## 1. Public Investment and Growth

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---

### Background
- High-quality public investment can drive sustainable economic growth by improving connectivity, communication, and administrative processes, and by attracting private sector investment.
- FSM recorded average public investment of around 12 percent of GDP during FY2004-23, while real growth averaged 0.3 percent in the period.
- Even after excluding the COVID-19 years, average growth in FSM was anemic at 0.3 percent, compared with 2.97 percent for other PICs (excl. FSM) and 6.5 percent for other Asian low-income countries.
- Weak public investment management, limited capacity to implement high-quality projects, inadequate planning, and lack of private sector participation contributed to the weak link between public investment and growth.
- Chronic shortage of skilled labor, an underdeveloped private sector, lack of well-paying jobs, and large outward emigration have constrained growth; FSM’s population is estimated to have declined continuously since 2001.

### DIGNAD Model and Scenarios
- Model overview:
  - The Debt, Investment, Growth, and Natural Disasters (DIGNAD) model is a dynamic small open economy model designed to simulate impacts of natural disasters and related policy trade-offs, including debt accumulation, public/private investment, and growth.
  - Key structural features include two types of households (including poor households with no access to financial markets), traded and non-traded sectors, and firm production requiring labor, private capital, and public infrastructure.
  - Public capital is subject to inefficiencies and absorptive capacity constraints and enters production functions in both traded and non-traded sectors.
  - Government has access to various types of debt and grants and uses an endogenous policy function to adjust labor and consumption taxes.
- Public capital types in the model:
  - Standard physical capital: vulnerable to natural disasters; a portion is destroyed when an event occurs.
  - Adaptation (climate-resilient) capital: designed to be more resilient, mitigating adverse disaster impacts on output and reducing post-disaster fiscal burdens.
- Baseline calibration: historical data for FSM and widely used parameters in the literature.
- Scenario definitions:
  - (i) Baseline: rebound in public investment starting in 2023-24, supported by available grants under the expired COFA; public investment gradually increases to 14.5 percent of GDP over the next two decades thanks to COFA renewal; no major PIM reforms; public investment effectiveness remains relatively low at 0.2 percent.
  - (ii) Baseline investment with higher public investment efficiency: same levels of public investment as baseline but with investment efficiency improving to the average for emerging markets (60 percent).
  - (iii) Historical public investment (highly volatile): calibrated to assume high volatility in public investment similar to 2010-2019, persisting for the next 20 years.

### Results: Higher Private Sector-Led Growth and Stronger Public Finances
- Growth and private sector effects under higher efficiency (Scenario 2):
  - Improving public investment efficiency would raise potential GDP growth to around 1.2 percent.
  - Private sector growth rate would be around 50 percent higher than in the baseline.
  - Real wages would be significantly higher, reflecting improvements in per capita income.
  - Higher accumulation of public capital for the same level of investment would crowd in private investment and boost consumption growth.
- Fiscal effects:
  - Higher economic growth under improved investment efficiency leads to higher tax revenues and lower deficits while maintaining relatively high expenditures.
  - Fiscal deficit would fall by 1.5 percent of GDP in FY2043 under the improved efficiency scenario.
  - Net financial assets would increase faster in nominal (USD) terms but fall as a share of GDP due to stronger economic growth.
  - Public finances would be less reliant on grants and more reliant on stable tax revenues.
- Risks from volatile public investment (Scenario 3):
  - High volatility in investment would spill over to growth and private sector activity, resulting in no significant improvement in the private sector.
  - Average growth in private investment and private consumption would remain highly volatile and around 1.8 and 2.7 percent points below the baseline, respectively, leading to lower average GDP growth rates and real wages.

