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Reserve Bank of Vanuatu
Half-Yearly Monetary Policy Statement
March 2013
1. Statement by Governor 2. Objectives of the RBV 3. International and Domestic Overview 4. International and Domestic Outlook
a. Economic Activity b. Inflation c. Balance of Payments & International Reserves
5. Monetary Policy Stance
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1. Statement by Governor
Since the September biannual Monetary Policy Statement the world economy has remained broadly weak despite improvements in sentiment of international financial markets, little evidence of sustained recovery in growth and employment is seen, particularly in advanced economies. This remains a concern for policy makers across the world. Vanuatu's economy is not sheltered from such external developments with changes in international commodity prices, capital flows and foreign interest rates having a direct impact on our own economic prospects. Over the coming months, we expect the Australian economy to face some challenges as we watch resource sector move to past its peak and begin to weigh on economic activity. However, policy makers are already looking towards other sources of demand with the Reserve Bank of Australia further reducing their policy interest rates over the last six months. Commodity prices are not expected to increase significantly over the coming months in line with subdued levels of world economic activity. These developments are being constantly monitored very closely by the Reserve Bank. Domestically we continue to see a mixed performance across sectors, however overall economic activity remains subdued. From the last Monetary Policy Statement the tourism industry underlined its particularly strong performance in comparison to 2011. Rapid growth in cruise ship and air visitor arrivals have helped support the economy and is expected to continue to perform well over coming months. In contrast, the impact of weak commodity prices, political uncertainty, delayed infrastructure projects have been weighing on construction, manufacturing and agricultural export growth. This assessment appears to be mirrored in the banking system where activity over the last six months has continued to slow. We do not expect this situation to change markedly over the next six months however; the outlook can change quickly with a rapid turnaround in economic activity and inflationary pressures, something we are aware of. Annual inflation reached 0.8 percent in December, the slowest rate for almost a decade but still within the Bank’s target band. This largely reflects the weakness in international price pressures with commodity prices growth remaining low and inflation rates remaining subdued in some of our nearest trading partners. Domestic price pressures are also weak reflecting the slowdown in economic activities and the strength of the US dollar against the domestic currency and the Australian dollar. We do not expect these drivers to change substantially over the coming months therefore inflation is forecasted to remain comfortably within the Reserve bank’s target. Despite some downward pressure on Official Reserves in recent months, they remain healthy at 6.6 months of import cover. Conservative forecasts projected Official Reserves to remain sufficient to meet our external commitments through 2013. Reflecting these developments, the Reserve Bank considers it appropriate to maintain a loose monetary stance to help foster economic activity. The Monetary Policy Committee has in its 26th March Meeting cut the re-discount rate by 0.5 percentage points while maintaining the Statutory Reserve Deposit at 7 percent. The Bank has made significant interventions in the form of open market operations to hold up commercial banks’ excess reserves. This appears to have helped place downward pressure on interest rates however we are yet to see a clear response in terms of lending growth.
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The Reserve Bank continues to monitor developments closely and remains ready to act as and when pressures look to be arising.
Odo Tevi Governor, Reserve Bank of Vanuatu
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2. Objectives of the RBV
The Reserve Bank of Vanuatu (RBV) is responsible for the formulation and implementation of monetary policy in Vanuatu. Through its conduct of monetary policy, the RBV seeks to promote monetary stability and economic growth by maintaining a stable value of the Vatu, both domestically and externally. Central to this is the need to maintain a low and stable rate of inflation and sufficient international reserves to meet the country’s external obligations. More specifically, the Bank strives to keep year-ended growth in inflation contained between 0 and 4 percent and to hold sufficient international reserves to cover at least 4 months of goods imports. Over the past six months both these targets have been comfortably met and current forecasts suggest that despite some recent downward pressure on official reserves, our key targets will continue to be achieved over the next 6 months.
