The World Bank Solomon Islands FY22 Supplemental Development Policy Operation (P178608) . Document of The World Bank FOR OFFICIAL USE ONLY Report No: PGD4936 INTERNATIONAL DEVELOPMENT ASSOCIATION SUPPLEMENTAL FINANCING DOCUMENT FOR A PROPOSED GRANT IN THE AMOUNT OF SDR 8.319 MILLION (EQUIVALENT TO US$11.5 MILLION) AND CREDIT IN THE AMOUNT OF SDR 2.532 MILLION (EQUIVALENT TO US$3.5 MILLION) TO SOLOMON ISLANDS FOR THE SOLOMON ISLANDS FY22 SUPPLEMENTAL DEVELOPMENT POLICY OPERATION May 5 2022 Macroeconomics, Trade And Investment Global Practice East Asia And Pacific Region This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. The World Bank Solomon Islands FY22 Supplemental Development Policy Operation (P178608) Solomon Islands GOVERNMENT FISCAL YEAR January 1 – December 31 CURRENCY EQUIVALENTS (Exchange Rate Effective as of March 31, 2022) Currency Unit USD 1 = SBD 7.93 SDR 1 = USD 1.3824 ABBREVIATIONS AND ACRONYMS ATS Automated Fund Transfer System CBSI Central Bank of Solomon Islands CDF Constituency Development Fund CEWG Core Economic Working Group DPO Development Policy Operation DSA Debt Sustainability Analysis FEDU Financial and Economic Development Unit GDP Gross Domestic Product IDA International Development Association IMF International Monetary Fund MoFT Ministry of Finance and Treasury PEFA Public Expenditure and Financial Accountability PFM Public Financial Management SDR Special Drawing Rights SIICAC Solomon Islands Independent Commission Against Corruption SIG Solomon Islands Government Regional Vice President: Manuela V. Ferro Country Director: Stephen N. Ndegwa Regional Director: Hassan Zaman Practice Manager (s): Lars Christian Moller Task Team Leader (s): Lodewijk Smets, Anna Robinson, Sonia Araujo The World Bank SOLOMON ISLANDS FY22 SUPPLEMENTAL DEVELOPMENT POLICY OPERATION TABLE OF CONTENTS SUMMARY OF PROPOSED FINANCING AND PROGRAM .......................................................................4 1. INTRODUCTION AND COUNTRY CONTEXT ...................................................................................7 2. THE IMPACT OF CRISIS, ECONOMIC DEVELOPMENTS AND OUTLOOK ...........................................8 3. RESPONSE TO THE CRISIS ..........................................................................................................14 3.1. THE GOVERNMENT’S RESPONSE .................................................................................................. 14 3.2. THE BANK’S RESPONSE, STRATEGY, AND COLLABORATION WITH DEVELOPMENT PARTNERS... 16 4. THE REFORM PROGRAM SUPPORTED THROUGH ORIGINAL OPERATION: AN UPDATE ................ 16 5. RATIONALE FOR PROPOSED SUPPLEMENTAL FINANCING ..........................................................19 6. OTHER DESIGN AND APPRAISAL ISSUES ....................................................................................20 7. SUMMARY OF RISKS AND MITIGATION .....................................................................................22 ANNEX 1: PARENT PROJECT POLICY AND RESULTS MATRIX ..............................................................24 ANNEX 2: FUND RELATIONS ANNEX .................................................................................................28 The Supplemental Financing Operation was prepared by an IDA team consisting of Lodewijk Smets (Senior Economist and Task Team Leader, EEAM2), Anna Robinson (Economist and Task Team Leader, EEAM2), Sonia Araujo (Senior Economist and Task Team Leader, ELCMU), Rashad Hasanov (Consultant, EEAM2), Heather Ruberl (Economist, EMFMD), Yuto Kanematsu (Junior Professional Officer, EMFMD), Sachiko Morita (Senior Counsel, LEGEN), Michelle Lee McDonall (Program Assistant, EACNF), Tony Shen (Senior Finance Officer, WFACS), Ha Thuy Tran (Senior Financial Management Specialist, EEAG2), Hang Thi Thu Nguyen (Senior Financial Sector Specialist, EFIFP), Christopher Miller (Senior Financial Sector Specialist, EEAF1), Virginia Horscroft (Senior Public Sector Specialist, EEAG2), Michael Osborne (Senior Procurement Specialist, EEAR2), Viet Anh Nguyen (Senior Public Sector Specialist, EEAG2), Da Woon Chung (Senior Program Officer, GTFS1), Darian Naidoo (Economist, EEAPV), Nathalie Staelens (Senior Environmental Engineer, SEAE1), Tevi Obed (Disaster Risk Management Specialist (SEAU1), Inka Schomer (Consultant, CNGIA) and Angela Quevedo (Consultant, SCCFM) under the supervision of Lars Christian Moller (Practice Manager, EEAM2), David Gould (Lead Economist and Program Leader, EACNF) and Annette Leith (Country Representative, EACNF) and the overall direction of Stephen Ndegwa (Country Director, EACNF) and Hassan Zaman (Regional Director, EEADR). Peer reviewers were Tobias Haque (Lead Economist, ESAMU) and Markus Kitzmuller (Lead Economist, EAWM1). Jan 18, 2022 Page 3 The World Bank Solomon Islands FY22 Supplemental Development Policy Operation (P178608) SUMMARY OF PROPOSED FINANCING AND PROGRAM BASIC INFORMATION Project ID Parent Project P178608 P172454 Proposed Development Objective(s) The Program Development Objectives and pillars of this operation are: (1) to strengthen fiscal management in the areas of debt management, cash management and procurement; (2) to strengthen the business environment through simplifying tax processes, fighting corruption and supporting more efficient payments systems; and (3) to improve environmental sustainability by strengthening national planning for climate change and reducing plastic pollution. Organizations Borrower: SOLOMON ISLANDS Implementing Agency: Ministry of Finance and Treasury PROJECT FINANCING DATA (US$, Millions) SUMMARY Total Financing 15.00 DETAILS International Development Association (IDA) 15.00 IDA Credit 3.50 IDA Grant 11.50 INSTITUTIONAL DATA Climate Change and Disaster Screening This operation has been screened for short and long-term climate change and disaster risks Overall Risk Rating Substantial . Page 4 The World Bank Solomon Islands FY22 Supplemental Development Policy Operation (P178608) Table 1: Results Indicators Indicator Name Baseline Current Value Target Results Indicator #1: (i) Government debt (i) Annual contracted (i) Annual contracted (i) Annual contracted operations comply with the Annual debt did not exceed the debt did not exceed the debt does not exceed Borrowing Limit (ABL); and (ii) the share of ABL (SI$74m contracted ABL (estimated at the ABL (2019 – 2022) domestic debt in total central government against 2018 ABL of SI$290m against 2021 debt has increased. SI$300m) (2018) ABL of SI$350m) (2021) (ii) 35 percent (Q3 2021) (ii) 24 percent (2018) (ii) 35 percent (2023) Results Indicator #2: Reduced accumulation Estimated arrears stock Estimated arrears stock (i) Arrears are reduced of expenditure arrears. of SI$138m of SI$95m below SI$100m (end-2017) (end-2021) (2023) Results Indicator #3: (i) Transparency in (i) No CTB contract (i) No CTB contract (i) 100 percent of CTB public procurement is improved, as awards published online awards published online contract awards are measured by an increased share of Central (2019) (2020 and 2021) published online. Tender Board (CTB) contract award notices being published online in accordance with (ii) 77 bid waivers (ii) In 2020, 354 bid (ii) Bid waivers are the Regulations; and (ii) competition is granted. waivers were granted. In reduced below pre- improved, as measured by a reduced (2019) Q1 and Q2 2021, 82 bid COVID-19 levels (i.e. less number of bid waivers (exemptions from waivers were granted. than 77) competitive tendering) granted for (2023) procurements over SI$100,000. Results Indicator #4: Tax administration is (i) 0 percent registered (i) 88 percent registered (i) At least 90 percent made more efficient, as measured by: (i) a for e-tax and 0 percent for e-tax and 10 percent registered for e-tax and greater share of large taxpayers filing tax filing returns via e-tax filing returns via e-tax 25 percent filing returns returns online via e-tax; (ii) an increase in the (Sept 2018) (Dec 2020) via e-tax on-time filing rate for large taxpayers; and (iii) a reduction in tax debt for the large (ii) 78 percent on-time (ii) 84 percent on-time (ii) At least 90 percent taxpayer segment. filing (July 2019) filing on-time filing (June 2021) (iii) SI$168m tax debt (iii) SI$136m tax debt (iii) Less than SI$125m (July 2019) (June 2021) (at least a 25 percent reduction) (2023) Results Indicator #5: The SIICAC is reporting No report First annual report 2020 - 2022 annual transparently on its activities, as measured (2019) covering 2020 activities reports have been by the tabling of its annual report in was submitted to presented to Parliament Parliament in accordance with the Anti- Parliament but has not and published online. Corruption Act. been tabled. (2023) (2021) Results Indicator #6: Female representation in No Commissioners Two out of five At least two out of five anti-corruption efforts is increased, as appointed Commissioners (40 Commissioners (40 measured by the share of female SIICAC (2018) percent) are female. percent) are female. Commissioners. (2020 and 2021) (2023) Page 5 The World Bank Solomon Islands FY22 Supplemental Development Policy Operation (P178608) Results Indicator #7: The efficiency of (i) Electronic payments N/A (the Automated (i) Electronic payments payment systems is improved, as measured by made up 0 percent of Transfer System is not make up at least 30 (i) an increased share of electronic payments payments by volume (0 yet live) percent of payments by in total payments cleared and settled by electronic payments and volume commercial banks; and (ii) a reduction in bank 183,000 