### Climate Adaptation and Resilience (model findings)
- FSM is highly vulnerable to climate change-induced natural disasters and has low climate readiness and adaptive capacity.
- Value of adaptive investment:
  - An alternative scenario assuming additional adaptive investment shows that higher adaptive investment would not raise potential GDP growth but can significantly minimize GDP loss and speed recovery when a large natural disaster occurs.
  - Adaptive investment can minimize GDP loss by around 4 percentage points in the year of the disaster and expedite recovery thereafter.
  - Losses to private sector activity would be contained, yielding much higher levels of private investment and consumption over the long term.
- Simulation assumption for adaptation scenario:
  - Staff assumes that an additional 20 percent of the total public investment would be targeted towards adaptive investment in contrast to the baseline.

### 1.      The frequency and intensity of climate related impact in the Pacific Island Countries

### Exposure and recent trends
- The frequency and intensity of extreme climate-related events in the Pacific Island Countries (PICs) has been increasing, with PICs particularly susceptible to cyclones, king tides, heatwaves, and other natural hazards.
- The Intergovernmental Panel on Climate Change notes the Pacific region is the most vulnerable to the impacts of climate change despite contributing least to global emissions.
- Global Climate Risk Index (CRI) ranks FSM as one of the most at-risk countries among PICs and the fourth most at risk in losses per unit GDP.
- FSM has the highest percentage of its population affected by disasters (Pathway to Adoption and Resilience study in the Pacific SIDS, 2022).
- The Notre Dame Global Adaptation Initiative index shows FSM's vulnerability to extreme climate events has increased during the last decade.

### Key economic and physical impacts
- Fisheries directly account for 11 percent of GDP and constitute most exports and an important source of government budget revenues (e.g., fishing licenses).
- Climate change could lead to a 13 percent decline in tuna catches in FSM (RCP 8.5 emission scenario).
- Climate change could lead to a 4 percent fall in GDP.
- Sea level is rising at 28-36mm per decade, exacerbating coastal erosion and placing coastal communities of atoll islands and islets at risk.
- Rising temperatures and heatwaves increase health risks when temperatures rise above 32-33°C (Human Health and Climate Change in the PICs study).

### Food security and current adaptation activities
- Decline in local food production over the last 50 years has increased reliance on imported and processed food.
- Initial climate-resilient agriculture efforts include pilot projects funded by the Green Climate Fund (GCF) testing crop varieties (jointly implemented by FSM National Government, College of Micronesia-FSM, Micronesia Conservation Trust).
- Australia’s Pacific Adaptation Strategy Assistance Program (PASAP) and the Secretariat of the Pacific Community (SPC) set two field trials for sweet potato and taro varieties across different ecological conditions.
- Replanting efforts: coconut trees and native plants (sea-oaks, pandanus, mangroves) along coastlines to protect arable land from erosion and salt spray.
- Seawalls constructed to protect land and freshwater resources from saltwater intrusion during high tides.

### Adaptive capacity and readiness
- Climate readiness score (based on economic, governance, and social readiness indicators) has only slightly improved over the past decade and remains below most other PICs.
- Frontier analysis suggests FSM has low adaptive capacity to climate risks relative to income level.
- A study estimated FSM spent an average of 2.7 percent of 2018 GDP (2011-18) on climate mitigation efforts; average spending on climate adaptation remained at around 1.2 percent of GDP (IMF CCPA, 2019).

### Obstacles to adaptation (identified constraints)
- Weak implementation capacity:
  - Weaknesses in public financial management (PFM) and public investment management (PIM) hinder accessing climate finance, accreditation, and meeting donor criteria.
  - Lack of accountability and compliance with international standards caused delays in fund disbursements.
  - Low administrative capacity for project preparation and implementation; delays in contracting and procurement.
- Limited policy coordination:
  - National Climate Change Policy (NCCP) and Joint State Action Plan (JSAP) exist, but no overarching National Adaptation Plan (NAP) yet.
  - GCF-supported NAP expected to start in 2024 and be completed in 3 years.
  - Disconnects between sectoral policies and absence of a Disaster Resilience Strategy (DRR) hinder integrated planning across national, state, and local levels.
- Lack of appropriate standards and regulations:
  - No national building code, no land zoning code, no land use policy, and limited hazard risk mapping.
- High cost of integrating adaptation in investment projects:
  - High cost of raw materials, transportation, and shipment impacts project implementation.
  - Early-stage climate change adaptation assessments recommended to integrate measures in project planning, design, and operation.
- Inadequate disaster preparedness and risk reduction:
  - Lack of access to adequate social protection amplifies vulnerabilities.
  - FSM does not have a disaster contingency fund to assist communities after disasters.
- Financing shortfalls:
  - IMF CCPA (2019) projects an estimated financing gap of US$400 million between climate change investment goals and available grant financing.
  - Renewal of the Compact could provide financing to help scale up adaptation investment, but more resources may be needed.

