Report and Recommendation of the President to the Board of Directors

Project Number: 52073-001 May 2020

Proposed Policy-Based Grant Nauru: Improving Public Investment 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 17 April 2020)

Currency unit – Australian dollar/s (A$)

A$1.00 = $0.6327 $1.00 = A$1.5805

ABBREVIATIONS

ADB

COVID-19 – –

Asian Development Bank Coronavirus disease

DOF – Department of Finance FMIS – financial management information system GDP – gross domestic product IMF – International Monetary Fund NTF – Nauru Intergenerational Trust Fund PPPF – post-program partnership framework RPC – Regional Processing Centre SOE – state-owned enterprise TA – technical assistance

NOTES

(i) The fiscal year (FY) of the Government of Nauru ends on 30 June. “FY” before a calendar year denotes the year in which the fiscal year ends, e.g., FY2019 ends on 30 June 2019.

(ii) In this report, “$” refers to United States dollars, unless otherwise stated. Vice-President Ahmed Saeed, Operations 2 Director General Leah Gutierrez, Pacific Department (PARD) Directors Lotte Schou-Zibell, Pacific Liaison and Coordination Office (PLCO),

PARD Emma Veve, Social Sectors and Public Sector Management Division, PARD

Team leaders Jacqueline Connell, Senior Economics Officer, PLCO, PARD Matthew Hodge, Senior Country Specialist, PLCO, PARD Team members Marie Miel de Villa, Project Analyst, PLCO, PARD

Vinoo Jose, Senior Operations Assistant, PLCO, PARD Roshan Ouseph, Senior Counsel, Office of the General Counsel Peer reviewer Alexander Julian, Financial Sector Economist, Public Management,

Financial Sector, and Trade Division, Central and West Asia 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 4

C. Impacts of the Reform 8

D. Development Financing Needs and Budget Support 8

E. Implementation Arrangements 8

III. DUE DILIGENCE 9

IV. ASSURANCES 10

V. RECOMMENDATION 10

APPENDIXES

1. Design and Monitoring Framework 11

2. List of Linked Documents 14

3. Development Policy Letter 15

4. Policy Matrix 18

Project Classification Information Status: Complete

PROGRAM AT A GLANCE

Source: Asian Development BankThis document must only be generated in eOps. 20042020063754029199 Generated Date: 20-Apr-2020 6:39:39 AM

1. Basic Data Project Number: 52073-001Project Name Improving Public Investment

Management ProgramDepartment/Division PARD/PLCO

Country Nauru Executing Agency Department of Finance

Recipient Department of Finance, Nauru

Country Economic Indicators https://www.adb.org/Documents/LinkedDocs/?id=52073-001-CEI

Portfolio at a Glance https://www.adb.org/Documents/LinkedDocs/?id=52073-001-PortAtaGlance

2. Sector Subsector(s) ADB Financing ($ million)Public sector management Public expenditure and fiscal management 2.50

Reforms of state owned enterprises 2.50

Total 5.00

3. Operational Priorities Climate Change InformationAddressing remaining poverty and reducing inequalities

Accelerating progress in gender equality

Strengthening governance and institutional capacity

Climate Change impact on the Project

Low

Sustainable Development Goals Gender Equity and MainstreamingSDG 1.bSDG 16.6

Effective gender mainstreaming (EGM)

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 5.00 Sovereign Stand-Alone Policy-Based Lending (Grant): Asian Development Fund

5.00

Cofinancing 0.32 Government of New Zealand - Stand-Alone Policy-Based Lending (Grant) (Not ADB Administered)

0.32

Counterpart 0.00 None 0.00

Total 5.32

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 Nauru for the Improving Public Investment Management Program. 2. The proposed program aims to strengthen Nauru’s public investment management and fiscal sustainability, which are critical for effective service delivery and inclusive growth. It is part of long-standing assistance provided by the Asian Development Bank (ADB).1 The program builds on progress under previous policy-based programs and technical assistance (TA) to improve the management of public expenditure and assets, and the governance of state-owned enterprises (SOEs).2 It is consistent with ADB’s Strategy 2030 priority of strengthening governance and institutional capacity, particularly in small island developing states.3

II. PROGRAM AND RATIONALE A. Background and Development Constraints 3. Economic development challenges. Nauru is a Pacific microstate. Its population of about 13,000 is concentrated along the narrow coastal belt of its single 21-square kilometer island. Small size and remoteness raise the cost of providing public infrastructure and services while limiting competitiveness and economies of scale. The government and SOEs dominate economic activity and employment, with SOEs alone creating about half of gross domestic product (GDP) and one third of formal sector jobs. Nauru reported double-digit economic growth from 2010 to 2014, but this has slowed since with (i) a scaling down of the operations of the Australian-funded Regional Processing Centre (RPC) for asylum seekers; and (ii) falling phosphate exports, as the primary deposits of the island’s main resource near depletion. The scope for economic diversification, private investment, and job creation is limited; and the levels of social vulnerability, inequality, and noncommunicable disease are high.4 Women held only 10.5% of seats in the national parliament in 2019. 4. COVID-19 impacts. Nauru’s economy is affected by trade and travel disruptions stemming from the coronavirus disease (COVID-19) pandemic.5 Construction of infrastructure projects, which rely on imports and foreign workers, will slow. This will have follow-on impacts to

