshika Singh, and Ruth Nikijuluw, with contributions from Vishesh Agarwal, Lodewijk Smets, Mehwish Ashraf, Samuel Wills, Angella Faith Montfaucon, Csilla Lakatos, Tuimasi Ulu, Sandra Kapota Murray, Debasish Das, Shohei Nakamura, Johanna Fajardo-Gonzalez, Blair Edward Lapres, Dana Vorisek, Daisuke Fukuzawa, Kersten Kevin Stamm, Warunthorn Puthong, and Sama Khan. The special focus section was prepared by Lars Sondergaard and Paul Marie Michel Cahu, drawing heavily on a recently completed World Bank report entitled Fixing the Foundation: Teachers and Basic Education in East Asia and Pacific. Tom Perry, Hamish Wyatt, Vika Waradi, and Amelia Taylor provided support on communications and Greenhouse Studio provided document design. Nika Asasi, Connor Syddall, and Serkan Altin provided overall project support. The team would like to express appreciation for feedback from Andrew Blackman, Kim Edwards, Michael F. Crawford, and Samuel Christopher Hill. This report is a product of the staff of The World Bank. The findings, interpretations, and conclusions expressed in this report do not necessarily reflect the views of the Executive Directors of the World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. The boundaries, colors, denominations, and other information shown on any map in this work do not imply any judgment on the part of the World Bank concerning the legal status of any territory or the endorsement or acceptance of such boundaries. To be included on an email distribution list for the Pacific Economic Updates and related publications, please contact Nika Asasi: nasasi@worldbank.org or Serkan Altin: saltin@worldbank.org. For questions and comments relating to this publication, please contact Ekaterine Vashakmadze: evashakmadze@worldbank.org, Lars Sondergaard: lsondergaard@worldbank.org, Reshika Singh: rsingh39@worldbank.org or Ruth Nikijuluw: rnikijuluw@worldbank. org. For information about the World Bank and its activities in the Pacific, please visit: www.worldbank.org/en/ country/pacificislands 7 Acronyms ADB Asian Development Bank AE Advanced economies AUD Australian dollars BoE Bank of England BoJ Bank of Japan BON Bank of Nauru CAL Computer-assisted learning CAR Capital adequacy ratio CBSI Central Bank of Solomon Islands CBR Correspondent banking relationships CLRW Come Let’s Read and Write EAP East Asia Pacific ECAL Environment and Climate Adaptation Levy ECB European Central Bank EMDE Emerging market and developing economies EQAP Educational Quality & Assessment Programme Fed Federal Reserve System FSM Federated States of Micronesia FY Fiscal year GATS General Agreement on Trade in Services GDP Gross Domestic Product GEP Global Economic Prospects HIES Household income and expenditure survey IFSWF International Forum for Sovereign Wealth Funds IMF International Monetary Fund ITTSI Inside In-Service Teacher Training LSCI Liner Shipping Connectivity Index LAR Liquid asset ratio MICS Multiple Indicator Cluster Surveys MISAT Marshall Islands Standards Assessment Test MTB-MLE Mother-tongue based multilingual education MTDS Medium-term debt strategies MTEF Medium-term expenditure frameworks NPLs Non-performing loans NPRT Nauru Phosphate Royalty Trust NTF Nauru Trust Fund OECD Organisation for Economic Co-operation and Development OPEC+ Organization of the Petroleum Exporting Countries PALM Australia’s Pacific Labour Mobility (PALM) scheme 8 PCRAFI Pacific Catastrophe Risk Assessment and Financing Initiative PER Public Expenditure Review PGST Palau Goods and Services Tax PIC Pacific island country PIRLS Progress in International Reading Literacy Study PNG Papua New Guinea PPG Public and publicly guaranteed R&D Research and Development RBA Reserve Bank of Australia RBV Reserve Bank of Vanuatu RBNZ Reserve Bank of New Zealand REER Real effective exchange rate RERF Revenue equalization and reserve fund RMI The Republic of the Marshall Islands RPC Regional Processing Centre RSE New Zealand’s Recognized Seasonal Employer SACMEQ The Southern and Eastern Africa Consortium for Monitoring Educational Quality SAS Sa Aklat Sisikat SBM School-based management SDs Standard deviations SEA-PLM Southeast Asia Primary Learning Metrics SR PICs Sovereign rent-led Pacific island countries SRD Statutory reserve deposit STAKI Standardized Tests of Achievement in Kiribati STRI Services Trade Restrictions Index SWFs Sovereign Wealth Funds T&R PICs Tourism and remittances-led Pacific island countries TALIS Teaching and Learning International Survey TARL Teaching at the Right Level TEGRA Tonga Early Grade Reading Assessment TFP Total-factor productivity TIMSS Trends in International Mathematics and Science Study UNWTO The United Nations World Tourism Organization US United States USD United States dollar VAT Value Added Tax WDI World Development Indicators WTO World Trade Organization 9 List of figures Figure 1: GDP growth 12 Figure 2: Inflation and policy rates 14 Figure 3: Global commodity prices 15 Figure 4: GDP growth 16 Figure 5: Visitor arrivals in Fiji 17 Figure 6: Measures of real output 22 Figure 7: Consumer price inflation 23 Figure 8: Fiscal balance and revenue (percent of GDP) 25 Figure 9: General government debt (percent of GDP) 26 Figure 10: Policy rates and bank lending-deposit rate spreads (percentage points) 28 Figure 11: Current account (share of GDP) 29 Figure 12: PIC-11 real GDP growth projections 31 Figure 13: Pacific real GDP growth projections (long-term) 33 Figure 14: PIC-11 GDP growth 33 Figure 15: Growth in the Pacific islands since 2000 35 Figure 16: Inflation (percent) 37 Figure 17: Poverty outlook and simulations with different growth scenarios, 2019-26 40 Figure 18: In nine out of 11 Pacific island countries, more than half of students are not meeting international 54 benchmarks in reading Figure 19: Teachers are central to student learning 55 Figure 20: Many teachers in the Pacific need to strengthen their use of teaching practices that are known to 57 help students learn Figure 21: Teacher content knowledge is often weak: Examples from Lao PDR and Indonesia 58 Figure 22: Teacher training programs do not employ practices linked to improved student learning 59 Figure 23: The majority of those expected to be teaching in 2035 have already been recruited 60 Figure 24: Impact evaluation of in-service teacher training programs in the region shows that it can lead to 62 better learning outcomes: Example from Tonga’s Come Let’s Read and Write intervention Figure 25: Computer assisted learning programs have helped improve student learning in the East Asia and 64 Pacific regions List of tables List of boxes Table 1: PIC-11 growth forecast summary 30 Box 1: Grouping of the Pacific island countries 19 Table 2: PIC-11 growth forecast 32 Box 2: The compact agreement in the North Pacific 34 Table 3: Pacific Consumer Prices 37 Box 3: Sovereign wealth funds in the Pacific 45 Table 4: Fiscal rule and medium-term 43 Box 4: Services trade restrictions 48 debt strategies in the Pacific islands 10 PART 1: Economic overview: Slow global recovery and enduring challenges in the Pacific 11 1.1 Global and regional context In 2024, global growth is projected to decelerate, posing a significant challenge for PIC-11 countries, which unlike advanced economies and many emerging markets and developing economies (EMDEs), are struggling to bring their output back to pre-pandemic levels. 1. Global growth, which declined to an estimated 2.6 percent in 2023 due to tight monetary policies and geopolitical tensions, is projected to slow further to 2.4 percent in 2024 (Figure 1). A modest upturn to 2.7 percent is projected in 2025, contingent on lower inflation and interest rates and geopolitical stability. In the United States, growth is projected to slow to an average of 1.7 percent in 2024-25 after a robust performance in 2023. Australia and New Zealand are expected to experience a slowdown, with growth rates decelerating from an estimated 1.8 percent and 1.1 percent in 2023 to 1.4 percent and 1 percent in 2024, respectively. This reflects the dampening impact of increasing mortgage repayments on real disposable household income and domestic demand. Despite ongoing policy support measures, China‘s economy is projected to slow to an average of 4.4 percent in 2024-25, following 5.2 percent growth in 2023, due to persistent weaknesses in the property sector. Figure 1. GDP Growth A. GDP growth, world, AEs, EMDEs, PICs (percent) B. GDP growth, major trading partners (percent) 8 10 8 3 6 4 -2 2 0 -7 -2 -4 -12 -6 2019 2020 2021 2022 2023e 2024f 2025f 2019 2021 2023e 2025f World AEs EMDEs PIC-11 China Australia Japan New Zealand USA Note: AEs= Advance Economies, EMDE=Emerging Market and Developing Economies, PIC = Pacific island countries. 2. The PIC-11's delayed catch-up from COVID-19 intensifies challenges. Many Pacific countries are grappling with the aftermath of the global recession, COVID-related lockdowns, terms of trade shock, and a protracted recovery in global tourism and travel. Pacific island countries initially bore the brunt of the global recession followed by the direct impact of lockdowns, as the virus arrived later than in other parts of the world. In many cases, these challenges were compounded by country-specific shocks, including natural disasters, policy uncertainties, and epidemics. This sequence of events has caused economic recovery to lag many other parts of the world, thereby prolonging the period of economic and social upheaval and leaving lasting scars on the Pacific islands. 12 3. A delayed global Asian tourist recovery has hindered the revival of the highly exposed Asian tourist market in Palau. Although international tourist arrivals approached 1.3 billion in 2023 (almost 90 percent of 2019 levels) and global tourist receipts reached an estimated USD 1.4 trillion in 2023, representing 93 percent of 2019 earnings, recoveries varied by region. The Middle East surpassed pre-pandemic levels by 22 percent. In Europe and Africa, the recovery stands at 94 percent and 96 percent of pre-pandemic levels, respectively. However, the Asia-Pacific region has experienced a slower recovery, remaining at 65 percent of pre-pandemic levels. 4. Growth in some exporting countries, like Solomon Islands, was also negatively affected by weak global goods trade in 2023. Global trade volume grew by an estimated 0.2 percent in 2023—the slowest in 50 years outside of global recessions (World Bank 2024). This resulted from a decline in goods trade partially offset by a rise in services trade following eased pandemic mobility restrictions. 5. The return to pre-pandemic output levels has been notably slow, with PIC-11 output following a lower trajectory than anticipated before the pandemic. Global shock in the Pacific was further exacerbated by country-specific idiosyncratic events, including political uncertainty in Solomon Islands and Vanuatu, a measles outbreak in Samoa, and natural disasters in Tonga and Vanuatu, with the latter experiencing multiple cascading shocks. Progress in closing the gap in per capita income with advanced economies has been limited, excluding Fiji. In 2023, per capita income is forecasted to be below its 2019 level in over one-third of these countries, signifying a concerning trend. Many PIC-11 countries are increasingly falling behind, indicating a critical need for strategic interventions. 6. Global trade is set to recover this year, contributing to growth in Pacific island countries after a stagnant 2023, supported by a rebound in goods trade. Global trade is projected to grow 2.3 percent in 2024, followed by a more robust 3.1 percent increase in 2025. Despite this positive trend, the responsiveness of global trade to output is expected to remain lower in the near term due to a subdued investment outlook. On a positive note, global tourist arrivals are forecast to return to pre-pandemic levels in 2024. The initial estimates point to two percent growth above 2019 level, driven by pent-up demand and improved air connectivity, especially in Asia and the Pacific. The positive outlook is reflected in the latest UNWTO Tourism Confidence Index survey, with 67 percent of tourism professionals indicating better or much better prospects for 2024 compared to 2023. Some 28 percent expect similar performance, while only six percent expect tourism performance in 2024 to be worse than last year (UN Tourism 2024). 7. While global inflation has peaked, it remains elevated and is maintaining pressure on imported inflation in the Pacific (Figure 2). After declining from its multi-decade peak of 8.7 percent in 2022 to an estimated 6.9 percent in 2023, global inflation decline has slowed. This trend, marked by major central bank tightening, a moderation in housing markets, and China’s property sector crisis, indicates a steady reduction. In China, inflation remains below target due to falling food and fuel prices and economic slack. Australia and New Zealand observe a gradual moderation of core inflation pressures influenced by tight labor markets and positive output gaps. 8. In 2024, global inflation is projected to stay about two percentage points above its long-term average, potentially continuing to exert pressure on inflation in Pacific island countries. Despite a projected decline to 5.8 percent in 2024 due to tighter monetary policies and falling commodity prices, a return to target levels may not occur in many countries until 2025. Across Asia, inflation is expected to meet central bank targets, outpacing achievements in other countries. Gaps in economies like Australia and New Zealand are projected to narrow, with a corresponding moderation in core inflation. In China, a gradual rise in inflation is anticipated as output gaps close, driven by increased food and fuel prices. 13 9. Global monetary policy is expected to remain tight until major economies achieve inflation targets. Tightened financial conditions result from policy rate hikes, impacting advanced and emerging economies. Since late 2021, advanced economies raised rates by approximately 400 basis points, while emerging markets increased by around 650 basis points (IMF 2023). Spillovers to emerging markets, particularly those with lower credit ratings, led to slower growth and financial stress. Despite this, many economies displayed resilience. However, core inflation remains elevated in Australia and New Zealand, prompting prolonged higher interest rates. In November 2023, Australia reached its highest policy rates in 12 years. As 2024 progresses, inflation is expected to slow, allowing for potential monetary policy easing. Figure 2. Inflation and policy rates A. Deviation of annual consumer price inflation B. Monetary policy expectations (basis points) from its long-term average rate (percent) 6 4 2 4 0 2 -2 -4 0 -6 -8 -2 2020 2021 2022 2023e 2024f 2025f -10 Jan-19 Jul-20 Jan-22 Jul-23 Jan-25 World AEs EMDEs United States United Kingdom Euro area C. Inflation outlook in selected economies D. Policy rates (basis points) (percent) 6 6 5 4 4 3 2 2 0 1 0 -2 2022 2023e 2024f 2025f -1 2019Q1 2020Q3 2022Q1 2023Q3 China Australia Japan New Zealand USA China Australia Japan New Zealand United Kingdom Euro area USA Source: IMF; ECB; RBA; Fed; RBNZ; BoJ; BoE. Note: AEs=advanced economies; EMDEs=emerging market and developing economies. 14 10. Despite moderation, high commodity prices place significant pressure on Pacific countries that are heavily reliant on commodity imports. Commodity prices, measured in U.S. dollars, declined in 2023 due to moderating demand (Figure 3). However, they still stand 35 percent higher on average than pre-pandemic levels. Crude oil prices, marked by Middle East tensions, averaged USD 83/bbl, a 17 percent drop from 2022’s USD 100/bbl. Projections suggest a slight moderation in prices to USD 81/bbl in 2024 due to OPEC+ easing production cuts and weaker global demand. Food prices fell nearly eight percent in 2023, except for rice, which saw a 23 percent increase due to export restrictions by India. Food prices are expected to drop two percent in 2024 and an additional three percent in 2025. Figure 3. Global commodity prices A. Agriculture, Energy, Metal and Mineral prices B.Change in Agriculture, Non-energy, Energy (Index. 2010=100) prices from 2019 (percent) 170 37 140 36 110 35 80 34 33 50 32 20 Jun-19 Dec-20 Jun-22 Dec-23 31 Energy Agriculture Metals & Minerals Energy Non-energy Agriculture Source: Haver Analytics; World Bank. 15 1.2 Recent economic developments Growth in the PIC-11 decelerated in 2023 but remained robust. This reflects a normalization of activity in Fiji, which accounts for more than half of the group’s output. The PIC-11, excluding Fiji, experienced a widespread resurgence with expansion gaining momentum in eight out of ten economies. The recovery has been supported by the gradual resumption of economic activity and travel. 1.2.1 Growth 11. Growth in the PIC-11 slowed to an estimated 5.5 percent in 2023, from a peak of 9.1 percent in 2022 (Figure 4; Table 1). This reflected a normalization of activity in Fiji, which accounts for more than 50 percent of the PIC-11’s output. Growth in Fiji slowed to a robust eight percent in 2023 following a 20 percent rebound in 2022, which was fueled by reopening after pandemic-related restrictions. The slower growth in Fiji was still higher than the modest recovery in the rest of the group. Despite the economic slowdown, Fiji contributed approximately 80 percent to the 2023 growth rate in PIC-11. Figure 4. GDP Growth A. GDP growth, the PIC-11, Fiji, and the PIC-11 B. Contribution to PIC-11 GDP growth excluding Fiji (percent change) (percentage point) 25 15 PIC-11 Fiji PIC-11 excl. Fiji 20 10 15 5 10 0 5 0 -5 -5 -10 -10 -15 -15 2019 2020 2021 2022 2023e PIC-11 excl. Fiji Fiji PIC-11 -20 2019 2020 2021 2022 2023e Source: Haver Analytics; World Bank. Source: IMF; World Bank. Note: All data in the report is presented on a calendar year basis for consistency and comparability. For countries with fiscal year different to the calendar year period, data in a calendar year basis are computed based on fiscal year’s estimates. The data presented, corresponding to fiscal years, is explicitly indicated as such. 16 12. Fiji’s growth slightly exceeded earlier expectations. With an estimated eight percent growth, Fiji’s economy fully recovered in 2023 to pre-COVID-19 levels, driven by the resurgence of tourism and consumption. At the end of 2023, tourist arrivals exceeded 2019 levels by four percent. This was led by visitors from Australia, New Zealand, and the United States following the release of pent-up demand (Figure 5). Canada is emerging as another source market for Fiji post-COVID. A new non-stop route, launched in late-November 2022, contributed to a 65 percent increase in arrivals in 2023 relative to 2019. Favorable local conditions in Fiji, such as an early border reopening, over 95 percent COVID-19 vaccination rate, and stringent COVID-19 safety protocols, underpinned a strong recovery in the tourism sector. Figure 5. Visitor arrivals in Fiji A. Monthly arrivals (thousands) B. Visitor arrivals by country, January-November 2023 (thousands) 120 400 100 80 300 60 200 40 Total (% of 2019) 20 100 0 Sep Oct Dec Jun Jul Jan Aug Apr Mar May Nov Feb 0 Australia NZ US China Other 2019 2020 2021 2022 2023 Number of visitors Share of 2019 Source: Haver Analytics; World Bank. 13. Following three consecutive years of contraction, PIC-11 output, excluding Fiji, expanded by an estimated 2.7 percent in 2023. This growth was a broad recovery as economic activity gained traction. Eight out of ten Pacific economies, excluding Fiji, experienced an acceleration in activity in 2023. Nauru and Vanuatu stood out as exceptions to the sub-regional pattern. In Nauru—the only country in the group that managed to avoid the pandemic-induced recession in 2020—growth slowed from 1.7 percent in 2022 to 1.0 percent in 2023, due to a scale down of the Regional Processing center (RPC).4 In Vanuatu, growth slowed from 1.9 percent in 2022 to 1.5 percent in 2023, as economic activity suffered from the impact of twin cyclones on tourism and agriculture amid political disruptions and uncertainty. 4 From 2012 to 2023, the average annual revenue from the RPC, an offshore Australian immigration processing facility, represented approximately 34.6 percent of Nauru’s GDP. The revenue peaked at 62.3 percent in 2020 and is estimated to have declined to 11 percent of GDP in 2023. 