RECENT DEVELOPMENTS, OUTLOOK, AND RISKS

Tuvalu’s economy has experienced a strong recovery from the COVID-19 pandemic. After falling for three consecutive years in 2020-22, GDP growth rebounded strongly at 7.9 percent in 2023, driven by the resumption of construction activity, the trade recovery, and higher government spending. GDP growth in 2024 is estimated to have reached 3.3 percent, supported by the continued effects of reopening and major infrastructure projects. Since peaking at 14.2 percent in 2022Q3, inflation has been trending down and slowed to 1.2 percent in 2024, in line with global food and commodities prices and continued easing of shipping bottlenecks.

The economic recovery is expected to continue, but growth is projected to moderate gradually over the medium term. Growth in 2025 is projected at 3 percent, driven by the construction of the new phase of the Tuvalu Coastal Adaptation Project and an increase in public spending. While externally financed projects are expected to continue to support economic activities, growth is projected to decline gradually to around 1.8 percent over the medium term, due to sluggish productivity growth, increasing emigration, and vulnerability to climate events. Inflation is expected to remain below 2 percent in 2025, reflecting the negative CPI at end-2024 and lower global commodity prices, and to rise gradually to 2.5 percent over the medium term, aligning with inflation dynamics of Tuvalu’s trading partners.

The fiscal balance is projected to turn to a surplus in 2025, reflecting higher grants, but would deteriorate again starting in 2026. Higher grants are expected to more than offset the increase in expenditures and improve the fiscal balance from a deficit of 7 percent of GDP in 2024 to a surplus of 2.9 percent of GDP in 2025. Over the medium term, grants are projected to gradually decline to historical levels of around 27 percent of GDP, while current expenditure pressures would remain elevated. As a result, fiscal balances are expected to deteriorate gradually and reach -6.8 percent of GDP by 2030. Because the projected withdrawals from Tuvalu’s sovereign funds are not sufficient to fully finance the fiscal deficits, foreign financing will be required to close the financing gap. Under these baseline projections, Tuvalu is assessed to remain at a high risk of debt distress.

Downside risks to the outlook remain high. The global environment has significantly changed this year, reflecting escalated trade tensions, heightened policy uncertainty, and tighter financial conditions. While Tuvalu’s export exposure is limited, heightened global uncertainty and volatility could affect Tuvalu’s external revenues, including from its internet domain, fishing licenses, and development assistance, and significantly impact Tuvalu’s public finances, external position, and growth outlook. Global risks of heightened trade tensions and higher commodity prices could also increase inflation. A sharp downward correction in financial market returns could affect the performance of Tuvalu’s sovereign funds. Underperformance of public corporations could cause fiscal risks, and further loss of CBRs would severely disrupt cross-border payments. An acceleration of outward migration would exacerbate labor shortages. Extreme climate events and climate change remain major risks to Tuvalu’s economic outlook. Upside risks include higher fishing licenses and grants and greater structural reform momentum, which could accelerate economic growth.

FISCAL POLICY

Fiscal policy should balance ensuring fiscal sustainability and supporting Tuvalu’s development priorities. Tuvalu’s high vulnerability to external shocks requires fiscal sustainability and adequate buffers against downside risks. Meanwhile, the government faces significant near-term spending pressures in order to deliver essential public services, while also having to address medium-term climate adaptation costs and labor shortages stemming from increasing emigration.

A multi-pronged fiscal strategy is required to address these challenges. Given persistent fiscal deficits and Tuvalu’s limited fiscal space, the main elements of the strategy should include: i) gradually reducing fiscal deficits; ii) increasing spending for priority areas; and iii) appropriately using fiscal buffers to stabilize fiscal accounts, cushion against shocks, and address long-term challenges. IMF staff’s simulations show that reducing the fiscal deficit gradually to around 2.3 percent of GDP by 2030 (compared to 6.8 percent of GDP in the baseline scenario) by utilizing the returns of the Tuvalu Trust Fund and the Consolidated Investment Fund (CIF) to finance deficits would keep public debt on a downward path. The domestic current balance would provide an appropriate anchor and is expected to improve to -40 percent of GDP by 2045 under the consolidation scenario, and the value of the buffer fund (CIF) would stabilize at around 40 percent of GDP, which is needed to cover major shocks and downside risks.