1 ADB. 2017. Pacific Approach, 2016–2020. Manila; ADB. 2016. Report and Recommendation of the President to

the Board of Directors: Proposed Policy-Based Grant to Nauru for the Fiscal Sustainability Reform Program. Manila; ADB. 2012. Report and Recommendation of the President to the Board of Directors: Proposed Policy-Based Grant to Nauru for the Public Financial Management Reform Program. Manila; ADB. 2013. Technical Assistance for the Establishment of the Pacific Region Infrastructure Facility Coordination Office. Manila; ADB. 2013. Technical Assistance for the Pacific Private Sector Development Initiative, Phase III. Manila; ADB. 2009. Technical Assistance for the Pacific Private Sector Development Initiative, Phase II. Manila; ADB. 2013. Technical Assistance for the Pacific Economic Management (Phase 2). Manila; ADB. 2013. Technical Assistance Completion Report: Regulatory and Governance Reform for Improving Water and Electricity Supply in Nauru. Manila; ADB. 2014. Technical Assistance to Nauru for the Tariff and Subsidy Policy Reform. Manila; and ADB. 2014. Technical Assistance to Nauru for the Institutional Strengthening of the Nauru Utilities Corporation. Manila.

2 The design and monitoring framework is in Appendix 1. 3 ADB. 2018. Strategy 2030: Achieving a Prosperous, Inclusive, Resilient, and Sustainable Asia and the Pacific.

Manila. 4 The 2012–2013 household income and expenditure survey showed that 24% of the population lived below the

national basic needs poverty line. The population Gini coefficient was estimated at 0.52. Ahmed Moustafa. Nauru Hardship and Poverty Report: Analysis of the 2012/13 Household Income and Expenditure Survey. Suva: Government of Nauru, National Statistics Office and United Nations Development Programme Pacific Centre.

5 The government declared a state of emergency on 16 March 2020 and has imposed significant containment measures including a near total ban on entry by air. Nauru had no reported cases of COVID-19 as at 22 April 2020.

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services, Nauru’s biggest sector, which are doubly affected by reduced activity associated with the RPC. Economic contraction of 1.7% is projected by the International Monetary Fund (IMF) in FY2020 followed by a recovery in FY2021 (Table 1). A slowdown in government revenue and an increase in spending is expected to erode the fiscal balance in FY2020. The government’s initial fiscal response to COVID-19 has included reprioritizing public expenditure towards health and containment efforts and providing liquidity support to SOEs to ensure critical services are maintained. Improved public expenditure management and governance of SOEs would help the government to confront rising fiscal risks related with COVID-19.

Table 1: Macro-Fiscal Performance and Outlook, FY2016–FY2021 (% of GDP unless otherwise indicated)

Item FY2016 FY2017 FY2018e FY2019e FY2020p FY2021p

Growth and Inflation Real GDP growth (% change)

3.0 (5.5) 5.7 1.0 (1.7) 1.3

Consumer prices (% change)

8.2 5.1 0.5 3.9 1.5 1.7

Government Finance Total revenue and grants 114.9 121.8 129.3 141.6 141.1 106.4

Revenue 91.6 100.6 108.5 126.6 120.7 90.6 Grants 23.3 21.3 20.8 15.1 20.4 15.8

Total expenditure 93.4 100.5 96.8 125.6 141.1 102.1 Overall balance 21.4 21.4 32.5 16.1 0.0 4.3

Including government NTF contributions

6.6

13.2

23.2 7.3 (10.3) (6.9)

NTF NTF stock 24.6 39.1 52.8 63.6 77.5 89.7 Debt Domestic debt 45.5 43.1 43.7 33.5 31.3 29.8 External debt 34.0 33.6 30.6 28.7 29.5 29.2

( ) = negative, e = estimate, FY = fiscal year, GDP = gross domestic product, IMF = International Monetary Fund, NTF = Nauru Intergenerational Trust Fund, p = projection. Sources: ADB estimates; Government of Nauru Budget Documents; International Monetary Fund.

5. Fiscal performance. Government domestic revenue increased fivefold from FY2012 to FY2019 because of the reopening of the RPC, improved fishing license receipts under a regional arrangement, and increased tax collection.6 The government has used recent fiscal surpluses to add to the Nauru Intergenerational Trust Fund (NTF) and reduce arrears. Fiscal surpluses have also enabled the government to build its cash buffer, resulting in government deposits equivalent to more than 2 months of non-RPC spending since August 2017, as recommended by the IMF.7 Limited access to credit markets and a vulnerability to economic shocks make it critical for Nauru to maintain adequate cash buffers (in addition to the NTF) to protect budget stability. If, as expected, RPC activity and the revenue this generates for the government decline over the medium-term, the IMF projects that fiscal spending would have to adjust to maintain sufficient cash buffers and contributions to the NTF.8 To maintain budget stability and to help put public debt on a sustainable path, the government needs to improve the management of its public investments.

6 In nominal terms. Sector Assessment (Summary): Public Sector Management (accessible from the linked

documents Appendix 2). 7 As at March 2020. Government of Nauru quarterly budget performance reports, various years. 8 IMF. 2020. Republic of Nauru 2019 Article IV Consultation—Press Release; Staff Report; and Statement by the

Executive Director for the Republic of Nauru. IMF Country Report No. 20/31. Washington, DC