17 14. Growth in Solomon Islands—the region’s second largest economy—rebounded less robustly than expected. Output expanded by 1.9 percent in 2023 after experiencing a 4.1 percent contraction in 2022. Economic activity was bolstered by the Pacific Games and significant investments in the energy and transport sectors. In addition, the revival of mining, spurred by the reopening of the Gold Ridge mine in late 2022, provided significant support to the construction and services sectors. However, the lasting impacts of the civil unrest in November 2021 and declines in logging and agriculture productivity continue to hold back growth. Growth in 2023 was 0.6 percentage points below August projections, reflecting lower-than-expected government spending. 15. Growth accelerated in tourism and remittances-led countries, supported by borders reopening. The aggregate growth for this group increased to an estimated 3.4 percent in 2023—more than twice its long-term average. This followed a nine percent cumulative output contraction in 2020-21 and a subdued 0.8 percent growth in 2022. The recovery was broad-based. Three out of four tourism and remittances-led countries, including Palau, Samoa, and Tonga experienced stronger growth in 2023. Vanuatu was an exception, with growth slowing to an estimated 1.5 percent in 2023 due to twin cyclones and policy uncertainty. 18 Box 1. Grouping of the Pacific island countries The Pacific islands consist of a diverse group of countries scattered across the Pacific Ocean. The PIC-11 varies in population, land area, and economic size. Fiji is the most populous nation and has the largest economy in the region, followed by Solomon Islands (Annex 1). Both countries are therefore classified into a separate group, leaving nine countries (PIC-9), which stand out for their relatively small size. These countries are sub-grouped based on their economic foundations and revenue sources. The first sub-group includes countries that rely on international tourism and earnings from nationals working abroad, namely Palau, Samoa, Tonga, and Vanuatu. These countries are classified as tourism and remittances-led countries. Except Palau, all the other countries are in the Southern Pacific. In these countries, revenue from tourism and remittances account for approximately 41 percent of GDP (Figure B1). The second sub-group is comprised of FSM, Kiribati, Marshall Islands, Nauru, and Tuvalu—all countries that receive significant revenue from natural resources, such as fishing, and other non-tax revenue. These countries are classified as sovereign rent-led countries. All countries in this group, except for FSM, are either full atoll or predominantly atoll (coral reef) islands. In these countries, sovereign rents (for example, fishing license revenues) account for approximately 30 percent of GDP, while the average contribution of tourism and remittance is only about 14 percent. These countries also have significant share of external grants in the economy, accounting for more than 35 percent of GDP on average.5 In tourism and remittances-led countries, economic fluctuations are influenced by tourism seasons and global economic conditions. These countries are extremely vulnerable to external shocks, such as global economic downturns or travel restrictions (as seen during the COVID-19 pandemic). Three countries within this group—Samoa, Tonga, and Vanuatu are more susceptible to natural disaster cycles than other Pacific island countries (IMF, 2019).6,7 In sovereign rent-led countries, economic stability is closely tied to global commodity prices, fishing revenue, and other non-tax income. These countries are vulnerable to fluctuations in global demand for their natural resources and income from non-tax revenue. As they have less diversified economies, they also receive more overseas aid. Fluctuations in grants, as well as external receipts from fishing or external trust funds, are the driving forces in their economies (Duncan, 2016). As aid plays a significant role in their economy, these countries may face challenges meeting conditions set by donors and ensuring sustainable development. While most tourism and remittances-led countries have their own currencies, all sovereign rent-led countries are dollarized economies and use either the Australian dollar or the U.S. dollar (Annex 1). The dual perspective dependencies explain the distinct growth trajectories of these sub-groups during and after the COVID-19 pandemic. The tourism and remittances-led countries experienced a more severe contraction in the aftermath of the COVID-19 pandemic, primarily due to the significant impact of border restrictions on tourism and remittances (Figure B1). 5 Tonga, identified as one of the tourism and remittances-led countries, ranks as the third highest in terms external grants as a share of revenue among the small PICs (PIC-9), following FSM. However, the size of aid in the Tongan economy (around 25 percent of GDP) is still significantly lower than the size of remittance and tourism which accounts for almost 40 percent of GDP. 6 All Pacific island countries, except for Nauru and Palau, are categorized as disaster-prone countries, defined as countries that belong to the fourth quartile (75-100%) of the Annual Probability Distribution of Natural Disasters. Historical data further show that damage from natural disasters can be substantial for some countries, in particular Samoa, Tonga, Vanuatu with damages from disaster ranging from 16 to 60 percent of GDP. For more details on this statistic please see IMF (2019) and Figure 16 in the August edition of Pacific Economic Update (World Bank 2023b). 7 Although disaster risk is a common underlying factor for these countries, the timing of disasters is not synchronized across them. Therefore, for the purposes of this regional report, we treat disasters as idiosyncratic risks that have significant impact on country-specific development paths but are the secondary factor when examining the regional outlook. The proposed classification captures the channels through which natural disasters impact the economy. For instance, severe natural disasters, which occur more frequently in the Southern Pacific countries (Samoa, Tonga, Vanuatu), affect tourism and remittances, leading to fluctuations in economic performance (Duncan, 2016). 19 Figure B.1 Income sources and GDP growth A. Main sources of income (percent of GDP) B. GDP growth (percent) 120 4 80 2 40 0 0 -2 Fiji Solomon Isl. Palau Tonga Vanuatu Samoa Tuvalu Kiribati Nauru FSM RMI -4 -6 -8 Tourism & Sovereign rent-led remittances-led 2019 2021 2023e Tourism & Remittances Sovereign rents Grants Tourism & remittances-led PICs Sovereign rent-led PICs Sources: Haver Analytics; IMF: World Bank. Note: 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. 16. There was notable variability in growth within tourism and remittances-led countries. This variability was largely due to an uneven resurgence in global tourism and travel, coupled with country-specific factors affecting economic activity. The vigorous return of tourists from Australia and New Zealand benefited Samoa, while the sluggish tourism recovery in Asia delayed economic recovery in Palau. Local factors also played a significant role. Samoa’s tourism recovery proved robust, partly driven by a surge in visitors whose travel plans were hampered even before the COVID-19 pandemic due to the measles outbreak in late 2019. Meanwhile, challenges persist in flight and accommodation availability, particularly after natural disasters in Tonga. Ongoing difficulties in flight availability also hindered the tourism recovery in Palau. 17. A surge in remittance inflows fueled by the global reopening also benefitted this group. The impact has been highest in labor-sending countries like Samoa and Tonga. Over one-third of nationals from these countries live in OECD countries as part of the diaspora population (World Bank, 2017a).8 Both countries also benefitted from the expansion of seasonal worker programs in Australia and New Zealand. The number of visas issued for workers in Australia’s Pacific Labour Mobility (PALM) scheme and New Zealand’s Recognized Seasonal Employer (RSE) doubled compared to pre-COVID-19 levels from July 2022 to June 2023. Samoa, Tonga, and Vanuatu are the largest suppliers, accounting for almost 60 percent of the total visas issued. Remittances continued to grow in Samoa, albeit at a slower pace, and are estimated at approximately 30 percent of GDP in 2023. It is estimated that remittances remained above 40 percent of GDP (approximately USD 239 million) in Tonga in 2023. 8 The ratio of diaspora living in OECD countries to nationals living at the home country is 50 percent for Tonga and around 46 percent for Samoa. Nationality here represents individual’s place of birth or ancestry. 20 18. Divergences in tourism recovery among tourism and remittance-led countries highlight distinct challenges. Palau’s tourism sector lags significantly, in contrast to stronger recoveries in Fiji and Samoa. The slow recovery in Palau is attributed to reliance on specific East Asian markets, delayed resumption of international flights, and the appreciation of the U.S. dollar affecting competitiveness. Late resumption of flights in 2023 deepened the contraction and delayed tourism recovery in Palau. Samoa faced hurdles like a measles outbreak in 2019, prolonged COVID-19 border closures, and severe floods in 2020, yet achieved around 90 percent of 2019 tourism levels in 2023. Natural disasters have significantly impeded tourism recovery in Tonga and Vanuatu, shaping the trajectory of their recovery. 19. Within tourism and remittances-led countries, recovery was led by Samoa. The country experienced a remarkable 5.6 percent growth in 2023 fueled by tourism and increased remittances. This followed a cumulative output contraction of over 12 percent in 2020-21, compounded by the measles outbreak. Growth in 2023 was almost double Samoa’s trend growth rates. In Tonga, a growth pickup to three percent in 2023 was somewhat subdued, reflecting lingering post-disaster challenges. Growth was led by reconstruction efforts and consumption driven by remittances, supported by a mild recovery in tourism, amid challenges related to severely damaged tourism infrastructure. In Palau, economic growth resumed at a subdued pace in 2023 after three consecutive years of recession, with output expanding by an estimated 3.7 percent—6.6 percentage point below earlier expectations. In Vanuatu, growth slowed to an estimated 1.5 percent in 2023 due to twin cyclones causing disruptions to tourism and agriculture. The opening of borders and public infrastructure investments partly offset these challenges. 20. Aggregate growth in sovereign rent-led countries accelerated moderately to 2.3 percent in 2023. The aggregate numbers, however, mask divergences within the group. Kiribati, Nauru, and Tuvalu— three Central Pacific countries which are also marked by the highest sovereign rents—have exhibited the least overall impact from COVID-19 and diverse recent growth performance. Nauru’s growth continued to decelerate, reaching one percent in 2023 due to a scale-down of the RPC. This comes after growth of 1.7 percent in 2022, following an impressive 8.1 percent expansion in 2021. In Kiribati, growth strengthened marginally, from 3.9 percent in 2022 to 4.2 percent in 2023—above trend growth—assisted by border reopening in August 2022.9 Tuvalu’s GDP grew by two percent in 2023, compared to 0.4 percent in 2022, attributed to dividends from the border reopening in December 2022. However, this was almost two percentage points below earlier projections due to delays in the implementation of investment projects. 21. FSM and Marshall Islands demonstrated less fluctuations in growth, but relatively weak overall growth compared to pre-pandemic levels. A gradual reopening of borders and an increase in public wages in the national government supported a resurgence in FSM’s growth, from near stagnation in 2022 to approximately one percent in 2023. However, labor shortages led to a slower-than-expected recovery of construction activity. In addition, revenues from registering a foreign insurance company in FSM declined. In the Marshall Islands, real GDP expanded by a modest 1.4 percent in 2022 despite a sharp contraction in fisheries output due to the sale of a domestic vessel. The rest of the economy expanded robustly, helped by a recovery in domestic demand. Growth strengthened to an estimated three percent in 2023, as performance in the fisheries sector improved, with construction activity supported by the resumption of donor-financed projects and preparations for the 2024 Micronesian Games. 9 Kiribati, which recovered early and strongly from the pandemic shock due to supportive fiscal policies, with real GDP growing 8.5 percent in 2021, experienced a deceleration as a domestic COVID-19 outbreak and a severe drought dampened economic activity in 2022. 21 22. By the end of 2023, regional output recovered to pre-pandemic levels, falling less than one percent short (Figure 6). The rebound was led by a swift recovery in Fiji following an equally severe contraction. However, the PIC-11 output (excluding Fiji) is estimated to have remained around four percent below its pre- pandemic level, reflecting a prolonged recession with significant output gaps in Samoa, Solomon Islands, and Palau. The combined economic output in tourism and remittances-led countries still lags almost five percent below its pre-pandemic level. In contrast, output in sovereign rent-led countries, which exhibited a relatively mild contraction in 2020, has rapidly rebounded and stood approximately four percent above its pre-pandemic level. Figure 6. Measures of real output A. Real GDP (2019=100) B. 2023 output compared to 2019 105 20 10 100 0 95 -10 -20 90 Fiji Solomon Isl. Vanuatu Tonga Samoa Palau Nauru Kiribati Tuvalu Marshall Isls. FSM 85 2019 2020 2021 2022 2023e T&R PICs SR PICs PIC-11 excl. Fiji Sovereign rent-led PICs Tourism and remittances-led PICs PIC-11 PICs PICs excl. Fiji Source: World Bank. 1.2.2 Inflation 23. Average inflation in the PIC-11 decreased from its 7.5 percent peak in 2022 to 6.5 percent in 2023. This decline reflects a broad-based trend, with inflation moderating in almost three-quarters of the PIC-11 countries in 2023. However, the PIC-11 witnessed its peak median inflation in 2023, occurring one year later than global, EMDE, and East Asian inflation (Figure 7). The median inflation in PIC-11, which experienced a notable acceleration to 5.5 percent in 2022, increased to an estimated 5.9 percent in 2023. The dynamics of inflation varied across countries and were influenced by the state of economic recovery, government policies, commodity dependence, impact of natural disasters on domestically produced goods, and the presence of supply bottlenecks. Elevated inflation poses a significant threat to the livelihoods of Pacific Islanders. Based on internationally comparable price information using 2017 data, the price of milk, cheese, and eggs in Fiji was more than 50 percent higher than expected, considering the size of the economy. 22 Figure 7. Consumer price inflation A. PIC-11 countries (percent) B. World, EMDE, East Asia, PIC-11 (percent) 18 9 12 6 6 0 Micronesia Tonga Nauru Marshall Islands Fiji Samoa Palau Tuvalu Solomon Islands Vanuatu Kiribati 3 T&R PIC SR PICs 0 2019 2020 2021 2022 2023e 2023e 2022 World PIC-11 East Asia EMDE Source: IMF; World Bank. Source: IMF; World Bank. Note: Annual average. Note: Median. World and EMDE exclude EAP countries. C. Price level index for Fiji and other world economies, 2017 250 Milk, cheese, and eggs 230 210 190 170 Other countries Price level index Fiji 150 130 110 90 70 50 6 7 8 9 10 11 12 Log of GDP per capita (US$ in 2017 PPP) Source: Staff calculations using the ICP 2017 data. Note: Price level index (PLI) = 100 for the world average. 23 24. In Fiji, consumer price inflation dropped from 4.3 percent in 2022 to 2.4 percent in 2023. This lower inflation allowed the central bank to maintain an accommodative monetary policy. Fiji’s inflation remained subdued compared to trading partners, leading to a depreciating real effective exchange rate (REER) and aiding the recovery of the tourism sector. Administered price controls and fiscal measures temporarily played a key role in mitigating the impact of high energy prices.10 On a monthly basis, inflation reached its lowest point in July 2023 at 0.3 percent and then surged to 5.1 percent by December. This was propelled by a rapid and strong demand recovery, coupled with the consequences of consolidating the nine percent and 15 percent VAT rates—a measure implemented in August 2023.11 25. The median inflation in PIC-11s (excluding Fiji) peaked at 6.9 percent in 2023, with significant variation between countries (Figure 7). In Solomon Islands, inflation eased to an estimated 4.7 percent in 2023. The easing of price pressures was driven by falling energy and food prices, coupled with the tightening monetary policy stance since March 2023. Nevertheless, inflation persisted well above the long-term average. 26. Given their greater exposure to global markets, tourism and remittances-led countries experienced significantly higher inflation than sovereign rent-led countries. The median inflation in tourism and remittances-led countries peaked at 10.6 percent in 2022, moderating to a still high figure of 8.2 percent in 2023. In Samoa, while both the headline and core inflation eased in 2023, they remain elevated at 7.9 and 11 percent, respectively. This is a result of high commodity prices, increased freight costs, persistently high inflation in key trading partners, a prolonged accommodative monetary policy, and a depreciating Tala. In late 2023, inflation in Tonga receded, moving closer to the central bank’s target rate of five percent after briefly surging to double-digit levels in 2022. Inflation reached its peak in 2022 driven by the substantial impacts of the disaster on agricultural crops, compounded by higher global commodity prices. However, core inflation remains high, reflecting labor shortages and supply bottlenecks amid significant migrant outflows, and heightened demand, including for reconstruction. In Palau—the country which relies the most on imported energy among the PIC-11—inflation has spiked to historical highs driven by import prices for food and fuel, the introduction of the Palau Goods and Services Tax (PGST), and a sizeable one-off utility tariff increase. In Vanuatu, inflation was estimated at 8.3 percent in 2023. The domestic economy is still grappling with rising global food and energy prices, high import and transport costs, domestic supply constraints relating to two cyclones in 2023, and the minimum wage increase. 27. The median inflation in sovereign rent-led countries decreased from an estimated 5.3 percent in 2022 to 4.4 percent in 2023. Among this sub-group, only Kiribati had a significant spike in inflation in 2023, following a severe drought that affected the agricultural sector and resulted in supply shortages, which were compounded by elevated freight costs. Inflation surged to an estimated 9.2 percent in 2023 from 5.3 percent in 2022. This rise was primarily driven by an acceleration in the prices of food and non-alcoholic beverages, with sugar alone accounting for nearly 70 percent of the overall increase in inflation. In Tuvalu, inflation is expected to dampen from 12.1 percent in 2022 to 5.9 percent in 2023 due to easing global inflationary pressures and commodity prices. Price pressure remained relatively contained in FSM and Marshall Islands in line with easing global commodity prices. 10 These measures include a zero VAT rate on essential items, removal of the Environment and Climate Adaptation Levy (ECAL), and fiscal duty elimination on fuel. 11 Before August 2023, most goods and services had a nine percent VAT rate, while some had a 15 percent rate. After August 2023, the VAT rate for all items previously at nine percent was raised to 15 percent, while zero-rated items remained unchanged. 