Mission Concluding Statement 

Republic of the Marshall Islands Preliminary Conclusions of the 2012 IMF Staff Visit

November 7, 2012

This statement summarizes the mission’s preliminary views and policy recommendations based on meetings in Majuro from November 5–7, 2012. This year’s staff visit takes stock of the economic developments since the 2011 Article IV consultation amid increasing uncertainties surrounding the global economy.

The economy of the Republic of the Marshall Islands (RMI) experienced an impressive recovery in FY2010 from the recession in preceding years, but the rebound proved short lived. After a 5½ percent expansion in FY2010, helped by an expanding fishery sector, growth fell sharply to 0.8 percent in FY2011, as a result of high commodity prices, labor shortages, and delay in the airport renovation project due to disagreement on the environment protection standard to be applied. Inflation remained elevated at 5½ percent in FY2011, reflecting high commodity prices. The economy is heavily dependent on foreign grants which fund a large public sector.

In the near term, staff estimates that growth will remain weak. GDP growth is projected at 1.9 percent in FY2012 and expected to stay around 1½ percent over the medium term. Resumption of the airport renovation project after the agreement between the U.S. and RMI government on the environment standard, and the planned Ebeye water and sanitation project to be funded by the Australian Agency for International Development and administered by Asian Development Bank (ADB), along with rising fish exports, will render support to the growth in the near term, but will be largely offset by shrinking public sector demand from declining Compact grants. Inflation will gradually decline from 5.7 percent in FY2012 as the effect of commodity prices increase tapers off, and is expected to approach 2 percent in the medium term.

Risks to the outlook are on the downside, with a further global slowdown affecting exports, foreign direct investments and non-U.S. grants. The economy’s high import dependence poses a substantial risk to real incomes from fluctuations in commodity prices and private foreign direct investment. On the upside, possible satellite upgrading project in the Kwajalein military base and airport renovation projects in outer islands could provide some additional support to growth over the next several years.

The fiscal balance is estimated to turn into a deficit in FY2012, according to the latest available data to the authorities. Although the FY2012 budget outturn data are still being finalized, the deficit is likely to be about $2.0 million (1.1 percent of GDP), compared to the surplus of 3.7 percent of GDP in FY2011. While budgeted current expenditure has been contained relative to GDP in recent years, volatile domestic revenue, declining foreign grants, and occasional off-budget spending by ad-hoc directives pose constant threats to maintaining fiscal surpluses. Financial assistance to SOEs in the form of subsidy and capital transfer remains sizable.

With the expiry of Compact grants looming in FY2023, achieving long-term budgetary self-reliance and sustained growth is becoming an even more urgent task for the RMI. The Compact Trust Fund (CTF), established in FY2004 to accumulate financial assets to generate sufficient investment income to offset the impact of Compact grants expiry in FY2023, had a lackluster investment performance in FY2011 and its trajectory of asset accumulation is well below the level needed to achieve self-sufficiency. Under the baseline projections, staff estimates a large revenue gap—the difference between expiring grants and CTF income in 2024—of about $10.9 million in 2011 prices, raising a significant challenge for the economic and fiscal viability of the RMI.

A steady and decisive fiscal adjustment is required to avoid a disruptive fiscal shock in FY2024. To generate cumulative savings in the Trust account large enough to avoid the projected large revenue gap in FY2024, the government would need to build up a fiscal surplus of 6.0 percent of GDP (about $10.2 million in 2011 prices) by FY2017, which would then need to be maintained until FY2023.

Submission of the tax reform bill to the Nitijela (Parliament) in September 2011 is a very positive step towards self-sufficiency. The mission believes that early implementation of the tax reform bill—with a modernized net profit tax and consumption tax—will make the RMI economy more business friendly, and looks forward to the passage of the tax reform bill envisaged in January 2012. While no strong oppositions from the public to the proposed tax reform are perceived so far by the authorities, it is important to step up public outreach to gain public buy-in. The mission also encourages the authorities to undertake the required revenue administration changes in parallel so as to implement the reform as planned once the bill is approved by the Nitijela.

On the expenditure side, it is critical to maintain the announced policy of containing public wage growth and reducing allowances. The targeted expenditure cuts could include rationalization of public payroll through workforce planning, limiting financial support to SOEs, and reducing excessive allowances to civil servants and public officials. In this context, the recommendations of the Comprehensive Adjustment Program (CAP) group, which were approved by the cabinet, could provide a valuable guidance on feasible options of expenditure cuts.

It is important to protect the benefits of reform through a strong institutional framework. While the improved tax collection and enforcement is a welcome development, further efforts to identify unreported tax liabilities as well as progress on the public finance management would be needed to complement the reform process. In this context, the mission strongly encourages the authorities to devise a framework that ensures that unexpected revenue increases are transferred into the CTF.

There is an eminent need to reform SOEs. The level of subsidy and capital transfer to SOEs amounted to over $8 million per year on average during the FY2009-FY2011 period. Recognizing the need to reform SOEs and reduce their fiscal strain on the budget, the Cabinet endorsed a set of good practice principles and a new SOE act was introduced into the Nitijela in September this year. The mission encourages the authorities to advance the SOE reform to address key issues of governance, disclosure, corporate planning, and pricing in selected SOEs, with the assistance of the ADB as needed.

Social security liabilities continue to constitute a sizeable contingent fiscal risk. The 2011 financial statements of the Marshall Islands Social Security Administration (MISSA) identify $222 million of unfunded liabilities (130 percent of GDP). In light of the unsustainable financial situation, the mission encourages swift preparation of a bill to reform the social security system. Reform options could include an increase in contribution rates, a revision of benefit structure, an increase in the standard retirement age, and a lengthening of the minimum contributions period.

To ensure the stability of banking sector, the mission encourages the authorities to place the Marshall Island Development Bank (MIDB) under appropriate supervision in line with international best practices. The MIDB continues to extend its consumer lending without being monitored or regulated by the appropriate authorities. This poses a significant risk to its capital base and to the government as its sole owner. The mission also supports an early modification of the Banking Act to strengthen bank supervision.

The RMI is facing a wide range of challenging reforms and those reforms cannot be carried out and sustained without broad-based support of the public. The mission encourages the authorities to step up its efforts to better communicate the benefit of reforms to the people of the RMI.

The mission would like to thank the authorities for their hospitality and thank members of the government, private sector, and civil society for the fruitful discussions.