COVID-19 can make anyone ill, but the risks are higher for those with underlying health conditions. In the same way, economies with pre-existing vulnerabilities are likely to be hit hardest from the impacts of COVID-19. The Solomon Island’s economy—similar to its pacific peers—fits this analogy well. Its narrow economic base and heavy reliance on commodities exports, exacerbated by inherent structural challenges from its size, remoteness from markets, and an ever-present risk to natural disasters, makes the county highly exposed to economic shocks.
Economic growth in recent years has slowed. After peaking at 5.9 per cent in 2016, growth has since fallen, easing to 1.2 per cent in 2019 from 3.9 per cent in 2018, its slowest pace in four years. A weaker external sector combined with muted domestic demand and limited government spending following last year’s national election underpinned the anaemic growth in 2019. On the external front, the current account which has been in deficit since 2013, deteriorated to -9 per cent of GDP in 2019, from -3 of GDP in 2018—its worst outcome since then. The overall balance of payment recorded a deficit of 2 per cent of GDP in 2019, shaving off gains from 4 per cent of GDP surplus posted in 2018. Gross foreign reserves, in turn, fell by 6 per cent to $4,706 million.
Budget pressures resurfaced in 2019 with the decline in revenue from both log exports and domestic sources while expenditure, although contained, remain elevated. This resulted in a fiscal deficit of -2 per cent of GDP in 2019, reversing the surplus of 2 per cent of GDP posted in 2018. Before 2018, cash reserves had been eroded from large fiscal deficits incurred in 2016, at -4 per cent of GDP, and in 2017, at -3 per cent of GDP. The stiff headwinds in 2019, and in prior years, left the country reeling when the COVID-19 pandemic struck, revealing a current account deficit and fiscal deficit.
With fiscal buffers eroding and the current account in deficit, the twin deficit posed immediate risks to macroeconomic stability early in 2020. The current account gap stemmed from loss of export revenue which eroded foreign exchange reserves in 2019. Loss of revenue, both from log exports and domestic sources, amid higher spending pressures, created the fiscal financing gap. Economic growth was below potential before the pathogen spread across the globe, infecting humans and economies alike.
By March 11, 2020, COVID-19 was declared a pandemic. Following the declaration, the Central Bank of Solomon Islands (CBSI) downgraded its 2020 growth outlook to minus 5 per cent, a recession in the second half of 2020 loomed large. Although the country has no confirmed COVID-19 cases, containment measures imposed abroad and at home were expected to dampen domestic economic activities, further weakening the external and fiscal position. The International Monetary Fund (IMF) estimated the external financing gap to widen to as high as 17.8 per cent of GDP in 2020, up from 8 per cent in its pre-pandemic baseline. It also forecast the fiscal deficit to widen to 5.8 per cent of GDP from 3.7 per cent in the its pre-pandemic baseline. With domestic resources already stretched, it became clear more funding will be required to tackle the looming financing gaps.
By March 2020, the current account and fiscal position, however, showed some improvements. The current account rebounded to a surplus of $44 million from $471 million deficit in the December quarter of 2019. The overall balance of payment narrowed to $30 million deficit from $86 million deficit in December 2019. Gross foreign reserves declined further by 3 per cent to $4,585 million, but still well above 6 months of import cover. On the fiscal front, the government reallocated its resources and cut spending as revenues declined. This led to a narrower deficit of $12 million from $345 million deficit in the December quarter of 2019.
With the global economy anticipating a synchronised downturn in the latter half of 2020, taming the twin deficit required immediate actions in order to maintain macroeconomic stability. The authorities, the government and the CBSI, promptly requested help from the IMF to ease the impending balance of payment needs. On June 1, the IMF approved around $SBD 234.8 million under the Rapid Credit Facility (RCF) and Rapid Financing Instrument (RFI). Two months earlier, on April 15, the Fund granted the country temporary debt service relief for repayments falling due from April 14 to October 13 under the Catastrophic Containment Relief Trust (CCRT) facility. The IMF funds helped to rebuild external reserves and ease immediate financing pressures while the grace period freed government resources for use elsewhere.
To help plug the fiscal gap, donors have been requested to front-load their allocations for infrastructure development. So far, the government has secured $606 million, $446 million (74 per cent) in donor support and $160 million (26 per cent) from domestic sources. Donor funds comprise $312 million grants and $134 million concessional loans. The government’s contribution is made up of 80 per cent loans and 20 per cent domestic revenue. Together, the total funding comprises 58 per cent grants and 42 per cent loans. The government has allocated $319 million of the total funding under the COVID-19 Economic Stimulus Package (ESP). The stimulus spending is expected to boost growth, improve business activities and ease the financing gaps in the medium term through increased revenue collections.
By June 2020, thanks to IMF support and donor inflows, external reserves have been restored to rosy levels. Gross foreign reserves soared by 14 per cent to a record $5,255 million, more than a year of import cover. For now, at least, the external sector is on solid footing, for how long, remains uncertain, in the face of a looming second wave of infection.
The government has been able to rally enough funds in the first quarter of 2020. But the fiscal position remains precarious. Revenues continued to decline. Cash reserves in June 2020 are barely above two months of recurrent spending cover. If COVID-19 remains protracted, the fiscal gap may reopen—wider. Additional borrowing to fill the revenue gaps may cause debt to rise faster than intended. Already, the debt stock has increased by 14 per cent to $1,221 million in the first six months of 2020. This equates to around 12 per cent of GDP, still one of the lowest in the region. Debt could increase further by year end since talks to tap additional funds continue as I write the piece.
What lessons have we learnt so far? The COVID-19 pandemic exposes the flimsy link between the external and fiscal sector in the economy. A shock to the external sector may translate quickly into a fiscal shock, cutting deeper into the fabrics of the domestic economy. In the absence of reserve buffers, rebooting the ailing economy—through increased borrowing and without donor grants—could harm long-term growth. Against the backdrop, it is imperative to maintain sufficient reserve buffers, always, to weather economic storms.
Jack Boe, Senior Analyst Government Finance Sector, Economic, Research and Statistical 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.