### GCF workplan composition and estimated costs (2019 IMF CCPA)
- Nationwide programs:
  - FSM Food and Water Security Program — 10 ($ millions)
  - FSM Renewable Energy Investment Program — 125 ($ millions)
  - FSM National College Resilient Infrastructure Development Program — 64 ($ millions)
  - Nation-wide Climate Change and Disaster Risk Management Coordination and Communications Program — 43 ($ millions)
  - Total: 242 ($ millions)
- Yap State:
  - Resilient Transport and Private Sector Development in the main and outer-islands of Yap Program — 93 ($ millions)
  - Yap Renewable Energy Investment Program Phase 3 — 96 ($ millions)
  - Resilient Infrastructure for Health and Education Delivery Program — 14 ($ millions)
  - Total: 203 ($ millions)
- Chuuk State:
  - Chuuk State Resilient Critical Infrastructure Program — 349 ($ millions)
  - Total: 349 ($ millions)
- Pohnpei State:
  - Pohnpei State Resilient Critical Infrastructure Program — 142 ($ millions)
  - Pohnpei State Resilient Social Protection Program — 25 ($ millions)
  - Pohnpei State Resilient Tourism Development Program — 3 ($ millions)
  - Total: 170 ($ millions)
- Kosrae State:
  - Kosrae State Inland Road Completion Project — 36 ($ millions)
  - Building Resilient Communities in Kosrae State Program — 97 ($ millions)
  - Total: 133 ($ millions)
- Overall total: 1,097 ($ millions)

### Policy implications and recommended actions
- Strengthen adaptation planning and coordination:
  - Develop and implement a comprehensive National Adaptation Plan (NAP) in coordination with sectoral and national development plans.
  - Streamline adaptation planning across national, state, and local levels and align with a Disaster Resilience Strategy (DRR).
- Integrate adaptation into budgeting and public investment:
  - Incorporate climate adaptation in the government budget process and early-stage project design.
  - Use higher grant financing more effectively and address the estimated financing gap of US$400 million.
- Build institutional and administrative capacity:
  - Implement the 2023-26 PFM roadmap to improve public financial management and public investment management.
  - Improve administrative capacity for project preparation, procurement, and implementation.
- Establish standards, land use policies, and hazard mapping:
  - Develop and implement national building codes, land zoning codes, land use policies, and hazard risk mapping.
- Enhance disaster preparedness, social protection, and risk financing:
  - Strengthen social protection to improve post-disaster resilience.
  - Explore multilateral risk-sharing mechanisms, insurance, and disaster risk insurance schemes (e.g., Pacific Insurance and Climate Adaptation program, Pacific Catastrophe Risk Insurance Company) given low insurance sector penetration.
- Leverage external partnerships and technical assistance:
  - Continue collaboration with development partners (e.g., USAID, NOAA, ADB, EU, GCF) to provide financial, technical, and capacity-building support for adaptation, disaster response, and recovery.

