## 1mdvea2019007

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### Fiscal developments and 2007 budget
- Overall expenditure is projected to rise by 45 percent in 2007.
- The domestically financed portion of the budget—excluding development grants and loans—would increase by 31 percent in 2007.
- The domestic expenditures-to-GDP ratio would rise from 46 percent in 2006 to 54 percent in 2007.
- The 2007 budget carries risks of a significant deficit because the large spending program is based on optimistic revenue assumptions.
- Executive Directors urged authorities to prioritize expenditures and bring them in line with realistic revenue estimates to achieve the stated objective of zero domestic financing of the budget.
- Recommended revenue-enhancing reforms include:
  - introduction of corporate taxation;
  - a broad-based sales tax;
  - replacing the current “per head” tourism tax with an ad valorem tax.
- Recommendation to develop a medium-term expenditure framework (MTEF) to accommodate development spending within the available resource envelope.

### Growth, inflation, and macroeconomic context
- Real GDP (annual percentage change): 2003: 8.5; 2004: 9.5; 2005: -4.5; 2006: 19.1; 2007 (proj.): 5.5.
- Inflation (period average): 2003: -2.8; 2004: 6.3; 2005: 3.3; 2006: 3.7; 2007 (proj.): 7.0.
- Per capita income cited as $2,800 (double the level 10 years earlier).
- The economy rebounded strongly from the 2004 tsunami, led by booming tourism and construction.

### External position and vulnerabilities
- Current account balance (percent of GDP, table): 2003: -4.6; 2004: -16.5; 2005: -35.8; 2006: -40.7; 2007 (proj.): -40.5.
- Current account balance (millions of U.S. dollars): 2003: -31.8; 2004: -128.4; 2005: -268.8; 2006: -369.2; 2007 (proj.): -414.8.
- External debt (percent of GDP, table): 2003: 41.8; 2004: 42.7; 2005: 57.2; 2006: 65.3; 2007 (proj.): 80.1.
- Public external debt (percent of GDP): 2003: 39.4; 2004: 40.1; 2005: 44.0; 2006: 40.7; 2007 (proj.): 50.9.
- Debt service (percent of domestic exports of GNFS): 2003: 4.0; 2004: 5.1; 2005: 10.1; 2006: 8.8; 2007 (proj.): 11.9.
- Gross official reserves (year-end, millions): 2003: 160.3; 2004: 204.4; 2005: 187.1; 2006: 232.2; 2007 (proj.): 208.0.
- Reserves (in months of imports of GNFS): 2003: 2.7; 2004: 2.9; 2005: 2.1; 2006: 2.4; 2007 (proj.): 2.1.
- Directors cautioned that fiscal slippages could rapidly magnify external vulnerabilities and cause international reserves to fall rapidly.

### Monetary policy, exchange rate, and financial market developments
- Maldives maintains a conventional fixed peg against the U.S. dollar; Rufiyaa per U.S. dollar (period average) reported as 12.8 for 2003–2007.
- Directors acknowledged the Maldives Monetary Authority Act as an important step toward central bank independence (separation of finance minister and central bank governor roles).
- Progress reported: first T-bill issue implemented and weekly issuance commenced in September 2006; introduction of treasury bills would help eliminate automatic central bank financing of fiscal deficits.
- Directors encouraged incremental development of the T-bill market and acceptance of the obligations of Article VIII.
- Monetary management indicators:
  - Minimum reserve requirement (MRR) at 25 percent after a 5 point reduction in June 2006.
  - Weekly auctions of treasury bills started in September 2006.
  - Broad money (millions Rf): 2006 8,063.3; 2007 9,102.3 (Dec. entry).
  - Net foreign assets (millions Rf): 2006 941.6; 2007 -328.0.

### Structural reforms and policy priorities
- Structural reform initiatives underway: fiscal, legal, and state-owned enterprises reforms to support private investment and growth.
- Directors pointed to the need for further structural reforms, including privatization to improve competitiveness and climate for private investment.
- Commended authorities for identifying several state-owned enterprises for divestment and for passage of the Audit Act and the Civil Services Act.
- Authorities preparing for elections in late 2008; further constitutional and political reforms under discussion.
- SOE and market details:
  - Out of 23 SOEs, 9 are still 100 percent government-owned.
  - No firm has been privatized since 2001.
  - Authorities plan sales of shares in Allied Insurance Company of Maldives, Housing Development and Finance Corporation, Maldives Industrial Fishing Company, Maldives National Shipping Limited, and Nasandra Palace Hotel.
- AML/CFT legislation drafted with Fund assistance; bill expected to be submitted to parliament by end-2007.

### Key risks, Board and staff assessment, and recommendations
- Main challenge: ensure favorable growth prospects are supported by a prudent fiscal policy and a viable macroeconomic framework.
- Risks identified:
  - 2007 budget’s reliance on overambitious resort development schedule for new revenue measures;
  - large domestic financing needs if revenue shortfalls materialize;
  - rising external debt and debt service increasing vulnerabilities.
- Board view: exchange rate peg and current level appear appropriate provided fiscal policy is tightened; with unchanged fiscal policies, reserves could fall sharply and undermine the peg.
- Some Directors concurred with staff assessment that Maldives is in a situation of fundamental misalignment; many Directors noted inadequate information to determine fundamental misalignment conclusively.
- Staff policy recommendations:
  - Prioritize expenditures and curtail budgeted expenditure in line with actual revenues.
  - Expedite revenue-enhancing reforms: introduction of corporate taxation; a broad-based sales tax; replace “per head” tourism tax with an ad valorem tax.
  - Develop a medium-term expenditure framework (MTEF).
  - Incrementally develop the T-bill market (secondary market, variable rate auctions) and build a liquidity forecasting framework.

### Detailed fiscal deterioration, 2004–2007 and domestic financing risks
- Fiscal deficit path (percent of GDP): 2004: 1.9; 2005: 11; 2006: 7.
- Domestic spending on tsunami reconstruction by National Disaster Management Center:
  - 2005: 1.6 percent of GDP
  - 2006: 0.7 percent of GDP
- 2007 budget drivers: increased community development spending; planned capital injections into SOEs; subsidies and welfare payments; opening of new embassies.
- New revenue measures forecast to yield about 11 percent of GDP, but staff cautioned these revenues may not materialize fully.
- Staff estimate of required domestic financing in absence of expenditure scaling: about 9 percent of GDP, based on revenue shortfall assumptions:
  - Shortfall in import duties: Rf 490 million (3.7 percent of GDP).
  - Shortfall from SOE dividends: Rf 120 million (0.9 percent of GDP) if dividends rise with nominal GDP instead of budget forecast of a 30 percent increase.
  - Conservative take on planned new revenue measures: shortfall of Rf 600 million (4.5 percent of GDP).
- Traditional financing by Maldives Monetary Authority (MMA) would rapidly expand the monetary base, risking inflation and reserve depletion and putting pressure on the exchange rate peg.
- Government option to issue treasury bills exists, but market is too thin to absorb large needs without crowding out private credit.

### Alternative fiscal scenario and medium-term outlook
- Mission advised trimming domestic expenditures to about 47 percent of GDP (7 percent of GDP lower than the 2007 budget), broadly at the level of the 2005 budget, achievable without affecting tsunami-related expenditures.
- Medium-term alternative projects domestic expenditures down to 42 percent of GDP by 2012.
- Growth implications under alternative scenario:
  - GDP grows by 6.5–7.5 percent per annum, about 3 percent higher than the baseline, underpinned by private investment in tourism, fisheries, and construction and quicker structural reforms including SOE restructuring.
  - Prudent fiscal policies lower central bank financing needs and lead to low and stable inflation of 2.5–3 percent per annum.
- Authorities committed to a Macroeconomic Coordination Committee to convene every three months to update budget situation.

### Debt dynamics, baseline and alternative scenarios (selected exact figures)
- Public sector debt (percent of GDP, baseline): 2006: 51.7; 2007: 69.7; 2008: 78.3; 2009: 78.1; 2010: 71.9; 2011: 66.1; 2012: 60.2.
- External debt (percent of GDP, baseline): 2006: 80.1; 2007: 88.8; 2008: 89.9; 2009: 85.9; 2010: 80.3; 2011: 68.3.
- Baseline: international reserves fall to 1.5 months of imports by projection period.
- Alternative (staff) scenario: with domestic financing requirement kept at zero over the medium term, public debt-to-GDP declines to 45.3 percent by end of projection period; international reserves rise to about three months of imports.
- Stress tests:
  - Worst public debt-to-GDP ratio of 85 percent under the growth shock scenario (permanent one-half standard deviation shock).
  - Current account shock would cause external debt-to-GDP to climb above 100 percent from 2008 through 2011.
  - One-time real depreciation of 30 percent would cause external debt-to-GDP to rise to 120 percent in the year the depreciation occurred.