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6. Public sector debt and state-owned enterprises. The IMF reports that total public sector debt, including SOE debt, equaled 86.8% of GDP in FY2018 and is considered unsustainable. This is higher than the level reported in the 2017 Article IV staff report because of the inclusion of some existing SOE debt and legacy debt pending resolution, and a new loan for phosphate mining. In addition, weak governance and monitoring have prevented Nauru’s SOEs from operating on strict commercial principles. Unfinanced directives to deliver community service obligations distort SOE financial performance incentives.9 SOE subsidies and equity injections totaled about 13.4% of Nauru’s public expenditure during the two years FY2019–FY2020, yet few SOEs keep up-to-date financial information. The absence of a central unit to monitor the performance of the SOE portfolio limited the government’s ability to ensure that they are run efficiently and in the best interest of the people of Nauru. Lacking a precise mandate, some SOEs compete with private companies, making it difficult for the private sector to grow in Nauru’s small market. The IMF has indicated that delays in implementing SOE reforms would lower growth prospects and jeopardize fiscal sustainability (footnote 8). The program will help address the risks posed by SOE debt by establishing directors’ obligations relating to public enterprise debt under the Public Enterprise Act, 2019; and creating a public enterprise monitoring unit with responsibility to advise the government on public enterprise loans and contingent liabilities, among other SOE issues. A measure to improve public debt reporting by the Department of Finance (DOF) is also included in the post-program partnership framework (PPPF). 7. Public expenditure management weaknesses. While a solid legislative framework existed in the Public Finance Act, 1997, the absence of adequate financial instructions meant that the responsibilities of delegated officers were unclear and fragmented. Unutilized modules of the government’s financial management information system (FMIS) further undermined expenditure management. The public could not easily access budget documents, which limited the transparency of public expenditure and debt. Combined with the effects of Nauru’s geographic isolation, continued weaknesses in public procurement often resulted in high unit costs for, and supply shortages of, publicly procured goods. 8. Public asset management weaknesses. Efficient management of assets has been a growing challenge for the government, given significant infrastructure investments by development partners and those made in connection with the RPC since 2012, as well as aging infrastructure assets in other sectors. Government departments generally lacked data on the condition and maintenance requirements of their assets to inform sound budget planning. This, combined with low institutional capacity for asset management, contributed to weak budget planning and maintenance spending. To build a sustainable future, Nauru needs to manage its public investments more effectively to ensure better value for money and better delivery of public services. 9. Past ADB engagement. ADB has addressed Nauru’s development financing needs and created incentives for reform through two policy-based programs, which were supported by TA to build government capacity to meet agreed policy actions.10 The 2012 Public Financial Management Reform Program, ADB’s first policy-based program in the country, provided

9 ADB. Nauru State Owned Enterprises Diagnostic. Unpublished. Nauru has 9 SOEs. 10 ADB. 2013. Technical Assistance for the Establishment of the Pacific Region Infrastructure Facility Coordination

Office. Manila; ADB. 2013. Technical Assistance for the Pacific Private Sector Development Initiative, Phase III. Manila; ADB. 2013. Technical Assistance for the Pacific Economic Management (Phase 2). Manila; ADB. 2013. Technical Assistance Completion Report; Regulatory and Governance Reform for Improving Water and Electricity Supply in Nauru. Manila; and ADB. 2008. Technical Assistance for the Pacific Private Sector Development Initiative, Phase II. Manila.

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$4 million in budget support during 2012–2014.11 The 2016 Fiscal Sustainability Reform Program, ADB’s second policy-based program in Nauru, provided $3.8 million for the NTF, including $1.8 million in cofinancing from Australia.12 These programs supported critical reforms, including (i) establishing the NTF in 2015 and saving windfall revenue from the RPC and fishing licenses which contributed to the NTF achieving a market value of more than $75.2 million by 30 June 2019;13 (ii) establishing a revenue office in 2011 and implementing the Employment and Services Tax Act 2014, which generated revenue equal to 9% of GDP in its first full year; (iii) introducing a fully automated FMIS in 2011, which helped to produce the government’s first financial statement since 1998, which was presented to Parliament in 2017; (iv) corporatizing the electricity and water utility in 2011, which has since implemented a performance-based management system and tariff reforms that have improved cost recovery and the supply of water and electricity; (v) adopting a debt management strategy in 2012; (vi) adopting a public procurement policy in 2012, which outsourced all major government and SOE procurement; and (vii) commencing the implementation of the cabinet-approved Nauru Economic Infrastructure Strategy and Investment Plan, which identified the country’s priority infrastructure investments for 2011–2018.14 10. Lessons. ADB’s previous policy-based grants have financed stand-alone operations that sequenced reforms to build on past achievements. Ongoing support in these reform areas was provided through TA. The program completion reports recommended that ADB’s focus on public financial management, asset management, the NTF, and SOE performance should continue in future operations (footnote 14). The program will do so while addressing the risks posed by SOE debt—a remaining weakness (para. 6). While previous policy-based programs have supported the adoption of a debt management strategy and corporate governance reforms at select SOEs, the program will establish clear responsibilities relating to debt across the SOE portfolio by establishing an overarching legal and monitoring framework. The program will also incorporate lessons during the first two policy-based programs by recognizing that (i) policy-based programs can achieve results when country ownership is strong, (ii) strong technical analysis can help ensure that a government will continue to view policy actions as appropriate even after the political and economic context changes, (iii) coordinated development partner TA support can help the government follow through on policy actions when local institutional capacity is low, and (iv) a tight focus on a limited set of policy actions can help ensure that reforms are delivered within the envisaged time frame. B. Policy Reform and ADB’s Value Addition 11. Government strategy. Nauru’s development vision, adopted in 2005, is “a future where individual, community, business, and government partnerships contribute to a sustainable quality of life for all Nauruans.”15 The Nauru Sustainable Development Strategy 2019-2030 translates this vision into seven development goals, two of which are relevant for the program: (i) the development of stable, trustworthy, fiscally responsible government; and (ii) the provision of enhanced social, infrastructure, and utility services. The Nauru Sustainable Development

11 ADB. 2012. Report and Recommendation of the President to the Board of Directors: Proposed Policy-Based Grant

to Nauru for the Public Financial Management Reform Program. Manila. 12 ADB. 2016. Report and Recommendation of the President to the Board of Directors: Proposed Policy-Based Grant

to Nauru for the Fiscal Sustainability Reform Program. Manila. 13 The NTF was established through a memorandum of understanding signed in November 2015 between the

governments of Australia and Nauru. It is governed by a committee that includes the Government of Nauru and contributing development partners. All service providers to the NTF—including the custodial bank, investment advisors, accountant, and auditor—are subject to supervision and regulation by Australian regulatory bodies.

