Palau: Economic Outline

Economic Indicators

Palau is among the most performing small insular countries of the Pacific, but it remains vulnerable to external economic shocks, the impact of climate change, and other environmental and weather-related risks. Since gaining independence, Palau has operated under a Compact of Free Association (COFA) with the United States, which expired in 2023. A new COFA agreement was approved by the U.S. on March 9, 2024, and will deliver a total of USD 6.5 billion in assistance to the three North Pacific countries (of which USD 889 million to Palau) over the next 20 years starting in FY24. Palau emerged from the pandemic grappling with significant output loss, high external debt, and inflation. Following a 2% contraction in FY2022, economic activity is estimated to have stagnated, growing by only 0.8% in FY2023. The decline in construction activity, due to delays in new infrastructure projects, offset a modest increase in tourism. Despite fully lifting border restrictions in July 2022, the recovery in the tourism sector has been slow, reflecting limited flights, stricter travel restrictions in Palau's East Asian source markets, and the appreciation of the U.S. dollar. Output is anticipated to pick up pace, reaching 12.4 percent growth in FY2024 (IMF).

After peaking at 13.1% in FY2020, the fiscal deficit declined to 3.2% in FY2022, largely due to the expiration of pandemic support measures. The fiscal deficit was projected to turn into a small surplus (0.3% of GDP) in FY2023, driven by higher tax revenues, partly from the early gains of tax reform, with PGST alone yielding about 6.5% of GDP in its first year. Expenditure is estimated to have significantly decreased (by 17.5% of GDP), primarily due to a 15.4% decline in project grants, including those related to the expiration of support from the US CARES Act. The FY2024 budget, recently passed by the Palau National Congress (OEK), includes conservative tax revenue projections and envisions a broadly flat expenditure envelope (excluding expenditures financed through non-Compact grants). It also accommodates an additional 7% increase in the public sector hourly wage. With the full-year impact of the tax reform and the anticipated recovery in economic activity, tax revenues are projected to rise. Furthermore, higher budgetary grants under CRA-23 are expected to provide a further boost, while expenditure is projected to remain contained. As a result, the fiscal surplus is projected to increase to 2.0% of GDP, up from the 0.3% of GDP projected for FY2023. Meanwhile, inflation surged to historical highs, reaching 13% in both FY2022 and FY2023. This rise was driven by elevated import prices for food and fuel, influenced by Russia's conflict in Ukraine and global disruptions in supply chains. Additionally, the introduction of the Palau Goods and Services Tax (PGST) and one-off adjustments in utility tariffs contributed to this increase. In FY2024, inflation is expected to ease to 5.9% as the effects of one-time price hikes diminish (IMF).

The archipelago of Palau has one of the highest living standards in the Pacific. The population enjoys a per capita income roughly double that of the Philippines and much higher than Micronesia (USD 15,572 in 2022 as per the World Bank). Around 70% of Palau's population resides in Koror, the center of the tourism industry. The unemployment rate is very low (1.7% according to government statistics). The country's main challenges are to strengthen its resilience and ensure its medium-term growth.

Source: World Bank - Latest available data.

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Latest Update: May 2024