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Foreword, Acknowledgments, Acronyms and Abbreviations, Definitions
I. Developing Asia and the world
II. Economic trends and prospects in developing Asia
East Asia
Southeast Asia
South Asia
Central Asia
The Pacific
Cook Islands
Fiji Islands
Kiribati
Republic of the Marshall Islands
Federated States of Micronesia
>>Nauru
Republic of Palau
Papua New Guinea
Samoa
Solomon Islands
Democratic Republic of Timor-Leste
Tonga
Tuvalu
Vanuatu
III. Promoting competition for long-term development
Statistical appendix
Asian Development Outlook 2005 : II. Economic trends and prospects in developing Asia

Nauru

Nauru continued its reliance on Australian financial and technical assistance in 2004 as phosphate production contracted and trust fund assets went into receivership. A reformist administration elected in October has a strong public mandate to implement economic reforms but, in the absence of an alternative to phosphate mining, the medium-term outlook is for continued dependence on external assistance.

Macroeconomic assessment of 2004

Macroeconomic analysis of the economy is severely hampered by the virtual absence of economic statistics, but it was clear that the economy remained in a critical condition in 2004. Phosphate production, which historically has been the only significant domestic economic activity, was at an almost negligible level following years of exploitation and mismanagement, and allowed for only limited exports of relatively low-quality product to Asian markets. Agricultural output was stagnant, constrained by inadequate rainfall and low fertility of the limited arable land area. Coconut, breadfruit, and a few fruits and vegetables were harvested for household consumption. Fishing output was largely confined to subsistence harvesting, and was held back by a lack of equipment. Services sector activity recorded no growth, with public sector wages in arrears, tourism virtually nonexistent, provision of power and water dependent on external assistance, and returns on overseas investments dried up. Net assets in the trust funds administered by the Nauru Phosphate Royalties Trust (NPRT) had been valued at A$1,300 million in 1991, but the combined impact of excessive consumption spending, poor investment advice, and mismanagement reduced the value to an estimated A$138 million in 2002. Continued mismanagement culminated in early 2004 with the placement of the asset portfolio into receivership, following the Government’s failure to meet the repayment deadline on a loan from General Electric Capital Corporation. Sale of NPRT’s Australian property portfolio reportedly covered the $188 million owed on this loan, and left a relatively small pretax amount of about $78 million with which to meet other debt-repayment obligations.

In the absence of phosphate and trust fund revenues, the economy remained reliant on income from fishing licenses and foreign aid. The established Australian bilateral assistance program continued, as did the provision of project assistance under Australia’s Rehabilitation and Development Cooperation Program begun in 1993. Additionally, assistance in health, education, and maintenance of public infrastructure was provided in return for Nauru hosting processing centers for asylum seekers, which held 82 people in September 2004. Under a February 2004 memorandum of understanding between the governments of Australia and Nauru, the former agreed to provide an A$22.5 million package of assistance to June 2005, which included the placement of Australians in three in-line positions in the Ministry of Finance (including the secretary) from late July. Australians also took up positions as director of police and special police advisor from late October. The finance team was tasked with improving public financial management, assisting in the formulation of the 2004/05 budget and assessing Nauru’s assets and liabilities. Assistance was also provided in late 2004 by the Pacific Islands Forum, which gave a cash grant for salaries and offered support for the judiciary, financial auditing and planning, and the health and education sectors.

Political instability in late 2003 disrupted the approval process for the 2003/04 budget, which was in any case quite unrealistic in its revenue and expenditure projections. Dividends to the Government from the state-owned Nauru Phosphate Company (NPC) ended in 1991 and the virtual standstill of phosphate production in 2004 prevented the Government from borrowing against phosphate sales revenues. Checks drawn on government accounts with the state-owned and technically insolvent Bank of Nauru remained worthless; and the shrinking of the NPRT investment portfolio meant that the Government could no longer rely on direct drawdowns from trust funds and collateralization of their assets as the principal means of funding a budget deficit.

In the event, government spending in 2003/04 was limited by the availability of revenues and authorized by the passage of three supply bills, with the result that a small surplus of A$37,600 was recorded. Actual expenditures were 35% of the budgeted level and involved a substantial shortfall in public service wage payments: only A$5 million was paid, compared with a salaries liability of A$13 million. The consequences for public service delivery were evident in education: the sector fell into crisis as expatriate teachers left Nauru without their back pay or their superannuation entitlements. Nauruan teachers were receiving incentive payments from the Australian Agency for International Development of $10 per week; but, like all government employees, they were receiving less than their full salaries and their productivity was reduced by inadequate supplies of complementary inputs such as teaching materials. Salaries for public enterprise employees were also in arrears, notably in NPC, which could neither pay nor immediately repatriate its foreign contract workers. Since almost all Nauruans in formal employment are in the public sector, economic hardship increased in 2004, with people using any public sector wages received, savings held offshore, and private remittances from relatives overseas to purchase essential supplies of rice and flour.