*Source: 1fsmea2024002 - 1.      The frequency and intensity of climate related impact in the Pacific Island Countries (PDF chapter).*

### 1. Public Investment and Growth _______________________________________________________ 4

### 1. Public Investment and Growth

### Background
- High-quality public investment can drive sustainable economic growth by improving connectivity, communication, and administrative processes, and by attracting private sector investment.
- FSM recorded average public investment of around 12 percent of GDP during FY2004-23, while real growth averaged 0.3 percent in the period.
- Even after excluding the COVID-19 years, average growth in FSM was anemic at 0.3 percent, compared with 2.97 percent for other PICs (excl. FSM) and 6.5 percent for other Asian low-income countries.
- Weak public investment management, limited capacity to implement high-quality projects, inadequate planning, and lack of private sector participation contributed to the weak link between public investment and growth.
- Chronic shortage of skilled labor, an underdeveloped private sector, lack of well-paying jobs, and large outward emigration have constrained growth; FSM’s population is estimated to have declined continuously since 2001.

### DIGNAD Model and Scenarios
- Model overview:
  - The Debt, Investment, Growth, and Natural Disasters (DIGNAD) model is a dynamic small open economy model designed to simulate impacts of natural disasters and related policy trade-offs, including debt accumulation, public/private investment, and growth.
  - Key structural features include two types of households (including poor households with no access to financial markets), traded and non-traded sectors, and firm production requiring labor, private capital, and public infrastructure.
  - Public capital is subject to inefficiencies and absorptive capacity constraints and enters production functions in both traded and non-traded sectors.
  - Government has access to various types of debt and grants and uses an endogenous policy function to adjust labor and consumption taxes.
- Public capital types in the model:
  - Standard physical capital: vulnerable to natural disasters; a portion is destroyed when an event occurs.
  - Adaptation (climate-resilient) capital: designed to be more resilient, mitigating adverse disaster impacts on output and reducing post-disaster fiscal burdens.
- Baseline calibration: historical data for FSM and widely used parameters in the literature.
- Scenario definitions:
  - (i) Baseline: rebound in public investment starting in 2023-24, supported by available grants under the expired COFA; public investment gradually increases to 14.5 percent of GDP over the next two decades thanks to COFA renewal; no major PIM reforms; public investment effectiveness remains relatively low at 0.2 percent.
  - (ii) Baseline investment with higher public investment efficiency: same levels of public investment as baseline but with investment efficiency improving to the average for emerging markets (60 percent).
  - (iii) Historical public investment (highly volatile): calibrated to assume high volatility in public investment similar to 2010-2019, persisting for the next 20 years.

### Results: Higher Private Sector-Led Growth and Stronger Public Finances
- Growth and private sector effects under higher efficiency (Scenario 2):
  - Improving public investment efficiency would raise potential GDP growth to around 1.2 percent.
  - Private sector growth rate would be around 50 percent higher than in the baseline.
  - Real wages would be significantly higher, reflecting improvements in per capita income.
  - Higher accumulation of public capital for the same level of investment would crowd in private investment and boost consumption growth.
- Fiscal effects:
  - Higher economic growth under improved investment efficiency leads to higher tax revenues and lower deficits while maintaining relatively high expenditures.
  - Fiscal deficit would fall by 1.5 percent of GDP in FY2043 under the improved efficiency scenario.
  - Net financial assets would increase faster in nominal (USD) terms but fall as a share of GDP due to stronger economic growth.
  - Public finances would be less reliant on grants and more reliant on stable tax revenues.
- Risks from volatile public investment (Scenario 3):
  - High volatility in investment would spill over to growth and private sector activity, resulting in no significant improvement in the private sector.
  - Average growth in private investment and private consumption would remain highly volatile and around 1.8 and 2.7 percent points below the baseline, respectively, leading to lower average GDP growth rates and real wages.

### Climate Adaptation and Resilience
- FSM is highly vulnerable to climate change-induced natural disasters and has low climate readiness and adaptive capacity.
- Value of adaptive investment:
  - An alternative scenario assuming additional adaptive investment shows that higher adaptive investment would not raise potential GDP growth but can significantly minimize GDP loss and speed recovery when a large natural disaster occurs.
  - Adaptive investment can minimize GDP loss by around 4 percentage points in the year of the disaster and expedite recovery thereafter.
  - Losses to private sector activity would be contained, yielding much higher levels of private investment and consumption over the long term.
- Simulation assumption for adaptation scenario:
  - Staff assumes that an additional 20 percent of the total public investment would be targeted towards adaptive investment in contrast to the baseline.