### Balance of payments and fiscal tables (selected exact figures)
- GDP (millions USD): 2003: 692.4; 2004: 776.5; 2005: 750.6; 2006: 906.9; 2007: 1,023.8.
- Exports, including re-exports (millions USD): 2003: 152.0; 2004: 181.0; 2005: 161.6; 2006: 225.2; 2007: 237.5.
- Imports (millions USD): 2003: -414.3; 2004: -567.3; 2005: -655.5; 2006: -815.3; 2007: -921.8.
- Nonfactor services (net, millions USD): 2003: 311.1; 2004: 352.4; 2005: 118.8; 2006: 240.0; 2007: 292.9.
- Gross official reserves (year-end, millions USD): 2003: 160.3; 2004: 204.4; 2005: 187.1; 2006: 232.2; 2007: 208.0.
- Central government—selected percent of GDP:
  - Revenue and grants: 2006: 62.9; 2007: 61.8.
  - Expenditure and net lending: 2006: 70.2; 2007: 79.6.
  - Domestic expenditure: 2006: 47.4; 2007: 54.6.
  - Overall balance: 2006: -7.3; 2007: -28.3.
  - Overall balance, excluding grants: 2006: -25.3; 2007: -34.6.
- Central government (millions Rf):
  - Total revenue and grants: 2006: 7,298.7; 2007: 8,097.5; Staff 7,305.7.
  - Expenditure and net lending: 2006: 8,144.4; 2007: 11,801.6; Staff 10,436.6.
  - Overall balance (millions Rf): 2006: -845.7; 2007: -3,704.1; Staff -3,131.0.
  - Government debt (end period, millions Rf): 2006: 6,002.8; 2007: 9,706.9; Staff 9,133.8.

### Recent developments (H1 2007) and authorities’ views
- Domestic expenditures running broadly as budgeted, but revenues fell below budget estimates.
- Domestic deficit in the first half of the year was almost 870 million rufiyaas, equivalent to about 6.6 percent of GDP.
- International reserves increased from US$ 232 million at end-2006 to about US$ 250 million in June and remained broadly unchanged in months of imports.
- Authorities indicate some new revenue sources assumed in the budget are likely not to materialize; intend to scale back budgetary expenditures and seek cabinet guidance on the fiscal path for the remainder of the year.
- Authorities’ medium-term fiscal scenario targets: deficits of 14, 10 and 9 percent of GDP in 2008, 2009 and 2010, respectively.
- Authorities maintain that the peg against the U.S. dollar and current exchange rate level are appropriate provided fiscal policy is tightened; authorities disagree with staff that the currency is presently misaligned.

### T-bill market development and financial sector
- Mission recommended further incremental steps to develop the new market for T-bills:
  - Create a secondary market to allow participants to manage risks.
  - Move to a variable rate auction with a good liquidity forecasting framework.
  - Progress made on liquidity forecasting, but unpredictability of government finances impedes the effort.
- Banking sector: one local and four international banks.
  - Private sector lending increased by 50 percent in 2006.
  - NPLs as a share of total loans: September 2005: 6.7 percent; End-2006: 2.4 percent.
  - Much expansion financed by foreign-owned banks borrowing from head offices and on-lending locally; country risk exposure limits and collateralization of resort property contain risks.
- On-site bank examinations conducted with MCM technical assistance.

*Source: Staff Report for the 2007 Article IV Consultation — Maldives; Approved by Daniel Citrin and Michael Hadjimichael; June 12, 2007. (Document: 1mdvea2019007)*

### 1.9 percent of GDP in 2004 to 11 and 7 percent of GDP in 2005 and 2006, respectively.

### 1mdvea2019007 - 1.9 percent of GDP in 2004 to 11 and 7 percent of GDP in 2005 and 2006, respectively.

### Fiscal developments and 2007 budget
- Overall expenditure is projected to rise by 45 percent in 2007.
- The domestically financed portion of the budget—excluding development grants and loans—would increase by 31 percent in 2007.
- The domestic expenditures-to-GDP ratio would rise from 46 percent in 2006 to 54 percent in 2007.
- The 2007 budget carries risks of a significant deficit because the large spending program is based on optimistic revenue assumptions.
- Executive Directors urged authorities to prioritize expenditures and bring them in line with realistic revenue estimates to achieve the stated objective of zero domestic financing of the budget.
- Recommended revenue-enhancing reforms include:
  - introduction of corporate taxation;
  - a broad-based sales tax;
  - replacing the current “per head” tourism tax with an ad valorem tax.
- Recommendation to develop a medium-term expenditure framework (MTEF) to accommodate development spending within the available resource envelope.

### Growth, inflation, and macroeconomic context
- GDP growth:
  - Real GDP: 2003: 8.5; 2004: 9.5; 2005: -4.5; 2006: 19.1; 2007 (proj.): 5.5 (annual percentage change).
- Inflation (period average): 2003: -2.8; 2004: 6.3; 2005: 3.3; 2006: 3.7; 2007 (proj.): 7.0.
- Per capita income cited as $2,800 (double the level 10 years earlier).
- The economy rebounded strongly from the 2004 tsunami, led by booming tourism and construction.

### External position and vulnerabilities
- Current account deficit widened from 36 percent of GDP in 2005 to 41 percent in 2006 (text); table figures for current account balance (in percent of GDP): 2003: -4.6; 2004: -16.5; 2005: -35.8; 2006: -40.7; 2007 (proj.): -40.5.
- External debt rose from 43 percent of GDP in 2004 to about 65 percent in 2006 (text).
- Table (External Debt, percent of GDP): 2003: 41.8; 2004: 42.7; 2005: 57.2; 2006: 65.3; 2007 (proj.): 80.1.
- Public External Debt (percent of GDP): 2003: 39.4; 2004: 40.1; 2005: 44.0; 2006: 40.7; 2007 (proj.): 50.9.
- Debt service (in percent of domestic exports of GNFS): 2003: 4.0; 2004: 5.1; 2005: 10.1; 2006: 8.8; 2007 (proj.): 11.9.
- Balance of payments (millions of U.S. dollars):
  - Current account balance: 2003: -31.8; 2004: -128.4; 2005: -268.8; 2006: -369.2; 2007 (proj.): -414.8.
  - Gross official reserves (year-end, millions): 2003: 160.3; 2004: 204.4; 2005: 187.1; 2006: 232.2; 2007 (proj.): 208.0.
  - Reserves (in months of imports of GNFS): 2003: 2.7; 2004: 2.9; 2005: 2.1; 2006: 2.4; 2007 (proj.): 2.1.
- Directors cautioned that fiscal slippages could rapidly magnify external vulnerabilities and cause international reserves to fall rapidly.

### Monetary policy, exchange rate, and financial market developments
- Maldives maintains a conventional fixed peg against the U.S. dollar; Rufiyaa per U.S. dollar (period average) reported as 12.8 for 2003–2007.
- Directors acknowledged the Maldives Monetary Authority Act as an important step toward central bank independence (separation of finance minister and central bank governor roles).
- Progress reported: first T-bill issue implemented and weekly issuance commenced in September 2006; introduction of treasury bills would help eliminate automatic central bank financing of fiscal deficits.
- Directors encouraged incremental development of the T-bill market and acceptance of the obligations of Article VIII.

### Structural reforms and policy priorities
- Structural reform initiatives underway: fiscal, legal, and state-owned enterprises reforms to support private investment and growth.
- Directors pointed to the need for further structural reforms, including privatization to improve competitiveness and climate for private investment.
- Commended authorities for identifying several state-owned enterprises for divestment and for passage of the Audit Act and the Civil Services Act.
- Authorities preparing for elections in late 2008; further constitutional and political reforms under discussion.

### Key risks and Board assessment
- Main challenge: ensure favorable growth prospects are supported by a prudent fiscal policy and a viable macroeconomic framework.
- Risks identified:
  - 2007 budget’s reliance on overambitious resort development schedule for new revenue measures;
  - large domestic financing needs if revenue shortfalls materialize;
  - rising external debt and debt service increasing vulnerabilities.
- Board view: exchange rate peg and current level appear appropriate provided fiscal policy is tightened; with unchanged fiscal policies, reserves could fall sharply and undermine the peg.
- Some Directors concurred with staff assessment that Maldives is in a situation of fundamental misalignment; many Directors noted inadequate information to determine fundamental misalignment conclusively.