Given the use of the Australian dollar as the currency and Australia’s position as the major supplier of imports, the inflation rate in the first 3 quarters of 2004 was probably around the Australian rate of 2.3%. With the Bank of Nauru insolvent, no effective commercial banking services were available; the contraction of economic activity inevitably discouraged financial development beyond cash-only exchange and barter. The merchandise trade deficit was covered primarily by official and private transfers.

Macroeconomic policy developments

Past budgets in Nauru have been characterized by overoptimistic revenue projections, underestimation of expenditure needs, and nontransparent funding of unsustainable deficits. The 2004/05 budget approved by Parliament in late October 2004 represents a fundamental change in approach to fiscal management. It explicitly acknowledges that the country is in financial crisis and accordingly aims at ensuring that expenditures are reduced and controlled within limits set by realistic, medium-term projections of revenues and grants.

Expenditure reduction is to be achieved through reducing the public service wage rate to an average of $75 every 2 weeks (pending completion of a review of public service salaries); cutting by 75% payments to landowners leasing land to the Government; scaling down diplomatic representation in Australia and the US; cutting expenditures on residential accommodation for Nauruans receiving medical treatment and studying in Australia; and transferring overseas Nauruan students from Australian to Fiji Islands institutions in 2005. Public service wages will account for 44% of reduced aggregate expenditures and there is provision for some reallocation of resources to education and health, as well as for the establishment of a price control board to prevent profiteering by merchants with monopoly power.

Revenue-raising measures include the introduction of a 10% import duty on goods (except for rice, flour, and fresh fruits and vegetables) previously imported free of duty; increased import duties on alcohol and tobacco; the transfer of fishing license fees from the Nauru Fisheries and Marine Resources Agency to the Government; and increases in various fees and charges.

Income from investments, dividends, and fishing license fees and from customs and excise duties is estimated to account for 35% and 26%, respectively, of total revenues. A budget deficit of A$497,000 is projected for 2004/05, to be followed in the next 2 years by budget surpluses in excess of A$2 million. The 2004/05 budget papers are silent on how the projected deficit is to be financed, implying that, in the absence of a revenue windfall, expenditures will have to be reduced to ensure budget balance. The probability that the 2004/05 budget and associated economic reforms will be implemented effectively is high because of the strong parliamentary majority held by the reformists and because technical assistance will help ensure sound cash management as well as expenditure control.

A key element in introducing responsible public financial management was the initiation of an assessment of assets in the trust funds administered by NPRT. Remaining trust fund assets will need to be restructured away from a heavy property orientation toward a properly managed portfolio of secure income-generating financial assets. The task of restructuring is complicated by the fact that the various trusts are owed millions of dollars by the Government and by the state-owned Republic of Nauru Finance Corporation (RONFIN), which has been technically bankrupt for at least a decade. The reform of the 11 major SOEs other than NPRT itself is a demanding medium-term requirement and will need to include an assessment of the state of NPC’s finances and future prospects. The 2004/05 budget affirms the Government’s commitment to public enterprise reform, beginning with the winding up of RONFIN.

Following the decision to close Nauru’s internationally notorious offshore banking sector, antimoney laundering legislation was passed in 2004. This is expected to culminate in Nauru’s removal from the Non-Cooperative Countries and Territories (NCCT) list of OECD’s Financial Action Task Force (FATF) on money laundering. In October 2004, FATF withdrew countermeasures against Nauru because of the passage of the legislation, but awaits evidence of implementation before complete removal from the NCCT list. The 2004/05 budget provides funding for the establishment of a financial investigations unit to support the implementation process. Setting up a viable domestic banking system is another major task to be addressed in the economic reform program.

Outlook for 2005-2007 and medium-term trends

Continued exploitation of phosphate deposits, which are almost exhausted, offers no prospect of medium-term economic growth. Even the extraction of remaining reserves is hampered by the deterioration of infrastructure and equipment due to past neglect of maintenance. Aid-funded rehabilitation of mined land will generate economic activity at a relatively low level over the medium to long term, and will thus indirectly generate some government revenues, as will other aid-funded projects. However, there is no obvious alternative to phosphate mining as a means of creating GDP. National income will be heavily reliant on external sources. Pelagic fish are abundant in Nauru’s exclusive economic zone, and revenues can be expected from fishing licenses issued to several deepwater fishing nations, though this is an inherently volatile revenue source that is difficult to predict. Revenues could also be generated by restructured trust funds, though the authorities do not expect them to be substantial.

The Government acknowledges that fiscal reform entails increased financial hardship for the population in the medium term. Nauruans employed in the public sector--almost everybody in formal employment--will bear the brunt of unavoidable wage cuts that will have flow-on effects in the rest of the economy. The mostly ethnic Chinese retailers who depend on public servants’ purchasing power will experience further reductions in business, and some may join other expatriates departing the country on Air Nauru’s solitary aircraft, which offers the only available commercial service and which will continue to struggle for financial viability.



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