Report and Recommendation of the President to the Board of ......H. Everett, Financial Sector Specialist (Public Finance), PARD Y. Kim, Counsel, Office of the General Counsel S. Lee,

Report and Recommendation of the President to the Board of Directors

Sri Lanka Project Number: 46497 February 2013

Proposed Policy-Based Grant

Solomon Islands: Economic and Financial Reform

Program

CURRENCY EQUIVALENTS (as of 18 February 2013)

Currency unit – Solomon Islands dollar (SI$) SI$1.00 = $0.1412

$1.00 = SI$7.0793

ABBREVIATIONS

ADB – Asian Development Bank CEWG – core economic working group CSO – community service obligation EITI – Extractive Industries Transparency Initiative ERSP – Economic Recovery Support Program GDP – gross domestic product IMF – International Monetary Fund M&E – monitoring and evaluation MOFT – Ministry of Finance and Treasury NEAP – National Education Action Plan NDS – national development strategy RAMSI – Regional Assistance Mission to Solomon Islands SIEA – Solomon Islands Electricity Authority SIWA – Solomon Islands Water Authority SOE – state-owned enterprise TA – technical assistance

NOTE

In this report, "$" refers to US dollars unless otherwise stated.

Vice-President S. Groff, Operations 2 Director General X. Yao, Pacific Department (PARD) Regional Director A. Iffland, Pacific Liaison and Coordination Office, PARD Team leader K. Lao-Araya, Senior Private Sector Development Specialist, PARD Team members S. Ataata, Development Coordinator to Solomon Islands, PARD M. de Villa, Associate Project Analyst, PARD H. Everett, Financial Sector Specialist (Public Finance), PARD Y. Kim, Counsel, Office of the General Counsel

S. Lee, Principal Social Development Specialist (Gender and Development), PARD

M. Lucich, Senior Economics Officer, PARD N. Sapkota, Safeguards Specialist, PARD

J. Williams, Senior Environment Specialist, PARD Peer reviewer A. Sumbal, Senior Economist (Public Finance), Central and West Asia

Department

In preparing any country program or strategy, financing any project, or by making any designation of or reference to a particular territory or geographic area in this document, the Asian Development Bank does not intend to make any judgments as to the legal or other status of any territory or area.

CONTENTS

Page

PROJECT AT A GLANCE

I. THE PROPOSAL 1

II. THE PROGRAM 1

A. Rationale 1

B. Impact and Outcome 3

C. Outputs 3

D. Development Financing Needs 7

E. Implementation Arrangements 7

III. DUE DILIGENCE 8

A. Economic and Financial 8

B. Governance 8

C. Poverty and Social 9

D. Safeguards 9

E. Risks and Mitigating Measures 9

IV. ASSURANCES AND CONDITIONS 10

V. RECOMMENDATION 10

APPENDIXES

1. Design and Monitoring Framework 11

2. List of Linked Documents 14

3. Development Policy Letter 15

4. Policy Matrix 19

PROJECT AT A GLANCE

1. Project Name: Economic and Financial Reform Program 2. Project Number: 46497-012 3. Country: Solomon Islands 4. Department/Division: Pacific Department/Pacific Liaison and Coordination Office in

Sydney, Australia 5. Sector Classification:

Sectors Primary Subsectors Health and social protection Health finance

Public sector management √ Economic and public affairs management

6. Thematic Classification: Themes Primary Subthemes Economic growth √ Widening access to markets and

economic opportunities Promoting economic efficiency

and enabling business environment

Promoting macroeconomic stability

Private sector development Policy reforms

6a. Climate Change Impact No climate change indicator available.

6b. Gender Mainstreaming Gender equity theme (GEN) Effective gender mainstreaming (EGM) √

Some gender benefits (SGB) No gender elements (NGE)

7. Targeting Classification:

General Intervention

Targeted Intervention Geographic dimensions of inclusive

growth

Millennium Development

Goals

Income poverty at household

level √

8. Location Impact: National High Regional Low Rural Medium Urban Medium

9. Project Risk Categorization: Low risk 10. Safeguards Categorization:

Environment C Involuntary resettlement C Indigenous peoples C

11. ADB Financing: Sovereign/Nonsovereign Modality Source Amount ($ Million) Sovereign Policy-based

grant Asian Development Fund 5.0

Total 5.0

12. Cofinancing: There is no direct cofinancing, but since early 2010 the European Union, Australia, and New Zealand have provided parallel cofinancing for budget support to the government based on the government’s comprehensive reform program.

13. Counterpart Financing:

No counterpart financing available.

14. Aid Effectiveness: Parallel project implementation unit No Program-based approach Yes

I. THE PROPOSAL

1. I submit for your approval the following report and recommendation on a proposed policy-based grant to Solomon Islands for the Economic and Financial Reform Program.1 2. The proposed program is a single-tranche policy-based grant of $5 million. The program continues to support efforts by the Government of Solomon Islands to reform public sector management in coordination with other development partners. It aims to strengthen the government’s implementation of policy reforms that ensure the adequate delivery of public investment and services.

