The assessment, which was concluded in late February, observed that Vanuatu has recently emerged from a long period of low growth and falling per capita incomes. Following two years of contraction, output growth recovered beginning in 2003, spurred by stronger performance in construction and a pickup in tourist arrivals.

Growth reached 7% in 2005 and an estimated 5.5% in 2006, well above the average for Pacific island countries. After peaking at 3% in 2003, inflation has since declined to 1.5% percent in 2006. The overall external balance has benefited from rising foreign direct investment, aid, and private capital inflows, with reserves increasing to over 7 months of imports.

Budget performance has also improved, the IMF revealed. With cuts in capital spending and improved tax collection, the budget moved from a deficit of 4% of GDP in 2002 to a surplus of nearly 2% of GDP in 2005.

If good macroeconomic policies continue and political stability is maintained, the Fund predicted, near-term prospects are positive. Growth should be maintained at about 4-5% over the next two-three years, boosted by the direct impact of aid and private capital inflows on investment and growing tourism following the launching of new flights to Vanuatu in 2006. Inflation is expected to increase modestly but remain subdued. There is, however, a risk that a loosening of fiscal policy and increased capital inflows could put upward pressure on private sector wages and prices.

Medium-term prospects will depend on the pace of structural reforms, an area where progress has been limited.

On the positive side, financial sector reforms have been impressive, with the government taking steps over the last several years to substantially improve supervision of domestic banks and the offshore financial sector. At the same time, fiscal structural reforms have not advanced. The wage bill remains high, crowding out development-related spending.

In addition, numerous exemptions on the value-added tax and duties have not been streamlined, and little progress has been made on reforms to address the substantial barriers to private sector development, which are key to placing Vanuatu on a higher growth path.

Without stronger efforts to undertake these reforms, the IMF warned that the positive growth projected in the near term could prove temporary, with medium-term growth reverting to its historical performance and per capita income growth remaining stagnant.

Commenting on this aspect of the report, the Executive Board officials stated:

"Directors emphasized that the present economic situation provides an opportune time for the authorities to begin undertaking long overdue fiscal restructuring. They urged the authorities to focus reforms on improving the delivery and efficiency of government services, restructuring the civil service and reducing the associated wage bill, and removing numerous tax exemptions and enhancing tax administration. Directors stated that loss-making state-owned enterprises should be restructured, including through privatization."

Speaking with regard to the supervision of the jurisdiction's financial sector, they added:

"Directors welcomed the considerable progress in reforming the financial sector, but noted that additional steps are needed in certain areas. In particular, they urged the authorities to place the proposed agriculture development bank under strict central bank supervision from its inception to prevent the mismanagement and loan losses experienced by the previous development bank. Directors encouraged the authorities to promote commercial bank awareness of their responsibilities under the Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) legislation."