FIJI'S ECONOMY - AT A CRISIS POINT?

C O N F I D E N T I A L SECTION 01 OF 04 SUVA 000127

SIPDIS

SIPDIS

E.O. 12958: DECL: 02/23/2017
TAGS: EFIN ECON ETRD PGOV MARR ASEC FJ
SUBJECT: FIJI'S ECONOMY - AT A CRISIS POINT?

REF: SUVA 110

Classified By: Ambassador Dinger, per 1.4 (B,D)

Summary
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1. (C) Fiji will experience a severe economic downturn in
2007 as an after-effect of the December 2006 coup. Foreign
reserves are very low (perhaps much lower than they appear in
the Reserve Bank's end-of-year accounts),exports are flat,
and levels of new investment are expected to be minimal. The
major hope for the economy is a rapid tourism rebound, but
tourism leaders tell us they expect a significant drop in
revenue caused by lower visitor levels and deep discounts.
Fiji Reserve Bank officials tell us they are determined to
avoid a devaluation or other drastic action that would
reverberate throughout the economy. How the interim
government deals with the economy will play a big role in
determining the level of discontent in Fiji over the coming
months and will have a direct impact on the stability of the
current regime. End summary.

Chaudhry Says GDP Will Fall 2-4% in 2007
--------------

2. (C) As noted reftel, Interim Minister of Finance
Mahendra Chaudhry went public earlier this month with an
estimate that Fiji's economy will contract 2-4% in 2007.
Chaudhry insisted the gloomy economic outlook was primarily
due to the economic policies of the Qarase government. "The
nation knows that we were heading for an economic disaster
before December 5," he said. Lorraine Seeto, Senior Manager
at the Reserve Bank of Fiji, told us that despite Chaudhry's
rhetoric, there is no doubt the economic downturn is a direct
result of the coup. 2007 would have been a tough year for
the economy, she said, even without the coup because of tight
foreign reserves and the unexpected decision in late 2006 by
Emperor Gold Mine to shut down operations. Exports, which
fell about 5% in 2006 from 2005 levels (primarily due to
textile declines),have shown few signs of picking back up.
Nevertheless, the Reserve Bank projects that the economy
would have grown 1-2% if the coup had not taken place. The
coup has had a direct negative impact on tourism, investment,
and consumption, Seeto said, above and beyond other factors.



3. (C) Seeto thinks the GDP forecast announced by Chaudhry
might be too pessimistic. She believes GDP will drop about
2%. Seeto admitted, however, that some optimistic
assumptions are built into her forecast, In mid-December the
Reserve Bank's best estimate was that GDP would drop up to
10% in 2007. A projected rebound in tourism led the Bank to
improve its forecast. Seeto admitted that other optimistic
assumptions are built into the GDP forecast, including the
assumption that EU funds to assist Fiji's sugar industry will
not be cut off (Fiji and the EU are expected to hold
consultations on EU aid in Brussels in March or April).
Anqian Huang, Asian Development Bank chief economist for
Fiji, told us he believes the minus 2-4% GDP forecast is
reasonable. Closing the Emperor Gold Mine will hurt (losing
about FJ$50 million in exports),but other export sectors,
such as agriculture, sugar, and mineral water, should not be
affected by the coup, thus keeping the GDP downturn from
turning into a free fall.

Financial Reserves on the Brink
--------------

4. (C) While the GDP numbers are worrying, Seeto and Huang
both said their biggest concern is Fiji's low financial
reserve level. The Reserve Bank's end of 2006 report puts
reserves at FJ$832 million (US$492 million),or about 3.3
months of imports, up from 2.5 months of imports in mid-2006.
Seeto said the numbers are misleading because they include
US$150 million (FJ$250 million) in proceeds from a bond
issued by the Qarase government on international markets last
September and FJ$60 million in deferred fuel payments. If
those two elements are deducted, Fiji's reserves would only
be FJ$520 million, or a little over two months of imports.


