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The intended impact of the program, as set out in the policy matrix and to be supported by the program grant and supporting technical assistance (TA), is to support the achievement of sustained economic growth and fiscal stability as prioritized in Tuvalu's national plan objectives, through facilitating achievement of the PBIs. The expected outcome is improved government fiscal planning and management capacity.

The achievement of the expected outcome will be reflected in: (i) an annual budget which is in alignment with medium term fiscal objectives, (ii) Government transparently monitoring its financial support to public enterprises and presenting such information in the budget papers; (iii) public enterprises acting in compliance with all aspects of the Public Corporations Act; and (iv) improvements in key financial indicators for public enterprises.

Widely scattered in a 900,000 km2 exclusive economic zone of ocean almost 1,000 km north of the Fiji Islands, Tuvalu consists of 9 low-lying coral atolls with a total area of only 26 km2, and a population of 9,652 people. Few opportunities exist for economic development and ecologically sustained growth. The annual gross domestic product (GDP) is around US$20 million, with the capital island, Fongafale on the Funafuti atoll hosting more than half of the population and accounting for two-thirds of the GDP. Real GDP per capita is estimated to have grown at an average annual rate of 2% between 1995 and 2005. The growth was supported by public expenditure, particularly through one-off construction projects and increases in the wage and salary budget.

The fragile nature of the Tuvalu economy stems from the heavy reliance on income earned from Tuvalu Trust Fund (TTF), fish licensing fees, 'tv' internet domain revenue sources that are largely outside the Government's control. The total revenue fluctuates for example annual revenue ranged from A$13 million to A$47 million annually over the period 2000-2005 and in addition to being volatile, the future revenue stream is difficult to accurately forecast. Expenditure decisions are, thus, made in the face of considerable uncertainty as to how they will be funded. The government has exhibited a tendency in the face of fluctuating revenues to increase expenditure in the windfall years. Budget credibility has suffered, together with reduced service delivery, as the planning and management of key public services is undermined by the general absence of a multi-year perspective and poor in-year reporting capability.

The fiscal budget revenue amounted to A$35.9 million and expenditure to A$39.7 million in 2007. The trend level of expenditure and net lending is found to be above the trend level of revenue and grants, giving rise to an underlying budget deficit. If recent trends continue, it is estimated that the budget will be in deficit by approximately A$2.5 million in a typical year, which is on the order of 10% of GDP. This would be an unsustainable fiscal position. The weak fiscal position has arisen because expenditure was allowed to grow in years when revenue was high, and it has been difficult to cut expenditure back to fit into the lower level of revenue and grants.

The principal structural weaknesses impeding public finance management are (i) a large and continuous trade imbalance; (ii) a large public sector with a low productivity rate and a lack of focus on customer service; (iii) a pervasive government ownership of enterprise activities, most of which require fiscal concessions and/or subsidies; (iv) an often weak fiscal situation; (v) a small under-developed private sector, which accounts for only one-quarter of GDP; (vi) high tax rates and import duties; (vii) an investment approval process that is non-transparent and burdensome for investors; (viii) an underdeveloped financial system typified by low domestic resource mobilization; (ix) a growing labor force experiencing high levels of under-employment; and, (x) a land tenure system which makes it difficult to obtain land for commercial development.

Tuvalu's national plan (Te Kakeega II) denotes paramount goals of sustainable budgets and the effective use of resources to achieve public policy priorities, attainment of education and health objectives. The Government of Tuvalu (GOT) recognizes the need for correction in fiscal management and has adopted, in close coordination and consultation with the Board of the Tuvalu Trust Fund (TTF) and the development partners more broadly, a road map for greater fiscal control based on a set of performance benchmark indicators. The Performance Benchmark Indicators adopted by the Government and agreed with the Asian Development Bank (ADB), AusAID, and NZAID are aimed at ensuring (i) prudent recurrent fiscal expenditures; (ii) maintenance of fiscal reserves; (iii) prudent debt management; (iv) prioritized education; and, (iv) health spending. Each Indicator has specific and measurable targets, which are updated annually as required and are linked to the objectives of the Te Kakeega II. The AusAID and NZAID assistance are largely linked with facilitating the gradual achievement of the Benchmarks, as outlined in the draft Country Partnership Strategy (CPS). In accordance with the CPS ADB has aligned its commitment to Te Kakeega II through a focus on improved public expenditure and financial management. The proposed program grant directly supports this focus. It is proposed that this is achieved by a program grant which will support improved fiscal stability, including through efforts to improve public enterprise performance.