In April this year, scores of public servants, those considered nonessential, were briefly put out of work. Although they have now been reinstated, their ministries’ budgets remain expurgated and workplans shelved. Many are content that they are still on the government’s payroll. Rightly so. It could have been worse back then had the government not taken swift and concerted actions to cushion the pandemic’s impact on the economy and its finances. But we are not out of the woods yet. The tail end risks of the pandemic lingering into 2021 is high and the near-term fiscal outlook remains highly uncertain.
The COVID-19 pandemic is like no other: in a span of few months, it hurled the global economy into a tailspin. In its most recent forecast, the International Monetary Fund (IMF) projects the global economy to contract by minus 4.9 per cent in 2020, its worst performance since the Great Depression of the 1930s. Unlike recent health-induced shocks where some countries were broadly shielded, this one is unusual. Not even the COVID-free countries—ten of them in the Pacific region including the Solomon Islands—are spared the pathogen’s effects. At home, the impacts and efforts to contain the coronavirus are draining government coffers and steadily raising the debt level.
How are government finances stacking up?
The impacts of COVID-19 on government finances became pronounced in the second quarter of 2020. A slower external sector, which dwarfed log export earnings, paired with muted domestic activities dented government revenue. With tax revenues shrinking and spending pressures swelling, the 2020 budget came under severe pressure. To cover revenue shortfalls, the government issued domestic bonds and donors were very supportive providing additional budget support, both grants and concessional loans. Besides, the government sought debt relief and requested additional funds from the IMF to tame balance of payments risks.
These timely actions eased budget pressures, enabling the government to manage public health systems and provide stimulus spending. Combined with expenditure restraints across the first six months of 2020, these measures helped narrow the deficit to $32 million from $331 million deficit posted in the second half of 2019.
Total revenues shrunk by 2 per cent to $1,789 million across the first half of 2020 despite a twofold increase in donor receipts to $299 million related to COVID-19 support. The largest fall came from tax receipts which fell by 12 per cent to $1,305 million. All major tax categories declined including tax on income and profit, goods and services and, tax on international trade. Non-tax revenue, mostly from fishing license fees, shrank by 14 per cent to $185 million amid sluggish fishing conditions across the first six months.
Consistent with the slowdown in revenue, total spending was slashed by 16 per cent to $1,821 million in the six months to June 2019. This mirrored expenditure restraints and resources reallocation towards containment measures and stimulus spending. This level of spending was 18 per cent below the half-year budget although 9 per cent higher year on year. Further tightening is expected in the second half of 2020 to keep spending within the government’s target deficit of $450 million by year end. But this is no easy feat as spending tends to be higher in the latter half, a cyclical pattern observed nearly every year.
2020 and beyond
In its September 2020 Monetary Policy Statement, the Central Bank of Solomon Islands forecasts a grim and highly uncertain fiscal outlook over the near term. Declines in revenue amid mounting spending pressures are expected to widen the fiscal deficit to as higher as 4% of GDP in 2020. Over the medium term, the logging sector is expected to trail off, leaving a sizable revenue gap that could further erode fiscal buffers. The quest to explore new, big-ticket revenue streams to fill the impending gaps must extend beyond the current tax reform and distortionary taxes on rice and sweets.
The report also highlighted few spending pressures across the medium term. With funds allocated for stimulus spending this year soon to be exhausted, a possible second fiscal stimulus may be required in 2021. The country’s growing population will demand more social services and strain existing infrastructures. Besides, Pacific Games’ preparation is set to ramp up in 2021 adding further spending pressures. These budget pressures could mean higher demand for debt financing, broader sources of tax and the need for sustained macroeconomic growth.
To begin the policy dialogue, the Central Bank offers two policy considerations. First, given fiscal policy’s efficacy in responding to COVID-19 and for future one-off shocks, the Bank suggests restoring resilience buffers through a rainy-day fund or sovereign wealth fund. Certain proceeds from the extractive industry could be allocated to the fund to absorb future shocks or finance budget shortfalls. Second, it recommends reserving certain debt ratios above the mandated debt threshold for disaster policy responses to avoid delaying large infrastructure projects.
With the bleak and highly uncertain fiscal outlook, the government must not lose sight of its shrinking finances in its ongoing efforts to keep the country COVID-19-free. A long-drawn-out pandemic could further hurt government finances. And in the worst case, nonessential public sector workers could again be forced to quit, this time indefinitely. Not all is gloomy though. There is still ample space for policy responses. The sooner the government takes concerted efforts to put its finances back on a sustainable path over the near to medium term the better.
Jack Boe, Senior Analyst, Government Finance Sector/Economics, Research and Statistics Department, Central Bank of Solomon Islands. The views expressed in this article are that of the author and do not necessarily represent the position of the Central Bank of Solomon Islands. For more articles on PIC economies, see Pacific Forum.