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Republic of the Marshall Islands and the IMF

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Public Information Notice (PIN) No. 04/8
February 13, 2004
International Monetary Fund
700 19th Street, NW
Washington, D.C. 20431 USA

IMF Concludes 2003 Article IV Consultation
with the Republic of the Marshall Islands

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board.

On January 26, 2004, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with the Republic of the Marshall Islands.1

Background

The Republic of the Marshall Islands, a small Pacific Island country, is heavily dependent on external assistance, with grants averaging almost 60 percent of GDP since independence in 1986. The United States has provided most of the assistance through funding under the economic provisions of the Compact of Free Association (Compact). The original 15-year Compact (FY1986-2001), which included provisions for an extension for a two-year renegotiation period through FY2003, was designed mainly to promote self-government and economic self-sufficiency of the Marshall Islands, as well as to protect the national security interests of the Marshall Islands (a former U.N. Trust Territory under U.S. administration) and the United States.

With grant flows declining in real terms in the 1990s, economic growth in the Marshall Islands weakened, and real per-capita income fell below the pre-independence level. Fiscal expenditure and economic growth were also constrained by the need to retire external public debt incurred on commercial terms in the early 1990s against future Compact revenues. During 1995-2001 (the latest official data), real GDP and real per-capita GDP contracted by nearly 25 percent and 35 percent, respectively. Employment has not increased since the late 1980s. Between 1988 and 1999, the unemployment rate jumped from 12 percent to over 30 percent and is estimated to have remained broadly unchanged in recent years. Human development indicators also lagged those in other middle income countries, and the income distribution was uneven with a high incidence of poverty on the outer atolls.

The new 20-year Compact agreement includes a revised economic assistance package and presents a further opportunity to advance economic self-reliance. The main economic provisions include a temporary increase in total grants—largely to help finance the creation of the Compact Trust Fund, which is meant to replace grant funding after FY2023. However, budgetary support from grants will decline steadily in real terms during the period covered by the agreement. The renewed Compact also includes a number of accountability measures to improve the efficiency of grant use.

The economy appears to have picked up since the last Article IV consultation mission in 2001. This mainly reflected increased government expenditure made possible by higher external assistance. Based on the available—but limited—data, annual GDP growth is estimated to have averaged about 3 percent during FY2002 and FY2003, following weaker or negative growth in previous years. In recent years, the Majuro-based CPI inflation rate remained under 2 percent-partly due to modest growth in import prices and the increasingly competitive retail environment.

Nonetheless, outside of construction, the private commercial sector generally remains stagnant. In recent years, bank loans to this sector declined sharply and a number of major retailers struggled, partly owing to the increased competition. Government purchases of contracted services decreased, particularly hurting private companies involved in transportation and facilities maintenance. Copra production plummeted, related to irregular shipping schedules and the lagged effect of weak export prices. On the positive side, the tuna processing plant expanded its operations.

With the pickup in growth, the current account (including official transfers) surplus narrowed as import growth strengthened. Exports were also relatively buoyant, albeit from a much smaller base, mainly due to increased re-exports of diesel fuel for foreign fishing fleets. Debt servicing now appears manageable after the repayment of high-cost commercial debt in FY2001.

The fiscal position weakened during the past two years. The deficit in FY2002—the first in seven years—reflected budget funding to account for longstanding nonperforming loans to two public sector projects. Excluding this write down, the underlying fiscal surplus narrowed to an average of 7 percent of GDP in FY2002 and FY2003 compared with 9½ percent of GDP in the previous two years. This mostly reflected the increase in the government payroll, which rose by 25 percent over the two years, but was partly offset by lower interest payments and more buoyant domestic revenue. The government set aside US$32.5 million in the intergenerational trust fund, more than required to meet the country's commitment under the renewed Compact with the United States, but the benefit of increased public saving was reduced by placing US$7 million in a 15-year, comparatively low-interest deposit with the Marshall Islands Development Bank, which was then onlent at below market rates to bailout struggling retailers. On the positive side, the finances of the health fund improved following the increase in the medical payroll contribution rate in 2001, and a significant drop in overseas medical referrals due to better management and improved domestic medical facilities.

Executive Board Assessment

Directors welcomed the steps taken by the authorities in recent years to help place the economy on a fiscally sustainable path, including by retiring high-cost commercial debt, placing public funds in the intergenerational trust fund, resolving longstanding problems in the health fund, and augmenting institutional capacities. They stressed that public sector reform, improvement of infrastructure and of health and education outcomes, and private sector development should be accelerated as essential components of a viable economic strategy for the Marshall Islands.

Directors emphasized that an immediate priority was to ensure that the FY2004 budget remains in surplus, by containing current expenditure on wages and goods and services and limiting some capital and development spending. In particular, they noted that it was worrisome that the wage bill had risen sharply in recent years, and cautioned that this trend must be reversed.

Directors underscored the need for substantial fiscal surpluses to be maintained over the medium term given the programmed real decline and eventual elimination of budgetary support under the renewed Compact agreement. They stressed that, beyond 2004, additional public saving will need to be achieved through continuing tight control on expenditure, improving tax administration, and broadening the tax base. They called for the government's medium-term budget and investment framework to be implemented fully.