14 ADB. 2016. Completion Report: Public Financial Management Reform Program in Nauru. Manila; and ADB. 2017. Completion Report: Fiscal Sustainability Reform Program in Nauru. Manila.

15 Government of Nauru. 2020. Nauru’s National Sustainable Development Strategy, 2019–2030. Yaren

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Strategy emphasizes the principles of effective leadership, collaboration, and cooperation with stakeholders; accountable and transparent processes; and measurable progress. The need to maintain economic stability, enhance public infrastructure, and rationalize SOEs to encourage greater private sector investment and economic diversification is also recognized. 12. Program description. ADB proposes a stand-alone policy-based program that improves the policy and institutional environment to enable higher returns to Nauru’s public investment. While the program supports critical reforms needed to address Nauru’s development constraints, policy dialogue has shown that several follow-up steps will be crucial when the program ends. The government and ADB have agreed on a PPPF, which will ensure that recently approved policy decisions and legislative changes are fully implemented, and that support will be there for the next phase of associated reforms.16 A follow-on program is included in the country operations business plan, but discussions are ongoing to determine which modality will be most appropriate to support the next phase of reforms.17 ADB is also considering support through its COVID-19 Pandemic Response Option to help counter the macroeconomic and health impacts of COVID-19 in Nauru. The stand-alone modality is considered appropriate for the current program because of (i) the success of the ADB’s Public Financial Management Reform Program and Fiscal Sustainability Reform Program, which also employed this modality; (ii) lessons from prior ADB-financed programs to avoid complexity and ensure a tight focus on a limited set of policy actions; (iii) the need to leverage support for reform in a targeted manner in fragile and conflict-affected environments; and (iv) the current uncertainties regarding the most appropriate modality to support the next phase of Nauru’s reforms. 13. Program alignment. ADB and the government agreed to focus reform efforts under the program in three areas critical to addressing Nauru’s development challenges and objective of a sustainable quality of life: (i) public expenditure management, (ii) public asset management, and (iii) the governance of SOEs. The eight prior actions to be accomplished before program grant effectiveness are outlined below and set out in the policy matrix (Appendix 4). The program is aligned with IMF policy advice (footnote 8); ADB’s Pacific Approach for 2016–2020, including its three-pronged strategy to reduce costs, manage risks, and enable value creation;18 and three operational priorities of ADB’s Strategy 2030 to address poverty and inequality (through better management of the public investments needed for equitable delivery of public services), to accelerate progress in gender equality (by incorporating gender provisions in public asset management and the governance of SOEs), and to strengthen governance and institutional capacity. The program is also in line with ADB’s Strategy 2030 requirement for a differentiated approach by ADB to focus on institutional strengthening in fragile and conflict-affected situations and to help small island developing states manage financial and economic risks, and reform SOEs (footnote 3). 14. Reform area 1: Public expenditure management improved. Policy actions under this reform area focus on strengthening budget control, reporting, and transparency; saving windfall revenue in the NTF to finance future development needs; and assessing the remaining weaknesses in public procurement. These actions will help Nauru sustain a responsible fiscal position, promote the strategic allocation of resources, and provide confidence to development partners to continue their ongoing support:

16 The PPPF has been used successfully in other Pacific developing member countries, providing a platform for

ongoing policy dialogue in years when ADB does not provide policy financing and guiding the focus of any subsequent program. ADB. 2016. Completion Report: Strengthening Fiscal Stability Program in Kiribati. Manila.

17 ADB. 2019. Country Operations Business Plan: Eleven Small Pacific Island Countries, 2020–2022. Manila. 18 ADB. 2017. Pacific Approach, 2016–2020. Manila.

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(i) Budget control, reporting, and transparency. As a prior action, the secretary of finance issued new financial instructions on general principles, payments, and budget in October 2018, which outline the responsibilities of delegated officers to ensure that financial transactions are properly managed, controlled, recorded, and reported, consistent with Nauru’s legislative framework for public finances; the general ledger and accounts receivable functions of the FMIS were made fully functional; and audited financial statements for FY2015 and FY2016, the annual and quarterly budget documents for FY2018 and FY2019, and the quarterly budget performance reports for FY2019 were published on the government website. Providing the public with easy access to information on government revenues, expenditure, and debt is a critical step in building public accountability and transparency.

(ii) Nauru Intergenerational Trust Fund. ADB’s Fiscal Sustainability Reform Program and TA supported the establishment of the NTF in FY2016 as a mechanism for saving windfall revenue and funding future service delivery (para. 9).19 Government contributions are guided by a set of targeted contribution ranges that specify the percentage of domestic revenue to be deposited by the government each year, with the rate rising progressively.20 As a prior action and in line with its targeted contribution, the government maintained its commitment toward the NTF by depositing an amount equivalent to 10.1% of FY2018 revenue (excluding pass-through RPC-related revenue) in the NTF for FY2019.21 In addition, the government used windfall revenue in FY2019 to make an early deposit of $1.4 million toward the following FY2020 targeted contribution.

