## 1fsmea2021002 ## Source details **Canonical URL:** [1fsmea2021002](https://www.imf.org/-/media/files/publications/cr/2021/english/1fsmea2021002.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2021/english/1fsmea2021002.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2021/english/1fsmea2021002.pdf.json) --- ### Key issues and context - COVID-19 pandemic and containment measures put severe strains on the economy; policy response described as strong and generally appropriate. - Significant medium-term uncertainty from possible expiration of Compact of Free Association (COFA) grants and assistance by end-FY2023. - High vulnerability to climate change-induced natural disasters and geographic remoteness that hinder infrastructure development and foreign direct investment. - Limited progress on past Fund advice due to capacity constraints and COVID-19-related travel disruptions. ### Selected headline statistics (FY2018–26) - Nominal GDP (FY2018): US$402 million - Population (FY2018): 104,286 - GDP per capita (FY2018): US$3,854 - IMF Quota: SDR 7.2 million - Real GDP growth (annual percent change): FY2018 0.2; FY2019 1.2; FY2020 -1.8; FY2021 -3.2; FY2022 0.6; FY2023 3.2; FY2024 1.9; FY2025 0.8; FY2026 0.6 - Consumer prices (annual percent change): FY2018 1.4; FY2019 1.5; FY2020 0.5; FY2021 2.6; FY2022 2.6; FY2023 2.6; FY2024 2.6; FY2025 2.5; FY2026 2.4 - Consolidated government finance (percent of GDP) — Revenue and grants: FY2018 79.7; FY2019 77.7; FY2020 69.3; FY2021 72.8; FY2022 67.7; FY2023 64.6; FY2024 57.2; FY2025 54.7; FY2026 54.8 - Revenue (percent of GDP): FY2018 53.5; FY2019 46.4; FY2020 33.5; FY2021 31.0; FY2022 31.6; FY2023 31.0; FY2024 42.2; FY2025 41.6; FY2026 41.1 - Tax revenue (percent of GDP): FY2018 32.2; FY2019 25.5; FY2020 12.3; FY2021 11.3; FY2022 11.4; FY2023 11.2; FY2024 11.2; FY2025 11.1; FY2026 11.1 - Corporate income tax (percent of GDP): FY2018 21.0; FY2019 14.9; FY2020 2.4; FY2021 3.0; FY2022 2.9; FY2023 2.7; FY2024 2.5; FY2025 2.4; FY2026 2.4 - Fishing license fees (percent of GDP): FY2018 18.0; FY2019 17.5; FY2020 17.8; FY2021 16.3; FY2022 16.9; FY2023 16.5; FY2024 15.4; FY2025 15.3; FY2026 15.1 - Grants (percent of GDP): FY2018 26.2; FY2019 31.3; FY2020 35.9; FY2021 41.9; FY2022 36.1; FY2023 33.5; FY2024 15.0; FY2025 13.1; FY2026 13.7 - Expenditure (percent of GDP): FY2018 55.5; FY2019 60.3; FY2020 68.8; FY2021 71.6; FY2022 64.8; FY2023 62.2; FY2024 61.3; FY2025 59.6; FY2026 59.8 - Net lending/borrowing (percent of GDP): FY2018 24.2; FY2019 17.4; FY2020 0.6; FY2021 1.3; FY2022 2.8; FY2023 2.4; FY2024 -4.1; FY2025 -4.9; FY2026 -5.0 - Net lending/borrowing (excl. grants, percent of GDP): FY2018 -1.9; FY2019 -13.9; FY2020 -35.3; FY2021 -40.6; FY2022 -33.3; FY2023 -31.2; FY2024 -19.0; FY2025 -18.0; FY2026 -18.7 - Balance of Compact Trust Funds (percent of GDP): FY2018 211.1; FY2019 230.5; FY2020 263.7; FY2021 317.3; FY2022 335.1; FY2023 344.3; FY2024 329.2; FY2025 318.6; FY2026 309.4 - Nominal GDP (millions of U.S. dollars): FY2018 401.9; FY2019 412.9; FY2020 407.3; FY2021 404.2; FY2022 417.2; FY2023 442.1; FY2024 462.3; FY2025 477.7; FY2026 491.9 - Current account (percent of GDP): FY2019 21.0; FY2020 3.0; FY2021 1.2; FY2022 1.1; FY2023 -0.4; FY2024 -5.1; FY2025 -4.9; FY2026 -5.2 - External debt (millions of U.S. dollars): FY2018 75.4; FY2019 77.3; FY2020 65.4; FY2021 61.0; FY2022 60.8; FY2023 60.2; FY2024 76.5; FY2025 98.2; FY2026 122.0 - External debt (percent of GDP): FY2018 18.8; FY2019 18.7; FY2020 16.1; FY2021 15.1; FY2022 14.6; FY2023 13.6; FY2024 16.5; FY2025 20.6; FY2026 24.8 - SDR allocation: SDR 6.9 million (about US$ 9.8 million or 2.4 percent of GDP), effective August 23, 2021 ### The COVID shock: impact, outlook, and risks - Real GDP estimated decline: FY2020 -1.8 percent; projected FY2021 -3.2 percent; slow recovery in FY2022. - Current account surplus estimated at 3.0 percent of GDP in FY2020; projected current account (percent of GDP) FY2019 21.0; FY2020 3.0; FY2021 1.2; FY2022 1.1; FY2023 -0.4; FY2024 -5.1; FY2025 -4.9; FY2026 -5.2. - External debt stock and ratios provided above. - Vaccination targets and status: authorities aim for at least 70 percent vaccination coverage; as of September 13, 2021 about 61 percent of the eligible population have been vaccinated; as of September 30, 2021 about 66 percent vaccination rate of the eligible population reported elsewhere in the text. ### Authorities’ actions and near-term policy response - Public health: - Strong, timely prevention measures; FSM among few countries with no confirmed COVID-19 cases as of the report; public health emergency extended through end of January 2022. - Aim to achieve at least 70 percent vaccination coverage to transit from COVID-free to COVID-protected. - Fiscal and income support: - Extended Economic Stimulus Package for businesses until June 2022. - Appropriated about US$ 2.5 million or 0.6 percent of GDP to augment social protection program for low-income household assistance. - Prioritize support for individuals most affected until funds run out. - Implementation and transparency: - Department of Finance and Administration prepared quarterly COVID-19 situation reports and beneficiary lists. - Authorities committed to audit COVID-19 related spending and publish relevant reports. ### Policy recommendations and priorities - Near-term: - Maintain policy support until recovery firmly underway; provide additional near-term fiscal support given projected further output decline in FY2021. - Extend income support to unemployed, low-income households, and informal workers. - Introduce pandemic-related spending safeguards: publication of COVID-related spending reports, procurement contracts, beneficial ownership information, and ex-post audit reporting. - Accelerate vaccination, including remote communities and the young population. - Medium-term fiscal resilience: - Phase in gradual fiscal consolidation to reduce risks related to expiration of U.S. Compact grants. - Suggested magnitude: gradual fiscal adjustment of about 1-2 percent of GDP per year over 5 years when growth rebounds above trend. - Estimated short-term growth cost of adjustment: lower GDP growth by about 0.2-0.4 percent annually; countered by growth-enhancing structural reforms. - Establish National Tax Reform Commission; consider VAT replacing the gross revenue tax (GRT); consider excises on tobacco and alcohol; introduce excise taxes on gasoline and diesel that mimic a carbon tax. - Expedite roll-out of a new tax administration IT system; save future revenue windfalls to build fiscal buffers. - Streamline and rationalize state support programs and goods and services purchases while protecting social spending and public infrastructure investment. - Strengthen Public Financial Management (PFM) and Public Investment Management (PIM); adopt a medium-term fiscal framework. ### Scenario analysis (Box 1 and Text Table highlights) - Baseline scenario: - Assumes U.S. Compact grants (22 percent of GDP) will not be renewed after FY2023. - Fiscal and external balances would turn from a small surplus to a deficit of around 4-5 percent of GDP from FY2024 onward. - Public debt would rise sharply to 82 percent of GDP over the next 20 years from the current low level. - Value and revenue-generating capacity of the Compact Trust Fund (CTF) would gradually erode; economy remains in a low-investment low-growth equilibrium. - Policy scenario: - Assumes gradual fiscal adjustment of 1-2 percent of GDP per year over 5 years from FY2023 through domestic revenue mobilization and expenditure rationalization, plus structural reforms. - Near-term dampening of growth offset by medium-term gains from improved business climate and fast-tracked infrastructure investment financed by external grants. - Would help avoid a fiscal cliff, stabilize trust fund balances, and keep public debt in check. - Policy scenario with renewal of U.S. Compact grants: - Assumes renewal of current Compact arrangements plus structural reforms as in the policy scenario. - Renewed grants relieve fiscal pressures and enable higher public investment; some fiscal adjustment and reforms remain beneficial. - Fiscal scenario numeric notes (selected table entries preserved exactly as presented): - Real GDP Growth (percent) entries include values such as: -3.2, 3.2, 0.6, -3.2, 2.9, 0.6, 0.0, -0.3, 0.0 - Fiscal Balance: 1.3, 2.4, -5.0 (percent of GDP) - CTF + FSM net assets per capita (USD thousands): 12.2, 14.5, 15.2, 12.2, 14.5, 15.9, 0.0, 0.0, 0.7 - CTF + FSM net assets per capita (real, USD thousands): 7.3, 8.2, 7.8, 7.3, 8.2, 8.2, 0.0, 0.0, 0.4 - Tax Revenue: 11.3, 11.2, 11.1, 11.3, 12.0, 15.4, 0.0, 0.8, 4.3 (percent of GDP) - Current Expenditure: 56.8, 44.6, 43.2, 56.8, 44.2, 38.6, 0.0, -0.4, -4.6 (percent of GDP) ### Compact of Free Association (Appendix I) — CTFs and post-FY2023 implications - Compact Trust Funds intended to be built up over 20 years until September 2023. - Rules allow yearly disbursement equal to previous year’s investment return and up to the amount of Compact grants adjusted for inflation that will be disbursed in FY2023—approximately US$96 million or 22 percent of FY2023 GDP. - Unless the Compact is renewed, projected CTF disbursements are unlikely to provide sufficient fiscal revenue post-FY2023. - Assuming a 5 percent investment return, projected CTF disbursement would amount to 11 percent of GDP in FY2024, compared to 22 percent of GDP in FY2023. - Post-FY2023 distributions subject to investment returns, introducing large fiscal revenue volatility. ### Debt sustainability (DSA) — key findings and projections - Public sector debt declined to 15.4 percent of GDP at end-May 2021 from peak 30.7 percent of GDP in FY2009. - As of May 2021, about 70.5 percent of the debt is from the Asian Development Bank (AsDB); U.S. Department of Agriculture share declined to 18.1 percent. - Total external debt service reached 6.7 percent of exports in FY2020 and expected to remain broadly stable over the medium term. - Baseline projections: - External debt-to-GDP ratio projected to rise from 13.6 percent in FY2023 to 81.1 percent in FY2041. - Public debt-to-GDP projected to rise from 13.6 percent in FY2023 to 82.3 percent in FY2041. - PV of external debt-to-GDP breaches threshold from FY2034 onward; PV of public debt-to-GDP breaches threshold starting in FY2035 under baseline. - Stress tests: - Natural disaster scenario (one-off shock of 10 percentage points to debt-GDP in FY2021, and reductions in real GDP growth and exports by 5.0 and 3.5 percentage points respectively in shock year) would accelerate breaches and produce an explosive debt path. - Standardized export shocks produce the highest PV of external PPG debt-to-GDP ratio, breaching its threshold seven years after the shock. - Risk rating: - Within a standard 10-year horizon, mechanical DSA external and overall debt-distress ratings are moderate (no thresholds breached). - Extending horizon to 20 years shows projected breaches warranting an assessment of high risk of external and overall debt distress. - Mitigating factors: - FSM Trust Fund and national assets provide additional debt-repaying capacity; authorities do not consider drawing on FSM Trust Fund as part of financing strategy. - Key policy recommendations from DSA: - Urgent fiscal adjustments and broader structural reforms to boost growth. - Develop climate resilience strategy and improve debt management capacity. - Continued grant support and careful fiscal policy to avoid fiscal cliff post-FY2023. ### Financial sector stability and intermediation priorities - Banking sector structure and indicators: - Two commercial banks account for 85 percent of total banking assets. - Regulatory capital to risk-weighted assets ratio of the two banks: 37.6 percent (Dec-2020). - NPL ratio of the two banks: 0.1 percent (Dec-2020). - FSM Development Bank (FSMDB) accounts for 14 percent of total banking assets; FSMDB NPL ratio reached 14 percent as of June 2021 (authority’s definition); under EIB classification NPL ratio rose to 47 percent at end-Dec-2020. - Measures taken: - Interest payment relief, a 90-day voluntary loan moratorium, and a concessional loan program for small businesses. - Near-term recommendations: - Maintain near-term financial sector support subject to close monitoring; consider extending interest payment relief and debt moratorium for viable firms. - Close monitoring of NPLs and broader credit quality indicators; maintain adequate loan-loss provisions and strengthen FSMDB Board oversight. - Consider placing FSMDB and credit unions under FSMBB regulation and supervision. - Structural constraints and reforms: - Land ownership restrictions for non-FSM citizens, complex land ownership structures, absence of functioning credit and land registry constrain credit supply. - Recommended reforms: upgrade legal/regulatory framework for banking supervision; amend Banking Act to align with international standards and clarify FSMBB role; finalize governance and risk management prudential standards; strengthen AML/CFT risk-based supervision to preserve U.S. dollar correspondent banking relationships; upgrade land tenure management including digitalizing the land registry. ### Public financial management (PFM), public investment management (PIM), and project implementation - Challenge: FSM has not fully utilized capital grants under the Compact and other partners due to lack of government consensus and administrative capacity; large amounts of unused funds mainly due to lack of implementation capacity. - Recommended actions: - Speedier investment implementation to support recovery and lift potential growth. - Proceed expeditiously with long-pending IT system upgrade and project management improvements. - Improve coordination between national and state governments. - Enhance public administrative capacity through training, standardization, and digital technology. - Develop a medium-term fiscal framework to guide annual budget planning and ensure fiscal sustainability. - Authorities’ measures: - Established a Project Management Unit at national level and Project Management Offices at state level. - Receiving capacity development from the European Union for a medium-term fiscal framework. - National Tax Reform Commission expected to report to the President by January 1st, 2022; authorities prioritize introduction of VAT in a revenue neutral manner and submitted revised tax legislation to increase excise taxes on cigarettes and tobacco. - Authorities estimate these tax reforms would raise tax revenue to about 16 percent of GDP, from the current level of about 12 percent. ### Structural reforms, private sector development, digital connectivity - Structural constraints: remoteness, small size, geographical dispersion, large public sector, cumbersome business environment. - Recommended reforms and actions: - Expedite amendment of the Foreign Investment Act; reduce business startup costs and time for settling disputes; lower regulatory burden on FDI; improve judicial efficiency; enhance coordination across states; establish a national single window system for trade and FDI. - Improve governance: adopt and implement national anti-corruption strategy; introduce prevention measures to enhance detection of corruption and conflicts of interest; enact legislative measures to enhance transparency. - Digital connectivity (Appendix VI): - Only one third of the population uses the internet. - Mobile penetration rate: "21 percent". - Fixed broadband subscriptions: around "3 out of 100 persons". - ITU (2021) estimates connectivity costs: around "7 percent of monthly Gross National Income (GNI) per capita" for fixed broadband and about "11 percent" for mobile broadband; UN target is less than "2 percent". - Development partner support and financing: World Bank and AsDB assistance for submarine cable systems; March 2020 World Bank grant "US$30.8 million" or about "8 percent of GDP" to improve digital connectivity; telecommunications liberalized by Telecommunications Act (2014). - Recommendations: expedite ICT infrastructure investment; adopt overarching ICT plan; develop digital identification and government platform; expand digital literacy; provide regulatory framework for privacy, data protection, cybersecurity. ### Climate change, resilience, and disaster preparedness (Appendix VII) - Vulnerabilities and impacts: - Exposure to storms, floods, droughts, ocean acidification, coral bleaching, and sea-level rise. - Climate change reduces crop productivity, changes fish distribution, declines tuna catches, damages tourism, and exacerbates human health. - Growth potential projected to decline to around "0.5 percent" in the longer term absent major reforms and rising climate risks. - IMF (2019a) estimated "0.6 percent" potential growth, with gradual fall from "0.6 percent in FY2029" to "0.47 percent in FY2041" after additional climate impacts. - Financing needs and commitments: - Adaptation investment financing gap: about "US$550 million" ("137 percent of 2021 GDP") over next 15 years. - Recent commitments: FSM’s first GCF project "US$ 9.4 million" (March 2021); World Bank "US$ 40 million" approved May 2021 for road network climate resilience; AsDB committed "US$ 6 million" (2020). - New public law (April 2021) mandates sovereign wealth funds invest in clean and green portfolios only. - Policy priorities: - Develop National Adaptation Plan (NAP) and disaster resilience strategy; strengthen PFM and PIM to accelerate adaptation investment; improve access to climate finance by strengthening PFM/PIM; increase training and standardized practices across states. ### Data, statistics, and technical assistance - Serious shortcomings in data provision hamper surveillance; need to improve adequacy and timeliness of economic data. - Ongoing discussions to address delayed release of key statistics; resuming tax data sharing between Statistical Office and Department of Finance and Administration is critical. - FSM relies on external consultant to produce and compile key statistics due to capacity constraints. - TA was halted in 2020 due to travel restrictions and connectivity issues; authorities request continued IMF and PFTAC TA, preferably in-person when feasible, on revenue administration, PFM, banking supervision, national accounts/statistics, and economic planning. ### Staff appraisal and final policy priorities - Near-term priorities: - Continued coordinated policy response to COVID-19; accelerate vaccination; maintain supportive fiscal measures targeted to affected sectors and households; rationalize generous assistance schemes. - Introduce pandemic-related spending safeguards and publish spending, procurement, and audit reports. - Execute existing commitments on public infrastructure investment expeditiously. - Medium-term priorities: - Gradual fiscal consolidation post-pandemic through domestic revenue mobilization and expenditure rationalization. - Timely and effective implementation of key tax reforms (including VAT) is crucial. - Accelerate PFM and PIM reforms, and steadfast implementation of priority reforms to promote stronger, greener, and more sustainable growth. *Source: Federated States of Micronesia: Staff Report for the 2021 Article IV Consultation (selected extracts).* ### introduction of the value-added tax. They also stressed the importance of strengthening public ### 1fsmea2021002 - introduction of the value-added tax. They also stressed the importance of strengthening public ### Key issues and context - The COVID-19 pandemic and containment measures have put severe strains on the economy; policy response has been strong and generally appropriate. - Significant medium-term uncertainty stems from the possible expiration of grants and other assistance provided under the Compact of Free Association (COFA) with the United States by end-FY2023. - The FSM is highly vulnerable to climate change-induced natural disasters and geographic remoteness that hinder infrastructure development and foreign direct investment. - Limited progress on past Fund advice due to capacity constraints and COVID-19-related travel disruptions. ### Selected headline statistics (from Table: Selected Economic Indicators, FY2018–26) - Nominal GDP (FY2018): US$402 million - Population (FY2018): 104,286 - GDP per capita (FY2018): US$3,854 - IMF Quota: SDR 7.2 million - Real GDP growth (annual percent change): FY2018 0.2; FY2019 1.2; FY2020 -1.8; FY2021 -3.2; FY2022 0.6; FY2023 3.2; FY2024 1.9; FY2025 0.8; FY2026 0.6 - Consumer prices (annual percent change): FY2018 1.4; FY2019 1.5; FY2020 0.5; FY2021 2.6; FY2022 2.6; FY2023 2.6; FY2024 2.6; FY2025 2.5; FY2026 2.4 - Consolidated government finance (in percent of GDP): Revenue and grants: FY2018 79.7; FY2019 77.7; FY2020 69.3; FY2021 72.8; FY2022 67.7; FY2023 64.6; FY2024 57.2; FY2025 54.7; FY2026 54.8 - Revenue (percent of GDP): FY2018 53.5; FY2019 46.4; FY2020 33.5; FY2021 31.0; FY2022 31.6; FY2023 31.0; FY2024 42.2; FY2025 41.6; FY2026 41.1 - Tax revenue (percent of GDP): FY2018 32.2; FY2019 25.5; FY2020 12.3; FY2021 11.3; FY2022 11.4; FY2023 11.2; FY2024 11.2; FY2025 11.1; FY2026 11.1 - Corporate income tax (percent of GDP): FY2018 21.0; FY2019 14.9; FY2020 2.4; FY2021 3.0; FY2022 2.9; FY2023 2.7; FY2024 2.5; FY2025 2.4; FY2026 2.4 - Fishing license fees (percent of GDP): FY2018 18.0; FY2019 17.5; FY2020 17.8; FY2021 16.3; FY2022 16.9; FY2023 16.5; FY2024 15.4; FY2025 15.3; FY2026 15.1 - Grants (percent of GDP): FY2018 26.2; FY2019 31.3; FY2020 35.9; FY2021 41.9; FY2022 36.1; FY2023 33.5; FY2024 15.0; FY2025 13.1; FY2026 13.7 - Expenditure (percent of GDP): FY2018 55.5; FY2019 60.3; FY2020 68.8; FY2021 71.6; FY2022 64.8; FY2023 62.2; FY2024 61.3; FY2025 59.6; FY2026 59.8 - Net lending/borrowing (percent of GDP): FY2018 24.2; FY2019 17.4; FY2020 0.6; FY2021 1.3; FY2022 2.8; FY2023 2.4; FY2024 -4.1; FY2025 -4.9; FY2026 -5.0 - Net lending/borrowing (excl. grants) (percent of GDP): FY2018 -1.9; FY2019 -13.9; FY2020 -35.3; FY2021 -40.6; FY2022 -33.3; FY2023 -31.2; FY2024 -19.0; FY2025 -18.0; FY2026 -18.7 - Balance of trust funds (Compact Trust Fund and FSM Trust Fund, percent of GDP): FY2018 211.1; FY2019 230.5; FY2020 263.7; FY2021 317.3; FY2022 335.1; FY2023 344.3; FY2024 329.2; FY2025 318.6; FY2026 309.4 - Nominal GDP (in millions of U.S. dollars): FY2018 401.9; FY2019 412.9; FY2020 407.3; FY2021 404.2; FY2022 417.2; FY2023 442.1; FY2024 462.3; FY2025 477.7; FY2026 491.9 ### The COVID shock: impact, outlook, and risks - Real GDP is estimated to have declined by 1.8 percent in FY2020; projected contraction of -3.2 percent in FY2021 and slow recovery in FY2022. - Current account: surplus estimated at 3.0 percent of GDP in FY2020; projections: FY2019 21.0 percent; FY2020 3.0 percent; FY2021 1.2 percent; FY2022 1.1 percent; FY2023 -0.4 percent; FY2024 -5.1 percent; FY2025 -4.9 percent; FY2026 -5.2 percent. - External debt outstanding stock (in millions of U.S. dollars): FY2018 75.4; FY2019 77.3; FY2020 65.4; FY2021 61.0; FY2022 60.8; FY2023 60.2; FY2024 76.5; FY2025 98.2; FY2026 122.0 - External debt (in percent of GDP): FY2018 18.8; FY2019 18.7; FY2020 16.1; FY2021 15.1; FY2022 14.6; FY2023 13.6; FY2024 16.5; FY2025 20.6; FY2026 24.8 - The SDR allocation of SDR 6.9 million (about US$ 9.8 million or 2.4 percent of GDP) came into effect on August 23, 2021. ### Authorities’ actions and views - Strong, timely prevention measures have kept FSM among the few countries with no confirmed COVID-19 cases as of the report; public health emergency extended through end of January 2022. - Authorities aim to achieve at least 70 percent vaccination coverage to transit from COVID-free to COVID-protected; as of September 13, 2021 about 61 percent of the eligible population have been vaccinated. - Authorities broadly agreed with staff assessment; cautious on reopening borders due to limited health system capacity; preparing groundwork for policy adjustments against the risk