II. THE PROGRAM

A. Rationale

3. Solomon Islands is a small, fragile, post-conflict island state and the poorest in the Pacific in terms of gross domestic product (GDP) per capita.2 The severity of its problems was made evident by the outbreak of civil unrest known as the ethnic tensions in 1999–2003 that caused hundreds of deaths and displaced over 20,000 people. Much of the income growth achieved after independence in 1978 was lost. The arrival of the Regional Assistance Mission to Solomon Islands (RAMSI) quickly restored civil order, which has generally been maintained.3 A surge in foreign aid under the umbrella of RAMSI funded large increases in development budget spending that lifted total government expenditure. This initiated a post-conflict recovery. GDP growth averaged 7.7% per annum in 2004–2008. 4. The Solomon Islands is among the Pacific economies most affected by the global economic crisis. In 2009, the GDP contracted by 4.7%. In response, the government and development partners formed the core economic working group (CEWG) in March 2009 to better meet the economic and fiscal challenges facing the country during the crisis. The partnership has developed a comprehensive economic and financial reform program to stabilize the country’s fiscal position, strengthen public finance management, promote priority structural reforms, and prioritize the needs of the most vulnerable members of the community.4 In 2010, the Asian Development Bank (ADB) approved a policy-based grant for the Economic Recovery Support Program (ERSP) to help the government respond to the crisis using the CEWG mechanism of joint coordination between the government and development partners.5 ERSP successfully helped the country achieve economic recovery. At the start of ERSP, it was feared that the economy could stagnate or continue to decline in 2010. However, the economy recovered strongly, with real GDP growth of 7.8% in 2010, 10.7% in 2011, and 5.5% in 2012.

1 The design and monitoring framework is in Appendix 1.

2 World Development Indicators, current price 2010, purchasing power parity. Comparator countries include the

Federated States of Micronesia, Fiji, Kiribati, Republic of Marshall Islands, Papua New Guinea, Samoa, Timor-Leste, Tonga, Tuvalu, and Vanuatu.

3 RAMSI is a partnership of the government and people of Solomon Islands and 15 contributing countries in the

Pacific region. It is a long-term initiative to help create the conditions necessary for a return to stability, peace, and a growing economy. RAMSI was deployed on 24 July 2003, with a mandate unanimously approved by the Solomon Islands National Parliament, to help the government restore law and order, strengthen government institutions, reduce corruption, and reinvigorate the economy. http://www.ramsi.org/

4 Details on the government’s program and the linkage of the proposed Economic and Financial Reform Program to

it are included in the development policy letter; policy matrix; linked documents on sector assessment and development coordination; and supplementary documents on economic analysis and the policy matrix of the government’s program.

5 ADB. 2010. Report and Recommendation of the President to the Board of Directors: Proposed Program Cluster

and Grant for Subprogram 1 to Solomon Islands for the Economic Recovery Support Program. Manila.

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Fiscal surpluses were achieved in 2010 and 2011, and expenditures on basic social services were protected while the affordability of basic education was improved.

5. CEWG development partners have provided technical and financial support, effectively contributing to reform progress together with ongoing International Monetary Fund (IMF) programs since 2010. The government and its partners have followed best practices, including connecting individual development partner programs to a unified policy matrix for economic and financial reforms and consenting to policy actions. RAMSI has provided technical assistance (TA) to implement the Financial Economic Management Strengthening Program from late 2010 through 2013 and has funded resident advisors in key government agencies, especially the Ministry of Finance and Treasury (MOFT). The IMF and the Australian Department of Finance and Deregulation have provided assistance in drafting fiscal responsibility legislation. The IMF will assist in revising National Provident Fund legislation. The World Bank has supported improving governance in the mining sector and strengthening analysis of line ministry expenditures. ADB has supported the drafting and review of a new customs and excise act, state-owned enterprise (SOE) reform, the reform of secured-transaction and business laws, and the development and implementation of the National Development Strategy (NDS), 2011–2020. Australia and New Zealand supported the analysis of strategies and reforms in health and education. The European Union supported public expenditure and financial assessments and the implementation of the NDS. 6. Despite the successful recovery and improved fiscal performance after the global economic crisis, political instability and poor government accountability and transparency remain, reflecting a weak institutional environment. 6 These weaknesses have undermined government effectiveness, which has slowed economic growth and continues to restrain economic prospects. Solomon Islands is likely to remain a weak performer (i.e., a fragile state) until such shortcomings are firmly addressed. In addition, the post-conflict economy has become dependent on high levels of development assistance and unsustainably high rates of logging. Diversifying economic activity is essential if growth is to be sustained.

7. Economic growth prospects rest on the private sector and on developments in mining, agriculture, fisheries, and tourism. The strongest immediate prospects for job creation and higher government revenue are in fishing, cocoa, copra, palm oil, fruits and vegetables, and tourism. 8. The program will support Solomon Islands’ transition from post-conflict recovery to sustainable development based on the NDS, 2011–2020. The NDS is the first long-term development strategy since the outbreak of ethnic tensions in 1999. The reforms under the program align with the government’s economic and financial reform program coordinated by CEWG. 9. ADB’s country partnership strategy for Solomon Islands proposes continuous and long-term engagement in selected areas. After the completion of its crisis-response program, ADB continued to provide policy advice and TA and to monitor reform progress. Lessons from the ERSP have been incorporated in the design of the program.7 For example, the overall design

6 The 2006 riots demonstrated the potential consequences of the unstable political environment. During the riots,

Parliament House was surrounded by protesters and many premises linked to Asian business interests were damaged or destroyed. The riots were incited by politicians who did not support the choice of Prime Minister following the general elections held that month. The nominated Prime Minister resigned when it became clear he would lose a vote of no confidence, just as his successor did in December 2007.

