Republic of the Marshall Islands— 2013 Article IV Consultation Concluding Statement of the Mission
November 1, 2013
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.
Securing fiscal sustainability and raising potential growth
The economy expanded by 3.2 percent in FY 2012, but lower growth rates are expected going forward. Fiscal deficits are projected to persist, driven by sizable transfers to poorly performing state-owned enterprises (SOEs). Swift and comprehensive reforms are needed to secure fiscal sustainability and raise long-term growth. SOE restructuring, public sector wage moderation, approval and implementation of tax and social security reforms are the top priorities.
I. Recent developments and Outlook
1. The economy grew by 3.2 percent in FY2012, but the outlook for the short and medium term is less favorable. In FY2013 growth is estimated at a weaker rate of 0.8 percent, due to the postponement of some construction activities. Growth is projected to rebound to 3.2 percent in FY2014, assuming the resumption of infrastructure projects. However, beyond the near term, growth potential is expected at about 1½ percent— weighted down by the scheduled reduction in Compact grants and limited private sector expansion. Inflation moderated to 4.3 percent in FY2012, and is estimated to have eased further to 1.6 percent in FY2013, thanks to subdued global commodity prices.
2. Risks to the outlook are tilted to the downside. In the short-term, further delays in the implementation of infrastructure projects could lower growth. The danger of natural disasters is ever-present. Longer-term risks include inadequate fiscal consolidation ahead of the scheduled drop in Compact grants, climate change, and continued outward migration of the working-age population. On the upside, a decisive push for structural reforms, and additional investment projects would support growth.
3. Government accounts are set to remain in deficit in the near term and beyond. In FY2012 the fiscal accounts recorded a deficit of 0.8 percent of GDP, reflecting an increase in transfers to SOEs of 1.1 percent of GDP and a rise in the wage bill. For FY2013, the fiscal deficit is estimated to have remained at 0.8 percent of GDP, driven by continuing sizable transfers to SOEs. Without fiscal adjustment, annual deficits of around 2 percent of GDP are expected to persist in the medium term.
II. Securing Fiscal Sustainability
4. A clear and bold medium-term consolidation strategy is urgently needed. Fiscal balances must turn back into surplus to secure long-term sustainability and build buffers against existing significant fiscal vulnerabilities. These include substantial fiscal risks from SOEs and the social security system, the sizable public debt— one of the highest among the Pacific Island Countries—, the expiration of most Compact grants after FY2023, uncertainty about Compact Trust Fund returns, future costs from climate change and limited credit access.
5. The fiscal adjustment path and composition should strike a right balance between consolidation needs and short-term growth implications. Taking into account the growth implications of fiscal adjustment, staff recommends that the government build up a fiscal surplus of at least 2.6 percent of GDP (about $ 4.6 million in 2012 prices) by FY2018, which will have to be maintained until FY2023.
6. Fiscal adjustment will require spending cuts. Containing public sector wage bills, including by curbing allowances to civil servants, is essential to produce fiscal savings, reduce the large public-private sector wage gap and encourage private sector development. The recommendations of the Comprehensive Adjustment Program (CAP) group provide useful guidance on additional options for spending cuts.
7. SOEs reforms should be a policy priority. In FY2012 SOE operating losses almost doubled to 8.5 percent of GDP from 4.4 percent in the previous year—driving up government subsidy expenditure. SOEs constitute a significant fiscal risk due to their continuing need for support and because the government has guaranteed US$34 million (20 percent of GDP) of their debt, as of FY2012. The mission urges the authorities to advance SOE restructuring, by addressing the key issues of governance, pricing policies, efficiency, enforcement of customers’ payments and cross-subsidization. The need for reforms is particularly urgent for Air Marshall Islands, the National Telecommunication Authority and the Marshall Islands Shipping Corporation.
8. Approval and swift implementation of the tax reform bill is critical to enhance efficiency and equity as well as tax compliance. Expanding the wage and salary tax base to include allowances, reducing the wage and salary tax on lower income earners, and allowing the same tax deduction for all income earners will make the system more equitable. Replacing existing import duties and local government sale taxes with a broad-based and modern consumption tax will enhance efficiency and tax compliance. The replacement of the Gross Revenue Tax with a new net profit tax for large business will make company taxation more business friendly. The creation of a new client focused and independent Customs and Revenue Authority and a more effective IT support system will improve revenue administration.
9. The mission welcomes the plan for Public Financial Management (PFM) reforms. The authorities are working on a comprehensive medium-term PFM Reform Roadmap, including measures to strengthen the budgeting framework, the accounting system, debt management, and revenue administration. It is important to move expeditiously toward the finalization and implementation of this reform, which is much needed given existing weaknesses in budget reporting and planning, and tax administration.
10. Social security liabilities constitute a significant contingent fiscal risk and warrant a swift reform. Under the current system, the fund of the social security administration would be depleted by 2022. Submission of a pension reform bill to the Nitijela (parliament) is a positive first step toward the creation of a more sustainable pension system. The mission urges the authorities to explore options for even further reforms that would secure full long-term sustainability.
III. Boosting Growth and Financial Stability
11. The RMI faces significant challenges in raising job and economic growth which are also essential to achieve fiscal sustainability. The public sector, which absorbs about half of total employment, remains the main source of economic activity. Going forward, further private sector development will be essential to support growth as Compact funding of government activities declines.
12. Measures to foster private sector growth need to be implemented. They should address the issues of weak competition due to SOE dominance in some industries, the wide public and private sector wage gap, and limited access to commercial credit. The authorities could consider the introduction of an insolvency law and further land registration reforms to facilitate access to credit. Furthermore, easing procedures for long-term land leases to nonresidents could help attract foreign direct investment.
13. The bank supervisory framework should be enhanced. The mission recommends strengthening Banking Commission’s authority and autonomy in carrying out effective supervision. Furthermore, The Banking Commission’s oversight should also be broadened to include the Marshall Island Development Bank (MIDB). The MIDB should refocus on its core mandate of providing commercial lending, rather than consumer loans.
The mission would like to thank the authorities for their hospitality and thank members of the government and representatives from the private sector for the fruitful discussions.