*Prepared by Pranav Gupta; IMF staff estimates and model simulations as presented in the source document.*

### 1.      The frequency and intensity of climate related impact in the Pacific Island Countries

### 1.      The frequency and intensity of climate related impact in the Pacific Island Countries

### Exposure and recent trends
- The frequency and intensity of extreme climate-related events in the Pacific Island Countries (PICs) has been increasing, with PICs particularly susceptible to cyclones, king tides, heatwaves, and other natural hazards.
- The Intergovernmental Panel on Climate Change notes the Pacific region is the most vulnerable to the impacts of climate change despite contributing least to global emissions.
- Global Climate Risk Index (CRI) ranks FSM as one of the most at-risk countries among PICs and the fourth most at risk in losses per unit GDP.
- FSM has the highest percentage of its population affected by disasters (Pathway to Adoption and Resilience study in the Pacific SIDS, 2022).
- The Notre Dame Global Adaptation Initiative index shows FSM's vulnerability to extreme climate events has increased during the last decade.

### Key economic and physical impacts
- Fisheries directly account for 11 percent of GDP and constitute most exports and an important source of government budget revenues (e.g., fishing licenses).
- Climate change could lead to a 13 percent decline in tuna catches in FSM (RCP 8.5 emission scenario).
- Climate change could lead to a 4 percent fall in GDP.
- Sea level is rising at 28-36mm per decade, exacerbating coastal erosion and placing coastal communities of atoll islands and islets at risk.
- Rising temperatures and heatwaves increase health risks when temperatures rise above 32-33°C (Human Health and Climate Change in the PICs study).

### Food security and current adaptation activities
- Decline in local food production over the last 50 years has increased reliance on imported and processed food.
- Initial climate-resilient agriculture efforts include pilot projects funded by the Green Climate Fund (GCF) testing crop varieties (jointly implemented by FSM National Government, College of Micronesia-FSM, Micronesia Conservation Trust).
- Australia’s Pacific Adaptation Strategy Assistance Program (PASAP) and the Secretariat of the Pacific Community (SPC) set two field trials for sweet potato and taro varieties across different ecological conditions.
- Replanting efforts: coconut trees and native plants (sea-oaks, pandanus, mangroves) along coastlines to protect arable land from erosion and salt spray.
- Seawalls constructed to protect land and freshwater resources from saltwater intrusion during high tides.

### Adaptive capacity and readiness
- Climate readiness score (based on economic, governance, and social readiness indicators) has only slightly improved over the past decade and remains below most other PICs.
- Frontier analysis suggests FSM has low adaptive capacity to climate risks relative to income level.
- A study estimated FSM spent an average of 2.7 percent of 2018 GDP (2011-18) on climate mitigation efforts; average spending on climate adaptation remained at around 1.2 percent of GDP (IMF CCPA, 2019).

### Obstacles to adaptation (identified constraints)
- Weak implementation capacity:
  - Weaknesses in public financial management (PFM) and public investment management (PIM) hinder accessing climate finance, accreditation, and meeting donor criteria.
  - Lack of accountability and compliance with international standards caused delays in fund disbursements.
  - Low administrative capacity for project preparation and implementation; delays in contracting and procurement.
- Limited policy coordination:
  - National Climate Change Policy (NCCP) and Joint State Action Plan (JSAP) exist, but no overarching National Adaptation Plan (NAP) yet.
  - GCF-supported NAP expected to start in 2024 and be completed in 3 years.
  - Disconnects between sectoral policies and absence of a Disaster Resilience Strategy (DRR) hinder integrated planning across national, state, and local levels.
- Lack of appropriate standards and regulations:
  - No national building code, no land zoning code, no land use policy, and limited hazard risk mapping.
- High cost of integrating adaptation in investment projects:
  - High cost of raw materials, transportation, and shipment impacts project implementation.
  - Early-stage climate change adaptation assessments recommended to integrate measures in project planning, design, and operation.
- Inadequate disaster preparedness and risk reduction:
  - Lack of access to adequate social protection amplifies vulnerabilities.
  - FSM does not have a disaster contingency fund to assist communities after disasters.
- Financing shortfalls:
  - IMF CCPA (2019) projects an estimated financing gap of US$400 million between climate change investment goals and available grant financing.
  - Renewal of the Compact could provide financing to help scale up adaptation investment, but more resources may be needed.