24 1.2.3 Fiscal and debt dynamics 28. While fiscal performance varied, around half of the PIC-11 initiated fiscal consolidation in 2023. Fiji successfully reduced its fiscal deficit from previously elevated levels, attributed to the gradual phasing out of stimulus measures and an increase in domestic revenues. However, additional efforts are required to diminish fiscal deficits and address vulnerabilities associated with elevated debt levels. In Solomon Islands, the fiscal deficit remained high at 3.9 percent of GDP, given the spending pressures from the significant investments for the 2023 Pacific Games and preparations for the 2024 elections. In 2023, expenditure on the Pacific Games and election activities constituted 2.6 percent and 1.5 percent of GDP, respectively. Figure 8. Fiscal balance and revenue (percent of GDP) A.Fiscal balance B.Composition of revenue source in 2023 180 10 160 5 140 0 120 -5 100 -10 80 -15 60 -20 40 Kiribati Fiji Solomon Isls. Vanuatu Tonga Palau Samoa Nauru Micronesia Marshall Isls. Tuvalu 20 0 Samoa Vanuatu Tuvalu Micronesia Solomon Isls. Palau Tonga Marshall Isls. Fiji Kiribati Nauru Tourism & remittances - Sovereign rent & grants T&R PICs dependent PICs SR PICs PICs - dependent Tourism & remittances-led PICs Sovereign rent-led PICs 2023 2022 Other non tax revenue Sovereign rent Tax revenue Grants 2022 2023 Source: IMF Article IV (2023), World Bank staff calculation. Note: Based on the PIC9 PER definition. Sovereign rent includes fishing license fees (FSM, Kiribati, Marshall Islands, Nauru, Tuvalu), Economic Citizenship Program (Vanuatu), TV domain (Tuvalu), and RPC revenue (Nauru). Data for FSM is based on the latest publised IMF Article IV reports. Data for 2023 are estimates. 29. Among the tourism and remittances-led countries, capital and reconstruction expenditure explains the fiscal balance dynamic, apart from Palau. Although revenues remained strong in Samoa in 2023, the fiscal surplus shrank as capital expenditure execution accelerated. Tonga shifted from a small surplus in 2022 to a fiscal deficit due to ongoing reconstruction and recovery from recent natural disasters. In Vanuatu, the government recorded a fiscal surplus in the first half of 2023, although it is expected to record a deficit by the end of the year. The surplus was supported by solid revenue performance, domestic economic recovery, and budget support from development partners to assist with recovery from the twin cyclones. Palau undertook fiscal consolidation, achieving a balanced budget in 2023 as part of its efforts to reduce its substantial public debt despite significant economic slack and a delayed recovery. 30. Most sovereign rent-led countries experienced declines in fiscal surpluses due to declines in revenue. FSM and Tuvalu have unwound their significant fiscal surpluses to offset revenue losses and bolster their slower economic recovery. In Nauru, the fiscal surplus declined due to a reduction in RPC-related activities but remained sizable at more than seven percent of GDP in 2023.12 Marshall Islands maintained a balanced budget in 2023 as lower grant inflows were offset by a decrease in current expenditure. Kiribati was the only country in this sub-group that recorded a fiscal deficit in 2023. It has successfully reduced its fiscal deficit from previously elevated levels due to the gradual phasing out of stimulus measures and an increase in domestic revenues. However, additional efforts are needed to achieve fiscal balances that are consistent with government’s fiscal responsibility ratio13 in the medium term. 12 The fiscal balance, excluding the government’s contribution to the Nauru Trust Fund (NTF). 25 13 Kiribati’s fiscal responsibility ratio requires cash reserves to be maintained above three months of fiscal expenditure. 31. In 2023, the Pacific experienced improved debt dynamics due to the overarching fiscal trend and growth rebound. Public debt as a share of GDP decreased in eight of the PIC-11 economies, driven by economic recovery and enhanced government revenues (Figure 9). In Fiji, public debt declined to 83 percent in 2023 after peaking at 93 percent in 2021 due to the fiscal consolidation but remained 30 percentage points higher than pre- COVID levels. Throughout the COVID-19 pandemic, Fiji’s public debt surged by more than 40 percentage points, driven by domestic and external debt, with the latter accounting for more than half (55 percent) of the build-up. This rise stemmed from fiscal stimulus measures aimed at safeguarding vulnerable households and businesses from the repercussions of COVID-19 and the twin cyclones. Conversely, and despite fiscal consolidation efforts, public debt in Palau remains high, at about 60 percent of GDP in 2023. Excluding Fiji and Palau, the median public debt in the region stood at approximately 22 percent of GDP in 2023, ranging from around 40 percent in tourism and remittances-led countries such as Tonga and Vanuatu to less than 15 percent in sovereign rent-led countries (FSM, Kiribati, and Tuvalu). Figure 9. General government debt (percent of GDP) A. Public debt B. Median government debt 90 100 80 60 60 40 20 30 0 Kiribati Fiji Nauru Vanuatu Micronesia Marshall Isl Tuvalu Samoa Palau Solomon Isl Tonga 0 Solomon Isl Sovereign Tourism & rent-led PICs Fiji remittances- led PICs T&R PICs SR PICs 2022 2023 2019 2023 2022 C. General government debt, Fiji 100 25 20 75 15 10 5 50 0 -5 25 -10 -15 0 -20 20 e 20 f f 15 16 17 18 19 20 21 20 2 24 25 23 2 20 20 20 20 20 20 20 20 External debt Domestic debt GDP growth (RHS) Source: IMF; World Bank. Note: In March 2021, Nauru settled with U.S.-based hedge fund Firebird, reducing external debt by 83 percent. The dispute stemmed from Nauru’s guarantee on defaulted bonds from the bankrupt Nauru Phosphate Royalty Trust (NPRT). Firebird, which acquired bonds in 2009, sought repayment through legal action. The settlement involved a A$4 million (4.4 percent of GDP) payment to Firebird, absolving Nauru from future claims. 26 32. Despite starting from high levels, debt dynamics are generally improving, particularly in Fiji and tourism-led economies. Fiji holds the highest level of public debt among the PIC-11, but it has been declining since 2022 in line with revenue-based fiscal consolidation. Solomon Islands, on the other hand, has a moderate level of debt, but is consistently increasing amid persistent fiscal deficits driven by spending associated with the COVID-19 response and the Pacific Games 2023. Tourism and remittances-led countries exhibit three times higher debt. Palau is at the upper end with public debt of approximately 60 percent of GDP, while Samoa sits with the lowest public debt in the group at just over 30 percent of GDP supported by recent fiscal surpluses. Debt in the sovereign rent-led countries (excluding Nauru) averaged approximately 10 percent of GDP in 2023. Nauru’s public debt to GDP was more than double the group’s average at (22 percent of GDP), a third of which was related to the liquidation of the Bank of Nauru. 1.2.4 Monetary policy and the financial sector 33. In 2023, monetary policies among countries with their own currencies diverged.14 The Reserve Bank of Fiji maintained an accommodative stance due to subdued inflation until late 2023. In contrast, the Central Bank of Solomon Islands (CBSI) transitioned from prolonged accommodation to tightening from 2023Q1, raising the cash reserve requirement from five to six percent in March 2023. In total, five of the PIC-11—including the two largest ones, Fiji and Solomon Islands and three tourism and remittances-led countries (Samoa, Tonga, and Vanuatu)—have their own currencies and operate under a fixed exchange rate regime pegged against a weighted basket of currencies. 34. Central banks in tourism and remittances-led countries with their own currencies (Samoa, Tonga, Vanuatu) are gradually withdrawing loose monetary conditions. The National Reserve Bank of Tonga (NRBT) increased the statutory reserve deposit (SRD) ratio from 10 to 15 percent in February 2023, while maintaining the policy rate at zero percent. The Central Bank of Samoa (CBS) aims to absorb liquidity, normalize monetary policy, and address domestic demand pressures and inflation. The Reserve Bank of Vanuatu (RBV) also responded to high price pressures by raising the SRD ratio by 0.25 basis points in December 2023. Effective January 2024, commercial banks must hold 5.5 percent of their deposit liabilities as statutory reserves with the RBV, up from the previous 5.25 percent. The policy rate, liquid asset ratio (LAR), and capital adequacy ratio (CAR) are maintained at 2.25 percent, five percent, and 10 percent, respectively.15 35. In the basket peg context, the rising U.S. dollar is partially offset by other currencies in the basket depreciating. This mitigates the necessity for abrupt increases in interest rates to uphold the exchange rate regime, which acts as a reliable nominal anchor, ensuring predictability in exchange rates and import payments. Despite the comparatively accommodative monetary policy, domestic lending rates have remained high— influenced by structural factors—placing Pacific countries with some of the highest interest margins in the world (World Bank, 2023c) (Figure 10). 36. Banking systems exhibit robust capitalization and liquidity, though non-performing loans raise concerns in some countries. The PIC-11 has largely avoided adverse effects from banking sector turmoil. Bank earnings and private sector lending show improvement in most countries, albeit at a modest pace. Non- performing loans (NPLs) are decreasing overall, except in Tonga, where the NPL rate reached 8.4 percent in mid-2023, up from 6.3 percent the previous year despite a rebound in credit growth. Countries with high NPLs and low provisioning, like Fiji, Solomon Islands, and Vanuatu, face financial stability risks. In these countries, the NPLs net of provisions to capital ratios stood at 20, 28, and 44 percent, respectively. 14 Five of the PIC-11—including the two largest ones, Fiji and Solomon Islands and three tourism and remittances-led countries (Samoa, Tonga, and Vanuatu)—have their own currencies and operate under a fixed exchange rate regime pegged against a weighted basket of currencies. The remining six PIC-11 countries, are dollarized and are using either the U.S. or the Australian dollar. None of the sovereign rent-led PIC (FSM, Kiribati, Marshall Islands, Nauru, and Tuvalu) countries and one of the tourism and remittances-led countries (Palau), have their own currencies or monetary policy. 15 RBV Press Release_SRD change Final.pdf (gov.vu) 27 Figure 10. Policy rates and bank lending-deposit rate spreads (percentage points) A.Central bank policy rates B. Bank lending-deposit rate spreads 1.0 3.5 12 3.0 0.8 10 2.5 8 0.6 2.0 6 1.5 0.4 4 1.0 0.2 2 0.5 0 0.0 0.0 2019Q1 2020Q3 2022Q1 2023Q3 2019Q1 2020Q3 2022Q1 2023Q3 Fiji Samoa Solomon Islands Vanuatu (RHS) Fiji Vanuatu Tonga Solomon Islands Samoa Source: Country authorities. Source: Country authorities; World Bank staff estimates Note: For Solomon Islands, rate is based on 28-day Bokolo Bills of CBSI. 1.2.5 External sector 37. The external sector has demonstrated positive trends, aligning with broader economic recovery, fiscal consolidation, and stronger exports. Fiji’s current account has experienced a significant improvement, driven by increased tourist inflows and economic recovery. This contributed to the maintenance of robust foreign reserve levels. By contrast, Solomon Islands continues to grapple with a persistent and large current account deficit, largely influenced by a negative trade balance. The continued appreciation in the REER and a decline in log export prices amid high import prices led to a decline in the terms of trade, worsening the current account. Despite modest growth in agricultural exports, the import acceleration associated with the 2023 Pacific Games is expected to have exerted further pressure on the trade balance. 38. Idiosyncratic factors led to a mixed performance of the external sector in tourism and remittances- led and sovereign rent-led countries. However, the external position improved because of services exports, in particular the strong rebound in tourism arrivals and earnings, as well as continued remittance inflows.16 Despite a rise in imports, the net positive impact has improved economic conditions (Figure 11). Samoa was significantly affected by the pandemic given its reliance on the tourism sector. As borders reopened and tourism rebounded strongly, the current account deficit halved in 2023 compared to 2022. Other tourism and remittances-led countries have maintained large current account deficits. Heightened import demands from reconstruction efforts following recent disasters affected the current account in Tonga and Vanuatu. A sluggish recovery in tourism arrivals and elevated commodity prices combined with a deteriorating term of trade have strained Palau’s external position. In addition, the strong U.S. dollar (relative to other major currencies) led to the overvaluation of the REER in 2022, impacting Palau’s competitiveness. In sovereign rent-led countries, such as Kiribati and FSM, the trade balance has seen marked improvement, driven by increased goods exports and a resumption of travel and transport services following the reopening of borders. Meanwhile, in Tuvalu, moderating revenue streams, including development grants and fishing license fees, led to a modest decline in the current account surplus. 16 Many Pacific countries maintain a service trade surplus with overall economies relying heavily on service sectors for employment and growth. Services contributed to more than half of the region’s GDP and employed nearly 48 percent of workers. However, the Pacific region is limited by the scale of internal markets, which limits competition in services. For more detailed discussion on services trade restrictions in Pacific, please see Box 4. 28 Figure 11. Current account (share of GDP) 30 20 10 0 -10 -20 -30 -40 -50 Fiji Solomon Islands Vanuatu Samoa Tonga Palau Kiribati Nauru Marshall Islands Tuvalu Micronesia Tourism and remittances-led PICs Sovereign rent-led PICs 2022 2023 2009-19 Source: Country authorities; World Bank staff estimates. 29 1.3 Pacific economic outlook The PIC-11 is anticipated to experience a continued deceleration in growth in 2024. After reaching its pre-pandemic GDP levels in 2023, Fiji’s growth is expected to normalize toward its long-term rate. In the rest of the region, growth is projected to marginally accelerate and surpass its pre- pandemic level only in 2025. Nevertheless, output is projected to linger nearly 10 percent below the pre-pandemic trend by the same year. 1.3.1 Growth outlook 39. In 2024, the PIC-11 is anticipated to experience a deceleration in growth to a still-strong 3.5 percent (Table 1). This reflects the ongoing normalization of activity in Fiji toward its long-term rate. Despite the deceleration, this will be the highest growth rate observed since 2017, excluding the recovery years of 2022 and 2023. Growth in the region is expected to remain above the trend rate of 2.2 percent in 2024-25. These projections broadly align with the August 2023 projections. Table 1. PIC-11 growth forecast summary (Real GDP growth at market prices in percent, unless indicated otherwise) Percentage point differences from August 2023 projections 2020 2021 2022 2023e 2024f 2025f 2023f 2024f PIC-11 -11.2 -2.8 9.1 5.5 3.5 3.3 0.0 -0.1 Memo items: GDP Fiji -17.0 -4.9 20.0 8.0 3.6 3.3 0.3 -0.4 Solomon Islands -3.4 -0.6 -4.1 1.9 2.8 3.1 -0.6 0.4 PICs excl. Fiji -4.8 -1.0 -0.5 2.7 3.4 3.3 -0.5 0.3 Tourism and -6.7 -2.4 -0.8 3.4 4.0 4.1 -0.5 0.5 remittances-led PICs Sovereign rent-led -1.8 2.2 1.4 2.3 2.7 1.8 -1.5 -0.8 PICs Source: World Bank. Note: e = estimate; f = forecast; World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries’ prospects do not differ at any given moment in time. The data is presented on a calendar year basis for consistency and comparability purposes. For countries with fiscal year different to the calendar year period, data in a calendar year basis are computed using the cubic splining method based on fiscal year’s estimates. 30 40. In Fiji, the trajectory of recovery is linked to the outlook for tourism. Despite experiencing a robust rebound, growth is poised to decelerate to just over three percent in the medium term. This deceleration comes as the initial post-COVID-19 demand boost for tourism gradually subsides and new source markets are constrained by limited hotel capacity. However, strategic measures such as diversifying beyond tourism, enhancing infrastructure resilience and adaptation, investing in human capital, and harnessing talent are expected to be drivers of sustained growth. 41. Solomon Islands’ recovery is forecast to gain traction with the support of significant energy and transport infrastructure projects (Table 2). In the medium term, the services sector is expected to play a pivotal role in sustaining growth, followed by the construction sector and an upswing in mining activity. These sources of growth assume heightened significance, particularly in the face of a projected decline in logging that could otherwise suppress primary sector growth. 42. In the PIC-11, excluding Fiji, where recovery has been delayed, growth is projected to exhibit a modest acceleration from 2.7 percent in 2023 to 3.4 percent on average in 2024-25 (Figure 12). Growth is expected to be driven by tourism and remittances-led countries, with a projected average grow of 4.1 percent in 2024-25—nearly double the group’s trend growth rate. Vanuatu is expected to see accelerated growth over the medium term. This relates to the confluence of recovery in the tourism sector and reconstruction efforts following the 2023 twin cyclones, which is expected to stimulate economic activity and contribute to growth. On the other hand, following a strong rebound in 2023, growth in Samoa and Tonga is expected to moderate towards long-term averages. The sovereign rent-led countries are projected to grow relatively modestly by 2.3 percent on average in 2024-25, already converging with their trend growth rates as they did not experience extreme growth volatility like the tourism and remittances-led countries. Figure 12. PIC-11 real GDP growth projections B.Tourism and remittances-led PICs and sovereign A. PIC-11, PIC-11 excl. Fiji, Fiji rent-led PICs 25 20 6 15 4 10 2 5 0 0 -2 -5 -4 -10 -15 -6 -20 -8 2019 2020 2021 2022 2023e 2024f 2025f 2019 2021 2023e 2025f PIC-11 Fiji PIC-11 excl. Fiji Tourism & remittances-led PICs Sovereign rent-led PICs Source: World Bank staff estimates. Note: All data in the report is presented on a calendar year basis for consistency and comparability. For countries with fiscal year different to the calendar year period, data in a calendar year basis are computed based on fiscal year’s estimates. 31 Table 2. PIC-11 growth forecast (Real GDP growth at market prices in percent, unless indicated otherwise) Percentage point differences from August 2023 projections 2020 2021 2022e 2023f 2024f 2025f 2023f 2024f Fiji -17.0 -4.9 20.0 8.0 3.6 3.3 0.3 -0.4 Solomon Islands -3.4 -0.6 -4.1 1.9 2.8 3.1 -0.6 0.4 Tourism and remittances-led -6.7 -2.4 0.8 3.4 4.0 4.1 -0.5 0.5 PICs Palau -10.0 -11.9 0.1 3.7 12.3 9.6 -6.6 3.9 Samoa -10.1 -2.3 0.0 5.6 4.3 3.7 0.1 0.1 Tonga -1.1 -3.1 0.4 3.0 2.3 1.9 0.1 -0.4 Vanuatu -5.4 0.4 1.9 1.5 2.6 3.9 0.0 0.0 Sovereign rent-led -1.8 2.2 1.4 2.3 2.7 1.8 -1.5 -0.8 PICs Kiribati -0.6 8.5 3.9 4.2 5.6 2.0 1.7 3.2 Marshall Islands -1.3 -0.5 1.4 3.0 2.7 1.9 1.1 0.5 Micronesia, Fed. -2.8 -1.8 -0.2 0.9 1.3 1.5 -2.3 -1.1 Sts. Nauru 0.9 8.1 1.7 1.0 1.3 1.9 0.2 -0.7 Tuvalu -4.3 1.8 0.4 2.0 1.8 2.4 -1.8 -1.7 Source: World Bank. Note: e = estimate; f = forecast; World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries’ prospects do not differ at any given moment in time. The data is presented on a calendar year basis for consistency and comparability purposes. For countries with fiscal year different to the calendar year period, data in a calendar year basis are computed based on fiscal year’s estimates. 43. Given the ongoing recovery and lingering economic slack, the aggregate growth in tourism and remittances-led countries is expected to continue to surpass the long-term average (Figure 13). In Samoa, sustained growth in the tourism sector and robust remittance inflows are expected to support the broader economy. This momentum will be complemented by the acceleration of post-border reopening capital investments, including preparation for the Commonwealth Heads of Government Meeting in October 2024, contributing to a broad-based recovery. For Tonga, the resurgence in agriculture and commerce and the completion of reconstruction projects are the primary forces behind economic recovery. The successful culmination of these factors is expected to propel Tonga toward a path of sustainable growth. Notably, remittances in Samoa and Tonga have played a crucial role in sustaining domestic consumption during the pandemic and are expected to contribute to ongoing growth. With remittance inflows projected to remain significantly above pre-pandemic levels due to new temporary migration schemes, an improved current account balance and an overall uptick in economic activity is anticipated. This highlights the resilience and adaptability of these economies in navigating challenging global circumstances. 