cheques) (2023) transaction fees for the Ministry of Finance (2020) and Treasury. (ii) Bank fees of SI$1.36m (ii) Bank fees of less than (2020) SI$0.95m (at least a 30 percent reduction) (2023) Results Indicator #8: Planning for climate (i) Integrated No change since baseline (i) Communities in at adaptation has improved, as measured by (i) Vulnerability and least three out of nine an increase in the number of communities Adaptation Assessments provinces are covered by covered by Integrated Vulnerability and have been completed for an Integrated Adaptation Assessments; and (ii) the the Reef Islands in Vulnerability and incorporation of gender analysis in all new Temotu Province and all Adaptation Assessment. assessments. of Malaita province (2023) except for the Ontong Java atolls. (Oct 2021) (ii) Assessments do not (ii) All new assessments include gender analysis. include gender analysis. (June 2021) (Jan 2022 – Dec 2023) Results Indicator #9: The consumption of 128,000 kilogram of 2021 data not yet No more than 115,000 single use plastic products has decreased, as polyethylene plastic bags available kilogram of polyethylene measured by a reduction in the volume of imported (2020) plastic bags imported (a imported polyethylene plastic bags. 10 percent reduction) (2022) Page 6 The World Bank Solomon Islands FY22 Supplemental Development Policy Operation (P178608) IDA SUPPLEMENTAL FINANCING DOCUMENT FOR A PROPOSED GRANT AND CREDIT TO SOLOMON ISLANDS 1. INTRODUCTION AND COUNTRY CONTEXT 1. The proposed operation provides US$15 million (0.9 percent of GDP) in supplemental financing for the Second Solomon Islands Transition to Sustainable Growth Development Policy Operation (P172454, parent DPO). The parent DPO of an amount of US$ 15 million was approved by the Board on November 30, 2021. The Program Development Objectives (PDOs) are to: (1) strengthen fiscal management in the areas of debt management, cash management and procurement; (2) strengthen the business environment through simplifying tax processes, fighting corruption and supporting more efficient payments systems; and (3) improve environmental sustainability by strengthening national planning for climate change and reducing plastic pollution. However, a period of civil unrest (and subsequent widespread community transmission of the coronavirus) have created an unanticipated financing gap which puts the satisfactory implementation of the reform program at risk. 2. At the end of November 2021, a period of civil unrest caused widespread destruction in the capital, Honiara, resulting in an unanticipated financing gap of 2 percent of GDP for the 2022 fiscal year. On November 24-26 2021, large protests and rioting broke out, driven by a complex web of local grievances and a lack of economic opportunities (including high youth unemployment, inequality, perceptions of elite capture, and longstanding tensions between rivaling geo-ethnic groups). The value of damage and losses to buildings and goods is estimated at 7 percent of GDP. In addition, the disruption to retail and manufacturing activity in Honiara reduced growth by 0.3 percentage points in 2021, with knock-on effects in 2022. Overall, the civil unrest created an unanticipated fiscal financing gap of 2 percent of GDP in 2022, taking into account reduced tax collections and increased expenditure needs for business recovery and reconstruction. Finally, in the aftermath of the civil unrest, a Motion of No Confidence was tabled against the government, which was defeated on December 6, 2021. 3. In addition to the economic, fiscal and political impacts of the unrest, the country subsequently experienced widespread community transmission of the coronavirus. The virus started spreading in the second half of December 2021. As of April 7, 2022, 11,856 cases of COVID-19 have been detected in Solomon Islands, although the actual number of cases is likely to be substantially higher. To contain a further spread of the coronavirus, the Solomon Islands Government (SIG) initially installed a curfew and partial lockdowns in localized hotspots, including the capital. The community transmission is putting considerable stress on the health system, which has very limited treatment capacity and is hindered by a large share of health workers infected with the virus. The community transmission has created additional spending needs while further compressing tax collections and complicating the functioning of government. On the other hand, demand for vaccination has increased and the vaccination rate stands at 17.8 percent of the population. 4. The proposed Supplemental Financing operation will enable the SIG to close the unanticipated financing gap and keep the reform program on track. While the government remains committed to the reform program and has made good progress in achieving results, the financing gap created by the riots is jeopardizing development outcomes. Given the government’s limited borrowing options, and the low levels of cash reserves (less than 2 months of regular recurrent spending), fast-disbursing financial Page 7 The World Bank Solomon Islands FY22 Supplemental Development Policy Operation (P178608) support is needed to respond to the country’s current challenges. Moreover, the absence of supplemental financing would risk deepening the economic contraction and social tensions, and lead to a build-up of expenditure arrears. Given the constraints placed on government officials and the urgency of the situation, the time available is too short to design a new reform program for a regular Development Policy Finance operation. 2. THE IMPACT OF CRISIS, ECONOMIC DEVELOPMENTS AND OUTLOOK 5. At the end of November 2021, civil unrest in the capital of Solomon Islands caused widespread damage and destruction, at a cost of about 7 percent of GDP. On Wednesday November 24, protests at the Solomon Islands Parliament escalated into looting and rioting, affecting the eastern part of Honiara. Despite an imposed lockdown, the civil unrest continued on November 25, spreading further throughout the capital. With the support of foreign security forces, however, order was restored on Friday November 26. According to a Damage, Loss and Needs Assessment (DLNA), a total of 76 buildings were considerably damaged, of which 59 would require full reconstruction. At least 137 businesses were affected – by arson and/or looting – in various parts of Honiara. The total reconstruction cost is estimated at 5.2 percent of GDP, while the total loss in the value of goods is estimated at 1.7 percent of GDP. 6. The civil unrest is the most recent manifestation of the country’s history of fragility. The 2021 unrest is rooted in the structural drivers of fragility, which also contributed to previous violent events, including the Tensions (1998-2003) and the 2006 riots. First, continued dependence on resource extraction and public perceptions of elite capture reinforce local grievances and social tensions. Second, existing historical grievances, including unresolved legacies of the Tensions, recurring debates on decentralization, youth exclusion, and persistent spatial disparities reinforce existing ethno-geographic fault lines, and undermine national cohesion. These drivers have been reinforced due to the impacts of the COVID-19 crisis. 7. The civil unrest reduced the economic growth rate by 0.3 percentage points in 2021, with knock-on effects in 2022. Economic growth for 2021 is now estimated at 0.1 percent, revised down from the latest pre-unrest estimate of 0.4 percent. 1 The downgrade reflects lower economic activity in the retail and wholesale sector, which accounted for half of all the civil unrest damage. Furthermore, a number manufacturing plants have been affected, including the country’s largest brewer and tobacco factory. The civil unrest also led to negative spillover effects to other sectors, including utilities, real estate and renting, communication, transport and public services. About 1,000 employees lost their job (0.3 percent of the labor force), with an estimated monthly loss in employment income of SI$ 1 million (the average income loss is about 5.5 percent of per capita GDP). With supply chains disrupted and inventories depleted, the riots resulted in transitory price hikes, including for food items, tobacco, and fuel (inflation is estimated to reach 3.7 percent in December 2021, up from an earlier estimate of 3.1 percent). The effects of the civil unrest on the economy will be felt in 2022, given that investments to replace damaged productive capacity are unlikely to gain pace until later in the year (see below). 