### GCF workplan composition and estimated costs (2019 IMF CCPA)
- Nationwide programs:
  - FSM Food and Water Security Program — 10 ($ millions)
  - FSM Renewable Energy Investment Program — 125 ($ millions)
  - FSM National College Resilient Infrastructure Development Program — 64 ($ millions)
  - Nation-wide Climate Change and Disaster Risk Management Coordination and Communications Program — 43 ($ millions)
  - Total: 242 ($ millions)
- Yap State:
  - Resilient Transport and Private Sector Development in the main and outer-islands of Yap Program — 93 ($ millions)
  - Yap Renewable Energy Investment Program Phase 3 — 96 ($ millions)
  - Resilient Infrastructure for Health and Education Delivery Program — 14 ($ millions)
  - Total: 203 ($ millions)
- Chuuk State:
  - Chuuk State Resilient Critical Infrastructure Program — 349 ($ millions)
  - Total: 349 ($ millions)
- Pohnpei State:
  - Pohnpei State Resilient Critical Infrastructure Program — 142 ($ millions)
  - Pohnpei State Resilient Social Protection Program — 25 ($ millions)
  - Pohnpei State Resilient Tourism Development Program — 3 ($ millions)
  - Total: 170 ($ millions)
- Kosrae State:
  - Kosrae State Inland Road Completion Project — 36 ($ millions)
  - Building Resilient Communities in Kosrae State Program — 97 ($ millions)
  - Total: 133 ($ millions)
- Overall total: 1,097 ($ millions)

### Policy implications and recommended actions
- Strengthen adaptation planning and coordination:
  - Develop and implement a comprehensive National Adaptation Plan (NAP) in coordination with sectoral and national development plans.
  - Streamline adaptation planning across national, state, and local levels and align with a Disaster Resilience Strategy (DRR).
- Integrate adaptation into budgeting and public investment:
  - Incorporate climate adaptation in the government budget process and early-stage project design.
  - Use higher grant financing more effectively and address the estimated financing gap of US$400 million.
- Build institutional and administrative capacity:
  - Implement the 2023-26 PFM roadmap to improve public financial management and public investment management.
  - Improve administrative capacity for project preparation, procurement, and implementation.
- Establish standards, land use policies, and hazard mapping:
  - Develop and implement national building codes, land zoning codes, land use policies, and hazard risk mapping.
- Enhance disaster preparedness, social protection, and risk financing:
  - Strengthen social protection to improve post-disaster resilience.
  - Explore multilateral risk-sharing mechanisms, insurance, and disaster risk insurance schemes (e.g., Pacific Insurance and Climate Adaptation program, Pacific Catastrophe Risk Insurance Company) given low insurance sector penetration.
- Leverage external partnerships and technical assistance:
  - Continue collaboration with development partners (e.g., USAID, NOAA, ADB, EU, GCF) to provide financial, technical, and capacity-building support for adaptation, disaster response, and recovery.

*Source: 1fsmea2024002 - 1.      The frequency and intensity of climate related impact in the Pacific Island Countries (PDF chapter).*

---


_Source: https://www.imf.org/-/media/files/publications/cr/2024/english/1fsmea2024002.pdf_