Report and Recommendation of the President to the Board of Directors

Project Number: 50377-001 October 2019

Proposed Policy-Based Grant Tuvalu: Improved Fiscal and Infrastructure Management Program Distribution of this document is restricted until it has been approved by the Board of Directors. Following such approval, ADB will disclose the document to the public in accordance with ADB's Access to Information Policy after excluding information that is subject to exceptions to disclosure set forth in the policy.

CURRENCY EQUIVALENTS (as of 9 September 2019)

Currency unit – Australian dollar/s (A$)

A$1.00 = $0.6846 $1.00 = A$1.4736

ABBREVIATIONS

ADB ANS CIF CPU

– – – –

Asian Development Bank Assessment of National Systems Consolidated Investment Fund Central Procurement Unit

GDP IMF MFED PCRAFI PEFA

– – – – –

gross domestic product International Monetary Fund Ministry of Finance and Economic Development Pacific Catastrophe Risk Assessment and Financing Initiative Public Expenditure and Financial Accountability

PFM PRM TA TAMF TTF

– – – – –

public financial management policy reform matrix technical assistance Tuvalu Asset Management Framework Tuvalu Trust Fund

NOTE

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

Vice-President Ahmed M. Saeed, Operations 2 Director General Ma. Carmela Locsin, Pacific Department (PARD) Directors Masayuki Tachiiri, Pacific Subregional Office (SPSO), PARD Emma Veve, Social Sectors and Public Sector Management

Division, PARD Team leader

Sivou Beatrice Olsson, Country Coordination Officer, SPSO, PARD

Team members Ananya Basu, Principal Economist, PARD Maureen A. Hazelman, Associate Project Analyst, SPSO, PARD Lily Anne F. Homasi, Senior Economics Officer, SPSO, PARD Douglas Perkins, Principal Counsel, Office of the General Counsel

Leba Resina Sovea, Senior Programs Assistant, SPSO, PARD Peer reviewer Hanif A. Rahemtulla, Senior Public Management Specialist,

Sustainable Development and Climate Change 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

PROGRAM AT A GLANCE

I. THE PROPOSAL 1

II. PROGRAM AND RATIONALE 1

A. Background and Development Constraints 1

B. Policy Reform and ADB’s Value Addition 5

C. Impacts of the Reform 8

D. Development Financing Needs and Budget Support 8

E. Implementation Arrangements 9

III. DUE DILIGENCE 9

IV. ASSURANCES 10

V. RECOMMENDATION 10

APPENDIXES

1. Design and Monitoring Framework 11

2. List of Linked Documents 13

3. Development Policy Letter 14

4. Policy Matrix (July 2018–June 2019) 17

Project Classification Information Status: Complete

PROGRAM AT A GLANCE

Source: Asian Development BankThis document must only be generated in eOps. 23092019120732976922 Generated Date: 08-Oct-2019 11:15:49 AM

1. Basic Data Project Number: 50377-001Project Name Improved Fiscal and Infrastructure Management

ProgramDepartment/Division PARD/SPSO

Country Tuvalu Executing Agency Ministry of Finance andEconomic DevelopmentBorrower Ministry of Finance

Country Economic Indicators

https://www.adb.org/Documents/LinkedDocs/?id=50377-001-CEI

Portfolio at a Glance https://www.adb.org/Documents/LinkedDocs/?id=50377-001-PortAtaGlance

2. Sector Subsector(s) ADB Financing ($ million)Public sector management

Public expenditure and fiscal management 4.00

Total 4.00

3. Operational Priorities Climate Change InformationStrengthening governance and institutional capacity Climate Change impact on

the ProjectLow

Sustainable Development Goals Gender Equity and MainstreamingSDG 1.aSDG 9.1

No gender elements (NGE)

Poverty TargetingGeneral Intervention on Poverty

4. Risk Categorization: Low .

5. Safeguard Categorization Environment: C Involuntary Resettlement: C Indigenous Peoples: C.

6. Financing

Modality and Sources Amount ($ million)

ADB 4.00 Sovereign Program grant: Asian Development Fund 4.00

Cofinancing 10.60 European Union - Program grant (Not ADB Administered) 1.50

Government of Australia - Program grant (Not ADB Administered) 1.00

Government of New Zealand - Program grant (Not ADB Administered) 0.60

World Bank - Program grant (Not ADB Administered) 7.50

Counterpart 0.00 None 0.00

Total 14.60

Currency of ADB Financing: US Dollar

I. THE PROPOSAL 1. I submit for your approval the following report and recommendation on a proposed policy-based grant to Tuvalu for the Improved Fiscal and Infrastructure Management Program.1 2. The program aims to strengthen Tuvalu’s fiscal sustainability by supporting priority policy actions under the government’s rolling multiyear policy reform matrix (PRM).2 Since 2012, the Asian Development Bank (ADB) has been closely engaged with the government and development partners in supporting the policy reforms under the multiyear matrix through technical assistance (TA) and two earlier ADB stand-alone operations.3 This single-tranche stand-alone grant supports reforms to improve the management of public finance and national infrastructure, building on past engagement by ADB and other development partners.4 In coordination with other development partners, ADB will continue to engage in the PRM process through policy dialogue, budget support, and TA. The program is consistent with ADB’s Strategy 2030 priorities of strengthening governance and institutional capacity; improving the access, quality, and reliability of services; and building climate resilience.5