1 In the parent DPO Program Document, 2021 economic growth was estimated at 2 percent. In January 2022, the IMF published its Article IV report, which puts 2021 real growth at 0.4 percent. The IMF estimate provides an update vis-à-vis the parent DPO but did not yet incorporate the economic impacts of the civil unrest. Page 8 The World Bank Solomon Islands FY22 Supplemental Development Policy Operation (P178608) 8. The civil unrest created immediate fiscal pressures in December 2021 and left an unanticipated financing gap of 2 percent of GDP for the 2022 fiscal year. In the month of December 2021, the revenue loss due to the civil unrest is estimated at SI$84 million (0.6 percent of GDP), including 0.4 percent of GDP in lost taxes and 0.2 percent of GDP in import duties. In response, the government introduced austerity measures limiting payments to payroll, essential items and COVID-19 related expenditures. The austerity measures only partially offset the revenue loss, and the remaining financing needs in 2021 were met by an unplanned reduction in cash buffers. In 2022, the revenue loss caused by the civil unrest is estimated at SI$ 126 million (0.9 percent of GDP), driven by a loss of income and tobacco taxes. Next to revenue losses, the riots also caused increased spending needs for 2022. The civil unrest led to the destruction of the Honiara high school, a police station and training center and Parliament infrastructure, which will require reconstruction estimated at SI$ 23.5 million (0.2 percent of GDP). Furthermore, the government is designing a package to support the affected businesses with reconstruction and recovery, costed at SI$ 125 million (0.9 percent of GDP; refer to Section 3 for more detail). Table 2: Key Macroeconomic Indicators 2019 2020 2021 2021 2022 2022 2023 2024 2025 pre- post- pre- post- shock shock shock shock Annual percentage change 1/ Real Economy Real GDP growth 1.2 -4.3 0.4 0.1 2.3 -2.9 5.3 3.8 3.3 contribution to growth (in % of GDP): agriculture -1.3 -0.6 0.1 -0.2 0.1 -1.8 0.6 -0.3 -0.3 industry 1.0 -2.1 0.1 0.7 1.4 -0.3 3.1 3.3 2.8 services 1.5 -1.5 0.2 -0.4 0.8 -0.8 1.7 0.8 0.8 Consumer prices (period average) 1.6 3.0 -0.2 2.4 3.8 8.8 3.5 3.5 3.5 In million US$ 1/ Balance of Payments Exports (in % of GDP) 37.5 27.5 21.7 20.1 22.3 22.1 25.0 26.2 28.2 Imports (in % of GDP) 47.7 35.6 26.3 32.0 31.5 45.5 50.4 44.5 41.0 Current Account Balance (in % of GDP) -9.8 -1.6 -5.2 -5.8 -12.4 -14.8 -13.8 -11.8 -9.8 Overall balance (BOP) -31.6 86.5 39.6 30.2 -59.6 -32.9 -64.6 -47.8 -32.9 Gross official foreign reserves 572 657 700.3 687.2 641 654 576 529 496 in months of next years imports 12.3 15.1 10.6 10.4 8.2 8.3 7.7 7.5 7.4 In percent of GDP Public sector finances Revenues 30.3 30.0 30.9 29.0 28.0 28.0 29.4 29.4 29.4 Expenditures 29.6 34.9 33.8 33.8 32.8 33.7 34.0 33.6 33.1 Overall fiscal balance 0.7 -4.9 -2.9 -4.8 -4.8 -5.7 -4.6 -4.2 -3.6 Public debt 8.3 14.0 16.2 20.6 22.2 22.9 26.3 28.7 30.9 of which external debt 6.2 10.5 10.6 15.4 16.6 17.3 19.7 20.1 19.5 Nominal GDP (US$) 1,578 1,562 1,652 1,635 1,766 1,740 1,869 2,006 2,072 Source: IMF, SIG, World Bank 1/ unless otherwise noted Page 9 The World Bank Solomon Islands FY22 Supplemental Development Policy Operation (P178608) 9. Since the civil unrest, the country has also been grappling with widespread community transmission of the coronavirus. As of April 7, 2022, 11,856 cases of COVID-19 have been detected in Solomon Islands, with COVID-related deaths in the country standing at 134.2 Cases have been reported in all but one province. To contain a further spread of the coronavirus, SIG initially installed a partial lockdown in localized hotspots, followed by a Honiara-wide lockdown, which has now been replaced with a curfew across the capital. Currently, most businesses are allowed to operate with strict COVID-19 protocols in place, as more emphasis is placed on sustaining economic livelihoods. International travel remains restricted to essential cargo and approved repatriation flights. Border reopening is unlikely until the second half of the year. Inter-island maritime and air travel was suspended and is slowly resuming under strict protocols, hampering food provision to the provinces. The community transmission is putting considerable stress on the health system, which has very limited treatment capacity and is hindered by a large share of health workers infected with the virus. As a result of the community transmission, demand for vaccination has increased substantially. 3 The authorities have adjusted the roll-out of the nationwide vaccination campaign to account for increased vaccination demand. Finally, the local COVID- 19 outbreak has fiscal implications. The 2022 revenue loss associated with the community transmission is estimated at 0.5 percent of GDP, while the COVID-related response is currently costed at 1.3 percent of GDP, 4 leaving an overall fiscal impact of 1.9 percent of GDP in 2022. 10. Finally, the country is now experiencing a commodity price shock due to the war in Ukraine. The sharp increase in commodity prices is generating an unfavorable terms of trade shock, as the Solomon Islands is a net importer of petroleum, oil and gas, of about 2.5 percent of GDP. A small export surplus of ores (0.3 percent of GDP) and rice (0.1 percent of GDP) will not compensate for the increase in energy prices. Consequently, inflation is expected to edge up to 8.8 percent, refraining private consumption and business activity, and causing a further deterioration in the growth outlook for 2022. Exports will decrease in line with downward growth revisions in main trading partners. 11. Overall, the triple shock from the civil unrest, COVID-19 and the Ukraine war has resulted in a sharp deterioration in the growth outlook, with a 2.9 percent contraction projected in 2022. This is in stark contrast to the 2.3 percent growth projected pre-unrest. First, the effects of the civil unrest on the economy will be felt in 2022, given that investments to replace damaged productive capacity are unlikely to gain pace until later in the year, while job losses stemming from the social unrest are expected to weigh on private consumption. At the same time, COVID restrictions have had a profound impact on several sectors. According to local authorities, the lockdown has dented output in sectors where production requires the physical presence of workers such as logging, manufacturing, and several service sectors such as transportation, trade and tourism, which represent a large share of output. Lack of transportation is also expected to have caused agriculture production to perish before reaching consumers. Borders are expected to reopen in the second half of 2022, allowing for a recovery of business tourism, making a modest contribution to output growth. 2 With limited testing capacity, the actual number of cases is likely to be substantially higher. As COVID-19 patients are instructed to stay at home, the actual number of COVID-related deaths is likely to be higher. 3 As of March 28, 17.8 percent of the population is fully vaccinated while 34.3 percent received at least one dose. The vaccination rate increased from 35 vaccinations per 100 population early January 2022 to 47 per 100 population on March 16, a 35 percent increase. 4 The COVID-19 response plan involves a cross-sectoral approach with measures targeting camp management, learning continuity, health response, livelihood support, protection of vulnerable groups, logistics, coordination and safety and security. Page 10 The World Bank Solomon Islands FY22 Supplemental Development Policy Operation (P178608) 12. The current account deficit will widen to 14.8 percent of GDP in 2022, but official foreign reserves will remain adequate. As noted above, the Ukraine war will dampen exports while putting upward pressure on the import bill. Moreover, the response to the civil unrest is expected to increase import needs by 2.3 percent of GDP over the coming three years, to re-supply looted and damaged inventories, as well as to acquire reconstruction material and machinery. However, strong official development assistance inflows are expected to help offset the trade deficit, with official reserves projected to remain well above adequate levels, at above 8 months of imports. This, in turn, will continue to support the credibility of the basket exchange rate regime. 13. The fiscal deficit is expected to reach 5.7 percent of GDP in 2022. This represents an increase from the 4.8 percent of GDP pre-shock projection. Tax revenues are expected to fall by 2.4 percent of GDP compared to 2022 pre-shock projections, with a reduction in all tax categories in line with the contraction of output. However, a significant increase in external budget support grants since the unrest will help to offset the decline in revenues. While the SIG recurrent budget will remain tightly constrained in 2022, the development budget is expected to increase to implement a COVID-19 response plan and a business response plan to support private sector reconstruction. Some development spending is expected to be reprioritized to accommodate these spending pressures, while allocations for Constituency Development Funds and other priority projects are likely to remain at 2021 levels. The 2022 deficit will be financed by a combination of external support, domestic bonds and a large drawdown of SIG’s scarce cash reserves, which stood at 3 percent of GDP at the end of January 2022 (see more detail in section 3 below). Table 3: Selected Fiscal Indicators 2019 2020 2021 2021 2022 2022 2023 2024 2025 pre- post- pre- post- Percent of GDP shock shock shock shock Total revenue and grants 30.3 30.0 30.9 29.0 28.0 28.0 29.4 29.4 29.4 Total revenue 26.4 23.8 22.3 21.7 22.4 19.6 23.4 23.7 24.1 Tax revenue 22.7 20.3 19.2 18.8 19.4 17.0 20.7 21.0 21.4 Income and profits 8.2 7.2 7.3 7.1 6.9 6.0 7.3 7.4 7.6 Goods and services 6.0 6.0 7.1 7.0 5.7 5.0 6.1 6.2 6.3 Trade taxes 8.5 7.1 4.8 4.7 6.8 5.9 7.2 7.3 7.5 Other revenue 3.7 3.5 3.0 2.9 3.0 2.6 2.7 2.7 2.7 Grants 3.9 6.2 8.6 7.3 5.6 8.4 6.0 5.7 5.3 Total expenditures 29.6 34.9 33.8 33.8 32.8 33.7 34.0 33.6 33.1 Recurrent expenditures 25.2 30.4 26.8 26.8 25.7 25.3 25.4 25.5 25.4 Compensation of employees 9.6 10.1 9.7 9.7 9.7 9.7 9.6 9.6 9.5 Interest payments 0.5 0.7 0.3 0.3 0.3 0.4 0.5 0.6 0.6 Other recurrent expenditures 15.1 19.6 16.7 16.7 15.7 15.3 15.3 15.3 15.3 Development expenditures 4.4 4.5 7.0 7.1 7.1 8.4 8.6 8.1 7.7 Overall balance 0.7 -4.9 -2.9 -4.8 -4.8 -5.7 -4.6 -4.2 -3.6 Total Financing -0.7 4.9 2.9 5.4 4.8 5.7 4.6 4.2 3.6 Source: IMF, SIG, World Bank Page 11 The World Bank Solomon Islands FY22 Supplemental Development Policy Operation (P178608) 14. Monetary policy is expected to remain accommodative, as the Central Bank aims to support the economic recovery. Given current lackluster economic conditions, low private sector credit growth, and moderate inflationary pressures, the Central Bank is expected to maintain the cash reserve requirements at 5 percent (down from 7.5 percent). The Central Bank is also expected to continue with the sovereign bond purchasing program in the secondary market and rolling out the Export Finance Facility. The exchange rate regime remains appropriate, according to the IMF, and its credibility is supported by ample reserves. The authorities have declared they will revise and update the weights of the currency basket. 