3. International and Domestic Economic Overview The International Economy Since the last Monetary Policy Statement financial market conditions have continued to show signs of improvement following interventions by central banks in the first half of 2012. In particular, concerns over the potential break-up of the Euro currency union have subsided owing to the actions of the European Central Bank and member governments. Meanwhile in the United States, some of the more worrying possibilities of rapid fiscal consolidation have been averted, although this has yet to be fully resolved. However, despite overall improvements in sentiment and financial stability, there remains little evidence of this feeding into a sustained recovery in economic growth and employment, which continues to be a central challenge for policy makers across the world. The latest estimates from the IMF highlight the extent of the slowdown in 2012 with estimates suggesting world economic growth in 2012 of 3.2 percent. This compares to 5.1 and 3.9 percent in 2010 and 2011 respectively and highlights the extent to which the world economy has been weighed down by the debt challenges facing some economies. This downturn has been felt by Advanced Economies and Emerging and Developing Economies alike. In 2012 Advanced Economies are estimated to have grown by 1.3 percent, while Emerging and Developing Economies grew by 5.1 percent, both significantly weaker than the 1.6 percent and 6.3 percent growth posted in 2011 respectively. Since the September Statement, the eurozone moved officially back into recession. Unemployment continued to increase to 11.7 percent recorded at the end of 2012; however this average hides the extent of the weakness in labour markets in individual European economies, particularly those that are facing sovereign debt challenges. Sentiment in the region has been improving over recent months however there are a number of countries in the region that continued to face the combined challenges of slow economic growth and high government debt. In the United States economic growth at the end of 2012 was flat with the slowing external environment and fiscal uncertainties weighing on economic growth. This was reflected in the labour market, where unemployment has remained around the same level since September 2012, putting an end to the string of relatively impressive improvements seen prior to this. Over the past six months, the United States have been faced with the challenge in managing the risk of rapid reductions in government spending and increases in tax rates, that has weighed heavily on confidence of investors. The economies of some of Vanuatu’s nearest trading partners, such as Australia and New Zealand, have experienced a slowdown over the past six months but continue to show signs of
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relative strength in comparison to many advanced economies. In the first half of 2012, the Australian economy experienced particularly strong growth rates thanks to robust resource sector investment, which brought economic growth rates to levels not experienced by any other advanced economy. Since this period, economic growth has gradually slowed but has benefited from the better-than-expected performance of the Chinese economy (a key Australian export destination). Reflecting this gradual slowdown, Australian unemployment increased over the past six months from 5.2 to 5.4 percent. New Zealand has also seen an easing in economic activity with the strong currency weighing on export prices and fiscal consolidation. New Zealand’s unemployment remains elevated at 6.9 percent having increased only slightly from over the last six months. Reflecting this weak global economic activity, oil prices have seen significant declines from the highs seen in 2011. According to the IMF, in 2012 prices of non-fuel commodities fell on average by 9.8 percent compared to the 17.8 percent increase seen over 2011. Oil increased by 1.0 percent compared to 31.6 percent increase over 2011. This is reflected in the average inflation rates of Advanced and Emerging and Developing Economies, which fell to 2.0 percent (from 2.7 percent in 2011) and 6.1 (from 7.2 percent in 2011) respectively. Of Vanuatu’s key exports, over the year to December 2012, beef and cocoa seeing some increases in prices on world markets however, prices of copra and coconut oil saw falls by as much as 45 percent. On the whole Central Banks continue to hold particularly loose monetary stances to help create an environment to foster economic activity. Since June 2012, the European Central Bank cut its headline policy rates once more to 0.75. The United States Federal Reserve implemented a third round of Quantitative Easing which injected liquidity into the banking system through expanding its purchases of mortgage-backed securities. Over the past six months, the Reserve Bank of Australia has continued to cut its policy interest rates to 3.0 percent placing significant downward pressure on short-term interest rates in Australia. This is the lowest policy rate seen since 2009. The Reserve Bank of New Zealand has also held its loose stance but has not made significant changes since the beginning of 2011. The Domestic Economy Following the last Monetary Policy Statement, the sectors of the Vanuatu economy, aside from tourism, showed signs of weakening. The Vanuatu National Statistics Office has now published it economic growth figures for both 2010 and 2011, suggesting weaker than expected activity at 1.6 percent and 1.4 percent respectively. Following impressive economic growth in the years leading to 2008, we have observed the combined effect of a reduction in donor-led infrastructure investment, a weakening property market investment, subdued export commodity prices and the slowing of activity in the telecommunications industry. In 2011 it is estimated that construction activity contracted by 38 percent following a contraction of 6.7 percent in 2010. This compares to the 84.8 percent expansion recorded in 2008, highlighting the extent to which the industrial sector has slowed with falling donor-led infrastructure spending. The agricultural sector grew by 12.5 percent and 9.4 percent respectively showing relatively robust growth compared to previous years. However, services sector growth in 2010 and 2011 remained flat at 4.5 percent and 5.0 percent respectively, posting relatively subdued performance compared to the years leading up to 2008.