of FY2023 expiration of Compact grants. ### Policy recommendations and priorities - Maintain policy support until recovery is firmly underway, ensuring emergency assistance is well-targeted. - Phase in gradual fiscal consolidation to reduce risks related to the expiration of U.S. Compact grants. - Strengthen public financial management and public investment management to accelerate donor-supported public investment and speed up climate adaptation. - Accelerate structural and financial sector reforms to support private sector development and financial deepening. - Continue upgrading the legal and regulatory framework for banking supervision and enhance supervisory capacity; place the FSM development bank and credit unions under supervision of the Banking Board to ensure effective supervision and prudent lending. - Strengthen AML/CFT risk-based supervision to preserve U.S. dollar correspondent banking relationships. - Prioritize enhancing the investment climate, improving governance, strengthening coordination across states, and expanding digital connectivity. - Speed up adaptation and enhance disaster preparedness by developing a National Adaptation Plan and a disaster resilience strategy. - Authorities welcomed continued technical assistance in revenue administration, public financial management, banking supervision, and statistics. ### Scenario analysis (Box 1: Baseline and Policy Scenarios) - Baseline scenario: - Assumes U.S. Compact grants (22 percent of GDP) will not be renewed after FY2023. - Fiscal and external balances would turn from a small surplus to a deficit of around 4-5 percent of GDP from FY2024 onward. - Public debt would rise sharply to 82 percent of GDP over the next 20 years from the current low level. - Value and revenue-generating capacity of the Compact Trust Fund (CTF) would gradually erode; economy remains in a low-investment low-growth equilibrium. - Policy scenario: - Assumes gradual fiscal adjustment of 1-2 percent of GDP per year over 5 years from FY2023 through domestic revenue mobilization and expenditure rationalization, plus structural reforms. - Near-term dampening of growth offset by medium-term gains from improved business climate and fast-tracked infrastructure investment financed by external grants. - Would help avoid a fiscal cliff, stabilize trust fund balances, and keep public debt in check. - Policy scenario with renewal of U.S. Compact grants: - Assumes renewal of current Compact arrangements and structural reforms as in the policy scenario. - Renewed grants relieve fiscal pressures and enable higher public investment; some fiscal adjustment and reforms remain beneficial. - Greater certainty and reforms would help attract foreign direct investment and put the economy on a stronger growth path. ### Financial sector and public investment management priorities - Upgrade legal and regulatory framework for banking supervision; enhance supervisory capacity. - Place FSM development bank and credit unions under Banking Board supervision to ensure effective supervision and prudent lending. - Strengthen AML/CFT risk-based supervision to preserve U.S. dollar correspondent banking relationships. - Strengthen public financial management and public investment management; adopt a medium-term fiscal framework to guide budget planning and accelerate implementation of key infrastructure projects. *Source: Federated States of Micronesia: Staff Report for the 2021 Article IV Consultation (selected extracts).* ### 11. The economic policy response to the COVID-19 shock has been strong and broadly ### 11. The economic policy response to the COVID-19 shock has been strong and broadly appropriate ### Policy response and near-term support - Response components: - Additional resources to strengthen health system capacity. - Financial assistance to affected firms. - Income support to the unemployed and vulnerable groups. - Implementation: - Initial implementation of unemployment assistance and economic stimulus was slow due to capacity constraints but picked up eventually. - Recent actions by authorities: - Extended the Economic Stimulus Package for businesses until June 2022. - Appropriated about US$ 2.5 million or 0.6 percent of GDP to augment the social protection program for low-income household assistance. - Intend to prioritize support for individuals most affected until funds run out. - Recommended near-term measures: - Maintain supportive fiscal measures until the recovery is firmly underway. - Provide some additional near-term fiscal support given projected further output decline in FY2021. - Extend income support to unemployed, low-income households, and informal workers. ### Spending safeguards and transparency - Identified needs: - Introduce pandemic-related spending safeguards to limit inefficiency and leakage from rapid scaling up of spending. - Existing capability: - Department of Finance and Administration prepared quarterly situation reports on COVID-19 response and beneficiaries. - Recommended additional safeguards: - Publication of COVID-related spending reports. - Publication of pandemic-related procurement contracts. - Collection and publication of beneficial ownership information for companies awarded contracts. - Ex-post audit reporting of pandemic-related spending. - Authorities’ commitments: - Authorities will audit COVID-19 related spending and publish relevant reports. ### Vaccination and targeting to strengthen recovery - Policy guidance: - Accelerate vaccination to achieve collective immunity as early as possible. - Intensify efforts to vaccinate remote communities and the young population. - Continue measures targeted to sectors and households most affected while rationalizing some generous assistance schemes. - Specific rationalization suggestions: reduce the compensation threshold and introduce a ceiling on wage subsidies. - Execute existing commitments for public infrastructure investment as soon as borders are reopened. ### Rebuilding longer-term fiscal resilience - Fiscal risks under current policies: - Possible fiscal cliff from expiration of U.S. Compact grants in FY2023. - Rising debt and declining trust fund assets. - CTF yield volatility could reduce revenue-generating capacity and increase revenue volatility. - Projection: record deficits of 4-5 percent of GDP from FY2024 onward under baseline, with public debt-to-GDP rising from 13.6 percent in FY2023 to around 83 percent in FY2041. - Debt Sustainability Analysis: FSM remains at high risk of overall debt distress though debt is assessed to be sustainable. - Recommended timing: - Implement gradual fiscal consolidation once recovery is firm. ### Fiscal consolidation options and numeric guidance - Suggested magnitude: - Gradual fiscal adjustment of about 1-2 percent of GDP per year over 5 years when growth rebounds above trend. - Estimated short-term growth cost: lower GDP growth by about 0.2-0.4 percent annually; countered by growth-enhancing structural reforms. - Revenue measures: - Establish National Tax Reform Commission to strengthen tax system, expand revenue base, and ensure equitable revenue sharing. - Consider introduction of a value-added tax (VAT) replacing the gross revenue tax (GRT). - Consider selected excises on tobaccos and alcohol, tightening eligibility on concessional fishing license fees for the domestic fishing industry. - Introduce excise taxes on gasoline and diesel that mimic a carbon tax. - Expedite roll-out of a new tax administration IT system. - Save any future revenue windfalls to build fiscal buffers. - Expenditure measures: - Streamline and rationalize state support programs and purchases of goods and services, particularly non-essential expenditures, while protecting social spending and public infrastructure investment. - Strengthen Public Financial Management (PFM) reforms to identify expenditure savings, enhance foreign aid effectiveness, and reduce leakages. ### Fiscal scenarios and selected indicators (from Text Table 2) - Real GDP Growth (percent) entries shown (FY2021, FY2023-2027, etc.) include values such as: - -3.2, 3.2, 0.6, -3.2, 2.9, 0.6, 0.0, -0.3, 0.0 (as presented in tabular layout). - Fiscal Balance: - 1.3, 2.4, -5.0 (percent of GDP) (as presented). - CTF + FSM net assets per capita (USD thousands): - 12.2, 14.5, 15.2, 12.2, 14.5, 15.9, 0.0, 0.0, 0.7 (as presented). - CTF + FSM net assets per capita (real, USD thousands): - 7.3, 8.2, 7.8, 7.3, 8.2, 8.2, 0.0, 0.0, 0.4 (as presented). - Tax Revenue: - 11.3, 11.2, 11.1, 11.3, 12.0, 15.4, 0.0, 0.8, 4.3 (percent of GDP) (as presented). - Current Expenditure: - 56.8, 44.6, 43.2, 56.8, 44.2, 38.6, 0.0, -0.4, -4.6 (percent of GDP) (as presented). - Note: Table entries above preserve numeric values exactly as presented in the source. ### PFM, public investment management, and project implementation - Implementation challenge: - FSM has not fully utilized capital grants under Compact and other development partners due to lack of government consensus and administrative capacity. - Large amounts of unused funds were mainly due to lack of implementation capacity. - Recommended actions: - Speedier investment implementation to support recovery and lift potential growth. - Proceed expeditiously with long-pending IT system upgrade. - Improve coordination between national and state governments. - Enhance public administrative capacity through training, standardization, and digital technology. - Develop a medium-term fiscal framework to guide annual budget planning and ensure fiscal sustainability. - Authorities’ measures: - Established a Project Management Unit at the national level and Project Management Offices at the state level to strengthen project coordination and technical support. - Receiving capacity development from the European Union for a medium-term fiscal framework. - National Tax Reform Commission expected to report to the President by January 1st, 2022, including legislative proposals; authorities prioritize introduction of VAT in a revenue neutral manner and submitted revised tax legislation to increase excise taxes on cigarettes and tobacco to the FSM Congress. - Authorities estimate these tax reforms would raise tax revenue to about 16 percent of GDP, from the current level of about 12 percent. ### Financial sector stability and measures to foster intermediation - Banking sector structure and indicators: - Two commercial banks account for 85 percent of total banking assets. - As of December 2020, regulatory capital to risk-weighted assets ratio of the two banks: 37.6 percent. - NPL ratio of the two banks: 0.1 percent (December 2020). - FSM Development Bank (FSMDB) accounts for 14 percent of total banking assets. - FSMDB NPL ratio reached 14 percent as of June 2021 (authority’s definition). - Under an alternative classification by European Investment Bank (EIB), NPL ratio rose to 47 percent at end-December 2020. - Measures taken: - Interest payment relief, a 90-day voluntary loan moratorium, and a concessional loan program for small businesses. - Near-term financial sector recommendations: - Maintain near-term financial sector support subject to close monitoring. - Consider extending interest payment relief and debt moratorium for viable firms; eligibility criteria could be based on firms’ financial strength. - Close monitoring of NPLs and broader credit quality indicators such as restructured and doubtful loans. - Maintain adequate loan-loss provisions and strengthen oversight by FSMDB Board of Directors. - Consider placing FSMDB and credit unions under FSMBB regulation and supervision. - Financial development constraints and structural reforms: - Constraints include prohibition for non-FSM citizens to own land, complex land ownership structures, and absence of a functioning credit and land registry. - Results: low credit growth, high intermediation spreads, limited access to credit. - Recommended reforms: - Continue upgrading legal and regulatory framework for banking supervision and supervisory capacity. - Finalize and implement draft governance and risk management prudential standards for banks. - Amend Banking Act to align with international standards and clarify FSMBB’s role and supervisory powers. - Strengthen AML/CFT framework and risk-based supervision to secure U.S. dollar correspondent banking relationships. - Upgrade land tenure management including digitalizing the land registry. - Pursue growth-enhancing structural reforms and digitalization to boost credit demand and financial inclusion. *Source: IMF staff chapter "11. The economic policy response to the COVID-19 shock has been strong and broadly appropriate" (Content unit: 1fsmea2021002).