## 1fsmea2019002

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### Executive summary — vulnerability and macro-fiscal implications
- CCPA purpose: reviews FSM’s climate response plans from macroeconomic and fiscal perspectives; joint IMF and World Bank initiative.  
- Assumption: FSM will lose access to certain Compact supports in 2023 unless arrangements are renewed or extended.  
- Key vulnerability findings:
  - Global Climate Risk Index (CRI) ranks FSM as the third most at risk country amongst peers in the Pacific island countries for the period 1998–2017.  
  - In terms of fatalities per 100 thousand inhabitants, FSM is ranked in the top 3 percent.  
  - Climate impacts: increases in rainfall, temperatures, sea level rise, and ocean acidification; primary extreme events: droughts, typhoons, flooding, landslides and wave action from storms.  
- Fiscal cliff and trust funds:
  - Compact grants amounting to 20 percent of GDP will expire in FY2023 and be replaced by investment returns from the Compact Trust Fund projected at around 11 percent of GDP in FY2024.  
  - Overall balance projected to move from a surplus of around 4½ percent of GDP in FY2023 to a deficit of 4½ percent of GDP in FY2024.  
  - IMF-World Bank Debt Sustainability Analysis assesses FSM’s risk of debt distress to be high.  
  - FSM Trust Fund stood at 57 percent of GDP in FY2019 but is not available for drawdown until 2030 (Law No. 20-185).  

### Macroeconomic impacts and disaster scenarios
- Climate change channels: lower agricultural output; depressed labor productivity in weather-exposed sectors; reduced capital accumulation; poorer human health.  
- Quantified baseline adjustments from Lee et al. (2018) for FSM:
  - Downward adjustment to annual growth in the baseline: 0.1 percentage point.  
  - Downward adjustment to annual projections of the trade balance: 0.4 percentage points.  
  - Downward adjustment to fiscal balance: 0.1 percentage point.  
- Large-disaster examples and tail risks:
  - Typhoon Maysak (2015) caused about 3.5 percent of GDP in damages in FSM.  
  - Under a Maysak-like event, GDP could fall by up to 5 percentage points; fiscal balance deterioration: 3.4 percentage points; trade balance deterioration: 13.4 percentage points.  
  - Probabilistic modeling: a cyclone causing damages of around 50 percent of GDP is to be expected once every 100 years.  
- Probable sectoral amplifiers:
  - El Niño and La Niña increase uncertainty in the fishery sector and fisheries-related government revenue.  
  - Rising temperature and sea-level rise dampen agricultural revival efforts; agriculture is important for livelihoods and food security.

### Mitigation status, targets and modeled policy scenarios
- Mitigation progress:
  - Renewables share increased from 4.3 percent in 2009 to 19 percent (current level).  
  - Emissions from diesel in electricity generation have fallen by around a third between 2000 and 2018.  
  - Transport is now the main source of emissions; registered vehicles rose from 7,658 in 2009 to 8,775 in 2015.  
  - Fuel import bill around 8 percent of GDP in 2018.  
- NDC target:
  - Reduction in CO2 emissions (energy and transport sectors) by 28 percent below 2000 levels by 2025; with additional technical and financial support FSM aims for an additional 7 percent reduction.  
  - FSM’s contribution to global GHG emissions: 0.003 percent.  
- Electricity and energy objectives:
  - Target: increase share of renewable energy sources to 30% of the generation mix; proposed additional 45 MW of solar power over the next 20 years.  
  - Renewable share was 19 percent in 2018 with a target of at least 30 percent by 2020.  
  - Energy master plan investment (2019–2023): US$101 million; donors estimated secured: around US$ 50–60 million.  
- Modeled mitigation scenarios (selected figures from Table 2):
  - Total CO2 emissions (tons of CO2 equivalent)
    - 2025: BAU 103488; Renewables 97495; Fuel tax 102308; Vehicle feebate 100754; Combination 93752  
    - 2030: BAU 102427; Renewables 92195; Fuel tax 101296; Vehicle feebate 99799; Combination 88596  
  - Renewables share (electricity)
    - 2025: BAU 0.19; Renewables 0.30; Combination 0.30  
    - 2030: BAU 0.19; Renewables 0.38; Combination 0.38  
  - Gasoline & Diesel tax revenue (percent of GDP)
    - 2025: BAU 0.2; Fuel tax 0.6; Combination 0.6  
    - 2030: BAU 0.2; Fuel tax 0.6; Combination 0.5  
  - Fuel import bill (percent of GDP)
    - 2025: BAU 7.0; Renewables 6.6; Combination 6.3  
    - 2030: BAU 7.1; Renewables 6.4; Combination 6.1
- Fuel/carbon taxation proposal:
  - Excise tax proposal: 25c/gallon increase bringing tax burden on diesel and gasoline to around 35c/gallon — equivalent to a carbon tax of US$ 35 per ton of CO2.  
  - Combusting a gallon of gasoline and diesel produces 0.009 and 0.010 tons of CO2, respectively (model uses 0.0088 and 0.0103 tons/gallon emission rates in Annex III).  
  - Price impacts: gasoline from US$4.50 to US$4.75 per gallon; diesel from US$4.81 to US$5.06 per gallon.  
  - Fiscal and emissions impacts: extra revenues 0.4 percent of GDP in 2025 and 0.3 percent in 2030; economywide CO2 emissions reduction estimated 1 percent below BAU in 2025 and 2030.  
- Vehicle feebates and combined policies:
  - Feebates: designed revenue-neutral; can shift vehicle mix to energy-efficient models but require administrative capacity and model-level data.  
  - Combination (renewables + fuel tax + feebates) by 2025: cuts economy-wide CO2 emissions by 38 percent below its level in 2000; adds 0.3 percent of GDP in revenue compared to BAU; reduces fuel import bill by 0.64 percent of GDP in 2025 and 0.93 percent in 2030.

### Adaptation planning, investment needs, and implementation capacity
- Fragmentation and planning gaps:
  - No comprehensive National Adaptation Plan (NAP) yet; adaptation actions addressed in JSAPs, sectoral plans, and IDP (2016–2025) but costs not consistently costed in IDP.  
  - DECEM established in 2018 to mainstream adaptation and disaster management; developed GCF country work program.  
- Investment totals and financing gap:
  - Consolidated IDP and GCF suggests total investment plan around US$1.3 billion (overall total 1,097 in $ millions by jurisdiction/program).  
  - FSM faces a financing gap of $400–500 million over the next 15 years between climate change investment plans and currently available grant funding.  
  - Regional study estimated FSM spent around US$8 million per year on climate related projects over 2011–2018, equating to around 2.7 percent of 2018 GDP; adaptation spending around 1.2 percent of GDP annually.  
- Implementation capacity constraints:
  - First three years of IDP implementation fell well behind plans; around US$200 million of unused Compact capital grants remain.  
  - Causes: land titling and tenure issues (particularly Chuuk), procurement contracting issues, staffing difficulties in state-level PMOs.  
  - Example solution cited: Dominica’s Climate Resilience Execution Agency to leverage execution capacity.

### Risk financing and disaster insurance stance
- Current reliance and gaps:
  - FSM relies heavily on U.S. post-disaster relief under the Compact (USAID/FEMA).  
  - Contingency funds exist (DAEF and DRF) but indemnity and catastrophe insurance under-utilized; almost no insurance for public/private assets.  
  - FSM does not participate in PCRIC pooled parametric insurance.  
- PCRAFI/PCRIC evidence:
  - Average expected losses: US$8 million per year from earthquakes and tropical cyclones (PCRAFI estimate).  
  - Over 50 years: 50 percent chance of losses exceeding US$105 million and casualties larger than 220 people; 10 percent chance of loss exceeding US$470 million and casualties larger than 600 people.  
  - Likelihood of one natural disaster per year for FSM: 24.3 percent.  
- Current quick-disbursing funds:
  - DAEF: FSM and U.S. governments contribute US$200,000 each annually; provides access to US$100,000 per event initially; expected DAEF balance at completion of current Compact term: US$6–8 million.  
- Recommended risk-layering and buffers:
  - Develop a National Disaster Risk Financing Strategy to combine: risk retention (contingency fund), risk transfer (PCRIC or parametric insurance), private sector insurance, and contingent financing (e.g., CAT-DDO).  
  - FSM Trust Fund (FSMTF) described as a large buffer (currently over 50 percent of GDP) but drawdown prohibited until 2030; guidance: FSMTF should be last resort and clarified within governance and National Disaster Risk Financing Strategy.

### Debt sustainability, fiscal strategy and scenarios
- Debt and fiscal outlook:
  - FSM assessed high-risk of debt distress; current public debt around 20 percent of GDP (all external).  
  - U.S. Compact grants around 20 percent of GDP expected to expire in 2023 unless renewed.  
  - Projection: fiscal balance projected to turn to a deficit of 4½ percent of GDP in 2024, putting debt on a rising path.  
  - DSA thresholds: breached in the 2030s under IMF and World Bank DSA.  
- DSA natural disaster stress test assumptions:
  - One-off increase of 10 percentage points in debt-to-GDP ratio in the year of a disaster.  
  - Reductions in growth rates of real GDP and exports by 5 and 3.5 percentage points, respectively, in the year of a disaster.  
  - Stress test result: public debt in 2030 higher by about 30 percent of GDP than under the no-disaster scenario.  
- Illustrative adaptation ramp-up scenario vs status quo:
  - Baseline (no adaptation ramp-up): potential GDP growth 0.6 percent; disaster in 2030: GDP declines 5 percent; public debt rises by 10 percent of GDP; post-2030 growth increases to 1.0 percent.  
  - With adaptation ramp-up (higher adaptation investment 2020–30): GDP growth increases to 1.0 percent during 2020–30; disaster in 2030: GDP declines 3 percent; public debt rises by 6 percent of GDP.  
  - Result: 2030 impacts (GDP loss and debt increase) are 40 percent smaller with adaptation ramp-up than status quo.