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Indicators from the last quarter of 2012 point to an overall slowing of the domestic economy that continued to expand at a rate considered below potential. However, there are some signs of strength in the tourism industry which continued to grow fairly rapidly compared to recent years. Contributing to this strong performance were increases in cruise ship scheduling, increased marketing efforts and some one-off factors such as the international conferences held in Port Vila and tourism diverting to Vanuatu following natural disasters in neighbouring Pacific countries. Overall, non-resident visitor arrivals increased over the year to December 2012 following strong growth in both cruise ships (up 41 percent) and air arrivals (up 15 percent). Towards the back end of the year agricultural exports weakened, which has led to exports under-performing 2011 in every quarter of 2012. This is a direct result of subdued international commodity prices which weighed heavily on the value of copra and coconut oil exports in the last quarter of the year. Over the last six months, the developments in the banking sector appear to underline overall developments in economic activity. The broadest measure of money and indicator of banking sector activity, M2, has started to see year-on-year declines for the first time since the middle of 2011. However, different from 2011, this has been driven by declines in net foreign assets and particularly weak private sector credit growth. Lending to the private sector has continued to slow with year-on-year growth rates in private sector credit falling below 7 percent for the first time since the middle of 2007. However, this in part reflects the write-off of one large loan in September. This compares to the rapid growth in credit to the private sector that reached highs of 48 percent year-on-year growth in 2008. During the last six months, high levels of liquidity driven by RBV policy decisions, alongside increased competition in the face of slowing activity has led to lending rates falling to levels not seen in the past decade. With deposit rates not declining as much, interest rate spreads of commercial banks have been squeezed. Inflationary pressures have continued to weak over the past six months. By December the annual rate of inflation was 0.8 percent with underlying inflation of 2.3 percent. Food price inflation over the year to December was 1.6 percent and made the most significant contribution to the overall inflation rate. Over the year, housing and utilities prices placed the most downward pressure on CPI, having fallen 1.4 percent. This compares to 1.1 percent recorded in the September quarter. Overall, these figures underline the assessment of the slow domestic and weak international food and fuel prices. Government revenue over 2012 was strong owing to improved collections of Value Added Tax that has continued into 2013. It is believed that most of these improvements reflect increased compliance activities by the Department for Customs and Inland Revenue, rather than economic activity. Revenues from taxes on international trade continue to remain weak with the implementation of various free trade agreements, however excise tax receipts continued to make up for this decline. Over 2012 outstanding government bonds increased by around a third, most of which were picked up by Other Financial Institutions. 4. International and Domestic Outlook Outlook for the International Economy Looking forward, the key risks facing the world economy remain the potential for renewed uncertainty in the euro zone and rapid fiscal consolidation in the United States. If these risks materialise, the outlook is likely to change rapidly and the IMF warn that their forecasts will be revised down again.