5. (C) Huang told us the reserve situation is even worse
than Seeto described. He pointed out that in early 2006 the
Reserve Bank changed its definition of "reserves" to include
offshore assets held by non-bank financial institutions.
Under the new definition, reserves immediately increased by
about FJ$270 million. Huang insisted that the change in
definition was not justified, and does not meet international

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standards. Andrew Milford, economist at the Pacific
Financial Technical Assistance Center, an IMF-World Bank
joint venture, told us the Reserve Bank's action was
"borderline," and he was unaware of any other country using a
similar definition of reserves. Nevertheless, the IMF had
reluctantly agreed to the change, with the stipulation that
those funds must be readily accessible to the Reserve Bank.
He said the new definition allows the Bank to include
offshore assets of the Fiji National Provident Fund (FNPF),
Fiji's social security system, in its reserve calculations.
Milford said Fiji tapped FNPF overseas funds at least once
during the Qarase administration, and is likely to do so
again, given the current shaky reserve situation. (Comment:
It appears that the majority of Fiji's financial reserves now
consist of a) proceeds from the USD$150 million bond
offering, and b) offshore holdings of the FNPF. If those two
items were deducted, Fiji's reserves would fall to about
FJ$250 million, or one month's supply of imports. End
comment.)

Qarase's $150 Million Bond - Chaudhry's Ace in the Hole?
-------------- --------------
6 (C) Seeto and Huang agreed it is somewhat ironic that
one factor keeping the interim government financially afloat
is the US$150 million bond the Qarase government floated in
Singapore last September. The five-year bond was snapped up
by investors at 7% interest. Heavy demand for the bond (it
was oversubscribed by nearly 700%) pushed its interest rate
down from the initial price guidance of 7.25%. Seeto
commented that investors, who purchased the bond at a time
which Fiji's prospects seemed bright, have not done well.
Since the coup, the bond's value has dropped by about 10%
from face value. From the Reserve Bank's perspective,
however, the timing of the bond offering was perfect. There
is no way, said Seeto, that Fiji could now borrow at anything
close to a 7% rate. Huang pointed out that the dismal
performance of the Fiji bond over the past three months does
not bode well for future Fiji borrowing on international
markets. Moreover, in only five years Fiji will have to pay
back the money it borrowed. Where will those funds come from?


7. (C) Seeto and Huang noted that, having already used the
bond to inflate reserve levels at the end of 2006, Chaudhry
is likely to use the bond proceeds to keep the deficit under
control in the new budget he will announce in March. Seeto
said she doesn't see how Chaudhry can avoid converting the
bond proceeds (now denominated in U.S. dollars) into Fiji
dollars to help pay bills. If he does this, however, reserve
levels will drop sharply. It's a difficult balancing act,
one that has received almost no publicity or public scrutiny.
Seeto said the only other option is to borrow heavily on the
domestic market. She noted that Chaudhry, long a critic of
government borrowing from FNPF, is now (privately) a
proponent of such borrowing.

What's the Interim Government's Fiscal Situation?
The Reserve Bank Doesn't Know
-------------- --------------

8. (C) Seeto said that, in theory, the Reserve Bank is
supposed to have access to all government financial records,
including weekly debit and credit receipts. The reports the
Bank is now getting, however, are far from complete.
Therefore, the Bank has a very limited understanding of the
interim government's fiscal situation, and even less
information about military spending. Anecdotal reports,
however, indicate that the regime is having real trouble
paying its bills. Seeto noted that Fiji's tax authority had
been unable to process tax refunds in a timely manner and
that every ministry she talks to complains about being short
of the funds needed to meet their obligations. (Note: We
made several requests to the Ministry of Finance for working
level meetings to discuss Fiji's fiscal situation and the
budget. All went unanswered. End note.)

Policy Steps to Ease the Financial Crunch
--------------

9. (C) Seeto said the Reserve Bank fully endorses the
interim government's efforts to cut spending. Reserve Bank
Governor Savenaca Narube is the Chairman of the interim
government's Economic Recovery Group (ERG),which recommended
lowering the civil service retirement age, deferring cost of
living increases, and cutting salaries. Seeto said the
Reserve Bank was a strong opponent of the wage and back-pay
package the Qarase government entered into with public sector
unions last year, and would be happy to see that agreement

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rescinded. Seeto questioned how, even with these steps,
Chaudhry will be able to keep to a 2% budget deficit, as he
has promised. Given the tricks a pro like Chaudhry can play
with budgets, she doubts the March budget presentation will
make things much clearer.