* ### 26. The authorities are planning to extend near-term support for borrowers and enhance ### 26. The authorities are planning to extend near-term support for borrowers and enhance ### Near-term borrower support and monitoring - The authorities concurred that interest payment relief and loan deferrals may need to be extended for viable firms as long as the border closure continues. - Close monitoring is warranted given risks that loan quality could deteriorate once extraordinary support measures are phased out. - Staff appraisal: Near-term support for borrowers should remain in place to limit permanent economic damage and support the recovery; policy measures such as interest payment relief and debt moratorium could be extended for viable firms, but close monitoring is needed as policy support may mask vulnerabilities. ### Banking regulation, supervision, and financial sector reform - The authorities agreed that banking regulation and supervision should be strengthened to cope with the possible expiration of FDIC oversight. - Needs identified: - Upgrade banking laws. - Adopt prudential banking regulations. - Strengthen supervisory capacity. - Current limitation: the banking laws only provide the FSMBB with a mandate to regulate deposit-taking banks. - Coverage expansion: While noting differences in business models of the non-deposit taking FSMDB and credit unions relative to traditional banks, the authorities agreed it would be beneficial to enhance monitoring of the FSMDB and credit unions through the FSMBB. - Staff recommendations and sequencing (from Text Table 4): - Maintain near-term financial sector support, subject to close monitoring. - Continue to upgrade the legal and regulatory framework for banking supervision and its supervisory capacity. - Place FSMDB and credit unions under the FSMBB’s regulation and supervision. - Strengthen AML/CFT framework to secure U.S. dollar CBRs. - Address bottlenecks to credit supply and demand, while enhancing financial inclusion and literacy. - Additional measures: upgrade management of land tenure including through digitalizing the land registry to help ease credit supply bottlenecks. ### Structural reforms and private sector development - Accelerating structural reforms to support private sector development remains a top priority. - Constraints highlighted: remoteness, small size, geographical dispersion, large public sector, and cumbersome business operating environment. - The authorities should revisit the FY2023 Action Plan to implement targeted structural reforms. - Note: The FSM adopted the FY2023 Action plan in 2012; the plan lays out an ambitious fiscal and structural reform agenda to help achieve budgetary self-reliance and economic self-sufficiency after FY2023 as the economic and financial support under the Compact Agreement is set to expire. - The plan is supported by the World Bank and the Asian Development Bank and prioritizes prospective sectoral reforms in information and communications technology (ICT), fishery, maritime, energy and sustainable niche tourism. - Specific recommendations: - Expedite amendment of the Foreign Investment Act. - Complement with reform efforts to reduce business startup costs and time for settling disputes, lower regulatory burden on FDI, improve efficiency of the judicial process, enhance coordination across states, and establish a national single window system for trade and FDI. - Continue efforts to improve governance: adopt and implement the national anti-corruption strategy, introduce prevention measures to enhance detection of corruption and conflicts of interest, and enact relevant legislative measures to enhance transparency. - Authorities’ views: The authorities believed promoting the private sector is key to economic growth; they have drafted amendments to the foreign investment bill, are finalizing details in consultation with four state governments, and aim to establish a one-stop shop and fast-tracking processing for priority sectors. ### Digital connectivity and ICT - Improved digital connectivity is essential to overcome geographical bottlenecks and expand economic opportunities. - Rationale: The COVID-19 pandemic and international border closures highlighted the need for improved ICT infrastructure. - Benefits: expand business markets, boost productivity, improve public service delivery efficiency, and enhance financial inclusion. - Recommendations: - Expedite ICT infrastructure investment, supported by development partners, to provide universal and affordable digital services. - Establish a clear digitalization strategy and a roadmap to expand e-government and online transactions. - Develop a regulatory framework for data protection and cybersecurity. - Increase digital literacy. - Authorities’ views: The authorities agreed with the need to improve digital connectivity; ongoing digitalization project in partnership with the World Bank would expand internet access and ensure affordability and is expected to boost online business transactions and mobile banking financial inclusion. ### Climate change, resilience, and disaster preparedness - FSM’s vulnerability to climate change makes accelerating climate-resilient economy efforts urgent. - Constraints: capacity limits and large financing needs for investment have constrained climate adaptation and disaster preparedness. - Recommendations: - Develop and implement an overarching National Adaptation Plan (NAP) and disaster resilience strategy swiftly. - Improve access to climate finance by strengthening PFM and PIM to expedite project selection, approval, and execution. - Develop a strategy to enhance disaster risk management and prepare financing options, given possible expiration of post-disaster reconstruction assistance under the Compact Agreement in FY2023. - Enhance climate mitigation efforts, including introduction of an excise tax on road fuels, a motor vehicle excise tax, and feebates. - Expand renewable sources for power generation and use of energy efficient vehicles and products; reconfigure the tax system to create incentives for greenhouse gas emission reduction. - Notable policy signal: recent amendment of the FSM trust fund law mandates the fund to invest in clean and green portfolio only. - Authorities’ views: Committed to strengthen climate resilience; work on the national climate adaptation plan is in progress with development partner support, joint state action plans are being updated, and authorities stressed the need to build climate-resilient infrastructure by revising the National Building Code and strengthening natural disaster management including contingency financing. ### Data, statistics, and technical assistance - Data shortcomings: - Serious shortcomings in data provision significantly hamper surveillance. - Need to improve adequacy and timeliness of economic data to support policymaking. - Ongoing discussions between FSM’s Statistical Office and the Department of Finance and Administration to address delayed release of key statistics. - Resuming tax data sharing between the two data agencies and ensuring consistent flow of key inputs for statistic compilation is critical. - The memorandum of understanding to ensure access of the statistical agency to administrative data should be revisited and consistently implemented. - Due to lack of capacity, FSM relies on an external consultant to produce and compile key economic statistics. - Continued support from development partners to build FSM capacity to compile key statistics remains important. - Technical assistance (TA): - TA was halted in 2020 due to international travel restrictions and connectivity issues. - Authorities expressed interest in TA on revenue administration, public financial management, banking supervision, and statistics. - Authorities expressed a strong preference for in-person TA and requested continued IMF and PFTAC TA; they intend to resolve delays of national account statistics and would appreciate TA to strengthen capacity to compile these statistics. - Modalities of TA should reflect FSM’s capacity constraints and require strong ownership by the authorities. ### Macroeconomic outlook and policy priorities (Staff appraisal excerpts) - Economic impact and outlook: - The FSM successfully prevented the spread of COVID-19, but the pandemic and containment policies are putting strains on the economy. - Economic activity declined sharply in FY2020 and the contraction in real GDP is expected to deepen in FY2021, followed by a slow recovery in FY2022. - The fiscal and external balances are expected to remain in surplus. - The overall external position is assessed to be broadly in line with fundamentals and desirable policy settings. - The economic outlook remains subject to heightened uncertainty and risks are tilted to the downside. - The FSM will likely face increasing fiscal risks with a possible fiscal cliff, rising debt, and declining trust fund assets, should the financial and public services support under the Compact Agreement set to expire. This has put the FSM at high risk of overall debt distress, though debt is assessed to be sustainable. - Policy priorities: - Continued coordinated policy response to address COVID-19 effects and support the economy is the near-term priority. - Accelerate vaccination pace to help support recovery. - Maintain supportive fiscal measures targeted to sectors and households most affected until recovery is firmly underway; rationalize and tighten the most generous assistance schemes. - Introduce pandemic-related spending safeguards: publication of spending, procurement, and audit reports to ensure transparency and accountability. - Execute existing commitments on public infrastructure investment expeditiously to help revive economic activity. - Gradual fiscal consolidation post-pandemic is needed to reduce fiscal risks related to possible expiration of Compact grants; implement adjustment through domestic revenue mobilization and expenditure rationalization. - National Tax Reform Commission establishment is welcome, but timely and effective implementation of key tax reforms including introduction of VAT will be crucial. - Accelerate public financial management (PFM) and public investment management (PIM) reforms to identify expenditure savings, enhance foreign aid effectiveness, and reduce leakages. - Steadfast implementation of priority reforms is crucial to promote stronger, greener, and more sustainable growth. *Source: 1fsmea2021002 - 26. The authorities are planning to extend near-term support for borrowers and enhance* ### 45. It is recommended that the next Article IV consultation take place on the current 24- ### 1fsmea2021002 - 45. It is recommended that the next Article IV consultation take place on the current 24- ### Real sector developments - The FSM economy grew above its long-term average in the years prior to the COVID-19 pandemic. - Real GDP (annual percent change): FY2018 0.2; FY2019 1.2; FY2020 -1.8; FY2021 -3.2; FY2022 0.6; FY2023 3.2; FY2024 1.9; FY2025 0.8; FY2026 0.6. - Consumer prices (annual percent change): FY2018 1.4; FY2019 1.5; FY2020 0.5; FY2021 2.6; FY2022 2.6; FY2023 2.6; FY2024 2.6; FY2025 2.5; FY2026 2.4. - Employment (annual percent change): FY2018 1.2; FY2019 0.6; FY2020 -1.2; FY2021 -3.8; FY2022 0.0; FY2023 2.6; FY2024 