### Public financial management (PFM), public investment management (PIM) and institutional gaps
- PIM/PFM overview and scores:
  - PIMA assessment: FSM scores 2.0 (top score 3.0); low-income developing country average 1.9; average for six small states 1.7.  
  - FSM’s PIM is highly decentralized; no standard methodology for project appraisal at national level; major Compact/donor-financed projects undergo rigorous review but domestic projects less so.  
- Key PFM gaps and recommended improvements:
  - Financial management regulations of four states out of date and need updating.  
  - Need to develop a comprehensive fiscal risk statement including climate and disaster risks.  
  - Budget classification and chart of accounts should distinguish capital vs recurrent expenditures and track mitigation/adaptation spending by source, location and activity.  
  - Improve procurement transparency and establish a complaints management system.  
  - More frequent in-year budget execution reporting and more rigorous congressional scrutiny of audit reports.  
- Specific national process recommendations:
  - Improve chart of accounts, budget classification and budget presentation to identify and track mitigation and adaptation spending. (Short term)  
  - Establish standard methodology for investment project appraisal and selection; build climate resilience into project screening and design. (Short term)  
  - Strengthen institutional and staff capacity in public investment and focus implementation resources on high priority projects. (Medium term)

### Priority recommendations and timelines (summary)
- General preparedness:
  - Improve climate data collection and use, including costs of high and low intensity disasters and disaster response expenditure. (Short term)  
  - Develop a comprehensive Disaster Resilience Strategy (DRS) in cooperation with IMF, World Bank and other development partners. (Medium term)  
  - Prepare for end of Compact by strengthening capacity for weather services and emergency management at the State and National level. (Medium term)
- Mitigation:
  - Continue expanding renewable power generation. (Short term)  
  - Introduce a moderate excise tax on road fuels (gasoline and diesel) and consider an excise tax or feebate system for passenger vehicles as part of a transport mitigation strategy. (Medium term)
- Adaptation:
  - Develop an overarching National Adaptation Plan reconciling GCF workplan and IDP. (Short term)  
  - Undertake hazard mapping for key infrastructure. (Short term)  
  - Address capacity shortages to accelerate infrastructure investment and integrate adaptation measures into sectoral strategies. (Medium term)  
  - Develop and enforce a land use policy and a national building code incorporating climate risks and energy efficiency. (Medium term)
- Financing and risk management:
  - Mobilize external grant financing to avoid worsening fiscal and debt sustainability. (Short term)  
  - Speed up implementation of adaptation investment projects. (Short term)  
  - Continue to develop contingency financing options and consider regional parametric insurance. (Short term)  
  - Formalize a national disaster risk financing strategy, inventory public assets, clarify budget processes and engage partners on financing modalities for a risk buffer. (Medium term)  
  - Clarify regulations for accessing disaster relief funds at conclusion of current Compact Agreement term. (Medium term)  
  - Explore insurance options for key government infrastructure and developing insurance markets for housing, flood risk and agriculture. (Medium term)

### Resource needs and quantified estimates
- Indicative additional resource needs: over US$500 million over the next 15 years.  
- Investment financing gap: $400–500 million.  
- Mitigation needs:
  - Private investment of around US$ 170 million by 2035, mainly for renewable energy generation.  
- Adaptation needs:
  - Filling financing gaps of up to US$400–500 million within a public investment envelope of US$ 1.3 billion by 2035.  
- Capacity-building and risk-layering support: smaller additional support needs (capacity building, parametric insurance premia).

### Annex model and policy instruments (technical notes)
- Annex III: spreadsheet model projects fuel use by sector using GDP projections and assumptions on price responsiveness; key parameters:
  - GDP expands by 8.4 percent between 2018 and 2030 (IMF forecast extrapolation).  
  - Income elasticities: households electricity = 1; gasoline = 0.6.  
  - Electricity and fuel use autonomous decline: 0.5 percent per year.  
  - 2018 baseline consumption: total electricity ~58.6 gigawatt-hours; diesel for power 4.2 million gallons; gasoline 5.3 million gallons; non-power diesel 1.35 million gallons; jet fuel ≈1.8 million gallons (excluded).  
  - 2018 retail prices: gasoline US$4.50/gal; diesel US$4.81/gal; diesel used in power generation US$2.96/gal; electricity average US$0.4/kWh.  
  - Price responsiveness: each 1 percent price increase reduces demand by 0.45 percent.  
- Annex IV: feebates framework for vehicles and appliances:
  - Design: ad valorem tax retained for revenue; feebate component pivoted on average fuel/energy performance updated annually to be approximately revenue-neutral.  
  - Illustrative feebate example for vehicles: pivot 250 grams CO2/mile and price US$100 per gram CO2 yields subsidies/taxes examples (subsidy US$5,000 for 45 mpg; tax US$10,000 for 25 mpg).  
  - Appliance feebates illustrated with refrigerators using kWh/(cubic foot) pivot mechanics.

*Source: Climate Change Policy Assessment for the Federated States of Micronesia, International Monetary Fund and World Bank; August 1, 2019.*

### EXECUTIVE SUMMARY __________________________________________________________________ 5

### EXECUTIVE SUMMARY

### Overview
- This Climate Change Policy Assessment (CCPA) reviews the Federated States of Micronesia (FSM)’s climate response plans from the perspective of macroeconomic and fiscal implications.  
- The CCPA is a joint initiative by the IMF and World Bank to assist small states to understand and manage the expected economic impact of climate change while safeguarding long-run fiscal and external sustainability.  
- The assessment explores the possible impact of climate change and natural disasters, the cost of FSM’s planned response, macroeconomically relevant reforms, policy gaps, and resource needs.  
- The report assumes that FSM will lose access to certain Compact supports in 2023 unless arrangements are renewed or extended.

### Key findings on vulnerability and macro-fiscal implications
- FSM is highly exposed to climate change and natural disaster risks; the Global Climate Risk Index (CRI) ranks FSM as the third most at risk country amongst peers in the Pacific island countries for the period 1998–2017.  
- In terms of fatalities per 100 thousand inhabitants, FSM is ranked in the top 3 percent.  
- Climate impacts include increases in rainfall, temperatures, sea level rise, and ocean acidification, with primary extreme events being droughts, typhoons, flooding, landslides and wave action from storms.  
- Projected fiscal shock from expiry of Compact grants: Compact grants amounting to 20 percent of GDP will expire in FY2023 and be replaced by investment returns from the Compact Trust Fund projected at around 11 percent of GDP in FY2024.  
- The overall balance is projected to move from a surplus of around 4½ percent of GDP in FY2023 to a deficit of 4½ percent of GDP in FY2024.  
- The IMF-World Bank Debt Sustainability Analysis assesses FSM’s risk of debt distress to be high.  
- The government’s FSM Trust Fund stood at 57 percent of GDP in FY2019 but is not available for drawdown until 2030.

### Status of mitigation and adaptation efforts
- FSM has made significant strides on mitigation (despite negligible global emissions contribution): begun expanding renewable power generation and improving efficiency; plans to continue expansion and encourage energy efficient building design and appliances.  
- Transport mitigation options in the short term are limited; policy scope exists to raise taxes on fuel and reform vehicle taxation to encourage fuel-efficient vehicles.  
- Adaptation planning is fragmented; significant gaps include the absence of a National Adaptation Plan and a comprehensive Disaster Resilience Strategy (DRS).  
- Investment to date has been skewed towards mitigation even though FSM’s adaptation financing needs are substantial.  
- FSM faces a financing gap of $400–500 million over the next 15 years between its climate change investment plans and currently available grant funding.  
- Progress in adaptation has been hindered by capacity constraints, particularly in investment project execution at the state level.  
- FSM’s current disaster preparedness benefits from Compact-era access to U.S. post-disaster relief (FEMA, USAID); preparedness for the post-2023 context is limited and uncertain.

### Fiscal and public financial management implications
- Accelerating adaptation investments requires addressing capacity constraints and increasing grant financing while maintaining fiscal and debt sustainability given the impending fiscal cliff.  
- Improvements in public financial management are needed, including: more rigorous project appraisal and prioritization; improved budget classification and chart of accounts; enhanced public investment management to support fiscally sustainable scaling-up of adaptation investment.

### Risk financing and insurance stance
- FSM currently uses some contingency funds but under-utilizes indemnity and catastrophe insurance, and relies heavily on U.S. disaster funding via the Compact.  
- FSM could strengthen preparedness for post-2023 by establishing a National Disaster Risk Financing Strategy as a central element of a broader Disaster Resilience Strategy.  
- Such a strategy would guide policy on risk transfer and retention, trade-offs between options, and provide a framework to seek increased international support.

### Recommendations—Summary (short-term priorities highlighted)
General Preparedness
- Improve climate data collection and use, including on the costs of high and low intensity disasters and disaster response expenditure (Short term).  
- Develop a comprehensive Disaster Resilience Strategy (DRS) in cooperation with IMF, World Bank and other development partners (Medium term).  
- Prepare for end of Compact by strengthening capacity for weather services and emergency management at the State and National level (Medium term).

Mitigation
- Continue expanding renewable power generation (Short term).  
- In the context of a transport mitigation strategy, introduce a moderate excise tax applied to road fuels (gasoline and diesel) and consider an excise tax or feebate system for passenger vehicles (Medium term).

Adaptation
- Develop an overarching National Adaptation Plan which reconciles GCF workplan and Infrastructure Development Plan (Short term).  
- Undertake hazard mapping for key infrastructure to identify areas that are vulnerable to climate and disaster risk (Short term).  
- Address capacity shortages to accelerate infrastructure investment and integrate climate adaptation measures into sectoral strategies (Medium term).  
- Develop and enforce a land use policy and a national building code that take into account climate risks, and incorporate energy efficiency requirements (Medium term).

Financing
- Mobilize external grant financing to avoid further worsening of fiscal and debt sustainability (Short term).  
- Speed up implementation of adaptation investment projects (Short term).

Risk Management
- Continue to develop contingency financing options and consider regional parametric insurance (Short term).  
- Formalize a national disaster risk financing strategy, including an inventory of public assets, clarify budget processes and engage development partners on financing modalities for a risk buffer (Medium term).  
- Clarify regulations for accessing disaster relief funds at the conclusion of the current Compact Agreement term (Medium term).  
- Explore insurance options for key government infrastructure and developing insurance markets for housing, flood risk and agriculture (Medium term).

National Processes
- Improve chart of accounts, budget classification and budget presentation to identify and track mitigation and adaptation spending (Short term).  
- Establish standard methodology for investment project appraisal and selection; build climate resilience into project screening and design process (Short term).  
- Strengthen institutional and staff capacity in public investment and focus implementation resources on high priority projects (Medium term).

*Source: EXECUTIVE SUMMARY, Climate Change Policy Assessment for the Federated States of Micronesia, International Monetary Fund and World Bank; August 1, 2019.*

### 7.      FSM’s GDP is expected to be critically

### 7. FSM’s GDP is expected to be critically impacted by climate change

### Macroeconomic impacts of climate change and natural disasters
- Climate change channels affecting macroeconomy: lower agricultural output; depressed labor productivity in weather-exposed sectors; reduced capital accumulation; poorer human health.
- Countries with relatively hot climates (such as FSM) incur more negative effects on per capita GDP from a given size increase in temperature (World Economic Outlook, 1950–2014 data reference).
- Natural disasters affect growth, fiscal balance, and trade balance through negative impacts on output and public finances.

### Quantified baseline adjustments from Lee et al. (2018) for FSM
- Downward adjustment to annual growth in the baseline: 0.1 percentage point.
- Downward adjustment to annual projections of the trade balance: 0.4 percentage points.
- Downward adjustment to fiscal balance: 0.1 percentage point.
- Fiscal impact is assessed as insignificant through 2023, cushioned by the large share of grants as a proportion of total revenue in FSM.

### Large-disaster (alternative) scenario and tail risks
- Example: Typhoon Maysak (2015) caused about 3.5 percent of GDP in damages in FSM.
- Under a Maysak-like event, GDP could fall by up to 5 percentage points in FSM.
- Corresponding deteriorations:
  - Fiscal balance: 3.4 percentage points.
  - Trade balance: 13.4 percentage points.
- Probabilistic modeling suggests a cyclone causing damages of around 50 percent of GDP is to be expected once every 100 years, implying much larger impacts on GDP, fiscal, and trade balances.
- IMF-World Bank Debt Sustainability Analysis confirms natural disaster shocks pose major risks to FSM’s debt sustainability.