How About a Devaluation?
--------------

10. (C) Seeto says she gets calls from reporters "almost
daily" asking about prospects for a devaluation of the Fiji
dollar. A devaluation, she told us, would only be an act of
last resort by the Reserve Bank, but could take place if
reserve levels were to drop precipitously. Because Fiji is
heavily import-dependent, a devaluation - with its resulting
higher price for imports - would mean an immediate drop in
the standard of living for most Fijians and would especially
impact the poor. Seeto thinks the Finance Ministry would be
willing to take far more drastic steps to reduce government
spending rather than risk a devaluation. The ADB's Huang
said he understands why the interim government and Reserve
Bank oppose a devaluation, but he insisted that a devaluation
is the only action that makes sense from a long-term
perspective. With reserves this low and no prospect of an
export or investment boom in the near future, a devaluation
is the only way to achieve economic equilibrium.

Banking on Tourism is Premature
--------------
11 (C) As Seeto noted, any optimism about Fiji's economy
stems from the widely-accepted notion that tourism is poised
to bounce back. Members of Fiji's private sector Tourism
Action Group (TAG),consisting of representatives from
hotels, airlines, and tour companies, told the Ambassador
February 22 that the interim government has unrealistic
expectations about tourism. The next four months are likely
to be "quite bad" they said, with many hotels showing
occupancy rates in the 20-40% range. Many hotels with higher
occupancy have relied on price cuts of 40% or more and are
not making any money. Tourism operators are banking on
improved occupancy and rates during the peak tourist season,
May to October. TAG estimates that if tourism "returns to
normal" by May, industry revenue will still be down FJ$120
million (about USD 75 million) from pre-coup projections.
They emphasize that forecast is very optimistic - occupancy
rates may go up, but rates may not return to pre-coup levels
for a long time. Moreover, several new hotels have opened in
the last year, and more are scheduled to open in 2007, making
the struggle to make a profit even harder.


12. (C) The TAG group complained that some government
departments and a number of academics "have been working
overtime churning out numbers" to show that tourism is
recovering. If those academics were to plant their feet on
the ground and look at things like a businessman, they'd
realize things are not so rosy. The TAG members say they are
worried that Chaudhry will view tourism as a "cash cow" he
can tap into to fund government programs. They see possible
new duties on "luxury" goods used in the tourism sector, new
taxes on tourists, and additional income and corporate taxes.
(Note: On February 13, Fiji's Department of Immigration
proposed a new visa/permit fee it said could raise FJ$10
million per year. The interim cabinet has not made a
decision on the proposed fee. End note.) Dixon Seeto, Head
of the Fiji Hotel Association and a TAG member, recounted how
at a meeting with the interim government he commented that
"to take the economy forward, it is not advisable to make
everyone poor." He told us the reaction to the comment "by
Chaudhry's socialist advisors" was distinctly negative.

Other Industries Worried Too
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13. (C) Rajesh Punja, head of the food manufacturer and
importer Punjas, also told us he is worried about interim
government actions that could harm industry. Punja said
various sources tell him that, with money tight and poverty
levels rising, Chaudhry will cut import tariffs on food items
to placate his main constituency, the poor. This will have
the unintended consequence of crippling Fiji's fledgling food
manufacturing industry. Punjas has a plan in place to adopt
to the change - the company will focus almost exclusively on
importing. But in the meantime hundreds of manufacturing
jobs will be lost as will an important export industry for
Fiji. Punjas sells food products manufactured in Fiji
throughout the Pacific. Punja, who insists that he has
always had a good relationship with Chaudhry, has asked for

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meetings with the interim Finance Minister, but has been
repeatedly rebuffed.

Comment - A Coming Winter of Discontent?
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14. (C) How the interim regime deals with the economy
will have a major impact on levels of discontent in Fiji in
the coming months and ultimately on the stability of the
regime. The interim government inherited a difficult
economic hand, exacerbated greatly by the after-effects of
the coup. Chaudhry will try very hard to avoid taking steps
that directly feed discontent, such as devaluing the Fiji
dollar or increasing the VAT. The business community and the
civil service have every reason to be concerned Chaudhry will
look to them to make up for Fiji's financial shortfall.
Another source that will be increasingly tapped is the FNPF,
Fiji's social security system. While Chaudhry may be able to
mask Fiji's fundamental financial problems for a while, the
regime will be able to live off bond proceeds, loans, and
FNPF funds for only so long. Sooner or later, Fiji's average
citizen will begin to feel the strong impact the coup has had
on the economy. It is not clear at all how the interim
government will cope when populist rhetoric confronts pocket
book reality.









DINGER