*Source: Staff Report for the 2007 Article IV Consultation — Maldives; Approved by Daniel Citrin and Michael Hadjimichael; June 12, 2007.*

### 6.      Macroeconomic and fiscal

### 6.      Macroeconomic and fiscal

### Fiscal deterioration and expenditure trends
- Macroeconomic and fiscal management have weakened sharply following the tsunami.
- Domestic expenditures rose to new highs post-2004, driven largely by non-tsunami-related spending on new recruits in police, national security, education, and health.
- Fiscal deficit path:
  - 2004: 1.9 percent of GDP
  - 2005: 11 percent of GDP
  - 2006: 7 percent of GDP
- Domestic spending on tsunami reconstruction by the National Disaster Management Center:
  - 2005: 1.6 percent of GDP
  - 2006: 0.7 percent of GDP

### Price and current account pressures
- Inflation (CPI):
  - Pre-tsunami average: 2.5 percent
  - 2005: 3.3 percent
  - 2006: 3.7 percent
- Current account deficits:
  - 2005: 36 percent of GDP (lower tourism arrivals)
  - 2006: 41 percent of GDP (higher reconstruction-related and petroleum imports despite recovery in tourism receipts)
- International reserves:
  - US$232 million at end-December (about 2.4 months of imports), buoyed by tsunami-related foreign grants and increased foreign borrowing by commercial banks

### Banking sector and credit boom
- Banking sector: one local and four international banks.
- Private sector lending increased by 50 percent in 2006.
- Lending concentrated in tourism and tourism-related trade and construction.
- Much expansion financed by foreign-owned banks borrowing from head offices and on-lending locally; risks contained by country risk exposure limits and collateralization of resort property.
- On-site bank examinations conducted with MCM technical assistance.
- NPLs (nonperforming loans) as a share of total loans:
  - September 2005: 6.7 percent
  - End-2006: 2.4 percent

### 2007 budget and financing risks
- 2007 budget projects overall expenditure to rise by 45 percent.
- Domestically financed portion would increase by 31 percent.
- Domestic expenditures-to-GDP ratio projected:
  - 2006: 46 percent
  - 2007 (budget): 54 percent
- Drivers: increased community development spending, planned capital injections into SOEs, subsidies and welfare payments, opening of new embassies.
- New revenue measures related to lease payments forecast to yield about 11 percent of GDP, but staff cautioned these revenues may not materialize fully.
- Planned tourism expansion and capacity:
  - Development of 46 island resorts and 2 city hotels by 2009 (planned expansion of capacity of 55 percent) — noted implementation and supply constraint risks (construction lagging, rising construction material prices).

### Revenue shortfall assumptions and domestic financing need
- Staff estimate of required domestic financing in absence of expenditure scaling: about 9 percent of GDP, based on revenue shortfall assumptions:
  - Shortfall in import duties: Rf 490 million (3.7 percent of GDP)
  - Shortfall from SOE dividends: Rf 120 million (0.9 percent of GDP) if dividends rise with nominal GDP instead of budget forecast of a 30 percent increase
  - Conservative take on planned new revenue measures: shortfall of Rf 600 million (4.5 percent of GDP)

### Risks of central bank financing and market constraints
- Traditional financing by Maldives Monetary Authority (MMA) would rapidly expand the monetary base, risking inflation and reserve depletion and putting pressure on the exchange rate peg.
- Government option to issue treasury bills exists, but market is too thin to absorb large needs without crowding out private credit.

### Alternative fiscal scenario and medium-term outlook
- Mission advised trimming domestic expenditures to about 47 percent of GDP (7 percent of GDP lower than the 2007 budget), broadly at the level of the 2005 budget, achievable without affecting tsunami-related expenditures.
- Medium-term alternative projects domestic expenditures down to 42 percent of GDP by 2012.
- Growth implications under alternative scenario:
  - GDP grows by 6.5–7.5 percent per annum, about 3 percent higher than the baseline, underpinned by private investment in tourism, fisheries, and construction and quicker structural reforms including SOE restructuring.
  - Prudent fiscal policies lower central bank financing needs and lead to low and stable inflation of 2.5–3 percent per annum.
- Authorities committed to a Macroeconomic Coordination Committee to convene every three months to update budget situation.

### Fiscal reform priorities
- Fiscal structure is inflexible; no income or sales tax; main revenues from nontax revenues, import tariffs, and a specific tourism tax.
- Recommended tax reforms and expected revenue impacts:
  - Business profit tax: estimated annual revenue of about 2–3 percent of GDP (factored in projections from 2008 onwards).
  - Broad-based sales tax: substitute for a large portion of import duties; staff encouraged a clear timetable.
  - Replace specific per-head tourism tax with an ad valorem tourism tax to capture higher-value tourism receipts.
- SAFTA implications:
  - SAFTA in force January 2006 requires tariff rates reduced to 0–5 percent within 10 years; authorities could reduce tariffs ahead of schedule if compensated as guaranteed under the agreement.
- Medium-term expenditure framework (MTEF) needed: integrated macroeconomic and revenue projections and policy commitment to strategic fiscal goals; authorities reaffirmed commitment to the MTEF.

### External vulnerabilities and debt outlook
- External debt and debt service:
  - External debt: 43 percent of GDP in 2004 to about 65 percent of GDP in 2006
  - Debt service ratio: 5.1 percent to 8.8 percent
- 2007 budget increases foreign debt financing for infrastructure (harbor and atoll development, land reclamation, electricity plants); combined public and private borrowing for resort construction would raise external debt ratios.
- Baseline projection:
  - International reserves projected to fall to 1.5 months of imports by 2010.
  - External public debt would rise to above 50 percent of GDP by end-2007.
  - Total external debt would approach 90 percent of GDP.
- Alternative scenario:
  - International reserves increase over projection period to about three months of imports.
  - More stable macro environment reduces private sector external borrowing needs and results in better overall debt ratios.

### Exchange rate regime and competitiveness
- Dollar peg maintained as appropriate exchange arrangement; has reduced transaction costs and foreign exchange risks, provided a nominal anchor, and limited inflation.
- Peg needs support from sustainable macroeconomic policies, particularly fiscal.
- Trade composition:
  - Most exports to euro-denominated areas; 80 percent of tourist arrivals from the EU.
  - Bulk of imports dollar-denominated; recent dollar depreciation against the euro has helped competitiveness.
- WEO forecasts of continued dollar depreciation over the medium term suggest downside competitiveness risks are unlikely.

### Monetary management and central bank independence
- Monetary policy traditionally passive with MMA monetizing fiscal deficits; financial markets undeveloped.
- Policy instruments:
  - Minimum reserve requirement (MRR) at 25 percent after a 5 point reduction in June 2006.
  - Excess liquidity absorbed via certificates of deposits through fixed-rate auctions.
  - Weekly auctions of treasury bills started in September 2006 to allow government financing without recourse to MMA.
- Institutional changes:
  - Amendments to the MMA Act passed in April 2007 to separate finance minister and central bank governor positions and reorganize the MMA board.
  - Inter-agency agreement empowers MMA to set interest rates and caps government borrowing through the Ways and Means Account.
- Staff recommendation: entrench MMA independence and ease monetary policy burden through more prudent fiscal path; sale of T-bills to MMA still poses a monetization risk.

*Source: 1mdvea2019007 - 6.      Macroeconomic and fiscal*

### 31.      The mission recommended further incremental steps to develop the new market

### 31.      The mission recommended further incremental steps to develop the new market for T-bills

### T-bill market development
- Creating a secondary market would allow participants to manage more actively their risks.
- Moving to a variable rate auction would allow market participants to determine interest rates in a competitive manner.
- A variable rate auction would require a good liquidity forecasting framework.
- Progress had been made in creating such a framework, but the unpredictability of government finances still impeded the effort.
- The authorities agreed with these goals, aiming to implement them in gradual steps as they build up experience with market operations.
- The recent introduction of treasury bills is an important step toward eliminating the practice of automatic central bank financing of fiscal deficits, and further incremental steps to develop this market should be pursued.

### Progress on structural reforms
- Staff recommended that the SOEs be encouraged to operate on commercial terms with a view towards privatization.
- No firm has been privatized since 2001.
- Out of 23 SOEs, 9 are still 100 percent government-owned.
- The public sector continues to be a dominant force in many areas of economic activity.
- The authorities noted that shares in several SOEs will be sold in the near future, including the Allied Insurance Company of Maldives, Housing Development and Finance Corporation, Maldives Industrial Fishing Company, Maldives National Shipping Limited, and Nasandra Palace Hotel.
- The Civil Service Act (setting up an independent commission to oversee appointments, promotions, and evaluations of civil servants) and the Audit Act (establishing an independent Auditor General’s Office) have been recently passed by parliament.
- The Banking Bill—to codify prudential regulations in the banking sector—and the Public Enterprise Bill—to introduce standards of corporate governance in SOEs—are being finalized.
- Staff proposed that the authorities consider acceptance of the obligations of Article VIII, Sections 2, 3, and 4, since Maldives maintains an exchange system free of restrictions on payments and transfers for current international transactions.
- MMA staff will prepare a note on this issue and present it to its board for discussion once the new board members are appointed.
- AML/CFT legislation has been drafted with Fund assistance and a bill is expected to be submitted to parliament by end-2007.

### Staff appraisal — macroeconomic developments and outlook
- The economy has rebounded strongly from the devastating impact of the tsunami.
- A strong recovery in tourist arrivals in 2006—which continued in the first quarter of 2007—underpinned growth of 19 percent.
- Construction is booming, partly due to investment in several new resorts.
- Inflation remains low but is on a rising trend.
- Post-tsunami reconstruction activities continue, with the assistance of external bilateral and multilateral donors.