Directors noted that fiscal management and governance need to be greatly strengthened. They emphasized that reserves be built up and managed prudently to protect against fiscal vulnerabilities. They stressed that the government avoid nontransparent and risky quasi-fiscal transactions involving trust fund assets, such as the recent deposit with the Marshall Islands Development Bank, which was onlent at below market interest rates to bailout struggling retailers.

On private sector development, Directors welcomed the recent passage of legislation to address land tenure issues, including establishing the Land Registration Authority, allowing government ownership of public land, and improving laws relating to real property mortgages and foreclosure procedures. Going forward, they called for the authorities to focus on removing key remaining obstacles to private sector development. Steps should include increasing the wage differentiation between skill levels by changing existing minimum-wage legislation and continuing the public sector wage freeze, and trimming extensive state involvement in business through privatization and contracting out some government services. In addition, Directors highlighted the importance of reducing constraints on foreign investment by decreasing areas reserved solely for citizens of the Marshall Islands and cutting administrative delays in the approval of investment proposals, and broadening the tariff base and modernizing customs processing and revenue collection.

Directors underlined that further efforts are needed to strengthen financial supervision. While welcoming the recent progress made by the Banking Commission in on-site and off-site supervision of the two commercial banks, they noted that additional steps are needed to continue to improve data and information collection, compilation, and assessment, including of loan quality. Directors stressed that an important priority is to improve the governance of the Marshall Islands Development Bank, including by placing it under the supervision of the Banking Commission, limiting permitted activities, shifting the focus of its lending from consumer loans to more traditional lending for a development bank, and appointing independent board members.

Directors commended the authorities for their efforts since the last Article IV consultation that led to the Marshall Islands being removed from the Financial Action Task Force money laundering list. They urged a continuation of the efforts to discourage money laundering and the financing of terrorism.

Directors encouraged the authorities to take steps to remedy deficiencies in economic statistics. In particular, core economic data need to be compiled and reported on a timely basis, and the quality of the data needs to be enhanced. Directors also encouraged the authorities to join the General Data Dissemination System.



Republic of the Marshall Islands: Selected Economic Indicators 1/


 

1999

2000

2001

2002

2003

2004

       

Est.

Est.

Proj.


Real GDP (percent change)

0.6

0.9

-1.3

4.0

2.0

1.5

Consumer prices (percent change)

1.9

0.9

1.8

1.7

-1.9

1.5

Central government finances (In percent of GDP)

 

Revenue and grants

67.6

75.2

82.5

76.0

75.4

75.1

Of which: Grants

40.1

50.4

58.7

49.8

50.0

50.6

Expenditure

57.1

66.0

72.8

79.5

66.6

78.2

Overall balance

10.6

9.2

9.7

-3.5

8.7

-3.1

             

Usable government financial assets

           

(US$ mn.; end of period) 2/

4.8

9.4

4.2

2.1

3.4

0.8

             

Trust Funds (US$ mn.; end of period) 3/

...

...

...

16.3

32.6

41.6

             

Commercial banks (US$ mn.; end-December) 4/

           

Foreign assets

25.0

30.6

31.7

40.1

48.4

...

Private sector claims

23.5

26.6

30.3

35.6

37.4

...

Total deposits

54.3

58.5

60.2

69.4

72.2

...

One-year time deposit rate (in percent)

5.0

6.2

4.1

4.0

3.9

...

Average consumer loan rate (in percent)

20.5

19.2

16.5

16.5

16.1

...

             

Balance of payments (US$ mn.)

           

Trade balance

-52.4

-41.9

-39.7

-41.1

-47.1

-51.1

Net services

-8.7

-2.2

-2.4

-3.3

-4.3

-4.1

Net income

22.6

26.3

19.7

25.1

33.2

26.6

Private and official transfers

32.6

43.5

51.9

40.1

40.3

42.9

Current account including official transfers

-5.9

25.7

29.5

20.8

22.2

14.4

Current account excluding official transfers

-44.6

-24.0

-28.6

-31.4

-30.3

-40.2

Overall balance

-7.6

4.6

-5.2

14.2

17.7

-27.3

             

External debt (US$ mn.; end of period) 5/

98.5

91.9

76.8

85.4

90.7

90.1

(In percent of GDP)

101.8

93.3

77.5

81.5

86.5

83.3

             

External debt service (US$ mn.)

36.2

20.6

26.3

3.2

4.1

4.1

(In percent of exports of goods and services)

327.1

130.4

150.6

16.8

20.0

18.1


Sources: Data provided by the Marshall Islands authorities; and IMF staff estimates.

1/ Fiscal year ending September 30.

2/ Cash and cash equivalents that are not reserved for specific uses.

3/ Assets in trust funds are treated as non-usable.

4/ Data refer to December within the fiscal year; for example, FY2001 refers to December 2000.

5/ Government and government-guaranteed debt only.


1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.




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