7 ADB. 2012. Completion Report: Economic Recovery Support Program in Solomon Islands. Manila.

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contributed to promoting country ownership through the following qualities: (i) relatively simple scope with realistic and achievable goals, (ii) long-term perspective and commitment, and (iii) strong development partner collaboration. Other lessons include (i) using development partners’ coordinated technical and capacity support to the government; (ii) jointly tracking reforms with development partners; (iii) using full-time development coordinators on the ground for policy dialogue; and (iv) fostering complementarity. In addition to policy actions for completion prior to program approval, the policy matrix includes a set of actions comprising the partnership monitoring framework, which aligns with the government’s medium-term reform agenda and is to be jointly monitored with CEWG members through 2013. B. Impact and Outcome 10. The impact will be the government’s delivery of improved public investment and services. The outcome will be its maintaining a strong fiscal position while delivering expanded and more equitable social services. The impact and outcome will be achieved through reforms in three areas, toward better public finance management, greater economic efficiency for a business-enabling environment, and broader access to social services. C. Outputs 11. The government's reform agenda is set out in its policy matrix presented to the CEWG. Its comprehensive policy matrix contains 77 policy actions, most of them already achieved and the rest to be accomplished by the end of June 2013. ADB’s program includes 13 policy actions that link to reforms undertaken previously in ADB’s ERSP (footnote 5). All the 13 policy actions have been met. In addition, 13 more actions have been included in the program partnership monitoring framework to facilitate continued policy dialogue and reform momentum (Appendix 4). ADB supported these reforms through a number of TA projects.8

1. Output 1: Better Public Finance Management 12. The first output is directed at achieving the medium-term goals of overall fiscal discipline and improved community participation in the budget process. This will ensure that effective expenditure controls improve the efficiency, transparency, and equity of the revenue system and the allocation of public resources through stronger budgeting and planning processes.9 13. Improving community awareness of, and input into, the budgetary process. Action 1.1 required the government to consult civil society organizations, including women’s groups, during the preparation of the 2013 budget. The government’s broader reform agenda is to provide services that meet the needs and aspirations of the people of Solomon Islands. The lack of community awareness of, and input to, the budget process has hindered service delivery and governance practice. The government therefore initiated, through MOFT’s budget unit, the

8 ADB. 2008. Technical Assistance for Strengthening Public Financial Management in Pacific Developing Member

Countries. Manila; ADB. 2009. Technical Assistance for Pacific Economic Management. Manila; ADB. 2006. Technical Assistance for Pacific Private Sector Development Initiative. Manila; ADB. 2010. Technical Assistance to Solomon Islands for Support for the Formulation of a National Strategic Plan. Manila; ADB. 2008. Technical Assistance for Enhancing Engagement with Pacific Developing Member Countries. Manila.

9 The actions under this output were derived from the government policy matrix using input from, among others:

European Union. 2012. Government of Solomon Islands Public Expenditure and Financial Accountability Assessment: First Draft Report. Unpublished; World Bank. 2012. Solomon Islands Operations Procurement Review. Washington, DC; World Bank. 2011. Solomon Islands Public Expenditure Review. Unpublished; and ADB. 2012. An Analysis of Customs Revenue Issues in Solomon Islands. Unpublished.

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involvement of citizens in the budget process throughout the country. To prepare the 2013 budget, consultations were conducted from May to June 2012 in almost all provinces. The views of provincial governments, civil society organizations, and churches were solicited on the delivery of social services, particularly for health and education. The focus was on accessibility, quality, and gaps in the existing health and education services. A consultation report was released among 2013 budget papers.10 14. Strengthening budgeting and planning processes. A recognized weakness of development plans prior to the NDS is the lack of an effective monitoring and evaluation (M&E) framework. Action 1.2 called for formulating and adopting an M&E framework for the NDS by developing results-oriented M&E capacity in the Ministry of Development Planning and Aid Coordination. An M&E unit was established in August 2012. The government will develop and establish a results-oriented assessment and reporting framework that will monitor progress against key dimensions of the NDS. This framework will track selected indicators for which data are cost-effectively available. The framework was approved by the NDS task force in October 2012 and endorsed by the cabinet in December 2012.

15. Ensuring effective expenditure controls. Action 1.3 required that MOFT develop a procurement manual, standard bidding documents, and standard procurement contracts. Improved procurement practices will constrain the corruption and leakage that undermine service delivery, allocation efficiency, and fiscal discipline. Procurement compliance has been strengthened with the adoption of a procurement reform plan in July 2012 and the staffing of a dedicated procurement unit in MOFT in October 2012. To further improve the operation of the unit, the government has developed and will adopt by April 2013 a procurement manual, standard bidding documents, and standard procurement contracts. 16. Improving customs administration and revenue collection. Action 1.4 required approval of the release of a draft customs and excise bill for public consultation. This policy action is critical, as the current Customs and Excise Act, 1964 is not up to date or conducive to efficient customs and excise tax collection. Solomon Islands does not have a substantial personal income or corporate tax base. Customs and excise duties provide one-third of government revenue. An appropriate customs and excise tax base is critical to improving the government’s ability to function. A new customs and excise bill has been prepared with measures to reduce discretionary exemptions to customs duty and excise and sales taxes. The new legislation will also improve duty collection and customs enforcement. Under the program, the government approved the release of a draft customs and excise bill for public consultation in February 2013. 17. Achieving overall fiscal discipline. Action 1.5 called on the government to adopt a new debt management strategy. This reform action evolved from the requirement that there be no public borrowing until the 2005 Honiara Club Agreement was reviewed.11 The strategy was endorsed by the cabinet in May 2012 and by representatives of the Honiara Club in July 2012. It has been incorporated into the amended Honiara Club Agreement. It specifies guidelines for all aspects of debt management and stipulates mechanisms for exercising prudence in borrowing

10

Government of Solomon Islands. 2012. Solomon Islands Budget 2013: Budget Strategy and Outlook. Budget Paper: Volume 1. Honiara.

11 The formal title of the agreement is Minutes on Restructuring the External Debt of Solomon Islands, which was signed in Honiara, Solomon Islands, on 20 October 2005 by the delegations representing Solomon Islands, Australia, the European Commission, the European Investment Bank, and the International Fund for Agricultural Development. The agreement is a key instrument for guiding the government’s achievement of overall fiscal consolidation to solve the public debt and arrears problem started in the early 2000s.