### Staff appraisal — fiscal policy and recommendations
- The main policy challenge for the Maldives will be to contain domestic expenditures in line with revenues, and ensure macroeconomic stability.
- The fiscal position has deteriorated recently, with large increases in domestic expenditures and the fiscal deficit.
- Most of the incremental spending is unrelated to alleviating social needs in the wake of the tsunami.
- The 2007 government budget envisages a substantial increase in expenditures, which would require significant domestic financing if an unprecedented level of increased revenues were not realized.
- New revenue measures are forecast to yield about 11 percent of GDP, but much of this may fail to materialize.
- Staff estimates that with unchanged expenditure policies, there may be need for large domestic financing of the budget, which would present serious threats to macroeconomic stability.
- Policy recommendations:
  - Prioritize expenditures and curtail budgeted expenditure in line with actual revenues.
  - To enhance medium-term fiscal sustainability, expedite revenue-enhancing reforms, including:
    - the introduction of corporate taxation,
    - a broad-based sales tax,
    - replacing the current “per head” tourism tax with an ad valorem tax.
  - Develop a medium-term expenditure framework.

### Staff appraisal — external vulnerabilities and exchange rate
- The current account deficit has widened further, with construction imports and high oil prices outweighing booming tourism exports.
- External debt and debt service have continued to rise.
- In the absence of prudent fiscal policies, external vulnerabilities would increase over the medium term.
- The level of the exchange rate appears appropriate, as does the peg against the dollar.
- The dollar’s decline against the euro has enhanced the country’s competitiveness in recent years, and downside risks to competitiveness would seem unlikely.

### Institutional and governance developments
- The new MMA Act and the Inter-Agency Agreement are welcome steps in establishing central bank independence.
- A new governor is expected to be appointed soon.
- Structural reforms, including selling shares in several SOEs, and passing important legislation, should be expedited.
- The identification of several SOEs for divestment of shares, and the recent passage of the Audit Act and the Civil Service Act are encouraging developments.

*Source: 1mdvea2019007 - 31.      The mission recommended further incremental steps to develop the new market*

### 43.      It is recommended that the next consultation with Maldives take place within the

### It is recommended that the next consultation with Maldives take place within the standard 12-month cycle.

### Real and external sector developments (1996–2006)
- Real GDP Growth: series shown for 1996–2006 with notable points:
  - A sharp contraction related to the tsunami followed by a strong rebound ("Output recovered following the tsunami-related contaction...").
  - Figure caption: "Maldives: Real and External Sector Developments, 1996–2006."
- Inflation: "Inflation (annual percentage change)" edged up in the period 1996–2006.
- Current account and external balance:
  - "Current account deficit deteriorated..." and "the current account deficit remains large..."
  - Tourism: "Tourism arrivals also bounced back."
- External debt and debt service rose over the period.
- External trade (in millions of U.S. dollars): exports and imports trends shown for 1996–2006; non-factor services net also plotted.
- Tourist Nights Index (three-month moving average, percent change year-year) shown Jan-00 to Jan-06 with volatility up to ±120 percent.
- Sources: "Maldivian authorities; and IMF staff estimates."

### Fiscal and monetary sector developments (1996–2006)
- Central government operations (in percent of GDP) and central government balance presented for 1996–2006:
  - "With expenditures growing faster than revenues... overall balance plunged deep into negative territory."
  - Central government financing (net) split into domestic and foreign financing; domestic financing rose as overall balance deteriorated.
- Money and credit:
  - "Broad money remained constant as falling net foreign assets offset rising net domestic assets."
  - "Dollarization has fallen slightly."
- Gross official reserves increased due to foreign grants and loans but import cover did not improve because of ballooning imports.
- Dollarization Ratio 1/: "Foreign currency deposits as a percentage of broad money."

### Selected economic indicators and projections (Table 1: 2003–07)
- Growth and prices:
  - Real GDP: 2003 8.5; 2004 9.5; 2005 -4.5; 2006 19.1; 2007 5.5 (Est./Proj. labels present).
  - Inflation (period average): 2003 -2.8; 2004 6.3; 2005 3.3; 2006 3.7; 2007 7.0.
- Central government (percent of GDP):
  - Revenue and grants: 2003 34.8; 2004 34.2; 2005 48.0; 2006 62.9; 2007 55.8.
  - Grants: 2003 1.4; 2004 0.7; 2005 8.6; 2006 18.1; 2007 10.7.
  - Expenditure and net lending: 2003 38.2; 2004 36.0; 2005 58.9; 2006 70.2; 2007 79.6.
  - Domestic spending: 2003 34.0; 2004 33.2; 2005 46.8; 2006 47.4; 2007 54.6.
  - Overall balance: 2003 -3.4; 2004 -1.9; 2005 -10.9; 2006 -7.3; 2007 -23.9.
  - Overall balance, excluding grants: 2003 -4.8; 2004 -2.6; 2005 -19.5; 2006 -25.3; 2007 -34.6.
- Financing:
  - Domestic: 2003 -1.3; 2004 -2.2; 2005 8.4; 2006 1.9; 2007 9.0.
  - Foreign: 2003 4.7; 2004 4.1; 2005 2.4; 2006 5.4; 2007 14.9.
- Balance of payments (millions of U.S. dollars):
  - Exports, including re-exports: 2003 152.0; 2004 181.0; 2005 161.6; 2006 225.2; 2007 237.5.
  - Imports: 2003 -414.3; 2004 -567.3; 2005 -655.5; 2006 -815.3; 2007 -921.8.
  - Nonfactor services (net): 2003 311.1; 2004 352.4; 2005 118.8; 2006 240.0; 2007 292.9.
  - Current account balance: 2003 -31.8; 2004 -128.4; 2005 -268.8; 2006 -369.2; 2007 -414.8.
    - (In percent of GDP) 2003 -4.6; 2004 -16.5; 2005 -35.8; 2006 -40.7; 2007 -40.5.
  - Official capital (net): 2003 29.9; 2004 25.0; 2005 18.6; 2006 38.4; 2007 152.3.
  - Private capital (net): 2003 70.3; 2004 140.1; 2005 145.8; 2006 237.5; 2007 163.3.
  - Overall balance (BoP): 2003 26.5; 2004 44.2; 2005 -17.3; 2006 45.1; 2007 -24.2.
- Gross official reserves (year-end, millions USD): 2003 160.3; 2004 204.4; 2005 187.1; 2006 232.2; 2007 208.0.
  - (In months of imports of GNFS) 2003 2.7; 2004 2.9; 2005 2.1; 2006 2.4; 2007 2.1.
- External debt (millions USD): 2003 289.5; 2004 331.8; 2005 429.1; 2006 592.3; 2007 819.6.
  - (In percent of GDP) 2003 41.8; 2004 42.7; 2005 57.2; 2006 65.3; 2007 80.1.
- Public external debt (millions USD): 2003 272.9; 2004 311.6; 2005 309.9; 2006 361.8; 2007 514.1.
  - (In percent of GDP) 2003 39.4; 2004 40.1; 2005 44.0; 2006 40.7; 2007 50.9.
- Debt service (millions USD): 2003 22.0; 2004 32.3; 2005 43.0; 2006 53.7; 2007 80.3.
  - (In percent of domestic exports of GNFS) 2003 4.0; 2004 5.1; 2005 10.1; 2006 8.8; 2007 11.9.
- Exchange rate: "Rufiyaa per U.S. dollar (period average) 12.8" across 2003–2007.