1.3; FY2025 0.2; FY2026 0.2. - Per capita income has been comparable with peers; inflation was contained due to low commodity prices. - Public sector employment declined but remained relatively large; large public-private wage gaps persisted. ### Fiscal developments and public finances - Fiscal balances were in surplus in recent years, supported by revenue windfalls and foreign grants. - Consolidated government finance (in percent of GDP): - Revenue and grants: FY2018 79.7; FY2019 77.7; FY2020 69.3; FY2021 72.8; FY2022 67.7; FY2023 64.6; FY2024 57.2; FY2025 54.7; FY2026 54.8. - Revenue: FY2018 53.5; FY2019 46.4; FY2020 33.5; FY2021 31.0; FY2022 31.6; FY2023 31.0; FY2024 42.2; FY2025 41.6; FY2026 41.1. - Tax revenue (percent of GDP): FY2018 32.2; FY2019 25.5; FY2020 12.3; FY2021 11.3; FY2022 11.4; FY2023 11.2; FY2024 11.2; FY2025 11.1; FY2026 11.1. - Non-tax revenue (percent of GDP): FY2018 21.3; FY2019 20.9; FY2020 21.1; FY2021 19.7; FY2022 20.2; FY2023 19.8; FY2024 31.0; FY2025 30.5; FY2026 30.0. - Fishing license fees (percent of GDP): FY2018 18.0; FY2019 17.5; FY2020 17.8; FY2021 16.3; FY2022 16.9; FY2023 16.5; FY2024 15.4; FY2025 15.3; FY2026 15.1. - Grants (percent of GDP): FY2018 26.2; FY2019 31.3; FY2020 35.9; FY2021 41.9; FY2022 36.1; FY2023 33.5; FY2024 15.0; FY2025 13.1; FY2026 13.7. - Expenditure and fiscal balance (percent of GDP): - Expenditure: FY2018 55.5; FY2019 60.3; FY2020 68.8; FY2021 71.6; FY2022 64.8; FY2023 62.2; FY2024 61.3; FY2025 59.6; FY2026 59.8. - Expense: FY2018 45.9; FY2019 44.6; FY2020 54.3; FY2021 56.8; FY2022 47.6; FY2023 44.6; FY2024 44.3; FY2025 44.1; FY2026 43.9. - Net acquisition of nonfinancial assets (percent of GDP): FY2018 9.6; FY2019 15.7; FY2020 14.5; FY2021 4.8; FY2022 17.2; FY2023 17.6; FY2024 16.9; FY2025 15.4; FY2026 15.8. - Net lending/borrowing (percent of GDP): FY2018 24.2; FY2019 17.4; FY2020 0.6; FY2021 1.3; FY2022 2.8; FY2023 2.4; FY2024 -4.1; FY2025 -4.9; FY2026 -5.0. - Net lending/borrowing excluding grants (percent of GDP): FY2018 -1.9; FY2019 -13.9; FY2020 -35.3; FY2021 -40.6; FY2022 -33.3; FY2023 -31.2; FY2024 -19.0; FY2025 -18.0; FY2026 -18.7. - Compact Trust Fund (CTF) balances: - CTF balance (in millions of US dollars): FY2018 211.1; FY2019 230.5; FY2020 263.7; FY2021 317.3; FY2022 335.1; FY2023 344.3; FY2024 329.2; FY2025 318.6; FY2026 309.4. - The CTF balance is low relative to peer economies and is likely to fall short of the 2023 target balance. ### External sector developments and balance of payments - Current account (in millions of U.S. dollars): - FY2018 84.6; FY2019 70.2; FY2020 12.1; FY2021 4.7; FY2022 4.7; FY2023 -1.5; FY2024 -23.8; FY2025 -23.6; FY2026 -25.4. - Current account (percent of GDP): FY2018 21.0; FY2019 17.0; FY2020 3.0; FY2021 1.2; FY2022 1.1; FY2023 -0.4; FY2024 -5.1; FY2025 -4.9; FY2026 -5.2. - Trade and external flows: - Trade balance (in millions): FY2018 -128.5; FY2019 -125.0; FY2020 -117.8; FY2021 -132.7; FY2022 -128.5; FY2023 -136.6; FY2024 -130.0; FY2025 -131.5; FY2026 -135.2. - Exports, f.o.b. (in millions): FY2018 47.2; FY2019 59.6; FY2020 53.1; FY2021 53.3; FY2022 65.0; FY2023 71.0; FY2024 73.6; FY2025 76.0; FY2026 78.3. - Imports, f.o.b. (in millions): FY2018 175.7; FY2019 184.6; FY2020 170.9; FY2021 186.1; FY2022 193.5; FY2023 207.6; FY2024 203.6; FY2025 207.5; FY2026 213.4. - Fishing license fees are a major source of income: FY2018 receipts 70.0 (in millions); FY2019 72.3; FY2020 72.3; FY2021 66.0; FY2022 70.3; FY2023 72.9; FY2024 71.4; FY2025 73.0; FY2026 74.4. - Trade composition and partners: - Offshore fish constitutes 82.6% of exports (2018 data); betel nuts 11.8%; kava 1.7%; reef fish 1.0%; other marine products 0.9%; cooked food 0.6%. - Main import categories (2018): Food and drink 28%; Machinery equipments 10%; Motor vehicles and parts 9%; Construction materials 9%; Fuels 15%; Tobacco 2%; Others 27%. - Main export and import trading partners include the United States, Guam, Japan, China, P.R., Philippines, Indonesia, and regional Pacific economies; exports by partner and imports by partner detailed in figure data. ### Monetary and financial sector developments - Bank intermediation: - Loans (percent of GDP, end period): FY2018 12.3; FY2019 11.1; FY2020 11.2; FY2021 10.8; FY2022 11.5; FY2023 11.7; FY2024 11.9; FY2025 12.1; FY2026 12.3. - Deposits (percent of GDP, end period): FY2018 83.5; FY2019 84.9; FY2020 94.3; FY2021 99.8; FY2022 88.9; FY2023 84.9; FY2024 84.9; FY2025 85.0; FY2026 85.0. - Loan-to-deposit ratio declined: loan/deposit ratio (percent): FY2015 16.4; FY2016 18.9; FY2017 14.7; FY2018 14.7; FY2019 13.0; FY2020 11.9. - Excess deposits invested in deposits and investment securities with banks abroad; financial deepening lags peers. - Credit and interest rates: - Consumer loan interest rates (percent, calendar year average): FY2015 16.0; FY2016 15.7; FY2017 15.7; FY2018 15.4; FY2019 14.7; FY2020 14.7. - Commercial loans rates: FY2015 6.7; FY2016 6.2; FY2017 7.7; FY2018 7.6; FY2019 7.8; FY2020 5.9. - Domestic lending dominated by consumer credit; high credit spreads continued to hinder access to credit. - Banking sector soundness (selected indicators): - Regulatory capital to risk-weighted assets (percent): Dec-17 35.5; Jun-18 37.6; Dec-18 33.3; Jun-19 33.9; Dec-19 35.2; Jun-20 34.2; Dec-20 37.6. - NPL to total gross loans (percent): Dec-17 0.4; Jun-18 0.4; Dec-18 0.3; Jun-19 0.2; Dec-19 0.3; Jun-20 0.6; Dec-20 0.1. - Return on assets (percent): Dec-17 1.1; Jun-18 1.6; Dec-18 1.8; Jun-19 2.0; Dec-19 2.0; Jun-20 1.2; Dec-20 0.9. - Liquid assets to total assets (percent): Dec-17 58.6; Jun-18 55.8; Dec-18 61.1; Jun-19 59.6; Dec-19 62.2; Jun-20 59.1; Dec-20 58.5. - Customer deposits to total (non-interbank) loans: Dec-17 416.3; Jun-18 456.1; Dec-18 422.0; Jun-19 451.0; Dec-19 418.6; Jun-20 471.3; Dec-20 506.4. ### Structural bottlenecks and connectivity - The FSM faces large structural bottlenecks, including heavy regulatory burdens for businesses and weak institutions. - Geographical dispersion and remoteness hinder physical connectivity; availability of essential infrastructure lags peers. - Digital and mobile technology could enhance connectivity but the country is lagging in access. - Rule of law and business regulatory environment indicators show gaps relative to Pacific peers (World Bank CPIA, Heritage Foundation indices referenced). ### Key vulnerability and memorandum indicators - Nominal GDP (FY2018): US$402 million. - Population (FY2018): 104,286. - GDP per capita (FY2018): US$3,854. - IMF Quota: SDR 7.2 million. - External debt (end period, in millions of U.S. dollars): FY2018 75.4; FY2019 77.3; FY2020 65.4; FY2021 61.0; FY2022 60.8; FY2023 60.2; FY2024 76.5; FY2025 98.2; FY2026 122.0. - Public external debt (percent of GDP): FY2018 18.8; FY2019 18.7; FY2020 16.1; FY2021 15.1; FY2022 14.6; FY2023 13.6; FY2024 16.5; FY2025 20.6; FY2026 24.8. - Memorandum: The U.S. dollar is legal tender and the official currency; real effective exchange rate (2010=100) FY2018 105.8; FY2019 107.7; FY2020 106.3. *Source: FSM authorities; IMF World Economic Outlook database; Gratcheva and Emery (2021); World Bank databases; IMF staff estimates and calculations.* ### Appendix I. Compact of Free Association between the United ### Appendix I. Compact of Free Association between the United States and the FSM and Post-FY2023 Arrangements ### Background and core provisions - The United States and the FSM signed the original Compact of Free Association (Compact) Agreement in 1986 and subsequently amended it in 2004. - The Compact Agreement provides for the United States’ responsibility for the security and defense of the FSM and the right of eligible FSM citizens to enter, study, and freely seek employment in the United States without visas. - The Compact Agreement provides the FSM with financial assistance and access to many U.S. domestic programs and other benefits, including annual Compact grants, contributions to the Compact Trust Fund (CTFs), and assistance for public services (examples cited: special education programs; post-disaster relief and reconstruction by FEMA and USAID; deposit insurance and supervisory oversight for the Bank of FSM by FDIC). - These Compact elements are set to expire after FY2023. ### Compact Trust Funds (CTFs) and the FSM Trust Fund - Under the Amended Compact, the Compact Trust Funds (CTFs) were established to contribute to economic advancement and long-term budgetary self-reliance by providing an annual source of revenue after FY2023. - The CTFs are intended to be built up over 20 years until September 2023. - The rules governing the CTFs allow a yearly disbursement equal to the previous year’s investment return and up to the amount of Compact grants adjusted for inflation that will be disbursed in FY2023—approximately US$96 million or 22 percent of FY2023 GDP—in order to ensure a sustainable source of income and prevent the nominal value of the Funds to deplete over time. - The FSM created the FSM Trust Fund to ensure the long-term financial viability of the FSM and provide an additional source of revenue. The FSM Trust Fund is accumulated with unspent revenues from fishing license fees, fiscal revenue windfalls, and occasional foreign grants. ### Post-FY2023 projections, fiscal implications, and volatility - Unless the Compact Agreement is renewed, the projected disbursements from CTFs are unlikely to provide sufficient fiscal revenue post FY2023. - Assuming a 5 percent investment return, the projected disbursement from CTFs would amount to 11 percent of GDP in FY2024, compared to annual Compact grants of 22 percent of GDP projected for FY2023—the last disbursement prior to the expected expiration of the agreements. - Post-FY2023 distributions from the CTFs are subject to investment returns, which will result in large fiscal revenue volatility. - Negotiations could lead to continuation of the status-quo or a partial renewal of the existing arrangements, which would help alleviate fiscal pressures and risks to long-term fiscal sustainability. ### Fiscal and policy responses highlighted in the source - In the context of uncertainty surrounding Compact renewal, recommended policy directions include: - Mobilize domestic revenue, contain government spending pressures, and align spending with sustainable revenues (noted as recommended action in related RAM entry on COFA uncertainty). - Mobilize domestic revenue to reduce reliance on the trust funds to finance government spending (noted as recommended action in RAM entry on rising core yields and risk premia). - Prioritize reforms to improve the business environment and facilitate private sector development (noted as recommended action in RAM entry on delays in structural reforms and infrastructure projects). *Prepared by Antoine Arnoud (APD). Source: IMF staff compilation from Appendix I of the referenced IMF document.