32 Figure 13. Pacific real GDP growth projections (long-term) A.Tourism and remittances-led countries (percent) B. Sovereign rent-led countries (percent) 6 6 4 4 2 2 0 0 -2 -2 -4 -4 -6 -6 -8 -8 2020 2021 2022 2023e 2024f 2025f 2020 2021 2022 2023e 2024f 2025f Source: World Bank staff estimates. Note: Red lines denote long-term average growth. 44. Palau is expected to record a strong 12.3 percent growth in 2024. This reflects a bounce-back following delayed post-COVID-19 tourism recovery and a resumption of direct airline routes from Asia (Figure 14). Palau will also benefit from the renewal of the U.S. compact agreement in the North Pacific, which is expected to play a pivotal role in determining economic assistance commitments to these countries (Box 2). The resulting economic assistance can serve as a catalyst for fostering sustainable development and enhancing the overall resilience of these economies. Figure 14. PIC-11 GDP growth 14 12 10 8 6 4 2 - Marshall Islands Fiji Solomon Isls. Palau Samoa Vanuatu Tonga Kiribati Tuvalu FSM Nauru T&R PICs SR PICs 2025 2024 Source: IMF, World Bank. Note: All data in the report is presented on a calendar year basis for consistency and comparability. For countries with fiscal year different to the calendar year period, data in a calendar year basis are computed based on fiscal year’s estimates. 45. The aggregate growth within the sovereign rent-led countries is projected to accelerate to 2.7 percent in 2024, before moderating to long-term average growth in 2025. In Nauru, the anticipated decline in RPC revenues is poised to exert pressure on both fiscal performance and overall growth. The renewal of the compact agreement in the North Pacific will be crucial for FSM and Marshall Islands, as it will determine the level of committed economic assistance to these countries. This extension has the potential to generate significant fiscal space, offering an opportunity to allocate more resources to public investment initiatives (Box 2). In Tuvalu, dividends from borders reopening in December 2022, elevated current spending, and full resumption in infrastructure projects are expected to play a pivotal role in shaping economic trajectory in 2024. 33 Box 2. The compact agreement in the North Pacific North Pacific countries heavily rely on U.S. aid. From 1987 to 2023, transfers under the U.S. Compact played a pivotal role, supporting a significant portion of economic activity, equivalent to approximately 30% of the region’s GDP. The aid primarily takes the form of annual budgetary support for specific sectors and contributions to sovereign trust funds. In addition to financial assistance, the U.S. grants citizens of North Pacific countries the right to reside and work in the US, along with access to various federal programs and services. The renewed Compact agreements mark a significant increase in aid for FY24, reversing a two-decade trend of decreasing levels. Since the renewal of the Compact agreements in 2003 for FSM and RMI, and 2010 for Palau, the region has experienced a considerable decline in Compact transfers, leading to a reduction in fiscal space for North Pacific budgets. The 2024 renewal represents a substantial short-term boost in funding for the region. Anticipated grant increases for FY24 are as follows: for FSM, from 20 percent of GDP in FY23 to 28 percent in FY24; for RMI and Palau aid is expected to double from 15 percent of GDP to 31 percent of GDP in RMI; and from 6 percent of GDP to 12 percent of GDP in Palau. Figure B.2.1: Compact transfers, Figure B.2.2: Compact transfers, FY23 FY10-FY43 (% of GDP) and FY24 (% of GDP) 40% 35% 35% 30% 30% 25% 25% 20% 20% 15% 15% 10% 10% 5% 5% 0% 0% FSM Marshall Islands Palau 30 20 38 36 28 26 40 32 34 24 22 42 10 18 16 12 14 FY23 FY24 FY FY FY FY FY FY FY FY FY FY FY FY FY FY FY FY FY FSM RMI Palau Sources: U.S. Congressional Office; ADB, IMF WEO; World Bank staff estimates. Note: Assistance for Marshall Islands does not include payments for Kwajalein under the MUORA (Military Use and Operating Rights Agreement). Projected growth rates from 2024-2028 are from IMF WEO October 2023 with the average pre-pandemic growth rate (2000-2019) assumed from 2029 onwards. Despite an expected increase in short-term Compact-related transfers, fiscal and structural reforms are critical to promote long-term fiscal sustainability and growth. Following a sharp increase in transfers in FY24, Compact transfers are expected to decline in the medium-term as a share of GDP (Figure B.2.1). The renewed Compact agreements are currently awaiting US Congressional approval. Even assuming a timely approval of the Compact, fiscal reforms are needed to provide the fiscal space for necessary climate investment to address the increased frequency of natural disasters and sea level rise. Structural reforms that focus on building climate resilience, removing barriers to private sector investment, and promote investments in human capital are equally critical to promote long-term growth. Financial sector reforms including FinTech initiatives have to be developed with sufficient controls to ensure financial integrity and stability. 34 1.3.2 Medium-term growth prospects 46. 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. Formidable obstacles, such as human capital constraints, connectivity deficiencies, and inadequate infrastructure, hinder growth and development. These intrinsic challenges magnify the influence of external factors, including geographical distance from key markets, limited economies of scale, and heightened vulnerability to the adverse effects of natural disasters and climate change. Despite a commendable rebound in growth post- border reopening, the PIC-11 countries are essentially reverting to their 2019 output levels, posing challenges to sustained development. 47. According to preliminary analysis, the medium-term growth prospects for the PIC-11 have declined from 3.2 percent per year in 2000-11 to 2.7 percent in 2012-19 (Figure 15; World Bank 2023b). 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, which was around 5.4 percent in the 2000s, is projected to slow to around three percent in the medium- term. Without fundamental reforms and sustained international support, PIC-11 growth is projected to plateau at this lower rate. Furthermore, more than half of PIC-11 countries, including 80 percent of sovereign rent-led countries, are projected to grow more slowly in per capita terms than advanced economies, resulting in a widening income gap. Figure 15. Growth in the Pacific islands since 2000 Over the past 20 years, growth in the Pacific islands has stagnated, with few exceptions. The highest cumulative growth rate of GDP per capita between 2000 and 2019 was achieved by Nauru. The slow growth is related to low potential growth amid subdued investment growth. A. Potential output growth B. Investment growth 5 5 4 Percent 3 3 2 1 0 0 2020-27 2000-11 2012-19 2020-27 2000-11 2012-19 2000-11 2012-19 2023-25f Pacific islands EAP excl China Source: International Monetary Fund, Kose and Ohnsorge (2023); United Nations World Population Prospects. A. For Pacific islands, bars show unweighted, average expected five-year ahead growth rate from the World Economic Outlook. For EAP excl. China, bars show GDP weighted averages of potential growth estimates derived from the production function approach. (Kose and Ohnsorge 2023). B. Bars show simple averages of investment growth for PIC countries with available data: Fiji, Palau, Solomon Islands, and Vanuatu. 35 48. Economic recovery in the PIC-11 will be crucial in supporting poverty reduction efforts. Under current policies, the PIC-11 are expected to continue reducing poverty in the next few years. To assess the potential impact, poverty rates have been simulated for 2023 to 2026 considering the latest GDP projections for five of the PIC-11: Fiji, Kiribati, Marshall Islands, Tonga, and Vanuatu. These simulations are based on recently collected household income and expenditure surveys. According to the baseline GDP forecasts, all five countries are expected to continue reducing poverty, albeit at varying degrees and paces. In Fiji, during the early stages of the COVID-19 pandemic, the poverty rate (measured by the upper-middle-income poverty line of $6.85 per day in 2017 PPP), reached nearly 70 percent. However, with a solid economic recovery, it is projected to return to the pre-COVID level of 50 percent by 2024. Tonga is projected to continue its progress in reducing poverty (measured by the upper-middle-income poverty line of $6.85 per day) until 2026 based on the baseline GDP projection.17 On the other hand, Vanuatu’s poverty (measured by the lower-middle-income poverty line of $3.65 per day) is anticipated to remain high at around 44 percent for the next few years due to weak economic growth. In Kiribati, poverty is expected to continue falling, albeit at a slower pace. The poverty rate in Kiribati (measured by the $3.65 poverty line) is projected to decrease gradually from 16.8 percent in 2023 to 15.5 percent in 2026. In the Marshall Islands, the poverty rate (measured by the $6.85 poverty line) is anticipated to return to the pre-COVID level of 31.2 percent only by 2026. 49. Poverty reduction may also face constraints in non-monetary terms. While the incidence of multidimensional poverty is relatively low in many Pacific countries (as shown in Panel A of Annex 2), some countries experience high levels of deprivation in access to services (Panel B) and education (Panel C). For instance, Kiribati, Solomon Islands, and Vanuatu have significantly high proportions of their population deprived of access to essential services such as water, sanitation, and electricity. In other countries like Nauru and Tuvalu, school enrollment rates are relatively low, indicating limited access to educational opportunities. 50. Empowering individuals with enhanced skills is crucial for poverty alleviation in the region. For those in poverty, human capital is often their most significant asset. To fully capitalize on this asset, further investments are essential. At present, a considerable number of adults in many Pacific island countries have not attained a secondary education, which significantly limits their opportunities to improve their economic circumstances. Completing secondary education can open doors for people to break free from poverty. As will be explored in the following section, a fundamental obstacle to achieving secondary education is the widespread lack of proficiency in reading comprehension among the youth. 1.3.3 Inflation 51. Aligning with global trends and declining global commodity prices, the median headline inflation in the PIC-11 is projected to decline from 5.9 percent in 2023 to 4.3 percent in 2024 and ease further to 3.4 percent in 2025 (Figure 16). By contrast, in Fiji, inflation is projected to temporarily accelerate to 5.5 percent in 2024 when the full impact of the increase in VAT and other taxes settles into final prices. Price pressures are projected to ease in 2025 and converge with the country’s long-term average trend as demand-side pressures moderate in line with softening growth. Tighter monetary policy combined with a decline in commodity prices is expected to contribute to a gradual deceleration of inflation in Solomon Islands to around 3.7 percent in 2024 and 3.3 percent in 2025. 17 Tonga’s poverty with the upper-middle-income poverty line based on the 2021 Household and Income Expenditure Survey (HIES) in this report is a preliminary estimate. 36 Figure 16. Inflation (percent) A. PIC-11, PIC-11 excl. Fiji, Fiji, and Solomon Islands B. Tourism and remittances-led and sovereign rent-led PICs 10 12 8 10 6 8 4 6 2 4 0 2 -2 0 -4 2020 2021 2022 2023e 2024f 2025f 2020 2021 2022 2023e 2024f 2025f Tourism and remittances-led PICs Sovereign rent-led PICs Fiji Solomon Islands PIC-11 PIC-11 excl. Fiji Source: World Bank staff estimates. Note: Median. 52. In many PIC-9 countries, especially tourism and remittances-led countries, inflation in 2024 is expected to remain above the targets set by the central banks, despite declining global commodity prices. This reflects some country-specific factors, including tight labor market conditions and supply constraints. Inflation is projected to remain elevated in the short term, with a gradual subsiding anticipated over the medium term (Table 3). Inflation is projected to remain above four percent for all countries in the group, led by Vanuatu at 5.6 percent. Despite an overall moderation of high inflation rates, core inflation in several countries is projected to remain elevated, primarily due to persistent supply shortages. Table 3. Pacific Consumer Prices Table 3a Pacific consumer price inflation summary 2020 2021 2022 2023e 2024f 2025f PIC-11 0.8 2.6 5.5 5.9 4.3 3.4 Memo items: Fiji -2.6 0.2 4.3 2.4 5.5 3.4 Solomon Islands 3.0 -0.1 5.5 4.7 3.7 3.3 Average Inflation PIC-11 excl. Fiji 1.2 3.3 7.8 6.9 4.1 3.0 Tourism and remittances-led 0.9 3.3 10.2 9.2 4.9 3.1 PICs Sovereign rent-led PICs 1.1 4.0 6.4 5.4 3.5 3.0 Median Inflation PIC-11 excl. Fiji 0.9 2.8 5.9 6.9 4.1 3.0 Tourism and led PICs 0.0 3.0 10.6 8.2 4.8 3.6 Sovereign rent-led PICs 0.9 2.6 5.3 4.4 3.5 2.8 Source: World Bank. Note: Median inflation reported for PIC-11. e = estimate; f = forecast; World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries’ prospects do not differ at any given moment in time. 37 Table 3b Pacific consumer price inflation projections (annual average) 2020 2021 2022 2023e 2024f 2025f Fiji -2.6 0.2 4.3 2.4 5.5 3.4 Solomon Islands 3.0 -0.1 5.5 4.7 3.7 3.3 Tourism and remmittances-led PICs Palau 0.0 3.0 15.1 12.7 4.3 1.7 Samoa -1.6 3.1 11.0 7.9 5.0 4.0 Tonga 0.0 4.8 10.3 8.0 4.6 3.6 Vanuatu 5.0 2.4 4.6 8.3 5.6 4.7 Sovereign rent-led PICs Kiribati 2.6 2.1 5.3 9.2 3.5 2.5 Marshall Islands -0.1 2.6 5.0 4.2 2.9 2.4 Micronesia, Fed. Sts. 0.8 6.4 6.3 3.3 3.0 2.8 Nauru 0.9 2.4 3.2 4.4 4.3 3.7 Tuvalu 1.6 6.7 12.1 5.9 3.7 3.4 Source: Country authorities; IMF and World Bank staff estimates. Note: Note: e = estimate; f = forecast. World Bank forecasts are frequently updated based on new information and changing (global) circumstances. Consequently, projections presented here may differ from those contained in other Bank documents, even if basic assessments of countries’ prospects do not significantly differ at any given moment in time. All data in the report is presented on a calendar year basis for consistency and comparability. For countries with fiscal year different to the calendar year period, data in a calendar year basis are computed based on fiscal year’s estimates. 1.3.4 External sector 53. In most cases, the external sector is anticipated to improve in 2024-25, aligning with overall economic recovery and stronger exports. The current account deficit in Fiji is projected to continue to gradually narrow with support from tourism and remittances. Inward remittances are projected to remain close to ten percent of GDP, reflecting Fiji’s higher participation in labor mobility schemes. In Solomon Islands, the current account deficit is projected to narrow but remain substantial, averaging around 10 percent of GDP over 2023-25. This is primarily driven by high import demand related to infrastructure investments and a projected decline in logging exports. 54. For tourism and remittances-led countries, the anticipated recovery in tourism is expected to help narrow current account deficits. In Palau, a gradual resumption of flights, additional planned flights from source tourism markets (e.g., Korea, Hong Kong SAR, China, Macao SAR, China, and Singapore), and the construction of two new hotels starting next year are expected to support recovery in tourism arrivals and the current account in Palau. Combined with buoyant remittances, normalizing economic activity will reduce demand pressures, lower imports, and improve external balances in Samoa and Tonga. This positive trend is expected to help maintain foreign reserve adequacy. 55. For sovereign rent-led countries, current account deficits are projected to widen over the medium term, except in Kiribati. This reflects the anticipation that imports will outpace exports, accompanied by a decrease in inflows, particularly grants. For these economies, fishing license fees serve as substantial revenue streams. Consequently, the trajectory of the current account is expected to be influenced by the growth or decline in fish income. However, there are substantial risks to these projections due to the inherent volatility of fishing income. 38 1.3.5 Risks 56. Risks to the outlook include a faster-than-expected slowdown in global growth, tourism, and trade. In addition, heightened geopolitical tensions, including the conflict in the Middle East, could increase commodity prices. Domestic policy uncertainty, natural disasters, climate-related challenges, and the implementation of the compact agreement for the North Pacific countries also pose outlook risks. 57. Increased uncertainty and weaker-than-expected external demand pose risks to trade. China’s economic growth is experiencing a further slowdown amid heightened downside risks, with adverse implications for trading partners.18 In addition, trade tensions and fragmentation, particularly among major economies, may disrupt international trade flows with adverse effects on output. The threat of trade fragmentation among major economies, notably the United States and China, jeopardizes interconnected and integrated global supply chains. It is estimated that the escalation of trade barriers alone could reduce long-term global output by up to seven percent (IMF, 2023). 58. Conflict in the Middle East may intensify inflationary pressure through elevated commodity prices. Rising geopolitical tensions introduce uncertainty to the trajectory of commodity prices worldwide. The escalating conflict in the Middle East could lead to a potential surge in energy prices, adding inflationary pressure to the Pacific islands as net-importers. The IMF (2023) estimates that a 10 percent rise in oil prices could contribute to a 0.4 percentage point increase in global inflation. 59. Banking systems face heightened vulnerability. Banks in the PIC-11 lack diversification in their lending and assets portfolios and have high exposure to sovereign credit risk. Despite increased bank earnings, vulnerabilities persist. In undiversified economies, bank loans are less varied, with a significant portion concentrated in sectors like real estate. The risk of deteriorating asset quality is high given elevated loan levels and real wage erosion from inflation. While system-wide data appears benign, some banks face liquidity shortages and higher NPLs than system averages. Banks could also be affected through deposit liabilities to pension funds. These risks are pertinent in countries with high public debt burdens and sovereign linkages, including Fiji and Palau. In USD-based jurisdictions (FSM, Marshall Islands, and Palau), significant holdings of U.S. government debt may face market value loss in a rising monetary policy rate environment (World Bank 2023c). 60. Risks to correspondent banking relationships (CBRs), particularly for small markets, remain a concern as they would impede access to the global financial system and undermine resilience. Over the past decade, cross-border CBRs have declined 30 percent globally and doubled in the Pacific. The withdrawal of CBRs would have adverse consequences, impeding access to cost-effective financial services needed for trade, investment, remittances, and commercial transactions. Withdrawal of CBRs could also drive financial activity out of the regulated financial system and into informal channels, posing risks and challenges for financial oversight. Remittance flows, which play a critical role in tourism and remittances-led countries, would become more expensive, impacting seasonal laborers and vulnerable populations, especially women. 18 China is one of the top-three export partners for Fiji, FSM, Solomon Islands, and Vanuatu (The Atlas of Economic Complexity, https://atlas.cid. harvard.edu/, using 2021 data). 