### FSM-specific channels amplifying growth impacts
- El Niño and La Niña events will continue, increasing uncertainty and volatility in the fishery sector and fisheries-related government revenue.
- Rising temperature and sea-level rise will dampen efforts to revive sustainable agriculture growth.
- Agriculture contributes significantly to livelihoods and food security and is identified as a key productive sector for sustainable economic growth.

### Institutional context and policy framework
- Overarching context: 2004–2023 Strategic Development Plan.
- Nation-Wide Integrated Disaster Risk Management and Climate Change Policy (2013).
- FSM Climate Change Act (2014).
- NDC developed in this context; NDC focuses on emissions reduction pledges and an ambitious renewable energy agenda.
- Adaptation actions were not included in the NDC but have been addressed subsequently in Joint State Action Plans (JSAPs), sectoral plans, and the Infrastructure Development Plan (IDP) (2016–2025). The costs of adapting to climate change have not been costed consistently in the IDP.
- Institutional change: Department Environment, Climate and Emergency Management (DECEM) established in 2018; responsible for mainstreaming climate change adaptation and disaster management policies and oversaw development of a Green Climate Fund country work program.
- Gap: no comprehensive and consolidated National Adaptation Plan yet.

### Disaster Resilience Strategy (DRS) needs
- FSM has institutions and plans to deal with natural disasters but lacks a comprehensive disaster resilience strategy (DRS).
- A national DRS would synthesize and prioritize investments and arrangements for resilience, covering:
  - Infrastructure and investments to limit disaster impacts.
  - Financial arrangements to respond to disasters.
  - Institutional arrangements for effective disaster response.
- The CCPA provides advice for developing an effective DRS; next sections focus on post-disaster resilience, investment, financing, risk management, and government process improvements.

### Capacity to cope with intensified disasters
- Primary government responsibilities: pre-disaster planning; immediate pre-disaster emergency mobilization, evacuation and sheltering; immediate post-disaster relief operations (reestablishing communications, clearing airport runways, reestablishing airport/road/port operations, emergency medical and other services).
- Under the Compact, USAID and FEMA provide the majority of finance for disaster management and reconstruction; USAID provides assistance while FEMA funds that assistance. NOAA supports early warning and weather services.
- Uncertainty about post-2023 arrangements under the Compact is a significant factor in preparedness for intense future disasters.
- Formal legal and planning framework: Disaster Relief Assistance Act (1989); Nation Wide Integrated Disaster Risk Management and Climate Change Policy (2013); National Disaster Response Plan (2016) establishing the National Disaster Committee.
- FSM is a signatory to the Sendai Framework for Disaster Risk Reduction (2015–2030) and the Hyogo Framework for Action (2005–2015).

### Capacity and data gaps
- DECEM is not resourced adequately for ex-ante multi-hazard preparedness and post-disaster response; state emergency preparedness facilities are critically under resourced (only one or two staff responsible at each of the four states).
- Priority attention needed for human and financial resources; operational capacity varies among states in skills and training.
- Systems for identifying, collecting and reporting damage and loss data need further development:
  - Need for country-specific and localized hazard, risk, and downscaled climate models to support resilient infrastructure and adaptation investment planning.
  - Current data collection focuses on high-intensity events and reflects sectors eligible under the Compact rather than comprehensive damage and loss database needs.
  - High-frequency, low-intensity events are not reported in detail across ministries.
  - Recommendation: establish a standardized damage and loss database aligned with standard methodology, with templates and guidelines for data entry; useful for recovery planning, reconstruction/retrofitting decisions, and backing financing requests to donors.
  - Short-term launch feasible; comprehensive database will take time to complete.

### Recommendations for General Preparedness (priority)
- 1. Improve climate data collection and use, including on the costs of high and low intensity disasters and disaster response expenditure. (Short term)
- 2. Develop a comprehensive Disaster Resilience Strategy (DRS) in cooperation with IMF, World Bank and other development partners. (Medium term)
- 3. Prepare for end of Compact by strengthening capacity for weather services and emergency management at the State and National level. (Medium term)

### Contribution to mitigation: targets and actions
- FSM plans to meet its Paris Agreement mitigation pledge by:
  - Expanding renewable power generation.
  - Improving efficiency of power generation.
  - Encouraging uptake of energy efficient building design and appliances by households and government.
- Short-term mitigation options for transport are limited, but scope exists to raise taxes on fuel and reform vehicle taxation to encourage fuel-efficient vehicles.
- FSM’s NDC target: reduction in carbon dioxide (CO2) emissions (energy and transport sectors) by 28 percent below 2000 levels by 2025; with additional technical and financial support from the international community, FSM aims for an additional 7 percent reduction in emissions.
- FSM’s contribution to global GHG emissions is 0.003 percent.

### Electricity and energy objectives and implementation status
- Energy policy goals (from 2012 national energy policy and energy master plan):
  - Increase share of renewable energy sources to 30% of the generation mix.
    - Proposed action: Investment in renewable generation leading to an additional 45 MW of solar power over the next 20 years.
  - Reduce energy losses such that generation efficiency increases by 20%.
    - Proposed actions: Commissioning of more fuel-efficient diesel generators and other measures to reduce technical losses (e.g., upgrading of overhead lines).
  - Increase energy efficiency by 50% by 2020.
    - Proposed actions: Energy-awareness campaign for households; procurement of inverter air conditioners for government; small program subsidizing loans for energy-efficient home design.
- Contextual figures: renewable share was 19 percent in 2018 with a target of at least 30 percent by 2020.
- Progress notes:
  - Detailed and ambitious plan exists for renewable energy target; progress toward energy efficiency objectives has been limited.
  - Electricity efficiency policy actions are less well-developed; no consistent national building code considered; concerns about regulatory capacity to monitor compliance.
  - Transport mitigation measures in the energy policy action plan have not been implemented (measures include setting standards for public transportation, incentives for mass transit and carpooling).

*Source: IMF staff compilation from the Federated States of Micronesia country CCPA chapter.*

### 24.      The expansion of renewables has helped to reduce GHG emissions from electricity

### 1fsmea2019002 - 24.      The expansion of renewables has helped to reduce GHG emissions from electricity

### Renewables and sectoral emissions
- Emissions from the use of diesel in electricity generation have fallen by around a third between 2000 and 2018.
- Renewable generation penetration increased from 4.3 percent in 2009 to 19 percent (current level).
- Diesel plants account for all non-renewable generation supply; solar accounts for the large majority of renewables other than a hydro facility in Pohnpei and a wind farm in Yap.
- Transportation is now the main source of emissions; the majority of transport emissions are from the use of gasoline in passenger vehicles.
- Registered vehicles in FSM increased from 7,658 vehicles in 2009 to 8,775 vehicles in 2015.
- Fuel import bill (around 8 percent of GDP in 2018).

### Quantitative evaluation of mitigation policies
- A streamlined tool, parameterized to FSM, projects fuel use by energy sector using projections of GDP and assumptions about how higher GDP affects energy demand and about the rate of technological change.
- Impacts of mitigation policies depend on their proportionate impact on energy prices and assumptions about price responsiveness of energy use.
- Annex III contains a description of the model and its parameterization for FSM.
- The spreadsheet tool can be provided upon request.

### Renewables targets and investment needs
- Increasing the share of renewables to 30 percent by 2025 would reduce CO2 emissions enough to allow FSM to meet its conditional NDC goal.
- State energy master plan target: 44 percent by 2020 (acknowledged as challenging within the timeframe).
- Planned projects: mix of new solar, battery, stand-alone solar systems (outer islands), and upgrading existing diesel generation.
- Access to enough sites for renewables varies across islands, particularly Chuuk (challenges securing land).
- Investment plan (2019–2023) calls for US$101 million of investment (generation and distribution).
- Authorities estimate donor funding secured for around US$ 50–60 million.
- A smaller component of investment needs filled by Independent Power Producers (IPPs); example: Pohnpei Utilities Company IPP arrangement for solar generation and storage.
- Electricity demand projections underlying the plan may be overly optimistic; investment needs for the main grid may be overestimated.

### Electricity and fuel price context
- Residential electricity prices in FSM are among the highest in the Pacific.
- Price of gasoline: US$4.50/gallon (around US$1.2/liter).
- Diesel price: US$4.81 per gallon (before proposed excise adjustment referenced later).
- There is no tax applied on the sale of electricity.

### Current tax system and carbon pricing
- Federal import tax on all types of imported fuel: 5c per gallon.
- State-level sales tax on the first commercial sale: average around 5c per gallon (varies across states).
- Federal import tax on motor vehicles: 4 percent; additional state-level tax around 5 percent; sales taxes applied for first commercial sale only (subsequent resales not subject to tax).
- Current fuel and motor vehicle taxes make up a small component of total gasoline cost compared to other Pacific Island countries.
- Under current mitigation policies, baseline (BAU) fossil fuel CO2 emissions forecast:
  - 2025: 2 percent lower than in 2018.
  - 2030: 3 percent lower than in 2018.
  - These BAU levels are 5 percent above FSM’s conditional NDC target.
- Declining energy intensity implies steady decline in fuel tax revenues from gasoline and diesel relative to GDP:
  - 0.3 percent of GDP in 2018
  - 0.2 percent in 2025 and 2030.
- BAU imported fuel bill (excluding jet fuel):
  - 6.5 percent of GDP in 2018
  - 7 percent in 2025
  - 7.1 percent in 2030.