* ### 3. A more effective and centralized mechanism for overseeing implementation should be ### 3. A more effective and centralized mechanism for overseeing implementation should be adopted. ### Performance indicators and resource allocation - Resource or budget allocation should be anchored by both sector needs and performance evaluation. - Example: expenditure in the education sector is relatively high at "12.5 percent of GDP", while net enrollment in primary education is "85 percent", which is much lower than in some peer countries. - Data gaps: enrollment in secondary education and expenditure per student are not available. - Health sector expenditures should be informed by outcome indicators such as mortality rates, immunization coverage, drug inventories, and hospitalizations. - Timely and reliable data would enable the authorities to set priorities and allocate resources where they are needed most and utilized most effectively. ### Monitoring system - Grant utilization and implementation should be systemically monitored and assessed. - Utilizing ICT technologies would facilitate data compilation and monitor real-time progress. - The FSM national government could build a centralized long-term grant utilization strategy that integrates national and state priorities. - Data and performance analysis should be shared among relevant authorities and across national and state governments to build consensus and allow concerted development actions. ### Capacity constraints - Human resources should be strengthened, especially at local authorities, since most Compact grants go directly to state governments. - Lack of staff in divisions of the Office of Statistics responsible for oversight of Compact implementation should be resolved. - Improved communication with institutions such as the U.S. government and the Joint Economic Management Committee (JEMCO), and better trained personnel, should enhance internal controls, financial accountability, and help prevent waste of funds. ### Strengthening public financial management (PFM) and public investment management (PIM) - PFM and PIM reforms, including regulations and IT systems, are critical to enhance the effectiveness of foreign aid. - Reforms would help identify higher priority projects and address weaknesses in implementation capacity and expenditure efficiency. - Areas for improvement: initial diagnostic and project design, monitoring, and implementation. - Move away from manual and paper-based systems by adopting digital technology to provide a shared digital platform, rationalize expenditure, monitor project progress, and enhance data collection. - Building a common digital platform and standardizing practices across national and state governments will improve nationwide coordination and speed up project execution. *Prepared by Antoine Arnoud (APD) and Shinya Kotera (OAP).* --- ### Appendix VI. Unlocking Digital Potential ### Key context and challenges - Digitalization in the FSM is constrained by low network coverage and affordability. - FSM geography: archipelago of more than 600 islands, occupies more than "2.6 million square kilometers", disperses across a longitudinal distance of nearly "2,700 kilometers". - COVID-19 pandemic and international border closures highlighted the need for improved ICT infrastructure. - Digital connectivity can expand business markets, boost productivity, improve public service delivery efficiency, and enhance financial inclusion. ### Connectivity and digital literacy indicators - Only one third of the population uses the internet. - Mobile penetration rate: "21 percent" — the lowest among Pacific Islands peers. - Fixed broadband subscriptions: around "3 out of 100 persons". - ITU (2021) estimates connectivity costs in the FSM at around "7 percent of monthly Gross National Income (GNI) per capita" for fixed broadband and about "11 percent" for mobile broadband. - UN target price for entry-level broadband services: less than "2 percent of monthly GNI per capita". - ICT skills are relatively low with a large gap between gender and urban-rural areas. ### Development partner support and recent financing - April 2018: World Bank and Asian Development Bank provided assistance to support construction of submarine cable systems for FSM and other Pacific Island countries. - March 2020: World Bank announced an additional grant of "US$30.8 million" or about "8 percent of GDP" to improve digital connectivity. The project aims to: - Support rollout of terrestrial fiber infrastructure. - Connect outer islands to basic broadband services. - Establish foundations for digital government services. - Strengthen legal and regulatory enabling environment for the digital economy. - Telecommunications Act (2014) liberalized the telecommunications sector and removed monopoly of state-owned incumbent operator. ### Digital transformation opportunities - Digital identification and government platform: - Existing government transactional services are mostly manual and paper based; no standardized document management system; data management is poor. - A unique digital identity and digital identification platform could: - Provide secure identity proofing. - Expand use of digital fiscal tools. - Enhance delivery of government benefits, health services, and financial services. - Facilitate compliance with Know Your Customer (KYC) regulation. - Help better target government spending, improve efficiency through online services, and raise higher revenue by reducing leakages and expanding the tax base. - Financial inclusion: - Only "8 branches" from two commercial banks throughout the nation. - Number of deposit accounts with commercial banks (per 1,000 adults, as of 2019 or latest available) is low relative to peers. - Improved digital connectivity could enable digital banking and mobile wallets to overcome physical access constraints. - Economic opportunity: - Insufficient infrastructure has hampered readiness for E-commerce. - Improved connectivity and internet adoption could open online business opportunities and enlarge domestic and international trade. - Further trade facilitation measures suggested: national single window system for customs, upgraded screening equipment and processes. - Logistics ecosystem improvements needed: cargo storage and warehousing facilities at air terminals and ports. ### Recommendations to expedite ICT investment - Expedite ICT infrastructure investment and adopt an overarching ICT plan to provide universal and affordable digital services. - Address weak implementation capacity that delays project execution despite abundant financing. - Enhance public investment management and public financial management to advance digital connectivity investment. - Develop a clear digitalization strategy with a roadmap to: - Create environment for e-government and online transactions. - Establish regulatory framework for privacy, data protection, cybersecurity and cybercrimes. - Expand digital literacy. *Prepared by Shinya Kotera (OAP).* --- ### Appendix VII. Building a Climate Resilient Economy ### Climate risks and impacts - FSM is highly vulnerable to climate change and natural disaster risks: storms, floods, droughts. - Pacific-Australia Climate Change Science and Adaptation Planning Program (2014) projections: continuation of El Niño and La Niña events, rising temperature, more extreme rain events, continuation of ocean acidification, increased risk of coral bleaching, and sea-level rise. - Macroeconomic impacts: - Climate change reduces crop productivity, changes fish distribution, declines tuna catches, damages tourism resources, and exacerbates human health (ADB, 2013). - Agriculture and fisheries are critical given their large share of labor utilization. - FSM's growth potential projected to decline further to around "0.5 percent" in the longer term in the absence of major structural reforms and rising climate change risks. - IMF (2019a) estimated "0.6 percent" potential growth for the FSM based on historical patterns, with an assumed gradual fall from "0.6 percent in FY2029" to "0.47 percent in FY2041" when incorporating additional climate impacts. ### Financing needs and commitments - Financing gap for adaptation investment: about "US$550 million" ("137 percent of 2021 GDP") over the next 15 years between the Infrastructure Development Plan (IDP) 2016-2025 and Green Climate Fund (GCF) workplan and currently available grant financing. - Recent financing commitments: - FSM’s first GCF project: "US$ 9.4 million" announced March 2021 for food security resilience (climate information, climate-smart agriculture, markets/value chains). - World Bank: "US$ 40 million" approved May 2021 to improve climate resilience of the road network (spatial and sector planning tools, asset management system, climate resilient infrastructure, enabling environment). - Asian Development Bank (AsDB): Pacific Disaster Resilience Program established December 2017; in 2020 AsDB committed "US$ 6 million" from the program to support climate resilience in FSM. ### Hurdles and implementation constraints - Hurdles to access climate finance: - Complex requirements and lengthy, burdensome process for national accreditation for direct access to international climate funds. - Project design and development hurdles. - FSM’s limited administrative capacity. - Weak implementation capacity: - Investment project implementation often delayed due to limited capacity. - COVID-19 border closures restricted movement of personnel and materials, halting most construction activities. - Maintenance of existing infrastructure is severely limited. - Disaster risk management challenge: - Assistance under the Compact Agreement (USAID and FEMA support for post-disaster reconstruction) may expire after FY2023 if not renewed. - FSM’s Disaster Assistance Emergency Fund and Disaster Relief Fund exist but may be insufficient for significant reconstruction needs. ### Policy priorities - Develop an overarching National Adaptation Plan (NAP) and Disaster Resilience strategy that reconciles the GCF workplan and the IDP; prioritize required infrastructure development, maintenance, and necessary financial and institutional arrangements for disaster response. - Strengthen PFM and PIM to accelerate adaptation investment: - Implementing adaptation investment supports climate resilience, pandemic recovery, and boosts longer-term potential growth. - Strengthening PFM and PIM, especially at local authority levels, is crucial for stakeholder coordination and project implementation. - Improving access to climate finance requires adequate PFM and PIM to expedite project approval and disbursement. - Increase training and establish standardized practices and platforms across FSM’s states to enhance project management and implementation capacity. *Prepared by Shinya Kotera (OAP) based on the FSM’s Climate Change Policy Assessment (IMF, 2019b).* *International Monetary Fund.* ### 9. There is scope to enhance climate mitigation. The FSM’s nationally determined ### 9. There is scope to enhance climate mitigation. The FSM’s nationally determined ### Mitigation target - The FSM’s nationally determined contribution aims for a reduction in carbon dioxide (CO2) emissions by 28 percent below 2000 levels by 2025, in the energy and transport sectors. ### Requirements to meet the mitigation pledge - To meet its mitigation pledge, the FSM needs to: - expand renewables, and - reconfigure the fuel and carbon taxation system. ### Progress with international support - With the support from the international community, progress has been made in the provision of renewable energy for power generation. ### Tax and fiscal policy recommendations to promote mitigation - The FSM could reconfigure the tax system to promote energy efficient vehicles and products by measures including: - introduction of excise tax on road fuels, - a motor vehicle excise tax, and - feebates on fuel-efficient vehicles and renewables (IMF, 2019b). *Source: Federated States of Micronesia — Staff Report for the 2021 Article IV Consultation (section 9).