IMF Concludes 2021 Article IV Consultation with Palau

Washington, DC: On November 29, 2021, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation [1] with Palau.

Palau entered the pandemic with some fiscal buffers, including a moderate public debt. While strict health measures and preemptive border closure have helped prevent local community spreads of COVID-19 to date, they have severely impacted the tourism-dependent economy. Real GDP contracted by 9.7 percent in FY2020 and is estimated to have further declined by 17.1 percent in FY2021. In contrast to the tourism sector, construction activities were resilient, reflecting progress on large infrastructure projects and strong housing construction. Inflation edged up, driven by a rise in food and energy prices, and the current account widened significantly on the back of a sharp decline in tourism receipts.

The authorities adopted a comprehensive policy response with measures that appropriately aimed at strengthening healthcare and mitigating the economic and social hardship of the pandemic. Despite job losses in the tourism sector, employment support prevented a notable deterioration of overall labor market conditions. The economic fallout of the pandemic and the cost of the fiscal response have led to large fiscal deficits and a rapid increase in public debt. With about 90 percent of the total population fully vaccinated, Palau has started to gradually reopen its borders with some safety measures.

The economic outlook remains challenging. Real GDP is projected rebound by 9.4 percent in FY2022 alongside a gradual recovery in tourist arrivals, which are expected to remain below pre-pandemic levels through FY2023. Inflation is expected to pick up on the back of elevated international fuel prices. The large fiscal and current account deficits are projected to narrow as tourism activities recover. The outlook is subject to high uncertainty, and risks are titled to the downside, including from a protracted pandemic, a domestic outbreak, and natural disasters. Palau’s graduation from the OECD’s list of countries eligible for official development assistance could lead to lower concessional financing, in particular grants.

Executive Board Assessment [2]

Executive Directors welcomed the authorities’ comprehensive policy response to the pandemic which helped limit its health and economic impacts. They noted that an economic recovery is underway, supported by a high vaccination rate and a gradual resumption of tourism. However, the outlook remains clouded by elevated uncertainty and risks. While support to the economy should remain until the recovery is broadly entrenched, prudent policies are needed over the medium-term to support macroeconomic stability and promote sustainable, greener and inclusive growth.

Directors welcomed the extension of measures to provide targeted fiscal support to still affected households and firms. They agreed that fiscal policy should continue to be the first line of defense in case downside risks materialize.

Directors noted that fiscal risks over the medium-term have increased substantially and underscored the need for fiscal adjustment to rebuild fiscal resilience and preserve debt sustainability. They welcomed the approval of the comprehensive tax reform, which will contribute to fiscal adjustment while improving the efficiency of the tax system. Directors also concurred that additional revenue mobilization and expenditure rationalization efforts are needed to help accommodate higher climate spending, improve the external position, and provide buffers against potentially lower grants and concessional financing.

Directors agreed that financial sector reforms should be accelerated to support financial deepening. They highlighted the need to enhance SMEs’ capacity to absorb credit and address the structural determinants of low credit creation. Risk-based supervision should be strengthened, including for non-bank financial institutions, and improving the AML/CFT framework should remain a high priority.

Directors underscored that steadfast implementation of structural reforms should continue to support sustained growth post-pandemic. They welcomed efforts to pursue greater diversification of source markets for tourism. Going forward, Directors saw merit in streamlining processes for foreign investment, improving the business environment, and enhancing human capital to encourage private investment within and outside the tourism sector.

Directors emphasized that strengthening resilience to climate change is essential for Palau’s sustainable development. In this regard, they called for a timely implementation of Palau’s climate change adaptation and mitigation strategy, including by tapping into climate risk financing, to enhance economic resilience.

Directors agreed that pursuing capacity building efforts will enhance macroeconomic management.