39 61. Several countries face specific risks. The election in Solomon Islands in April 2024, coupled with ongoing political instability in Vanuatu, could introduce economic uncertainty. The compact agreement implementation poses risk to FSM and Marshall Islands. The recent compact agreements in the North Pacific, while signed, are contingent on U.S. Congressional approval. This uncertainty may lead to delays and reliance on insufficient trust fund distributions. In the most extreme scenario, where funding gaps are notably significant—57 percent lower for FSM, 21 percent for Marshall Islands, and 18 percent for Palau—they could pose a hindrance to effective implementation.19 Further concerns involve limited state capacity affecting fund utilization and potential impacts on the countries’ reform appetite. Despite the infusion of new compact funding, structural reforms remain pivotal for growth and climate risk preparedness, emphasizing the essential need for coordinated efforts among donors. 62. Climate change persists as a pervasive and overarching risk. Most Pacific countries are facing heightened vulnerability to extreme weather events that affect agriculture and fisheries sectors. The Pacific atoll countries—Kiribati, Marshall Islands, and Tuvalu—bear substantial risk from climate variability and sea-level rise. 63. The realization of any downside risks could slow economic recovery, hampering progress in poverty reduction (Figure 17). Given the various risks faced by the PIC-11, simulations were conducted under multiple economic growth shock scenarios, including a 10 percent, 25 percent, and 50 percent lower growth rate each year to ascertain the impact on poverty rates. In Fiji, if the economic recovery is 25 percent slower than the baseline projection, although the poverty level is still expected to return to the pre-COVID level in 2024, the pace of poverty reduction would slow from approximately 2.5 points to 1.5 points annually. In Vanuatu, the poverty situation could worsen even further, leading to an increase in poverty rates in the event of a slower economic recovery. The poverty rate in Kiribati will stall if economic growth is 25 percent slower than the baseline. Figure 17. Poverty outlook and simulations with different growth scenarios, 2019-26 (A) Fiji 19 Funding gaps are defined as the disparity between the funding scenario with the renewal of the Compact and the scenario without further appropriations. For example, if the funding for FSM is X dollars with the new Compact, without the Compact, the funding would be 57 percent lower than X. The analysis by the Graduate School assumes additional appropriations from the trust funds for three years (FY24-27), after which these gaps might occur. There is also a possibility that, in addition to the trust funds, there could be temporary appropriations to bridge these gaps. Overall, the emergence of such substantial gaps is considered unlikely. 40 Tourism and remittance-led countries (B) Tonga (C) Vanuatu Sovereign rent-led countries (D) Kiribati (E) Marshall Islands Source: World Bank, Poverty and Equity Global Practice. Notes: A. The international poverty rate is $2.15 in 2017 PPP. The poverty rate for lower-middle-income countries is $3.65 in 2017 PPP. The poverty rate for upper-middle-income countries is $6.85 in 2017 PPP. B. Calculations based on EEAPOV harmonization using the most recent household income and expenditure survey (HIES) data for each country. Actual data: 2019. Nowcast: 2020-2022. Forecasts are from 2023 to 2026. C. Projections use a neutral distribution (2019) with a pass-through rate of 1 based on GDP per capita in constant LCU. D. The poverty impacts were calculated by re-estimating household consumption expenditures using the most recent harmonized data from HIES. The estimates assume a neutral pass-through of growth, with different scenarios of decrease in real GDP growth rates simulated since 2023. 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. 1.3.6 Policy considerations 64. Pacific countries are facing the challenge of convergence amid subdued growth and slower poverty reduction. Reversing this trend requires expediting economic growth through higher investment, which is pivotal for driving economic growth, poverty reduction, and achieving development goals in the region. However, without additional policy measures and international assistance, these economies are expected to witness tepid investment growth throughout the decade. Recent World Bank analysis highlights the potential for improvement. Countries experiencing investment accelerations have enjoyed significant economic benefits, including a two-percentage point increase in output growth and a 1.3 percentage point rise in productivity growth annually (World Bank 2024). Positive outcomes also encompass reduced inflation, improved fiscal and external balances, and a decline in the national poverty rate. Notably, policy shifts aimed at enhancing macroeconomic stability and implementing structural reforms, coupled with well-functioning institutions, proved effective in many cases. The role of a favorable external environment was pivotal in facilitating these positive outcomes. 41 65. In Pacific island countries, macroeconomic stability hinges upon the imperative of achieving a sustainable, effective, and pro-growth fiscal policy alongside a continued focus on building resilience to external shocks, natural disasters, and climate change, supported by ongoing international assistance. Fiscal policy priorities differ based on various factors. For example, in Fiji, the key fiscal policy priority should be to bring down the current elevated level of public debt to create fiscal space (World Bank 2023d). While this would strengthen the government’s capacity to respond effectively to future shocks, it would also help lower debt service obligations with the savings reoriented towards pro-poor and pro-growth measures. Lower debt service obligations would also ensure the stability of the financial system given the significant domestic government bonds in the government’s debt portfolio. Fiscal consolidation efforts could focus on diversifying revenue sources to reduce vulnerability, expenditure reprioritization towards areas that promote growth, resilience, and inclusion, improving efficiency of public spending, and ensuring fiscal resilience to natural disasters with insurance and other specialized financial instruments (World Bank 2023e). 66. Balancing social spending with fiscal constraints, investing in infrastructure strategically, and navigating global economic uncertainties are ongoing challenges. The effectiveness of fiscal policies hinges on the successful and consistent implementation of recent fiscal policy initiatives, including an increase in various tax rates and duties, such as VAT, corporate income tax, and excises. To mitigate the adverse distributional impacts of inflation, Fiji has been using fiscal measures such as reducing value-added taxes on essential goods, introducing subsidies on fuel, and implementing price controls on items like food. While these measures provide short-term relief, they lack targeted assistance for those most in need and strain already tight budgets. Implementing targeted and adaptive social protection programs could be considered as a more effective approach in addressing the challenges posed by rising food and fuel prices. 67. In Solomon Islands, fiscal policy should focus on restoring the government’s cash balance to reduce liquidity risks. This could be achieved through a combination of measures, including revenue diversification to reduce dependence on specific sectors and enhancing public expenditure efficiency and accountability (World Bank 2022a). Managing natural resources sustainably, allocating resources to social sectors, and strategically investing in physical and human capital are crucial. Additionally, building fiscal resilience to natural disasters remains a priority, reflecting the country’s vulnerability to such events. 68. In tourism and remittances-led countries, a key policy priority is creating fiscal space and building fiscal buffers to mitigate vulnerability to external shocks. This involves implementing reforms that foster private sector development, incentivize private investment, and ensure long-term economic sustainability. Tourism and remittances-led countries with limited fiscal space and a high risk of debt distress should prioritize expanding fiscal capacity through a medium-term consolidation strategy and fiscal rules. Fiscal consolidation is crucial for rebuilding fiscal buffers. This involves gradually withdrawing stimulus while safeguarding essential expenditures in areas such as health and education, ensuring a targeted social safety net and bolstering domestic revenue. 69. In countries where labor market shortages exacerbate price pressures, (Tonga and Samoa), a sound fiscal policy contributes to price stability. This is particularly important in the context of fixed exchange rate regimes, where discretionary monetary policy has limited effectiveness. Additionally, the implementation of structural reforms in the energy sector and efforts to boost domestic food production (where feasible) represents a strategic and long-term solution to reduce dependence on imports and create a buffer against high inflation. Furthermore, facilitating trade can contribute to lowering import costs, thereby contributing to effective inflation control measures. By combining these approaches, a comprehensive strategy can be developed to address both immediate concerns and establish resilient frameworks for sustained fiscal and economic stability. 42 70. In many tourism and remittances-led countries, fiscal positions can be strengthened by domestically mobilizing revenue. The tourism and remittances-led countries generate a smaller share of revenue from income, profits, and capital gains compared to its aspirational peers,20 reflecting significant structural tax gaps estimated at seven to 17 percent of GDP (World Bank 2023d). These gaps result from low compliance and narrow tax bases due to high thresholds and costly exemptions. A multifaceted approach, including VAT system enhancements, rationalizing tax exemptions, closing loopholes, and tax administration reform, could substantially increase tax revenues by several percentage points of GDP in the medium term (Sy et al. 2022; World Bank 2023d). Improving tax administration efficiency, including technology modernization, aims to enhance compliance, ease tax payment burdens, and strengthen enforcement through more effective audits. For instance, rationalizing tax exemptions in Tonga can enhance tax efficiency and equity by addressing distortions among sectors and businesses. 71. In sovereign rent-led countries, fiscal policy is crucial in the context of fixed exchange rates or dollarization. In these countries, fiscal policy is a primary tool for managing the economy, adjusting demand, and ensuring stability. Fiscal reforms should be underpinned by robust fiscal and regulatory frameworks. Crucially, addressing debt transparency, including on SOE guarantees and debts, and prioritizing non-concessional borrowing is vital to mitigate debt distress risks (Rivetti 2021). The implementation of clear medium-term fiscal frameworks, featuring well-designed fiscal rules, contributes to macroeconomic policy flexibility and bolsters investor confidence (Table 4). The medium-term expenditure frameworks (MTEF) also help prioritize spending and key investments, particularly to enhance climate resilience and link capital and current spending (World Bank 2023d).21 Table 4: Fiscal rule and medium-term debt strategies in the Pacific islands SWF Medium-term Public debt and fiscal Country Other fiscal rule Size (% of debt strategies deficit ceilings as of GDP) Fiji YES 0 Non-concessional Solomon Islands YES external borrowing 0 ceiling: 0% of GDP Tourism and remittances-led PICs Current Expenditure target Fiscal deficit ceiling: range: 35 to 38% of GDP 3.5% of GDP Samoa YES Personnel costs target 0 Disbursed Public Debt range: 40 to 45% and 40 to ceiling: 55% of GDP 41% of GDP Public wage bill ceiling: External public debt 53% of domestic revenue Tonga YES 0 ceiling: 50% of GDP Revenue floor: 21.5% of GDP Public debt ceiling: Vanuatu YES 0 60% of GDP 20 Tourism and remittances-led countries are relying more on indirect taxes (such as consumption and trade taxes) and much less on direct taxes (income, profit), compared to aspirational peer average. The aspirational peer refers to group of countries that are used in PIC-9 PER which includes Antigua & Barbuda, Fiji, Grenada, Mauritius, St. Kitts & Nevis, St. Lucia, Seychelles and Trinidad & Tobago. 21 Ongoing successful public financial and investment management reforms, exemplified in countries like Fiji, and two tourism and remittances- led countries (Samoa, Tonga), underscore the advantage of these initiatives. Several Pacific countries, including Solomon Islands, Fiji, and three tourism and remittances-led countries (Samoa, Tonga, and Vanuatu) have adopted medium-term debt strategies (MTDS) to guide debt management decisions. In addition, most of these countries (Samoa, Solomon Islands, Tonga, and Vanuatu) and Marshall Islands have borrowing ceilings or targets as part of domestic legislation or fiscal rules. The public debt ceiling varies, ranging from a zero ceiling for non-concessional external borrowing in Solomon Islands to a 60 percent of GDP ceiling for public and publicly guaranteed (PPG) debt in Vanuatu. The PIC-11, grappling with high macroeconomic volatility, may consider introducing structural balance rules. 43 SWF Medium-term Public debt and fiscal Country Other fiscal rule Size (% of debt strategies deficit ceilings as of GDP) Palau NO 107 FY20 Sovereign rent-led PICs Personnel costs: less than 30% of current expenditures Fiscal balance: non- Nauru NO Fiscal cash buffer: at least 122 FY21 negative two months of non-RPC expenditure FSM NO 143 FY20 RMI NO 205 FY20 Kiribati NO 456 Jul-21 Tuvalu NO 482 FY20 Source: IMF, World Bank. 72. In sovereign rent-led countries, implementing precautionary measures such as sovereign wealth funds (SWFs), could stabilize fiscal spending. FSM, Kiribati, Marshall Islands, Palau, and Tuvalu have established SWFs (Box 3). 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’ (IFSWF) 24 Santiago Principles. The funds also must be integrated into a comprehensive medium-term budgeting framework (Le Borgne and Medas 2007; Drew 2016). Many PIC SWFs have withdrawal rules that limit how much can be spent in any year, though the rules vary in strength (Box 3). PIC SWFs should adopt the Santiago Principles, institutionalize deposit, withdrawal and asset allocation rules, and ensure SWF withdrawals are invested in human and physical capital like healthcare and climate adaptation. 44 Box 3. Sovereign wealth funds in the Pacific All sovereign rent-led countries in the Pacific use sovereign wealth funds (SWFs) for managing fiscal revenues. Six of PIC-11 have at least one SWF: FSM, Kiribati, Marshall Islands, Nauru, Palau, and Tuvalu. The funds come from a mixture of non-renewable and renewable resources (FSM, Kiribati, Nauru, Tuvalu) as well as donor funds (Nauru, Tuvalu, and the US Compact countries of FSM, Marshall Islands, FSM, and Palau). It also varies widely in their size, investment performance, governance arrangements, and role in fiscal policy. Table B3: List of Pacific sovereign wealth funds islands Country SWF Year Source FSM Trust fund 1999 Fishing, taxes FSM Compact trust fund 2004 Donor: United States Revenue equalization and Kiribati 1956 Phosphate, fishing reserve fund Phosphate royalties trust Nauru 1968 Phosphate (closed) Donor: Australia, New Zealand, Nauru Intergenerational trust fund 2015 Taiwan SAR, China Marshall Donor: United States, Taiwan SAR, Compact trust fund 2004 Islands China, and tax revenue Donor: Australia, New Zealand, Tuvalu Trust fund 1987 United Kingdom, Japan, South Korea Consolidated investment Tuvalu 1987 Fishing, Tuvalu trust fund dividends fund Palau Compact trust fund 1994 Donor: United States Among the six countries in PIC-11, Kiribati has the largest funds, both in absolute terms and as a share of GDP, as well as the lowest management fees. Kiribati has a simple, diversified, low-cost investment strategy that allocates 50 percent of assets to global equities (managed by Blackrock), and 50 percent to AUD-denominated government bonds (managed by Northern Trust). It currently pays ~5.7bps in management fees, which is considerably less than most other Pacific funds. Kiribati’s low- cost investment strategy has also yielded the strongest returns in the Pacific (eight percent per annum for five years average). The funds have a variety of governance structures, though only Nauru is a signatory to the International Forum for Sovereign Wealth Funds’ (IFSWF) 24 Santiago Principles. These principles promote good governance, accountability, transparency, and prudent investments. PIC SWFs should be encouraged to adopt these principles. Governance in many Pacific funds would be improved with more advice from independent investment professionals. While donor-funded SWFs have boards that are appointed from the respective donor countries, the appointees are typically members of the civil service rather than investment professionals. For instance, the Kiribati’s Revenue Equalization and Reserve Fund (RERF) has received assistance from the World Bank treasury. 45 Figure B3: The size, performance, and management fees of Pacific SWFs Figure A. Size (% of GDP) Figure B. Five-year returns (% p.a net) Size (% GDP) 5y returns (% p.a. net) Kiribati RERF Kiribati RERF Tuvalu TF Tuvalu TF FSM CTF FSM CTF RMI CTF RMI CTF Palau CTF Palau CTF Nauru TF Nauru TF FSM TF FSM TF Tuvalu CIF Tuvalu CIF - 50 100 150 200 250 300 350 400 450 0 1 2 3 4 5 6 7 8 9 Figure C. Management fee (%) Figure D. Asset allocation (%) Management Fees Asset Allocation (%) Kiribati RERF Kiribati RERF Tuvalu TF Tuvalu TF FSM CTF FSM CTF RMI CTF RMI CTF Palau CTF Palau CTF Nauru TF Nauru TF FSM TF FSM TF Tuvalu CIF Tuvalu CIF 0 10 20 30 40 50 60 70 80 90 100 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 Fixed Income Equity Private Markets Sources: PIC-9 PER, Analysis-of-Pacific-National-Funds-Investment-Strategies-and-Results-Regional-Comparative-Study Note: Data as of: Nauru: 30 June 2022; FSM: 31 Dec 2022; Tuvalu: 31 Mar 2023; Kiribati & Palau: 30 Jun 2023. The PIC SWFs can be evaluated against principles from economic theory, which show that SWFs should be used to smooth fiscal revenues (James et al. 2022; van den Bremer et al. 2016; van der Ploeg & Venables 2017; Venables & Wills 2015a, 2015b, 2016; Wills 2018). Intergenerational funds make temporary windfalls, such as oil or aid, permanent by saving abroad and withdrawing a fraction each year. Volatility funds smooth out volatile resource income by depositing funds when prices are high, and withdrawing when they are low (van den Bremer & van der Ploeg 2013; van der Ploeg 2010), but require the average price of the resource to be steady over time. To decide how much to save in an SWF, governments must consider the opportunity cost of not investing at home. SWFs should focus on foreign investments, as domestic investments should be made through the typical budget process. This is particularly the case for developed countries with ready access to capital, where the opportunity cost of investing public funds at home is low. However, in developing countries with limited access to capital, domestic investments are likely to have a higher social rate of return than saving abroad (van der Ploeg & Venables, 2011, 2013). In these countries volatility funds make more sense than intergenerational funds. They may also consider a parking fund: a temporary SWF for holding revenues until domestic absorption constraints abate (van der Ploeg 2010, 2012). 