(iii) Public procurement. While Nauru had outsourced major government and SOE procurement, weaknesses remained that reduced the quality and value for money of Nauru’s public services.22 To address the remaining deficiencies, the government requested a review of public sector and SOE procurement practices, for which ADB provided TA support. As a prior action, in June 2019, the cabinet considered the outcome of this review and approved its proposed reform options to strengthen public procurement. The government has since amended the Public Finance Act to enable SOEs to be engaged in procurement. Improving procurement planning will be a critical next step and is included in the PPPF.

15. Reform area 2: Public asset management improved. Policy actions under this reform area aim to improve the balance between the government’s capital investments in infrastructure and its spending to maintain them. The cabinet approved an infrastructure asset management policy in 2017. To provide a framework for affordable asset management, the policy called for the development of an integrated infrastructure asset management plan, which has been supported under this program.

(i) Asset register. As a prior action, the government established a central asset

register to reflect the assets’ condition, location, and financial information—data that was generally not available previously, except for the Nauru Utilities Corporation. The register, which has been operational since June 2019, covers

19 ADB. 2013. Technical Assistance for Pacific Economic Management (Phase 2). Manila. 20 After the build-up phase, which is prospectively set to FY2033, the NTF will enter a distribution phase. The NTF

committee will determine when the distribution phase is to begin based on the ability of the NTF to provide a material amount of budget financing in perpetuity.

21 This was equivalent to $10.4 million. 22 The government’s procurement policy required the outsourcing of government and SOE procurement greater than

$3,521 (A$5,000 equivalent, excluding bulk fuel procurement) to an independent procurement agent.

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government assets (including buildings, roads, water and sanitation systems, coastal protection, and vehicles) with a replacement cost of $25,000 or more.23

(ii) Integrated infrastructure strategic plan. As a prior action, the cabinet approved the adoption and implementation of the Nauru Integrated Infrastructure Strategic Plan in November 2019. This plan uses information from the asset register and applies economic and social criteria, including a gender-specific provision relating to the employment prospects an investment would generate for women, and a climate change and disaster risk vulnerability provision, to provide a framework to identify and prioritize rehabilitation works, upgrades, and new capital investments for the next 5 years from 2019.24 It also estimates the annual maintenance budget required to maintain both current assets and priority infrastructure projects.

16. Reform area 3: Governance of state-owned enterprises enhanced. The intent of the program’s SOE governance policy actions is to overhaul the current policy and legislative framework and introduce centralized monitoring of SOE performance across all sectors.

(i) State-owned enterprise policy. As a prior action, the cabinet approved a commercially oriented SOE policy in November 2018. The policy outlines the rationale for government ownership of SOEs and establishes principles to guide SOE reforms.

(ii) Public enterprise bill. As a prior action, in June 2019, the cabinet approved a public enterprise bill for submission to Parliament, based on the new SOE policy. This bill, which was subsequently enacted by Parliament, creates the legislative framework for SOEs to be commercially successful, while establishing reporting and transparency requirements to the government as the owner of the SOEs. Under the bill, responsible ministers must present to Parliament the annual reports of public enterprises (which include audited financial statements), while directors of public enterprises must take steps to avoid insolvency and could be liable if they fail to take reasonable steps to ensure the public enterprise does not incur a debt it cannot repay. The bill establishes processes to make SOE delivery of community service obligations financially sustainable; and it directs SOEs to promote gender equality through their employment practices, policies, and board memberships.

(iii) State-owned enterprise monitoring. As a prior action, in February 2019, the cabinet approved the establishment and resourcing of the Public Enterprise Monitoring Unit in the DOF. The unit is responsible for reviewing public enterprise performance and advising the government on issues such as public enterprise operations and governance; community service obligations; the appointment of directors; restructuring initiatives; and investments in, loans to, and guarantees for public enterprises.

17. ADB’s value addition and development partner coordination. ADB is coordinating with other development partners to ensure policy actions are correctly sequenced and the TA is well targeted.25 Cooperation is particularly close with Australia and New Zealand. ADB also maintains a close working relationship with the IMF, including joining the IMF’s Article IV consultations in Nauru in September 2019. ADB and New Zealand, which is cofinancing the program, have coordinated policy dialogue through a single policy matrix. Australia is financing technical advisors

23 The register covers government departments and key SOEs. 24 The prioritization exercise also considered the general safety and security a planned infrastructure investment would

provide in the public space, which is particularly relevant to women. 25 Development Coordination (accessible from the linked documents Appendix 2).

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to the DOF. Along with advisory support provided by the IMF’s Pacific Financial Technical Assistance Centre, this support from Australia has helped the government improve its budget control, reporting, and transparency. Two regional ADB TA projects provided international expertise and advisory services to support six of the program’s eight prior actions.26 C. Impacts of the Reform 18. The program is aligned with the following impact: public investment management and fiscal sustainability strengthened, which are crucial for the effective delivery of public services and the achievement of inclusive growth. Nauru’s public expenditure management will be improved in reform area 1 through the full functionalization of the FMIS, the introduction of new financial instructions, the publication and public availability of budget documents and financial statements that include public debt, increased funding of the NTF for future service delivery, and a review of procurement practices that will enable the government to focus on its most pressing procurement issues (para. 14). Policy actions in reform area 2 will improve Nauru’s public asset management by ensuring better information on the condition and maintenance requirements of public assets and the introduction of a framework to prioritize infrastructure spending to enhance asset service life (para. 15). In reform area 3, the establishment of an overarching policy, legislative, and monitoring framework for SOE governance will reduce the fiscal risks that poorly performing SOEs and SOE borrowing pose; and free up public resources for critical expenditures (para. 16). Taken together, the program reforms will promote the strategic allocation of resources, which will help Nauru sustain a responsible fiscal position and achieve inclusive growth. By facilitating better asset maintenance and improving the governance of SOEs, the program will also create synergies with ADB’s infrastructure investments, including the new seaport and solar facility, which SOEs will own and manage.27 D. Development Financing Needs and Budget Support 19. The government has requested a grant not exceeding $5.00 million from ADB’s Special Funds resources (Asian Development Fund) to help finance the program. The Government of New Zealand will provide $0.32 million in budget support as cofinancing.28 The program will help the government to meet its FY2020 budget financing gap, which is estimated at $15.8 million without budget support. E. Implementation Arrangements 20. The program implementation period is from March 2018 to June 2020. The DOF will be the executing agency, responsible for the program’s overall implementation. This includes overseeing and coordinating the timely implementation of agreed policy actions with the Department of Infrastructure Development and the SOEs, providing evidence of the accomplishment of the policy actions, and managing disbursements and the maintenance of records. The DOF and the Department of Infrastructure Development will be the implementing agencies. Program funding will be provided as a single tranche grant of $5 million and will be