* ### 1. T h i s D ebt Sus tain abil ity An al ys is ( DSA) covers debt owed by the national and state ### 1fsmea2021002 - 1. T h i s D ebt Sus tain abil ity An al ys is ( DSA) covers debt owed by the national and state ### Background on debt - Public sector debt declined to 15.4 percent of GDP at end-May 2021, from a peak of 30.7 percent of GDP in FY2009. - As of May 2021, about 70.5 percent of the debt is from the Asian Development Bank (AsDB). - The share of the U.S. Department of Agriculture declined to 18.1 percent, from 27 percent in the previous DSA, due to principal repayments and some write-offs. - The remaining debt (11.4 percent of total) comprises the European Investment Bank (EIB), a commercial private lender, and domestic entities. - All loans except from the EIB are denominated in U.S. dollars. - Total external debt service reached 6.7 percent of exports in FY2020 and is expected to remain broadly stable over the medium term, but would rise in the long run as most concessional loans enter repayment periods. - Text Table 2 (End-FY2018 vs May-21 snapshot): - Total public debt: 88.16 (millions of U.S. dollars) / 61.8 (millions of U.S. dollars) — As a share of total 100.0 / In percent of GDP 15.3 (End-FY2018 row shown; May-21 values presented in text table format). - External: 83.76 / 61.19 — In percent of GDP 15.1. - Multilateral: 53.44 / 40.71 — In percent of GDP 10.9. - Asian Development Bank: 52.54 / 36.70 — In percent of GDP 10.8. - European Investment Bank: 0.9 / 0.5 — In percent of GDP 0.1. - Bilateral: 20.7 / 11.2 — In percent of GDP 2.8. - U.S. Department of Agriculture: 20.7 / 11.2 — In percent of GDP 2.8. - Commercial: 9.6 / 5.8 — In percent of GDP 1.4. - Telecom vendor: 5.0 / 3.2 — In percent of GDP 0.8. - Petrocorp: 4.6 / 2.6 — In percent of GDP 0.6. - Domestic: 4.4 / 0.7 — In percent of GDP 0.2. - Memorandum item: of which: SOE debt 2/: 31.2 / 17.5 — In percent of GDP 4.3. - Note: SOE debt comprises those of European Investment Bank, U.S. Department of Agriculture, Telecom Vendor, and Petrocorp. ### Background on macroeconomic forecasts (Box 1: Key Macroeconomic Assumptions) - Real GDP growth: - Projected to fall to -1.8 percent and -3.2 percent in FY2020 and FY2021 respectively. - Slow recovery expected in FY2022; potential growth estimated to be 0.6 percent in the medium term, with longer-run downward adjustment of 0.13 percentage point due to climate risks. - Vaccination progress: about 61 percent of the eligible population fully vaccinated as of September 13 (Box 1). - Inflation: - Moderate in FY2020; projected to rise from FY2022 and converge to 2 percent over the longer term. - GDP deflator assumed to move in tandem with inflation. - Fiscal balance: - Projected to be in a small surplus during FY2020-23. - Compact grants from the United States amounting to 22 percent of GDP will expire in FY2023 and be replaced by investment returns accruing to the Compact Trust Fund, projected at around 11 percent of GDP in FY2024 (baseline). - Baseline assumes no fiscal consolidation efforts between FY2021 and FY2024, leading to a possible fiscal cliff starting in 2024. - Current account balance: - Projected to remain in a small surplus prior to FY2023. - Projected to turn into a deficit of around 4 percent of GDP on average during FY2024 and FY2041, resulting from the possible fiscal cliff. - FSM Trust Fund: - Balance stood at US$307 million or about 75 percent of GDP at the end of FY2020. - Under the baseline, the balance will moderately increase to around 130 percent of GDP by end-FY2041 (assumes rate of investment return higher than nominal GDP growth and no drawdown). - Financing mix: - No new debt incurrence projected until FY2023 given surplus and grants. - World Bank support: net commitments stood at around 55 percent of GDP and total disbursements were around 15 percent of GDP (as at end-June 2021). - Baseline financing mix: external project loans finance 80 percent of gross financing needs; remaining 20 percent financed by domestic borrowing from banks. - Selected numeric macro assumptions table excerpts: - Real GDP (y/y growth): 2020 -1.8; 2021 -3.2; 2022-23 1.9; 2024-41 0.6/0.8/0.7/0.6/0.6 (table shows a range of medium/long-term values). - Inflation (y/y growth): 2020 0.5; 2021 2.6; 2022-23 2.6; 2024-41 2.1/2.0/2.0 (converging to 2.0). - Fiscal balance (percent of GDP): 2020 0.6; 2021 1.3; 2022.6 -5.0; 2024-41: 6.7/6.4/4.9 -5.3 (table format; baseline vs previous DSA comparisons shown). - Current account balance (percent of GDP): 2020 3.0; 2021 1.2; 2022-23 0.4 -4.6; 2024-41: 2.6/2.4/2.2 -4.2 (table format). ### Country classification and stress test determination - Debt carrying capacity assessed as weak; Composite Indicator (CI) index is 1.67 (based on April 2021 WEO and 2019 CPIA). - Applicable DSA thresholds for the FSM: - PV of external debt-to-GDP: 30 percent. - PV of external debt-to-exports: 140 percent. - External debt service-to-exports: 10 percent. - External debt service-to-revenue: 14 percent. - PV of public debt-to-GDP: 35 percent. - Given severity and frequency of natural disasters, a tailored natural disaster stress test was added: - Natural disaster scenario assumes a one-off shock of 10 percentage points to debt-GDP ratio in FY2021. - Real GDP growth and exports growth lowered by 5.0 and 3.5 percentage points, respectively, in the year of the shock. - Contingent liability shocks use default DSF parameters. Exchange rate depreciation scenario not considered as U.S. dollar is legal tender. ### Debt sustainability: External debt analysis - Baseline projections: - External debt-to-GDP ratio projected to rise from 13.6 percent in FY2023 to 81.1 percent in FY2041 due to loss of grants and resulting current account deficits post-FY2023. - PV of external debt-to-GDP breaches threshold from FY2034 onward. - PV of external debt-to-exports breaches its threshold starting from FY2038. - Comparison to previous DSA: - External debt path projected to deteriorate relative to previous DSA due to lower current account surpluses from COVID-19 impact and faster rise in external borrowing over medium and long term. - Stress test results: - Natural disaster shocks would raise PV of external debt-to-GDP ratio above the threshold five years earlier than in the baseline and lead to an explosive debt path. - Among standardized tests, export shocks produce the highest PV of external PPG debt-to-GDP ratio, breaching its threshold seven years after the shock. ### Debt sustainability: Public sector debt analysis - Public debt dynamics closely follow external debt. - Public debt-to-GDP projected to rise from 13.6 percent of GDP in FY2023 to 82.3 percent in FY2041. - Reflecting a gradually rising share of domestic debt in government financing mix, public debt rises faster than external debt. - PV of public debt-to-GDP breaches the threshold under the baseline starting in FY2035. - Stress tests indicate public debt dynamics are vulnerable to growth shocks. ### Risk rating, vulnerabilities, and mitigating factors - Risk rating: - Mechanical DSA external and overall debt-distress ratings are moderate within the standard 10-year horizon (no thresholds breached within 10 years). - Horizon extended to 20 years for FSM due to sizeable fiscal deficits and sharp increases of debt post-FY2023; projected breach of thresholds within 20-year forecast warrants assessment of high risk of external and overall debt distress. - Vulnerabilities: - High vulnerability to shocks in exports, growth, and natural disasters. - Contingent liabilities and SOE-related debt remain relevant risks; contingent liability stress tests applied with default parameters. - Mitigating factors and sustainability assessment: - Debt dynamics assessed to be sustainable given national assets, including the FSM Trust Fund, which provide an additional safeguard for debt-repaying capacity. - Authorities do not consider drawing on the FSM Trust Fund as part of the financing strategy; trust fund remains a significant national asset. - Continued grant disbursements and steadfast fiscal adjustment are necessary to keep debt on a sustainable path. - Critical dependence: - Future assessment of risk of debt distress will critically depend on outcome of Compact renegotiation (size, composition, duration of any grant support); renewal status not known before 2022. ### Key policy recommendations and implications - Urgent need to: - Implement fiscal adjustments. - Undertake broader structural reforms to boost growth. - Develop a strategy for climate change resilience. - Improve debt management capacity. - Continued grant support and careful fiscal policy are emphasized to avoid a fiscal cliff post-FY2023 and to sustain debt sustainability. *Source: IMF staff DSA for the Federated States of Micronesia (content unit 1fsmea2021002).* ### 12. The authorities agreed with Staff’s assessment that FSM remains at high risk of debt ### 1fsmea2021002 - 12. The authorities agreed with Staff’s assessment that FSM remains at high risk of debt ### Authorities' assessment and financing constraints - The authorities agreed with Staff’s assessment that FSM remains at high risk of debt distress. - They supported the use of a 20-year forecast horizon due to the pressure that the end of the Compact grants would put on the debt trajectory after FY2023. - They emphasized that the government is unlikely to be able to borrow more than 10 percent of financing needs domestically after FY2023. ### Baseline External Debt Sustainability Framework, Baseline Scenario, 2020-2041 (selected indicators) - External debt (nominal), in percent of GDP: - 2020: 16.1 - 2021: 15.1 - 2022: 14.6 - 2023: 13.6 - 2024: 17.8 - 2025: 21.9 - 2026: 26.0 - 2031: 44.2 - 2041: 26.7 - Change in external debt (percent of GDP): -2.7, -1.0, -0.5, -1.0, 4.2, 4.1, 4.1, 3.7, 3.1 (sequence by year) - Identified net debt-creating flows (percent of GDP): -2.7, -0.6, -1.2, 0.0, 5.0, 4.9, 5.1, 4.8, 4.8, -3.3, 3.3 (as listed) - Non-interest current account deficit (percent of GDP): -3.4, -1.6, -1.6, -0.1, 4.8, 4.5, 4.8, 4.6, 3.6, -3.3, -3.0 - Deficit in balance of goods and services (percent of GDP): 42.4, 47.3, 43.2, 43.0, 40.1, 39.4, 39.2, 37.5, 34.7, 45.6, 40.1 - Exports (percent of GDP): 24.0, 24.2, 31.7, 32.2, 32.1, 32.1, 32.1, 32.1, 32.1 - Imports (percent of GDP): 66.4, 71.5, 75.0, 75.2, 72.2, 71.4, 71.2, 69.5, 66.7 - Net FDI (negative = inflow) (percent of GDP): 0.1 (each year listed) - Endogenous debt dynamics (percent of GDP): 0.7, 1.0, 0.4, 0.0, 0.1, 0.3, 0.3, 0.2, 1.2 - Contribution from nominal interest rate: 0.5, 0.5, 0.5, 0.4, 0.4, 0.4, 0.4, 0.4, 1.5 - Contribution from real GDP growth: 0.3, 0.5, -0.1, -0.4, -0.2, -0.1, -0.1, -0.2, -0.4 - Residual (percent of GDP): 0.0, -0.4, 0.6, -0.9, -0.7, -0.8, -1.0, -1.1, -1.7, 2.0, -0.8 - Sustainability indicators: - PV of PPG external debt-to-GDP ratio: 14.3, 13.5, 12.5, 11.1, 11.9, 12.7, 13.8, 23.1, 56.7 - PV of PPG external debt-to-exports ratio: 59.4, 55.8, 39.2, 34.3, 36.9, 39.7, 43.1, 71.9, 176.7 - PPG debt service-to-exports ratio: 6.7, 6.7, 5.6, 5.3, 5.1, 5.0, 4.3, 3.4, 8.1 - PPG debt service-to-revenue ratio: 4.8, 5.2, 5.6, 5.5, 3.9, 3.9, 3.4, 2.7, 7.0 - Gross external financing need (Million of U.S. dollars): -7.2, 0.2, 0.9, 7.5, 29.8, 29.7, 30.6, 32.2, 44.8 - Key macroeconomic assumptions (selected): - Real GDP growth (in percent): -1.8, -3.2, 0.6, 3.2, 1.9, 0.8, 0.6, 0.6, 0.5, 0.3, 0.6 - GDP deflator in US dollar terms (change in percent): 0.5, 2.6, 2.6, 2.6, 2.6, 2.5, 2.4, 2.0, 2.0, 3.0, 2.3 - Effective interest rate (percent) 4/: 2.5, 2.8, 3.3, 3.2, 3.0, 2.3, 1.9, 1.0, 2.0, 2.6, 1.9 - Growth of exports of G&S (US dollar terms, in percent): -24.6, 0.0, 35.4, 7.6, 4.1, 3.3, 3.0, 2.6, 2.5, 4.8, 6.1 - Growth of imports of G&S (US dollar terms, in percent): -10.6, 6.8, 8.3, 6.3, 0.3, 2.3, 2.7, 2.4, 2.3, 1.3, 3.4 - Grant element of new public sector borrowing (in percent): 53.7, 61.0, 61.0, 61.0, 61.0, 61.0, 32.9, 28.7, 55.9 (as listed) - Government revenues (excluding grants, in percent of GDP): 33.5, 31.0, 31.6, 31.0, 42.2, 41.6, 41.1, 39.2, 37.0, 35.4, 38.0 (values appear across table) - Aid flows (Million of US dollars) 5/: 146.2, 169.5, 155.7, 153.4, 97.4, 90.8, 95.6, 46.9, 56.1 - Grant-equivalent financing (in percent of GDP) 6/: ...41.9, 36.8, 34.2, 18.7, 16.7, 17.2, 8.4, 8.1...19.4 - Nominal GDP (Million of US dollars): 407, 404, 417, 442, 462, 478, 492, 561, 720 - Nominal dollar GDP growth: -1.3, -0.8, 3.2, 6.0, 4.6, 3.3, 3.0, 2.6, 2.5, 3.3, 3.0 - Memorandum items: - PV of external debt (Million of US dollars): 58.1, 54.6, 52.0, 48.9, 54.8, 60.8, 68.0, 129.5, 407.9 - (PVt-PVt-1)/GDPt-1 (in percent): -0.9, -0.7, -0.7, 1.3, 1.3, 1.5, 3.6, 4.5 - Non-interest current account deficit that stabilizes debt ratio (percent of GDP): -0.8, -0.7, -1.1, 0.9, 0.5, 0.5, 0.7, 0.9, 0.5 ### Public Sector Debt Sustainability Framework, Baseline Scenario, 2020-2041 (selected indicators) - Public sector debt (percent of GDP): 16.5, 15.3, 14.6, 13.6, 17.1, 21.3, 