46 Defining economically justified deposit and withdrawal rules will improve management of fiscal revenues. Kiribati's RERF has performed well but lacks a formal deposit rule and has a volatile withdrawal policy. It allows the use of investment returns above two percent per annum for development purposes that are not clearly defined. This results in unpredictable withdrawals and overlooks potential high-return domestic investments, such as in clean water and sanitation. Similarly, Tuvalu's trust fund has no deposit rule, and its withdrawal rule is tied to benchmarks with a lack economic justification. The withdrawal rule is crucial since it manages how many transfers are allowed to the consolidated investment fund which serves as a volatility fund. Lastly, the donor-funded SWFs in Nauru and the compact countries are structured for intergenerational savings, with defined deposit and withdrawal rules, with withdrawals only allowed after a period of accumulation. If the donor relationships are likely to be ongoing, then this approach comes with the heavy opportunity cost of not investing to address basic development needs at home. 73. Fiscal policy should also play a key role in helping the PIC-11 boost their resilience to natural disasters and climate change. The Pacific islands acknowledge the inevitability of climate-related disasters. They adopt a comprehensive approach to crisis preparedness, investing in both pre-disaster resilience and post-disaster recovery. This strategy requires policy reforms, strategic resource allocation, and private capital mobilization, supported by international financial aid. Funding for recovery includes SWFs, catastrophe bonds, and region-specific insurance pools. National adaptation plans are crucial for ex ante climate resilience, with a focus on infrastructure initiatives to protect vulnerable industries. Prioritizing climate-related investments in fiscal frameworks is vital for mitigating reconstruction costs and safeguarding livelihoods in the face of disasters. 74. A range of structural reforms and policies can promote an acceleration in investment growth. This report only provides a glimpse into the extensive structural reform agenda of Pacific island countries, highlighting a select few challenges and priorities. In the medium-to-long term, increasing the rate of investment growth in Pacific island economies will be key to boosting GDP growth. As in other EMDEs, a supportive investment climate, with transparent rules, will help attract private investment when there is limited space for public investment (World Bank 2023a). Work is also needed to remove restrictions that hinder investment and trade, particularly in the services sector (Box 4). As opposed to the regulation of other product-based sectors, trade in services is regulated by a multitude of legislation and enforced by different agencies. It will be essential to identify discriminatory constraints to foreign investment in services and create a framework for liberalizing foreign investment in the sector. 47 Box 4. Services trade restrictions The Services Trade Restrictions Index (STRI) for the Pacific shows moderately high restrictiveness on foreign service providers, particularly the professional, financial, construction and transport services.22 This index is based on a regulatory audit that is designed to disaggregate findings amongst modes of services trade, including cross-border trade, consumption abroad, commercial presence (foreign direct investment), and temporary movement of natural persons. Although no broad services sector is entirely closed in the Pacific, there are combinations of subsectors and modes of supply in which foreign provision of services is not permitted. Policy closures at the subsector level are concentrated mainly in cross-border trade. Certain Pacific countries also maintain reserved and restricted lists for investment, which can inhibit some commercial presence of foreign direct investments.23 There is no instance of movement of natural persons being closed across Pacific island countries, although Vanuatu does have relatively high restrictions on work visas for foreign individuals. The combination of high restrictions and small market size can result in higher market concentration, reduced levels of competition, and impact consumer welfare. These restrictions are affecting social and economic outcomes and are correlated with stage of development. Figure B4.1: STRI outcome in the PICs by Broad Sector 100 (100=Most Restrictive) 80 60 STRI 40 20 0 Professional Computer And Communication Construction Distribution Financial Health Tourism And Transport Services Related Services Services And Related Services Services Services Travel Related Services Engineering Services Services Fiji Solomon Islands Tonga Vanuatu Samoa Opening to trade in services can create scale which helps lower equilibrium prices and/or alleviate market concentration in crucial industries. Such reform could help keystone service sectors achieve efficient scale, while better serving the needs of the domestic economy. One entry point to pursue this is by leveraging global and regional free trade agreements to enhance integration into the world economy. The General Agreement on Trade in Services (GATS) is a significant agreement that sets a baseline for restrictions on trade in services worldwide. Under this treaty, participants of the World Trade Organization (WTO) are prohibited from implementing new discriminatory or restrictive measures that hinder foreign providers from entering their service markets. It is hoped that other regional agreements will have a stronger impact in binding parties to a practical framework for liberalizing services. https://www.worldbank.org/en/country/pacificislands/brief/new-insights-into-trade-in-services-in-the-pacific 22 FDI is the most important mode of service imports to the pacific, accounting for about 50 percent of all trade. 23 48 The use of the internet, the backbone of digital activity, is not yet universal. About 70 percent of the population uses the internet in the median PIC-11. This is an improvement from 2016 but still lower than in other small states, where over 80 percent of the population has internet access. Challenges in access, affordability, governance, and skills need to be addressed to close the usage gap. • Access – Pacific islands 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. • Affordability – 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 two percent (Broadband Commission 2022). • Regulatory environment – The PIC-11 perform about where other small states and other developing economies did a decade ago in terms of ICT regulatory environment (ITU 2023). Weak regulation may deter the private sector and foreign investors from participating in the expansion of digital infrastructure and services, consequently limiting opportunities for people to benefit from digitalization. • Ability to use – Low levels of digital literacy and skills in the Pacific are commonly reported to hinder the effective use of digital tools and services, including in the workplace (ILO 2019). The need to upgrade digital skills is especially acute in countries including Kiribati, Marshall Islands, Micronesia, Nauru, and Tonga (World Bank forthcoming). 49 Figure B4.2 Individuals using the Figure B4.3 Population covered internet by mobile networks 100 100 80 80 Percent 60 Percent 60 40 20 40 0 20 Fiji Solomon Islands Samoa Tonga Vanuatu Nauru Tuvalu Kiribati Micronesia 0 PIC-11 PIC-11 excl. Fiji Developing economies T&R-led PICs SR-led PICs At least 3G At least 4G Developing economies Figure B4.4 Cost of internet Figure B4.5 ICT regulatory connectivity environment Percent of monthly GNI per capita 15 80 Index, 100=best 10 60 5 40 20 0 2017 2022 2017 2022 0 Data-only mobile Fixed-broadband PIC-11 PIC-11 excl. Fiji Developing broadband basket Internet basket economies PIC-11 PIC-11 excl. Fiji 2012 2017 2022 Developing economies Target Sources: International Telecommunication Union, World Bank. Note: Developing economies exclude the Pacific Islands. Figure B4.2: Data are for 2021. Lines show medians in country groups. Figure B4.3: Data are for 2021. Bars show medians in country groups. Figure B4.4: 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. Figure B4.5: Bars show medians in each country group. 50 75. Investing in well-functioning public institutions is critical to enable the PIC-11 to address the myriad of policy and service delivery challenges they face. Improving the quality of institutions is of disproportionate importance in Pacific island countries, given the lack of economies of scale in public administration in such small states. Reforms to simplify public administration and digitize key administrative services for citizens and businesses are priorities to improve the cost-effectiveness and efficiency of the public sector. Modernizing core government systems, including public financial management and procurement systems, can support more efficient resource use and better value-for-money in the public sector. Measures to strengthen transparency and citizen engagement can support improved accountability and public sector responsiveness. Finally, mechanisms to strengthen inter-ministerial coordination are vital to enable the PIC-11 to effectively address whole-of-government challenges such as climate change adaptation. 76. It is important that Pacific island countries continue to build their human capital to support long- term growth. There are gains to be made from prioritizing the quality of education and accurately measuring learning outcomes, for example, and from closing gaps in the rate of employment between women and men (Pennings 2023; Yarrow et al. 2023). Part two of this report focuses on the importance of investing in education. Examining the future landscape, the trajectory of accelerated and sustainable growth in PICs depends on the cultivation of a workforce equipped with enhanced skills and capabilities. A thorough exploration reveals compelling evidence indicating that a more educated workforce can substantially contribute to accelerated and sustainable growth through several mechanisms. These include heightened employability, increased economic mobility, and enhanced resilience to shocks. 51 PART 2. Investing in people: The Pacific’s most valuable asset Investing in people and developing their skills will allow Pacific island countries to find solutions to economic challenges and make the most of their available resources. Once children are in school, teachers are the key to developing this “human capital”. This chapter provides a snapshot of the challenges facing education systems in the Pacific and suggestions on how to address them. It draws on findings from a recent Public Expenditure Review for Pacific island countries, as well as Fixing the Foundation: Teachers and Basic Education in East Asia and Pacific, a regional World Bank report. 52 2.1 The region’s basic learning deficit 77. Education delivers a broad range of economic benefits (World Bank 2018). Education—and the skills it confers—contributes to higher growth. In particular, cross-country analysis reveals a robust relationship between the cognitive skills developed by education and economic growth. Education increases people’s incomes and employability, improves economic mobility, and enables families to escape poverty. It increases individuals’ and families’ resilience to shocks. In economies with large informal sectors, education is associated with greater access to full-time, formal sector jobs. It also facilitates greater productivity, technology adoption, and innovation.24 78. Education equips workers with better skills to gain better jobs and be more productive. Specifically, workers need a set of foundational and soft skills to perform their role and earn a good reputation. For instance, an educated worker in the tourism sector is more productive because they are more likely to possess a comprehensive understanding of customer service, cultural sensitivity, and communication skills, enabling them to enhance the visitor experience, efficiently solve problems, and thereby significantly contribute to the growth and reputation of the tourism industry.25 This is important both for the PIC’s domestic labor markets but also for the workers who migrate. Indeed, in the case of overseas job markets (especially relevant for PICs who rely on remittances), employers who observe a basic set of foundational skills in their workers are more likely to recruit more people from their country (World Bank 2023b). As the demand for overseas professions expands to include higher-skilled occupations such as aged care and hospitality, workers require strong interpersonal skills, literacy, and numeracy to qualify for these jobs. Improving basic skills is also crucial for preparing future talents to meet local employer’s needs. 79. Better education equips individuals with a range of skills that lead to better health, and better life choices. A large body of research has rigorously documented the range of benefits that are associated with individuals having more education. More-educated individuals live longer, have a lower probability of having a chronic health condition, and are less likely to smoke, drink in excess, be overweight, or use illegal drugs. Education reduces teen pregnancy and increases the control that women have over the size of their families. Better-educated mothers raise children who will be healthier and more likely to complete more years of schooling. Schooling reduces most types of crime committed by adults, as well as crime during late adolescence. More- educated individuals are more likely to participate in civic life; and they are more trusting and tolerant of people. A more educated population generally demands more transparent use of public resources, better service delivery, and government accountability.26 80. More workers with a secondary education (or higher) will be needed. But first, more students need to learn to read with understanding. If children cannot read proficiently by the end of primary school, they are less likely to succeed in secondary school and beyond (Fiester, 2013). Reading is the gateway skill to further learning. Children who are not reading well enough seldom catch up academically and often fail to graduate from high school or drop out altogether (Hernandez, 2011). 24 During the green revolution in Asia, farmers with basic education made more efficient allocation decisions in the face of technological changes (Foster & Rosenzweig, 1996). In manufacturing firms operating in more human capital-intensive industries across China, increases in employee education resulted in greater total-factor productivity (TFP) growth, technology adoption, and R&D investment (Che and Zhang 2017). Similar results are seen among firms in OECD countries (Criscuolo, Gal, Leidecker, Losma, & Nicoletti, 2021). 25 And, similarly, an educated worker in the fishery sector is more productive because they are more likely to bring advanced knowledge of sustainable fishing practices, marine ecology, and resource management to the table, ensuring that fishing operations are environmentally sustainable, economically viable, and capable of maintaining fish populations for future generations, thereby contributing to the long-term success of the industry. 26 Please see World Bank (2018) World Development Report, chapter 1 for details and references. 53 81. According to a regional assessment, learning poverty is prevalent in Pacific island countries. Specifically, more than half of 10-year-olds in nine of the 11 Pacific island countries cannot read and understand an age-appropriate text. This is known as ‘learning poverty’.27 In some countries (Kiribati, Tonga, and Tuvalu) more than two-thirds of children cannot read with understanding (Figure 17). A noticeable exception is Palau, where only 10 percent of 10-year-olds cannot read with understanding. By comparison, in high-income Japan, Singapore, and South Korea, learning poverty is only about three-to-four percent. 82. The findings reported in a regional assessment of students’ reading skills (Figure 18) are confirmed by national data. For instance, learning assessment data for Kiribati suggests that many children in primary education struggle with basic reading and literacy.28 The most recent results for the year six national standardized tests of achievement in Kiribati (STAKI) indicate that in 2018, 60 percent of students were not proficient in English literacy at the end of primary school, a figure roughly consistent with estimated learning poverty. Yet, English is the main language of instruction in secondary school. As a result, learning proves to be a challenge for secondary school students: nearly two-thirds of students do not acquire the adequate learning level assessed by examinations at the end of junior and senior secondary school. Only 37.4 percent of year nine students passed the junior secondary examination in 2020, and only 36.8 percent of year 12 students passed the end of senior secondary examination. 83. Emerging global evidence indicates that the COVID-19 pandemic has worsened education outcomes, adding urgency to efforts to improve student learning. Students’ academic performance declined in the Pacific islands, according to the 2021 Pacific Islands Literacy & Numeracy Assessment (PILNA) (EQAP 2021). Between 2018 and 2021, both numeracy and reading scores declined. Given the tightened fiscal space, countries will likely face the combined challenge of trying to recover learning losses and improve the overall performance of the system without the scope to greatly expand education budgets. As such, it will be imperative to identify cost-effective ways of improving learning outcomes, which is a focus of this chapter. poverty estimates (%) Figure 18. In nine out of 11 Pacific island countries, more than half of students are not meeting international benchmarks in reading 100% 90% 71% 73% 71% Interim learning poverty 80% 58% 58% 59% 61% learning 53% 59% 70% (%) 60% 41% 50% estimates 50% 40% Interim 30% 20% 10% 10% 0% Fiji Solomon Isls. Palau Vanuatu Samoa Tonga Micronesia Nauru Marshall Isls. Kiribati Tuvalu Average middle income T&R PICs SR PICs Source: Cahu & Sondergaard, 2023 for interim learning poverty for Pacific. Note: vertical lines represent high and low estimates of learning poverty.The learning poverty “average for middle income” is the (unweighted) average of learning poverty estimates for the 110 middle income countries for which official learning poverty data are avaialble in World Bank Learning database (June 2021 version). 27 “Learning poverty,” a concept and indicator developed by the World Bank and the United Nations Educational, Scientific and Cultural Organization (UNESCO) Institute for Statistics, is defined as the inability to read and understand a simple, age-appropriate text by age 10. No official learning poverty estimates exist for Pacific island countries. To address this knowledge gap, and in support of better learning diagnostics, Cahu and Sondergaard (2023) generated interim estimates of learning poverty in the Pacific islands. Details of the estimates, including the data used, can be found in Cahu and Sondergaard (2023). The Pacific Islands Literacy and Numeracy Assessment (PILNA) is conducted every three years and measures students’ literacy and 28 numeracy skills (in year four and six). 54 2.2 Better teaching is needed to improve student learning 84. Quality teaching is the key to good learning outcomes. A child’s family background remains the most important predictor of learning outcomes, including parents’ income and education levels, as well as a child’s nutrition, health, cognitive, and socioemotional development in the early years of life. However, once children get to school, no single factor is as critical as the quality of their teachers (Bruns and Luque 2015; Béteille and Evans 2021; Mary Breeding 2021). Figure 19. Teachers are central to student learning Switching from a 10th percentile to a 90th percentile teacher would move a student from the bottom third to the top third of the class Student performance Student with high- performance teacher 66th percentile 100th percentile (90th percentile in teaching quality) 32nd percentile points 50th percentile difference in Grade-5 Student with low- Two 2nd Grade students performance teacher with similar performance (10th percentile in teaching quality) 34th percentile End of End of 2nd Grade 5th Grade Sources: Authors estimate based on Carneiro et al (2021). 85. Research shows that going from a low-performing teacher to a high-performing teacher dramatically increases student learning. For instance, in Vietnam, differences in teaching quality mean that over a three- year period, an average second grade student can end up in either the top third or the bottom third of the class, depending on whether they benefit from a high- or low-quality teacher during that time (Figure 19). Where such data are available, they show that better teaching practices are consistently associated with better student learning outcomes. 86. Many Pacific island countries still face serious challenges in achieving high teacher quality. Some education systems are struggling to attract enough teachers, teaching practices are often weak, and teacher behavior may not always support student learning. Moreover, there are significant knowledge gaps in terms of teachers’ mastery of the subjects they teach. 