Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
2013 Staff Visit with the Federated States of Micronesia Concluding Statement of the IMF MissionOctober 28, 2013
This statement summarizes the mission’s preliminary views and policy recommendations based on meetings in Pohnpei from October 21–23, 2013. This year’s staff visit takes stock of the economic and policy developments since the 2012 Article IV consultation.
The real GDP growth was subdued at 0.4 percent in FY2012, and is expected to remain below 1 percent in the near term and beyond. Rapid growth in the fishery sector was mainly offset by contraction in the construction and wholesale and retail sectors in FY2012. The short- to medium-term outlook remains bleak as the private sector remains weak while US grants are declining. The fishery sector is expected to continue to grow, but recent rapid growth is unlikely to be sustained as concerns for depleting fish stocks persist. The construction sector has ceased to be a source of growth as the US-funded airport improvement projects have come to an end and other donor-funded planned infrastructure projects are delayed. Outward migration continues at a moderate pace. Inflation rate is expected to continue declining from the recent peak in FY2011 as food and fuel prices are contained. Although strong fish exports contributed to the decline in the trade deficit in FY2012, current account deficit is projected to stay at around 10 percent of GDP, which is financed by the inflow of official transfers.
The FSM has been registering small fiscal surpluses in recent years. While the consolidated tax revenue remains at 11–12 percent of GDP, low relative to its Pacific peers, non-tax revenue increased by 2 percent of GDP in FY2012 on account of strong growth in fishing license fees paid by foreign vessels. All of the 4 state governments have formulated their respective Long Term Fiscal Frameworks (LTFF) in light of the declining allocation of US Compact Grants and started to reflect them in the FY2014 budget. The national government’s domestic revenue continues to increase helped by strong growth in the fishing licensing fees.
The authorities need to draw up an ambitious fiscal and growth-enhancing reform plan to ensure budgetary self-sufficiency in the long-run, as the US Compact Grants will be expiring in FY2023 while investment income from the Compact Trust Fund (CTF) will not be sufficient to replace them. The CTF has achieved a record high return of around 15 percent in FY2012 on the back of strong performance in US and international equity markets, and is estimated to have grown strongly again in FY 2013 (net asset as of end July 2013 was over $300 million, equivalent to more than 90 percent of GDP). However, sustaining such a strong return in the medium-term would not be feasible. Average annual return through FY2012 since its inception in 2004 is significantly lower (4 percent), due in part to the financial crisis in 2008–09.
The IMF estimates that, gradual increase of the fiscal surplus to around 6.5 percent of GDP ($US 26 million) over a period of 4 years and maintaining it through FY2023, combined with growth-enhancing reforms, will ensure budgetary self-sufficiency after FY2023. While the authorities can make the fiscal adjustment over a longer period, the adjustment should be started expeditiously as further delay would increase the cost of adjustment. Negative growth impact could be mitigated by mobilizing additional resources from potential donors, while the release of unused balance of already allocated Compact Grant (close to $US 90 million for infrastructure sector grants as of end FY2012) incurred by implementation delays in the past could also provide stimulus to the economy. Consolidation and improved reporting on various trust funds held by the governments would aid efforts to accurately plan for the fiscal adjustment and to safeguard priority expenditures including essential social expenditures. Sharing more information with the public and enhancing fiscal transparency will be vital in government efforts to secure a broad support across the country.
The recently established “2023 Planning Committee” can play a greater role in drawing a realistic medium-term fiscal and growth-enhancing reforms strategy. As was agreed in the last Article IV consultations, the mission has shared its long-term fiscal projection framework to assist the work of the authorities.
Operational efficiency of current and capital expenditure should be improved. First, containing public wages is important. Although public sector payroll has been contained in recent years, the FSM still ranks high among the region in public wage to GDP ratio. A gap between public and private sector wages is large, with the public to private wage ratio of slightly above 2. Second, infrastructure spending could be more efficiently implemented through better planning and coordination between national and state governments. Third, a clear fiscal rule should be established to ensure that annual fiscal surplus is saved to enhance budgetary self-sufficiency after FY2023. Also, budget documents should reflect all the activities of the general government including the state governments and trust funds.
Swift implementation of the tax reform package is critically important. Introduction of a value added tax and a net profits tax and the creation of a Unified Revenue Authority are an indispensable and significant building block in ensuring long-term fiscal sustainability of the FSM, and are beneficial to improving the business environment as well. Due to delays in obtaining approval from some of the states, the sunset clause of the tax reform package has been extended by one year in total to April 30, 2014. State and central governments need to come together and swiftly implement the tax reform package for the greater good of the FSM. Following through the long-standing and much required tax reform agenda would demonstrate FSM authorities’ strong commitment to undertaking necessary reforms. This would send a positive signal to FSM’s partners to enhance their financial and technical assistance to the country.
Building institutional capacity is important in enhancing FSM’s fiscal sustainability. Pacific and Financial Technical Assistance Center (PFTAC) has been engaging with the FSM in the tax reform and public financial management areas, including through support for a Public Expenditures and Financial Accountability (PEFA) assessment.
Long-term sustainability of the social security system needs to be addressed. Despite recent efforts to strengthen collection and increase the contribution rate (effective January 2013, the rate was increased by 1 percent to 15 percent employer and employee combined), total benefit payments ($17.7 million) were still in excess of total contributions ($16.4 million) in 2012. The gap was covered by contribution from the FSM national government and investment income. Further reforms of the benefit structure and tax collection, together with a reduction in delinquent accounts are required so as to bring the system into long-term sustainability.
A vibrant private sector is a key to enhancing growth. While the FSM has a number of potential strengths such as its pristine nature, the business environment remains difficult. The World Bank’s Doing Business Report (2013) places the FSM at the 150th position out of 184 economies globally. The authorities need to undertake structural reforms in such areas as the facilitation of long-term land leases and inward foreign direct investment, while securing a wide buy-in to ensure that the reforms can be implemented swiftly. Dissemination of information regarding investment climate would also be important in drawing the attention of potential investors.
The financial sector should play a larger role in boosting the economy. While the banking sector is well capitalized with sufficient liquidity, most of FMS’s bank deposits are invested overseas, leading to a low loan-to-deposit ratio (about 30 percent). Further legislative measures to facilitate taking immovable property as collateral are necessary to increase commercial lending, on top of recent reform to facilitate taking movable property as collateral. The FSM Development Bank should continue complementing the private banks by promoting the growth of small- and medium-sized enterprises and supporting programs designed to help business achieve greater efficiency in their operations. Also, enhancing supervision of the insurance sector as well as the FSM Development Bank is important.
The mission would like to thank the authorities for their hospitality and fruitful discussions.