### Policy options analyzed and modeled scenarios (Table 2 summary)
- Metrics reported: total CO2 emissions (tons of CO2 equivalent), CO2 by electricity and transport & other, renewables share (electricity), Gasoline & Diesel tax revenue (percent of GDP), Fuel import bill (percent of GDP).
- BAU, Renewables, Fuel tax, Vehicle feebate, and Combination scenarios — selected figures from Table 2:
  - Total CO2 emissions (tons of CO2 equivalent)
    - 2025: BAU 103488; Renewables 97495; Fuel tax 102308; Vehicle feebate 100754; Combination 93752
    - 2030: BAU 102427; Renewables 92195; Fuel tax 101296; Vehicle feebate 99799; Combination 88596
  - Electricity CO2
    - 2025: BAU 42810; Renewables 36816; Fuel tax 42810; Vehicle feebate 42810; Combination 36816
    - 2030: BAU 42635; Renewables 32403; Fuel tax 42635; Vehicle feebate 42635; Combination 32403
  - Transport & other CO2
    - 2025: BAU 60678; Renewables 60678; Fuel tax 59499; Vehicle feebate 57944; Combination 56936
    - 2030: BAU 59792; Renewables 59792; Fuel tax 58661; Vehicle feebate 57164; Combination 56194
  - Renewables share (electricity)
    - 2025: BAU 0.19; Renewables 0.30; Fuel tax 0.19; Vehicle feebate 0.19; Combination 0.30
    - 2030: BAU 0.19; Renewables 0.38; Fuel tax 0.19; Vehicle feebate 0.19; Combination 0.38
  - Gasoline & Diesel tax revenue (percent of GDP)
    - 2025: BAU 0.2; Renewables 0.2; Fuel tax 0.6; Vehicle feebate 0.2; Combination 0.6
    - 2030: BAU 0.2; Renewables 0.2; Fuel tax 0.6; Vehicle feebate 0.2; Combination 0.5
  - Fuel import bill (percent of GDP)
    - 2025: BAU 7.0; Renewables 6.6; Fuel tax 6.9; Vehicle feebate 6.8; Combination 6.3
    - 2030: BAU 7.1; Renewables 6.4; Fuel tax 7.0; Vehicle feebate 6.9; Combination 6.1

### Fuel/carbon taxation policy details and impacts
- Excise tax proposal: 25c/gallon increase, bringing tax burden on diesel and gasoline to around 35c/gallon.
- This is equivalent to a carbon tax of US$ 35 per ton of CO2.
- Combusting a gallon of gasoline and diesel produces 0.009 and 0.010 tons of CO2, respectively.
- Proposed excise tax does not apply to aviation fuel.
- Price impacts from the one-off excise tax:
  - Gasoline: from US$4.50 per gallon (which includes taxes of around 10c per gallon) to US$4.75 per gallon.
  - Diesel: from US$4.81 per gallon (which includes taxes of around 10c per gallon) to US$5.06 per gallon.
- Estimated fiscal and emissions impacts of the excise tax:
  - Extra revenues: 0.4 percent of GDP in 2025 and 0.3 percent in 2030.
  - Economywide CO2 emissions reduction: estimated 1 percent below BAU levels in 2025 and 2030.
- Assumed behavioral response: a typical assumption that each 1 percent increase in the fuel price reduces fuel consumption by around 0.45 percent over the medium to longer term.
- Carbon taxation is identified as the most economically efficient policy to achieve emission reductions, but FSM’s lack of public transportation limits behavioral responses.
- Example sensitivity: A 10c/kWh tax on electricity would increase prices by 24 percent and lead only to an 8 percent reduction in demand.

### Vehicle taxation and feebates
- Motor vehicle excise tax alternative: increase with age and engine size of vehicle to incentivize smaller and newer cars.
- Suggested structure: excise on older cars could be around 30 percent higher than on newer cars to equalize costs on emissions; differentiated rates between hybrid and non-hybrid cars possible.
- Feebates: sliding scale of fees/rebates to shift demand toward more energy-efficient vehicles; designed to be revenue-neutral (fees balance rebates) though aggressive fees/rebates can be politically preferable.
- Feebates do not raise net tax burden on average household but are more difficult administratively; they do not encourage driving less and may induce a rebound effect (empirical studies suggest rebound is generally modest).

### Combined policy outcomes and trade-offs
- Combination of expanding renewables, strengthening fuel taxation, and implementing feebates:
  - By 2025, combination cuts economy-wide CO2 emissions by 38 percent below its level in 2000.
  - Leads to an additional 0.3 percent of GDP in revenue compared to BAU.
  - Reduces the fuel import bill below BAU levels by 0.64 percent of GDP in 2025 and 0.93 percent of GDP in 2030.
- Electricity-focused policy recommendation: continue to focus on expanding renewables to reduce emissions and bring down electricity costs; operational costs from solar can be less than half those from diesel (excluding up-front capital costs).
- Renewables capital costs are large and could lead to higher tariffs without proactive planning; master plan envisages foreign grants and concessional financing to cover part of capital investment. If all capital expenditure were covered by grants, electricity tariffs would fall significantly.
- Larger carbon pricing could make FSM’s energy prices among the highest in the Pacific and raise distributional concerns; analysis of social safety nets and transition measures for firms and workers would be required.

### Complementary non-fiscal policies for transport
- Taxation alone has limited effects given scarce alternatives to private vehicles and already-high prices.
- Broader transport mitigation strategy should include non-fiscal measures: development of affordable public transportation, provision of walking and cycling facilities, electrification of the transport fleet.
- Examples from other Pacific states:
  - Fiji: mitigation actions center on electric vehicles, public transportation, cycling, biofuels, and vehicle efficiency.
  - RMI: policies to encourage public transport, cycling, walking, and electrification of the transport fleet; established the Micronesian Center for Sustainable Transport to coordinate low-carbon transport solutions.
- Higher renewable generation increases potential for electric vehicle penetration; short distances in FSM improve electric fleet feasibility.
- The World Bank is working on a study to assess the practicality of an electric fleet in FSM.

*Source: 1fsmea2019002 - 24.      The expansion of renewables has helped to reduce GHG emissions from electricity*

### 41.      Regulatory approaches can also support the promotion of energy-efficient buildings.

### 1fsmea2019002 - 41.      Regulatory approaches can also support the promotion of energy-efficient buildings.

### Regulatory approaches and energy-efficient buildings
- Building codes may combine requirements for walls, floors, ceiling insulation, windows, air leakage, duct leakage, rather than a single energy efficiency rating.
- Building codes should be developed to reflect adaptation requirements and include energy-efficiency requirements (see Adaptation Plans section for recommendations).
- Recommendation for Mitigation Priority:
  - 1. Continue expanding renewable power generation. Short term
  - 2. In the context of a transport mitigation strategy Introduce a moderate excise tax applied to road fuels (gasoline and diesel) and consider an excise tax or feebate system for passenger vehicles (medium term). Medium term

### Adaptation Plans — overview and fragmentation
- FSM’s planning for adaptation is fragmented across several plans and documents; individual sectoral projects include varying levels of adaptation measures.
- Progress hindered by capacity constraints, particularly in investment project execution at the State level.
- Preparation of an overarching National Adaptation Plan (NAP), costed sectoral investments focused on resilient infrastructure (such as power systems), and development/implementation of a National Building Code with disaster and climate resilient provisions would enhance FSM’s adaptation capacity.

### Policy framework and sectoral strategies
- FSM has prioritized climate change adaptation and endorsed relevant international frameworks, but gaps and inconsistencies remain (Figure 8 references key plans and gaps).
- Fragmentation exists between state and national responsibilities and across documents (GCF Work Plan, JSAPs, IDP (2016–2025)); IDP does not consistently focus on climate resilient infrastructure or climate adaptation context.
- Need for a National Adaptation Plan (NAP) to:
  - consolidate prioritized climate change adaptation activities from existing national, state and sectoral plans;
  - provide framework for integrating climate considerations into planning and budgets to “climate-proof” public and private investments;
  - clarify multiple adaptation plans and provide a prioritized implementation schedule to assist fundraising.
- Implementation slow due to funding and human resource constraints despite well-developed sectoral policies.
- Progress in sector policies and regulations includes:
  - Department of Transport, Communication and Infrastructure: Climate Adaptation Guide for Infrastructure.
  - National Climate Change and Health Action Plan (2012).
  - Energy Policy and Action Plan (2010) and Energy Master Plan (2018) seek increased renewable energy, energy conservation and efficiency, and mitigation activities (limited reference to adaptation).
  - Agriculture Policy (2012–2016) includes climate change impacts; policy expired but is being renewed.

### Public investment: current state and needs
- A regional study estimated over 2011–2018 FSM spent around US$8 million per year on climate related projects; this equated to around 2.7 percent of 2018 GDP. Over half of this expenditure targeted mitigation projects; spending on adaptation was around 1.2 percent of GDP annually.
- Until recently there was no clear costed investment strategy for climate adaptation; two main sources:
  - IDP (2016–2025): detailed and costed plan for infrastructure-related compact capital grants; not primarily aimed at adaptation but considers climate-proof investments.
  - JSAPs: state-level climate change adaptation plans with itemized and costed investment plans; consistency with IDP unclear.
- GCF work program identifies investments of around US$1.1 billion aimed primarily at adaptation and disaster resilience; consolidation of IDP and GCF suggests total investment plan in the region of around US$1.3 billion.
- The GCF work program total (by jurisdiction/program estimated cost $ millions):
  - Nationwide: Total: 242 (components include FSM Food and Water Security Program10; FSM Renewable Energy Investment Program125; FSM National College Resilient Infrastructure Development Program 64; Nation-wide Climate Change and Disaster Risk Management Coordination and Communications Program 43)
  - Yap State: Total: 203 (Resilient Transport and Private Sector Development Program 93; Yap Renewable Energy Investment Program Phase 3 96; Resilient Infrastructure for Health and Education Delivery Program14)
  - Chuuk State: Total: 349 (Chuuk State Resilient Critical Infrastructure Program349)
  - Pohnpei State: Total: 170 (Pohnpei State Resilient Critical Infrastructure Program142; Pohnpei State Resilient Social Protection Program25; Pohnpei State Resilient Tourism Development Program3)
  - Kosrae State: Total: 133 (Kosrae State Inland Road Completion Project36; Building Resilient Communities in Kosrae State Program97)
  - Overall total 1,097

### Implementation capacity constraints
- Rising cost of infrastructure investment program contrasts with constrained implementation capacity.
- First three years of the IDP saw implementation fall well behind plans; around US$200 million of unused Compact capital grants remain.
- Implementation delays due to land titling and tenure issues (particularly in Chuuk state), contracting issues with procurement agents, and difficulties staffing project management offices at state level.
- Addressing systemic implementation challenges is key; example from another small state: Dominica established a Climate Resilience Execution Agency to leverage local and foreign expertise to plan and execute projects.

### Other public programs: land use and building codes
- FSM lacks a comprehensive land use policy that accounts for hazard risk; need for good quality cadastral data and hazard mapping for key infrastructure.
- FSM lacks a National Building Code and land zoning regulations; large infrastructure often designed to international codes but with limited FSM-specific adaptation.
- Some states (e.g., Pohnpei) have developed building codes but not implemented; enforcement capacity limited.
- Government support needed for:
  - (i) enabling legal framework to give Codes the force of law,
  - (ii) mechanism for accessible and affordable compliance, especially for private dwellings,
  - (iii) institutional capacity and financial resources to enforce codes.
- A National Building Code should be developed (based on the International Building Code and other U.S. based codes and standards), incorporate climate and disaster resilience, and include State-specific requirements where appropriate.
- Interim: adopt standards and practices appropriate to developing infrastructure, including climate change adaptation and energy efficiency standards, for public and private infrastructure.

### Financial sector preparedness
- FSM’s financial sector does not currently contribute significantly to climate resiliency.
- Insurance penetration low; no law requiring insurance for properties such as cars or houses; most public and private assets not insured from natural disasters. USAID/FEMA assistance under the Compact Agreement substitutes for insurance for post-disaster reconstruction.
- Strategy needed to increase insurance provision by the financial sector over the medium term.
- Private sector credit low: loan-to-GDP ratio as low as 15 percent. Credit mainly to existing businesses and consumer loans secured by steady income or cash assets. Commercial banks do not provide mortgages for housing.
- FSM Development Bank’s Home Efficiency Loan Program provides interest subsidy of up to US$10,000 for energy efficient residential house.