25.6, 45.1, 82.3, 23.8, 26.8 - of which: external debt (percent of GDP): 16.1, 15.1, 14.6, 13.6, 17.8, 21.9, 26.0, 44.2, 81.1, 23.6, 26.7 - Change in public sector debt (percent of GDP): -3.1, -1.2, -0.7, -0.9, 3.5, 4.2, 4.3, 3.8, 3.1 - Identified debt-creating flows (percent of GDP): -0.3, -0.9, -3.2, -3.1, 3.5, 4.3, 4.4, 3.8, 3.1, -9.3, 2.2 - Primary deficit (percent of GDP): -1.1, -1.8, -3.3, -2.8, 3.7, 4.5, 4.6, 4.4, 3.4, -9.2, 2.5 - Revenue and grants (percent of GDP): 69.3, 72.8, 67.7, 64.6, 57.2, 54.7, 54.8, 45.8, 43.4, 69.8, 55.0 - of which: grants (percent of GDP): 35.9, 41.9, 36.1, 33.5, 15.0, 13.1, 13.7, 6.6, 6.4 - Primary (noninterest) expenditure (percent of GDP): 68.3, 71.1, 64.3, 61.8, 60.9, 59.2, 59.4, 50.2, 46.8, 60.7, 57.5 - Automatic debt dynamics (percent of GDP): 0.8, 0.8, 0.1, -0.3, -0.2, -0.1, -0.2, -0.6, -0.3 - Contribution from interest rate/growth differential: 0.5, 0.8, 0.1, -0.3, -0.2, -0.1, -0.2, -0.6, -0.3 - Contribution from average real interest rate: 0.2, 0.3, 0.2, 0.1, 0.1, 0.0, -0.1, -0.4, 0.1 - Contribution from real GDP growth: 0.4, 0.6, -0.1, -0.5, -0.3, -0.1, -0.1, -0.2, -0.4 - Residual (percent of GDP): -2.9, -0.2, 2.5, 2.2, 0.0, -0.1, -0.1, 0.0, 0.0, 8.0, 0.4 - Sustainability indicators: - PV of public debt-to-GDP ratio 2/: 14.7, 13.7, 12.5, 11.1, 11.1, 12.1, 13.4, 24.0, 57.9 - PV of public debt-to-revenue and grants ratio: 21.1, 18.8, 18.4, 17.1, 19.4, 22.1, 24.5, 52.4, 133.4 - Debt service-to-revenue and grants ratio 3/: 3.1, 2.6, 2.9, 2.7, 2.9, 1.9, 1.8, 3.5, 7.6 - Gross financing need 4/: 1.1, 0.1, -1.4, -1.1, 5.3, 5.5, 5.5, 6.0, 6.7 - Key macro/fiscal assumptions (selected): - Real GDP growth (in percent): -1.8, -3.2, 0.6, 3.2, 1.9, 0.8, 0.6, 0.6, 0.5, 0.3, 0.6 - Average nominal interest rate on external debt (in percent): 2.5, 2.8, 3.3, 3.2, 3.0, 2.3, 1.9, 1.0, 2.0, 2.6, 1.9 - Average real interest rate on domestic debt (in percent): 4.5, 2.4, 2.3, 6.6, 6.4, 5.7, 6.8, 5.8, 6.2, 0.0, 5.6 - Growth of real primary spending (deflated by GDP deflator, in percent): 12.0, 0.7, -8.9, -0.8, 0.4, -2.1, 0.9, 0.2, -0.4, 0.9, -2.1 - Primary deficit that stabilizes the debt-to-GDP ratio 5/: 2.1, -0.6, -2.6, -1.8, 0.2, 0.2, 0.3, 0.6, 0.3, -12.6, -0.2 - PV of contingent liabilities (not included in public sector debt): 0.00 (each year listed) ### Stress tests, sensitivity analysis, and scenarios (high-level points) - Figures and tables present alternative scenarios, bound tests, and tailored stress tests for public and external debt indicators over 2021-2041. - Table 3: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, 2021-2041 - Baseline PV of debt-to-GDP ratio examples: 14 (2021), 12 (2022), 11 (2023), 12 (2024), 13 (2025), 15 (2026), 18 (2027), 20 (2028), 23 (2029), 57 (2030) - Tailored tests show large breaches under shocks such as Natural disaster and Combined contingent liabilities (values reach up to 203 in some indicators). - Table 4: Sensitivity Analysis for Key Indicators of Public Debt, 2021-2041 - Baseline PV of Debt-to-GDP Ratio: 14 (2021), 12 (2022), 11 (2023), 11 (2024), 12 (2025), 13 (2026), 15 (2027), 17 (2028), 19 (2029), 21 (2030), 24 (2031), 58 (2041) - Stress test outcomes include substantial increases in PV of debt-to-GDP and debt service ratios under shocks (e.g., Natural disaster: values increase markedly across projection years). - Figures illustrate drivers of debt dynamics (contributions from primary deficit, real interest rate, real GDP growth, valuation, residual) and highlight the historical versus projected composition of debt-creating flows. ### Key diagnostics and thresholds (selected) - Benchmarks and thresholds cited in tables and figures: - Several thresholds presented for tests, e.g., 30, 14, 10, 1010 (various threshold rows across tables). - Notes indicate bold values in sensitivity tables denote breaches of thresholds. - Stress testing customization: - The most extreme stress test is defined as the test that yields the highest ratio in or before 2031. The most extreme shock varies across indicators (Combination, Exports, Natural disaster, Growth). *Sources: Country authorities; and staff estimates and projections.* ### 1990. The size of 3-year adjustment from program inception is found on the horizontal axis; the ### 1fsmea2021002 - 1990. The size of 3-year adjustment from program inception is found on the horizontal axis; the ### Statement and country context - Statement by Chang Huh, Executive Director for the Federated States of Micronesia and Lae Tui Siliva, Advisor to the Executive Director — October 27, 2021. - The Federated States of Micronesia (FSM) is a small fragile island country spread out over the north western Pacific Ocean with more than 600 islands. - Population: just over 110,000 inhabitants of four main island states – Pohnpei, Kosrae, Chuuk and Yap. - Key structural constraints: remoteness and dispersed geography hinder infrastructure development, tourism, and foreign direct investments; heavy dependence on foreign grants. - Critical near-term challenge: expiration of critical assistance under the Compact of Free Association (COFA) with the United States by end FY2023. ### COVID-19 response, recent developments, and outlook - Public health emergency declared from March 2020, extending through the end of January 2022; national and state governments enacted strict containment measures including international border closure. - Pandemic response focus: strengthening the health system, and assistance to affected firms and vulnerable groups. - COVID-19 cases: effectiveness of containment resulted in no COVID-19 cases in FSM so far; repatriation flights recommenced since May 2021. - Vaccination targets and status: - Authorities aim for achieving at least 70 percent vaccination coverage this year. - Mandated vaccination for all 18 years and older citizens. - Achieved about 66 percent vaccination rate of the eligible population as of September 30, 2021. - Economic projections: - Economic contraction of -3.2 percent is projected for FY2021 due to international border closure. - Slow recovery expected in FY2022 with gradual border reopening. - Staff projected the return to pre-pandemic real growth levels in FY2024. - Policy stance: - Authorities cautious on gradual reopening given local health system capacity. - Policy support will continue for businesses and low-income households. - Authorities will audit and publish COVID-19 related spending reports. ### Fiscal policy - Authorities acknowledge staff analysis on fiscal risks and rising debt levels under current policies over the medium term. - Tax reform process: - Utilize National Tax Reform Commission study at national and state levels to determine improvements; report recommendations to be submitted to the President by January 1st, 2022, with proposed legislative developments and amendments to be considered by FSM Congress and State Legislatures. - Authorities agree with introduction of VAT in a revenue neutral manner; revenue boost expected through improved tax efficiency. - Revised legislation to increase excise taxes on cigarettes and tobacco has been submitted to the FSM Congress for consideration. - Consideration of changes to non-tax revenues, including reassessment of concessional domestic fishing license fees. - The FSM would welcome Fund TAs on these tax reform efforts. - Expected fiscal impact of reforms: - Tax reforms are estimated to collectively raise the tax revenue-to-GDP to about 16 percent, from the current level of around 12 percent. - Expenditure management and public investment: - Expenditure rationalization considered necessary going forward despite near-term support needs. - Project Management Unit established at the national level and Project Management Offices at state level to strengthen project coordination and provide technical support to accelerate project implementation and grant disbursement. - A medium-term fiscal framework would be beneficial; authorities receiving EU support in this area. ### Financial sector - Banking system: remained sound and well contained financial stability risks. - Near-term support: need to extend near-term financial sector support and enhance monitoring. - Interest payment relief and loan deferrals may need to be extended for targeted groups if border closure continues; measures subject to very close monitoring and gradual phasing out. - Regulatory and supervisory reforms: - Need to upgrade banking laws, adopt prudential banking regulations, and strengthen supervisory capacity. - Authorities emphasized strengthening banking regulation and supervision to cope with possible expiration of FDIC oversight. - Proposed amendments to the Banking Act will carefully consider extending FSMBB’s supervision to non-deposit taking entities such as the FSMDB and credit unions. - Strengthened risk-based supervision will monitor the CBRs, as well as compliance under the AML/CFT framework. ### Structural reforms and digitalization - FSM 2023 Action Plan guides long-term structural reforms and sustainable growth strategies with emphasis on private sector led growth and preparing the economy from FY2024 onwards. - Investment climate and FDI: - Key actions include amendments in the foreign investment bill to simplify the FDI application process. - Authorities aim to establish a one-stop shop to handle foreign investment. - ICT and connectivity: - Pandemic highlighted need for improved ICT infrastructure and digital connectivity given transportation constraints among islands. - Development of a digitalization strategy and roadmap to expand e-government is welcome. - Ongoing digitalization project in partnership with the World Bank expected to improve connectivity and affordability, promote online business transactions, and enhance financial inclusion. ### Climate change and resilience - Authorities committed to strengthening resilience to climate change; higher frequency and severity of natural disasters damage infrastructure and productive activities, particularly agriculture and fishing. - Medium-term policy recommendations acknowledged: - Development of an overarching National Adaptation Plan. - Speed up implementation of adaptation investment projects. - Strengthen capacity for public investment management. - Mobilize external grant financing. - Recent developments and financing: - Efforts ongoing to address gaps identified in the recent Climate Change Policy Assessment, including development of National Adaptation Plan and a Building Code Policy. - Authorities received two new grant approvals from the Green Climate Fund in calendar year 2021 — FSM is the only Pacific country to have two projects approved this year by GCF, and the first Enhancing Direct Access project for the Pacific region. - Authorities launched a $40million project financed by the World Bank in October 2021 to enhance climate resilience of the road transport infrastructure throughout the nation. - Combined programs expected to support climate-smart agriculture, climate resilience infrastructures and advance the enabling environment agenda. - New public law passed by Congress in April 2021 mandates FSM’s sovereign wealth funds seek investment opportunities associated with a global transition to a lower carbon economy and bans investments in assets associated with high carbon emitting companies. - Authorities encouraged other Small Island States with Sovereign Wealth Funds to follow similar investment shifts. ### Capacity development needs - Authorities appreciated IMF and PFTAC TAs and requested continuation of technical support, preferably in-person TAs when international travel resumes. - Specific longer-term TA requests: - Statistics / National Accounts. - Tax reforms. - Economic Planning. - Other TA needs to continue: - Revenue management. - Public financial management. - Banking supervision. *Statement by Chang Huh and Lae Tui Siliva — October 27, 2021.* --- _Source: https://www.imf.org/-/media/files/publications/cr/2021/english/1fsmea2021002.pdf_