15. Investment will be the main growth driver in 2023-2025. The growth profile is similar to the parent DPO. Growth will resume in 2023, driven by investment in infrastructure projects and the replacement of lost capital during the civil unrest of late 2021. Investments related to the Pacific Games will extend throughout 2023 while destroyed physical capital reposition is expected to extend throughout 2024. Investment will also be bolstered by several large projects in the energy and transport sectors. Following several years of subdued economic activity, growth is projected at 5.3 percent of GDP in 2023 and to moderate to 3.8 percent of GDP and 3.3 percent of GDP in 2024 and 2025, respectively. Compared with the parent DPO, GDP growth figures are higher in 2023 and 2024, driven by the economic contraction in 2022 (base effects) and the impetus provided by private investment to replace lost physical capital during the riots. Consistent with the country’s sustainable logging policy, the contribution of logging to agriculture output and exports is expected to decline. 16. The current account deficit deteriorates on the margin in 2023 while the fiscal deficit follows the same trajectory as the parent DPO, but at lower levels. Additional imports of materials and machinery needed to replace productive capital destroyed during the riots are expected to deepen the current account deficit. The fiscal deficit is projected to decline from 5.7 percent of GDP in 2022 to 3.6 percent of GDP in 2025, consistent with the rebound of economic activity and as expenditures associated with the external shocks cease. This is broadly similar to the medium-term fiscal developments of the parent DPO. 17. Public debt is sustainable, and the risk of debt distress remains moderate with substantial space to absorb shocks and unchanged compared to the previous Bank-Fund joint DSA. The most recent Bank- Fund DSA (published in January 2022) was updated for the purposes of this operation by Bank staff, in consultation with the IMF, on the basis of the new macroeconomic framework. It includes the impact of the civil unrest, COVID-19 and Ukraine-related commodity price shock. External and overall public debt increased, as a result of the COVID-19 pandemic. A slightly stronger recovery than the previous DSA over the next years will contribute to contain the public debt level over the projection period. All external debt indicators remain below the relevant indicative thresholds under the baseline scenario. The PV of external debt-to-exports ratio and the debt service-to-exports ratio breaches its threshold under an export shock scenario, consistent with the country’s low level of export diversification. The PV of public debt-to-GDP ratio remains below the indicative threshold under the baseline scenario, though breaches the threshold under the commodity price shock scenario. Solomon Islands is one of the countries expected to be most affected by climate change. A tailored natural disaster shock of similar scale to the largest shock in Solomon Islands’ history would cause a spike in debt trajectory in the aftermath of the event. With pronounced uncertainty around the economic outlook, continued debt sustainability will need to be anchored in a prudent fiscal policy to rebuild fiscal buffers and contain fiscal risks, along with a financing strategy that prioritizes grants and concessional external borrowing. Page 12 The World Bank Solomon Islands FY22 Supplemental Development Policy Operation (P178608) Figure 1: DSA analysis Source: World Bank 18. Macroeconomic risks are tilted to the downside and have deteriorated since the approval of the parent DPO. The COVID-19 pandemic had a severe impact on the economy and exacerbated pre-existing weaknesses. The recent social unrest, the lockdown and mitigation measures to arrest COVID-19 community spread and the Ukraine-related commodity price shock have further deteriorated socio- economic conditions. COVID-19 remains a risk to the economic outlook. A low vaccination intake may lead to the maintenance of a closed border policy, hampering tourism and delaying infrastructure projects, the main driver of economic growth in 2023-2025. This will in turn lower fiscal revenues, potentially deteriorating the fiscal position given the country’s long-standing challenges in controlling discretionary spending. Given that cash reserves are likely to be drawn down to finance the deficit in 2022, there is a risk that arrears will accumulate, impacting negatively on private sector activity and potentially on the health of the financial system, against a background of increased non-performing loans. Under an unfavorable economic environment, the risks of additional episodes of civil unrest cannot be ruled out, which would endanger the economic recovery and potentially lead to additional job losses and the destruction of productive capital. Other risks highlighted in the parent DPO remain and stem from exposure to international price volatility, weaker export demand from China, and the likelihood of frequent natural disasters. At above 11 percent, NPLs are elevated and have increased before the pandemic. Although the immediate impact of the lockdown appears to be limited, NPLs can constitute a source of vulnerability as economic activity is projected to remain subdued for a longer period and profitability declines. 19. The macroeconomic policy framework remains adequate for the purposes of the proposed operation. Following several years of subdued economic activity and the contraction expected in 2022, growth will resume and be driven by large infrastructure investments, replacement of productive capital lost during the riots, and new investment in the mining and fishing sectors. Growth will bring additional fiscal revenues, which will help to arrest the increase of the fiscal deficit observed during the pandemic. Public and external debt are projected to remain on a sustainable path and the risk of debt distress remains moderate. Furthermore, the government remains committed to keeping public debt below 35 percent of GDP in the medium-term. The current expansionary monetary policy stance is appropriate in view of weak economic conditions, and it is expected to tighten as the economy recovers. International reserves are projected to decline but to remain within the reserve adequacy range over the medium term. Page 13 The World Bank Solomon Islands FY22 Supplemental Development Policy Operation (P178608) Table 4: Sources and Uses of External Financing (in million USD) 2019 2020 2021 2022 2023 2024 2025 Financing requirements 161.6 30.3 100.1 262.8 267.9 251.5 214.5 Current account deficit 154.0 25.1 94.8 257.5 258.0 236.7 203.1 Short term debt amortizations 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Long term debt amortizations 7.6 5.2 5.3 5.3 9.9 14.8 11.4 Financing sources 71.3 218.4 288.6 124.0 176.9 181.3 198.5 FDI 28.7 5.6 43.8 62.1 64.1 64.6 66.8 Portfolio investment (net) -3.9 -1.5 0.0 0.0 0.0 0.0 0.0 Capital grants 63.6 63 86.3 76.6 106.2 97.4 97.4 Debt disbursements 16.5 37.4 128.5 18.5 89.6 77.1 77.1 Change in reserves -32 85 30 -33 -78 -48 -33 IMF credit (net) -2.1 28.8 -0.2 -0.3 -5 -9.8 -9.8 Net errors and omissions 90.3 -188.1 -188.5 138.8 91.1 70.2 16.0 Source: ADB, DFAT, EU, IMF, MFAT, World Bank 3. RESPONSE TO THE CRISIS 3.1. THE GOVERNMENT’S RESPONSE 20. When the civil unrest spread, the immediate response focused on restoring law and order. The moment the protests escalated into violence, the Royal Solomon Islands Police Force aimed to disperse the protesters. The authorities also issued a statement calling on all citizens to remain calm and refrain from illegal activity. Furthermore, roadblocks were installed, and a 36-hour lockdown was imposed. However, given the country’s limited law enforcement capacity, the government requested security support from Australia, Fiji, Papua New Guinea and New Zealand (see below). These measures helped to restore order by Friday November 26. In the aftermath of the civil unrest, a Motion of No Confidence was tabled against the government, which was defeated on December 6, allowing the government to remain in power. 