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and the utilization of public debts. Together with the government’s significantly improved debt position, the strategy will greatly enhance the government’s capacity to fund the infrastructure necessary for improved service delivery using concessional finance from international financial institutions and commercial finance for SOEs. Under the program, MOFT established a debt management advisory committee to advise the Minister of Finance and Treasury on new borrowing proposals in accordance with the guidelines laid down under the strategy. The government has set an annual threshold for public borrowing of SI$150 million for 2012 and SI$160 million for 2013 that incorporates contingent liabilities from SOEs.

2. Output 2: Greater Economic Efficiency for Business Enabling Environment 18. The second output, the enhanced economic efficiency of SOEs and the private sector, will create an enabling environment for the private sector and enhance corporate governance in SOEs and transparency in the resources sector. 19. Creating an enabling environment for the private sector. Action 2.1 required the adoption of administrative and legislative reforms to facilitate improved processes for women and men when registering formal businesses. This forms part of the government’s continued efforts to implement a number of reforms to create an enabling environment for the private sector. This will reduce the cost of doing business and ensure a level playing field for all businesses. Company details captured on a newly operationalized electronic companies registry are readily accessible to the public as a rich store of useful data, including for lenders. However, the administration of business name licensing, which has over 800 registrations per year, primarily from small trading businesses, remains entirely paper-based and inefficient. The underlying legislation is out of date, and office processes are slow and prone to error. Current legislation on business names includes outdated and cumbersome processes and gender distortions, requiring a married woman to include her husband’s name on the application form. Under the program, the government has committed to adopt legislative and administrative reforms, including the provision of an electronic registry similar to that under the recent company reforms, to further improve processes for women and men when registering businesses. 20. Enhanced corporate governance of state owned enterprises. Action 2.2 required the government to settle arrears owed by the Solomon Islands Water Authority (SIWA) to Solomon Islands Electricity Authority (SIEA). These SOEs signed a final debt settlement agreement on 31 May 2012 that includes provisions for (i) a capital injection into SIWA to be paid directly to SIEA; (ii) a long-term, interest-free loan from SIEA to SIWA; and (iii) a write-off of SI$9 million of the cross debt. The program provides for further actions to improve the sustainability of both organizations through the scheduled increase of water tariffs coupled with improved water quality and service delivery. Under the program, community service obligation (CSO) agreements were obtained for SIWA and SIEA.

21. The large amounts of scarce capital absorbed by Solomon Islands SOEs provide very low returns, divert government resources away from vital social investments in health and education, and drive up the cost of doing business where the SOEs are sole service providers. CSOs are defined in the SOE Act, 2007 as “a good or service provided by an SOE to a consumer or user on terms that are not expected to generate a normal return to the SOE.”12 The regulations of the SOE Act require that SOEs agree on a cost of CSO delivery with their accountable minister as compensation for the CSO. Without CSO agreements, SOEs cannot

12

Government of Solomon Islands. 2007. State Owned Enterprise Act, Section 2. Honiara.

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set and meet performance targets and the government cannot make informed policy decisions related to CSO assignments, the quality and efficiency of CSO delivery, and SOE performance. With continued support from ADB, the accounting and financial reporting systems of SOEs are being upgraded, which will facilitate the implementation of the CSO regulations.13 22. Action 2.3 under the program will enhance SOEs’ corporate planning processes by supporting the preparation of statements of corporate objectives for all eight SOEs, in compliance with the SOE Act. The Act requires that an SOE annually prepare its statement as a rolling 3-year document specifying business purpose, mission statement, corporative objectives and values, nature and scope of activities, regulatory framework, and strategic directions, for submission to the accountable minister. All SOEs have prepared and submitted their statements for 2013. In addition to implementing the SOE policy reforms, the government has collaborated, through MOFT’s Economic Reform Unit as its focal point, with the Solomon Islands Chamber of Commerce to implement a corporate governance services initiative to expand the pool of women qualified to serve on SOE boards. It involves director training programs and a database of potential directors. 23. Enhanced transparency in the resources sector. Under Action 2.4, the government has applied as a candidate to the Extractive Industries Transparency Initiative (EITI) international secretariat by forming a multi-stakeholder group and finalizing an EITI work plan in consultation with stakeholders. The reopening of the Gold Ridge mine and the possible development of nickel deposits has potential to raise community tensions, which could disrupt sector development. There will be a need to work with the mining companies and local communities to devise mechanisms to make the reporting of mining revenues more transparent, especially regarding arrangements for revenue sharing with local communities. This will be facilitated by government participation in the EITI.

3. Output 3: Broader Access to Social Services 24. Increased budget allocation to health and education. Budget support provided under the program will enable increased government expenditure for the social services that matter most to the poor, the vulnerable, and women. Actions 3.1 and 3.2 required increased budget allocation for education and health. The government has allocated 23.7% of consolidated expenditure in the 2013 budget for delivering education services, and 16.0% for health services, raising overall social expenditure from 34.0% in 2012 to 39.7% in 2013. 25. Gender equity in education. The government has adopted a number of policy plans and processes to improve equitable access to social services. Action 3.3 called on the government to adopt the medium-term National Education Action Plan (NEAP), 2013–2015, which includes result-based targets to make access to education services more equitable and a participatory assessment of the implementation of the previous NEAP, 2010–2012. The new NEAP builds on earlier progress by expanding access to early childhood education, secondary education, and technical and vocational education and training. Particular emphasis is on improving access for girls to senior secondary, technical, and vocational education and training, as well as to tertiary education. The new NEAP includes targets that promote gender equity, including measures to promote the enrollment of girls in secondary school and technical colleges.