26 ADB. 2013. Technical Assistance for the Pacific Economic Management (Phase 2). Manila; and ADB. 2013.

Technical Assistance for the Establishment of the Pacific Regional Infrastructure Facility Coordination Office. Manila.

27 ADB. 2017. Report and Recommendation of the President to the Board of Directors: Proposed Grant and Administration of Grants to Nauru for the Sustainable and Climate-Resilient Connectivity Project. Manila; and ADB. 2019. Pacific Renewable Energy Investment Facility—Nauru: Solar Power Development Project. Manila.

28 The Government of New Zealand plans to disburse its budget support (A$0.5 million) following ADB’s confirmation that all policy actions are completed. ADB will not administer this financing.

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withdrawn by the government following satisfaction of the conditions for effectiveness. The government will provide the necessary counterpart funds to finance costs associated with the implementation of the reforms under the program. Two regional ADB TA projects supported the government to implement the prior actions, while a third regional ADB TA, approved in 2019, will support the government in implementing actions laid out in the PPPF.29 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).30

III. DUE DILIGENCE 21. Safeguards. In accordance with ADB’s Safeguard Policy Statement (2009), the program is classified category C for the environment, involuntary resettlement, and indigenous peoples. Program activities are confined to policy and institutional reforms, and none will result in or lead to involuntary resettlement or affect indigenous peoples. No adverse environmental impacts have been identified. 22. Gender. While ADB’s 2016 Fiscal Sustainability Reform Program was classified no gender elements, the program is classified effective gender mainstreaming and two of the three reform areas have gender indicators. In reform area 2, consideration of the job opportunities for women that a project will provide is among the economic and social criteria the government’s integrated infrastructure strategic plan sets for prioritizing public infrastructure spending (para. 15). The government plans to incorporate the prioritization process into its budget planning beginning in FY2021 as a PPPF measure. In reform area 3, Nauru’s Public Enterprise Act, 2019 requires public enterprises to promote gender equality in their employment practices and policies and on their boards (para. 16). To ensure that directors of public enterprises are fully aware of their new responsibilities under the Public Enterprise Act, the DOF will coordinate training with current and prospective directors, with a target of at least 30% women, as a PPPF measure. 23. Poverty and social. The improved management of public expenditures and assets the program will bring about will help the government maintain public infrastructure and services in the event of economic shocks or declining government revenues. This is critical to the well-being and living standards of low-income households and the country’s population overall. Better SOE governance will also benefit the national welfare, given the dominance of underperforming SOEs in Nauru’s small economy and the range of services they alone provide. By helping ensure a strategic allocation of public resources, the program will help safeguard the responsible fiscal position the country needs to improve the lives of its people. 24. Governance. Weaknesses in budget reporting, transparency, and execution have been reduced through prior actions completed in the program’s reform area 1 (para. 14). Although the government is able to implement its budget, challenges remain in the areas of procurement, cash reconciliation, debt management, financial reporting on government equities in SOEs, and policy-based budgeting. Advisory services through development partner TA and ongoing policy dialogue are addressing some of these weaknesses.31

29 ADB. 2013. Technical Assistance for the Pacific Economic Management (Phase 2). Manila; ADB. 2013. Technical

Assistance for the Establishment of the Pacific Regional Infrastructure Facility Coordination Office. Manila; and ADB. 2019. Technical Assistance Report: Improving Pacific Public Financial Management Facility. Manila.

30 List of Ineligible Items (accessible from the linked documents Appendix 2). 31 Long-term advisors financed through the Government of Australia’s Pacific Technical Assistance Mechanism

supplement the human resources at Nauru’s Treasury and in the government’s accounting and revenue offices. ADB will also use regional TA to support measures identified in the PPPF. ADB. 2019. Technical Assistance for Improving Pacific Public Financial Management Facility. Manila.

10

25. Risks. Major risks and mitigating measures are summarized in Table 2 and described in detail in the risk assessment and risk management plan.32 Reform measures identified in the PPPF, including the audit of financial statements for FY2017–FY2019, and TA will help address the remaining fiduciary risks. The program’s integrated benefits and impacts are expected to outweigh the costs. ADB’s Anticorruption Policy (1998, as amended to date) was explained to and discussed with the government and the DOF.

Table 2: Summary of Risks and Mitigating Measures Risks Mitigation Measures

Capacity constraints and staff turnover at government agencies and SOEs slow the implementation of policy reforms.

Reforms are prioritized and sequenced to avoid overburdening the small public administration staff and decision makers. Technical assistance by development partners will continue to help the government undertake the required policy actions.