21. To support the affected businesses, the government is designing a Business Recovery Package. The Package will include a combination of short-term cashflow relief measures – i.e., rental subsidies, tax relief, cash transfers – as well as medium-term support with the reconstruction of properties, the rehabilitation of business assets and the compensation for damaged goods – i.e., import duty exemptions and fast-tracking of construction approvals. The short-term measures aim to prevent solvent businesses from exiting the market, while the medium-term measures serve to facilitate the reconstruction process and stimulate economic recovery. The Package is being costed at SI$ 125 million (0.9 percent of GDP). Page 14 The World Bank Solomon Islands FY22 Supplemental Development Policy Operation (P178608) Table 5: 2022 Financing Needs (FN) SI$m US$m % of GDP Projected FN pre-shock 807 99.7 5.7 Increase in FN post-shock 553 68.3 3.9 Revenue impact 396 48.9 2.8 Expenditure impact 157 19.4 1.1 Bus i nes s recovery a nd recons tructi on 125 15.5 0.9 Publ i c recons tructi on 24 3.0 0.2 COVID-19 res pons e 180 22.2 1.3 Budget repri ori ti za ti on -172 -21.3 -1.2 Overall FN post-shock 1359 168.0 9.6 Total financing 1359 168.0 9.6 External budget support grants 549 67.9 3.9 Already planned 94 11.6 0.7 ADB 40 5.0 0.3 Aus tra l i a 12 1.5 0.1 EU 24 3.0 0.2 New Zea l a nd 17 2.1 0.1 New commitments post-shock 455 56.3 3.2 ADB 40 5.0 0.3 Aus tra l i a 130 16.1 0.9 New Zea l a nd 12 1.5 0.1 Worl d Ba nk s uppl ementa l fi na nci ng 93 11.5 0.7 COVID-19 res pons e (mul ti pl e pa rtners )* 180 22.2 1.3 Fiscal deficit after grants 810 100.2 5.7 External budget support credits 259 32.0 1.8 New commitments post-shock 259 32.0 1.8 ADB 81 10.0 0.6 Ja pa n 150 18.5 1.1 Worl d Ba nk s uppl ementa l fi na nci ng 28 3.5 0.2 Domestic financing 551 68.1 3.9 Domes ti c bonds 241 29.8 1.7 Dra wdown of ca s h res erves 310 38.3 2.2 Year-end cash reserve balance 117 14.4 0.8 Sources: SIG, WB staff estimates * The SIG is currently in dialogue with key development partners regarding the financing of the COVID-19 response. 22. The civil unrest, community transmission and commodity price shock have created an unanticipated financing gap, which will be covered by additional donor support, domestic lending and a large drawdown of the cash buffers. The triple shock is projected to result in a revenue shortfall of 2.8 percent Page 15 The World Bank Solomon Islands FY22 Supplemental Development Policy Operation (P178608) of GDP in 2022. Meanwhile expenditure needs have increased by 1.1 percent of GDP in net terms, after taking into account savings from austerity measures and budget cuts. Overall, the country’s financing needs have increased by 3.9 percent of GDP compared with pre-shock projections, bringing total financing needs to 9.6 percent of GDP (see Table 5). Development partners and the World Bank will provide 3.9 percent of GDP in budget support grants, including the proposed supplemental financing. The remaining fiscal deficit of 5.7 percent of GDP will be partially financed by external concessional borrowing (1.8 percent of GDP) and domestic development bonds (1.7 percent of GDP). In order to maximize financing, SIG decided to increase the Annual Borrowing Limit to SI$500m in 2022 (compared with SI$350m in 2021) and reduce the borrowing limit to SI$200m from 2023 onwards, effectively bringing forward borrowing. Even with these measures, a major drawdown of cash reserves (by 2.2 percent of GDP) will be needed to close the expected financing gap in 2022. 3.2. THE BANK’S RESPONSE, STRATEGY, AND COLLABORATION WITH DEVELOPMENT PARTNERS 23. In addition to the proposed Supplemental Financing DPO, the World Bank will scale up three key investment projects to support SIG with the unrest response to address the drivers of fragility. The additional resources – for a total of US$19.5 million (1.1 percent of GDP), excluding the supplemental DPO – will be allocated to the Second Solomon Islands Roads and Aviation Project (P176548), the Integrated Economic Development and Community Resilience Project (P173688) and the Pacific Islands Regional Oceanscape Program - (PROPER) (P177239). The activities supported by the additional IDA will aim at addressing some of the drivers of fragility – such as spatial disparities in terms of access to basic services and livelihood opportunities and weakened citizen-state compact. These additional resources will help to increase quality jobs and livelihoods in rural areas, improve access and connectivity to lagging regions, and enhance the provincial governments’ responsiveness and accountability to citizens. Furthermore, the World Bank will strengthen its focus on fragility in its analytical work and operations, including with the development of a conflict risk monitoring tool and the operationalization of the recently updated Risk and Resilience Assessment. 24. The international community provided complementary support in response to the civil unrest. Following a request from the SIG under a Bilateral Security Treaty, Australia responded by deploying 67 Australian Federal Police, 29 Defense and 9 DFAT personnel on 25 November 2021. The funding for this deployment was sourced from emergency response funds across the Australian Government. Similarly, New Zealand deployed 70 Defense Force and Police personnel as well as a Protector-class Navy patrol vessel. Furthermore, New Zealand provided emergency funding to the Solomon Islands Red Cross and the Ministry of Health and is expected to fund the reconstruction of the Honiara High School. Fiji and Papua New Guinea also contributed security forces, while the People’s Republic of China has provided equipment and training support for the Royal Solomon Islands Police Force. Finally, the Asian Development Bank provided technical assistance and supervision with the Damage, Loss and Needs Assessment. 4. THE REFORM PROGRAM SUPPORTED THROUGH ORIGINAL OPERATION: AN UPDATE 25. SIG remains fully committed to the DPO Program, even though the civil unrest has complicated program implementation (see Table 5 below). Implementation progress in each reform area has been Page 16 The World Bank Solomon Islands FY22 Supplemental Development Policy Operation (P178608) satisfactory, with no policy reversals. In one case, progress has exceeded expectations, with the new environmental levy (Prior Action 7) being implemented at a higher rate per kg than expected. While there has been a delay in the passage of two key pieces of legislation linked to the Program – the Tax Administration Bill 5 and Payments Systems Bill – this was largely due to unforeseen circumstances. That is, the bills could not be passed in Parliament in late 2021 as expected, with Parliament instead needing to deliberate on a Motion of No Confidence raised in the wake of the riots. Given the country’s commitment to domestic resource mobilization, SIG has confirmed that the two bills are top priorities for Parliament in 2022, once the budget is passed. Both Bills have been submitted to Parliament and are expected to be passed in the coming months, further reflecting SIG’s strong commitment to the reform Program. 26. Many of the Results Indicators are on track to being met, but risks have increased (see Table 1 above). Results Indicator #1 on debt management is already being met, while the Large Taxpayer Office has achieved an impressive turnaround in filing, tax debt and e-tax indicators in only a short time (see Results Indicator #4). Fiscal restraint and cash rationing measures in 2021 helped to ensure that arrears did not grow, but the unanticipated financing gap has increased the risk of rising expenditures arrears (Results Indicator #2). The Independent Commission Against Corruption has maintained appropriate gender representation and fulfilled its statutory reporting requirements in 2021 (Results Indicators #5 and #6). For other results indicators, it is too soon to measure results. For example, the Automated Transfer System is only expected to go live later in 2022, 6 so it has not yet had an influence on electronic payment volumes (Results Indicator #7). However, the civil unrest and the COVID-19 outbreak increased the risk of a delayed implementation. It is also too early to track the results of the Procurement Regulations (approved in October 2021) or the environmental levy (which went into force in late December 2021). As travel to the provinces is hindered due to the austerity measures in place, progress on the gender- informed Vulnerability and Adaptation Assessments has been slow (Results Indicator #8). Table 5: Progress Under the Parent DPO Program Prior Action Status Update Pillar 1: Strengthening Fiscal Management in the Areas of Debt Management, Cash Management and Procurement. Prior Action #1. The Recipient, through its Satisfactory progress. Although the fiscal situation has created Cabinet, has approved, and published on the pressures to increase borrowing, the integrity of the Debt government website, the Medium-Term Debt Management Framework (including the MTDS) has been Management Strategy (MTDS) 2021-2024, in order maintained. New borrowing in 2021 complied with the Annual to improve debt management. Borrowing Limit (ABL), and SIG increased the share of domestic borrowing, in line with the MTDS objectives. MoFT decided on a higher ABL for 2022. As part of the MTDS implementation, MoFT is now working on operational guidelines for domestic bond issuances (an FY22 PPA under the SDFP). 5 The submission to Parliament of the Tax Administration Bill constitutes a Performance and Policy Action under the Sustainable Development Finance Policy (SDFP). The other FY22 PPAs is Cabinet approval of the Domestic Bond Guidelines. Both actions are expected to be completed before the end of the fiscal year. The Solomon Islands Government successfully implemented the FY21 PPAs, which included Cabinet approval of a Medium-Term Debt Strategy and the publication of monthly debt bulletins. 