26. Gender mainstreaming of health policies. Under Action 3.4, the government

13

ADB. 2009. Technical Assistance for Pacific Private Sector Development Initiative, Phase 2. Manila.

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established and operationalized a task force for mainstreaming gender in health policies, which reports to the national steering committee on gender equality and women’s development. The national health task force, comprising permanent secretaries and key stakeholders, was established to oversee gender-mainstreaming activities in the health sector, and held its first meeting in September 2012. The task force monitors the implementation of the Gender Equality and Women’s Development Policy and reports to Parliament annually through the Ministry of Women, Youth, Children, and Family Affairs. In November 2012, a gender focal point in the Ministry of Health and Medical Services was added to serve the task force. The task force is responsible for (i) coordinating the gathering of sex-disaggregated data and gender analysis from government ministries and stakeholders, (ii) building the capacity of human resources to ensure that plans and budgets are gender sensitive, and (iii) undertaking gender auditing and stocktaking of health sector policies.

D. Development Financing Needs 27. The government has requested a grant not exceeding $5 million from ADB’s Special Fund resources to help finance the program. 14 The grant size was determined with due consideration of (i) the relative importance of public sector management reform for ensuring sustained economic growth, (ii) the development financing needs of the country, (iii) the availability of additional financing from other development partners, and (iv) the significance and complexity of the policy actions of the program. The grant proceeds of $5 million (equivalent to 0.5% of GDP), together with contributions from other development partners, will substantially contribute to closing the $9 million recurrent financing gap in the 2013 budget. This allows the achievement of a small budget surplus to rebuild the fiscal buffer of at least 2 months of recurrent spending after the cash reserves were depleted in 2012. The rebuilding and maintenance of this buffer is important given the volatile nature of domestic revenues, as well as a key target and recommendation of the IMF program for the country.15 E. Implementation Arrangements 28. The program period is from 1 April 2012 to 31 December 2013. Program funding will be provided as a single tranche grant of $5 million to be disbursed when the government has met the conditions for effectiveness, including completing the agreed prior policy actions as set forth in the policy matrix. Grant proceeds will be disbursed to Solomon Islands using ADB’s simplified disbursement procedures and related requirements for program loans.16 The program will not finance the engagement of consultants. The government and ADB will continuously review program implementation using the design and monitoring framework and the policy matrix. Proceeds will be used to finance items produced and procured in ADB member countries, excluding items on the list of ineligible items and imports financed by other bilateral and multilateral sources.17 Grant proceeds disbursed to finance imports will require a certificate from the government stipulating that the value of total imports to Solomon Islands, minus its imports from nonmember countries, ineligible imports, and imports financed under other official development assistance, is greater than the amount of the grant to be disbursed during a

14

The country's eligibility for ADB’s Special Fund resources under the revised grant framework is determined by its risk of debt distress. The latest debt sustainability analysis in the International Monetary Fund's 2009 Article IV Consultation determined that Solomon Islands had a moderate risk of debt distress and was therefore eligible to receive 50% of its Asian Development Fund allocation as grants.

15 Sector Assessment (Summary): Public Sector Management (accessible from the list of linked documents in Appendix 2).

16 ADB. 1998. Simplification of Disbursement Procedures and Related Requirements for Program Loans. Manila.

17 List of Ineligible Items (accessible from the list of linked documents in Appendix 2).

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particular year. Local currency generated from the proceeds of the grants will be used to support public expenditure objectives under the program. 29. MOFT will be the executing and implementing agency. The CEWG mechanism and the government’s own processes will be used to monitor outcomes and impacts. MOFT is responsible for overall program implementation, including implementing all policy actions, administering the program, disbursing funds, and maintaining all program records. MOFT will monitor and report to ADB on the implementation of policy actions and their impact on budget outcomes in line with the design and monitoring framework. Monitoring outcomes and impacts will maximize the use of the government’s own processes and the CEWG mechanism. 30. In cooperation with MOFT and CEWG, ADB will carry out periodic reviews, continuing the well-functioning practice under the ERSP (footnote 5).18 The government will continue to keep ADB informed of the outcome of policy discussions with other multilateral and bilateral agencies that have implications for program implementation, as well as provide ADB with the opportunity to comment on any resulting policy proposals. The reviews will evaluate the implementation of the policy reform and assess impact, describe lessons identified during the program period, and outline policy actions and any assistance needed to accomplish the agreed reform targets. Program design draws on dialogue with stakeholders in the private sector and civil society such as the Solomon Islands Chamber of Commerce, Solomon Islands Women in Business Association, and Development Services Exchange (an umbrella organization for nongovernment organizations in Solomon Islands).

III. DUE DILIGENCE

A. Economic and Financial

31. Against the backdrop of a deteriorating macroeconomic position and lower revenue collection, the major constraint is the lack of public funds to finance social service delivery. Grant proceeds will cover short-term adjustment costs that will allow the government to maintain reasonable shares in the national budget to be allocated for social services. The reform program aims to ensure sustainable and inclusive economic growth with measures that usher the country through the transition to a strong public finance management system, and ensure domestic capacity for public administration and security, as RAMSI is being phased out.19 32. The program will improve government accountability and transparency by facilitating more civil society participation in the budget process, improving procurement processes, formulating a new debt strategy, and creating an M&E framework for the NDS. It will improve the SOE corporate governance and performance, which currently drag on economic growth. More generally, broader social service delivery will improve health and education outcomes, further enabling Solomon Islanders to generating income locally and abroad. B. Governance

33. Public finance management. Due diligence on various aspects of public finance

18

Detailed actions taken by MOFT and the joint annual review of the ERSP and the government’s comprehensive program are described in section 3 of the Sector Assessment (Summary): Public Sector Management (accessible from the list of linked documents in Appendix 2).