II. PROGRAM AND RATIONALE A. Background and Development Constraints 3. Tuvalu is a fragile microstate comprising nine low-lying atolls covering a land area of 26 square kilometers. More than half the population of 11,100 (2017) resides in Funafuti—an area of only 2.8 square kilometers. Tuvalu’s remoteness from major markets, dependence on imports, and vulnerability to external shocks and climate change pose significant risks to socioeconomic development. Tuvalu has a narrow economic base, and domestic revenues are highly reliant on volatile external revenue sources, including fishing license fees and “.tv” internet domain license fees. External grants from development partners are a critical source of budget financing. The public sector accounts for two-thirds of gross domestic product (GDP) and provides most of the formal sector employment. The private sector is small and struggles to grow because of the lack of economies of scale and high transaction costs. Given the dominance of the public sector, sound financial management is critical to ensure the effective delivery of public services and investments that underpin economic growth. 4. Recent macroeconomic performance. 6 Growth in Tuvalu accelerated to 4.9% per annum during 2015–2018 from 0.8% per annum during 2011–2014, driven by higher government

1 The design and monitoring framework is in Appendix 1. The program is in ADB. 2018. Country Operations Business

Plan: 11 Small Pacific Island Countries, 2019–2021. Manila. It aligns with ADB. 2016. Pacific Approach, 2016–2020. Manila. The concept paper for the program was circulated to the ADB Board of Directors on 3 September 2019.

2 The Policy Matrix, containing a prioritized list of reforms implemented between July 2018 and June 2019, is in Appendix 4.

3 ADB. 2012. Report and Recommendation of the President to the Board of Directors: Proposed Grant to Tuvalu for the Strengthened Public Financial Management Program. Manila; and ADB. 2015. Report and Recommendation of the President to the Board of Directors: Proposed Grant to Tuvalu for the Strengthened Fiscal Sustainability Program. Manila.

4 The Policy Reform Matrix containing reforms implemented between January 2012 and June 2018, is accessible from the list of linked documents in Appendix 2.

5 ADB. 2018. Strategy 2030: Achieving a Prosperous, Inclusive, Resilient, and Sustainable Asia and the Pacific. Manila.

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

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expenditure underpinned by substantial increases in fishing license revenues and several large infrastructure projects for hosting regional summits in 2018 and 2019. Fishing license revenues increased by 84.8% in 2018 with the receipt of a one-off payment from a subregional pooling scheme. Tuvalu recorded fiscal surpluses of 13.5% of GDP in 2017 and 33.9% of GDP in 2018. Higher public sector wages and infrastructure projects are expected to accelerate inflation for both 2019 and 2020. The International Monetary Fund (IMF) estimated external public debt at 28.0% of GDP in 2018, and continues to classify Tuvalu as being at high risk of debt distress primarily because of its vulnerability to external shocks.7 5. The Tuvalu Trust Fund (TTF) was created in 1987 to help smooth revenue volatility.8 Distributions are made from the TTF to its associated buffer fund—the Consolidated Investment Fund (CIF)—when the TTF’s balance exceeds its maintained value. Under the current fiscal policy, a minimum balance of 16% from the TTF maintained value is required to be maintained in the CIF to provide a buffer for budget expenditure. In 2015, the government established the Tuvalu Survival Fund for disaster relief and rehabilitation. As of 30 March 2019, the market value of TTF investments was $122.3 million, while the maintained value was $123.7 million. As of 30 March 2019, the CIF balance was $22.8 million (18% of the TTF maintained value), and the Tuvalu Survival Fund was $6.2 million. The government also holds contingent disaster financing from ADB, approved in 2017 and valued at $3.0 million.9 These funds provide the government with flexible buffers to address short-term financing gaps and the scaling up of reserve assets—increasing the country’s resilience to shocks. 6. Macroeconomic and fiscal management risks. Growth is projected to remain strong, above 4.0% from 2019 to 2021, driven by higher government spending on large infrastructure projects and housing for Tuvalu’s hosting of major events such as the Pacific Islands Forum Leaders Meeting held in August 2019. Despite the positive medium-term outlook, Tuvalu is exposed to substantial downside risks (particularly the link between the global economic environment and remittances, TTF returns, and volatile fisheries receipts) that challenge government’s fiscal management and macroeconomic sustainability. Fishing license revenues in 2019 are projected to decrease to $23.5 million—about the same level as in 2016 and about 65.7% lower than revenue receipts in 2018. This, plus higher infrastructure spending for the regional summit meeting, is expected to result in a budget deficit for 2019.10 Excluding grants, the domestic fiscal deficit in 2019 is estimated to be $22.5 million (47.9% of GDP) (Table 1).11 7. The Pacific Catastrophe Risk Assessment and Financing Initiative (PCRAFI) estimates that, on average, Tuvalu should expect annualized disaster-related losses and damages of 2% of GDP.12 While the government is implementing activities to improve resilience to shocks, the costs associated with physical adaptation, disaster risk reduction, and disaster response are large

7 IMF. Tuvalu: Article IV Consultation. Washington, DC. 8 The TTF was created with the initial balance of A$27 million contributed by Australia, New Zealand, the United

Kingdom, and Tuvalu. 9 ADB. 2017. Report and Recommendation of the President to the Board of Directors: Proposed Policy-Based Loans,

Policy-Based Grants, and Technical Assistance Grant for the Pacific Disaster Resilience Program. Manila. 10 ADB. 2019. Pacific Economic Monitor, July 2019. Manila. 11 Government of Tuvalu. 2019. National Budget. Funafuti. 12 PCRAFI, a multi-donor facility established in 2007 with World Bank as the trustee, provides Pacific island countries

with catastrophe risk insurance coverage on competitive terms and supports capacity building on disaster risk financing and the public financial management of disasters. A probabilistic catastrophe risk assessment conducted by PCRAFI in 2010 estimated the replacement cost of exposed assets in Tuvalu, including buildings (public and private), as well as infrastructure (ports, airports, roads, and bridges), at $268 million (about 85% represents buildings and 14% represents infrastructure).