55 2.2.1 Some education systems are struggling to attract enough teachers 87. Samoa is suffering from a lack of public teachers. In Samoa, the maximum pupil–teacher ratio in primary public schools is formally about 30-1. However, in 2019, only 47 percent of government schools were meeting this target. Class size has been increasing in the last five years, along with primary enrolment. About 14 percent of public primary schools had classes of more than 40 children. Based on official data, it is estimated that at least 33 percent more primary teachers are needed to meet the class size target in all public schools. Although containing costs could be a factor as well, the ministry underlines that the major impediment to adequate class size is the reluctance of teachers to live in rural and remote areas. 88. Across the Pacific, the teacher workforce needs to grow to meet expanding student numbers. According to projections by Tanaka and Sondergaard (2023), the teacher workforce will need to expand in most Pacific island countries between now and 2030 and by as much as 30 percent in Vanuatu and Solomon Islands. Such growth is needed to meet increasing student numbers, rising net enrollment rates, and ambitions to lower average class sizes. 2.2.2 Many teachers are not using effective teaching practices and a key unknown is whether teachers master the content they are teaching 89. Many teachers in the Pacific need to strengthen their use of teaching practices that are known to help students learn. Classroom observational tools have recently been used in several Pacific classrooms (at the secondary education level) to better understand teaching and teacher-training needs. With better information on what needs are, professional development can be better designed. The observations show that many teachers are not yet using effective teaching practices (Figure 20). While there are clearly strengths in areas such as classroom culture in Kiribati, Marshall Islands and Tonga, overall less than five percent of teachers use highly effective teaching practices in every teaching domain. For instance, only a small proportion of teachers in these countries pause and check whether students have understood the material being covered. And, accordingly, many teachers are failing to adjust their teaching to the level of students’ understanding, another effective instructional practice. One challenge in the Pacific island countries is that secondary school teachers are required to teach primarily in English, which is not the first language of most students or of the teachers (who may have limited English competency). While its impact on teaching practices is not well understood, it undoubtedly shapes teachers’ interactions with students. 56 Figure 20. Many teachers in the Pacific need to strengthen their use of teaching practices that are known to help students learn A.Kiribati secondary teachers B. Tonga secondary teachers 100% 100% 100% 100% teachers in each category teachers in each category Percentage of observed Percentage of observed 63% 63% 50% 50% 45%45% 48% 48% 50% 50% 32%32% 5% 5% 3% 3% 3% 3% 2% 2% 0% 0% 0% 0% Low MediumMedium Low Medium High Medium High Low MediumMedium Low Medium High Medium High LowLow High High LowLow High High Distribution of Scores Distribution of Scores Distribution Distribution of Scores of Scores C. Marshall Islands secondary teachers 100% teachers in each category Percentage of observed 65% 50% 19% 14% 2% 0% Low Medium Medium High Low High Distribution of Scores Source: Classroom observations carried out as part of ongoing technical support from World Bank. Note: The figures show data collected from classroom observations. This score, based on classroom observation, captures teachers’ capacity to create a classroom culture conducive to learning, to challenge and engage students, and to foster students’ socio-emotional skills to be successful learners. The higher the score, the more effective the teaching practices deployed by the observed teacher. For additional details, visit https://www.worldbank.org/en/topic/education/brief/teach-helping-countries-track-and-improve-teaching-quality. 90. Where data are available, they show that far too many teachers in middle-income countries have not mastered the content they are expected to teach. Unfortunately, such data are not yet available for Pacific countries, but data from middle-income countries in the East Asia region show a consistent, disconcerting picture. For instance, in Lao PDR only eight percent of year four teachers achieved a score of 80 percent or higher on an assessment of their math content knowledge (Figure 21). In Indonesia, only eight percent of year four teachers achieved an 80 percent score on an assessment of their Indonesian language skills. In Malaysia, only 35 percent of English language teachers tested in 2013 were judged to be sufficiently proficient in English to teach. Having information on the extent to which teachers master the content they are supposed to teach is invaluable to help design better professional development: which teachers need the training, and what amount of training is likely needed. 57 Figure 21. Teacher content knowledge is often weak: Examples from Lao PDR and Indonesia A. Lao PDR year four teacher math assessment scores B. Indonesia year four Indonesia language teachers (Percent of teachers achieving at each score interval) (Percent of teachers achieving at each score interval) 25 30 28 20 19 25 24 20 17 21 20 Frequency (%) 15 12 Frequency (%) 10 15 10 9 11 10 6 7 5 6 2 2 5 1 3 1 0 0 0 0 9 9 9 9 9 9 9 9 90 9 00 9 9 9 9 9 9 9 9 90 9 00 0- -1 -2 -3 -4 -5 -6 -7 -8 -2 0- -1 -3 -4 -5 -6 -7 -8 -1 -1 10 70 10 20 40 70 30 50 60 80 20 40 30 50 60 80 Score interval Score interval Source: (World Bank, 2017) (left); (Yarrow N. B., Afkar, Masood, & Gauthier, 2020) (right). For Indonesia, the results are from a nationally representative sample of schools of the Ministry of Religious Affairs and a smaller sample of schools of the Ministry of Education and Culture. The survey was collected in 2019 and used the same survey instrument (Service Delivery Indicators) used in Lao PDR. Note: Percentages represent the share of teachers achieving scores within each score interval. The red line marks the expected “minimum proficiency score”, defined as a score of 80 percent or better on the exam. 91. The gaps in teachers’ practices are not being filled because teachers’ professional development programs are often ineffective. Evidence from high-income countries shows that concrete, classroom-based professional development programs make the most difference to teacher’s development and student learning (Darling-Hammond et al 2009; Walter and Briggs 2012). However, the limited data available from Pacific countries suggest that a significant percentage of the region’s teachers are trained each year. Nevertheless, the data also suggest that the quality of training may not be effective in raising teachers’ capabilities or students’ learning outcomes. Specifically, new survey data reported in a recent World Bank publication Fixing the Foundation: Teachers and Basic Education in East Asia and Pacific indicates that many East Asian and Pacific countries’ in-service training programs lack the key elements of effective programs found elsewhere in the world. A global analysis of high-impact in-service teacher training programs indicates that effective programs have four key features (Popova et al. 2022): (1) a focus on content knowledge, (2) opportunities to practice what is learned with colleagues, (3) continued support through follow-up visits focused on training content, and (4) career incentives through promotion or increased salary. The new data collected for the region, however, show that the largest government-funded in-service teacher training programs in nine East Asian and Pacific middle-income countries do not consistently employ the practices shown to improve student learning. (Figure 22). 58 Figure 22: Teacher training programs do not employ practices linked to improved student learning Focus is subject content 14% 81% Proportion of face-to-face training spent practicing with teachers 5% 40% Includes follow-up visits 24% 85% Participation has implications for salary or promotion 48% 88% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% EAP training programs Top Performers Source: (Popova, Evans, Breeding, & Arancibia 2022) for top performers; World Bank staff calculations based on new data collected for 65 large-scale in-service teacher training programs in Cambodia, Fiji, Lao PDR, Mongolia, the Philippines, Thailand, Timor-Leste, Tonga, and Vietnam. Note: Percentages represent the proportion of programs containing a given feature, except for “practicing with teachers” where the percentage is the proportion of time training courses devote to this activity. 2.2.3 Teacher behavior often does not support learning 92. Teacher absences, as well as poor classroom management, adversely affect student learning. In 15 Pacific island countries, 36 percent of students attend a school in which their principal reports that instruction was hindered by teacher absenteeism (EQAP 2019). In contrast, data from China, Japan and Korea show teacher absence rates of one percent or less, and three percent in Singapore (OECD TALIS 2018 Database). Moreover, the class time dedicated to foundational learning is often low. For example, less than one-third of year five students in Lao PDR, Malaysia, Myanmar, and the Philippines have daily math and language lessons. 2.2.4 More than half of teachers expected to be employed in 2035 have already been recruited, so focusing on existing teachers is critical 93. Improving the capacity and behavior of existing teachers is critical to improving learning outcomes. In all Pacific island countries, except Vanuatu and Solomon Islands, more than half of teachers expected to be employed in 2035 have already been recruited (Figure 23). In Fiji, Marshall Islands, Micronesia, and Tonga, more than 60 percent of teachers expected to be employed in 2035 are already in place. Given this, it would take a long time for countries to realize improvements in the overall quality of the teacher workforce (and hence in student learning) by focusing predominantly on strengthening selection and recruitment of new teachers. To have an observable impact on learning outcomes over the next 10–15 years, the region’s policy makers must make more concerted efforts to raise the performance of existing teachers. 59 Figure 23: The majority of those expected to be teaching in 2030 have already been recruited 80 70 60 50 % 50 Percent 40 30 20 10 0 Solomon Islands Samoa Kiribati Vanuatu Palau Tuvalu Average Marshall Islands Fiji Nauru Micronesia Tonga T&R PICs SR PICs Source: Updated based on Tanaka & Sondergaard, 2023. Note: The figure shows the percentage of primary-school teachers projected to be teaching in 2035 who had already joined the teaching workforce by 2020. Simulations use the United Nations’ World Population Prospects 2022 (medium scenario) for children of primary age (UN DESA 2022) and the following assumptions: (a) countries will reach a net enrollment rate of 100 percent at least by 2030; (b) countries will lower pupil-teacher ratios to 25 to 1 (or maintain current levels if below that ratio) by 2030; and (c) teacher attrition rates are the average country- reported attrition rates for the past five years (if re-ported in the UNESCO Institute for Statistics database), or if countries are not reporting attrition rates, we use the average attrition rate over the past five years of the countries who do report. 60 2.3 The way forward 94. Strengthening the quality and effectiveness of teaching in the Pacific region will require action on several fronts. The discussion below focuses on three key areas: (i) mechanisms to make teaching more attractive and selective; (ii) enhancing teachers’ capacity to teach with the right training and tools; and (iii) encouraging greater teacher effort. Countries throughout the Pacific will need to recruit more new teachers over the next decade—in some countries, significantly more. Hence, improved selection and recruitment will help ensure that the region’s future teachers are better prepared. However, strengthening the quality of teaching in the region will require a strong focus on existing teachers because, in all countries, more than half of those who will be teaching in 2035 have already been recruited. 2.3.1 Mechanisms to make teaching more attractive and selective 95. High-performing education systems in East Asia have made teaching both attractive and selective through a combination of mechanisms. For instance: China – Teaching is a highly attractive career, driven by competitive pay, attractive working conditions, manageable pupil-to-teacher ratios, and clear career progression. The Teacher Law stipulates that teachers’ average salary should be equal to or higher than the national average salary of civil servants. South Korea – Rigorous, merit-based screening processes are in place. Only the top 10 percent of high school graduates are allowed into teacher education programs, and only one in 20 passes the arduous exams to become a teacher (Ferreras, Kessel, and Kim 2015). Singapore – Before becoming a teacher, candidates must undergo preparatory training that includes both compulsory contract teaching and formal study to earn the proper qualifications. Admitted candidates are paid throughout their training period and teachers receive attractive salary packages. Vietnam – Vietnam is a leader in education performance among middle-income countries and has consistently allocated resources into foundational skills and used them efficiently. The government has rolled out strategies to attract and select teachers with incentives and ongoing training opportunities. As a result, teacher absenteeism is significantly lower than elsewhere in the region. Teachers take part in regular internal and external evaluations that make them accountable for teaching quality. 96. Among East Asia’s middle-income countries, there are examples of ountries trying to make the profession more selective. For instance, Indonesia has recently undertaken reforms to make the teacher recruitment process more selective and meritocratic. In 2020, the country introduced a more rigorous recruitment process for those who wish to become government contract teachers. Prospective teachers are assessed on their content knowledge; there is a minimum passing score, and the examination is managed through an electronic process. These changes have made the teacher selection process more competitive. Nearly 1.2 million candidates took the test to become government contract teachers in September and December 2021. The government announced that just under 300,000 candidates passed, for a pass rate of 25 percent (Haryanto 2021). 61 2.3.2 The right training and tools can enhance teaching capacity 97. Teacher training needs to be guided by data and evidence. First, regular assessments of teachers’ knowledge and pedagogical skills can help make training more impactful by (a) identifying gaps that need addressing; (b) identifying teachers who may need more support than others; and (c) providing data to monitor the impact of the training (i.e., is the teachers’ subject content knowledge and/or pedagogical practices improving as a result of the training?). Second, as mentioned below, there are several rigorously evaluated interventions focusing on strengthening teachers that could be used to design interventions in PICs. Third, the roll-out of effective training programs should include four key features: (1) a focus on content knowledge; (2) opportunities to practice what is learnt with colleagues; (3) continued support through follow-up visits focused on training content; and (4) career incentives through promotion or increased salary. 98. Research shows that well-designed training programs can be effective in improving student learning. For instance, the Tonga ‘Come Let’s Read and Write’ (CLRW) program provided training focused on content, instructional materials, and coaching on a new method to teach reading. The program improved average reading scores by 0.19 standard deviations after one year and 0.33 standard deviations after two years of intervention, increasing the proportion of year two students who were good readers from 18 to 29 percent. The CLRW program also provided follow-up in the form of regular coaching focused on subject content. Figure 24: Impact evaluation of in-service teacher training programs in the region shows that it can lead to better learning outcomes: Example from Tonga’s Come Let’s Read and Write intervention 35 graders who are good readers 30 29 Percentage of 2nd 25 20 18 15 10 5 0 With regulary With better trained teachers trained teachers Source: (Macdonald et al. 2018). Note: The graph shows reading scores from the Tonga Early Grade Reading Assessment (TEGRA) of second-grade students in schools that have teachers who had been trained by the Come Let’s Read and Write (CLRW) program vs. regularly trained teachers. The schools that benefitted from the intervention were randomly selected to allow the program to be rigorously evaluated. 62 99. Effective teacher training programs yield very high returns on investment. For the Tonga CLRW program, per beneficiary benefits are estimated at USD1,425 (measured in terms of future student earnings) compared to a per beneficiary cost of USD116. This constitutes a benefit-cost ratio of 12.3 to 1. 100. A key feature of effective training programs is follow-up visits to teachers once they return to their schools. Coaching and mentoring support to teachers, either one-to-one or through groups, can address the challenges they face in applying the lessons from training to their classrooms. No rigorous evaluations have been carried out in East Asian or Pacific countries, but evidence from other middle-income countries highlights the contribution of coaching to improved learning. In Peru, for example, a program of monthly coaching visits to teachers was found to raise reading comprehension by 0.25 standard deviations and mathematics performance by 0.38 standard deviations. 101. There is a growing body of evidence on cost-effective interventions that help strengthen teachers. These rigorously evaluated interventions may provide inspiration for programs that could be adapted to Pacific island countries. Particularly promising interventions include: (1) structured lesson plans; (2) targeted instruction; (3) educational technology; and (4) the dual teacher model. Finally, (5) for teachers to become more effective in PICs, more focus needs to be brought to the issue of language of instruction. 102. Structured lesson plans are especially useful where teachers lack pedagogical skills or subject knowledge, as they lead the teacher—and thus the student—through a series of activities designed by the best teachers. These plans can be highly scripted lessons that teachers follow carefully. Teachers with higher capacity can use them more flexibly like guides. These lesson plans, along with training in how to use them, lead to significant learning gains, equivalent to an additional half year or more of learning, raising student language scores by 0.23 standards deviations and mathematics scores by 0.14 standard deviations on average. In the region, Papua New Guinea’s Reader Booster Programme had a particularly large effect on student reading skills for year three students, ranging from 0.6-0.7 standard deviations; in Cambodia there was also a large impact on language for years one to three of 0.5 standard deviations. 103. Targeted instruction, also known as teaching at the right level (TARL), helps teachers address the major challenge of children having different levels of learning. Targeted instruction involves grouping students in school by learning levels, rather than age/grade, and engaging them in activities appropriate to their level of achievements. Targeted instruction can be highly effective. In the Indian state of Uttar Pradesh, there was a 25-percentage point increase in the likelihood of being able to read a story due to this method (Banerjee, et al. 2017). Targeted instruction can also be highly cost-effective, delivering as much as three years of learning per USD100 spent (Angrist et al. 2020). 