6 There have been delays with system testing and training due to the riots and COVID, but the government is working with the system vendor to ensure that the system can be launched before the end of the year. Page 17 The World Bank Solomon Islands FY22 Supplemental Development Policy Operation (P178608) Prior Action #2. The Recipient, through its Prime Satisfactory progress. The Regulations entered into force on 14 Minister, acting in his capacity as the Acting Minister October, 2021. MoFT is now revising the Procurement and of Finance and Treasury, has issued the Contract Administration Manual for consistency with the Public Financial Management Regulations and preparing new standard procurement templates. (Procurement) Regulations 2021 under the Public Implementation has been temporary delayed due to a two-month Financial Management Act, to improve transparency, vacancy of the Accountant-General role, but the position has now integrity, and efficiency in public spending. been filled. Pillar 2: Strengthening the Business Environment through Simplifying Tax Processes, Fighting Corruption and Supporting more Efficient Payments Systems. Prior Action #3. The Recipient, through its Satisfactory progress. The new Large Taxpayer Office has already Minister of Finance and Treasury, has approved achieved reductions in tax debts and an improvement in on-time and operationalized the Large Taxpayer Office, as filing. an integral component of the restructure of the Inland Revenue Division, in order to improve tax SIG remains committed to the Tax Administration Bill, which revenue collection. provides the legislative underpinning for the tax reforms supported under the Program. It will be prioritized for the next Parliament sitting, after passage of the 2022 Budget. Submission of the Bill to Parliament is an FY22 PPA. Prior Action #4. In order to operationalize the Satisfactory progress, but funding may be insufficient. SIG has Solomon Islands Independent Commission Against confirmed that the SIICAC will once again have a separate budget Corruption (SIICAC), the Recipient has: (i) appointed allocation in the 2022 budget, with the proposed allocation being a director general for the SIICAC; (ii) issued the at the same level as 2021. Although it is positive that the SIICAC SIICAC Remuneration and Other Conditions will be protected from budget cuts in the current severely Regulations 2020, to define the remuneration constrained context, it is unlikely that the budget allocation will entitlements for the SIICAC; and (iii) established a be sufficient to implement the SIICAC’s full 2022 work plan. separate budget allocation for the SIICAC in the 2021 budget. Prior Action #5. The Recipient, through its Minister Satisfactory progress. With funding from the Australian of Finance and Treasury, has approved the use of government, MoFT has been working on software upgrades to the Automated Transfer System (ATS) for allow its financial management, payroll, revenue and customs government payments and receipts, to promote systems to integrate with the ATS. Recent progress has been fast and secure electronic transactions with the delayed by the vacancy of the Accountant-General role. private sector (including for customs and tax). SIG remains committed to the Payments Systems Bill, which provides the legal foundation for the ATS. It was submitted to Parliament in November 2021 and has undergone review by the Bills and Legislation Committee, but the reading of the bill could not be completed due to events surrounding the riots. It remains a priority for Parliament in 2022. Pillar 3: Improving Environmental Sustainability by Strengthening National Planning for Climate Change and Reducing Plastic Pollution Prior Action #6. The Recipient, through its Delays due to funding shortfalls and COVID-19 situation. Cabinet, has approved the Recipient’s Updated Community vulnerability assessments are one of the key activities Nationally Determined Contribution (NDC), to implement the revised NDC. However, further progress has to strengthen the ambition of climate change been hindered by the government cashflow situation, with no mitigation and adaptation actions. warrants being issued for official travel to the provinces. In addition, there are now public health restrictions on travel as a result of the COVID-19 outbreak. Page 18 The World Bank Solomon Islands FY22 Supplemental Development Policy Operation (P178608) Prior Action #7. The Recipient, through its Satisfactory progress. The environmental levy entered into force Minister of Finance and Treasury, has approved on 29 December 2021. The rate of SI$1.40 per kg is significantly the introduction of an environmental levy on higher than the SI$0.50 levy expected when the parent DPO was single-use plastics and other plastics with toxic approved. components in order to reduce plastic pollution. 5. RATIONALE FOR PROPOSED SUPPLEMENTAL FINANCING 27. Although there has been satisfactory progress with the Program to date, the unanticipated financing gap from the riots – 2 percent of GDP in 2022 – is directly jeopardizing the achievement of results. In the absence of supplementary financing, SIG will likely need to reduce the 2022 budget allocations of some of the public service divisions responsible for implementing the Program. This is likely to directly causes delays in implementation and the achievement of development outcomes. For example, it may not be possible for the Large Taxpayer Office and the Independent Commission Against Corruption to proceed with all of their planned recruitment efforts in 2022. The completion of community vulnerability assessments to implement the Revised Nationally Determined Contribution, which requires extensive consultations throughout rural areas, will also only be possible with sufficient budget allocations and cashflow (indeed, the Treasury already stopped approving warrants for domestic travel in December 2021, due to cashflow shortages following the riots). 28. Moreover, the absence of Supplemental Financing would exacerbate the existing substantial risks to the Program stemming from weak institutional capacity, the COVID-19 outbreak and political fragility. In addition to the direct impact on the budgets of implementing agencies, the absence of external financing could have indirect but potentially far-reaching impacts on the Program Development Objectives (PDOs), by exacerbating existing fragility risks. If SIG is unable to fund an appropriate fiscal response to the riots and COVID-19 outbreak, the likely result would be a deepening of both the economic contraction and social tensions. 7 In this scenario, SIG’s limited administrative capacity would need to be diverted to crisis management rather than the implementation of the reform Program, thereby putting results at risk across the board. In addition, the PDO to strengthen the business environment is unlikely to be meaningfully achieved if SIG is unable to secure sufficient financing to support reconstruction of the Honiara Central Business District and business recovery from the riots, or in a situation where instability or a protracted recession is deterring business investment. Specific results indicators around a reduction in expenditure arrears and an improvement in tax compliance would also be directly affected by a deterioration in the economic situation. 29. Given the country’s limited borrowing options, Solomon Islands is unable to obtain sufficient financing without the supplemental DPO. Solomon Islands does not have access to external capital markets and is relying on cash buffers, a small domestic market 8 and concessional lending from development partners 7 While the supplemental financing may prevent a deepening of social tensions and economic hardship, more is needed to address the structural drivers of fragility. The scaling up of three World Bank investment projects and increased attention on fragility in analytical work and operations are expected to contribute to improved resilience. 8 Since 2017, the government started issuing local development bonds, i.e., negotiated private placements with a limited number of state-owned enterprises, the National Provident Fund and the Central Bank. The government aims to increase domestic market borrowing and diversify its investor base, but this will take time. As a first important step, SIG is developing operational guidelines for the issuance and purchase of government securities in the domestic market, an action supported by the FY22 SDFP process. Page 19 The World Bank Solomon Islands FY22 Supplemental Development Policy Operation (P178608) to finance its development needs. Given the rapidly evolving situation and limited borrowing options, the government is unable to obtain sufficient funds without the supplemental DPO. Furthermore, given the depletion of the cash buffers and the constraints currently placed on government officials, the time available is too short to process a free-standing DPF. 6. OTHER DESIGN AND APPRAISAL ISSUES 30. There are no changes to the assessment of poverty and social impacts since the parent DPO was approved. As detailed in the Program Document of the Parent DPO, Pillars 1 and 2 of the Program are not expected to have any negative poverty or social impacts. To the extent that Pillar 1 contributes to greater fiscal resilience and more efficient public spending on goods and services, there may be positive poverty impacts in the long term. The procurement regulations and SIICAC may have positive social impacts, given they are expected to help in addressing drivers of fragility in Solomon Islands, such as perceived corruption and lack of transparency in public spending. Meanwhile, the Central Bank of