### Balance of payments details (Table 2: 2003–07, in millions of U.S. dollars)
- Current account balance: 2003 -31.8; 2004 -128.4; 2005 -268.8; 2006 -369.2; 2007 -414.8.
- Trade balance: 2003 -262.3; 2004 -386.4; 2005 -493.8; 2006 -590.1; 2007 -684.3.
  - Exports, f.o.b. (including re-exports): 2003 152.0; 2004 181.0; 2005 161.6; 2006 225.2; 2007 237.5.
  - Imports, f.o.b.: 2003 -414.3; 2004 -567.3; 2005 -655.5; 2006 -815.3; 2007 -921.8.
- Services (net): 2003 272.7; 2004 311.6; 2005 88.8; 2006 198.8; 2007 251.0.
  - Balance on nonfactor services: 2003 311.1; 2004 352.4; 2005 118.8; 2006 240.0; 2007 292.9.
    - Receipts: 2003 432.1; 2004 505.2; 2005 322.9; 2006 473.1; 2007 526.0.
      - Tourism receipts: 2003 401.6; 2004 470.9; 2005 284.2; 2006 433.7; 2007 482.2.
    - Payments: 2003 -121.0; 2004 -152.9; 2005 -204.1; 2006 -233.1; 2007 -233.1.
- Balance on factor services: 2003 -38.4; 2004 -40.8; 2005 -30.0; 2006 -41.2; 2007 -41.9.
- Unrequited transfers (net): 2003 -42.3; 2004 -53.6; 2005 136.2; 2006 22.1; 2007 18.5.
  - Official: 2003 12.7; 2004 7.6; 2005 205.7; 2006 105.3; 2007 110.0.
  - Private: 2003 -54.9; 2004 -61.1; 2005 -69.5; 2006 -83.2; 2007 -91.5.
- Nonmonetary capital (net): 2003 52.4; 2004 150.3; 2005 263.5; 2006 387.1; 2007 390.6.
- Official medium- and long-term (net): 2003 29.9; 2004 25.0; 2005 18.6; 2006 38.4; 2007 152.3.
  - Disbursements: 2003 46.6; 2004 46.5; 2005 42.5; 2006 61.8; 2007 184.4.
  - Amortization: 2003 -16.7; 2004 -21.6; 2005 -23.9; 2006 -23.4; 2007 -32.1.
- Private capital: 2003 70.3; 2004 140.1; 2005 145.8; 2006 237.5; 2007 163.3.
  - Commercial banks: 2003 -47.8; 2004 -14.8; 2005 99.0; 2006 111.2; 2007 75.0.
- Overall balance: 2003 26.5; 2004 44.2; 2005 -17.3; 2006 45.1; 2007 -24.2.
- Monetary movements: 2003 -26.5; 2004 -44.2; 2005 17.3; 2006 -45.1; 2007 24.2.
- Memorandum items:
  - Domestic export growth (value, in percent) 1/: 2003 24.5; 2004 8.7; 2005 -15.4; 2006 30.5; 2007 9.4.
  - Import growth (value, in percent): 2003 20.2; 2004 36.9; 2005 15.5; 2006 24.4; 2007 13.1.
  - Gross official reserves (millions USD): 2003 160.3; 2004 204.4; 2005 187.1; 2006 232.2; 2007 208.0.
    - (In months of imports of GNFS) 2003 3.6; 2004 3.4; 2005 2.6; 2006 2.7; 2007 2.2.
  - External debt (millions USD): 2003 289.5; 2004 331.8; 2005 429.1; 2006 592.3; 2007 819.6.
  - Debt service (millions USD): 2003 22.0; 2004 32.3; 2005 43.0; 2006 53.7; 2007 80.3.
  - Exchange rate (rufiyaa per U.S. dollar, average): 12.8 for 2003–2007.
  - GDP (millions USD): 2003 692.4; 2004 776.5; 2005 750.6; 2006 906.9; 2007 1,023.8.

### Central Government Finance (Table 3: 2003–07, in millions of rufiyaa and percent of GDP)
- Total revenue and grants (millions Rf): 2003 3,087.9; 2004 3,395.2; 2005 4,612.8; 2006 7,298.7; 2007 8,097.5; Staff 7,305.7.
  - Total revenue: 2003 2,964.3; 2004 3,320.7; 2005 3,788.3; 2006 5,203.3; 2007 7,138.6; Staff 5,897.7.
  - Grants (millions Rf): 2003 123.6; 2004 74.5; 2005 824.5; 2006 2,095.4; 2007 958.9; Staff 1,408.0.
- Expenditure and net lending (millions Rf): 2003 3,388.2; 2004 3,582.6; 2005 5,657.6; 2006 8,144.4; 2007 11,801.6; Staff 10,436.6.
  - Current expenditure: 2003 2,345.7; 2004 2,788.1; 2005 4,643.3; 2006 6,584.0; 2007 6,797.2; Staff 6,797.2.
  - Capital expenditure: 2003 1,206.2; 2004 991.0; 2005 1,132.1; 2006 1,631.2; 2007 5,078.5; Staff 3,713.5.
  - Domestic expenditure: 2003 3,009.1; 2004 3,299.2; 2005 4,500.0; 2006 5,497.8; 2007 7,153.3; Staff 7,153.3.
  - Net lending: 2003 -163.7; 2004 -196.5; 2005 -117.8; 2006 -70.8; 2007 -74.1; Staff -74.1.
- Overall balance (millions Rf): 2003 -300.3; 2004 -187.4; 2005 -1,044.8; 2006 -845.7; 2007 -3,704.1; Staff -3,131.0.
  - Overall balance, excluding grants: 2003 -423.9; 2004 -261.9; 2005 -1,869.3; 2006 -2,941.1; 2007 -4,663.0; Staff -4,539.0.
- Financing:
  - Domestic financing (millions Rf): 2003 -118.9; 2004 -218.0; 2005 809.8; 2006 223.7; 2007 15.0; Staff 1,181.5.
  - Foreign financing (millions Rf): 2003 419.2; 2004 405.4; 2005 235.0; 2006 622.0; 2007 3,689.1; Staff 1,949.4.
- Government debt (end of period, millions Rf): 2003 4,087.6; 2004 4,282.8; 2005 5,052.1; 2006 6,002.8; 2007 9,706.9; Staff 9,133.8.
  - Foreign portion (millions Rf): 2003 2,622.9; 2004 3,026.6; 2005 3,261.6; 2006 3,883.6; 2007 7,572.7; Staff 5,833.0.
- Percent of GDP (selected):
  - Total revenue and grants: 2003 34.8; 2004 34.2; 2005 48.0; 2006 62.9; 2007 61.8; Staff 55.8.
  - Expenditure and net lending: 2003 38.2; 2004 36.0; 2005 58.9; 2006 70.2; 2007 79.6.
  - Overall balance: 2003 -3.4; 2004 -1.9; 2005 -10.9; 2006 -7.3; 2007 -28.3; Staff -23.9.
  - Government debt (end period, percent of GDP) 2003 46.1; 2004 43.1; 2005 52.6; 2006 51.7; 2007 74.1; Staff 69.7.
    - Of which foreign: 2003 29.6; 2004 30.5; 2005 33.9; 2006 33.5; 2007 57.8; Staff 44.5.
    - Domestic: 2003 16.5; 2004 12.6; 2005 18.6; 2006 18.3; 2007 16.3; Staff 25.2.
- Memorandum items:
  - Nominal GDP (millions rufiyaa): 2003 8,863.2; 2004 9,939.2; 2005 9,607.7; 2006 11,608.3; 2007 13,104.1.

### Monetary accounts summary (Table 4: 2002–07)
- Broad money (millions Rf): 2002 3,936.0; 2003 4,543.7; 2004 5,983.7; 2005 6,685.0; 2006 8,063.3; 2007 9,102.3 (Dec. entry).
- Net foreign assets (millions Rf): 2002 1,676.6; 2003 2,613.4; 2004 3,357.1; 2005 1,787.7; 2006 941.6; 2007 -328.0.
  - Monetary authorities (net): 2002 1,704.9; 2003 2,050.3; 2004 2,605.1; 2005 2,303.5; 2006 2,490.7; 2007 2,571.4.
  - Commercial banks (net): 2002 -28.3; 2003 563.1; 2004 752.0; 2005 -515.8; 2006 -1,939.4; 2007 -2,899.4.
- Net domestic assets (millions Rf): 2002 2,259.4; 2003 1,930.4; 2004 626.6; 2005 4,897.2; 2006 7,121.8; 2007 9,430.3.
- Domestic credit (millions Rf): 2002 3,421.7; 2003 3,246.6; 2004 4,239.6; 2005 6,904.9; 2006 9,180.8; 2007 11,489.4.
  - Public sector: 2002 1,314.5; 2003 1,002.2; 2004 698.3; 2005 1,430.9; 2006 995.6; 2007 2,245.8.
  - Central government (net): 2002 1,103.5; 2003 911.8; 2004 456.3; 2005 953.0; 2006 423.1; 2007 1,604.6.
  - Private sector: 2002 2,107.2; 2003 2,244.4; 2004 3,541.3; 2005 5,474.1; 2006 8,185.2; 2007 9,243.5.
- Broad money (annual percent change): 2002 19.5; 2003 15.4; 2004 3.7; 2005 1.7; 2006 20.6; 2007 12.9.
- Net foreign assets (percent change): 2002 43.0; 2003 55.9; 2004 28.5; 2005 -46.7; 2006 -47.3; 2007 -134.8.
- Memorandum items:
  - GDP (millions rufiyaa): 2002 8,201.0; 2003 8,863.2; 2004 9,939.2; 2005 9,607.7; 2006 11,608.3; 2007 13,104.1.
  - Official reserves (US$ million): 2002 134.0; 2003 160.3; 2004 199.6; 2005 187.1; 2006 232.2; 2007 208.0.
  - Commercial banks' NFA (US$ million): 2002 -2.2; 2003 44.0; 2004 58.8; 2005 -40.3; 2006 -151.5; 2007 -226.5.

### Medium-term scenarios (Tables 5–6: Base Case and Alternative Policy, 2005–12)
- Base Case Medium-Term Scenario (2005–12) highlights:
  - Output and prices (selected):
    - Real GDP growth: 2005 -4.5; 2006 19.1; 2007 7.5; 2008 7.0; 2009 7.0; 2010 6.0; 2011 6.5; 2012 6.5.
    - Consumer prices (period average): 2005 3.3; 2006 3.7; 2007 3.0; 2008 3.0; 2009 2.5; 2010 2.5; 2011 2.5; 2012 2.5.
  - Central government (percent of GDP): revenue and grants, expenditure and net lending, and overall balance projections provided for 2005–12 (see table entries).
  - Current account balance (millions USD) and percent of GDP: e.g., 2005 -268.8 (-35.8); 2006 -369.2 (-40.7); 2007 -451.5 (-45.0); projections through 2012 show improvement to -29.6 (-1.9) by 2012 in the Base Case.
  - Gross official reserves (year-end, millions USD) projection: 2005 187.1; 2006 232.2; 2007 264.7; 2008 241.7; 2009 257.0; 2010 253.3; 2011 279.1; 2012 324.0.
  - External debt (year-end, millions USD) projections: 2005 429.1; 2006 592.3; 2007 819.6; 2008 972.6; 2009 1,068.8; 2010 1,088.7; 2011 1,108.6; 2012 1,018.7.
  - External debt (percent of GDP) projections: 2005 57.2; 2006 65.3; 2007 80.1; 2008 87.6; 2009 88.1; 2010 81.8; 2011 76.3; 2012 64.2.
- Alternative Policy Medium-Term Scenario (2005–12) (Table 6) provides alternative projections for revenue, expenditure, overall balance, and resulting debt and reserves paths (specific table entries for 2005–12 available).