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relative to the size of the economy and may necessitate higher development assistance than would otherwise be required.13 IMF’s 2018 Article IV assessment calls for a stronger fiscal framework by building fiscal buffers and a further improvement in climate change risk management.

Table 1: Fiscal Framework, 2016–2021 (% of GDP unless otherwise indicated)

Item 2016 2017 2018e 2019p 2020p 2021p

Total revenue and grants 176.5 142.4 138.3 138.0 109.5 116.0

Total revenue 145.1 117.9 117.5 91.3 86.1 81.7

Of which: tax revenue 15.1 14.7 12.3 14.1 13.3 12.6

Grants 31.4 24.5 20.8 46.7 23.5 34.4

Total expenditure 155.9 128.9 104.4 139.2 107.7 101.3

Current expenditure 116.5 97.9 73.7 95.7 89.5 84.7

Of which: Wages and salaries 37.2 35.8 32.2 39.4 37.0 35.0

Capital expenditure 39.4 30.9 30.7 43.4 18.2 16.6

Overall balance (including grants) 20.6 13.5 33.9 (1.1) 1.8 14.7

in $ million 7.8 5.5 14.9 (0.5) 0.9 8.0

Overall balance (excluding grants) (10.8) (10.9) 13.2 (47.9) (21.7) (19.7)

in $ million (4.1) (4.5) 5.8 (22.5) (11.0) (10.7)

GDP ($ million, current prices) 37.7 40.8 43.8 46.9 50.8 54.6 ( ) = negative, e = estimates, GDP = Gross Domestic Product, p = projection Sources: Asian Development Bank and Government of Tuvalu estimates.

8. Ongoing public financial management weaknesses. Tuvalu’s public financial management (PFM) has improved through the implementation of the PFM Roadmap, 2015–2018,

which has helped improve functions of the Treasury Department to better account for funds and support public spending.14 However, there are still areas to improve in fiscal management, including complying with public procurement regulations and accounting procedures, and managing infrastructure investments. Hence, the government updated the PFM Roadmap, 2018–2021 to guide the efforts of the government and development partners to address the remaining weaknesses in fiscal management and enhance the coordination and implementation of PFM reforms. Further, the limitation of the fiscal management framework concerns the credibility of the accounting and reporting system partly because of discrepancies associated with using both cash accounting and partial accrual accounting. The government has also identified public procurement as a priority area of PFM following initial reforms introduced in 2012.15 9. Challenges to infrastructure management. Infrastructure development is an important catalyst for economic growth but the benefits depend on how well it is managed (i.e., whether it results in quality and stable public service delivery). The government has carried out key reforms to improve public investment management. The reforms involve improving the predictability and planning of public investment by adopting the Tuvalu Infrastructure Strategy and Investment Strategy, 2016–2025.16 This broader plan is supported by the Building Act and asset management framework that help the government operationalize the Tuvalu Infrastructure Strategy and

13 Tuvalu’s Climate Change Policy 2012–2021 guides interventions for responding to climate change impacts and

related disaster risks and is linked to Tuvalu’s National Strategic Action Plan for Climate Change and Disaster Risk Management.

14 Government of Tuvalu. 2015. Public Financial Management Roadmap, 2015–2018. Funafuti. 15 Key PFM assessment documents include the 2015 Public Expenditure and Financial Accountability self-assessment,

annual auditor general’s reports, and the 2018 Assessment of National Systems (ANS) conducted by the Government of Australia.

16 Government of Tuvalu. 2015. Tuvalu Infrastructure Strategy and Investment Plan, 2016–2025. Funafuti.

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Investment Strategy and links to budgeting and implementation. The government, with support from ADB and IMF’s Pacific Financial Technical Assistance Centre, is working on a multiyear infrastructure budget for 2020, which will allow rollover funds for infrastructure development and increase the efficiency of public infrastructure management. This will prevent having to appropriate budget every year for major infrastructure projects and facilitate the planning and management of infrastructure projects and maintenance works. However, infrastructure development and management in Tuvalu remains challenging because of a lack of economies of scale, high transport costs, a harsh climate, and limited skills and technical capacity. Physical public investments are often not managed and maintained properly, eventually posing fiscal risks, impacting the quality of public service delivery, and compromising public health and safety. The harsh climate also causes physical infrastructure assets to corrode and age quickly. An outdated building code and lack of enabling legislation have also hindered the establishment of systems for regulatory implementation and the designation of public and private responsibilities for resilience in Tuvalu’s built environment.17 As the scale, frequency, and severity of natural hazards continue to rise, Tuvalu will experience losses in the built environment that will disrupt public services and financial and economic inefficiencies of the asset, and threaten human lives. 10. ADB engagement. ADB has a long history of providing budget support and TA in partnership with development partners to help implement the government’s public sector management reform priorities.18 In 2012, the government embarked on a comprehensive reform program, resulting in the adoption of the PRM containing time-bound reform actions, each one supported by development partners according to their areas of comparative advantage (footnote 4). ADB’s policy-based grants in 2012 and 2015, totaling $4.3 million, supported critical reform actions, including (i) establishing fiscal ratios to enable the government to better monitor its fiscal performance;19 (ii) establishing revenue and expenditure review committees in 2012 to identify new sources of revenue and advise the cabinet on strategies to control costs; (iii) strengthening public procurement through the development of the 2012 National Procurement Policy, the Public Procurement Act 2013, and the Public Procurement Regulations 2014 and establishing the Central Procurement Unit (CPU) in 2015; 20 (iv) strengthening the accounting and auditing practices of public enterprises to improve their transparency and accountability and encouraging greater private sector participation;21 and (v) changing the financial instructions under the Public Finance Act in 2015 to transform the CIF into a fiscal stabilization fund and to better insulate the budget and the economy from external shocks.22 These reforms, together with those supported by other development partners, demonstrate long-term engagement based on the PRM to improve public sector management and service delivery. The sequenced provision of