19 The program’s contribution to poverty reduction and the ADB results framework are in Contribution to the ADB Results Framework and Summary Poverty Reduction and Social Strategy (accessible from the list of linked documents in Appendix 2).

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management reforms (taxation, public expenditure, budget, and planning) continues to be coordinated under individual CEWG partners, government agencies, and the IMF. ADB regularly participates along with the government and CEWG partners in the annual review of the government’s progress in implementing its reform agenda since 2010. ADB, Australia, the European Union, the World Bank, and government representatives carried out joint due diligence related to public finance management and reforms under the government’s program from July to October 2012. 20 Subsequently, ADB and the World Bank shared their own assessments of the progress of target reform actions under their respective policy-based programs that support the reforms under the 2013 national budget. Several of the policy actions under the two programs are identical, as they are part of the government’s reform agenda.21 34. Anticorruption measures. ADB’s Anticorruption Policy (1998, as amended to date) was explained to and discussed with the government and MOFT. The specific policy requirements and supplementary measures are described in the legal documents.

C. Poverty and Social

35. The program will contribute to poverty reduction by helping to protect the delivery of basic services to the vulnerable. The program will foster poverty reduction and social development through (i) sustained, equitable, and inclusive economic growth over the long term; (ii) improved public finance management and creating a more enabling business environment; (iii) stronger delivery of health and education services; and (iv) greater job creation as the private sector grows. 36. The program is classified as effective gender mainstreaming. It will promote women’s participation in decision making by requiring that women’s groups be consulted as part of the annual budget process. It will improve women’s access to productive resources by reviewing the process and laws regarding the administration of business names. The program will improve women’s access to education through the adoption of a new education strategy that includes outputs to improve access to secondary education, the principal area of women’s relative disadvantage in education. The program is designed to give women greater access to better-quality health care through work carried out under the gender mainstreaming task force chaired by the permanent secretary of health and medical services, which was established in late 2011 and put into operation in 2012. D. Safeguards

37. The program is safeguard category C for environment, involuntary resettlement, and indigenous peoples. No adverse environmental impacts were identified. No involuntary resettlement or impacts on indigenous people are expected. During fact finding, a public consultation with representatives from civil society organizations discussed the program’s social impact and contribution to poverty reduction, in addition to the government’s consultation programs related to reforms during the preparation of the NDS, 2011–2020 (in the first half of 2011) and the 2013 national budget (May–June 2012). E. Risks and Mitigating Measures

38. Major risks and mitigating measures are summarized in Table 1 and described in detail

20

The Solomon Island Core Economic Working Group. 2012. Report of the Economic and Financial Reform Program: Third Annual Joint Review. Honiara.

21 Sector Assessment: Public Sector Management (accessible from the list of linked documents in Appendix 2).

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in the risk assessment and risk management plan.22

Table 1: Summary of Risks and Mitigating Measures

Risks Mitigating Measures

Political instability may weaken fiscal discipline and policy commitment.

ADB will continue to engage on policy with the government and key development partners through the CEWG, guided by the program partnership monitoring framework.

The government may have insufficient capacity to implement the program.

Ongoing and planned technical assistance will include activities to strengthen the government’s implementation capacity as necessary.

The revenue position of the government may deteriorate and impede service delivery.

Further legal reforms and more capacity building are expected from external assistance provided by ADB and other development partners.

Excessive spending growth in other budget areas may crowd out expenditures for social services, making it difficult to implement the policy actions of the program.

In coordination with key development partners, ADB will provide additional recommendations and assistance on expenditure control and management.

ADB = Asian Development Bank, CEWG = core economic working group. Source: Asian Development Bank.

IV. ASSURANCES AND CONDITIONS

39. The government and MOFT have assured ADB that implementation of the program shall conform to all applicable ADB policies including those concerning anticorruption measures, safeguards, gender, procurement, consulting services, and disbursement as described in detail in the grant documents. 40. The government and MOFT have agreed with ADB on certain covenants for the program, which are set forth in the grant agreement: (i) the government will (a) maintain the policies adopted and actions taken under the program prior to the date of the grant agreement, as described in the development policy letter and the policy matrix, for the duration of the program and subsequently; (b) promptly adopt the other policies and the other actions as specified in the development policy letter and the policy matrix; and (c) ensure that such policies and actions continue in effect for the duration of the program; and subsequently (ii) the government and the program implementing agencies will ensure that, throughout program implementation, adequate budgetary allocations of required counterpart funds are made, approved, and released on time to ensure proper program implementation.

V. RECOMMENDATION

41. I am satisfied that the proposed policy-based grant would comply with the Articles of Agreement of the Asian Development Bank and recommend that the Board approve the grant of $5,000,000 to Solomon Islands for the Economic and Financial Reform Program, from ADB’s Special Funds resources; and such other terms and conditions as are substantially in accordance with those set forth in the draft grant agreement presented to the Board.

Haruhiko Kuroda President

27 February 2013

22

Risk Assessment and Risk Management Plan (accessible from the list of linked documents in Appendix 2).

Appendix 1 11

DESIGN AND MONITORING FRAMEWORK

Design Summary Performance Targets and Indicators with Baselines

Data Sources and Reporting Mechanisms Assumptions and Risks

Impact The Government of Solomon Islands delivering improved public investment and services

The relative living standard of the most vulnerable people improves, as measured by a rising expenditure share of the poorest 20% of households. Baseline (2005–2006 survey): 7% Target (2016): 10% The literacy rate rises. Baseline (2005–2006): 77% Target (2016): 80% The maternal mortality ratio is reduced. Baseline (2005–2006): 200 per 100,000 live births Target (2016): 195 per 100,000 live births

Household income and expenditure surveys by the Statistics Office, MOFT Household income and expenditure surveys Records and reports from Ministry of Health and Medical Services

Assumptions There are no major natural disasters or other external shocks.