### Recommendation for Adaptation Priority
- 1. Develop an overarching National Adaptation Plan which reconciles GCF workplan and Infrastructure Development Plan. Short term
- 2. Undertake hazard mapping for key infrastructure to identify areas that are vulnerable to climate and disaster risk. Short term
- 3. Address capacity shortage in order to accelerate infrastructure investment and integrate climate adaptation measures into sectoral strategies. Medium term
- 4. Develop and enforce a land use policy and a national building code that take into account climate risks and incorporate energy efficiency requirements. Medium term

### Financing strategy for mitigation and adaptation programs
- Boosting public investment on climate change adaptation would soften economic and fiscal impacts of severe natural disasters.
- FSM faces a financing gap between ambitious climate change investment plans and grant funding realized in recent years; in the short to medium term implementation capacity rather than financing is the main constraint.
- Given FSM’s high risk of debt distress, further mobilizing external grants is crucial to implement climate strategy while maintaining fiscal sustainability.

### Institutional issues and financing outlook
- Key institutional financing issue: uncertainty around post-2023 relationship with the United States and the expected fiscal cliff in 2023, which reduces fiscal space and places FSM at high risk of debt distress.
- FSM’s federal structure complicates financing: much financing (including U.S. Compact grants) tied to specific states, fragmenting financing and implementation capacity; national-level financing gap analysis can mask state-level surpluses and larger gaps.
- Consolidated cost of the IDP and GCF workplans for 2016–25 estimated around US$1.3 billion (360 percent of 2018 GDP); financing identified in the IDP is around US$0.8 billion until 2025.
- Alternative implementation horizons:
  - Implementing over the next 15 years, up to 2035, aligns with limited implementation capacity and available grants.
  - A reform scenario implementing the IDP and GCF workplans over the next 10 years and completing by 2030 would require about a 50 percent increase in government capital expenditure on an annual basis over the 2018 outturn and additional financing of about US$40 million (10 percent of GDP) per year over 2020–30.

*Source: IMF staff analysis as presented in the content unit.*

### 57.      With the fiscal cliff expected to put public debt on an upward trajectory from 2024,

### 1fsmea2019002 - 57.      With the fiscal cliff expected to put public debt on an upward trajectory from 2024,

### Debt sustainability and fiscal outlook
- FSM is assessed as high-risk of debt distress.
- Current public debt: around 20 percent of GDP (all external).
- Fiscal balance: in surplus since 2012 due to increases in fishing license fees and corporate income taxes.
- FSM Trust Fund: US$210 million (57 percent of GDP) by 2018.
- Government policy: keep debt below 30 percent of GDP.
- U.S. Compact grants: amounting to around 20 percent of GDP are expected to expire in 2023 unless the Compact Agreement is renewed.
- Projection: fiscal balance projected to turn to a deficit of 4½ percent of GDP in 2024, putting debt on a rising path.
- DSA thresholds: breached in the 2030s under IMF and World Bank Debt Sustainability Analysis, leading to a high risk of debt distress.
- FSM Trust Fund access: not available for drawdown until 2030 (Law No. 20-185).

### Options to finance higher capital spending and preserve sustainability
- Need to further mobilize external grant financing to implement the climate change strategy while maintaining fiscal sustainability.
- Financing options under improved implementation capacity:
  - Unlock backlog of U.S. Compact capital grants currently amounting to about US$200 million (utilizable after 2023 under the current Compact Agreement).
  - Maximize access to available grants, particularly from climate and environmental funds.
  - If grants are limited, combine grants with enhanced domestic revenue mobilization (example: higher excise taxes on gasoline and diesel).
  - Incentivize private sector investment to support climate resilience.
  - Judicious drawdown on the FSM Trust Fund to finance major projects after 2030 can be justified for safeguarding the living standards of future generations.
- Policy priority: authorities should prioritize the IDP and GCF workplans, including shifting available financing focus from mitigation to adaptation.

### Natural disaster risk, DSA stress test, and impacts on debt
- Natural disasters can significantly reduce GDP via damages to public infrastructure and private capital and reductions in total factor productivity, and raise fiscal deficits through higher post-disaster spending.
- Tailored DSA natural disaster stress test assumptions:
  - One-off increase of 10 percentage points in debt-to-GDP ratio in the year of a disaster.
  - Reductions in growth rates of real GDP and exports by 5 and 3.5 percentage points, respectively, in the year of a disaster.
- Stress test result: upward shift in post-disaster debt trajectory; public debt in 2030 higher by about 30 percent of GDP than under the no-disaster scenario.

### Benefits of adaptation investment
- Short-term: increase in spending boosts growth through fiscal multiplier effects.
- Medium- and long-term:
  - Gradual increase in resilience from adaptation investment lowers reconstruction costs and output losses in natural disasters, leading to a lower fiscal deficit compared to no-adaptation scenario.
  - More resilient public infrastructure can raise returns to private investment, increasing private capital accumulation and contribution to growth.
  - Strong adaptation policies likely improve access to grant financing, expanding the envelope of capital spending and further increasing growth.

### Illustrative scenario analysis (adaptation ramp-up vs status quo)
- Baseline / without adaptation ramp-up:
  - GDP growth remains at potential, estimated at 0.6 percent under the baseline (pre-disaster period).
  - When disaster hits in 2030: real GDP declines by 5 percent; public debt rises by 10 percent of GDP.
  - Starting 2031: real GDP growth increases to 1.0 percent annually (compared to 0.6 under the baseline) throughout the implementation period, reflecting expected growth dividends of post-disaster reconstruction.
- With adaptation investment ramp-up (reflecting higher adaptation investment over 2020–30):
  - GDP growth increases to 1.0 percent during 2020–30.
  - When disaster hits in 2030: real GDP declines by only 3 percent; public debt rises by only 6 percent of GDP.
  - These 2030 impacts (GDP loss and debt hike) are 40 percent smaller than under the status quo scenario.
- Result: post-disaster debt-to-GDP path under high adaptation investment scenario is significantly below the path under the status quo scenario. Caution noted on parameter sensitivity and lack of a formal debt-investment-growth model.

### Recommendations for financing priority
- 1. Mobilize external grant financing to avoid further worsening of fiscal and debt sustainability — Short term
- 2. Speed up implementation of adaptation investment projects — Short term

### Risk management strategy and disaster financing arrangements
- Current state:
  - FSM has some elements of a risk layering strategy but is not well prepared for the post-2023 context.
  - Contingency funds exist, indemnity and catastrophe insurance are under-used.
  - Main risk transfer mechanism: provision of funding from USAID and FEMA through the Compact Agreement, set to expire in 2023 unless renewed.
- Suggested action: develop a National Disaster Risk Financing Strategy as a central element of the broader Disaster Risk Strategy (DRS) to guide risk retention and transfer choices and frame international support requests.

### Risk assessment and contingency figures
- PCRAFI estimates:
  - FSM likely to incur on average US$8 million per year in losses from earthquakes and tropical cyclones.
  - Over the coming 50 years: 50 percent chance of experiencing natural disaster losses exceeding US$105 million and casualties larger than 220 people.
  - 10 percent chance of experiencing a loss exceeding US$470 million and casualties larger than 600 people.
  - Likelihood of occurrence of one natural disaster per year for FSM: 24.3 percent.
- Current self-insurance:
  - Supplementary assistance under the Compact Agreement is the Government’s main self-insurance strategy.
  - Disaster Assistance Emergency Fund (DAEF): FSM and U.S. governments contribute US$200,000 each annually; provides FSM access to quick disbursing funds totaling US$100,000 per event.
  - Expected DAEF balance at completion of current Compact term: US$6–8 million.
  - Disaster Relief Fund (DRF): consolidated contributions from development partners; balances remain for future use.
- Budgetary practice:
  - Budgetary reallocations are used to fill the gap between DAEF response and Compact-funded reconstruction; supplementary budgets reallocate funds from recurrent or capital expenditures to crisis response.
- Contingent financing developments:
  - Current contingent financing via a Contingency Emergency Response component in a World Bank IDA grant for the Maritime Investment Project and via the Asian Development Bank.
  - Possible future tool: World Bank’s Catastrophe Deferred Drawdown Option (CAT-DDO).

### Insurance and risk transfer gaps
- FSM retains much of its disaster risk with limited risk transfer beyond Compact mechanisms.
- Insurance coverage:
  - Almost no insurance for public or private assets; coverage falls far short of expected damages.
  - Notable exception: Petrocorp energy plant facilities are insured.
  - Most public assets, including hospitals and schools, are not insured.
  - FSM does not participate in the Pacific Catastrophe Risk Insurance Company (PCRIC) disaster risk insurance program (the pooled parametric scheme for the Pacific region).
- Domestic insurance market:
  - Underdeveloped, with low demand and low product supply.
  - Scope exists for collaboration to develop traditional market products (including housing) and socially-desirable services such as food and agriculture insurance.
- Policy consideration: government can more cost-effectively mitigate natural disaster risk by insuring public assets and consolidating coverage into larger policies to reduce premiums.

*IMF staff analysis, Federated States of Micronesia (excerpts).*

### Box 2. Pacific Catastrophe Risk Insurance Company (PCRIC) Disaster Risk Insurance

### Box 2. Pacific Catastrophe Risk Insurance Company (PCRIC) Disaster Risk Insurance

### PCRIC disaster risk insurance: design and purpose
- PCRIC currently provides parametric insurance to four nations: the Cook Islands, Republic of the Marshall Islands, Tonga, and Samoa, with each benefiting from parametric earthquake and cyclone protection from the facility.
- Objective: increase the financial resilience of Pacific Island Countries (PICs) against natural disasters by improving their capacity to meet post-disaster funding needs through parametric insurance that ensures access to immediate funds after a disaster.
- Parametric insurance mechanism: settlements are based on a predefined formula using variables that are exogenous to both the individual policy holder and the insurer (the physical parameters of the event) and are strongly correlated to losses, rather than on on-the-ground individual loss assessments.

### Documented PCRIC/PCRAFI payouts
- A pay-out of US$1.3 million to Tonga in 2014 following Tropical Cyclone Ian (annual premium of US$300,000/year).
- A payout of US$1.9 million to Vanuatu following Tropical Cyclone Pam in 2015 (annual premium of US$300,000/year).
- A second payout of US$3.5 million to Tonga in 2018 following Tropical Cyclone Gita (annual premium of US$500,000/year).

### Origins, governance, and capitalization
- Established in June 2016 as the result of region-wide efforts across 14 Pacific Island Countries.
- Built on the pilot Pacific Catastrophe Risk Assessment and Financing Initiative (PCRAFI) pilot from 2013 to 2015.
- PCRIC is a captive insurance company owned by the Pacific Catastrophe Risk Insurance Foundation (PCRIF), directed by participating Pacific Island Countries.
- Initial capital funds were provided by the PCRAFI Program Multi-Donor Trust Fund with contributions from Germany, Japan, the United States and the United Kingdom.