17 A draft building code was first published in Tuvalu in 1990 as part of the Pacific Buildings Standards Project led by

the Government of Australia. 18 ADB. 2008. Report and Recommendation of the President to the Board of Directors: Proposed Grant to Tuvalu for

the Improved Public Financial Management Program. Manila; and two stand-alone operations approved in 2012 and 2015 (footnote 3).

19 The seven fiscal ratios are (i) tax revenue to GDP target of 20%, (ii) recurrent expenditure to GDP target of 60%, (iii) wages and salaries to domestic revenue target of 55%, (iv) Tuvalu overseas medical treatment scheme to domestic revenue target of 6%, (v) Tuvalu overseas scholarship scheme to domestic revenue target of 5%, (vi) primary balance to GDP target of 11%, and (vii) net present value of public debt to GDP target of 30%.

20 CPU oversees procurement and developed standard bidding documents. The publication of the CPU annual report and the development of a centralized procurement website have also helped strengthen public procurement governance.

21 Examples include the concession sale of the government-owned hotel to the Tuvalu National Provident Fund. 22 Changes to existing accumulation and withdrawal rules have helped regulate the use of the CIF and ensure its

replenishment, avoiding ad hoc fiscal tightening and the need to search for new, economically harmful revenue sources during economic downturns. The target CIF savings balance will be at least 16% of the maintained value of the TTF and regulated through a CIF contributions and savings plan.

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development partner grants also helps the government deliver their policy priorities, such as education, health, basic services in the outer islands, and climate change resilience. Complementary ADB and development partner TA has helped support the government’s efforts on these reforms.23 11. Lessons learned. The design and modality of the program reflects several lessons from previous budget support operations in Tuvalu and the Pacific and the 2015 evaluation of the PRM financed by the Government of Australia. Major lessons include (i) budget support can achieve results if there is strong government ownership; (ii) close coordination with development partners is critical for advancing reforms in sectors where ADB has limited engagement; (iii) TA support, coordinated across development partners and provided parallel to budget support programs, can help push the reform agenda; (iv) flexibility helps ensure that policy actions remain relevant and up-to-date on the latest evidence and conditions; (v) limiting reforms to a few substantive actions and sequencing implementation prevents overloading the national capacity; (vi) institutionalizing joint government–development partner coordination mechanisms reduces the demands on limited government capacity; and (vii) deep institutional and structural change requires time to become established.24 ADB’s prior policy-based grants have been single-tranche, stand-alone operations, with continuity provided through TA and policy dialogue coordinated through the PRM process. Since the approach has led to good results (para. 4), ADB will continue to use it for the program. B. Policy Reform and ADB’s Value Addition 12. Government development strategy. In its eighth national development plan––the National Strategy for Sustainable Development, 2016–2020––Tuvalu foresees a more protected, secure, and prosperous country; healthier people who are more engaged in national, regional, and international forums; and a government that encourages input from the community to improve project development so development efforts are sustained and adopted by the community. Climate change cuts across all 12 priority areas of the national development plan as sea level rise poses the most significant threat to Tuvalu’s survival. 25 With support of Tuvalu’s political leadership, the broad-based ownership of the policy reform program is strong and institutionalized through government-led coordination with development partners.26 13. Partner coordination. Since 2012, ADB, the Governments of Australia and New Zealand, the European Union, and the World Bank have been closely coordinating their budget support and TA operations through joint development and monitoring of the PRM. From 2012 to 2018, this partnership has helped support government reforms focused on PFM, fiscal policy, public administration, public enterprise performance and rationalization, health, and education (footnote 4). Since there has been progress in these areas, ADB and other development partners have provided $27.4 million in general budget support. An estimated $14.6 million in combined budget

23 ADB. 2008. Technical Assistance to Tuvalu for Capacity Development for Public Financial Management. Manila (TA

7161-TUV); ADB. 2012. Technical Assistance to Tuvalu for Institutional Strengthening of the Ministry of Finance and Economic Development. Manila (TA 8100-TUV); and ADB. 2017. Technical Assistance to Tuvalu for Supporting Reforms to Strengthen Fiscal Resilience and Improve Public Service Delivery. Manila (TA 9419-TUV).