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Figure 1: World Economic Growth (IMF World Economic Outlook; Annual Growth)
Reflecting recent developments, the IMF’s latest update to the World Economic Outlook contained further downward revisions to forecast of global economic growth. In 2013 the world economy is now expected to show only a modest recovery, expanding by 3.5 percent from the 3.2 percent growth seen in 2012. Growth in advanced economies is expected to remain at similar rates to 2012, with the IMF now estimating 1.4 percent growth. In slight contrast, the pick-up in Emerging and Developing Economies is expected to be more pronounced reaching 5.5 percent in 2013 from 5.1 percent in 2012. The outlook for the Australian economy remains fairly positive in comparison to many other advanced economies although we expect somewhat of a slowdown over coming months. In 2013 it is believed that investment in the resource sector is likely to peak, forcing policy makers to look toward other sources of demand to maintain levels of economic activity. However, the improved outlook for the Chinese economy bodes well for Australia maintaining its levels of exports. At the same time, the rapid loosening of the Reserve Bank of Australia’s monetary policy that continued until the end of 2012 is hoped to feed through into improved economic activity in other sectors over coming months. The key implication of the current world economic growth forecasts for Vanuatu is that we should expect international commodity prices and international capital flows to remain subdued at least until 2014. The IMF forecast oil prices to fall by 5.1 percent over 2013, while their index of non-fuel commodities is forecast to fall by 3.0 percent. Forecasts for inflation in advanced economies suggest a slight easing, while remaining flat in Emerging and Developing economies. In practice, these forecasts for price developments will depend heavily on the timing of a recovery in world economic activity and they have important implications for our own inflationary pressures and export earnings. External developments suggest the world economy will therefore remain weak through much of 2013. However, the most significant external risks to the prospects of the domestic economy come from a greater-than-expected slowdown in the Australian economy and further easing in the prices of Vanuatu’s export commodities. Outlook for the Domestic Economy
a. Economic Activity According to the latest Macroeconomic Committee estimates economic activity is expected to pick up in 2013 to 3.6 percent from an estimated 2.5 percent in 2012. This is a downward revision from the previous forecast of 4.3 percent owing to the increased likelihood that major donor projects originally planned to take place in 2013 will be shifted to 2014. With tourism prospects
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Figure 2: Vanuatu GDP (Contribution to Annual Growth; Major Sectors)
4.3 4.0
5.3
8.5
5.2
6.5
3.3
1.6 1.4
2.5
3.64.0 4.3
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0
2
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6
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10
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03 04 05 06 07 08 09 10 11 12e 13f 14f 15f
Add T -S -BSC*Services IndustryAgriculture, Forestry & FisheriesGDP Growth(%)
Source: VNSO ; * Add Tax less Subsidies on Products less Bank Service Charge; Forecastfor 2012 onwards are MEC projections (December 2012)
% %
Forecast
expected to improve, the domestic economy is forecast to grow further by 4.0 percent in 2014 and 4.3 percent in 2015. It is important to note that the expected upturn in domestic activity and the extent that economic growth deviates from these forecasts depends to a large extent on the implementation of planned donor infrastructure projects, which in turn will likely feed through into other sectors of the economy. These projects are expected to drive growth in the 3 year period leading to 2015. With a closer focus on 2013, the general consensus discussed above is that commodity prices on the whole are not expected to increase substantially over the year in line with global economic activity, suggesting activity in agriculture on the whole may remain weak. Latest scheduling for donor-led infrastructure projects currently suggests pick-up at the end of the year and in 2014. In contrast, the key sector where we expect to see strong performance is the tourism industry thanks to increased exposure of Vanuatu as a tourist destination, as well as continued expansion in the number of cruise-ship arrivals. It is expected that growth in tourism arrivals will remain strong over 2013, albeit slight decline on the levels of growth that observed in 2012. In the banking system we expect that activity will be subdued for much of 2013. Private sector credit growth is forecast to remain flat until we start to see significant increases in lending opportunities, which may not be until the end of 2013. At the same time, developments in Australia, including short-term interest rate movements and interventions by the Australian Tax Office are likely to continue to weigh on commercial banks’ net foreign assets (NFA) over the coming months. The overall result of these movements is that we expect money supply (M2) growth to be stronger than 2012 but will remain on the whole relatively weak. Overall the economy is expected to remain subdued throughout 2013, however the RBV remains mindful of the risks the domestic economy will be facing such as the potential for a greater-than-expected slowdown in the Australian economy, domestic political uncertainty or further declines in the export commodity prices. However, potential inflationary pressures remain on the horizon with spending on large donor-led infrastructure projects picking up and potentially creating domestic price pressures, while improvements in the world economic activity or developments internationally could push up international prices quicker than forecast. The current government budget points towards the possibility of budget surplus over the year. We do not currently expect to see the levels of new borrowing that took place in 2012 however there will be a need for some sizeable bond rollovers. It is expected that expenditure will increase15 percent while revenues will remain strong with increases of 20 percent projected by
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Figure 3: Consumer Price Index (Percentage Change)
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6
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Dec-02 Dec-04 Dec-06 Dec-08 Dec-10 Dec-12
Quarterly Year-ended
Source: VNSO
%%
the government. However, this position is likely to change with the new government and its institutional restructuring currently underway.