### Improving risk layering in FSM: findings and analysis
- Recommendation rationale: disaster risk financing is a key pillar of disaster risk management; strengthening financial protection mechanisms will fill critical gaps and enable cost-effective planning for disaster response and reduce natural hazards’ economic impact.
- A National Disaster Risk Financing Strategy should be developed to assess how to close existing and future gaps for FSM in the most cost-effective way.
- The strategy should:
  - focus on building complementarities between various risk retention and risk transfer instruments;
  - ensure policies that allow quick liquidity from such instruments after a disaster to be spent efficiently and transparently.
- Recommended layered buffer components:
  - risk retention mechanisms (including a natural disaster contingency fund),
  - risk transfer mechanisms such as PCRIC cover (or another parametric insurance product),
  - private sector insurance mechanisms,
  - contingent financing mechanisms.
- Use of grant financing to increase investment in resilient infrastructure would over time reduce the needed size of the fiscal risk buffer.

### Role and conditions for the FSM Trust Fund (FSMTF)
- The FSMTF can provide a further buffer for a catastrophic disaster; characterized as a large buffer (currently over 50 percent of GDP).
- Policy context:
  - FSM has followed a prudent policy to save revenue windfalls into the FSMTF in recent years and enacted a law prohibiting drawdown until 2030.
  - Given significant post-2023 uncertainty and an expected fiscal cliff, the FSMTF needs to be accumulated further and prudently managed.
- Guidance:
  - FSMTF should be viewed as a last resort; priority should be given to building buffers and reducing risk to minimize potential use of the FSMTF.
  - The role of the FSMTF as a buffer for catastrophic natural disaster needs clarification within the FSMTF’s governance framework and as part of the National Disaster Risk Financing Strategy.

### Policy guidance on buffer design and regulations
- Building buffers and improving regulations on their usage should be integral parts of the National Disaster Risk Financing Strategy.
- Short-term priorities:
  - develop adequate insurance coverage, in particular optimizing parametric coverage by broadening the use of indemnity and catastrophe insurance;
  - further build the Disaster Risk Fund (DRF) and establish clear regulations for its use.
- Medium-term actions:
  - clarify the framework for contributing and accessing the DAEF following the conclusion of the current Compact Agreement, with regulations specifying the circumstances for use;
  - enhance access to rapid and cheap contingent financing that can be triggered in the event of a natural disaster.

### Recommendations for Risk Management Priority
- 1. Continue to develop contingency financing options and consider regional parametric insurance. Short term
- 2. Formalize a national disaster risk financing strategy, including an inventory of public assets, clarify budget processes and engage development partners on financing modalities for a risk buffer. Medium term
- 3. Clarify regulations for accessing disaster relief funds at the conclusion of the current Compact Agreement term. Medium term
- 4. Explore insurance options for key government infrastructure and developing insurance markets for housing, flood risk and agriculture. Medium term

### Integration of climate change into national planning: findings
- FSM has largely integrated climate resilience into national planning, though it still lacks an overarching national adaptation plan.
- The National Strategic Development Plan 2004-2023 includes strategic goals related to climate resilience.
- All four states of FSM have developed the JSAP to address climate change risks across priority areas.
- Climate resilience has been mainstreamed in agriculture and health sectoral policies and plans, but not in the energy sector which focuses only on mitigation.
- FSM developed its GCF country program consolidating large scale and cross-sectoral priority projects, though limited progress has been achieved on financing.
- Institutional development: DECEM recently established as the central coordinating agency for climate change at the national level; DECEM is focal point for Adaptation Fund and Global Environment Fund, while other departments serve as focal points for different partners, contributing to fragmented climate financing.
- The Council on Climate Change and Sustainable Development faces difficulties meeting regularly and ensuring appropriate representation.

### Adequacy of the Public Investment Management (PIM) system: assessment and gaps
- FSM has improved PIM but still relies heavily on development partner expertise; gaps contribute to slow project execution and limited local capacity building.
- PIMA assessment summary:
  - FSM scores 2.0 (against the top score of 3.0),
  - low-income developing country average is 1.9,
  - average for six small states is 1.7.
  - Note: if assessment limited to local revenue financed projects, FSM’s score would be significantly lower, especially on institutions for project appraisal and selection.
- Key PIM planning and allocation findings:
  - Fiscal policy guided by an explicit debt ceiling of 30 percent of GDP and the principle of balancing budget; in practice, most capital spending is financed by grants and not constrained by the debt ceiling.
  - National and state governments prepare strategies/plans; information on outcomes/outputs of investments is inconsistent across plans.
  - Highly decentralized PIM; contingent liabilities reported by each government are not consolidated in national budget documents.
  - No well-defined standard methodology for project appraisal and limited central support; major projects financed by Compact and donors undergo rigorous technical, economic and financial analysis and usually independent external review.
  - Infrastructure investments mostly by government or public corporations; very limited private investment and no consolidated report on public corporations’ investment plans.
  - Total construction costs of major projects are approved by the congress; three-year breakdown cost information exists for each capital project included in the budget, but consolidated capital project information is not available and many projects are not included in the budget.
  - No multiyear ceiling on capital expenditures; projects financed by development partners are not included in the budget.
  - Capital spending mixed with other expenditures under the category "Capital Improvement & Human Resource Development."
  - No standard methodologies for determining maintenance needs; maintenance expenditures are not consistently identified in accounts.
  - Uniform project selection criteria are missing; IDP provides guidance for projects covered by IDP, and appraisals of major infrastructure projects are reviewed by DTCI and, if Compact-financed, independently reviewed by the U.S Army Engineer Association (AEA).
  - No comprehensive pipeline of appraised projects; projects are selected by cabinet based on the annual budget consultation.
- Implementation and oversight findings:
  - Major projects are tendered competitively with open tender information, but there is no procurement database nor independent body for procurement complaints.
  - Financing for capital spending at national level is usually timely; state governments may sometimes be short of cash.
  - External funding for capital projects is largely held in separate commercial bank accounts.
  - Several units have oversight functions, but their effectiveness is unclear; ex-post reviews are not required for Compact-financed or domestic revenue financed projects.
  - Slow implementation rates reflect capacity constraints of state-level Project Management Offices (PMOs); PMO staffing shortages persist (example: an engineer position advertised for three years).
  - Capital projects are usually audited, but audit reports are not always sufficiently scrutinized by congress.
  - FSM conducts an asset inventory once every two years; capital assets are reported in financial statements and depreciated over their useful lives.

### Adequacy of Public Financial Management (PFM) systems for climate financing
- PFM has desirable features and has been improving:
  - Clear and consistently followed budget calendar, roles, and responsibilities.
  - Hearings of the Congress Standing Committees are open to the public.
  - Consolidated financial statements are relatively comprehensive (revenues, expenditures, assets, liabilities), completed and audited on time, and accessible via the National Public Auditor website.
- Recent reforms and actions:
  - PFM reform momentum gained after the 2016 PEFA self-assessment (follow-up to 2011 PEFA assessment).
  - PFM reform roadmap 2017–2020 outlines actions including implementing a new IFMIS, completing a review of the Financial Management Regulation (FMR), improving reporting standards, and continuing capacity development.
  - The new FMR has been effective since March 2019 and related efforts are ongoing.

*Box 2 text from 1fsmea2019002 - Box 2. Pacific Catastrophe Risk Insurance Company (PCRIC) Disaster Risk Insurance*

### 75.      Nevertheless, further PFM enhancements are needed to ensure effective management

### 1fsmea2019002 - 75.      Nevertheless, further PFM enhancements are needed to ensure effective management

### Public financial management (PFM) enhancements — findings
- Financial management regulations of the four states are largely out of date and urgently need to be updated.
- Macroeconomic forecasting and fiscal strategy should factor in the impact of climate change and natural disasters.
- Limited information on fiscal risk is currently published in FSM; developing a comprehensive fiscal risk statement would organize such information, including fiscal risks originated from natural disasters and climate change.
- Budget documentation should clearly link policies and strategies, such as the climate change and natural disaster policy, to budget allocation.
- Budget classification and chart of accounts need to clearly differentiate capital expenditures from recurrent expenditures, such as maintenance and human resource development expenditures.
- Chart of accounts and budget classification should be updated to track climate resilience expenditures as well as recovery and reconstruction spending by source, location and economic activity.
- Government procurement processes should be more transparent and a complaint management system should be established.
- More frequent and timely in-year budget execution reporting and more rigorous congress scrutiny of audit reports would improve monitoring of climate resilience spending.

### Recommendations for national processes (explicit list)
- Improve chart of accounts, budget classification and budget presentation to identify and track mitigation and adaptation spending.
- Establish standard methodology for investment project appraisal and selection. Build climate resilience into project screening and design process.
- Strengthen the institutional and staff capacity in public investment and focus implementation resources on high priority projects.

### Resource needs — summary and quantified estimates
- An indicative tally of priorities points to additional resource needs of over US$500 million over the next 15 years.
- Investment financing gap of $400–500 million.
- Smaller levels of support required for capacity building and possibly for financing risk layering (for instance, parametric insurance premia).
- Mitigation:
  - Private investment of around US$ 170 million by 2035, mainly in renewable energy generation to fill financing gaps in the energy master plan.
  - Possible government financial involvement to resolve problems impeding private investors (financial support).
  - Development of a mitigation strategy for the transport sector (capacity building).
  - Expanded policy measures to improve energy efficiency (capacity building).
- Adaptation:
  - Filling financing gaps of up to US$400–500 million in a public investment envelope of US$ 1.3 billion by 2035 (financial support), to allow investment in resilient infrastructure, food and water security, wastewater and solid waste, tourism facilities and social protection.
  - Development of a National Adaptation Plan (capacity building).
  - Development of an enabling legal framework, such as land use policy and building codes (capacity building).
  - Improved capacity at state level to accelerate implementation of infrastructure investment (capacity building).
- Risk management:
  - Formalized national disaster risk financing strategy (capacity building).
  - Clarified regulations for accessing the DRF and DAEF at the conclusion of the current Compact Agreement term (capacity building).
  - Collaboration with a regional parametric insurance scheme, should arrangements for supplementary post disaster assistance from the United States change upon completion of the current Compact Agreement term (capacity building and financial support).
- National processes (additional):
  - Improvement of budget presentation to clarify linkage between climate resilience policy and resource allocation (capacity building).
  - Updated COA and budget classification to identify and track mitigation and adaptation spending (capacity building).
  - Establishment of standard methodology for project appraisal and selection with climate resilience as a key screening criterion (capacity building).