Domestic political and macroeconomic stability is maintained.

Risk Political support for continuing reforms is lost.

Outcome The government maintaining a strong fiscal position while delivering expanded and more equitable social services

The ratio of public debt to gross domestic product is maintained at a sustainable level with no deterioration from the IMF assessment of moderate risk of debt distress. Baseline (2012): 20.5% Target (2014): no more than 30% The average country performance assessment rating for policies affecting social inclusion and equity rises. Baseline (2012): 2.9 Target (2015): 3.1

IMF Article IV and staff reports, national accounts, budget documents, and Central Bank of Solomon Islands quarterly reviews and annual reports ADB annual country performance assessments

Assumption Government has the capacity and willingness to implement and sustain the policy adopted.

Risk The budget is affected by an external shock.

Outputs 1. Better public

finance management

Public sector management and institutional assessment ratings are maintained or improved. Baseline (2011): 3.1 Target (2014): 3.5 Civil society organizations, including women’s groups, are consulted during budget formulation. Baseline (2011): 0 Target (2014): 6

ADB annual country performance assessments Budget documents

Assumption Development partners continue to support government reform.

Risk Local capacity in government agencies cannot match the reform requirements once technical assistance provided by the Regional Assistance Mission to Solomon Islands.

12 Appendix 1

Design Summary Performance Targets and Indicators with Baselines

Data Sources and Reporting Mechanisms Assumptions and Risks

ends.

2. Greater economic efficiency for business enabling environment

The SOE portfolio rate of return on equity rises by at least 10%. Baseline (2010): 3.1% Target (2014): 3.5% Fiscal support to SOEs is limited to funding available through the community service obligation framework. Baseline (2002–2009): $52 million Target (2014): $0 The pool of trained women with potential to become SOE board members expands. Baseline (2010): 0 Target (2014): 50 The number of formal businesses managed or owned by women increases. Baseline (2011): 591 managed and 605 owned Target (2014): 620 managed and 635 owned

ADB Finding Balance

a report

using audited statements of SOEs ADB Finding Balance report MOFT reports Statistics from the Companies Registry website

Assumption Development partners continue to support for government reform.

Risks Political interference affects the management of SOEs.

Fuel prices increase sharply.

3. Broader access to social services

Access to health services improves. Baseline (2011): 67% of respondents to the annual people’s survey able to reach a health facility in 1 hour Target (2014): 70% The net primary school enrollment rate increases. Baseline (2010): 94% Target (2014): 95% Ratio of girls to boys enrolled in primary and secondary education improves. Baseline (2011): 80:100 Target (2014): 85:100

Household Income and Expenditure Survey, United Nations and/or ministry reports Records and reports from the Ministry of Education and Human Resources Development Records and reports from the Ministry of Education and Human Resource Development

Assumption Complementary resources (e.g., for transport and communication) or opportunities (e.g., time and community support) allow the poor to connect with or access the social services provided.

Risk Local capacity and counterpart resources are insufficient to efficiently deliver equitable social services.

Appendix 1 13

Activities with Milestones 1. Better public finance management

1.1 Consult with civil society organizations, including women's groups, in preparing the 2013 budget (Aug 2012).

1.2 Formulate and adopt a monitoring and evaluation framework and processes for the NDS (Dec 2012).

1.3 Develop a procurement manual, standard bidding documents, and standard procurement contracts (Feb 2013).

1.4 The cabinet approves the release of a draft customs and excise bill for public consultation (Feb 2013).

1.5 Adopt a debt management strategy (May 2012).

2. Greater economic efficiency for business enabling environment

2.1 Adopt policy framework and administrative reforms to facilitate processes for women to register formal businesses (Jan 2013)

2.2 SIEA and SIWA agree on a mechanism for reducing SIWA’s debts to SIEA (May 2012).

2.3 SOEs comply with the SOE Act, 2007 regarding the preparation and submission of statements of corporate objectives (Feb 2013).

2.4 Community service obligation agreements are in place for at least two SOEs (Jun 2012)

2.5 Complete the application for candidate status to the Extractive Industry Transparency Initiative international secretariat (Jun 2012).

3. Broader access to social services

3.1 Allocate no less than 22% of consolidated expenditure in the 2013 budget to delivering education services (Dec 2012).

3.2 Allocate no less than 10% of consolidated expenditure in the 2013 budget to delivering health services (Dec 2012).

3.3 Adopt a medium-term national education action plan that includes result-based targets and aims to improve gender equality in access to education services (Jun 2012).

3.4 Establish and operationalize a task force for mainstreaming gender in health policies (Jun 2012).

3.5 Conduct a consultation workshop with line ministries on the formulation of the manual for implementing a policy to streamline gender (Oct 2012).

Inputs

Grant ADB: $5 million

Government:

Government officials’ and staff inputs to support program design, implementation, monitoring, and reporting

ADB = Asian Development Bank, IMF = International Monetary Fund, MOFT = Ministry of Finance and Treasury, NDS = National Development Strategy, SIEA = Solomon Islands Electricity Authority, SIWA = Solomon Islands Water Authority, SOE = state-owned enterprise. a ADB. 2011. Finding Balance 2011: Benchmarking the Performance of State-Owned Enterprises in Fiji, Marshall

Islands, Samoa, Solomon Islands, and Tonga. Manila. Source: Asian Development Bank.