Solomon Islands’ (CBSI) expanded consumer protection mandate under the payment systems reforms may particularly benefit the poor and vulnerable, given that the poor are less likely to hold bank accounts and rely more on non-conventional payment methods. Reforms under Pillar 3 may have both positive and negative impacts. Adaptation activities under the Updated NDC may have large positive poverty and social impacts, by helping SIG to identify and address the adaptation challenges of the most vulnerable communities. However, the Updated NDC’s mitigation targets will entail a transition to a large share of hydroelectric power generation over the coming decades. Although there will be some positive poverty impacts (electricity prices are expected to decline significantly), there could be negative social impacts for local communities affected by hydroelectric dams. Technical support from development partners aims to address this risk (for example, safeguards support under the Tina River Hydropower Project). The new environmental levy may have some negative poverty impacts to the extent that it affects the prices of goods commonly consumed by the poor. 31. There are no changes to the assessment of environmental aspects since the parent DPO was approved. As analyzed in the Program Document of the Parent DPO, policies supported under Pillars 1 and 2 are not expected to have any negative environmental impacts, while Pillar 3 may have both positive and negative impacts. The environmental levy on single use and toxic plastics is expected to have positive environmental impacts through reduced plastics pollution. Furthermore, achieving climate mitigation targets such as net zero emissions by 2050 will have positive environmental impacts. However, targets will mainly be achieved by increasing hydroelectric power generation, which will have environmental impacts on the affected waterways and surrounding habitats. Environmental risks of major infrastructure investments are mitigated through SIG’s environmental protection framework, including the Environment Act 1998, which requires environmental impact assessments be carried out. However, enforcement capacity is weak and institutional capacity needs strengthening in order to effectively mitigate environmental risks and impacts. Support from development partners aims to address this (for example, World Bank-financed infrastructure projects in Solomon Islands include capacity building and technical support for safeguards issues). 32. Overall, the fiduciary risks associated with the proposed operation are substantial, with no significant changes since the parent DPO. Risks associated with the CBSI are low and SIG publishes the annual budget on time. However, despite those positive features, major weaknesses in SIG’s core PFM functions Page 20 The World Bank Solomon Islands FY22 Supplemental Development Policy Operation (P178608) contribute to a substantial overall risk. The external audit function remains weak, with limited scrutiny and follow-up on audit findings. A 2018 IMF assessment highlighted weaknesses in budget credibility, accounts reconciliation, commitment controls, procurement oversight, cash management, timeliness of annual financial reporting, and in accountability for discretionary funds such as CDFs (there is no recent PEFA, with the last one being prepared in 2012). 33. The supplemental financing operation will consist of a single tranche of SDR 8.319 million (US$11.5 million equivalent) in IDA grants and SDR 2.532 million (US$3.5m equivalent) in IDA credits on standard terms, to be available upon effectiveness. The disbursement arrangements are unchanged from the parent DPO. The proposed operation will follow IDA disbursement procedures for DPOs, and the proceeds will be disbursed in compliance with the stipulated release conditions. Disbursement will not be linked to any specific purchases and no procurement requirements will have to be satisfied. a. Dedicated Foreign Currency Bank Account (DA): Once the operation becomes effective, implementation of the program is satisfactory and the macroeconomic framework remains adequate, at the request of the Recipient, the proceeds will be deposited by IDA into a Dedicated Foreign Currency Bank Account (DA) at the CBSI which forms part of the country’s foreign exchange reserves, and the Recipient will promptly deposit an equivalent amount in its local currency budget accounting system. As a due diligence measure, within 30 days of receipt the Recipient will provide a written confirmation to IDA that the amount has been transferred to a local currency account available to finance budgeted expenditures. 9 Therefore, the Recipient shall ensure that upon each deposit of an amount of the IDA financing into the DA, an equivalent amount is accounted for in the Recipient’s budget management system, in a manner acceptable to the Bank. The proceeds of the operation would not be used to finance expenditures excluded under the General Conditions for IDA Financing: Development Policy Financing (2018) dated December 14, 2018 (revised on August 1, 2020, April 1, 2021 and January 1, 2022) (“General Conditions”). If, after being deposited in a Government account, the proceeds of the operation are used for ineligible purposes as defined in the General Conditions, IDA will require the Recipient to refund the amount directly to IDA. Any such amounts refunded to IDA shall be cancelled. b. Reporting and Auditing: Through CBSI, the Recipient will report the deposit of IDA funds into the DA and movement of funds from the DA to its local currency account, ensure that all withdrawals are for eligible expenditures, confirm that the IDA proceeds were received into an account of the government that is part of the country’s foreign exchange reserves and that an equivalent amount has been accounted for in the country’s budget management system (normally within 30 days after disbursement), and submit a report on receipts and disbursements for the DA. IDA may request the Recipient to submit an audited report of the DA if deemed necessary. 34. The closing date for the proposed operation is March 31st, 2023, the same closing date as the parent DPO. 35. There has been no change to monitoring and evaluation arrangements since the parent DPO. Monitoring of the operation will be conducted jointly between the MoFT and donors, under the Joint 9 This confirmation has been received for DPO1 and requested for DPO2. Page 21 The World Bank Solomon Islands FY22 Supplemental Development Policy Operation (P178608) Policy Reform Group (JPRG) process. 10 The MoFT Financial and Economic Development Unit (FEDU) has adequate capacity and is the main office responsible for monitoring the program and all associated outcome indicators. FEDU will provide half-yearly reports to the World Bank and other JPRG budget support partners on implementation progress against established timetables and agreed performance indicators. 36. Grievance Redress. Communities and individuals who believe that they are adversely affected by specific country policies supported as prior actions or tranche release conditions under a World Bank Development Policy Operation may submit complaints to the responsible country authorities, appropriate local/national grievance redress mechanisms, or the WB’s Grievance Redress Service (GRS). The GRS ensures that complaints received are promptly reviewed in order to address pertinent concerns. Affected communities and individuals may submit their complaint to the WB’s independent Inspection Panel which determines whether harm occurred, or could occur, as a result of WB non-compliance with its policies and procedures. Complaints may be submitted at any time after concerns have been brought directly to the World Bank's attention, and Bank Management has been given an opportunity to respond. For information on how to submit complaints to the World Bank’s corporate Grievance Redress Service (GRS), please visit http://www.worldbank.org/GRS. For information on how to submit complaints to the World Bank Inspection Panel, please visit www.inspectionpanel.org. 7. SUMMARY OF RISKS AND MITIGATION 37. The overall risk rating remains substantial, reflecting capacity constraints and Solomon Islands’ social fragility. The overall risk rating was also substantial under the parent DPO, reflecting the residual risks to achieving results due capacity constraints as well as political and fiduciary factors. Following the recent riots, the COVID-19 outbreak, and the associated deterioration of the fiscal position, macroeconomic and political risks to the achievement of results have now increased to substantial and high respectively. The most important risk categories are described in more detail below: • Residual risks related to institutional capacity remain high, particularly given the ongoing strain of COVID-19 and the riot response on the public service. Mitigations for this risk include the focused design of the DPO Program and technical assistance from the Bank and development partners to ensure the reform program remains on track. • Residual political and governance risk is upgraded from substantial to high, reflecting the increased possibility of political instability following the recent civil unrest. Most reforms under the Program are not politically sensitive and are unlikely to be reversed under a change of government. However, a period of renewed political instability could significantly delay the implementation of the Program, for example by causing further delays in the legislative schedule. Further, another incidence