Palau’s Economy Faces Challenges: CA Deficit Widens to 10.9% of GDP in FY2020

Economic Challenges Ahead

The International Monetary Fund (IMF) has reported that Palau’s current account (CA) deficit widened to 10.9% of its Gross Domestic Product (GDP) in Fiscal Year 2020, a significant increase from the previous year.

CA Deficit Expected to Narrow

While the CA gap is expected to narrow in the medium term as tourism activities resume, it will remain elevated. The IMF has warned that structural reforms are necessary to diversify the economy and fiscal adjustment to resolve the CA deficit.

External Position Weakens

Palau’s external position weakened in FY2020 due to a sharp decline in foreign investment and a rise in imports. The country’s foreign reserves have decreased, but they remain sufficient to cover about 5 months of government spending.

Banking System Remains Sound

The banking system is considered sound overall, with commercial banks having ample liquidity. However, private sector credit growth has softened, reflecting increased risk aversion and lower loan demand. Non-performing loans (NPLs) have also increased, but the ratio remains contained at 1.7%.

Economic Contraction and Recovery

Palau’s economy contracted by 17.1% in FY2021 due to the COVID-19 pandemic, with tourism arrivals plummeting by an estimated 92%. The country has started to reopen its borders and has implemented measures to support the tourism sector.

IMF Projections

The IMF has projected that real GDP will rebound by 9.4% in FY2022 and 18.3% in FY2023, but output is expected to remain on a lower trajectory over the medium term due to economic scarring in the tourism sector. Inflation is also expected to rise in FY2022 due to elevated international commodity prices.

Risks and Uncertainty

Uncertainty around the outlook remains high, with risks tilted to the downside. The main risk is a protracted COVID-19 pandemic and a domestic outbreak, which could further exacerbate the CA deficit and economic contraction.

Recommendations from the IMF

The IMF has urged Palau’s authorities to implement structural reforms to address imbalances in the public pension system and the public utility company, as well as to support growth through upgraded infrastructure and internet connectivity. The government has also been advised to continue its multi-year fiscal consolidation efforts and to implement a comprehensive tax reform.

Conclusion

Palau’s economic outlook remains challenging, with a difficult and uncertain recovery expected over the medium term. The country needs to take swift action to address its CA deficit and structural issues to ensure a sustainable and robust economic recovery.