14 Appendix 2

LIST OF LINKED DOCUMENTS http://www.adb.org/Documents/RRPs/?id=46497-001-2

1. Grant Agreement

2. Sector Assessment (Summary): Public Sector Management

3. Contribution to the ADB Results Framework

4. Development Coordination

5. Country Economic Indicators

6. International Monetary Fund Assessment Letter

7. Summary Poverty Reduction and Social Strategy

8. Risk Assessment and Risk Management Plan

9. List of Ineligible Items

Supplementary Documents

10. Macroeconomic Analysis

11. Solomon Islands Government Economic and Financial Reform Program Policy Matrix

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POLICY MATRIX

Policy actions–completed by December 2012

Policy actions —completed by February 2013 (Tranche release conditions)

Program partnership monitoring framework—policy actions to be completed by December 2013

and continued thereafter (Non tranche release conditions

1)

Output 1: Better public financial management

1.1 Consult with civil society organizations including women groups in the preparation for 2013 budget

(Completed as recorded in Permanent Secretary of Finance letter verifying consultations attaching the report on the consultation process together with a list of organizations consulted)

Continue consultations with civil society organizations in the preparation of 2014 and future budgets and key public financial management reforms.

1.2 Formulate and adopt a satisfactory monitoring and evaluation framework for the National Development Strategy

(Completed as recorded in Cabinet minutes endorsing the monitoring and evaluation framework for the National Development Strategy with the strategy attached)

Implement recommendations of the policy paper on the monitoring and evaluation framework for the National Development Strategy.

1.3 Develop a procurement manual, standard bidding documents, and standard procurement contracts (collectively, procurement documents), acceptable to ADB

(Completed as recorded in Permanent Secretary of Finance letter verifying completion of the procurement documents attaching copies of same)

Central Tender Board awards contracts based on the procurement documents and publishes details regarding same, including the name of awardees and contract amount, on the MOFT website.

1.4 Cabinet approves the release of a draft Customs and Excise Bill acceptable to ADB for public consultation

(Completed as recorded in Cabinet minutes approving the release of the draft Bill for public consultation attaching the draft Bill)

Cabinet endorses the new Customs and Excise Bill to be tabled in Parliament.

20

Ap

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4

Policy actions–completed by December 2012

Policy actions —completed by February 2013 (Tranche release conditions)

Program partnership monitoring framework—policy actions to be completed by December 2013

and continued thereafter (Non tranche release conditions

1)

1.5 Adopt a debt management strategy which includes establishing a Debt Management Advisory Committee and guidelines for public borrowing and debt management

(Completed as recorded in Cabinet minutes endorsing the debt management strategy with the strategy attached)

The government operates within the framework of the debt management strategy, including setting up annual borrowing ceiling.

Output 2: Greater economic efficiency for business enabling environment

2.1 Adopt a policy paper recommending legislative and administrative reforms of the business names registration process to facilitate improved processes for registering formal businesses

(Completed as recorded in Cabinet minutes endorsing the policy paper on reforms of the business names registration process, including its recommendations, with the policy paper attached)

Prepare and obtain Cabinet endorsement of amendment to the Registration of Business Names Act for tabling to Parliament.

2.2 SIEA and SIWA agree on a mechanism for the reduction of SIWA’s debts to SIEA

(Completed as recorded in signed debt settlement agreement between SIEA and SIWA)

Monitor compliance with the debt settlement agreement.

2.3 Obtain compliance with the 2007 SOE Act regarding the preparation and submission of Statements of Corporate Objectives (SCOs) by all 8 state-owned enterprises

(Completed as recorded in Permanent Secretary of Finance letter verifying compliance by all 8 SOEs attaching copies of the SCOs)

Publicize on the MOFT website and via press release information on the SCOs, including an outline of the nature of the SCO, the cost, and description on the government’s efforts to monitor the SCO.

2.4 Apply for Candidate Status to EITI International Secretariat

(Completed as recorded in a notification letter from EITI Secretariat)

Prepare proposal to remove barriers to EITI implementation with public consultation.

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Policy actions–completed by December 2012

Policy actions —completed by February 2013 (Tranche release conditions)

Program partnership monitoring framework—policy actions to be completed by December 2013

and continued thereafter (Non tranche release conditions

1)

Output 3: Broader access to social services

3.1 Allocate no less than 22% of consolidated expenditure for delivery of education services in the 2013 budget

(Completed as recorded in the gazetted 2013 Appropriations Act showing authorized expenditures for 2013)

Maintain sufficient budget allocation to preserve the delivery of education services.

3.2 Allocate no less than 10% of consolidated expenditure for delivery of health services in the 2013 budget

(Completed as recorded in the gazetted 2013 Appropriations Act showing authorized expenditures for 2013)

Maintain sufficient budget allocation to preserve the delivery of health services.

3.3 Adopt a medium-term National Education Action Plan 2013-2015 that includes result-based targets aiming to improve gender equality for access to education services

(Completed as recorded in the Ministry of Education and Human Resources Development letter verifying the adoption of the National Education Action Plan attaching the plan)

Implement, monitor, and report on the implementation of the new National Education Action Plan.

3.4 Establish and operationalize a taskforce for gender mainstreaming of health policies

(Completed as recorded in Permanent Secretary of Women, Youth, Children, and Family Affairs appointing Director of Child Health, Ministry of Health and Medical Services to be a member of the national taskforce and minutes or reports of meetings)

Implement, monitor, and report on the implementation of taskforce recommendations. Finalize a manual for line ministries to implement the ministerial gender mainstreaming policy

ADB = Asian Development Bank, EITI = Extractive Industries Transparency Initiative, MOFT = Ministry of Finance and Treasury, SCO = Statement of Corporate Objectives, SIEA = Solomon Islands Electricity Authority, SIWA = Solomon Islands Water Authority, SOE = state-owned enterprise. 1

To be verified as part of the monitoring and review under the program. Source: Asian Development Bank and Solomon Islands Government.