### Indicators of external vulnerability (Table 7, 2003–06)
- Financial indicators (in percent of GDP or percent change):
  - Government debt: 2003 46.1; 2004 43.1; 2005 52.6; 2006 51.7 (Est. label).
  - Broad money (annual percent change): 2003 15.4; 2004 3.7; 2005 1.7; 2006 20.6.
  - Private sector credit (annual percent change): 2003 6.5; 2004 57.8; 2005 54.6; 2006 49.5.
- External indicators:
  - Domestic exports (annual percent change, in U.S. dollars): 2003 24.5; 2004 8.7; 2005 -15.4; 2006 30.5.
  - Imports (annual percent change, in U.S. dollars): 2003 20.2; 2004 36.9; 2005 15.5; 2006 24.4.
  - Current account balance (percent of GDP): 2003 -4.6; 2004 -16.5; 2005 -35.8; 2006 -40.7.
  - Capital and financial account balance: 2003 7.6; 2004 19.4; 2005 35.1; 2006 42.7.
  - Gross official reserves (millions USD): 2003 160.3; 2004 204.4; 2005 187.1; 2006 232.2.
  - Official reserves in months of following year's imports GNFS: 2003 2.7; 2004 2.9; 2005 2.1; 2006 2.4.
  - Total external debt (percent of GDP): 2003 41.8; 2004 42.7; 2005 57.2; 2006 65.3.
  - Debt service to domestic exports of GNFS: 2003 4.0; 2004 5.1; 2005 10.1; 2006 8.8.
  - Exchange rate (rufiyaa/U.S. dollar, end-period): 12.8 (2003–2006).

### Annex I — Details of the 2007 domestic budget
- Overall budgetary change:
  - "The domestic budget—excluding foreign-financed spending—provides for significant increases in both current and capital expenditures."
  - "Overall expenditures rise by 31 percent relative to the 2006 budget, with current and capital expenditures increasing by 26 and 58 percent, respectively."
  - As a share of GDP, current and capital expenditures grow by 4.4 and 3.7 percentage points, respectively.
- Composition of current expenditure increase:
  - "The increase in current expenditures is dominated by government grants and subsidies. They double in the 2007 budget, and almost fully account for the overall rise of the share of current expenditure in GDP."
  - Only about a third of the increase in grants and subsidies is attributed to domestic spending on tsunami reconstruction by the National Disaster Management Center; the remainder reflects higher spending on food subsidies, welfare payments, fellowship assistance for overseas studies, and contributions to local associations.
  - Budgeted spending on salaries and wages declines as a share of GDP, but is offset by increases in interest payments on rising domestic debt, travel expenses, and supplies and repairs, including related to construction of a new penitentiary.
- Composition of capital expenditure increase:
  - "The rise in capital expenditures reflects mainly an increase in government paid-up capital in state-owned enterprises (SOEs). This accounts for almost 60 percent of the overall increase in capital spending."
  - Government rationale: the limited capital base of a number of SOEs impaired their ability to raise debt capital.
  - "Increased debt amortization and elevated spending on construction and equipment also contributed significantly to the overall rise in capital expenditure."
- New revenue measures to balance the budget:
  - The budget envisages Rf 1.4 million (about 11 percent of GDP) in new revenue measures.
  - Approximately 80 percent of new measures are tourism-related, including:
    - "Extension of resort lease period 239.7" (Rf mn).
    - "Development of airports in 10 islands 191.3" (Rf mn).
    - "Advance lease rent from MTDC (9 islands) 191.3" (Rf mn).
    - "Lease of Gulhifalhu land 127.5" (Rf mn).
    - "Development of additional resorts (5 islands) 127.5" (Rf mn).
    - "New hotels in the existing regional airports 95.6" (Rf mn).
    - "Lease rent arrears 67.8" (Rf mn).
    - "Other 158.2" (Rf mn) under tourism-related heading.
  - Other new measures (Rf mn):
    - "Other 228.5"
    - "Work permit fee 100"
    - "New import duties on tobacco and cigarettes 62.5"
    - "Increase in customs surcharge 36"
    - "New import duties on vehicles 14"
    - "Other 16.0"
- Expenditure category shifts (2006 to 2007):
  - Growth of current expenditures by category highlighted for: Salaries and wages; Travel; Supplies and Repairs; Interest Payments; Grants and subsidies; Other.
  - Expenditure categories as a share of GDP and growth of capital expenditure by category (Construction and Equipment; Increase in Equity Capital; Debt Amortization) are presented in charts and tables.

*Sources: Data provided by the Maldivian authorities; and IMF staff estimates and projections.*

### ANNEX II.  M

### ANNEX II.  MALDIVES: PUBLIC AND EXTERNAL DEBT SUSTAINABILITY

### Overview and scenarios
- Debt sustainability analysis indicates a rise in external and public sector vulnerabilities—underlined by falling international reserves—in the absence of fiscal reforms.
- Baseline scenario assumes GDP growth of 3.5–5.5 percent per annum.
- Alternative scenario (predicated on fiscal and structural reforms leading to a better investment climate) assumes growth of 6.5–7.5 percent per annum.
- The profile of public sector external debt is identical in nominal terms in the two scenarios; debt ratios differ across scenarios due to differences in nominal GDP (note: nominal GDP is higher in the baseline, due to higher inflation).
- Baseline: international reserves fall to 1.5 months of imports.
- Alternative scenario: reserves build up (international reserves rise to three months of imports).

### Public debt sustainability — findings
- Baseline projection:
  - Overall public debt rises from 51.7 percent in 2006 to 78.3 percent of GDP by 2008.
  - Public debt-to-GDP ratio continues to accelerate until 2009, then declines later into the projection period.
  - Domestic fiscal deficits from the deteriorating fiscal position in 2007 and beyond contribute to rising public debt-to-GDP.
  - Foreign public debt share in GDP reverts to pre-tsunami levels by 2012 in line with official repayment schedules, but lingering fiscal deficits keep domestic public debt relatively constant, yielding public debt-to-GDP of 60 percent in 2012—lower than its peak in 2008–09, but substantially higher than pre-tsunami levels (pre-tsunami level cited as 43.1 percent).
- Stress tests on public debt:
  - Worst public debt-to-GDP ratio of 85 percent under the growth shock scenario (permanent one-half standard deviation shock to assumed growth path).
  - Other shocks (interest rate, contingent liabilities, exchange rate, combined) also generate significant deterioration in public debt-to-GDP.
- Alternative (staff) scenario:
  - Assumes domestic financing requirement is kept at zero over the medium term (domestic public debt kept constant in nominal terms during 2006–12).
  - With prudent fiscal policy, public debt-to-GDP declines to 45.3 percent by end of projection period—close to pre-tsunami level of 43.1 percent.

### External debt sustainability — findings
- Baseline projection:
  - External debt-to-GDP ratio climbs until 2009 due to substantial planned increases in government borrowing in 2007 and 2008 for infrastructure projects and private-sector resort development borrowing.
  - External debt-to-GDP peaks in 2009; falls to 68.3 percent in 2012 (slightly above end-2006 level).
  - International reserves fall to 1.5 months of imports, indicating high external vulnerabilities despite lower debt ratios by 2012.
- Stress test outcomes for external debt:
  - Current account shock would cause external debt-to-GDP to climb above 100 percent from 2008 through 2011.
  - A real depreciation of 30 percent would cause the ratio to rise sharply to 120 percent in the year the depreciation occurred.
  - Combined shocks and current-account/exchange-rate shocks show high vulnerability.
  - Explanations of potential causes: Maldives’ large exposure to tourism patterns and world commodity prices (current account shock); fiscal slippages and monetization leading to high inflation or surge in import demand putting peg under pressure (real depreciation).
- Alternative scenario:
  - With domestic expenditures kept in line with a realistic revenue forecast and stable macroeconomic environment, international reserves rise to three months of imports.
  - Lower current account deficits permit reserve accumulation, limiting external vulnerabilities relative to baseline despite identical external public debt nominal profiles.