b. Inflation The key target of the RBV is an inflation rate that remains in the range of 0-4 percent. The latest figures from Vanuatu National Statistics Office (VNSO) placed the annual inflation rate at 0.8 percent. This is one of the lowest rates seen over the last decade. The expenditure groups contributing to the increases over the year included: food (1.6 percent), household supplies (2.5 percent), miscellaneous (5.6 percent), education (1.4 percent), recreation (2.2 percent), and clothing and footwear (2.8 percent). These developments in the headline inflation rate reflect the slowdown in domestic activity which has continued to hold domestic economic activity below potential. At the same time subdued international prices owing to weak international activity also explain a significant proportion of the weak rates of inflation. Over the year fuel prices have remained stable, while rice prices, which make up a significant proportion of Vanuatu’s CPI basket, have been below the levels seen in recent years. More generally, the levels of inflation in some of Vanuatu’s closet trading partners such as Australia and New Zealand remain low. Looking forward to the upcoming inflationary pressures, those coming domestically are likely to remain on the downside for much of 2013 with output expected to remain below potential for the course of the year. However, if donor activity picks up quicker-than-expected, we might expect inflationary pressures to pick up. International prices pressures are forecast to remain subdued as discussed above, while inflation of our trading partners such as New Zealand and Australia is forecast to remain low. All in all, this suggests that both domestic and international inflationary pressures are unlikely to be too strong over coming months and current forecasts place the rate of inflation well within the RBV’s target over the coming six months.
c. Balance of Payments and International Reserves Over 2012 growth in tourism earnings and donor inflows helped to offset a slight increase in the trade deficit. The trade deficit increased owing to falls in exports outweighing slight falls seen in imports. In 2013 we expect to see an increase in imports for donor funded projects, while tourism earning growth is expected to ease in comparison to 2012 but remaining strong.
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Figure 4: Net Foreign Exchange & Import Cover (Levels of FX & Months of Cover; Quarterly Data)
Figure 4 presents conservative forecasts for Vanuatu’s official foreign exchange holdings and months of import cover. It suggests that under these conservative assumptions we still would expect the level of official reserves to remain comfortable by the end of 2013. In December 2012 estimates suggest official reserves were sufficient to finance 7.4 months of imports. However, by February we saw a decrease to 6.6 months reflecting an easing in the level of official reserves driven primarily by slowing donor inflows. It is thought the second half of 2013 will see larger inflows of foreign exchange in line with scheduled donor projects. Overall the medium term outlook remains favourable. Demand for foreign exchange is expected to increase, both to finance imports as economic growth begins to pick-up and to service public borrowing abroad. However, significant inflows are expected to take place with as the implementation of sizeable donor-led infrastructure projects that are scheduled to take place from 2013 onward. 5. Monetary Policy Stance Overall the Reserve Bank has decided to loosen its monetary policy stance further to help foster an environment for promoting economic activity amidst low inflation and low private sector credit. On 26th March 2013 the Monetary Policy Committee cut its re-discount rate by 0.5 percentage points to 5.5 percent while maintaining its Statutory Reserve Deposit (SRD) at 7.0 percent. The SRD has been held at 7 percent (compared to 10 percent prior to the end of 2008), while the re-discount rate is now held at 5.5 percent (compared to 6 percent since December 2008). Some of the key developments in monetary policy since this period have come on the side of open market operations with changes in the use of central bank securities (RBV Notes). Over 2012 the RBV helped to hold up the high level of excess reserves through retiring a substantial proportion of its RBV Notes, this led to an injection of around Vt800m into the banking system. As a result, we have observed yields on RBV Notes fall to very low levels and commercial bank lending rates begin to fall. However, we are yet to observe this feed through into any strengthening in private sector credit growth. It is possible that the RBV may be reaching its limit of its ability to stimulate economic activity. Nevertheless, on the horizon, remains the prospect of an upturn in activity and inflationary pressures both domestically and internationally. The RBV will continue to closely monitor these economic developments and stands ready to move to adjust its stance as and when they occur.
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Reserve Bank of Vanuatu, Monetary Policy Stance A Chronology (in reverse order)
Effective Date Financial/Economic Situation (Brief)
Monetary Policy Stance
March 2013 Relaxation of monetary control to accommodate for low inflation, private sector credit and economic activity
Rediscount Rate reduced to 5.5 percent.