of civil unrest would have serious macroeconomic and capacity impacts on the Program. There are no direct mitigations against these risks. However, the Program is designed to ensure that reform progress can continue to the extent possible even when legislation is delayed (e.g. continued progress on institutional reform in advance of the Tax Administration Bill, and preparation of the payments system software rollout in advance of the 10The JPRG was formerly titled the Core Economic Working Group (CEWG) and was referred to as such in the parent DPO Program Document. Page 22 The World Bank Solomon Islands FY22 Supplemental Development Policy Operation (P178608) Payment Systems Bill). • Residual macroeconomic risk has increased from moderate to substantial. This reflects the economic impact of the riots, the COVID-19 outbreak and the Ukraine war, which cannot be fully mitigated. This has made the macroeconomic situation precarious and increased the likelihood and potential severity of downside risks that would impair or delay the achievement of results. If the current weak economic conditions continue longer than expected, this will further constrain the fiscal resources available for reform implementation across the board, and directly impact on some results indicators (e.g. in the area of tax debt and the reduction of arrears). The main risk mitigations are the provision of supplemental financing, which will reduce the financing gap, and technical assistance from partners. Table 6: Summary Risk Ratings Risk Categories Rating 1. Political and Governance  High 2. Macroeconomic  Substantial 3. Sector Strategies and Policies  Moderate 4. Technical Design of Project or Program  Moderate 5. Institutional Capacity for Implementation and  High Sustainability 6. Fiduciary  Substantial 7. Environment and Social  Substantial 8. Stakeholders  Moderate 9. Other Overall  Substantial . Page 23 The World Bank ANNEX 1: PARENT PROJECT POLICY AND RESULTS MATRIX Prior Actions and Triggers Results Prior Actions under DPF 1 Prior Actions under DPF 2 Indicator Name Baseline Target Pillar 1: Strengthening Fiscal Management in the Areas of Debt Management, Cash Management and Procurement. Prior Action #1. The Prior Action #1. The Recipient, Results Indicator #1: (i) (i) Annual contracted (i) Annual contracted Recipient, through its through its Cabinet, has Government debt operations debt did not exceed the debt does not exceed Minister of Finance and approved, and published on the comply with the Annual ABL (SI$74m contracted the ABL Treasury, has issued new government website, the Borrowing Limit (ABL); and (ii) against ABL of SI$300m) (2019 – 2022) Debt Management Medium-Term Debt the share of domestic debt in (2018) Regulations under the Public Management Strategy 2021- total central government debt Financial Management Act to 2024, in order to improve debt has increased. (ii) 31 percent (2020) (ii) 35 percent (2023) give legal force to the debt management. sustainability provisions of the Debt Management Framework. Prior Action #2. The Recipient, Results Indicator #2: Reduced Estimated arrears stock (i) Arrears stock is through its Minister of Finance accumulation of expenditure of SI$138m reduced below and Treasury, has established a arrears. (end-2017) SI$100m Cash Management Committee (2023) for payment prioritization and monitoring of cashflow-related risks, in order to prevent expenditure arrears. Prior Action #2. The Recipient, Results Indicator #3: (i) (i) No CTB contract (i) 100 percent of CTB through its Prime Minister, acting Transparency in public awards published online contract awards are in his capacity as the Acting procurement is improved, as (2019) published online. Minister of Finance and Treasury, measured by an increased has issued the Public Financial share of Central Tender Board (ii) 77 bid waivers (ii) Bid waivers are Management (CTB) contract award notices granted. reduced below pre- (Procurement) Regulations 2021 being published online in (2019) COVID-19 levels (i.e. under the Public Financial accordance with the less than 77) Page 24 The World Bank Prior Actions and Triggers Results Management Act, to Regulations; and (ii) (2023) improve transparency, competition is improved, as integrity, and efficiency in publicmeasured by a reduced spending. number of bid waivers (exemptions from competitive tendering) granted for procurements over SI$100,000. Pillar 2: Strengthening the Business Environment through Simplifying Tax Processes, Fighting Corruption and Supporting more Efficient Payments Systems. Prior Action #3. The Prior Action #3. The Recipient, Results Indicator #4: Tax (i) 88 percent registered (i) At least 90 percent Recipient, through its through its Minister of Finance administration is made more for e-tax and 10 percent registered for e-tax Cabinet, has approved the and Treasury, has approved and efficient, as measured by: (i) a filing returns via e-tax and 25 percent filing Tax Administration Bill 2020 operationalized the Large greater share of large (Dec 2020) returns via e-tax for submission to Parliament, Taxpayer Office, as an integral taxpayers filing tax returns to enhance the efficiency of component of the restructure of online via e-tax; (ii) an (ii) 84 percent on-time (ii) At least 90 percent tax administration. the Inland Revenue Division, in increase in the on-time filing filing on-time filing order to improve tax revenue rate for large taxpayers; and (June 2021) collection. (iii) a reduction in tax debt for the large taxpayer segment. (iii) SI$136m tax debt (iii) Less than SI$125m (June 2021) (at least a 25 percent reduction) (2023) Prior Action #4. The Recipient Prior Action #4. In order to Results Indicator #5: The No report 2020 - 2022 annual has brought into force the operationalize the Solomon SIICAC is reporting (2018) reports have been Anti-corruption Act 2018, to Islands Independent Commission transparently on its activities, presented to establish the Solomon Islands Against Corruption (SIICAC), the as measured by the tabling of Parliament and Independent Commission Recipient has: (i) appointed a its annual report in Parliament published online. Against Corruption (SIICAC). director general for the SIICAC; in accordance with the Anti- (2023) (ii) issued the SIICAC Corruption Act. Remuneration and Other Conditions Regulations 2020, to define the remuneration Page 25 The World Bank Prior Actions and Triggers Results entitlements for the SIICAC; and Results Indicator #6: Female No Commissioners At least two out of five (iii) established a separate budget representation in anti- appointed Commissioners (40 allocation for the SIICAC in the corruption efforts is (2018) percent) are female. 2021 budget. increased, as measured by the (2023) share of female SIICAC Commissioners. Prior Action #5. The Prior Action #5. The Recipient, Results Indicator #7: The (i) Electronic payments (i) Electronic payments Recipient, through its through its Minister of Finance efficiency of payment systems made up 0 percent of make up at least 30 Cabinet, has approved the and Treasury, has approved the is improved, as measured by payments by volume (0 percent of payments Payment Systems Bill 2019 use of the Automated Transfer (i) an increased share of electronic payments and by volume for submission to Parliament, System for government electronic payments in total 183,000 cheques) (2023) to improve the efficiency of payments and receipts, to payments cleared and settled (2020) payment systems in Solomon promote fast and secure by commercial banks; and (ii) Islands. electronic transactions with the a reduction in bank (ii) Bank fees of (ii) Bank fees of less private sector (including for transaction fees for the SI$1.36m than SI$0.95m (at least customs and tax). Ministry of Finance and (2020) a 30 percent Treasury. reduction) (2023) Pillar 3: Improving Environmental Sustainability by Strengthening National Planning for Climate Change and Reducing Plastic Pollution Prior Action #6. The Recipient, Results Indicator #8: Planning (i) Integrated (i)Communities in at through its Cabinet, has for climate adaptation has Vulnerability and least three out of nine approved the Recipient’s improved, as measured by (i) Adaptation Assessments provinces are covered Updated Nationally Determined an increase in the number of have been completed for by an Integrated Contribution, to strengthen the communities covered by the Reef Islands in Vulnerability and ambition of climate change Integrated Vulnerability and Temotu Province and all Adaptation mitigation and adaptation Adaptation Assessments; and of Malaita province Assessment. actions. (ii) the incorporation of except for the Ontong (2023) gender analysis in all new Java atolls. assessments. (ii) Assessments do not (ii) All new include gender analysis. assessments include (June 2021) gender analysis. (Jan 2022 – Dec 2023) Page 26 The World Bank Prior Actions and Triggers Results Prior Action #7. The Recipient, Results Indicator #9: The 128,000 kilograms of No more than 115,000 through its Minister of Finance consumption of single use polyethylene plastic bags kilograms of and Treasury, has approved the plastic products has imported (2020) polyethylene plastic introduction of an environmental decreased, as measured by a bags imported (a 10 levy on single-use plastics and reduction in the volume of percent reduction) other plastics with toxic imported polyethylene plastic (2022) components in order to reduce bags. plastic pollution. Page 27 The World Bank ANNEX 2: FUND RELATIONS ANNEX Page 28 The World Bank Page 29