External shocks, such as the COVID-19 pandemic, undermine the fiscal position and/or divert administrative and political attention away from reforms.

The program seeks to build fiscal resilience by improving expenditure and asset management and the governance of SOEs. The government has established fiscal cash reserves to provide a cushion against adverse external shocks. The NTF framework provides for lower, delayed, or no government contribution in the event of unforeseen negative shocks.

Source: Asian Development Bank.

IV. ASSURANCES

26. The government has assured ADB that 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.33 The government has agreed with ADB on certain covenants for the program, which are set forth in the draft grant agreement.

V. RECOMMENDATION 27. 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 $5,000,000 to Nauru from ADB’s Special Funds resources (Asian Development Fund) for the Improving Public Investment Management Program, on terms and conditions that are substantially in accordance with those set forth in the draft grant agreement presented to the Board.

Masatsugu Asakawa President

12 May 2020

32 Risk Assessment and Risk Management Plan (accessible from the list of linked documents in Appendix 2). 33 Grant Agreement (accessible from the list of linked documents in Appendix 2).

Appendix 1 11

DESIGN AND MONITORING FRAMEWORK

Country’s Overarching Development Objectives

Stable, trustworthy, and fiscally responsible government developed (National Sustainable Development Strategy, 2019–2030)a

Enhanced social, infrastructure, and utilities services provided (National Sustainable Development Strategy, 2019–2030)a

Results Chain Performance Indicators with

Targets and Baselines Data Sources and

Reporting Mechanisms Risks

Effect of the Reform Public investment management and fiscal sustainability strengthened

a. Government contributions to the NTF equal at least A$88 million by June 2021 (June 2018 baseline: A$47.13 million) b. More than 50% of infrastructure spending linked to the Nauru integrated infrastructure strategic plan during FY2021 (2018 baseline: Nauru integrated infrastructure strategic plan not approved) c. Four SOEs prepare audited financial statements and submit their annual reports for FY2021 to the responsible minister by 31 December 2021 (December 2018 baseline: Two SOEs published audited financial reports)

a. 2021 Annual Report for the NTF for the People of the Republic of Nauru b. National budget documents c. Confirmed by ADB and a letter from the minister for finance confirming the submission of the annual reports and preparation of audited financial statements

Severe shock to government revenue results in lower or deferred contributions to the NTF Capacity constraints among SOE management prevent the timely preparation of annual reports and accounts

Reform Areas 1. Public expenditure management improved

Key Policy Actions By December 2019: 1.1 Cabinet considers the review of Nauru’s procurement system and approves its proposed reform options to strengthen public procurement (2017 baseline: Not approved) 1.2 Department of Finance undertakes actions to ensure widespread access to information on public finances by groups including the private sector, men, and women, through the publication of the following

1.1 Cabinet decision 1.2 Government website, confirmed by ADB

Capacity constraints and staff turnover reduce the quality of reform implementation

12 Appendix 1

Results Chain Performance Indicators with

Targets and Baselines Data Sources and

Reporting Mechanisms Risks

whole-of-government reports on the government website: audited financial statements for FY2015 and FY2016, annual and supplementary budgets for FY2018 and FY2019, and quarterly budget performance reports for FY2019 (FY2017 baseline: Not available online) 1.3 The government undertakes action to help ensure that financial transactions are properly managed, controlled, recorded, and reported, through the issuance of new financial instructions on general principles, payments, and budget (2017 baseline: Not approved) 1.4 The government maintains its commitments toward the NTF through deposit of a financial contribution to the NTF for fiscal year (FY) 2019 in an amount equivalent to or exceeding 10.1% of the previous year’s revenue (excluding pass-through Regional Processing Centre revenue) in line with the target contribution range (FY2018 baseline: Financial contribution equivalent to 10.1% of the previous year’s revenue, excluding pass-through Regional Processing Centre revenue).

1.3 Government website, confirmed by ADB 1.4 Budget documents and deposits in the NTF

2. Public asset management improved

2.1 The government establishes a central asset register for managing public infrastructure assets to convey the assets’ condition, location, and financial information (2017 baseline: Not applicable) 2.2 Cabinet approves the adoption and implementation

2.1 Letter from the minister for finance attesting to the establishment of the asset register, confirmed by ADB 2.2 Cabinet decision

Appendix 1 13

Results Chain Performance Indicators with

Targets and Baselines Data Sources and

Reporting Mechanisms Risks

3. Governance of SOEs enhanced

of the Nauru Integrated Infrastructure Strategic Plan, which prioritizes capital investment, rehabilitation, and maintenance of public infrastructure based on criteria that include a gender-specific provision relating to the job prospects for women associated with planned investments (2017 baseline: Not approved) 3.1 Cabinet approves an SOE policy that establishes principles to guide SOE reform (2017 baseline: Not approved) 3.2 Cabinet approves submission to Parliament of a public enterprise bill that sets accountability, monitoring, and reporting responsibilities, and directs SOEs to promote gender equality through their employment practices and policies, and within board membership (2017 baseline: Not approved) 3.3 Cabinet approves the establishment and resourcing of a public enterprise monitoring unit responsible for providing analysis and advice on the operation, performance, and governance of SOEs (2017 baseline: Not approved)

3.1 Cabinet decision 3.2 Government gazette 3.3 Cabinet decision to establish the unit and a letter from the minister for finance confirming that the unit is resourced

Budget Support

ADB: $5 million (grant)

Government of New Zealand $0.32 million (grant) (A$0.5 million equivalent)

ADB = Asian Development Bank, NTF = Nauru Intergenerational Trust Fund, SOE = state-owned enterprise. a Government of Nauru. 2020. Nauru’s National Sustainable Development Strategy, 2019–2030. Yaren. Source: Asian Development Bank.