24 ADB. 2017. Completion Report: Strengthened Fiscal Sustainability Program in Tuvalu. Manila; ADB. 2014. Completion Report: Strengthened Public Financial Management Program in Tuvalu. Manila; Independent Evaluation Department. 2015. Corporate Evaluation Study: ADB Support to Small Pacific Island Countries. Manila: ADB. Government of Tuvalu. 2015. Evaluation of the Policy Reform Matrix, 2012–2015. Funafuti; and ADB. 2011. Policy Brief: Policy-Based Programs for the Pacific Islands. Manila.

25 Government of Tuvalu. 2015. National Strategy for Sustainable Development, 2016–2020. Funafuti. 26 National elections were held on 9 September 2019.

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support is expected by the Government of Tuvalu in 2019. The IMF has provided an assessment letter.27 14. Program description. This will be ADB’s third program to support the PRM and will facilitate reforms specific to improving PFM and infrastructure management. All six policy actions supported by ADB have been completed (Appendix 4).28 ADB has added value through extensive policy dialogue and TA support29 that has helped government to identify, prioritize, and implement the policy actions under the program. The program policy actions are outlined in paras. 15–16. 15. Reform area 1: policies and processes for public financial management improved. Policy actions focus on developing sound policy and processes to strengthen PFM and improve the quality, efficiency, and accountability of Tuvalu’s public financial system and practices. Effective PFM systems help strengthen transparency and accountability and build public confidence in the government’s ability to deliver timely and high-quality public service delivery.

(i) Public financial management reform strategy. Tuvalu’s PFM has improved through the government’s strong commitment to implementing the PFM Roadmap, 2015–2018, which has led to greater macroeconomic stability and improved the quality of public expenditures. 30 The Public Expenditure and Financial Accountability (PEFA) self-assessment and the Assessment of National Systems (ANS) conducted by the Government of Australia in 2018 highlight procurement and treasury functions as remaining weaknesses in fiscal management posing fiduciary risks and implementation delays of PFM reforms. Based on these assessments, the cabinet approved a PFM Reform Strategy, 2019–2021 to target these weaknesses as a prior action. The road map prioritizes four main areas for improvement, and implementation will be tracked and reflected in future PEFA assessments. The priorities include (a) improve the medium-term fiscal framework and credibility of the budget, (b) review financial legislation and subsidiary guidelines, (c) improve the capability and use of the government financial management and information system, and (d) build PFM capacity and service delivery.

(ii) Public financial reporting strategy. The government’s fiscal vulnerabilities are associated with the credibility of the government financial accounting system, partly because of discrepancies associated with using both cash accounting and partial accrual accounting. Although the government adopted accrual accounting in 2012, the existing accounting practice is still on cash and partial accrual basis. There is a mismatch in the reporting of accounts versus the auditing of financial statements by the auditor general’s office, creating inefficiencies in the use of staff time and in reporting the government’s finances. As a prior action, the cabinet endorsed a strategy towards a full accrual accounting system. The strategy identifies weaknesses in existing accounting practices and provides guidelines for each implementation phase of the transition from cash and partial accrual to full accrual accounting by 2024.

27 International Monetary Fund Assessment Letter (accessible from the list of linked documents in Appendix 2). 28 The six policy actions in the PRM (Appendix 4) supported by ADB are 1.1, 1.2, 1.3, 1.4, 2.1, and 2.2. Development

partners are supporting a combination of reform actions under the jointly agreed PRM, according to their areas of expertise, operational priorities, and alignment with their bilateral support programs in Tuvalu.

29 ADB. 2017. Technical Assistance to Tuvalu for Supporting Reforms to Strengthen Fiscal Resilience and Improve Public Service Delivery. Manila. This TA helped government implement public procurement and building code reforms supported by the program.

30 Government of Tuvalu. 2015. Public Financial Management Roadmap, 2015–2018. Funafuti. The reforms draw from the Government of Tuvalu’s 2015 Public Expenditure and Financial Accountability self-assessment.

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(iii) Public finance legislation. The Public Finance Act 2008 does not specify the accounting method to be used for public sector financial reporting. To ensure the consistency of financial reporting, budget planning, and public finance in general, legislation needs to be amended to ensure the government complies with Tuvalu’s Generally Accepted Accounting Practices (adopted in 2012), which are based on an accrual financial management system and align with the International Public Sector Accounting Standards and the International Financial Reporting Standards. As a prior action, the Parliament of Tuvalu approved the Public Finance (Amendment) Act in April 2019 to ensure national accounts are prepared in a consistent format and based on an accrual financial management system. This prior action is one of the requirements identified in the public financial reporting strategy that will guide the government towards a full accrual accounting practice by 2024.

(iv) Public procurement. Public procurement is still recognized as an area of significant weakness in PFM, particularly with regard to compliance and enforceability. The prior actions build on public procurement reforms implemented by the government since 2012. As prior actions, the cabinet endorsed the public procurement manual and associated guidelines. The manual will guide government staff through the public procurement process, the procurement complaints and appeals procedure, and the procurement suspension and debarment procedure. The improved public procurement system will promote public confidence in the integrity and fairness of procurement proceedings. It will also help ensure better value for money and higher-quality goods and services delivered by sound suppliers. These administrative processes do not substitute for the legal process, which the Government of Tuvalu may pursue for suspension and debarment.