### Stress tests and shocks — summary points
- Public debt bound tests indicate vulnerability to:
  - Growth shock: permanent one-half standard deviation downward shock → public debt-to-GDP up to 85 percent.
  - Interest rate shock, primary balance shock, exchange rate shock, contingent liabilities shock, and combined shocks all materially worsen public debt dynamics.
- External debt bound tests indicate vulnerability to:
  - Noninterest current account shock → external debt-to-GDP above 100 percent for 2008–2011.
  - One-time real depreciation of 30 percent in 2008 → external debt-to-GDP rises to 120 percent in that year.
  - Combined shocks and current-account shocks markedly increase gross external financing needs.
- Specific stress-test conventions:
  - Individual shocks are permanent one-half standard deviation shocks (figures in boxes represent average projections; ten-year historical averages shown).
  - Some tests use permanent 1/4 standard deviation shocks to real interest rate, growth rate, and primary balance.
  - One-time real depreciation of 30 percent and 10 percent of GDP shock to contingent liabilities occur in 2008 in specified scenarios.

### Key statistics and projections (selected exact figures from baseline and projections)
- Public sector debt (percent of GDP):
  - 2006: 51.7
  - 2007: 69.7
  - 2008: 78.3
  - 2009: 78.1
  - 2010: 71.9
  - 2011: 66.1
  - 2012: 60.2
- Public sector foreign-currency denominated (percent of GDP):
  - 2006: 33.5
  - 2007: 44.5
  - 2008: 51.1
  - 2009: 50.3
  - 2010: 43.8
  - 2011: 38.3
  - 2012: 33.4
- Public sector primary deficit and components (percent of GDP, selected):
  - Primary deficit 2006: 5.6; 2007: 22.2; 2008: 13.0; 2009: 4.4; 2010: -1.7; 2011: -1.9; 2012: -2.3
  - Revenue and grants 2006: 62.9; 2007: 55.8; 2008: 52.7; 2009: 47.5; 2010: 44.5; 2011: 43.0; 2012: 41.7
  - Primary (noninterest) expenditure 2006: 68.5; 2007: 77.9; 2008: 65.7; 2009: 51.9; 2010: 42.8; 2011: 41.1; 2012: 39.4
- Gross financing need (public sector, percent of GDP):
  - 2006: 43.2
  - 2007: 41.9
  - 2008: 35.4
  - 2009: 30.1
  - 2010: 29.6
  - 2011: 28.5
- Public sector debt-to-revenue ratio (percent):
  - 2006: 125.0
  - 2007: 148.7
  - 2008: 164.5
  - 2009: 161.5
  - 2010: 153.8
  - 2011: 144.3
- External debt (percent of GDP):
  - 2006: 80.1
  - 2007: 88.8
  - 2008: 89.9
  - 2009: 85.9
  - 2010: 80.3
  - 2011: 68.3
- Change in external debt (percent of GDP):
  - 2006: 14.7
  - 2007: 8.8
  - 2008: 1.0
  - 2009: -4.0
  - 2010: -5.6
  - 2011: -11.9
- Key macroeconomic assumptions underlying baseline (selected exact values):
  - Real GDP growth (in percent): 2006: 5.5; 2007: 4.5; 2008: 4.0; 2009: 4.0; 2010: 3.5; 2011: 3.5; 2012: 3.5
  - Inflation rate (GDP deflator, in percent): 2006: 7.0; 2007: 6.0; 2008: 6.0; 2009: 6.0; 2010: 6.0; 2011: 6.0; 2012: 6.0
  - Average nominal interest rate on public debt (in percent): 2006: 9.0; 2007: 9.0; 2008: 9.0; 2009: 9.0; 2010: 9.0; 2011: 9.0
  - Average real interest rate (in percent): 2006: 2.0; 2007: 3.0; 2008: 3.0; 2009: 3.0; 2010: 3.0; 2011: 3.0
- External sector key assumptions (selected exact values):
  - Growth of exports (U.S. dollar terms, in percent): 2006: 9.3; 2007: 8.5; 2008: 7.7; 2009: 7.8; 2010: 7.7; 2011: 7.8
  - Growth of imports (U.S. dollar terms, in percent): 2006: 10.2; 2007: 1.7; 2008: -8.0; 2009: -0.3; 2010: 2.9; 2011: 5.6
  - Current account balance, excluding interest payments (percent of GDP): 2006: -37.8; 2007: -33.2; 2008: -16.2; 2009: -9.1; 2010: -5.0; 2011: -3.2
- Gross external financing need:
  - 2006: 519.0 (in billions of U.S. dollars column shows 519.0 for 2006; corresponding percent of GDP 50.7)
  - 2007: 537.4 (in billions of U.S. dollars column shows 537.4; percent of GDP 47.4)
  - 2012: 249.0 (in billions of U.S. dollars; percent of GDP 15.0)

### Policy implications and recommendations (implicit in staff analysis)
- Fiscal consolidation and prudent fiscal policy are critical to:
  - Prevent further buildup of public debt-to-GDP and reduce reliance on domestic financing.
  - Avoid scenarios that would reduce international reserves to critically low levels (1.5 months of imports).
- Structural and fiscal reforms that improve the investment climate and keep domestic financing requirement at zero over the medium term can:
  - Support higher growth (6.5–7.5 percent per annum in the alternative scenario).
  - Bring public debt-to-GDP down toward pre-tsunami levels (45.3 percent by projection end).
  - Allow international reserves to build to about three months of imports and reduce external vulnerabilities.
- Managing contingent liabilities, limiting excessive public expenditure, and maintaining exchange rate and inflation stability are important to avoid large real depreciations or current account shocks that would sharply increase external debt ratios.

*International Monetary Fund. Staff Report for the 2007 Article IV Consultation—Informational Annex (ANNEX II).*

### APPENDIX II

### APPENDIX II — MALDIVES: RELATIONS WITH THE WORLD BANK GROUP

### IBRD/IDA Lending Operations and Portfolio (As of March 2007)
- Current portfolio (IDA)
  - Integrated human development: Net Commitments 16.4 2/, Disbursements 3.7, Undisbursed 8.6
  - Emergency recovery credit and grant: Net Commitments 13.9 3/, Disbursements 11.1, Undisbursed 2.9
  - Sub-total: Net Commitments 30.3, Disbursements 14.8, Undisbursed 11.5
- Closed projects (IDA) — selected entries
  - Fisheries I: Net Commitments 3.2, Disbursements 1.6
  - Fisheries II: Net Commitments 5.0, Disbursements 5.0
  - Fisheries III: Net Commitments 10.7, Disbursements 9.4
  - Male airport upgrading: Net Commitments 7.5, Disbursements 7.5
  - Education and training: Net Commitments 8.2, Disbursements 7.3
  - Education and training II: Net Commitments 13.4, Disbursements 12.9
  - Education and training III: Net Commitments 18.6 4/, Disbursements 16.8
  - Closed projects sub-total: Net Commitments 66.6, Disbursements 61.0
- Total (IBRD/IDA): Net Commitments 96.9, Disbursements 75.7, Undisbursed 11.5

- Notes on adjustments and financing
  - 2/: US$10 million were cancelled to make IDA resources available under the Maldives Post-Tsunami Emergency Recovery Credit and Grant. Original commitment was US$21.3 million. US$5.7 million were then regranted as additional financing in 2006.
  - 3/: Of this total, $8.4 million provided as credit and $5.6 million (40 percent of total financing) as grant.
  - 4/: US$2 million cancelled to make IDA resources available under the Maldives Post-Tsunami Emergency Recovery Credit and Grant. US$1.4 million in additional financing was contributed to the project in 2006.
  - Disbursement figures subject to SDR/USD exchange rate fluctuations. Source: WB Operations Portal and Client Connection.

### World Bank Country Assistance Strategy (CAS) and Lending Program
- Overarching objective of the previous CAS:
  - “The reduction of poverty and regional disparities in access to social and infrastructure services. To advance this objective, the strategy, in partnership with other donors, aims at supporting: (i) sustainable economic growth; (ii) improvements in public sector management, including institutional capacity; and (iii) human development.”
- CAS timeline and tsunami response
  - CAS originally intended to cover up to end-2004; December 2004 tsunami caused damage equivalent to more than 60 percent of the country’s GDP, prompting extension of assistance to include emergency reconstruction.
  - The Bank will prepare its new CAS during 2007. CAS will be based on the government’s Seventh National Development Plan (7NDP) pending adoption by the Cabinet.
  - Bank and Fund aim to discuss a Joint Staff Advisory Note on the 7NDP during the Fund’s upcoming Article IV consultations.
- Historical Bank group focus and recent shifts
  - Total net IDA commitments to date: over US$96 million.
  - Sectors supported: fisheries, tourism, human development (particularly education), and emergency recovery.
  - Shift from sector-specific project lending to more multisectoral and programmatic approaches (reflected in the Integrated Human Development Project approved in early FY05).
- Post-tsunami assistance and financing details
  - Maldives Post-Tsunami Emergency Recovery Credit/Grant: US$14 million (US$12 million reallocated from existing credits, and US$2 million from additional IDA resources).
  - Grant portion: 40 percent (US$5.6 million) provided as grant; remainder as credit.
  - Operation financed cash grants to affected persons, reconstruction of schools, and technical assistance. The grant portion was fully disbursed as of beginning of October 2006.
  - EU added additional funds equivalent to $17 million to this project for improved public accounting system, school reconstruction activities, health facilities, and a solid waste management component.
  - The Bank set up a temporary office in the Maldives managed by an experienced Special Representative; the Bank administers a Japan Social Development Trust Fund and the EU Trust Fund under the same program of activities for post-Tsunami recovery.
- Integrated Human Development Project
  - Inter-sectoral focus: education, health, social protection, improved development management at the atoll and island level.
  - Development objective: improve social service provision and economic opportunities in selected ecologically viable focus islands.
  - Project restructured after US$10 million of credit funds were cancelled to make room for post-tsunami support; US$5.7 million in financing restored in the second half of 2006.