104. Computer assisted learning (CAL) has proven effective in the region’s middle-income countries (Figure 24) and high-income countries (Hattie 2009). CAL refers to interventions in which students engage in self-directed learning with the assistance of a computer software program. CAL software packages aim to improve student learning in a specific subject area through drills and exercises that give students opportunities to practice material learned in class and by providing immediate feedback. The evidence suggests that CAL is most effective in improving learning outcomes when it is used to complement classroom learning and not as a substitute for instruction by a teacher. Educational technology (EdTech) also appears to hold some promise in the implementation of structured lesson plans, as lessons can be loaded onto a website or on tablets for offline use. It also holds the promise of providing reading material in multiple languages. 63 105. EdTech is especially relevant to the Pacific region. First, many Pacific islands are geographically isolated, making access to traditional educational resources challenging. EdTech can bridge this gap by providing online learning platforms, virtual classrooms, and educational content that can be accessed remotely, reducing isolation, and enhancing educational opportunities. Second, the Pacific region is characterized by diverse cultures and languages. EdTech allows for the customization of educational content to cater to various languages and cultural contexts, promoting inclusivity and ensuring that education is relevant and engaging for all students. Third, given the susceptibility of Pacific countries to natural disasters and environmental changes, the adaptability and resilience fostered through EdTech is highly beneficial. Digital learning materials can be easily updated, and online platforms enable swift recovery after disruptions caused by events such as cyclones or earthquakes. Figure 25. Computer assisted learning programs have helped improve student learning in the East Asia and Pacific regions 0.80 0.76 0.70 0.60 0.50 0.45 Effect Size 0.40 0.34 0.33 0.30 0.22 0.21 0.20 0.18 0.18 0.17 0.20 0.15 0.15 0.15 0.15 0.10 0.05 0.01 0.00 0.00 -0.03 0.00 -0.10 iw (Qi ina in a a ) (B g) g) ha ) ic i) in ) ha ) Ch ha i) Ch (Be i) Ch (Qin ) ) ) Ch R, i) (S ai) (B xi) g) le an in xi ai ng ai ai di x x x SA ha jin jin jin tip ng an an an an gh gh gh gh h Ch bo hu iji ng in , C ei ei ei Ch ha ua n ul m (B Qi Ch AR Q Q (M S S S (S (G Ca ( ( ( a a a a ( ( ( S a a a a a in in in in a a a a a a a in in in in in in in in in in in an an Ch Ch Ch Ch Ch Ch Ch Ch Ch Ch iw Ta Ta Math Language Multiple Computer Skills Source: Adapted from Yarrow N., 2023. 106. One EdTech intervention appears to be particularly promising: the dual teacher model. This extends the reach of the best teachers by enabling them to provide content and model elements of effective pedagogy either as pre-recorded or livestreamed sessions. This approach has had significant positive impacts on learning in several rural contexts where high-quality teachers are in short supply, including in Ghana, India, Mexico, and Pakistan. Impacts have been found in multiple subject areas across a range of grade levels. A study of year seven to nine students in China found improvements of 0.23 standard deviations in language and 0.18 standard deviations in mathematics. It is important to note that these remote instruction interventions took place in classrooms during the regular school day and involved the presence of a teacher in the classroom in addition to the remote teacher. 107. To improve the effectiveness of teachers, more focus is needed on the chosen language of instruction. A substantial and growing body of research shows that children learn better in their first language than in a second language. When taught in their first language, they are more likely to become proficient in a second language over time, and comfortably absorb academic content. They are also more likely to remain in school (The International Commision on Financing Global Education Opportunity 2016). 64 108. There is evidence from Pacific island countries that children underperform when they are not being taught to read in their first language. Analysis of numeracy skills using the latest multiple indicator cluster surveys (MICS) data shows that children who are taught in the language they are speaking at home perform on average about 0.7 years ahead of those who are not. Such an effect is quite large and contributes significantly to poor numeracy in Kiribati and Tuvalu where more than 30 percent of children are not taught in their vernacular tongue from year four. In fact, once this factor is accounted for, learning is no longer progressing more slowly in the PIC-9 than in the benchmark countries. Similarly, early grade assessments organized in 2014 and 2015 in Samoa demonstrated that students’ performance in English and vernacular language were highly correlated. They also showed that many children are still struggling with basic skills such as alphabetical principles, phonological awareness, and phonics. According to PILNA (Pacific Island Literacy and Numeracy Assessment) data, pupils in Solomon Islands who speak Pijin with their primary teachers are half a year ahead in reading English by year five. These findings suggest that learning in primary school can be enhanced by starting to teach literacy and numeracy skills in the student’s first language. 2.3.3 Incentives can motivate greater teacher effort 109. Further work is needed to help bring down the high rates of teacher absenteeism.29 This can be done by: first, collecting better data on the magnitude of the problem; second, identifying the underlying causes of such absenteeism; and third, designing and launching pilots to explore what will be needed to address these underlying causes (and what it will cost to do so). As discussed below, the evidence on what works on absenteeism is less clear than the evidence on what interventions can help improve teacher effectiveness. 110. In principle, several types of incentives could motivate teachers to perform effectively, but there is limited evidence on what works in practice. Such incentives include professional advancement, financial incentives, accountability mechanisms, and measures to deal with chronic underperformance. Some preliminary analysis of teacher salaries across the Pacific suggests that teacher wages are already quite large by international comparison. They are larger than the average wage in the economy, something which is quite rare in the OECD countries. Also, they are much larger than the per capita GDP even in the poorest PICs, something which is never seen in OECD countries. 111. Evidence on performance pay is mixed. While one study on promotion incentive among primary and middle school teachers in China found positive results (Karachiwalla and Park 2017), global evidence suggests that any impact tends to be small. Moreover, survey evidence suggests there is little support for it in high-income countries in the region. 112. There is some evidence that accountability mechanisms, such as school-based management (SBM), can affect teacher effort and help reduce absenteeism. SBM can induce change at the school level by increasing parental involvement and changing teacher behavior (for example, reducing absenteeism), and at the pupil level, by lowering repetition and dropouts. 29 As mentioned above, according to PILNA data, 36 percent of students attend a school in which their principal reports that instruction was hindered by teacher absenteeism. 65 2.3.4 Teachers cannot do it on their own 113. Parents in Pacific countries need to play a bigger role. Parental involvement in learning activities with young children (such as singing songs, naming objects, and reading stories) is limited in the region, which hinders children’s development. In Kiribati, only 15 percent of children have age-appropriate books at home. In Samoa, Tonga, and Tuvalu, about half of parents are not reading books to their children. In Kiribati, it is about 60 percent according to the latest MICS results. Analysis indicates that this type of parental stimulation has a sizeable impact on the child’s achievement. Children who are read to score about half a year ahead in numeracy than those who are not. This comes on top of a general exposure to children’s books. Children living in households with five children’s books are also scoring half a year ahead in numeracy than those without any books at home. Exposure to books and stories explains half of the numeracy gap in Kiribati. This suggests that pre- primary curricula should be specifically designed to counteract household poverty and lack of early stimulation, especially by having teachers frequently reading stories to children. In Tonga, community playgroups were implemented to provide an avenue for both child developmental supports and enhanced parenting practices through role modelling play-based activities. Initial setup of the playgroups included exposure to books, educational resources and training the community playgroup leaders. Impact evaluation results indicated a $6-8 return on the initial investment through enhanced development and early reading skills prior to school entry.30 114. Basic inputs are missing, which is having a detrimental impact on student learning. To be effective, teachers need basic inputs and there are signs that many of them are missing in PICs. For instance, in Samoa, additional classrooms are needed to accommodate a growing number of pupils. In Marshall Islands, Samoa, Tonga and Vanuatu, access to preschool is still limited and would also require the creation of adequate facilities. The lack of proper toilets has a large impact on both enrolment and quality. In Solomon Islands, less than 40 percent of schools have flush toilets and less than 30 percent have electricity.31 Similarly, in FSM, early childhood education centers lack relevant materials. In Solomon Islands, less than half of schools have a library. The lack of textbooks is hindering learning, as suggested by the fact that in PNG, students without textbooks are scoring half a year behind those who do have books. 2.3.5 Aligned efforts across a range of stakeholders is needed 115. Successful reforms require sustained and aligned efforts across a range of stakeholders. Heads of government provide vision and political leadership, which will be needed across successive government administrations. Ministries of education must develop credible agendas for reform. Ministries of finance will have to allocate sufficient resources to enable implementation of the reform agenda and get stakeholders on board. Teachers will need new tools and enhanced support and be ready to step up to the challenge. Parents and caregivers will need to be engaged in, and advocates for, improved learning. To convince officials from the region’s finance ministries that additional resources will be used productively, education ministries must develop credible, evidence-based programs of reform. They will also need to improve data and information to underpin the design, implementation, and evaluation of reform initiatives. Better and more accessible information will also be critical to empowering parents to support teachers—and to hold them to account—in the quest for improved foundational learning for their children. Such mutually reinforcing, and long-term, relationships between key stakeholders—between ministries of education and finance, between parents and teachers, and between heads of government and the general public—will be critical in countries’ efforts to improve student learning. Those efforts would set the stage for higher productivity and growth and more prosperous societies in the years to come. Progress takes time under the best of circumstances, so action must begin now. 30 For more details, see MacDonald et al. 2018. In PNG, 10 percent of primary-aged children are not enrolled because of the lack of toilets in schools according to the latest household survey. 31 66 Annex Annex 1: Grouping analysis of the PIC-11 The economic dependencies of the Pacific island countries highlight the significance of tourism and remittances as key factors that explain the changes in output (GDP) of these countries. Statistical analysis (Table A1) suggests a 10 percent increase in tourism receipts or remittance flows both correspond to 0.34-0.36 percent increase in GDP. This is consistent with a recent study by Kumar and Stauvermann (2023), which shows that tourism development is growth-enhancing for Fiji, Samoa, Solomon Islands, Tonga, and Vanuatu. While a meta-analysis study concludes that the effects of remittances on growth are positive for countries in the Asia-Pacific region (Cazachevici, et al, 2020). For small economies, remittances can serve as an alternative source of fundings for productive investment, given their inefficiency and underdeveloped financial systems (Jayaraman, et al, 2018). Table A1. Regression of PIC-11 output (1) (2) (3) Fixed Effect (log) GDP constant 2015 prices OLS Two-way FE (FE)` (log) tourism receipts 0.028*** 0.022** 0.034*** [0.011] [0.009] [0.012] (log) personal remittances 0.051*** 0.048*** 0.036*** [0.013] [0.011] [0.013] (log) GNI per capita 0.347*** 0.367*** 0.279*** [0.041] [0.036] [0.095] Gross capital formation 0.002** 0.002** 0.003*** [0.001] [0.001] [0.001] Country fixed effects No Yes Yes Year fixed effects No No Yes Observations 113 113 113 Standard errors in brackets. Using available data from 1995-2022 for 11Pacific islands countries from World Development Indicators (WDI) database. Variables are measured in US $, except for gross capital formation which is as a percentage of GDP. *** p<0.01, ** p<0.05, * p<0.1 Given the importance of both factors, this report groups PIC-9 countries that have tourism and remittances as leading factors in the economy together as Pacific island subcategory of tourism and remittances-led countries (Palau, Samoa, Tonga, and Vanuatu).32 Tourism and remittances themselves can have links where relatives and family friends are both visiting and sending remittances to the home country. The dependence on different sources of income also contributes to the variation in the external accounts. For countries in this sub-group, the current account balance as a share of GDP is less volatile compared to other PIC-9 countries that heavily rely on sovereign rents and grants. The volatility of current account balance in sovereign rent-led countries is 2.7 times higher than the average in tourism and remittances-led countries. Other than the two sub-groups mentioned above, the analysis also suggests Fiji and Solomon Islands to be classified as a distinct single country category. The population size of Fiji and Solomon Islands is more than nine and seven times higher than the average of the PIC-9 countries, respectively (Table A1). In terms of area, Fiji’s land area is nine times larger while Solomons Islands occupies fourteen times more area than the average PIC-9 countries. 32 Tonga, identified as a tourism and remittance-led nation, ranks as the third highest in terms of aid as a share of revenue among the small PICs (PIC-9), following FSM. Consequently, it exhibits certain characteristics common to sovereign rent-led countries. However, the size of aid in Tongan economy (around 25 percent of GDP) is still significantly lower than the size of remittance and tourism which accounts for almost 40 percent of GDP. 67 68 Table A1.1: Characteristics of the PIC-11 countries Size Main sources of income External sector Human capital Deprivation rate Sovereign Female rents, Current Human Tourism and Exchange rate labor force Drinking Population Area GDP non-tax account capital Sanitation remittances regime participation water revenue, balance index rate and grants Current (% of female (000) (Km2) prices, Percent of GDP Volatility (Scale 0-1) population Percent of population million US$ ages 15+) Fiji 963.4 18,272 4,980 28.2 2.8 Fixed ER 3.2 0.51 38.1 5.1 12 Solomon 740.4 28,896 1,597 6.9 12.8 Fixed ER 7.7 0.42 82.0 66.0 34.9 Islands Average PIC-9 111.3 1,998 412 27.2 42.6 15.3 0.50 47.0 29.9 5.2 Average T&R 171.5 4,059 648 41.5 15.5 6.3 0.53 50.9 16.7 4 PICs Palau 18.1 459 233 49.7 24.2 USD 5.1 0.59 59.2 N/A N/A Samoa 225.7 2842 833 37.3 5.9 Fixed ER 3.1 0.55 41.1 0.9 0.5 Tonga 107.8 747 469 37.4 19.2 Fixed ER 6.8 0.53 43.0 6.3 0.1 Vanuatu 334.5 12,189 1,056 41.6 12.8 Fixed ER 10.4 0.45 60.5 43.0 11.8 Average SR 76.1 429 265 14.0 55.9 17.7 0.48 45.2 44.3 6.7 PICs Kiribati 133.5 811 223 12.4 58.5 AUD 21.4 0.49 40.6 83.8 17.1 Nauru 12.8 21 152 10.6 85.5 AUD 23.7 0.51 56.8 21.7 2.7 Marshall 43.0 181 259 18.5 42.7 USD 11.6 0.42 37.3 29.0 1.7 Islands Micronesia 115.2 702 424 14.4 37.0 USD 14.3 0.51 46.2 42.8 5.2 Tuvalu 11.4 26 59 22.9 97.2 AUD 41.6 0.45 38.6 11.5 2.4 Note: Data for size, current account, income, and human capital are sourced from World Development Indicators. GDP are latest data available, mostly 2022. Volatility is calculated based on standard deviation of current account balance as a share of GDP between 2009 and 2019. Human capital index (HCI) is based on 2020 data. It measures the productivity as a future worker of a child born today relative to the benchmark of full health and complete education. Female labor force participation rate is based on latest data available either from national or ILO estimates. Deprivation rate is sourced from the Multidimensional Poverty Measurement (MPM) database published in April 2023. Annex 2: Non-monetary dimensions of poverty Figure A2. Non-monetary dimensions of poverty in Pacific island countries, circa 2020 (A) Multidimensional poverty Fiji 1.6 Tonga 0.4 TR PICs Vanuatu 19.9 OR PICs Kiribati 5.6 Republic of Marshall Islands 1.1 0 10 20 30 40 50 60 Multidimensional poverty headcount ratio (%) (B) Deprivations in access to services Fiji 21.7 Solomon Islands 64.6 84.7 Palau TR PICs Samoa Tonga Vanuatu 70.1 36.4 Kiribati 38.5 57.9 OR PICs Republic of Marshall Islands Nauru Tuvalu 0 10 20 30 40 50 60 70 80 90 100 110 No access to improved sources of drinking water (%) No access to improved sanitation facilities (%) No access to electricity (%) (C) Deprivations in schooling Fiji 36.0 Solomon Islands 71.6 Palau TR PICs Samoa Tonga Vanuatu 65.7 Kiribati OR PICs Republic of Marshall Islands 28.8 Nauru Tuvalu 0 10 20 30 40 50 60 70 80 90 100 School-age children not attending school (%) Adults with less than secondary as highest education level (%) Sources: World Bank, Poverty and Equity Global Practice. Note: A. The multidimensional poverty measurement (MPM) is calculated based on EEAPOV harmonization of the most recent household income and expenditure surveys (HIES). The MPM uses the following deprivation indicators: 1. Monetary poverty: a household is deprived if income or expenditure, in 2017 purchasing power parity US dollars, is less than USD 2.15 per person per day; 2. Educational attainment: a household is deprived if no adult (grade 9 equivalent age or older) has completed primary education; 3. Educational enrollment: a household is deprived if at least one school-age child up to the (equivalent) age of grade 8 is not enrolled in school; 4. Electricity: a household is deprived if it does not have access to electricity; 5. Sanitation: a household is deprived if it does not have access to limited-standard sanitation; and 6. Drinking water: a household is deprived if it does not have access to limited-standard drinking water. B. The reporting year is 2019 for Fiji, Kiribati, Marshall Islands, and Vanuatu, and 2021 for Tonga (based on preliminary estimates). No recent data are available for Micronesia. C. Sources of deprivations in access to services and schooling include the most recent Multiple Indicator Cluster Surveys MICS reports (2021 Fiji, 2019 Samoa, and 2019 Tuvalu), and Census reports (2019 Solomon Islands, 2020 Palau, 2021 Marshall Islands, 2020 Kiribati, 2021 Tonga, 2021 Nauru, and 2020 Vanuatu). No recent data are available for Micronesia. Only indicators available in these reports are displayed. Data on educational attainment by level are not available for Kiribati. 69 References Angrist, N., D. K. Evans, D. Filmer, R. Glennerster, F. H. Rogers, and S. Sabarwal. 2020. “How to Improve Education Outcomes Most Efficiently? A Comparison of 150 Interventions Using the New Learning-Adjusted Years of Schooling Metric.” Policy Research Working P Washington, DC, World Bank. Banerjee, A., R. Banerji, J. 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