16. Reform area 2: institutional and legal frameworks for infrastructure management improved. Policy actions under this reform area focus on strengthening Tuvalu’s institutional and legal framework to better construct, manage, and maintain public and private physical assets to better equip government to manage infrastructure investments that will improve service delivery. Prior to this reform, there was no framework to manage public capital investments. The government also had limited awareness about the quality of its assets to inform investment decisions and to determine operational and maintenance costs. The strengthened framework will limit associated fiscal risks because of poor capital budget planning and improve the quality of public service delivery. These policy actions will also help mitigate the risks of direct damage to infrastructure, including critical public facilities and residential buildings, and contain budgetary burdens for disaster recovery.

(i) Tuvalu Asset Management Framework. The construction and maintenance of infrastructure assets is challenging and costly in Tuvalu because of a lack of economies of scale, high transport costs, and a harsh climate.31 As a prior action, the cabinet endorsed the Tuvalu Asset Management Framework (TAMF). The framework applies to all physical infrastructure (buildings, roads, water and sanitation, coastal protection, and transport infrastructure) with an individual asset value greater than $10,000, owned by the national government, local island councils, and major public sector enterprises. The framework helps identify the

31 The TAMF is linked to the Tuvalu Infrastructure Strategy and Investment Plan, 2016–2025. As the custodian of all

major infrastructure assets, the Ministry of Public Utilities and Infrastructure Implementation will commence the implementation of the TAMF. Incremental implementation supported by TA from development partners is recommended for this framework because of the varying capacities of different ministries.

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maintenance requirements and replacement needs of public sector infrastructure assets and ensure that they deliver their intended functions with economic efficiency throughout their service life. The framework also aims to improve asset performance and resilience and extend assets’ service life by (a) building sufficient resilience in infrastructure design to reduce vulnerability to natural hazards and climate change impacts; (b) monitoring asset condition through simple, practical, and low-cost techniques and taking prompt corrective action when needed; (c) replacing the current reactive maintenance strategy with a planned preventative maintenance program; and (d) maintaining adequate records to allow the performance of assets to be benchmarked, and creating institutional memory.

(ii) Building legislation and code. Although the building code was developed in 1990, there was no enabling legal framework passed for its implementation. This lack of enabling legislation has hindered the establishment of systems for regulatory implementation and the designation of public and private responsibilities for resilience in Tuvalu’s built environment. The building code of 1990 also did not consider disaster risk reduction and climate change impacts. As a prior action, the Parliament of Tuvalu approved the Building Act in July 2019, and the minister for public utilities and infrastructure endorsed the draft building code, which will be finalized when public consultations are completed. The building code and associated legislation will ensure construction adheres to acceptable standards of structural sufficiency, safety, climate resilience, and amenities for the public.

C. Impacts of the Reform 17. The program will contribute to the objectives of the National Strategy for Sustainable Development, 2016–2020 (footnote 25) of sound macroeconomic management and efficient, high-quality, and resilient infrastructure and support services. The reform aims to improve the management of public finances and national infrastructure. The program will support efforts in two reform areas. Under reform area 1, Tuvalu’s PFM will be improved through the PFM Reform Strategy 2019–2021, the transition towards full accrual accounting in compliance with Tuvalu’s Generally Accepted Accounting Principles, and strengthened public procurement by putting in place mechanisms for redress and noncompliance. Under reform area 2, improvements to building standards and management of national infrastructure will help enhance resilience to disasters and ensure service delivery with economic efficiency throughout the service life of the infrastructure. These reforms help improve overall efficiency in public resource allocation and utilization. D. Development Financing Needs and Budget Support 18. The government estimates a domestic financing gap of $22.5 million in 2019, which will be financed by savings, drawdown from the CIF, and development partner grants. In 2019, budget support grants to Tuvalu are estimated to total $21.9 million, of which $14.6 million (64.0% of the 2019 projected domestic fiscal deficit) will be through the PRM budget support program. Of this, the government has requested a policy-based grant of $4.0 million from ADB’s Asian Development Fund allocation for Tuvalu. PRM budget support grants also include $1.5 million from the European Union, $1.0 million from the Government of Australia, $0.6 million from the Government of New Zealand, and $7.5 million from the World Bank.32 The grant proceeds will also support the government to deliver their national policy priorities.33

32 These are parallel collaborative partner financing not administered by ADB. 33 The Development Policy Letter (Appendix 3) highlights the Government’s vision, policy platform, and priorities.

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E. Implementation Arrangements 19. The Ministry of Finance and Economic Development (MFED) will be the executing agency for the program. Through the existing institutional structure for aid management in Tuvalu, it will oversee the implementation of agreed policy actions and be responsible for program administration, disbursements, and the maintenance of all records. The MFED and the Ministry of Public Utilities and Infrastructure will be the implementing agencies for the program. The proceeds of the policy-based grant will be withdrawn in accordance with ADB’s Loan Disbursement Handbook (2017, as amended from time to time).