### Advisory, Analytical Support, and Capacity Building
- Analytical outputs and technical assistance
  - Promoted understanding of poverty and vulnerability; completed a country economic update.
  - Provided technical advice and training on public expenditure management and pension reform.
  - Supported development of strategy and action plans in urban development, land management, land administration, and housing markets/finance.
  - Prepared assessment of damage and needs after December 2004 tsunami in partnership with AsDB and UN agencies, and in coordination with the IMF.
- Fiscal and macroeconomic support
  - Assisted government in managing large fiscal and balance of payment imbalances post-tsunami (including fall in tourism revenues in 2005 and rising expenditure needs).
  - FY06 activities: Fisheries Sector Development Strategy, investment climate assessment (ICA), pension and social security study, and Institutional Development Fund grant for public expenditure management capacity building.
  - ICA completed in 2005.
- Financial sector priorities
  - Government priorities: strengthen and deepen financial sector.
  - Assistance sought on reforming the provident fund and developing housing finance.
  - IFC assistance: insurance and leasing.
  - Need identified for introduction of anti-money laundering legislation.

*Source: INTERNATIONAL MONETARY FUND — MALDIVES: Staff Report for the 2007 Article IV Consultation — Supplementary Information. Prepared by the Asia and Pacific Department. Approved by Daniel Citrin and Michael Hadjimichael. July 25, 2007.*

### 1.      In light of the recent Decision on Bilateral Surveillance, this supplement to the staff

### 1mdvea2019007 - 1.      In light of the recent Decision on Bilateral Surveillance, this supplement to the staff

### Recent developments (H1 2007)
- Domestic expenditures running broadly as budgeted, but revenues fell below budget estimates.
- Domestic deficit in the first half of the year was almost 870 million rufiyaas, equivalent to about 6.6 percent of GDP.
- International reserves increased from US$ 232 million at end-2006 to about US$ 250 million in June and remained broadly unchanged in months of imports.
- Authorities indicate some new revenue sources assumed in the budget are likely not to materialize; intend to scale back budgetary expenditures and seek cabinet guidance on the fiscal path for the remainder of the year.
- Staff view: major effort needed to cut back budgetary expenditures over the remainder of the year; indications so far are that the cutbacks advocated by staff are unlikely to occur.

### The 2007 Decision on Bilateral Surveillance: staff assessment and implications
- Economic rebound since the December 2004 tsunami: rapid GDP growth underpinned by robust increases in tourist arrivals and construction activity for new resorts.
- Fiscal developments: fiscal expenditures have increased sharply, with a further large increase proposed in the 2007 budget, entailing a quadrupling of the overall budget deficit to 28 percent of GDP.
- Staff forecast: with unchanged fiscal policies there would be a sharp fall in reserves in months of import coverage, which could put pressure on the dollar peg.
- Staff conclusion: on unchanged fiscal policies, the exchange rate is fundamentally misaligned.
- Staff clarification: the underlying concern is the current stance of fiscal policy (negative implications for external stability and the equilibrium REER), not the nominal exchange rate per se.
- Staff view on exchange rate regime and level: the current exchange rate regime (a peg against the U.S. dollar) and the current level of the exchange rate are appropriate and sustainable, as long as fiscal policy is tightened.
- REER developments: the REER has depreciated substantially in recent years and would depreciate further if the U.S. dollar continues its decline against the euro.
- Competitiveness indicators: cumulative real depreciation since 2001 has been greater than that of competitors like Seychelles, Mauritius, Madagascar, and Sri Lanka; World Bank’s “Doing Business in South Asia in 2007” ranks the Maldives as the best in the region in ease of doing business and in the top third globally.

### Authorities’ views (response and policy intentions)
- Authorities agree with staff that unchanged fiscal policies could lead to a loss of reserves and pressure on the dollar peg and a fundamental misalignment, but they do not agree that the currency is presently misaligned.
- Authorities’ evidence: reserves increased in the first half of 2007 to around US$250 million and there has been no pressure on the dollar peg.
- Authorities’ concern: describing the exchange rate level as both appropriate and fundamentally misaligned (based on a forecast of unchanged fiscal policies) could confuse markets and precipitate speculative pressures.
- Authorities’ actions: cabinet deliberations underway; paper submitted on first five months of 2007 fiscal outturn and projections for full year; medium-term fiscal scenario in the paper targets deficits of 14, 10 and 9 percent of GDP in 2008, 2009 and 2010, respectively.
- Authorities’ assurance: will prioritize intended 2007 expenditures in line with revenue and grants receipts; temporary or new expenditures should be fully financed before disbursement; permanency in future expenditures would be financed by domestic revenues.
- Authorities’ view that staff baseline scenario is unduly pessimistic.

### Macroeconomic outlook and financial policies
- 2006 performance: GDP growth accelerated to about 19 percent; inflation was moderately low; foreign exchange reserves increased.
- External vulnerabilities: high dependence on tourism and fishing; geography makes country vulnerable to external shocks.
- External financing: concessional financing picked up to a generous level in 2006 and helped support reforms and reconstruction.
- External debt: external debt increased to 65 percent of GDP in 2006, over two-thirds of the increase driven by private sector borrowing.
- Despite export and GDP expansion, total debt-service ratio and domestic debt stock as a share of GDP fell.
- Fixed exchange rate regime: provided a simple and transparent nominal anchor and limited inflationary pressures; authorities determined to continue supporting the peg with appropriate fiscal and monetary policies.
- Institutional reforms:
  - April 2007 central bank act separates functions of minister of finance from governor of central bank.
  - Weekly treasury bills issuance commenced to develop a treasury bill market and cease automatic financing of the government deficit by the central bank.
  - With MCM technical assistance, a liquidity-forecasting framework is being developed to facilitate movement to an auction system for treasury bill issuance.
  - Required reserves ratio reduced gradually from 35 to 25 percent since 2003; authorities will consider further reductions per staff recommendation.
- Fiscal revenue performance (2005–2006):
  - Tax revenues increased from 18 to 21 percent of GDP between 2005 and 2006.
  - Nontax revenues rose from 21 to 24 percent of GDP.
  - Grants increased by 18 percent of GDP, enabling a scale-up in expenditures.
- Fiscal balance: overall fiscal balance for 2006 improved year-on-year, from a deficit of about 11 percent of GDP to just over 7 percent, largely reflecting increased foreign financing.
- Medium-term fiscal framework: Macroeconomic Coordination Committee to monitor; authorities committed to prioritizing 2007 expenditures in line with receipts.

### Structural and financial-sector reforms
- Banking sector: benefited from booming economy and strong private sector credit pick-up; public sector share in credit diminished; non-performing loans falling; risk exposure minimized through foreign-owned bank borrowing and collateralization of commercial domestic property.
- State-owned enterprises: corporatization underway; authorities plan privatizations through public share issuance for some firms and restructuring for others; Cabinet approved formation of a holding company for such enterprises (submitted for the President’s approval) to be governed under the Companies Act of the Maldives; Public Enterprises Bill will no longer be implemented.
- Legislative reform: Banking Bill and other reforms being finalized.
- World Bank support: strengthening fiscal systems to increase effectiveness of public spending, budget formulation, and expenditure management; further capacity building envisaged.
- Domestic revenue reforms: authorities committed to finalizing and tabling the Business Profit Tax Bill and other reforms as soon as feasible.

### Key statistics and targets (preserved as in source)
- Domestic deficit (H1 2007): almost 870 million rufiyaas (about 6.6 percent of GDP).
- International reserves: US$ 232 million at end-2006; about US$ 250 million in June 2007.
- Proposed overall budget deficit (2007 budget projection described as quadrupling): 28 percent of GDP.
- Medium-term fiscal scenario targets: deficits of 14, 10 and 9 percent of GDP in 2008, 2009 and 2010, respectively.
- GDP growth (2006): about 19 percent.
- External debt (2006): 65 percent of GDP.
- Tax revenues (2005 to 2006): from 18 to 21 percent of GDP.
- Nontax revenues (2005 to 2006): from 21 to 24 percent of GDP.
- Grants (2006): amounting to 18 percent of GDP.
- Required reserves ratio reduction: from 35 to 25 percent since 2003.

*Source: 1mdvea2019007*

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_Source: https://www.imf.org/-/media/files/publications/cr/2019/1mdvea2019007.pdf_