### Climate change impacts — key projections and vulnerabilities
- Climate projections:
  - Increase in temperature in the range of 1.1–2.0°F (0.6–1.1°C) by 2030 under a very high emissions scenario.
  - Increase in annual and seasonal mean surface air temperature by up to 4.5oF under a high emissions scenario by 2090.
  - Little change in rainfall predicted by 2030; by 2090 majority of models simulate an increase of at least 5 percent in wet season, dry season and annual rainfall under a high emissions scenario.
  - Under a very high emissions scenario, sea level rise projected to be in the range of 16.1–35.4 inches (41–90 cm) by 2090.
- Climate- and weather-related events observed or expected:
  - Between the 1977 and 2011 seasons, 248 tropical cyclones developed within or crossed FSM’s Exclusive Economic Zone (EEZ).
  - Expected changes: average annual temperature likely to increase; extreme rainfall days likely to occur more often; sea levels likely to continue to rise; El Niño and La Niña events will continue; typhoons likely to be less frequent but more intense.
- Key vulnerabilities and impacts:
  - Saltwater intrusion and storm surges damaging crops and contaminating freshwater supplies; exacerbated king tides causing intense coastal inundation damaging taro beds, soil, agro-forestry resources, and critical coastal infrastructure, particularly on low lying atoll islets.
  - Fisheries: coral reef degradation, ocean temperature rise and acidification may reduce coastal fish catches and shift oceanic fisheries (some projections indicate Skipjack tuna biomass moving East by 2035 to 2050).
  - Transportation: maritime and air transport systems are critical lifelines for outer islanders; increased extreme events raise vulnerability of outer island communities.
  - Telecommunications: current infrastructure is not well prepared to withstand disasters; move to submarine and underground fiber (vs. satellite and communications lines on power poles) will increase resilience.

### Post-disaster assistance from the U.S. Government — arrangements and procedures
- Under the Compact Agreement, the United States entered into a Federal Programs and Services Agreement with FSM; Article X commits the United States to provide disaster preparedness, response, and recovery assistance to FSM.
- In 2008 primary U.S. Government responsibility for FSM disaster assistance transferred from DHS/FEMA to USAID, while FEMA retained responsibility for funding that assistance; USAID and FEMA agreed an Operational Blueprint (OBP) in 2008 and revised it in 2017.
- USAID is responsible for providing disaster assistance and coordinating the U.S. Government response to disasters in FSM; FEMA provides funds to USAID following a U.S. Presidential Disaster Declaration (PDD) and may provide subject matter expertise.
- Key elements of USAID presence:
  - USAID’s Office of U.S. Foreign Disaster Assistance (OFDA) is the lead federal entity for coordinating U.S. humanitarian assistance overseas.
  - USAID maintains a Disaster Assistance Coordinator (DAC) in FSM as a liaison with the FSM Government.
  - A cooperative agreement between USAID and the International Organization of Migration (IOM) is a primary relief and reconstruction partnership; IOM operates offices in Pohnpei, Chuuk and Yap state in FSM, and an office in Majuro, RMI.
- Disaster Assistance Emergency Fund (DAEF):
  - Article X established a DAEF, with an annual deposit of $US200,000 by the Government of FSM, to be matched by a contribution of the same amount by the U.S. Government, starting in 2005 and ending with a contribution in 2023.
  - Thus, a total of $400,000 per year per will accrue toward the FSM contingency fund.
  - Expectation: fund will grow to address lesser-magnitude disasters and increase self-reliance.
- Assistance procedures following an eligible event:
  - USAID may provide initial assistance of $US100,000 for immediate relief.
  - If greater response needed, President of FSM may request a U.S. Presidential Disaster Declaration (PDD); following PDD, USAID implements relief and reconstruction and FEMA provides funding as a “safety net” of last resort.
  - Steps before U.S. President may determine a PDD include: (a) FSM President declares national state of emergency; (b) FSM has utilized its own resources including DAEF pursuant to Annex A to Article X by expending either up to 50 percent of DAEF balance at time of declaration or another mutually agreed amount; (c) FSM has requested assistance from the UN in writing (USAID verification fulfills requirement); (d) U.S. Chief of Mission has declared a disaster triggering a USAID request; (e) Joint Damage Assessment (JDA) findings support need for supplemental assistance; (f) President of FSM has made an official request for a PDD.

### Case study — Typhoon Maysak reconstruction response (2015)
- Event timeline:
  - Typhoon Maysak made landfall on Chuuk islands on March 29, 2015 and on Yap islands on March 20 and April 1, 2015.
- Initial impacts:
  - In Chuuk's Weno, 60–80 percent of houses were badly damaged.
  - Over 800 homes destroyed.
  - More than 6,000 people were displaced from their homes.
  - Significant crop damage; Ulithi Atoll (Yap) had destruction of most homes and widespread infrastructure and crop damage.
- U.S. response:
  - Governors of affected states and FSM President declared state of emergency and requested U.S. assistance; U.S. Presidential Disaster Declaration issued April 28, 2015.
  - USAID and FSM coordinated with FEMA, Department of Agriculture, Food and Nutrition Services, and Small Business Administration; reconstruction implemented by IOM.
- Reconstruction program:
  - Three-year program costing US$42 million.
  - Construction of over 400 new homes and over 150 public facilities (including schools, clinics, and rain catchment systems).
  - Provision of materials and vouchers worth nearly $2.8 million to over 1,350 beneficiaries.
  - Training of almost 1,500 local residents to rebuild homes and communities using resilient designs and high-quality materials.

*Source: 1fsmea2019002 - 75.      Nevertheless, further PFM enhancements are needed to ensure effective management*

### Annex III. Spreadsheet Model to Assess the Impacts of Mitigation

### Annex III. Spreadsheet Model to Assess the Impacts of Mitigation

### Model description and scope
- The spreadsheet model of fossil fuel consumption is similar to an IMF model applied recently to carbon mitigation policies for 135 countries.  
- Basic data on fuel use, prices, and fuel excises were obtained from documents and sources provided by the authorities including: the Department of Finance, Pohnpei Utilities Company and Petrocorp.  
- Many parameters are uncertain for FSM, most notably the price responsiveness of fuel use; model results provide a broad quantitative sense of impacts and sensitivity analysis with the spreadsheet tool is straightforward.  
- The model specifies demand functions for:
  - electricity consumption by household, industrial, and commercial sectors;
  - gasoline;
  - road diesel; and
  - diesel used in power generation.  
- The model does not incorporate capital of different vintages and therefore does not distinguish between short- and long-term responses to fuel price changes.

### BAU projections, income effects, and autonomous trends
- GDP expands by 8.4 percent between 2018 and 2030 based on IMF forecasts and extrapolation.  
- Income elasticities used (percent increase in electricity or fuel demand per 1 percent increase in GDP) are between 0.6 and 1:
  - households have an electricity income elasticity of 1;
  - gasoline is assumed to have an income elasticity of 0.6.  
- Electricity and fuel use are assumed to decline autonomously by 0.5 percent a year due to gradual retirement of older, less efficient capital.  
- In the BAU case:
  - demand for electricity rises over time relative to 2018 levels;
  - demand for road fuels falls.  
- 2018 baseline consumption and fuel notes:
  - Total electricity consumption in 2018 is about 58.6 gigawatt-hours.
  - 2018 fuel use is 4.2 million gallons for diesel used in power generation, 5.3 million for gasoline, 1.35 million for non-power diesel.
  - Approximately 1.8 million gallons of jet fuel is imported into FSM but this does not form part of the analysis.

### Price paths and price responsiveness
- International oil prices are assumed to increase by 22 percent between 2018 and 2030, in real terms.  
- Retail price changes between 2018 and 2030:
  - retail road fuel prices expected to increase by 10 percent;
  - electricity prices expected to increase by 9 percent.  
- 2018 retail prices:
  - US$ 4.50 per gallon for gasoline;
  - US$ 4.81 per gallon for diesel;
  - US$ 2.96 per gallon for diesel used in power generation.
  - Electricity prices between US$ 0.43 and US$ 0.55 across households, industry, and commerce and averaging US$ 0.4 across all users.  
- Price responsiveness assumption:
  - Each 1 percent increase in electricity or fuel prices is assumed to reduce electricity/fuel demand by 0.45 percent.
  - Breakdown of response: 2/3 from efficiency improvements and 1/3 from reduced product use.
  - Vehicle driving response is limited due to constrained alternatives (limited public transport, cycling, walking).

### Electricity supply and renewables assumptions
- In the BAU scenario, the share of renewable generation in electricity supply remains at 19 percent.  
- Changes in electricity demand lead to changes in generation from diesel and renewables equal to the change in demand times the respective supply shares for these fuels.  
- In policy scenarios, expansion of the renewables supply share leads to a corresponding reduction in the diesel fuel generation share.  
- The effect of a higher renewables share on electricity prices has not been incorporated; impact depends on source of financing (grant financed could lower prices relative to BAU; loan-financed on commercial terms could increase prices).

### Emissions and revenue calculations
- CO2 emission rates used:
  - gasoline: 0.0088 (metric) tons per gallon;
  - diesel fuels: 0.0103 ton per gallon.  
- Total emissions in a year = fuel use × emission rate, aggregated over fuels.  
- Revenues are computed by fuel use × relevant fuel excise tax and aggregated over fuels.  
- Excises in US$ per gallon (fixed to 2030 in the BAU):
  - 0.10 for gasoline;
  - 0.10 for diesel.

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### Annex IV. Applying Feebates to Key Sectors in FSM

### Rationale and high-level advantages of feebates
- Large fuel tax hikes in FSM have only modest effects because fuel prices are already high and there are limited transportation alternatives; large fuel tax increases are politically difficult and could damage competitiveness if undertaken unilaterally.  
- Feebates are recommended to achieve price-incentive effects of carbon taxation without increasing energy prices. Feebates are potentially:
  - Effective at reducing energy use if: (i) comprehensively applied across imported products (cars, trucks, buses, washing machines, light bulbs, air conditioners, refrigerators); (ii) provide continuous (rather than discrete) rewards for higher efficiency; and (iii) appropriately scaled.
  - Cost-effective if there is a uniform reward for saving energy across different product types.
  - Able to limit administrative burdens by incorporation into existing excise/import procedures.
  - Consistent with fiscal objectives if an ad valorem component of excises is retained to meet revenue needs and prevent refunds.
  - Able to limit burdens on vulnerable households and firms because they do not involve first-order pass through of new tax revenues into higher fuel/electricity/product prices.

### Transportation: design and trade-offs
- Current vehicle excise system provides no incentives for fuel-efficient vehicles; imported vehicles are subject to a flat rate tax at the federal and state level and do not reward fuel-saving vehicle attributes (smaller cabin size, lighter materials, better aerodynamics).
- Proposed structure: shift to an excise system with:
  - (i) a uniform percent (ad valorem) tax on all vehicles with the rate set to meet revenue requirements; and
  - (ii) a revenue-neutral feebate component.  
- Feebate mechanics for vehicles:
  - A vehicle receives a fee/rebate according to the formula: (vehicle fuel per mile / pivot fuel per mile − 1) × t, where the bar denotes the pivot point fuel per mile and t is a charge per gallon per mile (which accounts for expected use of the vehicle).
  - The pivot point can be set equal to the average fuel consumption rate of vehicles sold in the previous year and updated over time to keep the feebate approximately revenue-neutral.
  - The feebate preserves revenue from the ad valorem component as consumers shift to more efficient vehicles.
  - Implementing requires data on fuel per mile for different models; data are readily available for other countries (example source: www.fueleconomy.gov) and adjustments might be made for local driving conditions in FSM.
  - Alternative: levy tax/subsidy rates on differences between a vehicle’s CO2 emission per mile and a pivot point CO2 per mile.
- International experience and illustrative numbers:
  - Pivot points in other countries' schemes are typically equivalent to about 200 to 250 grams of CO2 per mile.
  - Feebate prices vary: about US$10 per gram CO2 in France up to US$155 in Norway.
  - Mauritius example: average fuel consumption rate of imported vehicles fell from 7 liters/100km in 2011 to 5.8 liters/100km in 2014; new hybrid vehicle sales registrations rose from 337 to over 1,400.
  - Illustration: a feebate with pivot point 250 grams CO2 per mile and price US$100 per gram CO2 would:
    - provide a subsidy of US$5,000 to a vehicle with fuel economy of 45 miles per (U.S.) gallon;
    - impose a tax of US$10,000 on a vehicle with fuel economy of 25 miles per (U.S.) gallon.
- Administrative considerations:
  - Feebates are more difficult to administer than a simple engine-size excise but have advantages: continuous rewards within engine-size/vintage categories and incentives for attributes beyond engine size that reduce fuel consumption.
  - The existing import tax system (HS codes) can be used to implement excise components; feebates require model-level fuel-per-mile data.