III. DUE DILIGENCE 20. Governance. Promoting good governance is a key national priority. The government is committed to implementing the PFM Reform Roadmap 2019–2021 to close the gaps identified through the 2015 PEFA and the 2018 ANS. Despite capacity limitations, the assessments indicate that, compared with international best practice, Tuvalu’s PFM system operates mostly at average levels. The government has the ability to implement its budget, but there are weaknesses in procurement, accounting, financial reporting, and auditing. Reform area 1, complemented by development partner TA, addresses some of these weaknesses.34 The joint policy dialogue with development partners on reform priorities will continue to be key in maintaining the government’s reform momentum. ADB’s Anticorruption Policy (1998, as amended to date) was explained to and discussed with MFED and the government. 21. Poverty and social. The policy actions supported under reform area 1 are likely to have positive impacts on poverty reduction. Reforms in financial management practices lead to greater macroeconomic stability and improved quality of public expenditure. Successful implementation of these reforms would provide a foundation for improved performance in government service delivery, including in sectors (e.g., health and education) that are vital for improving the lives of the poor and vulnerable. Reforms on procurement implementation would also increase efficiency and transparency of government expenditures. The policy actions supported under reform area 2 will have a positive impact on the resilience of the poor and vulnerable to climate and disaster-related shocks. Improving the climate and disaster resilience of public assets (through the asset management framework) and private assets (through the building code) can protect the poor from direct losses and disruptions to public services. The policy actions would have a substantial positive impact on the well-being of all citizens but particularly on the poor and vulnerable, who are more reliant on public services and more exposed to disaster risks because of a lack of formal safety nets. 22. Safeguards. Following ADB’s Safeguard Policy Statement (2009), the program is classified category C for the environment, involuntary resettlement, and indigenous peoples. Program activities will be confined to policy and institutional reforms. The prior policy actions have been assessed and are not expected to result in or lead to involuntary resettlement or negatively affect indigenous peoples or the environment. 23. Gender. The program is classified no gender elements. Although the improved management of public finances and national infrastructure will benefit all, the program contains

34 Long-term advisors, financed through the Government of Australia’s Pacific Technical Assistance Mechanism,

supplement human resources in Tuvalu’s Department of Budget and Planning, Treasury, and Tax and Audit Offices.

10

no proactive gender design features. Program preparation discussions with the government and development partners identified relevant gender issues, in particular the potential for gender-responsive budgeting and procurement, and gender actions related to the implementation of the Building Act and draft building code.35 However, the government’s readiness to address these areas will need further discussions with the government and development partners and TA will be needed to build capacity. ADB will explore including appropriate actions in its subsequent programs. 24. Risks. Major risks and mitigating measures are summarized in Table 2 and described in detail in the risk assessment and risk management plan.36 Development partners assess that PFM systems can support mostly reliable services for budget support. Policy reforms and TA support address the remaining fiduciary risks. The program’s integrated benefits and impacts are expected to outweigh the costs.

Table 2: Summary of Risks and Mitigating Measures

Risks Mitigation Measures The government cannot implement policy reform actions because it lacks the institutional capacity.

Reforms are prioritized and sequenced to avoid overburdening the small public administration and decision makers. Technical assistance is mobilized by development partners on a needs basis to supplement capacity.

External shocks (from disasters, climate change, and global economic conditions) impact the fiscal position and/or divert political focus from reform.

The government conservatively estimates revenues and grants to provide a cushion against external uncertainties. The government also has a sufficient fiscal buffer in the Consolidated Investment Fund, is eligible for contingent disaster financing from the Asian Development Bank, has established the Tuvalu Survival Fund, and will seek development partner assistance in case of disasters.

Source. Asian Development Bank.

IV. ASSURANCES

25. The government and the MFED have assured ADB that the 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 agreement. The government has agreed with ADB on certain covenants for the program, which are set forth in the grant agreement.

V. RECOMMENDATION 26. I am satisfied that the proposed policy-based grant would comply with the Articles of Agreement of the Asian Development Bank (ADB) and recommend that the Board approve the grant not exceeding $4,000,000 to Tuvalu, from ADB’s Special Funds resources (Asian Development Fund) for the Improved Fiscal and Infrastructure Management Program, on terms and conditions that are substantially in accordance with those set forth in the draft grant agreement presented to the Board.

Takehiko Nakao President

7 October 2019

35 These are aligned with Tuvalu’s National Gender Policy (2016) and the National Disability Policy (2018). 36 Risk Assessment and Risk Management Plan (accessible from the list of linked documents in Appendix 2).

Appendix 1 11

DESIGN AND MONITORING FRAMEWORK Country’s Overarching Development Objectives Prudent management of the macroeconomic status of the economy (Tuvalu National Strategy for Sustainable Development, 2016–2020)a

Efficient, high-quality infrastructure, and support services provided (Tuvalu National Strategy for Sustainable Development, 2016–2020)a

Results Chain

Performance Indicators with

Targets and Baselines

Data Sources and Reporting

Mechanisms

Risks

Effect of the Reform Improved management of public finances and national infrastructure

By 2021: a. Improvements in the PEFA ratings for Tuvalu: B for PI-17, C for PI-19, B+ for PI-20, B+ for PI-22, and A for PI-25 (2015 baseline: C for PI-17, D+ for PI-19, B for PI-20, B for PI-22, and B+ for PI-25)b

b. More than 50% of infrastructure spending linked to infrastructure and asset management framework (2018 baseline: Framework developed in April 2018 but not implemented)

a. PFM reform strategy quarterly reporting matrix b. National budget documents and medium-term fiscal framework

Change in government following September 2019 elections may impact reform sustainability. Deterioration in macroeconomic conditions causes government to shift resources away from sustaining the reforms.