The recommended fiscal strategy entails a combination of revenue mobilization, expenditure rationalization, and resource reprioritization measures. Expenditure measures should primarily focus on unwinding the recent increases in current expenditure, including containing the increase in the wage bill, implementing cost-saving measures for the Medical Referral Scheme and overseas scholarships, unwinding the increase in goods and services spending, and cutting broad-based utility subsidies. Revenue mobilization should prioritize strengthening the compliance and efficiency of tax collection, while considering reviewing tax policies and exploring options to boost tax revenue and streamline tax incentives. Part of the savings from the above measures should be redirected to areas such as targeted protection for the most vulnerable, infrastructure, human capital, and climate resilience.

Improving public financial management (PFM) can help manage revenue volatility and fiscal risks. The authorities have made progress in PFM, including introducing the new Financial Management Information System and formulating the Medium-Term Fiscal Framework. The publication of Tuvalu’s Fiscal Risk Reports is also welcome. Further efforts are needed to improve budget reliability, strengthen investment management to enhance absorption capacity, implement climate budget tagging, enhance fiscal reporting and transparency on extra-budgetary funds and SOEs, and reinforce procurement management.

FINANCIAL SECTOR POLICIES

Establishing effective regulatory and supervisory frameworks is urgently needed. Priorities include strengthening the statutory role and expanding the supervisory perimeter of the Banking Commission of Tuvalu (BCT), issuing the proposed new prudential standards, enforcing the timely submission of prudential returns, and addressing delays in the audits of the financial statements of the financial institutions. These measures should be supported through adequate resourcing of the BCT to conduct both on-site and off-site supervision.

Continued efforts are needed to strengthen Tuvalu’s connectivity to the global payment system and improve financial inclusion. Tuvalu’s membership of the Asia/Pacific Group on Money Laundering is a welcome step, and the authorities should continue to strengthen the legal framework and compliance. Efforts to address Correspondent Banking Relationship pressures should also take into account a potentially low ML/TF risk environment in Tuvalu and focus on the outreach to the key foreign regulatory authorities, including a corridor risk assessment. The ongoing efforts to modernize banking services, including the recent launch of Tuvalu’s first ATMs, can help overcome geographical barriers and improve efficiency. Improving financial literacy and establishing a reliable national digital ID system are also crucial for financial inclusion. Meanwhile, introducing digital services should consider supervisory capacities and ensure financial integrity.

STRUCTURAL REFORMS

Structural reforms need to be carefully prioritized, focusing on addressing development bottlenecks and attaining higher growth potential. Priorities should include: i) collaborating with local communities to effectively develop the reclaimed land; ii) improving internet connectivity and leveraging IT technology to deliver more public services; iii) ensuring proper maintenance of key infrastructure assets, particularly transportation and utilities including renewable energy; iv) strengthening SOE governance and performance, accompanied by reviewing utility pricing to ensure cost recovery; and v) exploring economic diversification in sectors with higher potential, including agricultural products such as coconut, eco-tourism, and commercial fishery.

Mitigating the impact of emigration and enhancing climate resilience are crucial. While outward emigration has supported remittances and consumption, measures to enhance both human capital and labor supply are required to address labor shortage issues. The authorities should focus on improving education access and quality, enhancing training, attracting returning migrants, and promoting skill transfer. Facilitating female labor force participation could help bridge significant gender gaps in employment, while alleviating labor shortages. Tuvalu should continue to engage with development partners to secure climate financing and implement major climate-resilient projects. In addition, the authorities need to further enhance disaster management through the enforcement of amended building codes, the use of risk maps to inform planning, and the strengthening of community disaster preparedness. Accelerating renewable energy production can lower Tuvalu’s energy costs, reduce its external sector vulnerability, and enhance energy security.

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Jonathan Kanter, Assistant Attorney General with the U.S. Department of Justice; Sarah Cardell, Chief Executive Officer of the U.K. Competition and Markets Authority; and Margrethe Vestager, Executive Vice-President and Competition Commissioner for the European Commission, joined Chair Khan in the joint statement outlining AI competition risks, as well as principles that can help protect competition in the AI ecosystem.