14 Appendix 2

LIST OF LINKED DOCUMENTS http://www.adb.org/Documents/RRPs/?id=52073-001-2

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

Appendix 3 15

DEVELOPMENT POLICY LETTER

16 Appendix 3

Appendix 3 17

18 Appendix 4

POLICY MATRIX

Reform Area

Policy Actions Post-Program Partnership Framework

1. Public Expenditure Management

1.1 Cabinet considered the review of Nauru’s procurement system, and approved its proposed reform options to strengthen public procurement. (Letter from Minister for Finance discussing the public procurement review. Copy of Cabinet conclusion approving the public procurement review and its proposed reform options, outlining the decision on next steps.)

To sustain efforts to improve public expenditure management : • The Government shall

undertake measures to strengthen public procurement planning.

• Department of Finance shall prepare cash reconciliations for FY2017, FY2018, FY2019;

• Department of Finance shall prepare and submit for audit the financial statements for FY2017, FY2018 and FY2019 in accordance with the international public sector accounting standards (IPSAS) for cash basis accounting;

• Department of Finance shall undertake measures to improve public debt recording and reporting; and

• The Government shall contribute to the NTF in FY2020 in line with the contribution guidelines.

1.2 Budget execution, reporting and transparency was improved through:

1.2.1 The Department of Finance’s general ledger and accounts receivable functions of the FMIS made fully functional; 1.2.2 Government undertook actions to help ensure financial transactions are properly managed, controlled, recorded and reported, through issuance of new Financial Instructions by the Secretary for Finance which govern general principles, payments and budget; and 1.2.3 Department of Finance undertook action to ensure widespread access to information on public finances by groups including the private sector, men and women, through publication of whole-of-government reports on the Department of Finance website: • Audited financial statements for FY2015

and FY2016; • FY2019 quarterly budget performance

reports; • FY2018 and FY2019 National Budgets;

and • FY2018 and FY2019 Supplementary

Budget(s). (Letter from the Minister for Finance certifying that the general ledger and accounts receivable functions are fully functional. Copy of the Regulation giving authority to the Secretary for Finance to issue Financial Instructions and a copy of the Financial Instructions governing general government principles, payments and budget. Screenshot of Government of Nauru website showing posting of the reports listed in 1.2.2 and 1.2.3).

Appendix 4 19

1.3 Government maintained its commitments towards the NTF by contributing the equivalent of 10.1% of FY2018 revenue (excluding pass-through RPC-related revenue) by June 2019 to the NTF for FY2019, in line with the target contribution range. (Letter from the Minister for Finance certifying the government has expended the funds and attached confirmation of the deposit in the NTF).

2. Public Asset Management

2.1 Government established a central asset register for managing public infrastructure assets to convey the assets’ condition, location, and financial information. (Letter from the Minister for Finance certifying that the central asset register for public infrastructure is fully functional).

To sustain efforts to improve public asset management, the Government shall: • Reflect the asset register

financial information (where appropriate) in the FMIS; and

• Incorporate the findings of the Nauru Integrated Infrastructure Strategic Plan into the budget planning for FY2021, including reference to the prioritization process that includes gender-based criteria such as women’s’ employment prospects, and the general safety advantages an investment will bring.

2.2 Cabinet approved the adoption and implementation of the Nauru Integrated Infrastructure Strategic Plan which prioritizes new rehabilitation and maintenance of public infrastructure investments based on criteria that includes a gender-specific provision on the employment prospects for women associated with planned investments. (Copy of Cabinet conclusion approving the Nauru Integrated Infrastructure Strategic Plan and a copy of the Strategic Plan).

3. Governance of State-Owned Enterprises (SOEs)

3.1 Cabinet approved a SOE Policy that establishes principles to guide SOE reform. (Copy of Cabinet conclusion approving the SOE Policy)

To sustain efforts to improve the governance of SOEs, the Government shall: • Prepare and bring into force

the implementing regulations required under the Public Enterprises Act to ensure compliance with the Act, including compliance by public enterprises with the Act’s requirements relating to appointment of directors and investments in, loans to and guarantees of public enterprises;

• Maintain adequate budget to staff the Public Enterprise Monitoring Unit within the Department of Finance;

3.2 Cabinet approved submission to Parliament of a public enterprise bill which creates a framework for SOEs to be commercially successful while establishing accountability and reporting arrangements to the government as owner of the SOEs, and directs SOEs to promote gender equality through their employment practices and policies, and within memberships of Boards. (Copy of the Government Gazette and the Public Enterprise Act)

20 Appendix 4

3.3 Cabinet approved the establishment and resourcing of a Public Enterprise Monitoring Unit in the Department of Finance responsible for providing analysis and advice on the operation, performance and governance of SOEs. (Copy of Cabinet conclusion approving the establishment of the Public Enterprise Monitoring Unit)

• The Public Enterprise Monitoring Unit, with TA support, provides training to current and prospective SOE directors, (with a target of at least 30% women trainees) on their responsibilities under the Public Enterprise Act, and collects sex-disaggregated data on board memberships; and

• Introduce reporting by the Public Enterprise Monitoring Unit to the Minister responsible for the administration of the Public Enterprise Act on the performance of public enterprises (as performance data becomes available).

FMIS = financial management information system; FY = fiscal year ending on 30 June of the year noted, e.g. FY2018 ends on 30 June 2018; NTF = Nauru Intergenerational Trust Fund; SOE = State-Owned Enterprise. Source: Asian Development Bank.