### Electricity sector: feebates for appliances and electricity-using capital
- Analogous ad valorem + feebate framework can apply to imported appliances and other electricity-using capital:
  - Ad valorem component retained to maintain revenue.
  - Feebate taxes products with relatively low energy efficiency in proportion to the difference between their consumption rate and a pivot point; conversely, efficient models receive subsidies.
- Feebate mechanics for appliances (example for refrigerators):
  - Fee/rebate formula uses kWh/(cubic foot cooled) as the electricity consumption rate; pivot point denotes the pivot consumption rate; t is the charge per kWh/(cubic foot cooled).
  - Illustration: if pivot point consumption rate = 5 kWh/month and feebate price = US$30 per kWh/month:
    - a refrigerator with energy consumption rate 8 kWh/month would be taxed US$90;
    - a refrigerator with energy consumption rate 2 kWh/month would receive a US$90 subsidy.
  - Feebate component can be made approximately revenue-neutral by setting the pivot point equal to the average electricity consumption rate of models sold in the previous year and updating over time.
  - To minimize cost of reducing electricity use across product classes, the same incremental reward on kWh (the tax rate t) should be uniform across products.
- Air conditioner example uses analogous formulation based on kWh and relevant pivot.

*Source: Annex III and Annex IV, "Spreadsheet Model to Assess the Impacts of Mitigation" and "Applying Feebates to Key Sectors in FSM", 1fsmea2019002.*

### Annex V. PIMA Institutional Questionnaire—Interview Responses

### Annex V. PIMA Institutional Questionnaire—Interview Responses (FSM)

### Fiscal principles, rules, and targets
- Debt target for general government: 30 percent of GDP.
- Budget Procedure Act requirement: balanced budget for central government.
- Medium-term fiscal framework (MTFF): only aggregate expenditure ceilings for the budget year are approved before the first budget circular; the annual budget presents estimates of revenue and expenditure for the budget year and the following fiscal years allocated by administrative and economic classification.

### National and sectoral planning, project costing, and targets
- Main national public investment strategy: Infrastructure Development Plan (IDP) 2016–2025; IDP covers projects financed by domestic revenue, U.S. Compact and grants, and other bilateral and multilateral development partners.
- Other strategies/plans: Joint State Action Plans (JSAP) (focus: climate change and natural disaster resilience), energy master plan, sectoral plans.
- PPPs: no major PPPs in FSM; long-term power purchase agreements exist and may become government liabilities.
- Costing:
  - IDP, JSAP, and energy master plan include costs of individual projects.
  - IDP identifies total project costs, available funding, and fund gaps.
- Targets:
  - Energy master plan includes measurable targets for outputs and outcomes.
  - IDP has outcomes; JSAP does not include measurable targets.

### Coordination between central government and subnational governments (SNGs)
- Capital spending coordination: national government discusses capital projects with SNGs during annual budget consultation; investment plans may not be published.
- Intergovernmental capital transfers:
  - Mainly from the Compact; some guidance on fund allocation.
  - States are notified of expected transfers after national congress authorizes the President to submit the Recommended National Government Compact Budget Request to the U.S. in May; this is less than six months before the start of fiscal year (October 1st).
- Reporting of contingent liabilities:
  - National and subnational governments’ loan guarantees to PCs are published in respective government financial reports.
  - Subnational governments do not report these guarantees to the national government.
  - PPPs are uncommon but long-term power purchase agreements may create contingent liabilities.

### Project appraisal and selection
- Funding sources: most capital projects funded by U.S. Compact and grants, and other bilateral and multilateral development partners; domestically financed projects tend to be small.
- Rigour of appraisal:
  - Major Compact- and donor-financed projects are subject to rigorous technical, economic, and financial analysis and usually undergo independent external review (Army Engineer Association reviews Compact-financed projects).
  - Domestic-revenue projects may not be subject to the same rigorous analysis.
- Methodology and central support:
  - No well-defined standard methodology for project appraisal at national government level.
  - Appraisal is done separately by each department and state without strong central support.
- Risk assessment: risk assessments and mitigation plans are usually included in appraisals for Compact- and development partner–funded projects.
- Central review and selection:
  - Infrastructure project appraisals are reviewed by DTCI; Compact projects are independently reviewed by AEA; donor projects follow donor procedures.
  - IDP contains some selection criteria, but adherence in practice is unclear; no clear selection criteria for projects outside IDP.
  - No comprehensive pipeline of appraised investment projects; projects are selected by the cabinet based on annual budget consultation.

### Alternative financing, public corporations (PCs), and PPPs
- Regulatory framework for competition: no apparent legal restrictions on private participation, but economic infrastructure is currently monopolized by public corporations.
- PPP strategy and legal framework: government has not developed PPP strategies, policies, or a legal/regulatory framework.
- Oversight of PCs:
  - Most PC capital projects (FSM Telecom and Vital FSM Petrocorp) are financed by donors and should be reviewed and approved by the government.
  - PCs’ financial statements are submitted to congress.
  - No consolidated report on investment plans or financial statements of PCs.

### Multiyear budgeting and comprehensiveness
- Multiyear forecasting:
  - For projects included in the budget, costs for the budget year and the following two years are included.
  - Many development partner–financed projects are not included in the budget and there is no total capital expenditure identified.
- Multiyear ceilings: there are no multiyear ceilings on capital expenditures.
- Publication of total construction cost: total construction costs of major capital projects are approved by congress though may not be included in the budget; annual breakdown of these costs is not available.
- Budget comprehensiveness:
  - PCs’ projects and development partner–financed projects are not in the budget book but are approved by congress individually.
  - Local revenue and Compact-financed projects are included in the budget.
  - Capital and recurrent budgets are prepared by DoFA and presented together in the budget documents; however, there is no functional classification.

### Budgeting for investment and protection during implementation
- Appropriation practice: congress appropriates total project outlays at a project’s commencement.
- Virement controls: Financial Management Regulation 2019 prohibits reprogramming in or out of any line item for investments capital of the annual budget, among others.
- Priority for ongoing projects: ongoing projects had already been appropriated in the past and thus are protected from competition with new projects.

### Maintenance funding and identification
- Routine maintenance methodology: no standard methodology for estimating routine maintenance needs, though FMR requires departments/agencies to include sufficient maintenance in their budget.
- Major improvements methodology: major improvements are included in IDP, but there is no standard methodology for determining major improvements.
- Budget identification:
  - Maintenance expenditures may be recorded under “Contract Services” or “Capital Improvement & Human Resource Development”.
  - Major improvements are under “Capital Improvement & Human Resource Development”.

### Procurement
- Openness/transparency: major projects (mainly Compact- and donor-financed) are tendered competitively; tender information is open to the public.
- Monitoring and complaints:
  - No procurement database.
  - No independent body responsible for reviewing procurement complaints.

### Availability of funding and cash management
- Planning and commitment: commitment ceilings are for the total project outlays.
- Cash release:
  - National government generally does not face cash constraints; cash for project outlays is usually released in a timely manner if financial management requirements are met.
  - State governments may sometimes be short of cash.
- Integration of external funding: external funding of capital projects is largely held in separate commercial bank accounts and not fully integrated into the main government bank account structure.

### Portfolio management, oversight, and ex-post review
- Monitoring during implementation:
  - Compact Management Unit monitors Compact-financed projects.
  - CIU within DoFA monitors other projects.
  - PMU under DTCI oversees implementation of infrastructure projects.
  - In practice, effectiveness of these oversight functions is unclear.
- Re-allocation between projects: investment projects are appropriated at commencement and, given no cash constraints, there is no need to reallocate between investment projects during implementation.
- Ex-post reviews: ex-post reviews are not required for either Compact-financed projects or domestic revenue–financed projects.

### Management of project implementation and audits
- Project management capacity:
  - Capital projects are mainly implemented by subnational governments.
  - Subnational Project Management Offices (PMOs) are usually short of capacity and cannot manage projects effectively.
- Rules and procedures for adjustments:
  - IDP has general policies on project adjustments.
  - Adjustments in scope require approval of Infrastructure Planning and Implementation Committee (IPIC).
  - No clear guidance on fundamental review and reappraisal.
- Ex-post audits: projects are audited, but audit reports are not always sufficiently scrutinized by congress.

### Monitoring of public assets and accounting
- Asset inventories: government conducts asset inventory once every two years; stock and conditions are updated though values are not updated.
- Nonfinancial asset recording:
  - Capital assets recorded in government financial accounts at historical cost if purchased or constructed.
  - Donated assets recorded at fair market value at date of donation.
  - These assets are reported on financial statements.
- Depreciation: capital assets are depreciated using the straight-line method.

### IT systems, legal framework, and staff capacity
- IT support: no comprehensive computerized information system for public investment projects to support decision making and monitoring.
- Legal framework: Financial Management Regulation (FMR) has some general provisions and IDP has some guidance.
- Staff capacity: significant staff capacity constraints; governments rely on external consultants/companies.

### Climate change and PIM considerations (Appendix I template content)
- Focus areas for assessment listed (no FSM-specific quantified projections provided in interview responses):
  - Climate vulnerability and impacts on macro-sustainability; recent and expected climatic developments.
  - Preparedness: NDC and national resilience strategies, disaster planning, contingency planning.
  - Mitigation: NDC pledge, clean energy plans, carbon taxation and subsidy policies, other carbon-pricing strategies, macro-relevant mitigation policies.
  - Adaptation: adequacy of adaptation strategy, public investment plans, Table of Costed Climate Change Projects (US$, %GDP).
  - Financing strategy: current financing state, consistency with fiscal and external debt sustainability, macro spillovers, institutional issues.
  - Risk management: fiscal risk assessment procedures, self-insurance (contingency provisions, rainy-day funds, NIR), risk transfer.
  - National processes: integration of climate change into planning, adequacy of PIM and PFM systems for climate-related investments.
  - Priority needs to mobilize resources for climate-change strategy.

*Annex V. PIMA Institutional Questionnaire—Interview Responses (Federated States of Micronesia) — IMF*

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_Source: https://www.imf.org/-/media/files/publications/cr/2019/1fsmea2019002.pdf_