Reform Areas under the Program 1. Policies and processes for public financial management improved

Key Policy Actionsc By July 2019: 1.1 PFM reform strategy, 2019–2021 endorsed by the cabinet (2018 baseline: PFM Roadmap, 2015–2018 time frame ended; new strategy) 1.2 Public financial reporting strategy endorsed by the cabinet (2018 baseline: Both cash and partial accrual accounting practiced; full accrual accounting practiced by 2024) 1.3 Public Finance (Amendment) Act 2019 approved by Parliament (2018 baseline: Public finance accounting practice not specific in the Public Finance Act, 2008; compliance with act) 1.4 Public procurement manual, procurement complaints and appeals procedure, and procurement suspension and

1.1 PFM quarterly reporting monitoring matrix 1.1, 1.2, 1.3. Annual

auditor general’s reports

1.3, 2.2 Copies of

legal instruments 1.4 Central

Procurement Unit annual report

1.1, 1.2, 1.4, 2.1

Cabinet decisions

Capacity constraints, workload pressures, and staff turnover reduce continuity and the quality of reform implementation. Stakeholders interfere with the reform process because of opposing individual interests.

12 Appendix 1

debarment procedure endorsed by the cabinet (2018 baseline: 47% of major procurement [over A$10,000] undergoes a competitive procurement process; 2012–2018: 50% or more)

2.1 National budget

documents and medium-term fiscal framework

2.2 Letter of approval

from Ministry of Public Utilities and Infrastructure

2. Institutional and legal framework for national infrastructure management improved

2.1 Tuvalu Asset Management Framework endorsed by the cabinet (Baseline: Infrastructure spending not linked to framework; improved maintenance of public infrastructure) 2.2 Building Act 2019 approved by Parliament and the draft building code endorsed by the implementing ministry (Baseline: Building code developed in 1990 but had no enabling legal framework for its implementation; more public infrastructure meeting a higher level of safety standards)

Budget Support Asian Development Bank: $4.0 million grant by Q4 2019 Government of Australia: $1.0 million (A$1.5 million) grant by Q3 2019 Government of New Zealand: $0.6 million (NZ$1.0 million) grant by Q3 2019 European Union: $1.5 million (€1.3 million) by Q3 2019 World Bank: $7.5 million grant by Q4 2019

PEFA = Public Expenditure and Financial Accountability, PFM = public financial management, Q = quarter. a Government of Tuvalu. 2015. National Strategy for Sustainable Development, 2016–2020. Funafuti. b PEFA indicators: PI-17 recording and management of cash management balances, debt, and guarantees; PI-19

transparency, competition, and complaints mechanism in procurement; PI-20 effectiveness of internal controls for non-salary expenditure; PI-22 timeliness and regularity of accounts reconciliation; PI-25 quality and timeliness of annual financial statements.

c The reform areas in the design and monitoring framework align with the policy reform matrix (PRM) (footnote 1 of the main text). The PRM is a rolling matrix, which is updated based on government priorities and the reform context. The PRM guides the overall reforms undertaken by the government. Not all actions in the PRM are prior policy actions for the Asian Development Bank’s budget support operations. However, the policy actions in this program are a subset of the PRM actions.

Source: Asian Development Bank.

Appendix 2 13

LIST OF LINKED DOCUMENTS http://www.adb.org/Documents/RRPs/?id=50377-001-2

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 Document

10. Policy Reform Matrix, 2012–2018

14 Appendix 3

DEVELOPMENT POLICY LETTER

Appendix 3 15

16 Appendix 3

Appendix 4 17

POLICY MATRIX (JULY 2018–JUNE 2019)

GOVERNMENT OF TUVALU: POLICY REFORM MATRIX

REFORMS AND POLICY ACTIONS (Achieved by June 2019)

TKIII Goal 2: Strengthen institutional capacity to serve the public interest; TKIII Goal 3:

Sound macroeconomic management and policy

1. IMPROVED PUBLIC FINANCIAL MANAGEMENT Reform Actions Supported by

1.1 PFM Reform Strategy, 2019–2021

PFM Reform Strategy, 2019-2021 endorsed by cabinet

ADB, Aust, EU, NZL, World Bank

1.2 Public financial reporting strategy The public financial reporting strategy endorsed by

cabinet

ADB, Aust, NZL

1.3 Public finance legislation

Public Finance (Amendment) Act 2019 approved by the

Parliament of Tuvalu

ADB, Aust, NZL

1.4 Public procurement

Public procurement manual; procurement complaints

and appeals procedure; and procurement suspension

and debarment procedure, endorsed by cabinet

ADB, Aust, EU, NZL, World Bank

TKIII Goal 5 & 9: Provide efficient, high quality infrastructure services for all, including

to outer islands

2. IMPROVED INFRASTRUCTURE MANAGEMENT Reform Actions Supported by

2.1. Tuvalu Asset Management Framework

Tuvalu Asset Management Framework endorsed by

cabinet

ADB, Aust, EU, NZL, World Bank

2.2. Building legislation and draft Building Code

Building Act 2019 approved by the Parliament of Tuvalu

and draft building code endorsed by the Ministry of

Public Utilities and Infrastructure

ADB, Aust, EU, NZL, World Bank

2.3. National Waste Policy

Waste Management Regulation and Import Waste Levy

endorsed by cabinet

EU, World Bank

TKIII Goal 4: Provide high standards of healthcare and improve gender equality, social

inclusion and social development for all

3. IMPROVED STANDARDS OF HEALTH AND

SOCIAL INCLUSION

Reform Actions Supported by

3.1. Tuvalu Medical Treatment Scheme

Establishment of TMTS Review Taskforce, Annual

Report on TMTS completed

Aust, NZ, World Bank

3.2. Disability Policy

Disability policy endorsed by cabinet

Aust, NZ, World Bank

ADB = Asian Development Bank; Aust. = Australia; EU = European Union; NZL = New Zealand