The joint statement notes that while AI has the potential to become one of the most significant technological developments of the past couple of decades, it also raises competition risks that may prevent the full benefits of AI from being realized. All four antitrust enforcers pledged in the joint statement to remain vigilant for potential competition issues and expressed their determination to use available powers to safeguard against tactics that would undermine fair competition or lead to unfair or deceptive practices in the AI ecosystem.

To assess competition risks to AI, the joint statement stressed the importance of focusing on how emerging AI business models drive incentives, and ultimately behavior. Competition questions in AI will be fact-specific but several common principles—fair dealing, interoperability, and choice—will generally help enable competition and foster innovation, as outlined in the joint statement. While potential harms may be felt across borders, the joint statement makes it clear that U.S. decision-making will always remain independent and sovereign. The FTC along with DOJ and CMA also have a consumer protection mission and noted the need to continue to monitor potential harms to consumers that may stem from the use and application of AI.

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Context and Recent Developments

Slovenia’s economy recovered well from the pandemic, only to be hit by spillovers from the war in Ukraine. After a strong recovery in 2021, growth slowed in 2022 because of adverse energy price spillovers from the war in Ukraine and supply chain disruptions. Growth is estimated to have fallen further last year to less than 1½ percent, reflecting subdued consumption, the unwinding of inventories, and weaker growth in trading partners.

Severe floods in August 2023 pose new challenges. Although the impact on economic growth was minor, direct damage is estimated by the authorities at almost 5 percent of GDP, with the cost of upgrading infrastructure to be more climate resilient estimated to be much higher. The government adopted emergency relief legislation shortly after the floods to assist those affected and to start reconstruction efforts.

Despite slower growth, the labor market remains tight. Unemployment is at a historic low and labor shortages have emerged in certain sectors, relieved only by net inward migration of foreign workers. Following earlier real wage declines, nominal wage growth has begun to outpace inflation.

Inflation has fallen from earlier highs. As pressures from commodity prices abated, and as tighter monetary policy fed through to prices, inflation fell noticeably in the second half of 2023, more than halving to about 4 percent in December compared to about 3 percent in the euro area.

Outlook and Risks

Growth is expected to recover and inflation to fall further this year. Despite tighter fiscal policy, growth is expected to increase to about 2 percent in 2024, led by domestic demand, including higher flood-related investment, and by higher consumption as real wages recover. Growth should return to its potential of about 2½-2¾ percent over the medium term as private consumption and euro area trading partners gather strength. Under the assumption of broadly stable commodity prices and interest rates on hold in the first half of the year, inflation is projected to decline to below 3 percent by the year and to 2 percent in 2025. The current account is expected to remain in surplus over the medium term.

Uncertainty remains high and risks appear on the downside. External risks include an intensification of regional conflicts, renewed commodity price volatility, and lower external demand. Supply chain disruptions pose additional risks but also may create opportunities for Slovenia in the event of nearshoring. Labor shortages and broader capacity constraints could affect post-flood reconstruction or undermine disinflation. Finally, new severe weather events could cause significant economic disruptions.

Fiscal Policy

A tighter fiscal stance would help reduce debt, rebuild fiscal space, and support disinflation. Given underlying increases in core public spending in recent years, age-related spending pressures, and relatively high public debt, sustained fiscal consolidation and fiscal structural reforms are needed to underpin long-term public debt sustainability. The elimination of remaining pandemic and energy measures will help such consolidation, despite additional flood-related spending. The authorities should also continue with their active debt management, which has helped to lower debt servicing costs, improve the debt profile, and allow the buildup of ample public cash buffers.

A phased and transparent approach to flood-related spending is critical. Lower-priority needs should only be addressed as labor market conditions ease. Otherwise, there is a danger of flood-related spending fueling construction cost increases rather than providing for needed rebuilding. The authorities’ transparency in handling flood-related spending—including by publishing details of publicly financed projects—is welcome given the extent of public spending.

Although ad hoc in nature, recent revenue measures to raise temporary corporate and bank taxes will help finance post-flood reconstruction. The bank tax is not ideal, including the use of bank assets as a taxation base, although the cap on the tax, set at 30 percent of banks’ pre-tax profits, is a welcome safeguard. EU grants and Slovenian Sovereign Holding profits will also support the rebuilding and upgrading of infrastructure.