August 2011 -Still too much excess liquidity in the domestic banking system – world economy begins to show tentative signs of recovery
SDR requirements increased from 6 percent to 7 percent, Rediscount rate remains at 6.00 percent
August 2010 High level of liquidity in the system – domestic sector recovery is happening
SRD requirements increased from 5 percent to 6 percent, Rediscount rate remains at 6.00 percent
January 2009 Low level of liquidity in the system coupled with possible slowdown in some sectors of the economy given the continued world economic meltdown
SRD requirements reduced from 8 percent to 5 percent, Rediscount rate remains at 6.00 percent
December 2008 Relaxation to monetary controls with the aim to increase liquidity
Rediscount rate reduce to 6.00 percent and introduction of a secured advanced facility. LAR reduced from 8 percent to 7 percent
November 2008 Monetary Policy Loosening with the aim of increasing liquidity in the market
SRD requirements reduced from 10 percent to 8 percent rediscount rate remains at 6.25 percent.
September 2008 Rediscount rate increased 25 basis points to 6.25 percent
November 2007 Rediscount rate reduced to 6.00 percent. LAR reduced further to 8%.
February 2005 Rediscount Rate reduced to 6.25%.
January 2004 LAR reduced from 15 percent to 12 percent.
December 2001 Rediscount rate reduced to 6.50%.
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February 2000 Reintroduction of the foreign exchange guidelines.
October 1999 Removal of guidelines of foreign exchange dealings.
May 1999 Secured Advance Facility was abolished. Rediscount facility and Repurchase Agreement amalgamated, rate remained 7.00 percent.
April 1999 Liquidity falls back to comfortable level after the crises.
SRD requirements rose to 10 percent. PRA abolished. LAR introduced at 15 percent.
February 1999 Excess liquidity rose, the aftermath of the VNPF riots.
RBV gradually phasing out the PRA and introduced SRD again. SRD remains at 6percent and PRA at 10 percent
December 1998 Still a result of the VNPF Liquidity crises
The RBV introduced the Rediscount and Repurchase Agreement facility at an interest rate of 7.00 percent
November 1998 VNPF Crisis cools down and liquidity almost return to normal
RBV starts gradually phasing out the PRA and reintroduce SRD. PRA was lowered to 10 percent and SRD was reintroduced at 6.0 percent.
April 1998 VNPF payout financed by issuance of Government bond. Too much Liquidity in the system due VNPF riot and withdrawals of member funds – approximately VT3.3billion liquidity injection
16 percent Prescribed Reserve Asset (a special form of Liquid Asset Ratio) replaces the 10 percent SRD The secured advance facility increased to 11.97 percent.
March 1998 The VNPF crises raises fear of capital outflows. This saw months of import cover reduced to less than four months.
Devaluation of Vatu currency by 20 percent. Three days later the Vatu currency was revalued. The RBV commenced its first issue of 91-day RBV note. RBV introduced temporary guidelines on foreign exchange dealings to Banks, that foreign exchange request would be honored for current transactions while capital transactions are to be settled
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by the Bank. January 1998 Vanuatu National Provident
Fund Crisis begins SRD remained at 10 percent.
1991-1997 Presumable the most stable period in the monetary and financial history of Vanuatu – relatively high economic growth
SRD remained unchanged at 10 percent
February - June 1988 Wide fluctuations in liquidity and other difficulties faced in the banking sector. Excess liquidity is a concern
First minimum reserve ratio introduced at 10 percent
March 1987 Commercial Banks tended to think the informal guideline was fully abolished that interest rates rise again
Issuance of firmer informal guideline to control interest rate spread –especially in productive sectors of the economy
1985-1986 Need to encourage export (copra & cocoa and other services including tourism)
Series of Currency Devaluation
February 1985 Increasing number of doubtful debts in the banking sector and absence of bankable projects
Intended to gradual abrogate the informal guidelines by first revoking restrictions to interest rates spread
1981 -1985 After Independence - A period of low liquidity, low economic growth and high interest rates spreads – RBV need to channel credit into productive sectors of the economy
Direct control/guidelines to credit rather than market-based policy instruments implemented (informal guidelines adopted) The secured advance facility was at 10.97 percent
We will continue to update this table in our next issue of Monetary Policy Statement.