Key structural fiscal reforms should be accelerated. Reforming the pension system remains a priority given the higher expected pension spending over the medium and longer term. Reforms to the retirement age, years of contributions (linked to life expectancy), and indexation would help contain pension costs. Stronger second and third pension pillars would help increase retirement savings and support capital market development. Public wage reforms—linking pay more closely to skills and performance—are also important given the high public wage bill alongside difficulties in hiring and retaining qualified staff. Reducing labor taxes while broadening the corporate and income tax bases and increasing property tax would also be helpful. Planned comprehensive reforms of the health sector should continue. Finally, building on the recommendations of the IMF’s recent Public Investment Management Assessment (PIMA), improved project preparation, evaluation, selection, and permit times would help increase public investment efficiency, which is important given the scale of public investment.

Financial Sector Policies

Banks appear in good health. Bank profitability and bank capital adequacy are strong and bank liquidity is among the strongest in the euro area. Bank of Slovenia stress test results also point to bank resilience.

Ongoing uncertainties warrant continued close monitoring of asset quality. Nonperforming loans are at historic lows, but high-interest rates increase repayment and rollover risks, particularly for firms where loans are of shorter maturity or at variable rates.

The Bank of Slovenia’s macroprudential stance is appropriate. The new positive neutral countercyclical capital buffer of one percent will help further strengthen capital buffers and strengthen the capacity of the banking system to respond to adverse shocks. The impact on financial intermediation of this measure is expected to be limited. Increased access to credit for lower-income borrowers is welcome. Finally, the reduction of the sectoral risk buffer on real estate exposures is appropriate given reduced risks in the housing market as valuation measures have softened.

Progress has been made on AML/CFT. This includes amendments to the Criminal Code; new Bank of Slovenia regulations and guidelines on related risks; guidance to banks on risk assessment; and measures to supervise virtual assets.

Structural Policies

Deeper structural reforms would help boost growth and foster greater income convergence. Convergence has slowed since the Global Financial Crisis as investment and productivity growth have fallen. Although labor contributions to growth have been strong in recent years—reflecting increased labor force participation, lower unemployment, and positive net inward migration—the limits to future such gains call for a shift to a focus on productivity growth, a key priority. Productivity would be helped by higher overall investment and by further structural reforms, supported by the EU-backed National Recovery and Resilience Plan and Cohesion policy funding. Addressing skill shortages and mismatches, improving regulatory quality, and deepening the financial sector would also help boost productivity growth.

The recent floods underscore the importance of continuing to adapt to climate change. As floods pose the highest risk, efforts should be focused on flood risk management, including zoning. On mitigation, continuing to promote investment in renewables and reducing carbon price exemptions in polluting industries would help Slovenia achieve its climate goals.

The team would like to thank the authorities for their exceptional assistance with the mission’s work and the authorities and other stakeholders for their warm hospitality and comprehensive and constructive discussions.

A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF’s Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.

The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that subject to management approval, will be presented to the IMF Executive Board for discussion and decision.

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The CRI’s Policy Pillar led efforts to counter the business model that underpins the ransomware ecosystem. This included research on cyber insurance, victim behavior, seizure and confiscation of virtual assets, ransom payments, and best practices in incident reporting and information sharing.

The Diplomacy and Capacity Building Pillar expanded the CRI’s like-minded umbrella by adding 13 new members to the coalition. The pillar also prioritized opportunities to inform potential new members about the initiative and developed tailored capacity-building opportunities to match members’ needs and requests.

The International Counter Ransomware Task Force (ICRTF), established at last year’s meeting, began developing platforms for coordinating and disrupting ransomware at an operational level. The ICRTF will continue to build upon the successes of its inaugural year by operationalizing the tools and platforms developed by its members.

The CRI’s joint policy statement declares that member governments should not pay ransoms. The initiative also created a shared blacklist of wallets through the U.S. Department of the Treasury’s pledge to share data on illicit wallets used by ransomware actors with all CRI members.

The CRI provides an opportunity to create long-term cooperative approaches and common understandings of accountability in cyberspace, consistent with international law as well as state actions as embodied in the Framework for Responsible State Behavior in Cyberspace, endorsed by all United Nations member states.

Overall, the CRI’s joint statement highlights the importance of international cooperation in combating ransomware threats and building collective resilience against future attacks.

Image Source: U.S. Department of Justice on X

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